Description
DGT Holdings corp. 10% Owner Holdings LLC SPH Group bought 26,629 shares on 10-18-2012 at $ 12.51
BUSINESS OVERVIEW
OPERATING SEGMENTS
The operating business that we report as a segment consists of the Power Conversion Group which was sold in the first quarter of fiscal year 2013. Our consolidated financial statements include a non-operating segment which covers unallocated corporate costs and a building in Italy. For the fiscal year ended July 28, 2012, two of our customers, DFAS and Raytheon Company, accounted for 10% or more of consolidated revenues. None of our business segments were dependent upon a single customer or a few customers.
POWER CONVERSION GROUP
Our Power Conversion Group designed, manufactured, marketed and sold high voltage precision components and sub-assemblies and electronic noise suppression components for a variety of applications. These products are utilized by original equipment manufacturers (“OEMs”) who build systems that are used in a broad range of markets. Our products were sold under the following industry brands: RFI, Filtron, Sprague and Stanley. This segment is comprised of electronic systems and components.
This segment designed and manufactured key electronic components such as transformers, magnetics, noise suppression filters and high voltage capacitors for use in precision regulated high voltage applications. Noise suppression filters and components are used to help isolate and reduce the electromagnetic interference (commonly referred to as “noise”) among the different components in a system sharing the same power source. Examples of systems that use our noise suppression products include aviation electronics, mobile and land-based telecommunication systems and missile guidance systems.
PRODUCTS
MILITARY APPLICATIONS – Through our relationships with many of the federal government’s top defense suppliers, such as Raytheon, Boeing, Lockheed Martin and Northrop Grumman, we supplied electronic components for various classified and unclassified programs including radar systems, guidance systems, weapons systems and communication electronics.
INDUSTRIAL APPLICATIONS – Our high voltage power components and EMI filters were used in many leading-edge high technology scientific and industrial applications by OEMs, universities and private research laboratories. Some industrial applications using high voltage subsystems include DNA sequencing, molecular analysis, printed circuit board inspection, structural inspection, food and mail sterilization and semiconductor capital equipment.
MARKETING, SALES AND DISTRIBUTION
We marketed our Power Conversion Group products through in-house sales personnel, independent sales representatives in the U.S., and international agents in Europe, Asia, the Middle East, Canada and Australia. Our sales representatives were compensated primarily on a commission basis and the international agents were compensated either on a commission basis or acted as independent distributors. Our marketing efforts emphasized our ability to custom engineer products to optimal performance specifications. We emphasized team selling where our sales representatives, engineers and management personnel all worked together to market our products. We also marketed our products through catalogs and trade journals and participation in industry shows. Sales of the Company’s products were typically on open account with 30 day terms. New accounts were established with cash on delivery or cash in advance terms.
RAW MATERIALS AND PRINCIPAL SUPPLIERS
The Power Conversion Group in most cases used two or more alternative sources of supply for each of its raw materials, which consisted primarily of electronic components and subassemblies, metal enclosures for its products and certain other materials. In certain instances, however, the Power Conversion Group used a single source of supply when directed by a customer or by need. In order to ensure the consistent quality of the Power Conversion Group’s products, the Company performed certain supplier evaluation and qualification procedures, and where possible, entered into strategic partnerships with its suppliers to assure a continuing supply of high quality critical components.
With respect to those items which were purchased from single sources, we believed that comparable items would be available in the event that there was a termination of our existing business relationships with any such supplier.
Actual experience could differ materially from this belief as a result of a number of factors, including the time required to locate an alternate source for the material.
The majority of the Power Conversion Group’s raw materials were purchased on open account from vendors pursuant to various individual or blanket purchase orders. Procurement lead times were such that the Company was not required to hold significant amounts of inventory in order to meet customer demand. The Company believed its sources of supply for the Power Conversion Group were adequate to meet its needs.
COMPETITION
Our Power Conversion Group competed with several small, privately owned suppliers of electronic systems and components. From our perspective, competition was primarily based on each company’s design, service and technical capabilities, and secondarily on price. Excluding the OEMs that manufacture their own components, based on market intelligence we gathered, we believed that we were among the top two or three in market share in supplying these products.
