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Bel Fuse 10-Q 2011 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
FORM 10-Q
(MARK ONE)
Commission File No. 0-11676
_____________________
BEL FUSE INC.
206 Van Vorst Street
Jersey City, NJ 07302
(201) 432-0463
(Address of principal executive offices and zip code)
(Registrant’s telephone number, including area code)
PART I. Financial Information
Item 1. Financial Statements (Unaudited)
Certain information and footnote disclosures required under accounting principles generally accepted in the United States of America have been condensed or omitted from the following condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. The following condensed consolidated financial statements should be read in conjunction with the year-end consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2010.
The results of operations for the three and six months ended June 30, 2011 are not necessarily indicative of the results for the entire fiscal year or for any other period.
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BEL FUSE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The condensed consolidated balance sheet as of June 30, 2011, and the condensed consolidated statements of operations, stockholders' equity and cash flows for the periods presented herein have been prepared by Bel Fuse Inc. (the "Company" or "Bel") and are unaudited. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the financial position, results of operations, changes in stockholders' equity and cash flows for all periods presented have been made. The results for the three and six months ended June 30, 2011 should not be viewed as indicative of the Company’s annual results or the Company’s results for any other period. The information for the condensed consolidated balance sheet as of December 31, 2010 was derived from audited financial statements. These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Bel Fuse Annual Report on Form 10-K for the year ended December 31, 2010.
On January 29, 2010, the Company completed its acquisition of 100% of the issued and outstanding capital stock of Cinch Connectors, Inc. (“Cinch U.S.”), Cinch Connectors de Mexico, S.A. de C.V. (“Cinch Mexico”) and Cinch Connectors Ltd. (“Cinch Europe”) (collectively “Cinch”) from Safran S.A. Accordingly, as of January 29, 2010, all of the assets acquired and liabilities assumed were recorded at their fair values and the Company’s condensed consolidated results of operations for the six months ended June 30, 2010 include Cinch’s operating results from January 29, 2010 through June 30, 2010. In accordance with the accounting guidance for business combinations, the results of operations and cash flows for the three and six months ended June 30, 2010 have been adjusted retrospectively to reflect measurement period adjustments as if they had been recorded on the date of acquisition. The measurement period adjustments did not have a significant impact on our condensed consolidated statement of operations or cash flows for the three or six months ended June 30, 2010.
Recent Accounting Pronouncements
The Company’s significant accounting policies are summarized in Note 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. There were no significant changes to these accounting policies during the six months ended June 30, 2011. A recent accounting pronouncement that will impact future periods is as follows:
Accounting Standards Update No. 2011-05 – Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU No. 2011-05”)
ASU No. 2011-05 amends existing guidance by allowing only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous statement of comprehensive income or (2) in two separate but consecutive financial statements, consisting of an income statement followed by a separate statement of other comprehensive income. Also, items that are reclassified from other comprehensive income to net income must be presented on the face of the financial statements. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This ASU requires retrospective application, and it is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company will implement the provisions of ASU 2011-05 by presenting the components of net income and other comprehensive income in two separate but consecutive statements beginning in the first quarter of 2012.
The Company utilizes the two-class method to report its (loss) earnings per share. The two-class method is a (loss) earnings allocation formula that determines (loss) earnings per share for each class of common stock according to dividends declared and participation rights in undistributed (loss) earnings. The Company’s Certificate of Incorporation, as amended, states that Class B common shares are entitled to dividends at least 5% greater than dividends paid on Class A common shares, resulting in the two-class method of computing (loss) earnings per share. In computing (loss) earnings per share, the Company has allocated dividends declared to Class A and Class B based on amounts actually declared for each class of stock and 5% more of the undistributed (loss) earnings has been allocated to Class B shares than to the Class A shares on a per share basis. Basic (loss) earnings per common share are computed by dividing net (loss) earnings by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share, for each class of common stock, are computed by dividing net earnings by the weighted-average number of common shares and potential common shares outstanding during the period. There were no potential common shares outstanding during the three or six months ended June 30, 2011 or 2010 which would have had a dilutive effect on (loss) earnings per share.
