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Black Box 10-K 2007 Documents found in this filing:Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
(Mark One)
For the fiscal year ended March 31, 2007
OR
For the transition period from to
Commission File Number: 0-18706
Black Box Corporation
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: 724-746-5500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. o Yes þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. o Yes þ No
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. o Yes þ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§
229.405 of this chapter) is not contained herein, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K.
þ
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. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). o Yes þ No
The aggregate market value of the voting stock held by non-affiliates of the registrant as of
September 30, 2006 (based on closing price of such stock as reported by NASDAQ on such date) was
$669,187,795. For purposes of this calculation only, directors and executive officers of the
registrant and their affiliates are deemed to be affiliates of the registrant.
As of August 7, 2007, there were 17,527,227 shares of common stock, par value $.001 (the “common
stock”), outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for 2007 Annual Meeting of Stockholders (the “Proxy Statement”) -- Part II and III
BLACK BOX CORPORATION
FOR THE FISCAL YEAR ENDED MARCH 31, 2007 INDEX
Table of Contents
EXPLANATORY NOTE
In this Annual Report on Form 10-K for the fiscal year ended March 31, 2007 (“Form 10-K”), Black
Box Corporation (“Black Box” or the “Company”) is restating its Consolidated Balance Sheets at
March 31, 2006, its Consolidated Statements of Income for the years ended March 31, 2006 and 2005,
its Consolidated Statements of Changes in Stockholders’ Equity for the years ended March 31, 2006
and 2005 and as of April 1, 2004, its Consolidated Statements of Cash Flows for the years ended
March 31, 2006 and 2005, its quarterly financial data as of and for all quarters ended in the
fiscal year ended March 31, 2006 and the first two quarters ended in the fiscal year ended March
31, 2007 and its Selected Financial Data as of and for the years ended March 31, 2006, 2005, 2004
and 2003. This Form 10-K also restates “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” presented in the Company’s Annual Report on Form 10-K for the
fiscal year ended March 31, 2006 as it relates to the fiscal years ended March 31, 2006 and 2005.
All restated information identified above is collectively referred to as the “Restatement.”
References herein to “Fiscal Year” or “Fiscal” mean the Company’s fiscal year ended March 31 for
the year referenced.
The Restatement reflects adjustments arising from the determinations of the Audit Committee (the
“Audit Committee”) of the Company’s Board of Directors (the “Board”), with the assistance of outside
legal counsel, and the Company’s management to record additional non-cash charges for stock-based
compensation expense and the related income tax effects relating to certain stock option grants
during the period from 1992 through September, 2006. Additionally, the Company has recorded an
adjustment to its financial statements for the quarter ended September 30, 2006 to reflect the
proper accounting treatment for its interest rate swap.
The Company has not amended and does not intend to amend any of its previously-filed reports on
Form 10-K or Form 10-Q for the periods affected by the Restatement other than its previously-filed
Quarterly Report on Form 10-Q/A for the three (3) month period ended July 1, 2006, its
previously-filed Quarterly Report on Form 10-Q/A for the three (3) and six (6) month periods ended
September 30, 2006 and its previously-filed Quarterly Report on Form 10-Q for the three (3) and
nine (9) month periods ended December 30, 2006. As previously disclosed and except as set forth in
the filings specifically referenced herein, the consolidated financial statements and related
financial information contained in previously-filed reports should no longer be relied upon.
Restatement through March 31, 2006
Background
On November 13, 2006, Black Box received a letter of informal inquiry from the Enforcement Division
of the Securities and Exchange Commission (the “SEC”) relating to the Company’s stock option
practices from January 1, 1997 to present. As a result, the Audit Committee, with the assistance
of outside legal counsel, commenced an independent review of the Company’s historical stock option
grant practices and related accounting for stock option grants during the period from 1992 to the
present (the “Review Period”).
On February 1, 2007, the Company announced that, while the review of option grant practices was
continuing, it believed that it would need to record additional non-cash charges for stock-based
compensation expense relating to certain stock option grants and, accordingly, cautioned investors
about relying on its historical financial statements until the Company could determine with
certainty whether a restatement would be required and, if so, the extent of any such restatement
and the periods affected.
On March 19, 2007, although the Audit Committee had not yet completed its review, the Audit
Committee concluded that the exercise price of certain stock option grants differed from the fair
market value of the underlying shares on the appropriate measurement date. At that time, the
Company and the Audit Committee announced that it was currently expected that the Company’s
additional non-cash, pre-tax charges for stock-based compensation expense relating to certain stock
option grants would approximate $63 million for the Review Period. In addition, the Company and
the Audit Committee concluded that the Company would need to restate its previously-issued
financial statements contained in reports previously filed by the Company with the SEC.
Accordingly, on March 19, 2007, the Company and the Audit Committee concluded that the Company’s
previously-issued financial statements and other historical financial information and related
disclosures for the Review Period, including applicable reports of its current or former
independent registered public accounting firms and related press releases, should not be relied
upon.
On May 25, 2007, the Company was advised by the Enforcement Division of the SEC that a Formal Order
of Private Investigation arising out of the Company’s stock option practices had been entered and
on May 29, 2007 the Company received a subpoena that was issued by the SEC.
On May 31, 2007, the Company announced that, as a result of the ongoing review of stock option
practices, Company management and the Audit Committee expected that the Company’s additional
non-cash, pre-tax charges for stock-based compensation expense relating to certain stock option
grants would approximate $70 million for the Review Period.
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Findings of the Audit Committee
During the Review Period, the Company granted stock options pursuant to an employee stock option
plan and a director stock option plan to acquire approximately 10.9 million shares of common stock.
Such plans at all relevant times provided for option grants to be approved by a designated
committee of non-employee directors or, in the case of the director stock option plan, by the
Board. Approximately 2,000 stock option grants were awarded during the Review Period with 69
recorded grant dates. No stock options have been granted since September, 2006. The Audit
Committee reviewed all stock options granted during the Review Period, including option grants to
the Company’s directors, officers and rank and file employees (including grants to new employees,
grants awarded in connection with Company acquisitions and grants made as individual or group
performance awards). The Audit Committee’s review of the Company’s stock option granting practices
included a comprehensive examination of reasonably available relevant physical and electronic
documents as well as interviews with current and former directors, officers and Company personnel.
The Audit Committee’s review was initially focused on determining whether the Company’s prior stock
option granting practices were in compliance with the plans’ granting provisions and applicable law
or called into question its accounting for such options. Once it became evident that such issues
and accounting implications existed, the inquiry focused on those matters necessary: to determine
whether any accounting charges were material and whether a restatement of the Company’s
previously-issued financial statements would be required; to establish a basis for effecting any
required restatement; to assure that, on as timely a basis as possible, the Company could file any
required curative disclosures with the SEC and assure its continued eligibility for listing on The
NASDAQ Stock Market (“NASDAQ”); and to provide an informed basis for the Company’s response to the
identified issues, including appropriate corrective and remedial actions.
The following information summarizes certain of the findings of the Audit Committee. The findings
identified approximately $71.5 million of unrecorded expense at the time of grant (i.e., the
difference between the fair market value of the common stock on the appropriate measurement date
and the stated exercise price), net of forfeitures, during the Review Period, of which $70.0
million was recorded in the Company’s consolidated financial statements through March 31, 2006 and
$1.5 million of unrecorded expense at the time of grant will be included, beginning at April 1,
2006, in the Company’s computation of compensation expense in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS
123(R)”). The following summarizes the unrecorded expense at the time of grant by time period and
category of recipient:
The Audit Committee’s additional key findings are summarized below:
Lack of Adequate Documentation: For a majority of grants issued by the Company during the
Review Period, there is either no or inadequate documentation of approval actions that satisfies
the requisites for establishing a measurement date under Accounting Principles Board Opinion No.
25, “Accounting for Stock Issued to Employees” (“APB 25”). Of the 69 recorded grant dates, there
are documented approval actions by the Board or the Option or Compensation Committee of the Board
(the “Compensation Committee”) with respect to particular grants for 12 dates. In the period
December, 1992 to May, 1996, neither the minutes of the Compensation Committee nor of the Board
reflect any action to approve specific grants. In some instances, evidence of single director (the
chairman of the Compensation Committee) approval actions exists. This absence of non-employee
director level documentation also applies to a majority of grants with a recorded grant date after
1996. In some cases, Compensation Committee minutes contain a reference to reports on the status
of the option pool but do not document any action to approve specific grants. Approval
documentation for certain grants has internal inconsistencies or conflicts with other documents
thereby rendering this documentation unreliable as a basis for establishing a measurement date. In
some cases, the only existing documentation is the executed option agreement and/or the entry of
the option grant into the option database. Notwithstanding these approval documentation
inadequacies, the Company entered into option agreements with grantees and has honored such grants.
Grant Approvals: During the Review Period, relatively few option grants were approved in
complete compliance with the Company’s stock option plans. Available documentation reflects that
the Company approved option grants in a variety of ways. With respect to the employee stock option
plan, grants were approved by the Compensation Committee as contemplated by the plan at various
times, by the full Board in 1998 and 1999, by a single director (the chairman of the Compensation
Committee) on nine recorded grant dates during the period 1994 through 2001 and by the Company’s
Chief Executive Officer (“CEO”) at various times. With respect to the director stock option plan,
grants were generally approved by the designated Board committee and, in a few cases, by the
chairman of the Compensation Committee. In one instance in 2000, there is no conclusive
documentary evidence of the approval of director grants other than the signed director option
agreements.
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The delegation of authority by the Compensation Committee to the CEO with respect to grants to rank
and file employees was not fully documented. However, there was an understood and accepted
practice between the CEO and the Compensation Committee whereby the CEO made certain awards to
individual employees. In some instances, this involved the allocation among rank and file
employees of blocks of shares approved by the Compensation Committee; in three (3) such instances,
the number of shares ultimately awarded pursuant to this process exceeded the approved size of the
block, which was contrary to the understanding of the Compensation Committee members. Further,
contrary to the understanding of the Compensation Committee members, the award and/or documentation
of those individual grants often significantly lagged the approval of the block grant. In August
2005, the Compensation Committee specifically acknowledged a prior grant of delegated authority to
the CEO to make option grants to rank and file employees and ratified all prior awards by the CEO.
In some cases, documentation of approval action is either inconclusive or missing, and the Company
therefore has been unable to determine what entity or person actually approved specific grants.
Option Pricing: The recorded grant dates for a majority of grants do not match the
applicable measurement dates as determined under APB 25. The grants of options with exercise
prices lower than the fair market values of the stock on the actual measurement dates did not
satisfy the fair market pricing requirement in the Company’s plans, as amended in 1998, and were
not consistent with the Company’s disclosures in SEC filings stating that the exercise price of
options was equal to the fair market value of the stock on the date of the grant.
The relationship between the stated exercise price of options and the fair market value of the
Company’s stock on the date of the identifiable approval actions varied from grant to grant. In
some cases, the exercise price of grants reflected the fair market value of the underlying shares
on the date of any documented approval action. In other cases, the exercise prices reflected the
fair market value of the underlying shares on a date either prior or subsequent to any such
documented approval action and the exercise price was lower than the fair market value on the date
of any such action. In several such cases before August 2002, the use of such grant dates and
lower exercise prices (together with other available evidence) supports a finding that the recorded
grant dates and corresponding exercise prices were selected with the benefit of hindsight. For
certain grants where the mismatch between the recorded grant date and the approval action was only
a matter of days, however, the mismatch appears to have been attributable to inaccurate recording
or administrative delays. In some cases, the apparent approval action did not identify all
grantees; for example, there are cases where a block grant was approved subject to a later
determination of individual grant recipients and grants were recorded with a grant date, and
corresponding exercise price, that matched the date of the apparent approval of the block grant and
the fair market value of the common stock on that date although individual grant recipients may
have been identified some time after approval of the block grant. Finally, in some cases, the
approval action for specific grants is not adequately documented. Where the recorded grant date
did not satisfy the requisites for a measurement date under APB 25, the Company relied on default
methodologies to determine an appropriate measurement date.
Internal Controls: As outlined above, the Company’s historical administration of its
options program lacked discipline as it relates to proper adherence to the plan requirements,
corporate recordkeeping and documentation. Since November 2003, however, the Company has properly
administered the stock option program as it relates to awards to directors and officers. During
the investigation, the Company identified control gaps related to grants made throughout the Review
Period. As of March 31, 2007, the Company implemented additional procedures to its process that
are focused on formalized documentation of appropriate approvals and determination of grant terms
to employees.
Procedural and Remedial Actions
The Audit Committee and other relevant Board committees are committed to a continued review and
implementation of procedural enhancements and remedial actions in light of the foregoing findings.
Consistent with its obligation to act in the best interests of the Company taking into account all
relevant facts and circumstances, the Audit Committee is continuing to assess the appropriateness
of a broad range of possible procedural enhancements and potential remedial measures in light of
the findings of its review.
While the Audit Committee has not completed its consideration of all such steps, procedural
enhancements may include recommendations regarding improved stock option administration procedures
and controls, training and monitoring compliance with those procedures, corporate recordkeeping,
corporate risk assessment, evaluation of the internal compliance environment and other remedial
steps that may be appropriate. Any such procedural enhancements will be recommended by the Audit
Committee to the Board and/or appropriate Board committee for adoption. In advance of action by
the Audit Committee, as noted above, the Company has implemented additional procedures to its
process for approving stock option grants that are focused on formalized documentation of
appropriate approvals and determination of grant terms to employees.
In light of the findings of the Audit Committee’s review, William F. Andrews, Thomas W. Golonski
and Thomas G. Greig, three current directors who also served during portions of the Review Period
and who hold options as to which the measurement date was adjusted in connection with the Company’s
restatement, agreed voluntarily to reprice those outstanding options with a recorded exercise price
less than the fair market value of the common stock on the accounting measurement date as
determined by the Audit Committee so that the exercise price matches the fair market value of the
common stock on such accounting measurement date. In addition, Michael McAndrew, who became the
Company’s Chief Financial Officer (“CFO”) in December, 2002, also agreed voluntarily to
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reprice the one option granted to him after he became CFO with a recorded
exercise price less than the fair market value of the common stock on the accounting measurement
date as determined by the Audit Committee so that the exercise price matches the fair market value
of the common stock on such accounting measurement date.
The Audit Committee’s ongoing review includes an evaluation of the role of and possible claims or
other remedial actions against current and former Company personnel who may be found to have had
responsibility for identified problems during the Review Period. Accordingly, the Audit Committee
has begun to address and is addressing and expects to continue to address issues of individual
conduct or responsibility, including those of the Board, CEOs and Chief Financial Officers (“CFOs”)
serving during the Review Period. In connection therewith, based on the findings of the Audit
Committee as to Fred C. Young, the Company’s former CEO who resigned on May 20, 2007, the Audit
Committee concluded and recommended to the Board, and the Board determined, that Mr. Young could
have been terminated due to Cause for Termination (as defined in his agreement dated May 11, 2004)
at the time Mr. Young resigned as a director and officer of the Company on May 20, 2007. In light
of that determination and the terms of the agreements with Mr. Young, all outstanding stock options
held by Mr. Young terminated as of the date of his resignation.
The Audit Committee may recommend additional remedial measures that appropriately address the
issues raised by its findings. Such potential remedial measures may include possible claims or
other remedial actions against current and former Company personnel who may be found to have been
responsible for identified problems during the Review Period.
Restatement Methodologies
As of April 1, 2006, the Company adopted SFAS 123(R) using the modified prospective transition
method. Under this transition method, compensation expense is to be recognized for all share-based
compensation awards granted after the date of adoption and for all unvested awards existing on the
date of adoption. Prior to April 1, 2006, the Company accounted for stock-based compensation
awards to directors, officers and rank and file employees using the intrinsic value method in
accordance with APB 25 as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation”
(“SFAS 123”). Under the intrinsic value method, no share-based compensation expense related to
stock options was required to be recognized if the exercise price of the stock option was at least
equal to the fair market value of the common stock on the “measurement date.” APB 25 defines the
measurement date as the first date on which are known both (1) the number of shares that an
individual grant recipient is entitled to receive and (2) the option or purchase price, if any.
In light of the Audit Committee’s review of the Company’s stock option granting practices during
the Review Period and as to those cases in which the Company previously used a recorded grant date
as the measurement date that the Company determined could no longer be relied upon, the Company has
developed and applied the following methodologies to remeasure those stock option grants and record
the relevant charges in accordance with APB 25 by considering the following sources of information:
(i) meeting minutes of the Board and of committees thereof and related materials, (ii) Unanimous
Written Consents of the Board and of committees thereof, (iii) the dates on which stock option
grants were entered into the Company’s stock option database (“create date”), (iv) relevant email
correspondence reflecting stock option grant approval actions, (v) individual stock option
agreements and related materials, (vi) employee and Board offer letters, (vii) documents relating
to acquisitions, (viii) reports on Form 4 filed with the SEC and (ix) guidance of the Office of the
Chief Accountant of the SEC on stock option matters as set forth in its letter dated September 19,
2006.
Grants with Appropriate Committee Approval. With respect to grants of approximately 1.0 million
shares, or approximately 9% of the total grants in the Review Period, the Company has evidence to
support the approval of the grant under the stock option plans by the relevant committee of the
Board, and such evidence includes the number of options each individual was entitled to receive and
the option price. However, the relationship between these documented approval actions and the
originally-recorded grant dates and exercise prices for the options so approved varied during the
Review Period. In some cases, grants were recorded with a grant date and a corresponding exercise
price that matched the date of the approval action or were otherwise consistent with the terms of
the approval action. In other cases, however, the recorded grant dates and corresponding exercise
prices of the grants reflected the fair market value of the common stock on a date prior to the
committee’s documented approval actions. The Company has restated the compensation expense for
stock option grants relating to approximately 0.4 million shares of common stock by using the date
of the documented approval action as the measurement date. The total additional non-cash, pre-tax
charge for these grants is approximately $1.8 million, net of forfeitures, amortized over the
appropriate vesting period through March 31, 2006, of which $0.07 million relates to director
options, $1.3 million relates to officer options and $0.4 million relates to rank and file employee
options.
Grants with Other Approvals. With respect to grants of approximately 1.9 million shares, or
approximately 18% of the total grants in the Review Period, the Company has evidence to support the
approval of the grant by the Board, an outside director or the Company’s CEO and the identification
of the number of options each individual was entitled to receive together with the option price.
These grants are distinguished from the grants described in the prior paragraph in that the nature
of the approval was not fully consistent with the terms of the relevant stock option plan. As with
the grants discussed in the preceding paragraph, the relationship between these documented approval
actions and the originally-recorded grant dates and exercise prices for the options so approved
varied during the Review Period. In some cases, grants were recorded with a grant date and a
corresponding exercise price that matched the date of the approval action or were otherwise
consistent with the terms of the approval action. In other cases, however,
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the recorded grant dates and corresponding exercise prices of the grants reflected the fair market
value of the Company’s stock on a date prior to the approval action. The Company has restated the
compensation expense for stock option grants relating to approximately 1.6 million shares of common
stock by using the date of the documented approval action as the measurement date. The total
additional non-cash, pre-tax charge for these grants is approximately $7.6 million, net of
forfeitures, amortized over the appropriate vesting period through March 31, 2006, of which $0.5
million relates to director options, $2.6 million relates to officer options and $4.5 million
relates to rank and file employee options.
Grants Lacking Adequate Documentation. With respect to grants of approximately 7.9 million shares
(5.0 million shares to rank and file employees), or 73.0% of the total grants in the Review Period,
the Company has been unable to locate adequate documentation of approval actions that would satisfy
the requisites for a measurement date under APB 25. For these grants, management considered all
available relevant information to form a reasonable conclusion as to the most reasonable
measurement date. For all grants in this category, the Company has established default
methodologies for determining the most appropriate measurement date under APB 25.
With respect to grants entered into the Company’s stock option database after September 9, 1999,
when the database began to reflect a create date which is the date on which a grant was entered
into the system, the Company has determined to use the individual create date for each grant as the
APB 25 measurement date, which was in most cases different from the originally-recorded grant date.
The Company believes that this create date is the most appropriate methodology in the absence of
sufficient evidence of approvals for these grants as it represents the earliest point in time at
which the evidence shows that all requisites for the establishment of the measurement date had been
satisfied. Such create dates preceded, often by a significant amount of time, the execution of
stock option agreements, which, generally, were manually signed by the Company’s CEO and manually
signed and dated by the grantee. In addition, in almost all cases, a grant entered into the
database, which established the create date, ultimately resulted in the creation of a stock option
agreement reflecting such grant. Accordingly, while execution of the stock option agreements
constituted a clear acknowledgement by the grantee and the Company of the grantee’s legal
entitlement to the grant, the Company believes the create date more accurately reflects the date of
approval than does the signed option agreement. The Company has restated the compensation expense
for stock option grants relating to approximately 4.2 million shares of common stock by using the
create date as the measurement date. The total additional non-cash, pre-tax charge for these
grants is approximately $49.8 million, net of forfeitures, amortized over the appropriate vesting
period through March 31, 2006, of which $0.5 million relates to director options, $17.2 million
relates to officer options and $32.2 million relates to rank and file employee options. The
Company’s procedures for evaluating the appropriateness of measurement dates fixed with reference
to such create dates included a sensitivity analysis which provided an understanding of the
differences between the additional recorded charge for stock-based compensation expense and the
charges that would result from using other identified alternative methods for determining
measurement dates. The Company’s sensitivity analysis included identifying the range of potential
grant dates defined by the recorded grant date and the create date for each grant. The Company
then identified the low and high closing prices of the common stock within that range of potential
grant dates and applied both the low and high closing prices of the common stock to the number of
shares granted for which the create date methodology was utilized to determine the range of
potential adjustments to stock-based compensation expense for these grants, which was $0.09 million
to $73.8 million, net of forfeitures, as compared to the additional non-cash, pre-tax charge for
these grants of approximately $49.8 million, net of forfeitures, included in the Restatement.
For options entered into the Company’s option database before September 9, 1999, the Company
determined the measurement date generally by reference to signed option agreements (or the deemed
signature date for certain options as discussed below). The executed option agreements
(hereinafter “signed option agreements”), manually signed by the Company’s CEO and manually signed
and dated by the grantee, constituted an acknowledgement by the grantee and the Company of the
grantee’s legal entitlement to the grant and, in the absence of authoritative information as to
when all the requisites for the establishment of the measurement date had been satisfied, provides
a measurement date framework based on entitlement. The Company has restated the compensation
expense for stock option grants relating to approximately 1.4 million shares of common stock by
using the signed option agreements as the measurement date. The total additional non-cash, pre-tax
charge for these grants is approximately $6.4 million, net of forfeitures, amortized over the
appropriate vesting period through March 31, 2006, of which $0.3 million relates to director
options, $3.6 million relates to officer options and $2.5 million relates to rank and file employee
options. The Company believes this methodology was the most appropriate in the absence of
sufficient evidence of approvals for these grants as it represents the earliest point in time at
which the evidence shows that all requisites for the establishment of the measurement date had been
satisfied for these grants. The Company’s procedures for evaluating the appropriateness of
measurement dates fixed with reference to the dating of signed option agreements included a
sensitivity analysis which provided an understanding of the differences between the additional
recorded charge for stock-based compensation expense and the charges that would result from using
other identified alternative methods for determining measurement dates. The Company’s sensitivity
analysis included identifying the range of potential grant dates defined by the recorded grant date
and the date of the grantee’s signature on the stock option agreement for each grant. The Company
then identified the low and high closing prices of the common stock within that range of potential
grant dates and applied both the low and high closing prices of the common stock to the number of
shares granted for which the signed option agreements methodology was utilized to determine the
range of potential adjustments to stock-based compensation expense for these grants, which was
$0.03 million to $9.6 million, net of forfeitures, as compared to the additional non-cash, pre-tax
charge for these grants of approximately $6.4 million, net of forfeitures, included in the
Restatement.
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In those cases where no reliably-dated signed option agreement could be located and where no
post-September 9, 1999 create date exists (stock option grants totaling approximately 0.9 million
shares), the Company used the average period between recorded grant date and date of the signatures
on all other grantee signed option agreements with the same grant date as the measurement date.
