RESULTS OF OPERATIONS
We distribute a wide variety of transistors, diodes and other semiconductors and optoelectronic devices and beginning in 1997, passive components to other electronic distributors, original equipment manufacturers and to contract manufacturers who incorporate them in their products.
The following table sets forth, for the periods indicated, certain operating amounts and ratios as a percentage of net sales.
Three Month Period Ended Nine Month Period Ended
September 30, September 30,
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1999 1998 1999 1998
---- ---- ---- ----
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
(Dollars in thousands) (Dollars in thousands)
--------------------------- ----------------------------
Net sales $ 7,750 $ 7,789 $22,051 $24,008
Cost of goods sold 5,605 5,522 15,722 16,988
Gross profit 2,145 2,267 6,329 7,020
% of net sales 27.7% 29.1% 28.7% 29.2%
Selling, general and administrative expenses 1,506 1,347 4,449 3,924
% of net sales 19.4% 17.3% 20.2% 16.3%
Operating earnings 639 920 1,880 3,096
% of net sales 8.2% 11.8% 8.5% 12.9%
Interest expense, net 220 324 651 932
% of net sales 2.8% 4.2% 3.0% 3.9%
Net earnings $ 269 $ 348 $ 797 $ 1,278
% of net sales 3.5% 4.5% 3.6% 5.3%
THREE MONTH PERIOD ENDED SEPTEMBER 30, 1999 COMPARED TO THE THREE MONTH PERIOD
ENDED SEPTEMBER 30, 1998
Net sales for the three months ended September 30, 1999 were $7,750,000, compared with net sales for the three months ended September 30, 1998 of $7,789,000, a decrease of $39,000 or .5%. This sales decrease was attributable principally to a decrease in the average per unit sales price on domestic sales. Additionally, the sales decrease was partially offset by an increase in export sales by approximately $376,000 or 59% as compared to the three months ended September 30, 1998.
Cost of goods sold increased by $83,000 to $5,605,000 for the three month period ended September 30, 1999, an increase of 1.5% from the three month period ended September 30, 1998. Gross profits decreased by $122,000 to $2,145,000 for the three months ended September 30, 1999 from $2,267,000 for the same period in 1998. Gross profit as a percentage of net sales was 27.7% for the three months ended September 30, 1999, a decrease from 29.1% for the same period in 1998. For the three months ended September 30, 1999, the average unit selling price was approximately 10.9% less than for the three months ended September 30, 1998. We believe the decrease in gross profit is a result of industry wide decline in demand for discrete semiconductors.
Selling, general and administrative expenses ("SG&A") increased by $159,000 or 11.8% for the three months ended September 30, 1999 compared to the same period of 1998. These SG&A expenses, as a percentage of net sales, increased to 19.4% for the three months ended September 30, 1999 from 17.3% for the three months ended September 30, 1998. The increase is primarily attributable to increased payroll and new operating costs incurred from opening our newest office in New York and additional SG&A expenses from our subsidiary in Mexico. Also, contributing to the increase are additional expenses related to the purchase of our new warehouse and headquarters. At the end of June, 1999, we purchased our new facilities for $3.3 million which increased depreciation and maintenance fees during the third quarter. There was no such purchase or related deprecation during the third quarter last year.
Operating earnings decreased by $281,000 or 30.5% between the three month period ended September 30, 1999 and 1998, and decreased as a percentage of net sales to 8.2% from 11.8%. Operating earnings decreased principally as a result of lower gross profit earned and higher SG&A expenses discussed above.
Interest expense, net of interest income for the three months ended September 30, 1999 decreased $104,000 compared to the three months ended September 30, 1998. The decrease is due to lower borrowings as smaller purchases of inventory were made during the current quarter as compared to the same quarter last year. Additionally, the decrease in lower borrowings were partially offset by financing the purchase of our new warehouse and headquarters mentioned above.
Income taxes were $189,000 in the three months ended September 30, 1999, representing an effective tax rate of 41%, compared to $239,000 for the same period in 1998, an effective tax rate of 41%.
We had net earnings of $269,000 for the three months ended September 30, 1999 as compared with net earnings of $348,000 for the three months ended September 30, 1998, a decrease of $79,000 or 22.7% for the reasons discussed above. Net earnings as a percentage of net sales decreased to 3.5% from 4.5%.
NINE MONTH PERIOD ENDED SEPTEMBER 30, 1999 COMPARED TO THE NINE MONTH PERIOD
ENDED SEPTEMBER 30, 1998
Net sales for the nine months ended September 30, 1999 were $22,051,000, compared with the nine months ended September 30, 1998 of $24,008,000, a decrease of $1,957,000 or 8.2%. This sales decrease was attributable principally to a decrease in the average per unit sales price on domestic sales. Additionally, the decrease in sales was partially offset by an increase in export sales of approximately $306,000 or 15% as compared to the nine months ended September 30, 1998.
Cost of goods sold decreased by $1,266,000 to $15,722,000 for the nine months ended September 30, 1999, a decrease of 7.5% from the nine month period ended September 30, 1998. Gross profits decreased by $691,000 to $6,329,000 for the nine months ended September 30, 1999 from $7,020,000 for the same period in 1998 and decreased as a percentage of net sales to 28.7% from 29.2%. For the nine months ended September 30, 1999, the average unit selling price was approximately 9.9% less than for the nine months ended September 30, 1998. We believe the decrease in gross profit is a result of industry wide decline in demand for discrete semiconductors.
Selling, general and administrative expenses increased by $525,000 or 13.4% for the nine months ended September 30, 1999 compared to the same period of 1998. These costs, as a percentage of net sales, were 20.2% for the nine months ended September 30, 1999 and 16.3% for the nine months ended September 30, 1998. The increase is primarily attributable to increased payroll and new operating costs incurred from opening our newest office in New York and additional SG&A expenses from our subsidiary in Mexico. Also, contributing to the increase is additional depreciation expense related to the Oracle Application System ("Oracle") purchased last year. In July 1998, we implemented Oracle which resulted in increased depreciation expense and maintenance fees beginning in the same month. As such, there were no Oracle related depreciation and maintenance fees during the first six months of last year. Also, contributing to the increase are additional expenses related to the purchase of our new warehouse and headquarters. At the end of June, 1999, we purchased our new facilities for $3.3 million which increased depreciation and maintenance fees during the third quarter. There was no such purchase or related depreciation during the same period last year.
Earnings from operations decreased by $1,216,000 or 39.3% for the nine months ended September 30, 1999 compared to the same period of 1998 and decreased as a percentage of net sales to 8.5% from 12.9%. This decrease in earnings from operations is due principally to lower gross profit and higher SG&A expenses discussed above.
Interest expense, net of interest income, for the nine months ended September 30, 1999 decreased by $281,000 compared to the nine months ended September 30, 1998. The decrease is due to lower borrowings as smaller purchases of inventory were made during the current nine months ended September 30, 1999 as compared to the same period last year. Additionally, the decrease in lower borrowings were partially offset by financing the purchase of our new warehouse and headquarters mentioned above.
Income taxes were $587,000 for the nine months ended September 30, 1999, representing an effective tax rate of 42% compared to $862,000 for the nine months ended September 30, 1998, an effective tax rate of 40%.
We had net earnings of $797,000 for the nine months ended September 30, 1999 compared to net earnings of $1,278,000 for the same period in 1998, a decrease of $481,000 or 37.6% for the reasons discussed above. Net earnings as a percentage of net sales decreased to 3.6% for the nine months ended September 30, 1999 compared to 5.3% for the same period in 1998.
SUPPLY AND DEMAND ISSUES
Beginning in 1996 and continuing through the current quarter ended September 30, 1999, the supply of most products distributed by us has been more than sufficient to meet customer's demand for these products. The weak demand left suppliers with large amounts of uncommitted products. When the opportunity arises, we may consider taking advantage of this situation by making opportunistic purchases of suppliers' uncommitted capacity at favorable pricing. However, since the later part of 1997, we also focused on reducing our overall inventory on hand. We attempt to structure inventory levels in such a way as to poise ourselves to take advantage of a recovery in the discrete semiconductor market. At the same time, if the market recovery is slow in taking place, inventory levels should not impose an unwarranted financial burden on our earnings.
Readers are cautioned that the foregoing statements are forward looking and are necessarily speculative. There can be no guarantee that a recovery in the discrete semiconductor market will take place. Also, if prices of components held in inventory decline or if new technology is developed that displaces products distributed by us and held in inventory, our business could be materially adversely affected. See "Cautionary Statement Regarding Forward Looking Information".
LIQUIDITY AND CAPITAL RESOURCES
We have satisfied our liquidity requirements principally through cash generated from operations and short-term commercial loans. A summary of our cash flows resulting from our operating, investing and financing activities for the nine months ended September 30, 1999 and 1998 are as follows:
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------
(In thousands) 1999 1998
---- ----
(Unaudited) (Unaudited)
Operating activities................... $ 4,555 $ 890
Investing activities................... $(3,654) $ (996)
Financing activities................... $(1,200) $ 6
Cash flows provided by operating activities increased to $4,555,000 during the nine months ended September 30, 1999, as compared to $890,000 during the nine months ended September 30, 1998. The change is primarily due to lower purchases of inventory. For example, in positioning ourselves as a "Discrete Superstore," we have been required to carry large inventory levels. However, since 1997, we have focused on utilizing our current inventory, thereby reducing inventory through 1999. As a result, inventory has decreased from $34.9 million at December 31, 1998 to $ 30.2 million at September 30, 1999, in turn, contributing to an increase in cash flow provided by operating activities during the current period ended September 30, 1999, as compared to the same time last year. Additionally, cash flows generated by the decrease in inventory was partially offset by a decrease in accounts payable and increase in accounts receivable during the current nine month period as compared to the same time last year.
