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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the Quarterly Period Ended December 31, 2010

 

OR

 

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

 

For the transition period from                to              

 

Commission File Number 001-34716

 

DynaVox Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

27-1507281

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

2100 Wharton Street, Suite 400
Pittsburgh, Pennsylvania 15203
(Address of principal executive offices) (Zip Code)

 

Telephone: (412) 381-4883

(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  x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company x

 

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

 

The number of shares of the registrant’s Class A common stock, par value $0.01 per share, outstanding was 9,383,335 as of February 1, 2011. The number of shares of the registrant’s Class B common stock, par value $0.01 per share, outstanding as of February 1, 2011 was 53 (excluding 47 shares of Class B common stock held by a subsidiary of the registrant).

 

 


Table of Contents

 

DYNAVOX INC.

QUARTERLY REPORT ON FORM 10-Q

For the quarterly period ended December 31, 2010

 

Table of Contents

 

 

 

Page

 

 

 

Forward-Looking Statements

3

 

 

Part I — Financial Information

5

 

 

Item 1.

Financial Statements

5

 

 

 

DynaVox Inc. and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited)

5

 

 

DynaVox Inc. and Subsidiaries Condensed Consolidated Statements of Operations (Unaudited)

6

 

 

DynaVox Inc. and Subsidiaries Condensed Consolidated Statements of Members’ and Stockholders’ Equity (Unaudited)

7

 

 

DynaVox Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited)

8

 

 

DynaVox Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

9

 

 

 

Item 2.

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

21

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

39

 

 

 

Item 4.

Controls and Procedures

39

 

 

 

Part II — Other Information

40

 

 

Item 1

Legal Proceedings

40

 

 

 

Item 1A.

Risk Factors

40

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

40

 

 

 

Item 3.

Defaults Upon Senior Securities

40

 

 

 

Item 4.

(Removed and Reserved)

40

 

 

 

Item 5.

Other Information

40

 

 

 

Item 6.

Exhibits

41

 

 

 

Signatures

 

42

 

2



Table of Contents

 

Forward-Looking Statements

 

This report contains forward-looking statements, which reflect our current views with respect to, among other things, our operations and financial performance. You can identify these forward-looking statements by the use of words such as “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates” or the negative version of these words or other comparable words. Such forward-looking statements are subject to various risks and uncertainties. Accordingly, there are or will be important factors that could cause actual outcomes or results to differ materially from those indicated in these statements. We believe these factors include but are not limited to those described under “Item 1A. Risk Factors” in our Annual Report on Form 10-K, as such factors may be updated by Quarterly Reports on Form 10-Q subsequently filed with the U.S. Securities and Exchange Commission (the “SEC”), including by “Item 1A. Risk Factors” of this report. Some of these important factors include, but are not limited, to the following:

 

·                  The current adverse economic environment, including the associated impact on government budgets, could adversely affect our business.

 

·                  Changes in funding for public schools could cause the demand for our speech generating devices, special education software and content to continue to decrease.

 

·                  Reforms to the United States healthcare system may adversely affect our business.

 

·                  Changes in third-party payor funding practices or preferences for alternatives may decrease the demand for, or put downward pressure on the price of, our speech generating devices.

 

·                  Legislative or administrative changes could reduce the availability of third-party funding for our speech generating devices.

 

·                  The loss of members of our senior management or other key personnel or the failure to attract and retain highly qualified personnel could compromise our ability to effectively manage our business and pursue our growth strategy.

 

·                  We may not be able to develop and market successful new products.

 

·                  New disruptive technologies may adversely affect our market position and financial results.

 

·                  We are dependent on the continued support of speech language pathologists and special education teachers.

 

·                  Our products are dependent on the continued success of our proprietary symbol sets.

 

·                  We depend upon certain third-party suppliers and licensing arrangements, making us vulnerable to supply problems and price fluctuations, which could harm our business.

 

·                  If our patents and other intellectual property rights do not adequately protect our products, we may lose market share to our competitors and be unable to operate our business profitably.

 

·                  Our products could infringe on the intellectual property of others, which may cause us to engage in costly litigation and could cause us to pay substantial damages and prohibit us from selling our products.

 

·                  The market opportunities for our products and content may not be as large as we believe.

 

·                  We may fail to successfully execute our strategy to grow our business.

 

·                  We may attempt to pursue acquisitions or strategic alliances, which may be unsuccessful.

 

·                  We are subject to a variety of risks due to our international operations that could adversely affect those operations or our profitability and operating results.

 

·                  We depend on third-party distributors to market and sell our products internationally in a number of markets. Our business, financial condition and results of operations may be adversely affected by both our distributors’ performance and our ability to maintain these relationships on terms that are favorable to us.

 

3



Table of Contents

 

·                  We may fail to obtain regulatory approval in foreign jurisdictions which could prevent us from marking our products abroad.

 

·                  Our business could be adversely affected by competition including potential new entrants.

 

·                  If we fail to comply with the U.S. Federal Anti-Kickback Statute and similar state and foreign laws, we could be subject to criminal and civil penalties and exclusion from Medicare, Medicaid and other governmental programs.

 

·                  If we fail to comply with the Health Insurance Portability and Accountability Act of 1996, (HIPAA), we could be subject to enforcement actions.

 

·                  Risks related to our organizational structure.

 

·                  Our use of leverage may expose us to substantial risks.

 

These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. These forward-looking statements speak only as of the date of this report or as of the date they were made, and we undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

 

DynaVox Inc. is a holding company and its sole asset is a controlling equity interest in DynaVox Systems Holdings LLC. Unless the context suggests otherwise, references in this report to “DynaVox,” the “Company,” the “Corporation,” “we,” “us” and “our” refer (1) prior to the April 2010 initial public offering (“IPO”) of the Class A common stock of DynaVox Inc. and related transactions, to DynaVox Systems Holdings LLC (or “DynaVox Holdings”) and its consolidated subsidiaries and (2) after our IPO and related transactions, to DynaVox Inc. and its consolidated subsidiaries. We refer to Vestar Capital Partners, a New York-based registered investment adviser, together with its affiliates, as “Vestar,” and to Park Avenue Equity Partners, L.P., together with its affiliates, as “Park Avenue.”

 

4


 


Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1.        FINANCIAL STATEMENTS

 

DYNAVOX INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share amounts)

 

 

 

Successor

 

Successor

 

 

 

December 31,
2010

 

July 2,
2010

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

12,576

 

$

20,777

 

Trade receivables—net of allowance for doubtful accounts of $1,939 and $1,393 as of December 31, 2010 and July 2, 2010, respectively

 

15,553

 

17,741

 

Other receivables

 

327

 

503

 

Inventories

 

6,950

 

6,808

 

Prepaid expenses and other current assets

 

1,160

 

1,210

 

Deferred taxes

 

728

 

728

 

Total current assets

 

37,294

 

47,767

 

PROPERTY AND EQUIPMENT—Net

 

7,319

 

7,065

 

GOODWILL

 

60,846

 

60,846

 

INTANGIBLES—Net

 

30,868

 

31,331

 

DEFERRED TAXES

 

41,644

 

41,474

 

OTHER ASSETS

 

2,570

 

2,683

 

TOTAL ASSETS

 

$

180,541

 

$

191,166

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Current portion of long-term debt

 

$

4,541

 

$

3,961

 

Trade accounts payable

 

4,566

 

5,541

 

Related-party payable

 

171

 

181

 

Deferred revenue

 

1,248

 

1,216

 

Payable to related parties pursuant to tax receivable agreement

 

629

 

 

Other liabilities

 

7,960

 

13,165

 

Total current liabilities

 

19,115

 

24,064

 

LONG-TERM DEBT

 

41,600

 

44,200

 

PAYABLE TO RELATED PARTIES PURSUANT TO TAX RECEIVABLE AGREEMENT

 

40,241

 

40,870

 

OTHER LONG-TERM LIABILITIES

 

2,956

 

4,168

 

Total liabilities

 

103,912

 

113,302

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 1,000,000,000 shares authorized, 9,383,335 shares issued and outstanding at December 31, 2010 and July 2, 2010

 

94

 

94

 

Class B common stock, par value $0.01 per share, 1,000,000 shares authorized, 100 shares issued and outstanding at December 31, 2010 and July 2, 2010

 

 

 

Preferred stock, par value $0.01 per share, 100,000,000 shares authorized, none issued or outstanding at December 31, 2010 and July 2, 2010

 

 

 

Additional paid-in capital

 

23,655

 

24,205

 

Retained earnings

 

1,954

 

2,306

 

Accumulated other comprehensive loss

 

(33

)

(46

)

Total stockholders’ equity attributable to DynaVox Inc.

 

25,670

 

26,559

 

Non-controlling interest

 

51,046

 

51,392

 

Non-controlling interest shareholder notes

 

(87

)

(87

)

Total equity

 

76,629

 

77,864

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

180,541

 

$

191,166

 

 

See notes to unaudited condensed consolidated financial statements.

 

5



Table of Contents

 

DYNAVOX INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(Unaudited)

 

(Dollars in thousands, except per share amounts)

 

 

 

Successor

 

Predecessor

 

Successor

 

Predecessor

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

December 31,
2010

 

January 1,
2010

 

December 31,
2010

 

January 1,
 2010

 

 

 

 

 

 

 

 

 

 

 

NET SALES

 

$

25,526

 

$

28,608

 

$

47,095

 

$

52,863

 

COST OF SALES

 

7,587

 

7,085

 

13,821

 

13,149

 

GROSS PROFIT

 

17,939

 

21,523

 

33,274

 

39,714

 

OPERATING EXPENSES:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

8,747

 

9,022

 

17,484

 

17,535

 

Research and development

 

2,358

 

2,341

 

4,892

 

4,582

 

General and administrative

 

4,977

 

3,901

 

9,764

 

6,784

 

Amortization of certain intangibles

 

114

 

421

 

222

 

841

 

Total operating expenses

 

16,196

 

15,685

 

32,362

 

29,742

 

INCOME FROM OPERATIONS

 

1,743

 

5,838

 

912

 

9,972

 

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

Interest income

 

4

 

9

 

13

 

31

 

Interest expense

 

(663

)

(1,920

)

(1,346

)

(3,930

)

Change in fair value and net loss on interest rate swap agreements

 

(9

)

(122

)

(76

)

(449

)

Other income (expense) —net

 

33

 

(13

)

(235

)

(74

)

Total other expense-net

 

(635

)

(2,046

)

(1,644

)

(4,422

)

INCOME (LOSS) BEFORE INCOME TAXES

 

1,108

 

3,792

 

(732

)

5,550

 

INCOME TAX EXPENSE (BENEFIT)

 

114

 

68

 

(7

)

166

 

NET INCOME (LOSS) ATTRIBUTABLE TO THE CONTROLLING AND NON-CONTROLLING INTERESTS

 

994

 

$

3,724

 

(725

)

$

5,384

 

Less: net (income) loss attributable to the non-controlling interests

 

(842

)

 

 

373

 

 

 

NET INCOME (LOSS) ATTRIBUTABLE TO DYNAVOX INC.

 

$

152

 

 

 

$

(352

)

 

 

Weighted-average shares of Class A common stock outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

9,375,000

 

 

 

9,375,000

 

 

 

Diluted

 

9,375,000

 

 

 

9,375,000

 

 

 

Net income (loss) available to Class A common stock per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.02

 

 

 

$

(0.04

)

 

 

Diluted

 

$

0.02

 

 

 

$

(0.04

)

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

6


 


Table of Contents

 

DYNAVOX INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF MEMBERS’ AND STOCKHOLDERS’ EQUITY

 

(Unaudited)

(In thousands, except unit and share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Units

 

Common A
 shares

 

Common B
shares

 

Treasury

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Non-
Controlling

 

Total
Members’

 

 

 

Number
of
Units

 

Amount

 

Number
of
Shares

 

Amount

 

Number
of
Shares

 

Amount

 

Number
of
Units

 

Amount

 

Management
Notes
Receivable

 

Contributed
(Distributed)
Capital

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Other
Comprehensive
(Loss) Income

 

Comprehensive
(Loss) Income

 

Non-
Controlling
Interest

 

Interest
Shareholder
Notes

 

and
Stockholders’
Equity

 

PREDECESSOR

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE—July 3, 2009

 

4,868,524

 

$

41,344

 

 

$

 

 

$

 

(2,196,961

)

$

(35,050

)

$

(425

)

$

13,248

 

$

 

$

6,149

 

$

(453

)

$

 

$

 

$

 

$

24,813

 

Issuance of common units

 

44,045

 

1,122

 

 

 

 

 

15,650

 

37

 

 

 

 

 

 

 

 

 

1,159

 

Forfeiture, redemption, and cancellation of management equity units

 

(5,000

)

(50

)

 

 

 

 

(7,508

)

(152

)

 

 

 

 

 

 

 

 

(202

)

Equity-based compensation expense

 

 

 

 

 

 

 

 

 

 

334

 

 

 

 

 

 

 

334

 

Issuance of notes receivable for management units

 

 

 

 

 

 

 

 

 

(245

)

 

 

 

 

 

 

 

(245

)

Payment of notes receivable for management units

 

 

 

 

 

 

 

 

 

325

 

 

 

 

 

 

 

 

325

 

Equity distributions

 

 

 

 

 

 

 

 

 

 

(87

)

 

 

 

 

 

 

(87

)

Net income

 

 

 

 

 

 

 

 

 

 

 

 

5,384

 

 

5,384

 

 

 

5,384

 

Net gain on derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

179

 

179

 

 

 

179

 

Currency translation gain

 

 

 

 

 

 

 

 

 

 

 

 

 

33

 

33

 

 

 

33

 

BALANCE—January 1, 2010

 

4,907,569

 

$

42,416

 

 

$

 

 

$

 

(2,188,819

)

$

(35,165

)

$

(345

)

$

13,495

 

$

 

$

11,533

 

$

(241

)

$

5,596

 

$

 

$

 

$

31,693

 

SUCCESSOR

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE—July 2, 2010

 

 

$

 

9,383,335

 

$

94

 

100

 

$

 

 

$

 

$

 

$

 

$

24,205

 

$

2,306

 

$

(46

)

$

 

$

51,392

 

$

(87

)

$

77,864

 

Equity-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

1,059

 

 

 

 

 

 

1,059

 

Equity distributions

 

 

 

 

 

 

 

 

 

 

 

(1,609

)

 

 

 

 

 

(1,609

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

(352

)

 

(352

)

(373

)

 

(725

)

Currency translation gain

 

 

 

 

 

 

 

 

 

 

 

 

 

13

 

13

 

27

 

 

40

 

BALANCE—December 31, 2010

 

 

$

 

9,383,335

 

$

94

 

100

 

$

 

 

$

 

$

 

$

 

$

23,655

 

$

1,954

 

$

(33

)

$

(339

)

$

51,046

 

$

(87

)

$

76,629

 

 

See notes to unaudited condensed consolidated financial statements

 

7


 


Table of Contents

 

DYNAVOX INC. AND SUBSIDIARIES

 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

 

 

Successor

 

Predecessor

 

 

 

Twenty-six Weeks Ended

 

 

 

December 31,
2010

 

January 1,
2010

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net (loss) income attributable to the controlling and non-controlling interests

 

$

(725

)

$

5,384

 

Depreciation

 

1,663

 

1,423

 

Amortization of certain intangibles

 

463

 

950

 

Amortization of deferred financing costs

 

318

 

407

 

Equity-based compensation expense

 

1,059

 

334

 

Change in fair value of interest rate swaps

 

(295

)

(98

)

Change in fair value of acquisition contingencies

 

(183

)

 

Deferred taxes

 

(170

)

 

Loss on disposal of assets

 

1

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Trade receivables

 

2,364

 

1,707

 

Inventories

 

(142

)

(1,004

)

Other assets

 

(6

)

(786

)

Deferred revenue

 

(148

)

(17

)

Trade accounts payable

 

(674

)

2

 

Accrued compensation

 

(4,860

)

(168

)

Accrued interest

 

(40

)

(37

)

Related-party payable

 

(10

)

(211

)

Disbursements on derivative instruments

 

(371

)

(547

)

Other—net

 

188

 

98

 

Net cash (used in) provided by operating activities

 

(1,568

)

7,437

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of property and equipment

 

(2,325

)

(2,405

)

Acquisition of businesses, net of cash acquired

 

 

(933

)

Cash used in investing activities

 

(2,325

)

(3,338

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Repayments of debt agreements

 

(2,020

)

(4,355

)

Payment on acquisition contingencies

 

(570

)

 

Equity distributions

 

(1,609

)

(87

)

Deferred issuance costs

 

(149

)

 

 

Issuances of common units

 

 

200

 

Redemptions of management and common units

 

 

(202

)

Payments received on non-controlling interest shareholder notes

 

 

325

 

Net cash used in financing activities

 

(4,348

)

(4,119

)

EFFECT OF CURRENCY EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

40

 

33

 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

 

(8,201

)

13

 

CASH AND CASH EQUIVALENTS:

 

 

 

 

 

Beginning of period

 

20,777

 

12,631

 

End of period

 

$

12,576

 

$

12,644

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

Net interest paid

 

$

1,031

 

$

3,532

 

Net income taxes paid

 

$

499

 

$

159

 

 

The Company had non-cash investing activities of $20 and $63 for accrued capital costs during the twenty-six weeks ended December 31, 2010 and January 1, 2010, respectively.

