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VIDE > SEC Filings for VIDE > Form 10-K on 29-May-2013All Recent SEC Filings

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Form 10-K for VIDEO DISPLAY CORP


29-May-2013

Annual Report


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

Overview

The Company is a worldwide leader in the manufacturing and distribution of a wide range of display devices, encompassing, among others, industrial, military, medical, and simulation display solutions. The Company is comprised of one segment-the manufacturing and distribution of displays and display components. The Company is organized into four interrelated operations aggregated into one reportable segment pursuant to the aggregation criteria of FASB ASC Topic 280 "Segment Reporting":

Monitors - offers a wide range of CRT, flat panel and projection display systems for use in training and simulation, military, medical, and industrial applications.

Data Display CRTs - offers a wide range of CRTs for use in data display screens, including computer terminal monitors and medical monitoring equipment.

Entertainment CRTs - offers a wide range of CRTs and projection tubes for television and home theater equipment. This division was closed in February 2013 and remaining inventory was moved to the Data Display CRTs Tucker location.

Component Parts - provides replacement electron guns and other components for CRTs primarily for servicing the Company's internal needs. This division was closed in February 2013 and the remaining inventory was transferred to the Company's CRT manufacturing operation in Lexington, Kentucky.

During fiscal 2013, management of the Company focused key resources on strategic efforts to dispose of unprofitable operations and seeking acquisition opportunities that enhance the profitability and sales growth of the Company's more profitable product lines. The Company continues to seek new products through acquisitions and internal development that complement existing profitable product lines. Challenges facing the Company during these efforts include:

Inventory management - The Company continually monitors historical sales trends as well as projected needs to ensure adequate on hand supplies of inventory and to ensure against overstocking of slower moving, obsolete items.

Certain of the Company's divisions maintain significant inventories of CRTs and component parts in an effort to ensure its customers a reliable source of supply. The Company's inventory turnover averaged 309 days during fiscal 2013, although in many cases the Company would anticipate holding 90 to 100 days of inventory in the normal course of operations. This level of inventory is higher than some of the Company's competitors because it sells a number of products representing older, or trailing edge, technology that may not be available from other sources. The Company also maintains inventory for warranty repairs and replacements for products out in the field which are no longer in its current products. In the monitor operations of the Company's business, the market for its products is characterized by rapid change as a result of the development of new technologies, particularly in the flat panel display area. If the Company fails to anticipate the changing needs of its customers or accurately forecast their requirements, it may accumulate inventories of products which its customers no longer need and which the Company will be unable to sell or return to its vendors. The Company's management monitors the adequacy of its inventory reserves regularly, and at February 28, 2013, believes its reserves to be adequate.

Interest rate exposure - The Company had outstanding debt of approximately $15 million and $17 million, as of February 28, 2013 and February 29, 2012, respectively, subject to interest rate fluctuations by the Company's lenders. Variable interest rates on the Company's loans and the potential for rate hikes could negatively affect the Company's future earnings. It is the intent of the Company to continually monitor interest rates and consider converting portions of the Company's debt from floating rates to fixed rates should conditions be favorable for such interest rate swaps or hedges.

Operations

The following table sets forth, for the fiscal years indicated, the percentages that selected items in the Company's consolidated statements of operations bear to total revenues (amounts in thousands):


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(See Item 1. Business - Description of Principal Business and Principal Products for discussion about the Company's Products and Divisions.)

                                                  2013                       2012
                                           Amount          %          Amount          %
   Net Sales
   Monitors                               $ 46,779         95.3 %    $ 58,596         91.2 %
   Data Display CRTs                         2,134          4.3         5,302          8.3
   Entertainment CRTs                           31          0.1           127          0.2
   Component Parts                             159          0.3           206          0.3

   Total Company                            49,103        100.0        64,231        100.0

   Costs and expenses
   Cost of goods sold                     $ 36,189         73.7 %    $ 44,286         69.0 %
   Selling and delivery                      5,350         10.9         5,485          8.5
   General and administrative                7,375         15.0         8,437         13.1

                                            48,914         99.6        58,208         90.6
   Income from operations                      189          0.4         6,023          9.4
   Interest expense                           (713 )       (1.5 )        (793 )       (1.3 )
   Other income, net                           381          0.8           120          0.2

   Income before income taxes                 (143 )       (0.3 )       5,350          8.3
   (Benefit)/provision for income taxes       (151 )       (0.3 )       1,773          2.8

   Net Income                             $      8          0.0 %    $  3,577          5.5 %

Fiscal 2013 Compared to Fiscal 2012

Net Sales

Consolidated net sales decreased $15.1 million or 23.6% to $49.1 million for fiscal 2013, compared to $64.2 million for fiscal 2012.

