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Entering the fiscal year ended June 30, 2002, several of the markets we serve, telecommunications in particular, remained weak. Although industry inventories were being worked down, a "wait and see" attitude prevailed with regard to new capital spending programs. That attitude continued throughout our fiscal year, the "recovery" always remaining at least "six months away."
We have yet to see the recovery. In fact, we saw just the opposite. Our fiscal fourth quarter (ended June 30, 2002) marked the low point of the year in terms of revenue and profit. Yet, on declining sales volume we managed to turn in a profitable performance for the year while most of our industry peers did not.
The Company earned $.06 per share for the full year with a loss of $.02 per share in the fourth quarter. This compares to fiscal 2001 earnings, excluding results of divested operations, of $.39 per share for the year and $.12 per share in the fourth quarter.
The major problem in our just completed year was a 26% decline in revenue from an adjusted $252.7 million the year before. On the good side, despite the revenue decrease, gross profit margins only declined from 26.4% of revenue in fiscal 2001 to 23.1% of revenue in fiscal 2002.
After improving dramatically in fiscal 2001, the Company's operating results were adversely impacted by weakness in telecom and, to a somewhat lesser degree, information technology (IT) markets throughout fiscal 2002. Only Magnetek's market diversity—primarily in consumer products, industrial controls and alternative energy—enabled us to remain profitable for the year.
After improving dramatically in fiscal 2001, the Company's operating results were adversely impacted by weakness in telecom… throughout fiscal 2002. | During the year, orders for 'smart' power supplies and regulators for consumer products such as home appliances and audio-visual equipment almost doubled to an annualized rate of over $27 million. In addition, sales of Magnetek industrial controls and power conversion systems increased, nearly offsetting declines in telecom and IT by year-end. Telecom was responsible for our loss in the fourth quarter. Clearly, the current problems in the telecom industry are systemic rather than cyclical, so its recovery is very difficult to predict. Therefore, we must | |
| manage our telecom power business more intensively, cut costs more aggressively, and gain shares of profitable telecom hardware and engineering, furnish and install (EF&I) markets. How are we going about that? | ||
First and foremost, we have tightened our management focus. Peter McCormick, whose team has done an outstanding job of building our industrial controls business, has been elected a vice president of Magnetek with corporate-level responsibility for industrial controls. This allows executive vice president Richard Pratt, who previously had overall responsibility for industrial controls as well as telecom power, to focus exclusively on North American telecom power.
| Under Mr. Pratt, we are implementing a new channel strategy that will enable us to better address the unique power needs of the wireless, broadband, access and wireline segments of the telecom marketplace. At the same time, we believe we will be able to cut telecom selling, general and administrative (SG&A) costs by nearly $1 million a year primarily by consolidating facilities, and we are implementing a new manufacturing resource planning (MRP) system that should reduce operating costs appreciably. | Even during the telecom downturn, substantial investments are still being made in infrastructure upgrades and maintenance. |
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On the marketing side, even during the current telecom downturn, substantial investments are being made in infrastructure upgrades and maintenance. In order to gain a greater share of that available market, we have brought aboard a proven industry sales executive, Shawn Doyle, formerly with Nortel for 19 years, to lead Magnetek's telecom power sales. And we have formed a Commercial Systems unit that will serve as the nucleus for the final marketing integration of our telecom power acquisitions, ADS, J-Tec and LAB Communications.
Further, we are seeking and finding new applications for our telecom power systems and services, including light rail communications networks in New York City and Pittsburgh, wireless "backhaul" projects (both landline and microwave) and emergency wireless "E911" installations.
| Despite weak telecom and IT markets, our power-electronics group continued to score major design wins throughout fiscal 2002. | Except for consumer-related products, we also experienced declining sales in our power supplies business in fiscal 2002. To reverse this trend, executive vice president Antonio Canova has realigned our North American sales organization and brought on board two industry all-stars, Michael Smith and Michael Ehrenberger, to lead the development of Magnetek's domestic OEM and distributor sales channels. We also have expanded our European technical sales force | |
| and added application specialists in promising markets such as utility power line monitoring. And we have launched an initiative to win new customers in Asia from our manufacturing center in Shen-Zhen, China, which we opened in fiscal 2001 at the request of existing customers. | ||
Despite weak telecom and IT markets, our power-electronics group continued to score major design wins‡ throughout fiscal 2002. Overall, we quoted on 361 programs and won 104 of them. That was up from 75 wins out of 199 quotes in fiscal 2001, and for the first time we quoted on as many programs in North America as in Europe. However, the question in many cases is when those programs will commence—and our customers' customers decide that.
‡ Programs expected to generate revenues in excess of $1 million each.
We are currently providing power conditioners for the world's largest fuel cell plant, a 1.4-megawatt installation at Verizon's call-routing center on Long Island, New York. And, we are designing advanced power conditioners for a number of other alternative energy sources, including solar power and micro-turbines. Use of on-site generators is predicted to grow, driven by increasing demands for energy reliability and security. With thousands of installations and millions of hours of operation, Magnetek is already one of the world's leading manufacturers of power conditioners and regulators for distributed power generators.
| Our industrial controls group as a whole continued to grow and gain market share in fiscal 2002. At the same time, the group was able to cut costs through consolidation of manufacturing facilities and sales forces, resulting in a substantial increase in profit margins toward fiscal year end. Now, we are developing new crane control systems for the marine terminal market and drive systems for the European elevator market, both of which hold great potential. | As of fiscal 2002 year end, we were deriving nearly two-thirds of our revenue from…markets other than telecom and IT. |
It is worth noting that, as of fiscal 2002 year end, we were deriving nearly two-thirds of our revenue from industrial controls, consumer products and appliances, power generation, digital imaging, business machines, semiconductor manufacturing, and medical electronics—in short, markets other than telecom and IT. It was Magnetek's market diversity that enabled us to remain profitable for the year, and market diversity is a key element of our strategy, both short- and long-term.
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As reported to you last year, we restructured Magnetek with the express intent of focusing on digital power markets. That we have done, with the added benefits of reducing our debt to practically zero and gaining the attention of "power technology" analysts. Four investment firms* initiated coverage of Magnetek in fiscal 2002, and three independent market research organizations** reported on our emergent position in the industry during the year.
* Stephens, Inc., Needham & Company, CIBC World Markets, and Wachovia Securities
** Micro-Tech Consultants, Darnell, Inc., and the Digital Power Group
We are including the most recent of these reports—the August 2002 issue of theDigital Power Report*** —with the mailing of our fiscal 2002 Annual Report to all shareholders because it describes what researchers Peter Huber and Mark Mills call the "highly ordered power industry" and Magnetek's competitive strategy in it.
***The August 2002 issue ofDigital Power Report can be accessed on Gilder Publishing Company's Internet website:
http://www.powercosm.com/free_reports/free_reports.htm
These reports are independent publications. The Company neither adopts nor endorses their contents.
In our own words: Magnetek's strategy is to leverage our superior knowledge of digital power electronics to provide innovative solutions, including integrated systems and services, in applications requiring precise, reliable and efficient power in diverse, growable market segments with global reach and multiple customers. The strategy is based on four "legs":
| One of the most important features distinguishing Magnetek from its competitors is the number of our products and systems that are 'smart'. | Technological Leadership is the first and most important leg. More than 200 of our 1,600 employees are engineers, over a third of whom hold advanced degrees. We are spending about 5% of total revenue (10% of power-electronics revenue) on new power-electronic product platforms. Counting both new platforms and new applications, we introduced 212 new products in fiscal 2002 compared to 179 in fiscal 2001. |
One of the most important features distinguishing Magnetek from its competitors is the number of our products and systems that are "smart". All of our industrial control systems are programmable, and 76% of our power control products incorporate digital logic components and software algorithms that enable them to monitor and often control the systems they power.
Product Line Breadth is the second leg of our strategy. Historically, most of our power-electronics business was derived from "custom" power components defined by single customers. During the past year, we moved aggressively into market-defined products. Dc-to-Dc converters are one example. They must meet certain industry standards such as pin configuration. But they are not commodities because, beyond these basic industry standards, the performance of our converters differentiates them from those of competitors.
Now, we are increasing thedepth as well as the breadth of our power-electronic product offering in order to gain market penetration through independent electronics sales representatives and distributors, who require full product lines to satisfy their customers.
Forward Integration into systems is the third leg of our strategy. We start by designing modular power-electronic sub-systems, then either integrate these "building blocks" into our own systems or sell them to others for use in theirs. At the end-user level, we are moving into system engineering, monitoring and control as well. The latest example is our HIQgrid™ system, which monitors and controls street lights. Successfully tested in Copenhagen, it is expected to reduce street lighting costs substantially when deployed on a citywide basis and may be used in other applications such as automated meter reading.
Market Diversity is the fourth leg of our strategy. We develop unique power platforms that convert, condition, control and save energy. At the same time, we scan the marketplace from the utility grid to the Internet for profitable applications requiring very precise, very reliable, efficient power. Examples include fuel cells and other alternative energy sources, semiconductor processing equipment, new modes of transportation, plasma display panels, home appliances, next-generation file servers, and wireless micro-cells. By so doing, we don't become overly dependent on any single market or customer.
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| In last year's Annual Report, I stated that whatever the impact and duration of the external factors affecting us, Magnetek's performance going forward would be better than in the past as a result of the fundamental strengths we have built into the Company. We outperformed most of our competitors in fiscal 2002, which we had not done the year before, and I believe I was right about the strengths we have built into the Company, which kept us profitable and essentially debt free. | The strengths we have built into the Company… kept us profitable and essentially debt-free in fiscal 2002. |
During fiscal 2003, assuming that telecom and IT remain depressed (a fairly safe bet), we continue to count on our non-telecom, non-IT markets to take up the slack.
We will have somewhat higher SG&A due to increased R&D investment, marketing costs and pension expense. As we announced in our year-end earnings release, we are reviewing our benefit programs to ensure that they are both competitive and adequate for current employees, while appropriate from an overall cost standpoint. As one result, the Board has decided to discontinue the Company's retiree medical plan. In most cases, this plan simply supplemented Medicare coverage, and supplemental insurance is available from other sources at competitive rates.
Under generally accepted accounting principles, the immediate effect of ending the retiree medical plan on Magnetek's income statement will be to add a one-time gain (net of taxes) of approximately $18 million, or $.75 per share, to the Company's fiscal 2003 first quarter results. The effect in subsequent quarters will be to reduce reported income by about $400,000, although there will be an increase in cash flow of approximately the same amount.
| Magnetek's technology and marketing strategy put it in an ideal position to ride the digital power supply demand wave for decades to come. | From an operating standpoint, our first fiscal quarter is seasonally our weakest due to summer vacation schedules in Europe, which accounts for approximately a third of Company revenue. However, midway into the first quarter, our book-to-bill ratio was better than 1-to-1, and our 90-day backlog was up to $54 million from $53 million at the end of fiscal 2002. Beyond that, unless there is an unanticipated reversal of current market trends, our performance in fiscal 2003 will depend largely on the pace of growth in our non-telecom businesses and our ability to win greater shares of available telecom and IT markets. |
I will simply repeat what I said in last year's Annual Report: I am confident that Magnetek is appropriately sized for today's market conditions and anticipated growth rates. We have the resources to (1) increase new product development, (2) expand our sales and marketing efforts and (3) make appropriate acquisitions. Most important, as the economy and our markets rebound, we believe we will emerge as a new leader in a new industry—digital power—that will grow increasingly important in the future.
