ITEM 1. BUSINESS
(a) General Development of Business
Ault Incorporated (herein "Ault" or "Company") was incorporated under the laws of the State of Minnesota in 1961. The Company designs, manufactures, and markets a line of external power conversion products and is a leading domestic supplier of such products to original equipment manufacturers (OEMs) of data communications equipment, telecommunications equipment, portable medical equipment, and microcomputers and related peripherals.
(b) Financial Information About Industry Segments
The Company operates in only one industry segment - the manufacture and sale of power conversion devices. Financial information regarding this segment is presented in the financial statements under Item 8 herein.
(c) Narrative Description of the Business
Ault's power conversion products are used to adapt alternating current (AC) to provide a source of power at various levels up to 90 watts for a wide variety of electronic equipment. Most of the Company's products are located outside the equipment they power as wall plug-in or as in-line components and are generally referred to as external power conversion products. A small portion of the Company's products are located inside the equipment they power, when this feature is required by OEM customers, and are generally know as internal power conversion devices. External power conversion products, in contrast to more widely used internal power conversion devices, enable designers of electronic equipment to remove heat and hazardous voltages from the end product thereby allowing the end product to function more safely and effectively. Also, by removing the power conversion feature from inside the end product, the OEM is afforded greater flexibility in designing and styling. These advantages have particular application in the Company's target markets where advances in semiconductor technology have reduced power requirements of many items of equipment to levels supplied by the Company's products, where rapid growth and strong competition have resulted in competitive pressure to bring new products to market quickly, and where there is increasing emphasis on smaller and portable products that perform increasingly sophisticated functions. Ault's business strategy is to offer OEMs in these markets an expanding line of high quality power conversion products and devices, related design engineering and flexible customer services.
(1) Products
Ault's product line includes the four major types of external power conversion products: switching power supplies, linear power supplies, battery chargers and transformers. The Company's power conversion products are capable of providing power at virtually all output levels which OEMs expect from an external device. The Company's design and application engineers work closely with customers to assure that these products are appropriately customized to meet each OEM customer's precise power conversion product requirements.
The following table summarizes the proportion of sales of the each of the Company's four major product categories for its last three fiscal years ended May 31, 1998:
Power Supplies. The Company's power supplies provide the entire power conversion requirements for electronic equipment in power outputs ranging from 1 to 90 watts. These products contain a component level transformer, which reduces the voltage level, as well as other circuit and components which convert alternating current (AC) to direct current (DC) and, in most cases, maintain voltage within specific limits.
* Switching Power Supplies. The Company believes, the market for switching power supplies is the fastest growing segment of the overall external power conversion product market. Switching power supplies use switching transistors to convert power from AC to DC and are more energy efficient and considerably smaller and lighter in weight than linear units with comparable power outputs. For power requirements exceeding 12 watts, switching power supplies are generally more cost effective. The Company currently manufactures these products up to 90 watts of power. The application in which these products are currently used include telecommunications products, data communications products, modems computers and computer peripherals, medical equipment, microprocessor controlled systems, security systems, automatic teller terminals, test equipment and multiplexers.
The Company's switching power supply products include a family of universal input power supplies which provide output power from input power sources ranging from 90 to 265 volts. This family of power supplies can be used in virtually any country for applications such as local area networks ("LANs"), printer and fiber optic links. The Company also designs universal input switching power supplies specifically for medical markets. The Company believes it offers the widest range of external switching power supply products currently available for medical applications.
* High Density Switching Power Supplies. In fiscal 1997, the Company introduced product families based upon patented high density power conversion technology. This technology enables the Company to offer switching power supply products less than one-half the size of its existing switching power supplies but provide comparable power output. The Company's high density switching power supplies provide approximately 45 watts to 80 watts of power. In addition, using its high density technology, the Company expects to introduce in late calendar year 1998 a family of switching power supplies capable of power outputs of up to 100 watts. The Company believes that the addition of this product line will enable it to compete for product applications currently not served by the Company or its competitors.
The company designs and manufactures switching power supplies principally for external applications but also designs and manufactures these products for internal power when such action enhances customer relations.
* Linear Power Supplies. Linear power supplies are larger and generally less expensive than switching power supplies because their design is based on technology employing steel laminations with windings of copper wire rather than switching transistors. Linear power supplies tend to be used when the wattage output required is relatively low. Ault manufactures linear power supplies that provide up to 11 watts of regulated power and 70 watts of unregulated power. The Company's linear power supplies are used in a variety of applications, including modems, telecommunications products, local area networks, microprocessor controlled systems, test equipment and multiplexers.
* Transformers. The Company manufactures a wide variety of wall plug-in transformers, as part of its full range of power conversion products. Transformers are used primarily in applications where OEMs desire to remove heat, electromagnetic interference and weight from electronic equipment, while incorporating the rest of the power conversion systems within the product. These products reduce AC voltage from approximately 110 volts (230 volts in some countries) down to lower voltage that range from 5 to 60 volts AC. The Company's product line also includes highly customized transformer that operate within stringent power output tolerances. This is a product not offered by most of the Company's competitors. The Company's transformers are utilized in a broad spectrum of applications, including modems, telephone sets, multimedia products and scanners.
* Battery Chargers. Ault has been an innovator in battery charging technology since the early 1980s. Ault specializes in providing custom designed, advanced solutions for manufactures of portable and battery powered equipment. Applications for the Company's battery chargers include medical devices, mobile telecom devices, notebook computers, global positioning equipment and radio frequency communications products.
The Company's products serve the entire range of widely used battery chemistries such as nickel cadmium, sealed lead acid, gel cell and nickel-metal hydride. In addition, the Company has developed battery chargers for the particular requirements of emerging battery chemistries such as zinc air, lithium ion and lithium polymer. The Company is committed to supporting these new emerging chemistries and to developing battery charger products to be introduced as these new battery chemistries become commercially accepted.
The Company sells primarily "smart" battery chargers as distinguished from trickle chargers. Smart charger products use integrated circuits to control various charging characteristics while allowing for fast charge time and extended battery life. Trickle charging is typically used for slow (8 to 10 hours) charging and/or standby battery maintenance.
The Company believes that the demand for high quality battery chargers will continue to increase to accommodate the growing sophistication of portable electronic equipment.
(2) Vertical Markets and Customers
The following table presents applications of the Company's various power conversion products.
The Company's marketing efforts are directed primarily toward OEMs producing non-consumer electronic equipment for telecommunications, computer peripheral and medical applications. These vertical markets are characterized by trends toward smaller, portable products capable of performing increasingly sophisticated functions, as well as intense competitive pressure to rapidly introduce new products and product enhancements. Based on its expertise in customizing a broad range of products to meet customer requirements, the Company believes it is well positioned to serve the needs of its OEM customers as they respond to these trends and competitive factors.
Historically, the most significant market for the Company's products has been OEMs of telecommunications equipment, and in fiscal 1998 sales in this market represented approximately 33% of net sales. Presently, the Company's products power network termination equipment (devices which interface between telephone network and the customer's PBX or other telephone system), line conditioning equipment (devices which prepare telephone lines for the transmission of computer generated data), and various items of equipment ancillary to business telephones, including speaker phones, automatic dialers, callers identification units and alpha numeric displays.
An equally significant market for the Company is OEMs of data communications equipment, and in fiscal 1998 sales in this market also represented approximately 28% of net sales. In this market Ault's products are principally being used to power a number of low to medium speed modems and multiplexers (equipment which enables the simultaneous transmission of multiple channels of information over the same telephone line).
