Ms. Angela Crane, Branch Chief
U.S. Securities and Exchange Commission
November 1, 2005
Page 2
November 1, 2005
By U.S. Mail and Facsimile to (202) 772-9218
Ms. Angela Crane
Branch Chief
Division of Corporation Finance
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549-6010
Re: Jaco Electronics, Inc.
Form 10-K for the fiscal year ended June 30, 2005 File No. 2-34664
Dear Ms. Crane,
Jaco Electronics, Inc. ("Jaco" or the "Company") has received your
correspondence dated October 18, 2005 regarding the comments of the Staff of the
Securities and Exchange Commission (the "Staff") to the above referenced filing
of the Company (the "Comment Letter"). As you requested, we have keyed our
responses to the number paragraphs in the Comment Letter and, if applicable,
have provided supplemental information.
Form 10-K for the Fiscal Year Ended June 30, 2005
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations, page 14
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Liquidity and Capital Resources, page 22
1. We note from your disclosures on page F-18 that you entered into a
supply agreement with Sagamore Holdings to supply electronic components
to Nexus. Please revise Management's Discussion and Analysis in future
filings to quantify and discuss any actual or expected impact of this
agreement on your results of operations, liquidity and capital
resources, if material.
The Company's sales to Nexus, subsequent to the date of its sale of
this subsidiary to Sagamore Holdings, were approximately $680,000 and
$88,000 for the fiscal year ended June 30, 2005 and the quarter ended
September 30, 2005, respectively, representing 0.3% and 0.2% of total
sales for these periods. As such, we did not feel that these amounts
were material for disclosure. We will revise Management's Discussion
and Analysis in future filings to quantify and discuss any actual or
expected impact of this agreement on our results of operations,
liquidity and capital resources, if we determine it to be material.
2. Please tell us and revise future filings to define the financial ratios
and minimum net worth levels required in your financial covenants.
Explain what would happen if you were unable to obtain a waiver or
amendment from your lender on reasonable terms.
In future filings, we will describe the financial ratios and minimum
net worth levels required in our financial covenants as follows:
Under our credit agreement, the Company is required to comply with the
following financial covenants: maintain a Fixed Charge Coverage Ratio
(as defined therein) of 1.0 to 1.0 for the six months ending December
31, 2005, 1.2 to 1.0 for the nine months ending March 31, 2006, and 1.3
to 1.0 for the twelve months ending June 30, 2006 and for each of the
twelve months ending each quarterly period thereafter; maintain
Operating Cash Flow (as defined therein) for the quarterly period
ending September 30, 2005 of not less than $475,000; maintain minimum
Net Worth (as defined therein), commencing August 31, 2005, of not less
than $40,500,000, increasing as of the end of each fiscal quarter
thereafter by 65% of the net profit for such quarter, if any, reduced
by the amount of specified Special Charges and Write-offs (as defined
therein); and a limitation on capital expenditures of $300,000 for the
fiscal year ending June 30, 2006 and for each fiscal year thereafter.
While we have provided some disclosure in both the last two sentences
of the third paragraph and in the last two sentences of the last
paragraph under Management's Discussion and Analysis-Liquidity and
Capital Resources regarding what would happen if Jaco were unable to
obtain a waiver or amendment from its lenders on reasonable terms, as
suggested by you, we will revise this disclosure in the manner provided
below in future filings in order to more clearly address this
contingency:
In the event that in the future we are unable to obtain such an
amendment or waiver of our noncompliance with our financial covenants,
the lenders under our credit facility could declare us to be in default
under the facility, requiring all amounts outstanding under the
facility to be immediately due and payable and/ or limit the Company's
ability to borrow additional amounts under the facility. If we did not
have sufficient available cash to pay all such amounts that become due
and payable, we would have to seek additional debt or equity financing
through other external sources, which may not be available on
acceptable terms, or at all. Failure to maintain financing arrangements
on acceptable terms would have a material adverse effect on our
business, results of operations and financial condition.
