UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2006 |
Commission File Number 1-9014 |
Chyron Corporation |
(Exact name of registrant as specified in its charter) |
New York | 11-2117385 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
5 Hub Drive, Melville, New York | 11747 | |
(Address of principal executive offices) | (Zip Code) | |
(631) 845-2000 | ||
(Registrant's telephone number, including area code) |
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. Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] | Accelerated filer [ ] | Non-accelerated filer [x] |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
The number of shares outstanding of the issuer's common stock, par value $.01 per share, on November 1, 2006 was 45,623,839.
CHYRON CORPORATION
INDEX
PART I | FINANCIAL INFORMATION | Page |
Item 1. | Financial Statements | |
Consolidated Balance Sheets as of September 30, 2006 (unaudited) and | ||
December 31, 2005 | 3 | |
Consolidated Statements of Operations and Comprehensive | ||
Income (unaudited) for the Three Months ended | ||
September 30, 2006 and 2005 | 4 | |
Consolidated Statements of Operations and Comprehensive | ||
Income (unaudited) for the Nine Months ended | ||
September 30, 2006 and 2005 | 5 | |
Consolidated Statements of Cash Flows (unaudited) for the Nine | ||
Months ended September 30, 2006 and 2005 | 6 | |
Notes to Consolidated Financial Statements (unaudited) | 7 | |
Item 2. | Management's Discussion and Analysis of Financial Condition | |
and Results of Operations | 14 | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 19 |
Item 4. | Controls and Procedures | 19 |
PART II | OTHER INFORMATION | |
Item 1. | Legal Proceedings | 20 |
Item 1A. | Risk Factors | 20 |
Item 6. | Exhibits | 20 |
2
CHYRON CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
Unaudited | ||
September 30, | December 31, | |
ASSETS | 2006 | 2005 |
Current assets: | ||
Cash and cash equivalents | $ 4,367 | $ 2,331 |
Accounts receivable, net | 3,348 | 4,613 |
Inventories, net | 3,224 | 2,492 |
Prepaid expenses and other current assets | 268 | 283 |
Total current assets | 11,207 | 9,719 |
Property and equipment, net | 918 | 653 |
Other assets | 21 | 6 |
TOTAL ASSETS | $12,146 | $10,378 |
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) | ||
Current liabilities: | ||
Accounts payable and accrued expenses | $ 3,396 | $ 3,318 |
Short term debt | 673 | 1,326 |
Deferred revenue | 1,501 | 1,038 |
Pension liability | 631 | 558 |
Capital lease obligations | 28 | 15 |
Total current liabilities | 6,229 | 6,255 |
Long term debt | 280 | 2,793 |
Pension liability | 1,340 | 1,490 |
Other liabilities | 570 | 433 |
Total liabilities | 8,419 | 10,971 |
Commitments and contingencies | ||
Shareholders' equity (deficit): | ||
Preferred stock, par value without designation | ||
Authorized - 1,000,000 shares, issued - none | ||
Common stock, par value $.01 | ||
Authorized - 150,000,000 shares | ||
Issued and outstanding - 45,623,839 at September 30, 2006 and | ||
41,378,610 at December 31, 2005 | 456 | 414 |
Additional paid-in capital | 74,945 | 71,989 |
Accumulated deficit | (71,670) | (72,995) |
Accumulated other comprehensive loss | (4) | (1) |
Total shareholders' equity (deficit) | 3,727 | (593) |
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) | $12,146 | $10,378 |
See Notes to Consolidated Financial Statements
3
CHYRON CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
THREE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(In thousands, except per share amounts)
(Unaudited)
2006 | 2005 | |
Net sales | $6,448 | $6,564 |
Cost of products sold | 1,929 | 2,624 |
Gross profit | 4,519 | 3,940 |
Operating expenses: | ||
Selling, general and administrative | 3,345 | 2,737 |
Research and development | 1,075 | 719 |
Total operating expenses | 4,420 | 3,456 |
Operating income | 99 | 484 |
Interest expense | (24) | (48) |
Interest income | 49 | 21 |
Other income (expense), net | 33 | (1) |
Net income | $ 157 | $ 456 |
Net income per common share - basic and diluted | $ 0.00 | $ 0.01 |
Weighted average shares outstanding: | ||
Basic | 41,542 | 41,352 |
Diluted | 44,572 | 41,659 |
Comprehensive income: | ||
Net income | $ 157 | $ 456 |
Other comprehensive loss: | ||
Foreign currency translation loss | (5) | - |
Total comprehensive income | $ 152 | $ 456 |
See Notes to Consolidated Financial Statements
4
CHYRON CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(In thousands, except per share amounts)
(Unaudited)
2006 | 2005 | |
Net sales | $19,872 | $18,321 |
Cost of products sold | 6,402 | 7,096 |