The markets for our products were subject to limited technological changes and gradually evolving industry requirements and standards. We believed that these trends would continue into the foreseeable future. Some of our current and potential competitors may have had substantially greater financial, marketing and other resources than we had. As a result, they may have been able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products than we could. Competition could increase if new companies entered the market or if existing competitors expanded their product lines or intensified efforts within existing product lines. Although we believed that our products were more cost-effective than those of our primary competitors, certain competing products may have had other advantages which may have limited our market.
PRODUCT DEVELOPMENT
We had a well developed engineering and technical staff in our Power Conversion Group. Our technical and scientific employees were generally employed in the engineering departments at our RFI business unit, and split their time, depending on business mix and their own technical background, between supporting existing production and development and research efforts for new product variations or new customer specifications. Our products included transformers, noise suppression filters and high voltage capacitors for use in precision regulated high voltage applications. Noise suppression filters and components are used to help isolate and reduce the electromagnetic interference (commonly referred to as “noise”) among the different components in a system sharing the same power source. Examples of systems that used our noise suppression products include aviation electronics, mobile and land-based telecommunication systems and missile guidance systems.
TRADEMARKS AND PATENTS
The majority of the Power Conversion Group’s products were based on technology that was not protected by patent or other rights. Within the Power Conversion Group, certain of our products and brand names were protected by trademarks, both in the U.S. and internationally.
GOVERNMENT REGULATION
We were subject to various U.S. government guidelines and regulations relating to the qualification of our non-medical products for inclusion in government qualified product lists in order to be eligible to receive purchase orders from a government agency or for inclusion of a product in a system which would ultimately be used by a governmental agency. We have had many years of experience in designing, testing and qualifying our products for sale to governmental agencies. Certain government contracts were subject to cancellation rights at the government’s election. We experienced no material termination of any government contract and are not aware of any pending terminations of government contracts.
SEASONALITY
Historically, revenue was typically lower during the first quarter of each fiscal year due to the shutdown of operations in our Bay Shore, New York facilities for part of August as a result of vacation schedules.
BACKLOG
Consolidated backlog for the Power Conversion Group at July 28, 2012 was $3.9 million versus backlog at July 30, 2011 of approximately $4.4 million. As of July 28, 2012, we believed that substantially all of the backlog would result in shipments within the next 12 to 15 months.
GEOGRAPHIC AREAS
For further information about Geographic areas the Company operated in, as well as other segment related disclosures, refer to Note 10 of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.
CEO BACKGROUND
T. Scott Avila has been a member of the Company’s Board since March 31, 2009. He has served as Managing Partner of CRG Partners, Group, a privately held professional services company since July 2007. Mr. Avila was also the Managing Partner of CRP Partners, Group, a privately held professional services company from July 2003 through July 2007. With more than 20 years of management and consulting experience, Mr. Avila brings to the Board considerable knowledge of financial and operational matters.
Jack L. Howard has been a member of the Company’s Board since September 21, 2011. Mr. Howard has been a registered principal of Mutual Securities, Inc., a FINRA registered broker-dealer, since 1989. Mr. Howard is currently the President of Steel Partners Holdings L.P. (“Steel Holdings”), a global diversified holding company that engages in multiple businesses through consolidated subsidiaries, associated companies and other interests. He is the President of Steel Partners LLC (“Steel Partners”), a global management firm, and has been associated with Steel Partners and its affiliates since 1993. Mr. Howard co-founded Steel Partners II, L.P. in 1993, a private investment partnership that is now a wholly-owned subsidiary of Steel Holdings. He has served as a director of Handy & Harman Ltd., a diversified industrial products manufacturing company, since July 2005. He has been a director of Steel Excel Inc., a publicly held company primarily focused on capital redeployment and identification of new business operations, since December 2007. Mr. Howard served as Chairman of the Board of a predecessor entity of Steel Holdings from June 2005 to December 2008, as a director from 1996 to December 2008 and its Vice President from 1997 to December 2008. From 1997 to May 2000, he also served as Secretary, Treasurer and Chief Financial Officer of Steel Holdings’ predecessor entity. Mr. Howard served as a director of SP Acquisition Holdings, Inc. (“SPAH”) from February 2007 until June 2007, and was Vice-Chairman from February 2007 until August 2007. He also served as Chief Operating Officer and Secretary of SPAH from June 2007 and February 2007, respectively, until October 2009. He currently holds the securities licenses of Series 7, Series 24, Series 55 and Series 63. As a result of these and other professional experiences, Mr. Howard is qualified to serve as a member of the Board due to his financial expertise and record of success as a director, chairman and top-level executive officer of numerous public companies.