 

See notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

 

DYNAVOX INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except unit and share amounts)

 

1. GENERAL

 

DynaVox Inc. (the “Corporation”) and subsidiaries design, manufacture, and distribute electronic and symbol-based augmentative communication equipment, software, and services in the United States and internationally.  Products include assistive technology speech devices, proprietary symbols, books, and software programs to aid in the communication skills of individuals affected by speech disabilities as a result of traumatic, degenerative, or congenital conditions.

 

The Corporation was formed as a Delaware corporation on December 16, 2009 for the purpose of facilitating an initial public offering (“IPO”) of common equity and to become the sole managing member of DynaVox Systems Holdings LLC and subsidiaries (“DynaVox Holdings”).  On April 21, 2010, a registration statement filed with the U.S. Securities and Exchange Commission (“SEC”) related to shares of Class A common stock of the Corporation was declared effective and the price of such shares was set at $15.00 per share.  The IPO closed on April 27, 2010.  Prior to the IPO, the Corporation had not engaged in any business or other activities except in connection with its formation and the IPO.

 

After the effective date of the registration statement but prior to the completion of the IPO, the limited liability company agreement of DynaVox Holdings was amended and restated to, among other things; modify its capital structure by replacing the different classes of interests previously held by the DynaVox Holdings owners to a single new class of units called “Holdings Units”. In addition, each Holdings Units unit holder received one share of the Corporation’s Class B common stock. We and our then-existing owners also entered into an exchange agreement under which (subject to the terms of the exchange agreement) they have the right to exchange their Holdings Units for shares of our Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. These transactions are collectively referred to as the “Recapitalization Transactions.”

 

The Corporation, as a result of the IPO and the related Recapitalization Transactions, became the sole managing member of, and has a controlling equity interest in, DynaVox Holdings. As the sole managing member of DynaVox Holdings, the Corporation operates and controls all of the business and affairs of DynaVox Holdings and, through DynaVox Holdings and its subsidiaries, conducts our business. The Corporation consolidates the financial results of DynaVox Holdings and its subsidiaries, and records non-controlling interest for the economic interest in DynaVox Holdings held by the non-controlling unit holders.  The non-controlling interest ownership percentage as of December 31, 2010 and July 2, 2010 is 68.6%.

 

Collectively, the Corporation and DynaVox Holdings are referred to as the “Company” and as such, references to the “Company” and “Successor” refer to the period subsequent to the IPO and Recapitalization Transactions, and references to “Predecessor” refer to the period prior to the IPO and related Recapitalization Transactions.

 

2. ACCOUNTING POLICIES

 

These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and note disclosures required by U.S. GAAP for complete financial statements. In the opinion of management, all estimates and adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2010.  The results of operations for these interim periods are not necessarily indicative of the operating results for other quarters, for the full fiscal year or for any future period.  The July 2, 2010 financial information has been derived from the Company’s audited financial statements.

 

There have been no significant changes in our significant accounting policies and estimates that were disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2010.

 

Recently Adopted Accounting Standards-In October 2009, the Financial Accounting Standards Board (“FASB”) issued changes to accounting for multiple-deliverable revenue arrangements, and arrangements that include software elements.  These

 

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changes require entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy.  The amendments eliminate the residual method of revenue allocation and require revenue to be allocated among the various deliverables in a multi-element transaction using the relative selling price method.  These changes remove tangible products from the scope of software revenue guidance and provide guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance.  These changes should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted.  The Company adopted the changes issued by the FASB on July 3, 2010 and it had no impact on the Company’s financial statements.

 

3. ACQUISITIONS

 

Eye Response Technologies-On January 4, 2010, the Company acquired all the outstanding shares of Eye Response Technologies, Inc. (“ERT”) in exchange for $3,703 in cash and a guaranteed minimum royalty of $3,500 over three years, plus other contingent consideration, as discussed below.  ERT’s results of operations have been included in the Company’s condensed consolidated statements of operations beginning January 4, 2010.

 

As of the acquisition date, the Company recorded the fair value of contingent consideration related to guaranteed minimum royalty payments due to the previous owner based on future sales of eye products over a period of three years of $3,728.  As of December 31, 2010, the liability was $2,864, which reflects cumulative payments of $677 and a fair value adjustment recorded to other expense of $37 and $187 during the thirteen and twenty-six weeks ended December 31, 2010 (Successor), respectively.

 

As of the acquisition date, the Company recorded the fair value of contingent consideration related to a consulting agreement due to the previous owner related to future service over three years of $430.  As of December 31, 2010, the liability was $303, which reflects cumulative payments totaling $138 and cumulative fair value adjustments of $11 of which $2 and $4 was recorded to interest expense during the thirteen and twenty-six weeks ended December 31, 2010 (Successor), respectively.

 

As of the acquisition date, the Company recorded the fair value of working capital adjustments based on the terms of the stock purchase agreement with the previous owner which was calculated based on a targeted value of $-0- compared to the actual amount of working capital acquired. The fair value of the contingent consideration is classified as a liability, with the acquisition date fair value of $117.  On October 13, 2010, the fair value of the working capital adjustment liability was paid in full.

 

The pro forma results for this acquisition are not material to the Company’s financial results.

 

Blink-Twice Inc.-On July 6, 2009, the Company acquired certain assets and liabilities of Blink-Twice Inc. (“Blink-Twice”), in exchange for $1,000 in cash, issuance of 19,602 Class A units valued at $712, and other contingent consideration, as discussed below. Blink-Twice’s results of operations have been included in the Company’s condensed consolidated statements of operations beginning July 6, 2009.

 

As of the acquisition date, the Company recorded the fair value of contingent consideration related to certain payments owed to the previous owner based on the order backlog acquired (“Acquired Backlog”). The fair value of the Acquired Backlog was determined to be $674 based on the fixed terms of the agreement with the previous owner and is recorded within related-party payable in the condensed consolidated balance sheets as the previous owner is a former employee and current stockholder of the Company. As of December 31, 2010, the related-party payable was $7, which reflects cumulative payments totaling $593 and cumulative fair value adjustment of $74 that were recorded to other income during fiscal year 2010.

 

The Company recorded the fair value of working capital adjustments owed to the previous owner. The acquisition date fair value of the working capital adjustment was determined to be $125 based on the terms of the agreement with the previous owner and was calculated based on a targeted value of $500 compared to the actual amount of working capital acquired. The fair value of the contingent consideration is classified as a liability. As of December 31, 2010, the related-party payable was $154, which reflects a fair value adjustment of $29 that was recorded to other expense during fiscal year 2010.

 

Acquisition-related costs for ERT and Blink-Twice, which include legal, accounting, and other external costs, were expensed as incurred and classified within general and administrative expenses in the condensed consolidated statements of operations. For the thirteen week period ended December 31, 2010 (Successor) and January 1, 2010 (Predecessor), such costs totaled $0 and $258, respectively.  For the twenty-six week period ended December 31, 2010 (Successor) and January 1, 2010 (Predecessor), such costs totaled $0 and $296, respectively.

 

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4. BALANCE SHEET ITEMS

 

Inventories as of December 31, 2010 and July 2, 2010 consist of the following:

 

 

 

Successor

 

Successor

 

 

 

December 31, 2010

 

July 2, 2010

 

 

 

 

 

 

 

Raw materials

 

$

4,724

 

$

4,443

 

Work in progress

 

79

 

79

 

Finished goods

 

2,147

 

2,286

 

Inventories

 

$

6,950

 

$

6,808

 

 

The components of property and equipment as of December 31, 2010 and July 2, 2010, are as follows:

 

 

 

Successor

 

Successor

 

 

 

December 31, 2010

 

July 2, 2010

 

 

 

 

 

 

 

Molds, machinery and equipment

 

$

8,663

 

$

6,278

 

Computer equipment and purchased software

 

4,590

 

4,436

 

Furniture, fixtures and office equipment

 

1,277

 

1,224

 

Leasehold improvements

 

635

 

599

 

Total property and equipment — gross

 

$

15,165

 

$

12,537

 

Less accumulated depreciation

 

(8,937

)

(7,274

)

Construction in process

 

1,091

 

1,802

 

Property and equipment — net

 

$

7,319

 

$

7,065

 

 

Accumulated other comprehensive loss as of December 31, 2010 and July 2, 2010, are as follows:

 

 

 

Successor

 

Successor

 

 

 

December 31, 2010

 

July 2, 2010

 

 

 

 

 

 

 

Attributable to DynaVox Inc.

 

 

 

 

 

Foreign currency translation

 

$

(33

)

$

(46

)

Accumulated other comprehensive loss attributable to DynaVox Inc.

 

$

(33

)

$

(46

)

Attributable to non-controlling interest

 

 

 

 

 

Foreign currency translation

 

$

(74

)

$

(101

)

Accumulated other comprehensive loss attributable to non-controlling interest

 

$

(74

)

$

(101

)

 

Foreign currency translation adjustments, including those pertaining to non-controlling interest, are generally not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries.

 

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5. GOODWILL AND INTANGIBLE ASSETS

 

As of December 31, 2010 and July 2, 2010 the carrying amount of the Company’s goodwill is $60,846.

 

The Company’s identifiable intangible assets with indefinite and finite lives are detailed below:

 

 

 

Successor

 

Successor

 

 

 

December 31, 2010

 

July 2, 2010

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Acquired software technology

 

$

3,253

 

$

1,632

 

$

1,621

 

$

3,253

 

$

1,403

 

$

1,850

 

Patent technology

 

4,330

 

433

 

3,897

 

4,330

 

216

 

4,114

 

Trade name

 

100

 

50

 

50

 

100

 

33

 

67

 

Symbols and trademarks (indefinite live)

 

25,300

 

 

25,300

 

25,300

 

 

25,300

 

 

 

$

32,983

 

$

2,115

 

$

30,868

 

$

32,983

 

$

1,652

 

$

31,331

 

 

The Company performs at least one annual test for impairment of goodwill and intangibles with indefinite lives.  The Company uses the end of its fiscal year for the annual test and has one reporting unit.  In accordance with its policy, the Company conducted its annual impairment test as of July 2, 2010 and concluded that the fair value of its goodwill and intangibles with indefinite lives substantially exceeded their carrying value, and no impairment charge was necessary.  During the first and second quarters of fiscal 2011 the Company determined there were indicators of potential impairment due to the significant decline in the Company’s stock price during the period.  As a result, the Company tested the carrying value of the reporting unit by utilizing a market approach to estimate fair value.  The market approach is based on the Company’s market capitalization as of the end of each reporting period.  The Company concluded no impairment charge was necessary in either quarter as the fair value of the reporting unit exceeded the carrying value at the end of each reporting period.

 

Amortization expense related to intangibles for the thirteen week periods ended December 31, 2010 and January 1, 2010 was $234 and $475, respectively. Amortization expense related to intangibles for the twenty-six week periods ended December 31, 2010 and January 1, 2010 was $463 and $950, respectively. Estimated amortization expense for the remainder of fiscal year 2011 and each subsequent four fiscal years is as follows: 2011—$463; 2012—$920; 2013—$829; 2014—$807; and 2015—$600.

 

6. LONG-TERM DEBT

 

Long-term debt as of December 31, 2010 and July 2, 2010 consists of the following:

 

 

 

Successor

 

Successor

 

 

 

December 31, 2010

 

July 2, 2010

 

2008 Credit Facility

 

$

46,141

 

$

47,066

 

Note payable

 

 

1,095

 

Total debt

 

46,141

 

48,161

 

Less current installments

 

(4,541

)

(3,961

)

Long-term debt—less current installments

 

$

41,600

 

$

44,200

 

 

2008 Credit Facility

 

On June 23, 2008, the Company entered into a third amended and restated secured credit facility (“2008 Credit Facility”) with a syndicate of financial institutions, including GE Business Financial Services Inc. (formerly known as Merrill Lynch Business Financial Services, Inc.), as administrative agent, that provides $52,000 of term loans and up to $10,000 of revolving loans and letters of credit. The 2008 Credit Facility is secured by all domestic assets and 65% of the equity in foreign subsidiaries, and requires principal amortization starting September 30, 2008, with final maturity on June 23, 2014. Advances under the revolving component of the 2008 Credit Facility are due in one installment on June 23, 2013.

 

On February 5, 2010, the Company amended certain aspects of its 2008 Credit Facility. In addition to other items, this amendment increased the Company’s available revolving loans and letters of credit from $10,000 to $12,925, increased the amount available for restricted distributions, as defined, to $12,000 provided the Company is in compliance with certain financial and non-financial covenants and provides for a fee to be paid by the Company if the 2008 Subordinated Note (hereinafter defined) was not paid in full by August 5, 2010.

 

On March 4, 2010, the Company entered into a second amendment to the 2008 Credit Facility which amendment became effective on April 27, 2010. As part of the second amendment, the agent and the lenders under the 2008 Credit Facility consented to DynaVox Holdings transfer of all of its obligations under the 2008 Credit Facility to a newly formed wholly-owned subsidiary of

 

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DynaVox Holdings that became the immediate holding company parent of DynaVox Systems LLC upon the consummation of the IPO. The lenders waived the requirement of any prepayment of the credit facility with the proceeds of the IPO and consented to the repayment in full of the 2008 Subordinated Note and the indebtedness outstanding under certain other notes payable with the proceeds of the IPO.

 

When the second amendment to the 2008 Credit Facility became effective, all obligations under the 2008 Credit Facility were unconditionally guaranteed by the immediate holding company parent of DynaVox Systems LLC and each of DynaVox Systems LLC’s existing and future wholly-owned domestic subsidiaries. The 2008 Credit Facility and the related guarantees are secured by substantially all of DynaVox Systems LLC’s present and future assets and all present and future assets of each guarantor on a first lien basis.

 

On December 21, 2010, the Company entered into a third amendment to the 2008 Credit Facility in order to address a pre-IPO distribution of $10,000 for the 12-month period ending December 31, 2010.  The third amendment modifies the following:  (1) calculation of the Fixed Charge Coverage Ratio for the 12-month period ending December 31, 2010 to exclude from the definition of restricted cash distributions a $10,000 distribution made in March 2010; (2) calculation of the ratios of net senior debt to Adjusted EBITDA and net total debt to Adjusted EBITDA by limiting the Company to net cash and cash equivalents from total debt and senior debt to only any 12-month period in which Adjusted EBITDA for such period is greater than $30,000, whereupon the amount of cash and cash equivalents that may be netted is limited to $5,000; and (3) requires the Company to provide monthly financial statements to the lenders within 30 days of the end of each month.  The Company incurred an arrangement fee of approximately $149 which was capitalized to deferred financing costs as a component of Other Assets and will be amortized through the remaining term of the 2008 Credit Facility.