Gross profit | 13,470 | 11,225 |
Operating expenses: | ||
Selling, general and administrative | 9,274 | 8,954 |
Research and development | 2,921 | 2,128 |
Total operating expenses | 12,195 | 11,082 |
Operating income | 1,275 | 143 |
Interest expense | (138) | (167) |
Interest income | 105 | 77 |
Other income (expense), net | 83 | (42) |
Net income | $ 1,325 | $ 11 |
Net income per common share - basic and diluted | $ 0.03 | $ 0.00 |
Weighted average shares outstanding: | ||
Basic | 41,442 | 41,341 |
Diluted | 43,721 | 41,608 |
Comprehensive income: | ||
Net income | $ 1,325 | $ 11 |
Other comprehensive loss: | ||
Foreign currency translation loss | (3) | - |
Total comprehensive income | $ 1,322 | $ 11 |
See Notes to Consolidated Financial Statements
5
CHYRON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(In thousands)
(Unaudited)
2006 | 2005 | |
CASH FLOWS FROM OPERATING ACTIVITIES | ||
Net income | $1,325 | $ 11 |
Adjustments to reconcile net income to cash provided by (used in) | ||
operating activities: | ||
Depreciation and amortization | 294 | 260 |
Loss on disposal of equipment | 64 | - |
Inventory provisions | 286 | - |
Share-based compensation expense | 274 | - |
Other | (116) | 182 |
Changes in operating assets and liabilities: | ||
Accounts receivable | 1,265 | (611) |
Inventories | (1,018) | (43) |
Prepaid expenses and other assets | (15) | 19 |
Accounts payable and accrued expenses | 78 | (108) |
Deferred revenue | 566 | 239 |
Other liabilities | (57) | (150) |
Net cash provided by (used in) operating activities | 2,946 | (201) |
CASH FLOWS FROM INVESTING ACTIVITIES | ||
Acquisitions of property and equipment | (562) | (160) |
Receipt of proceeds from sale of Pro-Bel | - | 428 |
Net cash (used in) provided by investing activities | (562) | 268 |
CASH FLOWS FROM FINANCING ACTIVITIES | ||
Principal payments on convertible debentures | (1,345) | (1,260) |
Borrowings from term loan | 1,345 | - |
Principal payments on term loan | (392) | - |
Proceeds from exercise of stock options | 59 | 5 |
Payments on capital lease obligations | (15) | (8) |
Net cash used in financing activities | (348) | (1,263) |
Change in cash and cash equivalents | 2,036 | (1,196) |
Cash and cash equivalents at beginning of period | 2,331 | 2,855 |
Cash and cash equivalents at end of period | $ 4,367 | $ 1,659 |
Supplemental cash flow information: | ||
Interest paid during the period | $ 209 | $ 22 |
Assets acquired under capital lease | 62 | |
Series D Debentures converted to common stock | 2,664 |
See Notes to Consolidated Financial Statements
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1.BASIS OF PRESENTATION
General
In the opinion of management of Chyron Corporation (the "Company" or "Chyron"), the accompanying unaudited consolidated interim financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of the Company as of September 30, 2006 and the consolidated results of its operations and its cash flows for the periods ended September 30, 2006 and 2005. The results of operations for such interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. In addition, management is required to make estimates and assumptions that affect the amounts reported and related disclosures. Estimates, by their nature, are based on judgment and available information. Also, during interim periods, certain costs and expenses are allocated among periods based on an estimate of time expired, benefit received, or other activity associated with the periods. Accordi ngly, actual results could differ from those estimates. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. The December 31, 2005 figures included herein were derived from such audited consolidated financial statements.
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Nature of Business
Chyron and its wholly-owned subsidiaries is a supplier of character generators ("CG") and graphics hardware and software related products to the television industry. The Company develops, manufactures, markets and supports hardware and software products that enhance the presentation of live and pre-recorded video, audio and other data. Chyron's products are used in broadcast production facilities worldwide for applications including news, sports, weather and election coverage. The Company's graphics products create, manipulate, store, playback and manage content including 2D/3D text, logos, graphics, animations and video stills/clips. In January 2005, Chyron introduced the ChyTV product line providing low-cost, easy to use graphics for microcasting and digital displays applications.