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The (loss) earnings and weighted-average shares outstanding used in the computation of basic and diluted (loss) earnings per share are as follows (dollars in thousands, except share and per share data):
3. ACQUISITION
On January 29, 2010 (the “Acquisition Date”), the Company completed its acquisition of 100% of the issued and outstanding capital stock of Cinch from Safran S.A. Bel paid $39.7 million in cash and assumed an additional $0.8 million of expenses in exchange for the net assets acquired. The transaction was funded with cash on hand. Cinch is headquartered in Lombard, Illinois and has manufacturing facilities in Vinita, Oklahoma; Reynosa, Mexico; and Worksop, England. The Company has made an election under IRC Section 338(h)10 to step-up the tax basis of the Cinch assets (held by the Cinch U.S., Cinch Mexico and Cinch U.K. entities) acquired to fair value. The elections made under Section 338(h)10 only affect U.S. income taxes (not those of the foreign countries where non-U.S. Cinch entities are incorporated).
Cinch manufactures a broad range of interconnect products for customers in the military and aerospace, high-performance computing, telecom/datacom, and transportation markets. The addition of Cinch’s well-established lines of connector and cable products and extensive clientele has enabled Bel to broaden its customer base to include aerospace and military markets. The acquisition of Cinch has also created the opportunity for expense reduction and the elimination of redundancies. The combination of these factors has given rise to $2.3 million of goodwill ($1.2 million allocated to the Company’s North America operating segment and $1.1 million allocated to the Company’s Europe operating segment).
During the three and six months ended June 30, 2010, the Company expensed $0 and $0.2 million, respectively, of acquisition-related costs. These costs are included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.
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Cinch’s results of operations have been included in the Company’s condensed consolidated financial statements for the period subsequent to the Acquisition Date. Cinch contributed revenues of $24.7 million and estimated net earnings of $0.1 million to the Company for the period from the Acquisition Date through June 30, 2010. The unaudited pro forma information presents the combined operating results of the Company and Cinch. The following unaudited pro forma consolidated results of operations assume that the acquisition of Cinch was completed as of January 1, 2010 (in thousands):
4. FAIR VALUE MEASUREMENTS
The Company utilizes the accounting guidance for fair value measurements and disclosures for all financial assets and liabilities and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the condensed consolidated financial statements on a recurring basis or on a nonrecurring basis during the reporting period. The fair value is an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants based upon the best use of the asset or liability at the measurement date. The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability. The accounting guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers are defined as follows:
Level 1 – Observable inputs such as quoted market prices in active markets
Level 2> – Inputs other than quoted prices in active markets that are either directly or indirectly observable
Level 3> – Unobservable inputs about which little or no market data exists, therefore requiring an entity to develop its own assumptions
As of June 30, 2011 and December 31, 2010, the Company held certain financial assets that are measured at fair value on a recurring basis. These consisted of the Company’s investments in a Rabbi Trust which are intended to fund the Company’s Supplemental Executive Retirement Plan (“SERP”) obligations and other marketable securities described below. These are categorized as available-for-sale securities and are included as other assets in the accompanying condensed consolidated balance sheets at June 30, 2011 and December 31, 2010.
During 2010, the Company purchased equity securities at a purchase price of $1.2 million. During the six months ended June 30, 2011, the Company purchased additional marketable equity securities at a purchase price of $0.1 million and invested $5.0 million in a mutual fund categorized as a fixed income available-for-sale marketable security. As of June 30, 2011 and December 31, 2010, these marketable securities had a fair value of $6.2 million and $1.7 million, respectively, and gross unrealized gains of $0.1 million and $0.5 million, respectively. Such unrealized gains are included, net of tax, in accumulated other comprehensive income. The fair value of the equity securities is determined based on quoted market prices in public markets and is categorized as Level 1. The fair value of the fixed income securities is determined based on other observable inputs, and are therefore categorized as Level 2 in the table below. The Company does not have any financial assets measured at fair value on a recurring basis categorized as Level 3, and there were no transfers in or out of Level 1, Level 2 or Level 3 during the six months ended June 30, 2011 and 2010. There were no changes to the Company’s valuation techniques used to measure asset fair values on a recurring or nonrecurring basis during the six months ended June 30, 2011.
