LGL GROUP INC - Quarter Report: 2003 March (Form 10-Q)

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SECURITIES & EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2003

or

For the transition period from              to

Commission File No. 1-106

LYNCH CORPORATION

(401) 453-2007

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 [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ]   No [X]

Indicate the number of shares outstanding of each of the Registrant’s classes of Common Stock, as of the latest practical date.

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INDEX

LYNCH CORPORATION AND SUBSIDIARIES

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Part 1 - FINANCIAL INFORMATION –

Item 1 - Financial Statements

LYNCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands except share amounts)

See accompanying notes

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PART I – FINANCIAL INFORMATION

Item 1 - Financial Statements

LYNCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, except share amounts)

See accompanying notes

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PART I – FINANCIAL INFORMATION

ITEM 1 – Financial Statements

LYNCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)

See accompanying notes

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2003, the Subsidiaries of the Registrant are as follows:

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003.

     The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

     On September 23, 2002, Lynch disposed of its remaining interest in Spinnaker Industries, Inc. (“Spinnaker”) for nominal consideration and completed the deconsolidation that commenced on September 30, 2001. The financial statements for the periods ending March 31, 2002; December 31, 2002; and March 31, 2003 therefore exclude Spinnaker. The net result of the deconsolidation was the recording of a non-cash gain of $19.4 million in the third quarter of 2002 and $27.4 million in the third quarter of 2001.

     For further information, refer to the consolidated financial statements and footnotes thereto included in the Registrant Company and Subsidiaries’ annual report on Form 10-K for the year ended December 31, 2002.

     In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Indebtedness of Others.

     The Company presently guarantees (unsecured) the SunTrust Bank loans of its subsidiary, Lynch Systems, and has guaranteed a Letter of Credit issued to the First National Bank of Omaha on behalf of its subsidiary, M-tron Industries, Inc. These guarantees are subject to FIN 45’s disclosure requirement only. As of March 31, 2003, there were no obligations to SunTrust Bank. As of March 31, 2003, the $1,000,000 Letter of Credit issued by Fleet Bank to The First National Bank of Omaha was secured by a $1,125,000 deposit in a Fleet Bank Treasury Fixed Income Fund.

     There are no other financial, performance, indirect guarantees or indemnification agreements.

     In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002; the Company does not have any exit or disposal activities underway.

     On December 31, 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”), which amends the

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disclosure provisions of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123”) and APBN opinion No. 28, “Interim Financial Reporting” (“APB 28”). See Note I to the Consolidated Financial Statements – “Earnings Per Share and Stockholders Equity”.

     In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The Company does not have any variable interest entities.

At both March 31, 2003 and December 31, 2002, the Company had $1.1 million of Restricted Cash that secures a Letter of Credit issued by Fleet Bank to the First National Bank of Omaha as collateral for its M-tron subsidiary’s loans.

     The following is a summary of marketable securities held by the Company (in Thousands):

     The Company has a margin liability against this investment of $251,000 at both March 31, 2003 and December 31, 2002 which must be settled upon the disposition of the related securities whose fair value is based on quoted market prices. The Company has designated these investments as available for sale pursuant to Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities”.

     Inventories are stated at the lower of cost or market value. At March 31, 2003, inventories were valued by two methods: last-in, first-out (LIFO) — 64%, and first-in, first-out (FIFO) — 36%. At December 31, 2002, inventories were valued by the same two methods: LIFO – 63%, and FIFO — 37%.

     Current costs exceed LIFO value of inventories by $1,230,000 and $1,212,000 at March 31, 2003 and December 31, 2002 respectively.

     Lynch Systems, Inc. and M-tron Industries, Inc. maintain their own credit facilities. The Lynch Systems facility includes an unsecured parent Company guarantee. M-tron’s revolving credit agreement is supported by a $1.0 million Letter of Credit that is secured by a $1.1 million deposit in a Fleet Bank Treasury Fixed Income Fund (see Note D - “Restricted Cash”).

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     In general, the credit facilities are secured by property, plant and equipment, inventory, receivables and common stock of certain subsidiaries and contain certain covenants restricting distributions to the Company.

