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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2002
--------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-31283
PECO II, INC.
(Exact name of Registrant as specified in its charter)
OHIO 34-1605456
(State or other jurisdiction (I.R.S. Employer
of Incorporation or organization) Identification No.)
1376 STATE ROUTE 598, GALION, OHIO 44833
(Address of principal executive office) (Zip Code)
Registrant's telephone number including area code: (419) 468-7600
Indicate by check mark ("X") whether the Registrant: (1) has filed all reports
to be filed by section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding twelve 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 X NO ____
---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT JULY 30, 2002
------ ----------------------------
Common Shares, without par value 21,036,420
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PECO II, INC.
INDEX
Page
PART 1 FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets ........................... 3
Condensed Consolidated Statements of Operations ................. 4
Condensed Consolidated Statements of Cash Flows ................. 5
Notes to Condensed Consolidated Financial Statements ............ 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................... 7-8
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...... 9
PART II OTHER INFORMATION
Item 2(c) Recent Sales of Unregistered Securities ......................... 9
Item 2(d) Use of Proceeds ................................................. 9
Item 4. Submission of Matters to Vote of Security Holders ............... 10
Item 6. Exhibits and Reports on Form 8-K ................................ 10
SIGNATURES ...................................................... 10
2
PECO II, INC.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------
June 30, December 31,
In thousands 2002 2001
- ------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ............................... $ 35,527 $ 49,807
Accounts receivable ..................................... 13,293 13,662
Inventories:
Raw materials .................................. 23,481 24,297
Work in process ................................ 2,025 1,490
Finished goods ................................. 3,579 3,736
-------- --------
Total inventories .............................. 29,085 29,523
Prepaid expenses and other current assets ............... 1,011 1,292
Prepaid and deferred income taxes ....................... 8,452 7,918
-------- --------
Total current assets ........................... 87,368 102,202
Property and equipment, net ...................................... 37,938 39,498
Other assets ..................................................... 18,255 18,468
-------- --------
TOTAL ASSETS ..................................................... $143,561 $160,168
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt and capital leases .... $ 637 $ 631
Accounts payable ........................................ 3,189 7,411
Accrued compensation expense ............................ 3,044 2,973
Other accrued expenses and income taxes ................. 7,975 9,836
-------- --------
Total current liabilities ...................... 14,845 20,851
Long term debt and capital leases ................................ 10,281 10,433
Shareholders' equity:
Common shares ........................................... 2,816 2,816
Additional paid-in capital .............................. 111,635 111,731
Retained earnings ....................................... 5,317 15,743
Treasury shares, at cost ................................ (1,333) (1,406)
-------- --------
Total shareholders' equity ..................... 118,435 128,884
======== ========
Total liabilities and shareholders' equity ....................... $143,561 $160,168
======== ========
The accompanying notes are an integral part of these
consolidated balance sheets.
3
PECO II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------
For the Three Months For the Six Months
Ended June 30 Ended June 30
In thousands, except per share data 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Net sales ......................................................... $ 16,485 $ 25,794 $ 33,460 $ 60,650
Cost of goods sold ................................................ 16,472 22,225 33,661 46,476
-------- -------- -------- --------
Gross margin ...................................................... 13 3,569 (201) 14,174
Operating expenses:
Research, development and engineering .................... 3,246 2,832 5,929 5,172
Selling, general and administrative ...................... 5,471 4,505 10,199 8,954
-------- -------- -------- --------
8,717 7,337 16,128 14,126
-------- -------- -------- --------
Income (loss) from operations ..................................... (8,704) (3,768) (16,329) 48
Interest income ................................................... 110 384 235 968
-------- -------- -------- --------
Income (loss) before income taxes ................................. (8,594) (3,384) (16,094) 1,016
Provision (benefit) for income taxes .............................. (2,911) (1,337) (5,668) 402
-------- -------- -------- --------
Net income (loss) ................................................. $ (5,683) $ (2,047) $(10,426) $ 614
======== ======== ======== ========
Basic earnings (loss) per share ................................... $ (0.26) $ (0.10) $ (0.48) $ 0.03
======== ======== ======== ========
Diluted earnings (loss) per share ................................. $ (0.26) $ (0.10) $ (0.48) $ 0.03
======== ======== ======== ========
Weighted average common shares-outstanding
Basic ............................................................. 21,900 21,376 21,855 21,178
======== ======== ======== ========
Diluted ........................................................... 21,900 21,376 21,855 21,348
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated statements.
