-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BorqGZ5HdfdvSyWrPqdsUVODN2Ef7/Z6cfZE//g500HEZHfceAt+WWE1lOjw9bC/ 4PiNyjRjhcOV6NBaT710iA== 0000815910-06-000041.txt : 20061108 0000815910-06-000041.hdr.sgml : 20061108 20061108080002 ACCESSION NUMBER: 0000815910-06-000041 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20061108 DATE AS OF CHANGE: 20061108 FILER: COMPANY DATA: COMPANY CONFORMED NAME: METROLOGIC INSTRUMENTS INC CENTRAL INDEX KEY: 0000815910 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 221866172 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24712 FILM NUMBER: 061195556 BUSINESS ADDRESS: STREET 1: COLES ROAD AT RTE 42 CITY: BLACKWOOD STATE: NJ ZIP: 08012 BUSINESS PHONE: 609-228-8100 MAIL ADDRESS: STREET 1: COLES ROAD ROUTE 42 CITY: BLACKWOOD STATE: NJ ZIP: 08012 10-Q 1 q32006.txt 10Q FOR THE PERIOD ENDED SEPTEMBER 30, 2006 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2006 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission file number 0-24712 Metrologic Instruments, Inc. (Exact name of registrant as specified in its charter) New Jersey 22-1866172 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 90 Coles Road, Blackwood, New Jersey 08012 (Address of principal executive offices) (Zip Code) (856) 228-8100 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 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 X No __ Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] As of October 31, 2006, there were 22,858,443 shares of Common Stock, $.01 par value per share, outstanding. METROLOGIC INSTRUMENTS, INC. INDEX Page No. Part I - Financial Information Item 1. Financial Statements Consolidated Balance Sheets - September 30, 2006 (unaudited) and December 31, 2005 3 Consolidated Statements of Operations (unaudited) -Three and Nine Months Ended September 30, 2006 and 2005 4 Consolidated Statement of Shareholders' Equity (unaudited) - Nine Months Ended September 30, 2006 5 Consolidated Statements of Cash Flows (unaudited) - Nine Months Ended September 30, 2006 and 2005 6 Notes to Consolidated Financial Statements (unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 3. Quantitative and Qualitative Disclosures about Market Risk 29 Item 4. Controls and Procedures 29 Part II - Other Information Item 1. Legal Proceedings 30 Item 1A. Risk Factors 32 Item 6. Exhibits 33 Signatures 34 PART I - FINANCIAL INFORMATION Item 1. Financial Statements Metrologic Instruments, Inc. Consolidated Balance Sheets (amounts in thousands except share and per share data) September 30, December 31, 2006 2005 ---- ---- (Unaudited) Assets Current assets: Cash and cash equivalents $ 44,809 $ 49,463 Marketable securities 27,732 24,475 Accounts receivable, net of allowance of $718 and $627, respectively 46,093 48,462 Inventory 36,188 29,364 Deferred income taxes 687 801 Other current assets 3,540 5,599 Assests of discontinued operation 24,398 - --------- --------- Total current assets 183,447 158,164 Property, plant and equipment, net 18,325 20,402 Goodwill 15,754 25,745 Computer software, net 7,159 8,949 Other intangibles, net 9,190 8,409 Deferred income taxes 1,354 4,262 Other assets 288 251 --------- --------- Total assets $ 235,517 $ 226,182 ========= ========= Liabilities and shareholders' equity Current liabilities: Lines of credit $ 15,966 $ 15,989 Current portion of notes payable 8 2,444 Accounts payable 13,873 14,200 Accrued expenses 17,636 32,509 Deferred contract revenue 211 739 Liabilities of discontinued operation 4,250 - --------- --------- Total current liabilities 51,944 65,881 Notes payable, net of current portion 3 3 Deferred income taxes 2,049 8 Shareholders' equity: Preferred stock, $0.01 par value: 500,000 shares authorized; none issued - - Common stock, $0.01 par value: 30,000,000 shares authorized; 22,770,094 and 22,320,014 shares issued and outstanding on September 30, 2006 and December 31, 2005, respectively 228 223 Additional paid-in capital 100,648 92,828 Retained earnings 81,328 68,975 Accumulated other comprehensive loss (683) (1,736) ---------- --------- Total shareholders' equity 181,521 160,290 ---------- --------- Total liabilities and shareholders' equity $ 235,517 $ 226,182 ========== ========= See accompanying notes. Metrologic Instruments, Inc. Consolidated Statements of Operations (Unaudited) (amounts in thousands except share data) Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 ---- ---- ---- ---- Sales $ 53,195 $ 45,907 $158,083 $126,350 Cost of sales 29,106 24,079 89,763 66,033 -------- -------- -------- -------- Gross profit 24,089 21,828 68,320 60,317 Selling, general and administrative expenses 17,533 10,563 46,147 32,402 Research and development expenses 2,902 2,003 7,563 5,750 -------- -------- -------- -------- Operating income 3,654 9,262 14,610 22,165 Other income (expenses) Interest income 703 410 1,963 1,111 Interest expense (260) (287) (1,274) (854) Other income (expense), net (62) 2,019 423 1,271) -------- -------- -------- -------- Total other income (expense) 381 2,142 1,112 1,528 -------- -------- -------- -------- Income from continuing operations before provision for income taxes 4,035 11,404 15,722 23,693 Provision for income taxes on continuing operations 1,272 4,087 5,382 8,532 -------- -------- -------- -------- Income from continuing operations 2,763 7,317 10,340 15,161 Income from discontinued operation, net of income taxes 820 383 2,013 1,093 ------- ------- ------- -------- Net income $ 3,583 $ 7,700 $ 12,353 $ 16,254 ======== ======== ======== ======== Basic earnings per share: Earnings from continuing operations $ 0.12 $ 0.33 $ 0.46 $ 0.69 Earnings from discontinued operation 0.04 0.02 0.09 0.05 -------- -------- -------- --------- $ 0.16 $ 0.35 $ 0.55 $ 0.74 ======== ======== ======== ======== Diluted earnings per share: Earnings from continuing operations $ 0.12 $ 0.31 $ 0.44 $ 0.65 Earnings from discontinued operation 0.04 0.02 0.09 0.05 -------- -------- -------- --------- $ 0.16 $ 0.33 $ 0.53 $ 0.70 ======== ======== ======== ======== See accompanying notes. Metrologic Instruments, Inc. Consolidated Statement of Shareholders' Equity (Unaudited) (amounts in thousands) Accumulated Additional Other Common Paid-in Retained Comprehensive Stock Capital Earnings Income/(Loss) Total ---- ------- -------- ---------- ------- Balances, January 1, 2006 $223 $ 92,828 $ 68,975 $ (1,736) $160,290 Comprehensive income: Net income - - 12,353 - 12,353 Other comprehensive income- foreign currency translation adjustment - - - 1,053 1,053 -------- Total comprehensive income - - - - 13,406 Stock-based compensation - 3,663 - - 3,663 Exercise of stock options 5 1,930 - - 1,935 Tax benefit from exercise of stock options - 2,063 - - 2,063 Stock issued through employee stock purchase plan - 164 - - 164 -------------------------------------------- Balances, September 30, 2006 $228 $100,648 $ 81,328 $ (683) $181,521 ============================================ See accompanying notes. Metrologic Instruments, Inc. Consolidated Statements of Cash Flows (Unaudited) (amounts in thousands) Nine Months Ended September 30, 2006 2005 -------- -------- Operating activities Net income $ 12,353 $ 16,254 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,774 2,638 Amortization 2,537 2,509 Stock-based compensation 3,663 - Deferred income tax benefit (478) - Excess tax benefits from stock-based compensation (2,063) - Gain on disposal of equipment - (4) Symbol litigation settlement payment (14,882) - Note discount amortization 16 84 Changes in operating assets and liabilities: Accounts receivable (3,338) (9,959) Inventory (8,272) (1,366) Other current assets 2,114 (1,987) Other assets (67) (77) Accounts payable 667 (1,531) Accrued expenses 9,441 1,913 Other liabilities - (10) ------- ------- Net cash provided by operating activities 4,465 8,464 Investing activities Purchase of property, plant and equipment (3,980) (3,203) Purchase of minority interest in subsidiary - (2,309) Purchases of marketable securities (158,241) (152,550) Sales of marketable securities 154,984 145,925 Patents and trademarks (1,751) (979) Proceeds from sale of equipment 39 79 ------- ------- Net cash used in investing activities (8,949) (13,037) Financing activities Proceeds from exercise of stock options and employee stock purchase plan 2,099 1,456 Excess tax benefits from stock-based compensation 2,063 - Net (repayments) borrowings on lines of credit (1,310) 4,269 Principal payments on notes payable (2,400) (1,658) Capital lease payments (58) (107) Net cash provided by ------- ------- financing activities 394 3,960 Effect of exchange rates on cash (564) 1,441 ------- ------- Net (decrease)increase in cash and cash equivalents (4,654) 828 Cash and cash equivalents at beginning of period 49,463 36,340 ------- ------- Cash and cash equivalents at end of period $ 44,809 $ 37,168 ======== ======= Supplemental Disclosure: Cash paid for interest $ 1,188 $ 658 ======== ======= Cash paid for income taxes $ 2,432 $ 5,027 ======== ======= See accompanying notes. METROLOGIC INSTRUMENTS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2006 (amounts in thousands except per share data) (Unaudited) 1. Business Metrologic Instruments, Inc. and its subsidiaries (collectively, the "Company") design, manufacture and market bar code scanning and high-speed automated data capture solutions using laser, holographic and vision-based technologies. The Company offers expertise in one-dimensional and two-dimensional bar code reading, portable data collection, optical character recognition, and image lift for customers in retail, commercial, manufacturing, transportation and logistics, and postal and parcel delivery industries. In September 2006, the Board of Directors of the Company approved the divestiture of its wholly owned subsidiary, Adaptive Optics Associates, Inc. ("AOA"), the subsidiary principally engaged in developing, manufacturing, marketing and distributing custom electro-optical and opto-mechanical systems which include wavefront correction, industrial inspection, and scanning and dimensioning systems for commercial and government customers. The sale of AOA was completed in October 2006 (see Note 9 - - Discontinued Operation). The Company's products are sold in more than 110 countries worldwide through the Company's sales, service and distribution offices located in North and South America, Europe and Asia. On September 12, 2006, the Company entered into a definitive agreement to be acquired by a group of investors led by Francisco Partners, C. Harry Knowles, Founder and Interim CEO of the Company, and Elliott Associates, L.P. Under the terms of the agreement, each outstanding share of common stock of the Company will be cancelled and converted into the right to receive $18.50 in cash, without interest. The transaction is anticipated to close during the fourth quarter of 2006. 2. Accounting Policies and Basis of Presentation Interim Financial Information The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments, except for the Brazil tax assessment matter noted below) necessary for a fair presentation of the Consolidated Financial Statements have been included. The results of the interim periods are not necessarily indicative of the results to be obtained for a full fiscal year. The Consolidated Financial Statements and these Notes should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in this Quarterly Report on Form 10-Q and the Company's Annual Report on Form 10-K for the year ended December 31, 2005, including the Consolidated Financial Statements and the Notes to Consolidated Financial Statements for the year ended December 31, 2005 contained therein. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Brazil Tax Assessments As a result of an audit by Brazilian taxing authorities during the third quarter of 2006, the Company was assessed approximately $0.4 million for the failure to withhold certain social taxes on certain payments between 2002 and 2004. This amount was paid during October 2006. The Company has accrued an additional $0.8 million during the third quarter of 2006 for the potential liability associated with similar payments during 2005 and 2006 and other similar matters, resulting in a total charge of approximately $1.2 million which is reflected in selling, general and administrative expenses in our Consolidated Statement of Operations. Discontinued Operation In September 2006, the Company entered into a definitive agreement to sell its wholly owned subsidiary Adaptive Optics Associates, Inc. ("AOA"). As of September 30, 2006, AOA met all of the criteria in Statement of Financial Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," to present the results of operations for AOA as a discontinued operation. Accordingly, all current and prior period Consolidated Statements of Operations reflect AOA as a discontinued operation. See Note 9 -- Discontinued Operation. Reclassifications Certain prior period amounts have been reclassified to conform to the current period presentation. Investments Marketable securities consist of investments in auction rate securities and other similar type instruments. All of these investments are classified as available-for-sale. The costs of these marketable securities approximate their market values as of September 30, 2006 and December 31, 2005. The Company invests excess cash in a variety of marketable securities, including auction rate securities. Auction rate securities have long-term underlying maturities, but have interest rates that are reset every 90 days or less, at which time the securities can typically be purchased or sold, creating a highly liquid market. The Company's intent is not to hold these securities to maturity, but rather to use the interest rate reset feature to provide liquidity as necessary. The Company's investment in these securities provides higher yields than money market and other cash equivalent investments. 3. Earnings per share Basic earnings per share ("Basic EPS") is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted earnings per share ("Diluted EPS") considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an anti-dilutive effect. Diluted EPS excludes certain options to purchase shares of common stock because the options' exercise prices were greater than the average market price of the common shares. For the three and nine month periods ended September 30, 2006 and 2005, potential common shares excluded were 1,229,084 and 816,000, respectively for the three month period and 1,152,696 and 800,023 respectively, for the nine month period. The following table reconciles the numerator and denominator of the computations of Diluted EPS for common stockholders for the periods presented: Three Months ended September 30, ----------------------------------------------------------- 2006 2005 -------------------------- ----------------------------- Per Per Share Share Income Shares Amount Income Shares Amount ------- ---------- ------ ------- ---------- -------- Earnings from continuing operations: Basic EPS $2,763 22,454,846 $0.12 $7,317 22,202,085 $0.33 Effect of dilutive securities 536,342 900,935 ------- ---------- ------ ------- ---------- -------- Diluted EPS $2,763 22,991,188 $0.12 $7,317 23,103,020 $0.31 ------- ---------- ------ ------- ---------- -------- Earnings from discontinued operation: Basic EPS $ 820 22,454,846 $0.04 $ 383 22,202,085 $0.02 Effect of dilutive securities 536,342 900,935 ------- ---------- ------ ------- ---------- -------- Diluted EPS $ 820 22,991,188 $0.04 $ 383 23,103,020 $0.02 ------- ---------- ------ ------- ---------- -------- Net Income: Basic EPS $3,583 22,454,846 $0.16 $7,700 22,202,085 $0.35 Effect of dilutive securities 536,342 900,935 ------- ---------- ------ ------- ---------- -------- Diluted EPS $3,583 22,991,188 $0.16 $7,700 23,103,020 $0.33 ------- ---------- ------ ------- ---------- -------- Nine Months ended September 30, ----------------------------------------------------------- 2006 2005 -------------------------- ----------------------------- Per Per Share Share Income Shares Amount Income Shares Amount ------- ---------- ------ ------- ---------- -------- Earnings from continuing operations: Basic EPS $10,340 22,518,212 $0.46 $15,161 22,081,901 $0.69 Effect of dilutive securities 626,204 1,019,128 ------- ---------- ------ ------- ---------- -------- Diluted EPS $10,340 23,144,416 $0.44 $15,161 23,101,029 $0.65 ------- ---------- ------ ------- ---------- -------- Earnings from discontinued operation: Basic EPS $ 2,013 22,518,212 $0.09 $ 1,093 22,081,901 $0.05 Effect of dilutive securities 626,204 1,019,128 ------- ---------- ------ ------- ---------- -------- Diluted EPS $ 2,013 23,144,416 $0.09 $ 1,093 23,101,029 $0.05 ------- ---------- ------ ------- ---------- -------- Net Income: Basic EPS $12,353 22,518,212 $0.55 $16,254 22,081,901 $0.74 Effect of dilutive securities 626,204 1,019,128 ------- ---------- ------ ------- ---------- -------- Diluted EPS $12,353 23,144,416 $0.53 $16,254 23,101,029 $0.70 ------- ---------- ------ ------- ---------- -------- 4. Inventory Inventory consists of the following: September 30, 2006 December 31, 2005 ------------------ ------------------ Raw materials $ 10,473 $ 10,368 Work-in-process 3,532 4,316 Finished goods 22,183 14,680 ------ ------ Total $ 36,188 $ 29,364 ------ ------ 5. Comprehensive Income The Company's total comprehensive income was as follows: Three Months Ended Nine Months Ended September 30, Septembeer 30, 2006 2005 2006 2005 ---- ---- ---- ---- Net income $ 3,583 $ 7,700 $12,353 $16,254 Other comprehensive income (loss): Change in equity due to foreign currency translation adjustments 308 610 1,053 (588) ------- ------- ------- ------- Comprehensive income $ 3,891 $ 8,310 $13,406 $15,666 ======= ======= ======= ======= 6. Goodwill and Other Intangible Assets The changes in the net carrying amount of goodwill for the nine months ended September 30, 2006 consist of the following: Data Capture & Industrial Collection Automation Total --------- ---------- --------- Balance as of January 1, 2006 $ 15,067 $ 10,678 $ 25,745 Reclassification of AOA goodwill to assets held for sale - (10,678) (10,678) Foreign currency translation adjustments 687 - 687 --------- --------- --------- Balance as of September 30, 2006 $ 15,754 $ - $ 15,754 ========= ========= ========= Other Intangibles The following table reflects the components of identifiable intangible assets: September 30, 2006 December 31, 2005 -------------------------- -------------------------- Amortizable Gross Net Gross Net Life Carrying Accumulated Book Carrying Accumulated Book (years) Amount Amortization Value Amount Amorization Value ----------- --------------------------- --------------------------- Computer software 5 $11,920 $ (4,761) $ 7,159 $11,920 $(2,971) $ 8,949 Patents and trademarks 17 10,735 (3,329) 7,406 9,207 (2,901) 6,306 Holographic technology 10 1,082 (1,082) - 1,082 (1,062) 20 Advance license fee 17 2,750 (1,199) 1,551 2,750 (1,075) 1,675 Covenants not to compete 3 700 (467) 233 700 (292) 408 ------ ------- ------ ------ ------ ------ Total $27,187 $(10,838) $16,349 $25,659 $(8,301) $17,358 ====== ======= ====== ====== ====== ====== The Company has determined that the lives previously assigned to these finite-lived assets are still appropriate and has recorded $2,537 and $2,509 of amortization expense for the nine months ended September 30, 2006 and 2005, respectively. 7. Stock-Based Compensation The Company adopted SFAS 123(R), "Share-based Payment" ("SFAS No. 123(R)") on January 1, 2006. SFAS No. 123(R) requires that the fair value of stock-based compensation be recognized in financial statements. Prior to January 1, 2006, the Company followed Accounting Principles Board ("APB") Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for stock compensation. The Company elected the modified prospective method in adopting SFAS No. 123(R). Under this method, the provisions of SFAS No. 123(R) apply to all awards granted or modified after the date of adoption. In addition, the unrecognized expense of awards not yet vested at the date of adoption is recognized in net income in the periods after the date of adoption using the same valuation method (Black-Scholes) and assumptions determined under the original provisions of SFAS 123, Accounting for Stock-Based Compensation, as disclosed in our previous filings. Under the provision of SFAS No. 123(R), the Company recorded $1,022 of stock-based compensation expense during the three-month period ended September 30, 2006 in relation to its Stock Option Plans. The Company recorded $3,640 and $23 of stock-based compensation expense during the nine-month period ended September 30, 2006 in relation to its Stock Option Plans and Employee Stock Purchase Plan, respectively. The Company recorded an associated tax benefit related to the stock-based compensation expense of $221 and $869 during the three-month and nine-month periods ended September 30, 2006, respectively. SFAS No. 123(R) also required the Company to change its classification, in our consolidated statement of cash flows, of any tax benefits realized upon the exercise of stock options in excess of that which is associated with the expense recognized for financial reporting purposes. This amount totaling $2,063 is presented as financing cash inflows rather than as reductions of income taxes paid in our consolidated statements of cash flows for the nine-month period ended September 30, 2006. Stock Option Plans During 2004, the Company's Board of Directors adopted the 2004 Equity Incentive Plan as the 1994 Incentive Plan had expired. The Company's Board of Directors has granted incentive and non-qualified stock options pursuant to the Company's Incentive Plans to certain eligible employees and board members. The shares issued will either be authorized and previously unissued common stock or issued common stock reacquired by the Company. The total number of shares authorized for issuance under the 2004 Equity Incentive Plan is 1,500,000. Shares canceled for any reason without having been exercised shall again be available for issuance under the Plan. An aggregate of 457,399 shares were available for grant under the 2004 Equity Incentive Plan at September 30, 2006. Options granted under the 2004 Equity Incentive Plan become exercisable over periods ranging from one to four years. Each option shall expire no more than ten years after becoming exercisable. The weighted-average fair value of the options granted under the stock option plans for the nine months ended September 30, 2006 and 2005 was $9.66 and $12.04, respectively. We utilized the Black-Scholes valuation model for estimating these fair values, with the following weighted-average assumptions: Nine Months Ended September 30, -------------------- 2006 2005 Expected Volatility 56.0 % 72.2 % Average risk-free interest rate 4.6 % 3.9 % Expected life (in years) 4.2 4.7 % Dividend yield 0.0 % 0.0 % The dividend yield of zero is based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends. Expected volatility is generally based on the historical volatility of our common stock over the period commensurate with the expected life of the options. The risk-free interest rate is derived from the U.S. Federal Reserve rate in effect at the time of grant. The expected life calculation is based on the observed and expected time to the exercise of options by our employees based on historical exercise patterns for similar type options. Based on our historical experience of pre-vesting option cancellations, the Company has assumed an annualized forfeiture rate of 2.6% for our options. Under the true-up provisions of SFAS No.123(R), we will record additional expense if the actual forfeiture rate is lower than we estimated, and will record a recovery of prior expense if the actual forfeiture is higher than we estimated. The amortization of stock compensation under SFAS 123(R) for the period after its adoption, and under APB 25 or SFAS 123 (pro forma disclosure) for the period prior to its adoption was calculated using the accelerated method in accordance with Financial Accounting Standard Board ("FASB") Interpretation ("FIN") No. 28. Total compensation cost of options granted but not yet vested, as of September 30, 2006, was $5.0 million, which is expected to be recognized over the weighted average period of 1.56 years. The following table summarizes activity under all stock option plans: Nine Months Ended September 30, 2006 ------------------------------------------------- Weighted