UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended November 30, 2004
or
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 0-22183
MEADE INSTRUMENTS CORP.
| Delaware (State or other jurisdiction of incorporation or organization) |
95-2988062 (I.R.S. Employer Identification No.) |
|
| 6001 Oak Canyon, Irvine, CA (Address of principal executive offices) |
92618 (Zip Code) |
(949) 451-1450
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ
Number of shares of common stock outstanding as of December 31, 2004 is 20,001,855, $0.01 par value per share.
MEADE INSTRUMENTS CORP.
TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
Page No.
ITEM 1. FINANCIAL STATEMENTS.
MEADE INSTRUMENTS CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
| November 30, | February 29, | |||||||
| 2004 | 2004 | |||||||
Current assets: |
||||||||
Cash |
$ | 894,000 | $ | 7,806,000 | ||||
Accounts receivable, less allowance for doubtful accounts of $742,000
at November 30, 2004 and $704,000 at February 29, 2004 |
43,948,000 | 22,462,000 | ||||||
Inventories |
49,678,000 | 39,777,000 | ||||||
Deferred income taxes |
6,629,000 | 7,888,000 | ||||||
Prepaid expenses and other current assets |
714,000 | 491,000 | ||||||
Total current assets |
101,863,000 | 78,424,000 | ||||||
Goodwill |
1,548,000 | 1,548,000 | ||||||
Acquisition-related intangible assets, net |
3,466,000 | 3,742,000 | ||||||
Property and equipment, net |
4,107,000 | 4,551,000 | ||||||
Other assets, net |
89,000 | 297,000 | ||||||
| $ | 111,073,000 | $ | 88,562,000 | |||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
Current liabilities: |
||||||||
Bank line of credit |
$ | 21,402,000 | $ | 5,059,000 | ||||
Accounts payable |
11,259,000 | 5,319,000 | ||||||
Accrued liabilities |
7,484,000 | 6,884,000 | ||||||
Income taxes payable |
2,185,000 | 3,059,000 | ||||||
Current portion long-term debt |
590,000 | 580,000 | ||||||
Total current liabilities |
42,920,000 | 20,901,000 | ||||||
Long-term bank debt |
1,354,000 | 1,729,000 | ||||||
Deferred income taxes |
1,054,000 | 1,054,000 | ||||||
Total long-term liabilities |
2,408,000 | 2,783,000 | ||||||
Commitments and contingencies
Stockholders’ equity: |
||||||||
Common stock, $0.01 par value, 50,000,000 shares authorized;
20,002,000 shares issued and outstanding at November 30, 2004
and 19,989,000 at February 29, 2004, respectively |
200,000 | 200,000 | ||||||
Additional paid-in capital |
40,452,000 | 40,445,000 | ||||||
Retained earnings |
26,650,000 | 25,891,000 | ||||||
Accumulated other comprehensive income |
617,000 | 882,000 | ||||||
| 67,919,000 | 67,418,000 | |||||||
Unearned ESOP shares |
(2,174,000 | ) | (2,540,000 | ) | ||||
Total stockholders’ equity |
65,745,000 | 64,878,000 | ||||||
| $ | 111,073,000 | $ | 88,562,000 | |||||
See accompanying notes to consolidated financial statements.
1
MEADE INSTRUMENTS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| Three Months Ended | Nine months Ended | |||||||||||||||
| November 30, | November 30, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Net sales |
$ | 49,687,000 | $ | 54,448,000 | $ | 92,060,000 | $ | 107,223,000 | ||||||||
Cost of sales |
35,775,000 | 37,892,000 | 67,626,000 | 76,773,000 | ||||||||||||
Gross profit |
13,912,000 | 16,556,000 | 24,434,000 | 30,450,000 | ||||||||||||
Selling expenses |
5,911,000 | 6,573,000 | 13,163,000 | 14,158,000 | ||||||||||||
General and administrative
expenses |
2,223,000 | 3,275,000 | 7,410,000 | 8,970,000 | ||||||||||||
ESOP expense |
130,000 | 341,000 | 318,000 | 635,000 | ||||||||||||
Research and development expenses |
672,000 | 462,000 | 1,639,000 | 1,451,000 | ||||||||||||
Operating income |
4,976,000 | 5,905,000 | 1,904,000 | 5,236,000 | ||||||||||||
Interest expense |
283,000 | 325,000 | 633,000 | 761,000 | ||||||||||||
Income before income taxes |
4,693,000 | 5,580,000 | 1,271,000 | 4,475,000 | ||||||||||||
Provision for income taxes |
1,894,000 | 2,204,000 | 512,000 | 1,771,000 | ||||||||||||
Net income |
$ | 2,799,000 | $ | 3,376,000 | $ | 759,000 | $ | 2,704,000 | ||||||||
Basic earnings per share |
$ | 0.14 | $ | 0.18 | $ | 0.04 | $ | 0.14 | ||||||||
Diluted earnings per share |
$ | 0.14 | $ | 0.17 | $ | 0.04 | $ | 0.14 | ||||||||
Weighted average number of shares
outstanding — basic |
19,312,000 | 19,070,000 | 19,269,000 | 18,911,000 | ||||||||||||
Weighted average number of shares
outstanding — diluted |
19,477,000 | 19,335,000 | 19,445,000 | 19,068,000 | ||||||||||||
See accompanying notes to consolidated financial statements.
