UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended September 30, 2003 |
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OR |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to |
Commission File No. 0-28582
CHANNELL COMMERCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
95-2453261
(I.R.S. Employer Identification No.)
26040 Ynez Road, Temecula, California
(Address of principal executive offices)
92591
(Zip Code)
(909) 719-2600
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o No ý
9,127,661 shares of common stock of the Registrant were outstanding at November 4, 2003.
PART 1 – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(amounts in thousands, except per share data)
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Nine months ended |
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Three months ended |
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2003 |
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2002 |
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2003 |
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2002 |
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Net sales |
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$ |
55,937 |
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$ |
65,065 |
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$ |
19,434 |
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$ |
19,401 |
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Cost of goods sold |
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39,491 |
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43,160 |
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13,919 |
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13,966 |
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Gross profit |
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16,446 |
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21,905 |
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5,515 |
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5,435 |
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Operating expenses |
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Selling |
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6,994 |
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6,973 |
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2,347 |
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2,012 |
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General and administrative |
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5,776 |
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8,799 |
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2,048 |
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2,144 |
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Research and development |
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1,193 |
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1,215 |
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408 |
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377 |
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13,963 |
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16,987 |
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4,803 |
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4,533 |
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Income from operations |
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2,483 |
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4,918 |
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712 |
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902 |
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Interest expense, net |
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438 |
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1,812 |
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178 |
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491 |
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Income before income taxes |
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2,045 |
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3,106 |
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534 |
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411 |
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Income taxes |
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730 |
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1,640 |
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(1 |
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261 |
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Net income |
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$ |
1,315 |
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$ |
1,466 |
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$ |
535 |
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$ |
150 |
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Net income per share |
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Basic |
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$ |
0.14 |
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$ |
0.16 |
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$ |
0.06 |
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$ |
0.02 |
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Diluted |
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$ |
0.14 |
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$ |
0.16 |
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$ |
0.06 |
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$ |
0.02 |
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Net income |
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$ |
1,315 |
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$ |
1,466 |
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$ |
535 |
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$ |
150 |
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Other comprehensive
income, net of tax |
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1,281 |
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635 |
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79 |
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20 |
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Comprehensive net income |
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$ |
2,596 |
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$ |
2,101 |
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$ |
614 |
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$ |
170 |
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The accompanying notes are an integral part of these financial statements.
1
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
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September 30, |
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December 31, |
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(Unaudited) |
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ASSETS |
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Current assets |
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Cash and cash equivalents |
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$ |
7,285 |
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$ |
3,162 |
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Accounts receivable, net |
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10,174 |
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10,156 |
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Inventories |
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8,959 |
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7,757 |
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Deferred income taxes |
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1,037 |
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1,037 |
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Prepaid expenses and misc. receivables |
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1,478 |
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1,090 |
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Income taxes receivable |
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248 |
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247 |
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Total current assets |
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29,181 |
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23,449 |
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Property and equipment at cost, net |
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19,271 |
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25,431 |
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Deferred income taxes |
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4,467 |
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4,367 |
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Intangible assets, net |
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504 |
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504 |
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Other assets |
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484 |
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412 |
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$ |
53,907 |
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$ |
54,163 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current liabilities |
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Accounts payable |
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$ |
5,211 |
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$ |
5,820 |
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Short term debt (including current maturities of long term debt) |
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952 |
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952 |
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Current maturities of capital lease obligations |
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87 |
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694 |
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Accrued restructuring liability |
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1,320 |
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2,155 |
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Accrued expenses |
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4,663 |
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3,625 |
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Total current liabilities |
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12,233 |
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13,246 |
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Long term debt, less current maturities |
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3,067 |
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4,877 |
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Capital lease obligations, less current maturities |
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31 |
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25 |
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Deferred gain on sale leaseback transaction |
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529 |
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574 |
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Commitments and contingencies |
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— |
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— |
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Stockholders’ equity |
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Preferred stock, par value $.01 per share, authorized - 1,000 shares, none issued and outstanding |
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— |
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— |
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Common stock, par value $.01 per share, authorized - 19,000 shares; issued - 9,369 shares in December 31, 2002 and 9,372 in September 30, 2003; outstanding - 9,125 shares in December 31, 2002 and 9,128 in September 30, 2003 |
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94 |
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94 |
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Additional paid-in capital |
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28,664 |
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28,655 |
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Treasury stock - 244 shares in 2002 and 2003 |
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(1,871 |
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(1,871 |
) |
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Retained earnings |
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11,872 |
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10,556 |
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Accumulated other comprehensive loss - Foreign currency translation |
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(712 |
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(1,993 |
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Total stockholders’ equity |
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38,047 |
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35,441 |
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Total liabilities and stockholders’ equity |
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$ |
53,907 |
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$ |
54,163 |
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The accompanying notes are an integral part of these financial statements.
2
CHANNELL COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(amounts in thousands)
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Nine months ended |
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2003 |
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2002 |
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Cash flows from operating activities: |
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Net income |
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$ |
1,315 |
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$ |
1,466 |
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Depreciation and amortization |
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4,785 |
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5,405 |
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Deferred income taxes |
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(100 |
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670 |
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Loss on disposal of fixed assets |
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62 |
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168 |
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Foreign currency transaction gain |
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16 |
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— |
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Change in assets and liabilities: |
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(Increase) decrease in assets: |
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Accounts receivable |
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374 |
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3,113 |
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Inventories |
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(859 |
) |
2,522 |
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Prepaid expenses |
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(160 |
) |
36 |
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Other |
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(70 |
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24 |
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Income taxes receivable |
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(71 |
) |
5,076 |
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Increase (decrease) in liabilities: |
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Accounts payable |
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(789 |
) |
414 |
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Accrued expenses |
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1,003 |
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385 |
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Restructuring liability |
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(899 |
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(1,359 |
) |
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Income taxes payable |
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— |
|
479 |
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Net cash provided by operating activities |
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4,607 |
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18,399 |
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Cash flows from investing activities: |
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Acquisition of property and equipment |
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(915 |
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(1,420 |
) |
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Proceeds from the sales of property and equipment |
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2,320 |
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6,614 |
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Net cash provided by investing activities |
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1,405 |
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5,194 |
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Cash flows from financing activities: |
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Repayment of debt |
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(1,809 |
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(27,795 |
) |
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Repayment of obligations under capital lease |
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(614 |
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(1,716 |
) |
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Exercise of stock options |
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9 |
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— |
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Net cash used in financing activities |
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(2,414 |
) |
(29,511 |
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Effect of exchange rates on cash |
|
525 |
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66 |
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Increase (decrease) in cash and cash equivalents |
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4,123 |
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(5,852 |
) |
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Cash and cash equivalents, beginning of period |
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3,162 |
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8,762 |
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Cash and cash equivalents, end of period |
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$ |
7,285 |
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$ |
2,910 |
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Cash paid during the period for: |
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Interest |
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$ |
239 |
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$ |
1,512 |
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Income taxes |
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$ |
757 |
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$ |
832 |
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The accompanying notes are an integral part of these financial statements.
3
CHANNELL COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2003 and 2002
(amounts in thousands, except per share data)
1. Unaudited financial statements: In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the consolidated financial position of Channell Commercial Corporation (the “Company”) as of September 30, 2003 and the results of its operations for the three months and nine months ended September 30, 2003 and September 30, 2002 and its cash flows for the nine months ended September 30, 2003 and September 30, 2002. The results of operations and cash flows for the nine months ended September 30, 2003, are not necessarily indicative of the results to be expected for any other interim period or the full year. These consolidated financial statements should be read in combination with the audited consolidated financial statements and notes thereto for the year ended December 31, 2002.
2. Inventories: Inventories stated at the lower of cost (first-in, first-out method) or market are summarized as follows:
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September 30, |
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December 31, |
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Raw Materials |
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$ |
3,327 |
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$ |
3,324 |
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Work-in-Process |
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2,595 |
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2,374 |
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Finished Goods |
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3,037 |
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2,059 |
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$ |
8,959 |
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$ |
7,757 |
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3. 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 nine month period and three month period ended September 30, 2003 and 2002. Diluted income per share reflects the potential dilution that could occur if dilutive 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 for the nine month and three month periods ended September 30, 2003 and 2002 (shares in thousands):
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Nine months ended September 30, |
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2003 |
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2002 |
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Shares |
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Per |
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Shares |
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Per |
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Basic income per share |
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9,126 |
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$ |
0.14 |
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9,026 |
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$ |
0.16 |
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Effect of dilutive stock options |
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38 |
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— |
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49 |
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— |
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Diluted income per share |
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9,164 |
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$ |
0.14 |
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9,075 |
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$ |
0.16 |
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The following options were not included in the computation of diluted income per share due to their antidilutive effect.
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September 30, |
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September 30, |
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Options to purchase shares of common stock |
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101 |
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866 |
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Exercise prices |
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$6.50- $13.75 |
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$6.50- $13.75 |
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Expiration dates |
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July 2006 - |
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July 2006 - |
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4
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Three months ended September 30, |
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2003 |
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2002 |
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Shares |
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Per |
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Shares |
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Per |
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Basic income per share |
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9,127 |
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$ |
0.06 |
|
9,026 |
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$ |
0.02 |
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Effect of dilutive stock options |
|
88 |
|
— |
|
11 |
|
— |
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Diluted income per share |
|
9,215 |
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$ |
0.06 |
|
9,037 |
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$ |
0.02 |
|
The following options were not included in the computation of diluted income per share due to their antidilutive effect.
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September 30, |
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September 30, |
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|
|
|
|
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Options to purchase shares of common stock |
|
101 |
|
866 |
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Exercise prices |
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$6.50- $13.75 |
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$6.50 - $13.75 |
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Expiration dates |
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July 2006 - |
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July 2006 - |
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May 2012 |
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May 2012 |
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In February 2003, the Company offered current employees and non-employee directors an opportunity to exchange their outstanding options granted under the 1996 Stock Plan. The tender offer expired on March 20, 2003. Pursuant to the offer, a total of 1,326,890 options were cancelled on March 20, 2003. On September 24, 2003, a total of 1,324,090 new options were exchanged for options cancelled in March 2003.
4. Stock Based Compensation: 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.
In February 2003, the Company offered current employees and non-employee directors an opportunity to exchange their outstanding options granted under the 1996 Stock Plan. The tender offer expired on March 20, 2003. Pursuant to the offer, a total of 1,326,890 options were cancelled on March 20, 2003. On September 24, 2003, a total of 1,324,090 new options were exchanged for those cancelled in March 2003. Eligible option holders who participated in the “Offer to Exchange” were granted a new option for each old cancelled option. For each new option granted, the vesting status and vesting schedule of the old option was preserved. The weighted average fair value of the options issued in September 2003 was $1.91. The weighted average exercise price was $4.84.
In accordance with the guidance of SFAS No. 148, the compensation on a proforma basis is recognized for each of the new options granted under the “Offer to Exchange” that is either fully or partially vested as of the end of the quarter ending September 30, 2003. Due to the preservation of the vesting status and vesting schedule of the old options, the cumulative proforma effect of these new options is significant in this quarter.
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:
5
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Nine Months Ended September 30, |
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||||
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2003 |
|
2002 |
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|
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|
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Reported net income (in thousands) |
|
$ |
1,315 |
|
$ |
1,466 |
|
|
Proforma net income (in thousands) |
|
$ |
425 |
|
$ |
1,253 |
|
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|
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|
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Reported basic net income per share |
|
$ |
0.14 |
|
$ |
0.16 |
|
|
Proforma basic net income per share |
|
$ |
0.05 |
|
$ |
0.14 |
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Reported diluted net income per share |
|
$ |
0.14 |
|
$ |
0.16 |
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Proforma diluted net income per share |
|
$ |
0.05 |
|
$ |
0.14 |
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Three Months Ended September 30, |
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|
|
2003 |
|
2002 |
|
||
|
|
|
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|
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|
||
|
Reported net income (in thousands) |
|
$ |
535 |
|
$ |
150 |
|
|
Proforma net income (loss) (in thousands) |
|
$ |
(303 |
) |
$ |
25 |
|
|
|
|
|
|
|
|
||
|
Reported basic net income per share |
|
$ |
0.06 |
|
$ |
0.02 |
|
|
Proforma basic net income (loss) per share |
|
$ |
(0.03 |
) |
$ |
0.00 |
|
|
|
|
|
|
|
|
||
|
Reported diluted net income per share |
|
$ |
0.06 |
|
$ |
0.02 |
|
|
Proforma diluted net income (loss) per share |
|
$ |
(0.03 |
) |
$ |
0.00 |
|
The fair value of options at date of grant was estimated using the Black-Scholes model with the following weighted average assumptions:
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|
Nine Months and |
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|
|
2003 |
|
2002 |
|
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|
|
|
|
Expected life (years) |
|
5 years |
|
5 years |
|
|
Risk-free interest rate |
|
3.0 |
% |
3.0 |
% |
|
Expected volatility |
|
40 |
% |
40 |
% |
|
Expected dividend yield |
|
— |
|
— |
|
5. Segments: The Company’s predominant business is the manufacturing and distribution of telecommunications equipment. As a result of rationalizing and streamlining international operations, the Company changed its segment reporting in the first quarter of 2003. There are now two segments: Americas and International. Americas includes the United States, Central and South America and Canada. International includes Europe, Africa, Middle East, Australia and Asia. Some of the previous reporting segments have been combined due to their reduced size as a result of the general downturn in the telecommunications industry, the rationalization of various product lines within the former segments and changes in the management structure of the Company. The new reporting segments reflect the current management structure and the reporting used internally by executive management. The following tables summarize segment information for the nine months and three months ended September 30, 2003 and 2002 (in thousands):
6
|
|
|
Nine Months Ended |
|
||||
|
|
|
2003 |
|
2002 |
|
||
|
Revenues from unrelated entities (1): |
|
|
|
|
|
||
|
Americas |
|
$ |
47,218 |
|
$ |
53,381 |
|
|
International |
|
8,719 |
|
11,684 |
|
||
|
|
|
$ |
55,937 |
|
$ |
65,065 |
|
|
Income (loss) from operations: |
|
|
|
|
|
||
|
Americas |
|
$ |
3,679 |
|
$ |
6,081 |
|
|
International |
|
(1,196 |
) |
(1,163 |
) |
||
|
|
|
$ |
2,483 |
|
$ |
4,918 |
|
|
Interest expense, net: |
|
|
|
|
|
||
|
Americas |
|
$ |
75 |
|
$ |
1,488 |
|
|
International |
|
363 |
|
324 |
|
||
|
|
|
$ |
438 |
|
$ |
1,812 |
|
|
|
|
Three
Months Ended |
|
||||
|
|
|
2003 |
|
2002 |
|
||
|
Revenues from unrelated entities (1): |
|
|
|
|
|
||
|
Americas |
|
$ |
16,762 |
|
$ |
15,272 |
|
|
International |
|
2,672 |
|
4,129 |
|
||
|
|
|
$ |
19,434 |
|
$ |
19,401 |
|
|
Income (loss) from operations: |
|
|
|
|
|
||
|
Americas |
|
$ |
1,189 |
|
$ |
1,082 |
|
|
International |
|
(477 |
) |
(180 |
) |
||
|
|
|
$ |
712 |
|
$ |
902 |
|
|
Interest expense, net: |
|
|
|
|
|
||
|
Americas |
|
$ |
60 |
|
$ |
394 |
|
|
International |
|
118 |
|
97 |
|
||
|
|
|
$ |
178 |
|
$ |
491 |
|
(1) Note: Revenues from any individual foreign country did not exceed 10% of total revenues for the period.
The Company has revenues from external customers from the following product lines:
|
|
|
Nine Months Ended September 30, |
|
||||
|
|
|
2003 |
|
2002 |
|
||
|
|
|
|
|
|
|
||
|
Enclosures |
|
$ |
43,871 |
|
$ |
50,524 |
|
|
Connectivity |
|
5,887 |
|
8,981 |
|
||
|
Other |
|
6,179 |
|
5,560 |
|
||
|
|
|
$ |
55,937 |
|
$ |
65,065 |
|
|
|
|
Three Months Ended September 30, |
|
||||
|
|
|
2003 |
|
2002 |
|
||
|
|
|
|
|
|
|
||
|
Enclosures |
|
$ |
15,009 |
|
$ |
14,836 |
|
|
Connectivity |
|
2,265 |
|
2,670 |
|
||
|
Other |
|
2,160 |
|
1,895 |
|
||
|
|
|
$ |
19,434 |
|
$ |
19,401 |
|
Included in the Connectivity revenues for the nine months ended September 30, 2002 are revenues from the RF product line of $1,956. The RF product line was sold in the second quarter of 2002 (See Note 11).
7
Included in the Connectivity revenues for the three months ended September 30, 2002 are revenues from the RF product line of $6.
The Company has identifiable assets in the following geographic regions:
|
|
|
September 30, |
|
December 31, |
|
||
|
|
|
2003 |
|
2002 |
|
||
|
|
|
(Unaudited) |
|
|
|
||
|
Identifiable Assets: |
|
|
|
|
|
||
|
Americas |
|
$ |
40,705 |
|
$ |
40,060 |
|
|
International |
|
13,202 |
|
14,103 |
|
||
|
|
|
$ |
53,907 |
|
$ |
54,163 |
|
6. Recent Accounting Pronouncements: In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is effective for the Company beginning July 1, 2003. The Company does not expect that provisions of SFAS No. 150 will have a material impact on the Company’s results of operations or financial position.
In January 2003, the FASB issued Interpretation “Consolidation of Variable Interest Entities - an interpretation of ARB No. 51” (“FIN 46”). FIN 46 requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. FIN 46 requires that its provisions are effective immediately for all arrangements entered into after January 31, 2003. For those arrangements entered into prior to January 31, 2003, the FIN 46 provisions are required to be adopted at the beginning of the first interim or annual period beginning after June 15, 2003. The Company does not expect that the provisions of FIN 46 will have a material impact on the Company’s results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS 123.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the estimate of the market value of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. The Company has adopted the annual disclosure provisions of SFAS No. 148 in its financial reports for the year ended December 31, 2002 and the interim disclosure provisions for its financial reports beginning with the quarter ended March 31, 2003. As the adoption of this standard involves disclosures only, SFAS No. 148 did not have a material impact on the results of operations, financial position or liquidity.
7. Restructuring Charge: In the fourth quarter of 2000, in connection with management’s plan to reduce costs and improve operating efficiencies, the Company recorded a restructuring charge of $1,513. The principal actions in the restructuring plan involved the closure of facilities and consolidation of support infrastructure. Most of the reductions occurred in the Company’s international operations.
In the third quarter of 2001, due to a continued slowdown in the telecommunications industry, the Company announced an additional restructuring plan in an effort to further reduce costs and align headcount and facilities with expected business levels in all regions. The additional restructuring charge totaled $2,999. The principal actions in the restructuring plan involved the closure of facilities and a reduction of headcount.
In the fourth quarter of 2002, the Company announced a restructuring plan to further rationalize international manufacturing operations. As part of the plan, various manufacturing operations previously performed in the U.K. were either transferred to Australia or outsourced. The management of Australia/Asia and Europe was
8
consolidated under the Managing Director, International. The restructuring charge totaled $1,228. The principal actions in the restructuring plan involved the closure of facilities and a reduction in head count.
The restructuring charges were determined based on formal plans approved by the Company’s management using the best information available to it at the time. The amounts the Company may ultimately incur could differ materially as the restructuring initiative is executed. The changes in the accrual for restructuring charges during 2003 are summarized in the table below:
|
|
|
Facilities |
|
Workforce |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Restructuring accrual balance at January 1, 2003 |
|
$ |
2,095 |
|
$ |
60 |
|
$ |
2,155 |
|
|
|
|
|
|
|
|
|
|
|||
|
Costs incurred in the nine months ended September 30, 2003 |
|
782 |
|
53 |
|
835 |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Restructuring accrual balance at September 30, 2003 |
|
$ |
1,313 |
|
$ |
7 |
|
$ |
1,320 |
|
8. Sale Leaseback Arrangement: In January 2003, the Company sold a facility located in Orpington Kent, United Kingdom. The proceeds from the sale totaled $2,441 and resulted in a pretax loss of $110 which is included in general and administrative expense in 2003. Terms of the sale included a provision for the Company to lease back the facility for one year at no charge. Included in the proceeds was prepaid rent for one year which totaled $213. The resulting lease is being accounted for as an operating lease.
In June, 2002, the Company entered into a sale and leaseback agreement for a warehouse facility located in Temecula, California. The proceeds from the sale totaled approximately $6,200 and resulted in a pretax deferred gain of $604. The resulting lease is being accounted for as an operating lease. The lease base term is ten years with two five-year options at rental amounts to be adjusted to the fair market rental value at the end of the base term. A portion of the proceeds from the sale was used to pay the outstanding mortgage balance on the facility of $4,036. As of September 30, 2003, the unamortized balance of the deferred gain is $529.
9. Income Taxes: The effective tax rate of 35.7% and (0.2%) for the nine month period and three month period ended September 30, 2003 differed from the statutory rate of 34.0% primarily due to state taxes and certain foreign operating losses incurred without a tax benefit recorded, offset by the benefit recognized from a research and development (“R&D”) tax credit. The Company analyzed its R&D activities for the years 2001, 2002, and 2003 and has changed its estimate of the R&D tax credit available to offset its federal income tax liability for the tax years 2001, 2002, and 2003. The change in the estimate had the effect of reducing income tax expense by approximately $322 in the three months ended September 30, 2003, equivalent to $.04 per basic and diluted share.
The Federal income taxes of the Company for the years ended December 31, 1997, 1998, 2000, and 2001 are currently under examination by the Internal Revenue Service (IRS). In July 2002, the IRS issued the proposed result of their examination for the years ended December 31, 1997 and 1998, which increases the 1997 income tax amount due by $315 related to transfer pricing for sales to the Company’s Canadian subsidiary. Management believes that the Company will prevail in its appeal of the proposed adjustment or that income re-allocated from Canada to the United States will result in a refund of Canadian income taxes which is substantially equal to the additional taxes due to the US.
10. Commitments and Contingencies: In 2001, the State of Texas issued a report assessing the Company additional sales and use tax of $1,600, including interest. The Company has appealed the assessment and is currently providing the State of Texas with documentation to support the Company’s contention that the transactions did not require the Company to remit sales and use tax to the State of Texas. The State of Texas has agreed to a reduction of the amount owed to $520. The Company has paid the State of Texas $400. The Company believes that it has meritorious defenses to the remaining claim of $120 and intends to vigorously defend its position. The Company believes that the ultimate outcome of this examination will not result in a material impact on the Company’s consolidated results of operations or financial position.
9
11. Related Party Transactions: In May 2002, the Company sold its RF line of passive electronic devices to RMS Communications, Inc., which is owned by Gary Napolitano, a former officer of the Company. A sale in the amount of $800 was recorded. RMS Communications, Inc. paid the Company $125 in cash at the time of sale, and the remaining $675 is payable in monthly installments through June 30, 2003, bearing interest at 7% per annum. The amount due from RMS Communications, Inc., included in accounts receivable at September 30, 2003 is $349. The account is currently in arrears. The Company has a security interest in the inventory and a personal guarantee from Mr. Napolitano and believes the amount will be paid in full.
12. Concentrations: Sales to Comcast of $14.8 million in the first nine months of 2003 represented 26.5% of Company sales in the period. Comcast acquired AT&T’s broadband business in the fourth quarter of 2002. Sales to Verizon of $6.1 million in the first nine months of 2003 represented 10.9% of Company sales.
Sales to AT&T of $13.8 million in the first nine months of 2002 represented 21.2% of Company sales for the period. Sales to Time Warner of $6.6 million the first nine months of 2002 represented 10.1% of Company sales.
10
|
ITEM 2. |
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Comparison of the Nine Months Ended September 30, 2003 with the Nine Months Ended September 30, 2002
Net Sales. Net sales in the first nine months of 2003 were $55.9 million, a decrease of $9.2 million or 14.0% compared to the first nine months of 2002. The decrease was in both the Americas and International segments.
Americas net sales were $47.2 million, a decrease of $6.2 million or 11.5%. In 2003, two major cable operators reduced purchases compared to the first nine months of 2002. One customer reduced purchases as a result of substantially completing its network upgrade program. The second customer reduced purchases due to deterioration in its financial condition and the need to reduce spending. These declines from cable customers were partially offset by a 22% increase in sales from the Company’s largest telephone customer, Verizon. In addition, the first nine months of 2002 had higher sales because one of the Company’s largest customers resumed capital spending in the second quarter of 2002 after nearly shutting down purchases in the previous nine months as part of a company wide program to minimize capital expenditures. The resumption of spending by this customer resulted in a significant increase in the Company’s sales in the first nine months of 2002. The Americas segment sold $1.5 million of slow moving inventory in the first nine months of 2002 as part of the Company’s debt reduction program which also contributed to the period over period sales decline. There were no material sales of slow moving inventory in the first nine months of 2003.
International net sales were $8.7 million, a decrease of $3.0 million or 25.4%. The decrease in International sales was primarily in European markets and was due to generally depressed industry conditions and lower sales of products subsequently discontinued as part of the Company’s restructuring program.
Sales to Comcast of $14.8 million in the first nine months of 2003 represented 26.5% of Company sales in the period. Comcast acquired AT&T’s broadband business in the fourth quarter of 2002 thereby increasing its purchases from the Company. The second largest customer in the first nine months of 2003 was Verizon with sales of $6.1 million representing 10.9% of the total. Sales to AT&T of $13.8 million in the first nine months of 2002 represented 21.2% of Company sales for the period. Combined AT&T/Comcast sales for the 2002 period were $16.6 million for 25.4%. Sales to Time Warner of $6.6 million the first nine months of 2002 represented 10.1% of Company sales.
Gross Profit. Gross profit in the first nine months of 2003 was $16.4 million, a decrease of $5.5 million or 24.9%. The decrease is mainly due to the lower sales volume, which resulted in lower manufacturing production rates and higher unabsorbed overhead. A secondary factor was product mix, predominately in the Americas. The change in product mix was due to: 1) a higher percentage of products purchased externally for resale that the Company sells as a package with core product lines which have lower gross profits than enclosures that are manufactured internally and 2) a higher percentage of connectivity products that had a lower gross profit than thermoplastic enclosures. The gross profit of connectivity products was affected by sales of new products whose manufacture is in the start up phase and thus current product costs are higher than those anticipated during full scale production. The unfavorable product mix was partially offset by the absence of sales of slow moving inventory in the first nine months of 2003.
As a percentage of net sales, gross profit decreased from 33.7% in the first nine months of 2002 to 29.4% in the first nine months of 2003. The reasons for the decrease are the same as those noted above for gross profit dollars.
General and Administrative. General and administrative expenses were $5.8 million in the first nine months of 2003, a decrease of $3.0 million or 34.4%. The first nine months of 2002 included a $2.0 million charge to increase the allowance for bad debt primarily as a result of the Chapter 11 bankruptcy filing of Adelphia. Excluding the charge, general and administrative expense decreased by $1.0 million or 15.0%. The decrease is due to cost reductions in administrative functions primarily within the Americas operations. As a percentage of net sales, general and administrative expenses decreased from 13.5% in the 2002 period to 10.3% in the 2003 period. Excluding the charge for bad debt, general and administrative expenses were 10.4% in the 2002 period and 10.3% in the 2003 period.
11
Research and Development. Research and development expenses of $1.2 million in the first nine months of 2003 were unchanged from the first nine months of 2002. As a percentage of net sales, research and development expenses increased from 1.9% in the first nine months of 2002 to 2.1% in the first nine months of 2003.
Income from Operations. Income from operations decreased from $4.9 million in the first nine months of 2002 to $2.5 million in the first nine months of 2003, a decrease of $2.4 million or 49.5%. The decline is primarily attributable to the lower level of net sales. Income from operations as a percentage of sales decreased from 7.6% to 4.4%.
Interest Expense, Net. Net interest expense in the first nine months of 2003 was $0.4 million, a decrease of $1.4 million or 75.8% from the first nine months of 2002. The decrease was primarily attributable to a lower debt level at more favorable interest rates.
Income Taxes. Income tax expense was $0.7 million in the first nine months of 2003 compared to $1.6 million in the first nine months of 2002. The effective income tax rate of 35.7% in the first nine months of 2003 compares to 52.8% in the same period of 2002. The decline in tax rate is the result of a change in estimate of the research and development tax credit available to offset the federal income tax liability for fiscal 2001, 2002 and the nine months ended September 30, 2003. The change in estimate reduced income tax expense for the nine month period ended September 30, 2003 by $322.
Comparison of the Three Months Ended September 30, 2003 with the Three Months Ended September 30, 2002
Net Sales. Net sales in the third quarter of 2003 were $19.4 million, unchanged from the third quarter of 2002.
Americas sales were $16.8 million, an increase of $1.5 million or 9.8%. The increase is due to higher sales of connectivity products to OEM customers and the resumption of purchases by Adelphia. Adelphia had reduced purchases in 2002 after filing for Chapter 11 bankruptcy.
International net sales were $2.6 million, a decrease of $1.5 million or 35.3%. The decrease in International sales was due primarily to generally depressed industry conditions.
Sales to Comcast of $5.0 million in the third quarter of 2003 represented 25.7% of Company sales in the period. Comcast acquired AT&T’s broadband business in the fourth quarter of 2002 thereby increasing its purchases from the Company. The second largest customer in the third quarter of was Verizon with sales of $2.0 million representing 10.4% of the Company’s sales. Sales to AT&T of $4.7 million in the third quarter of 2002 represented 24.2% of Company sales. Combined AT&T/Comcast sales in the third quarter of 2002 were $5.4 million or 28.1% of Company sales.
Gross Profit. Gross profit in the third quarter of 2003 was $5.5 million, an increase of $0.1 million or 1.5%. The increase is due to slightly higher gross profit in the Americas segment as a result of the increased sales noted above.
As a percentage of net sales, gross profit increased from 28.0% in the third quarter of 2002 to 28.4% in the third quarter of 2003 due to the improvement in gross profit in the Americas.
General and Administrative. General and administrative expenses were $2.0 million in the third quarter of 2003 compared to $2.1 million for the third quarter of 2002. As a percentage of net sales, general and administrative expenses reduced from 11.1% in the 2002 period to 10.5% in the 2003 period.
Research and Development. Research and development expenses of $0.4 million in the third quarter of 2003 were unchanged from the third quarter of 2002. As a percentage of net sales, research and development expenses increased from 1.9% to 2.1% quarter over quarter.
Income from Operations. Income from operations decreased from $0.9 million in the third quarter of 2002 to $0.7 million in the current quarter, a decrease of $0.2 million or 21.1%. The decline is primarily attributable to the higher selling expenses caused by increased freight costs for shipping.
12
Interest Expense, Net. Net interest expense in the third quarter of 2003 was $0.2 million, a decrease of $0.3 million or 63.7% from the third quarter of 2002. The decrease was primarily attributable to a lower debt level at more favorable interest rates.
Income Taxes. Income tax expense was ($0.001) million in the third quarter of 2003 compared to $0.3 million in the third quarter of 2002. The effective income tax rate of (0.2%) in the third quarter of 2003 compares to 63.4% in the same period of 2002. The decline in tax rate is the result of a change in estimate of the research and development tax credit available to offset the federal income tax liability for fiscal 2001, 2002 and the three months ended September 30, 2003. The change in estimate reduced income tax expense for the three month period ended September 30, 2003 by $322.
Liquidity and Capital Resources
Net cash provided by operating activities was $4.6 million for the nine months ended September 30, 2003, a decrease of $13.8 million compared to the same period of last year. The decrease in net cash provided by operating activities is due primarily to an income tax refund of $5.1 million and working capital reductions in accounts receivable that provided $3.1 million of cash and inventory that provided $2.5 million in cash in the first nine months of 2002 compared to no tax refund, a reduction in accounts receivable that provided $0.4 million of cash offset by an increase in inventory that used $0.9 million in cash in the first nine months of 2003. The higher level of cash provided by operating activities in 2002 was primarily the result of actions taken as part of the Company’s restructuring and debt reduction program intended to generate cash.
Net accounts receivable remained constant at $10.2 million at December 31, 2002 and September 30, 2003. Days sales outstanding increased from 48 days at December 31, 2002 to 50 days at September 30, 2003.
Inventories increased from $7.8 million at December 31, 2002 to $9.0 million at September 30, 2003. Days inventory was 52 days at December 31, 2002 and 57 days at September 30, 2003.
Accounts payable reduced from $5.8 million at December 31, 2002 to $5.2 million at September 30, 2003. Days payables was 34 days at December 31, 2002 and 36 days at September 30, 2003.
Net cash provided by investing activities was $1.4 million in the first half of 2003 compared to $5.2 million in the same period of 2002. The Company sold a building in the U.K. for $2.2 million in January of 2003 and completed a sale/leaseback of a building in its U.S. facilities for $6.2 million in June of 2002.
Net cash used in financing activities was $2.4 million in the first nine months of 2003 compared to $29.5 million in the first nine months of 2002. In both periods, the Company repaid debt.
The cash and cash equivalents balance increased from $3.1 million at December 31, 2002 to $7.3 million at September 30, 2003.
The Company entered into a three year Loan and Security Agreement with an asset-based lender on September 25, 2002. The Loan and Security Agreement’s initial term loan balance of $4.7 million and initial revolver balance of $2.1 million as well as $9.6 million in cash were used to repay in full the prior Credit Agreement. The three year term loan is repayable in quarterly payments based on a five-year amortization schedule with a balloon repayment at maturity. At September 30, 2003, the outstanding balance of the term loan was $4.0 million, with no outstanding balance in the revolver.
Under the Loan and Security Agreement, the outstanding balance bears interest payable monthly at a variable rate based on either LIBOR or the lender’s base rate. The weighted average interest rate under the Loan and Security Agreement at September 30, 2003 was 3.25%.
The Loan and Security Agreement contains various financial and operating covenants that impose limitations on the Company’s ability, among other things, 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 a fixed charge coverage ratio financial covenant among others. The Company was in compliance as of September 30, 2003 with the covenants of the Loan and Security Agreement.
The Company believes that cash flow from operations coupled with borrowings under the Loan and Security Agreement will be sufficient to fund the Company’s capital expenditure and working capital requirements through 2003.
13
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
We believe that the estimates, assumptions and judgments involved in the accounting policies described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our most recent Annual Report on Form 10-K have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. Certain of these critical accounting policies affect working capital account balances, including the policies for revenue recognition, the reserve for uncollectible accounts receivable and inventory reserves. These policies require that we make estimates in the preparation of our financial statements as of a given date.
Within the context of these critical accounting policies, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.
Forward-Looking Statements
All statements contained in this quarterly report on Form 10-Q that are not statements of historical facts constitute “forward-looking statements” and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any one or more of the expectations expressed in these forward-looking statements may not be realized. Although management believes that the expectations reflected in these statements are reasonable, such statements involve certain risks, uncertainties and other factors that could cause the actual results of the Company to be materially different from the historical results or from any future results expressed or implied by such forward-looking statements. These risks, uncertainties and other factors include customer demand for the Company’s products, material costs that may be incurred, the Company’s ability to integrate acquired businesses, the effectiveness of the restructuring program commenced by the Company during the third quarter of 2001, the effectiveness of any additional restructuring programs that may be undertaken by the Company in the future, the mix of products that may be sold by the Company (i.e., whether the mix is dominated by higher margin enclosure products or lower margin connectivity products), economic trends within the telecommunications industry and worldwide economic conditions generally. Additional risks and uncertainties are outlined in the Company’s filings with the Securities and Exchange Commission, including its most recent annual report on Form 10-K and its Registration Statement on Form S-1 under the heading “Risk Factors”. The Company undertakes no obligation to publicly release the results of any revisions to such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
|
ITEM 3. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The market risk inherent in the Company’s market risk sensitive instruments is the potential loss arising from adverse changes in interest rates and foreign currency exchange rates. All financial instruments held by the Company described below are held for purposes other than trading.
The Company’s Loan and Security Agreement allows for the outstanding balance to bear interest at a variable rate based on the lender’s base rate or LIBOR. The credit facility exposes the operations to changes in short-term interest rates since the interest rates on the credit facility are variable.
A hypothetical change of 1% in the interest rate for these borrowings, assuming debt levels at September 30, 2003, would change interest expense by approximately $0.01 million for the three months ended September 30, 2003. This analysis does not consider the effects of economic activity on the Company’s sales and profitability in such an environment.
The Company has assets and liabilities outside the United States that are subject to fluctuations in foreign currency exchange rates. Assets and liabilities outside the United States are primarily located in the United Kingdom, Australia, and Canada. The Company’s investment in foreign subsidiaries with a functional currency other than the U.S. dollar is generally considered long-term. Accordingly, the Company does not hedge these investments. The Company also purchases a limited portion of its raw materials from foreign countries. These purchases are generally denominated in U.S. dollars and are accordingly not subject to exchange rate fluctuations. The Company has not engaged in forward foreign and other similar contracts to reduce its economic exposure to changes in exchange rates because the associated risk is not considered significant.
14
|
ITEM 4. |
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CONTROLS AND PROCEDURES |
Based on their evaluation as of the end of the fiscal quarter covered by this report (the “Evaluation Date”), the Company’s principal executive officer and principal financial officer have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended) are effective to ensure that material information relating to the Company and its consolidated subsidiaries is recorded, processed, summarized, reported and made known to the Company’s management, including the Company’s principal executive and financial officers, on a timely basis by others within the Company and its consolidated subsidiaries.
To satisfy their responsibility for financial reporting, the Company’s CEO and CFO have established internal controls and procedures which they believe are adequate to provide reasonable assurance that the Company’s assets are protected from loss. These internal controls are reviewed by the Company’s management in order to ensure compliance. In addition, the Company’s Audit Committee meets regularly with management and the independent accountants to review accounting, auditing and financial matters. The Audit Committee and the independent accountants have free access to each other, with or without management being present.
Subsequent to the Evaluation Date, there were no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s disclosure controls and procedures.
PART II - - OTHER INFORMATION
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ITEM 1. |
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LEGAL PROCEEDINGS |
The Company is from time to time involved in ordinary routine litigation incidental to the conduct of its business. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate for such litigation matters. Management believes that no presently pending litigation matters are likely to have a material adverse effect on the Company’s financial statements or results of operations, taken as a whole.
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ITEM 2. |
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CHANGES IN SECURITIES AND USE OF PROCEEDS |
Not applicable.
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ITEM 3. |
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DEFAULTS UPON SENIOR SECURITIES |
Not applicable.
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ITEM 4. |
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SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
Not applicable.
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ITEM 5. |
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OTHER INFORMATION |
Not applicable.
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ITEM 6. |
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EXHIBITS AND REPORTS ON FORM 8-K |
(a) Exhibits
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Exhibit |
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Description |
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3.1 |
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Restated Certificate of Incorporation of the Company (1) |
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3.2 |
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Bylaws of the Company (1) |
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4 |
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Form of Common Stock Certificate (1) |
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10.1 |
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Tax Agreement between the Company and the Existing Stockholders (1) |
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10.2.1 |
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Channell Commercial Corporation 1996 Incentive Stock Plan (including form of Stock Option Agreements and Restricted Stock Agreement) (1) |
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10.2.2 |
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Channell Commercial Corporation 2003 Incentive Stock Plan (8) |
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10.3 |
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Loan and Security Agreement dated as of September 25, 2002 by and among the Company, Channell Commercial Canada Inc., Fleet Capital Corporation, Fleet Capital Canada Corporation and, under the circumstances set forth therein, Fleet National Bank, London U.K. Branch, trading as Fleet Boston Financial, and the U.K. Borrowers (as defined therein, if any) (6) |
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10.4 |
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Employment Agreement between the Company and William H. Channell, Sr. (1) |
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10.5 |
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Employment Agreement between the Company and William H. Channell, Jr. (1) |
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10.6 |
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Channell Commercial Corporation 1996 Performance-Based Annual Incentive Compensation Plan (1) |
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10.7 |
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Lease dated December 22, 1989 between the Company and William H. Channell, Sr., as amended (1) |
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10.8 |
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Lease dated May 29, 1996 between the Company and the Channell Family Trust (1) |
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10.9 |
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Lease dated October 26, 2000 between the Company and Belston Developments Inc. (4) |
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10.10 |
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Lease Agreement dated as of March 1, 1996 between Winthrop Resources Corp. and the Company (1) |
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10.11 |
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Form of Indemnity Agreement (1) |
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10.12 |
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Form of Agreement Regarding Intellectual Property (1) |
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10.13 |
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401(k) Plan of the Company (3) |
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10.14 |
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A.C. Egerton (Holdings) PLC Share Purchase Agreement (2) |
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10.15 |
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Amendment to Employment Agreement between the Company and William H. Channell, Jr., dated December 31, 1998 (3) |
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10.16 |
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Further Amendment to Employment Agreement between the Company and William H. Channell, Jr., dated July 15, 2002 (5) |
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10.17 |
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Lease dated June 27, 2002 between the Company and Ynez Street, Ltd (5) |
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10.18 |
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Mutual Specific and General Release between the Company and Richard A. Cude, dated August 2, 2002 (7) |
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31.1 |
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Certificate of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) under the Securities and Exchange Act of 1934. (9) |
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31.2 |
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Certificate of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) under the Securities and Exchange Act of 1934. (9) |
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32.1 |
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Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by William H. Channell, Sr., CEO; and Thomas Liguori, CFO. (9) |
(b) Reports filed on Form 8-K in the third quarter of 2003.
On July 24, 2003, the Company filed a Form 8-K issuing a press release announcement of its financial results for the fiscal quarter ended June 30, 2003.
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(1) |
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Incorporated by reference to the indicated exhibits filed in connection with the Company’s Registration Statement on Form S-1 (File No. 333-3621). |
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(2) |
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Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 8-K on May 18, 1998. |
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(3) |
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Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-K on March 31, 1999. |
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(4) |
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Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-K on April 2, 2001. |
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(5) |
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Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-Q on August 9, 2002. |
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(6) |
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Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 8-K dated September 25, 2002. |
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(7) |
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Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-Q on November 12, 2002. |
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(8) |
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Incorporated by reference to Appendix B filed in connection with the Company’s Definitive Proxy Statement on March 26, 2003. |
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(9) |
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Filed herewith. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: November 4, 2003
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CHANNELL COMMERCIAL CORPORATION |
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(Registrant) |
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By: |
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/s/ THOMAS LIGUORI |
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Thomas Liguori |
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Chief Financial Officer |
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(Duly authorized officer and principal financial |
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