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 June 30, 2007.

 

o  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: 1-10560

 

BENCHMARK ELECTRONICS, INC.

(Exact name of registrant as specified in its charter)

 

 

(979) 849-6550

(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 o

 

Indicate by check mark whether the registrant is a large accelerated filer, or a non-accelerated filer. See definition of “large accelerated filer and non-accelerated filer” in Rule 12b—2 of the Act.

 

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

 

As of August 7, 2007 there were 72,928,564 Common Shares of Benchmark Electronics, Inc., par value $0.10 per share, outstanding.

 

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

BENCHMARK ELECTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets

		June 30,			December 31,
(in thousands, except par value)		2007			2006
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	161,331		$	123,872
Short-term investments		157,135			100,460
Accounts receivable, net of allowance for doubtful accounts of $1,175 and $1,430, respectively		500,859			462,953
Inventories, net		384,557			420,347
Prepaid expenses and other assets		84,211			56,444
Deferred income taxes		18,809			6,534
Total current assets		1,306,902			1,170,610
Property, plant and equipment, net		154,111			110,912
Goodwill, net		288,875			112,999
Other, net		28,233			11,599
		$	1,778,121		$	1,406,120
Liabilities and Shareholders’ Equity
Current liabilities:
Notes payable and current installments of long-term debt and capital lease obligations		$	619		$	—
Accounts payable		369,105			335,470
Income taxes payable		6,529			31,300
Accrued liabilities		59,090			42,948
Total current liabilities		435,343			409,718
Long-term debt and capital lease obligations, less current installments		12,350			—
Other long-term liabilities		31,753			2,306
Deferred income taxes		10,658			9,074
Shareholders’ equity:
Preferred shares, $0.10 par value; 5,000 shares authorized, none issued		—			—
Common shares, $0.10 par value; 145,000 shares authorized; issued — 73,003 and 64,862, respectively; outstanding — 72,892 and 64,751, respectively		7,289			6,475
Additional paid-in capital		815,328			586,349
Retained earnings		468,681			398,949
Accumulated other comprehensive loss		(3,009		)	(6,479		)
Less treasury shares, at cost; 111 shares		(272		)	(272		)
Total shareholders’ equity		1,288,017			985,022
Commitments and contingencies
		$	1,778,121		$	1,406,120

 

See accompanying notes to condensed consolidated financial statements.

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BENCHMARK ELECTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(unaudited)

		Three Months Ended						Six Months Ended
		June 30,						June 30,
(in thousands, except per share data)		2007			2006			2007			2006
Sales		$	756,295		$	749,171		$	1,508,777		$	1,400,415
Cost of sales		701,800			696,871			1,399,794			1,302,749
Gross profit		54,495			52,300			108,983			97,666
Selling, general and administrative expenses		24,219			18,409			47,467			34,779
Amortization of intangibles		447			—			894			—
Restructuring charges and integration costs		2,205			1,261			5,550			4,030
Income from operations		27,624			32,630			55,072			58,857
Interest expense		(564		)	(97		)	(1,375		)	(183		)
Other income		3,587			1,981			5,302			3,670
Income before income taxes		30,647			34,514			58,999			62,344
Income tax expense		4,726			6,990			8,602			8,298
Net income		$	25,921		$	27,524		$	50,397		$	54,046
Earnings per share:
Basic		$	0.36		$	0.43		$	0.70		$	0.84
Diluted		$	0.35		$	0.42		$	0.69		$	0.83
Weighted-average number of shares outstanding:
Basic		72,540			64,320			71,991			63,963
Diluted		73,346			65,273			73,026			65,041

 

See accompanying notes to condensed consolidated financial statements.

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BENCHMARK ELECTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(unaudited)

		Three Months Ended						Six Months Ended
		June 30,						June 30,
(in thousands)		2007			2006			2007			2006
Net income		$	25,921		$	27,524		$	50,397		$	54,046
Other comprehensive income:
Foreign currency translation adjustments		2,094			(190		)	3,470			1,057
Comprehensive income		$	28,015		$	27,334		$	53,867		$	55,103

 

Accumulated unrealized foreign currency translation losses were $2.9 million and $6.4 million at June 30, 2007 and December 31, 2006. Foreign currency translation adjustments consist of adjustments to consolidate subsidiaries that use the local currency as their functional currency and transaction gains and losses related to intercompany dollar-denominated debt that is not expected to be repaid in the foreseeable future.

See accompanying notes to condensed consolidated financial statements.

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BENCHMARK ELECTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Shareholders’ Equity
(unaudited)

											Accumulated
							Additional				other				Total
				Common			paid-in		Retained		comprehensive		Treasury		shareholders’
(in thousands)		Shares		shares			capital		earnings		income (loss)		shares		equity
Balances, December 31, 2006		64,751		$	6,475		586,349		398,949		(6,479	)	(272	)	985,022
Adoption of FIN 48		—		—			—		19,335		—		—		19,335
Stock-based compensation expense		—		—			1,812		—		—		—		1,812
Merger		7,301		730			215,235		—		—		—		215,965
Conversion of debt		351		35			4,965		—		—		—		5,000
Stock options exercised		489		49			5,357		—		—		—		5,406
Federal tax benefit of stock options exercised		—		—			1,610		—		—		—		1,610
Comprehensive income		—		—			—		50,397		3,470		—		53,867
Balances, June 30, 2007		72,892		$	7,289		815,328		468,681		(3,009	)	(272	)	1,288,017

 

See accompanying notes to consolidated financial statements.

