ITEM 1. BUSINESS.
OVERVIEW
Aurora Electronics, Inc. ("Aurora" or the "Company") provides spare parts distribution and electronics recycling services to major personal computer manufacturers and computer service organizations. Aurora operates worldwide through its wholly-owned subsidiary, Aurora Electronics Group, Inc. ("AEG") with facilities in the United States, Canada, and Europe. AEG distributes new and refurbished computer spare parts, primarily to the field service departments of computer OEMs, third-party maintenance and multivendor service organizations ("TPMOs" and "MVSOs"), computer resellers and dealers, and large corporate self-maintainers. AEG distributes spare parts from over 500 manufacturers, with particular emphasis on products from Apple Computer, AT&T, AST Computer, Compaq, Dell Computer, Digital Equipment Corporation, Hewlett-Packard, IBM and Toshiba. In addition, AEG provides a broad range of materials management services, such as repair and repair logistics, advance exchange, returned materials management, inventory management, and electronic materials recycling and remarketing.
In March 1996, the Company completed its comprehensive plan to recapitalize the Company (the "Recapitalization"). The Recapitalization included: (1) a tender offer pursuant to which the Company repurchased approximately 4,268,000 shares of common stock at $2.875 per share; (2) the Company's sale of $40 million of convertible preferred stock, $.01 par value per share (the "Preferred Stock"), and $10 million in subordinated debt (with approximately 607,000 shares of common stock attached) to Welsh, Carson, Anderson & Stowe ("WCAS") and certain other purchasers; (3) establishment of a new $35 million senior credit facility with The Chase Manhattan Bank (formerly Chemical Bank, N.A.) (the "Credit Agreement"); (4) the repayment in full of AEG's existing senior bank indebtedness of approximately $26 million; and (5) the redemption of the Company's 9-1/4% Senior Subordinated Notes (approximately $9.3 million). The Preferred Stock is convertible into common stock at the ratio of $2.125 per share and votes on an as-converted basis. As a result, WCAS and its affiliates control about 76.4% of the voting power of the Company.
INDUSTRY
The worldwide personal computer installed base has grown to approximately 180 million units, and requires a wide range of support, maintenance, upgrade and recycling services. Due to the competitiveness of the personal computer industry and the increasingly short manufacturing life cycle of the products, companies involved in the manufacture, service and distribution of computers are seeking outsourcing solutions to meet these requirements, preferably from a single source. Aurora offers its customers a wide range of these critical aftermarket services through integrated outsourcing programs provided on a worldwide basis, thereby allowing its customers to achieve cost savings associated with reduced inventories, lower headcount and less investment in plant and equipment.
As a result of the trend toward outsourcing of support, maintenance, upgrade and recycling activities, an independent spare parts distribution, recycling and repair industry has emerged in support of personal computer manufacturers and maintenance service providers. This industry is comprised of companies that are unaffiliated with the manufacturers of computers and computer parts, yet possess expertise in providing spare parts procurement, distribution, logistics, repair and recycling services. Companies in this industry operate in the secondary market for both new and used spare parts, relying on thousands of parts sourcing contacts among system and subsystem manufacturers, distributors, brokers and large end-users. Aurora is among the largest companies in the independent parts distribution, recycling and repair industry.
BUSINESS STRATEGY
AEG's strategy is to supply an increasing portion of the spare parts-related aftermarket support requirements of major companies in the personal computer industry. Key components of this strategy include:
- Pursue Integrated Support Relationships with Major Computer OEMs and Service Providers. The Company is continuing to aggressively pursue comprehensive aftermarket support relationships with major customers. These relationships range from providing individual services to complete outsourcing of as many of their spare parts distribution, logistics, repair and recycling requirements as possible. The Company believes strongly that over time its customers will prefer developing integrated outsourcing approaches to meeting these needs, and will seek to have as few such partnerships as possible to address their worldwide support requirements.
- Integrate Recycling, Repair and Parts Supply. AEG has major market positions in both recycling of computer systems and spare parts supply. Generally, the most cost effective source for spare parts is recycled parts, and for out of production parts, it is frequently the only source. Conversely, the best use for recycled parts is to resell them for use in the installed base as either spares or low cost additions to existing systems. Similarly, recycled parts are also often both less expensive and more readily available than repaired parts. The Company's ability to meet a significant portion of its spare parts demand from used or recycled parts sources is a significant competitive advantage, and an area which the Company is attempting to expand.
- Build Strong Parts Supply Relationships with Major Parts Manufacturers. The Company will continue to work closely with both major system and subsystem manufacturers in order to source spare parts in a cost-effective manner. Increasingly, these relationships are based on sophisticated electronic links which allow both parties to service the after-market in a timely and economic fashion.
- Maintain And Extend Industry Leading Knowledge Of Computer Parts and the Associated Secondary Markets. The Company believes it currently is among the industry leaders with respect to knowledge about computer systems, subsystems and spare parts, and the secondary market sources and consumers thereof. This knowledge base is extended every day in operating its business, and catalogued in sophisticated, relational databases. In addition, the Company makes substantial efforts to gather such information from its customers, suppliers, computer OEMs and various reference sources. This knowledge is a key basis for its primary value added to its customers.
- Build a Sophisticated Technology Platform for Enhanced Service Delivery. During the last three years, the Company has invested more than $3 million in sophisticated information systems designed to improve customer service and establish electronic linkages with major customers, and it continues to spend aggressively on building its information systems capabilities. The Company believes that development of a sophisticated technology platform is critical to establishing a leadership position in its industry.
- Continue to Develop AEG's Worldwide Presence. The Company believes that it is critical to provide customers with a worldwide range of capabilities. Accordingly, AEG continues to make important investments in expanding its European operations.
SERVICES
The range of spare parts distribution, electronics recycling services and aftermarket service programs which AEG provides includes:
- Spare Parts Distribution. AEG sources and distributes a wide range of spare parts, many of which are out-of-warranty and often out-of-production. AEG sources these parts either from its own inventory or by utilizing its parts sourcing database to locate and procure the parts, and then ships them to the customer, typically within 24 hours. Currently, approximately 70% of AEG's shipments are products that are sourced, reconditioned and tested the same day. AEG also works directly with computer OEMs and spare parts manufacturers as an authorized parts distributor, providing same and next-day shipment of new spare parts stocked by AEG on behalf of the OEM.
- Aurora Exchange Programs. AEG provides selected customers with good working parts at a discounted price in exchange for their defective parts. In most cases, the defective unit is repaired and placed back into inventory to fulfill future requests under this program.
- Asset Recovery and Remarketing. AEG refurbishes, reconditions, and redistributes systems and subsystems received as a result of manufacturing fallout, field dispositions, dealer and distributor returns, stock rotations, excess and obsolete inventories and customer trade-in and exchange programs. Refurbished systems and subsystems are either utilized for AEG's spare parts inventories or redistributed worldwide.
- Returns Management Programs. AEG's returns management program assists OEMs and distributors by facilitating the return of units which are defective, returned due to buyer's remorse or stock rotation or otherwise removed from the marketplace. Returned units are received, processed, tested, refurbished, as required, and either returned to the manufacturer, sold in secondary channels or used for spare parts inventory.
- Repair and Logistics Programs. AEG's parts repair and logistics programs offer critical support for OEM customers and also serve to lower AEG's acquisition cost for spare parts, AEG maintains a wide range of parts remanufacturing and repair capabilities, with technical expertise in floppy disks, tape drives, laser printers, monitors, flat panel displays, and CD-ROMs.
- Inventory Management. Under AEG's inventory management programs, the Company takes responsibility for maintaining a customer's parts inventories at pre-arranged levels. Under this program, the Company takes responsibility for procuring, selling and liquidating customer- owned spare parts.
