FG Group Holdings Inc. - Quarter Report: 2006 June (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 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 June 30, 2006

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: 1-13906

BALLANTYNE OF OMAHA, INC.

(Exact Name of Registrant as Specified in Its Charter)

(402) 453-4444

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 twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

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

Large accelerated filer   o                 Accelerated filer   o                           Non-accelerated filer   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

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

 

 

TABLE OF CONTENTS

PART I. Financial Information

Item 1.		Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition And Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
		PART II. Other Information
Item 1.		Legal Proceedings
Item 1A.		Risk Factors
Item 4.		Submission of Matters to a Vote of Security Holders
Item 6.		Exhibits
		Signatures

 

 

Part I. Financial Information

Item 1.  Financial Statements

Ballantyne of Omaha, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, 2006 and December 31, 2005

		June 30, 2006			December 31, 2005
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	21,446,197		$	19,628,348
Restricted cash		602,984			—
Accounts receivable (less allowance for doubtful accounts of $463,812 in 2006 and $420,223 in 2005)		5,743,117			7,821,085
Inventories, net		10,674,762			9,942,065
Deferred income taxes		1,451,229			1,247,609
Other current assets		1,199,585			430,411
Total current assets		41,117,874			39,069,518
Property, plant and equipment, net		5,157,191			5,379,933
Goodwill, net		2,928,932			2,467,219
Other intangible assets, net		507,305			—
Other assets		19,257			19,257
Total assets		$	49,730,559		$	46,935,927
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt		$	28,726		$	27,761
Notes payable		200,284			—
Accounts payable		2,498,794			2,212,056
Warranty reserves		705,247			680,017
Accrued group health insurance claims		501,312			275,468
Accrued bonuses		42,621			983,235
Other accrued expenses		1,788,519			1,663,708
Customer deposits		580,860			536,724
Income tax payable		853,334			63,217
Total current liabilities		7,199,697			6,442,186
Long-term debt, net of current portion		—			14,609
Deferred income taxes		22,686			156,912
Other accrued expenses, net of current portion		417,935			324,715
Total liabilities		7,640,318			6,938,422
Commitments and contingencies
Stockholders’ equity:
Preferred stock, par value $.01 per share; Authorized 1,000,000 shares, none outstanding		—			—
Common stock, par value $.01 per share; Authorized 25,000,000 shares; issued 15,648,739 shares in 2006 and 15,495,336 shares in 2005		156,487			154,953
Additional paid-in capital		33,860,032			33,411,013
Retained earnings		23,389,176			21,746,993
		57,405,695			55,312,959
Less 2,097,805 common shares in treasury, at cost		(15,315,454		)	(15,315,454		)
Total stockholders’ equity		42,090,241			39,997,505
Total liabilities and stockholders’ equity		$	49,730,559		$	46,935,927

 

See accompanying notes to consolidated financial statements.

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Ballantyne of Omaha, Inc. and Subsidiaries
Consolidated Statements of Operations
Three and Six Months Ended June 30, 2006 and 2005
(Unaudited)

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Net revenues		$	11,854,768		$	13,041,594		$	24,288,106		$	25,553,463
Cost of revenues		9,122,640			9,354,602			18,225,011			18,471,880
Gross profit		2,732,128			3,686,992			6,063,095			7,081,583
Selling and administrative expenses:
Selling		705,181			616,497			1,439,704			1,355,909
Administrative		1,085,034			1,433,124			2,454,718			2,627,536
Total selling and administrative expenses		1,790,215			2,049,621			3,894,422			3,983,445
Gain on disposal of assets		41,003			10,000			41,003			10,000
Income from operations		982,916			1,647,371			2,209,676			3,108,138
Interest income		202,829			95,382			369,014			167,534
Interest expense		(20,420		)	(8,824		)	(28,442		)	(17,480		)
Other expense, net		(59,087		)	(9,387		)	(40,207		)	(38,906		)
Income before income taxes		1,106,238			1,724,542			2,510,041			3,219,286
Income tax expense		(378,803		)	(663,281		)	(867,858		)	(1,216,111		)
Net income		$	727,435		$	1,061,261		$	1,642,183		$	2,003,175
Basic earnings per share		$	0.05		$	0.08		$	0.12		$	0.15
Diluted earnings per share		$	0.05		$	0.08		$	0.12		$	0.14
Weighted average shares outstanding:
Basic		13,544,510			13,218,957			13,492,792			13,135,310
Diluted		13,977,937			13,886,873			13,962,463			13,865,167

 

See accompanying notes to consolidated financial statements.

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Ballantyne of Omaha, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Three and Six Months Ended June 30, 2006 and 2005
(Unaudited)

		2006		2005
Cash flows from operating activities:
Net income		$1,642,183		$2,003,175
Adjustments to reconcile net income to net cash provided by operating activities.
Provision for doubtful accounts		42,546		(39,301	)
Provision for inventory reserve		247,456		303,240
Depreciation of assets		550,396		563,471
Other amortization		—		20,134
Gain on sale of assets		(41,003	)	(10,000	)
Deferred income taxes		(337,846	)	(9,798	)
Share-based compensation		47,944		—
Excess tax benefits from stock options exercised		(207,146	)	—
Changes in assets and liabilities, net of effect of business acquisition:
Accounts receivable		2,604,005		173,187
Inventories		(864,860	)	(326,996	)
Other current assets		(758,889	)	33,205
Accounts payable		85,514		245,480
Warranty reserves		25,230		(72,225	)
Accrued group health insurance claims		225,844		(15,482	)
Accrued bonuses		(940,614	)	(306,445	)
Other accrued expenses		52,526		(23,460	)
Customer deposits		44,136		(196,006	)
Current income taxes		997,263		28,753
Other assets		—		4,499
Net cash provided by operating activities		3,414,685		2,375,431
Cash flows from investing activities:
Acquisition, net of cash acquired		(1,372,308	)	—
Increase in restricted cash		(602,984	)	—
Proceeds from sale of assets		265,301		10,000
Capital expenditures		(288,141	)	(538,117	)
Net cash used in investing activities		(1,998,132	)	(528,117	)
Cash flows from financing activities:
Payments on long-term debt		(19,864	)	(12,749	)
Proceeds from exercise of stock options		214,014		736,935
Excess tax benefits from stock options exercised		207,146		—
Net cash provided by financing activities		401,296		724,186
Net increase in cash and cash equivalents		1,817,849		2,571,500
Cash and cash equivalents at beginning of period		19,628,348		14,031,984
Cash and cash equivalents at end of period		$21,446,197		$16,603,484

 

See accompanying notes to consolidated financial statements.