Item 9A. Controls and Procedures, page 25
3. We note that your "disclosure controls and procedures are effective to
ensure that information required to be disclosed in the reports that
the Company files or submits
under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms." Please revise future filings
to clarify, if true, that your officers concluded that your disclosure
controls and procedures are also effective to ensure that information
required to be disclosed in the reports that you file or submit under
the Exchange Act is accumulated and communicated to your management,
including your chief executive officer and chief financial officer, to
allow timely decisions regarding required disclosure. See Exchange Act
Rule 13a-15(e).
In future filings, we will disclose, if true, in accordance with
Exchange Act Rule 13a-15(e), that our management has concluded that our
disclosure controls and procedures are also effective to ensure that
information required to be disclosed in the reports that we file or
submit under the Exchange Act is accumulated and communicated to our
management, including our chief executive officer and chief financial
officer, to allow timely decisions regarding required disclosure.
Supplementally, we advise you that the foregoing was true as of June
30, 2005.
Note B - Summary of Significant Accounting Policies, page F-9
2. Revenue Recognition, page F-9
4. We note your disclosures that "in general, revenue is recognized when
it is realized or realizable and earned" and "revenue from product
sales is recognized general1y when the product is shipped." Please tell
us when this would not be the case. In future filings, please discuss
any material exceptions to your revenue recognition policy.
We advise you that we recognize revenue when it is realized or
realizable and earned. In future filings, we will remove the word
"general" from the first disclosure item cited by you.
As for the second disclosure item cited by you, to clarify, shipment
along with transfer of title is the point at which Jaco's obligation is
complete and the customer's obligation begins. When the shipping terms
are FOB shipping point, revenue is appropriately recorded as the goods
leave our facility. In certain instances and to certain customers, we
ship goods with shipping terms of FOB destination point. In these
instances, we determine when the goods are delivered to our customer's
facility and calculate whether an adjustment to defer revenue
recognition is required. If such adjustment is material, we record such
adjustment in our financial statements. However, historically, such
adjustments have not been material.
In future filings, we will include more specific disclosure of our
revenue recognition policies, which will incorporate the additional
information provided above.
5. You state that a portion of your business involves shipments directly
from your suppliers to your customers. Please tell us if you report al1
revenue at gross (as a
principal) or if you act as an agent in certain
transactions. Discuss the consideration to the guidance in EITF 99-19
given the price protection, stock rotation privileges and the right to
return inventory typical in your agreements with suppliers as discussed
on page 8 of your business section. Also, please tell us if:
o The supplier is responsible for fulfilling the ordered
product or service, including remedies if the customer
is dissatisfied.
o The company earns a fixed dollar amount per customer
transaction regardless of the amount billed to the
customer.
o The credit risk is assumed by the supplier.
We maintain two distribution facilities from which we ship the majority
of our goods. We do, however, periodically ship goods directly from
third parties or from our vendors. During the year ended June 30, 2005,
the Company had sales of approximately $9.3 million, which represents
4.0% of total sales that were shipped directly from third parties or
vendors. We report all revenue at gross because we are the principals
in all such transactions.
EITF 99-19 assesses whether a company should recognize revenue based on
the gross amount billed to a customer or the net amount retained (i.e.,
the amount billed to a customer less the amount paid to a supplier)
depending on the facts and circumstances.
Indicators that we have considered, which are present in our sales
arrangements, in determining that we should report our sales based on
the gross amount include the following:
o the Company is the primary obligor, including
remedies if the customer is dissatisfied;
o the Company has general inventory risk;
o the Company has latitude in establishing the price,
and does not earn a fixed dollar amount per customer
transaction;
o the Company is involved in the determination of product
specifications;
o the Company has physical inventory loss risk; and
o the Company has the credit risk.
Because the indicators set forth above are present in our sales
arrangement, we believe we are the principals in all revenue
transactions and, as a result, that we are properly reporting revenue
as gross amounts.
6.Inventories, page F-ll
6. We note from your revenue recognition policy that you sell certain
products on a consignment basis. In future filings revise your
inventory presentation to separately report the value of inventory
consigned to others at each balance sheet date. Refer to Question 2 of
SAB Topic l3 (A)(2).