In the words of Huber and Mills'Digital Power Report, "Magnetek's technology and marketing strategy put it in an ideal position to ride the digital power supply demand wave for decades to come." We hope they are prophetic.
Andrew G. Galef
Chairman, President & Chief Executive Officer
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Statement of Income Data
| For the years ended June 30, (Amounts in thousands, except per share data) | 2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net Sales | $ | 188,224 | $ | 298,260 | $ | 293,575 | $ | 231,339 | $ | 244,040 | ||||||
| Income (loss): | ||||||||||||||||
| Continuing operations | $ | 1,408 | $ | 9,083 | $ | 1,282 | $ | (24,318 | ) | $ | 344 | |||||
| Discontinued operations | – | (3,350 | ) | 41,170 | 62,791 | 37,532 | ||||||||||
| Net income | $ | 1,408 | $ | 5,733 | $ | 42,452 | $ | 38,473 | $ | 37,876 | ||||||
| Per common share – basic: | ||||||||||||||||
| Income (loss) from continuing operations | $ | 0.06 | $ | 0.40 | $ | 0.05 | $ | (0.79 | ) | $ | 0.01 | |||||
| Net income | $ | 0.06 | $ | 0.25 | $ | 1.71 | $ | 1.25 | $ | 1.25 | ||||||
| Per common shares – diluted: | ||||||||||||||||
| Income (loss) from continuing operations | $ | 0.06 | $ | 0.39 | $ | 0.05 | $ | (0.79 | ) | $ | 0.01 | |||||
| Net income | $ | 0.06 | $ | 0.25 | $ | 1.70 | $ | 1.25 | $ | 1.25 | ||||||
Net income for the fiscal year ended June 30, 2001 includes a $4,114 after-tax loss on the sale of the Company's Lighting and Transformer business included in discontinued operations.
Net income for the fiscal year ended June 30, 2000 includes a $35,125 after-tax gain on the sale of the Company's Motor and European Lighting business included in discontinued operations.
Net income for the fiscal year ended June 30, 1999 includes a $50,988 after-tax gain on the sale of the Company's Generator business included in discontinued operations. Continuing and discontinued operations results in fiscal 1999 include charges aggregating $21,564 and $12,836 respectively, relating to downsizing, inventory adjustments, severance costs and other asset write-downs.
In fiscal year 1999, the effect of employee stock options is anti-dilutive as to earnings per share and is ignored in the computation of diluted earnings per share.
Balance Sheet Data
| As of June 30, (Amounts in thousands) | 2002 | 2001 | 2000 | 1999 | 1998 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total assets | $ | 304,891 | $ | 321,754 | $ | 400,673 | $ | 576,220 | $ | 595,534 | |||||
| Long-term debt, including current portion | 4,124 | 10,134 | 64,040 | 179,181 | 244,714 | ||||||||||
| Common stockholders' equity | 142,819 | 183,707 | 184,206 | 204,885 | 189,558 | ||||||||||
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
During fiscal 2002, Magnetek's operating results were adversely impacted by weakness in key end markets, primarily telecommunications and, to a lesser extent, information technology. Going into the fiscal year, sales to these two markets represented over 60% of our total revenues. As a result, net sales declined some 37% from net sales reported in fiscal 2001 (26% excluding a business divested in 2001). In spite of the sales decline, we were able to remain profitable in fiscal 2002 due to a combination of an improved product mix, cost reduction actions and increased penetration of markets other than telecommunications and information technology, most notably consumer and industrial. Magnetek's strategy will continue to emphasize diversity in both our product offerings and our targeted markets.
As a result of a major restructuring program completed in fiscal 2001, we had proactively adjusted our infrastructure and appropriately sized our manufacturing capacity and overhead. In spite of declining sales, during fiscal 2002 we increased our investment in research and development and also invested in upgrading our sales and marketing capability while reducing general and administrative costs. We intend to maintain our investment level in R&D and continue investment programs in sales and marketing. While we will continue our efforts to control general and administrative costs, we will see an increase in annual pension expense of approximately $2.5 million in fiscal 2003 as compared to fiscal 2002 as a result of lower than expected return on assets held in the pension trust (see Note 13 of Notes to Consolidated Financial Statements).
While profitable for the full fiscal year, Magnetek reported a loss of $.02 per share in the fiscal fourth quarter. Market visibility remains limited, and we may continue to report losses in the initial quarters of fiscal 2003. Beyond that, improved performance depends primarily upon demand levels in our end markets and general economic activity. Although conditions may continue to be challenging, we believe that the strategy we are pursuing will provide future opportunities for growth and improved operating performance.
Magnetek operates in a single business segment, Digital Power Products, including electronic converters, inverters, rectifiers and systems generally known as power controls. These products are used primarily in industrial, telecommunications, data processing, consumer, imaging, power generation and other applications requiring precise, efficient, reliable power. We believe that with our technical, productive and financial resources Magnetek is well positioned to respond to increasing demand for such power.
RESULTS OF OPERATIONS
Net Sales and Gross Profit
Net sales for the Company decreased 36.9% to $188.2 million in fiscal 2002 from $298.3 million in fiscal 2001 and $293.6 million in fiscal 2000. This decrease in fiscal 2002 reflects a substantial slow-down in product demand in the telecommunications sector. Management believes that this slow-down may continue across the telecommunications sector into fiscal 2003. However, excluding the impact of a standard drives product line that was divested in January 2001, revenues decreased 25.6% from fiscal 2001. Revenues increased 1.6% in fiscal 2001 compared to fiscal 2000, but when adjusted for the divestiture, revenues were up 19.0% over fiscal 2000 levels. Gross profits fell in fiscal 2002 to $43.6 million (23.1% of net sales) compared to $76.8 million (25.7% of net sales) in fiscal 2001 and $63.2 million (21.5% of net sales) in fiscal 2000. Gross profit in fiscal 2002 declined due to the sale of standard drives ($10 million) and reduced demand in the telecommunications sector. Gross profit improved in fiscal 2001 over fiscal 2000 due primarily to a more favorable mix of products sold in both power control and industrial control markets.
Operating Expenses
Selling, general and administrative expense (including research and development expenditures) was $41.3 million (21.9% of net sales) in fiscal 2002 compared to $55.8 million (18.7% of net sales) in fiscal 2001 and $56.4 million (19.2% of net sales) in fiscal 2000. The decline in operating expenses from fiscal 2001 included the elimination of $8.1 million of expenses associated with the standard drives product line, with the balance of the reduction due to reduced support costs on the lower revenue base in fiscal 2002. Operating costs were reduced in fiscal 2001 as compared to fiscal 2000 in the areas of sales and marketing while the Company increased expenditures in research and development.
Interest and Other Expenses
Interest expense was $.2 million in fiscal 2002 compared to $4.3 million in fiscal 2001 and $2.9 million in fiscal 2000. In fiscal 2002, the Company repaid all of its domestic bank debt with the proceeds from divestitures of discontinued operations. Interest expense in fiscal years 2001 and 2000 was recorded in accordance with accounting principles that require the allocation of interest expense between continuing and discontinued operations based upon the amount of debt that can be attributed to these operations. Interest expense increased in fiscal 2001 due to the acquisition of J-Tec, Inc. and ADS Power
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Resources, Inc., as well as a share repurchase program. The Company adopted the new rules for accounting for goodwill in the first quarter of fiscal 2002 (See Note 4 of Notes to Consolidated Financial Statements) and there was no goodwill amortization recorded in fiscal 2002, compared to expense of $2.2 million in fiscal 2001 and $1.8 million in fiscal 2000.
Net Income
In fiscal 2002, the Company recorded net income of $1.4 million or $.06 per share on both a basic and diluted basis. The Company recorded net income of $5.7 million or $.25 per share on both a basic and diluted basis in fiscal 2001. Fiscal 2001 results reflect net income of $9.1 million from continuing operations and a $3.4 million loss from discontinued operations (including a $4.1 million loss on the sale of the Company's Lighting and Transformer businesses). Continuing operations earned $.39 per diluted share in 2001 with discontinued operations accounting for a loss of $.14 per diluted share. Fiscal 2000 results reflect net income of $1.3 million from continuing operations, $6.1 million from discontinued operations and a $35.1 million gain on the divestiture of discontinued businesses.
Liquidity and Capital Resources
As of June 30, 2002, long-term borrowings (including current portion) were $4.1 million compared to $10.1 million as of June 30, 2001. The decrease in borrowing was due to the repayment of all of the Company's bank debt with the proceeds from the divestiture of the Company's Transformer business ($19.5 million received in July 2001). During fiscal 2002, the Company also sold a minority investment in a lighting controls company for $4.7 million and completed the acquisition of LAB Communications, Inc. (LAB) for a net cash payment of $1.7 million. The Company also repurchased shares of its common stock on the open market for a total cash outlay of $3.9 million. Net cash used in operating activities was $7.4 million, primarily due to decreases in accounts payable and accrued liabilities, partially offset by decreased levels of accounts receivable and inventories. Capital expenditures in fiscal 2002 were $7.6 million, primarily related to normal maintenance and upgrading of the existing capital infrastructure and the installation of an enterprise resource planning system in the Industrial Controls business.
We currently anticipate capital expenditures in fiscal 2003 to be less than $10 million. There are no current requirements or plans for major capacity expansion, although included in the fiscal 2003 capital budget are modest capital expenditures for expanding our operation in China. The amount of capital expenditures could change depending upon changes in revenue levels, our financial condition and the general economy.
The Company's Board of Directors has authorized the repurchase of up to 10% of the Company's outstanding common stock, or approximately 2.26 million shares. We do not anticipate significant share repurchases during fiscal 2003.
In connection with the acquisition of the net assets of LAB, the Company has a $3.8 million payable to LAB. (see Note 2 of Notes to Consolidated Financial Statements).
Primarily as a result of the decline in stock market equity values, as of June 30, 2002 the accumulated benefit obligation for the Company's defined benefit pension plan exceeded plan assets by approximately $14.4 million. During the two years ended June 30, 2002, the Company made aggregate contributions to the plan of $24.4 million (approximately $15.5 million in cash and the remainder in the Company's common stock). The amount and timing of future contributions to the plan are dependent upon values in equity and fixed income markets and, to a lesser extent, the level of interest rates (see Note 13 of Notes to Consolidated Financial Statements).
The Company may be subject to certain potential environmental and legal liabilities associated with the divestiture of discontinued operations (see Note 11 of Notes to the Consolidated Financial Statements).
The Company has an agreement with a group of banks to provide up to $40 million under a revolving loan facility. Available borrowings are based upon specified levels of domestic accounts receivable and inventories as measured on a quarterly basis. This facility also supports the issuance of letters of credit. As of June 30, 2002 the Company had approximately $31 million of available borrowings under the facility. Additionally, the Company's European subsidiary maintains borrowing arrangements with local banks, primarily to support working capital needs. No amounts were outstanding at June 30, 2002 under any of the Company's bank lending agreements.
Based upon current plans and business conditions, management believes that borrowing capacity under our revolving loan facilities and internally generated cash flows will be sufficient to fund anticipated working capital needs, capital expenditures and other near-term commitments during the next twelve months.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions by management that affect the reported amount of assets and liabilities, revenues and
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related disclosures. Actual results could differ from those estimates. Critical accounting policies and significant assumptions by management are disclosed in Note 1 of the accompanying consolidated financial statements.