 

The 2008 Credit Facility provides the option of borrowing at London InterBank Offered Rate (LIBOR) plus a credit spread (4.3% as of December 31, 2010 and July 2, 2010),  or the Prime rate plus a credit spread (6.3% as of December 31, 2010 and July 2, 2010) for all term loans and draws under the revolver.

 

Credit spreads for each term or revolver loan and the unused revolving credit facility fee vary according to the Company’s ratio of net total debt to Adjusted EBITDA (as defined) after December 31, 2008. As of December 31, 2010 and July 2, 2010, the Company’s credit spreads were as follows:

 

 

 

Successor

 

Successor

 

 

 

December 31, 2010

 

July 2, 2010

 

 

 

Prime

 

LIBOR

 

Prime

 

LIBOR

 

2008 Credit Facility

 

3.00

%

4.00

%

3.00

%

4.00

%

Revolver draw under 2008 Credit Facility

 

3.00

%

4.00

%

3.00

%

4.00

%

 

At December 31, 2010 and July 2, 2010, the commitment fee was 0.375% on the unused portion of the revolving credit facility.

 

2008 Subordinated Note

 

On June 23, 2008, the Company entered into a Senior Subordinated Note Agreement (“2008 Subordinated Note”) in the amount of $31,000, which required repayment in one installment on June 23, 2015. The 2008 Subordinated Note bore interest on the outstanding principal at a rate per annum of 15% payable on the last day of each fiscal quarter. The 2008 Subordinated Note was junior to the 2008 Credit Facility and carried a premium for prepayment of 5% after the first and up to the second anniversary date, 3% after the second and up to the third anniversary date, 2% after the third and up to the fourth anniversary date, and 0% thereafter.

 

On February 5, 2010, in conjunction with the 2008 Credit Facility amendment, the Company also amended certain aspects of the 2008 Subordinated Note. In addition to other items, this amendment increased the amount available for restricted distributions, as defined in the note purchase agreement relating to the 2008 Subordinated Notes, to $12,000 provided the Company was in compliance with certain financial and non-financial covenants and provided for a fee of $294 to be paid by the Company if the 2008 Subordinated Note was not paid in full by August 5, 2010. The $31,000 was paid off in full on April 27, 2010 with proceeds from the IPO, thus avoiding the $294 fee. The early repayment of the $31,000 resulted in a penalty equal to 5% of the principal balance plus related expenses, or $1,575 and write-off of deferred financing costs, for a total loss on extinguishment of debt of $2,441 which was recorded in the April 28, 2010 to July 2, 2010 Successor period of fiscal year 2010.

 

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Revolver Draw Under 2008 Credit Facility

 

On March 31, 2010, the Company borrowed $10,000 under the revolving loans provision of the 2008 Credit Facility. The Company distributed the $10,000 to the DynaVox Holdings owners who then used the $10,000 to invest in the securities of a related party portfolio company. The $10,000 was paid in full on April 27, 2010 with proceeds from the IPO. At December 31, 2010 and July 2, 2010, the Company had no outstanding letters of credit and the amount available from the revolving credit facility was $12,925 as of both dates.

 

Financial Covenants

 

Commencing on September 30, 2008, the 2008 Credit Facility and the 2008 Subordinated Note require the Company to comply with certain financial covenants, including maximum capital expenditures, minimum fixed-charge coverage ratio, net senior debt maximum leverage ratio, and net total debt maximum leverage ratio, and places certain restrictions on acquisitions and payment of dividends. The Company was in compliance with all financial covenants as required under the 2008 Credit Facility, as amended, at December 31, 2010 and July 2, 2010. The 2008 Credit Facility contains certain mandatory prepayments, including an excess cash flow provision. The Company was not required to make an excess cash flow payment for the year ended July 2, 2010.

 

Note Payable

 

The $1,095 note payable as of July 2, 2010 is related to an acquisition in 2004 and had an interest rate of 7% which was paid quarterly. The note payable matured on September 30, 2010 and as such was paid off in full during the first quarter of fiscal year 2011.

 

7. INCOME TAXES

 

The Company’s effective tax rate is summarized in the following table:

 

 

 

Successor

 

Predecessor

 

Successor

 

Predecessor

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

December 31,
2010

 

January 1,
2010

 

December 31,
2010

 

January 1,
2010

 

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

$

114

 

$

68

 

$

(7

)

$

166

 

Effective income tax rate

 

10.29

%

1.79

%

0.96

%

2.99

%

 

The tax provision for the current year period is based on an estimate of the Company’s annualized income tax rate.  The effective tax rate is calculated by dividing the provision for income taxes by income before income taxes.  The Company’s effective tax rate includes a rate benefit attributable to the fact that the Company’s subsidiaries operate as a limited liability company which is not subject to federal or state income tax.  Accordingly, a portion of the Company’s earnings are not subject to corporate level taxes.  This favorable impact is partially offset by the impact of certain permanent items, primarily attributable to certain entertainment and lobbying expenses that are not deductible for tax purposes.  During the twenty-six weeks ended December 31, 2010, the Company recorded discrete items that resulted in income tax expense, including (i) interest associated with the reserve for uncertainties in income tax positions and (ii) the effect of the deferred tax rate change in the United Kingdom.

 

A reconciliation of the beginning and ending gross amounts of unrecognized tax benefits is summarized as follows:

 

Balance as of July 2, 2010

 

$

67

 

Increases in prior period tax positions

 

9

 

Balance as of December 31, 2010

 

$

76

 

 

The Company recognizes interest and penalties related to income taxes as a component of corporate income tax expense.

 

The Company files income tax returns with federal, state, local, and foreign jurisdictions.  U.S. federal and state tax returns associated with fiscal years 2007 — 2009 are currently open for examination.  Foreign tax returns associated with fiscal year 2006 — 2009 also remain open under the statute.

 

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8. FAIR VALUE MEASUREMENTS

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. Fair value is an exit price and the exit price should reflect all the assumptions that market participants would use in pricing the asset or liability.

 

Accounting standards established three different valuation techniques; market approach, income approach, and cost approach. The Company uses the market and income approaches to value assets and liabilities for which the measurement attribute is fair value.

 

Valuation techniques used to measure fair value are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s internal market assumptions. These two types of inputs create the following fair value hierarchy:

 

Level 1—Inputs to the valuation methodology are based on quoted prices for an identical asset or liability in an active market.

 

Level 2—Inputs to the valuation methodology are based on quoted prices for a similar asset or liability in an active market, quoted prices for an identical or similar asset or liability in an inactive market, or model- derived valuations for which all significant inputs are observable or can be corroborated by observable market data.

 

Level 3—Inputs to the valuation methodology are unobservable and significant to the fair value measurement of the asset or liability.

 

Valuation of assets and liabilities requires consideration of market risks in our valuations that other market participants may consider. Specifically, consideration was given to the Company’s non-performance risk and counterparty credit risk to develop appropriate risk-adjusted discount rates used in our fair value measurements. The Company utilized the following valuation methodologies to measure our financial assets and liabilities:

 

Cash equivalents: Cash equivalents include investments in money market funds. Investments in this category can be redeemed immediately at the current net asset value per share. A money market fund is a mutual fund whose investments are primarily in short-term debt securities designed to maximize current income with liquidity and capital preservation, usually maintaining per share net asset value at a constant amount, such as one dollar. The carrying amounts approximate fair value because of the short maturity of the instruments.

 

Interest rate swaps: Interest rate swaps are financial contracts with counterparties that are valued using the income approach. The fair value of these contracts is measured by estimating the future cash flows of the contract based on the quoted future market prices of interest rates at the reporting date and discounting the fair value to the present value using a credit-adjusted discount rate.

 

The following table presents assets and liabilities measured at fair value on a recurring basis at December 31, 2010 and July 2, 2010:

 

 

 

Successor

 

 

 

As of December 31, 2010

 

Description

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Cash equivalents

 

$

252

 

$

 

$

 

$

252

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

252

 

$

 

$

 

$

252

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

 

$

(336

)

$

 

$

(336

)

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

$

 

$

(336

)

$

 

$

(336

)

 

 

 

Successor

 

 

 

As of July 2, 2010

 

Description

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Liabilities

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

 

$

(631

)

$

 

$

(631

)

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

$

 

$

(631

)

$

 

$

(631

)

 

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The carrying amounts reflected in the condensed consolidated balance sheets for cash, trade accounts receivable, and trade accounts payable approximate their respective fair values based on the short-term nature of these instruments. At December 31, 2010 and July 2, 2010, the fair value of the Company’s debt instruments approximated their respective carrying value as the debt was principally comprised of variable rate debt. The fair value of the Company’s long-term debt was based upon borrowing rates then available to the Company for similar debt instruments with like terms and maturities.

 

9. DERIVATIVE FINANCIAL INSTRUMENTS

 

The Company used interest rate swaps for all periods presented to hedge exposure to interest rate risk on its variable-rate debt. The Company does not enter into derivative instruments for speculative purposes. The Company enters into derivatives with high credit quality counterparties and diversifies its positions among such counterparties in order to reduce its exposure to credit losses. The Company has not experienced any credit losses on derivatives during the twenty-six week periods ended December 31, 2010 (Successor) and January 1, 2010 (Predecessor).

 

Prior to June 28, 2008, the Company designated its derivative instruments as cash flow hedges and recognized the derivative instruments as either assets or liabilities at fair value in the condensed consolidated balance sheets. To the extent that the derivative instrument was effective as a cash flow hedge, the change in fair value of the derivative was deferred in other comprehensive income and reclassified to earnings once the forecasted transaction affected earnings. Any portion considered to be ineffective was immediately reported in earnings.

 

During the year ended July 3, 2009, the Company removed the cash flow hedge designation of its derivative instruments due to a refinancing of the underlying debt which caused the critical terms of the hedged item and hedging instruments to no longer match. Upon removal of the cash flow hedge designation, prospective changes in fair value associated with the derivative instruments are recognized directly in earnings and amounts residing in other comprehensive income related to the previously cash flow designated hedge are reclassified to earnings once the forecasted transaction affects earnings.

 

The Company has entered into interest rate swaps that matured, or will mature, at various dates in calendar years 2010 and 2011. These swaps serve to convert an original notional amount of $37,500 of variable-rate debt to fixed-rate debt. As of December 31, 2010 and July 2, 2010, the outstanding notional amount was $23,100 and $27,000, respectively.

 

Information related to the fair value of derivative instruments and their location in the unaudited condensed consolidated balance sheet is presented below:

 

 

 

 

 

Successor

 

Successor

 

Derivatives Not Designated

 

Balance Sheet

 

Fair Value as of

 

Fair Value as of

 

as Hedging Instruments

 

Location

 

December 31, 2010

 

July 2, 2010

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Other current liabilities

 

$

336

 

$

631

 

 

 

 

 

 

 

 

 

Total

 

 

 

$

336

 

$

631

 

 

Information related to the amounts recognized for derivatives and their location in the unaudited condensed consolidated statements of operations for the thirteen week periods ended December 31, 2010 (Successor) and January 1, 2010 (Predecessor), are presented below:

 

 

 

 

 

Amount of Loss Reclassified
from AOCI to Income (1)

 

Amount of Loss Recognized
in Income

 

Total Loss Recognized
 in Income

 

 

 

 

 

Thirteen weeks ended

 

Thirteen weeks ended

 

Thirteen weeks ended

 

Derivatives Not Designated
as Hedging Instruments

 

Statement of Operations
Location

 

December 31,
2010

 

January 1,
2010

 

December 31,
2010

 

January 1,
 2010

 

December 31,
2010

 

January 1,
2010

 

Interest rate swaps

 

Change in fair value and net loss on interest rate swap agreements

 

$

 

$

(64

)

$

(9

)

$

(58

)

$

(9

)

$

(122

)

 


(1)          Represents reclassification from AOCI that results from the hedging instrument’s previous designation as a cash flow hedge.

 

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Information related to the amounts recognized for derivatives and their location in the unaudited consolidated statements of operations for the twenty-six week periods ended December 31, 2010 (Successor) and January 1, 2010 (Predecessor), are presented below:

 

 

 

 

 

Amount of Loss Reclassified
from AOCI to Income (1)

 

Amount of Loss Recognized
in Income

 

Total Loss Recognized
 in Income

 

 

 

 

 

Twenty-six weeks ended

 

Twenty-six weeks ended

 

Twenty-six weeks ended

 

Derivatives Not Designated
as Hedging Instruments

 

Statement of Operations
 Location

 

December 31,
2010

 

January 1,
2010

 

December 31,
2010

 

January 1,
2010

 

December 31,
2010

 

January 1,
2010

 

Interest rate swaps

 

Change in fair value and net loss on interest rate swap agreements

 

$

 

$

(179

)

$

(76

)

$

(270

)

$

(76

)

$

(449

)

 


(1)          Represents reclassification from AOCI that results from the hedging instrument’s previous designation as a cash flow hedge.

 

As of July 2, 2010, the Company had reclassified all amounts recorded in other comprehensive income into other expense.

 

10. EQUITY-BASED COMPENSATION

 

For a detailed description of past equity-based compensation activity, please refer to the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2010. There have been no significant changes in the Company’s equity-based compensation accounting policies and assumptions from those that were disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2010.

 

The Company recorded equity-based compensation expense with respect to (a) grants of legacy interest in DynaVox Holdings, (b) options to purchase shares of the Company’s Class A common stock (“Successor Options”) and (c) restricted stock awards (“Successor RSA’s”) as follows:

 

 

 

Thirteen Weeks Ended

 

 

 

December 31, 2010

 

January 1, 2010

 

 

 

Successor

 

Predecessor

 

 

 

Cost of
Sales

 

Selling and
Marketing

 

Research and
Development

 

General and
Administrative

 

Total

 

Cost of
Sales

 

Selling and
Marketing

 

Research and
Development

 

General and
Administrative

 

Total

 

Legacy interest in DynaVox Holdings

 

$

 

$

7

 

$

3

 

$

8

 

$

18

 

$

 

$

76

 

$

10

 

$

58

 

$

144

 

Successor Options

 

4

 

33

 

61

 

382

 

480

 

 

 

 

 

 

Successor RSA’s

 

 

 

 

16

 

16

 

 

 

 

 

 

Total

 

$

4

 

$

40

 

$

64

 

$

406

 

$

514

 

$

 

$

76

 

$

10

 

$

58

 

$

144

 

 

 

 

Twenty-six Weeks Ended

 

 

 

December 31, 2010

 

January 1, 2010

 

 

 

Successor

 

Predecessor

 

 

 

Cost of
Sales

 

Selling and
Marketing

 

Research and
Development

 

General and
Administrative

 

Total

 

Cost of
Sales

 

Selling and
Marketing

 

Research and
Development

 

General and
Administrative

 

Total

 

Legacy interest in DynaVox Holdings

 

$

 

$

19

 

$

7

 

$

16

 

$

42

 

$

 

$

152

 

$

44

 

$

138

 

$

334

 

Successor Options

 

8

 

74

 

131

 

765

 

978

 

 

 

 

 

 

Successor RSA’s

 

 

 

 

39

 

39

 

 

 

 

 

 

Total

 

$

8

 

$

93

 

$

138

 

$

820

 

$

1,059

 

$

 

$

152

 

$

44

 

$

138

 

$

334

 

 

A summary of the Company’s Successor stock option activity under the 2010 Long-Term Incentive Plan (“2010 Plan”) for the twenty-six weeks ended December 31, 2010 is as follows:

 

 

 

Options

 

Range of
Exercise Prices

 

Weighted-Average
Exercise Price

 

Weighted-Average
Remaining
Contractual Life

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

Outstanding—July 2, 2010

 

1,370,500

 

$

15.00

 

$

15.00

 

9.8

 

$

365

 

Granted

 

35,000

 

4.10-9.45

 

6.70

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

 

 

Cancelled

 

(24,500

)

15.00

 

 

 

 

 

 

 

Outstanding—December 31, 2010

 

1,381,000

 

$

4.10-$15.00

 

$

14.79

 

9.2

 

$

19

 

Exercisable at December 31, 2010

 

 

 

 

 

 

 

The weighted-average grant date fair value of stock options granted during the twenty-six weeks ended December 31, 2010 was $3.78 per share.

