WEDC White Electronic Designs Corp. (MM)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

 

Commission File Number 1-4817

 

 

WHITE ELECTRONIC DESIGNS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (602) 437-1520

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o      No  þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ      No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web Site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o      No  þ

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $63,117,000 as of April 3, 2009, based upon the sale price on the NASDAQ Global Market reported for such date. Shares of common stock held by each officer and director and by each person who owns 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The number of shares outstanding of the registrant’s common stock on December 9, 2009 was 23,215,272.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement prepared in connection with the 2010 Annual Meeting of Shareholders are incorporated by reference into PART III, Items 10, 11, 12, 13, and 14 of this Annual Report on Form 10-K.

 

 

TABLE OF CONTENTS

 

 

This Annual Report on Form 10-K (“Form 10-K”), including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and documents incorporated herein by reference contain “forward-looking statements” including financial projections regarding future events and our future results that are within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Private Securities Litigation Reform Act of 1995, as amended, provides a “safe harbor” for such forward-looking statements. The words “believe,” “expect,” “estimate,” “anticipate,” “intend,” “may,” “might,” “will,” “would,” “could,” “project” and “predict,” or similar words and phrases regarding expectations, generally identify forward-looking statements.

 

We intend to qualify both our written and/or oral forward-looking statements made from time to time in connection with filings with the Securities and Exchange Commission (“SEC”) or in public news releases for protection under the safe harbors discussed above. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they are based largely on management’s expectations and because they are estimates, such statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified and are beyond our control. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements, each of which speaks only as of the date the statement is made. Statements in this Form 10-K, including those set forth in the “Notes to the Consolidated Financial Statements,” the sections entitled “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and under the subheading entitled “Risk Factors,” describe factors that could contribute to or cause actual results to differ materially from our expectations. Some factors that could cause actual results to differ materially from those expressed in such forward-looking statements include, but are not limited to, the following:

 

 

In addition, new factors, other than those identified in this Form 10-K, may emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from forward-looking statements. We do not undertake, and we specifically disclaim, any obligation to publicly update or revise any forward-looking statement contained in this Form 10-K or in any document incorporated herein by reference, whether as a result of new information, future events or otherwise, except as required by applicable law.

 

 

GENERAL

 

We are a defense electronics manufacturer and supplier that designs, develops and manufactures innovative electronic components and systems for inclusion in high technology products for the defense and aerospace markets. Our defense electronic solutions include advanced semiconductor and state of the art multi-chip packaged components, circuit card assemblies and electromechanical assemblies, as well as our proprietary process for incorporating anti-tamper protection to mission critical semiconductor components. Our customers, which include military prime contractors, and the contract manufacturers who work for them, in the United States, Europe and Asia, outsource many of their defense electronic components and systems to us as a result of the combination of our design, development and manufacturing expertise.

 

We are an Indiana corporation, originally incorporated in 1951 as Bowmar Instrument Corporation (“Bowmar”). On October 26, 1998, Bowmar merged with Electronic Designs, Inc. (“EDI”). In connection with the merger, Bowmar changed its name to White Electronic Designs Corporation. The merger provided us with a diversified platform to expand our product offerings within both the military and commercial markets.

 

Two additional acquisitions followed the EDI merger in an effort to expand our commercial electronics product offerings. Panelview, Inc. (“Panelview”), a designer and manufacturer of enhanced commercial flat panel display products, was acquired in 2001. Interface Data Systems, Inc. (“IDS”), a designer and manufacturer of membrane keypads, flexible circuits, sensors, control panels and handheld and desktop electronic devices, was acquired in 2003.

 

During fiscal 2008, we made a strategic decision to exit all commercial electronics markets and focus our operations in the defense electronics market where we have superior technical knowledge, specialized manufacturing capabilities and an ongoing commitment to research and development. As a result of this decision, during fiscal 2009, we disposed of our operations in our Interface Electronics Division (“IED”), commercial microelectronic product lines and Display Systems Division (“DSD”), which were structured from the EDI, Panelview and IDS acquisitions above. All three operations are being reported as discontinued operations.

 

We are headquartered in Phoenix, Arizona. Our mailing address is 3601 E. University Drive, Phoenix, Arizona, 85034, and our telephone number at that location is (602) 437-1520. Our website, which contains links to our financial information and our filings with the SEC, is www.whiteedc.com . Unless otherwise indicated in this Form 10-K, “White Electronic Designs,” “us,” “we,” “our,” “the Company” and similar terms refer to White Electronic Designs Corporation and its subsidiaries as a whole.

 

BUSINESS SEGMENTS

 

Prior to our decision to dispose of IED, our commercial microelectronic product lines and DSD, we reported as two segments: microelectronic and display. We reevaluated our segment reporting as part of our strategic decision to exit all commercial electronic markets and concluded that we should move forward under one segment — Defense Electronics. During fiscal 2008, we reclassified the prior periods to conform to the presentation of one business segment.

 

DEFENSE ELECTRONICS SEGMENT

 

Our defense electronics segment manufactures semiconductor multi-chip packaged components, circuit card assemblies and electromechanical assemblies. Our products are generally sold to military prime contractors and the contract manufacturers who work for them in the defense and aerospace markets. These industries generally require products to pass specific qualifications due to the application requirements. These higher performing products, characterized as “high-reliability,” are often referred to as “military” products. Military products are designed to meet more stringent standards and are resistant to adverse conditions such as high and low temperature extremes. High-reliability products can also be used in industrial applications where products are exposed to harsh conditions.

We believe our multi-chip packaged components provide our customers with the following advantages over standard technology:

 

 

We also believe that our anti-tamper security processing for mission critical semiconductor components in military applications provides a distinct advantage to our customers. Additionally, we have expanded our defense electronics capabilities to include military grade circuit card assemblies in support of Global Positioning System (“GPS”) capability for secure communication devices and guidance systems.

 

Our defense products involve three fundamental functional categories:

 

The following table describes key products that we sell in the defense electronics segment and some of their applications:

 

 

Backlog

 

The backlog for defense electronics products (our continuing operations), represented by firm customer purchase orders, was $37.8 million at the end of fiscal year 2009 and $38.6 million at the end of fiscal year 2008. Approximately 87% of the fiscal year-end 2008 backlog was shipped during fiscal 2009, with the remaining backlog scheduled for shipment in fiscal 2010 and beyond. Our customers will on occasion request that we purchase material on their behalf in support of future program requirements. The value of this material is carried in backlog. In fiscal 2009, a customer’s program ended and the related material was returned. We recorded nominal revenue for the return and adjusted the backlog accordingly. Approximately 67% of the fiscal 2009 year-end backlog is planned for shipment during fiscal 2010, with the remaining backlog scheduled for shipment in fiscal 2011 and beyond. The backlog after fiscal 2010 is a result of customer scheduling requirements for our products and not constraints on our capacity.

 

Competition

 

In the defense electronic product markets, we compete primarily based on performance, quality, durability and price. We have a number of present and potential competitors, including customers, many of which have greater financial, technical, marketing, distribution and other resources than we do.

 

Our principal competitors in the defense electronic product markets are divisions of Aeroflex Corporation, Austin Semiconductor, Teledyne Microelectronics Group and Esterline. We also compete with manufacturers that provide single chip microelectronic products.

 

SALES, MARKETING AND DISTRIBUTION

 

We use an integrated sales approach to closely manage relationships at multiple levels of the customer’s organization, including management, engineering and purchasing personnel. This approach involves a team consisting of a senior executive, a business development specialist, and members of our engineering department and sales staff. Our sales team consists of approximately 21 people, including 6 sales managers. Our use of experienced engineering personnel as part of the sales effort enables close technical collaboration with our customers during the design and qualification phase of new equipment. We believe that this is critical to the

incorporation of our products into our customers’ equipment. Some of our executive officers are actively involved in key aspects of our relationships with our major customers and work closely with our customers’ senior management. We also use manufacturers’ representatives, independent sales representatives and distributors as needed.

 

The military sales cycle tends to be long in nature with a protracted design phase. Once a product is designed into a military system, it may be sole-sourced to a particular supplier. Due to the extensive qualification process and potential redesign required for using an alternative source, customers are reluctant to change the incumbent supplier. While we are generally not subject to seasonality factors, as we migrate towards a business base driven more by larger orders on major defense programs, we expect to experience more quarter-to-quarter fluctuations in bookings and revenues.

 

Our products are sold with a warranty which differs in terms and conditions depending on the product and customer. Our products may be subject to repair or replacement during the warranty period.

 

PRINCIPAL CUSTOMERS

 

Our customers consist mainly of military prime contractors and the contract manufacturers who work for them in the United States, Europe and Asia.

 

In fiscal 2009, Utexam Logistics (supplying BAE Systems PLC), Raytheon and L-3 Communications accounted for 12%, 10% and 10%, respectively, of total net sales. In fiscal 2008, L-3 Communications and Arrow Electronics accounted for 14% and 12%, respectively, of total net sales. In fiscal 2007, Arrow Electronics accounted for 11% of our total net sales.

 

Total foreign sales for fiscal 2009, 2008 and 2007 were approximately $19.5 million, $16.6 million and $18.2 million, respectively. Additional information concerning sales by geographic area can be found in Note 14 of the Notes to the Consolidated Financial Statements.

 

FOREIGN OPERATIONS

 

For information regarding risks associated with our foreign operations, see Part I, Item 1A “Risk Factors.” Our international operations subject us to risks inherent in doing business on an international level that could adversely impact our results of operations.

 

RESEARCH, ENGINEERING AND PRODUCT DEVELOPMENT

 

Our research and development efforts primarily involve engineering and design relating to:

 

 

Some of our product development costs are recoverable under contractual arrangements; however, the majority of these costs are self-funded. Our research and development expenditures were approximately $4.4 million, $3.6 million and $3.4 million in fiscal 2009, 2008 and 2007, respectively. We believe that strategic investment in process technology and product development is essential for us to remain competitive in the markets we serve. We are committed to maintaining appropriate levels of expenditures for product development.

