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RICHARDSON ELECTRONICS LTD/DE - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the consolidated financial statements and related notes. Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to assist the reader in better understanding our business, results of operations, financial condition, changes in financial condition, critical accounting policies and estimates, and significant developments. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes appearing elsewhere in this filing. This section is organized as follows: • Business Overview • Results of Continuing Operations - an analysis and comparison of our consolidated results of operations for the fiscal years ended May 31, 2014, June 1, 2013, and June 2, 2012, as reflected in our consolidated statements of comprehensive income (loss). • Liquidity, Financial Position, and Capital Resources - a discussion of our primary sources and uses of cash for the fiscal years ended May 31, 2014, June 1, 2013, and June 2, 2012, and a discussion of changes in our financial position. Business Overview Richardson Electronics, Ltd. ("we", "us", "the Company", and "our") is incorporated in the state of Delaware. We are a leading global provider of engineered solutions, power grid and microwave tubes and related components, and customized display solutions, serving customers in the alternative energy, aviation, broadcast, communications, industrial, marine, medical, military, scientific, and semiconductor markets. Our strategy is to provide specialized technical expertise and "engineered solutions" based on our core engineering and manufacturing capabilities. We provide solutions and add value through design-in support, systems integration, prototype design and manufacturing, testing, logistics, and aftermarket technical service and repair. Our products include electron tubes and related components, microwave generators, subsystems used in semiconductor manufacturing, and visual technology solutions. These products are used to control, switch or amplify electrical power signals, or are used as display devices in a variety of industrial, commercial, medical, and communication applications. On July 5, 2013, we acquired the assets of WVS-Technology ("WVS") for approximately $1.0 million. WVS, located in Meerbusch, Germany, develops and sells RF and microwave products, power grid tubes, vacuum capacitors, as well as industrial microwave equipment. This acquisition provides us with engineering and sales expertise to help expand our presence in the vacuum capacitor market. On September 4, 2012, we acquired the assets of D and C Import-Export, Inc. ("D and C") for approximately $2.6 million. D and C, a Florida-based distributor of power grid tubes and associated RF components, services the broadcast, commercial, industrial, medical, military, and scientific markets. This acquisition provides us with access to additional product lines, vendors, and customers. On September 5, 2011, we acquired the assets of Powerlink Specialist Electronics Support Limited ("Powerlink") for approximately $2.3 million. Powerlink, a UK-based technical service company with locations in London and Dubai, services TWT amplifiers and related equipment for the Satellite Communications market throughout Europe and the Middle East. We have two operating segments which we define as follows: Electron Device Group ("EDG") provides engineered solutions and distributes electronic components to customers in alternative energy, aviation, broadcast, communications, industrial, marine, medical, military, scientific, and semiconductor markets. EDG focuses on various applications including broadcast transmission, CO2 laser cutting, diagnostic imaging, dielectric and induction heating, high energy transfer, high voltage switching, plasma, power conversion, radar, and radiation oncology. EDG also offers its customers technical services for both microwave and industrial equipment. Canvys provides customized display solutions serving the corporate enterprise, financial, healthcare, industrial, and medical original equipment manufacturers ("OEM") markets. 17 -------------------------------------------------------------------------------- Table of Contents We currently have operations in the following major geographic regions: • North America; • Asia/Pacific; • Europe; and • Latin America. Results of Continuing Operations Overview - Fiscal Year Ended May 31, 2014 • Net sales for fiscal 2014 were $138.0 million, down 2.2%, compared to net sales of $141.1 million during fiscal 2013. • Gross margin increased to 29.7% during fiscal 2014, compared to 29.5% during fiscal 2013. • Selling, general, and administrative expenses increased to $43.5 million, or 31.5% of net sales, for fiscal 2014 compared to $41.5 million, or 29.4% of net sales, for fiscal 2013. • Operating loss during fiscal 2014 was $4.2 million, compared to breakeven during fiscal 2013. • Loss from continuing operations during fiscal 2014 was $0.3 million compared to income of $0.5 million, or $0.03 per diluted common share, during fiscal 2013. • Loss from