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IIN > SEC Filings for IIN > Form 10-K on 13-Mar-2013All Recent SEC Filings

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Form 10-K for INTRICON CORP


13-Mar-2013

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Company Overview

IntriCon Corporation, (the "Company" or "IntriCon", "we", "us" or "our") is an international firm engaged in the designing, developing, engineering and manufacturing of body-worn devices. The Company serves the body-worn device market by designing, developing, engineering and manufacturing micro-miniature products, microelectronics, micro-mechanical assemblies and complete assemblies, primarily for bio-telemetry devices, hearing instruments and professional audio communication devices.

As discussed below, the Company has one operating segment - its body-worn device segment. Our expertise in this segment is focused on three main markets:
medical, hearing health and professional audio communications. Within these chosen markets, we combine ultra-miniature mechanical and electronics capabilities with proprietary technology - including ultra low power (ULP) wireless and digital signal processing (DSP) capabilities - that enhances the performance of body-worn devices.

Business Highlights

In August 2012, the Company sold its 50% interest in its Global Coils joint venture, to joint venture partner Audemars SA. Global Coils is in the business of marketing, designing, manufacturing, and selling audio coils to the hearing health industry. Audemars paid $426 in cash at closing and will make future payments, both one time and recurring, as specified in the purchase agreement. Audemars also transferred certain hearing health inventory to IntriCon. The Company recorded a gain on the sale of $822, or $.14 per diluted share, in the gain on sale of investment in partnership line of the accompanying statement of operations.

In December 2012, the Company amended its credit facilities with The PrivateBank and Trust Company. Terms of the amendment included, among other things, permitting the Company to borrow an additional $1,250 by increasing the Company's term loan facility to $4,000, while keeping the existing amortization schedule in place. In addition, the amendment eliminated the Minimum EBITDA covenant, reset certain other financial covenants and changed the dates of covenant compliance from monthly to quarterly. Lastly, the amendment increased the inventory cap on the borrowing base from $3,000 to $3,500 and removed eligible equipment from the base. The Company is using the facilities to fund current growth opportunities, the Company's overseas low-cost manufacturing infrastructure and meet anticipated working capital requirements.

Forward-Looking Statements

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and the related notes appearing in Item 8. of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those under the heading "Risk Factors" in Item 1A of this Annual Report on Form 10-K. See also Item 1. "Business-Forward-Looking Statements" for more information.


Table of Contents

Results of Operations: 2012 Compared with 2011

Consolidated Net Sales

Our net sales are comprised of three main markets: medical, hearing health, and professional audio - collectively our body-worn device segment. Below is a recap of our sales by main markets for the years ended December 31, 2012 and 2011:

                                                                 Change
                                      2012       2011     Dollars     Percent
Medical                             $ 24,463   $ 22,923   $  1,540         6.7 %
Hearing Health                        23,806     21,032      2,774        13.2 %
Professional Audio Communications     15,664     12,103      3,561        29.4 %
Consolidated net sales              $ 63,933   $ 56,058   $  7,875        14.0 %

In 2012, we experienced a 6.7 percent increase in medical sales primarily driven by higher sales to Medtronic and other key medical customers. Management believes the industry-wide trend to shift the point of care from expensive traditional settings, such as hospitals, to less expensive non-traditional settings like the home, will result in growth of the medical bio-telemetry industry. IntriCon currently serves this market by offering medical manufacturers the capabilities to design, develop and manufacture medical devices that are easier to use, are more miniature, use less power, and are lighter. IntriCon has a strong presence in both the diabetes market, with its Medtronic partnership, and cardiac diagnostic monitoring bio-telemetry market. The Company believes there are growth opportunities in these markets as well other emerging biotelemetry and home care markets, such as sleep apnea, that could benefit from its capabilities to develop devices that are more technologically advanced, smaller and lightweight.