 

REGULATORY MATTERS

 

Government Contracting Regulations

 

A significant portion of our business is derived from subcontracts with prime contractors of the United States government. As a United States government subcontractor, we are subject to federal contracting regulations. Our extensive experience in the defense industry enables us to handle the strict requirements that accompany these contracts.

Under federal contracting regulations, the United States government is entitled to examine all of our cost records with respect to certain negotiated contracts or contract modifications for three years after final payment on such contracts to determine whether we furnished complete, accurate, and current cost or pricing data in connection with the negotiation of the price of the contract or modification. The United States government also has the right after final payment to seek a downward adjustment to the price of a contract or modification if it determines that the contractor failed to disclose complete, accurate and current data.

 

In addition, the Federal Acquisition Regulations govern the allowability of costs incurred by us in the performance of United States government contracts to the extent that such costs are included in its proposals or are allocated to United States government contracts during performance of those contracts.

 

Our subcontracts provide that they may be terminated at the convenience of the United States government. Upon such termination, the contractor is normally entitled to receive the purchase price for delivered items, reimbursement for allowable costs incurred and allocable to the contract, and an allowance for profit on the allowable costs incurred or adjustment for loss if completion of performance would have resulted in a loss. In addition, our subcontracts provide for termination for default if we fail to perform or breach a material obligation of a subcontract. In the event of a termination for default, the customer may have the unilateral right at any time to require us to return unliquidated progress payments pending final resolution of the propriety of the termination for default. We may also have to pay the excess, if any, of the cost of purchasing a substitute item from a third party. If the customer has suffered other ascertainable damages as a result of a sustained default, the customer could demand payment from us of such damages. Historically, we have not experienced any such terminations.

 

In connection with our United States government business, we are also subject to government investigations of our policies, procedures, and internal controls for compliance with procurement regulations and applicable laws. We may be subject to downward contract price adjustments, refund obligations or civil and criminal penalties. In certain circumstances in which a contractor has not complied with the terms of a contract or with regulations or statutes, the contractor might be debarred or suspended from obtaining future contracts for a specified period of time. Any such suspension or debarment would have a material adverse effect on our business.

 

It is our policy to cooperate with the government in any investigations of which we have knowledge, but the outcome of any such government investigations cannot be predicted with certainty. We believe we have complied in all material respects with applicable government requirements.

 

Environmental Matters

 

Our operations are regulated under a number of federal, state and local environmental laws and regulations, which govern, among other things, the discharge of hazardous materials into the air and water as well as the handling, storage and disposal of such materials. We currently use limited quantities of hazardous materials common to our industry in connection with the production of our products. In addition, because of our use of such hazardous materials, we may be subject to potential financial exposure for costs associated with an investigation and remediation of sites at which we have arranged for the disposal of hazardous wastes, if such sites become contaminated. This is true even if we fully comply with applicable environmental laws. Our compliance with federal, state and local laws and regulations, which govern the discharge of materials into the environment, has not had a material adverse effect upon our capital expenditures, earnings or competitive position within our markets. There have been no claims asserted and management is unaware of any unasserted environmental claims.

 

International Trade Regulations

 

We must comply with laws concerning the export of material used exclusively for military purposes. The export of materials and data of this type are covered under International Traffic in Arms Regulations (“ITAR”) laws. We are registered with the US Department of State and renew our registration annually. We currently hold several licenses that allow us to export technical data and product to certain foreign companies.

RAW MATERIALS

 

The most significant raw materials that we purchase for our operations are memory devices in silicon wafer and die forms. We are dependent on a few select manufacturers for our memory and package raw materials. We are also dependent on certain suppliers for particular customers due to their product specifications. Despite the risks associated with purchasing from a limited number of sources, we have made the strategic decision to select limited source suppliers in order to obtain lower pricing, receive more timely delivery and maintain quality control. We buy the same types of material components typically used in the commercial commodity markets which we enhance through packaging, testing, and other processes. As a result, we have to monitor the supply and demand and proactively plan our purchases. We have long-standing strategic relationships with world class semiconductor suppliers. Because of these capabilities and relationships, we believe we can continue to meet our customers’ requirements. In cases where unanticipated customer demand or supply shortages occur, we attempt to arrange, through strategic relationships with our semiconductor suppliers, for alternative sources of supply, where available, or defer planned production to meet anticipated availability of critical components or materials. We do not have specific long-term contractual arrangements with our vendors, but we believe we have good relationships with them. For more information on certain risks related to our sources of raw materials, see the risk factor entitled “We depend on limited suppliers for certain critical raw materials” in Part I, Item 1A “Risk Factors.”

 

INTELLECTUAL PROPERTY

 

We rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. The products we sell require a large amount of engineering design and manufacturing expertise. The majority of these technological capabilities, however, are not protected by patents and licenses. We rely on the expertise of our employees and our learned experiences in both the design and manufacture of our products. It is possible (and it has occurred in the past) that a competitor may also learn to design and produce products with similar performance capabilities as our products. An increase in the sophistication of our competitors’ products may result in increased competition and a reduction of sales for our products.

 

Our trade secret protection for our technology, including our process for incorporating anti-tamper protection into microelectronic products, is based in part on confidentiality agreements that we enter into with our employees, consultants and other third parties. However, these parties may breach these agreements, and since many agreements are made with companies much larger than us, we may not have adequate financial resources to adequately enforce our rights. Others may also come to know about or determine our trade secrets. In addition, the laws of certain territories in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as the laws of the United States.

 

No new patents related to our continuing operations were granted during fiscal 2009. We currently have two patent applications pending with the United States Patent and Trademark Office, which are currently under review.

 

EMPLOYEES

 

Within our continuing operations as of September 30, 2009, we had approximately 248 employees, including 21 in sales, 3 in marketing, 37 in research, development and engineering, 146 in manufacturing and quality assurance, and 41 in general and administrative. Approximately 29 of our active employees are employed pursuant to a three-year collective bargaining agreement covering workers at our Fort Wayne, Indiana facility that was ratified on November 16, 2007. The contract will expire on November 15, 2010. We believe we have a good working relationship with our employees.

 

FINANCIAL INFORMATION BY GEOGRAPHIC SEGMENT

 

See Note 14 of the Notes to the Consolidated Financial Statements for information relating to foreign sales by geographic region.

AVAILABLE INFORMATION

 

We make available, free of charge on or through our internet site www.whiteedc.com , the following filings as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC: our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act.

 

 

We are subject to various risks associated with our decision to streamline our business and dispose of operations classified as discontinued operations.

 

During fiscal 2008, we made a strategic decision to streamline our business and focus our operations in the defense electronics market. Accordingly, our discontinued operations, consisting of IED, DSD and our commercial microelectronic product lines are classified as assets and liabilities held for sale. We now have one segment which is focused on defense electronics. As a result of this decision, our revenue and profitability are concentrated in one industry and originate from customers who are generally military prime contractors and the contract manufacturers who work for them. Downturns, adverse events and other circumstances that may affect this industry and which are largely beyond our control will now uniquely and materially affect us. For instance, if the amount of potential business in this industry materially shrinks due to less governmental military spending, this would have a more material adverse effect on our results of operations, liquidity and our potential growth than in prior years.

 

Current economic conditions may adversely affect our industry, business and results of operations.

 

The United States and global economy is currently undergoing a recession and a period of unprecedented volatility. It is unclear how prolonged this recession will be and how it will affect our industry in particular. Many believe that the general future economic environment may continue to be less favorable than that of recent years. If the challenging economic conditions in the United States and other key countries persist or worsen, our customers may delay or reduce spending. This could result in reductions in sales of our products and services, longer sales cycles, slower adoption of new technologies, increased price competition and prolonged tightening of the credit markets. Any of these events would likely harm our business, results of operations and financial condition, whether directly or indirectly.

 

We are dependent on sales to defense-related companies for a large portion of our net sales and profits, and changes in military spending levels and patterns could negatively affect us.

 

Our current orders from defense-related companies account for a material portion of our overall net sales and military spending levels depend on factors that are outside of our control. Reductions or changes in military spending could have a material adverse effect on our sales and profits.

 

For instance, government contracts are conditioned upon the continuing availability of Congressional appropriations. Congress typically appropriates funds for a given program on a fiscal-year basis even though contract performance may take more than one year. As a result, at the beginning of a major program, a contract is typically only partially funded, and additional monies are normally committed to the contract by the procuring agency only as Congress makes appropriations available for future fiscal years. Additionally, a new executive branch administration took office in January 2009. A difference in philosophy and/or the worsening economic climate of the country could reduce or change appropriations.

 

The transition of the U.S. defense industry to purchase commercial off-the-shelf products and other trends within our industry could negatively affect us.

 

While we expect continued strength in bookings in fiscal 2010, no assurances can be given that this will occur. We believe that because of the unexpected length and cost of the wars in Iraq and Afganistan, and as part of a broad overhaul of U.S. priorities, funds for weapons and equipment have been reallocated away from high technology programs to areas that we do not supply, such as personnel and infrastructure in support of the wars’ operations. In addition, the United States defense industry is moving toward the purchase of commercial off-the-shelf products rather than those designed and manufactured to higher military specifications. To the extent that our products are replaced or materially offset by

commercial off-the-shelf products, our operations would suffer. Even if military spending continues to increase, these shifts in military spending would negatively affect business, results of operations and financial condition.

 

The competitive bid process for government contracts may negatively affect us.