2
MEADE INSTRUMENTS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| Nine months Ended | ||||||||
| November 30, | ||||||||
| 2004 | 2003 | |||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 759,000 | $ | 2,704,000 | ||||
Adjustments to reconcile net loss to net cash
used in operating activities: |
||||||||
Depreciation and amortization expense |
1,346,000 | 1,541,000 | ||||||
ESOP contribution |
318,000 | 635,000 | ||||||
Changes in assets and liabilities: |
||||||||
Increase in accounts receivable |
(20,292,000 | ) | (27,344,000 | ) | ||||
Increase in inventories |
(9,585,000 | ) | (6,955,000 | ) | ||||
Decrease in prepaid expenses and other assets |
940,000 | 1,224,000 | ||||||
Increase in accounts payable |
5,603,000 | 3,683,000 | ||||||
Increase (decrease) in accrued liabilities |
(571,000 | ) | 783,000 | |||||
Increase (decrease) in income taxes payable |
(190,000 | ) | 1,468,000 | |||||
Net cash used in operating activities |
(21,672,000 | ) | (22,261,000 | ) | ||||
Cash flows from investing activities: |
||||||||
Capital expenditures |
(562,000 | ) | (323,000 | ) | ||||
Net cash used in investing activities |
(562,000 | ) | (323,000 | ) | ||||
Cash flows from financing activities: |
||||||||
Net borrowings under bank lines of credit |
16,032,000 | 22,012,000 | ||||||
Payments on long-term bank notes |
(431,000 | ) | (398,000 | ) | ||||
Proceeds from the exercise of stock options |
32,000 | 410,000 | ||||||
Payments under capital lease obligations |
— | (25,000 | ) | |||||
Net cash provided by financing activities |
15,633,000 | 21,999,000 | ||||||
Effect of exchange rate changes on cash |
(311,000 | ) | 307,000 | |||||
Net increase (decrease) in cash |
(6,912,000 | ) | (278,000 | ) | ||||
Cash at beginning of period |
7,806,000 | 2,445,000 | ||||||
Cash at end of period |
$ | 894,000 | $ | 2,167,000 | ||||
See accompanying notes to consolidated financial statements.
3
MEADE INSTRUMENTS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. Basis of Presentation
In management’s opinion, the information and amounts furnished in this report reflect all adjustments (consisting of normal recurring adjustments) considered necessary for the fair presentation of the financial position and results of operations for the interim periods presented. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended February 29, 2004.
The Company has experienced, and expects to continue to experience, substantial fluctuations in its sales, gross margins and profitability from quarter to quarter. Factors that influence these fluctuations include the volume and timing of orders received, changes in the mix of products sold, market acceptance of the Company’s products, competitive pricing pressures, the Company’s ability to meet demand and delivery schedules and the timing and extent of research and development expenses, marketing expenses and product development expenses. In addition, a substantial portion of the Company’s net sales and operating income typically occur in the third quarter of the Company’s fiscal year primarily due to disproportionately higher customer demand for less-expensive products during the holiday season. The results of operations for the quarters ended November 30, 2004 and 2003, respectively, are not necessarily indicative of the operating results for the entire fiscal year.
B. Stock Based Compensation
The Company accounts for employee stock-based compensation in accordance with the intrinsic value method described in Accounting Principles Board Opinion No. 25 and related interpretations. The Company has adopted the disclosure only provisions of SFAS No. 123. Accordingly, no compensation cost has been recognized for the fixed stock option plans. Had compensation expense for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, consistent with the method prescribed by SFAS No. 123, the Company’s net income per share would have been adjusted to the pro forma amounts indicated below.
