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ASTRO MED INC /NEW/ - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Overview Astro-Med is a multi-national enterprise, that designs, develops, manufactures, distributes and services a broad range of products that acquire, store, analyze and present data in multiple formats. The Company organizes its structure around a core set of competencies, including research and development, manufacturing, service, marketing and distribution. It markets and sells its products and services through the following two sales product groups: • QuickLabel Systems Product Group (QuickLabel)-offers label printer hardware, labeling software, servicing contracts, and label and ink consumable products that digitally print color labels on a broad range of label and tag substrates. • Test and Measurement Product Group (T&M)-offers a suite of ruggedized printer products designed primarily for military and commercial aerospace applications to be used in the aerospace and defense industry to print weather maps, communications and other critical flight information. T&M also comprises a suite of telemetry recorder products sold to the aerospace and defense industries, as well as portable data acquisition recorders, which offer diagnostic and test functions to a wide range of manufacturers including automotive, energy, paper and steel fabrication. On January 22, 2014, Astro-Med completed the acquisition of the ruggedized printer product line from Miltope Corporation (Miltope), a company of VT Systems, which is engaged in the design, development, manufacture and testing of ruggedized computers and computer peripheral equipment for military, industry and commercial applications. Astro-Med's ruggedized printer product line is part of the Test & Measurement (T&M) product group and is reported as part of the T&M segment. The results of the Miltope's ruggedized printer product line operations since the acquisition date have been included in the consolidated financial statements of the Company. On January 31, 2013, the Company completed the sale of substantially all of the assets of its Grass Technologies Product Group (Grass) in order to focus on its existing core businesses. Grass manufactured polysomnography and electroenecephalography systems for both clinical and research use along with the related accessories and proprietary electrodes. Consequently, the Company has classified the results of operations of its Grass segment as discontinued operations for all periods presented. Astro-Med markets and sells its products and services globally through a diverse distribution structure of direct sales personnel, manufacturer's representatives and authorized dealers that deliver a full complement of branded products and services to customers in our respective markets. 15 -------------------------------------------------------------------------------- Table of Contents Our growth strategy centers on organic growth through product innovation made possible by research and development initiatives, as well as strategic acquisitions that fit into existing core businesses. Research and development activities are funded and expensed by the Company at approximately 7.4% of annual sales for fiscal 2014. We also continue to invest in sales and marketing initiatives by expanding the existing sales force and using various marketing campaigns to achieve our goals of sales growth and increased profitability notwithstanding today's challenging economic environment. Results of Operations The following table presents the net sales of each of the Company's segments, as well as the percentage of total sales and change from prior year. As previously noted, the Company's Grass segment has been classified as a discontinued operation and therefore not presented in the table or discussion below. ($ in thousands) 2014 2013 Net As a % of % Change Net As a % of Sales Total Net Sales Over Prior Year Sales Total Net Sales T&M $ 19,527 28.5 % 10.7 % $ 17,636 28.8 % QuickLabel 49,065 71.5 % 12.6 % 43,588 71.2 % Total $ 68,592 100.0 % 12.0 % $ 61,224 100.0 % Fiscal 2014 compared to Fiscal 2013 Astro-Med's sales in fiscal 2014 were $68,592,000, a 12.0% increase as compared to prior year sales of $61,224,000. Domestic sales of $48,679,000 increased 9.1% from the prior year sales of $44,613,000. International sales of $19,913,000 includes an favorable impact of $227,000 due to foreign exchange rates and reflects a 19.9% increase as compared to the prior year. Hardware sales in fiscal 2014 were $28,301,000, a 12.4% increase as compared to prior year's sales of $25,169,000. Both product segments achieved double-digit growth in the current year, with QuickLabel's hardware sales up 13.7% and T&M's hardware sales up 11.7%. The primary drivers of this increase relate to increases in T&M's Ruggedized and TMX product lines and increases in sales from QuickLabel's new Kiaro! product line. The increase in the current year's hardware sales was tempered by lower sales of QuickLabel's Vivo! and Zeo! product lines as well as a decline in sales of T&M's Dash recorder and data acquisition product lines. Consumable sales in fiscal 2014 were $36,317,000, representing an 11.6% increase as compared to prior year sales of $32,540,000. The key driver of the overall increase in consumable sales for the current fiscal year was primarily traceable to the double-digit increase in both digital color printer supplies and label and tag product sales in the QuickLabel segment. The increase in consumable product sales for the current year was tempered by a 5.6% decline in sales of QuickLabel's thermal transfer ribbon