4
PECO II, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
For the Six Months
Ended June 30,
In thousands 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................................................. $(10,426) $ 614
Adjustments to reconcile net income to net cash (used for)
provided by operating activities-
Depreciation and amortization ............................................... 1,758 1,509
Loss on disposals of property and equipment ................................. 6 11
Deferred income taxes ....................................................... 170 336
Stock compensation expense .................................................. 230 656
Working capital changes
Accounts receivable ...................................................... 313 17,009
Inventories .............................................................. 438 543
Prepaid expenses and other current assets ................................ 14 271
Accounts payable, other accrued expenses and accrued
income taxes ............................................................. (6,083) (10,359)
Accrued compensation expense ............................................. 71 (4,767)
-------- --------
Net cash provided by (used for) operating
activities ............................................................... (13,509) 5,823
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .............................................................. (204) (13,826)
Acquisition of businesses, net of cash acquired ................................... -- (3,224)
Proceeds from sale of property and equipment ...................................... -- 3
-------- --------
Net cash used for investing activities ............................................ (204) (17,047)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Restricted cash on industrial revenue bond ........................................ (168) (60)
Repayments under lines of credit .................................................. -- (375)
Repayment of long-term debt and capital leases .................................... (146) (172)
Proceeds from issuance of common shares ........................................... 351 1,625
Purchase of treasury shares (604) --
-------- --------
Net cash provided by (used for) financing activities ..................... (567) 1,018
-------- --------
Net decrease in cash ....................................................................... (14,280) (10,206)
Cash and cash equivalents at beginning of period ........................................... 49,807 54,920
-------- --------
Cash and cash equivalents at end of period ................................................. $ 35,527 $ 44,714
======== ========
Supplemental Disclosure of Cash Flow Information:
Income taxes paid ................................................................. $ 161 $ 1,075
Interest paid ..................................................................... 183 130
Supplemental Disclosure of Non Cash Investing and Financing Activities
Common shares issued in connection with acquisitions .............................. -- $ 9,533
The accompanying notes are an integral part of these consolidated statements.
5
PECO II, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying consolidated financial statements include the accounts of PECO
II, Inc. (the Company") and its wholly owned subsidiaries. In the opinion of
management, the accompanying unaudited interim condensed consolidated financial
statements reflect all adjustments, of a normal and recurring nature, necessary
to present fairly the results for the interim periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. The December 31, 2001 balance sheet data was
derived from audited financial statements, but does not include all disclosures
required by accounting principles generally accepted in the United States. It is
suggested that these condensed statements be read in conjunction with the
Company's most recent Annual Report on Form 10-K.
This Form 10-Q contains forward-looking statements, which involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
the Company's actual results or activities to differ materially from these
forward-looking statements include but are not limited to the statements under
"Forward Looking Statements" and other sections in the Company's Form 10-K filed
with the Securities and Exchange Commission and press releases.
Results for the interim period are not necessarily indicative of the results
that may be expected for the entire year.
2. Treasury Shares
In September 2001 the Board of Directors authorized the repurchase of up to one
million shares in the open market or in private transactions. During the second
quarter of 2002 we acquired 181,112 shares at a cost of $604,062. On July 26,
2002, the Board approved a one million share increase in the program. From July
1, 2002 through July 30, 2002, we acquired 792,400 shares at a cost of
$1,490,480. As of July 30, 2002 the Company has repurchased an aggregate of
1,381,512 shares at an average price of $2.71 per share.
3. Recent Accounting Pronouncements
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard No. 141 (SFAS 141), "Business Combinations" and SFAS 142,
"Goodwill and Other Intangible Assets." In July 2001. The statements were
effective for us on January 1, 2002. These statements result in modifications
relative to our accounting for goodwill and other intangible assets.
Specifically, we ceased goodwill and certain intangible asset amortization
beginning January 1, 2002. Additionally, intangible assets, including goodwill,
are now subjected to new impairment testing criteria annually or more frequently
when circumstances occur that goodwill might be impaired. The Company has
completed the first step of the transitional goodwill impairment test and there
is an indication of impairment of goodwill. The Company expects to complete the
measurement of the loss in the third quarter. Goodwill amortization approximated
$0.1 million in the first half of the prior year 2001.
