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UNITED STATES
SECURITIES & EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006
------------------
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File No. 1-106
The LGL Group, Inc.
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(Exact name of Registrant as Specified in Its Charter)
Indiana 38-1799862
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(State or Other Jurisdiction of I.R.S. Employer
Incorporation or Organization) Identification No.)
140 Greenwich Avenue, 4th Floor, Greenwich, CT 06830
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(Address of principal executive offices) (Zip Code)
(203) 622-1150
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Registrant's telephone number, including area code
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(Former address, changed since last report)
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 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.
Large accelerated filer [ ] Accelerated filer [ ] 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 [ ] No |X|
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock, as of the latest practical date.
Class Outstanding at September 30 ,2006
----------------------------- -----------------------------------
Common Stock, $0.01 par value 2,154,702
INDEX
THE LGL GROUP, INC. AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets:..........................................3
- September 30, 2006
- December 31, 2005
Consolidated Statements of Operations:................................4
- Three months ended September 30, 2006 and 2005
- Nine months ended September 30, 2006 and 2005
Consolidated Statements of Cash Flows:................................5
- Nine months ended September 30, 2006 and 2005
Notes to Condensed Consolidated Financial Statements:.................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................15
Item 3. Quantitative and Qualitative Disclosure About Market Risk............22
Item 4. Controls and Procedures..............................................23
PART II. OTHER INFORMATION
Item 1A. Risk Factors.........................................................23
Item 6. Exhibits ............................................................23
2
PART 1 -- FINANCIAL INFORMATION -
ITEM 1 -- FINANCIAL STATEMENTS
THE LGL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -- UNAUDITED
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
September 30, December 31,
2006 2005 (A)
-------- --------
ASSETS
Current Assets
Cash and cash equivalents $ 3,989 $ 5,512
Restricted cash (Note D) 650 650
Investments - marketable securities (Note E) 2,548 2,738
Accounts receivable, net of allowances of $715 and $325, respectively 8,701 7,451
Unbilled accounts receivable (Note H) 586 902
Inventories (Note F) 9,291 7,045
Deferred income taxes 111 111
Prepaid expense and other current assets 568 461
-------- --------
Total Current Assets 26,444 24,870
Property, Plant and Equipment
Land 855 855
Buildings and improvements 5,770 5,767
Machinery and equipment 15,115 14,606
-------- --------
21,740 21,228
Less: accumulated depreciation (14,909) (14,025)
-------- --------
Net Property, Plant and Equipment 6,831 7,203
Other assets 469 591
-------- --------
Total Assets $ 33,744 $ 32,664
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable to bank (Note G) $ 3,403 $ 2,838
Trade accounts payable 3,408 2,900
Accrued warranty expense (Note H) 208 357
Accrued compensation expense 1,787 1,372
Accrued income taxes 391 673
Accrued professional fees 471 574
Margin liability on marketable securities -- 330
Other accrued expenses 1,017 1,312
Commitments and contingencies (Note L) -- 859
Customer advances 532 515
Current maturities of long-term debt (Note G) 879 1,215
-------- --------
Total Current Liabilities 12,096 12,945
Long-term debt (Note G) 4,423 5,031
-------- --------
Total Liabilities 16,519 17,976
Shareholders' Equity
Common stock, $0.01 par value - 10,000,000 shares authorized; 2,188,510 shares 22 22
issued; 2,154,702 shares outstanding
Additional paid-in capital 21,053 21,053
Accumulated deficit (4,808) (6,576)
Accumulated other comprehensive income (Note J) 1,604 835
Treasury stock, at cost, 33,808 shares (646) (646)
-------- --------
Total Shareholders' Equity 17,225 14,688
-------- --------
Total Liabilities and Shareholders' Equity $ 33,744 $ 32,664
======== ========
(A) The Balance Sheet at December 31, 2005 has been derived from the audited financial statements at that date, but does not
include all of the information and footnotes required by accounting principles generally accepted in the United States
for complete financial statements.
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
PART I -- FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS
THE LGL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS -- UNAUDITED
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
----------- ----------- ----------- -----------
REVENUES ............................................... $ 13,038 $ 10,745 $ 38,275 $ 36,253
Cost and expenses:
Manufacturing cost of sales ......................... 9,575 7,784 27,151 24,503
Selling and administrative .......................... 3,492 3,277 10,309 9,838
Lawsuit settlement provision ........................... -- 200 -- 200
----------- ----------- ----------- -----------
OPERATING PROFIT (LOSS) ................................ (29) (516) 815 1,712
Other income (expense):
Investment income ................................... 711 583 1,229 600
Interest expense .................................... (151) (217) (493) (610)
Other income (expense) .............................. (17) (12) (25) 68
----------- ----------- ----------- -----------
543 354 711 58
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES ...................... 514 (162) 1,526 1,770
Income Tax Benefit ..................................... (389) (858) (242) (327)
----------- ----------- ----------- -----------
NET INCOME ............................................. $ 903 $ 696 $ 1,768 $ 2,097
Per Common Share:
Basic weighted average shares outstanding .......... 2,154,702 1,617,934 2,154,702 1,626,801
----------- ----------- ----------- -----------
BASIC INCOME PER SHARE ................................. $ 0.42 $ 0.43 $ 0.82 $ 1.29
----------- ----------- ----------- -----------
Fully diluted weighted average shares outstanding .. 2,159,702 1,617,934 2,156,702 1,626,801
----------- ----------- ----------- -----------
FULLY DILUTED INCOME PER SHARE: ........................ $ 0.42 $ 0.43 $ 0.82 $ 1.29
=========== =========== =========== ===========
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
PART I -- FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS
THE LGL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- UNAUDITED
(IN THOUSANDS)
Nine Months Ended
September 30,
2006 2005
------- -------
OPERATING ACTIVITIES
Net income ..................................................................................... $ 1,768 $ 2,097
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation ................................................................................... 884 1,050
Provision for doubtful accounts receivable ..................................................... 390 --
Amortization of definite-lived intangible assets ............................................... 82 85
Gain realized on sale of marketable securities ................................................. (1,171) (567)
Gain on sale of fixed assets ................................................................... -- (69)
Lawsuit settlement provision ................................................................... -- 200
Changes in operating assets and liabilities:
Receivables .................................................................................. (1,324) 734
Inventories .................................................................................. (2,246) 1,494
Accounts payable and accrued liabilities ..................................................... 111 21
Commitments and contingencies ................................................................ (859) --
Other assets/liabilities ..................................................................... (67) (2,161)
------- -------
Net cash (used in) provided by operating activities ............................................ (2,432) 2,884
------- -------
INVESTING ACTIVITIES
Capital expenditures ........................................................................... (512) (287)
Restricted cash ................................................................................ -- 475
Proceeds from sale of marketable securities .................................................... 2,113 1,348
Proceeds from sale of fixed assets ............................................................. -- 307
Net repayment of margin liability on marketable securities ..................................... (330) (1,241)
------- -------
Cash provided by investing activities .......................................................... 1,271 602
------- -------
FINANCING ACTIVITIES
Net (repayments) borrowings of notes payable .................................................. 565 (2,462)
Repayment of long-term debt .................................................................... (944) (588)
Purchase of treasury stock ..................................................................... -- (156)
Other .......................................................................................... 17 (36)
------- -------
Net cash used in financing activities .......................................................... (362) (3,242)
------- -------
(Decrease) increase in cash and cash equivalents ............................................... (1,523) 244
Cash and cash equivalents at beginning of period ............................................... 5,512 2,580
------- -------
Cash and cash equivalents at end of period ..................................................... $ 3,989 $ 2,824
======= =======
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A. SUBSIDIARIES OF THE REGISTRANT
As of September 30, 2006, the Subsidiaries of the Registrant are as
follows:
Owned by LGL
------------
Lynch Systems, Inc. ............................................. 100.0%
M-tron Industries, Inc. ......................................... 100.0%
M-tron Industries, Ltd. ................................. 100.0%
Piezo Technology, Inc. .................................. 100.0%
Piezo Technology India Private Ltd. ............. 99.9%
The LGL Group, Inc. (the "Company") has two reportable business segments
operating through three principal subsidiaries, M-tron Industries, Inc.
