Protect and Direct
– Net sales for the Protect and Direct segment for the first quarter of fiscal 2010 increased 2% to $20,472,000 from $19,982,000 for the first quarter last year with increases in domestic sales offsetting decreased international sales. Increased sales of permanent crash cushions, truck-mounted attenuators, parts and barrels offset decreased sales of delineators, Triton barrier products and ABC
terminals.
Inform
– Net sales for the Inform segment for the first quarter of fiscal 2010 increased 24%, or $1,233,000, to $6,390,000 from $5,157,000 for the first quarter last year. The increase in sales in the current first quarter compared to the first quarter of fiscal 2009 was due to volume increases across most major product lines.
Gross Profit Margin
Our gross profit margin for the first quarter of fiscal 2010 was 34.3% compared to 32.8% for the first quarter last year. The gross margin for the Protect and Direct segment increased primarily due to favorable product sales mix with increased sales of permanent crash cushions, which have higher gross margins, and decreased sales of ABC terminals, which have lower gross margins than some other product lines. The gross margin for the Inform segment
decreased slightly as volume efficiencies were offset by unfavorable product sales mix with increased sales of weather sensing products which have lower gross margins than some other product lines.
Selling and Administrative Expenses
Selling and administrative expenses for the first quarter of fiscal 2010 increased $289,000, or 5%, to $6,263,000 from $5,974,000 for the first quarter last year. Decreased selling and administrative expenses related to headcount reductions and other cost-savings initiatives were largely offset by $300,000 in expenses related to the shut-down of our China facility and increased costs associated with the increased sales level compared to last year.
Selling and administrative expenses decreased as a percentage of sales to 23.3% for the first quarter of 2010 from 23.8% in the prior year period.
Research and Development
Research and development expenditures for the first quarter of fiscal 2010 decreased $159,000, or 17%, to $763,000 from $922,000 for the same period last year due to decreases in both segments. We continue to focus our investment in research and development primarily in critical projects to support long term growth.
Severance Costs
We recorded $296,000 in severance costs in the first quarter of fiscal 2010 related to headcount reductions in the Protect and Direct segment.
Operating Profit
Operating profit for the first quarter of fiscal 2010 was $1,884,000, compared to operating profit of $1,342,000 for the first quarter of fiscal 2009. For the first quarter of fiscal 2010, operating profit for the Protect and Direct segment was $2,836,000, compared to operating profit of $2,372,000 in the same period last year, primarily due to the higher sales volume and favorable product sales mix, offset somewhat by severance costs and higher bad
debt expense. Operating profit for the Inform segment was $521,000 compared to operating profit of $420,000 for the first quarter of last year, primarily due to the higher sales volume.
19
Interest Expense
Interest expense for the first quarter of fiscal 2010 decreased $44,000, or 5% to $873,000 from $917,000 for the first quarter last year, primarily due to the lower level of revolving debt outstanding. The interest rate on our bank facility is based on LIBOR or the British Bankers Association LIBOR, plus a margin. Our overall weighted average interest rate was 6.7% as of September 30, 2009, primarily due to the 7% interest rate on our $40,000,000
in convertible debt.
Income Tax Provision
The income tax provision for the first quarter of fiscal 2010 was $384,000 representing a 38% effective income tax rate. The income tax provision for the first quarter of fiscal 2009 was $162,000, representing a 38% effective income tax rate.
Earnings from Continuing Operations
Earnings from continuing operations for the first quarter of fiscal 2010 were $627,000, or $0.07 per diluted share, compared to earnings from continuing operations of $263,000, or $0.03 per diluted share, for the first quarter last year.
Loss from Discontinued Operations, Net of Income Taxes
The loss from discontinued operations, net of income taxes, for the first quarter of fiscal 2009 was $758,000, or $0.08 per diluted share. Included in the loss was a $712,000 loss on the sale of the Intersection Control segment.
Net Earnings (Loss)
Net earnings for the first quarter of fiscal 2010 were $627,000, or $0.07 per diluted share, compared to a net loss of $495,000, or $0.05 per diluted share, for the first quarter last year.
FINANCIAL CONDITION
Liquidity and Capital Resources
Our principal sources of cash historically have been cash flows from operations and borrowings from banks and other sources. We had cash and cash equivalents of $7,526,000 as of September 30, 2009. As of September 30, 2009, we had $5,000,000 outstanding against our bank credit facility and $40,000,000 outstanding in 7% Convertible Senior Subordinated Notes due February 2025 (the “Convertible Notes”).
Our current secured bank credit agreement with our senior bank (the “Credit Agreement”) provides for a $5 million revolving credit facility and includes both fixed and floating interest rate options, at LIBOR or the British Bankers Association LIBOR rate, plus a margin. The Credit Agreement also contains affirmative and negative covenants including requirements that we meet certain consolidated financial criteria. The covenants also
limit the incurrence of additional indebtedness, acquisitions, liens and encumbrances and other matters customarily restricted in such agreements.