Risk Factors Affecting the Company's Financial Outlook
Reduced demand for power products in the telecommunications and information technology industries had a material adverse effect on the Company in fiscal 2002. While reduced demand in these two industries affected many companies to varying degrees, it did not apply to all companies, and if demand in one or both of these industries deteriorates further in subsequent periods, the adverse effect on Magnetek could continue to be material. In addition, the Company is subject to all of the business risks facing public companies, including business cycles and trends in the general economy, financial market conditions, changes in interest rates, demand variations and volatility, potential loss of key personnel, supply chain disruptions, government legislation and regulation, and natural causes.
In addition to variations in demand for power products in the markets Magnetek serves, management believes that the most significant potential risk factors faced by the Company, not necessarily in order of priority, are the following:
Dependence on Customers
Magnetek's sales to its top five customers represented approximately 27% of its net sales in fiscal 2002. The loss of any such customers or significant decreases in any such customers' levels of purchases from Magnetek could have a material adverse effect on the Company's financial position or results of operations.
Competitive Size
The Power Controls industry includes more than 1,000 enterprises, according to Micro-Tech Consultants, an industry research organization. Of these, Magnetek competes directly only with manufacturers of complex, non-commodity power products, which management estimates constitute less than 5% of the industry. However, certain of Magnetek's competitors are significantly larger and have substantially greater resources than the Company. Further, given the current excess capacity and the decline in valuations of companies within the industry, the risk of consolidation in the industry could result in larger competitors than exist today.
In Industrial Controls, Magnetek competes with crane and hoist drive manufacturers and drive system integrators, elevator drive manufacturers and control system integrators, and mining machinery drive builders. The total number of such enterprises with whom Magnetek competes directly is considered to be fewer than 50, and management believes that Magnetek commands the largest North American market share in each area. However, certain of Magnetek's competitors are significantly larger and have substantially greater resources than the Company, and some are global in scope, whereas Magnetek currently competes primarily in the North American market.
International Business
Magnetek's international operations are subject to risks associated with changes in local economic and political conditions, currency exchange restrictions, regulatory requirements and taxes.
Since international sales account for approximately 34% of Magnetek's revenue, currency exchange rates may impact the Company's results. This is partially a currency translation issue with no economic impact on actual results. However, a fluctuation in exchange rates between a foreign currency and the U.S. dollar may have an economic impact on revenue and profit. During fiscal 2002, Magnetek was not materially impacted by such currency fluctuations, but a substantial weakening in the value of the dollar against other currencies, primarily the euro, could have a material adverse effect on the Company's financial position or results of operations.
Intellectual Property
Management believes that Magnetek's intellectual property in the area of digital power-electronics is equal or superior to its competitors' and does not know of any new technologies that could cause a shift away from digital power-electronic solutions. However, as a technology-based company in an industry characterized by short product life cycles, Magnetek is highly dependent on both patented and confidential intellectual property. Therefore, major advancements in digital power-electronic technology by competitors or the advent of technologies obviating digital power-electronic solutions could have a material adverse effect on the Company's financial position or results of operations.
Likewise, the Company could be adversely affected financially should it be judged to have infringed upon the intellectual property of others. Magnetek is currently defending against one such claim alleging infringement of electronic ballast patents, and is seeking judicial relief from the claim (see Note 11 of Notes to Consolidated Financial Statements). The Company was engaged in no other patent infringement litigation at June 30, 2002.
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Environmental Issues
Magnetek has agreed to provide indemnification against environmental liabilities and potential liabilities associated with operations that it has divested, including certain motor, generator, lighting ballast, transformer and drive manufacturing operations. Such liabilities, if any, could have a material adverse effect on the Company's financial position. Further, Magnetek has been indemnified against potential environmental liabilities and potential liabilities associated with operations that it has acquired, including lighting ballast, transformer, capacitor and crane brake manufacturing operations that were subsequently divested. If not borne by the indemnifiers, such liabilities, if any, could have a material adverse effect on the Company's financial position or results of operations (see Note 11 of Notes to Consolidated Financial Statements).
Acquisitions
Magnetek's business strategy calls for growth and diversification in the digital power-electronic products business. Pursuing acquisition opportunities and attempting to integrate and manage acquired businesses requires significant resources, including management time and skill, and these efforts may detract from the management or operation of these and the Company's other businesses. Additionally, acquired businesses may not perform as anticipated, thereby causing Magnetek's operating results to suffer.
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risks in the areas of foreign exchange and interest rates. To mitigate the effect of such risks, the Company selectively utilizes specific financial instruments. Hedging transactions can be entered into under Company policies and procedures and are monitored monthly. Company policy clearly prohibits the use of such financial instruments for trading or speculative purposes. A discussion of the Company's accounting policies for derivative financial instruments is included in the Summary of Significant Accounting Policies under Note 1 in the Notes to Consolidated Financial Statements.
Interest Rates
The fair value of the Company's debt was $4 million and $10 million at June 30, 2002 and June 30, 2001, respectively. The fair value of the Company's debt is equal to the borrowings outstanding from domestic and foreign banks and small amounts owed under capital lease arrangements. Prospectively, the Company does not consider there to be material risk due to changes in the interest rate structure of borrowing rates applicable to such debt. For the Company's debt outstanding at June 30, 2002 and 2001, a hypothetical 10% adverse change in interest rates would have had minimal impact on the Company's pre-tax earnings and cash flow.
Foreign Currency Exchange Rates
The Company may selectively enter into foreign exchange contracts to hedge certain balance sheet exposures in Europe. In fiscal year 2001, the Company entered into foreign exchange contracts with respect to discontinued operations to hedge cost exposures related to manufacturing facilities in Mexico. The Company had no foreign currency contracts outstanding at June 30, 2002 and 2001.
As a condition to the sale of its Lighting business, the Company agreed to provide the buyer, for a period of five months following the sale, a fixed peso to dollar conversion rate for a specified amount of peso denominated costs. At June 30, 2001 the Company included in its loss on sale of the Lighting business the difference between the guaranteed conversion rate and the market rate at the sale date. All amounts due under the peso to dollar conversion agreement were finalized in the first six months of fiscal 2002.
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CONSOLIDATED STATEMENTS OF INCOME
| For the years ended June 30, (Amounts in thousands, except per share data) | 2002 | 2001 | 2000 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Net sales | $ | 188,224 | $ | 298,260 | $ | 293,575 | ||||
| Cost of sales | 144,663 | 221,494 | 230,366 | |||||||
| Gross profit | 43,561 | 76,766 | 63,209 | |||||||
| Research and development | 9,770 | 9,417 | 8,125 | |||||||
| Sales, general and administrative | 31,513 | 46,359 | 48,244 | |||||||
| Income from operations | 2,278 | 20,990 | 6,840 | |||||||
| Interest expense | 194 | 4,335 | 2,907 | |||||||
| Other expense (income), net | (224 | ) | 1,972 | 1,851 | ||||||
| Income from continuing operations before provision for income taxes | 2,308 | 14,683 | 2,082 | |||||||
| Provision for income taxes | 900 | 5,600 | 800 | |||||||
| Income from continuing operations | 1,408 | 9,083 | 1,282 | |||||||
| Discontinued operations - | ||||||||||
| Income from operations (net of taxes) | – | 764 | 6,045 | |||||||
| Gain (loss) from discontinued operations | – | (4,114 | ) | 35,125 | ||||||
| Net income | $ | 1,408 | $ | 5,733 | $ | 42,452 | ||||
| Per common share basic: | ||||||||||
| Income from continuing operations | $ | 0.06 | $ | 0.40 | $ | 0.05 | ||||
| Income (loss) from discontinued operations | – | (0.15 | ) | 1.66 | ||||||
| Net income | $ | 0.06 | $ | 0.25 | $ | 1.71 | ||||
| Per common share diluted: | ||||||||||
| Income from continuing operations | $ | 0.06 | $ | 0.39 | $ | 0.05 | ||||
| Income (loss) from discontinued operations | – | (0.14 | ) | 1.65 | ||||||
| Net income | $ | 0.06 | $ | 0.25 | $ | 1.70 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
10
| As of June 30, (Amounts in thousands, except per share data) | 2002 | 2001 | ||||||
|---|---|---|---|---|---|---|---|---|
| Assets | ||||||||
| Current assets: | ||||||||
| Cash | $ | 4,816 | $ | 5,310 | ||||
| Accounts receivable, less allowance for doubtful accounts of $2,432 in 2002 and $5,235 in 2001 | 41,532 | 51,074 | ||||||
| Inventories | 45,338 | 48,907 | ||||||
| Deferred income taxes | 6,348 | 8,053 | ||||||
| Prepaids and other assets | 2,419 | 3,624 | ||||||
| Total current assets | 100,453 | 116,968 | ||||||
| Property, plant and equipment: | ||||||||
| Land | 1,060 | 960 | ||||||
| Buildings and improvements | 10,894 | 8,665 | ||||||
| Machinery and equipment | 81,213 | 66,977 | ||||||
| Less accumulated depreciation and amortization | 61,194 | 45,664 | ||||||
| Net property, plant and equipment | 31,973 | 30,938 | ||||||
| Net assets of discontinued operations | – | 19,500 | ||||||
| Goodwill, less accumulated amortization of $9,720 in 2002 and 2001 | 95,533 | 88,784 | ||||||
| Prepaid pension and other assets | 76,932 | 65,564 | ||||||
| $ | 304,891 | $ | 321,754 | |||||
| Liabilities and Stockholders' Equity | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 25,386 | $ | 33,946 | ||||
| Accrued liabilities | 18,559 | 33,743 | ||||||
| Current portion of long-term debt | 407 | 5,822 | ||||||
| Total current liabilities | 44,352 | 73,511 | ||||||
| Long-term debt, net of current portion | 3,717 | 4,312 | ||||||
| Pension benefit obligations | 74,363 | – | ||||||
| Other long-term obligations | 39,640 | 37,915 | ||||||
| Deferred income taxes | – | 22,309 | ||||||
Commitments and contingencies | ||||||||
Stockholders' Equity: | ||||||||
| Common stock, $0.01 par value, 100,000,000 shares authorized 23,511,000 and 22,717,000 shares issued and outstanding in 2002 and 2001 | 236 | 227 | ||||||
| Additional paid-in capital | 106,216 | 97,951 | ||||||
| Retained earnings | 115,803 | 114,395 | ||||||
| Accumulated other comprehensive loss | (79,436 | ) | (28,866 | ) | ||||
| Total stockholders' equity | 142,819 | 183,707 | ||||||
| $ | 304,891 | $ | 321,754 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
11
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
| | Common Stock | | | | | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Amounts in thousands, except share data) | | | | | | |||||||||||||
| | Shares | Amount | Additional paid-in capital | Retained Earnings | Accumulated Other Comprehensive Loss | Total | ||||||||||||
| Balance, June 30, 1999 | 29,986,000 | $ | 300 | $ | 160,574 | $ | 66,210 | $ | (22,199 | ) | $ | 204,885 | ||||||
| Exercise of stock options | 195,000 | 2 | 1,730 | – | – | 1,732 | ||||||||||||
| Share value trust | – | – | (303 | ) | – | – | (303 | ) | ||||||||||
| Unearned employee compensation | – | – | 303 | – | – | 303 | ||||||||||||
| Share repurchase/retirement | (7,108,000 | ) | (71 | ) | (62,320 | ) | – | – | (62,391 | ) | ||||||||
| Tax benefit for options exercised | – | – | 415 | – | – | 415 | ||||||||||||
| Net income | – | – | – | 42,452 | – | 42,452 | ||||||||||||