 

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The fair value of the stock options issued under the 2010 Plan was estimated based on the closing market price of the Company’s common stock on the date of grant using a Black-Scholes option valuation model with the following assumptions:

 

 

 

Twenty-six Weeks
Ended

 

 

 

December 31, 2010

 

Black-Scholes Option Valuation Assumptions:

 

 

 

Dividend yield(1)

 

0

%

Expected volatility(2)

 

47.4-84.0

%

Risk-free interest rates(3)

 

2.0-2.1

%

Expected term of options(4)

 

6.4

 

 


(1)                                  The expected dividend yield was based on our expectation of not paying dividends on the Company’s Class A common stock for the foreseeable future.

 

(2)                                  The expected volatility was based on the historical volatility of the Company’s Class A common stock.

 

(3)                                  Based on the U.S. Treasury yield curve in effect at the time of grant with a term consistent with the expected life of our stock options.

 

(4)                                  Represents the period of time options are expected to be outstanding. The weighted-average expected term was determined using the “simplified method” for plain vanilla options as the Company lacks historical experience. The “simplified method” calculates the expected term as the average of the vesting term and original contractual term of the options.

 

As of December 31, 2010, there was $8,162 of unrecognized compensation expense related to nonvested stock option awards that is expected to be recognized over a weighted-average period of 4.1 years.

 

A summary of the Company’s Successor restricted stock award activity under the 2010 Plan for the twenty-six weeks ended December 31, 2010 is as follows:

 

 

 

Restricted
Shares of
Class A
Common
Stock

 

Weighted -
Average
Grant
Fair Value

 

Weighted-Average
Remaining
Contractual Life

 

Aggregate
Fair Value

 

 

 

 

 

 

 

 

 

(in thousands)

 

Outstanding—July 2, 2010

 

8,335

 

$

15.00

 

1.8

 

$

127

 

Granted

 

 

 

 

 

 

 

Vested

 

 

 

 

 

 

 

Cancelled

 

 

 

 

 

 

 

Outstanding—December 31, 2010

 

8,335

 

$

15.00

 

1.3

 

$

43

 

 

As of December 31, 2010, there was $81 of unrecognized compensation expense related to nonvested restricted share awards that is expected to be recognized over a weighted-average period of 1.3 years.

 

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A summary of the changes in non-vested Holdings Units outstanding during the twenty-six weeks ended December 31, 2010 is detailed in the following table below:

 

 

 

Number of
Awards

 

Weighted-Average
Per Unit
Grant Date
Fair Value

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

(in thousands)

 

Holdings Units:

 

 

 

 

 

 

 

Nonvested units as of July 2, 2010

 

165,573

 

$

2.97

 

 

 

Granted

 

 

 

 

 

Vested

 

(24,702

)

3.83

 

 

 

Forfeited

 

 

 

 

 

Redeemed

 

 

 

 

 

Nonvested units as of December 31, 2010

 

140,871

 

$

2.81

 

$

62

 

 

Non-vested Holdings Units that were service-based retained their original vesting date and unrecognized compensation expense associated with them will be expensed according to the original schedule.  As of December 31, 2010, there was $161 of unrecognized compensation expense related to non-vested Holdings Units that is expected to be recognized over a weighted-average vesting period of 2.9 years.

 

11. NET INCOME (LOSS) PER SHARE

 

The following table sets forth the computation of basic and diluted net income (loss) per common share:

 

 

 

Successor

 

 

 

Thirteen Weeks
Ended

December 31, 2010

 

Twenty-six Weeks
Ended

December 31, 2010

 

Numerator:

 

 

 

 

 

Numerator for basic and diluted net income (loss) per Class A common share- net income (loss) attributable to DynaVox Inc.

 

$

152

 

$

(352

)

Denominator:

 

 

 

 

 

Denominator for basic net income (loss) per Class A common share- weighted average shares

 

9,375,000

 

9,375,000

 

Effect of dilutive securities:

 

 

 

 

 

Option equivalents

 

 

 

Denominator for diluted net income (loss) per common share- adjusted weighted average shares

 

9,375,000

 

9,375,000

 

Basic net income (loss) attributable to DynaVox Inc. per Class A common share

 

$

0.02

 

$

(0.04

)

Diluted net income (loss) attributable to DynaVox Inc. per Class A common share

 

$

0.02

 

$

(0.04

)

 

Weighted-average shares of stock options and restricted stock, which were anti-dilutive and thus not included in the computation of weighted-average diluted common share amounts, were 1,380,694 and 8,335, respectively, for the thirteen week period presented and 1,376,729 and 8,335, respectively, for the twenty-six week period presented.  Earnings per share information is not applicable for reporting periods prior to the Successor period beginning April 28, 2010. The shares of Class B common stock do not share in the earnings or losses of DynaVox Inc. and are therefore not participating securities. Accordingly, basic and diluted net loss per share of Class B common stock has not been presented.

 

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Table of Contents

 

12. COMMITMENTS AND OTHER CONTINGENCIES

 

From time to time, we may be involved in a variety of claims, lawsuits, investigations and proceedings relating to securities laws, product liability, patent infringement, contract disputes and other matters relating to various claims that arise in the normal course of our business. The results of litigation and claims cannot be predicted with certainty, and unfavorable resolutions are possible and could materially affect our results of operations, cash flows or financial position. In addition, regardless of the outcome, litigation could have an adverse impact on us because of defense costs, diversion of management resources and other factors.

 

One such lawsuit is described in further detail below. We intend to defend it vigorously. Based on currently available information, we believe that we have meritorious defense to this action and that the resolution of this case is not likely to have a material adverse effect on our business, financial position or results of operations.

 

On October 14, 2010, a purported class action lawsuit was filed in the United States District Court for the Western District of Pennsylvania against us, two of our officers, Edward L. Donnelly, Jr. and Kenneth D. Misch, and two of the underwriters in our IPO. The lawsuit seeks unspecified damages on behalf of a putative class of persons who purchased our Class A common stock pursuant to our prospectus dated April 21, 2010, filed with the SEC in accordance with Rule 424(b) of the Securities Act on April 23, 2010. The complaint alleges that the defendants issued materially false and misleading statements in our prospectus in light of the Company’s September 30, 2010 press release announcing it had experienced a softening of demand for both its speech generating devices and software products during the first quarter of its fiscal year 2011 which ended October 1, 2010. The press release also announced that as a result of the softening of demand operating results for the fiscal first quarter would not be consistent with historical performance or indicative of what management believes to be the Company’s long-term future operating potential. Under a stipulation entered into by the parties, the lead plaintiff has until February 18, 2011 to file an amended complaint and the Company will file a motion to dismiss the amended complaint on or before April 19, 2011.

 

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Table of Contents

 

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

 

You should read the following discussion in conjunction with our condensed consolidated financial statements included elsewhere herein. The financial information set forth and discussed below is unaudited, but in the opinion of management, reflects all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of such information. The Company’s results of operations for a particular quarter may not be indicative of results expected during the other quarters or for the entire year. The following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those listed under the “Forward-Looking Statements” section above. These risks and uncertainties are described in more detail in our Annual Report on Form 10-K for the fiscal year ended July 2, 2010, and could cause our actual results to differ materially from any future performance suggested below.

 

We operate on a fiscal calendar that results in a given fiscal year consisting of a 52-week or 53-week period ending on the Friday closest to June 30th of each year. For example, references to “fiscal year 2011” refer to the 52-week period ending on July 1, 2011. Fiscal year 2011 and fiscal year 2010 each consists of 52-week periods.

 

Overview

 

We develop and market industry-leading software, devices and content to assist people in overcoming their speech, language or learning disabilities. Our proprietary software is the result of decades of research and development. We believe our trademark- and copyright-protected symbol sets are more widely used than any other in our industry. These assets have positioned us as a leader in two areas within the broader market for assistive technologies—speech generating technologies and special education software.

 

Sales of our speech generating technologies is our largest source of revenue. In fiscal years 2010, 2009 and 2008, sales of speech generating technologies produced approximately 79%, 82% and 79%, respectively, of our net sales. Our revenue from sales of speech generating technologies has grown to $90.0 million in fiscal year 2010 from $64.6 million in fiscal year 2008. We believe a primary driver of our sales of speech generating technologies has been and will continue to be the scale and effectiveness of our sales and marketing infrastructure and other awareness-building activities. The pricing levels at which third party payors, including Medicare, Medicaid and private insurers, are willing to provide coverage for speech generating technology also significantly influences our sales of speech generating technologies because a significant portion of the speech generating devices that we sell are funded by such third-party payors.

 

Our other source of revenue is sales of special education software. In fiscal years 2010, 2009 and 2008, sales of special education software produced approximately 21%, 18% and 21%, respectively, of our net sales. Our software products are generally purchased by special education teachers and are generally funded by schools, which receive funding from federal, state and local sources. The level of funding available for special education and educational technology is an important driver of our software sales. Currently, revenue from sales of our software products is generated primarily from up-front fees that we collect on the initial sale of our authoring tools. In August 2010, we introduced the next generation of our special education software, which we anticipate will be adopted by our existing customer base as well as new users. This new generation of our software products will allow us to diversify our revenue sources to include licensing fees and sales of professionally-generated content for use with our software platforms.

 

As we previously disclosed, we experienced a softening of demand for both our speech generating devices and software products during the first quarter of our fiscal year 2011. This softening of demand relative to our prior year continued during the second quarter of fiscal year 2011 for both our speech generating devices and software products. We continue to believe that reduced domestic government funding, and particularly more constrained state and local government funding of school budgets, is adversely affecting our product sales in the United States.  In addition, we believe that constraints in government spending in the Company’s key international markets, including Canada and the United Kingdom, have had a similar effect on our product sales in those regions.  The adverse impact of these factors on our net sales generation has been more significant than initially anticipated. We did experience some improvement in net sales, as compared to the corresponding month in the prior year, toward the later part of the second quarter of fiscal year 2011as the month of November net sales declined 9% and December grew 3% versus a 22% decline in October. Overall, net sales for the second quarter of fiscal year 2011 declined 11% as compared to the second quarter of fiscal year 2010. Although there were some encouraging signs in the later part of the second quarter of fiscal year 2011, we have not seen any material improvement in the demand for both our speech generating devices and software products, and we cannot predict when such improvement might occur. Although we are not yet seeing evidence of a material improvement in the government funding environment, we are continuing to invest in our business and have launched new products into our target markets which we continue to believe are underpenetrated.

 

Our cost of sales as a percentage of net sales is influenced by the mix of our net sales between speech generating technologies and special education software, with the gross margin on our software sales being moderately higher.

 

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Our primary operating expenses are selling and marketing, research and development and general and administrative. As of fiscal year 2010 our selling and marketing expenses increased in absolute terms during the most recent three fiscal years as we substantially increased the size of our selling and marketing operations. Our research and development expenses have increased over the past three fiscal years as a result of commercializing our pipeline of new products, product enhancements and new applications for our existing products. Our general and administrative expenses have also increased for the thirteen week and twenty-six week periods ended December 31, 2010 compared to the thirteen week and twenty-six week periods ended January 1, 2010 primarily as a result of us becoming a publicly-traded company in April 2010.

 

Significant Transactions

 

Incorporation of DynaVox Inc.

 

DynaVox Inc. was incorporated as a Delaware corporation on December 16, 2009 for the purposes of facilitating an initial public offering of common equity. Following the recapitalization and IPO transactions described below, DynaVox Inc.’s sole material asset is a controlling equity interest in DynaVox Systems Holdings LLC. As the sole managing member of DynaVox Systems Holdings LLC, DynaVox Inc. operates and controls all of the business and affairs of DynaVox Systems Holdings LLC and, through DynaVox Systems Holdings LLC and its subsidiaries, conducts our business. Prior to the initial public offering, DynaVox Inc. did not engage in any business or activities except in connection with its formation.

 

The certificate of incorporation of DynaVox Inc. authorizes two classes of common stock, Class A common stock and Class B common stock. On April 21, 2010, one or more shares of Class B common stock of DynaVox Inc. were distributed to each of our then-existing owners, each of which provides its owner with no economic rights but entitles the holder, without regard to the number of shares of Class B common stock held by such holder, to one vote on matters presented to stockholders of DynaVox Inc. for each Holdings Unit held by such holder. Holders of our Class A common stock and Class B common stock vote together as a single class on all matters presented to our stockholders for their vote or approval, except as otherwise required by applicable law.

 

Recapitalization Transactions

 

On April 21, 2010, the limited liability company agreement of DynaVox Systems Holdings LLC was amended and restated to, among other things, modify its capital structure by replacing the different classes of interests previously held by our then-existing owners with a single new class of units that we refer to as “Holdings Units.” We and our then-existing owners also entered into an exchange agreement under which (subject to the terms of the exchange agreement) they have the right to exchange their Holdings Units for shares of our Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. As of December 31, 2010 there were 20,451,648 Holdings Units held by parties other than DynaVox Inc. which upon exercise of the right to exchange would exchange for 20,451,648 shares of Class A common stock.

 

Initial Public Offering

 

On April 21, 2010, a registration statement relating to shares of Class A common stock was declared effective and the price of such shares was set at $15.00 per share. The IPO closed on April 27, 2010. Pursuant to the IPO, DynaVox Inc. issued and sold 9,375,000 shares of Class A common stock and acquired an equivalent number of Holdings Units.

 

Subsequent to the IPO and related offering transactions DynaVox Inc. consolidates the financial results of DynaVox Systems Holdings LLC and its subsidiaries, and the ownership interest of the other members of DynaVox Systems Holdings LLC is reflected as a non-controlling interest in DynaVox Inc.’s consolidated financial statements beginning April 28, 2010.

 

Tax Receivable Agreement

 

DynaVox Systems Holdings LLC intends to make an election under Section 754 of the Internal Revenue Code (the “Code”) effective for each taxable year in which an exchange of Holdings Units for shares of Class A common stock as described above occurs, which may result in an adjustment to the tax basis of the assets of DynaVox Systems Holdings LLC at the time of an exchange of Holdings Units. As a result of both the initial purchase of Holdings Units from our then-existing owners immediately prior to the IPO and these subsequent exchanges, DynaVox Inc. will become entitled to a proportionate share of the existing tax basis of the assets of DynaVox Systems Holdings LLC. In addition, the purchase of Holdings Units and subsequent exchanges are expected to result in increases in the tax basis of the assets of DynaVox Systems Holdings LLC that otherwise would not have been available. Both this proportionate share and these increases in tax basis may reduce the amount of tax that DynaVox Inc. would otherwise be required to pay in the future. These increases in tax basis may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.

