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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
(X) Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange
Act of 1934 For the Fiscal Year Ended December 31, 2004
OR
( ) Transition Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
Commission File Number 0-275
Allen Organ Company
(Exact name of registrant as specified in its charter)
Pennsylvania 23-1263194
(State of Incorporation) (IRS Employer Identification No.)
150 Locust Street, P. O. Box 36, Macungie, Pennsylvania 18062-0036
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 610-966-2200
Securities registered pursuant to section 12 (b) of the Act:
None
Securities registered pursuant to section 12 (g) of the Act:
Class B Common Shares, par value $1 per share
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of
this Form 10-K. ( )
The Class A voting stock of the registrant is not registered pursuant to the
Securities Exchange Act of 1934, is not publicly traded, and, therefore, no
market value information exists for such stock held by non-affiliates.
The number of shares outstanding of each of the Registrant's classes of common
stock, as of the close of business on March 29, 2005:
Class A - Voting 83,864 Class B - Non-voting 1,072,302
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act).
Yes No X
The aggregate market value of the Class B Common Shares held by non-affiliates
of the Registrant as of June 30, 2004: $42,038,347
1
ALLEN ORGAN COMPANY
INDEX
Item Page No.
PART I
1. Business
- General developments of business 3
- Industry segments 4
- Description of business 4 - 7
- Financial information about geographic areas 7
- Available information 7
2. Properties 7
3. Legal Proceedings 8
4. Submission of Matters to a Vote of Security Holders 8
PART II
5. Market for the Registrant's Common Equity,
Related Stockholder Matters and Issuer
Purchases of Equity Securities 8
6. Selected Consolidated Financial Data 9
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9 - 17
7A. Quantitative and Qualitative Disclosures About Market Risk 17
8. Financial Statements and Supplemental Data 18 - 39
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 17
9A Controls and Procedures 17
9B Other Information 17
PART III
10. Directors and Executive Officers of the Registrant 40 - 42
11. Executive Compensation 42 - 43
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 43 - 45
13. Certain Relationships and Related Transactions 45
14. Principal Accountant Fees and Services 45
PART IV
15. Exhibits and Financial Statement Schedules 46
Signatures 47
Financial Statement Schedules 48
Exhibits 49 - 53
2
PART I
Item 1. Business
General developments of business.
Incorporated in Pennsylvania in 1945, Allen Organ Company and
Subsidiaries ("Company") operate in four industry segments: Musical
Instruments, Data Communications, Electronic Assemblies and Audio
Equipment.
The Musical Instruments segment consists of the manufacture and
sale of electronic keyboard musical instruments, primarily digital
church organs and accessories. During 2004 the Musical Instruments
segment showed improvement in both net sales and operating results.
Management attributes this improvement to an improving economy and the
introduction of organs containing Quantum(TM) technology in the second
quarter of this year, with shipments beginning during the third
quarter. Quantum organs offer significant new features and product
benefits. Two major benefits of this technology are Quad Suite(TM) and
Acoustic PortraitT. Quad Suite allows Quantum organs to supply four
complete tonal specifications in one organ console thereby increasing
the instrument's versatility. Acoustic Portrait adds low-latency
convolution reverberation, currently an exclusive feature for the
church organ market. Convolution technology enables the Company to
accurately reproduce the response of desired rooms and include them in
Quantum organs.
The Musical Instruments segment is seeing increasing changes in
the type of music used in churches throughout North America, the
primary market for this segment's organs. Some churches have changed
their music programs from traditional styles that primarily include
the use of an organ, to more "contemporary" services where the organ
plays a lesser or no role. These changes may negatively impact future
sales volume of this segment. The Company recently introduced
products to address the changing needs of church music. This includes
the Allen EnsembleT that combines traditional organ sounds and more
contemporary General MIDI (Musical Instrument Digital Interface)
sounds. The Company also introduced EACT (Expanded Audio
Capabilities) which allows churches that have both traditional and
contemporary programs to utilize their Allen organ's audio
capabilities for playing back recorded music or amplifying other
musical instruments. The introduction of the Allen Ensemble and EAC
are intended to help maintain the organ as the cornerstone of church
music programs. Management is hopeful that recent improvement's in
the economy and spending patterns of religious institutions, this
segment's primary customers, along with the favorable reaction to
Quantum organs will continue in 2005.
The Data Communications segment designs and markets data
networking products. This segment's 2004 annual sales increased
approximately $18,958,000 (53%) when compared to 2003. Gross margins
and operating income in 2004 also increased significantly when
compared to 2003. This improvement in net sales and operating results
is attributable to an improvement in the overall data communications
market and the timing of completing sales with the Company's larger
customers. Sales in this segment have become increasingly dependent
on larger sales opportunities that could result in the amount and
timing of future net sales being more volatile.
The Electronics Assemblies segment provides subcontract
manufacture of electronic assemblies for outside customers. Recently,
the order rate for this segment has improved and management believes
that its efforts to diversify its customer base and recent signs of
improvement in the economy may continue to improve this segments order
rate in 2005.
The Audio Equipment segment designs, manufactures and markets
high-quality audio speaker cabinets for hi-fi stereo and home theater
applications. This segment's 2004 net sales decreased when compared
to 2003. This segment continues its efforts to develop an expanded
dealer network, however, adding quality dealers for its products has
been slower than expected.
3
Industry segments.
Description of business.
Musical Instruments.
Allen Organ Company is a leading manufacturer of electronic
keyboard musical instruments, primarily digital church organs and
accessories. This segment accounted for 26%, 34% and 37% of net sales
in 2004, 2003 and 2002, respectively.
The principal market for the Musical Instruments segment is
institutions, primarily churches. Sales to homes make up a smaller
portion of this segment's sales. Musical Instruments are distributed
mostly through dealers, primarily independent retail music stores
throughout the United States, with a lesser percentage distributed
through dealers internationally. The segment's business is not
seasonal.
The principal raw materials used in the segment's products are
electronic components and wood, which are readily available from
various sources without undue difficulty. Traditionally, organs have
longer service requirements than other digital products. As life
cycles for electronic components have shortened in recent years the
Company has had to redesign some circuit boards to satisfy the needs
of current and past customers. At the present time, management does
not expect this issue to significantly affect future product
shipments.
This segment does not engage in any significant amounts of
extended payment terms, or lease guarantees. The Company is
contingently liable in connection with certain customers' financing
arrangements (see Note 11 to the Consolidated Financial Statements).
The dollar amounts and number of times the Company has had to honor
these repurchase agreements have been negligible.
The Musical Instruments segment is not dependent on any single or
small group of customers, the loss of which would have a material
adverse effect on the business. The dollar amount of the segment's
unshipped order backlog at the end of February 2005 and 2004 was $4.9
million and $3.6 million, respectively. All orders are expected to be
filled in the current year.
The organ industry is competitive involving at least five
domestic and foreign manufacturers of digital organs. In addition,
there are many small pipe organ companies that serve the institutional
organ market. The organ market consists of two basic divisions,
institutional (primarily churches) and home or entertainment type
instruments. Management believes it is the largest supplier of organs
for the institutional market in the United States (largest world
market) because of product performance and competitive prices, and has
a smaller percentage of the home or entertainment organ market. This
segment also markets its organ consoles and control electronics to
customers that want to retain their wind-blown pipes and augment them
with digital voices. The Company maintains a research and development
program to take advantage of the latest in technological developments
relating to digital sound generation.
Data Communications.
The Data Communications segment consists of Eastern Research,
Inc. (ERI). This segments operations are headquartered in Moorestown,
New Jersey. ERI designs and markets data networking products enabling
network service providers to deliver services to their external or
internal customers. This segment accounted for 68%, 59% and 54% of
the Company's net sales in 2004, 2003 and 2002, respectively.
Data Communications products are predominantly sold directly to
end-users, to wholesale and retail distributors worldwide and to a
smaller extent under OEM agreements. The segment maintains an
inventory of in-process and finished goods to allow for rapid
fulfillment of orders.
4
The principal raw materials used in the Data Communications
products are electronic components, which are readily available from
various sources without undue difficulty. As life cycles for
electronic components have shortened in recent years, the Company has
had to redesign some circuit boards to satisfy the needs of current
and past customers. At the present time, management does not expect
this to significantly affect future product shipments.
The Data Communications segment derived 41% of its 2004 net sales
from two customers, 16% of its net sales from one customer in 2003,
and 40% of its net sales from two customers in 2002. While there have
been significant customers contributing to the revenue growth, some of
these customers have changed from year to year.
This segment derived approximately 27%, 19% and 28% of its net
sales from international markets in 2004, 2003 and 2002, respectively,
primarily from Asia Pacific and Europe. ERI will continue to pursue
growth opportunities in markets outside the United States. The
realization of future business from these opportunities could be
affected by currency fluctuations, social and political risks and
changes in foreign economies.
ERI has a diversified portfolio of customers serving three
primary segments: mobile network service providers, fixed network
service providers and private networks; both in the domestic and
international markets. While each segment continues to grow, the
mobile segment has accelerated the most and contributed 41% of 2004
revenues. Applications in the mobile segment involve optimizing and
managing the access portion of these networks, which are projected to
continue to grow and change. There are many competitors in this
market that is dominated by large data communications companies such
as Adtran, Tellabs and Alcatel. The Company's strategy has been to
target market niches with products that provide desirable features and
packaging with attractive pricing.
ERI initially built its business in the CSU/DSU market and also
developed router technology products. In 1997, ERI introduced its
multi-service access concentrator (DNX) family of products. ERI has
expanded this product family and broadened its feature set making the
DNX its flagship product. The DNX revenues represent approximately
90% of ERI's net sales for 2004. During 2002, ERI introduced the DNX-
1u, which is targeted at wireless service providers. The DNX-1u is
the smallest product in the DNX family and includes up to 8 T1 or E1
circuits. This and prior product introductions have strengthened the
DNX product line. The largest product in the DNX line is the DNX-88
that can handle as many as 600 T1 circuits and also includes T3 and
OC3 (optical) capabilities. While revenues are primarily product
sales, service revenues are a smaller, yet growing portion of the
business.
To properly capitalize on this market's opportunities, ERI has
implemented marketing strategies and product development work and will
continue to do so in a way that takes into account ERI's needs and the
economic environment.
On July 24, 2003, ERI purchased the assets of Avail Networks,
Inc. (Avail) in exchange for $200,000 in cash and contingent payments
based on future revenue related to the sale of Avail products during
the 30 months after the acquisition. The resources and technology
related to this acquisition have been redeployed and are currently
being used in the development of the Company's next generation
products.
The dollar amount of unshipped order backlog at the end of
February 2005 and 2004 was $5.2 million and $7.0 million,
respectively. All orders are expected to be filled in the current
year.
This segment has directed its sales and marketing efforts to
focus on markets for which its product line is well suited, including
the wireless, enterprise, government and certain international
markets. Future sales in this segment have become increasingly
dependent on larger sales opportunities that could result in the
amount and timing of future revenue being more volatile.
5
Electronic Assemblies.
Allen Integrated Assemblies (AIA) is the Company's division that
provides subcontract manufacture of electronic assemblies for outside
customers. The Electronic Assemblies segment is an outgrowth of the
technical skills and manufacturing capabilities developed by the
Company for its Musical Instruments business. AIA services are
supplied out of the Macungie, PA plant, the same plant in which the
Company manufactures Musical Instruments and Audio Equipment products.
This segment accounted for 4%, 5% and 7% of 2004, 2003 and 2002 net
sales, respectively. AIA derived 68% of its 2004 net sales from five
customers, 61% of its 2003 net sales from two customers and 73% of its
net sales from three customers in 2002. AIA continues to work on
diversifying its customer base.
The Electronic Assemblies segment is very competitive with
numerous companies offering similar services. AIA customers are
generally in a geographic area relatively close to the Company's
Macungie manufacturing facility.
The dollar amount of the segment's unshipped order backlog at the
end of February 2005 and 2004 was $1,551,000 and $909,000,
respectively. All orders are expected to be filled in the current
year.
Audio Equipment.
The Audio Equipment segment operates mainly through Legacy Audio,
Inc. (LAI). LAI designs, manufactures and markets high-quality audio
speaker cabinets for hi-fi stereo and home theater applications. This
segment accounted for 2% of net sales in 2004, 2003 and 2002,
respectively.
The principal raw materials used in the segment's products are
audio speakers, electronic components and wood, which are readily
available from various sources without undue difficulty.
LAI derived 12% of its 2004 net sales from one customer, no
single customer accounted for greater than 10% of this segments net
sales in 2003 or 2002.
The principal market for LAI's products is the consumer home
market. The segment's products are mainly distributed through
independent retail dealers and directly to end-users. This segment's
business is not seasonal.
LAI historically sold its products through direct marketing.
Management determined that this method of distribution limited its
ability to penetrate the broader market. The Company has and will
continue to add independent retail dealers in a conservative manner to
build a quality dealer network in an effort to distribute its products
more broadly. LAI has had difficulty adding dealers that are
appropriate for its products.
The high-end audio market is evolving from the traditional two-
channel to the multi-channel market, which is utilized in home theater
applications. LAI has developed and markets products specifically for
these home theater applications.
LAI competes with several other high-end audio speaker cabinet
manufacturers including Martin-Logan, Thiel, B&W, Celestion, and
others.
The dollar amount of the segment's unshipped order backlog at the
end of February 2005 and 2004 was $223,000 and $179,000, respectively.
All orders are expected to be filled in the current year.
General.
The Company's working capital is sufficient to meet the normal
expansion of inventory and receivables.
The Company spent $13,948,340, $8,785,522 and $7,782,571 in 2004,
2003 and 2002, respectively, on research and development. The 2004
and 2003 increases were mainly within the Data Communications segment.
The Company maintains an ongoing commitment to new product development
and expects future expenditures for these activities to exceed the
2004 level.
6
General. (Continued)
The Company monitors its compliance with applicable federal,
state, or local provisions with regard to the environment and
implements procedures or modifies its equipment as necessary. The
Company does not expect any significant capital additions in the
coming year to maintain its compliance.
The Company and its subsidiaries employ approximately 505 people.
None of our employees are covered by a collective bargaining
agreement. Management believes that relations with employees are
good.
