UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

Commission File Number:  0-26524

 

MACKIE DESIGNS INC.

(Exact name of registrant as specified in its charter)

 

 

 

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 ý    No o

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

MACKIE DESIGNS INC.

 

FORM 10-Q

For the quarter ended September 30, 2002

 

 

INDEX

 

PART I.  FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets
	Condensed Consolidated Statements of Operations
	Condensed Consolidated Statements of Cash Flows
	Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss)
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS

 

2

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MACKIE DESIGNS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

In thousands

 

		September 30, 2002			December 31, 2001
ASSETS
Current assets:
Cash and cash equivalents		$	3,495		$	2,095
Accounts receivable, less allowance for doubtful accounts of $2,874 and $1,349, respectively		35,742			35,092
Income taxes receivable		2,531			1,305
Inventories		60,504			51,507
Prepaid expenses and other current assets		5,670			2,157
Deferred income taxes		5,099			5,315
Total current assets		113,041			97,471
Property, plant and equipment, net		23,873			25,671
Goodwill, net		20,535			19,360
Intangible assets, net		6,532			6,854
Other assets, net		1,236			4,608
Total assets		$	165,217		$	153,964
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Short-term borrowings		$	45,516		$	35,395
Accounts payable		25,855			22,859
Accrued liabilities		10,626			11,009
Income taxes payable		1,244			968
Long-term debt callable under covenant provisions		14,232			—
Current portion of long-term debt		5,885			3,874
Total current liabilities		103,358			74,105
Long-term debt, excluding current portion		2,020			19,401
Employee and other liabilities		4,216			3,768
Deferred income taxes		2,895			3,880
Total liabilities		112,489			101,154
Commitments and contingencies		—			—
Shareholders’ equity:
Common stock		29,333			28,691
Retained earnings		24,024			26,556
Accumulated other comprehensive loss		(629		)	(2,437		)
Total shareholders’ equity		52,728			52,810
Total liabilities and shareholders’ equity		$	165,217		$	153,964

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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MACKIE DESIGNS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

In thousands, except per share data

 

		Three months ended September 30,						Nine months ended September 30,
		2002			2001			2002			2001
Net sales		$	46,404		$	48,431		$	144,321		$	159,684
Cost of goods sold		32,987			36,918			99,720			112,269
Gross profit		13,417			11,513			44,601			47,415
Operating expenses:
Selling, general and administrative		13,776			12,346			39,176			39,458
Research and development		2,665			2,936			8,166			9,185
Total operating expenses		16,441			15,282			47,342			48,643
Operating loss		(3,024		)	(3,769		)	(2,741		)	(1,228		)
Other income (expense):
Interest income		90			71			280			274
Interest expense		(891		)	(1,185		)	(3,041		)	(4,036		)
Other		8			325			286			(568		)
		(793		)	(789		)	(2,475		)	(4,330		)
Loss before income taxes		(3,817		)	(4,558		)	(5,216		)	(5,558		)
Income tax benefit		(2,883		)	(723		)	(2,684		)	(889		)
Net loss		$	(934	)	$	(3,835	)	$	(2,532	)	$	(4,669	)
Net loss per share		$	(0.07	)	$	(0.31	)	$	(0.20	)	$	(0.38	)

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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MACKIE DESIGNS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

In thousands

 

		Nine months ended September 30,
		2002			2001
Operating activities
Net loss		$	(2,532	)	$	(4,669	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		5,506			6,118
Deferred stock compensation		641			702
Deferred income taxes		(315		)	(1,169		)
Changes in operating assets and liabilities:
Accounts receivable		997			183
Inventories		(6,644		)	9,735
Prepaid expenses and other current assets		12			(291		)
Other assets		(247		)	219
Accounts payable and accrued expenses		2,113			392
Income taxes receivable and payable		(1,064		)	(1,247		)
Other long term liabilities		52			(97		)
Cash provided by (used in) operating activities		(1,481		)	9,876
Investing activities
Acquisition of business, net of cash acquired		—			(1,899		)
Proceeds from sales of available-for-sale securities		—			515
Purchases of property, plant and equipment		(2,317		)	(7,256		)
Cash used in investing activities		(2,317		)	(8,640		)
Financing activities
Proceeds from long-term debt		—			2,281
Payments on long-term debt		(1,918		)	(3,099		)
Net proceeds of short-term borrowings		8,074			431
Payments on debt from acquisition of business		(1,193		)	—
Net proceeds from exercise of stock options		1			—
Cash provided by (used in) financing activities		4,964			(387		)
Effect of exchange rate changes on cash		234			(911		)
Increase (decrease) in cash and cash equivalents		1,400			(62		)
Cash and cash equivalents at beginning of period		2,095			3,838
Cash and cash equivalents at end of period		$	3,495		$	3,776

