Item 1. Business
General developments of business.
Incorporated in Pennsylvania in 1945, Allen Organ Company and Subsidiaries ("Company") operate in four industry segments: musical instruments, data communications, electronic assemblies, and audio equipment.
Industry segments.
The Company operates in four industry segments: musical instruments, data communications, electronic assemblies, and audio equipment. For financial information concerning the segments, see Note 14 to the financial statements.
Description of business.
Musical Instruments.
Allen Organ Company, and its wholly owned subsidiary Rocky Mount Instruments, is a leading manufacturer of electronic keyboard musical instruments, primarily digital electronic church organs and accessories. This segment accounted for 58%, 69% and 81% of revenue in 1997, 1996 and 1995 respectively. The principal market for the musical instruments segment are institutions, primarily churches. Sales to the home market make up a smaller portion of the segment's sales. The segment's musical instruments are distributed mostly through dealers, primarily independent retail music stores throughout the United States, with a lesser percentage distributed through dealers internationally. The segment's business is not seasonal. The principal raw materials used in the segment's products are electronic components and wood, all of which are readily available from various sources without undue difficulty. The segment does not engage in any significant amounts of consignments, extended payment terms, or lease guarantees. The Company is contingently liable in connection with certain customers' financing arrangements. See Note 9 to the financial statements. The dollar amounts and number of times the Company has had to honor these repurchase agreements are negligible. The musical instruments segment is not dependent on any single or small group of customers, the loss of which would have a material adverse effect on the business. The dollar amount of the segment's unshipped order backlog at the end of February 1998 and 1997 was $4.4 million and $2.9 million respectively. Approximately $4.0 million of these orders will be filled in the current year with the remaining $400,000 to be filled in the following year. The electronic organ industry is competitive involving at least five (5) domestic and foreign companies. In addition, there are many small pipe organ companies in the institutional organ market. The organ market consists of two basic divisions, institutional (primarily churches) and home or entertainment. The Company believes it has a major position in the institutional market because of product performance and competitive prices, and a smaller percentage of the home or entertainment market.
Data Communications.
The data communications segment began during 1995 with the acquisition discussed in Note 2 to the financial statements. This segment accounted for 22%, 21% and 9% of revenues in 1997, 1996 and for the 5 month period from acquisition through December 31, 1995 respectively. Data communications products are sold primarily to wholesale and retail distributors worldwide. The segment maintains an inventory of in-process and finished goods to allow for rapid fulfillment of customer orders which is expected in the industry. The principal raw material used in the data communications products are electronic components, which are readily available from various sources without undue difficulty. The data communications segment derived 12% and 14% of its 1997 and 1996 revenue from one customer. The segment operates through three majority owned subsidiaries:
VIR, Inc. (VIR) and Linear Switch Corporation (LSC) During 1997, these two companies combined their marketing and research & development functions under the name of "VIR Linear Switch". The companies design, manufacture, and market a number of data communication products including patch and testing equipment, often referred to as tech control products, test access equipment and a matrix switch which can transport high-speed digital signals and allow "any-to-any" connectivity between and among connections. The products are of varying complexity and are used to connect, switch, test and trouble shoot data lines in large computer installations. The companies compete in a relatively mature field producing high quality products at competitive prices. The companies have approximately four major competitors all of which are larger than VIR/LSC. Since the acquisition, management has been implementing more aggressive sales and marketing programs. With the need for higher speed and more reliable communications circuits increasing, VIR/LSC has introduced a new family of products to provide the ability to access and configure these circuits for various test procedures. In April of 1997, Thomas Infantino was named President of VIR/LSC. Tom brings over 25-years experience in the field including positions at T-Bar, Inc., Dynatech Communications, and Hadax Electronics, Inc. The dollar amount of unshipped order backlog at the end of February, 1998 and 1997 was $555,000 and $234,000 respectively. All orders are expected to be filled in the current year.
Eastern Research, Inc. (ERI) Designs and markets data inter-networking products. These products include direct access equipment that allow users to utilize a broad range of services offered by the telephone companies. The company competes in a market that is in excess of $20 billion. However, the company's current and projected product lines and sales programs are targeted at only a fraction of that market. There are many competitors in this market that is dominated by several large data communications companies, such as Cisco Systems, Inc., Paradyne and ADC Kentrox. The company's strategy has been to target existing, yet still growing, markets with products that provide new features and packaging with attractive pricing. The company initially built its business in the CSU/DSU market and has also developed router technology products, sometimes referred to as "box" products. These products are relatively inexpensive and easy to manufacture, thus this is a competitive field where margins can erode as new products emerge. More recently this company has introduced a Digital Access Cross-connect Switch (DACS), a systems product called DNX (Digital Exchange Network). The DNX is beginning to contribute to revenues and is expected to become ERI's flagship product. The company is integrating additional technologies including its router technology, along with xDSL (Digital Subscriber Line) technology, into the DNX. In order to properly capitalize on this market's opportunities, ERI is implementing a more aggressive marketing strategy and is also increasing product development work. This will require further investment through the coming year. In May 1997, Michael Doyle became ERI's President. Michael Doyle has 20- years experience in the industry including positions at Infotron Systems Inc., Dowty Communications, Inc., Teleos Communications, Inc., and Madge Networks, Inc. The dollar amount of unshipped order backlog at the end of February, 1998 and 1997 was $1.2 million and $376,000 respectively. All orders are expected to be filled in the current year.
Electronic Assemblies.
Allen Integrated Assemblies (AIA), a division of the Allen Organ Company, provides subcontract manufacture of electronic assemblies for outside customers. The electronic assemblies segment is an outgrowth of the technical skills and manufacturing capabilities developed by the Company in its musical instruments business. This segment accounted for 15%, 10% and 10% of revenue in 1997, 1996, and 1995 respectively. AIA derived 55%, 85% and 90% of its revenues from one customer in 1997, 1996 and 1995 respectively. The electronic assemblies segment is very competitive with numerous manufacturers capable of producing such products. Customers are generally obtained from a geographic area close to the manufacturer. The dollar amount of the segment's unshipped order backlog at the end of February 1998 and 1997 was $3.0 million and $764,000 respectively. All orders are expected to be filled in the current year.
Audio Equipment.
The Audio Equipment segment began on April 1, 1997 with the acquisition of Legacy Audio, Inc. (LAI) discussed in Note 2 of the Financial Statements. LAI designs, manufactures and markets high-quality audio speaker cabinets for hi-fi stereo and home theater applications. It also markets electronic audio equipment amplifiers that are manufactured to its specifications by third party suppliers. This segment accounted for 5% of revenues for the 9 month period from acquisition to December 31, 1997. The principal market for the audio equipment segment is individual consumers for home use. The segment's products are primarily distributed directly to the customer with a lesser percentage distributed through dealer audition sites. This segment's business is not seasonal. LAI's manufacturing facility is currently operating near its full capacity. Many of their manufacturing needs are similar to those required in the musical instruments segment. The Company has begun building some of LAI's speaker cabinets at its Macungie, PA facility. The principal raw materials used in the segment's products are audio speakers, electronic components and wood, all of which are readily available from various sources without undue difficulty. The company competes with several other high-end audio speaker cabinet manufacturers including Martin-Logan, Thiel, B&W, Celestion, and others. LAI is not dependent on any single, or small group, of customers. The dollar amount of the segment's unshipped order backlog at the end of February 1998 was $579,000. All orders are expected to be filled in the current year.
General.
The Company's working capital is sufficient to meet the normal expansion of inventory and receivables. The Company spent $2,654,662, $2,786,390, and $1,307,691 annually in 1997, 1996, and 1995 respectively on research and development. The decrease in the 1997 expense relates primarily to the combining of the research and development efforts of VIR and LSC. The majority of the 1996 increase in research and development expense relates to the amounts expended by the data communications segment acquired in 1995. The Company and its subsidiaries employ approximately 580 persons. The Company is not aware of any problem in complying with applicable federal, state, or local provisions with regard to the environment. The manufacturing requirements do not require any special expenditures to meet environmental compliance.
Financial information about foreign operations and export sales.
