UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the quarterly period ended June 30, 2008 | ||
| OR | ||
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the transition period from _______________________ to _____________________ |
Commission file number:001-33207
Universal Power Group, Inc.
(Exact name of registrant as specified in its charter)
| TEXAS | 75-1288690 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| 1720 Hayden Road, Carrollton, Texas | 75006 | |
| (Address of principal executive offices) | (Zip Code) | |
(469) 892-1122
(Registrant’s telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filero Accelerated filero Non-accelerated filero Smaller reporting companyþ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
As of July 28, 2008, 5,000,000 shares of Common Stock were outstanding.
Table of Contents
2
PART I — FINANCIAL INFORMATION
UNIVERSAL POWER GROUP, INC.
UNAUDITED BALANCE SHEETS
ASSETS
| June 30, | December 31, | ||||||
| 2008 | 2007 | ||||||
| CURRENT ASSETS | |||||||
| Cash and cash equivalents | $ | 545,456 | $ | 691,288 | |||
| Accounts receivable: | |||||||
| Trade, net of allowance for doubtful accounts of $124,895 | |||||||
| and $129,371 | 16,183,450 | 12,593,430 | |||||
| Other | 156,979 | 149,262 | |||||
| Inventories – finished goods, net of allowance for | |||||||
| obsolescence of $288,350 and $193,780 | 28,349,734 | 32,345,377 | |||||
| Current deferred tax asset | 1,094,579 | 983,114 | |||||
| Prepaid expenses and other current assets | 1,397,522 | 880,907 | |||||
| Total current assets | 47,727,720 | 47,643,378 | |||||
| PROPERTY AND EQUIPMENT | |||||||
| Logistics and distribution systems | 1,546,126 | 1,417,269 | |||||
| Machinery and equipment | 495,228 | 338,220 | |||||
| Furniture and fixtures | 492,267 | 492,267 | |||||
| Leasehold improvements | 291,347 | 272,096 | |||||
| Vehicles | 137,336 | 151,598 | |||||
| 2,962,304 | 2,671,450 | ||||||
| Less accumulated depreciation and amortization | (1,205,156 | ) | (985,735 | ) | |||
| Net property and equipment | 1,757,148 | 1,685,715 | |||||
| OTHER ASSETS | 108,467 | 81,459 | |||||
| TOTAL ASSETS | $ | 49,593,335 | $ | 49,410,552 | |||
The accompanying footnotes are an integral part of these financial statements.
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UNIVERSAL POWER GROUP, INC.
UNAUDITED BALANCE SHEETS (Continued)
LIABILITIES AND SHAREHOLDERS’ EQUITY
| June 30, | December 31, | |||||
| 2008 | 2007 | |||||
| CURRENT LIABILITIES | ||||||
| Line of credit | $ | 12,009,608 | $ | 12,833,031 | ||
| Accounts payable | 11,863,316 | 12,257,350 | ||||
| Accrued liabilities | 919,105 | 537,248 | ||||
| Current portion of notes payable to Zunicom, Inc | 1,462,500 | 731,250 | ||||
| Current portion of capital lease obligations | 663 | 6,609 | ||||
| Current portion of deferred rent | 62,808 | 64,446 | ||||
| Total current liabilities | 26,318,000 | 26,429,934 | ||||
| NOTES PAYABLE TO ZUNICOM, INC | 4,387,500 | 5,118,750 | ||||
| NON-CURRENT DEFERRED TAX LIABILITY | 8,642 | 25,455 | ||||
| DEFERRED RENT, less current portion | 148,162 | 180,776 | ||||
| Total liabilities | 30,862,304 | 31,754,915 | ||||
| COMMITMENTS AND CONTINGENCIES | ||||||
| SHAREHOLDERS’ EQUITY | ||||||
| Common stock - $0.01 par value, 50,000,000 shares | ||||||
| authorized, 5,000,000 shares issued and outstanding | 50,000 | 50,000 | ||||
| Additional paid-in capital | 15,429,863 | 15,381,684 | ||||
| Retained earnings | 3,251,168 | 2,223,953 | ||||
| Total shareholders’ equity | 18,731,031 | 17,655,637 | ||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 49,593,335 | $ | 49,410,552 | ||
The accompanying footnotes are an integral part of these financial statements.
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UNIVERSAL POWER GROUP, INC.
