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Richardson Electronics 10-K 2005
Form 10-K
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

x FOR ANNUAL REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended May 28, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File Number: 0-12906

 

LOGO

 

RICHARDSON ELECTRONICS, LTD.

(Exact name of registrant as specified in its charter)

 

Delaware   36-2096643
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

40W267 Keslinger Road, P.O. Box 393

LaFox, Illinois 60147-0393

(Address of principal executive offices)

 

Registrant’s telephone number, including area code: (630) 208-2200

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.05 Par Value

 

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.    x  Yes    ¨  No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.  x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    x  Yes    ¨  No

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

 

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of November 27, 2004, was approximately $153,700,000.

 

As of August 24, 2005, there were outstanding 15,608,379 shares of Common Stock, $.05 par value, inclusive of 1,332,053 shares held in treasury, and 3,119,697 shares of Class B Common Stock, $.05 par value, which are convertible into Common Stock of the registrant on a share for share basis.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s Proxy Statement dated September 9, 2005 for the Annual Meeting of Stockholders scheduled to be held October 18, 2005, which will be filed pursuant to Regulation 14(A), are incorporated by reference in Part III of this Report. Except as specifically incorporated herein by reference, the above mentioned Proxy Statement is not deemed filed as part of this report.

 



Table of Contents

TABLE OF CONTENTS

 

          Page

Part I

         

Item 1.

  

Business

   3

Item 2.

  

Properties

   11

Item 3.

  

Legal Proceedings

   12

Item 4.

  

Submission of Matters to a Vote of Security Holders

   12

Part II

         

Item 5.

  

Market for Registrant’s Common Equity and Related Stockholder Matters

   13

Item 6.

  

Selected Consolidated Financial Data

   14

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   15

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   35

Item 8.

  

Financial Statements and Supplementary Data

   37

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   68

Item 9A.

  

Controls and Procedures

   68

Item 9B.

  

Other Information

   74

Part III

         

Item 10.

  

Directors and Executive Officers of the Registrant

   75

Item 11.

  

Executive Compensation

   75

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   75

Item 13.

  

Certain Relationships and Related Transactions

   75

Item 14.

  

Principal Accountant Fees and Services

   75

Part IV

         

Item 15.

  

Exhibits and Financial Statement Schedules

   76

Signatures

   77

Exhibit Index

   78

 

2


Table of Contents

PART I

 

Item 1. Business

 

The Company

 

Richardson Electronics, Ltd. (the “Company”) was originally incorporated in Illinois in 1947 and is currently incorporated in Delaware. The Company is a global provider of engineered solutions and a distributor of electronic components to the radio frequency (RF) and wireless communications, industrial power conversion, security, and display systems markets with sales in fiscal 2005 of $578.7 million. Utilizing its core engineering and manufacturing capabilities, the Company is committed to a strategy of providing specialized technical expertise and value-added products, or “engineered solutions,” in response to customers’ needs. These solutions consist of products which the Company manufactures or modifies and products which are manufactured to its specifications by independent manufacturers under the Company’s own private labels. Additionally, the Company provides solutions and adds value through design-in support, systems integration, prototype design and manufacturing, testing, and logistics for its customers’ end products. Design-in support includes component modifications or the identification of lower-cost product alternatives or complementary products.

 

The Company’s products include RF and microwave components, power semiconductors, electron tubes, microwave generators, data display monitors, and electronic security products and systems. These products are used to control, switch or amplify electrical power or signals, or as display, recording or alarm devices in a variety of industrial, communication, and security applications. The Company’s broad array of technical services and products supports both its customers and vendors.

 

The Company implemented restructuring actions during fiscal 2005, including changes in management and a reduction in workforce, in an effort to reduce its cost structure, accelerate the alignment of operations with the Company’s engineered solutions strategy, and improve operating efficiency. The Company recently sold approximately 205 acres of undeveloped real estate adjoining its headquarters in the fourth quarter of fiscal 2005, resulting in a realized gain of $9.9 million before taxes.

 

During the first quarter of fiscal 2005, the Company had an equity offering for three million shares of common stock that contributed $27.8 million in net proceeds that was used to reduce debt.

 

Strategic Business Units

 

The Company serves its customers through four strategic business units focused on different end markets with distinct product and application needs: RF and Wireless Communications Group; Industrial Power Group; Security Systems Division; and Display Systems Group.

 

Each strategic business unit has dedicated marketing, sales, product management, and purchasing functions to better serve its targeted markets. The strategic business units operate globally, serving North America, Europe, Asia/Pacific, and Latin America.

 

Selected financial data attributable to each strategic business unit and geographic data for fiscal 2005, 2004, and 2003 is set forth in Note L of the notes to the consolidated financial statements and is incorporated by reference herein.

 

RF and Wireless Communications Group

 

The RF and Wireless Communications (RFWC) Group serves the global RF and wireless communications market, including infrastructure and wireless networks. RFWC has a team of RF and wireless engineers who assist customers in designing circuits, selecting cost effective components, planning reliable and timely supply, prototype testing, and assembly. The group offers its customers and vendors complete engineering and technical

 

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support from the design-in of RF and wireless components to the development of engineered solutions for their system requirements.

 

The Company expects continued growth in wireless applications as the demand for many types of wireless communication increases worldwide. The Company believes wireless networking and infrastructure products for a number of niche applications will require engineered solutions using the latest RF technology and electronic components, including: automotive telematics, which is the use of computers and telecommunications to provide wireless voice and data applications in motor vehicles; RF identification, which is an electronic data collection and identification technology for a wide range of products to transfer data between a movable item and a reader to identify, track, or locate items; and wireless local area networks.

 

In addition to voice communication, the Company believes the rising demand for high-speed data transmission will result in major investments in both system upgrades and new systems to handle broader bandwidth.

 

The Company supports these growth opportunities by partnering with many of the leading RF and wireless component manufacturers. A key factor in the Company’s ability to maintain a strong relationship with its existing vendors and to attract new vendors is its ability to supply them with worldwide demand forecasts for their existing products as well as products they have in development. The Company has developed internal systems to capture forecasted product demand by potential design opportunity based on ongoing dialogue between its sales team and its customers. The Company shares this information with its manufacturing suppliers to help them predict near and long-term demand and product life cycles. The Company has global distribution agreements with such leading suppliers as ANADIGICS, Anaren, ATC, Freescale, HUBER+SUHNER, M/A-COM, and WJ Communications. In addition, the Company has relationships with many niche RF and wireless suppliers to allow it to serve as a comprehensive RF and wireless resource.

 

The Company participates in most RF and wireless applications and markets throughout the world, focusing on infrastructure rather than consumer-driven subscriber applications.

 

The following is a description of RFWC’s major product areas: RF and Microwave Devices—a wide variety of components, such as RF transistors, mixers, switches, amplifiers, oscillators, and RF diodes, which are used in infrastructure, wireless networking, and other related markets, such as broadcast, cable TV, cellular and personal communications service telephony, satellite, wireless local area networks, and various other wireless applications, including the Company’s recently developed In-home Amplifier, which helps increase the ability to send and receive cellular signals from the home. Interconnect Devices—passive components used to connect all types of electronic equipment including those employing RF technology. Digital Broadcast—components and assemblies used in a broad range of applications in the digital broadcast market, including satellite, transmission, and RF components.

 

Effective for fiscal 2006, management of the semiconductor product lines will be transferred from the Industrial Power Group to RFWC.

 

Industrial Power Group

 

The Industrial Power Group (IPG) provides engineered solutions for customers in diverse markets including the steel, automotive, textile, plastics, semiconductor manufacturing, broadcast, and transportation industries. The Company’s team of engineers design solutions for applications such as motor speed controls, industrial heating, laser technology, semiconductor manufacturing equipment, radar, and welding. The group builds on its expertise in power conversion technology to provide engineered solutions to fit its customers’ specifications using what the Company believes are the most competitive components from industry-leading vendors.

 

IPG serves the industrial market’s need for both vacuum tube and solid-state technologies. The Company provides replacement products for systems using electron tubes as well as design and assembly services for new systems employing power semiconductors. As electronic systems increase in functionality and become more complex, the Company believes the need for intelligent, efficient power management will continue to increase and drive power conversion demand growth.

 

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IPG represents leading manufacturers of electronic components used in industrial power applications. Among the suppliers IPG supports are Advanced Power Technology, Amperex, Cornell-Dubilier, CPI, Eimac, General Electric, International Rectifier, Jennings, Litton, Mitsubishi, NJRC, National, Powerex, Vishay Draloric and Wakefield.

 

The following is a description of IPG’s major product areas: Power Semiconductors—solid-state, high-frequency, high power products used in semiconductor manufacturing equipment, uninterruptible power supplies, medical radiation, broadcast, and industrial heating applications. Silicon Controlled Rectifiers, Heat Sink Assemblies, and Power Semiconductor Modules—components used in many industrial control applications because of their ability to switch large amounts of power at high speeds. These silicon power devices are capable of operating at up to 4,000 volts at 2,000 amperes. High Voltage and Power Capacitors—devices used in industrial, avionics, medical, and broadcast applications for filtering, high-current bypass, feed-through capacitance for harmonic attenuation, pulse shaping, grid and plate blocking, tuning of tank circuits, antenna coupling, and energy discharge. Power Amplifier/Oscillator Tubes—vacuum or gas-filled tubes used in applications where current or voltage amplification and/or oscillation is required. Applications include induction heating, diathermy equipment, communications, broadcast, and radar systems, and power supplies for voltage regulation or amplification. Microwave Generators—devices that incorporate magnetrons, which are high vacuum oscillator tubes used to generate energy at microwave frequencies. The pulsed magnetron is primarily used to generate high-energy microwave signals for radar applications. Magnetrons are also used in vulcanizing rubber, food processing, packaging, wood/glue drying, in the manufacture of wafers for the semiconductor industry and other industrial heating applications such as microwave ovens, and by the medical industry for sterilization and cancer therapy. Hydrogen Thyratrons—electron tubes capable of high speed and high voltage switching. They are used to control the power in laser and radar equipment and in linear accelerators for cancer treatment. Thyratrons and Rectifiers—vacuum or gas-filled tubes used to control the flow of electrical current. Thyratrons are used to control ignitrons, electric motor speed controls, theatrical lighting, and machinery such as printing presses and various types of medical equipment. Rectifiers are used to restrict electric current flow to one direction in power supply applications. Ignitrons—mercury pool tubes used to control the flow of large amounts of electrical current. Their primary applications are in welding equipment, power conversion, fusion research, and power rectification equipment.

 

Effective for fiscal 2006, management of the semiconductor product lines will be transferred from IPG to RFWC.

 

Security Systems Division

 

The Security Systems Division (SSD) is a global provider of closed circuit television, fire, burglary, access control, sound, and communication products and accessories for the residential, commercial, and government markets. The unit specializes in closed circuit television design-in support, offering extensive expertise with applications requiring digital technology. The products SSD provides are primarily used for security and access control purposes but are also utilized in industrial applications, mobile video, and traffic management.

 

The security systems industry is rapidly transitioning from analog to digital imaging technology. The Company is positioned to take advantage of this transition through its array of innovative products and solutions marketed under the Company’s National Electronics, Capture®, AudioTrak®, and Elite National Electronics® brands. The Company hopes SSD will gain additional market share by marketing itself as a value-added service provider and partnering with its other strategic business units to develop customized solutions as the transition to digital technology continues in the security industry.

 

SSD supports its customer base with products from more than 100 manufacturers including such well-known names as Aiphone, GE, Panasonic, Paradox, Pelco, Sanyo, and Sony, as well as our own private label brands, National Electronics, Capture®, AudioTrak®, and Elite National Electronics®.

 

The following is a description of SSD’s major product areas: Closed Circuit Television—products used in surveillance applications and for monitoring hazardous environments in the workplace. Products include: cameras, lenses, cathode ray tube and liquid crystal display monitors, multiplexers, time lapse recorders,

 

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computerized digital video recorders, internet-based video servers, and accessories. Burglar and Fire Alarms—devices used to detect the presence of smoke, fire, or intrusion, and communicate information both to occupants and to a central monitoring station. Access Control—hardware-based and software-based solutions used to prevent, monitor, and/or control access. Commercial, Residential, and Professional Sound Systems—sound reproduction components used in background music, paging, and telephonic interconnect systems, along with custom home audio equipment used for distributed music and home theater systems.

 

Display Systems Group

 

The Display Systems Group (DSG) is a global provider of integrated display products and systems to the public information, financial, point-of-sale, and medical imaging markets. The group works with leading hardware vendors to offer the highest quality liquid crystal display, plasma, cathode ray tube, and customized display monitors. The group’s engineers design custom display solutions that include touch screens, protective panels, custom enclosures, specialized finishes, application specific software, and privately branded products.

 

The medical imaging market is transitioning from film-based technology to digital technology. DSG’s medical imaging hardware partnership program allows it to deliver integrated hardware and software solutions for this growing market by combining the Company’s hardware expertise in medical imaging engineered solutions with its software partners’ expertise in picture archiving and communications systems. Through such collaborative arrangements, the Company is able to provide integrated workstation systems to the end user.

 

The Company’s legacy business of supplying replacement cathode ray tubes continues to be an important market. The Company believes it is successful in supplying replacement cathode ray tubes because of its extensive cross-reference capability. This database, coupled with custom mounting hardware installed by the Company, enables it to provide replacement tubes for more than 200,000 models.

 

DSG has long-standing relationships with key manufacturers including 3M, Clinton Electronics, IBM, Intel, LG, NEC/Mitsubishi Displays, Panasonic Industrial, Philips-FIMI, Planar Systems, and Siemens Displays. The Company believes these relationships allow it to maintain a well-balanced and technologically advanced line of products.

 

The following is a description of DSG’s major product areas: Cathode Ray Tubes—vacuum tubes that convert an electrical signal into a visual image to display information on data display monitors. Cathode ray tubes are used in various environments, including hospitals, financial institutions, airports, and numerous other applications wherever large user groups share electronic data visually. This product line includes both monochrome and color tubes. Flat Panel Displays—display monitors incorporating a liquid crystal or plasma panel, as an alternative to the traditional cathode ray tube technology, typically a few inches in depth and ranging from 10" to 52" measured diagonally. These displays are typically integrated with touchscreen technology or special mounting configurations based on the customer’s requirements. High Resolution Medical Displays—an integral component of picture archiving and communications systems, displays are used in diagnostic and non-diagnostic imaging to display the digital image generated from computed tomography, magnetic resonance imaging, radiography, and other digital modalities.

 

Business Strategies

 

The Company is pursuing a number of strategies designed to enhance its business and, in particular, to increase sales of engineered solutions.

 

Capitalize on Engineering and Manufacturing Expertise. The Company believes that its success is largely attributable to its core engineering and manufacturing competency and skill in identifying cost-competitive solutions for its customers, and the Company believes that these factors will be significant to its future success. Historically, the Company’s primary business was the distribution and manufacture of electron tubes, and the

 

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Company continues to be a major supplier of these products. This business enabled the Company to develop manufacturing and design engineering capabilities. Today, the Company uses this expertise to identify engineered solutions for customers’ applications—not only in electron tube technology but also in new and growing end markets and product applications. The Company works closely with its customers’ engineering departments that allow it to identify engineered solutions for a broad range of applications. The Company believes its customers use its engineering and manufacturing expertise as well as its in-depth knowledge of the components best suited to deliver a solution that meets their performance needs cost-effectively.

 

Target Selected Niche Markets. The Company focuses on selected niche markets that demand a high level of specialized technical service, where price is not the primary competitive factor. These niche markets include wireless infrastructure, high power/high frequency power conversion, custom display, and digital imaging. In most cases, the Company does not compete against pure commodity distributors. The Company often functions as an extension of its customers’ and vendors’ engineering teams. Frequently, the Company’s customers use its design and engineering expertise to provide a product solution that is not readily available from a traditional distributor. By utilizing the Company’s expertise, customers and vendors can focus their engineering resources on more critical core design and development issues.

 

Focus on Growth Markets. The Company focuses on markets it believes have high growth potential and can benefit from its engineering and manufacturing expertise and from its strong vendor relationships. These markets are characterized by substantial end-market growth and rapid technological change. For example, the continuing demand for wireless communications is driving wireless application growth. Power conversion demand continues to grow due to increasing system complexity and the need for intelligent, efficient power management. The Company also sees growth opportunities as security systems transition from analog to digital video recording and medical display systems transition from film to digital imaging.

 

Leverage the Existing Customer Base. An important part of the Company’s growth is derived from offering new products to its existing customer base. The Company supports the migration of its Industrial Power Group customers from electron tubes to newer solid-state technologies. Sales of products other than electron tubes represented approximately 83% of the Company’s sales in fiscal 2005 compared to 76% in fiscal 2000. In addition, the Company’s salespeople increased sales by selling products from all strategic business units to customers who currently may only purchase from one strategic business unit and by selling engineered solutions to customers who currently may only purchase standard components.

 

Growth and Profitability Strategies

 

The Company’s long-range growth plan centers around three distinct strategies by which it seeks to maximize its overall profitability:

 

Focus on Internal Growth. The Company believes that, in most circumstances, internal growth provides the best means of expanding its business, both on a geographic and product line basis. The recent economic downturn increased the trend to outsourcing engineering as companies focused on their own core competencies, which the Company believes contributed to the increased demand for its engineered solutions. As technologies change, the Company plans to continue to capitalize on its customers’ need for design engineering. In fiscal 2005, sales were made to approximately 37,000 customers. The Company has developed internal systems to capture forecasted product demand by potential design opportunity. This allows the Company to anticipate the customers’ future requirements and identify new product opportunities. In addition, the Company shares these future requirements with its manufacturing suppliers to help them predict near and long-term demand, technology trends and product life cycles.

 

Expansion of the Company’s product offerings is an ongoing program. In particular, the following areas have generated significant sales increases in recent years: RF amplifiers; interconnect and passive devices; silicon controlled rectifiers; custom and medical monitors; and digital closed circuit television security systems.

 

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Reduce Operating Costs Through Continuous Operational Improvements. The Company constantly strives to reduce costs in its business through initiatives designed to improve its business processes. Recently, the Company embarked on a vigorous program in an effort to improve operating efficiencies and asset utilization, with an emphasis on inventory control. The Company revised its incentive programs in fiscal 2004 to heighten its managers’ commitment to these objectives. Since fiscal 2004, the strategic business units’ goals are based on return on assets. Additional programs are ongoing, including a significant investment in enterprise resource planning software during fiscal 2006.

 

Grow Through Acquisitions. The Company has an established record of acquiring and integrating businesses. Since 1980, the Company acquired 35 companies or significant product lines and continues to evaluate acquisition opportunities on an ongoing basis. The Company seeks acquisitions that provide product line growth opportunities by permitting it to leverage its existing customer base, expand the geographic coverage for its existing product offerings, or add incremental engineering resources/expertise. The most significant acquisitions over the past five years include: Celti (fiber optic communication—now part of the RF and Wireless Communications Group) in fiscal 2001; Aviv (design-in services for active and passive components—now part of the RF and Wireless Communications Group) in fiscal 2001; Sangus (RF and microwave applications—now part of the RF and Wireless Communications Group) in fiscal 2002; and Evergreen (power conversion applications—now part of the Industrial Power Group) in fiscal 2004. Effective June 1, 2005, the Company acquired A.C.T. Kern GmbH & Co. KG located in Germany (display technology—now part of the Display Systems Group).

 

Products and Suppliers

 

The Company purchases numerous products from various suppliers as noted above under “Strategic Business Units.” During fiscal 2005, the Company added the following suppliers: Aavid Thermal Technologies, Raltron Electronics Corporation, Sony Ericsson Mobile Communications (USA) Incorporated, NEC Display Solutions, Fractus SA, Aeroflex-Inmet, Teledyne Relays, CTS Wireless, LG, and ATC.

 

The Company evaluates its customers’ needs and maintains sufficient inventories in an effort to ensure its customers a reliable source of supply. The Company would generally anticipate holding 90 days of inventory in the normal course of operations. This level of inventory is higher than some of its competitors due to the fact that the Company sells a number of products representing older, or trailing edge, technology that may not be available from other sources. The market for these trailing edge technology products is declining and as manufacturers for these products exit the business, the Company, at times, purchases a substantial portion of their remaining inventory. The Company also maintains an inventory of a broad range of products (which contributes to a higher total inventory) to be able to promptly service those customers who are buying product for replacement of components in equipment critical to preventing downtime of their operations. In other segments of the business, such as the RF and Wireless Communications Group, the market for the Company’s products is characterized by rapid change and obsolescence as a result of the development of new technologies, particularly in the semiconductor markets it serves. Since fiscal 2004, the Company has embarked on a vigorous program in an effort to improve operating efficiencies and asset utilization, with a particular emphasis on inventory control.

 

The Company has written distribution agreements with many of its suppliers; however, a number of these agreements provide for nonexclusive distribution rights and often include territorial restrictions that limit the countries in which the Company can distribute the products. The agreements are generally short-term, subject to periodic renewal, and some contain provisions permitting termination by either party without cause upon relatively short notice. Although some of these agreements allow the Company to return inventory periodically, others do not, in which case, the Company may have obsolete inventory that it cannot return to the supplier.

 

The Company’s suppliers generally warrant the products the Company distributes and allow return of defective products, including those returned to the Company by its customers. Except with respect to certain displays, the Company generally does not provide additional warranties on the products it sells. For information regarding the warranty reserves, see Note A of the notes to the consolidated financial statements.

 

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In addition to third party products, the Company distributes proprietary products principally under the trade names Amperex®, AudioTrak®, Call Capture, Capture®, Cetron®, Elite National Electronics®, National®, National Electronics®, Pixelink, and RF Gain.

 

The proprietary products the Company currently sells, which it manufactures or has manufactured for itself, include RF amplifiers, transmitters and pallet assemblies, thyratrons and rectifiers, power tubes, ignitrons, CW magnetron tubes, phototubes, spark gap tubes, microwave generators, custom RF matching networks, heatsinks, silicon controlled rectifier assemblies, large screen display monitors, liquid crystal display monitors, and computer workstations. The materials used in the manufacturing process consist of glass bulbs and tubing, nickel, stainless steel and other metals, plastic and metal bases, ceramics, and a wide variety of fabricated metal components. These materials generally are readily available, but some components may require long lead times for production and some materials are subject to shortages or price fluctuations based on supply and demand.

 

Sales and Marketing

 

As of the end of fiscal 2005, the Company employed approximately 565 sales personnel worldwide. In addition, there are approximately 158 authorized representatives, who are not the Company’s employees, selling its products, primarily in regions where the Company does not have a direct sales presence. Many of the Company’s field representatives focus on just one of its strategic business units, while others focus on all of its strategic business units within a particular geographic area. The Company’s sales representatives are compensated in part on a salaried basis and in part on a commission basis.

 

The Company offers various credit terms to qualifying customers as well as prepayment, credit card, and cash on delivery terms. The Company establishes credit limits prior to selling product to its customers and routinely reviews delinquent and aging accounts. The Company establishes reserves for estimated credit losses in the normal course of business.

 

Distribution

 

The Company maintains an inventory of more than 750,000 part numbers in its inventory database and estimates more than 80% of orders received by 6:00 p.m. local time are shipped complete the same day. Customers can access the Company’s product inventory through electronic data interchange either at the Company’s web site, www.rell.com, through its catalog, www.catalog.rell.com, or by telephone. Customer orders are processed by the regional sales offices and supported by one of the Company’s principal distribution facilities in LaFox, Illinois; Lincoln, England; Vancouver, British Columbia; or Singapore, Republic of Singapore and/or its 39 additional stocking locations throughout the world. The Company utilizes a sophisticated data processing network that provides on-line, real-time interconnection of all sales offices and central distribution operations, 24 hours per day, seven days per week. Information on stock availability, cross-reference information, customers, and market analyses are instantly obtainable throughout the entire distribution network.

 

International Sales

 

In fiscal 2005, 58.8% of the Company’s sales and 24.9% of the Company’s purchases of products were made outside the U.S. The Company anticipates that it may continue to expand its international operations to the extent that suitable opportunities become available. Accordingly, its future results could be adversely affected by a variety of factors which are not present for companies with operations and sales solely within the United States, including: changes in currency exchange rates; changes in a specific country’s or region’s political or economic conditions, particularly in emerging markets, including the possibility of military action or other hostilities and confiscation of property; increases in trade protection measures and import or export licensing requirements; changes in tax laws and international tax treaties; restrictions on the Company’s ability to repatriate investments and earnings from foreign operations; difficulty in staffing and managing widespread operations; differing labor regulations; differing protection of intellectual property; changes in regulatory requirements; shipping costs and

 

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delays; and difficulties in accounts receivable collection. Such risks could result in substantial increases in costs, the reduction of profit, the inability to do business, and other adverse effects.

 

Backlog

 

The Company’s backlog of orders was approximately $97.8 million and $100.7 million as of May 28, 2005 and May 29, 2004, respectively. The Company expects to fill all backlog orders within fiscal 2006.

 

Employees

 

As of May 28, 2005, the Company employed 1,165 individuals on a full-time basis. Of these, 586 were located in the United States and 579 were employed internationally. The worldwide employee base included 691 in sales and product management, 198 in distribution support, 148 in administrative positions, and 128 in value-added and product manufacturing. All of the Company’s employees are non-union. The Company considers its relationships with its employees to be good.

 

Competition

 

The Company believes that engineering capability, exclusive vendor relationships, and product diversity create segmentation among its competitors. The Company believes that the key competitive factors in its markets include the ability to provide engineered solutions, inventory availability, product quality, reliable delivery, and price. The Company believes that, on a global basis, it is a significant provider of engineered solutions and products which utilize RF and power semiconductors and subassemblies, electron tubes, cathode ray tubes, custom and medical monitors, and security systems. In many instances, the Company’s competition is its customer base and their decision to make or buy, as well as the original equipment manufacturer for sales of replacement parts and system upgrades to service existing installed equipment. In addition, the Company competes worldwide with other general line distributors and other distributors of electronic components.

 

Patents and Trademarks

 

The Company holds or licenses certain manufacturing patents and trademark rights. Although the Company’s patents and trademarks have some value, they are not material to the Company’s success, which depends principally upon its core engineering capability, marketing technical support, product delivery, and the quality and economic value of its products.

 

Seasonal Variations

 

The Company experiences moderate seasonality in its business and typically realizes higher sequential sales in its second and fourth fiscal quarters, reflecting increased transaction volume after the summer and holiday months in its first and third fiscal quarter periods.

 

Website Access to SEC Reports

 

The Company maintains an Internet website at www.rell.com. The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 are accessible through the website, free of charge, as soon as reasonably practicable after these reports are filed electronically with the Securities and Exchange Commission. To access these reports, go to the Company’s website at www.rell.com/investor.asp. The foregoing information regarding the Company’s website is for your convenience and the contents of the Company’s website is not deemed to be incorporated by reference in this report filed with the Securities and Exchange Commission.

 

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Item 2. Properties

 

The Company owns six facilities and leases 69 facilities. The Company owns its corporate facility and largest distribution center, which is located on approximately 96 acres in LaFox, Illinois, consisting of approximately 242,000 square feet of manufacturing, warehouse, and office space. The Company maintains geographically diverse facilities because management believes this will limit market risk and exchange rate exposure. The Company considers its properties to be generally well maintained, in sound condition and repair, and adequate for its present needs. The extent of utilization varies from property to property and from time to time during the year.

 

The principal facilities of the Company and the primary use and segments at those locations are as follows:

 

Location


  

Leased or
Owned


  

Use


  

Segment


Sao Paulo, Brazil

   Leased    Distribution    RFWC, IPG, SSD, DSG

Brampton, Canada

   Leased    Sales/Distribution    RFWC, IPG, SSD, DSG

Burnaby, Canada

   Leased    Sales/Distribution    SSD

Toronto, Canada

   Leased    Sales/Distribution    SSD

Montreal, Canada

   Leased    Sales/Distribution    SSD

Shanghai, China

   Leased    Sales    RFWC, IPG, DSG

Lincoln, England

   Owned    Sales/Distribution    RFWC, IPG, SSD, DSG

Colombes, France

   Leased    Sales/Distribution    RFWC, IPG, SSD, DSG

Puchheim, Germany

   Leased    Distribution    RFWC, IPG, SSD, DSG

Raanana, Israel

   Leased    Sales/Distribution    RFWC, IPG, SSD, DSG

Florence, Italy

   Owned    Sales/Distribution    RFWC, IPG, SSD, DSG

Tokyo, Japan

   Leased    Sales/Distribution    RFWC, IPG, DSG

Seoul, Korea

   Leased    Sales    RFWC, IPG, DSG

Singapore, Singapore

   Leased    Sales/Distribution    RFWC, IPG, DSG

Madrid, Spain

   Owned    Sales/Distribution    RFWC, IPG, SSD, DSG

Jarfalla, Sweden

   Leased    Sales    RFWC, IPG, SSD, DSG

Taipei, Taiwan

   Leased    Sales/Distribution    RFWC, IPG, DSG

San Jose, California

   Leased    Sales    RFWC, IPG, DSG

Woodland Hills, California

   Leased    Sales    RFWC, IPG, DSG

Atlanta, Georgia

   Leased    Sales/Distribution    SSD

Elgin, Illinois

   Leased    Distribution    RFWC

Geneva, Illinois

   Owned    Distribution    RFWC, IPG, DSG

Geneva, Illinois

   Leased    Distribution    RFWC, IPG, SSD, DSG

LaFox, Illinois*

   Owned    Sales/Distribution    RFWC, IPG, SSD, DSG

Hudson, Massachusetts

   Leased    Sales/Distribution    DSG

Ronkonkoma, New York

   Leased    Sales    RFWC, IPG, DSG

Cedars, Pennsylvania

   Leased    Sales    RFWC

Houston, Texas

   Leased    Distribution    SSD

Houston, Texas

   Leased    Sales    SSD

* LaFox, Illinois is also the location of the Company’s corporate headquarters.

 

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Table of Contents

Item 3. Legal Proceedings

 

The Company is involved in several pending judicial proceedings concerning matters arising in the ordinary course of its business. While the outcome of litigation is subject to uncertainties, based on currently available information, the Company believes that, in the aggregate, the results of these proceedings will not have a material adverse effect on its financial condition.

 

On December 20, 2002, the Company filed a complaint against Signal Technology Corporation in the United States District Court for the Northern District of Illinois, which the Company dismissed on February 27, 2003. On February 14, 2003, Signal Technology filed a declaratory judgment suit against the Company in Superior Court, Boston, Massachusetts, and on March 4, 2003, the Company filed a complaint against Signal Technology Corporation in the Circuit Court of Cook County, Illinois. On February 13, 2004, the Company dismissed its complaint in Circuit Court, Cook County, Illinois. From November 6, 2000 through December 6, 2001, Signal Technology issued six purchase orders to purchase low-frequency amplifiers and other electronic components from the Company and subsequently refused to take delivery of the components. The Company is claiming damages of approximately $2.0 million resulting from Signal Technology’s refusal to take delivery. Signal Technology’s declaratory judgment suit in Massachusetts seeks a ruling that it has no liability to the Company, but Signal Technology has not asserted any claim against the Company.

 

In fiscal 2003, two customers of the Company’s German subsidiary asserted claims against the Company in connection with heterojunction field effect transistors the Company sold to them. The Company acquired the heterojunction field effect transistors from the manufacturer pursuant to a distribution agreement. The customers claimed that the heterojunction field effect transistors did not meet the specification provided by the manufacturer. The Company has notified the manufacturer and its insurance carrier of these claims. In fiscal 2005, the claim of one of the two customers was settled without any admission of liability on the part of the Company, with a full release from liability and without any material consideration from the Company, the settlement amount being paid by the Company’s insurance carrier. Because the Company’s investigation has not been completed, it is unable to evaluate the merits of the remaining claim or the prospects of recovery from the manufacturer or insurance carrier. The Company intends to vigorously defend the remaining claim and, if it should have any liability arising from this claim, the Company intends to pursue a claim against the manufacturer and the insurer. As of August 26, 2005, no proceedings have been instituted regarding this claim.

 

The Company has been informed by one of its foreign subsidiaries that its records may not be adequate to support the taxable revenues and deductions included within income tax returns previously filed. At this time, the Company has not received notification from any tax authority regarding this matter. The Company will continue to investigate this matter and take the appropriate actions necessary to minimize any potential liability. As of August 18, 2005, the Company has not developed or obtained specific and definitive information sufficient to reasonably confirm the existence of a tax liability, determine a reasonable range of a potential liability, or otherwise evaluate any exposure to the Company. Although it is difficult to determine the ultimate exposure due to the lack of sufficient information, an unfavorable outcome may be material to the consolidated financial statements.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended May 28, 2005.

 

12


Table of Contents

PART II

 

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

 

Recent Sales of Unregistered Securities

 

On February 15, 2005, the Company issued 7 3/4% convertible senior subordinated notes (the Notes) in the amount of $44.7 million pursuant to an indenture with J.P. Morgan Trust Company dated February 14, 2005. The Notes were issued through a private exchange offer with qualified institutional buyers under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated thereunder. An aggregate principal amount of $22.2 million 7 1/4% debentures and $22.5 million 8 1/4% debentures were exchanged for the 7 3/4% notes. The Company previously reported this issuance of notes in a Current Report of Form 8-K filed on February 15, 2005.

 

Dividends

 

Annual dividend payments for fiscal 2005 amounted to $2.7 million. All future payments of dividends are at the discretion of the board of directors and will depend on earnings, capital requirements, operating conditions, and such other factors that the board of directors may deem relevant. In each of the last 18 years, the Company has paid a quarterly dividend of $0.04 per common share and $0.036 per Class B common share. Management currently expects this trend to continue in fiscal 2006.

 

Pursuant to the indentures, see Note F to consolidated financial statements, governing the Company’s 7 1/4% convertible subordinated debentures due December 2006 and 8 1/4% convertible senior subordinate debentures due June 2006, the Company is prohibited from paying a dividend if it is in default under such indenture or if the payment of such dividend would exceed the sum of the Company’s consolidated net income since the end of the last fiscal year prior to issuance of such debentures plus the net proceeds from the sale of Company stock and indebtedness which has been converted into Company stock since the end of the last fiscal year prior to issuance of such debentures plus $30,000,000 in the case of the indenture for the 8 1/4% convertible senior subordinated debentures due June 2006 and $20,000,000 in the case of the indenture for the 7 1/4% convertible subordinated debentures due December 2006. Pursuant to the credit agreement, see Note F to consolidated financial statements, the Company is prohibited from paying dividends in excess of an annualized rate of $0.16 per share of common stock and $0.144 per share of Class B common stock. In addition, the credit agreement prohibits subsidiaries of the Company, other than wholly owned subsidiaries, from paying dividends.

 

Market Price of Common Stock

 

The Company’s common stock is traded on the NASDAQ National Market under the trading symbol “RELL.” There is no established public trading market for the Company’s Class B common stock. As of August 24, 2005, there were approximately 910 stockholders of record for their common stock and approximately 18 stockholders of record for their Class B common stock. The following table sets forth, for the periods indicated, the high and low sales prices per share of “RELL” common stock as reported on the NASDAQ National Market.

 

     2005

   2004

     High

   Low

   High

   Low

Fiscal Quarters

                           

First

   $ 11.96    $ 7.53    $ 10.79    $ 7.83

Second

     11.30      7.50      12.57      9.65

Third

     11.76      9.70      14.00      10.00

Fourth

     11.49      7.46      14.08      9.41

 

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Table of Contents

Item 6. Selected Consolidated Financial Data

 

Five-Year Financial Review

(in thousands, except per share amounts)

 

This information should be read in conjunction with the Company’s consolidated financial statements, accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.

 

    Fiscal Year Ended(1)

    2005(2)

    2004(3)

  2003(4)

    2002(5)

    2001

Statement of Operations Data:

                                   

Net sales(6)

  $ 578,724     $ 519,823   $ 464,381     $ 443,415     $ 502,197

Costs of products sold

    441,817       392,117     365,427       349,326       370,819
   


 

 


 


 

Gross margin

    136,907       127,706     98,954       94,089       131,378

Selling, general and administrative expenses(6)

    128,733       108,299     100,613       98,993       94,272

(Gain) loss on disposal of assets(7)

    (9,918 )     579     —         —         —  

Other expense, net

    7,538       10,258     9,700       12,695       13,042
   


 

 


 


 

Income (loss) before income taxes and cumulative effect of accounting change

    10,554       8,570     (11,359 )     (17,599 )     24,064

Income tax provision (benefit)

    21,865       2,537     (2,370 )     (6,268 )     7,819
   


 

 


 


 

Income (loss) before cumulative effect of accounting change

    (11,311 )     6,033     (8,989 )     (11,331 )     16,245

Cumulative effect of accounting change, net of tax(8)

    —         —       (17,862 )     —         —  
   


 

 


 


 

Net income (loss)

  $ (11,311 )   $ 6,033   $ (26,851 )   $ (11,331 )   $ 16,245
   


 

 


 


 

Income (loss) per share—basic:

                                   

Before cumulative effect of accounting change

  $ (.67 )   $ .43   $ (.65 )   $ (.83 )   $ 1.22

Cumulative effect of accounting change, net of taxes

    —         —       (1.29 )     —         —  
   


 

 


 


 

Net income (loss) per share—basic

  $ (.67 )   $ .43   $ (1.94 )   $ (.83 )   $ 1.22
   


 

 


 


 

Income (loss) per share—diluted:

                                   

Before cumulative effect of accounting change

  $ (.67 )   $ .42   $ (.65 )   $ (.83 )   $ 1.12

Cumulative effect of accounting change, net of taxes

    —         —       (1.29 )     —         —  
   


 

 


 


 

Net income (loss) per share—diluted

  $ (.67 )   $ .42   $ (1.94 )   $ (.83 )   $ 1.12
   


 

 


 


 

Dividends per common share(9)

  $ .16     $ .16   $ .16     $ .16     $ .16

Weighted-average number of common shares outstanding:(10)

                                   

Basic

    16,942       14,040     13,809       13,617       13,333

Diluted

    16,942       14,418     13,809       13,617       17,568

Other Data:

                                   

Interest expense

  $ 8,903     $ 10,257   $ 10,352     $ 12,386     $ 11,146

Investment income

    388       227     124       352       575

Depreciation and amortization

    5,355       5,231     5,364       5,875       5,776

Capital expenditures

    7,086       5,434     6,125       5,727       7,883

Net Sales by Strategic Business Unit:(11)

                                   

RF & Wireless Communications Group (RFWC)

  $ 265,602     $ 231,389   $ 204,427     $ 181,969     $ 220,545

Industrial Power Group (IPG)

    122,906       112,737     95,508       95,018       112,889

Security Systems Division (SSD)

    105,581       101,979     92,090       85,087       82,352

Display Systems Group (DSG)

    78,078       66,452     64,191       60,697       59,476

Medical Glassware (MG)(12)

    —         —       —         12,940       15,966

Corporate(13)

    6,557       7,266     8,165       7,704       10,969
   


 

 


 


 

Consolidated

  $ 578,724     $ 519,823   $ 464,381     $ 443,415     $ 502,197
   


 

 


 


 

Balance Sheet Data:

                                   

Cash and cash equivalents

  $ 24,530     $ 16,927   $ 16,874     $ 15,296     $ 15,946

Working capital

    159,326       174,369     179,303       186,554       225,436

Property, plant and equipment, net

    31,821       30,589     31,088       28,827       28,753

Total assets

    287,818       282,945     267,408       286,653       321,557

Current maturities of long-term debt

    22,305       4,027     46       38       205

Long-term debt

    98,028       133,813     138,396       132,218       155,134

Stockholders’ equity

    104,048       88,167     78,821       102,955       112,795

 

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Table of Contents

(1) Fiscal Year—The Company’s fiscal year ends on the Saturday nearest the end of May. Each of the fiscal years presented contains 52/53 weeks. All references herein for the years 2005, 2004, 2003, 2002, and 2001 represent the fiscal years ended May 28, 2005, May 29, 2004, May 31, 2003, June 1, 2002, and June 2, 2001, respectively.
(2) In the third quarter of fiscal 2005, the Company recorded a $2.2 million restructuring charge to selling, general and administrative expenses as the Company terminated over 60 employees. In addition, the Company recorded incremental tax provisions of $13.1 million in fiscal 2005 to increase the valuation allowance related to its deferred tax assets in the United States ($12.3 million) and outside the United States ($0.8 million).
(3) The Company recorded incremental tax provisions of $2.5 million in fiscal 2004 to increase the valuation allowance related to its deferred tax assets outside the United States.
(4) In the fourth quarter of fiscal 2003, the Company recorded a $16.1 million charge ($10.3 million net of tax) principally related to inventory write-downs and restructuring charges, including a $1.7 million restructuring charge to selling, general and administrative expenses as the Company eliminated over 70 positions or approximately 6% of its workforce. In addition, the Company recorded incremental tax provisions of $1.6 million to establish a valuation allowance related to its deferred tax assets outside the United States.
(5) In the third quarter of fiscal 2002, the Company recorded a $4.6 million loss ($2.9 million net of tax) related to the disposition of its medical glassware business. In the fourth quarter of fiscal 2002, the Company recorded a $15.3 million charge ($9.8 million net of tax) primarily related to inventory obsolescence.
(6) The Company reclassified customer discounts from selling, general and administrative expenses to net sales for fiscal 2004, 2003, 2002, and 2001 to conform to the fiscal 2005 presentation.
(7) In the fourth quarter of fiscal 2005, the Company completed the sale of approximately 205 acres of undeveloped real estate adjoining its headquarter in LaFox, Illinois, resulting in a gain of $9.9 million before taxes.
(8) In the second quarter of fiscal 2003, the Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets” and as a result recorded a cumulative effect of accounting change of $17.9 million (net of tax of $3.7 million) to write off impaired goodwill. Additionally, effective at the beginning of fiscal 2003, the Company no longer amortizes goodwill. Income (loss) before income taxes included goodwill amortization of $577 in fiscal 2002 and $612 in fiscal 2001.
(9) The dividend per Class B common share was 90% of the dividend per common share.
(10) The weighted-average number of common shares outstanding includes 3,120, 3,168, 3,207, 3,207, and 3,220 Class B common shares for the fiscal years ended May 28, 2005, May 29, 2004, May 31, 2003, June 1, 2002, and June 2, 2001, respectively.
(11) Certain amounts in prior periods were reclassified to conform to the fiscal 2005 presentation.
(12) In the third quarter of fiscal 2002, the Company sold certain assets of its Medical Systems Group, specifically, inventory and other assets related to its medical glassware product line (MG). MG net sales of $390, $547, and $1,269 in fiscal 2005, 2004 and 2003, respectively, have been reclassified into Corporate.
(13) Includes freight billed to customers.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto.

 

Overview

 

For the second consecutive year, Richardson Electronics, Ltd. (the “Company”) achieved record sales with all four strategic business units growing sales for the third year in a row. Sales increased to $578.7 million in fiscal 2005 with strong demand for custom display and wireless products. Sales at all four of the Company’s geographic areas increased over fiscal 2004 with continued strength in Asia/Pacific where sales achieved double-digit growth for the seventh consecutive year.

 

In fiscal 2005, the Company recorded a net loss of $11.3 million, or $0.67 per diluted share, which included incremental tax provisions, gain on sale of land, restructuring and other charges. Incremental income tax provisions of $13.1 million were recorded in fiscal 2005 primarily to increase the valuation allowance related to the Company’s deferred tax assets. The Company sold approximately 205 acres of undeveloped real estate adjoining its headquarters in the fourth quarter of fiscal 2005, resulting in a realized gain of $9.9 million before taxes. In addition, the Company implemented restructuring actions at the end of the third quarter of fiscal 2005, which included changes in management and a reduction in workforce of over 60 employees, to accelerate the alignment of operations with the Company’s engineered solutions strategy and improve operating efficiency.

 

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Table of Contents

Restructuring charges of $2.2 million and incremental inventory write-down charges of $0.9 million were recorded in the fiscal year. The restructuring charges were recorded to selling, general and administrative expenses.

 

In December 2004, the Company acquired the assets of Evergreen Trading Company, a distributor of passive components in China. The aggregate acquisition price was $0.4 million, which was paid in cash. Evergreen Trading Company has been integrated into the Industrial Power Group (IPG). Evergreen Trading Company is similar to the Company in that they also emphasize engineered solutions by offering technical services and design assistance. This acquisition is intended to provide IPG with an infrastructure and a selling organization to more aggressively expand its business throughout China.

 

Also in December 2004, the Company formed a joint venture with Light Speed Labs, LP to support the Security System Division and Display Systems Group. The joint venture was organized as a limited liability company under the name VConex, LLC and is expected to develop distinctive and proprietary security and display solutions which will be exclusively marketed through the Company. This venture is expected to provide engineering resources and expertise to develop network video technology applications for large national accounts such as retail and hospitality chains for security and display solutions needs.

 

Description of Business

 

Richardson Electronics, Ltd. is a global provider of engineered solutions and a distributor of electronic components to the radio frequency (RF) and wireless communications, industrial power conversion, security, and display systems markets. Utilizing its core engineering and manufacturing capabilities, the Company is committed to a strategy of providing specialized technical expertise and value-added products, or “engineered solutions,” in response to customers’ needs. These solutions consist of products which the Company manufactures or modifies and products which are manufactured to its specifications by independent manufacturers under the Company’s own private labels. Additionally, the Company provides solutions and adds value through design-in support, systems integration, prototype design and manufacturing, testing, and logistics for its customers’ end products. Design-in support includes component modifications or the identification of lower-cost product alternatives or complementary products.

 

The Company’s products include RF and microwave components, power semiconductors, electron tubes, microwave generators, data display monitors, and electronic security products and systems. These products are used to control, switch or amplify electrical power or signals, or as display, recording, or alarm devices in a variety of industrial, communication, and security applications.

 

The Company’s marketing, sales, product management, and purchasing functions are organized as four strategic business units (SBUs): RF & Wireless Communications Group (RFWC), Industrial Power Group (IPG), Security Systems Division (SSD), and Display Systems Group (DSG), with operations in the major economic regions of the world: North America, Europe, Asia/Pacific, and Latin America.

 

16


Table of Contents

Results of Operations

 

Net Sales and Gross Margin Analysis

 

In fiscal 2005, consolidated net sales increased 11.3% to $578.7 million as all four SBUs increased net sales over the prior year with strong demand for custom display and wireless products. Consolidated net sales in fiscal 2004 increased 11.9% to $519.8 million due to increased demand across all SBUs. Net sales by SBU and percent of consolidated net sales are presented in the following table (in thousands):

 

     Fiscal Year Ended

 
     May 28,
2005


   May 29,
2004*


   May 31,
2003*


   FY05 vs FY04
% Change


    FY04 vs FY03
% Change


 

Net Sales

                                 

RFWC

   $ 265,602    $ 231,389    $ 204,427    14.8 %   13.2 %

IPG

     122,906      112,737      95,508    9.0 %   18.0 %

SSD

     105,581      101,979      92,090    3.5 %   10.7 %

DSG

     78,078      66,452      64,191    17.5 %   3.5 %

Other

     6,557      7,266      8,165    (9.8 )%   (11.0 )%
    

  

  

            

Total

   $ 578,724    $ 519,823    $ 464,381    11.3 %   11.9 %
    

  

  

            

* NOTE: The data has been reclassified to conform with the fiscal 2005 presentation. The modification includes reclassifying customer cash discounts from selling, general and administrative expenses to net sales. Other consists of freight, other non-specific sales and gross margins, and customer cash discounts.

 

Gross margin for each SBU and margin as a percent of each SBU’s net sales are shown in the following table. Gross margin reflects the distribution product margin less manufacturing variances, customer returns, scrap and cycle count adjustments, engineering costs, and other provisions. Gross margin on freight, inventory obsolescence provisions, and miscellaneous costs are included under the caption “Other” in fiscal 2004 and 2003. In fiscal 2005, the Company allocated charges related to inventory overstock directly to each SBU (in thousands):

 

     Fiscal Year Ended

 
     May 28, 2005

    May 29, 2004*

    May 31, 2003*

 

Gross Margin

                                          

RFWC

   $ 58,162     21.9 %   $ 52,340     22.6 %   $ 45,687     22.3 %

IPG

     37,005     30.1 %     34,694     30.8 %     29,523     30.9 %

SSD

     26,889     25.5 %     26,045     25.5 %     22,939     24.9 %

DSG

     17,865     22.9 %     17,105     25.7 %     16,218     25.3 %
    


       


       


     

Subtotal

     139,921     24.5 %     130,184     25.4 %     114,367     25.1 %

Other

     (3,014 )           (2,478 )           (15,413 )      
    


       


       


     

Total

   $ 136,907     23.7 %   $ 127,706     24.6 %   $ 98,954     21.3 %
    


       


       


     

* NOTE: The data has been reclassified to conform with the fiscal 2005 presentation. The modification includes reclassifying customer cash discounts from selling, general and administrative expenses to net sales. Other consists of freight, other non-specific sales and gross margins, and customer cash discounts.

 

In fiscal 2005, the Company implemented restructuring actions at the end of the third quarter, which included changes in management and a reduction in workforce of over 60 employees, in an effort to reduce its cost structure, accelerate the alignment of operations with the Company’s engineered solutions strategy, and improve operating efficiency. As a result of the restructuring actions, a restructuring charge of $2.2 million was recorded in selling, general and administrative expenses (SG&A) in the third quarter of fiscal 2005. During the fourth quarter of fiscal 2005, the employee severance and related costs were adjusted resulting in a $0.2 million

 

17


Table of Contents

decrease in SG&A due to the difference between estimated severance costs and actual payouts. Severance costs of $1.1 million were paid in fiscal 2005. The remaining balance payable in fiscal 2006 has been included in accrued liabilities. As of May 28, 2005, the following tables depict the amounts associated with the activity related to restructuring by reportable segment (in thousands):

 

     Restructuring
Liability
June 1, 2002


   Reserve
Recorded
Fiscal 2003


   Payments
Fiscal 2003


    Adjustment
to Reserve
Fiscal 2003


    Restructuring
Liability
May 31, 2003


Fiscal 2003

                                    

Employee severance and related costs:

                                    

RFWC

   $ —      $ 468    $ (125 )   $ —       $ 343

IPG

     —        86      (5 )     —         81

SSD

     —        161      (40 )     —         121

DSG

     —        62      (24 )     —         38

Corporate

     250      833      (474 )     —         609
    

  

  


 


 

Total

     250      1,610      (668 )     —         1,192

Lease termination costs:

                                    

SSD

     —        210      —         —         210
    

  

  


 


 

Total

   $ 250    $ 1,820    $ (668 )   $ —       $ 1,402
    

  

  


 


 

     Restructuring
Liability
May 31, 2003


   Reserve
Recorded
Fiscal 2004


   Payments
Fiscal 2004


    Adjustment
to Reserve
Fiscal 2004


    Restructuring
Liability
May 29, 2004


Fiscal 2004

                                    

Employee severance and related costs:

                                    

RFWC

   $ 343    $ 289    $ (632 )   $ —       $ —  

IPG

     81      —        (81 )     —         —  

SSD

     121      —        (121 )     —         —  

DSG

     38      —        (38 )     —         —  

Corporate

     609      —        (321 )     (288 )     —  
    

  

  


 


 

Total

     1,192      289      (1,193 )     (288 )     —  

Lease termination costs:

                                    

SSD

     210      —        —         (210 )     —  
    

  

  


 


 

Total

   $ 1,402    $ 289    $ (1,193 )   $ (498 )   $ —  
    

  

  


 


 

     Restructuring
Liability
May 29, 2004


   Reserve
Recorded
Fiscal 2005


   Payments
Fiscal 2005


    Adjustment
to Reserve
Fiscal 2005


    Restructuring
Liability
May 28, 2005


Fiscal 2005

                                    

Employee severance and related costs:

                                    

RFWC

   $ —      $ 909    $ (392 )   $ (199 )   $ 318

IPG

     —        325      (142 )     —         183

SSD

     —        99      (90 )     16       25

DSG

     —        416      (186 )     —         230

Corporate

     —        368      (298 )     —         70
    

  

  


 


 

Total

     —        2,117      (1,108 )     (183 )     826

Lease termination costs:

                                    

SSD

     —        35      —         —         35
    

  

  


 


 

Total

   $ —      $ 2,152    $ (1,108 )   $ (183 )   $ 861
    

  

  


 


 

 

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In addition to the restructuring charge, the Company recorded inventory write-down charges of $0.9 million in fiscal 2005. In fiscal 2003, the Company recorded a provision of $13.8 million primarily for inventory obsolescence, overstock, and shrink to write down inventory to net realizable value as the Company aligned its inventory and cost structure to current sales levels amid continued economic slowdown and limited visibility.

 

Net sales and gross margin trends are analyzed for each strategic business unit in the following sections.

 

RF & Wireless Communications Group

 

RF & Wireless Communications Group net sales increased 14.8% in fiscal 2005 to $265.6 million. The sales growth was driven by continued strength in the network access and passive/interconnect product lines as net sales grew 22.1% and 18.0% to $105.3 million and $53.3 million, respectively. Net sales in Asia/Pacific increased 22.9% to $94.2 million in fiscal 2005. In fiscal 2004, RFWC net sales increased 13.2% to $231.4 million due to stronger demand for network access and passive/interconnect products, partially offset by weaker demand in some specialty and broadcast products. The network access and passive/interconnect product line posted net sales growth of 25.7% and 29.1% to $86.4 million and $45.2 million, respectively, in fiscal 2004. RFWC Canadian net sales increased 51.2% to $11.0 million and its Asia/Pacific net sales increased 37.1% to $76.8 million in fiscal 2004.

 

Gross margins in fiscal 2005 decreased 70 basis points primarily due to inventory write-downs of $1.3 million recorded in the third quarter of fiscal 2005 when the Company implemented restructuring actions. In fiscal 2004, gross margins were up 30 basis points, led by the sales growth of higher margin network access and passive/interconnect product lines. Network access and passive/interconnect product lines gross margins were 24.1% and 25.7% in fiscal 2004 and 24.9% and 27.1% in fiscal 2003, respectively. Gross margins in Canada and Asia/Pacific increased 45.6% and 31.7% in fiscal 2004, respectively.

 

Industrial Power Group

 

Industrial Power Group net sales in fiscal 2005 grew 9.0% to $122.9 million as power component net sales increased 17.3% to $40.7 million. Tube net sales grew 4.3% in fiscal 2005 to $80.8 million. In fiscal 2004, net sales increased 18.0% to $112.7 million led by strong, broad-based demand. IPG tube net sales in fiscal 2004 increased 14.8% to $77.4 million and power component net sales increased 25.7% to $34.7 million.

 

Gross margins in fiscal 2005 decreased 70 basis points to 30.1% primarily due to additional freight expenses of $0.5 million and sales growth of lower margin power component products, which had gross margins of 26.1% in fiscal 2005. Gross margins were relatively flat at 30.8% and 30.9% in fiscal 2004 and 2003, respectively.

 

Security Systems Division

 

Net sales for the Security Systems Division increased 3.5% in fiscal 2005 to $105.6 million driven by stronger demand in Canada, partially offset by weaker demand in the U.S. and Europe. Net sales in Canada grew 12.9% to $58.5 million with net sales in the U.S. and Europe declining 8.7% and 4.4% to $27.9 million and $14.2 million, respectively, in fiscal 2005. Net sales in fiscal 2004 exceeded $100 million for the first time, up 10.7% from fiscal 2003 to $102.0 million with strong growth in Canada and renewed growth in the U.S. principally due to an increase in digital video recorder sales. SSD net sales increased 10.5% in the U.S. to $30.6 million and 14.2% in Canada to $51.8 million, respectively, in fiscal 2004.

 

Gross margins were 25.5% in both fiscal 2005 and 2004. Inventory write-downs of $0.3 million recorded in the third quarter of fiscal 2005 when the Company implemented restructuring actions and additional freight expenses of $1.0 million were partially offset by increased sales growth of higher margin private label sales. In fiscal 2004, gross margins were up 60 basis points as higher margin digital technology products represented a larger percentage of net sales.

 

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Display Systems Group

 

Display Systems Group net sales in fiscal 2005 grew 17.5% to $78.1 million as large orders drove custom display net sales to increase by 63.7% to $22.0 million. DSG net sales increased 3.5% in fiscal 2004 to $66.5 million as medical monitor net sales increased 14.7% to $26.8 million, reflecting the continued shift from a film-based environment to digital systems. Due to the timing of large project based business, custom display sales declined 18.3% in fiscal 2004 to $13.5 million.

 

Gross margins in fiscal 2005 decreased 280 basis points primarily due to declining average selling prices for medical monitors. In fiscal 2004, gross margins increased 40 basis points as monitors and specialty displays expanded margins, partially offset by slightly lower margins in custom displays and cathode ray tubes.

 

Sales by Geographic Area

 

The Company has grown through a balanced emphasis on investment in both North America and other areas of the world and currently has 34 facilities in North America, 20 in Europe, 16 in Asia/Pacific, and 5 in Latin America. On a geographic basis, the Company primarily categorizes its sales by destination: North America, Europe, Asia/Pacific, Latin America, and Corporate. Net sales and gross margin, as a percent of net sales, by geographic area are as follows (in thousands):

 

     Fiscal Year Ended

 
     May 28,
2005


   May 29,
2004*


   May 31,
2003*


  

FY05 vs FY04

% Change


   

FY04 vs FY03

% Change


 

Net Sales

                                 

North America

   $ 303,708    $ 275,491    $ 259,606    10.2 %   6.1 %

Europe

     123,846      116,714      103,029    6.1 %   13.3 %

Asia/Pacific

     124,799      104,068      78,146    19.9 %   33.2 %

Latin America

     21,366      20,065      20,521    6.5 %   (2.2 )%

Corporate

     5,005      3,485      3,079    43.6 %   13.2 %
    

  

  

            

Total

   $ 578,724    $ 519,823    $ 464,381    11.3 %   11.9 %
    

  

  

            

 

     May 28, 2005

    May 29, 2004*

    May 31, 2003*

 

Gross Margin

                        

North America

   $ 80,262     26.4 %   $ 71,763     26.0 %   $ 67,829     26.1 %

Europe

     35,258     28.5 %     33,603     28.8 %     28,287     27.5 %

Asia/Pacific

     29,691     23.8 %     23,304     22.4 %     17,895     22.9 %

Latin America

     5,879     27.5 %     4,860     24.2 %     5,272     25.7 %
    


       


       


     

Subtotal

     151,090     26.3 %     133,530     25.9 %     119,283     25.9 %

Corporate

     (14,183 )           (5,824 )           (20,329 )      
    


       


       


     

Total

   $ 136,907     23.7 %   $ 127,706     24.6 %   $ 98,954     21.3 %
    


       


       


     

* NOTE: The data has been reclassified to conform to the fiscal 2005 presentation. The modification includes reclassifying customer cash discounts. Europe includes sales and gross margins to Middle East and Africa. Corporate consists of freight and other non-specific sales and gross margins.

 

Net sales in North America increased 10.2% to $303.7 million in fiscal 2005 led by strong display systems and wireless demand in the U.S. and continued growth in security systems sales in Canada. In fiscal 2004, net sales in North America increased 6.1% to $275.5 million, primarily from Canada’s sales growth of 18.6% to $69.7 million, which was led by improved wireless demand and continued strength in the security systems market. The U.S. had limited sales growth in fiscal 2004 due to completion of a large wireless infrastructure project in the prior year and a trend of customers moving manufacturing to Asia. Gross margins in North

 

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America improved 40 basis points in fiscal 2005 due to expanding margins in Canada for security systems and wireless sales. In fiscal 2004, gross margins remained relatively flat compared to fiscal 2003.

 

Net sales in Europe increased 6.1% to $123.8 million in fiscal 2005 driven by continued wireless demand growth, particularly in the United Kingdom, France, and Israel. In fiscal 2004, net sales in Europe increased 13.3% to $116.7 million as all countries posted increases in sales, partially due to the weakening U.S. dollar. Italy and Israel led the sales growth in fiscal 2004 with strong wireless demand, specifically network access gains in Italy and infrastructure growth in Israel. Gross margins in Europe decreased 30 basis points in fiscal 2005 due to a decline in high margin cathode ray tube sales in DSG. In fiscal 2004, gross margins improved 130 basis points from 27.5% to 28.8%.

 

The Company experienced its seventh consecutive year of double-digit growth in Asia/Pacific as net sales grew 19.9% to $124.8 million led by China’s on-going demand growth. Net sales in China increased 60% in fiscal 2005 to $40.4 million. In fiscal 2004, net sales in Asia/Pacific advanced 33.2% in fiscal 2004 following a 13.6% increase in fiscal 2003. Net sales in China continued to grow rapidly, increasing 83.3% to $25.3 million in fiscal 2004 with RFWC net sales more than doubling from the prior year to $21.0 million, as a result of strong infrastructure, network access, and passive/interconnect demand. In fiscal 2005, The Company’s gross margins in Asia/Pacific improved 140 basis points due to expanding margins for wireless sales, particularly in Korea, partially offset by the large sales growth in China at lower margins. Fiscal 2004 gross margins in Asia/Pacific declined slightly from 22.9% to 22.4%.

 

Net sales in Latin America grew 6.5% in fiscal 2005 to $21.4 million as all four strategic business units increased sales. In fiscal 2004, net sales in Latin America declined 2.2% to $20.1 million as decreased broadcast demand in Colombia and Mexico was partially offset by increased industrial power demand in Brazil and Colombia. Gross margins in Latin America improved 330 basis points in fiscal 2005 as margins recovered for security systems and industrial power sales.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased 18.9% in fiscal 2005 to $128.7 million from $108.3 million in fiscal 2004. The Company implemented restructuring actions at the end of the third quarter of fiscal 2005, which included changes in management and a reduction in workforce, to accelerate the alignment of operations with the Company’s engineered solutions strategy and improve operating efficiency. Increases in expenses included $2.2 million of restructuring costs, $8.5 million of payroll-related expenses, $2.4 million of audit, tax and, Sarbanes-Oxley compliance fees, and incremental expenses related to bad debt, facility costs, and travel. The increase in payroll-related expenses, facility costs, and travel were mainly attributable to supporting the growth in sales.

 

Selling, general and administrative expenses increased $7.7 million in fiscal 2004 to $108.3 million. Payroll-related expenses increased $4.6 million due primarily to increased sales and additional headcount required to support the sales growth. For fiscal 2004, total selling, general and administrative expenses decreased to 20.8% of sales compared to 21.7% in fiscal 2003.

 

(Gain) Loss on Disposal of Assets

 

On May 26, 2005, the Company completed the sale of approximately 205 acres of undeveloped real estate adjoining its headquarters in LaFox, Illinois. The sale resulted in a gain of $9.9 million, before taxes, and was recorded in gain on disposal of assets in the Consolidated Statements of Operations in fiscal 2005.

 

Other Income and Expense

 

Interest expense decreased to $8.9 million in fiscal 2005 as a result of payments made to reduce debt from the proceeds received from an equity offering made in the first quarter of fiscal 2005 and elimination of a fixed

 

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rate swap, offset by interest on incremental borrowings to fund working capital requirements. Interest expense decreased slightly in fiscal 2004 to $10.3 million, partially due to lower interest on revolving credit agreement and bank loans. The weighted average interest rate was 6.38%, 5.98%, and 6.09% for fiscal 2005, 2004, and 2003, respectively.

 

Other, net expenses included a foreign exchange gain of $910 and investment income of $388 in fiscal 2005 compared to a foreign exchange loss of $363 and investment income of $227 in fiscal 2004.

 

Income Tax Provision

 

At May 28, 2005, domestic net operating loss carryforwards (NOL) amount to approximately $19.9 million. These NOLs expire between 2023 and 2025. Foreign net operating loss carryforwards total approximately $18.4 million with various or indefinite expiration dates. In fiscal 2005, the Company recorded an additional valuation allowance of approximately $0.8 million relating to deferred tax assets and net operating loss carryforwards relating to certain foreign subsidiaries. Also, due to changes in the level of certainty regarding realization, a valuation allowance of approximately $12.3 million was established in fiscal 2005 to offset certain domestic deferred tax assets and domestic net operating loss carryforwards. The Company also has an alternative minimum tax credit carryforward at May 28, 2005, in the amount of $1.2 million that has an indefinite carryforward period.

 

Income taxes paid, including foreign estimated tax payments, were $3.3 million, $1.7 million, and $2.7 million in fiscal 2005, 2004, and 2003, respectively.

 

At the end of fiscal 2004, all of the cumulative positive earnings of the Company’s foreign subsidiaries, amounting to $35.1 million, were considered permanently reinvested pursuant to APB No. 23, Accounting for Income Taxes-Special Areas. As such, U.S. taxes were not provided on these amounts. In fiscal 2005, the Company determined that approximately $12.9 million of its foreign subsidiaries’ earnings may be distributed in future years. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income tax and foreign withholding taxes. As such, the Company has established a deferred tax liability of approximately $4.9 million. The remaining cumulative positive earnings of the Company’s foreign subsidiaries were still considered permanently reinvested pursuant to APB No. 23 and amounted to $29.1 million.

 

The effective income tax rates for the fiscal years ended May 28, 2005 and May 29, 2004 were 36.7% and 29.6%, respectively, excluding the establishment of the domestic valuation allowance and deferred tax liabilities in fiscal 2005. Difference between the effective tax rate as compared to the U.S. federal statutory rate of 34% primarily results from the Company’s geographical distribution of taxable income and losses, certain non-tax deductible charges, and the Company’s extraterritorial income exclusion on export sales, net of state income taxes.

 

On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the Act). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase out ending December 31, 2006 of the existing extraterritorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with the international trade protocols by the European Union. The tax benefit from the current ETI exclusion was $166 and $491 for fiscal 2005 and 2004. When this benefit is fully phased out, it will have a negative impact on the rate because the new deduction for qualified domestic activity will be of minimal benefit to the Company.

 

Another provision of the Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends-received deduction for certain dividends from controlled foreign corporations. The calculation of the deduction is subject to a number of limitations. This provision of the Act has no material impact on the operations of the Company for fiscal year 2005 and is expected to have no material impact on the operations of the Company for fiscal year 2006, as the Company does not intend at this time to repatriate earnings to the U.S. from foreign countries.

 

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Table of Contents

Future effective tax rates could be adversely affected by lower than anticipated earnings in countries where the Company has lower statutory rates, changes in the valuation of certain deferred tax assets or liabilities, or changes in tax laws or interpretations thereof. In addition, the Company is subject to the examination of its income tax returns by U.S. and foreign tax authorities and regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of the provision for income taxes.

 

Net Income and Per Share Data

 

In fiscal 2005, the Company reported a net loss of $11.3 million, or $0.67 per diluted share, compared to net income of $6.0 million, or $0.42 per diluted share, in fiscal 2004. In fiscal 2003, the Company reported a net loss of $26.9 million, or $1.94 per diluted share.

 

Liquidity and Capital Resources

 

The Company has financed its growth and cash needs largely through income from operations, borrowings under the revolving credit facilities, an equity offering, issuance of convertible senior subordinated notes, and sale of assets. Liquidity provided by operating activities is reduced by working capital requirements, debt service, capital expenditures, dividends, and business acquisitions. Liquidity is increased by proceeds from borrowings and dispositions of businesses and assets.

 

Cash and cash equivalents was $24.5 million at May 28, 2005. During fiscal 2005, the Company utilized $2.0 million of cash in operating activities. The fiscal 2005 cash utilization was mainly due to the increase in inventories related to the Company’s stocking levels required for new exclusive supplier agreements. Cash and cash equivalents was $16.9 million at May 29, 2004. During fiscal 2004, the Company generated $12.6 million of cash from operating activities. Working capital utilized $0.4 million in fiscal 2004 as receivables rose due to increased sales, partially offset by increased accounts payable.

 

Inventory days were approximately 81 days at the end of fiscal 2005, compared with 77 days at the end of fiscal 2004, primarily due to initial stocking packages required for new exclusive supplier agreements in fiscal 2005. Inventory management remains an area of focus as the Company seeks to balance the need to maintain strategic inventory levels to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology and customer requirements.

 

The Company provides engineered solutions, including prototype design and assembly, in niche markets. Additionally, the Company specializes in certain products representing trailing-edge technology that may not be available from other sources, and may not be currently manufactured. In many cases, the Company’s products are components of production equipment for which immediate availability is critical to the customer. Accordingly, the Company enjoys higher gross margins, but has larger investments in inventory than those of a commodity electronics distributor.

 

Days sales outstanding were approximately 59 days at the end of fiscal 2005 as compared to approximately 52 days at the end of fiscal 2004. Days payable were approximately 28 days at the end of fiscal 2005, compared to 26 days at the end of fiscal 2004.

 

Net cash provided by financing activities was $6.3 million in fiscal 2005. During the first quarter, the Company had an equity offering for three million shares of common stock that contributed $27.8 million in net proceeds that was used to reduce debt by $17.5 million and to fund working capital requirements.

 

In October 2004, the Company renewed its multi-currency revolving credit agreement with the current lending group in the amount of $109.0 million. The agreement matures in October 2009, when the outstanding balance at that time will become due. At May 28, 2005, $53.3 million was outstanding on the agreement. The new agreement is principally secured by the Company’s trade receivables and inventory. The agreement bears

 

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interest at applicable LIBOR rates plus a margin, varying with certain financial performance criteria. At May 28, 2005, the applicable margin was 175 basis points. Outstanding letters of credit were $1.4 million at May 28, 2005, leaving an unused line of $54.3 million under the total agreement; however, this amount was reduced to $2.6 million due to maximum permitted leverage ratios. The commitment fee related to the agreement is 0.25% per annum payable quarterly on the average daily unused portion of the aggregate commitment.

 

At May 28, 2005, the Company was not in compliance with its credit agreement covenants with respect to the fixed charge coverage ratio. On August 24, 2005, the Company received a waiver from its lending group for the default and executed an amendment to the credit agreement. The amendment changed the maximum permitted leverage ratios and the minimum required fixed charge coverage ratios for each of the first three quarters of fiscal 2006 to provide the Company additional flexibility for these periods. The Company’s earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined in the credit agreement, was reduced in the second half of fiscal 2005 by restructuring charges, incremental inventory write-down charges, and additional SG&A spending due to higher costs related to audit, tax, and Sarbanes-Oxley compliance fees, as compared to previous quarters in fiscal 2005. As the Company continues to align operations with its engineered solutions strategy and improve operating efficiency in fiscal 2006, EBITDA may be impacted by additional costs associated with these initiatives. The Company anticipates that the amended credit agreement covenants will allow the Company flexibility to continue these initiatives while remaining in compliance with the credit agreement covenants. In addition, the amendment also provides that the Company will maintain excess availability on the borrowing base of not less than $23 million until June 30, 2006 if a default or event of default does not exist on or before this date. The applicable margin pricing has been increased by 25 basis points. In addition, the amendment extended the Company’s requirement to refinance the remaining $22.3 million aggregate principal amount of the 7 1/4% convertible subordinated debentures and the 8 1/4% convertible senior subordinated debentures from February 28, 2006 to June 10, 2006.

 

In February 2005, the Company issued $44.7 million of 7 3/4% convertible senior subordinated notes due 2011 in exchange for $22.2 million of its 7 1/4% convertible subordinated debentures due December 2006 and $22.5 million of its 8 1/4% convertible senior subordinated debentures due June 2006. The new notes are convertible at the holder’s option, at any time on or prior to maturity, into shares of the Company’s common stock at a price equal to $18.00 per share, subject to adjustments in certain circumstances. On or after December 19, 2006, the Company may elect to automatically convert the new notes into shares of common stock if the trading prices of the common stock exceeds 125% of the conversion price of the new notes for at least twenty trading days during any thirty trading day period ending within five trading days prior to the date of the automatic conversion notice. Subsequent to the exchange, the Company had outstanding $4.8 million of 7 1/4% convertible subordinated debentures due December 2006, $17.5 million of 8¼% convertible senior subordinated debentures due June 2006, and $44.7 million of 7 3/4% convertible senior subordinated notes due December 2011. The amended credit agreement, however, requires the Company to refinance the remaining $22.3 million aggregate principal amount of the 8 1/4% convertible senior subordinated debentures and the 7 1/4% convertible subordinated debentures by June 10, 2006.

 

Annual dividend payments for fiscal 2005 amounted to $2.7 million. The Company’s policy regarding payment of dividends is reviewed periodically by the Board of Directors in light of the Company’s operating needs and capital structure. Over the last 18 years, the Company has been in a position to regularly pay a quarterly dividend of $0.04 per common share and $0.036 per Class B common share. The Company currently expects this trend to continue in fiscal 2006.

 

The Company spent approximately $7.1 million on capital projects during fiscal 2005, primarily related to implementing PeopleSoft purchasing and inventory modules, facility improvements at the Corporate headquarters, disaster recovery equipment, and Sarbanes-Oxley remediation software and hardware. The Company spent approximately $5.4 million on capital projects in fiscal 2004. The fiscal 2004 amount primarily related to capitalized PeopleSoft development costs, system hardware and disaster recovery, storage area network, and software.

 

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In May 2005, the Company completed the sale of approximately 205 acres of undeveloped real estate adjoining its headquarters in LaFox, Illinois for $10.9 million, which was used to reduce debt.

 

The Company had interest rate exchange agreements to convert approximately $36.4 million of floating rate debt to an average fixed rate of 8.7%, which expired in July 2004. Additional interest expense recorded in the Consolidated Statement of Operations related to these agreements was $102, $1,265, and $789 in fiscal 2005, 2004, and 2003, respectively.

 

See Item 7A for “Risk Management and Market Sensitive Financial Instruments” for information regarding the effect on net income of market changes in interest rates.

 

Contractual Obligations and Commitments

 

Certain contractual obligations and other commercial commitments by expiration period are presented in the table below (in thousands):

 

     Payments Due by Period

     Total

   Less than
1 year


   1 – 3
years


   3 – 5
years


   More than
5 years


Convertible debentures/notes(1)(2)

   $ 66,974    $ 22,291    $ —      $ —      $ 44,683

Convertible debentures/notes—interest(1)(2)

     24,911      5,254      10,711      8,946      —  

Floating-rate multi-currency revolving credit agreement(3)

     53,314      —        —        53,314      —  

Floating-rate multi-currency revolving credit agreement—interest(3)

     10,737      2,431      7,293      1,013      —  

Lease obligations(4)

     10,538      5,092      5,037      409      —  

Performance bonds(5)

     492      —        492      —        —  

Other

     45      14      28      3      —  
    

  

  

  

  

Total

   $ 167,011    $ 35,082    $ 23,561    $ 63,685    $ 44,683
    

  

  

  

  


(1) Convertible debentures consist of the 8 1/4% debentures, with principal of $17.5 million due June 2006, and the 7 1/4% debentures, with principal of $4.8 million due December 2006, both of which are required by the Company’s amended credit agreement to be refinanced by June 2006.
(2) Convertible notes consist of the 7 3/4% notes, with principal of $44.7 million due December 2011.
(3) The floating rate multi-currency revolving credit facility matures in October 2009 and bears interest at applicable LIBOR rates plus a 175 basis point margin. Interest in the table above is calculated using 4.56% interest rate and $53,314 principal amount as of May 28, 2005 for all periods presented.
(4) Lease obligations are related to certain warehouse and office facilities and office equipment under non-cancelable operating leases.
(5) Certain French customers require a performance bond with an expiration date of August 2006, renewable annually.

 

The Company believes that the existing sources of liquidity, including current cash, as well as cash provided by operating activities, supplemented as necessary with funds available under credit arrangements, will provide sufficient resources to meet known capital requirements and working capital needs for the fiscal year ended June 3, 2006. However, the Company will need to raise additional capital through debt or equity financings, asset sales, or other sources to refinance the remaining $22.3 million aggregate principal amount of the 8 1/4% and the 7 1/4% convertible debentures by June 2006, as required by the amended credit agreement.

 

Critical Accounting Policies and Estimates

 

The Company’s consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses

 

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and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to allowances for doubtful accounts, inventories, intangible assets, income taxes, and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

The policies discussed below are considered by management to be critical to understanding the Company’s financial position and results of operations. Their application involves more significant judgments and estimates in preparation of the Company’s consolidated financial statements. For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.

 

Allowance for Doubtful Accounts

 

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The estimates are influenced by the following considerations: continuing credit evaluation of customers’ financial conditions; aging of receivables, individually and in the aggregate; large number of customers which are widely dispersed across geographic areas; collectability and delinquency history by geographic area; and the fact that no single customer accounts for 10% or more of net sales. Material changes in one or more of these considerations may require adjustments to the allowance affecting net income and net carrying value of accounts receivable. At May 28, 2005, the balance in the account was $1.9 million as compared to $2.5 million at May 29, 2004.

 

Impairment of Investments

 

The Company holds a portfolio of investment securities and periodically assesses its recoverability. In the event of a decline in fair value of an investment, the judgment is made whether the decline is other-than-temporary. Management’s assessment as to the nature of a decline is largely based on the duration of that market decline, financial health of and specific prospects for the issuer, and the Company’s cash requirements and intent to hold the investment. If an investment is impaired and the decline in market value is considered to be other-than-temporary, an appropriate write-down is recorded. The Company recognized investment impairment in fiscal 2005, 2004, and 2003 of $49, $226, and $72, respectively.

 

Inventories

 

In fiscal 2003, the Company carried its inventories at the lower of cost or market using the last-in, first-out (LIFO) method. Effective in fiscal 2004, the North American operations, which represent a majority of its operations and approximately 78% of its inventories, changed from the LIFO method to the first-in, first-out (FIFO) method. All other inventories were consistently stated at the lower of cost or market using the FIFO method. The Company believes the FIFO method is preferable in these circumstances because it provides a better matching of revenue and expenses in the Company’s business environment. The accounting change was not material to the financial statements for any of the periods, and accordingly, no retroactive restatement of prior years’ financial statements was made.

 

Provisions for obsolete or slow moving inventories are recorded based upon regular analysis of stock rotation, obsolescence, and assumptions about future demand and market conditions. If future demands, change in the industry, or market conditions differ from management’s estimates, additional provisions may be necessary.

 

The Company recorded inventory obsolescence and overstock provisions of $3.9 million, $2.0 million, and $13.8 million in fiscal 2005, 2004, and 2003, respectively, which was included in the cost of products sold. The provisions were principally for obsolete and slow moving parts. The parts were written down to estimated realizable value.

 

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Beginning in fiscal 2004, the Company implemented new policies and procedures to strengthen its inventory management process while continuing to invest in system technology to further enhance its inventory management tools. These policy and procedure changes included increased approval authorization levels for inventory purchases, quarterly quantitative and qualitative inventory aging analysis and review, changes in the budgeting process to establish targets and metrics that relate to its return on assets rather than only a revenue and profit expectation, and realignment of incentive programs in accordance with these targets and metrics. The Company is committed to inventory management as an ongoing process as the business evolves and technology changes.

 

Long-Lived and Intangible Assets

 

The Company periodically evaluates the recoverability of the carrying amounts of its long-lived assets, including software, property, plant and equipment. The Company assesses in accordance with Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the possibility of long-lived assets being impaired when events trigger the likelihood.

 

Impairment is assessed when the undiscounted expected cash flows derived from an asset are less than its carrying amount. If impairment exists, the carrying value of the impaired asset is written down and impairment loss is recorded in operating results. In assessing the potential impairment of the Company’s goodwill and other intangible assets, management makes significant estimates and assumptions regarding the discounted future cash flows to determine the fair value of the respective assets on an annual basis. These estimates and their related assumptions include, but are not limited to, projected future operating results, industry and economy trends, market discount rates, indirect expense allocations, and tax rates. If these estimates or assumptions change in the future as a result of changes in strategy, Company profitability, or market conditions, among other factors, this could adversely affect future goodwill and other intangible assets valuations and result in additional impairment charges.

 

Effective June 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. This statement changed the accounting for goodwill and indefinite-lived assets from an amortization approach to an impairment-only approach. As a result of the adoption of SFAS No. 142, the Company recorded a transitional impairment charge during the first quarter of fiscal 2003 of $21.6 million ($17.9 million net of tax), presented as a cumulative effect of accounting change. The Company performed its impairment test during the fourth quarter of each fiscal year. The Company did not find any indication that additional impairment existed and, therefore, no additional impairment loss was recorded in fiscal 2005.

 

Warranties

 

The Company offers warranties for specific products it manufactures. The Company also provides extended warranties for some products it sells that lengthen the period of coverage specified in the manufacturer’s original warranty. Terms generally range from one to three years.

 

The Company estimates the cost to perform under its warranty obligation and recognizes this estimated cost at the time of the related product sale. The Company reports this expense as an element of cost of products sold in its Consolidated Statement of Operations. Each quarter, the Company assesses actual warranty costs incurred, on a product-by-product basis, as compared to its estimated obligation. The estimates with respect to new products are based generally on knowledge of the manufacturers’ experience and are extrapolated to reflect the extended warranty period, and are refined each quarter as better information with respect to warranty experience becomes known.

 

Warranty reserves are established for costs that are expected to be incurred after the sale and delivery of products under warranty. The warranty reserves are determined based on known product failures, historical experience, and other currently available evidence.

 

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Income Taxes

 

The Company recognizes deferred tax assets and liabilities based on the differences between financial statement carrying amounts and the tax bases of assets and liabilities. The Company regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences, and the implementation of tax planning strategies. If the Company is unable to generate sufficient future taxable income in certain tax jurisdictions, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, the Company could be required to increase its valuation allowance against its deferred tax assets resulting in an increase in its effective tax rate and an adverse impact on operating results.

 

At May 28, 2005 and May 29, 2004, the Company’s deferred tax assets related to tax carryforwards were $14.2 million and $14.9 million, respectively. The tax carryforwards are comprised of net operating loss carryforwards and other tax credit carryovers. A majority of the net operating losses and other tax credits can be carried forward for 20 years.

 

The Company has recorded valuation allowances for the majority of its federal deferred tax assets, loss carryforwards, and tax loss carryforwards of certain non-U.S. subsidiaries. The Company believes that the deferred tax assets for the remaining tax carryforwards are considered more likely than not to be realizable based on estimates of future taxable income and the implementation of tax planning strategies.

 

New Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (FASB) revised SFAS No. 123, Accounting for Stock-Based Compensation. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) is effective at the beginning of the next fiscal year that begins after June 15, 2005, or the Company’s fiscal year 2007. The Company is evaluating the impact of the adoption of SFAS No. 123(R) on the financial statements.

 

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

 

Except for the historical information contained herein, the matters discussed in this Annual Report on Form 10-K are forward-looking statements relating to future events, which involve certain risks and uncertainties. Further, there can be no assurance that the trends reflected in historical information will continue in the future.

 

Investors should consider carefully the following risk factors, in addition to the other information included and incorporated by reference in this annual report on Form 10-K. All statements other than statements of historical facts included in this report are statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934. The words “expect,” “estimate,” “anticipate,” “predict,” “believe,” and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this report and

 

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include statements regarding the intent, belief or current expectations of the Company, its directors, or its officers with respect to, among other things: (i) trends affecting the Company’s financial condition or results of operations; (ii) the Company’s financing plans; (iii) the Company’s business and growth strategies, including potential acquisitions; and (iv) other plans and objectives for future operations. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and actual results may differ materially from those predicted in the forward-looking statements or which may be anticipated from historical results or trends.

 

In addition to the information contained in the Company’s other filings with the Securities and Exchange Commission, factors that could affect future performance include, among others, the following:

 

The Company has had significant operating and net losses in the past and may have future losses.

 

The Company reported net losses of approximately $11.3 million in fiscal 2002, $26.9 million in fiscal 2003, and $11.3 million in fiscal 2005 and cannot ensure that it will not experience operating losses and net losses in the future. The Company may continue to lose money if its sales do not continue to increase or its expenses are not reduced. The Company cannot predict the extent to which sales will continue to increase across its businesses or how quickly its customers will consume their inventories of the Company’s products.

 

The Company maintains a significant investment in inventory and has incurred significant charges for inventory obsolescence and overstock, and may incur similar charges in the future.

 

The Company maintains significant inventories in an effort to ensure that customers have a reliable source of supply. The market for many of its products is characterized by rapid change as a result of the development of new technologies, particularly in the semiconductor markets served by the Company’s RF and Wireless Communications Group, evolving industry standards, and frequent new product introductions by some of its customers. The Company does not have many long-term supply contracts with its customers. Generally, the Company’s product sales are made on a purchase-order basis, which permits its customers to reduce or discontinue their purchases. If the Company fails to anticipate the changing needs of its customers and accurately forecast their requirements, its customers may not continue to place orders with them and the Company may accumulate significant inventories of products which it will be unable to sell or return to its vendors, or which may decline in value substantially.

 

In fiscal 2002, the Company recorded a pre-tax provision for inventory obsolescence and overstock of $15.3 million, or $9.8 million net of tax, due to an industry-wide decline in sales, a prolonged recovery period, and changes in its mix of business toward higher technology products, particularly in the telecommunications market. In fiscal 2003, the Company recorded an additional pre-tax provision of $13.8 million, or $8.8 million net of tax, primarily for inventory obsolescence, overstock, and shrinkage, to write-down inventory to net realizable value as it sought to align its inventory and cost structure to then current sales levels amid continued economic slowdown and limited visibility. While the Company did not incur any material provisions for inventory in fiscal 2004, incremental inventory write-down charges of $0.9 million were recorded during fiscal 2005 when the Company implemented restructuring actions and certain product lines were discontinued. The Company cannot ensure that similar charges will not be incurred in the future.

 

If the Company does not maintain effective internal controls over financial reporting, it could be unable to provide timely and reliable financial information.

 

As disclosed in the Company’s Management’s Report on Internal Control over Financial Reporting in Part II, Item 9A, “Controls and Procedures” of this Form 10-K, the Company had discovered deficiencies, including material weaknesses, in its internal control over financial reporting. While the Company is taking immediate steps to correct its internal control weaknesses, the material weaknesses that have been discovered will not be considered remediated until the new and improved internal controls for a period of time, are tested and it is

 

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concluded that such new and improved internal controls are operating effectively. Pending the successful completion of such testing, the Company will perform mitigating procedures relating to its internal control weaknesses. If the Company fails to remediate any material weaknesses, the Company could be unable to provide timely and reliable financial information, which could have a material adverse effect on its business, results of operations, or financial condition. Furthermore, it is uncertain what impact an adverse opinion or a disclaimed opinion regarding internal controls would have upon the Company’s stock price or business.

 

Because the Company derives a significant portion of its revenue by distributing products designed and manufactured by third parties, it may be unable to anticipate changes in the marketplace and, as a result, could lose market share.

 

The Company’s business is driven primarily by customers’ needs and demands for new products and/or enhanced performance, and by the products developed and manufactured by third parties. Because the Company distributes products developed and manufactured by third parties, its business would be adversely affected if its suppliers fail to anticipate which products or technologies will gain market acceptance or if it cannot sell these products at competitive prices. The Company cannot be certain that its suppliers will permit the Company to distribute their newly developed products, or that such products will meet the Company’s customers’ needs and demands. Additionally, because some of the Company’s principal competitors design and manufacture new technology, those competitors may have a competitive advantage over the Company. To successfully compete, the Company must maintain an efficient cost structure, an effective sales and marketing team, and offer additional services that distinguish it from its competitors. Failure to execute these strategies successfully could harm its results of operations.

 

The Company has exposure to economic downturns and operates in cyclical markets.

 

As a supplier of electronic components and services to a variety of industries, the Company can be adversely affected by general economic downturns. In particular, demand for the products and services of the Company’s RF and Wireless Communications Group is dependent upon capital spending levels in the telecommunications industry and demand for products and services of its Industrial Power Group is dependent upon capital spending levels in the manufacturing industry, including steel, automotive, textiles, plastics, semiconductors, and broadcast, as well as the transportation industry. Many of its customers delay capital projects during economic downturns. Accordingly, the Company’s operating results for any particular period are not necessarily indicative of the operating results for any future period. The markets served by its businesses have historically experienced downturns in demand that could harm its operating results. Future economic downturns could be triggered by a variety of causes, including outbreaks of hostilities, terrorist actions, or epidemics in the United States or abroad.

 

The Company has significant debt, which could limit its financial resources and ability to compete and may make it more vulnerable to adverse economic events.

 

At May 28, 2005, the Company’s total debt was approximately $120.3 million, including its outstanding convertible debentures and convertible notes. The Company has incurred and will likely continue to incur indebtedness to fund potential future acquisitions, for strategic initiatives, to purchase inventory, and for general corporate purposes. Although the Company believes that the cash flow generated by its continuing operations, supplemented as necessary with funds available under credit arrangements is sufficient to meet its repayment obligations for the fiscal year ended June 3, 2006, the Company cannot ensure that this will be the case. However, the Company will need to raise additional capital through debt or equity financings, asset sales, or other sources to refinance the remaining $22.3 million aggregate principal amount of the 8 1/4% and 7 1/4% convertible debentures by June 2006, as required by its amended credit agreement. The Company’s incurrence of additional indebtedness could have important consequences. For example, it could:

 

    increase the Company’s vulnerability to general adverse economic and industry conditions;

 

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    require the Company to dedicate a substantial portion of its cash flow from operations to payments on its indebtedness, thereby reducing the availability of its cash flow to fund working capital, capital expenditures, acquisitions, engineering efforts, and other general corporate purposes, as well as to pay dividends;

 

    limit the Company’s flexibility in planning for, or reacting to, changes in its business and the industry in which it operates;

 

    place the Company at a competitive disadvantage relative to its competitors who have less debt; or

 

    limit, along with the financial and other restrictive covenants in its indebtedness, the Company’s ability to borrow additional funds which could affect its ability to make future acquisitions, among other things.

 

The Company’s ability to service its debt and meet its other obligations depends on a number of factors beyond its control.

 

At May 28, 2005, the Company’s total debt was approximately $120.3 million, resulting in a debt-to-equity ratio of 116%, and primarily consisted of:

 

    $4.8 million aggregate principal amount of its 7 1/4% debentures, which bear interest at a rate of 7 1/4% per year payable on June 15 and December 15 and mature on December 15, 2006 (the Company’s amended credit agreement requires refinancing by June 10, 2006);

 

    $17.5 million aggregate principal amount of its 8 1/4% debentures, which bear interest at a rate of 8 1/4% per year payable on June 15 and December 15 and mature on June 15, 2006 (the Company’s amended credit agreement requires refinancing by June 10, 2006);

 

    $44.7 million aggregate principal amount of its 7 3/4% debentures, which bear interest at a rate of 7 3/4% per year payable on June 15 and December 15 and mature on December 15, 2011; and

 

    $53.3 million principal amount of indebtedness under the Company’s credit agreement, which matures on October 29, 2009, bears interest at London Interbank Offered Rate (LIBOR), plus a margin varying with certain financial performance criteria. The interest rate was 4.56% at May 28, 2005.

 

The debt-to-equity ratio has been calculated based on the Company’s balance sheet dated May 28, 2005.

 

The Company’s ability to service its debt and meet its other obligations as they come due is dependent on its future financial and operating performance. This performance is subject to various factors, including factors beyond the Company’s control such as changes in global and regional economic conditions, changes in its industry or the end markets for its products, changes in interest or currency exchange rates, inflation in raw materials, energy and other costs. Although the Company believes there is available financing for the remaining $22.3 million aggregate principal amount of the 8 1/4% and 7 1/4% convertible debentures (due to be refinanced in June 2006 according to the Company’s amended credit agreement) based on discussions with various investment banking institutions, the Company cannot ensure that it will have the ability to refinance the convertible debentures by June 2006 successfully or with favorable commercial terms.

 

If the Company’s cash flow and capital resources are insufficient to enable it to service its debt and meet these obligations as they become due, the Company could be forced to:

 

    reduce or delay capital expenditures;

 

    sell assets or businesses;

 

    limit or discontinue, temporarily or permanently, business plans or operations;

 

    obtain additional debt or equity financing; or

 

    restructure or refinance debt.

 

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The Company cannot ensure the timing of these actions or the amount of proceeds that could be realized from them. Accordingly, the Company cannot ensure that it will be able to meet its debt service and other obligations as they become due or otherwise.

 

The Company’s success depends on its executive officers and other key personnel.

 

The Company’s future success depends to a significant degree on the skills, experience, and efforts of its executive officers and other key personnel. The loss of the services of any of its executive officers, particularly Edward J. Richardson, its chairman of the board and chief executive officer, or Bruce W. Johnson, its president and chief operating officer, could significantly harm its business and results of operations.

 

The Company’s future success will also depend on its ability to attract and retain qualified personnel, including technical and engineering personnel. Competition for such personnel is intense, and the Company cannot assure investors that it will be successful in retaining or attracting such persons. The failure to attract and retain qualified personnel could significantly harm its operations.

 

The Company’s credit agreement and the indentures for its outstanding debentures impose restrictions with respect to various business matters.

 

The Company’s credit agreement contains numerous restrictive covenants that limit the discretion of management with respect to certain business matters. These covenants place restrictions on, among other things, the Company’s ability to incur additional indebtedness, to create liens or other encumbrances, to pay dividends or make other payments in respect of its shares of common stock and Class B common stock, to engage in transactions with affiliates, to make certain payments and investments, to merge or consolidate with another entity, and to repay indebtedness junior to indebtedness under the credit agreement. The credit agreement also contains a number of financial covenants that require the Company to meet certain financial ratios and tests relating to, among other things, tangible net worth, a borrowing base, senior funded debt to cash flow, and annual debt service coverage. In addition, the indentures for its outstanding debentures contain covenants that limit, among other things, its ability to pay dividends or make other payments in respect of its shares of common stock and Class B common stock and merge or consolidate with another entity. If the Company fails to comply with the obligations in the credit agreement and indentures, it could result in an event of default under those agreements. If an event of default occurs and is not cured or waived, it could result in acceleration of the indebtedness under those agreements, any of which could significantly harm its business and financial condition.

 

Recent changes in accounting standards regarding stock option plans could limit the desirability of granting stock options, which could harm the Company’s ability to attract and retain employees, and could also negatively impact its results of operations.

 

On December 16, 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), Share Based Payment, which requires all companies to treat the fair value of stock options granted to employees as an expense. As a result of SFAS No. 123(R), the Company is required to record compensation expense equal to the fair value of each stock option granted. This change in accounting standards reduces the attractiveness of granting stock options because of the additional expense associated with these grants, which would negatively impact the Company’s results of operations. For example, the Company’s recorded net loss of $11.3 million in fiscal 2005 would have increased by $1.4 million, to a net loss of $12.7 million, and its recorded net income of $6.0 million in fiscal 2004 would have decreased by $1.0 million, to a net income of $5.0 million. Nevertheless, stock options are an important employee recruitment and retention tool, and the Company may not be able to attract and retain key personnel if it reduces the scope of its employee stock option program. Accordingly, as a result of the requirement to expense stock option grants, the Company’s future results of operations would be negatively impacted, as would its ability to use stock options as an employee recruitment and retention tool.

 

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The Company faces intense competition in the markets it serves and, if it does not compete effectively, it could significantly harm its operating results.

 

The Company faces substantial competition in its markets. The Company faces competition from hundreds of electronic component distributors of various sizes, locations, and market focuses as well as original equipment manufacturers, in each case for new products and replacement parts. Some of its competitors have significantly greater resources and broader name recognition than it. As a result, these competitors may be better able to withstand changing conditions within its markets and throughout the economy as a whole. In addition, new competitors could enter its markets.

 

Engineering capability, vendor representation, and product diversity create segmentation among distributors. The Company’s ability to compete successfully will depend on its ability to provide engineered solutions, maintain inventory availability and quality, and provide reliable delivery at competitive prices.

 

To the extent the Company does not keep pace with technological advances or fails to timely respond to changes in competitive factors in its industry, it could lose market share or experience a decline in its revenue and net income. In addition, gross margins in the businesses in which it competes have declined in recent years due to competitive pressures and may continue to decline.

 

The Company may not be able to continue to make the acquisitions necessary for it to realize its growth strategy or integrate acquisitions successfully.

 

One of the Company’s growth strategies is to increase its sales and expand its markets through acquisitions. Since 1980, the Company has acquired 35 companies or significant product lines and expects to continue making acquisitions if appropriate opportunities arise in its industry. The Company may not be able to identify and successfully negotiate suitable acquisitions, obtain financing for future acquisitions on satisfactory terms, or otherwise complete future acquisitions. Furthermore, the Company may compete for acquisition and expansion opportunities with companies that have substantially greater resources than it.

 

Following acquisitions, the acquired companies may encounter unforeseen operating difficulties and may require significant financial and managerial resources that would otherwise be available for the ongoing development or expansion of its existing operations. If the Company is unable to successfully identify acquisition candidates, complete acquisitions, and integrate the acquired businesses with its existing businesses, its business, results of operations and financial condition may be materially and adversely affected and it may not be able to compete effectively within its industry.

 

If the Company does not continue to reduce its costs, it may not be able to compete effectively in its markets.

 

The success of the Company’s business depends, in part, on its continuous reduction of costs. The electronic component industries have historically experienced price erosion and will likely continue to experience such price erosion. If the Company is not able to reduce its costs sufficiently to offset future price erosion, its operating results will be adversely affected. The Company has recently engaged in various cost-cutting and other initiatives intended to reduce costs and increase productivity. In fiscal 2005, the Company recorded a $2.2 million restructuring charge as it eliminated over 60 positions or approximately 5% of its workforce. The Company cannot ensure that it will not incur further charges for restructuring as it continues to seek cost reduction initiatives. Alternatively, the Company cannot ensure that it will be able to continue to reduce its costs

 

The Company’s Industrial Power Group is dependent on a limited number of vendors to supply it with essential products.

 

Electron tubes and certain other products supplied by the Company’s Industrial Power Group are currently produced by a relatively small number of manufacturers. The Company’s future success will depend, in large

 

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part, on maintaining current vendor relationships and developing new relationships. The Company believes that vendors supplying products to some of the product lines of its Industrial Power Group are consolidating their distribution relationships or exiting the business. The five largest suppliers to the Industrial Power Group by percentage of overall Industrial Power Group purchases in fiscal 2005 were Advanced Power Technology Inc., Communications & Power Industries, Inc., Cornell Dubilier Electronics, Covimag S.A., and New Japan Radio Co. Ltd. These suppliers accounted for approximately 56% of the overall Industrial Power Group purchases in fiscal 2005. The loss of one or more of the Company’s key vendors and the failure to find new vendors could significantly harm its business and results of operations. The Company has in the past and may in the future experience difficulties obtaining certain products in a timely manner. The inability of suppliers to provide it with the required quantity or quality of products could significantly harm its business.

 

Economic, political and other risks associated with international sales and operations could adversely affect the Company’s business.

 

In fiscal 2005, 58.8% of the Company’s sales were made outside the U.S. and 24.9% of the Company’s purchases of products were from suppliers located outside the U.S. The Company anticipates that it will continue to expand its international operations to the extent that suitable opportunities become available. Accordingly, the Company’s future results of operations could be harmed by a variety of factors which are not present for companies with operations and sales solely within the United States, including:

 

    changes in a specific country’s or region’s political or economic conditions, particularly in emerging markets, including the possibility of military action or other hostilities and confiscation of property;

 

    increases in trade protection measures and import or export licensing requirements;

 

    changes in tax laws and international tax treaties;

 

    restrictions on its ability to repatriate investments and earnings from foreign operations;

 

    difficulty in staffing and managing widespread operations;

 

    differing labor regulations;

 

    differing levels of protection of intellectual property;

 

    changes in regulatory requirements;

 

    shipping costs and delays; or

 

    difficulties in accounts receivable collection.

 

If any of these risks materialize, the Company could face substantial increases in costs, the reduction of profit, and the inability to do business.

 

The Company is exposed to foreign currency risk.

 

The Company expects that international sales will continue to represent a significant percentage of its total sales, which expose it to currency exchange rate fluctuations. Since the revenues and expenses of the Company’s foreign operations are generally denominated in local currencies, exchange rate fluctuations between local currencies and the U.S. dollar subject the Company to currency exchange risks with respect to the results of its foreign operations to the extent it were unable to denominate its purchases or sales in U.S. dollars or otherwise shift to its customers or suppliers the risk of currency exchange rate fluctuations. The Company currently does not engage in any significant currency hedging transactions. Fluctuations in exchange rates may affect the results of its international operations reported in U.S. dollars and the value of such operations’ net assets reported in U.S. dollars. Additionally, its competitive position may be affected by the relative strength of the currencies in countries where its products are sold. The Company cannot predict whether foreign currency exchange risks

 

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inherent in doing business in foreign countries will have a material adverse effect on its operations and financial results in the future.

 

Because the Company generally does not have long-term contracts with its vendors, it may experience shortages of products that could harm its business and customer relationships.

 

The Company generally does not have long-term contracts or arrangements with any of its vendors that guarantee product availability. The Company cannot ensure that its vendors will meet its future requirements for timely delivery of products of sufficient quality or quantity. Any difficulties in the delivery of products could harm its relationships with customers and cause it to lose orders that could result in a material decrease in its revenues. Further, the Company competes against certain of its vendors and its relationship with those vendors could be harmed as a result of this competition.

 

The Company may have underpaid taxes in a foreign country where is has operations.

 

The Company has been informed by one of its foreign subsidiaries that its records may not be adequate to support the taxable revenues and deductions included within income tax returns previously filed. At this time, the Company has not received notification from any tax authority regarding this matter. The Company will continue to investigate this matter and take the appropriate actions necessary to minimize any potential liability. As of August 26, 2005, the Company has not developed or obtained specific and definitive information sufficient to reasonably confirm the existence of a tax liability, determined a reasonable range of a potential liability, or otherwise evaluated any exposure to the Company. Although it is difficult to determine the ultimate exposure due to the lack of sufficient information, an unfavorable outcome may be material to the consolidated financial statements.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Risk Management and Market Sensitive Financial Instruments

 

The Company’s foreign denominated assets and liabilities are cash, accounts receivable, inventory, accounts payable, and intercompany receivables and payables, primarily in Canada and member countries of the European community and, to a lesser extent, in Asia/Pacific and Latin America. The Company monitors its foreign exchange exposures and has entered into forward contracts to hedge significant transactions; however, this activity is infrequent. The Company did not enter into any forward contracts in fiscal 2005. In fiscal 2004, the Company entered into one forward contract with an approximate value of $85. Other tools that may be used to manage foreign exchange exposures include the use of currency clauses in sales contracts and the use of local debt to offset asset exposures.

 

As discussed above, the Company’s debt financing, in part, varies with market rates exposing the Company to the market risk from changes in interest rates. Certain operations, assets and liabilities of the Company are denominated in foreign currencies subjecting the Company to foreign currency exchange risk. In order to provide the user of these financial statements guidance regarding the magnitude of these risks, the Securities and Exchange Commission requires the Company to provide certain quantitative disclosures based upon hypothetical assumptions. Specifically, these disclosures require the calculation of the effect of a 10% increase in market interest rates and a uniform 10% strengthening of the U.S. dollar against foreign currencies on the reported net earnings and financial position of the Company.

 

Under these assumptions, additional interest expense, tax effected, would have increased the net loss by $185 in fiscal 2005 and decreased income by $229 in fiscal 2004. These amounts were determined by considering the impact of the hypothetical 10% interest rate increase on the Company’s variable rate outstanding borrowings.

 

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Had the U.S. dollar strengthened 10% against various foreign currencies, sales would have been lower by an estimated $22.5 million in fiscal 2005 and $20.0 million in fiscal 2004. Total assets would have declined by $10.7 million and $8.2 million in fiscal 2005 and fiscal 2004, respectively, while the total liabilities would have decreased by $4.1 million and $5.0 million in fiscal 2005 and fiscal 2004, respectively. These amounts were determined by considering the impact of the hypothetical 10% decrease in average foreign exchange rates against the U.S. dollar on the sales, assets and liabilities of the Company’s international operations.

 

The interpretation and analysis of these disclosures should not be considered in isolation since such variances in interest rates and exchange rates would likely influence other economic factors. Such factors, which are not readily quantifiable, would likely also affect the Company’s operations.

 

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Item 8. Financial Statements and Supplementary Data

 

RICHARDSON ELECTRONICS, LTD.

 

Consolidated Balance Sheets

(in thousands)

 

    

May 28,

2005


    May 29,
2004


 
              

Assets

                

Current Assets

                

Cash and cash equivalents

   $ 24,530     $ 16,927  

Receivables, less allowance of $1,934 and $2,516

     106,928       106,130  

Inventories

     102,272       92,297  

Prepaid expenses

     3,293       3,817  

Deferred income taxes

     6,644       15,922  
    


 


Total current assets

     243,667       235,093  

Property, plant and equipment, net

     31,821       30,589  

Goodwill

     6,149       5,778  

Other intangible assets, net

     1,018       531  

Non-current deferred income taxes

     428       6,733  

Other assets

     4,735       4,221  
    


 


Total assets

   $ 287,818     $ 282,945  
    


 


Liabilities and stockholders’ equity

                

Current Liabilities

                

Accounts payable

   $ 39,305     $ 33,473  

Accrued liabilities

     22,731       23,224  

Current portion of long-term debt

     22,305       4,027  
    


 


Total current liabilities

     84,341       60,724  

Long-term debt, less current portion

     98,028       133,813  

Non-current liabilities

     1,401       241  
    


 


Total liabilities

     183,770       194,778  

Stockholders’ Equity

                

Common stock, $.05 par value; issued 15,597 shares at May 28, 2005 and 12,524 shares at May 29, 2004

     780       626  

Class B common stock, convertible, $.05 par value; issued 3,120 shares at May 28, 2005 and 3,168 shares at May 29, 2004

     156       158  

Preferred stock, $1.00 par value, no shares issued

     —         —    

Additional paid-in capital

     121,591       93,877  

Common stock in treasury, at cost; 1,332 shares at May 28, 2005 and 1,437 shares at May 29, 2004

     (7,894 )     (8,515 )

Retained earnings (accumulated deficit)

     (9,942 )     3,408  

Accumulated other comprehensive loss

     (643 )     (1,387 )
    


 


Total stockholders’ equity

     104,048       88,167  
    


 


Total liabilities and stockholders’ equity

   $ 287,818     $ 282,945  
    


 


 

Certain amounts in fiscal 2004 were reclassified to conform to the fiscal 2005 presentation; See accompanying notes to consolidated financial statements.

 

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RICHARDSON ELECTRONICS, LTD.

 

Consolidated Statements of Operations

(in thousands, except per share amounts)

 

     Fiscal Year Ended

 
     May 28,
2005


    May 29,
2004


    May 31,
2003


 

Net sales

   $ 578,724     $ 519,823     $ 464,381  

Cost of products sold

     441,817       392,117       365,427  
    


 


 


Gross margin

     136,907       127,706       98,954  

Selling, general and administrative expenses

     128,733       108,299       100,613  

(Gain) loss on disposal of assets

     (9,918 )     579       —    
    


 


 


Operating income (loss)

     18,092       18,828       (1,659 )

Other expense (income):

                        

Interest expense

     8,903       10,257       10,352  

Investment income

     (388 )     (227 )     (124 )

Foreign exchange and other, net

     (977 )     228       (528 )
    


 


 


       7,538       10,258       9,700  

Income (loss) before income taxes and cumulative effect of accounting change

     10,554       8,570       (11,359 )

Income tax provision (benefit)

     21,865       2,537       (2,370 )
    


 


 


Income (loss) before cumulative effect of accounting change

     (11,311 )     6,033       (8,989 )

Cumulative effect of accounting change, net of tax of $3,725

     —         —         (17,862 )
    


 


 


Net income (loss)

   $ (11,311 )   $ 6,033     $ (26,851 )
    


 


 


Average shares outstanding:

                        

For basic EPS

     16,942       14,040       13,809  

For diluted EPS

     16,942       14,418       13,809  

Net income (loss) per share—basic:

                        

Net income (loss) per share before cumulative effect of accounting change

   $ (0.67 )   $ 0.43     $ (0.65 )

Cumulative effect of accounting change, net of tax

     —         —         (1.29 )
    


 


 


Net income (loss) per share—basic

   $ (0.67 )   $ 0.43     $ (1.94 )
    


 


 


Net income (loss) per share—diluted:

                        

Net income (loss) per share before cumulative effect of accounting change

   $ (0.67 )   $ 0.42     $ (0.65 )

Cumulative effect of accounting change, net of tax

     —         —         (1.29 )
    


 


 


Net income (loss) per share—diluted

   $ (0.67 )   $ 0.42     $ (1.94 )
    


 


 


Dividends per common share

   $ 0.16     $ 0.16     $ 0.16  

 

Certain amounts in fiscal 2004 and 2003 were reclassified to conform to the fiscal 2005 presentation; See accompanying notes to consolidated financial statements.

 

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Table of Contents

RICHARDSON ELECTRONICS, LTD.

 

Consolidated Statements of Cash Flows

(in thousands)

 

    

Fiscal Year Ended


 
     May 28,
2005


    May 29,
2004


    May 31,
2003


 

Operating activities:

                        

Net income (loss)

   $ (11,311 )   $ 6,033     $ (26,851 )

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

                        

(Gain) loss on disposal of assets

     (9,918 )     579       —    

Depreciation

     5,039       4,899       5,093  

Amortization of intangibles and financing costs

     316       332       271  

Deferred income taxes

     15,583       1,190       (1,183 )

Provision for inventory obsolescence

     —         —         10,037  

Other charges

     —         —         6,041  

Goodwill and other intangible assets impairment, net of tax

     —         —         17,862  

Other non-cash items in net income (loss)

     2,323       (90 )     (290 )

Other liabilities

     1,156       4,737       1,319  

Receivables

     1,822       (19,306 )     4,297  

Inventories

     (8,917 )     4,691       2,484  

Other

     2,993       (207 )     (3,054 )

Accounts payable and accrued liabilities

     (1,118 )     9,699       (8,252 )
    


 


 


Net cash provided by (used in) operating activities

     (2,032 )     12,557       7,774  
    


 


 


Investing activities:

                        

Capital expenditures

     (7,086 )     (5,434 )     (6,125 )

Proceeds from sale of assets

     10,925       —         —    

Business acquisitions

     (971 )     (6,196 )     (1,108 )

Proceeds from sales of available-for-sale securities

     3,042       3,946       5,217  

Purchases of available-for-sale securities

     (3,042 )     (3,946 )     (5,217 )

Other

     —         83       (23 )
    


 


 


Net cash provided by (used in) investing activities

     2,868       (11,547 )     (7,256 )
    


 


 


Financing activities:

                        

Proceeds from borrowings

     113,229       52,105       41,880  

Payments on debt

     (131,624 )     (53,416 )     (40,982 )

Proceeds from issuance of common stock

     29,729       1,656       1,134  

Cash dividends

     (2,719 )     (2,206 )     (2,694 )

Other (including financing charges)

     (2,364 )     —         (304 )
    


 


 


Net cash provided by (used in) financing activities

     6,251       (1,861 )     (966 )
    


 


 


Effect of exchange rate changes on cash and cash equivalents

     516       904       2,026  
    


 


 


Increase in cash and cash equivalents

     7,603       53       1,578  

Cash and cash equivalents at beginning of year

     16,927       16,874       15,296  
    


 


 


Cash and cash equivalents at end of year

   $ 24,530     $ 16,927     $ 16,874  
    


 


 


Supplemental Disclosures of Cash Flow Information:

                        

Cash paid during the fiscal year for:

                        

Interest

   $ 9,131     $ 10,404     $ 10,246  

Income taxes

   $ 3,272     $ 1,656     $ 2,657  

 

Certain amounts in fiscal 2004 and 2003 were reclassified to conform to the fiscal 2005 presentation; See accompanying notes to consolidated financial statements.

 

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Table of Contents

RICHARDSON ELECTRONICS, LTD.

 

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

(in thousands, except per share amounts)

 

   

Comprehensive
Income (Loss)


    Shares Issued

   

Par
Value


 

Additional
Paid-In

Capital


   

Treasury
Stock


   

Retained

Earnings

(Accumulated

Deficit)


   

Accumulated
Other Com-
prehensive

Income (Loss)


   

Total


 
    Common

  Class B
Common


             

Balance June 1, 2002

          12,144   3,207     $ 767   $ 90,291     $ (9,386 )   $ 29,171     $ (7,888 )   $ 102,955  

Comprehensive income:

                                                               

Net loss

  $ (26,851 )   —     —         —       —         —         (26,851 )     —         (26,851 )

Recognition of unearned compensation

    —       —     —         —       181       —         —         —         181  

Currency translation

    3,519     —     —         —       —         —         —         3,519       3,519  

Fair value adjustments on investment, net of income tax effect

    (96 )   —     —         —       —         —         —         (96 )     (96 )

Cash flow hedges, net of income tax effect

    (147 )   —     —         —       —         —         —         (147 )     (147 )
   


                                                       

Comprehensive income (loss)

  $ (23,575 )                                                        
   


                                                       

Common stock issued

          112   —         6     949       464       —         —         1,419  

Dividends paid to:

                                                               

Class A ($0.04 per share)

          —     —         —       —         —         (1,697 )     —         (1,697 )

Class B ($0.036 per share)

          —     —         —       —         —         (462 )     —         (462 )
           
 

 

 


 


 


 


 


Balance May 31, 2003

          12,256   3,207       773     91,421       (8,922 )     161       (4,612 )     78,821  

Reclassification-correction of error (1)

          —     —         —       —         —         (580 )     906       326  

Comprehensive income:

                                                               

Net income

  $ 6,033     —     —         —       —         —         6,033       —         6,033  

Recognition of unearned compensation

    —       —     —         —       288       —         —         —         288  

Currency translation

    1,258     —     —         —       —         —         —         1,258       1,258  

Fair value adjustments on investment, net of income tax effect

    329     —     —         —       —         —         —         329       329  

Cash flow hedges, net of income tax effect

    732     —     —         —       —         —         —         732       732  
   


                                                       

Comprehensive income

  $ 8,352                                                          
   


                                                       

Common stock issued

          229   —         11     2,168       407       —         —         2,586  

Conversion of Class B shares to common stock

          39   (39 )     —       —         —         —         —         —    

Dividends paid to:

                                                               

Class A ($0.04 per share)

          —     —         —       —         —         (1,747 )     —         (1,747 )

Class B ($0.036 per share)

          —     —         —       —         —         (459 )     —         (459 )
           
 

 

 


 


 


 


 


Balance May 29, 2004

          12,524   3,168       784     93,877       (8,515 )     3,408       (1,387 )     88,167  

Comprehensive income (loss):

                                                               

Net loss

  $ (11,311 )   —     —         —       —         —         (11,311 )     —         (11,311 )

Recognition of unearned compensation

    —       —     —         —       242       —         —         —         242  

Currency translation

    557     —     —         —       —         —         —         557       557  

Fair value adjustments on investment, net of income tax effect

    121     —     —         —       —         —         —         121       121  

Cash flow hedges, net of income tax effect

    66     —     —         —       —         —         —         66       66  
   


                                                       

Comprehensive income (loss)

  $ (10,567 )                                                        
   


                                                       

Common stock issued

          3,025   —         152     28,153       621       —         —         28,926  

Conversion of Class B shares to common stock

          48   (48 )     —       —         —         —         —         —    

Dividends paid to:

                                                               

Class A ($0.04) per share)

          —     —         —       (568 )     —         (1,699 )     —         (2,267 )

Class B ($0.036 per share)

          —     —         —       (113 )     —         (340 )     —         (453 )
           
 

 

 


 


 


 


 


Balance May 28, 2005

          15,597   3,120     $ 936   $ 121,591     $ (7,894 )   $ (9,942 )   $ (643 )   $ 104,048  
           
 

 

 


 


 


 


 


 

(1) In the second quarter of fiscal 2005, an error was discovered with respect to the accounting treatment of certain foreign exchange gains and losses incurred during fiscal 2001 and 2002. These foreign exchange items related to the acquisition in fiscal 2001 of AVIV Electronics by one of the Company’s subsidiaries, and the reporting of subsequent intercompany transactions between the subsidiary and parent. The correction of this error amounted to $580 on a cumulative basis, net of taxes of $326, which is recorded as an adjustment to retained earnings, accumulated other comprehensive loss, and deferred income taxes as of May 29, 2004.

 

Certain amounts in fiscal 2004 and 2003 were reclassified to conform to the fiscal 2005 presentation; See accompanying notes to consolidated financial statements.

 

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Table of Contents

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

Note A—Significant Accounting Policies

 

Principles of Consolidation: Fiscal Year—Richardson Electronics, Ltd. (the “Company”) fiscal year ends on the Saturday nearest the end of May. Each of the fiscal years presented contains 52 weeks. All references herein for the years 2005, 2004, and 2003 represent the fiscal years ended May 28, 2005, May 29, 2004, and May 31, 2003, respectively.

 

The consolidated financial statements include the Company and its subsidiaries. Significant intercompany transactions and accounts have been eliminated.

 

Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires the Company’s 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.

 

Reclassifications and Presentation: Certain amounts in the prior years’ financial statements have been reclassified to conform to the fiscal 2005 presentation.

 

Fair Values of Financial Instruments: The fair values of financial instruments are determined based on quoted market prices and market interest rates as of the end of the reporting period. The Company’s financial instruments include accounts receivable, accounts payable, accrued liabilities, and long-term debt. The fair values of these financial instruments were, with the exception of long-term debt as disclosed in Note F, not materially different from their carrying or contract values at May 28, 2005 and May 29, 2004.

 

Cash Equivalents: The Company considers short-term investments that have maturity of three months or less, when purchased, to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate the fair market values of these assets.

 

Inventories: At May 28, 2005, the Company’s worldwide inventories were stated at the lower of cost or market using the first-in, first-out (FIFO) method. Effective June 1, 2003, the North American operations, which represent a majority of the Company’s operations and approximately 78% of the Company’s inventories, changed from the last-in, first-out (LIFO) method to the FIFO method. All other inventories were consistently stated at the lower of cost or market using FIFO method. The Company believes that the FIFO method is preferable because it provides a better matching of revenue and expenses. The accounting change was not material to the financial statements for any of the periods presented, and accordingly, no retroactive restatement of prior years’ financial statements was made. Inventories include material, labor, and overhead associated with such inventories. Substantially all inventories represent finished goods held for sale.

 

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Table of Contents

Notes to Consolidated Financial Statements—(Continued)

(in thousands, except per share amounts)

 

Property, Plant and Equipment: Property, plant and equipment are stated at cost. Improvements and replacements are capitalized while expenditures for maintenance and repairs are charged to expense as incurred. Provisions for depreciation are computed principally using the straight-line method over the estimated useful life of the asset. Depreciation expense was $5,039, $4,899, and $5,093 in fiscal 2005, 2004, and 2003, respectively. Property, plant and equipment consist of the following:

 

    

May 28,

2005


    May 29,
2004


 

Land and improvements

   $ 1,347     $ 2,363  

Buildings and improvements

     18,966       18,274  

Computer and communications equipment

     27,024       17,612  

Machinery and other equipment

     18,558       21,581  
    


 


       65,895       59,830  

Accumulated depreciation

     (34,074 )     (29,241 )
    


 


Property, plant and equipment, net

   $ 31,821     $ 30,589  
    


 


Supplemental disclosure information of the estimated useful life of the asset:

 

       

Land improvements

     10 years          

Buildings and improvements

     10 - 15 years          

Computer and communications equipment

       3 - 5 years          

Machinery and other equipment

       3 - 7 years          

 

The Company is in the application development stage of implementing certain modules of enterprise resource management software (PeopleSoft). In accordance with Accounting Standards Executive Committee (AcSEC) Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes all direct costs associated with the application development of this software including software acquisition costs, consulting costs, and internal payroll costs. The Statement requires these costs to be depreciated once the application development stage is complete. The unamortized balance of the aforementioned capitalized costs, included within computer and communications equipment, is $5,036 and $9,672 at May 28, 2005 and May 29, 2004, respectively. Depreciation expense for capitalized software costs that relate to PeopleSoft in the post-application development stage was $1,531, $1,239, and $776 in fiscal 2005, 2004, and 2003, respectively.

 

Other Assets: Other assets consist of the following:

 

     May 28,
2005


   May 29,
2004


Investments

   $ 3,445    $ 3,058

Notes receivable

     955      737

Other deferred charges, net

     335      426
    

  

Other assets

   $ 4,735    $ 4,221
    

  

 

The Company’s investments are primarily equity securities, all of which are classified as available-for-sale and are carried at their fair value based on the quoted market prices. Proceeds from the sale of the securities were $3,042, $3,946, and $5,217 during fiscal 2005, 2004, and 2003, respectively, all of which were consequently reinvested. Gross realized gains on those sales were $372, $366, and $351 in fiscal 2005, 2004, and 2003, respectively. Gross realized losses on those sales were $102, $59, and $412 in fiscal 2005, 2004, and 2003, respectively. Net unrealized holding gains of $121, net unrealized holding gains of $329, and net unrealized holding losses of $96 have been included in accumulated comprehensive income (loss) for fiscal 2005, 2004 and

 

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Table of Contents

Notes to Consolidated Financial Statements—(Continued)

(in thousands, except per share amounts)

 

2003, respectively. The following table is the disclosure under Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, for the investment in marketable equity securities with fair values less than cost basis:

 

Description of Securities


   Less than 12 months

   More than 12 months

   Total

   Fair Value

  

Unrealized

Losses


   Fair Value

  

Unrealized

Losses


   Fair Value

  

Unrealized

Losses


May 28, 2005

                                         

Common Stock

   $ 2,044    $ 33    $    $    $ 2,044    $ 33

May 29, 2004

                                         

Common Stock

   $ 2,252    $ 63    $ 97    $ 7    $ 2,349    $ 70

 

Deferred financing costs are amortized using the effective method.

 

Goodwill and Other Intangible Assets: Effective June 2, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which requires that goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment testing. Intangible assets with finite lives are amortized over their estimated useful lives on a straight line basis.

 

Accordingly, the Company discontinued amortization of goodwill and certain intangible assets. Management reviews the valuation of goodwill and intangible assets not subject to amortization at least annually. The Company utilizes the comparison of reporting units’ fair value derived by discounted cash flow analysis and their book value as an indicator of potential impairment. The application of SFAS No. 142 transitional accounting provisions and the annual impairment test are discussed in Note B.

 

Accrued Liabilities: Accrued liabilities consist of the following:

 

     May 28,
2005


   May 29,
2004


Compensation and payroll taxes

   $ 9,543    $ 9,828

Interest

     2,261      2,752

Income taxes

     7,401      6,306

Warranty reserve

     1,439      802

Other accrued expenses

     2,087      3,536
    

  

Accrued liabilities

   $ 22,731    $ 23,224
    

  

 

Warranties: The Company offers warranties for specific products it manufactures. The Company also provides extended warranties for some products it sells that lengthen the period of coverage specified in the manufacturer’s original warranty. Terms generally range from one to three years.

 

The Company estimates the cost to perform under its warranty obligation and recognizes this estimated cost at the time of the related product sale. The Company reports this expense as an element of cost of products sold in its Consolidated Statement of Operations. Each quarter, the Company assesses actual warranty costs incurred, on a product-by-product basis, as compared to its estimated obligation. The estimates with respect to new products are based generally on knowledge of the manufacturers’ experience and are extrapolated to reflect the extended warranty period, and are refined each quarter as better information with respect to warranty experience becomes known.

 

Warranty reserves are established for costs that are expected to be incurred after the sale and delivery of products under warranty. The warranty reserves are determined based on known product failures, historical experience, and other currently available evidence.

 

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Table of Contents

Notes to Consolidated Financial Statements—(Continued)

(in thousands, except per share amounts)

 

Non-Current Liabilities: Non-current liabilities of $1,401 at May 28, 2005 represent the pension obligations for qualified Korea and Italy employees and $241 at May 29, 2004 represent the pension obligations for qualified Korea employees.

 

Foreign Currency Translation: Foreign currency balances are translated into U.S. dollars at end-of-period rates. Revenues and expenses are translated at the current rate on the date of the transaction. Gains and losses resulting from foreign currency transactions are included in income. Foreign currency transactions reflected in operations was gain of $910 in fiscal 2005, loss of $363 in fiscal 2004, and gain of $1,096 in fiscal 2003, respectively. Gains and losses resulting from translation of foreign subsidiary financial statements are credited or charged directly to accumulated other comprehensive income (loss), a component of stockholders’ equity.

 

Revenue Recognition: The Company’s product sales are recognized as revenue generally upon shipment, when title passes to the customer, delivery has occurred or services have been rendered, and collectibility is reasonably assured. The Company’s terms are generally FOB shipping point and sales are recorded net of discounts, rebates, and returns based on the Company’s historical experience. The Company’s products are often manufactured to meet the specific design needs of its customers’ applications. Its engineers work closely with customers in ensuring that the product the Company seeks to provide them will meet their needs, but its customers are under no obligation to compensate the Company for designing the products it sells; the Company retains the rights to its designs.

 

Shipping and Handling Fees and Costs: Shipping and handling costs billed to customers are reported as revenue and the related costs are reported as cost of products sold.

 

Income Taxes: Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences in the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those differences are expected to be recovered or settled. In assessing the realizability of the deferred tax assets, management considers whether it is more likely than not that some portion of or all of the deferred tax assets will not be realized. A valuation allowance is recorded for the portion of the deferred tax assets that are not expected to be realized based on the level of historical taxable income, projections for future taxable income over the periods in which temporary differences are deductible, and allowable tax planning strategies.

 

In fiscal 2005, the Company determined that a portion of its foreign subsidiaries’ cumulative positive earnings may be distributed in future years. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income tax and foreign withholding taxes. As such, the Company established a deferred tax liability in fiscal 2005. The remaining portion of the foreign subsidiaries’ cumulative positive earnings was considered permanently reinvested pursuant to Accounting Principal Board Opinion (APB) No. 23, Accounting for Income Taxes—Special Areas. In fiscal 2004, all of the foreign subsidiaries’ cumulative positive earnings were considered permanently reinvested, and U.S. taxes were not provided on these amounts (see Note I).

 

Stock-Based Compensation: The Company accounts for its stock option plans in accordance with APB No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. However, the exercise price of all grants under the Company’s option plans has been equal to the fair market value on the date of grant. SFAS No. 123, Accounting for Stock-Based Compensation, requires estimation of the fair value of options granted to employees. Had the Company’s option plans and stock purchase plan been treated as compensatory under the provisions of SFAS No. 123, the Company’s net income (loss) and

 

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Table of Contents

Notes to Consolidated Financial Statements—(Continued)

(in thousands, except per share amounts)

 

net income (loss) per share would have been affected as follows (see Note J to Consolidated Financial Statements for underlying assumptions):

 

     Fiscal Year Ended

 
     May 28,
2005


    May 29,
2004


    May 31,
2003


 

Net income (loss), as reported:

   $ (11,311 )   $ 6,033     $ (26,851 )

Add: Stock-based compensation expense included in reported net income (loss), net of taxes

     425       284       315  

Deduct: Stock-based compensation expense determined under fair value-based method for all awards, net of taxes

     (1,834 )     (1,273 )     (1,561 )
    


 


 


Pro-forma net income (loss)

   $ (12,720 )   $ 5,044     $ (28,097 )
    


 


 


Net income (loss) per share—basic:

                        

Reported net income (loss)

   $ (0.67 )   $ 0.43     $ (1.94 )

Pro-forma compensation expense, net of taxes

     (0.08 )     (0.07 )     (0.09 )
    


 


 


Pro-forma net income (loss) per share—basic

   $ (0.75 )   $ 0.36     $ (2.03 )
    


 


 


Net income (loss) per share—diluted:

                        

Reported net income (loss)

   $ (0.67 )   $ 0.42     $ (1.94 )

Pro-forma compensation expense, net of taxes

     (0.08 )     (0.07 )     (0.09 )
    


 


 


Pro-forma net income (loss) per share—diluted

   $ (0.75 )   $ 0.35     $ (2.03 )
    


 


 


 

Earnings per Share: Basic earnings per share is calculated by dividing net income by the weighted average number of common and Class B common shares outstanding. Diluted earnings per share is calculated by dividing net income, adjusted for interest savings, net of tax, on assumed bond conversions, by the actual shares outstanding and share equivalents that would arise from the exercise of stock options, certain restricted stock awards, and the assumed conversion of convertible bonds when dilutive. The per share amounts presented in the Consolidated Statements of Operations are based on the following amounts:

 

     Fiscal Year Ended

 
     May 28,
2005


    May 29,
2004


   May 31,
2003


 

Numerator for basic EPS:

                       

Net income (loss)

   $ (11,311 )   $ 6,033    $ (26,851 )

Denominator for basic EPS:

                       

Weighted average shares outstanding

     16,942       14,040      13,809  

Numerator for diluted EPS:

                       

Net income (loss)

   $ (11,311 )   $ 6,033    $ (26,851 )

Denominator for diluted EPS:

                       

Weighted average shares outstanding

     16,942       14,418      13,809  

 

In computation of diluted loss per share for the fiscal year ended May 28, 2005, the assumed conversion of the Company’s 7 1/4% and 8 1/4% convertible debentures, the 7 3/4% convertible notes, all stock options, and all restricted stock awards were excluded because their inclusion would have been antidilutive. In computation of diluted earnings per share for the fiscal year ended May 29, 2004, the assumed conversion of the Company’s 8 1/4% and 7 1/4% convertible debentures and 451 stock options with exercise prices greater than the average

 

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Table of Contents

Notes to Consolidated Financial Statements—(Continued)

(in thousands, except per share amounts)

 

market price of the underlying stock were excluded because their inclusions would have been antidilutive. In computation of diluted loss per share for the fiscal year ended May 31, 2003, the assumed conversion of the Company’s 8 1/4% and 7 1/4% convertible debentures, all stock options, and all restricted stock awards were excluded because their inclusion would have been antidilutive.

 

Derivatives and Hedging Activities: The Company accounts for derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This standard requires the Company to recognize all derivatives on the balance sheet at fair value. Derivative value changes are recorded in income for any contracts not classified as qualifying hedging instruments. For derivatives qualifying as cash flow hedge instruments, the effective portion of the derivative fair value change must be recorded through other comprehensive income, a component of stockholders’ equity.

 

New Accounting Pronouncement: In December 2004, the Financial Accounting Standards Board (FASB) revised SFAS No. 123, Accounting for Stock-Based Compensation. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) is effective at the beginning of the next fiscal year that begins after June 15, 2005, or the Company’s fiscal year 2007. The Company is evaluating the impact of the adoption of SFAS No. 123(R) on the financial statements.

 

Note B—Goodwill and Other Intangible Assets

 

As discussed in Note A, the Company adopted the new rules on accounting for goodwill and other intangible assets effective June 2, 2002, and, accordingly, discontinued the amortization of goodwill and other intangible assets not subject to amortization.

 

During the second quarter of fiscal 2003, the Company completed both steps of the required impairment tests of goodwill and indefinite life intangible assets for each of the reporting units as required under the transitional accounting provisions of SFAS No. 142. In identifying reporting units, the Company evaluated its reporting structure as of June 2, 2002. The Company concluded that the following operating segments and their components qualified as reporting units: RF & Wireless Communications, Broadcast, Display Systems Group, Industrial Power Group, Burtek, and Security Systems Division excluding Burtek. The first step in the process of goodwill impairment testing is a screen for potential impairment of the goodwill and other long lived assets, while the second step measures the amount of the impairment. The Company used a discounted cash flow valuation (income approach) to determine the fair value of each of the reporting units. Sales, net income, and EBITDA multiples (market approaches) were used as a check against the impairment implications derived under the income approach. The first step indicated that goodwill and other long lived assets of RF & Wireless Communications, Broadcast and Security Systems Division excluding Burtek were impaired. In evaluating the amount of impairment, it was determined that all goodwill and other long lived assets were impaired for the aforementioned reporting units. Consequently, the Company recorded, effective at the beginning of fiscal 2003, an impairment loss of $21.6 million of which $21.5 million related to goodwill with the balance attributable to other intangible assets with indefinite useful lives. The impairment loss of $17.9 million, net of tax of $3.7 million, was recorded as a cumulative effect of a change in accounting principle.

 

The Company performed its annual impairment test during the fourth quarter of fiscal 2005. The same methodology was employed in completing the annual impairment test as in applying transitional accounting provisions of SFAS No. 142. The Company did not find any indication that additional impairment existed and, therefore, no additional impairment loss was recorded as a result of completing the annual impairment test.

 

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Table of Contents

Notes to Consolidated Financial Statements—(Continued)

(in thousands, except per share amounts)

 

The table below provides changes in carrying value of goodwill by reportable segment which includes RF & Wireless Communications Group (RFWC), Industrial Power Group (IPG), Security Systems Division (SSD), and Display Systems Group (DSG):

 

     Goodwill

     Reportable segments

     RFWC

   IPG

   SSD

   DSG

   Total

Balance at May 29, 2004

   $ —      $ 876    $ 1,482    $ 3,420    $ 5,778

Additions

     —        244      —        26      270

Foreign currency translation

     —        6      95      —        101
    

  

  

  

  

Balance at May 28, 2005

   $ —      $ 1,126    $ 1,577    $ 3,446    $ 6,149
    

  

  

  

  

 

The addition to goodwill during fiscal 2005 represents the acquisition of Evergreen under IPG and additional consideration for the Pixelink (under DSG) acquisition made in fiscal 1999 due to the acquired business achieving certain targeted operating levels.

 

The following table provides changes in carrying value of other intangible assets not subject to amortization:

 

     Other intangible assets not subject to amortization

     Reportable segments

     RFWC

   IPG

   SSD

   DSG

   Total

Balance at May 29, 2004

   $ —      $ 9    $ 248    $ —      $ 257

Foreign currency translation

     —        —        30      —        30
    

  

  

  

  

Balance at May 28, 2005

   $ —      $ 9    $ 278    $ —      $ 287
    

  

  

  

  

 

Intangible assets subject to amortization as well as amortization expense are as follows:

 

     Intangible assets subject to amortization as of

     May 28, 2005

   May 29, 2004

   May 31, 2003

Gross amounts:

                    

Deferred financing costs

   $ 2,968    $ 2,192    $ 2,191

Patents and trademarks

     478      478      478
    

  

  

Total gross amounts

     3,446      2,670      2,669
    

  

  

Accumulated amortization:

                    

Deferred financing costs

     2,241      1,935      1,647

Patents and trademarks

     474      461      448
    

  

  

Total accumulated amortization

   $ 2,715    $ 2,396    $ 2,095
    

  

  

 

Deferred financing costs increased during fiscal 2005 due to the renewal of the Company’s multi-currency revolving credit agreement during the second quarter of fiscal 2005 and the convertible debenture exchanges made in the third quarter of fiscal 2005 (see Note F).