| Three months ended | Nine months ended | |||||||||||||||
| November 30, | November 30, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Reported income |
$ | 2,799,000 | $ | 3,376,000 | $ | 759,000 | $ | 2,704,000 | ||||||||
Compensation expense determined under fair value
method, net of tax |
(268,000 | ) | (45,000 | ) | (781,000 | ) | (583,000 | ) | ||||||||
Pro forma net income (loss) |
$ | 2,531,000 | $ | 3,331,000 | ) | $ | (22,000 | ) | $ | 2,121,000 | ||||||
Reported net income per share – basic |
$ | 0.14 | $ | 0.18 | $ | 0.04 | $ | 0.14 | ||||||||
Reported net income per share – diluted |
$ | 0.14 | $ | 0.17 | $ | 0.04 | $ | 0.14 | ||||||||
Pro forma income (loss) per share – basic and diluted |
$ | 0.13 | $ | 0.17 | $ | (0.00 | ) | $ | 0.11 | |||||||
The fair value of the Company’s stock options used to compute pro forma net income and earnings per share disclosures is the estimated present value at grant date using the Black-Scholes option-pricing model with the following assumptions:
| Three months ended | Nine months ended | |||||||||||||||
| November 30, | November 30, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Weighted average expected life (years) |
6.0 | 6.0 | 6.0 | 6.0 | ||||||||||||
Volatility |
69.3 | % | 100.9 | % | 69.3 | % | 100.9 | % | ||||||||
Risk-free interest rate |
3.38 | % | 3.75 | % | 3.38 | % | 3.75 | % | ||||||||
Expected dividends |
None | None | None | None | ||||||||||||
Weighted average fair value of options granted |
$ | 2.01 | $ | 2.34 | $ | 2.01 | $ | 2.34 | ||||||||
4
C. Composition of Certain Balance Sheet Accounts
The composition of inventories is as follows:
| November 30, | February 29, | |||||||
| 2004 | 2004 | |||||||
Raw materials |
$ | 6,695,000 | $ | 7,691,000 | ||||
Work-in-process |
5,764,000 | 6,193,000 | ||||||
Finished goods. |
37,219,000 | 25,893,000 | ||||||
| $ | 49,678,000 | $ | 39,777,000 | |||||
The composition of acquisition-related intangible assets is as follows:
| November 30, | February 29, | |||||||
| 2004 | 2004 | |||||||
Brand names – non-amortizing |
$ | 2,041,000 | $ | 2,041,000 | ||||
Trademarks (7-15 year life) |
1,398,000 | 1,398,000 | ||||||
Customer relationships (10 year life) |
1,390,000 | 1,390,000 | ||||||
Accumulated amortization |
(1,363,000 | ) | (1,087,000 | ) | ||||
Total amortizing acquisition-related intangible assets |
1,425,000 | 1,701,000 | ||||||
Total acquisition-related intangible assets |
$ | 3,466,000 | $ | 3,742,000 | ||||
Amortization of trademarks and customer relationships over the next five fiscal years is estimated as follows:
| Fiscal Year | Amount | |||
2005 |
$ | 367,000 | ||
2006 |
367,000 | |||
2007 |
139,000 | |||
2008 |
139,000 | |||
2009 |
139,000 | |||
The Company accounts for goodwill and acquisition-related intangible assets in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” which requires that goodwill and identifiable assets determined to have an indefinite life no longer be amortized, but instead be tested for impairment at least annually or when an indicator of impairment exists.
D. Commitments and Contingencies
In 2001 and 2002, the Company filed suits against Tasco Sales, Inc. (“Tasco”) and Celestron International, Inc. (“Celestron”), charging the two companies with patent infringement and unfair competition. The complaints alleged that a number of Tasco’s and Celestron’s consumer telescopes willfully infringe certain of the Company’s U.S. patents. Tasco and Celestron filed answers and certain counterclaims denying the Company’s allegations. The counterclaims also alleged, among other things, that the Company infringed certain Celestron patents. On July 8, 2004, the Company announced that it had reached an agreement, effective May 10, 2004, under which all outstanding litigation between the parties had been resolved.
As stipulated in the agreement, Celestron acknowledges the validity of Meade’s claims to two utility patents (“Meade’s Patents”), including the “level-North” alignment technology for computerized telescopes, as well as a patented architecture by which several microprocessors in a computerized telescope optimally communicate with one another. Also as stipulated in the agreement, Meade acknowledges the validity of Celestron’s claim to two design patents and one utility patent covering certain telescope tripods and mounts (“Celestron’s Patents”). Celestron also transfers to Meade ownership of a patent, originally claimed by Celestron, covering “level-North” technology.
The settlement includes a licensing agreement under which, effective August 15, 2004, and continuing for the life of the Meade Patents, Meade granted Celestron a non-exclusive license to utilize the patents, and Celestron will pay to Meade royalties equal to the greater of $100-per-unit or 8% of Celestron’s net revenue from sales of all telescopes that utilize the “level-North” technology. Celestron in turn granted Meade royalty-free, non-exclusive licenses for the rights to use the designs and technology covered by Celestron’s Patents. Included in net sales for the three and nine months ended November 30, 2004 was approximately $23,000 for royalties received.
5
In accordance with the terms of the agreement the parties have dismissed with prejudice all claims and counterclaims in the pending litigation between them, including for past damages.
The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of such litigation will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
E. Earnings Per Share
Basic earnings per share amounts exclude the dilutive effect of potential shares of common stock. Basic earnings per share is based upon the weighted-average number of shares of common stock outstanding which excludes unallocated ESOP shares. Diluted earnings per share is based upon the weighted-average number of shares of common stock and dilutive potential shares of common stock outstanding for each period presented. Potential shares of common stock consist of outstanding stock options which are included under the treasury stock method. The sole difference between the basic weighted average number of shares outstanding and the diluted weighted average number of shares outstanding for the three and nine month periods ended November 30, 2004 and 2003 reflects additional potential shares of common stock for outstanding stock options.
F. Comprehensive Income
Comprehensive income is defined as a change in the equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources and, at November 30, 2004, includes foreign currency translation adjustments and adjustments to the fair value of highly effective derivative instruments. For the periods ended November 30, 2004, the Company had other comprehensive income as follows:
| Three months ended | Nine months ended | |||||||||||||||
| November 30, | November 30, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Net income |
$ | 2,799,000 | $ | 3,376,000 | $ | 759,000 | $ | 2,704,000 | ||||||||
Currency translation adjustments, net of tax |
540,000 | 412,000 | 392,000 | 408,000 | ||||||||||||
Change in fair value of foreign currency forward
contracts, net of tax |
165,000 | 392,000 | (674,000 | ) | (13,000 | ) | ||||||||||
Unrealized loss in marketable securities, net of tax |
— | — | — | (97,000 | ) | |||||||||||
Change in fair value of interest rate swap |
2,000 | 9,000 | 17,000 | 26,000 | ||||||||||||
Total other comprehensive income |
$ | 3,506,000 | $ | 4,189,000 | $ | 494,000 | $ | 3,028,000 | ||||||||
G. Product Warranties
The Company provides reserves for the estimated cost of product warranty-related claims at the time of sale, and periodically adjusts the provision to reflect actual experience. The amount of warranty liability accrued reflects management’s best estimate of the expected future cost of honoring Company obligations under its warranty plans. Additionally, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Meade and Bresser branded products, principally telescopes and binoculars, are generally covered by a one or two-year limited warranty. Many of the Simmons products, principally riflescopes and binoculars, have lifetime limited warranties. The following are changes in the warranty liability, which is included as a component of accrued liabilities on the accompanying Consolidated Balance Sheets.
| Three months ended | Nine months ended | |||||||||||||||
| November 30, | November 30, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Beginning balance |
$ | 1,159,000 | $ | 1,560,000 | $ | 1,427,000 | $ | 1,794,000 | ||||||||
Warranty accrual |
70,000 | 507,000 | 326,000 | 714,000 | ||||||||||||
Labor and material usage |
(151,000 | ) | (231,000 | ) | (675,000 | ) | (672,000 | ) | ||||||||
Ending balance |
$ | 1,078,000 | $ | 1,836,000 | $ | 1,078,000 | $ | 1,836,000 | ||||||||
6
H. Derivative instruments and hedging activities
The Company utilizes a variety of derivative financial instruments to manage its currency exchange rate and interest rate risks as summarized below. The Company does not enter into these arrangements for trading or speculation purposes.
| November 30, 2004 | February 29, 2004 | |||||||||||||||
| Notional amount | Fair Value | Notional amount | Fair Value | |||||||||||||
Interest rate swap agreement |
$ | — | $ | — | $ | 1,085,000 | $ | (17,000 | ) | |||||||
Cash flow forward currency contracts |
$ | 3,400,000 | $ | (1,123,000 | ) | — | — | |||||||||
At November 30, 2004, the fair values of forward currency contracts are recorded in accrued liabilities on the accompanying Consolidated Balance Sheets. As of November 30, 2004, the interest rate swap agreement had matured. Changes in the fair value of the interest rate swap agreement and the cash flow forward currency contracts have been recorded as a component of other comprehensive income, net of tax, as these items have been designated and qualify as cash flow hedges. The settlement dates on the forward currency contracts vary based on the underlying instruments through April 2005.
I. Bank Borrowings
At November 30, 2004, the Company was in compliance with all restrictive covenants and required ratios under its U.S. credit agreement, with the exception of its U.S. fixed charge coverage ratio requirement. On December 15, 2004 the Company executed the Third Amendment to Amended and Restated Credit Agreement (the “Amendment”). The Amendment amends the U.S. fixed charge coverage ratio covenant, the consolidated fixed charge coverage ratio covenant, sets minimum availability requirements, and makes several other changes, principally adjusting the facility’s pricing tables. The Company is required to report its covenant calculations to the bank for the quarter ended November 30, 2004 based upon the terms of the Amendment. The Company was in compliance with all restrictive covenants and required ratios as of November 30, 2004 after giving effect to the Amendment.
J. Subsequent event
On December 1, 2004, Coronado Instruments, Inc., a California corporation (“Coronado Instruments”) and wholly-owned subsidiary of Meade signed an agreement to purchase substantially all of the assets and assume substantially all of the liabilities of Coronado Technology Group LLC (“Coronado”), an Arizona limited liability company in the business of manufacturing and selling solar observation filters and equipment. Meade will account for the purchase as an asset purchase and will operate the business as Coronado Instruments. Under the terms of the agreement Meade is to pay an initial payment of $2.5 million to Coronado (payable as prescribed by the agreement). Meade may also pay an earn-out payment based upon the profitability of Coronado Instruments during the 2005 calendar year. Any earn-out payment will be accounted for as additional purchase price.
K. New Accounting Pronouncements
On October 22, 2004, the American Jobs Creation Act of 2004 was enacted in the United States. The Company is currently evaluating the impact of this new law on its operations and effective tax rate. In particular, the Company is evaluating the law's provisions relating to allowable deductions, beginning in 2005, for income attributable to United States production activities. At this time, the Company is unable to determine the effects of this new law and will continue to analyze its potential impact as guidance is made available.
In December 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4." SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005. The Company does not expect the adoption of SFAS No. 151 to have a material impact on its results of operations or financial position.
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised), “Share-Based Payment.” This standard requires expensing of stock options and other share-based payments and supersedes the FASB’s earlier rule (the original SFAS 123) that had allowed companies to choose between expensing stock options or showing pro forma disclosure only. The Company will be required to implement the new pronouncement at the beginning of the third quarter of fiscal 2006. The Company has not yet assessed the impact of adopting this new standard.
L. Reclassifications
Certain reclassifications have been made to conform prior periods to the current presentation.
7
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
Results of Operations
The nature of the Company’s business is seasonal. Historically, sales in the third quarter have been higher than sales achieved in each of the other three fiscal quarters of the year. Thus, expenses and, to a greater extent, operating income vary by quarter. Caution, therefore, is advised when appraising results for a period shorter than a full year, or when comparing any period other than to the same period of the previous year.
Three Months Ended November 30, 2004 Compared to Three Months Ended November 30, 2003
Net sales for the third quarter of fiscal 2005 were $49.7 million compared to $54.4 million for the third quarter of fiscal 2004, a decrease of 8.7%. Sales of the Company’s mid-priced and higher-priced telescopes were down approximately $5 million from the prior year quarter. This decrease in sales reflects current-year weakness in the mid-to-higher priced telescope categories. In addition, management believes that sales of mid-to-higher priced telescopes in the prior year were higher because of the Mars opposition. As the effects of the Mars opposition (i.e. high inventory levels at several of the Company’s dealers and distributors and sales pull from a unique celestial event) continue to diminish, and with the introduction of several new products slated for the mid-to-higher priced telescope market in the coming months, management believes that the downward trend in sales of telescopes in this price category will end. Sales of smaller-aperture telescopes were also down approximately $2 million largely due to decreased sales at one of the Company’s significant customers. Binocular sales were down approximately $2 million primarily due to continuing price competition in the digital camera/binocular market. Offsetting these reductions was an increase of approximately $2 million in riflescope sales, principally to one new customer, an increase of approximately $1 million in the company’s new night vision products, and an increase of over $1 million in microscope sales due to a large order in Europe. The weakened dollar versus the euro compared to the prior year period also positively affected sales (by approximately $1 million).
Gross profit decreased from $16.6 million (30.4% of net sales) for the third quarter of fiscal 2004 to $13.9 million (28.0% of net sales) for the third quarter of fiscal 2005, a decrease of 16.0%. The decrease was due to decreased sales compared to the prior year quarter. The decrease in gross margin (gross profit as a percent of net sales) was principally due to sales mix and the effect of relatively fixed costs on lower sales volume. The weakened dollar versus the euro did not have a significant effect on gross profit because the European subsidiary utilizes forward contracts on substantially all of its significant dollar inventory purchases.
Selling expenses decreased from $6.6 million (12.1% of net sales) for the third quarter of fiscal 2004 to $5.9 million (11.9% of net sales) for the third quarter of fiscal 2005, a decrease of 10.1%. Several expense categories decreased from the prior year. Shipping and sales department wages, freight, temporary help and allowance for doubtful accounts each decreased approximately $0.2 million dollars due principally to lower sales. Offsetting those selling expenses was an increase in marketing and advertising costs of approximately $0.2 million dollars. General and administrative expenses decreased from $3.3 million (6.0% of net sales) for the third quarter of fiscal 2004, to $2.2 million (4.5% of net sales) for the third quarter of fiscal 2005, a decrease of 32.1%. The decrease was principally due to lower performance based compensation, which was down approximately $1.0 million from the prior year, and consulting and professional fees which were down approximately $0.3 million.
ESOP contribution expense decreased from $0.3 million (0.6% of net sales) for the third quarter of fiscal 2004 to $0.1 million (0.3% of net sales) for the third quarter of fiscal 2005, a decrease of 61.9%. The decrease in this non-cash charge was principally due to a decrease in the number of shares allocated to the Employee Stock Ownership Plan during the period as compared to the prior year. The non-cash ESOP contribution expense may fluctuate as the number of shares allocated and the market value of the Company’s common stock changes.
Research and development expenses increased from $0.5 million (0.8% of net sales) for the third quarter of fiscal 2004 to $0.7 million (1.3% of net sales) for the third quarter of fiscal 2005, an increase of 45.5%. Outsourced expenditures affected the increase. The Company’s research and development efforts are principally concentrated on product improvement and new product development for the Company’s core consumer products market.
Interest expense remained flat at approximately $0.3 million for each quarter presented. Average borrowings and borrowing rates were comparable during the periods presented.
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Nine months Ended November 30, 2004 Compared to Nine months Ended November 30, 2003
Net sales for the nine months ended November 30, 2004 were $92.1 million compared to $107.2 million for the comparable prior year period, a decrease of 14.1%. Sales of the Company’s mid-priced and higher-priced telescopes were down approximately $14 million from the prior year period. This decrease in sales reflects current-year weakness in the mid-to-higher priced telescope categories. In addition, management believes that sales of mid-to-higher priced telescopes in the prior year were higher because of the Mars opposition. As the effects of the Mars opposition (i.e. high inventory levels at several of the Company’s dealers and distributors and sales pull from a unique celestial event) continue to diminish, and with the introduction of several new products slated for the mid-to-higher priced telescope market in the coming months, management believes that the downward trend in sales of telescopes in this price category will end. Sales of smaller-aperture telescopes were also down approximately $3 million largely due to decreased sales at one of the Company’s significant customers. Binocular sales were down approximately $3 million, primarily due to continuing price competition in the digital camera/binocular market. Offsetting these reductions was increase of approximately $2 million in the company’s new night vision products, and an increase of over $1 million in microscope sales due to a large order in Europe. The weakened dollar versus the euro compared to the prior year period also positively affected sales (by approximately $2 million).
Gross profit decreased from $30.5 million (28.4% of net sales) for the nine months ended November 30, 2003 to $24.4 million (26.6% of net sales) for the comparable current year period, a decrease of 19.8%. The decrease was due to decreased sales compared to the prior year period. Gross margin (gross profit as a percent of net sales) decreased overall due to changes in sales mix and the effect of relatively fixed costs on lower sales volume. The weakened dollar versus the euro did not have a significant effect on gross profit because the European subsidiary utilizes forward contracts on substantially all of its significant dollar inventory purchases.
Selling expenses decreased from $14.2 million (13.2% of net sales) for the nine months ended November 30, 2003 to $13.2 million (14.3% of net sales) for the comparable current year period, a decrease of 7.0%. The decrease was primarily due to lower in-store advertising costs (approximately $0.5 million), and lower freight costs on lower sales volume. General and administrative expenses decreased from $9.0 million (8.4% of net sales) for the nine months ended November 30, 2003 to $7.4 million (8.0% of net sales) for the comparable current year period, a decrease of 17.4%. The decrease was principally due to lower performance based compensation, which was down approximately $1.0 million from the prior year, and consulting and professional fees which were down approximately $0.5 million.
ESOP contribution expense decreased from $0.6 million (0.6% of net sales) for the nine months ended November 30, 2003 to $0.3 million (0.3% of net sales) for the comparable current year period, a decrease of 49.9%. The decrease in this non-cash charge was principally due to a decrease in the number of shares allocated to the Employee Stock Ownership Plan during the period as compared to the prior year. The non-cash ESOP contribution expense may fluctuate as the number of shares allocated and the market value of the Company’s common stock changes.
Research and development expenses increased from $1.5 million (1.4% of net sales) for the nine months ended November 30, 2003 to $1.6 million (1.8% of net sales) for the comparable current year period, an increase of 13.0%. The increase was largely related to outsourced expenditures. The Company’s research and development efforts are principally concentrated on product improvement and new product development for the Company’s core consumer products market.
Interest expense decreased from $0.8 million (0.7% of net sales) for the nine months ended November 30, 2003 to $0.6 million (0.7% of net sales) for the comparable current year period, a decrease of 16.8%. Small changes in average borrowings and borrowing rates from the prior year lowered interest expense slightly.
Seasonality
The Company has experienced, and expects to continue to experience, substantial fluctuations in its sales, gross margins and profitability from quarter to quarter. Factors that influence these fluctuations include the volume and timing of orders received, changes in the mix of products sold, market acceptance of the Company’s products, competitive pricing pressures, the Company’s ability to meet increasing demand and delivery schedules, the timing and extent of research and development expenses, the timing and extent of product development costs and the timing and extent of advertising expenditures. In addition, a substantial portion of the Company’s net sales and operating income typically occurs in the third quarter of the Company’s fiscal year primarily due to disproportionately higher customer demand for less-expensive telescopes during the holiday season. The Company continues to experience significant sales to mass merchandisers. Mass merchandisers, along with specialty retailers, purchase a considerable amount of their inventories to satisfy such seasonal customer demand. These purchasing patterns have caused the Company to increase its level of inventory during its second
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and third quarters in response to such demand or anticipated demand. As a result, the Company’s working capital requirements have correspondingly increased at such times.
Liquidity and Capital Resources
For the nine months ended November 30, 2004 the Company funded its operations with net income and short-term bank borrowings. In November 2004, approximately $3 million in cash was transferred from the Company’s European subsidiary to fund the initial payment for the Coronado acquisition. Payment of the Coronado initial payment is expected to occur during the Company’s fourth fiscal quarter. Until the payment of the Coronado initial payment is made, the cash will be used to pay down the Company’s U.S. revolving line of credit. Internally generated cash flow from net income adjusted for non-cash charges plus bank borrowings were used to increase accounts receivable and inventories. Operating cash flows were increased by an increase in accounts payable. Accounts payable increased with increased inventories. Inventories increased to $49.7 million at November 30, 2004 from $47.4 million at November 30, 2003 an increase of approximately 5%. Inventory levels have increased over the nine months ended November 30, 2004 on lower than expected sales during the year. The increase in inventories was partially funded by bank borrowings and partially by an increase in accounts payable. Net working capital totaled approximately $58.9 million at November 30, 2004, compared to $57.5 million at February 29, 2004. Working capital requirements fluctuate during the year due to the seasonal nature of the business. These requirements are typically financed through a combination of internally generated cash flow from operating activities and short-term bank borrowings.
The Company continues to depend on operating cash flow and availability under its bank lines of credit to provide short-term liquidity. Availability under its bank lines of credit at November 30, 2004 was approximately $15.4 million. At November 30, 2004, the Company was in compliance with all restrictive covenants and required ratios under its U.S. credit agreement, with the exception of its U.S. fixed charge coverage ratio requirement. On December 15, 2004 the Company executed the Third Amendment to Amended and Restated Credit Agreement (the “Amendment”). The Amendment amends the U.S. fixed charge coverage ratio covenant and the consolidated fixed charge coverage ratio covenant, sets minimum availability requirements, and makes several other changes, principally adjusting the facility’s pricing tables. The Company is required to report its covenant calculations to the bank for the quarter ended November 30, 2004 based upon the terms of the Amendment. The Company was in compliance with all restrictive covenants and required ratios as of November 30, 2004 after giving effect to the Amendment. In the event the Company’s plans require more capital than is presently anticipated, additional sources of liquidity such as debt or equity financings, may be required to meet its capital needs. There can be no assurance that such additional sources of capital will be available on reasonable terms, if at all. However, management believes that operating cash flow and bank borrowing capacity in connection with the Company’s business should provide sufficient liquidity for the Company’s obligations for at least the next twelve months.
Capital expenditures, including financed purchases of equipment, aggregated $0.6 million and $0.3 million for the nine months ended November 30, 2004 and 2003, respectively. The Company had no material capital expenditure commitments at November 30, 2004.
New Accounting Pronouncements
On October 22, 2004, the American Jobs Creation Act of 2004 was enacted in the United States. The Company is currently evaluating the impact of this new law on its operations and effective tax rate. In particular, the Company is evaluating the law's provisions relating to allowable deductions, beginning in 2005, for income attributable to United States production activities. At this time, the Company is unable to determine the effects of this new law and will continue to analyze its potential impact as guidance is made available.
In December 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4." SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005. The Company does not expect the adoption of SFAS No. 151 to have a material impact on its results of operations or financial position.
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised), “Share-Based Payment.” This standard requires expensing of stock options and other share-based payments and supersedes the FASB’s earlier rule (the original SFAS 123) that had allowed companies to choose between expensing stock options or showing pro forma disclosure only. The Company will be required to implement the new pronouncement at the beginning of the third quarter of fiscal 2006. The Company has not yet assessed the impact of adopting this new standard.
Forward-Looking Information
The preceding “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section contains various “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, which represent the Company’s reasonable judgment concerning the future and are subject to risks and uncertainties that could cause the Company’s actual operating results and financial position to differ materially, including the following: the Company’s ability to expand the markets for telescopes, binoculars, riflescopes, microscopes, night vision and other optical products; the Company’s ability to continue to develop and bring to market new and innovative products that will be accepted by consumers and end the downward trend in telescope sales; the Company’s ability to develop and grow the Simmons business; the Company’s ability to integrate and grow the Coronado business: the Company’s ability to further develop its wholly owned manufacturing facility in Mexico in combination with its existing manufacturing capabilities; the Company expanding its distribution network; the Company’s
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ability to further develop the business of its European subsidiary; the Company’s ability to recognize any benefits from its engineering and quality control office in China; the Company experiencing fluctuations in its sales, gross margins and profitability from quarter to quarter consistent with prior periods; the Company’s expectation that contingent liabilities will not have a material effect on the Company’s financial position or results of operations; the extent to which the Company will be able to leverage its design and manufacturing expertise in certain industrial applications such as digital imaging; and the Company’s expectation that it will have sufficient funds to meet any working capital requirements during the foreseeable future with internally generated cash flow and borrowing ability.
In addition to other information in this report, the Company cautions that certain factors, including, without limitation, the following, should be considered carefully in evaluating the Company and its business and that such factors may cause the Company’s actual operating results to differ materially from those set forth in the forward looking statements described above or to otherwise be adversely affected:
Our business is vulnerable to changing economic conditions, including:
| • | a decline in general economic conditions; | |||
| • | uncertainties affecting consumer spending; and | |||
| • | changes in interest rates causing a reduction of investment income or in the value of market interest rate sensitive instruments. | |||
Our intellectual property rights are subject to risks, including:
| • | the potential that we may be unable to obtain and maintain patents and copyrights to protect our proprietary technologies; | |||
| • | competitors’ infringement upon Meade’s existing and future intellectual property; and | |||
| • | competitors’ intellectual property rights that may restrict our ability to compete effectively. | |||
Our business is subject to other risks, including:
| • | a general decline in demand for the Company’s products; | |||
| • | an inability to continue to design and manufacture products that will achieve and maintain commercial success; | |||
| • | the potential that we may fail to penetrate the binocular, riflescope and solar observing markets and achieve meaningful sales; | |||
| • | any significant interruption of our manufacturing abilities in our domestic or Mexican facilities or in any of our suppliers located in the Far East; | |||
| • | greater than anticipated competition; | |||
| • | any loss of, or the failure to replace, any significant portion of the sales made to any significant customer of the Company; and | |||
| • | increasing ESOP charges in the event the market price of the Company’s stock increases. | |||
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The Company is exposed to certain levels of market risks, including changes in foreign currency exchange rates and interest rates. Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange and interest rates. The Company conducts business in a number of foreign countries and is primarily exposed to currency exchange-rate risk with respect to its transactions and net assets denominated in the Euro. Business activities in various currencies expose the Company to the risk that the eventual net United States dollar cash inflows resulting from transactions with foreign customers and suppliers denominated in foreign currencies may be adversely affected by changes in currency exchange rates. In prior years foreign currency fluctuations have not had a material impact on
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Meade’s revenues or results of operations. There can be no assurance that European or other currencies will remain stable relative to the U.S. dollar or that future fluctuations in the value of foreign currencies will not have a material adverse effect on the Company’s business, operating results, financial condition or cash flows.
The Company has adopted a hedging program to manage its foreign currency exchange rate and interest rate risks. Upon continuing evaluation and when deemed appropriate by management, the Company may enter into hedging instruments to manage its foreign currency exchange and interest rate risks.
Under the terms of its credit agreement, the Company was required to enter into an interest-rate swap to convert the variable interest rate on its U.S. Term Loan to a fixed interest rate. The resulting cost of funds (7.9% per annum) is currently higher than that which would have been available if the variable rate had been applied during the period. Under the interest-rate swap contract, the Company has agreed with the bank to exchange, at specified intervals, the difference between variable-rate and fixed-rate interest amounts, calculated by reference to agreed-upon notional amounts. The change in the fair value of the interest rate swap for the nine months ended November 30, 2004 was an unrealized gain of $17,000 which is included in other comprehensive income for the nine months ended November 30, 2004. As of November 30, 2004 the swap agreement had matured.
The Company’s financial instruments consist of cash, accounts receivable, accounts payable, and long-term obligations. The Company’s exposure to market risk for changes in interest rates relates primarily to short-term investments and short-term obligations. As a result, the Company does not expect fluctuations in interest rates to have a material impact on the fair value of these instruments.
| ITEM 4. | CONTROLS AND PROCEDURES |
As of the end of the period covered by this report, the Company’s chief executive officer and chief financial officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). These disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in the reports it files under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness.
The Company’s chief executive officer and chief financial officer concluded, based on their evaluation, that the Company’s disclosure controls and procedures are effective for the Company, taking into consideration the size and nature of the Company’s business and operations.
No change in the Company’s internal control over financial reporting occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of such litigation will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
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ITEM 6. EXHIBITS
Exhibits filed with this Form 10-Q.
| 1. | Exhibit 31.1 Sarbanes-Oxley Act Section 302 Certification by Steven G. Murdock | |||
| 2. | Exhibit 31.2 Sarbanes-Oxley Act Section 302 Certification by Brent W. Christensen | |||
| 3. | Exhibit 32.1 Sarbanes-Oxley Act Section 906 Certification by Steven G. Murdock | |||
| 4. | Exhibit 32.2 Sarbanes-Oxley Act Section 906 Certification by Brent W. Christensen | |||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: January 7, 2005
| MEADE INSTRUMENTS CORP. |
||||
| By: | /s/ STEVEN G. MURDOCK | |||
| Steven G. Murdock | ||||
| President, Chief Executive Officer and Secretary |
||||
| By: | /s/ BRENT W. CHRISTENSEN | |||
| Brent W. Christensen | ||||
| Senior Vice President, Finance and Chief Financial Officer |
||||
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EXHIBIT INDEX
Exhibits filed with this Form 10-Q.
| 1. | Exhibit 31.1 Sarbanes-Oxley Act Section 302 Certification by Steven G. Murdock | |||
| 2. | Exhibit 31.2 Sarbanes-Oxley Act Section 302 Certification by Brent W. Christensen | |||
| 3. | Exhibit 32.1 Sarbanes-Oxley Act Section 906 Certification by Steven G. Murdock | |||
| 4. | Exhibit 32.2 Sarbanes-Oxley Act Section 906 Certification by Brent W. Christensen | |||