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, 2006
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 a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act).
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [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 1, 2006 was
5,654,302.
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2006 (Unaudited) and December 31, 2005............ 1
Consolidated Statements of Income and Comprehensive Income
Three Months Ended September 30, 2006 and 2005 (Unaudited)
and Nine Months Ended September 30, 2006 and 2005 (Unaudited)... 2
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2006 and 2005 (Unaudited)....... 3
Notes to Consolidated Financial Statements (Unaudited)............. 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................ 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk............ 34
Item 4. Controls and Procedures............................................... 34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........... 35
Item 5. Other Information..................................................... 36
Item 6. Exhibits.............................................................. 36
SIGNATURES..................................................................... 37
Item 1. Financial Statements
SL INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2006 2005
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ -- $ 9,985,000
Receivables, net 27,715,000 16,436,000
Note receivable 1,125,000 --
Inventories, net 22,238,000 14,570,000
Prepaid expenses 2,192,000 632,000
Deferred income taxes, net 3,908,000 2,571,000
------------ ------------
Total current assets 57,178,000 44,194,000
------------ ------------
Property, plant and equipment, net 12,572,000 8,754,000
Deferred income taxes, net 6,385,000 3,409,000
Goodwill 13,759,000 10,303,000
Investments available for sale -- 670,000
Other intangible assets, net 3,401,000 1,085,000
Other assets and deferred charges 1,341,000 1,899,000
------------ ------------
Total assets $ 94,636,000 $ 70,314,000
============ ============
LIABILITIES
Current liabilities:
Debt, current portion $ -- $ --
Accounts payable 14,876,000 7,648,000
Accrued income taxes 1,445,000 417,000
Accrued liabilities:
Payroll and related costs 6,743,000 6,229,000
Other 5,917,000 4,093,000
------------ ------------
Total current liabilities 28,981,000 18,387,000
------------ ------------
Debt, less current portion 9,453,000 --
Deferred compensation and supplemental retirement benefits 2,961,000 3,829,000
Other liabilities 1,361,000 1,453,000
------------ ------------
Total liabilities 42,756,000 23,669,000
------------ ------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, no par value; authorized, 6,000,000 shares;
none issued $ -- $ --
Common stock, $0.20 par value; authorized, 25,000,000 shares;
issued, 8,298,000 shares 1,660,000 1,660,000
Capital in excess of par value 40,747,000 40,136,000
Accumulated other comprehensive (loss) income (39,000) 67,000
Retained earnings 29,537,000 24,837,000
Treasury stock at cost, 2,643,000 and 2,701,000 shares, respectively (20,025,000) (20,055,000)
------------ ------------
Total shareholders' equity 51,880,000 46,645,000
------------ ------------
Total liabilities and shareholders' equity $ 94,636,000 $ 70,314,000
============ ============
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,
------------------------- --------------------------
2006 2005 2006 2005
----------- ----------- ------------ -----------
Net sales .............................................. $45,165,000 $32,098,000 $127,564,000 $95,813,000
Cost and expenses:
Cost of products sold ............................... 30,809,000 20,931,000 85,946,000 61,356,000
Engineering and product development ................. 2,917,000 2,294,000 9,147,000 7,071,000
Selling, general and administrative ................. 8,034,000 5,050,000 22,852,000 17,765,000
Depreciation and amortization ....................... 623,000 481,000 1,803,000 1,452,000
----------- ----------- ------------ -----------
Total costs and expenses ............................... 42,383,000 28,756,000 119,748,000 87,644,000
----------- ----------- ------------ -----------
Income from operations ................................. 2,782,000 3,342,000 7,816,000 8,169,000
Other income (expense):
Amortization of deferred financing costs ............ (22,000) (236,000) (66,000) (460,000)
Interest income ..................................... 2,000 61,000 30,000 128,000
Interest expense .................................... (153,000) (236,000) (452,000) (385,000)
----------- ----------- ------------ -----------
Income from continuing operations before income taxes .. 2,609,000 2,931,000 7,328,000 7,452,000
Income tax provision ................................... 803,000 379,000 2,182,000 1,573,000
----------- ----------- ------------ -----------
Income from continuing operations ...................... 1,806,000 2,552,000 5,146,000 5,879,000
(Loss) from discontinued operations (net of tax) ....... (148,000) (98,000) (445,000) (398,000)
----------- ----------- ------------ -----------
Net income ............................................. $ 1,658,000 $ 2,454,000 $ 4,701,000 $ 5,481,000
=========== =========== ============ ===========
BASIC NET INCOME (LOSS) PER COMMON SHARE *
Income from continuing operations ................... $ 0.32 $ 0.46 $ 0.91 $ 1.06
(Loss) from discontinued operations (net of tax) .... (0.03) (0.02) (0.08) (0.07)
----------- ----------- ------------ -----------
Net income .......................................... $ 0.29 $ 0.44 $ 0.84 $ 0.99
=========== =========== ============ ===========
DILUTED NET INCOME (LOSS) PER COMMON SHARE *
Income from continuing operations ................... $ 0.31 $ 0.44 $ 0.88 $ 1.03
(Loss) from discontinued operations (net of tax) .... (0.03) (0.02) (0.08) (0.07)
----------- ----------- ------------ -----------
Net income .......................................... $ 0.28 $ 0.42 $ 0.81 $ 0.96
=========== =========== ============ ===========
Shares used in computing basic net income (loss)
per common share .................................... 5,644,000 5,580,000 5,628,000 5,528,000
Shares used in computing diluted net income (loss)
per common share .................................... 5,840,000 5,781,000 5,819,000 5,728,000
SL INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
2006 2005 2006 2005
----------- ----------- ------------ -----------
Net income ............................................. $ 1,658,000 $ 2,454,000 $ 4,701,000 $ 5,481,000
Other comprehensive income (net of tax):
Foreign currency translation ........................ (44,000) -- (26,000) --
Investments available for sale ...................... -- (101,000) (67,000) (54,000)
----------- ----------- ------------ -----------
Comprehensive income ................................... $ 1,614,000 $ 2,353,000 $ 4,608,000 $ 5,427,000
=========== =========== ============ ===========
* Earnings per share does not total due to rounding.
See accompanying notes to consolidated financial statements.
2
SL INDUSTRIES, INC.
CONSDOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
2006 2005*
------------ -----------
OPERATING ACTIVITIES:
Net income ............................................................. $ 4,701,000 $ 5,481,000
Add: losses from discontinued operations ............................ 445,000 398,000
------------ -----------
Income from continuing operations ...................................... 5,146,000 5,879,000
------------ -----------
Adjustments to reconcile income from continuing operations to net cash
(used in) provided by operating activities:
Depreciation ........................................................ 1,522,000 1,167,000
Amortization ........................................................ 281,000 285,000
Amortization of deferred financing costs ............................ 66,000 460,000
Non-cash compensation expense ....................................... 453,000 40,000
Stock-based compensation ............................................ 49,000 --
Provisions for losses on accounts receivable ........................ (138,000) 27,000
Deferred compensation and supplemental retirement benefits .......... 363,000 272,000
Deferred compensation and supplemental retirement benefit payments .. (1,226,000) (404,000)
Deferred income taxes ............................................... 474,000 (38,000)
Loss on sale of equipment ........................................... 2,000 --
Changes in operating assets and liabilities, excluding effects of
business acquisition:
Accounts receivable .............................................. (4,913,000) (579,000)
Inventories ...................................................... (3,797,000) 2,016,000
Prepaid expenses ................................................. (630,000) (41,000)
Other assets ..................................................... 304,000 (411,000)
Accounts payable ................................................. 251,000 (160,000)
Accrued liabilities .............................................. 42,000 (1,522,000)
Accrued income taxes ............................................. 1,266,000 (90,000)
------------ -----------
Net cash (used in) provided by operating activities
from continuing operations .......................................... (485,000) 6,901,000
Net cash (used in) operating activities from discontinued operations ... (567,000) (103,000)
------------ -----------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES ....................... (1,052,000) 6,798,000
------------ -----------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ............................. (2,798,000) (1,186,000)
Acquisition of a business, net of cash acquired ........................ (16,145,000) --
Proceeds from sales of equipment ....................................... 5,000 --
Purchases of securities available for sale ............................. -- (567,000)
Purchases of other assets .............................................. -- (310,000)
------------ -----------
NET CASH (USED IN) INVESTING ACTIVITIES ................................... (18,938,000) (2,063,000)
------------ -----------
FINANCING ACTIVITIES:
Payments of deferred financing costs ................................... -- (207,000)
Payments of term loans ................................................. -- (2,015,000)
Net borrowings from Revolving Credit Facility .......................... 9,453,000 --
Proceeds from stock options exercised .................................. 810,000 1,511,000
Tax benefit from exercise of stock options ............................. 177,000 --
Treasury stock (purchases) sales ....................................... (396,000) 13,000
------------ -----------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ....................... 10,044,000 (698,000)
------------ -----------
Effect of exchange rate changes on cash ................................ (39,000) --
------------ -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS ................................... (9,985,000) 4,037,000
------------ -----------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .......................... 9,985,000 2,659,000
------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................ $ -- $ 6,696,000
============ ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest ............................................................ $ 362,000 $ 444,000
Income taxes ........................................................ $ 1,093,000 $ 1,321,000
* Revised classification.
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, 2006. 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, 2005.
2. RECEIVABLES
Receivables at September 30, 2006 and December 31, 2005 consisted of the
following:
September 30, December 31,
2006 2005
------------- ------------
(in thousands)
Trade receivables $28,696 $16,638
Less allowances for doubtful accounts (1,370) (569)
------- -------
27,326 16,069
Recoverable income taxes 17 2
Other 372 365
------- -------
$27,715 $16,436
======= =======
3. INVENTORIES
Inventories at September 30, 2006 and December 31, 2005 consisted of the
following:
September 30, December 31,
2006 2005
------------- ------------
(in thousands)
Raw materials $17,696 $ 9,774
Work in process 5,752 4,699
Finished goods 2,946 1,926
------- -------
26,394 16,399
Less allowances (4,156) (1,829)
------- -------
$22,238 $14,570
======= =======
4. INCOME PER SHARE
The Company has presented net income per common share pursuant to Financial
Accounting Standards Board Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("SFAS 128"). Basic net income per common share is computed
by dividing reported net
4
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 tables below set forth the computation of basic and diluted net income per
share:
Three Months Ended September 30,
---------------------------------------------------------
2006 2005
--------------------------- ---------------------------
(in thousands, except per share amounts)
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------ ------ --------- ------ ------ ---------
Basic net income per
common share $1,658 5,644 $0.29 $2,454 5,580 $0.44
Effect of dilutive
securities -- 196 (0.01) -- 201 (0.02)
------ ----- ----- ------ ----- -----
Diluted net income per
common share $1,658 5,840 $0.28 $2,454 5,781 $0.42
====== ===== ===== ====== ===== =====
Nine Months Ended September 30,
---------------------------------------------------------
2006 2005
--------------------------- ---------------------------
(in thousands, except per share amounts)
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------ ------ --------- ------ ------ ---------
Basic net income per
common share $4,701 5,628 $0.84 $5,481 5,528 $0.99
Effect of dilutive
securities -- 191 (0.03) -- 200 (0.03)
------ ----- ----- ------ ----- -----
Diluted net income per
common share $4,701 5,819 $0.81 $5,481 5,728 $0.96
====== ===== ===== ====== ===== =====
For the nine-month periods ended September 30, 2006 and September 30, 2005,
stock options of 12,500 and 6,250, respectively, were excluded from the dilutive
computations because the option exercise prices were greater than the average
market price of the Company's common stock.
STOCK-BASED COMPENSATION
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"), using the
modified prospective application method. Prior to adopting SFAS No. 123(R), the
Company followed the intrinsic value method of accounting for stock-based
employee compensation in accordance with Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations.
5
The Company maintains two shareholder approved stock option plans: the
Non-Employee Director Nonqualified Stock Option Plan (the "Director Plan") and
the Long-Term Incentive Plan (the "1991 Incentive Plan"). Both plans have
expired, however, stock options issued under each plan remain outstanding.
The Director Plan provided for the granting of nonqualified options to purchase
up to 250,000 shares of the Company's common stock to non-employee directors of
the Company in lieu of paying quarterly retainer fees and regular quarterly
meeting attendance fees, when elected. The Director Plan enabled the Company to
grant options, with an exercise price per share not less than fair market value
of the Company's common stock on the date of grant, which are exercisable at any
time. Each option granted under the Director Plan expires no later than ten
years from date of grant. The expiration date of the Director Plan was May 31,
2003. The 1991 Incentive Plan enabled the Company to grant either nonqualified
options, with an exercise price per share established by the Board's
Compensation Committee, or incentive stock options, with an exercise price per
share not less than the fair market value of the Company's common stock on the
date of grant, which are exercisable at any time. Each option granted under the
1991 Incentive Plan expires no later than ten years from date of grant. The Plan
expired on September 25, 2001 and no future options can be granted under the
Plan.
During 2005, the Company issued 25,000 options to a newly hired executive of the
Company in accordance with the rules and regulations of the Securities and
Exchange Commission.
For the nine months ended September 30, 2006, the Company recognized stock-based
employee compensation expense of $49,000, less a related income tax benefit of
approximately $20,000 under the provisions of the SFAS No. 123(R). Also under
the new standard, excess income tax benefits related to share-based compensation
expense that must be recognized directly in equity are treated as cash flow from
financing rather than operating activities. For the nine months ended September
30, 2005, no compensation expense was recognized for stock option awards granted
at fair market value under the provisions of APB No. 25. However, the Company
has recognized an expense of approximately $417,000 and a benefit of
approximately $450,000 in the three-month periods ended September 30, 2006 and
September 30, 2005, respectively, and expenses of approximately $453,000 and
$40,000 in the nine-month periods ended September 30, 2006 and September 30,
2005, respectively, in compensation expense related to certain stock-based
compensation arrangements. The following table illustrates the pro forma effect
on earnings per share if the Company had accounted for its stock option plans
prior to January 1, 2006, using the fair value method of accounting under SFAS
No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure."
6
Three Months Nine Months
Ended Ended
September 30, 2005 September 30, 2005
------------------ ------------------
(in thousands, except per share
amounts)
Net income, as reported $2,454 $5,481
Add: Stock-based employee compensation
(benefit) expense included in reported net income,
net of related tax effects (286) 26
------ ------
2,168 5,507
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 (109)
------ ------
Pro forma net income $2,454 $5,398
====== ======
Earnings per common share:
Basic - as reported $ 0.44 $ 0.99
Basic - pro forma $ 0.44 $ 0.98
Diluted - as reported $ 0.42 $ 0.96
Diluted - pro forma $ 0.42 $ 0.94
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
Ended
September 30, 2005
------------------
Expected dividend yield 0.0%
Expected stock price volatility 44.31%
Risk-free interest rate 4.18%
Expected life of stock option 5 years
7
The following table summarizes stock option activity for all plans:
Outstanding Weighted Average Weighted Average Aggregate Intrinsic
Options Exercise Price Remaining Life Value
-------------- ---------------- ---------------- -------------------
(in thousands) (in thousands)
Outstanding as of December 31, 2005 633 $10.41 4.78
Granted -- --
Exercised (81) $ 9.98
Forfeited -- --
Expired -- --
--- ------ ---- ------
Outstanding as of September 30, 2006 552 $10.47 4.13 $4,808
=== ====== ==== ======
Exercisable as of September 30, 2006 539 $10.32 4.13 $4,781
=== ====== ==== ======
At September 30, 2006, approximately $121,000 of total unrecognized compensation
expense associated with unvested stock options was expected to be recognized
over a period of 1.8 years. During the nine month periods ended September 30,
2006 and September 30, 2005, the total intrinsic value of options exercised was
$526,000 and $725,000, respectively, and the actual tax benefit realized for the
tax deduction from these option exercises was $177,000 and $306,000,
respectively. During the nine months ended September 30, 2005, options to
purchase 123,000 shares of common stock with an aggregate exercise price of
$1,238,000 were exercised by option holders.