discontinued operations, net of tax, was $0.2 million, during fiscal 2014, compared to income of $0.8 million, or $0.05 per diluted common share, during fiscal 2013. • Net loss during fiscal 2014 was $0.5 million compared to net income of $1.2 million, or $0.08 per diluted common share, during fiscal 2013. Net Sales and Gross Profit Analysis Net sales by segment and percent change for fiscal 2014, 2013, and 2012 were as follows (in thousands): FY14 vs. FY13 FY13 vs. FY12 Net Sales FY 2014 FY 2013 FY 2012 % Change % Change EDG $ 103,274 $ 102,593 $ 112,586 0.7 % (8.9 %) Canvys 34,686 38,473 45,250 (9.8 %) (15.0 %) Total $ 137,960 $ 141,066 $ 157,836 (2.2 %) (10.6 %) During fiscal 2014 consolidated net sales decreased 2.2% compared to fiscal 2013. Sales for Canvys declined by 9.8%, slightly offset by a 0.7% increase in sales for EDG. During fiscal 2013 consolidated net sales decreased 10.6% compared to fiscal 2012. Sales for Canvys declined by 15.0%, and sales for EDG declined 8.9%. Gross profit by segment and percent of segment net sales for fiscal 2014, 2013, and 2012 were as follows (in thousands): Gross Profit FY 2014 FY 2013 FY 2012 EDG $ 31,610 30.6% $ 31,431 30.6 % $ 34,626 30.8 % Canvys 9,404 27.1% 10,114 26.3 % 12,155 26.9 % Total $ 41,014 29.7% $ 41,545 29.5 % $ 46,781 29.6 % Gross profit reflects the distribution and manufacturing product margin less manufacturing variances, inventory obsolescence charges, customer returns, scrap and cycle count adjustments, engineering costs, unabsorbed manufacturing labor and overhead, and other provisions. Consolidated gross profit was $41.0 million during fiscal 2014, compared to $41.5 million during fiscal 2013. Consolidated gross margin as a percentage of net sales increased slightly to 29.7% during fiscal 2014, from 29.5% during fiscal 2013. Gross margin during fiscal 2014 included expense related to inventory provisions for EDG and Canvys of $0.6 million and $0.2 million, respectively. Gross margin during fiscal 2013 included expense related to inventory provisions for EDG and Canvys of $0.2 million and $0.2 million, respectively. In addition, gross margin for EDG included $0.5 million and 18 -------------------------------------------------------------------------------- Table of Contents $0.8 million related to unabsorbed manufacturing labor and overhead for continuing operations during fiscal 2014 and 2013, respectively. Consolidated gross profit was $41.5 million during fiscal 2013, compared to $46.8 million during fiscal 2012. Consolidated gross margin as a percentage of net sales declined slightly to 29.5% during fiscal 2013, from 29.6% during fiscal 2012. Gross margin during fiscal 2013 and fiscal 2012 included expense related to inventory provisions for EDG and Canvys of $0.2 million and $0.2 million, respectively. In addition, gross margin for EDG included $0.8 million and $0.2 million related to unabsorbed manufacturing labor and overhead for continuing operations during fiscal 2013 and 2012, respectively. Electron Device Group Net sales for EDG increased 0.7% to $103.3 million during fiscal 2014, from $102.6 million during fiscal 2013. Net sales of tubes grew in the industrial heating, marine, and laser markets but were offset by declines primarily in the broadcast and aviation markets. Gross margin as a percentage of net sales remained flat at 30.6% during fiscal 2014 compared to fiscal 2013. Net sales for EDG decreased 8.9% to $102.6 million during fiscal 2013, from $112.6 million during fiscal 2012. Net sales of tubes decreased to $80.8 million during fiscal 2013, as compared to $90.1 million during fiscal 2012, due primarily to economic factors and weaker demand, particularly in Europe and China, as well as overall declines in the plastic, wood, and semiconductor fabrication markets. Net sales of continuous wave magnetrons and related assemblies sold primarily into the semi-conductor fabrication market decreased to $9.7 million during fiscal 2013, as compared to $10.1 million during fiscal 2012. Gross margin as a percentage of net sales decreased slightly to 30.6% during fiscal 2013, as compared to 30.8% during fiscal 2012. Canvys Net sales for Canvys decreased 9.8% to $34.7 million during fiscal 2014, from $38.5 million during fiscal 2013. Sales were flat in the North America Healthcare segment, up slightly in Europe OEM and down in the North America OEM market as suppliers sold directly to end users. Gross margin as a percentage of net sales increased to 27.1% during fiscal 2014 as compared to 26.3% during fiscal 2013, due to continued margin improvement in Europe and lower inbound freight costs associated with inventory management. Canvys net sales decreased 15.0% to $38.5 million during fiscal 2013, from $45.3 million during fiscal 2012. Sales were negatively impacted in North America by healthcare reform. Sales in Europe were down due to continuing economic pressures. Gross margin as a percentage of net sales decreased to 26.3% during fiscal 2013 as compared to 26.9% during fiscal 2012, due to lower margin in Europe associated with customer mix and currency exchange. Sales by Geographic Area