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| VII > SEC Filings for VII > Form 10-Q on 14-May-2012 | All Recent SEC Filings |
14-May-2012
Quarterly Report
General
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's consolidated financial statements for the
periods indicated, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. On an on-going basis, management evaluates its estimates and
judgments, including those related to revenue recognition, bad debts, product
warranties, inventories, long lived assets, income taxes and contingencies and
litigation. Management bases its estimates and judgments on historical
experience and on various other factors including general market conditions that
are believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. Results for the
periods reported herein are not necessarily indicative of results that may be
expected in future periods.
Overview
The Company designs, assembles and markets video management systems and system
components for use in security, surveillance, safety and communication
applications by a broad group of end users worldwide. The Company's product line
consists of various elements of a video system, including digital video and
network video recorders, video encoders, decoders, servers and related video
management software, data storage units, analog, HD and IP fixed and robotic
cameras, virtual and analogue matrix video switchers and controls, and system
peripherals.
The Company sells video systems and system components in a highly competitive worldwide marketplace principally to authorized security dealers and system integrators. Such dealers and integrators typically resell the Company's products directly to end users, among other services. The Company's sales are principally project based and are largely dependent upon winning projects, construction activities and the timing of funding. Sales will vary from period to period depending upon many factors including seasonal and geographic trends in construction activities and the timing of deliveries due to changes in project schedules and funding. The Company usually does not have a large backlog as its customer orders are typically deliverable within three months or often upon receipt of order.
Since fiscal year 2009, the Company's sales levels have been impacted by the worldwide economic downturn as capital expenditures for new construction, expansion and renovation projects have weakened. Such sales declines have had an adverse impact on the Company's financial results for these periods. The Company's operating cost structure has been principally fixed and therefore profitability has been largely dependent upon sales levels. For the most part, the Company has maintained its selling, general and administrative cost structure in anticipation of improving market conditions. In the second half of fiscal 2011, the Company recognized $200,000 of severance charges on certain staff reductions and may consider additional cost cutting measures in fiscal 2012.
The Company competes in a market of rapid technology shifts which influence the performance capability of security systems. As a result, the Company spends a significant amount on new product development. In fiscal 2011 and 2010, the Company incurred $5.9 million and $5.5 million of engineering and development expense or 13% and 11% of net sales, respectively. The Company's expenditures for product development are substantially less than its larger competitors. In recent years, the rapid pace of technology changes has placed increased burden on the Company's development resources which has necessitated an increase in annual expense for product development. Further, the Company's sales effort requires a high level of customer service and technical support for its products. Customer support levels were maintained during fiscal 2011 despite a reduction in sales and such expenditure levels are expected to continue in fiscal 2012. The Company has considered various strategic initiatives that may augment or supplement its present product offerings and technology platforms, among other benefits.
The Company has a foreign sales and distribution subsidiary in Europe that conducts business in British pounds and Euros that represented approximately 28% of the Company's consolidated sales for fiscal 2011. It also has an Israel based engineering and development subsidiary that incurs a majority of its operating expenses in Shekels that represented approximately 21% of the Company's recurring operating expenses for fiscal 2011. During fiscal 2009, there were material changes in exchange rates between world currencies that affected the Company's financial statements. In 2009, U.S. dollar gained on average 21% against the British pound, 10% against the Euro and 8% against the Shekel compared with 2008. This served to reduce the Company's consolidated reported sales and costs in these currencies on a translation basis, increase the cost of European subsidiaries U.S. dollar based sourced product costs and incur company-wide negative result impacts on the settlements of transactional balances between
companies. Since fiscal 2009, European currency exchange rate changes has moderated, which significantly lessened the Company's currency impacts. However, in fiscal 2011, the U.S. dollar weakened against the shekel by an average of 6% compared with 2010, thus increasing the Company's Israel based subsidiary's operating costs. The Company has historically entered into selected forward currency exchange contracts to help stabilize the impact of changing exchange rates and will continue to do so in fiscal 2012. However, nothing can totally eliminate the long term effects of foreign currency exchange movements.