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The following table sets forth by level, within the fair value hierarchy, the Company’s financial assets accounted for at fair value on a recurring basis as of June 30, 2011 and December 31, 2010 (dollars in thousands).
The Level 2 fixed income securities noted in the table above represent the Company’s investment in a fund that consists of debt securities (bonds), primarily U.S. government securities, corporate bonds, asset-backed securities and mortgage-backed securities. The value of the fund is determined based on quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data.
The Company has other financial instruments, such as cash equivalents, accounts receivable, accounts payable and accrued expenses, which are not measured at fair value on a recurring basis but are recorded at amounts that approximate fair value due to their liquid or short-term nature. The Company did not have any other financial liabilities within the scope of the fair value disclosure requirements as of June 30, 2011 or December 31, 2010.
Nonfinancial assets and liabilities, such as goodwill, indefinite-lived intangible assets and long-lived assets, are accounted for at fair value on a nonrecurring basis. These items are tested for impairment on the occurrence of a triggering event or, in the case of goodwill, on at least an annual basis. There were no triggering events that occurred during the six months ended June 30, 2011 or 2010 that would warrant interim impairment testing.
5. INVENTORIES
The components of inventories are as follows (dollars in thousands):
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6. BUSINESS SEGMENT INFORMATION
The Company operates in one industry with three reportable operating segments, which are geographic in nature. The segments consist of North America, Asia and Europe. The primary criteria by which financial performance is evaluated and resources are allocated are revenues and operating income. The following is a summary of key financial data (dollars in thousands):
The following items are included in the income (loss) from operations presented above:
Litigation Charges – During the second quarter of 2011, the Company recorded $3.2 million of litigation charges related to ongoing lawsuits, as further described in Note 11. These charges primarily impacted the Company’s Asia operating segment.
Segment Revenues – Segment revenues are attributed to individual segments based on the geographic source of the billing for such customer sales. Transfers between geographic areas include finished products manufactured in foreign countries which are then transferred to the United States and Europe for sale; finished goods manufactured in the United States which are transferred to Europe and Asia for sale; and semi-finished components manufactured in the United States which are sold to Asia for further processing. Income (loss) from operations represents net sales less operating costs and expenses.
7. INCOME TAXES
As of June 30, 2011 and December 31, 2010, the Company has approximately $4.2 million and $3.8 million, respectively, of liabilities for uncertain tax positions ($1.0 million and $0.9 million, respectively, included in income taxes payable and $3.2 million and $2.9 million, respectively, included in liability for uncertain tax positions) all of which, if reversed, would reduce the Company’s effective tax rate.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. The Company is no longer subject to U.S. federal examinations by tax authorities for years before 2007 and for state examinations before 2005. Regarding foreign subsidiaries, the Company is no longer subject to examination by tax authorities for years before 2003 in Asia and generally 2005 in Europe. During September 2010 and April 2011, the Company was notified of an Internal Revenue Service (“IRS”) tax audit for the years ended December 31, 2004 through 2009. The Company believes the audit is a result of various carryback claims to the years ended December 31, 2004, 2005 and 2006. As the statute of limitations for the years 2004, 2005 and 2006 has expired, any tax adjustment proposed by the IRS for these years would be limited to the amount of the carryback claims of approximately $2.5 million.
As a result of the expiration of the statute of limitations for specific jurisdictions, it is reasonably possible that the related unrecognized benefits for tax positions taken regarding previously filed tax returns may change materially from those recorded as liabilities for uncertain tax positions in the Company’s condensed consolidated financial statements at June 30, 2011. A total of $1.0 million of previously recorded liabilities for uncertain tax positions relates to the 2007 tax year. The statute of limitations related to this liability is scheduled to expire on September 15, 2011.