| Translation adjustments | – | – | – | – | (2,887 | ) | (2,887 | ) | ||||||||||
| Comprehensive income - 2000 | – | – | – | – | – | 39,565 | ||||||||||||
| Balance, June 30, 2000 | 23,073,000 | $ | 231 | $ | 100,399 | $ | 108,662 | $ | (25,086 | ) | $ | 184,206 | ||||||
| Exercise of stock options | 301,000 | 3 | 2,589 | – | – | 2,592 | ||||||||||||
| Shares retired from trust | (180,000 | ) | (2 | ) | – | – | – | (2 | ) | |||||||||
| Shares sold from trust | – | – | 216 | – | – | 216 | ||||||||||||
| Shares issued for acquisition | 598,000 | 6 | 6,658 | – | – | 6,664 | ||||||||||||
| Share repurchase/retirement | (1,075,000 | ) | (11 | ) | (12,342 | ) | – | – | (12,353 | ) | ||||||||
| Tax benefit for options exercised | – | – | 431 | – | – | 431 | ||||||||||||
| Net income | – | – | – | 5,733 | – | 5,733 | ||||||||||||
| Translation adjustments | – | – | – | – | (3,780 | ) | (3,780 | ) | ||||||||||
| Comprehensive income - 2001 | – | – | – | – | – | 1,953 | ||||||||||||
| Balance, June 30, 2001 | 22,717,000 | $ | 227 | $ | 97,951 | $ | 114,395 | $ | (28,866 | ) | $ | 183,707 | ||||||
| Exercise of stock options | 252,000 | 3 | 2,172 | – | – | 2,175 | ||||||||||||
| Share repurchase / retirement | (264,000 | ) | (3 | ) | (3,030 | ) | – | – | (3,033 | ) | ||||||||
| Employee stock purchase plan | 2,000 | – | 17 | – | – | 17 | ||||||||||||
| Pension plan contribution | 900,000 | 9 | 8,892 | – | – | 8,901 | ||||||||||||
| Deferred compensation plan | – | 1 | 883 | – | – | 884 | ||||||||||||
| Share value trust | (96,000 | ) | (1 | ) | (883 | ) | – | – | (884 | ) | ||||||||
| Tax benefit for options exercised | – | – | 214 | – | – | 214 | ||||||||||||
| Net income | – | – | – | 1,408 | – | 1,408 | ||||||||||||
| Translation adjustments | – | – | – | – | 6,394 | 6,394 | ||||||||||||
| Minimum pension liability | – | – | – | – | (56,964 | ) | (56,964 | ) | ||||||||||
| Comprehensive loss - 2002 | – | – | – | – | – | (49,162 | ) | |||||||||||
| Balance, June 30, 2002 | 23,511,000 | $ | 236 | $ | 106,216 | $ | 115,803 | $ | (79,436 | ) | $ | 142,819 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
12
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the years ended June 30, (Amounts in thousands) | 2002 | 2001 | 2000 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Cash flows from operating activities: | |||||||||||
| Income from continuing operations | $ | 1,408 | $ | 9,083 | $ | 1,282 | |||||
| Adjustments to reconcile income from continuing operations to net cash used in operating activities: | |||||||||||
| Depreciation | 9,369 | 9,442 | 10,501 | ||||||||
| Amortization | 17 | 2,958 | 2,837 | ||||||||
| Changes in operating assets and liabilities of continuing operations | (18,232 | ) | (41,610 | ) | (21,844 | ) | |||||
| Total adjustments | (8,846 | ) | (29,210 | ) | (8,506 | ) | |||||
| Net cash used in operating activities | (7,438 | ) | (20,127 | ) | (7,224 | ) | |||||
| Cash flows from investing activities: | |||||||||||
| Purchase and investment in companies, net of cash acquired | (1,691 | ) | (33,348 | ) | (48,245 | ) | |||||
| Proceeds from sale of businesses and other assets | 24,264 | 133,995 | 255,445 | ||||||||
| Capital expenditures | (7,626 | ) | (9,006 | ) | (8,375 | ) | |||||
| Net cash provided by investing activities | 14,947 | 91,641 | 198,825 | ||||||||
| Cash flows from financing activities: | |||||||||||
| Proceeds from sale of trust shares | — | 214 | — | ||||||||
| Proceeds from issuance of common stock | 2,175 | 2,592 | 1,732 | ||||||||
| Proceeds from employee stock purchase plan | 17 | — | — | ||||||||
| Repurchase of common stock | (3,917 | ) | (12,353 | ) | (62,391 | ) | |||||
| Repayment of bank and other long-term obligations | (6,010 | ) | (53,906 | ) | (115,141 | ) | |||||
| Increase in deferred financing costs | (268 | ) | — | (746 | ) | ||||||
| Net cash used in financing activities | (8,003 | ) | (63,453 | ) | (176,546 | ) | |||||
| Net cash provided by (used in) continuing operations | (494 | ) | 8,061 | 15,055 | |||||||
| Cash flows from discontinued operations: | |||||||||||
| Income from discontinued operations | — | 764 | 6,045 | ||||||||
| Adjustments to reconcile income to net cash used in discontinued operations: | |||||||||||
| Depreciation and amortization | — | 10,608 | 11,208 | ||||||||
| Changes in operating assets and liabilities of discontinued operations | — | (5,701 | ) | (28,750 | ) | ||||||
| Capital expenditures | — | (8,765 | ) | (9,105 | ) | ||||||
| Net cash used in discontinued operations | $ | — | $ | (3,094 | ) | $ | (20,602 | ) | |||
| Net increase (decrease) in cash | (494 | ) | 4,967 | (5,547 | ) | ||||||
| Cash at the beginning of the year | 5,310 | 343 | 5,890 | ||||||||
| Cash at the end of the year | $ | 4,816 | $ | 5,310 | $ | 343 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All amounts in the notes to consolidated financial statements are expressed in thousands except share and per share data)
1. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Magnetek, Inc. and its subsidiaries (the "Company" or "Magnetek"). All significant inter-company accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant areas requiring management estimates include the following key financial areas:
Accounts Receivable
Accounts receivable represent receivables from customers in the ordinary course of business. The Company is subject to losses from uncollectible receivables in excess of its allowances. The Company maintains allowances for doubtful accounts for estimated losses from customers' inability to make required payments. In order to estimate the appropriate level of this allowance, the Company analyzes historical bad debts, customer concentrations, current customer creditworthiness, current economic trends and changes in customer payment patterns. If the financial conditions of the Company's customers were to deteriorate and to impair their ability to make payments, additional allowances may be required in future periods. The Company's management believes that all appropriate allowances have been provided.
Inventories
The Company's inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method, including material, labor and factory overhead. Inventory on hand may exceed future demand either because the product is obsolete, or the amount on hand is more than can be used to meet future needs. The Company identifies potentially obsolete and excess inventory by evaluating overall inventory levels. In assessing the ultimate realization of inventories, the Company is required to make judgments as to future demand requirements and compare those with the current or committed inventory levels. If future demand requirements are less favorable than those projected by management, additional inventory write-downs may be required.
Reserves for Litigation and Environmental Issues
The Company periodically records the estimated impacts of various conditions, situations or circumstances involving uncertain outcomes. The accounting for such events is prescribed under Statement of Financial Accounting Standards (SFAS) No. 5, "Accounting for Contingencies." SFAS No. 5 defines a contingency as "an existing conditions, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur."
SFAS No. 5 does not permit the accrual of gain contingencies under any circumstances. For loss contingencies, the loss must be accrued if (1) information is available that indicates it is probable that the loss has been incurred, given the likelihood of uncertain events; and (2) the amount of the loss can be reasonably estimated.
The accrual of a contingency involves considerable judgment on the part of management. The Company uses its internal expertise, and outside experts, as necessary, to help estimate the probability that a loss has been incurred and the amount (or range) of the loss.
Income Taxes
The Company uses the liability method to account for income taxes. The preparation of consolidated financial statements involves estimating the Company's current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the consolidated balance sheets. An assessment of the recoverability of the deferred tax assets is made, and a valuation allowance is established based upon this assessment.
14
Federal income taxes are not provided currently on undistributed earnings of foreign subsidiaries since the Company presently intends to reinvest any earning overseas indefinitely.
Pensions and Post Retirement Benefits
The valuation of the Company's pension and other post-retirement plans requires the use of assumptions and estimates that are used to develop actuarial valuations of expenses and assets/liabilities. These assumptions include discount rates, investment returns, projected salary increases and benefits, and mortality rates. Changes in assumptions and future investment returns could potentially have a material impact on the Company's expenses and related funding requirements.
Revenue Recognition
The Company's policy is to record and recognize sales only upon shipment. Amounts billed to customers for shipping costs are reflected in net sales; shipping costs incurred are reflected in cost of sales.
Property, Plant and Equipment
Additions and improvements are capitalized at cost, whereas expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is provided over the estimated useful lives of the respective assets principally on the straight-line method (machinery and equipment normally five to ten years, buildings and improvements normally ten to forty years).
Accounting For Stock Options
As permitted under SFAS No. 123, "Accounting for Stock-Based Compensation," the Company has elected to follow Accounting Principles Board Opinion (APB) No. 25 "Accounting for Stock Issued to Employees" and related interpretations in accounting for stock based awards to employees. Under APB 25, the Company recognizes no compensation expense with respect to such awards when the exercise price is equal to or greater than the market price at the date of grant.
Recent Accounting Pronouncements
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138 requires all derivatives to be recorded on the balance sheet at fair value. This results in the offsetting changes in fair values or cash flows of both the hedge and the hedged item being recognized in earnings or in other comprehensive income in the same period. Changes in fair value of derivatives not meeting the Statement's hedge criteria are included in income. The Company adopted the Statement on July 1, 2000, and the adoption did not have a significant effect on its results of operations or financial position.
In June 2001, SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," were issued. Under the new rules, goodwill is no longer amortized but is subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. The Company applied the new rules for accounting for goodwill and other intangible assets beginning in fiscal year 2002. The Company performed the required impairment test in fiscal year 2002 and found no indication of impairment as of the measurement date.
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and the accounting and reporting provision of APB Opinion No. 30, "Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions" was issued. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and removes goodwill from its scope and clarified other implementation issues related to SFAS No. 121. SFAS No. 144 also provides a single framework for evaluating long-lived assets to be disposed of by sale. The Company does not expect SFAS No. 144 to have a material impact on its results of operations or financial position.
Research and Development
Expenditures for research and development are charged to expense as incurred and aggregated $9,770, $9,417 and $8,125 for the years ended June 30, 2002, 2001, and 2000, respectively.
15
Derivative Financial Instruments
The Company utilizes derivative financial instruments to reduce financial market risks. These instruments are used to hedge foreign currency and interest rate market exposures. The Company does not use derivative financial instruments for speculative or trading purposes. The accounting policies for these instruments are based on the Company's designation of such instruments as hedging transactions. The criteria the Company uses for designating an instrument as a hedge include the instrument's effectiveness in risk reduction and the matching of the derivative to the underlying transaction. The resulting gains or losses are accounted for as part of the transactions being hedged, except that losses not expected to be recovered upon the completion of the hedge transaction are expensed.
Deferred Financing Costs, Intangible and Other Assets
Costs incurred to obtain financing are deferred and amortized over the term of the financing. Amortization expense relating to deferred financing costs was $17, $683 and $582 for the years ended June 30, 2002, 2001 and 2000, respectively. Based upon the Company's adoption of SFAS No. 142, no goodwill amortization was recorded in the fiscal year ended June 30, 2002. Amortization expense relating to goodwill was $2,183 and $1,768 for the years ended June 30, 2001 and 2000, respectively.