Because it believes the telecommunications/data communications market is growing at a rapid rate, the Company is devoting a significant portion of its product development effort towards annual market introductions of new products including product families for applications in this combined market.
In fiscal 1998 approximately 22% of the Company's net sales were to OEMs of computers and computer peripherals such as digitizers, printers, plotters, portable terminals, point of sales scanners and optical character readers, LAN hardware and multimedia speakers for computer applications.
Approximately 14% of net sales in fiscal 1998 were to OEMs of portable medical equipment such as infusion pumps, patient monitoring systems, apnea monitors, and portable terminals for patient history input diagnostics.
The balance of approximately 3% of the Company's net sale in fiscal 1998 were to OEMs of various industrial equipment, including digital cameras and mine safety devices.
(3) Design Engineering and Product Development
Design engineering teams at the Company's facilities in the United States and South Korea are responsible for developing new power conversion products and customizing existing products to meet customer needs. The Company has an engineering staff of 27 and over the last three fiscal years has spent an average of at least 4.3% of revenues on product engineering. The Company's product development activities are divided equally between developing products to satisfy customer needs and new products based upon anticipated customer needs and marker trends. New product development opportunities are evaluated based upon criteria such as global market potential, return on investment and technological advantages. The Company believes that its collaborative efforts with customers, combined with its forward-looking concern for power technology and market Trends, have enabled it to gain a reputation as a leading innovator of new external power conversion products. The following table summarizes Ault's product development cycle.
Reflecting an increased emphasis on new product development during the past years, the Company developed and introduced 29 new products in 1998, 18 new product families in 1997 and several product families are currently in various stages of development. The Company expects to introduce approximately 20 product families during fiscal 1999. Anticipating continued growth of approximately 30% annually in the switching power supply segment of the power conversion product market, a significant portion of the new products under development are switching power supplies.
In December 1995, the Company purchased a U.S. patent for high density power conversion technology which it is using to develop a family of power supplies providing output comparable to the Company's existing power supplies that are approximately twice as large. This technology serves as a platform upon which a family of high density switching power supplies providing approximately 45 watts of power and a series of external power supplies providing 80 watts of power. Later in calendar year 1998, the Company expects to offer a new series of external power supplies which will provide approximately 100 watts of power have been introduced. The Company believes that these higher output products will enable it to compete for new electronic equipment applications that traditionally have been outside the range that could feasibly be powered by external products.
Other product development efforts currently underway at the Company include the development of products tailored to the needs of European markets and the development of low cost AC to DC transformers and AC to DC linear power supplies.
(4) Sales and Distribution
The Company markets its products primarily in the U.S. and Canada through a network of 20 manufacturer representatives employing approximately 115 salespersons, each of whom represents, in addition to Ault's products, several different but complementary product lines of other manufactures. The Company also sells through six national distributor organizations which employ over 200 salespersons. The Company selects representatives based upon their industry knowledge as well as account expertise with products that are synergistic with the Company's products. Individual salespersons are trained, mentored and technically assisted by the Company's application engineers and other sales administration staff. Any reduction in the efforts of these manufactured representatives or distributors could adversely affect the Company's business and operating results.
The Company begins the sales process by identifying a potential customer or market; researching the target or potential customer's total business, product and strategic needs; and then preparing a total solution proposal that includes engineering, product development, safety agency approvals, logistics and project development processes, coordinating pilot runs and assisting OEMs with their product introductions. Among the logistics services provided by the Company are warehousing and shipping of finished products and customs clearance in order to facilitate just-in-time production schedules.
The Company focuses its selling efforts primarily on OEMs in the U.S. and Canada. Many of the larger OEM customers of the Company manufacture and sell their products globally. As a result, the Company has extended its presence to markers throughout the world.
The Company's sales in the Pacific Rim had been limited and made primarily to customers in South Korea. In fiscal year 1998, further efforts to penetrate Korean market were enhanced to grasp opportunity offered by the devalued Won for sales to Korean OEMs. Results, so far, though minimal, have been meeting increasing success. In fiscal 1998, the Company finalized an agreement, with a well-recognized sales representative organization in Japan which will sell the Company's product in Japan and most Pacific Rim countries other than South Korea. Certain of the Company's products have already obtained required MITI approvals in Japan and sales promotion in that market was initiated during the second half of fiscal 1997. Steps are being taken to establish a sales administrative presence in Japan to further strengthen opportunity for selling in that market.
The Company currently markets its products in Europe through a network of distributors (with a total of approximately 15 salespersons) with products and promotional methods that are tailored for this market. Sales in Europe during fiscal 1997 and 1998 relating to direct market activities were, respectively, 2.2% and 2.9% of total net sales for these periods. Plans are also to establish sales administrative presence in this market in fiscal 1999.
(5) Safety Agency Certification
The power conversion system is potentially the most hazardous element in most electronic equipment because the power supply modifies standard power to a level appropriate for such equipment. Virtually all of the Company's customers require that the power conversion products supplied by the Company meet or exceed established international safety and quality standards, since many of the Company's products are used in conjunction with equipment which are distributed through the world. In response to these customer requirements, the vast majority of the Company's products are designed and manufactured in accordance with certification requirements of many safety agencies, including Underwriters Laboratories Incorporated ("UL") in the United Stares; the Canadian Standards Association (CSA) in Canada; Technischer Uberwachungs-Verein `(TUV") in Germany; the British Approval Board for Telecommunication "(BABT") in the United Kingdom, the International Electrotechnical Committee ("IEC"), a European standards organization and (EC) a standard for the European Community. In addition, some of the Company's products have also received Japanese MITI approval. For certain safety applications, the Company's products conform to FCC Class B requirements which regulate the levels of electronic magnetic interference that may be emitted by electronic equipment. Unlike most of its competitors, the Company is a certified test laboratory for UL and CSA and is able to conduct most certification tests at its plant in Minneapolis. This procedure reduces the time required to obtain safety certifications. The Company's Minneapolis facility is certified to ISO 9001 and the Company's South Korea facility is certified to ISO 9002.
(6) Innovative Team Approach
For the past several years, the Company has used a team-based organizational structure consisting initially of four recently increased to six distinct teams. The Company's customer base is divided into six geographical regions with a specific Ault team assigned to manage the needs of customers in each region. Each team is headed by a coordinator selected by the president and an assistant coordinator who is elected annually by the team. The teams consist of people from all areas of the business, including salespersons from manufacturer representative organizations and national distributors as well as the Company's own production personnel, engineers, technicians, administrative personnel and others. Guided by a written statements of corporate values, these teams are charged with responsibility for all aspects of the customer relationship, including sales, manufacturing, design engineering and other support functions with a view to achieving continuous improvements in customer service. The Company believes that its innovative implementation of this team-based organizational structure provides competitive advantages by increasing communication with customers as well as facilitating responsiveness to the needs of the Company's diverse worldwide customer base. In 1996, Ault received recognition for its innovative approach from the trade publication of the American Manufacturing Association.
(7) Competition
The Company competes primarily with various manufactures of external power conversion products. The industry is highly fragmented, with manufacturers generally focusing their marketing on specific segments. The Company has experienced strong competition from Taiwanese-based manufacturers principally on price. Many of these competitors have a smaller presence in the external conversion market than the Company, although several are engaged in more than one business and have significantly greater financial resources.