 

In connection with the IPO we entered into a tax receivable agreement with our then-existing owners that provide for the payment from time to time by DynaVox Inc. to our then-existing owners of 85% of the amount of the benefits, if any, that DynaVox Inc. is deemed to realize as a result of (i) the existing tax basis in the intangible assets of DynaVox Holdings on the date of the IPO, (ii) an increase in the tax basis of the assets of DynaVox Holdings that otherwise would not have been available (iii) certain other tax benefits related to our entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. These payment obligations are

 

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Table of Contents

 

obligations of DynaVox Inc. and not of DynaVox Holdings . For purposes of the tax receivable agreement, the benefit deemed realized by DynaVox Inc. will be computed by comparing the actual income tax liability of DynaVox Inc. (calculated with certain assumptions) to the amount of such taxes that DynaVox Inc. would have been required to pay had there been no increase to the tax basis of the assets of DynaVox Holdings as a result of the purchase or exchanges, had there been no tax benefit from the tax basis in the intangible assets of DynaVox Holdings on the date of the IPO and had DynaVox Inc. not entered into the tax receivable agreement. The term of the tax receivable agreement will continue until all such tax benefits have been utilized or expired, unless DynaVox Inc. exercises its right to terminate the tax receivable agreement for an amount based on the agreed payments remaining to be made under the agreement or DynaVox Inc. breaches any of its material obligations under the tax receivable agreement in which case all obligations will generally be accelerated and due as if DynaVox Inc. had exercised its right to terminate the agreement.

 

For a complete discussion of the tax receivable agreement see “Item 13. Certain Relationships and Related Transactions, and Director Independence” in our Annual Report on Form 10-K for the fiscal year ended July 2, 2010.

 

Predecessor and Successor Periods

 

DynaVox Inc. completed an initial public offering on April 27, 2010. As a result of the IPO and certain other recapitalization transactions, DynaVox Inc. became the sole managing member of and has a controlling interest in DynaVox Systems Holdings LLC and its subsidiaries (“DynaVox Holdings” or “Predecessor”). References to “Successor” refer to DynaVox Inc. and its consolidated subsidiaries.

 

The results of operations and following discussion present income statement line items down to income before non-controlling interest and income taxes. We also present a separate explanatory discussion on the Predecessor operating performance for the thirteen and twenty-six week periods ended January 1, 2010 and for the Successor operating performance for the thirteen and twenty-six week periods ended December 31, 2010.

 

Components of Results of Operations

 

Net Sales

 

Our sales are recorded net of product returns and an allowance for discounts and adjustments at the time of the sale based upon contractual arrangements with insurance companies, Medicare allowable billing rates and state Medicaid rates. Our net sales are derived from the sales of speech generating devices and special education software and content. The following table summarizes our net sales by product categories for the periods indicated both in dollars and as a percentage of net sales:

 

 

 

Successor

 

Predecessor

 

Successor

 

Predecessor

 

 

 

Thirteen weeks ended

 

Twenty-six weeks ended

 

 

 

December 31,

 

January 1,

 

December 31,

 

January 1,

 

 

 

2010

 

2010

 

2010

 

2010

 

 

 

(Amounts in thousands)

 

Net sales

 

 

 

 

 

 

 

 

 

Speech generating devices

 

$

20,809

 

$

22,109

 

$

37,993

 

$

40,721

 

Special education software

 

4,717

 

6,499

 

9,102

 

12,142

 

 

 

$

25,526

 

$

28,608

 

$

47,095

 

$

52,863

 

 

 

 

 

 

 

 

 

 

 

Percentage of net sales

 

 

 

 

 

 

 

 

 

Speech generating devices

 

81.5

%

77.3

%

80.7

%

77.0

%

Special education software

 

18.5

%

22.7

%

19.3

%

23.0

%

 

 

100.0

%

100.0

%

100.0

%

100.0

%

 

A majority of our net sales for devices are generated by our direct sales efforts for products that are shipped to clients and billed to Medicare (national), Medicaid (local) and private insurance companies as well as products that are shipped and directly billed to school districts, evaluation centers and Department of Veterans Affairs centers.

 

Our business is seasonal and historically has realized a higher portion of net sales, net income, and operating cash flows in the second half of the fiscal year and especially in the fourth fiscal quarter (second calendar quarter). Fourth quarter sales represented 29% and 33% of total annual sales for fiscal years 2010 and 2009, respectively. In our fiscal year ended July 2, 2010, 54% of our net sales occurred in the second half of our fiscal year compared to 57% of our net sales occurring in the second half of our fiscal year 2009. Sales of our speech generating technologies and of our special education software are highly seasonal as schools make a large percentage of their purchases of these products at the end of the school year, which is the second quarter of the calendar year and the fourth quarter of our fiscal year.

 

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Table of Contents

 

Cost of Sales

 

Cost of sales includes the direct labor and indirect costs of the final assembly operations performed at our facility in Pittsburgh, the cost of the component materials used in the final assembly, quality control testing, certain royalties, the distribution costs of our special education software center and other third-party costs. Our cost of sales is substantially higher in higher volume quarters, generally increasing as net sales increase. Changes in the mix of our products, such as changes in the proportion of synthesized to digitized devices or the proportion of sales of speech generating devices to special education software may also impact our overall cost of sales. We review our inventory levels on an ongoing basis in order to identify potentially obsolete products and record any adjustments to our reserve as a component of cost of sales.

 

Operating Expenses

 

Selling and Marketing.  Selling and marketing expenses consist primarily of salaries, commissions, benefits and other personnel related expenses for employees engaged in field sales, front-end technical support to assist the sales process, sales operations (order authorization, processing and billing), marketing and external advertising and promotion. While some of these expenses vary proportionally with net sales, such as commissions, the majority of these expenses do not. As a result, selling and marketing expense as a percentage of net sales is usually higher in lower volume quarters and lower in higher volume quarters.

 

Research and Development.  Our research and development expenses consist primarily of compensation of employees associated with the development, design and testing of new products, product enhancements and new applications for our existing products. We expense all of our research and development costs as they are incurred. Certain patent technology costs are capitalized using an estimated useful life of 10 years.

 

General and Administrative.  General and administrative expenses consist primarily of salaries, benefits and other personnel related expenses for employees engaged in finance, legal, human resources and executive management. Other costs include outside legal and accounting fees, investor relations, risk management (insurance) and other administrative costs.

 

Amortization of Certain Intangible Assets.  We have finite-lived intangible assets composed of non-compete agreements, acquired software technology, patent technology, trade names, and acquired backlog which are amortized on a straight-line basis over their estimated useful lives. Non-competition agreements are amortized over six years, acquired software technology is amortized over three to ten years, patent technology is amortized over 10 years, trade names are amortized over three years, and acquired backlog was amortized over a six-month period. Amortization related to acquired software technology and trade names is included in cost of sales. Amortization of non-competition agreements and acquired backlog is included in operating expenses.

 

Equity-Based Compensation

 

We estimate the grant date fair value of stock options for our Class A common stock using the Black-Scholes valuation model. Significant assumptions we use in the model are: (i) an expected dividend yield of 0% based on our expectation of not paying dividends for the foreseeable future; (ii) the expected volatility based on the historical volatility of our Class A common stock; (iii) a risk-free interest rate based on the U.S, Treasury yield curve in effect at the time of the grant; and (iv) a weighted-average expected term using the “simplified method”. The “simplified method” calculates the expected term as the average of the vesting term and original contractual term of the options.

 

Interest Expense

 

Interest expense consists primarily of interest on borrowings under our existing and previous credit facilities and the previous senior subordinated notes. We issued the senior subordinated notes in the amount of $31.0 million in June of 2008 to fund the repurchase of all of the Holdings Units held by a related party. In April 2010 we repaid the senior subordinated notes with a portion of the proceeds from the IPO. If this repayment would have occurred at the beginning of fiscal year 2010 interest expense for the thirteen weeks and twenty-six weeks ended January 1, 2010 would have decreased by approximately $1.2 million and $2.4 million, respectively.

 

Income Taxes

 

Prior to April 28, 2010, the Company had not been subject to U.S. federal income taxes and most applicable state and local income taxes as the Predecessor entity is a limited liability company. As a partnership, the taxable income or loss is passed through to and included in the tax returns of our members. Accordingly, the accompanying condensed consolidated financial statements prior to April 28, 2010 do not include a provision for federal and most state and local income taxes. However, we generally made distributions to our members, per the terms of our limited liability company agreement, related to such taxes. We are subject to entity level taxation in certain states, and certain domestic and foreign subsidiaries are subject to entity level U.S. and foreign income taxes. As a result, the accompanying condensed consolidated statements of income prior to April 28, 2010 include tax expense related to those states and to U.S. and

 

24



Table of Contents

 

foreign jurisdictions where those subsidiaries operate. Subsequent to April 28, 2010 DynaVox Inc. became subject to U.S. federal, state, local and foreign income taxes with respect to its allocable share of any taxable income of DynaVox Systems Holdings LLC and is taxed at the prevailing corporate tax rates.

 

Adjusted EBITDA

 

Adjusted EBITDA represents income (loss) before income taxes, interest income, interest expense, depreciation, amortization and other adjustments noted in the table below. We present Adjusted EBITDA because:

 

·                  Adjusted EBITDA is used by management in managing our business as an indicator of our operating performance;

 

·                  our compliance with certain covenants in our credit agreement is measured based on Adjusted EBITDA; and

 

·                  targets for Adjusted EBITDA are among the measures we use to evaluate our management’s performance for purposes of determining their compensation under our management incentive bonus plan.

 

Our management uses Adjusted EBITDA principally as a measure of our operating performance and believes that Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties in their evaluation of the operating performance of companies in industries similar to ours. We also believe Adjusted EBITDA is useful to our management and investors as a measure of comparative operating performance from period to period. Our management also uses Adjusted EBITDA for planning purposes, including the preparation of our annual operating budget and financial projections. Adjusted EBITDA, however, does not represent and should not be considered as an alternative to net income (loss) or cash flow from operating activities, as determined in accordance with GAAP, and our calculations thereof may not be comparable to similarly entitled measures reported by other companies. Although we use Adjusted EBITDA as a measure to assess the operating performance of our business, Adjusted EBITDA has significant limitations as an analytical tool because it excludes certain material costs. For example, it does not include interest expense or the change in fair value on our related interest rate swap agreements, which have been necessary elements of our costs. Because we use capital assets, depreciation expense is a necessary element of our costs and ability to generate revenue. In addition, the omission of the substantial amortization expense associated with our intangible assets further limits the usefulness of this measure. Adjusted EBITDA also does not include the payment of taxes, which is also a necessary element of our operations. Adjusted EBITDA also does not include expenses incurred in connection with equity-based compensation to our employees, certain costs relating to restructuring and acquisitions, debt refinancing fees and management fees that we have historically paid to Vestar and certain other existing owners pursuant to a management agreement. In connection with the IPO, the management agreement with Vestar and certain other pre-IPO owners was terminated. Because Adjusted EBITDA does not account for these expenses, its utility as a measure of our operating performance has material limitations. Because of these limitations management does not view Adjusted EBITDA in isolation or as a primary performance measure and also uses other measures, such as net income (loss), net sales, gross profit and income from operations, to measure operating performance.

 

Non-Controlling Interest

 

The Company, as a result of the IPO and the related transactions, became the sole managing member of, and has a controlling equity interest in, DynaVox Holdings. As the sole managing member of DynaVox Holdings, the Company operates and controls all of the business and affairs of DynaVox Holdings and, through DynaVox Holdings and its subsidiaries, conducts our business. As of April 28, 2010, the Company consolidates the financial results of DynaVox Holdings and its subsidiaries, and records non-controlling interest for the economic interest in the Company held by the non-controlling unitholders. Non-controlling interest on the statement of operations represents the portion of earnings or loss attributable to the economic interest in the Company held by the non-controlling unitholders. Non-controlling interest on the balance sheet represents the portion of net assets of the Company attributable to the non-controlling unitholders, based on the portion of the Holdings Units owned by such unitholders. The non-controlling interest ownership percentage as of December 31, 2010 is calculated as follows:

 

 

 

Non-
controlling
Unitholders
Holdings
Units

 

DynaVox
Inc.
Outstanding
Common A
Shares

 

Total*

 

December 31, 2010

 

20,451,648

 

9,383,335

 

29,834,983

 

 

 

68.6

%

31.4

%

100.0

%

 


*                                         Assumes all of the holders of Holdings Units exchange their Holdings Units for shares of the Corporation’s Class A common stock on a one-for-one basis

 

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Table of Contents

 

The non-controlling interest allocation for the thirteen week and twenty-six week periods ended December 31, 2010 is calculated as follows (dollars in thousands):

 

 

 

Thirteen weeks
ended

December 31, 2010

 

Twenty-six weeks
ended

December 31, 2010

 

 

 

 

 

 

 

Non-controlling interest associated with other comprehensive income

 

$

24

 

$

27

 

Allocation of net income (loss) of DynaVox Inc.

 

842

 

(373

)

Non-controlling interest allocation

 

$

866

 

$

(346

)

 

Results of Operations

 

The following table summarizes key components of our results of operations for the periods indicated:

 

 

 

Successor

 

Predecessor

 

Successor

 

Predecessor

 

 

 

Thirteen weeks ended

 

Twenty-six weeks ended

 

 

 

December 31,
2010

 

% of Net
Sales

 

January 1,
2010

 

% of Net
Sales

 

December 31,
2010

 

% of Net
Sales

 

January 1,
2010

 

% of Net
Sales

 

 

 

(unaudited)

 

 

 

(Dollar in thousands)

 

Net sales

 

$

25,526

 

100.0

%

$

28,608

 

100.0

%

$

47,095

 

100.0

%

$

52,863

 

100.0

%

Costs of goods sold

 

7,587

 

29.7

%

7,085

 

24.8

%

13,821

 

29.3

%

13,149

 

24.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

17,939

 

70.3

%

21,523

 

75.2

%

33,274

 

70.7

%

39,714

 

75.1

%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and marketing

 

8,747

 

34.3

%

9,022

 

31.5

%

17,484

 

37.1

%

17,535

 

33.2

%

Research and development

 

2,358

 

9.2

%

2,341

 

8.2

%

4,892

 

10.4

%

4,582

 

8.7

%

General and administrative

 

4,977

 

19.5

%

3,901

 

13.6

%

9,764

 

20.7

%

6,784

 

12.8

%

Amortization of intangibles

 

114

 

0.4

%

421

 

1.5

%

222

 

0.5

%

841

 

1.6

%

Total operating expenses

 

16,196

 

63.4

%

15,685

 

54.8

%

32,362

 

68.7

%

29,742

 

56.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

1,743

 

6.8

%

5,838

 

20.4

%

912

 

1.9

%

9,972

 

18.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

4

 

0.0

%

9

 

0.0

%

13

 

0.0

%

31

 

0.1

%

Interest expense, net

 

(663

)

-2.6

%

(1,920

)

-6.7

%

(1,346

)

-2.9

%

(3,930

)

-7.4

%

Change in fair value and net loss on interest rate swap agreements

 

(9

)

-0.0

%

(122

)

-0.4

%

(76

)

-0.2

%

(449

)

-0.8

%

Other income (expense) — net

 

33

 

0.1

%

(13

)

-0.0

%

(235

)

-0.5

%

(74

)

-0.1

%

Total other expense

 

(635

)

-2.5

%

(2,046

)

-7.2

%

(1,644

)

-3.5

%

(4,422

)

-8.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

$

1,108

 

4.3

%

$

3,792

 

13.3

%

$

(732

)

-1.6

%

$

5,550

 

10.5

%

 

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Table of Contents

 

 

 

Successor

 

Predecessor

 

Successor

 

Predecessor

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

December 31,
2010

 

January 1,
 2010

 

December 31,
2010

 

January 1,
 2010

 

 

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

 

 

(Amounts in thousands)

 

Other Financial Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA (1)

 

$

3,901

 

$

7,707

 

$

4,693

 

$

13,227

 

 


(1)           Adjusted EBITDA represents income (loss) before income taxes, interest income, interest expense, depreciation, amortization and the other adjustments noted in the table below.

