Form
10-Q for VIDEO DISPLAY CORP
30-Jan-2006
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion
should be read in conjunction with the attached interim consolidated financial
statements and with the Company's 2005 Annual Report to Shareholders, which
included audited financial statements and notes thereto for the fiscal year
ended February 28, 2005, as well as Management's Discussion and Analysis of
Financial Condition and Results of Operations.
Overview
The Company is a worldwide
leader in the manufacture and distribution of a wide range of display devices,
encompassing, among others, entertainment, military, medical and simulation
display solutions. The Company is comprised of two segments - (1) the
manufacture and distribution of monitors, projection systems and CRT displays
and (2) the wholesale distribution of consumer electronic parts. The display
segment is organized into four interrelated operations aggregated into one
operating segment pursuant to the aggregation criteria of SFAS 131:
• Monitors - offers a
complete range of CRTs, flat panel displays and projection systems for use in
training and simulation, military, medical and industrial applications.
• Data Display - offers a
complete range of CRTs for use in data display screen, including computer
terminal monitors and medical monitoring equipment.
• Home Entertainment -
offers a complete range of CRTs and projection tubes for television and home
theater equipment.
• Components - provides
replacement electron guns for CRTs for independent customers as well as
servicing the Company's internal needs.
Third Quarter and Year to
Date 2006 Highlights
• Monitor division revenue -
The Company continues to focus its growth efforts on various niche markets
within the defense, medical and projection display industries. Net sales within
this division decreased in the third quarter of fiscal 2006 by $1.0 million
compared to the third quarter of fiscal 2005 due to the fulfillment of a
military contract for replacement CRTs earlier in fiscal 2006, which has not
been renewed. For the nine months ended November 30, 2005, net revenue
decreased $0.1 million or 0.3% compared to the same period a year ago. On a
year to date basis, the decline in replacement military CRT sales was largely
offset by the Evans & Sutherland product line acquired in November 2004,
which was consolidated with the Company's Display Systems operations in Cape
Canaveral, FL.
• Data Display division
revenue - the Company's Data Display division sales decreased $0.5 million for
the three months ended November 30, 2005, as compared to the same period a year
ago, due to a larger concentration of lower priced replacement CRTs in the current
quarter's sales mix compared to the prior year period. Sales in this division
increased $1.1 million for the nine months ended November 30, 2005 as compared
to the same period a year ago. These increases reflect the Company's decision
to distribute projection tubes from its Data Display location in Tucker, GA.
These projection units carry a higher sales price per unit than the Company's
normal inventory.
• Acquisition - during the
first quarter of fiscal 2006, the Company acquired the IDS division of Three
Five Systems, Inc., consisting of inventory and certain assets. The newly
acquired operation has acquired leased facilities in Marlboro, MA and has now
completed its relocation to the new facility and will operate as a division of
the Company's Aydin Display Systems operations.
• New credit facility - in
April 2005, the Company finalized a new line of credit to replace a prior
facility. Under the terms of this new facility, the Company paid off the
existing line of credit as well as a mortgage securing the
land and building of Fox International, Ltd. The maximum amount available
for borrowings under this new line is $3.5 million compared to approximately
$2.8 million under the prior facility. Proceeds from this line are available
for working capital needs of the Company.
Fiscal 2006 Challenges
Inventory management - the
Company continually monitors historical sales trends as well as projected
future needs to ensure adequate on hand supplies of inventory and to ensure
against overstocking of slower moving, obsolete items.
Certain of the Company's
divisions maintain significant inventories of CRTs and component parts in an
effort to ensure its customers a reliable source of supply. The Company's
inventory turnover averages over 175 days, although in many cases the Company
would anticipate holding 90 to 100 days of inventory in the normal course of
operations. This level of inventory is higher than some of the Company's
competitors due to the fact that it 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 discontinue production or exit the
business, the Company may make last time buys. In the monitor operations of the
Company's business, the market for its products is characterized by fairly
rapid change as a result of the development of new technologies, particularly
in the flat panel display area. If the Company fails to anticipate the changing
needs of its customers and accurately forecast their requirements, it may
accumulate inventories of products which its customers no longer need and which
the Company will be unable to sell or return to its vendors. Because of this, the
Company's management monitors the adequacy of its inventory reserves regularly,
and at November 30, 2005, believes its reserves to be adequate.
Interest rate exposure - The
Company had outstanding bank debt in excess of $24.0 million as of November 30,
2005, all of which is subject to interest rate fluctuations by the Company's
lenders. Higher rates applied by the Federal Reserve Board over the past four
fiscal quarters and potential continued rate hikes have negatively affected the
Company's earnings and will continue to negatively impact the Company's
earnings. It is the intent of the Company to continually monitor interest rates
and consider converting portions of the Company's debt from floating rates to
fixed rates should conditions be favorable for such interest rate swaps or
hedges.
Prior Period Restatement
During preparation of the
3rd quarter Fiscal 2006 financial statements, the Company discovered an error
in its accounting for the treatment of foreign subsidiary losses for income tax
purposes in the fiscal year ended February 28, 2005 and certain non-income
tax-based franchise taxes in the fiscal year ended February 28, 2005 and
several prior fiscal years. A clerical error in the calculation of the tax
effects of foreign losses resulted in an understatement of the Company's fiscal
2005 consolidated provision for income taxes by approximately $129,000. In
addition, for several years, the Company has applied the payment of non-income
based franchise taxes against income taxes payable. Due to improper income
taxes payable account reconciliation procedures, this error was not detected.
The Company did not recognize general and administrative expense when the
franchise taxes were paid. Proper recognition of these franchise taxes in
general and administrative expenses reduces reported net income by
approximately $86,000 in fiscal 2005, $53,000 in fiscal 2004, $47,000 in fiscal
2003, $26,000 in fiscal 2002 and approximately $53,000 in fiscal 2001 and years
prior. These adjustments did not have a material impact on reported cash flows.
The effect of these errors on reported net income is summarized as follows (in
thousands):
Fiscal Year 2005 2004 Prior Net income, previously reported $ 3,722 $ 3,165 General and Administrative expense, net of income taxes (86 ) (53 ) $ (126 ) Provision for income taxes (129 ) - - Net effect of adjustments (215 ) (53 ) $ (126 ) Net income, as restated $ 3,507 $ 3,112 Diluted earnings per share of common stock, previously reported $ .38 $ .33 Diluted earnings per share of common stock, as restated $ .35 $ .32 |
Management has determined
that the error was the result of a control deficiency with respect to the
Company's procedures in calculating and reporting its franchise tax and the
treatment of foreign losses in the provision for income taxes under SFAS 109, and
the proper reconciliation of those items to related consolidated balance sheet
accounts. Management believes that this control deficiency constituted a
material weakness. A material weakness is a control deficiency, or a
combination of control deficiencies, that results in a more than remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. The Company has recently employed
additional experienced financial staff, as reported in its Form 8-K filed
December 20, 2005, to address this weakness and has amended its procedures for
the preparation and review of recorded income tax amounts included in the
Company's consolidated financial statements.
Management has reviewed the
impact of these errors on reported results of operations for the years
affected, utilizing criteria set forth in Staff Accounting Bulletin 99,
including the qualitative and quantitative elements outlined in that statement.
Management has determined that the impact of this adjustment in each of the
years affected is not material to
reported results of operations on either a qualitative or quantitative
basis in the respective years. Based on this determination, the Company does
not plan to re-file its Annual Report on Form 10-K for fiscal 2005.
Results of Operations The following table sets forth, for the three and nine months ended November 30, 2005 and 2004, the percentages which selected items in the Statements of Income bear to total sales: Three Months Nine Months Ended November 30, Ended November 30, 2005 2004 2005 2004 Sales Display Segment Monitors 62.0 % 61.5 % 60.6 % 62.2 % Data Display CRTs 8.9 10.3 11.3 9.9 Entertainment CRTs 4.5 5.0 4.6 5.4 Electron Guns and Components 0.9 1.3 0.9 1.1 Total Display Segment 76.3 % 78.1 % 77.4 % 78.6 % Wholesale Distribution Segment 23.7 21.9 22.6 21.4 100.0 % 100.0 % 100.0 % 100.0 % Costs and expenses Cost of goods sold 67.2 % 66.3 % 67.6 % 66.7 % Selling and delivery 9.8 8.1 8.7 8.5 General and administrative 19.0 16.6 17.2 15.4 96.0 % 91.0 % 93.5 % 90.6 % Income from Operations 4.0 % 9.0 % 6.5 % 9.4 % Interest expense (1.8 )% (1.1 )% (1.6 )% (1.2 )% Other income, net 0.0 0.1 0.1 0.4 Income before income taxes 2.2 % 8.0 % 5.0 % 8.5 % Provision for income taxes 0.9 3.1 1.9 3.3 Net Income 1.3 % 4.9 % 3.1 % 5.3 % |
Net sales
Consolidated net sales
decreased $1.8 million for the three months ended November 30, 2005 and
increased $1.4 million for the nine months ended November 30, 2005, as compared
to the same periods ended November 30, 2004. Display segment sales decreased
$1.7 million for the three-month comparative period and increased $0.4 million
for the nine-month comparative period. Sales within the Wholesale Distribution
segment were flat for the three-month comparative period and increased $1.0
million for the nine-month comparative period.
The net decrease in Display
Segment sales for the three months ended November 30, 2005 is primarily
attributed to declines within the Monitor and Data Display CRTs divisions, as
compared to the same periods ended November 30, 2004. The Monitor division's
sales declined $1.0 million over the three-month period due to the fulfillment
of a military contract for replacement CRTs earlier in fiscal 2006, which has
not been renewed. The Data Display CRTs division sales declined $0.5 million
over the three-month period due to a larger concentration of lower priced replacement
CRTs in the current quarter's
sales mix compared to the prior year period. Sales of the Entertainment
CRTs and Electron Gun and Components divisions declined $0.2 million and $0.1
million, respectively over the comparable three-month period.
Display Segment net sales
increased $0.4 million for the nine months ended November 30, 2005 as compared
to the same period a year ago. This increase is the result of a $1.1 million
increase in the Data Display CRTs division's sales due to improved sales of
projection tubes, which carry a higher selling price than replacement CRTs, in
the first two quarters of fiscal 2006, partially offset by a $0.4 million
decline in the Entertainment CRTs divisions sales. The Monitors division and
the Electron Gun and Components division sales reflected slight declines of
$0.1 million each for the comparative periods.
The Company is the primary
supplier of replacement television CRTs to the domestic entertainment market. A
large portion of the Entertainment CRTs division's sales (37%) are to major
television retailers as replacements for products sold under manufacturer and
extended warranties. Due to continued lower retail sales prices for mid-size
television sets (25" to 30"), fewer extended warranties were sold by
retailers, a trend consistent with the past two fiscal years. The Company
remains the primary supplier of product to meet manufacturers' standard
warranties. Growth in this division will be impacted by the timing and number
of extended warranties sold for the larger, more expensive sets. Because the
Company is in the replacement market, it has the ability to track retail sales
trends and, accordingly, can attempt to adjust quantities of certain size CRTs
carried in stock and reduce exposure to obsolescence.
Sales in the Electron Gun
and Components division have declined during recent fiscal years due to weaker
demand for electron gun and stem sales. Electron gun sales have historically
been dependent upon the demand by domestic and foreign television CRT remanufacturers.
These sales have declined over the past few years as consumers move towards
purchasing new technology as opposed to repairing existing sets. The Company's
Wintron location is in the process of transitioning to two newer camera
technologies. One such technology will assist border guards with under car
inspections and another will assist correctional facilities with the
supervision of inmates. If this transition is successful, the Company believes
these new technologies will have a positive impact on the component division
sales.
Wholesale Distribution
segment net sales were flat for the three-month period, and increased $1.0
million for the nine- month period, ended November 30, 2005 compared to the
same periods a year ago. Management attributes the fiscal year to date increase
to opening a new call center in the second half of fiscal 2005. This call
center acts as a consumer and dealer support center for both in-warranty and
out-of-warranty household products, appliances, parts and accessories for Black
& Decker, Delonghi, Norelco, Coby and various other manufacturers. This
call center also acts as a technical support center for these same
manufacturers. Other increases within this segment reflect increased volume of
sales to Best Buy and Applica for the comparative periods.
Gross margins
Consolidated gross margins
decreased from 33.7% to 32.8% for the third quarter and from 33.3% to 32.4% for
the nine months ended November 30, 2005 as compared to the same periods ended
November 30, 2004.
Display segment margins
decreased from 29.9% to 25.9% and from 30.4% to 26.4% for the comparative three
and nine month periods. Gross margins within the Monitor division decreased to
26.3% for the nine months ended November 30, 2005 compared to 31.1% for the same
period a year ago and from 30.0% to 26.6% for the three months ended November
30, 2005 compared to the prior year. These decreases are primarily attributable
to decreased sales volume at the Company's Aydin, Teltron and Lexel locations,
costs associated with the integration of the Three Five Systems operation,
higher than expected design costs on certain products, as well as management's
decision to close the XKD location at the end of fiscal 2005.
The Wholesale Distribution
segment margins increased from 47.3% to 54.9% and from 43.9% to 53.3% for the
three and nine months ended November 30, 2005 as compared to the same periods
ended November 30, 2004. These increases are
primarily due to additional revenue generated from its new call center.
Expenses for the call center are classified as operating expenses.
Operating expenses
Operating expenses as a
percentage of sales increased from 24.7% to 28.8% for the quarter ended
November 30, 2005 compared to the quarter ended November 30, 2004 and increased
from 23.9% to 25.9% for the nine-month comparative period.
Display segment operating
expenses increased $0.2 million for the three-month period, and increased $0.5
million for the nine-month period, ended November 30, 2005, as compared to the
comparable prior year periods. Management attributes the majority of these
increases to corporate expenses, such as increased professional fees.
Wholesale Distribution
segment operating expenses increased $0.2 million and $1.2 million compared to
the three and nine month periods a year ago, primarily due to additional
expenses associated with the new call center opened in late fiscal 2005. These
expenses (primarily payroll and telephone) are classified in general and
administrative expense in the consolidated financial statements.
Interest expense
Interest expense increased
$0.1 million and $0.3 million for the three and nine months ended November 30,
2005 as compared to the same periods a year ago. The Company maintains various
debt agreements with different interest rates, most of which are based on the
prime rate or LIBOR. These increases in interest expense primarily reflect
higher market interest rates in effect during Fiscal 2006 compared Fiscal 2005.
Income taxes
The effective tax rate for
the nine months ended November 30, 2005 and November 30, 2004 was 38.5% and
38.2%, respectively. These rates are greater than the Federal statutory rate
primarily due to the effect of state taxes and the permanent non-deductibility
of certain expenses for tax purposes.
Foreign currency translation
Gains or losses resulting
from the transactions with the Company's UK subsidiary are reported in current
operations while currency translation adjustments are recognized in a separate
component of shareholders' equity. There were no significant gains or losses
recognized in either period related to the UK subsidiary.
Liquidity and Capital
Resources
As of November 30, 2005, the
Company had total cash of $1.8 million. The Company's working capital was $42.8
million and $37.2 million at November 30, 2005 and February 28, 2005,
respectively. In recent years, the Company has financed its growth and cash
needs primarily through income from operations, borrowings under revolving
credit facilities and long-term debt. Liquidity provided by operating
activities of the Company is reduced by working capital requirements, largely
inventories and accounts receivable, debt service, capital expenditures,
product line additions and dividends.
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
instances, the Company's products are components of larger display systems for
which immediate availability is critical for the customer. Accordingly, the
Company enjoys higher gross margins, but typically has larger investments in
inventories than those of its competitors.
The Company continues to monitor its cash and financing positions, seeking
to find ways to lower its interest costs and to produce positive operating cash
flow. The Company examines possibilities to grow its business as opportunities
present themselves, such as new sales contracts or niche acquisitions. There
could be an impact on working capital requirements to fund this growth. As in
the past, the intent is to finance such projects with operating cash flows or
existing bank lines; however, more permanent sources of capital may be required
in certain circumstances. In May 2005, the Company acquired the IDS division of
Three Five Systems, Inc. The acquisition consisted of cash to the seller of
approximately $1.4 million total consideration.
Cash provided by operations
for the nine months ended November 30, 2005 was $1.9 million as compared to
cash provided of $1.8 million for the nine months ended November 30, 2004. This
slight increase is attributable to improved collections of receivables as
compared to the same period a year ago and the impact of reduced sales in the
comparable third quarters, partially offset by increases in inventory over the
comparable periods.
Investing activities used
cash of $2.8 million in the first nine months of fiscal 2006, compared to $5.9
million for fiscal 2005. This decrease primarily reflects cash of approximately
$1.4 million used to acquire the IDS division of Three Five Systems, Inc.
during fiscal 2006 compared to cash of approximately $5.3 million used to
acquire certain assets of Evans and Sutherland, Inc. during fiscal 2005.
Capital expenditures increased $1.3 million for the comparable periods. These
expenditures relate primarily to investments in new computer equipment within
the Company's monitors division and upgrades to the call center in the
Wholesale Distribution segment.
Financing activities
provided cash of $1.2 million for the nine months ended November 30, 2005,
compared to cash provided of $5.2 million for the same period a year ago. The
Company executed a new line of credit in November 2004, which provided a higher
borrowing availability in conjunction with its acquisition activities. The
increase in borrowings was partially offset by the Company's decision to
repurchase $317,000 of its common stock in fiscal 2006. No shares were
repurchased in fiscal 2005.
The Company's debt
agreements with financial institutions contain affirmative and negative
covenants, including requirements related to tangible net worth and debt
service coverage and new loans. Additionally, dividend payments, capital
expenditures and acquisitions have certain restrictions. Substantially all of the
Company's retained earnings are restricted based upon these covenants.
The Company was not in
compliance with the consolidated Senior Funded Debt to EBITDA ratio covenant
under the Line of Credit agreements at November 30, 2005. On January 17, 2006,
the Company obtained a waiver of this default from the lender. The Company
expects to be in compliance with the financial covenants over the next twelve
months based on current financial projections and the availability of
subordinated advances from the Company's Chief Executive Officer, if required.
The Company has a stock
repurchase program, approved by the Board of Directors of the Company in
increments starting in fiscal 1998, pursuant to which it is authorized to
repurchase up to 462,500 shares of the Company's common stock in the open
market. The Company repurchased 25,621 shares in May 2005. No shares were
repurchased in fiscal 2005. Under this program, an additional 144,900 shares
remain authorized to be repurchased by the Company at November 30, 2005.
On January 11, 2006, the
Board of Directors of the Company approved a continuation of the stock
repurchase program, and authorized the repurchase of up to 600,000 additional
shares of the Company's common stock, depending on the market price of the shares.
There is no minimum or maximum number of shares required to be repurchased
under the program.
The Company paid a cash
dividend of $0.4 million in the fourth quarter of fiscal 2005. The policy
regarding future payments of dividends will be reviewed periodically by the
Board of Directors and will be based on the earnings and financial position of
the Company and other factors which the Board of Directors deems appropriate.
Critical Accounting Policies
Management's Discussion and
Analysis of Financial Condition and Results of Operations are based upon the
Company's consolidated financial statements. These financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States of America. These principles require the use of estimates and
assumptions that affect amounts reported and disclosed in the financial
statements and related notes. The accounting policies that may involve a higher
degree of judgments, estimates, and complexity include reserves on inventories,
revenue recognition, the allowance for bad debts and warranty reserves. The
Company uses the following methods and assumptions in determining its
estimates:
Reserves on inventories
Reserves on inventories
result in a charge to operations when the estimated net realizable value
declines below cost. Management regularly reviews the Company's investment in
inventories for declines in value and establishes reserves when it is apparent
that the expected net realizable value of the inventory falls below its
carrying amount. Management considers the projected demand for CRTs in this
estimate of net realizable value. Management is able to identify consumer
buying trends, such as size and application, well in advance of supplying
replacement CRTs. Thus, the Company is able to adjust inventory-stocking levels
according to the projected demand. The average life of a CRT is five to seven
years, at which time the Company's replacement market develops. Management
reviews inventory levels on a quarterly basis. Such reviews include
observations of product development trends of the OEMs, new products being
marketed, and technological advances relative to the product capabilities of
the Company's existing inventories. There have been no significant changes in
management's estimates in fiscal 2006 and 2005; however, the Company cannot
guarantee the accuracy of future forecasts since these estimates are subject to
change based on market conditions.
Revenue Recognition
Revenue is recognized on the
sale of products when the products are shipped, all significant contractual
obligations have been satisfied, and the collection of the resulting receivable
is reasonably assured. The Company's delivery term typically is F.O.B. shipping
point.