February 3, 1999 (Part 2)
Results of Operations
Three Months Ended December 31, 1998 as compared to Three Months Ended December 31, 1997.
Sales. Consolidated sales increased $3.7 million or 2.7% to $136.8 million for the three months ended December 31, 1998 as
compared to $133.1 million for the same period last year.
Sales of communications test products decreased $3.9 million to $66.3 million or 5.5% for the three months ended December
31, 1998 as compared to $70.2 million for the same period last year. The Company has been experiencing a decrease in
demand for its core instruments which has been partially offset by an increase in demand for its systems and services.
Sales for industrial computing and communications products increased $3.1 million to $46.6 million or 7.1% for the three
months ended December 31, 1998 as compared to $43.5 million from the same period last year. During the quarter the
Company shipped a higher number of ruggedized laptop computers as a result of the strong order rate and backlog position at
Itronix. This higher shipping volume was offset by fewer shipments of its rack-mounted computers.
Sales of visual communications products increased $4.4 million to $23.9 million or 22.9% for the three months ended
December 31, 1998 as compared to $19.4 million from the same period last year. The increase was primarily attributable to the
continued demand for the Company's real-time flight information passenger video displays. In addition, the Company also
incurred additional sales from Pacific which were slightly offset by the reduction in sales from the divestiture of ComCoTec.
Gross Profit. Consolidated gross profit increased $1.9 million to $76.7 million or 56.1% of consolidated sales for the three
months ended December 31, 1998 as compared to $74.9 million or 56.2% of consolidated sales for the same period a year
ago. The percentage decrease was attributable to a change in the product mix as the Company shipped more industrial
computing and communications products during the quarter which are sold at lower gross margins. However, selling prices and
costs of sales across the Company's product lines remained at levels similar to those during the same period last year.
Operating Expenses. Operating expenses consist of selling, marketing and distribution expense; general and administrative
expense; product development expense; amortization of intangibles; and amortization of unearned compensation. Total
operating expenses were $51.8 million or 37.8% of consolidated sales as compared to $54.4 million or 40.9% of consolidated
sales for the same period last year. The decrease in operating expenses during the quarter was primarily attributable to greater
expense control throughout the corporation.
Selling, general and administrative expense was $36.3 million or 26.6% of consolidated sales for the three months ended
December 31, 1998, compared to $38.5 million or 28.9% of consolidated sales for the same period a year ago. The decrease
was primarily attributable to cost containment programs as the Company continues to respond to the leveling of incoming orders
for some of the Company's products.
Product development expense was $13.2 million or 9.7% of consolidated sales for the three months ended December 31, 1998
as compared to $14.5 million or 10.9% of consolidated sales for the same period last year. The decrease was due primarily to
the timing of expenses for ongoing research and development programs.
Amortization of intangibles was $1.6 million or 1.2% of consolidated sales for the three months ended December 31, 1998 as
compared to $1.4 million or 1.1% of consolidated sales for the same period last year. The increase was primarily attributable to
increased goodwill amortization related to the acquisition of Pacific in June, 1998.
Amortization of unearned compensation of $0.6 million relates to the amortization of the $9.7 million recorded within
shareholders' equity related to the 14.3 million options that were issued in July, 1998 at a grant price lower than fair market
value.
Operating income. Operating income increased 22.2% to $25.0 million or 18.2% of consolidated sales for the three months
ended December 31, 1998 as compared to $20.4 million or 15.3% of consolidated sales for the same period a year ago. The
increase is primarily attributable to the increase in sales and the reduction in operating expenses.
Interest. Interest expense, net of interest income, was $12.3 million for the third quarter of fiscal 1999 as compared to net
interest income of $0.7 million for the same period last year. The increase in net interest expense was attributable to the debt
incurred in connection with the Merger. Also included in interest expense is $0.8 million of amortization expense related to
deferred debt issuance costs.