Net sales in our hearing health business for the year ended December 31, 2012 increased 13.2 percent over the same period in 2011 driven by sales to hi HealthInnovations and sales into the nontraditional PSAP hearing health market. These gains were partially offset by temporary declines in legacy products. In mid-2012, we satisfied hi HealthInnovations' initial product ramp-up needs for 2012 and in the near term we expect minimal new orders. The hi HealthInnovations program is based on a development of an innovative new distribution channel. While hi HealthInnovations continues to make progress, there are challenges to be overcome and it is difficult to project program needs at this time; however, we do believe in the long-term potential of this program. We continue to support hi HealthInnovations in building the infrastructure to provide high quality, affordable hearing healthcare to their customers. Examples of our efforts include the development and validation of hardware and software, providing quality management system support, and device tracking and analysis support. We believe this will position hi HealthInnovations to aggressively expand this program to their customer base. With market dynamics such as low penetration rates, an aging population, and the need for reduced cost and convenience, the Company believes the hearing health market offers significant growth opportunities, including the emergence of alternative care models, such the insurance channel and PSAP channel. IntriCon believes it is very well positioned to serve these value hearing health market channels. Over the past several years the company has invested heavily in core technologies, product platforms and its global manufacturing capabilities geared to provide high-tech, lower-cost hearing devices. Our DSP devices provide better clarity and an improved ability to filter out background noise at attractive pricing points. We believe product platform introductions such as the APT™ and Lumen™ devices will drive market share gains into all channels of the emerging value hearing health market.

Net sales to the professional audio device sector increased 29.4 percent in 2012 compared to the same period in 2011. The significant increase over the prior year was due to continued demand for securities products domestically and to the fulfillment of a large headset contract with the Singapore government, providing technically advanced headsets to be worn in difficult listening environments. While the Singapore government contract has been fulfilled in 2012, we believe there is potential for additional future contracts with the Singapore government and other agencies. Additionally, we believe our extensive portfolio of communication devices that are portable, smaller and perform well in noisy or hazardous environments will provide for future long-term growth in this market.

Gross Profit

Gross profit, both in dollars and as a percent of sales, for 2012 and 2011, were
as follows:


                        2012                     2011                   Change
                          Percent of               Percent of
               Dollars       Sales      Dollars       Sales      Dollars     Percent

Gross profit $ 14,976 23.4 % $ 12,666 22.6 % $ 2,310 18.2 %

In 2012, gross profit increased primarily due to greater sales across our three core markets, partially offset by infrastructure costs in Asia and an unfavorable product mix in our professional audio communications market. The Company further expanded its low-cost manufacturing capabilities during the year. The continued ramp-up of the Company's Indonesian facility provides low-cost manufacturing options to drive ongoing margin improvement and the ability to pursue additional high-volume manufacturing opportunities. In addition, the Company increased the medical manufacturing infrastructure at its Singapore facility to support the transfer of certain medical business. The Company has a number of initiatives to expand margins, including transferring select labor-intensive programs to Singapore and Indonesia, and increasing the percentage of proprietary IntriCon technology into all of its product platforms. However, due to the relatively fixed global cost manufacturing structure, the most immediate impact on margin growth will be through increased revenue volume.


Table of Contents

Sales and Marketing, General and Administrative and Research and Development
Expenses

Sales and marketing, general and administrative and research and development
expenses for the years ended December 31, 2012 and 2011 were:


                                  2012                         2011                      Change
                                      Percent of                  Percent of
                         Dollars        Sales         Dollars        Sales        Dollars      Percent

Sales and marketing     $   3,324             5.2 %  $   3,185            5.7 %  $     139          4.3 %
General and
administrative              5,958             9.3 %      5,797           10.3 %        161          2.8 %
Research and
development                 4,694             7.3 %      4,876            8.7 %       (182 )       (3.7 )%

Sales and marketing increased over the prior year due to increased sales and related selling commissions and a headcount addition in late 2012. Management expects to focus more capital and resources in sales and marketing in the upcoming years to expand its reach in the medical bio-telemetry and value hearing health markets. General and administrative expenses increased over the prior year period primarily driven by increased stock based compensation as compared to 2011. Research and development decreased over the prior year primarily due to a temporary reduction in fee for service work by third parties.

Interest Expense

Interest expense for 2012 was $755, an increase of $146 from $609 in 2011. The increase in interest expense was primarily due to higher average debt balances and higher interest rates as compared to the prior year.