("Mtron"), Piezo Technology, Inc. ("PTI") and Lynch Systems, Inc. ("Lynch
Systems"). The combined operations of Mtron and PTI are referred to herein
as "Mtron/PTI."
B. BASIS OF PRESENTATION
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 and nine month period ended
September 30, 2006 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2006.
The balance sheet at December 31, 2005 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.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Registrant Company and Subsidiaries Annual
Report, as amended, on Form 10-K/A for the year ended December 31, 2005,
filed with the Securities and Exchange Commission on May 18, 2006.
Certain amounts in 2005 have been reclassified to conform to 2006
classifications.
C. ACCOUNTING PRONOUNCEMENTS
On January 1, 2006 the Company adopted revised Statement of Financial
Accounting Standards No. 123 ("SFAS No. 123-R"), "Share-Based Payments." SFAS
No. 123-R impacts the Company's accounting for its stock option plan. The
Company's stock options were fully vested at December 31, 2005 and there were no
new options issued through the third quarter of 2006. On September 5, 2006, the
Company issued 20,000 non-vested (restricted) shares of stock to two senior
executives. Fifty percent of these shares become vested in September 2007 and
the remainder, quarterly in December 2007, March, July, and September 2008. The
Company has recognized the compensation expense related to the vested portion of
these shares in the three months ended September 30, 2006, and the potential
increase in the number of shares outstanding in accordance with the provisions
of SFAS No. 123-R.
In July 2006, the FASB issued Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" ("FIN
48"). This Interpretation provides a comprehensive model for the financial
statement recognition, measurement, presentation and disclosure of uncertain tax
positions taken or expected to be taken in income tax returns. This statement is
6
effective for fiscal years beginning after December 15, 2006. The Company will
adopt this Interpretation in the first quarter of 2007. The cumulative effects,
if any, of applying FIN 48 will be recorded as an adjustment to retained
earnings. The Company is currently assessing the impact of this Interpretation
on its financial position and results of operations.
In September 2006, the FASB issued SFAS No. 157 "Fair Value Measurements".
This Statement replaces multiple existing definitions of fair value with a
single definition, establishes a consistent framework for measuring fair value,
and expands financial statement disclosures regarding fair value measurements.
This Statement applies only to fair value measurements that are already required
or permitted by other accounting standards and does not require any new fair
value measurements. SFAS 157 is effective for fiscal years beginning subsequent
to November 15, 2007. The Company will adopt this Statement in the first quarter
of 2008, and is currently evaluating the impact on its financial position and
results of operations.
D. RESTRICTED CASH
At September 30, 2006 and December 31, 2005, the Company had $650,000 of
Restricted Cash that secured a Stand-By Letter of Credit issued by Bank of
America to the First National Bank of Omaha ("FNBO") as collateral for its Mtron
subsidiary's loans. As of October, 16, 2006, the stand-by letter of credit is no
longer in place and as of October 19, 2006 the restriction on the $650,000 on
deposit at Bank of America was lifted.
E. INVESTMENTS
The following is a summary of marketable equity securities held by the
Company (in thousands).
Gross Gross Estimated
Unrealized Unrealized Fair
Equity Securities Cost Gains Losses Value
-------------------------------------------------- ---------- ---------- ---------- ----------
September 30, 2006 ............................... $1,049 $1,499 -- $2,548
December 31, 2005 ................................ $1,991 $ 747 -- $2,738
The Company had a margin liability of $330,000 against this investment at
December 31, 2005 which was settled upon the disposition of the related
securities whose fair value is based on quoted market prices. The Company paid
off the margin liability in January 2006. The Company had designated these
investments as available for sale pursuant to SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities".
FAIR VALUE OF FINANCIAL INSTRUMENTS - INTEREST RATE SWAP
On September 30, 2005, the Company entered into a 5-year interest rate
swap to eliminate the interest rate exposure on the RBC Term Loan that is
described in Note G (the "Swap"). This Swap eliminates the variability of cash
flows for the interest payments for the variable-rate term loan by offsetting
the changes in interest rate payments on the debt, with payments received, based
on the same LIBOR base rate Because the critical terms (notional amount,
interest rate reset dates, maturity/expiration date and underlying index) of the
Swap and the term loan coincide, the hedge is expected to exactly offset changes
in expected cash flows despite fluctuations in the LIBOR base rate over the term
of the loan. The Company has designated the Swap as a cash-flow hedge.
Accordingly, this Swap qualifies for the short-cut method and therefore changes
in the fair value of the Swap are recorded in "Other Comprehensive Income." The
fair value of the interest rate swap at September 30, 2006 is $20,000 or
$13,500, net of income tax.
7
F. INVENTORIES
Inventories are stated at the lower of cost or market value. At September 30,
2006, inventories were valued by two methods: last-in, first-out ("LIFO") -
49.6%, and first-in, first-out ("FIFO") - 50.4%. At December 31, 2005,
inventories were valued by the same two methods: LIFO - 52.2%, and FIFO - 47.8%.
September 30 December 31,
2006 2005
------------ ------------
(in thousands)
Raw materials ......................................... $3,178 $2,817
Work in process ....................................... 4,138 2,232
Finished goods ........................................ 1,975 1,996
------ ------
Total Inventories ................................... $9,291 $7,045
====== ======
Current costs exceed LIFO value of inventories by $1,007,000 and $1,075,000
at September 30, 2006 and December 31, 2005, respectively.