Earnings Per Share
In accordance with SFAS No. 128, "Earnings Per Share," basic earnings per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share incorporate the incremental shares issuable upon the assumed exercise of stock options as if all exercises had occurred at the beginning of the fiscal year.
Fiscal Year
The Company uses a fifty-two, fifty-three week fiscal year ending on the Sunday nearest June 30. For consistency of presentation, all periods are presented as if the year ended on June 30. Fiscal years 2002 and 2001 contained 52 weeks and fiscal year 2000 contained 53 weeks.
2. Acquisitions/Divestitures
On May 24, 2002, the Company purchased the net assets of LAB Communications, Inc. (LAB) for cash of approximately $1.7 million (net of cash acquired of approximately $.2 million) and a payable to LAB of $3.8 million, subject to post closing adjustments. The Company acquired assets of approximately $1.7 million and assumed liabilities of $1.3 million. The purchase price has been allocated to the net assets acquired based upon their estimated fair market values. The acquisition was financed from the Company's available cash balances.
On March 2, 2001, the Company acquired ADS Power Resource, Inc., for approximately $8.8 million in cash and 597,691 shares of the Company's stock, valued at approximately $6.7 million. The Company acquired assets of approximately $4.7 million (including cash balances approximating $.4 million) and assumed liabilities of $.9 million. Costs in excess of net assets acquired, approximately $11.8 million, were recorded as goodwill. The cash portion of the purchase price was financed from the Company's revolving credit facility.
On January 29, 2001, the Company sold its Standard Drives business to Yaskawa Electric of America for approximately $27.6 million in cash. The business was part of the Company's Drives and Industrial Controls business and was responsible for assembling, marketing, selling, servicing and repairing Yaskawa general purpose AC drives and related products. Proceeds from the sale were used for debt repayment.
On November 13, 2000, the Company purchased all of the outstanding shares of J-Tec, Inc. for approximately $24 million. The Company acquired assets of approximately $13.1 million (including cash balances approximating $2.9 million) and assumed liabilities of $4.6 million. Post closing adjustments were completed in the third quarter of fiscal 2001 based upon the change in net assets acquired at closing versus a contractually agreed upon level of transferred net assets. Subsequent to post closing adjustments, total acquisition costs in excess of net assets acquired, approximately $19.2 million, were recorded as goodwill. J-Tec, Inc. is a power systems integrator serving the domestic telecommunications industry. The acquisition was financed from the Company's revolving credit facility.
On December 16, 1999 the Company purchased the shares of Mondel ULC, a Nova Scotia unlimited liability company for approximately $10 million. The Company acquired assets of approximately $2.5 million and assumed liabilities of $.3 million. Costs in excess of net assets acquired, approximately $7.8 million, were recorded as goodwill. Mondel ULC
16
manufactures a variety of industrial brakes for the crane and hoist market. The acquisition was financed from the Company's revolving credit facility.
On July 23, 1999, the Company purchased the assets of Electric Motor Systems, Inc., Electromotive Systems, Inc., and EMS/Rosa Automation Engineering, Inc., (the "EMS Group") for cash of approximately $38.3 million. The Company acquired assets of approximately $19.8 million and assumed liabilities of $8.1 million. Costs in excess of net assets acquired, approximately $26.6 million, were recorded as goodwill. The acquisition was financed from the Company's revolving credit facility.
The above acquisitions have been accounted for under the purchase method of accounting and, accordingly the purchase price has been allocated to the net assets acquired based upon their estimated fair market values.
Operating results were included, or excluded, for all of the acquisitions and divestitures in the Company's consolidated results effective as of the acquisition or divestiture dates. The following pro forma information includes the operations of the acquired/divested entities for fiscal years 2001 and 2000 as if the respective transactions had occurred on the first day of the fiscal year immediately preceding the year of acquisition or divestiture. Pro forma information has not been presented for fiscal year 2002 as results would not differ materially from historical results.
| For the years ended June 30, (Amounts in thousands, except per share data) | (actual) | (pro forma) | (pro forma) | ||||||
| 2002 | 2001 | 2000 | |||||||
| Net sales | $ | 188,224 | $ | 273,241 | $ | 255,591 | |||
| Income from continuing operations | 1,408 | 10,198 | 4,988 | ||||||
| Net income | $ | 1,408 | $ | 6,848 | $ | 46,158 | |||
Continuing operations | |||||||||
| Basic EPS | $ | 0.06 | $ | 0.45 | $ | 0.20 | |||
| Diluted EPS | $ | 0.06 | $ | 0.44 | $ | 0.20 | |||
Net income | |||||||||
| Basic EPS | $ | 0.06 | $ | 0.30 | $ | 1.61 | |||
| Diluted EPS | $ | 0.06 | $ | 0.30 | $ | 1.61 | |||
The pro forma results of operations do not purport to represent what the Company's results would have been had such transactions occurred at the beginning of the periods presented or to project the Company's results of operations in any future period.
3. Discontinued Operations
For the year ending June 30, 2002 there was no income related to discontinued operations. The results of the Company's electrical products businesses (Generators, Motors, Lighting and Transformers) are included in prior years within discontinued operations. The accompanying financial statements have been restated to conform to discontinued operations treatment for all historical periods.
On June 15, 2001 the Company sold its Lighting business to Universal Lighting Technologies, Inc., a subsidiary of Littlejohn Fund II, L.P., and on June 29, 2001 sold its Transformer business to American Circuit Breaker Corporation. Pre-tax proceeds received from the sale of the Lighting business were $105 million and were used to repay borrowings under the Bank Loan Agreement and repurchase shares of its common stock in fiscal year 2001. As of June 30, 2001, the $19.5 million classified on the balance sheet as net assets of discontinued operations represents the receivable value for the sale on June 29, 2001 of the Transformer business, which was subsequently collected on July 2, 2001 (fiscal year 2002). Proceeds from the sale of the Transformer business were used to repay debt and repurchase shares of common stock in fiscal year 2002.
On December 23, 1999, the Company sold its European Magnetic Lighting business to a group including former and current management. Net assets of the Company's German operations and certain inventory and fixed assets located in Milan, Italy were included in the transaction. Net proceeds, including the assumption of debt by the buyers, approximated $2.5 million. In addition, the buyers agreed to indemnify Magnetek for substantially all past, present and future obligations in connection with the business' operations in Germany. In connection with the sale, the Company also announced the closure of its Milan factory, which was completed in fiscal year 2000.
In April, 1999 the Company sold its Generator business to Emerson Electric, and in August, 1999 the Company sold its Motor business to A. O. Smith. Pre-tax proceeds received from the divestiture of the Generator and Motor businesses were
17
$115 million and $253 million, respectively. These proceeds were used to repay debt, repurchase shares of common stock and fund acquisitions made in fiscal year 2000.
The operating results of discontinued operations are as follows:
| Year ended June 30 | 2002 | 2001 | 2000 | ||||||
|---|---|---|---|---|---|---|---|---|---|
| Net sales | $ | – | $ | 353,803 | $ | 452,274 | |||
| Income before provision for income taxes | – | 1,164 | 9,745 | ||||||
| Provision for income taxes | – | 400 | 3,700 | ||||||
| Income from discontinued operations | $ | – | $ | 764 | $ | 6,045 | |||
A portion of the Company's interest expense has been allocated to discontinued operations in accordance with EITF 87-24, "Allocation of Interest to Discontinued Operations" (interest expense allocated to discontinued operations was $3.5 million in fiscal 2001, and $3.3 million in fiscal 2000). Taxes have been allocated using the same overall rate for the Company in each of the fiscal years presented.
Net income for the year ended June 30, 2001 includes a $4,114 (including a tax benefit of $2,600) loss on the sale of the Company's Lighting and Transformer business included in discontinued operations. Net income for the year ended June 30, 2000 includes a $35,125 (including a tax benefit of $3,000) gain on the sale of the Company's Motor and European Lighting business included in discontinued operations.
4. Goodwill
The Company adopted SFAS No. 142, Goodwill and other Intangible Assets, effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but rather reviewed for impairment annually, or more frequently if certain indicators arise. The Company completed its required test under the SFAS and determined there is no impairment to its recorded goodwill balances. Had the Company accounted for its goodwill under SFAS No. 142 for all periods presented, net income and earnings per share would have been as follows:
| | 2002 | 2001 | 2000 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Reported net income | $ | 1,408 | $ | 5,733 | $ | 42,452 | ||||
| Add back goodwill amortization net of tax | – | 1,340 | 1,089 | |||||||
| Adjusted net income | $ | 1,408 | $ | 7,073 | $ | 43,541 | ||||
| Basic earnings per share | ||||||||||
| Reported net income | $ | 0.06 | $ | 0.25 | $ | 1.71 | ||||
| Goodwill amortization net of tax | – | 0.06 | 0.04 | |||||||
| Adjusted net income | $ | 0.06 | $ | 0.31 | $ | 1.75 | ||||
| Diluted earnings per share | ||||||||||
| Reported net income | $ | 0.06 | $ | 0.25 | $ | 1.70 | ||||
| Goodwill amortization net of tax | – | 0.06 | 0.04 | |||||||
| Adjusted net income | $ | 0.06 | $ | 0.31 | $ | 1.74 | ||||
5. Inventories
Inventories at June 30, consist of the following:
| | 2002 | 2001 | ||||
|---|---|---|---|---|---|---|
| Raw materials | $ | 29,201 | $ | 29,513 | ||
| Work-in-process | 10,747 | 8,839 | ||||
| Finished goods | 5,390 | 10,555 | ||||
| $ | 45,338 | $ | 48,907 | |||
18
6. Long-Term Debt and Bank Borrowing Arrangements
Long-term debt at June 30, consists of the following:
| | 2002 | 2001 | ||||
|---|---|---|---|---|---|---|
| Revolving bank loans | $ | – | $ | 4,900 | ||
| Miscellaneous installment notes, capital leases and other obligations at rates ranging from 4.3 percent to 10.5 percent, due through 2007 | 4,124 | 5,234 | ||||
| 4,124 | 10,134 | |||||
| Less current portion | 407 | 5,822 | ||||
| $ | 3,717 | $ | 4,312 | |||
Bank Borrowing Arrangements
At June 30, 2002, the Company had an agreement with a syndicate of banks to lend up to $40,000 under a revolving loan facility through December 17, 2003. Borrowings under the agreement (the "Bank Loan Agreement") bear interest at the bank's prime lending rate or, at the Company's option, the London Interbank Offered Rate plus one and a half percent. These rates may be reduced or increased based on the level of certain funded debt ratios. At June 30, 2002, there were no borrowings under the Bank Loan Agreement. The Company is required to pay a commitment fee of .3 percent on unused commitments.
Borrowings under the Bank Loan Agreement are secured by equipment, accounts receivable, general intangibles and inventories of the Company and certain of its subsidiaries, and by the outstanding stock of certain of the Company's subsidiaries. The Bank Loan Agreement contains certain provisions and covenants which, among other things, restrict the payment of cash dividends on common stock, limit the amount of future indebtedness and require the Company to maintain specified levels of net worth and cash flow.
The Company's European subsidiary has certain limited local borrowing arrangements to finance working capital needs. The borrowings under these arrangements are secured by accounts receivable and inventories of the subsidiary. The Company has provided parent guarantees to the local banks which provide the related financing.