The Company's business is more concentrated in the monitor division of the Company where all the new growth is occurring as the market for CRTs declines and moves to newer technologies. The Company is now a video display solutions company, while it still services the existing CRT markets, which overall account for approximately 25% of the Company's revenues. The Monitor revenues decreased $11.8 million due to the delay of long-term contracts at Aydin Displays and a slowdown in Z-Axis' custom manufacturing and power supply sales due to the leveling off of business at its two largest customers, one in custom manufacturing and one in power supplies. Overall, Aydin Displays revenues decreased 34% over the prior fiscal year to $17.7 million and Z-Axis decreased 30% in net revenues to $11.8 million over the prior fiscal year. Display Systems business was down 30% from the prior fiscal year as it transitions from selling and refurbishing CRTs to developing and selling digital display solutions. Lexel experienced a 1.5% decline in revenues due to a decline in orders for various types of its CRT business. Lexel is expected to rebound in fiscal 2014 due to foreign sales projections which were down in fiscal 2013. Data Display CRT sales in fiscal 2013 declined due to decreased demand in the CRT market including the division's largest customer.

Entertainment CRT and Component Parts net sales declined by a combined 43% in fiscal 2013 compared to fiscal 2012. The two divisions represent only 0.4% of the Company's revenues for fiscal 2013. The two divisions were both closed at the end of the fiscal year ended February 28, 2013. The remaining inventory for the Entertainment division was transferred to the Display Division in Tucker, Georgia and the remaining inventory for the Component Parts Division was transferred to the Company's CRT manufacturing operation in Lexington, Kentucky. Due to the continued shift to flat screen televisions, the market for replacement CRTs in the consumer market has diminished. Component Parts sales have generally declined in recent years due to weaker demand for electron gun and stem sales. This business will continue to decline as the CRT industry moves to the new technologies. The division primarily supplies the other divisions with parts they need to complete the assembly of their products.


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Gross Margins

Consolidated gross margins decreased to 26.3% for fiscal 2013 from 31.1% for fiscal 2012. Overall gross margin dollars decreased by $7.0 million or 35.3% versus the prior fiscal year.

The Company's reductions in gross margins were a direct reflection of the decreased revenues which were across the board at all divisions. $2.3 million of the $7.0 million dollar decrease was due to the decrease in the gross margin percentage caused somewhat by product mix and by the fixed costs of production. The remaining $4.7 million dollar decrease was due to the decreased sales of $15.1 million dollars.

The Company had two divisions which heavily contributed to the decrease in the gross margin percentage decrease, Display Systems in Cape Canaveral and a new division, Aydin Cyber security in Palm Bay, Florida. Display Systems gross margin percentage decreased 47% and Aydin Cyber Security posted a negative 42% gross margin. Both divisions are expected to improve on those numbers as new, better margin business is forecasted.

The Aydin Displays and Z-Axis divisions are primarily the cause of the overall decrease in gross margin dollars. Both divisions maintained or improved their gross margin percentage, but due to their decrease in sales their gross margin dollars decreased 27% and 31% respectively.

Operating Expenses

Operating expenses as a percentage of sales increased to 25.9% for fiscal 2013 from 21.7% for fiscal 2012 primarily reflecting increases in sales salaries and outside contractors. The higher salaries are attributable to increases in additional sales people including the new divisions, Aydin Visual Solutions (full year) and Aydin CyberSecurity. The outside contractors increased due to certain government contracts the Company was pursuing. The percentage increase was also attributed to the lower sales volume.

Although operating expenses increased as a percentage to sales, overall operating expenses decreased in fiscal 2013 compared to fiscal 2012. The Company believes it can maintain the fixed operating costs at current levels and the variable costs, such as commissions will increase as revenues increase but in an orderly manner.

Plant Closure

As of February 28, 2013, the Company closed its Novatron facility in Bossier City, Louisiana, a distributor of entertainment CRTs, and Southwest Vacuum Systems, a manufacturer of electron guns and other components for CRTs. The remaining inventory and CRT-related operations were moved to the Company's Lexel Imaging Systems subsidiary in Lexington, Kentucky where they will continue to be manufactured and its Data Displays distribution facility in Tucker, Georgia.

