|
|
 | | | |
- close
- close
- close
- close
LOUD Technologies 10-Q 2007 Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
Commission File Number: 0-26524
LOUD TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
(425) 487-4333
(Registrant’s telephone number, including area code) N/A
(Former name or former address, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
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 o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act.): Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of
the latest practicable date.
LOUD TECHNOLOGIES INC.
FORM 10-Q
For the quarter ended June 30, 2007 INDEX
2
Table of Contents
LOUD
TECHNOLOGIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (In thousands, except share amounts)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
3
Table of Contents
LOUD TECHNOLOGIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (In thousands, except for per share data)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4
Table of Contents
LOUD TECHNOLOGIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In thousands)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5
Table of Contents
LOUD TECHNOLOGIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME STATEMENTS Six months ended June 30, 2007 (Unaudited) (In thousands)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
6
Table of Contents
LOUD TECHNOLOGIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2007 (Unaudited) 1. Description of Business
LOUD Technologies Inc. (“LOUD” or the “Company”) was founded in 1988. The Company was incorporated
in Washington under the name Mackie Designs Inc., and subsequently changed its name to LOUD
Technologies Inc. on September 13, 2003. LOUD is one of the world’s largest dedicated professional
audio and music products companies. As the corporate parent for world-recognized brands Alvarez
®,
Ampeg®, Crate
®, EAW
®, Knilling
®, Mackie
®, Martin Audio
®,
SIA® and TAPCO®, LOUD engineers,
manufactures, markets and distributes a wide range of professional audio and musical instrument
products worldwide. Additionally, LOUD is a distributor of branded professional audio and music
accessories through its St. Louis Music catalog.
LOUD’s product lines include sound reinforcement speakers, analog mixers, guitar and bass
amplifiers, professional loudspeaker systems, and branded musical instruments. These products can
be found in professional and project recording studios, video and broadcast suites, post-production
facilities, sound reinforcement applications including churches and nightclubs, retail locations,
and on major musical concert tours. The Company distributes its products primarily through retail
dealers, mail order outlets and installed sound contractors. The Company has its primary
operations in the United States with other operations in the United Kingdom, Canada, China and
Japan.
On April 11, 2007, the Company acquired all of the outstanding capital stock of Martin Audio, Ltd.
(“Martin Audio”), a UK-based manufacturer of loudspeakers and related equipment. The purchase
price was $33.6 million, plus fees of $2.1 million, for a total consideration amount of $35.7
million. Management believes that the acquisition of Martin Audio adds another well-known brand to
the Company’s growing portfolio of brands and provides the Company with additional geographic and
channel diversification.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared by LOUD
in accordance with U.S. generally accepted accounting principles for interim financial statements
and include the accounts of the Company and its subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation. They do not include all of the
information and disclosures required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the financial statements included in
the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. In management’s
opinion, all adjustments, consisting of normal recurring adjustments necessary for the fair
presentation of the results of the interim periods are reflected herein. Operating results for the
three and six-month periods ended June 30, 2007, are not necessarily indicative of future financial
results.
Stock Based Compensation
The Company recorded stock based compensation expense for the relevant periods as follows (in
thousands):
The expected life for each award granted is calculated using the simplified method as described in
SAB No. 107. Expected volatility is based on the historical volatility of LOUD common stock. The
risk free interest rate is based on the constant maturity U.S. Treasury rate with a remaining term
equal to the expected life. Compensation expense recorded includes estimates of the ultimate
number of options that are expected to vest. No options were granted during the three and
six-month periods ended June 30, 2007.
7
Table of Contents
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles
requires the Company to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period.
Significant items subject to such estimates and assumptions include the allocation of purchase
costs to the estimated fair value of assets acquired and liabilities assumed, the carrying amount
of property and equipment and intangibles; valuation allowances for receivables, inventories, and
deferred income tax assets and liabilities. Actual results may differ from those estimates.
Revenue Recognition
Revenues from sales of products, net of sales discounts, returns and allowances, are recognized
upon shipment under an agreement with a customer when risk of loss has passed to the customer, all
significant contractual obligations have been satisfied, the fee is fixed or determinable and
collection of the resulting receivable is considered probable. Products are generally shipped “FOB
shipping point” with no right of return. The Company does have some dealers who finance their
purchases through finance companies. The Company has a manufacturer’s repurchase agreement with
the finance companies and defers the revenue and related cost of goods sold of these sales at the
time of the sale. The Company then recognizes the revenue and related cost of goods sold of these
sales when the right of return no longer exists. Sales with contingencies, such as rights of
return, rotation rights, conditional acceptance provisions and price protection, are rare and
insignificant. The Company generally warrants its products against defects in materials and
workmanship for periods of between one and six years, with the exception of Alvarez Yairi guitars,
which have a limited lifetime warranty. The estimated cost of warranty obligations, sales returns
and other allowances are recognized at the time of revenue recognition based on contract terms and
prior claims experience.