Equity in Income (Loss) of Partnerships

The equity in income (loss) of partnerships for 2012 was $(116) compared to $174 in 2011.

The Company recorded a $166 decrease in the carrying amount of its investment in the Hearing Instrument Manufacturers Patent Partnership ("HIMPP") for 2012, reflecting amortization of the patents and other intangibles and the Company's portion of the partnership's operating results for the year ended December 31, 2012, compared to a $34 decrease in the carrying amount of the investment in 2011 for the amortization of the patents and other intangibles and the Company's portion of the partnership's operating results for the year ended December 31, 2011.

Prior to the sale of the Global Coils joint venture interest, the Company recorded a $50 and $208 increase in the carrying amount of IntriCon's investment in this joint venture, reflecting the Company's portion of the joint venture's operating results for year ended December 31, 2012 and 2011, respectively.

Gain on Sale of Investment in Partnership

In August 2012, the Company sold its 50% interest in its Global Coils joint venture, to its joint venture partner Audemars SA. The Global Coils joint venture is in the business of marketing, designing, manufacturing, and selling audio coils to the hearing health industry. Audemars paid $426 in cash at closing and will make future payments, both one time and recurring, as specified in the purchase agreement. Audemars also transferred certain hearing health inventory to IntriCon. The Company recorded a gain on the sale of $822 in the gain on sale of investment in partnership line of the accompanying statement of operations.

The net gain was computed as follows:

                           Cash proceeds         $  426
                           Receivables              721
                           Inventory                186
                           Net assets disposed     (486 )
                           Transaction costs        (25 )
                           Gain on sale          $  822


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Other Income (Expense), net

In 2012, other income (expense), net was $(78) compared to $42 in 2011 primarily related to the gain (loss) on foreign currency exchange.

Income Tax (Expense) Benefit

Income taxes were as follows:


                                       2012     2011
Income tax (expense) benefit          $ (164 ) $   160
Percentage of pre-tax income (loss)     18.8 %   (10.1 %)

The (expense) benefit in 2012 and 2011 was primarily due to foreign taxes on German and Singapore operations. The Company is in a net operating loss position ("NOL") for US federal income tax purposes and, consequently, minimal income tax expense from the current period domestic operations was recognized. Our deferred tax asset related to the NOL carry forwards has been offset by a full valuation allowance. We estimate we have approximately $19,888 of NOL carry forwards available to offset future federal income taxes that begin to expire in 2022.

Results of Operations: 2011 Compared with 2010

Consolidated Net Sales

Below is a recap of our sales by main markets for the years ended December 31, 2011 and 2010:

                                                                 Change
                                      2011       2010     Dollars     Percent
Medical                             $ 22,923   $ 24,594   $ (1,671 )      (6.8 %)
Hearing Health                        21,032     21,007         25         0.1 %
Professional Audio Communications     12,103     13,096       (993 )      (7.6 %)
Consolidated net sales              $ 56,058   $ 58,697   $ (2,639 )      (4.5 %)

In 2011, we experienced a 6.8 percent decrease medical sales primarily due to extended regulatory lead times and anticipated fluctuations in demand. The persisting economic softness and regulatory delays has caused many patients to defer discretionary medical procedures, and hospitals and doctors to cut back on purchases of legacy med-tech products. As a result, during the course of 2011, a few large medical customers experienced fluctuations in demand. As the year progressed, we were encouraged by the reengagement of Medtronic and other key medical customers, driving four quarters of sequential growth.

Net sales in our hearing health business for the year ended December 31, 2011 remained flat compared to the same period in 2010 driven by growth in our DSP circuits and sales to hi HealthInnovations, offset by temporary declines in legacy products.

Net sales to the professional audio device sector decreased 7.6 percent in 2011 compared to the same period in 2010. We believe that the primary driver of the decrease was due to the possible U.S. government shutdown and budgetary approval process which delayed our contract product launches with certain government organizations.