Income before income taxes. Income before income taxes for the three months of fiscal 1999 decreased 42% to $12.4 million,
or 9% of consolidated sales as compared to $21.4 million or 16% of consolidated sales for the same period last year. The
decrease was primarily attributable to an increase in interest expense incurred in connection with the Merger, offset by higher
gross profit and lower operating expenses.
Taxes. The effective tax rate for the third quarter of fiscal 1999 was 44.0%, compared to 40.5% for the same period a year
ago. The increase is due to permanent differences arising as a result of the accounting for the Merger.
Net income. Net income decreased $5.8 million to $6.9 million or $0.05 per share on a diluted basis for the three months
ended December 31, 1998 as compared to $12.7 million or $0.73 per share on a diluted basis for the same period a year ago.
The decrease was primarily attributable to the additional interest expense incurred in connection with the Merger which was
offset by higher sales and lower operating expenses during the third quarter of fiscal 1999. The reduction in earnings per share is
also attributable to a higher number of common shares outstanding in connection with the Merger.
Nine Months Ended December 31, 1998 as compared to Nine Months Ended December 31, 1997
Sales. Consolidated sales increased $16.2 million or 4.6% to $369.5 million for the nine months ended December 31, 1998 as
compared to $353.3 million for the same period last year.
Sales of communications test products decreased $2.7 million to $182.2 million or 1.4% for the nine months ended December
31, 1998 as compared to $184.9 million from the same period last year. The decrease was primarily a result of the slowdown
of orders from the RBOCs.
Sales for industrial computing and communications products increased $8.7 million to $119.7 million or 7.8% for the nine
months ended December 31, 1998 as compared to $111.0 million from the same period last year. The increase was
attributable to increased sales for the Company's ruggedized laptops which was partially offset by a decrease in shipments of the
Company's rack-mounted computers.
Sales of visual communications products increased $10.2 million to $67.6 million or 17.7% for the nine months ended
December 31, 1998 as compared to $57.5 million from the same period last year. The increase was primarily attributable to
sales for the Company's real-time flight information passenger video displays, which continued to be strong, as well as increased
sales from Pacific. Offsetting this increase were lower sales for graphical user-interface (GUI) products as well as a reduction in
sales from the sale of ComCoTec.
Gross Profit. Consolidated gross profit increased $9.1 million to $210.7 million or 57.0% of consolidated sales for the nine
months ended December 31, 1998 as compared to $201.6 million or 57.1% of consolidated sales for the same period a year
ago, due primarily to an increased volume of shipments of products.
Operating Expenses. Operating expenses consist of selling, marketing and distribution expense; general and administrative
expense; product development expense; recapitalization-related costs; amortization of intangibles; and amortization of unearned
compensation. Total operating expenses were $196.9 million or 53.3% of consolidated sales for the nine months ended
December 31, 1998 as compared to $149.4 million or 42.3% of consolidated sales for the same period last year. Included in
the operating expenses for the nine months ended December 31, 1998 were $43.4 million of expenses related to the
Recapitalization, primarily for the option cancellation payments. Excluding these Recapitalization-related expenses, operating
expenses for the nine months ended December 31, 1998 were $153.5 million or 41.5% of consolidated sales.
Selling, general and administrative expense was $107.5 million or 29.1% of consolidated sales for the nine months ended
December 31, 1998, compared to $103.5 million or 29.3% of consolidated sales for the same period a year ago. The
Company continued to manage its selling, general and administrative expenses to ensure that these expenses increase at a
slower rate than sales growth.
Product development expense was $40.3 million or 10.9% of consolidated sales for the nine months ended December 31,
1998 as compared to $41.6 million or 11.8% of consolidated sales for the same period last year.
Recapitalization-related costs. In connection with the Merger, the Company incurred $43.4 million, consisting of $39.9 million
(including a $14.6 million non-cash charge) for the cancellation payments of employee stock options and compensation expense
due to the acceleration of unvested stock options, and $3.5 million for certain other expenses resulting from the Merger,
including employee termination expense. The Company incurred an additional $41.3 million in expenses, of which $27.3 million
was capitalized and will be amortized over the life of the Senior Secured Credit Facilities and Senior Subordinated Notes, and
$14.0 million was charged directly to shareholders' equity.