Foreign Currency
The financial statements of one of our non-U.S. subsidiaries, Martin Audio, have been translated
into U.S. Dollars. The functional currency of this subsidiary is the British Pound. All assets and
liabilities in the balance sheets of this subsidiary, whose functional currency is not the U.S.
Dollar, are translated at period end exchange rates. Net sales, costs and expenses are translated
at average rates of exchange prevailing during the period. Translation gains and losses are
accumulated in a separate component of shareholders’ equity.
The functional currency of the Company’s other international subsidiaries is the U.S. Dollar.
Assets and liabilities recorded in foreign currencies are translated into U.S. Dollars at the
exchange rate on the balance sheet date. Net sales, costs and expenses and cash flows are
translated at average rates of exchange prevailing during the period. Foreign currency transaction
gains and losses are included in other income (expense).
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the period that includes the
enactment date. The Company has recorded a valuation allowance due to the uncertainty surrounding
the ultimate realization of such assets. Management evaluates, on a periodic basis, the
recoverability of the net deferred tax assets and the amount of the valuation allowance. At such
time as it is determined that it is more likely than not the deferred tax assets are realizable,
the valuation allowance will be reduced.
The Company has recorded a deferred tax liability related to goodwill associated with the St. Louis
Music acquisition, which is being amortized for tax purposes, but not for book purposes. As
goodwill has an indeterminable life, the Company cannot reasonably estimate the amount, if any, of
deferred tax liabilities related to goodwill which will reverse during the net operating loss carry
forward period. Accordingly, the Company increases the valuation allowance with a corresponding
deferred tax provision as the deferred tax liability related to goodwill increases due to continued
amortization of goodwill for tax purposes.
8
Table of Contents
The Company has also recorded a deferred tax liability related to the identifiable intangibles and
fair value adjustments to the assets purchased associated with the acquisition of Martin Audio.
The Company will recognize a tax benefit as these assets are amortized for book purposes.
Concentration of Credit and Supply Risk
The Company sells products on a worldwide basis and a significant portion of its accounts
receivable is due from customers outside of the U.S. Where the Company is exposed to material
credit risk, it generally requires letters of credit or advance payments. No individual country
outside of the U.S. accounted for more than 10% of net sales from continuing operations in any of
the periods presented. Sales to U.S. customers are generally on open credit terms. In the U.S.,
the Company primarily sells its products through third-party resellers and experiences individually
significant annual sales volumes with major resellers. For the three-month periods ended June 30,
2007 and 2006, the Company had sales to one customer of $9.0 million and $9.1 million, or 17.7% and
17.0%, respectively of consolidated net sales. For the six-month periods ended June 30, 2007 and
2006, the Company had sales to the same customer of $18.3 million and $18.7 million, or 18.1% and
16.7%, respectively of consolidated net sales.
Many of LOUD’s products are currently being manufactured exclusively by contract manufacturers on
its behalf. For the three-month periods ended June 30, 2007 and 2006, net sales of products
manufactured by one manufacturer were $16.5 million and $18.1 million, or 32.6% and 33.8%,
respectively of net sales, while net sales of products manufactured by another manufacturer were
$6.6 million and $6.3 million, or 13.1% and 11.8%, respectively of consolidated net sales. For the
six-month periods ended June 30, 2007 and 2006, net sales of products manufactured by one
manufacturer were $34.1 million and $37.1 million, or 33.6% and 33.1%, respectively of net sales,
while net sales of products manufactured by another manufacturer were $12.7 million and $12.8
million, or 12.5% and 11.4%, respectively of consolidated net sales.
At June 30, 2007, the Company had approximately 528 employees of which approximately 34 were
members of an organized labor union.