20
After several waivers and amendments to our Credit Agreement during fiscal 2009, we were in compliance with financial covenants as of June 30, 2009 and as of September 30, 2009. On October 23, 2009 we entered into an amended bank credit agreement which reduced the amount of the revolver commitment from $15 million to $5 million, changed the expiration date from November 1, 2009 to January 31, 2010 and added two financial covenants including minimum
EBITDA and a fixed charge coverage ratio. Although the amount of the facility was reduced, we believe that this facility, along with cash currently on hand and cash expected to be generated in the next several months, will give us sufficient liquidity through that period.
We expect to be in compliance with the covenants of our Credit Agreement, as amended, through the term of the Agreement. However, our ability to remain in compliance with the covenants and to modify our capital structure is dependent upon our future performance and may be affected in part by events beyond our control, including the current economic downturn. Reduced cash flows from operations, regardless of cause, may make it more difficult to comply
with our bank covenants and to obtain an extension of our Credit Agreement. Continuing uncertainty in the credit markets may affect our ability to access those markets and may increase costs associated with borrowing and issuing debt instruments. However, we are currently generating positive cash flow in fiscal 2010 and we expect we may continue to do so throughout the fiscal year.
The holders of our $40,000,000 of 7% Senior Subordinated Convertible Notes may require us to repurchase the Notes in February 2010, which we expect they will do. Beginning in the third quarter of fiscal 2009, we implemented a series of cost control measures to improve our financial performance by eliminating approximately $4 million from our annualized cost structure. These costs include approximately $2,000,000 in salaries and related benefits through
the reduction of 42 domestic employees in our Protect and Direct segment; $900,000 in salaries and related benefits through the reduction of 11 domestic employees in our Inform segment; $400,000 in costs including salaries and related benefits through the reduction of 15 employees in connection with closing our Protect and Direct facility in China; and $700,000 by renegotiating service agreements and reducing discretionary spending. We have also suspended our semi-annual dividend to
conserve cash which will save approximately an additional $4 million in cash annually. We are restricting capital expenditures to those items critical to the effectiveness of our operations and plan to reduce capital expenditures from $3.4 million in fiscal 2009 to $2 million in fiscal 2010. We are currently generating positive operating cash flow in fiscal 2010 and we expect to continue to do so throughout the fiscal year, but our existing cash balances and the cash we expect to
generate from operations in fiscal 2010 will not be sufficient to pay the principal amount of those Notes in fiscal 2010. We believe that the credit markets are improving and we are working with advisors to explore financing alternatives, including issuing other debt or equity and the sale of certain product lines which may include the sale of a segment of our business. We, along with our advisors, believe we have the alternatives available to us to achieve a satisfactory result for the
Company.
There is no assurance that we will be able to refinance this debt on a timely basis and on satisfactory terms, if at all. Refinancing the Notes through the issuance of new debt or equity may significantly dilute our shareholders. If we are unable to refinance the debt and the holders of the Notes demand payment in February 2010, it would have a material adverse effect on the Company’s business, liquidity and financial position. We may elect to
seek protection from our creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy.
Although the variable interest rates under our revolving credit facility have been volatile due to the current credit environment, the financial effect on us has not been significant as the amount outstanding against the facility was only $5,000,000 as of September 30, 2009. Currently, we do not believe that our operating cash flow needs will require us to significantly increase our bank borrowings in the near term. Our $40 million of 7 % Convertible
Notes accounted for the majority of our $45.0 million in outstanding debt as of September 30, 2009.
21
There are currently no default interest provisions in connection with a default on our Credit Agreement. The provisions of our Credit Agreement and Convertible Notes each include cross-default provisions such that a default on any individual payment obligation greater than $5 million is a default under both agreements.
Our outstanding borrowings were $45,000,000, or 56.4% of total capitalization, as of September 30, 2009, of which $5,000,000 was outstanding against our bank credit facility. This compares to outstanding borrowings of $41,000,000, or 54.5% of total capitalization, as of June 30, 2009. Included in current debt as of September 30, 2009 and June 30, 2009 was the $40 million of Convertible Notes. The amount of standby letters of credit outstanding was
$920,250 as of September 30, 2009 and $1,120,000 as of June 30, 2009.
Cash Flows
Cash flows provided by continuing operations were $3,866,000 during the first three months of fiscal 2010 compared with $332,000 provided by continuing operations in the first three months of fiscal 2009. For the first three months of fiscal 2010, earnings from continuing operations were $627,000, net of income taxes compared to $263,000, net of income taxes for the first three months of fiscal 2009. Non-cash depreciation and amortization were $860,000
for the current period compared to $969,000 for the year ago period. The increase in cash provided by operations was primarily due to increased cash provided by decreased working capital in the first quarter of fiscal 2010. Decreased working capital provided $1,903,000 in cash, primarily representing decreased inventories and increased accounts payables due to our focus on increasing cash flow. This compares to a decrease in cash due to increased working capital of $1,139,000 for the
first quarter of fiscal 2009.
Cash used in discontinued operations was $1,545,000 during the first three months of fiscal 2009 and primarily representing increased working capital including increased inventory and decreased accounts payable.
Investing activities of continuing operations used cash of $438,000 during the first three months of fiscal 2010, compared to $19,566,000 provided in the first three months of the prior year. Proceeds from the sale of the Intersection Control segment provided cash of $20 million in the first quarter of fiscal 2009. Expenditures during the first three months of fiscal 2010 included $418,000 for capital expenditures compared with $411,000 for the first
three months last year as we continue to manage our capital spending in this difficult environment.