UNAUDITED STATEMENTS OF INCOME
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
| 2008 | 2007 | 2008 | 2007 | ||||||||||
| Net sales | $ | 30,199,945 | $ | 26,403,048 | $ | 59,724,201 | $ | 49,942,922 | |||||
| Cost of sales | 25,684,726 | 22,258,190 | 50,734,924 | 42,357,431 | |||||||||
| Gross profit | 4,515,219 | 4,144,858 | 8,989,277 | 7,585,491 | |||||||||
| Operating expenses | 3,470,952 | 2,699,388 | 6,771,113 | 5,335,898 | |||||||||
| Operating income | 1,044,267 | 1,445,470 | 2,218,164 | 2,249,593 | |||||||||
| Other income (expense) | |||||||||||||
| Interest expense (including $87,510, $87,510, | |||||||||||||
| $174,058 and $174,058 to Zunicom, Inc.) | (247,267 | ) | (365,165 | ) | (501,582 | ) | (732,254 | ) | |||||
| Interest income | 513 | 167,377 | 513 | 340,291 | |||||||||
| Total other expense | (246,754 | ) | (197,788 | ) | (501,069 | ) | (391,963 | ) | |||||
| Income before provision for income taxes | 797,513 | 1,247,682 | 1,717,095 | 1,857,630 | |||||||||
| Provision for income taxes | (326,952 | ) | (513,977 | ) | (689,880 | ) | (755,968 | ) | |||||
| Net income | $ | 470,561 | $ | 733,705 | $ | 1,027,215 | $ | 1,101,662 | |||||
| Net income per share | |||||||||||||
| Basic | $ | 0.09 | $ | 0.15 | $ | 0.21 | $ | 0.22 | |||||
| Diluted | $ | 0.09 | $ | 0.15 | $ | 0.21 | $ | 0.22 | |||||
| Weighted average shares outstanding | |||||||||||||
| Basic | 5,000,000 | 5,000,000 | 5,000,000 | 5,000,000 | |||||||||
| Diluted | 5,000,000 | 5,002,114 | 5,000,000 | 5,005,707 | |||||||||
The accompanying footnotes are an integral part of these financial statements.
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UNIVERSAL POWER GROUP, INC.
UNAUDITED STATEMENTS OF CASH FLOWS
| Six Months Ended June 30, | |||||||
| 2008 | 2007 | ||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | |||||||
| Net income | $ | 1,027,215 | $ | 1,101,662 | |||
| Adjustments to reconcile net income to net cash provided by | |||||||
| (used in) operating activities: | |||||||
| Depreciation and amortization of property and equipment | 266,006 | 103,864 | |||||
| Provision for bad debts | 62,300 | 55,034 | |||||
| Provision for obsolete inventory | 110,000 | 60,000 | |||||
| Deferred income taxes | (128,278 | ) | (94,024 | ) | |||
| Stock-based compensation | 48,179 | 46,816 | |||||
| Change in operating assets and liabilities: | |||||||
| Accounts receivable – trade | (3,652,320 | ) | (1,896,896 | ) | |||
| Accounts receivable – other | (7,717 | ) | (304,246 | ) | |||
| Inventories | 3,885,643 | (1,065,356 | ) | ||||
| Prepaid expenses and other current assets | (535,365 | ) | (717,284 | ) | |||
| Other assets | (27,008 | ) | (37,500 | ) | |||
| Accounts payable | (394,034 | ) | 2,100,359 | ||||
| Accrued liabilities | 381,857 | 466,983 | |||||
| Due from Zunicom, Inc | — | 186,617 | |||||
| Deferred rent | (34,252 | ) | (15,027 | ) | |||
| Net cash provided by (used in) operating activities | 1,002,226 | (8,998 | ) | ||||
| CASH FLOWS FROM INVESTING ACTIVITIES | |||||||
| Purchase of property and equipment | (318,689 | ) | (142,836 | ) | |||
| CASH FLOWS FROM FINANCING ACTIVITIES | |||||||
| Net activity on line of credit | (823,423 | ) | 408,510 | ||||
| Payments on capital lease obligations | (5,946 | ) | (10,928 | ) | |||
| Net cash (used in) provided by financing activities | (829,369 | ) | 397,582 | ||||
| NET (DECREASE) INCREASE IN CASH AND CASH | |||||||
| EQUIVALENTS | (145,832 | ) | 245,748 | ||||
| Cash and cash equivalents at beginning of period | 691,288 | 13,036,447 | |||||
| Cash and cash equivalents at end of period | $ | 545,456 | 13,282,195 | ||||
| SUPPLEMENTAL DISCLOSURES | |||||||
| Interest paid | $ | 501,582 | $ | 732,254 | |||
| Income taxes paid | $ | 653,971 | $ | 524,960 | |||
The accompanying footnotes are an integral part of these financial statements.
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NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE A – BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included for the three and six month periods ended June 30, 2008. The results for the three and six month periods ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008. The unaudited financial statements included in this filing should be read in conjunction with the Company's audited financial statements and notes thereto included in the Company's annual report on form 10-K for the year ended December 31, 2007.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements (SFAS 157) which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. SFAS 157 is effective for fiscal years beginning after November 15, 2007. However, on December 14, 2007, the FASB issued FSP FAS 157-b which would delay the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). This proposed FSP partially defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. Effective January 1, 2008, the Company has adopted SFAS 157 except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in the proposed FSP SFAS 157-b. The partial adoption of SFAS No. 157 will not have a material impact on the Company’s financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option For Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115(SFAS 159). SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS 159 effective January 1, 2008 and did not record any adjustment to the financial statements.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS 141(R)), which replaces SFAS 141. The provisions of SFAS 141(R) are similar to those of SFAS 141; however, SFAS 141(R) requires companies to record most identifiable assets, liabilities, non-controlling interests, and goodwill acquired in a business combination at “full fair value.” SFAS 141(R) also requires companies to record fair value estimates of contingent consideration and certain other potential liabilities during the original purchase price allocation and to expense acquisition costs as incurred. This statement applies to all business combinations, including combinations by contract alone. Further, under SFAS 141(R), all business combinations will be accounted for by applying the acquisition method. SFAS 141(R) was adopted and is effective beginning January 1, 2008. The provisions of SFAS 141(R) will impact the Company if it is a party to a business combination.