 

We have in the past and will likely in the future attempt to obtain U.S. government contracts and subcontracts through the process of competitive bidding. The competitive bid process typically requires us to estimate costs and the timing for completion of projects. If we do not accurately estimate the costs associated with a given project our profitability may be negatively affected or we could potentially even lose money. If we do not accurately estimate the timing required to complete a project, we may be penalized monetarily or our reputation may be impaired. In addition, the competitive bid process often requires substantial and focused allocation of resources, including management’s time, with no guarantee of success or award of the contract. Ultimately, our sales and profits connected to competitive bidding on U.S. government contracts and subcontracts are unpredictable and are subject to many factors that are beyond our control, as well as trends and events that are difficult to predict.

 

Our goodwill may become impaired in the future.

 

We have goodwill resulting from one of our acquisitions. At least annually, we evaluate the goodwill for impairment based on the fair value of the related reporting unit. This estimated fair value could change if there were future changes in our capital structure, cost of debt, interest rates, capital expenditure levels, ability to perform at levels that were forecasted or a permanent change to the market capitalization of our company. These changes have in the past, and may in the future, result in an impairment that would require a material non-cash charge to our results of operations.

 

We may make strategic acquisitions and cannot assure you that any future acquisitions will be successful.

 

We regularly look for strategic opportunities to grow and diversify our product offerings and strengthen our current product lines through acquisitions. There can be no assurance that we will identify appropriate acquisition candidates or successfully integrate products and operations with any such candidates that we may acquire. Any such acquisitions could involve the dilutive issuance of equity securities and/or the incurrence of debt. In addition, acquisitions may involve numerous additional risks, including, but not limited to, the following:

 

 

Even when an acquired company already has developed and marketed products, there can be no assurance that the products will continue to be successful, that product enhancements will be made in a timely fashion, that we will be able to incorporate such products into our sales pipeline and strategy, or that pre-acquisition due diligence will have identified all possible issues that might arise with respect to the acquired company or its products.

 

Our customers may cancel their orders, change production quantities or delay production at any time, which could materially reduce our net sales and operating results.

 

We generally do not receive firm, long-term purchase commitments from our customers. Customers may cancel their orders, change production quantities or delay production for a number of reasons. Cancellations, reductions or delays by a significant customer or by a group of customers would seriously harm our results of operations for a period by reducing our net sales in that period. In addition, because many of our costs and operating expenses are fixed, a reduction in customer demand could harm our gross profit and operating income.

We have a concentrated customer base and, as a result, our net sales could decline significantly if we lose a major customer.

 

Historically, a large portion of our net sales have been derived from sales to a small number of our customers and we expect this trend to continue for the foreseeable future. Our five largest customers accounted for 48% of our net sales in fiscal 2009 and 43% of our net sales in fiscal 2008. Our customers are not subject to any minimum purchase requirements and can discontinue the purchase of our products at any time. In the event one or more of our major customers reduces, delays or cancels orders with us, and we are not able to sell our services and products to new customers at comparable levels, our net sales could decline significantly, which could adversely affect our financial condition and results of operations. In addition, any difficulty in collecting amounts due from one or more key customers would negatively impact our results of operations.

 

We depend on military prime contractors for the sale of our products and the failure of these customers to achieve significant sales of products incorporating our components would reduce our net sales and operating results.

 

We sell substantially all of our products to military prime contractors and the contract manufacturers who work for them. The timing and amount of sales to these customers ultimately depend on sales levels and shipping schedules for the products into which our components are incorporated. We have no control over the volume of products shipped by our military prime contractors and the contract manufacturers who work for them or shipping dates, and we cannot be certain that our military prime contractors or the contract manufacturers who work for them will continue to ship products that incorporate our components at current levels, or at all. Our business will be harmed if our military prime contractors or the contract manufacturers who work for them fail to achieve significant sales of products incorporating our components or if fluctuations in the timing and volume of such sales occur. Failure of these customers to inform us of changes in their production needs in a timely manner could also hinder our ability to effectively manage our business.

 

We depend on the continuing trend of outsourcing by prime military contractors, which is subject to factors beyond our control.

 

Our net sales and future growth in our net sales depend in part on outsourcing pursuant to which we assume additional manufacturing and supply chain management responsibilities from military prime contractors. To the extent that these opportunities are not available, either because military prime contractors decide to perform these functions internally or because these contractors use other providers of these services, our results of operations may be adversely affected.

 

Our failure to comply with United States government laws, regulations and manufacturing facility certifications would reduce our ability to be awarded future military business.

 

We must comply with laws, regulations and certifications relating to the formation, administration and performance of federal government contracts as passed down to us by our customers in their purchase orders, which affects our military business and may impose added cost on our business. We are subject to government investigations (including private party “whistleblower” lawsuits) of our policies, procedures, and internal controls for compliance with procurement regulations and applicable laws. If a government investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including the termination of our contracts, the forfeiture of profits, the suspension of payments owed to us, fines, and our suspension or debarment from doing business with federal government agencies. In addition, we could expend substantial amounts defending against such charges and incur damages, fines and penalties if such charges are proven or result in negotiated settlements. Since military sales account for a significant portion of our business, any debarment or suspension of our ability to obtain military sales would greatly reduce our overall net sales and profits, and would likely affect our ability to continue as a going concern.

We may have an adverse resolution of litigation which may harm our operating results or financial condition.

 

At times, we are a party to lawsuits in the normal course of our business. In addition, we have been defendants in several shareholder class action lawsuits. Litigation can be unforeseeable, expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results, or financial condition.

 

We may fail to meet projected financial results because our net sales, gross profits and net income fluctuates from period to period, which may in turn adversely affect the market price of our common stock.

 

Our operating results have varied in the past and will likely continue to fluctuate. In connection with our business, a wide array of factors could cause our net sales, gross profits and net income to fluctuate in the future from period to period. In addition to other factors mentioned in this report, primary factors that might affect our results of operations in this regard include:

 

 

As a result of any of these or other factors, we could fail to achieve our expectations as to future net sales, gross profits and net income. Any downward fluctuation or failure to meet expectations will likely adversely affect the value of an investment in our securities. Due to the foregoing factors, it is likely that in some future periods our operating results will be below the expectations of public market analysts and investors and, as a result, the market price of our common stock may decline.

 

We have a lengthy sales cycle, which increases the likelihood that our quarterly net sales will fluctuate and which may, in turn, adversely affect the market price of our common stock.

 

Due to the complexity of our technology, our customers perform, and require us to perform, extensive process and product evaluation and testing, which results in a lengthy sales cycle. Our sales cycles often last for several months, and may last for up to a year or more. Additionally, as we are a tier three supplier, our orders are dependent on funding and contract negotiations through multiple parties which can affect our receipt of orders due to matters outside of our control. Our business is moving towards a business base driven more by larger orders on major defense programs. As a result of these factors, our net sales and operating results may vary unpredictably from period to period. This fact makes it more difficult to forecast our quarterly results and can cause substantial variations in operating results from quarter to quarter that are unrelated to the long-term trends in our business. This lack of predictability in our results could adversely affect the market price of our common stock in particular periods.

 

Our failure to detect defects in our products could materially harm our relationship with customers, our reputation and our business.

 

Notwithstanding the testing that we perform on our products, defects could be found in our existing or new products. These defects could result in product liability or warranty claims. In addition, any defects found in our products could result in a loss of net sales or market share, failure to achieve market acceptance, injury to our reputation, indemnification claims, litigation, increased insurance costs and increased service costs, any of which could discourage customers from purchasing our products. Although we maintain a warranty reserve, we cannot be

certain that this reserve will be sufficient to cover our warranty or other expenses that could arise in the future as a result of defects found in our products.

 

Our operating results could be negatively impacted if the markets in which we sell our products do not grow.

 

Our continued success depends in large part on the continued growth of the defense and aerospace equipment market sector in which our products are used. Slow growth in this market in which we sell our products could reduce our sales, adversely affecting our business, financial condition and results of operations.

 

Downturns in the defense and aerospace markets could reduce the value of our inventories and cause a reduction in our profits.

 

In the past, we have experienced reductions in the value of our inventories due to unexpected demand declines. Such declines have caused us to write down several million dollars worth of inventory, which greatly reduced our profits for the given period. If any of the markets in which our customers operate suffers a decline, we may be forced to write down existing inventory, which could adversely affect our results of operations.

 

We are dependent on international markets for a large portion of our purchases and sales.

 

Foreign suppliers of semiconductor related materials are regularly threatened with, or involved in, trade disputes and sanctions. If trade disputes or sanctions arise that affect our suppliers, we may be unable to obtain access to critical sources of raw materials that we need to produce our products, in which event our business could be materially adversely affected.

 

We anticipate that our foreign sales will continue to account for a significant portion of our net sales. If the United States government places additional restrictions and/or prohibitions on exporting military technology using our products in countries where we have customers or vendors or we are unable to renew our ITAR and other export licenses, it could cause a significant reduction in our sales. Our foreign sales are subject to numerous risks, including, but not limited to, the following:

 

 

We maintain all of our cash and cash equivalents, some of which are not insured, at two depository institutions.

 

We maintain all of our cash and cash equivalent accounts at two depository institutions. As of September 30, 2009, our aggregate balances in such accounts were $65.0 million. Of such amount, $500,000 was covered by

Federal Deposit Insurance Corporation (FDIC) insurance. The remaining amounts were not insured as of the end of fiscal 2009.

 

Although we believe that the risk of loss associated with our uninsured deposit accounts is low given the financial strength and reputation of our depository institutions, we could suffer losses with respect to the uninsured balances if the depository institutions failed and the institutions’ assets were insufficient to cover its deposits and/or the Federal government did not take actions to support deposits in excess of existing FDIC insured limits. Any such losses could have a material adverse effect on our liquidity, financial condition and results of operations.

 

If we are unable to retain employees with key technical expertise, our financial condition and future prospects could be materially harmed.

 

The products that we sell require a large amount of engineering design and manufacturing expertise. However, the majority of our technological capabilities are not protected by patents and licenses. We rely on the expertise of our employees and our learned experiences in both the design and manufacture of our products. If we were to lose one or more of our key employees, then we would likely lose some portion of our institutional knowledge and technical know-how, which could adversely affect our business.