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The Company’s policy is to recognize interest and penalties related to uncertain tax positions as a component of the current provision for income taxes. During the six months ended June 30, 2011 and 2010, the Company recognized $0.1 million and $0.2 million, respectively, in interest and penalties in the condensed consolidated statements of operations. The Company has approximately $0.6 million and $0.4 million accrued for the payment of interest and penalties at June 30, 2011 and December 31, 2010, respectively, which is included in both income taxes payable and liability for uncertain tax positions in the condensed consolidated balance sheets.
In connection with the Cinch acquisition, the Company acquired certain tax assets and liabilities. Cinch Europe had net operating loss and capital loss carryforwards in the amounts of $0.6 million and $0.2 million, respectively, as of the acquisition date. The related tax benefits were $0.2 million and $0.1 million, respectively. The capital loss carryforward was acquired with a valuation allowance, which the Company maintained at June 30, 2011. During the year ended December 31, 2010, the entire $0.6 million net operating loss was utilized. Additionally, Cinch Europe had a deferred tax liability in the amount of $0.1 million for various timing differences and $0.1 million in refundable income taxes. Cinch U.S. had a deferred tax asset in the amount of $0.1 million relating to vacation accruals, $0.1 million of net refundable income tax and a deferred tax asset related to inventory capitalization in the amount of $0.2 million at the time of the acquisition. Of these amounts, $0.1 million of net refundable income tax remains on the condensed consolidated balance sheet as of June 30, 2011. Cinch Mexico was acquired with a refundable income tax in the amount of $0.1 million, which was applied to current year income tax for 2010. The Company has received a fair market value report of property, plant and equipment, and intangibles related to Cinch Europe and Cinch Mexico which resulted in the establishment of deferred tax liabilities at the date of acquisition in the amounts of $0.4 million and an immaterial amount, respectively. At June 30, 2011, a deferred tax liability of $0.3 million remains on the condensed consolidated balance sheet. None of the reversals of the deferred tax asset or deferred tax liabilities or use of NOL carryforwards acquired from the Cinch acquisition will impact the condensed consolidated statement of operations.
The Company has made an election under IRC Section 338(h)10 to step-up the tax basis of the Cinch assets (held by the Cinch U.S., Cinch Mexico and Cinch U.K. entities) acquired to fair value. The elections made under Section 338(h)10 only affect U.S. income taxes (not those of the foreign countries where non-U.S. Cinch entities are incorporated).
On August 10, 2010, President Obama signed into law the “Education Jobs & Medicaid Assistance Act” (H.R. 1586) (the “Act”). The Act’s international tax provisions place certain restrictions on the use of foreign tax credits. The Company has evaluated the newly-enacted international tax provisions and determined that they do not materially affect the Company’s operating results or financial condition.
The Company continues to monitor proposed legislation affecting the taxation of transfers of U.S. intangible property and other potential tax law changes.
8. ACCRUED EXPENSES
Accrued expenses consist of the following (dollars in thousands):
Accrued Restructuring Costs
Activity and liability balances related to restructuring charges for the six months ended June 30, 2011 are as follows (these charges are associated with the 2008 closure of the Company’s facility in Westborough, Massachusetts):
The Company has included the current portion of $0.2 million in accrued restructuring costs in the condensed consolidated balance sheet at June 30, 2011, and has classified the remaining $0.2 million of the liability related to the facility lease obligation as noncurrent.
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9. RETIREMENT FUND AND PROFIT SHARING PLAN
The Company maintains a domestic 401(k) plan, which consists of profit sharing, contributory stock ownership and individual voluntary savings to provide non-defined retirement benefits for plan participants. The expense for the three months ended June 30, 2011 and 2010 amounted to approximately $0.1 million in each period. The expense for the six months ended June 30, 2011 and 2010 amounted to approximately $0.3 million in each period. As of June 30, 2011, the plans owned 15,926 and 227,760 shares of Bel Fuse Inc. Class A and Class B common stock, respectively.
The Company’s subsidiaries in Asia have a non-defined retirement fund covering substantially all of their Hong Kong-based full-time employees. The expense for the three months ended June 30, 2011 and 2010 amounted to approximately $0.1 million in each period and the expense for the six months ended June 30, 2011 and 2010 amounted to approximately $0.1 million in each period. As of June 30, 2011, the plan owned 3,323 and 17,342 shares of Bel Fuse Inc. Class A and Class B common stock, respectively.