 

 

 

Adjusted EBITDA Reconciliation

 

 

 

Successor

 

Predecessor

 

Successor

 

Predecessor

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

December 31,
2010

 

January 1,
 2010

 

December 31,
2010

 

January 1,
 2010

 

 

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

 

 

(Amounts in thousands)

 

Income (loss) before income taxes

 

$

1,108

 

$

3,792

 

$

(732

)

$

5,550

 

Depreciation

 

884

 

759

 

1,663

 

1,423

 

Amortization

 

234

 

475

 

463

 

950

 

Interest income

 

(4

)

(9

)

(13

)

(31

)

Interest expense

 

663

 

1,920

 

1,346

 

3,930

 

Change in fair value and net loss on interest rate swaps

 

9

 

122

 

76

 

449

 

Other (income) expense, net (a)

 

(36

)

(3

)

201

 

2

 

Equity-based compensation

 

514

 

144

 

1,059

 

334

 

Employee severance and other costs

 

248

 

 

244

 

 

Acquisition costs (b)

 

209

 

274

 

241

 

312

 

Management fee (c)

 

 

75

 

 

150

 

Other adjustments (d)

 

72

 

158

 

145

 

158

 

Adjusted EBITDA

 

$

3,901

 

$

7,707

 

$

4,693

 

$

13,227

 

 


(a)                                  Excludes realized foreign currency gains or losses.

 

(b)                                 Legal, accounting and other external costs related to the purchase of certain assets and liabilities of Blink-Twice Inc. and the purchase of Eye Response Technologies, Inc. including certain post-closing expenses which may be reimbursed to the Company at a later date under the terms of the applicable agreements.

 

(c)                                  Prior to April 21, 2010 we received advisory services from Vestar and certain pre-IPO owners. These arrangements concluded on April 21, 2010.

 

(d)                                 Includes certain amounts related to other taxes, executive recruiting fees, relocation and other costs.

 

27



Table of Contents

 

Successor Period from October 2, 2010 to December 31, 2010

 

Net Sales

 

Net sales were $25.5 million for the Successor period from October 2, 2010 to December 31, 2010. The $25.5 million of net sales were comprised of $20.8 million of speech generating devices and $4.7 million of software sales.

 

Gross Profit

 

Gross profit was 70.3%, or $17.9 million, in the Successor period from October 2, 2010 to December 31, 2010.

 

Operating Expenses

 

Operating expenses for the Successor period from October 2, 2010 to December 31, 2010 were $16.2 million and consisted primarily of selling and marketing expenses of $8.7 million, research and development expenses of $2.4 million and general and administrative expenses of $5.0 million. Operating expenses during the Successor period from October 2, 2010 to December 31, 2010 also included $0.1 million of  amortization of certain intangible assets.

 

Income From Operations

 

Income from operations was $1.7 million for the Successor period from October 2, 2010 to December 31, 2010 as a result of the items described above.

 

Interest Expense

 

Interest expense was $0.7 million for the Successor period from October 2, 2010 to December 31, 2010 primarily as a result of interest on borrowings under our 2008 Credit Facility. Outstanding debt under the 2008 Credit Facility as of December 31, 2010 was $46.1 million.

 

Income Before Income Taxes

 

Income before income taxes was $1.1 million, or 4.3% of net sales, for the Successor period from October 2, 2010 to December 31, 2010 due to the reasons discussed above.

 

Adjusted EBITDA.

 

Adjusted EBITDA was $3.9 million for the Successor period from October 2, 2010 to December 31, 2010. The Adjusted EBITDA measure presented consists of income (loss) before income taxes, interest income, interest expense, depreciation, amortization and the other adjustments noted in the table above.

 

Predecessor Period from October 3, 2009 to January 1, 2010

 

Net Sales

 

Net sales were $28.6 million for the Predecessor period from October 3, 2009 to January 1, 2010. The $28.6 million of net sales were comprised of $22.1 million of speech generating devices and $6.5 million of software sales.

 

Gross Profit

 

Gross profit was 75.2%, or $21.5 million, in the Predecessor period from October 3, 2009 to January 1, 2010.

 

Operating Expenses

 

Operating expenses for the Predecessor period from October 3, 2009 to January 1, 2010 were $15.7 million and consisted primarily of selling and marketing expenses of $9.0 million, research and development expenses of $2.3 million, general and administrative expenses of $3.9 million and amortization of certain intangibles of $0.4 million.

 

Income From Operations

 

Income from operations was $5.8 million for the Predecessor period from October 3, 2009 to January 1, 2010 as a result of the items described above.

 

Interest Expense

 

Interest expense was $1.9 million for the Predecessor period from October 3, 2009 to January 1, 2010 primarily as a result of interest on borrowings under our 2008 Credit Facility and our 2008 Subordinated Note. Outstanding debt under the 2008 Credit Facility and the 2008 Subordinated Note as of January 1, 2010 was $78.1 million. We redeemed the $31.0 million 2008 Subordinated Note, which bore interest at 15.0%, in April 2010 with proceeds from the IPO.

 

28



Table of Contents

 

Income Before Income Taxes

 

Income before income taxes was $3.8 million, or 13.3% of net sales, for the Predecessor period from October 3, 2009 to January 1, 2010 due to the reasons discussed above.

 

Adjusted EBITDA.

 

Adjusted EBITDA was $7.7 million for the Predecessor period from October 3, 2009 to January 1, 2010. The Adjusted EBITDA measure presented consists of income (loss) before income taxes, interest income, interest expense, depreciation, amortization and the other adjustments noted in the table above.

 

Successor Period from July 3, 2010 to December 31, 2010

 

Net Sales

 

Net sales were $47.1 million for the Successor period from July 3, 2010 to December 31, 2010. The $47.1 million of net sales were comprised of $38.0 million of speech generating devices and $9.1 million of software sales.

 

Gross Profit

 

Gross profit was 70.7%, or $33.3 million, in the Successor period from July 3, 2010 to December 31, 2010.

 

Operating Expenses

 

Operating expenses for the Successor period from July 3, 2010 to December 31, 2010 were $32.4 million and consisted primarily of selling and marketing expenses of $17.5 million, research and development expenses of $4.9 million and general and administrative expenses of $9.8 million. Operating expenses during the Successor period from July 3, 2010 to December 31, 2010 also included $0.2 million of amortization of certain intangible assets.

 

Income From Operations

 

Income from operations was $0.9 million for the Successor period from July 3, 2010 to December 31, 2010 as a result of the items described above.

 

Interest Expense

 

Interest expense was $1.3 million for the Successor period from July 3, 2010 to December 31, 2010 primarily as a result of interest on borrowings under our 2008 Credit Facility. Outstanding debt under the 2008 Credit Facility as of December 31, 2010 was $46.1 million.

 

Loss Before Income Taxes

 

Loss before income taxes was $0.7 million, or 1.6% of net sales, for the Successor period from July 3, 2010 to December 31, 2010 due to the reasons discussed above.

 

Adjusted EBITDA.

 

Adjusted EBITDA was $4.7 million for the Successor period from July 3, 2010 to December 31, 2010. The Adjusted EBITDA measure presented consists of income (loss) before income taxes, interest income, interest expense, depreciation, amortization and the other adjustments noted in the table above.

 

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Table of Contents

 

Predecessor Period from July 4, 2009 to January 1, 2010

 

Net Sales

 

Net sales were $52.9 million for the Predecessor period from July 4, 2009 to January 1, 2010. The $52.9 million of net sales were comprised of $40.7 million of speech generating devices and $12.2 million of software sales.

 

Gross Profit

 

Gross profit was 75.1%, or $39.7 million, in the Predecessor period from July 4, 2009 to January 1, 2010.

 

Operating Expenses

 

Operating expenses for the Predecessor period from July 4, 2009 to January 1, 2010 were $29.7 million and consisted primarily of selling and marketing expenses of $17.5 million, research and development expenses of $4.6 million, general and administrative expenses of $6.8 million and amortization of certain intangibles of $0.8 million.

 

Income From Operations

 

Income from operations was $10.0 million for the Predecessor period from July 4, 2009 to January 1, 2010 as a result of the items described above.

 

Interest Expense

 

Interest expense was $3.9 million for the Predecessor period from July 4, 2009 to January1, 2010 primarily as a result of interest on borrowings under our 2008 Credit Facility and our 2008 Subordinated Note. Outstanding debt under the 2008 Credit Facility and the 2008 Subordinated Note as of January 1, 2010 was $78.1 million. We redeemed the $31.0 million 2008 Subordinated Note, which bore interest at 15.0%, in April 2010 with proceeds from the IPO.

 

Income Before Income Taxes

 

Income before income taxes was $5.6 million, or 10.5% of net sales, for the Predecessor period from July 4, 2009 to January 1, 2010 due to the reasons discussed above.

 

Adjusted EBITDA.

 

Adjusted EBITDA was $13.2 million for the Predecessor period from July 4, 2009 to January 1, 2010. The Adjusted EBITDA measure presented consists of income (loss) before income taxes, interest income, interest expense, depreciation, amortization and the other adjustments noted in the table above.

 

Thirteen Week Period Ended December 31, 2010 Compared to the Thirteen Week Period Ended January 1, 2010

 

Net Sales

 

Net sales decreased 10.8%, or $3.1 million, to $25.5 million for the thirteen week period ended December 31, 2010 from $28.6 million for the thirteen week period ended January 1, 2010. The decline in device sales was 5.9%, or $1.3 million. Software sales decreased 27.4%, or $1.8 million, in the thirteen week period ended December 31, 2010 compared to the thirteen week period ended January 1, 2010. We experienced a softening of demand for both our speech generating devices and software products during the thirteen week period ended December 31, 2010 compared to the thirteen week period ended January 1, 2010.  We believe that reduced domestic government funding, and particularly more constrained state and local government funding of school budgets, adversely affected our product sales in the United States during the thirteen weeks ended December 31, 2010 as compared to the thirteen week period ended January 1, 2010.  We also believe that constraints in government spending in the Company’s key international markets, including the United Kingdom, had a similar effect on our product sales in those regions during the second quarter of our fiscal year 2011. The prior year thirteen week period ended January 1, 2010 includes $0.8 million of software sales to one international customer which did not recur in the thirteen week period ended December 31, 2010.

 

Gross Profit

 

Gross profit decreased 16.7%, or $3.6 million, to $17.9 million for the thirteen week period ended December 31, 2010 from $21.5 million for the thirteen week period ended January 1, 2010. Gross margin decreased 490 basis points to 70.3% for the thirteen week period ended December 31, 2010 from 75.2% for the thirteen week period ended January 1, 2010. The $3.6 million decrease in gross profit was due mainly to the 10.8% decline in net sales and a less favorable product mix including lower software sales for which the gross margin is moderately higher as compared to device sales.

 

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Operating Expenses

 

Selling and Marketing.  Selling and marketing expenses decreased by 3.0%, to $8.7 million for the thirteen week period ended December 31, 2010 from $9.0 million for the thirteen week period ended January 1, 2010. Wages, recruiting costs and travel expense increased approximately $0.9 million as a result of the continued investment in both direct marketing associates and in the field sales organization. In addition, we incurred incremental advertising expense of approximately $0.3 million in the thirteen weeks ended December 31, 2010 as compared to the thirteen weeks ended January 1, 2010. However, lower variable compensation expense totaling approximately $1.5 million more than offset the headcount expansion and advertising increases discussed above. Selling and marketing expenses totaled 34.3% and 31.5% of net sales for the thirteen week periods ended December 31, 2010 and January 1, 2010, respectively.

 

Research and Development.  Research and development expenses remained relatively constant at $2.4 million for the thirteen week period ended December 31, 2010 as compared to the thirteen week period ended January 1, 2010. This was due primarily to the continued investment in research and development resources being offset by lower variable compensation expense. The incremental increase in research and development resources for the thirteen weeks ended December 31, 2010 was approximately $0.4 million and was offset by lower variable compensation expense of $0.4 million. Research and development expenses totaled 9.2% and 8.2% of net sales for the thirteen week periods ended December 31, 2010 and January 1, 2010, respectively.

 

General and Administrative.  General and administrative expenses increased 27.6%, or $1.1 million, to $5.0 million for the thirteen week period ended December 31, 2010 from $3.9 million for the thirteen week period ended January 1, 2010. Approximately $1.3 million of the net increase was attributable to costs associated with being a public company. We completed our IPO in April 2010. The $1.3 million includes $0.3 million of stock-based compensation. The remaining $1.0 million incremental increase included approximately $0.6 million of insurance, outside professional fees for such items as our outside independent accountants, attorneys, Sarbanes-Oxley compliance consultants and external tax consultants in addition to approximately $0.4 million of higher wage expense associated with the expansion of our finance, legal and human resource headcount. The increase in general and administrative expenses for the thirteen week period ended December 31, 2010, as compared to the thirteen week period ended January 1, 2010, also included higher costs of approximately $0.3 million for such items as staffing and professional fees and other ordinary expenses associated with the expansion of a business. Variable compensation expense for the thirteen week period ended December 31, 2010 was $0.5 million lower as compared to the thirteen week period ended January 1, 2010. General and administrative expenses as a percentage of net sales were 19.5% and 13.6% for the thirteen week periods ended December 31, 2010 and January 1, 2010, respectively.

 

Amortization of Certain Intangibles.  Amortization of certain intangibles was $0.1 million for the thirteen week period ended December 31, 2010 compared to $0.4 million for the thirteen week period ended January 1, 2010. The $0.3 million net decrease was mainly the result of $0.3 million of amortization expense during the thirteen week period ended January 1, 2010 on the intangible assets acquired in the Blink-Twice Inc. acquisition compared to no amortization expense in the thirteen week period ended December 31, 2010 for these intangible assets as they had reached full amortization.

 

Income From Operations.  Income from operations was $1.7 million for the thirteen week period ended December 31, 2010 compared to income from operations of $5.8 million for the same thirteen week period of the prior year. The change in income from operations was due to the reasons discussed above.

 

Interest Expense. Interest expense decreased $1.3 million to $0.7 million for the thirteen week period ended December 31, 2010 from $1.9 million for the thirteen week period ended January 1, 2010 primarily as a result of  the Company redeeming a $31.0 million subordinated note, which bore interest at 15.0%, in April 2010 with proceeds from the IPO.

 

Change in Fair Value and Net Gain (Loss) on Interest Rate Swap Agreements. For the thirteen week period ended December 31, 2010, there was a decrease of $0.1 million of expense to $0.0 million from $0.1 million for the thirteen week period ended January 1, 2010. The decrease is primarily attributable to a reduction in the notional amount from $28.5 million as of January 1, 2010 to $23.1 million as of December 31, 2010.

 

Adjusted EBITDA. Adjusted EBITDA decreased $3.8 million to $3.9 million for the thirteen week period ended December 31, 2010 compared to $7.7 million for the prior year thirteen week period ended January 1, 2010. Adjusted EBITDA represents income (loss) before income taxes, interest income, interest expense, depreciation, amortization and the other adjustments noted in the table above.

 

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Twenty-six Week Period Ended December 31, 2010 Compared to the Twenty-six Week Period Ended January 1, 2010

 

Net Sales

 

Net sales decreased 10.9%, or $5.8 million, to $47.1 million for the twenty-six week period ended December 31, 2010 from $52.9 million for the twenty-six week period ended January 1, 2010. The decline in device sales was 6.7%, or $2.7 million. Software sales decreased 25.0%, or $3.0 million, in the twenty-six week period ended December 31, 2010 compared to the twenty-six week period ended January 1, 2010. We experienced a softening of demand for both our speech generating devices and software products during the twenty-six week period ended December 31, 2010 compared to the twenty-six week period ended January 1, 2010.  We believe that reduced domestic government funding, and particularly more constrained state and local government funding of school budgets, adversely affected our product sales in the United States during the twenty-six weeks ended December 31, 2010 as compared to the twenty-six week period ended January 1, 2010.  We also believe that constraints in government spending in the Company’s key international markets, including Canada and the United Kingdom, had a similar effect on our product sales in those regions during the first-half of our fiscal year 2011. The prior year twenty-six week period ended January 1, 2010 includes $0.8 million of software sales to one international customer which did not recur in the twenty-six week period ended December 31, 2010.

