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| FEP > SEC Filings for FEP > Form 10-Q on 12-Nov-2008 | All Recent SEC Filings |
12-Nov-2008
Quarterly Report
This 2008 Quarterly Report on Form 10-Q may contain statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended. Those statements include statements regarding the intent and belief or current expectations of Franklin and its management team. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, among other things, the affects of the deepening economic slow-down both in the United States and Europe, the timely availability and acceptance of new electronic books and other electronic products, changes in technology, the successful integration of acquisitions, the impact of competitive electronic products, the management of inventories, dependence on key licenses, titles and products, dependence on sales to a small group of customers, dependence on third party component suppliers and manufacturers, including those that provide Franklin-specific parts, credit risk and other risks and uncertainties that may be detailed herein, and from time-to-time, in Franklin's reports filed with the Securities and Exchange Commission. Franklin undertakes no obligation to publicly update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
RESULTS OF OPERATIONS
Overview
For the quarter ended September 30, 2008, net income decreased by $3,013 to a loss of $231 from income of $2,782 in the same period last year. In the prior year period we executed an agreement with Seiko Instruments, Inc. ("SII") under which SII made a one time payment to the Company of $3,000 on July 31, 2007 in consideration for the elimination of minimum purchase commitments of both parties in the agreements under which SII distributes our products in Japan and we distribute SII's products in the United States and Germany. The $3,000 was recorded as other revenue in the quarter ended September 2007 and resulted in a contribution of $2,400 to net income after deducting approximately $600 in related costs which are reflected in the prior year's operating expenses. Sales decreased by $2,546 primarily from North American business operations. Gross margin dollars, excluding the SII payment in the prior year period, decreased by $1,094 primarily from lower sales in our North American business operation partially offset by a decrease in operating expense, excluding the approximately $600 SII related expenses, of $374.
For the six months ended September 30, 2008, net income decreased by $4,246 to a loss of $1,394 from income of $2,852 in the same period last year. The decrease is primarily due to lower sales of $4,228 which resulted in decreased gross margin dollars of $2,049, excluding the SII payment, partially offset by decreased operating expense of $448, excluding the approximately $600 in related SII expenses. Operating expense for the six months ended September 30, 2008 included one time charges totaling $718 relating to separation pay from our cost cutting initiative of $348 and an investment loss of $370 resulting from the liquidation by its sponsor of a short-term fixed income fund. In the prior year period we recorded other revenue of $3,000 from the SII agreement reduced by approximately $600 in related costs.
Sales of monolingual products in our North American business operation have been trending downward over the past several years primarily due to indirect competition from the internet, providing consumers with alternative solutions (often free) for their spell correction and reference needs. The downward trend has been partially offset by growth in our bilingual products in the North American market. In addition, the current turmoil in the financial markets has had a negative impact on consumer spending which in turn contributed to our shortfall in sales for the three months ended September 30, 2008. Despite these pressures we continued to maintain strong margins consistent with the second quarter of 2007 and have benefited from our efforts to become more cost effective
by the reduction in operating expenses of 13% quarter on quarter. We share the global view of the near term future and do not believe that this negative environment will change for the better during our current third quarter. While we expect our sales decline to continue during our third quarter, we also expect to continue to benefit from expense reductions, strong gross margins and the introduction of our new multimedia language learning devices in the German speaking markets.
Three months ended September 30, 2008 compared with three months ended September 30, 2007:
Net Sales
Sales of $12,434 for the quarter ended September 30, 2008 decreased by $2,546 from sales of $14,980 for the same quarter last year. The decrease in sales was primarily in our North American business operations where sales decreased by $2,345 due to the slowdown in consumer spending from the declining economic situation, the absence of purchases by a significant customer in the current quarter and a voluntary reduction of shipments to another significant customer due to credit issues and the unavailability of credit insurance with respect to such customer. Sales in our European business operations decreased by $348 primarily as a result of lower sales in our UK division of $233.