Financing activities provided cash of $4,000,000 during the first three months of fiscal 2010, compared with $18,529,000 of cash used during the first three months of fiscal 2009. The $20 million in proceeds from the sale of the Intersection Control segment was used to pay down substantially all of our bank debt in the first quarter of fiscal 2009. During the first three months of fiscal 2010, we borrowed $4,000,000 against our outstanding revolving
credit facility. The payment of our semi-annual cash dividend used cash of $1,829,000 in the first quarter of fiscal 2009. Our decision made in fiscal 2009 to suspend payment of the semi-annual dividend will save nearly $4 million in annual cash expenditures.
22
For 2010, we anticipate spending approximately $2,000,000 in cash for capital expenditures as we manage our capital spending in this difficult environment. We currently believe that future operating and capital cash needs will be financed either through cash on-hand, cash generated from operations, cash obtained under our Credit Agreement, cash from proceeds resulting from the sale of assets or cash from other financing alternatives. We currently
believe that these sources of cash should be sufficient for all planned operating and capital requirements in the near term. However, our current Credit Agreement expires at the end of January 2010. In addition, the holders of our $40,000,000 of 7% Senior Subordinated Convertible Notes may require us to repurchase the Notes in February 2010, which we expect they will do. We have implemented a series of cost control measures to improve our financial performance and also have suspended
our semi-annual dividend and reduced capital expenditures to conserve cash. We believe that the credit markets are improving and we are working with an advisor to explore other financing alternatives. However, there is no assurance that we will be able to refinance this debt on a timely basis and on satisfactory terms, if at all. See Liquidity and Capital Resources, above and Note 2 to the Consolidated Financial Statements for additional information.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
We are subject to certain debt obligations, guarantees, commitments and contingent liabilities further described in our Annual Report on Form 10-K for the year ended June 30, 2009. The following table presents our contractual obligations to make future payments under contracts, such as debt and lease agreements, as of September 30, 2009:
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Less than
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More than
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Total
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|
1 Year
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|
1-3 Years
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|
3-5 Years
|
|
5 Years
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|
|
|
|
|
|
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|
|
|
|
|
|
|
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|
|
|
|
|
|
|
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|
|
|
|
|
|
Long-term debt (1)
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|
$
|
45,000,000
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|
$
|
45,000,000
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|
|
|
|
|
|
|
|
|
|
Estimated interest payments (2)
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|
|
1,777,000
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|
|
1,777,000
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|
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
4,991,000
|
|
|
915,000
|
|
$
|
1,713,000
|
|
$
|
2,215,000
|
|
$
|
148,000
|
|
Minimum royalty payments
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|
|
1,110,000
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|
|
510,000
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|
|
600,000
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|
|
|
|
|
|
|
Uncertain tax benefits
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|
|
183,000
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|
|
72,000
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|
|
111,000
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|
|
|
|
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Purchase obligations (3)
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|
|
1,156,000
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|
|
1,156,000
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Total
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$
|
54,217,000
|
|
$
|
49,430,000
|
|
$
|
2,424,000
|
|
$
|
2,215,000
|
|
$
|
148,000
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|
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(1)
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Amount includes expected cash payments on long-term debt based upon current and effective maturities. Amount does not include renewals relating to refinancing of long-term debt currently outstanding as future terms are unknown at this time and difficult to estimate.
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(2)
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Amount includes estimated interest payments based on interest rates as of the current period. Interest rates on variable-rate debt are subject to change in the future. Interest is estimated based upon current and effective maturities of long-term debt currently outstanding and does not include an estimate of future interest payments relating to refinancing of long-term debt per (1) above. Cash paid for interest was $3,519,000 in fiscal 2009
and we currently expect cash for interest to be approximately that amount or higher in fiscal 2010.
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(3)
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Purchase obligations include non-cancellable orders with suppliers in the normal course of business on a short-term basis.
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As disclosed in the footnotes to the consolidated financial statements, we have entered into bid and performance related bonds associated with various contracts. Potential payments due under these bonds are related to our performance under certain contracts. The total amount of bid and performance related bonds that were available and undrawn as of September 30, 2009 was $737,000. We also have standby letters of credit covering potential workers’
compensation liabilities and other liabilities. The total standby exposure relating to letters of credit as of September 30, 2009 was $920,000. Subsequent to September 30, 2009 we obtained an additional letter of credit in the amount of $150,000.
23
FUTURE OUTLOOK
Looking forward, we remain cautious given the continued weak global economic conditions and the difficult financial markets. This unfavorable market environment may negatively affect demand for our products indefinitely.
The United States domestic market for highway and transportation safety products is directly affected by federal, state, and local governmental policies. Historically, federal funds have been allocated and highway policy has been developed through six-year federal highway authorization bills. The federal highway authorization law, the Safe, Accountable, Flexible and Efficient Transportation Equity Act-A Legacy for Users, or SAFETEA-LU, expired September
30, 2009, but was extended through December 18, 2009. We anticipate further delays in the enactment of a new highway authorization bill with additional extensions for limited times (perhaps 1, 3, 6 or 12 months) at current funding levels.
