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The following is an excerpt from a 10-Q SEC Filing, filed by MACKIE DESIGNS INC on 5/14/1998.
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LOUD TECHNOLOGIES INC - 10-Q - 19980514 - MANAGEMENT_ANALYSIS

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

The following information contains certain forward-looking statements that anticipate future trends or events. These statements are based on certain assumptions that may prove to be erroneous and are subject to certain risks including, but not limited to, the Company's ability to introduce new products, the concentration of the Company's current products in a relatively narrow segment of the professional audio market, technological change and increased competition in the industry, the Company's ability to manage its rapid growth, its limited protection of technology and trademarks, various factors that impact the Company's international operations including economic conditions in various countries, custom and tariff regulations, currency fluctuations and lower gross margins, the Company's dependence on a limited number of suppliers and on its network of representatives and distributors, and its dependence on certain key personnel within the Company. Accordingly, actual results may differ, possibly materially, from the predictions contained herein.

The Company derives its operating revenue from worldwide sales of audio mixers and other professional audio equipment. Sales outside the U.S. account for a significant portion of the Company's total sales. International sales volumes have historically been affected by foreign currency fluctuations relative to the U.S. dollar. The Company prices its products in U.S. dollars worldwide. When weaknesses of local currencies have made the Company's products more expensive, sales to those countries have declined.

The Company's gross margins are also affected by its international sales. Typically, gross margins from exported products are lower than from those sold in the U.S. due to discounts offered to the Company's international distributors. These discounts are given because the international distributor typically incurs certain expenses, including technical support, product service and in-country advertising, that the Company normally incurs for domestic sales. The Company offered its international distributors a weighted average discount of approximately 8.1% in 1995, 12.7% in 1996, 14.8% in 1997, and 14.9% in the first three months of 1998. The increase in discounts is attributable to the fact that the Company increased its discounts to international distributors after it terminated the services of its exclusive representative for sales to international distributors in 1995 and began supervising international marketing and sales internally. The increase in discounts in 1997 and the first three months of 1998 is also attributable to additional discounts offered on certain products. In conjunction with the increase in discounts, the Company also eliminated the commissions it was paying to its international representative. While the Company has eliminated these commissions, the Company has incurred and will continue to incur additional expenses associated with managing the international marketing and sales of its products. Sales outside the U.S. represented approximately 34%, 38%, 38%, and 25% of the Company's net sales in 1995, 1996, 1997 and the first three months of 1998, respectively.

The Company's gross margins are also affected by the purchase of some components abroad. As a result of fluctuations in the value of local currencies relative to the U.S. dollar, some of the Company's international component suppliers have increased prices and may further increase prices. The Company currently does not employ any foreign exchange hedging strategies, but may employ such strategies in the future.

The Company's gross margins have fluctuated from time to time due primarily to inefficiencies related to the introduction and manufacturing of new products and inefficiencies associated with integrating new equipment into the Company's manufacturing processes. Historically, fluctuations have also resulted from increases in overhead associated with each of the Company's several relocations, varying prices of components and competitive pressures.

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The Company plans to introduce new products and product revisions at a more rapid rate than it has in the past. Some anticipated new products will require the implementation of manufacturing practices with which the Company is not familiar. This could result in lower margins as the Company becomes more familiar with new manufacturing procedures.

RESULTS OF OPERATIONS

QUARTER ENDED MARCH 31, 1998 AS COMPARED WITH QUARTER ENDED MARCH 31, 1997

Net sales increased 3.3% to $17.4 million in the first quarter of 1998 from $16.8 million in the first quarter of 1997. The increase in sales was primarily attributable to sales from products introduced in the last twelve months (the HR824 active studio monitor and the HUI-Registered Trademark- digital audio workstation controller), partially offset by a decrease in sales of certain other product lines. Sales outside the United States decreased to 25% of the Company's total net sales in the first quarter of 1998 from 41% in the first quarter of 1997. This decrease was primarily due to economic conditions and competitive pressures in certain parts of the world.

Gross margin increased to 39.4% in the first quarter of 1998 from 38.1% in the first quarter of 1997. The gross margin percentage increased due to a decrease in the percentage of sales from outside the United States which caused a decrease in the discounts offered to international distributors. Additionally, the increase in gross margin percentage was due to improved manufacturing efficiencies when compared with the first quarter of 1997.

Marketing and sales expenses increased to $2.6 million in the first quarter of 1998 from $2.3 million in the corresponding period of 1997. This increase was due primarily to increased marketing and sales staff, and increases in other various expenses. As a percentage of net sales, marketing and sales expenses increased to 15.0% in the first quarter of 1998 from 13.8% in the corresponding period of 1997.

Administrative expenses increased to $1.6 million for the first quarter of 1998 from $1.1 million for the corresponding period of 1997. This increase was due primarily to increased administrative staff, and increased legal expenses due to the lawsuit filed by the Company against certain parties alleging infringement of its intellectual property rights (see Part II, Item 1. "Legal Proceedings" in this Form 10-Q). As a percentage of net sales, these expenses were 9.3% in the first quarter of 1998 compared with 6.7% in the corresponding period of 1997.

Research and development expenses decreased to $1.1 million in the first quarter of 1998 from $1.5 million in the corresponding period of 1997. As a percentage of net sales, these expenses decreased to 6.3% in the first quarter of 1998 from 8.7% in the corresponding period of 1997. This decrease was due primarily to decreases in prototype and other expenditures.

Interest income decreased to $168,000 in the first quarter of 1998 compared with $213,000 in the first quarter of 1997 due to a lower average cash balance.

The provision for income taxes for the first quarter of 1998 of $496,000 is based upon an expected overall effective rate for 1998 of 30%. The provision for income taxes for the first quarter of 1997 of $561,000 was based upon an expected overall effective rate for 1997 of 33%. The decrease in the expected overall effective rate in 1998 compared with 1997 is due to the increased benefits provided by the Company's foreign sales corporation and the research and development tax credit.

LIQUIDITY AND CAPITAL RESOURCES

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During the first three months of 1998, the Company's operating activities generated cash of $1.6 million. Accounts receivable, net of allowances, increased slightly to $11.0 million at March 31, 1998 from $10.6 million at December 31, 1997. Inventory levels increased to $18.6 million at March 31, 1998 from $17.8 million at December 31, 1997 due to increased inventory quantities of finished goods. Net cash provided by investing activities totaled $450,000 during this period, attributable to net proceeds from marketable securities of $956,000 and net purchases of furniture and equipment of $506,000. During this same period, the Company repurchased 81,000 shares of its own stock at a total cost of $536,000.

The Company has entered into a business loan agreement with a bank which provides three credit facilities to the Company, including a $5.0 million unsecured line of credit to finance any unexpected working capital requirements. The line of credit bears interest at the bank's prime rate, or at a specified IBOR rate plus 1.5%, whichever the Company chooses. The agreement also provides a $2.5 million credit facility for capital equipment purchases or general corporate purposes. Certain terms under this facility, such as interest rate, repayment period and collateral, will be determined at the time advances are made to the Company. The Company also has a $1.75 million line of credit for the purchase of foreign exchange contracts. There were no borrowings outstanding on any of the bank credit facilities at March 31, 1998. These credit facilities expire June 30, 1998. Under the terms of the business loan agreement, the Company must maintain certain financial ratios and tangible net worth. The Company is in compliance with all such covenants. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, and acquisitions. The agreement also imposes an annual capital expenditure limit of $10 million.

Although the Company cannot accurately anticipate the effects of inflation, the Company does not believe inflation has had or is likely to have a material effect on its results of operations or liquidity.

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