     Notes payable to banks and long-term debt consists of:

     Lynch Systems, a 100% wholly owned subsidiary of the Company, is engaged in the manufacture and marketing of glass-forming machines and specialized manufacturing machines. Certain sales contracts require an advance payment (usually 30% of the contract price) which is accounted for as a customer advance. The contractual sales prices are paid either (i) as the manufacturing process reaches specified levels of completion or (ii) based on the shipment date. Guarantees by letter of credit from a qualifying financial institution are required for most sales contracts. Because of the specialized nature of these machines and the period of time needed to complete production and shipping, Lynch Systems accounts for these contracts using the percentage-of-completion accounting method as costs are incurred compared to total estimated project costs (cost to cost basis). At March 31, 2003 and December 31, 2002, unbilled accounts receivable (included in accounts receivable) were $1.2 million and $0.7 million, respectively.

     Lynch Systems provides a full warranty to world-wide customers who acquire machines. The warranty covers both parts and labor and normally covers a period of one year or thirteen months. Based upon experience, the warranty accrual is based upon three to five percent of the selling price of the machine. The Company periodically assesses the adequacy of the reserve and adjusts the amounts as necessary.

     I.     Earnings Per Share and Stockholders’ Equity

     The Company’s basic and diluted earnings per share are equivalent as the options issued in May 2002 to purchase 228,000 shares of the Company’s common stock were anti-dilutive throughout 2002 and the first quarter of 2003.

     On December 10, 2001, the Board of Directors approved, subject to shareholder approval at the May 2002 Annual Meeting, the 2001 Equity Incentive Plan and the issuance of up to 300,000 options to purchase shares of Company common stock to certain employees of the Company, of which 228,000 options were granted (subject to shareholder approval) at $17.50 per share on December 10, 2001. Although the grants were approved by the shareholders on May 2, 2002, the shares are not considered issued until exercised or in the money, neither event having transpired to-date. 200,000 of these options are fully vested, with the remaining options vesting quarterly over the next seven quarters.

     The Company has a stock-based employee compensation plan. The Company accounts for the plan under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No stock-based employee compensation cost is reflected in net

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income, as all options granted under those plans had an exercise price equal to or above the market value of the underlying common stock on the date of grant. The Company provides pro forma disclosures of the compensation expense determined under the fair value provisions of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” as follows:

     The net loss as reported in each period did not include any stock-based compensation.

     The weighted average fair value of options granted in 2002 is $17.50.

     Total comprehensive loss was $763,000 and $260,000 for the three months ended 3/31/03 and 3/31/02 respectively, including other comprehensive loss of $25,000 in the first quarter of 2003 resulting from losses on available for sale securities as opposed to other comprehensive income of $32,000 in the first quarter of 2002 resulting from gains on available for sale securities.

     The Company has two reportable business segments. The first segment is Lynch Systems’ glass manufacturing equipment business. Frequency control devices (quartz crystals and oscillators) manufactured and sold by M-tron is the other segment. Both businesses are located domestically.

     EBITDA (after corporate allocation) is equal to operating profit before interest, taxes, depreciation, and amortization. EBITDA is presented because it is a widely accepted financial indicator of value and ability to incur and service debt. EBITDA is a key measure that is used by Lynch's management to evaluate and manage its operating businesses. EBITDA is not a substitute for operating income or cash flows from operating activities in accordance with generally accepted accounting principles.

     Operating loss is equal to revenues less operating expenses, excluding investment income, interest expense and income taxes. The Company allocates a negligible portion of its general corporate expenses to its operating segments.

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     In the normal course of business, subsidiaries of the Registrant are defendants in certain product liability, worker claims and other litigation in which the amounts being sought may exceed insurance coverage levels. The resolution of these matters is not expected to have a material adverse effect on the Company’s financial condition or operations. In addition, Registrant and/or one or more of its subsidiaries are parties to the following additional legal proceedings:

     There has been no change in the status of this lawsuit as last reported in Registrant’s Form 10-K for its fiscal year ended December 31, 2002.

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     There has been no change in the status of this lawsuit as last reported in Registrant’s Form 10-K for its fiscal year ended December 31, 2002.

     The Spinnaker Chapter 11 reorganization was concluded on April 10, 2003 by order of the United States Bankruptcy Court confirming the joint plan of liquidation. The findings of fact are not reported herein because, on September 23, 2002, Lynch disposed of its entire remaining interest in Spinnaker and no longer has any economic interest in or affiliation with Spinnaker.

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

Results of Operations

First Quarter 2003 Compared to First Quarter 2002

Sales and Revenues/Gross Margin

     Revenues for the first quarter of 2003 decreased by $2.3 million from first quarter 2002 to $4.7 million due mainly to the low beginning backlog and the timing of deliveries for orders booked by Lynch Systems in February and March of 2003.

     First quarter 2003 gross margin as a percent of revenues of 16.7% was 14.0% below the first quarter of 2002 due mainly to the low level of sales.

     Revenues at M-tron increased by $0.6 million, or 21.3%, to $3.3 million for the first quarter of 2003 due partly to the acquisition of Champion Technologies, Inc. (“Champion”). On October 18, 2002, M-tron acquired certain assets of an industry competitor, Champion Technologies, Inc., from U.S. Bank in a transaction accounted for as a purchase. Champion’s product line includes crystals, clock oscillators, specialized crystal oscillators, and timing solutions.

     Lynch Systems’ revenues for the first quarter of 2003 declined by $2.8 million from the corresponding 2002 period to $1.5 million due mainly to depressed bookings for glass press machines throughout 2002. However, order backlog of $8.7 million at March 31, 2003 represented an improvement of $4.8 million since December 31, 2002 and was virtually equal to the backlog last March.

     M-tron’s gross margin as a percentage of net sales for the three month period of 2003 was up 12.1% to 20.0% from the same period of 2002. The sales improvement of 21.3% in the quarter more than offset the costs incurred in manufacturing the more sophisticated Champion parts..

     Lynch Systems’ gross margin as a percentage of net sales for the three month period of 2003 declined 35.3% to 9.6% from the same period of 2002. This reduction was the result of the 65.6% sales decline in the first quarter that included a major drop-off in higher margin repair parts business.

Operating Loss

     Operating loss for the first quarter 2003 was $1.0 million compared to the first quarter 2002 operating loss of $0.4 million, representing an unfavorable variance of $0.6 million on $2.3 million less revenue.

     For the first quarter of 2003, M-tron had an operating loss of $0.2 million, an improvement of $0.6 million over the $0.8 million loss in the first quarter of 2002 due mainly to the improved sales volume mentioned above and better product mix.

     For the 2003 first quarter, Lynch Systems had an operating loss of $0.5 million compared to an operating profit of $0.7 million in the first quarter of 2002. Although Lynch Systems operating costs were reduced by $0.6 million from the first quarter of 2002, the company could not compensate for the 66 percent volume decline and poor product mix.

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     For the first quarter of 2003, Lynch’s corporate headquarters incurred unallocated expenses of $0.3 million, the same as the first quarter of 2002.

Other Income (Expense), Net

     Investment income decreased $17,000 for the three months ended March 31, 2003 due to lower investment rates and lower average cash balances.

     Interest expense of $69,000 for the first quarter 2003 was $29,000 higher than the first quarter of 2002 due to Letter of Credit fees and higher average borrowings to fund losses and finance the “Champion” acquisition.

Tax Benefit

     The income tax benefit includes federal, as well as state, local, and foreign taxes. The first quarter 2003 net tax benefit of $349,000 is the result of operating losses incurred which are expected to be realized during the remainder of the year.

Net Loss

     Net loss for the first quarter of 2003 was $0.7 million compared to a net loss of $0.3 million in the quarter ending March 31, 2002. The $0.4 million additional loss is primarily due to the 14.0% reduction in gross profit caused by 32.2% less volume that could not be offset by the $0.7 million reduction in selling and administration expenses. Fully diluted first quarter 2003 loss per share was $0.49 compared to a loss of $0.19 per share in the first quarter 2002.

Backlog/New Orders

     Total backlog of manufactured products at March 31, 2003 was $11.3 million, a $5.0 million improvement over the backlog at December 31, 2002, and $0.3 million more than the backlog at March 31, 2002.

