Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 4, 2006
OR
¨ | 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: 0-12906
RICHARDSON ELECTRONICS, LTD.
(Exact name of registrant as specified in its charter)
Delaware | 36-2096643 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
40W267 Keslinger Road, P.O. Box 393 LaFox, Illinois 60147-0393 | ||
(Address of principal executive offices) |
Registrant’s telephone number, including area code: (630) 208-2200
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. x Yes ¨ 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 x | Non-Accelerated Filer ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
As of August 28, 2006, there were outstanding 14,403,442 shares of Common Stock, $.05 par value, inclusive of 1,260,935 shares held in treasury, and 3,092,985 shares of Class B Common Stock, $.05 par value, which are convertible into Common Stock of the registrant on a share for share basis.
Table of Contents
Page | ||||
Part I. | Financial Information | |||
Item 1. | Financial Statements | 2 | ||
Condensed Consolidated Balance Sheets as of March 4, 2006 and May 28, 2005 | 2 | |||
3 | ||||
4 | ||||
5 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 19 | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 30 | ||
Item 4. | Controls and Procedures | 31 | ||
Part II. | Other Information | |||
Item 1 | Legal Proceedings | 33 | ||
Item 3. | Defaults Upon Senior Securities | 33 | ||
Item 6. | Exhibits | 33 | ||
Signatures | 34 | |||
Exhibit Index | 35 |
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Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)
Unaudited | ||||||||
March 4, 2006 | May 28, 2005 (restated) | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 18,712 | $ | 24,301 | ||||
Receivables, less allowance of $2,284 and $1,934 | 109,305 | 106,152 | ||||||
Inventories | 113,060 | 101,555 | ||||||
Prepaid expenses | 3,720 | 3,380 | ||||||
Deferred income taxes | 5,641 | 4,911 | ||||||
Total current assets | 250,438 | 240,299 | ||||||
Other assets: | ||||||||
Property, plant and equipment, net | 31,800 | 31,712 | ||||||
Goodwill | 12,649 | 6,149 | ||||||
Other intangible assets, net | 2,475 | 1,045 | ||||||
Non-current deferred income taxes | 353 | — | ||||||
Assets held for sale | 160 | — | ||||||
Other assets | 4,887 | 4,735 | ||||||
Total other assets | 52,324 | 43,641 | ||||||
Total assets | $ | 302,762 | $ | 283,940 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 47,267 | $ | 40,392 | ||||
Accrued liabilities | 26,856 | 23,762 | ||||||
Current portion of long-term debt | 15,165 | 22,305 | ||||||
Total current liabilities | 89,288 | 86,459 | ||||||
Non-current liabilities: | ||||||||
Long-term debt, less current portion | 112,009 | 98,028 | ||||||
Non-current deferred income taxes | — | 656 | ||||||
Non-current liabilities | 1,111 | 1,401 | ||||||
Total non-current liabilities | 113,120 | 100,085 | ||||||
Total liabilities | 202,408 | 186,544 | ||||||
Stockholders’ equity: | ||||||||
Common stock, $.05 par value; issued 15,661 shares at March 4, 2006 and 15,597 shares at May 28, 2005 | 783 | 780 | ||||||
Class B common stock, convertible, $.05 par value; issued 3,093 shares at March 4, 2006 and 3,120 shares at May 28, 2005 | 155 | 156 | ||||||
Preferred stock, $1.00 par value, no shares issued | — | — | ||||||
Additional paid-in capital | 119,809 | 121,591 | ||||||
Common stock in treasury, at cost; 1,329 shares at March 4, 2006 and 1,332 shares at May 28, 2005 | (7,876 | ) | (7,894 | ) | ||||
Accumulated deficit | (15,439 | ) | (16,406 | ) | ||||
Accumulated other comprehensive income (loss) | 2,922 | (831 | ) | |||||
Total stockholders’ equity | 100,354 | 97,396 | ||||||
Total liabilities and stockholders’ equity | $ | 302,762 | $ | 283,940 | ||||
See notes to condensed consolidated financial statements.
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Condensed Consolidated Statements of Operations
and Comprehensive Income
(Unaudited) (in thousands, except per share amounts)
Three Months Ended | Nine Months Ended | |||||||||||||||
March 4, 2006 | February 26, 2005 (restated) | March 4, 2006 | February 26, 2005 (restated) | |||||||||||||
Statements of Operations | ||||||||||||||||
Net sales | $ | 152,128 | $ | 141,700 | $ | 466,110 | $ | 431,421 | ||||||||
Cost of sales | 115,039 | 108,034 | 350,983 | 328,038 | ||||||||||||
Gross margin | 37,089 | 33,666 | 115,127 | 103,383 | ||||||||||||
Selling, general and administrative expenses | 35,502 | 34,087 | 100,766 | 95,689 | ||||||||||||
(Gain) loss on disposal of assets | 75 | 1 | (87 | ) | (26 | ) | ||||||||||
Operating income (loss) | 1,512 | (422 | ) | 14,448 | 7,720 | |||||||||||
Other (income) expense: | ||||||||||||||||
Interest expense | 2,479 | 2,234 | 7,076 | 6,675 | ||||||||||||
Investment income | (117 | ) | (196 | ) | (248 | ) | (286 | ) | ||||||||
Foreign exchange (gain) loss | (1,611 | ) | (226 | ) | 2,071 | (2,624 | ) | |||||||||
Other, net | 54 | (30 | ) | 229 | 8 | |||||||||||
Total other (income) expense | 805 | 1,782 | 9,128 | 3,773 | ||||||||||||
Income (loss) before income taxes | 707 | (2,204 | ) | 5,320 | 3,947 | |||||||||||
Income tax provision | 1,853 | 20,483 | 4,353 | 22,440 | ||||||||||||
Net income (loss) | $ | (1,146 | ) | $ | (22,687 | ) | $ | 967 | $ | (18,493 | ) | |||||
Net income (loss) per share - basic: | ||||||||||||||||
Common stock | $ | (0.07 | ) | $ | (1.34 | ) | $ | 0.06 | $ | (1.12 | ) | |||||
Common stock average shares outstanding | 14,328 | 14,179 | 14,310 | 13,698 | ||||||||||||
Class B common stock | $ | (0.06 | ) | $ | (1.20 | ) | $ | 0.05 | $ | (1.01 | ) | |||||
Class B common stock average shares outstanding | 3,093 | 3,120 | 3,093 | 3,120 | ||||||||||||
Net income (loss) per share - diluted: | ||||||||||||||||
Common stock | $ | (0.07 | ) | $ | (1.34 | ) | $ | 0.06 | $ | (1.12 | ) | |||||
Common stock average shares outstanding | 14,328 | 14,179 | 17,476 | 13,698 | ||||||||||||
Class B common stock | $ | (0.06 | ) | $ | (1.20 | ) | $ | 0.05 | $ | (1.01 | ) | |||||
Class B common stock average shares outstanding | 3,093 | 3,120 | 3,093 | 3,120 | ||||||||||||
Dividends per common share | $ | 0.040 | $ | 0.040 | $ | 0.120 | $ | 0.120 | ||||||||
Dividends per Class B common share | $ | 0.036 | $ | 0.036 | $ | 0.108 | $ | 0.108 | ||||||||
Statements of Comprehensive Income (Loss) | ||||||||||||||||
Net income (loss) | $ | (1,146 | ) | $ | (22,687 | ) | $ | 967 | $ | (18,493 | ) | |||||
Foreign currency translation | 772 | (832 | ) | 2,151 | 968 | |||||||||||
Fair value adjustments on investments, net of income tax effect | 99 | 40 | 175 | 99 | ||||||||||||
Cash flow hedges, net of income tax effect | — | — | — | 41 | ||||||||||||
Comprehensive income (loss) | $ | (275 | ) | $ | (23,479 | ) | $ | 3,293 | $ | (17,385 | ) | |||||
See notes to condensed consolidated financial statements.
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Condensed Consolidated Statements of Cash Flows
(Unaudited) (in thousands)
Three Months Ended | Nine Months Ended | |||||||||||||||
March 4, 2006 | February 26, 2005 (restated) | March 4, 2006 | February 26, 2005 (restated) | |||||||||||||
Operating activities: | ||||||||||||||||
Net income (loss) | $ | (1,146 | ) | $ | (22,687 | ) | $ | 967 | $ | (18,493 | ) | |||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||||||||||
Depreciation and amortization | 1,583 | 1,356 | 4,648 | 3,980 | ||||||||||||
(Gain) loss on disposal of assets | 75 | 1 | (87 | ) | (26 | ) | ||||||||||
Deferred income taxes | (1,239 | ) | 20,155 | (1,723 | ) | 22,465 | ||||||||||
Receivables | 932 | 5,286 | (1,031 | ) | 1,263 | |||||||||||
Inventories | (762 | ) | (1,637 | ) | (7,265 | ) | (12,651 | ) | ||||||||
Accounts payable and accrued liabilities | (1,329 | ) | (2,950 | ) | 7,914 | (522 | ) | |||||||||
Other liabilities | 68 | 3,053 | (264 | ) | 782 | |||||||||||
Other | (407 | ) | (1,578 | ) | 1,463 | (4,569 | ) | |||||||||
Net cash provided by (used in) operating activities | (2,225 | ) | 999 | 4,622 | (7,771 | ) | ||||||||||
Investing activities: | ||||||||||||||||
Capital expenditures | (1,492 | ) | (1,754 | ) | (4,229 | ) | (6,449 | ) | ||||||||
Proceeds from sale of assets | — | — | 274 | 12 | ||||||||||||
Business acquisitions, net of cash acquired | — | (336 | ) | (6,833 | ) | (881 | ) | |||||||||
Proceeds from sales of available-for-sale securities | 554 | 1,474 | 1,290 | 2,608 | ||||||||||||
Purchases of available-for-sale securities | (554 | ) | (1,474 | ) | (1,290 | ) | (2,608 | ) | ||||||||
Net cash used in investing activities | (1,492 | ) | (2,090 | ) | (10,788 | ) | (7,318 | ) | ||||||||
Financing activities: | ||||||||||||||||
Proceeds from borrowings | 104,801 | 63,622 | 194,898 | 100,122 | ||||||||||||
Payments on debt | (96,691 | ) | (56,341 | ) | (190,874 | ) | (106,134 | ) | ||||||||
Proceeds from issuance of common stock | 1 | 460 | 284 | 28,374 | ||||||||||||
Cash dividends | (685 | ) | (680 | ) | (2,051 | ) | (2,038 | ) | ||||||||
Other | (327 | ) | (279 | ) | (1,665 | ) | (605 | ) | ||||||||
Net cash provided by financing activities | 7,099 | 6,782 | 592 | 19,719 | ||||||||||||
Effect of exchange rate changes on cash and cash equivalents | 554 | 253 | (15 | ) | 1,310 | |||||||||||
Increase (decrease) in cash and cash equivalents | 3,936 | 5,944 | (5,589 | ) | 5,940 | |||||||||||
Cash and cash equivalents at beginning of period | 14,776 | 16,568 | 24,301 | 16,572 | ||||||||||||
Cash and cash equivalents at end of period | $ | 18,712 | $ | 22,512 | $ | 18,712 | $ | 22,512 | ||||||||
See notes to condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(in thousands, except per share amounts and except where indicated)
Note A – Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Item 10 of Regulation S-K. Accordingly, they do not include all the information and notes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of interim periods have been made and such adjustments were of a normal and recurring nature. The results of operations and cash flows for the three-month and nine-month periods ended March 4, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ended June 3, 2006.
Richardson Electronics, Ltd’s. (the Company) fiscal quarter ends on the Saturday nearest the end of the quarter ending month. The first nine months of fiscal 2006 contains 40 weeks, and the first nine months of fiscal 2005 contains 39 weeks. The additional week occurred in the first quarter of fiscal 2006.
The financial information contained in this report should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended May 28, 2005. Certain amounts in financial statements for prior periods’and related notes have been reclassified to conform with the fiscal 2006 presentation. Customer cash discounts were reclassified from selling, general and administrative expenses to net sales. The reclassifications had no impact on net income or stockholders’ equity for any reportable period presented.