6
PECO II, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
Net sales declined to $16.5 million and $33.5 million, respectively, for the
three and six months ended June 30, 2002, a decrease of $9.3 million, or 36%,
and $27.2 million, or 45%, respectively, compared to the corresponding prior
year periods. This decrease was primarily due to the industry downturn and
depressed economic conditions commencing in March 2001, which resulted in the
decreased demand for power systems, power distribution equipment and systems
integration. As we had stated in our last quarterly report, the reduction in
capital spending by communication service providers does not appear to be
abating. This decline was offset partially by increased demand for engineering
and installation services, largely due to our acquisitions of Thornton
Communications in June 2001 and JNB Communications in August 2001, which
subsequently led to increased demand for the services. As of June 30, 2002, our
sales backlog, which represents total dollar volume of firm sales orders not yet
recognized as revenue, was $9.3 million, an 11% decline from $10.5 million at
December 31, 2001.
Gross margin dollars were $13,000 and a negative $0.2 million, respectively, for
the quarter and six months ended June 30, 2002, as compared to $3.6 million and
$14.2 million, respectively, for the quarter and six months ended June 30, 2001.
Gross margin as a percentage of net sales declined to 0.1% and (0.6)%
respectively, for the three and six months ended June 30, 2002 compared to 13.8%
and 23.4%, respectively, for the comparable prior year periods. The margin
percentage was lower in 2002, due primarily to unabsorbed overhead costs
attributable to lower volume.
Research, development and engineering expense increased to $3.2 million and $5.9
million, respectively, for the quarter and six months ended June 30, 2002, from
$2.8 million and $5.2 million, respectively, for the quarter and six months
ended June 30, 2001. The higher dollar level of expenses reflects the
development of new power plants and monitoring products. As a percentage of net
sales, research, development and engineering expense was 19.7% and 17.7%,
respectively, for the three and six months ended June 30, 2002 compared to 11%
and 8.5%, respectively, in the comparable prior year periods. We anticipate the
future research, development and engineering expenses will decline for the
remainder of 2002 as a result of fewer new projects.
Selling, general and administrative expense increased to $5.5 million and $10.2
million, respectively, for the quarter and six months ended June 30, 2002, from
$4.5 million and $9.0 million, respectively, for the quarter and the six months
ended June 30, 2001. The increase resulted from expanding administrative and
sales staffs in our E&I service centers and a $0.5 million added provision for
doubtful accounts in the current quarter due to the financial situation of a
certain customer. The increases were offset partially by a decrease in stock
compensation costs of $0.1 million and $0.3 million, respectively, in the
quarter and first six months of the prior year periods. As a percentage of net
sales, selling, general and administrative expense was 33.2% and 30.5%,
respectively, for the three and six months ended June 30, 2002 compared to 17.5%
and 14.8%, respectively, in the comparable prior year periods.
Interest income net was $0.1 million and $0.2 million, respectively, in the
three and six months ended June 30, 2002 from $0.4 million and $1.0 million,
respectively, in the comparable prior year periods. The decrease in interest
income in the current quarter and six months ended in 2002 was due primarily to
reduced investment rates from excess cash funds.
As a result of our operating loss in the six months ended June 30, 2002 and a
$0.3 million adjustment to deferred tax assets resulting from exercises of
employee stock options awards, our effective benefit income tax rate was 35.2%
as compared to a provision of 39.6% in the first half of the prior year.
7
PECO II, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Cont.)
Liquidity and Capital Resources
Our primary liquidity needs are for working capital, capital expenditures and
investments, including strategic acquisitions. In August 2000 we completed an
initial public offering of 5.75 million shares of common stock at $15 per share,
generating net proceeds of approximately $78.3 million. A portion of these
proceeds was used to repay bank indebtedness. At June 30, 2002 readily
convertible cash equivalents approximated $32.5 million.
Working capital was $72.5 million at June 30, 2002, which represented a working
capital ratio of 5.9 to 1, compared to $81.4 million at December 31, 2001. Our
working capital declined in the first six months due primarily to operating
losses and lower payables and accrued expenses due to the lower business volume.
Our investment in inventories and accounts receivables was $42.4 million at June
30, 2002 and $43.2 million at December 31, 2001. Our capital expenditures were
$0.2 million for the six months ended June 30, 2002 as we have again recently
reduced our forecasted capital expenditures to $4-6 million in 2002 from our
original budget of $10 million due to the continuing lower business volume.
Cash flows used in operating activities for the first half of 2002 were $13.5
million, due primarily to operating losses, and a decrease in accounts payable
and accrued expenses due to the lower business level.
During the second quarter of 2002 we repurchased 118,112 shares at a cost of
$604,602 under the September 2001 stock repurchase program. On July 26, 2002 the
Board approved a one million share increase in the program. From July 1, 2002
through July 30, 2002 we acquired 792,400 shares at a cost of $1,490,480.
