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| FEP > SEC Filings for FEP > Form 10-Q on 5-Feb-2009 | All Recent SEC Filings |
5-Feb-2009
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. 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 dependence on a small number of manufacturers for purchases of inventory, 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, 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 December 31, 2008, net income decreased by $8 to income of $733 from income of $741 in the same period last year. Sales decreased by $3,509 due to a slow down in consumer spending from the declining worldwide economic situation that affected sales in all of our global retail markets. Gross margin dollars decreased by $1,370 primarily from lower sales across all of our business operations and a stronger US dollar, partially offset by a decrease in operating expense of $1,127.
For the nine months ended December 31, 2008, net income decreased by $4,255 to a loss of $663 from income of $3,592 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 $7,736, which resulted in decreased gross margin dollars of $3,397, excluding the SII payment, partially offset by decreased operating expense of $1,577, excluding the approximately $600 in related SII expenses in the prior year period. Operating expense for the nine months ended December 31, 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 nine months ended December 31, 2008. Despite these pressures we improved our gross margin by 3% compared with the third quarter of 2007 and have
benefited from our efforts to become more cost effective by the reduction in operating expenses of 15% 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 fourth quarter. While we expect our sales decline to continue during our fourth quarter, we also expect to continue to benefit from expense reductions and strong gross margins.
Three months ended December 31, 2008 compared with three months ended December 31, 2007:
Net Sales
Sales of $13,535 for the quarter ended December 31, 2008 decreased by $3,509 from sales of $17,044 for the same quarter last year. The decrease was primarily due to lower sales in the retail markets across all of our regional segments as a result of the worldwide economic crisis and its impact on consumer spending during the holiday season. Sales in our North American business operations, our largest retail market, declined by $2,029 or 24%. Sales in our European business operations decreased by $1,427 or 22% with $973 as a result of lower sales and $454 as a result of exchange rates differences. Sales in our Proximity Technology Division ("Proximity") increased by $311 or 126% primarily due to the renewal of a technology licensing agreement.
Gross Margin
Gross margin dollars decreased by $1,370 to $7,154 in the current quarter from $8,524 in the prior year period. Gross margin percentage increased by three percentage points from 50% to 53% resulting in additional margin dollars of $385 for the quarter. The gross margin percentage increase was due to an increased gross margin dollar contribution from our Proximity division primarily relating to the renewal of a technology license agreement. All other business operations maintained strong margins consistent with the third quarter of 2007.
Operating Expenses
Total operating expenses decreased by $1,127 to $6,422 in the current quarter from $7,549 in the same period last year. Sales and marketing expenses decreased by $1,009 to $3,892 (29% of sales) from $4,901 (29% of sales) primarily due to decreased variable commissions and freight costs of $256, personnel costs of $200, and marketing and advertising expenses of $436. Other reductions in sales and marketing expenses include dealer chargebacks, press releases, shows and exhibits, and consulting of $39, $35, $24, and $16, respectively. Research and development expenses increased by $12 to $775 (6% of sales) from $763 (4% of sales) last year primarily due to increased outside engineering and consulting costs of $135, partially offset by decreased personnel costs of $107. General and administrative expenses decreased by $130 to $1,755 (13% of sales) from $1,885 (11% of sales) last year primarily due to decreased consulting costs, personnel costs, depreciation, and travel costs of $136, $102, $40 and $36, respectively. These decreases were partially offset by increased doubtful account expense of $78 and a reduction in inventory overhead allocation of $136.
Interest Income, net
For the quarter ended December 31, 2008, there was net interest income of $7 compared with $20 in the prior year period primarily due to lower interest income on investments.
Other, net
Other, net was a loss of $16 for the quarter ended December 31, 2008 compared with a gain of $4 in the same period last year. We recorded a loss on our program of selling euros at current rates for future settlement of $92 compared with a loss of $83 in the same quarter last year. We recorded a gain of $84
on the repatriation of funds from our foreign subsidiaries in the quarter ended December 31, 2008, compared with a gain of $88 in the same period last year.