No single company dominates the overall external power conversion product market, and the Company's competitors vary depending upon the particular power conversion product category. The companies with which Ault competes most directly in each of its major product categories are: Leader Electronics, Inc. and Golden Pacific Electronics, Inc. for transformers; Dee Van Enterprise Co., Ltd and Sino American Electronics Company., Ltd. for linear power supplies; Portrans Electrical Corp., Ltd. and Phihong Enterprise Co., Ltd. for switching power supplies; and Engineering Design Sales, Inc. and Xenotronics Company for battery chargers.
Recently, certain electronic equipment manufactures have dismantled or spun off their power supply operations. While this change created greater opportunities in the merchant market where the Company competes, certain of these spin-off have created large power supply manufacturers with the state-of-the-art manufacturing facilities. Most of these newer companies are now focusing on the internal power supply market and/or continue to sell exclusively to a single customer. These companies, some of which enjoy far greater resources than Ault, could focus on external power conversion products and/or expand into the same electronic markets in which the Company now competes, thus intensifying competitions.
The Company competes on the basis of the quality and performance of its products, the breadth of its product line, customer service, dependability in meeting delivery schedules, design engineering services, and price. The Company believes it is currently one of a small number of companies that design, manufacture and obtain certifying agency approvals for the full range of external power conversion devices which OEMs consider in designing their electronic product.
The Company provides a total solution approach to the OEM's entire external power conversion product needs through its commitment to reliable partnerships and its delivery of high quality products supported by solution oriented design engineering. In addition, the presence of Ault Korea and Ault China and the expanding arrangements with manufacturers in China and Thailand provide the Company with additional strength to compete effectively when price is the primary consideration.
Internal power conversion products continue to be used for most electronic equipment, and as a result the Company experiences competition from numerous companies providing such internal products, including both OEMs and independent suppliers. With the trend toward lower power requirements in portable electronic equipment and with the increasing availability of smaller, competitively-priced internal switching power supplies, certain customers of the Company may choose to return to internal power supplies in place of the external power conversion products they currently purchase. In relation to this competition, the Company stresses the several advantages of external power conversion products, which generally can be obtained with only a relatively small increase in unit cost.
(8) Manufacturing and Sources of Supply
The Company's manufacturing operations consist of assembly and integration of electronic components to meet product specifications and design requirements for a variety of power conversions applications. Manufacturing is currently conducted at the Company's facility in Minneapolis, Minnesota (which accounted for 18% of 1998 net sales); at the Ault Korea facility near Seoul, South Korea (which accounted for 31% of 1998 net sales); at the newly formed subsidiary, Ault China, which had no significant sales contribution in fiscal 1998, and at three locations in China and Thailand using manufacturing subcontractors (which accounted for 51% of 1998 net sales). Ault typically manufactures prototypes and low volume products at its facilities in Minneapolis, Minnesota. Ault Korea is and it anticipated that by fiscal year 2000, Ault China will be equipped to manufacture substantially all of the Company's products.
A number of the components and raw material integral to the manufacture of the Company's products are purchased from a single supplier or a limited number of suppliers. Electronic components and raw material used in the Company's products are nevertheless generally available from a large number of suppliers, although from time to time shortages of particular items are experienced.
Quality and reliability are emphasized in both the design and manufacture of the Company's products. This emphasis is reflected in the ISO 9001 certification of the Company's Minneapolis facility in 1991 and the ISO 9002 certification of its South Korea facility in 1996. The Company tests 100% of its finished products against its own customers' specifications, then ships the products in custom engineered protective packaging to minimize any damage during shipment.
The Company has subcontract manufacturing arrangements with one subcontractor in Thailand and two in China. The Company does not have long term commitments from the subcontractors and the subcontractors build product for the Company pursuant to individual purchase orders. The Company selects its subcontract manufactures based upon their ability to manufacture high quality products, the sufficiency of their engineering capabilities to support products being manufactured; and their ability to meet required delivery times. In addition, each of the Company's subcontract manufacturers is regularly reviewed by the Company's Taiwanese-based Director of Far East Operations with respect to product quality and other performance criteria.
(9) Significant Customers: Backlog
The Company sells its products to over 200 customers and it is the Company's objective to maintain a diversified customer base and to avoid, where practicable, dependence upon a single customer. In fiscal 1998; however, two customers accounted for 9.7% and 9.6% of the Company's net sales.
The Company enters into buying commitments and other scheduling agreements with certain customers. For its larger customers, these agreements allow for order increases and decreases within scheduled limits and include cancellation charges for completed and in-process products and procured materials. Most products are shipped within 4 to 10 weeks of an order. Order backlog at August 1, 1998 was $13,643,000 as compared to $15,333,000 on August 1, 1997. See Order Backlog, under ITEM 7, MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS.
(10) Warranties
The Company provides up to a three-year parts and labor warranty against defects in materials or workmanship on all of its products. Servicing and repairs are conducted at the Company's manufacturing facilities in Minneapolis and South Korea. The Company's warranty expenses have not been significant.
(11) Patents
The Company holds four patents, three of which it no longer considers significant. The fourth patent, acquired in December 1995, covers high density power conversion technology ("high density patent") which will enable the Company to offer external switching power supplies less than one-half the size of current power supply products but with comparable power outputs.
The high density patent was issued by the United States Patent Office in 1994 and the original applicant did not pursue patent protection in foreign countries. Since the high density patent was issued prior to its being assigned to the Company, the Company is precluded from seeking patent protection in most foreign countries. For that reason, some of its competitions may use this type of technology for products manufactured and sold outside the United States. Also there can be no assurance that the scope of the high density patent will prevent competitors, many of whom have greater financial and other resources, from introducing competitive products or from challenging the validity of the high density patent.
(12) Seasonality
As indicated by ITEM 8(b) SUPPLEMENTAL FINANCIAL INFORMATION, net sales of the Company have reflected a certain degree of seasonality. The Company's first quarter falls during the summer months and during the first quarter of fiscal 1997 and fiscal 1998, the Company recorded the lowest level of sales followed by increased sales in successive quarters. The Company attributes this seasonality to the buying patterns of its customers, the timing of industry trade shows where new products are introduced and to other factors. The Company believes that similar seasonality trends will be represented in the future.
(13) Employees
As of August 4, 1998, the Company employed approximately 399 full- time employees at its facilities as follows:
None of the Company's employees are represented by a labor organization and the Company has never experienced a work stoppage or interruption due to a labor dispute. Management believes that its relations with its employees are good.
(14) Executive Officers of the Registrant
Certain information with respect to the executive officers of the Company is set forth:
(15) Risk Factors
The following risk factors are relevant to an understanding of the business matters discussed herein
* Technological Change and New Product Development. The electronic equipment market is characterized by rapidly changing technology and shorter product life cycles. The Company's future success will continue to depend upon its ability to enhance its current products and to develop new products that keep pace with technological developments and respond to changes in customer requirements. Any failure by the Company to respond adequately to technological changes and customer requirements or any significant delay in new product introductions could have a material adverse effect on the Company's business and results of operations. In addition, there can be no assurance that new products to be developed by the Company will achieve market acceptance. See "Business-Design Engineering and Product Development."