Weighted Average Average Aggregate Exercise Remaining Intrinsic Shares Price Per Contractual Value Outstanding Share Term (000's) ----------- --------- ----------- ---------- Balance at December 31, 2005 1,712,553 $11.72 Options Granted 474,900 $20.16 Options Exercised (436,073) $ 4.42 Options Cancelled (175,798) $18.47 ---------- Balance at September 30, 2006 1,575,582 $15.53 7.61 $ 6,695 ========== Exercisable at September 30, 2006 780,087 $10.84 6.41 $ 6,689 SFAS No. 123R requires us to present pro-forma information for the comparative period prior to the adoption as if we had accounted for all our stock options under the fair value method of the original SFAS 123. The following table illustrates the effect on net income and net income per share if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation in the comparable period in 2005: Three Months Ended Nine Months Ended September 30, 2005 September 30, 2005 (Pro forma) (Pro forma) Net income: Net income as reported: $ 7,700 $ 16,254 Deduct: (total stock-based employee compensation expense determined under fair value based method, net of related taxes) (701) (2,166) -------- -------- Pro forma net income $ 6,999 $ 14,088 ======== ======== Earnings per share: Basic: As reported $ 0.35 $ 0.74 Pro forma 0.32 0.64 Diluted: As reported $ 0.33 $ 0.70 Pro forma 0.30 0.61 Employee Stock Purchase Plan The Company has an Employee Stock Purchase Plan whereby eligible employees have the opportunity to acquire the Company's common stock quarterly through payroll deductions, at 90% of the lower of (a) the fair market value of the stock on the first day of the applicable quarterly offering period or (b) the fair market value of the stock on the last day of the applicable quarterly offering period. This plan is considered a compensatory plan under the provisions of SFAS No. 123(R). 8. Business Segment Information The Company generates its revenue from the sale of laser bar code scanners primarily to distributors, value-added resellers, original equipment manufacturers and directly to end users, in locations throughout the world. No individual customer accounted for 10% or more of revenues in the three-month and nine-month periods ended September 30, 2006 or 2005. The Company manages its business on a business segment basis dividing the business into two major segments: Data Capture and Collection and Industrial Automation. The Industrial Automation business segment was previously titled "Industrial Automation/Optical Systems"; however due to the divestiture of our wholly owned subsidiary, Adaptive Optics Associates, Inc. ("AOA"), we changed its title to be reflective of the current business activities within this segment. See Note 9 - Discontinued Operation for additional information regarding the divestiture of AOA. The accounting policies of the segments are the same as those described in the summary of the significant accounting policies. A summary of the business segment of continuing operations for the three-and nine-month periods ended September 30, 2006 and 2005 is included below: Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 --------------------- -------------------- Business segment net sales: Data Capture and Collection $ 50,553 $ 43,962 $ 151,881 $119,618 Industrial Automation 2,642 1,945 6,202 6,732 --------------------- -------------------- Total $ 53,195 $ 45,907 $ 158,083 $126,350 --------------------- -------------------- Business segment gross profit: Data Capture and Collection $ 22,767 $ 20,510 $ 66,031 $ 56,869 Industrial Automation 1,322 1,318 2,289 3,448 --------------------- -------------------- Total $ 24,089 $ 21,828 $ 68,320 $ 60,317 --------------------- -------------------- Business segment operating income: Data Capture and Collection $ 3,441 $ 8,739 $ 15,483 $ 21,109 Industrial Automation 213 523 (873) 1,056 --------------------- -------------------- Total $ 3,654 $ 9,262 $ 14,610 $ 22,165 --------------------- -------------------- Total other income (expenses) $ 381 $ 2,142 $ 1,112 $ 1,528 --------------------- -------------------- Income from continuing operations before provision for income taxes $ 4,035 $11,404 $ 15,722 $ 23,693 --------------------- -------------------- 9. Discontinued Operation In September 2006, the Company entered into a definitive agreement to sell its wholly owned subsidiary, AOA, for approximately $40 million, subject to certain working capital adjustments upon finalization of the closing balance sheet. The agreement also provides for $4 million of the consideration to be placed in escrow to secure the Company's obligations under certain representation and warranty provisions. The transaction closed in October 2006 and is expected to result in a gain on sale before income taxes of approximately $18 million. Income from discontinued operation consists of direct revenues and direct expenses of AOA, including cost of revenues, as well as other fixed costs to the extent that such costs will be eliminated as a result of the transaction. Certain general corporate overhead costs have not been allocated to the discontinued operation as they are recorded on a consolidated basis. A summary of the operating results included in discontinued operation in the accompanying consolidated statements of operations is as follows: Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 --------- -------- --------- -------- Sales $ 10.927 $ 8,098 $ 28,824 $ 23,110 Cost of sales 8,335 6,262 21,423 18,085 --------- -------- --------- -------- Gross profit 2,592 1,836 7,401 5,025 Selling, general and administrative expense 1,125 858 3,329 2,547 Research and Development expenses 200 351 789 774 --------- -------- --------- -------- Income from discontinued operation before taxes 1,267 627 3,283 1,704 Income taxes on discontinued operation 447 244 1,270 611 --------- -------- --------- -------- Income from discontinued operation, net of income taxes $ 820 $ 383 $ 2,013 $ 1,093 ========= ======== ========= ======== The following table summarizes the major classes of assets and liabilities of AOA as of September 30, 2006 and December 31, 2005: September 30, December 31, 2006 2005 ---- ---- Accounts receivable, net $ 7,489 $ 8,531 Inventory 2,374 3,011 Other current assets 220 241 Property, plant and equipment, net 3,384 3,356 Goodwill 10,678 10,678 Other intangibles 223 214 Other assets 30 30 --------- --------- Assets of discontinued operation held for sale $ 24,398 $ 26,061 --------- --------- Accounts payable $ 1,272 $ 1,894 Accrued expenses 2,423 3,287 Deferred contract revenue 102 239 Deferred income tax liability 453 36 --------- --------- Liabilities of discontinued operation held for sale $ 4,250 $ 5,456 --------- --------- 10. Acquisitions and Asset Purchases Visible-RF, LLC On May 5, 2006, the Company acquired all of the assets of Visible-RF, LLC, a privately held start-up company located in Needham, MA for $750. The acquisition of the assets of Visible-RF, LLC represents a significant addition to the Company's technology portfolio. This technology combines the benefits of a paper label with the advantages of RFID to display visible information that is updated via a wireless signal. The Company allocated the cost to intangibles for the Visible-RF patent portfolio which is being amortized over its estimated useful life of 17 years. Omniplanar, Inc. On September 24, 2004, the Company acquired 100% of the common stock of Omniplanar, Inc. ("Omniplanar"), an imaging software company, for $12,851, at present value, including acquisition costs and assumed liabilities. The Company paid $9,050 at closing, $1,950 during the year ended December 31, 2005 and $1,950 in March 2006. Omniplanar supplies a complete package of bar code reading software for 2D imaging for fixed position, conveyor belt and hand held readers which can be optimized for specific hardware applications. The acquisition of Omniplanar represents a significant addition to the Company's technology portfolio. The Company has licensed the SwiftDecoder software since the year 2000 for use in its iQ(R) line of industrial vision-based products. The Company uses this software's unique decoding ability in other products as well. The assets acquired have been recorded at their estimated fair values. The results of operations for Omniplanar have been included in the Industrial Automation business segment. In connection with the acquisition, the Company allocated $12,620 to identifiable intangible assets comprising $11,920 of computer software which is being amortized over 5 years and $700 to a non-compete agreement which is being amortized over 3 years. Metrologic do Brasil On February 4, 2003, the Company paid cash of $71 and signed three annual promissory notes with a total discounted value of $204 for the remaining 49% interest in Metrologic do Brasil. During the period ended March 31, 2006, the Company paid the final promissory note in the amount of $75. The total purchase price and costs in excess of assets acquired (goodwill) was $275. Metrologic Eria Iberica ("MEI") On August 5, 2003, the Company entered into an agreement to purchase the remaining 49% interest in MEI for a purchase price of 5,900 Euros. Payments were being made in twelve quarterly installments over three years which commenced August 5, 2003 with a scheduled maturity date of April 3, 2006. On December 1, 2005, the Company accelerated the payments and purchased the remaining 23% interest for approximately 2,700 Euros or $3,200 at the exchange rate on December 31, 2005. The aggregate purchase price was 5,854 Euros or $7,099 at various exchange rates over the installment period. The Company now owns 100% of MEI. 11. Recently Issued Accounting Standards In November 2004, the FASB issued Statement No. 151, "Inventory Costs-An Amendment of ARB No. 43, Chapter 4" ("SFAS No. 151"). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, handling costs and wasted material (spoilage). Among other provisions, the new rule requires that such items be recognized as current-period charges, regardless of whether they meet the criterion of "so abnormal" as stated in ARB 43. SFAS 151 is effective for fiscal years beginning after June 15, 2005. The adoption of this statement did not have a material effect on the Company's consolidated financial position, consolidated results of operations or liquidity. In February 2006, the FASB issued Statement No. 155, "Accounting for Certain Hybrid Financial Instruments-An Amendment of FASB Statements No. 133 and 140" ("SFAS No. 155"). SFAS No. 155 allows financial instruments that contain an embedded derivative that otherwise would require bifurcation to be accounted for as a whole on a fair value basis, at the holders' election. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. This statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The Company does not expect that the adoption of SFAS No. 155 will have a material impact on the Company's consolidated financial position, consolidated results of operations or liquidity. In March 2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial Assets-An Amendment of FASB Statements No. 140" ("SFAS No. 156"). SFAS No. 156 provides guidance on the accounting for servicing assets and liabilities when an entity undertakes an obligation to service a financial asset by entering into a servicing contract. This statement is effective for all transactions in fiscal years beginning after September 15, 2006. The Company does not expect that the adoption of SFAS No. 156 will have a material impact on the Company's consolidated financial position, consolidated results of operations or liquidity. In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the way companies are to account for uncertainty in income taxes recognized in financial statements and prescribes a consistent recognition threshold and measurement attribute for recognizing, derecognizing, and measuring the tax benefits of a tax position taken, or expected to be taken, on a tax return. This Interpretation is effective for fiscal years beginning after December 15, 2006, although early adoption is permitted. The Company does not plan to adopt early and is currently in the process of evaluating the impact, if any, the adoption of the Interpretation will have on the Company's consolidated financial position, consolidated results of operations or liquidity. In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements for fair-value measurements that are already required or permitted by other GAAP. The provisions of SFAS No. 157 are to be applied prospectively and are effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact, if any, the adoption of this statement will have on the Company's consolidated financial position, consolidated results of operations or liquidity. 