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Ballantyne of Omaha, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Three and Six Months Ended June 30, 2006 and 2005
(Unaudited)

1.     Company

Ballantyne of Omaha, Inc., a Delaware corporation (“Ballantyne” or the “Company”), and its wholly-owned subsidiaries Strong Westrex, Inc., Design & Manufacturing, Inc. and Strong Technical Services, Inc., design, develop, manufacture, service and distribute commercial motion picture equipment and lighting systems and distribute restaurant products.  The Company’s products are distributed to movie exhibition companies, sports arenas, auditoriums, amusement parks, special venues, and the food service industry.  Refer to the Business Segment Section (note 13) for further information.

2.     Summary of Significant Accounting Policies

The principal accounting policies upon which the accompanying consolidated financial statements are based are summarized as follows:

a.     Basis of Presentation and Principles of Consolidation

The consolidated financial statements included herein are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America for annual reporting purposes or those made in the Company’s annual Form 10-K filing.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for fiscal 2005.

In the opinion of management, the unaudited consolidated financial statements of the Company reflect all adjustments of a normal recurring nature necessary to present a fair statement of the financial position and the results of operations and cash flows for the respective interim periods.  The results for interim periods are not necessarily indicative of trends or results expected for a full year.

b.              Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results and changes in facts and circumstances may alter such estimates and affect results of operations and financial position in future periods.

c.     Allowance for Doubtful Accounts

Accounts receivable are presented net of allowance for doubtful accounts of $463,812 and $420,223 at June 30, 2006 and December 31, 2005, respectively.  This allowance is developed based on several factors including overall customer credit quality, historical write-off experience and a specific analysis that projects the ultimate collectibility of the account.  As such, these factors may change over time causing the reserve level to adjust accordingly.

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d.     Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market and include appropriate elements of material, labor and manufacturing overhead.  Inventory balances are net of reserves of slow moving or obsolete inventory estimated based on management’s review of inventories on hand compared to estimated future usage and sales.

e.     Goodwill and Other Intangible Assets

Goodwill represents the excess of cost over the fair value of assets of businesses acquired through purchase business combinations in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. Goodwill and intangible assets that are determined to have an indefinite useful life are not amortized but instead tested for impairment at least annually. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s estimated fair value. Intangible assets with estimatable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”

f.      Property, Plant and Equipment

Significant expenditures for the replacement or expansion of property, plant and equipment are capitalized.  Depreciation of property, plant and equipment is provided over the estimated useful lives of the respective assets using the straight-line method.  For financial reporting purposes, assets are depreciated over the estimated useful lives of 20 years for buildings and improvements, 3 to 10 years for machinery and equipment, 7 years for furniture and fixtures and 3 years for computers and accessories.  The Company generally uses accelerated methods of depreciation for income tax purposes.

g.     Income Taxes

Income taxes are accounted for under the asset and liability method.  The Company uses an estimate of its annual effective rate at each interim period based on the facts and circumstances at the time while the actual effective rate is calculated at year-end.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

h.     Revenue Recognition

The Company recognizes revenue from product sales upon shipment to the customer when collectibility is reasonably assured.  Revenues related to services are recognized as earned over the terms of the contracts or delivery of the service to the customer.

The Company enters into transactions that represent multiple element arrangements, which may include a combination of services and asset sales.  Under EITF 00-21, Revenue Arrangements with Multiple Deliverables, multiple element arrangements are assessed to determine whether they can be separated into more than one unit of accounting.  A multiple element arrangement is separated into more than one unit of accounting if all of the following criteria are met.

·                                          The delivered item(s) has value on a standalone basis;

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·                                          There is objective and reliable evidence of the fair value of the undelivered item(s);

·                                          If the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company.

If these criteria are not met, then revenue is deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered.  If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value.  There may be cases, however, in which there is objective and reliable evidence of fair value of the undelivered item(s) but no such evidence for the delivered item(s).  In those cases, the residual method is used to allocate the arrangement consideration.  Under the residual method, the amount of consideration allocated to the delivered item(s) equals the total arrangement consideration less the aggregate fair value of the undelivered item.

i.      Fair Value of Financial Instruments

The fair value of a financial instrument is the amount at which the instruments could be exchanged in a current transaction between willing parties.  All financial instruments reported in the consolidated balance sheets equal or approximate their fair values.

j.      Cash and Cash Equivalents

All highly liquid financial instruments with maturities of three months or less from date of purchase are classified as cash equivalents in the consolidated balance sheets and statements of cash flows.

k.     Restricted Cash

The Company had restricted cash of $602,984 at June 30, 2006 related to the acquisition of National Cinema Service Corp. (NCSC) that were placed in an escrow for potential contingent payments to the seller. See Note 3 to the Consolidated Financial Statements for further detail regarding the acquisition of NCSC.

l.      Earnings Per Common Share

The Company computes and presents earnings per share in accordance with SFAS No. 128, Earnings Per Share.  Basic earnings per share has been computed on the basis of the weighted average number of shares of common stock outstanding.  Diluted earnings per share has been computed on the basis of the weighted average number of shares of common stock outstanding after giving effect to potential common shares from dilutive stock options.  The following table provides a reconciliation between basic and diluted earnings per share:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Basic earnings per share:
Income applicable to common stock		$	727,435		$	1,061,261		$	1,642,183		$	2,003,175
Weighted average common shares outstanding		13,544,510			13,218,957			13,492,792			13,135,310
Basic earnings per share		$	0.05		$	0.08		$	0.12		$	0.15
Diluted earnings per share:
Income applicable to common stock		$	727,435		$	1,061,261		$	1,642,183		$	2,003,175
Weighted average common shares outstanding		13,544,510			13,218,957			13,492,792			13,135,310
Assuming conversion of options outstanding		433,427			667,916			469,671			729,857
Weighted average common shares outstanding, as adjusted		13,977,937			13,886,873			13,962,463			13,865,167
Diluted earnings per share		$	0.05		$	0.08		$	0.12		$	0.14