The discrete semiconductor products distributed by us are mature products, used in a wide range of commercial and industrial products and industries. As a result, we have never experienced any material amounts of product obsolescence. We also attempt to control our inventory risks by matching large customer orders with simultaneous orders to suppliers. Nonetheless, the high levels of inventory carried by us increase the risks of price fluctuations and product obsolescence.
Cash flows used in investing activities increased to $3,654,000 from $996,000 during the nine months ended September 30, 1999 and 1998, respectively. The increase is due primarily to the purchase of our new warehouse and headquarters in the amount of $3.3 million. We anticipate moving into the offices of our newly purchased building during the first quarter of 2000, however, as of the date of this Report, our interior office improvements remain in progress. Moreover, during the first nine months of fiscal 1998, we began to purchase our Oracle Application System. There was no such Oracle purchase during the current nine months ended September 30, 1999.
Cash flows used in financing activities changed to $1,200,000 from $6,000 cash provided during the nine months ended September 30, 1999 and 1998, respectively. The change resulted from higher net repayments on our revolving line of credit during the current nine month period as compared to the same time last year.
We believe that funds generated from operations and our bank revolving lines of credit will be sufficient to finance our working capital and capital expenditure requirements for the foreseeable future.
As of the date of this Report, we had no commitments for other equity or debt financing or other capital expenditures.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING INFORMATION
Several of the matters discussed in this document contain forward looking statements that involve risks and uncertainties. Such forward looking statements are usually denoted by words or phrases such as "believes," "expects," "projects," "estimates," "anticipates," "will likely result," or similar expressions. We wish to caution readers that all forward looking statements are necessarily speculative and not to place undue reliance on such forward looking statements, which speak only as of the date made, and to advise readers that actual results could vary due to a variety of risks and uncertainties. Factors associated with the forward looking statements that could cause the forward looking statements to be inaccurate and could otherwise impact our future results are set forth in detail in our most recent annual report on Form 10-K. In addition to the other information contained in this document, readers should carefully consider the information contained in our Form 10-K for the year ended December 31, 1998 under the heading "Cautionary Statements and Risk Factors."
YEAR 2000
Our Year 2000 Project ("Project") is proceeding on schedule. The Project is addressing the issue of computer chips being unable to distinguish between the year 1900 and the year 2000. The Project consists of three elements. First, we are evaluating our Year 2000 readiness in both information technology ("IT") and non-IT systems. Non-IT systems typically include embedded technology in electronic equipment, such as microprocessors. Non-IT systems are more difficult to assess and repair than IT systems. Second, for both IT and non-IT systems, we are planning and implementing any necessary changes that we believe will make us ready for the Year 2000. Third, we are evaluating the effect that third-parties Year 2000 readiness may have on our business.
PROJECT
In 1997, in order to improve access to business information and to prepare us
for any future growth, we began a systems replacement project to convert our
then existing system to Oracle Application System. Oracle Application System
was implemented during the third quarter of 1998. Oracle has represented that
their products used by us are Year 2000 fully compliant meeting the requirements
set out by the British Standards Institute in DISC PD-2000-1 A DEFINITION OF
YEAR 2000 CONFORMITY REQUIREMENTS. Year 2000 conformity means that neither performance
nor functionality is affected by dates prior to, during and after the year 2000.
The other material computer software programs utilized by us are supplied by
vendors that also publish that their products are Year 2000 compliant. We believe
that our IT systems are approximately 95% Year 2000 compliant now and if further
evaluation uncovers a problem the software will be replaced before December
31, 1999. We have evaluated our non-IT systems and where necessary, replacement
equipment was installed. We have also begun the evaluation of third-parties
Year 2000 readiness. This includes identifying and prioritizing critical suppliers,
customers and other third-parties by communicating with them about their plans
and progress in addressing the Year 2000 problem. These evaluations will be
followed by the development of contingency plans, which are scheduled to be
developed and monitored through the year 2000.
COSTS
The total cost associated with required modifications to become Year 2000 compliant
is not expected to be material to our financial position. The estimated total
cost of the Year 2000 Project is less than $25,000 and consists principally
of replacing old IT and Non-IT equipment where compliance with Year 2000 is
in doubt. The cost of implementing the Oracle system and any resulting equipment
replacement or upgrades are not included in these costs estimates as we did
not accelerate the replacement of our old system due to Year 2000 issues.
RISKS
The failure to correct a material Year 2000 problem could result in an interruption
in, or a failure of, certain normal business activities or operations. Such
failure could materially and adversely affect our results of operations, liquidity
and financial condition. Due to the general uncertainty inherent in the Year
2000 problem, resulting in part from the uncertainty of the Year 2000 readiness
of third-party suppliers and customers, we are unable to determine at this time
whether the consequences of Year 2000 failures will have a material impact on
our results of operations, liquidity or financial condition. The Year 2000 Project
is expected to significantly reduce our level of uncertainty about the Year
2000 problem and, in particular, about the Year 2000 compliance and readiness
of our material external third-parties. We believe that, with the implementation
of new business systems and completion of the Project, as scheduled, the possibility
of significant interruptions of normal operations should be reduced.