Net Income Per Share
Basic net income per share is computed based on the weighted average number of common shares outstanding. Diluted net income per share is based on the sum of the weighted average number of common shares outstanding and common stock equivalents. Shares used to calculate net income per share are as follows (in thousands):
Three Months | Nine Months | |||
Ended | Ended | |||
September 30, | September 30, | |||
2006 | 2005 | 2006 | 2005 | |
Basic weighted average shares outstanding | 41,542 | 41,352 | 41,442 | 41,341 |
Effect of dilutive stock options | 1,796 | 307 | 1,437 | 267 |
Effect of dilutive convertible debentures | 1,234 | - | 842 | - |
Diluted weighted average shares outstanding | 44,572 | 41,659 | 43,721 | 41,608 |
Weighted average shares which are not included | ||||
in the calculation of diluted net income per | ||||
share under the treasury stock method: | ||||
Stock options | 4,412 | 5,081 | 4,271 | 4,989 |
Convertible debentures | 2,807 | 4,917 | 3,236 | 4,917 |
7,219 | 9,998 | 7,507 | 9,906 |
2.SHARE BASED COMPENSATION
Incentive awards are provided to employees under the terms of our 1999 Incentive Compensation Plan (the "Plan"). The Plan allows for the award of incentive and non-incentive options to employees and non-incentive options to non-employee members of our Board of Directors (the "Board"). The Plan is administered by a committee, designated by the Board, to determine the time and circumstances under which an employee option may be exercised. Generally, employee options vest one-third each year, are fully vested three years from grant date and have a term of ten years. Options awarded to our Board on an annual basis are fully vested at grant date and have a term of ten years.
Effective January 1, 2006, the Company adopted the provisions of FAS No. 123(R), "Share-Based Payment" ("FAS123(R)"). Under FAS123(R), share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense over the requisite service period. The Company adopted the provisions of FAS123(R) using a modified prospective application. Under this method, compensation cost is recognized for all share-based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were granted prior to the date of adoption. Prior periods are not revised for comparative purposes. Because the Company previously adopted only the pro forma disclosure provisions of SFAS 123, it will recognize compensation cost relating to the unvested portion of awards granted prior to the date of adoption, using the same estimate of the grant-date fair value and the same attribution method used to determine the pro forma disclosures under SFAS 123, except that forfeitures rates will be estimated for all options, as required by FAS123(R). The cumulative effect of applying the forfeiture rates is not material.
8
The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. Expected volatility is based on the historical volatility of the price of the Company's stock. The risk-free interest rate is based on U.S. Treasury issues with a term equal to the expected life of the option. The Company uses historical data to estimate expected dividend yield, expected life and forfeiture rates. The fair values of the options granted during the three and nine month periods ended September 30, 2006 and 2005, were estimated based on the following weighted average assumptions:
Three Months | Nine Months | |||
Ended | Ended | |||
September 30, | September 30, | |||
2006 | 2005 | 2006 | 2005 | |
Expected volatility | 107.0% | 96.0% | 108.9% | 95.9% |
Risk-free interest rate | 4.87% | 4.10% | 4.89% | 3.85% |
Expected dividend yield | 0.00% | 0.00% | 0.00% | 0.00% |
Expected life (in years) | 4.0 | 4.0 | 4.0 | 4.0 |
Estimated fair value per option granted | $0.66 | $0.31 | $0.66 | $0.26 |
Stock option activity during the nine months ended September 30, 2006, is as follows:
Weighted | ||||
average | ||||
Weighted | remaining | |||
Number | average | contracted | Aggregate | |
of | exercise | term | intrinsic | |
options | price | (years) | value | |
Outstanding at January 1, 2006 | 5,248,233 | $0.84 | ||
Options granted | 1,274,000 | 0.87 | ||
Options exercised | (146,926) | 0.41 | ||
Options forfeited and cancelled | (65,212) | 7.61 | ||
Options outstanding at September 30, 2006 | 6,310,095 | 0.78 | 7.15 | $2,778,516 |
Options exercisable at September 30, 2006 | 4,623,531 | 0.81 | 6.37 | $2,166,895 |
The aggregate intrinsic value of options exercised during the three and nine month periods ended September 30, 2006 were $64,292 and $94,123, respectively.