 

If we are unable to protect our intellectual property or if we are found to have infringed third party intellectual property rights, our business could be adversely and materially affected.

 

We rely on trade secret protection for most of our proprietary technology, in part through confidentiality agreements with our employees, consultants and third parties. If any of these agreements are found to be unenforceable, we may be unable to adequately protect our technology. If any of these agreements are breached, especially by companies much larger than us, we may not have adequate financial resources to adequately enforce our rights. Also, others may come to know about or determine our trade secrets. In addition, the laws of certain territories in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as the laws of the United States. If any of the foregoing occurs, our business could be adversely and materially affected.

 

While we are currently not aware of any claims against us for the infringement of intellectual property rights, any such claim could divert the efforts of our technical and management personnel and require us to spend significant resources to develop or otherwise obtain non-infringing technology. Any successful claim against us would likely require us to pay substantial damages or cease the use and sale of infringing products, or both.

 

Our business is dependent upon retaining key personnel and attracting new employees.

 

Our success depends, to a significant degree, upon the continued contributions of our senior management and other key personnel. The loss of the services of any of our senior management or other key personnel could adversely affect our business. We may not be able to retain these employees and searching for their replacements could divert the attention of other senior management and increase our operating expenses. We currently do not maintain any key person life insurance. To manage our operations effectively, we may need to hire and retain additional qualified employees in the areas of product design, engineering, operations management, manufacturing production, sales, accounting and finance. We may have difficulty recruiting these employees or integrating them into our business. Employee retention can also be challenging following acquisitions, with respect to current and integrated employees. Accordingly, in the event of a future acquisition or strategic transaction, we and our employees may face challenges and distractions that may adversely affect our financial condition and operating results.

 

Our failure to comply with environmental regulations could subject us to costs and production delays.

 

We currently use limited quantities of hazardous materials common to our industry in connection with the production of our products. We must follow federal, state and local environmental laws and regulations regarding the handling, storage and disposal of these materials. To our knowledge, we are currently in material compliance with all federal, state and local environmental laws and regulations regarding the handling, use, storage and disposal of these materials. We could be subject to fines, suspensions of production, alteration of our manufacturing

processes or interruption or cessation of our operations if we fail to comply with present or future laws or regulations related to the use, storage, handling, discharge or disposal of toxic, volatile or otherwise hazardous chemicals used in our manufacturing processes. These regulations could require us to acquire expensive remediation equipment or to incur other expenses to comply with environmental regulations. Our failure to control the handling, use, storage or disposal of, or adequately restrict the discharge of, hazardous substances could subject us to liabilities and production delays, which could cause us to miss our customer’s delivery schedules, thereby reducing our sales for a given period. We may also have to pay regulatory fines, penalties or other costs (including remediation costs), which could materially reduce our profits and adversely affect our financial condition.

 

If our selling prices decline and we fail to reduce our costs, our sales and operating results will decline.

 

Even in the absence of cyclical conditions, the average selling prices of our products have historically decreased during the products’ lives, and we expect this trend to continue. In order to offset these average selling price decreases, we attempt to decrease manufacturing costs, and introduce new, higher priced products that incorporate advanced features. If these efforts are not successful, we will not be competitive because we will not be able to remain profitable at decreased selling prices, possibly leading to our exit from certain market sectors.

 

In addition to following the general pattern of decreasing average selling prices, the selling prices for certain products, particularly SRAM, DRAM and Double Data Rate (“DDR”) II products, fluctuate significantly with real and perceived changes in the balance of supply and demand for these products. If we are unable to decrease per unit manufacturing costs faster than the rate at which average selling prices continue to decline, our business, financial condition and results of operations will be seriously harmed. In addition, we expect our competitors to invest in new manufacturing capacity and achieve significant manufacturing yield improvements in the future. These developments could result in a dramatic increase in worldwide supply and result in associated downward pressure on prices.

 

If we fail to develop, introduce and sell new products or fail to develop and implement new manufacturing technologies, our operating results could be adversely affected.

 

We operate in a highly competitive, quickly changing environment marked by rapid obsolescence of existing products. The future success of our business will depend in large part upon our ability to maintain and enhance our technological capabilities, make required capital investments, design, develop, manufacture, market and sell services and products that meet our customers’ changing needs, and successfully anticipate or respond to technological changes on a cost effective and timely basis. Our sales will be reduced, either through loss of business to our competitors or discontinuance of our products in the market, if any of the following occur:

 

 

Increasing complexity generally requires the use of smaller geometries in semiconductor chips. This makes manufacturing new generations of products substantially more difficult and costly than prior products. Ultimately, whether we can successfully introduce these and other new products depends on our ability to develop and implement new ways of manufacturing our products. If we are unable to design, develop, manufacture, market and sell new products successfully, we will lose business and possibly be forced to exit from the particular market or sector.

Increasing competition could reduce the demand for our products.

 

Although we believe we have certain competitive advantages, each of our markets is highly competitive. Many of our competitors have, and potential competitors could have, greater name recognition, a more extensive product base, more extensive engineering, manufacturing and marketing capabilities, and greater financial, technological and personnel resources. New or existing competitors may also develop new technologies that could adversely affect the demand for our products. If any of the foregoing occurs, our results of operations and financial condition could be materially adversely affected.

 

We depend on limited suppliers for certain critical raw materials.

 

Our manufacturing operations require raw materials that must meet exacting standards. Additionally, certain customers require us to buy from particular vendors due to their product specifications. The most significant raw materials that we purchase are memory devices in silicon wafer and die forms. Shortages of wafers and other raw materials may occur when there is a strong demand for memory integrated circuits and other related products and could materially affect our business. In addition, a major decline in a supplier’s financial condition could cause a production slowdown or stoppage, which could affect our ability to obtain raw materials. We rely heavily on our ability to maintain access to steady sources of these raw materials at favorable prices. We are highly dependent on one or two semiconductor manufacturers for memory devices, such as SRAM, DRAM, DDR II, flash, etc., and one package manufacturer of ceramic packages for military components. We do not have specific long-term contractual arrangements, but we believe we are on good terms with our suppliers. We cannot be certain that we will continue to have access to our current sources of supply at favorable prices, or at all, or that we will not encounter supply problems in the future. Any interruption in our supply of raw materials could reduce our sales in a given period, and possibly cause a loss of business to a competitor, if we could not reschedule the deliveries of our product to our customers. In addition, our gross profits could suffer if the prices for raw materials increase, especially with respect to sales associated with military contracts where prices are typically fixed.

 

Terrorism and the global responses to terrorism, the unsettled world political situations and perceived nuclear threats increase uncertainties with respect to many of our businesses and may adversely affect our business and results of operations.

 

Terrorism and the global responses to terrorism, unsettled world political situations and perceived nuclear threats, increase uncertainties with respect to U.S. and other business and financial markets. Several factors associated, directly or indirectly, with terrorism, the Iraq and Afganistan situations and perceived nuclear threats and responses may adversely affect us. We will predominately be uninsured for losses and interruptions caused by terrorist acts or acts of war.

 

Various United States government responses to these factors could realign government programs and affect the composition, funding or timing of the government programs in which we participate. Government spending could shift to programs in which we may not participate or may not have current capabilities. The influence of any of these factors, which are largely beyond our control, could adversely affect our business.

 

While we believe our control systems are effective, there are inherent limitations in all control systems, and misstatements due to error or fraud may occur and not be detected.

 

We continue to take action to assure compliance with the internal controls, disclosure controls and other requirements of the Sarbanes-Oxley Act of 2002. Our management, including our President and Chief Executive Officer and Chief Financial Officer, cannot guarantee that our internal controls and disclosure controls will prevent all possible errors or all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be relative to their costs. Because of the inherent limitations in all control systems, no system of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Further, controls can be circumvented by individual acts of some persons,

by collusion of two or more persons, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may be inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

Our Board of Directors is authorized to issue shares of preferred stock that could have rights superior to our outstanding shares of common stock, and, if issued, could adversely impact the value of our common stock.

 

Our amended and restated articles of incorporation permit our Board of Directors, in its sole discretion, to issue up to 1,000,000 shares of preferred stock. These shares may be issued without further action by our shareholders, and may include any of the following rights, among others, which may be superior to the rights of our outstanding common stock:

 

 

Since our Board of Directors has the authority to determine, from time to time, the terms of our authorized preferred stock, there is no limit on the amount of common stock that could be issuable upon conversion of any future series of preferred stock that may be issued. The rights of holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any series of preferred stock that may be issued in the future. In addition, the market price of our common stock may be adversely affected by the issuance of any series of preferred stock with voting or other rights superior to those of our common stock. The issuance of any series of preferred stock could also have the effect of making it more difficult for a third party to acquire a majority of our outstanding common stock.

 

Our stock price has been volatile.

 

The price of our common stock fluctuates. Like most publicly-held companies, the trading price of our common stock could be subject to wide fluctuations in response to:

 

 

 

To our knowledge, we have no written unresolved comments regarding our periodic or current reports from the staff of the SEC.

 

The following table sets forth the locations and general characteristics of the physical properties that we own or lease in connection with the conduct of our business:

 

 

 

 

In addition to the above properties, we own 10 acres of vacant land adjacent to the Fort Wayne, Indiana facility. Our headquarters lease covers approximately 74,000 square feet. The lease term will expire in July 2015 and is subject to two five-year renewal options.

 

We consider all of our facilities to be well maintained and adequate for current operations. All facilities have additional capacity, which could be utilized in the event of increased production requirements. Our manufacturing facilities that serve the military market must comply with stringent military specifications. Our manufacturing facility in Phoenix, Arizona is certified to ISO-9001/2000, AS9100, MIL-PRF 38534, MIL-PRF 38535, and has Class B, H and K status.