12. Legal Matters Symbol Technologies, Inc. v. Metrologic On May 3, 2002, we were served with a lawsuit that was filed on April 12, 2002 by Symbol Technologies, Inc. ("Symbol"), in the U.S. District Court for the Eastern District of New York alleging that we were in breach of the terms of the License Agreement between us and Symbol (the "Symbol Agreement"). The Complaint sought a declaratory judgment from the Court that we were in breach of the Symbol Agreement. On March 31, 2003, the Court entered its decision on the parties' respective motions for summary judgment, and finding in our favor, the Court dismissed certain counts of Symbol's complaint. On April 9, 2003, Symbol voluntarily dismissed the remaining counts of the complaint. Symbol filed its Notice of Appeal with the U.S. Court of Appeals for the Second Circuit on May 7, 2003. On December 23, 2003, the Court of Appeals dismissed Symbol's appeal in this matter. In the interim, Symbol decided to proceed with the arbitration for which the Company had filed a Demand in June 2002, which had been stayed pending the decision by the lower court. On June 26, 2003, Symbol filed an Amended Answer and Counterclaims asserting that (a) eleven of Metrologic's products are royalty bearing products, as defined under the Symbol Agreement, and (b) in the alternative, those products infringe upon one or more of Symbol's patents. In February 2005, the arbitrator entered an interim award, finding that eight of the products are not royalty bearing products under the Symbol Agreement but that three of the products are royalty bearing products. In August 2005, the arbitrator entered a final ruling in the arbitration awarding Symbol past royalties on certain of the Company's products plus interest. Symbol then filed a motion to enter the judgment with the U.S. District Court for the Southern District of New York. In response, the Company filed its motion to vacate the arbitrator's award in the same Court. In February 2006, the Judge granted Symbol's motion to enter a judgment affirming the arbitrator's award for past royalties. On March 13, 2006, the Company paid $14.9 million reflecting royalties and interest due in accordance with the judgment of which $14.4 million was accrued for at December 31, 2005, and recorded a charge of $0.5 million for interest due through the payment date. With the payment made on August 15, 2006 for royalties due for the quarter ended June 30, 2006, significant royalty obligations for these products ended. On September 23, 2005, Symbol filed suit against the Company in the U.S. District Court for the Eastern District of Texas alleging patent infringement. Symbol filed a related case before the International Trade Commission ("ITC") also alleging patent infringement of the same patents. A notice of the investigation instituted by the ITC was served on the Company on October 24, 2005. The case in the U.S. District Court for the Eastern District of Texas has been stayed pending the outcome of the matter before the ITC. Trial before the ITC commenced on July 24, 2006 and concluded on August 1, 2006. The parties submitted post trial briefs and a decision by the Administrative Law Judge is expected in late January 2007. Metrologic stands firm in its belief that its products do not infringe Symbol's patents. In this regard, by order dated April 17, 2006, the Administrative Law Judge found one of Symbol's patents to be invalid. Metrologic has vigorously defended the remaining allegations of patent infringement. On November 4, 2005, Symbol filed another suit against the Company in the U.S. District Court for the Eastern District of Texas alleging patent infringement. The complaint has been served on and answered by the Company. Symbol claims, and we deny, that three of our products infringe six of their patents. Discovery is in the early stages. We plan a vigorous defense of this claim. Metrologic v. Symbol Technologies, Inc. On June 18, 2003, the Company filed suit against Symbol in the U.S. District Court for the District of New Jersey alleging claims of patent infringement of certain of our patents by at least two Symbol products. The complaint also contains a claim for breach of the Symbol Agreement between the parties. Symbol's answer to the complaint, filed on July 30, 2003, included counterclaims requesting that a declaratory judgment be entered that the patents in suit are invalid, are not infringed by Symbol and that Symbol is not in breach of the Symbol Agreement. The Court heard arguments on the construction of the claims in the patents in suit in March 2006 and issued its decision in this regard on September 22, 2006. On October 25, 2006, the matter was settled, in principle, and court papers ending the litigation have been submitted for approval. Upon approval, the case will be dismissed. On May 17, 2005, the Company filed suit against Symbol in the U.S. District Court for the District of New Jersey for breach of contract for failure to pay royalties in accordance with the terms of the Symbol Agreement. In September 2005, the parties filed cross motions for summary judgment. On May 1, 2006, Symbol's motion for summary judgment was denied. On June 27, 2006, our motion for summary judgment was granted. An order calling for the payment to us of $2.65 million was signed by the Court on August 3, 2006. Symbol has appealed the judgment to the Third Circuit Court of Appeals. A briefing schedule for the appeal is expected shortly. The amounts received as a consequence of the August 3 order, less the approximately $0.8 million previously set up as a receivable from Symbol, have been recorded as a current liability in the Company's Consolidated Balance Sheet. The Company will not record a gain relating to this matter in its Consolidated Statement of Operations until the decision is finalized and all appeal rights are exhausted by Symbol. On May 8, 2006, the Company filed a Complaint against Symbol in the U.S. District Court for New Jersey. This new Complaint asserts infringement by Symbol of several Metrologic patents and seeks declaratory, injunctive and monetary relief. More specifically, we assert that several of Symbol's mobile computers infringe our mobile computing patent portfolio. Symbol has filed an answer and counterclaim asserting, among other things, that it is licensed to use our patents and that the patents are invalid. Discovery in this matter is in the early stages. Brazil Our subsidiary in Brazil has received notices from the local taxing authorities disputing the amount of import taxes and duties paid on imported products prior to December 2002. We have filed appeals of their assessments in the administrative courts and are awaiting decisions on our appeals. We have accrued a liability for these claims based on what we believe to be the most likely outcome of these appeals and other potential administrative processes. If we are unsuccessful in our appeals and other administrative processes, the actual liability could be approximately $0.7 million higher than the amount we have accrued as of September 30, 2006. Janet Norton v. Metrologic Instruments, Inc. On May 1, 2006, the Company received a Complaint filed in the Superior Court of New Jersey which asserts an employment based claim by a current employee. Our investigation to date demonstrates that this claim has no merit. The plaintiff has filed an amended complaint and we have filed an answer. Discovery is just beginning. PSC Scanning v. Metrologic Instruments, Inc. On May 10, 2006, PSC Scanning ("PSC") filed an action against the Company in the U. S. District Court in Oregon. In its complaint, PSC asserted that our Stratos line of bi-optic scanners infringe two new patents issued on December 13, 2005 and January 31, 2006. We have filed an answer and counterclaim and are vigorously defending this matter. Discovery is underway in anticipation of a possible August 2007, trial date. Additionally, complying with the terms of the settlement agreement effective March 16, 2005, we have notified PSC that two lines of their products infringe our patents. Metrologic Instruments, Inc. Shareholders Litigation On September 12, 2006, the Company announced the signing of a merger agreement, a consequence of which, upon closing, will be that Metrologic will no longer be a publicly held company. Within approximately two weeks after the announcement, four shareholder actions were filed naming as defendants the Company and its individual Board of Directors, among others. All four actions were initiated in New Jersey state courts. An agreement has been reached to have these four matters consolidated and heard by the Superior Court, Law Division, Camden County. An order to this effect will be filed shortly. In anticipation of this order, an amended class action complaint was filed on October 31, 2006. This pleading again asserts, among other things, that the redemption price for the stock specified in the merger agreement is unfair to shareholders. The Amended Complaint seeks among other relief, an injunction blocking the merger or a rescission of the merger or damages. The Company plans on vigorously defending this case. We anticipate that discovery will begin shortly. On October 6, 2006, the Company received a letter from the Securities and Exchange Commission ("SEC") notifying us of the commencement of an informal investigation to determine if violations of the Federal Securities Laws have occurred and requesting certain information. The Company is in the process of responding to the SEC's information request. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward Looking Statements; Certain Cautionary Language Written and oral statements provided by us from time to time may contain certain forward looking information, as that term is defined in the Private Securities Litigation Reform Act of 1995 (the "Act") and in releases made by the Securities and Exchange Commission ("SEC"). This report contains forward-looking statements which may be identified by their use of words like "plans," "expects," "will," "anticipates," "intends," "projects," "estimates" or other words of similar meaning. All statements that address expectations or projections about the future, including statements about the company's strategy for growth, product development, market position, expenditures, and financial results, are forward-looking statements. Forward-looking statements are based on certain assumptions and expectations of future events. The Company cannot guarantee that these assumptions and expectations are accurate or will be realized. See the Risk Factors discussion set forth under Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2005 for a description of risk factors that could significantly affect the Company's financial results. General The following discussion of our results of operations and liquidity and capital resources should be read in conjunction with our Consolidated Financial Statements and the related Notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q and the Consolidated Financial Statements and the Notes to Consolidated Financial Statements for the year ended December 31, 2005 contained in our Annual Report on Form 10-K for the year ended December 31, 2005. The Consolidated Financial Statements for the three and nine months ended September 30, 2006 and 2005 are unaudited. Metrologic Instruments, Inc. and its subsidiaries (collectively, "we", "us", "our" or the "Company") are experts in optical image capture and processing solutions. We utilize our expertise to design, manufacture and market sophisticated imaging and scanning solutions serving a variety of point-of-sale, commercial and industrial applications. Our solutions utilize a broad array of laser, holographic