Aggregate principal maturities on long-term debt outstanding at June 30, 2002 are as follows:
| Year ended June 30 | | ||
|---|---|---|---|
| 2003 | $ | 407 | |
| 2004 | 1,038 | ||
| 2005 | 872 | ||
| 2006 | 678 | ||
| 2007 | 519 | ||
| Thereafter | 610 | ||
| $ | 4,124 | ||
19
The following table sets forth the computation of basic and diluted earnings per share.
| | 2002 | 2001 | 2000 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Basic earnings per share: | ||||||||||
| Income from continuing operations | $ | 1,408 | $ | 9,083 | $ | 1,282 | ||||
| Income from discontinued operations | – | 764 | 6,045 | |||||||
| Gain (loss) on sale of discontinued businesses (net of taxes) | – | (4,114 | ) | 35,125 | ||||||
| Net income | $ | 1,408 | $ | 5,733 | $ | 42,452 | ||||
| Weighted average shares for basic earnings per share | 22,517 | 22,548 | 24,862 | |||||||
| Basic earnings per share | ||||||||||
| Income from continuing operations | $ | 0.06 | $ | 0.40 | $ | 0.05 | ||||
| Income from discontinued operations | – | 0.03 | 0.25 | |||||||
| Gain (loss) on sale of discontinued businesses (net of taxes) | – | (0.18 | ) | 1.41 | ||||||
| Basic earnings per share | $ | 0.06 | $ | 0.25 | $ | 1.71 | ||||
| Diluted earnings per share: | ||||||||||
| Income from continuing operations | $ | 1,408 | $ | 9,083 | $ | 1,282 | ||||
| Income from discontinued operations | – | 764 | 6,045 | |||||||
| Gain (loss) on sale of discontinued businesses (net of taxes) | – | (4,114 | ) | 35,125 | ||||||
| Net income | $ | 1,408 | $ | 5,733 | $ | 42,452 | ||||
| Weighted average shares for diluted earnings per share | 22,517 | 22,548 | 24,862 | |||||||
| Effect of dilutive stock options | 471 | 605 | 85 | |||||||
| Weighted average shares for diluted earnings per share | 22,988 | 23,153 | 24,947 | |||||||
| Diluted earnings per share: | ||||||||||
| Income from continuing operations | $ | 0.06 | $ | 0.39 | $ | 0.05 | ||||
| Income from discontinued operations | – | 0.03 | 0.24 | |||||||
| Gain (loss) on sale of discontinued businesses (net of taxes) | – | (0.17 | ) | 1.41 | ||||||
| Diluted earnings per share: | $ | 0.06 | $ | 0.25 | $ | 1.70 | ||||
8. Fair Values of Financial Instruments
The carrying amounts of certain financial instruments such as cash, annuity contracts and borrowings under revolving credit agreements approximate their fair values.
9. Derivative Financial Instruments
The Company periodically uses certain foreign exchange contracts, primarily to minimize its risk of loss from fluctuations in exchange rates affecting foreign currency receivables. Gains and losses from these transactions are recorded in cost of sales as the contracts are liquidated. The Company liquidated all forward currency contracts as of June 30, 2002. With the sale of discontinued operations, the Company liquidated all copper and aluminum forward contracts as of June 30, 2001. Due to significantly lower debt levels, the Company liquidated all interest rate swaps in fiscal year 2000. The Company does not use derivative financial instruments for speculative or trading purposes.
As a condition of the sale of its Lighting business, the Company agreed to provide for a period of five months following the sale, a fixed peso to dollar conversion rate for a specified amount of peso denominated costs. This derivative does not qualify for hedge treatment under SFAS No. 133. As such, the Company recorded $937 as the fair value of the liability as of June 30, 2001. The actual liability incurred was less than the fair value of the liability as of June 30, 2001 by an immaterial amount.
20
10. Income Taxes
Income tax expense (benefit) is allocated in the financial statements as follows:
| Year ended June 30 | 2002 | 2001 | 2000 | ||||||
|---|---|---|---|---|---|---|---|---|---|
| Income tax expense (benefit) attributable to continuing operations | $ | 900 | $ | 5,600 | $ | 800 | |||
| Discontinued operations | – | (2,200 | ) | 700 | |||||
| Total | $ | 900 | $ | 3,400 | $ | 1,500 | |||
The expense for income taxes applicable to continuing operations is as follows:
| Year ended June 30 | 2002 | 2001 | 2000 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Current: | |||||||||||
| Federal | $ | (89 | ) | $ | – | $ | (7,167 | ) | |||
| State | 472 | 1,429 | 855 | ||||||||
| Foreign | 4,121 | 7,351 | 2,590 | ||||||||
| Deferred: | |||||||||||
| Federal | (816 | ) | (1,739 | ) | 4,765 | ||||||
| State and Foreign | (2,788 | ) | (1,441 | ) | (243 | ) | |||||
| $ | 900 | $ | 5,600 | $ | 800 | ||||||
A reconciliation of the Company's effective tax rate to the statutory Federal tax rate for income from continuing operations is as follows:
| 2002 | 2001 | 2000 | ||||||||||||||
| Year ended June 30 | Amount | % | Amount | % | Amount | % | ||||||||||
| Provision computed at the statutory rate | $ | 808 | 35.0 | $ | 5,139 | 35.0 | $ | 729 | 35.0 | |||||||
| State income taxes, net of federal benefit | 289 | 12.5 | 873 | 5.9 | 556 | 26.4 | ||||||||||
| Foreign tax rates in excess of federal statutory rate | 145 | 6.3 | 1,077 | 7.3 | (1,607 | ) | (76.4 | ) | ||||||||
| Benefit due to federal tax law change | (1,154 | ) | (50.0 | ) | – | – | – | – | ||||||||
| Provision for additional taxes | 794 | 34.4 | (3,063 | ) | (20.9 | ) | 1,056 | 50.2 | ||||||||
| Other - net | 18 | 0.8 | 1,574 | 10.7 | 66 | 2.8 | ||||||||||
| $ | 900 | 39.0 | $ | 5,600 | 38.0 | $ | 800 | 38.0 | ||||||||
Income before provision for income taxes of the Company's foreign subsidiaries was approximately $3,655, $14,632 and $9,812 for the years ended June 30, 2002, 2001 and 2000.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets for continuing operations as of June 30, 2002 and 2001 are as follows:
| Year ended June 30 | 2002 | 2001 | |||||
|---|---|---|---|---|---|---|---|
| Deferred tax liabilities: | |||||||
| Depreciation and amortization (including differences in the basis of acquired assets) | $ | 11,534 | $ | 16,224 | |||
| Prepaid pension asset | – | 18,791 | |||||
| Total deferred tax liabilities | 11,534 | 35,015 | |||||
| Deferred tax assets: | |||||||
| Postretirement medical benefit obligation | 11,617 | 12,706 | |||||
| Warranty reserves | 143 | 180 | |||||
| Inventory and other reserves (including restructuring) | 6,122 | 7,873 | |||||
| Total gross deferred tax assets | 17,882 | 20,759 | |||||
| Net deferred tax liability (asset) | $ | (6,348 | ) | $ | 14,256 | ||
The Company has determined that, as of June 30, 2002, it is more likely than not that the deferred tax asset will be realized. Therefore, no valuation allowance is necessary.
21
11. Commitments and Contingencies
Leases
The Company leases certain facilities and machinery and equipment primarily under operating lease arrangements. Future minimum rental payments under noncancelable operating leases as of June 30, 2002 total $37,307 and are payable in future fiscal years as follows: $7,598 in 2003; $6,042 in 2004; $4,409 in 2005; $2,299 in 2006; $1,896 in 2007 and $15,063 thereafter.
Aggregate future minimum rentals to be received under noncancelable subleases as of June 30, 2002 total $18,547.
For the years ended June 30, 2002, 2001 and 2000, rent expense was $7,325, $4,994 and $4,314 respectively, while sublease rental income was $2,878, $1,939 and $453 respectively.
Litigation—Product Liability
The Company is a party to a number of product liability lawsuits, many of which involve fires allegedly caused by defective lighting ballasts. All of these cases are being defended by the Company, and management believes that its insurers will bear all liability, except for applicable deductibles, and that none of these proceedings individually or in the aggregate will have a material effect on the Company. In June 2001 the Company sold its Lighting business (see Note 3 of Notes to Consolidated Financial Statements).
The Company is frequently named, along with numerous other defendants, in asbestos-related lawsuits. While the outcome of these cases cannot be predicted with certainty, the Company is aggressively seeking to be dismissed from the proceedings and does not believe the proceedings, individually or in the aggregate, will have a material adverse effect on its finances or operations. The Company has never produced asbestos-containing products and is either contractually indemnified against liability for asbestos-related claims or believes that it has no liability for such claims, all of which arise from business operations the Company acquired but no longer owns.
Litigation—Patent Infringement
In April 1998, Ole K. Nilssen filed a lawsuit in the U.S. District Court for the Northern District of Illinois alleging infringement by the Company of seven of his patents pertaining to electronic ballast technology. Mr. Nilssen seeks unspecified damages and injunctive relief to preclude the Company from making, using or selling products allegedly infringing his patents. The Company denies that any of its products infringe any valid patent and has filed a response asserting its affirmative defenses, as well as a counterclaim for a judicial declaration that its products do not infringe the patents asserted by Nilssen and also that the asserted patents are invalid. The Company intends to vigorously defend against Nilssen's claims and although it cannot predict the outcome of the lawsuit, management does not believe that the financial impact of this matter will be material.
Environmental Matters—General
The Company has from time to time discovered the existence of hazardous substances at certain of its facilities. In response, the Company conducts remediation activities to bring its facilities into compliance with applicable laws and regulations. The Company's remediation activities for fiscal 2002 did not involve material expenditures, and the Company does not expect its expenditures for fiscal 2003 to be material. The Company has also been identified by the United States Environmental Protection Agency and certain state agencies as a potentially responsible party for cleanup costs associated with alleged past waste disposal practices at several facilities and offsite locations. Its remediation activities as a potentially responsible party were not material for fiscal 2002 and are not expected to be material for fiscal 2003. Although the materiality of future expenditures for environmental activities may be affected by the level and type of contamination, the extent and nature of cleanup activities required by governmental authorities, the nature of the Company's alleged connection to the contaminated sites, the number and financial resources of other potentially responsible parties, the availability of indemnification rights against third parties and the identification of additional contaminated sites, the Company's estimated share of liability, if any, for environmental remediation is not expected to be material.
In connection with certain divestitures, the Company has agreed, from time to time, to indemnify buyers with respect to environmental liabilities associated with the divested operations, subject to various conditions and limitations. Expenditures related to the Company's indemnification obligations were not material in fiscal 2002 and are not expected to be material in fiscal 2003. Although future expenditures pursuant to such indemnification obligations could be material, depending upon the extent and nature of subsequently discovered contamination, the Company does not expect its obligations to require material expenditures.
