Creative 2006 Annual Report Download - page 11

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11
YEAR฀ENDED฀JUNE฀30,฀2006฀COMPARED฀TO฀YEAR฀ENDED฀JUNE฀30,฀2005
Net฀sales
Net฀sales฀for฀the฀year฀ended฀June฀30,฀2006฀decreased฀by฀8%฀compared฀to฀the฀year฀ended฀June฀30,฀2005.฀Sales฀of฀personal฀digital฀
entertainment฀(“PDE”)฀products,฀which฀include฀digital฀audio฀players฀and฀digital฀cameras,฀decreased฀by฀5%฀compared฀to฀fiscal฀year฀
2005฀and฀represented฀65%฀of฀sales฀in฀fiscal฀year฀2006฀compared฀to฀63%฀of฀sales฀in฀fiscal฀year฀2005.฀During฀the฀first฀six฀months฀
of฀fiscal฀year฀2006,฀sales฀of฀PDE฀products฀increased฀by฀34%฀compared฀to฀the฀same฀period฀in฀the฀prior฀fiscal฀year,฀but฀sales฀of฀
such฀products฀slowed฀significantly฀in฀the฀second฀half฀of฀the฀fiscal฀year.฀The฀slowdown฀in฀sales฀of฀PDE฀products฀in฀the฀second฀half฀
of฀fiscal฀year฀2006฀was฀mainly฀due฀to฀a฀steep฀drop฀in฀flash฀memory฀prices฀during฀that฀period,฀which฀has฀created฀uncertainty฀and฀
price฀instability฀ in฀the฀retail฀ market฀for฀flash-based฀digital฀ audio฀players฀and฀contributed฀ to฀ a฀ significant฀slowdown฀in฀worldwide฀
sales฀of฀digital฀audio฀players,฀and฀Creative’s฀decision฀to฀streamline฀its฀lineup฀of฀digital฀audio฀players฀to฀focus฀on฀strategic฀and฀more฀
profitable฀products.฀Sales฀of฀audio฀products,฀which฀consist฀of฀Sound฀Blaster฀audio฀cards฀and฀chipsets,฀decreased฀by฀12%฀compared฀
to฀fiscal฀year฀2005฀and฀represented฀13%฀of฀sales฀in฀fiscal฀year฀2006฀compared฀to฀14%฀in฀fiscal฀year฀2005.฀The฀decrease฀in฀audio฀
product฀sales฀was฀mainly฀due฀to฀a฀decrease฀in฀sales฀of฀low-end฀audio฀sound฀cards.฀Sales฀of฀speakers฀decreased฀by฀12%฀in฀fiscal฀
year฀2006฀compared฀to฀fiscal฀year฀2005฀and฀represented฀13%฀of฀sales฀in฀fiscal฀year฀2006฀compared฀to฀14%฀in฀fiscal฀year฀2005.฀
The฀decrease฀was฀primarily฀attributable฀to฀lower฀sales฀of฀non-multimedia฀speakers.฀Sales฀from฀all฀other฀products,฀which฀include฀
graphics฀products,฀communication฀products,฀ accessories฀ and฀other฀miscellaneous฀items,฀decreased฀ by฀ 16%฀compared฀to฀fiscal฀
year฀2005฀and฀represented฀9%฀of฀sales฀in฀fiscal฀years฀2006฀and฀2005.฀The฀decrease฀was฀primarily฀attributable฀to฀decreases฀in฀
sales฀of฀graphics฀and฀communication฀products.
฀
Gross฀profit
Gross฀ profit฀ in฀ fiscal฀ year฀ 2006฀ was฀ 14.6%฀ of฀ sales฀ compared฀ to฀ 22.5%฀ in฀ fiscal฀ year฀ 2005.฀ The฀ decrease฀ in฀ gross฀ profit฀ was฀
primarily฀attributable฀to฀a฀substantial฀write-down฀of฀flash฀memory฀inventory฀in฀the฀third฀quarter฀of฀fiscal฀year฀2006฀due฀to฀a฀steep฀
drop฀in฀the฀flash฀memory฀prices.฀The฀drop฀in฀flash฀memory฀prices฀has฀caused฀market฀uncertainty฀that฀resulted฀in฀lower฀sales฀and฀
reductions฀in฀the฀selling฀prices฀of฀digital฀audio฀players,฀which฀negatively฀impacted฀gross฀profit.