 

 

From time to time, we are subject to claims and litigation incident to our business. There are currently no such pending proceedings to which we are a party that we believe will have a material adverse effect on our consolidated results of operations, liquidity, or financial condition.

 

 

None.

PART II

 

 

Market Information

 

Our common stock is currently traded on the NASDAQ Global Market under the symbol “WEDC”. The following table sets forth the high and low sales prices for the common stock by quarter during the fiscal years ended September 30, 2009 and September 27, 2008.

 

As of December 1, 2009, our stock price was $4.38, and there were approximately 6,103 holders of record of our common stock. We have not paid cash dividends on our common stock and do not expect to do so in the foreseeable future. We intend to retain all earnings to provide funds for the operation and expansion of our business. In addition, our revolving line of credit agreement precludes the payment of cash dividends on our common stock.

 

Issuer Purchases of Equity Securities

 

On April 8, 2008, we announced our third repurchase program to acquire up to an additional 10%, or approximately 2.2 million shares, of our then outstanding common stock. No purchases were made under this program during the fourth quarter of fiscal 2009. The Board of Directors suspended the program during the strategic alternatives review and believes that, at this time, our cash should be used to enhance the technological capabilities of the Company.

 

Performance Graph

 

The following Performance Graph and related information shall not be deemed “soliciting material” or to be filed with the SEC, nor shall such information be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates it by reference into such filing.

 

The graph below matches the cumulative 5-year total return of holders of White Electronic Designs Corporation’s common stock with the cumulative total returns of the NASDAQ Composite index and the S&P Aerospace & Defense index. The graph assumes that the value of the investment in the Company’s common stock and in each of the indexes (including reinvestment of dividends, if any) was $100 on September 30, 2004 and tracks it through September 30, 2009.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among White Electronic Designs Corporation, The NASDAQ Composite Index
And The S&P Aerospace & Defense Index

 

 

 

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

The following table contains selected consolidated financial data for the fiscal years 2005-2009 (in thousands, except per share data):

 

 

This table should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements provided elsewhere herein.

 

 

 

 

In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to risks described under “Risk Factors,” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

 

Overview

 

We are a defense electronics manufacturer and supplier that designs, develops and manufactures innovative electronic components and systems for inclusion in high technology products for the defense and aerospace markets. Our defense electronics solutions include advanced semiconductor and state of the art multi-chip packaged components, integrated circuit card assemblies with anti-tamper (“AT”) components and electromechanical assemblies, as well as our proprietary process for incorporating AT protection into mission critical semiconductor components. Our customers, which include military prime contractors, and the contract manufacturers who work for them, in the United States, Europe and Asia, outsource many of their defense electronic components and systems to us as a result of the combination of our design, development and manufacturing expertise.

 

During fiscal 2008, we made a strategic decision to exit all commercial electronics markets and focus our operations in the defense electronics market where we have superior technical knowledge, specialized manufacturing capabilities and an ongoing commitment to research and development. As a result of this decision, during fiscal 2009, we disposed of our operations in our Interface Electronics Division (“IED”), commercial microelectronic product lines and Display Systems Division (“DSD”). All three operations are being reported as discontinued operations and the assets and liabilities of the discontinued operations are classified as assets and liabilities held for sale.

 

Prior to our decision to dispose of IED, our commercial microelectronic product lines and DSD, we reported as two segments: microelectronic and display. We reevaluated our segment reporting as part of our strategic decision to exit all commercial electronic markets and concluded that we should move forward under one segment — Defense Electronics. During fiscal 2008, we reclassified the prior periods to conform to the presentation of one business segment.

 

Executive Summary

 

Continuing Operations

 

Net sales for the fiscal year ended September 30, 2009 were approximately $62.6 million, compared to net sales of $56.4 million for fiscal 2008. Net sales increased $6.2 million, or 11%, from fiscal 2008 primarily due to higher sales of our modules, integrated circuit card assemblies with AT components, and electromechanical assemblies which more than offset decreases in sales of our AT component only and power PC products. While AT component only bookings increased over the prior year, customer requirements determine the timing of shipments.

 

A key indicator of our future sales is the amount of new orders received compared to current net sales, known as the book-to-bill ratio. During the year, we received new orders of approximately $64.4 million, which equates to a book-to-bill ratio of 1.03:1. Bookings increased $8.2 million, or 15%, over fiscal 2008 bookings of $56.2 million. This increase was negatively impacted by lower fourth quarter bookings due to delays in funding on several projects which remain high defense priorities. As we move to a business base driven more by larger orders on major defense programs, we expect to experience more quarter-to-quarter fluctuations in bookings and revenue. New AT orders, which include bookings for AT components as well as integrated circuit cards with AT components, were approximately $19.1 million for fiscal 2009 and we had sales of approximately $14.5 million. We currently expect to see continued growth for AT technology products over the next several years.

 

Our gross margins were approximately 39% for fiscal 2009 compared to approximately 41% for fiscal 2008. The decrease is primarily due to yield costs related to our entrance into production volumes of circuit card assemblies with AT components. Our gross margin historically has been a blend of margins derived from custom and standard microelectronic components and electromechanical assemblies. We have traditionally experienced a

range of margins in the 40% to 43% range depending on the custom versus standard concentration. As we move vertical with the introduction of military grade circuit card assemblies, which are more price sensitive, we expect overall margins to center around 40%.

 

Income from continuing operations for fiscal 2009 was $3.0 million, or $0.13 per diluted share, compared to income of $2.5 million, or $0.11 per diluted share, for fiscal 2008. The $0.5 million increase was primarily due to the increase in gross profit of $1.7 million offset by a decrease in interest income of $1.1 million.

 

Organizationally, fiscal 2009 was a year of change. After the resignation of our previous Chief Executive Officer in August 2008, Edward A. White, the Company’s founder, was elected Chairman of the Board and the Board of Directors (“Board”) appointed Roger A. Derse, Vice President and Chief Financial Officer, and Dante V. Tarantine, Executive Vice President, Sales and Marketing, to perform the duties of the Office of the President. The Office of the President reported to a committee of the Board headed by Mr. White. The Board also formed a special committee to evaluate all possible strategic alternatives for the Company. In February 2009, we added two new members to our Board, Brian R. Kahn and Melvin L. Keating. In June 2009, we announced the completion of the strategic alternative exploration, the retirement of Mr. White and the election of Mr. Kahn as Chairman of the Board. In August 2009, we announced the appointment of Gerald R. Dinkel as President and Chief Executive Officer for the Company and also as a member of the Board. Additionally, Thomas M. Reahard retired from the Board in August 2009. Subsequent to year end, in November 2009, we announced the appointment of Kenneth J. Krieg to the Board.

 

On February 4, 2009, we entered into a Settlement Agreement with Wynnefield Capital, Inc. and its affiliates, and Caiman Partners L.P. and its affiliates (“Shareholder Group”). Under the terms of the Settlement Agreement, we expanded our Board from five to seven members and appointed Mr. Kahn and Mr. Keating as directors. In accordance with the Settlement Agreement, our Articles of Incorporation were amended at our 2009 Annual Meeting to enable shareholders representing more than 50% of our outstanding shares to amend our Bylaws. In connection with this Settlement Agreement, the Shareholder Group terminated its proxy solicitation, withdrew its proposed slate of director nominees and voted all of its shares in favor of all of the Board’s director nominees at the 2009 Annual Meeting. The Shareholder Group filed an amendment to its Schedule 13D terminating its status as a group on February 22, 2009. The Settlement Agreement also permitted each of the members of the Shareholder Group to acquire up to 9.9% of the then outstanding shares of our Common Stock. Lastly, the Settlement Agreement provided that we reimburse the Shareholder Group for actual expenses incurred up to $250,000 in connection with the activities relating to the matters in the agreement. Combined with our cost for legal and other outside services in connection with this Settlement Agreement, our general and administrative expenses increased approximately $0.7 million.

 

On August 12, 2009, we announced the termination of our Shareholder Rights Agreement, commonly referred to as a “poison pill.” This decision was a reflection of the Board’s commitment to continue to implement corporate governance decisions that benefit all shareholders. On August 13, 2009, we entered into Amendment No. 1 to the February 4, 2009 Settlement Agreement. Amendment No. 1 provided our Chaiman of the Board, Brian R. Kahn, through his affiliated entities, to purchase up to 19.99% of our issued and outstanding common stock in exchange for certain additional obligations set forth in the Amendment. On November 16, 2009, we entered into Amendment No. 2 to the February 4, 2009 Settlement Agreement. Pursuant to Amendment No. 2, Mr. Kahn, through his affiliated entities, may purchase up to 35% of the issued and outstanding shares of our common stock for additional obligations. Some of these obligations include until the later of (i) the end of Mr. Kahn’s service on the Board, or (ii) two business days following our 2010 annual meeting of shareholders, Mr. Kahn’s entities shall not participate in any group to (1) acquire substantially all of our assets without Board approval, (2) acquire shares in excess of 35% without approval from the Board, (3) sell shares of our common stock in a privately negotiated transaction not open to other shareholders at an above market price or (4) seek to take any action inconsistent with the items above without approval from the Board.

 

Discontinued Operations

 

On April 3, 2009, we completed the sale of DSD to the U.S. subsidiary of VIA optronics GmbH, a German company (“VIA”). We sold the operating assets of DSD, primarily consisting of inventory, equipment and

intellectual property, for approximately $2.3 million. As of the date of sale, other non-operating net assets of approximately $0.9 million, consisting primarily of accounts receivable and residual liabilities, were retained to be settled in the normal course of business. Other non-operating liabilities of ($0.3) million remained as of September 30, 2009. These non-operating liabilities are included as part of continuing operations. During the second quarter of fiscal 2009, we also completed the disposition of our commercial microelectronic product lines. We recorded a loss on sale of discontinued operations of ($0.7) million, net of tax, on these two disposals during fiscal year 2009.