products. Service and other sales revenue in fiscal 2014 were $3,974,000, a 13.1% increase compared to prior year sales of $3,515,000 due to increases in service and parts revenue. The Company achieved $26,983,000 in gross profit for fiscal 2014 and generated a gross profit margin of 39.3%, an increase as compared to prior year's gross profit margin of 38.8%. The increase in gross profit margin for the current year is due to favorable product mix. Operating expenses for the current year were $25,450,000, representing a 22.3% increase from prior year's operating expenses of $20,802,000. Specifically, selling and marketing expenses increased 19.0% from prior year to $14,774,000 in fiscal 2014, representing 21.5% of sales, an increase as compared to the prior year's 20.3% of sales. The increase in selling and marketing was primarily the result of increases in personnel cost and marketing expenditures, as well as an increase in travel costs for the period. General and administrative (G&A) expenses increased 22.5% from prior year to $5,604,000 in fiscal 2014. The higher G&A expense in the current year as 16 -------------------------------------------------------------------------------- Table of Contents compared to the prior year was primarily due to the cost related to a non-compete agreement entered into with the Company's former CEO, as well as an increase in wages and benefits and an increase in professional fees spending including professional fees associated with the Miltope acquisition. Funding of research & development (R&D) in fiscal 2014 has increased 32.9% to $5,072,000. The increase in R&D for fiscal 2014 is primarily due to increased costs related to outside R&D testing for the avionic printers for the current year and continued investments in the QuickLabel's line of color printers. The R&D spending level for fiscal 2014 represents 7.4% of net sales, an increase as compared to prior year's level of 6.2%. Other expense in fiscal 2014 was $121,000 as compared to $41,000 in fiscal 2013. This increase for the current year is primarily the result of an increase in foreign exchange loss recognized in the current year. Astro-Med's fiscal 2014 pretax income was reduced by approximately $562,000 related to stock-based compensation expense as compared to fiscal 2013 pretax income, which was reduced by approximately $480,000 in stock-based compensation expense. During fiscal 2014, the Company recognized income tax expense on income from continuing operations of $175,000 and had an effective tax rate of 12.4%. This compares to an income tax expense on income from continuing operations of $847,000 in fiscal 2013 and related effective tax rate of 29.4%. Included in the current year income tax expense is a benefit of $500,000 related to a ASC 740 adjustment as well as foreign and state rate adjustments. Income from continuing operations for fiscal 2014 was $1,237,000, providing a return of 1.8% on sales and generating an EPS of $0.16 per diluted share and includes: (1) an expense of $359,000, equal to $0.05 per diluted share, related to a non-compete agreement entered into with the Company's former CEO and (2) a net expense of $205,000, equal to $0.03 per diluted share, related to product replacement costs recognized in the first quarter pertaining to replacing components on certain of T&M's ruggedized printers after the Company discovered that one of its suppliers was using a non-conforming part in certain models. On a comparative basis, fiscal 2013 income from continuing operations was $2,038,000, providing a return of 3.3% on sales and generating $0.27 per diluted share. Discontinued Operation On January 31, 2013, the Company completed the sale of substantially all of the assets of its Grass Technologies Product Group (Grass) for a purchase price of $18,600,000 of which $16,800,000 was recognized in fiscal 2013 and the remaining $1,800,000, which had been held in escrow at the closing date, has been recognized in fiscal 2014 as part of the gain on the sale of Grass. The Company has classified the results of operations of its Grass segment as discontinued operations for all periods presented. Results for discontinued operations are as follows: ($ in thousands) 2014 2013 Net Sales $ 8,401 $ 19,195 Gross Profit $ 1,048 $ 10,123 Gain on Sale of Assets of Discontinued Operations $ 1,800 $ 10,162 Income from Discontinued Operations, net of taxes $ 1,975 $ 8,729 17 -------------------------------------------------------------------------------- Table of Contents Segment Analysis ($ in thousands) Astro-Med reports two segments consistent with its sales product groups: Test & Measurement (T&M) and QuickLabel Systems (QuickLabel). Segment performance is evaluated based on the operating segment's profit before corporate and financial administration expenses. The following table summarizes selected financial information by segment. As previously noted, the Company's Grass segment has been classified as a discontinued operation for all periods presented. Segment Operating Profit as ($ in thousands) Net Sales Segment Operating Profit a % of Net Sales 2014 2013 2014 2013 2014 2013 T&M $ 19,527 $ 17,636 $ 2,655 $ 3,109 13.6 % 17.6 % QuickLabel 49,065 43,588 5,154 4,380 10.5 % 10.0 % Total $ 68,592 $ 61,224 7,809 7,489 11.4 % 12.2 % Product Replacement Related Costs 672 - Corporate Expenses 5,604 4,563 Operating Income 1,533 2,926 Other Expense, Net 121 41 Income from Continuing Operations Before Income Taxes 1,412 2,885 Income Tax Provision for Continuing Operations 175 847 Income from Continuing Operations 1,237 2,038 Income from Discontinued Operations, Net of Taxes 1,975 8,729 Net Income $ 