Note B – Restatement
On April 4, 2006, the Company concluded that certain previously issued condensed consolidated financial statements, including those for its three-month and nine-month periods ended February 26, 2005, should not be relied upon as a result of errors discovered by the Company in the accounts of an Italian subsidiary, RES S.r.l. (Ingenium). During the third quarter of fiscal 2005, the Company recorded a valuation allowance to offset certain domestic deferred tax assets and domestic net operating loss carryforwards. At that time, the Company did not record a valuation allowance for a deferred tax asset related to goodwill. The Company has subsequently determined that a valuation allowance should have been recorded during the third quarter of fiscal 2005 for the deferred tax asset related to goodwill. The unaudited condensed consolidated financial statements for the three-month and nine-month periods ended February 26, 2005 have been amended and restated to correct these errors and certain other errors. The following table summarizes the effects of the restatement adjustments as described above on net loss:
Three Months ended | Nine Months ended | |||||||
February 26, | February 26, | |||||||
2005 | 2005 | |||||||
Net loss, as previously reported | $ | (18,665 | ) | $ | (13,814 | ) | ||
Decreased income: | ||||||||
Ingenium adjustments | (1,000 | ) | (1,576 | ) | ||||
Valuation allowance-goodwill adjustment | (2,970 | ) | (2,970 | ) | ||||
Other adjustments | (52 | ) | (133 | ) | ||||
Net loss, as restated | $ | (22,687 | ) | $ | (18,493 | ) | ||
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The following tables summarize the significant effects of the restatement:
Balance Sheet
May 28, 2005 | ||||||||
As Reported | As Restated | |||||||
Cash | $ | 24,530 | $ | 24,301 | ||||
Receivables | 106,928 | 106,152 | ||||||
Inventories | 102,272 | 101,555 | ||||||
Prepaid expenses | 3,293 | 3,380 | ||||||
Deferred income taxes | 6,644 | 4,911 | ||||||
Total current assets | 243,667 | 240,299 | ||||||
Property, plant and equipment, net | 31,821 | 31,712 | ||||||
Other intangible assets, net | 1,018 | 1,045 | ||||||
Non-current deferred income taxes | 428 | — | ||||||
Total assets | 287,818 | 283,940 | ||||||
Accounts payable | 39,305 | 40,392 | ||||||
Accrued liabilities | 22,731 | 23,762 | ||||||
Total current liabilities | 84,341 | 86,459 | ||||||
Non-current deferred income taxes | — | 656 | ||||||
Total liabilities | 183,770 | 186,544 | ||||||
Accumulated deficit | (9,942 | ) | (16,406 | ) | ||||
Accumulated other comprehensive income (loss) | (643 | ) | (831 | ) | ||||
Total stockholders’ equity | 104,048 | 97,396 | ||||||
Total liabilities and stockholders’ equity | 287,818 | 283,940 |
Statements of Income (Loss)
For the three months ended February 26, 2005 | For the nine months ended February 26, 2005 | |||||||||||||||
As Reported | As Restated | As Reported | As Restated | |||||||||||||
Cost of sales | $ | 108,033 | $ | 108,034 | $ | 327,271 | $ | 328,038 | ||||||||
Gross margin | 33,667 | 33,666 | 104,150 | 103,383 | ||||||||||||
Selling, general & administrative expenses | 34,009 | 34,087 | 95,273 | 95,689 | ||||||||||||
Operating income (loss) | (342 | ) | (422 | ) | 8,877 | 7,720 | ||||||||||
Income before income taxes | (2,125 | ) | (2,204 | ) | 5,129 | 3,947 | ||||||||||
Income tax provision | 16,540 | 20,483 | 18,943 | 22,440 | ||||||||||||
Net loss | (18,665 | ) | (22,687 | ) | (13,814 | ) | (18,493 | ) | ||||||||
Net loss per share - basic: | ||||||||||||||||
Common stock | $ | (1.10 | ) | $ | (1.34 | ) | $ | (0.84 | ) | $ | (1.12 | ) | ||||
Class B common stock | $ | (0.99 | ) | $ | (1.20 | ) | $ | (0.76 | ) | $ | (1.01 | ) | ||||
Net loss per share - diluted: | ||||||||||||||||
Common stock | $ | (1.10 | ) | $ | (1.34 | ) | $ | (0.84 | ) | $ | (1.12 | ) | ||||
Class B common stock | $ | (0.99 | ) | $ | (1.20 | ) | $ | (0.76 | ) | $ | (1.01 | ) | ||||
Statements of Cash Flows
For the three months ended February 26, 2005 | For the nine months ended February 26, 2005 | |||||||||||||||
As Reported | As Restated | As Reported | As Restated | |||||||||||||
Net cash provided by (used in) operating activities | $ | 204 | $ | 999 | $ | (7,861 | ) | $ | (7,771 | ) | ||||||
Net cash used in investing activities | (1,831 | ) | (2,090 | ) | (7,374 | ) | (7,318 | ) |
Note C – Investment in Marketable Equity Securities
The Company’s investments are primarily equity securities, all of which are classified as available-for-sale and are carried at their fair value based on the quoted market prices. Proceeds from the sale of the securities were $554 and $1,290 during the third quarter and first nine months of fiscal 2006, respectively, and $1,474 and $2,608 during the same periods of fiscal 2005, all of which were subsequently reinvested. Gross realized gains on those sales were $84 and $185 for the third quarter and first nine months of fiscal 2006, respectively, and $228 and $338 for the same periods of fiscal 2005. Gross realized losses on those sales were $46 and $89 for the third quarter and first nine months of fiscal 2006, respectively, and $42 and $90 for the same periods of fiscal 2005. Net unrealized holding gains of $160 and $283 for the third quarter and first nine months of fiscal 2006, respectively, and $64 and $160 for the same periods of fiscal 2005 have been included in accumulated comprehensive income (loss) for fiscal 2006 and 2005.
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The following table is the disclosure under Statement of Financial Accounting Standards (SFAS) No. 115,Accounting for Certain Investments in Debt and Equity Securities, for the investment in marketable equity securities with fair values less than cost basis:
Marketable Security Holding Length | ||||||||||||||||||
Less Than 12 Months | More Than 12 Months | Total | ||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||
Description of Securities | Value | Losses | Value | Losses | Value | Losses | ||||||||||||
March 4, 2006 | ||||||||||||||||||
Common Stock | $ | 147 | $ | 18 | $ | 339 | $ | 28 | $ | 486 | $ | 46 | ||||||
May 28, 2005 | ||||||||||||||||||
Common Stock | $ | 2,044 | $ | 33 | $ | — | $ | — | $ | 2,044 | $ | 33 |
Note D – Assets Held for Sale
On August 4, 2005, the Company entered into a contract to sell approximately 1.5 acres of real estate and a building located in Geneva, Illinois for $3,000. The contract is subject to a number of conditions, including inspections, environmental testing, and other customary conditions. The sale of the real estate and building is expected to close during the first or second quarter of fiscal 2007, however, the Company cannot give any assurance as to the actual timing or successful completion of the transaction.
Note E – Goodwill and Other Intangible Assets
The Company performed its annual impairment test during the fourth quarter of fiscal 2005. The same methodology was employed in completing the annual impairment test as in applying transitional accounting provisions of SFAS No. 142,Goodwill and Other Intangible Assets. The Company did not find any indication that additional impairment existed, and therefore, no additional impairment loss was recorded as a result of completing the annual impairment test.
The table below provides changes in carrying value of goodwill by reportable segment, which includes RF, Wireless & Power Division (RFPD), Electron Device Group (EDG), Security Systems Division (SSD), and Display Systems Group (DSG):
Goodwill | |||||||||||||||||
Reportable Segments | |||||||||||||||||
RFPD | EDG | SSD | DSG | Total | |||||||||||||
Balance at May 28, 2005 | $ | 245 | $ | 881 | $ | 1,577 | $ | 3,446 | $ | 6,149 | |||||||
Additions | — | — | — | 6,534 | 6,534 | ||||||||||||
Foreign currency translation | 7 | 6 | 189 | (236 | ) | (34 | ) | ||||||||||
Balance at March 4, 2006 | $ | 252 | $ | 887 | $ | 1,766 | $ | 9,744 | $ | 12,649 | |||||||
The addition to goodwill in the first nine months of fiscal 2006 represents the acquisition of A.C.T. Kern GmbH & Co. KG (“Kern”) located in Germany, effective June 1, 2005. The cash outlay for Kern was $6,583, net of cash acquired. Kern is one of the leading display technology companies in Europe with world wide customers in manufacturing, OEM, medicine, multimedia, IT trading, system houses, and other industries.
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The following table provides changes in carrying value of other intangible assets not subject to amortization:
Other Intangible Assets Not Subject to Amortization | |||||||||||||||
Reportable Segments | |||||||||||||||
RFPD | EDG | SSD | DSG | Total | |||||||||||
Balance at May 28, 2005 | $ | — | $ | 9 | $ | 278 | $ | — | $ | 287 | |||||
Foreign currency translation | — | — | 35 | — | 35 | ||||||||||
Balance at March 4, 2006 | $ | — | $ | 9 | $ | 313 | $ | — | $ | 322 | |||||
Intangible assets subject to amortization, as well as amortization expense are as follows:
Intangible Assets Subject to Amortization | ||||||||||||
March 4, 2006 | May 28, 2005 | |||||||||||
Gross Amounts | Accumulated Amortization | Gross Amounts (restated) | Accumulated Amortization (restated) | |||||||||
Deferred financing costs | $ | 4,593 | $ | 2,443 | $ | 2,968 | $ | 2,241 | ||||
Patents and trademarks | 478 | 475 | 554 | 523 | ||||||||
Total | $ | 5,071 | $ | 2,918 | $ | 3,522 | $ | 2,764 | ||||
Deferred financing costs increased during the first nine months of fiscal 2006 primarily due to the issuance of the Company’s 7 3/4% convertible senior subordinated notes (7 3/4% notes) and the 8% convertible senior subordinated notes (8% notes).
Amortization expense for the three-month and nine-month periods ended March 4, 2006 and February 26, 2005 is as follows:
Amortization Expense for | Amortization Expense for | |||||||||||
Third Quarter | Nine Months | |||||||||||
FY 2006 | FY 2005 | FY 2006 | FY 2005 | |||||||||
Deferred financing costs | $ | 129 | $ | 100 | $ | 245 | $ | 271 | ||||
Patents and trademarks | — | 3 | 1 | 10 | ||||||||
Total | $ | 129 | $ | 103 | $ | 246 | $ | 281 | ||||
The amortization expense associated with the intangible assets subject to amortization is expected to be $354, $446, $446, $445, $357, $297, and $50 in fiscal 2006, 2007, 2008, 2009, 2010, 2011, and 2012, respectively. The weighted average number of years of amortization expense remaining is 5.31.
Note F – Restructuring and Severance Charges
As a result of the Company’s fiscal 2005 restructuring initiative, a restructuring charge, including severance and lease termination costs of $2,152, was recorded in selling, general and administrative expenses (SG&A) in the third quarter of fiscal 2005. During the fourth quarter of fiscal 2005, the employee severance and related costs were adjusted, resulting in a $183 decrease in SG&A due to the difference between estimated severance costs and the actual payouts. Severance costs of $1,108 were paid in fiscal 2005. During the first nine months of fiscal 2006, severance and lease termination costs of $719 were paid. During the first nine months of fiscal 2006, the employee severance and related costs were adjusted resulting in a $122 decrease in SG&A due to the difference between estimated severance costs and the actual payouts. The remaining balance payable during fiscal 2006 has been included in accrued
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liabilities. Terminations affected over 60 employees across various business functions, operating units, and geographic regions. As of March 4, 2006, the following table depicts the amounts associated with the activity related to restructuring by reportable segment:
Restructuring Liability May 28, 2005 | For the nine months ended | Restructuring Liability March 4, 2006 | |||||||||||||||
March 4, 2006 | |||||||||||||||||
Reserve Recorded | Payment | Adjustment to Reserve | |||||||||||||||
Employee severance and related costs: | |||||||||||||||||
RFPD | $ | 318 | $ | — | $ | (289 | ) | $ | (29 | ) | $ | — | |||||
EDG | 183 | — | (73 | ) | (110 | ) | — | ||||||||||
SSD | 25 | — | (22 | ) | (3 | ) | — | ||||||||||
DSG | 230 | — | (227 | ) | (3 | ) | — | ||||||||||
Corporate | 70 | — | (73 | ) | 23 | 20 | |||||||||||
Total | 826 | — | (684 | ) | (122 | ) | 20 | ||||||||||
Lease termination costs: | |||||||||||||||||
SSD | 35 | — | (35 | ) | — | — | |||||||||||
Total | $ | 861 | $ | — | $ | (719 | ) | $ | (122 | ) | $ | 20 | |||||
During the fourth quarter of fiscal 2006, the Company recorded employee severance costs of $2,724 for certain employees whose termination costs became probable and estimable.