The impact on our results of operations of recording share-based compensation expense for the three and nine month periods ended September 30, 2006 is as follows:
Three Months | Nine Months | |
Ended September 30, 2006 | ||
Cost of products sold | $ 28,813 | $ 41,172 |
Research and development | 57,624 | 82,343 |
Selling, general and administrative | 105,644 | 150,963 |
$192,081 | $274,478 |
9
As of September 30, 2006, there was approximately $634,000 of total unrecognized share-based compensation expense related to options granted under our plans that will be recognized over the next three years.
A summary of our non-vested options as of September 30, 2006 and changes during the nine months ended September 30, 2006 is presented below:
Weighted average | ||
grant date | ||
Shares | fair value | |
Nonvested at January 1, 2006 | 885,583 | $0.26 |
Granted | 1,274,000 | 0.66 |
Vested | (407,807) | 2.38 |
Forfeited and cancelled | (65,212) | 1.81 |
Nonvested at September 30, 2006 | 1,686,564 | 0.24 |
Awards granted prior to the adoption of FAS123(R) were accounted for under the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and its related interpretations. Under this intrinsic value method there was no compensation expense recognized for the three and nine month periods ended September 30, 2005 because all options had exercise prices equal to the market value of the underlying stock on the date of grant. The following table illustrates the effect on net income and net income per common share if the fair value method had been applied (in thousands except per share amounts):
Three Months | Nine Months | |
Ended September 30, 2005 | ||
Net income - as reported | $ 456 | $ 11 |
Total share-based compensation expense | ||
determined under fair value based method | (56) | (832) |
Pro forma net income (loss) | $ 400 | $ (821) |
Earnings (loss) per share: | ||
Basic and diluted - as reported | $0.01 | $ 0.00 |
Basic and diluted - pro forma | $0.01 | $(0.02) |
3.INVENTORIES
Inventory, net is comprised of the following (in thousands):
September 30, | December 31, | |
2006 | 2005 | |
Finished goods | $ 589 | $ 540 |
Work-in-progress | 417 | 329 |
Raw materials | 2,218 | 1,623 |
$3,224 | $2,492 |
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4.LONG-TERM DEBT
September 30, | December 31, | |
2006 | 2005 | |
Term Loan | $ 953 | $ - |
Series C Debentures | - | 1,326 |
Series D Debentures | - | 2,793 |
953 | 4,119 | |
Less current portion | 673 | 1,326 |
$ 280 | $2,793 |
On March 1, 2006, the Company amended its lending agreement to provide for a $1.5 million revolving line of credit ("revolver"), with an advance rate of up to 80% of eligible accounts receivable. At September 30, 2006, available borrowings on the revolver were $1.3 million. No amounts have been borrowed under the revolver since its inception. The revolver will mature on April 13, 2008 and will bear interest at Prime +1%. The lending agreement also provides for a $1.5 million term loan, which the Company drew down on March 20, 2006, in the amount of $1.3 million in order to redeem the Series C Debentures which were scheduled to mature in April 2006. The term loan will be payable in twenty-four equal monthly installments plus interest at Prime +1.75% (10.0% at September 30, 2006). Interest expense on the term loan totaled $27 thousand and $62 thousand in the three and nine month periods ended September 30, 2006, respectively. The Company is required to maintain cash or availab ility of $1 million and minimum cumulative EBITDA as follows (2007 and future levels will be determined in late 2006 or early 2007):
Q1 2006 | $100,000 |
Q2 2006 | (250,000) |
Q3 2006 | 125,000 |
Q4 2006 | 775,000 |
The Company did not meet the EBITDA requirement for Q1 2006, for which period a waiver was obtained. The Company did meet the EBITDA requirement for Q2 and Q3 2006. The future covenant levels will be reviewed with our lender and we believe we will meet the covenant requirements going forward. As is usual and customary in such lending agreements, the lending agreement also contains certain non-financial requirements, such as required periodic reporting to the bank and various representations and warranties. The lending agreement also restricts our ability to pay dividends without the bank's consent.
The Series C Debentures, which totaled $1.3 million in principal and accrued interest at March 20, 2006, were redeemed in full on that date with the proceeds from the term loan. The Series C Debentures accrued interest at an annual rate of 7%, which totaled nil and $22 thousand in the third quarter of 2006 and 2005, respectively. Interest expense totaled $19 thousand and $86 thousand in the nine month periods ended September 30, 2006 and 2005, respectively.