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BENCHMARK ELECTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited)

		Six Months Ended
		June 30,
(in thousands)		2007			2006
Cash flows from operating activities:
Net income		$	50,397		$	54,046
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		20,771			12,980
Deferred income taxes		3,361			411
Gain on the sale of property, plant and equipment		(472		)	(19		)
Asset impairment		273			—
Stock-based compensation expense		1,812			1,662
Federal tax benefit of stock options exercised		549			1,089
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable		95,180			(86,471		)
Inventories		103,845			(118,834		)
Prepaid expenses and other assets		(6,295		)	(3,246		)
Accounts payable		(90,058		)	96,081
Accrued liabilities		(22,132		)	4,665
Income taxes		3,523			(2,088		)
Net cash provided by (used in) operations		160,754			(39,724		)
Cash flows from investing activities:
Purchases of short-term investments		(265,125		)	(205,600		)
Proceeds from sales and maturities of short-term investments		208,450			238,450
Additions to property, plant and equipment		(10,044		)	(20,160		)
Proceeds from the sale of property, plant and equipment		1,195			492
Additions to purchased software		(793		)	(2,209		)
Net cash acquired in acquisitions		5,736			—
Net cash provided by (used in) investing activities		(60,581		)	10,973
Cash flows from financing activities:
Proceeds from stock options exercised		5,406			12,117
Federal tax benefit of stock options exercised		1,061			4,259
Principal payments on long-term debt and capital lease obligations		(88,465		)	—
Proceeds from long-term debt		16,760			—
Stock split costs		—			(66		)
Net cash provided by (used in) financing activities		(65,238		)	16,310
Effect of exchange rate changes		2,524			507
Net increase in cash and cash equivalents		37,459			(11,934		)
Cash and cash equivalents at beginning of year		123,872			110,845
Cash and cash equivalents at June 30		$	161,331		$	98,911

 

See accompanying notes to condensed consolidated financial statements.

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BENCHMARK ELECTRONICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(amounts in thousands, unless otherwise noted)
(unaudited)

Note 1 - Basis of Presentation

Benchmark Electronics, Inc. (the Company) is a Texas corporation in the business of manufacturing electronics and provides services to original equipment manufacturers (OEMs) of computers and related products for business enterprises, medical devices, industrial control equipment, testing and instrumentation products and telecommunication equipment. The Company has manufacturing operations located in the Americas, Asia and Europe.

The condensed consolidated financial statements included herein have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). The financial statements reflect all normal and recurring adjustments which in the opinion of management are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in accordance with generally accepted accounting principles. Actual results could differ from those estimates.

Certain reclassifications of prior period amounts have been made to conform to the current presentation.

Note 2 — Acquisitions

Effective January 8, 2007, the Company acquired Pemstar Inc. (Pemstar), a publicly traded electronics manufacturing services (EMS) company headquartered in Rochester, Minnesota (the Merger). Pursuant to the Agreement and Plan of Merger among the Company and Pemstar dated October 16, 2006 (the Merger Agreement), each issued and outstanding share of common stock, par value $0.01 per share, of Pemstar was converted into the right to receive 0.160 of a common share, par value $0.10 per share, of the Company. With the closing of the Merger, Pemstar became a wholly owned subsidiary of the Company. This acquisition expanded the Company’s customer base and deepened its engineering and systems integration capabilities.

The aggregate purchase price was $221.4 million, including common shares valued at $202.5 million, stock options and warrants valued at $9.0 million, conversion feature of debt valued at $4.8 million and estimated acquisition costs of $5.1 million. The value of the 7.3 million common shares issued was based on the average market price of the Company’s common shares over the 2-day period before and after the terms of the acquisition were agreed to and announced.

As a direct result of the Merger, the Company assumed approximately $89.4 million of indebtedness, including $5 million in convertible senior subordinated notes. Subsequent to the Merger, the Company reduced the assumed debt by $71.7 million. The convertible senior subordinated notes matured on May 1, 2007 and were converted into 0.4 million common shares at the request of the noteholders. Prior to the Merger, the Company had no outstanding debt.

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The Company is accounting for the Merger utilizing the accounting principles promulgated by Statement of Financial Accounting Standards (SFAS) Nos. 141 and 142. Therefore, the results of operations of the Pemstar operations since January 8, 2007 have been included in the accompanying consolidated statement of income. The preliminary allocation of the net purchase price of the Merger resulted in goodwill of approximately $171.1 million. The ultimate allocation of the purchase price may differ from the amounts included in these financial statements. Adjustments to the purchase price allocations, if any, are expected to be finalized by the end of 2007, and will be reflected in future filings. Management does not expect these adjustments, if any, to have a material effect on the Company’s financial position or results of operations. In connection with the Merger, the Company amended its Amended and Restated Credit Agreement dated June 23, 2000 to permit the Merger.

The following is an estimate of the purchase price for Pemstar and the preliminary purchase price allocation (in thousands):

Acquisition of the 45.6 million shares of outstanding common stock of Pemstar at $4.44 per share		$	202,475
Estimated fair value of Pemstar stock options and warrants		9,023
Estimated fair value of the conversion feature of debt		4,773
Acquisition costs		5,140
Total purchase price		$	221,411
Current assets		$	236,227
Property, plant and equipment		52,090
Deferred taxes		11,286
Goodwill		171,127
Intangible assets		17,877
Other assets		7,151
Total assets acquired		495,758
Current liabilities		182,202
Long-term debt, capital lease obligations and other long-term liabilities		92,145
Total liabilities assumed		274,347
Net assets acquired		$	221,411

 

On March 1, 2007, we terminated a joint venture agreement and acquired for $5.3 million the remaining 40% minority interest in the Company’s Romanian subsidiary. We acquired the other 60% interest in the Merger discussed above. The purchase price in excess of the 40% minority interest liability resulted in goodwill of $4.7 million.