There were no options granted during the nine months ended September 30, 2006.
There were 25,000 options granted during the nine months ended September 30,
2005.
5. INCOME TAX
The following is a reconciliation of income tax expense from continuing
operations at the applicable federal statutory rate and the effective rates:
Nine Months
Ended
September 30,
-------------
2006 2005
---- ----
Statutory rate 34% 34%
Tax rate differential on extraterritorial
income exclusion benefit earnings (1) (1)
Tax rate differential on domestic
manufacturing deduction (1) (1)
International rate differences (1) 1
State income taxes, net of federal income
tax benefit 3 4
Research and development credits (5) (6)
Foreign tax credit -- (9)
Other 1 (1)
--- ---
30% 21%
=== ===
8
During the nine months ended September 30, 2006, the Company recorded additional
benefits from research and development tax credits of $365,000. As of September
30, 2006, the Company's gross research and development tax credit carryforwards
totaled approximately $2,193,000. Of these credits, approximately $1,718,000 can
be carried forward for fifteen years and will expire between 2013 and 2021, and
approximately $475,000 can be carried forward indefinitely.
As of September 30, 2006, the Company's gross foreign tax credits totaled
approximately $1,531,000. These credits can be carried forward for ten years and
will expire between 2009 and 2016.
6. RECENT AND PROPOSED ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board (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
adopted SFAS 151, and it did not have an impact on its financial position and
results of operations.
In December 2004, the FASB issued SFAS 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 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 adopted SFAS 153
and it did not have an impact on its financial position and results of
operations.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"), which replaces APB Opinion No. 20, "Accounting
Changes," and SFAS No. 3 "Reporting Accounting Changes in Interim Financial
Statements." 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
9
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 provisions of any existing pronouncements. The Company
adopted SFAS 154 and it did not have an impact on its financial position and
results of operations. The Statement will have an impact in the future only if
the Company has any changes or corrections of errors.
In June 2006, the FASB issued Interpretation (FIN) 48, "Accounting for
Uncertainty in Income Taxes." FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise's financial statements in accordance
with SFAS 109, "Accounting for Income Taxes" ("SFAS 109"). This Interpretation
defines the minimum recognition threshold a tax position is required to meet
before being recognized in the financial statements. FIN 48 is effective for
fiscal years beginning after December 15, 2006. The Company is currently
evaluating the effect that the adoption of FIN 48 will have on its financial
position and results of operations.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) Topic 1N, "Financial Statements - Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements" ("SAB 108"). The SEC staff has provided guidance on
how prior year misstatements should be taken into consideration when quantifying
misstatements in current year financial statements for purposes of determining
whether the current year's financial statements are materially misstated. The
SEC staff indicated that "registrants must quantify the impact of correcting all
misstatements, including both the carryover and reversing effects of prior year
misstatements, on the current year financial statements." If correcting a
misstatement in the current year would materially misstate the current year's
income statement, the SEC staff indicated that the prior year financial
statements should be adjusted. These adjustments to prior year financial
statements are necessary even though such adjustments were appropriately viewed
as immaterial in the prior year. If the Company determines that an adjustment to
prior year financial statements is required upon adoption of SAB 108 and does
not elect to restate its previous financial statements, then it must recognize
the cumulative effect of applying SAB 108 in fiscal 2007 beginning balances of
the affected assets and liabilities with a corresponding adjustment to the
fiscal 2007 opening balance in retained earnings. Early application of the
guidance in Topic 1N is encouraged by the SEC staff in any report for an interim
period of the fiscal year ending after November 15, 2006. The Company is
currently evaluating the impact of the guidance on its current and prior year
financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles and expands disclosures
about fair value measurements. The statement does not require new fair value
measurements, but is applied to the extent that other accounting pronouncements
require or permit fair value measurements. The statement emphasizes that fair
value is a market-based measurement that should be determined based on the
assumptions that market participants would use in pricing an asset or liability.
Companies will be required to disclose the extent to which fair value is used to
measure assets and liabilities, the inputs used to develop the measurements, and
the effect of certain of the measurements on earnings (or changes in net assets)
for the period. SFAS 157 is effective for fiscal years
10
beginning after November 15, 2007. The Company is currently evaluating the
effect that the adoption of SFAS 157 will have on its financial position and
results of operations.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - and amendment of FASB
Statements No. 87, 88, 106 and 132R," ("SFAS 158") which requires an employer to
recognize the over-funded or under-funded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income of a
business entity or changes in unrestricted net assets of a not-for-profit
organization. SFAS 158 also requires an employer to measure the funded status of
a plan as of the date of its year-end statement of financial position, with
limited exceptions. This statement is effective for fiscal years ending after
December 15, 2006. The Company does not currently provide for a defined benefit
pension but does have supplemental retirement agreements with certain active and
retired directors, officers and key employees. The Company is currently
evaluating the effect that adoption of SFAS 158 will have on its financial
position and results of operations.
7. GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets consist of the following:
September 30, 2006 December 31, 2005
-------------------------------------- --------------------------------------
Accumulated Accumulated
Gross Value Amortization Net Value Gross Value Amortization Net Value
----------- ------------ --------- ----------- ------------ ---------
(in thousands)
Goodwill $13,759 $ 0 $13,759 $10,303 $ 0 $10,303
------- ---- ------- ------- ---- -------
Other intangible assets:
Customer relationships 1,100 -- 1,100 -- -- --
Patents 1,219 776 443 919 723 196
Trademarks 872 -- 872 572 -- 572
Developed technology 600 -- 600 -- -- --
Licensing fees 355 80 275 355 53 302
Covenant-not-to-compete 100 -- 100 -- -- --
Other 51 40 11 51 36 15
------- ---- ------- ------- ---- -------
Total other intangible assets 4,297 896 3,401 1,897 812 1,085
------- ---- ------- ------- ---- -------
$18,056 $896 $17,160 $12,200 $812 $11,388
======= ==== ======= ======= ==== =======
The other intangible assets that have definite lives are all amortizable and
have original estimated useful lives as follows: customer relationships are
amortized over approximately six years; patents are amortized over approximately
13 years, seven years or five years; developed technology is amortized over
approximately five years; licensing fees over approximately 10 years;
covenants-not-to-compete are amortized over approximately one and two-thirds
years; and trademarks are not amortized. Amortization expense for intangible
assets for each of the three-month periods ended September 30, 2006 and
September 30, 2005 was $28,000. Amortization expense for intangible assets for
each of the nine-month periods ended September 30, 2006 and September 30, 2005
was $83,000 and $84,000, respectively. Amortization expense for intangible
assets subject to amortization in each of the next five fiscal years is
estimated to be: $214,000 for the fiscal year ending 2006, $522,000 in the
second year, $442,000 in the third
11
year, and $390,000 in each of the fourth and fifth years. Intangible assets
subject to amortization have a weighted average life of approximately seven
years.