The SERP is designed to provide a limited group of key management and highly compensated employees of the Company with supplemental retirement and death benefits.
The components of SERP expense are as follows (dollars in thousands):
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10. COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income for the three and six months ended June 30, 2011 and 2010 consists of the following (dollars in thousands):
The components of accumulated other comprehensive income (loss) as of June 30, 2011 and December 31, 2010 are summarized below (dollars in thousands):
11. LEGAL PROCEEDINGS
The Company is, from time to time, a party to litigation arising in the normal course of its business, including various claims of patent infringement. See the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 for the details of Bel’s material pending lawsuits. Updates to pending litigation since the Company’s Form 10-K filing are described below.
The Company is a defendant in a lawsuit captioned SynQor, Inc. v. Artesyn Technologies, Inc., et al. brought in the United States District Court, Eastern District of Texas in November 2007. The plaintiff alleged that eleven defendants, including Bel, infringed its patents covering certain power products. With respect to the Company, the plaintiff claimed that the Company infringed its patents related to unregulated bus converters and/or point-of-load (POL) converters used in intermediate bus architecture power supply systems. The case went to trial in December 2010 and a judgment was entered on December 29, 2010. The jury found that certain products of the defendants directly and/or indirectly infringe the SynQor patents. The jury awarded damages of $8.1 million against the Company, which was recorded by the Company as a litigation charge in the statement of operations in the fourth quarter of 2010. On July 11, 2011, the Court awarded supplemental damages of $2.5 million against the Company. Of this amount, $1.9 million is covered through an indemnification agreement with one of Bel’s customers. The additional expense to Bel of $0.6 million was recorded as a litigation charge in the statements of operations during the three and six months ended June 30, 2011. The Company is in the process of appealing the verdict and judgment. The Company has been advised that the full amount of the damage awards will need to be placed in escrow upon filing of the notice of appeal. The form of escrow is not yet determined.
The Company was a defendant in a lawsuit captioned Halo Electronics, Inc. (“Halo”) v. Bel Fuse Inc., Pulse Engineering, Inc. and Technitrol, Inc. brought in Nevada Federal District Court. The plaintiff claimed that the Company had infringed its patents covering certain surface mount discrete magnetic products made by the Company. Halo sought unspecified damages, which it claimed should be trebled. In December 2007, this case was dismissed by the Nevada Federal District Court for lack of personal jurisdiction. Halo then re-filed this suit, with similar claims against the Company, in the Northern California Federal District Court, captioned Halo Electronics, Inc. v. Bel Fuse Inc., Elec & Eltek (USA) Corporation, Wurth Electronics Midcom, Inc., and Xfmrs, Inc. In June 2011, a memorandum of understanding was signed by the Company and Halo with regard to this lawsuit, whereby the Company has agreed to pay Halo a royalty on past sales. The Company recorded a $2.6 million liability related to past sales during the second quarter of 2011. This is included as a litigation charge in the accompanying condensed consolidated statement of operations for the three and six months ended June 30, 2011. Bel has also agreed to take a license with respect to the Halo patents at issue in the lawsuit and pay an 8% royalty on all net worldwide sales of the above-mentioned products from June 7, 2011 through August 10, 2015.
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The Company is a plaintiff in a lawsuit captioned Bel Fuse Inc. v. Halo Electronics, Inc. brought in the United States District Court of New Jersey during June 2007. The Company claims that Halo has infringed a patent covering certain integrated connector modules made by Halo. The Company is seeking an unspecified amount of damages plus interest, costs and attorney fees. In June 2011, a memorandum of understanding was signed by the Company and Halo with regard to this lawsuit, whereby Halo has agreed to pay the Company a 10% royalty related to its net worldwide sales of its integrated connector modules in exchange for a fully paid-up license of the Bel patent. This royalty income has been included in net sales in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2011.