Note G – Warranties
The Company offers warranties for specific products it manufactures. The Company also provides extended warranties for some products it sells that lengthen the period of coverage specified in the manufacturer’s original warranty. Terms generally range from one to three years.
The Company estimates the cost to perform under its warranty obligation and recognizes this estimated cost at the time of the related product sale. The Company reports this expense as an element of cost of sales in its Condensed Consolidated Statements of Operations. Each quarter, the Company assesses actual warranty costs incurred, on a product-by-product basis, as compared to its estimated obligation. The estimates with respect to new products are based generally on knowledge of the products, are extrapolated to reflect the extended warranty period, and are refined each quarter as better information with respect to warranty experience becomes known.
Warranty reserves are established for costs that are expected to be incurred after the sale and delivery of products under warranty. The warranty reserves are determined based on known product failures, historical experience, and other currently available evidence.
Changes in the warranty reserve for the first nine months ended March 4, 2006 were as follows:
Warranty | ||||
Reserve | ||||
Balance at May 28, 2005 | $ | 1,439 | ||
Accruals for products sold | 707 | |||
Utilization | (402 | ) | ||
Change in estimate | (946 | ) | ||
Balance at March 4, 2006 | $ | 798 | ||
During the second quarter of fiscal 2003, DSG provided a three-year warranty on some of its products. As the extended warranty on the first products sold under the warranty program expired during the second
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quarter of fiscal 2006, along with additional warranty experience available during the first six months of fiscal 2006, the Company revised its estimate of the warranty reserve to reflect the actual warranty experience to date. As a result, a change in estimate of $946 was recorded during the second quarter of fiscal 2006.
Note H – Debt
Long-term debt consists of the following:
March 4, | May 28, | |||||||
2006 | 2005 | |||||||
8 1/4% convertible debentures, due June 2006 | $ | — | $ | 17,538 | ||||
7 1/4% convertible debentures, due December 2006 | — | 4,753 | ||||||
7 3/4% convertible notes, due December 2011 | 44,683 | 44,683 | ||||||
8% convertible notes, due June 2011 | 25,000 | — | ||||||
Floating-rate multi-currency revolving credit agreement, due October 2009 (6.20% at March 4, 2006) | 56,303 | 53,314 | ||||||
Other | 1,188 | 45 | ||||||
Total debt | 127,174 | 120,333 | ||||||
Less: current portion | (15,165 | ) | (22,305 | ) | ||||
Long-term debt | $ | 112,009 | $ | 98,028 | ||||
At March 4, 2006, the Company maintained $112,009 in long-term debt, primarily in the form of the issuance of two convertible notes and a multi-currency credit agreement (“credit agreement”). The Company used the net proceeds from the sale of the 8% notes to repay amounts outstanding under its credit agreement. The Company redeemed all of the outstanding 8 1/4% convertible senior subordinated debentures (8 1/4% debentures) on December 23, 2005 in the amount of $17,538 and redeemed all of the outstanding 7 1/4% convertible subordinated debentures (7 1/4% debentures) on December 30, 2005 in the amount of $4,753 by borrowing amounts under the credit agreement to effect these redemptions. The Company maintains $14,000 of the 8% notes in current portion of long-term debt at March 4, 2006. This current classification is due to the Company entering into two separate agreements in August 2006 with certain holders of its 8% notes to purchase $14,000 of the 8% notes. As the 8% notes are subordinate to the Company’s existing credit agreement, the Company received a waiver from its lending group to permit the purchase. The purchases will be financed through additional borrowings under the Company’s credit agreement. In the first quarter of fiscal 2007, the Company will record early extinguishment expenses of approximately $2,700.
On November 21, 2005, the Company sold $25,000 in aggregate principal amount of 8% notes pursuant to an indenture dated November 21, 2005. The 8% notes bear interest at a rate of 8% per annum. Interest is due on June 15 and December 15 of each year. The 8% notes mature on June 15, 2011. The 8% notes are convertible at the option of the holder, at any time on or prior to maturity, into shares of the Company’s common stock at a price equal to $10.31 per share, subject to adjustment in certain circumstances. In addition, the Company may elect to automatically convert the 8% notes into shares of common stock if the trading price of the common stock exceeds 150% of the conversion price of the 8% notes for at least 20 trading days during any 30 trading day period subject to a payment of three years of interest if the Company elects to convert the 8% notes prior to December 20, 2008.
The indenture provides that on or after December 20, 2008, the Company has the option of redeeming the 8% notes, in whole or in part, for cash, at a redemption price equal to 100% of the principal amount of the 8% notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. Holders may require the Company to repurchase all or a portion of their 8% notes for cash upon a change-of-control event, as described in the indenture, at a repurchase price equal to 100% of the principal amount of the 8% notes to be repurchased, plus accrued and unpaid interest, if any, to, but excluding the repurchase date. The 8% notes are unsecured and subordinate to the Company’s existing and future senior debt. The 8% notes rank on parity with the Company’s existing 7 3/4% notes.
In October 2004, the Company renewed its credit agreement with the current lending group in the amount of approximately $109,000 (the size of the credit line varies based on fluctuations in foreign currency exchange rates). The agreement expires in October 2009, and the outstanding balance at that time
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will become due. At March 4, 2006, $56,303 was outstanding under the agreement. The credit agreement is principally secured by the Company’s trade receivables and inventory. The credit agreement bears interest at applicable LIBOR rates plus a margin, varying with certain financial performance criteria. At March 4, 2006, the applicable margin was 1.25%. Outstanding letters of credit were $1,710 at March 4, 2006, leaving an unused line of $51,695 under the total credit agreement; although none of this amount was available for the Company to borrow because the Company was not in compliance with credit agreement covenants with respect to the leverage ratio and tangible net worth covenants for the third quarter ending March 4, 2006. The commitment fee related to the credit agreement is 0.25% per annum payable quarterly on the average daily unused portion of the aggregate commitment. The Company’s credit agreement consists of the following facilities as of March 4, 2006:
Capacity | Amount Outstanding | Interest Rate | |||||||
US Facility | $ | 70,000 | $ | 43,200 | 6.47 | % | |||
Canada Facility | 15,026 | 6,685 | 5.25 | % | |||||
Sweden Facility | 8,179 | — | — | ||||||
UK Facility | 7,893 | 4,210 | 6.87 | % | |||||
Euro Facility | 6,020 | 482 | 4.64 | % | |||||
Japan Facility | 2,590 | 1,726 | 1.85 | % | |||||
Total | $ | 109,708 | $ | 56,303 | 6.20 | % | |||
Note: Due to maximum permitted leverage ratios, the amount of the unused line cannot be calculated on a facility-by-facility basis.
On August 24, 2005, the Company executed an amendment to the credit agreement. The amendment changed the maximum permitted leverage ratios and the minimum required fixed charge coverage ratios for each of the first three quarters of fiscal 2006 to provide the Company additional flexibility for these periods. In addition, the amendment also provided that the Company will maintain excess availability on the borrowing base of not less than $23,000 until the 8 1/4% and 7 1/4% debentures were redeemed, at which time the Company will maintain excess availability of the borrowing base of not less than $10,000. The applicable margin pricing was increased by 25 basis points. In addition, the amendment extended the Company’s requirement to refinance the remaining $22,291 aggregate principal amount of the Company’s 7 1/4% debentures and the 8 1/4% debentures from February 28, 2006 to June 10, 2006.
At September 3, 2005, the Company was not in compliance with credit agreement covenants with respect to the tangible net worth covenant due solely to the additional goodwill recorded as a result of the Kern acquisition. On October 12, 2005, the Company received a waiver from its lending group for the default and executed an amendment to the credit agreement. The amendment changed the minimum tangible net worth requirement to adjust for the goodwill associated with the Kern acquisition.
At March 4, 2006, the Company was not in compliance with credit agreement covenants with respect to the leverage ratio, fixed charge coverage ratio and tangible net worth covenants. On August 4, 2006, the Company received a waiver from its lending group for the default and executed an amendment to the credit agreement. In addition, the amendment also (i) permitted the purchase of $14,000 of the 8% notes; (ii) adjusted the minimum required fixed charge coverage ratio for the first quarter of fiscal 2007; (iii) adjusted the minimum tangible net worth requirement; (iv) permitted certain sales transactions contemplated by the Company; (v) eliminated the Company’s Sweden Facility; (vi) reduced the Company’s Canada Facility by approximately $5,400; (vii) changed the definition of “Adjusted EBITDA” for covenant purposes; and (viii) provided that the Company maintain excess availability on the borrowing base of not less than $20,000 until the Company filed its Form 10-Q for the quarter ended March 4, 2006, at which time the Company will maintain excess availability of the borrowing base of not less than $10,000.
Note I – Income Taxes
The effective income tax rates for the third quarter and first nine months of fiscal year 2006 were 262.1% and 81.8%, respectively. The difference between the effective tax rates as compared to the U.S. federal statutory rate of 34% primarily results from the Company’s geographical distribution of taxable income or losses and, in the three and nine months ended March 4, 2006, valuation allowances related to net operating losses. For the nine months ended March 4, 2006, the tax benefit primarily related to net operating losses was limited by the requirement for a valuation allowance of $3,646, which increased the effective income tax rate by 68.5%. During the second quarter of fiscal 2006, income tax reserves of approximately $1,000 for certain income tax exposures were reversed because the statute of limitations with respect to these income tax exposures expired.
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As of February 26, 2005, domestic net operating loss carryforwards (NOL) were approximately $22.0 million. These NOLs expire in 2024. Foreign net operating loss carryforwards were approximately $15.3 million. In the second quarter of fiscal 2005, the Company recorded a valuation allowance of approximately $0.6 million primarily relating to certain foreign subsidiaries recording deferred tax assets on net operating losses.
Net domestic deferred tax assets, including the domestic NOL, were approximately $15.5 million at February 26, 2005. Due to changes in the level of certainty regarding realization, a valuation allowance of approximately $16.2 million was established in the third quarter of fiscal 2005 to offset certain domestic deferred tax assets and domestic net operating loss carryforwards.
At the end of fiscal 2004, all of the cumulative positive earnings of the Company’s foreign subsidiaries, amounting to $35.1 million, were considered permanently reinvested pursuant to APB No. 23,Accounting for Income Taxes-Special Areas. As such, U.S. taxes were not provided on these amounts. In the third quarter of fiscal 2005, because of a strategic decision, the Company determined that approximately $12.4 million of one of its foreign subsidiaries’ earnings could no longer be considered permanently reinvested as those earnings may be distributed in future years. Based on management’s potential future plans regarding this subsidiary, it was determined that these earnings would no longer meet the specific requirements for permanent reinvestment under APB No. 23. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income tax and foreign withholding taxes. As such, during the third quarter of fiscal 2005, the Company established a deferred tax liability of approximately $4.8 million. The remaining cumulative positive earnings of the Company’s foreign subsidiaries were still considered permanently reinvested pursuant to APB No. 23 and amounted to $29.1 million. Due to various tax attributes that are continually changing, it is not possible to determine what, if any, tax liability might exist if such earnings were to be repatriated.
In May 2005, the Company was informed by one of its foreign subsidiaries that its records may not be adequate to support the taxable revenues and deductions included within tax returns previously filed for the tax years 2003 and 2004. At this time, the Company has not received notification from any tax authority regarding this matter. The Company has increased its income tax reserve for this potential exposure.
During fiscal 2005, the Canadian taxing authority proposed an income tax assessment for fiscal 1998 through fiscal 2002. The Company appealed the income tax assessment; however, the Company paid the entire tax liability in fiscal 2005 to the Canadian taxing authority to avoid additional interest and penalties if the Company’s appeal was denied. The payment was recorded as an increase to income tax provision in fiscal 2005. In May 2006, the appeal was settled in the Company’s favor. The Company will receive a refund of approximately $1,000, which will be recorded as a reduction to income tax provision in the fourth quarter of fiscal 2006.
Note J – Calculation of Earnings Per Share
The Company has authorized 30,000 shares of common stock, 10,000 shares of Class B common stock, and 5,000 shares of preferred stock. The Class B common stock has ten votes per share. The Class B common stock has transferability restrictions; however, it may be converted into common stock on a share-for-share basis at any time. With respect to dividends and distributions, shares of common stock and Class B common stock rank equally and have the same rights, except that Class B common stock cash dividends are limited to 90% of the amount of common stock cash dividends.