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5

 

MACKIE DESIGNS INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS)

Nine months ended September 30, 2002

(Unaudited)

 

In thousands

 

							Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
		Common Stock
		Shares		Amount
Balance at December 31, 2001		12,424		$	28,691		$	26,556		$	(2,437	)	$	52,810
Exercise of stock options		132		1			—			—			1
Amortization of deferred stock compensation		—		641			—			—			641
Net loss		—		—			(2,532		)	—			—
Foreign currency translation adjustment, net of tax		—		—			—			1,808			—
Comprehensive loss		—		—			—			—			(724		)
Balance at September 30, 2002		12,556		$	29,333		$	24,024		$	(629	)	$	52,728

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

6

 

MACKIE DESIGNS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002

(Unaudited)

 

1.  Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared by Mackie Designs Inc. in accordance with accounting principles generally accepted in the United States of America for interim financial statements and include the accounts of Mackie Designs Inc. and its subsidiaries, all of which are wholly-owned. They do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2001. In our opinion, all normal recurring adjustments necessary for the fair presentation of the results of the interim periods are reflected herein. Operating results for the nine-month period ended September 30, 2002, are not necessarily indicative of future financial results.

 

2.  Net Loss Per Share

 

The following table sets forth the computation of net loss per share for the three-month and nine-month periods ended September 30, 2002 and 2001. Stock options representing 4,143,000 shares in the three-month and nine-month periods ended September 30, 2002 and 4,646,000 shares in the three-month and nine-month periods ended September 30, 2001, were excluded from the calculation of diluted per share amounts because they are antidilutive.

 

		Three months ended September 30,						Nine months ended September 30,
		2002			2001			2002			2001
		(in thousands, except per share data)
Numerator:
Net loss		$	(934	)	$	(3,835	)	$	(2,532	)	$	(4,669	)
Denominator:
Denominator for net loss per share – weighted average shares		12,528			12,399			12,466			12,382
Net loss per share		$	(0.07	)	$	(0.31	)	$	(0.20	)	$	(0.38	)

 

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3.  Comprehensive Loss

 

Comprehensive loss for the three-month and nine-month periods ended September 30, 2002 and 2001, is detailed below.

 

		Three months ended September 30,						Nine months ended September 30,
		2002			2001			2002			2001
		(in thousands)
Net loss		$	(934	)	$	(3,835	)	$	(2,532	)	$	(4,669	)
Other comprehensive income (loss):
Foreign currency translation adjustments		(185		)	668			1,808			(798		)
Comprehensive loss		$	(1,119	)	$	(3,167	)	$	(724	)	$	(5,467	)

 

4.  Inventories

 

Inventories consisted of the following:

 

		September 30, 2002			December 31, 2001
		(in thousands)
Raw materials		$	25,952		$	17,506
Work in process		5,393			4,073
Finished goods		29,159			29,928
		$	60,504		$	51,507

 

5.  Goodwill and Intangible Assets

 

Goodwill totals $20.5 million at  September 30, 2002 of which approximately $6.2 million results from our acquisition of Mackie Designs (Italy) S.p.A. (Mackie Italy) in 1998, $3.4 million from the 2001 acquisition of Mackie Designs Engineering Services BVBA in Belgium (Mackie Belgium) and $10.9 from our North American acquisitions, primarily Eastern Acoustic Works, Inc. (EAW), in 2000.