 

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At June 30, 2006, options to purchase 316,051 shares of common stock at a weighted average price of $7.80 per share were outstanding, but were not included in the computation of diluted earnings per share for the three and six months ended June 30, 2006 as the options’ exercise price was greater than the average market price of the common shares.  These options expire between January 2007 and May 2011.  At June 30, 2005, options to purchase 268,800 shares of common stock at a weighted average price of $8.43 per share were outstanding, but were not included in the computation of diluted earnings per share for the three and six months ended June 30, 2005.

m.    Share-Based Payments

Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123R (“SFAS 123R”), “Share-Based Payments,” which requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on estimated fair values.  SFAS 123R supersedes the Company’s previous accounting methodology using the intrinsic value method under Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.”  Under the intrinsic value method, no share-based compensation expense related to stock option awards granted to employees had been recognized in the Company’s consolidated statements of operations, as all stock option awards granted under the plans had an exercise price equal to the market value of the common stock on the date of the grant.

The Company adopted SFAS 123R on January 1, 2006 using the modified prospective transition method. Under this transition method, compensation expense recognized during the three and six months ended June 30, 2006 include: (a) compensation expense for all share-based awards granted prior to, but not yet vested, as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based awards granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.  In accordance with the modified prospective transition method, the Company’s consolidated financial statements for prior periods have not been restated to reflect the impact of SFAS 123R.

On November 10, 2005 the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. 123R-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.”  The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123R.  The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC Pool and consolidated statements of cash flows of the tax effects of employee and director share-based awards that are outstanding upon adoption of SFAS 123R.

Options

The Company currently maintains a 2001 Non-Employee Directors Stock Option Plan (“2001 Directors Plan”) and a 2005 Outside Directors Stock Option Plan (“2005 Outside Directors Plan”) which have been approved by the Company’s stockholders.  The Company also maintained a 1995 Employee Stock Option Plan and a 1995 Directors Stock Plan which expired in 2005, however, there are outstanding stock options remaining under these two expired plans.

All past and future grants under the Company’s stock option plans were granted at prices based on the fair market value of the Company’s common stock on the date of grant.  The outstanding options generally vest over periods ranging from zero to three years from the grant date and expire between 5 and 10 years.

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All options granted under the 2001 Directors Plan and the 1995 Employee Stock Option Plan were fully vested, based on their original terms, prior to January 1, 2006.  As such, no compensation expense related to those options has been recognized under SFAS 123R.  The 1995 Outside Directors Stock Plan had 47,250 shares outstanding not yet vested at January 1, 2006 and were subject to the recognition of compensation expense.

A total of 1,152,940 shares of common stock have been reserved for issuance pursuant to the Company’s stock option plans at June 30, 2006.

The Company records compensation expense for stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model.  The Company uses historical data among other factors to estimate the expected price volatility, the expected option life and the expected forfeiture rate.  The risk-free rate is based on the U.S. Treasury yield in effect at the time of grant for the estimated life of the option.  The Company has not and is not expected to pay cash dividends in the future.  The Company granted 47,250 and 70,875 stock options under the 2005 and 1995 Outside Directors plans during the six months ended June 30, 2006 and 2005, respectively. All stock options granted during 2006 and 2005 were granted during the three months ended June 30, 2006 and 2005, respectively.

The fair value of option grants during the six months ended June 30, 2006 and 2005 was estimated using the following weighted average assumptions:

 

The following table summarizes the Company’s activities with respect to its stock options for the six months ended June 30, 2006 as follows:

							Weighted-
				Weighted			Average
				Average			Remaining
		Number of		Exercise Price			Contractual		Aggregate
		Shares		Per Share			Term		Intrinsic Value
Outstanding at January 1, 2006		987,078		$	2.86
Granted		47,250		$	4.25
Exercised		(153,403	)	$	1.40
Forfeited		—		$	—
Outstanding at June 30, 2006		880,925		$	3.19		3.54		$	1,834,514
Exercisable at June 30, 2006		825,800		$	3.10		3.48		$	1,834,514

 

The aggregate intrinsic value in the table above represents the total that would have been received by the option holders if all in-the-money options had been exercised on June 30, 2006.  The total intrinsic value for options exercised during the three and six months ended June 30, 2006 was $66,722 and $436,317, respectively.  The total intrinsic value for options exercised during the three and six months ended June 30, 2005 was $449,781 and $775,530, respectively.  The weighted average grant date fair value of options

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granted in the six months ended June 30, 2006 and 2005 was $1.86 and $2.29, respectively.  As of June 30, 2006, the total unrecognized compensation cost related to stock option awards was $139,956 and is expected to be recognized over a weighted average period of 16 months.

Cash received from option exercises under all plans for the six months ended June 30, 2006 and 2005 was $214,014 and $736,935, respectively.  The actual tax benefit realized for the tax deductions from option exercises under all plans totaled $207,146 and $0, respectively, for six months ended June 30, 2006 and 2005.

The following table summarizes information regarding non-vested stock granted for the six months ended June 30, 2006.

				Weighted
				Average
				Grant Date
		Shares		Fair Value
		Outstanding		per Share ($)
Outstanding at January 1, 2006		47,250		$	4.75
Granted		47,250		$	4.25
Vested		(39,375	)	$	4.55
Forfeited		—		—
Outstanding at June 30, 2006		55,125		$	4.46

 

The weighted-average grant date fair value of non-vested stock granted during the three months ended June 30, 2006 and 2005, was $4.25 and $4.75, respectively. As of June 30, 2006, the total unrecognized compensation cost related to non-vested stock option awards was approximately $72,629 and is expected to be recognized over a weighted average period of 16 months.

Restricted Stock Plan

During 2005, the Company adopted and the stockholders approved, the 2005 Restricted Stock Plan.  Under terms of the plan, the compensation committee of the Board of Directors selects which employees of the Company are to receive restricted stock awards and the terms of such awards.  The total number of shares reserved for issuance under the plan is 250,000 shares. There have been no shares issued under the plan through June 30, 2006.  The plan expires in September 2010.