While uncertainty in funding for our markets continues, we are encouraged by a turnaround to profitability in our fourth quarter of fiscal 2009 as well as our continued performance in the first quarter of fiscal 2010. We continue to believe that our business will gain strength if the federal funding issue is resolved. We anticipate that our fiscal 2010 results will continue to benefit from the federal funding for transportation projects, enacted as part
of the American Recovery and Reinvestment Act, which includes approximately $27 billion in stimulus funding for highways and bridges. However, we believe that this one-time spending package cannot substitute for enactment of the multi-year highway authorization legislation and the long term funding of the highway trust fund. Until a new multi-year highway authorization bill becomes law, the transportation safety allotment in federal and state budgets may be uncertain and we believe that
prolonged uncertainty may adversely impact sales of our products and our financial performance in fiscal 2010. In addition, state budgetary constraints and deficit issues are expected to continue into fiscal 2010, which will negatively impact our performance in fiscal 2010.
Although we expect business to slow down in the fiscal 2010 second quarter, due to seasonality, we anticipate that our second quarter will be improved over last year’s second quarter. We believe that domestic demand for our products is uncertain due to the domestic funding issues and economic environment. We believe we will continue to see growth in international sales. We believe that we have strong market share positions, brand name recognition
and a talented employee base and that we are well positioned with our leaner cost structure. However it is difficult to predict to what extent we will see increased spending for our products and there can be no assurance that either domestic or international sales will increase.
Our fiscal 2010 operating outlook will be affected by our ability to refinance our 7% Convertible Senior Subordinated Notes as well as our ability to extend or refinance our senior bank debt on terms attractive to us. See Liquidity and Capital Resources, above and Note 2 to the Consolidated Financial Statements for additional information.
24
SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. Management’s estimates also affect the reported amounts of revenues and expenses during the
reporting period. In addition, certain normal and recurring estimates are made, including estimates in determining the allowance for doubtful accounts receivable, inventory valuation reserves, valuation allowance on deferred tax assets and health care liabilities. These estimates are made using management’s best judgment given relevant factors and available data. Actual results could differ materially from those estimates. Note 2 to our June 30, 2009 consolidated financial
statements includes a summary of the significant accounting policies, methods and estimates used in the preparation of our consolidated financial statements. There have been no material changes in accounting policies, methods and estimates used by management during this fiscal year except for the adoption of accounting guidance as described in Note 1 in the Notes to Consolidated Financial Statements. In most instances, we must use an accounting policy or method because it is the only
policy or method permitted under U.S. GAAP. We are providing updated information for the following significant accounting policies:
LONG-LIVED ASSETS: Long-lived assets include such items as goodwill, patents, product rights, other intangible assets and property, plant and equipment. For purposes of evaluating the recoverability of long-lived assets, we assess the possibility of obsolescence, demand, new technology, competition, and other pertinent economic factors and trends that may have an impact on the value or remaining lives of these assets. In performing our impairment
assessments, we first assess our indefinite-lived intangibles; second, assess our amortized long-lived assets (including amortized intangible assets and property, plant and equipment); and third, assess our goodwill. Additionally, we reassess the remaining useful lives of our amortized long-lived assets.
Amortized long-lived assets (including amortized intangible assets and property, plant and equipment) held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in relation to future undiscounted cash flows of underlying asset groups. The net carrying value of assets not recoverable is reduced to fair value. Fair values of amortized long-lived assets
are determined based upon the performance of a fair value appraisal. Patents and other finite-lived intangible assets are amortized on a straight-line or systematic method over the life of the patent or intangible asset.
Goodwill and other indefinite-lived intangible assets are tested for impairment annually or when a triggering event occurs. The indefinite-lived intangible asset impairment test is performed by comparing the fair value of the intangible asset to its carrying value in a one-step analysis. If the fair value of the intangible asset is less than its carrying value, the intangible asset is written down to its fair value. The goodwill impairment test is
performed at the reporting unit level and is a two-step analysis. First, the fair value of the reporting unit is compared to its book value. If the fair value of the reporting unit is less than its book value, we perform a hypothetical purchase price allocation based on the reporting unit’s fair value to determine the implied fair value of the reporting unit’s goodwill. If the implied fair value of the goodwill is less than its carrying value, the goodwill is written down to
its implied fair value. Fair values are determined using discounted cash flow methodologies.
We performed the first step of the goodwill impairment test for our two reporting units, which represent our two financial reporting segments, in the third quarter of fiscal 2009 and determined that the carrying value of our Inform segment exceeded its fair value, indicating that goodwill of that segment was impaired. Having determined that the Inform segment goodwill was impaired, we then performed the second step of the goodwill impairment test which
involved calculating the implied fair value of goodwill by allocating the fair value of the segment to all of its assets and liabilities other than goodwill and comparing the residual amount to the carrying value of goodwill. Based upon that test, we determined that the entire amount of the Inform segment goodwill was impaired and we recorded a goodwill impairment charge in the Inform segment of $9,246,000, or $6,877,000 net of income tax benefits, in the third quarter of fiscal 2009.