Results of Operations
Three Months Ended March 31, 2012 Compared with March 31, 2011
Net sales for the quarter ended March 31, 2012 increased 3% to $12.5 million compared with $12.1 million in the year ago period. Domestic sales increased 5% to $7.4 million compared with $7.1 million in the year ago period while international sales increased 1% to $5.1 million compared with $5.0 million in the year ago period. Order intake for the quarter ended March 31, 2012 increased 12% to $13.5 million compared with $12.1 million in the year ago period. In the current quarter, the Company experienced a significant improvement in its North American sales and order rates and persistent soft sales and order rates in Europe. The backlog of unfilled orders increased $1.2 million to $5.9 million at March 31, 2012 compared with $4.7 million at September 30, 2011.
Gross profit margins for the second quarter of fiscal 2012 increased to 39.7% compared with 38.9% in the year ago period. The increase in current quarter margins was the result of lower indirect expenses relative to sales for the quarter.
Total operating expenses for the second quarter of fiscal 2012 decreased $538,000 to $5.2 million compared with $5.8 million in the year ago quarter. Selling, general and administrative expenses for the second quarter of fiscal 2012 decreased to $3.9 million compared with $4.1 million in the year ago quarter. Engineering and development expense in the current quarter was $1.3 million compared with $1.5 million in the year ago period. The prior year quarter operating costs included $169,000 of patent litigation expense (see Note 8).
The Company incurred an operating loss of $281,000 in the second quarter of fiscal 2012 compared with an operating loss of $1.1 million in the year ago period.
Interest income decreased $41,000 to $7,000 for the second quarter of fiscal 2012 compared with $48,000 in the year ago quarter due principally to reduced cash balances and marketable security investments in the current quarter. Other income was $14,000 for the second quarter of 2012 compared with $1,000 in the year ago quarter. The current quarter amount represents gains realized on the liquidation of certain marketable securities and changes in the market value of certain equity securities held.
The Company recorded income tax expense of $19,000 for the second quarter of
fiscal 2012 compared with a tax benefit of $308,000 in the year ago quarter. In
the third quarter of fiscal 2011, the Company recognized a $2.6 million income
tax charge to provide a valuation allowance against its deferred tax assets due
to the uncertainty of future realization and, thus, no tax benefit has been
recognized on reported pretax losses for the current quarter (see Note 10:
Income Taxes).
As a result of the foregoing, the Company reported a net loss of $279,000 for the second quarter of fiscal 2012 compared with a net loss of $713,000 in the year ago period.
Results of Operations
Six Months Ended March 31, 2012 Compared with March 31, 2011
Net sales for the six months ended March 31, 2012 increased 4% to $24.8 million compared with $23.8 million in the year ago period. Domestic sales increased 8% to $15.5 million compared with $14.4 million in the year ago period while international sales decreased 2% to $9.3 million compared with $9.4 million in the year ago period. Order intake for the six months ended March 31, 2012 increased 3% to $26.1 million compared with $25.4 million in the year ago period. In the current year period, the Company experienced a significant improvement in its North American sales and order rates and persistent soft sales and order rates in Europe.
Gross profit margins for the first six months of fiscal 2012 decreased to 39.8% compared with 40.0% in the year ago period. Both period margins were weakened by continuing competitive pressures in markets served by the Company's U.K. based subsidiary.
Total operating expenses for the first six months of fiscal 2012 decreased $840,000 to $10.5 million compared with $11.3 million in the year ago period. Selling, general and administrative expenses for the first six months of fiscal 2012 decreased to $7.8 million compared with $8.1 million in the year ago period. Engineering and development expense in the current year period was $2.7 million compared with $2.9 million in the year ago period. The prior year period operating costs included $250,000 of patent litigation expense (see Note 8).