 

Gross Profit

 

Gross profit decreased 16.2%, or $6.4 million, to $33.3 million for the twenty-six week period ended December 31, 2010 from $39.7 million for the twenty-six week period ended January 1, 2010. Gross margin decreased 440 basis points to 70.7% for the twenty-six week period ended December 31, 2010 from 75.1% for the twenty-six week period ended January 1, 2010. The $6.4 million decrease in gross profit was due mainly to the 10.9% decline in net sales and a less favorable product mix including lower software sales for which the gross margin is moderately higher as compared to device sales.

 

Operating Expenses

 

Selling and Marketing.  Selling and marketing expenses remained relatively constant at $17.5 million for the twenty-six week period ended December 31, 2010 as compared to the twenty-six week period ended January 1, 2010. This was due primarily to the net effect of approximately $1.4 million of higher wages, recruiting costs and travel expense as a result of the continued investment in both direct marketing associates and in the field sales organization and an additional $1.2 million of advertising which were offset almost entirely by $2.7 million of lower variable compensation. Selling and marketing expenses totaled 37.1% and 33.2% of net sales for the twenty-six week periods ended December 31, 2010 and January 1, 2010, respectively.

 

Research and Development.  Research and development expenses increased 6.8%, or $0.3 million for the twenty-six week period ended December 31, 2010 as compared to the twenty-six week period ended January 1, 2010. This was due primarily to continued investment in research and development resources being offset by lower variable compensation expense. The incremental increase in research and development resources for the twenty-six weeks ended December 31, 2010 was approximately $1.1 million and was offset by lower variable compensation expense of $0.9 million. Research and development expenses totaled 10.4% and 8.7% of net sales for the twenty-six week periods ended December 31, 2010 and January 1, 2010, respectively.

 

General and Administrative.  General and administrative expenses increased 43.9%, or $3.0 million, to $9.8 million for the twenty-six week period ended December 31, 2010 from $6.8 million for the twenty-six week period ended January 1, 2010. Approximately $2.5 million of the net increase was attributable to costs associated with being a public company. We completed our IPO in April 2010. The $2.5 million includes $0.7 million of stock-based compensation. The remaining $1.8 million incremental increase included approximately $1.2 million of insurance, outside professional fees for such items as our outside independent accountants, attorneys, Sarbanes-Oxley compliance consultants and external tax consultants in addition to approximately $0.6 million of higher wage expense associated with the expansion of our finance, legal and human resource headcount. The increase in general and administrative expenses for the twenty-six week period ended December 31, 2010, as compared to the twenty-six week period ended January 1, 2010, also included higher costs of approximately $1.3 million for such items as staffing and professional fees and other ordinary expenses associated with the expansion of a business. Variable compensation expense for the twenty-six week period ended December 31, 2010 was $0.9 million lower as compared to the twenty-six week period ended January 1, 2010. General and administrative expenses as a percentage of net sales were 20.7% and 12.8% for the twenty-six week periods ended December 31, 2010 and January 1, 2010, respectively.

 

Amortization of Certain Intangibles.  Amortization of certain intangibles was $0.2 million for the twenty-six week period ended December 31, 2010 compared to $0.8 million for the twenty-six week period ended January 1, 2010. The $0.6 million net decrease was mainly the result of $0.6 million of amortization expense during the twenty-six week period ended January 1, 2010 on the

 

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intangible assets acquired in the Blink-Twice Inc. acquisition compared to no amortization expense in the twenty-six week period ended December 31, 2010 for these intangible assets as they had reached full amortization.

 

Income From Operations.  Income from operations was $0.9 million for the twenty-six week period ended December 31, 2010 compared to income from operations of $10.0 million for the same twenty-six week period of the prior year. The change in income from operations was due to the reasons discussed above.

 

Interest Expense. Interest expense decreased $2.6 million to $1.3 million for the twenty-six week period ended December 31, 2010 from $3.9 million for the twenty-six week period ended January 1, 2010 primarily as a result of  the Company redeeming a $31.0 million subordinated note, which bore interest at 15.0%, in April 2010 with proceeds from the IPO.

 

Change in Fair Value and Net Gain (Loss) on Interest Rate Swap Agreements. For the twenty-six week period ended December 31, 2010, there was a decrease of $0.3 million of expense to $0.1 million from $0.4 million for the twenty-six week period ended January 1, 2010. The decrease is primarily attributable to a reduction in the notional amount from $28.5 million as of January 1, 2010 to $23.1 million as of December 31, 2010.

 

Adjusted EBITDA. Adjusted EBITDA decreased $8.5 million to $4.7 million for the twenty-six week period ended December 31, 2010 compared to $13.2 million for the prior year twenty-six week period ended January 1, 2010. Adjusted EBITDA represents income (loss) before income taxes, interest income, interest expense, depreciation, amortization and the other adjustments noted in the table above.

 

Liquidity and Capital Resources

 

The primary sources of cash are existing cash and cash equivalents, cash flow from operations and borrowings under the $12.9 million revolving loan portion of our credit facility.

 

 

 

Successor

 

 

 

As of

 

 

 

December 31,
2010

 

July 2,
2010

 

 

 

(Amounts in thousands)

 

Cash and cash equivalents

 

$

12,576

 

$

20,777

 

Revolving loan availability

 

$

12,925

 

$

12,925

 

 

Our primary cash needs are to fund normal working capital requirements, capital expenditures, repay our indebtedness (scheduled interest and principal payments) and for tax distributions to members, including any payments made under the Tax Receivable Agreement. On April 27, 2010 a portion of the IPO proceeds were used to redeem the $31.0 million senior subordinated notes. This reduces originally scheduled interest expense by approximately $24.4 million over the next five years. On March 31, 2010, we borrowed $10.0 million under the revolving loans provision of the 2008 Credit Facility, as amended. We distributed the $10.0 million to the DynaVox Holdings owners who then used the $10.0 million to invest in the securities of a related party portfolio company. The $10.0 million was repaid with proceeds from the IPO on April 27, 2010. Our revolving loan availability was $12.9 million as of December 31, 2010. Any borrowings under the revolving loan facility is either at the London Inter Bank Offered Rate (LIBOR), plus a credit spread or the Prime rate, plus a credit spread, at the Company’s option. The credit spread is determined based on the then current predefined leverage ratio of the Company. The $12.9 million of availability is subject to the Company’s compliance with certain contractual financial and non-financial covenants.

 

As part of the IPO and related transactions we entered into a tax receivable agreement with our then-existing owners that provides for the payment from time to time by DynaVox Inc. to our then-existing owners of 85% of the amount of the benefits, if any, that DynaVox Inc. is deemed to realize as a result of (i) the existing tax basis in the intangible assets of DynaVox Holdings on the date of the IPO, (ii) an increase in the tax basis of the assets of DynaVox Holdings that otherwise would not have been available (iii) certain other tax benefits related to our entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. These payment obligations are obligations of DynaVox Inc. and not of DynaVox Holdings. For purposes of the tax receivable agreement, the benefit deemed realized by DynaVox Inc. will be computed by comparing the actual income tax liability of DynaVox Inc. (calculated with certain assumptions) to the amount of such taxes that DynaVox Inc. would have been required to pay had there been no increase to the tax basis of the assets of DynaVox Holdings as a result of the purchase or exchanges, had there been no tax benefit from the tax basis in the intangible assets of DynaVox Holdings on the date of the IPO and had DynaVox Inc. not entered into the tax receivable agreement. The term of the tax receivable agreement will continue until all such tax benefits have been utilized or expired, unless DynaVox Inc. exercises its right to terminate the tax receivable agreement for an amount based on the agreed payments remaining to be made under the agreement or DynaVox Inc. breaches any of its material

 

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obligations under the tax receivable agreement in which case all obligations will generally be accelerated and due as if DynaVox Inc. had exercised its right to terminate the agreement.

 

We believe that our cash position, net cash provided by operating activities and availability under our senior secured credit facility will be adequate to finance working capital needs, planned capital expenditures, debt repayments and tax distributions to members, including any payments made under the Tax Receivable Agreement, for at least the next twelve months.

 

We may, however, require additional liquidity as we continue to execute our business strategy. We anticipate that to the extent that we require additional liquidity, it will be funded through the incurrence of indebtedness, additional equity financings or a combination of these potential sources of liquidity, although no assurance can be given that such forms of capital will be available to us, or available to us on terms which are acceptable, at such time.

 

Cash Flow

 

A summary of cash flows from operating, investing and financing activities are shown in the following table:

 

 

 

Successor

 

Predecessor

 

 

 

Twenty-six weeks ended

 

 

 

December 31,
2010

 

January 1,
2010

 

 

 

(Amounts in thousands)

 

Cash flow summary

 

 

 

 

 

(Used in) provided by operating activities

 

$

(1,568

)

$

7,437

 

Used in investing activities

 

(2,325

)

(3,338

)

Used in financing activities

 

(4,348

)

(4,119

)

Effect of currency exchange rate changes on cash

 

40

 

33

 

(Decrease) increase in cash

 

$

(8,201

)

$

13

 

 

Operating Activities

 

Our operations consist of all the activities required to provide products to our customers. The net cash provided by these activities is dependent upon the timing of receipt of payment from our private pay and publicly funded customers and the timing of payment to our vendors, employees, taxing authorities and landlords, among others. We generally collect our accounts receivable within 75 days.

 

The principal factors impacting net cash provided by or used in operating activities are the operation of our business and the management of our working capital as shown below for the twenty-six week periods ended December 31, 2010 and January 1, 2010:

 

 

 

Successor

 

Predecessor

 

 

 

Twenty-six weeks ended

 

 

 

December 31,
2010

 

January 1,
2010

 

 

 

(Amounts in thousands)

 

Operating activities

 

 

 

 

 

Net (loss) income

 

$

(725

)

$

5,384

 

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

 

 

 

 

 

Depreciation and amortization

 

2,444

 

2,780

 

Equity-based compensation expense

 

1,059

 

334

 

Change in fair value of interest rate swaps

 

(295

)

(98

)

Change in fair value of acquisition contingencies

 

(183

)

 

Deferred taxes

 

(170

)

 

Loss on disposal of assets

 

1

 

 

 

 

2,131

 

8,400

 

Changes in operating assets and liabilities

 

(3,699

)

(963

)

Net cash (used in) provided by operating activities

 

$

(1,568

)

$

7,437

 

 

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The most significant components of changes in assets and liabilities are trade receivables, inventories, accounts payable and accrued expenses and other current liabilities as shown below:

 

 

 

Successor

 

Predecessor

 

 

 

Twenty-six weeks ended

 

 

 

December 31,
2010

 

January 1,
2010

 

 

 

(Amounts in thousands)

 

Changes in operating assets and liabilities details:

 

 

 

 

 

Trade receivables

 

$

2,364

 

$

1,707

 

Inventories

 

(142

)

(1,004

)

Trade accounts payable

 

(674

)

2

 

Accrued expenses and other current liabilities

 

(4,900

)

(205

)

Other

 

(347

)

(1,463

)

Changes in operating assets and liabilities

 

$

(3,699

)

$

(963

)

 

Our net cash used in operating activities was $1.6 million for the twenty-six week period ended December 31, 2010, compared to cash provided by operating activities of $7.4 million for the twenty-six week period ended January 1, 2010. The $9.0 million change in net operating cash was primarily a result of a $6.1 million decrease in net income and a $2.7 million increase in change in operating assets and liabilities which were offset to some degree by an increase in non-cash charges totaling $0.4 million. The $2.7 million increase in change in operating assets and liabilities was comprised mainly of a larger decrease in accrued compensation of approximately $4.7 million reflecting higher amounts paid out related to our annual bonus award and profit sharing funding and less accrued compensation in the twenty-six weeks ended December 31, 2010 compared to the twenty-six week period ended January 1, 2010. The incremental payout amounts totaled $1.7 million and were a result of our improved performance in fiscal year 2010 compared to fiscal year 2009. The lower accrued compensation was primarily a result of us not achieving certain bonus and profit sharing metrics in the twenty-six weeks ended December 31, 2010 whereas we did in the twenty-six weeks ended January 1, 2010. In addition, the increase in change in operating assets and liabilities was impacted by a larger decrease in trade receivables of $0.7 million and a lower reduction in inventories of $0.9 million during the twenty-six week period ended December 31, 2010 compared to the twenty-six week period ended January 1, 2010.

 

Investing Activities

 

Investing activities for the twenty-six week periods ended December 31, 2010 and January 1, 2010 consisted of capital expenditures and an acquisition of a business.

 

 

 

Successor

 

Predecessor

 

 

 

Twenty-six weeks ended

 

 

 

December 31,
2010

 

January 1,
2010

 

 

 

(Amounts in thousands)

 

Investing activities

 

 

 

 

 

Capital expenditures

 

$

(2,325

)

$

(2,405

)

Acquisition of business

 

 

(933

)

Cash used in investing activities

 

$

(2,325

)

$

(3,338

)

 

Net cash used in investing activities consists primarily of capital expenditures for each twenty-six week period presented and one strategic acquisition in the twenty-six weeks ended January 1, 2010. We disbursed $0.9 million of cash (net of cash acquired) for the Blink-Twice acquisition during the twenty-six weeks ended January 1, 2010. Capital expenditures decreased $0.1 million for the twenty-six weeks ended December 31, 2010 compared to the twenty-six weeks ended January 1, 2010.

 

Management anticipates that capital expenditures during fiscal year 2011 will approximate our recent historical capital expenditures.

 

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Financing Activities

 

Financing activities for the twenty-six week periods ended December 31, 2010 and January 1, 2010 consisted primarily of equity distributions and repayments of our outstanding indebtedness.

 

 

 

Successor

 

Predecessor

 

 

 

Twenty-six weeks ended

 

 

 

December 31,
2010

 

January 1,
2010

 

 

 

(Amounts in thousands)

 

Financing activities

 

 

 

 

 

Repayment of debt agreements

 

$

(2,020

)

$

(4,355

)

Payment on acquisition contingencies

 

(570

)

 

Deferred issuance costs

 

(149

)

 

Equity distributions

 

(1,609

)

(87

)

Issuance of common units

 

 

200

 

Redemption of management and common units

 

 

(202

)

Payments received on non-controlling interest shareholder notes

 

 

325

 

Net cash used in financing activities

 

$

(4,348

)

$

(4,119

)

 

Net cash of $4.3 million was required for financing activities during the twenty-six week period ended December 31, 2010 compared to $4.1 million required in the twenty-six week period ended January 1, 2010.  The $0.2 million increase in cash used in financing activities was mainly a net result of $2.3 million less in debt repayments during the twenty-six weeks ended December 31, 2010 compared to the twenty-six week period ended January 1, 2010 offset to some degree by a $1.5 million increase in equity distributions in the current fiscal year first-half compared to the same time period of the prior fiscal year. Debt repayments during the twenty-six week period ended January 1, 2010 included a $3.3 million excess cash flow payment whereas there was no excess cash flow payment in the twenty-six week period ending December 31, 2010. The debt repayments of $2.0 million for the twenty-six weeks ended December 31, 2010 included $1.1 million for a note payable related to an acquisition in 2004 and $0.9 million repayment on our 2008 Credit Facility. Financing activity disbursements included $0.6 million in the twenty-six week period ended December 31, 2010 for royalty, consulting and working capital adjustment payments related to the January 2010 acquisition of Eye Response Technologies, Inc.

 

Financing Agreements

 

As of December 31, 2010 we were in compliance in all material respects with all covenants, as amended, contained in our financing agreements. We are required to make debt payments during the 12 months starting January 1, 2011 of approximately $4.5 million.