Gross Margin
Gross margin dollars decreased by $4,094 from $10,069 to $5,975 primarily due to the $3,000 of other revenue from the SII agreement in the prior year period. Gross margin percentage, excluding the $3,000, increased by one percentage point from 47% to 48% resulting in additional margin dollars of $107 for the quarter.
Operating Expenses
Total operating expenses decreased by $974 to $6,244 in the current quarter from $7,218 in the same period last year. Sales and marketing expenses decreased by $84 to $3,901 (31% of sales) from $3,985 (27% of sales) primarily due to decreased variable commissions and freight costs of $133 and personnel costs of $128 partially offset by increased marketing and advertising of $40, consulting fees of $97 and recruiting fees of $28. Research and development expenses decreased by $193 to $765 (6% of sales) from $958 (6% of sales) last year primarily due to reduced outside engineering and personnel costs of $109 and $105 respectively, partially offset by increased travel expenses of $14. General and administrative expenses decreased by $697 to $1,578 (13% of sales) from $2,275 (15% of sales) last year primarily due to approximately $600 of additional expenses related to the SII settlement agreement including an increase in incentive compensation accruals and associated legal and travel expenses in the prior year period. In the current quarter consulting fees decreased by $112 compared to the prior year quarter primarily relating to MIS and acquisition activities.
Interest Income, net
In the current period, there was net interest income of $16 compared with $15 in the prior year period.
Other, net
Other, net was a gain of $44 for the quarter ended September 30, 2008 compared with a loss of $28 in the same period last year. We recorded gains on our program of selling euros at current rates for future settlement of $110 compared with a loss of $172 in the same quarter last year. We recorded a loss of $51 on the repatriation of funds from our foreign subsidiaries in the quarter ended September 30, 2008, compared with a gain of $63 in the same period last year.
Net Income
For the quarter ended September 30, 2008, net income decreased by $3,013 to a loss of $231 from a gain of $2,782 in the same period last year. The decrease is primarily due to the SII revenue of $3,000 which contributed $2,400 of net income after deducting approximately $600 in related costs in the prior year period. Sales decreased by $2,546 resulting in a decrease in gross margin dollars, excluding the SII payment, of $1,094 primarily from the North American business operations partially offset by a decrease in operating expense of $374, excluding the approximately $600 SII relating expenses.
We have operations in a number of foreign countries and record sales and incur expenses in various foreign currencies. As the values of these currencies fluctuate from year to year against the US dollar, our revenues, operating expenses and results of operations are impacted. For the quarter ended September 30, 2008, approximately 35% of our sales were denominated in currencies other than the US dollar. For the quarter ended September 30, 2008, our sales and gross margin benefited by approximately $304 and $294 respectively from the year over year change in exchange rates for the various currencies (primarily the euro) in which we operate, while our operating expenses increased by approximately $139 due to the fluctuations in exchange rates. The net effect of the year over year fluctuations in exchange rates on our results of operations for the quarter ended September 30, 2008 was an increase in net income of approximately $155.
Six months ended September 30, 2008 compared with six months ended September 30, 2007:
Net Sales
Sales of $24,427 for the six months ended September 30, 2008 sales decreased by $4,228 from sales of $28,655 for the same period in the prior year primarily due to decreased sales in our North American business operations. The decrease in our North American business operations of $3,875 was due to the slowdown in consumer spending from the declining economic situation, the absence of purchases by a significant customer in the current quarter and a voluntary reduction of shipments to another significant customer due to credit issues and the unavailability of credit insurance with respect to such customer. Sales in our European operations declined by $406 primarily due to a promotional sale to a customer in the prior year period that did not purchase in the current year partially offset by increased sales in the Benelux region due to increased distribution.
Gross Margin
Gross margin decreased by $5,027 due to the revenue of $3,000 from SII received in the prior year and lower sales of $4,228. The sales decrease accounted for $2,049 of the lower gross margin dollars partially offset by a $22 gain from a marginal increase in gross margin percentage.