3,212 $ 10,767 Test & Measurement T&M's sales increased 10.7% in fiscal 2014 to $19,527,000 from $17,636,000 in the prior year. The increase is primarily due to the 19.8% growth in the Ruggedized printer product line due to the continued increase in contract sales. Also contributing to the increase in sales was the continued increase in demand for the TMX product line, as current year sales grew 19.3% as compared to the prior year. The current year sales increase is tempered by declining sales in the legacy data acquisition and recorder product lines as compared to the prior year. T&M's segment operating profit was $2,655,000 in fiscal 2014, reflecting a profit margin of 13.6%, a decline as compared to the prior year's segment operating profit of $3,109,000 and related profit margin of 17.6%. The fiscal 2014 decrease in operating profit and related margin is due to product mix and higher R&D expenses. QuickLabel Systems QuickLabel Systems sales increased 12.5% in fiscal 2014 with sales of $49,065,000 compared to sales of $43,588,000 in the prior year. The increase in sales is due to both the hardware and consumables product lines which increased 13.7% and 11.6%, respectively, from the prior year. The increases are attributable to the increased demand for digital color printer supplies, as well as for label and tag products. Also contributing to the current quarter increase was the new Kario! product line sales, which more than doubled compared to the prior year. These sales increases were slightly tempered by the decrease in sales of the Vivo! and Zeo! product lines. QuickLabel's current year's segment operating profit was $5,154,000, reflecting a profit margin of 10.5%, an increase from prior year's segment profit of $4,380,000 and related profit margin of 10.0%. The increase in QuickLabel's current year's segment operating profit and related margin is primarily due to higher sales and favorable product mix. 18 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources The Company expects to finance its future working capital needs, capital expenditures and acquisition requirements through internal funds and believes that cash provided by operations will be sufficient to meet our operating and capital needs for at least the next twelve months. To the extent our capital and liquidity requirements are not satisfied internally, we may utilize a $10.0 million revolving bank line of credit, all of which is currently available. Borrowings under this line of credit bear interest at either a fluctuating rate equal to 75 basis points below the base rate, as defined in the agreement, or at a fixed rate equal to 150 basis points above LIBOR. Astro-Med's Statements of Cash Flows for the two years ended January 31, 2014 and 2013 are included on page 37. Net cash flows used by operating activities was $3,567,000 in the current year compared to net cash provided by operating activities of $3,863,000 in the previous year. The decrease in net cash flow from operations for the current year is related to income tax payments made in connection with the gain on the sale of Grass Technologies, as well as increased working capital requirements, as both the accounts receivable and inventory balances increased during the current year. The accounts receivable collection cycle increased to 54 days sales outstanding at January 31, 2014 compared to 51 days outstanding at prior year end. Inventory days on hand increased to 113 days at the end of the current fiscal year from 109 days at prior year end. Net cash flow used by investing activities for fiscal 2014 was $18,090,000, which includes $10,230,000 to purchase securities and $6,732,000 used for the acquisition of the ruggedized printer product line from Miltope. Cash used for investing activities for fiscal 2014 also included cash used for capital expenditures of approximately $1,128,000, including $647,000 for information technology, $202,000 for machinery and equipment, $165,000 for land and building improvements, $99,000 for tools and dies, and $15,000 for furniture and fixtures and other capital expenditures. Included in net cash flow used by financing activities for fiscal 2014 were dividends paid of $2,103,000. Dividends paid in fiscal 2013 were $2,595,000. The Company's annual dividend per share was $0.28 in fiscal 2014 and $0.35 in fiscal 2013. The Company has not repurchased any shares of its common stock in fiscal 2014; however, since the inception of the common stock buy back program in fiscal 1997, the Company has repurchased a total of 1,530,000 shares of its common stock. At January 31, 2014, the Company's Board of Directors has authorized the purchase of an additional 390,000 shares of the Company's common stock in the future. Contractual Obligations, Commitments and Contingencies Astro-Med is subject to contingencies, including legal proceedings and claims arising out of its businesses that cover a wide range of matters, such as: contract and employment claims; workers compensation claims; product liability claims; warranty claims; and claims related to modification, adjustment or replacement of component parts of units sold. While it is impossible to ascertain the ultimate legal and financial liability with respect to contingent liabilities, including lawsuits, we believe that the aggregate amount of such liabilities, if any, in excess of amounts provided or covered by insurance, will not have a material adverse effect on our consolidated financial position or results of operations. It is possible, however, that results of operations for any particular future period could be materially affected by changes in our assumptions or