UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange
Act of 1934
For the quarterly period ended February 28, 2005
Commission file number 0-28839
AUDIOVOX CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-1964841
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
180 Marcus Blvd., Hauppauge, New York 11788
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (631) 231-7750
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------ ------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes X No
------ ------
Number of shares of each class of the registrant's Common Stock
outstanding as of the latest practicable date.
Class Outstanding at April 5, 2005
Class A Common Stock 20,872,538 Shares
Class B Common Stock 2,260,954 Shares
1
AUDIOVOX CORPORATION
I N D E X
Page
Number
PART I - FINANCIAL INFORMATION 3
ITEM 1. FINANCIAL STATEMENTS 3
Consolidated Balance Sheets at November 30,
2004 and February 28, 2005 (unaudited) 3
Consolidated Statements of Operations (unaudited) for the Three
Months Ended February 29, 2004 and February 28, 2005 5
Consolidated Statements of Cash Flows (unaudited) for the Three
Months Ended February 29, 2004 and February 28, 2005 6
Notes to Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK 32
ITEM 4. CONTROLS AND PROCEDURES 33
PART II - OTHER INFORMATION 36
ITEM 1. LEGAL PROCEEDINGS 36
ITEM 6. EXHIBITS 38
SIGNATURES 39
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AUDIOVOX CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)
November 30, February 28,
2004 2005
---------- -----------
(unaudited)
Assets
Current assets:
Cash and cash equivalents $ 43,409 $ 18,624
Restricted cash 8,264 8,296
Short-term investments 124,237 139,609
Accounts receivable, net 118,388 94,125
Inventory 139,307 136,065
Receivables from vendors 7,028 5,274
Prepaid expenses and other current assets 14,057 15,074
Deferred income taxes 6,873 6,286
Current assets of discontinued operations 20,582 3,012
-------- --------
Total current assets 482,145 426,365
Investment securities 5,988 6,721
Equity investments 12,878 11,024
Property, plant and equipment, net 19,707 20,665
Excess cost over fair value of assets acquired 7,019 17,818
Intangible assets 8,043 8,440
Other assets 413 361
Deferred income taxes 6,220 5,120
Non-current assets of discontinued operations 925 825
-------- --------
Total assets $543,338 $497,339
======== ========
See accompanying notes to consolidated financial statements.
3
Audiovox Corporation
Consolidated Balance Sheets (continued)
(In thousands, except share and per share data)
November 30, February 28,
2004 2005
--------- ------------
(unaudited)
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 26,004 $ 20,263
Accrued expenses and other current liabilities 32,814 25,885
Accrued sales incentives 7,584 5,450
Income taxes payable 42,790 12,349
Bank obligations 5,485 5,900
Current portion of long-term debt 2,497 2,411
Current liabilities of discontinued operations 2,953 2,760
--------- ---------
Total current liabilities 120,127 75,018
Long-term debt 7,709 7,337
Capital lease obligation 6,001 6,091
Deferred compensation 4,888 5,821
--------- ---------
Total liabilities 138,725 94,267
--------- ---------
Minority interest 426 375
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred stock $50 par value; 50,000 shares authorized and outstanding, liquidation
preference of $2,500 2,500 2,500
Series preferred stock $.01 par value, 1,500,000 shares authorized; no shares issued
or outstanding -- --
Common stock:
Class A $.01 par value; 60,000,000 shares authorized; 20,859,846 and
20,867,046 shares issued at November 30, 2004 and February 28, 2005,
respectively 209 209
Class B $.01 par value; convertible 10,000,000 shares authorized; 2,260,954
shares issued and outstanding 22 22
Paid-in capital 253,959 254,071
Retained earnings 157,835 156,630
Accumulated other comprehensive loss (1,841) (2,238)
Treasury stock, at cost, 1,070,957 shares of Class A common stock at November 30,
2004 and February 28, 2005 (8,497) (8,497)
--------- ---------
Total stockholders' equity 404,187 402,697
--------- ---------
Total liabilities and stockholders' equity $ 543,338 $ 497,339
========= =========
See accompanying notes to consolidated financial statements.
4
AUDIOVOX CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the Three Months Ended February 29, 2004 and February 28, 2005
(In thousands, except share and per share data)
(unaudited)
February 29, February 28,
2004 2005
------------ ------------
Net sales $ 135,356 $ 115,980
Cost of sales 114,228 99,909
------------ ------------
Gross profit 21,128 16,071
------------ ------------
Operating expenses:
Selling 7,141 7,991
General and administrative 12,487 12,414
Warehousing and technical support 969 1,467
------------ ------------
Total operating expenses 20,597 21,872
------------ ------------
Operating income (loss) 531 (5,801)
------------ ------------
Other income (expense):
Interest and bank charges (963) (633)
Equity in income of equity investees 1,071 353
Other, net 624 4,605
------------ ------------
Total other income, net 732 4,325
------------ ------------
Income (loss) from continuing operations before income taxes 1,263 (1,476)
Income taxes (benefit) 602 (924)
Minority interest 35 --
------------ ------------
Net income (loss) from continuing operations 696 (552)
Net income (loss) from discontinued operations, net of tax 1,174 (653)
------------ ------------
Net income (loss) $ 1,870 $ (1,205)
============ ============
Net income (loss) per common share (basic):
From continuing operations $ 0.03 $ (0.02)
From discontinued operations 0.06 (0.03)
------------ ------------
Net income (loss) per common share (basic) $ 0.09 $ (0.05)
============ ============
Net income (loss) per common share (diluted):
From continuing operations $ 0.03 $ (0.02)
From discontinued operations 0.05 (0.03)
------------ ------------
Net income (loss) per common share (diluted) $ 0.08 $ (0.05)
============ ============
Weighted average number of common shares outstanding (basic) 21,922,100 22,051,443
============ ============
Weighted average number of common shares outstanding (diluted) 22,254,488 22,051,443
============ ============
See accompanying notes to consolidated financial statements.
5
AUDIOVOX CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Three Months Ended February 29, 2004 and February 28, 2005
(In thousands)
(unaudited)
February 29, February 28,
2004 2005
-------------- ---------------
Cash flows from operating activities:
Net income (loss) $ 1,870 $ (1,205)
Net (income) loss from discontinued operations (1,174) 653
--------- ---------
Net income (loss) from continuing operations 696 (552)
Adjustments to reconcile net income (loss) to net cash provided by (used in) continuing
operating activities:
Depreciation and amortization 809 757
Provision for (recovery of) bad debt expense 11 (284)
Equity in income of equity investees (1,071) (353)
Minority interest (35) --
Deferred income tax expense, net 440 1,770
Tax benefit on stock options exercised 21 4
Non-cash stock compensation 268 285
Gain on trading security -- (2,516)
Changes in operating assets and liabilities, net of assets and liabilities
acquired:
Accounts receivable 36,221 35,931
Inventory 15,234 5,181
Receivables from vendors (2,480) 1,754
Prepaid expenses and other 591 (555)
Investment securities-trading (815) (933)
Accounts payable, accrued expenses, accrued sales incentives and other current
liabilities (30,407) (23,097)
Income taxes payable (2,024) (30,418)
Change in assets and liabilities of discontinued operations (17,671) 16,733
--------- ---------
Net cash provided by (used in) operating activities (212) 3,707
--------- ---------
Cash flows from investing activities:
Purchases of property, plant and equipment (528) (942)
Proceeds from sale of property, plant and equipment 18 12
Proceeds from distribution from an equity investee 2,526 178
Purchase of short-term investments -- (81,075)
Sale of short-term investments -- 65,703
Proceeds from sale of Cellular business -- 5,666
Purchase of patent -- (150)
(Purchase) proceeds of acquired business 510 (13,631)
--------- ---------
Net cash provided by (used in) investing activities 2,526 (24,239)
--------- ---------
Cash flows from financing activities:
Borrowings from bank obligations 253,069 452
Repayments on bank obligations (252,638) (4,098)
Principal payments on capital lease obligation (16) (17)
Proceeds from exercise of stock options and warrants 71 108
Principal payments on debt (2,697) (672)
--------- ---------
Net cash used in financing activities (2,211) (4,227)
--------- ---------
Effect of exchange rate changes on cash 176 (26)
--------- ---------
Net increase (decrease) in cash and cash equivalents 279 (24,785)
Cash and cash equivalents at beginning of period 4,702 43,409
--------- ---------
Cash and cash equivalents at end of period $ 4,981 $ 18,624
========= =========
See accompanying notes to consolidated financial statements.
6
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three Months Ended February 29, 2004 and February 28, 2005
(Dollars in thousands, except share and per share data)
(unaudited)
(1) Basis of Presentation
The accompanying consolidated financial statements of Audiovox Corporation
and subsidiaries ("Audiovox" or the "Company") were prepared in accordance
with accounting principles generally accepted in the United States of
America and include all adjustments (consisting of normal recurring
adjustments), which, in the opinion of management, are necessary to present
fairly the consolidated financial position, results of operations and cash
flows for all periods presented. The results of operations are not
necessarily indicative of the results to be expected for the full fiscal
year.
These consolidated financial statements do not include all disclosures
associated with consolidated financial statements prepared in accordance
with accounting principles generally accepted in the United States of
America. Accordingly, these statements should be read in conjunction with
the Company's consolidated financial statements and notes thereto contained
in the Company's Form 10-K for the year ended November 30, 2004.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts of
assets, liabilities, revenues and expenses reported in those financial
statements as well as the disclosure of contingent assets and liabilities
at the date of the consolidated financial statements. These judgments can
be subjective and complex, and consequently, actual results could differ
from those estimates and assumptions. Significant estimates made by the
Company include the allowance for doubtful accounts, inventory valuation,
recoverability of deferred tax assets, valuation of long-lived assets,
accrued sales incentives and warranty reserves.
A summary of the Company's significant accounting policies is identified in
Note 1 of Notes to Consolidated Financial Statements included in the
Company's 2004 Annual Report filed on Form 10-K. There have been no changes
to the Company's significant accounting policies subsequent to November 30,
2004.
The Company has one reportable segment ("Electronics") which is organized
by product class. The Electronics Segment sells autosound, mobile
electronics and consumer electronics, primarily to mass merchants,
specialty retailers, new car dealers, original equipment manufacturers
("OEM"), independent installers of automotive accessories and the U.S.
military.
On November 1, 2004, the Company completed the divestiture of its Cellular
business (formerly known as "ACC", "Cellular" or "Wireless"). In addition,
on February 25, 2005, the Company entered into a plan to discontinue
ownership of the Company's majority-owned subsidiary, Audiovox Malaysia
("AVM"). Accordingly, the Company has presented the financial results of
Cellular and AVM as discontinued operations for all periods presented (see
Note 3 of Notes to Consolidated Financial Statements). In addition, certain
reclassifications have been made to the 2004 consolidated financial
statements in order to conform to the current period presentation.
7
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
(2) Accounting for Stock-Based Compensation
The Company applies the intrinsic value method as outlined in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
(APB No. 25), and related interpretations in accounting for stock options
and share units granted under these programs. Under the intrinsic value
method, no compensation expense is recognized if the exercise price of the
Company's employee or independent director's stock options equals the
market price of the underlying stock on the date of grant. SFAS No. 123,
"Accounting for Stock-Based Compensation", requires that the Company
provide pro-forma information regarding net income (loss) and net income
(loss) per common share as if compensation cost for the Company's stock
option programs had been determined in accordance with the fair value
method prescribed therein. The Company adopted the disclosure portion of
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" requiring more prominent pro-forma disclosures as described in
SFAS No. 123. The following table illustrates the effect on net income and
income per common share as if the Company had measured the compensation
cost for the Company's stock option programs under the fair value method in
each period presented:
For the Three Months Ended
----------------------------
February 29, February 28,
2004 2005
--------- -----------
Net income (loss):
As reported $ 1,870 $ (1,205)
Stock based compensation expense -- (44)
--------- ---------
Pro-forma $ 1,870 $ (1,249)
========= =========
Net income (loss) per common share (basic):
As reported $ 0.09 $ (0.05)
Pro-forma 0.09 (0.06)
Net income (loss) per common share (diluted):
As reported $ 0.08 $ (0.05)
Pro-forma 0.08 (0.06)
(3) Discontinued Operations
On February 25, 2005 the Company entered into a plan to discontinue
ownership of the Company's majority owned subsidiary, AVM and sell its
ownership to the current minority interest shareholder. The Company has
planned to discontinue ownership of AVM due to increased competition from
non local OEM's and deteriorating credit quality of local customers. The
Company plans to sell its remaining equity in AVM for $550 by May 31, 2005,
at which time the Company will be released from all of its Malaysian
liabilities including bank obligations. As a result of the intended sale of
AVM, the Company compared the carrying value of AVM's assets on the
Company's consolidated balance sheets to their estimated fair value. As a
result of this review, the Company recorded an impairment charge of $408
within discontinued operations for the quarter ended February 28, 2005
8
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
as the carrying value exceeded their estimated fair value.
On November 1, 2004, the Company completed the divestiture of its Cellular
business (formerly known as "ACC" or "Wireless") to UTStarcom, Inc. In
connection with the divestiture of Cellular, the Company recorded a
receivable for the net working capital adjustment of $8,472, which is
included in other current assets on the accompanying consolidated balance
sheet at November 30, 2004. During the three months ended February 28,
2005, the Company collected $5,666 of the working capital adjustment
resulting in a receivable balance of $2,806 at February 28, 2005. In
addition, the Company was required to deposit 5% of the purchase price for
Cellular in an escrow amount, which is reflected as restricted cash on the
accompanying consolidated balance sheet. Subsequent to February 28, 2005,
the Company received the escrow amount and remaining balance of the working
capital adjustment in full.
In accordance with Financial Accounting Standards Board ("FASB") Statement
No. 144, "Accounting for the Impairment of Long-lived Assets," the Company
reclassified all associated assets and liabilities of AVM and Cellular as
discontinued operations for all periods presented. The following sets forth
the carrying amounts of the major classes of assets and liabilities, which
are classified as assets and liabilities of discontinued operations in the
accompanying consolidated balance sheets.
November 30, February 28,
2004 2005
---------- -----------
Assets
Accounts receivable, net $18,534 $ 1,312
Inventory 1,432 1,076
Prepaid expenses and other current assets 616 624
------- -------
Current assets of discontinued operations $20,582 $ 3,012
======= =======
Property, plant and equipment, net $ 711 $ 619
Other assets 214 206
------- -------
Non-current assets of discontinued operations $ 925 $ 825
======= =======
Liabilities
Accounts payable $ 172 $ 24
Accrued expenses and other current liabilities 572 615
Bank obligations 2,209 2,121
------- -------
Current liabilities of discontinued operations $ 2,953 $ 2,760
======= =======
Included in current assets of discontinued operations at November 30, 2004
is $16,958 of Cellular accounts receivable.
9
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
The following is a summary of financial results included within
discontinued operations for the three months ended February 29, 2004:
Net sales from discontinued operations $241,528
Income from discontinued operations before income taxes 1,372
Provision for income taxes 198
--------
Income from discontinued operations, net of tax $ 1,174
========
Interest expense of $461 was allocated to discontinued operations for the
three months ended February 29, 2004. This allocation represents
consolidated interest that cannot be attributed to other operations of the
Company and such allocations were based on the required working capital
needs of the Cellular business.
The following is a summary of financial results included within
discontinued operations for the three months ended February 28, 2005:
Net sales from discontinued operations $ 714
Loss from discontinued operations before income taxes (694)
Recovery of income taxes (41)
-----
Loss from discontinued operations, net of tax $(653)
======
Included in income from discontinued operations are tax provisions
(recovery of) of $198, and $(41) for the three months ended February 29,
2004 and February 28, 2005, respectively. The Company established valuation
allowances for state net operating loss carryforwards as well as other
deferred tax assets of Cellular. The net change in the total valuation
allowance, which resulted from the utilization of previously fully reserved
net operating loss carryforwards of Cellular, for the three months ended
February 29, 2004, was a decrease of $529. Such change positively impacted
the provision for income taxes during the period indicated.
(4) Net Income (Loss) Per Common Share
Basic net income (loss) per common share is based upon the weighted average
number of common shares outstanding during the period. Diluted net income
(loss) per common share reflects the potential dilution that would occur if
securities or other contracts to issue common stock were exercised or
converted into common stock.
10
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
A reconciliation between the denominator of basic and diluted net income
(loss) per common share is as follows:
Three Months Ended
----------------------------
February 29, February 28,
2004 2005
---------- ----------
Weighted average number of common shares outstanding
(denominator for net income (loss) per common share,
basic) 21,922,100 22,051,443
Effect of dilutive securities:
Stock options and warrants 332,388 --
---------- ----------
Weighted average number of common shares and potential
common shares outstanding (denominator for net income
(loss) per common share, diluted) 22,254,488 22,051,443
========== ==========
Stock options and warrants totaling 1,465,000 for the three months ended
February 29, 2004 were not included in the net income per diluted share
calculation because the exercise price of these options and warrants was
greater than the average market price of the common stock during the
period. Stock options and warrants totaling 2,571,155 for the three months
ended February 28, 2005 were not included in the net loss per diluted share
calculation because these options and warrants were anti-dilutive.
(5) Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss of $1,841 and $2,238 at November 30,
2004 and February 28, 2005, respectively, includes the net accumulated
unrealized loss on the Company's available-for- sale investment securities
of $796 and $930 at November 30, 2004 and February 28, 2005, respectively,
and foreign currency translation loss of $1,045 and $1,308 at November 30,
2004 and February 28, 2005, respectively.
The Company's total comprehensive income (loss) was as follows:
Three Months Ended
--------------------------
February 29, February 28,
2004 2005
------------ ------------
Net income (loss) $ 1,870 $(1,205)
Other comprehensive income (loss):
Foreign currency translation adjustments 545 (263)
Unrealized holding loss on available-for-sale investment
securities arising during period, net of tax (207) (134)
------- -------
Other comprehensive income (loss), net of tax 338 (397)
------- -------
Total comprehensive income (loss) $ 2,208 $(1,602)
======= =======
11
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
The change in the net unrealized loss arising during the periods presented
above are net of tax benefits of $127 and $82 for the three months ended
February 29, 2004 and February 28, 2005, respectively.
(6) Supplemental Cash Flow Information / Changes in Stockholders' Equity
The following is supplemental information relating to the consolidated
statements of cash flows:
Three Months Ended
-------------------------------
February 29, February 28,
2004 2005
------------ -------------
Cash paid during the period:
Interest (excluding bank charges) $ 1,000 $ 824
Income taxes (net of refunds) $ 3,030 $27,929
Changes in Stockholders' Equity
During the three months ended February 28, 2005, 7,200 stock options were
exercised into shares of Class A common stock aggregating proceeds of $108
to the Company.
Non-Cash Transactions
During the three months ended February 29, 2004 and February 28, 2005, the
Company recorded an unrealized holding loss relating to available-for-sale
marketable investment securities, net of deferred taxes, of $207 and $134,
respectively, as a component of accumulated other comprehensive loss.
During the three months ended February 29, 2004 and February 28, 2005, the
Company recorded a non-cash stock compensation charge of $268 and $285,
respectively, related to the rights under the call/put options previously
granted to certain employees of Audiovox German Holdings GmbH ("Audiovox
Germany").
(7) Business Acquisition
On January 4, 2005, the Company's wholly-owned subsidiary, Audiovox
Electronics Corporation, signed an asset purchase agreement to purchase
certain assets of Terk Technologies Corp. ("Terk") for a purchase price of
$13,100. The purchase price is subject to a working capital adjustment
based on the working capital of Terk at the time of closing, plus
contingent debentures with a maximum value of $9,280 based on the
achievement of future revenue targets. The acquisition of Terk was not
significant to the consolidated statement of operations or financial
condition. The results of operations of this acquisition have been included
in the consolidated financial statements from the date of acquisition. The
purpose of this acquisition is to increase the Company's market share for
satellite radio products as well as accessories for antennas and HDTV
products.
12
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
The total purchase price, which includes an estimated working capital
adjustment of $2,783 and acquisition costs of $531, approximated $16,414
for the acquisition of $24,122 (including $11,583, $10,789 and $1,750 in
accounts receivable, inventory and other assets, respectively) in assets
and assumption of $18,507 (including $14,247, $4,098 and $162 in accounts
payable, bank obligations and other liabilities, respectively) in
liabilities. The purchase price and purchase price allocation for the Terk
acquisition is not final and is subject to change based upon the completion
of an audit of net assets acquired and related working capital adjustment
as well as the completion of an independent valuation study. The excess of
the estimated purchase price over the fair value of assets and liabilities
acquired of $10,799 has been preliminarily allocated to goodwill.
The following unaudited pro-forma financial information for the three
months ended February 29, 2004 and February 28, 2005 represents the
combined results of the Company's operations and Terk as if the Terk
acquisition had occurred at the beginning of fiscal 2004. The unaudited
pro-forma financial information does not necessarily reflect the results of
operations that would have occurred had the Company constituted a single
entity during such periods.
February 29, February 28,
2004 2005
-------------- -------------
(unaudited)
Net sales $ 146,857 $ 119,814
Net income (loss) 1,639 (1,282)
Net income (loss) per share-diluted $ 0.07 $ (0.06)
(8) Goodwill and Other Intangible Assets
The change in the carrying amount of goodwill is as follows:
Balance at November 30, 2004 $ 7,019
Goodwill from purchase of Terk (see Note 7 of Notes to Consolidated
Financial Statements) 10,799
-------
Balance at February 28, 2005 $17,818
=======
At November 30, 2004, intangible assets consisted of the following:
Gross
Carrying Accumulated Total Net
Value Amortization Book Value
----------- ------------- ------------
Patents subject to amortization $ 677 $ 677 --
Trademarks not subject to amortization 8,043 -- $8,043
------ ------ ------
Total $8,720 $ 677 $8,043
====== ====== ======
13
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
At February 28, 2005, intangible assets consisted of the following:
Gross
Carrying Accumulated Total Net
Value Amortization Book Value
----------- ------------- ------------
Patents subject to amortization $ 827 $ 681 $ 146
Trademarks not subject to amortization 8,294 -- 8,294
------ ------ ------
Total $9,121 $ 681 $8,440
====== ====== ======
During the quarter ended February 28, 2005, the Company acquired $251 of
trademarks in connection with the Terk acquisition (see Note 7 of Notes to
Consolidated Financial Statements) and purchased $150 of patents which
expire in February of 2015. The estimated aggregate amortization expense
for each of the succeeding years ending February 28, 2010 amounts to $75.
(9) Equity Investments
As of November 30, 2004 and February 28, 2005, the Company had a 50%
non-controlling ownership interest in Audiovox Specialized Applications,
Inc. ("ASA") which acts as a distributor to specialized markets for
specialized vehicles, such as RV's and van conversions, of televisions and
other automotive sound, security and accessory products. During the quarter
ended February 28, 2005, one of the Company's former equity investments,
Bliss-tel, issued shares in an initial public offering (see Note 10 of
Notes to Consolidated Financial Statements).
The following presents summary financial information for ASA. Such summary
financial information has been provided herein based upon the individual
significance of ASA to the consolidated financial information of the
Company.
November 30, February 28,
2004 2005
------------ ----------
Current assets $22,008 $21,153
Non-current assets 4,425 4,482
Current liabilities 4,710 3,586
Members' equity $21,723 $22,049
Three Months Ended
-----------------------------------
February 29, February 28,
2004 2005
------------ ----------------
Net sales $13,966 $10,868
Gross profit 4,432 3,261
Operating income 1,537 493
Net income $ 1,994 $ 682
14
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
The Company's share of income from ASA for the three months ended February
29, 2004 and February 28, 2005, was $997 and $341, respectively. In
addition, the Company received distributions from ASA totaling $178 during
the three months ended February 28, 2005, which was recorded as a reduction
to equity investments on the accompanying consolidated balance sheet.
(10) Bliss-tel Initial Public Offering
On December 13, 2004, one of the Company's former equity investment's,
Bliss-tel Public Company Limited ("Bliss-tel"), issued 230,000,000 shares
on the SET (Security Exchange of Thailand) for an offering price of 6.20
baht per share. Prior to the issuance of these shares, the Company was a
20% shareholder in Bliss-tel and, subsequent to the offering, the Company
owns 30,000,000 shares (or approximately 13%) of Bliss-tel's outstanding
stock. As such, beginning in the quarter ended February 28, 2005, the
Company accounted for the Bliss-tel investment as a trading security in
accordance with FASB Statement No. 115 "Accounting for Certain Investments
in Debt and Equity Securities" whereby the unrealized holding gains on
losses on Bliss-tel stock will be included in earnings. As a result of this
transaction, the Company recorded a net gain of $2,516 for the three months
ended February 28, 2005 which is included in other income on the
accompanying statement of operations.
As of February 28, 2005, the Bliss-tel investment had a value of $4,532 and
is reflected within other current assets on the accompanying consolidated
balance sheet.
(11) Income Taxes
Quarterly tax provisions are generally based upon an estimated annual
effective tax rate per taxable entity, including evaluations of possible
future events and transactions, and are subject to subsequent refinement or
revision. When the Company is unable to estimate a part of its annual
income or loss, or the related tax expense or benefit, the tax expense or
benefit applicable to that item is reported in the interim period in which
the income or loss occurs.
A reconciliation of the provision for (benefit of) income taxes from
continuing operations computed at the Federal statutory rate to the
reported provision for (benefit of) income taxes is as follows:
Three Months Ended
------------------------------------------------
February 29, February 28,
2004 2005
------------------ -------------------
Tax provision at Federal statutory rate $ 442 35.0% $(517) (35.0)%
State income taxes, net of Federal benefit 76 6.0 (57) (3.8)
Foreign tax rate differential 35 2.8 (87) (5.9)
Permanent items 17 1.2 (193) (13.1)
Changes in rates and other, net 32 2.7 (70) (4.8)
----- ---- ----- ----
$ 602 47.7% $(924) (62.6)%
===== ===== ===== =======
15
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
Changes in rates and other, net, is a combination of various factors,
including changes in the taxable income or loss between various tax
entities with differing effective tax rates, changes in the allocation and
apportionment factors between taxable jurisdictions with differing tax
rates of each tax entity, changes in tax rates and other legislation in the
various jurisdictions, and other items. A valuation allowance is provided
when it is more likely than not that some portion, or all, of the deferred
tax assets will not be realized.
The effective tax rate for the three months ended February 28, 2005, was a
benefit of 62.6% compared to a provision of 47.7% in the prior period. The
increase in the effective benefit rate for 2005 was primarily due to tax
exempt interest income earned on short-term investments during the three
months ended February 28, 2005.
(12) Accrued Sales Incentives
A summary of the activity with respect to the Company's sales incentives is
provided below:
For the Three Months Ended
-------------------------------------
February 29, February 28,
2004 2005
------------- ----------------
Opening balance $ 14,605 $ 7,584
Accruals 2,967 3,860
Payments (8,322) (4,673)
Reversals for unearned sales incentive (1,370) (732)
Reversals for unclaimed sales incentives (1,054) (589)
-------- --------
Ending balance $ 6,826 $ 5,450
======== ========
(13) Product Warranties and Product Repair Costs
The following table provides a summary of the activity with respect to the
Company's product warranties and product repair costs:
Three Months Ended
---------------------------------
February 29, February 28,
2004 2005
------------ -----------
Opening balance $ 14,695 $ 11,794
Liabilities accrued for warranties issued during the period 2,324 1,365
Warranty claims paid during the period (1,716) (1,765)
-------- --------
Ending balance $ 15,303 $ 11,394
======== ========
16
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
(14) Financing Arrangements
The Company has the following financing arrangements:
November 30, February 28,
2004 2005
------------ ------------
Bank Obligations
Domestic bank obligation (a) - -
Euro factoring obligation (b) $ 5,485 $ 5,900
Debt
Euro loan agreement (c) $ 9,377 $ 8,639
Other (d) 829 1,109
-------- --------
Total debt $ 10,206 $ 9,748
======= ========
(a) Domestic Bank Obligations
At November 30, 2004 and February 28, 2005, the Company has an
un-guaranteed credit line to fund the temporary short-term working
capital needs of the domestic operations. This line expires on May 30,
2005 and allows aggregate borrowings of up to $25,000 at an interest
rate of Prime (or similar designations) plus 1%. As of November 30,
2004 and February 28, 2005, no direct amounts are outstanding under
this agreement.
(b) Euro Factoring Obligation
The Company has a 16,000 Euro accounts receivable and inventory
factoring arrangement for the Company's subsidiary, Audiovox Germany
which expires on October 25, 2005 and is renewable on an annual basis.
Selected accounts receivable are purchased from the Company on a
non-recourse basis at 80% of face value and payment of the remaining
20% upon receipt from the customer of the balance of the receivable
purchased. The rate of interest is Euribor plus 2.5%, and the Company
pays 0.4% of its gross sales as a fee for this arrangement.
(c) Euro Loan Agreement
On September 2, 2003, Audiovox Germany borrowed 12 million Euros under
a new term loan agreement. This agreement was for a 5 year term loan
with a financial institution consisting of two tranches. Tranche A is
for 9 million Euros and Tranche B is for 3 million Euros. The term
loan matures on August 30, 2008. Payments are due in 60 monthly
installments and interest accrues at (i) 2.75% over the Euribor rate
for the Tranche A and (ii) 3.5% over the three months Euribor rate for
Tranche B. Any amount repaid may not be reborrowed. The term loan
becomes immediately due and payable if a change of control occurs
without permission of the financial institution.
17
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
Audiovox Corporation guarantees 3 million Euros of this term loan. The
term loan is secured by the pledge of the stock of Audiovox German
Holdings GmbH and on all brands and trademarks of the Audiovox German
Holdings Group. The term loan requires the maintenance of certain
yearly financial covenants that are calculated according to German
Accounting Standards for Audiovox German Holdings. Should any of the
financial covenants not be met, the financial institution may charge a
higher interest rate on any outstanding borrowings. The short and long
term amounts outstanding under this agreement were $2,497 and $6,880,
respectively, at November 30, 2004 and $2,411 and $6,228,
respectively, at February 28, 2005.
(d) Other Debt
This amount consists primarily of a call put option owed to certain
employees of Audiovox Germany in the amount of $829 and $1,109 at
November 30, 2004 and February 28, 2005, respectively.
(15) Contingencies and Legal Matters
The Company is currently, and has in the past been, a party to various
routine legal proceedings incident to the ordinary course of business. The
Company believes that the outcome of all such pending legal proceedings in
the aggregate is unlikely to have a material adverse effect on the business
or consolidated financial condition of the Company.
During the fourth quarter of 2004, several purported derivative and class
actions were filed in the Court of Chancery of the State of Delaware, New
Castle County. On January 10, 2005, Vice Chancellor Steven Lamb of the
Court of Chancery of the State of Delaware, New Castle County, granted an
order permitting the filing of a Consolidated Complaint by several
shareholders of Audiovox Corporation derivatively on behalf of Audiovox
Corporation against Audiovox Corporation, ACC and the directors of Audiovox
Corporation captioned "In Re Audiovox Corporation Derivative Litigation".
The complaint seeks (a) rescission of: agreements; amendments to long-term
incentive awards; and severance payments pursuant to which Audiovox and ACC
executives were paid from the net proceeds of the sale of certain assets of
ACC to UTStarcom, Inc., (b) disgorgement to ACC of $16 million paid to
Philip Christopher pursuant to a Personally Held Intangibles Purchase
Agreement in connection with the UTStarcom transaction, (c) disgorgement to
Audiovox of $4 million paid to Philip Christopher as compensation for
termination of his Employment Agreement and Award Agreement with ACC, (d)
disgorgement to ACC of $1,916,477 paid to John Shalam pursuant to an Award
Agreement with ACC, and (e) recovery by ACC of $5 million in severance
payments distributed by Philip Christopher to ACC's former employees. ACC
is sued as a nominal defendant only. Defendants have filed a motion to
dismiss the complaint. Defendants Paul C. Kreuch, Jr, Dennis F. McManus,
Irving Halevy and Peter A. Lesser, have been appointed as the members of a
Special Litigation Committee (the "SLC") of the Board of Directors of the
Company. On March 30, 2005, the SLC filed a Motion to Stay Proceedings (the
"Motion to Stay") seeking to stay the derivative action pending an
investigation by the SLC of the matters alleged in the consolidated
complaint. The Motion to Stay is scheduled for oral argument on April 22,
2005. The Company intends to vigorously defend this matter. However, no
18
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
assurances regarding the outcome of this matter can be given at this point
in the litigation.
During the first quarter of 2005, the litigation commenced by Compression
Labs, Incorporated in the United States District Court for the Eastern
District of Texas, Marshall Division, against the Company and its
subsidiary Audiovox Electronics Corp. ("AEC") was dismissed without
prejudice as to the Company and settled with respect to AEC. The litigation
against ACC is still pending and although ACC intends to vigorously defend
this matter, no assurances regarding the outcome can be given at this point
in the litigation.
During the third quarter of 2004, an arbitration proceeding was commenced
by the Company and several of its subsidiaries against certain Venezuelan
employees and two Venezuelan companies ("Respondents") before the American
Arbitration Association, International Centre in New York, New York,
seeking recovery of monies alleged to have been wrongfully taken by
individual Respondents and damages for fraud. Respondents asserted
counterclaims alleging that the Company engaged in certain business
practices that caused damage to Respondents. The matter was submitted to
mediation during the fourth quarter of fiscal 2004 and settled subsequent
to year end. The settlement provides, in pertinent part, for a payment (to
be made upon satisfaction of certain pre- closing conditions) from the
Company to the Respondents of $1,700 in consideration of which the Company
will acquire all of Respondents' ownership in the Venezuelan companies and
a release of any and all claims. As of February 28, 2005, the satisfaction
of the aforementioned pre-closing conditions were not satisfied and no
liability has been recorded.
On September 17, 2004, Shintom Co. Ltd. commenced action against Audiovox
Corporation in the Chancery Court of the State of Delaware, New Castle
County, seeking recovery of the sum of $2,500 or the value of Audiovox
preferred stock determined as of April 16, 1987 (the date of the merger of
Audiovox Corp., a New York corporation, with Audiovox Corporation, a
Delaware corporation) which preferred stock was purchased by Shintom from
Audiovox in April 1981. In lieu of answering, the Company has moved to
dismiss the complaint. The motion to dismiss was heard on April 5, 2005 and
we are awaiting Chancellor Chandler's decision on the motion. The Company
believes that the lawsuit is baseless and it intends to vigorously defend
this matter. However, no assurance regarding the outcome of this matter can
be given at this point in the litigation.
The consolidated class actions transferred to a Multi-District Litigation
Panel of the United States District Court of the District of Maryland
against the Company and other suppliers, manufacturers and distributors of
hand-held wireless telephones alleging damages relating to exposure to
radio frequency radiation from hand-held wireless telephones is still
pending. On March 16, 2005, the United States Court of Appeals for the
Fourth Circuit reversed the District Court's order dismissing the
complaints on grounds of federal pre-emption. The Fourth Circuit remanded
the actions to each of their respective state courts, except for the Naquin
litigation which was remanded to the local Federal Court. Defendants intend
to file a petition for rehearing with the Fourth Circuit.
The Company and ACC, along with other manufacturers of wireless phones and
cellular service providers, were named as defendants in two class action
lawsuits alleging non-compliance with Federal Communications Commission
("FCC") ordered emergency 911 call processing capabilities. These lawsuits
were consolidated and transferred to the United States District Court for
19
AUDIOVOX CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Three Months Ended February 29, 2004 and February 28, 2005
the Northern District of Illinois, which in turn referred the cases to the
FCC to determine if the manufacturers and service providers are in
compliance with the FCC's order on emergency 911 call processing
capabilities. During the third quarter of 2004, the FCC confirmed that
plaintiffs' interpretation of the FCC's second order on emergency 911 call
processing capabilities was incorrect and as a result, plaintiffs have
filed a consolidated amended complaint in the United States District Court
for the Northern District of Illinois. Defendants have moved to dismiss the
consolidated amended complaint, but to date, the motion has not been heard.
The Company and ACC intend to vigorously defend this matter. However, no
assurances regarding the outcome of this matter can be given at this point
in the litigation.
(16) New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 123R ("Statement 123R"), "Share Based Payment".
Statement 123R is a revision of FAS Statement 123, "Accounting for Stock
Based Compensation" and supersedes APB Opinion No. 25, "Accounting for
Stock issued to Employees" (APB No.25). Statement 123R requires a public
entity to measure the cost of employee services recognized in exchange for
an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). Statement 123R is effective the first
interim or annual period that begins after June 15, 2005 or the Company's
fourth quarter and fiscal year ended November 30, 2005. The adoption of
Statement 123R will rescind the Company's current accounting for stock
based compensation under the intrinsic method as outlined in APB No. 25.
Under APB No. 25, the issuance of stock options to employees generally
resulted in no compensation expense to the Company. The adoption of
Statement 123R will require the Company to measure the cost of stock
options based on the grant-date fair value of the award as discussed in
Note 2 of Notes to Consolidated Financial Statements.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Dollars in thousands, except share and per share data)
We begin Management's Discussion and Analysis of Financial Condition and
Results of Operations (MD&A) with an overview of the business. This is followed
by a discussion of the Critical Accounting Estimates that we believe are
important to understanding the assumptions and judgments incorporated in our
reported financial results. In the next section, we discuss our Results of
Operations for the three months ended February 29, 2004 compared to the three
months ended February 28, 2005. We then provide an analysis of changes in our
balance sheet and cash flows, and discuss our financial commitments in the
sections entitled "Liquidity and Capital Resources, including Contractual and
Commercial Commitments," We conclude this MD&A with a discussion of "Related
Party Transactions" and "Recent Accounting Pronouncements". All financial
information, except share and per share data, is presented in thousands.
Business Overview and Strategy
The Company through its four wholly-owned subsidiaries: Audiovox
Electronics Corporation, American Radio Corp., Code Systems, Inc. ("Code") and
Audiovox German Holdings GmbH and three majority-owned subsidiaries: Audiovox
Communications (Malaysia) Sdn. Bhd., Audiovox Holdings (M) Sdn. Bhd. and
Audiovox Venezuela, C.A. markets its products under the Audiovox(R) brand name
and other brand names, such as Jensen(R), Prestige(R), Pursuit(R), Rampage(TM),
Code-Alarm(R), Car Link(R), Movies 2 Go(R), Magnate(R), Mac Audio(R), Heco(R),
Acoustic Research(R), Advent(R), and Phase Linear(R), as well as private labels
through a large and diverse distribution network both domestically and
internationally.
On November 1, 2004, the Company completed the divestiture of its Cellular
business (formerly known as "ACC", "Cellular" or "Wireless"). In addition, on
February 25, 2005, the Company entered into a plan to discontinue ownership of
the Company's majority-owned subsidiary, Audiovox Malaysia ("AVM"). Accordingly,
the Company has presented the financial results of Cellular and AVM as
discontinued operations for all periods presented (see Note 3 of Notes to
Consolidated Financial Statements). In addition, certain reclassifications have
been made to the 2004 consolidated financial statements in order to conform to
the current period presentation.
On January 4, 2005, the Company's wholly-owned subsidiary, Audiovox
Electronics Corporation, signed an asset purchase agreement to purchase certain
assets of Terk Technologies Corp. ("Terk") for a purchase price of $13,100. The
purchase price is subject to a working capital adjustment based on the working
capital of Terk at the time of closing, plus contingent debentures with a
maximum value of $9,280 based on the achievement of future revenue targets. The
purpose of this acquisition is to increase the Company's market share for
satellite radio products as well as accessories for antennas and HDTV products.
Management reviews the financial results of the Company based on the
performance of the Electronics Group and Administrative Group. The Electronics
Group is comprised of sales operating subsidiaries that sell Mobile and Consumer
Electronics. The Administrative Group consists of treasury, legal, human
resources, Information Technology ("IT") and accounting services that are
provided to the Electronics Group. In prior years, the Electronics Group had
three sales categories (Mobile, Consumer and Sound). Based on the current
marketplace and management's overall assessment of the Company, the sales
categories have been reclassified into Mobile Electronics and Consumer
Electronics, therefore eliminating the Sound category.
Mobile electronics products include:
o mobile video products, including overhead, headrest and portable
mobile video systems,
21
o autosound products including mobile multi-media products, radios,
speakers, amplifiers, CD changers,
o satellite radios including plug and play models and direct connect
models,
o automotive security and remote start systems,
o navigation systems,
o rear observation systems, collision avoidance systems and
o automotive power accessories, including cruise control systems.
Consumer electronics include:
o LCD, flat panel and under-cabinet televisions,
o portable DVD players,
o home and portable stereos,
o GMRS radios and
o Digital multi-media products such as personal video recorders, MP3
players, MPG 4 products
The Company reclassified the Cellular and Audiovox Malaysia Group results
from continuing operations and now reflects these results within discontinued
operations (refer to discussion below under Discontinued Operations).
Critical Accounting Policies and Estimates
As disclosed in the Annual Report on Form 10-K for the fiscal year ended
November 30, 2004, the discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in conformity with general accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses reported in
those financial statements. These judgments can be subjective and complex, and
consequently, actual results could differ from those estimates. Our most
critical accounting policies and estimates relate to revenue recognition; sales
incentives; accounts receivable; inventory, goodwill and other intangible
assets; warranties and income taxes. Since November 30, 2004, there have been no
changes in our critical accounting policies and no other significant changes to
the assumptions and estimates related to them.
Results of Operations
In this discussion and analysis, we explain the general financial condition
and the results of operations for Audiovox, including the following:
o our earnings and costs in the periods presented,
o changes in earnings and costs between periods,
o sources of earnings, and
o the impact of these factors on our overall financial condition.
As you read this discussion and analysis, refer to the accompanying
consolidated statements of operations, which present the results of our
operations for the three months ended February 29, 2004 and February 28, 2005.
We analyze and explain the differences between periods in the specific line
items of the consolidated statements of operations.
22
Management Key Indicators
Management reviews the following financial indicators to assess the
performance of the Company's operating results:
o Net sales by product class - Management reviews this indicator in
order to determine sales trends for certain product classes as this
indicator is directly impacted by new product introductions.
o Gross profit margin - This indicator allows management to assess the
effectiveness of product introductions, inventory purchases and
significance of inventory write-downs.
o Operating expenses as a percentage of net sales - This indicator is
reviewed to determine the efficiency of operating expenses in relation
to the Company's operations and identify significant fluctuations or
possible future trends.
o Inventory and accounts receivable turnover - Inventory purchases and
accounts receivable collections are two significant liquidity factors
that determine the Company's ability to fund current operations and
determine if additional borrowings may be necessary for future capital
outlays.
Three Months Ended February 29, 2004 Compared to Three Months Ended February 28,
2005
Continuing Operations
The following tables sets forth, for the periods indicated, certain
statement of operations data for the three months ended February 29, 2004 and
February 28, 2005.
Net Sales
February 29, February 28, $ %
2004 2005 Change Change
------------ ------------- --------- ----------
Mobile Electronics $ 89,103 $ 74,678 $(14,425) (16.2)%
Consumer Electronics 46,253 41,302 (4,951) (10.7)
-------- -------- -------- ------
Total net sales $135,356 $115,980 $(19,376) (14.3)%
======== ======== ======== =======
Mobile Electronics sales, which represented 64.4% of net sales, decreased
primarily due to the continual price erosion and competition within the mobile
video category brought on by lower portable DVD prices and increased presence by
original equipment car manufacturers. The decline in Mobile Electronics was
partially offset by sales generated from the recent acquisition of Terk in
January of 2005 and increased Code sales due to increased sales to its customer
base which includes OEM's.
Consumer Electronics sales, which represented 35.6%, of net sales,
decreased primarily due to the timing of product shipments. In 2004, a large
volume of sales orders were shipped in February, whereas in 2005, a large volume
of sales orders were shipped in March. The decline in Consumer Electronics was
partially offset by increased sales for LCD flat-panel TV's as result of
increased demand.
Sales incentive expense increased $1,996 to $2,539 for the three months
ended February 28, 2005 as a result of the Company offering more sales incentive
programs to mass merchants and large retailers in an effort to increase sales.
Also, the increase in sales incentive expense is attributable to a $1,103
decrease in reversals for the three months ended February 28, 2005 as compared
to the prior year. Specifically,
23
reversals for unearned and unclaimed sales incentives for the three months ended
February 28, 2005 decreased $638 and $465 as compared to the prior year,
respectively. The decline in reversals is due to increased achievement of Volume
Incentive Rebate programs and increased claims from customers as compared to the
prior year. The Company believes that the reversal of earned but unclaimed sales
incentives upon the expiration of the claim period is a disciplined, rational,
consistent and systematic method of reversing unclaimed sales incentives. The
majority of sales incentive programs are calendar-year programs. Accordingly,
the program ends on the month following the fiscal year end and the claim period
expires one year from the end of the program. These sales incentive programs are
expected to continue and will either increase or decrease based upon competition
and customer demands.
Gross Profit
February 29, February 28,
2004 2005
------------ -------------
Gross profit $ 21,128 $ 16,071
Gross margins 15.6% 13.9%
Gross margins decreased to 13.9% for the three months ended February 28,
2005 as compared to 15.6% for the three months ended February 29, 2004. Gross
margins were adversely impacted by a reduction in selling prices within the
mobile video category as a result of the continual increase in competition and
price erosion. Inventory write-downs adversely impacted gross margins by $2,630
(1.9%) and $924 (0.8%) during the three months ended February 29, 2004 and
February 28, 2005, respectively. The decrease in write-downs was primarily due
to better inventory positions coming out of the holiday season. In fiscal 2004,
the Company experienced significant write-downs as a result of new product
introductions during the three months ended February 29, 2004 which resulted in
a decline in selling prices of older models.
The above declines in margins were offset by margins achieved in Code due
to an increase in sales as well as increased margins from the sale of Terk
products. Furthermore, reversals of sales incentive expense favorably impacted
gross margins by 1.8% and 1.1% during the three months ended February 29, 2004
and February 28, 2005, respectively.
Operating Expenses and Operating Income (Loss)
The following table presents the results of the Company separated by the
Electronics and Administrative Groups.
February 29, February 28, $ %
2004 2005 Change Change
------------------ ---------------- ----------- ------------
Selling $ 6,115 $ 6,949 $ 834 13.6%
General and administrative 9,670 8,847 (823) (8.5)
Warehousing and technical support 969 1,468 499 51.5
--------- -------- --------
Electronics operating expenses 16,754 17,264 510 3.0
Electronics operating income (loss) 4,374 (1,193) (5,567) *
Electronics other income (expense) 755 (530) (1,285) *
--------- -------- --------
Electronics pre-tax income (loss) 5,129 (1,723) (6,852) *
Administrative operating expenses 3,843 4,608 765 19.9%
Administrative other income (loss) (23) 4,855 4,878 *
--------- -------- --------
Consolidated pre-tax income (loss) $ 1,263 $ (1,476) $ (2,739) *
========= ======== =========
* Greater than 100 percent
24
<page>
Consolidated operating expenses increased $1,275, or 6.2%, for the three
months ended February 28, 2005, as compared to 2004. As a percentage of net
sales, operating expenses increased to 18.9% for the three months ended February
28, 2005, from 15.2% in 2004.
Electronics operating expenses increased $510, or 3.0%, for the three
months ended February 28, 2005 as compared to 2004. As a percentage of net
sales, Electronics operating expenses increased to 14.9% for the three months
ended February 28, 2005, compared to 12.4% in 2004.
Electronics selling expenses increased during the three months ended
February 28, 2005, due to the following:
o $484 increase in commissions and $136 in salesmen salaries as a result
of changes in compensation programs related to commissionable sales
for Jensen products as well as the additional costs necessary to
promote the recently acquired Terk product line.
o Trade show expenses and travel and lodging increased $122 and $257,
respectively, as a result of the acquired Terk product line and
additional promotions presented at the Consumer Electronics show.
o The above increases were partially offset by a $216 decrease in
advertising due to a decline in Audiovox Germany sales.
Electronics general and administrative expenses decreased due to the
following:
o $316 decrease in officer and office salaries as a result of cost
cutting initiatives due to the decline in sales. This decline was
partially offset by increased salaries as a result of the Terk
acquisition.
o $186 decrease in occupancy costs due to decreased costs of Audiovox
Germany due to decreased space requirements partially offset by
increased costs as a result of the Terk acquisition.
o $296 decrease in bad debt expense due to the recovery of a previously
reserved bad debt. The Company does not consider this to be a trend in
the overall accounts receivable.
o The above decreases were partially offset by an increase of $123 in
professional fees due to legal costs incurred to develop, settle and
protect patent rights. The Company expects, as technology for
electronic products become more complex, the Company will have to
expend more resources on defending patent rights and obtaining patents
on new products.
Electronics warehousing and technical support increased due to an increase
in direct labor of $407 as a result of: increased inventory levels, the recent
Terk acquisition and the continual increase in product complexity which has
resulted in the Company hiring additional engineers and providing added customer
service.
Electronics operating income decreased to a loss of $1,193 for the three
months ended February 28, 2005, as a result of a decline in gross margins and
increased operating expenses.
25
The following is a summary of administrative operating expenses:
February 29, February 28, $ %
2004 2005 Change Change
---------------- --------------- ------------ ------------
Advertising $ 1,025 $ 1,043 $ 18 1.8%
Professional fees 956 1,185 229 24.0
Depreciation 241 311 70 29.0
Insurance 264 248 (16) (6.1)
Officers' salaries 383 242 (141) (36.8)
Office salaries and other 2,287 2,521 234 10.2
Allocations (1,313) (942) 371 28.3
------- ------- ------- ------
Total administrative operating expenses 3,843 4,608 765 19.9%
Administrative other income (loss) (23) 4,855 4,878 *
-------- ------- -------
Administrative pre-tax income (loss) $(3,866) $ 247 $ 4,113 *
======== ======= =======
* Greater than 100 percent
The increase in professional fees is a result of increased legal and
auditing fees. Other administrative operating expenses, which are mainly
comprised of occupancy costs, accounting, IT and office salaries, increased
primarily due to an increase in occupancy costs, telecommunications, taxes and
licenses. Corporate allocations decreased as certain administrative expenses
were allocated to the Company's discontinued Cellular Group in the prior year.
The Company entered into a transition service agreement in November 2004 with
UTStarcom to provide certain IT services in connection with the sale of the
Cellular Group. The fees billed for the transition service agreement amounted to
$170 during the three months ended February 28, 2005 and such fees are included
in other income on the consolidated statements of operations. The Company is in
the process of reducing administrative expenses as a result of the change in
business structure.
The decline in Electronics operating income coupled with administrative
operating expenses resulted in a consolidated operating loss of $5,801 for the
three months ended February 28, 2005.
Other Income (Expense)
February 29, February 28, $
2004 2005 Change
------------ ------------ --------
Interest and bank charges $ (963) $ (633) $ 330
Equity in income of equity investees 1,071 353 (718)
Other, net 624 4,605 3,981
------- ------- -------
Total other income (expense) $ 732 $ 4,325 $ 3,593
======= ======= =======
Interest expense and bank charges decreased primarily due to the reduction
in outstanding bank obligations. The Company expects interest expense to
decrease in fiscal 2005 as the Company repaid all amounts outstanding under its
domestic bank obligations on November 1, 2004 and the Company has no outstanding
amounts under its domestic bank obligations at February 28, 2005. Interest and
bank charges during the three months ended February 28, 2005 primarily represent
expenses for debt and bank obligations of Audiovox Germany and interest for a
capital lease.
26
Equity in income of equity investees decreased primarily due to a decrease
in the equity income of ASA as a result of decreased sales due to increased
competition for van conversion products and a decline in sales of one major
customer.
Other income increased due to a $2,516 unrealized gain as a result of an
initial public offering of Bliss-tel, a former equity investment. In addition,
interest income increased $818 due to the returns on the purchase of short-term
investments. Furthermore, other expense decreased $414 as a result of lower
foreign exchange devaluation in the Company's Venezuelan subsidiary as compared
to the prior year. The Company expects other income to increase during fiscal
2005 as a result of expected returns on short-term investments purchased in
November of fiscal 2004.
Provision (Benefit) for Income Taxes
The effective tax rate for the three months ended February 28, 2005, was a
benefit of 62.6% compared to a provision of 47.7% in the prior period. The
increase in the effective benefit rate for 2005 was primarily due to tax exempt
interest income earned on short-term investments during the three months ended
February 28, 2005.
Income (Loss) from Discontinued Operations
On February 25, 2005 the Company entered into a plan to discontinue
ownership of the Company's majority owned subsidiary, Audiovox Malaysia ("AVM")
and sell its ownership to the current minority interest shareholder. In
addition, on November 1, 2004, the Company completed the divestiture of its
Cellular business (formerly known as "ACC" or "Wireless") to UTStarcom.
The following is a summary of financial results included within
discontinued operations for the three months ended February 29, 2004:
Net sales from discontinued operations $241,528
Income from discontinued operations before income taxes 1,372
Provision for income taxes 198
--------
Income from discontinued operations, net of tax $ 1,174
========
Interest expense of $461 was allocated to discontinued operations for the
three months ended February 29, 2004. This allocation represents consolidated
interest that cannot be attributed to other operations of the Company and such
allocations were based on the required working capital needs of the Cellular
business.
The following is a summary of financial results included within
discontinued operations for the three months ended February 28, 2005:
Net sales from discontinued operations $ 714
Loss from discontinued operations before income taxes (694)
Recovery of income taxes (41)
-----
Loss from discontinued operations, net of tax $(653)
======
Loss from discontinued operations, net of tax
Income from discontinued operations, net of tax, provided income of $1,174
for the three months ended February 29, 2004 compared to a loss from
discontinued operations of $653 for the three months ended February 28, 2005.
Included in loss from discontinued operations for the three months ended
February 28, 2005 is a write-down charge of $408 for AVM assets as a result of
27
the intended sale of AVM. The decline of income from discontinued operations for
the three months ended February 28, 2005 as compared to the prior year is due to
increased losses of AVM as well as the sale of the Cellular Group on November 1,
2004.
Net Income (Loss)
As a result of decreased sales and gross margins partially offset by
increased other income, net loss for the three months ended February 29, 2004
was $1,870 compared to net income of $1,205 in 2005. Earnings (loss) per share
for the three months ended February 29, 2004 was $0.09 (basic) and $0.08
(diluted) as compared to ($0.05) (basic and diluted) for 2005. Net income was
favorably impacted by sales incentive reversals of $3,100 and $1,321 for the
three months ended February 29, 2004 and February 28, 2005, respectively.
The Company believes that the Electronics Group has an expanding market
with a certain level of volatility related to both domestic and international
new car sales and general economic conditions. Also, all of its products are
subject to price fluctuations which could affect the carrying value of
inventories and gross margins in the future.
Liquidity and Capital Resources
Cash Flows, Commitments and Obligations
As of February 28, 2005, the Company had working capital of $351,347, which
includes cash and short-term investments of $158,233 compared with working
capital of $362,018 at November 30, 2004, which includes cash and cash
equivalents and short-term investments of $167,646. The Company plans to utilize
its current cash position as well as collections from accounts receivable to
fund the current operations of the business. However, the Company may utilize
all or a portion of the current capital resources to pursue other business
opportunities, including acquisitions.
Historically, the Company had financed its operations through a combination
of available borrowings under bank lines of credit and debt and equity
securities, which was typically dependent on the collections of accounts
receivable and purchase of inventory. As of November 30, 2004 and February 28,
2005, the Company has a credit line to fund the temporary short-term working
capital needs of the Company. This line expires on May 30, 2005 and allows
aggregate borrowings of up to $25,000 at an interest rate of Prime (or similar
designations) plus 1%.
Operating activities provided cash of $3,707 for the three months ended
February 28, 2005 compared to cash used of $212 in 2004. The increase in cash
provided by operating activities as compared to the prior year is primarily due
to the collection of accounts receivable, including assets of discontinued
operations and decreased inventory, partially offset by a decrease in accounts
payable and income taxes.
The following significant fluctuations in the balance sheets impacted cash
flow from operations:
o Cash flows from operating activities for the three months ended
February 28, 2005 were favorably impacted by a decrease in accounts
receivable primarily from collections. Accounts receivable turnover
approximated 4.6 during for the three months ended February 28, 2005
compared to 4.4 in the comparable period in the prior year. Overall
collections of accounts receivable and credit quality of customers has
improved, however, accounts receivable collections are often impacted
by general economic conditions.
o Cash flow from operations were favorably impacted by a decrease in
28
inventory due to a decline in purchasing. The increase was partially
offset by decreased inventory turnover which approximated 3.0 during
for the three months ended February 28, 2005 compared to 3.1 in the
comparable period in the prior year due to a decline in sales.
o In addition, cash flow from operating activities for the three months
ended February 28, 2005, was impacted by a decrease in accounts
payable, primarily from payments made to inventory vendors. The timing
of payments made can fluctuate and are often impacted by the timing of
inventory purchases and amount of inventory on hand.
o Income taxes payable decreased $30,418 during the three months ended
February 28, 2005, primarily due to a tax payment made in connection
with the gain on the sale of the Cellular business in fiscal 2004.
Investing activities used $24,239 during the three months ended February
28, 2005, primarily due to the acquisition of Terk and purchase (net of sales)
of short-term investments. The usage of cash from investing activities was
partially offset by the collection of a working capital adjustment of $5,666 in
connection with the sale of the sale of the Cellular business. Investing
activities provided cash of $2,526 during the three months ended February 29,
2004, primarily due to a distribution received from an equity investee.
Financing activities used $4,227 during the three months ended February 28,
2005, primarily from the payment of bank obligations which were acquired in
connection with the Terk acquisition. Financing activities for the three months
ended February 29, 2004 used cash of $2,211 mainly due to payments of debt.
The Company has certain contractual cash obligations and other commercial
commitments which will impact its short and long-term liquidity. At February 28,
2005, such obligations and commitments are as follows:
Payments Due By Period
---------------------------------------------------------------------
Contractual Cash Less than 1-3 4-5 After
Obligations Total 1 Year Years Years 5 Years
- ------------------------ ------- ------- ------- ------- -------
Capital lease obligation (1) $13,359 $ 771 $ 1,324 $ 1,156 $10,108
Operating leases (2) 8,312 2,891 4,559 862 --
------- ------- ------- ------- -------
Total contractual cash
obligations $21,671 $ 3,662 $ 5,883 $ 2,018 $10,108
======= ======= ======= ======= =======
29
Amount of Commitment
Expiration per period
-----------------------------------------------------------------------------------
Total
Other Commercial Amounts Less than After
Commitments Committed 1 Year 1-3 Years 4-5 Years 5 years
----------- --------- --------- --------- --------- -------
Lines of credit (3) $ 5,900 $ 5,900 -- -- --
Stand-by letters of
credit (4) 2,807 2,807 -- -- --
Commercial letters of
credit (4) 141 141 -- -- --
Debt (5) 9,748 2,411 $ 6,091 $ 1,246
Unconditional
purchase obligations(6) 78,544 78,544 -- -- --
------- ------- ------- ------- ----
Total commercial commitments $97,140 $89,803 $ 6,091 $ 1,246 --
======= ======= ======= ======= =====
(1) Represents total payments due under a capital lease obligation which has a
current and long term principal balance of $126 and $6,091, respectively at
February 28, 2005.
(2) The Company enters into operating leases in the normal course of business.
(3) Represents amounts outstanding under the German factoring agreement at
February 28, 2005. The German credit facility consists of accounts
receivable and inventory factoring up to 16,000 Euros and a working capital
facility, secured by accounts receivable and inventory, up to 6,000 Euros.
The facilities are renewable on an annual basis.
(4) Commercial letters of credit are issued by the Company during the ordinary
course of business through major domestic banks as requested by certain
suppliers. The Company also issues standby letters of credit to secure
certain bank obligations and insurance requirements.
(5) Represents amounts outstanding under a loan agreement for Audiovox Germany
which was acquired in connection with the Recoton Acquisition. This amount
also includes amounts due under a call-put option with certain employees of
Audiovox Germany.
(6) Unconditional purchase obligations represent inventory commitments. These
obligations are not recorded in the consolidated financial statements until
commitments are fulfilled and such obligations are subject to change based
on negotiations with manufacturers.
Under the asset purchase agreement for the sale of the Cellular business to
UTStarcom ("UTSI"), the Company agreed to indemnify UTSI for any breach or
violation by ACC and its representations, warranties and covenants contained in
the asset purchase agreement and for other matters, subject to certain
limitations. Significant indemnification claims by UTSI could have a material
adverse effect on the Company's financial condition. The Company is not aware of
any such claim(s) for indemnification.
The Company regularly reviews its cash funding requirements and attempts to
meet those requirements through a combination of cash on hand, cash provided by
operations, available borrowings under bank lines of credit and possible future
public or private debt and/or equity offerings. At times, the Company evaluates
possible acquisitions of, or investments in, businesses that are complementary
to those
30
of the Company, which transaction may require the use of cash. The Company
believes that its cash, other liquid assets, operating cash flows, credit
arrangements, access to equity capital markets, taken together, provide adequate
resources to fund ongoing operating expenditures. In the event that they do not,
the Company may require additional funds in the future to support its working
capital requirements or for other purposes and may seek to raise such additional
funds through the sale of public or private equity and/or debt financings as
well as from other sources. No assurance can be given that additional financing
will be available in the future or that if available, such financing will be
obtainable on terms favorable to the Company when required.
Treasury Stock
The Company's Board of Directors approved the repurchase of 1,563,000
shares of the Company's Class A common stock in the open market under a share
repurchase program (the Program). No shares were purchased under the Program
during fiscal 2004 or fiscal 2005. As of November 30, 2004 and February 28,
2005, 1,070,957 shares were repurchased under the Program at an average price of
$7.93 per share for an aggregate amount of $8,497.
Off-Balance Sheet Arrangements
The Company does not maintain any off-balance sheet arrangements,
transactions, obligations or other relationships with unconsolidated entities
that would be expected to have a material current or future effect upon our
financial condition or results of operations.
Related Party Transactions
During 1998, the Company entered into a 30-year capital lease for a
building with its principal stockholder and chief executive officer, which was
the headquarters of the discontinued Cellular operation. Payments on the capital
lease were based upon the construction costs of the building and the
then-current interest rates. The effective interest rate on the capital lease
obligation is 8%. On November 1, 2004 the Company entered into an agreement to
sub-lease the building to UTSI for monthly payments of $46 until November 1,
2009. The Company also leases another facility from its principal stockholder.
Total lease payments required under the leases for the five-year period ending
February 29, 2010 are $4,920.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 123R ("Statement 123R"), "Share Based Payment". Statement
123R is a revision of FAS Statement 123, "Accounting for Stock Based
Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock issued to
Employees" (APB No.25). Statement 123R requires a public entity to measure the
cost of employee services recognized in exchange for an award of equity
instruments based on the grant-date fair value of the award (with limited
exceptions). Statement 123R is effective the first interim or annual period that
begins after June 15, 2005 or the Company's fourth quarter and fiscal year ended
November 30, 2005. The adoption of Statement 123R will rescind the Company's
current accounting for stock based compensation under the intrinsic method as
outlined in APB No. 25. Under APB No. 25, the issuance of stock options to
employees generally resulted in no compensation expense to the Company. The
adoption of Statement 123R will require the Company to measure the cost of stock
options based on the grant-date fair value of the award as discussed in Note 2
of Notes to Consolidated Financial Statements.
31
Forward-Looking Statements
Except for historical information contained herein, statements made in this
Form 10-Q that would constitute forward-looking statements may involve certain
risks such as our ability to keep pace with technological advances, significant
competition in the mobile and consumer electronics businesses, quality and
consumer acceptance of newly-introduced products, our relationships with key
suppliers and customers, market volatility, non-availability of product, excess
inventory, price and product competition, new product introductions, the
dependency on key executives, the uncertain economic and political climate in
the United States and throughout the rest of the world and the potential that
such climate may deteriorate further and other risks detailed in the Company's
Form 10-K for the fiscal year ended November 30, 2004. These factors, among
others, may cause actual results to differ materially from the results suggested
in the forward- looking statements. Forward-looking statements include
statements relating to, among other things:
o growth trends in the mobile and consumer electronic businesses
o technological and market developments in the mobile and consumer
electronics businesses
o liquidity
o availability of key employees
o expansion into international markets
o the availability of new consumer and mobile electronic products
These forward-looking statements are subject to numerous risks,
uncertainties and assumptions about the Company including, among other things:
o the ability to keep pace with technological advances
o impact of future selling prices on Company profitability and inventory
carrying value
o significant competition in the mobile and consumer electronics
businesses
o quality and consumer acceptance of newly introduced products
o the relationships with key suppliers
o the relationships with key customers
o possible increases in warranty expense
o changes in the Company's business operations
o the loss of key employees
o foreign currency risks
o political instability
o changes in U.S. federal, state and local and foreign laws
o changes in regulations and tariffs
o seasonality and cyclicality
o inventory obsolescence and availability
o changes in global or local economic conditions
o investments and pursuit of acquisitions
o diversification of our business
o contingent liabilities
o litigation from intellectual property rights
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Sensitive Instruments
The market risk inherent in the Company's market risk sensitive instruments
and positions is the potential loss arising from adverse changes in marketable
equity security prices, foreign currency exchange rates and interest rates.
32
Marketable Securities
Marketable securities at November 30, 2004 and February 28, 2005, which are
recorded at fair value of $5,988 and $6,721, respectively, include an unrealized
loss of $1,284 and $1,501, respectively, and have exposure to price risk. This
risk is estimated as the potential loss in fair value resulting from a
hypothetical 10% adverse change in prices quoted by stock exchanges and amounts
to $599 and $672 as of November 30, 2004 and February 28, 2005, respectively.
Actual results may differ.
Interest Rate Risk
The Company's earnings and cash flows are subject to fluctuations due to
changes in interest rates from its investment of available cash balances in
money market funds and investment grade corporate and U.S. government
securities. Under its current policies, the Company does not use interest rate
derivative instruments to manage exposure to interest rate changes. In addition,
the Company's bank loans expose earnings to changes in short-term interest rates
since interest rates on the underlying obligations are either variable or fixed
for such a short period of time as to effectively become variable. The fair
values of the Company's bank loans are not significantly affected by changes in
market interest rates.
Foreign Exchange Risk
In order to reduce the risk of foreign currency exchange rate fluctuations,
the Company hedges transactions denominated in a currency other than the
functional currencies applicable to each of its various entities. The
instruments used for hedging are forward contracts with banks. The Company does
not obtain collateral to support financial instruments, but monitors the credit
standing of the financial institution. The changes in market value of such
contracts have a high correlation to price changes in the currency of the
related hedged transactions. Intercompany transactions with foreign subsidiaries
and equity investments are typically not hedged. There were no hedge
transactions at November 30, 2004 or February 28, 2005. Therefore, the potential
loss in fair value for a net currency position resulting from a 10% adverse
change in quoted foreign currency exchange rates as of November 30, 2004 and
February 28, 2005 is not applicable.
The Company is subject to risk from changes in foreign exchange rates for
its subsidiaries and equity investments that use a foreign currency as their
functional currency and are translated into U.S. dollars. These changes result
in cumulative translation adjustments which are included in accumulated other
comprehensive income. On November 30, 2004 and February 28, 2005, the Company
had translation exposure to various foreign currencies with the most significant
being the Euro, Malaysian ringgit, Thailand baht and Canadian dollar. The
potential loss resulting from a hypothetical 10% adverse change in quoted
foreign currency exchange rates, as of November 30, 2004 and February 28, 2005,
amounts to $3,194 and $3,565, respectively. Actual results may differ.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the reports that the
Company files or submits under the Securities and Exchange Act is recorded,
processed, summarized, and reported within the time periods specified in the
SEC's rules and regulations, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required financial disclosures.
As of the end of the period covered by this Quarterly Report on Form 10-Q,
the Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
33
our disclosure controls and procedures pursuant to the Securities and Exchange
Act Rule 13a-15. Based upon this evaluation as of February 28, 2005, the Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were not effective for the reasons more fully described
below related to the weaknesses in our internal control over financial reporting
identified during the fiscal 2004 internal control over financial reporting
evaluation in connection with Section 404 of the Sarbanes-Oxley Act of 2002. To
address these control weaknesses, the Company performed additional analysis and
performed other procedures to ensure the unaudited quarterly consolidated
financial statements are prepared in accordance with generally accepted
accounting principles. Accordingly, management believes that the consolidated
financial statements included in this Quarterly Report on Form 10-Q, fairly
presents, in all material respects our financial condition, results of
operations and cash flows for the periods presented.
Management's assessment identified the following material weaknesses in the
Company's internal control over financial reporting as of February 28, 2005
(this section of Item 4. Controls and Procedures, should be read in conjunction
with Item 9A. Controls and Procedures, included in the Company's Form 10-K for
the fiscal year ended November 30, 2004, for additional information on
Management's Report on Internal Controls Over Financial Reporting):
1. Deficiencies in the general controls over information technology security
and user access, including segregation of duties (automated controls to
ensure authorization, execution, monitoring and review by independent
individuals) and unrestricted access to data and business applications
existed. Accordingly, management concluded that these matters represent a
material weakness as controls over information security and access to data
and applications are necessary to have an effective control environment;
2. A deficiency in the lack of evidential documentation supporting the
approval of divisional journal entries and the existence of inadequate
segregation of duties as it relates to entering and approving corporate
journal entries existed. The divisional deficiency is a result of the
reconciliation of the manual journal entries to the Company's ERP system
not being signed as evidence of review by the individual performing the
review and the corporate deficiency relates to the reconciliation of the
manual journal entries to the Company's ERP system being performed by the
same individual who processes the journal entries into the system.
Accordingly, management concluded that this matter represents a material
weakness as controls over journal entries may materially impact all
significant accounts and business processes;
3. A deficiency in the design of the controls pertaining to the processing of
non-routine customer sales orders existed. These sales orders, which
represent 3% of consolidated net sales, require the expedited shipment of
the Company's merchandise to the customer. The specific control deficiency
identified relates to the lack of evidence supporting the approval of these
non-routine sales orders. Accordingly, management concluded that this
matter represents a material weakness as it may have a potential material
impact on net sales, accounts receivable and the Company's inventory
balances;
4. A deficiency in the lack of evidential documentation supporting the
oversight and monitoring activities of the financial statements and the
internal control environment of the Company's international subsidiary in
Germany existed. The Germany subsidiary, which was acquired in July 2003,
accounted for approximately 6% of the Company's total consolidated assets
and approximately 13% of consolidated net sales as of and for the three
months ended February 28, 2005. The specific control deficiencies
identified relate to the lack of evidence documenting the review of
significant transactions, account analysis and accounting entries by the
appropriate personnel and the lack of evidence documenting the Company's
oversight and monitoring activities of its German operations even though
the review process was indeed performed. Accordingly, management concluded
that these matters represent a material weakness to the Company's overall
34
control environment.
The Company identified these deficiencies in its internal control over
financial reporting during the fiscal 2004 implementation of Section 404 of the
Sarbanes-Oxley Act of 2002 and; accordingly, these control deficiencies have
either been remediated or are in the process of being remediated subsequent to
February 28, 2005, and before the issuance of this Quarterly Report on Form
10-Q. The findings outlined above were classified as material weaknesses in
accordance with the rules and regulations of the Securities and Exchange
Commission, as a more than remote possibility that a material misstatement to
the Company's interim or annual financial statements could occur. However,
substantially all the material control findings identified by management did not
cause a material misstatement or have an adverse impact to the Company's
financial position or results of operations as of and for the three months ended
February 28, 2005. Refer to the specific remediation steps identified below.
Planned Remediation Efforts to Address Material Weaknesses
The Company developed remediation plans and initiated action steps designed
to address each of the material weaknesses in the internal control over
financial reporting identified above and to implement any and all corrective
actions that are required to improve the design and operating effectiveness of
internal control over financial reporting, including the enhancement of the
Company's policies, systems and procedures. The Company implemented the
following measures to remediate the numbered control deficiencies identified
above:
1. Remediated the information technology security controls in connection with
user access conflicts and segregation of duties related to certain
applications and business processes to ensure there is appropriate
authorization, execution, monitoring and review by independent individuals
by implementing a turnover software package to manage the information
technology change management system and a security software solution to
manage the Company's user access security and restrict access to data and
applications;
2. Enhanced the design of the monthly control at corporate relating to the
reconciliation of the manual journal entries to the Company's ERP system by
segregating the duties of the individual processing the manual journal
entries with the individual performing the reconciliation and to ensure the
individual performing this review procedure at the operating division is
compliant with the evidential documentation requirements supporting their
review.
3. Enhanced the design of the controls relating to the Company's non-routine
customer sales order process by requiring the warehouse personnel to check
and verify that there is evidence of an authorized signature from the
financial department (from the authorized signature sheet) before the
non-routine sales order is shipped to the customer;
4. Increase the review and adherence to the Company's policies and procedures
in connection with the fiscal 2005 monitoring activities of Section 404 of
the Sarbanes-Oxley Act of 2002 and to ensure that process owners are
compliant with the evidential documentation requirements and the rules and
regulations of the Securities and Exchange Commission that require the
appropriate evidence of review and approval of significant transactions,
account analysis and related accounting entries by implementing a
documentation and review process. In addition, management will frequently
(during the fiscal 2005 second, third and fourth quarters) measure against
the results of its fiscal 2004 remediation plans by significant business
process to ensure compliance by the Company's process owners with their
documented remediation plans.
35
The Company believes that the above measures have addressed all matters
identified as a material weakness by management. The Company will continue to
monitor the effectiveness of its disclosure controls and procedures on an
ongoing basis and will take further actions, as appropriate.
Changes in Internal Control Over Financial Reporting
There have been no significant changes in the Company's internal control
over financial reporting during the most recently completed fiscal quarter that
has materially affected, or is reasonable likely to materially affect, the
Company's internal control over financial reporting. However, the Company made
changes to the design and operation of internal control over financial reporting
during the fiscal 2005 first quarter in order to increase the design and
operating effectiveness of internal controls in connection with the fiscal 2004
implementation of Section 404 of the Sarbanes-Oxley Act of 2002. In addition,
the Company is currently implementing enhancements to the Company's internal
control over financial reporting to address the material weaknesses described
above.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently, and has in the past been, a party to various
routine legal proceedings incident to the ordinary course of business. The
Company believes that the outcome of all such pending legal proceedings in the
aggregate is unlikely to have a material adverse effect on the business or
consolidated financial condition of the Company.
During the fourth quarter of 2004, several purported derivative and class
actions were filed in the Court of Chancery of the State of Delaware, New Castle
County. On January 10, 2005, Vice Chancellor Steven Lamb of the Court of
Chancery of the State of Delaware, New Castle County, granted an order
permitting the filing of a Consolidated Complaint by several shareholders of
Audiovox Corporation derivatively on behalf of Audiovox Corporation against
Audiovox Corporation, ACC and the directors of Audiovox Corporation captioned
"In Re Audiovox Corporation Derivative Litigation". The complaint seeks (a)
rescission of: agreements; amendments to long-term incentive awards; and
severance payments pursuant to which Audiovox and ACC executives were paid from
the net proceeds of the sale of certain assets of ACC to UTStarcom, Inc., (b)
disgorgement to ACC of $16 million paid to Philip Christopher pursuant to a
Personally Held Intangibles Purchase Agreement in connection with the UTStarcom
transaction, (c) disgorgement to Audiovox of $4 million paid to Philip
Christopher as compensation for termination of his Employment Agreement and
Award Agreement with ACC, (d) disgorgement to ACC of $1,916,477 paid to John
Shalam pursuant to an Award Agreement with ACC, and (e) recovery by ACC of $5
million in severance payments distributed by Philip Christopher to ACC's former
employees. ACC is sued as a nominal defendant only. Defendants have filed a
motion to dismiss the complaint. Defendants Paul C. Kreuch, Jr, Dennis F.
McManus, Irving Halevy and Peter A. Lesser, have been appointed as the members
of a Special Litigation Committee (the "SLC") of the Board of Directors of the
Company. On March 30, 2005, the SLC filed a Motion to Stay Proceedings (the
"Motion to Stay") seeking to stay the derivative action pending an investigation
by the SLC of the matters alleged in the consolidated complaint. The Motion to
Stay is scheduled for oral argument on April 22, 2005. The Company intends to
vigorously defend this matter. However, no assurances regarding the outcome of
this matter can be given at this point in the litigation.
During the first quarter of 2005, the litigation commenced by Compression
Labs, Incorporated in the United States District Court for the Eastern District
of Texas, Marshall Division, against the Company and its subsidiary Audiovox
Electronics Corp. ("AEC") was dismissed without prejudice as to the Company and
settled with respect to AEC. The litigation against ACC is still pending and
although ACC intends to
36
vigorously defend this matter, no assurances regarding the outcome can be given
at this point in the litigation.
During the third quarter of 2004, an arbitration proceeding was commenced
by the Company and several of its subsidiaries against certain Venezuelan
employees and two Venezuelan companies ("Respondents") before the American
Arbitration Association, International Centre in New York, New York, seeking
recovery of monies alleged to have been wrongfully taken by individual
Respondents and damages for fraud. Respondents asserted counterclaims alleging
that the Company engaged in certain business practices that caused damage to
Respondents. The matter was submitted to mediation during the fourth quarter of
fiscal 2004 and settled subsequent to year end. The settlement provides, in
pertinent part, for a payment (to be made upon satisfaction of certain
pre-closing conditions) from the Company to the Respondents of $1,700 in
consideration of which the Company will acquire all of Respondents' ownership in
the Venezuelan companies and a release of any and all claims. As of February 28,
2005, the satisfaction of the aforementioned pre-closing conditions were not
satisfied and no liability has been recorded.
On September 17, 2004, Shintom Co. Ltd. commenced action against Audiovox
Corporation in the Chancery Court of the State of Delaware, New Castle County,
seeking recovery of the sum of $2,500 or the value of Audiovox preferred stock
determined as of April 16, 1987 (the date of the merger of Audiovox Corp., a New
York corporation, with Audiovox Corporation, a Delaware corporation) which
preferred stock was purchased by Shintom from Audiovox in April 1981. In lieu of
answering, the Company has moved to dismiss the complaint. The motion to dismiss
was heard on April 5, 2005 and we are awaiting Chancellor Chandler's decision on
the motion. The Company believes that the lawsuit is baseless and it intends to
vigorously defend this matter. However, no assurance regarding the outcome of
this matter can be given at this point in the litigation.
The consolidated class actions transferred to a Multi-District Litigation
Panel of the United States District Court of the District of Maryland against
the Company and other suppliers, manufacturers and distributors of hand-held
wireless telephones alleging damages relating to exposure to radio frequency
radiation from hand-held wireless telephones is still pending. On March 16,
2005, the United States Court of Appeals for the Fourth Circuit reversed the
District Court's order dismissing the complaints on grounds of federal
pre-emption. The Fourth Circuit remanded the actions to each of their respective
state courts, except for the Naquin litigation which was remanded to the local
Federal Court. Defendants intend to file a petition for rehearing with the
Fourth Circuit.
The Company and ACC, along with other manufacturers of wireless phones and
cellular service providers, were named as defendants in two class action
lawsuits alleging non-compliance with Federal Communications Commission ("FCC")
ordered emergency 911 call processing capabilities. These lawsuits were
consolidated and transferred to the United States District Court for the
Northern District of Illinois, which in turn referred the cases to the FCC to
determine if the manufacturers and service providers are in compliance with the
FCC's order on emergency 911 call processing capabilities. During the third
quarter of 2004, the FCC confirmed that plaintiffs' interpretation of the FCC's
second order on emergency 911 call processing capabilities was incorrect and as
a result, plaintiffs have filed a consolidated amended complaint in the United
States District Court for the Northern District of Illinois. Defendants have
moved to dismiss the consolidated amended complaint, but to date, the motion has
not been heard. The Company and ACC intend to vigorously defend this matter.
However, no assurances regarding the outcome of this matter can be given at this
point in the litigation.
37
ITEM 6. EXHIBITS
Exhibit Number Description
31.1 Certification of Principal Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (furnished
herewith)
31.2 Certification of Principal Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (furnished
herewith)
32.1 Certification of Principal Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
herewith)
32.2 Certification of Principal Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
herewith)
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AUDIOVOX CORPORATION
By:/s/John J. Shalam
--------------------------------
John J. Shalam
President and Chief
Executive Officer
Dated: April 11, 2005
By:/s/Charles M. Stoehr
--------------------------------
Charles M. Stoehr
Senior Vice President and
Chief Financial Officer
39