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NOTES TO UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
NOTE A – BASIS OF PRESENTATION (CONTINUED)
In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. Management is currently evaluating the effects of this statement, but it is not expected to have a material impact on the Company’s financial statements.
NOTE B – ORGANIZATION
Universal Power Group, Inc. (“UPG” or the “Company”), a Texas corporation, is a distributor and supplier to a diverse and growing range of industries of portable power and related synergistic products, a provider of third-party fulfillment and logistics services and a custom battery pack assembler. The Company’s primary logistics center is located in Carrollton, Texas and regional logistic centers are located in Oklahoma City, Oklahoma, Las Vegas, Nevada and Columbus, Georgia. The Company’s customers are primarily located in the United States. However, a small portion of the Company’s sales are to customers located in the United Kingdom, Australia, Ireland, China and Canada.
Until December 20, 2006, the Company was a wholly-owned consolidated subsidiary of Zunicom, Inc. (“Zunicom”), a Texas corporation, whose stock is traded on the OTC Bulletin Board under the symbol “ZNCM.OB.” On December 20, 2006, the U.S. Securities and Exchange Commission declared effective a registration statement filed by the Company registering the sale of 2,000,000 shares of its common stock by the Company and 1,000,000 of the Company’s common stock owned by Zunicom. As a result of the offering, Zunicom’s interest in the Company was reduced to 40%. Zunicom no longer owns a controlling interest in UPG; however, as the largest shareholder, Zunicom does have significant influence over UPG.
NOTE C – STOCK-BASED COMPENSATION
At June 30, 2008, common shares reserved for future issuance include 1,500,000 shares issuable under the 2006 Stock Option Plan, 20,000 shares issuable upon exercise of options not granted under the 2006 Stock Option Plan and 300,000 shares issuable upon exercise of outstanding warrants. At June 30, 2008, there are 1,288,728 options outstanding under the 2006 Stock Option Plan, and 211,272 options are available for future grants.
Stock-based compensation expense recognized in the statement of income for the three and six months ended June 30, 2008 includes compensation expense for the amortization of partially vested stock-based payment awards granted prior to June 30, 2008 and for the three and six months ended June 30, 2007 includes compensation expense for fully vested and the amortization of partially vested stock-based payment awards granted prior to June 30, 2007.
On June 25, 2007 the Company’s former parent, Zunicom, Inc. (“Zunicom”), issued 645,133 shares of restricted stock to certain employees of UPG for past and future services. The fair value of the shares at the issue date was approximately $377,000. UPG is amortizing the fair value as an compensation expense over the 48 month vesting period in accordance with EITF Issue No. 00-12 “Accounting by an Investor for Stock-Based Compensation Granted to Employees of an Equity Method Investee” and FASB 123(R) “Share-Based Payment”. As of June 30, 2008, approximately $280,000 remains unrecognized.
8
NOTES TO UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
NOTE C – STOCK-BASED COMPENSATION (CONTINUED)
Valuation Assumptions
There were no options granted during the three and six month periods ended June 30, 2008. There were no options granted during the three months ended June 30, 2007. During the six months ended June 30, 2007 there were 40,000 options granted for a total outstanding as of June 30, 2007 of 1,227,500. The fair values of option awards granted during the six months ended June 30, 2007 were estimated at the grant date using a Black-Scholes option pricing model with the following assumptions:
| For the Six Months | ||||
| Ended June 30, 2007 | ||||
| Weighted average grant date fair value | $ | 1.15 | ||
| Weighted average assumptions used: | ||||
| Expected dividend yield | 0.00 | % | ||
| Risk-free interest rate | 4.57 | % | ||
| Expected volatility | 17.00 | % | ||
| Expected life (in years) | 5 |
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Historically, the Company has elected to use the calculated value method to account for options granted. As there was no significant active market for the Company’s common shares prior to the six month period ended June 30, 2008, the Company used historical volatility of the Dow Jones Small Cap Non-Durable Household Companies, which is representative of the Company’s size and industry. The Company has used the historical closing values of that index to estimate volatility, which was calculated at 17-18%. The expected term considers the contractual term of the option as well as expectations for exercise and forfeiture behavior. The risk-free interest rate is based on the rates in effect on the grant date for U.S. Treasury instruments with maturities matching the relevant expected term of the award.