In future filings, in accordance with question 2 of SAB Topic 13
(A)(2), we will disclose the amount of the Company's consignment
inventory at each balance sheet date. We supplementally advise you that
such consignment inventory was $394,684 and $864,710 at June 30, 2005
and 2004, respectively.
7. We note your provision for inventory of $6.9 million as of
June 30, 2005. Please tell us more about your inventory
management practices. Specifical1y;
o Tell us how you determined the amount and timing of the
write-downs.
o Explain why this inventory is not included in the price
protection from your suppliers.
o Explain if any of the provision relates to customized
customer orders that were cancelled or if these
inventories are sold to many customers.
o Tell us the consideration given to the fact that sales
of these inventory items in the future could materially
distort future profit margins.
The Company evaluates inventories, on at least a quarterly basis, for
excess, obsolescence or other factors rendering inventories as
unsellable at normal gross profit margins. The Company evaluates all
slow moving inventory and writes down the inventories to reflect its
approximate market value and takes into account the Company's
contractual provisions with its suppliers governing price protection
and stock rotations. The process of price protections and stock
rotations requires estimates to be made regarding the valuation of
inventory at market value. Each of the Company's suppliers has
differing terms and conditions as to which products are price protected
or can be returned under a stock rotation or scrap policy.
In addition, assumptions about future demand, market conditions and
decisions to discontinue certain product lines can impact the decision
to write-down inventories. Senior management met to modify its business
model to pursue the business available in the United States, increase
its support of global contract manufacturers that require its
value-added services and logistics programs, and aggressively promote
its flat panel display product offerings, which the Company believes
have promising potential for future growth. The Company began
implementing this revised strategy in the fourth quarter of fiscal
2005.
During the fourth quarter of fiscal 2005, we took a write-down of
approximately $2.2 million for inventory based on our determination
that, due to changes in market conditions in the United States, certain
of our products primarily intended for distribution to specific
customers were no longer saleable. In addition, our revised
marketing strategy included a paring down of our vendors to only a
certain number of core vendors, which resulted in additional
write-downs.
Since the inventory has been written down to the lower of cost or
market, management believes that sales or scrap of these items will not
have a material effect on the Company's overall future profit margins.
8. Goodwill and Other Intangible Assets, page F-11
8. Please provide us with a summary of the relevant facts, assumptions,
and estimates you considered in your goodwill impairment analysis
supporting your conclusion that no impairment of goodwill existed at
June 30, 2005. Please refer to paragraphs 19 - 22 of SFAS 142 in your
response.
The Company performed its annual impairment test of its seven reporting
units discussed in Note B on page F-18 in accordance with the
requirements of SFAS 142 paragraphs 19-22 by comparing the fair value
of the reporting unit to its carrying amount, including goodwill.
The Company used a present value technique, consistent with acceptable
valuation methodology discussed in paragraphs 23-25 of SFAS 142. The
present value technique utilized cash flow assumptions over a five-year
period that marketplace participants would use in their estimates of
fair value. Specifically, a discount rate of 14% was used for this
analysis, consistent with a current weighted average cost of capital.
Forecasts of sales and operating margins were based on management
projections of future trends and historical operating performance by
each reporting unit. For the largest reporting unit (which comprises
$18.9 million of the $25.4 million of total goodwill), the Company used
a weighted average of three different economic scenarios. The
assumptions used in the sales forecasts for the three different
economic scenarios (as compared to historical sales for fiscal 2005)
ranged from a negative 6% decrease to a positive 10% increase in year
one, and from a 0% increase to a 7% compounded increase in years two
through five. Expense estimates (as compared to historical expenses for
fiscal 2005) ranged from a 0% increase to a 10% compounded increase in
years one through five. For the six other reporting units, the
assumptions used in the sales forecasts were based upon management's
budgeted forecasted sales for each unit for fiscal 2006 (an
approximately 10% to 15% increase over fiscal 2005 sales, depending
upon the unit) in year one, and a compounded growth ranging from a 5%
to 15% increase in years two through five, depending upon the unit.
Expense estimates for the six other reporting units ranged from a 3% to
5% compounded increase over historical expenses in fiscal 2005. Working
capital requirements for all seven reporting units were estimated at 4%
of projected sales consistent with historical levels, and capital
expenditures and depreciation were estimated based on what management
considered reasonably necessary to support anticipated growth and, with
respect to capital expenditures, limitations imposed by our credit
facility financial covenant described above.