 

During the third quarter of fiscal 2009, we concluded that there was a change in the plan for the disposal of IED and that, rather than one disposal group, there were to be three disposal groups. We sold a group of assets of IED, primarily equipment and a patent, in the third quarter of fiscal 2009. The second group of IED, which consisted of the remaining equipment, was disposed of in the fourth quarter of fiscal 2009. Land and the building comprise the third disposal group of IED, which is expected to be sold in December 2009. All production and shipments by IED were completed in the third quarter of fiscal 2009. We recorded a total gain on sale of discontinued operations of $0.1 million, net of tax, on these disposals during fiscal year 2009.

 

Our discontinued operations generated $14.4 million in revenues in fiscal 2009 compared to $40.1 million in fiscal 2008. The decrease in revenue of $25.7 million, or 64%, was primarily due to the sale of DSD and completion of operations of our commercial microelectronics product lines in the second quarter of fiscal 2009 and the final sales for IED in the third quarter of fiscal 2009. Gross profit for discontinued operations for fiscal 2009 was $3.2 million, or 22%, compared to $5.4 million, or 14%, in fiscal 2008. Loss from discontinued operations, net of tax was ($0.3) million in fiscal 2009 compared to ($5.0) million in fiscal 2008. The decrease in the loss was due to the final disposition of DSD and the commercial microelectronics product lines in fiscal 2009, as well as the last time buys for IED resulting in a lower loss than the write-off of intangibles, inventory and fixed assets in fiscal 2008. Loss on sale of discontinued operations, net of tax was ($0.6) million, in fiscal 2009 compared to a loss of ($3.5) million in fiscal 2008.

 

Including the charges in connection with the disposal of the product lines discussed above, net income for the fiscal year ended September 30, 2009 was $2.0 million, or $0.09 per diluted share, compared to net loss of ($6.0) million, or ($0.26) per diluted share, for fiscal 2008.

 

Business Outlook

 

As part of our renewed focus on defense electronics, we have developed a plan that builds on our core competencies and expands beyond multichip components. The plan focuses on expanding revenue opportunities in three key areas: Aircraft, Missiles and Ordnance and Net Centric Operations. Programs that require secure communications, guidance of munitions to minimize collateral damage and enhance war fighter safety will be addressed by our GPS components with our AT protection and integrated circuit card assemblies with AT components. We additionally expect to expand our integrated circuit card assembly product offerings through increased use of radio frequency technology. Additionally, we believe that there are significant opportunities in solid state technology which replaces mechanical storage devices. In the overall defense market, we see participation in the broader GPS, cyber security and information assurance environments as logical potential extensions of our capability. Paths to participating in these markets include research and development, strategic partnerships and acquisitions.

Results of Operations

 

The following table sets forth, for the periods indicated, certain operating data expressed as a percentage of net sales:

 

 

Fiscal Year ended September 30, 2009 compared to Fiscal Year ended September 27, 2008

 

Net Sales

 

Net sales were $62.6 million for the year ended September 30, 2009, an increase of $6.2 million, or approximately 11%, from $56.4 million for the year ended September 27, 2008. The increase was due to higher sales of our modules, integrated circuit card assemblies with AT components and electromechanical assemblies, which more than offset decreases in AT component only and Power PC products. We expect net sales to increase in fiscal 2010 as compared to fiscal 2009.

 

Utexam Logistics (supplying BAE Systems PLC), Raytheon and L-3 Communications accounted for approximately $7.2 million, $6.0 million and $6.0 million, or 12%, 10% and 10%, respectively, of our fiscal 2009 total net sales. In fiscal 2008, L-3 Communications and Arrow Electronics accounted for $7.7 million and $6.6 million, or 14% and 12%, respectively, of total net sales.

 

The majority of our sales are not subject to seasonal fluctuations over the course of a year. However, as we move to a business base driven more by larger orders on major defense programs, we expect to experience more quarter-to-quarter fluctuations in bookings and revenue.

 

Gross Profit

 

Gross profit was $24.6 million for the year ended September 30, 2009, an increase of $1.7 million, or 7%, from $22.9 million for the year ended September 27, 2008. Gross margin as a percentage of net sales was approximately 39% for the year ended September 30, 2009, compared to approximately 41% for the year ended September 27, 2008. The increase in gross profit resulted from higher sales partially offset by a decrease in gross margin

percentage. The lower gross margin as a percentage of net sales was due to yield costs related to our entrance into production volumes of circuit card assemblies with AT components.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses consist mainly of compensation expense, selling expenses, including commissions, information technology expenses and corporate administrative expenses. Selling, general and administrative expenses were $16.4 million for the year ended September 30, 2009, a decrease of $0.9 million, or approximately 5%, from $17.3 million for the year ended September 27, 2008. This decrease resulted from a decrease in general and administrative expenses of $0.8 million over the comparable period. General and administrative expenses decreased mainly because of $2.8 million in severance-related costs in connection with the departure of our Chief Executive Officer in fiscal 2008. This was offset by (i) $0.7 million of legal and outside service costs in connection with the shareholder agreement, (ii) $0.5 million in board-related and outside advisor fees due to the completion of the Strategic Alternatives Committee work and the retirement of our founder and former Chairman of the Board, Edward A. White, and (iii) $0.7 million for system, process, and organizational revisions as part of our structural upgrade of the business in support of higher volume manufacturing and higher salary expenses incurred in 2009.

 

As a percentage of net sales, s elling, general and administrative expenses were approximately 26% as compared with 31% for the prior year. The decrease was caused by the higher expenses in fiscal 2008. We expect selling, general and administrative expenses to average between 25% and 27% of net sales in the future at the current net sales level.

 

Research and Development Expenses

 

Research and development expenses consist primarily of compensation for our engineering personnel, consulting expenses and project materials. Research and development expenses were $4.4 million for the year ended September 30, 2009, an increase of $0.8 million, or 22%, as compared to $3.6 million for the year ended September 27, 2008. The increase was primarily attributable to higher payroll costs due to increased headcount in connection with our investment in advanced development for solid state drives (“SSD”). Research and development expenses as a percentage of net sales have been approximately 6% to 7% of net sales over the past three years. We are committed to the research and development of new and existing products and expect research and development expenses to increase as a percentage of net sales in the future at the current net sales level due to our continued investment in SSD.

 

Ongoing product development projects include new product designs for various types of memory products including DDR II, DDR III, FLASH and microprocessors, and ball grid arrays using these semiconductors; continuing development of AT technologies and integrated circuit card assembly design; advanced development for SSD; and advanced custom designs for use in defense markets.

 

Interest Income

 

Interest income consists of interest earned on our cash balances invested primarily in money market accounts. Interest income was approximately $0.4 million for the year ended September 30, 2009, a decrease of approximately $1.2 million, or approximately 72%, from approximately $1.6 million for the year ended September 27, 2008. This decrease was primarily attributable to decreased interest rates. Our cash balance increased approximately $11.6 million during fiscal 2009. We expect interest income to remain at these lower levels in fiscal 2010 due to macroeconomic conditions.

 

Income Taxes

 

Income tax expense consists of current and deferred federal and state income taxes. Income tax expense was $1.2 million for the year ended September 30, 2009, compared to $1.1 million for the year ended September 27, 2008. The effective tax rate was approximately 29% for the fiscal year ended September 30, 2009 and 31% for the fiscal year ended September 27, 2008. The Company’s effective tax rate differs from the federal statutory tax rate of

34% due to the impact of state taxes and is decreased by research and experimentation tax credits and a reduction in the tax reserve. See Note 7 to the Consolidated Financial Statements.

 

Fiscal Year ended September 27, 2008 compared to Fiscal Year ended September 29, 2007

 

Net Sales

 

Net sales were $56.4 million for the year ended September 27, 2008, an increase of $4.3 million, or approximately 8%, from $52.1 million for the year ended September 29, 2007. The increase was due to higher sales of our anti-tamper and BGA products which more than offset decreases in modules and Power PC products, as well as our electromechanical assemblies.

 

In fiscal 2008, L-3 Communications and Arrow Electronics accounted for $7.7 million and $6.6 million, or 14% and 12%, respectively, of our total net sales. In fiscal 2007, Arrow Electronics accounted for $5.9 million, or 11%, of total net sales. No other customer accounted for 10% or more of our net sales for these periods.

 

Gross Profit

 

Gross profit was $22.9 million for the year ended September 27, 2008, an increase of $0.5 million, or approximately 2%, from $22.4 million for the year ended September 29, 2007. Gross margin as a percentage of net sales was approximately 41% for the year ended September 27, 2008 compared to approximately 43% for the year ended September 29, 2007. The increase in gross profit resulted from higher sales volume partially offset by a decrease in gross margin. The lower gross margin as a percentage of net sales was due to lower margin product mix and higher costs associated with product yield, as well as startup costs associated with circuit card assembly introduction.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses consist mainly of compensation expense, selling expenses, including commissions, information technology expenses and corporate administrative expenses. Selling, general and administrative expenses were $17.3 million for the year ended September 27, 2008, an increase of $3.3 million, or approximately 24%, from $14.0 million, for the year ended September 29, 2007. This increase was due to a decrease in selling expenses of $0.2 million, offset by an increase in general and administrative expenses of $3.5 million over the comparable period. Selling expenses decreased primarily due to a decrease in commissions as the commission percentage decreased from fiscal 2007. General and administrative expenses increased mainly because of $2.8 million in severance-related costs in connection with the departure of our Chief Executive Officer and $0.6 million of payroll-related expenses.

 

As a percentage of net sales, selling, general and administrative expenses were approximately 31% for fiscal year 2008 as compared with 27% for fiscal year 2007. The increase was caused by higher expenses in fiscal 2008.