For example, if there were four stock option grants with a grant date of January 1, 1996, the
Company had the signed option agreements for three of these stock option grants and the average
number of days between the grant date and the signature dates of these three signed option
agreements was 20 days, January 21, 1996 was used as the measurement date for the grant for which
no signed option agreement could be located. The Company has restated the compensation expense for
stock option grants relating to approximately 0.7 million shares of common stock using this
“average days to sign agreement” method. The total additional non-cash, pre-tax charge for these
grants is approximately $4.4 million, net of forfeitures, amortized over the appropriate vesting
period through March 31, 2006, of which $0.06 million relates to director options, $4.2 million
relates to officer options and $0.2 million relates to rank and file employee options. The Company
believes this methodology was the most appropriate in the absence of sufficient evidence of
approvals for these grants because it gives a reasonable approximation of the measurement date
related to these options in light of the available evidence. The Company conducted a sensitivity
analysis by comparing the Company’s current default methodology (i.e., “average days to sign
agreement”) with another default methodology. For this analysis, the Company identified the range
of potential grant dates defined by the earliest signed option agreement and the latest signed
option agreement. The Company then identified the low and high closing prices of the common stock
over the range of potential grant dates and applied both the low and high closing prices of the
common stock to the number of shares granted to determine the range of potential adjustments to
stock-based compensation expense for these grants, which was $2.6 million to $5.9 million, net of
forfeitures. The Company’s analyses indicate that stock-based compensation expense computed using
other identified alternative default methodologies would not materially differ from stock-based
compensation expense computed using the “average days to sign agreement” methodology. The
Company’s procedures for evaluating the appropriateness of measurement dates fixed with reference
to the average days to sign agreements also included a sensitivity analysis which provided an
understanding of the differences between the additional recorded charge for stock-based
compensation expense and the charges that would result from using other identified alternative
methods for determining measurement dates. The Company’s sensitivity analysis included identifying
the range of potential grant dates defined by the recorded grant date and the average days to sign
agreement for each grant. The Company then identified the low and high closing prices of the
common stock within that range of potential grant dates and applied both the low and high closing
prices of the common stock to the number of shares granted to determine the range of potential
adjustments to stock-based compensation expense for these grants, which was $0.03 million to $6.1
million, net of forfeitures, as compared to the additional non-cash, pre-tax charge for these
grants of approximately $4.4 million, net of forfeitures, included in the Restatement.
Given the volatility of the common stock during much of the Review Period, the use of methodologies
and measurement dates different from those described above could have resulted in a higher or lower
cumulative compensation expense which would have caused net income or loss to be different from the
amounts reported in the restated consolidated financial statements. The Company’s procedures for
evaluating the appropriateness of measurement dates fixed using the default methodologies described
above also included a sensitivity analysis which provided an understanding of the differences
between the additional recorded charge for stock-based compensation expense and the charges that
would result from using other identified alternative methods for determining measurement dates.
The Company’s sensitivity analysis included identifying the range of potential grant dates defined
by the recorded grant date and the appropriate measurement date for each grant. The Company then
identified the low and high closing prices of the common stock within that range of potential grant
dates and applied both the low and high closing prices of the common stock to the number of shares
granted to determine the range of potential adjustments to stock-based compensation expense for
these grants, which was $9.3 million to $99.3 million, net of forfeitures, as compared to the
additional non-cash, pre-tax charge for these grants of approximately $70.0 million, net of
forfeitures, included in the Restatement.
Other adjustments through March 31, 2006
From 1994 through 1998, the Company did not properly account for stock options for one officer that
were modified after the grant date pursuant to a separation agreement. Some of these modifications
were not identified in the Company’s financial reporting processes and were therefore not properly
reflected in its financial statements. As a result, the Company has recorded a non-cash charge for
stock-based compensation of $1.0 million during Fiscal 1999.
Summary
In summary, the Company recorded cumulative non-cash charges for stock-based compensation of $70.9
million through March 31, 2006, offset in part by a cumulative income tax benefit of $27.7 million,
for a total after-tax charge of $43.2 million. These charges had no impact on net sales or cash
and cash equivalents as previously reported in the Company’s financial statements; as a result, no
changes to these items are reflected in the Restatement. Non-cash charges for stock-based
compensation expense have been recorded as adjustments to Selling, general & administrative
expenses within the Company’s Consolidated Statements of Income.
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1Q07 and 2Q07 Restatement
Stock-based compensation expense
In addition to the Restatement noted above through March 31, 2006, the Company has recorded
additional non-cash charges for stock-based compensation during the first and second quarters of
Fiscal 2007 of $1.6 million and $2.2 million, respectively, offset in part by income tax benefits
of $0.6 million and $0.8 million, respectively, or total after-tax charges of $1.0 million and $1.4
million, respectively. This charge was recorded to reflect additional non-cash, stock-based
compensation expense recognized under the fair value method (SFAS 123(R)) because the exercise
price for certain stock option grants prior to, but not vested as of March 31, 2006, differed from
the fair market value of the underlying shares on the appropriate measurement date, some of which
occurred during Fiscal 2007.
Accounting for derivatives
On July 26, 2006, the Company entered into an interest rate swap to reduce its exposure from
fluctuating interest rates. SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities” (“SFAS 133”) requires that all derivative instruments be recorded on the balance sheet
as either an asset or liability measured at their fair value, and that changes in the derivatives’
fair value be recognized currently in earnings unless specific hedge accounting criteria are met.
From inception of the hedge, the Company had applied a method of cash flow hedge accounting under
SFAS 133 to account for the interest rate swap that allowed the Company to assume no
ineffectiveness in such agreements, called the “short-cut” method.
Subsequently, the Company analyzed its eligibility for the “short-cut” method in light of certain
clarifications delivered by the Office of the Chief Accountant of the SEC, and determined that its
interest rate swap did not qualify for the “short-cut” method under SFAS 133 because certain
prepayment features relating to the underlying actual debt were not identical to those contained in
the interest rate swap. Because the Company’s documentation at hedge inception reflected the
“short-cut” method rather than the “long-haul” method for determining hedge ineffectiveness, the
derivative did not meet the requirements for a cash flow hedge. Documentation for the “long-haul”
method of accounting at hedge inception cannot be retrospectively applied under SFAS 133.
Therefore, fluctuations in the interest rate swap’s fair value should have been recorded through
the Company’s Consolidated Statements of Income instead of through Other Comprehensive Income
(Loss) (“OCI”), which is a component of Stockholders’ equity. The adjustment for the second
quarter of Fiscal 2007 will decrease reported net income and increase OCI by approximately $1.4
million. This change in accounting for this derivative instrument could result in significant
volatility in the Company’s reported net income and earnings per share due to increases and
decreases in the fair value of the interest rate swap. However, the derivative instrument remains
highly effective and the change in accounting for this derivative instrument does not impact
operating cash flows or total Stockholders’ equity.
The table below reflects the impact of the additional non-cash charges for stock-based compensation
expense and the non-cash charge related to the interest rate swap on the Company’s Consolidated
Statements of Income, including the corresponding cumulative adjustment to Retained earnings as of
September 30, 2006 and March 31, 2006, 2005, 2004 and 2003 on the Company’s Consolidated Balance
Sheets. Prior to this Restatement, the Company had not recorded any non-cash stock-based
compensation expense in its Consolidated Statements of Income with the exception of $0.7 million
recorded during the second quarter of Fiscal 2005 for a modification of a previous stock option
award for a retiring director. All dollar amounts are presented in thousands except per share
amounts. Per share amounts may not total due to rounding.
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Income Tax Considerations
In the course of the investigation, the Company determined that a number of officers may have
exercised options for which the application of Section 162(m) of the Internal Revenue Code of 1986,
as amended (the “Code”), may apply. It is possible that these options will be treated as having
been granted at less than fair market value for federal income tax purposes because the Company
incorrectly applied the measurement date as defined in APB 25. If such options are deemed to have
been granted at less than fair market value, pursuant to Section 162(m) of the Code (“Section
162(m)”), any compensation to officers, including proceeds from options exercised in any given tax
year, in excess of $1.0 million will be disallowed as a deduction for tax purposes. The Company
estimates that the potential tax effected liability for any such disallowed Section 162(m)
deduction would approximate $3.6 million, which has been recorded as a current liability within
Income taxes within the Company’s Consolidated Balance Sheets. The Company may also incur interest
and penalties if it were to incur any such tax liability, which could be material.
In addition, the Company is considering the application of Section 409A of the Code (“Section
409A”) to those options for which it incorrectly applied the measurement date as defined in APB 25.
It is possible that these options will be treated as having been granted at less than fair market
value for federal income tax purposes and thus subject to Section 409A. Accordingly, the Company
may adopt measures to address the application of Section 409A. The Company does not currently know
what impact Section 409A will have, or any such measures, if adopted, would have, on its results of
operations, financial position or cash flows, although such impact could be material.
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Expenses Incurred by the Company
The Company has incurred expenses for legal fees and external audit firm fees, in excess of its
insurance deductible of $0.5 million, in Fiscal 2007, in relation to (i) the Audit Committee’s
review of the Company’s historical stock option practices and related accounting for stock option
grants, (ii) the informal inquiry and formal order of investigation by the SEC regarding the
Company’s past stock option practices, (iii) the previously-disclosed derivative action relating to
the Company’s historical stock option practices
filed against the Company as a nominal defendant and certain of the Company’s current and former
directors and officers, as to whom it may have indemnification obligations and (iv) related
matters. Further, the Company has incurred and expects to continue to incur significant additional
expense related to the foregoing matters in the fiscal year ending March 31, 2008. The Company and
the insurance company for its directors’ and officers’ indemnification insurance are currently in
discussions with respect to which of the fees in excess of the deductible will be paid by the
insurance company. Accordingly, there can be no assurance that all fees submitted to the insurance company for
reimbursement will be reimbursed under the Company’s directors’ and officers’ indemnification
insurance.
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PART I
Item
1. Business.
Overview. Black Box is the world’s largest dedicated network infrastructure services provider.
Black Box offers one-source network infrastructure services for communication systems. The
Company’s service offerings include design, installation, integration, monitoring and maintenance
of voice, data and integrated communication systems. The Company’s primary service offering is
voice solutions, while providing premise cabling and other data related services and products. The
Company provides 24/7/365 technical support for all of its solutions which encompasses all major
voice and data manufacturers as well as 118,000 network infrastructure products that it sells
through its catalog and Internet Web site and its Voice and Data services (collectively referred to
as “On-Site services”) offices. With more than 3,000 professional technical experts and 173
offices, Black Box serves more than 175,000 clients in 141 countries throughout the world. Founded
in 1976, Black Box, a Delaware corporation, operates subsidiaries on five continents and is
headquartered near Pittsburgh in Lawrence, Pennsylvania.
Black Box differentiates itself from its competitors by providing exceptional levels of superior
technical services for communication solutions, its capability to provide these services globally
and its private-labeled BLACK BOX® brand network infrastructure products which feature
some of the most comprehensive warranties in the industry.
As the world’s largest and highest quality network infrastructure services company 100% dedicated
to this market, Black Box is in a unique position to capitalize on its service advantages, current
leadership position, diverse and loyal client base and strong financial performance.
Industry Background. Black Box participates in the worldwide network infrastructure market
estimated at $20 billion.
Products and services are distributed to this market primarily through value-added resellers,
manufacturers, direct marketers, large system integrators and other technical services companies.
These companies range from very large, international companies, some of which have access to
greater resources than those available to Black Box, to small, local or regionally-focused
companies. In addition, competition for our Hotline business includes direct marketing
manufacturers, mass merchandisers, “big box” retailers, web retailers and others. Black Box
believes that it competes on the basis of its solution features offerings, technical capabilities,
service levels and price.
Business Strategy. Black Box’s business strategy is to provide its clients with one source for
services and products to meet all their networking infrastructure needs – whether at a single
location or multiple locations worldwide. The Company believes that its combination of worldwide
Voice and Data services performed at client locations – integrated with Hotline Services – provides
a unique advantage over its competitors in the network infrastructure market. The Company believes
its record of consistent operating profitability, positive cash flow and its high rate of repeat
clients is evidence of the strength of its strategy. Keys to the Company’s success include the
following:
Expert Technical Support Deployed Three Ways.
Locally
at Client Sites. Black Box provides complete voice, data and integrated solutions –
including design, installation, remote monitoring and routine and emergency maintenance – with
consistent high quality and uniformity. The Company maintains certifications from leading voice and
data product manufacturers including Avaya®, Cisco®, Microsoft®, Nortel®, NEC® and Siemens®, among
others. In addition, the Company maintains what it believes is the industry’s largest staff of
Registered Communications Distribution Designers (RCDDs) who assure that all designs meet or exceed
ANSI, TIA/EIA and National Electric Code® (NEC®) standards.
24/7/365
Technical Support. Black Box provides around-the-clock, seven days per week
technical support, available to clients in 141 countries worldwide. In Fiscal 2007, the Company’s
technical experts responded to approximately 1.5 million client calls. Black Box specialists
receive continuous training to stay up-to-date on the latest technologies.
www.blackbox.com
Internet Web Site. Black Box offers its 24/7/365 technical support on-line
at www.blackbox.com. With one click by an existing or a potential client on “Talk to a Tech,” a
technical expert makes contact with that person immediately. Technical information, including
“Black Box Explains” and “Technology Overviews,” is always available as well as the ability to
easily design and configure custom products on-line.
Worldwide Coverage. With 173 offices serving 141 countries, Black Box has the largest
footprint in the industry, serving every major industry sector. This worldwide coverage and 31
years of experience makes one-source project management a reality for Black Box clients. Black Box
ensures that clients with these needs receive consistent high-quality design, workmanship and
technology from a single service provider. The Company is exposed to certain risks because of its
global operations discussed under the caption “International operations” in Part I, Item 1A, “Risk
Factors,” which is incorporated herein by reference.
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Strategic Partnerships with Leading Voice and Data Product Manufacturers. Black Box has
partnerships and distribution agreements with leading voice and data product manufacturers. Access
to these multi-technology platforms provides Black Box clients with the convenience of a one-source
provider for its network infrastructure needs.
Quality Networking Solutions and Comprehensive Warranties. Black Box products and services
are covered by an umbrella of protection that extends beyond standard warranties. Black Box was the
first in the industry to introduce a “No Questions Asked” product warranty program offering full
protection regardless of cause of failure, including accidental, surge or water damage for the life
of the warranty – and many products are guaranteed for life. Exclusive to Black Box are its
Guaranteed-for-Life Structured Cabling System and Certification Plus® guarantees that
provide assurance that a client’s network will operate within the application it was designed to
support for life.
Brand Name. BLACK BOX is a widely recognized brand name associated with high quality
products and services. The Company believes that the BLACK BOX trademark is important to its
business.
ISO 9001:2000 Certified. Black Box has received ISO 9001:2000 certification in Australia,
Brazil, Canada, Chile, France, Germany, Ireland, Italy, Japan, Mexico, Netherlands, Puerto Rico,
Singapore, Spain, the United Kingdom and the United States. Rigorous quality control processes must
be documented and practiced to earn and maintain ISO 9001:2000 certification.
Proprietary Client List. Over the course of its 31 year history, the Company has built a
proprietary mailing list of approximately 1.5 million names representing over 1.0 million clients.
This database includes information on the past purchases of its clients. The Company routinely
analyzes this data in an effort to enhance client purchasing and ensure that targeted marketing
programs reach their specified audiences. The Company believes that its proprietary client list is
a valuable asset that represents a significant competitive advantage. The Company does not rent its
client list.
Rapid Order Fulfillment. The Company has developed efficient inventory management and order
fulfillment systems that allow most standard product to be shipped that same day. Requests for same
day counter-to-counter delivery and special labeling, kitting and packaging are also available from
Black Box.
Growth Strategy. The principle components of Black Box’s growth strategy include: (i) cross-selling
marketing activities capitalizing on its one-source solution of DVH™ (Data, Voice and Hotline)
Services, (ii) expanded product offerings and (iii) expanded global technical support services
primarily through mergers and acquisitions.
Mergers and Acquisitions. As part of the growth strategy through mergers and acquisitions,
the Company has completed the following transactions during Fiscal 2007, Fiscal 2006 and Fiscal
2005:
Fiscal
2007
On April 30, 2006, Black Box acquired the privately-held USA Commercial and Government and Canadian
operations of NextiraOne, LLC (“NextiraOne”). The acquired operations service commercial and
various government agency clients. Black Box and NextiraOne have nearly completed the integration
process, including the re-branding of the NextiraOne business as Black Box Network Services.
On May 1, 2006, Black Box acquired Nu-Vision Technologies, Inc. and Nu-Vision Technologies, LLC
(collectively referred to as “NUVT”), privately-held companies, which provide planning,
installation, monitoring and maintenance services for voice and data network systems. NUVT has an
active customer base, which includes commercial, education and various government agency accounts.
On October 30, 2006, Black Box acquired Nortech Telecommunications, Inc. (“NTI”), a privately-held
company based out of Chicago, IL. NTI has an active customer base which includes commercial,
education and various government agency accounts.
On February 1, 2007, Black Box acquired ADS Telecom, Inc. (“ADS”), a privately-held company based
out of Orlando, FL. ADS has an active customer base which includes commercial, financial,
healthcare and various government agency accounts.
The results of operations of NextiraOne, NUVT, NTI and ADS are included in the Company’s
Consolidated Statements of Income beginning on their individual acquisition dates during Fiscal
2007.
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Fiscal 2006
During Fiscal 2006, the Company completed six (6) acquisitions. During the first quarter of Fiscal
2006, the Company acquired Telecommunication Systems Management, Inc. (“TSM”), GTC Technology
Group, Inc. and Technology Supply, Inc. (collectively referred to as “GTC”) and Business
Communications, Inc., Bainbridge Communication, Inc., BCI of Tampa, LLC and Networx, L.L.C.
(collectively referred to as “BCI”). These companies provide full-service voice communication
solutions and services in the Florida and Virginia markets. During the second quarter of Fiscal
2006, the Company acquired substantially all of the assets and certain liabilities of Universal
Solutions of North America, L.L.C. and related entities (“Universal”). Universal primarily provides
planning, installation, monitoring and maintenance services for voice and data network systems in
14 states. During the third quarter
of Fiscal 2006, the Company purchased 100% of the issued and outstanding equity interests in
Communication is World InterActive Networking, Inc. (“C=WIN”) and Converged Solutions Group, LLC
(“CSG”). Both C=WIN and CSG primarily provide planning, installation and maintenance services for
voice and data network systems in 15 states. The results of operations of TSM, GTC, BCI, Universal,
C=WIN and CSG are included in the Company’s Consolidated Statements of Income beginning on their
individual acquisition dates during Fiscal 2006.
Fiscal 2005
On January 25, 2005, the Company acquired 100% of the outstanding shares of common stock of
Norstan, Inc. (“Norstan”). Norstan primarily provides full-service communications solutions and
services, delivering voice and data technology solutions and remanufactured equipment to corporate
end-users and public sector companies. Norstan had offices throughout the U.S. and Canada. The
Norstan solution was complementary to Black Box’s existing service solutions and allowed the
Company to immediately expand its operational footprint, provide additional marketing opportunities
via cross-selling and, most importantly, provide its collective customers a stronger worldwide
technical services partner.
These acquired companies, which are focused on servicing the North America Voice Services market,
have influenced the composition of the Company’s service segments as profiled below:
Clients. Black Box clients range from small organizations to many of the world’s largest
corporations and institutions. Black Box clients participate in many diverse industries, including
manufacturing, business services, retail, finance, education and government. Revenues from the
Company’s clients are segmented as 45% from large companies, 20% from medium-sized companies and
35% from small companies.
Marketing. Black Box’s services are primarily marketed through direct sales driven by its nearly
300 team members exclusively devoted to these efforts. This sales force is further supported with
the Company’s direct marketing materials and online through the Company’s Internet Web site. Black
Box was the first company to engage exclusively in the sale of a broad range of networking products
through direct marketing techniques. Black Box targets its catalogs and marketing materials
directly to its client-users who make systems design and purchasing decisions. Black Box marketing
materials present a wide choice of items using a combination of product features and benefits,
photographs, product descriptions, product specifications, compatibility charts, potential
applications and other helpful technical information. The Company’s catalogs have earned numerous
awards in recent years. In 2006, the Black Box Cable Catalog won Multichannel Merchant magazine’s
top award, Catalog of the Year. The catalog also took top honors in the Computer Equipment and
Software category which a Black Box catalog has won for the eleventh year in a row.
Technical Services. Black Box believes that its technical services are the foundation of its
success enabling the Company to provide services ranging from quick-turn hotline consultation to
site surveys, design and engineering, project management, single-site and multi-site installations,
remote monitoring, certification and maintenance of voice, data and integrated communication
solutions.
Worldwide Headquarters. The Company’s worldwide headquarters and certain U.S. operations are
located in Lawrence, Pennsylvania (a suburb 20 miles south of Pittsburgh). This Company-owned
352,000 square foot facility is on an 84-acre site.
Products. Black Box believes that its ability to offer broad, innovative product solutions across
multiple technologies, supported by its 24/7/365 technical services capability, has been an
important competitive factor. Black Box currently offers more than 118,000 products through its
catalogs, On-Site services offices and Internet Web site. New products are regularly introduced.
Manufacturers and Suppliers. Black Box utilizes a network of original equipment manufacturers
(“OEM”) and suppliers throughout the world. Each supplier is monitored for quality, delivery
performance and cost through a well-established certification program. This network has
manufacturing and engineering capabilities to customize products for specialized applications.
Black Box operates its own manufacturing and assembly operation at its Lawrence, Pennsylvania
location. The Company chooses to manufacture certain products in-house when outside OEMs are not
economical. Sourcing decisions of in-house versus third-party suppliers are based upon a balance of
quality, performance, delivery and cost.
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Information Systems. The Company has committed significant resources to the development of
information systems that are used to manage all aspects of its business. The Company’s systems
support and integrate technical support, client services, inventory management, purchasing,
distribution activities, accounting and project cost management. The Company continues to develop
and
implement exclusive worldwide web applications. These applications allow clients to view order
status and product availability, view up-to-date information on their projects that are being
managed on a world-wide basis and provide a project management and forecasting tool for the
Company’s offices. A technical knowledge-based application is also used to access problem
resolution information to help solve client issues more quickly. Information systems are focused on
delivering high quality business applications that are geared to improve internal efficiencies as
well as client interactions.
The Company’s new product introductions, multiple language requirements and design enhancements
require efficient modification of product presentations for its various catalogs. Black Box also
supports a publishing system that provides the flexibility and speed for both text and graphic
layout. This enables the timely, efficient and cost effective creation of marketing materials.
Backlog. The worldwide backlog of unfilled orders believed to be firm (i.e., to be completed within
six months) was approximately $159 million at March 31, 2007 compared to $96 million at March 31,
2006.
Team
Members. As of March 31, 2007, the Company had approximately 4,581 team members worldwide
compared to 3,295 as of March 31, 2006. Of the 4,581 current team members, approximately 660 are
subject to collective bargaining agreements. The Company believes that its relationship with its
team members is good.
Financial Information. Financial information regarding the Company, including segment data, is set
forth in Item 8 of this Form 10-K and is incorporated herein by reference.
International Revenues. Revenues from countries outside North America were $166 million, or 16% of
total revenues, for Fiscal 2007 comparable to $157 million, or 22% of total revenues, for Fiscal
2006.
Other Information. The Company maintains an investor relations page on its Internet Web site at
http://www.blackbox.com. The Company’s annual, quarterly and current reports and amendments to such
reports filed with or furnished to the SEC are made available, as soon as reasonably practical
after such filing, and may be viewed or downloaded free of charge in the “About Us” section of the
Web site. The Company’s Standards of Business Conduct, Code of Ethics and Board committee charters
are also available on its Web site, and may be viewed or downloaded free of charge in the “About
Us” section of the Web site.
Item
1A. Risk Factors.
The following are some of the potential risk factors that could cause our actual results to
differ materially from those projected in any forward-looking statements. You should carefully
consider these factors, as well as the other information contained in this document, when
evaluating your investment in our securities. The below list of important factors is not
all-inclusive or necessarily in order of importance.
Stock option matters – As previously disclosed, on November 13, 2006, we received a letter
of informal inquiry from the Enforcement Division of the SEC relating to the Company’s stock option
practices from January 1, 1997 to present. Our Audit Committee, with the assistance of outside
legal counsel, is conducting an independent review of the Company’s historical stock option grant
practices and related accounting for stock option grants. On May 24, 2007, the SEC issued a formal
order of investigation in connection with this matter, and, on May 29, 2007, we received a document
subpoena from the SEC acting pursuant to such order. We have cooperated with the SEC in this
matter and intend to continue to do so. See the “Explanatory Note” preceding Part I, Item 1 of
this Form 10-K for more information regarding this and related matters.
On September 20, 2006, the Company received formal notice from the Internal Revenue Service (“IRS”)
regarding its intent to begin an audit of the Company’s tax years 2004 and 2005. In connection with
this normal recurring audit, the IRS has requested certain documentation with respect to stock
options for the Company’s 2004 and 2005 tax years. The Company has produced various documents
requested by the IRS and is currently in the process of responding to additional documentation
requests.