As of February 29, 2012, the Company closed its Clinton Displays facility in Loves Park, Illinois, a manufacturer of CRTs. The remaining inventory and CRT-related operations were moved to the Company's Lexel Imaging Systems subsidiary in Lexington, Kentucky where they will continue to be manufactured and its Data Displays distribution facility in Tucker, Georgia. The operating loss generated by Clinton Displays for the year ended February 29, 2012 was approximately $1.3 million and is included in the Company's results from operations for fiscal 2012.

Interest Expense

Interest expense decreased to $0.7 million for fiscal 2013 compared to $0.8 million in fiscal 2012. Overall, interest expense decreased by $0.1 million as the Company reduced debt by nearly $1.5 million during the current fiscal year. The Company maintains various debt agreements with different interest rates, most of which are based on the prime rate or LIBOR.

The Company's interest expense will increase during the first two quarters of the upcoming fiscal year until it can reach a more favorable bank agreement with another bank.


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Income Taxes

The Company had net loss before taxes of approximately ($143) thousand dollars and an income benefit of approximately ($151) thousand dollars for fiscal 2013 or a rate of 105%, compared to a tax expense of $1.7 million or a 33.1% rate for fiscal 2012 on net income before taxes of $5.3 million dollars.

Liquidity and Capital Resources

As of February 28, 2013, the Company was not in compliance with the fixed charge coverage ratio, the senior funded debt to EBITDA ratio (which the Company believes is the most restrictive covenant) and permitted share repurchases covenants as defined by the Banks credit line agreements. The breach of these covenants resulted in a default under our debt agreement and a current classification of the loans earlier in this fiscal year. This default could prompt the lender to declare all amounts outstanding under the debt agreement to be immediately due and payable and terminate all commitments to extend further credit; however, the Banks have given no current indication of any intention of calling the loans. If the debts were called and the Company was unable to repay those amounts, the lender could proceed against the collateral granted to secure that indebtedness. If the lender under the debt agreement accelerates the repayment of the borrowings, there can be no assurance that the Company will have sufficient assets and funds to repay the borrowings under its debt agreements. Additionally, due to the activity generated by the chairman's remarks at the 2012 annual shareholder meeting concerning any potential mergers, spinoffs, sale of the Company as a whole or any other method (see 8-K), the Company put negotiations on hold with the current syndication of banks.

As the current syndication of banks has given no indication of calling the loans, management believes the most appropriate plan of action is to continue to operate the Company, while exploring those options mentioned by the chairman above, and to continue to make timely and current payments under the debt agreements. Management has forecast this plan and believes that in the absence of the current syndication calling the loans, it can operate in this manner. The Company believes conditions are improving throughout all the divisions and has seen significant activity in new quotes and business won.

Management, while operating as noted above, is exploring opportunities for potential mergers, spinoffs, sale of the Company as a whole or other methods. In the absence of obtaining new funding and/or any potential mergers, spinoffs, sale of the Company as a whole or any other method, management believes continuing and newly generated business as well as CEO's commitment to infuse additional capital, if needed, will sustain the Company going forward.

As the debt is maturing on December 1, 2013 and classified as current, the need for refinancing exists. Therefore, the Company has resumed talks with other banks about refinancing the current debt under an agreement with less restrictive covenants and borrowing base calculations. Management believes that a new debt agreement can be obtained by the end of the second quarter of fiscal 2014; however, there can be no assurance that an agreement can be reached that is reasonable to the Company or at all.

At February 28, 2013 and February 29, 2012, the Company had total cash of $0.3 million and $0.1 million, respectively. The Company's working capital was $22.2 and $37.3 million at February 28, 2013 and February 29, 2012, respectively. The reduction in working capital is caused by the classification of the bank debt as all current, which causes a reduction in working capital of $13.6 million. In recent years, the Company has financed its growth and cash needs primarily through income from operations, borrowings under revolving credit facilities, borrowings from its CEO and long-term debt.

The Company specializes in certain products representing trailing-edge technology that may not be available from other sources, and may not be manufactured currently. In many instances, the Company's products are components of larger display systems for which immediate availability is critical for the customer. Accordingly, the Company enjoys higher gross margins, but typically has larger investments in inventories than those of its competitors.

The Company continually monitors its cash and financing positions in order to find ways to lower its interest costs and to produce positive operating cash flow. The Company examines possibilities to grow its business through internal sales growth or niche acquisitions. There could be an impact on working capital requirements to fund this growth. As in the past, the intent is to finance such projects with operating cash flows or existing bank lines; however, more permanent sources of capital may be required in certain circumstances.

Cash provided by operations was $2.2 million in fiscal 2013 and $4.2 million in fiscal 2012. Of this, $3.1 million was from the operating activities of the Company due primarily to the reduction of inventory reserves of $2.5 million and depreciation and amortization of $1.1 million offset by the change in deferred taxes of $0.3 million and other small changes totaling $0.2 million. During fiscal 2013, net working capital items decreased by $0.9 million. The primary changes were an increase in inventory of $4.2 million that resulted from the Company's two new divisions' inventories partially off-set by write-offs of previously reserved inventories and a $1.9 million increase in accounts payable due to tighter credit restrictions with the Company's line of credit causing a need to slow payments to vendors. There were also decreases in accounts receivables ($0.3 million), cost in excess of billings ($0.7 million), income taxes refundable ($0.3 million) and prepaid expenses ($0.1 million).

Investing activities used cash of $0.4 million in fiscal 2013 and used $0.2 million of cash in fiscal 2012.

Investing activities in fiscal 2013 consisted of capital expenditures of $0.7 million offset by the redemption of a note for $0.3 million. During fiscal 2012 the use of a letter of credit purchased in fiscal 2011 provided $1.4 million which was offset by capital expenditures of $0.9 million for used equipment by Z-Axis, Aydin Displays and Lexel Imaging, $0.8 million payment for the settlement of Clinton and $0.2 million for the purchase of a note receivable for StingRay56. The Company does not anticipate significant investments in capital assets for fiscal 2014 beyond normal maintenance requirements.

Financing activities used cash of $1.6 million in fiscal 2013 and $5.2 million during fiscal 2012 primarily to pay down debt.

On December 23, 2010, the Company and its subsidiaries executed a Credit Agreement with RBC Bank and Community & Southern Bank (collectively, the "Banks") to provide financing to the Company to replace the prior credit agreement with RBC Bank that terminated in conjunction with this Agreement. The current Agreement initially provided for a line of credit of up to $17.5 million and two term loans of $3.5 million and $3.0 million. On March 5, 2012 PNC Bank replaced RBC Bank in our agreement having acquired the U.S. operations of RBC Bank.

1st Amendment: On May 26, 2011, the Banks amended the Credit Agreement to reduce the revolver commitment to $15.0 million, restate the covenants to pertain to only continuing operations of the Company and to adjust the targets for the senior funded debt to EBITDA covenant for the Company's quarters ending May 31, 2011 and August 31, 2011.


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2nd Amendment: On July 26, 2011, the Banks again amended the Credit Agreement to include a swing-line promissory note of $1.0 million that is included in the revised $15.0 million revolver commitment.

3rd Amendment: On September 1, 2011, the Banks amended the Credit Agreement to allow the Company to repurchase a limited amount of the Company's common stock, equal to ten percent of the Company's net earnings after taxes, subject to meeting certain share repurchase conditions and revised the definition of the fixed charge coverage ratio and total liabilities to tangible net worth to exclude such repurchases.

4th Amendment: On January 17, 2012, the Banks amended the Credit Agreement to allow the Company to purchase a promissory note, dated July 23, 2010, held by Hetra Secure Solutions Corporation on StingRay56.

5th Amendment: On March 5, 2012, the Banks amended the Credit Agreement to allow the Company to acquire StingRay56, Inc.

The outstanding balance of the line of credit at February 28, 2013 was $9.9 million and the balances of the term loans were $2.0 million and $2.6 million, respectively. These loans are secured by all assets and personal property of the Company and a limited guarantee of the Chief Executive Officer of $3.0 million. The $3.0 million term loan is secured by real estate property of the Company and a building owned by Southeastern Metro Savings, LLC, a company in which the Company's Chief Executive Officer is a minority officer. The building will continue to be in the collateral pool until such time as the note is sufficiently paid down or it is replaced by other collateral.

The agreement contains three covenants, as amended: a fixed charge coverage ratio, ratio of senior funded debt to earnings before interest, taxes, depreciation and amortization (EBITDA), and total liabilities to tangible net worth. The agreement also includes restrictions on the incurrence of additional debt or liens, investments (including Company stock, as amended), divestitures and certain other changes in the business. The Agreement expires on December 1, 2013. The interest rate on these loans is a floating LIBOR rate based on a fixed charge coverage ratio, minimum 4.0%, as defined in the loan documents.

The Company has a stock repurchase program, pursuant to which it was originally authorized to repurchase up to 1,632,500 shares of the Company's common stock in the open market. On July 8, 2009, the Board of Directors of the Company approved a one time continuation of the stock repurchase program, and authorized the Company to repurchase up to 1,000,000 additional shares of the Company's common stock, depending on the market price of the shares. There is no minimum number of shares required to be repurchased under the program. During the fiscal year ended February 28, 2013, the Company repurchased 22,031 shares at an average price of $4.10 per share, which were added to treasury shares on the consolidated balance sheet. Under this program, an additional 705,106 shares remain authorized to be repurchased by the Company at February 28, 2013. As discussed in Note 5, the Loan and Security Agreement executed by Company on December 23, 2010 included restrictions on investments that restricted further repurchases of stock under this program. On September 1, 2011, the Agreement was amended to allow the Company to repurchase a limited amount of the Company's common stock, equal to ten percent of the Company's net earnings after taxes subject to meeting certain share repurchase conditions.


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Transactions with Related Parties, Contractual Obligations, and Commitments

In conjunction with an agreement involving re-financing of the Company's lines of credit and Loan and Security Agreement, on June 29, 2006, the Company's CEO provided a $6.0 million subordinated term note to the Company with monthly principal payments of $33.3 thousand plus interest through July 2021. The interest rate on this note was equal to the prime rate plus one percent. Interest payments of $86.4 thousand were paid on this note in fiscal 2012. The note was secured by a general lien on all assets of the Company, subordinate to the lien held by the syndicate of RBC Bank and Community & Southern Bank. The Company repaid the remaining balance outstanding under this loan agreement on November 28, 2011 with consent from PNC Bank, formerly RBC Bank and Community & Southern Bank. The payoff was approximately $1.0 million.

The Company's CEO provides a portion of the collateral for one of the term loans with the consortium of PNC Bank, formerly RBC Bank and Community & Southern Bank. (see Note 5)

Contractual Obligations

Future contractual maturities of long-term debt (should the lender continue to
forebear and not call the debt under its original terms), future contractual
obligations due under operating leases, and other obligations at February 28,
2013 are as follows (in thousands):



                                                                  Payments due by period
                                                            Less than       1 - 3      3 - 5       More than
                                               Total         1 year         years      years        5 years
Long-term debt obligations                    $ 15,318     $    15,037     $    98     $  106     $        77
Interest obligations on long-term debt (a)       2,505           1,095         520        330             560
Operating lease obligations                      3,364           1,313       1,577        474              -
Purchase obligations                             5,026           5,026          -          -               -
Warranty reserve obligations                       220             220          -          -               -

Total                                         $ 26,433     $    22,691     $ 2,195     $  910     $       637

(a) This line item was calculated by utilizing the effective rate on outstanding debt as of February 28, 2013.

Off-Balance Sheet Arrangements

Effective March 1, 2011, the Company has an arrangement with RBC Bank and Community & Southern Bank allowing a building owned by the Chief Executive Officer to be used as part of the collateral on a $3.0 term loan with a consortium between RBC Bank and Community & Southern Bank.

Critical Accounting Estimates

Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations are based upon the Company's consolidated financial statements. These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the consolidated financial statements and related notes. The accounting policies that may involve a higher degree of judgments, estimates, and complexity include reserves on inventories, the allowance for bad debts, contract revenue recognition as well as profitability or loss recognition estimates and warranty reserves. The Company uses the following methods and assumptions in determining its estimates:

Reserves on inventories

Reserves on inventories result in a charge to operations when the estimated net realizable value declines below cost. Management regularly reviews the Company's investment in inventories for declines in value and establishes reserves when it is apparent that the expected net realizable value of the inventory falls below its carrying amount. Management attempts to determine by historical usage analysis and numerous other market factors, the projected demand for CRTs in this estimate of net realizable value. Management is able to identify consumer-buying trends, such as size and application, well in advance of . . .

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