Employee Stock Purchase Plan

The Company’s Employee Stock Purchase Plan, approved by the stockholders, provides for the purchase of shares of Ballantyne common stock by eligible employees at a per share purchase price equal to 85% of the fair market value of a share of Ballantyne common stock at either the beginning or end of the offering period, as defined, whichever is lower.  Purchases are made through payroll deductions of up to 10% of each participating employee’s salary.  The number of shares that can be purchased by participants in any offering period is 2,000 shares.  Additionally, the Plan has set certain limits, as defined, in regard to the number of shares that may be purchased by all eligible employees during an offering period.  At June 30, 2006, 150,000 shares of common stock remained available for issuance under the Plan.  The Plan expires in September 2010.  The total estimated grant date fair value of purchase rights outstanding under the Employee Stock Purchase Plan was $1.48 using the Black-Scholes option-pricing model made with the following weighted average assumptions:  risk-free interest rate - 5.21%, dividend yield - 0%, expected volatility - 32.3% and expected life in years - 1.  At June 30, 2006, the total unrecognized estimated compensation cost was $8,843 which is expected to be recognized over a period of 4 months.

Share-Based Compensation Expense

The table below shows the amounts recognized in the financial statements for the three and six months ended June 30, 2006 for share-based compensation related to employees and directors.

		Three Months			Six Months
		Ended June 30,			Ended June 30,
		2006			2006
Total cost of share-based compensation included
in selling and administrative expenses
before income tax		$	16,222		$	47,944
Amount of income tax benefit recognized		(3,744		)	(12,984		)
Amount charged against net income		$	12,478		$	34,960
Impact on earnings share:
Basic		$	(0.00	)	$	(0.00	)
Diluted		$	(0.00	)	$	(0.00	)

 

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There were no amounts relating to share-based compensation capitalized in inventory during the three and six months ended June 30, 2006.

Pro Forma Share-Based Compensation Expense

Prior to December 31, 2005, the Company accounted for share-based compensation arrangements in accordance with the provisions and related interpretations of APB 25.  Had compensation cost for share-based awards been determined consistent with SFAS No. 123R, the net income and earnings per share would have been adjusted to the following pro forma amounts:

		Three Months			Six Months
		Ended June 30,			Ended June 30,
		2005			2005
Net income, as reported		$	1,061,261		$	2,003,175
Deduct: Total share-based compensation
expense determined under fair value
based method for all awards,
net of related tax effects		594			(37,001		)
Pro forma net income		$	1,061,855		$	1,966,174
Earnings per share:
Basic-as reported		$	0.08		$	0.15
Basic-pro forma		$	0.08		$	0.15
Diluted-as reported		$	0.08		$	0.14
Diluted-pro forma		$	0.08		$	0.14

 

n.     Impairment of Long-Lived Assets

The Company reviews long-lived assets, exclusive of goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset.  If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair value.  Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

The Company’s most significant long-lived assets subject to these periodic assessments of recoverability are property, plant and equipment, which have a net book value of $5.2 million at June 30, 2006.  Because the recoverability of property, plant and equipment is based on estimates of future undiscounted cash flows, these estimates may vary due to a number of factors, some of which may be outside of management’s control.  To the extent that the Company is unable to achieve management’s forecasts of future income, it may become necessary to record impairment losses for any excess of the net book value of property, plant and equipment over its fair value.

o.     Warranty Reserves

The Company generally grants a warranty to its customers for a one-year period following the sale of all new equipment, and on selected repaired equipment for a one-year period following the repair.  The warranty period is extended under certain circumstances and for certain products.  The Company accrues for these costs at the time of sale or repair or when events dictate that additional accruals are necessary.

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The following table summarizes warranty activity for the periods indicated below:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Balance at beginning of period		$	690,162		$	676,480		$	680,017		$	668,268
Charged to expense		57,752			16,482			115,502			85,727
Amounts written off, net of recoveries		(42,667		)	(96,919		)	(90,272		)	(157,952		)
Balance at end of period		$	705,247		$	596,043		$	705,247		$	596,043

 

p.     Comprehensive Income

The Company’s comprehensive income consists solely of net income.  All other items were not material to the consolidated financial statements.

q.     Litigation

During March 2006, Ballantyne settled an asbestos case entitled Bercu v. BICC Cables Corporation, et al., originally filed June 27, 2003 in the Supreme Court of the State of New York.  The settlement amount was not material to the Company’s results of operations, financial position or cash flows.

Ballantyne is a party to various other legal actions which are ordinary routine litigation matters incidental to the Company’s business, such as products liability.  Based on currently available information, management believes that the ultimate outcome of these matters individually and in the aggregate, will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.

r.      Reclassifications

Certain amounts in the accompanying Consolidated Financial Statements have been reclassified to conform to the 2006 presentation.

s.     Environmental

The Company is subject to various federal, state and local laws and regulations pertaining to environmental protection and the discharge of material into the environment.  During 2001, Ballantyne was informed by a neighboring company of likely contaminated soil on certain parcels of land adjacent to Ballantyne’s main manufacturing facility in Omaha, Nebraska.  The Environmental Protection Agency and the Nebraska Health and Human Services System subsequently determined that certain parcels of Ballantyne property had various levels of contaminated soil relating to a former pesticide company which previously owned the property and that burned down in the 1960’s.  During October 2004, Ballantyne agreed to enter into an Administrative Order on Consent (“AOC”) to resolve the matter.  The AOC holds Ballantyne and two other parties jointly and severally responsible for the cleanup.  In this regard, the three parties have also entered into a Site Allocation Agreement by which they will divide past, current and future costs of the EPA, the costs of remediation and the cost of long term maintenance.  In connection with the AOC, the Company has paid its share of the costs.  At June 30, 2006, the Company has provided for management’s estimate of any future payments relating to this matter which is not material to the consolidated financial statements.

