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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X[ Annual report pursuant Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1997 or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number ________________________
CHANNELL COMMERCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 95-2453261
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(State or other jurisdiction of incorporation) (IRS Employer Identification
No.)
26040 Ynez Road
Temecula, CA 92591-9022
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(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (909) 694-9160
Securities registered pursuant to Section 12(b) of the Act:
None
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Securities registered pursuant to Section 12(g) of the Act:
Title of Class
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Common Stock, $0.01 Par Value
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 the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
On March 16, 1998, the Registrant had 9,237,000 shares of Common Stock
outstanding with a par value of $.01 per share. The aggregate market value of
the 3,312,173 shares held by non-affiliates of the Registrant was $36,434,000.
Shares of Common Stock held by each officer and director and by each person who
may be deemed to be an affiliate have been excluded.
TABLE OF CONTENTS
PART I
Item 1. BUSINESS......................................................... 1
Item 2. PROPERTIES....................................................... 8
Item 3. LEGAL PROCEEDINGS................................................ 8
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 8
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS.............................................. 9
Item 6. SELECTED FINANCIAL DATA.......................................... 10
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................ 12
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................... 22
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE......................................... 22
PART III
Item 10. EXECUTIVE OFFICERS AND DIRECTORS................................. 23
Item 11. EXECUTIVE COMPENSATION........................................... 25
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT... 29
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 30
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.. 31
FINANCIAL STATEMENTS....................................................... F-1
GLOSSARY OF TERMS.......................................................... G-1
i
PART I
ITEM 1. BUSINESS
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BACKGROUND
Channell Commercial Corporation (the "Company") was incorporated in Delaware
on April 23, 1996, as the successor to Channell Commercial Corporation, a
California corporation. The Company's executive offices are located at 26040
Ynez Road, Temecula, California 92591-9022, and its telephone number at that
address is (909) 694-9160.
GENERAL
The Company is a leading designer and manufacturer of precision-molded,
thermoplastic and metal fabricated enclosures supplied worldwide to
telecommunications network operators. The Company believes it was the first to
design, manufacture and market thermoplastic enclosure products for use in the
telecommunications industry on a wide scale, and the Company believes it
currently supplies a substantial portion of the enclosure product requirements
of a number of major community antenna TV ("CATV") and telephone operators. The
Company's products house, protect and provide access to advanced
telecommunications electronics and transmission media, including coaxial cable,
copper wire and optical fibers, used in the delivery of voice, video and data
services. The products are deployed within the portion of local signal delivery
network, commonly known as the "outside plant", that connects the network
provider's signal origination office with residences and businesses. As a
result of the acquisition of RMS Electronics, Inc. ("RMS"), the Company is a
supplier of passive RF electronics, which are typically used in conjunction with
enclosure products. The Company also supplies enclosures for the power utility
industry and markets a complete line of grade level boxes for buried and
underground network applications, in order to provide a full system solution to
meet its customer's outside plant requirements.
INDUSTRY
For a number of years, the communications industry has experienced rapid
expansion, both domestically and internationally, in response to a number of
factors, including developments in high-speed communications technologies, the
convergence occurring within the CATV and telecommunications industries,
consumer demand for enhanced communications services, and a changing regulatory
and competitive environment leading to the deregulation or privatization of
signal delivery operations in many markets. For numerous countries throughout
the world, the implementation or improvement of advanced communications systems
has become a national priority in order to enable such countries to participate
in the information-based global economy.
CATV and local telephone operators are responding to these changes in the
industry by expanding, rebuilding and upgrading their signal delivery networks
in order to deliver enhanced communications services to their customers. These
networks are designed to deliver video, voice and data transmissions and provide
internet access to individual residences and businesses. The networks employ a
variety of signal delivery technologies and architectures, including HFC, DLC,
FTTC and ADSL (see "Glossary of Terms"), which generally carry broadband and
narrowband signals over a combination of electronic hardware, coaxial cable,
copper wire and optical fibers. The outside plants of such networks include
various access devices, fiber optic trunks, nodes and feeders and other signal
transmission electronics. These devices are required to be housed in secure,
protective enclosures, such as those manufactured by the Company.
Enclosure products are critical components of the outside plants of CATV
operators and local telephone companies, providing protection against weather
and vandalism, access for technicians who maintain and manage the outside plant
and, in some cases, dissipation of heat created by active electronic hardware.
CATV operators and local telephone companies rely significantly on manufacturers
of protective enclosures because any material damage to the signal delivery
networks is likely to disrupt communication services.
1
Demand for enclosures in the communications industry depends primarily on the
construction, rebuilding, upgrading and maintenance of signal delivery networks
by CATV operators and local telephone companies. In particular, technological
developments in the communications industry are resulting in significant
increases in system upgrades. For example, within the CATV segment of the
industry, networks are being upgraded to support new advanced two-way services,
including internet access via cable modems, telephony and PCS transport. Within
the local telephone company segment of the industry, local telephone operators
are employing new advanced technologies, such as HDSL and ADSL, which utilize
traditional copper wires for broadband services and which are expected to
increase the need for fully sealed outside plant facilities in order to improve
network reliability and longevity. In addition, as local telephone companies
build broadband networks for the delivery of integrated voice, video and data
services competitive with CATV, they are expected to require new enclosure
products designed for optical fiber-based networks. These and other
technological, regulatory and competitive factors are expected to result in
continued growth of the market for enclosure products designed for the
communications industry.
BUSINESS STRATEGY
The Company's strategy is to capitalize on opportunities in the global
communications industry by providing enclosures and complementary products to
meet the evolving needs of its customers' communications networks. The Company's
wide range of products, manufacturing expertise, application-based sales and
marketing approach and reputation for high quality products address key
requirements of its customers. Principal elements of the Company's strategy
include the following:
CONTINUE TO FOCUS ON CORE CATV BUSINESS. The Company will continue to seek to
capitalize on its position as a leading designer, manufacturer and marketer of
broadband enclosures for the CATV industry in the United States and Canada
through new product development for both domestic and international market
applications. The Company believes it currently supplies a substantial portion
of the enclosure product requirements of a number of major CATV and telephone
company operators. In addition to its core thermoplastic broadband enclosure
products, the Company has positioned itself to increase its participation in the
large scale CATV network construction and upgrade programs anticipated over the
next several years by attaining incremental sales opportunities through the
recently acquired RMS and Standby Electronics Corp. ("Standby Electronics"),
product lines which can be marketed as complementary product lines by the
Company. With the addition of these acquisitions, the Company is now able to
offer a more complete package of products used by CATV network orperators as
they upgrade their networks in order to provide additional services and expand
network capacity. These expansions and upgrades are expected to enable CATV
operators to accommodate increased consumer demand for internet access via cable
modem, telephone and enhanced video services. From 1993 to 1997, the Company's
net sales to the CATV industry increased from $20.4 million to $52.7 million.
INCREASE SALES TO LOCAL TELEPHONE COMPANIES. The Company seeks to leverage its
in-depth knowledge of, and expertise in, the broadband telecommunications and
telephone markets to provide innovative enclosure solutions for the telephone
industry. From 1993 to 1997, the Company's net sales to local telephone
companies increased from $3.3 million to $7.2 million. The Company intends to
continue to invest in the development of a broader range of products designed
specifically for telephone market applications. The Company has already achieved
significant success in marketing its traditional CATV/broadband products to
local telephone companies which have been designing and deploying broadband
networks to deliver competitive video and data services. The Company will
continue to target this market for growth, both directly with telephone network
operators and major system OEMs.
EXPAND INTERNATIONAL PRESENCE. Management believes international markets offer
significant opportunities for increased sales in both the CATV and telephone
segments. The Company's principal international markets currently consist of
Canada, Mexico, South America, the Pacific Rim, the Middle East and Europe. From
1993 to 1997, the Company's international net sales increased from $3.4 million
to $10.9 million. Trends expected to result in international growth
opportunities include the deregulation and privatization of telecommunications
in many international markets, the focus of numerous countries on building,
expanding and enhancing their communications systems in order to participate
fully in the information-based global economy, and multi-national expansion by
many U.S. based network carriers. The Company will concentrate on expansion in
international markets that are characterized by deregulation or privatization of
telecommunications and the availability of capital for the construction of
signal delivery networks.
2
DEVELOP NEW PRODUCTS AND ENTER NEW BUSINESS SEGMENTS. The Company continues to
leverage its core capabilities by developing innovative products that meet the
changing needs of its customers. Examples of innovative products developed by
the Company include its low profile (i.e., close to the ground) enclosures that
permit 360 degree access and advanced heat dissipation enclosures and products
acquired through its acquisitions. Such features, in addition to other product
improvements developed by the Company over many years, received U.S. patent
protection and improve the performance and ease of use of the Company's products
in its customers' outside plant systems. The Company has a proven record in
designing, developing and manufacturing "next generation" products that provide
solutions for its customers and offer differential advantages over other
suppliers to the industry. In addition, the Company will seek to diversify its
customer base by developing new products for customers outside the
communications industry that require enclosure products, such as the utility
industry.
PRODUCTS
The Company manufactures precision-molded, highly engineered thermoplastic and
metal fabricated enclosures that are considered state-of-the-industry for many
applications, having received field testing and other approvals and
standardization certifications from major CATV and telephone company operators.
The majority of the Company's products are specifically designed for buried and
underground network architectures, including enclosures that provide technicians
with access to these networks for maintenance, upgrades and installation of new
services. These types of networks and enclosures are generally preferred by the
Company's customers due to increased network reliability, lower maintenance
requirements, improved security, utility right of way issues and aesthetic
appeal. Enclosure products for these networks must be secure, durable and
aesthetically pleasing and often provide advanced heat dissipation
characteristics required for active electronics. The Company also manufactures
products that are flush-to-grade and buried, requiring environmental sealing and
load-bearing capabilities. The majority of the Company's products are
constructed of thermoplastic and fitted with metal frameworks, fasteners and
locking mechanisms. The Company also designs and manufactures a series of
termination blocks, brackets and cable management devices that are mounted
inside its enclosure products. The Company is recognized for its differentiated
product designs and the functionality, field performance and service life of its
products as compared with alternative products.
To support its complete system approach in the "curb to home infrastructure"
portion of broadband telecommunications networks, the Company acquired RMS. RMS
is a designer and supplier of high performance RF passive electronic devices,
such as outdoor and indoor taps, signal splitters/combiners and power inserters,
all standard components deployed in CATV systems and broadband
telecommunications networks. The Company also acquired Standby Electronics, a
designer and supplier of metal fabricated enclosures to house advanced
electronics, fiber optic cable and power systems for broadband
telecommunications networks. The above electronic devices and enclosures are
components of the complete systems approach and are used in conjunction with the
Company's core enclosure products.
In order to position itself as a full-line product supplier, the Company also
offers a variety of complementary products, including grade level boxes and
cable-in-conduit. These products are typically purchased by customers as part of
a system package and are sold by the Company through marketing arrangements with
original equipment manufacturers ("OEMs"). The Company seeks strategic alliances
with these OEMs that generally include technical information exchanges that are
used by the Company in the development of new products and enhancements to
existing designs. The Company has established additional relationships with
system integrators and innovative end users.
The Company currently markets 50 enclosure product families, with numerous
options that result in several thousand product configurations.
The primary functions of the Company's products designed for the
telecommunications industry are cable routing and management, equipment access,
heat dissipation and security. The Company believes that it offers the broadest
line of enclosure products for use in the telecommunications industry. In
addition to being widely deployed by CATV operators, these products are also now
being approved for use by a number of telephone companies that are adding fiber
optic and broadband functionality to their networks. The Company anticipates
demands for the broadband product line to result from continued construction of
broadband networks and upgrades of existing CATV networks to accommodate
enhanced video services, internet access via cable modems and wireless PCS
transport.
The Company also specializes in the manufacture of products designed to meet
the needs of its local telephone company customers, including sealed plant
products. These products include a sealed chamber to provide environmental
protection for copper wires, coaxial cable and optical fibers that have been
exposed for purposes of splicing and termination. The Company's sealed plant
products feature a mechanical sealing system which, unlike many competitors'
products, does not require gels, compounds or heat shrink to create and maintain
the required seal. This system provides significant value to users in terms of
faster installations, repeat access and elimination of excessive components and
the need for special tools.
Historically, the Company's sealed plant products have been deployed in areas
characterized by severe flooding, moisture and corrosion problems. Recently,
some telephone companies have adopted a complete sealed plant strategy designed
to enhance the reliability of their networks, reduce maintenance costs and
extend the service life of their copper-based systems. In addition, management
expects that demand for sealed plant products may result from new transmission
technologies that enhance the capabilities and capacity of existing copper
networks, such as HDSL and ADSL, which support high-speed data, video and
internet access over existing copper wires. As a result of these technologies,
it is anticipated that network operators may seek to upgrade their copper wire
facilities in order to improve reliability and performance. The Company's active
electronic enclosures and sealed plant products are well suited for such
applications.
3
The Company continues to review new products to complement its existing
product line and marketing strengths. New product development initiatives being
studied by the Company include additional products for the telecommunications
markets as well as new products for customers in industries outside of the
communications industry, such as the utility industry.
MARKETING AND SALES
The Company markets its products primarily through a direct sales force of 26
technically trained salespeople as of December 31, 1997. The Company's sales
force is based in North America and select international markets and is divided
into three groups covering domestic CATV customers, domestic telecommunications
customers and international customers. The Company employs an application-based,
system approach to marketing its products, offering the customer, where
appropriate, a complete, cost-effective system solution to meet its enclosure
and other outside plant requirements. All sales personnel have technical
expertise in the products they market and are assisted by the Company's
engineering and technical marketing specialists in designing these system
solutions.
The Company's direct sales force is supported by a sales/customer service
department that administers and schedules incoming orders, requests for product
enhancements and service inquiries. This department has locations in Temecula,
California, Canada and the United Kingdom, and maintains direct communications
with customers and the Company's field sales and operations personnel. As of
December 31, 1997, the Company employed eleven people in its sales/customer
service department.
The sales force receives additional support from the Company's technical and
product marketing department. The field technical service personnel within this
department work closely with the sales staff and customers to develop system
solutions and provide a full range of technical support, training and
certification for users of the Company's products. The product marketing
personnel within this department perform a variety of functions, including
product line management and general marketing services. These individuals also
provide the Company with strategic plans for product development, new market
access, acquisitions and strategic alliances and work closely with the Company's
sales, engineering and manufacturing departments to implement such strategic
plans. As of December 31, 1997, the Company employed eleven people in its
technical and product marketing department.
The marketing department also promotes and positions the Company both
domestically and internationally by performing functions relating to public
relations, product literature, market research and advertising. The Company
participates regularly in industry trade shows and exhibits for the
telecommunications markets.
4
MANUFACTURING OPERATIONS
The Company's products are manufactured at its facility in Temecula,
California. The Company's vertically integrated and modern manufacturing
processes enable the Company to control each step in the manufacturing process,
including product design and engineering; design and development of its own
dies, tools and molds; and wiring, assembly and packaging. The Company's
manufacturing expertise enables it to tailor its products to satisfy customer
demands, rapidly and efficiently produce large volumes of products, control
expenses and ensure product quality. Management considers the Company's
manufacturing expertise a significant competitive advantage, providing it with
the ability to satisfy the requirements of major customers with relatively short
lead-times and reduce backlog by promptly booking and shipping orders.
The Company's Temecula facility contains approximately 352,000 square feet of
manufacturing, warehouse and office space designed and constructed specifically
to the Company's requirements, including an adjacent 92,000 square foot building
purchased in November 1997. The newly purchased building will house a
vertically integrated sheet metal fabrication and assembly cell, an expanded
tool and die production facility and a new research and development center. The
Company also has a 24,000 square foot manufacturing, warehouse and office
facility located in Mississauga, Ontario, Canada. In the second quarter of
1997, the Company was awarded ISO-9000 certification, a world-wide industry
standards certification, with respect to its Temecula manufacturing facility.
Management has followed a long-term capacity plan, adding the equipment,
facilities and trained personnel required to support anticipated growth of the
Company's business. As a result, management believes the Company's
manufacturing facilities are adequate to meet anticipated product demand for the
foreseeable future.
The Company owns its manufacturing equipment, which is generally state-of-the-
industry, and all manufacturing processes are performed by trained Company
personnel. The Company's broad range of manufacturing processes includes
injection molding, structural foam molding, rotational molding, metal
fabrication, rubber injection, transfer and compression molding, and termination
block fabrication. The Company has implemented several quality and process
assurance programs, including continuous monitoring of key processes and regular
product inspection and testing.
PRODUCT DEVELOPMENT AND ENGINEERING
The Company believes it was the first to design, manufacture and market
thermoplastic enclosure products for use in the communications industry on a
wide scale. Since the original introduction of its products, the Company has
continued to design all of its own products and develop core capabilities in
product engineering and development. As a result, in response to demands of the
communications industry for increasingly sophisticated enclosure products, the
Company has been able to develop a series of products with effective heat
dissipation qualities; a superior environmental sealing and protection system
that, unlike many competitors' products, does not require gels, compounds or
heat shrink to maintain the required seal; easy access for technicians through
circular covers that can be removed to fully expose the enclosed electronics;
compatibility with a variety of signal delivery network architectures; and
versatility to accommodate network growth through custom hardware and universal
mounting systems that adapt to a variety of new electronic hardware. Many of the
Company's thermoplastic enclosure products are now considered state-of-the-
industry, having received field testing and other approvals and standardization
certifications from major CATV and telephone company operators. With the
acquisitions of RMS and Standby Electronics, the Company is engaged in extensive
new product development programs in both RF passive electronics and metal
fabricated enclosures.
The Company's new product development philosophy is applications based and
customer driven, focusing on the complete design cycle from product concept
through tooling and high-volume manufacturing. A team comprised of engineering,
marketing, manufacturing and direct sales personnel work together to define,
develop and deliver complete system solutions to customers. The Company is
equipped to conduct many of its own product testing procedures for performance
qualification purposes, enabling it to accelerate the product development
process.
As of December 31, 1997, the Company employed 13 people in its product
development and engineering department. The Company spent approximately $0.5
million in 1994, 1995 and 1996, and $1.0 million in 1997 on research and
development.
5
CUSTOMERS
The Company sells its products directly to CATV operators and telephone
companies throughout the United States, Canada and certain other international
markets, principally developed nations. During 1997, the Company shipped
products to more than 4,000 customer locations, and its five largest customers
accounted for 42.7% of total net sales. In 1997, the Company's five largest
customers (by sales volume) were, in the United States, Cox, Comcast, GTE, Media
One and Time Warner. In international markets, the Company's five largest
customers (by sales volume) were Rogers Communications (Canada), Shaw Cable
(Canada), Telonix (Canada), Union De Compas Canitec (Mexico), and Satel
(Poland). Two customers, Media One and Time Warner, accounted for 10.0% and
15.1%, respectively, of the Company's net sales in 1997.
The Company's customers generally do not enter into long-term supply contracts
providing for future purchase commitments for the Company's products. Further,
the Company believes that many of its customers periodically review their supply
relationships and alter buying patterns based upon their current assessment of
the products and pricing available in the marketplace. This periodic review can
and does result in significant changes from fiscal period to fiscal period in
the level of purchases of the Company's products by specific customers.
INTELLECTUAL PROPERTY
Following the consummation of its initial public offering (the "Initial Public
Offering") in 1996, the Company became the owner of all of the patents and other
technology employed by it in the manufacture and design of its products. The
Company's patents, which expire through the year 2010, cover various aspects of
the Company's products. In addition, the Company has certain trade secrets,
know-how and trademarks related to its technology and products. Management does
not believe any single patent or other intellectual property right is material
to the Company's success as a whole. The Company intends to maintain an
intellectual property protection program designed to preserve its intellectual
property assets.
COMPETITION
The industries in which the Company operates are highly competitive. The
Company believes, however, that several factors, including its ability to
service national and multi-national customers, its direct sales force, its focus
on enclosure products, its specialized engineering resources and vertically
integrated manufacturing operations provide the Company with a competitive
advantage. Management believes the principal competitive factors in the
communications equipment market are product availability, customer service,
product performance, new product capabilities and price. Competitive price
pressures are common in the industry. In the past, the Company has responded to
these pressures effectively with cost control through vertical integration
utilizing advanced manufacturing techniques, cost-effective product designs and
material selection and an aggressive procurement philosophy. In addition, in the
past, certain of the Company's telecommunications customers have required
relatively lengthy field testing of new products prior to purchasing such
products in quantity. In connection with the deregulation of the
telecommunications segment and the related convergence occurring within the CATV
and telecommunications industries, it is uncertain whether and the extent to
which such field testing will continue to be required. While field testing can
delay the introduction of new products, it can also act as a competitive
advantage in that it makes new product introduction and sales by competitors
more difficult.
RAW MATERIALS; AVAILABILITY OF COMPLEMENTARY PRODUCTS
The principal raw materials used by the Company are thermoplastic resins,
neoprene rubbers, hot and cold rolled steel, stainless steel and copper. The
Company also uses certain other raw materials, such as fasteners, packaging
materials and communications cable. Management believes the Company has adequate
sources of supply for the raw materials used in its manufacturing processes and
attempts to develop and maintain multiple sources of supply for raw materials in
order to help ensure the availability and competitive pricing of these
materials.
6
Most plastic resins are purchased under annual and multi-year contracts to
help stabilize cost and improve supplier delivery performance. Neoprene rubbers
are manufactured by multiple custom compounders using the Company's proprietary
formulas. Metal products are supplied in standard stock shapes, coils and custom
rollforms. All hot and cold rolled steels are either hot dipped galvanized or
zinc or cadmium electro-plated. The coating operations are conducted by local
outside processors.
In addition, in order to position itself as a full-line product supplier, the
Company also relies on certain manufacturers to supply products that complement
the Company's own product line, such as grade level boxes and cable-in-conduit.
The Company believes there are multiple sources of supply for these products.
EMPLOYEES
As of December 31, 1997, the Company employed 296 people (including 33
temporary employees), of whom 45 were in sales, 224 were in manufacturing
operations (including the 33 temporary employees) and 27 were in finance and
administration. The Company considers its employee relations to be good, and it
recognizes that its ability to attract and retain qualified employees is an
important factor in its growth and development. None of the Company's employees
is subject to a collective bargaining agreement, and the Company has not
experienced any material business interruption as a result of labor disputes
within the past five years.
REGULATION
The communications industry is subject to regulations in the United States and
other countries. Federal and state regulatory agencies regulate most of the
Company's domestic customers. On February 1, 1996, the United States Congress
passed the Telecommunications Act, which the President signed into law on
February 8, 1996. The Telecommunications Act lifts certain restrictions on the
ability of companies, including RBOCs and other customers of the Company, to
compete with one another and generally reduces the regulation of the
communications industry.
The Company is also subject to a wide variety of federal, state and local
environmental laws and regulations. The Company utilizes, principally in
connection with its thermoplastic manufacturing processes, a limited number of
chemicals which are classified as hazardous or similar substances. It is
difficult to predict what impact these environmental laws and regulations may
have on the Company in the future. Restrictions on chemical uses or certain
manufacturing processes could restrict the ability of the Company to operate in
the manner that it currently operates or is permitted to operate. Management
believes that the Company's operations are in compliance in all material
respects with current environmental laws and regulations. Nevertheless, it is
possible that the Company may experience releases of certain chemicals to
environmental media which could constitute violations of environmental law (and
have an impact on its operations) or which could cause the incurrence of
material cleanup costs or other damages. For these reasons, the Company might
become involved in legal proceedings involving exposure to chemicals or the
remediation of environmental contamination from past or present operations.
Because certain environmental laws impose joint, several, strict and
retrospective liability upon current owners or operators of facilities from
which there have been releases of hazardous substances, the Company could be
held liable for remedial measures or other damages (such as liability for
personal injury actions) at properties it owns or utilizes in its operations,
even if the contamination was not caused by the Company's operations.
7
ITEM 2. PROPERTIES
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The Company occupies approximately 260,000 square feet of space in Temecula,
California, of which approximately 54%, 38% and 8% is used for manufacturing,
warehouse and office space, respectively. These facilities are leased from
William H. Channell, Sr., the Company's Chairman of the Board and Chief
Executive Officer. The lease term for these facilities extends through 2005, and
the Company has two five-year renewal options to extend the term to 2015. Rental
expense for 1998 under the leases for the Company's existing facilities in
Temecula, California is expected to be $1.1 million. The Company also leases an
aggregate of approximately 70,000 square feet of warehouse and regional sales
office space in North Carolina, New Jersey, Canada and the United Kingdom. In
order to improve and consolidate operations, the Company will, in the first
quarter of 1998, relocate RMS from New Jersey to its North Carolina facility.
In November 1997, the Company acquired a 92,000 square foot building adjacent to
its existing facilities in Temecula, California which will be used for metal
fabrication, tool and die production and research and development. The Company
considers its current facilities to be adequate for its operations.
ITEM 3. LEGAL PROCEEDINGS
-----------------
The Company is from time to time involved in ordinary routine litigation
incidental to the conduct of its business. The Company regularly reviews all
pending litigation matters in which it is involved and establishes reserves
deemed appropriate for such litigation matters. Management believes that no
presently pending litigation matters will have a material adverse effect on its
business or on its results of operations.
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 the fiscal year covered by this report.
8
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
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The Company's Common Stock is listed and traded on the NASDAQ Stock Market
(National Market System) under the symbol CHNL. The following table sets forth,
for the periods indicated, the high and low sale prices for the Company's Common
Stock, as reported on the NASDAQ Stock Market (National Market System) for the
third and fourth quarters of 1996. There was no existing public market for the
Company's Common Stock prior to the third quarter of 1996.
High LOW
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YEAR ENDED DECEMBER 31, 1996:
Third Quarter $15.25 $11.00
Fourth Quarter 13.00 9.00
High LOW
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YEAR ENDED DECEMBER 31, 1997:
First Quarter $13.75 $10.00
Second Quarter 13.75 9.63
Third Quarter 16.50 13.00
Fourth Quarter 14.00 11.00
The Company has not declared any dividends since termination of the S
corporation election in connection with its Initial Public Offering in July
1996. During the years ended December 31, 1994, 1995 and 1996, while an S
corporation, the Company declared dividends on its common stock in the amounts
of $3.8 million, $5.4 million and $14.2 million, respectively.
The Company currently anticipates it will retain all available funds to
finance its future growth and business expansion. The Company does not
presently intend to pay cash dividends in the foreseeable future. Under the
terms of the Company's credit agreement, the Company has agreed, under certain
circumstances, not to pay any dividends during the term of this agreement.
As of December 31, 1997, the Company had 9,237,000 shares of its Common Stock
outstanding, held by approxmimately 822 shareholders of record (which does not
include shareholders whose shares are held in securities position listings).
9
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The following table sets forth financial data of the Company. The summary
financial data in the table is derived from the consolidated financial
statements of the Company. Certain pro forma, net income per share and adjusted
financial data has not been presented for all periods because it is not
applicable to those periods. The data should be read in conjunction with the
financial statements, related notes and other financial information included
therein (in thousands, except per share data).
Year Ended December 31,
-----------------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- ---------- ----------
OPERATING DATA:
Net sales.............................. $23,713 $34,504 $40,972 $47,282 $59,943
Cost of goods sold..................... 14,834 19,750 23,059 25,447 35,032
-------- -------- -------- --------- --------
Gross profit........................... 8,879 14,754 17,913 21,835 24,911
Commission income(1)................... 686 904 1,098 985 606
-------- -------- -------- --------- --------
9,565 15,658 19,011 22,820 25,517
Operating expenses
Selling............................. 3,767 4,952 5,600 6,559 7,251
General and administrative.......... 1,100 1,445 1,707 2,021 4,077
License fees(2)..................... 1,039 1,560 2,035 531 -
Research and development............ 486 518 498 531 1,009
-------- -------- -------- --------- --------
6,392 8,475 9,840 9,642 12,337
-------- -------- -------- --------- --------
Income from operations................. 3,173 7,183 9,171 13,178 13,180
Interest income (expense), net......... (166) (156) (339) 291 879
-------- -------- -------- --------- --------
Income before income taxes............. 3,007 7,027 8,832 13,469 14,059
Income taxes........................... 69 429 349 2,359 5,589
-------- -------- -------- --------- --------
Net income............................. $ 2,938 $ 6,598 $ 8,483 $11,110 $ 8,470
======== ======== ======== ========= ========
Pro forma net income(3)................ $ 1,816 $ 4,129 $ 5,377 $ 8,921
Pro forma net income per share(4)...... .70 1.06
Pro forma weighted average shares
outstanding(4).................... 7,695 8,403
NET INCOME PER SHARE:
Basic.................................. $ .92
Diluted................................ $ .91
OTHER DATA:
Gross margin(5)........................ 37.4% 42.8% 43.7% 46.2% 41.6%
Operating margin(6).................... 13.4 20.8 22.3 27.9 22.0
EBITDA(7).............................. $ 3,949 $ 8,255 $10,583 $14,729 $15,224
Capital expenditures................... 1,480 5,880 2,161 1,554 5,966
S Corporation dividends declared....... 1,048 3,764 5,427 14,157 -
Cash provided by (used in):
Operating activities................. 4,181 6,201 9,758 11,424 3,730
Investing activities................. (1,475) (5,880) (2,161) (12,960) (8,958)
Financing activities................. (3,101) 398 (7,019) 9,351 (122)
ADJUSTED FINANCIAL DATA(8):
Net sales (as historically reported)... $23,713 $34,504 $40,972 $47,282
Adjusted EBITDA(9)..................... 4,713 9,540 12,343 15,122
Adjusted income from operations........ 3,937 8,468 10,931 13,571
Adjusted operating margin(10).......... 16.6% 24.5% 26.7% 28.7%
Adjusted net income.................... $ 2,274 $ 4,899 $ 6,431 $ 8,179
Adjusted net income per share(11)...... .84 .97
10
Year Ended December 31,
-----------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- -------
BALANCE SHEET DATA:
Current assets...................... $ 5,068 $ 8,093 $ 8,502 $31,274 $33,252
Total assets........................ 10,189 17,951 19,103 42,658 50,625
Long-term obligations
(including current maturities)... 1,018 3,684 3,213 - 400
Stockholders' equity................ 6,881 9,417 12,473 37,422 45,892
Notes to Selected Financial Data
(amounts in thousands, except per share data)
(1) Commission income represents the amount of commissions paid to the Company
by the manufacturer of certain cable-in-conduit products in connection with
the Company's sale of such products, which the Company offers to its
customers in order to complement its own product line.
(2) License fees represent the amounts paid by the Company to William H.
Channell, Sr., the Company's Chairman of the Board and Chief Executive
Officer, for the use of six patents ("Channell Patents") covering products
manufactured and sold by the Company. Prior to the consummation of the
Initial Public Offering, these patents were sold to the Company, the
license fee arrangements with Mr. Channell, Sr. were terminated and,
thereafter, the Company no longer paid any license fees with respect to the
Channell Patents.
(3) Prior to the Initial Public Offering, the Company was an S corporation for
federal and state income tax purposes. The pro forma presentation reflects
the income tax provision of the Company as recorded in its income statement
plus the additional tax on S Corporation income at C Corporation rates.
Such presentation does not reflect the adjustments set forth in note (8)
below. The effect of the Company's use of a portion of the net proceeds of
the Initial Public Offering to repay outstanding bank indebtedness has not
been reflected in pro forma net income or pro forma net income per share
because the impact is not material.
(4) Pro forma net income per share has been computed by dividing pro forma net
income by the pro forma weighted average shares outstanding. Pro forma
weighted average shares outstanding include 1,558 (779 for 1996) of the
shares offered by the Company at a price of $11.00 per share, the net
proceeds of which were used to fund the distributions in connection with
the termination of the Company's S corporation status.
(5) Gross margin is gross profit as a percentage of net sales.
(6) Operating margin is income from operations as a percentage of net sales.
(7) EBITDA represents income from operations before interest and income taxes,
plus depreciation and amortization expense. EBITDA is not intended to
represent cash flow, operating income or any other measure of performance
in accordance with generally accepted accounting principles, but is
included here because management believes that certain investors find it to
be a useful tool for measuring a company's ability to service its debt.
(8) The adjusted financial data reflects, (i) the elimination of the expense
for the license fees payable to Mr. Channell, Sr., which license fees were
terminated as part of the termination of the Company's S corporation
status, (ii) an increase in Mr. Channell, Sr.'s annual base salary from
$225 to $500 in connection with the Initial Public Offering, and (iii)
provision for income taxes as if the Company had always been a C
corporation at an assumed rate of 41%.
(9) Adjusted EBITDA represents adjusted income from operations before interest
and income taxes, plus depreciation and amortization expense. See note (7)
above.
(10) Adjusted operating margin is adjusted income from operations as a
percentage of net sales.
(11) Adjusted net income per share is adjusted net income divided by 7,695 pro
forma weighted average shares outstanding for 1995 an 8,403 pro forma
weighted average shares outstanding for 1996. The S corporation dividends
declared in 1996 include $11,665 of distributions made in connection with
the termination of the Company's S Corporation status.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
GENERAL
The Company is a leading designer, manufacturer and marketer of precision-
molded thermoplastic and metal fabricated enclosures supplied worldwide to
telecommunications network operators. The Company believes it currently supplies
a substantial portion of the enclosure product requirements of a number of major
CATV and telephone company operators. The Company was incorporated on April 23,
1996 as the successor to the Predecessor, which has been merged into the Company
in connection with the Initial Public Offering. All financial data contained
herein with respect to the Company include the financial data of the
Predecessor.
Since 1990, the Company was an S corporation for federal and state income tax
purposes. During 1996, due to the Company's Initial Public Offering, the Company
changed in form from an S corporation to a C corporation. As an S corporation,
the Company's income, whether or not distributed, was taxed at the stockholder
level for federal income tax purposes. For California franchise tax purposes, S
corporations were taxed at 2.5% of taxable income in 1993 and 1.5% of taxable
income in 1994, 1995 and the first six months of 1996. During 1996, the top
federal tax rate for C corporations was 35% and the corporate tax rate in
California was 9.3%. As a result, the change in form affected the earnings and
the cash flows of the Company by increasing the level of federal and state
income tax. The pro forma provision for income taxes in the accompanying
statements of income reflects the income tax provision of the Company as
recorded in its income statement plus the additional tax on S Corporation income
at C Corporation rates.
Prior to the Initial Public Offering, the Company had obtained the exclusive
rights to certain patents owned by Mr. Channell, Sr. and paid him license fees
based on the sale of the patented products. In connection with the Initial
Public Offering, the Company purchased the Channell Patents and, accordingly,
the license fee arrangement between the Company and Mr. Channell, Sr. with
respect to such patents was terminated and, thereafter, no license fees were
paid to Mr. Channell, Sr. or any other party with respect to the Channell
Patents. In addition, any patents obtained in the future with respect to new
technology developed by Mr. Channell, Sr. will be owned by the Company. Prior to
the termination, a 10% license fee on the sale of certain products utilizing the
Channell Patents was payable to Mr. Channell, Sr. (See Item 13.) During 1993,
1994, 1995 and the first quarter of 1996, the license fees payable to Mr.
Channell, Sr. were $1.0 million, $1.6 million, $2.0 million and $0.5 million,
respectively. In connection with the consummation of the Initial Public
Offering, no license fees were incurred with respect to product sales subsequent
to the first quarter of 1996.
In connection with the Initial Public Offering, the annual base salary of Mr.
Channell, Sr. was increased from $225,000 to $500,000, and the annual base
salary of William H. Channell, Jr., the Company's President, was increased from
$350,000 to $500,000, which amounts do not include any bonuses that may be
payable to such executive officers. Upon consummation of the Initial Public
Offering, Mr. Channell, Jr. received options to acquire 100,000 shares of Common
Stock with an exercise price equal to the Initial Public Offering price per
share, which options will become exercisable in three equal annual installments
beginning on the first anniversary of the date of issuance.
The Company's core business consists of enclosure product sales to the CATV
market, which comprised approximately 86% of the Company's total net sales
during 1995, 87% in 1996, and 88% during 1997, with two customers, Media One and
Time Warner, accounting for 10.0% and 15.1%, respectively, of the Company's
total net sales during 1997. The Company believes that many of its customers
periodically review their supply relationships, and the Company can experience
significant changes in buying patterns from specific customers between fiscal
periods. The Company has historically operated with a relatively small backlog,
and sales and operating results in any quarter are principally dependent upon
orders booked and products shipped in that quarter. Further, the Company's
customers generally do not enter into long-term supply contracts providing for
future purchase commitments for the Company's products. These factors, when
combined with the Company's operating leverage and the need to incur certain
capital expenditures and expenses in part based upon the expectation of future
sales, results in the Company's operating results being at risk to changing
customer buying patterns. If sales levels in a particular period do not meet the
Company's expectations, operating results for that period may be materially and
adversely affected.
12
The Company uses numerous raw materials in its manufacturing processes.
Although management believes that the Company has adequate sources of supply for
such raw materials, increases in the market prices of the Company's raw
materials could significantly increase the Company's cost of goods sold and
materially adversely affect the Company's profitability. The Company's
profitability may also be materially adversely affected by decreases in its
sales volume because many of the costs associated with the Company's rent,
product development, engineering, tooling and other manufacturing processes are
fixed in nature and must be spread over its sales base in order to maintain
historic levels of profitability.
In addition to Company manufactured products, the Company markets
complementary products manufactured by third parties. With respect to sales of
cable-in-conduit products, the Company generally receives a commission upon the
sale of such products. Pursuant to the agreements under which the Company
markets such products, during the terms thereof and for a period of two years
thereafter, each of the Company and the manufacturer of such products is
prohibited from competing with the other in any product line that is, or within
the year prior to termination has been, represented, manufactured or sold by the
other within the specified markets covered by the agreements.
During the periods discussed under "Results of Operations" below, the
Company's sales increases resulted primarily from additional sales to the
Company's existing customers as they expanded, rebuilt and upgraded their signal
delivery networks in order to deliver enhanced communications services, as well
as additional sales to new customers, particularly telephone companies that have
recently entered the CATV market, international customers, and through the RMS
and Standby Electronics acquisitions.
RESULTS OF OPERATIONS
The following table sets forth the Company's operating results for the
periods indicated expressed as a percentage of sales.
Year Ended December 31,
--------------------------
1995 1996 1997
-------- ------ ------
Net sales............................ 100.0% 100.0% 100.0%
Cost of goods sold................... 56.3 53.8 58.4
------ ----- -----
Gross profit......................... 43.7 46.2 41.6
Commission income.................... 2.7 2.1 1.0
------ ----- -----
46.4 48.3 42.6
Selling.............................. 13.7 13.9 12.1
General and administrative........... 4.2 4.3 6.8
License fees......................... 5.0 1.1 -
Research and development............. 1.2 1.1 1.7
------ ----- -----
Income from operations............... 22.3 27.9 22.0
Interest income (expense), net....... (0.8) 0.6 1.5
------ ----- -----
Income before income taxes........... 21.5 28.5 23.5
Pro forma income taxes(1)............ 8.4 9.6 9.4
------ ----- -----
Pro forma net income(1).............. 13.1% 18.9% 14.1%
====== ===== =====
Adjusted income from operations(2)... 26.7% 28.7%
- ------
(1) Pro forma income taxes and pro forma net income have been determined giving
effect to the termination of the Company's S Corporation status in July
1996. Actual income tax expense has been reflected for the last six months
of 1996 and for all of 1997. See note (3) to "Selected Financial Data".
(2) Adjusted income from operations has been determined giving effect to the
transactions described in notes (3) and (8) to "Selected Financial Data".
Adjusted financial data is not applicable for 1997.
13
NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 128, Earnings Per Share ("SFAS 128"), which superseded
APB Opinion No. 15. Income per share for all periods presented has been
restated to reflect the adoption of SFAS 128. SFAS 128 requires companies to
present basic income per share, and, if applicable diluted income per share,
instead of primary and fully diluted income per share. Basic income per share
is computed by dividing net income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted
income per share reflects the potential dilution that could occur if options to
issue common stock were exercised into common stock.
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive
Income, which prescribes standards for reporting comprehensive income and its
components. Comprehensive income consists of net income or loss for the current
period and other comprehensive income (income, expenses, gains and losses that
currently bypass the income statement and are reported directly in a separate
component of equity). SFAS 130 requires that components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. SFAS 130 is effective for financial statements
issued for periods beginning after December 15, 1997.
In 1997, the FASB issued Statement of Financial Accounting Standards No. 131
("SFAS 131"), Disclosures about Segments of an Enterprise and Related
Information, which applies only to publicly held business entities. A
reportable segment, referred to as an operating segment, is a component of an
entity about which separate financial information is produced internally, that
is evaluated by the chief operating decision-maker to assess performance and
allocate resources. SFAS 131 is effective for financial statements issued for
periods beginning after December 15, 1997. Management has not determined
whether adoption of SFAS 131 will have a significant impact on the disclosures
included in the consolidated financial statements.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1997 WITH THE YEAR ENDED DECEMBER 31,
1996
Net Sales. Net sales increased $12.6 million or 26.6% from $47.3 million in
1996 to $59.9 million in 1997. CATV net sales increased $11.6 million or 28.2%
from $41.1 million in 1996 to $52.7 million in 1997 as a result of the sales of
$8.9 million of RF passive electronic devices by RMS, $1.7 million of Channell
proprietary products due to moderate growth from system upgrade and new network
construction projects worldwide, and $1.0 million of Standby Electronics metal
enclosures. Telecommunications net sales increased $1.0 million or 16.1% from
$6.2 million in 1996 to $7.2 million in 1997, as a result of increased activity
in sealed plant products.
The Company has historically provided a breakdown of sales to the CATV and
telephone industries based on product sales, i.e., each product has been
traditionally purchased by one or the other industry. With the gradual
convergence of the two industries, an industry breakdown based on product sales
becomes less valid each year as telephone companies purchase equipment
heretofore purchased only by CATV companies and vice versa. Management believes
continuation of an industry sales breakdown based on product sales would be
misleading and has decided that all future reports and publications will combine
these two market segments under the title "Telecommunications".
Domestic net sales increased $7.3 million or 17.5% from $41.7 million in 1996
to $49.0 million in 1997. This increase was a result of the sales of $4.3
million of RF passive electronic devices and $3.0 million of Channell
proprietary products due to moderate system upgrade and new network construction
growth. International net sales increased $5.3 million or 94.6% from $5.6
million in 1996 to $10.9 million in 1997, primarily due to the sales of $4.6
million of RF passive electronic devices and $1.0 million of metal enclosures.
14
Gross Profit. Gross profit increased $3.1 million or 14.2% from $21.8 million
in 1996 to $24.9 million in 1997. $2.4 million of this improvement is
attributable to the sales of RF passive devices, $0.5 million was attributable
to increased volume of Channell proprietary products, and $0.2 million was
attributable to the sales of metal enclosures. Gross margin decreased from
46.2% in 1996 to 41.6% in 1997 primarily due to a 26.5% and 21.3% margin
contribution from the sales of RF passive devices and metal enclosures,
respectively. Gross margin on Channell's proprietary products decreased from
46.2% to 44.7% during the comparable periods primarily due to increased
depreciation expense from capital expenditures in the comparative periods and
increased manufacturing staffing.
Commission Income. Commission income decreased $0.4 million or 40.0% from
$1.0 million in 1996 to $0.6 million in 1997, due to a decrease in sales of
cable-in-conduit products as a result of aggressive pricing by competition and
lower sales in the eastern part of the United States due to severe winter
weather conditions during the first quarter of 1997.
Selling. Selling expense increased $0.7 million or 10.6% from $6.6 million in
1996 to $7.3 million in 1997, primarily as a result of $1.0 million of increased
sales and marketing expenses related to the RMS and Standby Electronics
subsidiaries, and $0.4 million for increased payroll and related expenses in
connection with expanded staffing to support increased sales and marketing
activities worldwide. The increased selling expenses discussed above were
offset by the salary and expenses of an officer now being classified as general
and administrative expenses due to expanded responsibility. As a percentage of
net sales, selling expense decreased from 13.9% in 1996 to 12.1% in 1997.
General and Administrative. General and administrative expenses increased
$2.1 million or 105.0% from $2.0 million in 1996 to $4.1 million in 1997. Such
increase occurred primarily as a result of increased payroll and employee
benefits in the amount of $0.7 million due to increased staffing in the
administrative and information systems departments as a result of the RMS and
Standby Electronics acquisitions, as well as the reclassification of the salary
of an executive officer. Travel, legal, auditing and professional services
increased $0.6 million as a result of being a publicly traded company for a full
year in 1997 as compared to having such status for six months in 1996.
Depreciation, insurance and facilities expense increased $0.2 million as a
result of the RMS acquisition. Computer hardware and software expenses
increased $0.3 million as a result of the installation of a new MIS platform.
As a percentage of net sales, general and administrative expenses increased from
4.3% in 1996 to 6.8% in 1997.
License Fees. License fees decreased $0.5 million in 1997 as a result of the
termination of the Channell Patents during 1996.
Research and Development. Research and development expenses increased $0.5
million or 100.0% from $0.5 million in 1996 to $1.0 million in 1997, primarily
as a result of increased payroll and expenses associated with increased
staffing. As a percentage of net sales, research and development expenses
increased from 1.1% in 1996 to 1.7% in 1997.
Income from Operations. As a result of the items discussed above, income from
operations was $13.2 million in both 1996 and 1997, but declined as a percentage
of net sales from 27.9% in 1996 to 22.0% in 1997.
Income Taxes. Income taxes increased $3.2 million from $2.4 million in 1996
to $5.6 million in 1997. The increase is principally due to the termination of
the S Corporation status as a result of the Initial Public Offering, at which
time the Company recorded deferred tax assets on its balance sheet with a
corresponding credit to its income tax expense. Since the Initial Public
Offering, the Company pays federal and state income taxes as a C Corporation.
15
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1996 WITH THE YEAR ENDED DECEMBER 31,
1995
Net Sales. Net sales increased $6.3 million or 15.4% from $41.0 million in
1995 to $47.3 million in 1996. CATV net sales increased $5.7 million or 16.1%
from $35.4 million in 1995 to $41.1 million in 1996 as a result of new account
development during the period and a continued moderate growth from rebuild and
new network construction projects. Telecommunications net sales increased $0.6
million or 10.7% from $5.6 million in 1995 to $6.2 million in 1996. This sales
increase was due to the introduction of new sealed products during the period
and an increased activity in conventional copper-based telephone products.
Domestic net sales increased $6.8 million or 19.5% from $34.9 million in 1995
to $41.7 million in 1996. This increase is a result of the items discussed
above, in the CATV and telecommunications sections. International net sales
decreased $0.5 million or 8.2% from $6.1 million in 1995 to $5.6 million in
1996, mainly due to a slowdown in broadband network construction by certain
Pacific Rim and European customers.
Gross Profit. Gross profit increased $3.9 million or 21.8% from $17.9 million
in 1995 to $21.8 million in 1996. Gross margin increased from 43.7% in 1995 to
46.2% in 1996. The improvement in gross profit and gross margin was primarily
due to an increase in the sales mix of products with a higher margin as well as
an overall increase in sales volume, which resulted in higher operating leverage
(i.e., a higher percentage of sales relative to fixed costs).
Commission Income. Commission income decreased $0.1 million or 9.1% from $1.1
million in 1995 to $1.0 million in 1996, due to lower sales volume of cable-in-
conduit products.
Selling. Selling expense increased $1.0 million or 17.9% from $5.6 million in
1995 to $6.6 million in 1996, primarily as a result of increased payroll and
related expense in the amount of $0.8 million in connection with expanded
staffing to support increased sales and marketing activities, and increased
outbound freight expense in the amount of $0.3 million resulting from higher net
sales during the 1996 period. As a percentage of net sales, selling expense
increased from 13.7% in 1995 to 13.9% in 1996.
General and Administrative. General and administrative expenses increased
$0.3 million or 17.7% from $1.7 million in 1995 to $2.0 million in 1996,
primarily as a result of increased payroll in the amount of $0.4 million due to
increased staffing in the administrative and information systems departments.
Legal, auditing and professional services increased $0.2 million as a result of
becoming a publicly traded company. As a percentage of net sales, general and
administrative expense was 4.3% during 1995 and 1996.
License Fees. License fees declined $1.5 million or 75.0% from $2.0 million
in 1995 to $0.5 million in 1996 as a result of the termination of the Channell
patents during 1996.
Research and Development. Research and development expenses were $0.5 million
in both 1995 and 1996, but declined as a percentage of net sales from 1.2% in
1995 to 1.1% in 1996. Research and development expense is expected to be higher
in the future in light of the Company's plans for new product development.
Income from Operations. As a result of the items discussed above, income from
operations increased $4.0 million or 43.5% from $9.2 million in 1995 to $13.2
million in 1996 and operating margin increased from 22.3% to 27.9%.
Income Taxes. Income taxes increased $2.1 million from $0.3 million in 1995
to $2.4 million in 1996 due to the termination of the S corporation status at
the time of the Initial Public Offering. After the Initial Public Offering, the
Company pays federal and state income taxes as a regular corporation, offset by
the recording of deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
Upon the termination of the S corporation status and prior to the Initial
Public Offering in July 1996, the Company declared a dividend to its then
existing stockholders representing all of the Company's S corporation
"accumulated adjustment account" remaining at the time. The S corporation
distribution totalled $11.7 million and was paid out of the net proceeds of the
Initial Public Offering.
Prior to the Initial Public Offering, the Company's Chairman of the Board and
Chief Executive Officer owned six patents utilized by the Company in its
business (the "Channell Patents"), and was entitled to receive license fees
based upon the sale of certain products embodying the Channell Patents. Prior
to the Initial Public Offering, the Channell Patents were sold to the Company
for the aggregate consideration of $3.1 million, which was initially funded
through borrowings under the Company's bank line and then repaid from the net
proceeds of the Initial Public Offering.
Upon the closing of the Initial Public Offering, the Company used $2.7 million
from the net proceeds to repay the Company's bank indebtedness.
16
Upon the closing of the Initial Public Offering in July 1996 and the exercise
of the underwriter's over-allotment in August 1996, the Company received net
proceeds from the issuance of stock of $30.6 million. As of December 31, 1996,
the Company has invested $20.2 million, which includes the remaining proceeds
from the Initial Public Offering, in marketable securities and cash equivalents.
Interest income earned on these securities for the year ended December 31, 1996
was $0.5 million and $1.0 million for the year ended December 31, 1997.
Net cash provided by operating activities was $11.4 million and $3.7 million
in 1996 and 1997, respectively. Net cash provided by financing activities was
$9.4 million in 1996 and net cash used in financing activities was $0.1 million
in 1997. Net cash used in investing activities was $12.9 million and $9.0
million in 1996 and 1997, respectively. The purchase of $11.4 and $7.3 million
(including $7.1 million of maturities) in short-term securities was included in
investing activities for the years ended December 31, 1996 and 1997,
respectively.
Accounts receivable increased from $6.7 million for the year ended December
31, 1996 to $9.2 million for the year ended December 31, 1997 as a result of
higher sales during the fourth quarter of 1997 as compared to the same period in
1996. Inventories increased from $2.9 million for the year ended December 31,
1996 to $7.3 for the year ended December 31, 1997 as a result of increased work-
in-process and finished goods inventories required for the increased sales
volume forecasted and the acquisitions of RMS and Standby Electronics.
The Company made capital expenditures of $1.6 million and $6.0 million in 1996
and 1997, respectively, and anticipates increased capital spending for
machinery, product tooling, test equipment and computer hardware and software as
it continues to implement its new product development plans. The Company's
material commitment consists of a capital lease for certain computer equipment
in connection with the Company's new management information system. Such lease
will require aggregate payments of approximately $0.6 million through December
2000. The Company also leases its manufacturing and warehouse facility in
Temecula, California consisting of two buildings totalling approximately 260,000
square feet which require annual lease payments of approximately $1.1 million.
The Company is heavily dependent upon complex computer systems for all phases
of its operations, which include production, sales and distribution. The
Company's computer software programs recognize only the last two digits of the
year in any date (e.g., "97" for "1997"), and therefore some software may
inaccurately process data in 1999 or 2000 if the software is not reprogrammed,
upgraded or replaced (the "Year 2000 Issue"). The Company has initiated a
program intended to timely mitigate and/or prevent on a timely basis the adverse
effects of the Year 2000 Issue, and to pursue compliance by suppliers. The
Company believes that many of its suppliers and customers may also have Year
2000 Issues which could affect the Company. At this time, it is not possible to
quantify the overall cost of this work, nor the financial effect of the Year
2000 Issue if it is not resolved on a timely basis. However, the Company
presently believes that the cost of fixing the Year 2000 Issue will not have a
material adverse impact on the Company's financial position and result of
operations.
The Company currently maintains a revolving credit facility (as amended to
date, the "Revolving Credit Facility") with the Bank of America National Trust
and Savings Association ("Bank of America"), consisting of (i) a $5.0 million
working capital revolving line of credit, which had no outstanding balance at
December 31, 1997, and (ii) a $5.0 million equipment revolving line of credit
and a standby letter of credit facility, which had no outstanding balance at
December 31, 1997. Loans under the working capital line bear interest at the
Bank of America's reference rate and mature on May 1, 1999, while loans under
the equipment line bear interest at the Bank of America's reference rate, plus
0.25% and are repayable in sixty equal monthly installments of principal and
interest commencing in the first month after issuance of each advance.
Availability of advances under the Revolving Credit Facility expires on May 1,
1999. The equipment line of credit is collateralized by the related equipment
financed by the Bank of America. The Revolving Credit Facility contains various
financial and operating covenants which, among other things, impose limitations
on the Company's ability to incur additional indebtedness, merge or consolidate,
sell its assets, make certain investments or, under certain circumstances, pay
dividends. The Company is also required to comply with covenants related to
tangible net worth and other financial ratios.
The Company believes that, in order to carry on its current operations, income
from operations, the remaining proceeds from the Initial Public Offering and the
Revolving Credit Facilities will be sufficient to fund its capital expenditures
and working capital requirements through 1998.
FORWARD-LOOKING STATEMENTS
This Report on Form 10-K contains certain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are being provided pursuant to that legislation. In addition to the
other information contained in this Form 10-K, the following risk factors should
be carefully considered in evaluating the Company and its business. The
following is not intended as, and should not be considered, an exhaustive list
of relevant factors.
OBSOLESCENCE; UNCERTAINTY OF MARKET ACCEPTANCE OF NEW PRODUCTS
The communications industry is characterized by rapid technological change.
The introduction of products embodying new technologies or the emergence of new
industry standards can render existing products or products under development
obsolete or unmarketable. For example, satellite, wireless and other
communication technologies currently being deployed may represent a threat to
copper, coaxial and fiber optic-based systems by reducing the need for wire-line
networks. To date, however, the Company believes that these technologies have
not had a significant impact on the
17
demand for traditional wire-line network based services, and management
anticipates that a number of factors, including network capacity requirements,
existing investments in wire-line networks, security and long-term cost
effectiveness, will result in continued growth of wire-line networks. However,
there can be no assurance that future advances or further development of these
or other new technologies will not have a material adverse effect on the
Company's business. Further, the Company's growth strategies are designed, in
part, to take advantage of opportunities that the Company believes are emerging
as a result of the development of enhanced voice, video and other transmission
networks and internet access in the telecommunications industry. There can be no
assurance that demand resulting from these emerging trends will develop rapidly
or that the Company's products will meet with market acceptance.
IMPORTANCE OF NEW PRODUCT DEVELOPMENT TO GROWTH
The Company's ability to anticipate changes in technology and industry
standards and to successfully develop and introduce new products on a timely
basis will be a significant factor in the Company's ability to grow and remain
competitive. New product development often requires long-term forecasting of
market trends, development and implementation of new designs and processes and a
substantial capital commitment. The trend toward consolidation of the
communications industry may require the Company to quickly adapt to rapidly
changing market conditions and customer requirements. Although the Company's
manufacturing and marketing expertise has enabled it to successfully develop and
market new products in the past, any failure by the Company to anticipate or
respond in a cost-effective and timely manner to technological developments or
changes in industry standards or customer requirements, or any significant
delays in product development or introduction, could have a material adverse
effect on the Company's business, operating results and financial condition.
CONCENTRATION OF CUSTOMERS; LIMITED BACKLOG
The Company's core business consists of enclosure product sales to the CATV
market. Such sales comprised approximately 86% of the Company's total net sales
during 1995. 87% in 1996, and 88% during 1997. The CATV industry is
concentrated, with relatively few cable operators accounting for a large
percentage of the Company's available market. Consequently, while the Company
shipped product to over 4,000 customer locations in 1997, its five largest
customers (by sales volume) accounted for 42.7% of the Company's total net sales
in 1997. Two customers, Media One and Time Warner, accounted for 10.0% and
15.1%, respectively, of the Company's total net sales during the period.
18
The Company's customers typically require prompt shipment of the Company's
products. As a result, the Company has historically operated with a relatively
small backlog, and sales and operating results in any quarter are principally
dependent upon orders booked and products shipped in that quarter. Further, the
Company's customers generally do not enter into long-term supply contracts
providing for future purchase commitments for the Company's products. These
factors, when combined with the Company's operating leverage (see "Operating
Leverage" below) and the need to incur certain capital expenditures and expenses
in part based upon the expectation of future sales, results in the Company's
operating results being at risk to changing customer buying patterns. If sales
levels in a particular period do not meet the Company's expectations, operating
results for that period may be materially and adversely affected.
DEPENDENCE ON THE COMMUNICATIONS INDUSTRY
The Company's sales to the telecommunications industry represent substantially
all of the Company's historical sales and are expected to continue to do so for
the foreseeable future. Within that industry, approximately 88% of the
Company's total net sales in 1997 were derived from domestic and international
sales to the CATV segment, with 25.1% of total net sales for the year
attributable to two customers in that industry, Media One and Time Warner. The
Company expects that sales to the CATV industry will continue to represent a
substantial portion of its total sales. Demand for products to this segment
depends primarily on capital spending by cable operators for constructing,
rebuilding, maintaining or upgrading their systems. The amount of capital
spending and, therefore, the Company's sales and profitability are affected by a
variety of factors, including general economic conditions, access by cable
operators to financing, government regulation of cable operators, demand for
cable services and technological developments in the broadband communications
industry. The Company's remaining sales in 1997 were derived from the
telecommunications industry, primarily local telephone operators. Although
local telephone operators may have greater access to capital than many cable
operators, the same factors dictating the demand for products in the CATV
segment of the industry also apply to the local telephone segment. Thus, the
Company's success is dependent upon continued demand for products used in signal
transmission systems from the communications industry generally, including both
CATV and telephone, which may be affected by factors beyond the Company's
control, including the convergence of voice, data and video transmission systems
occurring within the CATV and telephone markets, continuing consolidation of
companies within those markets and the provision of internet access by cable
operators and local telephone companies.
PRICE FLUCTUATIONS OF RAW MATERIALS; AVAILABILITY OF COMPLEMENTARY PRODUCTS
The Company's cost of sales may be materially affected by increases in the
market prices of the raw materials used in the Company's manufacturing
processes, including resin. The Company does not engage in hedging transactions
for such materials, although it periodically enters into contracts for certain
raw materials for as much as one year or more. There can be no assurance that
price increases in raw materials can be passed on to the Company's customers
through increases in product prices. In addition, in order to position itself
as a full-line product supplier, the Company relies on certain manufacturers to
supply products that complement the Company's own product line, including grade
level boxes and cable-in-conduit. Although the Company believes there are
multiple sources of supply for these products, disruptions or delays in the
supply of such products could have a material adverse effect on sales of the
Company's own products.
ACQUISITIONS AND FAILURE TO INTEGRATE ACQUIRED BUSINESSES
One of the Company's principal strategies is to increase its revenues and the
markets it serves through the acquisition of complementary businesses. There
can be no assurance that the Company will be able to identify and acquire
attractive acquisition candidates, profitably manage such acquired businesses or
successfully integrate such acquired businesses into the Company without
substantial costs, delays or other problems. Acquisitions may involve a number
of special risks, including, but not limited to, adverse short-term effects on
the Company's reported financial condition or results of operations, diversion
of management's attention, dependence on retention, hiring and training of key
personnel, risks associated with unanticipated problems or liabilities and
amortization of acquired intangible assets, some or all of which could have a
material adverse effect on the Company's business, financial condition or
results or operations. In addition, there can be no assurance that businesses
acquired in the future will be profitable at the time of acquisition or that the
businesses recently acquired or acquired in the future will achieve sales and
profitability justifying the Company's investment therein or that the Company
will recognize the synergies expected from such acquisitions. The failure to
obtain any or all of the desired results from these acquisitions could have a
material adverse effect on the Company's business, financial condition or
results of operations.
IMPACT OF OPERATING LEVERAGE IN THE EVENT OF SALES DECLINE
Because of the relatively high percentage of fixed costs for rent, product
development, engineering, tooling and related fixed manufacturing costs as a
percentage of total costs, the Company's ability to maintain its historic
profitability is dependent on generating a sufficient volume of product sales,
thereby spreading fixed costs over the sales base. Due to this "operating
leverage", a reduction in sales or the rate of sales growth could have a
disproportionately adverse effect on the Company's financial results.
SEASONALITY AND FLUCTUATIONS IN OPERATING RESULTS
19
The Company's business is somewhat seasonal in nature, with the first and
fourth quarters generally reflecting lower sales due to the impact of adverse
weather conditions on construction projects that may alter or postpone the needs
of customers for delivery of the Company's products. The Company's operating
results may also fluctuate significantly from quarter to quarter due to several
other factors, including the volume and timing of orders from, and shipments to,
major customers, the timing of new product announcements and the availability of
products by the Company or its competitors, the overall level of capital
expenditures by CATV operators and local telephone companies, market acceptance
of new and enhanced versions of the Company's products, variations in the mix of
products the Company sells, and the availability and cost of raw materials.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
International sales accounted for 14.4%, 11.7% and 18.2% of the Company's net
sales in 1995, 1996 and 1997, respectively, and the Company expects that
international sales may increase as a percentage of sales in the future. Due to
its international sales, the Company is subject to the risks of conducting
business internationally, including unexpected changes in, or impositions of,
legislative or regulatory requirements, fluctuations in the U.S. dollar which
could materially adversely affect U.S. dollar revenues or operating expenses,
tariffs and other barriers and restrictions, potentially longer collection
cycles, greater difficulty in accounts receivable collection, potentially
adverse taxes and the burdens of complying with a variety of international laws
and communications standards. The Company is also subject to general
geopolitical risks, such as political and economic instability and changes in
diplomatic and trade relationships, in connection with its international
operations. There can be no assurance that these risks of conducting business
internationally will not have a material adverse effect on the Company's
business.
COMPETITION
The industries in which the Company operates are highly competitive. Further,
in connection with the anticipated growth in the communications industry
generally and demand for products required in signal transmission networks in
particular, the level and intensity of competition may increase in the future.
In the telephone segment of the industry, the Company's competition includes a
company that has a significant market share. While the Company's net sales to
this segment have increased from $3.3 million in 1993 to $7.2 million in 1997,
and the Company's strategy, which includes continued focus on increasing sales
to this segment, there can be no assurance that the Company will be able to
compete successfully against that company or other competitors, many of which
may have access to greater financial resources than the Company.
DISRUPTIONS AT THE COMPANY'S MANUFACTURING FACILITY; LEASE WITH RELATED PARTY
All of the Company's manufacturing operations are currently located at the
Company's facility in Temecula, California, which also includes the Company's
principal warehouse and corporate offices. The Company's success depends in
large part on the orderly operation of this facility. Because the Company's
manufacturing operations and administrative departments are concentrated at this
facility, a fire, earthquake or other disaster at this facility could materially
and adversely affect its business and results of operations. The Company
maintains standard property and earthquake insurance on this facility as well as
business interruption insurance and back-up data systems.
The Company currently leases the Temecula facility from William H. Channell,
Sr., a principal stockholder and Chairman of the Board and Chief Executive
Officer of the Company. The Company believes the terms of these leases are no
less favorable than would be available from an unrelated third party after arm's
length negotiations. Although the Company has renewal options through the year
2015 under these leases, there can be no assurance that the Company and Mr.
Channell, Sr. will be able to agree on renewal options for the properties
currently leased by the Company. The failure of the Company to renew the leases
would require the Company to relocate its existing facilities which could have a
material adverse affect on the Company's business, financial condition or
results of operations.
DEPENDENCE ON KEY PERSONNEL
The future success of the Company depends in part on its ability to attract
and retain key executive, engineering, marketing and sales personnel. Key
personnel of the Company include William H. Channell, Sr., the Chairman of the
Board and Chief Executive Officer, William H. Channell, Jr., the President and
Chief Operating Officer, and the other executive officers of the Company.
Competition for qualified personnel in the communications industry is intense,
and the loss of certain key personnel could have a material adverse affect on
the Company. The Company has entered into employment contracts with Mr.
Channell, Sr. and Mr. Channell, Jr.
CHANGING REGULATORY ENVIRONMENT
The communications industry is subject to regulation in the United States and
other countries. Federal and state regulatory agencies regulate most of the
Company's domestic customers. On February 1, 1996, the United States Congress
passed the Telecommunications Act of 1996 (the "Telecommunications Act"), which
the President signed into law on February 8, 1996. The Telecommunications Act
lifts certain restrictions on the liability of companies, including RBOCs and
other customers of the Company, to compete with one another and liberally
reduces the regulation of the communications industry. While the Company
believes that the deregulation of the communications industry may increase the
Company's opportunities to provide solutions for its customers' signal
transmission network needs, the effect of the Telecommunications Act on the
market for the Company's
20
products is difficult to predict at this time, and there can be no assurance
that competition in the Company's markets will not intensify as a result of such
deregulation. Changes in current or future laws or regulations, in the United
States or elsewhere, could materially adversely affect the Company's business.
UNCERTAIN ABILITY TO MANAGE GROWTH; RISKS ASSOCIATED WITH IMPLEMENTATION OF NEW
MANAGEMENT INFORMATION SYSTEM
The growth in the Company's business has required, and is expected to continue
to require, significant Company resources in terms of personnel, management and
other infrastructure. The Company's ability to manage any future growth
effectively will require it to attract, train, motivate and manage new employees
successfully, to integrate new employees into its overall operations and to
continue to improve its operational, financial and management information
systems. In 1998, the Company intends to complete the implementation of a new
management information system ("MIS"). The Company believes the new MIS will
significantly affect many aspects of its business, including its accounting,
operations, purchasing, sales and marketing functions. The successful
implementation of this system will be important to the Company's provision of
services and to facilitate future growth. If the Company is not successful in
implementing its MIS or if the Company experiences difficulties in such
implementation, the Company could experience problems with delivery of its
products or an adverse impact on its ability to access financial and accounting
information on a timely basis.
ENVIRONMENTAL MATTERS
The Company is subject to a wide variety of federal, state and local
environmental laws and regulations and uses a limited number of chemicals that
are classified as hazardous or similar substances. Although management believes
that the Company's operations are in compliance in all material respects with
current environmental laws and regulations, the Company's failure to comply with
such laws and regulations could have a material adverse effect on the Company.
21
SELECTED QUARTERLY FINANCIAL DATA
Set forth below is certain unaudited quarterly financial information. The
Company believes that all necessary adjustments, consisting only of normal
recurring adjustments, have been included in the amounts stated below to present
fairly, and in accordance with generally accepted accounting principles, the
selected quarterly information when read in conjunction with the Financial
Statements included elsewhere herein.
Year Ended Year Ended
December 31, 1996 December 31, 1997
------------------------------------------ --------------------------------
(amounts in thousands) (amounts in thousands)
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ---------- --------- ------- ------- ---------- --------- -------
Net sales............... $10,279 $12,961 $11,954 $12,088 $12,804 $15,664 $15,353 $16,122
Gross profit............ 4,541 5,986 5,531 5,777 5,143 7,005 6,399 6,364
Income from operations.. 2,189 3,814 3,802 3,373 2,093 4,099 3,670 3,318
Income before income
taxes.................. 2,124 3,751 3,994 3,600 2,392 4,301 3,880 3,486
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
Consolidated Financial Statements of Channell Commercial Corporation are as
follows:
Report of Independent Certified Public Accountants................................................... F-1
Consolidated Balance Sheets as of December 31, 1996 and December 31, 1997............................ F-2
Consolidated Statements of Income for the years ended December 31, 1995, December 31, 1996,
and December 31, 1997......................................................................... F-3
Consolidated Statement of Stockholders' Equity for the years ended December 31, 1995,
December 31, 1996 and December 31, 1997....................................................... F-4
Consolidated Statement of Cash Flows for the years ended December 31, 1995, December 31, 1996,
and December 31, 1997......................................................................... F-5
Notes to Consolidated Financial Statements........................................................... F-7
Financial statement schedules are as follows:
All schedules are omitted because they are not applicable, or the required
information is included in the financial statements or the notes thereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
There has been no Form 8-K filed reporting a change of accountants or
reporting disagreements on any matter of accounting principle, practice,
financial statement disclosure or auditing scope or procedure.
22
PART III
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS
--------------------------------
The following table sets forth information with respect to the Company's current
executive officers and directors and their ages as of December 31, 1997.
Name Age Positions
- -------------------------- --- -----------------------------------
William H. Channell, Sr... 69 Chairman of the Board and
Chief Executive Officer
William H. Channell, Jr... 40 President, Chief Operating Officer
and Director
Gary W. Baker............. 54 Vice President, Finance and
Chief Financial Officer
Andrew M. Zogby........... 37 Vice President, Marketing
Edward J. Burke........... 42 Vice President, Engineering
Dale C. Wooding........... 47 Vice President, Manufacturing
John B. Kaiser............ 45 Vice President, Broadband Sales
Gary M. Napolitano........ 42 Vice President, General Manager RMS
Jacqueline M. Channell.... 66 Secretary and Director
Eugene R. Schutt, Jr...... 44 Director
Richard A. Cude........... 64 Director
The directors of the Company are staggered into three classes, with the
directors in a single class elected at each annual meeting of stockholders to
serve for a term of three years or until their successors have been elected and
qualified. The authorized number of members of the Board of Directors is
currently seven. The executive officers of the Company serve at the pleasure of
the Board of Directors. The Company is currently evaluating other director
candidates and anticipates adding two directors to the Board.
William H. Channell, Sr., the son of the Company's founder, James W. Channell,
has been the Chairman of the Board and Chief Executive Officer since the Initial
Public Offering. Prior to this time, he had held the position of President and
Chief Executive Officer since 1966. Mr. Channell, Sr. is a co-trustee of the
Channell Family Trust, which is a principal stockholder of the Company, and is
the husband of Jacqueline M. Channell and the father of William H. Channell, Jr.
His initial term as a director expires in 1999.
William H. Channell, Jr. has been President and Chief Operating Officer of the
Company since the Initial Public Offering. He has been a Director of the Company
since 1984. Since joining the Company in 1979, Mr. Channell, Jr. has held the
positions of Executive Vice President, Director of Marketing and National Sales
Manager. Mr. Channell, Jr. is a principal stockholder of the Company and is the
son of William H. Channell, Sr. and Jacqueline M. Channell. His term as a
director expires in 2000.
Gary W. Baker has been the Company's Vice President, Finance since May 1996,
and the Chief Financial Officer since 1990. Mr. Baker was the Company's
Corporate Controller from 1985 to 1990. From 1983 to 1985, Mr. Baker was the
Corporate Controller of Symbolics, Inc., a publicly traded manufacturer of
computer products.
Andrew M. Zogby has been the Company's Vice President, Marketing since March
1996. Prior to joining the Company, Mr. Zogby was Director of Strategic
Marketing, Broadband Connectivity Group for ADC Telecommunications, a publicly
traded, telecommunications equipment supplier to both telephone and CATV network
providers worldwide. He had been with ADC Telecommunications since 1990. Mr.
Zogby has held various technical marketing positions in the telecommunications
equipment industry since 1984.
23
Edward J. Burke has been the Company's Vice President, Engineering since May
1996 and has served in various similar capacities with the Company since 1984.
Mr. Burke has held various technical positions in the thermoplastic product
engineering and tooling design field since 1978.
Dale C. Wooding has been the Company's Vice President, Manufacturing since May
1996 and has served in various similar capacities with the Company since 1985.
Mr. Wooding has held various positions in the manufacturing management field
since 1976.
John B. Kaiser has been the Company's Vice President, Broadband Sales since
May 1996. He held the position of Director of Marketing for the Company from
1987 to 1991. Between 1991 and his return to the Company, Mr. Kaiser held the
position of District Manager, Southern California, for the General Polymers
Division of Ashland Chemical, a thermoplastics distributor, where his
responsibilities included general management of district operations, including
sales, warehousing, procurement and logistics.
Gary M. Napolitano joined the Company as Vice President and General Manager of
RMS, in January 1997, as a result of the acquisition of RMS. Mr. Napolitano had
been President of RMS since 1992 and was the Vice President of Finance prior to
becoming President.
Jacqueline M. Channell has been the Company's Secretary and a Director since
1966. She is a co-trustee of the Channell Family Trust, which is a principal
stockholder of the Company, and is the wife of William H. Channell, Sr. and the
mother of William H. Channell, Jr. Mrs. Channell's term as a director expires
in 1998.
Eugene R. Schutt, Jr. has been a Director of the Company since July 1996. Mr.
Schutt's initial term expires in 1999. Since January 1992, Mr. Schutt has been
the President of Avco International, a division of Avco Financial Services,
Inc., an international financial services company. From 1984 to 1992, he served
as President of Pratt Industries, Inc., a manufacturer of paper and related
products.
Richard A. Cude became a director of the Company during 1996. Mr. Cude has
been the General Manager of the Los Angeles Support Center for Courtaulds PLC
London, England since 1994 and has served in various capacities with Courtaulds
since 1988. Prior to that, Mr. Cude has been with various companies involved in
the marketing of products to the communications and telecommunications industry.
Mr. Cude's term as Director expires in 2000.
COMPENSATION OF DIRECTORS
Directors who are also officers of the Company (except as indicated below)
receive no additional compensation for their services as directors. The
Company's non-management directors receive compensation consisting of an annual
retainer fee of $15,000 plus $1,000 for attendance at any meeting of the Board
of Directors or any committee thereof, plus direct out-of-pocket costs related
to such attendance. Mrs. Channell also receives non-management director retainer
and attendance fees. Mrs. Channell does not receive separate compensation for
serving as the Company's Secretary. In addition, pursuant to the Company's 1996
Incentive Stock Plan (as described below), each non-management director
(including Mrs. Channell) received options to acquire 1,000 shares of the
Company's Common Stock with an exercise price equal to the Initial Public
Offering price, and on the date of each of the Company's annual stockholder
meetings after the Initial Public Offering, each non-management director
(including non-executive officers who serve as directors) serving on the Board
of Directors immediately following such meeting will receive options to acquire
an additional 1,000 shares of the Company's Common Stock with an exercise price
equal to the market value of the Common Stock on the date such options are
granted. These options will become exercisable at a rate of 33 1/3% per year
commencing on the first anniversary of the date of issuance and will have a term
of 10 years.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Information required by Item 405 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement relating to its 1998 annual meeting
of stockholders.
24
ITEM 11. EXECUTIVE COMPENSATION
----------------------
SUMMARY COMPENSATION TABLE
The following table sets forth the annual and long-term compensation of the
Company's Chief Executive Officer and the four additional most highly
compensated executive officers for the year ended December 31, 1997
(collectively, the "Named Officers").
Long-Term Compensation
-------------------------------
Awards Payouts
------------------------ ---------
Securities
Other Annual Restricted Underlying All Other
Name and Positions Annual Compensation Compensation Stock Options/ LTIP Compensation
Held with the Company Salary($) $Bonus($)(3) ($)(1) Awards($) SARS(#) Payouts($) ($)(2)
- --------------------- -------- ----------- ---------- --------- ------- --------- ------------
William H. Channell, Sr......
Chairman of the Board and
Chief Executive Officer $520,000 $ - $ - $ - - $ - $ -
William H. Channell, Jr......
President and Chief
Operating Officer 520,000 130,000 - - 50,000 - 460
Gary W. Baker................
Vice President, Finance and
Chief Financial Officer 142,800 83,666 - - 6,000 - 478
Edward J. Burke..............
Vice President, Engineering 131,250 83,666 - - 6,000 - 984
Dale C. Wooding..............
Vice President,
Manufacturing 115,500 83,666 - - 6,000 - 906
- --------------
(1) For each individual named, compensation excludes perquisites and other
personal benefits, that did not exceed the lesser of $50,000 or 10% of the
total annual salary and bonus reported for such individual.
(2) Payments to the Company's 401K plan.
(3) As an incentive for continued services, the Company, in 1996, granted a cash
bonus of $200,000 to Mr. Baker, Mr. Burke, and Mr. Wooding, which is earned
and payable in three equal installments on each of December 31, 1997, 1998,
and 1999, provided each remains employed by the Company and subject to
continued payment in the event of death.
1996 INCENTIVE STOCK PLAN
The Company's 1996 Incentive Stock Plan (the "Stock Plan") currently permits
the granting to the Company's key employees, directors and other service
providers of (i) options to purchase shares of the Company's Common Stock and
(ii) shares of the Company's Common Stock that are subject to certain vesting
and other restrictions ("Restricted Stock"). A maximum of 750,000 shares of
Common Stock have been reserved for issuance under the Stock Plan. The Company
granted "non-qualified" options to acquire 512,700 shares of Common Stock to 92
of the Company's employees and directors (including 100,000 stock options being
issued to William H. Channell, Jr., the Company's President) at the time of the
Initial Public Offering in 1996 with an exercise price equal to the public
offering price. During 1997, the Company granted 164,700 "non-qualified" options
to 37 employees and directors (including 50,000 stock options issued to William
H. Channell, Jr., the Company's President). These options will vest at a rate
of 33 1/3% per year beginning on the first anniversary of the date of issuance
and will have a term of 10 years.
The Stock Plan is administered by the Compensation Committee of the Board of
Directors. The aggregate number of stock options or shares of Restricted Stock
that may be granted to any single participant under the Stock Plan during any
fiscal year of the Company is 100,000. The purpose of the Stock Plan is to
secure for the Company and its stockholders the benefits arising from stock
ownership by key employees, directors and other service providers selected by
the Compensation Committee.
25
All options granted under the Stock Plan are non-transferable and exercisable
in installments determined by the Compensation Committee, except that each
option is to be exercisable in minimum annual installments of 20% commencing
with the first anniversary of the option's grant date. Each option granted has a
term specified in the option agreement, but all options expire no later than ten
years from the date of grant. Options under the Stock Plan may be designated as
"incentive stock options" for federal income tax purposes or as options which
are not qualified for such treatment, or "non-qualified stock options." In the
case of incentive stock options, the exercise price must be at least equal to
the fair market value of the stock on the date the option is granted. The
exercise price of a non-qualified option need not be equal to the fair market
value of the stock at the date of grant, but may be granted with any exercise
price which is not less than 85% of the fair market value at the time the option
is granted, as the Compensation Committee may determine. The aggregate fair
market value (determined at the time the options are granted) of the shares
covered by incentive stock options granted to any employee under the Stock Plan
(or any other plan of the Company) which may become exercisable for the first
time in any one calendar year may not exceed $100,000.
Upon exercise of any option, the purchase price must generally be paid in full
either in cash or by certified or cashier's check. However, in the discretion of
the Compensation Committee, the terms of a stock option grant may permit payment
of the purchase price by means of (i) cancellation of indebtedness owed by the
Company, (ii) delivery of shares of Common Stock already owned by the optionee
(valued at fair market value as of the date of exercise), (iii) delivery of a
promissory note secured by the shares issued, (iv) delivery of a portion of the
shares issuable upon exercise (i.e., exercise for the "spread" on the option
payable in shares), or (v) any combination of the foregoing or any other means
permitted by the Compensation Committee.
Any grants of Restricted Stock will be made pursuant to Restricted Stock
Agreements, which will provide for vesting of shares at a rate to be determined
by the Compensation Committee with respect to each grant of Restricted Stock.
Until vested, shares of Restricted Stock are generally non-transferable and are
forfeited upon termination of employment.
OPTIONS/SAR GRANTS TABLE
The following table sets forth the stock options granted to the named officers
for the year ended December 31, 1997.
Potential
% of Total Realized
Number of Options/ Value at
Securities SARS Assumed Annual
Underlying Granted to Exercise Rates of Stock Price
Options/ Employees On Base Appreciation of
SARS in Fiscal Price Expiration Option Term
NAME Granted Year 1997 ($/SH) Date 5% 10%
---- ------- --------- ------ ---------- ---- -----
William H. Channell, Sr. - - $ - - $ - $ -
William H. Channell, Jr. 50,000 30.4% $13.25 July 2007 416,500 1,056,000
Gary W. Baker 6,000 3.6% $13.25 July 2007 49,980 126,720
Edward J. Burke 6,000 3.6% $13.25 July 2007 49,980 126,720
Dale C. Wooding 6,000 3.6% $13.25 July 2007 49,980 126,720
26
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND DECEMBER 31, 1997
OPTION/SAR VALUES
The following table sets forth the number and value of outstanding stock
options at December 31, 1997. No options have been exercised in 1997.
Number of Shares
Shares Underlying Unexercised Value of Unexercised In-
Acquired Options/SARs the-Money Options/SARs
on Value at December 31, 1997 at December 31, 1997
Name Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable
- -------- -------- ---------- ------------------------- -------------------------
William H. Channell, Sr. - $ - - $ - /$ -
William H. Channell, Jr. - - 33,333/116,667 50,000/100,000
Gary W. Baker - - 6,000/18,000 9,000/18,000
Edward J. Burke - - 6,000/18,000 9,000/18,000
Dale C. Wooding - - 6,000/18,000 9,000/18,000
PROFIT SHARING AND SAVINGS PLANS
As of September 30, 1997, the assets of the Company's prior defined
contribution profit sharing plan were merged into a plan established in 1993 in
accordance with Section 401(K) of the Internal Revenue Code. Under the terms of
this plan, eligible employees may make voluntary contributions to the extent
allowable by law. Employees of the Company are eligible to participate in the
plan after 90 days of employment. Matching contributions by the Company to this
plan are discretionary and will not exceed that allowable for Federal income tax
purposes. The Company's contributions are vested over five years in annual
increments.
EMPLOYMENT CONTRACTS
The Company has entered into employment agreements with each of William H.
Channell, Sr. and William H. Channell, Jr., engaging them as the Chairman of the
Board and Chief Executive Officer, and President and Chief Operating Officer of
the Company, respectively. For their service, each of Messrs. Channell, Sr. and
Channell, Jr., is entitled to receive an annual salary of $500,000, subject to
annual cost of living increases. After the cost of living adjustment, the base
salary for each during 1997 was $520,000. In addition, each executive is
entitled to participate in the Incentive Stock Plan, the 401(K) Plan and the
Incentive Compensation Plan. The employment agreements provide that each
executive is entitled to certain other benefits paid for by the Company,
including an automobile allowance, health insurance and sick leave, in
accordance with the Company's customary practices for senior executive officers.
In the case of Mr. Channell, Sr., such benefits also include (i) during the
term of the agreement, the payment of premiums for a term disability policy
providing for $250,000 in annual benefits in the case of his temporary or
permanent disability, (ii) during the lifetime of Mr. Channell, Sr. and his
wife, Jacqueline M. Channell, medical insurance for each of Mr. and Mrs.
Channell comparable to that provided to the Company's senior executive officers,
subject to a premium reimbursement obligation in the case of the medical
insurance provided to Mrs. Channell, and (iii) during Mr. Channell, Sr.'s
lifetime, a portion of the premiums on a life insurance policy owned by Mr.
Channell, Sr., under which Mrs. Channell is the beneficiary.
Each of the employment agreements has a term of five years. In the event
either executive is terminated without cause (as defined in the employment
agreements), he is entitled to receive, as a severance benefit, an amount equal
to three times his annual base salary, and any options or Restricted Stock
previously granted to such executive will become immediately vested.
27
At the time of the Initial Public Offering, as an incentive for continued
services, the Company entered into a bonus agreement with Mr. Baker, Mr. Burke
and Mr. Wooding. This agreement grants to each of the three officers a bonus in
the amount of $200,000, which is earned and payable in three equal installments
on December 31, 1997, 1998 and 1999, provided each remains employed by the
Company. The bonus is subject to continued payment in the event of the death of
the employee.
INCENTIVE COMPENSATION PLAN
Effective beginning in the Company's 1996 fiscal year, the Board of Directors
adopted the Company's 1996 Performance-Based Annual Incentive Compensation Plan
(the "Incentive Plan"). Eligible participants consist of key employees of the
Company. The Incentive Plan is administered by the Compensation Committee of the
Board of Directors. The amount of awards granted under the Incentive Plan are
determined based on an objective computation of the actual performance of the
Company relative to pre-established performance goals. Measures of performance
may include level of sales, EBITDA, net income, income from operations, earnings
per share, return on sales, expense reductions, return on capital, stock
appreciation, return on equity, invention, design or development of proprietary
products or improvements thereto (patented or otherwise), or sales of such
proprietary products or improvements or profitability achieved from sales of
proprietary products or improvements. Awards under the Incentive Plan are
payable in cash or, at the election of the Compensation Committee, Common Stock
of the Company. The Compensation Committee may establish a bonus pool from which
all awards under the Incentive Plan may be granted as well as individual, non-
bonus pool awards. No participant in the Incentive Plan may receive awards under
such plan during any fiscal year of the Company in excess of $1,000,000 or
100,000 shares of Common Stock.
The Company's executive compensation program is administered by the
Compensation Committee of the Board of Directors. This committee is composed of
Mr. William H. Channell, Sr., an executive officer and employee of the Company,
Mr. Eugene R. Schutt, Jr. and Mr. Richard A. Cude. (See "Certain Relationships
and Related Transactions".) It is the responsibility of the Committee to review
and approve the Company's executive compensation plans and policies and to
monitor these compensation programs in relation to the performance of the
particular executive and the overall performance of the Company.
The following is a line graph presentation comparing the Company's cumulative
total return since the Initial Public Offering in July 1996 to December 31, 1997
with the performance of the NASDAQ market, the S & P Industrials and a similar
Industry Index for the same period.
CHANNELL COMMERCIAL CORPORATION
COMPARISON OF CUMULATIVE TOTAL RETURNS
(ASSUMES DIVIDENDS, IF ANY, ARE REINVESTED)
[GRAPHIC APPEARS HERE]
INDUSTRY INDEX IS A MARKET CAPITALIZATION WEIGHTED COMPOSITE THAT INCLUDES
AMPHENOL CORP., ANTEC CORP., OAK INDUSTRIES AND TII INDUSTRIES.
28
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The following table sets forth certain information concerning those persons
who are known by management of the Company to be beneficial owners of more than
5% of the Company's outstanding common stock (as provided to the Company by such
persons or the recordholder of such shares).
Amount and Nature of Beneficial Ownership
------------------------------------------
Name and Address No. of Shares Exercisable Percent
of Beneficial Owner Owned Options(1) Total of Class
- ---------------------- ------------- -------------- --------- ---------
William H. Channell Sr. and 3,420,830 - 3,420,830 36.4%
Jacqueline M. Channell, as co-trustees
of the Channell Family Trust
26040 Ynez Road
Temecula, CA 92591-9022
William H. Channell, Jr. 1,519,250 33,333 1,552,583 16.5%
26040 Ynez Road
Temecula, CA 92591-9022
Wellington Management Company, LLP 841,100 - 841,100 9.0%
75 State Street
Boston, MA 02109
Kern Capital Management, LLC 551,300 - 551,300 5.9%
114 West 47th Street, Suite 1926
New York, NY 10036
Carrie S. Rouveyrol 490,960 - 490,960 5.2%
P.O. Box 1080
Stinson Beach, CA 94970
The Taylor Family Trust 490,960 - 490,960 5.2%
1450 Ravenswood Lane
Riverside, CA 92506
(1) Refers to the number of shares covered by options exercisable within 60
days of March 15, 1998.
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth certain information, as of March 16, 1998,
concerning the beneficial ownership of common stock by the Company's directors
and named executive officers, and all directors and executive officers of the
Company as a group.
Amount and Nature of Beneficial Ownership
------------------------------------------
Name and Address No. of Shares Exercisable Percent
of Beneficial Owner Owned Options(1) Total of Class
- ------------------- ------------- -------------- --------- ---------
William H. Channell Sr. 3,420,830 - 3,420,830 36.4%
William H. Channell, Jr. 1,519,250 33,333 1,552,583 16.5%
Gary W. Baker 400 6,000 6,400 .1%
Edward J. Burke - 6,000 6,000 .1%
Dale C. Wooding 300 6,000 6,300 .1%
All present directors and executive
officers as a group (11 in number) 4,942,907 70,332 5,013,239 53.4%
(1) Refers to the number of shares covered by options exercisable within 60
days of March 16, 1998.
29
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The Company has two leases for approximately 260,000 square feet of
manufacturing, warehouse and office space in Temecula, California, with William
H. Channell, Sr., a principal stockholder and the Chairman of the Board and
Chief Executive Officer of the Company. The term of the first lease is through
December 31, 2005, with two five-year renewal options. The monthly rental
payment is $54,182, and the lease provides for annual cost of living increases.
For the 1993-1996 period, the lease was amended to waive the cost of living
increases. Additionally, an adjacent 100,000 square foot building was
constructed and completed in 1996. In 1996, the Company advanced $3.1 million
to Mr. Channell, Sr. for the construction of this building. The advances were
repaid in full as of December 31, 1996. Subsequent to December 31, 1996, the
Company guaranteed debt of Mr. Channell, Sr. of approximately $2.7 million
incurred in connection with construction of the building. This building is also
being leased from Mr. Channell, Sr. through 2005, with two five-year renewal
options, requiring monthly rental payments of $35,000. The Company believes that
the terms of these leases are no less favorable to the Company than could be
obtained from an independent third party.
Prior to the Initial Public Offering, Mr. Channell, Sr. received from the
Company a 10% license fee on the sale of certain products utilizing the Channell
Patents. For 1994, 1995 and 1996, the expense for these license fees was $1.6
million, $2.0 million and $0.5 million, respectively. Prior to the consummation
of the Initial Public Offering, the Channell Patents were sold to the Company,
the license fee arrangement between the Company and Mr. Channell, Sr. was
terminated in April 1996, and thereafter, no license fees are to be paid to Mr.
Channell, Sr. or any other person with respect to the Channell Patents.
Prior to the consummation of the Initial Public Offering, the Company
maintained and paid the premiums with respect to a $1.5 million whole life
insurance policy for Mr. Channell, Sr., under which the Company was named as the
beneficiary. In connection with the Initial Public Offering, this policy was
transferred to Mr. Channell, Sr. in consideration of the payment by Mr.
Channell, Sr. to the Company of an amount equal to the estimated $0.3 million
cash surrender value of this policy as of the closing of the Initial Public
Offering, and the beneficiary under this policy was redesignated as Mr.
Channell, Sr.'s wife, Jacqueline M. Channell. The Company continues to pay a
portion of the premiums with respect to this policy during Mr. Channell, Sr.'s
lifetime.
During 1994, Mr. Channell, Sr. made a non-interest bearing loan of $0.1
million to the Company, which loan was repaid in full as of March 31, 1996.
Mr. Channell, Sr. is a director and executive officer of the Company and also
serves as one of three members of the Compensation Committee of the Board of
Directors. This committee administers all of the executive compensation plans
of the Company.
30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
---------------------------------------------------------------
(a) The following financial statements and schedules are filed as a part of
this report:
(1) Consolidated Financial Statements
See index included in Part II, Item 8.
(2) Consolidated Financial Statement Schedules
All schedules are omitted because they are not applicable, or the required
information is included in the financial statements or notes thereto.
(a)(3) and (c). The following exhibits are filed herewith:
Exhibit
Number Exhibit Title
------ -------------
3.1 Restated Certificate of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
4 Form of Common Stock Certificate (1)
10.1 Tax Agreement between the Company and the Existing Stockholders (1)
10.2 Channell Commercial Corporation 1996 Incentive Stock Plan (including
form of Stock Option Agreements and Restricted Stock Agreement) (1)
10.3 Business Loan Agreement dated as of May 13, 1997 between the Company
and Bank of America National Trust and Savings Association ("Bank of
America") (3)
10.5 The Company's Profit Sharing Plan (1)
10.6 Agreement dated as of September 30, 1982 between the Company and
Integral Corporation, as amended (1)
10.7 Telephone Sales Agreement dated as of January 23, 1991 between the
Company and Integral Corporation (1)
10.8 Employment Agreement between the Company and William H. Channell, Sr.
(1)
10.9 Employment Agreement between the Company and William H. Channell, Jr.
(1)
10.10 Channell Commercial Corporation 1996 Performance-Based Annual
Incentive Compensation Plan (1)
10.11 Lease dated December 22, 1989 between the Company and William H.
Channell, Sr., as amended (1)
10.12 Lease dated May 29, 1996 between the Company and the Channell Family
Trust (1)
10.13 Lease dated May 17, 1994 between the Company and the Z. Paul Akian and
Sonia Akian Family Trust (1)
10.14 Lease dated March 1, 1994 between the Company and Allstate Life
Insurance Company (1)
10.15 Lease dated November 2, 1989 between the Company and Meadowvale Court
Property Management Ltd., as amended (1)
10.16 Lease Agreement dated as of March 1, 1996 between Winthrop Resources
Corp. and the Company (1)
10.17 Form of Indemnity Agreement (1)
10.18 Form of Agreement Regarding Intellectual Property (1)
10.19 401(k) Plan of the Company (4)
10.20 Letter agreement regarding employment, Andrew M. Zogby (2)
10.21 Letter agreement regarding employment, John B. Kaiser (2)
11 Computation of Proforma Income per share (2)
27 Financial Data Schedule (4)
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1997.
_____________
(1) Incorporated by reference to the indicated exhibits filed in connection
with the Company's Registration Statement on Form S-1 (File No. 333-3621).
(2) Incorporated by reference to the indicated exhibits filed in connection
with the Company's Form 10-K on March 31, 1997.
(3) Incorporated by reference to the indicated exhibits filed in connection
with the Company's Form 10-Q on August 13, 1997.
(4) Filed herewith.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Channell Commercial Corporation
We have audited the consolidated balance sheets of Channell Commercial
Corporation as of December 31, 1996 and 1997, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1997.
31
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Channell
Commercial Corporation as of December 31, 1996 and 1997, and the consolidated
results of its operations and its consolidated cash flows for each of the three
years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
Los Angeles, California
February 13, 1998
F-1
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
1996 1997
---------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,190 $3,840
Investments 11,406 11,651
Accounts receivable 6,685 9,191
Inventories 2,908 7,269
Deferred income taxes 321 688
Prepaid expenses 764 613
------- ------
Total current assets 31,274 33,252
PROPERTY AND EQUIPMENT at cost, net 10,608 14,758
DEFERRED INCOME TAXES 559 664
INTANGIBLE ASSETS, net of amortization of $137 - 1,649
OTHER ASSETS 217 302
------- ------
$42,658 $50,625
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 2,048 $ 2,606
Current maturities of capital lease
obligations 135 226
Accrued expenses 1,167 791
Income taxes payable 1,548 390
------- -------
Total current liabilities 4,898 4,013
LONG-TERM OBLIGATIONS - 400
CAPITAL LEASE OBLIGATIONS 338 320
COMMITMENTS - -
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share,
authorized--1,000 shares,
none issued and outstanding - -
Common stock, par value $.01 per share,
authorized--19,000 shares;
issued and outstanding--9,237 shares 92 92
Additional paid-in capital 27,991 27,991
Retained earnings 9,339 17,809
------- -------
Total stockholders' equity 37,422 45,892
------- -------
$42,658 $50,625
======= =======
The accompanying notes are an integral part of these financial statements.
F-2
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
1995 1996 1997
--------------- -------------- ---------------
Net sales $40,972 $47,282 $59,943
Cost of goods sold 23,059 25,447 35,032
------- ------- -------
Gross profit 17,913 21,835 24,911
Commission income 1,098 985 606
------- ------- -------
19,011 22,820 25,517
------- ------- -------
Operating expenses
Selling 5,600 6,559 7,251
General and administrative 1,707 2,021 4,077
License fees--related party 2,035 531 -
Research and development 498 531 1,009
------- ------- -------
9,840 9,642 12,337
------- ------- -------
Income from operations 9,171 13,178 13,180
Interest income (expense), net (339) 291 879
------- ------- -------
Income before income
taxes 8,832 13,469 14,059
Income taxes 349 2,359 5,589
------- ------- -------
Net income $ 8,483 $11,110 $ 8,470
======= ======= =======
Net income per share
Basic $ .92
=======
Diluted $ .91
=======
Pro forma information (unaudited):
Historical income before taxes $ 8,832 $13,469
Pro forma income taxes 3,455 4,548
------- -------
Pro forma net income $ 5,377 $ 8,921
======= =======
Pro forma net income per
share--basic and diluted $ .70 $ 1.06
======= =======
Pro forma weighted average
shares outstanding 7,695 8,403
======= =======
The accompanying notes are an integral part of these financial statements.
F-3
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Common stock Additional Total
-------------------------- paid-in Retained stockholders'
Shares Amount capital earnings equity
------------ ------------ -------------- ------------- -------------
Balance, January 1, 1995 6,137 $61 $ 26 $ 9,330 $ 9,417
Net income for the year - - - 8,483 8,483
Dividends declared ($.88 per share) - - - (5,427) (5,427)
------------ ------------ -------------- ------------- -------------
Balance, December 31, 1995 6,137 61 26 12,386 12,473
Proceeds from initial public offering of common stock,
net of expenses 3,100 31 30,534 - 30,565
Reorganization distribution - - - (11,665) (11,665)
Dividends declared ($.41 per share) - - - (2,492) (2,492)
Acquisition of patents from stockholders - - (3,100) - (3,100)
Contribution of accrued license fees
previously owed to stockholder - - 531 - 531
Net income for the year - - - 11,110 11,110
------------ ------------ -------------- ------------- ------------
Balance, December 31, 1996 9,237 92 27,991 9,339 37,422
Net income for the year - - - 8,470 8,470
------------ ------------ -------------- ------------- ------------
Balance, December 31, 1997 9,237 $92 $27,991 $ 17,809 $ 45,892
============ ============ ============== ============= ============
The accompanying notes are an integral part of this financial statement.
F-4
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS)
1995 1996 1997
------------- -------------- -------------
Cash flows from operating activities:
Net income $ 8,483 $ 11,110 $ 8,470
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,412 1,551 2,044
Deferred income taxes - (880) (472)
(Increase) decrease in assets:
Accounts receivable 236 (2,563) (1,197)
Inventories (4) (299) (2,716)
Prepaid expenses (63) (368) 201
Other 6 322 (19)
Increase (decrease) in liabilities:
Accounts payable (52) 797 (602)
Accrued expenses 3 255 (820)
Income taxes payable (263) 1,499 (1,159)
------------- -------------- -------------
Net cash provided by operating activities 9,758 11,424 3,730
------------- -------------- -------------
Cash flows from investing activities:
Acquisition of property and equipment (2,161) (1,554) (5,966)
Advances to stockholder for building construction - (3,119) -
Collection of advances to stockholder - 3,119 -
Acquisitions, net of cash acquired - - (2,747)
Purchases of investments - (11,406) (7,316)
Maturities of investments - - 7,071
------------- -------------- -------------
Net cash used in investing activities (2,161) (12,960) (8,958)
------------- -------------- -------------
Cash flows from financing activities:
Repayment of debt (877) (3,213) (195)
Repayment of obligations under capital lease - (70) 73
Proceeds from initial public offering - 30,565 -
Acquisition of patents from stockholders - (3,100) -
Dividends paid (6,547) (3,166) -
Reorganization distribution - (11,665) -
Proceeds from issuance of long-term debt 405 - -
------------- -------------- -------------
Net cash provided by (used in) financing activities (7,019) 9,351 (122)
------------- -------------- -------------
Increase (decrease) in cash and cash equivalents 578 7,815 (5,350)
Cash and cash equivalents, beginning of year 797 1,375 9,190
------------- -------------- -------------
Cash and cash equivalents, end of year $ 1,375 $ 9,190 $ 3,840
============= ============== =============
The accompanying notes are an integral part of these financial statements.
F-5
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEAR ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS)
1995 1996 1997
------------ --------------- -------------
Cash paid during the year for:
Interest $ 351 $ 185 $ 128
============ =============== =============
Income taxes $ 957 $1,967 $ 5,753
============ =============== =============
Noncash investing and financing activities:
Assets acquired under capital lease $ - $ 543 $ 214
============ =============== =============
Contribution of accrued license fees to paid-in capital $ - $ 531 $ -
============ =============== =============
Fair value of assets acquired, including goodwill $ - $ - $ 4,974
Note payable issued - - (400)
Cash paid - - (2,774)
------------ --------------- -------------
Liabilities assumed $ - $ - $ 1,800
============ =============== =============
The accompanying notes are an integral part of these financial statements.
F-6
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE A--DESCRIPTION OF BUSINESS
The Company is a designer, manufacturer and marketer of precision-molded
thermoplastic and metal-fabricated enclosures used by cable television operators
and local telephone companies. The Company's products house, protect and
provide access to advanced telecommunications electronics and transmission
media, including coaxial cable, copper wire and optical fibers, used in the
delivery of CATV and telephone services. The products are deployed within the
portion of the local signal delivery network, commonly known as the "outside
plant", that connects the network provider's signal origination office with
residences and businesses. The Company also designs and distributes high
performance radio frequency passive electronic devices which are typically used
in conjunction with the Company's enclosure products. The Company also markets
a variety of complementary products manufactured by third parties, including
grade level boxes and cable-in-conduit, in order to provide a full system
solution to meet its customer's outside plant requirements.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates--In preparing financial statements in conformity with generally
accepted accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Basis of Consolidation--The consolidated financial statements include the
accounts of the Company and its subsidiaries. All significant intercompany
transactions and balances have been eliminated.
Foreign Currency Translation--Assets and liabilities of certain foreign
operations are translated into U.S. dollars at current exchange rates. Income
and expenses are translated into U.S. dollars at average rates of exchange
prevailing during the period. Adjustments resulting from translating foreign
functional currency financial statements into U.S. dollars are not significant
to the consolidated financial statements.
Cash--For purposes of reporting cash flows, cash and its equivalents include
cash on hand, cash in banks and short-term investments with original maturities
of 90 days or less.
Investments--The Company has invested in certain U.S. Government issued debt
instruments and other taxable securities. These investments are classified as
available for sale. The investment in these securities is therefore recorded at
fair value with any differences between fair value and cost recorded as a
separate component of stockholder's equity. At December 31, 1997, there were no
material differences between the fair value and cost of these marketable
securities. Investments mature as follows: $11,379 in 1998, $132 in 1999 and
$140 in 2000. Interest income for the years ended December 31, 1996 and 1997
totaled $477 and $1,006, respectively; it has been reflected net of interest
expense in the accompanying statement of income. Interest income was not
significant in 1995.
Inventories--Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out method of accounting.
F-7
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
Property and Equipment--Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Capital lease assets are amortized using the
straight-line method over the useful lives of the assets. Expenditures for all
maintenance and repairs are charged against income. Additions, major renewals
and replacements that increase the useful lives of assets are capitalized.
Amortization of leasehold improvements is computed using the straight-line
method over the shorter of the lease term or the estimated useful life of the
leasehold improvements.
Intangible Assets--The excess of cost over net assets acquired (goodwill) is
being amortized on a straight-line basis over 15 years. The Company reviews the
carrying value of goodwill for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. Other
acquired intangibles are being amortized on a straight-line basis over their
estimated useful lives of 3 years.
Revenue Recognition--The Company recognizes revenue from product sales and
commission income at the time of shipment.
Income taxes--Deferred income taxes reflect the impact of temporary
differences between the amounts of assets and liabilities recognized for
financial reporting purposes and the amounts recognized for income tax purposes.
These deferred income taxes are measured by applying currently enacted income
tax rates. A valuation allowance reduces deferred income tax assets when it is
more likely than not that some portion or all of the deferred income tax assets
will not be realized.
Income per share--In 1997, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"), which
superseded APB Opinion No. 15. Income per share for all periods presented has
been restated to reflect the adoption of SFAS 128. SFAS 128 requires companies
to present basic income per share, and, if applicable diluted income per share,
instead of primary and fully diluted income per share. Basic income per share
is computed by dividing net income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted
income per share reflects the potential dilution that could occur if options to
issue common stock were exercised into common stock.
The following is a reconciliation of the number of shares (denominator) used
in the basic and diluted income per share computations for 1997:
Per Share
Shares Amount
----------- -------------
Basic income per share........................ 9,237 $ .92
Effect of dilutive stock options.............. 54 (.01)
----------- -------------
Diluted income per share...................... 9,291 $ .91
=========== =============
F-8
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
Income per share--continued--The following options were not included in the
computation of diluted income per share in 1997 because the options' exercise
price was greater than the average market price of the common shares:
Options to purchase shares of common stock.... 140
Exercise price................................ $13.25
Expiration dates.............................. July 2007
Pro forma financial information (unaudited)--Prior to the Company's initial
public offering of common stock in July 1996 (the "IPO"), it was an S
Corporation for federal and state income tax purposes. The pro forma provision
for income taxes reflects the income tax provision of the Company as recorded in
its income statement plus the additional tax on S Corporation income at C
Corporation rates.
Pro forma net income per share (basic and diluted) has been computed by
dividing pro forma net income by the pro forma weighted average shares
outstanding. Pro forma weighted average shares outstanding includes 1,558
shares for the year ended December 31, 1995, and 779 shares for the year ended
December 31, 1996, assumed to have been sold by the Company at a price of $11.00
per share, the net proceeds of which were used to fund the reorganization
distribution. The effect of the Company's use of a portion of the net proceeds
of the IPO to repay approximately $2.7 million of bank indebtedness outstanding
as of June 30, 1996, has not been reflected in pro forma net income or pro forma
net income per share because the impact is not material.
A reconciliation of pro forma income taxes to the Federal statutory rate is as
follows:
1995 1996
---------- ----------
Federal statutory rate............................... 34% 34%
State income taxes, net of Federal tax benefit....... 6 6
Deferred income tax benefit recorded upon
termination of S Corporation status................ - (5)
Other................................................ (1) (1)
---------- ----------
39% 34%
========== ==========
Fair value of financial instruments--The carrying amount of cash, accounts
receivable, accounts payable, accrued expenses and long-term obligations
approximates fair value because of the short maturity of these financial
instruments. The carrying amount of investments, which is the fair value, is
based upon values provided by external investment managers or quoted market
values.
Reclassifications--Certain reclassifications have been made to the 1996
financial statements to conform with the 1997 presentation.
F-9
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE C--INVENTORIES
Inventories are summarized as follows:
1996 1997
------------- -------------
Raw materials............................................. $1,508 $1,692
Work-in-process........................................... 549 1,240
Finished goods............................................ 851 4,337
------------- -------------
$2,908 $7,269
============= =============
NOTE D--PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows:
ESTIMATED
1996 1997 USEFUL LIVES
--------------- ---------------- ----------------
Machinery and equipment............................ $14,739 $ 16,802 3-10 years
Office furniture and equipment..................... 1,042 1,333 3- 7 years
Leasehold improvements............................. 2,196 2,285 15-20 years
Building........................................... - 3,150 30 years
Land............................................... - 600 --
Construction in progress........................... 891 755 --
--------------- ----------------
18,868 24,925
Less accumulated depreciation and amortization..... (8,260) (10,167)
--------------- ----------------
$10,608 $ 14,758
=============== ================
Included in the $16,802 of machinery and equipment is $757 of computer
equipment acquired under capital lease. Accumulated amortization of assets
under capital lease totaled $185 at December 31, 1997. See Note I.
NOTE E--ACCRUED EXPENSES
Accrued expenses consist of the following:
1996 1997
----------- ------------
Accrued vacation............................................. $ 448 $ 477
Other........................................................ 719 314
----------- ------------
$1,167 $ 791
=========== ============
F-10
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE F--LINES OF CREDIT
The Company has in place a $5,000 line of credit with a bank for working
capital purposes. This line of credit bears interest at the bank's reference
rate, payable monthly. In addition, the Company has a $5,000 equipment line of
credit. The equipment line of credit bears interest at the bank's reference
rate plus .25%. The lines of credit expire on May 1, 1999. The equipment line
of credit is collateralized by the related equipment financed by the bank, if
any. The lines of credit contain various financial and operating covenants
which, among other things, impose certain limitations on the Company's ability
to incur additional indebtedness, merge or consolidate, sell its assets, make
certain investments or, under certain circumstances, pay dividends. The Company
is also required to comply with covenants related to tangible net worth and
other financial ratios. The Company had both lines fully available at December
31, 1997.
NOTE G--LONG-TERM OBLIGATIONS
Long-term debt consists of a note payable issued in connection with the
acquisition of RMS Electronics, Inc. (Note K). Principal is payable in three
annual installments of $133 beginning January 1, 1999. Interest accrues at a
rate equal to the Company's investment yield (effective rate at December 31,
1997 of 5.85%) and is payable quarterly.
NOTE H--INCOME TAXES
The components of income taxes are as follows:
1995 1996 1997
------------ ------------ ------------
Current
Federal.......................................... $ -- $2,104 $4,275
State............................................ 36 743 1,243
Foreign.......................................... 313 392 543
------------ ------------ ------------
349 3,239 6,061
------------ ------------ ------------
Deferred
Federal.......................................... -- (669) (416)
State............................................ -- (211) 14
Foreign.......................................... -- -- (70)
------------ ------------ ------------
-- (880) (472)
------------ ------------ ------------
$ 349 $2,359 $5,589
============ ============ ============
A reconciliation from the U.S. Federal statutory income tax rate to the
effective income tax rate for the year ended December 31, 1997 is as follows:
U.S. Federal statutory rate................... 34%
State income taxes, net of federal tax benefit 6
--------------
40%
==============
F-11
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE H--INCOME TAXES--CONTINUED
Prior to July 1996, the Company was taxed as an S Corporation. Accordingly,
all Federal taxable earnings of the Company through July 1996 were taxed at the
individual stockholder level and the Company incurred no Federal income tax
liability. The Company was, however, subject to California's Corporation tax.
Income taxes for 1995 consist primarily of the state corporate franchise tax for
California and the Canadian tax imposed on the taxable income of the Company's
Canadian operations. In 1995, the actual state tax provision differs from the
expected statutory tax due to non-deductible entertainment expense and
officers'life insurance premiums.
In July 1996, the Company terminated its election to be taxed as an S
Corporation. As a result of this termination, the Company became liable for
income taxes. Accordingly, as required by generally accepted accounting
principles, the Company recorded deferred tax assets and liabilities on
temporary differences between the income tax basis and book basis of certain
assets and liabilities. The effect of recording these net deferred tax assets
upon the results of operations for the year ended December 31, 1996 was $1,063
($0.13 per share).
Significant components of the Company's deferred tax assets and liabilities
are as follows:
1996 1997
------------ ------------
Assets
Patents.................................................... $1,286 $1,162
Allowance for bad debts.................................... 32 41
Inventory capitalization................................... 59 146
Vacation pay............................................... 190 187
State taxes................................................ - 314
Net operating loss carryforward-foreign operations......... - 70
------------ ------------
1,567 1,920
------------ ------------
Liabilities
Accelerated depreciation................................... 615 568
State taxes................................................ 72 -
------------ ------------
687 568
------------ ------------
Net deferred tax asset.................................. $ 880 $1,352
============ ============
The classification of the net deferred tax assets between current and non-
current is as follows:
1996 1997
------------ ------------
Current...................................................... $ 321 $ 688
Non-current.................................................. 559 664
------------ ------------
$ 880 $1,352
============ ============
F-12
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE I--CAPITAL LEASE OBLIGATIONS
The Company leases certain computer equipment under various agreements which
are classified as capital leases. The equipment is under lease through August
2000. Future minimum payments, by year, are as follows:
1998 $291
1999 300
2000 52
----
643
Less amount representing
interest 97
----
546
Less current maturities 226
----
$320
====
NOTE J--STOCKHOLDERS' EQUITY
In 1996, 3,100 shares of the Company's common stock were sold in a public
offering. Proceeds of approximately $30,565, net of issuance expenses, were
used to fund the distribution to stockholders, fund the acquisition of certain
patents from stockholders and to repay outstanding borrowings on the bank lines
of credit.
Effective June 14, 1996, as part of the initial public offering of the
Company's common stock, the Company was merged into a newly formed corporation,
with the newly formed corporation being the surviving entity while retaining the
same name as the predecessor. As part of the merger, the predecessor's existing
stockholders were issued 12.274 shares of the newly formed corporation's common
stock in exchange for each outstanding share of the predecessor's common stock.
This exchange has been accounted for as a reorganization and the number of
outstanding shares has been restated on a retroactive basis similar to a stock
split.
The Company had been an S Corporation for both federal and state tax income
tax purposes since 1990. As discussed in Note H, the Company terminated its S
Corporation status effective July 6, 1996 in connection with the initial public
offering of its common stock. Upon the termination of the S Corporation status
and prior to the initial public offering, the Company declared a dividend to its
then existing stockholders representing all of the Company's S Corporation
"accumulated adjustments account" remaining at the time. The S Corporation
distribution totaled $11,665 and was paid out of the net proceeds of the initial
public offering.
In July 1996, the Company adopted the 1996 Incentive Stock Plan, under which
it was authorized to issue non-qualified stock options and incentive stock
options to key employees, directors and consultants to purchase up to an
aggregate of 750 shares of the Company's common stock. The options have a term
of ten years and generally become fully vested by the end of the third year.
F-13
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE J--STOCKHOLDERS' EQUITY--CONTINUED
Statement of Financial Accounting Standards No. 123, "Accounting for Stock
Based Compensation", encourages, but does not require companies to record
compensation cost for stock-based employee compensation plans at fair value.
The Company has chosen to continue to account for stock-based compensation using
the intrinsic value method prescribed in previously issued standards.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's stock at the date of grant over
the amount an employee must pay to acquire the stock. Compensation costs has
not been significant.
Plan transactions are as follows:
1996 1997
----------------------------------- ------------------------------------
Weighted Weighted
average average
exercise exercise
Shares price Shares price
------------- ---------------- ------------- ----------------
Options outstanding
January 1,................. -- $ -- 513 $11.00
Granted..................... 513 11.00 165 12.91
Exercised................... -- -- -- --
Canceled.................... -- -- (42) 11.00
------------- -------------
Options outstanding
December 31,............... 513 $11.00 636 $11.49
============= =============
Options available for
grant at December 31,...... 237 113
Weighted average fair value of options granted during the year are as follows:
1996 1997
------------ ------------
Exercise price is below market price at date of grant -- $6.75
Exercise price equals market price at date of grant $5.47 $5.90
The range of exercise prices of options outstanding at December 31, 1997 is
$11.00 to $13.25 and have a weighted average remaining contractual life of 9
years. At December 31, 1997, 171 of the 636 options outstanding are exercisable
by the optionee.
F-14
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE J--STOCKHOLDERS' EQUITY--CONTINUED
The fair value of options at date of grant was estimated using the Black-
Scholes model with the following weighted average assumptions:
1996 1997
-------------- --------------
Expected life (years)..................................... 5 years 5 years
Risk-free interest rate................................... 5.5% 6.25%
Volatility................................................ 50% 40%
Dividend yield............................................ -- --
Had compensation cost for the plan been determined based on the fair value of
the options at the grant dates based on the above method, the Company's 1997 net
income and income per share would have been:
Net income per share
------------------------------------
Net income Basic Diluted
--------------- --------------- ---------------
As reported..................................... $8,470 $.92 $.91
Pro forma....................................... 7,812 .84 .83
The Company's adjusted pro forma net income and adjusted pro forma net income
per share (basic and diluted) for 1996 would have been $8,351 and $.99,
respectively.
NOTE K--ACQUISITIONS
During 1997, the Company acquired the entities described below. The
acquisitions were accounted for by the purchase method of accounting:
RMS Electronics, Inc.--On January 2, 1997, the Company acquired substantially
all of the assets of RMS Electronics, Inc. and an affiliated company, RMS - UK
Limited (collectively referred to as "RMS") for $2,695, including acquisition
costs. The purchase price comprised $2,295 in cash and the remainder through the
issuance of a promissory note. RMS is a designer, importer and distributor of
passive electronic products and devices for various segments of the broadband
telecommunications industry. These devices are typically used in conjunction
with the Company's enclosure products. The excess of the purchase price over the
fair values of the net assets acquired was $1,134 and has been recorded as
goodwill, which is being amortized on a straight-line basis over 15 years. Other
intangible assets acquired in connection with the acquisition totaled $100 and
is being amortized over three years.
F-15
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995, 1996 and 1997
(amounts in thousands, except per share data)
NOTE K--ACQUISITIONS - CONTINUED
Standby Electronics Corp.--On June 30, 1997, the Company acquired all of the
outstanding shares of Standby Electronics Corp. ("Standby"), a designer and
supplier of metal-fabricated enclosures to house advanced electronics fiber
optic cable and power systems for broadband telecommunications networks, for
$479. In addition, the purchase agreement provides for additional consideration
up to $300 to be paid over three years, contingent upon Standby achieving
specified revenue levels over the three year period. Accordingly, contingent
consideration has not been reflected as a liability as of December 31, 1997. The
excess of the purchase price (excluding the contingent consideration) over the
fair values of the net assets acquired was $552 and has been recorded as
goodwill, which is being amortized on a straight-line basis over 15 years.
The fair value of tangible assets acquired and liabilities assumed of both
entities was $3,188 and $1,800, respectively. The operating results of these
acquired businesses have been included in the consolidated statement of income
from the dates of acquisition. The following unaudited pro forma information
presents a summary of consolidated results of operations of the Company and the
acquired businesses as if the acquisitions had occurred January 1, 1996.
Consolidated pro forma results of operations for fiscal 1997 would not have been
materially different from the reported amounts.
1996
------
Net sales $56,020
Net income 9,113
Income per share (basic and diluted) $ 1.08
The 1996 pro forma information assumes that the Company was taxed as a C
Corporation for the entire year. These unaudited pro forma results have been
presented for comparative purposes only and include certain adjustments, such as
additional amortization expense of goodwill and increased interest expense on
acquisition debt. They do not purport to be indicative of the results of
operations which actually would have resulted had the acquisitions been
effective January 1, 1996 or of future results of operations of the consolidated
entities.
NOTE L--RETIREMENT PLANS
As of September 30, 1997, the assets of the Company's prior defined
contribution profit-sharing plan were merged into a plan established in 1993 in
accordance with section 401(k) of the Internal Revenue Code. Under the terms of
this plan, eligible employees may make voluntary contributions to the extent
allowable by law. Employees of the Company are eligible after 90 days of
employment. Matching contributions by the Company to this plan are
discretionary and will not exceed that allowable for Federal income tax
purposes. The Company's contributions are vested over five years in equal
increments. The accompanying statements of income include expenses of $198,
$200 and $40 which have been incurred for the plans for the years ended December
31, 1995, 1996 and 1997, respectively.
F-16
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE M--RELATED PARTY TRANSACTIONS
Prior to the initial public offering, the Company's Chairman of the Board and
Chief Executive Officer, William H. Channell, Sr. (Mr. Channell, Sr.) owned six
patents utilized by the Company in its business. Under the terms of exclusive
licensing agreements, the Company made payments to Mr. Channell, Sr. for the use
of these patents. These payments were based on the sale of products. Operations
have been charged with $2,035 and $531 for the years ended December 31, 1995 and
1996, respectively. In connection with the initial public offering of the
Company's common stock, the Company acquired these patents from Mr. Channell,
Sr. and certain members of the Channell family for $3,100. The aggregate
consideration of $3,100 has been reflected as a reduction of additional paid-in
capital in 1996. The licensing agreements with Mr. Channell, Sr. were
terminated in April 1996 and, accordingly, no license fee expense has been
reflected in the accompanying statement of income since March 31, 1996. In July
1996, Mr. Channell, Sr., contributed $531 of accrued license fees owed to him to
additional paid-in capital.
The Company leases its facilities in Temecula, California from Mr. Channell,
Sr. The leases provide for payments of insurance, repairs, and maintenance and
property taxes, and extend through 2005. The Company has two five-year renewal
options to extend the terms to 2015. Rent expense was $650, $755 and $1,081 for
the years ended December 31, 1995, 1996 and 1997, respectively. The following
is a schedule of future minimum rental payments, exclusive of property taxes and
insurance:
1998 $1,102
1999 1,125
2000 1,147
2001 1,169
2002 1,193
Thereafter 3,725
--------
$9,461
========
In 1997, the Company guaranteed debt of Mr. Channell, Sr. of approximately
$2,700. The guaranteed debt was incurred in connection with construction of the
facilities leased to the Company and is expected to decline over a 20 year
period before expiring in 2016. It is not practicable to estimate the fair
value of the guarantee; however, the Company does not anticipate that it will
incur losses as a result of this guarantee.
NOTE N--CREDIT CONCENTRATIONS AND MAJOR CUSTOMERS
The Company maintains the majority of its cash balances in one financial
institution located in California which, at times, may exceed federally insured
limits. The Company has not experienced any losses in such accounts and believes
it is not exposed to any significant credit risk on cash and cash equivalents.
In 1997, one customer made up 15.1% of sales and a second customer made up
10.0% of sales. In 1995 and 1996, a different customer made up 17.5% and 17.3%
of sales, respectively. Also in 1995 and 1996, a second customer made up 15.6%
and 14.9% of sales, respectively. Credit risk with respect to accounts
receivable is generally diversified due to the large number of entities
comprising the Company's base and their geographic dispersion. The Company
controls credit risk through credit approvals, credit limits and monitoring
procedures.
F-17
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE O - SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in one industry segment as a supplier of
telecommunications equipment. While the Company offers a wide range of items
for sale, many of them are marketed by a common sales force.
In 1995 and 1996, revenue generated by the Company's foreign operations from
sales to unrelated entities was less than 10 percent of consolidated revenue.
In addition, identifiable assets of the Company's foreign operations were less
than 10% of consolidated total assets as of December 31, 1995 and 1996. A
summary of the Company's operations by geographic area for 1997 is presented
below:
Revenue from unrelated entities
United States (1) $51,299
Canada 5,587
Europe 3,057
-----------
Consolidated $59,943
===========
Intercompany revenue between geographic areas
United States $ 1,932
===========
Income from operations
United States $12,074
Canada 1,055
Europe 51
-----------
Consolidated $13,180
===========
Identifiable assets
United States $31,283
Canada 2,953
Europe 1,809
Corporate assets and eliminations 14,580
-----------
Consolidated $50,625
===========
(1) Included in United States revenue are export sales of $2,255.
F-18
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1995, 1996 AND 1997
(amounts in thousands, except per share data)
NOTE P--QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for 1996 and 1997 follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- ------------- ------------- -------------
1996
Net sales $10,279 $12,961 $11,954 $12,088
Gross profit 4,541 5,986 5,531 5,777
Net income 2,002 3,653 3,640 1,815
Income per share
Basic N/A N/A .41 .20
Diluted N/A N/A .40 .20
Pro forma net income 1,279 2,187 N/A N/A
Pro forma net income per share -
Basic and diluted .17 .28 N/A N/A
1997
Net sales $12,804 $15,664 $15,353 $16,122
Gross profit 5,143 7,005 6,399 6,364
Net income 1,387 2,538 2,289 2,256
Income per share
Basic .15 .27 .25 .24
Diluted .15 .27 .24 .24
NOTE Q--NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive
Income, which prescribes standards for reporting comprehensive income and its
components. Comprehensive income consists of net income or loss for the current
period and other comprehensive income (income, expenses, gains and losses that
currently bypass the income statement and are reported directly in a separate
component of equity). SFAS 130 requires that components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. SFAS 130 is effective for financial statements
issued for periods beginning after December 15, 1997.
In 1997, the FASB issued Statement of Financial Accounting Standards No. 131
("SFAS 131"), Disclosures about Segments of an Enterprise and Related
Information, which applies only to publicly held business entities. A reportable
segment, referred to as an operating segment, is a component of an entity about
which separate financial information is produced internally, that is evaluated
by the chief operating decision-maker to assess performance and allocate
resources. SFAS 131 is effective for financial statements issued for periods
beginning after December 15, 1997. Management has not determined whether
adoption of SFAS 131 will have a significant impact on the disclosures included
in the consolidated financial statements.
F-19
GLOSSARY OF TERMS
ADSL (Asymmetric Digital Subscriber Line): A standard allowing digital
broadband signals and standard telephone service to be transmitted up to 12,000
feet over a twisted copper pair.
Broadband: Transmission rates in excess of 1.544 mega bits per second
typically deployed for delivery of high-speed data, video and voice services.
Cable Modem: Electronic transmission device placed on the CATV network,
located at end user locations, providing two-way, high-speed data service
capability, including internet access for subscribers.
CATV (Community Antenna TV, commonly called cable television): A system for
distributing television programming by a cable network rather than by
broadcasting electromagnetic radiation.
Coaxial Cable: The most commonly used means of transmitting cable television
signals. It consists of a cylindrical outer conductor (shield) surrounding a
center conductor held concentrically in place by an insulating material.
DLC (Digital Loop Carrier): Telecommunications transmission technology which
multiplexes multiple individual voice circuits onto copper or fiber cables.
Fiber Node: Refers to the equipment that terminates the fiber cables
originating from the host digital terminal. This network element converts the
optical signals to their coax electrical, RF equivalents. Synonymous with
optical network interface (ONI).
Fiber Optics: The process of transmitting infrared and visible light
frequencies through a low-loss glass fiber with a transmitting laser or LED and
a photo diode receiver.
FTTC (Fiber-To-The-Curb): In a long distance network consisting of fiber
optics, fiber-to-the-curb refers to the fiber optics running from the
distribution plant to the curb, at which point copper is used for the curb-to-
home connection.
HDSL (High bit rate Digital Subscriber Line): By using sophisticated coding
techniques, a large amount of information may be transmitted over copper. The
HDSL scheme uses such coding over four copper wires and is primarily intended
for high capacity bi-directional business services.
Headend: The primary transmission point in a cable system supplying the hubs
and trunk cables.
HFC (Hybrid Fiber Coax): A type of distribution plant that utilizes fiber
optics to carry service from a CO to the carrier serving area, then coaxial
cable within the CSA to or close to the individual residences.
ONU (Optical Network Unit): The curb mounted electronics device which
converts fiber optic signals to electrical for service delivery or copper wires.
PCS (Personal Communications Services): Any service offered on a personal
communications network. These include basic telephone, voice mail, paging and
others. Personal communications networks operate in the 1800-2000 mHz range,
utilizing low power cells compared to traditional cellular technology.
RBOC (Regional Bell Operating Company): A term for the seven regional holding
companies created when AT&T divested the Bell operating companies.
RF (Radio Frequency): An electromagnetic wave frequency intermediate between
audio frequencies and infrared frequencies used especially in wireless
telecommunication and CATV transmission.
Sealed Plant: An industry term referring to the environmental protection
devices built into access and termination products deployed in the outside plant
portion of the telecommunications network.
G-1
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Form 10-K Annual Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Temecula,
State of California, on March 25, 1998.
CHANNELL COMMERCIAL CORPORATION
a Delaware corporation
By /s/ WILLIAM H. CHANNELL, SR.
-----------------------------------
William H. Channell, Sr.
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Form
10-K Annual Report has been signed by the following persons in the capacities
indicated below as of March 25, 1998.
SIGNATURE CAPACITY IN WHICH SIGNED
--------- ------------------------
/s/ WILLIAM H. CHANNELL, SR. Chairman of the Board and
----------------------------
William H. Channell, Sr. Chief Executive Officer
(Principal Executive Officer)
/s/ WILLIAM H. CHANNELL, JR.
---------------------------- President, Chief Operating
William H. Channell, Jr. Officer and Director
/s/ Gary W. Baker
---------------------------- Vice President,
Gary W. Baker Finance and Chief Financial
Officer
/s/ JACQUELINE M. CHANNELL Secretary and Director
-----------------------------
Jacqueline M. Channell
/s/ EUGENE R. SCHUTT, JR. Director
---------------------------
Eugene R. Schutt, Jr.
/s/ RICHARD A. CUDE Director
---------------------------
Richard A. Cude