The Company does not own manufacturing or sales facilities in any foreign countries. See Note 13 to the financial statements, for additional information on export sales. Export sales are all made in US dollars and for the most part are made under Letter of Credit or on a prepaid basis. The Company has established a Foreign Sales Corporation within the meaning of the Internal Revenue Code of 1986. This wholly-owned subsidiary is Allen Organ International, Inc., a Virgin Islands corporation.
Item 2.
Item 2. Properties
The following sets forth the location, approximate square footage and use of the Company's operating locations segregated by segment. The Company believes that its facilities are generally suitable and adequate for its needs.
Approximate Location Square Footage Use
Musical Instruments and Electronic Assemblies: Macungie, Pennsylvania 242,000 Administrative, research and manufacturing facility. Owned by Allen Organ Company. Operating at approximately 90% capacity.
Macungie, Pennsylvania 27,000 International sales, exhibition center, museum and teaching facility. Owned by Allen Organ Company.
Rocky Mount, North Carolina 70,000 Manufacturing and sales facility. Owned by Rocky Mount Instruments. Operating at approximately 85% capacity. Data Communications: Southampton, Pennsylvania 22,000 Administrative, research and manufacturing facility. Leased until July, 2000. Operating at approximately 80% capacity.
Moorestown, New Jersey 16,800 Administrative, sales and research facility. Leased until February, 2001.
Audio Equipment: Springfield, Illinois 15,000 Administrative, research and manufacturing facility. Owned by Legacy Audio, Inc. Operating at approximately 95% capacity.
Item 3.
Item 3. Legal Proceedings
There is no litigation requiring disclosure pursuant to Item 103 of regulation S-K.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 1997.
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters
The Company's Class A voting shares are not registered pursuant to the Securities Exchange Act of 1934 and are not publicly traded. The Company's Class B non-voting stock trades on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol AORGB.
The high and low bid quotations for each quarter during the last two years as reported by NASDAQ Market Information System is as follows:
1997 High Low
First Quarter 41 38 1/2 Second Quarter 41 1/4 39 Third Quarter 40 1/2 38 7/8 Fourth Quarter 44 3/4 39 3/4
1996 High Low
First Quarter 43 1/2 35 1/2 Second Quarter 40 1/2 35 3/4 Third Quarter 40 1/8 37 3/4 Fourth Quarter 39 15/16 38 1/2
The Company has 9 Class A Shareholders and 362 Class B Shareholders of record as of March 23, 1998.
During the past two fiscal years, the Company has declared dividends on both it's class A and B shares as follows:
Record of Quarterly Dividends Paid in 1997
Record Date Payable Amount
Cash 2/21/97 3/7/97 $.14 Cash 5/23/97 6/6/97 $.14 Cash 8/22/97 9/5/97 $.14 Cash 11/21/97 12/5/97 $.14
Record of Quarterly Dividends Paid in 1996
Record Date Payable Amount
Cash 2/16/96 3/1/96 $.13 Cash 5/17/96 5/31/96 $.13 Cash 8/16/96 8/30/96 $.13 Cash 11/15/96 11/29/96 $.16
Item 6.
Item 6. Selected Financial Data
Years Ended December 31, 1997 1996 1995 1994 1993
Net Sales $40,348,084 $36,715,128 $30,024,761 $28,842,789 $26,477,983
Net Income $ 3,512,142 $ 3,865,876 $ 4,015,105 $ 4,449,703 $ 3,456,154
Earnings per share$ 2.79 $ 2.88 $ 2.94 $ 3.25 $ 2.48
Cash dividends per share $ .56 $ .55 $ .55 $ .55 $ .50
At Year End
Total Assets $62,562,004 $63,966,646 $65,299,426 $58,464,695 $55,752,570
Long-Term Debt, net of current portion $ 0 $ 0 $ 1,388,000 $ 0 $ 0
The 1997 results of operations include the audio equipment segment acquired April 1, 1997. The 1997, 1996 and 1995 results of operations include the data communications segment acquired August 1, 1995. See Note 2 of the financial statements for additional information.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources: The Company continues to maintain a strong financial position and high level of liquidity which enables it to generate funds internally to meet operating needs, capital expenditures and short-term obligations. Key indicators of the Company's liquidity are presented below: December 31, 1997 1996 Working Capital $42,445,212 $47,511,096 Current Ratio 15 to 1 29 to 1 Debt to Equity Ratio .06 to 1 .04 to 1
The Company's ratio of debt to equity has remained very low because of management's continuing policy of financing expansion with internally generated funds. This policy has enabled the Company to maintain its competitive advantage without incurring the costs associated with borrowed funds. Cash flows provided by operating activities declined during 1997 compared to 1996 primarily due to increased working capital requirements, particularly accounts receivable and inventory. These increases are due primarily to new product introductions and higher order volumes in most segments. Accounts receivable increased approximately $500,000 and $400,000 in the Data Communications and Electronic Assemblies segments respectively. Inventory increased approximately $900,000, $800,000 and $1,500,000 respectively in the Musical Instruments, Data Communications and Electronic Assemblies segments during 1997. Cash flows provided by operating activities increased during 1996 when compared to 1995 primarily from an approximately $1,000,000 contribution to the company pension plans made in 1995. During 1997 and 1996, cash flows from investing activities were used primarily to fund the purchase of treasury shares. Cash flows from investing activities were also used to fund the acquisition of Legacy Audio, Inc. in April, 1997. During 1997, the company increased its expenditures for property and equipment including approximately $700,000 additional automated equipment and building improvements to enhance its electronics manufacturing capabilities used in the musical instruments and electronic assemblies segments. During 1997 the Company began implementing new information systems and has invested nearly $500,000 in software and computer equipment as part of this project which the Company estimates will require another $300,000 to complete. The Company has undertaken this implementation as part of a business improvement program initiated to up-grade production and product planning processes. While these business improvement programs have and will continue to involve additional expense through 1998, it is anticipated that these improvements will provide long-term benefits in all areas of the Company. See Note 1 to the consolidated financial statements regarding new accounting standards.
Results of Operations:
Sales and Operating Income Consolidated net sales increased $3,632,956 (10%) during 1997 as compared to 1996 primarily due to sales from the audio equipment segment which was acquired in April, 1997 and increased sales in the data communications segment resulting from additional sales and marketing efforts initiated since the acquisition. In 1996, sales increased $6,690,367 (22%) as compared to 1995 primarily due to sales from the data communications segment which was acquired in August, 1995.
December 31, 1997 1996 1995
Net Sales Musical Instruments Domestic $18,918,509 $19,824,334 $18,913,194 Export 4,432,974 5,594,286 5,408,720 Total 23,351,483 25,418,620 24,321,914 Data communications Domestic 6,933,787 6,229,961 1,634,036 Export 2,103,734 1,417,636 1,027,826 Total 9,037,521 7,647,597 2,661,862 Electronic Assemblies Domestic 5,935,381 3,648,911 3,040,985
Audio Equipment Domestic 1,812,138 -- -- Export 211,561 -- -- Total 2,023,699 -- --
Total $40,348,084 $36,715,128 $30,024,761
Income (Loss) from Operations Musical instruments $ 2,718,085 $ 3,634,901 $ 3,332,103 Data communications (1,069,165) (349,785) 122,417 Electronic assemblies 631,521 520,602 457,167 Audio Equipment 337,495 -- -- Total $ 2,617,936 $ 3,805,718 $ 3,911,687
Musical Instruments Segment
The 1997 decrease in domestic sales reflects lower order rates during the early part of the year. New orders in the fourth quarter of 1997 were approximately $500,000 ahead of the same period in 1996. However, the product mix of these orders required production lead times beyond year end and increased the order backlog at year end by approximately $900,000 when compared to 1996. The 1996 increase in domestic sales reflected slight increases in selling prices and product mix changes. Sales in 1996 included more larger models and custom organs. These types of variations, to a large extent, are unpredictable from one year to the next. Export sales decreased in 1997 primarily from changes in economic conditions in certain world markets, particularly Far East countries. Export sales increased in 1996 due to the relative weakness of the US dollar in relation to foreign currencies. Economic changes in foreign countries and foreign exchange rates may affect future export sales. Gross profit margins on sales were 28.1%, 31.8% and 32.8% for the three years ended December 31, 1997. The decrease in the 1997 gross profit margin is a result of start-up expenses of new organ models introduced in May, 1997, increases in overhead costs and lower sales over which to absorb fixed costs. The decrease in the 1996 gross profit margin reflects slight increases in the direct material and labor costs used in the company's products. Selling, administrative and other expenses increased approximately $200,000 in 1997 as a result of marketing and advertising of new products. 1996 expenses were approximately equal to 1995. Research and development expenses increased approximately $40,000 in 1997 related to the new organ models introduced in during 1997.