- Parts Procurement Outsourcing. In some cases, customers are interested in total outsourcing of the parts ownership, management and logistics function. In these cases, AEG commits to certain service levels with respect to parts availability and response time, and takes responsibility for all aspects of the parts fulfillment process, including ownership of the part.
CUSTOMERS AND SUPPLIERS
AEG provides spare parts sourcing and distribution services primarily to five groups of customers:
- Customer Maintenance Departments of Major Computer OEMs -- AEG provides spare parts and related repair, spare parts inventory management and logistics programs to support the customer maintenance departments of customers such as AT&T, Compaq, DEC, Hewlett-Packard, IBM and ICL.
- Third-Party Maintenance Organizations and Multi-Vendor Service Organizations -- Customers in this category include not only independent field service organizations (DecisionOne, Entex, Granada, Sorbus, Vanstar), but also MVSOs of current or former computer OEMs (IBM, DEC, Hewlett-Packard, Data General, Unisys).
- Computer Resellers, Distributors and Dealers -- Major computer resellers, distributors and dealers are increasingly offering maintenance services to their customers as a means of capturing additional margin. AEG supports these organizations through parts sourcing and inventory remarketing programs. Typical customers include Circuit City, Compucom, Inacom and Microage.
- Corporate Self-Maintainers -- An increasing number of large corporations are satisfying their internal service requirements through in-house organizations which meet their spare parts requirements through external suppliers such as AEG.
- Major Computer OEM's -- By using recycling services, OEM customers, such as Apple Computer, Compaq Computer, Dell Computer, Hewlett-Packard, IBM and Storage Technology, can reduce or eliminate the potential liability and expense related to disposing of excess, obsolete and defective products, while realizing an economic return on these products
For fiscal 1996, IBM accounted for approximately 19% of the Company's sales. For fiscal 1995 and 1994, no single AEG customer accounted for more than 10% of the Company's revenues.
OPERATIONS
AEG services more than 5,000 customers worldwide, maintains a parts sourcing database of over 8,000 contacts, and completes over 150,000 transactions annually.
Sales and Marketing. AEG believes that it is a market leader in terms of its approach to the sales and marketing of its materials management services, spare parts, and recycled parts, and its utilization of sophisticated information systems to support these efforts. AEG maintains an internal sales and customer support group of 76 employees which handles daily sales transactions involving spare parts and recycled product sales. In addition, AEG's materials management services are marketed through a direct sales force of 9 employees, who work closely with computer OEMs, TPMOs and MVSOs, and computer resellers in developing customized programs that meet their particular materials management requirements. Supporting these sales forces is a marketing department comprised of 9 employees who perform: (i) marketing communications; (ii) OEM and distributor relations; (iii) industry and competitive analysis; and (iv) development of new customer targets and new applications for AEG services.
Information Systems. AEG's spare parts distribution services depend upon the ability to rapidly identify, locate, procure, as is necessary, and deploy a particular spare part from among the thousands of parts that comprise the computer industry installed base. Critical to AEG's success is a sophisticated information system, which relies on a spare parts identification and sourcing database developed over the last ten years. This database allows AEG's sales force to quickly find and deliver a spare part from inventory or, if a part is not available in inventory, to rapidly query the spare parts sourcing database to locate and procure the part from the hundreds of sources with which AEG regularly does business. The database also allows the salesperson to identify functional equivalents for a part. The system provides the salesperson with a complete pricing history for the part to assist in price discussions with the customer, as well as a transaction history with that particular customer.
Purchasing. Because customers are often under severe time pressure in procuring spare parts, AEG's ability to confirm a customer request immediately from inventory, rather than initiating just-in-time procurement from its parts sourcing suppliers, increases the likelihood of completing a transaction. In order to increase the percentage of spare parts sourced directly from inventory, AEG maintains a department which procures a variety of commonly requested parts in advance and attempts to select parts from the recycle flow which can be sold as spares. AEG's information system regularly examines parts usage patterns and available stocks and performs trend-line analyses to assist this department in its procurement activities.
Processing. AEG provides its spare parts distribution services primarily through distribution facilities in Marina del Rey, California; Toronto, Canada; and Hoofddorp, The Netherlands; and through repair and recycling facilities in Sacramento, California; San Diego, California; and Irvine, Scotland. AEG's distribution operations receive purchased spare parts or perform specific tear-down of whole systems in order to obtain spare parts, identify and cross-reference those parts for the AEG database, test and/or refurbish, as required, package, warehouse and ship. Often these activities must be performed within a 12 hour period in order to fulfill same-day requirements. AEG's recycling operations rely on the Company's ability to receive, identify, test, tear down as appropriate and dispose of materials rapidly, in large volumes and consistent with customers' requirements. The Company's San Diego facility has recently been awarded ISO 9002 certification, and the Company believes it is the only such certified electronics recycling facility in the world. The Company is currently working towards similar certification for all of its recycling operations. AEG has developed proprietary methods for recycling and reconditioning certain materials, particularly including integrated circuits (ICs), the purpose of which is to produce material that is of the highest value for either return to the recycling customer or resale. A key value to customers is the Company's ability to dispose of all unsalable materials in environmentally safe ways, thus minimizing such customers', and the Company's, environmental liability.
AEG's principal repair facility in Sacramento, California is also ISO 9002 certified. In Sacramento the Company has repair and repair logistics processes for disk drives, CD-ROM drives, CRT monitors, flat panel displays, printed circuit boards, laser and ink-jet printers, and a variety of other computer products. The facility is an authorized service center for several major brands of computers and sub systems. During 1996, the Sacramento facility performed work for various major manufacturers including Apple, Compaq, Digital, Hewlett Packard, IBM, NCR, Nokia, MKE, and Packard Bell.
COMPETITION
The independent spare parts distribution and the electronic recycling services industry is fragmented with widespread competition from a variety of small independent suppliers. AEG believes that competition for OEM, TPMO and MVSO customers is based on a number of factors, including: (i) breadth of parts distributed; (ii) ability to offer sophisticated inventory and materials management programs; (iii) ability to offer rapid delivery and sophisticated logistics programs; and (iv) price. Among AEG's major independent competitors are DecisionOne, Data Trend, PC Service Source, and The Cerplex Group
PATENTS/TRADEMARKS
The Company does not currently hold any patents or registered trademarks. However, the Company has developed several private labels for use in its business, including PartSmart, Micro-C, Memory Master, MM, and Advantage. The Company has applied for registration of "The PartSmart Company" trademark. While management believes that this approach helps distinguish the Company to its customers, none of these brand names is material to the continuation of the business.
ENVIRONMENTAL REGULATION
The Company's business is subject to various federal, state and local environmental laws and regulations relating to the disposal of waste material. The Company believes that it is in compliance with such environmental laws and regulations and is not aware of any situation or condition that could reasonably be expected to have a material adverse affect on the Company's financial condition or competitive position.
SEASONALITY
The Company does not consider its business to be seasonal.
EMPLOYEES
On December 20, 1996, the Company had approximately 413 employees. None of the Company's employees is represented by a union and none are subject to a collective bargaining agreement. The Company has never experienced a work stoppage due to labor difficulties and believes that its employee relations are good.
ITEM 2.
ITEM 2. PROPERTIES.
The following table sets forth certain information as of December 20, 1996 relating to the Company's principal properties, all of which are leased. The Company believes that its properties are adequate and suitable for its current needs.
(1) The Company subleased 48,473 square feet of the Marina del Rey, California facility to an unrelated third party for a five year period, commencing December 1, 1994. (2) The Chicago facility is subject to a sale/leaseback arrangement between the Company and an unrelated third party, as lessor. This property relates to a discontinued operation. See Note C of the Notes to Consolidated Financial Statements -- Discontinued Operations, and Note M of the Notes to Consolidated Financial Statements -- Commitments and Contingencies. The lease expires in 2005.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is engaged in routine legal proceedings incidental to its business, none of which the Company believes will have a material adverse effect on the financial position of the Company. See Note M of the Notes to Consolidated Financial Statements -- Commitments and Contingencies.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
The names of the executive officers of the Company, their ages, titles and biographies as of December 20, 1996, are set forth below. All officers are elected for a one-year term.