* Dependence on Outside Contractors. The Company currently depends on third parties located in foreign countries for a significant portion of the manufacture and assembly of certain of its products. Some of these countries are economically troubled areas. The Company's reliance on such outside contractors reduces its control over quality and delivery schedules. While the Company takes an active role in overseeing quality control with its third party manufacturers, the failure by one or more of these subcontractors to deliver quality products or to deliver products in a timely manner could have a material adverse effect on the Company's operations. In addition, the Company's third-party manufacturing arrangements are short term in nature and could be terminated with little or no notice. If this happened, the Company would be compelled to seek alternative sources to manufacture certain of its products. There can be no assurance that any such attempts by the Company would result in suitable arrangements with new third-party manufacturers. See "Manufacturing and Sources Supply."
* Dependence on Key Personnel; Management of Growth. The Company's success depends in part upon the continued services of many of its highly skilled personnel involved in management, engineering and sales, and upon its ability to attract and retain additional highly qualified employees. The loss of service of any of these key personnel could have a material adverse effect on the Company. The Company does not have key-person life insurance on any its employees. In addition, the Company's future success will depend on the ability of its officers and key employees to manage growth successfully and to attract, retain, motivate and effectively utilize the team approach to manage its employees. If the Company's management is unable to manage growth effectively, the Company's business and results of operations could be adversely affected.
* Anti-takeover Considerations. Certain anti-takeover provisions of the Minnesota Business Corporation Act and the ability of the Board of Directors to issue preferred stock without stockholder approval under the Company's Right Plan may have the effect of delaying or preventing a change in control or merger of the Company. These provisions could delay, discourage, hinder or preclude an unsolicited acquisition of the Company, could make it less likely that stockholders receive a premium for their shares as a result of any such attempt and could adversely affect the market price of the Common Stock. See "Note 7 - Stockholders' Equity under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
* Year 2000 Interruptions. The Company utilizes several microchip based date referenced systems for its business operations, including the timely procurement of material and supporting customer requirements. Because these business matters are also dependent on support from external sources, the Company cannot provide any assurance that its ability to provide service to customers will not be interrupted by the inability of any supporting microchip-based date referenced system to timely process data. This situation could have an adverse material effect on the Company's ability to retain customers and to generate revenue and profitability.
(d) Financial Information About Foreign and Domestic Operations and Export Sales
Export Sales by the U.S. Operations in fiscal year 1998 ending May 31 represented 27.1% of the Company's gross sales most of which were to OEMs in Europe and Canada. All other revenues were derived from domestic sales principally in the U.S. For other financial information about foreign and domestic operations and export sales including the amount of export sales for the last 3 years, refer to Note 10, Operations Information, under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Management recognizes that there are certain risks involved in the Company's foreign operations, such as political risks that may interrupt the flow of products to customers but believes that any interruption would be only temporary because of the diversity, capability and flexibility of its operations.
ITEM 2.
ITEM 2. PROPERTIES The Company's headquarters and US manufacturing facility is located in Brooklyn Park, a suburb of Minneapolis, Minnesota. Approximately 50,000 square feet in size , this facility houses all of the Company's U.S. operations. The lease on this property expires in August 1999.
The Company's subsidiary, Ault Korea Corporation, operates in a 36,000 square foot facility in Suwon City in the province of Kyungki-Do Korea, which the subsidiary purchased in May 1995. The Company has no other property ownership.
Ault China, a subsidiary of Ault Korea Corporation occupies a 40,000 square foot leased facility in The Province of Xiang-He in China. The lease expires in the year 2009.
Management considers all of the Company's properties to be well maintained and current manufacturing arrangements including arrangements made in China and Thailand to be adequate for manufacturing requirements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable. PART II.
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information
Ault common shares are traded in the national over-the-counter market under the symbol AULT. The following table presents the range of closing bid prices for the Company's common stock as reported by NASDAQ National Market Issues for fiscal 1998 and 1997. The bid quotations representing prices in the over-the-counter market between dealers in securities do not include retail mark-ups, mark-downs or commissions and do not necessarily represent actual transactions.
(b) Holders
As of August 6, 1998 there were 290 shareholders of record for the Company's common stock. This number of record stockholders does not include beneficial owners of common stock whose shares are held of record by Depository Trust under the name CEDE & Co.
(c) Dividends
Ault has not paid cash dividends on its common shares, and, under present policy of its Board of Directors to retain any earnings for use in the business, does not anticipate paying cash dividends on its common shares in the near future. In addition, the Company's bank line of credit agreement precludes the payment of dividends.
ITEM 7.
ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
From time to time, in reports filed with the Securities and Exchange Commission, in press releases, and in other communications to shareholders or the investing public, the Company may make forward- looking statements concerning possible or anticipated future results of operations or business developments which are typically preceded by the words "believes", "expects", "anticipates", "intends" or similar expressions. For such forward-looking statements, the Company claims the protection of the safe harbor for forward looking statements contained in the Private Securities Litigation Reform Act of 1995. Shareholders and the investing public should understand that such forward-looking statements are subject to risks and uncertainties which could cause results or developments to differ significantly from those indicated in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the overall level of sales by OEMs in the telecommunications, data communications, computer peripherals and the medical markets; buying patterns of the Company's existing and prospective customers; the impact of new products introduced by competitors; delays in new product introductions; higher than expected expense related to sales and new marketing initiatives; availability of adequate supplies of raw materials and components; and other risks affecting the Company's target markets generally
RESULTS OF OPERATIONS
Net sales for fiscal 1998 were $41,136,000, up 2.8% from net sales of $40,012,000 in fiscal 1997 which were up by 18.5% from net sales of $33,774,000 in fiscal 1996. The Company achieved only modest improvement in its fiscal 1998 net sales principally because infrastructure, such as transmission stations and wired systems were not sufficiently in place to support anticipated demand for cable modems, an emerging new technology product. Because of this situation, significant orders that were expected from customers who are leading OEMs in this market did not materialize. The Company believes that the infrastructure issue is being addressed and, as a result, anticipates increased demand for cable modems in fiscal 1999. If this happens, the Company believes that orders for its products in support of the cable modem industry could improve significantly in fiscal 1999, thereby enhancing growth in revenue, principally in the later quarters of the fiscal year. The telecommunications/data communications market , of which the market for cable modems is a segment, is a principal user of the Company's products. Other segments of the telecommunications/data communications market and other markets served by the Company experienced normal growth rates in fiscal 1998 and are expected to do so in fiscal 1999. Driven by its successful customer service strategies, the Company's sales grew in fiscal 1997 due to growth in the data communications and telecommunications market and its resulting demand for power conversion products and related services. Service to customers continues as a strong strategic focus. To this end, the Company's engineering activities are directed to various customer product applications that are anticipated to generate revenue in fiscal 1999. These applications include uninterruptible power supplies, as well as power supplies for asymmetric digital subscriber line modems (a competing technology to cable modem); medical product applications, and hubs, routers and switches for the networking market. Like the cable modem market, these programs are anticipated to generate sales for the Company mainly in the later quarters of fiscal 1999.
The Company's order backlog at May 31,1998 totaled $15,340,000, up from $14,720,000 at June 1, 1997, which was down from $16,971,000 at June 2, 1996. The order backlog at May 31, 1998, represented shipments for approximately four months and reflected the posture of many OEMs to limit their contractual commitments to the best lead - times of their customers. Aided by the order backlog at May 31, 1998, management believes that sales for the first quarter of fiscal 1999 will compare favorably with sales that were attained in the comparable quarter of fiscal 1998.