Our annual impairment review did not indicate that our assets were impaired as of June 30, 2009. In performing the first step of the goodwill impairment test for the Protect and Direct segment, we determined that the fair value of that segment was substantially in excess of its carrying value as of March 31, 2009 and June 30, 2009. We also evaluated intangible assets and other long-lived assets for impairment and determined that their fair value was substantially in excess of their
carrying value as of March 31, 2009 and June 30, 2009. There was no impairment charge recorded in the Protect and Direct segment during fiscal 2009 due to the relatively low level of long-lived assets within the segment as compared to the Inform segment with a higher relative level of long-lived assets.
25
The impairment review is highly judgmental and involves the use of significant estimates and assumptions. These estimates and assumptions have a significant impact on the amount of any impairment charge recorded. Estimates of fair value are primarily determined using discounted cash flow methods and are dependent upon assumptions of future sales trends, market conditions and cash flows of each reporting unit over several years. Actual cash flows in the
future may differ significantly from those previously forecasted. Other significant assumptions include growth rates and the discount rate applicable to future cash flows. Our stock price is also a factor impacting the assessment of the fair value of our underlying reporting segment for purposes of performing a goodwill impairment assessment. Our stock price can be affected by, among other things, the relatively small public float of our stock, quarterly fluctuations in our operating
results, and changes in estimates of our future earnings.
If either of our segments records significantly lower than expected operating profits in interim periods during fiscal 2010, or if we experience changes in expectations related to the extent and duration of the economic downturn and its impact on the operating results of our segments, or if our market capitalization falls below our carrying value for a sustained period, we may need to perform an interim impairment test. The amount of an impairment loss
could be up to the total amounts of goodwill and intangible assets recorded as of September 30, 2009 of $8,139,000 and $1,910,000, respectively.
INCOME TAXES: We recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. In assessing
the realizability of the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. To the extent that any future tax benefits are not expected to be fully realized, such future tax benefits are reduced by a valuation allowance. Realization of deferred tax assets assumes that we will be able to generate sufficient future taxable income so that the assets will be realized. The factors that we
consider in assessing the likelihood of realization include the forecast of future taxable income, available tax planning strategies that could be implemented to realize the deferred tax assets as well as certain federal and state laws that impose restrictions on the utilization of net operating loss and tax credit carryforwards. During the first quarter of fiscal 2010, we performed an Internal Revenue Code Section 382 analysis with respect to our net operating loss and credit
carryforwards and determined that there was currently no such limitation. We are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities, and currently our income tax returns for tax years 2007 and 2008 are under investigation by the Internal Revenue Service. Although we assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes, there is no assurance that
such determinations by us are in fact adequate. Changes in our effective tax rates or amounts assessed upon examination of our tax returns may have a material adverse impact on our results and our financial condition. We currently expect the net deferred tax assets of $21,001,000 recorded as of September 30, 2009 to be fully realizable in part based upon expected future projected income and the significant length of time to utilize net operating losses.
RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 1 in the Notes to Consolidated Financial Statements.
26
FORWARD LOOKING STATEMENTS
Various statements made within the Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report constitute “forward-looking statements” for purposes of the SEC’s “safe harbor” provisions under the Private Securities Litigation Reform Act of 1995 and Rule 3b-6 under the Securities Exchange Act of 1934, as amended. Except for historical information, any statement
that addresses expectations or projections about the future, including statements about our strategy for growth, product development, market position, expenditures, financial results or changes in governmental legislation, policies and conditions, is a forward-looking statement.
Readers are cautioned not to place undue reliance on these forward-looking statements and that all forward-looking statements involve risks and uncertainties, including those detailed in our public filings with the SEC, news releases and other communications, which speak only as of the dates of those filings or communications. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of unanticipated events. There can be no assurance that actual results will not differ materially from our expectations. Factors which could cause materially different results include uncertainties related to continued weakening of the global economic conditions and the constricted financial markets; continued federal, state and municipal funding for highways and risks related to reductions in government expenditures;
market demand for our products; pricing and competitive factors, among others which are set forth in the “Risk Factors” of Part II, Item 1A, to this Report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Part I, Item 7.A. of our Annual Report on Form 10-K for the year ended June 30, 2009 presents information regarding Quantitative and Qualitative Disclosures about Market Risk.
We are exposed to market risk from fluctuations in interest rates on our revolving credit facility, and, to a limited extent, currency exchange rates. The majority of our debt is at a fixed interest rate. Given that our exposure to interest rate fluctuations is low, we currently believe that the use of derivative instruments in the form of non-trading interest rate swaps to manage the risk is not necessary.
Assets, liabilities and commitments that are to be settled in cash and are denominated in foreign currencies for transaction purposes are sensitive to changes in currency exchange rates. The U.S. dollar is the functional currency for substantially all of our operations. Accounts of foreign operations with functional currencies other than the U.S. dollar are translated into U.S. dollars using the year-end exchange rate for assets and liabilities and
average monthly rates for revenue and expense accounts. Net foreign exchange gains and losses resulting from foreign currency transactions included in net income were immaterial for the first quarter of fiscal 2010 and in fiscal year 2009. We will continue to evaluate the need for the use of derivative financial instruments to manage foreign currency exchange rate changes. In the next few years we may confront greater risks from currency exchange fluctuations as our business expands
internationally.
27
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required disclosures. The design of any system of disclosure controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any disclosure controls and procedures will succeed in achieving their stated goals under all potential future conditions.