and vision-based technologies designed to provide superior functionality and a compelling value proposition for our customers. On September 12, 2006, the Company entered into a definitive agreement to be acquired by a group of investors led by Francisco Partners, C. Harry Knowles, Founder and Interim CEO of the Company, and Elliott Associates, L.P. Under the terms of the agreement, each outstanding share of common stock of the Company will be cancelled and converted into the right to receive $18.50 in cash, without interest. The transaction is anticipated to close during the fourth quarter of 2006. Critical Accounting Policies In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States, the Company's management must make decisions which impact the reported amounts and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and assumptions on which to base estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to allowances for doubtful accounts, inventory reserves, legal contingencies, stock-based compensation, and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Other than the Company's compliance with the new accounting requirements of Financial Accounting Standards Board Statement No. 123(R), "Share Based Payment" ("SFAS 123(R)"), there have been no material changes to the critical accounting policies listed and described in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's 2005 Annual Report on Form 10-K. Stock-Based Compensation. Effective January 1, 2006, the Company adopted SFAS 123(R) using the modified prospective method, in which compensation cost is recognized for (a) all share-based payments granted after the effective date and (b) for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested as of the effective date. Under the fair value recognition provisions of SFAS 123(R), the Company recognizes share-based compensation net of an estimated forfeiture rate and only recognizes compensation cost for those shares expected to vest. The Black-Scholes option-pricing model used in calculating the fair value of share-based payment awards requires the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates, and these estimates involve inherent uncertainties and the application of management judgment. As a result, should factors and assumptions change, such as volatility, the expected life, and forfeiture rates, the share-based compensation expense could be materially different in the future. Executive Overview We are experts in optical image capture and processing solutions. In recent years, we have increased sales, cash flow from operations and net income primarily through the introduction of new products, penetration into new markets and a focus on cost reduction activities to maintain a competitive advantage. Success factors critical to our business include sales growth through continued penetration within our existing markets through new product introductions and expanded sales efforts, entering into new markets, maintaining a highly responsive and cost efficient infrastructure, achieving the financial flexibility to ensure that we can respond to new market opportunities in order to return value to our shareholders and selectively pursuing strategic acquisitions. In order to continue our penetration into new and existing markets, our strategy involves expanding our sales channels and expanding our product development activities. We have concentrated our direct sales efforts to further penetrate some of the largest retailers in the United States as well as focusing on the adoption of bar coding technology in the healthcare industry. During fiscal 2005 and year-to-date 2006, we continued to see increased orders with key retail accounts which contributed to our quarter over quarter sales growth. Another key factor in achieving this sales growth is expanding our geographic reach by capitalizing on our presence throughout Asia and emerging markets in Central and Eastern Europe. We believe these geographic areas will continue to be an opportunity for continued growth, as evidenced by our investment in the expansion of our Suzhou, China manufacturing facility which was completed in 2004, as well as the opening of new sales offices in these territories. Our plans are to open additional offices in the Asia/Pacific region as we continue to implement and build upon our "globally local" philosophy. In addition, we continue to invest in developing new and improved products to meet the changing needs of our existing customers. We are continuing to focus on executing our core strategy of leveraging our engineering expertise to produce new bar code scanners and industrial automation products that will allow us to penetrate new markets that we have not previously served and gain market share in our existing markets. To maintain a highly responsive and cost efficient infrastructure, our focus is to maximize the efficiency of our organization through process improvements and cost containment. We continue to focus on our strategy for margin expansion through specific engineering initiatives to reduce product and manufacturing costs while improving product quality and yields and believe that fiscal 2006 will benefit from these specific initiatives. We also intend to further expand our manufacturing capabilities at our Suzhou, China facility in future years to continue to take advantage of these cost efficiencies. Closely linked to the success factors discussed above is our continued focus to maintain financial flexibility. As of September 30, 2006, we had total debt of approximately $16.0 million. Furthermore, we had cash and cash equivalents and marketable securities of approximately $72.5 million as of September 30, 2006. We believe that our current cash and working capital positions and expected operating cash flows will be sufficient to fund our working capital, planned capital expenditures and debt repayment requirements for the foreseeable future. In addition to our internal development and organic growth, we may selectively pursue strategic acquisitions that we believe will broaden or complement our current technology base and allow us to serve additional end users and the evolving needs of our existing customers. In an effort to expand our market presence in RFID (Radio Frequency Identification) as part of our planned growth strategy, on May 5, 2006, the Company acquired all of the assets of Visible-RF, LLC, a privately held company located in Needham, MA. The acquisition of Visible-RF, LLC represents a significant addition to the Company's technology portfolio. This technology combines the benefits of a paper label with the advantages of RFID to display visible information that is updated via a wireless signal. The Company intends to utilize its extensive worldwide sales and distribution network to expand this new technology through its existing customer base. In addition, Metrologic entered into a strategic partnership with MaxID during March 2006 which has resulted in two recently introduced RFID readers for the North American Market. Adding this RFID technology enables us to serve customers in the supply chain and transportation/logistics markets and will help redefine our Industrial Business strategy. Results of Operations The following table sets forth certain of our consolidated statement of operations data as a percentage of revenues for the periods indicated. The following discussion should be read in conjunction with our Consolidated Financial Statements and the Notes to our Consolidated Financial Statements. Three Months Ended Nine Months Ended September 30, Septmeber 30, ------------------ -------------------- 2006 2005 2006 2005 ------------------ -------------------- Sales 100.0% 100.0% 100.0% 100.0% Cost of sales 54.7% 52.5% 56.8% 52.3% Gross profit 45.3% 47.5% 43.2% 47.7% Operating expenses: Selling, general and administrative expenses 33.0% 23.0% 29.2% 25.6% Research and development expenses 5.4% 4.4% 4.8% 4.6% Total operating expenses 38.4% 27.4% 34.0% 30.2% Operating income 6.9% 20.1% 9.2% 17.5% Other income (expenses), net 0.7% 4.7% 0.7% 1.3% Income from continuing operations before income taxes 7.6% 24.8% 9.9% 18.8% Provision for income taxes on continuing operations 2.4% 8.9% 3.4% 6.8% Net income from continuing operations 5.2% 15.9% 6.5% 12.0% Income from discontinued operations net of income taxes 1.5% 0.9% 1.3% 0.9% Net income 6.7% 16.8% 7.8% 12.9% Our business is divided into two major segments: Data Capture and Collection, and Industrial Automation. The Industrial Automation business segment was previously titled "Industrial Automation/Optical Systems"; however, due to the divestiture of our wholly owned subsidiary, Adaptive Optics Associates, Inc. ("AOA"), we changed its title to be reflective of the current business activities within this segment. See Note 9 - Discontinued Operation for additional information regarding the divestiture of AOA. Bar code scanners are typically either handheld scanners or fixed projection scanners. Handheld bar code scanners are principally suited for retail point-of-sale, document processing, library, healthcare and inventory applications. Fixed projection scanners, which can be mounted on or in a counter, are principally suited for supermarkets, convenience stores, mass merchandisers, health clubs and specialty retailers. Industrial automation products are comprised of fixed position systems that are either laser- or vision-based. These systems range from simple, one-scanner solutions to complex, integrated systems incorporating multi-scanner, image capture and dimensioning technologies. The following table sets forth certain information regarding our revenues by our two business segments for the periods indicated. Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 --------- -------- -------- -------- ($ in Thousands) ($ in Thousands) Data Capture & Collection $ 50,553 $ 43,962 $151,881 $119,618 Industrial Automation 2,642 1,945 6,202 6,732 --------- -------- -------- -------- Total Company $ 53,195 $ 45,907 $158,083 $126,350 ========= ======== ======== ======== Most of our product sales in Western Europe, Brazil and Asia are billed in foreign currencies and are subject to currency exchange rate fluctuations. For the nine months ended September 30, 2006, sales and gross profit were negatively affected by fluctuations in the value of the U.S. dollar relative to certain foreign currencies, especially the euro, when compared to the comparable period in 2005. The following table sets forth certain information as to our sales by geographic location: ------------------------------ ------------------------------- Three Months Ended Nine Months Ended September 30, September 30, 2006 % 2005 % 2006 % 2005 % ------------------------------ ------------------------------- ($ in Thousands) The Americas(1) $18,670 35.1% $19,588 42.7% $ 54,314 34.4% $ 50,342 39.8% EMEA (2) 26,477 49.8% 19,185 41.8% 83,302 52.7% 57,438 45.5% Asia/Pacific 8,048 15.1% 7,134 15.5% 20,467 12.9% 18,570 14.7% ------- ------ ------- ------ -------- ------ -------- ------ Total $53,195 100.0% $45,907 100.0% $158,083 100.0% $126,350 100.0% ======= ====== ======= ====== ======== ====== ======== ====== (1) The Americas is defined as North America, South America, Canada and Mexico (2) EMEA is defined as Europe, Middle East and Africa Three Months Ended September 30, 2006 Compared with Three Months Ended September 30, 2005 Sales increased 15.9% to $53.2 million in the three months ended September 30, 2006 from $45.9 million in the three months ended September 30, 2005. Sales of our data capture and collection products increased by 15.0% while sales in our industrial automation segment increased by 35.8%. Data capture and collection sales increased approximately $1.5 million due to the strengthening of the euro against the U.S. dollar and an increase of approximately $7.9 million due to increased unit sales of handheld and in-counter scanners, including new product offerings. These factors were partially offset by a decrease of approximately $2.9 million resulting from lower average selling prices due to competitive pricing pressures experienced in the retail sector, primarily in the United States and Europe. Our Industrial Automation business has exhibited a greater degree