G. NOTES PAYABLE AND LONG-TERM DEBT
Notes payable and long-term debt consists of:
September 30 December 31,
2006 2005
------------ ------------
Notes payable: (in thousands)
Mtron/PTI variable interest rate revolving credit
facility, at greater of prime or 4.5%, due May 2007 $ 1,497 $ 2,082
Lynch Systems working capital revolving loan at one
month LIBOR + 2.75%. 8.08% at September 30, 2006
and 7.06% at December 31, 2005), due January 2007 1,906 756
------- -------
$ 3,403 $ 2,838
======= =======
Long-term debt:
Lynch Systems term-loan, repaid in February 2006 $ -- $ 378
Mtron Term loan, variable rate at LIBOR plus 2.75%
essentially converted to fixed rate 7.51% with
interest rate swap, due October 2010 2,981 3,030
Mtron variable interest rate Term Loan, greater of
prime plus 50 basis points, or 4.5%, due October 2007
1,370 1,612
Mtron commercial bank term loan at variable interest
rate, due April 2007 . 279 456
Mtron loan from South Dakota Board of Economic
Development at a fixed interest rate of 3.0%, due
December 2007 252 262
Mtron loan from Yankton Areawide Business Council
loan at a fixed interest rate of 5.5%, due
November 2007 68 74
Mtron loan from Rice University Promissory Note at a
fixed interest rate of 4.5%, due August 2009 223 275
Mtron loan from Smythe Estate Promissory Note at a
fixed interest rate of 4.5% due August 2009 129 159
------- -------
5,302 6,246
Current maturities (879) (1,215)
------- -------
$ 4,423 $ 5,031
======= =======
At September 30, 2006, the prime rate is 8.25% and at December 31, 2005 was
7.75%.
8
At September 30, 2006, Mtron/PTI's variable interest rate revolving loan
provides for a line of credit in the maximum principal amount of $5.5 million,
of which $4.0 million is unused and available. Borrowings under the loan
agreement bear interest at the greater of prime or 4.5%. On October 3, 2006,
Mtron/PTI renewed its credit agreement with FNBO extending the due date for the
revolving credit facility to May 31, 2007. In addition, on October 3, 2006,
Mtron/PTI entered into a third amendment to its FNBO Loan Agreement to allow the
Company to loan Mtron/PTI up to $3 million. Mtron/PTI is allowed to invest the
loan proceeds in accordance with its business expansion needs.
Effective October 6, 2005, Lynch Systems entered into a variable interest
rate revolving loan agreement with Branch Banking & Trust ("BB&T"), providing
for a line of credit in the maximum principal amount of $3.5 million (the "BB&T
Loan Agreement"). At September 30, 2006, there were no outstanding Letters of
Credit and $1.6 million was unused and available under the line of credit. This
line of credit replaced the working capital revolving loan that Lynch Systems
had with SunTrust Bank, which expired by its terms on September 30, 2005.
Borrowings under the loan agreement bear interest at the one month LIBOR Rate
plus 2.75% and accrued interest is payable on a monthly basis, with the
principal balance due to be paid on the first anniversary of the loan agreement.
On October 4, 2006 the permitted borrowing capacity under this Line of Credit
was reduced to $2 million, and the remainder can be used for letters of credit.
The loan was extended to January 29, 2007.
The BB&T Loan Agreement contains a variety of affirmative and negative
covenants of types customary in an asset-based lending facility, including those
relating to reporting requirements, maintenance of records, properties and
corporate existence, compliance with laws, incurrence of other indebtedness and
liens, restrictions on certain payments and transactions and extraordinary
corporate events. The BB&T Loan Agreement also contains financial covenants
relating to maintenance of levels of minimal tangible net worth, a debt to worth
ratio, and restricting the amount of capital expenditures. In addition, the BB&T
Loan Agreement provides that the following will constitute events of default
there under, subject to certain grace periods: (i) payment defaults; (ii)
failure to meet reporting requirements; (iii) breach of other obligations under
the BB&T Loan Agreement; (iv) default with respect to other material
indebtedness; (v) final judgment for a material amount not discharged or stayed;
and (vi) bankruptcy or insolvency. The Company was in compliance with all
financial covenants at September 30, 2006 except at Lynch Systems with regard to
the covenant to maintain tangible net worth at or above $4,450,000. On September
30, 2006, [Lynch System's] tangible net worth was $4,308,000. The Company has
received a waiver from BB&T for the non-compliance.
During 2005, the Company executed various amendments and extensions with one
of Lynch Systems' commercial lenders, SunTrust. As a result, certain required
repayments were made on amounts owed to SunTrust, and the expiring working
capital loan was not renewed. Additionally, it was agreed that the Company's
remaining obligation to SunTrust, a $378,000 term note would be payable on March
1, 2006. This amount was repaid in full in February 2006.
On September 30, 2005, Mtron/PTI entered into a Loan Agreement with RBC
Centura Bank ("RBC"). The Loan Agreement provides for a loan in the amount of
$3,040,000 ("RBC Term Loan"), the proceeds of which were used to pay off the
$3,000,000 bridge loan with First National Bank of Omaha ("FNBO") which had been
due October 2005. The RBC Term Loan bears interest at LIBOR Base Rate plus 2.75%
and is to be repaid in monthly installments based on a twenty year amortization,
with the then remaining principal balance to be paid on the fifth anniversary.
The RBC Term Loan is secured by a mortgage on PTI's premises. In connection with
this RBC Term Loan, Mtron/PTI entered into a five-year interest rate swap to
hedge the variable interest rate volatility. Under the terms of the interest
rate swap, the variable interest rate RBC Term Loan is essentially converted to
a 7.51% fixed rate loan. The Company has designated this swap as a cash flow
hedge in accordance with FASB 133 "Accounting for Derivative Instruments and
Hedging Activities". The fair value of the interest rate swap at September 30,
2006 is $20,000, or $13,500, net of related income taxes.
In connection with the completion of the acquisition of PTI, on October 14,
2004, Mtron and PTI had entered into a Loan Agreement with First National Bank
of Omaha. The Loan Agreement provided for loans in the amounts of $2,000,000
9
(the "Term Loan") and $3,000,000 (the "Bridge Loan"), in addition to the
$5,500,000 Revolving Line of Credit discussed above. The Term Loan bears
interest at the greater of prime rate plus 50 basis points, or 4.5%, and is to
be repaid in monthly installments of $37,514, with the then remaining principal
balance plus accrued interest to be paid on the third anniversary of the Loan
Agreement. The Bridge Loan was repaid in 2005 from proceeds received from the
RBC Term Loan, as discussed above. The Loan Agreement contains a variety of
affirmative and negative covenants of types customary in an asset-based lending
facility. The Loan Agreement also contains financial covenants relating to
maintenance of levels of minimal tangible net worth and working capital, and
current, leverage and fixed charge ratios, restricting the amount of capital
expenditures.
Lynch Systems and Mtron/PTI maintain their own short-term line of credit
facilities. 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 parent company. Lynch
Systems' credit facility includes an unsecured parent company guarantee.
The Company has guaranteed a letter of credit issued to the First National
Bank of Omaha ("FNBO") on behalf of its subsidiary, Mtron Industries, Inc. The
Letter of Credit is secured by a $650,000 restricted deposit at Bank of America
and is classified as restricted cash on the balance sheet. As of October, 16,
2006, the letter of credit is no longer in place and as of October 19, 2006, the
restriction on the $650,000 on deposit at Bank of America was lifted. In
addition, on October 3, 2006, Mtron/PTI entered into a third amendment to its
FNBO Loan Agreement to allow the Company to loan Mtron/PTI up to $3 million.