Gross profit for fiscal 1998 amounted to $10,761,000 or 26.2% of net sales , compared to $10,523,000, which was 26.3% of net sales for fiscal 1997, and $8,265,000, which amounted to 24.5% of net sales in fiscal 1996. The relatively stable rates of gross profit for fiscal 1998 and fiscal 1997 are due mainly to better prices on sales of switching power supplies and battery chargers compared to sales of other products. Compared to fiscal 1996, the greater gross margin posted by the Company in fiscal 1997 was also due to better margins on switching power supplies and the efficiencies of scale supporting the larger amounts of sales in fiscal 1997.
Operating expenses for fiscal 1998 totaled $8,883,000, which amounted to 21.6% of net sales, compared to $7,940,000 for fiscal 1997, which were 19.8% of net sales. In fiscal 1996, operating expenses were $6,699,000, which were also 19.8% of net sales. Compared to fiscal 1997, the increased expenditure of $942,000 in fiscal 1998 was incurred principally for payments made to certify the reliability of new products and for expenditure relating to the implementation of strategic initiatives, some of which began during the second half of fiscal 1997. The strategic initiatives were implemented for the following purposes:
1. Strengthening the Company's sales and marketing competitive position in the US and Asia. 2. Enhancing Asian manufacturing supervision 3. Providing promotional material for the Company's products 4. Providing direct internet communication links between Ault US and Ault Korea 5. Installing software for upgrading the quality of management information services.
It is anticipated that these strategic initiatives will be beneficial to the generation of future sales and the provision of information for managing the Company. Compared to fiscal 1996, the increased expenditure of $1,242,000 in fiscal 1997 was incurred principally for commissions paid to sales representatives on the higher sales, expenses incurred for sales promotional activities and to position the Company to better compete in the Asian market. Additionally, the Company incurred expenses in fiscal 1997 to initiate upgrading of its management information system program, as well as for administration of its expanding foreign manufacturing activities. Also, in adherence to its policy of making performance bonus payments to its US employees for attaining certain levels of targeted profitability, payments amounting to two weeks of salaries were made to each employee in fiscal 1997 and fiscal 1996. No bonus payments were made in fiscal 1998.
Operating income decreased by 27.3% to $1,877,000 from $2,582,000 in fiscal 1997 principally due to the expenditures that were incurred for implementation of the strategic initiatives discussed above. Operating income grew in fiscal 1997 by 64.9% from $1,566,000 in fiscal 1996 due principally to the greater sales attained in fiscal 1997.
Non-operating income of $198,000, $183,000 and $84,000 for fiscal years 1998, 1997 and 1996, respectively, represented primarily interest income, currency exchange rate gains from importation of raw material by the Korean subsidiary and income derived from rented portions of the Korean manufacturing facility. The Company incurred interest expenses of $148,000 in fiscal 1998, $490,000 in fiscal 1997, and $742,000 in fiscal 1996. Interest expenses declined in fiscal 1997 and interest income increased due to the availability of funds that were raised from the public offering of common shares in the third quarter of the fiscal year, portions of which were used for the repayment of debt.
The Company had pre-tax income of $1,927,000 for fiscal 1998 on which its recorded income tax liability totaled $609,000, which included the utilization of deferred tax assets totaling $415,000. In fiscal 1997, the Company had pre-tax income of $2,275,000 but derived a net tax benefit of $90,000 after the recognition of deferred tax assets amounting to $681,000. Pre-tax income totaled $908.000 in fiscal 1996, of which income tax expense totaled $25,000. Ault Korea Corporation reported pre-tax income of $476,000 in fiscal 1998 on which it recorded Korean income tax liability of $57,000. The subsidiary incurred losses in fiscal 1997 and fiscal 1996 and had no income tax expenses. See Note 4. Income Taxes, under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
The Company reported diluted per share earnings of $0.31 for fiscal 1998 based on 4,254,172 of outstanding weighted average shares, compared to diluted per share earnings of $0.72 in fiscal 1997, which was based on 3,279,709 outstanding weighted average shares. The Company reported diluted per share earnings of $0.39 for fiscal 1996 which was calculated from weighted average outstanding shares of 2,256,211.
LIQUIDITY AND CAPITAL RESOURCES
The following table describes the Company's working capital resources and cash flows from operations at May 31, 1998, and June 1, 1997.
Current Working Capital Position
The Company's principal sources of working capital for normal growth in revenue and attainment of profit goals have been its credit facilities and cash flows from operations. Since fiscal 1995, however, market conditions for sale of power conversion products have significantly improved at the same time that strategies of the Company to grow by offering competitive engineering and services to customers were achieving increasing success. These factors presented opportunities to enhance revenue and profits above that which its existing sources of working capital would support. Also, growth in trade receivables and inventories that resulted from increased sales and growing requirement of customers for suppliers to maintain finished products for their emergency needs were using increasing amounts of cash. This situation placed greater reliance on credit facilities as a source of working capital. To lessen reliance on credit facilities, the Company conducted a public offering of its common shares in fiscal 1997. The proceeds from that public offering enabled the Company to repay certain debt, to strengthen its operations and to commence fiscal 1998 with cash amounting to $3,677,000 and trading securities of $849,000.
At May 31, 1998, the Company had cash and cash equivalents and investments in trading securities totaling $6,801,000, up from $4,526,000 at June 1, 1997. Ratio of current assets to current liabilities increased to 4.02 to 1 from 3.44 to 1 at June 1, 1997, and working capital increased during the period to $15,303,000 from $15,231,000 at June 1, 1997.
Credit Facilities
The Company currently maintains two credit facilities; its primary credit facility with USBank, and a smaller facility with Korea Exchange Bank that supports the South Korean subsidiary.
The credit arrangement with USBank includes the following: (a) A revolving credit facility of $2.0 million at prime rate of interest, secured by trade receivables and expiring on October 1, 1998, although it may be amended for an extended period. At the end of the fiscal year, there were no outstanding borrowings against it. (b) One or more term loans, each up to an amount of $300,000. At May 31, 1998, borrowings amounting to $483,000 were outstanding on two term loans. See Note 3,under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
The South Korean credit facility is for approximately $1.5 million of which borrowings at May 31, 1998, were $236,000.
Cash Flows
Operations: Operations provided $4,801,000 of net cash in fiscal 1998, which came from activities that provided $5,560,000 of cash and activities that used $759,000 of cash. The activities that provided $5,560,000 of cash were the following:
(a) Net profit adjusted for non-cash items provided net cash of $2,348 ,000, of which net profit before adjustments totaled $1,318,000. The non-cash items were principally depreciation of assets which provided $528,000 of cash, and utilization of deferred tax assets which provided $415,000 of cash. (b) Reduction in trade receivables provided $2,665,000 of cash. The reduction was principally afforded by collections in fiscal 1998 of the greater sales that were made during the fourth quarter of fiscal 1997, as compared to growth in receivables from sales during the fourth quarter of fiscal 1998. (c) Reduction in inventories due to enhanced control measures and lower customer requirements for stocking of products for emergencies provided $646,000 of cash.
The activities that used $759,000 of cash were:
(a) Changes in accounts payable, prepaid expenses and accrued expenses used $509,000 of cash. The reduction occurred principally because of payment of liabilities that were incurred to support shipments for the fourth quarter of fiscal 1997. (b) Increases in investment trading securities used $17,000 of cash. These trading securities are principally investment-grade preferred stocks with dividends that provide a tax advantage to the Company. (c) Changes in income taxes payable used $233,000 of cash..