Recently Adopted Accounting Principles
In June 2006, the FASB issued Financial Interpretation (FIN) No. 48, Accounting for Uncertainty in
Income Taxes — an interpretation of FASB Statement No. 109. FIN No. 48 clarifies the accounting
for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance
with SFAS No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and
measurement process for financial statement recognition and measurement of tax positions taken or
expected to be taken in tax returns. FIN No. 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
On January 1, 2007, date of adoption of FIN No. 48, the Company had $2.3 million of unrecognized
tax benefits, of which $1.4 million would affect the effective tax rate if recognized. During the
three months ended June 30, 2007, the Company recorded an additional $0.2 million of unrecognized
tax benefit. As of June 30, 2007, the Company had $2.5 million of unrecognized tax benefits, of
which $1.6 million would affect the effective tax rate if recognized.
In accordance with FIN No. 48, the Company has elected to recognize potential accrued interest and
penalties related to unrecognized tax benefits as a component of income tax expense. As of June
30, 2007, the Company is still assessing the amount of accrued interest and penalties related to
uncertain tax positions, which is included as a component of the $1.6 million of unrecognized tax
benefit noted above.
In June 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue 06-3, How Taxes Collected
from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement
(That Is, Gross versus Net Presentation). EITF 06-3 requires a company to disclose its accounting
policy (i.e., gross or net presentation) regarding the presentation of taxes within the scope of
EITF 06-3. If taxes are significant, a company should disclose the amount of such taxes for each
period for which an income statement is presented. The guidance is effective for periods beginning
after December 15, 2006. The adoption of EITF 06-3 did not result in a change to the Company’s
accounting policy or have an effect on the Company’s consolidated financial statements.
New Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value,
establishes a
9
Table of Contents
framework for measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS No. 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a fair value
hierarchy used to classify the source of the information. SFAS No. 157 is effective for fiscal
years beginning after November 15, 2007 and interim periods within those fiscal years. The Company
is currently assessing the impact of SFAS No. 157 on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities, which provides companies with an option to report selected financial assets
and liabilities at fair value. The objective of SFAS No. 159 is to reduce both the complexity in
accounting for financial instruments and the volatility in earnings caused by measuring related
assets and liabilities differently. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. The Company is currently assessing the impact of SFAS No. 159 on its
consolidated financial statements.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current year presentation.
3. Net
Income (Loss) Per Share
Basic net
income (loss) per common share is computed on the basis of the weighted average number of common
shares outstanding for the period including warrants and options to purchase shares exercisable for
little cash consideration. Diluted earnings per common share is computed on the basis of the
weighted average number of common shares plus dilutive potential common shares outstanding.
Dilutive potential common shares are calculated under the treasury stock method. Securities that
could potentially dilute basic income per share consist of outstanding stock options.
Stock options to purchase 461,000 and 214,000 shares for the three-month periods ended June 30,
2007 and 2006, respectively, were excluded from the calculation of diluted per share amounts
because they are antidilutive in 2007 and were out of the money in 2006. Stock options to purchase
461,000 and 606,000 shares for the six-month periods ended June 30, 2007 and 2006, respectively,
were excluded from the calculation of diluted per share amounts because they are antidilutive.
4. Restructuring Costs
During 2006, management approved and implemented a restructuring plan. Actions primarily consisted
of costs related to the consolidation of the St. Louis Music and service operations. The Company
incurred approximately $1.6 million in restructuring costs during 2006, primarily representing
employee severance and related costs for approximately 94 terminated employees. During 2006, the
Company began implementing a plan to shift its domestic manufacturing to overseas contract
manufacturers. The Company incurred approximately $0.5 million and $1.6 million in restructuring
costs during the three and six-month periods ended June 30, 2007, respectively, primarily
representing employee severance and related costs for approximately 186 terminated employees. The
restructuring liability is summarized as follows (in thousands):
5. Inventories
Inventories consist of the following (in thousands):
10
Table of Contents
6. Other Intangible Assets
Intangible assets consist of the following (in thousands):
The Company acquired Martin Audio on April 11, 2007. Certain identifiable intangible assets were
recorded as a result of this acquisition. See Note 10 for further explanation of these intangible
assets. Amortization for the three months ended June 30, 2007 for these additional intangible
assets was approximately $249,000.
7. Financing
On March 30, 2007, the Company closed on a new $112 million senior secured credit facility. The
$112 million senior secured credit facility consists of a $10.0 million revolving loan, a $20.0
million Term Loan A, a $40.0 million US Term Loan B, a $30.0 million UK Term Loan B, and a $12.0
million Term Loan C. The Company’s obligations under the senior secured credit facility are
automatically accelerated upon certain bankruptcy or insolvency events, and may be accelerated upon
the occurrence of other events of default under the security agreement, such as non-payment of
principal, interest or fees when due, or failure to comply with affirmative and negative covenants,
subject to any applicable grace periods.