The Company has determined that, under Emerging Issues Task Force (EITF) Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share,” a two-class method of computing earnings per share is required. According to the EITF Issue No. 03-6, the Company’s Class B common stock is considered a participating security requiring the use of the two-class method for the computation of basic and diluted earnings per share. The two-class computation method for
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each period reflects the cash dividends paid per share for each class of stock, plus the amount of allocated undistributed earnings per share computed using the participation percentage which reflects the dividend rights of each class of stock. Basic and diluted earnings per share reflect the application of EITF Issue No. 03-6 and was computed using the two-class method. Prior periods have been restated to reflect this change. The shares of Class B common stock are considered to be participating convertible securities since the shares of Class B common stock are convertible on a share-for-share basis into shares of common stock and may participate in dividends with common stock according to a predetermined formula (90% of the amount of common stock cash dividends).
Diluted earnings per share is calculated by dividing net income, adjusted for interest savings, net of tax, on assumed conversion of convertible debentures and notes, by the actual shares outstanding and share equivalents that would arise from the exercise of stock options, certain restricted stock awards, and the assumed conversion of convertible debentures and notes when dilutive. The Company’s 7 3/4% notes and 8% notes are excluded from the calculation for the third quarter and first nine months of fiscal 2006, and the Company’s 8 1/4% debentures and 7 1/4% debentures are excluded from the calculation for the first nine months of fiscal 2006 and the third quarter and first nine months of fiscal 2005, as assumed conversion and the effect of the interest savings would be anti-dilutive. The per share amounts presented in the Condensed Consolidated Statements of Operations for the third quarter and first nine months of fiscal 2006 and 2005 are based on the following amounts:
Third Quarter | Nine Months | |||||||||||||||
FY 2006 | FY 2005 (restated) | FY 2006 | FY 2005 (restated) | |||||||||||||
Numerator for basic and diluted EPS: | ||||||||||||||||
Net income (loss) | $ | (1,146 | ) | $ | (22,687 | ) | $ | 967 | $ | (18,493 | ) | |||||
Less dividends: | ||||||||||||||||
Common stock | 573 | 568 | 1,716 | 1,698 | ||||||||||||
Class B common stock | 112 | 112 | 335 | 340 | ||||||||||||
Undistributed losses | $ | (1,831 | ) | $ | (23,367 | ) | $ | (1,084 | ) | $ | (20,531 | ) | ||||
Common stock undistributed losses | $ | (1,533 | ) | $ | (19,504 | ) | $ | (907 | ) | $ | (17,038 | ) | ||||
Class B common stock undistributed losses - basic | (298 | ) | (3,863 | ) | (177 | ) | (3,493 | ) | ||||||||
Total undistributed losses – common stock and Class B common stock – basic | $ | (1,831 | ) | $ | (23,367 | ) | $ | (1,084 | ) | $ | (20,531 | ) | ||||
Common stock undistributed losses | $ | (1,533 | ) | $ | (19,504 | ) | $ | (908 | ) | $ | (17,038 | ) | ||||
Class B common stock undistributed losses - diluted | (298 | ) | (3,863 | ) | (176 | ) | (3,493 | ) | ||||||||
Total undistributed losses – Class B common stock – diluted | $ | (1,831 | ) | $ | (23,367 | ) | $ | (1,084 | ) | $ | (20,531 | ) | ||||
Denominator for basic and diluted EPS: | ||||||||||||||||
Denominator for basic EPS: | ||||||||||||||||
Common stock weighted average shares | 14,328 | 14,179 | 14,310 | 13,698 | ||||||||||||
Class B common stock weighted average shares, and shares under if-converted method for diluted earnings per share | 3,093 | 3,120 | 3,093 | 3,120 | ||||||||||||
Effect of dilutive securities: | ||||||||||||||||
Unvested restricted stock awards | — | — | 4 | — | ||||||||||||
Dilutive stock options | — | — | 69 | — | ||||||||||||
Denominator for diluted EPS adjusted weighted average shares and assumed conversions | 17,421 | 17,299 | 17,476 | 16,818 | ||||||||||||
Net Income (Loss) Share: | ||||||||||||||||
Common stock – basic | $ | (0.07 | ) | $ | (1.34 | ) | $ | 0.06 | $ | (1.12 | ) | |||||
Class B common stock – basic | $ | (0.06 | ) | $ | (1.20 | ) | $ | 0.05 | $ | (1.01 | ) | |||||
Common stock – diluted | $ | (0.07 | ) | $ | (1.34 | ) | $ | 0.06 | $ | (1.12 | ) | |||||
Class B common stock – diluted | $ | (0.06 | ) | $ | (1.20 | ) | $ | 0.05 | $ | (1.01 | ) | |||||
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As of the third quarter and first nine months of fiscal 2006, 2,009 common stock options were anti-dilutive and were not included in the dilutive earnings per common share calculation. As of the third quarter and first nine months of fiscal 2005, 1,347 common stock options and 1,687 common stock options, respectively, were anti-dilutive and were not included in the dilutive earnings per common share calculation.
Note K – Stock-Based Compensation
The Company accounts for its stock option plans and stock purchase plan in accordance with Accounting Principles Board Opinion (APB) No. 25,Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. However, the exercise price of all grants under the Company’s option plans has been equal to the fair market value on the date of grant. SFAS No. 123,Accounting for Stock-Based Compensation, requires estimation of the fair value of options granted to employees. Had the Company’s option plans and stock purchase plan been treated as compensatory under the provisions of SFAS No. 123, the Company’s net income and net income per share for the third quarter and first nine months of fiscal 2006 would have been affected as follows:
Third Quarter | Nine Months | |||||||||||||||
FY 2006 | FY 2005 (restated) | FY 2006 | FY 2005 (restated) | |||||||||||||
Net income (loss), as reported | $ | (1,146 | ) | $ | (22,687 | ) | $ | 967 | $ | (18,493 | ) | |||||
Add: Stock-based compensation expense included in reported net income, net of income tax | 2 | 55 | 5 | 157 | ||||||||||||
Deduct: Stock-based compensation expense determined under fair value-based method for all awards, net of income tax | (185 | ) | (220 | ) | (552 | ) | (651 | ) | ||||||||
Pro-forma net income (loss) | $ | (1,329 | ) | $ | (22,852 | ) | $ | 420 | $ | (18,987 | ) | |||||
Net income (loss) per share, as reported: | ||||||||||||||||
Common stock – basic | $ | (0.07 | ) | $ | (1.34 | ) | $ | 0.06 | $ | (1.12 | ) | |||||
Class B common stock – basic | $ | (0.06 | ) | $ | (1.20 | ) | $ | 0.05 | $ | (1.01 | ) | |||||
Common stock – diluted | $ | (0.07 | ) | $ | (1.34 | ) | $ | 0.06 | $ | (1.12 | ) | |||||
Class B common stock – diluted | $ | (0.06 | ) | $ | (1.20 | ) | $ | 0.05 | $ | (1.01 | ) | |||||
Net income (loss) per share, pro forma: | ||||||||||||||||
Common stock – basic | $ | (0.08 | ) | $ | (1.35 | ) | $ | 0.02 | $ | (1.15 | ) | |||||
Class B common stock – basic | $ | (0.07 | ) | $ | (1.21 | ) | $ | 0.02 | $ | (1.04 | ) | |||||
Common stock – diluted | $ | (0.08 | ) | $ | (1.35 | ) | $ | 0.02 | $ | (1.15 | ) | |||||
Class B common stock – diluted | $ | (0.07 | ) | $ | (1.21 | ) | $ | 0.02 | $ | (1.04 | ) | |||||
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Note L – Segment Information
During the second quarter of fiscal 2006, the Company implemented a reorganization plan encompassing the Company’s RF & Wireless Communications Group (RFWC) and Industrial Power Group (IPG) business units. Effective for the second quarter of fiscal 2006, IPG has been designated as Electron Device Group (EDG) and RFWC has been designated as RF, Wireless & Power Division (RFPD). The reorganization was implemented to increase efficiencies by integrating IPG’s power conversion sales and product management into RFWC, improving the geographic sales coverage and driving sales growth by leveraging RFWC’s larger sales resources. In addition, the Company believes that EDG will benefit from an increased focus on the high-margin tube business with a simplified global sales and product management structure to work more effectively with customers and vendors. The data presented has been reclassified to reflect the reorganization.
The following disclosures are made in accordance with the SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information. The Company’s strategic business units (SBUs) in fiscal 2006 are: RF, Wireless & Power Division (RFPD), Electron Device Group (EDG), Security Systems Division (SSD), and Display Systems Group (DSG).
RFPD serves the voice and data telecommunications market and the radio and television broadcast industry predominately for infrastructure applications, as well as the industrial power conversion market.
EDG serves a broad range of customers including the steel, automotive, textile, plastics, semiconductor manufacturing, and broadcast industries.
SSD provides security systems and related design services which includes such products as closed circuit television, fire, burglary, access control, sound, and communication products and accessories.
DSG provides system integration and custom display solutions for the public information, financial, point-of-sale, and medical imaging markets.
Each SBU is directed by a Vice President and General Manager who reports to the Chief Executive Officer (CEO). The CEO evaluates performance and allocates resources, in part, based on the direct operating contribution of each SBU. Direct operating contribution is defined as gross margin less product management and direct selling expenses.
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Accounts receivable, inventory, and goodwill are identified by SBU. Cash, net property, and other assets are not identifiable by SBU. Operating results for each SBU are summarized in the following table:
Gross | Direct Operating | |||||||||||
Sales | Margin | Contribution | Assets | |||||||||
Third Quarter Fiscal 2006 | ||||||||||||
RFPD | $ | 80,526 | $ | 19,049 | $ | 11,751 | $ | 109,966 | ||||
EDG | 21,907 | 7,099 | 4,458 | 41,772 | ||||||||
SSD | 25,316 | 6,016 | 1,050 | 38,307 | ||||||||
DSG | 23,537 | 6,426 | 2,548 | 37,644 | ||||||||
Total | $ | 151,286 | $ | 38,590 | $ | 19,807 | $ | 227,689 | ||||
Third Quarter Fiscal 2005 | ||||||||||||
RFPD (restated) | $ | 72,253 | $ | 15,379 | $ | 6,788 | $ | 106,919 | ||||
EDG | 22,672 | 7,044 | 3,901 | 42,338 | ||||||||
SSD | 25,607 | 6,260 | 1,566 | 37,357 | ||||||||
DSG | 19,498 | 4,097 | 1,321 | 24,614 | ||||||||
Total (restated) | $ | 140,030 | $ | 32,780 | $ | 13,576 | $ | 211,228 | ||||
Gross | Direct Operating | |||||||||||
Sales | Margin | Contribution | Assets | |||||||||
Nine Months Fiscal 2006 | ||||||||||||
RFPD | $ | 241,252 | $ | 55,890 | $ | 34,460 | $ | 109,966 | ||||
EDG | 70,352 | 22,543 | 14,448 | 41,772 | ||||||||
SSD | 80,488 | 20,185 | 5,710 | 38,307 | ||||||||
DSG | 69,881 | 18,559 | 7,973 | 37,644 | ||||||||
Total | $ | 461,973 | $ | 117,177 | $ | 62,591 | $ | 227,689 | ||||
Nine Months Fiscal 2005 | ||||||||||||
RFPD (restated) | $ | 220,024 | $ | 48,942 | $ | 25,766 | $ | 106,919 | ||||
EDG | 67,637 | 21,680 | 12,887 | 42,338 | ||||||||
SSD | 78,728 | 20,062 | 6,975 | 37,357 | ||||||||
DSG | 60,040 | 13,528 | 5,911 | 24,614 | ||||||||
Total (restated) | $ | 426,429 | $ | 104,212 | $ | 51,539 | $ | 211,228 | ||||
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A reconciliation of net sales, gross margin, direct operating contribution, and assets to the relevant consolidated amounts is as follows. Other assets not identified include miscellaneous receivables, manufacturing inventories, and other assets.