 

Intangible assets consist of the following:

 

		September 30, 2002			December 31, 2001
		(in thousands)
Developed technology		$	6,306		$	6,200
Trademark		1,380			1,380
		7,686			7,580
Less accumulated amortization		1,154			726
		$	6,532		$	6,854

 

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In June 2001, the Financial Accounting Standards Board issued FAS No. 141, “Business Combinations” and FAS No. 142, “Goodwill and Other Intangible Assets,” which supercede Accounting Principles Board Opinion No. 17, “Intangible Assets.” FAS No.141 requires that all business combinations be accounted for under the purchase method. The statement also specifies criteria for recognizing and reporting intangible assets apart from goodwill; however, assembled workforce must be recognized and reported in goodwill. FAS 142 requires the use of a non-amortization approach to account for purchased goodwill and intangibles having an indefinite life. Under a non-amortization approach, goodwill and certain intangible assets are no longer amortized into results of operations, but instead are reviewed for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is more than fair value.

 

We adopted FAS 142 on January 1, 2002. Accordingly, we reclassified an assembled workforce intangible asset with an unamortized balance of $1.1 million and a related deferred tax liability of $383,000 to goodwill on January 1, 2002. We have also reviewed the useful lives of our identifiable intangible assets and determined that the original estimated lives remain appropriate. FAS 142 prescribes a two-phase process for impairment testing of goodwill and the timing of transitional impairment steps. The first phase identifies indications of impairment; while the second phase (if necessary), measures the impairment. We have completed step one of the transitional impairment test, and believe that a transitional impairment loss associated with our European segment will be required to be recognized as the cumulative effect of a change in accounting principle as of January 1, 2002. The second phase is required to be completed by December 31, 2002 and will measure the impairment. Additionally, an annual impairment review will be completed during the fourth quarter of 2002.

 

Effective January 1, 2002, we ceased amortization of goodwill. Prior to 2002, we amortized goodwill associated with our acquisitions over 10 - 20 years using the straight-line method. Identifiable intangibles are currently amortized, using the straight-line method, over 5 years for Mackie Belgium and 20 years for other acquisitions.

 

Expected future amortization expense related to identifiable intangible assets for the next five fiscal years is as follows:

 

		(in thousands)
October 1 to December 31, 2002		$	133
Year ending December 31, 2003		532
Year ending December 31, 2004		532
Year ending December 31, 2005		532
Year ending December 31, 2006		381

 

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Summarized below are the effects on net loss and net loss per share, if we had followed the amortization provisions of FAS 142 for the three-month and nine-month periods ended September 30, 2001.

 

		Three months ended September 30, 2001			Nine months ended September 30, 2001
		(in thousands, except per share data)
Net loss:
As reported		$	(3,835	)	$	(4,669	)
Add: goodwill and assembled workforce amortization, net of taxes		378			1,047
Adjusted net loss		$	(3,457	)	$	(3,622	)
Net loss per share:
As reported		$	(0.31	)	$	(0.38	)
Add: goodwill and assembled workforce amortization, net of taxes		0.03			0.09
Adjusted net loss per share		$	(0.28	)	$	(0.29	)

 

Net income (loss) and income (loss) per share for the years ended December 31, 2001, 2000 and 1999 adjusted to exclude goodwill amortization expense are as follows:

 

		2001			2000			1999
		(in thousands, except per share data)
Net income (loss):
As reported		$	(5,329	)	$	6,226		$	3,257
Add: goodwill and assembled workforce amortization, net of taxes		1,431			966			442
Adjusted net income (loss)		$	(3,898	)	$	7,192		$	3,699
Basic net income (loss) per share:
As reported		$	(0.43	)	$	0.51		$	0.27
Add: goodwill and assembled workforce amortization, net of taxes		0.12			0.08			0.03
Adjusted basic net income (loss) per share		$	(0.31	)	$	0.59		$	0.30
Diluted net income (loss) per share:
As reported		$	(0.43	)	$	0.49		$	0.27
Add: goodwill and assembled workforce amortization, net of taxes		0.12			0.07			0.03
Adjusted diluted net income (loss) per share		$	(0.31	)	$	0.56		$	0.30

 

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6.  Financing

 

We have a credit agreement with a U.S. bank covering a revolving bank line of credit and two term loans. Under the terms of this agreement, we must maintain certain financial ratios and tangible net worth. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, acquisitions, and an annual capital expenditure limit. The line of credit and term loans are secured by all U.S. based assets including, but not limited to, accounts receivable, inventory, fixed assets, intangibles and patents.