General Merrill A. McPeak has been a member of the Company’s Board since April 27, 2005. General McPeak is the President of McPeak and Associates, a management-consulting firm he founded in 1995. General McPeak was Chief of Staff of the U.S. Air Force from November 1990 to October 1994, when he retired from active military service. General McPeak was for several years Chairman of ECC International Corp. He had long service as a director of several other public companies, including Tektronix, Inc. and Trans World Airlines, Inc. He also served as a director of Mathstar, Inc., QPC Lasers, Inc. and Gigabeam Corp. Currently, General McPeak is Chairman of the Board of Ethicspoint, Inc., a company providing confidential corporate governance compliance and whistleblower reporting services. He is a director of Miller Energy Resources, Inc., a public company engaged in oil and gas exploration, production and related property management. General McPeak has been a director of Point Blank Solutions, Inc., a designer and manufacturer of protective body armor, since August 2008. He is also a director of Genesis Biopharma, an early stage research-oriented company focused on immunotherapy for the treatment of Stage IV metastatic melanoma. General McPeak also currently serves as a director of Derycz Scientific, Inc. General McPeak received a Bachelor of Arts degree in economics from San Diego State College and a Master of Science degree in international relations from George Washington University. He is a member of the Council on Foreign Relations, New York City. General McPeak brings to the Board extensive experience in management consulting and a successful military career, including his position as Chief of Staff of the U.S. Air Force and a member of the Joint Chiefs of Staff, during which time he was the senior officer responsible for organization, training and equipage of a combined active duty, National Guard, Reserve and civilian work force of over 850,000 people serving at 1,300 locations in the United States and abroad and advised the Secretary of Defense, the National Security Council and the President of the United States. In 2010, President Obama appointed him to the American Battle Monuments Commission, and in 2011, the other commissioners elected him Chairman. The ABMC provides oversight for 24 overseas military cemeteries that provide final resting places for nearly 125,900 American war dead.
James A. Risher has been a member of the Company’s Board since April 27, 2005. On August 31, 2006, Mr. Risher became the President and CEO of the Company. On August 28, 2009, Mr. Risher resigned from his position as President and Chief Executive Officer of the Company effective August 31, 2009. Mr. Risher continues to serve as a director of the Company. Mr. Risher has been the Managing Partner of Lumina Group, LLC, a private company engaged in the business of consulting and investing in small and mid-size companies, since 1998. From February 2001 to May 2002, Mr. Risher served as Chairman and Chief Executive Officer of BlueStar Battery Systems International, Inc., a Canadian public company that is an e-commerce distributor of electrical and electronic products to selected automotive aftermarket segments and targeted industrial markets. From 1986 to 1998, Mr. Risher served as a director, Chief Executive Officer and President of Exide Electronics Group, Inc. (“Exide”), a global leader in the uninterruptible power supply industry. He also served as Chairman of Exide from December 1997 to July 1998. Mr. Risher has also been a director of SL Industries, Inc. since May 2003 and was a director of New Century Equity Holdings Corp., a holding company seeking to acquire a new business, from October 2004 to January 2010. As a former President and CEO of the Company and with previous experience in the management of several companies, Mr. Risher provides the Board with intimate knowledge of the Company and the industries in which it operates.