Third Quarter | Nine Months | |||||||||||||||
FY 2006 | FY 2005 (restated) | FY 2006 | FY 2005 (restated) | |||||||||||||
Segment net sales | $ | 151,286 | $ | 140,030 | $ | 461,973 | $ | 426,429 | ||||||||
Corporate | 842 | 1,670 | 4,137 | 4,992 | ||||||||||||
Net sales | $ | 152,128 | $ | 141,700 | $ | 466,110 | $ | 431,421 | ||||||||
Segment gross margin | $ | 38,590 | $ | 32,780 | $ | 117,177 | $ | 104,212 | ||||||||
Manufacturing variances and other costs | (1,501 | ) | 886 | (2,050 | ) | (829 | ) | |||||||||
Gross margin | $ | 37,089 | $ | 33,666 | $ | 115,127 | $ | 103,383 | ||||||||
Segment contribution | $ | 19,807 | $ | 13,576 | $ | 62,591 | $ | 51,539 | ||||||||
Manufacturing variances and other costs | (1,501 | ) | 886 | (2,050 | ) | (829 | ) | |||||||||
Regional selling expenses | (4,219 | ) | (4,817 | ) | (14,253 | ) | (14,063 | ) | ||||||||
Administrative expenses | (12,500 | ) | (10,066 | ) | (31,927 | ) | (28,953 | ) | ||||||||
Gain (loss) on disposal of assets | (75 | ) | (1 | ) | 87 | 26 | ||||||||||
Operating income (loss) | $ | 1,512 | $ | (422 | ) | $ | 14,448 | $ | 7,720 | |||||||
March 4, | May 28, | |||||
2006 | 2005 (restated) | |||||
Segment assets | $ | 227,689 | $ | 202,223 | ||
Cash and cash equivalents | 18,712 | 24,301 | ||||
Other current assets | 17,008 | 20,211 | ||||
Net property | 31,800 | 31,712 | ||||
Other assets | 7,553 | 5,493 | ||||
Total assets | $ | 302,762 | $ | 283,940 | ||
Geographic net sales information is primarily grouped by customer destination into five areas: North America, Europe, Asia/Pacific, Latin America, and Corporate. Europe includes sales to the Middle East and Africa. Net sales to Mexico are included as part of Latin America. Corporate consists of freight and non-area specific sales.
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Net sales and gross margin by geographic region are presented in the table below:
Third Quarter | Nine Months | |||||||||||||||
FY 2006 | FY 2005 (restated) | FY 2006 | FY 2005 (restated) | |||||||||||||
Net Sales | ||||||||||||||||
North America | $ | 75,291 | $ | 73,443 | $ | 236,631 | $ | 227,548 | ||||||||
Europe | 34,138 | 31,118 | 101,869 | 94,284 | ||||||||||||
Asia/Pacific | 34,707 | 30,652 | 106,700 | 91,217 | ||||||||||||
Latin America | 5,780 | 5,544 | 17,760 | 15,392 | ||||||||||||
Corporate | 2,212 | 943 | 3,150 | 2,980 | ||||||||||||
Total | $ | 152,128 | $ | 141,700 | $ | 466,110 | $ | 431,421 | ||||||||
Gross Margin | ||||||||||||||||
North America | $ | 20,813 | $ | 19,047 | $ | 63,354 | $ | 58,783 | ||||||||
Europe | 10,298 | 9,424 | 28,665 | 26,280 | ||||||||||||
Asia/Pacific | 8,805 | 7,104 | 26,164 | 21,560 | ||||||||||||
Latin America | 1,910 | 1,458 | 5,059 | 4,184 | ||||||||||||
Corporate | (4,737 | ) | (3,367 | ) | (8,115 | ) | (7,424 | ) | ||||||||
Total | $ | 37,089 | $ | 33,666 | $ | 115,127 | $ | 103,383 | ||||||||
The Company sells its products to customers in diversified industries and performs periodic credit evaluations of its customers’ financial condition. Terms are generally on open account, payable net 30 days in North America, and vary throughout Europe, Asia/Pacific, and Latin America. Estimates of credit losses are recorded in the financial statements based on periodic reviews of outstanding accounts, and actual losses have been consistently within management’s estimates.
Note M – Recently Issued Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) revised SFAS No. 123,Accounting for Stock-Based Compensation. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) is effective at the beginning of the next fiscal year that begins after June 15, 2005, or the Company’s fiscal year 2007. The Company is evaluating the impact of the adoption of SFAS No.123(R) on the financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109,Accounting for Income Taxes and 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 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 will become effective for the Company beginning in fiscal 2008. The Company is currently evaluating the impact of the adoption of FIN 48 on the financial statements.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per share amounts and except where indicated)
Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q are forward-looking statements relating to future events, which involve certain risks and uncertainties. Further, there can be no assurance that the trends reflected in historical information will continue in the future.
Investors should consider carefully the following risk factors, in addition to the other information included and incorporated by reference in the Quarterly Report on Form 10-Q. All statements other than statements of historical facts included in this report are statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934. The words “expect,” “estimate,” “anticipate,” “predict,” “believe,” and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this report and include statements regarding the intent, belief, or current expectations of the Company, its directors, or its officers with respect to, among other things: (i) trends affecting the Company’s financial condition or results of operations; (ii) the Company’s financing plans; (iii) the Company’s business and growth strategies, including potential acquisitions; and (iv) other plans and objectives for future operations. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and actual results may differ materially from those predicted in the forward-looking statements or which may be anticipated from historical results or trends.
In addition to the information contained in the Company’s other filings with the Securities Exchange Commission, factors that could affect future performance include, among others, the following:
• | The Company has had significant operating and net losses in the past and may have future losses. |
• | The Company maintains a significant investment in inventory and has incurred significant charges for inventory obsolescence and overstock, and may incur similar charges in the future. |
• | If the Company does not maintain effective internal controls over financial reporting, it could be unable to provide timely and reliable financial information. |
• | Because the Company derives a significant portion of its revenue by distributing products designed and manufactured by third parties, it may be unable to anticipate changes in the marketplace and, as a result, could lose market share. |
• | The Company has exposure to economic downturns and operates in cyclical markets. |
• | The Company has significant debt, which could limit its financial resources and ability to compete and may make it more vulnerable to adverse economic events. |
• | The Company’s ability to service its debt and meet its other obligations depends on a number of factors beyond its control. |
• | The Company’s success depends on its executive officers and other key personnel. The Company has experienced significant turnover in its senior management over the past few years. |
• | The Company’s credit agreement and the indentures for its outstanding notes impose restrictions with respect to various business matters. |
• | The Company was not in compliance with certain financial covenants of its credit agreement for the quarters ended May 28, 2005, September 3, 2005 and March 4, 2006, and may not be able to comply with these financial covenants in the future. |
• | Changes in accounting standards regarding stock option plans, which the Company is required to adopt for its fiscal 2007, could limit the desirability of granting stock options, which could harm the Company’s ability to attract and retain employees, and could also negatively impact its results of operations. |
• | The Company faces intense competition in the markets it serves and, if it does not compete effectively, it could significantly harm its operating results. |
• | The Company may not be able to continue to make the acquisitions necessary for it to realize its growth strategy or integrate acquisitions successfully. |
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• | If the Company does not continue to reduce its costs, it may not be able to compete effectively in its markets. |
• | The Company’s Electron Device Group is dependent on a limited number of vendors to supply it with essential products. |
• | Economic, political, and other risks associated with international sales and operations could adversely affect the Company’s business. |
• | The Company is exposed to foreign currency risk. |
• | Because the Company generally does not have long-term contracts with its vendors, it may experience shortages of products that could harm its business and customer relationships. |
• | The Company may have underpaid taxes in a foreign country where it has operations. |
• | The Company is exposed to highly variable income tax expense due to its unpredictable geographic distribution of taxable income or losses and its valuation allowances related to net operating losses. |
For more discussion of such risks, see “Risk Factors” in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on August 26, 2005.
These risks are not exhaustive. Other sections of this report may include additional factors, which could adversely affect the Company’s business and financial performance. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors on the Company’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictions of actual results.
Investors should also be aware that while the Company does, from time to time, communicate with securities analysts, it is against the Company’s policy to disclose to them any material non-public information or other confidential commercial information. Accordingly, stockholders should not assume that the Company agrees with any statement or report issued by any analyst irrespective of the content of the statement or report. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts, or opinions, such reports are not the responsibility of the Company.
Overview
Description of Business
The Company is a global provider of engineered solutions and a distributor of electronic components to the radio frequency (RF), wireless and power conversion, electron device, security, and display systems markets. Utilizing its core engineering and manufacturing capabilities, the Company is committed to a strategy of providing specialized technical expertise and value-added products, or “engineered solutions,” in response to customers’ needs. These solutions consist of products which the Company manufactures or modifies and products which are manufactured to its specifications by independent manufacturers under the Company’s own private labels. Additionally, the Company provides solutions and adds value through design-in support, systems integration, prototype design and manufacturing, testing, and logistics for its customers’ end products. Design-in support includes component modifications or the identification of lower-cost product alternatives or complementary products.
The Company’s products include RF and microwave components, power semiconductors, electron tubes, microwave generators, data display monitors, and electronic security products and systems. These products are used to control, switch or amplify electrical power or signals, or as display, recording, or alarm devices in a variety of industrial, communication, and security applications.
The Company’s marketing, sales, product management, and purchasing functions are organized as four strategic business units (SBUs): RF, Wireless & Power Division (RFPD), Electron Device Group (EDG), Security Systems Division (SSD), and Display Systems Group (DSG), with operations in the major economic regions of the world: North America, Europe, Asia/Pacific, and Latin America.
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During the second quarter of fiscal 2006, the Company implemented a reorganization plan encompassing the Company’s RF & Wireless Communications Group (RFWC) and Industrial Power Group (IPG) business units. Effective for the second quarter of fiscal 2006, IPG has been designated as Electron Device Group (EDG) and RFWC has been designated as RF, Wireless & Power Division (RFPD). The reorganization was implemented to increase efficiencies by integrating IPG’s power conversion sales and product management into RFWC, improving the geographic sales coverage and driving sales growth by leveraging RFWC’s larger sales resources. In addition, the Company believes that EDG will benefit from an increased focus on the high-margin tube business with a simplified global sales and product management structure to work more effectively with customers and vendors. The data presented has been reclassified to reflect the reorganization.
Results of Operations
Net Sales and Gross Margin Analysis
During the third quarter of fiscal 2006, consolidated net sales increased 7.4% to $152,128 due to higher sales in display systems and wireless products over the prior year. During the first nine months of fiscal 2006, consolidated net sales increased 8.0% to $466,110 from $431,421 in the same period last year, as all four SBUs increased net sales over the prior year’s first nine months with strong demand for custom displays and wireless products. In addition, effective June 1, 2005, the Company acquired A.C.T. Kern GmbH & Co. KG (Kern), a leading display technology company in Europe. Net sales for Kern, included in DSG and the Europe region, in the third quarter and first nine months of fiscal 2006 were $3,277 and $10,206, respectively. The first nine months of fiscal 2006 contained 40 weeks as compared to 39 weeks for the first nine months of fiscal 2005. The additional week occurred in the first quarter of fiscal 2006. Net sales by SBU are presented as follows (in thousands):
Net Sales
FY 2006 | FY 2005 | % Change | |||||||
Third Quarter | |||||||||
RFPD | $ | 80,526 | $ | 72,253 | 11.5 | % | |||
EDG | 21,907 | 22,672 | (3.4 | )% | |||||
SSD | 25,316 | 25,607 | (1.1 | )% | |||||
DSG | 23,537 | 19,498 | 20.7 | % | |||||
Corporate | 842 | 1,670 | |||||||
Total | $ | 152,128 | $ | 141,700 | 7.4 | % | |||
Net Sales
FY 2006 | FY 2005 | % Change | |||||||
Nine Months | |||||||||
RFPD | $ | 241,252 | $ | 220,024 | 9.6 | % | |||
EDG | 70,352 | 67,637 | 4.0 | % | |||||
SSD | 80,488 | 78,728 | 2.2 | % | |||||
DSG | 69,881 | 60,040 | 16.4 | % | |||||
Corporate | 4,137 | 4,992 | |||||||
Total | $ | 466,110 | $ | 431,421 | 8.0 | % | |||
Note: The fiscal 2005 data has been reclassified to conform with the fiscal 2006 presentation. The modification includes the reorganization of RFPD (formerly RFWC) and EDG (formerly IPG) in the second quarter of fiscal 2006. Corporate consists of freight, other non-specific net sales, and customer cash discounts.
