Channell Commercial 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number 0-28582
CHANNELL COMMERCIAL CORPORATION
(Exact name of registrant as specified in its charter)
26040 Ynez Road
Temecula, CA 92591
(Address of principal executive offices, including zip code)
Registrants telephone number, including area code: (951) 719-2600
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Title of Class
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 ý No o
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 Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A-1 or any amendment to this Form 10-K/A-1. ý
On March 11, 2005, the Registrant had 9,383,942 shares of Common Stock outstanding with a par value of $.01 per share. The aggregate market value of the 4,454,412 shares held by non-affiliates of the Registrant was $19,153,972 computed by reference to the price at which the shares were last sold, as of the last business day of the Registrants most recently completed second fiscal quarter. 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.
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No ý
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K/A-1 incorporates by reference certain information from the Registrants definitive proxy statement (the Proxy Statement) for its annual meeting of stockholders to be held on May 12, 2005.
TABLE OF CONTENTS
i. Explanatory Note
This Amendment No. 1 on Form 10-K/A (this Amendment) amends the registrants annual report on Form 10-K for the period ended December 31, 2004 originally filed on March 21, 2005 (the Original Filing). Channell Commercial Corporation (the Company) is filing the amendment to correct errors in the calculation of the cumulative timing difference between book and tax depreciation. The original error in the computation that occurred in 2001 and the effect of this error carried forward to years ended December 31, 2002, 2003 and 2004. In addition, the Company had a mathematical error in the 2004 deferred income tax calculation that resulted in an additional error in the reported deferred income tax balance The recording error resulted in a restatement of deferred income taxes as of December 31, 2003 and December 31, 2004 as well as income tax expense (benefit), net income (loss) before minority interest, net income (loss), net income (loss) per share and comprehensive net (loss) income for the fiscal years ended December 31, 2002, 2003 and 2004. The effect of the restatement is described in Note R to the Consolidated Financial Statements included in this Form 10-K/A-1.
Except as described above, no other changes have been made to the original filing. This Amendment continues to speak as of the date of the original filing, and the Registrant has not updated the disclosures contained therein to reflect any events which occurred at a date subsequent to the filing of the original filing.
Channell Commercial Corporation (the Company) was incorporated in Delaware on April 23, 1996, as the successor to Channell Commercial Corporation, a California corporation. The Companys executive offices are located at 26040 Ynez Road, Temecula, California 92591, and its telephone number at that address is (951) 719-2600.
The Company is a designer and manufacturer of telecommunications equipment supplied to broadband and telephone 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 for fiber to the premise (FTTP) networks, and heat shrink products. The Companys 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 access portion of the local signal delivery network, commonly known as the outside plant, local loop or last mile, that connects the network providers signal origination point or local office with its residential and business customers. The Companys connectivity products provide critical network connection points between cables or network transmission devices.
The Company also designs, manufactures and markets polyethylene water tanks for rural and residential markets in Australia. The Companys primary product line of rotational molded tanks is used in the agricultural sector where water shortages require storage of rain and ground water. The Company also markets a range of water storage tanks for use in residential and rural-residential markets. The Company operates out of four leased facilities in Australia. The facilities are located in Dalby, Orange, Terang, and Adelaide.
The Company entered the Australian water storage tank market in August 2004 with the acquisition of Bushman Tanks. Bushman Tanks is Australias largest manufacturer and distributor of rotational molded polyethylene water storage tanks.
The Companys enclosure product line accounted for 78%, 79% and 59% of the Companys net sales in 2002, 2003 and 2004, respectively. The Company has recently diversified a portion of its business with the acquisition of Bushman Tanks. The Companys water related products product line accounted for 30% of the Companys net sales in 2004. The Company has long-lived assets in Australia of $2.6 million, $2.4 million and $5.5 million in 2002, 2003 and 2004, respectively.
The Company operates primarily in two industries, the telecommunications industry and the Australian water storage tank industry.
In the telecommunications industry, broadband and local telephone operators are building, rebuilding or upgrading signal delivery networks around the world. These networks are designed to deliver video, voice and/or data transmissions to individual residences and businesses. Operators deploy a variety of network technologies and architectures, such as HFC,
VoIP, DLC, ADSL and FTTP (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.
As critical components of the outside plant, enclosure products provide (i) protection against weather and vandalism, (ii) ready access for technicians who maintain and manage the outside plant and, (iii) in some cases, provide dissipation of heat generated by the active electronic hardware. Broadband 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. Connectivity products provide critical data-rated connection points which support cost effective service deployment and ensure signal integrity is maintained throughout the network.
The primary drivers of demand for enclosures in the communications industry are the construction, rebuilding, upgrading and maintenance of signal delivery networks by broadband operators and local telephone companies. For example, broadband networks are being upgraded and prepared for advanced two-way services such as high-speed Internet access via cable modems, telephony and PCS transport. Local telephone service providers are employing 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. Local telephone service providers are also employing various fiber to the premise (FTTP) technologies to deliver higher bandwidth services to customers. FTTP utilizes outside plant enclosures to protect the networks as well as fiber cable management devices that are both manufactured by the Company.
In the Australian water storage tank industry, consumers utilize plastic, steel or concrete tanks for the storage of water. Australia is an arid climate with limited water resources. The combination of a growing population, a movement of people away from urban areas and limited rainfall has resulted in water shortages in most geographic areas. Water storage tanks are used to store rain and ground water in residential and commercial properties. The water is used for outside the home purposes such as gardening, pumped into the home for non potable uses such as washing machines and toilets and may often be used as a source of drinking water. Local, state and national governments have implemented several regulations intended to conserve water. These include restrictions on the use of potable water and requirements to install water storage tanks or other conservancy products in new residential dwellings in selected areas.
The Companys strategy is to capitalize on its core strengths in the design and manufacture of thermoplastic products, metal products and connectivity products and to use these strengths to be a leading company in the markets it operates in as well as to enter new markets.
The Company pursues 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 Companys wide range of products, manufacturing expertise, application-based sales and marketing approach and reputation for high quality products address key requirements of its customers.
In addition to the communications industry, the Company seeks to leverage its expertise in plastics and metal manufacturing technologies to diversify into other industries. The Companys acquisition of the Bushman Tanks business is an example of this diversification. Bushman Tanks utilizes plastic rotational molding technology to produce water tanks, a process similar to that used by the Company to manufacture thermoplastic enclosures for the communications industry. The Company believes it can apply its advanced rotational manufacturing technologies to the Bushman Tanks operations to improve performance.
Principal elements of the Companys strategy include the following:
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 and copper wire connectors for the broadband/CATV and local telephone industries in the North America, Europe, Middle East, Africa, Australia and Asia markets through new product development. The Company believes it currently supplies a substantial portion of the enclosure product requirements of a number of major broadband operators.
The Company has invested in the development of a broad range of products designed specifically for telecom applications. These include connectivity and enclosure products for DSL and FTTP based networks. The Company has successfully marketed its traditional 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 with telephone network operators and with major system OEMs.
Expand International Presence in Communications Industry. Management believes international markets offer significant opportunities for increased sales to both broadband and telephone companies. The Companys principal international markets currently include Canada, Mexico, Asia, the Pacific Rim, the Middle East, Africa and Europe. Trends expected to result in international growth opportunities include the on-going deregulation and privatization of telecommunications in many nations around the world and the focus of numerous countries on building, expanding and enhancing their communications systems to deliver broadband services in order to participate fully in the information-based global economy. The Company will concentrate on expansion in international markets that are characterized by deregulation or privatization of telecommunications and by the availability of capital for the construction of signal delivery networks.
Develop New Products and Enter New Markets. The Company continues to leverage its core capabilities in developing innovative products that meet the evolving needs of its customers. Innovative products offered by the Company include its MAH Series free-breathing telephony enclosures, GLMTM sub surface enclosures, the Mini-Rocker insulation displacement copper connectivity products, and a range of Rhino metal fabricated enclosures. The Company continually invests in ongoing improvement and enhancement projects for the existing products developed by the Company, several of which have received U.S. patent protection. The Companys products are designed to improve the performance of 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. The Company also believes its core capabilities are applicable to markets outside the telecommunications industry.
The Company is expanding its product offering of water storage tanks to include underground tanks and related products primarily for the residential markets in Australia. The Companys principal customers are currently in rural areas. The Company continues to develop innovative products to expand its presence in the residential and rural-residential markets of Australia. The Company may also pursue water storage tank markets beyond Australia in the future.
Concentrate on Core Capabilities to Diversify into Other Industries. The Company believes its core competencies are in the design and manufacture of plastic and metal infrastructure products. The Company is pursuing a strategy to utilize these core competencies to diversify into other industries to profitably grow. Relevant industries that the Company may pursue include water, irrigation, power utility and other outside plant infrastructure products. The acquisition of Bushman Tanks to operate in the water industry is an example of this diversification strategy.
The Company currently markets over 60 product families, with several thousand optional product configurations. The primary functions of the Companys 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 primary functions of the Companys products designed for the water industry are the filtration, storage and pumping of water for both outside and inside the home usage.
Enclosures. The Company manufactures precision-molded, highly engineered and application-specific thermoplastic and metal fabricated enclosures for the communications industry that are considered state-of-the-industry for many applications, having been field tested and received approvals and standardization certifications from major broadband and telephone company operators. Most of the Companys products are designed for buried and underground network applications. The Companys enclosure products provide technicians access to network equipment for maintenance, upgrades and installation of new services. Buried and underground networks and enclosures are generally preferred by broadband operators for increased network reliability, lower maintenance, improved security, reduced utility right-of-way conflicts, and aesthetic appeal. The enclosure products, particularly the thermoplastic versions, must provide advanced heat dissipation characteristics increasingly required for the protection of active electronics in many network installations. The Company is also a designer and manufacturer of metal fabricated enclosures that house advanced electronics, fiber optic cable and power systems for broadband telecommunications networks (branded as Rhino Enclosures). The Company designs and manufactures a series of termination blocks, brackets and cable management devices for mounting inside its enclosure products. To position itself as a full-line product supplier, the Company also offers a variety of complementary products, including thermoplastic and composite grade level boxes for sub surface network applications.. 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 customer base. The Company is recognized in the industry for its differentiated product designs and the functionality, field performance and service life of its products.
Copper Connectivity. The Company is a designer and manufacturer of innovative telephone connectivity devices. The Companys Insulation Displacement Connector (IDC) technology provides advanced tool-less termination systems for copper wires, the predominant medium used in the Last Mile for telephone services worldwide. These proprietary IDC products environmentally seal network termination points with a high level of reliability. The Companys DSLink TM modular terminal block offers telephone service providers a Category 5 (Cat- 5) solution to the rising costs of DSL deployment in the local loop. The Companys Mini-Rocker line of copper connectivity modules, blocks and accessories offer environmentally sealed and Cat-5 data rated IDC tool-less circuit installation and have been accepted as a universal connectivity platform for network applications worldwide, including xDSL and VoIP services.
Fiber Optic Products. The Company offers a range of fiber optic cable management products designed for use in telephone and broadband networks. These products are particularly well suited for fiber to the premises (FTTP) network architectures. Fiber optic electronic enclosures house optical electronics, power supplies and cables. The Companys fiber optic splice cases are used for organizing, managing and protecting the connection points between separate lengths of fiber optic cable in the outside plant network. Fiber optic cable assemblies and interconnect hardware are used to connect fiber optic electronics and fiber optic cables primarily for in-building applications. All of these products are designed and manufactured by the Company and marketed worldwide.
OEM Programs. The Company has OEM marketing programs through which other manufacturers incorporate the Companys products as components of their telecommunications 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.
Water Products. The Company offers a range of water tank products for the storage of potable and non potable water. These products typically store rain water collected from the roofs of homes or other buildings or water pumped from underground wells. These products are primarily used by residential homes, agricultural properties and commercial buildings. Accessory products for these water tanks include filtration systems, connection devises and pumps.
In addition to water storage tanks, the Companys water product line includes applications for the communications industry. Below ground enclosures protect networks from water and other damage.
Marketing and Sales
The Company markets its products primarily through a direct sales force of technically trained salespeople. The Company employs an application-specific, systems approach to marketing its products, offering the customer a complete, cost-effective system solution to meet its outside plant requirements. All sales personnel have technical expertise in the products they market and are supported by the Companys engineering and technical marketing staff.
Internal sales/customer service departments administer and schedule incoming orders, handle requests for product enhancements and service inquiries and support the Companys direct sales force. This department maintains direct communications with customers and the Companys 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 markets throughout the year.
Specific to the Companys water tank products, a network of agents and distributors are utilized to market the Companys products in addition to the use of a direct sales force.
The Company participates in agricultural field days in Australia to market water storage products. Agricultural field days are held in most rural areas once or twice per year and are used by rural customers to purchase a variety of hardware products by attending a single event. The Company uses radio and television advertising to promote its water storage tank products throughout Australia.
The Companys vertically integrated manufacturing operations enable the Company to control each step in the manufacturing process, including product design and engineering; design and production of many of its own dies, tools, molds and fixtures. This vertically integrated manufacturing strategy applies to both the communications equipment and water product lines.
The Companys 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 Companys 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. Manufacturing processes are performed by trained Company personnel. These manufacturing processes include injection molding, structural foam molding, rotational molding, metal fabrication, automated discrete connector 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.
The Companys manufacturing and distribution facilities as of December 31, 2004, include approximately 367,000 square feet in Temecula, California; 7,000 square feet in Mississauga, Ontario, Canada; 34,000 square feet in Sydney, 43,000 square feet in Dalby, 22,000 square feet in Orange, 16,000 square feet in Terang, and 13,000 square feet in Adelaide. The manufacturing operations in the United Kingdom were closed in June, 2004.
Product Development and Engineering
The Companys product development and engineering staff has designed and tested the Companys products and has developed core competencies in telecommunications outside plant and water storage products. As a direct result, the Company has been able to develop a broad series of superior products designed to meet the specific needs of customers. Distinguishing characteristics of the Companys products include:
Advanced mechanical innovations providing unique application specific performance and feature sets;
Sub-surface network access systems;
Modular metal fabricated enclosure product line covering multiple applications;
Effective heat dissipation qualities for enclosure products;
Advanced copper IDC connectivity products;
A superior environmental sealing and protection system in enclosure products that, unlike many competitors products, does not require gels, compounds or other methods to maintain the required seal;
Product designs allowing communications equipment technicians easy access through covers that can be removed to fully expose the enclosed electronics;
Compatibility with a variety of communications equipment signal delivery network architectures;
Versatility of design to accommodate communications network growth through custom hardware and universal mounting systems that adapt to a variety of new electronic hardware;
Excellent protection and management of optical fibers and cables;
Thermoplastic Laminated Coating (TLC®) that bonds directly to metal hardware and protects against rust and deterioration;
High strength and UV protected water storage products;
Underground water storage products; and
A complete line of water storage accessories products including filtration, pumps and connection devices.
The Companys 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 requirements for performance qualification purposes, enabling it to accelerate the product development process. The Company spent $1.6 million in 2002, $1.9 million in 2003, and $2.3 million in 2004 on research and development.
The Company sells its telecommunications related products directly to broadband operators and telephone companies throughout the world, principally within developed nations. The Company sells its products to OEMs on a global basis. The Company sells its water storage products in Australia directly to end users as well as to retailers, wholesalers, distributors and agents. During 2004, the Companys five largest customers accounted for 48.7% of total net sales. In 2004, the Companys five largest customers by sales in the United States were Verizon, Comcast, Cox, Time Warner and Bright House Networks. Verizon and Comcast accounted for 21.7% and 14.6%, respectively, of the Companys net sales in 2004. In international markets, the Companys five largest customers in 2004 by sales were Telstra (Australia), Rogers (Canada), Shaw (Canada), Uni Telco (Malaysia) and Eircom (Ireland).
The Company has historically operated with a relatively small backlog. Sales and operating results in any quarter are primarily dependent upon orders booked and products shipped in the quarter. The Companys customers generally do not enter into long-term supply contracts providing for future purchase commitments of the Companys 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 Companys products by specific customers can and do result from this periodic assessment. Customers of water products in Australia are typically individual users that may keep their product for several years before a repeat purchase, in addition to the distributors that are used to market the Companys products.
The Company owns substantially all of the patents and other technology employed by it in the manufacture and design of its products. The Companys patents, which expire through the year 2010, cover various aspects of the Companys 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 Companys success as a whole. The Company maintains an intellectual property protection program designed to preserve its intellectual property assets.
The telecommunications industry is highly competitive. The Companys competitors include companies that are much larger than the Company, such as Tyco, 3M, Emerson, Arris and Corning in addition to competitors similar in size to the Company such as Carson Industries. The Company believes its competitive advantages include its ability to service national and multi-national customers, its direct sales force, its specialized engineering resources and its vertically integrated manufacturing operations.
Management believes the principal competitive factors in the telecommunications equipment market are customer service, new product capabilities, price, product availability, and product performance.
Competitive price pressures are common in the industry. In the past, the Company has responded effectively to competition with cost controls 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 Companys telecommunications customers have required relatively lengthy field testing of new products prior to purchasing such products in quantity. While field testing can delay the introduction of new products, it can also act as a competitive advantage for those products tested and approved because to a certain extent it creates a barrier to new product introduction and sales by competitors.
The water storage products industry in Australia is characterized by a few large competitors, including ARI Industries and Clark Tanks, and a high number of smaller, regional competitors. The Company believes its competitive advantages include its low cost structure, manufacturing expertise, product design, marketing and sales expertise and its nationwide coverage. The Company is the only nationwide manufacturer of water storage tanks in Australia.
Management believes that the principle competitive factors in the water storage industry are product quality, manufacturing capacity, and geographic location for logistics support, technical support and customer service. The multiple manufacturing plant locations provide nationwide market coverage in the industry which is not presently offered by any current competitors.
Competitive price pressures are prevalent in this industry. The Company has responded to these with ongoing process improvements, design optimization and targeted procurement programs.
The existing customer base is widely dispersed throughout the rural market areas. Promotion and awareness of the Companys products and services is strongly reinforced. Long term direct marketing programs including media advertising, radio and television, and high profile promotion at exhibitions have been developed by the Company over many years. These marketing programs have established strong brand equity which creates a competitive advantage/barrier to entry for other suppliers in several significant market areas.
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, copper and brass. The Company also uses certain other raw materials, such as fasteners, packaging materials and communications cable. Management believes the Company has adequate sources of supply for the raw materials used in its manufacturing processes and 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 or multi-year purchase agreements to stabilize costs and improve supplier delivery performance. Neoprene rubbers are manufactured using the Companys proprietary formulas. Metal products are supplied in standard stock shapes, coils and custom roll forms.
The Company also relies on certain other manufacturers to supply products that complement the Companys own product line, such as grade level boxes. The Company believes there are multiple sources of supply for these products.
As of December 31, 2004, the Company employed 592 people, of whom 70 were in sales, 431 were in manufacturing operations, 32 were in research and development and 59 were in administration. The Company considers its employee relations to be good and recognizes its ability to attract and retain qualified employees is an important factor in its growth and development. None of the Companys 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.
The telecommunications industry is subject to regulations in the United States and other countries. Federal and state regulatory agencies regulate most of the Companys 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 lifted certain restrictions on the ability of companies, including RBOCs and other customers of the Company, to compete with one another and generally reduced 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 Companys 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 strict joint and several 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 were not caused by the Companys operations.
The water storage products industry in Australia is also subject to regulation. Federal, state and local regulatory agencies regulate and in some cases mandate the use of water storage products to conserve water usage. Examples include restrictions on the use of potable water for gardening, the washing of cars and other non-essential uses. In addition, several agencies have offered rebates to those who purchase water storage products to conserve water. Most recently, government agencies have mandated that new residential dwellings in the states of New South Wales and Victoria require a water conservation device such as water storage tanks. The city of Sydney is located in New South Wales and the city of Melbourne is located in Victoria. The affect of these regulations has been to increase the demand for water storage tanks in Australia. There can be no guarantee that these regulations and rebates will remain in existence.
The Companys Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports are available as soon as reasonably practicable after they are filed or furnished to the Securities and Exchange Commission (SEC), through our Internet website, www.channellcomm.com. Company filings are also available through a database maintained by the SEC at www.sec.gov.
The Companys facilities approximate 504,000 square feet, of which approximately 63%, 22% and 15% were used for manufacturing, warehouse and office space, respectively. In Temecula, California, 261,000 square feet of the total 367,000 square feet are leased from William H. Channell, Sr., the Companys Chairman of the Board. (See Certain Relationships and Related Transactions, Item 13.) The Company also leases an aggregate of approximately 137,000 square feet of manufacturing, warehouse and office space in Canada, Australia and the United Kingdom. In Australia, 94,000 square feet of manufacturing and distribution space in Orange, Dalby, Terang and Adelaide are leased from the former owners of Bushman Tanks (See Certain Relationships and Related Transactions, Item 13). In December, 2002, the Company announced steps to rationalize international manufacturing operations to consolidate operations. The Company has completed the facilities reduction program. In 2002, the Company completed a sale and leaseback of approximately 103,000 square feet of manufacturing, warehouse and office space in Temecula, California. The Company sold approximately 43,000 square feet of manufacturing, warehouse and office space in the United Kingdom in January, 2003. In the fourth quarter of 2003, the Company further evaluated International operations to improve profitability. A manufacturing facility in the United Kingdom was closed in June 2004. The Company considers its current facilities, and its facilities following the completion of the foregoing restructuring activities, to be adequate for its operations.
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.
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
The following table sets forth, for the periods indicated, the high and low sale prices for the Companys Common Stock, as reported on the NASDAQ National Market.
The Company has not declared any dividends subsequent to its initial public offering in July 1996.
The Company currently anticipates it will retain all available funds to finance its business. The Company does not intend to pay cash dividends in the foreseeable future. Under the terms of the Companys Loan and Security Agreement, the Company has agreed not to pay any dividends.
As of March 2, 2005, the Company had 9,383,942 shares of its Common Stock outstanding, held by approximately 1,050 shareholders of record.
The selected consolidated financial data presented below for each of the five years in the period ended December 31, 2004, have been derived from audited consolidated financial statements, which for the most recent three years appear elsewhere herein. The data should be read in conjunction with the financial statements, related notes and other financial information included therein (amounts in thousands, except per share data).
(1) Gross margin is gross profit as a percentage of net sales.
(2) Operating margin is income (loss) from operations as a percentage of net sales.
(3) Includes all interest bearing debt and capital lease obligations.
The Company is a designer and manufacturer of telecommunications equipment supplied to telephone and broadband network providers worldwide and of water storage products marketed primarily in Australia. In addition to Company manufactured products, the Company markets complementary products manufactured by third parties. The Company sells products directly to broadband operators and telephone companies throughout the United States, Canada, Australia, Asia, Europe, the Middle East and Africa and certain other international markets, principally within developed nations. The Companys customers of water storage products in Australia are typically individual users whom will keep the product for several years without a repeat purchase. The Company believes that many of its customers periodically review their supply relationships and consequently 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 with sales and operating results in any quarter principally dependent upon orders booked and products shipped in that quarter. The Companys customers generally do not enter into long-term supply contracts providing for future purchase commitments for the Companys products. These factors, when combined with the Companys operating leverage and the need to incur certain capital expenditures and expenses in part based upon the expectation of future sales, causes the Companys operating results to be at risk to changing customer buying patterns. If sales levels in a particular period do not meet the Companys expectations, operating results for that period may be materially and adversely affected.
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 Companys raw materials could significantly increase the Companys cost of goods sold and materially adversely affect the Companys profitability. The Companys profitability may also be materially and adversely affected by decreases in its sales volume because many of the costs associated with the Companys facilities, product development, engineering, tooling and other manufacturing processes are essentially fixed in nature and must be spread over its sales base in order to maintain historical levels of profitability.
Critical Accounting Policies
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management bases its estimates on historical experience and on assumptions that are believed to be reasonable under the circumstances and revises its estimates, as appropriate, when changes in events or circumstances indicate that revisions may be necessary. Although these estimates are based on managements knowledge of and experience with past and current events and on managements assumptions about future events, it is possible that they may ultimately differ materially from actual results.
The critical accounting policies requiring estimates and assumptions that management believes have the most significant impact on the Companys consolidated financial statements are:
Accounts receivables reserves
Allowances for excess and obsolete inventory
Valuation of goodwill and long-lived assets
Accounting for income taxes
Foreign currency translation
Accounts receivable Reserves and estimated sales returns. Allowances for doubtful accounts are maintained for estimated losses expected to result from the inability of our customers to make required payments. Provisions for uncollectible accounts are made based on the Companys specific assessment of the collectability of all past due accounts. An adverse change in financial condition of a significant customer or group of customers could materially affect managements estimates related to doubtful accounts. Provisions for sales returns are made based on historical experience.
Allowances for excess and obsolete inventory. The estimates of excess and obsolete inventory are based on managements assumptions about and analysis of relevant factors including historical sales and usage of items in inventory, current levels of orders and backlog, forecasted demand, product life cycle and market conditions. If actual market conditions become less favorable than anticipated by management, additional allowances for excess and obsolete inventory could be required. In the event management adjusts estimates such as forecasted sales or expected product lifecycles, the value of the Companys inventory may become understated or overstated and recognition of such understatement or
overstatement will affect cost of sales in a future period, which could materially affect the Companys operating results and financial position.
Valuation of goodwill and long-lived assets. Management reviews goodwill and long-lived assets for impairment when events or changes in circumstances indicate the carrying values may not be fully recoverable. Management assesses potential impairment of the carrying values of these assets based on market prices, if available, and/or assumptions about and estimates of future cash flows expected to be generated from these assets. Future cash flows may be adversely impacted by operating performance, market conditions and other factors. An impairment charge would be based on the amount by which the carrying value exceeds fair value. Fair value is estimated by management based on market prices, if available, and/or forecasted discounted cash flows, using a discount rate commensurate with the risks involved. Assumptions related to future cash flows and discount rates involve management judgment and are subject to significant uncertainty. If future cash flows, discount rates and other assumptions used in the assessment and measurement of impairment differ from managements estimates and forecasts, additional impairment charges could be required.
Restructuring costs. Restructuring costs are recorded in accordance with FASB Statement 146, Accounting for Costs Associated With Exit or Disposal Activities. One-time severance benefits for employees terminated are recorded at the time management commits to the plan to reduce the work force, knows the amount of the termination benefit, is unlikely to change the plan and has communicated to employees the intended work force reduction. Liabilities for costs that will continue to be incurred under a contract for its remaining term without an economic benefit, such as for facility lease payments for premises vacated, are recorded when the Company ceases to use the right conveyed by the contract. In the case of vacated leased facilities, the liability is based on the future lease payments required under the contract less the estimated future rental income the Company may earn by subletting the facilities or estimates of costs incurred to terminate a lease with a landlord. These estimates of future sublet income are based on current economic conditions, current condition of the local leasing market, past experience and judgments supplied by professionals in the local real estate market. These estimates are subject to significant uncertainty and may change. Additional charges could be required as a result in the changes in estimates.
Accounting for income taxes. Income taxes are recorded for each of the jurisdictions in which the Company operates. Management records the actual current income tax payable and assesses the temporary differences resulting from differing treatment of items, such as reserves and accruals, for tax and accounting purposes. These differences result in deferred tax assets and liabilities which are included within the consolidated balance sheet. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. In addition, the realization of deferred tax assets is also dependent upon audits by tax authorities of tax filings which may result in a revision to previous amounts claimed. Significant management judgment is involved in assessing the Companys ability to realize any future benefit from deferred tax assets. In the event that actual results differ from management estimates and management adjusts these estimates in future periods, the Companys operating results and financial position could be materially affected.
Foreign currency translation. The Company has foreign subsidiaries that together accounted for 31.5 % of the Companys net revenues and 48.8% of the Companys assets as of and for the year ended December 31, 2004. In preparing the Companys consolidated financial statements, the Company is required to translate the financial statements of its foreign subsidiaries from the currencies in which they keep their accounting records into United States dollars. This process results in exchange gains and losses which, under relevant accounting guidance, are either included within the Companys statement of operations or as a separate part of the Companys net equity under the caption cumulative translation adjustment.
Under relevant accounting guidance, the treatment of these translation gains or losses depends upon managements determination of the functional currency of each subsidiary. This determination involves consideration of relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts a majority of its transactions, including billings, financing, payroll and other expenditures, would be considered the functional currency. However, management must also consider any dependency of the subsidiary upon the parent and the nature of the subsidiarys operations.
If management deems any subsidiarys functional currency to be its local currency, then any gain or loss associated with the translation of that subsidiarys financial statements is included in a cumulative translation adjustment. However, if management deems the functional currency to be United States dollars, then any gain or loss associated with the translation of these financial statements would be included within the Companys statement of operations.
If the Company disposes of any of its subsidiaries, any cumulative translation gains or losses would be realized into the Companys statement of operations. If management determines that there has been a change in the functional currency of a subsidiary to United States dollars, then any translation gains or losses arising after the date of the change would be included within the Companys statement of operations.
Based on managements assessment of the factors discussed above, the Company considers the functional currency of each of its international subsidiaries to be each subsidiarys local currency. Accordingly, the Company had cumulative translation gains of ($1.0) million that were included as part of accumulated other comprehensive loss within the Companys balance sheet at December 31, 2004. During the year ended December 31, 2004, the Company included translation adjustments of a gain of approximately ($1.1) million under accumulated other comprehensive income and loss.
If the Company had determined that the functional currency of its subsidiaries was United States dollars, these gains or losses would have decreased or increased the Companys loss for the year ended December 31, 2004. The magnitude of these gains or losses depends upon movements in the exchange rates of the foreign currencies in which the Company transacted business as compared to the value of the United States dollar. These currencies include the British pound, the Canadian dollar and the Australian dollar. Any future translation gains or losses could be significantly higher than those the Company recorded for the year ended December 31, 2004.
New Accounting Pronouncements
Recent Accounting Pronouncements. In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, Inventory Costs, an Amendment of ARB No. 43, Chapter 4. SFAS No. 151 retains the general principle of ARB No.43, Chapter 4, Inventory Pricing, that inventories are presumed to be stated at cost; however, it amends ARB No. 43 to clarify that abnormal amounts of idle facilities, freight, handling costs and spoilage should be recognized as current period expenses. Also, SFAS No. 151 requires fixed overhead costs be allocated to inventories based on normal production capacity. The guidance in SAFS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company believes that implementing SFAS No. 151 should not have a material impact on its financial condition or results of operations.
In December 2004, the FASB issued Statement 123 (revised 2004), Share-Based Payment (Statement 123(R)). This Statement is a revision to Statement 123, Accounting for Stock-Based Compensation, and supersedes Opinion 25, Accounting for Stock Issued to Employees. Statement 123(R) requires the measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render service. The Company will adopt Statement 123(R) on July 1, 2005, requiring compensation cost to be recognized as expense for the portion of outstanding unvested awards, based on the grant-date fair value of those awards calculated using the Black-Scholes option pricing model under Statement 123 for pro forma disclosures. The effect of adopting Statement 123(R) will decrease the Companys pretax net income by approximately $400 during 2005.
Results of Operations
The following table sets forth the Companys operating results for the periods indicated expressed as a percentage of net sales.
Comparison of Year Ended December 31, 2004 with Year Ended December 31, 2003
In August of 2004 the Company acquired 75% of the Bushman Tanks business (the acquired company). Bushman Tanks is Australias largest manufacturer of plastic water storage tanks. The Bushman Tanks financial results have been consolidated in the Companys financial statements for the twelve months ended December 31, 2004. The consolidated results include five months of business activity of Bushman Tanks. A minority interest has been recorded for the 25% equity owned by ANZ Private Equity, a unit of Australia and New Zealand Banking Group Ltd.
Net Sales. Net sales increased $23.6 million or 30.8% from $76.5 million in 2003 to $100.1 million in 2004. The increase was due to the addition of the acquired business and growth in both the core Americas and International segments.
Americas net sales increased $7.6 million or 11.7% from $64.8 million to $72.4 million. The increase was due to higher sales to a major telephone customer and due to growth in connectivity and metal enclosure sales. The major telephone customer purchased plastic enclosures for a construction project to install fiber communication lines to customer premises.
International net sales increased $16.0 million or 136.3% from $11.7 million to $27.7 million. The increase was primarily due to sales of the acquired company. In addition, higher sales to telephone customers in the Asian market contributed to the sales growth.
Sales to Verizon of $21.8 million in 2004 represented 21.7% of Company sales in the period. Sales to Verizon in 2003 were $8.0 million representing 10.5% of the Company sales in the period. The second largest customer in 2004 was Comcast with sales of $14.6 million representing 14.6% of the total. Sales to Comcast in 2003 were $20.7 million representing 27.1% of the Company sales in the period.
Gross Profit. Gross profit increased $5.4 million from $22.6 million in 2003 to $28.0 million in 2004. The increase was primarily due to the addition of gross profit earned by the acquired company. Gross profit dollars in the Americas segment decreased due to higher raw material costs for plastic and steel. Gross profit dollars in the International segment increased due to the addition of the acquired company and the closure of a manufacturing facility in the United Kingdom. The
closure of the United Kingdom facility lowered the overhead cost structure of International operations primarily due to the elimination of facility lease costs, middle management and indirect support costs.
As a percentage of net sales, gross profit decreased from 29.5% in 2003 to 27.9% in 2004. The decline is due primarily to increased raw material costs for plastic and steel in the Americas segment. Gross profit as a percentage of net sales increased in the international segment due to the addition of the acquired company which has a higher gross profit percentage than the other Channell businesses and savings associated with the closure of the manufacturing facility in the United Kingdom.
Selling. Selling expenses increased $4.8 million or 50.9% from $9.5 million in 2003 to $14.3 million in 2004. The increase is due to the addition of selling expenses of the acquired company and higher commissions and freight costs as a result of the increased sales level. The freight cost increase is also due to an increase in full truckload shipments to customers in which the Company pays the freight cost.
As a percentage of net sales, selling expense increased from 12.4% in the 2003 period to 14.3% in the 2004 period. The higher percentage is primarily due to the increase in freight costs and the addition of selling expenses for the acquired company. The acquired company has a higher percentage of selling expense to net sales than the other Channell businesses primarily due to the freight costs incurred to transport water storage tanks to customers.
General and Administrative. General and administrative expenses increased $0.9 million or 11.3% from $7.7 million in 2003 to $8.6 million in 2004. The increase is due to the addition of the acquired company partially offset by lower general and administrative expense in the Americas segment. In December of 2004 the Company sold its receivable owed from Adelphia at a discount for $1.4 million. The receivable had previously been written off and thus the $1.4 million proceeds were recorded as a reduction to general and administrative expenses in the Americas segment in 2004. Partially offsetting this credit to expense in the fourth quarter of 2004 were additional accruals and charges for management incentive bonus $0.5 million, state sales tax $0.4 million, expenses to evaluate an acquisition candidate that the Company decided not to further pursue $0.2 million and audit and consulting fees mostly related to the worthless stock deduction associated with the United Kingdom operations and costs associated with review and modification of internal controls in response to the disclosure requirements of the Sarbanes Oxley Act $0.1 million.
As a percentage of net sales, general and administrative expenses decreased from 10.1% in the 2003 period to 8.6% in the 2004 period. The decrease is due to the lower costs in the Americas segment as well as the increased sales level without a corresponding increase in general and administrative costs.
Research and Development. Research and development expenses increased $0.4 million or 22.8% from $1.9 million in 2003 to $2.3 million in 2004. The increase is due to spending on new product development programs, primarily for telephone connectivity products and thermoplastic enclosures for both telephone and cable customers.
As a percentage of net sales, research and development expenses decreased from 2.5% to 2.3% due to the addition of the acquired company which has a lower level of research and development spending as compared to the other Channell businesses.
Restructuring charge. Restructuring charges of ($0.7) million in 2004 compare to $1.6 million in 2003.
In 2003, the Company evaluated International operations to improve profitability. A plan was developed to close a manufacturing facility in International operations by mid-year 2004. Additional restructuring charges of $1.6 million were recorded in the fourth quarter of 2003 for employee severance and facility closure cost.
In 2004, a credit to restructuring charge of ($0.7) million was recorded primarily due to the subletting of a vacated facility in the United Kingdom at a cost less than previously estimated by management.
Impairment of Fixed Assets. In 2003, an asset impairment charge of $1.2 million was recorded for production equipment in International operations as part of the closure of a manufacturing facility. There was no impairment of fixed assets in 2004.
Income from Operations. As a result of the items discussed above, income from operations increased $2.8 million or 398.4% from $0.7 million in 2003 to $3.5 million in 2004. Operating margin as a percent of sales increased from 0.9% to 3.5%.
Interest Expense, Net. Net interest expense decreased from $0.6 million in 2003 to $0.5 million in 2004. The decrease was attributable to lower amortization of prepaid bank origination fees in 2004. Total debt and interest expense increased in August due to the acquisition of Bushman Tanks.
Income Taxes. Income tax expense decreased from $0.2 million in 2003 to ($0.8) million in 2004. The effective tax rate of 159% in 2003 compares to (26.5%) in 2004. The decline is due to an ordinary worthless stock deduction in 2004 offset by an increase in the valuation allowance. The worthless stock deduction is associated with the United Kingdom operations. As a result of the decision to close the manufacturing facility in the United Kingdom, an independent party was commissioned to appraise the value of the legal entity. The appraisal concluded that the entity was financially insolvent. Being insolvent, the entity therefore met the requirements for a worthless stock deduction.
Comparison of Year Ended December 31, 2003 with Year Ended December 31, 2002
The Company implemented actions in 2002 and 2003 to restructure the Company due to decreased demand in the telecommunications industry. These actions resulted in a lower cost structure, a return to a positive income from operations, lower debt and an increase in the Companys cash balance. Shown below are the sales, income from operations, loss per share, debt and cash balance for 2001, 2002 and 2003:
In the fourth quarter of 2003, the Company further evaluated International operations to improve profitability. A plan was developed to close a manufacturing facility in International operations by mid-year 2004. Additional non-recurring charges were recorded in 2003 as a result of these actions including employee severance benefits, inventory reserves, impairment of assets and facility closure cost. The facility closure cost charge is a revision to restructuring costs recorded in the third quarter of 2001 and the fourth quarter of 2002. The revision is due to a change in the estimated sublease income from vacated facilities based on managements latest estimate.
Net Sales. Net sales decreased $8.3 million or 9.7% from $84.8 million in 2002 to $76.5 million in 2003. The decrease resulted from a slowdown in equipment purchases by telecommunications service providers in both the Americas and International operations.
Americas net sales decreased $5.2 million or 7.4% from $70.0 million to $64.8 million. In 2003, two major broadband operators reduced purchases compared to 2002. One customer reduced purchases as a result of substantially completing its network upgrade program. The second customer reduced purchases in the first half of 2003 due to deterioration in its financial condition and the need to reduce spending. The second customer resumed purchases at a higher level in the second half of 2003. The declines from broadband customers were partially offset by a 16.6% increase in sales from the Companys largest telephone customer, Verizon. In addition, the Americas segment sold $1.5 million of slow moving inventory in 2002 as part of the Companys debt reduction program which also contributed to the period over period sales decline. There were no material sales of slow moving inventory in 2003.
International net sales decreased $3.1 million or 20.8% from $14.8 million to $11.7 million. The decrease in International sales was due to generally depressed industry conditions and lower sales of products discontinued as part of the Companys restructuring program.
Sales to Comcast of $20.7 million in 2003 represented 27.1% of Company sales in the period. Comcast acquired AT&Ts broadband business in the fourth quarter of 2002 thereby increasing its purchases from the Company. The second largest customer in 2003 was Verizon with sales of $8.0 million representing 10.5% of the total. Sales to AT&T of $20.2 million in 2002 represented 23.8% of Company sales for the period. Combined AT&T and Comcast sales for the 2002 period were $23.7 million or 28.0% of the Companys sales in the period. Sales to Time Warner of $8.3 million in 2002 represented 9.8% of Company sales.
Gross Profit. Gross profit decreased $4.7 million from $27.3 million in 2002 to $22.6 million in 2003. 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
that have a lower gross profit 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 still in the start up phase and thus current product costs are higher than those anticipated during full scale production.
In 2002, gross profit was reduced by $0.4 million of special charges in the fourth quarter to write down inventory of discontinued products. In 2003, gross profit was reduced by $0.1 million of special charges to write down inventory as part of the closure of an International manufacturing facility. Excluding the special charges in both years, gross profit decreased $5.0 million from $27.7 million in 2002 to $22.7 million in 2003.
As a percentage of net sales, gross profit decreased from 32.2% in 2002 to 29.5% in 2003. Excluding the special charges recorded in both years, gross profit as a percentage of net sales decreased from 32.7% in 2002 to 29.7% in 2003. The reasons for the decrease are the same as those noted above for gross profit dollars.
Selling. Selling expenses increased $0.2 million or 2.4% from $9.3 million in 2002 to $9.5 million in 2003. The increase is primarily in freight costs due to higher fuel prices and an increase in full truckload shipments to customers in which the Company pays the freight costs.
As a percentage of net sales, selling expense increased from 10.9% in 2002 to 12.4% in 2003. The higher percentage is primarily due to the reasons noted above.
General and Administrative. General and administrative expenses decreased $3.7 million or 32.7% from $11.4 million in 2002 to $7.7 million in 2003. The year 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 a major broadband customer. Excluding the charge, general and administrative expense decreased by $1.7 million or 18.4%. 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 10.1% in the 2003 period. Excluding the charge for bad debt, general and administrative expenses as a percentage of net sales were 11.1% in the 2002 period and 10.1% in the 2003 period.
Research and Development. Research and development expenses increased $0.3 million or 17.5% from $1.6 million in 2002 to $1.9 million in 2003. The increase is due to spending on projects for new product development in connectivity and thermoplastic enclosure product lines. As a percentage of net sales, research and development expenses increased from 1.9% in 2002 to 2.5% in 2003.
Restructuring charge. In the fourth quarter of 2002, the Company initiated actions to improve profitability in International operations. The actions taken included head count and facility square footage reductions in International operations. In addition, the management of International operations was consolidated under one management team. Restructuring charges of $1.2 million were recorded in 2002 as a result of these actions.
Impairment of Fixed Assets. In 2002, an asset impairment charge of $2.2 million was recorded for production equipment in International operations as part of the rationalization and downsizing of International manufacturing operations and for tooling associated with products discontinued in the Americas.
In 2003, an asset impairment charge of $1.2 million was recorded for production equipment in International operations as part of the closure of a manufacturing facility.
Impairment of Goodwill. In 2002, a goodwill impairment charge in the International segment was recorded for $1.0 million. This impairment charge resulted in the full amortization of the goodwill associated with the A.C. Egerton acquisition.
There were no goodwill impairment charges in 2003.
Income (Loss) from Operations. As a result of the items discussed above, income from operations was unchanged at $0.7 million in both 2002 and 2003. Operating margin as a percent of sales increased from 0.8% to 0.9%.
Interest Expense, Net. Net interest expense decreased from $2.0 million in 2002 to $0.6 million in 2003. The decrease was attributable to the lower level of debt in 2003.
Income Taxes. Income tax expense decreased from $1.7 million in 2002 to $0.2 million in 2003. The effective tax rate of 129% in 2002 compares to 159% in 2003. The higher tax expense in 2002 was primarily attributable to an increase in the
valuation allowance for deferred tax assets related to net operating loss carry forwards of foreign subsidiaries. The increase in valuation allowance was due to the uncertainty of future taxable income in these subsidiaries. In both years, the Company recorded a tax expense for income earned in the Americas. In both years, a tax benefit was not recorded for foreign operating losses in International operations due to the uncertainty of the realization of the tax loss carry forwards.
Liquidity and Capital Resources
Cash and cash equivalents on December 31, 2004 were $5.5 million, a decrease of $4.1 million from the December 31, 2003 balance of $9.5 million. The decrease was due to cash used for the acquisition of the Bushman Tanks business partially offset by cash generated from on going operations and a decrease in working capital primarily due to a larger accounts payable balance.
Net cash used by investing activities was ($20.7) million in 2004 as compared to net cash provided by investing activities of $1.2 million in 2003. In the 2004 period, the Company acquired the Bushman Tanks business. Capital expenditures for property and equipment were higher in the 2004 period due to equipment required to refacilitate manufacturing facilities in the Americas as part of the transfer of operations previously performed in Europe. In the 2003 period, the Company sold a building in the U.K. for $2.2 million.
Net cash provided by financing activities in 2004 was $8.3 million compared to net cash used of ($2.7) million in 2003. In the 2004 period, the Company acquired the Bushman Tank business and financed the purchase with a term loan from The National Australia Bank Ltd. and equity provided by ANZ Private Equity. In the 2003 period, the Company repaid debt.
Accounts receivable increased from $10.1 million at December 31, 2003 to $13.9 million at December 31, 2004 primarily to due the addition of the acquired company and the higher level of sales. In terms of days sales outstanding, accounts receivable decreased from 44 days at December 31, 2003 to 37 days at December 31, 2004.
Inventories increased from $8.9 million at December 31, 2003, to $14.2 million at December 31, 2004. The increase is due to the addition of the acquired company and due to additional inventory necessary to meet the higher sales demand. Days inventory on hand decreased from 55 days at December 31, 2003 to 52 days at December 31, 2004.
Accounts payable increased from $5.1 million at December 31, 2003 to $16.1 million at December 31, 2004. Days payables increased from 32 days to 59 days, respectively. The increase is due to the addition of the acquired company in the consolidated financial statements, a higher percentage of product being purchased versus produced in house, higher inventory purchases to meet sales demand and the extension of vendor payment terms.
The Company and its subsidiaries have entered into the following financing arrangements:
1. On September 25, 2002, the Company entered into a three-year Loan and Security Agreement with an asset-based lender in the United States. The Loan and Security Agreements 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 December 31, 2004, the outstanding balance of the term loan was $2.8 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 lenders base rate. The weighted average interest rate under the Loan and Security Agreement at December 31, 2004 was 4.41%.
The Loan and Security Agreement contains various financial and operating covenants that impose limitations on the Companys 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 December 31, 2004 with the covenants of the Loan and Security Agreement.
2. In July 2004, a subsidiary of the Company located in Australia, Channell Pty Ltd., entered into a one-year Loan and Security Agreement with a commercial bank in Australia. The Loan and Security Agreement contains a revolver line of credit for working capital needs. The agreement is reviewed annually with the bank for yearly renewals. At December 31, 2004 the outstanding balance of the facility was $0.2 million.
Under the Loan and Security Agreement, the balance bears interest payable monthly at a variable rate based on the lenders base rate. The weighted average interest rate at December 31, 2004 was 6.75%.
The Loan and Security Agreement contains various financial and operating covenants that impose limitations on Channell Pty Ltd.s ability, among other things, to incur additional indebtedness, merge or consolidate and sell assets except in the ordinary course of business. Channell Pty Ltd. is also required to comply with an interest coverage ratio. Channell Pty Ltd. was in compliance as of December 31, 2004 with the covenants of the Loan and Security Agreement.
3. On August 2, 2004, a subsidiary of the Company, Channell Bushman Pty Ltd., entered into a five-year Loan and Security Agreement with a commercial bank in Australia. Channell Bushman Pty Ltd. is the holding company established to acquire the Bushman Tanks business. The Loan and Security Agreements initial term loan balance of $5.8 million was used as part of the consideration paid to acquire the Bushman Tanks business. The five-year term loan is repayable in quarterly payments based on a five-year amortization schedule. The loan and security agreement also includes a revolving credit facility, reviewed annually, for working capital needs in the amount of $1.4 million, a capital expenditure line of credit in the amount of $4.2 million and a $1.2 million facility to fund future earn out payments to the seller if the Bushman Tanks business achieves specified performance targets in 2005 and 2006. The Loan and Security Agreement is guaranteed by Channell Pty Ltd., a subsidiary of the Company in Australia. At December 31, 2004, the outstanding balance of the term loan was $5.6 million and $0.0 million on the revolving line of credit. There were no advances on either the capital expenditure line of credit or the earn line credit facility.
Under the Loan and Security Agreement, the outstanding balance bears interest payable monthly at a variable rate based on the lenders base rate. The weighted average interest rate under the Loan and Security Agreement at December 31, 2004 was 5.75%.
The Loan and Security Agreement contains various financial and operating covenants that impose limitations on Channell Bushman Pty Ltd.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. Channell Bushman Pty Ltd. is also required to comply with a Debt/EBIT ratio, capital adequacy ratio, debit service coverage ratio and interest coverage ratio. Channell Bushman Pty Ltd. was in compliance as of December 31, 2004 with the covenants of the Loan and Security Agreement.
4. On August 2, 2004, the Company and Channell Bushman Pty Ltd. entered into an Investment and Shareholders Agreement with a private equity firm in Australia. The private equity investment was obtained as part of the financing of the Bushman Tanks acquisition. The private equity party invested $2.6 million, the net amount received after paying a capital raising fee, for ownership of 25% of the outstanding and voting shares of Channell Bushman Pty Ltd. As part of the agreement, the private equity party has the right to appoint one member of the Board of Directors of Channell Bushman Pty Ltd. with the Company appointing the remaining three members. The agreement specifies that certain actions taken by the Board of Directors require unanimous approval, among other things, a proposal to sell all or substantially all of the assets of Channell Bushman Pty Ltd., material asset acquisitions or disposals not included in the annual business plan, any plan to limit or dissolve the business, the issuance of any securities, capital restructuring, granting of a security interest on assets and related party transactions.
It is the intent of the private equity party to exit its investment in Channell Bushman Pty Ltd. within 5 years. The Agreement contains clauses to facilitate the exit of the private equity party. The agreement specifies that after two years, the Company has an option to acquire all of the shares owned by the private equity party. The agreement specifies that the value of the shares is to be fair market value as determined by an independent appraiser. There are no minimum or maximum amounts specified in the agreement. After five years, both the Company and the private equity party have the right to initiate a sale of Channell Bushman Pty Ltd. At such time, the other party may elect to buy out the shares of the party initiating the sale at the fair market value as determined by an independent appraiser. Otherwise, Channell Bushman Pty Ltd. would be offered for sale with the assistance of a financial advisor.
Contractual obligations, consisting principally of payment for noncancellable operating lease obligations, long term debt and capital leases. Future payments required under these contractual obligations have been summarized in the notes to the Consolidated Financial Statements as follows: (i) lease commitments Note M, (ii) long term debt Note F, and (iii) capital lease obligations Note G.
The Company believes that cash flow from operations should be sufficient to fund the Companys capital expenditure and working capital requirements through 2005.
Contractual Obligations and Other Commitments
The following table summarizes the Companys contractual obligations and other commitments as of December 31, 2004:
(1) The Company entered into a three-year Loan and Security Agreement which includes a term loan and revolver line of credit with an asset-based lender in the United States on September 25, 2002. The Company entered into a one-year Loan and Security Agreement which includes a revolver line of credit with a commercial bank in Australia in July 2004. The Company also entered into a five-year Loan and Security Agreement which includes a term loan and revolver line of credit with a commercial bank in Australia in August 2004. See Note F to the Consolidated Financial Statements.
(2) The Company leases manufacturing and office space and machinery & equipment under several operating leases expiring through 2012. See Note M to the Consolidated Financial Statements.
(3) The Company has employment agreements with its Chairman of the Board expiring July 7, 2006 and its President and Chief Executive Officer expiring December 8, 2008. Both contracts are renewable every 5 years. The Chairman of the Boards salary is set at $50,000 per annum for the remainder of the term. The President and Chief Executive Officers base salary is $745,616 per year effective July 2004, and is subject to an annual cost of living increase based on the consumer price index. Base salary may also be increased based on the discretion of the Board of Directors. In the event the President and Chief Executive Officer is terminated the Company will be obligated to make a lump sum severance payment equal to three times his then current base salary.
(4) The Company believes it 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 or multi-year pricing agreements to stabilize costs and improve supplier delivery performance. The Company is not contractually obligated to purchase product over the life of these agreements.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist of operating leases, employment contracts and purchase obligations as described above. In addition, as discussed in Note L to the Consolidated Financial Statements, the Company guaranteed debt of the Companys principal stockholder and Chairman of the Board of approximately $0.8 million in 1997. 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 unsecured guarantee is expected to decline before expiring in 2017. 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. The Company has not recorded a liability for this guarantee. If the principal stockholder were to default on the outstanding loan balance, the Company may be required to repay the remaining principal balance. The maximum potential amount the Company would be required to pay is equal to the outstanding principal and interest balance of the loan to the stockholder. At December 31, 2004, the outstanding loan balance subject to the guarantee totaled $0.6 million.
Forward-Looking Statements and Risk Factors
Certain statements contained in this Annual Report on Form 10-K/A-1 are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act), which provides certain safe harbor provisions for forward-looking statements. All forward-looking statements made in this Annual Report on Form 10-K/A-1 are made pursuant to the Act. Forward-looking statements include statements which are predictive in nature; which depend upon or refer to future events or conditions; or which include words such as expects, anticipates, intends, plans, believes, estimates, or variations or negatives thereof or by similar or comparable words or phrases. In addition, any statement concerning future financial performance, ongoing business strategies or prospects, and possible future Company actions that may be provided by management are also forward-looking statements as defined by the Act. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about the Company; and economic and market factors in the countries in which the Company does business, among other things. These statements are not guarantees of future performance, and the Company has no specific intentions to update these statements.
Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The principal important risk factors that could cause the Companys actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, the risk factors discussed below.
Obsolescence and Technological Change. The 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 Companys 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. Further, while 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 growth of wire-line networks, 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 Companys business. The Companys 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 continue or that the Companys products will be met with market acceptance.
Importance of New Product Development to Growth. A significant factor in the Companys ability to grow and remain competitive will be its ability to anticipate changes in technology, industry standards and customer preferences, 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. Trends in consumer preferences in Australia for the aesthetic design of water storage tanks may require the Company to redesign or develop new water tanks and accessory products.
The Companys 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 Companys business, operating results and financial condition.
Concentration of Customers. The telecommunications industry is the largest industry the Company operates in and is highly concentrated. A relatively small number of customers account for a large percentage of the Companys available market. Consequently, the Companys five largest customers accounted for 57.7% and 48.7% of the Companys total net sales in 2003 and 2004, respectively. Verizon accounted for 21.7% of the Companys total net sales in 2004 and 10.5% of the Companys net sales in 2003. Comcast accounted for 14.6% of the Companys total net sales in 2004 and 27.1% of the Companys net sales in 2003. Mergers and acquisitions in the telecommunications industry, which are expected to continue, not only increase the concentration of the industry and of the Companys customer base but also from time to time delay customers capital expenditures as newly merged service providers consolidate operations. In the event one of the Companys major customers were to terminate purchases of the Companys products, the Companys operating results would be adversely affected.
Dependence on the Telecommunications Industry. Although the Company has recently diversified a portion of its business with the acquisition of Bushman Tanks, a manufacturer of water storage tanks, 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 service providers for constructing, rebuilding, maintaining or upgrading their systems. The amount of capital spending and, therefore, the Companys sales and profitability, are affected by a variety of factors, including general economic conditions, access by service providers to financing, government regulation of service providers, demand for services and technological developments in the telecommunications technology. While the industry generally experienced above average growth in the late 1990s, since 2001 the telecommunications equipment industry has been materially adversely affected by service providers reductions of their capital expenditures.
The Companys success is dependent upon continued demand by the communications industry for products used in signal transmission systems which may be affected by factors beyond the Companys control, including the convergence of video, voice, and data transmission systems occurring within the broadband and telephone markets, continuing consolidation of companies within those markets and the provision of Internet access by broadband operators and local telephone companies.
Limited Backlog. The Companys customers typically require prompt shipment of the Companys 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
Companys customers generally do not enter into long-term supply contracts providing for future purchase commitments for the Companys products. These factors, when combined with the Companys 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 Companys operating results at risk to changing customer buying patterns. If sales levels in a particular period do not coincide with the Companys expectations, operating results for that period may be materially and adversely affected.
Price Fluctuations of Raw Materials; Availability of Complementary Products. The Companys cost of sales may be materially affected by increases in the market prices of the raw materials, including resins, used in the Companys manufacturing processes. The Company does not engage in hedging transactions for such materials, although it periodically enters into purchase agreements 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 Companys 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, including grade level boxes that complement the products manufactured by the Company. 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 Companys own products.
Energy Costs and Availability. The Companys cost of sales may be materially affected by increases in the market prices of electricity, natural gas and water used in the Companys manufacturing processes. California is the site of the Companys largest manufacturing operation. The energy costs of California manufacturing firms may increase. There exists the possibility of interruption(s) in the supply of energy to Californias manufacturing firms. There can be no assurance that the Companys energy costs can be passed on to the Companys customers through increases in product prices. Further, disruptions or delays in the supply of electricity, natural gas and water to the Company could have a material adverse effect on sales of the Companys products.
Acquisitions and Failure to Integrate Acquired Businesses. In the event of any acquisition by the Company, there can be no assurance that the Company will be able to identify and acquire attractive acquisition candidates, profitably manage any such acquired businesses or successfully integrate such acquired businesses into the Company without substantial costs, delays or other problems. Acquisitions involve a number of special risks, including, but not limited to, adverse short-term effects on the Companys reported financial condition or results of operations, diversion of managements 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 Companys business, financial condition or results of operations.
The Company acquired Bushman Tanks in August 2004. The successful integration of this business into Channell requires among other things the retention of key personnel, the implementation of the Oracle information system used by all Channell businesses, the implementation of financial accounting and internal controls required by all U.S. publicly owned corporations, the time and attention of Channell executive management, the integration of management styles and culture as well as the hiring of people necessary to implement the aforementioned items and to expand the business
In addition, there can be no assurance that any businesses acquired in the future will be profitable at the time of acquisition or will achieve sales and profitability justifying the Companys 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 acquisitions could have a material adverse effect on the Companys business, financial condition and results of operations.
Operating Leverage. Because the fixed costs of facilities, product development, engineering, tooling and manufacturing are a relatively high percentage of total costs, the Companys ability to operate profitably 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 has had in the past and could have in the future a disproportionately adverse effect on the Companys financial results.
Seasonality and Fluctuations in Operating Results. The Companys business is 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 Companys telecommunications products. In addition, first quarter sales may also reflect telecommunication customer delays in implementation of their annual capital expenditure plans. The water storage tank business in Australia is traditionally slow during the fourth quarter due to holidays and restrictions on the number of days in which large trucks can utilize major roads to deliver water storage tanks to customers. The Companys 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 introductions and deployment as well as the availability of products by the Company or its competitors, weather conditions in Australia which may affect the sales of water storage tanks as a large percentage of sales occur at outdoor agricultural farm fairs, the
overall level of capital expenditures by broadband operators and telephone companies, market acceptance of new and enhanced versions of the Companys products, variations in the mix of products the Company sells, and the availability and costs of raw materials.
Risks Associated with International Operations. International sales, including export sales from U.S. operations, accounted for 23.8%, 21.2% and 33.9% of the Companys net sales in 2002, 2003 and 2004, respectively. The percentage of international sales to total Company sales has increased with the acquisition of the Bushman Tanks business. 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, 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 Companys business.
Competition. The industries in which the Company operates are highly competitive. The level and intensity of competition may increase in the future. The Companys competitors in the telecommunications industry include companies that are much larger than the Company, such as Tyco, 3M, Marconi, Arris and Corning. The Companys business strategy includes increased focus on telephone connectivity. There can be no assurance that the Company will be able to compete successfully against its competitors, most of whom have access to greater financial resources than the Company. The Companys competitors in the Australian water storage tank business includes Nylex which is much larger than the Company as well as smaller companies that have market position in specific geographic regions. There can be no assurances that the Company will be able to successfully compete against these competitors or increase its sales by obtaining a higher market share.
Disruptions at the Companys Manufacturing Facility; Lease with Related Party. The majority of the Companys manufacturing operations are currently located at the Companys facilities in Temecula, California, which also includes the Companys principal warehouse and corporate office operations. The Companys success depends in large part on the orderly operation of these facilities. Because the Companys manufacturing operations and administrative departments are concentrated at this facility, a fire, earthquake, power interruption or other disaster at this facility could materially and adversely affect its business and results of operations. The Company maintains property insurance on this facility as well as business interruption insurance.
The Company currently leases a portion of its Temecula facilities from William H. Channell, Sr., a principal stockholder and Chairman of the Board 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 arms 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 additional renewal terms 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 effect on the Companys business, financial condition or results of operations.
The Company currently leases four facilities in Australia from the former owners of Bushman Tanks. Although the Company believes these leases are in total in excess of fair market value by $27,000 per year, the Company does not believe that amount is significant compared to total manufacturing costs and thus does not place it in a competitive disadvantage. Although the Company also has renewal options through the year 2015 under these leases, there can be no assurance that the Company and then former owners will be able to agree on additional renewal terms 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 effect on the Companys business, financial condition or results of operations.
Dependence on Key Personnel. The future success of the Company depends in part on its ability to attract and retain key executive, engineering, marketing and sales personnel. Key personnel of the Company include William H. Channell, Sr., Chairman of the Board, William H. Channell, Jr., President and Chief Executive Officer and the other executive officers of the Company. The market for qualified personnel in the communications industry is competitive and the loss of certain key personnel could have a material adverse effect on the Company. The Company has employment contracts with William H. Channell, Jr. and William H. Channell, Sr.
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 Companys domestic customers. Changes in current or future laws or regulations, in the United States or elsewhere, could materially adversely affect the Companys business. Government regulation in Australia has increased demand for water storage tanks through the offering of rebates to those whom purchase water tanks and by requiring the installation of water storage tanks or other water conservation products in
new homes built in selected regions. There can be no assurances that these regulations will remain in affect. A lessening of these regulations most likely would lead to lower demand for water storage products and thus negatively affect the Companys sales.
Uncertain Ability to Manage Industry Volatility. The Companys business has required and is expected to continue to require significant Company resources in terms of personnel, management and other infrastructure. The Companys ability to manage effectively the volatility of the telecommunications industry requires 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.
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 or could be classified as hazardous or similar substances. Although management believes that the Companys operations are in compliance in all material respects with current environmental laws and regulations, the Companys failure to comply with such laws and regulations could have a material adverse effect on the Company.
Weather Matters. The Company business may be affected by adverse changes in weather patterns in Australia that may affect the demand for water storage tanks. Australia is currently experiencing a severe water shortage due to less rainfall, inadequate national infrastructure to store water for use during drought periods and the growth in population in non urban areas. A change in the weather pattern which provides additional rainfall and lessens the affect of the drought could have a negative impact on the demand for water storage tanks.
Selected Quarterly Financial Data
Set forth below is certain unaudited quarterly financial information. (See also Note P to the Consolidated 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.
The market risk inherent in the Companys 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.
The Company and its subsidiaries have entered into three financing agreements. In September 2002, the Company entered into a three-year Loan and Security Agreement with an asset based lender in the United States. The agreement contains a term loan and a revolver line of credit. In July 2004, the Company entered into a one-year Loan and Security Agreement which contains a revolver line of credit with a commercial bank in Australia. In August 2004, the Company entered into a five-year Loan and Security Agreement which contains a term loan and revolver line of credit with a commercial bank in Australia. The loan and security agreements allow for the outstanding balance to bear interest at a variable rate based on the lenders base rate. The credit facility exposes operations to changes in short-term interest rates since the interest rates on the credit facility are variable.
If the variable rates on the Companys loan and security agreements were to increase by 1% from the rate at December 31, 2004, and if the Company had borrowed during all of fiscal 2004 the maximum amount (approximately $39 million) at any time in 2004 under its credit facility at the increased interest rate, the Companys interest expense would have increased, and net income would have decreased by $0.2 million. A marginal income tax rate of 38.0% was used in this analysis. This analysis does not consider the effects of economic activity on the Companys sales and profitability in such an environment.
Foreign Exchange Risk
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 Companys investment in foreign subsidiaries with a functional currency other than the U.S. dollar are generally considered long-term. Accordingly, the Company does not hedge these net 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 exchange and other similar contracts to reduce its economic exposure to changes in exchange rates because the associated risk is not considered significant.
Consolidated Financial Statements of Channell Commercial Corporation are as follows:
Financial statement schedules are as follows:
Schedule II - Valuation and Qualifying Accounts
All remaining schedules are omitted because they are not applicable, or the required information is included in the financial statements or the notes thereto.
There has been no change of accountants or disagreements on any matter of accounting principle, practice, financial statement disclosure or auditing scope or procedure during the period covered by this report.
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934 (the Exchange Act), that are designed to ensure that information required to be disclosed in the Companys Exchange Act reports are recorded, processed, summarized, and reported within the time periods specified in rules and forms of the Securities and Exchange Commission regulations, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of December 31, 2004, the management of the Company carried out an assessment concluding that the Companys disclosure controls and procedures were not effective as of December 31, 2004, because of the material weaknesses described below.
Due to the material weaknesses described below, the Companys management performed additional analyses and other post-closing procedures including reviewing all significant account balances and disclosures in the consolidated financial statements contained in this Annual Report on Form 10-K/A, to ensure the Companys consolidated financial statements are in accordance with accounting principles generally accepted in the United States of America. Accordingly,
management believes that the consolidated financial statements included in this Annual Report, fairly present in all material respects, the Companys financial condition, results of operations, and cash flows for all periods presented.
Managements Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Companys assets that could have a material effect on the interim or annual consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Companys management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2004. In performing its assessment of the effectiveness of the Companys internal control over financial reporting, management applied the criteria described in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management identified the following control deficiencies which represent material weaknesses in the Companys internal control over financial reporting as of December 31, 2004:
The Company did not maintain effective controls over the accuracy of its accounting for income taxes and the determination of income taxes payable, deferred income tax assets and liabilities and the related income tax provision. Specifically, the Company did not have effective controls to accurately calculate current income tax expense. In addition, the Company did not have effective controls to monitor the difference between the income tax basis and the financial reporting basis of assets and liabilities and reconcile the difference to its deferred income tax asset and liability balances. This control deficiency resulted in restatements to the Companys 2002, 2003, and 2004 annual consolidated financial statements to correct deferred taxes and the tax provisions. Additionally, this control deficiency could result in a misstatement of deferred taxes, tax accruals and the tax provision that would result in a material misstatement to the Companys interim or annual consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency constitutes a material weakness.
The control deficiency described above could result in a misstatement of the aforementioned accounts or disclosures that would result in a material misstatement to the Companys interim or annual consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that the control deficiencies described above constitutes a material weakness.
Changes in Internal Control Over Financial Reporting
During the fourth quarter of the year ended December 31, 2004, there were no changes in the Companys internal control over financial reporting that have materially affected, or was reasonably likely to materially affect, our internal control over financial reporting.
Recent Developments Relating to the Companys Internal Control Over Financial Reporting
The Company is implementing enhancements and changes to its internal control over financial reporting to remediate the material weakness described above. This remediation began in 2005.
The Company has enhanced the competence of the organization by hiring staff competent in accounting principles generally accepted in the United States of America (GAAP), and the Company will continue to enhance its financial
accounting and reporting competencies by recruiting additional qualified staff and further developing its existing staff by reinforcing existing continuing education programs.
The Companys Audit Committee meets regularly with management and the independent accountants to review accounting, auditing, financial matters and internal control structure. The Audit Committee and the independent accountants have free access to each other, with or without management being present.
There were no events required to be reported on Form 8-K during the fourth quarter of 2004 that were not so reported.
The following table sets forth information with respect to the Companys executive officers and directors and their ages as of March 4, 2005.
(1) Audit Committee Member
(2) Compensation Committee Member
The Companys Board of Directors was comprised of seven members at March 4, 2005. 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 Companys founder, James W. Channell, has been the Chairman of the Board since July, 1996. From 1966 to November, 2001 and from July, 2002 to December, 2003 Mr. Channell, Sr. was Chief Executive Officer. 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 term as a Director expires in 2005.
William H. Channell, Jr. has been President and Chief Executive Officer since December, 2003. He was President and Chief Operating Officer of the Company from 1996 to December, 2003. 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 2006.
Jacqueline M. Channell is Secretary and has been a Director since 1966 except for approximately three months in 2001. 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. Channells term as a Director expires in 2006.
Guy Marge became a Director of the Company in August, 2002. Mr. Marge is President and Chief Executive Officer of Western Brass Industries, Inc. and Storm Industries, Inc. From 1988 to 2001, Mr. Marge was Chief Executive Officer of the Milhous Group, Inc., a manufacturer of plastic, metal-formed and pre-cast concrete products. From 1978 to 1988, Mr. Marge held executive management positions with Kearney-National, Inc., The United Groups, Inc., and Uniroyal Technology Corporation. Mr. Marges term as a Director expires in 2007.
Dana Brenner became a Director of the Company in March, 2003. Mr. Brenner is the managing partner of Brenner, Bigler & Associates, an accounting firm with offices in Woodland Hills and Blythe, California, focused on medium and small businesses as well as individuals. Mr. Brenner has over 35 years of public accounting experience with companies in
various industries including manufacturing, construction, real estate, mortgage banking and credit unions. Mr. Brenners term as a Director expires in 2005.
David Iannini became a Director of the Company in May, 2004. Mr. Iannini is President of MAR & Associates. MAR & Associates provides strategic and investment banking services to public and private companies. Mr. Iannini served as Chief Financial Officer of YP.Net, Inc., from 2002 to 2004. From 1999 to 2002, Mr. Iannini was Treasurer and Vice President of Corporate Development of Viad Corp. Mr. Iannini was an investment banker primarily with Salomon Brothers from 1986 to 1999. Mr. Ianninis term as a director expires in 2007.
Stephen Gill became a Director of the Company in May, 2004. Mr. Gill has spent 35 years in the aerospace composites manufacturing industry with M.C. Gill Corporation, serving as President and CEO from 1991 to 2001. Mr. Gill has also served on the boards of M. C. Gill Corp, Spaulding Composites and SIR Worldwide, Inc. Mr. Gills term as a director expires in 2007.
Edward J. Burke has been the Companys Vice President, Corporate 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.
Timothy Hankinson joined the Company in 1998 as Managing Director, Australia and Asia as a result of the acquisition of A.C. Egerton PLC. Mr. Hankinson had been Managing Director of A.C. Egerton PLC since 1991. Prior to 1991, Mr. Hankinson had served as General Manager of an Australian aircraft manufacturer. Mr. Hankinson became Managing Director, International in December, 2002.
John B. Kaiser has been the Companys Vice President, North American Sales since 1999. He held the position of Director of Marketing for the Company from 1987 to 1991 and he was Vice President, Broadband Division from 1995 through 1998. Between 1991 and 1995, 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.
Scott Kiefer has been the Companys Corporate Controller since 2002 and was named interim Chief Financial Officer in February of 2005. Mr. Kiefer joined the Company as Manager of Cost Accounting in 2001. From 2000 to 2001 Mr. Kiefer was Chief Accounting Officer of Imaging Technologies Corporation. From 1996 to 2000, Mr. Kiefer was U.S. Controller for Flowserve. From 1992 to 1996 Mr. Kiefer was North American Finance Manager for Flowserve. He has over 20 years of financial, accounting and management experience.
Andrew M. Zogby has been the Companys Vice President, Corporate 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 broadband 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.
Compensation of Directors
Directors who are also officers of the Company (except as indicated below) receive no additional compensation for their services as directors. Prior to 2003, the Companys non-management directors received compensation consisting of an annual retainer fee of $25,000 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. Effective January 2003, the fee for committee meetings was reduced to $500. In November 2004, the Board of Directors approved increasing the annual retainer fee to $50,000 for the Chair of the Audit Committee and to $30,000 for non-Chair members of the Audit Committee. These increases are effective January 2005. The Board of Directors also approved an additional payment of $10,000 to the Chair of Audit Committee for 2004. Mrs. Channell also receives non-management director retainer and attendance fees. In addition, pursuant to the Companys 1996 Incentive Stock Plan (as described below), each non-management director (including Mrs. Channell) received options to acquire 1,000 shares of the Companys Common Stock with an exercise price equal to $11.00 per share, and on the date of each of the Companys 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 Companys 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.
Audit Committee Financial Expert
The Board of Directors has determined that Mr. Dana Brenner qualifies as a financial expert within the meaning of SEC rules. Mr. Brenner is the managing partner of Brenner, Bigler & Associates, an accounting firm with offices in Woodland Hills and Blythe, California. Mr. Brenner has over 35 years of public accounting experience with companies in various industries, including manufacturing, construction, real estate, mortgage banking and credit unions. Mr. Brenner is independent as defined by SEC and NASD rules.
Code of Ethics
The Company has adopted a Code of Ethics within the meaning of Item 406(b) of Regulation S-K. This Code of Ethics applies to all employees, including its principal executive officer, principal financial officer and principal accounting officer. This Code of Ethics has been filed as Exhibit 14 to the 2003 Annual Report on Form 10-K. If the Company makes substantive amendments to this Code of Ethics or grants any waiver, including any implicit waiver, the Company will disclose the nature of such amendment or waiver on its web site within five days of such amendment or waiver.
Section 16(a) Beneficial Ownership Reporting Compliance
Information required by Item 405 of Regulation S-K is incorporated by reference to the Companys Proxy Statement relating to its 2004 annual meeting of stockholders.
Summary Compensation Table
The following table sets forth the annual and long-term compensation of the Companys Chief Executive Officer and the four additional most highly compensated executive officers for the years ended December 31, 2002, 2003 and 2004 (collectively, the Named Officers).
1996 Incentive Stock Plan
The Companys 1996 Incentive Stock Plan (the 1996 Stock Plan) currently permits the granting to the Companys key employees, Directors and other service providers of (i) options to purchase shares of the Companys Common Stock and (ii) shares of the Companys Common Stock that are subject to certain vesting and other restrictions (Restricted Stock). Initially, a maximum of 750,000 shares of Common Stock were reserved for issuance under the 1996 Stock Plan. In 1999, the 1996 Stock Plan was amended to allow a maximum of 1,500,000 shares to be issued under the 1996 Stock Plan.
The 1996 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 1996 Stock Plan during any fiscal year of the Company is 100,000. The purpose of the 1996 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.
All options granted under the 1996 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 options 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 1996 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 1996 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 cashiers 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.
In January, 2003, the Board of Directors approved an offer allowing current employees and non-employee directors to exchange all of their outstanding options granted under the 1996 Stock Plan for new options to be granted under the 2003 Stock Plan or any other stock option plan that may be adopted by the Company. At the time the Board approved the offer, certain employees and non-employee directors outstanding options had exercise prices that were significantly higher than the current market price of the Companys common stock. The Board of Directors made the offer in order to provide these option holders with the benefit of owning options that, over time, may have a greater potential to increase in value. The Board of Directors believes that this will create better performance incentives for these option holders. The offer expired on March 20, 2003. A total of 1,326,890 options to purchase shares of the Company were accepted for exchange and cancelled on March 20, 2003. The 2003 Incentive Stock Plan was approved at the Annual Meeting of Stockholders on April 25, 2003. On September 24, 2003, a total of 1,324,090 new options were exchanged for options cancelled in March, 2003.
Eligible option holders who participated in the offer received a new option on the new grant date in exchange for each old option that was validly tendered and accepted for exchange. The number of shares covered by each new option was equal to the number of shares covered by the old options, and the vested status and vesting schedule of the old options was preserved and continued. The exercise price of the new options was equal to the closing sale price of the Companys common stock as reported on the Nasdaq National Market on the grant date of the new options.
2003 Incentive Stock Plan
The Companys 2003 Incentive Stock Plan (the 2003 Stock Plan) currently permits the granting of (i) incentive stock options to purchase shares of the Companys Common Stock to employees of the Company and the Companys subsidiaries and (ii) nonqualified stock options to purchase shares of the Companys Common Stock to employees, Directors and consultants of the Company and the Companys subsidiaries. The 2003 Stock Plan also permits the granting of shares of the Companys Common Stock (Stock Awards) that are subject to vesting restrictions based on continued employment or attainment of performance goals (Restricted Stock) to employees, Directors and consultants of the Company and the Companys subsidiaries. Incentive stock options and nonqualified stock options are granted subject to the terms of a stock option agreement entered into between the participant and the Company. A maximum of 3,100,000 shares of Company Common Stock are reserved for issuance under the 2003 Stock Plan.
The 2003 Stock Plan is administered by the Compensation Committee of the Board of Directors. The aggregate number of stock options that may be granted to any single participant under the 2003 Stock Plan during any fiscal year of the Company is 1,000,000. The purpose of the 2003 Stock Plan is to secure for the Company and its stockholders the benefits arising from stock ownership by employees, directors and consultants selected by the Compensation Committee.
Options granted under the 2003 Stock Plan are non-transferable other than by will or by the laws of descent or distribution and exercisable, during the lifetime of the participant, only by the participant at times and under conditions determined by the Compensation Committee. Each option granted has a term specified in the stock option agreement, but all options expire no later than ten years from the date of grant. Options under the 2003 Stock Plan may be designated as incentive stock options for federal income tax purposes or as nonqualified stock options. In the case of incentive stock options, the exercise price must be at least equal to the fair market value of the share of Company Common Stock on the date the option is granted. The exercise price of a nonqualified stock option need not be equal to the fair market value of the share of Company Common Stock on the date of grant, but may be granted, at the discretion of the Compensation Committee, at any exercise price which is not less than 85% of the fair market value at the time the option is granted. The aggregate fair market value (determined at the time the options are granted) of the shares of Company Common Stock covered by incentive stock options granted to any employee under the 2003 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 an option, the purchase price must generally be paid in full in cash or by cashiers check. However, at the discretion of the Compensation Committee, the terms of a stock option agreement may permit payment of the purchase price by means of (i) delivery of shares of Common Stock already owned by the participant (valued at fair market value as of the date of exercise), (ii) to the extent permitted by applicable law, delivery of a promissory note secured by the shares issued, (iii) delivery of a portion of the shares issuable upon exercise (i.e., exercise for the spread on the option payable in shares), or (iv) any combination of the foregoing or any other means permitted by the Compensation Committee.
Grants of Stock Awards are made pursuant to a restricted stock agreement entered into between the Company and the participant. A stock agreement provides (i) the rate at which shares of Restricted Stock will vest and (ii) any other terms and restrictions deemed appropriate by the Compensation Committee. Until vested, shares of Restricted Stock are generally non-transferable and forfeitable upon termination of employment.
In the event of a merger, reorganization or sale of substantially all of the assets of the Company, the Compensation Committee, may, in its discretion, do one or more of the following: (i) shorten the period during which options are exercisable, (ii) accelerate any vesting schedule to which an option or Stock Award is subject; (iii) arrange to have the surviving or successor entity assume the Stock Awards and the options or grant replacement options or (iv) cancel options or Stock Awards upon payment to the participants in cash, with respect to each option or Stock Award to the extent then exercisable or vested, of an amount that is equal to the excess of the fair market value of the Companys Common Stock (at the effective time of the merger, reorganization, sale or other event) over (in the case of options) the exercise price of the option.
The Board of Directors may at any time amend, alter or suspend or terminate the 2003 Stock Plan. No amendment, alteration or suspension or termination of the 2003 Stock Plan may impair the rights of a participant, unless mutually agreed to by the Company and the participant.
Options/SAR Grants Table
The following table sets forth the stock options granted to the Named Officers for the year ended December 31, 2004.
Aggregated Option/SAR Exercises in Last Fiscal Year and December 31, 2004 Option/SAR Values
The following table sets forth the number and value of outstanding stock options at December 31, 2004. No options were exercised in 2004.
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 Companys contributions are vested over five years in annual increments.
The Company in December, 2003 entered into a five-year employment agreement, renewable every five years, with William H. Channell, Jr. Mr. Channell, Jr.s annual salary is $745,616 effective July 2004, subject to an annual cost of living adjustment. Mr. Channell, Jr. is entitled to participate in the Stock Plan, the 401(k) Plan and the Incentive Compensation Plan. Additionally, the employment agreement provides for incentive compensation to Mr. Channell, Jr., based upon personal performance objectives and increases in the Companys market capitalization over a three-year period. Mr. Channell, Jr. is also entitled to certain other benefits paid for by the Company, including an automobile allowance, health insurance and sick leave, in accordance with the Companys customary practices for senior executive officers. In the event that the Company were to terminate Mr. Channell, Jr. without cause (as defined in the agreement), or Mr. Channell, Jr. were to terminate his employment for good reason (also as defined in the agreement and including, without limitation, a change of control of the Company), then Mr. Channell, Jr. would be entitled to a lump sum payment equal to three times his then current base salary, all health and life insurance benefits for three years, and accelerated vesting of any stock options or restricted stock granted to him.
The Company amended in December, 2003 the employment agreement with Mr. Channell, Sr. originally entered into in July, 1996. Mr. Channell, Sr.s annual salary starting in December, 2003 is $50,000. Mr. Channell, Sr.s benefits 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 Companys senior executive officers, (iii) during Mr. Channell, Sr.s lifetime, a portion of the premiums on a $1,500,000 life insurance policy owned by Mr. Channell, Sr., under which Mrs. Channell is the beneficiary, and (iv) an automobile allowance.
Effective beginning in the Companys 1996 fiscal year, the Board of Directors adopted the Companys 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 is 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 Companys President and Chief Executive Officer, receives a bonus based on the factors above. The bonus was earned and payable based on continued service in subsequent years for fiscal year 2001 and prior. In 2002, the Compensation Committee changed the bonus to be earned and payable in the current year. 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.
The Companys executive compensation program is administered by the Compensation Committee of the Board of Directors. As of March 4, 2005, the members of this Committee included Mr. Guy Marge, as Chairperson, Mr. David Iannini and Mr. Stephen Gill. It is the responsibility of the Committee to review and approve the Companys 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.
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. (See Executive Compensation1996 Incentive Stock Plan, Item 11.)
The following is a line graph presentation comparing the Companys cumulative total return from December 31, 1999 to December 31, 2004 with the performance of the NASDAQ market, the S & P Industrials and a similar Industry Index for the same period.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
AMONG CHANNELL COMMERCIAL CORPORATION,
THE NASDAQ STOCK MARKET (U.S.) INDEX
* $100 invested on 12/31/99 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.
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Board Meetings and Committees
The Board of Directors held 11 meetings during the fiscal year ending December 31, 2004. The Board has two standing committees: the Audit Committee and the Compensation Committee; both established in June 1996. The Board does not have a Nominating Committee. The Audit Committee recommends engagement of the Companys independent accountants, approves the services performed by such accountants and reviews and evaluates the Companys accounting systems and its system of internal accounting controls. All members of the Audit Committee are independent as defined by NASD rule 4200(a)(14). Mr. Brenner is the managing partner of Brenner, Bigler & Associates, an accounting firm with offices in Woodland Hills and Blythe, California. Mr. Brenner has over 35 years of public accounting experience with companies in various industries, including manufacturing, construction, real estate, mortgage banking and credit unions. The Board has adopted a written charter for the Audit Committee. The Compensation Committee makes recommendations to the full Board of Directors regarding levels and types of compensation of the Companys executive officers and administers the 1996 Stock Plan, the 2003 Stock Plan and the Incentive Compensation Plan. See Executive Compensation and Description of Certain Plans. In 2004, the Audit Committee met 7 times and the Compensation Committee met 2 times in performing their responsibilities. In 2004, no director failed to attend at least 75% of the aggregate number of Board and Committee meetings during the period of his or her service.
Compensation Committee Interlocks and Insider Participation in Compensation Decisions
During 2004, members of the Companys Compensation Committee consisted of Messrs. Guy Marge as Chairman, David Iannini and Stephen Gill. No additional information concerning the Compensation Committee or the Companys executive officers is required by Item 402 of Regulation S-K.
Compensation Committee Report
The Compensation Committee Report required by Item 402(k) of Regulations S-K is incorporated by reference to the Companys Proxy Statement relating to the 2005 Annual Meeting of Stockholders.
Information required by Item 201(d) of Regulation S-K is incorporated by reference to the Companys Proxy Statement relating to the 2005 Annual Meeting of Stockholders.
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 Companys outstanding common stock (as provided to the Company by such persons or the record holder of such shares).
Security Ownership of Management
The following table sets forth certain information, as of March 11, 2005, concerning the beneficial ownership of common stock by the Companys directors and Named Officers, and all directors and executive officers of the Company as a group.