On a geographic basis, our sales are categorized by destination: North America; Europe; Asia/Pacific; Latin America; and Other. Net sales by geographic area and percent change for fiscal 2014, 2013, and 2012 were as follows (in thousands): FY14 vs. FY13 FY13 vs. FY12 Net Sales FY 2014 FY 2013 FY 2012 % Change % Change North America $ 57,137 $ 62,269 $ 68,980 (8.2 %) (9.7 %) Asia/Pacific 24,069 22,732 25,588 5.9 % (11.2 %) Europe 47,610 45,663 48,998 4.3 % (6.8 %) Latin America 8,936 9,447 9,870 (5.4 %) (4.3 %) Other 208 955 4,400 (78.2 %) (78.3 %) Total $ 137,960 $ 141,066 $ 157,836 (2.2 %) (10.6 %) 19-------------------------------------------------------------------------------- Table of Contents Gross profit by geographic area and percent of geographic net sales for fiscal 2013, 2012, and 2011 were as follows (in thousands): Gross Profit (Loss) FY 2014 FY 2013 FY 2012 North America $ 18,905 33.1 % $ 20,963 33.7 % $ 22,380 32.4 % Asia/Pacific 7,849 32.6 % 7,805 34.3 % 9,068 35.4 % Europe 15,506 32.6 % 14,248 31.2 % 15,107 30.8 % Latin America 3,231 36.2 % 3,296 34.9 % 3,712 37.6 % Other (4,477 ) (4,767 ) (3,486 ) Total $ 41,014 29.7 % $ 41,545 29.5 % $ 46,781 29.6 % We sell our products to customers in diversified industries and perform periodic credit evaluations of our customers' financial condition. Terms are generally on open account, payable net 30 days in North America, and vary throughout Asia/Pacific, Europe, and Latin America. Estimates of credit losses are recorded in the financial statements based on monthly reviews of outstanding accounts. Other primarily includes net sales not allocated to a specific geographical region, unabsorbed value-add costs, and unallocated freight expenses. Selling, General, and Administrative Expenses Selling, general, and administrative expenses ("SG&A") increased during fiscal 2014 to $43.5 million from $41.5 million during fiscal 2013. SG&A as a percentage of sales from continuing operations, increased to 31.5% during fiscal 2014 from 29.4% during fiscal 2013. The increase in SG&A costs of $2.0 million during fiscal 2014, compared to fiscal 2013, includes severance costs of $1.2 million, new system implementation expenses of $0.8 million, expenses related to evaluating potential acquisitions of $1.1 million, and new product development costs of $0.4 million, partially offset by a $1.5 million decrease within EDG, Canvys, and support functions. SG&A increased during fiscal 2013 to $41.5 million from $40.6 million during fiscal 2012. SG&A as a percentage of sales, from continuing operations, increased to 29.4% during fiscal 2013 from 25.8% during fiscal 2012. SG&A in fiscal 2013 includes a $1.4 million increase for EDG partially offset by a $0.1 million reduction of support function costs and a decrease of SG&A costs for Canvys of $0.9 million. SG&A in fiscal 2013 includes employee-related termination costs of $0.5 million, $0.3 million, and $0.4 million relating to EDG, Canvys, and support functions, respectively, compared to no employee-related terminations costs for fiscal 2012. Impairment of Goodwill The results of our goodwill impairment tests as of March 1, 2014, indicated that the balance of goodwill reported, entirely attributed to our EDG reporting unit, was fully impaired. The goodwill impairment test revealed that there was no implied goodwill value as of the measurement date. As a result, we recorded a pre-tax goodwill impairment charge of $1.7 million. Additionally, a $0.6 million tax benefit was recorded related to the goodwill impairment. The results of our goodwill impairment test as of March 2, 2013, and March 1, 2012, indicated no goodwill impairment as estimated fair value of the EDG reporting unit exceeded the carrying value. Other Income/Expense Other income/expense was income of $3.5 million during fiscal 2014, compared to income of $0.6 million during fiscal 2013. Fiscal 2014 included an antitrust class action lawsuit settlement of $2.6 million. The $0.6 million in fiscal 2013 included a foreign exchange loss of $0.8 million. Our foreign exchange gains and losses are primarily due to the translation of U.S. dollars held in non-U.S. entities. We currently do not utilize derivative instruments to manage our exposure to foreign currency. Fiscal 2014 and fiscal 2013 also included $1.0 million and $1.3 million, respectively, of investment income. Other income was $0.6 million during fiscal 2013, compared to $1.4 million during fiscal 2012. Other income included a foreign exchange loss of $0.8 million, as compared to a foreign exchange gain of less than $0.1 million during fiscal 2012. Our foreign exchange gains and losses are primarily due to the translation of U.S. dollars held in non-U.S. entities. We currently do not utilize derivative instruments to manage our exposure to foreign currency. Fiscal 2013 and fiscal 2012 also included $1.3 million and $1.4 million, respectively, of investment income. 