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The following summary pro forma condensed consolidated financial information reflects the acquisition of Pemstar as if it had occurred on January 1, 2006 for purposes of the statements of income. The summary pro forma information is not necessarily representative of what the Company’s results of operations would have been had the acquisition of Pemstar in fact occurred on January 1, 2006 and is not intended to project the Company’s results of operations for any future period or date. Pro forma results of operations for the six months ended June 30, 2007 related to the Merger have not been presented since the operating results for Pemstar for the period up to the date of acquisition are immaterial.

Pro forma condensed consolidated financial information for the six months ended June 30, 2006 (unaudited):

		Six months ended
		June 30, 2006
Net sales		$	1,668,000
Gross profit		$	123,253
Income from operations		$	70,038
Net income		$	59,614
Earnings per share:
Basic		$	0.84
Diluted		$	0.82
Weighted-average number of shares outstanding:
Basic		71,265
Diluted		72,970

 

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Note 3 — Stock-Based Compensation

The Company’s stock awards plan permits the grant of a variety of types of awards, including stock options, restricted stock awards, stock appreciation rights, performance awards, and phantom stock awards, or any combination thereof, to key employees of the Company. Stock options are granted to employees with an exercise price equal to the market price of the Company’s stock on the date of grant, vest over a four-year period from the date of grant and have a term of ten years. Members of the Board of Directors of the Company who are not employees of the Company participate in a separate stock option plan that provides for the granting of stock options upon the occurrence of the non-employee director’s election or re-election to the Board of Directors. All awards under the non-employee director stock option plan are fully vested upon the date of grant and have a term of ten years. As of June 30, 2007, 5.6 million additional options may be granted under the Company’s existing plans.

Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The total compensation cost recognized for stock-option awards was $1.2 million and $1.8 million for the three and six month periods ended June 30, 2007, and  $1.2 million and $1.7 million for the three and six month periods ended June 30, 2006. The compensation expense for stock-based awards includes an estimate for forfeitures and is recognized over the vesting period of the options using the straight-line method. SFAS No. 123R requires that cash flows from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for stock-based awards (excess tax benefits) be classified as cash flows from financing activities.

As of June 30, 2007, there was approximately $7.2 million of total unrecognized compensation cost related to nonvested stock options. That cost is expected to be recognized over a weighted-average period of 2.9 years.

During the three months and six months ended June 30, 2007, the Company issued 0.1 million and 0.4 million options, respectively. In connection with the Merger, all outstanding Pemstar options were converted into options of the Company at the 0.160 exchange ratio on January 8, 2007. These were the only options issued during the three months ended March 31, 2007. During the three months and six months ended June 30, 2006, the Company issued 0.1 million and 1.1 million options, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average assumptions used to value the options converted from Pemstar and the option grants during the three and six months ended June 30, 2007 and 2006 were as follows:

		Three Months Ended				Six Months Ended
		June 30,				June 30,
		2007		2006		2007		2006
Expected term of options		7.0 years		5.4 years		2.7 years		4.5 years
Expected volatility		42	%	42	%	29	%	46	%
Risk-free interest rate		4.65	%	5.04	%	4.83	%	4.43	%
Dividend yield		zero		zero		zero		zero

 

The expected term of the options represents the estimated period of time until exercise and is based on historical experience, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Separate groups of employees that have similar

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historical exercise behavior are considered separately for valuation purposes. Expected stock price volatility is based on the historical volatility of the Company’s stock. The risk-free interest rate is based on the U.S. Treasury zero-coupon rates in effect at the time of grant with an equivalent remaining term. The dividend yield reflects that the Company has not paid any cash dividends since inception.

The weighted-average fair value per option granted during the three and six months ended June 30, 2007 was $11.01 and $9.45. The total cash received as a result of stock option exercises for the six months ended June 30, 2007 and 2006 was approximately $5.4 million and $12.1 million, respectively. The tax benefit realized as a result of the stock option exercises was $1.6 million and $5.3 million during the first six months of 2007 and 2006. For the six months ended June 30, 2007 and 2006, the total intrinsic value of stock options exercised was $5.2 million and $17.3 million, respectively.

The following table summarizes the activities relating to the Company’s stock option plans:

							Weighted-
				Weighted-			Average
				Average			Remaining		Aggregate
		Number of		Exercise			Contractual		Intrinsic
		Options		Price			Term (Years)		Value
Outstanding at December 31, 2006		5,716		$	18.54		6.37
Granted		51		$	21.35
Converted from Merger		369		$	25.48
Exercised		(489	)	$	11.06
Canceled		(188	)	$	29.65
Outstanding at June 30, 2007		5,459		$	19.33		6.09		$	25,595
Exercisable at June 30, 2007		3,884		$	17.08		4.95		$	25,592

 

The aggregate intrinsic value in the table above is before income taxes and is calculated as the difference between the exercise price of the underlying options and the Company’s closing stock price of $22.62 as of the last business day of the period ended June 30, 2007 for options that had exercise prices that were lower than the closing price.

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Note 4 — Earnings Per Share

Basic earnings per share is computed using the weighted-average number of shares outstanding. Diluted earnings per share is computed using the weighted-average number of shares outstanding adjusted for the incremental shares attributed to outstanding stock equivalents during the three and six months ended June 30, 2007 and 2006. Stock equivalents include common shares issuable upon the exercise of stock options and other equity instruments, and are computed using the treasury stock method. The following table sets forth the calculation of basic and diluted earnings per share.

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2007			2006			2007			2006
Numerator for basic per share - net income		$	25,921		$	27,524		$	50,397		$	54,046
Interest expense on outstanding equity instruments, net of tax		32			—			147			—
Numerator for diluted earnings per share		$	25,953		$	27,524		$	50,544		$	54,046
Denominator for basic earnings per share - weighted-average number of common shares outstanding during the period		72,540			64,320			71,991			63,963
Incremental common shares attributable to exercise of outstanding dilutive options		538			953			658			1,078
Incremental common shares attributable to conversion of 6.5% convertible debt		133			—			241			—
Incremental common shares attributable to exercise of warrants		135			—			136			—
Denominator for diluted earnings per share		73,346			65,273			73,026			65,041
Basic earnings per share		$	0.36		$	0.43		$	0.70		$	0.84
Diluted earnings per share		$	0.35		$	0.42		$	0.69		$	0.83

 

Options to purchase 3.1 million and 0.1 million common shares for the three and six months ended June 30, 2007 and 2006, respectively were not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price of the common shares for the period.