In addition, in November, 2006, two stockholder derivative lawsuits were filed against the Company,
as a nominal defendant, and several of our current and former officers and directors in the United
States District Court for the Western District of Pennsylvania. The two substantially identical
stockholder derivative complaints allege that the individual defendants improperly backdated grants
of stock options to several officers and directors in violation of our stockholder-approved stock
option plans during the period 1996-2002, improperly recorded and accounted for backdated stock
options in violation of generally accepted accounting principles, improperly took tax deductions
based on backdated stock options in violation of the Code, produced and disseminated false
financial statements and SEC filings to our stockholders and to the market that improperly recorded
and accounted for the backdated option grants, concealed the alleged improper backdating of stock
options and obtained substantial benefits from sales of Company stock while in the possession of
material inside information. The complaints seek damages on behalf of the Company against certain
current and former officers and directors and allege breach of fiduciary duty, unjust enrichment,
securities law violations and other claims. The two lawsuits have been consolidated into a single
action as In re Black Box Corporation Derivative Litigation, Master
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File No. 2:06-CV-1531-TMH, and plaintiffs filed a consolidated amended complaint on January 29,
2007. The parties have stipulated that responses by the defendants, including the Company, are due
on or before September 4, 2007.
The stock option investigations and related litigation have imposed, and are likely to continue to
impose, significant costs on us, both monetarily and in requiring attention by our management team.
While we are unable to estimate the costs that we may incur in the future, these are likely to
include:
• professional fees in connection with the conduct of the investigations, the restatement of our
financial statements and the defense of the litigation;
• potential damages, fines, penalties or settlement costs; and
• payments to, or on behalf of, our current and former officers and directors subject to the
investigation or named in the litigation pursuant to our indemnification obligations (in certain
circumstances these indemnification payments are recoverable if it is determined that the officer
or director at issue acted improperly, but there is no assurance that we will be able to recover
such payments).
While we expect that certain of such costs will be reimbursed pursuant to an insurance policy, at
this point such costs have not been reimbursed.
In the course of our investigation, we have determined that a number of executives may have
exercised options for which the application of Section 162(m) may apply. It is possible that
these options will be treated as having been granted at less than fair market value for federal
income tax purposes because we incorrectly applied the measurement date as defined in APB 25. If
such options are deemed to have been granted at less than fair market value, pursuant to Section
162(m), any compensation to our executive officers, including proceeds from options exercised in
any given tax year in excess of $1.0 million, will be disallowed as a deduction for tax purposes.
We estimate that the potential tax effected liability for any such disallowed Section 162(m)
deduction would approximate $3.6 million. We may also incur interest and penalties if we were to
incur any such tax liability, which could be material.
In addition, we are considering the application of Section 409A to those options for which we
incorrectly applied the measurement date as defined in APB 25. It is possible that these options
will be treated as having been granted at less than fair market value for federal income tax
purposes and thus subject to Section 409A. Accordingly, we may adopt remedial measures to address
the application of Section 409A. We do not currently know what impact Section 409A will have, or
any such remedial measures, if adopted, would have on our results of operations, financial position
or cash flows, although such impact could be material.
Adverse developments in the legal proceedings or the investigation arising out of our historical
stock option granting practices or any other matter raised as a result thereof could have an
adverse impact on our business and our stock price, including increased stock volatility.
Competition – we operate in a highly competitive industry. Our competitors may be able to
deliver products and services at better prices or more quickly due to factors beyond our control.
New competitors may also arise in the future, which threaten our ability to sustain or grow our
market share. We cannot guarantee that we can continue to compete effectively in the future and
still be able to sustain our historical levels of profit margin.
Economic environments – we, our customers or our vendors may experience economic hardships
due to inflation or recession, changes in laws and regulations, business disruptions due to natural
disasters, acts of terrorism or war or other factors that are beyond our control and that could
negatively impact our financial condition or our ability to meet our future financial goals.
Successful integration of acquired businesses – we have completed several acquisitions in
recent years. Our future financial results are dependent on the successful integration of those
acquisitions within the projected timeframes and cost parameters. We also face pressure to
adequately conduct our ongoing operations while working toward the integration of these businesses.
We cannot guarantee that we will successfully integrate our acquisitions as projected or without
disruption to other areas of our business which could have a negative impact on our financial
results.
International operations – we operate in several countries outside of the United States.
Our operations or our financial condition may be negatively affected by events surrounding our
international operations such as changes in laws and regulations, political or economic
instability, currency fluctuations, supply chain disruptions, acts of terrorism, natural disasters
or other political, economic or environmental factors. We cannot rely on the past results of our
international operations as an indicator of future results or assure you that we will not be
adversely affected by those factors inherent with international operations.
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Retention
of key personnel – the success of our business depends on our ability to attract
and retain quality employees, executives and directors. We offer comprehensive salary and benefit
packages including stock options as a means of attracting and retaining personnel. We face
pressure to maintain our profit margins and remain competitive in our industry while we compete for
personnel
in our local markets with a variety of different businesses that may be able to offer more
attractive incentives due to their individual financial situations. We cannot guarantee that we
will continue to attract and retain personnel with our current incentives and at costs that are
consistent with our projected profit margins. In addition, the success of our compensation program
has relied heavily on the use of stock options which provided both a compensation and retention
element due to vesting. If we are not able to replicate the compensation and retention benefits
historically provided by our stock options, we will need to rely more heavily on other forms of
compensation, primarily cash compensation to adequately compensate employees, executives and
directors.
Demand for products and services – we and our competitors in the industry are dependent on
the demand for the products and services that we deliver. Changes in technology or other
unforeseen developments within our industry could result in decreased demand for our products and
services. We cannot guarantee that historical levels of demand will continue or increase in the
future.
Supply
chain and distribution agreements – through our recent acquisitions, we have
significant arrangements with a small number of suppliers of voice technology. If we experience
disruptions in our supply chain with these manufacturers for any reason or lose our distribution
rights, we may not be able to fulfill customer commitments with an acceptable alternative or we may
not be able to obtain alternative solutions at similar costs.
Future mergers and acquisitions – a key component of our growth strategy is through
strategic mergers and acquisitions. We may not continue to be successful in our search for
potential acquisition candidates that are acceptable for our business model, or we may not be
successful in our attempts to acquire new businesses that we have identified as attractive
acquisition candidates. We cannot guarantee that we will meet our projected growth targets in the
future if we are unsuccessful in our efforts to acquire additional businesses.
Public sector business – our revenues from sales to the public sector, including sales to
federal, state and local governments and governmental agencies has grown in recent years. These
sales are made through various direct contracts, through reseller agreements with government
contractors and through open market sales. Government contracting is a highly-regulated area.
Failure to comply with the technical requirements of regulations or contracts could subject us to
fines, penalties, suspension or debarment from doing business with such customers, which could have
a material adverse effect on our business.
Revenue growth – our revenue is primarily generated through individual sales of products
and services and the nature of our business provides us with very little guaranteed or contractual
revenue beyond a relatively short time horizon. We depend on repeat customer business as well as
our ability to develop new customer business to sustain and grow our revenue. Although our focus
on delivering high-quality sales and service has proven to be successful in the past, we cannot
guarantee that we will be able to grow or even sustain our current level of revenue in the future.
Liquidity – although we generate positive cash flow and have access to a significant amount
of additional credit, we cannot be sure that our current liquidity situation will be adequate in
future periods. We cannot guarantee that we will be able to maintain our positive cash flow
position or to obtain additional credit or raise additional capital which may restrict our ability
to operate or to pursue new business opportunities in the future.
Stock price – our stock price is affected by a number of factors, including quarterly
variations in our financial results. As a result, our stock price is subject to volatility.
Item
1B. Unresolved Staff Comments.
None.
Item 2. Properties.
The Company’s worldwide headquarters and certain U.S. operations are located in Lawrence,
Pennsylvania (located 20 miles south of Pittsburgh) in a 352,000 square foot owned facility on 84
acres.
The Company owns or leases 173 additional offices or facilities throughout the world, none of which
are material in nature to Black Box.
The Company believes that its properties are adequate for its present and foreseeable needs.
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Item 3. Legal Proceedings.
Regulatory Matters
As previously disclosed, on November 13, 2006, the Company received a letter of informal inquiry
from the Enforcement Division of the SEC relating to the Company’s stock option practices from
January 1, 1997 to present. On May 24, 2007, the SEC issued a formal order of investigation in
connection with this matter and, on May 29, 2007, the Company received a document subpoena from the
SEC acting pursuant to such order. The Company has cooperated with the SEC in this matter and
intends to continue to do so.
As previously announced, the Audit Committee, with the assistance of outside legal counsel, is
conducting an independent review of the Company’s historical stock option grant practices and
related accounting for stock option grants. See the “Explanatory Note” preceding Part I, Item 1 of
this Form 10-K for more information regarding this and related matters.
On September 20, 2006, the Company received formal notice from the Internal Revenue Service (“IRS”)
regarding its intent to begin an audit of the Company’s tax years 2004 and 2005. In connection with
this normal recurring audit, the IRS has requested certain documentation with respect to stock
options for the Company’s 2004 and 2005 tax years. The Company has produced various documents
requested by the IRS and is currently in the process of responding to additional documentation
requests.
At the conclusion of these regulatory matters, the Company could be subject to additional taxes,
fines, penalties or other costs which could be material.
Litigation Matters
In November, 2006, two stockholder derivative lawsuits were filed against the Company itself, as a
nominal defendant, and several of the Company’s current and former officers and directors in the
United States District Court for the Western District of Pennsylvania. The two substantially
identical stockholder derivative complaints allege that the individual defendants improperly
backdated grants of stock options to several officers and directors in violation of the Company’s
stockholder-approved stock option plans during the period 1996-2002, improperly recorded and
accounted for backdated stock options in violation of generally accepted accounting principles,
improperly took tax deductions based on backdated stock options in violation of the Code, produced
and disseminated false financial statements and SEC filings to the Company’s stockholders and to
the market that improperly recorded and accounted for the backdated option grants, concealed the
alleged improper backdating of stock options and obtained substantial benefits from sales of
Company stock while in the possession of material inside information. The complaints seek damages
on behalf of the Company against certain current and former officers and directors and allege
breach of fiduciary duty, unjust enrichment, securities law violations and other claims. The two
lawsuits have been consolidated into a single action as In re Black Box Corporation Derivative
Litigation, Master File No. 2:06-CV-1531-TMH, and plaintiffs filed a consolidated amended complaint
on January 29, 2007. The parties have stipulated that responses by the defendants, including the
Company, are due on or before September 4, 2007. The Company may have indemnification obligations
arising out of this matter to its current and former directors and officers named in this
litigation. The Company has made a claim for such costs under an insurance policy.
As previously disclosed, the Company received a subpoena, dated December 8, 2004, from the United
States General Services Administration (“GSA”), Office of Inspector General. The subpoena requires
production of documents and information. The Company understands that the materials are being
sought in connection with an investigation regarding potential violations of the terms of a GSA
Multiple Award Schedule contract. The Company has not received any communication on this matter
from the GSA since June 2005.
The Company is involved in, or has pending, various legal proceedings, claims, suits and complaints
arising out of the normal course of business. Based on the facts currently available to the
Company, management believes the matters described under this caption “Litigation Matters” are
adequately provided for, covered by insurance, without merit or not probable that an unfavorable
outcome will result.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted during the three month period ended March 31, 2007 to a vote of security
holders, through the solicitation of proxies or otherwise.
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Executive Officers of the Registrant
The executive officers of the Company and their respective ages and positions are as follows:
The following is a biographical summary of the experience of the executive officers of the Company:
TERRY BLAKEMORE, 50, was appointed as the Interim President and Chief Executive Officer of the
Company on May 21, 2007. Previously, on May 15, 2007, the Board had named Mr. Blakemore a Senior
Vice President of the Company. Prior to becoming a Senior Vice President, Mr. Blakemore served as a
manager of business development and, prior thereto, as a manager of the Company’s Voice Services
business unit. Mr. Blakemore has been with the Company since 1999.
MICHAEL MCANDREW, 47, was promoted to Vice President and Chief Financial Officer on December 13,
2002. He became Secretary and Treasurer on January 31, 2003. He was Manager of Corporate Planning
and Analysis prior to December 13, 2002. Mr. McAndrew has been with the Company for 17 years.
FRANCIS W. WERTHEIMBER, 54, was promoted to Senior Vice President – Pacific Rim/Far East in May
2004. He was promoted to Vice President – Pacific Rim/Far East on May 9, 1997. He was Managing
Director of Black Box Japan prior to May 9, 1997. Mr. Wertheimber has been with Black Box for 14
years.
Directors of the Registrant
The following sets forth certain information concerning the members of the Board of Directors of
the Company:
WILLIAM F. ANDREWS, 75, was elected as a director on May 18, 1992. Mr. Andrews currently is
Chairman of Corrections Corporation of America (private prisons), Chairman of Katy Industries, Inc.
(diversified manufacturing company) and Chairman of SVP Holdings Limited (Singer sewing machines).
He was Chairman of Scovill Fasteners, Inc. and Northwestern Steel and Wire from 1996 to 2001. He
has been a principal with Kohlberg & Co., a private investment company, since 1995. He is also a
director of Corrections Corporation, Katy Industries, O’Charley’s, Inc. and Trex Company, Inc., all
publicly-held companies.
RICHARD L. CROUCH, 60, was elected as a director on August 10, 2004. Mr. Crouch was a General
Partner with the firm of PricewaterhouseCoopers LLP from 1979 to 2004, having served as an Audit
Partner principally assigned to public companies. He served in various capacities for the firm,
including service as a regional accounting, auditing and Securities and Exchange Commission (“SEC”)
services consultant. He retired from the firm on July 2, 2004.
THOMAS W. GOLONSKI, 64, was selected to be a director on February 11, 2003 and was elected by our
stockholders on August 12, 2003. Mr. Golonski served as Chairman, President and Chief Executive
Officer of National City Bank of Pennsylvania and Executive Vice President of National City
Corporation from 1996 to 2005. He retired from National City in 2005. He is a director of several
economic development organizations and active in other charitable and financial organizations.
THOMAS G. GREIG, 59, was elected as a director on August 10, 1999 and appointed as non-executive
Chairman of the Board in May 2004. Mr. Greig has been a Managing Director of Liberty Capital
Partners, a private equity partnership, since 1998. He is also a director of publicly-held Rudolph
Technologies, Inc., a number of privately-held companies and a public, not-for-profit foundation.
EDWARD A. NICHOLSON, PH.D., 67, was elected as a director on August 10, 2004. Dr. Nicholson served
as President of Robert Morris University from 1989 to 2005 and is presently a Professor of
Management at Robert Morris. He has served a number of businesses and government agencies as a
consultant in the areas of long-range planning, organization design and labor relations. He is also
a director of Brentwood Bank, publicly-held Shopsmith Inc. and several regional economic,
charitable and cultural organizations.
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PART II
Item
5.
Market for
Registrant’s
Common
Equity,
Related
Stockholder
Matters and
Issuer
Purchases of
Equity
Securities.
Common Stock Information:
The common stock is traded on NASDAQ under the symbol “BBOX” and has been assigned to the NASDAQ
Global Select tier. As of March 31, 2007, 24,963,338 shares of the common stock were issued, of
which 7,436,111 shares were held in treasury.
The following table sets forth the quarterly high and low sale prices of the common stock as
reported by the Nasdaq Global Select Market during each of the Company’s fiscal quarters indicated
below.
On August 7, 2007, the last reported sale price of the common stock was $39.62 per share.
Dividend Policy:
Cash dividends of $0.06 per share of common stock were declared during each quarter during Fiscal
2007 and 2006. Dividends declared during Fiscal 2007 were paid on July 14, 2006, October 13, 2006,
January 15, 2007 and April 16, 2007. Dividends declared during Fiscal 2006 were paid on July 15,
2005, October 14, 2005, January 13, 2006 and April 14, 2006. While the Company expects to continue
to declare quarterly dividends, the payment of future dividends is at the discretion of the Board
and the timing and amount of any future dividends will depend upon earnings, cash requirements and
financial condition of the Company. Under the Company’s Second Amended and Restated Credit
Agreement dated January 24, 2005, as amended February 17, 2005 and March 28, 2006 (collectively, the
“Credit Agreement”), the Company is permitted to pay dividends on and repurchase its common stock
as long as no Event of Default or Potential Default (each as defined in the Credit Agreement)
occurs or is continuing.
Stockholders:
As of March 31, 2007, there were approximately 2,227 holders of record of the common stock.
Equity Plan Compensation Information:
The information required under Item 5 of Part II of this Form 10-K is incorporated herein by
reference to the information set forth under the caption “Equity Plan Compensation Information” in
the Proxy Statement.
Issuance of Unregistered Securities:
There were no issuances of unregistered securities during the three month period ended March 31,
2007.
Issuer Purchases of Equity Securities:
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As of December 31, 2006, 1,063,945 shares were available under repurchase programs approved by the
Board and announced on November 20, 2003, August 12, 2004 and November 7, 2006.
The repurchase programs have no expiration date and no programs were terminated prior to the full
repurchase of the authorized amount.
Additional repurchases of common stock may occur from time to time depending upon factors such as
the Company’s cash flows and general market conditions. While the Company expects to continue to
repurchase shares of the common stock for the foreseeable future, there can be no assurance as to
the timing or amount of such repurchases. Under the Company’s Credit Agreement, the Company is
permitted to repurchase its common stock as long as no Event of Default or Potential Default (each
as defined in the Credit Agreement) occurs or is continuing.
Performance Graph:
The graph below represents and compares the value, through March 31, 2007, of a hypothetical
investment of $100 made on March 31, 2002, in each of (i) the common stock, (ii) the S&P Small Cap
600, (iii) the Nasdaq Composite, (iv) the Russell 2000 and (v) a peer group of companies determined
by the Company (the “Peer Group”), assuming the reinvestment of dividends in each case. The Peer
Group consists of CDW Corporation, Cisco Systems, Inc., Avaya Inc., Nortel Networks Corporation,
International Business Machines Corporation and Electronic Data Systems Corporation. The Peer Group
was added to the performance graph because the Company believes that, given its current mix of
revenues generated from network infrastructure On-Site services and products, the performance of
this Peer Group is a relevant metric.
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Item 6. Selected Financial Data.
The following tables set forth certain selected historical financial data for the Company for the
periods indicated below (in thousands, except for per share amounts). This information should be
read in conjunction with the Company’s consolidated financial statements, “Management’s Discussion
and Analysis of Financial Condition and Results of Operation,” and the Notes to the Consolidated
Financial Statements included elsewhere in this report. The information presented in the following
table has been adjusted to reflect the restatement of the Company’s consolidated financial results
which is more fully described in Item 7. “Management’s Discussion and Analysis of Financial
Condition and Results of Operation” and Note 3 of the Notes to the Consolidated Financial
Statements within this Form 10-K. Data and Voice Services may collectively be referred to as
“On-Site services.” Per share amounts may not total due to rounding.
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The following tables reconcile selected historical financial data for the Company from the
previously reported results to the restated results for fiscal years ended March 31, 2005, 2004 and
2003. See Note 3 of the Notes to the Consolidated Financial Statements for reference to our
reconciliations for the fiscal year ended March 31, 2006. All dollar amounts are in thousands,
except per share amounts. Per share amounts may not total due to rounding.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
The discussion and analysis set forth below in this Item 7 for the fiscal year ended March 31,
2006 and 2005 has been amended to reflect the Restatement as described in the Explanatory Note and
in Note 3 of the Notes to the Consolidated Financial Statements. For this reason, the data set
forth in this section may not be comparable to discussions and data in the Company’s
previously-filed Annual Reports on Form 10-K. All dollar amounts are presented in thousands unless
otherwise noted.
Restatement through March 31, 2006
Background
On November 13, 2006, Black Box received a letter of informal inquiry from the Enforcement Division
of the SEC relating to the Company’s stock option practices from January 1, 1997 to present. As a
result, the Audit Committee, with the assistance of outside legal counsel, commenced an independent
review of the Company’s historical stock option grant practices and related accounting for stock
option grants during the Review Period.
On February 1, 2007, the Company announced that, while the review of option grant practices was
continuing, it believed that it would need to record additional non-cash charges for stock-based
compensation expense relating to certain stock option grants and, accordingly, cautioned investors
about relying on its historical financial statements until the Company could determine with
certainty whether a restatement would be required and, if so, the extent of any such restatement
and the periods affected.
On March 19, 2007, although the Audit Committee had not yet completed its review, the Audit
Committee concluded that the exercise price of certain stock option grants differed from the fair
market value of the underlying shares on the appropriate measurement date. At that time, the
Company and the Audit Committee announced that it was currently expected that the Company’s
additional non-cash, pre-tax charges for stock-based compensation expense relating to certain stock
option grants would approximate $63 million for the Review Period. In addition, the Company and
the Audit Committee concluded that the Company would need to restate its previously-issued
financial statements contained in reports previously filed by the Company with the SEC.
Accordingly, on March 19, 2007, the Company and the Audit Committee concluded that the Company’s
previously-issued financial statements and other historical financial information and related
disclosures for the Review Period, including applicable reports of its current or former
independent registered public accounting firms and related press releases, should not be relied
upon.
On May 25, 2007, the Company was advised by the Enforcement Division of the SEC that a Formal Order
of Private Investigation arising out of the Company’s stock option practices had been entered and
on May 29, 2007 the Company received a subpoena that was issued by the SEC.
On May 31, 2007, the Company announced that, as a result of the ongoing review of stock option
practices, Company management and the Audit Committee expected that the Company’s additional
non-cash, pre-tax charges for stock-based compensation expense relating to certain stock option
grants would approximate $70 million for the Review Period.
Findings of the Audit Committee
During the Review Period, the Company granted stock options pursuant to an employee stock option
plan and a director stock option plan to acquire approximately 10.9 million shares of common stock.
Such plans at all relevant times provided for option grants to be approved by a designated
committee of non-employee directors or, in the case of the director stock option plan, by the
Board. Approximately 2,000 stock option grants were awarded during the Review Period with 69
recorded grant dates. No stock options have been granted since September, 2006. The Audit
Committee reviewed all stock options granted during the Review Period, including option grants to
the Company’s directors, officers and rank and file employees (including grants to new employees,
grants awarded in connection with Company acquisitions and grants made as individual or group
performance awards). The Audit Committee’s review of the Company’s stock option granting practices
included a comprehensive examination of reasonably available relevant physical and electronic
documents as well as interviews with current and former directors, officers and Company personnel.
The Audit Committee’s review was initially focused on determining whether the Company’s prior stock
option granting practices were in compliance with the plans’ granting provisions and applicable law
or called into question its accounting for such options. Once it became evident that such issues
and accounting implications existed, the inquiry focused on those matters necessary: to determine
whether any accounting charges were material and whether a restatement of the Company’s
previously-issued financial statements would be required; to establish a basis for effecting any
required restatement; to assure that, on as timely a basis as possible, the Company could file any
required curative disclosures with the SEC and assure its continued eligibility for listing on
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NASDAQ; and to provide an informed basis for the Company’s response to the identified issues,
including appropriate corrective and remedial actions.
The following information summarizes certain of the findings of the Audit Committee. The findings
identified approximately $71.5 million of unrecorded expense at the time of grant (i.e., the
difference between the fair market value of the common stock on the appropriate measurement date
and the stated exercise price), net of forfeitures, during the Review Period, of which $70.0
million was recorded in the Company’s consolidated financial statements through March 31, 2006 and
$1.5 million of unrecorded expense at the time of grant will be included, beginning at April 1,
2006, in the Company’s computation of compensation expense in accordance with SFAS 123(R). The
following summarizes the unrecorded expense at the time of grant by time period and category of
recipient:
The Audit Committee’s additional key findings are summarized below:
Lack of Adequate Documentation: For a majority of grants issued by the Company during the
Review Period, there is either no or inadequate documentation of approval actions that satisfies
the requisites for establishing a measurement date under APB 25. Of the 69 recorded grant dates,
there are documented approval actions by the Board or the Option or Compensation Committee with
respect to particular grants for 12 dates. In the period December, 1992 to May, 1996, neither the
minutes of the Compensation Committee nor of the Board reflect any action to approve specific
grants. In some instances, evidence of single director (the chairman of the Compensation
Committee) approval actions exists. This absence of non-employee director level documentation also
applies to a majority of grants with a recorded grant date after 1996. In some cases, Compensation
Committee minutes contain a reference to reports on the status of the option pool but do not
document any action to approve specific grants. Approval documentation for certain grants has
internal inconsistencies or conflicts with other documents thereby rendering this documentation
unreliable as a basis for establishing a measurement date. In some cases, the only existing
documentation is the executed option agreement and/or the entry of the option grant into the option
database. Notwithstanding these approval documentation inadequacies, the Company entered into
option agreements with grantees and has honored such grants.