John J. Quicke was appointed as the Company’s President and Chief Executive Officer on September 1, 2009 and a member of the Company’s Board on September 17, 2009. Mr. Quicke is a Managing Director and operating partner of Steel Partners. Mr. Quicke has been associated with Steel Partners and its affiliates since September 2005. He has served as a director of Rowan Companies, Inc., a contract drilling company, since January 2009. He has served as a director of Steel Excel Inc. since December 2007 and as the Interim President and Chief Executive Officer since January 2010. He served as a director of Angelica Corporation, a provider of health care linen management services, from August 2006 to July 2008. Mr. Quicke served as Chairman of the Board of NOVT Corporation, a former developer of advanced medical treatments for coronary and vascular disease, from April 2006 to January 2008, and served as President and Chief Executive Officer of NOVT Corporation from April 2006 to November 2006. Mr. Quicke also served as a director of Layne Christensen Company, a provider of products and services for the water, mineral, construction and energy markets, from October 2006 to June 2007. He served as a director of Handy & Harman Ltd. from July 2005 to December 2010. Mr. Quicke continues to serve as a Vice President of Handy & Harman Ltd., a position he has held since July 2005. He served as a director, President and Chief Operating Officer of Sequa Corporation, a diversified industrial company, from 1993 to March 2004, and as Vice Chairman and Executive Officer of Sequa Corporation from March 2004 to March 2005. As Vice Chairman and Executive Officer of Sequa Corporation, Mr. Quicke was responsible for the Automotive, Metal Coating, Specialty Chemicals, Industrial Machinery and Other Product operating segments of the company. Mr. Quicke brings to the Board significant managerial experience and technical expertise, having served in senior management positions and as a director of several public companies, in addition to being a Certified Public Accountant and member of the AICPA.
During the Company’s fiscal year ended July 30, 2011, the Board held five (5) regularly scheduled and special meetings. During this period, all of the directors attended or participated in more than 75% of the aggregate of the total number of meetings of the Board and the total number of meetings held by all committees of the Board on which each such director served (during the periods during which such director served on such committee), except for Mr. Henderson, who attended one of two meetings of the Nominating Committee.
MANAGEMENT DISCUSSION FROM LATEST 10K
OVERVIEW
Prior the sale of our Villa Sistemi Medicali S.p.A. subsidiary (“Villa”) and our power conversion business (the “Power Conversion Business” or “Power Conversion Group”) operated by our RFI Corporation subsidiary (“RFI”), we were a leader in developing, manufacturing and marketing medical and dental imaging systems and power conversion subsystems and components worldwide. Our products included stationary and portable medical and dental diagnostic imaging systems and electronic systems and components such as electronic filters, transformers and capacitors.
On November 12, 2009, we sold our DynaRad product line and on November 24, 2009, we sold the remainder of our Del Medical U.S. business unit including our Del Medical and UNIVERSAL product lines. On November 3, 2011, we sold Villa. These businesses comprised the entire Medical Systems Group and are reported as discontinued operations in the financial statements of the Company and prior periods have been restated. See Note 2 of Notes to Consolidated Financial Statements in Part II, Item 8 “Financial Statements and Supplementary Data.”
On August 16, 2012, we sold our Power Conversion Business to EMS Development Corporation (“EMS”), a New York corporation and an affiliate of Ultra Electronics Defense, Inc. (“UEDI”), pursuant to the asset purchase agreement (the “Asset Purchase Agreement”), dated as of June 6, 2012, by and among UEDI, the Company and RFI. The sale of the Power Conversion Business was subject to the approval of our shareholders, which approval was obtained at the special meeting of shareholders held on August 15, 2012. In consideration for the sale of the Power Conversion Business, EMS paid an aggregate of $12,500 in cash. $1,250 of such amount is being held in escrow to serve as security for payments in satisfaction of certain of the Company’s and RFI’s indemnification obligations and $237 is being held in escrow to cover any potential net working capital adjustment. The sale of the Power Conversion Business will be reported as a gain from discontinued operations in our quarterly report on Form 10-Q for the first quarter of fiscal year 2013. See Note 16 of Notes to Consolidated Financial Statements in Part II, Item 8 “Financial Statements and Supplementary Data.” Consequently, our historical financial statements may not be indicative of future results.
The Company currently has a real estate business. The Company’s business is expected to consist primarily of capital redeployment and identification of new, profitable operations where it can utilize its existing working capital and maximize the use of the Company’s net operating losses.