Under the terms of the senior secured credit facility, the Company is required to maintain certain
financial ratios, such as a fixed charge coverage ratio and a consolidated leverage ratio. The
Company is also required to meet certain EBITDA targets and adhere to certain capital expenditure
limits. As of June 30, 2007, the Company met all of its covenant requirements. The agreement also
provides, among other matters, restrictions on additional financing, dividends, mergers, and
acquisitions.
(a) Short-term borrowings
The Company has a line of credit where it can borrow up to $10.0 million, subject to certain
restrictions, including available borrowing capacity. At June 30, 2007, the line of credit was
unused, and the Company had the ability to borrow up to $10.0 million. Interest is due quarterly
and is based on Chase Manhattan Bank’s prime rate plus 0.5% or LIBOR plus 3.0%.
(b) Long-term debt
Long-term debt consisted of the following (in thousands):
11
Table of Contents
The $102.0 million term loans under the $112 million senior secured credit facility have
quarterly principal payments. Term Loan A bears interest at the Chase Manhattan Bank’s prime rate
plus 0.5% or LIBOR plus 3.0%. Term Loans B bear interest at the Chase Manhattan Bank’s prime rate
plus 2.6% or LIBOR plus 4.85%. Term Loan C bears interest at the Chase Manhattan Bank’s prime rate
plus 4.5% or LIBOR plus 7.0%. In addition, Term Loan C bears additional paid in kind interest of
3.5%, added to the principal balance of Term Loan C on a monthly basis. Interest is due quarterly
on each term loan. On April 10, 2007, in connection with the Martin Audio, Ltd. (“Martin Audio”)
acquisition, the UK Term Loan B was funded. The $112 million senior secured credit facility is
secured by substantially all of the assets of the Company and its subsidiaries.
8. Guarantees
In the ordinary course of business, the Company is not subject to any significant obligations under
guarantees that fall within the scope of FIN No. 45, Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others except for
standard indemnification and warranty provisions and give rise only to disclosure requirements.
Indemnification and warranty provisions contained within the Company’s sales agreements are
generally consistent with those prevalent in its industry. The duration of product warranties is
generally one to six years following delivery of products, with the exception of the Company’s
Alvarez and Alvarez Yairi guitars, which have a limited lifetime warranty.
The warranty liability is summarized as follows (in thousands):
9. Commitments and Contingencies
In November 2005, the Company, its subsidiary, St. Louis Music, Inc., and other companies were
named as defendants in a lawsuit in the United States District Court, Southern District of Florida.
The plaintiff, Ace Pro Sound and Recordings, claims that a leading US retailer of musical products
gave notice to the Company and six other defendants that it would no longer trade with plaintiff
and that the seven defendants then refused to trade with plaintiff in violation of federal
antitrust laws. Other claims are also made against the Company and St. Louis Music based upon the
same assertions. The Company believes that the plaintiff misunderstands certain actions taken by
the Company and that its actions were proper and lawful. The case is in an early stage, and the
Company will defend the action to a satisfactory resolution.
The Company is also involved in various legal proceedings and claims that arise in the ordinary
course of business.
12
Table of Contents
10. Business Combinations
On April 11, 2007 the Company acquired all of the outstanding capital stock of Martin Audio, a UK
based manufacturer of loudspeakers and related equipment. The purchase price was $33.6 million,
plus fees of $2.1 million, for a total consideration of $35.7 million. For the year ended December
31, 2006, Martin Audio had $28.2 million in net sales. The acquisition of Martin Audio adds
another premiere brand to the Company’s growing portfolio of brands. In addition, Martin Audio
provides the Company with additional geographic and channel diversification.
In connection with the acquisition, the preliminary purchase price has been allocated as follows
(in thousands):
Amortization of the $17.2 million of goodwill is not expected to be deductible for tax purposes.
The following unaudited pro forma information represents the results of operations for LOUD and
Martin Audio for the six months ended June 30, 2007 and 2006, as if the acquisition had been
consummated on January 1, 2007 and 2006, respectively. This pro forma information does not purport
to be indicative of what may occur in the future:
UNAUDITED PRO FORMA CONDENSED COMBINED
Statement of Operations Data (In thousands, except per share data)
Included in the pro forma adjustments are fair value adjustments that relate to inventories and
property, plant, and equipment; reversal of interest expense on Martin Audio’s debt that was in
existence prior to the acquisition; reversal of interest expense and deferred financing fees on
LOUD’s previous credit facility; recording of interest expense and deferred financing fees on the
$102 million senior secured credit facility obtained as a result of the acquisition; and
amortization of the intangible assets recorded as a result of the acquisition.