During the nine-months ended September 30, 2006, the Company recorded goodwill
related to the acquisition of Ault Incorporated ("Ault") in the amount of
$3,456,000 (see Note 11). The change in the carrying amount of goodwill (in
thousands) for the quarter ended September 30, 2006 is as follows:
Balance as of June 30, 2006 $ 5,687
Property and equipment (334)
Intangible assets (2,400)
Deferred tax assets 491
Acquisition costs 12
-------
Balance as of September 30, 2006 $ 3,456
=======
The Company reduced goodwill during the period due to the allocation of the
purchase price to certain other intangible assets of $2,400,000 and adjusting
property and equipment to fair market value by $334,000. The Company increased
goodwill by $491,000 due to a reduction in deferred tax assets related to
acquired net operating loss carryforwards.
8. DEBT
Debt consists of the following:
September 30, December 31,
2006 2005
------------- ------------
(in thousands)
Prime rate loan $3,653 $ 0
LIBOR rate loan 5,800 --
------ ---
9,453 --
Less current portion -- --
------ ---
Total long-term debt $9,453 $ 0
====== ===
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"). 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, 2006, the Company
had outstanding balances under its Revolving Credit Facility of $3,653,000 at
the Bank of America prime rate and $5,800,000 under the LIBOR rate.
12
9. ACCRUED LIABILITIES - OTHER
Accrued liabilities - other consist of the following:
September 30, December 31,
2006 2005
------------- ------------
(in thousands)
Taxes (other than income) and insurance $ 559 $ 483
Commissions 815 451
Accrued litigation and legal fees 475 558
Other professional fees 482 484
Environmental 1,195 1,220
Warranty 1,042 851
Deferred revenue/customer advance 752 --
Other 1,524 973
Reclassified to long-term liabilities (927) (927)
------ ------
$5,917 $4,093
====== ======
Included in the category, "Other," above as of September 30, 2006, are accrued
liabilities of $316,000 assumed in the Ault acquisition.
The Company's warranty reserve, which is included in "Accrued Liabilities -
Other" above, for the period ended September 30, 2006, is as follows:
September 30,
2006
--------------
(in thousands)
Liability, beginning of year $ 851
Acquired liability 181
Expense for new warranties issued 206
Expense related to accrual revisions
for prior year 114
Warranty claims (310)
------
Liability, end of period $1,042
======
10. 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.
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
13
the case may be, will have a material adverse impact on its consolidated
financial position or results of operations of the Company.
On June 12, 2002, the Company and its wholly owned subsidiary, SL Surface
Technologies, Inc. ("SurfTech"), were served with a class action complaint by
twelve individual plaintiffs (the "Complaint") filed in Superior Court of New
Jersey for Camden County (the "Private Action"). (Substantially all of the
operating assets of SurfTech were sold in November 2003). The Company and
SurfTech are currently two of approximately 39 defendants named in the Private
Action. The Complaint alleges, among other things, that the plaintiffs may
suffer personal injuries as a result of consuming water distributed from the
Puchack Wellfield located in Pennsauken Township, New Jersey (which supplied
Camden, New Jersey).
The Private Action arises from similar factual circumstances as current
environmental litigation and administrative actions involving the Pennsauken
Landfill and Puchack Wellfield, with respect to which the Company has been
identified as a potentially responsible party. These actions are discussed
below. These actions and the Private Action both allege that SurfTech and other
defendants contaminated ground water through the disposal of hazardous
substances at facilities in the area. SurfTech once operated a chrome-plating
facility in Pennsauken Township, New Jersey (the "SurfTech Site").
On June 30, 2006, the Superior Court denied class certification in the Private
Action and the plaintiffs have not appealed this decision. With the denial of a
class certification, the Private Action is proceeding as twelve individual
claims. The Company believes it has significant defenses against the plaintiffs'
claims and intends to pursue them vigorously. Technical data has not established
that offsite migration of hazardous substances from the SurfTech Site have
contributed to the contamination of the Puchack Wellfield. 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 a strong defense
against the claims alleged in the Private Action, as well as the environmental
litigation and administrative actions discussed below.
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 $1,195,000. 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
14
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 results of operations. Most 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 lawsuits and administrative actions
relating to environmental issues concerning the Pennsauken Landfill and the
Puchack Wellfield in connection with the SurfTech Site. The New Jersey
Department of Environmental Protection (the "NJDEP") served a directive in
connection with the SurfTech Site that would subject the Company to, among other
things, $9,266,000 in collective reimbursements (with other parties). On July
26, 2006, the United States Environmental Protection Agency (the "EPA") held a
public meeting to present its analysis for the remediation of the Puchack
Wellfield, which the EPA designated a Superfund Site and proposed a remediation
plan with an estimated cost of approximately $17 million. The EPA named the
Company as a potential responsible party. Notwithstanding the assertions of the
EPA, technical data has not established that offsite migration of hazardous
substances from the SurfTech Site contributed to the contamination of the
Puchack Wellfield. 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 neither probable nor reasonably estimable at
this time.
The Company has reported a ground water contamination plume on its property
located in the City of Camden, New Jersey (the "Camden Site"). In February 2006,
the Company submitted to the NJDEP a plan to certify the potential areas of
concern for the Camden Site, which is currently under review. Based on the
information so far, the Company believes that the cost to remediate the Camden
Site should not exceed approximately $560,000, which has been fully reserved.
These costs have been recorded as a component of discontinued operations in
previous years.
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 $195,000 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 $821,000, as payment
of their contingent commitments through 2006, which have been recorded as
income, net of tax, in discontinued operations.
15
As of September 30, 2006 and December 31, 2005, the Company has accrued
$1,195,000 and $1,220,000, respectively, for known costs believed to be probable
related to environmental matters, which have been included in "Accrued
Liabilities - Other" (Note 9).
NOTE 11. ACQUISITION
On January 26, 2006, the Company, through a wholly owned subsidiary, acquired
approximately 86.9% of the outstanding common stock of Ault at $2.90 per share.
The Company had previously purchased in the open market approximately 4.8% of
the outstanding common stock of Ault for an average price of $2.39 per share.
Immediately after acquiring the Ault shares, the Company's wholly owned
subsidiary was merged with and into Ault. As a result, Ault became a wholly
owned subsidiary of the Company, and the shares not tendered were converted into
the right to receive $2.90 per share in cash, without interest. The total
purchase price for the common stock of Ault was approximately $13,986,000, which
includes the shares already owned by the Company. The Company also paid
approximately $2,079,000, including interest, to acquire all of the outstanding
shares of Ault's preferred stock and incurred additional acquisition related
costs of $2,589,000 primarily related to legal and investment banking fees, due
diligence expenses and the payment of certain pre-acquisition contingencies. The
source of funds for the acquisition was a combination of the Company's available
cash and borrowings of approximately $5,900,000 from its Revolving Credit
Facility.
Ault is headquartered in Minneapolis, Minnesota and has an engineering and sales
office in Norwood, Massachusetts, and engineering, sales and manufacturing
facilities in the People's Republic of China. Ault's operating results are
reported in the segment SLPE (Note 12) from the date of acquisition.
The following table summarizes the estimated fair value of the net assets
acquired. A third party appraiser was used to value certain tangible and
intangible assets. The purchase price (in thousands) of the Ault acquisition was
allocated as follows:
Accounts receivable, net $ 6,243
Inventory, net 3,871
Note receivable - short term 1,125
Other current assets 785
Deferred income taxes, net 4,168
Plant and equipment, net 2,657
Goodwill 3,456
Intangible assets 2,400
Note receivable - long term 563
Other assets 111
Accounts payable (6,977)
Accrued compensation (659)
Other current liabilities (564)
-------
Total purchase price, net of cash acquired $17,179
Acquisition costs incurred in 2005 (1,034)
-------
Acquisition costs for the nine months
ended September 30, 2006 $16,145
-------
Of the $2,400,000 of intangible assets, $1,100,000 was allocated to customer
relationships, $600,000 was allocated to developed technology and $700,000 to
other intangibles. The
16
Company estimates the amortization period for the customer relationships and the
developed technology to be six years and five years, respectively. The
amortization period for the other intangible assets that are subject to
amortization range from approximately one and two-thirds years to seven years.