 

The revolving bank line of credit provides up to $25.0 million of short-term borrowing subject to certain limitations. This line of credit also provides a guarantee of approximately $1.8 million of certain of our debt in Italy. At September 30, 2002 there was $20.6 million outstanding on the line of credit and approximately $2.6 million available. The renewal date for the line of credit is April 2003.

 

There are two term loans. The Term Loan A principal balance is $5.6 million at September 30, 2002 payable at $100,000 per month plus interest at the bank’s prime rate or at LIBOR plus a specified margin. The principal amount of Term Loan B is $8.6 million at September 30, 2002. Interest on this loan is payable monthly and is calculated at the bank’s prime rate plus a specified margin. A principal repayment due in 2003 is calculated based upon our 2002 earnings before interest, taxes, depreciation and amortization, less cash taxes paid, certain capital expenditures and debt repayments. This amount is due in two equal payments in February and July 2003. The renewal date for the term loans is September 2003.

 

At September 30, 2002, we were out of compliance with certain of our financial covenants. We were out of compliance with certain of these covenants in 2001 and the first quarter of 2002 but were able to restructure the covenants and receive waivers for these violations. The lender can declare an event of default, which would allow it to accelerate payment of all amounts due under the credit agreement. Additionally, this non-compliance may result in higher interest costs and/or other fees. We are highly leveraged and would be unable to pay the accelerated amounts that would become immediately due and payable if a default is declared. As a result of this non-compliance, the total of Term Loans A and B is classified as a current liability under the caption, “Long-term debt callable under covenant provisions.”

 

We have taken various actions to ensure our ongoing ability to cover scheduled debt servicing payments. In the third and fourth quarters of 2001 we laid off some of our personnel and closed certain facilities. There have been additional headcount reductions in the third quarter of 2002 and we expect more to be incurred in the remainder of the year. Throughout 2002, we have maintained close controls over capital expenditures. Finally, we are pursuing a variety of alternative financing sources, including loan restructuring, possible equity investment and/or divestiture of certain operating assets.

 

If management controls over spending are successful and costs of sales and overhead costs reduced to levels consistent with our sales, we believe that our cash and available credit facilities, along with cash generated from operations will be sufficient to provide working capital to fund operations over the next twelve months. Although there is no assurance, additional credit facilities may be available from our existing lender or from other sources.

 

7.  Segments and Geographic Information

 

Business segments were previously identified using primarily geographic factors. There have been continuing changes within the structure of our internal reporting that have caused the composition of these segments to change. As a result, we now have one segment. Major operations outside the U.S. include manufacturing facilities in Italy, and sales and support offices in Germany, Italy, the United Kingdom and France. The factory in Italy as well as third-party facilities in China produce certain products that are comparable to those produced in U.S. factories. Other functional operations are consolidated across the organization.

 

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8.  Contingencies

 

In April 2000, we acquired 100% of the capital stock of Eastern Acoustic Works, Inc. (EAW). We have subrogated claims asserted against us from insurance companies who paid claims made by EAW’s landlord and other tenants in the building who were affected by a fire started by a loaned employee in a portion of the building occupied by EAW in 1996. The range of potential loss ranges from $2.1 million to $2.9 million. The Massachusetts Superior Court has set a date for trial in July 2003. We believe that these losses are not attributable to us under Massachusetts’ law and are vigorously defending the litigation. The claims of the other tenants have been covered by EAW’s insurance carrier. The ultimate resolution of this matter is not known at this time.  No provision has been made in our consolidated financial statements related to these claims.

 

We are also involved in various legal proceedings and claims that arise in the ordinary course of business. We currently believe that these matters will not have a material adverse impact on our financial position, liquidity or results of operations.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

The following discussion and analysis should be read in conjunction with our financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2001. This discussion contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “project,” “will be,” “will continue,” “will likely result,” or words or phrases of similar meaning.

 

Our actual results could differ materially from those discussed here. We undertake no obligation to publicly release any revisions to these forward-looking statements that may be required to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

General

 

We develop, manufacture and sell high-quality, affordable digital and analog audio mixers, speakers, amplifiers and other professional audio equipment on a worldwide basis. Our products are used by professional musicians, sound installation contractors and broadcast professionals both in sound recordings, live presentations systems and installed sound systems. We distribute our products primarily through retail dealers, mail order outlets and installed sound contractors.

