Basic earnings per share is calculated using the weighted average number of shares outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average basic shares outstanding plus the dilutive effect of convertible participating preferred stock and outstanding stock options using the “treasury stock” method.
The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share data):
Options to purchase 480,000 shares of common stock were outstanding but not included in the computation of diluted earnings per share for the three and six months ended June 30, 2001 because the exercise prices were greater than the average market price of the common shares for the periods. Options to purchase 419,000 and 399,000 shares of common stock were outstanding but not included in the computation of diluted earnings per share for the three and six months ended June 30, 2000 because the exercise prices were greater than the average market price of the common shares for the periods.
NOTE 5 – FINANCING ARRANGEMENTS
In April 2001, the Company amended its credit facility, which under the terms of the amendment, has been converted to a $19.0 million term loan, of which $18.0 million is outstanding at June 30, 2001, and a $5.0 million revolving credit facility, of which $1.5 million was outstanding at June 30, 2001. The borrowings under the revolving credit facility are limited to eligible accounts receivables and inventory as defined by the agreement. Under the terms of the amended agreement, the Company may borrow at the prime rate of interest plus a margin of .0% to .75% or LIBOR plus a margin of 1.25% to 2.75%, based upon the maintenance of certain financial coverage ratios. Interest is payable within 30 to 90 days, as defined by the agreement. The agreement calls for principal repayments of $1.0 million per quarter, with the loan maturing on April 1, 2002. The credit facility requires, among other things, the maintenance of specified financial ratios including fixed charge coverage and total debt to EBITDA, as defined in the agreement, and restrictions on capital expenditures and the payment of dividends.
NOTE 6 – NEW ACCOUNTING STANDARDS
Effective April 1, 2001, the Company adopted Financial Accounting Standards Board Emerging Issues Task Force (EITF) issue 00-14, Accounting for Certain Sales Incentives. In accordance with the EITF, the Company has reclassified certain sales incentive expenses totaling $461,000 for the three months ended June 30, 2000 and $847,000 for the six months ended June 30, 2000 from selling, general and administrative expenses and shown them as a reduction of net sales.
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. The Company must adopt these standards no later than January 1, 2002. All business combinations under SFAS No. 141 are to be accounted for using the purchase method of accounting. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets upon their acquisition and how they should be accounted for after initial recognition. SFAS No. 142 states that an intangible asset with a finite useful life be amortized over the period the asset is expected to contribute to the future cash flows of the entity. An intangible asset with an indefinite life is not to be amortized. All intangible assets are subject to periodic impairment tests. The Company is reviewing the requirements of these standards and has not determined the impact, if any, on the Company’s financials statements.
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
The following discussion and analysis should be read in conjunction with our Condensed Financial Statements and related Notes included in this report. This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The statements contained in this report that are not historic in nature, particularly those that utilize terminology such as “may,” “will,” “should,” “expects,” “anticipates,” “estimates,” “believes,” or “plans” or comparable terminology are forward-looking statements based on current expectations and assumptions. All forward-looking statements in this document are based on information currently available to us as of the date of this report, and we assume no obligation to update any forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.
Background
We are a developer, manufacturer and supplier of desktop systems that personalize plastic identification cards by printing images and text onto the cards, laminating them and electronically encoding them with information. We also sell the consumable supplies, such as ink ribbons, printheads and blank cards that are used with our systems.
Results of Operations
The following table sets forth, for the periods indicated, certain selected financial data expressed as a percentage of net sales:
| | Three Months Ended | | Six Months Ended | |
| | June 30, | | June 30, | |
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| | 2001 | | 2000 | | 2001 | | 2000 | |
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| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Cost of sales | 62.9 | | 61.1 | | 62.8 | | 58.9 | |
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| Gross profit | 37.1 | | 38.9 | | 37.2 | | 41.1 | |
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| Operating expenses: | | | | | | | | |
| | Research and development | 5.8 | | 9.1 | | 6.7 | | 8.7 | |
| | Selling, general and administrative | 17.3 | | 18.8 | | 19.3 | | 17.0 | |
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| | Total operating expenses | 23.1 | | 27.9 | | 26.0 | | 25.7 | |
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| Operating income | 14.0 | % | 11.0 | % | 11.2 | % | 15.4 | % |
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Comparison of Three Months Ended June 30, 2001 and 2000
Net sales. Net sales increased 24.7% to $17.0 million for the three-month period ended June 30, 2001 from $13.6 million in the same period of 2000. Sales of plastic card personalization products increased 25.7% to $16.9 million in the second quarter of 2001 from $13.4 million in the same period of 2000. The remaining sales in the second quarter of 2001 and 2000 are from products not related to plastic card personalization. Of the $16.9 million in sales attributable to plastic card personalization products in the second quarter of 2001, sales of equipment increased 54.9% to $8.5 million from $5.5 million in the second quarter of 2000, and sales of supplies increased 5.5% to $8.4 million from $7.9 million in the second quarter of 2000. The increase in sales of equipment is largely attributable to completion of the shipment of printers for the Department of Defense (DoD) “Common Access” Identification Card Project.