Summary and Activity
Stock option activity under our 2006 Stock Option Plan was as follows:
| Weighted Average | |||||
| Number of Shares | Exercise Price | ||||
| Options outstanding at January 1, 2008 | 1,289,364 | $ | 6.92 | ||
| Granted | — | $ | — | ||
| Exercised | — | $ | — | ||
| Canceled, forfeited or expired | 636 | $ | 7.00 | ||
| Options outstanding at June 30, 2008 | 1288,728 | $ | 6.92 |
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NOTES TO UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
NOTE C – STOCK-BASED COMPENSATION (CONTINUED)
The following table summarizes stock options outstanding under our 2006 Stock Option Plan at June 30, 2008:
| Options Outstanding | Options Exercisable | ||||||||||||
| Weighted Average | |||||||||||||
| Remaining | Weighted | Number of | Weighted | ||||||||||
| Range of | Number of Options | Contractual Life | Average | Options | Average | ||||||||
| Exercise Prices | Outstanding | (in years) | Exercise Price | Exercisable | Exercise Price | ||||||||
| $ | 4.48 | 40,000 | 8.48 | $ | 4.48 | 40,000 | $ | 4.48 | |||||
| $ | 7.00 | 1,248,728 | 8.48 | $ | 7.00 | 1,248,728 | $ | 7.00 | |||||
| $ | 4.48 - $ 7.00 | 1,288,728 | 8.48 | $ | 6.92 | 1,288,728 | $ | 6.92 | |||||
At June 30, 2008, the aggregate intrinsic value of options outstanding and exercisable was $0.0 (zero). The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for those awards that have an exercise price currently below the quoted price.
At June 30, 2008, all outstanding options under our 2006 Stock Option Plan were fully vested.
Other Stock Options
On March 21, 2007, the Company issued stock options to non-employees to purchase 20,000 shares of the Company’s common stock at an exercise price of $7.00 per share vesting over the next three years and expiring December 19, 2016. These stock options were valued at approximately $6,300 using the Black-Scholes model and remain outstanding as of June 30, 2008.
NOTE D – NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period.
Diluted net income per share is computed by dividing net income by the weighted average number of common shares and dilutive common stock equivalents outstanding for the period. The Company’s common stock equivalents include all common stock issuable upon the exercise of outstanding stock options and warrants.
For the three and six month periods ended June 30, 2008, 1,308,728 stock options and 300,000 warrants are excluded from the calculation as they are antidilutive. For the three month and six month periods ended June 30, 2007, the dilutive effect of 40,000 stock options are included in the diluted net income per share calculation. 1,207,500 stock options and 300,000 warrants are exluded from the calculation as they are antidilutive.
NOTE E – LINE OF CREDIT
The Company has a $30 million line of credit with Compass Bank which matures on July 5, 2012. The facility bears interest at LIBOR Index Rate plus a sliding range from 1.25% to 2.50% based on quarterly covenant performance. At June 30, 2008 that rate was 4.48% . In June, 2008 the Company entered into an interest rate swap agreement which “locks-in” a fixed rate of 5.85% on the first $6.0 million outstanding under the line of credit, thus swapping the fixed rate for the current variable rate as calculated under the
10
NOTES TO UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
NOTE E – LINE OF CREDIT (CONTINUED)
original loan agreement through its maturity date of July 5, 2012. The rate swap agreement’s fair value at June 30, 2008 was not material. The line of credit is due on demand and is secured by accounts receivable, inventories, and equipment. The line's availability is based on a borrowing formula, which allows for borrowings equal to 85% of the Company’s eligible accounts receivable and a percentage of eligible inventory. In addition, the Company must maintain certain financial covenants including ratios on funded debt to EBITDA, as well as a fixed charge ratio. At June 30, 2008, $12.0 million was outstanding under the line of credit and approximately $8.3 million remained available for borrowings under the line of credit based on the borrowing formula.
NOTE F – CONCENTRATIONS
A significant portion of UPG’s business is with one major customer, Brink’s Home Security, which represented approximately 45% and 53% of UPG’s revenues for the three months ended June 30, 2008 and 2007, respectively, and also for the six months ended June 30, 2008 and 2007, respectively. At June 30, 2008, the Company had aggregate accounts receivable from this customer in the amount of approximately $4.6 million. Through the date of this report, substantially all of this amount has been collected.
NOTE G – LEGAL PROCEEDINGS
The Company is subject to legal proceedings and claims that arise in the ordinary course of business. Management does not believe that the outcome of these matters will have a material adverse effect on the Company’s financial position, operating results, or cash flows. However, there can be no assurance that such legal proceedings will not have a material impact.