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Consolidated gross margins increased 10.2% to $37,089 and 11.4% to $115,127 in the third quarter and first nine months of fiscal 2006, respectively, as compared with $33,666 and $103,383 in the same periods last fiscal year due mainly to an increase in sales volume. Consolidated gross margin as a percentage of net sales increased to 24.4% and 24.7% in the third quarter and first nine months of fiscal 2006, respectively, versus 23.8% and 24.0% in the third quarter and first nine months of fiscal year 2005, respectively. As a percentage of sales, gross margin improved in fiscal 2006 due primarily to favorable excess and obsolete inventory and warranty experience. Gross margin for each SBU and gross margin as a percentage of net sales are presented in the following table. Gross margin reflects the distribution and manufacturing product margin less manufacturing variances, customer returns, scrap and cycle count adjustments, engineering costs, inventory overstock charges, and other provisions. Gross margin on freight, general inventory obsolescence provisions, and miscellaneous costs are included under the caption “Corporate.”
Gross Margin
Third Quarter | FY 2006
| % of
| FY 2005 (restated) | % of
| ||||||||||
RFPD | $ | 19,049 | 23.7 | % | $ | 15,379 | 21.3 | % | ||||||
EDG | 7,099 | 32.4 | % | 7,044 | 31.1 | % | ||||||||
SSD | 6,016 | 23.8 | % | 6,260 | 24.4 | % | ||||||||
DSG | 6,426 | 27.3 | % | 4,097 | 21.0 | % | ||||||||
Corporate | (1,501 | ) | 886 | |||||||||||
Total | $ | 37,089 | 24.4 | % | $ | 33,666 | 23.8 | % | ||||||
Nine Months | FY 2006
| % of Net Sales
| FY 2005 (restated) | % of Net Sales
| ||||||||||
RFPD | $ | 55,890 | 23.2 | % | $ | 48,942 | 22.2 | % | ||||||
EDG | 22,543 | 32.0 | % | 21,680 | 32.1 | % | ||||||||
SSD | 20,185 | 25.1 | % | 20,062 | 25.5 | % | ||||||||
DSG | 18,559 | 26.6 | % | 13,528 | 22.5 | % | ||||||||
Corporate | (2,050 | ) | (829 | ) | ||||||||||
Total | $ | 115,127 | 24.7 | % | $ | 103,383 | 24.0 | % | ||||||
Note: The fiscal 2005 data has been reclassified to conform with the fiscal 2006 presentation. The modification includes the reorganization of RFPD (formerly RFWC) and EDG (formerly IPG) in the second quarter of fiscal 2006. Corporate consists of freight, other non-specific gross margins, and customer cash discounts.
Net sales and gross margin trends are analyzed for each strategic business unit in the discussion below.
RF, Wireless & Power Division
RFPD net sales increased 11.5% and 9.6% in the third quarter and first nine months of fiscal 2006, respectively, to $80,526 and $241,252 as compared with $72,253 and $220,024 in the same periods last fiscal year. The net sales growth for the third quarter of fiscal 2006 was due mainly to an increase in sales of the network access and passive/interconnect product lines with growth of 15.2% and 16.2% to $29,490 and $13,552, respectively, versus $25,590 and $11,666, in the same period last fiscal year. The increase in the network access product lines was driven by semiconductor product sales in all geographic areas, with the largest growth coming from Asia/Pacific. North America also experienced strong network access product sales growth, where cellular infrastructure and military/defense are the primary markets. Sales of the passive product lines increased due to the addition of two new global, exclusive franchise suppliers. The RFPD net sales growth for the first nine months of fiscal 2006 was mainly due to an increase in sales of the network access product line with growth of 21.2% to $90,978 from $75,072 in the same period of
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last fiscal year, primarily due to sales growth in Asia/Pacific.The net sales growth was the main contributor to the gross margin increase of 23.9% and 14.2% to $19,049 and $55,890 for the third quarter and first nine months of fiscal 2006, respectively. RFPD’s gross margin percentage increased to 23.7% and 23.2% from 21.3% and 22.2% for the third quarter and first nine months of fiscal 2006 and 2005, respectively, primarily due to inventory write-downs of $1.3 million recorded in the third quarter of fiscal 2005 and a shift in product mix in fiscal 2006 as a result of higher sales of engineered solutions. The gross margin improvement was partially offset by the increase in Asia/Pacific sales that reduced the overall gross margin percentage due to lower gross margins in Asia/Pacific than other geographic regions.
Electron Device Group
EDG net sales decreased 3.4% in the third quarter of fiscal 2006 to $21,907 from $22,672 during the same period last fiscal year, while increasing 4.0% during the first nine months of fiscal 2006 to $70,352 from $67,637 during the same period last fiscal year. Tube sales decreased 8.2% during the third quarter of fiscal 2006 to $15,581 versus $16,970 in the same period last fiscal year, partially offset by an increase in semiconductor fabrication equipment sales of 38.5% to $4,390 during the third quarter of fiscal 2006 as compared to $3,169 last year. The decrease in tube sales was due to one of the Company’s key vendors relocating its facilities, thus delaying shipments to the Company for further distribution to customers. Semiconductor fabrication equipment sales increased as new replacement parts were introduced into the Asia/Pacific market in fiscal 2006. Semiconductor fabrication sales increased 27.0% during the first nine months of fiscal 2006 to $12,345 as compared to $9,724 in the same period of fiscal 2005. Gross margin for EDG increased 0.8% and 4.0% to $7,099 and $22,543, respectively, for the third quarter and first nine months of fiscal 2006 due to an improved product mix. Gross margin as a percentage of net sales increased to 32.4% from 31.1% for the third quarter of fiscal 2006 and 2005, respectively, due to an improved product mix primarily as a result of the increase in semiconductor fabrication equipment sales. Gross margin as a percentage of net sales remained relatively flat during the first nine months of fiscal 2006 as compared to fiscal 2005.
Security Systems Division
Net sales for SSD of $25,316 in the third quarter of fiscal 2006 were relatively flat with sales of $25,607 in the third quarter last year. During the first nine months of fiscal 2006, net sales for SSD increased 2.2% to $80,488 as compared with $78,728 during the same period last year. Net sales of private label products increased 9.1% to $25,494 during the first nine months of fiscal 2006 as compared with $23,369 during the same period of last fiscal year, and were partially offset by a decrease in distribution products. Gross margins for SSD during the third quarter and first nine months of fiscal 2006 of $6,016 and $20,185, respectively, were relatively flat with gross margins of $6,260 and $20,062 for the same periods last year. Gross margin as a percent of net sales decreased to 23.8% and 25.1% for the third quarter and first nine months of fiscal 2006, respectively, as compared with 24.4% and 25.5% during the same time periods of last fiscal year, primarily due to inventory adjustments.
Display Systems Group
DSG net sales increased 20.7% and 16.4% in the third quarter and first nine months of fiscal 2006, respectively, to $23,537 and $69,881 as compared with $19,498 and $60,040 in the same periods last fiscal year. Net sales for Kern in the third quarter and first nine months of fiscal 2006 were $3,277 and $10,206, respectively. In addition to the Kern acquisition, net sales growth during the third quarter of fiscal 2006 was due primarily to the increase in the medical monitors and custom display product lines of 17.5% and 7.9% to $9,149 and $7,053, respectively, as compared to $7,785 and $6,539 for the third quarter of fiscal 2005, partially offset by lower sales in the specialty displays and cathode ray tube products lines. The sales growth for the nine-month period was mainly due to the Kern acquisition and an increase in sales of the custom display product line which increased 11.4% to $19,415 in fiscal 2006 from $17,428 in fiscal 2005, partially offset by lower sales in the specialty displays and cathode ray tube products lines . DSG gross margin increased 56.8% and 37.2% to $6,426 and $18,559 during the third quarter and first nine months of fiscal 2006, respectively, from $4,097 and $13,528 for the same time periods last year. The gross margin percentage increased to 27.3% and 26.6% from 21.0% and 22.5% during the third quarter and first nine months of fiscal 2006 and 2005, respectively. The gross margin
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improvement was due mainly to an improved product mix primarily in the specialty display and medical monitor product lines. In addition, during the second quarter of fiscal 2006, the Company recorded a reduction in warranty expense of $946 as a result of a change in estimate due to favorable warranty experience.
Sales by Geographic Area
On a geographic basis, the Company categorizes its sales by destination: North America, Europe, Asia/Pacific, Latin America, and Corporate. Net sales and gross margin, as a percent of net sales, by geographic area are as follows (in thousands):
Net Sales
Third Quarter | FY 2006 | FY 2005 | % Change | ||||||
North America | $ | 75,291 | $ | 73,443 | 2.5 | % | |||
Europe | 34,138 | 31,118 | 9.7 | % | |||||
Asia/Pacific | 34,707 | 30,652 | 13.2 | % | |||||
Latin America | 5,780 | 5,544 | 4.3 | % | |||||
Corporate | 2,212 | 943 | |||||||
Total | $ | 152,128 | $ | 141,700 | 7.4 | % | |||
Nine Months | FY 2006 | FY 2005 | % Change | ||||||
North America | $ | 236,631 | $ | 227,548 | 4.0 | % | |||
Europe | 101,869 | 94,284 | 8.0 | % | |||||
Asia/Pacific | 106,700 | 91,217 | 17.0 | % | |||||
Latin America | 17,760 | 15,392 | 15.4 | % | |||||
Corporate | 3,150 | 2,980 | |||||||
Total | $ | 466,110 | $ | 431,421 | 8.0 | % | |||
Gross Margin
Third Quarter | FY 2006
| % of
| FY 2005 (restated) | % of
| ||||||||||
North America | $ | 20,813 | 27.6 | % | $ | 19,047 | 25.9 | % | ||||||
Europe | 10,298 | 30.2 | % | 9,424 | 30.3 | % | ||||||||
Asia/Pacific | 8,805 | 25.4 | % | 7,104 | 23.2 | % | ||||||||
Latin America | 1,910 | 33.0 | % | 1,458 | 26.3 | % | ||||||||
Corporate | (4,737 | ) | (3,367 | ) | ||||||||||
Total | $ | 37,089 | 24.4 | % | $ | 33,666 | 23.8 | % | ||||||
Nine Months | FY 2006
| % of Net Sales
| FY 2005 (restated) | % of Net Sales
| ||||||||||
North America | $ | 63,354 | 26.8 | % | $ | 58,783 | 25.8 | % | ||||||
Europe | 28,665 | 28.1 | % | 26,280 | 27.9 | % | ||||||||
Asia/Pacific | 26,164 | 24.5 | % | 21,560 | 23.6 | % | ||||||||
Latin America | 5,059 | 28.5 | % | 4,184 | 27.2 | % | ||||||||
Corporate | (8,115 | ) | (7,424 | ) | ||||||||||
Total | $ | 115,127 | 24.7 | % | $ | 103,383 | 24.0 | % | ||||||
Note: Europe includes sales and gross margins to Middle East and Africa. Latin America includes sales and gross margins to Mexico. Corporate consists of freight and other non-specific sales and gross margins.
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Net sales in North America increased 2.5% and 4.0% in the third quarter and first nine months of fiscal 2006, respectively, to $75,291 and $236,631 as compared with $73,443 and $227,548 in the same periods of fiscal 2005. The sales increase in the third quarter and first nine months of fiscal 2006 was mainly due to increases in demand for security systems in Canada and wireless products in the U.S. In addition, net sales in Canada experienced an overall gain of 11.7% to $57,765 in the first nine months of fiscal 2006 versus $51,723 in the prior fiscal year. An increase in net sales of higher margin products resulted in gross margin improvement in North America to 27.6% and 26.8% for the third quarter and first nine months of fiscal 2006, respectively, as compared with 25.9% and 25.8% in fiscal 2005.
Net sales in Europe grew 9.7% and 8.0% in the third quarter and first nine months of fiscal 2006, respectively, to $34,138 and $101,869 from $31,118 and $94,284 in the same periods a year ago due to the Kern acquisition, partially offset by lower sales of security systems and electron device products in Europe. Gross margin in Europe in the third quarter of fiscal 2006 was relatively flat with the prior year, while gross margin increased to 28.1% from 27.9% during the first nine of fiscal 2006 and 2005, respectively, primarily due to shifts in product mix.