 

In April 2001, we acquired Mackie Designs Engineering Services BVBA in Belgium (Mackie Belgium), formerly known as Sydec, for approximately $4.4 million. Mackie Belgium is a developer of products and services in the area of embedded electronics and software, networking, digital signal processing and Windows TM driver applications. The transaction was accounted for as a purchase business combination. Operations after April 2001 include the results of operations for Mackie Belgium.

 

Critical Accounting Policies and Estimates

 

We believe our policy on valuing inventory, including market value adjustments, is our most critical accounting policy. Inventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out method, or market. Included in our inventories balance are demonstration products used by our sales representatives and marketing department including finished goods that have been shipped to customers for evaluation. Market value adjustments are recorded for obsolete material, slow-moving product, service and demonstration products. We make judgments regarding the carrying value of our inventory based upon current market conditions. These conditions may change depending upon competitive product introductions, customer demand and other factors. If the market for our previously released products changes, we may be required to write down the cost of our inventory.

 

We assess the impairment of long-lived assets and enterprise goodwill in the fourth quarter of the year and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Significant judgment is required in assessing factors which might trigger impairment including significant underperformance relative to expected operating results, significant changes in our use of the assets or the strategy for our overall business, and significant negative industry or economic trends. We believe that a transitional impairment loss on our enterprise goodwill will be required to be recognized as the cumulative effect of a change in accounting principle as of January 1, 2002. This will be recorded in the fourth quarter. In addition, we assess the useful lives of our long-lived assets and intangible assets which also requires judgment to determine what factors are present that would indicate a change in those useful lives.

 

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Results of Operations

 

Net sales during the third quarter of 2002 were $46.4 million, a decrease of 4% from $48.4 million in the comparable quarter of 2001. Net sales for the nine months ended September 30, 2002 were $144.3 million, a decrease of 10% from $159.7 million during the nine months ended September 30, 2001. The decrease in both periods is primarily due to lower sales volumes in both the U.S. and Europe resulting from the continuing general economic slowdown. A price increase implemented for certain products during the first quarter slightly offset the decrease for the nine-month period.

 

Gross margin was $13.4 million or 29% of net sales for the quarter ended September 30, 2002 compared to $11.5 million or 24% of net sales for the same period in 2001. For the nine months ended September 30, 2002, gross profit was $44.6 million or 31% of net sales compared to $47.4 million or 30% of net sales for the same period in 2001. The increase in gross margin percentage for the quarter relates in part to greater sales of certain products that are manufactured in a third-party, offshore facility. At the end of 2001, we began to transition the manufacture of certain of our product lines to offshore facilities and are continuing this transfer in 2002. Additionally, the lower gross margins in both the three-month and nine-month periods ended September 30, 2001 reflect certain inventory adjustments in our Italian operation which were incurred in the third quarter of 2001. Gross margin for the quarter ended September 30, 2002 was lower than in previous quarters of 2002 due to excess capacity created in our Italian factory as a result of the scheduled summer shutdown and in the Woodinville factory due both to sluggish sales and to the ongoing transition of product mentioned above.  Additionally in the third quarter of 2002 we recorded an inventory adjustment of approximately $550,000 associated with the discontinuation of one of our older product lines.

 

Selling, general and administrative expenses were $13.8 million or 30% of net sales for the third quarter of 2002 compared to $12.3 million or 25% for the third quarter of 2001. During the nine months ended September 30, 2002, selling general and administrative expenses were $39.2 million or 27% of net sales compared to $39.4 million or 25% of net sales for the same period of 2001.  The change in the third quarter of 2002 has several components. First, we increased our allowance for doubtful accounts receivable by approximately $1.0 million during the quarter. The largest portion of this related to the bankruptcy filing of one of our largest U.S. customers. We expect that the bankruptcy of this retail customer and liquidation of its inventory may depress sales in the fourth quarter, but not by a significant amount, as end-user demand should not be affected. Second, we incurred certain professional fees during the quarter relating to certain tax services performed during the quarter. The tax benefits associated with this work are included as an element of our income tax benefit. Finally, the three months and nine months ended September 30, 2001 included amortization of goodwill that totaled $406,000 and $1,132,000, respectively. FAS 142, which requires that assets with indefinite lives are no longer amortized but are tested at least annually for impairment, was adopted January 1, 2002.