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t.      Concentrations

The Company’s top ten customers accounted for approximately 49% of 2006 consolidated net revenues.  Trade accounts receivable from these customers represented approximately 48% of net consolidated receivables at June 30, 2006.  Sales to AMC Theatres, Inc. (“AMC”) represented over 10% of consolidated revenues.  In addition, receivables from AMC, NCS Corporation and Vari International each represented over 10% of net consolidated receivables at June 30, 2006.  While the Company believes its relationships with such customers are stable, most arrangements are made by purchase order and are terminable at will by either party.  A significant decrease or interruption in business from the Company’s significant customers could have a material adverse effect on the Company’s business, financial condition and results of operations.  The Company could also be adversely affected by such factors as changes in foreign currency rates and weak economic and political conditions in each of the countries in which the Company sells its products.

u.     Recently Issued Accounting Pronouncements

The Financial Accounting Standards Board (FASB) has adopted SFAS No. 151, “Inventory Costs — an Amendment of ARB No. 43, Chapter 4.”  The provisions of SFAS 151 are intended to eliminate narrow differences between the existing accounting standards of the FASB and the International Accounting Standards Board (IASB) related to inventory costs, in particular, the treatment of abnormal idle facility expense, freight, handling costs and spoilage.  SFAS 151 requires that these costs be recognized as current period charges regardless of the extent to which they are considered abnormal.  The provisions of SFAS 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005.  The adoption of SFAS 151 did not have a significant impact on the Company’s results of operations, financial position or cash flows.

During 2005, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets” which eliminates the exception to the fair-value principle for exchanges of “similar productive assets,” which had been accounted for based on the book value of the asset surrendered with no gain recognition. Nonmonetary exchanges have to be accounted for at fair-value, recognizing any gain or loss, if the transactions meet the commercial-substance criterion and fair-value determinable.  The Statement reduces the differences between U.S. and international accounting standards.  This Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005.  The Company adopted this Statement in the first quarter of fiscal 2006 and the pronouncement did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

During 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (SFAS 154).  SFAS 154 is a replacement of Accounting Principles Board No. 20, “Accounting Changes” and FASB Statement No. 3 “Reporting Accounting Changes in Interim Financial Statement.”  SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections.  It establishes retrospective application as the required method for reporting a change in accounting principle.  SFAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable.  The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS 154.  SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 31, 2005.  The Company adopted this pronouncement in the first quarter of 2006.

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In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 (“FSP FAS 109-1”), “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities provided by the American Jobs Creation Act of 2004.”  FSP FAS 109-1 clarifies that the deduction will be treated as a “special deduction” as described in SFAS 109, “Accounting for Income Taxes.”  As such, the special deduction has no effect on deferred tax assets and liabilities existing at the date of enactment.  The impact of the deduction will be reported in the period in which the deduction is claimed.  The incentive for U.S. qualified production activities included in the Act is effective as of December 21, 2004.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The intrepretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the impact FIN 48 will have on its consolidated financial statements.

3.   Acquisition of National Cinema Service Corp.

On May 31, 2006, the Company acquired certain assets and assumed certain liabilities of National Cinema Service Corp. (NCSC). The results of NCSC’s operations have been included in the consolidated financial statements from the acquisition date through the reporting period ending June 30, 2006. NCSC is a national provider of cinema services including film and digital projector maintenance, repair, equipment installations, site surveys and other theatre services and has a reputation for quality work, responsiveness and an experienced technical team. As a result of the acquisition, Strong Technical Services, Inc., a wholly-owned subsidiary of Ballantyne, will form a core business established to service the digital and film cinema marketplace.

The total purchase price of NCSC was $1.7 million including cash acquired and funds transferred to escrow under a non-competition agreement. The Company has entered into an agreement to pay the former owner of NCSC, $150,000 in consideration over a five year period from the date of closing of which $25,000 was paid at closing with the remaining $125,000 being placed in escrow. The payments are contingent upon the satisfaction of the requirement to not compete with the Company in the cinema service business over a five-year period. The purchase price excludes an additional $0.5 million of restricted funds that were placed in escrow for contingent payments. These contingencies relate to certain aged accounts receivable, inventories deemed to have a heightened risk of becoming obsolete and certain contingent sales tax liabilities.  These funds will become due and payable to seller upon satisfaction of terms as identified in the purchase agreement.

Funds for the purchase were provided by internally generated cash flows.  Direct transaction costs were not material to the transaction.

The assets acquired and liabilities assumed were recorded at estimated fair values as determined by Company’s management based on information currently available, assumptions as to future operations and preliminary independent appraisals.  Based on the preliminary analysis, $113,729 was assigned to a non-compete agreement entered into with the former owner of NCSC and will be amortized over the five-year life of the agreement. The remaining $393,576 of acquired intangible assets is subject to amortization using an estimated useful life not exceeding 8 years.  The allocation of the purchase

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price is subject to revision, which is not expected to be material, based on the final determination of appraised and other fair values. The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition.

 

Cash acquired		$	313,941
Other current assets		694,161
Property and equipment		263,811
Amortizable intangible assets		507,305
Goodwill		461,713
Total assets acquired		2,240,931
Current liabilities		(465,954		)
Non-current liabilities		(88,728		)
Total liabilities assumed		(554,682		)
Net assets acquired		$	1,686,249

 

Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is expected to be deductible for tax purposes.

The following tables summarize the unaudited pro forma results of operations for the three months and six months ended June 30, 2006 as if NCSC had been combined as of the beginning of the year. In addition, the tables summarize the unaudited results of operations for comparable periods ended June 30, 2005 as if NCSC has been combined at the beginning of that period.

 The pro forma results include estimates and assumptions which management believes are reasonable. However, the pro forma results are not necessarily indicative of the results which would have occurred if the business combination had been in effect on the dates indicated, or which may result in the future.

 

		Three Months Ended
		June 30, 2006			June 30, 2005
Net sales		$	12,874,925		$	14,740,186
Earnings before taxes		1,126,021			1,631,997
Net income		739,878			1,008,202
Basic earnings per common share		$	0.05		$	0.08
Diluted earnings per common share assuming dilution		$	0.05		$	0.07

 

		Six Months Ended
		June 30, 2006			June 30, 2005
Net sales		$	26,794,881		$	28,941,648
Earnings before taxes		2,563,709			2,965,208
Net income		1,676,701			1,985,997
Basic earnings per common share		$	0.12		$	0.15
Diluted earnings per common share assuming dilution		$	0.12		$	0.14

 

 

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4.   Goodwill

The changes in the carrying value of goodwill for the six months ended June 30, 2006 are as follows:

 

5.   Intangible Assets

Amortizable Intangible assets consist of the following:

 

The intangible assets relate entirely to the purchase of National Cinema Service Corp. during June of 2006.

The Company recorded amortization expense related to identifiable intangible assets of $0 for the three and six months ended June 30, 2006, respectively, as compared to $10,068 and $20,134 for the three and six months ended June 30, 2005, respectively.