Amortization of intangibles was $4.7 million or 1.3% of consolidated sales for the nine months ended December 31, 1998 as
compared to $4.3 million or 1.2% of consolidated sales for the same period last year. The dollar increase was primarily
attributable to increased goodwill amortization related to the acquisition of Pacific.
Amortization of unearned compensation of $1.0 million relates to the amortization of the $9.7 million recorded within
shareholders' equity related to the 14.3 million options that were issued in July, 1998 at a grant price lower than fair market
value.
Operating income (loss). Operating income decreased 73.6% to $13.8 million or 3.7% of consolidated sales for the nine
months ended December 31, 1998 as compared to $52.2 million or 14.8% of consolidated sales for the same period a year
ago. The loss is primarily attributable to the Recapitalization-related costs in connection with the Merger. Excluding these
expenses, the Company generated operating income of $57.2 million or 15.5% of consolidated sales. The percentage increase
was primarily attributable to lower operating expenses described above.
Interest. Interest expense, net of interest income, was $30.2 million for the first nine months of fiscal 1999 as compared to net
interest income of $1.3 million for the same period last year. The increase in net interest expense was attributable to the debt
incurred in connection with the Merger on May 21, 1998. Also included in interest expense is $1.8 million of amortization
expense related to deferred debt issuance costs.
Gain on sale of subsidiary. On June 30, 1998 the Company sold the assets of ComCoTec for $21 million which resulted in a
gain of $15.9 million.
Income (loss) before income taxes. The Company incurred a loss before income taxes of $0.8 million for the nine months ended
December 31, 1998 as compared to income before income taxes of $54.2 million for the same period last year. The loss is
primarily due to an increase in interest expense and to the one- time Recapitalization-related costs which were in part offset by
the gain on the sale of ComCoTec. Excluding the one-time charge and gain, income before income taxes for the nine months
ended December 31, 1998 was $26.6 million or 7.2% of consolidated sales. The decrease is primarily due to additional interest
expense offset in part by higher sales.
Taxes. The effective tax rate for the first nine months of fiscal 1999 was 58% compared to a tax rate of 40.5% for the same
period a year ago due to the permanent differences arising as a result of the accounting for the recapitalization, and a smaller
amount of income (loss) before income taxes, which magnified the effect of such permanent differences.
Net income (loss). Net income decreased $33.6 million to a net loss of $1.3 million or ($0.01) per share on a diluted basis for
the nine months ended December 31, 1998 as compared to net income of $32.2 million or $1.85 per share on a diluted basis
for the same period a year ago. The decrease was primarily attributable to the additional interest expense and the
Recapitalization- related expenses incurred in connection with the Merger, offset by the gain on the sale of ComCoTec.
Backlog. Backlog at December 31, 1998 was $142.4 million, an increase of $63.3 million over the backlog at March 31,
1998. The increase is due primarily to the significant orders received at Itronix.
Capital Resources and Liquidity
The Company broadly defines liquidity as its ability to generate sufficient cash flow from operating activities to meet its
obligations and commitments. In addition, liquidity includes the ability to obtain appropriate debt and equity financing and to
convert into cash those assets that are no longer required to meet existing strategic and financial objectives. Therefore, liquidity
cannot be considered separately from capital resources that consist of current or potentially available funds for use in achieving
long-range business objectives and meeting debt service commitments.
The Company's liquidity needs arise primarily from debt service on the substantial indebtedness incurred in connection with the
Merger and from the funding of working capital and capital expenditures. As of December 31, 1998, the Company had $536.4
million of indebtedness, primarily consisting of $275.0 million principal amount of the Senior Subordinated Notes, $254.0
million in borrowings under the Term Loan Facility and $7.0 million in borrowings under the new Revolving Credit Facility.
Cash flows. The Company's cash and cash equivalents decreased $28.4 million during the first nine months of fiscal 1999
principally due to the Recapitalization of the Company and repayment of debt.