 

Research and development expenses were $2.7 million for the third quarter of 2002 compared to $2.9 million for the comparable quarter of 2001. During the nine months ended September 30, 2002, we incurred research and development expenses of $8.2 million compared to $9.2 million for the same period in 2001. As a percentage of sales, research and development expense has remained constant at 6%. The decrease in absolute dollars resulted from certain headcount reductions in the U.S. in the last half of 2001 offset in part by the operations of Mackie Belgium which was acquired in April 2001.

 

Net other expense was $793,000 for the third quarter of 2002 as compared to $789,000 in the third quarter of 2001. For the nine months ended September 30, 2002 other expense was $2.5 million compared to $4.3 million for the comparable period of 2001. Included in this amount is interest expense which decreased to $900,000 in the third quarter of 2002 from $1.2 million in the corresponding period of 2001. Interest expense for the nine months ended September 30, 2002 decreased to $3.0 million from $4.0 million in the comparable period of 2001.The decrease relates to lower interest rates in 2002 versus 2001. Additionally, we have other income in the three-month and nine-month periods ended September 30, 2002 relating to foreign exchange transaction gains. The three-month and nine-month periods of 2001

 

14

 

show $325,000 income and $568,000 expense, respectively also relating to foreign exchange transactions.  The 2002 gains are due to the increase in the value of the Euro as compared to the U.S. dollar.

 

Income tax benefit for the third quarter of 2002 was $2.9 million compared to a benefit of $723,000 for the same period of 2001. Income tax benefit for the nine months ended September 30, 2002 was $2.7 million compared to a benefit of $889,000 for the nine months ended September 30, 2001. The benefit for the third quarter of 2002 is comprised of several factors. We have estimated benefits to be received or taxes to be paid in various tax jurisdictions for the full year and have calculated an effective tax benefit rate for the year of 28% to be recorded on the loss to date. Additionally in the quarter we have recorded approximately $1.2 million of tax benefit associated with tax filings made in the U.S. which increase tax savings associated with foreign activities.

 

Liquidity and Capital Resources

 

Cash used in operating activities was $1.5 million for the nine months ended September 30, 2002. In the comparable period of 2001, cash provided by operations was $9.9 million. Net cash used in operating activities in 2002 was primarily attributable to the net loss and increases in inventories, offset by increases in accounts payable and accrued expenses. The primary reason for the growth in inventories is lower than anticipated sales. In 2001, cash was provided primarily by a decrease in inventories.

 

Cash used in investing activities was $2.3 million for the first nine months of 2002 and $8.6 million for the first nine months of 2001. The cash flows used in investing activities in 2002 included purchases of property, plant and equipment of $2.3 million, while purchases of property, plant and equipment for 2001 were $7.3 million. Payments for the acquisition of Mackie Belgium are scheduled from the closing of the transaction in April 2001 through December 2002. Payments made under this schedule of $1.9 million in 2001 are reflected as acquisition of business in the Condensed Consolidated Statements of Cash Flows.

 

Cash provided by financing activities during the nine months ended September 30, 2002 was $5.0 million. $8.1 million in 2002 represents net proceeds from short-term borrowings; repayments of long-term debt were $1.9 million. Continuing payments in 2002 for the acquisition of Mackie Belgium total $1.2 million. In the comparable period of 2001, cash flows used in financing activities included net proceeds from short-term borrowings as well as proceeds from long-term debt, offset by payments on long-term debt.

 

We have a credit agreement with a U.S. bank covering a revolving bank line of credit and two term loans. Under the terms of this agreement, we must maintain certain financial ratios and tangible net worth. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, acquisitions, and an annual capital expenditure limit. The line of credit and term loans are secured by all U.S. based assets including, but not limited to, accounts receivable, inventory, fixed assets, intangibles and patents. Additionally, we have agreements with several banks in Italy that provide short-term credit facilities totaling approximately $27.1 million, subject to certain limitations. These limitations reduced the actual availability to approximately $24.4 million. At September 30, 2002, there was $24.4 million outstanding on these facilities.