12. RELATED PARTY TRANSACTIONS
As of June 30, 2011, the Company has $2.0 million invested in a money market fund with GAMCO Investors, Inc., a current stockholder of the Company, with holdings of its Class A stock of approximately 30.5%.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Company’s quarterly and annual operating results are impacted by a wide variety of factors that could materially and adversely affect revenues and profitability, including the risk factors described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. As a result of these and other factors, the Company may experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect its business, financial condition, operating results, and stock prices. Furthermore, this document and other documents filed by the Company with the Securities and Exchange Commission (the “SEC”) contain certain forward-looking statements under the Private Securities Litigation Reform Act of 1995 (“Forward-Looking Statements”) with respect to the business of the Company. These Forward-Looking Statements are subject to certain risks and uncertainties, including those detailed in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, which could cause actual results to differ materially from these Forward-Looking Statements. The Company undertakes no obligation to publicly release the results of any revisions to these Forward-Looking Statements which may be necessary to reflect events or circumstances after the date such statements are made or to reflect the occurrence of unanticipated events. An investment in the Company involves various risks, including those which are detailed from time to time in the Company’s SEC filings.
Overview
Our Company
Bel is a leading producer of electronic products that help make global connectivity a reality. The Company designs, manufactures and markets a broad array of magnetics, modules, circuit protection devices and interconnect products. These products are designed to protect, regulate, connect, isolate or manage a variety of electronic circuits. Bel’s products are primarily used in the networking, telecommunications, computing, military, aerospace and transportation industries. Bel’s portfolio of products also finds application in the automotive, medical and consumer electronics markets.
Bel’s business is operated through three geographic segments: North America, Asia and Europe. During the six months ended June 30, 2011, 43% of the Company’s revenues were derived from Asia, 45% from North America and 12% from its Europe operating segment. The Company’s revenues are primarily driven by working closely with customers’ engineering staffs and aligning new and existing product offerings with industry standards committees and various integrated circuit (IC) manufacturers. Sales of the Company’s interconnect products represented approximately 37% of our total net sales for the six months ended June 30, 2011. The remaining revenues related to sales of the Company’s modules products (31%), magnetic products (28%) and circuit protection products (4%).
The Company’s expenses are driven principally by the cost of labor where Bel’s factories are located, the cost of the materials that it uses and its ability to efficiently manage overhead costs. As labor and material costs vary by product line, any significant shift in product mix has an associated impact on the Company’s costs of sales. Bel generally enters into processing arrangements with several independent suppliers of wire-wound components in Asia. Costs are recorded as incurred for all products manufactured. Such amounts are determined based upon the estimated stage of production and include labor cost and fringes and related allocations of factory overhead. The Company’s products are manufactured at various facilities in the People’s Republic of China (“PRC”); Glen Rock, Pennsylvania; Inwood, New York; Haina, Dominican Republic; Reynosa and Cananea, Mexico; Louny, Czech Republic; Vinita, Oklahoma; and Worksop, England.
In the PRC, where the Company generally enters into processing arrangements with several independent third-party contractors and also has its own manufacturing facilities, the availability of labor is cyclical and is significantly affected by the migration of workers in relation to the annual Lunar New Year holiday as well as economic conditions in the PRC. In addition, the Company has little visibility into the ordering habits of its customers and can be subjected to large and unpredictable variations in demand for its products. Accordingly, the Company must continually recruit and train new workers to replace those lost to attrition each year and to address peaks in demand that may occur from time to time. These recruiting and training efforts and related inefficiencies, and overtime required in order to meet demand, can add volatility to the costs incurred by the Company for labor in the PRC.
Trends Affecting our Business
The Company believes the key factors affecting Bel’s six months ended June 30, 2011 and/or future results include the following:
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Bel is expecting a competitive atmosphere for the remainder of 2011. As lead times have stabilized, we believe that customers will again be focused on pricing rather than delivery. Bel continues to address pricing issues from customers, while managing the rising costs of raw materials and assembly labor. In addition, the Company is working to manage its fixed and indirect costs in light of the recent shift in product mix.