Grant Approvals: During the Review Period, relatively few option grants were approved in
complete compliance with the Company’s stock option plans. Available documentation reflects that
the Company approved option grants in a variety of ways. With respect to the employee stock option
plan, grants were approved by the Compensation Committee as contemplated by the plan at various
times, by the full Board in 1998 and 1999, by a single director (the chairman of the Compensation
Committee) on nine recorded grant dates during the period 1994 through 2001 and by the Company’s
CEO at various times. With respect to the director stock option plan, grants were generally
approved by the designated Board committee and, in a few cases, by the chairman of the Compensation
Committee. In one instance in 2000, there is no conclusive documentary evidence of the approval of
director grants other than the signed director option agreements.
The delegation of authority by the Compensation Committee to the CEO with respect to grants to rank
and file employees was not fully documented. However, there was an understood and accepted
practice between the CEO and the Compensation Committee whereby the CEO made certain awards to
individual employees. In some instances, this involved the allocation among rank and file
employees of blocks of shares approved by the Compensation Committee; in three (3) such instances,
the number of shares ultimately awarded pursuant to this process exceeded the approved size of the
block, which was contrary to the understanding of the Compensation Committee members. Further,
contrary to the understanding of the Compensation Committee members, the award and/or documentation
of those individual grants often significantly lagged the approval of the block grant. In August
2005, the Compensation Committee specifically acknowledged a prior grant of delegated authority to
the CEO to make option grants to rank and file employees and ratified all prior awards by the CEO.
In some cases, documentation of approval action is either inconclusive or missing, and the Company
therefore has been unable to determine what entity or person actually approved specific grants.
Option Pricing: The recorded grant dates for a majority of grants do not match the
applicable measurement dates as determined under APB 25. The grants of options with exercise
prices lower than the fair market values of the stock on the actual measurement dates did not
satisfy the fair market pricing requirement in the Company’s plans, as amended in 1998, and were
not consistent with the Company’s disclosures in SEC filings stating that the exercise price of
options was equal to the fair market value of the stock on the date of the grant.
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The relationship between the stated exercise price of options and the fair market value of the
Company’s stock on the date of the identifiable approval actions varied from grant to grant. In
some cases, the exercise price of grants reflected the fair market value of
the underlying shares on the date of any documented approval action. In other cases, the exercise
prices reflected the fair market value of the underlying shares on a date either prior or
subsequent to any such documented approval action and the exercise price was lower than the fair
market value on the date of any such action. In several such cases before August 2002, the use of
such grant dates and lower exercise prices (together with other available evidence) supports a
finding that the recorded grant dates and corresponding exercise prices were selected with the
benefit of hindsight. For certain grants where the mismatch between the recorded grant date and
the approval action was only a matter of days, however, the mismatch appears to have been
attributable to inaccurate recording or administrative delays. In some cases, the apparent
approval action did not identify all grantees; for example, there are cases where a block grant was
approved subject to a later determination of individual grant recipients and grants were recorded
with a grant date, and corresponding exercise price, that matched the date of the apparent approval
of the block grant and the fair market value of the common stock on that date although individual
grant recipients may have been identified some time after approval of the block grant. Finally, in
some cases, the approval action for specific grants is not adequately documented. Where the
recorded grant date did not satisfy the requisites for a measurement date under APB 25, the Company
relied on default methodologies to determine an appropriate measurement date.
Internal Controls: As outlined above, the Company’s historical administration of its
options program lacked discipline as it relates to proper adherence to the plan requirements,
corporate recordkeeping and documentation. Since November 2003, however, the Company has properly
administered the stock option program as it relates to awards to directors and officers. During
the investigation, the Company identified control gaps related to grants made throughout the Review
Period. As of March 31, 2007, the Company implemented additional procedures to its process that
are focused on formalized documentation of appropriate approvals and determination of grant terms
to employees.
Procedural and Remedial Actions
The Audit Committee and other relevant Board committees are committed to a continued review and
implementation of procedural enhancements and remedial actions in light of the foregoing findings.
Consistent with its obligation to act in the best interests of the Company taking into account all
relevant facts and circumstances, the Audit Committee is continuing to assess the appropriateness
of a broad range of possible procedural enhancements and potential remedial measures in light of
the findings of its review.
While the Audit Committee has not completed its consideration of all such steps, procedural
enhancements may include recommendations regarding improved stock option administration procedures
and controls, training and monitoring compliance with those procedures, corporate recordkeeping,
corporate risk assessment, evaluation of the internal compliance environment and other remedial
steps that may be appropriate.
Any such procedural enhancements will be recommended by the Audit Committee to the Board and/or
appropriate Board committee for adoption. In advance of action by the Audit Committee, as noted
above, the Company has implemented additional procedures to its process for approving stock option
grants that are focused on formalized documentation of appropriate approvals and determination of
grant terms to employees.
In light of the findings of the Audit Committee’s review, William F. Andrews, Thomas W. Golonski
and Thomas G. Greig, three current directors who also served during portions of the Review Period
and who hold options as to which the measurement date was adjusted in connection with the Company’s
restatement, agreed voluntarily to reprice those outstanding options with a recorded exercise price
less than the fair market value of the common stock on the accounting measurement date as
determined by the Audit Committee so that the exercise price matches the fair market value of the
common stock on such accounting measurement date. In addition, Michael McAndrew, who became the
Company’s CFO in December, 2002, also agreed voluntarily to reprice the one option granted to him
after he became CFO with a recorded exercise price less than the fair market value of the common
stock on the accounting measurement date as determined by the Audit Committee so that the exercise
price matches the fair market value of the common stock on such accounting measurement date.
The Audit Committee’s ongoing review includes an evaluation of the role of and possible claims or
other remedial actions against current and former Company personnel who may be found to have had
responsibility for identified problems during the Review Period. Accordingly, the Audit Committee
has begun to address and is addressing and expects to continue to address issues of individual
conduct or responsibility, including those of the Board, CEOs and CFOs serving during the Review
Period. In connection therewith, based on the findings of the Audit Committee as to Fred C. Young,
the Company’s former CEO who resigned on May 20, 2007, the Audit Committee concluded and
recommended to the Board, and the Board determined, that Mr. Young could have been terminated due
to Cause for Termination (as defined in his agreement dated May 11, 2004) at the time Mr. Young
resigned as a director and officer of the Company on May 20, 2007. In light of that determination
and the terms of the agreements with Mr. Young, all outstanding stock options held by Mr. Young
terminated as of the date of his resignation.
The Audit Committee may recommend additional remedial measures that appropriately address the
issues raised by its findings. Such potential remedial measures may include an evaluation of the
role of and possible claims or other remedial actions against current and former Company personnel
who may be found to have been responsible for identified problems during the Review Period.
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Restatement Methodologies
As of April 1, 2006, the Company adopted SFAS 123(R) using the modified prospective transition
method. Under this transition method, compensation expense is to be recognized for all share-based
compensation awards granted after the date of adoption and for all unvested awards existing on the
date of adoption. Prior to April 1, 2006, the Company accounted for stock-based compensation
awards to directors, officers and rank and file employees using the intrinsic value method in
accordance with APB 25 as allowed under SFAS 123. Under the intrinsic value method, no share-based
compensation expense related to stock options was required to be recognized if the exercise price
of the stock option was at least equal to the fair market value of the common stock on the
“measurement date.” APB 25 defines the measurement date as the first date on which are known both
(1) the number of shares that an individual grant recipient is entitled to receive and (2) the
option or purchase price, if any.
In light of the Audit Committee’s review of the Company’s stock option granting practices during
the Review Period and as to those cases in which the Company previously used a recorded grant date
as the measurement date that the Company determined could no longer be relied upon, the Company has
developed and applied the following methodologies to remeasure those stock option grants and record
the relevant charges in accordance with APB 25 by considering the following sources of information:
(i) meeting minutes of the Board and of committees thereof and related materials, (ii) Unanimous
Written Consents of the Board and of committees thereof, (iii) create date, (iv) relevant email
correspondence reflecting stock option grant approval actions, (v) individual stock option
agreements and related materials, (vi) employee and Board offer letters, (vii) documents relating
to acquisitions, (viii) reports on Form 4 filed with the SEC and (ix) guidance of the Office of the
Chief Accountant of the SEC on stock option matters as set forth in its letter dated September 19,
2006.
Grants with Appropriate Committee Approval. With respect to grants of approximately 1.0 million
shares, or approximately 9% of the total grants in the Review Period, the Company has evidence to
support the approval of the grant under the stock option plans by the relevant committee of the
Board, and such evidence includes the number of options each individual was entitled to receive and
the option price. However, the relationship between these documented approval actions and the
originally-recorded grant dates and exercise prices for the options so approved varied during the
Review Period. In some cases, grants were recorded with a grant date and a corresponding exercise
price that matched the date of the approval action or were otherwise consistent with the terms of
the approval action. In other cases, however, the recorded grant dates and corresponding exercise
prices of the grants reflected the fair market value of the common stock on a date prior to the
committee’s documented approval actions. The Company has restated the compensation expense for
stock option grants relating to approximately 0.4 million shares of common stock by using the date
of the documented approval action as the measurement date. The total additional non-cash, pre-tax
charge for these grants is approximately $1.8 million, net of forfeitures, amortized over the
appropriate vesting period through March 31, 2006, of which $0.07 million relates to director
options, $1.3 million relates to officer options and $0.4 million relates to rank and file employee
options.
Grants with Other Approvals. With respect to grants of approximately 1.9 million shares, or
approximately 18% of the total grants in the Review Period, the Company has evidence to support the
approval of the grant by the Board, an outside director or the Company’s CEO and the identification
of the number of options each individual was entitled to receive together with the option price.
These grants are distinguished from the grants described in the prior paragraph in that the nature
of the approval was not fully consistent with the terms of the relevant stock option plan. As with
the grants discussed in the preceding paragraph, the relationship between these documented approval
actions and the originally-recorded grant dates and exercise prices for the options so approved
varied during the Review Period. In some cases, grants were recorded with a grant date and a
corresponding exercise price that matched the date of the approval action or were otherwise
consistent with the terms of the approval action. In other cases, however, the recorded grant
dates and corresponding exercise prices of the grants reflected the fair market value of the
Company’s stock on a date prior to the approval action. The Company has restated the compensation
expense for stock option grants relating to approximately 1.6 million shares of common stock by
using the date of the documented approval action as the measurement date. The total additional
non-cash, pre-tax charge for these grants is approximately $7.6 million, net of forfeitures,
amortized over the appropriate vesting period through March 31, 2006, of which $0.5 million relates
to director options, $2.6 million relates to officer options and $4.5 million relates to rank and
file employee options.
Grants Lacking Adequate Documentation. With respect to grants of approximately 7.9 million shares
(5.0 million shares to rank and file employees), or 73.0% of the total grants in the Review Period,
the Company has been unable to locate adequate documentation of approval actions that would satisfy
the requisites for a measurement date under APB 25. For these grants, management considered all
available relevant information to form a reasonable conclusion as to the most reasonable
measurement date. For all grants in this category, the Company has established default
methodologies for determining the most appropriate measurement date under APB 25.
With respect to grants entered into the Company’s stock option database after September 9, 1999,
when the database began to reflect a create date which is the date on which a grant was entered
into the system, the Company has determined to use the individual create date for each grant as the
APB 25 measurement date, which was in most cases different from the originally-recorded grant date.
The Company believes that this create date is the most appropriate methodology in the absence of
sufficient evidence of approvals for these grants as it represents the earliest point in time at
which the evidence shows that all requisites for the establishment of the measurement date had been
satisfied. Such create dates preceded, often by a significant amount of time, the execution of
stock option
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agreements, which, generally, were manually signed by the Company’s CEO and manually signed and
dated by the grantee. In addition, in almost all cases, a grant entered into the database, which
established the create date, ultimately resulted in the creation of a stock option agreement
reflecting such grant. Accordingly, while execution of the stock option agreements constituted a
clear acknowledgement by the grantee and the Company of the grantee’s legal entitlement to the
grant, the Company believes the create date more accurately reflects the date of approval than does
the signed option agreement. The Company has restated the compensation expense for stock option
grants relating to approximately 4.2 million shares of common stock by using the create date as the
measurement date. The total additional non-cash, pre-tax charge for these grants is approximately
$49.8 million, net of forfeitures, amortized over the appropriate vesting period through March 31,
2006, of which $0.5 million relates to director options, $17.2 million relates to officer options
and $32.2 million relates to rank and file employee options. The Company’s procedures for
evaluating the appropriateness of measurement dates fixed with reference to such create dates
included a sensitivity analysis which provided an understanding of the differences between the
additional recorded charge for stock-based compensation expense and the charges that would result
from using other identified alternative methods for determining measurement dates. The Company’s
sensitivity analysis included identifying the range of potential grant dates defined by the
recorded grant date and the create date for each grant. The Company then identified the low and
high closing prices of the common stock within that range of potential grant dates and applied both
the low and high closing prices of the common stock to the number of shares granted for which the
create date methodology was utilized to determine the range of potential adjustments to stock-based
compensation expense for these grants, which was $0.09 million to $73.8 million, net of
forfeitures, as compared to the additional non-cash, pre-tax charge for these grants of
approximately $49.8 million, net of forfeitures, included in the Restatement.
For options entered into the Company’s option database before September 9, 1999, the Company
determined the measurement date generally by reference to signed option agreements (or the deemed
signature date for certain options as discussed below). The executed option agreements
(hereinafter “signed option agreements”), manually signed by the Company’s CEO and manually signed
and dated by the grantee, constituted an acknowledgement by the grantee and the Company of the
grantee’s legal entitlement to the grant and, in the absence of authoritative information as to
when all the requisites for the establishment of the measurement date had been satisfied, provides
a measurement date framework based on entitlement. The Company has restated the compensation
expense for stock option grants relating to approximately 1.4 million shares of common stock by
using the signed option agreements as the measurement date. The total additional non-cash, pre-tax
charge for these grants is approximately $6.4 million, net of forfeitures, amortized over the
appropriate vesting period through March 31, 2006, of which $0.3 million relates to director
options, $3.6 million relates to officer options and $2.5 million relates to rank and file employee
options. The Company believes this methodology was the most appropriate in the absence of
sufficient evidence of approvals for these grants as it represents the earliest point in time at
which the evidence shows that all requisites for the establishment of the measurement date had been
satisfied for these grants. The Company’s procedures for evaluating the appropriateness of
measurement dates fixed with reference to the dating of signed option agreements included a
sensitivity analysis which provided an understanding of the differences between the additional
recorded charge for stock-based compensation expense and the charges that would result from using
other identified alternative methods for determining measurement dates. The Company’s sensitivity
analysis included identifying the range of potential grant dates defined by the recorded grant date
and the date of the grantee’s signature on the stock option agreement for each grant. The Company
then identified the low and high closing prices of the common stock within that range of potential
grant dates and applied both the low and high closing prices of the common stock to the number of
shares granted for which the signed option agreements methodology was utilized to determine the
range of potential adjustments to stock-based compensation expense for these grants, which was
$0.03 million to $9.6 million, net of forfeitures, as compared to the additional non-cash, pre-tax
charge for these grants of approximately $6.4 million, net of forfeitures, included in the
Restatement.
In those cases where no reliably-dated signed option agreement could be located and where no
post-September 9, 1999 create date exists (stock option grants totaling approximately 0.9 million
shares), the Company used the average period between recorded grant date and date of the signatures
on all other grantee signed option agreements with the same grant date as the measurement date.
For example, if there were four stock option grants with a grant date of January 1, 1996, the
Company had the signed option agreements for three of these stock option grants and the average
number of days between the grant date and the signature dates of these three signed option
agreements was 20 days, January 21, 1996 was used as the measurement date for the grant for which
no signed option agreement could be located. The Company has restated the compensation expense for
stock option grants relating to approximately 0.7 million shares of common stock using this
“average days to sign agreement” method. The total additional non-cash, pre-tax charge for these
grants is approximately $4.4 million, net of forfeitures, amortized over the appropriate vesting
period through March 31, 2006, of which $0.06 million relates to director options, $4.2 million
relates to officer options and $0.2 million relates to rank and file employee options. The Company
believes this methodology was the most appropriate in the absence of sufficient evidence of
approvals for these grants because it gives a reasonable approximation of the measurement date
related to these options in light of the available evidence. The Company conducted a sensitivity
analysis by comparing the Company’s current default methodology (i.e., “average days to sign
agreement”) with another default methodology. For this analysis, the Company identified the range
of potential grant dates defined by the earliest signed option agreement and the latest signed
option agreement. The Company then identified the low and high closing prices of the common stock
over the range of potential grant dates and applied both the low and high closing prices of the
common stock to the number of shares granted to determine the range of potential adjustments to
stock-based compensation expense for these grants, which was $2.6 million to $5.9 million, net of
forfeitures. The Company’s analyses indicate that stock-based compensation expense computed using
other identified alternative default methodologies would not materially differ from stock-based
compensation expense computed using the “average days to sign agreement” methodology. The
Company’s procedures for evaluating the appropriateness of measurement dates fixed with reference
to the average days to sign agreements also
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included a sensitivity analysis which provided an understanding of the differences between the
additional recorded charge for stock-based compensation expense and the charges that would result
from using other identified alternative methods for determining measurement dates. The Company’s
sensitivity analysis included identifying the range of potential grant dates defined by the
recorded grant date and the average days to sign agreement for each grant. The Company then
identified the low and high closing prices of the common stock within that range of potential grant
dates and applied both the low and high closing prices of the common stock to the number of shares
granted to determine the range of potential adjustments to stock-based compensation expense for
these grants, which was $0.03 million to $6.1 million, net of forfeitures, as compared to the
additional non-cash, pre-tax charge for these grants of approximately $4.4 million, net of
forfeitures, included in the Restatement.
Given the volatility of the common stock during much of the Review Period, the use of methodologies
and measurement dates different from those described above could have resulted in a higher or lower
cumulative compensation expense which would have caused net income or loss to be different from the
amounts reported in the restated consolidated financial statements. The Company’s procedures for
evaluating the appropriateness of measurement dates fixed using the default methodologies described
above also included a sensitivity analysis which provided an understanding of the differences
between the additional recorded charge for stock-based compensation expense and the charges that
would result from using other identified alternative methods for determining measurement dates.
The Company’s sensitivity analysis included identifying the range of potential grant dates defined
by the recorded grant date and the appropriate measurement date for each grant. The Company then
identified the low and high closing prices of the common stock within that range of potential grant
dates and applied both the low and high closing prices of the common stock to the number of shares
granted to determine the range of potential adjustments to stock-based compensation expense for
these grants, which was $9.3 million to $99.3 million, net of forfeitures, as compared to the
additional non-cash, pre-tax charge for these grants of approximately $70.0 million, net of
forfeitures, included in the Restatement.
Other adjustments through March 31, 2006
From 1994 through 1998, the Company did not properly account for stock options for one officer that
were modified after the grant date pursuant to a separation agreement. Some of these modifications
were not identified in the Company’s financial reporting processes and were therefore not properly
reflected in its financial statements. As a result, the Company has recorded a non-cash charge for
stock-based compensation of $1.0 million during Fiscal 1999.
Summary
In summary, the Company recorded cumulative non-cash charges for stock-based compensation of $70.9
million through March 31, 2006, offset in part by a cumulative income tax benefit of $27.7 million,
for a total after-tax charge of $43.2 million. These charges had no impact on net sales or cash
and cash equivalents as previously reported in the Company’s financial statements; as a result, no
changes to these items are reflected in the Restatement. Non-cash charges for stock-based
compensation expense have been recorded as adjustments to Selling, general & administrative
expenses within the Company’s Consolidated Statements of Income.
1Q07 and 2Q07 Restatement
Stock-based compensation expense
In addition to the Restatement noted above through March 31, 2006, the Company has recorded
additional non-cash charges for stock-based compensation during the first and second quarters of
Fiscal 2007 of $1.6 million and $2.2 million, respectively, offset in part by income tax benefits
of $0.6 million and $0.8 million, respectively, or total after-tax charges of $1.0 million and $1.4
million, respectively. This charge was recorded to reflect additional non-cash, stock-based
compensation expense recognized under the fair value method (SFAS 123(R)) because the exercise
price for certain stock option grants prior to, but not vested as of March 31, 2006, differed from
the fair market value of the underlying shares on the appropriate measurement date, some of which
occurred during Fiscal 2007.
Accounting for derivatives
On July 26, 2006, the Company entered into an interest rate swap to reduce its exposure from
fluctuating interest rates. SFAS 133 requires that all derivative instruments be recorded on the
balance sheet as either an asset or liability measured at their fair value, and that changes in the
derivatives’ fair value be recognized currently in earnings unless specific hedge accounting
criteria are met. From inception of the hedge, the Company had applied a method of cash flow hedge
accounting under SFAS 133 to account for the interest rate swap that allowed the Company to assume
no ineffectiveness in such agreements, called the “short-cut” method.
Subsequently, the Company analyzed its eligibility for the “short-cut” method in light of certain
clarifications delivered by the Office of the Chief Accountant of the SEC, and determined that its
interest rate swap did not qualify for the “short-cut” method under SFAS 133 because certain
prepayment features relating to the underlying actual debt were not identical to those contained in
the interest rate swap. Because the Company’s documentation at hedge inception reflected the
“short-cut” method rather than the “long-haul” method for determining hedge ineffectiveness, the
derivative did not meet the requirements for a cash flow hedge. Documentation for the “long-haul”
method of accounting at hedge inception cannot be retrospectively applied under SFAS 133.
Therefore, fluctuations
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in the interest rate swap’s fair value should have been recorded through the Company’s
Consolidated Statements of Income instead of through OCI, which is a component of Stockholders’
equity. The adjustment for the second quarter of Fiscal 2007 will decrease reported net income and
increase OCI by approximately $1.4 million. This change in accounting for this derivative
instrument could result in significant volatility in the Company’s reported net income and earnings
per share due to increases and decreases in the fair value of the interest rate swap. However, the
derivative instrument remains highly effective and the change in accounting for this derivative
instrument does not impact operating cash flows or total Stockholders’ equity.
The table below reflects the impact of the additional non-cash charges for stock-based compensation
expense and the non-cash charge related to the interest rate swap on the Company’s Consolidated
Statements of Income, including the corresponding cumulative adjustment to Retained earnings as of
September 30, 2006 and March 31, 2006, 2005, 2004 and 2003 on the Company’s Consolidated Balance
Sheets. Prior to this Restatement, the Company had not recorded any non-cash stock-based
compensation expense in its Consolidated Statements of Income with the exception of $0.7 million
recorded during the second quarter of Fiscal 2005 for a modification of a previous stock option
award for a retiring director. All dollar amounts are presented in thousands except per share
amounts. Per share amounts may not total due to rounding.
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Income Tax Considerations
In the course of the investigation, the Company determined that a number of officers may have
exercised options for which the application of Section 162(m) of the Code may apply. It is
possible that these options will be treated as having been granted at less than fair market value
for federal income tax purposes because the Company incorrectly applied the measurement date as
defined in APB 25. If such options are deemed to have been granted at less than fair market value,
pursuant to Section 162(m), any compensation to officers, including proceeds from options exercised
in any given tax year, in excess of $1.0 million will be disallowed as a deduction for tax
purposes. The Company estimates that the potential tax effected liability for any such disallowed
Section 162(m) deduction would approximate $3.6 million, which has been recorded as a current
liability within Income taxes within
the Company’s Consolidated Balance Sheets. The Company may
also incur interest and penalties if it were to incur any such tax liability, which could be
material.
In addition, the Company is considering the application of Section 409A to those options for which
it incorrectly applied the measurement date as defined in APB 25. It is possible that these
options will be treated as having been granted at less than fair market value for federal income
tax purposes and thus subject to Section 409A. Accordingly, the Company may adopt measures to
address the application of Section 409A. The Company does not currently know what impact Section
409A will have, or any such measures, if adopted, would have, on its results of operations,
financial position or cash flows, although such impact could be material.
Expenses Incurred by the Company
The Company has incurred expenses for legal fees and external audit firm fees, in excess of its
insurance deductible of $0.5 million, in Fiscal 2007, in relation to (i) the Audit Committee’s
review of the Company’s historical stock option practices and related accounting for stock option
grants, (ii) the informal inquiry and formal order of investigation by the SEC regarding the
Company’s past stock option practices, (iii) the previously-disclosed derivative action relating to
the Company’s historical stock option practices filed against the Company as a nominal defendant
and certain of the Company’s current and former directors and officers, as to whom it may have
indemnification obligations and (iv) related matters. Further, the Company has incurred and
expects to continue to incur significant additional expense related to the foregoing matters in the
fiscal year ending March 31, 2008. The Company and the insurance company for its directors’ and
officers’ indemnification insurance are currently in discussions with respect to which of the fees
in excess of the deductible will be paid by the insurance company. Accordingly, there can be no assurance that all fees submitted to the insurance company for
reimbursement will be reimbursed under the Company’s directors’ and officers’ indemnification
insurance.