Income Tax Provision
The Company's benefit for income taxes was approximately $10 for the quarter ended December 31, 2008, compared to an income tax expense of $258 for the comparable period last year, a reduction of $268 quarter on quarter. The reduction was primarily due to a Federal refund of the Alternative Minimum Tax on the Company's U.S. operations partially offset by lower income generated during the quarter ended December 31, 2008 by the Company's international operation.
Net Income
For the quarter ended December 31, 2008, net income decreased marginally by $8 to a gain of $733 from a gain of $741 in the same period last year. The decrease is due to lower sales of $3,509 resulting in a decrease in gross margin dollars of $1,370 partially offset by a decrease in operating expense of $1,127.
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 December 31, 2008, approximately 46% of our sales were denominated in currencies other than the US dollar. For the quarter ended December 31, 2008, our sales and gross margin decreased by approximately $842 and $815 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 decreased by approximately $236 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 December 31, 2008 was a decrease in net income of approximately $579.
Nine months ended December 31, 2008 compared with nine months ended December 31, 2007:
Net Sales
Sales of $37,962 for the nine months ended December 31, 2008 decreased by $7,736 from sales of $45,698 for the same period in the prior year. The decrease was primarily due to lower sales in the retail markets across all of our regional segments as a result of the worldwide economic crisis and its impact on consumer spending. This, along with the absence of purchases by a significant customer in the current period, resulted in a decline of $5,901 or 23% in sales in our North American business operations, our largest retail market. Sales in our European business operations decreased by $1,835 or 12% with $2,083 attributable to lower sales partially offset by a gain of $248 as a result of exchange rates differences. The European operations decline was 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 through broader distribution.
Gross Margin
For the nine months ended December 31, 2008, gross margin decreased by $6,397 primarily due to the revenue of $3,000 from SII received in the prior year and lower overall sales. The sales decrease accounted for $3,790 of the lower gross margin dollars partially offset by a $393 gain from an increase in gross margin percentage on sales, excluding the SII payment. Gross margin percentage, excluding the $3,000, increased by one percentage point from 49% to 50% for the nine months ended December 31, 2008.
Operating Expenses
Total operating expenses decreased to $19,236 in the nine months ended December 31, 2008 from $21,413 in the same period last year. Sales and marketing expenses decreased by $1,581 to $11,352 (30% of sales) from $12,933 (28% of sales) primarily due to decreased variable marketing and advertising, commissions, and freight costs of $731, $135, and $392, respectively. Personnel and shows and exhibition costs decreased by $444 and $126, respectively partially offset by increased consulting fees and product support costs of $158, and $40 respectively. Research and development expenses decreased by $124 to $2,520 (7% of sales) from $2,644 (6% of sales) last year primarily due to reduced personnel costs of $256 partially offset by increased consulting, outside engineering, and samples costs of $24, $79 and $19, respectively. General and administrative expenses decreased by $820 to $5,016 (13% of sales) from $5,836 (13% 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 $209 compared to the prior year partially offset by a reduction in consulting, bank fees and depreciation $166, $98, and $86, respectively. Miscellaneous Income included $100 for the settlement of a patent infringement lawsuit.
In May 2008, we reduced our U.S. workforce by 10% 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 nine months to December 31, 2008 reflects a charge of $348 to cover the associated separation expenses.
Interest Income, net
For the nine months ended December 31, 2008 we had net interest income of $27 compared with $79 in the same period last year, primarily due to lower interest income 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 loss of $13 for the nine months ended December 31, 2008 compared with a loss of $141 in the same period last year. For the nine months ended December 31, 2008 we recorded a gain on our program of selling euros at current rates for future settlement of $20 compared with a loss of $319 in the same period last year. We recorded a loss of $11 on the repatriation of funds from our foreign subsidiaries in the nine months ended December 31, 2008, compared with a gain of $97 in the same period last year.