of volatility than our data capture and collection business due to the timing and size of related contracts in this business. The increase in the industrial automation sales is attributed to higher contributions from our Omniplanar business during the three months ended September 30, 2006 when compared to the comparable period in 2005. Sales to "The Americas" region decreased $0.9 million, or 4.7%, in the three months ended September 30, 2006 when compared to the comparable period in 2005. The decrease is attributed to the rollout of a significant order with a Tier 1 retailer in 2005. EMEA sales increased $7.3 million, or 38.0% in the three months ended September 30, 2006 when compared to the same period a year ago. The increase in EMEA sales is attributable to increased unit volume and the strengthening of the euro against the U.S. dollar, offset by lower average selling prices. The increased unit volume, in part, reflects penetration into Tier 1 retailers. Asia/Pacific sales increased $0.9 million, or 12.8% in the three months ended September 30, 2006 when compared with the comparable period in 2005. We continue to experience sizable growth in this region as a result of continued penetration into both new and existing key markets. No individual customer accounted for 10.0% or more of sales in the three months ended September 30, 2006 or 2005. Cost of sales increased to $29.1 million in the three months ended September 30, 2006 from $24.1 million in the three months ended September 30, 2005. As a percentage of sales, cost of sales increased to 54.7% in 2006 from 52.5% in 2005. The increase in the percentage of cost of sales can be primarily attributed to the following key factors: o Competitive pricing on growing direct sales to Tier 1 retailers in the United States and EMEA. o Less favorable product mix within our data capture and collection business segment resulting from increased sales of our newer product offerings that have lower margins and have not yet been fully cost reduced as well as sales of certain non-Metrologic products. o Increased compensation costs as a result of the adoption of SFAS No. 123(R). Selling, general and administrative ("SG&A") expenses increased 66.0% to $17.5 million in the three months ended September 30, 2006 from $10.6 million for the three months ended September 30, 2005. As a percentage of sales, SG&A expenses increased from 23.0% of sales in the three months ended September 30, 2005 to 33.0% of sales in the corresponding period in 2006. The increase in SG&A expenses was primarily attributable to the following key factors: o Increased legal fees associated with ongoing litigation matters. o Transactions costs incurred as a result of the merger transaction. o Higher social taxes accrued during the third quarter of 2006 as a result of the completion of a tax audit in Brazil. Such amounts had not been reserved previously. o Severance charges recorded for certain employees whose employment ceased during the quarter. o Increased selling expenses associated with the higher sales volume than the comparable period in 2005. o Increased compensation costs as a result of the adoption of SFAS No. 123(R). Research and Development ("R&D") expenses increased 44.9% to $2.9 million in the three months ended September 30, 2006 from $2.0 million in the corresponding period in 2005. As a percent of sales, R&D expenses increased to 5.5% of sales from 4.4% of sales. The increase is primarily due to stock-based compensation expense resulting from the adoption of SFAS No. 123(R) and an increase in personnel and professional fee costs associated with ongoing product development initiatives. Net interest income/expense reflects net interest income of $0.4 million for the three months ended September 30, 2006 compared with net interest income of $0.1 million for the comparable period in 2005. The increase can be attributed to higher interest income due to higher cash and cash equivalent balances. Other income/expense reflects net other expense of $0.06 million for the three months ended September 30, 2006 compared with net other income of $2.0 million for the comparable period in 2005. The change can be attributed to the PCS litigation settlement pursuant to which we recorded income of $2.25 million during the third quarter of 2005, offset by higher foreign currency exchange losses in 2005 of approximately $0.2 million. Income from continuing operations was $2.8 million, or $0.12 per diluted share for the three months ended September 30, 2006 compared with income from continuing operations of $7.3 million or $0.31 per diluted share in the comparable period in 2005. Income from discontinued operation, net of income taxes was $0.8 million, or $0.04 per diluted share for the three months ended September 30, 2006 compared with income from discontinued operation, net of income taxes of $0.4 million or $0.02 per diluted share in the comparable period in 2005. The increase is primarily due to an increase in optical systems sales for both new and ongoing customer funded programs. Net income was $3.6 million, or $0.16 per diluted share for the three months ended September 30, 2006 compared with net income of $7.7 million or $0.33 per diluted share in 2005. Net income reflects a 32.4% effective tax rate for 2006 and 36% for 2005. The effective rate for 2006 does not reflect any benefit for research and development tax credits as the federal legislation authorizing such credits expired on December 31, 2005, and has not yet been renewed. Nine Months Ended September 30, 2006 Compared with Nine Months Ended September 30, 2005 Sales increased 25.1% to $158.1 million in the nine months ended September 30, 2006 from $126.4 million in the nine months ended September 30, 2005. Sales of our data capture and collection products increased by 27.0% and sales of our industrial automation products decreased by 7.9%. Data capture and collection sales increased approximately $38.3 million due to increased unit sales of handheld and in-counter scanners, including new product offerings. This was offset by a weakening of the euro against the U.S. dollar which accounted for a decrease of approximately $1.0 million and a decrease of approximately $5.1 million resulting from lower average selling prices and increased promotional programs due to competitive pricing pressures experienced in the retail sector in all geographic regions. Our Industrial Automation business has exhibited a greater degree of volatility than our data capture and collection business due to the timing and size of related contracts in this business which is the primary reason for the decrease in revenues during the nine month period ended September 30, 2006. Sales to "The Americas" region increased $4.0 million, or 7.9%, in 2006 when compared to the comparable period in 2005. This increase is primarily attributed to ongoing penetration into new vertical markets and Tier 1 retailers, higher demand in our South America markets, and consistent growth with our key distributors. EMEA sales increased $25.9 million, or 45.0% in 2006 when compared to the same period a year ago. The increase in EMEA sales is attributable to increased unit volume offset by lower average selling prices. The increased unit volume, in part, reflects penetration into Tier 1 retailers as well as increased sales of certain of our products utilized in reverse-vending applications attributable to legislative mandates. Asia/Pacific sales increased $1.9 million, or 10.2%, in 2006 when compared with the comparable period in 2005. We continue to experience growth in this region as a result of continued penetration into both new and existing key markets. No individual customer accounted for 10.0% or more of sales in the nine months ended September 30, 2006 or 2005. Cost of sales increased to $89.8 million in the nine months ended September 30, 2006 from $66.0 million in the nine months ended September 30, 2005. As a percentage of sales, cost of sales increased to 56.8% in 2006 from 52.3% in 2005. The increase in the percentage of cost of sales can be primarily attributed to the following key factors: o Competitive pricing on growing direct sales to Tier 1 retailers in the United States and EMEA. o Less favorable product mix within our data capture and collection business segment resulting from increased sales of our newer product offerings that have lower margins and have not yet been fully cost reduced as well as sales of certain non-Metrologic products. o Increased royalty costs through the first six months of 2006 as a result of the court decision upholding the arbitration award that we are required to pay royalty payments of $10 per unit on sales of certain of our scanners. o Increased compensation costs as a result of the adoption of SFAS No. 123(R). Selling, general and administrative ("SG&A") expenses increased 42.4% to $46.1 million in the nine months ended September 30, 2006 from $32.4 million for the nine months ended September 30, 2005. As a percentage of sales, SG&A expenses increased from 25.6% of sales in the nine months ended September 30, 2005 to 29.2% of sales in the corresponding period in 2006. The increase in SG&A expenses was primarily attributable to the following key factors: o Increased legal fees associated with ongoing litigation matters. o Transactions costs incurred as a result of the merger transaction. o Higher social taxes accrued during the third quarter of 2006 as a result of the completion of a tax audit in Brazil. Such amount had not been previously reserved. o Severance charges recorded for certain employees whose employment ceased during the quarter. o Increased selling expenses associated with the higher sales volume than the comparable period in 2005. o Increased compensation costs as a result of the adoption of SFAS No. 123(R). Research and Development ("R&D") expenses increased 31.5% to $7.6 million in the nine months ended September 30, 2006 from $5.8 million in the corresponding period in 2005. As a percent of sales, R&D expenses increased slightly to 4.8% of sales from 4.6% of sales. The increase is primarily due to stock-based compensation expense resulting from the adoption of SFAS No. 123(R) and an increase in personnel and professional fee costs associated with ongoing product development initiatives. Net interest income/expense reflects net interest income of $0.7 million for the nine months ended September 30, 2006 compared with net interest income of $0.3 million for the comparable period in 2005. The increase can be attributed to higher invested cash balances and higher interest yields on investment earnings in 2006 than in the comparable period in 2005, offset by higher interest expense as a result of the charge of $0.5 million in interest on the Symbol litigation settlement recorded in the quarter ended March 31, 2006. Other income/expense reflects net other income of $0.4 million for the nine months ended September 30, 2006 compared with net other income of $1.3 million for the comparable period in 2005. The change can be attributed to the PCS litigation settlement pursuant to which we recorded income of $2.25 million during the third quarter of 2005, offset by $0.4 million of foreign exchange gains in 2006 compared to $0.9 million of losses in 2005. Income from continuing operations was $10.3 million, or $0.44 per diluted share for the nine months ended September 30, 2006 compared with net income of $15.2 million or $0.65 per diluted share in 2005. Income from discontinued operation, net of income taxes was $2.0 million, or $0.09 per diluted share for the nine months ended September 30, 2006 compared with income from discontinued operation, net of income taxes of $1.1 million or $0.05 per diluted share in the comparable period in 2005. The increase is primarily due to an increase in optical systems sales for both new and ongoing customer funded programs. Net income was $12.4 million, or $0.53 per diluted share for the nine months ended September 30, 2006 compared with net income of $16.3 million or $0.70 per diluted share in 2005. Net income reflects a 35% effective tax rate for 2006 and 36% for 2005. The effective rate for 2006 does not reflect any benefit for research and development tax credits as the federal legislation authorizing