Operating Expenses
Total operating expenses decreased to $12,815 in the six months ended September 30, 2008 from $13,863 in the same period last year. Sales and marketing expenses decreased by $572 to $7,460 (31% of sales) from $8,032 (28% of sales) primarily due to decreased variable marketing, advertising commissions and freight costs of $533, shows and exhibition costs of $102 and personnel costs of $112 partially offset by increased consulting fees of $174. Research and development expenses decreased by $136 to $1,745 (7% of sales) from $1,881 (7% of sales) last year primarily due to reduced personnel costs of $152 partially offset by increased samples cost of $13. General and administrative expenses decreased by $688 to $3,262 (13% of sales) from $3,950 (14% of sales) last year primarily due to approximately $600 of additional expenses related to the SII settlement agreement including an increase in incentive compensation accruals and associated legal and travel expenses in the prior year period. In the current year legal fees increased by $195 compared to the prior year partially offset by a reduction in inventory overhead allocation, bank, depreciation and temporary labor expense of $89, $75, $46 and $45, respectively.
In May 2008, we eliminated 10 percent of our U.S. workforce to reduce our operating expenses. These workforce reductions transitioned some U.S. based positions to our Hong Kong facility and outsourced certain others in order to increase efficiencies and bottom line profitability. The six months to September 30, 2008 reflects a charge of $348 to cover the associated separation expenses.
Interest Income, net
For the six month ended September 30, 2008 we had net interest income of $22 compared with $59 in the same period last year, primarily due to reduced return on investments.
Loss on Investment
The current year expense was the result of an investment loss of $370 resulting from the liquidation by its sponsor of a short-term fixed income fund.
Other, net
Other, net was a gain of $3 for the six months ended September 30, 2008 compared with a loss of $146 in the same period last year. For the six months ended September 30, 2008 we recorded a gain on our program of selling euros at current rates for future settlement of $112 compared with a loss of $236 in the same period last year. We recorded a loss of $95 on the repatriation of funds from our foreign subsidiaries in the six months ended September 30, 2008, compared with a gain of $10 in the same period last year.
Net Income
For the six months ended September 30, 2008, net income decreased by $4,246 to a loss of $1,394 from a gain of $2,852 in the same period last year. The decrease is primarily due to the prior year period SII revenue of $3,000 which resulted a contribution to net income of $2,400 after deducting approximately $600 of related costs. Sales decreased by $4,228 primarily from North American business operations. Excluding the SII payment, gross margin decreased by $2,027 with lower sales accounting for a decrease of $2,049 partially offset by a $22 gain from a marginal increase in gross margin percentage.
We have operations in a number of foreign countries and record sales and incur expenses in various foreign currencies. As the values of these currencies fluctuate from year to year against the US dollar, our revenues, operating expenses and results of operations are impacted. For the six months ended September 30, 2008, approximately 35% of our sales were denominated in currencies other than the US dollar. For the six months ended September 30, 2008, our sales and gross margin benefited by approximately $848 and $828 respectively from the year over year change in exchange rates for the various currencies (primarily the euro) in which we operate, while our operating expense increased by approximately $363 due to the fluctuations in exchange rates. The net effect of the year over year fluctuations in exchange rates on our results of operations for the six months ended September 30, 2008 was an increase in income of approximately $465.
We enter into forward foreign exchange contracts from time to time to offset the impact of changes in the value of the euro on our revenue, operating expense and net income and to protect the cash flow from our existing assets valued in foreign currency. Although economic gains or losses on these contracts are generally offset by the gains or losses on underlying transactions, we seek to minimize our foreign currency exposure on a macro basis rather than at the transactional level. We only enter into contracts with major financial institutions that have an "A" (or equivalent) credit rating. All outstanding foreign exchange contracts are marked-to market at the end of each accounting period with unrealized gains and losses included in results of operations.
As of September 30, 2008 we had no outstanding foreign exchange contracts.
As of September 30, 2007 we had two outstanding foreign exchange contracts in the amount of 1,500 and 1,000 euros, respectively (equivalent at that date to total US dollars of $3,443) with a combined unrealized loss of $121 and expiration dates of January 2008 and November 2007, respectively. The unrealized loss was included in results of operations under the Other, net caption with the offsetting balance included in the Accounts Payable and Accrued Expenses caption of our balance sheet.