The Company
Black Box is the world’s largest dedicated network infrastructure services provider. Black Box
offers one-source network infrastructure services for communication systems. The Company’s service
offerings include design, installation, integration, monitoring and maintenance of voice, data and
integrated communication systems. The Company’s primary service offering is voice solutions, while
providing premise cabling and other data related services and products. The Company provides
24/7/365 technical support for all of its solutions which encompasses all major voice and data
manufacturers as well as 118,000 network infrastructure products that it sells through its catalog
and Internet Web site and its Voice and Data services (collectively referred to as “On-Site
services”) offices. References herein to “Fiscal Year” or “Fiscal” mean the Company’s fiscal year
ended March 31 for the year referenced.
Management is presented with and reviews revenues and operating income by geographical segment. In
addition, revenues and gross profit information by service type are provided herein for purposes of
further analysis.
The Company has completed several acquisitions from April 1, 2004 through March 31, 2007 that have
had a significant impact on the Company’s consolidated financial statements and, more specifically,
North America Voice Services for the periods under review. Fiscal 2005 acquisitions include
Norstan, Inc. (“Norstan”). Fiscal 2006 acquisitions include (i) Telecommunication Systems
Management, Inc. (“TSM”), (ii) GTC Technology Group, Inc. and Technology Supply, Inc. (collectively
referred to as “GTC”), (iii) Business Communications, Inc., Bainbridge Communication, Inc., BCI of
Tampa, LLC and Networx, L.L.C. (collectively referred to as “BCI”), (iv) Universal Solutions of
North America, L.L.C. and related entities (“Universal”), (v) Communication is World InterActive
Networking, Inc. (“C=WIN”) and (vi) Converged Solutions Group, LLC (“CSG”). Fiscal 2007
acquisitions include (i) USA Commercial and Government and Canadian operations of NextiraOne, LLC
(“NextiraOne”), (ii) Nu-Vision Technologies, Inc. and Nu-Vision Technologies, LLC (collectively
referred to as “NUVT”), (iii) Nortech Telecommunications, Inc. (“NTI”) and (iv) ADS Telecom, Inc.
(“ADS”). The acquisitions noted above are collectively referred to as the “Acquired Companies.”
References to the Acquired Companies within our comparison of Fiscal 2007 and Fiscal 2006 are
intended to describe the Acquired Companies from April 1, 2005 through March 31, 2007. References to
the Acquired Companies within our comparison of Fiscal 2006 and Fiscal 2005 are intended to
describe the Acquired Companies from April 1, 2004 through March 31, 2006. The results of
operations of the Acquired Companies are included in the Company’s Consolidated Statements of
Income beginning on their respective acquisition dates.
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In connection with certain acquisitions, the Company incurs expenses that it excludes when
evaluating the continuing operations of the Company. The following table is included to provide a
schedule of the past, current and an estimate of future acquisition-related expenses based on the
acquisition activity through March 31, 2007.
The following table is included to provide a schedule of an estimate of acquisition-related
expenses for Fiscal 2008 (by quarter) based on the acquisition activity through March 31, 2007.
During the fourth quarter of Fiscal 2006, the Company incurred a pre-tax charge of $7,065 related
to an adjustment of earnings over multiple years, from Fiscal 2003 through Fiscal 2006, from the
Company’s Italian Operations (“Italian Operations Adjustment”). Of the total charge, $3,588 was
recorded in Cost of Sales and $3,477 was recorded in Selling, general & administrative expense. The
Italian Operations Adjustment resulted from intentional misconduct by certain local operational and
financial managers of the Company’s Italian Operations acting in collusion with one another for the
purpose of overstating local financial results. All involved team members have been terminated and
the Company intends to pursue all available legal remedies against these individuals. The
misconduct was brought to the Company management’s attention by a team member of the Italian
Operations pursuant to the Company’s “Open Door” Policy. Company management responded by
immediately suspending the management team of the Italian Operations and conducting a full
investigation of the matter. The Company believes that all accounting irregularities have been
identified, corrective action taken and that the Italian Operations Adjustment captures all
necessary corrections.
The Company’s management concluded, with the concurrence of the Audit Committee, that the impact of
the Italian Operations Adjustment was not material to the Company’s consolidated financial
statements for any interim or annual period between Fiscal 2003 through Fiscal 2006. In reaching
this conclusion, the Company reviewed and analyzed the SEC’s Staff Accounting Bulletin (“SAB”) No.
99, “Materiality,” in order to determine that the impact was not material on a quantitative or
qualitative basis to any one period. As a result, the Company recorded a cumulative adjustment in
the fourth quarter of Fiscal 2006.
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Information on revenues and operating income by reportable geographic segment (North America,
Europe and All Other) is presented below. The tables below should be read in conjunction with the
following discussion. The additional non-cash charges for stock-based compensation expense was
recorded in Selling, general & administrative expenses which is included in the Company’s measure
of Operating Income. See Note 3 of the Notes to the
Consolidated Financial Statements.
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Information on revenues and gross profit by service type (Data Services, Voice Services and Hotline
Services) is presented below. The additional non-cash charges for stock-based compensation expense
were recorded in Selling, general & administrative expenses which is not included in the Company’s
measure of Gross Profit and therefore does not impact the following table or the corresponding
discussions.
The Company has received notification that its distribution agreement with Avaya, Inc. will be
terminated effective September 8, 2007. The Company is in discussions with Avaya concerning the
future business relationship of the parties and the handling of key accounts. The Company is
evaluating the potential financial impact of this event as well as potential business strategies to
minimize such impact. The Company currently anticipates that this impact will not have a material
impact on its Fiscal 2008 operating results.
Fiscal 2007 Compared To Fiscal 2006
Total Revenues
Total revenues for Fiscal 2007 were $1,016,310, an increase of 41% compared to total revenues for
Fiscal 2006 of $721,335. The increase was primarily due to the incremental revenue from the
Acquired Companies, which added $367,211 and $52,427 for Fiscal 2007 and Fiscal 2006, respectively.
Excluding the effects of the acquisitions and the positive exchange rate impact of $7,956 relative
to the U.S. dollar, total revenues would have decreased 4% from $668,908 to $641,143 for the
reasons discussed below.
Revenues by Geography
North America
Revenues in North America for Fiscal 2007 were $850,088, an increase of 51% compared to revenues
for Fiscal 2006 of $564,700. The increase was primarily due to the incremental revenue from the
Acquired Companies, which added $367,211 and $52,427 for Fiscal 2007 and Fiscal 2006, respectively.
Excluding the effects of the acquisitions and the positive exchange rate impact of $1,009 relative
to the U.S. dollar, North American revenues would have decreased 6% from $512,273 to $481,868. The
Company believes the decrease is due to the completion of several nonrecurring projects; offset in
part by success in the Company’s Data, Voice and Hotline (“DVH”) cross-selling initiatives.
Europe
Revenues in Europe for Fiscal 2007 were $129,278, an increase of 8% compared to revenues for Fiscal
2006 of $120,051. Excluding the positive exchange rate impact of $7,078 relative to the U.S.
dollar, Europe revenues would have increased 2% from $120,051 to $122,200. The Company believes the
increase is due to the success in the Company’s DVH cross-selling initiatives.
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All Other Revenues
Revenues for All Other for Fiscal 2007 were $36,944, an increase of 1% compared to revenues for
Fiscal 2006 of $36,584. Excluding the negative exchange rate impact of $131 relative to the U.S.
dollar, All Other revenues would have increased 1% from $36,584 to $37,075.
Revenue by Service Type
Data Services
Revenues from Data Services for Fiscal 2007 were $182,129, a decrease of 7% compared to revenues
for Fiscal 2006 of $196,585. Excluding the positive exchange rate impact of $3,351 relative to the
U.S. dollar for its International Data Services, Data Service revenues would have decreased 9% from
$196,585 to $178,778. The Company believes the decrease in Data
Services revenues was due to the
completion of several nonrecurring projects.
Voice Services
Revenues from Voice Services for Fiscal 2007 were $611,278, an increase of 97% compared to revenues
for Fiscal 2006 of $310,804. The increase was primarily due to the incremental revenue from the
Acquired Companies, which added $367,211 and $52,427 for Fiscal 2007 and Fiscal 2006, respectively.
Excluding the effects of the acquisitions, Voice Services revenues would have decreased 6% from
$258,377 to $244,067. The Company believes that this decrease in
Voice Services revenues is
primarily due to the completion of several nonrecurring projects and planned post-merger client
attrition from the acquisition of Norstan in the fourth quarter of Fiscal 2005. There was no
exchange rate impact on Voice Service revenues as all of the Company’s Voice Services revenue is
denominated in U.S. dollars.
Hotline Services
Revenues from Hotline Services for Fiscal 2007 were $222,903, an increase of 4% compared to
revenues for Fiscal 2006 of $213,946. Excluding the positive exchange rate impact of $4,587
relative to the U.S. dollar for its International Hotline Services, Hotline Service revenues would
have increased 2% from $213,946 to $218,316. The Company believes this increase is primarily due to
the success in the Company’s DVH cross-selling initiatives.
Gross Profit
Gross profit dollars for Fiscal 2007 were $373,989, an increase of 32% compared to gross profit
dollars for Fiscal 2006 of $282,350. The Company believes the increase in gross profit dollars was
primarily due to the acquisition of the Acquired Companies. Gross profit as a percent of revenues
for Fiscal 2007 was 36.8%, a decrease of 2.3% compared to gross profit as a percentage of revenues
for Fiscal 2006 of 39.1%. The Company believes the percent decrease was due primarily to the impact
of lower gross profit in its Voice Services segment driven by the acquisition of NextiraOne,
partially offset by certain non-cash or non-operating expenses incurred by the Company during
Fiscal 2006, including $1,543 of inventory write-ups due to acquisitions and $3,588 for the Italian
Operations Adjustment (discussed above) for which there were no comparable expenses for Fiscal
2007.
Gross profit dollars for Data Services for Fiscal 2007 were $55,598, or 30.5% of revenues, compared
to gross profit dollars for Fiscal 2006 of $57,068, or 29.0% of revenues. Gross profit dollars for
Voice Services for Fiscal 2007 were $209,268, or 34.2% of revenues, compared to gross profit
dollars for Fiscal 2006 of $119,556, or 38.5% of revenues. Gross profit dollars for Hotline
Services for Fiscal 2007 were $109,123, or 49.0% of revenues, compared to gross profit dollars for
Fiscal 2006 of $105,726, or 49.4% of revenues.
Selling, General & Administrative Expenses
Selling, general & administrative expenses for Fiscal 2007 were $290,355, an increase of $73,444
compared to Selling, general & administrative expenses for Fiscal 2006 of $216,911. The increase in
Selling, general & administrative expense dollars over the prior year was due primarily to the
Acquired Companies. Selling, general & administrative expense as a percent of revenue for Fiscal
2007 were 28.6% compared to 30.1% for Fiscal 2006. During Fiscal 2006, the Company incurred $3,477
for the Italian Operations Adjustment (discussed above) for which there was no comparable expense
during Fiscal 2007. The decrease in Selling, general & administrative expense as a percent of revenue was
due primarily to lower Selling, general & administrative expense as a percent of revenues related to the
Acquired Companies and a decrease in non-cash stock-based compensation expense of $1,737, partially
offset by non-cash or non-operating expenses of $2,196 for depreciation expense on asset write-ups
due to acquisitions and $1,777 for employee severance.
Restructuring and Other Charges
The Company did not record any restructuring charges during Fiscal 2007. During the first quarter
of Fiscal 2006, the Company recorded a restructuring charge of $5,290. This charge was comprised
of $3,473 for staffing level adjustments and $1,817 for real estate consolidations in Europe and
North America. Of this charge, $3,742 and $1,548 related to Europe and North America,
respectively. See Note 11 of the Notes to the Consolidated Financial Statements for further
details.
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Intangibles Amortization
Intangibles amortization for Fiscal 2007 was $10,285, an increase of $5,286 compared to intangible
amortization for Fiscal 2006 of $4,999. The increase was primarily attributable to the amortization
of intangible assets acquired through the purchase of the Acquired Companies. See Note 7 and 10 of
the Notes to the Consolidated Financial Statements for further details.
Operating Income
Operating income for Fiscal 2007 was $73,349, or 7.2% of revenues, an increase of $18,199 compared
to operating income for Fiscal
2006 of $55,150, or 7.6% of revenues.
Interest Expense, Net
Net interest expense for Fiscal 2007 was $18,407, an increase of $9,284 compared to net interest
expense for Fiscal 2006 of $9,123. The increase in interest expense is due to an increase in the
weighted average outstanding debt and weighted average interest rate from approximately $155,898
and 5.1% for Fiscal 2006, respectively, to approximately $253,129 and 6.2% for Fiscal 2007,
respectively. The increase in debt relates primarily to the acquisitions of NextiraOne and NUVT
during the first quarter of Fiscal 2007. Also included in interest expense for Fiscal 2007 is
$1,734 related to the change in fair value of the Company’s interest rate swap.
Provision for Income Taxes
The tax provision for Fiscal 2007 was $19,291, an effective tax rate of 35.1%. This compares to the
tax provision for Fiscal 2006 of $15,221, an effective tax rate of 33.1%. The tax rate for Fiscal
2007 was higher than Fiscal 2006 due to the impact of book stock option expense and the associated
tax asset and changes in the overall mix of taxable income among worldwide offices. The Company
anticipates that its deferred tax asset is realizable in the foreseeable future.
Net Income
As a result of the foregoing, net income for Fiscal 2007 was $35,609, or 3.5% of revenues, compared
to net income for Fiscal 2006 of $30,770, or 4.3% of revenues.
Fiscal 2006 Compared To Fiscal 2005
Total Revenues
Total revenues for Fiscal 2006 were $721,335, an increase of 35% compared to total revenues for
Fiscal 2005 of $535,076. The increase was primarily due to the incremental revenue from the
Acquired Companies, which added $227,313 and $35,208 for Fiscal 2006 and Fiscal 2005, respectively.
Excluding the effects of the acquisitions and the negative exchange rate impact of $4,321 relative
to the U.S. dollar, total revenues would have decreased less than 1% from $499,868 to $498,343 for
the reasons discussed below.
Revenues by Geography
North America
Revenues in North America for Fiscal 2006 were $564,700, an increase of 59% compared to revenues
for Fiscal 2005 of $355,013. The increase was primarily due to the incremental revenue from the
Acquired Companies, which added $227,313 and $35,208 for Fiscal 2006 and Fiscal 2005, respectively.
Excluding the effects of the acquisitions and the negative exchange rate impact of $281 relative to
the U.S. dollar, North American revenues would have increased 6% from $319,805 to $337,668. The
Company believes this increase was generally due to the increased demand for Data and Voice
Services and success in the Company’s DVH cross-selling initiatives.
Europe
Revenues in Europe for Fiscal 2006 were $120,051, a decrease of 16% compared to revenues for Fiscal
2005 of $142,838. Excluding the negative exchange rate impact of $4,046 relative to the U.S.
dollar, Europe revenues would have decreased 13% from $142,838 to $124,097. The Company believes
the decrease was due to the weak general economic conditions that affected client demand and the
Italian Operations Adjustment.
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All Other
Revenues for All Other for Fiscal 2006 were $36,584, a decrease of 2% compared to revenues for
Fiscal 2005 of $37,225. Excluding the negative exchange rate impact of $556 relative to the U.S.
dollar, All Other revenues would have decreased less than 1%.
Revenue by Service Type
Data Services
Revenues from Data Services for Fiscal 2006 were $196,585, a decrease of 2% compared to revenues
for Fiscal 2005 of $200,935. Excluding the negative exchange rate impact of $1,357 relative to the
U.S. dollar for its International Data Services, Data Service revenues would have decreased 1% from
$200,935 to $197,942. The Company believes the decline in Data Services revenues was driven by weak
general economic conditions in the European market and the Italian Operations Adjustment.
Voice Services
Revenues from Voice Services for Fiscal 2006 were $310,804, an increase of 192% compared to
revenues for Fiscal 2005 of
$106,540. The increase was primarily due to the incremental revenue from the Acquired Companies,
which added $227,313 and $35,208 for Fiscal 2006 and Fiscal 2005, respectively. Excluding the
effects of the acquisitions, Voice Services revenues would have increased 17% from $71,332 to
$83,491. The Company believes the increase in Voice Services revenues was driven by increased
client demands and the Company’s ability to successfully cross-sell its DVH services to existing
customers. There was no exchange rate impact on Voice Services revenues as all of the Company’s
Voice Services revenue is denominated in U.S. dollars.
Hotline Services
Revenues from Hotline Services for Fiscal 2006 were $213,946, a decrease of 6% compared to revenues
for Fiscal 2005 of $227,601. Excluding the negative exchange rate impact of $2,966 relative to the
U.S. dollar for its International Hotline Services, Hotline Services revenues would have decreased
5% from $227,601 to $216,912. The Company believes the decline in Hotline Services revenues was
driven by weak general economic conditions in the European market and the Italian Operations
Adjustment.
Gross Profit
Gross profit dollars for Fiscal 2006 were $282,350, an increase of 31% compared to gross profit
dollars for Fiscal 2005 of $214,929. The Company believes the increase in gross profit dollars was
primarily due to the acquisition of the Acquired Companies, offset in part by the Italian
Operations Adjustment. Gross profit as a percent of revenues for Fiscal 2006 was 39.1%, a decrease
of 1.1% compared to gross profit as a percentage of revenues for Fiscal 2005 of 40.2%. The Company
believes the percent decrease was primarily related to a lower gross profit percent in Hotline
Services and the Italian Operations Adjustment.
Gross profit dollars for Data Services for Fiscal 2006 were $57,068, or 29.0% of revenues, compared
to gross profit dollars for Fiscal 2005 of $59,354, or 29.5% of revenues. Gross profit dollars for
Voice Services for Fiscal 2006 were $119,556, or 38.5% of revenues, compared to gross profit
dollars for Fiscal 2005 of $36,255, or 34.0% of revenues. Gross profit dollars for Hotline Services
for Fiscal 2006 were $105,726, or 49.4% of revenues, compared to gross profit dollars for Fiscal
2005 of $119,320, or 52.4% of revenues.
Selling, General & Administrative Expenses
Selling, general & administrative expenses for Fiscal 2006 were $216,911, an increase of $51,731
compared to Selling, general & administrative expenses for Fiscal 2005 of $165,180. The dollar
increase is primarily due to the acquisition of the Acquired Companies offset in part by lower
expenses as a result of execution of a previously announced restructuring plan. Selling, general &
administrative expenses as a percent of revenue for Fiscal 2006 were 30.1% compared to 30.9% for
Fiscal 2005, which included an increase in non-cash stock-based compensation expense of $5,187.
During Fiscal 2006, the Company incurred $3,477 for the Italian Operations Adjustment (discussed
above) for which there was no comparable expense during Fiscal 2005.
Restructuring and Other Charges
During the first quarter of Fiscal 2006, the Company recorded a restructuring charge of $5,290.
This charge was comprised of $3,473 for staffing level adjustments and $1,817 for real estate
consolidations in Europe and North America. Of this charge, $3,742 and $1,548 related to Europe
and North America, respectively. See Note 11 of the Notes to the Consolidated Financial Statements
for further details.
During the fourth quarter of Fiscal 2005, the Company recorded a restructuring charge of $5,059.
This charge was comprised of $3,019 for staffing level adjustments and for real estate
consolidations in Europe and North America and $2,040 for the satisfaction of a
previously-disclosed litigation judgment. Of this charge, $4,056 and $1,003 related to North
America and Europe, respectively. See Note 17 of the Notes to the Consolidated Financial Statements
for further details.
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Intangibles Amortization
Intangibles amortization for Fiscal 2006 was $4,999, an increase of $3,667 compared to intangible
amortization for Fiscal 2005 of $1,332. The increase was primarily attributable to the amortization
of intangible assets acquired through the purchase of the Acquired Companies. See Note 7 and 10 of
the Notes to the Consolidated Financial Statements for further details.
Operating Income
Operating income for Fiscal 2006 was $55,150, or 7.6% of revenues, an increase of 27% compared to
operating income for Fiscal 2005 of $43,358, or 8.1% of revenues.
Interest Expense, Net
Net interest expense for Fiscal 2006 was $9,123, an increase of 231% compared to net interest
expense for Fiscal 2005 of $2,755 due to an increase in the weighted average outstanding debt of
$80,921 from $74,977 for Fiscal 2005 to $155,898 for Fiscal 2006. The increase in debt relates
primarily to the Acquired Companies during Fiscal 2006. Additionally, the weighted average interest
rate on outstanding debt for Fiscal 2006 was 5.10% compared to the Fiscal 2005 rate of 2.98%.
Provision for Income Taxes
The tax provision for Fiscal 2006 was $15,221, an effective tax rate of 33.1%. This compares to the
tax provision for Fiscal 2005 of $13,442, an effective tax rate of 33.2%. The tax rate for Fiscal
2006 was lower than that for Fiscal 2005 due to the impact of book stock option expense and the
associated tax asset. The annual effective tax rate is lower than the U.S. statutory rate of 35.0%
primarily due to foreign income taxes at rates lower than 35.0%. The Company anticipates that its
deferred tax asset is realizable in the foreseeable future.
Net Income
As a result of the foregoing, net income for Fiscal 2006 was $30,770, or 4.3% of revenues, compared
to net income for Fiscal 2005 of $27,046, or 5.1% of revenues.
Liquidity and Capital Resources
Cash Flows from Operating Activities
Net cash provided by operating activities for Fiscal 2007 was $36,636. Significant factors
contributing to a source of cash were: net income of $35,609 inclusive of non-cash charges of
$22,610, $9,308 and $1,734 for amortization / depreciation expense, stock-based compensation
expense and change in fair value of interest rate swap, respectively; a decrease in other current
assets of $6,126; a decrease in accounts receivable of $19,202 inclusive of a non-cash contract
adjustment of $18,400; and an increase in billings in excess of costs and estimated earnings on
uncompleted contracts of $3,304. Significant factors contributing to a use of cash were: an
increase in costs and estimated earnings in excess of billings on uncompleted contracts and net
inventory of $13,323 and $3,595, respectively; a decrease in the short and long term restructuring
reserve of $17,913; a decrease of deferred revenue of $19,369, inclusive of a non-cash contract
adjustment of $18,400; and an offset of $5,269 related to accrued acquisition costs, which have not
been recognized as Investing Activities at year-end. Changes in the above accounts are based on an
average Fiscal 2007 exchange rate.
Net cash provided by operating activities for Fiscal 2006 was $51,797. Significant factors
contributing to a source of cash were: net income of $30,770, inclusive of non-cash charges of
$13,930 and $11,045 for amortization / depreciation expense and stock compensation expense,
respectively; a decrease in accounts receivable and costs and estimated earnings in excess of
billings on uncompleted contracts of $9,369 and $3,573, respectively; and a decrease in net
inventory consistent with efforts to increase inventory turns. Significant factors contributing to
a use of cash were: a decrease in the short and long term restructuring reserve of $5,948; a
decrease of deferred revenue and billings in excess of costs and estimated earnings on uncompleted
contracts of $3,267; and an offset of $5,825 related to accrued acquisition costs, which have not
been recognized as Investing Activities at year-end. Changes in the above accounts are based on an
average Fiscal 2006 exchange rate.
Net cash provided by operating activities for Fiscal 2005 was $52,206. Significant factors
contributing to a source of cash were: net income of $27,046 inclusive of non-cash charges of
$7,955 and $5,858 for amortization / depreciation expense and stock compensation expense,
respectively; a decrease in accounts receivable and costs and estimated earnings in excess of
billings on uncompleted contracts of $8,878 and $7,635, respectively, consistent with the decrease
in revenue; and an increase in billings/collections efforts. Changes in the above accounts are
based on an average Fiscal 2005 exchange rate.
As of March 31, 2007, 2006 and 2005, the Company had cash and cash equivalents of $17,157, $11,207
and $11,592, respectively, working capital of $117,059, $99,669 and $108,948, respectively, and a
current ratio of 1.52, 1.76 and 1.85, respectively.
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The Company believes that its cash provided by operating activities and availability under its
credit facility will be sufficient to fund the Company’s working capital requirements, capital
expenditures, dividend program, potential stock repurchases, potential future acquisitions or
strategic investments and other cash needs for the next 12 months.
Investing Activities
Net cash used by investing activities during Fiscal 2007 was $134,909. Significant factors
contributing to a use of cash were: $5,886 for gross capital expenditures and $127,716 to acquire
NextiraOne, NUVT, NTI and ADS. See Note 10 of the Notes to the Consolidated Financial Statements
for additional details regarding these acquisitions.