6.   Inventories

Inventories consist of the following:

 

The inventory balances are net of reserves for slow moving or obsolete inventory of approximately $1,232,000 and $1,138,000 as of June 30, 2006 and December 31, 2005, respectively.

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7.   Property, Plant and Equipment

Property, plant and equipment include the following:

 

Depreciation expense amounted to $270,462 and $550,396 for the three and six months ended June 30, 2006, respectively, as compared to $282,066 and $563,471 for the three and six months ended June 30, 2005, respectively.

8.   Debt

The Company is a party to a revolving credit facility with First National Bank of Omaha expiring August 28, 2006.  The Company expects to renew the credit facility in the ordinary course of business.  The credit facility provides for borrowings up to the lesser of $4.0 million or amounts determined by an asset based lending formula, as defined. Borrowings available under the credit facility amounted to $4.0 million at June 30, 2006.  No amounts are currently outstanding. The Company would pay interest on outstanding amounts equal to the Prime Rate plus 0.25% (8.5% at June 30, 2006) and pays a fee of 0.125% on the unused portion.  The credit facility contains certain restrictive covenants primarily related to maintaining certain earnings, as defined, and restrictions on acquisitions and dividends.  All of the Company’s personal property and stock in its subsidiaries secure this credit facility.

In connection with the acquisition of National Cinema Service Corp, the Company assumed notes payable in the amount of $200,284 pertaining to certain acquired automobiles.  The notes have various interest rates and terms and were paid off subsequent to June 30, 2006.  As such, the notes are included in current liabilities in the accompanying balance sheet.

Long-term debt at June 30, 2006 consisted of installment payments relating to the purchase of certain intangible assets.  Future maturities of long-term debt for the remainder of fiscal 2006 and the remaining years are as follows:  2006: $14,118 and 2007;$14,608.

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9.   Supplemental Cash Flow Information

Supplemental disclosures to the consolidated statements of cash flows are as follows:

 

10.   Stockholder Rights Plan

On May 26, 2000, the Board of Directors of the Company adopted a Stockholder Rights Plan (the “Rights Plan”).  Under terms of the Rights Plan, which expires June 9, 2010, the Company declared a distribution of one right for each outstanding share of common stock.  The rights become exercisable only if a person or group (other than certain exempt persons, as defined) acquires 15 percent or more of Ballantyne common stock or announces a tender offer for 15 percent or more of Ballantyne’s common stock.  Under certain circumstances, the Rights Plan allows stockholders, other than the acquiring person or group, to purchase the Company’s common stock at an exercise price of half the market price.

11.   Postretirement Health Care

The Company sponsors a postretirement health care plan (the “Plan”) for certain current and former executives and their spouses.  The Company’s policy is to fund the cost of the Plan as expenses are incurred.  The costs of the postretirement benefits are accrued over the employees’ service lives.

In accordance with SFAS No. 132, Disclosures About Pensions and Other Postretirement Benefits, the following table sets forth the components of the net period benefit cost for the three and six months ended June 30, 2006 and 2005:

 

The Company expects to pay $6,045 under the plan in 2006. As of June 30, 2006, benefits of $1,295 have been paid.

In December 2003, the United States enacted into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”).  The Act established a prescription drug benefit under Medicare, known as “Medicare Part D” and a federal subsidy to sponsors of retired healthcare benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.  On May 19, 2004, the FASB issued Staff Position No.  FAS-106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (FSP-106-2), which requires measures of the accumulated postretirement benefit obligation and net periodic postretirement benefit costs to

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reflect the effects of the Act in the first interim or annual period beginning after June 15, 2004.  On January 21, 2005, final regulations under the Act were issued.  The effects of the Act did not have a material impact on the consolidated financial statements of the Company.

12.   Self-Insurance

The Company is self-insured up to certain loss limits for group health insurance.  Accruals for claims incurred but not paid as of June 30, 2006 and December 31, 2005 are included in accrued group health insurance claims in the accompanying consolidated balance sheets.  The Company’s policy is to accrue the employee health benefit accruals based on historical information along with certain assumptions about future events.

13.   Business Segment Information

The presentation of segment information reflects the manner in which management organizes segments for making operating decisions and assessing performance.

As of June 30, 2006, the Company’s operations were conducted principally through three business segments: Theatre, Lighting and Restaurant.  Theatre operations include the design, manufacture, assembly, sale and service of motion picture projectors, xenon lamphouses and power supplies, sound systems, film handling equipment and the sale and service of xenon lamps, lenses and digital projection equipment.  The lighting segment operations include the design, manufacture, assembly and sale of follow spotlights, stationary searchlights and computer operated lighting systems for the motion picture production, television, live entertainment, theme parks and architectural industries.  The restaurant segment includes the manufacture and sale of replacement parts and the sale of seasonings, marinades and barbeque sauces.  The Company allocates resources to business segments and evaluates the performance of these segments based upon reported segment gross profit. However, certain key operations of a particular segment are tracked on the basis of operating profit. There are no significant intersegment sales. All intersegment transfers are recorded at historical cost.

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Summary by Business Segments

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Net revenue
Theatre		$	10,931,933		$	12,106,621		$	22,064,139		$	23,577,824
Lighting		738,520			707,681			1,858,944			1,537,045
Restaurant		184,315			227,292			365,023			438,594
Total net revenue		$	11,854,768		$	13,041,594		$	24,288,106		$	25,553,463
Gross profit
Theatre		$	2,415,191		$	3,327,103		$	5,348,161		$	6,387,373
Lighting		242,025			235,376			560,668			490,370
Restaurant		74,912			124,513			154,266			203,840
Total gross profit		2,732,128			3,686,992			6,063,095			7,081,583
Selling and administrative expenses		(1,790,215		)	(2,049,621		)	(3,894,422		)	(3,983,445		)
Gain on sale of assets		41,003			10,000			41,003			10,000
Operating income		982,916			1,647,371			2,209,676			3,108,138
Net interest income		182,409			86,558			340,572			150,054
Other expense, net		(59,087		)	(9,387		)	(40,207		)	(38,906		)
Income before income taxes		$	1,106,238		$	1,724,542		$	2,510,041		$	3,219,286
Expenditures on capital equipment
Theatre		$	163,884		$	432,833		$	275,966		$	511,130
Lighting		5,481			22,264			12,175			26,987
Total		$	169,365		$	455,097		$	288,141		$	538,117
Depreciation and amortization
Theatre		$	250,927		$	275,903		$	509,280		$	551,662
Lighting		19,535			16,231			41,116			31,943
Total		$	270,462		$	292,134		$	550,396		$	583,605
Gain on sale of assets
Theatre		$	39,203		$	10,000		$	39,203		$	10,000
Lighting		1,800			—			1,800			—
Total		$	41,003		$	10,000		$	41,003		$	10,000
								At June 30, 2006			At December 31, 2005
Identifiable assets
Theatre								$	45,019,007		$	42,866,118
Lighting								3,955,614			3,382,738
Restaurant								755,938			687,071
Total								$	49,730,559		$	46,935,927