| Item 2. | Management’s Discussion and Analysis of Financial Analysis of Financial Condition and Results of Operation |
CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS
The following discussion and analysis should be read in conjunction with our unaudited interim financial statements and notes thereto included elsewhere in this Form 10-Q. This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995. Forward-looking statements, including statements regarding our plans, objectives, expectations and intentions, involve forward-looking statements that reflect the current view about future events and financial performance based on certain assumptions. They include opinions, forecasts, projections, assumptions, guidance, expectations, beliefs or other statements that are not statements of historical fact. In some cases, forward-looking statements can be identified by words such as “may”, “can”, “will”, “should”, “could”, “expects”, “hopes”, “believes”, “plans”, “anticipates”, “estimates”, “predicts”, “projects”, “potential”, “intends”, “approximates” or the negative or other variation of such terms and other comparable expressions. Forward-looking statements in this Report may include statements about:
future financial and operating results, including projections of revenues, income, expenditures,cash balances and other financial items;
our capital requirements and the need for additional financing;
our ability to acquire new customers or expand our relationships with our existing customers;
our ability to find alternative suppliers for batteries and other portable power products
our ability to successfully consummate financing and merger and acquisition transactions;
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our ability to protect our intellectual property rights and secure the right to use other intellectualproperty that we deem to be essential to the conduct of our business;
the outcome of various regulatory and legal proceedings in which we are currently involved;
our ability to execute our growth and expansion and acquisition strategies;
current and future economic and political conditions;
overall industry and market performance;
competition;
management’s goals and plans for future operations; and
other assumptions described in this Report underlying or relating to any forward-lookingstatements
The forward-looking statements in this Form 10-Q are only predictions. Actual results could, and likely will, differ materially from these forward-looking statements for many reasons, including the risks described under “Risk Factors” for the year ended December 31, 2007 filed with the SEC in our form 10-K and the other risks and uncertainties you can find in our press releases and other SEC filings. No guarantee about future results, performance or achievements can be made. These forward-looking statements are made only as of the date hereof, and we undertake no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise.
Overview
Revenues in the second quarter of 2008 rose 14.4% to $30.2 million compared to $26.4 million for the second quarter of 2007, reflecting the strength in our new and existing customer relationships and successful execution of our growth strategy. Second quarter 2008 revenues from sources other than Brinks Home Security (“Brinks”) and their dealers rose 35.0% to $16.8 million from $12.4 million in the second quarter of 2007, reflecting growth of new and existing customer accounts as well as price increases implemented by us to offset higher costs of goods sold. Growth in our higher margin business for the second quarter was driven 21% by volume and 79% by price increases. Second quarter revenues from Brinks decreased to $13.5 million, or 3.9% compared to $14.0 million in the second quarter of 2007. We believe this slight decrease primarily reflects slower growth in the residential housing market. Additionally, and of note, our concentration of revenues with Brinks and their dealers fell to 44.6% of our total revenues in the second quarter 2008 compared to 53.0% in the second quarter of 2007.
Gross margin grew 8.9% but decreased as a percentage of revenues for the second quarter of 2008 to 15.0% compared to 15.7% in the comparable period in 2007. We attribute the decrease to timing of passing along our product cost increases. This decrease reflects product mix improvement as well as some price increases to offset higher raw material costs. However, while we improved our product mix toward our historically higher margin products, the margins realized did not reflect the benefit of price increases implemented slowly due to a very competitive market especially for our “commodity” influenced products. Of note, our 15.0 % second quarter 2008 margin as a percentage of sales is only slightly down from 15.2% for the first quarter of 2008 and ahead of the third and fourth quarters of 2007, continuing a generally upward trend. The product mix improvement also includes our reduced concentration with Brinks, as noted above. We experienced cost increases during the second quarter of 2008 and expect continued volatility throughout the year in certain raw materials such as lead, copper and zinc. Growing our gross margins will continue to be more challenging when prices for raw materials are volatile. We will continue recovering cost increases from our customers wherever possible. Currently, there is no indication that we will not be able to obtain supplies of all the materials that we require. We continue to focus on and develop higher margin products and markets.
During the second quarter of 2008, our net income decreased 35.9% to $0.5 million, or $0.09 per share, compared to $0.7 million, or $0.15 per share, for the second quarter of 2007. The decrease is primarily
12
attributable to a decrease in gross margins, approximately $0.1 million in increased costs of being a public company and increases of approximately $0.6 in general operating expenses largely related to growth.
In addition to targeted organic growth, acquisitions are a significant component of our expansion initiatives and growth plans. We continue to diligently evaluate markets and suitable acquisition candidates that will facilitate reaching our strategic objectives.
We continue implementation of our Sarbanes-Oxley 404 compliance plan and expect associated costs during 2008 to be less than the approximately $0.3 million incurred during all of 2007.
A more detailed analysis of our results of operations and financial condition follows.
Results of Operations For Period Ending June 30, 2008 Compared to June 30, 2007
For the three months ended June 30, 2008 and 2007:
Revenues
For the three month period ended June 30, 2008, we had revenues of $30.2 million compared to $26.4 million for the similar period in 2007, an increase of $3.8 million or 14.4%. Revenues from Brinks Home Security and its authorized dealers in the quarter were $13.5 million compared to $14.0 million from the second quarter of 2007, a decrease of 3.9% . As most of our Brinks business is related to residential security systems, we attribute this slight decrease in our sales to them to the overall slowdown in the growth of residential construction, offset by price increases. On the other hand, revenues from customers other than Brinks increased from $12.4 million in the second quarter of 2007 to $16.8 million in the second quarter of 2008, or 35.0% reflecting growth of new and existing customer accounts as well as price increases implemented by us to offset higher costs of goods sold. We anticipate continued growth in revenue from the sales of battery, battery-powered product lines and new products.
Cost of Revenues
For the three month period ended June 30, 2008, our cost of revenues increased to $25.7 million compared to $22.3 million for the similar period in 2007, an increase of $3.4 million or 15.4% . A portion of this increase was attributable to increases in the prices of lead, copper and zinc, the significant commodity raw materials for batteries and wire. Cost of revenues as a percentage of revenues was slightly higher at 85.0% compared to 84.3% for the similar period in 2007 due primarily to timing of passing on cost increases. As we expect raw material cost increases to continue in the near future, we continually monitor customer and vendor pricing.
Operating Expenses
For the three month period ended June 30, 2008, our operating expenses, consisting of selling, general and administrative expenses as well as depreciation and amortization of property and equipment, increased approximately $0.8 million or 28.6% to approximately $3.5 million from $2.7million for the similar period in 2007. Of this increase, approximate amounts totaling $0.4 million were attributable to compensation and other employee related expenses due to overall growth, $0.1 million for costs related to increased sales such as commissions, travel, and trade show participation, additional facilities costs of $0.1 million and general corporate expenses of $0.2 million.
For the three month period ending June 30, 2008 we incurred approximately $135,000 in depreciation and amortization expense compared to approximately $47,000 in the similar period for 2007. This increase is primarily related to our new logistics and distribution system that was placed into service at the beginning of 2008.
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Interest Expense and Income
Our interest expense totaled approximately $247,000 for the three month period ended June 30, 2008 compared to $365,000 for the similar period in 2007, a decrease of approximately $118,000. The decrease is due to lower average interest rates in 2008 and decreased average borrowings under our line of credit. The average outstanding loan balance on the line of credit for the 2008 and 2007 periods was $11.5 million and $15.1 million, respectively and the weighted average interest rates during the two periods was 5.57% and 7.82%, respectively.
Our interest income for the three months ended June 30, 2008 was nominal and totaled approximately $167,000 for the three month period ending June 30, 2007. The decrease is due to funds raised during our initial public offering being maintained in short term investments.
For the six months ended June 30, 2008 and 2007:
Revenues
For the six month period ended June 30, 2008, we had revenues of approximately $59.7 million compared to $50.0 million for the similar period in 2007, an increase of $9.8 million, or 19.6% . Revenues from Brinks Home Security and their dealers for the six month period were approximately $27.0 million compared to $26.5 million for the similar period in 2007, an increase of 1.9% . As most of our Brinks business is related to residential security systems, we attribute this modest increase primarily to the overall slowdown in the residential construction industry, thus slowing the demand for certain security products. However, revenues from other customers for the similar periods increased to approximately $32.7 million in 2008 from $23.4 million in 2007, or 39.6% . We attribute this increase to more focused marketing to existing and new accounts. In addition, we experienced price increases in certain battery and battery-related products as a result of increases in the cost of lead and copper which we were able to successfully pass along to our customers. We anticipate continued growth in revenue from the sales of battery, battery-powered product lines and new products.
Cost of Revenues
For the six month period ended June 30, 2008, our cost of revenues increased to approximately $50.7 million compared to $42.4 million for the similar period in 2007, an increase of $8.4 million, or 19.8% . Cost of revenues as a percentage of revenues was relatively flat at 84.9% compared to 84.8% for the similar period in 2007. We continue to monitor customer and vendor pricing due to raw material cost increases, which are expected to continue in the near future.
Operating Expenses
For the six month period ended June 30, 2008 our operating expenses, consisting of selling, general and administrative expenses as well as depreciation and amortization of property and equipment, increased approximately $1.5 million, or 26.9% to approximately $6.8 million from $5.3 million for the similar period in 2007. Of this increase, approximate amounts totaling $0.6 million were attributable to compensation and other employee related expenses due to overall growth, $0.2 million for costs related to increased sales such as commissions, travel, and trade show participation, additional facilities costs of $0.3 million and general corporate expenses of $0..4 million.
For the six month period ending June 30, 2008 we incurred approximately $266,000 in depreciation and amortization expense compared to $104,000 for the similar period in 2007.
Interest Expense and Income
Our interest expense totaled approximately $0.5 million and $0.7 million for the six month periods ended June 30, 2008 and 2007, respectively, a decrease of approximately $0.2 million. The decrease is due to lower average interest rates in 2008 and decreased average borrowings under our line of credit. The
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average outstanding loan balance on the line of credit was $11.0 million and $14.4 million, respectively, for the six month periods ending June 30, 2008 and 2007. The weighted average interest rate during the periods was 5.9% and 7.8%, respectively, for 2008 and 2007.
Our interest income was nominal for the six month period ended June 30, 2008 and totaled approximately $0.3 million for the six month period ending June 30, 2007. The decrease is due to funds raised during our initial public offering being maintained in short term investments during 2007.
Liquidity
We had cash and cash equivalents of approximately $0.5 million and $13.3 million at June 30, 2008 and 2007, respectively. The 2007 amount includes approximately $11.8 million of net proceeds from our IPO that was consummated in late December 2006. We have used approximately $1.8 million of the IPO funds for specific projects and approximately $10.0 million has been applied to temporarily reduce our line of credit pending acquisition opportunities or other designated IPO uses.
For the six month period ended June 30, 2008, net cash provided by operating activities was approximately $1.0 million compared to a nominal amount used in operating activities for the six month period ended June 30, 2007. The net cash provided by operating activities is due primarily to net income of approximately $1.0 million, non-cash charges for depreciation, amortization, provision for bad debts and obsolete inventory and stock-based compensation totaling approximately $0.5 million and a decrease of approximately $3.9 million in inventories, offset by approximate increases of $3.7 million in our accounts receivable – trade, and $0.5 million in prepaid expenses. The overall improvement toward cash provided by, rather than used in operating activities is attributable generally to our increased cash flow from growing operations and managing inventory growth.
Cash used in investing activities for the six month periods ended June 30, 2008 and 2007, was approximately $319,000 and $143,000, respectively. The cash used in 2008 and 2007 was related to the purchases of property and equipment.
Net cash used in financing activities for the six month period ended June 30, 2008 was approximately $0.8 million compared to cash provided by financing activities of $0.4 million for the similar period in 2007. The net cash used in financing activities for 2008 was primarily comprised of reductions in net borrowings on our line of credit.
We have a $30 million line of credit with Compass Bank which matures on July 5, 2012. The facility bears interest at LIBOR Index Rate plus a sliding range from 1.25% to 2.50% based on quarterly covenant performance. At June 30, 2008 that rate was 4.48% . In June, 2008 We entered into an interest rate swap agreement which “locks-in” a fixed rate of 5.85% on the first $6.0 million outstanding under the line of credit, thus swapping the fixed rate for the current variable rate as calculated under the original loan agreement through its maturity date of July 5, 2012. The rate swap agreement’s fair value at June 30, 2008 was not material. The line of credit is due on demand and is secured by accounts receivable, inventories, and equipment. The line's availability is based on a borrowing formula, which allows for borrowings equal to 85% of our eligible accounts receivable and a percentage of eligible inventory. In addition, we must maintain certain financial covenants including ratios on funded debt to EBITDA, as well as a fixed charge ratio. At June 30, 2008, $12.0 million was outstanding under the line of credit and approximately $8.3 million remained available for borrowings under the line of credit based on the borrowing formula.
We believe that cash provided by operations and cash available under our line of credit will be sufficient to meet our operational needs over the next year.
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Item 3. Quantitative and qualitative disclosures about market risk
Foreign Currency Exchange
Our customers are primarily located in the United States. On the other hand, many of our suppliers are located outside the United States. As a result, our financial results could be impacted by foreign currency exchange rates and market conditions abroad. Since a significant portion of our products are imported from China, we continue to monitor the current weakness of the U. S. dollar against the strength of the Chinese reminibi. We have not used derivative instruments to hedge our foreign exchange risks though we may choose to do so in the future.
Our international business is subject to risks typical of an international business, including, but not limited to differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. The effect of foreign exchange rate fluctations on us during the year ended December 31, 2007 was not material.
Interest Rates
Our exposure to market rate risk for changes in interest rates is related primarily to our line of credit. A portion of the outstanding borrowings on the line of credit bears an interest rate of LIBOR plus a sliding range up to 2.5% . A change in the LIBOR rate could have a material effect on interest expense. In June, 2008 we entered into an interest rate swap agreement which “locks-in” a fixed rate of 5.85% on the first $6.0 million outstanding under the line of credit, thus swapping the fixed rate for the current variable rate as calculated under the original loan agreement through its maturity date of July 5, 2012. The rate swap agreement’s fair value at June 30, 2008 was not material.
Item 4T. Controls and procedures
Our management, with the participation of our chief executive officer and chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is: (i) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms; and (ii) accumulated and communicated to management, including our chief executive and chief financial officers, as appropriate to allow timely decisions regarding required disclosure.
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
In April 2003 Energizer Holdings, Inc. and Eveready Battery Company, Inc. (collectively “Eveready”) initiated legal proceedings against us and over 20 other respondents relating to the manufacture, importation and sale of certain alkaline batteries alleged to infringe U.S. Patent No. 5,464,709. Eveready is seeking a general exclusion order with respect to future importation of these batteries. We denied infringement and have been vigorously defending this action. In October 2004 the International Trade Commission ruled against Eveready and Eveready then appealed to the United States Court of Appeals for
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the Federal Circuit. On January 25, 2006, in the Federal Circuit reversed the Commission’s holding of invalidity and remanded for further proceedings based on its construction of Eveready’s patent. On February 23, 2007, the International Trade Commission again ruled that Everyready’s patent was invalid and terminated the investigation. Eveready appealed that decision to the Federal Circuit where oral arguments were heard on November 5, 2007. On April 21, 2008 a three judge panel of the Federal Circuit Court affirmed the International Trade Commission’s ruling of invalidity. On June 5, 2008 Eveready filed a Petition for Rehearing (which has been denied) and an En Banc Petition (pending). As of the date of this report we are not aware of any further proceedings in this matter. For more information, see In re Certain Zero-Mercury-Added Alkaline Batteries, Parts Thereof and Products Containing Same, Investigation No. 337-TA-493, in the United States International Trade Commission.
In A.J. Gilson v. Universal Power Group, Inc., Cause No. 05-09448-H, in the 160th Judicial Court of Dallas County, Texas plaintiff, a former independent sales representative, brought an action asserting claims for breach of contract, promissory estoppel and quantum meruit, alleging that Universal failed to pay him commissions owed in the amount of $430,722. We denied plaintiff’s allegations. Trial was conducted in this case on July 30-August 1, 2007, and a final judgement was entered on October 12, 2007 dismissing the plaintiff’s claims with prejudice. As of the date of this report no appeal has been filed.
There are no material changes to the risk factors set forth in Item 1A of Part 1 of our Form 10-K for the year ended December 31, 2007 filed with the U.S. Securities and Exchange Commission on June 30, 2008 except as follows.
The risk factor immediately following, which was disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007, has been modified to provide additional disclosure related to changes since we filed our Annual Report on Form 10-K for the year ended December 31, 2007. See Item 1A to Part I of our Annual Report on Form 10-K for the year ended December 31, 2007 for an expanded description of other risks we face under “Other Risk Factors.”
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Our initial public offering (IPO) was declared effective on December 20, 2006. In the offering, we received net proceeds of approximately $11.8 million. We have used proceeds totaling approximately $1.3 million implementing our new warehouse management system, $0.2 million in start up of our Columbus, Georgia logistics center and $0.3 million for new product development. As of June 30, 2008 the remaining approximately $10.0 million in net proceeds were applied to temporarily reduce our outstanding line of credit pending acquisition opportunities or other designated IPO uses. We have made no direct or indirect payments to any directors or officers from the proceeds.
The following exhibits are furnished as part of this report or incorporated herein as indicated.
| Exhibit | Description | |
| 3(i) | Amended and Restated Certificate of Formation (including Amended and Restated Articles of | |
| Incorporation) (1) | ||
| 3(ii) | Amended and Restated Bylaws (1) | |
| 4.1 | Specimen stock certificate (1) | |
| 4.2 | Form of representatives’ warrant (1) | |
| 10.1(a) | Form of 2006 Stock Option Plan (1) | |
| 10.1(b) | Form of Stock Option Agreement (1) | |
| 10.2 | Form of Randy Hardin Employment Agreement (1)(2) | |
| 10.3 | Form of Ian Edmonds Employment Agreement (1)(2) | |
| 10.4 | Form of Mimi Tan Employment Agreement (1)(2) | |
| 10.5 | Amended and Restated Revolving Credit and Security Agreement with Compass Bank dated |
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| June 19, 2007 | ||||
| 10.6 | Purchase Agreement, dated June 1, 2004, with Brinks Home Security (1) | |||
| 10.7 | Real Property Lease for 1720 Hayden Road, Carrollton, Texas (1) | |||
| 10.8 | Real Property Lease for 11605-B North Santa Fe, Oklahoma City, Oklahoma (1) | |||
| 10.9 | Real Property Lease for Las Vegas, Nevada (1) | |||
| 10.10 | Agreement with Import Consultants (1) | |||
| 10.11(a) | Form of Promissory Note in the amount of $2,850,000 payable to Zunicom (1) | |||
| 10.11(b) | Form of Promissory Note in the amount of $3,000,000 payable to Zunicom (1) | |||
| 10.12 | Director-Nominee Consents | |||
| a) | Leslie Bernhard(1) | |||
| b) | Marvin I. Haas(1) | |||
| c) | Garland P. Asher(1) | |||
| d) | Robert M. Gutkowski(1) | |||
| 10.13 | Third Party Logistics & Purchase Agreement, dated as of November 20, 2006, with Brinks Home Security (1) | |||
| 21.1 | Subsidiaries** | |||
| 31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* | |||
| 31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* | |||
| 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* | |||
| 32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* | |||
| * | Filed herewith. | ||
| ** | UPG does not have any significant subsidiaries. | ||
| (1) | Incorporated by reference to the Exhibit with the same number to UPG’s Registration Statement on Form S-1 (SEC File No. 333-137265) effective as of December 20, 2006. | ||
| (2) | Management contract, compensation plan or arrangement. | ||
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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.
| Universal Power Group, Inc. | |||
| Date: August 11, 2008 | /s/Randy Hardin | ||
| Randy Hardin | |||
| President and Chief Executive Officer | |||
| (Principal executive officer) | |||
| Date: August 11, 2008 | /s/Roger Tannery | ||
| Roger Tannery | |||
| Chief Financial Officer | |||
| (Principal financial and accounting | |||
| officer) | |||
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