22
Century Electric (McMinnville, Tennessee)
Prior to the Company's purchase of Century Electric, Inc. ("Century Electric") in 1986, Century Electric acquired a business from Gould Inc. ("Gould") in May 1983 that included a leasehold interest in a fractional horsepower electric motor manufacturing facility located in McMinnville, Tennessee. In connection with this acquisition, Gould agreed to indemnify Century Electric from and against liabilities and expenses arising out of the handling and cleanup of certain waste materials, including but not limited to cleaning up any polychlorinated biphenyls ("PCBs") at the McMinnville facility (the "1983 Indemnity"). Investigation has revealed the presence of PCBs and other substances, including solvents, in the soil and in the groundwater underlying the facility and in certain offsite soil, sediment and biota samples. Century Electric notified the Tennessee Department of Environment and Conservation, Division of Superfund, of the test results from its investigation and the McMinnville plant is listed as a Tennessee Inactive Hazardous Waste Substance Site. A report on the site was presented to the Tennessee legislature and community officials and plant employees were notified of the presence of contaminants at the McMinnville facility. In 1995, Gould completed an interim remedial excavation and disposal of onsite soil containing PCBs. Gould also conducted a preliminary investigation and cleanup of certain onsite and offsite contamination. The cost of any further investigation and cleanup of onsite and offsite contamination cannot presently be determined, but the Company believes such costs (including ancillary costs) are covered by the 1983 Indemnity. The Company sold its leasehold interest in the McMinnville plant and while the Company believes that Gould will continue to perform substantially under its indemnity obligations, Gould's substantial failure to perform such obligations could have a material adverse effect on the Company's financial position or results of operations.
Effect of Fruit of the Loom Bankruptcy
The Company acquired the stock of Universal Manufacturing Company ("Universal") from a predecessor of Fruit of the Loom ("FOL"), and the predecessor agreed to indemnify the Company against certain environmental liabilities arising from Universal's pre-acquisition activities. Environmental liabilities covered by the indemnification agreement include completion of additional cleanup activities, if any, at the Bridgeport, Connecticut facility (recently sold in connection with the sale of the transformer business) and defense and indemnification against liability related to offsite disposal locations where Magnetek may have a share of potential response costs. In 1999 FOL filed a petition for Reorganization under Chapter 11 of the Bankruptcy Code and the Company filed a proof of claim in the proceeding for obligations related to the environmental indemnification agreement. The Company believes that FOL has substantially completed the clean-up obligations required by the indemnification agreement. In November 2001, the Company and FOL entered into an agreement involving the allocation of certain potential tax credits and Magnetek withdrew its claims in the bankruptcy proceeding. FOL's ability to set aside any remaining obligations to the states of Connecticut and New Jersey through bankruptcy, or the discovery of additional environmental contamination at the Bridgeport facility, could have an adverse effect on the Company's financial position or results of operations.
Letters of Credit
The Company had approximately $10,244 of outstanding letters of credit as of June 30, 2002. The Company is permitted to issue up to $18,000 of letters of credit under the Bank Loan Agreement through July 31, 2002 and up to $10,000 thereafter.
12. Stock Option Agreements
The Company has three stock option plans (the "Plans"), two of which provide for the issuance of both incentive stock options (under Section 422A of the Internal Revenue Code of 1986) and non-qualified stock options at exercise prices not less than the fair market value at the date of grant, and one of which only provides for the issuance of non-qualified stock options at exercise prices not less than the fair market value at the date of grant. One of the Plans also provides for the issuance of stock appreciation rights, restricted stock, unrestricted stock, restricted stock rights and performance units, and one of the Plans also provides for the issuance of incentive bonuses and incentive stock. The total number of shares of the Company's common stock authorized to be issued upon exercise of the stock options and other stock rights under the Plans is 4,000,000. Options granted under two of the Plans vest in three or four equal annual installments, and options under the third Plan vest in two equal annual installments.
23
A summary of certain information with respect to options under the Plans follows:
| Year ended June 30 | 2002 | 2001 | 2000 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Options outstanding, beginning of year | 4,983,265 | 4,638,909 | 4,729,325 | |||||||
| Options granted | 1,645,569 | 1,191,500 | 1,958,568 | |||||||
| Options exercised | (252,041 | ) | (301,488 | ) | (195,528 | ) | ||||
| Weighted average exercise price | $ | 8.63 | $ | 8.60 | $ | 8.86 | ||||
| Options cancelled | (563,948 | ) | (545,656 | ) | (1,853,456 | ) | ||||
| Options outstanding, end of year | 5,812,845 | 4,983,265 | 4,638,909 | |||||||
| Weighted average price | $ | 11.27 | $ | 11.59 | $ | 12.29 | ||||
| Exercisable options | 3,449,229 | 2,848,374 | 2,456,295 | |||||||
The following table provides information regarding exercisable and outstanding options as of June 30, 2002.
| Exercisable | Outstanding | |||||||||||
| Range of exercise price per share | Options exercisable | Weighted average exercise price per share | Options outstanding | Weighted average exercise price per share | Weighted average remaining contractual life (years) | |||||||
| Under $10.00 | 1,620,382 | $ | 8.74 | 2,613,332 | $ | 8.61 | 7.29 | |||||
| $10.00 - $12.50 | 308,628 | 10.90 | 1,565,961 | 10.87 | 8.39 | |||||||
| $12.51 - $15.00 | 414,112 | 13.41 | 527,445 | 13.31 | 4.73 | |||||||
| Over $15.00 | 1,106,107 | 17.16 | 1,106,107 | 17.16 | 5.15 | |||||||
| Total | 3,449,229 | $ | 12.20 | 5,812,845 | $ | 11.27 | 6.95 | |||||
As permitted under Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," the Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) in accounting for stock-based awards to employees. Under APB 25, the Company generally recognizes no compensation expense with respect to such awards.
Pro forma information regarding net income (loss) and net income (loss) per share is required by SFAS 123 for awards granted in fiscal years after December 31, 1994 as if the Company had accounted for its stock-based awards to employees under the fair value method of SFAS 123. The fair value of the Company's stock-based awards to employees was estimated using a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, the Black-Scholes model requires the input of highly subjective assumptions, including expected stock price volatility. Because the Company's stock-based awards to employees have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards to employees. The fair value of the Company's stock-based awards to employees was estimated assuming no dividends, using the following assumptions:
| Options | |||||||
| 2002 | 2001 | 2000 | |||||
| Expected life (years) | 6.1 | 5.9 | 5.6 | ||||
| Expected stock price volatility | 46.4 | % | 39.1 | % | 39.1 | % | |
| Risk-free interest rate | 4.8 | % | 5.9 | % | 6.1 | % | |
24
For pro forma purposes, the estimated fair value of the Company's stock-based awards to employees is amortized over the options' vesting period. The Company's pro forma information follows:
| (Thousands except per share amounts) | 2002 | 2001 | 2000 | ||||||
|---|---|---|---|---|---|---|---|---|---|
| Net income - as reported | $ | 1,408 | $ | 5,733 | $ | 42,452 | |||
| Net income (loss) - pro forma | $ | (3,255 | ) | $ | 2,802 | $ | 41,750 | ||
| Basic net income per share - as reported | $ | 0.06 | $ | 0.25 | $ | 1.71 | |||
| Basic net income (loss) per share - pro forma | $ | (0.14 | ) | $ | 0.12 | $ | 1.68 | ||
| Diluted net income per share - as reported | $ | 0.06 | $ | 0.25 | $ | 1.70 | |||
| Diluted net income (loss) per share - pro forma | $ | (0.14 | ) | $ | 0.12 | $ | 1.67 | ||
In fiscal year 2002, a total of 1,645,569 options were granted with exercise prices equal to the market price of the stock on the grant date. The weighted average exercise price was $10.60 and the average fair value of the options were $5.46.
In fiscal year 2001, a total of 1,191,500 options were granted with exercise prices equal to the market price of the stock on the grant date. The weighted average exercise price was $8.65 and the average fair value of the options was $4.11. In fiscal year 2000, a total of 1,958,568 options were granted with exercise prices equal to the market price of the stock on the grant date. The weighted average exercise price was $9.07 and the average fair value of these options were $4.02.
The Company has granted stock appreciation rights (SARs) to certain of its directors under director incentive compensation plans. As of June 30, 2002, SARs related to 4,000 shares, with a weighted average exercise price of $19.37, were outstanding under these plans.
25
13. Employee Benefit Plans
Benefit obligations at year-end, fair value of plan assets and prepaid (accrued) benefit costs for the years ended June 30, 2002 and 2001 were as follows:
| Pension Benefits | Other Benefits | ||||||||||||
| 2002 | 2001 | 2002 | 2001 | ||||||||||
| Change in Benefit Obligation | |||||||||||||
| Benefit obligation at beginning of year | $ | 148,065 | $ | 139,188 | $ | 13,172 | $ | 12,704 | |||||
| Service cost | 674 | 1,438 | 2 | 6 | |||||||||
| Interest cost | 10,965 | 10,952 | 952 | 916 | |||||||||
| Plan participants' contributions | 22 | 75 | 1,454 | 409 | |||||||||
| Actuarial loss | 5,446 | 10,235 | 333 | 1,732 | |||||||||
| Curtailment gain | – | (3,361 | ) | – | (43 | ) | |||||||
| Benefits paid | (14,211 | ) | (10,462 | ) | (2,193 | ) | (2,552 | ) | |||||
| Benefit obligation at end of year | $ | 150,961 | $ | 148,065 | $ | 13,720 | $ | 13,172 | |||||
Change in Plan Assets | |||||||||||||
| Fair value of plan assets at beginning of year | $ | 148,464 | $ | 148,420 | $ | – | $ | – | |||||
| Actual return on plan assets | (9,288 | ) | (3,069 | ) | – | – | |||||||
| Employer contributions | 10,926 | 13,500 | 739 | 2,143 | |||||||||
| Plan participants' contributions | 22 | 75 | 1,454 | 409 | |||||||||
| Benefits paid | (14,211 | ) | (10,462 | ) | (2,193 | ) | (2,552 | ) | |||||
| Settlements | – | – | – | – | |||||||||
| Fair value of plan assets at end of year | $ | 135,913 | $ | 148,464 | $ | – | $ | – | |||||
Funded Status | $ | (15,048 | ) | $ | 399 | $ | (13,720 | ) | $ | (13,172 | ) | ||
| Unrecognized transition amount | – | (263 | ) | – | – | ||||||||
| Unrecognized net actuarial (gain)/loss | 74,635 | 47,526 | (11,352 | ) | (14,074 | ) | |||||||
| Unrecognized prior service cost | 399 | 452 | (4,793 | ) | (5,417 | ) | |||||||
| Prepaid/(accrued) benefit cost | $ | 59,986 | $ | 48,114 | $ | (29,865 | ) | $ | (32,663 | ) | |||
Amounts Recognized in Statement of Financial Position | |||||||||||||
| Prepaid benefit cost | $ | 59,986 | $ | 48,114 | $ | – | $ | – | |||||
| Accured benefit liability | (74,363 | ) | – | (29,865 | ) | (32,663 | ) | ||||||
| Intangible asset | 399 | – | – | – | |||||||||
| Accumulated other comprehensive income | 73,964 | ||||||||||||
| Net amount recognized | $ | 59,986 | $ | 48,114 | $ | (29,865 | ) | $ | (32,663 | ) | |||
Weighted-Average Assumptions as of June 30 | |||||||||||||
| Discount rate | 7.375 | % | 7.625 | % | 7.375 | % | 7.625 | % | |||||
| Expected return on plan assets | 9.50 | % | 9.50 | % | N/A | N/A | |||||||
| Rate of compensation increase | 4.50 | % | 4.50 | % | N/A | N/A | |||||||
Under SFAS No. 87, "Employers' Accounting for Pensions," when the accumulated benefit obligation ("ABO") exceeds the fair value of the plan assets, a minimum liability (net of related income tax benefit) must be established on the balance sheet with a corresponding amount in other comprehensive income in shareholders' equity. The minimum pension liability must also include any prepaid pension asset balance (the amount by which contributions to a plan have exceeded expense recorded under SFAS No. 87) as of the measurement date. Pursuant to SFAS No. 87, the Company recorded a pension liability of $74,363 at June 30, 2002. This amount, net of tax benefits of $17,000 has been recorded as a reduction to equity in "Accumulated Other Comprehensive Loss" on the Company's balance sheet.
