Polk Co-Founders to Get $83,000 Each As Advisers to New Owners

As holders of significant blocks of Polk shares, Klopfer and Polk stand to reap big financial gains from the $136.25 million “stock purchase” agreement with Directed. But their exact take from the sale likely won’t be disclosed. That’s because management -- dissatisfied that a decade of trading on the Nasdaq hadn’t boosted Polk’s value -- took the company private several years ago. Klopfer and Polk have been at the Polk Audio helm 35 years and have “gone through a number of transitions,” Minarik said in answer to an analyst’s question why the co-founders wanted to sell. They ceded day-to- operations to Pres. Jim Herd 2-3 years ago, Minarik said. Their ages, estate planning and other considerations “played into their decision to sell,” he said, referring further questions to Klopfer and Polk. Herd and members of his executive team will continue in their roles, Minarik said.

“Acquisitions are something you can’t exactly time,” Minarik said when asked why Directed bought Polk now. Directed began talks with Polk several years ago, he said. Competition to acquire Polk was “heated” among private equity buyers, Minarik said: “The management at Polk decided they were going to go through this transition. They were fully committed to it. We felt we had somewhat of an inside track. Obviously, by concluding the transaction we were able to prove that. We don’t necessarily pick the perfect time, but we picked the time that the right acquisition was available.”

Polk is “a very major supplier” to Circuit City, Minarik said. Herd and his team “often talk to Best Buy,” Minarik said. But barring “market changes,” there are no “imminent plans” to sell the Polk brand through Best Buy, he said. During its “due diligence,” Directed was “very careful to check” the strength of Polk’s relationships with Circuit City and its other major retailers, Minarik said. “While all suppliers stand on their year-to-year performance with any of the major retailers, the relationship between Polk, Circuit City, Tweeter, Fry’s and AVAD Distributors is very, very strong. In most if not all cases, they're viewed as the number one supplier in the category.” Senior Vp Kevin Duffy said Polk has been sold at Circuit City about 8 years and is chain’s the top-selling brand in home and mobile speakers.

The Polk business is expected to add 3 cents-4 cents a share to Directed’s earnings this year and 8 cents-11 cents in 2007, Minarik said. Directed already is the leading supplier of vehicle security and satellite radio products, and adding Polk will give Directed that same status in home audio, Minarik said. Polk’s sales have been growing about 13% yearly, Duffy said, and Minarik said Directed believes that growth is “sustainable.”

CFO John Morberg said Polk’s gross margins historically have averaged more than 52%. For the year ended June 30, Polk had $18.9 million EBITDA on about $86 million sales, Morberg said. Adding Polk will help Directed in “counterbalancing” the gross margin “compression” it has undergone with the “explosive” growth of Sirius aftermarket receiver sales -- not known for high gross margin percentages, Morberg said. But abiding by “purchase- accounting” rules will cause a “temporary” dip in Polk gross margins to levels “substantially below” 52% as Directed sells off the Polk inventory left after the acquisition closes, Morberg said.

Duffy said Directed’s estimates on what Polk will add to profits this year and next don’t account for savings from possible “synergies” that may raise projections further. Regarding revenue growth, Duffy said Polk “has been going down the road developing innovative technologies” for next- generation products, and those technologies might be applied to other Directed-owned brands. As for gross margin benefits, about 55% of product sourced by Directed and Polk are from the same suppliers. “That’s something we'll be looking at over time in terms of consolidating purchases to get the most reasonable prices on our acquisition of inventory,” Duffy said.

Directed will finance the acquisition through a $141 million increase in its senior credit facility from the Canadian Imperial Bank of Commerce and JPMorgan Chase. The $141 million covers the purchase price, legal fees and other costs, Morberg said. Duffy said Directed will pay down the additional debt with proceeds of a new stock offering after the Polk deal is closed.

Klopfer, Polk, Herd and 3 other senior Polk executives will be bound by noncompete and confidentiality agreements for 5 years after the sale closes, Directed said in its 8-K filing. Other 8-K disclosures: (1) Klopfer, Polk and another senior executive, Craig Georgi, are partners in the “landlord entity” that manages Polk’s Baltimore hq and a facility it has in San Diego. The 3 have agreed to use their “commercially reasonable efforts to induce or persuade” mortgage lender GE Commercial Credit to amend the leases on both facilities. (2) After the closing, Herd will designate who among “certain Polk management employees” will qualify for Directed’s executive compensation and short- and long- term incentive program. Herd’s suggestions are subject to Minarik’s approval.