The Company incurred an operating loss of $584,000 for the first six months of fiscal 2012 compared with an operating loss of $1.8 million in the year ago period.
Interest income decreased to $31,000 for the first six months of fiscal 2012 compared with $132,000 in the year ago period due principally to reduced cash balances and marketable security investments in the current year period. Other income was $29,000 for the first six months of 2012 compared with $12,000 in the year ago period. These amounts represent gains realized on the liquidation of certain marketable securities and changes in the market value of certain equity securities held.
The Company recorded income tax expense of $38,000 for the first six months of
fiscal 2012 compared with a tax benefit of $485,000 in the year ago period. In
the third quarter of fiscal 2011, the Company recognized a $2.6 million income
tax charge to provide a valuation allowance against its deferred tax assets due
to the uncertainty of future realization and, thus, no tax benefit has been
recognized on reported pretax losses for the current year period (see Note 10:
Income Taxes).
As a result of the foregoing, the Company reported a net loss of $562,000 for the first six months of fiscal 2012 compared with a net loss of $1.2 million in the year ago period.
Liquidity and Capital Resources
Net cash used in operating activities was $2.9 million for the first six months of fiscal 2012 relating principally to increases in inventories and accounts receivable of $1.3 million and $383,000, respectively, and decreases in accounts payable and accrued expenses aggregating $1.1 million. Inventory increases for the period included additional stocks held for the introduction of certain new product lines. The reported loss of $562,000 was substantially offset by $453,000 of non-cash charges. Net cash provided by investing activities was $1.4 million for the first six months of fiscal 2012 consisting of $1.6 million of net marketable security liquidations principally used for operating activities and $168,000 of general capital expenditures. The marketable security liquidations consisted of mutual fund investments principally in federal, state and local government debt securities. Net cash used in financing activities was $81,000 for the first six months of fiscal 2012 consisting of common stock repurchases. As a result of the foregoing, cash (exclusive of marketable securities) decreased by $1.5 million for the first six months of fiscal 2012 after the minimal effect of exchange rate changes on the cash position of the Company.
The Company believes that it will have sufficient cash to meet its anticipated operating costs and capital expenditure requirements for at least the next twelve months.
The Company does not have any off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have, a material effect on the Company's financial condition, results of operations, liquidity, capital expenditures or capital resources.
The Company was a defendant in a patent infringement suit commenced by Lectrolarm Custom Systems, Inc. ("Lectrolarm") in May 2003 in the United States District Court for the Western District of Tennessee. The alleged infringement by the Company related to its dome camera and system controller product lines, among other products that collectively represent significant sales to the Company. On July 13, 2011, the Company entered into a settlement and release agreement with Lectrolarm to settle the patent infringement suit. Under the settlement, the Company made a one-time payment of $5 million to Lectrolarm in exchange for the release of all current and future claims against the Company and the dismissal of Lectrolarm's suit pending in the U.S. District Court. Such settlement amount was recognized as patent litigation settlement expense in the third quarter ended June 30, 2011. Patent litigation settlement expense for the six months ended March 31, 2011 represents legal costs incurred in connection with such litigation. Although the Company and its outside patent counsel believed that the suit was without merit and had vigorously defended itself for over eight years, it decided to settle the matter to end years of management distraction and financial uncertainty since the suit was brought in 2003.
Critical Accounting Policies
The Company's significant accounting policies are fully described in Note 1 to the Company's consolidated financial statements included in its September 30, 2011 Annual Report on Form 10-K. Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
Revenue is generally recognized when products are sold and title is passed to the customer. Advance service billings are deferred and recognized as revenues on a pro rata basis over the term of the service agreement. Pursuant to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 605-25-05 (EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables"), the Company evaluates multiple-element revenue arrangements for separate units of accounting, and follows appropriate revenue recognition policies for each separate unit. Elements are considered separate units of accounting provided that (i) the delivered item has stand-alone value to the customer, (ii) there is objective and reliable evidence of the fair value of the undelivered item, and (iii) if a general right of return exists relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially within the control of the Company. As applied to the Company, under arrangements involving the sale of product and the provision of services, product sales are recognized as revenue when the products are sold and title is passed to the customer, and service revenue is recognized as services are performed.