Investing Activities: Investing activities used net cash of $1,385,000 which was expended mainly for the purchase of capital equipment and tooling, expanding manufacturing capacity in China and for upgrading management information systems.
Financing Activities: Financing activities used net cash of $229,000 of which $519,000 was expended to reduce Ault Korea's bank indebtedness in view of the currency exchange rate that favored the US dollar. Additionally, the Company received an amount of $304,000 from the exercise of common stock options by employees.
Effect of Foreign Currency Exchange Rate Fluctuations: The current economic crisis in South Korea saw a dramatic devaluation in the Won, the country's currency, late in the Company's second quarter of fiscal 1998. The Won has since regained some strength, but, compared to its value during the past several years, remains weak in relation to the value of the US dollar. The effect of the translation of the Korean financial statements, which were prepared in Won, to US dollars, resulted in a net asset value decrease of $929,000, which related principally to long-term inter-company receivables as follows:
Summary:
The Company's cash and working capital positions are sound and, together with its credit facilities, are adequate for the support of normal growth in revenue and profit beyond the current fiscal year.
Impact of Recent Accounting Standard Changes:
Statement No. 128: The FASB has issued Statement No. 128, Earnings Per Share, which supersedes APB Opinion No. 15. Statement No. 128 requires the presentation of earnings per share by all entities that have common stock or potential common stock, such as options, warrants, and convertible securities outstanding that trade in a public market. Those entities that have only common stock outstanding are required to present basic earnings per-share amounts. All other entities are required to present basic and diluted per-share amounts. Diluted per-share amounts assume the conversion ,exercise, or issuance of all potential common stock instruments unless the effect is to reduce a loss or increase the income per common share from continuing operations. The Company initially applied Statement No. 128 for the year ended May 31, 1998, and, as required by the statement, has restated al1 per share information for the prior years. See Note 1, Nature of Business and Significant Accounting Policies, and Note 8, Earnings Per Share, Under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Statement No. 130: The FASB has issued Statement No. 130, Reporting Comprehensive Income, effective for fiscal years beginning after December 15, 1997. Statement No. 130 requires reporting items which are components of other comprehensive income, such as foreign currency items and unrealized gains and losses on certain investments in debt and equity securities. The Company will adopt this statement in the fiscal year ending May, 30, 1999. See Note 1, Nature of Business and Significant Accounting Policies, Under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Statement No. 131: FASB has issued Statement No. 131, Disclosures About Segments of an Enterprise and Related Information, effective for fiscal years beginning after December 15, 1997. Statement No. 131 requires disclosure of certain information for each reportable segment, including general information, profit and loss information, segment assets, etc. The Company will adopt this statement in the fiscal year ending May 30, 1999. The Company does not expect this statement to have a significant effect on its financial statements. See Note 1, Nature of Business and Significant Accounting Policies, Under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impact of Foreign Operations and Currency changes:
South Korea had a significant fall in the value of its currency during the third quarter of fiscal 1998, but recovered portions of the early loss by the end of the fiscal year. Although products that were manufactured by the Korean subsidiary contributed a very significant portion of total sales, the devalued Won had no significant impact on the Company's consolidated sales for the fiscal year because the greater portions of the subsidiary's sales were made under intercompany contracts with the US operations. Sales by the subsidiary in its local market are comprised only of a small portion of its total sales in contrast to its intercompany sales. The Company's US operations have no significant exposure to currency risks because the predominant portions of its foreign contracts are made in US dollars.
Microchip Based Date-referenced Systems and Year 2000 Compliance
Most of the Company's microchip-based date referenced systems, including computer software and hardware are already year 2000 compliant. Others are being examined for compliance and it is believed that the solution to any non-compliance found will not be difficult. There are no internal matters, therefore, that are expected to affect the Company's ability to process systems date- referenced information when year 2000 arrives. The Company does not yet know of the extent to which the current preparedness of its external business associates and external infrastructure would show to adversely affect its business transactions if they were tested today. The Company is communicating with these external sources and its objective is to obtain their commitment, with some verification, that they will be Year 2000 compliant by December 31, 1998.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Approximately 3% of the Company's total assets is invested in trading securities of various domestic companies. Although the market value of these investments is subject to fluctuation from time to time, management does not believe that any risk of loss of the principal amounts would be material to the Company's profitability or asset value.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
(a) Financial Statements
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors Ault Incorporated and Subsidiary Minneapolis, Minnesota
We have audited the accompanying consolidated balance sheets of Ault Incorporated and Subsidiary as of May 31, 1998, and June 1, 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three fiscal years in the period ended May 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 Ault Incorporated and Subsidiary as of May 31, 1998, and June 1, 1997, and the results of their operations and their cash flows for each of the three fiscal years in the period ended May 31, 1998, in conformity with generally accepted accounting principles.
Minneapolis, Minnesota July 8, 1998
AULT INCORPORATED AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS May 31, 1998 and June 1, 1997
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
AULT INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended May 31, 1998, June 1, 1997, and June 2, 1996
See Notes To Consolidated Financial Statements.
AULT INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended May 31, 1998, June 1, 1997, and June 2, 1996
(Continued)
AULT INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued) Years Ended May 31, 1998, June 1, 1997, and June 2, 1996
See Notes to Consolidated financial Statements.
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies
Nature of business: The Company and its subsidiary operate in one business segment which includes the design, manufacturing, and marketing of power conversion products, principally to original equipment manufactures of data communications equipment, microcomputers and related peripherals, telecommunications equipment, and portable medical equipment. Sales are to customers worldwide, and credit is granted based upon the credit policies of the Company.
A summary of the Company's significant accounting policies follows:
Principles of consolidation: The accompanying consolidated financial statement include the accounts of Ault Incorporated, its wholly-owned subsidiary, Ault Korea Corporation, and its wholly-owned subsidiary, Ault Xianghe Co. Ltd. (located in China), which commenced operations in May 1997. All significant intercompany transactions have been eliminated. The foreign currency translation adjustment represents the translation into United States dollars of the Company's investment in the net assets for its foreign subsidiary in accordance with provisions of FASB Statement No. 52.
Cash and cash equivalents: The Company maintains its cash in bank deposit accounts which, at times may exceed federally insured limits. The Company has not experienced any loses in such accounts.
For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of short-term commercial paper.
Inventories: Inventories are stated at the lower of cost (first- in, first-out method) or market.
Investment in trading securities: Trading securities are held for resale in anticipation of short-term (generally 90 days or less) fluctuations in market prices. Trading securities, consisting of marketable equity securities, are stated at fair value, which approximates cost at May 31, 1998, and June 1, 1997. Realized and unrealized gains and losses are included in income.
Prepaid and other expenses: Prepaid and other expenses at May 31, 1998, and June 1, 1997, include refundable value-added tax and refundable custom duties relating to the Korean operations of approximately $236,000 and $224,000, respectively.
Patent: The patent is stated at cost and is being amortized using the straight-line method over its economic useful life, which has been estimated to be five years.
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Depreciation: It is the Company's policy to include depreciation expenses on assets acquired under capital leases with depreciation expense on owned assets. Depreciation is based on the estimated useful lives of the individual assets. The methods and estimated useful lives are as follows:
Retirement and severance benefits: Retirement and severance benefits represents the accrual of compensation expense, net of deposit, for the Korean operations' employees that is payable upon termination of employment.