Income Tax Provision
The Company's provision for income taxes was $63 for the nine months ended December 31, 2008 compared to $322 for the comparable period last year, a decrease of $259. The reduction was primarily due to a Federal refund of the Alternative Minimum Tax on the Company's U.S. operations partially offset by lower income generated during the nine months ended December 31, 2008 by the Company's international operations.
Net Income
For the nine months ended December 31, 2008, net income decreased by $4,255 to a loss of $663 from a gain of $3,592 in the same period last year. The decrease is primarily due to the prior year period SII revenue of $3,000 which resulted in a contribution to net income of $2,400 after deducting approximately $600 of related costs. Sales decreased by $7,736 primarily from lower sales in the retail markets across all of our regional segments as a result of the worldwide economic crisis and its impact on consumer spending during the holiday season. As a result sales in our North American and European business operations, our two largest retail markets, declined by $5,901 (23%) and $1,835 (12%), respectively. Excluding the SII payment, gross margin decreased by $3,397 with lower sales accounting for a decrease of $3,790 partially offset by a $393 gain from an 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 nine months ended December 31, 2008, approximately 39% of our sales were denominated in currencies other than the US dollar. For the nine months ended December 31, 2008, our sales benefited by approximately $6 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 $127 due to the fluctuations in exchange rates. There was no currency impact to gross margin during the nine months ended December 31, 2008. The net effect of the year over year fluctuations in exchange rates on our results of operations for the nine months ended December 31, 2008 was a decrease in income of approximately $113.
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 December 31, 2008 we had two outstanding foreign exchange contracts in the amounts of 500 euros each (equivalent to total US dollars of $1,320) with a combined unrealized loss of $76 and expiration dates of January 5, 2009 and January 20, 2009. The unrealized loss was included in the 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.
As of December 31, 2007 we had two outstanding foreign exchange contracts in the amount of 1,500 and 1,000 euros (equivalent to total US dollars of $3,652) with a combined unrealized loss of $123 and expiration dates of July 2008 and March 2008 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 $2,629 to $8,729 at December 31, 2008 from $6,100 at March 31, 2008 primarily because of a seasonal increase in sales of $2,152 during the December 2008 quarter compared to the March 2008 quarter. Inventory decreased by $453 to $8,809 on December 31, 2008 from $9,262 on March 31, 2008 due to normal seasonal trends and reduced inventory purchases in line with the decline in sales this year compared to the same period last year. Accounts payable and accrued expenses decreased by $504.
Liquidity and Capital Resources
We had cash and cash equivalents of $10,319 at December 31, 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 December 31, 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, Letter of Extension dated May 6, 2008 and Amendment to the Revolving Loan and Security Agreement dated May 19, 2008.
The Amendment modifies the Credit Agreement with PNC by providing for a $15,000 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 plus 50 basis points to the PNC Base Rate plus 100 basis points or LIBOR Rate Loans with the interest rate varying from LIBOR plus 200 basis points to LIBOR plus 300 basis points, in each case depending upon the ratio of the Company's Funded Debt to EBITDA and the composition of collateral provided. The minimum Fixed Charge Coverage Ratio under the Credit Agreement was amended for the quarter ended December 31, 2008 to no less than .85x to 1.0. The minimum Fixed Charge Coverage Ratio reverts back to 1.25x to 1.0 for the fiscal quarter ending March 31, 2009 and each fiscal quarter thereafter. The Loans under the Credit Agreement are payable in full on the last day of the Term.
The Credit Agreement contains certain other financial covenants as well as restrictions on indebtedness, business combinations and other related items. We were in compliance with all covenants of the amended Credit Agreement as of December 31, 2008. As of December 31, 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 December 31, 2008, we had credit available of $9,228. 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, from those enumerated in our Annual Report on Form 10-K for the year ended March 31, 2008.
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