Working capital. During the first nine months of fiscal 1999, the Company's working capital increased as its operating assets
and liabilities provided an $8.6 million source of cash, excluding the acquisition of Pacific. Inventory levels decreased, creating a
source of cash of $8.1 million, due primarily to better inventory management at the Company's industrial computing and
communications operations. Accounts receivable increased, creating a use of cash of approximately $19.8 million, due in part to
the large increase in shipments at the end of the quarter as well as an increase in deferred service contract billings. Other current
assets decreased, creating a source of cash of $2.4 million mainly due to the recognition of expenses previously capitalized in
connection with the Merger. Accounts payable decreased, creating a use of cash of $1.0 million as a result of the timing of the
payment of bills. Other current liabilities increased, creating a source of cash of $19.0 million. This is due to the increase in
deferred service contract revenue; the accrual of interest on the debt incurred in connection with the recapitalization; and the
accrual of expenses related to the final phase of the Merger.
Investing activities. The Company's investing activities used a total of $10.8 million during the first nine months of fiscal 1999
primarily for the purchase and replacement of property and equipment and the payment of an earnout incentive related to the
fiscal 1998 operating results of Advent Design, Inc., a subsidiary purchased in March, 1997. Also included in this total are the
proceeds received from the sale of ComCoTec, offset by the cash purchase price for Pacific. The Company's capital
expenditures were $7.4 million compared with $11.0 million for the same period last year. The decrease is primarily due to the
timing of certain capital expenditure purchases. The Company anticipates capital expenditures to be approximately 30% below
fiscal 1998 levels, primarily as a result of the reduction of commitments at the Company's test and industrial computing
businesses.
Debt and equity. The Company's financing activities used $33.6 million in cash during the first nine months of fiscal 1999, due
mainly to the Merger.
Debt Service. In connection with the Merger, the Company entered into a senior secured credit agreement (the "Senior Secured
Credit Agreement") consisting of a $260 million term loan facility (the "Term Loan Facility") and a $110 million revolving credit
facility (the "Revolving Credit Facility") (collectively, the "Senior Secured Credit Facilities"). In addition, the Company incurred
$275 million of debt through the sale of its 9 3/4% Senior Subordinated Notes (the "Senior Subordinated Notes").
In connection with the Merger and related transactions, Dynatech LLC became the primary obligor with respect to the Senior
Secured Credit Facility and the Senior Subordinated Notes. See Note D. Financial Position of Dynatech Corporation and
Dynatech LLC. Dynatech Corporation has guaranteed the Senior Secured Credit Facilities and the Senior Subordinated Notes.
Principal and interest payments under the new Senior Secured Credit Agreement and interest payments on the Senior
Subordinated Notes represent significant liquidity requirements for the Company. During fiscal 1999 the Company is required to
make mandatory principal payments of $8 million of which $6 million was repaid during the first nine months of fiscal 1999.
With respect to the $260 million initially borrowed under the Term Loan Facility (which is divided into four tranches, each of
which has a different term and repayment schedule), the Company is required to make scheduled principal payments of the $50
million of tranche A term loan thereunder during its six-year term, with substantial amortization of the $70 million tranche B term
loan, $70 million tranche C term loan and $70 million tranche D term loan thereunder occurring after six, seven and eight years,
respectively. The $275 million of Senior Subordinated Notes will mature in 2008, and bear interest at 9 3/4% per annum. Total
interest expense including the amortization of deferred debt issuance costs is expected to be approximately $47 million in fiscal
1999.
The Senior Secured Credit Facilities are also subject to mandatory prepayment and reduction in an amount equal to, subject to
certain exceptions, (a) 100% of the net proceeds of (i) certain debt offerings by the Company and any of its subsidiaries, (ii)
certain asset sales by the Company or any of its subsidiaries, and (iii) casualty insurance, condemnation awards or other
recoveries received by the Company or any of its subsidiaries, and (b) 50% of the Company's excess cash flow (as defined in
the Senior Secured Credit Agreement) for each fiscal year in which the Company exceeds a certain leverage ratio. The Senior
Subordinated Notes are subject to certain mandatory prepayments under certain circumstances.
The Revolving Credit Facility matures in 2004, with all amounts then outstanding becoming due. The Company expects that its
working capital needs will require it to obtain new revolving credit facilities at the time that the Revolving Credit Facility matures,
by extending, renewing, replacing or otherwise refinancing the Revolving Credit Facility. No assurance can be given that any
such extension, renewal, replacement or refinancing can be successfully accomplished or accomplished on acceptable terms.
The loans under the Senior Secured Credit Agreement bear interest at floating rates based upon the interest rate option elected
by the Company. The Company's weighted-average interest rate on the loans under the Senior Credit Agreement was 8.5%
per annum for the period commencing May 21, 1998 and ending December 31, 1998, and is expected to be approximately
8.3% per annum for the period commencing January 1, 1999 and ending March 31, 1999. However, the Company has entered
into interest rate swaps which will be effective for periods ranging from two to three years beginning September 30, 1998 to fix
the interest charged on a portion of the total debt outstanding under the Term Loan Facility. After giving effects to these
arrangements, approximately $220 million of the debt outstanding will be subject to an effective average annual fixed rate of
5.71% plus an applicable margin. See Note N. Interest Rate Swaps to the notes to condensed consolidated financial statements
provided elsewhere in this report. As a result of the substantial indebtedness incurred in connection with the Merger, it is
expected that the Company's interest expense will be higher and will have a greater proportionate impact on net income in
comparison to preceding periods.
Future Financing Sources and Cash Flows. The amount under the Revolving Credit Facility that remained undrawn following the
May, 1998 closing of the Recapitalization was $70 million. The undrawn portion of this facility will be available to meet future
working capital and other business needs of the Company. At December 31, 1998, the undrawn portion of this facility was
$103 million. The Company believes that cash generated from operations, together with amounts available under the Revolving
Credit Facility and any other available sources of liquidity, will be adequate to permit the Company to meet its debt service
obligations, capital expenditure program requirements, ongoing operating costs and working capital needs, although no
assurance can be given in this regard. The Company's future operating performance and ability to service or refinance the Senior
Subordinated Notes and to repay, extend or refinance the Senior
Secured Credit Facilities (including the Revolving Credit Facility) will be, among other things, subject to future economic
conditions and to financial, business and other factors, many of which are beyond the Company's control.
Covenant Restrictions. The Senior Secured Credit Agreement imposes restrictions on the ability of the Company to make
capital expenditures and both the Senior Secured Credit Facilities and the indenture governing the Senior Subordinated Notes
limit the Company's ability to incur additional indebtedness. Such restrictions, together with the highly leveraged nature of the
Company, could limit the Company's ability to respond to market conditions, to meet its capital-spending program, to provide
for unanticipated capital investments, or to take advantage of business opportunities. The covenants contained in the Senior
Secured Credit Agreement also, among other things, restrict the ability of the Company and its subsidiaries to dispose of assets,
incur guarantee obligations, prepay other indebtedness, make restricted payments, create liens, make equity or debt
investments, make acquisitions, modify terms of the indenture governing the Senior Subordinated Notes, engage in mergers or
consolidations, change the business conducted by the Company and its subsidiaries taken as a whole or engage in certain
transactions with affiliates. These restrictions, among other things, preclude Dynatech LLC from distributing assets to Dynatech
Corporation (which has no independent operations and no significant assets other than its membership interest in Dynatech
LLC), except in limited circumstances. In addition, under the Senior Secured Credit Agreement, the Company is required to
comply with a minimum interest expense coverage ratio and a maximum leverage ratio. These financial tests become more
restrictive in future years. The term loans under the Senior Secured Credit Facilities (other than the $50 million tranche A term
loan) are governed by negative covenants that are substantially similar to the negative covenants contained in the indenture
governing the Senior Subordinated Notes, which also impose restrictions on the operation of the Company's business. |