The Company does not fund the retirement and severance benefits accrued, rather provides for the estimated accrued liability under the plans as of the balance sheet date. Under the National Pension Scheme of Korea, the Company is required to transfer a certain portion of the retirement allowances of employees to the National Pension Fund. The amount transferred reduces the amount payable to employees and is reflected in the accompanying financial statements.
Design engineering: Design engineering costs are those incurred for research, design, and development of new products and redesign of existing products. These costs are expensed currently.
Income taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assists are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Investment tax credits, research and development credits, and job credits are accounted for by the flow-through method whereby they reduce income taxes currently payable and the provision for income taxes in the period the assets giving rise to such credits are placed in service. To the extent such credits are not currently utilized on the Company's tax return, deferred tax assets, subject to considerations about the need for a valuation allowance, are recognized for the for the carryforward amount.
Use of estimates in the preparation of financial statement: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent 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.
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Long-lived assets: In accordance with Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of, the Company reviews its long-lived assets and intangibles related to those assets periodically to determine potential impairment by comparing the carrying value of the long-lived assets outstanding with estimated future cash flows expected to result from the use of the assets, including cash flows from disposition. Should the sum of the expected future cash flows be less than the carrying value, the Company would recognize an impairment loss. An impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value of the long-lived assets and intangibles. To date, management has determined that no impairment of long-lived assets exists.
Fair value of financial instruments: The following methods and assumptions were used to estimate the fair value of certain financial instruments:
Cash equivalents: The carrying amount approximates fair value.
Investments in available-for-sale securities: The fair value of these investments is based on quoted market prices. The carrying amount approximates fair value.
Long-term debt: The fair value of the long-term debt is estimated based on interest rates for the same or similar debt offered to the Company having the same or similar remaining maturities and collateral requirements. The carrying value of the long-term debt approximates fair value.
Earning per share: The FASB has issued Statement No. 128, Earning Per Share, which superseded APB Opinion No. 15. Statement No. 128 requires the presentation of earnings per share by all entities that have common stock or potential common stock, such as options, warrants, and convertible securities, outstanding that trade in a public market. Those entities that have only common stock outstanding are required to present basic earnings per share amounts. All other entities are required to present basic and diluted per share amounts. Diluted per share amounts assume the conversion, exercise, or issuance of all potential common stock instruments unless the effect is to reduce a loss or increase the income per common share from continuing operations.
The Company initially applied Statement No. 128 for the year ended May 31, 1998, and, as required by the statement, has restated all per share information for the prior years.
Comprehensive income: The FASB has issued Statement No. 130, Reporting Comprehensive Income, effective for fiscal years beginning after December 15, 1997. Statement No. 130 requires reporting items which are components of other comprehensive income, such as foreign currency items and unrealized gains and losses on certain investments in debt and equity securities. The Company will adopt this statement in the fiscal year ending May 30, 1999.
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Segments: The FASB has issued Statement No. 131, Disclosures About Segments of an Enterprise and Related Information, effective for fiscal years beginning after December 15, 1997. Statement No. 131 requires disclosure of certain information for each reportable segment, including general information, profit and loss information, segment assets, etc. The Company will adopt this statement in the fiscal year ending May 30, 1999. The Company does not expect this statement to have a significant effect on the financial statements.
Fiscal year: The Company operates on a 52- to 53-week fiscal year. The fiscal years for the financial statements presented ended May 31, 1998, June 1, 1997, and June 2, 1996.
Note 2. Inventories
The components of inventory at May 31, 1998, and June 1, 1997, are as follows:
Note 3. Financing Arrangement and Long-Term Debt
Financing arrangement: At May 31, 1998, the Company had a $2,000,000 revolving line-of- credit agreement through October 1, 1998. Interest on advances is at the bank's reference rate, 8.5 percent at May 31, 1998. All advances are due on demand and are secured by trade receivables. In addition, the agreement contains certain reporting and operating covenants, one of which is a restriction on the payment of any dividends. There were no advances outstanding at May 31, 1998. Also, the Company's Korean subsidiary maintains a modest facility agreement to cover bank overdrafts, short- term financing, and export financing. Advances outstanding relating to the Korean facility were $236, 468 at May31, 1998.
Long-term debt:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3. Financing Arrangement and Long-Term Debt (Continued)
Approximate maturities of long-term debt for years subsequent to May 31, 1998, are as follows:
Note 4. Income Taxes
Pretax income (loss) for domestic and foreign operations was as follows:
The components of the provision (benefit) for income taxes are as follows:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4. Income Taxes (Continued)
(a) Stock options which were exercised by employees resulted in compensation to them for income tax purposes based on the increase in fair market value of the Company's common stock subsequent to the date of grant of those options. As required, this compensation was not recognized as an expense for financial accounting purposes, and the related tax benefits were recorded directly to the Company's capital. The compensation deductions resulting from the excise of stock options were not material in 1996 and 1998.
The income tax provision differs from the amount of income tax determined by applying U.S. federal income tax rate to pretax income for the year ended May 31, 1998, June 1, 1997, and June 2, 1996, due to the following:
Net deferred taxes consist of the following components as of May 31, 1998, June 1, 1997:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4. Income Taxes (continued)
The components giving rise to the net deferred tax asset described above have been included in the accompanying consolidated balance sheet as of May 31, 1998, as follows:
At June 1, 1997, the Company reduced the valuation allowance to reflect the deferred tax assets utilized in 1997 to reduce current income taxes and to recognize net deferred tax assets of $681,000 at June 1, 1997. The recognized deferred tax assets results from the expected utilization of net operating losses and tax credit carryforwards and reversal of certain temporary differences.
The Company has assessed its past earnings history and trends, budgeted sales, and expiration of dates of carryforwards and has determined that it is more likely than not that the $266,000 of deferred tax assets at May 31, 1998, will be realized.
At May 31, 1998, the Company had net operating loss carryforwards to reduce future taxable income in Korea of approximately $137,000. The Company also has tax credit carryforwards of approximately $107,000 available to reduce future income taxes in the United States for income tax purposes. The net operating loss and tax credit carryforwards expire in varying amounts as follows for income tax reporting purposes:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5. Employee Benefit Plans
Pension plan: The company has a pension plan covering substantially all U.S. employees. The Company is required to match 25 percent of the employees' first 6 percent of contributions and may make additional contributions to the plan to the extent authorized by the Board of Directors. The contribution amounts charged to operating expenses in the years ended May 31, 1998, June 1, 1997, and June 2, 1996, approximated $39,000, $37,000, and $38,000, respectively.
Stock purchase plan: On March 10, 1996, the Company established a stock purchase plan in which up to 100,000 shares of common stock may be purchased by employees. The purchase price is equal to the lesser of 85 percent of the fair market value of the shares on the date the Phase commences or 85 percent of the fair market value of the shares on the termination date of the Phase. Each Phase is one year from the commencement date of a Phase. There were 10,825 and 13,957 shares purchased under this plan during the years ended May 31, 1998, and June 1, 1997, respectively.
Note 6. Stock Option Plan
The Company's 1996 stock option plan has reserved 500,000 common shares for issuance under qualified and nonqualified stock options for its key employees and directors. Option prices are the market value of the stock at the time the option was granted. Options become exercisable as determined at the date of grant by a committee of the Board of Directors. Options expire ten years after the date of grant unless an earlier expiration date is set at the time of grant.