 

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Summary by Geographical Area

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Net revenue
United States		$	8,928,126		$	9,629,762		$	18,225,177		$	18,230,323
Canada		348,348			95,983			418,970			360,329
Asia		1,417,878			1,302,670			3,058,926			3,268,484
Mexico and South America		832,797			1,319,530			1,931,077			2,747,464
Europe		290,241			674,737			600,318			897,887
Other		37,378			18,912			53,638			48,976
Total		$	11,854,768		$	13,041,594		$	24,288,106		$	25,553,463
								At June 30, 2006			At December 31, 2005
Identifiable assets
United States								$	48,170,941		$	44,910,526
Asia								1,559,618			2,025,401
Total								$	49,730,559		$	46,935,927

 

Net revenues by business segment are to unaffiliated customers. Net sales by geographical area are based on destination of sales. Identifiable assets by geographical area are based on location of facilities.

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

The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. Management’s discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934 that involve risks and uncertainties, including but not limited to: quarterly fluctuations in results; customer demand for the Company’s products; the development of new technology for alternate means of motion picture presentation; domestic and international economic conditions; the achievement of lower costs and expenses; the continued availability of financing in the amounts and on the terms required to support the Company’s future business; credit concerns in the theatre exhibition industry; and other risks detailed from time to time in the Company’s other Securities and Exchange Commission filings. Actual results may differ materially from management’s expectations.  The risks included here are not exhaustive.  Other sections of this report may include additional factors which could adversely affect the Company’s business and financial performance.  Moreover, the Company operates in a very competitive and rapidly changing environment.  New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.  Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Investors should also be aware that while the Company does communicate with securities analysts from time to time, it is against its policy to disclose to them any material non-public information or other confidential information.  Accordingly, investors should not assume that the Company agrees with any statement or report issued by any analyst irrespective of the content of the statement or report.  Furthermore, the Company has a policy against issuing or confirming financial forecast or projections issued by others.  Therefore, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of the Company.

Overview

The Company designs, develops, manufactures and distributes commercial motion picture equipment and lighting systems and also distributes restaurant products.  The Company business was founded in 1932.

The Company has three reportable core operating segments:  theatre, lighting and restaurant.  Approximately 91% of year-to-date 2006 revenues were theatre products, 8% were lighting products and 1% were restaurant products.

Critical Accounting Policies and Estimates

General

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities.  Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of the Board of Directors.  Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on

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assumptions about matters that are uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements.

The Company’s accounting policies are discussed in note 2 to the consolidated financial statements in this report.  Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the consolidated financial statements.

Revenue Recognition

The Company normally recognizes revenue upon shipment of goods or delivery of the service to customers when collectibility is reasonably assured.  In certain circumstances revenue is not recognized until the goods are received by the customer or upon installation and customer acceptance based on the terms of the sale agreement.  During 2003, the Company adopted the provisions of EITF 00-21, Revenue Arrangements With Multiple Deliverables (EITF 00-21).  EITF 00-21 addresses certain aspects of revenue recognition on contracts with multiple deliverable elements.

Allowance for Doubtful Accounts

The Company makes judgments about the credit worthiness of both current and prospective customers based on ongoing credit evaluations performed by the Company’s credit department.  These evaluations include, but are not limited to, reviewing customers’ prior payment history, analyzing credit applications, monitoring the aging of receivables from current customers and reviewing financial statements, if applicable.  The allowance for doubtful accounts is developed based on several factors including overall customer credit quality, historical write-off experience and a specific account analysis that project the ultimate collectibility of the accounts.  As such, these factors may change over time causing the reserve level to adjust accordingly.  When it is determined that a customer is unlikely to pay, a charge is recorded to bad debt expense in the consolidated statements of operations and the allowance for doubtful accounts is increased.  When it becomes certain the customer cannot pay, the receivable is written off by removing the accounts receivable amount and reducing the allowance for doubtful accounts accordingly.

At June 30, 2006, there were approximately $6.2 million in gross outstanding accounts receivable and $0.5 million recorded in the allowance for doubtful accounts.  At December 31, 2005, there were approximately $8.2 million in gross outstanding accounts receivable and $0.4 million recorded in the allowance for doubtful accounts to cover potential future customer non-payments.  If economic conditions deteriorate significantly or if one of the Company’s large customers were to declare bankruptcy, a larger allowance for doubtful accounts might be necessary.

Inventory Valuation

Inventories are stated at the lower of cost (first-in, first-out) or market and include appropriate elements of material, labor and overhead.  The Company’s policy is to evaluate all inventory quantities for amounts on-hand that are potentially in excess of estimated usage requirements, and to write down any excess quantities to estimated net realizable value.  Inherent in the estimates of net realizable values are management’s estimates related to the Company’s future manufacturing schedules, customer demand and the development of digital technology, which could make the Company’s theatre products obsolete, among other items.  Management has managed these risks in the past and believes that it can manage them in the future, however, operating margins may suffer if they are unable to effectively manage these risks.  At June 30, 2006 the Company had recorded gross inventory of approximately $11.9 million and $1.2 million of inventory reserves.  This compared to $11.0 million and $1.1 million, respectively, at December 31, 2005.

Warranty

The Company’s products must meet certain product quality and performance criteria.  In addition to known claims or warranty issues, the Company estimates future claims on recent sales.  The Company

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relies on historical product claims data to estimate the cost of product warranties at the time revenue is recognized.  In determining the accrual for the estimated cost of warranty claims, the Company considers experience with: 1) costs for replacement parts; 2) costs of scrapping defective products; 3) the number of product units subject to warranty claims and 4) other direct costs associated with warranty claims.  If the cost to repair a product or the number of products subject to warranty claims is greater than originally estimated, the Company’s accrued cost for warranty claims would increase.