20 -------------------------------------------------------------------------------- Table of Contents Income Tax Provision (Benefit) Our income tax benefit during fiscal year 2014 was $0.3 million. Our income tax provision for fiscal year 2013 was $0.2 million. During fiscal 2012, we had an income tax benefit of $0.3 million. The effective income tax rates for continuing operations during fiscal 2014, 2013, and 2012, were 47.0%, 24.9%, and (4.4%), respectively. The difference between the effective tax rates as compared to the U.S. federal statutory rate of 34% during 2014, 2013, and 2012 resulted from our geographical distribution of taxable income or losses, return to provision adjustments, the release of income tax reserves for uncertain tax positions, changes in the amount of foreign earnings considered to be permanently reinvested, and changes in valuation allowance. There were no changes in judgment during the fiscal year end regarding the beginning-of-year valuation allowance which would require a benefit to be excluded from the annual effective tax rate and allocated to the interim period. As of May 31, 2014, we had no domestic federal net operating loss ("NOL") carryforwards. Domestic state NOL carryforwards amounted to approximately $2.3 million. Foreign NOL carryforwards totaled approximately $1.1 million with various or indefinite expiration dates. We also had no alternative minimum tax credit carryforward or foreign tax credit carryforwards as of May 31, 2014. Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. A significant component of objective evidence evaluated was the cumulative income or loss incurred in each jurisdiction over the three-year period ended May 31, 2014. On the basis of this evaluation, as of May 31, 2014, a valuation allowance of $4.1 million has been established to record only the portion of the deferred tax asset that more likely than not will be realized. The valuation allowance relates to deferred tax assets in jurisdictions where historical taxable losses have been incurred, and domestic state NOL carryforwards related to jurisdictions where the utilization of NOLs have been suspended. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income during the carryforward period are reduced or increased, or if objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as our projections for growth. Our future U.S. federal, state, and foreign effective tax rates are expected to be closer to 34.0%, 3.8%, and 27.3%, respectively. Income taxes paid, including foreign estimated tax payments, were $2.1 million, $1.7 million, and $40.1 million during fiscal 2014, 2013, and 2012, respectively. We have historically determined that certain undistributed earnings of our foreign subsidiaries, to the extent of cash available, will be repatriated to the U.S. Accordingly, we have provided a deferred tax liability totaling $7.0 million and $6.8 million as of May 31, 2014 and June 1, 2013, respectively, on foreign earnings of $41.3 million. In addition, as of May 31, 2014, $45.4 million of cumulative positive earnings of some of our foreign subsidiaries are still considered permanently reinvested pursuant to ASC 740-30, Income Taxes - Other Considerations or Special Areas ("ASC 740-30"). Due to various tax attributes that are continuously changing, it is not practical to determine what, if any, tax liability might exist if such earnings were to be repatriated. In the normal course of business, we are subject to examination by taxing authorities throughout the world. Generally, years prior to fiscal 2005 are closed for examination under the statute of limitation for U.S. federal, state or local, or non-U.S. tax jurisdictions. We are also currently under examination in Germany (fiscal 2009, 2010, and 2011), Italy (fiscal 2011), and Thailand (fiscal 2008 through 2011). Our primary foreign tax jurisdictions are Germany and the Netherlands. We have tax years open in Germany beginning in fiscal 2007 and the Netherlands beginning in fiscal 2008. Discontinued Operations During fiscal year 2011, we completed the sale of the assets primarily used or held for use in, and certain liabilities of our RF, Wireless, and Power Division ("RFPD"), as well as certain other Company assets, including our information technology assets, to Arrow Electronics, Inc. ("Arrow") in exchange for $238.8 million ("the Transaction"). In accordance with Accounting Standards Codification ("ASC") 205-20, Presentation of Financial Statements - Discontinued Operations ("ASC 205-20"), we reported the financial results of RFPD as a discontinued operation. Refer to Note 4 "Discontinued Operations" of the notes to our consolidated financial statements in Part II, Item 8 of this Annual Report on form 10-K. 21-------------------------------------------------------------------------------- Table of Contents Financial Summary - Discontinued Operations Summary financial results for fiscal 2014, 2013, and 2012 are presented in the following table (in thousands): Fiscal 2014 Fiscal 2013 Fiscal 2012 Net sales $ 402 $ 636 $ 2,984 Gross loss (1) (330 ) (553 ) (227 ) Selling, general, and administrative expenses (2) 215 714 552 Additional (gain)/loss on sale - 18 (266 ) Income tax benefit (3) (375 ) (2,051 ) (1,049 ) Income (loss) from discontinued operations, net of tax (170 ) 766 536 Notes: (1) Gross loss for fiscal year 2014, 2013, and 2012 includes unabsorbed manufacturing labor and overhead expenses related to the Manufacturing Agreement with RFPD which ended March 1, 2014. (2) Selling, General and Administrative expenses in fiscals 2014, 2013, and 2012 related primarily to professional fees for tax audits resulting from the Transaction. (3) The income tax benefits in fiscal years 2014, 2013, and 2012 relates to the reversal of tax reserves. In accordance with ASC 230, Statement of Cash Flows, entities are permitted but not required to separately disclose, either in the statement of cash flows or footnotes to the financial statements, cash flows pertaining to discontinued operations. Entities that do not present separate operating cash flows information related to discontinued operations must do so consistently for all periods presented, which may include periods long after the sale or liquidation of the operation. We did not have cash balances that were specific to RFPD and elected not to present separate cash flows from discontinued operations on our statement of cash flows. Assets and liabilities classified as discontinued operations on our consolidated balance sheets as of May 31, 2014, and June 1, 2013, include the following (in thousands): May 31, 2014 June 1, 2013 Inventories $ 18 $ 303 Discontinued operations - Assets $ 18 $ 303 Accrued liabilities - current $ 7 $ 245 Accrued liabilities - non-current (1) 130 - Discontinued operations - Liabilities $ 137 $ 245 (1) Included in accrued liabilities - non-current as of May 31, 2014, is a reserve for an income tax liability due to an ongoing audit. Liquidity, Financial Position, and Capital Resources Our growth and cash needs have been primarily financed through income from operations and the proceeds from the sale of RFPD during fiscal 2011. Cash and cash equivalents were $102.8 million at May 31, 2014. In addition, CD's and time deposits, classified as short-term investments were $31.7 million and long-term investments were $1.5 million including equity securities of $0.5 million. Cash and investments at May 31, 2014, consisted of $71.8 million in North America, $20.5 million in Europe, $0.9 million in Latin America, and $42.8 million in Asia/Pacific. Cash and cash equivalents were $102.0 million at June 1, 2013. In addition, CD's and time deposits classified as short-term investments were $38.9 million and long-term investments were $5.5 million, including equity securities of $0.4 million. Cash and investments at June 1, 2013, consisted of $82.1 million in North America, $22.1 million in Europe, $1.2 million in Latin America, and $41.0 million in Asia/Pacific. 22 -------------------------------------------------------------------------------- Table of Contents Cash Flows from Discontinued Operations In accordance with ASC 230, Statement of Cash Flows, entities are permitted but not required to separately disclose, either in the statement of cash flows or footnotes to the financial statements, cash flows pertaining to discontinued operations. Entities that do not present separate operating cash flow information related to discontinued operations must do so consistently for all periods presented, which may include periods long after the sale or liquidation of the operation. We believe we will continue to have sufficient liquidity to fund our future growth strategies for our business in the foreseeable future. Cash Flows from Operating Activities Cash flow from operating activities primarily resulted from our net income, adjusted for non-cash items, and changes in our operating assets and liabilities. Operating activities, which include our discontinued operations, provided $4.6 million of cash during fiscal 2014. We had net loss of $0.5 million during fiscal 2014, which included non-cash stock-based compensation expense of $0.8 million associated with the issuance of stock option awards primarily to our directors and officers and depreciation and amortization expense of $1.1 million associated with our property and equipment as well as amortization of our intangible assets. Changes in our operating assets and liabilities, net of effects of acquired businesses, provided $2.6 million of cash during fiscal 2014, due primarily to the decrease in our income tax receivable of $3.5 million, decrease in inventory of $1.5 million, partially offset by a decrease to our accounts payable of $2.1 million. The decrease in our inventory was the result of reduced inventory purchases during fiscal 2014 due to the decline in net sales. Operating activities, which include our discontinued operations, provided $8.6 million of cash during fiscal 2013. We had net income of $1.2 million during fiscal 2013, which included non-cash stock-based compensation expense of $0.6 million associated with the issuance of stock option awards primarily to our directors and officers and depreciation and amortization expense of $1.1 million associated with our property and equipment as well as amortization of our intangible assets. Changes in our operating assets and liabilities, net of effects of acquired businesses, provided $7.4 million of cash during fiscal 2013, due primarily to the decrease in inventory of $2.5 million, decrease in our accounts receivable of $1.8 million, partially offset by an increase to our prepaid expenses of $0.3 million. The decrease in our inventory was the result of reduced inventory purchases during fiscal 2013 due to the decline in net sales. The decrease in our receivables of $1.8 million was due primarily to the improvement in our day sales outstanding and lower sales volume. The increase in prepaid expenses of $0.3 million was due primarily to the renewal of our liability insurance coverage. Cash Flows from Investing Activities The cash flow from investing activities has consisted primarily of purchases and maturities of investments and capital expenditures. Cash provided by investing activities during fiscal 2014, included proceeds from the maturities of investments of $342.3 million, offset by the purchase of investments of $331.0 million, $1.0 million for the acquisition of WVS, and $2.8 million in capital expenditures, primarily related to a new ERP system implementation. Cash provided by investing activities during fiscal 2013, included proceeds from the maturities of investments of $154.2 million, offset by the purchase of investments of $82.9 million, $2.6 million for the acquisition of D and C, and $1.6 million in capital expenditures. Our purchases and proceeds from investments consist of time deposits and CDs. Purchasing of future investments may vary from period to period due to interest and foreign currency exchange rates. Cash Flows from Financing Activities The cash flow from financing activities primarily consists of repurchases of common stock and cash dividends paid. Cash used in financing activities of $11.9 million during fiscal 2014, resulted from $8.7 million of cash used to repurchase common stock and $3.3 million in dividends paid, offset by $0.2 million of proceeds from the issuance of common stock. The repurchase of common stock relates to our share repurchase authorizations. Cash dividends paid of $3.3 million were approved by the Board of Directors on July 23, 2013, October 8, 2013, January 7, 2014, and April 8, 2014. 23 -------------------------------------------------------------------------------- Table of Contents Cash used in financing activities of $18.4 million during fiscal 2013, was due primarily to $15.0 million related to the repurchases of common stock and $3.6 million in cash dividends paid, offset by $0.2 million in proceeds from the issuance of common stock. The repurchase of common stock relates to our share repurchase authorizations. Cash dividends paid of $3.6 million were approved by the Board of Directors on July 23, 2012, October 8, 2012, January 8, 2013, and April 9, 2013. Dividend payments during fiscal 2014 were approximately $3.3 million. All future payments of dividends are at the discretion of the Board of Directors. Dividend payments will depend on earnings, capital requirements, operating conditions, and such other factors that the Board may deem relevant. Contractual Obligations Contractual obligations by expiration period are presented in the table below as of May 31, 2014 (in thousands): Less than 1 - 3 3 - 5 More than 1 year years years 5 years Total Lease obligations (1) $ 352 $ 1,770 $ 171 $ 331 $ 2,624 IT services (2) 1,075 - - - 1,075 Total $ 1,427 $ 1,770 $ 171 $ 331 $ 3,699 (1) Lease obligations are related to certain warehouse and office facilities under non-cancelable operating leases. (2) IT services are related to the Transaction. We believe that the existing sources of liquidity, including current cash, will provide sufficient resources to meet known capital requirements and working capital needs for the fiscal year ending May 30, 2015. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management continuously evaluates its critical accounting policies and estimates, including the allowance for doubtful accounts, revenue recognition, inventory obsolescence, goodwill and other intangible assets, loss contingencies, and income taxes. Management bases the estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances, however, actual results could differ from those estimates. The policies discussed below are considered by management to be critical to understanding our financial position and the results of operations. Their application involves significant judgments and estimates in preparation of our consolidated financial statements. For all of these policies, management cautions that future events rarely develop exactly as forecasted, and the best estimates routinely require adjustment. Allowance for Doubtful Accounts Our allowance for doubtful accounts includes estimated losses that result from uncollectible receivables. The estimates are influenced by the following: continuing credit evaluation of customers' financial conditions; aging of receivables, individually and in the aggregate; a large number of customers which are widely dispersed across geographic areas; collectability and delinquency history by geographic area; and the fact that no single customer accounts for