Net cash used by investing activities during Fiscal 2006 was $43,730. Significant factors
contributing to a use of cash were: $4,115 for gross capital expenditures and $40,682 to acquire
TSM, GTC, BCI, Universal, C=WIN and CSG. See Note 10 of the Notes to the Consolidated Financial
Statements for additional details regarding these acquisitions.
Net cash used by investing activities during Fiscal 2005 was $104,765. Significant factors
contributing to a use of cash were: $3,506 for gross capital expenditures and $102,553 to acquire
Norstan. See Note 10 of the Notes to the Consolidated Financial Statements for additional details
regarding this acquisition.
Financing Activities
Net cash provided by financing activities during Fiscal 2007 was $104,703. Significant factors
contributing to the cash inflow were $114,175 of net borrowings on long term debt and $14,970 of
proceeds from the exercise of stock options. Significant uses of cash
were $20,209 for the repurchase of common stock and $4,203 for the payment of dividends.
Net cash used in financing activities during Fiscal 2006 was $7,978. Significant factors
contributing to the cash outflow were $26,107 in long term debt payments and $4,094 for the payment
of dividends. Significant factors contributing to the cash inflow was $23,320 from the exercise of
stock options.
Net cash provided by financing activities during Fiscal 2005 was $55,800. Significant factors
contributing to the cash inflow were $110,450 of net borrowings on long term debt and $7,919 of
proceeds from the exercise of stock options. Significant uses of cash were $56,912 for the
repurchase of common stock and $3,847 for the payment of dividends.
Total Debt
Revolving Credit Agreement - The Company has entered into the Credit Agreement with Citizens Bank
of Pennsylvania, as agent, and a group of lenders. The Credit Agreement expires on March 28, 2011.
Borrowings under the Credit Agreement are permitted up to a maximum amount of $310,000, which
includes up to $15,000 of swing line loans and $25,000 of letters of credit. The Credit Agreement
may be increased by the Company up to an additional $90,000 with the approval of the lenders and
may be unilaterally and permanently reduced by the Company to not less than the then outstanding
amount of all borrowings. Interest on outstanding indebtedness under the Credit Agreement accrues,
at the Company’s option, at a rate based on either: (a) the greater of (i) the prime rate per annum
of the agent then in effect and (ii) 0.50% plus the rate per annum announced by the Federal Reserve
Bank of New York as being the weighted average of the rates on overnight Federal funds transactions
arranged by Federal funds brokers on the previous trading day or (b) a rate per annum equal to the
LIBOR rate plus 0.75% to 1.25% (determined by a leverage ratio based on the Company’s EBITDA). The
Credit Agreement requires the Company to maintain compliance with certain non-financial and
financial covenants such as minimum net worth, leverage and fixed charge coverage ratios. As of
March 31, 2007, the Company was in compliance with all financial covenants under the Credit
Agreement.
For Fiscal 2007, the Company increased net borrowings under the Credit Agreement by approximately
$115,412. The Company primarily utilized the proceeds from net borrowings to fund the acquisitions
of NextiraOne and NUVT during the first quarter of Fiscal 2007, NTI during the third quarter of
Fiscal 2007 and ADS during the fourth quarter of Fiscal 2007 and to repurchase the common stock
during the second and third quarters of Fiscal 2007.
As of March 31, 2007, the Company had total debt outstanding of $240,614. Total debt was comprised
of $236,715 outstanding under the Credit Agreement, $1,734 for the fair value of an interest rate
swap, $2,123 of obligations under capital leases and $42 of various other third-party, non-employee
loans. The maximum amount of debt outstanding under the Credit Agreement, the weighted average
balance outstanding under the Credit Agreement and the weighted average interest rate on all
outstanding debt for Fiscal 2007 was $284,470, $253,129 and 6.2%, respectively, compared to
$173,535, $155,898 and 5.1%, respectively, for Fiscal 2006.
Dividends
Fiscal 2007 - During each of the four (4) quarters in Fiscal 2007, the Board declared cash
dividends of $0.06 ($0.24 for Fiscal 2007) per share on all outstanding shares of the common stock
at the close of business on June 30, 2006, September 29, 2006, December 29, 2006 and March 30,
2007. The dividends totaled $4,200 (including $1,052 for the fourth quarter of Fiscal 2007) and
were paid on July 14, 2006, October 13, 2006, January 15, 2007 and April 16, 2007.
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Fiscal 2006 - During each of the four (4) quarters in Fiscal 2006, the Board declared cash
dividends of $0.06 ($0.24 for Fiscal 2006) per share on all outstanding shares of the common stock
at the close of business on June 30, 2005, September 30, 2005, December 30, 2005 and March 31,
2006. The dividends totaled $4,137 (including $1,055 for the fourth quarter of Fiscal 2006) and
were paid on July 15, 2005, October 14, 2005, January 13, 2006 and April 14, 2006.
Fiscal 2005 - During Fiscal 2005, the Board declared cash dividends of $0.22 per share for a total
dividend payout of $3,955.
While the Company expects to continue to declare dividends for the foreseeable future, there can be
no assurance as to the timing or amount of such dividends.
Repurchase of Common Stock
Fiscal 2007 - During Fiscal 2007, the Company repurchased 500,712 shares of its common stock for an
aggregate purchase price of $20,209, or an average purchase price per share of $40.36.
Fiscal 2006 - During Fiscal 2006, the Company repurchased 565 shares of its common stock for an
aggregate purchase price of $27, or an average purchase price per share of $47.45.
Fiscal 2005 - During Fiscal 2005, the Company repurchased 1,400,486 shares of its common stock for
an aggregate purchase price of $56,912, or an average purchase price per share of $40.64.
Since the inception of the repurchase program in April 1999 through March 31, 2007, the Company has
repurchased 7,436,111 shares for an aggregate purchase price of $317,033, or an average purchase
price per share of $42.63. As of March 31, 2007, 1,063,889 shares were available under repurchase
programs approved by the Board. Additional repurchases of common stock may occur from time to time
depending upon factors such as the Company’s cash flows and general market conditions. While the
Company expects to continue to repurchase shares of the common stock for the foreseeable future,
there can be no assurance as to the timing or amount of
such repurchases. Under the Company’s Credit Agreement, the Company is permitted to repurchase its
common stock as long as no Event of Default or Potential Default (each as defined in the Credit
Agreement) occurs or is continuing.
Contractual Obligations
The Company has various contractual obligations and commitments to make future payments including
debt agreements, operating and capital lease obligations and discounted lease rental commitments.
The following table summarizes significant contractual obligations and commitments of the Company
as of March 31, 2007. Except as set forth in the following table, the Company does not have any
material long-term purchase obligations or other long-term liabilities that are reflected on its
balance sheet as of March 31, 2007:
The estimated interest expense payments reflected in the table above are based on both the amount
outstanding under the credit facility and the weighted average interest rate in effect as of March
31, 2007.
As of March 31, 2007, the Company had commercial commitments of $4,009, which are generally due
within the next twelve months.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on its financial condition, changes in its financial condition, revenues
or expenses, results of operations, liquidity, capital expenditures or capital resources, other
than those disclosed above, that are material to investors.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States, which require the Company to make estimates and
assumptions that may affect the reported financial condition and results of operations should
actual results differ. The Company bases its estimates and assumptions on the best available
information and believes them to be reasonable for the circumstances. The Company’s significant
accounting policies are described in Note 2 of the Notes to the Consolidated Financial Statements.
The Company believes that of its significant accounting policies, the following may involve a
higher degree of judgment and complexity.
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Allowance for doubtful accounts receivable
The Company records an allowance for doubtful accounts receivable as an offset to accounts
receivable in order to present a net balance the Company believes will be collected. This allowance
is based on both recent trends of certain accounts receivable (“specific reserve”) estimated to be
a greater credit risk as well as general trends of the entire accounts receivable pool (“general
reserve”). The Company computes a specific reserve by identifying specifically at-risk accounts
receivable and applying historic reserve factors to the outstanding balance. The Company computes a
general reserve by reviewing the accounts receivable aging and applying reserve factors based upon
the age of the account receivable. If our estimate of uncollectible accounts receivable should
prove inaccurate at some future date, the results of operations for the period could be materially
affected by any necessary correction to the allowance for doubtful accounts.
Inventories
The Company’s inventory is valued at the lower of cost or market value and has been reduced by an
allowance for excess and obsolete inventories. The Company records an estimate for slow moving and
obsolete inventory (“inventory reserve”) based upon product knowledge, physical inventory
observation, future demand, market conditions and an aging analysis of the inventory on hand. If
actual market conditions are less favorable than those projected by management at some future date,
the results of operations for the period could be materially affected by any necessary correction
to the inventory reserve.
Deferred Income Taxes
The Company records deferred income tax assets and liabilities in its Consolidated Balance Sheets
related to events that impact our financial statements and tax returns in different periods.
Deferred tax asset and liability balances are computed by identifying differences between the book
basis and tax basis of assets and liabilities (“temporary differences”) which are multiplied by the
current tax rate. A valuation allowance is provided on deferred tax assets if it is determined that
it is more likely than not that the asset will not be realized. If the Company’s estimate of the
realizable deferred tax assets should prove inaccurate at some future date, the results of
operations for the period could be materially affected by any necessary correction to the deferred
tax asset allowance.
Long-Lived Assets other than Goodwill
The Company reviews long-lived assets, including property, plant, equipment and indefinite /
definite lived intangibles for
impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. If the sum of the estimated future cash flows (undiscounted) expected
to result from the use and eventual disposition of an asset is less than the carrying amount of the
asset, an impairment loss is recognized. Measurement of an impairment loss is based on the fair
value of the asset. No impairments of long-lived assets have been identified during any of the
periods presented.
Goodwill
The Company’s Goodwill is subject to, at a minimum, an annual impairment assessment of its carrying
value. Goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its
estimated fair value. Estimated fair values of the reporting units are estimated using an earnings
model and a discounted cash flow valuation model. The discounted cash flow model incorporates the
Company’s estimates of future cash flows, allocations of certain assets and cash flows among
reporting units, future growth rates and management’s judgment regarding the applicable discount
rates used to discount those estimated cash flows. If the Company’s estimates and assumptions used
in the discounted cash flow valuation model should prove inaccurate at some future date, the
results of operations for the period could be materially affected by an impairment of goodwill. No
impairment of goodwill has been identified during any of the periods presented.
Loss Contingencies
The Company incurs contingencies as a normal part of its business operations, such as future
warranty obligations and potential liabilities relating to legal or regulatory matters. The
Company accrues for contingent obligations when a loss is probable and the amount can be reasonably
estimated.
Restructuring Costs
The Company accrues the cost of restructuring activities in accordance with the appropriate
accounting guidance depending upon the facts and circumstances surrounding the situation. The
Company exercises its judgment in estimating the total costs of each of these activities. As these
activities are implemented, the actual costs may differ from the estimated costs due to changes in
the facts and circumstances that were not foreseen at the time of the initial cost accrual.
Revenue Recognition
Within the Company’s Hotline Services, revenues are recognized when title to products sold passes
to the customer, which generally occurs upon shipment from the Company’s location.
Within the Company’s Data Services and Voice Services segments, revenues are recognized from
maintenance service contracts, moves, adds and changes and network integration services, when the
services are provided. Service contracts are generally pre-billed and are reflected on the balance
sheet as deferred revenue and are generally recognized over the service period on a straight-line
basis. Revenues from the sale and installation of products and systems are recognized using the
percentage-of-completion method based upon the proportion of actual costs incurred to estimated
total costs. At the time a loss on a contract becomes known, the entire
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amount of the estimated
loss is recognized immediately in the financial statements. The Company has historically made
reasonably accurate estimates of the extent of progress towards completion, contract revenues and
contract costs on its long-term contracts. However, due to uncertainties inherent in the estimation
process, actual results could differ materially from those estimates.
Impact of Recently Issued Accounting Pronouncements
Fair Value Option for Financial Assets and Financial Liabilities
In February, 2007, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB
Statement No. 115” (“SFAS 159”). SFAS 159 permits an entity to elect to measure eligible items at
fair value (“fair value option”) including many financial instruments. The provisions of SFAS 159
are effective for the Company as of April 1, 2008. If the fair value option is elected, the Company
will report unrealized gains and losses on items for which the fair value option has been elected
in earnings at each subsequent reporting date. Upfront costs and fees related to items for which
the fair value option is elected shall be recognized in earnings as incurred and not deferred. The
fair value option may be applied for a single eligible item without electing it for other identical
items, with certain exceptions, and must be applied to the entire eligible item and not to a
portion of the eligible item. The Company is currently evaluating the irrevocable election of the
fair value option pursuant to SFAS 159.
Prior Year Misstatements on Current Year Financial Statements
In September, 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), “Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements.” SAB 108 provides interpretive guidance on how the effects of prior year uncorrected
misstatements should be considered when quantifying misstatements in current year financial
statements for the purpose of a materiality assessment. SAB 108 is effective as of the Company’s
fiscal year end March 31, 2007. The Company adopted SAB 108 as of March 31, 2007. The adoption of
SAB 108 did not have a material impact on the Company’s consolidated financial statements.
Fair Value Measurements
In September, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which
defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective
for the Company beginning on April 1, 2008. The Company is evaluating the impact of the
adoption of SFAS 157 on the Company’s consolidated financial statements.
Defined Benefit Pension and Other Postretirement Plans
In
September, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans” (“SFAS 158”). This standard requires, among other things, companies
to recognize on the balance sheet the funded or unfunded status of pension and other postretirement
benefit plans and to recognize the change in funded status in the period the change occurs through
comprehensive income. The provisions of SFAS 158 are effective as of the Company’s fiscal year
ended March 31, 2007. The Company adopted SFAS 158 as of March 31, 2007. The Company adopted SFAS 158 as of March 31, 2007. The adoption of SFAS 158 had no impact on the
Company’s Statement of Operations on the date of adoption. However, the Company did record a
liability of $3,452 representing the unfunded portion of the CWA Plan included in Other liabilities
within the Company’s Consolidated Balance Sheets and an unrecognized gain of $2,717 ($1,670 net of
tax) into OCI.
Uncertainty in Income Taxes
In July, 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (“FIN 48”). FIN 48 requires that realization of an uncertain income tax position must be
“more likely than not” (i.e., greater than 50% likelihood of receiving a benefit) before it can be
recognized in the financial statements. Further, FIN 48 prescribes the benefit to be recorded in
the financial statements as the amount most likely to be realized assuming a review by tax
authorities having all relevant information and applying current conventions. FIN 48 also clarifies
the financial statement classification of tax-related penalties and interest and sets forth new
disclosures regarding unrecognized tax benefits. FIN 48 is effective for the next fiscal year
beginning after December 15, 2006. The Company plans to adopt FIN 48 as of April 1, 2007, as
required. The Company expects to record an increase in contingent tax liabilities and a decrease to
Retained earnings through a cumulative effect adjustment of between approximately $4.0 million and
$6.0 million upon adoption of FIN 48.
Definition of Settlement in FIN 48
In May, 2007, the FASB issued staff position No. FIN 48-1, “Definition of Settlement in FASB
Interpretation No. 48” (“FSP FIN 48-1”) which amended FIN 48 to provide guidance about how an
enterprise should determine whether a tax position is effectively settled for the purpose of
recognizing previously unrecognized tax benefits. Under FSP FIN 48-1, a tax position could be
effectively settled on completion of an examination by a taxing authority. The Company plans to
adopt FSP FIN 48-1 in conjunction with adoption of FIN 48 as of April 1, 2007. The Company does not
expect a material adjustment to the Company’s consolidated financial statements upon the adoption
of FSP FIN 48-1.
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Stock-Based Compensation
On April 1, 2006, the Company adopted the provisions of SFAS 123(R). For Fiscal 2007, the Company
recognized compensation expense of $9,308 ($6,050 net of tax) or $0.34 per diluted share on the
Company’s Consolidated Statements of Income. See Note 2 and Note 14 of the Notes to the
Consolidated Financial Statements for reference.
Tax Effects of Share-Based Payment Awards
On November 10, 2005, the FASB issued Staff Position No. SFAS 123(R)-3, “Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards” (“SFAS 123(R)-3”). The
alternative transition method includes simplified methods to establish the beginning balance of the
Additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based
compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements
of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding
upon adoption of SFAS 123(R). The Company has elected this transition method for calculating tax
effects of share-based payment awards.
Inflation
The overall effects of inflation on the Company have been nominal. Although long-term inflation
rates are difficult to predict, the Company continues to strive to minimize the effect of inflation
through improved productivity and cost reduction programs as well as price adjustments within the
constraints of market competition.
Cautionary Forward Looking Statements
When included in this Form 10-K or in documents incorporated herein by reference, the words
“expects,” “intends,” “anticipates,” “believes,” “estimates” and analogous expressions are intended
to identify forward-looking statements. Such statements are inherently subject to a variety of
risks and uncertainties that could cause actual results to differ materially from those projected.
Such risks and uncertainties include, among others, the timing and final outcome of the ongoing
review of the Company’s stock option practices, including the related SEC investigation,
shareholder derivative lawsuit, NASDAQ process regarding listing of the common stock and tax
matters, and the impact of any actions that may be required or taken as a result of such review,
SEC investigation, shareholder derivative lawsuit, NASDAQ process or tax matters, levels of
business activity and operating expenses, expenses relating to corporate compliance requirements,
cash flows, global economic and business conditions, successful integration of acquisitions,
including the NextiraOne business, the timing and costs of restructuring programs, successful
marketing of DVH (Data, Voice, Hotline) services, successful implementation of our M&A program,
including identifying appropriate targets, consummating transactions and successfully integrating
the businesses, competition, changes in foreign, political and economic conditions, fluctuating
foreign currencies compared to the U.S. dollar, rapid changes in technologies, client preferences,
the ability of the Company to identify, acquire and operate additional technical services companies, the Company’s
arrangements with suppliers of voice equipment and technology
and various other matters, many of which are beyond the Company’s control. These forward-looking
statements are made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 and speak only as of the date of this Form 10-K. The Company expressly disclaims
any
obligation or undertaking to release publicly any updates or any changes in the Company’s
expectations with regard thereto or any change in events, conditions or circumstances on which any
statement is based.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is exposed to market risks in the ordinary course of business that include
interest rate volatility and foreign currency exchange rates volatility. Market risk is measured as
the potential negative impact on earnings, cash flows or fair values resulting from a hypothetical
change in interest rates or foreign currency exchange rates over the next year. The Company does
not hold or issue any other financial derivative instruments (other than those specifically noted
below) nor does it engage in speculative trading of financial derivatives.
Interest Rate Risk
The Company’s primary interest rate risk relates to its long-term debt obligations. As of March 31,
2007, the Company had total long-term obligations of $240,614, including the current portion of
those obligations of $686. Of the outstanding debt, $2,165 was in fixed rate obligations, $100,000
was in variable rate debt that was effectively converted to a fixed rate through an interest rate
swap agreement during Fiscal 2007 and $138,449 was in variable rate obligations. As of March 31,
2007, an instantaneous 100 basis point increase in the interest rate of the variable rate debt
would reduce the Company’s net income in the subsequent fiscal year by $1,404 ($913 net of tax)
assuming the Company employed no intervention strategies.
To mitigate the risk of interest-rate fluctuations associated with the Company’s variable rate
long-term debt, the Company has implemented an interest-rate risk management strategy that
incorporates the use of derivative instruments to minimize significant unplanned fluctuations in
earnings caused by interest-rate volatility. The Company’s goal is to manage interest-rate
sensitivity by modifying the re-pricing characteristics of certain balance sheet liabilities so
that the net-interest margin is not, on a material basis, adversely affected by the movements in
interest rates.
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On July 26, 2006, the Company entered into an interest rate swap which has been used to effectively
convert a portion of the Company’s variable rate debt to fixed rate. The interest rate swap has a
notional value of $100,000 reducing to $50,000 after three years and does not qualify for hedge
accounting. Changes in the fair market value of the interest rate swap are recorded as an asset or
liability in the Company’s Consolidated Balance Sheets and Interest expense (income) in the
Company’s Consolidated Statements of Income.
Foreign Exchange Rate Risk
The Company has operations, clients and suppliers worldwide, thereby exposing the Company’s
financial results to foreign currency fluctuations. In an effort to reduce this risk of foreign
currency fluctuations, the Company generally sells and purchases inventory based on prices
denominated in U.S. dollars. Intercompany sales to subsidiaries are generally denominated in the
subsidiaries’ local currency. The Company has entered and will continue in the future, on a
selective basis, to enter into foreign currency forward contracts to reduce the foreign currency
exposure related to certain intercompany transactions, primarily trade receivables and loans. All
of the foreign currency forward contracts have been designated and qualify as cash flow hedges. The
effective portion of any changes in the fair value of the derivative instruments is recorded in OCI
until the hedged forecasted transaction occurs or the recognized currency transaction affects
earnings. Once the forecasted transaction occurs or the recognized currency transaction affects
earnings, the effective portion of any related gains or losses on the cash flow hedge is
reclassified from OCI to the Company’s Consolidated Statements of Income. In the event it becomes
probable that the hedged forecasted transaction will not occur, the ineffective portion of any gain
or loss on the related cash flow hedge would be reclassified from OCI to the Company’s Consolidated
Statements of Income.
As of March 31, 2007, the Company had open foreign exchange contracts in Australian and Canadian
dollars, Danish krone, Euros, Japanese yen, Mexican pesos, Norwegian kroner, Pounds sterling,
Swedish krona and Swiss francs. The open contracts have contract rates ranging from 1.2446 to
1.2980 Australian dollar, 1.1412 to 1.1442 Canadian dollar, 5.5680 to 5.8136 Danish krone, 0.7406
to 0.7732 Euro, 105.47 to 110.10 Japanese yen, 11.0112 to 11.0735 Mexican peso, 5.9442 to 6.3840
Norwegian kroner, 0.5053 to 0.5435 Pound sterling, 6.7671 to 7.1925 Swedish krona and 1.1938 to
1.2146 Swiss franc, all per U.S. dollar. The total open contracts had a notional amount of
approximately $56,719, have a fair value of $56,371 and will expire within twenty-four months.
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Item 8. Financial Statements and Supplementary Data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Black Box Corporation Lawrence, Pennsylvania We have audited the accompanying consolidated balance sheets of Black Box Corporation as of March
31, 2007 and 2006 and the related consolidated statements of income, stockholders’ equity, and cash
flows for each of the three years in the period ended March 31, 2007. We have also audited the
schedule listed in the accompanying index. These financial statements and schedule are the
responsibility of the Company’s management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and schedule are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements and schedule, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall presentation of the
financial statements and schedule. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Black Box Corporation at March 31, 2007 and 2006 and
the results of its operations and cash flows for each of the three years in the period ended March
31, 2007, in conformity with accounting principles generally accepted in the United States of
America.
Also, in our opinion, the schedule presents fairly, in all material respects, the information set
forth therein.
As discussed in Note 3, the accompanying consolidated balance sheets as of March 31, 2006 and 2005
and the related consolidated statements of income, stockholders’ equity, and cash flows for each of
the two years in the period ended March 31, 2006 have been restated.
Also, as disclosed in Note 14 to the consolidated financial statements, effective April 1, 2006,
the Company adopted the fair value method of accounting provisions of Statement of Financial
Accounting Standard No. 123 (revised 2004), “Share Based Payment.”
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of Black Box Corporation’s internal control over financial
reporting as of March 31, 2007, based on criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and
our report dated August 10, 2007 expressed an unqualified opinion on management’s assessment and an
adverse opinion on the effectiveness of internal control over financial reporting.
/s/ BDO Seidman, LLP
Chicago, Illinois
August 10, 2007 48
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BLACK BOX CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (1)
See Notes to the Consolidated Financial Statements
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BLACK BOX CORPORATION
CONSOLIDATED BALANCE SHEETS (1)
See Notes to the Consolidated Financial Statements
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BLACK BOX CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (1)
See Notes to the Consolidated Financial Statements
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BLACK BOX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (1)
See Notes to the Consolidated Financial Statements
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BLACK BOX CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Business and Basis of Presentation
Black Box Corporation (“Black Box” or the “Company”) is the world’s largest dedicated network
infrastructure services provider. Black Box offers one-source network infrastructure services for
communication systems. The Company’s service offerings include design, installation, integration,
monitoring and maintenance of voice, data and integrated communication systems. The Company’s
primary service offering is voice solutions, while providing premise cabling and other data related
services and products. The Company provides 24/7/365 technical support for all of its solutions
which encompasses all major voice and data manufacturers as well as 118,000 network infrastructure
products that it sells through its catalog and Internet Web site and its Voice and Data services
(collectively referred to as “On-Site services”) offices.