Our management, under the supervision of and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of September 30, 2009.
(b) Changes in Internal Controls over Financial Reporting
There have been no changes in our internal controls over financial reporting that may have materially affected, or are likely to materially affect, our internal control over financial reporting. Our process for evaluating controls and procedures is continuous and encompasses review of the design and effectiveness of established controls and procedures and the remediation of any deficiencies which may be identified during this process.
28
PART II – OTHER INFORMATION
There is no information required to be reported under any items except as indicated below:
Item 1. Legal Proceedings
In January, 2008 we were served in a lawsuit entitled
Olga Mata, Individually as Representative of the Estate of Elpido Mata et al. vs. Energy Absorption Systems, Inc., Quixote Transportation Safety, Inc., William Brothers Construction, Keller Crash Cushions d/b/a Contractors Barricade Service, J.I.T. Distributing Inc. and Gustavo Reyes d/b/a Cerrito Trucking,
State of Texas, District Court of Brazoria County, No. 44361. This case involves a
tractor-trailer collision with a crash cushion. The plaintiffs allege various theories of liability against all defendants, including negligence, misrepresentations and breach of warranty. The case was tendered to our insurance carrier and we are subject to a $100,000 deductible. Pursuant to Texas law, we had accepted the defense and indemnity of our distributor who was also named in the complaint. On September 15, 2009 and prior to trial, the Court granted our Motions for Summary
Judgment against the plaintiffs and we and our distributor are now dismissed on all causes of action. Plaintiffs subsequently filed a Motion for Reconsideration and for New Trial which is pending. Plaintiffs had not pled specific damages in its complaint, but had demanded $3,600,000 in damages from the defendants prior to trial.
We are involved in several pending judicial proceedings for product liability and other damages arising out of the conduct of our business. While the outcome of litigation is subject to uncertainties, we believe, after consultation with counsel, that the outcome of these proceedings, based on current available information and after taking into account the availability and limits of our insurance coverage, will not have a material effect on our
consolidated financial condition and results of operations.
Item 1A. Risk Factors
There are many factors which are frequently beyond our control that pose material risks to our business, operating results and financial condition. The factors we believe are material to our business are listed below.
Our business could be adversely affected by reduced levels of cash, whether from operations or pursuant to the terms of our debt, as well as our ability to refinance our existing debt.
Reduced levels of cash generated from operations as well as our ability to refinance our existing debt could adversely impact our current business and our ability to grow.
Historically, our principal sources of cash have been cash flows from operations and borrowings from banks and other sources. Given continued weak global economic conditions, operations may continue to generate less cash than we need. Our current bank credit agreement expires in January 2010. There is no assurance that we will be able to negotiate a new bank credit agreement with satisfactory
terms and conditions on a timely basis.
In addition, the holders of our $40,000,000 of 7% Senior Subordinated Convertible Notes may, as of February 2010, require us to repurchase those Notes at 100% of the principal plus unpaid interest, and we expect that they will do so. Our existing cash balance and the cash we generate from operations will not be sufficient to pay the principal amount of these Notes. As further discussed in Note
2 to the Consolidated Financial Statements, we believe that the credit markets are improving and we are working with an advisor to explore financing alternatives. There is no assurance that we will be able to refinance this debt on a timely basis on satisfactory terms.
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Refinancing the Notes through the issuance of new debt or equity may significantly dilute our shareholders. If we are unable to refinance the debt and the holders of the Notes demand payment in February 2010, it would have a material adverse effect on the Company’s business, liquidity and financial position. We may elect to seek protection from our creditors by filing a voluntary petition
in bankruptcy or may be subject to an involuntary petition in bankruptcy.
A decrease or delay in federal government funding of transportation safety and highway construction and maintenance may cause our revenues, profits and cash flow to decrease.
Sales of our products are sensitive to foreign, domestic and regional economies in general, and in particular, changes in government infrastructure spending which can be adversely impacted by reduced tax revenues. We depend substantially on federal, state and local funding for transportation safety, highway construction and maintenance and other related infrastructure projects. Federal
government funding for infrastructure projects is usually accomplished through highway authorization bills, which establish funding over a multi-year period. The most recent highway authorization legislation, the SAFETEA-LU, expired September 30, 2009, but was extended through December 18, 2009. We anticipate further delays in the enactment of a new highway authorization bill with additional extensions for limited times (perhaps 1, 3, 6 or 12 months) at current funding levels. Even
after federal legislation is enacted, funding appropriations may be revised in future congressional sessions, and federal funding for infrastructure projects may be reduced in the future.
Federal transportation spending is funded through a highway trust fund which derives most of its money from gasoline tax revenue. When the price of gasoline increased in 2008, the number of miles driven decreased significantly which depleted the surplus in the federal highway trust fund. Reduced tax revenues and altered driving patterns may impact the solvency of the highway trust fund. Failure
to replenish the highway trust fund expeditiously may have an adverse impact on our sales and financial performance in fiscal 2010.
Congress enacted the American Recovery and Reinvestment Act in February 2009 which includes approximately $27 billion in stimulus funding for highway and bridge improvements, aimed at increasing jobs through infrastructure projects. We believe that the Federal stimulus funding has had a positive impact on our domestic sales, although we are not able to quantify the amount of the impact. There
is no assurance that this stimulus spending program will positively affect the demand for our products in fiscal 2010, or thereafter.