International sales increased 4.5% to $5.4 million in the second quarter of 2001 from $5.2 million in the same period of 2000 and accounted for 32.0% of net sales for the three months ended June 30, 2001 compared to 38.2% of net sales in the same period of 2000. The decrease in international sales as a percent of total sales was principally due to the increase in sales in the United States in the second quarter of 2001 from the shipment of the printers to the DoD.
Gross profit. Gross profit as a percentage of net sales decreased to 37.1% for the three months ended June 30, 2001 from 38.9% in the same period of 2000. This decrease was primarily due to promotional discounts and sales of more lower margin printers as a percentage of the overall mix of printers sold in the second quarter of 2001. The mix of printers sold contributed to an increase in the average unit cost of our printers.
Research and development. Research and development expenses decreased 21.0% to $1.0 million for the three months ended June 30, 2001 from $1.2 million in the same period of 2000. Research and development expenses as a percentage of net sales were 5.8% for the second quarter of 2001 compared to 9.1% for the same period of 2000. The decrease in the second quarter of 2001 was primarily due to lower salary expense.
Selling, general and administrative. Selling, general and administrative expenses increased 15.0% to $2.9 million for the three months ended June 30, 2001 from $2.6 million in the same period of 2000. As a percentage of net sales, selling, general and administrative expenses were 17.3% in the second quarter of 2001, compared to 18.8% for the same period of 2000. The dollar increase is principally attributable to additional legal and professional fees, which include fees paid to outside consultants to improve our manufacturing processes. The increases in these fees were partially offset by lower marketing expenses.
Operating income. Operating income increased 58.4% to $2.4 million for the quarter ended June 30, 2001 from $1.5 million during the same period of 2000. As a percentage of net sales, operating income was 14.0% in the second quarter of 2001 compared to 11.0% in the same period of 2000.
Interest expense. Interest expense totaled $398,000 for the three months ended June 30, 2001, compared to $579,000 for the comparable period in 2000. The reduction in our outstanding debt combined with reduced interest rates led to the lower interest expense. The weighted average interest rate on our outstanding debt for the three months ended June 30, 2001 was 6.9% as compared to 8.2% in the same period of 2000.
Income tax expense. Income tax expense was $736,000 for the three months ended June 30, 2001, which results in an effective tax rate of 36.4%, compared to income tax expense of $360,000 and an effective tax rate of 37.6% for the same period of 2000.
Comparison of Six Months Ended June 30, 2001 and 2000
Net sales. Net sales increased 8.3% to $30.1 million for the six-month period ended June 30, 2001 from $27.8 million in the same period of 2000. Sales of plastic card personalization products increased 9.0% to $29.9 million for the six months ended June 30, 2001, from $27.5 million in the same period of 2000. The remaining sales for the six months ended June 30, 2001 and 2000 are from products not related to plastic card personalization. Of the $29.9 million in sales attributable to plastic card personalization products for the six months ended June 30, 2001, sales of equipment increased 29.4% to $15.0 million from $11.6 million in the comparable period of 2000, and sales of supplies decreased 6.0% to $14.9 million from $15.9 million in the same period of 2000. The increase in sales of equipment is largely attributable to shipment of printers for the Department of Defense “Common Access” Identification Card Project. The decrease in sales of supplies is primarily due to less unit volume in the first quarter of 2001 in which we focused on higher margin supply sales.
International sales decreased 4.7% to $10.6 million for the six months ended June 30, 2001, from $11.1 million in the same period of 2000. International sales accounted for 35.2% of net sales for the six months ended June 30, 2001, compared to 40.0% of net sales in the same period of 2000. The decrease in international sales as a percent of total sales was principally due to the increase in sales in the United States from the shipment of printers to the DoD for the six months ended June 30, 2001. We also saw decreased sales in Europe and Asia during the six months ended June 30, 2001 caused by less printer and supplies volume.
Gross profit. Gross profit as a percentage of net sales decreased to 37.2% for the six months ended June 30, 2001, from 41.1% in the same period of 2000. This decrease was primarily due to manufacturing start-up costs associated with new products, increased discounts and sales of more lower margin printers as a percentage of the overall mix of printers sold during the six months ended June 30, 2001. The mix of printers sold contributed to an increase in the average unit cost of our printers.
Research and development. Research and development expenses decreased 16.7% to $2.0 million for the six months ended June 30, 2001 from $2.4 million in the same period of 2000. Research and development expenses as a percentage of net sales were 6.7% for the six months ended June 30, 2001, compared to 8.7% for the same period of 2000. The decrease was primarily due to lower salary expense.
Selling, general and administrative. Selling, general and administrative expenses increased 22.7% to $5.8 million for the six months ended June 30, 2001, from $4.8 million in the same period of 2000. As a percentage of net sales, selling, general and administrative expenses were 19.3% for the six months ended June 30, 2001, compared to 17.0% for the same period of 2000. The dollar and percentage increases are principally attributable to additional legal and professional fees, which include fees paid to outside consultants to improve our manufacturing processes. The increases in these fees were partially offset by lower marketing expenses.
Operating income. Operating income decreased 21.1% to $3.4 million for the six-month period ended June 30, 2001, from $4.3 million during the same period in 2000. As a percentage of net sales, operating income was 11.2% for the six months ended June 30, 2001, compared to 15.4% in the same period of 2000.
Interest expense. Interest expense totaled $878,000 for the six months ended June 30, 2001, compared to $1.6 million for the comparable period in 2000. This decrease in interest expense is attributable to lower outstanding debt and reduced interest rates for the six months ended June 30, 2001. The weighted average interest rate on our outstanding debt for the six months ended June 30, 2001 was 7.3% as compared to 8.6% in the same period of 2000.
Income tax expense. Income tax expense was $919,000 for the six months ended June 30, 2001, which results in an effective tax rate of 36.5%, compared to $995,000 and an effective tax rate of 36.9% for the same period of 2000.
Liquidity and Capital Resources
We have historically financed our operations, debt service and capital requirements through cash flows generated from operations. As discussed below, we have restructured our bank debt to provide that our note payable and line of credit become payable in full on April 1, 2002. As a result, our entire bank debt is now classified as a current liability so that our working capital at June 30, 2001 was negative $5.0 million . Excluding the classification of our outstanding note payable as a current liability, our working capital was $13.0 million and $14.9 million at June 30, 2001 and 2000, respectively. We plan to extend the existing credit facility agreement for an additional period of time prior to April 1, 2002.
During the first six months of 2001 and 2000, net cash flows provided by operating activities were $5.6 million and $635,000, respectively. The increase in cash provided by operating activities was mainly due to a decrease in inventories and an increase in accounts payable and accrued liabilities. The decrease in inventories is primarily due to management initiatives in 2001 focused on inventory reduction and also due to increased product shipments. The increase in accounts payable and accrued liabilities is mainly due to the timing of purchases and increased revenue activity relative to the fourth quarter of 2000. Net cash flows used in investing activities were $321,000 and $672,000 in each of these periods. Net cash flows used in financing activities were $3.3 million and $1.0 million, respectively.
As of June 30, 2001, our borrowings consisted of $19.5 million owed under the credit agreement with LaSalle Bank and Harris Bank. In April 2001, we amended our credit facility, which under the terms of the amendment, has been converted to a $19.0 million term loan, with $18.0 million outstanding at June 30, 2001, and a $5.0 million revolving credit facility, of which $1.5 million was outstanding at June 30, 2001. The agreement calls for principal repayments of $1.0 million per quarter, with the remaining principal balance and unpaid interest under both the term loan and the revolving loan becoming due and payable in full on April 1, 2002. We plan to extend our existing credit facility for an additional period of time prior to April 1, 2002.
The revolving credit facility requires, among other things, the maintenance of specified financial ratios including fixed charge coverage and total debt to EBITDA, as defined in the agreement, and restrictions on capital expenditures and the payment of dividends.
We believe that funds generated from operations and funds available to us under our revolving credit facility agreement, assuming our credit facility is extended beyond April 1, 2002, will be sufficient to finance our current operations and planned capital expenditure requirements for at least the next 12 months.
Recently Issued Accounting Standards
Effective April 1, 2001, the Company adopted Financial Accounting Standards Board Emerging Issues Task Force (ETIF) issue 00-14, Accounting for Certain Sales Incentives. In accordance with the EITF, the Company has reclassified certain sales incentive expenses totaling $461,000 for the three months ended June 30, 2000 and $847,000 for the six months ended June 30, 2000 from selling, general and administrative expenses and shown them as a reduction of net sales.
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. The Company must adopt these standards no later than January 1, 2002. All business combinations under SFAS No. 141 are to be accounted for using the purchase method of accounting. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets upon their acquisition and how they should be accounted for after initial recognition. SFAS No. 142 states that an intangible asset with a finite useful life be amortized over the period the asset is expected to contribute to the future cash flows of the entity. An intangible asset with an indefinite life is not to be amortized. All intangible assets are subject to periodic impairment tests. The Company is reviewing the requirements of these standards and has not determined the impact, if any, on the Company’s financials statements.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, commodity prices, equity prices and other market changes. Market risk is attributable to all market sensitive financing instruments, including long-term debt.
For additional information on market risk, refer to the “Quantitative and Qualitative Disclosures About Market Risk” section (Item 7A) of our Annual Report on Form 10-K for the year ended December 31, 2000.
PART II: OTHER INFORMATION
| ITEM 4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
Our Annual Meeting of Stockholders was held on May 3, 2001. The following individuals were elected at the Annual Meeting to serve as directors of Fargo for terms of three years expiring at our 2004 Annual Meeting of Stockholders or until their successors are elected and qualified. Shares voted in favor of these directors and shares withheld were as follows:
| Name | Shares Voted FOR | | Shares Withheld | |
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| Elaine A. Pullen | 8,205,650 | | 367,945 | |
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| Everett V. Cox | 8,213,463 | | 360,132 | |
In addition to the directors named above, the following directors’ terms continued after the Annual Meeting and will expire at the Annual Meeting of Stockholders in the year indicated below:
| Name | Term Expires | |
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Michael C. Child
| 2002 | |
William H. Gibbs
| 2002 | |
Gary R. Holland
| 2003 | |
| Kent O. Lillemoe | 2003 | |
Shareholders adopted our 2001 Employee Stock Purchase Plan, with shares voted as follows:
| Shares For | | 6,036,810 | |
| | | | |
| Shares Against | | 29,703 | |
| | | | |
| Shares Abstaining | | 3,850 | |
| | | | |
| Broker Non-Vote | | 2,503,232 | |
Shareholders approved an amendment to our Amended and Restated 1998 Stock Option and Grant Plan to increase the maximum number of shares of stock reserved and available for issuance under the plan from twelve percent (12%) to fifteen percent (15%) of the outstanding stock at the time of determination, with shares voted as follows:
| Shares For | 5,505,967 | |
| | | |
| Shares Against | 521,846 | |
| | | |
| Shares Abstaining | 42,550 | |
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| Broker Non-Vote | 2,503,232 | |
ITEM 5 - OTHER INFORMATION
As previously disclosed, on July 31, 2001, Fargo entered into an Acquisition Agreement with Zebra Technologies Corporation, pursuant to which a wholly-owned subsidiary of Zebra commenced on August 3, 2001 a cash tender offer for all of our outstanding shares at a price of $7.25 per share. If this transaction is not completed or is significantly delayed, we could be adversely affected.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
| Item No. | Description |
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| 10.1 | Amended and Restated Employment Agreement dated June 19, 2001 between Fargo Electronics, Inc. and Gary R. Holland, as amended (incorporated by reference to Exhibit 99(e)(6) of Fargo's Schedule 14D-9 filed on August 3, 2001 (File No. 0-29029).
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| 10.2 | Control Agreement with a Securities Intermediary among Fargo Electronics, Inc., LaSalle Bank, NA and Wells Fargo Brokerage Services, LLC (filed herewith).
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| 10.3 | Control Agreement (Deposit Account), dated as of June 8, 2001, among Fargo Electronics, Inc., LaSalle Bank National Association, as agent for the banks party to that certain Credit Agreement dated as of September 15, 2000, and Wells Fargo Bank, N.A. (filed herewith).
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| 10.4 | Pledge Agreement, dated as of June 29, 2001, by and between Fargo Electronics, Inc. and LaSalle National Bank National Association, as Agent for the Lender Parties (filed herewith).
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| 10.5 | Form of Direct Reports Agreement dated April 30, 2001 between Fargo Electronics, Inc. and each of Scott Ackerman, Mark Andersen, Kathleen Phillips, Thomas Platner, Paul Stephenson and Jeffrey Upin (incorporated by reference to Exhibit 99(e)(7) of Fargo's Schedule 14D-9 filed on August 3, 2001 (File No. 0-29029).
|
| 10.6 | Form of Management Agreement dated April 30, 2001 between Fargo Electronics, Inc. and several of its employees (incorporated by reference to Exhibit 99(e)(8) of Fargo's Schedule 14D-9 filed on August 3, 2001 (File No. 0-29029). |
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | FARGO ELECTRONICS, INC. |
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| August 9, 2001 | /s/ Gary R. Holland |
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| | Gary R. Holland |
| | President and |
| | Chief Executive Officer |
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| | /s/ Paul W.B. Stephenson |
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| | Paul W.B. Stephenson |
| | Chief Financial Officer |
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