Financial information about geographic areas.
The Company does not own manufacturing or sales facilities in any
foreign countries. See Note 13 to the Consolidated Financial
Statements for additional information on export sales.
Export sales are all made in US dollars and, based on customer
credit information, are made either on open credit terms, under letter
of credit or on a prepaid basis.
Available information.
The Company files annual reports on Form 10-K, quarterly reports
of Form 10-Q, current reports on Form 8-K and amendments to those
reports pursuant to Section 13(a) or 15(d) of The Securities and
Exchange Act of 1934 with the Commission. The public may read and
copy any materials filed with the Securities and Exchange Commission
at their Public Reference Room at 450 Fifth Street, NW, Washington, DC
20549. The public may also obtain this information by calling the
Commission at 1-800-SEC-0330. The Securities and Exchange also
maintains an Internet site that contains reports and other information
statements and other information regarding electronic filers at
www.sec.gov.
Item 2. Properties
The following sets forth the location, approximate square footage
and use of the Company's operating locations by segment. Management
believes that its Macungie, PA facilities are generally suitable and
adequate for the needs of the Musical Instruments, Electronic
Assemblies and Audio Equipment segments. The Data Communications
segment will need to expand the size of its present facility in New
Jersey or relocate to another leased facility during 2005.
Approximate
Location Square Footage Use
Musical Instruments, Audio Equipment and Electronic Assemblies:
Macungie, Pennsylvania 242,000 Administrative, research and
manufacturing facility. Owned
by Allen Organ Company.
Operating at approximately
85% capacity.
Macungie, Pennsylvania 27,000 International sales, exhibition
center, museum and teaching
facility. Houses the sales
offices for Musical Instruments
and Legacy Audio. Owned by
Allen Organ Company.
Data Communications:
Moorestown, New Jersey 46,000 Administrative, sales and
research facility. Leased until
September 2005.
Ann Arbor, Michigan 5,000 Research facility. Leased
until July 2005.
In October 2002, the Company's subsidiary, Legacy Audio, Inc.,
sold its manufacturing and sales facility located in Springfield,
Illinois. See Note 21 to the Consolidated Financial Statements for
additional information.
7
Item 3. Legal Proceedings
There is no litigation requiring disclosure pursuant to Item 103
of Regulation S-K.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during
the fourth quarter of fiscal year 2004.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
The Company's Class A voting shares are not registered pursuant
to The Securities Exchange Act of 1934 and are not publicly traded.
The Company's Class B non-voting stock trades on the NASDAQ Stock
Market under the symbol AORGB.
The high and low bid quotations for each quarter during the last
two years as reported by NASDAQ Market Information System are as
follows:
2004 High Low
First Quarter $ 48.00 $ 43.15
Second Quarter 54.66 47.50
Third Quarter 64.00 47.74
Fourth Quarter 70.36 53.05
2003 High Low
First Quarter $ 40.64 $ 37.00
Second Quarter 42.58 35.46
Third Quarter 44.11 37.97
Fourth Quarter 50.03 43.00
The Company has 6 Class A Stockholders and 232 Class B
Stockholders of record as of March 29, 2005.
During the past two fiscal years, the Company has declared
dividends on both its Class A and B shares as follows:
Record of Quarterly Dividends Paid in 2004
Record Date Payable Amount
Cash 2/20/2004 3/5/2004 $0.14
Cash 5/14/2004 5/28/2004 $0.14
Cash 8/13/2004 8/27/2004 $0.14
Cash 11/19/2004 12/3/2004 $0.14
Record of Quarterly Dividends Paid in 2003
Record Date Payable Amount
Cash 2/14/2003 2/28/2003 $0.14
Cash 5/16/2003 5/30/2003 $0.14
Cash 8/15/2003 8/29/2003 $0.14
Cash 11/14/2003 11/28/2003 $0.14
8
Item 6. Selected Financial Data
The selected consolidated financial data presented below has been
derived from the Company's consolidated financial statements for each of
the periods indicated. The data set forth below is qualified by reference
to and should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the
Company's Consolidated Financial Statements included as Items 7 and 8 in
this Annual Report on Form 10-K.
Years Ended December 31,
2004 2003 2002 2001 2000
Net Sales $80,170,788 $60,788,058 $67,739,548 $60,490,513 $72,516,208
Operating Income
(Loss) $ 5,729,224 $ 889,497 $ 3,080,022 $(7,113,614) $ 3,784,196
Net Income
(Loss) $ 4,709,047 $ 1,396,896 $ 2,685,357 $(4,083,810) $ 3,954,896
Basic earnings
(loss) per share $ 4.07 $ 1.20 $ 2.29 $ (3.49) $ 3.38
Diluted earnings
(loss) per share $ 4.06 $ 1.20 $ 2.29 $ (3.49) $ 3.38
Cash dividends
per share $ 0.56 $ 0.56 $ 0.56 $ 0.56 $ 0.56
At Year End
Cash $ 8,949,691 $ 5,907,576 $ 4,515,189 $ 4,449,998 $ 2,712,368
Investments $18,338,350 $17,143,171 $17,176,750 $11,609,416 $24,694,377
Working Capital $46,943,904 $43,917,002 $41,551,690 $38,656,758 $41,648,400
Total Assets $78,472,735 $71,950,276 $73,362,868 $66,472,252 $80,807,742
Long-Term Debt,
net of
current portion $ 0 $ 0 $ 0 $ 0 $ 0
Stockholders'
Equity $59,888,146 $56,364 833 $56,306,332 $56,315,015 $62,434,901
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Business Overview:
As discussed in Note 21 of the financial statements, Allen Organ
Company and Subsidiaries ("Company") operate in four industry segments:
Musical Instruments, Data Communications, Electronic Assemblies and Audio
Equipment.
Sales for the year ended December 31, 2004 increased $19,382,730 when
compared to 2003, primarily due to increased sales in the Company's Data
Communications segment. Net income increased $3,312,151 during the year
ended December 31, 2004, compared to 2003, primarily due to the higher
sales in the Data Communications segment and improved operating results in
the Musical Instruments segment.
Net sales consist of revenues obtained for the sale of electronic
keyboard musical instruments in the Musical Instruments segment; data
networking products and support services in the Data Communications
Segment; electronic assembly services in the Electronic Assemblies segment;
and audio speaker cabinets in the Audio Equipment segment. Sales credits
and adjustments are also included in net sales.
Cost of sales consist primarily of material costs of products sold,
salary and benefit costs related to production and manufacturing support
personnel, incoming shipping and facility related costs, such as
depreciation and maintenance.
Consolidated selling, general and administrative expenses and research
and development expenses increased approximately $8,197,000 and $1,554,000
during the years ended December 31, 2004 and 2003, respectively, primarily
related to the growth in the Data Communications segment. Selling expenses
consist primarily of employee salary and benefit costs, advertising and
marketing expenses. General and administrative expenses consist primarily
of employee salary and benefit costs, professional services fees and other
general corporate expenses. Research and development expenses consist
primarily of employee salary and benefit costs for engineering staff, third
party contracted development services, product prototyping and compliance
costs.
9
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Liquidity and Capital Resources:
The Company continues to maintain a strong financial position and high
level of liquidity, which enables it to generate funds internally to meet
operating needs, capital expenditures and short-term obligations. Key
indicators of the Company's liquidity are presented below:
December 31,
2004 2003
Working Capital $46,943,904 $43,917,002
Current Ratio 5.3 to 1 6.5 to 1
Total Liabilities to Equity Ratio 0.31 to 1 0.28 to 1
Cash flows from operating activities increased by approximately
$3,718,000 during 2004 when compared to 2003, primarily due to improved
operating results in the Musical Instruments, Electronic Assemblies and
Data Communications segments. Net income improved by approximately
$3,312,000 during the year ended December 31, 2004 as compared to 2003,
after reflecting a non-cash charge of approximately $363,000 in 2004 from
the write-off of goodwill and intangibles in the Audio Equipment segment.
Cash of $454,000 was used to increase working capital components in 2004,
versus changes in working capital providing cash of $806,000 and $3,315,000
in 2003 and 2002, respectively. The increase in working capital components
in 2004 is primarily attributable to higher levels of inventory
($1,693,000) to support the increased sales activity, payment of estimated
income taxes ($1,466,000, net of current year accruals) and payment of
pension contributions ($544,000, net of current year accruals), offset by
increases in payables and other accruals (total of $3,079,000) and customer
deposits ($634,000).
Cash flows provided by operating activities decreased during 2003 as
compared to 2002, primarily due to operating losses incurred in the Musical
Instruments segment. Working capital decreased in 2003 due to decreases in
receivables and inventory (total of $2,830,000) primarily from collection
of a receivable from a large sales transaction in late 2002 and improved
inventory management, offset by a decrease in payables and accruals
($3,238,000) primarily from payment of inventory purchases to fulfill the
large sales transaction in late 2002. Working capital decreased in 2002
due to a decrease in inventory ($1,073,000) primarily from improved
inventory management, payment of estimated income taxes ($945,000, net of
income tax accruals) and an increase in payables and accruals ($3,604,000)
primarily from inventory purchases to fulfill a large sales transaction in
late 2002, offset by an increase in accounts receivable ($2,237,000)
primarily related to a large sales transaction in late 2002.
Cash flows used in investing activities during 2004 includes
approximately $2,743,000 of property additions, of which approximately
$2,320,000 is primarily computer and test equipment purchased for the Data
Communications segment and net purchase of investments of approximately
$1,268,000.
Cash flows used in investing activities during 2003 were used to
purchase approximately $160,000 and $900,000 of property and equipment in
the Musical Instruments and Data Communications segments, respectively. In
addition, the Data Communications segment used $200,000 as payment for the
acquisition of Avail Networks.
Cash flows used in investing activities during 2002 were used to
purchase approximately $1,039,000, $188,000 and $672,000 of property and
equipment in the Musical Instruments, Electronic Assemblies and Data
Communications segments, respectively and net purchase of investments of
approximately $5,376,000.
Cash flows from financing activities during 2004 and 2002 were made up
primarily of dividend payments to Company shareholders. Cash flows from
financing activities during 2003 in addition to dividend payments to
Company shareholders, included approximately $505,000 paid for the
repurchase of Class B common shares and $449,000 paid for the repurchase of
subsidiary company stock.
10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Results of Operations:
Sales and Operating Income
December 31,
2004 2003 2002
Net Sales
Musical Instruments
Domestic $16,961,307 $17,033,746 $21,694,445
Export 3,925,493 3,348,158 3,248,480
Total 20,886,800 20,381,904 24,942,925
Data Communications
Domestic 40,275,770 29,252,691 26,107,275
Export 14,704,274 6,769,565 10,428,899
Total 54,980,044 36,022,256 36,536,174
Electronic Assemblies
Domestic 2,822,019 2,819,640 4,750,143
Audio Equipment
Domestic 1,227,055 1,390,526 1,441,084
Export 254,870 119,780 69,222
Total 1,481,925 1,564,258 1,510,306
Total $80,170,788 $60,788,058 $67,739,548
Income (Loss) from Operations
Musical Instruments $ 613,203 $ (764,639) $ 2,024,144
Data Communications 6,436,161 2,446,213 2,091,520
Electronic Assemblies (124,425) (457,366) (401,165)
Audio Equipment (1,195,715) (334,711) (634,477)
Total $ 5,729,224 $ 889,497 $ 3,080,022
Consolidated sales for 2004 increased $19,382,730 (32%) when compared
to 2003, primarily due to higher sales in the Data Communications segment
of approximately $18,958,000. Consolidated sales for 2003 decreased
$6,951,490 (10%) when compared to 2002, primarily due to a $4,561,000
decrease in Musical Instruments sales and a $1,930,000 decrease in
Electronic Assemblies segment sales.
Consolidated gross margins increased to 48% in 2004 compared to 41% in
2003. This was due to the Data Communications segment representing 69% of
consolidated net sales in 2004 versus 59% in 2003, which segment provides
the highest gross profit percent (58% in 2004). In addition, the Musical
Instruments segment gross margins increased by six percentage points to
27.5% in 2004 versus 21.1% in 2003 attributable to cost reduction efforts
that were initiated in 2003 to reduce material and other operating costs.
Consolidated gross margins in 2003 increased to 41% compared to 38% in 2002
due to a 6% increase in the gross margins in the Data Communications
segment attributable to higher sales volume, reductions in product cost and
changes in product mix, offset by a 6% decrease in the gross margin in the
Musical Instrument segment due to lower sales volume over which to absorb
fixed costs.
Consolidated selling, administrative and other expenses increased
$3,034,102 during the year ended December 31, 2004 when compared to 2003,
primarily related to a $2,565,000 increase in the Data Communications
segment for increased salaries and commissions related to the higher sales
volume and additional sales and marketing efforts implemented in 2004.
Consolidated selling, administrative and other expenses increased $503,940
during the year ended December 31, 2003, when compared to 2002, primarily
related to an $872,000 increase in the Data Communications segment for
increased salaries and benefits related to its increased sales and
marketing efforts.
11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Consolidated research and development expenses increased $5,162,818
during the year ended December 31, 2004 when compared to 2003 primarily
related to a $5,292,000 increase in the Data Communications segment. This
increase was primarily from salaries and benefits for additional
engineering staff, prototype costs and contracted design services
associated with the development of the Data Communications segments next
generation products. Consolidated research and development expenses
increased $1,002,951 during the year ended December 31, 2003, when compared
to 2002, primarily related to an $820,000 increase in the Data
Communications segment. This increase was made up primarily of salaries
and benefits for additional engineering staff.
Consolidated costs and expenses for the year ended December 31, 2004
also includes a charge for impairment of goodwill and intangibles of
$362,611 related to the write down of the carrying value of Legacy Audio's
goodwill and intangibles.
Investment income decreased $39,649 and $283,936 during the years ended
December 31, 2004 and 2003, respectively, due to lower rates of return
available on invested funds. The minority interest in consolidated
subsidiaries represents the ERI employee shareholders interest in the net
income of Eastern Research after recovering accumulated losses from prior
years that were absorbed by the parent company. There was no minority
interest in consolidated subsidiaries in 2003 and 2002, as all consolidated
subsidiaries had accumulated losses that had been absorbed by the parent
and, in the case of Eastern Research, were being recovered by subsequent
net income of the subsidiary.
The effective tax rate (benefit) was 22.5%, (5.7%) and 29.3% in 2004,
2003 and 2002, respectively. See Note 16 of the Consolidated Financial
Statements for a reconciliation of the income tax provision to the
statutory rates. The effective tax rate in 2004, 2003 and 2002 is lower
than statutory tax rates primarily due to foreign income with the benefit
of lower tax rates, research and development credits and non-taxable
investment income derived from investment in municipal bond funds. The
2004 rate increased compared to 2003 primarily due to higher levels of
taxable income in 2004 offset by higher levels of tax credits and tax
exempt income. The 2003 rate decreased when compared to 2002 due to the
low level of taxable income which, after deducting tax credits and exempt
income, resulted in a small tax benefit.
Consolidated net income increased $3,312,151 during the year ended
December 31, 2004, compared to 2003, primarily due to the higher sales and
operating income in the Data Communications segment and improved operating
results in the Musical Instruments segment. Consolidated net income
decreased $1,288,461 during the year ended December 31, 2003, compared to
2002, primarily due to operating losses of $765,000 and $457,000 incurred
in the Musical Instruments and Electronic Assemblies segments,
respectively.
The Company is in the process of implementing regulations contained in
the Sarbanes-Oxley Act of 2002 applicable to companies with a class of
securities registered under the Securities Exchange Act of 1934, in
particular Section 404 relating to Management's Assessment of Internal
Controls. Compliance with these regulations is estimated to cost in the
range of $400,000 to $600,000 for initial implementation. These costs will
be incurred over 2005 and 2006. In addition, there will be ongoing
compliance costs thereafter which management expects will range from
$250,000 to $400,000 annually.
Musical Instruments Segment
Domestic sales for 2004 were approximately equal to 2003. The 2004
order rate and backlog on December 31, 2004 continue to be higher than the
same periods in 2003 reflecting favorable customer reaction to the
Company's Quantum organs that include significant new features and product
benefits, as well as an improved economic environment. Quantum organs
offer Quad SuiteT and Acoustic PortraitT. Quad Suite allows Quantum organs
to supply four complete tonal specifications in one organ console
increasing the instrument's versatility. Acoustic Portrait adds low-
latency convolution reverberation, currently an exclusive feature for the
church organ market. Convolution technology enables the Company to
accurately reproduce the response of desired rooms and include them in
Quantum organs. The domestic sales for 2003 decreased $4,661,000 from 2002
due to lower order volume, which management believed was caused by the
economic downturn, declines in financial markets and general global
uncertainty caused by the war in Iraq.
12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Musical Instruments Segment (Continued)
This segment is seeing changes in the type of music used in churches
throughout North America, the primary market for this segment's organs,
which may negatively impact future sales volume for this segment. Some
churches have changed their music programs from traditional styles that
primarily use an organ, to more "contemporary" services where the organ
plays a lesser or no role. To address the changing needs of church music,
the Company recently introduced products including the Allen EnsembleT that
combines traditional organ sounds and more contemporary General MIDI
(Musical Instrument Digital Interface) sounds. The Company also introduced
EACT (Expanded Audio Capabilities) that allows churches that have both
traditional and contemporary programs to utilize their Allen organ's audio
capabilities for playing back recorded music or amplifying other musical
instruments. The introduction of the Allen Ensemble and EAC are intended
to help maintain the organ as the cornerstone of church music programs.
Export sales increased approximately $577,000 during the year ended
December 31, 2004 when compared to 2003, which management believes is
attributable to the decreased value of the US dollar compared to certain
foreign currencies making the Company's products more affordable in those
countries. Export sales were approximately equal in 2003 when compared to
2002. Certain foreign markets continue to be affected by unfavorable
economic conditions.
Gross profit margins on sales were 27.5%, 21.1% and 29.5% for the years
ended December 31, 2004, 2003 and 2002, respectively. The 2004 increase is
attributable to the higher sales volume, favorable product mix changes
caused by the introduction of Quantum organs and the effect of cost
reduction efforts initiated to reduce material and other operating costs.
The 2003 decrease in gross profit margins was a result of lower sales
volume over which to absorb fixed costs and higher operating costs
including employee pension expense, which increased by $597,000 (103%) in
2003 versus 2002.
Selling and advertising expenses during 2004 were approximately equal
to 2003 and decreased approximately $71,000 during 2003 when compared to
2002, due to lower sales volume. General and administrative expenses
increased approximately $108,000 during 2004 when compared to 2003,
primarily due to higher fees incurred for professional services including
legal and audit services. General and administrative expenses decreased
approximately $60,000 in 2003 when compared to 2002.
Research and development expenses decreased approximately $152,000
during 2004 compared to 2003 primarily due to lower retirement benefit
costs and increased approximately $82,000 during 2003 when compared to
2002.
Several of the Company's operating expenses continue to rise at
significant rates including business insurances, medical insurance and
other employee benefit expenses. As discussed in Note 14 to the financial
statements, effective December 31, 2003, the Company froze future benefit
accruals in both of its defined benefit pension plans and replaced this
benefit with a discretionary contribution to the Allen Organ Company
Savings and Profit Sharing Plan.
During 2005, management has implemented a profit sharing bonus plan for
employees at its Macungie, PA facility which contains its Musical
Instrument, Electronic Assemblies and Audio Equipment segments. The
Company will contribute 10% of this plants operating income to eligible
employees. The plan has been implemented to incent employees to work along
with management in lowing costs, improving processes and quality and
improving the plants operating results.
Data Communications Segment
Domestic sales increased $11,023,079 and $3,145,416 in 2004 and 2003,
respectively. International sales increased $7,934,709 in 2004 when
compared to 2003, and decreased $3,659,334 in 2003 when compared to 2002.
The 2004 increases are due to higher order volume which management believes
is attributable to an improvement in the overall data communications market
and the timing of completing sales with the Company's larger customers.
Future sales visibility for this segment has improved, but remains limited
throughout the markets served by this segment. The total 2003 sales were
approximately equal to 2002.
Gross profit margins were 58%, 56% and 50% in 2004, 2003 and 2002,
respectively. The 2004 increase is due to higher sales volume, reductions
in product costs and changes in product mix. In addition, the 2003 gross
margin was reduced by approximately 3% due to an accrual for warranty
costs. The 2003 increase is due to favorable product mix changes offset by
an $850,000 accrual for warranty costs and also includes $1,400,000 of
revenue recognized on product software development for a customer during
the second quarter of 2003. Excluding this product software development
sale the 2003 gross margin was 54%. While the Company strives to maintain
profit margins by developing products that offer desirable features, the
industry is very competitive which can negatively affect margins.
13
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Data Communications Segment (Continued)
Selling expenses increased approximately $2,138,000 (28%) in 2004 when
compared to 2003, primarily due to increases in ERI's domestic sales force
($983,000), marketing ($344,000) and higher costs associated with
international sales efforts ($621,000). Selling expenses increased
approximately $823,000 in 2003 when compared to 2002, due to increases in
ERI's sales efforts both domestic and international.
Administrative expenses increased approximately $426,000 (15%) in 2004
compared to 2003, and increased approximately $50,000 in 2003 compared to
2002. These increases are primarily due to additional management and
administrative personnel to support the segment's growth.
Research and development expenses were $12,465,063, $7,173,393 and
$6,352,909 for the years ended December 31, 2004, 2003 and 2002,
respectively. The 2004 increase is due primarily to additional personnel
and related costs associated with the development of the Company's next
generation products. The products under development are expected to
continue to serve emerging segments of the mobile and fixed network service
providers, as well as private networks, and may also present the Company
with a much broader market opportunity. The 2003 increase was due to
increased expenditures incurred in connection with the July 2003
acquisition of Avail Networks and the commencement of work on next
generation products. The segment is committed to new product development
and expects these expenditures to increase during 2005.
The combination of higher sales and higher gross margins resulted in
operating income of $6,436,161, $2,446,213 and $2,091,520 during 2004, 2003
and 2002, respectively, for this segment. Future sales in this segment
have become increasingly dependent on larger sales opportunities that could
result in the amount and timing of future revenue and operating income to
be more volatile. In addition, this segment will increase future operating
costs, primarily research and development to develop next generation
products, which is expected to negatively impact future operating results.
Electronic Assemblies Segment
Sales for 2004 were approximately equal to 2003, which had decreased
$1,930,503 compared to 2002. The segment's order rate decreased in 2003 as
a result of the economic slowdown that affected the Company's contract
manufacturing customers. Management believes that its efforts to diversify
its customer base and recent signs of improvement in the economy may
improve this segment's order rate in 2005.
The gross profit margin for 2004 was 5% compared to a loss of
approximately $(114,000) (4%) and $(61,000) (1%) in 2003 and 2002,
respectively. The 2004 increase is due to the Company's efforts initiated
in 2003 to reduce its operating costs. Selling, general and administrative
expenses in 2004 were approximately equal to 2003 and 2002. This segment
continues its efforts to diversify its customer base and to improve its
production capabilities to offer state of the art manufacturing services to
its customers.
Audio Equipment Segment
Sales decreased $82,333 in 2004 and increased $53,952 in 2003 when
compared to the previous year. Legacy Audio has historically sold its
products through a direct marketing program. Management believes that this
method of distribution has limited its ability to penetrate the broader
market. In 2002, Legacy began distributing its products through a more
traditional dealer network. The Company has added independent retail
dealers and will continue to do so in a conservative manner to build a
quality dealer network. During this period, Legacy has shifted marketing
resources to the new method of distribution.
Gross profit margins were 20%, 35%, and 22% for the years ended
December 31, 2004, 2003 and 2002, respectively. The 2004 decrease is
primarily due to changes in products mix and $150,000 in additional
inventory reserves recorded.
Selling, general and administrative costs increased approximately
$217,000 during 2004 when compared to 2003, primarily related to increased
marketing and advertising costs associated with the introduction of
Legacy's new products. Selling, general and administrative costs decreased
approximately $29,000 in 2003 compared to the previous year, as a result of
steps taken to reduce operating costs. The Company has taken steps to
lower these costs in 2005.
As discussed in Note 7 of the Consolidated Financial Statements, 2004
operating expenses includes a charge of $362,611 related to the write down
of the carrying value of Legacy's goodwill and intangibles. This write
down is attributable to Legacy's past and continuing operating losses and
its inability to significantly expand distribution of its products, all of
which reduced expectations of future cash flows from Legacy's operations
and correspondingly it estimated fair market value.
14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Significant Accounting Policies
The significant accounting policies of the Company are described in
Note 1 of the Consolidated Financial Statements. The preparation of
financial statements in conformity with accounting principles generally
accepted in the United State of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expense during the reporting period.
Certain accounting estimates and assumptions are particularly sensitive
because of their significance to the consolidated financial statements and
the possibility that future events affecting them may differ markedly.
Management considers the following accounting estimates to be the most
critical in preparing the consolidated financial statements. These
critical accounting estimates have been discussed with the Company's audit
committee.
Allowance for Doubtful Accounts: Management performs ongoing credit
evaluations of customers and adjusts credit limits based upon payment
history and the customer's current credit worthiness, as determined by
a review of their current credit information. Management continuously
monitors collections and payments from customers and maintains a
provision for estimated credit losses based upon historical experience
and any specific customer collection issues that have been identified.
If the financial condition of a specific customer or the Company's
general customer base were to deteriorate, resulting in an impairment
of their ability to make payments, additional allowances may be
required.
Carrying Value of Obsolete and Slow Moving Inventory: The Company
values inventory at the lower of cost or market. Management regularly
reviews inventory quantities on-hand and records a provision for
excess and obsolete inventory based primarily on estimated forecasts
of product demand and historical usage, after considering the impact
of new products. If actual market conditions and product demand are
less favorable than projected, additional inventory write-downs may be
required.
Carrying Value of Goodwill and Intangible Assets: In assessing the
recoverability of goodwill and intangible assets, management is
required to make assumptions regarding estimated future cash flows and
other factors to determine whether the fair value of the business
supports the carrying value of goodwill, intangible assets and net
operating assets. This analysis includes assumptions and estimates
about future sales, costs, working capital, capital expenditures, and
cost of capital. If these assumptions and estimates change in the
future, the Company may be required to record an impairment charge
related to goodwill and intangible assets.
Realization of Deferred Income Tax Benefits: As discussed in Note 16
of the Consolidated Financial Statements, the Company has recorded
valuation allowances related to the uncertainty of realizing certain
federal and state net operating loss carryforwards and state credit
carryforwards. If the estimates and related assumptions relating to
the likely utilization of the deferred tax asset change in the future,
the valuation allowance may change accordingly.
Warranty Reserve: The Company provides warranties on some of its
products for varying lengths of time. A warranty liability is recorded
at the time of product sale based on estimates that are developed from
historical information and certain assumptions about future events.
Future warranty obligations are affected by product failure rates,
usage and service costs incurred in addressing warranty claims. These
factors are impacted by the level of new product introductions and the
mix of equipment sold. If actual warranty costs differ from the
estimates, adjustments to the warranty liability would be required.
15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Contractual Obligations and Commercial Commitments
Following is a summary of contractual obligations and other commercial
commitments of the Company:
Payments Due by Period
Less
Contractual than 1-3 4-5 After
Obligations Total 1 year years years 5 years
Operating Leases(a) $341,983 $339,508 $2,475 $0 $0
Purchase
Obligations (b) $9,575,186 $9,189,880 $385,306 $0 $0
Amount of Commitment Expiration Per Period
Less
Other Commercial Total Amounts than 1-3 4-5 After
Commitments Committed 1 year years years 5 years
Contingent Repurchase
Commitments Related to
Customer Financing
Arrangements (a) $972,676 $972,676 $0 $0 $0
(a) Refer to Note 11 of the Consolidated Financial Statements for more
information regarding Operating Leases and Contingent Repurchase Commitments.
(b) Purchase Obligations are defined as agreements to purchase goods or
services that are enforceable and legally binding and specify all significant
terms. The amounts listed above for purchase obligations include contractual
commitments for items such as raw materials, supplies, services and capital
expenditures. Cancelable purchase obligations that the Company intends to
fulfill are also included in the purchase obligations amount listed above.
Factors that May Affect Operating Results
The statements contained in this report on Form 10-K that are not
purely historical are forward looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, including statements regarding the Company's
expectations, hopes, intentions or strategies regarding the future.
Forward looking statements include: statements regarding future products or
product development; statements regarding future research and development
spending and the Company's marketing and product development strategy and
statements regarding future production capacity. All forward looking
statements included in this document are based on information available to
the Company on the date hereof, and the Company assumes no obligation to
update any such forward looking statements. Readers are cautioned not to
place undue reliance on these forward looking statements, which reflect
management's opinions only as of the date hereof. Readers should carefully
review the risk factors described in other documents the Company files from
time to time with the Securities and Exchange Commission, including the
Quarterly Reports on Form 10-Q to be filed by the Company in fiscal year
2005. It is important to note that the Company's actual results could
differ materially from those in such forward looking statements. Some of
the factors that could cause actual results to differ materially are set
forth below.
The Company has experienced and expects to continue to experience
fluctuations in its results of operations. Factors that affect the
Company's results of operations include the volume and timing of orders
received, changes in global economics and financial markets, changes in the
mix of products sold, market acceptance of the Company's and its customer's
products, competitive pricing pressures, global currency valuations, the
availability of electronic components that the Company purchases from
suppliers, the Company's ability to meet increasing demand, the Company's
ability to introduce new products on a timely basis, the timing of new
product announcements and introductions by the Company or its competitors,
changing customer requirements, delays in new product qualifications, the
timing and extent of research and development expenses and fluctuations in
manufacturing yields. As a result of the foregoing or other factors, there
can be no assurance that the Company will not experience material
fluctuations in future operating results on a quarterly or annual basis,
which would materially and adversely affect the Company's business,
financial condition and results of operations.
16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
New Accounting Standards
During 2004 the Financial Accounting Standards Board issued the
following new statements that are applicable to the Company. These
statements did not have a material effect on the Company's 2004 financial
statements.
SFAS 123, (revised), "Share Based Payment" - establishes standards for
the accounting for transactions in which an entity exchanges its equity
instruments for goods or services. The Statement requires a public entity
to measure the cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value of the award. That
cost will be recognized over the period during which an employee is
required to provide service in exchange for the award-the requisite service
period (usually the vesting period). This statement is effective as of the
beginning of the first interim reporting period that begins after June 15,
2005, which for the Company will be the third quarter of 2005. The Company
does not expect that this revised statement will have a material effect on
the Company's consolidated financial statements.
SFAS 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4" -
clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted material. In addition, this Statement
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities.
This Statement is effective for the Company for inventory costs incurred on
or after January 1, 2006
SFAS 153, "Exchange of Nonmonetary Assets-an amendment of APB Opinion
No. 29" - This Statement amends the accounting for the exchange of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. This Statement
is effective for nonmonetary asset exchanges occurring on or after
January 1, 2006.
In December 2003, FASB Statement No. 132 (revised), "Employers
Disclosures about Pensions and Other Postretirement Benefits", was issued.
This Statement prescribes employers' disclosures about pension plans and
other postretirement benefit plans; it does not change the measurement or
recognition of those plans. The new annual disclosure requirements became
effective for the Company as of the year ended December 31, 2004. This
additional disclosure is included in Note 14 to the consolidated financial
statements.
Item 7A Quantitative and Qualitative Disclosures About Market Risk.
Financial instruments that potentially subject the Company to market
and/or credit risk consist principally of short-term investments and trade
receivables. The Company places substantially all of its investments in
mutual funds holding federal, state and local government obligations and,
by policy, limits the amount of credit exposure in any one investment. The
Company's Musical Instruments segment sells most of its products through
established dealer networks. The Data Communications segment sells most of
their products directly to end-users, to wholesale and retail distributors
worldwide and to a smaller extent under OEM agreements with other data
communications companies. The market and credit risk associated with
related receivables is limited due to the large number of dealers and
distributors and their geographic dispersion. The Company has no other
material exposure to market risk.
Item 8. Financial Statements and Supplemental Data
The information required by this Item is set forth on pages 18 through
39 hereto and is incorporated by reference herein.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There were no reportable events as described in Item 304(b) of
Regulation S-K.
Item 9A. Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer have
evaluated the effectiveness of the design and operation of the Company's
disclosure controls and procedures, which are designed to insure that the
Company records, processes, summarizes and reports in a timely and
effective manner the information required to be disclosed in the reports
filed with or submitted to the Securities and Exchange Commission. Based
upon this evaluation, they concluded that the Company's disclosure controls
are effective as of December 31, 2004. There has been no change in the
Company's internal control over financial reporting that occurred during
the quarter ended December 31, 2004 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Item 9B. Other Information
None
17
KPMG
4905 Tilghman Street
Allentown, PA 18104
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
and Stockholders
Allen Organ Company:
We have audited the accompanying consolidated balance sheets of Allen Organ
Company and Subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of income, stockholders' equity and cash flows and the
related financial statement schedule for each of the years in the three-year
period ended December 31, 2004. These consolidated financial statements and
financial statement schedule are the responsibility of the management of Allen
Organ Company. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Allen Organ
Company and Subsidiaries as of December 31, 2004 and 2003, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2004, in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects,
the information set forth therein.
/s/KPMG LLP
Allentown, Pennsylvania
February 24, 2005
18
ALLEN ORGAN COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 2004 2003
CURRENT ASSETS
Cash $ 8,949,691 $ 5,907,576
Investments including accrued interest 18,338,350 17,143,171
Accounts receivable, net of allowance for
doubtful accounts of $ 445,804 in 2004
and $605,496 in 2003 10,993,833 11,652,365
Inventories 15,619,326 13,926,173
Prepaid income taxes 1,466,029 --
Prepaid expenses 532,175 491,444
Deferred income taxes 2,045,087 2,741,167
Total Current Assets 57,944,491 51,861,896
PROPERTY, PLANT AND EQUIPMENT, NET 10,878,469 10,167,004
OTHER ASSETS
Note receivable from related party 2,397,291 2,397,291
Cash value of life insurance 2,822,638 2,474,002
Deferred income taxes 3,700,899 3,493,238
Intangible assets, net 682,258 1,347,822
Goodwill, net 24,701 194,523
Other assets 21,988 14,500
Total Other Assets 9,649,775 9,921,376
Total Assets $78,472,735 $71,950,276
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 3,285,659 $ 1,278,535
Accrued income taxes -- 657,941
Accrued expenses 4,882,754 3,811,025
Customer deposits 2,832,174 2,197,393
Total Current Liabilities 11,000,587 7,944,894
NONCURRENT LIABILITIES
Deferred and other noncurrent liabilities 1,529,890 1,946,696
Accrued pension costs 6,012,185 5,693,853
Total Noncurrent Liabilities 7,542,075 7,640,549
Total Liabilities 18,542,662 15,585,443
MINORITY INTEREST 41,927 --
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Class A Voting Common stock, $1 par value,
400,000 shares authorized, 127,232 shares issued 127,232 127,232
Class B Non-Voting Common stock, $1 par value,
3,600,000 shares authorized,
1,410,761 shares issued 1,410,761 1,410,761
Additional paid-in capital 13,197,610 13,150,610
Retained earnings 62,076,690 58,015,139
Accumulated other comprehensive loss (4,417,842) (3,832,694)
Treasury stock, at cost, 43,368 Class A shares
in 2004 and 2003, 338,382 Class B shares in 2004
and 338,380 in 2003 (12,506,305) (12,506,215)
Total Stockholders' Equity 59,888,146 56,364,833
Total Liabilities and Stockholders' Equity $78,472,735 $71,950,276
See accompanying notes to Consolidated Financial Statements.
19
ALLEN ORGAN COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
2004 2003 2002
NET SALES $80,170,788 $60,788,058 $67,739,548
COSTS AND EXPENSES
Cost of sales 41,653,317 35,693,613 41,963,839
Selling, administrative and other
expenses 18,424,333 15,390,231 14,886,291
Research and development 13,948,340 8,785,522 7,782,571
Other expense 52,963 29,195 26,825
Impairment of goodwill and
intangibles 362,611 -- --
Total 74,441,564 59,898,561 64,659,526
INCOME FROM OPERATIONS 5,729,224 889,497 3,080,022
INVESTMENT INCOME 392,750 432,399 716,335
MINORITY INTERESTS IN CONSOLIDATED
SUBSIDIARY (41,927) -- --
INCOME BEFORE INCOME TAXES 6,080,047 1,321,896 3,796,357
INCOME TAXES
Current 533,000 571,000 1,669,000
Deferred 838,000 (646,000) (558,000)
Total 1,371,000 (75,000) 1,111,000
NET INCOME $ 4,709,047 $ 1,396,896 $ 2,685,357
OTHER COMPREHENSIVE LOSS,
NET OF TAX
Unrealized (loss) gain on investments:
Unrealized (loss) gain arising
during period $ (47,865) $ (26,898) $ 132,305
Less: reclassified adjustment
for gain (loss) included in
income 12 2,495 (97,186)
Sub-total (47,853) (24,403) 35,119
Minimum pension liability adjustment (537,295) (347,828) (2,121,282)
Other comprehensive loss (585,148) (372,231) (2,086,163)
COMPREHENSIVE INCOME $ 4,123,899 $ 1,024,665 $ 599,194
EARNINGS PER SHARE OF COMMON STOCK
BASIC $ 4.07 $ 1.20 $ 2.29
DILUTED $ 4.06 $ 1.20 $ 2.29
See accompanying notes to Consolidated Financial Statements.
20
ALLEN ORGAN COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Additional
Class A Class B Paid-in
Shares Amount Shares Amount Capital
Balance-December 31,2001 127,232 $127,232 1,410,761 $1,410,761 $12,903,610
Tax benefit from
exercise of subsidiary
stock options 58,000
Balance-December 31,2002 127,232 127,232 1,410,761 1,410,761 12,961,610
Tax benefit from
exercise ofsubsidiary
stock options 189,000
Balance-December 31,2003 127,232 127,232 1,410,761 1,410,761 13,150,610
Tax benefit from
exercise of subsidiary
stock options 47,000
Balance-December 31,2004 127,232 $127,232 1,410,761 $1,410,761 $13,197,610
Accumulated
Other
Retained Comprehensive Treasury Stock
Earnings Income (Loss) Shares Amount
Balance-December 31,2001 $55,237,713 $(1,374,300) 367,672 $(11,990,001)
Net income 2,685,357
Reacquired Class B Shares 261 (10,570)
Change in unrealized gain
(loss) on securities
available for sale 35,119
Minimum pension
liability adjustment (2,121,282)
Cash dividend paid
($0.56 per share) (655,307)
Balance-December 31,2002 57,267,763 (3,460,463) 367,933 (12,000,571)
Net income 1,396,896
Reacquired Class B Shares 13,815 (505,644)
Change in unrealized gain
(loss) on securities
available for sale (24,403)
Minimum pension
liability adjustment (347,828)
Cash dividend paid
($0.56 per share) (649,520)
Balance-December 31,2003 58,015,139 (3,832,694) 381,748 (12,506,215)
Net income 4,709,047
Reacquired Class B Shares 2 (90)
Change in unrealized
loss on securities
available for sale (47,853)
Minimum pension
liability adjustment (537,295)
Cash dividend paid
($0.56 per share) (647,496)
Balance-December 31,2004 $62,076,690 $(4,417,842) 381,750 $12,506,305
See accompanying notes to Consolidated Financial Statements.
21
ALLEN ORGAN COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
2004 2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $4,709,047 $1,396,896 $2,685,357
Adjustments to reconcile net income to
net cash provided by
operating activities
Depreciation and amortization 2,480,881 2,518,612 2,801,512
Minority interest in consolidated
subsidiary 41,927 -- --
Loss from impairment of goodwill and
intangibles 362,611 -- --
(Gain) loss on sale of property,
plant and equipment (378) 16,554 55,184
Loss (gain) on sale of investments -- 4,000 (156,248)
Tax benefit from exercise of stock
options 47,000 189,000 58,000
Deferred income taxes 838,000 (624,135) (518,984)
Change in assets and liabilities
Accounts receivable 658,532 532,199 (2,236,722)
Inventories (1,693,153) 2,297,509 1,073,475
Prepaid income taxes (1,466,029) 161,071 945,143
Prepaid expenses (40,731) (172,501) 67,478
Other assets (7,488) 1,592 --
Accounts payable 2,007,124 (4,410,432) 2,938,716
Accrued income taxes (657,941) 657,941 --
Accrued expenses 1,071,729 1,172,769 665,104
Customer deposits 634,781 (496,587) (284,043)
Accrued pension costs (544,045) 144,349 (175,071)
Deferred and other noncurrent
liabilities (416,806) 917,911 321,016
Net Cash Provided by
Operating Activities 8,025,061 4,306,748 8,239,917
CASH FLOWS FROM INVESTING ACTIVITIES
Cash proceeds from sale of investments
classified as available for sale 791,464 526,866 30,633,381
Cash paid for purchase of investments
classified as available for sale (2,058,995) (521,690) (36,009,348)
Increase in cash value of life
insurance (348,636) (200,839) (99,597)
Increase in note receivable -- -- (400,184)
Payment for acquisition of business -- (200,000) --
Cash proceeds from sale of property,
plant and equipment 7,000 5,100 319,155
Cash paid for purchase of property,
plant and equipment (2,743,457) (1,063,231) (1,898,586)
Net Cash Used In Investing
Activities (4,352,624) (1,453,794) (7,455,179)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid in cash (647,496) (649,520) (655,307)
Reacquired Class B common shares (90) (505,644) (10,570)
Subsidiary company stock reacquired
from minority stockholders (24,939) (448,659) (89,386)
Proceeds from sale of subsidiary stock 42,203 143,256 35,716
Net Cash Used in Financing Activities (630,322) (1,460,567) (719,547)
NET INCREASE IN CASH 3,042,115 1,392,387 65,191
CASH, JANUARY 1 5,907,576 4,515,189 4,449,998
CASH, DECEMBER 31 $8,949,691 $5,907,576 $4,515,189
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION
Cash paid (refunded) for income taxes $2,619,970 $ (439,012) $ 750,008
Cash paid for interest $ -- $ -- $ --
The above changes in assets and
liabilities excludes the following
adjustments related to the minimum
pension liability.
Accumulated other comprehensive income $ 537,295 $ 347,828 $2,121,282
Deferred income tax benefits 325,082 195,128 1,312,295
Accrued pension costs (862,377) (542,956) (3,433,577)
See accompanying notes to Consolidated Financial Statements.
22
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 Background and Significant Accounting Policies
Background:
Allen Organ Company and Subsidiaries (Company) operate in four
industry segments: Musical Instruments, Data Communications, Electronic
Assemblies, and Audio Equipment. See Note 21 for additional information
on the operating activities of each segment.
Principles of Consolidation:
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries (Allen Diversified, Inc. and
Legacy Audio, Inc.) and majority-owned (91%) subsidiary (Eastern Research,
Inc.). In addition, the Company has other inactive, wholly-owned
subsidiaries. All material intercompany accounts and transactions have
been eliminated.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reported period. Actual results could differ from
those estimates.
Cash Equivalents:
Cash equivalents of $5,861,878 and $1,556,578 at December 31, 2004 and
2003, respectively, consist of money market funds. For purposes of the
consolidated statements of cash flows, the Company considers all highly
liquid debt instruments with original maturities of three months of less
to be cash equivalents.
Investments:
Investment securities at December 31, 2004 and 2003 consist of U.S.
Treasury and equity securities. The Company classifies its debt
securities in one of three categories: trading, available for sale, or
held to maturity and its equity securities into trading or available for
sale. Trading securities are bought and held principally for the purpose
of selling them in the near term. Held to maturity debt securities are
those securities in which the Company has the ability and intent to hold
the security until maturity. All other securities not included in trading
or held to maturity are classified as available for sale. The Company has
no trading or held to maturity securities.
Available-for-sale securities are recorded at fair value. Unrealized
holding gains and losses, net of the related tax effect, on available-for-
sale securities are excluded from earnings and are reported as a separate
component of other comprehensive income until realized. Realized gains
and losses from the sale of available-for-sale securities are determined
on a specific-identification basis.
A decline in the market value of any available-for-sale security below
cost that is deemed to be other-than-temporary results in a reduction in
carrying amount to fair value. The impairment is charged to earnings and
a new cost basis for the security is established. To determine whether an
impairment is other-than-temporary, the Company considers whether it has
the ability and intent to hold the investment until a market price
recovery and considers whether evidence indicating the cost of the
investment is recoverable outweighs evidence to the contrary. Evidence
considered in this assessment includes the reasons for the impairment, the
severity and duration of the impairment, changes in value subsequent to
year-end, and forecasted performance of the investee.
Premiums and discounts are amortized or accreted over the life of the
related available-for-sale security as an adjustment to yield using the
effective-interest method. Dividend and interest income are recognized
when earned.
Accounts Receivable Allowance:
The Company records an allowance for uncollectible accounts
receivable based on historical loss experience, customer payment patterns
and current economic trends. Management reviews the adequacy of the
allowance for uncollectible accounts receivable on a quarterly basis and,
if necessary, increases or decreases the allowance.
23
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 Background and Significant Accounting Policies (Continued)
Inventories:
Inventories are valued at the lower of cost or market. Cost is
determined using the first-in, first- out (FIFO) method for all
inventories.
Property, Plant and Equipment:
Property, plant and equipment are stated at cost. Depreciation is
computed over the estimated useful asset lives using both straight-line
and accelerated methods for financial reporting and accelerated methods
for tax reporting purposes.
Goodwill and Intangible Assets:
Goodwill represents the excess of costs over fair value of assets of
businesses acquired. The Company accounts for its goodwill and intangible
assets in accordance with Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets". Goodwill and
intangible assets acquired in a purchase business combination and
determined to have an indefinite useful life are not amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible
assets with useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for
impairment in accordance with SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets".
Intangible assets represent identifiable assets such as customer
lists, developed technology and trademarks acquired in connection with the
purchase of the Company's subsidiaries. Intangible assets are amortized
on a straight-line basis over various periods, generally from 5 - 15
years, and are presented net of accumulated amortization on the
consolidated balance sheets.
The carrying value of goodwill and intangible assets for each business
is continually reviewed to assess its recoverability from future
operations, based on future cash flows (undiscounted) expected to be
generated by such operations. Any impairment in value indicated by the
assessment would be computed based on discounted cash flows and charged
against current operations.
Revenue Recognition:
The Company recognizes revenue when products are shipped and the
customer takes ownership and assumes risk of loss, collection of the
relevant receivable is probable, persuasive evidence of an arrangement
exists and the sales price is fixed or determinable. Service revenues are
recognized when the services are performed. Service revenues are derived
from providing extended warranties to customers, equipment maintenance and
repairs, engineering and hardware support, and subcontract assembly
services. Deferred revenues represent cash received from customers in
advance of revenues being recognized for the related payment.
Sales are recorded net of anticipated product returns. The estimated
product returns are based on a historical analysis and are recorded when
the associated product revenue is recognized.
Research and Development and Advertising:
Research and development and advertising expenditures are charged to
expense as incurred. Research and development expenses are separately
disclosed in the consolidated statements of operations while advertising
costs were $459,812, $278,327, and $333,695 in 2004, 2003 and 2002,
respectively.
Income Taxes:
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date.
24
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 Background and Significant Accounting Policies (Continued)
Financial Instruments:
Financial instruments that potentially subject the Company to credit
risk consist principally of short-term investments and trade receivables.
The Company places substantially all of its investments in mutual funds
holding federal, state and local government obligations and, by policy,
limits the amount of credit exposure in any one investment. The Company's
Musical Instruments segment sells most of its products through established
dealer networks. The Data Communications segment sells most of its
products direct to customers, to distributors worldwide and to a lesser
extent under OEM agreements with other data communications companies. The
credit risk associated with related receivables is limited due to the
large number of customers and their geographic dispersion.
Reclassifications:
Certain amounts in the 2003 and 2002 financial statements have been
reclassified to conform to the 2004 presentation.
New Accounting Standards:
During 2004 the Financial Accounting Standards Board issued the
following new statements that are applicable to the Company. These
statements did not have a material effect on the Company's 2004 financial
statements.
SFAS 123, (revised), "Share Based Payment" - establishes standards for
the accounting for transactions in which an entity exchanges its equity
instruments for goods or services. The Statement requires a public entity
to measure the cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value of the award.
That cost will be recognized over the period during which an employee is
required to provide service in exchange for the award-the requisite
service period (usually the vesting period). This statement is effective
as of the beginning of the first interim reporting period that begins
after June 15, 2005, which for the Company will be the third quarter of
2005. The Company does not expect that this revised statement will have a
material effect on the Company's consolidated financial statements.
SFAS 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4" -
clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted material. In addition, this Statement
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities.
This Statement is effective for the Company for inventory costs incurred
on or after January 1, 2006
SFAS 153, "Exchange of Nonmonetary Assets-an amendment of APB Opinion
No. 29" - This Statement amends the accounting for the exchange of similar
productive assets and replaces it with a general exception for exchanges
of nonmonetary assets that do not have commercial substance. This
Statement is effective for nonmonetary asset exchanges occurring on or
after January 1, 2006.
In December 2003, FASB Statement No. 132 (revised), "Employers
Disclosures about Pensions and Other Postretirement Benefits", was issued.
This Statement prescribes employers' disclosures about pension plans and
other postretirement benefit plans; it does not change the measurement or
recognition of those plans. The new annual disclosure requirements became
effective for the Company as of the year ended December 31, 2004. This
additional disclosure is included in Note 14.
25
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1 Background and Significant Accounting Policies (Continued)
Stock-Based Compensation:
The Company accounts for its stock-based compensation plans using the
accounting prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Since the Company is not
required to adopt the fair value based recognition provisions prescribed
under Statement of Financial Accounting Standards No. 123, as amended by
SFAS No. 148, "Accounting for Stock-Based Compensation", only the
disclosure requirements set forth in the Statements are presented.
Had compensation cost been determined on the basis of fair value
pursuant to SFAS No. 123, as amended by SFAS No. 148, net income and
earnings per share would have been as follows:
2004 2003 2002
Net income
As reported $4,709,047 $1,396,896 $2,685,357
Stock-based employee compensation
expense included in reported net
income, net of tax 71,693 90,402 35,661
Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (653) (121,859) (105,035)
Pro forma $4,780,087 $1,365,439 $2,615,983
Earnings per share
As reported
Basic $4.07 $1.20 $2.29
Diluted $4.06 $1.20 $2.29
Pro forma
Basic $4.13 $1.18 $2.23
Diluted $4.12 $1.18 $2.23
The fair value of each option granted is estimated on the grant date
using the Black-Scholes option pricing model. The following assumptions
were made in estimating the fair value of options granted under the Allen
Organ Company stock option plan in 2004 and 2002; there were no option
grants under the Allen Organ Company stock option plan in 2003.
2004 2002
Dividend yield 1.40% 1.40%
Risk-free interest rate 2.25% 2.50%
Expected life 6 years 7 years
Expected volatility 25% 10%
NOTE 2 Business Acquisition
On July 24, 2003, the Company's subsidiary, Eastern Research, Inc.
(ERI), purchased the assets of Avail Networks, Inc. (Avail) in exchange
for $200,000 in cash and contingent payments of 5% of net revenues related
to the sale of Avail products in excess of $1,500,000 during the first 30
months after the acquisition. ERI has not paid any royalties in
connection with this acquisition and does not expect that revenue related
to the sales of Avail products during the 30 months following the
acquisition will exceed $1,500,000, the amount after which any royalty
would be due.
Avail's sales prior to the acquisition date were minimal. As such,
pro-forma financial information is not required for this acquisition.
The purchase price was allocated $114,300 to property and equipment
and $85,700 to intangibles.
26
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3 Investments
The cost and fair value of investments in debt and equity securities
are as follows:
Gross Gross Fair
Amortized Unrealized Unrealized Value
Cost Gains Losses
December 31, 2004
Available for sale
Equity securities $ 29,310 $ -- $ 50 $ 29,260
Mutual Funds
Short Term Gov't
Funds 3,318,087 -- 72,088 3,245,999
Municipal Bond
Funds 15,049,871 -- 46,056 15,003,815
Equity Funds 57,213 2,063 -- 59,276
Totals $18,454,481 $ 2,063 $118,194 $18,338,350
December 31, 2003
Available for sale
Equity securities $ 29,310 $ -- $ 50 $ 29,260
Mutual Funds
Short Term Gov't
Funds 2,281,775 -- 36,422 2,245,353
Municipal Bond
Funds 14,840,033 -- 6,593 14,833,440
Equity Funds 35,832 -- 714 35,118
Totals $17,186,950 $ -- $ 43,779 $17,143,171
Marketable debt securities have an average contractual maturity of
approximately 1 year or less.
Realized gains and losses are determined based on the original cost of
these investments using a first-in, first-out method. During 2004, 2003
and 2002, sales proceeds and gross realized gains and losses on securities
classified as available for sale were:
2004 2003 2002
Sales proceeds $ 791,464 $ 526,866 $30,633,381
Gross realized losses $ -- $ 4,000 $ 379,804
Gross realized gains $ -- $ -- $ 536,052
The change in net unrealized holding (loss) gain on securities
available for sale of $(72,352) $(36,537), and $55,961, net of deferred
tax (benefit) expense of $(24,499), $(12,134), and $20,842, has been
included in accumulated other comprehensive loss in stockholders' equity
for the years ended December 31, 2004, 2003, and 2002, respectively.
27
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4 Inventories
December 31,
2004 2003
Finished goods $5,685,024 $3,945,007
Work in process 5,535,795 5,525,106
Raw materials 4,398,507 4,456,060
Total $15,619,326 $13,926,173
Inventory is net of allowance for obsolete and slow moving items of
$3,134,223 and $3,851,749 at December 31, 2004 and 2003, respectively.
Finished goods consist primarily of completed organs, speaker
cabinets and completed data communications products.
NOTE 5 Property, Plant and Equipment
Estimated
December 31, Useful
2004 2003 Lives
Land and improvements $ 2,369,298 $ 2,369,298 10 yrs
Buildings and improvements 9,502,949 9,085,523 2 - 40 yrs
Machinery and equipment 12,411,711 11,263,861 5 - 10 yrs
Office furniture and equipment 6,480,353 5,385,231 3 - 8 yrs
Vehicles 212,453 179,369 4 yrs
Sub-total 30,976,764 28,283,282
Less accumulated depreciation 20,098,295 18,116,278
Total $10,878,469 $10,167,004
Depreciation expense charged to operations was $2,025,370,
$1,846,367 and $2,158,302 in 2004, 2003 and 2002, respectively.
NOTE 6 Note Receivable
The Company has entered into two split-dollar life insurance
agreements with its President, who is the insured and owner of the
policies. The policy owner is required to pay the portion of the
premiums equal to the value of the economic benefit determined in
accordance with applicable IRS Revenue Rulings. Due to rules included
in the Sarbanes-Oxley Act of 2002 prohibiting the payment of these
types of premiums, the Company did not pay any insurance premiums in
2004 or 2003 related to these split-dollar agreements. In the past,
the Company paid the balance of the net premiums, which approximates
$450,000 annually.
The agreements provide that the Company shall be entitled to
recover the amount of premiums paid out of the built-up cash value upon
termination of the agreement or out of the proceeds upon the death of
the insured. As security for repayment, the Company is a collateral
assignee of the policy to the extent of any such unreimbursed premiums.
The note receivable is also secured by the personal obligation of its
President. The note receivable exceeds the cash surrender value of
these policies by approximately $457,000 and $431,000 at December 31,
2004 and 2003, respectively. However, the Company's President has an
adequate level of personal net assets to cover these amounts.
28
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7 Intangible Assets
Intangible assets subject to amortization are as follows:
December 31, 2004 December 31, 2003
Weighted
Gross Gross Average
Carrying Accumulated Carrying Accumulated Amortization
Amount Amortization Amount Amortization Period
Customer Lists $ 105,679 $ 105,679 $ 105,679 $ 87,583 7 years
Developed
Technology 4,643,246 3,960,988 4,660,509 3,515,220 5 years
Trademark 278,396 278,396 278,396 93,959 20 years
Total $5,027,321 $4,345,063 $5,044,584 $3,696,762
Amortization expense was $455,511, $672,245 and $643,210 in 2004, 2003
and 2002, respectively. Estimated amortization expense for the next five
years is as follows:
2005 $224,856
2006 167,605
2007 136,356
2008 87,875
2009 65,566
As discussed in Note 2, in July 2003, ERI acquired the assets of Avail
Networks for $200,000, which included $85,700 of intangible assets
allocated to developed technology and will be amortized over five years.
In addition, intangible assets of $(17,264), $305,403 and $53,670 were
recorded in 2004, 2003 and 2002, respectively, in connection with stock
transactions with minority stockholders of ERI.
During June 2004, the Company recorded a charge to operating expenses
of $362,611 related to the impairment in the carrying value of goodwill
($169,822) and intangibles ($192,789) which arose in connection with the
acquisition of Legacy Audio, Inc. This write down is attributable to
Legacy's past and continuing operating losses and its inability to
significantly expand distribution of its products, all of which reduced
expectations of future cash flows from Legacy's operations and
correspondingly its estimated fair market value.
NOTE 8 Accrued Expenses
December 31,
2004 2003
Accrued salaries and commissions $2,279,036 $1,876,287
Accrued warranty costs 555,000 970,000
Deferred revenue 535,113 405,959
Accrued profit sharing contribution 826,640 248,349
Other 686,965 310,430
Total $4,882,754 $3,811,025
29
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9 Deferred and Other Noncurrent Liabilities
December 31,
2004 2003
Deferred compensation (see Note 14 and 18) $ 925,157 $1,190,549
Deferred revenue 254,940 516,147
Accrued warranty costs 349,793 240,000
Total $1,529,890 $1,946,696
NOTE 10 Warranty Costs
The Musical Instruments segment provides a 10 year warranty on its
organs, the Data Communications segment provides a 2 year warranty on all
of its data communication products, the Electronic Assemblies segment
provides a 1 year warranty on assemblies manufactured for outside
customers and the Audio Equipment segment provides a 5 year warranty of
its line of home audio speakers. The Company's policy is to accrue the
estimated cost of warranty coverage at the time the sale is recorded. The
activity in the warranty accrual is summarized as follows:
December 31,
2004 2003
Accrual at beginning of year $1,210,000 $ 300,000
Revision to prior year estimate (298,105) --
Additions charged to warranty expense 315,000 1,080,357
Claims paid and charged against
the accrual (322,102) (170,357)
Accrual at end of year $ 904,793 $1,210,000
NOTE 11 Commitments and Contingencies
As of December 31, 2004, the Company is contingently liable for a
maximum amount of approximately $973,000 in connection with the financing
arrangements of certain customers.
Under the terms of an agreement with the wife of the late Chairman and
principal stockholder of the Company, the Company may be required to
purchase within eight months of her death, at the option of her personal
representative, an amount of Class A and/or B Common Shares then owned by
her or includable in her estate for Federal Estate Tax purposes sufficient
to pay estate taxes and costs, subject to the limitations of Section 303
of the Internal Revenue Code. At December 31, 2004, the stockholder owned
or would have includable in her estate 81,531 Class A shares and 267,429
Class B shares. The Company's obligation under this agreement is limited
to the insurance proceeds to be received by the Company on life insurance
purchased on the life of the stockholder, which policy has a face value of
$6,000,000.
In connection with the purchase of Avail Networks (see Note 2), ERI
agreed to pay royalties of 5% of total net sales of qualifying products
through January 2006 in excess of $1,500,000. The royalties are payable
quarterly. There were no royalty payments made during 2004 and 2003.
ERI leases its offices and production facility under non-cancelable
operating leases which expire at various dates through March 2006. Rent
expense for all Company operating leases was $571,851, $453,414, and
$413,733 in 2004, 2003 and 2002, respectively. Minimum annual rent
payments for the operating leases are $339,508 and $2,475 in 2005 and
2006, respectively.
At December 31, 2004, the Company had open purchase obligations with
expected payment obligations of $9,575,186 in 2005 and $385, 306 in 2006.
30
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12 Accumulated Other Comprehensive Loss
December 31,
2004 2003
Unrealized loss on investments, net $ (76,720) $ (28,867)
Minimum pension liability adjustment (4,341,122) (3,803,827)
Total $(4,417,842) $(3,832,694)
NOTE 13 Export Sales
Export sales are all made in US dollars and based on the customers
credit information are made either on open credit terms, under letter of
credit or on a prepaid basis
In 2004, 2003 and 2002, net sales by the Musical Instruments segment
include export sales, principally to Canada, Europe and the Far East, of
$3,925,493, $3,348,158, and $3,248,480, respectively. Net sales by the
Data Communications segment include export sales principally to South
Africa, Europe and Asia Pacific of $14,704,274 for 2004, $6,769,565 for
2003, and $10,428,899 for 2002. Included in the export sales of the Data
Communications segment are sales to Australia of $6,622,621, $2,321,937
and $6,979,993 in 2004, 2003 and 2002, respectively. Net sales by the
Audio Equipment segment include export sales principally to Russia of
$254,870 for 2004, $119,780 for 2003, and $69,222 for 2002.
NOTE 14 Retirement Plans
The Company sponsors two noncontributory defined benefit pension plans
which cover substantially all of its employees. Salaried plan benefits
are generally based on the employee's years of service and compensation
levels. Hourly plan benefits are based on various monthly amounts for
each year of credited service. The Company's funding policy is to
contribute amounts to the plans sufficient to meet the minimum funding
requirements set forth in the Employee Retirement Income Security Act of
1974, plus such additional amounts as the Company may determine to be
appropriate from time to time.
Effective December 31, 2003, the Company froze future benefit accruals
under both the salaried and hourly defined benefit pension plans. The
Company will continue to fund the plans and may terminate the plans in the
future. The Company has replaced the retirement benefit previously
provided to its employees under the defined benefit pension plan with a
discretionary contribution to the Allen Organ Company Saving and Profit
Sharing Plan. The discretionary contribution will be allocated to
employee accounts based on their salary.
The measurement date used to calculate the benefit obligations is
December 31.
31
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14 Retirement Plans (Continued)
Following are reconciliations of the pension benefit obligation and the
value of plan assets:
2004 2003 2002
Pension benefit obligation
Balance, beginning of year $17,945,952 $17,468,426 $16,112,915
Service cost -- 436,305 393,927
Interest cost 1,016,079 1,089,526 1,085,299
Benefits paid to
participants (1,142,374) (1,112,879) (1,117,494)
Actuarial loss 862,985 -- --
Increase due to changes
in data/assumptions -- 64,574 993,779
Balance, end of year $18,682,642 $17,945,952 $17,468,426
Plan assets
Fair value, beginning of year $12,252,099 $11,514,344 $13,398,564
Actual investment returns 560,732 820,634 (1,663,508)
Company contributions 1,000,000 1,030,000 852,041
Benefits paid to participants (1,142,374) (1,112,879) (1,072,753)
Fair value, end of year $12,670,457 $12,252,099 $11,514,344
The funded status of the plans is as follows:
December 31,
2004 2003 2002
Excess of the benefit
obligation over the value of
plan assets $(6,012,185) $(5,693,853) $(5,954,082)
Unrecognized net actuarial loss 6,967,646 6,105,269 6,509,847
Adjustment to recognize
minimum liability (6,967,646) (6,105,269) (5,562,313)
Accrued benefit cost $(6,012,185) $(5,693,853) $(5,006,548)
The adjustment to recognize the minimum pension liability of
$6,967,646, net of deferred tax benefit of $2,626,524, has been included
in accumulated other comprehensive loss in stockholders' equity at
December 31, 2004.
The following weighted-average rates were used in determining the
above plan information:
2004 2003 2002
Discount rate on the benefit obligation 5.50% 5.75% 6.25%
Discount rate on net periodic benefit cost 5.75% 6.25% 6.75%
Expected long-term rate of return on plan assets 7.00% 7.00% 7.00%
Rate of long-term compensation increase N/A 5.00% 5.00%
The expected long-term rate of return is based on the portfolio that
management expects to maintain as a whole and not on the sum of the
returns on individual asset categories. The return is based exclusively
on historical returns, without adjustments. The expected rate of long-
term compensation is not applicable as accrued benefits in the plans have
been frozen.
Pension expense is comprised as follows:
2004 2003 2002
Service cost $ -- $ 436,305 $ 393,927
Interest cost 1,016,079 1,089,526 1,085,299
Expected return on plan assets (868,347) (768,716) (1,036,157)
Amortization of net gain from
prior service cost -- -- 133,903
Amortization of net loss 308,223 417,234 --
Net pension cost $ 455,955 $1,174,349 $ 576,972
32
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14 Retirement Plans (Continued)
The allocation of the fair value of plan assets of the Company's
pension plans at December 31, 2004, 2003 and 2002 were as follows:
December 31,
2004 2003 2002
Equity Security Funds 33% 20% --
Stable Asset Fund 34% 34% --
Cash and Equivalents Fund 33% 46% 100%
Total 100% 100% 100%
The Company's investment policies and strategies for the pension
benefit plans do not use target allocations for the individual asset
categories. Management expects to increase its allocation to Equity
Security Funds to approximately 40%, with the balance being invested in
the Stable Asset Fund. Management will continue to monitor market
conditions and make changes in asset allocation that it feels are
appropriate to balance the risk and return on plan investments. The
Company's investment goals are to maximize returns subject to specific
risk management policies. Its risk management policies permit investments
in mutual funds and prohibit direct investments in debt and equity
securities and derivative financial instruments. The Company addresses
diversification by the use of mutual fund investments whose underlying
investments are in domestic and international fixed income securities and
domestic and international equity securities. These mutual funds are
readily marketable and can be sold to fund benefit payment obligations as
they become payable.
The Company expects to contribute a total of $1,000,000 to its pension
plans in 2005.
Future benefit payments are estimated as follows:
2005 $1,165,633
2006 1,188,586
2007 1,274,828
2008 1,330,150
2009 1,318,210
2010-2014 6,277,407
The Company provides a 401(k) deferred compensation and profit sharing
plan for the benefit of eligible employees. The plan allows eligible
employees to defer a portion of their annual compensation, pursuant to
Section 401(k) of the Internal Revenue Code. Profit-sharing contributions
to the plan are discretionary as determined by the Company's Board of
Directors. Expenses related to this plan were $826,640, $248,349 and
$58,325 in 2004, 2003 and 2002, respectively.
The Company provides supplemental executive retirement plans (deferred
compensation) for several of its officers and key employees of the
Company. These plans provide for discretionary Company contributions,
which vest over a five year period, accrue interest at the prime rate, not
to exceed 9%, and are payable upon the executive's death or retirement.
Expense related to these arrangements was $159,647, $138,760 and $143,512
in 2004, 2003 and 2002, respectively. The accrued benefits were $629,157
and $667,549 at December 31, 2004 and 2003, respectively.
NOTE 15 Investment Income
December 31,
2004 2003 2002
Interest Income $ 377,753 $ 429,440 $ 550,697
Dividend Income 14,997 6,959 9,390
Gain (Loss) on Sale of Investments -- (4,000) 156,248
Total $ 392,750 $ 432,399 $ 716,335
33
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16 Income Taxes
The provision for income taxes consists of the following:
2004 2003 2002
Currently Currently Currently
Payable Deferred Payable Deferred Payable Deferred
Federal $ 432,000 $ 783,000 $ 439,000 $ (448,000) $1,252,000 $ (456,000)
State 101,000 55,000 132,000 (198,000) 417,000 (102,000)
Total $533,000 $ 838,000 $ 571,000 $ (646,000) $1,669,000 $ (558,000)
A reconciliation of the provision for income taxes with the
statutory rate follows:
2004 2003 2002
Statutory provision for
federal income tax $2,081,000 34.0% $ 449,000 34.0% $1,291,000 34.0%
State taxes, net of
federal tax benefits 203,000 3.3 106,000 8.0 143,000 3.8
Tax credits for research
and development (510,000) (8.3) (347,000) (26.3) (311,000) (8.2)
Tax-exempt income (71,000) (1.1) (56,000) (4.2) (64,000) (1.7)
Extraterritorial
income exclusion (309,000) (5.1) (104,000) (7.9) (136,000) (3.6)
Other items, net 77,000 1.3 27,000 2.0 18,000 0.5
Effect of change in
valuation allowance
of deferred tax assets:
Federal -- -- -- -- 105,000 2.8
State (100,000) (1.6) (150,000) (11.3) 65,000 1.7
Total $1,371,000 22.5% $ (75,000) (5.7)% $1,111,000 29.3%
The following temporary differences give rise to the net deferred
tax asset at December 31, 2004 and 2003.
2004 2003
Deferred Tax Assets
Excess of book depreciation/amortization
over tax depreciation/amortization $ 352,792 $ 375,529
Excess of book over tax pension expense 1,881,358 1,766,324
Loss on investments not recognized
for tax purposes 39,414 14,913
Deferred compensation not recognized
for tax purposes 316,157 447,759
Net operating loss and credit carryforwards 1,729,610 1,872,221
Other liabilities 659,323 646,331
Reserve for bad debts 167,560 227,846
Warranty reserve 340,852 454,989
Inventory reserve 1,178,920 1,448,493
Sub-total 6,665,986 7,254,405
Valuation Allowance (920,000) (1,020,000)
Total Deferred Tax Assets $5,745,986 $6,234,405
Deferred taxes are included in the Company's financial statements as
follows:
2004 2003
Current deferred tax asset $2,045,087 $2,741,167
Non-current deferred tax asset 3,700,899 3,493,238
Total deferred tax asset $5,745,986 $6,234,405
34
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16 Income Taxes (Continued)
At December 31, 2004, the Company has available approximately
$2,337,000 of unused federal and $13,886,000 of unused state net operating
loss carryforwards that may be applied against future taxable income and
that expire in various years from 2007 to 2024. In addition, the Company
has $872,000 in state tax credit carryforwards that expire in various
years from 2008 to 2019. The Company has a valuation allowance of
$920,000 for the deferred tax assets related to the uncertainty of
realizing state net operating loss carryforwards, state credit
carryforwards and federal net operating losses generated by a subsidiary
prior to inclusion in the consolidated federal income tax return. The
decrease in the 2004 valuation allowance is primarily related to state net
operating losses that were reduced due to state apportionment.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies
in making this assessment. Based upon the level of historical taxable
income and projections for future taxable income over the periods in which
the deferred tax assets are deductible, management believes it is more
likely than not that the Company will realize the benefits of these
deductible differences, net of the existing valuation allowance at
December 31, 2004. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of
future taxable income during the carryforward period are reduced.
NOTE 17 Earnings Per Share
The following shows the amounts used in computing earnings per share
and the effect on weighted average number of shares for dilutive potential
common stock.
2004 2003 2002
Weighted average number of
common shares used in basic
earnings per share 1,156,243 1,160,008 1,170,191
Effect of stock options 2,576 473 --
Weighted average number of
common shares used in diluted
earnings per share 1,158,819 1,160,481 1,170,191
Outstanding stock options to purchase 12,000 shares of common stock
were not included in computing earnings per share for 2002 because the
effect was antidilutive.
35
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 18 Stock Option Plans
In July 2002, the Company established an employee stock-based
compensation plan to assist in attracting and retaining personnel. The
maximum number of the Company's Class B shares that may be issued under
the plan approximates a 9% interest in the Company. Options are issued at
the fair market value on the date of grant. The maximum term of the
options is ten years, and generally vest equally over four years.
As of December 31, 2004, total options issued represent 1.40% of the
shares currently outstanding. Vested options represent 0.75% of the
currently outstanding shares.
Following is a summary of the activity under the plan:
December 31,
2004 2003 2002
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
Outstanding at
beginning of year 12,000 $39.00 12,000 $39.00 -- $ --
Granted 4,500 43.15 -- -- 12,000 39.00
Exercised -- -- -- -- -- --
Forfeited -- -- -- -- -- --
Outstanding at end
of year 16,500 $40.13 12,000 $39.00 12,000 $39.00
Weighted average
fair value of
options granted
during the year $10.32 $ -- $ 5.03
Following is a summary of the status of options outstanding at
December 31, 2004:
Options Outstanding Options Exercisable
Weighted Avg.
Remaining Weighted Avg. Weighted Avg
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Exercisable Price
$39.00 12,000 7.56 years $39.00 7,200 $39.00
43.15 4,500 9.08 years 43.15 1,500 43.15
Total 16,500 7.98 years $40.13 8,700 $39.72
ERI also provides an employee stock-based compensation plan to assist
in attracting and retaining personnel. The maximum number of subsidiary
shares that may be issued under the plan approximates a 15% interest in
the subsidiary. Options are generally issued at the estimated fair market
value. The maximum term of the options is six years, and generally vest
equally over four years.
As of December 31, 2004, total options issued and outstanding
represents 8% of the ERI shares currently outstanding. Vested options
consist of 5% of the currently outstanding shares of ERI.
ERI recognized compensation expense of $115,188 in 2004, $144,875 in
2003, and $59,375 in 2002 related to options granted with an exercise
price less than the fair market value on the date of grant. Deferred
compensation relating to these option grants is $296,000 and $523,000 at
December 31, 2004 and 2003, respectively.
See Note 1 for the pro forma effects on net income and earnings per
share had compensation cost been determined on the basis of fair value
pursuant to SFAS No. 123, as amended by SFAS No. 148.
36
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19 Related Party Transactions
The Company maintains two classes of stock, Class A voting common
stock and Class B non-voting common stock. The majority (97%) of the
Class A voting common stock is held by a Trust for the benefit of the
family of company founder Jerome Markowitz. Accordingly, the Markowitz
family has the ability to elect all board of directors and control the
vote on substantially all matters without the approval of other
stockholders.
A member of the Company's Board of Directors is a principal in firms
providing legal and financial advisory services. Legal fees paid were
$265,447, $153,149 and $45,851 in 2004, 2003 and 2002, respectively.
Financial advisory fees paid were $6,000 in both 2003 and 2002. There
were no related party financial advisory fees paid in 2004.
NOTE 20 Major Customers
The Company derived 20% of its consolidated net sales from one
customer in 2004. Receivables from this customer represented 41% of total
consolidated accounts receivable at December 31, 2004. No single customer
represented 10% or more of consolidated net sales in 2003 or 2002.
NOTE 21 Industry Segment Information
The Company's operations are classified into four industry segments:
Musical Instruments, Data Communications, Electronic Assemblies and Audio
Equipment. The Musical Instruments segment is comprised of operations
principally involved in the design, manufacture, sale and distribution of
electronic keyboard musical instruments, primarily digital organs and
related accessories. Musical instruments are sold primarily to retail
dealers worldwide.
The Data Communications segment is involved in the design, sale and
distribution of data communications equipment. Data communications
products are sold direct to customers, to distributors worldwide and to a
smaller extent under OEM agreements with some customers.
The Electronic Assemblies segment is involved in the manufacture, sale
and distribution of electronic assemblies for outside customers used
primarily as control devices and other circuitry in their products.
Subcontract assembly services are provided primarily to industrial
concerns in Pennsylvania and New Jersey.
The Audio Equipment (Legacy Audio, Inc.) segment is involved in the
design, manufacture, sale and distribution of high quality speaker
cabinets for hi-fi stereo and home theater applications. Legacy's
products are sold worldwide primarily through independent retail dealers
and, to a lesser extent, directly to individual customers.
Intersegment sales are generally priced at cost plus a percentage mark-
up, and are generally marginally less than prices which would be charged
for the same product to unaffiliated customers. Intersegment sales are
excluded from net sales reported in the accompanying consolidated
statements of income. Identifiable assets by segment are those assets
that are used in the Company's operations within that segment. General
corporate assets consist principally of cash and short-term investments.
The Electronic Assemblies segment derived 68% of its 2004 net sales
from five customers, 61% of its 2003 net sales from two customers and 73%
of its 2002 net sales from three customers. The Data Communications
segment derived 41% of its 2004 net sales from two customers, 16% of its
net sales from one customer in 2003 and 40% of its net sales from two
customers in 2002. The Audio Equipment segment derived 12% of its 2004
net sales from one customer. The Company's Musical Instruments segment is
not dependent on any single customer.
In October 2002, Legacy Audio, Inc. sold its manufacturing plant
located in Springfield, Illinois for $285,000 (net of selling expenses)
and recognized a gain on the sale of approximately $7,000. Legacy ceased
operations at this facility effective August 31, 2002 and consolidated all
of its production into the Company's manufacturing facility in Macungie,
PA.
37
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 21 Industry Segment Information (Continued)
Following is a summary of segmented information for 2004, 2003 and
2002.
December 31,
2004 2003 2002
Net Sales to
Unaffiliated Customers
Musical Instruments $20,886,800 $20,381,904 $24,942,925
Data Communications 54,980,044 36,022,256 36,536,174
Electronic Assemblies 2,822,019 2,819,640 4,750,143
Audio Equipment 1,481,925 1,564,258 1,510,306
Total $80,170,788 $60,788,058 $67,739,548
Intersegment Sales
Musical Instruments $ 905,340 $ 823,199 $ 435,915
Data Communications -- 84,418 --
Electronic Assemblies 951,919 344,553 131,540
Audio Equipment 31,411 88,205 88,909
Total $ 1,888,670 $ 1,340,375 $ 656,364
Income (Loss) from Operations
Musical Instruments $ 613,203 $ (764,639) $ 2,024,144
Data Communications 6,436,161 2,446,213 2,091,520
Electronic Assemblies (124,425) (457,366) (401,165)
Audio Equipment (1,195,715) (334,711) (634,477)
Total $ 5,729,224 $ 889,497 $ 3,080,022
Identifiable Assets
Musical Instruments $16,474,486 $16,762,054 $17,301,133
Data Communications 30,152,927 26,164,502 25,868,894
Electronic Assemblies 1,850,634 2,065,776 2,373,162
Audio Equipment 1,015,729 1,541,238 1,623,546
Sub-total 49,493,776 46,533,570 47,166,735
General corporate assets 28,978,959 25,416,706 26,196,133
Total $78,472,735 $71,950,276 $73,362,868
Capital Expenditures
Musical Instruments $ 423,417 $ 155,195 $ 1,037,338
Data Communications 2,320,040 904,861 670,320
Electronic Assemblies -- -- 188,487
Audio Equipment -- 3,175 2,441
Total $ 2,743,457 $ 1,063,231 $ 1,898,586
Depreciation and Amortization
Musical Instruments $ 712,558 $ 765,196 $ 759,689
Data Communications 1,640,861 1,596,862 1,864,921
Electronic Assemblies 104,184 120,679 126,321
Audio Equipment 23,278 35,875 50,581
Total $ 2,480,881 $ 2,518,612 $ 2,801,512
Income Tax Expense (Benefit)
Musical Instruments $ 521,000 $ (20,000) $ 1,240,000
Data Communications 1,303,000 312,000 138,000
Electronic Assemblies (25,000) (204,000) (152,000)
Audio Equipment (428,000) (163,000) (115,000)
Total $ 1,371,000 $ (75,000) $ 1,111,000
38
ALLEN ORGAN COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 22 Quarterly Financial Data (Unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
2004
Net Sales $16,718,716 $19,747,048 $21,353,653 $22,351,371 $80,170,788
Gross Profit 7,879,016 9,857,983 10,553,944 10,226,528 38,517,471
Net Income 682,674 1,199,172 1,607,432 1,219,769 4,709,047
Earnings per Share
Basic 0.59 1.04 1.39 1.05 4.07
Diluted 0.59 1.04 1.39 1.05 4.06
2003
Net Sales $13,874,464 $12,725,880 $14,932,091 $19,255,623 $60,788,058
Gross Profit 5,274,954 5,222,827 6,588,075 8,008,589 25,094,445
Net Income (Loss) (19,808) (149,898) 200,923 1,365,679 1,396,896
Earnings (Loss) per
Share
Basic (0.02) (0.13) 0.17 1.18 1.20
Diluted (0.02) (0.13) 0.17 1.18 1.20
2002
Net Sales $15,977,488 $17,403,733 $15,705,708 $18,652,619 $67,739,548
Gross Profit 6,628,428 7,158,583 5,755,644 6,233,054 25,775,709
Net Income 931,539 1,009,634 528,362 215,822 2,685,357
Earnings per Share
Basic 0.80 0.86 0.45 0.18 2.29
Diluted 0.80 0.86 0.45 0.18 2.29
39
PART III
Item 10. Directors and Executive Officers of the Registrant.
(a) Identification of Directors
Time Period
Date Term Position
Name Expires Age Position Held
Steven Markowitz Next Annual 51 Director Since 1980
Meeting in 2005
Eugene Moroz (1) Next Annual 81 Director Since 1968
Meeting in 2005
Leonard W. Helfrich Next Annual 75 Director 1964-1968 and
Meeting in 2005 1972 to present
Orville G. Hawk (1) Next Annual 87 Director Since 1989
Meeting in 2005
Albert F. Schuster Next Annual 85 Director Since 1989
Meeting in 2005
Martha Markowitz Next Annual 83 Director Since 1991
Meeting in 2005
Jeffrey L. Schucker (1) Next Annual 50 Director Since 1996
Meeting in 2005
Ernest Choquette Next Annual 51 Director Since 1998
Meeting in 2005
Michael F. Doyle Next Annual 50 Director Since 2001
Meeting in 2005
(1) Audit Committee member.
(b) Identification of Executive Officers.
Date Term Time Period
Name Expires Age Position Position Held
Steven Markowitz Next Annual 51 President 1990 to present
Meeting in 2005
Barry J. Holben Next Annual 52 Vice President-Sales October 1995 to
Meeting in 2005 present
Dwight A. Beacham Next Annual 58 Vice President- October 1995 to
Meeting in 2005 Product Development present
Nathan S. Eckhart Next Annual 41 Vice President- May 1996 to
Meeting in 2005 Finance, Treasurer, present
Secretary
(c) Identification of Certain Significant Employees.
Not applicable.
(d) Family Relationships.
Except for Martha Markowitz and Steven Markowitz,
who are mother and son, there is no family relationship
between any officers or directors of the Company.
40
(e) Business Experience.
(1) Steven Markowitz, Barry Holben, Dwight
Beacham and Nathan Eckhart, have been employees of
the Company in executive capacities for at least the
last five years.
Mr. Moroz was employed by the Company for
over 50 years, having last held the position of Vice
President. He retired from active employment in May
1998 and continues to serve on the Board of
Directors.
Mr. Helfrich was employed by the Company
for nearly 40 years as Vice President-Finance and
Secretary before retiring in March 2000 and
continues to serve on the Board of Directors.
Mr. Hawk, who has been retired more than
five (5) years, was formerly Chairman of the Board
and President of First National Bank of Allentown.
Mr. Schuster is a church director of music
and prior to his retirement more than five (5) years
ago was a supervisor at Bethlehem Steel Corporation.
Mrs. Markowitz is the widow of Jerome
Markowitz, the Company's founder, and she represents
the family's interest in the Company.
Mr. Schucker is a Vice President at
National Penn Bank. Prior to joining the bank, he
worked as an investment banker at various firms
including Managing Director with Griffin Financial
Group, President of Middle Market Capital Advisors,
L.L.C. (MMCA) and Vice President of Meridian Capital
Markets.
Mr. Choquette has been a member of the law
firm of Stevens & Lee, Reading PA, for over 20 years
and currently serves as Co-Chairman of their
Corporate Group. Stevens & Lee serves as general
counsel to the Company.
Mr. Doyle is President of the Company's
subsidiary, Eastern Research, Inc. Prior to joining
ERI in May of 1997, Mr. Doyle had 20 years
experience in the data communications industry
including positions at Infotron Systems, Inc., Dowty
Communications, Inc., Teleos Communications, Inc.
and Madge Networks, Inc.
(f) Involvement in Certain Legal Proceedings by
Directors or Officers.
None.
(g) Section 16(a) Beneficial Ownership Reporting
Compliance.
Section 16(a) of the Securities Exchange Act of 1934
requires that Company Directors, Executive Officers and
greater-than-ten-percent Share Owners file with the
Securities and Exchange Commission and the Company an
initial statement of beneficial ownership and certain
statements of changes in beneficial ownership of Common
Stock of the Company. Based solely on its review of such
forms received by the Company, Martha Markowitz and
Steven Markowitz both individually and as trustees of the
Jerome Markowitz Trust inadvertently failed to timely
report the following share transactions in December 2004
due to a failure of the transfer agent to timely notify
the filer of the date the shares were transferred. The
Company is unaware of any other instances of
noncompliance with such filings during the year ended
December 31, 2004.
Name Transaction Number and Class of
Type Shares
Martha Markowitz Purchase 1,047 Class B shares
Steven A. Markowitz Sale 869 Class B Shares
Jerome Markowitz
Trust, Martha &
Steven Markowitz
Trustees Purchase 3,000 Class B Shares
41
(h) Audit Committee Financial Expert
The Company's Board of Directors has determined that
Jeffrey L. Schucker is a financial expert serving on the
Company's audit committee and that he is independent
within the meanings of the NASDAQ listing standards and
the Exchange Act.
(i) Code of Ethics.
The Company has adopted a Code of Business Conduct
and Ethics that applies to all employees including its
principal executive and financial officers. A copy of
the Code of Business Conduct and Ethics is incorporated
by reference to Exhibit 14 of the 2003 Form 10-K.
Item 11. Executive Compensation.
Deleted paragraphs and/or columns are not applicable.
(b) SUMMARY COMPENSATION TABLE:
Long Term
Compensation
Annual Compensation Securities All Other
Name and Salary Bonus Underlying Compensation
Principal Position Year $ $ Options(#) $
Steven A. Markowitz,
President 2004 155,027 - - 39,995 (1)
(Chief Executive Officer) 2003 151,675 - - 38,886
2002 147,855 - - 20,969
Dwight A. Beacham, 2004 107,438 - - 27,994 (2)
Vice President - 2003 104,850 - - 17,052
Product Development 2002 101,918 - 4,000 12,049
Barry J. Holben, 2004 107,642 - - 27,994 (2)
Vice President-Sales 2003 106,628 - - 17,052
2002 104,008 - 4,000 12,049
Nathan S. Eckhart, 2004 112,313 - - 22,142 (2)
Vice President-Finance, 2003 107,630 - - 13,533
(Treasurer and Secretary) 2002 102,823 - 4,000 9,527
(1)-Value of split dollar life insurance policy. See Note 6 to the
accompanying Consolidated Financial Statements for additional information
on this arrangement.
(2)-Value of vested deferred compensation earned under supplemental
executive retirement plans. See Note 14 to the accompanying Consolidated
Financial Statements for additional information on these arrangements.
(c) OPTION GRANTS IN LAST FISCAL YEAR:
There were no stock options granted to or exercised
by the above named executive officers of the Company
during 2004 under the Allen Organ Company stock
option plan.
42
(d) AGGREGATE OPTIONS EXERCISED IN LAST YEAR
AND DECEMBER 31, 2004 OPTION VALUE:
Number of Securities Value of
Underlying Unexercised In-The
Unexercised Options Money Options at
Shares at December 31, 2004(#) December 31, 2004($)
Name Acquired
on Value
exercise Realized (1) (1)
(#) ($) Exercisable Unexercisable Exercisable Unexercisable
Dwight A.
Beacham 0 0 2,400 1,600 $72,000 $48,000
Barry J.
Holben 0 0 2,400 1,600 $72,000 $48,000
Nathan S.
Eckhart 0 0 2,400 1,600 $72,000 $48,000
(1) Based on market value of $69.00 per share for Allen Organ Company
Class B common stock at December 31, 2004.
(f) Defined Benefit or Actuarial Plan Disclosure.
As discussed in Note 14 to the Company's
consolidated financial statements included in Item 8,
future benefit accruals under the Company's defined
benefit pension plan were frozen as of December 31, 2003.
Based on the 2004 actuarial report for the Plan the
estimated annual retirement benefit under the Plan to
each of the named executive officers are as follows:
Steven A. Markowitz (age 51) - $33,890; Dwight A. Beacham
(age 58) - $21,378; Barry J. Holben (age 52) - $15,742;
Nathan S. Eckhart (age 41) - $13,870.
(g) Compensation of Directors:
Non-employee directors receive $450 for
each Board and committee meeting attended plus reasonable
expenses in connection with attendance. Employee
directors receive no additional compensation for their
services as a director.
(h) Employment Contracts and Termination of
Employment and Change in Control Arrangements:
There are no employment contracts between
the Company and any of the Company's executive officers.
The Company has established an Executive Bonus Program in
the form of executive supplemental retirement plans for
the benefit of Mr. Beacham, Mr. Holben and Mr. Eckhart.
These plans provide for discretionary Company
contributions which vest over a five year period, accrue
interest at the prime rate, not to exceed 9%, and are
payable upon the executives death or retirement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
(a) Voting securities of the registrant owned of record or
beneficially by each person who owns of record, or is known by
the registrant to own beneficially, more than five percent of
any class of such securities. Class A Common Shares
constitute the only securities with voting rights.
Information as of February 29, 2005.
Amount and
Nature of
Names and Title of Beneficial % of
Addresses Class Ownership Class
Jerome Markowitz A 81,531 97.22%
Trust (2) (1)
821 N. 30th St.
Allentown, PA
(1) Sole voting and investment power
(2) The shares are held by Trustees under an Inter Vivos
Trust established by Mr. Markowitz, who died in February
1991, for the benefit of his family, principally his widow,
Martha Markowitz. The Trustees are Steven Markowitz,
President and a Director of the Company, and Martha
Markowitz, a Director of the Company.
43
(b) Each class of equity securities of the registrant
beneficially owned directly or indirectly by all directors
naming them and directors and officers of the registrant, as a
group, without naming them. Directors not named in the
following table do not beneficially own any equity securities
of the registrant. Information as of December 31, 2004.
Percent Percent
Nature of of of
Class Class Beneficial Class Class
Directors A B Ownership A B
Steven Markowitz 58 (1) (3) .07 %
12,693 (1) (3) 1.18%
81,531* (2) (4) 97.22 %
245,016* (2) (4) 22.85%
Eugene Moroz 6,290 (1) (3) as
to 6,290
6,000 (2) (4) as
to 6,000 1.15%
Leonard W. Helfrich 258 (2) (4) .02%
Orville G. Hawk 50 (2) (4) .005%
Martha Markowitz 22,413 (1) (3) 2.09%
81,531* (2) (4) 97.22 %
245,016* (2) (4) 22.85%
Percent Percent
All Directors of of
and Officers Class Class Class Class
as a Group A B A B
12 81,589** 292,720** 97.29%** 27.30%
(1) Sole voting power
(2) Shared voting power
(3) Sole investment power
(4) Shared investment power
* Shares owned by the Jerome Markowitz Trust for
which Martha Markowitz and Steven Markowitz, Co-
Trustees, have shared voting and investment power, and
of which Martha Markowitz is the primary beneficiary and
Steven Markowitz is one of the residuary beneficiaries.
** The shares held by the Jerome Markowitz Trust are
not duplicated in the totals for the Class A and Class B
Shares.
(c) Changes in Control. Not applicable.
44
(d) Securities authorized for issuance under equity compensation
plans:
Plan category Number of Weighted-average Number of
securities to be exercise price of securities
issued upon outstanding remaining
exercise of options, warrants available for
outstanding and rights future issuance
options, warrants under equity
and rights compensation plans
(excluding
securities
reflected in
column (a))
(a) (b) (c)
Equity
compensation
plans
approved by
security
holders 16,500 $40.13 83,500
Equity
compensation
plans not
approved by
security
holders -- -- --
Total 16,500 $40.13 83,500
Item 13. Certain Relationships and Related Transactions
See Note 11 to the Consolidated Financial Statements concerning
an agreement between the Company and Martha Markowitz, a
Director of the Company.
Ernest Choquette, a member of the Company's Board of Directors,
is a principal in firms providing legal and financial advisory
services. Legal fees paid were $265,447, $153,149 and $45,851
in 2004, 2003 and 2002, respectively. Financial advisory fees
paid were $6,000 in both 2003 and 2002, none were paid in 2004.
Item 14. Principal Accountant Fees and Services
2004 2003
(1) Audit Fees $185,000 $116,000
(2) Audit-Related Fees 14,100 13,500
(3) Tax Fees 92,200 116,200
(4) All Other Fees -- --
Total Fees $291,300 $245,700
(1) Audit Fees represent the fees to complete the annual
audit and quarterly reviews.
(2) Audit-Related Fees include assurance services provided
for the Company's retirement plans in 2003 and other
miscellaneous services in 2004.
(3) Tax Fees include fees for compliance services,
assistance with compliance documentation and various other
tax issues that arise from time to time.
(4) No other fees paid in 2004 and 2003.
The audit committee of the Board of Directors pre-approves
all audit and permissible non-audit services provided by the
Company's independent registered public accounting firm.
All of the services provided by the Company's independent
registered public accounting firm set forth above were pre-
approved by the audit committee.
45
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements
The following consolidated financial statements of
Allen Organ Company and its subsidiaries are included in
Part II, Item 8:
Report of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets as of December 31, 2004 and 2003.
Consolidated Statements of Income for the years ended
December 31, 2004, 2003, and 2002.
Consolidated Statements of Stockholders' Equity for
the years ended December 31, 2004, 2003, and 2002.
Consolidated Statements of Cash Flows for the years
ended December 31, 2004, 2003, and 2002.
Notes to Consolidated Financial Statements.
The individual financial statements of the
Registrant's subsidiaries have been omitted, as they are
all included in the Consolidated Financial Statements
referred to above.
(a) (2) Financial Statement Schedules
Schedule II. Valuation and Qualifying Accounts for
the three years ended December 31, 2004.
Schedules other than those
listed above are omitted because they are
either not required, are not applicable or the
required information is presented in the
Consolidated Financial Statements.
(a) (3) Exhibits
Exhibit No. Description
3.1(1) Articles of Incorporation, as amended
3.2(2) Bylaws, as amended
10.1(7) Allen Organ Company Stock Option Plan
10.2(3) Agreement of Amendment between the Company
and Martha Markowitz
10.3(5) Executive Bonus Program and Endorsement Split
Dollar Life Insurance Agreements between the
Company and Dwight A. Beacham, Nathan S.
Eckhart and Barry J. Holben
14(8) Code of Business Conduct and Ethics
21 Subsidiaries of the registrant
23.1 Consent of KPMG LLP
31.1 Rule 13a-14(a)/15d-14(a)
Certification - Chief Executive Officer
31.2 Rule 13a-14(a)/15d-14(a)
Certification - Chief Financial Officer
32 Section 1350 Certifications
99.1(6) Audit Committee Charter
1. Incorporated by reference to the exhibit
filed with the Registrants Annual Report on Form 10-K
for the year ended December 31, 1984.
2. Incorporated by reference to the exhibit
filed with the Registrants Annual Report on Form 10-K
for the period ended December 31, 1991.
3. Incorporated by reference to the exhibit
filed with the Registrants Annual Report on Form 10-K
for the year ended December 31, 1992.
4. Incorporated by reference to the exhibit filed with the
Registrants Quarterly Report on Form 10-Q for the period
ended September 30, 1999.
5. Incorporated by reference to the exhibit filed with the
Registrants Annual Report on Form 10-K for the year
ended December 31, 2000.
6. Incorporated by reference to the exhibit filed with the
Registrants Quarterly Report on Form 10-Q for the
period ended September 30, 2002.
7. Incorporated by reference to the exhibit filed with the
Registrants Annual Report on Form 10-K for the year
ended December 31, 2003.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
ALLEN ORGAN COMPANY
Date: March 31, 2005 /s/STEVEN A. MARKOWITZ
Steven A. Markowitz
Chief Executive Officer,
President and Director
Date: March 31, 2005 /s/NATHAN S. ECKHART
Nathan S. Eckhart
Vice President-Finance,
Chief Financial and
Principal Accounting Officer
Date: March 31, 2005 /s/LEONARD W. HELFRICH
Leonard W. Helfrich
Director
Date: March 31, 2005 /s/MARTHA MARKOWITZ
Martha Markowitz
Director
Date: March 31, 2005 /s/ERNEST CHOQUETTE
Ernest Choquette
Director
Date: March 31, 2005 /s/MICHAEL F. DOYLE
Michael F. Doyle
Director
47
Allen Organ Company and Subsidiaries
Schedule II - Valuation and Qualifying Accounts
For the Years Ended December 31, 2004, 2003 and 2002
Balance Additions Charged Reductions, Balance
at Charged to Write Offs at
Description Beginning to Other And End
Of Year Expense Accounts Recoveries Of Year
Year Ended
December 31, 2004
Allowance for
Doubtful Accounts $ 605,496 $ (119,078) $ - $ (40,614) $ 445,804
Allowance for
Obsolete and slow
moving inventory 3,851,749 744,323 - (1,461,849) 3,134,223
Valuation Allowance
Deferred Tax Asset 1,020,000 - - (100,000) 920,000
Year Ended
December 31, 2003
Allowance for
Doubtful Accounts $ 502,209 $ 174,614 $ - $ (71,328) $ 605,496
Allowance for
Obsolete and slow
moving inventory 3,497,436 890,391 - (536,078) 3,851,749
Valuation Allowance
Deferred Tax Asset 1,170,000 - - (150,000) 1,020,000
Year Ended
December 31, 2002
Allowance for
Doubtful Accounts $ 350,492 $ 234,117 $ - $ (82,400) $ 502,209
Allowance for
Obsolete and slow
moving inventory 3,178,050 974,251 - (654,865) 3,497,436
Valuation Allowance
Deferred Tax Asset 1,000,000 170,000 - - 1,170,000
48