Constraints on state and local government budgets and decreases in state highway funding adversely affect our financial performance.
States and municipalities may continue to reduce spending on highways due to reduced tax revenues and other budget constraints and priorities. Loss of tax revenues and such budgetary constraints adversely affect the ability of states to fund transportation, highway and infrastructure projects, and therefore reduce the demand for our products. Municipalities also suffer from budget constraints
that can reduce transportation safety spending.
Like the federal highway trust fund which depends on gasoline tax revenue, state highway funds also are dependent on revenue from state gasoline taxes. A number of states also contribute a portion of their sales tax on new car purchases into their state highway funds. A decrease in miles driven or new car sales may adversely affect the ability of states to fund transportation projects, and
correspondingly, reduce the demand for our products. The majority of states have been experiencing budgetary constraints and deficits which are expected to continue into fiscal 2010.
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Global economic conditions, as well as difficulties in managing and expanding in international markets, could affect future growth in these markets.
In fiscal year 2009, international sales were $25,938,000 or 28%, of our total sales and we believe international markets are an important source of our growth. We plan to continue to increase our presence in these markets. However, the current deterioration of the global economy has had an adverse impact on our international sales, and we anticipate, will continue to adversely affect our
international sales, as foreign governments reduce spending for transportation and infrastructure projects.
In connection with an increase in international sales efforts, we need to hire, train and retain qualified personnel in countries where language, cultural or regulatory barriers may exist. Moreover, funding and government requirements vary by country with respect to transportation safety. In a number of countries there are no governmental requirements or funding for transportation safety and we
must educate officials and demonstrate the need for and the benefits of our products. In addition, our international revenues are subject to the following risks:
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fluctuating currency exchange rates could reduce the demand for or profitability of foreign sales by affecting the pricing of our products;
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the burden of complying with a wide variety of foreign laws and regulations, including the requirements for additional testing of our products;
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dependence on foreign sales agents;
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difficulty collecting foreign receivables,
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political and economic instability of foreign governments; and
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imposition of protective legislation such as import or export barriers.
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We are in a competitive marketplace.
To the extent one or more of our current or future competitors introduce products that better address customer requirements, or are less expensive than our products, our business can be adversely affected and we may be unable to maintain our leadership position in certain product lines. Competition may adversely affect the selling prices and the profit margins on our products. If we are unable
to timely develop and introduce new products, or enhance existing products, or reduce costs in response to changing market conditions or customer requirements or demands, our business and results of operations could be materially and adversely affected.
We hold numerous patents covering technology and applications related to many of our products and systems, and numerous trademarks and trade names registered with the U.S. Patent and Trademark Office and in foreign countries. Our existing and future patents and trademarks may not adequately protect us against infringements, especially in certain foreign countries, and pending patent or
trademark applications may not result in issued patents or trademarks. Our patents, registered trademarks and patent applications may not be upheld if challenged, and competitors may develop similar or superior methods or products outside the protection of our patents. This could increase competition for our products and materially decrease our revenues. If our products are deemed to infringe the patents or proprietary rights of others, we could be required to modify the design of our
products, change the name of our products or obtain a license for the use of some of the technologies used in our products. We may be unable to do any of the foregoing in a timely manner, upon acceptable terms and conditions, or at all, and the failure to do so could cause us to incur additional costs or lose expected revenue.
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We have been affected by increased prices for certain commodities, particularly steel, aluminum and resin, which are a significant component of the cost of certain of our products. Such price increases negatively impact our gross margin for certain products, when we are unable to pass along to our customers cost increases. Increasing fuel and freight costs may also adversely affect our
performance.
Management’s estimates and assumptions affect reported amounts of expenses and changes in those estimates could impact operating results.
Goodwill and other indefinite-lived intangible assets are tested for impairment at least annually, and the results of such testing may adversely affect our financial results. We recorded a goodwill impairment charge of $9,246,000 in the Inform segment in the third quarter of fiscal 2009. We use a variety of valuation techniques in determining fair value. The impairment review is highly
judgmental and involves the use of significant estimates and assumptions. These estimates and assumptions have a significant impact on the amount of any impairment charge recorded. Estimates of fair value are primarily determined using discounted cash flow methods and are dependent upon assumptions of future sales trends, market conditions and cash flows of each reporting unit over several years. Actual cash flows in the future may differ significantly from those previously forecasted.
Other significant assumptions include growth rates and the discount rate applicable to future cash flows. Our stock price is also a factor impacting the assessment of the fair value of our underlying reporting segment for purposes of performing a goodwill impairment assessment. Our stock price can be affected by, among other things, the relatively small public float of our stock, quarterly fluctuations in our operating results, and changes in estimates of our future earnings. Actual
results may differ significantly from the estimates and assumptions used.