     M-tron’s backlog improved by $0.8 million since last March, due mainly to the acquisition of Champion Technology, Inc. in October, 2002.

     Lynch Systems backlog has improved by $4.8 million since December 31 as a result of two significant orders for glass press machines. First quarter 2003 orders of $5.4 million exceeded first quarter 2002 bookings by $3.9 million; Lynch Systems continues to submit a large number of quotes, predominantly to tableware manufacturers, and should sustain its recent momentum.

Financial Condition

     At March 31, 2003, the Company has current assets of $18.9 million and current liabilities of $11.3 million. Working capital was therefore $7.6 million as compared to $8.0 million at December 31, 2002 and $9.4 million at March 31, 2002. The ratio of current assets to current liabilities was 1.68 to 1.00 at March 31, 2003; 1.79 to 1.00 at December 31, 2002; and 1.62 to 1.00 ratio at March 31, 2002.

     Cash provided by operating activities was approximately $0.4 million in the first quarter 2003 compared to cash used of approximately $1.6 million in the first quarter of 2002. The year over year favorable change in operating cash flow of $2.0 million was mainly the result of $2.2 million difference in cash provided in working capital. Capital expenditures were $33,000 in first quarter 2003 compared to $36,000 in the period ending March 31, 2002.

     Total debt of $4.5 million at March 31, 2003 was $0.4 million greater than the amount outstanding at December 31, 2002 and $1.2 million more than the debt at March 31, 2002. The year over year increase in debt is primarily due to increases in M-tron’s loans to finance operating losses and acquire “Champion” in October 2002. Debt outstanding at March 31, 2003 included $1.2 million of fixed rate debt at an average interest rate of 4.9%, and $3.3 million of variable rate debt at a March 31, 2003 average interest rate of 4.6%.

     Restrictions on dividends under the M-tron loan with First National Bank of Omaha disallow distributions to the parent company without consent of the bank. Lynch Systems, under its loan with Sun Trust Bank, may pay a cash dividend to the parent company equal to 50% of LS’s net income for the prior fiscal year. Under the M-tron

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loan agreement, advances to the parent company are disallowed without the prior written consent of the lending bank. Under its loan agreement, LS may pay an annual management fee to the parent company in an amount not to exceed $250,000. In addition, LS may reimburse the parent company for expenses and taxes paid by the parent on behalf of LS.

     At March 31, 2003, the Company’s total cash, cash equivalents and investments in marketable securities total $8.7 million (including $1.1 million of restricted cash). In addition, the Company had a consolidated total $2.1 million borrowing capacity under M-tron’s and LS’s revolving line of credit. Therefore, gross cash and securities and availability under the revolving credit loans total $10.8 million and exceed the outstanding debt of $4.5 million by $6.3 million. In the near term, the Company expects to receive a $0.5 million cash tax benefit through carry-backs for prior periods operating losses. The Company presently does not guarantee M-tron’s bank debt. The parent company has provided an unsecured guarantee of Lynch Systems debt to Sun Trust Bank.

     Lynch Systems is finalizing negotiations to renew its SunTrust Bank loan that matures on May 31, 2003. This incumbent lender has committed to provide up to a $7 million line-of-credit which can be used entirely for stand-by Letters of Credit or up to $2 million for domestic revolving credit within the credit line. The present Lynch Systems loan includes an unsecured parent company guarantee. At March 31, 2003, there were outstanding Letters of Credit of $1.6 million and no borrowings under the working capital line.

     M-tron’s lending bank, First National Bank of Omaha, has agreed to renew the revolving credit loan which expired on April 30, 2003. The lender will renew the loan under the following conditions:

     The aforementioned conditions have no yet been finalized, but all steps leading to the renewal are in process and will be completed by mid-May.

     The Company does not at present have credit facilities at the parent company level. The Company believes that existing cash and cash equivalents, cash generated from operations and available borrowings under its subsidiaries lines of credit will be sufficient to meet its on-going working capital and capital expenditure requirements for the foreseeable future.

Adoption of Accounting Pronouncements

     In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Indebtedness of Others.

     The Company presently guarantees (unsecured) the SunTrust Bank loans of its subsidiary, Lynch Systems, and has guaranteed a Letter of Credit issued to the First National Bank of Omaha on behalf of its subsidiary, M-tron Industries, Inc. These guarantees are subject to FIN 45’s disclosure requirement only. As of March 31, 2003, there were no obligations to the SunTrust Bank. As of March 31, 2003, the $1,000,000 Letter of Credit issued by Fleet Bank to The First National Bank of Omaha was secured by a $1,125,000 deposit in a Fleet Bank Treasury Fixed Income Fund.

     There are no other financial, performance, indirect guarantees or indemnification agreements.

     In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The provisions of SFAS 146

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are effective for exit or disposal activities that are initiated after December 31, 2002; the Company does not have any exit or disposal activities underway.

     On December 31, 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS 148”), which amends the disclosure provisions of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123”) and APBN opinion No. 28, “Interim Financial Reporting” (“APB 28”). See Note I to the Consolidated Financial Statements - “Earnings Per Share and Stockholders Equity”.

     In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The Company does not have any variable interest entities.

Market Risk

     The Company is exposed to market risk relating to changes in the general level of U.S. interest rates. Changes in interest rates affect the amounts of interest earned on the Company’s cash equivalents and short-term investments (approximately $7.8 million at March 31, 2003). The Company generally finances the debt portion of the acquisition of long-term assets with fixed rate, long-term debt. The Company generally maintains the majority of its debt in nature by borrowing on a fixed long-term basis. The Company does not use derivative financial instruments for trading or speculative purposes. Management does not foresee any significant changes in the strategies used to manage interest rate risk in the near future, although the strategies may be reevaluated as market conditions dictate. There has been no significant change in market risk since March 31, 2003.

     At March 31, 2003, approximately $3.3 million of the Company’s debt bears interest at variable rates. Accordingly, the Company’s earnings and cash flows are only slightly affected by changes in interest rates. Assuming the current level of borrowings for variable rate debt, and assuming a two percentage point increase in the 2003 average interest rate under these borrowings, it is estimated that the Company’s interest expense would change by less than $0.1 million.

Risk Factors

     Certain subsidiaries and business segments of the Company sell to industries that are subject to cyclical economic changes. Any downturns in the economic environment would have a financial impact on the Company and its consolidated subsidiaries and may cause the reported financial information herein not to be indicative of future operating results, financial condition or cash flows.

     Future activities and operating results may be adversely affected by fluctuating demand for capital goods such as large glass presses, delay in the recovery of demand for components used by telecommunications infrastructure manufacturers, disruption of foreign economies and the inability to renew or obtain new financing for expiring loans.

     Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments, and trade accounts receivable.

     The Company maintains cash and cash equivalents and short-term investments with various financial institutions. These financial institutions are located throughout the country and the Company’s policy is designed to limit exposure to any one institution. The Company performs periodic evaluations of the relative credit standing of those financial institutions that are considered in the Company’s investment strategy. Other than certain accounts receivable, the Company does not require collateral on these financial instruments. In relation to export sales, the Company requires letters of credit supporting a significant portion of the sales price prior to production to limit exposure to credit risk. The Company maintains an allowance for doubtful accounts at a level that management believes is sufficient to cover potential credit losses.

Forward Looking Information

     Included in this Management Discussion and Analysis of Financial Condition and Results of Operations are certain forward looking financial and other information, including without limitation matters relating to “Risks”.

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It should be recognized that such information are projections, estimates or forecasts based on various assumptions, including without limitation, meeting its assumptions regarding expected operating performance and other matters specifically set forth, as well as the expected performance of the economy as it impacts the Company’s businesses, government and regulatory actions and approvals, and tax consequences, and the risk factors and cautionary statements set forth in reports filed by the Company with the Securities and Exchange Commission. As a result, such information is subject to uncertainties, risks and inaccuracies, which could be material.

     The Registrant makes available, free of charge, its annual report on Form 10-K, Quarterly Reports on Form 10-Q, and current reports, if any, on Form 8-K.

     The Registrant also makes this information available on its website, who’s internet address is www.lynchcorp.com.