For products that include more than incidental software, and for separate licenses of the Company's software products, the Company recognizes revenue in accordance with the provisions of FASB Accounting Standards Update (ASU) 2009-13, "Revenue Recognition (Topic 605) - Multiple-Deliverable Revenue Arrangements" (ASU 2009-13). ASU 2009-13, which was adopted by the Company effective October 1, 2010 on a prospective basis, provides revenue recognition guidance for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable in the arrangement based on the fair value of the elements. The fair value for each deliverable is based on vendor-specific objective evidence ("VSOE") if available, third-party evidence ("TPE") if VSOE is not available, or best estimate of selling price ("BESP") if neither VSOE nor TPE is available. BESP must be determined in a manner that is consistent with that used to determine the price to sell the specific elements on a standalone basis.
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
The Company provides for the estimated cost of product warranties at the time revenue is recognized. While the Company engages in product quality programs and processes, including monitoring and evaluating the quality of its component suppliers, its warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from its estimates, revisions to the estimated warranty liability may be required.
The Company writes down its inventory for estimated obsolescence and slow moving inventory equal to the difference between the carrying cost of inventory and the estimated net realizable market value based upon assumptions about future demand and market conditions. Technology changes and market conditions may render some of the Company's products obsolete and additional inventory write-downs may be required. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
The Company assesses the recoverability of the carrying value of its long-lived assets, including identifiable intangible assets with finite useful lives, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates the recoverability of such assets based upon the expectations of undiscounted cash flows from such assets. If the sum of the expected future undiscounted cash flows were less than the carrying amount of the asset, a loss would be recognized for the difference between the fair value and the carrying amount.
The Company's ability to recover the reported amounts of deferred income tax assets is dependent upon its ability to generate sufficient taxable income during the periods over which net temporary tax differences become deductible. In the third quarter of fiscal 2011, the Company recognized a $2.6 million charge to provide a valuation allowance against all deferred tax assets due to the uncertainty of future realization. The Company plans to provide a full valuation allowance against its deferred tax assets until such time that it can achieve a sustained level of profitability or other positive evidence arises that would demonstrate an ability to recover such assets.
The Company accrues liabilities for identified tax contingencies that result from positions that are being challenged or could be challenged by tax authorities. The Company believes that its accrual for tax liabilities is adequate for all open years, based on Management's assessment of many factors, including its interpretations of the tax law and judgments about potential actions by tax authorities. However, it is possible that the ultimate resolution of any tax audit may be materially greater or lower than the amount accrued.
The Company is subject to proceedings, lawsuits and other claims related to labor, product and other matters. The Company assesses the likelihood of an adverse judgment or outcomes for these matters, as well as the range of potential losses. A determination of the reserves required, if any, is made after careful analysis. The required reserves may change in the future due to new developments.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Statements in this Report on Form 10-Q and other statements made by the Company or its representatives that are not strictly historical facts including, without limitation, statements included herein under the Management's Discussion and Analysis captions "Overview", "Results of Operations", "Liquidity and Capital Resources" and "Critical Accounting Policies" are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 that should be considered as subject to the many risks and uncertainties that exist in the Company's operations and business environment. The forward-looking statements are based on current expectations and involve a number of known and unknown risks and uncertainties that could cause the actual results, performance and/or achievements of the Company to differ materially from any future results, performance or achievements, express or implied, by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, and that in light of the significant uncertainties inherent in forward-looking statements, the inclusion of such statements should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. The Company also assumes no obligation to update its forward-looking statements or to advise of changes in the assumptions and factors on which they are based.
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