 

Senior Secured Credit Facility

 

DynaVox Systems LLC, a wholly-owned subsidiary of DynaVox Systems Holdings LLC, entered into a third amended and restated senior secured credit facility, dated as of June 23, 2008, with a syndicate of financial institutions, including GE Business Financial Services Inc. (formerly known as Merrill Lynch Business Financial Services Inc.), as administrative agent. On February 5, 2010, certain terms of our credit facility were amended to, among other items, increase our available revolving loans and letters of credit and increase the amount available for restricted distributions, as defined in the credit facility. The credit facility, as so amended, provides for a $52.0 million term loan facility that matures on June 23, 2014 and a revolving credit facility with a $12.9 million aggregate loan commitment amount available, including a $5.0 million sub-facility for letters of credit and a $2.0 million sub-facility for swingline loans, that matures on June 23, 2013. As of December 31, 2010, $46.1 million was outstanding under the term loan facility and there were no borrowings outstanding under the revolving credit facility.

 

On March 4, 2010, we entered into a second amendment to our credit facility which amendment became effective in April 2010. As part of the amendment, the agent and the lenders under our credit facility consented to DynaVox Systems Holdings LLC’s transfer of all of its obligations under the credit facility to a newly formed wholly- owned subsidiary of DynaVox Systems Holdings LLC that became the immediate holding company parent of DynaVox Systems LLC. The lenders further waived the requirement of any prepayment of the credit facility with the proceeds of our IPO and consented to the repayment in full of our senior subordinated notes and the indebtedness outstanding under certain other notes payable with the proceeds of our IPO.

 

On December 21, 2010, we entered into a third amendment to our credit facility which became effective immediately. As part of the amendment, the agent and the lenders under our credit facility consented to the modification of the calculation of the Fixed Charge Coverage Ratio (which is calculated by dividing the sum of cash interest expense (net of interest income), cash taxes paid, scheduled principal payments on all debt, restricted cash distributions and management fees paid to Vestar and other certain pre-IPO owners by operating cash flow) for the 12-month period ending December 31, 2010 to exclude from the definition of restricted cash distributions a $10.0 million distribution made by the Company in March 2010. In addition, the third amendment modifies the calculation of the ratios of net senior debt to Adjusted EBITDA and net total debt to Adjusted EBITDA by limiting the ability of the

 

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Company to net cash and cash equivalents from total debt and senior debt to only any 12-month period in which Adjusted EBITDA for such period is greater than $30.0 million, whereupon the amount of cash and cash equivalents that may be so netted is limited to $5.0 million. The credit facility was further amended by requiring the Company to provide the agent and lenders monthly financial statements within 30 days of the end of each month commencing with the month ending November 30, 2010.

 

All obligations under the credit facility are unconditionally guaranteed by the immediate holding company parent of DynaVox Systems LLC and each of DynaVox Systems LLC’s existing and future wholly-owned domestic subsidiaries. The credit facility and the related guarantees are secured by substantially all of DynaVox Systems LLC’s present and future assets and all present and future assets of each guarantor on a first lien basis.

 

In general, borrowings under the credit facility bear interest, at our option, at either (1) the Base Rate (as defined in the credit facility) plus a margin of between 3.00-3.75% (depending on the ratio of net total debt to Adjusted EBITDA (as defined in the credit facility)), or (2) a rate based on LIBOR plus a margin of between 4.00-4.75% (depending on the ratio of net total debt to Adjusted EBITDA). We incur an annual commitment fee of 0.375% or 0.5% (depending on the ratio of net total debt to Adjusted EBITDA) of the unused portion of the revolving credit facility.

 

No principal payments will be due on the revolving credit facility until the applicable maturity date. Commencing on September 30, 2008 and ending on June 23, 2014, on the last date of each quarter, we are required to repay borrowings under the term loan facility in increasing percentages per year, beginning at 2.5%, with the remaining balance to be repaid on the applicable maturity date. If our ratio of net total debt to Adjusted EBITDA as of the end of any fiscal year is greater than or equal to 1.50 to 1.00, the credit facility will require a mandatory prepayment in an amount equal to between 25.0-75.0% (depending on the ratio of net total debt to Adjusted EBITDA) of Excess Cash Flow (as defined in the credit facility) for such fiscal year. No mandatory prepayment was required for fiscal year 2010.

 

The credit facility requires DynaVox Systems LLC to maintain certain financial ratios at the end of each fiscal quarter. These include a maximum ratio of net senior debt to Adjusted EBITDA for the preceding twelve-month period of 2.00 to 1.00, a maximum ratio of net total debt to Adjusted EBITDA for the preceding twelve-month period of 4.00 to 1.00 and a minimum Fixed Charge Coverage Ratio for the preceding twelve-month period of 1.20 to 1.00, which minimum Fixed Charge Coverage Ratio increases to 1.25 to 1.00 as of the last day of the first quarter of fiscal year 2012 and then to 1.30 to 1.00 as of the last day of the first quarter of fiscal year 2013. In addition, the credit facility provides for a maximum amount of Capital Expenditures in each fiscal year. The Capital Expenditures limit for fiscal year 2011 is $6.3 million which includes a $0.3 million carryover from the prior fiscal year.

 

As of December 31, 2010, the ratio of net senior debt to Adjusted EBITDA for the twelve-month period then ended was 1.89 to 1.00, the ratio of net total debt to Adjusted EBITDA for the twelve-month period then ended was 1.89 to 1.00 and the Fixed Charge Coverage Ratio for the twelve-month period then ended was 2.43 to 1.00.

 

The ratio of net senior debt to Adjusted EBITDA for a twelve-month period is calculated by dividing net senior debt as of the last day of such twelve-month period (calculated by subtracting the aggregate amount of subordinated debt permitted under the credit facility from net total debt (as defined below)) by Adjusted EBITDA for such twelve-month period. The ratio of net total debt to Adjusted EBITDA for a twelve-month period is calculated by dividing net total debt as of the last day of such twelve-month period by Adjusted EBITDA for such twelve-month period. Net total debt is defined as the sum of the average daily principal balance under the revolving credit facility for the one-month period ending on such date plus the outstanding principal balance of the term loan under the credit facility plus the outstanding principal balance of all other debt. Net total debt may be reduced by up to $5.0 million of cash and cash equivalents for any 12-month period in which Adjusted EBITDA for such period is greater than $30.0 million. As of December 31, 2010, net senior debt and net total debt were both $46.1 million and Adjusted EBITDA for the twelve-month period then ended was $24.4 million.

 

The Fixed Charge Coverage Ratio is calculated by dividing the sum of cash interest expense (net of interest income), cash taxes paid, scheduled principal payments on all debt, restricted cash distributions and management fees paid to Vestar and other certain pre-IPO owners (which items totaled $8.3 million for the twelve months ended December 31, 2010) by operating cash flow. Restricted cash distributions for the twelve months ended December 31, 2010 excludes the $10.0 million we borrowed on March 31, 2010 under the revolving loans provision of the 2008 Credit Facility, as amended, and which was subsequently distributed to the DynaVox Holdings owners. The $10.0 million was repaid with proceeds from the IPO on April 27, 2010. Operating cash flow is defined as Adjusted EBITDA for a twelve-month period less any unfinanced capital expenditures for such twelve-month period. Operating cash flow for the twelve months ended December 31, 2010 was $20.1 million.

 

Capital Expenditures are calculated based on the amount capitalized during the fiscal year less net cash proceeds of asset dispositions or proceeds from property insurance policies received during the fiscal year. Capital Expenditures for the first twenty-six weeks of fiscal year 2011 were $1.9 million.

 

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Our ability to maintain our compliance with these covenants is dependent upon our financial performance, which is influenced by a number of factors, including the levels of government funding in the U.S. and key international markets. Violation of any of the covenants described above would result in an event of default under the credit facility.

 

The credit facility also contains affirmative and negative covenants customarily found in loan agreements for similar transactions, including, but not limited to, restrictions on our ability to incur indebtedness, create liens on assets, incur certain contingent obligations, engage in mergers or consolidations, change the nature of our business, dispose of assets, make certain investments, engage in transactions with affiliates, enter into negative pledges, pay dividends or make other restricted payments, modify certain payments or modify certain debt documents, and modify our constituent documents if the modification materially adversely affect the interests of the lenders.

 

The credit facility contains customary events of default, including defaults based on a failure to pay principal, reimbursement obligations, interest, fees or other obligations, a material inaccuracy of representations and warranties; breach of covenants; failure to pay other indebtedness and cross defaults; failure to comply with ERISA or labor laws; change of control events; events of bankruptcy and insolvency; material judgments; the passive holding company status of the immediate holding company parent of DynaVox Systems LLC and DynaVox International Holdings, Inc., a wholly owned subsidiary of DynaVox Systems LLC; and an impairment of collateral.

 

Upon the occurrence of an event of default, including in the event of non-compliance with the financial ratios described above, the lenders would have the ability to accelerate all amounts then outstanding under the credit facility, except that, upon bankruptcy and insolvency events of default, such acceleration is automatic. Upon the occurrence, and during the continuance, of an event of default under the credit facility, we further would no longer have access to our revolving credit facility and we would have to reclassify on our balance sheet amounts currently shown as long-term debt under the 2008 Credit Facility to short-term debt. Under these circumstances, we may not be able to pay our debt or borrow sufficient funds to refinance it on terms that are acceptable to us or at all.

 

Note Payable

 

We had a $1.1 million note payable as of July 2, 2010 related to an acquisition consummated in fiscal year 2004, which carried an interest rate of 7% to be paid quarterly. This note payable matured, and was repaid, on September 30, 2010.

 

Critical Accounting Policies

 

Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of these financial statements requires estimates and judgments that affect the reported amounts of our assets, liabilities, revenue and expenses. Management bases estimates on historical experience and other assumptions it believes to be reasonable under the circumstances and evaluates these estimates on an on-going basis. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies consist of revenue recognition, trade receivables and related allowances, inventory valuation, goodwill and intangible assets, derivative financial instruments and equity-based compensation, descriptions of which are included in our Annual Report on Form 10-K for the fiscal year ended July 2, 2010, filed with the SEC on September 30, 2010.

 

Off- Balance Sheet Arrangements

 

We are not a party to any off- balance sheet arrangements.

 

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

Foreign Exchange Risk Management

 

Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies could adversely affect our financial results. Approximately 5% and 9% of our net sales for the twenty-six weeks ended December 31, 2010 and for our fiscal year 2010, respectively, was derived from currencies other than the U.S. dollar, mainly the Canadian Dollar, British Pound and the Euro. A 1.0% fluctuation in the exchange rate between the U.S. dollar and the Canadian Dollar, British Pound and Euro for the thirteen and twenty-six weeks ended December 31, 2010, would have resulted in a $0.01 million and $0.02 million, respectively, change in the net sales recorded on our statement of income.

 

Interest Rate Risk

 

We are exposed to interest rate risk in connection with our senior secured credit facility, including any borrowings under the revolving facility thereunder, which bear interest at floating rates based upon certain spreads plus either LIBOR or Prime Rate. As of December 31, 2010, there was $46.1 million outstanding under the senior secured credit facility.

 

For variable rate debt, interest rate changes generally do not affect the fair value of the debt instrument, but do impact future earnings and cash flows, assuming other factors are held constant. At December 31, 2010, the interest rate on our variable-rate borrowings was 4.26%. Based upon the outstanding borrowings and interest rate as of December 31, 2010, a 50 basis point increase in the interest rate would result in an increase in annual interest expense of $0.2 million.

 

The Company uses interest rate swaps to hedge exposure to interest rate risk on its variable-rate debt. The Company does not enter into derivative instruments for speculative purposes. The Company enters into derivatives with high credit quality counterparties and diversifies its positions among such counterparties in order to reduce its exposure to credit losses. The Company has not experienced any credit losses on derivatives for the periods presented in this report.

 

Item 4.    Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2010. Based upon that evaluation and subject to the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2010, the design and operation of our disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

Management has not identified any changes in the Company’s internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2010 that have materially affected, or are 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

 

From time to time, we may be involved in a variety of claims, lawsuits, investigations and proceedings relating to securities laws, product liability, patent infringement, contract disputes and other matters relating to various claims that arise in the normal course of our business. The results of litigation and claims cannot be predicted with certainty, and unfavorable resolutions are possible and could materially affect our results of operations, cash flows or financial position. In addition, regardless of the outcome, litigation could have an adverse impact on us because of defense costs, diversion of management resources and other factors.

 

One such lawsuit is described in further detail below. We intend to defend it vigorously. Based on currently available information, we believe that we have meritorious defense to this action and that the resolution of this case is not likely to have a material adverse effect on our business, financial position or results of operations.

 

Purported Shareholder Class Action Lawsuit filed October 14, 2010

 

On October 14, 2010, a purported class action lawsuit was filed in the United States District Court for the Western District of Pennsylvania against us, two of our officers, Edward L. Donnelly, Jr. and Kenneth D. Misch, and two of the underwriters in our IPO. The lawsuit seeks unspecified damages on behalf of a putative class of persons who purchased our Class A common stock pursuant to our prospectus dated April 21, 2010, filed with the SEC in accordance with Rule 424(b) of the Securities Act on April 23, 2010. The complaint alleges that the defendants issued materially false and misleading statements in our prospectus in light of the Company’s September 30, 2010 press release announcing it had experienced a softening of demand for both its speech generating devices and software products during the first quarter of its fiscal year 2011 which ended October 1, 2010. The press release also announced that as a result of the softening of demand operating results for the fiscal first quarter would not be consistent with historical performance or indicative of what management believes to be the Company’s long-term future operating potential. Under a stipulation entered into by the parties, the lead plaintiff has until February 18, 2011 to file an amended complaint and the Company will file a motion to dismiss the amended complaint on or before April 19, 2011.

 

Item 1A. Risk Factors

 

For a discussion of our potential risks and uncertainties, see the information under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended July 2, 2010.

 

See Part I. Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview” in this report for a discussion of the recent market conditions affecting our business. This discussion updates, and should be read together with, the risk factors entitled “The current adverse economic environment, including the associated impact on government budgets, could adversely affect our business.” “Changes in funding for public schools could cause the demand for our speech generating devices, special education software and content to decrease” and “We are subject to a variety of risks due to our international operations that could adversely affect those operations or our profitability and operating results” in our Annual Report on Form 10-K for the fiscal year ended July 2, 2010.

 

See Part I. Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Financing Agreements” in this report for a discussion of our sources and uses of liquidity. This discussion updates and should be read together with, the risk factor entitled “Our use of leverage may expose us to substantial risks” in our Annual Report on Form 10-K for the fiscal year ended July 2, 2010.

 

The risks described in our Form 10-K are not the only risks facing us. Additional risks and uncertainties, not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results,

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. (Removed and Reserved)

 

Item 5. Other Information

 

Not Applicable.

 

 

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Item 6. Exhibits

 

The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.

 

Exhibit
Number

 

Description of Exhibit

 

 

 

3.1

 

Restated Certificate of Incorporation of DynaVox Inc. (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to the Registration Statement on Form S-1 filed by DynaVox Inc. on February 16, 2010 (File No. 333-164217)).

 

 

 

3.2

 

Amended and Restated Bylaws of DynaVox Inc. (incorporated by reference to Exhibit 3.2 to Amendment No. 1 to the Registration Statement on Form S-1 filed by DynaVox Inc. on February 16, 2010 (File No. 333-164217)).

 

 

 

10.1

*

Third Amendment, dated December 21, 2010, to the Third Amended and Restated Credit Agreement.

 

 

 

31.1

*

Certification required by Rule 13a-14(a).

 

 

 

31.2

*

Certification required by Rule 13a-14(a).

 

 

 

32.1

**

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

 

 

 

32.2

**

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

 


*                                         Filed herewith.

 

**                                  Furnished herewith.

 

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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.

 

 

DynaVox Inc.

 

 

 

Date: February 9, 2011

By

/s/ Edward L. Donnelly

 

 

Edward L. Donnelly

 

 

Chief Executive Officer

 

 

 

 

 

 

Date: February 9, 2011

By

/s/ Kenneth D. Misch

 

 

Kenneth D. Misch

 

 

Chief Financial Officer

 

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