13
Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our financial statements
included in our Annual Report on Form 10-K for the year ended December 31, 2006. This discussion
contains certain “forward-looking statements” within the meaning of Section 21D of the Securities
Exchange Act of 1934, as amended, which involve risks and uncertainties, such as statements of our
plans, objectives, expectations and intentions. Actual results may differ materially from those
discussed herein. The cautionary statements made in this Quarterly Report on Form 10-Q and the
Annual Report on Form 10-K may apply to all forward-looking statements wherever they appear. We
undertake no obligation to publicly release any revisions to these forward-looking statements that
may be required to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events. Forward-looking statements include, without limitation, any
statement that may predict, forecast, indicate, or imply future results, performance, or
achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “project,”
“will be,” “will continue,” “will likely result,” or words or phrases of similar meaning.
Overview
LOUD Technologies Inc. was founded in 1988 and incorporated in Washington under the name Mackie
Designs Inc., and changed its name to LOUD Technologies Inc. on September 13, 2003. LOUD is one of
the world’s largest dedicated pro audio and music products companies. As the corporate parent for
world-recognized brands Alvarez®, Ampeg®, Crate®, EAW®, Knilling®, Mackie®, Martin Audio®, SIA® and
Tapco®, LOUD engineers, markets and distributes a wide range of professional audio and musical
instrument products worldwide. Additionally, LOUD is one of the largest distributors of branded
professional audio and music accessories through its SLM Marketplace catalog.
Our product lines include sound reinforcement speakers, analog mixers, guitar and bass amplifiers,
professional loudspeaker systems, and branded musical instruments. These products can be found in
professional and project recording studios, video and broadcast suites, post-production facilities,
sound reinforcement applications including churches and nightclubs, retail locations, and on major
musical concert tours. We distribute our products primarily through retail dealers, mail order
outlets and installed sound contractors. We have our primary operations in the United States with
other operations in the United Kingdom, Canada, China and Japan.
On April 11, 2007 we acquired all of the outstanding capital stock of Martin Audio, Ltd. (“Martin
Audio”), a UK based manufacturer of loudspeakers and related equipment. The purchase price was
$33.6 million, plus fees of $2.1 million, for a total consideration of $35.7 million. The
acquisition of Martin Audio adds another premiere brand to our growing portfolio of brands. In
addition, Martin Audio provides us with additional geographic and channel diversification.
Our stock is listed on the Nasdaq Capital Market ™ under the symbol “LTEC”.
“MACKIE,” the running man figure, “TAPCO,” “EAW,” and “SIA” are registered trademarks of LOUD
Technologies Inc. “Alvarez”, “Ampeg”, “Crate”, and “Knilling” are registered trademarks of our
wholly owned subsidiary, St. Louis Music, Inc. “Martin Audio” is a registered trademark of our
wholly owned subsidiary, Martin Audio, Ltd. To the extent our trademarks are unregistered, we are
unaware of any conflicts with trademarks owned by third parties. This document also contains names
and marks of other companies, and we claim no rights in the trademarks, service marks and trade
names of entities other than those in which we have a financial interest or licensing right.
Critical Accounting Policies and Judgments
The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from these estimates.
We believe there have been no additional significant changes in our critical accounting policies
during the six months ended June 30, 2007 as compared to what was previously disclosed in our Form
10-K for the year ended December 31, 2006.
Estimates and Assumptions Related to Financial Statements
The discussion and analysis of our financial condition and results of operations is based upon our
unaudited condensed
14
Table of Contents
consolidated financial statements, which have been prepared in accordance with U.S. generally
accepted accounting principles for interim financial statements. The preparation of these condensed
consolidated financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those
affecting revenue recognition, the allowance for doubtful accounts, inventory valuation, intangible
assets, income taxes and general business contingencies. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form our basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
Results of Operations
Three Months Ended June 30, 2007 vs. Three Months Ended June 30, 2006
Net Income (Loss)
For the three months ended June 30, 2007, we showed a net loss of $2.7 million, a decrease of $3.0
million from net income of $0.3 million for the comparable period in 2006. Operating income for
the three months ended June 30, 2007 was $0.1 million compared to $2.1 million in the comparable
period in 2006. The decrease is primarily the result from the decrease in net sales and lower
gross profit on the 2007 sales. Operating expenses for the three months ended June 30, 2007 were
$1.3 million lower than the comparable period in 2006, due to the effect of cost-cutting programs
implemented in 2006.
Net Sales
Net sales decreased by 5.5% to $50.6 million during the three months ended June 30, 2007 from $53.5
million in the comparable period in 2006. We have experienced general softening in the demand for
most of our product lines over the last twelve months. These trends are reflective of challenges
facing our major customers and the industry as a whole. These trends were partially offset by the
inclusion of sales of Martin Audio products from April 11, 2007 through June 30, 2007 of $6.4
million.
Gross Profit
Gross profit decreased to $14.5 million, or 28.7% of net sales, in the three months ended June 30,
2007 from $17.8 million, or 33.2% of net sales, in the three months ended June 30, 2006. Gross
profit for 2007 was affected by $1.4 million due to recording Martin Audio’s inventories
at fair value as a result of the purchase price allocation of Martin Audio. Gross profit was also
reduced by the costs associated with the factory shutdowns and additional sales discounting done in
2007 to reduce the carrying balances of our inventories during the three months ended June 30,
2007. Excluding the $1.4 million fair value adjustment for Martin Audio’s inventory, gross profit
for the three months ended June 30, 2007 was 31.5%.
15
Table of Contents
Selling, General and Administrative
Selling, general and administrative expenses decreased by $1.0 million to $11.0 million in the
three months ended June 30, 2007 from $12.0 million in the comparable period in 2006. The decrease
was primarily attributable to the effect of cost-cutting programs implemented in 2006.
Research and Development
Research and development expenses decreased by $0.4 million to $2.8 million in the three months
ended June 30, 2007 from $3.2 million in the comparable period in 2006. The decrease is primarily
attributable to the reduction in prototype costs and salaries associated with the effect of
cost-cutting programs implemented in 2006 and 2007.
Restructuring Costs
Restructuring costs were $0.5 million in both the three months ended June 30, 2007 and 2006. The
2007 costs were primarily severance accruals related to the closure and overseas transfer of our
domestic manufacturing plants and the closure of our St. Louis Music engineering functions. The
2006 costs were primarily severance accruals related to reductions in work force from the
consolidation of the St. Louis Music and service operations.
Other Expense
Net other expense was $2.9 million for the three months ended June 30, 2007 as compared to $1.7
million for the three months ended June 30, 2006. The primary cause of this increase was an
increase in interest expense of $1.1 million. The increase in interest expense is primarily
attributable to increasing variable interest rates and increased debt as a result of the $112
million senior secured credit facility.
The majority of our debt has variable interest rates, and the interest expense component of other
income (expense) in future quarters will be affected by changing interest rates.
Income Taxes
Income tax benefit for the three months ended June 30, 2007 was $39,000 compared to income tax
expense of $14,000 for the comparable period in 2006. The primary components of the 2007 benefit
are current taxes due from our foreign subsidiaries and an increase to our income tax reserve
offset by the deferred tax benefit recorded as a result of the partial amortization of the deferred
tax liability recorded as a result of the acquisition of Martin Audio. The primary component of
the 2006 tax is the deferred tax expense recorded as a result of the goodwill that is amortized for
tax purposes only from the St. Louis Music, Inc. acquisition. The resulting deferred tax liability
is not able to be offset against other deferred tax assets.
Six Months Ended June 30, 2007 vs. Six Months Ended June 30, 2006
Net Sales
Net sales from continuing operations decreased by 9.4% to $101.5 million during the six months
ended June 30, 2007 from $112.1 million in the comparable period in 2006. We have experienced
general softening in the demand for most of our product lines over the last twelve months. These
trends are reflective of challenges facing our major customers and the industry as a whole. These
trends were partially offset by the inclusion of sales of Martin Audio products from April 11, 2007
through June 30, 2007 of $6.4 million.
Gross Profit
Gross profit decreased to $28.1 million, or 27.7% of net sales, in the six months ended June 30,
2007 from $37.4 million, or 33.4% of net sales, in the six months ended June 30, 2006. Gross
profit for 2007 was affected by $1.4 million due to recording Martin Audio’s inventories
at fair value as a result of the purchase price allocation of Martin Audio. Gross profit was also
reduced by the costs associated with the factory shutdowns and additional sales discounting done in
2007 to reduce the carrying balances of our inventories during the six months ended June 30, 2007.
Excluding the $1.4 million fair value adjustment for Martin Audio’s inventory, gross profit of the
six months ended June 30, 2007 was 29.1%.
16
Table of Contents
Selling, General and Administrative
Selling, general and administrative expenses decreased by $4.2 million to $22.5 million in the six
months ended June 30, 2007 from $26.7 million in the comparable period in 2006. The decrease was
primarily attributable to the effect of cost-cutting programs implemented in 2006.
Research and Development
Research and development expenses decreased by $0.9 million to $5.6 million in the six months ended
June 30, 2007 from $6.5 million in the comparable period in 2006. The decrease was primarily
attributable to the effect of cost-cutting programs implemented in 2006 and 2007.
Restructuring Costs
Restructuring costs were $1.6 million in the six months ended June 30, 2007, primarily representing
employee severance and related costs for approximately 186 employees. Restructuring costs were
$0.6 million in the six months ended June 30, 2006. The 2007 costs were primarily severance
accruals related to the closure and overseas transfer of our domestic manufacturing plants and the
closure of our St. Louis Music engineering functions. The 2006 costs were primarily severance
accruals related to reductions in work force from the consolidation of the St. Louis Music and
service operations.
Other Expense
Net other expense was $7.1 million for the six months ended June 30, 2007 as compared to $3.7
million in the six months ended June 30, 2006. This increase was primarily caused by an increase
to interest expense of $1.3 million and the write-off of $2.5 million of unamortized fees related
to the prior debt facility as a result of the refinancing of our debt facilities in March 2007.
The increase in interest expense is primarily attributable to increasing variable interest rates
and increased debt as a result of the $112 million senior secured credit facility.
Income Taxes
Income tax benefit for the first six months of 2007 was $5,000 compared to income tax expense of
$74,000 for the comparable period in 2006. The primary components of the 2007 benefit are current
taxes due from our foreign subsidiaries and an increase to our income tax reserve offset by the
deferred tax benefit recorded as a result of the partial amortization of the deferred tax liability
recorded as a result of the acquisition of Martin Audio. The primary component of the 2006 tax
relate to our Canadian subsidiary and the deferred tax expense recorded as a result of the goodwill
that is amortized for tax purposes only from the St. Louis Music, Inc. acquisition. The resulting
deferred tax liability is not able to be offset against other deferred tax assets.
Liquidity and Capital Resources
As of June 30, 2007, we had cash and cash equivalents of $6.7 million and total debt and short-term
borrowings of $101.6 million. At June 30, 2007 we had availability of $10.0 million on our
revolving line of credit.
Net Cash Provided by Operating Activities
Cash provided by operating activities was $1.6 million for the six months ended June 30, 2007 and
the comparable period in 2006. The net loss for the first six months of 2007 was $8.7 million that
included $2.3 million in depreciation and amortization, $2.8 million in amortization of deferred
financing fees, $0.2 million in stock based compensation expense, and a gain on asset dispositions
of $0.5 million. In the first six months of 2007, a decrease in accounts payable and accrued
liabilities of $7.8 million and increases to inventories and accounts receivable of $11.8 million
and $2.0 million, respectively, used cash. The net loss for the first six months of 2006 was $0.3
million that included $2.2 million in depreciation and amortization, $0.3 million in amortization
of deferred financing fees and $0.3 million in stock based compensation expense. In the first six
months of 2006, an increase in accounts payable, accrued liabilities and payable to our former
Italian subsidiary of $1.9 million provided cash, while increases to inventories and accounts
receivable of $2.3 million and $0.6 million, respectively, used cash.
17
Table of Contents
Net Cash Used in Investing Activities
Cash used in investing activities was $35.2 million for the first six months of 2007 compared to
$1.2 million for the first six months of 2006. The cash used in investing activities for the first
six months of 2007 is primarily related to the acquisition of Martin Audio and the payment of the
St. Louis Music, Inc. future commitment to pay of $3.2 million. The cash used in investing
activities in 2006 related to the purchases of capital expenditures.
Net Cash Provided by (Used in) Financing Activities
Cash provided by financing activities was $40.0 million during the first six months of 2007,
compared to cash used of $0.5 million during the first six months of 2006. Cash provided in the
first six months of 2007 is primarily attributable to a new credit facility of $102 million
consisting of a Term Loan A of $20.0 million, a US Term Loan B of $40.0 million, a UK Term Loan B
of $30.0 million and a Term Loan C of $12.0 million. Along with this refinance, we paid off our
existing credit facility of $67.2 million as of March 30, 2007, which consisted of a revolving loan
facility of $26.2 million, a Term Loan A of $11.9 million, a Term Loan B of $14.3 million and a
senior subordinated note for $14.8 million. We also incurred $2.9 million of deferred financing
costs relating to this refinance. Cash used in the first six months of 2006 is primarily
attributable to payments made on our long-term debt of $2.0 million partially offset by an increase
in our borrowings from our bank line of credit of $1.5 million.
Ability to stay in compliance with debt covenants
Under the terms of the senior secured credit facility, we are required to maintain certain
financial ratios, such as a fixed charge coverage ratio and a consolidated leverage ratio. We are
also required to meet certain EBITDA targets and adhere to certain capital expenditure limits. The agreement also
provides, among other matters, restrictions on additional financing, dividends, mergers,
acquisitions, and an annual capital expenditure limit. As of June 30, 2007, we met all of our
covenant requirements and we believe we will continue to meet these requirements each quarter
thereafter in 2007.
Commitments
We had the following material contractual commitments related to operating leases for facilities at
June 30, 2007. In addition, we had material obligations related to short-term and long-term debt
arrangements, excluding our accounts payable, accrued liabilities and taxes payable of $35.4
million at June 30, 2007 (in thousands):
Included in the debt line above is expected future interest expense relating to our $112 million
senior secured credit facility.
We also have purchase commitments that range between $26 million to $31 million that are primarily
due to our contract manufacturers.
We believe we will have adequate resources to meet our material obligations as they come due
through December 31, 2007.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our $102.0 million term loans have variable interest rates. As such, changes in U.S. interest
rates affect interest paid on debt, and we are exposed to interest rate risk. For the quarter
ended June 30, 2007, an increase in the average interest rate of 10%, i.e. from 10.54% to 11.59%,
would have resulted in an approximately $272,000 decrease in net income before income taxes. The
fair value of such debt approximates the carrying amount on the consolidated balance sheet at June
30, 2007.
18
Table of Contents
Foreign Currency Risk
A majority of our sales are denominated in U.S. Dollars, and during the three months ended June 30,
2007 approximately 25% of our sales were denominated in foreign currencies. We ordinarily do not
engage in hedging, rate swaps, or other derivatives as a means to minimize our foreign currency
risk and, instead, mitigate that exposure by limiting the portion of our sales that are denominated
in other than U.S. Dollars. Assuming the same level of foreign currency denominated sales as in
the three months ended June 30, 2007, a 10% decline in the average exchange rates for all these
currencies would have caused a decline of approximately $1.2 million, or 2%, of our sales.
The majority of our products are manufactured by foreign third-party contract manufacturers with
the majority of the contracts denominated in U.S. Dollars. The exchange rate for these contracts
is adjusted quarterly based on the Chinese Yuan Renminbi. Foreign third-party manufacturing
creates risks that include fluctuations in currency exchange rates that could affect the price we
pay for our product. Our two largest foreign contract manufacturers’ products represented 45.6% of
our net sales for the three months ended June 30, 2007. A 10% increase to the cost of the product
sold that was manufactured by these two manufacturers would have resulted in an increase to cost of
sales for the three months ended June 30, 2007 of approximately $1.0 million.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and
15(d)-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) that are
designed to ensure that information required to be disclosed in the Company’s reports under the
Exchange Act, is recorded, processed, summarized and reported within the time periods specified in
the SEC’s rules and forms, and that such information is accumulated and communicated to the
Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosure.
As noted in the Company’s Quarterly Report on Form 10-Q filed on May 25, 2007, during management’s
preparation of the financial statements as of and for the three month period ended March 31, 2007,
and management’s related review of the Company’s disclosure controls and procedures for such
period, management discovered an ambiguity relating to the method for computing gross margin for
certain of the Company’s product lines. The determination of the appropriate allocations of
expense items to the relevant products resulted in a delay in the Company’s filing of that report
and, if left unaddressed, may have been considered a material weakness in the Company’s internal
control over financial reporting because it would result in more than a remote likelihood that a
material misstatement of the annual or interim financial statements would not be prevented or
detected. Following a review of the Company’s disclosure controls and procedures relating to the
computation of gross margin, management modified its disclosure controls and procedures relating to
such methodology. Those modified disclosure controls and procedures were deemed to be operating
effectively for the three months ended June 30, 2007.
As such, there has been no change in the Company’s internal control over financial reporting (as
defined in Rules 13(a)-15(f) and 15(d)-15(f) under the Exchange Act) during the period covered by
this report that has materially affected, or is reasonably likely to materially affect, the
Company’s internal control over financial reporting.
19
Table of Contents
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits
Exhibits
20
Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
21
Table of Contents
EXHIBIT INDEX
22 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| |||||||