CRITICAL ACCOUNTING POLICIES
Complete descriptions of significant accounting policies are outlined in Note 1 of the Notes to Consolidated Financial Statements included in Part II, Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. Within these policies, we have identified the accounting for revenue recognition, deferred income taxes, the allowance for obsolete and excess inventory and goodwill as having been critical accounting policies due to the significant amount of estimates involved. In addition, for interim periods, we have identified the valuation of finished goods inventory as being critical due to the amount of estimates involved.
REVENUE RECOGNITION
The Company recognizes revenue upon shipment, provided there is persuasive evidence of an arrangement, there are no uncertainties concerning acceptance, the sales price is fixed, collection of the receivable is probable and only perfunctory obligations related to the arrangement need to be completed.
The Company’s products are covered primarily by one year warranty plans and in some cases optional extended warranties for up to five years are offered. The Company establishes allowances for warranties on an aggregate basis for specifically identified, as well as anticipated, warranty claims based on contractual terms, product conditions and actual warranty experience by product line. The Company recognizes service revenue when repairs or out of warranty repairs are completed. These repairs are billed to the customers at market rates. The Company periodically evaluates the collectibility of their accounts receivable and provides an allowance for doubtful accounts when collection is not certain.
DEFERRED INCOME TAXES
The Company accounts for deferred income taxes in accordance with Accounting Standards Codification (“ASC”) 740 “Income Taxes” whereby we recognize deferred income tax assets and liabilities for temporary differences between financial reporting basis and income tax reporting basis and for tax credit carry forwards.
The Company periodically assesses the realization of our net deferred income tax assets. This evaluation is primarily based upon current operating results and expectations of future operating results. A valuation allowance is recorded if the Company believes its net deferred income tax assets will not be realized. Our determination is based on what we believe will be the more likely than not result.
During fiscal years 2012, 2011 and 2010, the Company’s discontinued foreign tax reporting entity was profitable and its U.S. tax reporting entities incurred a taxable loss. Based primarily on these results, the Company concluded that it should maintain a 100% valuation allowance on its net U.S. deferred tax assets. As of July 28, 2012, the Company continues to carry a 100% valuation allowance on its net U.S. deferred income tax assets.
The Company follows the provisions of ASC 740-10-25, formerly FASB Interpretation No. 48, “ Accounting for Uncertainty in Income Taxes ” (“FIN 48”) with respect to uncertain tax positions. The guidance specifies how tax benefits for uncertain tax positions are to be measured, recognized and disclosed in the financial statements. The Company recognizes penalties and interest, if any, related to the unrecognized tax obligations as a tax provision expense.
EXCESS AND OBSOLETE INVENTORY
We re-evaluate our allowance for obsolete inventory once a quarter, and this allowance comprises the most significant portion of our inventory reserves. The re-evaluation of reserves is based on a written policy, which requires at a minimum that reserves be established based on our analysis of historical actual usage on a part-by-part basis. In addition, if management learns of specific obsolescence in addition to this minimum formula, these additional reserves will be recognized as well. Specific obsolescence might arise due to a technological or market change, or based on cancellation of an order. As we typically do not purchase inventory substantially in advance of production requirements, we do not expect cancellation of an order to be a material risk. However, market or technology changes can occur.
VALUATION OF FINISHED GOODS INVENTORIES
In addition, we use certain estimates in determining interim operating results. The most significant estimates in interim reporting relate to the valuation of finished goods inventories. For certain subsidiaries, for interim periods, we estimate the amount of labor and overhead costs related to finished goods inventories. These estimates are revised based on actual results at year end. As of July 28, 2012, finished goods represented 8.3% of the gross carrying value of our total gross inventory. We believe the estimation methodologies used are appropriate and are consistently applied.
GOODWILL
The Company’s goodwill was subject to, at a minimum, an annual fourth fiscal quarter impairment assessment of its carrying value. Goodwill impairment was deemed to exist if the net book value of a reporting unit exceeded its estimated fair value. Estimated fair values of the reporting units were estimated using an earnings model and a discounted cash flow valuation model. The discounted cash flow model incorporated the Company’s estimates of future cash flows, future growth rates and management’s judgment regarding the applicable discount rates used to discount those estimated cash flows.