We recognize deferred tax assets and liabilities for the expected future tax consequences of events which are included in the financial statements or tax returns. In assessing the realizability of the deferred tax assets, management makes certain assumptions about whether the deferred tax assets will be realized. Realization of deferred tax assets assumes that we will be able to generate
sufficient future taxable income so that the assets will be realized. The factors that we consider in assessing the likelihood of realization include the forecast of future taxable income, available tax planning strategies that could be implemented to realize the deferred tax assets as well as certain federal and state laws that impose restrictions on the utilization of net operating loss and tax credit carryforwards. During the first quarter of fiscal 2010, we performed Internal
Revenue Code Section 382 analyses with respect to our net operating loss and credit carryforwards and determined that there was currently no such limitation. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. Although we assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes, there is no assurance that such determinations by us
are in fact adequate. Changes in our effective tax rates or amounts assessed upon examination of our tax returns may have a material adverse impact on our results and our financial condition. We currently expect the net deferred tax assets of $21,001,000 recorded as of September 30, 2009 to be fully realizable in part based upon expected future projected income and the significant length of time to utilize net operating losses. However, changes in expectations related to the extent and
duration of the economic downturn and its impact on our operating results as well as a subsequent change in ownership which may limit the utilization of net operating losses and tax credit carryforwards could cause us to further review the realizability of our deferred tax assets. It is possible that the review would result in an increased valuation allowance, increasing income tax expense, which would adversely affect our net income.
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Item 1B. Unresolved Staff Comments
We received a comment letter from the Securities and Exchange Commission (the “SEC”) Division of Corporation Finance dated October 27, 2009 regarding our Annual Report on Form 10-K for the fiscal year ended June 30, 2009 and our Definitive Proxy Statement on Schedule 14A filed on October 13, 2009. These comments are considered unresolved as of November 9, 2009 because our response back to the SEC was not yet due. However, we have
incorporated into this filing additional disclosures that we believe are responsive to many of the SEC’s comments.
Item 6. Exhibits
(a) Exhibits
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10.1
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Amended and Restated Credit Agreement dated as of April 20, 2005 among Quixote Corporation as the borrower (the “Borrower”) and LaSalle Bank National Association as lender (the “Lender”); Revolving Loan Note dated April 20, 2005 from Borrower to the Lender; and the following additional auxiliary documents all dated as of April 20, 2005: Reaffirmation and Amendment of California Deed of Trust between Energy Absorption
Systems, Inc. and Lender; Reaffirmation and Amendment of Pennsylvania Mortgage between Nu-Metrics, Inc. and Lender; Reaffirmation and Amendment of Alabama Mortgage between Energy Absorption Systems (AL) LLC and Lender; Reaffirmation and Amendment of Security Agreement in favor of the Lender by certain identified subsidiaries of the Borrower; Reaffirmation and Amendment of Trademark Security Agreement in favor of Lender by Energy Absorption Systems, Inc.; Reaffirmation and
Amendment of Patent Security Agreement in favor of Lender by Energy Absorption Systems, Inc.; and Reaffirmation and Amendment of Subsidiary Stock Pledge Agreements in favor of Lender by the Company, Quixote Transportation Safety, Inc., TranSafe Corporation and Energy Absorption Systems, Inc. filed herewith.
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10.2
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Amended and Restated Schedules to Amended and Restated Credit Agreement dated as of October 23, 2009, filed herewith.
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10.3
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Seventh Amendment to Amended and Restated Credit Agreement and Reaffirmation of Guaranties and Third Amended and Restated Revolving Loan Note, both dated as of October 23, 2009, filed herewith.
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Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 to be signed on its behalf by the undersigned thereunto duly authorized.
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QUIXOTE CORPORATION
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DATED: November 9, 2009
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/s/ Daniel P. Gorey
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Daniel P. Gorey
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Chief Financial Officer,
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Executive Vice President and Treasurer
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(Chief Financial & Accounting Officer)
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EXHIBIT INDEX
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Exhibits:
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10.1
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Amended and Restated Credit Agreement dated as of April 20, 2005 among Quixote Corporation as the borrower (the “Borrower”) and LaSalle Bank National Association as lender (the “Lender”); Revolving Loan Note dated April 20, 2005 from Borrower to the Lender; and the following additional auxiliary documents all dated as of April 20, 2005: Reaffirmation and Amendment of California Deed of Trust between Energy Absorption
Systems, Inc. and Lender; Reaffirmation and Amendment of Pennsylvania Mortgage between Nu-Metrics, Inc. and Lender; Reaffirmation and Amendment of Alabama Mortgage between Energy Absorption Systems (AL) LLC and Lender; Reaffirmation and Amendment of Security Agreement in favor of the Lender by certain identified subsidiaries of the Borrower; Reaffirmation and Amendment of Trademark Security Agreement in favor of Lender by Energy Absorption Systems, Inc.; Reaffirmation and
Amendment of Patent Security Agreement in favor of Lender by Energy Absorption Systems, Inc.; and Reaffirmation and Amendment of Subsidiary Stock Pledge Agreements in favor of Lender by the Company, Quixote Transportation Safety, Inc., TranSafe Corporation and Energy Absorption Systems, Inc. filed herewith.
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10.2
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Amended and Restated Schedules to Amended and Restated Credit Agreement dated as of October 23, 2009, filed herewith.
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10.3
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Seventh Amendment to Amended and Restated Credit Agreement and Reaffirmation of Guaranties and Third Amended and Restated Revolving Loan Note, both dated as of October 23, 2009, filed herewith.
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Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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