11
On September 22, 2006, we notified all holders of our Series D 8% Convertible Subordinated Debentures ("Debentures") due December 31, 2007 of our intent to redeem, on October 9, 2006, all outstanding Debentures which aggregated to $2.66 million. All holders responded by electing to convert their Debentures. As a result, as of September 30, 2006, the total outstanding Debentures were converted into 4,098,303 shares of restricted common stock of the Company based upon the conversion price of $0.65 and all Debentures were cancelled. Interest expense totaled $29 thousand and $52 thousand in the nine month periods ended September 30, 2006 and 2005, respectively. The reported amount of interest expense has been adjusted as a result of amortization of a gain on exchange that took place in 2004, that was deferred in accordance with SFAS No. 15. The amortization, which reduced interest expense, totaled $129 thousand and $97 thousand in the nine month periods ended September 30, 2006 and 2005, respectively.
5.BENEFIT PLANS
The net periodic benefit cost is as follows (in thousands):
Three Months Ended | Nine Months Ended | |||
September 30, | September 30, | |||
2006 | 2005 | 2006 | 2005 | |
Service cost | $133 | $140 | $325 | $288 |
Interest cost | 74 | 58 | 168 | 142 |
Expected return on plan assets | (37) | (54) | (115) | (116) |
Amortization of prior service cost | (9) | (8) | (25) | (26) |
Amortization of prior gain | 9 | 4 | 9 | - |
$170 | $140 | $362 | $288 |
During the nine months ended September 30, 2006, we made contributions of $439 thousand to the Company's Pension Plan. Our policy is to fund the minimum contributions required under the Employee Retirement Income Security Act (ERISA). During the balance of 2006, we expect to contribute approximately $120 thousand for the 2006 plan year, based on these funding requirements. In addition, during 2006, the Company has been paying all Pension Plan expenses, as permitted by ERISA, whereas in 2005, certain expenses were paid by the Pension Plan. Furthermore, subject to cash flow levels, it is the Company's intention to make additional contributions to the Pension Plan to reduce the unfunded liability.
6.GEOGRAPHIC INFORMATION
The details of the Company's geographic sales are as follows (in thousands):
| Three Months Ended | Nine Months Ended | ||
September 30, | September 30, | |||
2006 | 2005 | 2006 | 2005 | |
United States | $4,486 | $5,075 | $15,796 | $14,409 |
Europe | 1,224 | 781 | 2,480 | 2,456 |
Rest of world | 738 | 708 | 1,596 | 1,456 |
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7.PRODUCT WARRANTY
We provide product warranties for our various products, typically for one year. Liabilities for the estimated future costs of repair or replacement are established and charged to cost of sales at the time the sale is recognized. We established our reserve based on historical data, taking into consideration specific product information. The following table sets forth the movement in the warranty reserve (in thousands):
Three Months Ended | Nine Months Ended | |||
September 30, | September 30, | |||
2006 | 2005 | 2006 | 2005 | |
Balance at beginning of period | $ 50 | $ 50 | $223 | $ 50 |
Expenses (credits) | (24) | 111 | (222) | 316 |
Warranty services provided | 24 | - | 49 | (205) |
$ 50 | $161 | $ 50 | $ 161 |
8.RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140" which is effective for fiscal years beginning after September 15, 2006. The statement was issued to clarify the application of FASB Statement No. 133 to beneficial interests in securitized financial assets and to improve the consistency of accounting for similar financial instruments, regardless of the form of the instruments. We have evaluated the new statement and have determined that it will not have a significant impact on the determination of our financial results.
In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156, "Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140" which is effective for fiscal years beginning after September 15, 2006. This statement was issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement attributes. We have evaluated the new statement and have determined that it will not have a significant impact on the determination of our financial results.
In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 will be effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to the opening balance of retained earnings. We have not yet evaluated the impact of implementation on our consolidated financial statements.
13
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to U.S. GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We have not yet evaluated the impact of implementation on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" (SFAS No. 158). SFAS No. 158 requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. SFAS No. 158 also requires additional disclosures in the notes to financial statements. SFAS No. 158 is effective as of the end of fiscal years ending after December 15, 2006. We are currently assessing the impact of SFAS No. 158 on our consolidated financial statements. However, based on the funded status of our defined benefit pension plan as of December 31, 2005 (our most recent measurement date), we would be required to increa se our net liabilities for pension benefits, which would result in an estimated decrease to shareholders' equity of approximately $300 thousand, net of taxes, in our consolidated balance sheet. This estimate may vary from the actual impact of implementing SFAS No. 158. The ultimate amounts recorded are highly dependent on a number of assumptions and changes in these assumptions since our last measurement date could increase or decrease the expected impact of implementing SFAS No. 158 in our consolidated financial statements at December 31, 2006.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
From time to time, including in this Quarterly Report on Form 10-Q, we may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, changes in the industry, new products, research and development activities and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for such forward-looking statements. In order to comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results to differ from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our business include, without limitation, the following: product concentration in a mature market, dependence on the emerging digital market and the industry's transition to DTV ("digital television") and HDTV ("high definition telev ision"), consumer acceptance of DTV and HDTV, resistance within the broadcast or cable industry to implement DTV and HDTV technology, use and improvement of the Internet, new technologies that could render certain Chyron products to be obsolete, a highly competitive environment, competitors with significantly greater financial resources, new product introductions by competitors, seasonality, fluctuations in quarterly operating results, ability to maintain adequate levels of working capital, viability of the Over the Counter Bulletin Board as a trading platform, and expansion into new markets.
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The following discussion should be read along with our 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission, and with the unaudited financial statements included in this Form 10-Q.
Comparison of the Three and Nine Months Ended September 30, 2006 and 2005
Revenues for the quarter ended September 30, 2006 were $6.4 million, a decrease of $0.2 million, or 3% from the $6.6 million reported for the third quarter of 2005. Revenues for the nine months ended September 30, 2006 were $19.9 million, an increase of $1.6 million or 9% from the $18.3 million reported for the first nine months of 2005.
Revenues derived from U.S. customers were $4.4 million in the third quarter of 2006 as compared to $5.1 million in the third quarter of 2005. Revenues derived from international customers were $2.0 million in the third quarter of 2006 as compared to $1.5 million in the third quarter of 2005. Year-to-date revenues in the U.S. were $15.8 million in 2006 and $14.4 million in the comparable period in 2005. Year-to-date international revenues were $4.1 million in 2006 and $3.9 million in 2005.
While domestic revenues in Q3 of 2006 were below Q3 2005 levels, year to date 2006 revenues are well ahead of 2005 amounts. The quarterly variance was impacted by the realization of orders that were completed outside of the Q3 2006 timeframe, both due to customer requirements to accelerate shipments thereby benefiting our earlier strong second quarter and from shipments that were delayed into Q4 2006. The overall improvement in year to date revenues is a result of the contribution from new products and software releases that were introduced earlier in the year. In addition, consumer demand for HD television content have increased, requiring broadcasters to accelerate the implementation of their HD programs, resulting in increased demand for Chyron's HyperX systems. International revenues in all periods in 2006 were higher than 2005 in part as a result of a continuing European government's upgrade program. We also expect that HDTV acceptance will also continue to increase internationally, which could be beneficial to Chyron in future periods. Sales of our digital displays product line accounted for 5% and 3% of total revenues in the three and nine month periods in 2006, respectively. In 2005, this product line accounted for 2% and 1% of total revenues in the respective three and nine month periods.
Gross margins for the third quarter of 2006 increased to 70% from 60% in the comparable quarter in 2005. Gross margins in the nine month periods in 2006 and 2005 were 68% and 61%, respectively. Improvements in gross margins are primarily a result of lower material costs. The reduction in material costs has been driven by several factors, primarily the result of newer technology, which lowers the purchase cost and also results in greater reliability and lower warranty costs. In addition, we have been able to purchase in greater quantities due to the interchangeability of components across product lines and overall higher sales volume.
Selling, general and administrative (SG&A) expenses increased by $0.6 million, to $3.3 million in the quarter ended September 30, 2006 compared to $2.7 million in the third quarter of 2005. SG&A expenses increased by $0.3 million, to $9.3 million in the first nine months of 2006 compared to $9.0 million for the first nine months of 2005. The increase in the quarterly SG&A expenses was driven by the adoption of FAS123(R) which accounted for $0.1 million, employee related benefits of $0.2 million, trade shows and other costs related to international marketing
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efforts of $0.1 million, legal and other consulting costs of $0.1 million and $0.1 million related to the cost of marketing efforts associated with our digital display products.
The increase in year to date SG&A expenses was also impacted by the adoption of FAS123(R) which accounted for $0.2 million, employee related benefits of $0.1 million, legal costs of $0.1 million for matters incidental to our business, and sales commissions of $0.1 million associated with greater year to date revenue levels. These costs were offset by $0.1 million in consulting costs related to systems upgrades in 2005, and $0.1 million in 2005 severance costs which did not recur in 2006.
Research and development (R&D) costs in the third quarter of 2006 of $1.1 million increased by $0.3 million compared to the quarter ended September 30, 2005. R&D costs increased by $0.8 million, to $2.9 million in the first nine months of 2006, compared to $2.1 million for the first nine months of 2005. The primary factor contributing to the increase in all periods in 2006 is the Company's investment, primarily in the form of personnel and related costs, in the development of new products for HDTV, mobile content, channel branding and the digital display product line.
The components of other income (expense), net are as follows (in thousands):
Three Months Ended | Nine Months Ended | |||
September 30, | September 30, | |||
2006 | 2005 | 2006 | 2005 | |
Foreign exchange transaction gain (loss) | $17 | $(15) | $38 | $(83) |
Other | 16 | 14 | 45 | 41 |
$33 | $ (1) | $83 | $(42) |
Interest expense declined in all periods in 2006 as a result of lower average borrowings. Interest income increased in all periods in 2006 as a result of higher average balances and the investment income earned thereon.
Liquidity and Capital Resources
At September 30, 2006, we had cash on hand of $4.4 million and working capital of $5 million.
During the nine months ended September 30, 2006, net cash of $2.9 million was provided by operations. The amount of net cash from operations was primarily driven by the net income in the period and the effect of non cash charges of $0.8 million, and a decrease in accounts receivable, offset by an increase in inventory.
On March 1, 2006, the Company amended its lending agreement with its U.S. bank to provide for a $1.5 million revolving line of credit ("revolver"), with an advance rate of up to 80% of eligible accounts receivable. At September 30, 2006, available borrowings on the revolver were $1.3 million. No amounts have been borrowed under the revolver since its inception. The revolver will mature on April 13, 2008 and will bear interest at Prime +1%. The agreement also provides for a $1.5 million term loan, which the Company drew down on March 20, 2006, in the
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amount of $1.3 million in order to redeem the Series C Debentures which were scheduled to mature in April 2006. The term loan will be payable in twenty-four equal monthly installments plus interest at Prime +1.75% (10.0% at September 30, 2006). The Company is required to maintain cash or availability of $1 million and minimum cumulative EBITDA as follows (2007 and future levels will be determined in late 2006 or early 2007):
Q1 2006 |
|
Q2 2006 | (250,000) |
Q3 2006 | 125,000 |
Q4 2006 | 775,000 |
The Company did not meet the EBITDA requirement for Q1 2006, for which period a waiver was obtained. The Company did meet the EBITDA requirement for Q2 and Q3 2006. The future covenant levels will be reviewed with our lender and we believe we will meet the covenant requirements going forward. As is usual and customary in such lending agreements, the agreement also contains certain non-financial requirements, such as required periodic reporting to the bank and various representations and warranties. The agreement also restricts our ability to pay dividends without the bank's consent.
On September 22, 2006, we notified all holders of our Series D 8% Convertible Subordinated Debentures ("Debentures") due December 31, 2007 of our intent to redeem, on October 9, 2006, all outstanding Debentures which aggregated to $2.66 million. All holders responded by electing to convert their Debentures. As a result, as of September 30, 2006 the total outstanding Debentures were converted into 4,098,303 shares of restricted common stock of the Company based upon the conversion price of $0.65 and all Debentures were cancelled. As a result of the conversion, the Company will no longer be obligated to pay quarterly interest, which interest was payable on the first business day after the end of each quarter, through the stated maturity date. Future interest expense that would otherwise have been recorded and paid totals $0.27 million through December 31, 2007. Total Company debt (consisting of a term loan from our bank) is less than $1.0 million.
We provide graphics products to the broadcast industry for use in digital television. Our future growth and success will depend to a significant degree on the continued growth of various markets that use our products. We operate in a rapidly changing environment and must remain responsive to changes as they occur. In the event that revenues are significantly below forecasted revenues, we believe we have the ability to reduce or delay discretionary expenditures, including capital purchases, and reduce headcount, so that we will have sufficient cash resources. However, there can be no assurance that we will be able to adjust our costs in sufficient time to respond to revenue and cash shortfalls, should that occur.