JIM C. COWART, since December 1992, has served as the Chairman of the Board and Chief Executive Officer of the Company and formerly served as Vice President of Strategic Development of the Company. Since February 1992, Mr. Cowart has served as Chairman of EOS Capital, Inc., a private capital firm which has been, from time to time, retained by the Company. From 1987 to 1991, Mr. Cowart was a founding General Partner of Capital Resource Partners, a private capital firm and investment manager for institutional investors. Mr. Cowart is also a director of B/E Aerospace, Inc. ("BEAV" - NASD), a leading manufacturer of aircraft cabin interior products. Mr. Cowart has been a director of the Company since October 1992.
JOHN P. GRAZER, since October 1996, has served as President and Chief Financial Officer. From May 1993 to October 1996 Mr. Grazer served as Senior Vice President, Finance and Administration of the Company. From 1992 to April 1993, Mr. Grazer served as Vice President of Finance and Administration of Home Fashions Inc. From 1990 to 1992, Mr. Grazer served as Vice President of Finance and Chief Financial Officer of RB Industries, Inc. From 1985 to 1990, Mr. Grazer served as Vice President, Finance of Amplica, Inc. a COMSAT company.
RICHARD A. KAIN, since October 1996, has served as Senior Vice President - North American Operations. Mr. Kain joined Aurora in May, 1995 as Vice President Operations and General Manager. From 1985 to 1995, Mr. Kain served as Vice President Operations for Symbol Technologies, Inc. From 1984 to 1985, Mr. Kain served as Vice President - Operations for Pancretec, Inc. From 1978 to 1984, Mr. Kain served as Manager - Manufacturing Scientific Instruments Division for Beckman Instruments, Inc.
GEORGE M. KORCHINSKY is Managing Director - European Operations and Senior Vice President. Mr. Korchinsky joined Aurora in November 1996. From May 1991 to October 1996, Mr. Korchinsky served as Vice President & Managing Director - Europe, Middle East, Africa for Symantec. From January 1989 to May 1991, Mr. Korchinsky served as General Manager Northern & Central Europe from Cognos Ltd. From January 1987 to January 1989, Mr. Korchinsky served as Managing Director Data Communications Equipment for Paradyne Ltd. and from 1984 to 1987 held various sales, marketing and technical management positions with Paradyne Ltd.
AMIR ASADI joined Aurora in April 1996 as Vice President - Information Systems. From June 1990 to April 1996, Mr. Asadi served as Vice President, Information Systems for Home Fashions Inc. From October 1987 to June 1990, Mr. Asadi served as Director, Systems Development of Beech Street of California. From May 1986 to October 1987, Mr. Asadi served as Information Systems Consultant, Project Manager for Fremont Indemnity.
JONATHAN SHULTZ, since October 1996, has served as Vice President Finance and Administration. Since joining Aurora in October 1992, Mr. Shultz has held the following positions: From May 1995 to October 1996, Mr. Shultz served as Vice President Finance and Administration, ARS Division. From June 1994 to May 1995, Mr. Shultz served as Vice President Controller/Treasurer. From September 1993 to June 1994, Mr. Shultz served as Corporate Controller, and from October 1992 to September 1993, he served as Controller, Micro-C Division. From January 1986 to October 1992, Mr. Shultz served as Audit Manager/Technology Coordinator for Ernst & Young.
STEPHEN F. WEBER, since May 1996, has served as Vice President Marketing. From January 1995 to May 1996, Mr. Weber was a co-founder of MindShare Associates, LLC. From July 1993 to January 1995, Mr. Weber served as Director, Storage Marketing for Avnet EMG. From March 1992 to July 1993, Mr. Weber served as Corporate Marketing Manager for Avnet EMG. From 1984 to 1992, Mr. Weber was a sales representative for Anthem Electronics.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded on the American Stock Exchange ("AMEX") under the symbol AUR. The following table sets forth the range of the high and low sales prices for the Common Stock for each quarterly period during the last two fiscal years.
On December 20,1996 the last sale price of the Common Stock as reported by AMEX was $1- 9/16 per share. As of December 20, 1996, the Company had 634 recordholders of its Common Stock, and four (4) holders of warrants to purchase, in the aggregate, up to 1,694,000 shares of its Common Stock. See Note J of the Notes to Consolidated Financial Statements -- Stockholders' Equity.
The Company has not paid any cash or stock dividend on its Common Stock since September 30, 1993. At present, it is the policy of the Company to retain all earnings for reinvestment into the Company. In addition, the Credit Agreement restricts AEG's ability to pay dividends to the Company, and thus limits the Company's ability to pay dividends to its stockholders.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data regarding the Company's results of operations and financial position. This information should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and related Notes included elsewhere herein.
(In thousands, except per share figures)
- ----------
(1) During the fourth quarter of fiscal 1996, approximately $16,580 relating to a write-down of intangible assets associated with the integrated circuit business acquired in fiscal 1992 in connection with the Micro-C Corporation acquisition was charged to operations.
(2) During fiscal 1995, approximately $7,400 relating to a write-down of intangible assets associated with the repair business acquired in fiscal 1993 in connection with the FRS, Inc. acquisition was charged to operations.
(3) During fiscal 1994, approximately $2,400 relating to a write-down of intangible assets associated with a covenant not to compete was charged to operations.
(4) During fiscal 1995, the Company substantially completed a major corporate reorganization into two core businesses operating through the IC recycling and recovery division and the spare parts distribution division.
(5) In connection with the Recapitalization, on March 29, 1996, the Company repurchased approximately 4,268 shares of Common Stock and issued 607 shares of Common Stock and 400 shares of Preferred Stock to WCAS and certain other purchasers. The Preferred Stock is convertible into 18,824 shares of Common Stock.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(In thousands, except per share figures)
OVERVIEW
Aurora as it exists today was formed on September 30, 1992. Prior to September 30, 1992, the corporation was known as BSN Corp. and was engaged in the sporting goods industry. From 1990 through 1992, BSN divested itself of a majority of its sporting goods assets and, effective September 30, 1992, announced that all of its remaining sporting goods assets would be accounted for as discontinued operations and that such operations would be sold. Effective September 30, 1992, the Company entered the computer and electronics industry through the acquisition of Micro-C Corporation, a San Diego, California based company founded in 1985, which provided both IC recycling services to computer OEMs and memory IC distribution services for semiconductor manufacturers. Effective September 30, 1993, Aurora acquired FRS, Inc., a Sacramento, California based company founded in 1984, which provided depot repair services to computer and peripherals OEMs. Effective March 1, 1994, Aurora acquired Century Computer Marketing, a Marina del Rey, California based company founded in 1984, a leading supplier of new and refurbished spare parts to the computer maintenance market.
In the third quarter of fiscal 1995, the Company completed a corporate reorganization, in which it: (a) exited the memory upgrade manufacturing and supply business (formerly known as the Premier Division); and (b) substantially downsized its depot repair services operation (acquired in the FRS, Inc. acquisition), and refocused these operations to support the Company's remaining spare parts distribution and electronic recycling services business.
In March 1996, the Company completed the Recapitalization. See Item 1. Business -- Overview.
RESULTS OF OPERATIONS -- YEAR ENDED SEPTEMBER 30, 1996, COMPARED WITH YEAR ENDED SEPTEMBER 30, 1995.