Data Communications Segment
Domestic sales in each of the last two years have increased as a result of additional sales and marketing efforts initiated since the acquisition. International sales for 1997 increased as compared to 1996 primarily due to additional sales and marketing efforts in those markets. International sales for 1996 decreased when compared to 1995 primarily due to a large order in 1995 which was not repeated in 1996. Each of the companies increased their sales and marketing efforts throughout 1997 and 1996 and expects to continue to do so throughout 1998, which management believes should positively affect future sales and operating results. Gross profit margins were 46% in 1997 compared to 52% in 1996 from competitive pressures on selling prices and variations in product mix. While the companies strive to maintain profit margins by trying to develop products which offer more features at competitive prices, the industry is competitive which often results in pricing changes to obtain and maintain market share. Selling expenses increased approximately $500,000 and $600,000 in 1997 and 1996 respectively, reflecting the additional sales and marketing efforts. Selling expenses will continue to increase in the future as sales and marketing programs and personnel are added to further promote the segment's products and obtain additional market share. Administrative expenses increased approximately $550,000 and $650,000 in 1997 and 1996 respectively, resulting from additional management and support personnel added to promote and oversee the segment. Research and development expenses were $1,799,665 and $1,972,167 for the years ended December 31, 1997 and 1996, respectively and $637,468 for the five months ended December 31, 1995. The 1997 decrease is attributed to the combining of the research and development efforts of VIR, Inc. and Linear Switch Corporation. The segment is committed to new product development and support and expects to increase these expenditures by 30% to 50% during 1998.
Electronic Assemblies Segment
Sales increased during 1997 and 1996 from higher order volume from existing customers and orders received from several new customers. Gross profit margins were 14.5%, 20.0% and 21.0% for the three years ended December 31, 1997. The decrease is related to competitive pressures common in the industry and higher production costs related to inefficiencies in production scheduling caused by rapid growth in sales. Selling, general and administrative expenses have remained approximately the same in each of the last three year periods. The segment continues its marketing efforts and has begun to diversify its customer base. The Company continues to improve its production capabilities to offer state of the art manufacturing services to its customers.
Audio Equipment Segment
Sales for the nine months ended December 31, 1997 increased approximately 40% when compared to the same period in 1996 on a pro forma basis. This increase is a result of increased awareness of the Company through both increased marketing and sales efforts, and positive product reviews in several trade publications during the year. The Company will continue to promote awareness of its products through increased marketing efforts which management believes will continue to positively affect future sales. Gross profit margins were 48.3% in 1997. Selling, general and administrative costs increased approximately $300,000 during 1997 as compared to the same period in 1996 resulting from increased sales and marketing efforts and additional administrative personnel added to support the company's growth.
Other Income (Expense)
The variations in interest income in 1997, 1996, and 1995 are primarily attributable to the yields available on short-term investments, realized gains, and the amounts of principal invested. The 1997, 1996, and 1995 amounts include $765,109, $287,982 and $295,560 of realized capital gains respectively. Interest expense represents interest on the notes payable issued in connection with the acquisition discussed in Note 2 to the financial statements.
Income Taxes
The decrease in the 1997 tax provision is attributable to a decrease in the estimated effective tax rate for the current and prior tax year resulting from a change in state revenue allocations. The effective tax rate increased in 1996 due to a lower amount of tax-free non-operating investment income.
Factors that May Affect Operating Results
The statements contained in this report on Form 10-K that are not purely historical are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding the Company's expectations, hopes, intentions or strategies regarding the future. Forward looking statements include: statements regarding future products or product development; statements regarding future research and development spending and the Company's marketing and product development strategy, statements regarding future production capacity. All forward looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which reflect management's opinions only as of the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q to be filed by the Company in fiscal year 1998. It is important to note that the Company's actual results could differ materially from those in such forward looking statements. Some of the factors that could cause actual results to differ materially are set forth below. The Company has experienced and expects to continue to experience fluctuations in its results of operations. Factors that affect the Company's results of operations include the volume and timing of orders received, changes in the mix of products sold, market acceptance of the Company's and its customer's products, competitive pricing pressures, global currency valuations, the Company's ability to meet increasing demand, the Company's ability to introduce new products on a timely basis, the timing of new product announcements and introductions by the Company or its competitors, changing customer requirements, delays in new product qualifications, the timing and extent of research and development expenses and fluctuations in manufacturing yields. As a result of the foregoing or other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis, which would materially and adversely affect the Company's business, financial condition and results of operations. See Note 1 to the financial statements for information concerning the effects of new accounting standards and Year 2000 issues.
Item 8.
Item 8. Financial Statements See Item 14 for index.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The information required by Item 304(a) of Regulation S-K was previously reported in a Current Report on Form 8-K (items 4 and 7) dated July 31, 1997 to report a change in the Company's independent accountants. There were no reportable events as described in Item 304(b).
KPMG Peat Marwick LLP
4905 Tilghman Street Allentown, PA 18104
Independent Auditors' Report
The Board of Directors Allen Organ Company:
We have audited the accompanying consolidated balance sheet of Allen Organ Company and Subsidiaries as of December 31, 1997, and the related consolidated statements of income, stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Allen Organ Company and Subsidiaries as of December 31, 1997, and the consolidated results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP KPMG Peat Marwick LLP
Allentown, PA January 30, 1998
CONCANNON, GALLAGHER, MILLER & COMPANY, P.C. CERTIFIED PUBLIC ACCOUNTANTS AND BUSINESS CONSULTANTS Michael J. Gallagher, CPA Michael R. Miller, CPA William C. Mason, CPA E. Barry Hetzel, CPA Edward J. Quigley, Jr., CPA John G. Estock, CPA Howard D. Gneiding, CPA Robert A. Oster, CPA Robert E. Vitale, CPA John F. Sharkey, Jr., CPA Victor J. Meyer, CPA David C. Gehringer, CPA Gerard D. Stanus, CPA Robert M. Caster, CPA Anthony M. Bragano, CPA INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders Allen Organ Company
We have audited the accompanying consolidated balance sheet of Allen Organ Company and Subsidiaries as of December 31, 1996 and the related consolidated statements of income and retained earnings, and cash flows for each of the two years in the period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Allen Organ Company and Subsidiaries at December 31, 1996 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
CONCANNON, GALLAGHER, MILLER AND COMPANY, P.C.
Allentown, PA January 30, 1997
Member of AICPA Division for CPA Firms SEC and Private Companies Practice Sections
ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, ASSETS 1997 1996 CURRENT ASSETS Cash $ 1,020,348 $ 781,202 Investments including accrued interest 20,040,334 29,016,935 Accounts receivable 5,732,432 4,817,939 Inventories 17,923,387 14,072,147 Prepaid income taxes 232,895 397,404 Prepaid expenses 483,300 142,769 Total Current Assets 45,432,696 49,228,396
PROPERTY, PLANT AND EQUIPMENT, NET 9,515,012 7,847,515
OTHER ASSETS Prepaid pension costs 795,107 889,206 Inventory held for future service 1,260,346 1,237,986 Note receivable 203,557 163,148 Cash value of life insurance 1,122,495 858,217 Goodwill, net 3,755,483 3,278,114 Intangible and other assets, net 477,308 464,064 Total Other Assets 7,614,296 6,890,735 Total Assets $62,562,004 $63,966,646
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES Accounts payable $ 913,110 $ 396,173 Deferred income taxes 74,091 60,033 Other accrued expenses 692,282 499,355 Customer deposits 1,308,001 761,739 Total Current Liabilities 2,987,484 1,717,300 NONCURRENT LIABILITIES Deferred liabilities 721,264 782,189 Total Liabilities 3,708,748 2,499,489
MINORITY INTERESTS 321,424 157,826
COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Common stock, par value $1 per share Authorized Class A Shares - 400,000 in 1997 and 1996 Class B Shares - 3,600,000 in 1997 and 1996 Issued Common Stock 1997 1996 Class A 127,232 shares; 128,104 shares 127,232 128,104 Class B 1,410,761 shares; 1,409,889 shares 1,410,761 1,409,889 Total Common Stock 1,537,993 1,537,993 Capital in excess of par value 12,758,610 12,758,610 Retained earnings 55,725,180 52,915,056 Unrealized gain on investments, net 128,474 89,380 Sub-total 70,150,257 67,458,865 Less cost of common shares in treasury 1997 - 43,120 Class A shares and 314,155 Class B shares (11,618,425) -- 1996 - 43,120 Class A shares and 170,636 Class B shares -- (5,991,708) Total Stockholders' Equity 58,531,832 61,309,331 Total Liabilities and Stockholders' Equity $62,562,004 $63,966,646
See accompanying notes to Consolidated Financial Statements.
ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997 1996 1995
NET SALES $40,348,084 $36,715,128 $30,024,761
COSTS AND EXPENSES Cost of sales 26,785,916 23,789,872 20,109,427 Selling, administrative and 8,289,570 6,333,148 4,695,956 other expenses Research and development 2,654,662 2,786,390 1,307,691 Total Costs and Expenses 37,730,148 32,909,410 26,113,074
INCOME FROM OPERATIONS 2,617,936 3,805,718 3,911,687
OTHER INCOME (EXPENSE) Investment income 2,114,722 2,025,024 2,115,551 Other income, net 14,443 24,621 26,810 Interest expense -- (10,309) (42,856) Minority interests in consolidated subsidiaries 6,041 55,822 23,913 Total Other Income (Expense) 2,135,206 2,095,158 2,123,418
INCOME BEFORE TAXES ON INCOME 4,753,142 5,900,876 6,035,105
TAXES ON INCOME Current 1,296,000 2,087,000 1,559,000 Deferred (55,000) (52,000) 461,000 Total Taxes on Income 1,241,000 2,035,000 2,020,000
NET INCOME $ 3,512,142 $ 3,865,876 $ 4,015,105
BASIC AND DILUTED EARNINGS PER SHARE $ 2.79 $ 2.88 $ 2.94
See accompanying notes to Consolidated Financial Statements.
ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Capital in Class A Class B Excess of Shares Amount Shares Amount Par Value
Balance-December 31,1994 128,104 $128,104 1,409,889 $1,409,889 $12,610,377
Reissued Class B Shares 148,233
Balance-December 31,1995 128,104 $128,104 1,409,889 $1,409,889 $12,758,610
Balance-December 31,1996 128,104 $128,104 1,409,889 $1,409,889 $12,758,610
Exchange Class A Shares for Class B Shares (872) (872) 872 872
Balance-December 31,1997 127,232 $127,232 1,410,761 $1,410,761 $12,758,610
Unrealized Pension Retained Gain(Loss)on Liability Treasury Stock Earnings Investments Adjustment Shares Amount
Balance-December 31,1994 $46,524,142 $(98,399) $(489,823) 173,456 $4,313,067
Net Income 4,015,105 Reacquired Class B Shares 25,889 1,060,749 Reissued Class B Shares (24,390) (851,767) Change in unrealized gain on securities available for sale 192,535 Pension liability adjustment 489,823 Cash dividend paid ($.55 per share) (753,084)
Balance-December 31,1995 $49,786,163 $ 94,136 $ -- 174,955 $4,522,049
Net Income 3,865,876 Reacquired Class B Shares 38,801 1,469,659 Change in unrealized gain on securities available for sale (4,756) Cash dividend paid ($.55 per share) (736,983)
Balance-December 31,1996 $52,915,056 $ 89,380 $ -- 213,756 $5,991,708
Net Income 3,512,142 Reacquired Class B Shares 143,519 5,626,717 Change in unrealized gain on securities available for sale 39,094 Cash dividend paid ($.56 per share) (702,018)
Balance-December 31,1997 $55,725,180 $128,474 $ -- 357,275$11,618,425
See accompanying notes to Consolidated Financial Statements.
ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 3,512,142 $ 3,865,876 $ 4,015,105 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 1,114,639 815,277 636,777 Minority interest in consolidated subsidiaries (6,041) (55,822) (23,913) Amortization of bond premiums -- 4,349 58,918 Gain (Loss) on sale of property, plant and equipment (3,984) 5,692 (437) Gain on sale of investments (765,110) (287,982) (295,560) Change in assets and liabilities (net of acquisition effects) Accounts receivable (914,493) (386,440) 120,141 Inventories (3,188,750) (1,292,561) (2,014,580) Prepaid income taxes 164,509 459,226 (580,050) Prepaid expenses (328,631) (39,349) (4,517) Deferred income tax benefits -- -- 110,536 Prepaid pension costs 94,099 132,311 (1,109,038) Accounts payable 498,632 (139,103) (267,387) Other accrued expenses 192,927 (1,518,438) (325,032) Customer deposits 546,262 298,720 16,362 Deferred liabilities (32,217) (59,500) 474,702 Net Cash Provided by Operating Activities 883,984 1,802,256 812,027
CASH FLOWS FROM INVESTING ACTIVITIES Cash proceeds from maturity of investments classified as held to maturity -- -- 54,960,373 Cash paid for purchase of investments classified as held to maturity -- -- (21,631,598) Cash proceeds from sale of investments classified as available for sale 30,263,188 38,938,452 3,520,772 Cash paid for purchase of investments classified as available for sale (20,497,033) (36,914,531) (30,402,728) Increase in cash value of life insurance (264,278) (228,736) (221,343) Increase in note receivable (40,409) (40,562) (40,731) Payment for acquisition, net of cash acquired (1,512,000) -- (3,639,338) Additions to intangible and other assets (211,690) -- (533,084) Purchase of minority stockholders' interest in subsidiary -- (20,000) -- Cash proceeds from sale of property, plant and equipment 7,841 10,000 500 Cash paid for purchase of property, plant and equipment (2,046,097) (761,483) (940,689) Net Cash Provided by Investing Activities 5,699,522 983,140 1,072,134
CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid in cash (702,018) (736,983) (753,084) Reacquired Class B common shares (5,626,717) (1,469,659) (1,060,749) Subsidiary company stock reacquired from minority stockholders (15,625) (3,572) -- Subsidiary company stock issued to minority stockholders -- 9,920 20,705 Net Cash Used in Financing Activities (6,344,360) (2,200,294) (1,793,128)
NET INCREASE IN CASH 239,146 585,102 91,033
CASH, JANUARY 1 781,202 196,100 105,067
CASH, DECEMBER 31 $ 1,020,348 $ 781,202 $ 196,100
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION Cash paid for income taxes $ 1,758,833 $ 1,793,338 $ 2,142,682 Cash paid for interest $ -- $ 53,322 $ --
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES Liability incurred to purchase inventory in connection with acquisition $ -- $ -- $ 1,243,601 Long term debt incurred in connection with asset acquisition $ -- $ -- $ 1,735,000 Purchase price adjustment of August 1,1995 acquisition Decrease of accrued liability to purchase inventory $ -- $ 630,885 $ -- Decrease in long term debt -- 1,735,000 -- Decrease in minority interest -- 86,641 -- Decrease in inventory -- (630,885) -- Decrease in intangible assets (Goodwill) -- (864,291) -- Increase in current accrued liabilities -- (957,350) -- Total $ -- $ -- $ --
See accompanying notes to Consolidated Financial Statements.
ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 Significant Accounting Policies Background: Allen Organ Company and Subsidiaries operate in four industry segments: musical instruments, data communications, electronic assemblies, and audio equipment. See note 14 for additional information on the operating activities of each segment.
Principles of Consolidation: The consolidated financial statements include the accounts of the Allen Organ Company and the following subsidiaries. All material intercompany transactions have been eliminated. Subsidiary Name Ownership % Rocky Mount Instruments, Inc. 100.00% Allen Organ International, Inc. 100.00% VIR, Inc. 98.09% Eastern Research, Inc. 92.52% Linear Switch Corporation 92.20% Legacy Audio, Inc. 75.00%
Reclassifications: Certain amounts in the 1996 and 1995 financial statements have been reclassified to conform to the 1997 presentation.
Off-Balance Sheet Risk: Financial instruments that potentially subject the Company to credit risk consist principally of short-term investments and trade receivables. The Company places substantially all of its investments in mutual funds holding federal, state and local government obligations and, by policy, limits the amount of credit exposure in any one investment. The Company sells most of its products through established dealer networks. The credit risk associated with related receivables is limited due to the large number of dealers and their geographic dispersion.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
Investments: The Company accounts for its short-term investments in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Management determines the appropriate classification of its investments in debt and equity securities at the time of purchase and reevaluates such determination at each balance sheet date.
Inventories: Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first- out (FIFO) method for substantially all inventories.
Property, Plant and Equipment: Property, plant and equipment are stated at cost. Depreciation is computed over estimated useful asset lives using both straight-line and accelerated methods for financial reporting and accelerated methods for tax reporting.
Goodwill and Intangibles: Goodwill represents the excess of cost over the net assets of acquired subsidiaries. Goodwill is amortized on a straight-line basis over various periods from 3 - 20 years and is presented net of accumulated amortization of $348,862 and $129,696 at December 31, 1997 and 1996 respectively. The carrying value of goodwill for each business is continually reviewed to assess its recoverability from future operations of the acquired subsidiaries, based on future cash flows (undiscounted) expected to be generated by such operations. Any impairment in value indicated by the assessment would be charged against current operations. During 1997 the Company re-evaluated the useful life of goodwill acquired through business acquisitions and began amortizing the goodwill associated with acquisitions over useful lives of 3 - 20 years. Previously, goodwill was being amortized over 40 years. This change in the estimated life of the goodwill had the effect of decreasing net income for 1997 by approximately $60,000 ($0.05 per share). Intangible assets consist of organization costs which are stated at cost and amortized using the straight-line method over ten years. Intangible assets are presented net of accumulated amortization of $134,225 and $75,520 at December 31, 1997 and 1996, respectively.
Income Taxes: Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes. Deferred taxes are recognized for differences between the basis of assets and liabilities for financial statement and income tax purposes.
Research and Development: Research and development expenditures are charged to expense as incurred.
Stock-Based Compensation: The Company accounts for its stock-based compensation plans using the accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Since the Company is not required to adopt the fair value based recognition provisions prescribed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, it has elected only to comply with the disclosure requirements set forth in the Statement. (See Note 17.)
Year 2000: The Company has taken actions to make its systems, products and infrastructure Year 2000 compliant. The Company began work several years ago to prepare its products and its financial information and other computer-based systems for the Year 2000, including replacing and/or updating existing legacy systems. Allen continues to evaluate the estimated costs associated with these efforts based on actual experience. While these efforts will involve additional costs, the Company believes, based on available information, that it will be able to manage its total Year 2000 transition without any material adverse effect on its business operations, products or financial prospects.
New Accounting Standards: The Financial Accounting Standards Board has issued the following new Statements, all of which are effective for financial statements for periods beginning after December 15, 1997. SFAS 130, Reporting Comprehensive Income - establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. SFAS 131, Disclosures about Segments of an Enterprise and Related Information - establishes standards for reporting selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services. SFAS 132, Employers' Disclosures about Pensions and Other Post Retirement Benefits - revises disclosures about pensions and other post retirement benefit plans. The Company will implement these standards during 1998 and believes that they will not have a material effect on the Company's financial statements.
NOTE 2 Business Acquisitions Legacy Audio: On April 1, 1997 the Company purchased a 75% interest in Legacy Audio in exchange for $1,512,000 in cash. In connection with the acquisition, the company established a new subsidiary, Legacy Audio, Inc. (LAI), to acquire the assets of the seller. A founding owner of the seller contributed the remaining 25% of the assets of the seller to the new company in exchange for a 25% interest in LAI. Additionally, this founding owner has been named the President and Chief Designer of LAI. The acquisition has been accounted for as a purchase. The results of operations of LAI have been included in the Company's consolidated financial statements from the date of acquisition. Assets and liabilities have been recorded at their estimated fair market values with the excess being recorded as goodwill which will be amortized over periods from 10 - 20 years.
VIR, Inc., Eastern Research, Inc., Linear Switch Corporation: On August 1, 1995, the Company acquired the assets of VIR, Inc. (VIR), Eastern Research, Inc. (ERI) and Linear Switch Corporation (LSC), three related companies which were under common control, for $7,653,234. The purchase price was made up of 24,390 shares of Allen Organ stock valued at approximately $1,000,000, notes and liabilities totaling $2,978,601 and $3,674,633 in cash. On September 7, 1995, the Company repurchased the Allen Organ Company stock issued in connection with the asset acquisition for $1,000,000. The Securities Restriction Agreement dated August 1, 1995 was terminated along with the stock repurchase. On May 10, 1996, the Company entered into an agreement with the seller of the three data communications companies acquired on August 1, 1995, to settle an indemnity claim against the seller by adjusting the purchase price and payment terms for the acquired companies. The terms of the agreement provided for the $880,885 balance due on the obligation incurred to purchase some of the inventory to be satisfied by the payment of $250,000. Further, the Note Payable of $1,735,000 issued as part of the purchase price has been canceled in exchange for a current payment of $900,000 and a contingent annual payment for five years, effective January 1, 1996, of 4.5% of the acquired companies annual sales exceeding $7,000,000. The total contingent payment for 1997 and 1996 amounted to $92,432 and $29,142, respectively. The agreement provides that the total of the contingent payments shall not exceed $2,000,000. The employment agreement between VIR and its President (majority owner of the selling companies) has been modified so that he shall now be a consultant to the companies, with payment based on the number of hours worked at the request of the companies. In connection with the acquisition, the Company established three new subsidiary companies to acquire the assets of sellers. As additional consideration, the new subsidiaries issued shares of their stock to minority employee stockholders equivalent to their interest in the selling companies. The acquisitions have been accounted for as purchases. The results of operations of VIR, ERI, and LSC have been included in the Company's consolidated financial statements from the date of acquisition through December 31, 1997. Assets and liabilities have been recorded at their estimated fair market values with the excess being recorded as goodwill and is being amortized over periods from 3 - 20 years. Organizational costs have been capitalized in connection with the acquisitions are being amortized over 10 years.
NOTE 3 Investments The cost and fair value of investments in debt and equity securities are as follows:
Gross Gross Fair Amortized Unrealized Unrealized Value Cost Gains Losses
December 31, 1997 Available for sale Equity securities $ 215,354 $ 82 $ 69,663 $ 145,773 Mutual Funds Short Term Gov't Funds 10,268,613 -- 10,268,613 Municipal Bond Funds 5,725,690 111,096 -- 5,836,786 Equity Funds 2,071,521 169,121 7,480 2,233,162 U.S. Treasury Bills 1,556,000 -- -- 1,556,000 Totals $ 19,837,178 $ 280,299 $ 77,143 $ 20,040,334
December 31, 1996 Available for sale Equity securities $ 288,981 $ -- $ 21,298 $ 267,683 Mutual Funds Short Term Gov't Funds 11,925,188 40,000 -- 11,965,188 Municipal Bond Funds 5,957,538 -- 12,847 5,944,691 Corporate Bond Funds 1,609,509 37,795 -- 1,647,304 Equity Funds 2,968,685 101,386 -- 3,070,071 U.S. Treasury Bills 5,889,064 -- -- 5,889,064 Federal Agency Bonds 228,560 4,374 -- 232,934 Totals $ 28,867,525 $ 183,555 $ 34,145 $ 29,016,935
Marketable debt securities have an average contractual maturity of approximately 1 year or less. Realized gains and losses are determined based on the original cost of these investments using a first-in, first-out method. During 1997, 1996 and 1995, sales proceeds and gross realized gains and losses on securities classified as available for sales were:
1997 1996 1995
Sales proceeds $30,263,188 $38,938,452 $ 3,520,772
Gross realized losses $ 44,448 $ 9,100 $ 12,514
Gross realized gains $ 809,558 $ 297,082 $ 308,074
The change in net unrealized holding gains (losses) on securities available for sale in the amount of $53,746, $(9,046), and $324,273 net of deferred tax expense (benefits) of $14,650, $(4,290), and $131,738 has been included in stockholders' equity for the years ended December 31, 1997, 1996 and 1995, respectively.
NOTE 4 Inventories December 31, 1997 1996 Finished goods $ 2,046,835 $ 1,709,962 Work in process 7,343,590 5,912,456 Raw materials 8,532,962 6,449,729 Total Inventory $17,923,387 $14,072,147
The Company maintains an inventory of various parts to be used to service musical instruments as future needs arise. This inventory, $1,260,346 and $1,237,986 at December 31, 1997 and 1996, respectively, is reported as a noncurrent asset.
NOTE 5 Property, Plant and Equipment Estimated December 31, Useful 1997 1996 Lives Land and improvements $ 2,445,579 $ 2,407,579 10 yrs Buildings and improvements 8,100,068 7,585,667 10 - 40 yrs Machinery and equipment 7,751,766 6,379,116 5 - 10 yrs Office furniture and equipment 1,545,262 1,191,378 3 - 8 yrs Vehicles 241,869 177,391 4 yrs Sub-Total 20,084,544 17,741,131 Less accumulated depreciation 10,569,532 9,893,616 Property, plant and equipment net of accumulated depreciation $ 9,515,012 $ 7,847,515
Depreciation expense charged to operations was $836,769, $676,775 and $570,064 in 1997, 1996 and 1995 respectively.
NOTE 6 Note Receivable The Company has entered into a Split-Dollar Life Insurance agreement with its President who is the insured and owner of the policy. The policy owner shall pay the portion of the premium equal to the value of the economic benefit determined in accordance with applicable IRS Revenue Rulings. The Company shall pay the balance of the net premiums which shall approximate $40,000 annually. The agreement provides that the Company shall be entitled to recover the amount of premiums paid out of the built up cash value upon termination of the agreement or out of the proceeds upon the death of the insured. As security for repayment the Company is a collateral assignee of the policy to the extent of any such unreimbursed premium. The note receivable does not materially exceed the cash surrender value of this policy.
NOTE 7 Income Taxes The provision for income taxes consists of the following:
1997 1996 1995 Currently Currently Currently Payable Deferred Payable Deferred Payable Deferred
Federal $1,270,000 $ 73,000 $1,620,000 $ 59,000 $1,300,000 $ 380,000 State 26,000 (128,000) 467,000 (111,000) 259,000 81,000 Total $1,296,000 $ (55,000) $2,087,000 $ (52,000) $1,559,000 $ 461,000
A reconciliation of the provision for income taxes with the statutory rate follows: 1997 1996 1995 Statutory provision for federal income tax $1,614,000 34.0% $1,987,000 34.0% $2,044,000 34.0% State taxes, net of federal tax benefits 81,000 1.6 235,000 4.0 224,000 3.7 Tax credits (60,000) (1.3) (60,000) (1.0) (8,000) (0.1) Tax-exempt income (110,000) (2.3) (65,000) (1.1) (161,000) (2.7) Exempt income of foreign sales corporation (101,000) (2.1) (104,000) (1.8) (82,000) (1.4) Other items, net (38,000) (0.8) (42,000) (0.7) (3,000) (0.1) Effect of change in prior year's state tax revenue allocations (229,000) (4.8) -- -- -- -- Effect of change in state valuation allowance of deferred tax asset 84,000 1.8 -- -- -- -- Total $1,241,000 26.1% $2,035,000 34.8% $2,020,000 33.6%
The decrease in the 1997 tax provision is attributable to a decrease in the estimated effective tax rate for the current and prior tax year resulting from a change in state tax revenue allocations. The following temporary differences give rise to the net deferred tax liability at December 31, 1997 and 1996. 1997 1996 Deferred Tax Liabilities Excess of tax depreciation/amortization over book depreciation/amortization $ (533,989) $ (487,166) Excess of pension expense for tax purposes over book (288,801) (359,646) Unrealized gain not recognized for tax purposes (74,091) (60,033) Total Deferred Tax Liabilities (896,881) (906,845) Deferred Tax Assets Deferred compensation not recognized for tax purposes 20,211 25,540 State net operating loss carry forwards 185,716 102,000 Reserve for Bad Debts 11,383 -- Inventory Reserve 23,633 -- Sub-total 240,943 127,540 Valuation Allowance (84,000) -- Total Deferred Tax Assets 156,943 127,540 Net Deferred Tax Liability $ (739,938) $ (779,305)
Deferred taxes are included in the company's financial statements as follows: 1997 1996 Current deferred tax liability $ (74,091) $ (60,033) Non-current deferred tax liability (665,847) (719,272) Net deferred tax liability $ (739,938) $(779,305)
The Company has available at December 31, 1997, approximately $3,250,000 of unused state net operating loss carry forwards that may be applied against future taxable income and that expire in various years from 2002 to 2004. At December 31, 1997 the Company recorded a valuation allowance of $84,000 against the deferred tax assets relating to uncertainty of realizing state net operating loss carry forwards.
NOTE 8 Other Accrued Expenses
December 31, 1997 1996 Accrued salaries and commissions $ 385,176 $ 302,223 Other 307,106 197,132 Total $ 692,282 $ 499,355
NOTE 9 Commitments and Contingencies As of December 31, 1997, the Company is contingently liable for a maximum amount of approximately $1,472,107 in connection with the financing arrangements of certain customers. Under the terms of an agreement with the wife of the late Chairman and principal shareholder, the Company may be required to purchase within eight months of her death, at the option of her personal representative, an amount of Class B Common Shares then owned by her or includable in her estate for Federal Estate Tax purposes sufficient to pay estate taxes and costs, subject to the limitations of Section 303 of the Internal Revenue Code. At December 31, 1997, the shareholder owned or would have includable in her estate 261,072 shares of Class B Common Stock. The Company has purchased life insurance on the life of the shareholder with a face value of $6,000,000. Management believes that the insurance proceeds would be sufficient to substantially fund this possible future commitment and that any excess would not have a material effect on the financial condition of the Company. The Company's data communications segment leases its offices and production facility under non-cancelable operating leases which expire at various dates through February 2001. These leases include renewal options for periods ranging from two to fifteen years with increases of lease payments based on changes in the Consumer Price Index. Rent expense was $179,765 and $169,493 for 1997 and 1996 and $70,233 for the period from August 1 (inception) to December 31, 1995. Minimum annual rent payments for the operating leases are as follows:
1998 $ 218,633 1999 236,320 2000 199,220 2001 24,220 Total $ 678,393
NOTE 10 Retirement Plans The Company sponsors two noncontributory pension plans which cover substantially all of its employees. Salaried plan benefits are generally based on the employee's years of service and compensation levels. Hourly plan benefits are based on various monthly amounts for each year of credited service. The Company's funding policy is to contribute amounts to the plans sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as the Company may determine to be appropriate from time to time. Plan assets are comprised principally of cash equivalents, U.S. Government obligations, fixed income securities, and equity securities. A summary of the components of net periodic pension cost for the plans is as follows: 1997 1996 1995 Service cost - benefits earned during the period $ 299,166 $ 282,303 $ 279,432 Interest cost on projected benefit obligations 953,842 952,301 887,261 Return on assets Actual (2,057,294) (1,544,571) (1,772,567) Deferred gain 1,025,998 554,953 978,678 Amortization of net loss from prior periods -- 9,513 48,463 Amortization of unrecognized prior service cost 73,990 73,990 73,990 Amortization of initial unrecognized net asset (72,008) (72,008) (72,008) Net Pension Cost $ 223,694 $ 256,481 $ 423,249
The funded status of the Company's pension plans is as follows:
December 31, 1997 1996 Actuarial present value of benefit obligations: Vested benefits $(12,222,438) $(11,768,830) Nonvested benefits (89,213) (60,134) Accumulated benefit obligation (12,311,651) (11,828,964) Effect of assumed increase in compensation levels for salaried plan (910,741) (1,423,492) Projected benefit obligations for service rendered to date (13,222,392) (13,252,456) Plan assets at fair value 14,764,799 13,641,779 Plan assets in excess of projected benefit obligation 1,542,407 389,323 Unrecognized prior service cost 221,303 295,293 Unrecognized net asset at transition (288,036) (360,044) Unrecognized net (gain) loss (680,567) 564,634 Prepaid Pension Cost $ 795,107 $ 889,206
The projected benefit obligation for the plans was determined using an assumed discount rate of 7.5%. An assumed long-term compensation increase rate of 6% and 7% in 1997 and 1996, respectively, was used for the salaried plan. The assumed long-term rate of return on plan assets was 8%. The Company provides a 401(k) deferred compensation and profit sharing plan for the benefit of eligible employees. The plan allows eligible employees to defer a portion of their annual compensation, pursuant to Section 401(k) of the Internal Revenue Code. Company profit-sharing contributions to the plan are discretionary as determined by the Company's board of directors. The Company contributions were $147,160, $139,732 and $157,483 to the plans in 1997, 1996 and 1995 respectively.
NOTE 11 Deferred Liabilities December 31, 1997 1996 Deferred compensation expense $ 55,417 $ 62,917 Deferred income taxes 665,847 719,272 Total Deferred Liabilities $ 721,264 $ 782,189
NOTE 12 Earnings Per Share Earnings per share were computed using 1,258,966 shares in 1997, 1,340,047 shares in 1996, and 1,366,076 shares in 1995, the weighted average number of shares outstanding during each year. The Company does not have any dilutive equity instruments.
NOTE 13 Export Sales In 1997, 1996 and 1995, net sales by the musical instruments segment include export sales, principally to Canada, Europe and the Far East of $4,432,974, $5,594,286, and $5,408,720, respectively. Net sales by the data communications segment include export sales principally to Europe and the Far East of $2,103,734 for 1997, $1,417,636 for 1996 and $1,027,826 for the five months ended December 31, 1995. Net sales by audio equipment segment include export sales principally to Europe and the Far East of $211,561 for the nine months ended December 31, 1997.
NOTE 14 Industry Segment Information The Company's operations are classified into four industry segments: musical instruments, data communications, electronic assemblies, and audio equipment. The musical instruments segment is comprised of operations principally involved in the design, manufacture, sale and distribution of electronic keyboard musical instruments, primarily digital computer organs and related accessories. Musical instruments are sold primarily to retail distributors worldwide. The data communications segment began during 1995 with the acquisition discussed in Note 2. The segment is involved in the design, manufacture, sale and distribution of data communications equipment. Data communications products are sold primarily to wholesale and retail distributors worldwide. The electronic assemblies segment is involved in the manufacture, sale and distribution of electronic assemblies for outside customers used primarily as control devices and other circuitry in their products. Subcontract assembly services are provided primarily to industrial concerns in Pennsylvania and New Jersey. The audio equipment segment began in 1997 with the acquisition discussed in Note 2. The segment is involved in the design, manufacture, sale and distribution of high quality speaker cabinets and related equipment for hi-fi stereo and home theater applications. The segment's products are sold worldwide directly to individual customers for home use with a lesser percentage distributed through dealer audition sites.
Following is a summary of segmented information for 1997, 1996 and 1995. December 31, 1997 1996 1995 Net Sales to Unaffiliated Customers Musical instruments $ 23,351,483 $ 25,418,620 $ 24,321,914 Data communications 9,037,521 7,647,597 2,661,862 Electronic assemblies 5,935,381 3,648,911 3,040,985 Audio equipment 2,023,699 -- -- Total $ 40,348,084 $ 36,715,128 $ 30,024,761
Intersegment Sales Musical Instruments $ 5,252 $ -- $ -- Data Communications 84,939 125,288 -- Electronic Assemblies 938,479 296,132 -- Audio Equipment 52,244 -- -- Total $ 1,080,914 $ 421,420 $ --
Income (Loss) from Operations Musical instruments $ 2,718,085 $ 3,634,901 $ 3,332,103 Data communications (1,069,165) (349,785) 122,417 Electronic assemblies 631,521 520,602 457,167 Audio equipment 337,495 -- -- Total $ 2,617,936 $ 3,805,718 $ 3,911,687
Identifiable Assets Musical instruments $ 22,669,782 $ 20,790,307 $ 20,505,183 Data communications 10,294,411 8,937,839 9,181,209 Electronic assemblies 4,422,908 2,600,627 2,108,721 Audio equipment 2,153,922 -- -- Sub-total 39,541,023 32,328,773 31,795,113 General corporate assets 23,020,981 31,637,873 33,504,313 Total $ 62,562,004 $ 63,966,646 $ 65,299,426
Capital Expenditures Musical instruments $ 1,574,743 $ 530,624 $ 903,737 Data communications 386,308 230,859 36,952 Audio equipment 85,046 -- -- Total $ 2,046,097 $ 761,483 $ 940,689
Depreciation and Amortization Musical instruments $ 657,686 $ 580,090 $ 557,052 Data communications 392,108 235,187 79,725 Audio equipment 64,845 -- -- Total $ 1,114,639 $ 815,277 $ 636,777
Intersegment sales are generally priced at cost plus a percentage mark-up, and are generally thought to be marginally less than prices which would be charged for the same product to unaffiliated customers. Intersegment sales are excluded from net sales reported in the accompanying consolidated income statements. Identifiable assets by segment are those assets that are used in the Company's operations within that segment. General corporate assets consist principally of cash and short-term investments. The electronic assemblies segment derived 55%, 85% and 90% of its revenues from one customer in 1997, 1996 and 1995 respectively. The data communications segment derived 12% and 14% of its revenue from one customer in 1997 and 1996, respectively. The Company's musical instrument and audio equipment segments are not dependent on any single customer.
NOTE 15 Investment Income
December 31, 1997 1996 1995
Interest Income $ 1,198,362 $ 1,382,301 $ 1,712,340 Dividend Income 151,250 354,741 107,651 Gain on Sale of Investments 765,110 287,982 295,560 Total $ 2,114,722 $ 2,025,024 $ 2,115,551
NOTE 16 Pro Forma Financial Information The following pro forma financial information have been prepared giving effect to the acquisitions of Legacy Audio, Inc., VIR, ERI and LSC (including settlement agreement dated May 10, 1996) as if the transactions had taken place at the beginning of the respective year (1997 and 1996 for Legacy Audio and 1995 for all other). The pro forma financial information is not necessarily indicative of the results of operations which would have been attained had the acquisitions been consummated on any of the foregoing dates or which may be attained in the future.
Years Ended December 31, 1997 1996 1995 Pro forma Net Sales $40,809,887 $38,681,238 $34,760,371 Pro forma Net Income 3,490,772 3,889,960 4,309,302 Pro forma Net Income Per Share $ 2.77 $ 2.90 $ 3.15
NOTE 17 Stock Option Plans During 1997, VIR, Inc. (VIR) and Eastern Research, Inc. (ERI) established employee stock-based compensation plans to assist them in attracting and retaining personnel. The maximum number of these subsidiaries' shares that may be issued under the plans approximates a 15% interest in each of the respective companies. Options are issued at estimated fair market value and the Company has a right of first refusal for any shares issued under these options. The maximum term of the options is 6 years, and they generally vest equally over 4 years. As of December 31, 1997, total options issued for VIR and ERI represent 12% and 10%, respectively, of the shares currently outstanding. Vested options consist of 2% of the currently outstanding shares of ERI. No compensation expense was recognized for these plans in 1997. Had compensation cost been determined pursuant to FASB Statement No. 123, net income and earnings per share would have been $3,431,897 and $2.73, respectively.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
(a) Identification of Directors Time Period Date Term Position Name Expires Age Position Held
Steven Markowitz Next Annual 44 Director Since 1980 Meeting in 1998 Eugene Moroz Next Annual 74 Director Since 1968 Meeting in 1998 Leonard W. Helfrich Next Annual 68 Director 1964 - 1968 and Meeting in 1998 1972 to present Orville G. Hawk Next Annual 80 Director Since 1989 Meeting in 1998 Albert F. Schuster Next Annual 78 Director Since 1989 Meeting in 1998 Martha Markowitz Next Annual 76 Director Since 1991 Meeting in 1998 Jeffrey L. Schucker Next Annual 43 Director Since July 1996 Meeting in 1998
(b) Identification of Executive Officers.
Time Period Date Term Position Name Expires Age Position Held
Steven Markowitz Next Annual 44 President 1990 to Meeting in 1998 present Eugene Moroz Next Annual 74 Vice President Since 1965 Meeting in 1998 Leonard W. Helfrich Next Annual 68 Vice President, 1958 - 1968 Meeting in 1998 Secretary and 1971 to present Barry J. Holben Next Annual 45 Vice President October 1995 Meeting in 1998 to present Dwight A. Beacham Next Annual 51 Vice President October 1995 Meeting in 1998 to present Nathan S. Eckhart Next Annual 34 Treasurer, Since 1996 Meeting in 1998 Assistant Secretary
(c) Identification of Certain Significant Employees.
Not required to be answered.
(d) Family Relationships.
Except for Martha Markowitz and Steven Markowitz, who are mother and son, there is no family relationship between any officers or directors of the Company.
(e) Business Experience.
(1) Steven Markowitz, Eugene Moroz, Leonard W. Helfrich and Dwight Beacham, have been employees of the Company in executive capacities for at least the last five years. Mr. Holben has been employed by the Company since 1989, spending two years in product development and four years in various sales capacities. Mr. Eckhart has been employed by the Company from 1993 to 1996 as Controller and prior to that time was a manager for a public accounting firm. Mr. Hawk who has been retired more than five (5) years was formerly Chairman of the Board and President of First National Bank of Allentown. Mr. Schuster is a church director of music and prior to his retirement more than five (5) years ago was a supervisor at Bethlehem Steel Corporation. Mr. Schucker is currently President of Middle Market Capital Advisors, L.L.C. and formerly a Vice President of Meridian Capital Markets. Mrs. Markowitz is the widow of Jerome Markowitz, the Company's founder, and represents the family interests.
(f) Involvement in Certain Legal Proceedings by Directors or Officers.
None.
(g) Compliance with Section 16(a) of the Exchange Act.
No transaction required to be reported.
Item 11.
Item 11. Executive Compensation. Deleted paragraphs and/or columns are not required to be answered.
(b) SUMMARY COMPENSATION TABLE: Annual Compensation All Other Salary Bonus Compensation * Name and Principal Position Year $ $ $
Steven A. Markowitz, President 1997 100,090 18,598 30,650 (Chief Executive Officer) 1996 96,547 22,865 30,766 1995 93,010 20,125 31,537
Leonard W. Helfrich, 1997 93,624 17,402 Vice President - Finance 1996 88,113 21,385 (Secretary) 1995 84,746 19,005
*Value of Split Dollar Life Insurance. See Note 6 to the accompanying consolidated financial statements for additional information on this arrangement.
(f) Defined Benefit or Actuarial Plan Disclosure.
Estimated Annual Benefit obtained from 1997 Actuarial Valuation Report:
Steven A. Markowitz $55,819. Age 44. Leonard W. Helfrich $35,354. Age 68.
Amount shown is calculated from prior compensation to date and estimated compensation to normal retirement age (65).
(g) Compensation of Directors:
Non-employee Directors receive $350 for each Board and committee meeting attended plus reasonable expenses in connection with attendance. Employee Directors receive no additional compensation for their services as a Director.
(h) Employment Contracts and Termination of Employment and Change in Control Arrangements:
There are no employment contracts between the Company and any of the Company's Executive Officers. Mr. Markowitz, Mr. Helfrich, Mr. Beacham, Mr. Holben and Mr. Eckhart participate in an Executive Incentive Plan whereby a bonus is distributed to each participant executive in proportion to the annual salary of the participants. The bonus pool is 1% of consolidated pre-tax profit for the fiscal year after elimination of bonus accrual and non-operating extraordinary gains or losses as determined by the Board of Directors.
(j) Additional Information with Respect to Compensation Committee Interlocks and Insider Participation in Compensation Decisions:
(1) Leonard W. Helfrich, Vice President, Secretary, and Director of the Company, is the sole member of the Compensation Committee of the Board of Directors whose function is to set the compensation of the President. The compensation of all other employees is set by or at the direction of the President.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Voting securities of the registrant owned of record or beneficially by each person who owns of record, or is known by the registrant to own beneficially, more than 5 percent of any class of such securities. Class A Common Shares constitute the only securities with voting rights. Information as of February 28, 1998. Amount and Nature of Names and Title of Beneficial % of Addresses Class Ownership Class Jerome Markowitz A 81,531 95.9% Trust (2) (1) 821 N. 30th St. Allentown, PA
(1) Sole voting and investment power
(2) The shares are held by Trustees under an Inter Vivos Trust established by Mr. Markowitz, who died in February, 1991, for the benefit of his family, principally his widow, Martha Markowitz. The Trustees are Steven Markowitz, President and a Director of the Company, and Martha Markowitz, a Director of the Company.
(b) Each class of equity securities of the registrant or any of its parents or subsidiaries, other than directors' qualifying shares, beneficially owned directly or indirectly by all directors naming them and directors and officers of the registrant, as a group, without naming them. Information as of December 31, 1997.
Percent Percent Nature of of of Class Class Beneficial Class Class Directors A B Ownership A B
Steven Markowitz 58 (1) (3) .07 % 13,562 (1) (3) 1.09 % 81,531* (2) (4) 95.94 % 242,016* (2) (4) 19.53 %
Eugene Moroz 719 (1) (3) as to 719 11,771 (2) (4) as to 11,771 .94 %
Leonard W. Helfrich 328 (2) (4) .03 %
Orville G. Hawk 50 (2) (4) .004%
Martha Markowitz 19,056 (1) (3) 1.53 % 81,531* (2) (4) 95.94 % 242,016* (2) (4) 19.53 %
Percent Percent All Directors of of and Officers Class Class Class Class as a Group A B A B
7 81,589** 287,502** 96.01 %** 23.20 %
(1) Sole voting power (2) Shared voting power (3) Sole investment power (4) Shared investment power
* Shares owned by the Jerome Markowitz Trust for which Martha Markowitz and Steven Markowitz, Co- Trustees, have shared voting and investment power and of which Martha Markowitz is the primary beneficiary and Steven Markowitz, one of the residuary beneficiaries.
** The shares held by the Jerome Markowitz Trust are not duplicated in the totals for the Class A and Class B Shares.
(c) Changes in Control. Not required to be answered.
Item 13.
Item 13. Certain Relationships and Related Transactions
See Note 9 to Financial Statements, concerning an agreement between the Company and Martha Markowitz, a Director of the Company.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements
The following consolidated financial statements of Allen Organ Company and its subsidiaries are included in Part II, Item 8:
Independent Auditors' Reports.
Consolidated Balance Sheets as of December 31, 1997 and 1996.
Consolidated Statements of Income for the years ended December 31,1997, 1996, and 1995.
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995.
Consolidated Statements of cash flows for the years ended December 31, 1997, 1996, and 1995.
Notes to Consolidated Financial Statements.
The individual financial statements of the Registrant's subsidiaries have been omitted, as they are all included in the consolidated financial statements referred to above.
(a) (2) Financial Statement Schedules
Financial schedules are omitted as not applicable.
(a) (3) Exhibits Exhibit No. Description 2(4) Plan of acquisition 3.1(1) Articles of Incorporation as amended 3.2(2) Bylaws, as amended 10.1(2) Executive Incentive Plan adopted October 24, 1996 10.2(3) Agreement of Amendment between the Company and Martha Markowitz 21 Subsidiaries of the registrant
1. Incorporated by reference to the exhibit filed with the Registrants Annual Report on Form 10-K for the year ended December 31, 1984. 2. Incorporated by reference to the exhibit filed with the Registrants Quarterly Report on Form 10-Q for the period ended September 30, 1996. 3. Incorporated by reference to the exhibit filed with the Registrants Annual Report on Form 10-K for the year ended December 31, 1992. 4. Incorporated by reference to the exhibit filed with the Registrants Current Report on form 8-K dated August 1, 1995.
(b) Reports on Form 8-K. None filed during fourth quarter of 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ALLEN ORGAN COMPANY
Date: March 25, 1998 STEVEN A. MARKOWITZ Steven A. Markowitz Chief Executive Officer, President and Director
Date: March 25, 1998 LEONARD W. HELFRICH Leonard W. Helfrich Vice President-Finance, and Director, Chief Financial and Principal Accounting Officer
Date: March 25, 1998 MARTHA MARKOWITZ Martha Markowitz Director
Date: March 25, 1998 JEFFREY L. SCHUCKER Jeffrey L. Schucker Director