Operating฀expenses
Selling,฀ general฀ and฀ administrative฀ (“SG&A”)฀ expenses฀ in฀ fiscal฀ year฀ 2006฀ decreased฀ marginally฀ by฀ 1%฀ compared฀ to฀ fiscal฀ year฀
2005.฀As฀a฀percentage฀of฀sales,฀SG&A฀expenses฀were฀18%฀of฀sales฀compared฀to฀16%฀of฀sales฀in฀fiscal฀year฀2005.฀฀
Research฀ and฀ development฀ (“R&D”)฀ expenses฀ decreased฀ by฀ 6%฀ compared฀ to฀ fiscal฀ year฀ 2005.฀ As฀ a฀ percentage฀ of฀ sales,฀ R&D฀
expenses฀were฀7%฀of฀sales฀in฀fiscal฀years฀2006฀and฀2005.฀
Other฀charges฀of฀$37.3฀million฀for฀fiscal฀year฀2006฀comprised฀a฀$4.9฀million฀of฀restructuring฀charge฀related฀to฀3Dlabs,฀a฀$31.4฀
million฀impairment฀of฀goodwill฀and฀other฀intangible฀assets฀charge฀related฀to฀3Dlabs,฀and฀$1.0฀million฀in฀employee฀separation฀costs฀
under฀a฀worldwide฀workforce฀reduction฀exercise.฀The฀restructuring฀charge฀related฀to฀3Dlabs฀was฀due฀to฀a฀change฀in฀business฀strategy฀
to฀refocus฀on฀ the฀portable฀handheld฀device฀ market฀instead฀of฀ the฀professional฀workstation฀ graphics฀business.฀The฀restructuring฀
charge฀ comprised฀ $3.0฀ million฀ in฀ employee฀ severance฀ costs,฀ $0.3฀ million฀ in฀ facility฀ exit฀ costs฀ and฀ $1.6฀ million฀ in฀ fixed฀ assets฀
impairment฀ write-downs.฀ As฀ a฀ result฀ of฀ the฀ change฀ in฀ business฀ strategy,฀ the฀ fair฀ value฀ of฀ 3Dlabs฀ could฀ no฀ longer฀ support฀ the฀
carrying฀value฀of฀the฀goodwill฀and฀other฀intangible฀assets฀associated฀with฀the฀acquisition฀of฀3Dlabs฀in฀May฀2002,฀and฀accordingly,฀
Creative฀recorded฀a฀$31.4฀million฀impairment฀of฀goodwill฀and฀other฀intangible฀assets฀in฀fiscal฀year฀2006.฀See฀Note฀3฀and฀12฀of฀
“Notes฀to฀Consolidated฀Financial฀Statements.”
The฀impairment฀of฀goodwill฀and฀intangible฀assets฀charge฀of฀$65.2฀million฀in฀fiscal฀year฀2005฀resulted฀from฀a฀review฀of฀the฀goodwill฀
and฀ intangible฀ assets฀ of฀ 3Dlabs฀ during฀ the฀ second฀ quarter฀ of฀ fiscal฀ year฀ 2005.฀ During฀ the฀ second฀ quarter฀ of฀ fiscal฀ year฀ 2005,฀
management฀noted฀that฀the฀revenue฀of฀3Dlabs฀continued฀to฀perform฀below฀expectations฀due฀to฀delays฀in฀the฀launch฀of฀new฀products.฀
Therefore,฀in฀accordance฀with฀SFAS฀No.฀142,฀an฀impairment฀test฀was฀performed฀by฀an฀independent฀assessor฀on฀the฀goodwill฀and฀
other฀intangible฀assets฀of฀3Dlabs.฀The฀fair฀value฀was฀determined฀based฀on฀a฀combination฀of฀the฀projected฀discounted฀cash฀flow฀
method฀and฀the฀market฀comparable฀method฀whereby฀market฀multiples฀of฀3Dlabs฀were฀compared฀to฀the฀market฀multiples฀of฀other฀
publicly฀traded฀companies฀in฀similar฀lines฀of฀business.฀The฀conclusion฀of฀the฀impairment฀review฀was฀that฀the฀fair฀value฀of฀3Dlabs฀