The Company's valuation methodology, discount rate and assumptions used
in its impairment analysis of the largest reporting unit were reviewed
by an independent nationally recognized valuation firm who concluded
that this methodology and these assumptions were reasonable for such
reporting unit and that the same methodology would be reasonable for
the Company's analysis of its six other reporting units as well.
9. Please expand your disclosure in future filings to specifically
identify your reporting units and the amount of goodwill for each, as
required by SFAS 142, paragraph 45.
We believe that the requirements of SFAS 142, paragraph 45 require the
disclosure relating to goodwill described in paragraph 45 (b) and
(c)(1)-(c)(3) to relate to reportable segments in accordance with SFAS
131. Since the Company has only one reportable segment, we believe that
our current disclosure is in accordance with SFAS 142.
Note C -Discontinued Operations, page F-18
10. We note that in connection with your sale of Nexus that you and
Sagamore Holdings are in dispute regarding the final adjustment related
to Nexus' working capital. Please tell us the nature of this dispute
and how you have accounted for this contingency in your June 30, 2005
financial statements. Additionally please tell us if this dispute has
been subsequently resolved and if there have been any post purchase
price adjustments.
The Company's dispute with Sagamore relates to its position that the
net working capital adjustment provided for in the purchase agreement
is required to be made in accordance with GAAP, including the
consistent application of inventory valuation procedures and reserves
which were used when the net working capital target was established, in
contrast to Sagamore's position that inventory should be valued based
on an audit which may use procedures and reserves that differ from
those which had been used when the net working capital target was
established. The maximum amount of the net working capital adjustment
is $500,000. The Company believes that it is probable that this dispute
will be settled and therefore has established a $250,000 reserve for
this contingency in its June 30, 2005 financial statements, which is
reflected in the Statement of Operations, Discontinued Operations: Gain
on sale of net assets of subsidiary. Since this dispute remains
unresolved, there has to date been no purchase price adjustment between
the Company and Sagamore.
11. We note that you reported the sale of Nexus as discontinued operations.
Tell us how you met the criteria in paragraph 42(b) of SFAS 144.
Specifically, please tell us why you believe the purchase and earn out
agreements entered into with Sagamore Holdings do not constitute a
significant continuing involvement that would preclude treatment of the
component as discontinued operations.
In considering the criteria in paragraph 42(b) of SFAS 144, the Company
looked to the guidance provided in EITF 03-13. As set forth in
paragraphs 9-11 of EITF 03-13, the post sale supply agreement with
Sagamore does not allow the Company to exert significant influence over
Nexus's operating and financial policies. Specifically, there is no
retention of risk and no ability on the part of the Company to obtain
benefits from Nexus outside of the normal supplier/customer
relationship. Pricing and terms under this agreement are no more
favorable to Nexus than those that the Company extends to its other
customers of similar size and purchasing volume. As indicated by
our response to comment 1 above, the amount of sales by Jaco to Nexus
to date has clearly not been significant to Jaco.
The earn out agreement does not constitute significant continuing
involvement as set forth in paragraph 12(a) of EITF 03-13, which states
that a resolution of contingencies that arise pursuant to the terms of
the disposal transaction, such as the resolution of purchase price
adjustments, does not constitute significant continuing involvement.
In connection with our above responses to the Staff's comments, the Company
acknowledges that:
o the Company is responsible for the adequacy and
accuracy of the disclosure in the filing;
o Staff comments or changes to disclosure in response to
Staff comments do not foreclose the Commission from
taking any action with respect to the filing; and
o the Company may not assert Staff comments as a defense
in any proceeding initiated by the Commission or any
person under the federal securities laws of the United
States.
We appreciate the Staff's comments. If you or any other member of the Staff has
any further questions or comments concerning these responses, please feel free
to contact me at 631-273-5500 extension 3015.
Sincerely,
/s/ Jeffrey D. Gash
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Executive Vice President,
Finance and Secretary
cc: Mr. Eric Atallah