At June 30, 2006, the warranty accrual amounted to $0.7 million and the amount charged to expense for the three and six months ending June 30, 2006 was approximately $58,000 and $116,000, respectively.  At June 30, 2005, the warranty accrual amounted to $0.6 million and the amount charged to expense for the three and six months ending June 30, 2005 was approximately $16,000 and $86,000, respectively.

Long-Lived Assets

The Company reviews long-lived assets, exclusive of goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset.  If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds their fair value.  Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

The Company’s most significant long-lived assets subject to these periodic assessments of recoverability are property, plant and equipment, which have a net book value of $5.2 million at June 30, 2006.  Because the recoverability of property, plant and equipment is based on estimates of future undiscounted cash flows, these estimates may vary due to a number of factors, some of which may be outside of management’s control.  To the extent that the Company is unable to achieve management’s forecasts of future income, it may become necessary to record impairment losses for any excess of the net book value of property, plant and equipment over its fair value.

Goodwill and Other Intangible Assets

Goodwill represents the excess of cost over the fair value of assets of businesses acquired through purchase business combinations in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. Goodwill and intangible assets that are determined to have an indefinite useful life are not amortized but instead tested for impairment at least annually. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s estimated fair value. Intangible assets with estimatable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”

In accordance with SFAS No. 142, the Company evaluates its goodwill for impairment on an annual basis based on values at the end of the fourth quarter or whenever indicators of impairment exist.  The Company has evaluated its goodwill for impairment in the fourth quarter of fiscal 2005 and determined that the fair value of the reporting units exceeded their carrying value, so no impairment of goodwill was recognized.  Goodwill of approximately $2.9 and $2.5 million is included in the consolidated balance sheets at June 30, 2006 and December 31, 2005, respectively.  Management’s assumptions about future cash flows for the reporting units require significant judgment and actual cash flows in the future may differ significantly from those forecasted today.

Deferred Income Taxes

Income taxes are accounted for under the asset and liability method.  The Company uses an estimate of its annual effective rate at each interim period based on the facts and circumstances known at the time, while the actual effective rate is calculated at year-end.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

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Self-insurance Reserves

The Company is partially self-insured for certain employee health benefits.  The related liabilities are included in the accompanying consolidated financial statements.  The Company’s policy is to accrue the liabilities based on historical information along with certain assumptions about future events.

Share-Based Compensation

Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123R (“SFAS 123R”), “Share-Based Payments,” which requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on estimated fair values.  SFAS 123R supersedes the Company’s previous accounting methodology using the intrinsic value method under Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.”  Under the intrinsic value method, no share-based compensation expense related to stock option awards granted had been recognized in the Company’s consolidated statements of operations, as all stock option awards granted under the plans had an exercise price equal to the market value of the common stock on the date of the grant.

The Company adopted SFAS 123R using the modified prospective transition method. Under this transition method, compensation expense recognized during the six months ended June 30, 2006 included: (a) compensation expense for all share-based awards granted prior to, but not yet vested, as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based awards granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.  In accordance with the modified prospective transition method, the Company’s consolidated financial statements for prior periods have not been restated to reflect the impact of SFAS 123R.  The Company has recorded stock compensation expense of $16,222 and $47,944 for the three and six months ended June 30, 2006, respectively.

On November 10, 2005 the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. 123R-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.”  The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123R.  The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC Pool and consolidated statements of cash flows of the tax effects of employee and director share-based awards that are outstanding upon adoption of SFAS 123R.

Recent Accounting Pronouncements

See note 2 to the consolidated financial statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

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Six Months Ended June 30, 2006 Compared to the Six Months Ended June 30, 2005

Revenues

Net revenues during the first six months of 2006 decreased to $24.3 million from $25.6 million in 2005.  As discussed in further detail below, the decrease resulted primarily from lower theatre revenues.

 

Theatre Segment

Sales of theatre products decreased 6.4% from $23.6 million in 2005 to $22.1 million in 2006 due to lower demand for projection equipment which decreased to $13.7 million in 2006 from $16.2 million in 2005, a decrease of 15.6%.  The Company has begun to see the theatre exhibition industry’s transition to digital cinema and theatre owners appear to be evaluating their options as they plan capital expenditures relative to new or used film projectors or digital equipment.  In large part, the decrease in theatre revenues pertain to this uncertainty as certain customers have either delayed or cancelled previous film projector orders with the Company.  While digital cinema remains a critical component of the Company’s long-term growth strategy, management is unsure how the transition will affect future revenues but does expect revenues to continue to fall short of 2005 levels during the second half of fiscal 2006.

Sales of xenon lamps rose 27.3% in 2006 to $3.0 million from $2.3 million a year ago primarily a result of the Company gaining market share and a general improvement of the theatre exhibition industry. The uncertainty regarding digital cinema has not impacted lamp sales as they are a necessary replacement item for projectors in service.

Sales of lenses declined 18.6% in 2006 to $1.2 million from $1.5 million a year ago.  These sales were also impacted by the uncertainty in the industry but not to the same extent as projector sales.  As such, sales are expected to rebound somewhat in the second half of the year.

Revenues from theatre replacement parts amounted to $4.2 million in 2006 compared to $3.6 million in 2005.  As with lamp sales, the uncertainty regarding digital cinema has not yet impacted part sales as they are a necessary maintenance item needed to keep film projectors operating properly.  In addition, the acquisition of National Cinema Service Corp. generated $0.4 million of replacement part sales and services.

The Company’s top ten theatre customers accounted for approximately 54% of total theatre revenues compared to 51% in 2005.

Lighting Segment

Sales of lighting products rose 20.9% to $1.9 million in 2006 from $1.5 million a year ago.  The increase primarily pertains to higher revenues from britelights and spotlights.  The increase in britelight sales came from a $0.2 million sale of 10K lights to be used by NASA.  Spotlight sales rose to $0.8 million from $0.7 million a year-ago due to a general increase in demand.  Sales of replacement parts and Sky-trackers were comparable to a year-ago at approximately $0.3 million each, respectively.

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