References herein to “Fiscal Year” or “Fiscal” mean the Company’s fiscal year ended March 31 for
the year referenced. All references to dollar amounts herein are presented in thousands, except per
share amounts, unless otherwise noted.
The consolidated financial statements include the accounts of the parent company and its
subsidiaries. All significant intercompany accounts and transactions have been eliminated in
consolidation. Certain items in the consolidated financial statements of prior years have been
reclassified to conform to the current year’s presentation.
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Note 2: Significant Accounting Policies
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three
months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which
approximates fair value.
Allowance for doubtful accounts receivable
An allowance for doubtful accounts is recorded as an offset to accounts receivable in order to
present a net balance the Company believes will be collected. In estimating the appropriate balance
for this allowance, the Company considers (1) specific reserves for accounts it believes may prove
to be uncollectible and (2) additional reserves, based on historical collections, for the remainder
of its accounts. Additions to the allowance for doubtful accounts are charged to Selling, general &
administrative expense within the Company’s Consolidated Statement of Income, and deductions from
the allowance are recorded when specific accounts receivable are written off as uncollectible.
Inventories
Inventories are valued at the lower of cost or market. The Company uses the first-in, first-out
average cost method to value the majority of its inventory. However, several locations within the
Company use other valuation methods, including first-in, first-out (“FIFO”) and actual current
costs. The Company records an estimate for slow moving and obsolete inventory based upon product
knowledge, physical inventory observation and an aging analysis of the inventory on hand. Upon a
subsequent sale or disposal of the impaired inventory, the corresponding reserve is relieved to
ensure the cost basis of the inventory reflects any reductions.
Property, Plant and Equipment
Property, plant and equipment are stated at cost, net of accumulated depreciation. Maintenance,
repairs and minor renewals are charged to operations as incurred. Major renewals and betterments,
which substantially extend the useful life of the property, are capitalized at cost. Upon sale or
other disposition of assets, the costs and related accumulated depreciation are removed from the
accounts and the resulting gain or loss, if any, is reflected in income.
Depreciation is computed using the straight-line method based on the estimated useful lives of
30-40 years for buildings and improvements and 3 to 5 years for machinery and equipment. Leasehold
improvements are depreciated over their lease terms, or useful lives, if shorter. The Company
reviews property, plant and equipment for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. If the sum of the estimated
future cash flows (undiscounted) expected to result from the use and eventual disposition of an
asset is less than the carrying amount of the asset, an impairment loss is recognized. Measurement
of an impairment loss is based on the fair value of the asset. No impairment of property, plant and
equipment has been identified during any of the periods presented.
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Goodwill
Goodwill is the excess of purchase price over the value of net assets acquired in acquisitions.
Goodwill is subject to, at a minimum, an annual impairment assessment of its carrying value.
Goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its
estimated fair value. Estimated fair values of the reporting units are estimated using an earnings
model and a discounted cash flow valuation model. The discounted cash flow model incorporates the
Company’s estimates of future cash flows, allocations of certain assets and cash flows among
reporting units, future growth rates and management’s judgment regarding the applicable discount
rates used to discount those estimated cash flows. No impairment of goodwill has been identified
during any of the periods presented.
Intangible Assets
Definite-lived intangible assets are amortized on a straight-line basis over their estimated useful
lives of 3-5 years for non-compete agreements, one year for backlog and 10-20 years for customer
relationships. Indefinite-lived intangible assets not subject to amortization consist solely of the
Company’s trademark portfolio also obtained through acquisitions. The Company reviews intangible
assets for impairment whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. If the sum of the estimated future cash flows (undiscounted)
expected to result from the use and eventual disposition of an asset is less than the carrying
amount of the asset, an impairment loss is recognized. Measurement of an impairment loss is based
on the fair value of the asset. No impairments of intangible assets have been identified during any
of the periods presented.
Derivative Instruments and Hedging Activities
Foreign Currency Forward Contract
The Company has operations, clients and suppliers worldwide, thereby exposing the Company’s
financial results to foreign currency fluctuations. In an effort to reduce this risk of foreign
currency fluctuations, the Company generally sells and purchases inventory based on prices
denominated in U.S. dollars. Intercompany sales to subsidiaries are generally denominated in the
subsidiaries’ local currency. The Company has entered and will continue in the future, on a
selective basis, to enter into foreign currency forward contracts to reduce the foreign currency
exposure related to certain intercompany transactions, primarily trade receivables and loans. All
of the foreign currency forward contracts have been designated and qualify as cash flow hedges. The
effective portion of any changes in the fair value of the derivative instruments is recorded in
Other Comprehensive Income (Loss) (“OCI”) until the hedged forecasted transaction occurs or the
recognized currency transaction affects earnings. Once the forecasted transaction occurs or the
recognized currency transaction affects earnings, the effective portion of any related gains or
losses on the cash flow hedge is reclassified from OCI to the Company’s Consolidated Statements of
Income. In the event it becomes probable that the hedged forecasted transaction will not occur, the
ineffective portion of any gain or loss on the related cash flow hedge would be reclassified from
OCI to the Company’s Consolidated Statements of Income.
Interest Rate Swap
To mitigate the risk of interest-rate fluctuations associated with the Company’s variable rate
long-term debt, the Company has implemented an interest-rate risk management strategy that
incorporates the use of derivative instruments to minimize significant unplanned fluctuations in
earnings caused by interest-rate volatility. The Company’s goal is to manage interest-rate
sensitivity by modifying the re-pricing characteristics of certain balance sheet liabilities so
that the net-interest margin is not, on a material basis, adversely affected by the movements in
interest rates. The Company’s interest rate swap does not meet the requirements for hedge
accounting and is marked to market through Interest expense (income) in the Company’s Consolidated
Statement of Operations.
Foreign Currency Translation
The financial statements of the Company’s foreign subsidiaries, except those subsidiaries in Brazil
and Mexico, are recorded in the local currency, which is the functional currency. Foreign currency
assets and liabilities are translated into U.S. dollars at the rate of exchange existing at the
year-end date. Revenues and expenses are translated at the average monthly exchange rates.
Adjustments resulting from these translations are recorded in OCI in the Company’s Consolidated
Balance Sheets and will be included in income upon sale or liquidation of the foreign investment.
Gains and losses from foreign currency transactions, denominated in a currency other than the
functional currency, are recorded in Other Expenses (Income) in the Company’s Consolidated
Statements of Income. The U.S. dollar is the functional currency for those subsidiaries located in
Brazil and Mexico.
Revenue
Within the Company’s Hotline Services segment, revenues are recognized when title to products sold
passes to the customer, which generally occurs upon shipment from the Company’s location.
Within the Company’s Data Services and Voice Services segments, revenues are recognized from
maintenance service contracts, moves, adds and changes and network integration services when the
services are provided. Service contracts are generally pre-billed and are reflected on the balance
sheet as deferred revenue and are generally recognized over the service period on a straight-line
basis. Revenues from the sale and installation of products and systems are recognized using the
percentage-of-completion method based upon the proportion of actual costs incurred to estimated
total costs. At the time a loss on a contract becomes known, the entire amount of the estimated
loss is recognized immediately in the financial statements. The Company has historically made
reasonably accurate estimates of the extent of progress towards completion, contract revenues and
contract costs on its long-term contracts. However, due to uncertainties inherent in the estimation
process, actual results could differ materially from those estimates.
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Sales returns - At the time of sale, an estimate for sales returns is recorded based on historical
experience.
Warranties: Estimated future warranty costs related to certain products are charged to operations
in the period the related revenue is recognized based on historical experience.
Shipping and Handling Fees and Costs — All fees billed to clients for shipping and handling are
classified as a component of Net Revenues. All costs associated with shipping and handling are
classified as a component of Cost of Sales.
Stock-Based Compensation
On April 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123
(revised 2004), “Share-Based Payment” (“SFAS 123(R)”) which requires companies to estimate the fair
value of share-based payment awards and recognize compensation expense over the requisite service
period for the portion of the award that is ultimately expected to vest. Prior to the adoption of
SFAS 123(R), the Company accounted for share-based awards to employees and directors using the
intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting
for Stock Issued to Employees” (“APB 25”) as allowed under SFAS No. 123, “Accounting for
Stock-Based Compensation” (“SFAS 123”). Under the intrinsic value method, no stock-based
compensation expense related to stock options was required to be recognized if the exercise price
of the Company’s stock options granted to employees and directors was equal to or greater than the
fair market value of the underlying stock on the measurement date.
The Company adopted SFAS 123(R) using the modified prospective transition method which requires
compensation cost to be recognized for all share-based payments granted after the date of adoption
and for all unvested awards existing on the date of adoption. In accordance with the modified
prospective transition method, the Company’s consolidated financial statements for prior periods
have not been retroactively adjusted to reflect, and do not include, the impact of SFAS 123(R).
However, the modified prospective transition method does require the Company to provide pro forma
disclosure of specific income statement line items for periods prior to the adoption of SFAS 123(R)
as if the fair-value-based method had been applied to all awards. See Note 14.
SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the
grant-date using an option-pricing model. Upon adoption of SFAS 123(R), the Company began using the
Black-Scholes option pricing model as the method of valuation for the Company’s stock options. The
model requires the use of various assumptions. The key assumptions are summarized as follows:
Expected volatility: The Company estimates the volatility of its common stock, par value $.001 per
share (the “common stock”), at the date of grant based on the historical volatility of its common
stock.
Dividend yield: The Company estimates the dividend yield assumption based on the Company’s
historical and projected dividend payouts.
Risk-free interest rate: The Company derives its risk-free interest rate on the observed interest
rates appropriate for the term of the Company’s employee stock options.
Annual forfeiture rate and expected holding period: The Company estimates the annual forfeiture
rate and expected holding period based on historical experience.
Amortization period: The Company recognizes the fair value of awards into expense over the
requisite service periods associated with the award.
Advertising Expenses
Catalogs and other direct marketing pieces are capitalized and amortized over their expected period
of future benefit ranging from 1-2 years, which is recorded in Prepaid and other current assets
within the Company’s Consolidated Balance Sheets. All other advertising costs are expensed as
incurred.
Advertising expense was $9,120, $9,414 and $11,649 for Fiscal 2007, Fiscal 2006 and Fiscal 2005,
respectively and is recorded in Selling, general & administrative expenses.
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Income Taxes
The Company accounts for income taxes using an asset and liability approach, which requires the
recognition of deferred income tax assets and liabilities for the expected future tax consequences
of events that have been recognized in the Company’s financial statements or tax returns. Deferred
income tax assets and liabilities are determined based on the temporary differences between the
financial statement and tax bases of assets and liabilities using enacted tax rates. A valuation
allowance is provided on deferred tax assets if it is determined that it is more likely than not
that the asset will not be realized.
Earnings per common Share
Basic earnings per common share (“basic EPS”) are computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding during the period. Diluted
earnings per common share (“diluted EPS”) is computed similarly to that of basic EPS, except that
the weighted-average number of common shares outstanding during the period is
adjusted to include the number of additional common shares that would have been outstanding if the
dilutive potential common shares had been issued.
Recent Accounting Pronouncements
Fair Value Option for Financial Assets and Financial Liabilities
In February, 2007, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB
Statement No. 115” (“SFAS 159”). SFAS 159 permits an entity to elect to measure eligible items at
fair value (“fair value option”) including many financial instruments. The provisions of SFAS 159
are effective for the Company as of April 1, 2008. If the fair value option is elected, the Company
will report unrealized gains and losses on items for which the fair value option has been elected
in earnings at each subsequent reporting date. Upfront costs and fees related to items for which
the fair value option is elected shall be recognized in earnings as incurred and not deferred. The
fair value option may be applied for a single eligible item without electing it for other identical
items, with certain exceptions, and must be applied to the entire eligible item and not to a
portion of the eligible item. The Company is currently evaluating the irrevocable election of the
fair value option pursuant to SFAS 159.
Prior Year Misstatements on Current Year Financial Statements
In September, 2006, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting
Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive
guidance on how the effects of prior year uncorrected misstatements should be considered when
quantifying misstatements in current year financial statements for the purpose of a materiality
assessment. The SEC staff believes that registrants should quantify errors using both a balance
sheet and an income statement approach and evaluate whether either approach results in quantifying
a misstatement that, when all relevant quantitative and qualitative factors are considered, is
material. SAB 108 is effective as of the Company’s fiscal year end March 31, 2007. The Company
adopted SAB 108 as of March 31, 2007. The adoption of SAB 108 did not have a material impact on the
Company’s consolidated financial statements.
Fair Value Measurements
In September, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which
defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective
for the Company beginning on April 1, 2008. The requirements of SFAS 157 will be applied
prospectively except for certain derivative instruments that would be adjusted through the opening
balance of Retained earnings in the period of adoption. The Company is evaluating the impact of the
adoption of SFAS 157 on the Company’s consolidated financial statements.
Defined Benefit Pension and Other Postretirement Plans
On April 30, 2006, the Company acquired the USA Commercial and Government and Canadian operations
of NextiraOne, LLC (“NextiraOne”), who is a sponsor of a non-contributory defined benefit plan (the
“CWA Plan”) for the Communication Workers of America Local 1109 (“CWA 1109”). Benefits from the CWA
Plan are based upon years of service and rates negotiated by the Company and CWA 1109. Pension
costs are funded to satisfy minimum requirements prescribed by the Employee Retirement Income
Security Act of 1974.
In
September, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans” (“SFAS 158”) that would amend SFAS No. 87, “Employers’ Accounting
for Pensions,” SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits,” SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions” and SFAS No. 132 (Revised 2003), “Employers’
Disclosures about Pensions and Other Postretirement Benefits.” This standard requires, among other
things, companies to recognize on the balance sheet the funded or unfunded status of pension and
other postretirement benefit plans and to recognize the change in funded status in the period the
change occurs through comprehensive income. The provisions of SFAS 158 are effective as of the
Company’s fiscal year ended March 31, 2007. The Company adopted SFAS 158 as of March 31, 2007. The
adoption of SFAS 158 had no impact on the Company’s Statement of Operations on the date of
adoption. However, the Company did record a liability of $3,452 representing the unfunded portion
of the CWA Plan included in Other liabilities within the Company’s Consolidated Balance Sheets and
an unrecognized gain of $2,717 ($1,670 net of tax) into OCI.
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Uncertainty in Income Taxes
In July, 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (“FIN 48”). FIN 48 requires that realization of an uncertain income tax position must be
“more likely than not” (i.e., greater than 50% likelihood of receiving a benefit) before it can be
recognized in the financial statements. Further, FIN 48 prescribes the benefit to be recorded in
the financial statements as the amount most likely to be realized assuming a review by tax
authorities having all relevant information and applying current conventions. FIN 48 also clarifies
the financial statement classification of tax-related penalties and interest and sets forth new
disclosures regarding unrecognized tax benefits. FIN 48 is effective for the next fiscal year
beginning after December 15, 2006. The Company plans to adopt FIN 48 as of April 1, 2007, as
required. The Company expects to record an increase in contingent tax liabilities and a decrease to
Retained earnings through a cumulative effect adjustment of between approximately $4.0 million and
$6.0 million upon adoption of FIN 48.
Definition of Settlement in FIN 48
In May, 2007, the FASB issued staff position No. FIN 48-1, “Definition of Settlement in FASB
Interpretation No. 48” (“FSP FIN 48-1”) which amended FIN 48 to provide guidance about how an
enterprise should determine whether a tax position is effectively settled for the purpose of
recognizing previously unrecognized tax benefits. Under FSP FIN 48-1, a tax position could be
effectively settled on completion of an examination by a taxing authority. The Company plans to
adopt FSP FIN 48-1 in conjunction with adoption of FIN 48 as of April 1, 2007. The Company does not
expect a material adjustment to the Company’s consolidated financial statements upon the adoption
of FSP FIN 48-1.
Stock-Based Compensation
In December, 2004, the FASB issued SFAS 123(R). SFAS 123(R) is a revision of SFAS No. 123,
supersedes APB 25 and amends SFAS No. 95, “Statement of Cash Flows.” SFAS 123(R) requires that
companies recognize all share-based payments to employees, including grants of employee stock
options, in the financial statements. The recognized cost is based on the fair value of the equity
or liability instruments issued. Pro-forma disclosure of this cost is no longer an alternative
under SFAS 123(R). SFAS 123(R) was effective for public companies at the beginning of the first
annual reporting period beginning after June 15, 2005.
As permitted by SFAS 123, the Company accounted for its stock-based compensation plans under APB
25’s intrinsic value method and, as such, recognized no stock-based compensation expense if the
exercise price of the Company’s stock options granted to employees and directors was equal to or
greater than the fair market value of the underlying stock on the measurement date. The adoption of
SFAS 123(R)’s fair value method has had no impact on the Company’s overall financial position or
cash flows. Based on SFAS 123(R), the Company transitioned to the new requirements by using the
modified prospective transition method. This transition method requires compensation cost to be
recognized for all share-based payments granted after the date of adoption and for all unvested
awards existing on the date of adoption.
SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost
be reported as a financing cash flow, rather than as an operating cash flow as required under past
standards. This requirement will reduce net operating cash flows and increase net financing cash
flows in periods after adoption when the benefits of tax deductions are in excess of recognized
compensation cost.
The Company adopted the provisions of SFAS 123(R) as of April 1, 2006. For Fiscal 2007, the Company
recognized compensation expense of $9,308 ($6,050 net of tax) or $0.34 per diluted share on the
Company’s Consolidated Statements of Income. See Significant Accounting Policies (within this Note
2) and Note 14 for further reference to the disclosures required by SFAS 123(R).
Tax Effects of Share-Based Payment Awards
On November 10, 2005, the FASB issued Staff Position No. SFAS 123(R)-3, “Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards” (“SFAS 123(R)-3”). The
alternative transition method includes simplified methods to establish the beginning balance of the
additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based
compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements
of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding
upon adoption of SFAS 123(R). The company has elected this transition method for calculating tax
effects of share-based payment awards.
Note 3: Restatement of Consolidated Financial Statements
Restatement through March 31, 2006
Background
On November 13, 2006, Black Box received a letter of informal inquiry from the Enforcement Division
of the SEC relating to the Company’s stock option practices from January 1, 1997 to present. As a
result, the Audit Committee (the “Audit Committee”) of the Company’s Board of Directors (the
“Board”), with the assistance of outside legal counsel, commenced an independent review of the
Company’s historical stock option grant practices and related accounting for stock option grants
during the period from 1992 to the present (the “Review Period”).
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On February 1, 2007, the Company announced that, while the review of option grant practices was
continuing, it believed that it would need to record additional non-cash charges for stock-based
compensation expense relating to certain stock option grants and, accordingly, cautioned investors
about relying on its historical financial statements until the Company could determine with
certainty whether a restatement would be required and, if so, the extent of any such restatement
and the periods affected.
On March 19, 2007, although the Audit Committee had not yet completed its review, the Audit
Committee concluded that the exercise price of certain stock option grants differed from the fair
market value of the underlying shares on the appropriate measurement date. At that time, the
Company and the Audit Committee announced that it was currently expected that the Company’s
additional non-cash, pre-tax charges for stock-based compensation expense relating to certain stock
option grants would approximate $63 million for the Review Period. In addition, the Company and
the Audit Committee concluded that the Company would need to restate its previously-issued
financial statements contained in reports previously filed by the Company with the SEC.
Accordingly, on March 19, 2007, the Company and the Audit Committee concluded that the Company’s
previously-issued financial statements and other historical financial information and related
disclosures for the Review Period, including applicable reports of its current or former
independent registered public accounting firms and related press releases, should not be relied
upon.
On May 25, 2007, the Company was advised by the Enforcement Division of the SEC that a Formal Order
of Private Investigation arising out of the Company’s stock option practices had been entered and
on May 29, 2007 the Company received a subpoena that was issued by the SEC.
On May 31, 2007, the Company announced that, as a result of the ongoing review of stock option
practices, Company management and the Audit Committee expected that the Company’s additional
non-cash, pre-tax charges for stock-based compensation expense relating to certain stock option
grants would approximate $70 million for the Review Period.
Findings of the Audit Committee
During the Review Period, the Company granted stock options pursuant to an employee stock option
plan and a director stock option plan to acquire approximately 10.9 million shares of the common
stock. Such plans at all relevant times provided for option grants to be approved by a designated
committee of non-employee directors or, in the case of the director stock option plan, by the
Board. Approximately 2,000 stock option grants were awarded during the Review Period with 69
recorded grant dates. No stock options have been granted since September, 2006. The Audit
Committee reviewed all stock options granted during the Review Period, including option grants to
the Company’s directors, officers and rank and file employees (including grants to new employees,
grants awarded in connection with Company acquisitions and grants made as individual or group
performance awards). The Audit Committee’s review of the Company’s stock option granting practices
included a comprehensive examination of reasonably available relevant physical and electronic
documents as well as interviews with current and former directors, officers and Company personnel.
The Audit Committee’s review was initially focused on determining whether the Company’s prior stock
option granting practices were in compliance with the plans’ granting provisions and applicable law
or called into question its accounting for such options. Once it became evident that such issues
and accounting implications existed, the inquiry focused on those matters necessary: to determine
whether any accounting charges were material and whether a restatement of the Company’s
previously-issued financial statements would be required; to establish a basis for effecting any
required restatement; to assure that, on as timely a basis as possible, the Company could file any
required curative disclosures with the SEC and assure its continued eligibility for listing on The
NASDAQ Stock Market (“NASDAQ”); and to provide an informed basis for the Company’s response to the
identified issues, including appropriate corrective and remedial actions.
The following information summarizes certain of the findings of the Audit Committee. The findings
identified approximately $71.5 million of unrecorded expense at the time of grant (i.e., the
difference between the fair market value of the common stock on the appropriate measurement date
and the stated exercise price), net of forfeitures, during the Review Period, of which $70.0
million was recorded in the Company’s consolidated financial statements through March 31, 2006 and
$1.5 million of unrecorded expense at the time of grant will be included, beginning at April 1,
2006, in the Company’s computation of compensation expense in accordance with SFAS 123(R). The
following summarizes the unrecorded expense at the time of grant by time period and category of
recipient:
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The Audit Committee’s additional key findings are summarized below:
Lack of Adequate Documentation: For a majority of grants issued by the Company during the
Review Period, there is either no or inadequate documentation of approval actions that satisfies
the requisites for establishing a measurement date under APB 25. Of the 69 recorded grant dates,
there are documented approval actions by the Board or the Option or Compensation Committee of the
Board (the “Compensation Committee”) with respect to particular grants for 12 dates. In the period
December, 1992 to May, 1996, neither the minutes of the Compensation Committee nor of the Board
reflect any action to approve specific grants. In some instances, evidence of single director (the
chairman of the Compensation Committee) approval actions exists. This absence of non-employee
director level documentation also applies to a majority of grants with a recorded grant date after
1996. In some cases, Compensation Committee minutes contain a reference to reports on the status
of the option pool but do not document any action to approve specific grants. Approval
documentation for certain grants has internal inconsistencies or conflicts with other documents
thereby rendering this documentation unreliable as a basis for establishing a measurement date. In
some cases, the only existing documentation is the executed option agreement and/or the entry of
the option grant into the option database. Notwithstanding these approval documentation
inadequacies, the Company entered into option agreements with grantees and has honored such grants.
Grant Approvals: During the Review Period, relatively few option grants were approved in
complete compliance with the Company’s stock option plans. Available documentation reflects that
the Company approved option grants in a variety of ways. With respect to the employee stock option
plan, grants were approved by the Compensation Committee as contemplated by the plan
at various times, by the full Board in 1998 and 1999, by a single director (the chairman of the
Compensation Committee) on nine recorded grant dates during the period 1994 through 2001 and by the
Company’s Chief Executive Officer (“CEO”) at various times. With respect to the director stock
option plan, grants were generally approved by the designated Board committee and, in a few cases,
by the chairman of the Compensation Committee. In one instance in 2000, there is no conclusive
documentary evidence of the approval of director grants other than the signed director option
agreements.
The delegation of authority by the Compensation Committee to the CEO with respect to grants to rank
and file employees was not fully documented. However, there was an understood and accepted
practice between the CEO and the Compensation Committee whereby the CEO made certain awards to
individual employees. In some instances, this involved the allocation among rank and file
employees of blocks of shares approved by the Compensation Committee; in three (3) such instances,
the number of shares ultimately awarded pursuant to this process exceeded the approved size of the
block, which was contrary to the understanding of the Compensation Committee members. Further,
contrary to the understanding of the Compensation Committee members, the award and/or documentation
of those individual grants often significantly lagged the approval of the block grant. In August
2005, the Compensation Committee specifically acknowledged a prior grant of delegated authority to
the CEO to make option grants to rank and file employees and ratified all prior awards by the CEO.