12. SEGMENT INFORMATION
The Company currently operates under four business segments: SL Power
Electronics Corp., Teal Electronics Corp. ("Teal"), SL Montevideo Technology,
Inc. ("SL-MTI") and RFL Electronics Inc. ("RFL"). The Company acquired Ault on
January 26, 2006. In the period following the acquisition, the Company
consolidated the operations of Ault and its subsidiary, Condor D.C. Power
Supplies, Inc. ("Condor"), into one business segment in accordance with the
guidance provided in SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information." This segment is presented as SL Power Electronics
Corp. ("SLPE"). Management has combined SLPE and Teal into one business unit
classified as the Power Electronics Group.
SLPE produces a wide range of standard and custom internal and external 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. SLPE is a major supplier to the original
equipment manufacturers of medical, wireless and wire line communications
infrastructure, computer peripherals, handheld devices, and industrial
equipment. Teal is a leader in the design and manufacture of custom power
conditioning and power distribution units. Teal products are developed and
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 communication and power
protection 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 of its products. The
Other segment includes corporate related items, financing activities and other
costs not allocated to reportable segments, which includes but is 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 the nine-month
periods ended September 30, 2006 and September 30, 2005 are as follows:
17
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2006 2005* 2006 2005*
------- ------- -------- -------
(in thousands)
NET SALES
Power Electronics Group:
SLPE $23,903 $10,617 $ 65,065 $33,001
Teal 9,184 8,840 26,976 24,077
------- ------- -------- -------
Total 33,087 19,457 92,041 57,078
------- ------- -------- -------
SL-MTI 6,137 7,440 18,825 21,120
RFL 5,941 5,201 16,698 17,615
------- ------- -------- -------
Consolidated $45,165 $32,098 $127,564 $95,813
======= ======= ======== =======
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2006 2005* 2006 2005*
------- ------- -------- -------
(in thousands)
INCOME FROM OPERATIONS
Power Electronics Group:
SLPE $ 2,289 $ 832 $ 5,631 $ 3,260
Teal 1,265 1,590 4,100 3,725
------- ------ ------- -------
Total 3,554 2,422 9,731 6,985
------- ------ ------- -------
SL-MTI 317 1,117 818 2,941
RFL 707 546 1,417 1,862
Other (1,796) (743) (4,150) (3,619)
------- ------ ------- -------
Consolidated $ 2,782 $3,342 $ 7,816 $ 8,169
======= ====== ======= =======
* SLPE does not include the net sales and income from the operations of Ault
for 2005. The Power Electronics Group and SLPE do include net sales and
income from operations of Ault from the acquisition date, January 26, 2006
to September 30, 2006 (see Note 11).
September 30, December 31,
2006 2005*
------------- ------------
(in thousands)
TOTAL ASSETS
Power Electronics Group:
SLPE $46,662 $13,330
Teal 13,712 12,574
------- -------
Total $60,374 $25,904
------- -------
SL-MTI 13,001 12,495
RFL 16,367 15,825
Other 4,894 16,090
------- -------
Consolidated $94,636 $70,314
======= =======
18
September 30, December 31,
2006 2005*
------------- ------------
(in thousands)
INTANGIBLE ASSETS, NET
Power Electronics Group:
SLPE $ 5,856 $ 0
Teal 5,769 5,822
------- -------
Total $11,625 $ 5,822
------- -------
SL-MTI 11 15
RFL 5,524 5,551
------- -------
Consolidated $17,160 $11,388
======= =======
* The Power Electronics Group and SLPE do not include the total assets and
intangible assets of Ault for December 31, 2005.
13. RETIREMENT PLANS AND DEFERRED COMPENSATION
The Company maintains four noncontributory, defined contribution pension plans
covering all of its full-time, U.S. 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, Ault, 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 $701,000 and $763,000 during the nine-month
periods ended September 30, 2006 and September 30, 2005, 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 $307,000 and $263,000 for
the nine-month periods ended September 30, 2006 and September 30, 2005,
respectively.
14. 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 Glen Kassan, the Company's Vice
Chairman, as well as other assistance provided by SPL from time to time. Until
August 10, 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, 2006, the Company expensed
$356,000 for SPL services. Of this amount, $40,000 remained payable at September
30, 2006. The Company expensed $356,000 for services performed for the
nine-month period ended September 30, 2005.
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
19
Communications for each of the nine-month periods ended September 30, 2006 and
September 30, 2005 were $642,000 and $771,000, respectively. Accounts receivable
due from RFL Communications at September 30, 2006 were $166,000.
NOTE 15. SUBSEQUENT EVENTS
On October 31, 2006, the Company completed the acquisition of MTE Corporation
("MTE"), an electromagnetic products manufacturer, for $15,503,000. The
acquisition was financed under the Company's Revolving Credit Facility. MTE
designs and manufactures power quality electromagnetic products used to protect
equipment from power surges, bring harmonics into compliance and improve the
efficiency of variable speed motor drives. MTE's product lines include:
three-phase AC reactors, DC link chokes and a series of harmonic, RFI/EMI and
motor protection filters. These products are typically used in industrial plants
and commercial buildings where non-linear loads and attendant harmonics produced
by these loads are present. MTE employs approximately 90 people and has
corporate headquarters and manufacturing in two leased facilities in Milwaukee,
Wisconsin. It also manufactures subassemblies through a contract manufacturer in
Juarez, Mexico. The purchase price will be allocated to the underlying assets
and liabilities based on their estimated fair values, pending the results of
appraisals and further financial analysis. For the nine months ended September
30, 2006, MTE recorded net sales of $12,536,000 (unaudited) and income from
operations of $1,931,000 (unaudited).
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 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, three of which have significant
manufacturing operations in Mexico. With the acquisition of Ault on January 26,
2006, the Company added manufacturing, engineering and sales capability in the
People's Republic of China. 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 through the penetration of attractive new market
niches, 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.
20
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 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 and in certain instances, Emerging Issues
Task Force ("EITF") Issue No. 00-21 "Revenue Arrangements with Multiple
Deliverables." 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
21
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 SFAS No. 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
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, 2006 and
December 31, 2005, the Company had recorded total valuation allowances of
$3,814,000 and $3,572,000, 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, 2006 and December 31, 2005 were
$10,293,000 and $5,980,000, respectively, net of valuation allowances of
$3,814,000 and $3,572,000, 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 to utilize these assets. 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.
In accordance with SFAS 109 and SFAS No. 141, as of the date of acquisition of
Ault, the Company has recorded, separate from goodwill, the deferred taxes
related to Ault's federal and state net operating loss carryforwards. At the
date of acquisition, Ault's net operating loss carryforwards were $8,783,000.
The Company believes that these deferred tax assets will more likely than not be
realized.
22
The Company has made a provision for U.S. and state income taxes for the
anticipated repatriation of the profits of its Mexican subsidiaries. The Company
considers the undistributed earnings of its Chinese subsidiaries to be
permanently reinvested. As of September 30, 2006, $422,000 of such undistributed
earnings were expected to be permanently reinvested.
LEGAL CONTINGENCIES
The Company is currently involved in certain legal proceedings. As discussed in
Note 10 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.
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. SFAS No. 142 "Goodwill and Other
Intangible Assets" 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, Mexican and Chinese 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
23
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 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,
2006 2005 $ Variance % Variance
------------- ------------ ---------- ----------
(in thousands)
Cash and cash equivalents $ 0 $ 9,985 ($9,985) (100%)
Bank debt $ 9,453 $ 0 $ 9,453 100%
Working capital (less cash) $28,197 $15,822 $ 12,375 78%
Shareholders' equity $51,880 $46,645 $ 5,235 11%
During the nine-month period ended September 30, 2006, the net cash used in
continuing operations was $485,000, as compared to net cash provided from
continuing operations of $6,901,000 during the nine-month period ended September
30, 2005. The primary sources of cash from operating activities for the
nine-month period ended September 30, 2006 were income from continuing
operations of $5,146,000, increased accrued income taxes of $1,266,000 and
decreased deferred income tax assets of $474,000. These sources of cash were
offset by accounts receivable increases of $4,913,000, primarily due to
increases at SLPE of $5,494,000 from increased sales related to the Ault
acquisition and slower collections. Teal's receivables increased by $503,000 due
to the higher sales and RFL's receivables increased by $347,000 due to the
volume of shipments made late in the third quarter. SL-MTI had a decrease in
receivables of $418,000 over the nine-month period ended September 30, 2006. The
Company also recorded an aggregate increase in inventory of $3,797,000 over the
nine-month period ended September 30, 2006. SLPE's inventory level increased
$2,036,000, which was caused by an increase in current period bookings and a
shift in existing orders. Teal's inventory increased by $573,000, primarily due
to its relatively high backlog and the deferral of a customer order. SL-MTI's
24
inventory level increased by $801,000, primarily due to a customer deferral of a
large order and, to a lesser extent, a customer redesign of a product. RFL's
inventory increased $409,000, primarily due to purchases of materials in bulk to
achieve volume discounts. During the nine-month period ended September 30, 2005,
the net cash provided by operating activities from continuing operations was
$6,901,000. 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 was 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 SL-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 was primarily related to payments made
by the Company to settle certain litigation, fees and claims, which the Company
had accrued at December 31, 2004.
During the nine-month period ended September 30, 2006, net cash used in
investing activities was $18,938,000. The primary uses of cash in investing
activities during the period were related to the purchase of Ault on January 26,
2006 in the amount of $16,145,000, net of cash acquired (cash in the amount of
$1,034,000 was used in 2005 (see Note 11)). In addition, the Company purchased
machinery and equipment and made leasehold improvements in the amount of
$2,798,000. 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 with respect to the Ault acquisition and the purchase of
machinery and equipment in the amount of $1,186,000.
During the nine-month period ended September 30, 2006, net cash provided by
financing activities was $10,044,000. This source of cash was principally
related to proceeds from the Revolving Credit Facility in the amount of
$9,453,000. Of this amount, approximately $5,900,000 was used in the acquisition
of Ault. Also, $810,000 was received as proceeds from the exercise of stock
options. 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 to reduce the Company's bank debt in the amount of $2,015,000,
partially offset by the proceeds from the exercise of stock options of
$1,511,000.
The Company's current ratio was 1.97 to 1 at September 30, 2006 and 2.40 to 1 at
December 31, 2005. The current ratio changed primarily due to a reduction in
cash and cash equivalents of $9,985,000. Current assets increased by $12,984,000
from December 31, 2005, while current liabilities increased by $10,594,000
during the same period. The increase in current liabilities is primarily related
to the acquisition of Ault.
As a percentage of total capitalization, consisting of debt and shareholders'
equity, total borrowings by the Company were 15% at September 30, 2006 and 0% at
December 31, 2005. During the first nine months of 2006, total debt increased by
$9,453,000.
Capital expenditures of $2,798,000 were made during the first nine months of
2006. SLPE spent approximately $1,200,000 on facility costs related to its move
of its corporate office. Other expenditures primarily related to computer
equipment and factory machinery and equipment. Capital expenditures for the
period represent a $1,612,000 increase from the comparable period in 2005.
25
During the first nine months of 2006, the Company, through a combination of
available cash and borrowings available under the Revolving Credit Facility, was
able to obtain adequate amounts of cash to meet its operating needs, purchase
Ault for $16,145,000 (see Note 11), incur capital expenditures in the amount of
$2,798,000 and fund its inventory levels. All of the Company's operating
segments had income from operations for the nine months ended September 30,
2006.
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, working capital requirements and strategic objectives.
CONTRACTUAL OBLIGATIONS
The following is a summary of the Company's contractual obligations that existed
as of September 30, 2006:
Less Than 1 to 3 4 to 5 After
1 Year Years Years 5 Years Total
--------- ------- ------ ------- -------
(in thousands)
Operating Leases $1,778 $ 1,864 $817 $ 0 $ 4,459
Debt -- 9,453 -- -- 9,453
Capital Leases 24 -- -- -- 24
Other Obligations 54 183 143 108 488
------ ------- ---- ---- -------
$1,856 $11,500 $960 $108 $14,424
====== ======= ==== ==== =======
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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2006, COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2005
The table below shows the comparison of net sales for the quarter ended
September 30, 2006 ("2006") and the quarter ended September 30, 2005 ("2005"):
26
Three Months Three Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Quarter Same Quarter
2006 2005 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
Power Electronics Group:
SLPE $23,903 $10,617 $13,286 125%
Teal 9,184 8,840 344 4%
------- ------- ------- ---
Total 33,087 19,457 13,630 70%
------- ------- ------- ---
SL-MTI 6,137 7,440 (1,303) (18%)
RFL 5,941 5,201 740 14%
------- ------- ------- ---
Total $45,165 $32,098 $13,067 41%
======= ======= ======= ===
The table below shows the comparison of income from operations for 2006 and
2005:
Three Months Three Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Quarter Same Quarter
2006 2005 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
Power Electronics Group:
SLPE $ 2,289 $ 832 $ 1,457 175%
Teal 1,265 1,590 (325) (20%)
------- ------ ----- ----
Total 3,554 2,422 1,132 47%
------- ------ ----- ----
SL-MTI 317 1,117 (800) (72%)
RFL 707 546 161 29%
Other (1,796) (743) (1,053) (142%)
------- ------ ----- ----
Total $ 2,782 $3,342 ($560) (17%)
======= ====== ===== ====
Consolidated net sales for 2006 increased by $13,067,000, or 41%, compared to
the same period in 2005. On a comparative basis, without the sales of Ault,
consolidated sales decreased by $676,000, or 2%. RFL and Teal experienced
increases in sales of $740,000, or 14%, and $344,000, or 4%, respectively.
SL-MTI experienced a decline in sales of 18%, which is discussed more fully
below.
The Company had income from operations of $2,782,000 for the three-month period
ended September 30, 2006, as compared to income from operations of $3,342,000
for the corresponding period last year, a decrease of $560,000, or 17%.
Income from continuing operations was $1,806,000, or $0.31 per diluted share, in
the third quarter of 2006, compared to $2,552,000, or $0.44 per diluted share,
for the same period in 2005. 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 now comprised of SLPE (a combination of
Condor and Ault) and Teal, recorded a sales increase of $13,630,000, or 70%,
when comparing the third quarter of 2006 to the third quarter of 2005. Without
the Ault acquisition, sales would have decreased by $113,000. Income from
operations increased by $1,132,000, or 47%, due primarily
27
to the Ault acquisition. As a percentage of revenue, income from operations for
SLPE was 10% in 2006, compared to 8% in 2005. Teal experienced a sales increase
of $344,000, or 4%, and a decrease in income from operations of $325,000, or
20%. Teal's sales increase was primarily due to increased business activity in
the semiconductor market, partially offset by decreased demand from its medical
imaging equipment manufacturers. Teal's income from operations decreased by
$325,000, or 20%, primarily due to higher raw material costs. In addition, Teal
recorded an increase in selling, general and administrative costs principally
due to higher stock-based compensation expense.
SL-MTI's sales decreased $1,303,000, or 18%, while income from operations
decreased $800,000, or 72%, when comparing the third quarter of 2006 to the
third quarter of 2005. The sales decrease was driven by a $1,594,000, or 33%,
decrease to customers in the military/aerospace industry. Commercial aerospace
sales increased by $448,000, or 25%, over the comparable periods. The decrease
in income from operations is primarily due to lower sales of high-volume
programs, which decreased factory productivity and increased severance costs.
Engineering and product development expenses increased slightly in 2006, due to
an increase in ongoing development programs and a decrease in customer funded
programs. SL-MTI reduced its selling, general and administrative expenses by 12%
over the comparable periods.
RFL's sales increased by $740,000, or 14%, in the third quarter of 2006,
compared to the third quarter of 2005. Income from operations increased by
$161,000, or 29%, for the comparable periods. Sales of RFL's carrier
communications product line increased by $1,673,000, or 97%, while sales of
protection products decreased by $454,000, or 18%, for the comparable periods.
RFL's other product lines decreased by $479,000. The sales increase was
primarily driven by the sales of a new product and sales to an international
customer. Domestic sales increased by $128,000, or 3%, while international sales
increased by $612,000, or 85%. The increase in income from operations is
primarily related to increased volume, partially offset by increased costs of
products sold and selling, general and administrative expenses.
COST OF PRODUCTS SOLD
As a percentage of net sales, cost of products sold for the third quarter of
2006 and for the third quarter of 2005 were approximately 68% and 65%,
respectively. Without the Ault operations, the comparable percentages were at
69% and 65%, respectively. SLPE's cost of products sold percentage increased to
69% from 65%, primarily as a result of the Ault acquisition and higher product
costs. Teal's cost of products sold percentage increased by approximately 3%,
primarily due to increases in raw material prices. Copper prices increased by
approximately 5% in the three months ended September 30, 2006 and by
approximately 75% year-to-date. In an effort to improve its labor costs and to
offset higher material costs, Teal has transferred manufacturing of
approximately 44% of its products to operations in Tecate, Mexico. In the third
quarter of 2006, SL-MTI experienced an increase in its cost of products sold, as
a percentage of net sales, to 78%, compared to 71% in the same period last year.
This increase was primarily due to lower plant productivity and higher overhead
and severance costs, which resulted in less absorption of fixed overhead. To a
lesser extent, SL-MTI incurred additional training costs and operational
inefficiencies related to the transfer of new lower volume programs to its
manufacturing facility in Matamoros, Mexico. RFL's cost of products sold, as a
percentage of sales, increased by approximately 2% due to product mix.
28
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES
Engineering and product development expenses for the third quarter of 2006
remained at approximately 7% of net sales. Engineering and product development
expenses in 2006 increased by $623,000, or 27%, of which Ault added $715,000.
SL-MTI recorded an increase of 11%, as ongoing development jobs increased and
customer funded programs decreased, compared to the same period in 2005. RFL
experienced a decrease of $82,000 in 2006 compared to 2005 due to the completion
of a development program related to a new product. The Company's other operating
entities experienced relatively minor decreases.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses, as a percentage of net sales, for
the third quarter of 2006 and for the third quarter of 2005 were 18% and 16%,
respectively. These expenses increased by $2,984,000, or 59%, with Ault
contributing $2,110,000 of the increase. Selling, general and administrative
expenses, without Ault, increased by $874,000, or 17%, for the comparable
periods. Teal's selling, general and administrative expenses increased by 18%
due to a volume increase and an increase in stock based compensation expense.
RFL had an increase of 15% primarily due to an increase in volume. SL-MTI
decreased its expenses by 12%. Corporate and other expenses increased by
$1,053,000, primarily due to a non-cash charge of $741,000 related to certain
stock based compensation arrangements and an increase in litigation fees
incurred during the current quarter.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses remained relatively constant at
approximately 1% of net sales for each of the three-month periods ended
September 30, 2006 and September 30, 2005.
AMORTIZATION OF DEFERRED FINANCING COSTS
In connection with entering into a Revolving Credit Facility on August 3, 2005,
the Company incurred costs of approximately $258,000. These costs have been
deferred and are being amortized over the three-year term of the Revolving
Credit Facility. For the third quarter of 2006, amortization of deferred
financing costs was $22,000, all of which related to the Revolving Credit
Facility. For the third quarter of 2005, amortization of deferred financing
costs was $236,000, which included the write-off of the deferred financing costs
related to the Company's former line of credit and the amortization of the
deferred financing costs related to the Revolving Credit Facility.
INTEREST INCOME (EXPENSE)
Interest income for the third quarter of 2006 was $2,000, compared to $61,000 in
the same period last year. Interest expense was $153,000 for the third quarter
of 2006, compared to $236,000 for the third quarter of 2005. The 2006 expense is
primarily related to debt incurred as a result of the acquisition of Ault.
Interest expense for the third quarter in 2005 includes $185,000 in early
termination fees related to the Company's former line of credit.
TAXES
The effective tax rate for continuing operations for the third quarter of 2006
was approximately 31%. The effective tax rate reflects the statutory rate after
adjustments for state and international tax provisions, and the recording of
benefits primarily related to research and development tax credits. The
effective tax rate for the comparable period in 2005 was approximately 13%. The
effective tax rate reflected the statutory rate after adjustments for state and
international tax
29
provisions, offset by the recording of benefits primarily related to foreign tax
credits and, to a lesser extent, research and development tax credits.
DISCONTINUED OPERATIONS
For the third quarter of 2006, the Company recorded a loss from discontinued
operations, net of tax, of $148,000. For the third quarter of 2005, the Company
recorded a loss from discontinued operations, net of tax, of $98,000. These
amounts represent legal and environmental charges related to discontinued
operations.
NINE MONTHS ENDED SEPTEMBER 30, 2006, COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2005
The table below shows the comparison of net sales for the nine-month periods
ended September 30, 2006 and September 30, 2005. Ault's sales are reflected from
the date of acquisition (January 26, 2006) to September 30, 2006 and are
included as part of the SLPE segment.
Nine Months Nine Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Period Same Period
2006 2005 Last Year Last Year
------------- ------------- ----------- -----------
(in thousands)
Power Electronics Group:
SLPE $ 65,065 $33,001 $32,064 97%
Teal 26,976 24,077 2,899 12%
-------- ------- ------- ---
Total 92,041 57,078 34,963 61%
-------- ------- ------- ---
SL-MTI 18,825 21,120 (2,295) (11%)
RFL 16,698 17,615 (917) (5%)
-------- ------- ------- ---
Total $127,564 $95,813 $31,751 33%
======== ======= ======= ===
The table below shows the comparison of income from operations for the
nine-month periods ended September 30, 2006 and September 30, 2005. Ault's
income from operations is reflected from the date of acquisition to September
30, 2006 and is included in the SLPE segment.
Nine Months Nine Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Period Same Period
2006 2005 Last Year Last Year
------------- ------------- ----------- -----------
(in thousands)
Power Electronics Group:
SLPE $ 5,631 $ 3,260 $ 2,371 73%
Teal 4,100 3,725 375 10%
------- ------- ------- ---
Total 9,731 6,985 2,746 39%
------- ------- ------- ---
SL-MTI 818 2,941 (2,123) (72%)
RFL 1,417 1,862 (445) (24%)
Other (4,150) (3,619) (531) (15%)
------- ------- ------- ---
Total $ 7,816 $ 8,169 ($353) (4%)
======= ======= ======= ===
30
Consolidated net sales for the nine-month period ended September 30, 2006
increased $31,751,000, or 33%, compared to the nine-month period ended September
30, 2005. On a comparative basis, without the sales of Ault, consolidated sales
decreased by $2,921,000, or approximately 3%. In addition to the Ault
acquisition, increased sales at the Power Electronics Group was attributable to
a sales increase at Teal of $2,899,000, or 12%. SL-MTI reported a sales decrease
of $2,295,000, or 11%, for the comparable periods. RFL experienced a sales
decrease of $917,000, or 5%, over the nine-month period, with a $1,481,000
decrease occurring in the first quarter of 2006.
The Company recorded income from operations of $7,816,000 for the nine-month
period ended September 30, 2006, compared to income from operations of
$8,169,000 for the corresponding period last year. This change represents a
decrease of $353,000, or 4%.
Income from continuing operations was $5,146,000, or $0.88 per diluted share, in
the first nine months of 2006, compared to $5,879,000, or $1.03 per diluted
share, for the same period in 2005. Research and development tax credits
benefited income from continuing operations by approximately $365,000, or $0.06
per diluted share, in the nine-month period ended September 30, 2006, and
$447,000, or $0.08 per diluted share, for the same period in 2005. Also income
from continuing operations benefited by approximately $671,000, or $0.12 per
diluted share, in 2005 due to foreign tax credits recorded principally in the
first quarter of 2005. Income from continuing operations decreased by $733,000
in the first nine months of 2006, compared to the same period in 2005, and were
4% of net sales the first nine months of 2006, compared to 6% in the same period
in 2005.
The Power Electronics Group recorded a sales increase of $34,963,000, or 61%,
and an increase in income from operations of $2,746,000, or 39%, when comparing
the first nine months of 2006 to the first nine months of 2005. Within the Power
Electronics Group, net sales increased $34,672,000 due to the Ault acquisition.
In addition, Teal reported a sales increase of $2,899,000, or 12%. SLPE had an
increase in income from operations of $2,371,000, or 73%, while Teal's income
from operations increased by $375,000, or 10%. SLPE's income from operations was
9% of net sales for the first nine months of 2006, compared to 10% of net sales
for the same period in 2005. Teal's sales increase was primarily attributable to
improved business demand in the semiconductor market and increased sales to
medical equipment manufacturers. Teal's increase in income from operations was
attributable to a 12% increase in volume, partially offset by higher selling,
general and administrative costs.
SL-MTI's sales decreased by $2,295,000, or 11%, when comparing the first nine
months of 2006 to the first nine months of 2005. Income from operations
decreased by $2,123,000, or 72%, for the comparable periods. The decrease in
sales was attributable to a $3,359,000, or 24%, decrease to customers in the
defense industry. This decrease was partially offset by an increase of sales
into other markets. Most notably, sales to commercial aerospace customers
increased by $923,000, or 19%, for the comparable periods. The decrease in
income from operations was the result of decreased sales volume, operating
inefficiencies and severance costs. In addition, engineering and product
development expenses increased $267,000, or 16%, in the first nine months of
2006, compared to the same period last year. These increases were mostly offset
by a $262,000, or 15%, decrease of selling, general and administrative costs.
RFL's sales decreased by $917,000, or 5%, in the nine-month period of 2006,
compared to the same period of 2005. The largest decreases in sales were
experienced in customer service
31
revenue, which decreased by approximately $511,000, or 43% and protection
product lines, which decreased $340,000, or 5%. Income from operations decreased
by $445,000, or 24%, for the comparable periods. The decrease in income from
operations was primarily due to lower sales volume, partially offset by
decreases in engineering and product development and decreases in 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, 2006 and September 30, 2005 were approximately 67% and 64%,
respectively. Without the Ault operations, the comparable percentages remained
relatively the same. SLPE's cost of products sold percentage increased to 68%
from 64%, primarily related to lower Condor sales volume and the Ault
acquisition. Teal's cost of products sold percentage remained relatively
constant in the first nine months of 2006, compared to the same period of 2005.
SL-MTI experienced an increase of approximately seven percentage points due to
less absorption of fixed overhead, manufacturing inefficiencies and severance
costs, as previously discussed. RFL's cost of products sold percentage remained
relatively stable in both periods.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES
Engineering and product development expenses for the nine months ended September
30, 2006 and September 30, 2005 remained at approximately 7% of sales.
Engineering and product development expenses increased in the first nine months
of 2006 by $2,076,000, or 29%, of which Ault added $2,015,000. The most
significant increase in engineering and product development costs on a
comparative basis was experienced at SL-MTI, which recorded an increase of
$267,000, or 16%, for reasons previously discussed. RFL's expenses decreased by
7%, due to the higher costs incurred in 2005 related to the development of new
products. Teal's expenses remained relatively constant.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the nine months ended September
30, 2006 were approximately 18% of sales, compared to 19% of sales for the same
period of 2005. These expenses increased by $5,087,000, or 29%, for the
comparable periods. Without the Ault acquisition, these expenses would have
decreased by $745,000 for the comparative periods. All of the operating entities
had decreases in selling, general and administrative expenses except Teal.
Selling, general and administrative expenses at Teal increased 8%, on increased
sales volume of 12%. For the comparable periods, corporate and other expenses
increased by $531,000, or 15%, primarily related to certain stock based
compensation arrangements, which increased by $378,000 and increased
professional fees, which increased by $309,000.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses for the first nine months of each of 2006
and 2005 were approximately 2% of sales.
AMORTIZATION OF DEFERRED FINANCING COSTS
Amortization of deferred financing costs was $66,000 and $460,000 in the first
nine months of 2006 and 2005, respectively. These costs were less than 1% of
sales in each period. The 2005 costs primarily relate to the write-off of
deferred financing costs related to the senior credit facility, which was
terminated on August 2, 2005.
32
INTEREST INCOME (EXPENSE)
Interest income for the nine months ended September 30, 2006 decreased by
$98,000, as compared to the same period last year. At September 30, 2005, the
Company had $6,696,000 in cash and cash equivalents. Interest expense for the
first nine months of 2006 increased by $67,000, as compared to the same period
last year. Increased interest expense was due to higher debt levels and
increased interest rates.
TAXES
The effective tax rate for the nine months ended September 30, 2006 was
approximately 30%, compared to 21% for the nine months ended September 30, 2005.
The effective tax rate for both periods reflects the statutory rate after
adjustments for state and international tax provisions, offset by the recording
of certain income exclusion benefits from research and development tax credits
of 5% in 2006 and 6% in 2005. 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, 2006, the Company recorded a loss from
discontinued operations, net of tax, of $445,000. For the nine months ended
September 30, 2005, the Company recorded a loss from discontinued operations,
net of tax, of $398,000. These amounts consisted primarily of the cost of
environmental and legal charges, net of tax, 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.
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
33
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, 2005,
Part I, Item 1A - 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, 2005, 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 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
34
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Please see Note 13 to the Consolidated Financial Statements and the Company's
Annual Report on Form 10-K for the twelve months ended December 31, 2005, which
is incorporated by reference.
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, 2006 and
September 30, 2005, the Company did not purchase any shares pursuant to the
repurchase program; however, it did purchase 43,600 and 21,700 shares,
respectively, through its deferred compensation plans during these periods.
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 2006 -- -- -- 48,024
February 2006 -- -- -- 48,024
March 2006 6,200(1) $15.06 -- 48,024
April 2006 8,800(1) $16.47 -- 48,024
May 2006 12,000(1) $17.00 -- 48,024
June 2006 3,900(1) $17.00 -- 48,024
July 2006 1,500(1) $16.10 -- 48,024
August 2006 3,800(1) $17.09 -- 48,024
September 2006 7,400(1) $18.08 -- 48,024
------ ------ ---
Total 43,600 $16.78 --
====== ====== ===
1. The Company purchased these shares other than through a publicly announced
plan or program in open market transactions or in negotiated transactions.
35
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 first nine months of 2006 by
its Audit Committee to be performed by Grant Thornton, the Company's external
auditor. During the first nine months of 2006, there were $33,900 of non-audit
services performed by Grant Thornton.
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).
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).
36
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, 2006 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)
37