strategies related to these contingencies or changes out of the Company's control. Critical Accounting Policies and Estimates Astro-Med's discussion and analysis of financial condition and results of operations are based upon the Company's Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Certain of our accounting policies require the application of judgment in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. We periodically evaluate the judgments and estimates used for our critical accounting policies to ensure that such judgments and estimates are reasonable for our 19 -------------------------------------------------------------------------------- Table of Contents interim and year-end reporting requirements. These judgments and estimates are based on the Company's historical experience, current trends and information available from other sources, as appropriate. If different conditions result from those assumptions used in our judgments, the results could be materially different from our estimates. We believe the following are our most critical accounting policies as they require significant judgments and estimates in the preparation of our financial statements: Revenue Recognition: Our product sales are recognized when all of the following criteria have been met: persuasive evidence of an arrangement exists; price to the buyer is fixed or determinable; delivery has occurred and legal title and risk of loss have passed to the customer; and collectability is reasonably assured. When other significant obligations remain after products are delivered, revenue is recognized only after such obligations are fulfilled. Returns and customer credits are infrequent and are recorded as a reduction to sales. Rights of return are not included in sales arrangements. Revenue associated with products that contain specific customer acceptance criteria is not recognized before the customer acceptance criteria are satisfied. When a sale arrangement involves training or installation, the deliverables in the arrangement are evaluated to determine whether they represent multiple element arrangements. This evaluation occurs at inception of the arrangement and as each item in the arrangement is delivered. The total fee from the arrangement is allocated to each unit of accounting based on its relative fair value. Fair value for each element is established generally based on the sales price charged when the same or similar element is sold separately. We allocate revenue to each element in our multiple-element arrangements based upon their relative selling prices. We determine the selling price for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on our vendor specific objective evidence (VSOE) if available, third-party evidence (TPE) if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. Revenue allocated to each element is then recognized when the basic revenue recognition criteria for that element have been met. The amount of product revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements. Astro-Med recognizes revenue for non-recurring engineering (NRE) fees, as necessary, for product modification orders upon completion of agreed-upon milestones. Revenue is deferred for any amounts received prior to completion of milestones. Certain of our NRE arrangements include formal customer acceptance provisions. In such cases, we determine whether we have obtained customer acceptance for the specific milestone before recognizing revenue. Infrequently, the Company receives requests from customers to hold product being purchased from us for the customers' convenience. We recognize revenue for such bill and hold arrangements provided the transaction meets the following criteria: a valid business purpose for the arrangement exists; risk of ownership of the purchased product has transferred to the buyer; there is a fixed delivery date that is reasonable and consistent with the buyer's business purpose; the product is ready for shipment; the payment terms are customary; we have no continuing performance obligation in regards to the product; and the product has been segregated from our inventories. Warranty Claims and Bad Debts: Provisions for the estimated costs for future product warranty claims and bad debts are recorded in cost of sales and general and administrative expense, respectively, at the time a sale is recorded. The amounts recorded are generally based upon historically derived percentages while also factoring in any new business conditions that might impact the historical analysis such as new product introduction for warranty and bankruptcies of particular customers for bad debts. We also periodically evaluate the adequacy of our reserves for warranty and bad debts recorded in its consolidated balance sheet as a further test to ensure the adequacy of the recorded provisions. Warranty and bad debt analysis often involves subjective analysis of a particular customer's ability to pay. As a result, significant judgment is required in determining the appropriate amounts to record and such judgments may prove to be incorrect in the future. We believe that our procedures for estimating such amounts are reasonable and historically have not resulted in material adjustments in subsequent periods when the estimates are adjusted to the actual amounts. Inventories: Inventories are stated at the lower of cost (first-in, first-out) or market. The Company records provisions to write-down obsolete and excess inventory to its estimated net realizable value. The process for evaluating obsolete and excess inventory consists of analyzing the inventory supply on hand and estimating the 20 -------------------------------------------------------------------------------- Table of Contents net realizable value of the inventory based on historical experience, current business conditions and anticipated future sales. We believe that our procedures for estimating such amounts are reasonable and historically have not resulted in material adjustments in subsequent periods when the estimates are adjusted to actual experience. Income Taxes: A valuation allowance is established when it is "more-likely-than-not" that all or a portion of deferred tax assets will not be realized. A review of all available positive and negative evidence must be considered, including our performance, the market environment in which we operate, length of carryforward periods, existing sales backlog and future sales projections. If actual factors and conditions differ materially from the estimates made by management, the actual realization of the net deferred tax assets or liabilities could vary materially from the amounts previously recorded. At January 31, 2014, the Company has provided valuation allowances for future tax benefits resulting from certain R&D tax credits which could expire unused. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions. Although guidance on the accounting for uncertain income taxes prescribes the use of a recognition and measurement model, the determination of whether an uncertain tax position has met those thresholds will continue to require significant judgment by management. If the ultimate resolution of tax uncertainties is different from what we have estimated, our income tax expense could be materially impacted. Long-Lived Assets, Intangible Assets and Goodwill: The impairment of long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the asset. Management evaluates the recoverability of goodwill annually or more frequently if events or changes in circumstances, such as declines in sales, earnings or cash flows, or material adverse changes in the business climate, indicate that the carrying value of an asset might be impaired. Goodwill is first qualitatively assessed to determine whether further impairment testing is necessary. Factors that management considers in this assessment include macroeconomic conditions, industry and market considerations, overall financial performance (both current and projected), changes in management and strategy and changes in the composition or carrying amount of net assets. If this qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a two step process is then performed. Step one compares the fair value of the reporting unit with its carrying value, including goodwill. If the carrying amount exceeds the fair value of the reporting unit, step two is required to determine if there is an impairment of the goodwill. Step two compares the implied fair value of the reporting unit goodwill to the carrying amount of the goodwill. We estimate the fair value of our reporting units using the income approach based upon a discounted cash flow model. We believe that this approach is appropriate because it provides a fair value estimate based upon the reporting unit's expected long-term operating cash flow performance. In addition, we use the market approach, which compares the reporting unit to publicly-traded companies and transactions involving similar business, to support the conclusions based upon the income approach. The income approach requires the use of many assumptions and estimates including future revenue, expenses, capital expenditures, and working capital, as well as discount factors and income tax rates. Share-Based Compensation: Share-based compensation expense is based on the estimated fair value of the share-based award when granted. We have estimated the fair value of each option on the date of grant using the Black-Scholes option-pricing model. Our estimate of share-based compensation requires a number of complex and subjective assumptions including our stock price volatility, employee exercise patterns (expected life of the options), the risk free interest rate and the Company's dividend yield. The stock price volatility assumption is based on the historical weekly price data of our common stock over a period equivalent to the weighted average expected life of our options. Management evaluated whether there were factors during that period which were unusual and would distort the volatility figure if used to estimate future volatility and concluded that there were no such factors. In determining the expected life of the option grants, the Company has observed the actual terms of prior grants with similar characteristics and the actual vesting schedule of the grant and has assessed the 21 -------------------------------------------------------------------------------- Table of Contents expected risk tolerance of different option groups. The risk-free interest rate used in the model is based on the actual U.S. Treasury zero coupon rates for bonds matching the expected term of the option as of the option grant date. The dividend assumption is based upon the prior year's average dividend yield. No compensation expense is recognized for options that are forfeited for which the employee does not render the requisite service. Our accounting for share-based compensation for restricted stock awards ("RSA") and restricted stock units ("RSU") is also based on the fair value method. The fair value of the RSUs and RSAs is based on the closing market price of the Company's common stock on the grant date of the RSU or RSA. Recent Accounting Pronouncements Reference is made to Note 1 of our Consolidated Financial Statements included herein. |