As of June 30, 2002, there were no borrowings on our unsecured $20 million loan
agreement. At June 30, 2002, we complied with the covenants under the borrowing
agreement.
We do not currently plan to pay dividends, but rather to retain earnings for use
in the operation of our business and to fund future growth.
We will expend cash funds to purchase selective strategic acquisitions to
increase our product and service offerings. Our current credit agreement
prohibits us from making any acquisitions without the consent of our lender.
We believe that cash and cash equivalents on hand, anticipated cash flow from
operations and our credit facilities will be sufficient to fund our working
capital and capital expenditure requirements for at least the next 24 months.
Critical Accounting Policies
In response to the SEC's Release No. 33-8040, "Cautionary Advice Regarding
Disclosure about Critical Accounting Policies", the Company considers certain
accounting policies related to revenue recognition, inventory valuation and
impairment of long lived assets to be critical policies due to the estimation
processes involved in each. We state these accounting policies in the notes to
the consolidated financial statements in our annual report on Form 10-K for the
year ended December 31, 2001, which was filed on March 15, 2002, and at relevant
sections in this discussion and analysis.
8
PECO II, INC.
ITEM 3. Qualitative and Quantitative Disclosure About Market Risk
We are exposed to the impact of interest rate changes and, to a lesser extent,
foreign currency fluctuations. We have not entered into interest rate
transactions for speculative purposes or otherwise. Our foreign currency
exposures were immaterial as of June 30, 2002. Our primary interest rate risk
exposure has resulted from floating rate debt related to our revolving loan
facility. As of June 30, 2002 we had no borrowings under our revolving loan
facility. We currently do not hedge our exposure to floating interest rate risk.
PART II. OTHER INFORMATION
ITEM 2(c) Recent Sales of Unregistered Securities
During the second quarter of 2002, we sold unregistered securities in the
amount, at the times and for the aggregate amount of consideration as listed
below. The securities were sold to purchasers directly by us and the sales did
not involve any underwriter.
From April 1, 2002 to June 30, 2002, certain of our employees and directors
exercised options to purchase 21,250 common shares for an aggregate
consideration of $25,270. The options exercised were issued under compensatory
benefit plans in a transaction exempt under Section 4(2) of the Securities Act
of 1933 and Rule 701 under the Securities Act of 1933.
Of the 21,250 common shares issued to employees from April 1, 2002 to June
30, 2002 from the exercise of options, options to purchase 18,100 common shares
were granted on July 14, 1997; options to purchase 1,000 common shares were
granted on July 13, 1998; options to purchase 700 common shares were granted on
June 22, 1999; and options to purchase 1,450 common shares were granted on July
22, 1999.
ITEM 2(d) Use of Proceeds
On August 17, 2000, the SEC declared effective a Registration Statement on
Form S-1 (File No. 333-37566) filed by us in connection with an initial public
offering of 5,000,000 of our common shares, without par value. From the date of
receipt of the proceeds from the offering through June 30, 2002, of the $78.3
million in net proceeds, $14.4 million was used to repay bank indebtedness, $5.2
million was used in connection with the acquisitions of Thornton Communications
and JNB Communications, $15.5 million was used for capital expenditures,
excluding the purchase of the Denver regional operating center in February 2001
which is being financed through industrial revenue bonds and the remainder for
general working capital purposes. The remaining net proceeds has been invested
in short-term, interest-bearing, investment grade securities or guaranteed
obligations of the U.S. government.
9
PECO II, INC.
PART II. OTHER INFORMATION (Cont.)
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Shareholders was held on April 25, 2002. The
following actions were taken at the meeting:
Election of Directors for a term of three years
For Withheld
Lucille Garber Ford 18,515,419 167,265
E. Richard Hottenroth 18,432,234 250,450
Charles D. Taylor 18,523,588 159,096
ITEM 6(a) Exhibits
None
ITEM 6(b) Reports on Form 8-K
On June 24, 2002 we filed a current report on Form 8-K reporting
that the Company notified Arthur Andersen LLP that the Board of
Directors upon recommendation of the Audit Committee approved the
dismissal of Andersen as the Company's independent auditors
effective immediately.
The current report on Form 8-K also reported that the Board of
Directors approved the appointment of the firm of Grant Thornton
LLP to serve as the Company's independent auditors for fiscal year
2002.
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.
PECO II, INC.
Date: August 13, 2002 By: /S/ JOHN C. MAAG
----------------
John C. Maag
Chief Financial Officer and Treasurer
And Authorized Officer
10