UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-4987
SL INDUSTRIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
NEW JERSEY 21-0682685
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
520 FELLOWSHIP ROAD, SUITE A114, MT. LAUREL, NJ 08054
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 856-727-1500
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed
Since Last Report)
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 No X
----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act) Yes No X
---- -----
The number of shares of common stock outstanding as of November 3,
2005 were 5,589,611.
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets September 30, 2005 (Unaudited) and
December 31, 2004............................................. 1
Consolidated Statements of Income and Comprehensive Income Three
Months Ended September 30, 2005 and 2004 (Unaudited) and Nine
Months Ended September 30, 2005 and 2004 (Unaudited).......... 2
Consolidated Statements of Cash Flows Nine Months Ended
September 30, 2005 and 2004 (Unaudited)....................... 3
Notes to Consolidated Financial Statements (Unaudited)........... 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................... 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 32
Item 4. Controls and Procedures.......................................... 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...... 33
Item 5. Other Information................................................ 34
Item 6. Exhibits......................................................... 34
SIGNATURES............................................................... 36
Item 1. Financial Statements
SL INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2005 2004
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ............... $ 6,696,000 $ 2,659,000
Marketable securities ................... 485,000 --
Receivables, net ........................ 16,199,000 15,734,000
Inventories, net ........................ 13,823,000 15,839,000
Prepaid expenses ........................ 1,051,000 714,000
Deferred income taxes, net .............. 2,629,000 3,044,000
------------ ------------
Total current assets .............. 40,883,000 37,990,000
------------ ------------
Property, plant and equipment, net ......... 8,494,000 8,509,000
Deferred income taxes, net ................. 3,568,000 3,280,000
Goodwill, net .............................. 10,303,000 10,303,000
Other intangible assets, net ............... 1,112,000 1,209,000
Other assets and deferred charges .......... 1,748,000 1,793,000
------------ ------------
Total assets ...................... $ 66,108,000 $ 63,084,000
============ ============
LIABILITIES
Current liabilities:
Debt, current portion ................... $ -- $ 559,000
Accounts payable ........................ 5,465,000 5,626,000
Accrued income taxes .................... 693,000 962,000
Accrued liabilities
Payroll and related costs ............ 5,918,000 6,059,000
Other ................................ 4,171,000 5,288,000
------------ ------------
Total current liabilities ......... 16,247,000 18,494,000
------------ ------------
Debt, less current portion ................. -- 1,456,000
Deferred compensation and supplemental
retirement benefits ..................... 3,719,000 3,858,000
Other liabilities .......................... 1,505,000 1,589,000
------------ ------------
Total liabilities ................. 21,471,000 25,397,000
------------ ------------
Commitments and contingencies (Note 11)
SHAREHOLDERS' EQUITY
Preferred stock, no par value; authorized,
6,000,000 shares; none issued ........... $ -- $ --
Common stock, $.20 par value; authorized,
25,000,000 shares; issued, 8,298,000
shares .................................. 1,660,000 1,660,000
Capital in excess of par value ............. 40,007,000 39,210,000
Accumulated other comprehensive income ..... (54,000) --
Retained earnings .......................... 23,169,000 17,690,000
Treasury stock at cost, 2,718,000 and
2,844,000 shares, respectively .......... (20,145,000) (20,873,000)
------------ ------------
Total shareholders' equity ........ 44,637,000 37,687,000
------------ ------------
Total liabilities and shareholders'
equity ......................... $ 66,108,000 $ 63,084,000
============ ============
See accompanying notes to consolidated financial statements.
1
SL INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net sales .................................................... $32,098,000 $30,910,000 $95,813,000 $88,059,000
Cost and expenses:
Cost of products sold ..................................... 20,931,000 19,630,000 61,356,000 55,795,000
Engineering and product development ....................... 2,294,000 2,284,000 7,071,000 6,867,000
Selling, general and administrative ....................... 5,050,000 5,827,000 17,765,000 17,803,000
Depreciation and amortization ............................. 481,000 498,000 1,452,000 1,441,000
----------- ----------- ----------- -----------
Total cost and expenses ...................................... 28,756,000 28,239,000 87,644,000 81,906,000
----------- ----------- ----------- -----------
Income from operations ....................................... 3,342,000 2,671,000 8,169,000 6,153,000
Other income (expense):
Amortization of deferred financing costs .................. (236,000) (112,000) (460,000) (336,000)
Interest income ........................................... 61,000 22,000 128,000 83,000
Interest expense .......................................... (236,000) (59,000) (385,000) (207,000)
----------- ----------- ----------- -----------
Income from continuing operations before income taxes ........ 2,931,000 2,522,000 7,452,000 5,693,000
Income tax provision (benefit) ............................... 379,000 (32,000) 1,573,000 894,000
----------- ----------- ----------- -----------
Income from continuing operations ............................ 2,552,000 2,554,000 5,879,000 4,799,000
Income (loss) from discontinued operations (net of tax) ...... (98,000) (3,000) (398,000) 2,473,000
----------- ----------- ----------- -----------
Net income ................................................... $ 2,454,000 $ 2,551,000 $ 5,481,000 $ 7,272,000
=========== =========== =========== ===========
BASIC NET INCOME (LOSS) PER COMMON SHARE
Income from continuing operations ......................... $ 0.46 $ 0.44 $ 1.06 $ 0.82
Income (loss) from discontinued operations (net of tax) ... (0.02) 0.00 (0.07) 0.42
----------- ----------- ----------- -----------
Net income ................................................ $ 0.44 $ 0.44 $ 0.99 $ 1.24
=========== =========== =========== ===========
DILUTED NET INCOME (LOSS) PER COMMON SHARE ................... *
Income from continuing operations ......................... $ 0.44 $ 0.43 $ 1.03 $ 0.80
Income (loss) from discontinued operations (net of tax) ... (0.02) 0.00 (0.07) 0.41
----------- ----------- ----------- -----------
Net income ................................................ $ 0.42 $ 0.43 $ 0.96 $ 1.22
=========== =========== =========== ===========
Shares used in computing basic net income (loss)
per common share .......................................... 5,580,000 5,801,000 5,528,000 5,873,000
Shares used in computing diluted net income (loss)
per common share .......................................... 5,781,000 5,909,000 5,728,000 5,978,000
SL INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net income ................................................... $2,454,000 $2,551,000 $5,481,000 $7,272,000
Other comprehensive loss (net of tax):
Unrealized loss on securities ............................. (101,000) -- (54,000) --
---------- ---------- ---------- ----------
Comprehensive income ......................................... $2,353,000 $2,551,000 $5,427,000 $7,272,000
========== ========== ========== ==========
* Earnings per share does not add due to rounding.
See accompanying notes to consolidated financial statements.
2
SL INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND SEPTEMBER 30, 2004
(Unaudited)
2005 2004
----------- -----------
OPERATING ACTIVITIES:
Income from continuing operations .............................................. $ 5,879,000 $ 4,799,000
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities:
Depreciation ................................................................ 1,167,000 1,232,000
Amortization ................................................................ 285,000 209,000
Amortization of deferred financing costs .................................... 460,000 336,000
Non-cash compensation expense ............................................... 40,000 602,000
Provisions for losses on accounts receivable ................................ 27,000 75,000
Deferred compensation and supplemental retirement benefits .................. 272,000 354,000
Deferred compensation and supplemental retirement benefit payments .......... (404,000) (405,000)
Increase in deferred income taxes ........................................... (38,000) (661,000)
Gain on sale of equipment ................................................... -- (8,000)
Changes in operating assets and liabilities, excluding effects of business
dispositions:
Accounts receivable ...................................................... (579,000) (4,150,000)
Inventories .............................................................. 2,016,000 (4,224,000)
Prepaid expenses ......................................................... (41,000) 254,000
Other assets ............................................................. (411,000) (465,000)
Accounts payable ......................................................... (160,000) 3,117,000
Accrued liabilities ...................................................... (1,522,000) (174,000)
Accrued income taxes ..................................................... (90,000) 2,014,000
----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES ......................................... 6,901,000 2,905,000
----------- -----------
INVESTING ACTIVITIES:
Proceeds from sale of subsidiary (cash and notes receivable) ................... -- 1,000,000
Proceeds from sale of equipment ................................................ -- 9,000
Purchases of property, plant and equipment ..................................... (1,186,000) (1,167,000)
Purchases of securities available for sale ..................................... (567,000) --
Purchases of other assets ...................................................... (310,000) --
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES ............................................. (2,063,000) (158,000)
----------- -----------
FINANCING ACTIVITIES:
Payments of deferred financing costs ........................................... (207,000) --
Payments of term loans ......................................................... (2,015,000) (747,000)
Proceeds from stock options exercised .......................................... 1,511,000 272,000
Treasury stock sales (purchases) ............................................... 13,000 (6,218,000)
----------- -----------
NET CASH USED IN FINANCING ACTIVITIES ............................................. (698,000) (6,693,000)
----------- -----------
NET CASH (USED IN) PROVIDED BY DISCONTINUED OPERATIONS ............................ (103,000) 1,523,000
----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS ........................................... 4,037,000 (2,423,000)
----------- -----------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .................................. 2,659,000 3,501,000
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ........................................ $ 6,696,000 $ 1,078,000
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest .................................................................... $ 444,000 $ 214,000
Income taxes ................................................................ $ 1,321,000 $ 1,426,000
See accompanying notes to consolidated financial statements.
3
SL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying financial
statements contain all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation. Operating results for interim
periods are not necessarily indicative of the results that may be expected for
the year ending December 31, 2005. These financial statements should be read in
conjunction with the Company's audited financial statements and notes thereon
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2004.
2. MARKETABLE SECURITIES
The Company has classified its investments in marketable securities as
"available-for-sale" in accordance with the provisions of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"). The investments, which have a cost basis of $567,000,
are carried at fair value determined by currently available market prices. The
unrealized loss, net of tax, in the amount of $54,000, is reported in
accumulated other comprehensive income as a component of shareholders' equity
until realized.
3. RECEIVABLES
Receivables at September 30, 2005 and December 31, 2004 consisted of the
following:
September 30, December 31,
2005 2004
------------- ------------
(in thousands)
Trade receivables $16,408 $15,771
Less allowances for doubtful accounts (517) (472)
------- -------
15,891 15,299
Recoverable income taxes 64 82
Other 244 353
------- -------
$16,199 $15,734
======= =======
4
4. INVENTORIES
Inventories at September 30, 2005 and December 31, 2004 consisted of the
following:
September 30, December 31,
2005 2004
------------- ------------
(in thousands)
Raw materials $ 8,916 $ 9,669
Work in process 5,592 5,000
Finished goods 1,956 3,633
------- -------
16,464 18,302
Less allowances (2,641) (2,463)
------- -------
$13,823 $15,839
======= =======
5. INCOME PER SHARE
The Company has presented net income per common share pursuant to Financial
Accounting Standards Board Statement of Financial Accounting Standard No. 128,
"Earnings per Share" ("SFAS 128"). Basic net income per common share is computed
by dividing reported net income available to common shareholders by the weighted
average number of shares outstanding for the period. Diluted net income per
common share is computed by dividing reported net income available to common
shareholders by the weighted average shares outstanding for the period, adjusted
for the dilutive effect of common stock equivalents, which consist of stock
options, using the treasury stock method.
The table below sets forth the computation of basic and diluted net income per
share:
Three Months Ended September 30,
---------------------------------------------------------
2005 2004
--------------------------- ---------------------------
(in thousands, except per share amounts)
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------ ------ --------- ------ ------ ---------
Basic net income per
common share $2,454 5,580 $0.44 $2,551 5,801 $0.44
Effect of dilutive
securities -- 201 (0.02) -- 108 (0.01)
------ ----- ----- ------ ----- -----
Diluted net income per
common share $2,454 5,781 $0.42 $2,551 5,909 $0.43
====== ===== ===== ====== ===== =====
5
Nine Months Ended September 30,
---------------------------------------------------------
2005 2004
--------------------------- ---------------------------
(in thousands, except per share amounts)
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------ ------ --------- ------ ------ ---------
Basic net income per
common share $5,481 5,528 $ 0.99 $7,272 5,873 $ 1.24
Effect of dilutive
securities -- 200 (0.03) -- 105 (0.02)
------ ----- ------ ------ ----- ------
Diluted net income per
common share $5,481 5,728 $ 0.96 $7,272 5,978 $ 1.22
====== ===== ====== ====== ===== ======
For the nine-month periods ended September 30, 2005 and September 30, 2004,
common stock options of 6,250 and 480,857, respectively, were excluded from the
dilution computations because the exercise prices of such options were greater
than the average market price of the Company's common stock during these
periods.
STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 148, "Accounting for Stock Based Compensation-Transition and Disclosure"
("SFAS 148"), an amendment of SFAS No. 123 "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 148 provides alternative methods for a
voluntary change to the fair value method of accounting for stock-based employee
compensation and amends the disclosure requirements of SFAS 123. The Company has
elected to continue to account for its stock-based employee compensation plans
under Accounting Principles Board Opinion 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations. The following disclosures are
provided in accordance with SFAS 148.
Under APB 25, compensation expense is measured as the excess, if any, of the
fair value of the Company's common stock at the date of the grant over the
amount a grantee must pay to acquire the stock. The Company's stock option plans
enable the Company to grant options with an exercise price not less than the
fair value of the Company's common stock at the date of the grant. However, the
Company has recognized a benefit of approximately $450,000 and an expense of
$24,000 in the three-month periods ended September 30, 2005 and September 30,
2004, respectively, and expenses of approximately $40,000 and $451,000 in the
nine-month periods ended September 30, 2005 and September 30, 2004,
respectively, in compensation expense related to certain stock-based
compensation arrangements.
The exercise price of stock options generally equals the market price of the
Company's common stock on the date of grant. Compensation cost has been
recognized for the Company's stock option plans as noted in the table below. Had
compensation cost for the Company's stock option plans been determined based
upon the fair value at the grant date for awards under these plans, consistent
with the methodology prescribed under SFAS 123, the Company's net income and net
income per common share would have been as follows:
6
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- ------------------
2005 2004 2005 2004
------ ------ ------ ------
(in thousands, except per share amounts)
Net income, as reported $2,454 $2,551 $5,481 $7,272
Add/(Deduct): Stock-based employee compensation
expense (benefit) included in reported net income,
net of related tax effects (286) 15 26 316
------ ------ ------ ------
2,168 2,566 5,507 7,588
Add/(Deduct): Total stock-based employee
compensation expense (benefit) determined under
fair value based method for awards granted,
modified, or settled, net of related tax effects 286 (17) (109) (462)
------ ------ ------ ------
Pro forma net income $2,454 $2,549 $5,398 $7,126
====== ====== ====== ======
Earnings per common share:
Basic - as reported $ 0.44 $ 0.44 $ 0.99 $ 1.24
Basic - pro forma $ 0.44 $ 0.44 $ 0.98 $ 1.21
Diluted - as reported $ 0.42 $ 0.43 $ 0.96 $ 1.22
Diluted - pro forma $ 0.42 $ 0.43 $ 0.94 $ 1.19
In December 2004, the FASB revised SFAS 123 by issuing SFAS 123(R), "Share-Based
Payment" (Note 7).
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model, with the following weighted average
assumptions:
Nine Months Nine Months
Ended Ended
September 30, September 30,
2005 2004
------------- -------------
Expected dividend yield 0.0% 0.0%
Expected stock price volatility 44.31% 58.97%
Risk-free interest rate 4.18% 2.81%
Expected life of stock option 5 years 5 years
The fair value of the above stock-based compensation costs was determined using
the Black-Scholes option valuation model. The Black-Scholes option valuation
model was developed for use in estimating the fair value of traded options,
which have no vesting restrictions, are fully transferable and do not include a
discount for large block trades. In addition, option valuation models require
the input of highly subjective assumptions, including the expected stock price
volatility, expected life of the option and other estimates.
7
6. INCOME TAX
The following is a reconciliation of income tax expense at the applicable
federal statutory rate and the effective rates:
Nine Months Ended
September 30,
-----------------
2005 2004
---- ----
Statutory rate 34% 34%
Tax rate differential on extraterritorial
income exclusion benefit earnings (1) (2)
Tax rate differential on domestic
manufacturing deduction (1) --
International rate differences 1 1
State income taxes, net of federal income tax benefit 4 5
Research and development tax credits (6) (22)
Foreign tax credit (9) --
Other (1) --
--- ---
21% 16%
=== ===
During the nine months ended September 30, 2005, the Company recorded additional
benefits from research and development tax credits of $426,000, of which
approximately $145,000 relates to prior years and $281,000 relates to the
current year. As of September 30, 2005, the Company's gross research and
development tax credit carryforwards totaled approximately $3,027,000. Of these
credits, approximately $2,513,000 can be carried forward for fifteen years and
expire between 2013 and 2020, while $514,000 will carry forward indefinitely.
During the quarter ended September 30, 2005, the Company recorded the benefits
from foreign tax credits of $681,000. As of September 30, 2005, the Company's
gross foreign tax credits totaled approximately $1,205,000. These credits can be
carried forward for ten years and expire between 2009 and 2015.
7. RECENT AND PROPOSED ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued Statement of Financial Accounting Standards
No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4" ("SFAS 151").
SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to
clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage) and requires these costs be
treated as current period charges. In addition, SFAS 151 requires that
allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. These provisions of SFAS 151
are effective for inventory costs incurred during fiscal years beginning after
June 15, 2005. The Company is currently evaluating the impact of SFAS 151 on its
financial position and results of operations.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 153, "Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29"
("SFAS 153"). SFAS 153 amends the guidance in APB Opinion No. 29, "Accounting
for Nonmonetary Transactions," which is based on the principle that exchanges of
nonmonetary assets should be measured based on the fair value of the assets
exchanged, with certain exceptions. SFAS 153 amends APB Opinion No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has commercial
substance if
8
the future cash flows of the entity are expected to change significantly as a
result of the exchange. The provisions of SFAS 153 are effective for nonmonetary
asset exchanges occurring in fiscal periods beginning after June 15, 2005. The
Company is currently evaluating the impact of SFAS 153 on its financial position
and results of operations.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"). SFAS 123R is a
revision of Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees" and its related implementation guidance. SFAS 123R
establishes standards for the accounting of transactions in which an entity
exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. SFAS 123R
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. SFAS 123R requires a
public entity to measure the cost of employee services received in exchange for
an award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award. The
provisions of SFAS 123R were to be effective for public entities that do not
file as small business issuers as of the beginning of the first interim or
annual reporting period that begins after June 15, 2005. On April 14, 2005, the
Securities and Exchange Commission adopted a new rule that amends the compliance
dates for SFAS 123R. The new rule allows companies to implement SFAS 123R at the
beginning of their next fiscal year, which for the Company would be for the
period ended March 31, 2006. The Company is currently evaluating the impact of
SFAS 123R on its financial position and results of operations. The Company may
experience a negative impact on its financial position and results of operations
by the first quarter of 2006 as a consequence of adopting the grant date fair
value provisions of the statement.
In May 2005, the FASB issued Statement of Financial Accounting Standards No.
154, "Accounting Changes and Error Corrections" ("SFAS 154"), which replaces APB
Opinion No. 20, "Accounting Changes," and Statement of Financial Accounting
Standards No. 3 "Reporting Accounting Changes in Interim Financial Statements"
("SFAS 3"). This Statement changes the requirements for the accounting for and
reporting of a change in accounting principles, and applies to all voluntary
changes in accounting principles, as well as changes required by an accounting
pronouncement in the unusual instance it does not include specific transition
provisions. Specifically, this Statement requires retrospective application to
prior periods' financial statements, unless it is impracticable to determine the
period-specific effects or the cumulative effect of the change. When it is
impracticable to determine the effects of the change, the new accounting
principle must be applied to the balances of assets and liabilities as of the
beginning of the earliest period for which retrospective application is
practicable and a corresponding adjustment must be made to the opening balance
of retained earnings for that period rather than being reported in an income
statement. When it is impracticable to determine the cumulative effect of the
change, the new principle must be applied as if it were adopted prospectively
from the earliest practicable date. This Statement also requires that a change
in depreciation, amortization, or depletion method for long-lived, non-financial
assets be accounted for as a change in accounting estimate effected by a change
in accounting principle. This Statement is effective for the Company for all
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. This Statement does not change the transition
9
provisions of any existing pronouncements. The Company does not believe that the
adoption of SFAS 154 will have a significant impact on its financial position
and results of operations.
8. GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets consist of the following:
September 30, 2005 December 31, 2004
-------------------------------------- --------------------------------------
Accumulated Accumulated
Gross Value Amortization Net Value Gross Value Amortization Net Value
----------- ------------ --------- ----------- ------------ ---------
(in thousands)
Goodwill $12,167 $1,864 $10,303 $12,167 $1,864 $10,303
------- ------ ------- ------- ------ -------
Other Intangible Assets:
Patents 919 705 214 946 666 280
Covenant Not to Compete -- -- -- 110 110 --
Trademarks 922 350 572 922 350 572
Licensing Fees 355 45 310 355 18 337
Other 51 35 16 437 417 20
------- ------ ------- ------- ------ -------
Total Other Intangible Assets 2,247 1,135 1,112 2,770 1,561 1,209
------- ------ ------- ------- ------ -------
$14,414 $2,999 $11,415 $14,937 $3,425 $11,512
======= ====== ======= ======= ====== =======
The other intangible assets that have definite lives are all amortizable and
have original estimated useful lives as follows: patents are amortized over
approximately 13 years, licensing fees over approximately 10 years, and
trademarks are not amortized. Amortization expense for intangible assets for
each of the three-month periods ended September 30, 2005 and September 30, 2004
was $28,000 and $37,000, respectively. Amortization expense for intangible
assets for each of the nine-month periods ended September 30, 2005 and September
30, 2004 was $84,000 and $95,000, respectively. Amortization expense for
intangible assets subject to amortization in each of the next five fiscal years
is estimated to be: $113,000 for the next three years, $68,000 in the fourth
year and $41,000 in the fifth year. Intangible assets subject to amortization
have a weighted average life of approximately twelve years.
9. DEBT
Debt consists of the following:
September 30, December 31,
2005 2004
------------- ------------
(in thousands)
Term loan A $-- $1,600
Term loan B -- 415
--- ------
-- 2,015
Less current portion -- (559)
--- ------
Total long-term debt $-- $1,456
=== ======
During 2005 until August 2, 2005, the Company was a party to a three-year senior
secured credit facility (the "Senior Credit Facility") with LaSalle Business
Credit LLC. The Senior Credit Facility provided for a revolving loan and two
term loans up to a maximum indebtedness of $20,000,000. The revolving loan of up
to $16,810,000 was based upon eligible receivables and
10
inventory, as well as an overadvance amount of $1,500,000. The overadvance
amount was fully paid down on April 7, 2004. The two term loans of $2,350,000
and $840,000 were to be paid down over a three-year term. The Senior Credit
Facility restricted investments, acquisitions, capital expenditures and
dividends. The Senior Credit Facility also contained financial covenants
relating to minimum levels of net worth, fixed charge coverages, levels of
earnings before interest, taxes, depreciation and amortization and maximum
levels of capital expenditures, as defined.
The Company's Senior Credit Facility bore interest ranging from the prime rate
plus fifty basis points to the prime rate plus 2%. The Senior Credit Facility
was secured by all of the Company's assets. The Senior Credit Facility also
provided for certain reserves for outstanding letters of credit and other
contingencies. These reserves reduced the Company's availability under the
revolving loan portion of the Senior Credit Facility. In July 2005, the Company
received a waiver related to the reserves for other contingencies. This waiver
reduced the Company's reserve requirement by $3,000,000. The entire amount of
the loan balances had been classified as current debt for 2005, as the Senior
Credit Facility was set to expire on January 6, 2006. The outstanding term loan
balances bore interest at an annual rate of 6.75%.
On August 2, 2005, the Company paid the outstanding term loan balances under its
existing Senior Credit Facility in the amount of $1,641,000. The Company also
paid legal and early termination fees of $212,000. These payments were made from
the Company's available funds. Also the Company wrote off approximately $112,000
of the remaining deferred financing costs related to the Senior Credit Facility.
On August 3, 2005, the Company entered into a revolving credit facility (the
"Revolving Credit Facility") with Bank of America, N.A. ("Bank of America") to
replace its Senior Credit Facility. The Revolving Credit Facility (with a
standby and commercial letter of credit sub-limit of $5,000,000) provides for
borrowings up to $25,000,000 and under certain circumstances maximum borrowings
of $30,000,000. The Revolving Credit Facility expires on June 30, 2008.
Borrowings under the Revolving Credit Facility bear interest, at the Company's
option, at the London interbank offering rate ("LIBOR") plus a margin rate
ranging from 0.9% to 1.9%, or the higher of a Base Rate plus a margin rate
ranging from 0% to 0.5%. The Base Rate is equal to the higher of (i) the Federal
Funds Rate plus 0.5%, or (ii) Bank of America's publicly announced prime rate.
The margin rates are based on certain leverage ratios, as defined. The Company
is subject to compliance with certain financial covenants set forth in the
Revolving Credit Facility, including but not limited to, capital expenditures,
consolidated net worth, and certain interest and leverage ratios, as defined. As
of September 30, 2005, the Company did not have any outstanding balances under
its Revolving Credit Facility.
10. ACCRUED LIABILITIES - OTHER
Accrued liabilities - other consist of the following:
11
September 30, December 31,
2005 2004
------------- ------------
(in thousands)
Taxes (other than income) and insurance $ 477 $ 805
Commissions 450 482
Accrued litigation and legal fees 607 1,190
Other professional fees 493 689
Environmental 1,214 1,275
Warranty 863 921
Other 1,056 915
Reclassified to other long-term liabilities (989) (989)
------ ------
$4,171 $5,288
====== ======
The Company's warranty reserve, which is included in "Accrued Liabilities -
Other" above, for the period ended September 30, 2005, is as follows:
September 30,
2005
--------------
(in thousands)
Liability, beginning of year $ 921
Expense for new warranties issued 722
Expense related to accrual revisions for prior year 32
Warranty claims paid (812)
-----
Liability, end of period $ 863
=====
11. COMMITMENTS AND CONTINGENCIES
LITIGATION
In the ordinary course of its business, the Company is subject to loss
contingencies pursuant to foreign and domestic federal, state and local
governmental laws and regulations and is also party to certain legal actions,
which may occur in the normal operations of the Company's business. It is
management's opinion that the impact of these legal actions will not have a
material adverse effect on the consolidated financial position or results of
operations of the Company.
On February 3, 2004, the Company and American Power Conversion Corporation
("APC") executed a settlement agreement in connection with a lawsuit brought by
the Company against APC. Among other things the settlement agreement provided
for the payment to the Company of $4,000,000, which was paid on March 5, 2004.
The Company, through its wholly-owned subsidiary SLW Holdings, Inc., has been a
party to an arbitration proceeding brought by Niles Audio, Inc. SLW Holdings,
Inc. was formerly known as SL Waber, Inc., all the assets of which were sold in
August 2001. Niles Audio, Inc. is a former customer of SL Waber, Inc. The
parties are currently in discussions to settle this dispute. The Company
believes that neither the results of arbitration nor the terms of a potential
settlement, as the case may be, will have a material adverse impact on its
consolidated financial position or results of operations of the Company.
12
On June 12, 2002, the Company and its wholly owned subsidiary, SL Surface
Technologies, Inc. ("SurfTech"), were served with notice of a class action
complaint filed in Superior Court of New Jersey for Camden County.
(Substantially all of the operating assets of SurfTech were sold in November
2003). The Company and SurfTech are currently two of approximately 39 defendants
in this action. The complaint alleges, among other things, that the plaintiffs
suffered personal injuries as a result of consuming water distributed from the
Puchack Wellfield in Pennsauken, New Jersey (which supplied Camden, New Jersey).
This case arises from the same factual circumstances as current administrative
actions involving the Puchack Wellfield, to which the Company is a party. The
administrative actions are discussed below. The administrative actions and the
class action lawsuit both allege that SurfTech and other defendants contaminated
ground water through the disposal of hazardous substances at industrial
facilities in the area. SurfTech once operated a chrome-plating facility in
Pennsauken, New Jersey (the "SurfTech Site").
As with the administrative actions, the Company believes it has significant
defenses against the class action plaintiffs' claims and intends to pursue them
vigorously. Technical data generated as part of remedial activities at the
SurfTech Site have not established offsite migration of contaminants and there
are several other technical factors and defenses available to the Company. Based
on the foregoing, the Company has been advised by its outside counsel that it
has a strong defense against the claims alleged in the class action plaintiffs'
complaint, as well as the environmental administrative actions.
It is management's opinion that the impact of legal actions brought against the
Company and its operations will not have a material adverse effect on its
consolidated financial position or results of operations. However, the ultimate
outcome of these matters, as with litigation generally, is inherently uncertain,
and it is possible that some of these matters may be resolved adversely to the
Company. The adverse resolution of any one or more of these matters could have a
material adverse effect on the business, operating results, financial condition
or cash flows of the Company.
ENVIRONMENTAL
Loss contingencies include potential obligations to investigate and eliminate or
mitigate the effects on the environment of the disposal or release of certain
chemical substances at various sites, such as Superfund sites and other
facilities, whether or not they are currently in operation. The Company is
currently participating in environmental assessments and cleanups at a number of
sites under these laws and may in the future be involved in additional
environmental assessments and cleanups. Based upon investigations completed by
the Company and its independent engineering-consulting firms to date, management
has provided an estimated accrual for all known costs believed to be probable in
the amount of $1,214,000. However, it is in the nature of environmental
contingencies that other circumstances might arise, the costs of which are
indeterminable at this time due to such factors as changing government
regulations and stricter standards, the unknown magnitude of defense and cleanup
costs, the unknown timing and extent of the remedial actions that may be
required, the determination of the Company's liability in proportion to other
responsible parties, and the extent, if any, to which such costs are recoverable
from other parties or from insurance. Although these contingencies could result
in additional expenses or judgments, or off-sets thereto, at present such
expenses or judgments are not expected to have a material effect on the
Company's consolidated financial position or
13
results of operations. Substantially all of the Company's environmental costs
relate to discontinued operations and such costs have been recorded in
discontinued operations.
The Company is the subject of various other lawsuits and actions relating to
environmental issues, including an administrative action in connection with the
SurfTech Site, which could subject the Company to, among other things,
$9,266,000 in collective reimbursements (with other parties) to the New Jersey
Department of Environmental Protection (the "NJDEP"). Technical data generated
as part of remedial activities at the SurfTech Site have not established offsite
migration of contaminants. Other technical factors and defenses are also
available to the Company. Based on the foregoing, the Company has been advised
by its outside counsel that it has significant defenses against all or any part
of the claim and that any material impact is unlikely.
The Company has reported a ground water contamination plume on its property in
Camden, New Jersey. In January 2003, the Company submitted to the NJDEP a plan
to remediate the site, which is currently under review. Based on the information
so far, the Company believes that the cost to remediate the property should not
exceed approximately $560,000, which has been fully reserved. These costs have
been recorded as a component of discontinued operations.
The Company is investigating soil and ground water contamination on SL-MTI's
property in Montevideo, Minnesota. The Company has submitted to the Minnesota
Department of Environmental Protection a plan to remediate the site, which is
currently under review. The Company currently has an accrual of $214,000 for all
known costs believed to be probable related to this site. These costs are
recorded as a component of continuing operations.
The Company filed claims with several of its insurers seeking reimbursement for
past and future environmental costs. In settlement of its claims, the Company
received aggregate cash payments of $2,800,000 prior to fiscal 2001 and
contingent commitments from three insurers to pay for a portion of environmental
costs associated with the SurfTech Site equal to: 15% of costs up to $300,000,
15% of costs up to $150,000 and 20% of costs up to $400,000, respectively. The
Company has received from these three insurers a total of $654,000, as payment
of their contingent commitments through 2004, which have been recorded as
income, net of tax, in discontinued operations.
As of September 30, 2005 and December 31, 2004, the Company has accrued
$1,214,000 and $1,275,000, respectively, for known costs believed to be probable
related to environmental matters, which have been included in "Accrued
Liabilities - Other" (Note 10).
12. SEGMENT INFORMATION
The Company currently operates under four business segments: Condor D.C. Power
Supplies, Inc. ("Condor"), Teal Electronics Corp. ("Teal"), SL Montevideo
Technology, Inc. ("SL-MTI") and RFL Electronics Inc. ("RFL"). Since the second
quarter of 2003, management has combined Condor and Teal into one business unit
classified as the Power Electronics Group.
Condor produces a wide range of standard and custom power supply products that
convert AC or DC power to direct electrical current to be used in customers' end
products. Power supplies closely regulate and monitor power outputs, using
patented filter and other technologies, resulting in little or no electrical
interference. Teal is a leader in the design and manufacture of customized power
conditioning and power distribution units. Teal products are developed and
14
manufactured for custom electrical subsystems for original equipment
manufacturers of semiconductor, medical imaging, graphics, and
telecommunications systems. SL-MTI is a technological leader in the design and
manufacture of intelligent, high power density precision motors. These motor and
motion controls are used in numerous applications, including aerospace, medical,
and industrial products. RFL designs and manufactures teleprotection
products/systems that are used to protect utility transmission lines and
apparatus by isolating faulty transmission lines from a transmission grid. RFL
also provides customer service and maintenance for all electric utility
equipment protection systems. The Other segment includes corporate related
items, financing activities and other costs not allocated to reportable
segments, which include but are not limited to certain legal, litigation and
public reporting charges and the results of insignificant operations.
The unaudited comparative results for the three-month periods and nine-month
periods ended September 30, 2005 and September 30, 2004 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2005 2004 2005 2004
------- ------- ------- -------
(in thousands)
NET SALES
Power Electronics Group:
Condor $10,617 $11,442 $33,001 $30,966
Teal 8,840 8,394 24,077 23,194
------- ------- ------- -------
Total 19,457 19,836 57,078 54,160
------- ------- ------- -------
SL-MTI 7,440 5,599 21,120 17,381
RFL 5,201 5,475 17,615 16,518
------- ------- ------- -------
Consolidated $32,098 $30,910 $95,813 $88,059
======= ======= ======= =======
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2005 2004 2005 2004
------- ------- ------- -------
(in thousands)
INCOME FROM OPERATIONS
Power Electronics Group:
Condor $ 832 $ 1,357 $ 3,260 $ 2,758
Teal 1,590 1,291 3,725 3,719
------ ------- ------- -------
Total 2,422 2,648 6,985 6,477
------ ------- ------- -------
SL-MTI 1,117 588 2,941 1,846
RFL 546 496 1,862 1,332
Other (743) (1,061) (3,619) (3,502)
------ ------- ------- -------
Consolidated $3,342 $ 2,671 $ 8,169 $ 6,153
====== ======= ======= =======
15
September 30, December 31,
2005 2004
------------- ------------
(in thousands)
TOTAL ASSETS
Power Electronics Group:
Condor $12,953 $14,105
Teal 12,243 12,742
------- -------
Total 25,196 26,847
------- -------
SL-MTI 11,589 10,849
RFL 15,897 16,767
Other 13,426 8,621
------- -------
Consolidated $66,108 $63,084
======= =======
September 30, December 31,
2005 2004
------------- ------------
(in thousands)
INTANGIBLE ASSETS, NET
Teal $ 5,839 $ 5,906
SL-MTI 16 20
RFL 5,560 5,586
------- -------
Consolidated $11,415 $11,512
======= =======
13. DISCONTINUED OPERATIONS
SL WABER, INC.
In August 2001, SL Waber, Inc. ("SL Waber") sold substantially all of its assets
including the stock of Waber de Mexico S.A. de C.V. As part of this transaction,
the purchaser acquired the rights to the SL Waber name and assumed certain
liabilities and obligations of SL Waber. Subsequent to the sale, SL Waber
changed its name to SLW Holdings, Inc. ("SLW Holdings"). There was no activity
from operations of SLW Holdings during the fourth quarter of 2001 and
thereafter. Net income or losses of SLW Holdings are included in the
consolidated statements of income under discontinued operations for all periods
presented. In 1997, SL Waber commenced patent infringement litigation against
APC, the rights to which were retained by SL Waber after the sale. In February
2004, the Company and APC executed a settlement agreement that provided, among
other things, for a release of all claims against APC and granted to APC a
paid-up license, in return for the payment to the Company of $4,000,000. The
settlement agreement was conditioned on the dismissal with prejudice of the
lawsuit. On March 5, 2004, the settlement fee was paid to the Company. The
settlement fee, net of tax, in the amount of $2,516,000 is recorded as part of
discontinued operations in the Company's consolidated statements of income and
cash flows for the nine months ended September 30, 2004. A third party had
threatened certain claims against the Company relating to this matter for a
portion of the payment. On March 22, 2005, the Company paid a settlement fee to
that third party related to this matter, which had been fully reserved at
December 31, 2004. The cash effect of the payment is recorded in the cash flow
statement as part of discontinued operations for 2005. SLW Holdings is also a
party to arbitration proceedings brought by a former customer. The parties are
currently in discussions to settle this dispute. The Company believes that
neither the results of arbitration nor
16
the terms of a potential settlement, as the case may be, will have a material
adverse impact on its consolidated financial position or results of operations.
The result of any arbitration award or settlement fee, as the case may be, as
well as any costs to litigate the matter are recorded as part of discontinued
operations.
ELEKTRO-METALL EXPORT GMBH
On January 6, 2003, the Company sold its wholly-owned, indirect German
subsidiary, Elektro-Metall Export GmbH ("EME"). Part of the proceeds of the sale
included a $1,000,000 unsecured note which was paid in full in April 2004. All
cash proceeds relating to the purchase price for the sale of EME have been
received by the Company.
SL SURFACE TECHNOLOGIES, INC.
In November 2003, the Company sold the operating assets, including current
assets and equipment, of SurfTech. The purchaser paid $600,000 in cash, plus the
assumption of certain liabilities. The Company continues to own the land and
building on which SurfTech's operations were conducted, and has entered into a
ten-year lease with the buyer. The Company continues to make payments related to
its withdrawal liability from the pension plan in which SurfTech was a
participant. There has not been any operational activity related to SurfTech
since the sale in November 2003.
14. RETIREMENT PLANS AND DEFERRED COMPENSATION
The Company maintains three noncontributory, defined contribution pension plans
covering all of its full-time, US employees. The Company's contributions to
these plans are based on a percentage of employee contributions and/or plan year
gross wages, as defined. Condor, Teal, SL-MTI and the Corporate office provide
contributions to their plans based on a percentage of employee contributions.
Condor, SL-MTI, RFL and the Corporate office also provide profit sharing
contributions annually, based on plan year gross wages. Costs incurred under
these plans amounted to $763,000 and $750,000 during the nine-month periods
ended September 30, 2005 and September 30, 2004, respectively.
The Company has agreements with certain active and retired directors, officers
and key employees providing for supplemental retirement benefits. The liability
for supplemental retirement benefits is based on the most recent mortality
tables available at discount rates ranging from 6% to 12%. The amount charged to
income in connection with these agreements amounted to $263,000 and $314,000 for
the nine-month periods ended September 30, 2005 and September 30, 2004,
respectively.
15. RELATED PARTY TRANSACTIONS
The compensation committee has approved the payment of certain fees from the
Company to Steel Partners, Ltd. ("SPL"), a company controlled by the Chairman of
the Board of the Company, Warren Lichtenstein. These fees are in consideration
for the services of Mr. Lichtenstein and the Company's Vice Chairman, Glen
Kassan, as well as other assistance provided by SPL from time to time. Until
August 15, 2005, Mr. Lichtenstein had been serving as both Chairman and Chief
Executive Officer, and Mr. Kassan had been serving as President of the Company.
During the nine-month period ended September 30, 2005, the Company expensed
$356,000 for SPL services. Of this amount, $40,000 remained payable at September
30, 2005. The Company expensed $356,000 for services performed for the
nine-month period ended September 30, 2004.
17
RFL has an investment of $15,000 in RFL Communications PLC ("RFL
Communications"), representing 4.5% of the outstanding equity thereof. RFL
Communications is a distributor of teleprotection and communication equipment
located in the United Kingdom. It is authorized to sell RFL products in
accordance with an international sales agreement. Sales to RFL Communications
for each of the nine-month periods ended September 30, 2005 and September 30,
2004 were $771,000 and $1,005,000, respectively. Accounts receivable due from
RFL Communications at September 30, 2005 were $201,000.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company, through its subsidiaries, designs, manufactures and markets power
electronics, motion control, power protection, teleprotection and specialized
communication equipment that is used in a variety of aerospace, computer,
datacom, industrial, medical, telecom, transportation and utility equipment
applications. The Company is comprised of four domestic business segments, two
of which have significant manufacturing operations in Mexico. Most of the
Company's sales are made to customers who are based in the United States.
However, over the years the Company has increased its presence in international
markets. The Company places an emphasis on high quality, well-built, dependable
products and continues its dedication to product enhancement and innovations.
The Company's business strategy has been to enhance the growth and profitability
of each of its businesses by way of accelerated growth through the penetration
of attractive new market niches, additional growth in existing markets, further
improvement of operations and expansion of global capabilities. The Company
expects to achieve these goals through organic growth and strategic
acquisitions. The Company also continues to pursue strategic alternatives to
maximize the value of its businesses. Some of these alternatives have included,
and will continue to include, selective acquisitions, divestitures and sales of
certain assets. The Company has provided, and may from time to time in the
future provide, information to interested parties regarding portions of its
businesses for such purposes.
CRITICAL ACCOUNTING POLICIES
The Company's Consolidated Financial Statements have been prepared in accordance
with accounting principles generally accepted in the United States. These
generally accepted accounting principles require management to make estimates
and assumptions that affect the amounts of reported and contingent assets and
liabilities at the date of the Consolidated Financial Statements and the amounts
of reported net sales and expenses during the reporting period.
The Company's significant accounting policies are described in Note 1 in the
Notes to Consolidated Financial Statements included in Part IV of the Company's
Annual Report on Form 10-K. Not all of these significant accounting policies
require management to make difficult, subjective or complex judgments or
estimates. However, the following policies are deemed to be critical, as that
term is defined by the Securities and Exchange Commission.
REVENUE RECOGNITION
Revenue from product sales is recognized at the time the product is shipped,
with provisions established for estimated product returns and returns related to
one business segment's stock scrap program with distributors. Upon shipment, the
Company provides for the estimated cost that may be incurred for product
warranties. Rebates and other sales incentives offered by the
18
Company are recorded as a reduction of sales at the time of shipment. Revenue
recognition is significant because net sales is a key component of results of
operations. In addition, revenue recognition determines the timing of certain
expenses, such as commissions and royalties. The Company follows generally
accepted accounting principles in measuring revenue. Revenue is recorded in
accordance with Staff Accounting Bulletin ("SAB") No. 104. However, certain
judgments affect the application of its revenue policy. Revenue results are
difficult to predict, and any shortfall in revenue or delay in recognizing
revenue could cause operating results to vary significantly from quarter to
quarter and could result in future operating losses.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company's estimate for the allowance for doubtful accounts related to trade
receivables is based on two methods. The amounts calculated from each of these
methods are combined to determine the total amount reserved. First, the Company
evaluates specific accounts where it has information that the customer may have
an inability to meet its financial obligations (bankruptcy, etc.). In these
cases, the Company uses its judgment, based on the best available facts and
circumstances, and records a specific reserve for that customer against amounts
due to reduce the receivable to the amount that is expected to be collected.
These specific reserves are re-evaluated and adjusted as additional information
is received that impacts the amount reserved. Second, a general reserve is
established for all customers based on several factors, including historical
write-offs as a percentage of sales. If circumstances change (e.g., higher than
expected defaults or an unexpected material adverse change in a major customer's
ability to meet its financial obligation), the Company's estimates of the
recoverability of amounts due could be reduced by a material amount.
INVENTORIES
The Company values inventory at the lower of cost or market and continually
reviews the book value of discontinued product lines to determine if these items
are properly valued. The Company identifies these items and assesses the ability
to dispose of them at a price greater than cost. If it is determined that cost
is less than market value, then cost is used for inventory valuation. If market
value is less than cost, then related inventory is adjusted to that value.
If a write down to the current market value is necessary, the market value
cannot be greater than the net realizable value, which is defined as selling
price less costs to complete and dispose, and cannot be lower than the net
realizable value less a normal profit margin. The Company also continually
evaluates the composition of its inventory and identifies slow-moving and excess
inventories. Inventory items identified as slow-moving or excess are evaluated
to determine if reserves are required. If the Company is not able to achieve its
expectations of the net realizable value of the inventory at current market
value, it adjusts its reserves accordingly.
ACCOUNTING FOR INCOME TAXES
The Company's income tax policy records the estimated future tax effects of
temporary differences between the tax basis of assets and liabilities and
amounts reported in the accompanying consolidated balance sheets, as well as
operating loss and tax credit carryforwards. The Company follows the guidelines
under Statement of Financial Accounting Standard No. 109 ("SFAS 109") in
determining the recoverability of any tax assets recorded on the balance sheet
and provides any necessary allowances as required. As part of the process of
preparing its consolidated financial statements, the Company is required to
estimate its income taxes in each of the jurisdictions in which it operates.
This process involves estimating the actual current tax exposure, together with
assessing temporary differences resulting from the differing
19
treatment of certain items for tax and accounting purposes. These differences
result in deferred tax assets and liabilities, which are included within the
consolidated balance sheet. Management must then assess the likelihood that
deferred tax assets will be recovered from future taxable income, to the extent
it believes that recovery is not likely, the Company must establish a valuation
allowance. To the extent it establishes a valuation allowance or increases or
decreases this allowance in a period, it must include expense or income, as the
case may be, within the tax provision in the consolidated statement of income.
Significant management judgment is required in determining the provision for
income taxes, the deferred tax assets and liabilities and any valuation
allowance recorded against deferred tax assets. As of September 30, 2005 and
December 31, 2004, the Company had recorded total valuation allowances of
$3,682,000 and $3,267,000, respectively, due to uncertainties related to the
utilization of some deferred tax assets, primarily consisting of certain
research and development tax credits, loss carryforwards and foreign tax
credits, before they expire. The valuation allowance is based on estimates of
taxable income, expenses and credits by the jurisdictions in which the Company
operates and the period over which deferred tax assets will be recoverable. In
the event that actual results differ from these estimates or these estimates are
adjusted in future periods, the Company may need to establish an additional
valuation allowance that could materially impact its consolidated financial
position and results of operations.
The net deferred tax assets as of September 30, 2005 and December 31, 2004 were
$6,197,000 and $6,324,000, respectively, net of valuation allowances of
$3,682,000 and $3,267,000, respectively. The carrying value of the Company's net
deferred tax assets assumes that the Company will be able to generate sufficient
future taxable income in certain tax jurisdictions, based on estimates and
assumptions. If these estimates and related assumptions change in the future,
the Company may be required to record additional valuation allowances against
its deferred tax assets resulting in additional income tax expense in the
consolidated statement of income. Management evaluates the ability to realize
the deferred tax assets and assesses the need for additional valuation
allowances quarterly.
The Company's results do not reflect the impact of the American Jobs Creation
Act of 2004 (the "Jobs Act"). The Company has completed the process of
re-evaluating its position with respect to the indefinite reinvestment of
foreign earnings to take into account the possible election of the repatriation
provisions contained in the Jobs Act and has determined that it will have no
impact on the Company.
LEGAL CONTINGENCIES
The Company is currently involved in certain legal proceedings. As discussed in
Note 11 in the Notes to the Consolidated Financial Statements included in Part I
to this Quarterly Report on Form 10-Q, the Company has accrued an estimate of
the probable costs for the resolution of these claims. This estimate has been
developed after investigation and is based upon an analysis of potential
results, assuming a combination of litigation and settlement strategies.
Management does not believe these proceedings will have a material adverse
effect on the Company's consolidated financial position. It is possible,
however, that future results of operations for any particular quarterly or
annual period could be materially affected by changes in these assumptions, or
the effectiveness of these strategies, related to these proceedings.
20
IMPAIRMENT OF LONG-LIVED AND INTANGIBLE ASSETS
The Company's long-lived and intangible assets primarily consist of fixed
assets, goodwill and other intangible assets. Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") requires
that goodwill be tested for impairment at the reporting unit level (operating
segment or one level below an operating segment) on an annual basis and between
annual tests in certain circumstances. Application of the goodwill impairment
test requires judgment, including the identification of reporting units,
assigning assets and liabilities to reporting units, assigning goodwill to
reporting units, and determining the fair value of each reporting unit.
Significant judgments are required to estimate the fair value of reporting
units, including an estimate of future cash flows, a determination of
appropriate discount rates and other assumptions. Changes in these estimates and
assumptions could materially affect the determination of fair value for each
reporting unit.
The Company periodically reviews the carrying value of its long-lived assets
held and used, other than goodwill and intangible assets with indefinite lives,
and assets to be disposed, whenever events or circumstances indicate that the
carrying amount of an asset may not be recoverable. The Company assesses the
recoverability of the asset by estimated cash flows and at times by independent
appraisals. It compares estimated cash flows expected to be generated from the
related assets, or the appraised value of the asset, to the carrying amounts to
determine whether impairment has occurred. If the estimate of cash flows
expected to be generated changes in the future, the Company may be required to
record impairment charges that were not previously recorded for these assets. If
the carrying value of a long-lived asset is considered impaired, an impairment
charge is recorded for the amount by which the carrying value of the long-lived
asset exceeds its fair value.
ENVIRONMENTAL EXPENDITURES
The Company is subject to United States and Mexican environmental laws and
regulations concerning emissions to the air, discharges to surface and
subsurface waters, and generation, handling, storage, transportation, treatment
and disposal of waste materials. The Company is also subject to other federal,
state and local environmental laws and regulations, including those that require
it to remediate or mitigate the effects of the disposal or release of certain
chemical substances at various sites, including some where the Company has
ceased operations. It is impossible to predict precisely what effect these laws
and regulations will have in the future.
Expenditures that relate to current operations are charged to expense or
capitalized, as appropriate. Expenditures that relate to an existing condition
caused by past operations are expensed and recorded as part of discontinued
operations. Expenditures include costs of remediation and legal fees to defend
against claims for environmental liability. Liabilities are recorded when
remedial efforts are probable and the costs can be reasonably estimated. The
liability for remediation expenditures includes, as appropriate, elements of
costs such as site investigations, consultants' fees, feasibility studies,
outside contractor expenses and monitoring expenses. Estimates are not
discounted, and they are not reduced by potential claims for recovery from
insurance carriers. The liability is periodically reviewed and adjusted to
reflect current remediation progress, prospective estimates of required activity
and other relevant factors, including changes in technology or regulations.
The above listing is not intended to be a comprehensive list of all of the
Company's accounting policies. In many cases, the accounting treatment of a
particular transaction is specifically
21
dictated by generally accepted accounting principles with no need for
management's judgment in their application. There are also areas in which
management's judgment in selecting any available alternatives would not produce
a materially different result. See the Company's audited Consolidated Financial
Statements and Notes thereto included in Part IV of its Annual Report on Form
10-K, which contain accounting policies and other disclosures required by
generally accepted accounting principles.
LIQUIDITY AND CAPITAL RESOURCES
September 30, December 31,
2005 2004 $ Variance % Variance
------------- ------------ ---------- ----------
(in thousands)
Cash and cash equivalents $ 6,696 $ 2,659 $ 4,037 152%
Bank debt $ -- $ 2,015 $(2,015) (100%)
Working capital $24,636 $19,496 $ 5,140 26%
Shareholders' equity $44,637 $37,687 $ 6,950 18%
At September 30, 2005, the Company maintained a cash balance of $6,696,000.
During the nine-month period ended September 30, 2005, the net cash provided by
operating activities was $6,901,000, as compared to net cash provided by
operating activities of $2,905,000 during the nine-month period ended September
30, 2004. The primary sources of cash from operating activities for the
nine-month period ended September 30, 2005 were income from continuing
operations of $5,879,000 and a decrease in inventories of $2,016,000. These
sources of cash were partially offset by a decrease in accrued liabilities of
$1,522,000. The decrease in inventory is primarily attributable to activities at
RFL and Condor, which had decreases in inventory of $1,389,000 and $1,117,000,
respectively, offset by an increase in inventory at MTI of $670,000. Decreases
in inventory at RFL and Condor were due to the timing of sales in the third
quarter of 2005, compared to the quarter ended December 31, 2004. The decrease
in accrued liabilities is primarily related to payments made by the Company to
settle certain litigation, fees and claims, which the Company had accrued at
December 31, 2004. In the nine-month period ended September 30, 2004, net cash
provided by operating activities was $2,905,000. The primary sources of cash
were income from continuing operations, an increase in accounts payable of
$3,117,000 and, to a lesser extent, an increase in accrued income taxes of
$2,014,000. The primary uses of cash from operating activities for the
nine-month period ended September 30, 2004 were increases in accounts receivable
and in inventory in the amount of $8,374,000.
During the nine-month period ended September 30, 2005, net cash used in
investing activities was $2,063,000. The primary uses of cash in investing
activities were related to purchases of securities available for sale in the
amount of $567,000 and the purchase of machinery and equipment in the amount of
$1,186,000. During the nine-month period ended September 30, 2004, net cash used
in investing activities was $158,000. The uses of cash in investing activities
were primarily related to the purchases of machinery and equipment in the amount
of $1,167,000. These uses of cash were principally offset by the proceeds of
$1,000,000 received by the Company on April 2, 2004 as a final cash payment from
the sale of EME.
During the nine-month period ended September 30, 2005, net cash used in
financing activities was $698,000. This use of cash was principally related to
payments against the Senior Credit Facility in the amount of $2,015,000,
partially offset by the proceeds from the exercise of stock
22
options of $1,511,000. During the nine-month period ended September 30, 2004,
net cash used in financing activities was $6,693,000, primarily due to the
purchase of treasury stock. During 2004, the Company purchased treasury stock in
the amount of approximately $6,076,000, for 545,900 shares at an average price
of $11.13 per share, under the Company's repurchase program approved by the
Board of Directors on December 12, 2003. Also during this period, the Company
made payments of $747,000 against the Senior Credit Facility. These uses of cash
were partially offset by proceeds from stock options exercised during the year
in the amount of $272,000.
During 2005 until August 2, 2005, the Company was a party to a three-year Senior
Secured Credit Facility with LaSalle Business Credit LLC. The Senior Credit
Facility, which provided for a revolving loan facility and two term loans, up to
a maximum indebtedness of $20,000,000. The revolving loan of up to $16,810,000
was based upon eligible receivables and inventory, as well as an overadvance
amount of $1,500,000, which was repaid in full on April 7, 2004. The two term
loans of $2,350,000 and $840,000 were to be amortized over a three-year term.
The Senior Credit Facility restricted investments, acquisitions, capital
expenditures and dividends. It contained financial covenants relating to minimum
levels of net worth, fixed charge coverage and EBITDA levels, as defined. The
Senior Credit Facility bore interest ranging from the prime rate plus fifty
basis points to prime rate plus 2%. The Senior Credit Facility was secured by
all of the Company's assets.
On August 2, 2005, the Company paid the outstanding term loan balances under the
above Senior Credit Facility in the amount of $1,641,000. The Company also paid
$212,000 in early termination and legal fees. On August 3, 2005, the Company
entered into a Revolving Credit Facility with Bank of America, N.A. (see Note 9
in Part I Notes to Consolidated Financial Statements under this Form 10-Q).
The Company's current ratio was 2.52 to 1 at September 30, 2005 and 2.05 to 1 at
December 31, 2004. The current ratio changed primarily due to an increase in
cash of $4,037,000 primarily due to net cash provided by operating activities
and cash from stock option exercises of $1,511,000, a decrease in accrued
liabilities of $1,258,000 and a decrease in current debt of $559,000.
As a percentage of total capitalization, consisting of debt and shareholders'
equity, total borrowings by the Company were 0% at September 30, 2005 and 5% at
December 31, 2004. During the first nine months of 2005, total debt decreased by
$2,015,000.
Capital expenditures of $1,186,000 were made during the first nine months of
2005. These expenditures primarily related to computer equipment and factory
machinery and equipment. Capital expenditures for the period represent a $19,000
increase from the comparable period in 2004.
During the first nine months of 2005, the Company was able to generate adequate
amounts of cash to meet its operating needs, reduce total borrowings by
$2,015,000, purchase machinery and equipment in the amount of $1,186,000 and
purchase securities available for sale in the amount of $567,000. All of the
Company's operating segments had income from operations for the nine months
ended September 30, 2005.
23
Management believes that cash from operations and funds expected to be available
under the Revolving Credit Facility will be sufficient to fund the Company's
operations and working capital requirements.
CONTRACTUAL OBLIGATIONS
The following is a summary of the Company's contractual obligations that existed
as of September 30, 2005:
Less Than 1 to 3 4 to 5 After
1 Year Years Years 5 Years Total
--------- ------ ------ ------- -------
(in thousands)
Operating Leases $431 $1,605 $ 8 $ -- $2,044
Debt -- -- -- -- --
Capital Leases 54 27 -- -- 81
Other Obligations 51 172 134 182 539
---- ------ ---- ---- ------
$536 $1,804 $142 $182 $2,664
==== ====== ==== ==== ======
OFF-BALANCE SHEET ARRANGEMENTS
It is not the Company's usual business practice to enter into off-balance sheet
arrangements, such as guarantees on loans and financial commitments,
indemnification arrangements, and retained interests in assets transferred to an
unconsolidated entity for securitization purposes. Consequently, the Company has
no off-balance sheet arrangements, except for operating lease commitments
disclosed in the table above, that have, or are reasonably likely to have, a
material current or future effect on its financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.
24
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2005, COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2004
The table below shows the comparison of net sales for the quarter ended
September 30, 2005 and the quarter ended September 30, 2004:
Three Months Three Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Quarter Same Quarter
2005 2004 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
Power Electronics Group:
Condor $10,617 $11,442 $ (825) (7%)
Teal 8,840 8,394 446 5%
------- ------- ------ ---
Total 19,457 19,836 (379) (2%)
------- ------- ------ ---
SL-MTI 7,440 5,599 1,841 33%
RFL 5,201 5,475 (274) (5%)
------- ------- ------ ---
Total $32,098 $30,910 $1,188 4%
======= ======= ====== ===
The table below shows the comparison of income from operations for the quarter
ended September 30, 2005 and the quarter ended September 30, 2004:
Three Months Three Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Quarter Same Quarter
2005 2004 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
Power Electronics Group:
Condor $ 832 $ 1,357 $(525) (39%)
Teal 1,590 1,291 299 23%
------ ------- ----- ---
Total 2,422 2,648 (226) (9%)
------ ------- ----- ---
SL-MTI 1,117 588 529 90%
RFL 546 496 50 10%
Other (743) (1,061) 318 30%
------ ------- ----- ---
Total $3,342 $ 2,671 $ 671 25%
====== ======= ===== ===
Consolidated net sales for the three-month period ended September 30, 2005
increased by $1,188,000, or 4%, compared to the same period in 2004.
Contributing to the increased revenues were SL-MTI, which recorded a sales
increase of $1,841,000, or 33%, and Teal, which experienced a sales increase of
$446,000, or 5%. Condor recorded decreased sales from 2004 of $825,000, or 7%,
and RFL recorded a sales decrease of $274,000, or 5%.
The Company had income from operations of $3,342,000 for the three-month period
ended September 30, 2005, as compared to income from operations of $2,671,000
for the corresponding period last year, an increase of $671,000, or 25%.
25
Income from continuing operations was $2,552,000, or $0.44 per diluted share,
compared to $2,554,000, or $0.43 per diluted share in 2004. Income from
continuing operations decreased by a minor amount in 2005 compared to 2004. The
Company's business segments and the components of operating expenses are
discussed more fully in the following sections.
The Power Electronics Group, which is comprised of Condor and Teal, recorded a
sales decrease of $379,000, or 2%, and a decrease in income from operations of
$226,000, or 9%. Condor experienced a decrease in sales of $825,000, or 7%, and
a decrease in income from operations of $525,000, or 39%. Condor's decrease in
income from operations is primarily due to its decrease in sales. Condor
experienced a decrease in sales to manufacturers of industrial equipment of
$1,371,000, or 29%, while sales of its medical product line increased
approximately $766,000, or 13%. Sales to electrical and electronic distributors
also decreased from 2004. Condor's international sales increased approximately
68%, aided by sales to two international customers of new products. Domestic
sales decreased by approximately 15%, primarily due to the decrease in sales to
the industrial market. Teal experienced a sales increase of $446,000, or 5%, and
an increase in income from operations of $299,000, or 23%. Teal's sales increase
was attributable to its medical imaging product line. Teal's increase in income
from operations is primarily due to increased sales, as well as a reduction in
operating costs.
SL-MTI's sales increased $1,841,000, or 33%, while income from operations
increased $529,000, or 90%. The increase in sales was driven by increases in
sales to the defense industry and the commercial aerospace markets. Sales of
SL-MTI's DC Brush and Brushless Motors increased by $1,392,000, or 34%, in the
third quarter of 2005, compared to third quarter of 2004. Also sales of its
windings product line increased by $383,000 or 37%. The increase in income from
operations is primarily due to the increase in sales.
RFL's sales decreased by $274,000, or 5%, during the third quarter of 2005,
compared to the third quarter of 2004, while income from operations increased by
$50,000, or 10%, for the comparable periods. Sales of RFL's carrier
communications product line decreased by $966,000, or 36%, in the third quarter
of 2005, compared to 2004, partially due to a labor strike encountered at one of
its largest customers. Sales of RFL's teleprotection products increased by
$556,000, or 31%, partially due to sales of new product offerings. The increase
in income from operations is attributable to a combination of improved gross
profit margins and a reduction in operating costs.
COST OF PRODUCTS SOLD
As a percentage of net sales, cost of products sold for each of the three-month
periods ended September 30, 2005 and September 30, 2004 was approximately 65%
and 64%, respectively. Although the cost of products sold, as a percentage of
net sales, remained relatively constant for the comparative quarters, the mix
within the Company's business segments changed. The cost of products sold
percentage for the Power Electronics Group increased by approximately 2%. Both
Condor and Teal experienced increases in their cost of products sold, as a
percentage of net sales. Condor's cost of products sold, as a percentage of net
sales, increased primarily due to lower volume. Teal's cost of products, sold as
a percentage of net sales, increased primarily due to increases in the costs of
raw materials. SL-MTI recorded an increase in its cost of products sold, as a
percentage of net sales, in the third quarter of 2005, as compared to the same
period last year, due to product mix, additional training costs and operational
inefficiencies, primarily
26
related to the transfer of new programs to its Cedro manufacturing facility in
Matamoros, Mexico. RFL's cost of products sold, as a percentage of sales,
improved slightly in 2005, compared to 2004, due to product mix.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES
Engineering and product development expenses for each of the three-month periods
ended September 30, 2005 and September 30, 2004 were approximately 7% of net
sales. All of the Company's business segments engineering and product
development expenditures remained relatively constant in 2005, compared to 2004.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses, as a percentage of net sales, for
the third quarter of each of 2005 and 2004 were 16% and 19%, respectively. These
expenses decreased by $777,000, or 13%, while consolidated sales increased by
4%. All of the Company's business segments reduced or had relatively minor
increases in selling, general and administrative expenses in the comparative
quarters. During the quarter ended September 30, 2005, the Company recorded a
net benefit of $450,000 in compensation expense related to certain stock based
compensation arrangements with key executives. This is a favorable decrease in
expense of $474,000 from the comparable period in 2004.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses remained relatively constant at
approximately 2% of net sales for each of the third quarters of 2005 and 2004.
AMORTIZATION OF DEFERRED FINANCING COSTS
In connection with entering into the Senior Credit Facility on January 6, 2003,
the Company incurred costs of approximately $1,342,000. These costs had been
deferred and were being amortized over the three-year term of the Senior Credit
Facility. On August 2, 2005 the Company terminated its Senior Credit Facility
and accordingly wrote off the remaining deferred financing costs related to this
facility. In connection with entering into the Revolving Credit Facility with
Bank of America, N.A. on August 3, 2005, the Company has incurred costs of
approximately $207,000. These costs have been deferred and are being amortized
over the three-year term of the Revolving Credit Facility. For the quarter ended
September 30, 2005, amortization of deferred financing costs was $236,000 which
included the write-off of the deferred financing costs related to the Senior
Credit Facility and the amortization of the deferred financing costs related to
the current Revolving Credit Facility with Bank of America, N. A. For the
quarter ended September 30, 2004, amortization of deferred financing assets was
$112,000.
INTEREST INCOME (EXPENSE)
Interest expense for the three-month period ended September 30, 2005 was
$236,000, as compared to $59,000 in the same period last year. Included in
interest expense for the quarter ended September 30, 2005 is $185,000 in early
termination fees related to the Senior Credit Facility. Interest income was
$61,000, for the quarter ended September 30, 2005, compared to $22,000 for the
quarter ended September 30, 2004.
TAXES
The effective tax rate for the three-month period ended September 30, 2005 was
approximately 13%. The effective tax rate reflects the statutory rate after
adjustments for state and international tax provisions, offset by the recording
of benefits primarily related to foreign tax credits and, to a
27
lesser extent, research and development tax credits. The effective tax rate for
the comparable period in 2004 was a benefit of approximately 1%. This tax
benefit reflects the statutory rate after adjustments for state and
international tax provisions, offset by the recording of benefits from research
and development tax credits primarily related to prior years, which were
recorded during the period.
DISCONTINUED OPERATIONS
For the three months ended September 30, 2005, the Company recorded a loss from
discontinued operations, net of tax, of $98,000. This amount includes current
legal and litigation charges related to discontinued operations. For the three
months ended September 30, 2004, the Company recorded a net loss from
discontinued operations, net of tax, of $3,000. This amount includes net
billings to insurance companies related to the recovery of certain legal fees
for environmental matters in the amount of $190,000, net of tax. These income
amounts were offset by environmental, legal and litigation charges related to
discontinued operations.
NINE MONTHS ENDED SEPTEMBER 30, 2005, COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2004
The table below shows the comparison of net sales for the nine months ended
September 30, 2005 and September 30, 2004:
Nine Months Nine Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Period Same Period
2005 2004 Last Year Last Year
------------- ------------- ------------ -----------++
(in thousands)
Power Electronics Group:
Condor $33,001 $30,966 $2,035 7%
Teal 24,077 23,194 883 4%
------- ------- ------ --
Total 57,078 54,160 2,918 5%
------- ------- ------ --
SL-MTI 21,120 17,381 3,739 22%
RFL 17,615 16,518 1,097 7%
------- ------- ------ ---
Total $95,813 $88,059 $7,754 9%
======= ======= ====== ===
28
The table below shows the comparison of income from operations for the nine
months ended September 30, 2005 and September 30, 2004:
Nine Months Nine Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Period Same Period
2005 2004 Last Year Last Year
------------- ------------- ----------- -----------
(in thousands)
Power Electronics Group:
Condor $ 3,260 $ 2,758 $ 502 18%
Teal 3,725 3,719 6 N/M
------- ------- ------ ---
Total 6,985 6,477 508 8%
------- ------- ------ ---
SL-MTI 2,941 1,846 1,095 59%
RFL 1,862 1,332 530 40%
Other (3,619) (3,502) (117) (3%)
------- ------- ------ ---
Total $ 8,169 $ 6,153 $2,016 33%
======= ======= ====== ===
Consolidated net sales for the nine months ended September 30, 2005 increased
$7,754,000, or 9%, compared to the nine month period ended September 30, 2004.
All of the Company's operating entities had increases in sales ranging from 22%
to 4% for the comparable nine month periods. SL-MTI reported a sales increase of
$3,739,000, or 22%. Condor sales increased $2,035,000, or 7%. RFL experienced a
sales increase of $1,097,000, or 7%. Teal experienced a sales increase of
$883,000, or 4%.
The Company recorded income from operations of $8,169,000 for the nine months
ended September 30, 2005, compared to income from operations of $6,153,000 for
the corresponding period last year. This change represents an increase of
$2,016,000, or 33%.
Income from continuing operations was $5,879,000, or $1.03 per diluted share, in
2005, compared to $4,799,000, or $0.80 per diluted share, in 2004. Income from
continuing operations benefited by approximately $671,000, or $0.12 per diluted
share, in 2005 due to foreign tax credits recorded during the year and by
approximately $447,000, or $0.08 per diluted share, related to research and
development tax credits recorded principally in the first quarter of 2005.
Income from continuing operations benefited by approximately $1,252,000, or
$0.21 per diluted share, due to research and development tax credits recorded
during 2004. Income from continuing operations increased by $1,080,000, or 23%,
for the nine months ended September 30, 2005, compared to the same period in
2004. The Company's business segments and the components of operating expenses
are discussed more fully in the following sections.
The Power Electronics Group recorded a sales increase of $2,918,000, or 5%, and
an increase in income from operations of $508,000, or 8%. Within the Power
Electronics Group, Condor recorded a sales increase of $2,035,000, or 7%, and
Teal reported a sales increase of $883,000, or 4%. Condor's income from
operations increased by $502,000, or 18%, while Teal's income from operations
increased slightly compared to 2004. Condor's sales increase is primarily
related to its medical product line, which increased approximately by
$3,996,000, or 25%. Most of the increase in this product line was achieved in
the first quarter of 2005. Condor's industrial product line sales decreased
approximately $1,833,000, or 15%. The increase in income from operations
29
is primarily due to the increase in sales. Teal's sales increase was primarily
attributable to increases in its medical product line of approximately
$4,401,000, partially offset by decreases in its semiconductor business of
approximately $3,474,000.
SL-MTI's sales increased by $3,739,000, or 22%. Income from operations increased
by $1,095,000, or 59%. The increase in sales was primarily due to increased
sales in both the defense and medical markets of 31% and 36%, respectively.
Sales of its DC brush and brushless motors increased $2,842,000, or 24%, while
the windings product line increased by $886,000, or 25%. The increase in income
from operations was the result of increased sales volume and slightly improved
gross profit margins, partially offset by an increase in engineering and product
development expenses of $96,000, or 6%, over the same period in 2004.
RFL's sales increased by $1,097,000, or 7%, in 2005, compared to the same period
in 2004. Income from operations increased by $530,000, or 40%, for the
comparable periods. All of RFL's product lines experienced increases in sales,
except teleprotection equipment, which decreased by approximately $302,000, or
4%. The largest increase in sales was attributable to its carrier communication
product line, which increased by $555,000, or 8%. This sales increase was
primarily due to the introduction of new products. Income from operations
increased by $530,000, or 40%, primarily due to higher sales volume and lower
engineering and product development costs, partially offset by higher selling,
general and administrative costs.
COST OF PRODUCTS SOLD
Cost of products sold, as a percentage of sales, for the nine months ended
September 30, 2005 and September 30, 2004 was approximately 64% and 63%,
respectively. Cost of products sold percentage improved at RFL due to increased
volume and product mix. Teal experienced a higher cost of products sold, as a
percentage of net sales, in 2005, compared to 2004, due primarily to higher raw
material costs. The cost of products sold, as a percentage of net sales,
remained relatively constant at Condor and SL-MTI for the nine months ended
September 30, 2005, compared to the same period in 2004.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES
Engineering and product development expenses for the nine months ended September
30, 2005 and September 30, 2004 was approximately 7% and 8% of net sales,
respectively. Engineering and product development expenses increased $204,000,
or 3%, in the nine-month period of 2005, as compared to 2004. Other than RFL,
all of the Company's business segments increased their engineering and product
development expenditures in 2005, compared to 2004. RFL incurred significant
expenditures in 2004 related to the development of several new product designs
and applications.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the nine months ended September
30, 2005 were approximately 19% of net sales, compared to 20% of net sales in
2004. These expenses decreased by $38,000, while sales increased by 9% over the
comparative periods. Compensation expenses related to certain stock based
compensation arrangements with key executives were $40,000 for the first nine
months of 2005, compared to $451,000 for the same period in 2004, or a decrease
of $411,000 from the prior year. Without these non-cash charges, selling general
and administrative expenses would have increased by $373,000 over the comparable
period.
30
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses for the first nine months of 2005 and
2004 were approximately 2% of sales, and remained relatively constant for each
period.
AMORTIZATION OF DEFERRED FINANCING COSTS
Amortization of deferred financing costs was $460,000 and $336,000 for the first
nine months of 2005 and 2004, respectively. These costs were less than 1% of net
sales for each period. The increase in amortization of deferred financing cost
in 2005 is primarily related to the write-off of the deferred financing costs
related to the Senior Credit Facility, which was terminated on August 2, 2005.
INTEREST INCOME (EXPENSE)
Interest income for the nine months ended September 30, 2005 increased by
$45,000, as compared to the same period last year. Interest expense increased by
$178,000, due to the payment of early termination fees of $185,000 related to
the Company's Senior Credit Facility. Without these fees, interest expenses
would have decreased for the first nine months of 2005 due to reduced debt
levels.
TAXES
The effective tax rate for the nine months ended September 30, 2005 was
approximately 21%, compared to 16% for the nine months ended September 30, 2004.
The effective tax rate for both periods reflects the statutory rate after
adjustments for state and international tax provisions, offset by the recording
of benefits from research and development tax credits and certain income
exclusion benefits. Also in 2005, the Company recorded foreign tax credits,
which lowered the tax rate by approximately 9%.
DISCONTINUED OPERATIONS
For the nine months ended September 30, 2005, the Company recorded a loss from
discontinued operations, net of tax, of $398,000. This amount consisted
primarily of the cost of environmental and legal charges, net of tax, related to
discontinued operations. For the nine months ended September 30, 2004, the
Company recorded income from discontinued operations, net of tax, of $2,473,000.
This amount is primarily related to a settlement fee received by SLW Holdings,
net of tax, in the amount of $2,516,000 (see Note 13) and the reversal of tax
reserves related to discontinued operations. These income amounts, net of tax,
were partially offset by environmental, legal and litigation charges related to
discontinued operations.
FORWARD-LOOKING INFORMATION
From time to time, information provided by the Company, including written or
oral statements made by representatives, may contain forward-looking information
as defined in the Private Securities Litigation Reform Act of 1995. All
statements, other than statements of historical facts, contain forward-looking
information, particularly statements that address activities, events or
developments that the Company expects or anticipates will or may occur in the
future, such as expansion and growth of the Company's business, future capital
expenditures and the Company's prospects and strategy. In reviewing such
information, it should be kept in mind that actual results may differ materially
from those projected or suggested in such forward-looking information. This
forward-looking information is based on various factors and was derived
utilizing numerous assumptions. Many of these factors previously have been
identified in filings or statements made by or on behalf of the Company.
31
Important assumptions and other important factors that could cause actual
results to differ materially from those set forth in the forward-looking
information include changes in the general economy, changes in capital
investment and/or consumer spending, competitive factors and other factors
affecting the Company's business in or beyond the Company's control. These
factors include a change in the rate of inflation, a change in state or federal
legislation or regulations, an adverse determination with respect to a claim in
litigation or other claims (including environmental matters), the ability to
recruit and develop employees, the ability to successfully implement new
technology and the stability of product costs. These factors also include the
timing and degree of any business recovery in certain of the Company's markets
that are currently experiencing a cyclical economic downturn.
Other factors and assumptions not identified above could also cause actual
results to differ materially from those set forth in the forward-looking
information. The Company does not undertake to update forward-looking
information contained herein or elsewhere to reflect actual results, changes in
assumptions or changes in other factors affecting such forward-looking
information.
Future factors include the effectiveness of cost reduction actions undertaken by
the Company; increasing price, products and services competition by U.S. and
non-U.S. competitors, including new entrants; rapid technological developments
and changes and the Company's ability to continue to introduce and develop
competitive new products and services on a timely, cost-effective basis;
availability of manufacturing capacity, components and materials; credit
concerns and the potential for deterioration of the credit quality of customers;
customer demand for the Company's products and services; ability of the Company
to continue to finance its operations on satisfactory terms; U.S. and non-U.S.
governmental and public policy changes that may affect the level of new
investments and purchases made by customers; changes in environmental and other
U.S. and non-U.S. governmental regulations; protection and validity of patent
and other intellectual property rights; compliance with the covenants and
restrictions of bank credit facilities; and outcome of pending and future
litigation and governmental proceedings. These are representative of the future
factors that could affect the outcome of the forward-looking statements. In
addition, such statements could be affected by general industry and market
conditions and growth rates, general U.S. and non-U.S. economic conditions,
including increased economic uncertainty and instability, and interest rate and
currency exchange rate fluctuations and other future factors.
For a further description of future factors that could cause actual results to
differ materially from such forward-looking statements, see the discussion in
the Company's Annual Report on Form 10-K for the year ended December 31, 2004,
Part I, Item 1 - Risk Factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in quantitative and qualitative market risk
from the disclosure contained in Item 7A of the Company's Annual Report on Form
10-K for the year ended December 31, 2004, which is incorporated herein by
reference.
ITEM 4. CONTROLS AND PROCEDURES
The Company, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the design and operation of the
Company's "disclosure controls and
32
procedures," as such term is defined in Rules 13a-15(e) and 15d-15(e)
promulgated under the Securities Exchange Act of 1934, as amended, (the
"Exchange Act") as of this Quarterly Report on Form 10-Q (this "Report"). Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
have concluded that the Company's disclosure controls and procedures were
effective as of the end of the period covered by this Report to provide
reasonable assurance that information required to be disclosed by the Company in
reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. There have been no changes in
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within a company have been detected.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Please see Note 12 to the Consolidated Financial Statements and the Company's
Annual Report on Form 10-K for the twelve months ended December 31, 2004.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On December 12, 2003, the Company announced that its Board of Directors had
authorized the repurchase of up to 10% of the outstanding shares of common stock
of the Company. Any repurchases are to be made on the open market or in
negotiated transactions. For the nine months ended September 30, 2005, the
Company did not purchase any shares pursuant to the repurchase program; however,
it did purchase 21,700 shares through its deferred compensation plans during
this period.
33
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number Maximum Number
of Shares of Shares That May
Total Purchased as Part Yet Be Purchased
Number of Average of Publicly under Publicly
Shares Price Paid Announced Plans Announced Plans or
Period Purchased per Share or Programs Programs
------ --------- ---------- ----------------- ------------------
January 1 - 31, 2005 -- -- -- 48,024
February 1 - 28, 2005 -- -- -- 48,024
March 1 - 31, 2005 1,700(1) $13.50 -- 48,024
April 1 - 30, 2005 -- -- -- 48,024
May 1 - 31, 2005 3,800(1) $16.71 -- 48,024
June 1 - 30, 2005 5,400(1) $17.93 -- 48,024
July 1 - 31, 2005 6,900(1) $17.94 -- 48,024
August 1 - 31, 2005 -- -- -- 48,024
September 1 - 30, 2005 3,900(1) $14.57 -- 48,024
------ ------ ---
Total 21,700 $16.77 --
====== ====== ===
(1.) The Company purchased these shares other than through a publicly announced
plan or program in open market transactions or in negotiated transactions.
ITEM 5. OTHER INFORMATION
Pursuant to Section 10A(i)(2) of the Exchange Act, the Company is responsible
for listing the non-audit services approved in the third quarter of 2005 by its
Audit Committee to be performed by Grant Thornton, the Company's external
auditor. Each of the permitted non-audit services has been pre-approved by the
Audit Committee or the Audit Committee's Chairman pursuant to delegated
authority by the Audit Committee. During the third quarter of 2005, the Audit
Committee pre-approved the following non-audit services anticipated to be
performed by Grant Thornton: 1) Review of Forms 1118 and 5471 to be included in
the Company's 2004 U.S. Corporation Income Tax Return; and 2) Analysis and
consultation in connection with allowable foreign tax credits.
ITEM 6. EXHIBITS
31.1 Certification by Principal Executive Officer pursuant to Rule 13a-15(e) or
15(d)-15(e) of the Securities Exchange Act of 1934, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (transmitted
herewith).
31.2 Certification by Principal Financial Officer pursuant to Rule 13a-15(e) or
15(d)-15(e) of the Securities Exchange Act of 1934, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (transmitted
herewith).
34
32.1 Certification by Principal Executive Officer pursuant to Rule 13a or 15(d)
of the Securities Exchange Act of 1934, as amended, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002 (transmitted herewith).
32.2 Certification by Principal Financial Officer pursuant to Rule 13a or 15(d)
of the Securities Exchange Act of 1934, as amended, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002 (transmitted herewith).
35
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.
Date: November 7, 2005 SL INDUSTRIES, INC.
(Registrant)
By: /s/ James C. Taylor
------------------------------------
James C. Taylor
Chief Executive Officer
(Principal Executive Officer)
By: /s/ David R. Nuzzo
------------------------------------
David R. Nuzzo
Chief Financial Officer
(Principal Accounting Officer)
36