Net sales in Asia/Pacific increased 13.2% and 17.0% to $34,707 and $106,700 in the third quarter and first nine months of fiscal 2006, respectively, versus $30,652 and $91,217 in the same periods last fiscal year, led by continued strong demand for wireless products in the cellular infrastructure, semiconductor fabrication and broadcasting markets. Net sales in Korea, Singapore and Japan increased 17.2%, 63.3% and 36.6% to $9,846, $5,932 and $5,302 in the third quarter of fiscal 2006, respectively, and net sales increased 32.8%, 21.7% and 16.7% to $30,785, $16,038 and $16,211 in the first nine months of fiscal 2006, respectively. Gross margins increased in all strategic business units in Asia/Pacific for the third quarter and first nine months of fiscal 2006, as compared with last fiscal year due mainly to shifts in product mix focused on exclusive franchises, design registration programs and the reduction of lower margin programs.
Net sales in Latin America improved 4.3% and 15.4% to $5,780 and $17,760 in the third quarter and first nine months of fiscal 2006, respectively, as compared with $5,544 and $15,392 in the third quarter and first nine months of fiscal 2005, respectively. The net sales growth was mainly driven by an increase in sales of security products/systems integration and refocusing the EDG sales team after the realignment. Gross margin in Latin America increased to 33.0% and 28.5% in the third quarter and first nine months of fiscal 2006, respectively, versus 26.3% and 27.2% in the year ago period primarily due to shifts in product mix.
Selling, General and Administrative Expenses
Selling, general and administrative expenses (SG&A) increased 4.2% and 5.3% to $35,502 and $100,766 in the third quarter and first nine months of fiscal 2006, respectively, as compared with $34,087 and $95,689 in the same periods last fiscal year. The increase in expenses for the third quarter and first nine months of fiscal 2006 as compared with the third quarter and first nine months of fiscal 2005 was primarily due to the acquisition of Kern, severance expense and sales and use tax expense. The Company recorded severance expense of $697 during the third quarter of fiscal 2006. During the third quarter of fiscal 2005, the Company recorded a restructuring charge, including severance and lease termination costs, of $2,152. In addition, during the third quarter of fiscal 2006, the Company increased its sales and use tax reserve by $876 for potential exposure in certain states where the Company conducts business. For the third quarter and first nine months of fiscal 2006, total SG&A decreased to 23.3% and 21.6% of net sales, respectively, compared with 24.1% and 22.2% in last fiscal year’s third quarter and first nine months, respectively. During the fourth quarter of fiscal 2006, the Company recorded employee severance costs of $2,724 for certain employees whose termination costs became probable and estimable.
Other (Income) Expense
In the third quarter of fiscal 2006, other (income) expense decreased to an expense of $805 from an expense of $1,782 during the third quarter of fiscal 2005, however, in the first nine months of fiscal 2006, other (income) expense increased to an expense of $9,128 from an expense of $3,773 during the first nine months of fiscal 2005. Other (income) expense included a foreign exchange
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gain of $1,611 during the third quarter of fiscal 2006 and a foreign exchange loss of $2,071 during first nine months of fiscal 2006, respectively, as compared with a foreign exchange gain of $226 and $2,624 during the same periods last fiscal year. The foreign exchange variance for the first nine months of fiscal 2006 was due to the strengthening of the U.S. dollar, primarily related to receivables due from foreign subsidiaries to the U.S. parent company and denominated in foreign currencies. Interest expense increased to $2,479 and $7,076 for the third quarter and first nine months of fiscal 2006, respectively, as compared with $2,234 and $6,675 during the same periods of last fiscal year due to higher interest rates related to the Company’s credit agreement.
Income Tax Provision
The effective income tax rates for the third quarter and first nine months of fiscal year 2006 were 262.1% and 81.8%, respectively. The difference between the effective tax rates as compared to the U.S. federal statutory rate of 34% primarily results from the Company’s geographical distribution of taxable income or losses and, in the three and nine months ended March 4, 2006, valuation allowances related to net operating losses. For the nine months ended March 4, 2006, the tax benefit primarily related to net operating losses was limited by the requirement for a valuation allowance of $3,646, which increased the effective income tax rate by 68.5%. During the second quarter of fiscal 2006, income tax reserves of approximately $1,000 for certain income tax exposures were reversed because the statute of limitations with respect to these income tax exposures expired.
As of February 26, 2005, domestic net operating loss carryforwards (NOL) were approximately $22.0 million. These NOLs expire in 2024. Foreign net operating loss carryforwards were approximately $15.3 million. In the second quarter of fiscal 2005, the Company recorded a valuation allowance of approximately $0.6 million primarily relating to certain foreign subsidiaries recording deferred tax assets on net operating losses.
Net domestic deferred tax assets, including the domestic NOL, were approximately $15.5 million at February 26, 2005. Due to changes in the level of certainty regarding realization, a valuation allowance of approximately $16.2 million was established in the third quarter of fiscal 2005 to offset certain domestic deferred tax assets and domestic net operating loss carryforwards.
At the end of fiscal 2004, all of the cumulative positive earnings of the Company’s foreign subsidiaries, amounting to $35.1 million, were considered permanently reinvested pursuant to APB No. 23,Accounting for Income Taxes-Special Areas. As such, U.S. taxes were not provided on these amounts. In the third quarter of fiscal 2005, because of a strategic decision, the Company determined that approximately $12.4 million of one of its foreign subsidiaries’ earnings could no longer be considered permanently reinvested as those earnings may be distributed in future years. Based on management’s potential future plans regarding this subsidiary, it was determined that these earnings would no longer meet the specific requirements for permanent reinvestment under APB No. 23. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income tax and foreign withholding taxes. As such, during the third quarter of fiscal 2005, the Company established a deferred tax liability of approximately $4.8 million. The remaining cumulative positive earnings of the Company’s foreign subsidiaries were still considered permanently reinvested pursuant to APB No. 23 and amounted to $29.1 million. Due to various tax attributes that are continually changing, it is not possible to determine what, if any, tax liability might exist if such earnings were to be repatriated.
In May 2005, the Company was informed by one of its foreign subsidiaries that its records may not be adequate to support the taxable revenues and deductions included within tax returns previously filed for the tax years 2003 and 2004. At this time, the Company has not received notification from any tax authority regarding this matter. The Company has increased its income tax reserve for this potential exposure.
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During fiscal 2005, the Canadian taxing authority proposed an income tax assessment for fiscal 1998 through fiscal 2002. The Company appealed the income tax assessment; however, the Company paid the entire tax liability in fiscal 2005 to the Canadian taxing authority to avoid additional interest and penalties if the Company’s appeal was denied. The payment was recorded as an increase to income tax provision in fiscal 2005. In May 2006, the appeal was settled in the Company’s favor. The Company will receive a refund of approximately $1,000, which will be recorded as a reduction to income tax provision in the fourth quarter of fiscal 2006.
Net Income and Per Share Data
Net loss for the third quarter of fiscal 2006 was $1,146 or $0.07 per diluted common share or $0.06 per Class B diluted common share as compared with $22,687 for the third quarter of fiscal 2005, or $1.34 per diluted common share or $1.20 per Class B diluted common share. Net income (loss) for the first nine months of fiscal 2006 was income of $967 or $0.06 per diluted common share or $0.05 per Class B diluted common share as compared with a loss of $18,493 for the first nine months of fiscal 2005, or $1.12 per diluted common share or $1.01 per Class B diluted common share.
Liquidity and Capital Resources
The Company has financed its growth and cash needs largely through income from operations, borrowings under the revolving credit facilities, an equity offering, issuance of convertible senior subordinated notes, and sale of assets. Liquidity provided by operating activities is reduced by working capital requirements, debt service, capital expenditures, dividends, and business acquisitions. Liquidity provided by operating activities is increased by proceeds from borrowings and dispositions of businesses and assets.
Cash and cash equivalents were $18,712 at March 4, 2006, a decrease of $5,589 from fiscal 2005 year end. The decrease in cash is primarily due to the collection of receivables due from foreign subsidiaries to the U.S. parent company. The cash received by the U.S. parent company was used to reduce the amount outstanding under the Company’s credit agreement.
Cash provided by operating activities for the first nine months of fiscal 2006 was $4,622 primarily due to higher accounts payable, partially offset by the increase in inventories. The increase in inventories, due to inventory stocking programs to support anticipated sales growth, was more than offset by the increase in accounts payable due to the timing of inventory purchases during the third quarter of fiscal 2006. Cash used in operating activities for the first nine months of fiscal 2005 was $7,771 mainly due to an increase in inventories. Initial stocking packages for exclusive supplier programs caused inventory to increase.
Net cash used in investing activities of $10,788 for the first nine months of fiscal 2006 was mainly the result of the acquisition, effective June 1, 2005, of Kern located in Donaueschingen in southern Germany. The cash outlay for Kern was $6,583, net of cash acquired. In addition, effective October 1, 2005, the Company acquired Image Systems, a division of CSI in Hector, Minnesota. The initial cash outlay for Image Systems was $250. Image Systems is a specialty supplier of displays, display controllers, and calibration software for the healthcare market. In addition, the Company spent $4,229 on capital projects during the first nine months of fiscal 2006 primarily related to facility and information technology projects. The Company spent $6,449 on capital projects during the first nine months of fiscal 2005 related to PeopleSoft development costs and ongoing investments in information technology infrastructure.
Net cash provided by financing activities for the first nine months of fiscal 2006 was $592. During the first nine months of fiscal 2005, net cash provided by financing activities was $19,719. During the first quarter of fiscal 2005, the Company had an equity offering for three million shares of stock that contributed $27,915 in proceeds that was used to reduce long-term debt by $13,293 and fund working capital requirements.
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On November 21, 2005, the Company sold $25,000 in aggregate principal amount of 8% notes pursuant to an indenture dated November 21, 2005. The 8% notes bear interest at a rate of 8% per annum. Interest is due on June 15 and December 15 of each year. The 8% notes mature on June 15, 2011. The 8% notes are convertible at the option of the holder, at any time on or prior to maturity, into shares of the Company’s common stock at a price equal to $10.31 per share, subject to adjustment in certain circumstances. In addition, the Company may elect to automatically convert the 8% notes into shares of common stock if the trading price of the common stock exceeds 150% of the conversion price of the 8% notes for at least 20 trading days during any 30 trading day period subject to a payment of three years of interest if the Company elects to convert the 8% notes prior to December 20, 2008.
The indenture provides that on or after December 20, 2008, the Company has the option of redeeming the 8% notes, in whole or in part, for cash, at a redemption price equal to 100% of the principal amount of the 8% notes to be redeemed, plus accrued and unpaid interest, if any, but excluding, the redemption date. Holders may require the Company to repurchase all or a portion of their 8% notes for cash upon a change-of-control event, as described in the indenture, at a repurchase price equal to 100% of the principal amount of the 8% notes to be repurchased, plus accrued and unpaid interest, if any, to, but excluding the repurchase date. The 8% notes are unsecured and subordinate to the Company’s existing and future senior debt. The 8% notes rank on parity with the Company’s existing 7 3/4% convertible senior subordinated notes (7 3/4% notes).
The Company maintains $14,000 of the 8% notes in current portion of long-term debt at March 4, 2006. This current classification is due to the Company entering into two separate agreements in August 2006 with certain holders of its 8% notes to purchase $14,000 of the 8% notes. As the 8% notes are subordinate to the Company’s existing credit agreement, the Company received a waiver from its lending group to permit the purchase. The purchases will be financed through additional borrowings under the Company’s credit agreement. In the first quarter of fiscal 2007, the Company will record early extinguishment expenses of approximately $2,700.
The Company used the net proceeds from the sale of the 8% notes to repay amounts outstanding under its credit agreement. The Company redeemed all of the outstanding 8 1/4% convertible senior subordinated debentures (8 1/4% debentures) on December 23, 2005 in the amount of $17,538 and all of the outstanding 7 1/4% convertible subordinated debentures (7 1/4% debentures) on December 30, 2005 in the amount of $4,753 by borrowing amounts under the credit agreement to effect these redemptions.