The long term success of the Company will be dependent on maintaining profitable operating results and the ability to raise additional capital should such additional capital be required. In the event the Company is unable to achieve expected goals of profitability or raise sufficient additional capital, if needed, we may have to scale back or eliminate certain parts of our operations.
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We believe that cash on hand, net cash to be generated in the business, and availability under our line of credit, will be sufficient to meet our cash needs if we are able to achieve our planned results of operations and retain availability of credit under our lending agreement.
Recent Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140" which is effective for fiscal years beginning after September 15, 2006. The statement was issued to clarify the application of FASB Statement No. 133 to beneficial interests in securitized financial assets and to improve the consistency of accounting for similar financial instruments, regardless of the form of the instruments. We have evaluated the new statement and have determined that it will not have a significant impact on the determination of our financial results.
In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156, "Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140" which is effective for fiscal years beginning after September 15, 2006. This statement was issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement attributes. We have evaluated the new statement and have determined that it will not have a significant impact on the determination of our financial results.
In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 will be effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to the opening balance of retained earnings. We have not yet evaluated the impact of implementation on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to U.S. GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We have not yet evaluated the impact of implementation on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" (SFAS No. 158). SFAS No. 158 requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. SFAS No. 158 also requires additional disclosures in the notes to financial statements. SFAS No. 158 is effective as of the end of fiscal years ending after December 15, 2006. We are currently assessing the impact of SFAS No. 158 on our consolidated financial statements. However, based on the funded status of our defined benefit pension plan as of
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December 31, 2005 (our most recent measurement date), we would be required to increase our net liabilities for pension benefits, which would result in an estimated decrease to shareholders' equity of approximately $300 thousand, net of taxes, in our consolidated balance sheet. This estimate may vary from the actual impact of implementing SFAS No. 158. The ultimate amounts recorded are highly dependent on a number of assumptions and changes in these assumptions since our last measurement date could increase or decrease the expected impact of implementing SFAS No. 158 in our consolidated financial statements at December 31, 2006.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
We are exposed to foreign currency and exchange risks in the normal course of business related to investments in our foreign subsidiaries and sales to foreign customers. For the three months ended September 30, 2006 and 2005, sales to foreign customers were 30% and 23% of total sales, respectively. For the nine months ended September 30, 2006 and 2005, sales to foreign customers were 21% of total sales. All sales generated outside of the U.S. are denominated in British Pounds Sterling, Euros and U.S. Dollars.
The net impact on earnings of foreign exchange transactions was a gain of $17 thousand and a loss of $15 thousand in the three months ended September 30, 2006 and 2005, respectively. The net impact of foreign exchange transactions was a gain of $38 thousand in the nine month period ended September 30, 2006 and a loss of $83 thousand in the nine month period ended September 30, 2005. We record translation gain or loss as a separate component of other comprehensive income or loss in shareholders' equity (deficit).
Additionally, we are exposed to interest rate risk with respect to any bank debt that carries a variable interest rate, such as our term loan. Rates that affect the variable interest on this debt include the Prime Rate. We have evaluated the foreign currency exchange risk and interest rate risk and believe that our exposure to these risks are not material to our near-term financial position, earnings, or cash flows.
Item 4. CONTROLS AND PROCEDURES
As of September 30, 2006, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of September 30, 2006. There have been no significant changes in the Company's internal control over financial reporting during the most recent quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company from time to time is involved in routine legal matters incidental to its business. In the opinion of management, the ultimate resolution of such matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity.
Item 1A. RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part 1, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition and/or operating results.
Item 6. EXHIBITS
(a) Exhibits:
Exhibit No. | Description of Exhibit | |
31.1 | Certification of Chief Executive Officer pursuant to Rule 13A-14(a) or 15D-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Chief Financial Officer pursuant to Rule 13A-14(a) or 15D-14(a) of the Securities Exchange Act of 1934, as adopted 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 |
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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.
CHYRON CORPORATION | ||
(Registrant) | ||
November 8, 2006 | /s/ Michael Wellesley-Wesley | |
(Date) | Michael Wellesley-Wesley | |
President and | ||
Chief Executive Officer | ||
November 8, 2006 | /s/ Jerry Kieliszak | |
(Date) | Jerry Kieliszak | |
Chief Financial Officer and | ||
Senior Vice President |
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