such credits expired on December 31, 2005, and has not yet been renewed. Inflation and Seasonality Inflation and seasonality have not had a material impact on our results of operations. However, our sales are typically impacted by fluctuation decreases in seasonal demand from European customers in our third quarter. In addition, our first quarter is also impacted by factors, such as: (i) the establishment of new budgets, (ii) the expiration of legislative calendar-year programs and (iii) start-up investment of pilot efforts. Liquidity and Capital Resources Operating activities Net cash provided by operating activities was $4.5 million and $8.5 million for the nine-month periods ended September 30, 2006 and 2005, respectively. Net cash provided by operating activities for the nine months ended September 30, 2006 can be attributed primarily to net income of $12.4 million, depreciation and amortization of approximately $5.3 million and stock-based compensation expense of $3.7 million; offset by payment of the Symbol litigation award of $14.9 million and net increases in operating assets and liabilities of $2.0 million. Included in net cash provided by operating activities for the nine-month period ended September 30, 2006 was approximately $2.5 million related to the discontinued operation. Our working capital increased $39.2 million or 42.5% to $131.5 million as of September 30, 2006 from $92.3 million as of December 31, 2005. Working capital as of September 30, 2006 includes $20.1 million of net assets held for sale relating to our AOA subsidiary, $13.9 million of which were previously classified as long term. The other key components of the increase in working capital from continuing operations were increases in inventory of $9.8 million and an increase in accounts receivable of $6.2 million as a result of sales concentrations at the end of the quarter and increases in marketable securities of $3.3 million. Investing activities Cash used in investing activities was $8.9 million for the nine months ended September 30, 2006 as compared to $13.0 million for the comparable period in 2005. The decrease in cash used in investing activities is primarily due to changes in the purchases, sales and maturities of marketable securities of $3.4 million plus the scheduled purchase of the remaining 49% interest in Metrologic Eria Iberica in 2005 for $2.3 million, offset by increases in patents and trademarks of $0.8 million as a result of the acquisition of Visible-RF, LLC (See Note 10-"Acquisitions" for additional information) and increased spending for capital expenditures of $0.8 million. Financing activities Cash provided by financing activities was $0.4 million for the nine months ended September 30, 2006 as compared to $4.0 million for the comparable period in 2005. Cash provided by financing activities for the nine months ended September 30, 2006 consists primarily of $4.1 million of proceeds and related tax benefits from the exercise of stock options and purchases under the employee stock purchase plan offset by repayments of scheduled notes of $2.4 million (See "Outstanding debt and financing arrangements" below for additional information on scheduled notes) and repayments under lines of credit by our foreign subsidiaries of $1.3 million. Outstanding debt and financing arrangements In connection with the acquisition of Omniplanar, the Purchase Agreement set forth a schedule of payments over 18 months. We paid $9.0 million at closing, $2.0 million in 2005 and the final payment of $2.0 million in March 2006. On September 1, 2005 the Company entered into a Cross-License Agreement with Intermec IP Corp., a division of Intermec Inc., which includes a license origination fee of $0.8 million. The Company paid $0.4 million during the year ended December 31, 2005, $0.2 million for the period ended March 31, 2006, and the remaining scheduled payments of $0.2 million in June 2006. Some of our European subsidiaries have entered into working capital and invoice discounting agreements with HypoVereinsbank, Dresdner, Societe Generale and GE Commercial Finance. Outstanding borrowings under the working capital agreement with HypoVereinsbank have been guaranteed by Metrologic Instruments, Inc., the parent company. These agreements provide the Company with availability of up to $21.0 million, using September 30, 2006 exchange rates, at interest rates ranging from 4.0% to 6.5%. In addition, our subsidiary Metrologic do Brasil has a working capital agreement with Banco Bradesco SA with availability of up to 0.8 million real or $0.4 million, using September 30, 2006 exchange rates. At September 30, 2006, $16.0 million was outstanding under such agreements and accordingly is included in lines of credit in our Consolidated Balance Sheets. We believe that our current cash and working capital positions and expected operating cash flows will be sufficient to fund our working capital, planned capital expenditures and debt repayment requirements for the foreseeable future. Foreign Currency Exchange Our liquidity has been, and may continue to be, affected by changes in foreign currency exchange rates, particularly the value of the U.S. dollar relative to the Euro, the Brazilian real, the Singapore dollar, and the Chinese renminbi. In an effort to mitigate the financial implications of the volatility in the exchange rate between the Euro and the U.S. dollar, we have in the past entered and may selectively enter into derivative financial instruments to offset our exposure to foreign currency risks. Derivative financial instruments may include (i) foreign currency forward exchange contracts with our primary bank for periods not exceeding six months, which partially hedge sales to our German subsidiary and (ii) Euro-based loans, which act as a partial hedge against outstanding intercompany receivables and the net assets of our European subsidiary, which are denominated in Euros. Additionally, our European subsidiary invoices and receives payment in certain other major currencies, including the British pound, which results in an additional mitigating measure that reduces our exposure to the fluctuation between the Euro and the U.S. dollar, although it does not offer protection against fluctuations of that currency against the U.S. Dollar. No derivative instruments were outstanding at September 30, 2006. Impact of Recently Issued Accounting Standards In November 2004, the FASB issued Statement No. 151, "Inventory Costs, An amendment of ARB No. 43, Chapter 4" ("SFAS No. 151"). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, handling costs and wasted material (spoilage). Among other provisions, the new rule requires that such items be recognized as current-period charges, regardless of whether they meet the criterion of "so abnormal" as stated in ARB 43. SFAS 151 is effective for fiscal years beginning after June 15, 2005. The adoption of this statement did not have a material effect on the Company's consolidated financial position, consolidated results of operations or liquidity. In February 2006, the FASB issued Statement No. 155, "Accounting for Certain Hybrid Financial Instruments-An Amendment of FASB Statements No. 133 and 140" ("SFAS No. 155"). SFAS No. 155 allows financial instruments that contain an embedded derivative that otherwise would require bifurcation to be accounted for as a whole on a fair value basis, at the holders' election. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. This statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The Company does not expect that the adoption of SFAS No. 155 will have a material impact on the Company's consolidated financial position, consolidated results of operations or liquidity. In March 2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial Assets-An Amendment of FASB Statements No. 140" ("SFAS No. 156"). SFAS No. 156 provides guidance on the accounting for servicing assets and liabilities when an entity undertakes an obligation to service a financial asset by entering into a servicing contract. This statement is effective for all transactions in fiscal years beginning after September 15, 2006. The Company does not expect that the adoption of SFAS No. 156 will have a material impact on the Company's consolidated financial position, consolidated results of operations or liquidity. In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the way companies are to account for uncertainty in income taxes recognized in financial statements and prescribes a consistent recognition threshold and measurement attribute for recognizing, derecognizing, and measuring the tax benefits of a tax position taken, or expected to be taken, on a tax return. This Interpretation is effective for fiscal years beginning after December 15, 2006, although early adoption is permitted. The Company does not plan to adopt early and is currently in the process of evaluating the impact, if any, the adoption of the Interpretation will have on the Company's consolidated financial position, consolidated results of operations or liquidity. In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements for fair-value measurements that are already required or permitted by other GAAP. The provisions of SFAS No. 157 are to be applied prospectively and are effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact, if any, the adoption of this statement will have on the Company's consolidated financial position, consolidated results of operations or liquidity. Item 3- Quantitative and Qualitative Disclosures about Market Risk There have been no material changes in our quantitative and qualitative disclosure about market risk since December 31, 2005. Item 4- Controls and Procedures As required by Rule 13a-15 under the Exchange Act, as of the end of the period covered by this report, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our Management, including our principal executive officer and principal financial officer. Based on that evaluation these officers concluded that these disclosure controls and procedures are effective as of the end of the period covered by this report. There have been no changes in the Company's internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II. OTHER INFORMATION Item 1. Legal Proceedings We protect our technological position and new product development with domestic and foreign patents. When we believe competitors are infringing on these patents, we may pursue claims or other legal action against these parties. Additionally, from time-to-time, we receive legal challenges to the validity of our patents or allegations that our products infringe the patents of others. We are currently involved in matters of litigation arising in the normal course of business including the matters described below. We believe that such litigation either individually or in the aggregate will not have a material adverse effect on our consolidated financial position, results of operations or cash flows, except as noted below. Symbol Technologies, Inc. v. Metrologic On May 3, 2002, we were served with a lawsuit that was filed on April 12, 2002 by Symbol Technologies, Inc. ("Symbol"), in the U.S. District Court for the Eastern District of New York alleging that we were in breach of the terms of the License Agreement between us and Symbol (the "Symbol Agreement"). The Complaint sought a declaratory judgment from the Court that we were in breach of the Symbol Agreement. On March 31, 2003, the Court entered its decision on the parties' respective motions for summary judgment, and finding in our favor, the Court dismissed certain counts of Symbol's complaint. On April 9, 2003, Symbol voluntarily dismissed the remaining counts of the complaint. Symbol filed its Notice of Appeal with the U.S. Court of Appeals for the Second Circuit on May 7, 2003. On December 23, 2003, the Court of Appeals dismissed Symbol's appeal in this matter. In the interim, Symbol decided to proceed with the arbitration for which the Company had filed a Demand in June 2002, which had been stayed pending the decision by the lower court. On June 26, 2003, Symbol filed an Amended Answer and Counterclaims asserting that (a) eleven of Metrologic's products are royalty bearing products, as defined under the Symbol Agreement, and (b) in the alternative, those products infringe upon one or more of Symbol's patents. In February 2005, the arbitrator entered an interim award, finding that eight of the products are not royalty bearing products under the Symbol Agreement but that three of the products are royalty bearing products. In August 2005, the arbitrator entered a final ruling in the arbitration awarding Symbol past royalties on certain of the Company's products plus interest. Symbol then filed a motion to enter the judgment with the U.S. District Court for the Southern District of New York. In response, the Company filed its motion to vacate the arbitrator's award in the same Court. In February 2006, the Judge granted Symbol's motion to enter a judgment affirming the arbitrator's award for past royalties. On March 13, 2006, the Company paid $14.9 million reflecting royalties and interest due in accordance with the judgment of which $14.4 million was accrued for at December 31, 2005, and recorded a charge of $0.5 million for interest due through the payment date. With the payment made on August 15, 2006 for royalties due for the quarter ended June 30, 2006, significant royalty obligations for these products ended. On September 23, 2005, Symbol filed suit against the Company in the U.S. District Court for the Eastern District of Texas alleging patent infringement. Symbol filed a related case before the International Trade Commission ("ITC") also alleging patent infringement of the same patents. A notice of the investigation instituted by the ITC was served on the Company on October 24, 2005. The case in the U.S. District Court for the Eastern District of Texas has been stayed pending the outcome of the matter before the ITC. Trial before the ITC commenced on July 24, 2006 and concluded on August 1, 2006. The parties submitted post trial briefs and a decision by the Administrative Law Judge is expected in late January 2007. Metrologic stands firm in its belief that its products do not infringe Symbol's patents. In this regard, by order dated April 17, 2006, the Administrative Law Judge found one of Symbol's patents to be invalid. Metrologic has vigorously defended the remaining allegations of patent infringement. On November 4, 2005, Symbol filed another suit against the Company in the U.S. District Court for the Eastern District of Texas alleging patent infringement. The complaint has been served on and answered by the Company. Symbol claims, and we deny, that three of our products infringe six of their patents. Discovery is in the early stages. We plan a vigorous defense of this claim. Metrologic v. Symbol Technologies, Inc. On June 18, 2003, the Company filed suit against Symbol in the U.S. District Court for the District of New Jersey alleging claims of patent infringement of certain of our patents by at least two Symbol products. The complaint also contains a claim for breach of the Symbol Agreement between the parties. Symbol's answer to the complaint, filed on July 30, 2003, included counterclaims requesting that a declaratory judgment be entered that the patents in suit are invalid, are not infringed by Symbol and that Symbol is not in breach of the Symbol Agreement. The Court heard arguments on the construction of the claims in the patents in suit in March 2006 and issued its decision in this regard on September 22, 2006. On October 25, 2006, the matter was settled, in principle, and court papers ending the litigation are have been submitted for approval. Upon approval, the case will be dismissed. On May 17, 2005, the Company filed suit against Symbol in the U.S. District Court for the District of New Jersey for breach of contract for failure to pay royalties in accordance with the terms of the Symbol Agreement. In September 2005, the parties filed cross motions for summary judgment. On May 1, 2006, Symbol's motion for summary judgment was denied. On June 27, 2006, our motion for summary judgment was granted. An order calling for the payment to us of $2.65 million was signed by the Court on August 3, 2006. Symbol has appealed the judgment to the Third Circuit Court of Appeals. A briefing schedule for the appeal is expected shortly. The amounts received as a consequence of the August 3 order, less the approximately $0.8 million previously set up as a receivable from Symbol, have been recorded as a current liability in the Company's Consolidated Balance Sheet. The Company will not record a gain relating to this matter in its Consolidated Statement of Operations until the decision is finalized and all appeal rights are exhausted by Symbol. On May 8, 2006, the Company filed a Complaint against Symbol in the U.S. District Court for New Jersey. This new Complaint asserts infringement by Symbol of several Metrologic patents and seeks declaratory, injunctive and monetary relief. More specifically, we assert that several of Symbol's mobile computers infringe our mobile computing patent portfolio. Symbol has filed an answer and counterclaim asserting, among other things, that it is licensed to use our patents and that the patents are invalid. Discovery in this matter is in the early stages. Brazil Our subsidiary in Brazil has received notices from the local taxing authorities disputing the amount of import taxes and duties paid on imported products prior to December 2002. We have filed appeals of their assessments in the administrative courts and are awaiting decisions on our appeals. We have accrued a liability for these claims based on what we believe to be the most likely outcome of these appeals and other potential administrative processes. If we are unsuccessful in our appeals and other administrative processes, the actual liability could be approximately $0.7 million higher than the amount we have accrued as of September 30, 2006. Janet Norton v. Metrologic Instruments, Inc. On May 1, 2006, the Company received a Complaint filed in the Superior Court of New Jersey which asserts an employment based claim by a current employee. Our investigation to date demonstrates that this claim has no merit. The plaintiff has filed an amended complaint and we have filed an answer. Discovery is just beginning. PSC Scanning v. Metrologic Instruments, Inc. On May 10, 2006, PSC Scanning ("PSC") filed an action against the Company in the U. S. District Court in Oregon. In its complaint, PSC asserted that our Stratos line of bi-optic scanners infringe two new patents issued on December 13, 2005 and January 31, 2006. We have filed an answer and counterclaim and are vigorously defending this matter. Discovery is underway in anticipation of a possible August 2007, trial date. Additionally, complying with the terms of the settlement agreement effective March 16, 2005, we have notified PSC that two lines of their products infringe our patents. Metrologic Instruments, Inc. Shareholders Litigation On September 12, 2006, the Company announced the signing of a merger agreement, a consequence of which, upon closing, will be that Metrologic will no longer be a publicly held company. Within approximately two weeks after the announcement, four shareholder actions were filed naming as defendants the Company and its individual Board of Directors, among others. All four actions were initiated in New Jersey state courts. An agreement has been reached to have these four matters consolidated and heard by the Superior Court, Law Division, Camden County. An order to this effect will be filed shortly. In anticipation of this order, an amended class action complaint was filed on October 31, 2006. This pleading again asserts, among other things, that the redemption price for the stock specified in the merger agreement is unfair to shareholders. The Amended Complaint seeks among other relief, an injunction blocking the merger or a rescission of the merger or damages. The Company plans on vigorously defending this case. We anticipate that discovery will begin shortly. On October 6, 2006, the Company received a letter from the Securities and Exchange Commission ("SEC") notifying us of the commencement of an informal investigation to determine if violations of the Federal Securities Laws have occurred and requesting certain information. The Company is in the process of responding to the SEC's information request. We are not aware of any other legal claim or action against us, which could be expected to have a material adverse effect on our consolidated financial position, results of operations or cash flows. Item 1A. Risk Factors There have been no material changes to the risk factors faced by the Company since December 31, 2005. For identification and discussion of the most significant risks applicable to the Company and its business, please refer to the Risk Factors section in Item 1A of our 2005 Form 10-K. Item 6. Exhibits 10.1 Agreement and Plan of Merger dated September 12, 2006 by and between Meteor Holding Corporation, Meteor Merger Corporation and Metrologic Instruments, Inc. (incorporated by reference from the Registrant's Current Report on Form 8-K filed September 13, 2006). 10.2 Stock Purchase Agreement dated September 19, 2006 by and among MTLG Investments, Inc., Metrologic Instruments, Inc., Adaptive Optics Associates, Inc. and Essex Corporation (incorporated by reference from the Registrant's Current Report on Form 8-K filed September 21, 2006). 31.1 Certification by Chairman of the Board and Interim Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 executed by the Chairman of the Board and Interim Chief Executive Officer of the Company. 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 executed by the Chief Financial Officer of the Company. SIGNATURES Pursuant to the requirements 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. METROLOGIC INSTRUMENTS, INC. Date: November 8, 2006 By:/s/ C. Harry Knowles ----------------- ---------------------------------------- C. Harry Knowles Chairman of the Board and Interim Chief Executive Officer (Interim Principal Executive Officer) Date: November 8, 2006 By:/s/ Michael Coluzzi ----------------- ----------------------------------------- Michael Coluzzi Chief Financial Officer (Principal Financial and Accounting Officer) Exhibit Index Page Number 31.1 Certification by Chairman of the Board and Interim Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 33 31.2 Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 34 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 executed by the Chairman of the Board and Interim Chief Executive Officer of the Company. 35 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 executed by the Chief Financial Officer of the Company. 36 Exhibit 31.1 CERTIFICATION I, C. Harry Knowles, Chairman of the Board and Interim Chief Executive Officer of Metrologic Instruments, Inc., certify that: 1. I have reviewed this report on Form 10-Q of Metrologic Instruments, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/C. Harry Knowles ---------------------------------- Name: C. Harry Knowles Title: Chairman of the Board and Interim Chief Executive Officer Date: November 8, 2006 Exhibit 31.2 CERTIFICATION I, Michael Coluzzi, Chief Financial Officer of Metrologic Instruments, Inc., certify that: 1. I have reviewed this report on Form 10-Q of Metrologic Instruments, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/Michael Coluzzi ---------------------------------- Name: Michael Coluzzi Title: Chief Financial Officer Date: November 8, 2006 EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Report of Metrologic Instruments, Inc. (the "Company") on Form 10-Q for the quarter ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, C. Harry Knowles, Chairman of the Board and Interim Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/C. Harry Knowles - ------------------------------------ C. Harry Knowles Chairman of the Board and Interim Chief Executive Officer November 8, 2006 EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Report of Metrologic Instruments, Inc. (the "Company") on Form 10-Q for the quarter ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael Coluzzi, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/Michael Coluzzi - ------------------------------- Michael Coluzzi Chief Financial Officer November 8, 2006 -----END PRIVACY-ENHANCED MESSAGE-----