Gross Profit

Gross profit, both in dollars and as a percent of sales, for 2011 and 2010, were
as follows:


                                 2011                       2010                     Change
                                    Percent of                 Percent of
                        Dollars        Sales       Dollars        Sales       Dollars     Percent

Gross profit $ 12,666 22.6 % $ 15,013 25.6 % $ (2,347 ) (15.6% )

In 2011, gross profit decreased primarily due to lower sales volumes, costs related to establishing the Company's Indonesian facility and ramp up costs associated with the hi HealthInnovations agreement. The decrease in gross profits was partially offset by the impact of various profit enhancement programs.

In an effort to drive for further gross profit improvements, the Company evaluated low cost manufacturing options in Asia. In July 2011, the Company signed a five year lease agreement for a manufacturing facility in Batam, Indonesia. The Company commenced manufacturing at the facility in October 2011.


Table of Contents

Sales and Marketing, General and Administrative and Research and Development
Expenses

Sales and marketing, general and administrative and research and development
expenses for the years ended December 31, 2011 and 2010 were:


                                  2011                        2010                      Change
                                     Percent of                  Percent of
                         Dollars        Sales        Dollars        Sales        Dollars      Percent

Sales and marketing     $   3,185            5.7 %  $   3,133            5.3 %  $      52          1.7 %
General and
administrative              5,797           10.3 %      5,801            9.9 %         (4 )       (0.0 %)
Research and
development                 4,876            8.7 %      4,485            7.6 %        391          8.7 %

Sales and marketing and general and administrative expenses were relatively flat as compared to the prior year periods. Research and development increased over the prior year period primarily due to continued development of core technologies and research and development to support product offerings under the hi HealthInnovations' manufacturing agreement.

Interest Expense

Interest expense for 2011 was $609, a decrease of $46 from $655 in 2010. The decrease in interest expense was primarily due to lower average debt balances and interest rates as compared to the prior year.

Equity in Income (Loss) of Partnerships

The equity in income (loss) of partnerships for 2011 was $174 compared to $(135) in 2010.

The Company recorded a $34 decrease in the carrying amount of its investment in HIMPP for 2011, reflecting amortization of the patents and other intangibles and the Company's portion of the partnership's operating results for the year ended December 31, 2011, compared to a $191 decrease in the carrying amount of the investment in 2010 for the amortization of the patents and other intangibles and the Company's portion of the partnership's operating results for the year ended December 31, 2010.

The Company recorded a $208 and $56 increase in the carrying amount of IntriCon's investment in the Global Coils joint venture, reflecting the Company's portion of the joint venture's operating results for year ended December 31, 2011 and 2010, respectively.

Other Income (Expense), net

In 2011, other income (expense), net was $42 compared to $(4) in 2010.

Income Tax (Expense) Benefit

Income taxes were as follows:


                                       2011       2010
Income tax (expense) benefit          $   160    $ (145 )
Percentage of pre-tax income (loss)     (10.1 %)   18.1 %

The (expense) benefit in 2011 and 2010 was primarily due to foreign taxes on German and Singapore operations. The Company is in a net operating loss position ("NOL") for US federal income tax purposes and, consequently, minimal income tax expense from the current period domestic operations was recognized. Our deferred tax asset related to the NOL carry forwards has been offset by a full valuation allowance.

Discontinued Operations

We had no discontinued operations in 2011. We recorded a loss from discontinued operations (electronics business) in 2010 as follows:

2010 Loss from discontinued Electronics Products Business $ (294 )


Table of Contents

The 2010 net loss of $(294), or $(0.05) per diluted share, was primarily due to loss in operations, net of a $35 gain on sale of the electronics business.

Liquidity and Capital Resources

Our primary sources of cash have been cash flows from operations, bank borrowings, and other financing transactions. For the last three years, cash has been used for repayments of bank borrowings, purchases of equipment, establishment of an additional Asian manufacturing facility and working capital to support research and development, including product offerings under our hi HealthInnovations agreement.

As of December 31, 2012, we had approximately $226 of cash on hand. Sources and uses of our cash for the year ended December 31, 2012 have been from our operations, as described below.

Consolidated net working capital increased to $8,893 at December 31, 2012 from $8,207 at December 31, 2011. Our cash flows from operating, investing and financing activities, as reflected in the statement of cash flows for the years ended December 31, are summarized as follows:

                                            2012       2011       2010
Cash provided (used) by:
Operating activities                      $  2,007   $     (3 ) $  1,616
Investing activities                        (1,109 )   (2,582 )   (1,043 )
Financing activities                          (799 )    2,420       (668 )
Effect of exchange rate changes on cash          8          3         (9 )

Increase (decrease) in cash               $    107   $   (162 ) $   (104 )

Operating Activities. The most significant items that contributed to the $2,007 of cash provided by continuing operations were increases in net income and decreases in inventory and receivables partially offset by decreases in accounts payable. Days sales in inventory decreased from 95 at December 31, 2011 to 78 at December 31, 2012. Days payables outstanding decreased from 64 days at December 31, 2011 to 39 days at December 31, 2012.

Investing Activities. Net cash used by investing activities consisted of purchases of property, plant and equipment of $1,735 primarily related to the infrastructure investment at our Asian facilities. Partially offsetting the purchase of property plant and equipment was net cash proceeds received of $626 on the sale of the 50 percent ownership interest in the Global Coils joint venture.

Financing Activities. Net cash used by financing activities of $799 was comprised primarily of borrowings under our credit facilities, partially offset by proceeds of new borrowings.

Cash generated from operations may be affected by a number of factors. See "Forward Looking Statements" and "Item 1A: Risk Factors" contained in this Form 10-K for a discussion of some of the factors that can negatively impact the amount of cash we generate from our operations.

We had the following bank arrangements at December 31,:

                                                     2012       2011
Total availability under existing facilities       $ 13,233   $ 13,517

Borrowings and commitments:
Domestic revolving credit facility                    4,360      5,369
Domestic term loans                                   3,750      3,500
Foreign overdraft and letter of credit facility       1,795      1,881
Total borrowings and commitments                      9,905     10,750

Remaining availability under existing facilities   $  3,328   $  2,767


Table of Contents

Domestic Credit Facilities

To finance a portion of the Company's acquisition of Jon Barron, Inc. doing business as Datrix ("Datrix") and replace the Company's existing credit facilities with Bank of America, including capital leases, the Company and its domestic subsidiaries entered into a credit facility with The PrivateBank and Trust Company on August 13, 2009. The credit facility, as amended, provides for:

† an $8,000 revolving credit facility, with a $200 sub facility for letters of credit. Under the revolving credit facility, the availability of funds depends on a borrowing base composed of stated percentages of the Company's eligible trade receivables and eligible inventory, and eligible equipment less a reserve; and

† a term loan in the original amount of $4,000.

In December 2012, the Company and its domestic subsidiaries entered into a Fifth Amendment to the Loan and Security Agreement with The PrivateBank and Trust Company. The amendment, among other things:

† permitted the Company to borrow an additional $1,250 under the term loan by increasing the then current principal balance of the term loan from $2,750 to $4,000, while keeping the existing amortization schedule in place.

† increased the inventory cap on the borrowing base from $3,000 to $3,500 and removed eligible equipment from the base. Under the revolving credit facility as amended, the availability of funds depends on a borrowing base composed of stated percentages of the Company's eligible trade receivables and inventory, less a reserve;

† eliminated the minimum EBITDA covenant and amended certain other financial covenants; and

† changed the dates when covenant compliance will be tested from monthly to quarterly.

In March 2012, the Company entered into an amendment with The PrivateBank to waive certain covenant violations at December 31, 2011 and reset certain covenants in the agreement. In August 2012, the credit facility was amended to amend the fixed charge covenant ratio and to consent to the Global Coils sale and the application of the proceeds to the pay down of the revolving credit facility.

Loans under the credit facility are secured by a security interest in substantially all of the assets of the Company and its domestic subsidiaries including a pledge of the stock of its domestic subsidiaries. Loans under the credit facility bear interest at varying rates based on the Company's leverage ratio of funded debt / EBITDA, at the option of the Company, at:

† the London InterBank Offered Rate ("LIBOR") plus 3.00% - 4.00%, or

† the base rate, which is the higher of (a) the rate publicly announced from time to time by the lender as its "prime rate" and (b) the Federal Funds . . .

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