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. Accordingly, no compensation cost has been recognized for the stock option plan. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in 1998 and 1997 consistent with the provisions of SFAS No. 123, the Company's net income and net income per share would have changed to the pro forma amounts indicated below:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6. Stock Option Plan (Continued)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998 and 1997:
The pro forma effect on net income in 1998 and 1997 is not representative of the pro forma effect in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1996.
Additional information relating to all outstanding options as of May 31, 1998, June 1, 1997, and June 2, 1996, is as follows:
The following table summarizes information about stock options outstanding at May 31, 1998:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7. Stockholders' Equity The Board of Directors is empowered to establish and to designate classes and series of preferred shares and to set the terms of such shares, including terms with respect to redemption, dividends, liquidation, conversion, and voting rights. The Restated Articles of Incorporation provide that the preferred shares are senior to the common shares with respect to dividends and liquidation. No preferred shares have been issued.
The Company has a shareholders' rights plan. Under this plan, a Class A, Junior Participating Preferred Stock with no par value was created. In addition, a dividend of one right was declared for each share of common stock at an exercise price of $36 per right and a redemption price of $36 per right and a redemption price of $0.001 per right. Each right is equal to a right to purchase one one-hundredth of a share of the class A, Junior Participating Preferred Stock, 100,000 shares of preferred stock are reserved for the exercise of the rights. No rights were exercised during the year-ended May 31, 1998, and June 1, 1997.
The Company has notes receivable from certain officers of the Company arising from the sale of common stock as an offset to stockholders' equity. The notes are due in September 2001.
In December 1996, the Company completed a secondary stock offering of 1,840,000 shares of common stock. Proceeds from the issuance of common stock were $10,620,794, net of offering expenses of $442,109. In connection with this offering, warrants to purchase 112,000 shares of common stock were issued. These warrants are exercisable at $7.80 per share through December 2001.
Note 8. Earnings Per Share In fiscal 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. Earning per share amounts presented for 1997 and 1996 have been restated for the adoption of SFAS No. 128. The following table reflects the calculation of basic and diluted earnings per share.
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
Note 9. Commitments and Contingencies
Operating leases: The Company leases its United States plant under an operating lease through August 1999. In addition, certain equipment and motor vehicles are leased under operating leases with terms of approximately 36 months.
The lease on the United States plant and office facilities includes scheduled base rent increases over the term of the lease. The total amount of the base rent payments is being charged expense on the straight-line method over the term of the lease. In addition to the base rent payment, the Company pays a monthly allocation of the building's operation expenses. The Company has recorded a deferred credit to reflect the excess of rent expense over cash payments since inception of the lease.
Approximate minimum annual rental commitments at May 31, 1998, are as follows:
Total rental expense for the years ended May 31, 1998, June 1, 1997, and June2, 1996, was approximately $391,000, $456,00, and $385,000, respectively.
Note 10. Operations Information
Foreign manufacturing is done by the Korean subsidiary, including its wholly-owned subsidiary located in China, and certain nonaffiliated companies in China and Thailand. All United States manufacturing is done by Ault Incorporated. A summary of the Company's manufacturing operations by geographic area is presented below:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10. Operations information (Continued)
Sales from the subsidiary to the parent company are based upon profit margins which represent competitive pricing similar products.
Export sales: The Company also had foreign export sales amounting to 27.1, 20.4, and 19.4 percent of total sales for the years ended May 31, 1998, June 1, 1997, and June 2, 1996, respectively.
The sales were made principally to the following locations:
AULT INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
Note 10. Operations Information (Continued) Other foreign production: In addition to the manufacturing done by the Korean subsidiary, the Company has subcontracting agreements for the purchase of finished assemblies from certain manufacturers in China and Thailand. Total purchases under these agreements were approximately $15,340,000, $15,248,000, and $9,941,000 for the years ended May 31, 1998, June 1, 1997, and June 2, 1996, respectively.
Note 11. Major Customers The Company had major customers during the years ended May 31, 1998, June 1, 1997, and June 2, 1996, as follows:
ITEM 8(B) SUPPLEMENTAL FINANCIAL INFORMATION
QUARTERLY FINANCIAL DATA (Unaudited) (Amounts in thousands, Except Per Share Data)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information called for by Item 405 under Registration S-K with respect to the Company's executive officers is contained under Item 1, Narrative Description of The Business -- Executive Officers of the Registrant. The information required by this item with respect to directors will be presented under the caption "Election of Directors" in the Company's definitive proxy statement for its Annual Meeting to be held on September 28, 1998 and is expressly incorporated herein by reference. Such proxy statement will be filed with the Securities and Exchange Commission not later than 120 days from the end of the Company's 1998 fiscal year.
Information called for by item 405 under Regulation S-K with respect to the information relating to compliance with 16(a) of the Exchange Act is presented under the caption "Compliance with Section 16(a) of the Securities Exchange Act 1934" in the Company's definitive proxy statement for its Annual Meeting to be held on September 28, 1998 and is expressly incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 403 under Regulation S-K, to the extent applicable, will be set forth under the caption "Executive Compensation and Other Information" under "General" in the Company's definitive proxy materials for its September 29, 1998 Annual Meeting to be filed within 120 days from the end of the Company's fiscal 1998 which information is expressly incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K, to the extent applicable, will be set forth under the caption "Security Ownership of Principal Shareholders and Management" in the Company's definitive proxy statement for its September 28, 1998 Annual Meeting to be filed within 120 days from the end of the Company's fiscal year 1998, which information is expressly incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not Applicable.
PART IV.
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES AND REPORTS
(a)(1) The following financial statements are included in Part II, Item 8:
(2) The following financial statements schedule for the years ended May 31, 1998, June 1, 1997 and June 2, 1996 are submitted herein following the signature page of this report.
All other Schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
(3) Exhibits
The Exhibits required to be filed with this report or incorporated by reference are listed in the Exhibit Index which follows the Financial Statements Schedules.
(b) Reports on Form 8-K during 3 months ended May 31, 1998.
There were no reports on Form 8-K filed for the quarter ended May 31, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Ault Incorporated has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AULT INCORPORATED
/S/Frederick M. Green August 25, 1998 Frederick M. Green President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
AULT INCORPORATED
FOR
YEAR ENDED MAY 31,1998
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FINANCIAL STATEMENT SCHEDULES
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G25
INDEPENDENT AUDITOR'S REPORT ON THE SUPPLEMENTARY INFORMATION
To the Board of Directors Ault Incorporated and Subsidiary Minneapolis, Minnesota
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The consolidated supplemental schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a part of the basic consolidated financial statements. This schedule has been subject as to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
McGladrey & Pullen, LLP
Minneapolis, Minnesota July 8, 1998
SCHEDULE II AULT INCORPORATED AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNTS Years Ended May 31, 1998, June 1, 1997, and June 2, 1996
*******************************************************************
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
AULT INCORPORATED
FOR
YEAR ENDED MAY 31, 1998
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EXHIBITS
*******************************************************************
AULT INCORPORATED
EXHIBIT INDEX TO FORM 10-K FOR THE YEAR ENDED JUNE 1, 1997
Required Registration S-K Exhibit Items
SK Reference
Pursuant to provisions of Item 601(b)(A)(iii)(a) of Regulation S-K, copies of instruments defining the rights of holders of long-term debt of the Company are note being filed and in lieu thereof, Company agrees to furnish copies thereof to the Securities and Exchange Commission upon request. 27, 1998