Net revenues for the year ended September 30, 1996 for the Company were $98,019 as compared to $141,852 for the year ended September 30, 1995. The Company's decline in revenues was due primarily to the discontinuation of the Premier Division ($36,254) during fiscal 1995. Excluding the Premier Division, net revenues for fiscal 1996 decreased 7.2% over the comparable period in fiscal 1995. The decrease was due to a 27.4% decline in revenues in the IC recycling and recovery business known as the Asset Recovery Services Division (ARS), offset by an increase of 5.3% in revenues for the spare parts distribution business, known as the Parts Support Services Division (PSS). The decline in revenues for ARS was due primarily to a decline during the year in the average sales price for DRAM chips of approximately 87.0%.
Gross profit for fiscal 1996 was $24,443 (24.9% of net revenues) as compared to $34,582 in gross profit for the comparable period last year (24.4% of net revenues). The decrease in gross profit was due primarily to the discontinuation of the Premier Division and the decrease of approximately $6,261 for ARS over the comparable period in fiscal 1995. This decline in profitability is due to the fallen DRAM prices discussed above.
SG&A expenses for fiscal 1996 were $25,943, or 26.5% of revenues, as compared to $28,170, or 19.9% of revenue for fiscal 1995. Included in the SG&A expenses were approximately $725 in one time charges related to the Recapitalization. The increase of the SG&A expenses as a percentage of revenue was due to the reduction in revenues from the discontinuation of the Premier Division and the decline in revenues for ARS.
Amortization expense for fiscal 1996 was $18,042, or 18.4% of revenues, as compared to $9,073, or 6.4% of revenues, for fiscal 1995. The increase was due to the write-off in the fourth quarter of fiscal 1996 of $16,580 of goodwill related to the acquisition of Micro-C Corporation, which was only partially matched by the third quarter of fiscal 1995 write-off of goodwill related to the acquisition of FRS, Inc. Management wrote off the goodwill related to the Micro-C acquisition due to the deterioration of the pricing levels in the integrated circuit market and their negative effects on the Company's business prospects going forward.
Net interest expense for fiscal 1996 was $6,221, or 6.3% of revenues, as compared to $5,522, or 3.9% of revenues, for fiscal 1995. The interest expense for 1996 includes approximately $2,243 of charges related to the Recapitalization completed on March 29, 1996. This amount includes approximately $1,070 of previously capitalized financed charges, $917 of interest, fees and expenses due to the Company's previous lenders and $256 relating to the 9-1/4% Senior Subordinated Notes.
Other expense for fiscal 1996 included writedowns and disposal of property and equipment totaling $1,369.
Provision for income taxes for fiscal 1996 was $3,306, or 3.4% of revenues, as compared to $1,320, or .9% of revenues, for fiscal 1995. This provision includes the increase of the deferred income tax valuation allowance in the amount of $3,234 due to management's determination that the deferred tax asset will not be fully realized. Management reached this conclusion as a result of the limitation in the utilization of the Company's net operating loss carryforwards caused by the change of ownership pursuant to the Recapitalization.
Net loss applicable to common stockholders for fiscal 1996 was $31,753 as compared to a net loss of $15,030 for fiscal 1995. The fiscal 1996 loss included approximately $6,620 of charges incurred in the second quarter of fiscal 1996 due to the Recapitalization completed on March 29, 1996, $6,320 of reduced operating income from the ARS when compared to 1995, dividends on preferred stock of approximately $1,400, writedowns and disposal of property and equipment totaling $1,369, and the write-off of goodwill from the Micro-C acquisition totaling $16,580.
RESULTS OF OPERATIONS -- YEAR ENDED SEPTEMBER 30, 1995, COMPARED WITH YEAR ENDED SEPTEMBER 30, 1994.
Net revenues for the year ended September 30, 1995 for the Company were $141,852 as compared to $120,386 in net revenues for the year ended September 30, 1994. The increase in revenues was primarily due to the inclusion of the PSS business for a full twelve months ($27,860) and a 54% revenue growth in the ARS business ($15,752). These revenue increases offset a 53% revenue decrease in the repair business and a 24% revenue decrease in the Premier Division.
Gross profit for the year ended September 30, 1995 was $34,582 (24.4% of net revenues) as compared to $26,350 in gross profit for the year ended September 30, 1994 (21.9% of net revenues). The increase was due primarily to the gross profits associated with the higher volumes in ARS and Century's parts distribution business. This increase was partially offset by the significant decreases in the volume and profitability for both the Premier Division and the repair business.
SG&A expenses for the year ended September 30, 1995 were $28,170, or 19.9% of revenues, as compared to $17,573, or 14.6% of revenues for the comparable 1994 period. The increase of approximately $10,600 was due primarily to the inclusion of a full year of PSS's SG&A expenses, expenditures related to the reorganization, non-recurring professional fees, and the investments in systems and support costs required to support the growth in the Company's business.
Amortization expense for the year ended September 30, 1995 was $9,073, or 6.4% of revenues, as compared to $4,539, or 3.8% of revenues, for the comparable 1994 period. With the completion of the corporate reorganization in the third quarter of fiscal 1995, management charged the remaining balance of goodwill related to the acquisition of FRS totaling $7,407 to operations. This charge was determined to be necessary as management estimated that the amortization of the goodwill balance over its remaining life would not be recovered through the projected non-discounted future cash flows over the remaining amortization period.
Restructuring charges for the year ended September 30, 1995 were $5,643 and consisted of costs related to the shutdown of the Premier Division and the restructuring and downsizing of the Company's repair services operations. The charge consists primarily of $2,800 in inventory writedowns, $900 in employee severance, and $600 in facilities termination costs associated with the reorganized product lines and businesses. In addition, there were no program development costs for the year ended September 30, 1996 as compared to $925, or .8% of revenues, for the comparable 1994 period. The expense in the 1994 period was related to development of a new service line to complement the then existing repair business. Also included in the restructuring charges were losses on disposition of assets of approximately $944. This was primarily due to a charge of $695 related to the writedown of the investment in the Aurora Merchant Systems joint venture.
Net interest expense for the year ended September 30, 1995 was $5,522 or 3.9% of revenues, as compared to $4,449 or 3.7% of revenues, for the comparable 1994 period. The increase of $1,073 in net interest expense was principally the interest expense related to the Company's working capital facilities.
The net loss for the year ended September 30, 1995 was $15,030 as compared to a net loss of $6,518 for the comparable period in 1994. The increase in net loss is due primarily to the charges recorded in connection with the restructuring and reorganization of the Company's businesses.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary requirements for capital are directly related to its accounts receivable, inventory levels and improvements to its property and equipment, as well as costs resulting from the consolidation of its businesses. The Company's working capital was $610 as of September 30, 1996, compared to $196 as of September 30, 1995.
On March 29, 1996, the Company completed the Recapitalization of the Company (see Note J of the Notes to Consolidated Financial Statements -- Stockholders' Equity). In conjunction with the Recapitalization, the Company entered into a $35,000 senior credit facility pursuant to a Credit Agreement dated March 29, 1996. The facility consists of a $15,000 Senior Secured Asset Based Revolving Credit ("Working Capital Revolving Credit") and a $20,000 Senior Secured Reducing Revolving Credit ("Reducing Revolving Credit"). The purpose of the Working Capital Revolving Credit is to fund ongoing working capital needs. Funds are available based on a percentage of eligible accounts receivables and inventory. The Reducing Revolving Credit is to be used for (i) approved acquisitions, (ii) regularly scheduled payments due under the Subordinated Notes, and (iii) other payments as mutually agreed upon in the Credit Agreement. As of September 30, 1996, the Company had drawn down $3,707 on the Working Capital Revolving Credit and $2,635 on the Reducing Revolving Credit. The facilities bear interest at a rate of either LIBOR plus 2.75% or prime rate plus 1.25%, at the Company's option. All indebtedness of the Company under the Credit Agreement is secured by substantially all of the assets of the Company, and the Company is subject to a number of restrictions including covenants relating to Company's financial performance and various other limitations on the Company's activities.