Changes in Financial Condition
Accounts receivable increased by $2,208 to $8,308 at September 30, 2008 from $6,100 at March 31, 2008 primarily because of a seasonal increase in sales of $1,051 during the September 2008 quarter compared to the March 2008 quarter. Inventory increased by $1,482 to $10,744 on September 30, 2008 from $9,262 on March 31, 2008 due to normal seasonal increases as we build inventory for the holiday selling season. Accounts payable and accrued expenses decreased by $102.
Liquidity and Capital Resources
We had cash and cash equivalents of $8,266 at September 30, 2008 compared with cash and cash equivalents of $11,824 as of March 31, 2008. The decrease was due primarily to seasonal cash requirements to build inventory for the holiday season.
On May 19, 2008, we entered into an amendment (the "Amendment") to the Revolving Credit and Security Agreement (the "Credit Agreement") with PNC Bank, National Association ("PNC") dated December 7, 2004, as amended by a First Amendment to Revolving Credit and Security Agreement dated December 29, 2005, an Amendment to Loan Documents dated December 22, 2006, an Amendment to Loan Documents dated March 30, 2007, an Amendment to Loan Documents dated as of December 7, 2007, Letter of Extension dated March 4, 2008 and Letter of Extension dated May 6, 2008.
The Amendment modifies the Credit Agreement with PNC by providing for a $20,000 revolving credit facility with sublimits of $1,000 for Letters of Credit, $500 for foreign currency borrowings and $10,000 for acquisitions by the Company (the "Loans"). Loans under the Credit Agreement are secured by all of the assets of the Company. The term of the Credit Agreement has been amended to December 7, 2010 (the "Term"). At the Company's option, Loans under the Credit Agreement will be either Domestic Rate Loans based on PNC's Base Rate with the interest rate varying from the PNC Base Rate minus 50 basis points to the PNC Base Rate plus 50 basis points or LIBOR Rate Loans with the interest rate varying from LIBOR plus 100 basis points to LIBOR plus 225 basis points in each case depending upon the ratio of the Company's Funded Debt to EBITDA and the composition of collateral provided. The Loans under the Credit Agreement are payable in full on the last day of the Term.
The Credit Agreement contains certain financial covenants and restrictions on indebtedness, business combinations and other related items. We were in compliance with all covenants of the amended Credit Agreement as of September 30, 2008. As of September 30, 2008, we had no borrowings under the Credit Agreement.
We rely primarily on our operating cash flow to support our operations. Over the last three fiscal years we generated cash flow from operations of $9,696. This operating cash flow is supplemented by our Credit Agreement to meet seasonal financing needs. We believe our cash flow from operations, available borrowing under our Credit Agreement and existing cash and short-term investment balances will be adequate to satisfy our cash needs for the next twelve months. The amount of credit available under the facility at any time is based upon a formula applied to our accounts receivable and inventory. As of September 30, 2008, we had credit available of $10,644. Our credit availability and borrowings under the facility fluctuate during the year because of the seasonal nature of our business. During the year ended March 31, 2008, maximum availability and borrowings under our Credit Agreement approximated $12,635 and $1,000, respectively. We do not have any significant capital leases and anticipate that depreciation and amortization for fiscal 2009 will exceed planned capital expenditures.
Seasonality
The "back to school" season (August to mid-September) and Christmas selling season (October, November and December) are the strongest selling periods at retail for our products.
Future Income Tax Benefits
We have income tax benefits of $16,900 which can be utilized against future earnings and have provided an income tax valuation allowance of $11,200 against these tax assets. The remaining $5,700 balance is based upon our estimate of taxes that would be due and offset against our net operating loss carried forward, based upon our estimate of future earnings.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an ongoing basis, we evaluate these estimates and judgments based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We annually review our financial reporting and disclosure practices and accounting policies to ensure that our financial reporting and disclosures provide accurate and transparent information relative to the current economic and business environment. There have been no changes in critical accounting policies and estimates enumerated in our Annual Report on Form 10-K for the year ended March 31, 2008.
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