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Summary by Reportable Operating Segment
Net sales to external customers by reportable operating segment for the three and six months ended June 30, 2011 and 2010 were as follows (dollars in thousands):
Income (loss) from operations by reportable operating segment for the three and six months ended June 30, 2011 and 2010 were as follows (dollars in thousands):
The shift in net sales among the Company’s reportable operating segments during the first half of 2011 was primarily due an $11.7 million increase in sales of a product line within the modules product group which is manufactured in China but sold to third parties in North America. In addition, the Cinch acquisition brought in an additional $8.8 million in sales during Bel’s first half of 2011 as compared to the first half of 2010, primarily in the North America operating segment and to a lesser extent in the Europe operating segment. The Company recorded $3.2 million in litigation charges during the second quarter of 2011, which primarily impacted the Company’s Asia operating segment. See Note 6 to the notes to condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q for additional segment discussion.
Overview of Financial Results
Strong shipments of modules and interconnect products drove record revenue for the second quarter and first half of 2011. Bel’s growing modules product business, which typically has higher material content thus resulting in lower average profit margins, reduced the second quarter gross margin percentage. In addition, there has been ongoing cost pressure due to mandated wage increases in China, as well as price increases on certain components. There were also developments in two of the Company’s lawsuits during the second quarter of 2011, resulting in litigation charges of $3.2 million during the quarter.
Bel’s sales increased by 1.9% during the second quarter of 2011 as compared to the second quarter of 2010, while cost of sales increased 6.2% compared to last year’s second quarter. This is primarily due and a shift in product mix, as the Company manufactured a higher volume of product with higher material content. As an offsetting factor, labor costs were lower in 2011 associated with the smoother transition out of the Lunar New Year holiday than what was experienced in 2010. Selling, general and administrative expenses increased by $0.1 million during the second quarter 2011 as compared to the second quarter of 2010. Additional details related to these factors affecting the second quarter results are described in the Results of Operations section below.
During the six months ended June 30, 2011, the Company experienced a 12.5% increase in sales as compared to the first half of 2010. Of this increase, 6.6% relates to the inclusion of a full six months of Cinch’s sales volume in 2011, as compared to five months of Cinch’s sales volume in the first half of 2010, combined with an increase in Cinch’s sales volume versus the prior year. The remaining 5.9% increase related to Bel sales growth due to a rebound in demand for legacy Bel products, primarily in modules products. Cost of sales increased by 12.7% during the first half of 2011 compared to 2010 due to the same factors described above. Selling, general and administrative expenses increased by $1.0 million during the first half of 2011 as compared to the first half of 2010, primarily due to the inclusion of a full six months of Cinch’s expenses in 2011, as compared to five months of Cinch’s expenses in the first half of 2010, as well as increased legal costs associated with the Halo and SynQor lawsuits. Additional details related to these factors affecting the six-month results are described in the Results of Operations section below.
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Critical Accounting Policies
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to product returns, bad debts, inventories, goodwill, intangible assets, investments, SERP expense, income taxes and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Recent Accounting Pronouncements
The Company’s significant accounting policies are summarized in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. There were no significant changes to these accounting policies during the six months ended June 30, 2011. A recent accounting pronouncement that will impact future periods is as follows:
Accounting Standards Update No. 2011-05 – Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU No. 2011-05”)
ASU No. 2011-05 amends existing guidance by allowing only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous statement of comprehensive income or (2) in two separate but consecutive financial statements, consisting of an income statement followed by a separate statement of other comprehensive income. Also, items that are reclassified from other comprehensive income to net income must be presented on the face of the financial statements. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This ASU requires retrospective application, and it is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company will implement the provisions of ASU 2011-05 in the first quarter of 2012.
Results of Operations
The following table sets forth, for the periods presented, the percentage relationship to net sales of certain items included in the Company’s condensed consolidated statements of operations.
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The following table sets forth the year over year percentage increase (decrease) of certain items included in the Company's condensed consolidated statements of operations.
Sales
Net sales increased 1.9% from $77.7 million during the three months ended June 30, 2010 to $79.2 million during the three months ended June 30, 2011. Net sales increased 12.5% from $133.8 million during the six months ended June 30, 2010 to $150.6 million during the six months ended June 30, 2011. The Company’s net sales by major product line for the three and six months ended June 30, 2011 and 2010 were as follows (dollars in thousands):
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