At June 30, 2007, the Company has outstanding warrants to purchase common shares as follows:

 

These warrants were assumed in the Merger.

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Note 5 — Goodwill and Other Intangible Assets

Goodwill associated with each of the Company’s business segments and changes in those amounts during the six-month period ended June 30, 2007 were as follows:

		Americas			Asia			Europe			Total
Goodwill, December 31, 2006		$	106,931		$	6,068		$	—		$	112,999
Acquisitions		119,742			36,420			19,686			175,848
Currency translation adjustment		28			—			—			28
Goodwill, June 30, 2007		$	226,701		$	42,488		$	19,686		$	288,875

 

Identifiable intangible assets totaling $17.9 million consist of customer relationships acquired in the Merger. Amortization of intangible assets for the three and six months ended June 30, 2007 totaled $0.4 million and $0.8 million. Amortization of these intangible assets for 2007 through 2017 will be approximately $1.8 million per year.

Note 6 — Borrowing Facilities

Notes payable, long-term debt and capital lease obligations outstanding as of June 30, 2007 consists of the following:

Notes payable and long-term debt		$	356
Capital lease obligations		12,613
Total		12,969
Less current notes payable and current installments		619
Notes payable, long-term debt and capital lease obligations, less current installments		$	12,350

 

In connection with the Merger, the Company assumed approximately $89.4 million of debt, including $5 million in convertible senior subordinated notes. Subsequent to the Merger, the Company reduced the assumed debt by $71.7 million. The convertible senior subordinated notes matured on May 1, 2007 and were converted into 0.4 million common shares at the request of the noteholders. Prior to the Merger, the Company had no outstanding debt.

Under the terms of a Credit Agreement (the Credit Agreement), the Company has a $100 million three-year revolving credit line for general corporate purposes which can be increased to a total of $200 million and which expires January 20, 2008. Interest on outstanding borrowings under the Credit Agreement is payable quarterly, at the Company’s option, at either the bank’s Eurodollar rate plus 1.00% to 1.75% or its prime rate plus 0.00% to 0.25%, based upon the Company’s debt ratio as specified in the Credit Agreement. A commitment fee of 0.20% to 0.35% per annum (based upon the Company’s debt ratio) on the unused portion of the revolving credit line is payable quarterly in arrears. As of June 30, 2007, the Company had no borrowings outstanding under the Credit Agreement and $100 million was available for future borrowings. The Credit Agreement is secured by the Company’s domestic inventory and accounts receivable, 100% of the stock of the Company’s domestic subsidiaries, 65% of the voting capital stock of each direct foreign subsidiary and substantially all of the other tangible and intangible assets of the Company and its domestic subsidiaries. The Credit Agreement contains customary financial covenants as to working capital, debt leverage, fixed charges, and consolidated net worth, and restricts the ability of the Company to incur additional debt, pay dividends, sell assets, and to merge or consolidate

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with other persons, without the consent of the banks. As of June 30, 2007, the Company was in compliance with all such covenants and restrictions.

The Company’s Thailand subsidiary has a credit agreement with Kasikornbank Public Company Limited (the Thai Credit Agreement). The Thai Credit Agreement provides that the lender will make available to the Company’s Thailand subsidiary up to approximately $16 million in revolving loans and machinery loans. The Thai Credit Agreement is secured by land, buildings and machinery in Thailand. In addition, the Thai Credit Agreement provides for approximately $1.9 million (62 million Thai baht) in working capital availability in the form of working capital loans (10 million Thai baht) and bank guarantees (52 million Thai baht). Availability of funds under the Thai Credit Agreement is reviewed annually and is currently accessible through September 2007. As of June 30, 2007, the Company’s Thailand subsidiary had no working capital borrowings outstanding.

In addition, the Company had two other available banking facilities assumed in the Merger which have been terminated.

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Note 7 - Inventories

Inventory costs are summarized as follows:

		June 30,			December 31,
		2007			2006
Raw materials		$	273,222		$	296,814
Work in process		81,930			90,787
Finished goods		29,405			32,746
		$	384,557		$	420,347

 

Note 8 - Income Taxes

Income tax expense (benefit) consists of the following:

		Six Months Ended
		June 30,
		2007			2006
Federal — Current		$	2,525		$	6,102
Foreign — Current		2,167			(131		)
State — Current		549			1,916
Deferred		3,361			411
		$	8,602		$	8,298

 

Income tax expense differs from the amount computed by applying the U.S. federal statutory income tax rate to income before income tax primarily due to the impact of foreign income taxes, state income taxes (net of federal benefit) and tax-exempt interest income.

The Company considers earnings from foreign subsidiaries to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state income taxes has been made for these earnings. Upon distribution of foreign subsidiary earnings in the form of dividends or otherwise, such distributed earnings would be reportable for U.S. income tax purposes (subject to adjustment for foreign tax credits).

The Company has been granted certain tax incentives, including tax holidays, for its subsidiaries in China, Ireland, and Thailand. These tax incentives, including tax holidays, expire on various dates through 2012, and are subject to certain conditions with which the Company expects to comply. The net impact of these tax incentives was to lower income tax expense for the six months periods ended June 30, 2007 and 2006 by approximately $9.1 million (approximately $0.12 per diluted share) and $7.7 million (approximately $0.12 per diluted share), respectively.

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Note 9 - Segment and Geographic Information

The Company has manufacturing facilities in the Americas, Asia and Europe to serve its customers. The Company is operated and managed geographically. The Company’s management evaluates performance and allocates the Company’s resources on a geographic basis. Intersegment sales are generally recorded at prices that approximate arm’s length transactions. Operating segments’ measure of profitability is based on income from operations. The accounting policies for the reportable operating segments are the same as for the Company taken as a whole.

The Company has three reportable operating segments: the Americas, Europe, and Asia. Information about operating segments was as follows:

		Three Months						Six Months Ended
		June 30,						June 30,
		2007			2006			2007			2006
Net sales:
Americas		$	572,778		$	688,393		$	1,133,101		$	1,280,210
Asia		229,966			227,626			455,932			409,866
Europe		99,601			102,094			198,322			187,248
Elimination of intersegment sales		(146,050		)	(268,942		)	(278,578		)	(476,909		)
		$	756,295		$	749,171		$	1,508,777		$	1,400,415
Depreciation and amortization:
Americas		$	5,045		$	3,407		$	10,309		$	6,710
Asia		3,999			2,411			7,902			4,694
Europe		525			128			1,253			320
Corporate		573			631			1,307			1,256
		$	10,142		$	6,577		$	20,771		$	12,980
Income from operations:
Americas		$	18,011		$	22,769		$	32,884		$	44,190
Asia		12,981			17,274			29,307			29,811
Europe		2,013			(597		)	2,055			(1,796		)
Corporate and intersegment eliminations		(5,381		)	(6,816		)	(9,174		)	(13,348		)
		$	27,624		$	32,630		$	55,072		$	58,857
Capital expenditures:
Americas		$	1,349		$	4,002		$	2,708		$	9,746
Asia		836			6,392			6,794			9,921
Europe		334			318			542			493
		$	2,519		$	10,712		$	10,044		$	20,160

 

		June 30,			December 31,
		2007			2006
Total assets:
Americas		$	1,132,387		$	977,432
Asia		476,863			333,945
Europe		164,845			89,003
Corporate and other		4,026			5,740
		$	1,778,121		$	1,406,120

 

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The following enterprise-wide information is provided in accordance with SFAS No. 131.  Geographic net sales information reflects the destination of the product shipped.  Long-lived assets information is based on the physical location of the asset.

		Three Months						Six Months Ended
		June 30,						June 30,
		2007			2006			2007			2006
Geographic net sales:
United States		$	583,503		$	583,821		$	1,150,191		$	1,080,396
Asia		40,561			24,000			87,268			46,797
Europe		121,519			136,120			251,844			263,409
Other Foreign		10,712			5,230			19,474			9,813
		$	756,295		$	749,171		$	1,508,777		$	1,400,415

 

		June 30,			December 31,
		2007			2006
Long-lived assets:
United States		$	93,373		$	66,491
Asia		69,432			45,287
Europe		11,185			1,419
Other		8,354			9,314
		$	182,344		$	122,511

 

Note 10 — Supplemental Cash Flow Information

The following is additional information concerning supplemental disclosures of cash payments.

		Three Months						Six Months Ended
		June 30,						June 30,
		2007			2006			2007			2006
Income taxes paid (refunded), net		$	(866	)	$	10,367		$	(52	)	$	10,748
Interest paid		539			62			1,059			115

 

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Note 11 — Contingencies

The Company is involved in various legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

The following legal proceedings were acquired in the Merger and are considered outside the ordinary course of business.

On June 16, 2005 a putative class action was filed by an individual shareholder against Pemstar and certain of its officers and directors. The lawsuit is pending in the United States District Court for the District Court of Minnesota and is captioned: In re PEMSTAR INC. Securities Litigation, Civil Action No. 05-CV-01182 — JMR/FLN. The lawsuit alleges violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Section 11 of the Securities Act of 1933. An Amended Complaint was filed on November 28, 2005. The plaintiff alleges, in essence, that the defendants defrauded Pemstar’s shareholders by failing to timely disclose the circumstances around the discrepancies in the accounting of the Mexico facility that generated a restatement. The lawsuit also alleges that the registration statement filed by Pemstar in connection with a secondary offering contained false, material misrepresentations. The plaintiff seeks to represent a class of persons who purchased Pemstar stock from January 30, 2003 through and including January 12, 2005. The Amended Complaint does not specify an amount of damages. The Company and the individuals will vigorously defend against the claim and believe the lawsuit is without merit.

The Company is subject to examination by tax authorities for varying periods in various U.S. and foreign taxing jurisdictions. During the course of such examinations disputes occur as to matters of fact and/or law. Also, in most taxing jurisdictions the passage of time without examination will result in the expiration of applicable statutes of limitations thereby precluding the taxing authority from conducting an examination of the tax period(s) for which such statute of limitation has expired. The Company believes that it has adequately provided for its tax liabilities.

Note 12 — Impact of Recently Issued Accounting Standards

On January 1, 2007, we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. Under FIN 48, the Company must determine whether it is “more-likely-than-not” that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the financial statements. FIN 48 applies to all tax positions related to income taxes subject to SFAS No. 109, “Accounting for Income Taxes”. The cumulative effect of adopting FIN 48 was a $19.3 million decrease to income taxes payable with a corresponding increase to the January 1, 2007 balance of retained earnings for tax benefits not previously recognized.

The total balance of the reserve for uncertain income tax benefits as of the date of adoption was $16.8 million. The reserve is classified as a current or long-term liability in the consolidated balance sheet based on the Company’s expectation of when the items will be settled. Included in the total reserve is accrued interest of $0.2 million. There are no penalties accrued as of the date of adoption. If the total amount of the unrecognized tax benefits as of the date of adoption were recognized, the Company’s income tax expense would have decreased by $16.8 million. The

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Company records interest expense and penalties accrued in relation to uncertain income tax benefits as a component of current income tax expense.

As of June 30, 2007, the total amount of the reserve for uncertain tax benefits including interest and penalties is $35.8 million and it is classified as a current or long-term liability in the consolidated balance sheet based on the Company’s expectation of when the items will be settled. Interest and penalties are included in the total reserve of approximately $2.1 million and $1.6 million, respectively. The increase in the total reserve is primarily the result of the addition of uncertain tax benefits acquired from Pemstar. The analysis of the uncertain tax positions related to Pemstar for both U.S. and foreign jurisdictions under FIN 48 was performed as of the acquisition date. Any adjustments recorded related to the uncertain tax positions of the Pemstar acquisition was recognized as part of a business combination pursuant to SFAS No. 141.

During the next twelve months, it is reasonably possible that the reserve for uncertain tax benefits will decrease by approximately $7.1 million as it relates to certain U.S. and foreign income tax benefits for worthless stock deductions, and income tax audits due to the expiration of the statute of limitations or final audit settlements in respective countries. If realized, the Company’s income tax expense would decrease by $7.1 million. As of January 1, 2007, the Company’s business locations in the United States, Ireland, Mexico, Thailand, Singapore, Netherlands, China, and Luxembourg remain open to examination by the various local taxing authorities, in total or in part, for years ended 2001 to 2006, respectively.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements’’ (SFAS No. 157), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands the requisite disclosures for fair value measurements. SFAS No. 157 is effective in fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of adopting SFAS No. 157 on its consolidated results of operations and financial condition.

In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 159 on its consolidated financial position and results of operations.

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Note 13 — Restructuring Charges and Integration Costs

The Company has undertaken initiatives to restructure its business operations with the intention of improving utilization and realizing cost savings in the future. These initiatives have included changing the number and location of production facilities, largely to align capacity and infrastructure with current and anticipated customer demand. This alignment includes transferring programs from higher cost geographies to lower cost geographies. The process of restructuring entails, among other activities, moving production between facilities, reducing staff levels, realigning our business processes and reorganizing our management.

The Company recognized restructuring charges during 2006 related to reductions in workforce and the re-sizing and closure of certain facilities. These charges were recorded pursuant to plans developed and approved by management. Restructuring charges associated with these realignment efforts, primarily related to the closure of the Company’s Leicester, England and Loveland, Colorado facilities, were approximately $4.7 million ($4.0 million net of tax) during the year ended December 31, 2006.

The following table summarizes the respective payments and the remaining accrued balance as of June 30, 2007 for estimated restructuring charges incurred during the year ended December 31, 2006:

					Facility			Other
					Lease			Exit			Total
		Severance			Costs			Costs			Costs
Balance as of December 31, 2006		$	200		$	57		$	142		$	399
Payments		(144		)	(14		)	(142		)	(300		)
Balance as of March 31, 2007		$	56		$	43		$	—		$	99
Provision for charges incurred		(11		)	(40		)	—			(51		)
Payments		(8		)	(3		)	—			(11		)
Currency translation adjustments		2			—			—			2
Balance as of June 30, 2007		$	39		$	—		$	—		$	39

 

Accruals related to restructuring activities are recorded in accrued liabilities in the accompanying consolidated balance sheets. The Company expects to pay all 2006 restructuring charges by September 30, 2007.

The Company recognized restructuring charges during 2007 related to reductions in workforce and the re-sizing of certain facilities. These charges were recorded pursuant to plans developed and approved by management. Restructuring charges associated with these realignment efforts, primarily related to the transfer of the Company’s PCBA operations in Dublin, Ireland to Brasov, Romania and the consolidation and resizing of certain other facilities, were approximately $0.6 million and $1.4 million  ($0.4 million and $1.2 million net of tax) during the three and six months ended June 30, 2007.

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The following table summarizes the respective payments and the remaining accrued balance as of June 30, 2007 for estimated restructuring charges incurred during the six months ended June 30, 2007:

					Facility			Other
					Lease			Exit			Total
		Severance			Costs			Costs			Costs
Balance as of December 31, 2006		$	—		$	—		$	—		$	—
Provision for charges incurred		521			—			314			835
Payments		(348		)	—			(4		)	(352		)
Non-cash charges incurred		—			—			(273		)	(273		)
Balance as of March 31, 2007		$	173		$	—		$	37		$	210
Provision for charges incurred		476			200			(69		)	607
Payments, net of cash receipts		(582		)	—			32			(550		)
Currency translation adjustments		1			—			—			1
Balance as of June 30, 2007		$	68		$	200		$	—		$	268

 

Accruals related to restructuring activities are recorded in accrued liabilities in the accompanying consolidated balance sheets. The Company expects to pay all 2007 restructuring charges by December 31, 2007.

The components of the 2007 restructuring charges during the first six months of 2007 were as follows:

		Americas			Asia			Europe			Total
Severance costs		$	381		$	189		$	427		$	997
Facility lease costs		200			—			—			200
Other exit costs		—			—			245			245
		$	581		$	189		$	672		$	1,442

 

During the first six months of 2007, the Company recorded approximately $1.0 million of employee termination costs associated with the involuntary terminations of 172 identified employees in connection with various facility closures, consolidations and resizing of certain facilities. The identified involuntary employee terminations by reportable geographic region amounted to approximately 118, 16 and 38 for the Americas, Asia and Europe, respectively.

During the first six months of 2007, the Company recorded approximately $0.2 million for facility lease obligations. The restructuring charges recorded during the first six months of 2006 also included approximately $0.2 million for other exit costs.

In connection with the Pemstar acquisition, a total of $1.7 million ($1.1 million net of tax) and $4.2 ($3.0 million net of tax) in integration costs were incurred during the three and six months ended June 30, 2007. These costs include redundant operating costs that are expected to be eliminated in future periods.

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Note 14 — Subsequent Event

On July 25, 2007, the Board of Directors of the Company approved the repurchase of up to $125 million of the Company’s outstanding common shares. Share purchases may be made in the open market, in privately negotiated transactions or block transactions, at the discretion of the Company’s management and as market conditions warrant. Purchases will be funded from available cash and may be commenced, suspended or discontinued at any time without prior notice. Shares repurchased under the program will be retired.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

References in this report to “the Company,” “Benchmark,” “we,” or “us” mean Benchmark Electronics, Inc. together with its subsidiaries. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts. They use words such as “anticipate,” “believe,” “intend,” “plan,” “projection,” “forecast,” “strategy,” “position,” “continue,” “estimate,” “expect,” “may,” “will,” or the negative of those terms or other variations of them or comparable terminology. In particular, statements, express or implied, concerning future operating results or the ability to generate sales, income or cash flow are forward-looking statements. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions, including those discussed under Part II, Item 1A of this report. The future results of our operations may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results are beyond our ability to control or predict. You should not put undue reliance on any forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.

The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto.

OVERVIEW

We are in the business of manufacturing electronics and provide our services to original equipment manufacturers (OEMs) of computers and related products for business enterprises, medical devices, industrial control equipment, testing and instrumentation products, and telecommunication equipment. The services that we provide are commonly referred to as electronics manufacturing services (EMS). We offer our customers comprehensive and integrated design and manufacturing services, from initial product design to volume production and direct order fulfillment. Our manufacturing and assembly operations include printed circuit boards and subsystem assembly, box build and systems integration. Systems integration is the process of integrating subsystem and PCBAs and, often, downloading and integrating software, to produce a fully configured product. We also provide specialized engineering services, including product design, printed circuit board layout, prototyping, and test development. We believe that we have developed strengths in the manufacturing process for large, complex, high-density printed circuit boards as well as the ability to manufacture high and low volume products in lower cost regions such as Brazil, China, Mexico, Romania and Thailand.

As our customers have continued to expand their globalization strategy during the past several years, we have continued to make the necessary changes to align our business operations with our customers’ demand. These changes include, among other activities, moving production between facilities, reducing staff levels, realigning our business processes and reorganizing our management. Restructuring charges associated with these realignment efforts, primarily related to the closure of our Leicester, England and Loveland, Colorado facilities, were approximately $4.7 million (pre-tax) during the year ended December 31, 2006. During the six months ended June 30, 2007, we incurred $1.4 million (pre-tax), primarily related to the transfer of the Company’s PCBA operations in Dublin, Ireland to Brasov, Romania and the consolidation and resizing of certain other facilities, as we continue to expand our low-cost capacity while realigning and

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further strengthen our global footprint to support continued business opportunities. These efforts will continue throughout 2007. We believe that our global manufacturing presence increases our ability to be responsive to our customers’ needs by providing accelerated time-to-market and time-to-volume production of high quality products. These capabilities should enable us to build stronger strategic relationships with our customers and to become a more integral part of their operations. Our customers face challenges in planning, procuring and managing their inventories efficiently due to customer demand fluctuations, product design changes, short product life cycles and component price fluctuations. We employ production management systems to manage their procurement and manufacturing processes in an efficient and cost-effective manner so that, where possible, components arrive on a just-in-time, as-and-when needed basis. We are a significant purchaser of electronic components and other raw materials, and can capitalize on the economies of scale associated with our relationships with suppliers to negotiate price discounts, obtain components and other raw materials that are in short supply, and return excess components. Our expertise in supply chain management and our relationships with suppliers across the supply chain enables us to reduce our customers’ cost of goods sold and inventory exposure.

We recognize revenue from the sale of circuit board assemblies, systems and excess inventory when the goods are shipped, title and risk of ownership have passed, the price to the buyer is fixed and determinable and recoverability is reasonably assured. Revenue from design, development and engineering services is recognized when the services are performed and collectibility is reasonably certain. Such services provided under fixed price contracts are accounted for using the percentage of completion method. We assume no significant obligations after product shipment as we typically warrant workmanship only. Therefore, our warranty provisions are insignificant.

Our cost of sales includes the cost of materials, electronic components and other materials that comprise the products we manufacture, the cost of labor and manufacturing overhead, and adjustments for excess and obsolete inventory. Our procurement of materials for production requires us to commit significant working capital to our operations and to manage the purchasing, receiving, inspection and stocking of materials. Although we bear the risk of fluctuations in the cost of materials and excess scrap, we periodically negotiate cost of materials adjustments with our customers. Our gross margin for any product depends on the sales price, the proportionate mix of the cost of materials in the product and the cost of labor and manufacturing overhead allocated to the product. We typically have the potential to realize higher gross margins on products where the proportionate level of labor and manufacturing overhead is greater than that of materials. As we gain experience in manufacturing a product, we usually achieve increased efficiencies, which result in lower labor and manufacturing overhead costs for that product and higher gross margins.

Recent Acquisition

Effective January 8, 2007, we acquired Pemstar Inc. (Pemstar), a publicly traded EMS company headquartered in Rochester, Minnesota (the Merger). Pursuant to the Agreement and Plan of Merger among Benchmark and Pemstar dated October 16, 2006 (the Merger Agreement), each issued and outstanding share of common stock, par value $0.01 per share, of Pemstar was converted into the right to receive 0.160 of a common share, par value $0.10 per share, of Benchmark. With the closing of the Merger, Pemstar became a wholly owned subsidiary of Benchmark. This acquisition expanded our customer base and deepened our engineering and systems integration capabilities.

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The aggregate purchase price was $221.4 million, including common shares valued at $202.5 million, stock options and warrants valued at $9.0 million, conversion feature of debt valued at $4.8 million and estimated acquisition costs of $5.1 million. The value of the 7.3 million common shares issued was based on the average market price of our common shares over the 2-day period before and after the terms of the acquisition were agreed to and announced.

As a direct result of the Merger, we assumed approximately $89.4 million of indebtedness, including $5 million in convertible senior subordinated notes. Subsequent to the Merger, we reduced the assumed debt by $71.7 million. The convertible senior subordinated notes matured on May 1, 2007 and were converted into 0.4 million common shares at the request of the noteholders. Prior to the Merger, the Company had no outstanding debt.

We are accounting for the Merger utilizing the accounting principles promulgated by Statement of Financial Accounting Standards (SFAS) Nos. 141 and 142. Therefore, the results of operations of the Pemstar operations since January 8, 2007 have been included in the accompanying consolidated statements of income.  The preliminary allocation of the net purchase price of the Merger resulted in goodwill of approximately $171.1 million.

The inclusion of the operations of the acquired facilities in Benchmark’s accounts is responsible for a substantial portion of the variations in the results of our operations (including components thereof) from period to period.  The effects of the Merger on our financial condition and our reported results of operations should be considered when reading the financial information contained herein.

The Merger constitutes a significant expansion of our operations.  Accordingly, the potential effect of the Merger on our future financial condition, liquidity and results of operations should be considered when reading the historical financial information and related discussions set forth in the following section.  See Note 2 to the Condensed Consolidated Financial Statements.

Summary of Results

Sales for the three months ended June 30, 2007 increased 1% to $756.3 million compared to $749.2 million for the same period of 2006. Sales to our largest customer, Sun Microsystems, Inc., represented 25% of our sales in 2007 compared to 41% of our sales in 2006. Sales to our largest customer decreased $123.6 million from $310.2 million in the second quarter of 2006 to $186.6 million in the second quarter of 2007. For the remainder of 2007, we expect that revenues from our top customer will remain in the mid 20% range. The decrease in sales to our largest customer was offset by an increase in sales of $130.7 million, primarily a result of the Merger and increased sales under new programs.

Our gross profit as a percentage of sales increased to 7.2% in 2007 from 7.0% in 2006. We do experience fluctuations in gross profit from period to period. Comparing 2007 to 2006, the fluctuations were due primarily to changes in production levels, production mix, inventory levels, new program ramps, product crossovers and other factors, including the impacts of the Merger. Different programs can contribute different gross profits depending on factors such as the types of services involved, location of production, size of the program, complexity of the product, and level of material costs associated with the various products. New programs can contribute relatively less to our gross profit in their early stages when manufacturing volumes are usually lower, resulting in inefficiencies and unabsorbed manufacturing overhead costs. In addition, a number of our new and higher volume programs remain subject to competitive constraints that could exert downward pressure on our margins in the near future.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2006. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to allowance for doubtful accounts, inventories, deferred taxes, impairment of long-lived assets, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe 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. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Allowance for doubtful accounts

Our accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers. Because our accounts receivable are typically unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customer’s ability to pay as well as the age of the receivables. To evaluate a specific customer’s ability to pay, we analyze financial statements, payment history, third-party credit analysis reports and various information or disclosures by the customer or other publicly available information. In cases where the evidence suggests a customer may not be able to satisfy its obligation to us, we set up a specific allowance in an amount we determine appropriate for the perceived risk. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventory valuation reserve

We purchase inventory based on forecasted demand and record inventory at the lower of cost or market. We reserve for estimated obsolescence as necessary in an amount equal to the difference between the cost of inventory and estimated market value based on assumptions of future demands and market conditions. We evaluate our inventory valuation on a quarterly basis based on current and forecasted usage and the latest forecasts of product demand and production requirements from our customers. Customers frequently make changes to their forecasts, requiring us to make changes to our inventory purchases, commitments, and production scheduling and may require us to cancel open purchase commitments with our vendors. This process may lead to on-hand inventory quantities and on-order purchase commitments that are in excess of our customer’s revised needs, or parts that become obsolete before use in production. We record inventory reserves on excess and obsolete inventory. These reserves are established on inventory which we have determined that our customers are not responsible for or on inventory that we believe our customers are unable to fulfill their obligation to ultimately purchase such inventory from us. If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required.

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Income Taxes

We estimate our income tax provision in each of the jurisdictions in which we operate, including estimating exposures related to examinations by taxing authorities. We must also make judgments regarding the ability to realize the deferred tax assets. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to subsequently determine that we would be able to realize our deferred tax assets in excess of our net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Similarly, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would reduce income in the period such determination was made.

We are subject to examination by tax authorities for varying periods in various U.S. and foreign taxing jurisdictions. During the course of such examinations disputes occur as to matters of fact and/or law. Also, in most taxing jurisdictions the passage of time without examination will result in the expiration of applicable statutes of limitations thereby precluding the taxing authority from conducting an examination of the tax period(s) for which such statute of limitations has expired. We believe that we have adequately provided for our tax liabilities.

Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge would be recognized by the amount that the carrying amount of the asset exceeds the fair value of the asset.

Goodwill is tested annually for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss would be recognized to the extent that the carrying amount exceeds the asset’s fair value. We completed the annual impairment test during the fourth quarter of 2006 and determined that no impairment existed as of the date of the impairment test. Goodwill and intangible assets are measured at the reporting unit level, which we have determined to be consistent with our operating segments as defined in Note 9 to the Condensed Consolidated Financial Statements in Item 1 of this report, by determining the fair values of the reporting units using a discounted cash flow model and comparing those fair values to the carrying values, including goodwill, of the reporting unit. At June 30, 2007, we had net goodwill of approximately $288.9 million, including $175.8 million resulting from 2007 acquisitions. Circumstances that may lead to impairment of goodwill include unforeseen decreases in future performance or industry demand, and the restructuring of our operations as a result of a change in our business strategy.

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