The Company’s fiscal 2011 impairment assessment on its Villa reporting unit did not suggest impairment. The assets of Villa were sold at a gain of $6,837.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s sources of capital include, but are not limited to, cash on hand, cash flow from operations and short-term credit facilities. We believe that available short-term and long-term capital resources are sufficient to fund our working capital requirements, scheduled debt payments, interest payments, capital expenditures and income tax obligations for the next 12 months.
FISCAL 2012 COMPARED TO FISCAL 2011
Working Capital — At July 28, 2012 and July 30, 2011, our working capital was approximately $45,193 and $38,147, respectively. The increase in working capital for fiscal 2012 as compared to fiscal 2011 related primarily to the net proceeds from the sale of Villa of $22,194 during the second quarter of fiscal 2012. At July 28, 2012 and July 30, 2011, the Company had $44,956 and $23,629 in cash and cash equivalents and marketable securities, respectively. This increase is due to the proceeds from the sale of Villa during fiscal 2012.
On October 13, 2010, following approval by shareholders at a special meeting, the Company filed with the New York Secretary of State an amendment to the Company’s Certificate of Incorporation to increase the number of shares of Common Stock authorized for issuance by the Company from 50,000,000 to 100,000,000.
The Company completed its rights offering in December 2010 and raised $14,340, net of expenses of the offering.
Cash Flows from Operating Activities — For the year ended July 30, 2011, the Company provided $5,009 of cash from operations, compared to $6,205 in the prior fiscal year. The decrease is largely due to an increase in trade accounts payable and accrued expenses, offset by increases in receivables and inventories in the discontinued operations.
Cash Flows from Investing Activities – The Company made $52 in facility improvements and capital equipment expenditures for the fiscal year ended July 30, 2011, compared to $568 in the prior fiscal year period. Discontinued operations had capital expenditures of $258 in fiscal 2011 compared to $280 in the prior year period.
Cash Flows from Financing Activities – During the year ended July 31, 2011, the Company completed a Rights Offering which provided $14,340, net of expenses. The Company also received proceeds of $2,500 for a mortgage on its Bay Shore, NY facility. In addition, $2,474 of long-term debt related to discontinued operations was repaid, including the $1,117 for the purchase price of the manufacturing facility in Milan, Italy at the conclusion of its lease in April 2011. During the year ended July 31, 2010, the Company repaid $7,400 of indebtedness on its revolving loan agreement and $1,566 of long term debt in discontinued operations.
OFF BALANCE SHEET COMMITMENTS AND ARRANGEMENTS
The Company has not had any investments in unconsolidated variable interest entities or other off balance sheet arrangements during any of the periods presented in this Annual Report on Form 10-K.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
OVERVIEW
The Company manufactures proprietary high-voltage power conversion systems including electronic filters, high voltage capacitors, pulse modulators, transformers and reactors, and a variety of other products designed for industrial, medical, military and other commercial applications. The Company manages its business in one operating segment: the Power Conversion Group. In addition, the Company has a second reportable segment, Other, comprised of certain unallocated corporate General and Administrative expenses and the building in Italy that was retained on the sale of Villa. See Note 8 of the Notes to the Unaudited Financial Statements in this Quarterly Report on Form 10-Q for discussion of the Company’s segments.
On November 3, 2011, the Company sold Villa Sistemi Medicali S.p.A. (“Villa”), its Italian subsidiary, which comprised the Medical Systems Group. It is reflected as a discontinued operation in the financial statements of the Company and prior periods have been restated. See Note 2 of the Notes to the Unaudited Financial Statements in this Quarterly Report on Form 10-Q for details.
On June 6, 2012, the Company, along with its RFI Corporation subsidiary (“RFI”), entered into an asset purchase agreement (the “Asset Purchase Agreement”) with Ultra Electronics Defense, Inc. (the “Purchaser”), an affiliate of Ultra Electronics Holdings plc, a UK corporation.
Under the terms of the Asset Purchase Agreement, the Company has agreed to sell (the “Asset Sale”) its power conversion business, which is currently operated by RFI, to the Purchaser for the purchase price of $12,500 (the “Purchase Price”) (subject to a potential working capital adjustment), payable in cash. $1,250 of the Purchase Price is to be held in escrow to serve as security for payments in satisfaction of certain of the Company’s indemnification obligations and $237 of the Purchase Price is to be held in escrow to cover any potential net working capital adjustment. The Purchaser has also agreed to lease the RFI facility in Bay Shore, New York following the Asset Sale.
The obligations of each of the parties to consummate the Asset Sale are subject to customary conditions, including, among other things, the conclusion of a review by the Committee on Foreign Investment in the United States with respect to national security concerns, the approval of at least two-thirds of the outstanding shares of our common stock, and the exercise by the holders of no more than 10% of the outstanding shares of our common stock of their statutory appraisal or dissenters’ rights with respect to the Asset Sale. The Company has agreed to pay to the Purchaser a termination fee of $725 in the event the Asset Purchase Agreement is terminated under certain circumstances.
CRITICAL ACCOUNTING POLICIES
Complete descriptions of significant accounting policies are outlined in Note 1 of the Notes to Financial Statements included in our Form 10-K. Within these policies, the Company has identified the accounting for revenue recognition, deferred tax assets and the allowance for excess and obsolete inventory as being critical accounting policies due to the significant amount of estimates involved. In addition, for interim periods, the Company has identified the valuation of finished goods inventory as being critical due to the amount of estimates involved.
Revenue Recognition
The Company recognizes revenue upon shipment, provided there is persuasive evidence of an arrangement, there are no uncertainties concerning acceptance, the sale price is fixed, collection of the receivable is probable and only perfunctory obligations related to the arrangement need to be completed. The Company’s products are covered primarily by ninety day warranty plans and in some cases optional extended warranties for a period of up to one year are offered. The Company establishes allowances for warranties on an aggregate basis for specifically identified, as well as anticipated, warranty claims based on contractual terms, product conditions and actual warranty experience by product line. The Company recognizes service revenue when repairs or out of warranty repairs are completed. These repairs are billed to the customers at market rates. The Company periodically evaluates the collectability of their accounts receivable and provides an allowance for doubtful accounts when collection is not certain.
Deferred Income Taxes
The Company accounts for deferred income taxes in accordance with ASC 740, “Income Taxes,” whereby we recognize deferred income tax assets and liabilities for temporary differences between financial reporting basis and income tax reporting basis and for tax credit carryforwards.
The Company periodically assesses the realization of its net deferred income tax assets. This evaluation is primarily based upon current operating results and expectations of future operating results. A valuation allowance is recorded if the Company believes its net deferred income tax assets will not be realized. The Company’s determination is based on what it believes will be the more likely than not result.
For fiscal year 2011 the Company’s foreign tax reporting entity (which is classified as discontinued operations) was profitable, and its U.S. tax reporting entities incurred a taxable loss. Based primarily on these results, the Company concluded that it should maintain a 100% valuation allowance on its net U.S. deferred income tax assets. For the quarter ended April 28, 2012, the Company continues to carry a 100% valuation allowance on its net U.S. deferred income tax asset.
Excess and Obsolete Inventory
We re-evaluate our allowance for obsolete inventory once a quarter, and this allowance comprises the most significant portion of our inventory reserves. The re-evaluation of reserves is based on a written policy, which requires at a minimum that reserves be established based on our analysis of historical actual usage on a part-by-part basis. In addition, if management learns of specific obsolescence in addition to this minimum formula, these additional reserves will be recognized as well. Specific obsolescence might arise due to a technological or market change, or based on cancellation of an order. As we typically do not purchase inventory substantially in advance of production requirements, we do not expect cancellation of an order to be a material risk. However, market or technology changes can occur.
Valuation of Finished Goods Inventory
In addition, we use certain estimates in determining interim operating results. The most significant estimates in interim reporting relate to the valuation of finished goods inventories. For interim periods, we estimate the amount of labor and overhead costs related to finished goods inventories. As of April 28, 2012, finished goods represented approximately 8.6% of the gross carrying value of our total gross inventory. We believe the estimation methodologies used are appropriate and are consistently applied.
Total operating expenses in the first nine months of fiscal 2012 were $3,978, or 46.4% of sales, compared to $3,322, or 44.5% of sales in the same period of the prior year. The increase is primarily due to stock compensation expense (see Note 9 of Notes to Financial Statements) and legal fees related to the pending sale of the RFI business.
Operating loss for the fiscal 2012 third quarter was $478 compared to an operating loss of $279 in the third quarter of fiscal 2011. The Power Conversion Group had operating income of $141 in the fiscal 2012 third quarter, compared to an operating income of $121 in the comparable period of last year. The Other segment, consisting of unallocated corporate expenses and the building in Italy, had an operating loss for the third quarter of fiscal 2012 totaled $619 as compared to $400 in the third quarter of the prior year.
Operating loss for the first nine months of fiscal 2012 was $1,156 compared to an operating loss of $1,679 in the first nine months of the prior year. The Power Conversion Group had an operating income of $478 in the first nine months of fiscal 2012, compared to an operating loss of $464 in the same period of the prior year. The Other segment had an operating loss for the first nine months of fiscal 2012 were $1,634 compared to $1,215 in the first nine months of fiscal 2011.
Loss from continuing operations in the third quarter of fiscal 2012 was $439, or $0.11 per basic and diluted share, compared to a loss from continuing operations of $270, or $0.07 per basic and diluted share in the prior year period. For the third quarter of fiscal 2012, there were 3.8 million weighted average diluted common shares outstanding (“shares outstanding”), compared to 3.8 million in the third quarter of fiscal 2011.
Loss from continuing operations in the first nine months of fiscal 2012 was $1,111, or $0.29 per basic and diluted share, compared to a loss from continuing operations of $1,716, or $0.62 per share, in the comparable prior year period. For the first nine months of fiscal 2012, there were 3.8 million weighted average diluted common shares outstanding, compared to 2.8 million in the first nine months of fiscal 2011. The shares outstanding have been restated to reflect the reverse and forward stock splits effected in January 2011.
Discontinued operations had no activity during the third quarter of fiscal 2012, compared to a net loss of $80 in the third quarter of fiscal 2011 on sales of $9,920. The Villa subsidiary was sold on November 3, 2011.
Discontinued operations had net income of $1,230 during the first nine months of fiscal 2012 on sales of $16,714, compared to net income of $2,769 in the first nine months of the prior fiscal year on sales of $45,581. The Villa subsidiary was sold on November 3, 2011 and the fiscal 2012 results only include four months of activity compared to nine months in the prior year. The prior fiscal year first quarter sales included unusually high volume that was not repeated in fiscal year 2012.
A net gain on the sale of Villa of $6,837 was recognized during the first nine months of fiscal 2012.
Net loss for the third quarter of fiscal 2012, was $439, or $0.11 per basic and diluted share, compared to net loss of $350, or $0.09 per basic and diluted share in the comparable prior year period. Net income for the first nine months of fiscal 2012 was $6,956, or $1.81 per basic and diluted share, which includes the gain on the disposal of Villa, compared to net income of $1,053, or $0.38 per basic and diluted share, in the first nine months of fiscal 2011.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The Company’s sources of capital include, but are not limited to, cash flow from operations. We believe that available short-term and long-term capital resources are sufficient to fund our working capital requirements, scheduled debt payments, interest payments, capital expenditures and income tax obligations for the next 12 months.
Working Capital — At April 28, 2012 and July 30, 2011, our working capital was approximately $47,305 and $38,147, respectively. The increase in working capital for the first nine months of fiscal 2012 related primarily to proceeds from the sale of Villa. At April 28, 2012 and July 30, 2011, the Company had approximately $43,276 and $23,629, respectively in unrestricted cash.
On October 13, 2010, following approval by shareholders at a special meeting, the Company filed with the New York Secretary of State an amendment to the Company’s Certificate of Incorporation to increase the number of shares of common stock authorized for issuance by the Company from 50,000,000 to 100,000,000.
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Fund Letters