 

Research and Development Expenses

 

Research and development expenses consist primarily of compensation for our engineering personnel, consulting expenses and project materials. Research and development expenses were $3.6 million for the year ended September 27, 2008, an increase of $0.2 million, or 6%, as compared to $3.4 million for the year ended September 29, 2007. The increase was primarily attributable to increased payroll costs.

 

Interest Income

 

Interest income consists of interest earned on our cash balances invested primarily in money market accounts. Interest income was $1.6 million for the year ended September 27, 2008, a decrease of $0.9 million, or 36%, compared to $2.5 million for the year ended September 29, 2007. This decrease was attributable to decreased interest rates.

Income Taxes

 

Income tax expense consists of current and deferred federal and state income taxes. Income tax expense was $1.1 million for the year ended September 27, 2008, compared to $2.3 million for the year ended September 29, 2007. The effective tax rate was approximately 31% for both the year ended September 27, 2008 and September 29, 2007. The Company’s effective tax rate differs from the federal statutory tax rate of 34% due to the impact of state taxes and is decreased by reductions for the manufacturers’ deduction, research and experimentation tax credits, and a reduction in the tax reserve.

 

Liquidity and Capital Resources

 

Cash on hand as of September 30, 2009 totaled approximately $64.2 million and was primarily invested in money market accounts. During fiscal year 2009, net cash provided by operating activities was approximately $4.7 million compared to $3.5 million in fiscal 2008. The year over year increase was primarily a result of the increase in income from continuing operations and accounts payable, offset by the decrease in accrued expenses and deferred revenue. Depreciation totaled approximately $2.8 million and $2.5 million for fiscal years 2009 and 2008, respectively. We expect depreciation in fiscal 2010 to be higher than fiscal 2009 due to our increased investment in capital equipment in fiscal 2009.

 

Accounts receivable in fiscal 2009 decreased approximately $0.4 million from fiscal 2008, primarily as a result of the timing of invoicing and receipts. Days sales outstanding at September 30, 2009 was 59 days, which was lower than the 68 days at September 27, 2008. Our days sales outstanding typically approximates 68 days.

 

Inventories increased approximately $0.3 million from fiscal year 2008. Inventory of approximately $15.6 million as of September 30, 2009 represents 150 days of inventory on hand, a decrease from 168 days on hand at September 27, 2008. The levels of inventory fluctuate based on changes in expected production requirements, the fulfillment of orders and availability of raw materials. Inventory amounts will generally take several quarters to adjust to significant changes in future sales. Also, as lead times for raw materials increase, we are required to purchase larger amounts of inventory per order and hold it for longer periods of time. This has the effect of increasing the number of days of inventory on hand. We expect to fund any increases in inventory caused by sales growth or manufacturing planning requirements from our cash balances and operating cash flows.

 

Prepaid expenses and other current assets increased approximately $1.6 million from the end of fiscal 2008. This was primarily due to the prepayment of income taxes.

 

Accrued expenses and deferred revenue as of September 30, 2009 decreased approximately $2.4 million from the end of fiscal 2008. Accrued salaries and benefits were approximately $0.4 million higher at September 30, 2009 compared to the end of fiscal year 2008 due to an additional week of accrued payroll. Other accrued expenses were approximately $0.3 million higher, primarily due to an increase in accrued warranty related to DSD as the warranty liability was retained as part of the sale. Deferred revenue decreased approximately $3.1 million compared to the end of fiscal year 2008 due primarily to the shipment of bonded inventory back to a customer of approximately $2.6 million.

 

Purchases of property, plant and equipment during the year ended September 30, 2009 totaled approximately $4.3 million, with $0.1 million remaining in accounts payable at year-end.

 

We maintain a pension plan for eligible union employees at our Fort Wayne, Indiana facility pursuant to a collective bargaining agreement. See Note 8 to the Consolidated Financial Statements for additional information. We expect to fund our pension obligation through returns on plan assets and our contributions to the plan over the next several years. Actual contributions will be dependent on the actual investment returns during that period. While the current market conditions could have an adverse effect on our plan investments, any additional required contribution is not expected to have a material effect on our consolidated financial statements and we expect to fund such contributions from our cash balances and operating cash flows. We contributed $0.5 million to the pension plan in fiscal year 2009. We believe that funding the plan over the next several years will not significantly impact our liquidity.

An additional $0.6 million of cash was received pursuant to common stock options exercised throughout fiscal year 2009.

 

We have repurchased, pursuant to two separate stock repurchase programs, a total of approximately 2.4 million shares, or 10%, of our then outstanding common stock. The number of shares repurchased under these programs in fiscal 2009, 2008 and 2007 was 0, 0.6 million and 1.5 million, for a total cost of $0, $3.2 million and $8.0 million, inclusive of commissions and fees, respectively. All repurchases were funded from our cash balances and operating cash flows.

 

On April 8, 2008, we announced our third repurchase program to acquire up to an additional 10%, or approximately, 2.2 million shares, of our then outstanding common stock. The timing and amount of any repurchases under the program will depend on market conditions and corporate and regulatory considerations. No repurchases were made during the fiscal year ended September 30, 2009. During the fiscal year ended September 27, 2008, we repurchased 13,179 shares under this program for a total cost of $0.1 million, inclusive of commissions and fees. The duration of the program is twenty-four months and any additional repurchases will be funded from our cash balances and operating cash flows. The Board of Directors suspended the program during the strategic alternatives review and believes that, at this time, our cash should be used to enhance the technological capabilities of the Company.

 

On March 31, 2009, we entered into a Third Modification Agreement to our revolving line of credit agreement with JPMorgan Chase Bank, N.A. (“Revolving Line of Credit Agreement”). The amendment reduced the line from $30.0 million to $10.0 million and made certain other adjustments to (i) the interest rates charged in connection with borrowings under the line of credit, (ii) the commitment fee charged on the unused portion of the line and (iii) certain financial covenants and restricted payments. The borrowings, if any, under the revolving line of credit bear interest at the lower of the London Interbank Offered Rate (“LIBOR”) plus 2.5%, or the JPMorgan Chase Bank, N.A. “prime rate.” A commitment fee of 0.5% is charged on the unused portion of the line. The revolving line of credit expires on March 31, 2011. We are in compliance with all debt covenant requirements contained in the Revolving Line of Credit Agreement. As of September 30, 2009, there were no borrowings against the revolving line of credit, and we have not borrowed against any credit facility since April 2003.

 

We believe that our existing sources of liquidity, including expected cash flows from operating activities, existing cash balances, existing credit facilities and other financing sources, will satisfy our expected cash requirements for at least the next twelve months.

 

Contractual Obligations

 

We have entered into certain long-term contractual obligations in our continuing operations that will require various payments over future periods as follows (in thousands):

 

 

 

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.

Contingencies

 

From time to time, we are subject to claims and litigation incident to our business. There are currently no such pending proceedings to which we are a party that we believe will have a material adverse effect on our consolidated results of operations, liquidity, or financial condition.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make 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. Actual results could differ from those estimates. The most significant accounting estimates inherent in the preparation of our consolidated financial statements include the following items:

 

Revenue Recognition

 

We sell defense electronics products primarily to military prime contractors. A portion of our products are also sold through distributors or resellers. We recognize revenue on product sales when persuasive evidence of an arrangement with the customer exists, title to the product has passed to the customer (usually occurs at time of shipment), the sales price is fixed or determinable, and collectability of the related billing is reasonably assured. Advance payments from customers are deferred and recognized when the related products are shipped. Revenue relating to products sold to distributors or resellers who either have return rights or where the Company has a history of accepting product returns are deferred and recognized when the distributor or reseller sells the product to the end customer. We also provide limited design services pursuant to related customer purchase orders and generally recognize the associated revenue as such services are performed. However, it may be deferred until certain elements are completed. We may from time to time enter into certain arrangements that contain multiple elements such as performing limited design services accompanied with follow-on manufacturing of related products. We allocate revenue to the elements based on relative fair value, and recognize revenue for each element when there is evidence of an arrangement, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. Arrangements with multiple elements that are not considered separate units of accounting require deferral of revenue until certain other elements have been delivered or the services have been performed. The amount of the revenue recognized is impacted by our judgment as to whether an arrangement includes multiple elements, and whether the elements are considered separate units of accounting, as well as management’s judgments regarding the fair values of the elements used to determine relative fair values.

 

Excess and Obsolete Inventory

 

Historically, we have experienced fluctuations in the demand for our products based on cyclical fluctuations in the defense electronics markets. These fluctuations may cause inventory on hand to lose value or become obsolete. In order to present the appropriate inventory value on our financial statements, we identify slow moving or obsolete inventories and record provisions to write down such inventories to net realizable value. These provisions are based on management’s comparison of the value of inventory on hand against expected future sales. If future sales are less favorable than those projected by management, additional inventory provisions may be required.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

We record trade accounts receivable at the invoiced amount and they do not bear interest. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We make these estimates based on an analysis of accounts receivable using available information on our customers’ financial status and payment histories. Historically, bad debt losses have not differed materially from our estimates. Continuing operation write-offs against the allowance were $85,000 in fiscal 2009, $0 in fiscal 2008 and $1,000 in fiscal 2007.

Defined Benefit Plan

 

We maintain a pension plan for eligible union employees at our Fort Wayne, Indiana facility. To account for the cost of this plan, we make estimates concerning the expected long-term rate of return on plan assets, and discount rates to be used to calculate future benefit obligations. Changes in the expected long-term rate of return on plan assets affect the amount of investment income expected to be earned in the future. We base our related estimates using historical data on the rate of return from equities and fixed income investments, as well as projections for future returns on such investments. If the actual returns on plan assets do not equal the estimated amounts, we may have to fund future benefit obligations with additional contributions to the plan. Changes in the discount rate affect the value of the plan’s future benefit obligations. A lower discount rate increases the liabilities of the plan because it raises the value of future benefit obligations. This will also cause an increase in pension expense recognized. We use published bond yields to estimate the discount rate used for calculating the value of future benefit obligations.