Mtron/PTI under this amendment would be allowed to invest the proceeds in
accordance with its business expansion needs. On October 3, 2006, Mtron/PTI
renewed its credit agreement with FNBO extending the due date for the revolving
credit facility to May 31, 2007.
H LONG-TERM CONTRACTS AND WARRANTY EXPENSE
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 or (iii) negotiated terms of sale. 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 September 30,
2006 unbilled accounts receivable was $586,000 and at December 31, 2005, it was
$902,000.
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 to 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.
(in thousands)
Balance, December 31, 2005 ................................... $ 357
Warranties issued during the period .......................... 168
Settlements made during the period ........................... (317)
-----
Balance, September 30, 2006 .................................. $ 208
=====
I. EARNINGS PER SHARE AND STOCKHOLDERS' EQUITY
The Company's basic and fully diluted earnings per share were equal as of
September 30, 2005, however the Company increased its fully diluted shares
outstanding, to account for the unvested portion of restricted stock referred to
below.
10
Prior to January 1, 2006, the Company accounted for their 2001 Equity
Incentive Plan ("the Plan") under the recognition and measurement principles of
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations. No stock-based employee compensation cost was reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
Company has provided pro forma disclosures of the compensation expense
determined under the fair value provisions of SFAS No.
123R, "Accounting for Stock-Based Compensation."
On May 26, 2005, the Company's shareholders approved amendments to the Plan
to increase the total number of shares of the Company's Common Stock available
for issuance from 300,000 to 600,000 shares and to add provisions that require
terms and conditions of awards to comply with section 409A of the Internal
Revenue Code of 1986. Also on May 26, 2005, the Company granted options to
purchase 120,000 shares of Company common stock to certain employees and
directors of the Company at $13.17 per share. These options were anti-dilutive
and expire on May 26, 2010. On December 10, 2001, the Company had granted
options to purchase 180,000 shares of Company common stock to a director of the
Company at $17.50 per share. As of September 30, 2006, options to purchase these
300,000 shares are outstanding and fully vested.
For purposes of pro forma disclosures under SFAS No. 123R, the estimated fair
value of the options is amortized to expense over the options' vesting period.
The Company's pro forma information follows:
Three Months Nine Months
Ended Ended
September 30, 2005
(in thousands, except per
Share amounts)
-------------------------
Net income as reported ............................................ $ 696 $ 2,097
Deduct: Total stock based employee compensation
expense determined under fair value based method for
all awards, net of related tax effect ............................ -- (222)
------- -------
Pro-forma net income .............................................. $ 696 $ 1,875
------- -------
Basic and fully diluted income per share:
As reported ....................................................... $ 0.43 $ 1.29
Pro forma ......................................................... $ 0.43 $ 1.15
On September 5, 2006, the Company issued 20,000 non-vested (restricted)
shares of stock to two senior executives. Fifty percent of these shares become
vested in September 2007 and the remainder, quarterly, December 2007, March,
July, and September 2008. The Company has recognized the compensation expense
and the potential increase in the number of shares outstanding in accordance
with the provisions of SFAS No. 123-R.
J. ACCUMULATED OTHER COMPREHENSIVE INCOME
Total comprehensive income was $952,000 and $2.5 million and in the three
months and nine months ended September 30, 2006, respectively, compared to total
comprehensive income of $684,000 and $2.4 million respectively, in the three and
nine month periods ended September 30, 2005.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2006 2005 2006 2005
------- ------- ------- --------
Net income as reported .............................. $ 903 $ 696 $ 1,768 $ 2,097
Foreign currency translation ........................ (33) (71) 3 (37)
Deferred gain on hedge contract ..................... (38) -- 14 --
Unrealized gain on available for sale
securities .................................... 120 59 752 292
------- ------- ------- -------
Total comprehensive income .......................... $ 952 $ 684 $ 2,537 $ 2,352
======= ======= ======= =======
11
The components of accumulated other comprehensive income, net of related tax,
at September 30, 2006, and December 31, 2005 are as follows:
9 Months 9 Months
Ended Ended
September 30, December 31, September 30,
2006 2005 2005
------------- ------------ -------------
Balance beginning of period ...................................... $ 835 $ 849 $ 849
Foreign currency translation ..................................... 3 75 (37)
Deferred gain (loss) on hedge contract ........................... 15 (1) --
Unrealized gain on available for-sale securities ................. 751 (88) 292
------- ------- -------
Accumulated other comprehensive income ........................... $ 1,604 $ 835 $ 1,104
======= ======= =======
K. SEGMENT INFORMATION
The Company has two reportable business segments: 1) glass manufacturing
equipment business, which represents the operations of Lynch Systems and 2)
frequency control devices (quartz crystals and oscillators) which represents
products manufactured and sold by Mtron/PTI. The Company's foreign operations in
Hong Kong and India are under the control of Mtron/PTI.
Operating profit (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. Such allocation was $125,000 in the three months ending
September 30, 2006 and 2005, respectively. Identifiable assets of each industry
segment are the assets used by the segment in its operations excluding general
corporate assets. General corporate assets are principally cash and cash
equivalents, short-term investments and certain other investments and
receivables.
12
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
2006 2005 2006 2005
-------- -------- -------- ---------
REVENUES
Glass manufacturing equipment - USA .................... $ 230 $ 394 $ 1,145 $ 1,460
Glass manufacturing equipment - Foreign ................ 1,766 1,358 5,766 8,567
-------- -------- -------- --------
Total Glass manufacturing equipment .................... 1,996 1,752 6,911 10,027
Frequency control devices - USA ........................ $ 5,622 $ 5,303 $ 15,493 $ 14,994
Frequency control devices - Foreign .................... 5,420 3,690 15,871 11,232
-------- -------- -------- --------
Total Frequency control devices ........................ 11,042 8,993 31,364 26,226
-------- -------- -------- --------
Consolidated total revenues ............................ $ 13,038 $ 10,745 $ 38,275 $ 36,253
======== ======== ======== ========
OPERATING PROFIT (LOSS)
Glass manufacturing equipment .......................... $ (311) $ (518) $ (922) $ 1,330
Frequency control devices .............................. 686 540 2,788 1,757
-------- -------- -------- --------
Total manufacturing .................................... 375 22 1,866 3,087
Unallocated Corporate expense .......................... (404) (538) (1,051) (1,375)
-------- -------- -------- --------
Consolidated total operating profit (loss) ............ $ (29) $ (516) $ 815 $ 1,712
======== ======== ======== ========
OTHER PROFIT (LOSS)
Investment income ...................................... $ 711 $ 583 $ 1,229 $ 600
Interest expense ....................................... (151) (217) (493) (610)
Other income (expense) ................................. (17) (12) (25) 68
-------- -------- -------- --------
Consolidated total profit before taxes.................. $ 514 $ (162) $ 1,526 $ 1,770
======== ======== ======== ========
CAPITAL EXPENDITURES
Glass manufacturing equipment .......................... $ 1 $ -- $ 15 $ 16
Frequency control devices .............................. 174 100 497 270
General Corporate ...................................... -- -- 1
-------- -------- -------- --------
Consolidated total capital expenditures................. $ 175 $ 100 $ 512 $ 287
-------- -------- -------- --------
TOTAL ASSETS
Glass manufacturing equipment .......................... $ 8,549 $ 9,176
Frequency control devices .............................. 22,196 16,688
General Corporate ...................................... 2,999 4,323
-------- --------
Consolidated total assets .............................. $ 33,744 $ 30,187
======== ========
13
For the significant three and nine months ended September 30, 2006 and
September 30, 2005, significant foreign revenues (10% or more of foreign sales
by segment) were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2006 2005 2006 2005
------ ------ ------ ------
GLASS MANUFACTURING EQUIPMENT - FOREIGN REVENUES
Brazil ..................................................... $1,172 $ 210 $2,865 $ 226
Democratic Republic of the Congo ........................... -- -- 385 385
China ...................................................... 296 765 805 5,191
Pakistan ................................................... -- -- 306 --
Indonesia .................................................. 33 81 142 1,082
All other foreign countries ................................ 265 302 1,263 1,683
------ ------ ------ ------
Total foreign revenues ................................ $1,766 $1,358 $5,766 $8,567
====== ====== ====== ======
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2006 2005 2006 2005
------ ------ ------- -------
FREQUENCY CONTROL DEVICES - FOREIGN REVENUES
China ...................................................... $ 1,175 $ 1,054 $ 3,241 $ 2,484
Malaysia ................................................... 1,187 595 2,525 1,927
Canada ..................................................... 967 731 3,117 2,435
Thailand ................................................... 494 289 1,678 608
Mexico ..................................................... 523 425 1,167 1,550
All other foreign countries ................................ 1,074 596 4,143 2,228
------- ------- ------- -------
Total foreign revenues ................................ $ 5,420 $ 3,690 $15,871 $11,232
======= ======= ======= =======
"All other foreign countries" include countries with less than 10% of total
foreign revenues for each segment
L. COMMITMENTS AND CONTINGENCIES
In the normal course of business, subsidiaries of the Company 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, the Company and/or one or more
of its subsidiaries were parties to the following additional legal proceedings.
QUI TAM LAWSUIT
The Company, Lynch Interactive and numerous other parties were named as
defendants in a lawsuit originally brought under the so-called "qui tam"
provisions of the federal False Claims Act in the United States District Court
for the District of Columbia. The main allegation in the case is that the
defendants participated in the creation of "sham" bidding entities that
allegedly defrauded the United States Treasury by improperly participating in
Federal Communications Commission ("FCC") spectrum auctions restricted to small
businesses, as well as obtaining "bidding credits" in other spectrum auctions
allocated to "small" and "very small" businesses. In May 2006, a tentative
settlement was reached pursuant to which the defendants agreed to pay the
government $130 million, plus approximately $8.7 million to relator's counsel as
legal fees and expenses. In June 2006, the defendants reached a tentative
agreement allocating the above-mentioned settlement amounts among themselves;
however, the Company did not have to make any payments under such allocations.
In July 2006, the definitive settlement agreements with the government and the
14
relator were signed and approved by the federal judge hearing the case, and the
case was dismissed with prejudice in August 2006. In entering into the
settlement agreements, the Company admitted no liability and the conduct giving
rise to the case is expressly excluded as a basis for any future administrative
proceedings by the FCC.
For a historical chronology of the case, please refer to the Company's prior
SEC filings.
M. INCOME TAXES
The Company files consolidated federal income tax returns, which includes all
U.S. subsidiaries. The Company has a $2,404,000 net operating loss ("NOL")
carry-forward as of December 31, 2005. This NOL expires through 2024 if not
utilized prior to that date. For the three and nine month period ended September
30, 2006 and 2005, the Company has reported a net income tax benefit. For these
periods, the net benefit is the result of foreign income tax provisions on the
Company's Hong Kong and India operations which were more than offset by the
reversal of income tax related reserves, in the third quarter of 2006 and 2005,
which were no longer warranted. The Company continues to utilize net operating
loss carry-forwards to offset federal income tax expense on the Company's
profitable U.S. operations."
N. GUARANTEES
The Company guarantees (unsecured) the BB&T loan of its subsidiary, Lynch
Systems. The Company had guaranteed an unsecured loan of Lynch Systems, which
loan was repaid in February 2006. At September 30, 2006, the Company had
guaranteed the FNBO loans of its subsidiary, Mtron, and had guaranteed a letter
of credit issued to FNBO which had been secured by a $650,000 restricted deposit
at Bank of America. (see Note G - "Notes Payable to Banks and Long-term Debt").
As of October, 16, 2006, the stand-by letter of credit is no longer in place and
as of October 19, 2006, the restriction on the $650,000 on deposit at Bank of
America was lifted.
There was no other financial, performance, indirect guarantees or
indemnification agreements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The Company has identified the accounting policies listed below that we
believe are most critical to our financial condition and results of operations,
and that require management's most difficult, subjective and complex judgments
in estimating the effect of inherent uncertainties. This section should be read
in conjunction with Note 1 to the Consolidated Financial Statements, included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2005,
which includes other significant accounting policies.
ACCOUNTS RECEIVABLE
Accounts receivable on a consolidated basis consists principally of amounts
due from both domestic and foreign customers. Credit is extended based on an
evaluation of the customer's financial condition and collateral is not generally
required except at Lynch Systems. 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. Certain subsidiaries and
business segments have credit sales to industries that are subject to cyclical
economic changes. The Company maintains an allowance for doubtful accounts at a
level that management believes is sufficient to cover potential credit losses.
We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our clients to make required payments. We base our
estimates on our historical collection experience, current trends, credit policy
and relationship of our accounts receivable and revenues. In determining these
estimates, we examine historical write-offs of our receivables and review each
15
client's account to identify any specific customer collection issues. If the
financial condition of our customers was to deteriorate, resulting in an
impairment of their ability to make payment, additional allowances may be
required. Our failure to estimate accurately the losses for doubtful accounts
and to ensure that payments are received on a timely basis could have a material
adverse effect on our business, financial condition, and results of operations.
INVENTORY VALUATION
Inventories are stated at the lower of cost or market value. Inventories
valued using the LIFO method comprised approximately 49.6% of consolidated
inventories at September 30, 2006 and 52.2% at December 31, 2005, respectively.
The balance of inventories is valued using the FIFO method. If actual market
conditions are more or less favorable than those projected by management,
including the demand for our products, changes in technology, internal labor
costs and the costs of materials, adjustments may be required.
REVENUE RECOGNITION AND ACCOUNTING FOR LONG-TERM CONTRACTS
Revenues, with the exception of certain long-term contracts discussed below,
are recognized upon shipment when title passes. Shipping costs are included in
manufacturing cost of sales.
Lynch Systems, a 100% 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; or (iii) negotiated terms of sale. 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 September 30,
2006, and December 31, 2005, unbilled accounts receivable were $586,000 and
$902,000, respectively.
The percentage of completion method is used since reasonably dependable
estimates of the revenues and costs applicable to various stages of a contract
can be made, based on historical experience and milestones set in the contract.
These estimates include current customer contract specifications, related
engineering requirements and the achievement of project milestones. Financial
management maintains contact with project managers to discuss the status of the
projects and, for fixed-price engagements, financial management is updated on
the budgeted costs and required resources to complete the project. These budgets
are then used to calculate revenue recognition and to estimate the anticipated
income or loss on the project. In the past, we have occasionally been required
to commit unanticipated additional resources to complete projects, which have
resulted in lower than anticipated profitability or losses on those contracts.
Favorable changes in estimates result in additional profit recognition, while
unfavorable changes in estimates result in the reversal of previously recognized
earnings to the extent of the error of the estimate. We may experience similar
situations in the future. Provisions for estimated losses on contracts are made
during the period in which such losses become probable and can be reasonably
estimated. To date, such losses have not been significant.
WARRANTY EXPENSE
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.
16
RESULTS OF OPERATIONS
THIRD QUARTER
THREE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2005
CONSOLIDATED REVENUES AND GROSS MARGIN
Consolidated revenues for the third quarter 2006 were $13.0 million, an
increase of $2.3 million or 21.5% over the revenues for the same quarter 2005.
The increase was caused primarily by improved sales of filters and resonators at
Mtron/PTI. Revenues at Mtron/PTI were $11.0 million for the third quarter 2006,
compared to $9.0 over the same quarter prior year. Revenues at Lynch Systems
were $2.0 million for the third quarter 2006, compared with $1.8 million for the
third quarter of 2005.
The consolidated gross margin as a percentage of revenues for the third
quarter decreased slightly to 26.6%, compared to 27.6% for the comparable period
in 2005. Mtron/PTI's gross margin as a percentage of revenues for the third
quarter decreased to 27.4% from 29.2% for the comparable period in 2005. Lynch
Systems' gross margin as a percentage of revenues for the third quarter declined
to 21.8%, from 24.7% for the comparable period in 2005, because of lower sales
of spare parts which earn higher margins.
OPERATING PROFIT (LOSS)
Consolidated operating loss decreased $487,000, to a $29,000 loss for the third
quarter 2006 from a $516,000 loss for the comparable period in 2005. Operating
profit at Mtron/PTI was $686, 000 for the third quarter 2006 compared to $540,
000 for the comparable period in 2005 primarily due to a 23% increase in
revenues. Operating loss at Lynch Systems was $311,000 for the third quarter
2006 as compared with a $518,000 loss for the comparable period in 2005 partly
due to lower overhead expenses and provisions taken in 2005 for doubtful
accounts. Corporate expenses were $404,000 for the third quarter 2006 as
compared with $538,000 for the comparable period in 2005, due to a non-recurring
reserve for a lawsuit settlement of $200,000 in September 2005.
OTHER INCOME (EXPENSE)
Investment income was $711,000 for the third quarter 2006 due to gains on
sales of marketable securities. This compares to $583,000 for the third quarter
of 2005. Interest expense for the third quarter 2006 was $151,000 versus
$217,000 in the comparable quarter of 2005 due to an overall reduction in debt.
INCOME TAXES
The Company files consolidated federal income tax returns, which includes all
U.S. subsidiaries. The income tax provision for the three and nine month period
ended September 30, 2006 included federal, state and foreign taxes. The income
tax benefit for the quarter was $389,000. The income tax benefit included a
non-recurring reduction to an income tax reserve of $504,000. The provision was
increased during the quarter by a $115,000 provision for foreign and state
income taxes relating to the quarter.
NET INCOME
Net income was $903,000 for the third quarter 2006, compared to $696,000 for
the comparable period in 2005. Fully diluted income per share for the third
quarter 2006 was $0.42 compared to $0.43 per share for the comparable period in
2005, due to an increase in the weighted average shares outstanding.
17
NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO SEPTEMBER 30, 2005
CONSOLIDATED REVENUES AND GROSS MARGIN
Consolidated revenues for the nine month period ending September 30, 2006
increased $2.0 million, or 5.6%, to $38.3 million from $36.3 million for the
comparable period in 2005. Revenues at Mtron/PTI increased by $5.2 million, or
19.6%, to $31.4 million for the nine month period ending September 30, 2006 from
$26.2 million for the comparable period in 2005. The increase was primarily due
to a strengthening of the foreign market. Revenues at Lynch Systems decreased by
$3.1 million, or 31.1%, to $6.9 million for the nine month period ending
September 30, 2006 from $10.0 million for the comparable period in 2005 due to a
reduction in sales of CRT machines.
The consolidated gross margin as a percentage of revenues for the nine month
period ending September 30, 2006 decreased to 29.1%, compared to 32.4% for the
comparable period in 2005. Mtron/PTI's gross margin as a percentage of revenues
for the nine month period ending September 30, 2006 increased to 30.3% from
29.4% reflecting a slightly improved sales mix. Lynch Systems' gross margin as a
percentage of revenues for the nine month period ending September 30, 2006
decreased to 23.3% from 40.4% for the comparable period in 2005, due to lower
CRT machine revenue and a decline in higher margin spare parts sales.
OPERATING PROFIT (LOSS)
Consolidated operating profit decreased $897,000, to $815,000 for the nine month
period ended September 30, 2006 from an operating profit of $1.7 million for the
comparable period in 2005. Operating profit at Mtron/PTI increased $1.0 million
to $2.8 million for the nine month period ended September 30, 2006 from $1.8
million for the comparable period in 2005 because of a 19.6% increase in sales.
Operating profit at Lynch Systems decreased $2.2 million to a loss of $922,000
for the nine month period ended September 30, 2006 from a $1.3 million profit
for the comparable period in 2005, due to a 31.1% decline in revenues. Corporate
expenses decreased $324,000 or 23.1% to $1.1 million for the nine month period
ending September 30, 2006 from $1.4 million for the comparable period in 2005.
The lower expenses at Corporate were primarily due to the absence of a lawsuit
settlement provision of $200,000 and lower audit and legal expenses.
OTHER INCOME (EXPENSE)
Investment income was $1.2 million for the nine month period ended September
30, 2006, up 104.8% from the comparable period in 2005 due to realized gain on
sales of marketable securities. Interest expense, net of interest income,
decreased $117,000 or 19.2% to $493,000 for the nine month period ended
September 30, 2006 from $610,000 for the comparable period in 2005 due to a
decrease in the total debt level and an increase in interest income at corporate
as a result of more cash in the bank.
INCOME TAXES
The Company files consolidated federal income tax returns, which includes all
U.S. subsidiaries. The income tax benefit for the nine month period ended
September 30, 2006 was $242,000. The income tax benefit included a non-recurring
reduction to an income tax reserve of $504,000. The provision was increased
during the period by a $262,000 provision for foreign and state taxes identified
during the period.
NET INCOME
Net income for the nine months ended September 30, 2006 was $1.8 million
compared to $2.1 million in the comparable period in 2005. Fully diluted income
per share for the nine month period ended September 30, 2006 was $0.82 per share
compared to $1.29 per share for the comparable period in 2005 due to lower net
income and the increase in the weighted average shares outstanding from 1.6
million to 2.2 million.