more than 10% of net sales. Significant changes in one or more of these considerations may require adjustments affecting net income and net carrying value of accounts receivable. The allowance for doubtful accounts was approximately $0.6 million as of May 31, 2014, and $1.1 million as of June 1, 2013. Revenue Recognition Our product sales are recognized as revenue upon shipment, when title passes to the customer, when delivery has occurred or services have been rendered, and when collectability is reasonably assured. We also record estimated discounts and returns based on our historical experience. Our products are often manufactured to meet the specific design needs of our customers' applications. Our engineers work closely with customers to ensure that our products will meet their needs. Our customers are under no obligation to compensate us for designing the products we sell. Inventories Our worldwide inventories are stated at the lower of cost or market, generally using a weighted-average cost method. Our inventories included approximately $30.9 million of finished goods and $3.0 million of raw materials and work-in-progress as of May 31, 2014, as compared to approximately $31.6 million of finished goods and $2.4 million of raw materials and work-in-progress as of June 1, 2013. 24 -------------------------------------------------------------------------------- Table of Contents Provisions for obsolete or slow moving inventories are recorded based upon regular analysis of stock rotation privileges, obsolescence, the exiting of certain market segments, and assumptions about future demand and market conditions. If future demand, changes in the industry, or market conditions differ from management's estimates, additional provisions may be necessary. We recorded provisions to our inventory reserves of $0.8 million, $0.4 million, and $0.4 million during fiscal 2014, 2013, and 2012, respectively, which were included in cost of sales. The provisions were primarily for obsolete and slow moving parts. The parts were written down to estimated realizable value. Goodwill and Other Intangible Assets Goodwill is initially recorded based on the premium paid for acquisitions and is subsequently tested for impairment. We test goodwill for impairment annually and whenever events or circumstances indicate an impairment may have occurred, such as a significant adverse change in the business climate, loss of key personnel or a decision to sell or dispose of a reporting unit. During the fourth quarter of each fiscal year, our goodwill balances are reviewed for impairment through the application of a fair-value based test, using the third quarter as the measurement date. In performing our annual review of goodwill balances for impairment, we estimate the fair value of each of our reporting units based on projected future operating results, market approach, and discounted cash flows. Projected future operating results and cash flows used for valuation purposes may reflect considerable improvements relative to historical periods with respect to, among other things, revenue growth and operating margins. Although we believe our projected future operating results and cash flows and related estimates regarding fair values are based on reasonable assumptions, historically, projected operating results and cash flows have not always been achieved. In accordance with ASC 350 "Intangibles - Goodwill and Other", if indicators of impairment are deemed to be present, we would perform an interim impairment test and any resulting impairment loss would be charged to expense in the period identified. Our goodwill impairment testing follows the two-step process as defined in ASC 350. The first step in the process compares the fair value of the reporting unit to its carrying value. If the carrying value of the reporting unit exceeds its fair value, the second step of the impairment test is performed to measure the amount of impairment loss to be recognized. In the second step, the fair value of the reporting unit resulting from the first step of the evaluation is allocated to the fair value of all of the assets and liabilities of the reporting unit in order to determine an implied goodwill value. This allocation is similar to the purchase price allocation performed in purchase accounting. If the carrying amount of the goodwill reported exceeds the implied goodwill value, an impairment loss should be recognized in an amount equal to that excess. Intangible assets are initially recorded at their fair market values determined on quoted market prices in active markets, if available, or recognized valuation models. Intangible assets that have finite useful lives are amortized on a straight-line basis over their useful lives. Our intangible assets represent the fair value for trade name, customer relationships, and non-compete agreements acquired in connection with the acquisitions of Powerlink during our second quarter of fiscal 2012 and D and C acquired during our second quarter of fiscal 2013. Intangible assets fully relate to our EDG segment. Long-Lived Assets We review property and equipment, definite-lived intangible assets, and other long-lived assets for impairment whenever adverse events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. Loss Contingencies We accrue a liability for loss contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible losses can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. If we determine that there is at least a reasonable possibility that a loss may have been incurred, we will include a disclosure describing the contingency. 