 

Our U.S. bank line of credit provides up to $25.0 million of short-term borrowing subject to certain limitations. This line of credit also provides a guarantee of approximately $1.8 million of certain of our debt in Italy. At September 30, 2002 there was $20.6 million outstanding on the line of credit and approximately $2.6 million available. The renewal date for the line of credit is April 2003.

 

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There are two U.S. term loans. The Term Loan A principal balance is $5.6 million at September 30, 2002 payable at $100,000 per month plus interest at the bank’s prime rate or at LIBOR plus a specified margin. The principal amount of Term Loan B is $8.6 million at September 30, 2002. Interest on this loan is payable monthly and is calculated at the bank’s prime rate plus a specified margin. A principal repayment due in 2003 is calculated based upon our 2002 earnings before interest, taxes, depreciation and amortization, less cash taxes paid, certain capital expenditures and debt repayments. This amount is due in two equal payments in February and July 2003. The renewal date for the term loans is September 2003. There are other bank term loans and notes in Italy totaling $7.8 million at September 30, 2002. Specific assets of Mackie Italy secure certain of these loans. Of this Italian debt, approximately $5.9 million is due within the next twelve months, the majority of which is secured by zero coupon bonds which have a maturity date consistent with the debt payment due date.

 

At September 30, 2002, we were out of compliance with certain of the financial covenants of our credit agreement with the U.S. bank. We were out of compliance with certain of these covenants in 2001 and the first quarter of 2002 but were able to restructure the covenants and receive waivers for these violations. The lender can declare an event of default, which would allow it to accelerate payment of all amounts due under the credit agreement. Additionally, this non-compliance may result in higher interest costs and/or other fees. We are highly leveraged and would be unable to pay the accelerated amounts that would become immediately due and payable if a default is declared. As a result of this non-compliance, the total of Term Loans A and B is classified as a current liability under the caption, “Long-term debt callable under covenant provisions.”

 

We have taken various actions to ensure our ongoing ability to cover scheduled debt servicing payments. In the third and fourth quarters of 2001 we laid off some of our personnel and closed certain facilities. There have been additional headcount reductions in the third quarter of 2002 and we expect more to be incurred in the remainder of the year. Throughout 2002, we have maintained close controls over capital expenditures. Finally, we are pursuing a variety of alternative financing sources, including loan restructuring, possible equity investment and/or divestiture of certain operating assets.

 

If management controls over spending are successful and costs of sales and overhead costs reduced to levels consistent with our sales, we believe that our cash and available credit facilities, along with cash generated from operations will be sufficient to provide working capital to fund operations over the next twelve months. Although there is no assurance, additional credit facilities may be available from our existing lender or from other sources.

 

New Accounting Pronouncements

 

In July 2002, the Financial Accounting Standards Board issued FAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities. FAS No. 146 nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between FAS No. 146 and Issue No. 94-3 relates to the recognition of a liability for a cost associated with an exit or disposal activity. FAS No. 146 requires that a liability be recognized for those costs only when the liability is incurred, that is, when it meets the definition of a liability in the FASB’s conceptual framework. In contrast, under Issue No. 94-3, a company recognized a liability for an exit cost when it committed to an exit plan. FAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. The Statement is effective for exit or disposal activities that are initiated after December 31, 2002 although earlier application is encouraged.

 

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In April 2002, the FASB issued FAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement 13, and Technical Corrections.” FAS 145 rescinds and amends certain previous standards related primarily to debt and leases. The most substantive amendment requires sales-leaseback accounting for certain lease modifications that have economic effects that are similar to sales-leaseback transactions. The provisions of FAS No. 145 related to the rescission of FAS No. 4 are effective for financial statements issued for fiscal years beginning after May 15, 2002 and will become effective for Mackie commencing in 2003. The provisions of FAS No. 145 related to the amendment of FAS No. 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of FAS No. 145 are effective for financial statements issued on or after May 15, 2002. This accounting pronouncement is not expected to have a significant impact on our financial position or results of operations.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

We are exposed to various market risks, including changes in foreign currency rates and interest rates. We may enter into various derivative transactions to manage certain of these exposures; however we did not have any derivative financial instruments as of September 30, 2002.

 

At September 30, 2002, we had variable rate debt of approximately $66.6 million provided by U.S. and Italian banks. As such, changes in U.S. and European interest rates affect interest paid on debt and we are exposed to interest rate risk. In the nine months ended September 30, 2002, an increase in the average interest rate of 10%, i.e. from 6% to 6.6%, would have resulted in an approximately $288,000 increase in net loss before income taxes. The fair value of the variable rate debt approximates the carrying amount on the consolidated balance sheet at September 30, 2002.

 

The assets and liabilities of our non-U.S. subsidiaries, have functional currencies other than the U.S. Dollar, and are translated into U.S. Dollars at exchange rates in effect at the balance sheet date.  These subsidiaries are primarily located in western Europe, the functional currency of which is the Euro. Income and expense items are translated at the average exchange rates prevailing during the period. Additionally, a portion of sales from our U.S. entity is denominated in other than the U.S. Dollar. A 10% decrease in the value of the U.S. Dollar compared to the functional currencies of our non-U.S. subsidiaries, throughout the nine months ended September 30, 2002, would have resulted in an approximately $976,000 increase in net loss before income taxes.

 

Item 4.  Controls and Procedures

 

The Chief Executive Officer and the Chief Financial Officer have reviewed, as of a date within 90 days of the date of filing of this Quarterly Report, the disclosure controls and procedures pursuant to Exchange Act Rules 13a-14(c) and 15d-14(c). Based on that evaluation, such officers have concluded that, as of the evaluation date, the disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in this Quarterly Report. There have been no significant changes in the internal controls, or in other factors that could significantly affect such internal controls.

 

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PART II.  OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

We have subrogated claims asserted against us from insurance companies who paid claims made by EAW’s landlord and other tenants in the building who were affected by a fire started by a loaned employee in a portion of the building occupied by EAW in 1996. The range of potential loss ranges from $2.1 million to $2.9 million. The Massachusetts Superior Court has set a date for trial in July 2003. We believe that these losses are not attributable to us under Massachusetts’ law and are vigorously defending the litigation. The claims of the other tenants have been covered by EAW’s insurance carrier. The ultimate resolution of this matter is not known at this time.  No provision has been made in our consolidated financial statements related to these claims.

 

We are also involved in various legal proceedings and claims that arise in the ordinary course of business. We currently believe that these matters will not have a material adverse impact on our financial position, liquidity or results of operations.

 

Item 2.  Changes in Securities

 

None.

 

Item 3.  Defaults upon Senior Securities

 

None.

 

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

 

None.

 

Item 5. Other Information

 

None.

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

3.2                     Restated Bylaws, as amended August 30, 2002.

 

99.1               Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

99.2               Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)         Reports on Form 8-K

 

The Company filed three reports on Form 8-K during the third quarter of 2002. The report dated September 3, 2002 announced the appointment of Gregory W. Riker as Chairman of the Board of Directors. The report dated September 6, 2002 announced the appointment of Paul Gallo and Kenneth A. Williams as directors and the resignations of C. Marcus Sorenson and David M. Tully as directors. The report dated September 9, 2002 announced the appointment of Jon W. Gacek as director and Chairman of the Audit Committee.

 

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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.

 

 

		Mackie Designs Inc.
				(Registrant)
Dated:  November 14, 2002	By:		/s/ James T. Engen
				James T. Engen
				President, Chief Executive Officer and Director
Dated:  November 14, 2002	By:		/s/ William A. Garrard
				William A. Garrard
				Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer)

 

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CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

 

 

I, James T. Engen, certify that:

 

(1)          I have reviewed this quarterly report on Form 10-Q of Mackie Designs Inc;

 

(2)          Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

(3)          Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

(4)          The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a.               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b.              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c.               presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

(5)          The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a.               all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b.              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

(6)          The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Dated:  November 14, 2002	By:	/s/ James T. Engen
			James T. Engen
			President and Chief Executive Officer

 

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CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

 

I, William A. Garrard, hereby certify that:

 

(1)          I have reviewed this quarterly report on Form 10-Q of Mackie Designs Inc;

 

(2)          Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

(3)          Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

(4)          The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a.               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b.              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c.               presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

(5)          The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a.               all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b.              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

(6)          The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Dated:  November 14, 2002	By:	/s/ William A. Garrard
			William A. Garrard
			Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer)

 

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