In October 2004, the Company renewed its credit agreement with the current lending group in the amount of approximately $109,000 (the size of the credit line varies based on fluctuations in foreign currency exchange rates). The agreement expires in October 2009, and the outstanding balance at that time will become due. At March 4, 2006, $56,303 was outstanding under the credit agreement. The credit agreement is principally secured by the Company’s trade receivables and inventory. The credit agreement bears interest at applicable LIBOR rates plus a margin, varying with certain financial performance criteria. At March 4, 2006, the applicable margin was 1.25%. Outstanding letters of credit were $1,710 at March 4, 2006, leaving an unused line of $51,695 under the total credit agreement; although none of this amount was available for the Company to borrow because the Company was not in compliance with credit agreement covenants with respect to the leverage ratio and tangible net worth covenants for the third quarter ending March 4, 2006. The commitment fee related to the credit agreement is 0.25% per annum payable quarterly on the average daily unused portion of the aggregate commitment. The Company’s credit agreement consists of the following facilities as of March 4, 2006:
Capacity | Amount Outstanding | Interest Rate | |||||||
US Facility | $ | 70,000 | $ | 43,200 | 6.47 | % | |||
Canada Facility | 15,026 | 6,685 | 5.25 | % | |||||
Sweden Facility | 8,179 | — | — | ||||||
UK Facility | 7,893 | 4,210 | 6.87 | % | |||||
Euro Facility | 6,020 | 482 | 4.64 | % | |||||
Japan Facility | 2,590 | 1,726 | 1.85 | % | |||||
Total | $ | 109,708 | $ | 56,303 | 6.20 | % | |||
Note: Due to maximum permitted leverage ratios, the amount of the unused line cannot be calculated on a facility-by-facility basis.
On August 24, 2005, the Company executed an amendment to the credit agreement. The amendment changed the maximum permitted leverage ratios and the minimum required fixed charge coverage ratios for each of the first three quarters of fiscal 2006 to provide the Company additional flexibility for these
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periods. In addition, the amendment also provided that the Company will maintain excess availability on the borrowing base of not less than $23,000 until the 8 1/4% and 7 1/4% debentures were redeemed, at which time the Company will maintain excess availability of the borrowing base of not less than $10,000. The applicable margin pricing was increased by 25 basis points. In addition, the amendment extended the Company’s requirement to refinance the remaining $22,291 aggregate principal amount of the Company’s 7 1/4% debentures and the 8 1/4% debentures from February 28, 2006 to June 10, 2006.
At September 3, 2005, the Company was not in compliance with its credit agreement covenants with respect to the tangible net worth covenant due solely to the additional goodwill recorded as a result of the Kern acquisition. On October 12, 2005, the Company received a waiver from its lending group for the default and executed an amendment to the credit agreement. The amendment changed the minimum tangible net worth requirement to adjust for the goodwill associated with the Kern acquisition. At March 4, 2006, the Company was in compliance with its credit agreement covenants.
At March 4, 2006, the Company was not in compliance with credit agreement covenants with respect to the leverage ratio, fixed charge coverage ratio and tangible net worth covenants. On August 4, 2006, the Company received a waiver from its lending group for the default and executed an amendment to the credit agreement. In addition, the amendment also (i) permitted the purchase of $14,000 of the 8% notes; (ii) adjusted the minimum required fixed charge coverage ratio for the first quarter of fiscal 2007; (iii) adjusted the minimum tangible net worth requirement; (iv) permitted certain sales transactions contemplated by the Company; (v) eliminated the Company’s Sweden Facility; (vi) reduced the Company’s Canada Facility by approximately $5,400; (vii) changed the definition of “Adjusted EBITDA” for covenant purposes; and (viii) provided that the Company maintain excess availability on the borrowing base of not less than $20,000 until the Company filed its Form 10-Q for the quarter ended March 4, 2006, at which time the Company will maintain excess availability of the borrowing base of not less than $10,000.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) revised SFAS No. 123,Accounting for Stock-Based Compensation. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) is effective at the beginning of the next fiscal year that begins after June 15, 2005, or the Company’s fiscal year 2007. The Company is evaluating the impact of the adoption of SFAS No.123(R) on the financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109,Accounting for Income Taxes and 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 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 will become effective for the Company beginning in fiscal 2008. The Company is currently evaluating the impact of the adoption of FIN 48 on the financial statements.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Management and Market Sensitive Financial Instruments
The Company’s foreign denominated assets and liabilities are cash, accounts receivable, inventory, accounts payable, and intercompany receivables and payables, primarily in Canada and member countries of the European Union and, to a lesser extent, in Asia/Pacific and Latin America. The Company has not entered into any forward contracts to hedge significant transactions in fiscal 2006 or fiscal 2005. Other tools that the Company may use to manage foreign exchange exposures include the use of currency clauses in sales contracts and the use of local debt to offset asset exposures.
As discussed above, the Company’s debt financing expense, in part, varies with market rates exposing the Company to the market risk from changes in interest rates. Certain operations, assets, and liabilities are denominated in foreign currencies subjecting the Company to foreign currency exchange risk. In order to provide the user of these financial statements guidance regarding the magnitude of these risks, the Securities and Exchange Commission requires the Company to provide certain quantitative disclosures based upon hypothetical assumptions. Specifically, these disclosures require the calculation of the effect of a uniform 10% strengthening of the U.S. dollar against foreign currencies on the reported net earnings and financial position of the Company.
Had the U.S. dollar strengthened 10% against various foreign currencies, sales would have been lower by an estimated $6,100 and $18,500 for the three and nine months ended March 4, 2006, respectively, and $5,500 and $16,800 for the three and nine months ended February 26, 2005, respectively. Total assets would have declined by an estimated $12,300 as of the third quarter ended March 4, 2006 and an estimated $10,600 as of the fiscal year ended May 28, 2005, while the total liabilities would have decreased by an estimated $2,900 as of the third quarter ended March 4, 2006 and an estimated $4,200 as of the fiscal year ended May 28, 2005.
The interpretation and analysis of these disclosures should not be considered in isolation since such variances in interest rates and exchange rates would likely influence other economic factors. Such factors, which are not readily quantifiable, would likely also affect the Company’s operations.
For an additional description of the Company’s market risk, see “Item 7A – Quantitative and Qualitative Disclosures about Market Risk – Risk Management and Market Sensitive Financial Instruments” in the Company’s Annual Report on Form 10-K/A for the fiscal year ended May 28, 2005.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Management of the Company, with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of March 4, 2006. Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of March 4, 2006 due to material weaknesses in the Company’s internal control over financial reporting disclosed in “Item 9A. Controls and Procedures” of the Company’s Annual Report on Form 10-K/A for the fiscal year ended May 28, 2005. The weaknesses were (1) deficiencies in the Company’s control environment, (2) inadequate controls associated with the accounting for income taxes, (3) inadequate financial statement preparation and review procedures, and (4) deficiency related to the application of accounting literature. To address these material weaknesses, the Company has expanded its disclosure controls and procedures to include additional analysis and other post-closing procedures. Accordingly, management believes that the financial statements included in this report fairly present in all material respects the Company’s financial position, results of operations, and cash flows for the periods presented.
(b) Changes in Internal Control over Financial Reporting
There were nine changes in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the first nine months of fiscal 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
• | In June 2005, the Company hired a Director of Tax to increase its focus on processes and procedures associated with accounting for income taxes; |
• | The Company has implemented a program to provide training for accounting personnel in the Company’s foreign subsidiaries, which has been implemented by the Company’s European and Asia/Pacific subsidiaries; |
• | The Company has enhanced its account reconciliation process to ensure that accounts are being reconciled on a timely basis, the reconciliations are independently reviewed, and any reconciling items are cleared on a timely basis; |
• | The Company has implemented a system to review and approve journal entries through system automation; |
• | The Company has implemented formal procedures for financial statement variance analysis and balance sheet reconciliations. The monthly closing schedule is formally communicated to all subsidiaries; |
• | The Company has improved documentation of management review and reconciliation performance through policies, education and re-enforcement, a listing of employees who reconcile and approve balance sheet account reconciliations, and the implementation of key financial manager checklists; |
• | The Company has engaged outside tax professionals to provide global compliance and reporting services to ensure that the Company has appropriate resources to conduct timely reviews and evaluations of the Company’s current and deferred tax provisions, deferred tax assets and liabilities, and related complex tax issues; |
• | The Company has developed a policy related to controls over end-user computing; and |
• | The Company hired a Director of Internal Audit to assist the Company in its ongoing evaluation and monitoring of internal control over financial reporting. |
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(c) Remediation Efforts to Address Material Weaknesses in Internal Control over Financial Reporting
In order to remediate the material weaknesses identified in internal control over financial reporting and ensure the integrity of our financial reporting processes, the Company has implemented or is in the process of implementing the measures described in Item 4(b) above, as well as continuing to train personnel in its other foreign subsidiaries throughout fiscal 2006.
In addition, in an effort to improve internal control over financial reporting, the Company continues to emphasize the importance of establishing the appropriate environment in relation to accounting, financial reporting, and internal control over financial reporting and the importance of identifying areas for improvement and to create and implement new policies and procedures where material weaknesses or significant deficiencies exist.
During the implementation of its remediation plan, the Company discovered the accounting errors as disclosed in Note B of the Notes to Condensed Consolidated Financial Statements. Because the accounting errors relate to material weaknesses the Company already identified and disclosed, the certifying officers do not believe that these errors are an indication of any additional material weaknesses impacting the adequacy of the Company’s disclosure controls and procedures.
It should be noted the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, do not expect that the Company’s internal controls will prevent all error and all fraud, even after completion of the described remediation efforts. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
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The Company is involved in several pending judicial proceedings concerning matters arising in the ordinary course of its business. While the outcome of litigation is subject to uncertainties, based on currently available information, the Company believes that, in the aggregate, the results of these proceeding will not have a material effect on the Company’s financial condition.
In fiscal 2003, two customers of the Company’s German subsidiary asserted claims against the Company in connection with heterojunction field effect transistors the Company sold to them. The Company acquired the heterojunction field effect transistors from the manufacturer pursuant to a distribution agreement. The customers claimed that the heterojunction field effect transistors did not meet the specification provided by the manufacturer. The Company notified the manufacturer and its insurance carrier of these claims. In fiscal 2005, the claim of one of the two customers was settled without any admission of liability on the part of the Company, with a full release from liability, and without any material consideration from the Company, the settlement amount being paid by the Company’s insurance carrier. On December 12, 2005, the claim of the second of the two customers was settled without any admission of liability on the part of the Company, with a full release from liability, and without any material consideration from the Company, the settlement amount being paid by the Company’s insurance carrier.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
At March 4, 2006, the Company was not in compliance with credit agreement covenants with respect to the leverage ratio, fixed charge coverage ratio and tangible net worth covenants. On August 4, 2006, the Company received a waiver from its lending group for the default and executed an amendment to the credit agreement. In addition, the amendment also (i) permitted the purchase of $14,000 of the 8% notes; (ii) adjusted the minimum required fixed charge coverage ratio for the first quarter of fiscal 2007; (iii) adjusted the minimum tangible net worth requirement; (iv) permitted certain sales transactions contemplated by the Company; (v) eliminated the Company’s Sweden Facility; (vi) reduced the Company’s Canada Facility by approximately $5,400; (vii) changed the definition of “Adjusted EBITDA” for covenant purposes; and (viii) provided that the Company maintain excess availability on the borrowing base of not less than $20,000 until the Company filed its Form 10-Q for the quarter ended March 4, 2006, at which time the Company will maintain excess availability of the borrowing base of not less than $10,000.
See exhibit index.
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Pursuant to the requirements of Section 13 or 15(d) 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.
RICHARDSON ELECTRONICS, LTD. | ||||
By: | /s/ David J. DeNeve
| |||
Date: August 31, 2006 | David J. DeNeve Senior Vice President and Chief Financial Officer | |||
(on behalf of the Registrant and as Principal financial and accounting officer) |
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(c) EXHIBITS
Exhibit Number | Description | |
3(a) | Restated Certificate of Incorporation of the Company, incorporated by reference to Appendix B to the Proxy Statement / Prospectus dated November 13, 1986, incorporated by reference to the Company’s Registration Statement on Form S-4, Commission File No.33-8696. | |
3(b) | Amended and Restated By-laws of the Company, incorporated by reference to Exhibit 3.1 of the Company’s Report on Form 8-K dated July 20, 2006, Commission File No. 000-12906. | |
10(ao) | Agreement between the Company and Bruce W. Johnson, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated January 19, 2006, Commission File No. 000-12906. | |
10(ap) | Employment, Nondisclosure and Non-Compete Agreement between the Company and Arthur R. Buckland, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 1, 2006, Commission File No. 000-12906. | |
31.1 | Certification of Edward J. Richardson pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed pursuant to Part I). | |
31.2 | Certification of David J. DeNeve pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed pursuant to Part I). | |
32 | Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed pursuant to Part I). |
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