25 -------------------------------------------------------------------------------- Table of Contents Income Taxes We recognize deferred tax assets and liabilities based on the differences between financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and determine the need for a valuation allowance based on a number of factors, including both positive and negative evidence. These factors include historical taxable income or loss, projected future taxable income or loss, the expected timing of the reversals of existing temporary differences, and the implementation of tax planning strategies. In circumstances where we, or any of our affiliates, have incurred three years of cumulative losses which constitute significant negative evidence, positive evidence of equal or greater significance is needed to overcome the negative evidence before a tax benefit is recognized for deductible temporary differences and loss carryforwards. See Note 8 "Income Taxes" of the notes to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for further information. New Accounting Pronouncements In June 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-12, Compensation - Stock Compensation (Topic718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU standardizes the reporting for these awards by requiring that entities treat these performance targets as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. For all entities, ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015; early adoption is permitted. We are currently evaluating the impact that the adoption of ASU 2014-11 will have on our financial condition, results of operations and disclosures. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 is principles based guidance that can be applied to all contracts with customers, enhancing comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. The core principle of the guidance is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The guidance details the steps entities should apply to achieve the core principle. For public entities, ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period; early adoption is not permitted. We are currently evaluating the impact that the adoption of ASU 2014-09 will have on our financial condition, results of operations and disclosures. In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This ASU limits discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity's operations and financial results. In addition, the amendments in this ASU require expanded disclosures for discontinued operations as well as for disposals that do not qualify as discontinued operations. For public entities, ASU 2014-08 is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2014. Early adoption is permitted for disposals that have not been reported in financial statements previously issued. We are currently evaluating the impact that the adoption of ASU 2014-08 will have on our financial condition, results of operations and disclosures. We have evaluated and adopted the guidance of the following ASUs issued by the FASB in 2013; adopting these ASUs did not materially impact the presentation of our financial condition, results of operations and disclosures: • ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists issued in July 2013. ASU 2013-11 standardizes the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists; it does not require new recurring disclosures. ASU 2013-11 requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward unless specific criteria exist, in which case the unrecognized tax benefit should be presented as a liability and should not be combined with deferred tax assets . 26-------------------------------------------------------------------------------- Table of Contents • ASU No. 2013-05, Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity issued in March 2013. ASU 2013-05 provides guidance on releasing cumulative translation adjustments ("CTA") when an entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity, and also provides guidance on releasing CTA in partial sales of equity method investments and in step acquisitions. • ASU No. 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date issued in February 2013. The guidance in ASU 2013-04 requires entities to measure obligations resulting from joint and several liability arrangements, for which the total obligation amount is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount it expects to pay on behalf of its co-obligors. ASU 2013-04 also specifies disclosure requirements. 27-------------------------------------------------------------------------------- Table of Contents |