As of June 30, 1996, the Company was not in compliance with certain financial covenants under its Credit Agreement dated March 29, 1996. The primary reason for the non-compliance was due to the decline in operating income from ARS due to the fallen DRAM prices discussed above and the flatness in revenue performance in the PSS. To obtain a waiver of noncompliance from the bank lender, the Company obtained WCAS' limited guarantee of up to $3 million under the Working Capital Revolving Credit and, if drawn upon, up to $9 million under the Reducing Revolving Credit. In return, the Company granted WCAS warrants that, if fully vested, would give WCAS the right to buy a number of shares equal to the indebtedness guaranteed divided by the lower of the Common Stock price on the date the guarantees were initially issued or on certain anniversary dates. The warrants vest 20% on issuance, 20% on June 1, 1997, 20% on March 1, 1998 and 100% if at any time the bank calls the guarantees. The guarantees will be released, and unvested warrants will expire, if and when the Company returns to full compliance with the original financial covenants under the Credit Agreement.
As of September 30, 1996, the bank had waived compliance with the financial covenants under the Credit Agreement, and effective December 31, 1996, amended financial covenants took effect under which the Company expects to be in compliance.
Other than the funds for the remaining discontinued operations, the Company had no material capital commitments at September 30, 1996.
Management believes existing cash on hand, funds generated from operations, and funds available under its credit facilities will be sufficient to meet the operating requirements for the next twelve months. The Company's cash and credit facilities are managed in order to be available for strategic investment opportunities.
OUTLOOK AND UNCERTAINTIES
Aurora does not provide forecasts of potential future financial performance. While management of the Company is optimistic about Aurora's long-term prospects, the following issues and uncertainties, among others, should be considered in evaluating its growth outlook.
Market in Early Stages of Development. The Company believes that the market for its spare parts distribution and electronics recycling services is in the early stages of development and that awareness among certain potential customers of the availability of these services may be relatively low. Once customers are made aware of the availability of and benefits provided by these aftermarket support services, however, the Company's experience is that customers are generally receptive to making these services an important element of their manufacturing, post-sales support and environmental strategies. While the Company believes that it offers a mutually beneficial solution to large customers' and field service organizations' spare parts, recycling and asset recovery requirements, and has therefore targeted these entities as its primary potential customers, there is no assurance that these entities will choose to make use of these services, continue to outsource their spare parts, recycling and asset recovery needs, or choose not to become direct competitors of the Company. The Company addresses these issues in many ways, particularly including the development of information tools to use in its business, and the installation of information processing software. These projects require large budgets and manpower commitments, and have uncertain time schedules. Successful completion of these projects is not certain, and a failure of these projects may have adverse consequences for the development of the Company's business and/or its ability to successfully compete.
Dependence on the Computer Industry. The Company's business is dependent upon the continued growth, viability and financial stability of its customers and potential customers in the computer industry. The computer industry has been characterized by rapid technological change, compressed product life cycles, and pricing and margin pressures. While these factors could be beneficial to the Company's business, such factors affecting segments of the computer industry in general, and the Company's customers in particular, could have an adverse effect on the Company's business.
Inventory Obsolescence. The market for personal computers and subsystems is characterized by rapidly changing technology and frequent new product introductions. Innovations and improvements in computer and subsystem design, engineering and production may shorten the useful lives of existing systems and associated spare parts. Such rapid changes and improvements in technology, coupled with the need to maintain sufficient inventory levels of spare parts to ensure ready availability, subject the Company to the risk of inventory obsolescence. The Company has successfully reduced its exposure to such inventory obsolescence by maintaining rapid inventory turnover. There can be no assurance that the Company's efforts in this area will continue to be successful.
Lack of Long-Term Supply Contracts. The Company's success is dependent on its ability to continue to sell spare parts to its customers and to attract a reliable stream of recyclable material from its customers. Generally, the Company distributes spare parts to, and receives its recyclable material from, customers pursuant to non-exclusive contracts that to do not contain guaranteed or minimum quantities and are subject to cancellation on short notice at the customer's discretion. There is no assurance that the
Company's customers will continue to do business with the Company. The termination of a material contract or any substantial decrease in demand for spare parts or of the supply of recyclable material from significant customers could result in a significant decrease in the Company's sales.
Cyclicality and Price Fluctuation in the IC Industry. The Company derives some of its revenue from the sale of ICs. The IC industry has been characterized in the past periods of cyclicality in which prices of commodity ICs, such as DRAMs, SRAMs, EPROMs and microprocessors, have fluctuated. In periods of IC oversupply, prices have declined. Similarly, one generation of commodity ICs can decline in price as the next generation comes to market. Significant declines in unit volume demand or unit pricing could have an adverse effect on the Company's business.
Dependence on Key Personnel. The success of the Company is dependent, in part, upon key management personnel. The loss of the services of any of the Company's key management personnel could have a material adverse effect on the Company. Expansion of the Company's business may require additional managers and employees with industry experience. Competition for skilled management personnel in the industry is intense.
Competition. The independent spare parts distribution and the electronic recycling services industry is fragmented with widespread competition from a variety of small independent suppliers. The Company believes that competition for OEM, TPMO and MVSO customers is based on a number of factors, including: (i) breadth of parts distributed; (ii) ability to offer sophisticated inventory and materials management programs; (iii) ability to offer rapid delivery and sophisticated logistics programs; and (iv) price. Among the Company's major independent competitors are DecisionOne, Data Trend, PC Service Source, and The Cerplex Group. Certain of these competitors are larger in total company revenue or have larger capitalizations than the Company.
Control by Major Shareholder. As discussed above under "Recapitalization," WCAS, and their affiliates, own approximately 76.4% of the Company's voting stock. As a result, WCAS is able to elect the entire Board of Directors, and will retain the voting power to control all matters requiring shareholder approval. The Company's ability to raise additional capital or to sell control of the Company to third parties will be restricted if it is unable to obtain such shareholder approval.
Other Uncertainties. Other operating, financial or legal risks or uncertainties are discussed in the Form 10-K in specific contexts. The Company is, of course, also subject to general economic risks, the risk of interruption in the source of supply, the risk of loss of a major customer, dependence on key personnel and other risks and uncertainties.
NEW ACCOUNTING STANDARDS
In 1997, the Company will be required to adopt SFAS No. 123, Accounting for Stock-Based Compensation. However, the Company has decided to continue to account for employee stock options under Accounting Principles Board Opinion No. 25. This standard will be effective for transactions entered into after October 1, 1996. The primary impact of this standard will be to disclose the fair market value of equity issued to employees and third parties.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
All other financial statement schedules are omitted as the required information is presented in the financial statements or the notes thereto or is not necessary.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Aurora Electronics, Inc.:
We have audited the accompanying consolidated balance sheets of Aurora Electronics, Inc. (a Delaware Corporation) and subsidiaries as of September 30, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended September 30, 1996, 1995 and 1994. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Aurora Electronics, Inc. and subsidiaries as of September 30, 1996 and 1995, and the results of their operations and their cash flows for the years ended September 30, 1996, 1995 and 1994 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index to the consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.
Orange County, California December 30, 1996
ARTHUR ANDERSEN LLP
AURORA ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
AURORA ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE FIGURES)
The accompanying notes are an integral part of these financial statements.
AURORA ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
AURORA ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
AURORA ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
AURORA ELECTRONICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share figures)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization. Aurora Electronics, Inc. operates in one business segment providing spare parts distribution and electronics recycling services to major personal computer manufacturers and field service organizations.
Principles of Consolidation. The accompanying consolidated financial statements include the accounts of Aurora Electronics, Inc. (the "Company") and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain operating segments that have been sold and segments for which a plan of disposal had been adopted as of September 30, 1992 have been reported as discontinued operations.
Use of Estimates. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's industry is subject to significant fluctuations in prices and technologies.
Cash and Cash Equivalents. The Company considers all liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents.
Inventories. Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. Reserves for cost in excess of net realizable value are determined periodically by comparing sales prices and volumes to cost and quantity of inventory on hand.
Property, Plant and Equipment. Property, plant and equipment is recorded at cost and is depreciated over the estimated useful lives of the related assets by the straight-line method for financial reporting purposes, and accelerated methods with respect to certain assets for income tax purposes. Property, plant and equipment includes computer hardware, software and implementation costs which are purchased, acquired and modified for internal use. The Company's policy is to capitalize and accumulate such costs as incurred and to commence amortization when placed in service. Leasehold improvements are amortized over the terms of the related leases or their useful lives, whichever is shorter.
Intangible Assets. Goodwill associated with acquisitions is amortized using the straight-line method over forty years. The Company assesses the recoverability of its goodwill by determining whether the amortization of the goodwill balance over its remaining life can be recovered through projected non-discounted future cash flows over the remaining amortization period. If projected future cash flows indicate that unamortized goodwill will not be recovered, an adjustment is made to reduce the net goodwill to an amount consistent with projected future cash flows discounted at the Company's incremental borrowing rate. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and management's estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions.
Revenue Recognition. Revenue is recognized upon shipment of products to customers. The Company warrants products against defects and has policies permitting the return of products under
certain circumstances. Provisions are made for warranty costs and returns. Such costs generally have not been material. The Company does not offer price protection to its customers.
The Company performs ongoing credit evaluations of its customers and has established provisions for potential credit losses.
Earnings Per Share of Common Stock. Earnings per share of common stock is based upon the weighted average number of common and common equivalent shares outstanding, less cumulative dividends to holders of the Company's preferred stock. Outstanding stock options and warrants are treated under the treasury stock method as common stock equivalents when dilution results from their assumed exercise. The Company's Redeemable Convertible Preferred Stock, 7-3/4% Convertible Subordinated Debentures due April 15, 2001, and 7% Subordinated Convertible Promissory Notes (the "7% Notes") due September 30, 1997, were not common stock equivalents at the time of issuance and are therefore not included in the calculation of primary earnings per share. Fully diluted net earnings per share is not presented as it is anti-dilutive.
New Accounting Standards
In 1997, the Company will be required to adopt SFAS No. 123, Accounting for Stock-Based Compensation. However, the Company has decided to continue to account for employee stock options under Accounting Principles Board Opinion No. 25. This standard will be effective for transactions entered into after October 1, 1996. The primary impact of this standard will be to disclose the fair market value of equity issued to employees and third parties.
NOTE B - ACQUISITIONS
Micro-C Corporation ("Micro-C")
Effective September 30, 1992, the Company acquired all of the outstanding Common Stock of Micro-C, a recycler of integrated circuits for the electronics industry. The purchase price consisted of $10,949 in cash and the issuance of the 7% Notes in the original principal amount of $7,379. Additionally, the purchase agreement provided for the issuance of up to approximately 447 shares of the Company's Common Stock valued at $11.20 per share (subject to anti-dilution adjustments) to the sellers over a three year period commencing in 1993. In fiscal 1996, 1995 and 1994, the Company issued 82, 77 and 61 shares, respectively in connection with the fiscal 1995, 1994 and 1993 operating results. Pursuant to the terms of a settlement agreement, the remaining 227 shares will not be issued.
FRS, Inc. ("FRS")
On September 30, 1993, the Company acquired all of the outstanding Common Stock of FRS, a provider of maintenance and repair services on selected computer peripherals and products. FRS also provides inventory management control services to certain manufacturers of electronic products and third party maintenance organizations. Pursuant to the Merger Agreement, the total consideration paid to the former shareholders of FRS was approximately $5,400 comprised of cash of approximately $100 and 744 shares of the Company's Common Stock valued at $7.125 per share (the last closing share price of Aurora's Common Stock prior to signing the Merger Agreement on September 12, 1993).
Century Computer Marketing ("Century")
Effective March 1, 1994, the Company acquired substantially all of the assets and assumed substantially all of the liabilities of Century. Century is a distributor of new and refurbished spare parts to the computer maintenance market, supporting the products of over 500 manufacturers. Pursuant to the terms of the Asset Purchase Agreement, the total consideration paid to Century was approximately $29,000 in cash, $2,000 in Common Stock of the Company and an additional $2,700 in Common Stock of the Company. The Company financed the acquisition of Century with proceeds from a five year $25,000 senior term loan and internally generated cash.
All acquisitions have been accounted for by the purchase method of accounting, and accordingly each purchase price has been allocated to the assets acquired and the liabilities assumed based on the
estimated fair values at the date of the acquisitions. The excess of the purchase price over the estimated fair values of the net assets acquired was recorded as goodwill amortizable over 40 years. The contingent consideration was recorded as additional goodwill when the related contingencies were resolved and the consideration was determined. Goodwill from the Micro-C and FRS acquisitions has been written off. See Note F -- Intangibles and Other Assets.
The estimated fair value of assets and liabilities as of the date of the acquisitions are summarized as follows:
The following table presents the unaudited pro forma results of operations of the Company for the year ended September 30, 1994, assuming the Century acquisitions had occurred on October 1, 1993.
NOTE C - DISCONTINUED OPERATIONS
Commencing in 1990, the Company began to discontinue its sporting goods operations and divest itself of the related assets. Effective September 30, 1992, the Company announced that its remaining sporting goods operations would be accounted for as discontinued operations and the remaining assets would be sold. As of September 30, 1994, no material assets remained related to the discontinued operations. During 1994, management revised the estimated reserve for remaining contractual and contingent obligations resulting in a provision for loss on disposal of $2,400. Such obligations and contingencies relate primarily to a leased building, reserves for helmet litigation, and estimation of liabilities due to an income tax dispute. (See Note M of the Notes to Consolidated Financial Statements -- Commitments and Contingencies).
NOTE D - INVENTORIES
Inventories at September 30, 1996 and 1995 consisted of the following:
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at September 30, 1996 and 1995 consisted of the following:
The Company leases office, processing and warehousing facilities under various operating leases through 2001. Future minimum lease payments under non-cancelable operating leases with remaining terms in excess of one year for the fiscal year ending September 30 are as follows: 1997 - $1,789; 1998 - $1,676; 1999 - $1,592; 2000 - $842; 2001 - $104. Rent expense was approximately $1,246, $1,662, and $1,393 for the years ended September 30, 1996, 1995 and 1994, respectively.
NOTE F - INTANGIBLES AND OTHER ASSETS
Intangibles and other assets at September 30, 1996 and 1995 consisted of the following:
Due to the deterioration of the pricing levels in the integrated circuit market in the latter part of fiscal 1996 and their related negative effects on the Company's business prospects, management charged the remaining balance of goodwill related to the acquisition of Micro-C, totaling $16,580, to operations in the fourth quarter of fiscal 1996. Also, upon the completion of a major corporate reorganization in the third quarter of fiscal 1995, management charged the remaining balance of goodwill related to the acquisition of FRS, totaling $7,407, to operations in fiscal 1995. These charges were determined necessary as management estimated that the amortization of the respective goodwill balances over their remaining lives would not be recovered through the projected non-discounted future cash flows over their respective remaining amortization periods. Other reductions of goodwill related to the reduction of the notes payable due to the sellers of Micro-C as a result of a favorable arbitration award in April 1995. (See Note G -- Long-Term Debt.)
In fiscal 1994, management determined that the remaining unamortized balance of $2,400, which had been assigned to a non-compete agreement with the sellers of Micro-C, should be charged to operations. The non-compete agreement was determined to be of no continuing value due to the decision by the Company's major supplier of reduced specification ICs to indefinitely suspend shipments and to the decline of the Company's activities in general in the reduced specification IC business.
NOTE G - LONG-TERM DEBT
Long-term debt consists of the following:
Bank Financing
In March 1996, in conjunction with the successful recapitalization of the Company ("Recapitalization"), the Company's operating subsidiary, Aurora Electronics Group, Inc. ("AEG"), entered into a the Credit Agreement with a group of financial institutions (lenders) which provides for up to $35,000 of borrowings. The Credit Agreement consists of borrowings totaling $15,000 for working capital purposes, and $20,000 ($18,000 at September 30, 1996) that may be used to repay outstanding debt and for approved future acquisitions. All borrowings under the Credit Agreement are secured by substantially all of the assets of AEG.
The term of the Credit Agreement is five years. The availability of the $20,000 portion of the Facilities is reduced by $1,000 each quarter commencing June 1996, with the remainder due and payable at maturity. The Facilities also provide for mandatory prepayments in the event of asset sales, new stock or debt financing and extraordinary receipts. The interest rate will be based on LIBOR plus 2.75% or the Bank's Base Rate plus 1.25%, with interest rate adjustments based on the ratio of total funded senior debt to the Company's earnings before interest, taxes, amortization and depreciation.
AEG failed to meet certain of the financial covenants imposed by the Credit Agreement for the year ended September 30, 1996. The lenders waived compliance for failure to meet certain of the fiscal 1996 covenants. Effective December 31, 1996, the lenders have issued modified covenants for two years through September 30, 1998. The covenants include minimum levels of earnings and interest coverage (as defined) and stipulate maximum levels of leverage (as defined).
In connection with the Credit Agreement, the Company's largest shareholder agreed to guarantee up to $3,000 of AEG borrowings. In consideration for the guarantee, the shareholder will receive warrants to purchase up to 1,397 shares of common stock. at an exercise price of $2.075 per share. The number of shares under warrant is determined based on the length of time the guarantee remains in force and the price may be adjusted lower due to antidulution provisions in the warrant agreements. (See Note J of the Notes to Consolidated financial Statements -- Stockholders' Equity.)
10% Senior Subordinated Notes
In connection with the Recapitalization, the Company issued 10% Notes to its largest shareholder with a face value of $10 million due September 30, 2001. The Notes are shown net of the value of 607 shares of common stock issued simultaneously with the Notes. Interest on the Notes is payable on March 31 and September 30 of each year beginning September 30, 1996 through maturity. The proceeds of the Notes were used to repay the 9-1/4% Senior Subordinated Notes due November 1996. (See Note J of the Notes to Consolidated Financial Statements - -- Stockholders' Equity.)
7-3/4% Convertible Subordinated Debentures
The 7-3/4% Convertible Subordinated Debentures mature April 15, 2001 ("Convertible Debentures") and are shown net of unamortized discount of approximately $125 and $152 at September 30, 1996 and 1995, respectively. The Company is required to make partial sinking fund payments of approximately $117 and $2,516 in 1999 and 2000, respectively. The Convertible Debentures are convertible into Common Stock of the Company at a conversion price, subject to adjustment in certain instances, of $11.66 per share, and are redeemable at the option of the Company at face value plus accrued interest thereon. Interest on the 7-3/4% Debentures is payable on April 14 and October 14 of each year through maturity.
7% Subordinated Convertible Promissory Notes
In connection with the acquisition of Micro-C, the Company issued 7% Notes to the sellers aggregating approximately $7,379. In April 1995, the Company was awarded in arbitration a final settlement which reduced the outstanding balance of the notes to $2,648. Interest on the 7% Notes is payable on March 31 and September 30 of each year beginning March 31, 1993 through maturity. The remaining principal balance of the 7% Notes is due in monthly installments totaling $74 beginning September 30, 1996 through September 30, 1997, and a final installment of $804 due September 30, 1997. The 7% Notes are convertible into shares of the Company's Common Stock at a rate of $11.20 per share, subject to certain adjustments as defined in the note agreements.
Other Long-term Debt
Additional long-term debt consists primarily of secured equipment financing and capital lease obligations with interest rates ranging from 8.9% to 12.9%, due in monthly installments through 1999.
Aggregate maturities of long-term debt for the fiscal years ending September 30 are as follows: 1997 - $1,974, 1998 - $90, 1999 - $168, 2000 - $2,516 and 2001 - $23,068.
NOTE H - INCOME TAXES
The provision for income taxes for the years ended September 30, 1996, 1995 and 1994 consists of the following:
The provision (benefit) for income taxes in the accompanying consolidated statements of operations differs from the amount of tax based on the statutory federal income tax rate as follows:
The components of the Company's deferred income tax benefit as of September 30, 1996 and 1995 are as follows:
At September 30, 1996, the Company had tax basis net operating losses ("NOLs") of approximately $39,400 available to offset future ordinary taxable income. The utilization of the Company's NOLs will be substantially limited due to the Recapitalization. These carryforwards begin to expire during 2007. The income tax benefit related to these NOLs, as well as to certain reserves recorded by the Company, have been reflected in the deferred income tax asset accounts to the extent they are considered realizable.
A valuation allowance is provided against the deferred tax asset when it is more likely than not that some portion of the deferred tax asset will not be realized. The Company has established a valuation allowance for the portion of the deferred tax asset that is not likely to be realized within approximately the next fiscal year based on Management's best estimate of results of operations for that upcoming period.
NOTE I - REDEEMABLE CONVERTIBLE PREFERRED STOCK
Concurrent with the Recapitalization, the Company issued 400 shares of Redeemable Convertible Preferred Stock to its largest shareholder. The shares have a par value of $.01 per share and were issued for $100 per share. The Preferred Stock has a liquidation preference of $100 per share plus accrued and unpaid dividends. The dividends accrue at 7% per annum. The Preferred Stock (including all unpaid dividends) is convertible into common stock of the Company at a conversion price of $2.125 per share, subject to antidilusion adjustments. The Preferred Stock is subject to mandatory redemption by the Company on September 30, 2006 at the price of $100 per share plus all accrued and unpaid dividends to the redemption date. The holders of the Preferred Stock have voting rights equivalent to the holders of common stock on an "as converted" basis.
NOTE J - STOCKHOLDERS' EQUITY
The Company has 1,000 shares of authorized $.01 par value preferred stock, with none issued or outstanding. The Company has 50,000 shares of authorized $.03 par value Common Stock with 10,486 shares issued and 5,743 shares outstanding at September 30, 1996, (compared to 8,062 and 7,501, respectively, at September 30, 1995).
In October 1995, the Company sold 340 shares of Common Stock to investors in a private placement of equity securities in exchange for proceeds totaling $883, net of issuance costs. Proceeds from the offering were used to make the principal payment due September 30, 1996 on the 7% notes payable.
In March 1996, the Company completed its comprehensive plan to recapitalize the Company, pursuant to which the Company (a) sold (i) 400 shares of Redeemable Convertible Preferred Stock, $.01 par value, to WCAS and certain other investors for an aggregate purchase price of $40,000 and (ii) 607 shares of Common Stock, along with a $10,000 10% Senior Subordinated Note due September 2001, to WCAS Capital Partners II, L.P. ("WCAS CP II") for an aggregate purchase price of $10,000, and (b) repurchased 4,268 shares of the Company's Common Stock, $.03 par value at $2.875 per share pursuant to a tender offer for up to 6,500 shares of Common Stock.
To obtain a waiver of noncompliance with certain covenants as of June 30, 1996 from the bank lender, the Company obtained WCAS' limited guarantee of up to $3 million in revolving indebtedness and, if drawn upon, up to $9 million in acquisition-related indebtedness under the Credit Agreement. In return, the Company granted WCAS, and its affiliates, warrants that, if fully vested, would give WCAS, and its affiliates, the right to buy a number of shares equal to the indebtedness guaranteed divided by the lower of the Common Stock price on the date the guarantees were initially issued or on certain anniversary dates. The warrants vest 20% on issuance, 20% on June 1, 1997, 20% on March 1, 1998 and 100% if at any time the bank calls the guarantees. The guarantees will be released, and unvested warrants will expire, if and when the Company returns to full compliance with the original financial covenants under the Credit Agreement.
In connection with AEG's prior Senior Credit Agreement dated May 1994, and the Third Amendment effective September 30, 1995 which was repaid in full as part of the Recapitalization. The Company issued Warrants to the lenders to acquire 397 shares of common stock at $2.18 per share.
NOTE K - EMPLOYEE STOCK AND SAVINGS PLANS
Employee stock purchase plan. Effective October 1, 1994, the Company established an employee stock purchase plan for all eligible employees. Under the plan, shares of the Company's Common Stock may be purchased at three-month intervals at 85% of the lower of the fair market value on the first or the last day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period. At September 30, 1996, 350 shares were reserved for future issuance.
Savings plan. The Company has a savings plan, which qualifies under Section 401(k) of the Internal Revenue Code. Under the plan, participating U.S. employees may defer up to 15% of their pretax salary, but not more than statutory limits. The Company contributes a discretionary amount, set by the Board of Directors, for each dollar contributed by a participant, with a maximum of 6% of participant earnings. The Company's matching contribution to the savings plan was $252, $279 and $161 for the years ended September 30, 1996, 1995 and 1994, respectively.
Stock option plan. The Company has a stock option plan for directors, officers, and key employees which provides for incentive and nonqualified stock options. A committee comprised of disinterested directors determines the option price (not less than the fair market value of the stock at the date of grant). The options generally expire ten years from the date of grant and vest over five years. As of September 30, 1996, options for 4,031 shares were issued and 1,377 shares were available for future grants under the plan. Options for 200 shares were issued outside the Stock Option Plan. The new stock option plan was instituted at the time of the Recapitalization. At that time, the Company offered to exchange options issued under prior stock option plans for options under the new plan at the market price per share ($2.125) at the time of the Recapitalization.
NOTE L - FAIR VALUE INFORMATION
The following disclosure of the estimated fair value of financial instruments at September 30, 1996 and 1995 is made in accordance with the requirements of SFAS No. 107 "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The carrying amounts of cash and cash equivalents, short - term investments, trade receivables, and accounts payable are a reasonable estimate of their fair value. The carrying amount of long-term debt approximates fair value because the obligations either bear interest at floating rates, or compare favorably with fixed rate obligations that would be available to the Company.
The fair value information presented herein is based on pertinent information available to management as of September 30, 1996. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since that date, and current estimates of fair value may differ significantly from the amounts presented herein.
NOTE M - COMMITMENTS AND CONTINGENCIES
Discontinued operations
The Company is subject to a non-cancelable building lease though 2005. Management is pursuing various alternatives which would terminate this obligation prior to the expiration of the lease and has recorded a reserve which contemplates termination prior to 1999. In estimating the reserve management has considered operating costs, net present value of the remaining lease payments, an early termination payment and sublease rental income. However, additional reserves may be needed in the event management is not able to successfully negotiate an early termination of the lease.
Pursuant to a Tax Indemnity Agreement entered into between the Company and Sport Supply Group, Inc. ("SSG") in connection with the SSG Public Offering, the Company agreed to indemnify SSG against certain consolidated income tax liabilities of the Company incurred prior to the SSG Public Offering. The Company does not believe that amounts paid, if any, pursuant to these agreements will have a material effect on the results of operations and financial condition of the Company.
Class Action Settlement
In connection with the settlement of a class action complaint, the parties reached agreement on the terms of a settlement, which required the Company to contribute $250 in cash and $1,250 in Common Stock priced at the issuance date. The balance of the settlement ($1,500 in cash) would be funded by the Company's insurer. The settlement was approved on September 5, 1995. The Company will issue the settlement stock after proofs of claims have been filed and verified as entitling the holders thereof to a share of the settlement proceeds.
NOTE N - EXPORT SALES AND MAJOR CUSTOMERS
Export sales to customers in foreign countries amounted to approximately $21,192, $28,032 and $15,600 in fiscal 1996, 1995 and 1994, respectively. Revenues from the Company's foreign operations approximated $9,278, $10,109 and $8,100 in 1996, 1995 and 1994, respectively. In fiscal 1996, one customer accounted for approximately 19% of sales. No customer accounted for 10 percent or more of sales in fiscal 1995 and 1994.
NOTE O - TRANSACTIONS WITH RELATED PARTIES
The Company's Chairman and Chief Executive Officer and its former President are owners of EOS Capital, Inc. ("EOS"), a private capital firm previously retained by the Company for consulting and investment banking services. During the first quarter of fiscal 1994, the Company did not pay these individuals salaries as they were not employees of the Company until January 1, 1994. The Company paid EOS $45 for consulting and investment banking services for the first quarter of fiscal 1994. Additionally, the Company paid $21 during the same period for reimbursement of incurred expenses. Effective January 1, 1994, these individuals became employees of the Company.
To obtain a waiver of noncompliance with certain financial covenants under the Credit Agreement, in September 1996, the Company obtained WCAS' limited guarantee of up to $3 million in revolving indebtedness and, if drawn upon, up to $9 million in acquisition-related indebtedness under the Credit Agreement. In return, the Company granted WCAS warrants that, if fully vested, would give WCAS the right to buy a number of shares equal to the indebtedness guaranteed divided by the lower of the Common Stock price on the date the guarantees were initially issued or on certain anniversary dates. The warrants vest 20% on issuance, 20% on June 1, 1997, 20% on March 1, 1998 and 100% if at any time the bank calls the guarantees. The guarantees will be released, and unvested warrants will expire, if and when the Company returns to full compliance with the original financial covenants under the Credit Agreement.
SCHEDULE II
AURORA ELECTRONICS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AMOUNTS IN THOUSANDS
(1) Uncollectible accounts written off, net of recoveries (2) Century Acquisition
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information regarding the directors of the Company is set forth under the caption "Election of Directors" contained in the Proxy Statement for the Annual Meeting of Stockholders currently expected to be held March 25, 1997, which is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding the Company's compensation of its executive officers is under the caption "Executive Compensation" contained in the Proxy Statement for the Annual Meeting of Stockholders currently expected to be held March 25, 1997, which is incorporated herein by reference except that information in subsections titled "Report of Compensation Committee and the Stock Option Committee on Executive Compensation" and "Performance Graph" of such section are not incorporated by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding security ownership of certain beneficial owners and management is under the caption "Security Ownership of Management and Principal Stockholders" contained in the Proxy Statement for the Annual Meeting of Stockholders currently expected to be held March 25, 1997, which is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding transactions with the Company's executive officers and directors is under the caption "Transactions with Management and Related Parties" contained in the Proxy Statement for the Annual Meeting of Stockholders currently expected to be held March 25, 1997, which is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements. See Item 8.
(a)(2) Supplemental Schedules Supporting Financial Statements. See Item 8.
(c) Exhibits. See Index to Exhibits.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: December 30, 1996
AURORA ELECTRONICS, INC.
By: /s/John P. Grazer ___________________________________ John P. Grazer, President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on December 30, 1996 by the following persons on behalf of the registrant and in the capacities indicated.
INDEX TO EXHIBITS
- -------------------- *Filed herewith.