In some cases, documentation of approval action is either inconclusive or missing, and the Company
therefore has been unable to determine what entity or person actually approved specific grants.
Option Pricing: The recorded grant dates for a majority of grants do not match the
applicable measurement dates as determined under APB 25. The grants of options with exercise
prices lower than the fair market values of the stock on the actual measurement dates did not
satisfy the fair market pricing requirement in the Company’s plans, as amended in 1998, and were
not consistent with the Company’s disclosures in SEC filings stating that the exercise price of
options was equal to the fair market value of the stock on the date of the grant.
The relationship between the stated exercise price of options and the fair market value of the
Company’s stock on the date of the identifiable approval actions varied from grant to grant. In
some cases, the exercise price of grants reflected the fair market value of the underlying shares
on the date of any documented approval action. In other cases, the exercise prices reflected the
fair market value of the underlying shares on a date either prior or subsequent to any such
documented approval action and the exercise price was lower than the fair market value on the date
of any such action. In several such cases before August 2002, the use of such grant dates and
lower exercise prices (together with other available evidence) supports a finding that the recorded
grant dates and corresponding exercise prices were selected with the benefit of hindsight. For
certain grants where the mismatch between the recorded grant date and the approval action was only
a matter of days, however, the mismatch appears to have been attributable to inaccurate recording
or administrative delays. In some cases, the apparent approval action did not identify all
grantees; for example, there are cases where a block grant was approved subject to a later
determination of individual grant recipients and grants were recorded with a grant date, and
corresponding exercise price, that matched the date of the apparent approval of the block grant and
the fair market value of the common stock on that date although individual grant recipients may
have been identified some time after approval of the block grant. Finally, in some cases, the
approval action for specific grants is not adequately documented. Where the recorded grant date
did not satisfy the requisites for a measurement date under APB 25, the Company relied on default
methodologies to determine an appropriate measurement date.
Internal Controls: As outlined above, the Company’s historical administration of its
options program lacked discipline as it relates to proper adherence to the plan requirements,
corporate recordkeeping and documentation. Since November 2003, however, the Company has properly
administered the stock option program as it relates to awards to directors and officers. During
the investigation, the Company identified control gaps related to grants made throughout the Review
Period. As of March 31, 2007, the Company implemented additional procedures to its process that
are focused on formalized documentation of appropriate approvals and determination of grant terms
to employees.
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Procedural and Remedial Actions
The Audit Committee and other relevant Board committees are committed to a continued review and
implementation of procedural enhancements and remedial actions in light of the foregoing findings.
Consistent with its obligation to act in the best interests of the Company taking into account all
relevant facts and circumstances, the Audit Committee is continuing to assess the appropriateness
of a broad range of possible procedural enhancements and potential remedial measures in light of
the findings of its review.
While the Audit Committee has not completed its consideration of all such steps, procedural
enhancements may include recommendations regarding improved stock option administration procedures
and controls, training and monitoring compliance with those procedures, corporate recordkeeping,
corporate risk assessment, evaluation of the internal compliance environment and other remedial
steps that may be appropriate. Any such procedural enhancements will be recommended by the Audit
Committee to the Board and/or appropriate Board committee for adoption. In advance of action by
the Audit Committee, as noted above, the Company has implemented additional procedures to its
process for approving stock option grants that are focused on formalized documentation of
appropriate approvals and determination of grant terms to employees.
In light of the findings of the Audit Committee’s review, William F. Andrews, Thomas W. Golonski
and Thomas G. Greig, three current directors who also served during portions of the Review Period
and who hold options as to which the measurement date was adjusted in connection with the Company’s
restatement, agreed voluntarily to reprice those outstanding options with a recorded exercise price
less than the fair market value of the common stock on the accounting measurement date as
determined by the Audit
Committee so that the exercise price matches the fair market value of the common stock on such
accounting measurement date. In addition, Michael McAndrew, who became the Company’s Chief
Financial Officer (“CFO”) in December, 2002, also agreed voluntarily to reprice the one option
granted to him after he became CFO with a recorded exercise price less than the
fair market value of the common stock on the accounting measurement date as determined by the Audit
Committee so that the exercise price matches the fair market value of the common stock on such
accounting measurement date.
The Audit Committee’s ongoing review includes an evaluation of the role of and possible claims or
other remedial actions against current and former Company personnel who may be found to have had
responsibility for identified problems during the Review Period. Accordingly, the Audit Committee
has begun to address and is addressing and expects to continue to address issues of individual
conduct or responsibility, including those of the Board, CEOs and CFOs serving during the Review
Period. In connection therewith, based on the findings of the Audit Committee as to Fred C. Young,
the Company’s former CEO who resigned on May 20, 2007, the Audit Committee concluded and
recommended to the Board, and the Board determined, that Mr. Young could have been terminated due
to Cause for Termination (as defined in his agreement dated May 11, 2004) at the time Mr. Young
resigned as a director and officer of the Company on May 20, 2007. In light of that determination
and the terms of the agreements with Mr. Young, all outstanding stock options held by Mr. Young
terminated as of the date of his resignation.
The Audit Committee may recommend additional remedial measures that appropriately address the
issues raised by its findings. Such potential remedial measures may include possible claims or
other remedial actions against current and former Company personnel who may be found to have been
responsible for identified problems during the Review Period.
Restatement Methodologies
As of April 1, 2006, the Company adopted SFAS 123(R) using the modified prospective transition
method. Under this transition method, compensation expense is to be recognized for all share-based
compensation awards granted after the date of adoption and for all unvested awards existing on the
date of adoption. Prior to April 1, 2006, the Company accounted for stock-based compensation
awards to directors, officers and rank and file employees using the intrinsic value method in
accordance with APB 25 as allowed under SFAS 123. Under the intrinsic value method, no share-based
compensation expense related to stock options was required to be recognized if the exercise price
of the stock option was at least equal to the fair market value of the common stock on the
“measurement date.” APB 25 defines the measurement date as the first date on which are known both
(1) the number of shares that an individual grant recipient is entitled to receive and (2) the
option or purchase price, if any.
In light of the Audit Committee’s review of the Company’s stock option granting practices during
the Review Period and as to those cases in which the Company previously used a recorded grant date
as the measurement date that the Company determined could no longer be relied upon, the Company has
developed and applied the following methodologies to remeasure those stock option grants and record
the relevant charges in accordance with APB 25 by considering the following sources of information:
(i) meeting minutes of the Board and of committees thereof and related materials, (ii) Unanimous
Written Consents of the Board and of committees thereof, (iii) the dates on which stock option
grants were entered into the Company’s stock option database (“create date”), (iv) relevant email
correspondence reflecting stock option grant approval actions, (v) individual stock option
agreements and related materials, (vi) employee and Board offer letters, (vii) documents relating
to acquisitions, (viii) reports on Form 4 filed with the SEC and (ix) guidance of the Office of the
Chief Accountant of the SEC on stock option matters as set forth in its letter dated September 19,
2006.
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Grants with Appropriate Committee Approval. With respect to grants of approximately 1.0 million
shares, or approximately 9% of the total grants in the Review Period, the Company has evidence to
support the approval of the grant under the stock option plans by the relevant committee of the
Board, and such evidence includes the number of options each individual was entitled to receive and
the option price. However, the relationship between these documented approval actions and the
originally-recorded grant dates and exercise prices for the options so approved varied during the
Review Period. In some cases, grants were recorded with a grant date and a corresponding exercise
price that matched the date of the approval action or were otherwise consistent with the terms of
the approval action. In other cases, however, the recorded grant dates and corresponding exercise
prices of the grants reflected the fair market value of the common stock on a date prior to the
committee’s documented approval actions. The Company has restated the compensation expense for
stock option grants relating to approximately 0.4 million shares of common stock by using the date
of the documented approval action as the measurement date. The total additional non-cash, pre-tax
charge for these grants is approximately $1.8 million, net of forfeitures, amortized over the
appropriate vesting period through March 31, 2006, of which $0.07 million relates to director
options, $1.3 million relates to officer options and $0.4 million relates to rank and file employee
options.
Grants with Other Approvals. With respect to grants of approximately 1.9 million shares, or
approximately 18% of the total grants in the Review Period, the Company has evidence to support the
approval of the grant by the Board, an outside director or the Company’s CEO and the identification
of the number of options each individual was entitled to receive together with the option price.
These grants are distinguished from the grants described in the prior paragraph in that the nature
of the approval was not fully consistent with the terms of the relevant stock option plan. As with
the grants discussed in the preceding paragraph, the relationship between these documented approval
actions and the originally-recorded grant dates and exercise prices for the options so approved
varied during the Review Period. In some cases, grants were recorded with a grant date and a
corresponding exercise price that matched the date of the approval action or were otherwise
consistent with the terms of the approval action. In other cases, however, the recorded grant
dates and corresponding exercise prices of the grants reflected the fair market value of the
Company’s stock on a date prior to the approval action. The Company has restated the compensation
expense for stock option grants relating to
approximately 1.6 million shares of common stock by using the date of the documented approval
action as the measurement date. The total additional non-cash, pre-tax charge for these grants is
approximately $7.6 million, net of forfeitures, amortized over the appropriate vesting period
through March 31, 2006, of which $0.5 million relates to director options, $2.6 million relates to
officer options and $4.5 million relates to rank and file employee options.
Grants Lacking Adequate Documentation. With respect to grants of approximately 7.9 million shares
(5.0 million shares to rank and file employees), or 73.0% of the total grants in the Review Period,
the Company has been unable to locate adequate documentation of approval actions that would satisfy
the requisites for a measurement date under APB 25. For these grants, management considered all
available relevant information to form a reasonable conclusion as to the most reasonable
measurement date. For all grants in this category, the Company has established default
methodologies for determining the most appropriate measurement date under APB 25.
With respect to grants entered into the Company’s stock option database after September 9, 1999,
when the database began to reflect a create date which is the date on which a grant was entered
into the system, the Company has determined to use the individual create date for each grant as the
APB 25 measurement date, which was in most cases different from the originally-recorded grant date.
The Company believes that this create date is the most appropriate methodology in the absence of
sufficient evidence of approvals for these grants as it represents the earliest point in time at
which the evidence shows that all requisites for the establishment of the measurement date had been
satisfied. Such create dates preceded, often by a significant amount of time, the execution of
stock option agreements, which, generally, were manually signed by the Company’s CEO and manually
signed and dated by the grantee. In addition, in almost all cases, a grant entered into the
database, which established the create date, ultimately resulted in the creation of a stock option
agreement reflecting such grant. Accordingly, while execution of the stock option agreements
constituted a clear acknowledgement by the grantee and the Company of the grantee’s legal
entitlement to the grant, the Company believes the create date more accurately reflects the date of
approval than does the signed option agreement. The Company has restated the compensation expense
for stock option grants relating to approximately 4.2 million shares of common stock by using the
create date as the measurement date. The total additional non-cash, pre-tax charge for these
grants is approximately $49.8 million, net of forfeitures, amortized over the appropriate vesting
period through March 31, 2006, of which $0.5 million relates to director options, $17.2 million
relates to officer options and $32.2 million relates to rank and file employee options. The
Company’s procedures for evaluating the appropriateness of measurement dates fixed with reference
to such create dates included a sensitivity analysis which provided an understanding of the
differences between the additional recorded charge for stock-based compensation expense and the
charges that would result from using other identified alternative methods for determining
measurement dates. The Company’s sensitivity analysis included identifying the range of potential
grant dates defined by the recorded grant date and the create date for each grant. The Company
then identified the low and high closing prices of the common stock within that range of potential
grant dates and applied both the low and high closing prices of the common stock to the number of
shares granted for which the create date methodology was utilized to determine the range of
potential adjustments to stock-based compensation expense for these grants, which was $0.09 million
to $73.8 million, net of forfeitures, as compared to the additional non-cash, pre-tax charge for
these grants of approximately $49.8 million, net of forfeitures, included in the Restatement.
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For options entered into the Company’s option database before September 9, 1999, the Company
determined the measurement date generally by reference to signed option agreements (or the deemed
signature date for certain options as discussed below). The executed option agreements
(hereinafter “signed option agreements”), manually signed by the Company’s CEO and manually signed
and dated by the grantee, constituted an acknowledgement by the grantee and the Company of the
grantee’s legal entitlement to the grant and, in the absence of authoritative information as to
when all the requisites for the establishment of the measurement date had been satisfied, provides
a measurement date framework based on entitlement. The Company has restated the compensation
expense for stock option grants relating to approximately 1.4 million shares of common stock by
using the signed option agreements as the measurement date. The total additional non-cash, pre-tax
charge for these grants is approximately $6.4 million, net of forfeitures, amortized over the
appropriate vesting period through March 31, 2006, of which $0.3 million relates to director
options, $3.6 million relates to officer options and $2.5 million relates to rank and file employee
options. The Company believes this methodology was the most appropriate in the absence of
sufficient evidence of approvals for these grants as it represents the earliest point in time at
which the evidence shows that all requisites for the establishment of the measurement date had been
satisfied for these grants. The Company’s procedures for evaluating the appropriateness of
measurement dates fixed with reference to the dating of signed option agreements included a
sensitivity analysis which provided an understanding of the differences between the additional
recorded charge for stock-based compensation expense and the charges that would result from using
other identified alternative methods for determining measurement dates. The Company’s sensitivity
analysis included identifying the range of potential grant dates defined by the recorded grant date
and the date of the grantee’s signature on the stock option agreement for each grant. The Company
then identified the low and high closing prices of the common stock within that range of potential
grant dates and applied both the low and high closing prices of the common stock to the number of
shares granted for which the signed option agreements methodology was utilized to determine the
range of potential adjustments to stock-based compensation expense for these grants, which was
$0.03 million to $9.6 million, net of forfeitures, as compared to the additional non-cash, pre-tax
charge for these grants of approximately $6.4 million, net of forfeitures, included in the
Restatement.
In those cases where no reliably-dated signed option agreement could be located and where no
post-September 9, 1999 create date exists (stock option grants totaling approximately 0.9 million
shares), the Company used the average period between recorded grant date and date of the signatures
on all other grantee signed option agreements with the same grant date as the measurement date.
For example, if there were four stock option grants with a grant date of January 1, 1996, the
Company had the signed option agreements for three of these stock option grants and the average
number of days between the grant date and the signature dates of these three signed option
agreements was 20 days, January 21, 1996 was used as the measurement date for the grant for which
no signed option
agreement could be located. The Company has restated the compensation expense for stock option
grants relating to approximately 0.7 million shares of common stock using this “average days to
sign agreement” method. The total additional non-cash, pre-tax charge for these grants is
approximately $4.4 million, net of forfeitures, amortized over the appropriate vesting period
through March 31, 2006, of which $0.06 million relates to director options, $4.2 million relates to
officer options and $0.2 million relates to rank and file employee options. The Company believes
this methodology was the most appropriate in the absence of sufficient evidence of approvals for
these grants because it gives a reasonable approximation of the measurement date related to these
options in light of the available evidence. The Company conducted a sensitivity analysis by
comparing the Company’s current default methodology (i.e., “average days to sign agreement”) with
another default methodology. For this analysis, the Company identified the range of potential
grant dates defined by the earliest signed option agreement and the latest signed option agreement.
The Company then identified the low and high closing prices of the common stock over the range of
potential grant dates and applied both the low and high closing prices of the common stock to the
number of shares granted to determine the range of potential adjustments to stock-based
compensation expense for these grants, which was $2.6 million to $5.9 million, net of forfeitures.
The Company’s analyses indicate that stock-based compensation expense computed using other
identified alternative default methodologies would not materially differ from stock-based
compensation expense computed using the “average days to sign agreement” methodology. The
Company’s procedures for evaluating the appropriateness of measurement dates fixed with reference
to the average days to sign agreements also included a sensitivity analysis which provided an
understanding of the differences between the additional recorded charge for stock-based
compensation expense and the charges that would result from using other identified alternative
methods for determining measurement dates. The Company’s sensitivity analysis included
identifying the range of potential grant dates defined by the recorded grant date and the average
days to sign agreement for each grant. The Company then identified the low and high closing prices
of the common stock within that range of potential grant dates and applied both the low and high
closing prices of the common stock to the number of shares granted to determine the range of
potential adjustments to stock-based compensation expense for these grants, which was $0.03 million
to $6.1 million, net of forfeitures, as compared to the additional non-cash, pre-tax charge for
these grants of approximately $4.4 million, net of forfeitures, included in the Restatement.
Given the volatility of the common stock during much of the Review Period, the use of methodologies
and measurement dates different from those described above could have resulted in a higher or lower
cumulative compensation expense which would have caused net income or loss to be different from the
amounts reported in the restated consolidated financial statements. The Company’s procedures for
evaluating the appropriateness of measurement dates fixed using the default methodologies described
above also included a sensitivity analysis which provided an understanding of the differences
between the additional recorded charge for stock-based compensation expense and the charges that
would result from using other identified alternative methods for determining measurement dates.
The Company’s sensitivity analysis included identifying the range of potential grant dates defined
by the recorded grant date and the appropriate measurement date for each grant. The Company then
identified the low and high closing prices of the common stock within that range of potential grant
dates and applied both the low and high closing prices of the common stock to the number of shares
granted to determine the range of potential adjustments to stock-based compensation expense for
these grants, which was $9.3 million to $99.3 million, net of forfeitures, as compared to the
additional non-cash, pre-tax charge for these grants of approximately $70.0 million, net of
forfeitures, included in the Restatement.
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Other adjustments through March 31, 2006
From 1994 through 1998, the Company did not properly account for stock options for one officer that
were modified after the grant date pursuant to a separation agreement. Some of these modifications
were not identified in the Company’s financial reporting processes and were therefore not properly
reflected in its financial statements. As a result, the Company has recorded a non-cash charge for
stock-based compensation of $1.0 million during Fiscal 1999.
Summary
In summary, the Company recorded cumulative non-cash charges for stock-based compensation of $70.9
million through March 31, 2006, offset in part by a cumulative income tax benefit of $27.7 million,
for a total after-tax charge of $43.2 million. These charges had no impact on net sales or cash
and cash equivalents as previously reported in the Company’s financial statements; as a result, no
changes to these items are reflected in the Restatement. Non-cash charges for stock-based
compensation expense have been recorded as adjustments to Selling, general & administrative
expenses within the Company’s Consolidated Statements of Income.
1Q07 and 2Q07 Restatement
Stock-based compensation expense
In addition to the Restatement noted above through March 31, 2006, the Company has recorded
additional non-cash charges for stock-based compensation during the first and second quarters of
Fiscal 2007 of $1.6 million and $2.2 million, respectively, offset in part by income tax benefits
of $0.6 million and $0.8 million, respectively, or total after-tax charges of $1.0 million and $1.4
million, respectively. This charge was recorded to reflect additional non-cash, stock-based
compensation expense recognized under the fair value method (SFAS 123(R)) because the exercise
price for certain stock option grants prior to, but not vested as of March 31, 2006, differed from
the fair market value of the underlying shares on the appropriate measurement date, some of which
occurred during Fiscal 2007.
Accounting for derivatives
On July 26, 2006, the Company entered into an interest rate swap to reduce its exposure from
fluctuating interest rates. SFAS No.133, “Accounting for Derivative Instruments and Hedging
Activities” (“SFAS 133”) requires that all derivative instruments be recorded on the balance sheet
as either an asset or liability measured at their fair value, and that changes in the derivatives’
fair value be recognized currently in earnings unless specific hedge accounting criteria are met.
From inception of the hedge, the Company had applied a method of cash flow hedge accounting under
SFAS 133 to account for the interest rate swap that allowed the Company to assume no
ineffectiveness in such agreements, called the “short-cut” method.
Subsequently, the Company analyzed its eligibility for the “short-cut” method in light of certain
clarifications delivered by the Office of the Chief Accountant of the SEC, and determined that its
interest rate swap did not qualify for the “short-cut” method under SFAS 133 because certain
prepayment features relating to the underlying actual debt were not identical to those contained in
the interest rate swap. Because the Company’s documentation at hedge inception reflected the
“short-cut” method rather than the “long-haul” method for determining hedge ineffectiveness, the
derivative did not meet the requirements for a cash flow hedge. Documentation for the “long-haul”
method of accounting at hedge inception cannot be retrospectively applied under SFAS 133.
Therefore, fluctuations in the interest rate swap’s fair value should have been recorded through
the Company’s Consolidated Statements of Income instead of through OCI, which is a component of
Stockholders’ equity. The adjustment for the second quarter of Fiscal 2007 will decrease reported
net income and increase OCI by approximately $1.4 million. This change in accounting for this
derivative instrument could result in significant volatility in the Company’s reported net income
and earnings per share due to increases and decreases in the fair value of the interest rate swap.
However, the derivative instrument remains highly effective and the change in accounting for this
derivative instrument does not impact operating cash flows or total Stockholders’ equity.
The table below reflects the impact of the additional non-cash charges for stock-based compensation
expense and the non-cash charge related to the interest rate swap on the Company’s Consolidated
Statements of Income, including the corresponding cumulative adjustment to Retained earnings as of
September 30, 2006 and March 31, 2006, 2005, 2004 and 2003 on the Company’s Consolidated Balance
Sheets. Prior to this Restatement, the Company had not recorded any non-cash stock-based
compensation expense in its Consolidated Statements of Income with the exception of $0.7 million recorded
during the second quarter of Fiscal 2005 for a modification of a previous stock option award for a
retiring director. All dollar amounts are presented in thousands except per share amounts. Per
share amounts may not total due to rounding.
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Income Tax Considerations
In the course of the investigation, the Company determined that a number of officers may have
exercised options for which the application of Section 162(m) of the Internal Revenue Code of 1986,
as amended (the “Code”), may apply. It is possible that these options will be treated as having
been granted at less than fair market value for federal income tax purposes because the Company
incorrectly applied the measurement date as defined in APB 25. If such options are deemed to have
been granted at less than fair market value, pursuant to Section 162(m) of the Code (“Section
162(m)”), any compensation to officers, including proceeds from options exercised in any given tax
year, in excess of $1.0 million will be disallowed as a deduction for tax purposes. The Company
estimates that the potential tax effected liability for any such disallowed Section 162(m)
deduction would approximate $3.6 million, which has been recorded as a current liability within
Income taxes within the Company’s Consolidated Balance Sheets. The Company may also incur interest
and penalties if it were to incur any such tax liability, which could be material.
In addition, the Company is considering the application of Section 409A of the Code (“Section
409A”) to those options for which it incorrectly applied the measurement date as defined in APB 25.
It is possible that these options will be treated as having been granted at less than fair market
value for federal income tax purposes and thus subject to Section 409A. Accordingly, the Company
may adopt measures to address the application of Section 409A. The Company does not currently know
what impact Section 409A will have, or any such measures, if adopted, would have on its results of
operations, financial position or cash flows, although such impact could be material.
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Expenses Incurred by the Company
The Company has incurred expenses for legal fees and external audit firm fees, in excess of its
insurance deductible of $0.5 million, in Fiscal 2007, in relation to (i) the Audit Committee’s
review of the Company’s historical stock option practices and related accounting for stock option
grants, (ii) the informal inquiry and formal order of investigation by the SEC regarding the
Company’s past stock option practices, (iii) the previously-disclosed derivative action relating to
the Company’s historical stock option practices filed against the Company as a nominal defendant
and certain of the Company’s current and former directors and officers, as to whom it may have
indemnification obligations and (iv) related matters. Further, the Company has incurred and
expects to continue to incur significant additional expense related to the foregoing matters in the
fiscal year ending March 31, 2008. The Company and
the insurance company for its directors’ and officers’ indemnification insurance are currently in
discussions with respect to which of the fees in excess of the deductible will be paid by the
insurance company. Accordingly, there can be no assurance that all fees submitted to the insurance company for
reimbursement will be reimbursed under the Company’s directors’ and officers’ indemnification
insurance.
Restatement Impact on the Consolidated Statements of Income
The following tables reconcile the Company’s Consolidated Statements of Income from the previously
reported results to the restated results for Fiscal 2006 and Fiscal 2005. All dollar amounts are in
thousands, except per share amounts. Per share amounts may not total due to rounding.
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Restatement Impact on the Consolidated Balance Sheets
The following tables reconcile the Company’s Consolidated Balance Sheets from the previously
reported results to the restated results as of March 31, 2006. All dollar amounts are in thousands.
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Restatement Impact on the Consolidated Statement of Cash Flows
The following tables reconcile the Company’s Consolidated Statements of Cash Flows from the
previously reported results to the restated results for Fiscal 2006 and Fiscal 2005. All dollar
amounts are in thousands.
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Note 4: Inventories
The Company’s inventories consist of the following:
Note 5: Property, Plant and Equipment
The Company’s property, plant and equipment consist of the following:
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