For measurement purposes, a 5.0% annual rate of increase in the per capita cost of covered health benefits was assumed for all participants.
Pension plan assets include $12,802 in Company stock.
26
Net periodic postretirement benefit costs (income) for pension and other benefits for the years ended June 30, 2002, 2001 and 2000 were as follows:
| Pension Benefits | Other Benefits | ||||||||||||||||||
| 2002 | 2001 | 2000 | 2002 | 2001 | 2000 | ||||||||||||||
| Components of Net | |||||||||||||||||||
| Periodic Benefit Cost (Income) | |||||||||||||||||||
| Service cost | $ | 674 | $ | 1,438 | $ | 2,024 | $ | 2 | $ | 6 | $ | 9 | |||||||
| Interest cost | 10,965 | 10,952 | 10,388 | 952 | 916 | 1,157 | |||||||||||||
| Expected return on plan assets | (13,587 | ) | (13,703 | ) | (14,544 | ) | – | – | – | ||||||||||
| Amortization of transition amount | (263 | ) | (263 | ) | (268 | ) | – | – | – | ||||||||||
| Amortization of prior service cost | 53 | 161 | (28 | ) | (624 | ) | (624 | ) | (408 | ) | |||||||||
| Recognized net actuarial (gain)/loss | 1,212 | 1,003 | 208 | (2,388 | ) | (1,143 | ) | (1,275 | ) | ||||||||||
| Net periodic benefit cost | $ | (946 | ) | $ | (412 | ) | $ | (2,220 | ) | $ | (2,058 | ) | $ | (845 | ) | $ | (517 | ) | |
| Curtailment/settlement (gain)/loss | – | 1,098 | 1,290 | – | (43 | ) | (6,705 | ) | |||||||||||
| Net benefit cost | $ | (946 | ) | $ | 686 | $ | (930 | ) | $ | (2,058 | ) | $ | (888 | ) | $ | (7,222 | ) | ||
The curtailment/settlement gain or loss resulted from the following:
Fiscal 2001: The sale of the Standard Drives, Lighting and Transformer business.
Fiscal 2000: The sale of the Motor business.
The health care plans are contributory, with participants' contributions adjusted annually. The life insurance plans are noncontributory. The accounting for the health care plans anticipates future cost-sharing changes.
Assumed health care cost trends have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have had the following effects for Fiscal Year 2002:
| | 1-Percentage Point Decrease | 1-Percentage Point Increase | |||||
|---|---|---|---|---|---|---|---|
| Effect on total service and interest cost components | |||||||
| —based on 7.625% discount rate | $ | (64 | ) | $ | 72 | ||
| Effect on postretirement benefit obligation | |||||||
| — based on 7.375% discount rate | $ | (923 | ) | $ | 1,040 | ||
The Company implemented a contribution policy for retiree health coverage effective January 1, 2000 that essentially removed any incremental cost to the Company in the event annual health insurance cost increases exceed five percent.
In addition to the defined benefit retirement plans and health care plans, the Company contributes to a defined contribution (401k) savings plan. In December of 2001, the Company changed its third party administrator for its defined contribution plan and modified the plan year to end on December 31, from the previous March 31 ending date. Contributions made by the Company from April 1, 2001 through June 30, 2002, totaled $573. Company contributions for the plan years ending March 2001 and 2000 were $926 and $531, respectively.
14. Related Party Transactions
The Company has an agreement with the Spectrum Group, Inc. whereby Spectrum will provide management services to the Company through December 2002 at an annual fee plus certain allocated and out of pocket expenses. The Company's chairman, president and chief executive officer is also the chairman, president and sole shareholder of Spectrum. Services provided include consultation and direct management assistance with respect to operations, strategic planning and other aspects of the business of the Company. Fees and expenses paid to Spectrum for these services under the agreement amounted to $764, $936 and $904 for the years ended June 30, 2002, 2001 and 2000, respectively. In fiscal 2001, a performance bonus was awarded in the amount of $408 and paid to Spectrum in July of 2001.
During the years ended June 30, 2001 and 2000, the Company paid approximately $32 and $36, respectively in fees to charter an aircraft owned by a company in which Magnetek's chairman is the principal shareholder. No amounts were paid during the year ended June 30, 2002.
27
During fiscal 2000, the Company engaged ABN AMRO (formerly ING Barings) to assist in the divestiture of its Lighting business. Upon the completion of the sale of this business (see Note 3) in June of fiscal year 2001, fees of $1,020 were paid to ABN AMRO. One of the Company's directors was a principal at ABN AMRO Inc. during fiscal year 2001.
15. Accrued Liabilities
Accrued liabilities consisted of the following at June 30:
| | 2002 | 2001 | ||||
|---|---|---|---|---|---|---|
| Salaries, wages and related items | $ | 6,309 | $ | 11,536 | ||
| General insurance | 4,148 | 4,631 | ||||
| Income taxes | 141 | 2,608 | ||||
| Other | 7,961 | 14,968 | ||||
| $ | 18,559 | $ | 33,743 | |||
16. Supplemental Cash Flow Information
Changes in operating assets and liabilities of continuing operations were as follows:
| Year ended June 30 | 2002 | 2001 | 2000 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (Increase) decrease in accounts receivable | $ | 11,079 | $ | (1,077 | ) | $ | 1,382 | ||||
| (Increase) decrease in inventories | 5,240 | (8,632 | ) | 7,244 | |||||||
| (Increase) decrease in prepaids and other current assets | 2,370 | 6,284 | 847 | ||||||||
| (Increase) decrease in other operating assets | (4,749 | ) | (13,020 | ) | (1,364 | ) | |||||
| Increase (decrease) in accounts payable | (9,595 | ) | (8,120 | ) | (5,783 | ) | |||||
| Increase (decrease) in accrued liabilities | (15,193 | ) | (6,400 | ) | (29,033 | ) | |||||
| Increase (decrease) in deferred income taxes | (5,309 | ) | (10,683 | ) | 7,658 | ||||||
| Increase (decrease) in other operating liabilities | (2,075 | ) | 38 | (2,795 | ) | ||||||
| $ | (18,232 | ) | $ | (41,610 | ) | $ | (21,844 | ) | |||
CASH PAID FOR INTEREST AND INCOME TAXES FOLLOWS: | |||||||||||
| Interest | $ | 661 | $ | 8,348 | $ | 6,171 | |||||
| Income taxes | $ | 5,168 | $ | 695 | $ | 6,967 | |||||
17. Business Segment and Geographic Information
The Company currently operates within a single business segment, Digital Power Products. Within the segment there exists two product lines, power control products and industrial control products. The Company sells its products primarily to large original equipment manufacturers and distributors. The Company performs ongoing credit evaluations of its customers' financial conditions and generally requires no collateral. The Company has a single customer, IBM, whose purchases represented 9%, 13% and 16% of the Company's total revenues in fiscal years 2002, 2001 and 2000, respectively. Outstanding receivables with the Company's largest customer were 8%, 6% and 12% of the total receivables of the Company as of fiscal year-end 2002, 2001 and 2000, respectively. Beyond the Company's single largest customer, management believes that there is no significant concentration of credit risk.
During the year ended June 30, 2002, sales of power control products were $122,763 and sales of industrial control products were $65,461. Sales of power control products were $183,102 and sales of industrial control products were $115,158 (including $45,516 related to a divested business) for the year ended June 30, 2001. During the year ended June 30, 2000, sales of power control products were $155,485 and sales of industrial control products were $138,090 (including $81,162 related to a divested business).
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Information with respect to the Company's foreign subsidiaries follows:
| For the year ended June 30 | 2002 | 2001 | 2000 | ||||||
|---|---|---|---|---|---|---|---|---|---|
| Sales | $ | 57,535 | $ | 81,690 | $ | 75,685 | |||
| Operating income | 2,112 | 9,764 | 5,727 | ||||||
| Identifiable assets | 83,085 | 89,782 | 90,322 | ||||||
| Capital expenditures | 4,694 | 6,208 | 5,644 | ||||||
| Depreciation and amortization | 7,152 | 7,029 | 7,731 | ||||||
Operating income for foreign subsidiaries does not include any allocation of corporate costs incurred in the United States. Sales by foreign subsidiaries include only sales of products to customers outside of the U.S.
The Company's foreign operations outside of Europe are not material. Export sales from the United States were $6,948, $10,655 and $5,580 in 2002, 2001 and 2000, respectively.
18. Quarterly Results (unaudited)
| 2002 quarter ended | Sept. 30 | Dec. 31 | Mar. 31 | June 30 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net sales | $ | 52,456 | $ | 47,087 | $ | 44,444 | $ | 44,237 | |||||||
| Gross profit | 11,840 | 10,931 | 10,527 | 10,263 | |||||||||||
| Provision benefit for income taxes | 664 | 284 | 186 | (234 | ) | ||||||||||
| Net income (loss) | $ | 1,082 | $ | 464 | $ | 302 | $ | (440 | ) | ||||||
| Per common share: | |||||||||||||||
| Basic: | |||||||||||||||
| Net income (loss) | $ | 0.05 | $ | 0.02 | $ | 0.01 | $ | (0.02 | ) | ||||||
| Diluted: | |||||||||||||||
| Net income (loss) | $ | 0.05 | $ | 0.02 | $ | 0.01 | $ | (0.02 | ) | ||||||
| 2001 quarter ended | Sept. 30 | Dec. 31 | Mar. 31 | June 30 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net sales | $ | 71,870 | $ | 81,868 | $ | 78,956 | $ | 65,566 | |||||||
| Gross profit | 16,946 | 20,177 | 21,254 | 18,389 | |||||||||||
| Provision for income taxes | 612 | 1,290 | 2,015 | 1,683 | |||||||||||
| Income from continuing operations | $ | 998 | $ | 2,090 | $ | 3,282 | $ | 2,713 | |||||||
| Net income (loss) | $ | 2,803 | $ | 3,913 | $ | 2,191 | $ | (3,174 | ) | ||||||
| Per common share: | |||||||||||||||
| Basic: | |||||||||||||||
| Income from continuing operations | $ | 0.04 | $ | 0.09 | $ | 0.15 | $ | 0.12 | |||||||
| Net income (loss) | $ | 0.12 | $ | 0.17 | $ | 0.10 | $ | (0.14 | ) | ||||||
| Diluted: | |||||||||||||||
| Income from continuing operations | $ | 0.04 | $ | 0.09 | $ | 0.14 | $ | 0.12 | |||||||
| Net income (loss) | $ | 0.12 | $ | 0.17 | $ | 0.10 | $ | (0.14 | ) | ||||||
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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Magnetek, Inc.
We have audited the accompanying consolidated balance sheets of Magnetek, Inc. as of June 30, 2002 and 2001, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Magnetek, Inc. at June 30, 2002 and 2001 and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2002, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 4 to the consolidated financial statements, in fiscal 2002 the Company changed its method of accounting for goodwill.
| Ernst & Young LLP |
Nashville, Tennessee
August 8, 2002
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SELECTED FINANCIAL DATA
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS