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, 2007
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 Identification No.)
incorporation or organization)
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 7, 2007
was 5,842,167.
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2007 (Unaudited) and December 31, 2006................... 1
Consolidated Statements of Income and Comprehensive Income
Three Months Ended September 30, 2007 and 2006 (Unaudited)
and Nine Months Ended September 30, 2007 and 2006 (Unaudited)......... 2
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2007 and 2006 (Unaudited)............. 3
Notes to Consolidated Financial Statements (Unaudited)..................... 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................... 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk................... 35
Item 4. Controls and Procedures...................................................... 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................... 35
Item 1A. Risk Factors ............................................................. 35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............... 35
Item 3. Defaults upon Senior Securities........................................... 36
Item 4. Submission of Matters to a Vote of Security Holders....................... 36
Item 5. Other Information......................................................... 36
Item 6. Exhibits.................................................................. 37
SIGNATURES............................................................................ 38
Item 1. Financial Statements
SL INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2007 2006
---------------- ----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 15,000 $ 757,000
Receivables, net 31,146,000 30,621,000
Note receivable - 563,000
Inventories, net 23,514,000 21,090,000
Prepaid expenses 2,202,000 1,576,000
Deferred income taxes, net 2,140,000 2,190,000
---------------- ----------------
Total current assets 59,017,000 56,797,000
---------------- ----------------
Property, plant and equipment, net 11,097,000 12,132,000
Deferred income taxes, net 6,140,000 6,340,000
Goodwill 21,827,000 22,548,000
Other intangible assets, net 6,998,000 7,472,000
Other assets and deferred charges 1,581,000 1,254,000
---------------- ----------------
Total assets $ 106,660,000 $ 106,543,000
================ ================
LIABILITIES
Current liabilities:
Debt, current portion $ - $ -
Accounts payable 14,727,000 13,902,000
Accrued income taxes 746,000 1,347,000
Accrued liabilities:
Payroll and related costs 8,078,000 6,742,000
Other 6,429,000 7,295,000
---------------- ----------------
Total current liabilities 29,980,000 29,286,000
---------------- ----------------
Debt, less current portion 10,000,000 19,800,000
Deferred compensation and supplemental retirement benefits 2,815,000 2,884,000
Other liabilities 4,125,000 4,154,000
---------------- ----------------
Total liabilities 46,920,000 56,124,000
---------------- ----------------
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 42,801,000 40,889,000
Retained earnings 35,027,000 28,390,000
Accumulated other comprehensive (loss) (15,000) (29,000)
Treasury stock at cost, 2,460,000 and 2,658,000 shares, respectively (19,733,000) (20,491,000)
---------------- ----------------
Total shareholders' equity 59,740,000 50,419,000
---------------- ----------------
Total liabilities and shareholders' equity $ 106,660,000 $ 106,543,000
================ ================
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,
2007 2006 2007 2006
----------------- ----------------- ---------------- ---------------
Net sales $ 50,652,000 $ 45,165,000 $ 151,709,000 $ 127,564,000
Cost and expenses:
Cost of products sold 34,419,000 30,809,000 101,570,000 85,946,000
Engineering and product development 3,193,000 2,917,000 9,606,000 9,147,000
Selling, general and administrative 8,280,000 8,034,000 25,921,000 22,852,000
Depreciation and amortization 876,000 623,000 2,705,000 1,803,000
----------------- ----------------- ---------------- ---------------
Total cost and expenses 46,768,000 42,383,000 139,802,000 119,748,000
----------------- ----------------- ---------------- ---------------
Income from operations 3,884,000 2,782,000 11,907,000 7,816,000
Other income (expense):
Amortization of deferred financing costs (22,000) (22,000) (66,000) (66,000)
Interest income 15,000 2,000 33,000 30,000
Interest expense (130,000) (153,000) (710,000) (452,000)
----------------- ----------------- ---------------- ---------------
Income from continuing operations before income taxes 3,747,000 2,609,000 11,164,000 7,328,000
Income tax provision 1,280,000 803,000 3,423,000 2,182,000
----------------- ----------------- ---------------- ---------------
Income from continuing operations 2,467,000 1,806,000 7,741,000 5,146,000
(Loss) from discontinued operations (net of tax) (316,000) (148,000) (1,104,000) (445,000)
----------------- ----------------- ---------------- ---------------
Net income $ 2,151,000 $ 1,658,000 $ 6,637,000 $ 4,701,000
================= ================= ================ ===============
BASIC NET INCOME (LOSS) PER COMMON SHARE
Income from continuing operations $ 0.43 $ 0.32 $ 1.37 $ 0.91
(Loss) from discontinued operations (net of tax) (0.06) (0.03) (0.19) (0.08)
----------------- ----------------- ---------------- ---------------
Net income $ 0.38* $ 0.29 $ 1.17* $ 0.84*
================= ================= ================ ===============
DILUTED NET INCOME (LOSS) PER COMMON SHARE
Income from continuing operations $ 0.42 $ 0.31 $ 1.33 $ 0.88
(Loss) from discontinued operations (net of tax) (0.05) (0.03) (0.19) (0.08)
----------------- ----------------- ---------------- ---------------
Net income $ 0.36* $ 0.28 $ 1.14 $ 0.81*
================= ================= ================ ===============
Shares used in computing basic net income (loss)
per common share 5,730,000 5,644,000 5,669,000 5,628,000
Shares used in computing diluted net income (loss)
per common share 5,906,000 5,840,000 5,834,000 5,819,000
SL INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2007 2006 2007 2006
---------------- ----------------- ---------------- ----------------
Net income $ 2,151,000 $ 1,658,000 $ 6,637,000 $ 4,701,000
Other comprehensive income (net of tax):
Foreign currency translation (41,000) (44,000) (9,000) (26,000)
Unrealized gain (loss) on securities 112,000 - - (67,000)
---------------- ----------------- ---------------- ----------------
Comprehensive income $ 2,222,000 $ 1,614,000 $ 6,628,000 $ 4,608,000
================ ================= ================ ================
* Earnings per share does not total due to rounding.
See accompanying notes to consolidated financial statements.
2
SL INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
2007 2006
--------------- ----------------
OPERATING ACTIVITIES
Net income $ 6,637,000 $ 4,701,000
Adjustment for losses from discontinued operations 1,104,000 445,000
--------------- ----------------
Income from continuing operations 7,741,000 5,146,000
--------------- ----------------
Adjustments to reconcile income from continuing operations to net cash provided by (used
in)
operating activities:
Depreciation 1,678,000 1,522,000
Amortization 1,027,000 281,000
Amortization of deferred financing costs 66,000 66,000
Non-cash compensation expense 1,015,000 453,000
Stock-based compensation - 49,000
Provisions for losses on accounts receivable 12,000 (138,000)
Deferred compensation and supplemental retirement benefits 328,000 363,000
Deferred compensation and supplemental retirement benefit payments (392,000) (1,226,000)
Deferred income taxes 995,000 474,000
Loss on sale of equipment 32,000 2,000
Changes in operating assets and liabilities, excluding effects of business
acquisition:
Accounts and note receivable 64,000 (4,913,000)
Inventories (2,425,000) (3,797,000)
Prepaid expenses (627,000) (630,000)
Other assets (147,000) 304,000
Accounts payable 826,000 251,000
Accrued liabilities (887,000) 42,000
Accrued income taxes 12,000 1,266,000
--------------- ----------------
Net cash provided by (used in) operating activities from continuing operations 9,318,000 (485,000)
Net cash (used in) operating activities from discontinued operations (1,709,000) (567,000)
--------------- ----------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 7,609,000 (1,052,000)
--------------- ----------------
INVESTING ACTIVITIES
Acquisition of a business, net of cash acquired (65,000) (16,145,000)
Purchases of property, plant and equipment (1,170,000) (2,798,000)
Proceeds from sales of equipment - 5,000
--------------- ----------------
NET CASH (USED IN) INVESTING ACTIVITIES (1,235,000) (18,938,000)
--------------- ----------------
FINANCING ACTIVITIES
Proceeds from Revolving Credit Facility 18,570,000 34,543,000
Payments of Revolving Credit Facility (28,370,000) (25,090,000)
Proceeds from stock options exercised 2,530,000 810,000
Tax benefit from exercise of stock options 551,000 177,000
Treasury stock (purchases) (411,000) (396,000)
--------------- ----------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (7,130,000) 10,044,000
--------------- ----------------
Effect of exchange rate changes on cash 14,000 (39,000)
--------------- ----------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (742,000) (9,985,000)
--------------- ----------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 757,000 9,985,000
--------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 15,000 $ -
=============== ================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 855,000 $ 362,000
Income taxes $ 2,118,000 $ 1,093,000
See accompanying notes to consolidated financial statements.
3
SL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying financial
statements contain all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation. Operating results for interim
periods are not necessarily indicative of the results that may be expected for
the year ending December 31, 2007. 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, 2006.
2. RECEIVABLES
Receivables consist of the following:
September 30, December 31,
2007 2006
-------------- -------------
(in thousands)
-----------------------------
Trade receivables $ 31,829 $ 31,044
Less: allowance for doubtful accounts (842) (830)
-------------- -------------
30,987 30,214
Other 159 407
-------------- -------------
$ 31,146 $ 30,621
============== =============
3. INVENTORIES
Inventories consist of the following:
September 30, December 31,
2007 2006
-------------- -------------
(in thousands)
-----------------------------
Raw materials $ 17,056 $ 15,307
Work in process 4,938 4,213
Finished goods 5,100 4,442
-------------- -------------
27,094 23,962
Less: allowances (3,580) (2,872)
-------------- -------------
$ 23,514 $ 21,090
============== =============
4. INCOME PER SHARE
The Company has presented net income per common share pursuant to the Financial
Accounting Standards Board ("FASB") Statement of Financial Accounting Standard
No. 128, "Earnings per Share." Basic net income per common share is computed by
dividing reported net income
available to common shareholders by the weighted average number of shares
outstanding for the period.
Diluted net income per common share is computed by dividing reported net income
available to common shareholders by the weighted average shares outstanding for
the period, adjusted for the dilutive effect of common stock equivalents, which
consist of stock options, using the treasury stock method.
The table below sets forth the computation of basic and diluted net income per
share:
Three Months Ended September 30,
2007 2006
---------------------------------- -------------------------------
(in thousands, except per share amounts)
-------------------------------------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------------ -------- ----------- ---------- ------- ---------
Basic net income per
common share $ 2,151 5,730 $ 0.38 $ 1,658 5,644 $ 0.29
Effect of dilutive
securities - 176 (0.02) - 196 (0.01)
------------ -------- ----------- ---------- ------- ----------
Diluted net income per
common share $ 2,151 5,906 $ 0.36 $ 1,658 5,840 $ 0.28
============ ======== =========== ========== ======= ==========
Nine Months Ended September 30,
2007 2006
---------------------------------- -------------------------------
(in thousands, except per share amounts)
-------------------------------------------------------------------
Net Per Share Net Per Share
Income Shares Amount Income Shares Amount
------------ -------- ----------- ---------- ------- ----------
Basic net income per
common share $ 6,637 5,669 $ 1.17 $ 4,701 5,628 $ 0.84
Effect of dilutive
securities - 165 (0.03) - 191 (0.03)
------------ -------- ----------- ---------- ------- ----------
Diluted net income per
common share $ 6,637 5,834 $ 1.14 $ 4,701 5,819 $ 0.81
============ ======== =========== ========== ======= ==========
For the nine-month period ended September 30, 2007, no stock options were
excluded from the dilutive computations because there were no option exercise
prices greater than the average market price of the Company's common stock. For
the nine-month period ended September 30, 2006, 12,500 stock options 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
Standard 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
5
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.
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, to a newly retained executive, 25,000 incentive
stock options in accordance with the rules and regulations of the Securities and
Exchange Commission. At December 31, 2006, approximately 12,000 of these options
were vested. These options were forfeited, unexercised, in March 2007.
For the nine months ended September 30, 2007, the Company did not recognize any
stock-based employee compensation expense under the provisions of the SFAS No.
123(R). 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).
Under this 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. Also, the Company has
recognized expenses of approximately $826,000 and $417,000 in the three-month
periods ended September 30, 2007 and September 30, 2006, respectively, and
expenses of approximately $1,015,000 and $453,000 in the nine-month periods
ended September 30, 2007 and September 30, 2006, respectively, in compensation
expense related to certain stock-based compensation arrangements.
6
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, 2006 528 $ 10.30 3.80
Granted - -
Exercised (223) $ 11.37
Forfeited (12) $ 17.01
Expired - -
-------------- ---------------- ---------------- -------------------
Outstanding as of September 30, 2007 293 $ 9.20 3.70 $ 4,017
-------------- ---------------- ---------------- -------------------
Exercisable as of September 30, 2007 293 $ 9.20 3.70 $ 4,017
-------------- ---------------- ---------------- -------------------
During the nine month periods ended September 30, 2007 and September 30, 2006,
the total intrinsic value of options exercised was $1,989,000 and $526,000,
respectively, and the actual tax benefit realized for the tax deduction from
these option exercises was $551,000 and $177,000, respectively. During the nine
months ended September 30, 2007, options to purchase approximately 223,000
shares of common stock with an aggregate exercise price of $2,530,000 were
exercised by option holders. During the nine months ended September 30, 2006,
options to purchase approximately 81,000 shares of common stock with an
aggregate exercise price of $810,000 were exercised by option holders.
There were no options granted during the nine month periods ended September 30,
2007 and September 30, 2006.
5. INCOME TAX
In June 2006, the FASB issued Interpretation 48, "Accounting for Uncertainty in
Income Taxes" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise's financial statements in accordance
with Statement of Financial Accounting Standard No. 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 was effective for fiscal years beginning after
December 15, 2006.
On January 1, 2007, the Company adopted the provisions of FIN 48. At the
adoption date, the Company applied the provisions of FIN 48 to all tax positions
for which the statute of limitations remained open. Any cumulative effect of the
change from this accounting principle was to be recorded in the opening balance
in retained earnings. As a result of the implementation of FIN 48, the Company
did not recognize any change in its unrecognized tax benefits and did not adjust
the January 1, 2007 balance of retained earnings. The amount of unrecognized tax
benefits as of September 30, 2007 was $2,081,000, excluding interest and
penalties. This represents unrecognized tax benefits, which, if ultimately
recognized, will reduce the Company's effective tax rate.
The Company is subject to federal and state income taxes in the United States,
as well as income taxes in certain foreign jurisdictions. Tax regulations within
each jurisdiction are subject to the interpretation of the related tax laws and
regulations and require significant judgment to apply.
7
With few exceptions, the Company is not subject to U.S. federal, state and
local, or non-U.S. income tax examinations by tax authorities for the years
before 2003.
The Company is currently under examination by United States and Chinese taxing
authorities for years subsequent to 2003. The Company expects these examinations
to be concluded and settled within the next twelve months. The Company has
unrecognized benefits of $23,000 for foreign taxes primarily related to
expenses. It is reasonably possible that the resolution of these issues could
result in tax payments of approximately $23,000.
In adopting FIN 48, the Company classifies interest and penalties related to
unrecognized tax benefits as income tax expense. Previously, these items were
classified as interest and income tax expense. At September 30, 2007, the
Company has accrued approximately $169,735 for the payment of interest and
penalties. Due to the recognition of previously unrecognized tax benefits during
the third quarter, the Company reduced the amount of accrued interest and
penalty by $18,000.
The following is a reconciliation of income tax expense (benefit) at the
applicable federal statutory rate and the effective rates from continuing
operations:
Nine Months Ended
September 30,
-----------------
2007 2006
------ --------
Statutory rate 34% 34%
Tax rate differential on extraterritorial
income exclusion benefit earnings - (1)
Tax rate differential on domestic
manufacturing deduction (1) (1)
International rate differences - (1)
State income taxes, net of federal income
tax benefit 4 3
FIN 48 liability (3) -
Research and development credits (3) (5)
Foreign tax credits - -
Other - 1
--- ---
31% 30%
=== ===
During the nine months ended September 30, 2007, the Company recorded additional
benefits from research and development tax credits of $606,000. As of September
30, 2007, the Company's gross research and development tax credit carryforwards
totaled approximately $1,387,000. Of these credits, approximately $1,011,000 can
be carried forward for fifteen years and will expire between 2013 and 2022,
while $376,000 can be carried forward indefinitely.
As of September 30, 2007, the Company's gross foreign tax credits totaled
approximately $1,685,000. These credits can be carried forward for ten years and
will expire between 2009 and 2017.
8
6. RECENT AND PROPOSED ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued Statement of Financial Accounting Standard
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 beginning after November 15,
2007. The Company is evaluating the potential effects that SFAS 157 will have on
the reporting of its financial position, results of operations or debt
covenants.
In February 2007, the FASB issued Statement of Financial Accounting Standard No.
159 "The Fair Value Option for Financial Assets and Financial Liabilities,"
("SFAS 159"). The Statement provides companies an option to report certain
financial assets and liabilities at fair value. The intent of SFAS 159 is to
reduce the complexity in accounting for financial instruments and the volatility
in earnings caused by measuring related assets and liabilities differently. SFAS
159 is effective for financial statements issued for fiscal years after November
15, 2007. The Company is evaluating the impact this new standard will have on
the reporting of its financial position, results of operations or debt
covenants.
In June 2007, the FASB Emerging Issues Task Force ("EITF") published Issue No.
07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services to Be
Used in Future Research and Development Activities." The EITF reached a
consensus that these payments made by an entity to third parties should be
deferred and capitalized. Such amounts should be recognized as an expense as the
related goods are delivered or the related services are performed. Entities
should report the effects of applying this Issue as a change in accounting
principle through a cumulative-effect adjustment to retained earnings as of the
beginning of the year of adoption. EITF Issue No. 07-3 is effective for the
Company beginning on January 1, 2008. Earlier application is not permitted. The
Company does not expect that adoption of this new standard will have a material
affect on the reporting of its financial position or results of operations.
9
7. GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets consist of the following:
September 30, 2007 December 31, 2006
----------------------------------------- --------------------------------------------
Accumulated Accumulated
Gross Value Amortization Net Value Gross Value Amortization Net Value
------------- ------------- ----------- ------------- -------------- -------------
(in thousands)
Goodwill $ 21,827 - $ 21,827 $ 22,548 - $ 22,548
------------- ------------- ----------- ------------- -------------- -------------
Other intangible assets:
Customer relationships 3,700 427 3,273 3,300 45 3,255
Patents 1,219 894 325 1,219 805 414
Trademarks 1,672 - 1,672 1,772 - 1,772
Developed technology 1,700 258 1,442 1,700 30 1,670
Licensing fees 355 115 240 355 89 266
Covenant-not-to-compete 100 60 40 100 15 85
Other 51 45 6 51 41 10
------------- ------------- ----------- ------------- -------------- -------------
Total other intangible assets 8,797 1,799 6,998 8,497 1,025 7,472
------------- ------------- ----------- ------------- -------------- -------------
$ 30,624 $ 1,799 $ 28,825 $ 31,045 $ 1,025 $ 30,020
============= ============= =========== ============= ============== =============
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 and eight years; patents are amortized
over approximately 13 years, seven years or five years; developed technology is
amortized over approximately five years and six years; licensing fees are
amortized over approximately 10 years; covenants-not-to-compete are amortized
over approximately one and two-thirds years. Trademarks are not amortized.
Amortization expense for intangible assets for each of the three-month periods
ended September 30, 2007 and September 30, 2006 was $257,000 and $28,000,
respectively. Amortization expense for intangible assets for each of the
nine-month periods ended September 30, 2007 and September 30, 2006 was $774,000
and $83,000, respectively. Amortization expense for intangible assets subject to
amortization in each of the next five fiscal years is estimated to be:
$1,030,000 in 2007, $951,000 in 2008, $898,000 in each of 2009 and 2010 and
$863,000 in 2011. Intangible assets subject to amortization have a weighted
average life of approximately seven years.
Changes in goodwill balances by segment are as follows:
Acquisition
Balance Costs Balance
December 31, Deferred Intangible Purchase September 30,
2006 Taxes Assets Adjustments 2007
------------- --------- ------------ ----------- --------------
(in thousands)
-------------------------------------------------------------------
SLPE (Ault) $ 3,999 $ (663) $ 0 $ (2) $ 3,334
High Power Group (MTE) 8,245 118 (300) 126 8,189
High Power Group (Teal) 5,055 - - - 5,055
RFL 5,249 - - - 5,249
------------- --------- ------------ ----------- --------------
Total $ 22,548 $ (545) $ (300) $ 124 $ 21,827
============= ========= ============ =========== ==============
10
During the nine months ended September 30, 2007, the Company reduced goodwill
related to the acquisition of Ault Incorporated ("Ault") in the amount of
$665,000. The change in the carrying amount of goodwill (in thousands) for the
nine months ended September 30, 2007 is as follows:
Balance as of December 31, 2006 $ 3,999
Deferred tax assets (663)
Acquisition costs (2)
---------
Balance as of September 30, 2007 $ 3,334
=========
The Company reduced goodwill during the period primarily due to a change in the
estimated expected tax rate applied to the Company's deferred tax assets,
primarily related to net operating losses, recorded at acquisition.
During the nine months ended September 30, 2007, the Company reduced goodwill
related to the acquisition of MTE Corporation ("MTE") in the amount of $56,000.
MTE was acquired on October 31, 2006. MTE is expected to broaden the product
portfolio of the Power Electronics Group within the high power market. MTE has
an excellent brand reputation, a stable customer base and provides immediate
cross selling opportunities with Teal. Also, MTE's engineering group will
compliment Teal's capabilities.
The change in the carrying amount of goodwill (in thousands) for the nine months
ended September 30, 2007 is as follows:
Balance as of December 31, 2006 $ 8,245
Intangible assets (300)
Deferred tax assets 118
Inventory valuation adjustment 61
Acquisition costs 65
--------
Balance as of September 30, 2007 $ 8,189
========
Upon closing an acquisition, the Company estimates the fair value of assets and
liabilities acquired and consolidates the acquisition as quickly as possible.
The adjustments related to MTE made during the nine month period ended September
30, 2007 relate to revisions made to the initial fair value of intangible
assets, the related deferred taxes recorded at acquisition, inventory valuation
and additional direct acquisition costs. The adjustments resulted in a decrease
of $100,000 in the value of trademarks, an increase of $400,000 in the value of
customer relationships, a reduction of $118,000 to deferred taxes (related to
the above adjustments), a decrease of $61,000 related to an inventory valuation
adjustment and additional direct acquisition costs of $65,000. The Company may
further adjust its initial estimates in subsequent periods.
11
8. DEBT
Debt consists of the following:
September 30, December 31,
2007 2006
------------- --------------
(in thousands)
-----------------------------
Prime rate loan $ 0 $ 0
LIBOR rate loan 10,000 19,800
------------- --------------
10,000 19,800
Less current portion - -
------------- --------------
Total long-term debt $ 10,000 $ 19,800
============= ==============
On August 3, 2005, the Company entered into a revolving credit facility (the
"Revolving Credit Facility") with Bank of America, N.A. ("Bank of America") to
replace its former senior credit facility. The Revolving Credit Facility (with a
standby and commercial letter of credit sub-limit of $5,000,000) provides for
borrowings up to $30,000,000. The Revolving Credit Facility had an original term
of three years and was extended during the third quarter to June 30, 2009.
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, 2007, the Company had an outstanding balance under the
Revolving Credit Facility of $10,000,000 at the LIBOR rate, which bore interest
at 6.70%. As of December 31, 2006, the Company had an outstanding balance under
the Revolving Credit Facility of $19,800,000 at the LIBOR rate, which bore
interest at 6.25%.
9. ACCRUED LIABILITIES - OTHER
Accrued liabilities - other consist of the following:
September 30, December 31,
2007 2006
-------------- -------------
(in thousands)
-----------------------------
Commissions $ 778 $ 892
Litigation and legal fees 557 476
Other professional fees 584 741
Environmental 1,445 1,455
Warranty 1,175 1,197
Deferred revenue 334 690
Other 1,556 1,844
-------------- -------------
$ 6,429 $ 7,295
============== =============
12
A summary of the Company's warranty reserve is as follows:
Nine Months Ended
September 30, 2007
------------------
(in thousands)
------------------
Liability, beginning of year $ 1,197
Expense for new warranties issued 220
Expense related to accrual revisions for prior year 96
Warranty claims (338)
------------------
Liability, end of period $ 1,175
==================
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.
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., formerly known as SL Waber, Inc., sold all of its assets in August 2001.
Niles Audio, Inc. was a former customer of SLW Holdings. The parties are
currently in discussions to settle this dispute. The Company believes that
neither the results of arbitration nor the terms of a potential settlement, as
the case may be, will have a material adverse impact on its consolidated
financial position or results of operations of the Company.
On June 12, 2002, the Company and SL Surface Technologies, Inc. ("SurfTech") (a
wholly owned subsidiary, the operating assets of which were sold in November
2003), 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"). 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 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.
These actions are discussed below.
With respect to the Private Action, the Superior Court denied class
certification in June 2006. In 2007, the Superior Court dismissed the claims of
all plaintiffs on statute of limitations grounds. The plaintiffs have appealed
the Court's decision.
13
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 $5,178,000, of which $3,733,000 is included as other long-term
liabilities as of September 30, 2007. However, it is the nature of environmental
contingencies that other circumstances might arise, the costs of which are
indeterminable at this time due to such factors as changing government
regulations and stricter standards, the unknown magnitude of defense and cleanup
costs, the unknown timing and extent of the remedial actions that may be
required, the determination of the Company's liability in proportion to other
responsible parties, and the extent, if any, to which such costs are recoverable
from other parties or from insurance. Although these contingencies could result
in additional expenses, judgments or offsets thereto, at the present time such
expenses or judgments are not expected to have a material adverse effect on the
Company's consolidated financial position or results of operations, beyond the
amount already reserved. Most of the Company's environmental costs relate to
discontinued operations and such costs have been recorded in discontinued
operations.
There are two sites on which the Company may incur material environmental costs
in the future as a result of past activities of SurfTech. These sites are the
Company's properties located in Pennsauken Township, New Jersey (the "Pennsauken
Site"), and in Camden, New Jersey (the "Camden Site"). With respect to the
Pennsauken Site, the Company is the subject of various lawsuits and
administrative actions relating to environmental issues concerning the
Pennsauken Landfill and the Puchack Wellfield. In 1991 and 1992, the New Jersey
Department of Environmental Protection (the "NJDEP") served directives that
would subject the Company to, among other things, $9,266,000 in collective
reimbursements (with other parties) for the remediation of the Puchack
Wellfield. The Company believes it has a significant defense against all or part
of the directives based on technical data. Moreover, the Company believes the
recent action by the EPA, discussed below, may have superseded the NJDEP
directives.
In late August 2006, the United States Environmental Protection Agency (the
"EPA") notified the Company that it was a potential responsible party (a "PRP"),
jointly and severally liable, for the investigation and remediation of the
Puchack Wellfield Superfund Site under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended. Thereafter, in September
2006, the EPA issued a Record of Decision for the national priority listed
Puchack Wellfield Superfund Site and selected a remedy to address the first
phase of groundwater contamination that the EPA contemplates being conducted in
two phases (known as
14
operable units). The estimated cost of the EPA selected remedy for the first
groundwater operable unit, to be conducted over a five to ten year timeframe, is
approximately $17.6 million. Prior to the issuance of the EPA's Record of
Decision, the Company had retained an experienced environmental consulting firm
to prepare technical comments on the EPA's proposed remediation of the Puchack
Wellfield Superfund Site. In those comments, the Company's consultant, among
other things, identified flaws in the EPA's conclusions and the factual
predicates for certain of the EPA's decisions and for the proposed selected
remedy.
Following the issuance of its Record of Decision, in early November 2006, the
EPA sent another letter to the Company encouraging the Company to either perform
or finance the remedial actions for operable unit 1 identified in the EPA's
Record of Decision. The Company advised the EPA that it is willing to
investigate the existence of other PRPs and to undertake the activities
necessary to design a final remediation for the Superfund Site. In July 2007,
the EPA declined the Company's offer to prepare the remediation design for the
Superfund Site, but encouraged it to submit probative evidence with respect to
other PRPs.
Prior to its last communication, in May 2007, the EPA sent a letter to the
Company demanding reimbursement of approximately $11,500,000 for past costs
associated with the Superfund Site. The Company has requested documentation to
support the EPA's claim.
Notwithstanding these assertions, based on discussions with its attorneys and
consultants, the Company believes the EPA analytical effort is far from
complete. Further, technical data has not established that offsite migration of
hazardous substances from the Pennsauken Site contributed to the contamination
of the Puchack Wellfield. In any event, the evidence establishes that hazardous
substances from the Pennsauken Site could have contributed only a portion of the
total contamination delineated at the Puchack Wellfield. There are other
technical factors and defenses that indicate that the remediation proposed by
the EPA is technically flawed. Based on the foregoing, the Company believes that
it has significant defenses against all or part of the EPA claim and that other
PRPs should be identified to support the ultimate cost of remediation.
Nevertheless, the Company's attorneys have advised that it is likely that it
will incur some liability in this matter. Based on the information so far, the
Company has estimated remediation liability for this matter of $4,000,000
($2,480,000, net of tax), which has been reserved and recorded as part of
discontinued operations in the fourth quarter of 2006.
The Company has reported a ground water contamination plume at the Camden Site.
In March 2007, the Company submitted to the NJDEP a Preliminary Assessment
Report/Remedial Investigation Report to address requests and directives of the
NJDEP with respect to potential areas of concern for the Camden Site. This
Report is currently under review. Based on the information so far, the Company
believes that the cost to remediate the Camden Site should not exceed $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 at the facility
of SL Montevideo Technology, Inc. ("SL-MTI") located in Montevideo, Minnesota.
SL-MTI has conducted analysis of the contamination and performed remediation at
the site. Further remediation efforts will be required and the Company is
engaged in discussions with the Minnesota Pollution Control Agency to develop a
remediation plan. Based on the current information, the Company believes it will
incur remediation costs at this site of approximately
15
$178,000, which has been accrued at September 30, 2007. 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 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. These payments have been recorded as
income, net of tax, in discontinued operations.
As of September 30, 2007 and December 31, 2006, the Company recorded
environmental accruals of $5,178,000 and $5,188,000, respectively.
11. SEGMENT INFORMATION
The Company currently operates under four business segments: SL Power
Electronics Corp. ("SLPE"), the High Power Group, SL Montevideo Technology, Inc.
("SL-MTI") and RFL Electronics Inc. ("RFL"). Following its acquisition of Ault
on January 26, 2006, the Company consolidated the operations of Ault and its
subsidiary, Condor D.C. Power Supplies, Inc. ("Condor"), into SLPE. In
accordance with the guidance provided in Statement of Financial Accounting
Standard No. 131, "Disclosures about Segments of an Enterprise and Related
Information," ("SFAS No. 131") this subsidiary is reported as one business
segment. Following the acquisition of MTE on October 31, 2006, the Company
combined MTE with its subsidiary, Teal Electronics Corp. ("Teal"), into one
business segment, which is reported as the High Power Group. Management has
combined SLPE and the High Power Group into one business unit classified as the
Power Electronics Group. The Company aggregates operating business subsidiaries
into a single segment for financial reporting purposes if aggregation is
consistent with the objectives of SFAS No. 131 and if the segments have similar
characteristics in each of the following areas:
- nature of products and services
- nature of production process
- type or class of customer
- methods of distribution
SLPE produces a wide range of custom and standard 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, which sells products under two brand names
(Condor and Ault), is a major supplier to original equipment manufacturers
("OEMs") of medical equipment, wireless and wire line communications
infrastructure, computer peripherals, handheld devices and industrial equipment.
The High Power Group sells products under two brand names (Teal and MTE). Teal
designs and manufactures custom power conditioning and power distribution units.
Products are developed and manufactured for custom electrical subsystems for
OEMs of semiconductor, medical imaging and industrial systems. 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. SL-MTI designs and manufactures high power density
precision motors.
16
New motor and motion controls are used in numerous applications, including
military and commercial aerospace equipment, medical devices 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. 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 and nine month periods
ended September 30, 2007 and September 30, 2006 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2007 2006* 2007 2006*
-------- -------- -------- --------
(in thousands)
-----------------------------------------------------
NET SALES
Power Electronics Group:
SLPE $ 22,367 $ 23,903 $ 69,622 $ 65,065
High Power Group 15,690 9,184 44,512 26,976
-------- -------- -------- --------
Total 38,057 33,087 114,134 92,041
-------- -------- -------- --------
SL-MTI 6,800 6,137 20,865 18,825
RFL 5,795 5,941 16,710 16,698
-------- -------- -------- --------
Consolidated $ 50,652 $ 45,165 $151,709 $127,564
======== ======== ======== ========
Three Months Ended Nine Months Ended
September 30, September 30,
2007 2006* 2007 2006*
-------- -------- -------- --------
(in thousands)
-----------------------------------------------------
INCOME FROM OPERATIONS
Power Electronics Group:
SLPE $ 2,017 $ 2,289 $ 6,209 $ 5,631
High Power Group 2,397 1,265 6,189 4,100
-------- -------- -------- --------
Total 4,414 3,554 12,398 9,731
-------- -------- -------- --------
SL-MTI 651 317 2,352 818
RFL 877 707 1,725 1,417
Other (2,058) (1,796) (4,568) (4,150)
-------- -------- -------- --------
Consolidated $ 3,884 $ 2,782 $ 11,907 $ 7,816
======== ======== ======== ========
* SLPE includes net sales and income from operations of Ault from the
acquisition date, January 26, 2006 to September 30, 2006. The High Power Group
does not include net sales and income from operations of MTE, for the three and
nine month periods ended September 30, 2006, since the acquisition was not
completed until October 31, 2006.
17
September 30, December 31,
2007 2006
------------- ------------
(in thousands)
--------------------------------
TOTAL ASSETS
Power Electronics Group:
SLPE $ 40,030 $ 41,809
High Power Group 30,999 29,606
------------- ------------
Total $ 71,029 $ 71,415
------------- ------------
SL-MTI 11,992 12,035
RFL 15,841 16,271
Other 7,798 6,822
------------- ------------
Consolidated $ 106,660 $ 106,543
============= ============
September 30, December 31,
2007 2006
------------- ------------
(in thousands)
--------------------------------
INTANGIBLE ASSETS, NET
Power Electronics Group:
SLPE $ 5,323 $ 6,298
High Power Group 18,007 18,197
------------- ------------
Total $ 23,330 $ 24,495
------------- ------------
SL-MTI 6 10
RFL 5,489 5,515
------------- ------------
Consolidated $ 28,825 $ 30,020
============= ============
12. RETIREMENT PLANS AND DEFERRED COMPENSATION
During the nine months ended September 30, 2007, the Company maintained a
defined contribution pension plan covering all of its full-time, U.S. employees
of SLPE, Teal, SL-MTI, RFL and the corporate office. The Company's contributions
to this plan are based on a percentage of employee contributions and/or plan
year gross wages, as defined, and profit sharing contributions annually, based
on plan year gross wages.
For the first four months of 2007, the Company also maintained a defined
contribution pension plan covering all of its full-time, U.S. employees of MTE.
The Company's contributions to this plan were based on a percentage of employee
contributions and/or plan year gross wages, as defined. On May 1, 2007, this
plan was merged into the Company's plan covering all of the Company's full-time,
U.S. employees of SLPE, Teal, SL-MTI, RFL and the corporate office with the same
terms and conditions.
Costs incurred under the plans amounted to $858,000 during the nine-month period
ended September 30, 2007 and $701,000 for the nine-month period ended September
30, 2006. During 2006, the Company maintained five separate plans, four of which
were merged into one plan on January 2, 2007.
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 and discount rates
18
ranging from 6% to 12%. The amount charged to income in connection with these
agreements amounted to $291,000 and $307,000 for the nine-month periods ended
September 30, 2007 and September 30, 2006, respectively.
13. RELATED PARTY TRANSACTIONS
RFL has an investment of $15,000 in RFL Communications PLC, ("RFL
Communications"), representing 4.5% of the outstanding equity thereof. RFL
Communications is a distributor of teleprotection and communication equipment
located in the United Kingdom. It is authorized to sell RFL products in
accordance with an international sales agreement. Sales to RFL Communications
for each of the nine-month periods ended September 30, 2007 and September 30,
2006 were $849,000 and $642,000, respectively. Accounts receivable due from RFL
Communications at September 30, 2007 were $274,000.
As a result of certain services being provided to the Company by Steel Partners,
Ltd. ("SPL"), a company controlled by Warren Lichtenstein, the Chairman of the
Board of the Company, the Compensation Committee has approved fees for services
provided by SPL. These fees are the only consideration for the services of Mr.
Lichtenstein and the Company's Vice Chairman, Glen Kassan, and other assistance
from SPL. The services provided include management and advisory services with
respect to operations, strategic planning, finance and accounting, merger, sale
and acquisition activities and other aspects of the businesses of the Company.
Fees of $356,000 were expensed by the Company for SPL's services for each of the
nine-month periods ended September 30, 2007 and September 30, 2006 pursuant to a
Management Agreement dated as of January 23, 2002 by and between the Company and
SPL. Approximately $40,000 was payable at September 30, 2007.
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, power quality electromagnetics
and specialized communication equipment that is used in a variety of commercial
and military 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. SLPE has 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.
19
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.
In December 2001, the Securities and Exchange Commission (the "SEC") issued
disclosure guidance for "critical accounting policies." The SEC defines
"critical accounting policies" as those that require application of management's
most difficult, subjective or complex judgments, often as a result of the need
to make estimates about the effect of matters that are inherently uncertain and
may change in subsequent periods.
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 within the
SEC definition. The Company's senior management has reviewed these critical
accounting policies and estimates and the related Management's Discussion and
Analysis of Financial Condition and Results of Operations with the Audit
Committee of the Board of Directors.
REVENUE RECOGNITION
Revenue is recognized when persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, the purchase price is
fixed or determinable and collectibility is reasonably assured. Revenue is
recorded in accordance with Staff Accounting Bulletin ("SAB") No. 104 and in
certain circumstances in accordance with the guidance provided by the EITF 00-21
"Revenue Arrangements with Multiple Deliverables." The major portion of revenue
is derived from equipment sales. However, RFL has customer service revenue,
which accounted for less than one percent of consolidated net revenue for each
of the nine month periods ended September 30, 2007 and September 30, 2006. The
Company recognizes equipment revenue upon shipment and transfer of title.
Provisions are established for product warranties, principally based on
historical experience. At times the Company establishes reserves for specific
warranty issues known by management. Service and installation revenue is
recognized when completed. At SL-MTI, revenue from one particular contract is
considered a multiple element arrangement and, in that case, is allocated among
the separate accounting units based on relative fair value. In this case the
total arrangement consideration is fixed and there is objective and reliable
evidence of fair value. SLPE has two sales programs with distributors in which
credits are given with no cash paid to distributors: (1) a scrap program and (2)
a competitive discount program. The distributor scrap program allows
distributors to scrap up to a pre-determined percentage of their purchases over
the previous six month period. SLPE provides for this allowance as a decrease to
revenue based upon the amount of sales to each distributor and other historical
factors. The competitive discount program allows distributors to sell a product
out of their inventory at less than list price in order to meet certain
competitive situations. SLPE records this discount as a reduction to revenue
based on the distributor's eligible inventory. The eligible distributor
inventory is reviewed at least quarterly. These distributor programs affected
consolidated gross revenue for the nine months ended September 30, 2007 by
approximately one percent.
20
Certain judgments affect the application of the Company's revenue policy, as
mentioned above. Revenue recognition is significant because net revenue is a key
component of results of operations. In addition, revenue recognition determines
the timing of certain expenses, such as commissions and royalties. Revenue
results are difficult to predict. 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 (e.g., bankruptcy or insolvency).
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 reevaluated 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. The Company's allowance for doubtful accounts represented 2.6% and 2.7%
of gross trade receivables at September 30, 2007 and December 31, 2006,
respectively.
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 market value.
If a write down to the current market value is necessary, the market value
cannot be greater than the net realizable value, which is defined as selling
price less costs to complete and dispose, and cannot be lower than the net
realizable value less a normal profit margin. The Company also continually
evaluates the composition of its inventory and identifies slow-moving and excess
inventories. Inventory items identified as slow-moving or excess are evaluated
to determine if reserves are required. If the Company were not able to achieve
its expectations of the net realizable value of the inventory at current market
value, it would have to adjust its reserves accordingly.
ACCOUNTING FOR INCOME TAXES
On January 1, 2007, the Company adopted the provisions of FIN 48. At the
adoption date, the Company applied the provisions of FIN 48 to all tax positions
for which the statute of limitations remained open. As required, the cumulative
effect of the change from the adoption of FIN 48 was to be recorded in the
opening balance as retained earnings. As a result of the implementation of FIN
48, the Company did not recognize any change in its unrecognized tax benefits
and did not adjust the January 1, 2007 balance of retained earnings. The amount
of unrecognized tax benefits as of September 30, 2007 was $2,081,000, excluding
interest and penalties. This
21
represents unrecognized tax benefits, which, if ultimately recognized, will
reduce the Company's effective tax rate.
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, 2007 and
December 31, 2006, the Company had recorded total valuation allowances of
$2,696,000 and $2,157,000, respectively. Such valuation allowances were
attributable to uncertainties related to the Company's ability to utilize
certain deferred tax assets prior to expiration. These deferred tax assets
primarily consist of loss carryforwards and foreign tax credits. 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, 2007 and December 31, 2006 were
$8,280,000 and $8,530,000, respectively, net of valuation allowances of
$2,696,000 and $2,157,000, 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. Each quarter, management
evaluates the ability to realize the deferred tax assets and assesses the need
for additional valuation allowances.
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 Item I
of 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 further
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.
GOODWILL
The Company has allocated its adjusted goodwill balance to its reporting units.
The Company tests goodwill for impairment annually and in interim periods if
certain events occur indicating that the carrying value of goodwill may be
impaired. The goodwill impairment test is a two-step process. The first step of
the impairment analysis compares the fair value to the net book value. In
determining fair value, the accounting guidance allows for the use of several
valuation methodologies, although it states quoted market prices are the best
evidence of fair value. The Company uses a combination of expected present
values of future cash flows and comparable or quoted market prices, when
applicable. If the fair value is less than the net book value, the second step
of the analysis compares the implied fair value of goodwill to its carrying
amount. If the carrying amount of goodwill exceeds its implied fair value, the
Company recognizes an
22
impairment loss equal to that excess amount. 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 required to estimate the fair value of reporting units
include estimating future cash flows, determining appropriate discount rates and
other assumptions. Changes in these estimates and assumptions could materially
affect the determination of fair value for each reporting unit. There were no
impairment charges in either of the nine month periods ended September 30, 2007
and September 30, 2006. As of September 30, 2007 and December 31, 2006, goodwill
totaled $21,827,000 (representing 20% of total assets) and $22,548,000
(representing 21% of total assets), respectively. For the nine month period
ended September 30, 2007 and fiscal year ended December 31, 2006, there were
four reporting units identified for impairment testing. Those units are Ault,
MTE, Teal and RFL.
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. 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 of
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. Asset impairment evaluations are by nature highly subjective. There were
no asset impairment changes for the periods presented.
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 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 formerly owned 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.
During the fourth quarter of fiscal 2006,
23
the Company recorded a $4,000,000 reserve in response to an EPA letter related
to remediation of a designated Superfund Site. Additional information pertaining
to environmental matters is found in the Notes to the Consolidated Financial
Statements included in Part IV of the Company's Annual Report on Form 10-K.
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 the Company's 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,
2007 2006 $ Variance % Variance
------------- ------------ ---------- ----------
(in thousands)
----------------------------------------------------------------
Cash and cash equivalents $ 15 $ 757 $ (742) (98%)
Bank debt $ 10,000 $ 19,800 $ (9,800) (49%)
Working capital (less cash) $ 29,022 $ 26,754 $ 2,268 8%
Shareholders' equity $ 59,740 $ 50,419 $ 9,321 18%
============= ============ ========== ========
During the nine-month period ended September 30, 2007, net cash provided by
continuing operations was $9,318,000, as compared to net cash used in continuing
operations of $485,000 during the nine-month period ended September 30, 2006.
The primary sources of cash from operating activities for the nine-month period
ended September 30, 2007 were income from continuing operations of $7,741,000, a
decrease in deferred income tax assets of $995,000, non-cash compensation
expense of $1,015,000 and an increase in accounts payable of $826,000. These
increases in cash were partially offset by increases in inventory of $2,425,000.
SLPE experienced an increase in inventory of $2,409,000 during the period. Raw
materials, work-in-process and finished goods inventories at SLPE increased as a
result of higher sales volume and an increase in backlog of $1,444,000 from
year-end. All other operating entity's inventory either decreased or remained
relatively stable from year-end levels.
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. The
Company also recorded an aggregate increase in inventory of $3,797,000 over the
nine-month period ended September 30, 2006.
During the nine-month period ended September 30, 2007, net cash used in
investing activities was $1,235,000. This use of cash in investing activities
was primarily related to the purchase of machinery and equipment. 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
24
$16,145,000, net of cash acquired (cash in the amount of $1,034,000 was used in
2005). 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, 2007, net cash used in
financing activities was $7,130,000. This use of cash was principally related to
the repayment of debt under the Revolving Credit Facility in the net amount of
$9,800,000. 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.
The Company's current ratio was 1.97 to 1 at September 30, 2007 and 1.94 to 1 at
December 31, 2006. Current assets increased by $2,220,000 from December 31,
2006, while current liabilities increased by $694,000 during the same period.
The increase in current assets is primarily due to a significant increase in
accounts receivable and inventories resulting from strong sales in the first
nine months of 2007. The increase in current liabilities is due to increases in
accounts payable and payroll related costs due to the timing of payments.
Total borrowings by the Company, as a percentage of total capitalization,
consisting of debt and shareholders' equity were 14.3% at September 30, 2007 and
28.2% at December 31, 2006. During the first nine months of 2007, total debt
decreased by $9,800,000.
Capital expenditures of $1,170,000 were made during the first nine months of
2007. These expenditures are primarily related to computer equipment and factory
machinery and equipment. Capital expenditures for the period represent a
decrease of $1,628,000 from the comparable period in 2006.
The Company has been able to generate adequate amounts of cash to meet its
operating needs and expects to do so in the future.
With the exception of the segment reported as "Other" (which consists primarily
of corporate office expenses, financing activities, public reporting costs,
legal, litigation and other costs not allocated to reportable segments) all of
the Company's operating segments recorded income from operations for the periods
presented.
CONTRACTUAL OBLIGATIONS
The following is a summary of the Company's contractual obligations at September
30, 2007 for the periods indicated:
Less Than 1 to 3 4 to 5 After
1 Year Years Years 5 Years Total
--------- ------- ------- -------- -------
(in thousands)
-----------------------------------------------------------------------
Operating Leases $ 1,590 $ 1,935 $ 1,137 $ 130 $ 4,792
Debt - 10,000 - - 10,000
Capital Leases 8 14 - - 22
Other Obligations 57 196 152 30 435
--------- ------- ------- -------- -------
$ 1,655 $12,145 $ 1,289 $ 160 $15,249
========= ======= ======= ======== =======
25
Other obligations include the Company's withdrawal liability to a
union-administered defined benefit multi-employer pension plan to which SurfTech
had made contributions.
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, which 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, 2007, COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2006
The tables below show the comparisons of net sales and income from operations
for the three months ended September 30, 2007 ("the third quarter 2007") and the
three months ended September 30, 2006 ("the third quarter 2006"). For the third
quarter 2007, sales and income from operations of Ault and MTE are included for
the full period. Ault is included as part of SLPE, while MTE is recorded within
the High Power Group. Sales and income from operations of Ault are reflected for
the third quarter 2006. Sales and income from operations of MTE are not
reflected in the third quarter 2006. MTE was acquired on October 31, 2006.
Three Months Three Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Quarter Same Quarter
2007 2006 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
-------------------------------------------------------------
Power Electronics Group:
SLPE $22,367 $23,903 ($1,536) (6%)
High Power Group 15,690 9,184 6,506 71%
------- ------- -------- ---
Total 38,057 33,087 4,970 15%
------- ------- -------- ---
SL-MTI 6,800 6,137 663 11%
RFL 5,795 5,941 (146) (2%)
------- ------- -------- ---
Total $50,652 $45,165 $ 5,487 12%
======= ======= ======== ===
26
The table below shows the comparison of income from operations for 2007 and
2006:
Three Months Three Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Quarter Same Quarter
2007 2006 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
-------------------------------------------------------------
Power Electronics Group:
SLPE $ 2,017 $ 2,289 $ (272) (12%)
High Power Group 2,397 1,265 1,132 89%
------- ------- -------- ---
Total 4,414 3,554 860 24%
------- ------- -------- ---
SL-MTI 651 317 334 105%
RFL 877 707 170 24%
Other (2,058) (1,796) (262) (15%)
------- ------- -------- ---
Total $ 3,884 $ 2,782 $ 1,102 40%
======= ======= ======== ===
Consolidated net sales for the third quarter 2007 increased by $5,487,000, or
12%, compared to the third quarter 2006. Without the sales of MTE recorded in
the third quarter 2007, consolidated sales decreased by $101,000. All of the
operating entities, except SLPE, reported increases in income from operations
for the comparable periods.
The Company recorded income from operations of $3,884,000 for the third quarter
2007, compared to income from operations of $2,782,000 for the third quarter
2006, an increase of $1,102,000, or 40%. Without MTE, the increase would be
$140,000, or 5%.
In the third quarter 2007, income from continuing operations was $2,467,000, or
$0.42 per diluted share, compared to $1,806,000, or $0.31 per diluted share, for
the third quarter 2006. Income from continuing operations was approximately 5%
of sales for the third quarter 2007, and approximately 4% of sales for the same
period last year. 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 the High Power Group (a combination of Teal and MTE)
recorded a sales increase of $4,970,000, or 15%, when comparing the third
quarter 2007 to the same period last year. Without the MTE acquisition, sales
would have decreased by $618,000, or 2%. Income from operations increased by
$860,000, or 24%, due to an increase at the High Power Group of $1,132,000. MTE
recorded income from operations of $962,000.
As a percentage of SLPE's revenue, income from operations for the third quarter
of each of 2007 and 2006 was 9% and 10%, respectively. While the third quarter
2007, sales decreased by $1,536,000, as compared to 2006, SLPE reduced its
operating costs by approximately $733,000. This decrease is primarily due to
reduced salary, commission, travel and the reclassification of freight charges
to cost of products sold. The High Power Group recorded income from operations,
as a percentage of revenue, of 15%, compared to 14% in the third quarter 2006.
This increase was primarily related to the inclusion of MTE for the third
quarter of 2007, which recorded income from operations of $962,000, or 17%, of
sales. Teal, which experienced a sales increase of $918,000, or 10%, and had an
increase in income from operations of $170,000, or 13%. Teal's sales increase
was primarily due to increased demand from medical imaging
27
equipment manufacturers. This sales increase was partially offset by a 14%
increase ($123,000) in selling general and administrative costs, primarily due
to increased stock-based compensation expense, sales related expenses and agency
approval costs.
For the third quarter 2007, SL-MTI's sales increased $663,000, or 11%, while
income from operations increased by $334,000, or 105%, compared to the same
period last year. The sales increase was driven by a $611,000 increase in sales
to customers in the defense and commercial aerospace industries and to a lesser
extent increases in sales to medical equipment manufacturers. MTI's cost of
products sold percentage improved slightly in 2007, compared to 2006, primarily
due to higher volume and favorable product mix. Also, MTI recorded a decrease of
$194,000 in engineering and product development costs, compared to the prior
year. This decrease is primarily related to increased customer funding and
smaller research and development programs. SL-MTI experienced a $138,000
increase in selling, general and administrative expenses over the comparable
periods, due primarily to increased volume.
For the third quarter 2007, RFL's sales decreased by $146,000 compared to the
same period in 2006. Income from operations increased by $170,000, or 24%, for
the comparable periods. Sales of RFL's protection products increased by
$1,343,000, or 63%, aided by the sale of a new product, while sales of its
carrier communications product line decreased by $1,471,000, or 41%, for the
comparable periods. RFL's other product line decreased slightly. Domestic sales
increased by $366,000, or 8%, while international sales decreased by $512,000,
or 38%. The increase in income from operations is primarily related to increased
margins and a decrease in selling, general and administrative expenses of
$131,000. This decrease is due to the receipt of $241,000 related to the sale of
securities and the receipt of a death benefit pertaining to certain insurance
policies carried by RFL. Without these benefits, selling, general and
administrative expenses would have increased by $110,000.
COST OF PRODUCTS SOLD
As a percentage of net sales, cost of products sold was 68%, for each of the
third quarters of 2007 and 2006. Without MTE, the comparable percentages were
slightly higher in 2007, compared to 2006. SLPE's cost of products sold
percentage increased slightly, primarily as a result of lower sales volume and
increased freight costs. Teal's cost of products sold percentage remained
relatively constant in 2007 and 2006. SL-MTI experienced a 2% decrease in its
cost of products sold, compared to the same period last year. This decrease is
primarily related to higher volume, favorable product mix and greater
manufacturing efficiencies. RFL's cost of products sold, as a percentage of
sales, decreased by approximately 2% due to a favorable product mix and a higher
proportion of domestic sales.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES
For the third quarter of 2007, engineering and product development expenses were
approximately 6% of net sales, compared to 7% of net sales for the third quarter
2006. Engineering and product development expenses increased by $276,000, or
10%. Without MTE, engineering and product development expenses increased by
$9,000. SLPE experienced an increase of approximately 9%, due to higher
consulting and agency fees incurred in the third quarter 2007, compared to the
third quarter 2006. RFL and Teal experienced relatively minor increases in the
comparable periods. SL-MTI experienced a 38% decrease, due to a significant
increase in customer funding and smaller research and development programs.
28
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses, as a percentage of net sales, for
the third quarter 2007 and for the third quarter 2006 were approximately 16% and
18%, respectively. These expenses increased by $246,000, or 3%, with MTE
contributing $853,000 of the increase. Selling, general and administrative
expenses, without MTE, decreased by $607,000, or 8%, for the comparable periods.
SLPE recorded a decrease in selling, general and administrative expenses of 30%,
on decreased sales of 6%. This decrease is primarily due to reduced salary,
commission, relocation expenses and the reclassification of freight charges to
cost of products sold. SL-MTI reported an increase of such expenses of 30%, on
increased sales of 11%. This increase is primarily due to sales related costs
and bonus accruals. Teal recorded increased selling, general and administrative
expenses of 14%, primarily related to increased sales and increased stock-based
compensation expense. RFL recorded a decrease of such expenses of 9%. This
decrease is related to the receipt of $241,000 related to certain insurance
policies carried by RFL, as mentioned previously. Without these receipts,
selling, general and administrative expenses would have increased by $110,000.
This increase is primarily due to increased matching costs related to its
conversion to the Company's 401(k) Pension and Savings Plan and increased bonus
accruals. Corporate and Other selling, general and administrative expenses
increased by $262,000, or 15%, primarily due to increased salary and bonus
expenses of $101,000 related to the addition of an executive position and
increased stock-based compensation expense of $363,000. Without these expenses,
Corporate and Other expenses would have decreased by $202,000, primarily due to
a decrease in professional fees of $236,000.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses increased by $253,000, or 41%. The
increase was largely attributable to the amortization of intangibles of $127,000
and $103,000 related to the acquisitions of MTE and Ault, respectively.
Depreciation and amortization expense for the third quarters of 2007 and 2006
was approximately 2% and 1% of net sales, respectively.
AMORTIZATION OF DEFERRED FINANCING COSTS
In connection with entering into the 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 each of the third quarters 2007 and 2006, amortization of
deferred financing costs was $22,000, all of which related to the Revolving
Credit Facility.
INTEREST INCOME (EXPENSE)
For the third quarter 2007, interest expense was $130,000, compared to $153,000
for the third quarter 2006. The decrease in interest expense is due to decreased
debt levels partially offset by higher interest rates.
TAXES
The effective tax rate for continuing operations was 34% for the third quarter
2007 and 31% for the third quarter 2006. The effective tax rate reflects the
statutory rate after adjustments for federal, state and international tax
provisions and the recording of benefits primarily related to research and
development tax credits.
29
DISCONTINUED OPERATIONS
For the third quarter 2007 and for the third quarter 2006, the Company recorded
losses from discontinued operations, net of tax, of $316,000 and $148,000,
respectively. These amounts represent legal and environmental charges, net of
tax related to discontinued operations.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2007, COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2006
The tables below show the comparisons of net sales and income from operations
for the nine months ended September 30, 2007 (the "nine months of 2007") and the
nine months ended September 30, 2006 (the "nine months of 2006"). For the nine
months of 2007, sales and income from operations of Ault and MTE are included
for the full period. Ault is included as part of SLPE, while MTE is recorded
within the High Power Group. For the nine months of 2006, sales and income from
operations of Ault are reflected from the date of acquisition, January 26, 2006.
Sales and income from operations of MTE are not reflected for 2006, as the
acquisition was completed on October 31, 2006.
Nine Months Nine Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Period Same Period
2007 2006 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
-------------------------------------------------------------
Power Electronics Group:
SLPE $ 69,622 $ 65,065 $ 4,557 7%
High Power Group 44,512 26,976 17,536 65%
-------- -------- -------- ---
Total 114,134 92,041 22,093 24%
-------- -------- -------- ---
SL-MTI 20,865 18,825 2,040 11%
RFL 16,710 16,698 12 n/m
-------- -------- -------- ---
Total $151,709 $127,564 $ 24,145 19%
======== ======== ======== ===
30
The table below shows the comparison of income from operations for 2007 and
2006:
Nine Months Nine Months $ Variance % Variance
Ended Ended Over Over
September 30, September 30, Same Period Same Period
2007 2006 Last Year Last Year
------------- ------------- ------------ ------------
(in thousands)
-------------------------------------------------------------
Power Electronics Group:
SLPE $ 6,209 $ 5,631 $ 578 10%
High Power Group 6,189 4,100 2,089 51%
-------- -------- -------- ---
Total 12,398 9,731 2,667 27%
-------- -------- -------- ---
SL-MTI 2,352 818 1,534 188%
RFL 1,725 1,417 308 22%
Other (4,568) (4,150) (418) (10%)
-------- -------- -------- ---
Total $ 11,907 $ 7,816 $ 4,091 52%
======== ======== ======== ===
Consolidated net sales for the nine months of 2007 increased by $24,145,000, or
19%, compared to the same period in 2006. Without the sales of MTE recorded in
2007, consolidated sales increased by $8,993,000, or 7%. All of the operating
entities reported increases in sales and income from operations for the nine
months of 2007, compared to the nine months of 2006.
The Company recorded income from operations of $11,907,000 for the nine months
of 2007, compared to income from operations of $7,816,000 for the corresponding
period last year. This represents an increase of $4,091,000, or 52%. Without
MTE, the increase would be $1,937,000, or 25%.
For the nine months of 2007, income from continuing operations was $7,741,000,
or $1.33 per diluted share, compared to $5,146,000, or $0.88 per diluted share,
for the same period in 2006. Income from continuing operations was approximately
5% of sales in 2007, compared to 4% of sales in 2006. 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 the High Power Group (a combination of Teal and MTE)
recorded a sales increase of $22,093,000, or 24%, when comparing the nine months
of 2007 to the nine months of 2006. Without MTE, sales would have increased by
$6,941,000, or 8%. Income from operations increased by $2,667,000, or 27%. MTE
recorded income from operations of $2,154,000 for the nine months of 2007.
Without MTE, income from operations would have increased by $513,000. SLPE
(which included the Ault product line for a full nine months in 2007) recorded
an increase in income from operations of $578,000. Teal's income from operations
decreased by $65,000.
For the nine months of 2007, income from operations, as a percentage of SLPE's
revenue, was 9%, which is the same percentage experienced 2006. The High Power
Group recorded income from operations, as a percentage of revenue, of 14%,
compared to 15% for the nine months of last year. This decline was partially due
to the inclusion of MTE in 2007. MTE recorded income from operations, as a
percentage of sales, equal to 14%. Teal experienced a sales increase of
$2,383,000, or 9%, while income from operations decreased $65,000, or 2%,
compared to prior year. Teal's sales increase was primarily due to increased
demand from medical imaging
31
equipment manufacturers. Teal's income from operations was negatively impacted
by an increase in its percentage of cost of products sold by 2%, primarily due
to higher material costs, product mix and decrease in efficiency at its Tecate
facility, as more products are being transferred there. Teal's selling, general
and administrative costs increased by 8%, primarily due to increased sales, the
addition of a quality manager, increased training and recruiting expenses and
increased stock-based compensation expense.
For the nine months of 2007, SL-MTI's sales increased $2,040,000, or 11%, while
income from operations increased by $1,534,000, or 188%, compared to the same
period last year. The sales increase was driven by a $2,434,000 increase in
sales to customers in the defense and commercial aerospace industries. This
increase was partially offset by a decrease in sales to medical equipment
manufacturers and other industrial customers. The increase in income from
operations is primarily due to a 4% increase in gross margin resulting from
higher volume, favorable product mix and greater manufacturing efficiencies. In
addition, income from operations improved as a result of a $486,000 decrease of
engineering and product development costs, when compared to the relatively large
product development costs incurred last year. SL-MTI experienced a 20% increase
in selling, general and administrative expenses over the comparable periods due
to an increase in sales volume and bonus accruals.
For the nine months of 2007, RFL's sales increased by $12,000, compared to the
nine months of 2006. Income from operations increased by $308,000, or 22%, for
the comparable periods. Sales of RFL's protection products increased by
$2,134,000, or 31%, while sales of its carrier communications product line
decreased by $2,081,000, or 23%, for the comparable periods. RFL's other product
line decreased by $41,000. Domestic sales increased by 13% aided by the sale of
a new product, while international sales decreased by 31%. The increase in
income from operations is primarily related to improved gross margins, partially
offset by higher selling, general and administrative costs.
COST OF PRODUCTS SOLD
For the first nine months of 2007, cost of products sold, as a percentage of net
sales, was 67% for each of the nine months of 2007 and 2006. Without MTE, cost
of products sold percentage remained relatively unchanged. SLPE's cost of
products sold percentage increased slightly in 2007, compared to 2006. Teal's
cost of products sold percentage increased by approximately 2%, due to increased
raw material costs, product mix and manufacturing inefficiencies. In 2007,
SL-MTI experienced a 4% decrease in its cost of products sold, compared to the
same period last year. This decrease is primarily related to favorable product
mix and greater manufacturing efficiencies. RFL's cost of products sold, as a
percentage of sales, improved by 2%, primarily due to a higher proportion of
domestic sales.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES
For the nine months of 2007, engineering and product development expenses were
approximately 6% of net sales, compared to 7% for the same period in 2006.
Engineering and product development expenses increased by $459,000, or 5%.
Without MTE, engineering and product development expenses decreased $242,000, or
3%. This decrease was primarily attributable to a 26% decrease of engineering
expenses at SL-MTI. RFL and Teal experienced relatively minor changes in the
nine months of 2007, compared to the same period in 2006. SLPE experienced an
increase of $230,000, or 5%, partially due to the inclusion of the Ault product
line for a full nine months in 2007, compared to eight months in 2006 and higher
agency
32
approval costs. MTE's engineering and product development expenses for the nine
months of 2007 were $701,000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
For the nine months of 2007, selling, general and administrative expenses, as a
percentage of net sales, were 17%, compared to 18% in the nine months of 2006.
These expenses increased by $3,069,000, or 13%. MTE recorded selling, general
and administrative costs of $2,341,000. Selling, general and administrative
expenses, without MTE, increased by $728,000, or 3%, for the comparable periods.
MTI recorded increased selling costs of $298,000, or 20%, on increased sales of
11%. SLPE recorded a 5% decrease of selling, general and administrative costs on
increased sales of 7%. The decrease in selling, general and administrative
expenses is primarily related to reduced salaries. Teal's expenses increased 8%
and RFL's expenses increased slightly. The Corporate and Other selling, general
and administrative expenses increased $418,000, or 10%, related to the addition
of a senior executive to the corporate staff, stock-based compensation
arrangements and an increase in professional services attributable to litigation
fees, consulting costs for compliance reviews and international tax advice and
planning. These costs were primarily incurred during the first quarter of 2007.
These increases were partially offset by a $224,000 credit recorded in the
second quarter of 2007. This credit is related to the Company's insurance
programs.
DEPRECIATION AND AMORTIZATION
For the nine months of 2007, depreciation and amortization expenses increased by
$902,000, or 50%, compared to prior year. These charges were incurred in
connection with the amortization of intangibles related to the MTE and Ault
acquisitions of $381,000 and $310,000, respectively. Depreciation and
amortization expense for each of the nine months of 2007 and 2006 was
approximately 2% and 1% of net sales, respectively.
INTEREST INCOME (EXPENSE)
For the nine months of 2007, interest income was $33,000, compared to $30,000
for the same period last year. Interest expense was $710,000 for the nine months
of 2007, compared to $452,000 for the nine months of 2006. The increase in
interest expense for 2007 is related to increased debt levels to finance the
acquisitions of Ault and MTE and an increase in interest rates.
TAXES
The effective tax rate for continuing operations for each of the nine months of
2007 and 2006 was approximately 31% and 30%, respectively. 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.
DISCONTINUED OPERATIONS
For each of the nine months of each of 2007 and 2006, the Company recorded
losses from discontinued operations, net of tax, of $1,104,000 and $445,000,
respectively. These amounts represent legal and environmental charges related to
discontinued operations, net of tax.
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
33
facts, contain forward-looking information, particularly statements which
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 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; the timing and degree of any business recovery in certain of the
Company's markets that are currently experiencing economic uncertainty;
increasing prices, products and services offered 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; 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 economic instability in the event of a future terrorist attack or
sharp increases in the cost of energy 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
Part I, Item 1A - Risk Factors in the Company's Annual Report on Form 10-K for
the year ended December 31, 2006.
34
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, 2006, which is incorporated herein by
reference.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES: The Company, under the
supervision and with the participation of its management, including the 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-15e and 15d-15e promulgated
under the Securities Exchange Act of 1934, as amended, (the "Exchange Act").
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer have concluded that (i) the Company's disclosure controls and procedures
were effective as of September 30, 2007, and (ii) no change in internal control
over financial reporting occurred during the quarter ended September 30, 2007,
which has materially effected, or is reasonably likely to materially effect,
such internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Please see Note 10 in the Notes to the Consolidated Financial Statements
included in Part I to this Quarterly Report on Form 10-Q. Also, see Note 12 to
the Consolidated Financial Statements and the Company's Annual Report on Form
10-K for the year ended December 31, 2006, which is incorporated herein by
reference.
ITEM 1A. RISK FACTORS
There have been no material changes in risk factors from the disclosure
contained in Item 1A of the Company's Annual Report on Form 10-K for the year
ended December 31, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On March 26, 2007, the Company announced that its Board of Directors had
authorized the repurchase of up to 560,000 shares of the Company's common stock.
Any repurchases pursuant to the Company's stock repurchase program would be made
if and when management considers appropriate and in the open market or in
negotiated transactions. For the nine months ended September 30, 2007, the
Company purchased 11,801 shares pursuant to the repurchase program. For the nine
month periods ended September 30, 2007 and September 30, 2006, the Company
purchased 86,549 and 43,600 shares, respectively, through its deferred
compensation plans.
35
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 (2)
--------------------- --------- ---------- ----------------- --------------------
January 2007 14,460 (1) $ 16.25 - -
February 2007 42,049 (1) $ 15.30 - -
March 2007 3,680 (1) $ 13.12 - 560,000
April 2007 14,801 (3) $ 15.00 11,801 548,199
May 2007 6,620 (1) $ 16.62 - 548,199
June 2007 1,300 (1) $ 17.15 - 548,199
July 2007 4,300 (1) $ 17.92 - 548,199
August 2007 7,390 (1) $ 21.15 - 548,199
September 2007 3,750 (1) $ 22.11 - 548,199
------ ------- ------ -------
Total 98,350 $ 16.24 11,801 548,199
====== ======= ====== =======
1. The Company purchased these shares other than through a publicly announced
plan or program.
2. The Company had a previously authorized repurchase plan, of which 48,024
shares have yet to be purchased.
3. The Company purchased 3,000 of these shares other than through a publicly
announced plan or program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Pursuant to Section 10A(i)(2) of the Exchange Act, the Company is responsible
for listing the non-audit services performed by Grant Thornton, the Company's
external auditor, in the first nine months of 2007, as approved by its Audit
Committee. During the first nine months of 2007, there were $6,600 of non-audit
services performed by Grant Thornton.
36
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).
37
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 12, 2007 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)
38