18
BACKLOG/ NEW ORDERS
Total backlog of manufactured products at September 30, 2006 was $13.7
million, $638,000 more than the backlog at September 30, 2005, which was $13.1
million. The September 30, 2006 back log is $152,000 less than the backlog at
December 31, 2005.
Mtron/PTI had backlog orders of $8.9 million at September 30, 2006, which was
unchanged from December 31, 2005 and a $688,000 increase from September 30,
2005. Lynch Systems has backlog orders of $4.8 million at September 30, 2006,
compared to $4.9 million at December 31, 2005 and at September 30, 2005.
FINANCIAL CONDITION
The Company's cash, cash equivalents and investments in marketable securities
at September 30, 2006 was $7.2 million as compared to $8.9 million at December
31, 2005 (including $650,000 of restricted cash in both periods). In addition,
the Company had borrowing capacity of $4.1 million under Lynch Systems' and
Mtron/PTI's revolving lines of credit at September 30, 2006, as compared to $5.3
million at December 31, 2005.
At September 30, 2006, the Company's net working capital was $14.3 million as
compared to $12.0 million at December 31, 2005. At September 30, 2006, the
Company had current assets of $26.4 million and current liabilities of $12.1
million. At December 31, 2005, the Company had current assets of $24.9 million
and current liabilities of $12.9 million. The ratio of current assets to current
liabilities was 2.18 to 1.00 at September 30, 2006, compared to 1.93 to 1.00 at
December 31, 2005. The increase in net working capital was primarily due to
realized and unrealized gains on marketable securities.
Cash used in operating activities was $2.4 million for the nine months ended
September 30, 2006, compared to cash provided by operating activities of $2.9
million for the nine months ended September 30, 2005. The year to year
unfavorable change in operating cash flow of $5.3 million was primarily due to
payments relating to a litigation settlement in the first quarter 2006 and
increases in receivables and inventories. The Company and United Steel workers
of America Local 1069, formerly known as PACE Local 1-1069 reached a settlement
of their severance pay litigation, which arose out of the July 2001 closure of
the Spinnaker-Maine manufacturing plant in Westbrook, Maine. The settlement
includes payment of a total of $800,000 to resolve the claims of 67 workers who
lost their jobs in 2001. Capital expenditures were $512,000 in the nine months
ended September 30, 2006, compared to $287,000 for the comparable period in
2005.
At September 30, 2006, the Company had $3.4 million in notes payable to First
National Bank of Omaha and BB&T. The FNBO Note is a revolving credit facility
note borrowed by Mtron/PTI for $1.5 million due in May, 2007. The BB&T Note is a
Lynch Systems working capital revolver for $1.9 million which is due in January
2007. The Company intends to renew these facilities with the existing banks,
however, there can be no assurances the existing facilities will continue to be
renewed. At September 30, 2006, the Company also had $879,000 in current
maturities of long-term debt. The Company believes that existing cash and cash
equivalents, cash generated from operations and available borrowings under its
subsidiaries' lines of credit, including the proposed renewals, will be
sufficient to meet its ongoing working capital and capital expenditure
requirements for the foreseeable future.
At September 30, 2006, total debt of $8.7 million was $379,000 less than the
total debt at December 31, 2005 of $9.1 million. The debt decreased at both
Mtron/PTI and Lynch Systems due to repayments of revolving debt, repayment of
the SunTrust term loan, and scheduled payments on long-term debt.
The Company is in compliance with all financial covenants at September 30,
2006 except with regard to the covenant to maintain tangible net worth at or
above $4,450,000. On September 30, 2006 the Company's tangible net worth was
$4,308,000. A waiver was received from BB&T.
19
In connection with the completion of the acquisition of PTI, on October 14,
2004, Mtron and PTI, each wholly-owned subsidiaries of the Company, entered into
a Loan Agreement with FNBO. The Loan Agreement provided for loans in the amounts
of $2,000,000 (the "Term Loan") and $3,000,000 (the "Bridge Loan"), together
with a $5,500,000 Revolving Line of Credit (the "Revolving Loan"). The Term Loan
bears interest at the greater of prime rate plus 50 basis points, or 4.5%, and
is to be repaid in monthly installments of $37,514, with the then remaining
principal balance plus accrued interest to be paid on the third anniversary of
the Loan Agreement. The Bridge Loan was repaid in 2005 from proceeds received
from the RBC Term Loan. The Revolving Loan was renewed on June 30, 2005 as
previously discussed. The Loan Agreement contains a variety of affirmative and
negative covenants of types customary in an asset-based lending facility. The
Loan Agreement also contains financial covenants relating to maintenance of
levels of minimal tangible net worth and working capital, and current, leverage
and fixed charge ratios, restricting the amount of capital expenditures.
The Company has guaranteed a letter of credit issued to the First National
Bank of Omaha on behalf of its subsidiary, Mtron as collateral for its Mtron's
loans. As of September 30, 2006, the $650,000 letter of credit issued by Bank of
America to The First National Bank of Omaha was secured by a $650,000 deposit at
Bank of America. As of October 16, 2006, the stand-by letter of credit is no
longer in place and, as of October 19, 2006, the restriction on the $650,000 on
deposit at Bank of America was lifted.
As of September 30, 2006, the Company has a total of $2,500,000 of
subordinated promissory notes issued from Mtron/PTI.
At September 30, 2006, Mtron/PTI's short-term credit facility provides for a
line of credit in the maximum principal amount of $5.5 million of which $4.0
million was available under the line of credit. On October 3, 2006, Mtron/PTI
renewed its credit agreement with FNBO extending the due date for the revolving
credit facility to May 31, 2007. On October 3, 2006, Mtron/PTI renewed its
credit agreement with FNBO extending the due date for the revolving credit
facility to May 31, 2007. In addition, on October 3, 2006, Mtron/PTI entered
into a third amendment to its FNBO Loan Agreement to allow the Company to loan
Mtron/PTI up to $3 million Mtron/PTI under this amendment would be allowed to
invest the proceeds in accordance with its business expansion needs
Effective October 6, 2005, Lynch Systems entered into a variable interest
rate revolving loan agreement with BB&T, providing for a line of credit in the
maximum principal amount of $3.5 million. At September 30, 2006, there were no
outstanding Letters of Credit and $1.6 million was unused and available under
the line of credit. This line of credit replaced the working capital revolving
loan that Lynch Systems had with SunTrust Bank, which expired by its terms on
September 30, 2005. Borrowings under the loan agreement bear interest at the
one month LIBOR Rate plus 2.75% and accrued interest is payable on a monthly
basis, with the principal balance due to be paid on the first anniversary of the
loan agreement. On October 14, 2006 the permitted borrowing capacity under this
Line of Credit was reduced to $2 million, and the remainder can be used for
letters of credit. The loan was extended to January 29, 2007.
During 2005, the Company executed various amendments and extensions with one
of Lynch Systems' commercial lenders, SunTrust. As a result, certain required
repayments were made on amounts owed to SunTrust, and the expiring working
capital loan was not renewed. Additionally it was agreed that the Company's
remaining obligation to SunTrust, a $378,000 term note would be payable on March
1, 2006. This amount was repaid in full in February 2006.
On September 30, 2005, Mtron/PTI entered into a Loan Agreement with RBC
Centura Bank ("RBC"). The Loan Agreement provides for a loan in the amount of
$3,040,000 (the "RBC Term Loan"), the proceeds of which were used to pay off the
$3,000,000 bridge loan with First National Bank of Omaha which had been due
October 2005. The RBC Term Loan bears interest at LIBOR Base Rate plus 2.75% and
is to be repaid in monthly installments based on a twenty year amortization,
with the then remaining principal balance to be paid on the fifth anniversary.
The RBC Term Loan is secured by a mortgage on PTI's premises. In connection with
this RBC Term Loan, Mtron/PTI entered into a five-year interest rate swap to
20
hedge the variable interest rate volatility. Under the terms of the interest
rate swap, the variable interest rate RBC Term Loan will be essentially
converted to a 7.51% fixed rate loan. The Company has designated this swap as a
cash flow hedge in accordance with FASB 133 "Accounting for Derivative
Instruments and Hedging Activities". The fair value of the interest rate swap at
September 30, 2006 is $20,000, which is included in "Other Current Assets" or
$13,500, net of related income taxes, which is included in "Other Comprehensive
Income."
The BB&T Loan Agreement contains a variety of affirmative and negative
covenants of types customary in an asset-based lending facility, including those
relating to reporting requirements, maintenance of records, properties and
corporate existence, compliance with laws, incurrence of other indebtedness and
liens, restrictions on certain payments and transactions and extraordinary
corporate events. The BB&T Loan Agreement also contains financial covenants
relating to maintenance of levels of minimal tangible net worth, a debt to worth
ratio, and restricting the amount of capital expenditures. In addition, the BB&T
Loan Agreement provides that the following will constitute events of default
thereunder, subject to certain grace periods: (i) payment defaults; (ii) failure
to meet reporting requirements; (iii) breach of other obligations under the BB&T
Loan Agreement; (iv) default with respect to other material indebtedness; (v)
final judgment for a material amount not discharged or stayed; and (vi)
bankruptcy or insolvency.
The Board of Directors has adopted a policy of not paying cash dividends, a
policy which is reviewed annually. This policy takes into account the long-term
growth objectives of the Company, especially in its acquisition program,
shareholders' desire for capital appreciation of their holdings and the current
tax law disincentives for corporate dividend distributions. Accordingly, no cash
dividends have been paid since January 30, 1989 and none are expected to be paid
in 2006. (See Note G to the Condensed Consolidated Financial Statements - "Notes
Payable to Banks and Long-term Debts" - for restrictions on the company's
assets).
ACCOUNTING PRONOUNCEMENTS
On January 1, 2006 the Company adopted SFAS No. 123-R, "Share-Based
Payments." SFAS No. 123-R impacts the Company's accounting for its stock option
plan. Because all of the Company's stock options were fully vested at December
31, 2005 and there were no new options issued in the first three quarters of
2006, there was no impact on the Company's 2006 financial statements from the
adoption of this standard. On September 5, 2006, the Company issued 20,000
non-vested (restricted) shares of stock to two senior executives. Fifty percent
of these shares become vested in September 2007 and the remainder, quarterly, in
December 2007, March, July, and September 2008. The Company has recognized the
compensation expense and the potential increase in the number of shares
outstanding in accordance with the provisions of SFAS No. 123-R
In July 2006, the FASB issued Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes - An interpretation of FASB Statement No. 109" ("FIN
48"). This Interpretation provides a comprehensive model for the financial
statement recognition, measurement, presentation and disclosure of uncertain tax
positions taken or expected to be taken in income tax returns. The Company will
adopt this Interpretation in the first quarter of 2007. The cumulative effects,
if any, of applying FIN 48 will be recorded as an adjustment to retained
earnings. The Company is currently assessing the impact of this Interpretation
on its financial position and results of operations.
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In September 2006, the FASB issued SFAS No. 157 "Fair Value Measurements."
This Statement replaces multiple existing definitions of fair value with a
single definition, establishes a consistent framework for measuring fair value,
and expands financial statement disclosures regarding fair value measurements.
This Statement applies only to fair value measurements that are already required
or permitted by other accounting standards and does not require any new fair
value measurements. SFAS 157 is effective for fiscal years beginning subsequent
to November 15, 2007. The Company will adopt this Statement in the first quarter
of 2008, and is currently evaluating the impact on its financial position and
results of operations.
OFF-BALANCE SHEET ARRANGEMENT
Aside from the Company's stand-by Letter of Credit in the amount of $650,000,
which is no longer in place as of October 16, 2006, the Company does not have
any off-balance sheet arrangements.
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". 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, whose
internet address is WWW.LGLGROUP.COM.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT 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 and cash equivalents and restricted cash
(approximately $4.6 million at September 30, 2006). The Company generally
finances the debt portion of the acquisition of long-term assets with fixed and
variable rate, long-term debt. 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 December 31,
2005.
As the Company's international sales are in U.S. Dollars, there is no
associated monetary risk.
At September 30, 2006, $8,032,000 of the Company's debt bears interest at
variable rates. Accordingly, the Company's earnings and cash flows are affected
by changes in interest rates. In October 2005, in connection with the RBC Term
Loan, Mtron/PTI entered into a five-year interest rate swap from which it will
receive periodic payments at the LIBOR Base Rate and make periodic payments at a
fixed rate of 7.51% with monthly settlement and rate reset dates, effectively
reducing the variable rate debt exposed to interest rate fluctuations to
$5,051,000.
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ITEM 4. CONTROLS AND PROCEDURES
The principal executive officer and principal financial officer have
concluded that the Company's disclosure controls and procedures were effective
as of the end of the period covered by this report based on the evaluation of
these controls and procedures required by Exchange Act Rule 13a-15.
There has been no changes in the Registrant's internal control over financial
reporting that occurred during the Registrant's last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Registrant's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1A. 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.
For a complete list of risk factors, see the Company's Annual Report, as
amended, on Form 10-K/A for the year ended December 31, 2005 filed with the
Securities and Exchange Commission on May 18, 2006.
ITEM 6. EXHIBITS
Exhibits filed herewith:
31.1* Certification by Principal Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2* Certification by Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32* Certification by Principal Executive Officer and Principal Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The LGL Group, Inc.
(Registrant)
November 14, 2006 By: /s/ Jeremiah M. Healy
--------------------------------
Jeremiah M. Healy
Principal Financial Officer
EXHIBIT INDEX
Exhibit
No. Description
-------- -----------
31.1* Certification by Principal Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2* Certification by Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32* Certification by Principal Executive Officer and Principal Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* filed herewith
The Exhibits listed above have been filed separately with the Securities and
Exchange Commission in conjunction with this Quarterly Report on Form 10-Q or
have been incorporated by reference into this Quarterly Report on Form 10-Q.
Upon request, the Company. will furnish to each of its shareholders a copy of
any such Exhibit. Requests should be addressed to the Office of the Secretary,
The LGL Group, Inc., 140 Greenwich Avenue, 4th Floor, Greenwich CT 06830.
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