 

Goodwill and Intangible Assets

 

Goodwill is tested for impairment on an annual basis (and more frequently in certain circumstances) and written down when impaired. Goodwill recorded was $1.8 million at both September 30, 2009 and September 27, 2008. Purchased intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite. Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets. We also regularly evaluate intangible assets for impairment and evaluate the continued appropriateness of estimated future lives assigned to these assets.

 

Stock-Based Compensation Expense

 

We are required to record the fair value of stock-based compensation awards as an expense. In order to determine the fair value of stock options on the date of grant, the Company applies the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected price volatility, option life, risk-free interest rate and dividend yield. While the risk-free interest rate and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock price volatility and option life assumptions require a greater level of judgment which makes them critical accounting estimates.

 

Product Warranties

 

Our products typically carry a warranty for a one year period. We record a liability for product warranty obligations in the period the related revenue is recorded based on historical warranty experience. Related costs are charged to the warranty accrual as incurred.

 

Income Taxes

 

Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized, net of any valuation allowance, for deductible temporary differences and net operating loss and tax credit carry forwards. We regularly review our deferred tax assets for recoverability by assessing our forecasts of future taxable income and reviewing available tax planning strategies that could be implemented to realize our deferred tax assets and, if necessary, establish a valuation allowance.

 

The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. A recognition threshold and a measurement attribute are used for the financial statement recognition of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is 50 percent likely of being realized upon ultimate settlement. Differences between tax positions taken in a tax return and amounts recognized in the financial statements are recorded as adjustments to income taxes payable or receivable, or adjustments to deferred taxes, or both.

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board (“FASB”) has established the Accounting Standards Codification ^tm (“Codification” or “ASC”) as the single source of authoritative GAAP recognized by the FASB to be applied by non-governmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification has become non-authoritative. The FASB will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates, which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification. GAAP is not intended to be changed as a result of the FASB’s Codification project, but it will change the way the guidance is organized and presented. As a result, these changes will have a significant impact on how companies reference GAAP in their financial statements and in their accounting policies for financial statements issued for interim and annual periods ending after September 15, 2009. We have implemented the Codification in this Annual Report by providing a plain English approach when describing any new or updated authoritative guidance.

 

In December 2008, the FASB issued additional disclosure requirements for plan assets of defined benefit pension or other postretirement plans. Required disclosures provide information on how investment allocation decisions are made, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets and significant concentrations of risk within plan assets. These additional disclosures become effective for us in fiscal year 2010 beginning October 1, 2009. Their adoption does not change the accounting treatment for postretirement benefit plans.

 

In May 2009, the FASB issued general standards for the accounting and reporting of subsequent events that occur between the balance sheet date and issuance of financial statements. Issuers will be required to recognize the effects, if material, of subsequent events in the financial statements if the subsequent event provides additional evidence about conditions that existed as of the balance sheet date. The issuer must also disclose the date through which subsequent events have been evaluated and the nature of any nonrecognized subsequent events. Nonrecognized subsequent events include events that provide evidence about conditions that did not exist as of the balance sheet date, but which are of such a nature that they must be disclosed to keep the financial statements from being misleading. These new standards became effective for financial reporting periods ending after June 15, 2009. The adoption of them has had no material effect on our consolidated financial statements.

 

 

As of September 30, 2009, we had no borrowings on our revolving line of credit with JPMorgan Chase Bank, N.A. In the event we borrow against our revolving line of credit, the interest charged on these borrowings would be at the lower of the bank’s “prime rate” or the LIBOR plus 2.5%. During fiscal 2009, the bank’s “prime rate” averaged 3.47% and was 3.25% as of September 30, 2009.

 

We are subject to changes in the “prime rate” based on Federal Reserve actions and fluctuations in the LIBOR. As of September 30, 2009, the LIBOR was approximately 1.27%. In the event we borrow against our revolving line of credit, annual interest expense (at 3.25%) would be approximately $32,500 for every $1.0 million borrowed. A hypothetical 1% increase in the interest rate would increase annual interest expense by approximately $10,000 per $1.0 million borrowed. We believe that moderate interest rate increases will not have a material adverse impact on our consolidated results of operations, liquidity or financial position.

 

We believe that we are not subject in any material way to other forms of market risk, such as foreign currency exchange risk on foreign customer purchase orders (we accept payment in U.S. dollars only) or commodity price risk.

 

The financial statements and supplementary data required by Regulation S-X are included under Part IV, Item 15 of this Annual Report on Form 10-K.

 

 

Not applicable.

 

 

Evaluation of Disclosure Controls and Procedures.   Attached as exhibits to this Form 10-K are certifications of our President and Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and the controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the evaluation process.

 

We have evaluated, under the supervision and with the participation of management, including our CEO and CFO, the effectiveness of the design and operation of our disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon this evaluation, our management, including our CEO and CFO, concluded that as of September 30, 2009 our disclosure controls and procedures were effective in ensuring that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Management, including our CEO and CFO, has also concluded that our disclosure controls are designed to ensure such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Furthermore, our disclosure controls include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with GAAP.

 

Changes in Internal Control over Financial Reporting.   There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Management’s Report on Internal Control over Financial Reporting.   Our management, including our CEO and CFO, is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or the degree of compliance with internal control policies or procedures may deteriorate.

 

Our management, with the participation of our CEO and CFO, has undertaken an evaluation of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2009 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation under the COSO framework, management has concluded that the Company’s internal control over financial reporting was effective as of September 30, 2009.

 

Grant Thornton LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K, has also audited the effectiveness of the Company’s internal control over financial reporting as of September 30, 2009, as stated in their report which appears in the “Report of Independent Registered Public Accounting Firm” elsewhere in this Form 10-K.

 

Annual Salary Increases

 

On December 9, 2009, the Compensation Committee of our Board (the “Compensation Committee”) increased the annual base salary of two of our named executive officers by five percent. The new salaries are as follows:

 

Name		Title		New Salary
Roger A. Derse		Vice President, Chief Financial Officer, Secretary and Treasurer		$	252,525
Dan Tarantine		Executive Vice President		$	268,800

 

Cash Bonuses

 

In addition to the above increase, the Compensation Committee approved fiscal year 2009 discretionary cash bonus payments to two of our named executive officers in the following amounts:

 

Name		Title		Bonus
Roger A. Derse		Vice President, Chief Financial Officer, Secretary and Treasurer		$	30,000
Dan Tarantine		Executive Vice President		$	20,000

 

Bonuses were awarded in accordance with the policy established by the Board and the Compensation Committee. Base salaries and participation in cash bonus plans may be adjusted from time to time as determined by the Compensation Committee.

PART III

 

 

Unless otherwise set forth below, the information required by this Item 10 will be set forth in our proxy statement (which will be filed with the SEC no later than 120 days following our 2009 fiscal year-end or will be filed in an amendment to this Annual Report on Form 10-K) relating to our 2010 annual meeting of shareholders (the “2010 Proxy Statement”), and is incorporated herein by this reference.

 

We have adopted a Code of Ethics and Business Conduct that applies to all of our directors, executive officers, director of financial reporting and compliance, corporate controller and division controllers. A copy of the Code of Ethics and Business Conduct is posted on our internet web site at www.whiteedc.com . If we make any amendment to, or grant any waivers of, a provision of the Code of Ethics and Business Conduct that applies to our principal executive officers, principal financial officer, director of financial reporting and compliance, corporate controller or division controllers where such amendment or waiver is required to be disclosed under applicable SEC rules, we intend to disclose such amendment or waiver and the reasons therefore on our internet web site. In addition, any waiver of a provision of the Code of Ethics and Business Conduct applicable to any of our directors or executive officers will be disclosed on Form 8-K as required by the NASDAQ Marketplace Rules.

 

 

The information required by this Item 11 will be set forth in the 2010 Proxy Statement and is incorporated herein by this reference.

 

 

Unless set forth below, information required by this Item 12 is set forth in the 2010 Proxy Statement and is incorporated herein by this reference.

Equity Compensation Plan Information

 

The following table provides information as of September 30, 2009, with respect to the shares of the Company’s common stock that may be issued under the Company’s existing equity compensation plans:

 

 

 

 

 

 

The information required by this Item 13 will be set forth in the 2010 Proxy Statement and is incorporated herein by this reference.

 

 

The information required by this Item 14 will be set forth in the 2010 Proxy Statement and is incorporated herein by this reference.

 

 

(a)(1) Financial Statements

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

(a)(2) Financial Statement Schedules

 

INDEX TO FINANCIAL STATEMENT SCHEDULES

 

 

(a)(3) Exhibits

 

 

 

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

WHITE ELECTRONIC DESIGNS CORPORATION

 

 

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 Company and in the capacities and on the date indicated:

 

 

To the Shareholders and Board of Directors of

White Electronic Designs Corporation

 

We have audited the accompanying consolidated balance sheets of White Electronic Designs Corporation and subsidiaries (collectively, the “Company”) as of September 30, 2009 and September 27, 2008, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended September 30, 2009. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). We also have audited the Company’s internal control over financial reporting as of September 30, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express an opinion on these financial statements and financial statement schedule and an opinion on the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of White Electronic Designs Corporation and subsidiaries as of September 30, 2009 and September 27, 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

In our opinion, White Electronic Designs Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of September 30, 2009, based on criteria established in Internal Control — Integrated Framework issued by COSO.

 

Phoenix, Arizona

December 11, 2009

WHITE ELECTRONIC DESIGNS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

 

The accompanying notes are an integral part of these consolidated financial statements.

WHITE ELECTRONIC DESIGNS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

The accompanying notes are an integral part of these consolidated financial statements.

WHITE ELECTRONIC DESIGNS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY