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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 1998 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number 0-28582
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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 15, 1999, the Registrant had 9,099,377 shares of Common Stock
outstanding with a par value of $.01 per share. The aggregate market value of
the 3,204,250 shares held by non-affiliates of the Registrant was $28,937,582.
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
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Item 2. Properties............................................................................ 8
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Item 3. Legal Proceedings..................................................................... 8
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Item 4. Submission of Matters to a Vote of Security Holders................................... 8
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PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters................. 9
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Item 6. Selected Financial Data............................................................... 10
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 12
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Item 7a. Quantitative and Qualitative Disclosures about Market Risk............................ 23
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Item 8. Financial Statements and Supplementary Data........................................... 23
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . 23
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PART III
Item 10. Executive Officers and Directors...................................................... 24
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Item 11. Executive Compensation................................................................ 26
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Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 30
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Item 13. Certain Relationships and Related Transactions........................................ 31
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PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................... 32
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FINANCIAL STATEMENTS............................................................................... F-1
GLOSSARY OF TERMS.................................................................................. G-1
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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 designer and manufacturer of telecommunications equipment
supplied to telephone, cable television and power utility network providers
worldwide. Major product lines include a complete line of thermoplastic and
metal fabricated enclosures, advanced copper termination and connectorization
products, fiber optic cable management systems, coaxial-based passive RF
electronics and heat shrink products. 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 television ("CATV") and telephone
operators. The Company's enclosure products house, protect and provide access
to advanced telecommunications hardware, including both radio frequency ("RF")
electronics and photonics, and transmission media, including coaxial cable,
copper wire and optical fibers, used in the delivery of voice, video and data
services. The enclosure products are deployed within the portion of a local
signal delivery network, commonly known as the "outside plant" or "local loop",
that connects the network provider's signal origination office with residences
and businesses.
As a result of the acquisitions of RMS Electronics, Inc. ("RMS") and Standby
Electronics Corp. ("Standby Electronics") in 1997, and A.C. Egerton (Holdings)
PLC ("Egerton") in 1998, the Company is also a supplier of passive RF
electronics and a manufacturer of metal fabricated enclosures in addition to
designing and manufacturing a full range of copper and fiber optic connectivity
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, thus offering network operators a full system solution to
their outside plant requirements.
Industry
The communications industry continues the accelerated expansion it has
experienced for a number of years, both domestically and worldwide.
Contributing to this growth is the increasing need for network signal
transmission bandwidth to accommodate new high-speed communications applications
deployed on upgraded existing networks and newly constructed broadband networks.
Major developments including the Internet and other high-speed data
communications technologies, on-going convergence between the CATV and
telecommunications industries, and demand for enhanced communications services,
have led to a changing regulatory and competitive environment in many markets.
Throughout the world, the deployment of new networks or improvements to existing
networks for advanced broadband applications is a national priority for many
countries, permitting them to participate and compete in the rapidly emerging
information-based global economy.
To meet today's demands and anticipating future demand, CATV, local telephone
operators and power utilities are building, rebuilding or upgrading signal
delivery networks around the world. These networks are designed to deliver
video, voice, data or power transmissions and provide Internet connectivity to
individual residences and businesses. Operators deploy a variety of network
technologies and architectures, such as HFC, FTTC, DLC and ADSL (see "Glossary
of Terms") to carry broadband and narrowband signals. These architectures are
constructed of electronic hardware connected via coaxial cables, copper wires
and/or optical fibers, including various access devices, amplifiers, nodes, hubs
and other signal transmission and powering electronics. Many of these devices
in the outside plant require housing in secure, protective enclosures and cable
management connectivity systems, such as those manufactured by the Company.
1
As critical components of the outside plant, enclosure products provide
protection against weather and vandalism, ready access to devices for
technicians who maintain and manage the outside plant and, in some cases,
provide dissipation of heat generated by the active electronic hardware. CATV
and local telephone network operators place great reliance on manufacturers of
protective enclosures because any material damage to the signal delivery
networks is likely to disrupt communications services.
The primary drivers of demand for enclosures in the communications industry is
the construction, rebuilding, upgrading and maintenance of signal delivery
networks by CATV operators and local telephone companies. Particular
technological developments in the communications industry are resulting in
significant increases in system upgrades. For example, CATV networks are being
upgraded and prepared for advanced two-way services such as high-speed 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 a variety of digital
subscriber line ("DSL") technologies, which utilize installed copper wires for
broadband services. These "local loop" copper wire systems often require
significant upgrading and maintenance to provide the optimal throughput
necessary to carry high-speed broadband signals, increasing the need for fully
sealed outside plant facilities in order to sustain 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
and connectivity products designed for the communications industry.
Business Strategy
The Company's strategy has been, and remains, to capitalize on opportunities
in the global communications industry by providing enclosures, connectivity
products and other complementary components 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 Telecommunications Business. The Company will
continue to seek to capitalize on its position as a leading designer,
manufacturer and marketer of enclosures for the CATV and local telephone
industries 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 enclosure products for the CATV and
telephone industries, the Company has positioned itself to increase its
participation in the large scale broadband network construction and upgrade
programs anticipated over the next several years by attaining incremental sales
opportunities through the recently acquired RMS, Standby and Egerton product
lines, which are marketed as complementary product lines by the Company. With
these acquisitions, the Company is now able to offer a more complete package of
products used by all telecommunications network operators as they upgrade their
networks in order to provide additional services and expand network capacity.
These expansions and upgrades are expected to enable telecommunications network
operators to increase network bandwidth to accommodate increased demand for
faster and larger throughput of signal transmissions and greater reliability of
their infrastructure.
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 achieved significant success in marketing its traditional
CATV/broadband products to local telephone companies that 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, Asia, the Pacific Rim, the Middle East and Europe. Trends
expected to result in international growth opportunities include the on-going
deregulation and privatization of
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telecommunications in many national contexts around the world, 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 multinational expansion by many U.S. based network carriers. The Company
currently operates overseas manufacturing and sales operations in Australia,
Canada and the UK in order to focus directly on the unique requirements of each
major market. 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.
Develop New Products and Enter New Business Segments. The Company continues
to leverage its core capabilities in developing innovative products that meet
the evolving needs of its customers. Examples of innovative products offered by
the Company include its low profile (i. e., close to the ground) enclosures,
self-locking security system 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, have 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 advantages over
those offered by other suppliers to the industry. In addition, the Company
seeks 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 and application-
specific, thermoplastic and metal fabricated enclosures that are considered
state-of-the-industry for many applications, having been field tested and
received approvals and standardization certifications from major CATV and
telephone company operators. As a result of the Egerton acquisition, the
Company now designs and supplies a full range of copper and fiber optic
connectivity products. Most of the Company's products are designed for buried
and underground network applications. The Company's enclosure products provide
technicians access to these networks and equipment for maintenance, upgrades and
installation of new services. Buried and underground networks and enclosures
are generally preferred by CATV operators for increased network reliability,
lower maintenance, improved security, reduced utility right of way conflicts,
and aesthetic appeal. The enclosure products must provide advanced heat
dissipation characteristics as required for the protection of active electronics
in many network installations. The Company also designs and manufactures a
series of termination blocks, brackets and cable management devices for mounting
inside its enclosure products. The Company is recognized in the industry for
its differentiated product designs and the functionality, field performance and
service life of its products, as compared with alternative products.
To enhance its complete system approach in the "curb to the home
infrastructure" portion of broadband networks, the Company acquired RMS in 1997.
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 in
1997, a designer and supplier of metal fabricated enclosures to house advanced
electronics, fiber optic cable and power systems for broadband
telecommunications networks which are now branded as the Rhino Enclosures(TM).
These electronic devices and enclosures are complementary with the Company's
core broadband enclosure products and are now components of the Company's
complete systems approach.
In 1998, the Company acquired Egerton, a UK-based company, with an operation
in Australia, giving the Company expanded presence in the European, Southeast
Asian and other world telecommunications markets. Egerton, a designer and
manufacturer of innovative telephone connectorization devices, as well as fiber
optic and heat shrink products for CATV, provides high quality component
products to the Company's telecommunications networks product line. The
Company's Insulation Displacement Connector ("IDC") technology provides advanced
"tool-less" termination systems for copper wires, the predominant medium used
for telecommunications services worldwide. These proprietary IDC products
environmentally seal network termination points with a high level of
reliability.
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To position itself as a full-line product supplier, the Company also offers a
variety of complementary products, including thermoplastic and concrete grade
level boxes. These products are typically purchased by customers as part of a
system package and are marketed by the Company through its direct sales force to
its existing customer base.
Over the past several years, the Company has developed OEM marketing programs
through which other manufacturers incorporate the Company's products as
components of their systems. These OEM programs generally include exchanges of
technical information that the Company can use in developing new products and
improvements and enhancements to existing designs. The Company has established
additional relationships with systems integrators and innovative end users that
provide valuable product improvement information.
The Company currently markets over 50 product families, with several thousand
optional 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 one of the most complete lines of outside plant
infrastructure products in the telecommunications industry. The Company
anticipates the demand for its broadband product line to be sustained by the
continued construction of broadband networks, both CATV and telephone, and
upgrades of existing CATV networks to accommodate expanded video services, high-
speed Internet access via cable modems, and wireless PCS transport. Recent
announcements in the power utility market indicate additional growth
opportunities from this industry segment as well.
The Company also specializes in the manufacture of high performance products
designed to meet or exceed the requirements of local telephone company networks,
including sealed plant products. These products are designed with
environmentally sealed specifications to provide exceptional long-term
protection for copper wires, coaxial cable and optical fibers exposed for the
purposes of splicing and termination. The sealing systems of the Company's
sealed plant products are available in several styles and specifications which
can be configured to individual customer requirements. This provides
significant value to customers in terms of faster installations, re-entry and
access, and cost management.
Traditionally, the Company's sealed plant products have been deployed in
regions where the potential for damage from severe flooding, moisture and
corrosion is high. More recently, some telephone companies, to improve the
general reliability of their copper wire networks, reduce maintenance costs and
extend the service life of their infrastructure, have adopted a complete sealed
plant strategy. In addition, Company management expects that increased demand
for sealed plant products, both enclosures and IDC connector 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 these
critical applications are implemented, it is anticipated that network operators
may seek to upgrade their copper wire facilities to improve reliability and
performance. The Company's active electronic enclosures and sealed plant
products are well suited for such applications.
The Company continues to assess new product innovations to complement its
existing product line and marketing strengths. Additional products for the
telecommunications markets as well as new products for customers in industries
outside of the communications industry, such as the power utility industry, are
new product development initiatives being studied by the Company.
Marketing and Sales
The Company markets its products primarily through a direct sales force of
technically trained salespeople. The Company's sales force is deployed
worldwide and divided into major market groups as follows: US; Canada;
South/Central America; Australia/Asia; and Europe/Middle East. The Company
employs an application-specific, systems 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 supported
by the Company's engineering and technical marketing staff.
The Company's technical and product marketing department provides its sales
force with extensive support. The field technical service personnel within this
department work closely with the outside sales staff and customers to develop
system solutions and provide a full range of technical support, training and
certification for
4
users of the Company's products. Product marketing personnel
perform a variety of functions, including product line management and general
marketing services. These individuals also provide strategic plans for product
development, new market entry, acquisitions and strategic alliances, and work
closely with the Company's sales, engineering and manufacturing departments to
implement such strategic plans.
An internal sales/customer service department that administers and schedules
incoming orders, handles requests for product enhancements and service
inquiries, also supports the Company's direct sales force. With locations in
California, North Carolina, Canada, the United Kingdom and Australia, this
department maintains direct communications with customers and the Company's
field sales and operations personnel.
By engaging in public relations activities, product literature development,
market research and advertising, the marketing department also promotes and
positions the Company, within both domestic and international markets. The
Company regularly attends, participates and exhibits its products at industry
trade shows and conferences within domestic and international telecommunications
markets throughout the year.
Manufacturing Operations
The Company's primary product manufacturing facilities are as follows:
Temecula, California; Mississauga, Ontario; Kent, UK; Sydney, Australia. The
Company's modern, vertically integrated 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 modify its product lines
to meet changing market demands, rapidly and efficiently produce large volumes
of products, control expenses and ensure product quality. Management considers
the Company's manufacturing expertise a distinct and significant competitive
advantage, providing it with the ability to satisfy the requirements of major
customers with relatively short lead-times by promptly booking and shipping
orders.
The Company owns a majority of its manufacturing equipment, which is generally
state-of-the-art, and all manufacturing processes are performed by trained
Company personnel. These manufacturing processes include injection molding,
structural foam molding, rotational molding, metal fabrication, rubber
injection, transfer and compression molding, and termination block fabrication.
The Company has implemented several comprehensive process and quality assurance
programs, including continuous monitoring of key processes, regular product
inspections and comprehensive testing. In the second quarter of 1997, the
Company's Temecula manufacturing facility was awarded ISO-9001 certification, a
worldwide industry standards certification.
The Company's facilities include approximately 352,000 square feet in
Temecula, California; 24,000 square feet in Mississauga, Ontario, Canada; 92,000
square feet in Orpington, Kent, UK; 39,000 square feet in Sydney, Australia; and
44,000 square feet in Charlotte, North Carolina.
Management has followed a long-term capacity plan, adding the equipment,
facilities and trained personnel as 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.
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. Continuous from its earliest introductions, the Company has
designed all of its own products and developed core competencies in product
engineering and development.
As a direct result, the Company has been able to develop a broad series of
superior products. Distinguishing characteristics of the Company's products
include:
. Effective heat dissipation qualities;
. Advanced copper IDC connectivity products;
. A superior environmental sealing and protection system that, unlike many
competitors' products, does not require gels, compounds or other methods
to maintain the required seal;
. Sub-surface network access systems;
. Product designs allowing technicians easy access through circular covers
that can be removed to
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fully expose the enclosed electronics;
. High performance passive RF electronics products;
. Compatibility with a variety of signal delivery network architectures;
. Modular metal fabricated enclosure product line covering multiple network
applications; and
. Versatility of design to accommodate network growth through custom
hardware and universal mounting systems that adapt to a variety of new
electronic hardware.
The Company's product development and engineering processes enable the Company
to respond to demands of the communications industry for increasingly
sophisticated enclosure products. Many of the Company's thermoplastic enclosure
products are now considered state-of-the-industry, having been field tested and
received approvals and standardization certifications from major CATV and
telephone company operators.
With the acquisitions of RMS, Standby Electronics and Egerton, the Company is
engaged in extensive new product development programs in RF passive electronics,
metal fabricated enclosures and telephone connectorization devices.
The acquisition of Egerton has expanded the Company's telecommunications
product line and extended its presence in the global marketplace. The Egerton
product line includes advanced IDC connectorization and cross-connect products
for the telephone industry, and fiber optic and heat shrink products that
complement the Company's CATV core enclosure products.
The Company's new product development approach is applications-based and
customer driven. A team comprised of engineering, marketing, manufacturing and
direct sales personnel work together to define, develop and deliver
comprehensive systems solutions to customers, focusing on the complete design
cycle from product concept through tooling and high-volume manufacturing. The
Company is equipped to conduct many of its own product testing regimens for
performance qualification purposes, enabling it to accelerate the product
development process. The Company spent approximately $0.5 million in 1994, 1995
and 1996, $1.0 million in 1997, and $1.9 million in 1998 on research and
development.
Customers
The Company sells its products directly to CATV operators and telephone
companies throughout the United States, Canada and certain other international
markets, principally within developed nations. During 1998, the Company shipped
products to more than 4,700 customer locations and its five largest customers
accounted for 42.8% of total net sales. In 1998, the Company's five largest
customers in the United States (by sales volume) were Cox, Comcast, Media One,
TCI and Time Warner. Two customers, Media One and Time Warner, accounted for
11.7% and 12.5%, respectively, of the Company's net sales in 1998.
In international markets, the Company's five largest customers (by sales
volume) were Telstra (Australia), Rogers Communications (Canada), Cable and
Wireless (UK), Techlink Services (UK) and British Telecom (UK).
The Company's customers generally do not enter into long-term supply contracts
providing for future purchase commitments of the Company's products. Rather,
the Company believes that many of its customers periodically review their supply
relationships and adjust buying patterns based upon their current assessment of
the products and pricing available in the marketplace. From fiscal period to
fiscal period, significant changes in the level of purchases of the Company's
products by specific customers can and do result from this periodic assessment.
Intellectual Property
Upon 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.
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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 core enclosure products and other compatible products, its specialized
engineering resources and vertically integrated manufacturing operations provide
the Company with significant competitive advantages.
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 effectively with cost control through vertical integration
utilizing advanced manufacturing techniques, cost-effective product designs and
material selection, and an aggressive procurement approach.
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. With the deregulation of the telecommunications
industry and the continuing convergence occurring within the CATV and
telecommunications industries, it is uncertain whether, and the extent to which,
such field testing may be required. While field testing can delay the
introduction of new products, it can also act as a competitive advantage for
those companies tested and approved, in that it creates a barrier to new product
introduction and sales by competitors.
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, and
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 it
attempts to develop and maintain multiple sources of supply in order to extend
the availability and encourage competitive pricing of these materials.
Most plastic resins are purchased under annual and multi-year contracts to
affect stabilization of 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 Company out-
sources to local processors to perform the coating operations.
Positioning itself as a full-line product supplier, the Company also relies on
certain other 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, 1998, the Company employed 713 people (including 41
temporary employees), of whom 78 were in sales, 541 were in manufacturing
operations (including the 41 temporary employees), 20 were in research and
development and 74 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 business
interruption as a result of labor disputes within the past five years.
7
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 of 1996 that 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, or similar substances, that are classified as hazardous. 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 Company to incur
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 and 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 in
personal injury actions) at properties it owns or utilizes in its operations,
even if the contamination was not caused by the Company's operations.
Item 2. Properties
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The Company's facilities approximate 551,000 square feet, of which
approximately 56%, 32% and 12% is used for manufacturing, warehouse and office
space, respectively. In Temecula, California, 260,000 square feet of the total
352,000 square feet are leased from William H. Channell, Sr., the Company's
Chairman of the Board and Chief Executive Officer. (See Certain Relationships
and Related Transactions, Item 13.) The Company also leases an aggregate of
approximately 168,000 square feet of manufacturing, warehouse and office space
in Canada, Australia, United Kingdom and North Carolina. The Company owns
approximately 123,000 square feet of manufacturing, warehouse and office space
in Temecula, California and the United Kingdom. The Company considers its
current facilities to be adequate for its operations.
Item 3. Legal Proceedings
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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
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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). There
was no existing public market for the Company's Common Stock prior to the third
quarter of 1996.
High Low
-------------------- -------------------
Year Ended December 31, 1996:
Third Quarter $15.25 $11.00
Fourth Quarter 13.00 9.00
High Low
-------------------- -------------------
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
High Low
-------------------- -------------------
Year Ended December 31, 1998:
First Quarter $13.25 $ 9.63
Second Quarter 13.88 9.00
Third Quarter 11.50 7.25
Fourth Quarter 9.13 5.75
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 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, 1998, the Company had 9,099,377 shares of its Common Stock
outstanding, held by approximately 650 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,
------------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- ---------- ---------- ----------
OPERATING DATA:
Net sales.............................. $ 34,504 $ 40,972 $ 47,282 $ 59,943 $ 92,710
Cost of goods sold..................... 19,750 23,059 25,447 35,032 56,578
-------- -------- --------- -------- ---------
Gross profit........................... 14,754 17,913 21,835 24,911 36,132
Commission income (1).................. 904 1,098 985 606 292
-------- -------- --------- -------- ---------
15,658 19,011 22,820 25,517 36,424
Operating expenses
Selling............................. 4,952 5,600 6,559 7,251 11,570
General and administrative.......... 1,445 1,707 2,021 4,077 8,057
License fees(2)..................... 1,560 2,035 531 - -
Research and development............ 518 498 531 1,009 1,863
-------- -------- --------- -------- ---------
8,475 9,840 9,642 12,337 21,490
-------- -------- --------- -------- ---------
Income from operations................. 7,183 9,171 13,178 13,180 14,934
Interest income (expense), net......... ( 156) ( 339) 291 879 ( 1,076)
-------- -------- --------- -------- ---------
Income before income taxes 7,027 8,832 13,469 14,059 13,858
Income taxes 429 349 2,359 5,589 5,749
-------- -------- --------- -------- ---------
Net income $ 6,598 $ 8,483 $ 11,110 $ 8,470 $ 8,109
======== ======== ========= ======== =========
Pro forma net income(3)................ $ 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 $.88
Diluted $.91 $.88
OTHER DATA:
Gross margin(5)........................ 42.8% 43.7% 46.2% 41.6% 39.0%
Operating margin(6).................... 20.8 22.3 27.9 22.0 16.1
EBITDA(7).............................. $ 8,255 $ 10,583 $ 14,729 $ 15,224 $ 18,994
Capital expenditures (excluding capital
leases).............................. 5,880 2,161 1,554 5,966 10,579
S Corporation dividends declared....... 3,764 5,427 14,157 - -
Cash provided by (used in):
Operating activities................. 6,201 9,758 11,424 3,730 6,606
Investing activities................. (5,880) (2,161) (12,960) (8,958) (22,308)
Financing activities................. 398 (7,019) 9,351 (122) 17,919
ADJUSTED FINANCIAL DATA(8):
Net sales (as historically reported)... $ 34,504 $ 40,972 $ 47,282
Adjusted EBITDA(9)..................... 9,540 12,343 15,122
Adjusted income from operations........ 8,468 10,931 13,571
Adjusted operating margin(10).......... 24.5% 26.7% 28.7%
Adjusted net income.................... $ 4,899 $ 6,431 $ 8,179
Adjusted net income per share(11)...... .84 .97
10
Year Ended December 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- -------
BALANCE SHEET DATA:
Current assets...................... $ 8,093 $ 8,502 $31,274 $33,252 $40,505
Total assets........................ 17,951 19,103 42,658 50,625 98,442
Long-term obligations
(including current maturities)... 3,684 3,213 473 946 35,911
Stockholders' equity................ 9,417 12,473 37,422 45,892 52,580
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. See Footnote B to the
Financial Statements included elsewhere herein for weighted average shares
outstanding in 1997 and 1998.
(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 and 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 designer and manufacturer of telecommunications equipment
supplied to telephone, cable television and power utility network providers
worldwide. The Company sells its products directly to CATV operators and
telephone companies throughout the United States, Canada, Australia, United
Kingdom and certain other international markets, principally within developed
nations. 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 received a commission upon the
sale of such products. Pursuant to the agreement, which was terminated in 1998,
under which the Company marketed such products, during the terms thereof and for
a period of two years thereafter, both 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,
Standby Electronics and Egerton 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,
--------------------------
1996 1997 1998
------- ------- ------
Net sales........................ 100.0% 100.0% 100.0%
Cost of goods sold............... 53.8 58.4 61.0
----- ----- -----
Gross profit..................... 46.2 41.6 39.0
Commission income................ 2.1 1.0 0.3
----- ----- -----
48.3 42.6 39.3
Selling.......................... 13.9 12.1 12.5
General and administrative....... 4.3 6.8 8.7
License fees..................... 1.1 - -
Research and development......... 1.1 1.7 2.0
----- ----- -----
Income from operations........... 27.9 22.0 16.1
Interest income (expense), net... 0.6 1.5 1.2
----- ----- -----
Income before income taxes....... 28.5 23.5 14.9
Pro forma income taxes(1)........ 9.6 9.4 6.2
----- ----- -----
Pro forma net income(1).......... 18.9% 14.1% 8.7%
===== ===== =====
Adjusted income from operations(2).. 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 and 1998. 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 and 1998.
13
New Accounting Pronouncement
In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), Accounting for Derivative
Instruments and Hedging Activities, which is effective for 2000. SFAS 133 will
require the Company to record all derivatives on the balance sheet at fair
value. For derivatives that are hedges, changes in the fair value of
derivatives will be offset by the changes in the fair value of the hedged
assets, liabilities or firm commitments. The Company believes the impact of
adopting this standard will not be material to results of operations or equity.
Comparison of the Year Ended December 31, 1998 With Year Ended December 31, 1997
Net Sales. Net sales increased $32.8 million or 54.8% from $59.9 million in
1997 to $92.7 million in 1998, as a result of increased sales of
telecommunication enclosure and component products of $32.0 million (including
$20.1 million of Egerton products) and $0.8 million of other related equipment.
Domestic net sales increased $14.6 million or 29.8% from $49.0 million in 1997
to $63.6 million in 1998, primarily due to accelerated growth in both upgrade
and rebuild construction as a result of increased broadband requirements.
International net sales increased $18.2 million or 167.0% from $10.9 million in
1997 to $29.1 million in 1998, due to the sales of $20.1 million of Egerton
products while Channell's broadband sales decreased $1.9 million due to the
sluggish Asian economy.
Gross Profit. Gross profit increased $11.2 million or 45.0% from $24.9
million in 1997 to $36.1 million in 1998. Of this improvement, $6.8 million is
attributable to sales of Egerton products and $4.4 million was attributable to
increased sales volume of Channell's telecommunications enclosure and component
products. Gross margin decreased from 41.6% in 1997 to 39.0% in 1998, primarily
due to a 33.8% margin contribution from Egerton revenues, while margin on
Channell's telecommunications enclosure and component products decreased from
41.6% in 1997 to 40.4% in 1998 due to increased depreciation expenses from
capital expenditures in the comparative periods and increased manufacturing
staffing.
Commission Income. Commission income decreased $0.3 million or 50.0% from
$0.6 million in 1997 to $0.3 million in 1998. The decrease is a result of the
termination of a marketing agreement for the sale of cable-in-conduit products.
Selling. Selling expense increased $4.3 million or 58.9% from $7.3 million in
1997 to $11.6 million in 1998, as a result of $2.0 million for increased payroll
and related expenses in connection with expanded staffing to support increased
sales and marketing activities worldwide and $2.3 million of increased selling
expenses related to the Egerton operations. As a percentage of net sales,
selling expense increased from 12.1% in 1997 to 12.5% in 1998.
General and Administrative. General and administrative expenses increased $4.0
million or 97.8% from $4.1 million in 1997 to $8.1 million in 1998. Such
increase occurred as a result of increased payroll and related expenses due to
increased staffing requirements in the amount of $0.7 million and $0.5 million
of increased legal, auditing and professional services. General and
administrative expense increased $2.9 million as a result of the Egerton
operations including $0.5 million of goodwill amortization. As a
percentage of net sales, general and administrative expenses increased from 6.8%
in 1997 to 8.7% in 1998.
Research and Development. Research and development expenses increased $0.9
million or 90.0% from $1.0 million in 1997 to $1.9 million in 1998, as a result
of increased payroll and expenses in the amount of $0.7 million associated with
increased staffing and $0.3 million related to Egerton. As a percentage of net
sales, research and development expenses increased from 1.7% in 1997 to 2.0% in
1998.
Income from Operations. As a result of the items discussed above, income from
operations increased $1.7 million or 12.1% from $13.2 million in 1997 to $14.9
million in 1998, but declined as a percentage of net sales from 22.0% in 1997 to
16.1% in 1998.
14
Interest Income (Expense). Interest income decreased from $1.0 million in 1997
to $0.3 million in 1998, a reduction of 73.6%. This decrease was caused by a
reduction in the amount of the Company's investments in 1998, as the Company
used approximately $10.2 million of its investments to fund the purchase of
Egerton. Interest expense increased from $0.1 million in 1997 to $1.3 million
in 1998 as a result of increased borrowings to fund the Egerton acquisition and
capital expenditures.
Income Taxes. Income taxes were $5.6 million in 1997 and $5.7 million in 1998,
with effective tax rates of 40.0% and 41.0%, respectively. The increase in the
effective tax rate is primarily due to the increase in the amount of non-
deductible amortization of goodwill.
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.
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.
15
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 RMS and
Standby Electronics operations, 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 Management
Information System ("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.
Liquidity and Capital Resources
Net cash provided by operating activities was $3.7 million and $6.6 million in
1997 and 1998, respectively. Net cash used in investing activities was $9.0
million and $22.3 million in 1997 and 1998, respectively. The cost of
acquisitions, net of cash acquired, used in investing activities was $2.7
million and $24.0 million in 1997 and 1998, respectively. Net cash used in
financing activities was $0.1 million in 1997 and net cash provided by financing
activities was $17.9 million in 1998, including $24.7 million in proceeds from
the issuance of long-term debt.
Accounts receivable increased from $9.2 million for the year ended December
31, 1997 to $17.9 million for the year ended December 31, 1998, as a result of
higher sales during the fourth quarter of 1998 as compared to the same period of
1997 and $6.1 million attributable to Egerton operations. Inventories increased
from $7.3 million for the year ended December 31, 1997, to $15.0 million for the
year ended December 31, 1998, as a result of increased work-in-process and
finished goods inventories required for the increased sales volume forecasted
and $5.1 million attributable to Egerton operations.
The Company made capital expenditures (excluding capital leases) of $6.0
million and $10.6 million in 1997 and 1998, respectively, including $6.0 million
to acquire 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 acquired machinery and
equipment under capital leases totaling $0.2 million in 1997 and $6.2 million
in 1998.
The Board of Directors, on April 1, 1998, having determined such action to be
in the best interest of the Company, authorized a stock repurchase plan of up to
$2.0 million worth of Company stock. During the third and fourth quarters of
1998, the Company repurchased 137,623 shares of its Common Stock at a cost of
approximately $1.2 million.
16
The Company on May 1, 1998, acquired 100% of the outstanding shares of Common
Stock of Egerton, a public limited company incorporated in England and Wales.
The purchase price, paid in cash, amounted to $27.9 million, including $1.3
million of acquisition costs. The fair value of assets acquired in excess of
liabilities assumed amounted to $13.8 million which resulted in goodwill in the
amount of $14.1 million. Goodwill is being amortized on the straight-line basis
over twenty years. The purchase price of the stock was paid from the proceeds
of bank borrowing and the liquidation of short-term investments.
In conjunction with the acquisition of Egerton, the Company entered into a new
Senior Revolving Loan Agreement ("Revolving Facility") with a bank to provide
funds for the Egerton acquisition as well as for working capital and equipment
acquisition purposes. The Revolving Facility is in the amount of $25.0 million
of which $16.4 million had been drawn down as of December 31, 1998. The
outstanding balance bears interest at a variable rate based on either the bank's
base rate or the applicable LIBOR rate depending on the nature of the
borrowings. At December 31, 1998, the weighted average interest rate was 6.0%.
The loan is collateralized by substantially all the Company's tangible and
intangible assets and up to 65% of the capital stock of the Company's
subsidiaries and is due April 30, 2003.
The Revolving Facility contains various financial and operating covenants
which, among other things, imposes limitations on the Company's ability to incur
additional indebtedness, merge or consolidate, sell assets except in the
ordinary course of business, make certain investments, enter into leases and pay
dividends. The Company is also required to comply with covenants related to
minimum net worth and other financial ratios.
The Company also has a credit facility available to the Egerton subsidiaries,
which includes an overdraft facility totaling approximately $5.0 million plus
the combined cash balances of those subsidiaries, which were approximately $4.2
million at December 31, 1998. The facility also includes approximately $2.0
million, to provide financing for international letters of credit, forward
exchange contracts and other items. The outstanding balance (net of cash
balances) bears interest at the bank's base rate, 6.25% at December 31, 1998,
plus a factor ranging from 1.25% to a maximum of 4.0% depending on the amount
borrowed. The facility is collateralized by the assets of the subsidiaries and
due for renewal in August 1999.
The Company believes that income from operations, coupled with borrowing under
its revolving credit facilities will be sufficient to fund the Company's capital
expenditure and working capital requirements through 1999.
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
Today's communications industry is in a state of rapid technological change.
The introduction of new technologies, network architectures or changes in
industry standards can render the Company's existing products or products under
development obsolete or unmarketable. For example, satellite, wireless and
other communication technologies under development or 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 demand
for traditional wire-line network based services. Further, 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. 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, data and other transmission
networks, and high-speed 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 be met with market
acceptance.
17
Importance of New Product Development to Growth
A significant factor in the Company's ability to grow and remain competitive,
will be its ability to anticipate changes in technology and industry standards,
and to successfully develop and introduce new products on a timely basis. New
product development often requires long-term forecasting of market trends,
development and implementation of new designs and processes, and substantial
capital commitment. Trends toward consolidation of the communications industry
and convergence of technologies may require the Company to quickly adapt to
rapidly changing market conditions and customer requirements.
The Company's manufacturing and marketing expertise has enabled it to
successfully develop and market new products in the past. However, 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 telecommunications industry is concentrated, with relatively few operators
accounting for a large percentage of the Company's available market.
Consequently, while the Company shipped product to over 4,700 customer locations
in 1998, its five largest customers (by sales volume) accounted for 42.8% of the
Company's total net sales in 1998. Two customers, Media One and Time Warner,
accounted for 11.7% and 12.5%, respectively, of the Company's total net sales
during the period.
The Company's customers typically require prompt shipment of the Company's
products within a narrow timeframe. As a result, the Company has historically
operated with a relatively small backlog. 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,
may place the Company's operating results 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 expects that sales to the telecommunications industry will
continue to represent a substantial portion of its total sales. Demand for
products within this industry 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 technology.
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 customers. 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 video, voice, and data
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.
18
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 resins. 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. 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,
earnings per share 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 realize 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 the related fixed costs for rent, product development, engineering,
tooling and manufacturing are a relatively high 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
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.
19
Risks Associated with International Operations
International sales, including export sales from U.S. operations, accounted
for 11.7%, 18.2% and 31.4% of the Company's net sales in 1996, 1997, and 1998
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,
because of the anticipated growth in the telecommunications industry generally,
the demand for products required in signal transmission networks in particular,
the level and intensity of competition may increase in the future.
The Company's competition includes a company that has a significant market
share in the telephone segment of the industry. The Company's strategy includes
continued focus on increasing sales to this segment. While the Company's net
sales to this segment have increased, there can be no assurance that the Company
will be able to compete successfully against that company or other competitors,
many of whom may have access to greater financial resources than the Company.
Disruptions at the Company's Manufacturing Facility; Lease with Related Party
The majority of the Company's manufacturing operations is 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 a portion of its Temecula facilities 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.
Year 2000 Computer Systems Compliance
The Year 2000 problem concerns the inability of certain computers and computer
systems to process data beyond January 1, 2000. Many software programs refer to
years in terms of their final two digits only. These programs may interpret the
year 2000 as 1900 and may not recognize that the year 2000 is a leap year. (The
year 1900 was not a leap year.) If not corrected, these programs could shut
down or generate incorrect critical data.
The Company has developed a plan to deal with the Year 2000 issues that it
faces. The Company, independent of the Year 2000 issues has embarked on a
worldwide project to implement a new business information system throughout the
Company using i2 Rhythm Factory Planner, Oracle ERP software and associated
hardware. These new systems will make the Company's business information
systems approximately 85% Year 2000 compliant and are scheduled for completion
domestically in the second quarter of 1999 and internationally in the third
quarter of 1999. The Company is on schedule for implementation of these new
systems.
20
In addition to business information systems, the Company's plan calls for the
analysis, correction and testing of embedded systems which might not operate or
might not operate properly after January 1, 2000. Those Systems include, but
are not limited to, telephone and voice mail systems, manufacturing and
production equipment, freight and shipping software, office machines, elevators
and building security systems. The Company has completed 60% of the in-house
testing and/or obtaining of manufacturer's certifications for the Year 2000
compatibility of these systems. Any items that cannot be determined to be
compliant or cannot be upgraded to be compliant are being replaced if they are
deemed to be critical to the operations of the Company.
The Company's plan also includes a procedure for analyzing the Year 2000
status of key outside suppliers, service providers and customers whose failure
to comply could have an adverse affect on the Company. These procedures include
a standard Year 2000 compliance agreement as well as a survey-type questionnaire
designed to help measure the vendor's progress in dealing with the Year 2000
issues. The Company has identified its key vendors and customers and has
completed 60% of the process of mailing the questionnaire and/or obtaining the
certification agreements. This phase of the plan is on-going, but is
anticipated to be complete in the third quarter of 1999.
The Company has contingency plans to deal with the failure of the above to
meet the Year 2000 issue with regard to the systems upgrade. The contract with
the suppliers includes a guarantee that the new Systems will be implemented and
tested timely, and that the systems will be Year 2000 compliant. In addition, in
the event that the business information system implementation (Oracle) does not
meet the project time line (5/1/99), the Company will install Y2K patches for
its existing Data General operating system along with the Apollo business
application software. This will ensure, on a short-term basis, that the Company
will continue in a production environment while meeting the Year 2000-compliance
situation. No contingency plan has been established to deal with the embedded
Systems issue in that any critical, non-compliant systems will be replaced or
corrected as they are discovered. Contingency plans to deal with outside
suppliers and customers will be developed as indicated by the on-going analysis
of these entities. Such contingency plans could include the building of
inventories, the search for alternative suppliers, or the request for advance
payments or deposits from customers, all as the case may indicate.
The total costs associated with becoming Year 2000 compliant are not expected
to be material to the Company's financial position or results of operations.
Total costs associated with the business information systems project are
expected to be $3.5 million, most of that attributable to the systems upgrade
that was being done independent of the Year 2000 problems. Approximately 50% of
the costs associated with the Systems upgrade have already been incurred.
Failure to anticipate and correct the Year 2000 problem could result in an
interruption in or a failure of certain normal business activities including,
but not limited to temporary plant closings, delays in the delivery of products,
delays in receipt of supplies, invoice and collection errors, delays in the
collection of receivables and inventory obsolescence. The Company believes that
with the implementation of the new business information systems and completion
of the other procedures contained in the Year 2000 plan (particularly the
analysis of third party vendor and customer Year 2000 compliance activities),
that any significant interruptions and negative impacts from Year 2000 problems
will be reduced.
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.
21
Changing Regulatory Environment
The communications industry is subject to regulation in the United States and
other countries. Federal and state 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 for its customers' signal transmission network needs,
the effect of the Telecommunications Act on the market for the Company's
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 1999, 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.
Selected Quarterly Financial Data
Set forth below is certain unaudited quarterly financial information. (See
also Footnote P to the Financial Statements included elsewhere herein.) 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.
Year Ended Year Ended
December 31, 1997 December 31, 1998
------------------------------------------ -----------------------------------------
(amounts in thousands) (amounts in thousands)
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ---------- --------- ------- ------- ---------- --------- -------
Net sales.............. $12,804 $15,664 $15,353 $16,122 $15,704 $23,108 $27,159 $26,739
Gross profit........... 5,143 7,005 6,399 6,364 6,414 9,621 10,609 9,488
Income from
operations............. 2,093 4,099 3,670 3,318 2,493 4,180 4,460 3,801
Income before income
taxes.................. 2,392 4,301 3,880 3,486 2,645 3,852 3,840 3,521
22
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
The market risk inherent in the Company's market risk sensitivity instruments
is the potential loss arising from adverse changes in interest rates and foreign
currency exchange rates. All financial instruments held by the Company and
described below are held for purposes other than trading.
Market Risk
The Company's revolving line of credit allows the outstanding balance to bear
interest at a variable rate based on either the bank's base rate or the
applicable LIBOR rate depending on the nature of the borrowings. The revolving
line of credit exposes earnings to changes in short-term interest rates since
the interest rates on the revolving line of credit are variable.
If the variable rates on the Company's revolving line of credit were to
increase by 1% from the rate at December 31, 1998, and the Company borrowed the
maximum amount available under its revolving line of credit ($25.0 million) for
all of fiscal 1999, the Company's interest expense would increase, and net
income would decrease by $0.1 million. If LIBOR were to increase 1% from the
rate at December 31, 1998, and the Company borrowed the maximum amount
available, the Company's interest expense would increase, and also net income
would decrease by $0.1 million. A marginal income tax rate of 41.0% was used.
This analysis does not consider the effects of the reduced level of overall
economic activity that could exist in such an environment. In the event of a 1%
change in interest rates, management would likely take actions to further
mitigate its exposure to the change.
Foreign Exchange Risk
The Company typically does not hedge its foreign currency exposure.
Management does not believe it currently has any material exposure to foreign
currency rate fluctuations.
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, 1997 and December 31, 1998.......................... F-2
Consolidated Statements of Income and Comprehensive Income for the years ended
December 31, 1996, December 31, 1997, and December 31, 1998................................... F-4
Consolidated Statement of Stockholders' Equity for the years ended December 31, 1996,
December 31, 1997 and December 31, 1998..................................................... F-6
Consolidated Statement of Cash Flows for the years ended December 31, 1996, December 31, 1997,
and December 31, 1998....................................................................... F-7
Notes to Consolidated Financial Statements....................................................... F-9
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.
23
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, 1998.
Name Age Positions
- -------------------------- --- -------------------------------------
William H. Channell, Sr... 70 Chairman of the Board and
Chief Executive Officer
William H. Channell, Jr... 41 President, Chief Operating Officer
and Director
Gary W. Baker............. 55 Vice President, Finance and
Chief Financial Officer
Andrew M. Zogby........... 38 Vice President, Marketing
Edward J. Burke........... 43 Vice President, Engineering
Dale C. Wooding........... 48 Vice President, Manufacturing
John B. Kaiser............ 46 Vice President, Broadband Sales
Gary M. Napolitano........ 43 Vice President, International Finance
Jacqueline M. Channell.... 67 Secretary and Director
Eugene R. Schutt, Jr...... 45 Director
Richard A. Cude........... 65 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.
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.
24
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. Since the fourth quarter 1998, Mr. Napolitano has been Vice
President, International Finance.
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 2001.
Eugene R. Schutt, Jr. has been a Director of the Company since July 1996. Mr.
Schutt's initial term expires in 1999. Mr. Schutt is currently serving as a
consultant to international and domestic businesses. From January 1992 to
February 1999, Mr. Schutt was 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 is currently retired. 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 are to 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 1999 annual meeting
of stockholders.
25
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, 1998
(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 520,000 360,000 - - 25,000 - 4,257
Gary W. Baker................
Vice President, Finance and
Chief Financial Officer 160,660 81,666 - - 2,000 - 4,409
Edward J. Burke..............
Vice President, Engineering 136,063 81,666 - - 2,000 - 4,082
Dale C. Wooding..............
Vice President,
Manufacturing 119,735 81,666 - - 2,000 - 3,592
(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). During 1998, the Company granted
114,500 "non-qualified" options to 29 employees and directors (including 25,000
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.
26
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 $100,000.
Upon exercise of any option, the purchase price must generally be paid in full
either in cash or by certified or cashier's check. However, in the discretion of
the Compensation Committee, the terms of a stock option grant may permit payment
of the purchase price by means of (i) cancellation of indebtedness owed by the
Company, (ii) delivery of shares of Common Stock already owned by the optionee
(valued at fair market value as of the date of exercise), (iii) delivery of a
promissory note secured by the shares issued, (iv) delivery of a portion of the
shares issuable upon exercise (i.e., exercise for the "spread" on the option
payable in shares), or (v) any combination of the foregoing or any other means
permitted by the Compensation Committee.
Any grants of Restricted Stock will be made pursuant to Restricted Stock
Agreements, which will provide for vesting of shares at a rate to be determined
by the Compensation Committee with respect to each grant of Restricted Stock.
Until vested, shares of Restricted Stock are generally non-transferable and are
forfeited upon termination of employment. The Company has not made any grants
of Restricted Stock.
Options/SAR Grants Table
The following table sets forth the stock options granted to the named officers
for the year ended December 31, 1998.
% of Total Potential Realized
Number of Options/ Value at
Securities SARs Assumed Annual
Underlying Granted to Exercise Rates of Stock Price
Options/ Employees on Base Appreciation of
SARS in Fiscal Price Expiration Option Term
Name Granted Year 1998 ($/Sh) Date 5% 10%
---- ---------- ---------- -------- ---------- -------- --------
William H. Channell, Sr. - - $ - - $ - $ -
William H. Channell, Jr. 25,000 21.8% $ 8.813 Aug 2008 138,500 351,175
Gary W. Baker 2,000 1.8% $11.500 Jan 2008 14,460 36,660
Edward J. Burke 2,000 1.8% $11.500 Jan 2008 14,460 36,660
Dale C. Wooding 2,000 1.8% $11.500 Jan 2008 14,460 36,660
27
Aggregated Option/SAR Exercises in Last Fiscal Year and December 31, 1998
Option/SAR Values
The following table sets forth the number and value of outstanding stock
options at December 31, 1998. No options have been exercised in 1998.
Number of Shares
Shares Underlying Unexercised Value of Unexercised In-
Acquired Options/SARs the-Money Options/SARs
on Value at December 31, 1998 at December 31, 1998
Name Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable
- ---- ------------ ------------ ------------------------- -------------------------
William H. Channell, Sr. - $ - - $ - /$ -
William H. Channell, Jr. - - 83,333/91,667 - /
Gary W. Baker - - 14,000/12,000 - /
Edward J. Burke - - 14,000/12,000 - /
Dale C. Wooding - - 14,000/12,000 - /
Profit Sharing and Savings Plans
The Company maintains 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 and $520,000,
respectively. Mr. Channell, Sr.'s salary is subject to annual cost of living
increases. After the cost of living adjustment, the base salary for each during
1998 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.
28
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. Mr. William H. Channell, Jr., the Company's President, receives
a bonus calculated using the factors above, but such bonus is earned and payable
based on continued service in subsequent years. 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, 1998
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)
COMPARISON OF FOUR-YEAR CUMULATIVE TOTAL RETURN
AMONG CHANNELL COMMERCIAL, S&P INDUSTRIAL,
NASDAQ COMPOSITE PEER GROUP INDEX
PERFORMANCE GRAPH APPEARS HERE
Measurement Period CHANNELL S&P NASDAQ PEER
(Fiscal Year Covered) COMMERCIAL CORP INDUSTRIAL COMPOSITE GROUP
- ------------------------ --------------- ---------- ---------- -------
Measurement Pt- JUL-96 $100.00 $100.00 $100.00 $100.00
FYE DEC-96 $ 99.00 $109.92 $108.50 $ 75.91
FYE DEC-97 $100.00 $144.02 $132.52 $155.66
FYE DEC-98 $ 67.00 $192.56 $185.78 $141.48
The Peer Group Index is a market capitalization weighted composite that includes
Amphenol Corp., Antec Corp., Oak Industries and TII Industries.
29
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 36.2%
Jacqueline M. Channell, as co-trustees
of the Channell Family Trust
26040 Ynez Road
Temecula, CA 92591-9022
William H. Channell, Jr. 1,489,250 83,333 1,572,583 16.6%
26040 Ynez Road
Temecula, CA 92591-9022
Wellington Management Company, LLP 914,100 - 914,100 9.7%
75 State Street
Boston, MA 02109
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, 1999.
Security Ownership of Management
The following table sets forth certain information, as of March 15, 1999,
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 36.2%
William H. Channell, Jr. 1,489,250 83,333 1,572,583 16.6%
Gary W. Baker 700 14,000 14,700 .2%
Edward J. Burke - 14,000 14,000 .1%
Dale C. Wooding 300 14,000 14,300 .2%
All present directors and executive
officers as a group (11 in number) 4,913,207 131,337 5,044,544 53.3%
(1) Refers to the number of shares covered by options exercisable within 60
days of March 15, 1999.
30
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 lease provides for
annual cost of living increases; however, for 1996, 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. During 1998, the Company paid rents to
Mr. Channell, Sr. of $1.1 million on the two leases. 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.
31
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 Senior Revolving Loan Agreement dated as of May 1, 1998, between the
Company and Fleet National Bank (3)
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)
10.14 Lease dated September 24, 1997 between the Company and SCI North
Carolina Limited Partnership (4)
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 (5)
10.20 Letter Agreement regarding employment, Andrew M. Zogby (2)
10.21 Letter Agreement regarding employment, John B. Kaiser (2)
10.22 A.C. Egerton (Holdings) PLC Share Purchase Agreement (3)
10.23 Amendment to Employment Agreement, William H. Channell, Jr. dated
December 31, 1998 (5)
11 Computation of Proforma Income per Share (2)
27 Financial Data Schedule (5)
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1998.
_______
(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 8-K on May 18, 1998.
(4) Incorporated by reference to the indicated exhibits filed in connection with
the Company's Form 10-Q on May 6, 1998.
(5) Filed herewith.
32
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, 1997 and 1998, and the related consolidated
statements of income and comprehensive income, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1998. 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, 1997 and 1998, and the consolidated
results of its operations and its consolidated cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
Los Angeles, California
March 11, 1999
F-1
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
(amounts in thousands, except per share data)
ASSETS 1997 1998
---- ----
CURRENT ASSETS
Cash and cash equivalents $3,840 $5,828
Investments 11,651 -
Accounts receivable 9,191 17,890
Inventories 7,269 14,992
Deferred income taxes 688 630
Prepaid expenses 613 1,165
--------- ---------
Total current assets 33,252 40,505
PROPERTY AND EQUIPMENT, net 14,758 42,081
DEFERRED INCOME TAXES 664 -
INTANGIBLE ASSETS, net of amortization of $137
and $741 in 1997 and 1998 1,649 15,100
OTHER ASSETS 302 756
--------- ---------
$50,625 $98,442
========= =========
The accompanying notes are an integral part of these statements.
F-2
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS - CONTINUED
December 31,
(amounts in thousands, except per share data)
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1998
--------------- ---------------
CURRENT LIABILITIES
Accounts payable $ 2,606 $ 6,504
Short term debt (including current maturities of
long term debt) - 8,862
Current maturities of capital lease obligations 226 2,009
Accrued expenses 791 2,537
Income taxes payable 390 625
--------------- ---------------
Total current liabilities 4,013 20,537
LONG-TERM DEBT, less current maturities 400 20,855
CAPITAL LEASE OBLIGATIONS 320 4,185
DEFERRED INCOME TAXES - 285
COMMITMENTS AND CONTINGENCIES - -
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 - 9,237; outstanding - 9,237 shares in 1997
and 9,099 shares in 1998 92 92
Additional paid-in capital 27,991 27,991
Treasury stock - 138 shares in 1998 - (1,175)
Retained earnings 17,809 25,918
Accumulated other comprehensive income -
Foreign currency translation - (246)
--------------- ---------------
Total stockholders' equity 45,892 52,580
--------------- ---------------
$ 50,625 $ 98,442
=============== ===============
The accompanying notes are an integral part of these statements.
F-3
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year ended December 31,
(amounts in thousands, except per share data)
1996 1997 1998
--------- --------- ----------
Net sales $47,282 $59,943 $92,710
Cost of goods sold 25,447 35,032 56,578
--------- --------- ----------
Gross profit 21,835 24,911 36,132
Commission income 985 606 292
--------- --------- ----------
22,820 25,517 36,424
--------- --------- ----------
Operating expenses
Selling 6,559 7,251 11,570
General and administrative 2,021 4,077 8,057
License fees--related party 531 - -
Research and development 531 1,009 1,863
--------- --------- ----------
9,642 12,337 21,490
--------- --------- ----------
Income from operations 13,178 13,180 14,934
Interest income 477 1,006 266
Interest expense (186) (127) (1,342)
--------- --------- ----------
Income before income taxes 13,469 14,059 13,858
Income taxes 2,359 5,589 5,749
--------- --------- ----------
Net income $11,110 $ 8,470 $ 8,109
========= ========= ==========
Net income per share
Basic $ .92 $ .88
========= ==========
Diluted $ .91 $ .88
========= ==========
The accompanying notes are an integral part of these statements.
F-4
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME -
CONTINUED
Year ended December 31,
(amounts in thousands, except per share data)
1996 1997 1998
---------- ---------- ----------
Pro forma information (unaudited):
Historical income before income taxes $ 13,469
Pro forma income taxes 4,548
----------
Pro forma net income $ 8,921
==========
Pro forma net income per share-basic and diluted $ 1.06
==========
Pro forma weighted average shares outstanding 8,403
==========
Net income $ 11,110 $ 8,470 $ 8,109
Other comprehensive income, net of tax
Foreign currency translation adjustments - - (246)
---------- ---------- ----------
Comprehensive net income $ 11,110 $ 8,470 $ 7,863
========== ========== ==========
The accompanying notes are an integral part of these statements.
F-5
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years ended December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
Accumulated
Common stock Additional Treasury stock other Total
---------------- paid-in ---------------- Retained comprehensive stockholders'
Shares Amount capital Shares Amount earnings income equity
-------- ------ ------------ ------- ------- --------- ------- ------------
Balance, January 1, 1996 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
Treasury stock acquired 138 (1,175) - (1,175)
Foreign currency translation - - - - - - (246) (246)
Net income for the year - - - - - 8,109 - 8,109
-------- ------ ------------ ------- ------- --------- ------- ------------
Balance, December 31, 1998 9,237 $ 92 $27,991 138 $(1,175) $ 25,918 $ (246) $ 52,580
======== ====== ============ ======= ======= ========= ======= ============
The accompanying notes are an integral part of these statements
F-6
CHANNELL COMMERICAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
(amounts in thousands)
1996 1997 1998
------ ------ ------
Cash flows from operating activities:
Net income $11,110 $8,470 $8,109
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,551 2,044 4,060
Deferred income taxes (880) (472) 486
Changes in assets and liabilities, net of effects
of acquisitions:
Accounts receivable (2,563) (1,197) (3,453)
Inventories (299) (2,716) (3,289)
Prepaid expenses (368) 201 (539)
Other assets 322 (19) (442)
Accounts payable 797 (602) 1,003
Accrued expenses 255 (820) 786
Income taxes payable 1,499 (1,159) (115)
------ ------- ------
Net cash provided by operating activities 11,424 3,730 6,606
------ ------ ------
Cash flows from investing activities:
Purchase of property and equipment (1,554) (5,966) (10,579)
Proceeds from sale of property and equipment - - 585
Advances to stockholder for building construction (3,119) - -
Collection of advances to stockholder 3,119 - -
Business acquisitions, net of cash acquired - (2,747) (23,965)
Purchases of investments (11,406) (7,316) -
Maturities of investments - 7,071 11,651
------ ------ -------
Net cash used in investing activities (12,960) (8,958) (22,308)
------ ------ -------
The accompanying notes are an integral part of these statements.
F-7
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
(amounts in thousands)
1996 1997 1998
------------ ------------ ------------
Cash flows from financing activities:
Repayment of debt $ (3,213) $ (195) $ (4,712)
Proceeds from issuance of long-term debt - - 24,661
Repayment of capital lease obligations (70) 73 (855)
Proceeds from initial public offering 30,565 - -
Acquisition of patents from stockholders (3,100) - -
Dividends paid (3,166) - -
Reorganization distribution (11,665) - -
Purchase of treasury stock - - (1,175)
------------ ------------ ------------
Net cash provided by (used in) financing activities 9,351 (122) 17,919
------------ ------------ ------------
Effect of exchange rates on cash - - (229)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 7,815 (5,350) 1,988
Cash and cash equivalents, beginning of year 1,375 9,190 3,840
------------ ------------ ------------
Cash and cash equivalents, end of year $ 9,190 $ 3,840 $ 5,828
============ ============ ============
Cash paid during the year for:
Interest (net of capitalized interest of $339 in 1998) $ 185 $ 128 $ 1,138
============ ============ ============
Income taxes $ 1,967 $ 5,753 $ 4,974
============ ============ ============
Noncash investing and financing activities:
Assets acquired under capital lease $ 543 $ 214 $ 6,248
============ ============ ============
Contribution of accrued license fees to paid-in capital $ 531 $ - $ -
============ ============ ============
Note received for property and equipment sold $ - $ - $ 166
============ ============ ============
Fair value of assets acquired, including goodwill $ - $ 4,974 $ 42,675
Note payable issued - (400) -
Cash paid - (2,774) (27,900)
------------ ------------ ------------
Liabilities assumed $ - $ 1,800 $ 14,775
============ ============ ============
F-8
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE A--DESCRIPTION OF BUSINESS
The Company is a designer and manufacturer of telecommunications equipment
supplied to telephone, cable television and power utility network providers
worldwide. Major product lines include a complete line of thermoplastic and
metal fabricated enclosures, advanced copper termination and connectorization
products, fiber optic cable management systems, coaxial-based passive RF
electronics and heat shrink products. The Company's enclosure products house,
protect and provide access to advanced telecommunications hardware, including
both radio frequency electronics and photonics, and transmission media,
including coaxial cable, copper wire and optical fibers, used in the delivery of
voice, video and data services. The enclosure products are deployed within the
portion of a local signal delivery network, commonly known as the "outside
plant" or "local loop", that connects the network provider's signal origination
office with residences and businesses.
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. Foreign currency transaction gains and losses are
included in net income. Adjustments resulting from translating foreign
functional currency financial statements into U.S. dollars are included in other
comprehensive income.
Cash and Cash Equivalents--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.
F-9
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Investments--At December 31, 1997 the Company had invested in certain U.S.
Government issued debt instruments and other taxable securities. These
investments were classified as available for sale. The investment in these
securities were 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.
Inventories--Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out method of accounting.
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 periods ranging from 15 to 20
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. Amortization
expense charged to income amounted to $137 and $603 in 1997 and 1998,
respectively.
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.
F-10
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Income per share--Basic income per share excludes dilution and 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 acquire common
stock were exercised.
The following is a reconciliation of the number of shares (denominator) used in
the basic and diluted income per share computations:
1997 1998
--------------------- ----------------------
Per Share Per Share
Shares Amount Shares Amount
------ --------- ------ ---------
Basic income per share 9,237 $ .92 9,199 $ .88
Effect of dilutive stock options 54 (.01) 31 -
------ ------ ------ ------
Diluted income per share 9,291 $ .91 9,230 $ .88
====== ====== ====== ======
The following options were not included in the computation of diluted income per
share as a result of the options' exercise price exceeding the average market
price of the common shares:
1997 1998
----------- ------------
Options to purchase shares of common stock 140 626
Exercise prices $13.25 $11.00 - $13.25
Expiration dates July 2007 July 2007 -
October 2008
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.
F-11
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
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 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 as the impact is not material.
A reconciliation of pro forma income taxes to the Federal statutory rate for the
year ended December 31, 1996 is as follows:
Federal statutory rate 34%
State income taxes, net of Federal tax benefit 6
Deferred income tax benefit recorded upon
termination of S Corporation status (5)
Other (1)
----
34%
====
Fair value of financial instruments--The carrying amount of cash, accounts
receivable, accounts payable, accrued expenses and short-term borrowings
approximates fair value because of the short maturity of these financial
instruments. Long-term obligations are carried at amounts that approximate fair
value. The estimated fair value of the long-term obligations is based on
borrowing rates currently available to the Company for loans with similar terms
and maturities. 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 and
1997 financial statements to conform with the 1998 presentation.
F-12
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE C--INVENTORIES
Inventories are summarized as follows:
1997 1998
-------------------
Raw materials $1,692 $ 4,686
Work-in-process 1,240 2,312
Finished goods 4,337 7,994
-------------------
$7,269 $14,992
===================
NOTE D--PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows:
1997 1998 Estimated
Useful lives
---------------------------------------
Machinery and equipment $ 16,802 $ 41,681 3-10 years
Office furniture and equipment 1,333 2,222 3- 7 years
Leasehold improvements 2,285 2,556 15-20 years
Building and building improvements 3,055 6,161 30 years
Land 695 1,646 --
Construction in progress 755 943 --
-----------------------
24,925 55,209
Less accumulated depreciation and amortization (10,167) (13,128)
-----------------------
$ 14,758 $ 42,081
=======================
Included in machinery and equipment is $757 and $7,157 of equipment under
capital lease at December 31, 1997 and 1998, respectively. Accumulated
amortization of assets under capital lease totaled $185 and $653 at December 31,
1997 and 1998, respectively. See Note H.
F-13
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE E-- ACCRUED EXPENSES
Accrued expenses consist of the following:
1997 1998
-----------------
Accrued vacation $ 477 $ 549
Other 314 1,988
-----------------
$ 791 $2,537
=================
NOTE F-- LONG-TERM DEBT
Long-term debt consists of the following:
1997 1998
------ -----
Senior revolving credit facility that provides
borrowings up to $25,000. The outstanding balance
bears interest, payable currently, at a variable rate
based on either the bank's base rate or the applicable
LIBOR rate, depending on the nature of the
borrowings. At December 31, 1998, the weighted
average interest rate on outstanding borrowings was
6%. The loan is collateralized by substantially all of
the Company's assets. The entire principal is payable $ - $16,361
on April 30, 2003.
Note payable to financial institution payable in
monthly principal and interest installments of $30
with the unpaid principal and interest due on
November 1, 2008. The note bears interest at 6.85%
and is collateralized by certain land and buildings. - 4,289
Note payable issued to an individual in connection
with the acquisition of RMS Electronics, Inc. (Note
J). 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 of 5.75% at December 31, 1997 and
1998) and is payable quarterly. 400 400
F-14
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE F-- LONG-TERM DEBT--Continued
1997 1998
------ -------
Egerton credit facility $ - $ 8,667
----- -------
400 29,717
Less current maturities - (8,862)
----- -------
$ 400 $20,855
===== =======
The senior revolving credit facility contains various financial and operating
covenants which, among other things, imposes limitations on the company's
ability to incur additional indebtedness, merge or consolidate, sell assets
except in the ordinary course of business, make certain investments, enter into
leases and pay dividends. The Company is also required to comply with covenants
related to minimum net worth and other financial ratios.
The Company also has a credit facility available to the Egerton subsidiaries
that includes an overdraft facility totaling approximately $5,000 plus the
combined cash balances of those subsidiaries, which were approximately $4,200 at
December 31, 1998. Also included are facilities, totaling approximately $2,000,
to provide financing for international letters of credit, forward exchange
contracts, and other items. Outstanding borrowings (net of cash balances) bear
interest at the bank's base rate (6.25% at December 31, 1998) plus a factor
ranging from 1.25% to a maximum of 4% depending on the amount borrowed. The
facility is collateralized by the assets of the subsidiaries and is due for
renewal in August, 1999.
Long-term debt at December 31, 1998 matures as follows:
Year Amount
-------- ----------
1999 $ 8,862
2000 205
2001 212
2002 83
2003 16,450
Thereafter 3,905
-------
$29,717
=======
F-15
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE G--INCOME TAXES
The components of income taxes are as follows:
1996 1997 1998
---------------------------
Current
Federal $2,104 $4,275 $3,796
State 743 1,243 1,123
Foreign 392 543 344
---------------------------
3,239 6,061 5,263
---------------------------
Deferred
Federal (669) (416) 357
State (211) 14 78
Foreign -- (70) 51
---------------------------
(880) (472) 486
---------------------------
$2,359 $5,589 $5,749
===========================
A reconciliation from the U.S. Federal statutory income tax rate to the
effective income tax rate for the year ended December 31, is as follows:
1997 1998
--------------
U.S. Federal statutory rate 34% 34%
State income taxes, net of federal tax benefit 6 6
Amortization of intangibles - 1
-------------
40% 41%
=============
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.
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).
F-16
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE G--INCOME TAXES--Continued
Significant components of the Company's deferred tax assets and liabilities are
as follows:
1997 1998
-------------------
Assets
Patents $1,162 $1,051
Allowance for bad debts 41 33
Inventory capitalization 146 125
Vacation pay 187 235
State taxes 314 237
Net operating loss carryforward-foreign operations 70 -
-------------------
1,920 1,681
-------------------
Liabilities
Accelerated depreciation 568 1,336
-------------------
568 1,336
-------------------
Net deferred tax asset $1,352 $ 345
===================
The classification of the net deferred tax asset (liability) between current and
non-current is as follows:
1997 1998
-----------------
Net current asset $ 688 $ 630
Net non-current (liability) asset 664 (285)
-----------------
Net deferred tax asset $1,352 $ 345
=================
F-17
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE H--CAPITAL LEASE OBLIGATIONS
The Company leases certain machinery and equipment under various agreements,
which are classified as capital leases. The leases expire on various dates
through August 2003. Future minimum payments, by year, are as follows:
1999 $ 2,410
2000 1,978
2001 1,318
2002 791
2003 628
-------
7,125
Less amount representing interest 931
-------
6,194
Less current maturities 2009
-------
$4,185
=======
NOTE I--STOCKHOLDERS' EQUITY
In 1996, 3,100 shares of the Company's common stock were sold in a public
offering resulting in proceeds of $30,565, net of issuance expenses. A portion
of the proceeds 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.
The Company had been an S Corporation for both federal and state tax income tax
purposes since 1990. As discussed in Note G, 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-18
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE I--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 cost has not been
significant.
Plan transactions are as follows:
1996 1997 1998
----------------- ------------------- ------------------
Weighted Weighted Weighted
average Average average
exercise Exercise exercise
Shares price Shares Price Shares price
------ ----- ------ ------ ------ ---------
Options outstanding
January 1, -- -- 513 $11.00 636 $11.49
Granted 513 $11.00 165 12.91 114 9.83
Exercised -- -- -- -- -- --
Canceled -- -- (42) 11.00 (47) 11.33
----- ----- ----
Options outstanding
December 31, 513 $11.00 636 $11.49 703 $11.22
===== ==== =====
Options available for
grant at December 31, 237 114 47
Weighted average fair value of options granted during the year are as follows:
1996 1997 1998
-------- ------ ------
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 $3.93
The range of exercise prices of options outstanding at December 31, 1998 is
$8.81 to $13.25 and the options have a weighted average remaining contractual
life of 8 years. At December 31, 1998, 356 of the 703 options outstanding are
exercisable by the optionee.
F-19
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE I--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 1998
--------------------------------
Expected life (years) 5 years 5 years 5 years
Risk-free interest rate 5.5% 6.25% 5.5%
Expected volatility 50% 40% 35%
Expected 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 net
income and income per share would have been:
Net income per share
Net -----------------------
income Basic Diluted
------------------------------------------
1997
As reported $8,470 $.92 $.91
Pro forma 7,812 .84 .83
Net income per share
Net -----------------------
income Basic Diluted
------------------------------------------
1998
As reported $8,109 $.88 $.88
Pro forma 7,286 $.79 $.79
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.
F-20
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE J--ACQUISITIONS
During 1997 and 1998, 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 consisted of $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
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 fifteen years.
Other intangible assets acquired in connection with the acquisition totaled $100
and are being amortized over three years.
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 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. Contingent consideration has not been
reflected as a liability as of December 31, 1997 or 1998. 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 fifteen years.
The fair value of tangible assets acquired and liabilities assumed of RMS and
Standby was $3,188 and $1,800, respectively.
A.C. Egerton (Holdings) PLC--On May 1, 1998, the Company acquired 100% of the
outstanding common stock of A.C. Egerton (Holdings) PLC ("Egerton"), a public
limited company incorporated in England and Wales. Egerton is a manufacturer of
outside plant splicing and terminating products for both optical fiber and
copper applications used in the telecommunications industry. The purchase
price, paid in cash, amounted to $27,900, including $1,325 of acquisition costs.
The fair value of tangible assets acquired in excess of liabilities assumed
amounted to $13,847, which resulted in goodwill in the amount of $14,053. The
final appraisal of the property and equipment acquired was completed in the
fourth quarter of 1998, resulting in adjustments to Egerton's property and
equipment and goodwill and the related depreciation and amortization. The
effect of recording these adjustments was to increase net income for the fourth
quarter of 1998 by $435 ($.05 per share). Goodwill is being amortized on the
straight-line basis over twenty years.
F-21
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE J--ACQUISITIONS--Continued
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 of
RMS and Standby had occurred January 1, 1996 and the acquisition of Egerton had
occurred January 1, 1997.
1996 1997 1998
-------- ------- --------
Net sales $56,020 $94,088 $101,798
Net income 9,113 7,786 6,798
Income per share (basic and diluted) $ 1.08 $ .84 $ .74
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 of RMS and
Standby been effective January 1, 1996 and the acquisition of Egerton been
effective January 1, 1997, or of future results of operations of the
consolidated entities.
NOTE K--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 ninety 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 $200, $40 and $174 which have been
incurred for the plans for the years ended December 31, 1996, 1997 and 1998,
respectively.
F-22
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE L--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 $531 for the year ended December 31, 1996. 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 a portion of 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 paid to Mr.
Channell, Sr. was $755, $1,081 and $1,103 for the years ended December 31, 1996,
1997 and 1998, respectively.
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 collateralized by said facilities. The
loan amount subject to the guarantee 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.
F-23
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE M--COMMITMENTS
The Company leases equipment and manufacturing and office space under several
operating leases expiring through 2005. Rent expense under all operating leases
amounted to $775, $1,081 and $1,777 for the years ended December 31, 1996, 1997
and 1998, respectively. Total future minimum rental payments under
noncancellable operating leases as of December 31, 1998, including the operating
lease with Mr. Channell, Sr. discussed in Note L, are as follows:
Year Amount
---------- ---------
1999 $1,628
2000 1,517
2001 1,292
2002 1,266
2003 1,232
Thereafter 2,486
------
$9,421
========
In addition to these minimum rental commitments, certain of these operating
leases provide for payments of insurance, repairs and maintenance and property
taxes.
NOTE N--CREDIT CONCENTRATIONS AND MAJOR CUSTOMERS
The Company maintains cash balances in financial institutions located in the
United States, Canada, Australia and the United Kingdom. At December 31, 1997
and 1998, the amount of cash balances held in financial institutions outside of
the United States were $498 and $4,621, respectively. Cash balances held in
financial institutions located in the United States may, at times, 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 1998, one customer accounted for 12.5% of sales and a second customer
accounted for 11.7% of sales. In 1997, one customer accounted for 15.1% of sales
and a second customer made up 10.0% of sales. In 1996, a different customer
accounted for 17.3% of sales. Also in 1996, a second customer accounted for
14.9% of sales. 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 but does not generally
require collateral.
F-24
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE O--SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in one industry segment as a manufacturer and supplier of
telecommunications equipment. In 1996, foreign operations were not significant.
Currently, the Company is organized into four geographic regions: the United
States, Europe/Middle East, Canada and Australia/Asia. The following tables
summarize segment information, for 1997 and 1998:
1997 1998
-------- -------
Revenues from unrelated entities/(1)/:
United States/(2)/ $51,299 $65,314
Europe/Middle East 3,057 16,230
Canada 5,587 5,136
Australia/Asia - 6,030
------- -------
$59,943 $92,710
=================
Income from operations:
United States $12,074 $13,616
Europe/Middle East 51 408
Canada 1,055 80
Australia/Asia - 830
------- -------
$13,180 $14,934
=================
Interest income:
United States $ 1,006 $ 261
Europe/Middle East - 5
Canada - -
Australia/Asia - -
------- -------
$ 1,006 $ 266
=================
Interest expense:
United States $ 97 $ 875
Europe/Middle East 30 462
Canada - -
Australia/Asia - 5
------- -------
$ 127 $ 1,342
=================
/(1)/Inter-geographic revenues were not significant.
/(2)/Includes export sales of approximately $2,300 and $1,700 in 1997 and
1998, respectively.
F-25
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE O--SEGMENT AND GEOGRAPHIC INFORMATION--Continued
1997 1998
------- -------
Income tax expense (benefit):
United States $ 5,116 $ 5,354
Europe/Middle East - (99)
Canada 473 44
Australia/Asia - 450
------- -------
$ 5,589 $ 5,749
=================
Identifiable assets:
United States $45,866 $50,992
Europe/Middle East 1,807 32,464
Canada 2,952 2,577
Australia/Asia - 12,409
------- -------
$50,625 $98,442
=================
Depreciation and
amortization expense:
United States $ 1,994 $ 2,560
Europe/Middle East 22 1,029
Canada 28 78
Australia/Asia - 393
------- -------
$ 2,044 $ 4,060
=================
Capital expenditures:
United States/(3)/ $ 5,785 $ 9,513
Europe/Middle East 50 684
Canada 131 90
Australia/Asia - 292
------- -------
$ 5,966 $10,579
=================
/(3)/Excludes assets acquired under capital leases of $214 and $6,248 in
1997 and 1998, respectively.
F-26
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 1996, 1997 and 1998
(amounts in thousands, except per share data)
NOTE P--QUARTERLY FINANCIAL DATA (Unaudited)
Summarized quarterly financial data for 1997 and 1998 follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------
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
1998
Net sales 15,704 23,108 27,159 26,739
Gross profit 6,414 9,621 10,609 9,488
Net income 1,547 2,293 2,335 1,934
Income per share
(basic and diluted) .17 .25 .25 .21
NOTE Q--NEW ACCOUNTING PRONOUNCEMENT
In 1998, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133 ("SFAS 133)", Accounting for Derivative Instruments
and Hedging Activities, which is effective for 2000. SFAS 133 will require the
Company to record all derivatives on the balance sheet at fair value. For
derivatives that are hedges, changes in the fair value of derivatives will be
offset by the changes in the fair value of the hedged assets, liabilities or
firm commitments. The Company believes the impact of adopting this standard will
not be material to results of operations or equity.
F-27
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.
DSL (Digital Subscriber Line): Generic descriptor covering various versions
of DSL services delivered over copper wires. Included are HDSL and ADSL
services.
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 Communication 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.
G-1
SIGNATURE
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 29, 1999.
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 29, 1999.
Signature Capacity in Which Signed
--------- ------------------------
/s/ William H. Channell, Sr. Chairman of the Board and
- ---------------------------- Chief Executive Officer
William H. Channell, Sr. (Principal Executive Officer)
/s/ William H. Channell, Jr. President, Chief Operating Officer
- ---------------------------- and Director
William H. Channell, Jr.
/s/ Gary W. Baker Vice President, Finance and
- ---------------------------- Chief Financial Officer
Gary W. Baker
/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