ITEM 1. BUSINESS
GENERAL
Spectrum Control, Inc. was incorporated in Pennsylvania in 1968. Spectrum Control, Inc. and its consolidated subsidiaries (the "Company") design, manufacture and market a broad line of electromagnetic compatibility (EMC) products designed to protect electronic equipment against interference from random electromagnetic waves. The Company provides an integrated approach to EMC problem solving by offering customers consulting, diagnostic testing and manufacturing services. These services include testing for EMC problems (at the Company's own test facilities or on location), analyzing test results, proposing design solutions, producing the required components and supplying these components on a continuing basis. A majority of the Company's products are custom designed, in many instances at the recommendation of Company engineers based upon their analysis of test results. The Company sells its EMC testing services and components to a broad base of customers for use in communication systems, data processing, telecommunications, process control and other equipment. On occasion, the Company also acts as an engineering consultant with respect to EMC problems where no purchase of the Company's product is contemplated. Less than 1% of the Company's revenue is derived from pure consulting. However, a number of the Company's manufactured product applications result from consulting activity.
The need for EMC products results from the increasing dependency of our society on electrical equipment of various kinds, ranging from radios and televisions to sophisticated computers and communication systems. This equipment both emits, and is sensitive to, random electromagnetic waves over a broad spectrum of wave lengths, which can interfere with and degrade the performance of other electric equipment. The Company's products are designed to suppress the emission of unwanted waves or to reduce their strength to an innocuous level, by reflecting them from one component to another in series or by converting their energy into heat which is then dissipated.
In addition to EMC products, the Company recently expanded its product offerings to include certain ceramic resonators and band pass filters. Sales of these microwave products, however, were not significant during the fiscal year ended November 30, 1996.
Spectrum Control Technology, Inc., a wholly-owned subsidiary, maintains a facility in New Orleans, Louisiana, with advanced manufacturing equipment designed for the production of ceramic capacitors. Currently, this subsidiary primarily manufactures ceramic discoidal and tubular capacitors used in the Company's EMC filter products.
Spectrum Control, GmbH, a wholly-owned subsidiary of the Company located in Schwabach, Germany (the "Subsidiary"), acts as a distributor for the Company's electronic filter products in the European market.
PRODUCTS
Control of unwanted electromagnetic waves is accomplished through various combinations of electromagnetic interference (EMI) suppression devices. The EMI suppression devices currently produced by the Company include those that are utilized as circuit components and whose function is to permit the desired frequencies to pass through a circuit while rejecting or preventing the unwanted signals. The majority of these products are composed of either reactive (reflecting energy) or loss (dissipating energy) elements or at times, combinations of the two. These products can be utilized as individual components or combined in various configurations to provide the amount of EMI control needed.
The Company also manufactures and sells passive electromagnetic components including ceramic discoidal capacitors and tubular capacitors (Spectrum Control Technology, Inc.).
The Company's products are sold to manufacturers of a wide variety of electronic equipment, including telephone systems, mobile radios and CATV systems; navigational aids and radio communication systems used in military and commercial aircraft; communications and telemetry systems used in aerospace programs; computers and computer peripherals and various types of electronic testing equipment.
Approximately 36% of the Company's total revenue during fiscal year 1996 was derived from sales of its components for use in telecommunications. Most of these components are custom designed not only to conform to the specifications and requirements of the particular purchaser, but also to meet the performance and quality standards set by the agency or other governmental body whose regulations are applicable to the specific equipment or usage involved. A significant reduction in orders from such customers would have a materially adverse effect on the Company's business.
PRODUCTION
The Company's wholly-owned subsidiary, Spectrum Control Technology, Inc. in New Orleans, Louisiana, designs and manufactures ceramic capacitors. These elements are utilized in the manufacture and assembly of various electronic filter products at the Company's two Filter Products Group facilities, both of which are located in Fairview, Pennsylvania. Although the Company produces a standardized line of electronic filter products for sale from inventory and to customer order, most orders require relatively short production runs of custom designed components.
The Company purchases brass bushings, castings, miniature metal stampings, as well as other hardware used in the assembly and production of its components. These items are available from numerous sources. The principal raw materials used by the Company in the manufacture of ceramic capacitors are silver, palladium, platinum and barium titanate ceramic. Precious metals are available from many sources; however, their prices may be subject to significant fluctuations.
Historically, the Company has not experienced difficulty in obtaining any of the component parts or raw materials necessary for its manufacturing operations.
SALES AND DISTRIBUTION
The Company markets its products through direct factory sales, its own field sales engineers, as well as sales representatives, agents and distributors. The Company's field sales engineers are able to match the Company's product offerings to customer requirements through specifications provided by customer buyers and design engineers. In so doing, the field sales engineer serves a dual role of designing solutions to electromagnetic compatibility problems, as well as conducting normal field sales activities.
During fiscal year 1996, the Company sold its products to approximately 1,200 accounts. Sales of components to the Company's top ten customers represented 49% ($28.0 million) of total consolidated net sales in 1996. The Company's largest single customer, an original equipment manufacturer of telecommunications equipment, represented 12% in 1996, 14% in 1995 and 12% in 1994 of total consolidated net sales. The Company's second largest single customer represented 8% of total consolidated net sales in 1996 and 9% in 1995 and 1994. All of the Company's major customers are unaffiliated with Spectrum Control, Inc. and its subsidiaries.
The Company maintains in inventory certain standard component products. Domestic distribution is done through various national and regional distributors. International distribution is done through Spectrum Control GmbH.
Shipments are made by common carrier. Since most components are either small or miniaturized and light weight, shipping charges do not affect the Company's ability to compete for business domestically or abroad.
No material portion of the Company's business is subject to renegotiation of profits or termination of contracts or sub-contracts at the election of the U.S. Government.
BACKLOG
The Company's backlog, which consists of purchase orders by customers, totalled approximately $17.3 million at November 30, 1996 and $18.7 million at November 30, 1995. It is anticipated that approximately 90% of the Company's backlog as of November 30, 1996 will be shipped within one year. Annual requirement contracts are taken into backlog only to the extent that orders are actually released thereunder. Although the terms and conditions contained in the Company's quotation forms place certain restrictions on a customer's right to cancel, purchase orders generally provide for cancellation. In practice, the Company negotiates each cancellation and schedule change based on the cost it has incurred prior to such occurrence. During the next two years, the Company expects to significantly reduce its average lead time (the length of time from the receipt of a customer order to shipment of finished product to the customer). As a result, the Company's backlog may decrease in the future due to reduced lead times.
EMPLOYEES
At November 30, 1996, the Company employed 693 persons, including officers. The Company has never suffered a work stoppage and regards its employee relations as good. The employees are not covered by collective bargaining agreements.
PATENTS
The Company is the owner of United States Patents for a solderless mounting filter connection and filtered-shielded D-Subminiature connectors. While these patents are believed to have commercial value, they are not material to the Company's business.
The Company holds twenty (20) United States Patents relating to polymer multilayer technology. The Company has entered into several agreements regarding licensing the technology covered by these patents. However, it is not known what commercial value these patents and related licenses may have.
None of the Company's issued patents have been legally challenged.
GOVERNMENTAL REGULATIONS
In order to qualify as an approved supplier of EMI/EMC products for use in equipment purchased by the military services or aerospace programs, the Company is required to meet the applicable portions of the quality specifications and performance standards designed by the Air Force, the Army, the Navy, NASA, NSA and the AEC. The Company's products must also conform to the specifications of the Defense Electronic Supply Center for replacement parts supplied to the military. Components produced by the Company for use in commercial and industrial equipment must conform to the specifications of certain other agencies concerned with EMC problems, including the Bureau of Radiological Health, the Department of Transportation and the Department of Defense, in addition to the FCC. To the extent required, the Company meets or exceeds all of these specifications.
The Company is subject to numerous federal, state and local regulations relating to air and water quality, the disposal of hazardous waste materials, safety, and health. Compliance with applicable environmental regulations has not significantly changed the Company's competitive position, capital spending, or earnings in the past and the Company does not presently anticipate that compliance with such regulations will change its competitive position, capital spending, or earnings for the foreseeable future. The Company continuously monitors regulatory matters and believes that it is currently in compliance in all material respects with applicable environmental laws and regulations.
COMPETITION
The Company is subject to competition in all of its marketing areas. There are presently over twenty (20) other firms engaged in producing electromagnetic compatibility components, a number of which have substantially larger financial resources and facilities. It is difficult to determine the annual sales volume of competing firms, because a number of such competitors are also engaged in other lines of business or are closely held and, accordingly, authoritative statistics are not available.
Among the Company's principal competitors are: AMP, AVX, Amphenol, Corcom and Tusonix. The Company believes that it is competitive with these companies in the areas of quality, delivery, price and technological innovation; however, to the extent it produces a broader line of EMC products and provides customers with more complete testing facilities, the Company believes that it may enjoy a competitive advantage.
Obsolescence has not been a material factor in the Company's business in the past; however, in common with other manufacturers of sophisticated electrical products, the possibility exists that technological developments by competitors may have an adverse effect on the Company's business.
RESEARCH AND DEVELOPMENT
In recent years, the Company's research and development efforts have focused on expanding the Company's materials technology, improving existing product offerings, developing product offering variations, and designing specialized production equipment to improve manufacturing efficiencies. Research and development expense amounted to $821,000 in 1996, $771,000 in 1995, and $237,000 in 1994.
OTHER MATTERS
The business of the Company is not subject to any significant seasonal fluctuations.
The Company does not believe that it has any special practices or special conditions affecting working capital items that are significant for an understanding of its business.
(1)In addition to the above mortgages, the Company's properties are encumbered in connection with the collateralization of certain short-term and long-term bank indebtedness.
(2)The Company's office and manufacturing space is adequate for its existing requirements and its projected business needs.
(3) In addition to the facilities described above, the Company leases certain sales office space.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any litigation of a material nature.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq Stock Market under the symbol SPEC. The high and low sales prices for the Common Stock for each quarter during fiscal years 1996 and 1995 are set forth below.
High Low
Fiscal 1996
First quarter $3.75 $2.88 Second quarter 6.25 3.00 Third quarter 6.13 3.50 Fourth quarter 4.63 3.00
High Low Fiscal 1995
First quarter $2.38 $1.63 Second quarter 3.00 2.00 Third quarter 4.25 2.25 Fourth quarter 4.50 3.13
At January 31, 1997, the Company had 10,774,233 shares of Common Stock outstanding, which were held by approximately 3,000 registered shareholders. The Company has not paid cash dividends on its Common Stock since 1988. While subject to periodic review, the current policy of the Board of Directors is to retain all earnings to provide funds for the continued growth of the Company.
(1) In 1993, the Company adopted a formal plan to discontinue its hybrid integrated circuit operations ("HIC") and sell the related HIC assets. A loss of $2,433,000 on the disposal of the discontinued HIC operations was provided for and charged against income in 1993. HIC operating results have been segregated and reported separately from continuing operations for each of the years included above.
(2) In 1993, the Company recognized a gain on extinguishment of debt of $4,012,000, net of applicable income taxes of $446,000.
(3) In 1994, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". The cumulative effect, through November 30, 1993, of this change in accounting amounted to $1,845,000 or $0.18 per share. See Note 2 of the Notes to Consolidated Financial Statements.
ITEM 7.
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Consolidated 1996 net sales increased by $8.0 million or 16% from 1995. In 1995, consolidated net sales increased by $5.6 million or 13% from 1994. In each year, the increase in sales primarily reflects additional shipment volume of electromagnetic interference ( EMI ) filtered connectors and EMI filtered arrays used by customers in the telecommunication industry. Overall, average selling prices declined slightly in 1996 and 1995 as a result of competitive and market pressures.
Gross margin was $18.1 million or 32% of sales in 1996, compared to $16.1 million or 33% of sales in 1995, and $13.0 million or 30% of sales in 1994. In 1994, gross margin was negatively impacted by increased production costs at the Company s ceramic capacitor manufacturing operations in New Orleans, Louisiana. These ceramic capacitor production problems were substantially corrected late in 1994. Along with the selling price pressures indicated above, 1996 and 1995 gross margins were negatively affected by changes in sales mix. These negative impacts were offset by economies of scale realized with additional shipment volume.
Selling, general and administrative expense, as a percentage of sales, was stable during 1996, 1995, and 1994 at 22% of sales. Because of greater sales volume, selling expense increased throughout the period, amounting to $6.6 million in 1996, $6.2 million in 1995, and $5.4 million in 1994. In 1994, the Company delayed or postponed certain discretionary expenditures. This reduction in general and administrative expense was not sustained. Accordingly, general and administrative expense increased by approximately $500,000 in 1995. In 1996, general and administrative expense amounted to $6.0 million, an increase of $1.2 million from 1995. This increase primarily reflects additional personnel costs, enhancements in the Company s information system, and expenses associated with the Company s Rapid Response program. Management believes that the Rapid Response program, which will continue to be implemented throughout 1997, will significantly reduce manufacturing lead times, decrease inventories, and provide greater responsiveness to customers.
Interest expense decreased by $155,000 in 1996, $95,000 in 1995, and $154,000 in 1994, with interest expense amounting to $753,000 in 1996, $908,000 in 1995, and $1.0 million in 1994. The decrease in interest expense primarily reflects reduced bank indebtedness. The Company repaid indebtedness of $2.8 million in 1996, $2.9 million in 1995, and $3.0 million in 1994. The Company s average short-term interest rates were 7.5% in 1996, 8.5% in 1995, and 7.5% in 1994.
The Company s German subsidiary transacts business with certain customers and vendors in currencies other than the Deutsche Mark. As a result, the Company recognizes gains and losses on foreign currency transactions. The Company incurred net gains of $38,000 in 1996, and net losses of $45,000 in 1995 and $80,000 in 1994 on these foreign currency transactions.
In 1996, as part of management s ongoing efforts to reduce operating costs, the Company sold certain land and building in Schwabach, Germany at a net selling price of $1.7 million. A loss of $27,000, representing the excess of the cost basis of the land and building over the net selling price, was realized and recorded as other expense in 1996. The land and building had been utilized as the Company s European sales distribution office and warehouse. As part of the sale agreement, the Company will leaseback a portion of the property to continue its foreign sales distribution function.
The Company s effective income tax rate was approximately 28% in 1996, 27% in 1995, and 23% in 1994. Differences in the effective tax rate primarily reflect changes in the deferred tax asset valuation allowance relating to certain foreign net operating loss carryforwards.
Effective December 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ( SFAS No. 109 ). Previously, the Company had recorded income taxes in accordance with Statement of Financial Accounting Standards No. 96. The changes in accounting for income taxes required by SFAS No. 109 include, among other provisions, changes in the criteria for recognizing deferred tax assets.
The cumulative effect, through November 30, 1993, of adopting the new method of accounting for income taxes amounted to approximately $1.8 million or $0.18 per share. As permitted by SFAS No. 109, prior period financial statements were not restated. Accordingly, the cumulative effect of this change in accounting for income taxes has been included in net income in the Company s Consolidated Statement of Income for the year ended November 30, 1994.
At November 30, 1996, the Company had recorded net deferred tax assets of $76,000, primarily related to U.S. tax credit carryforwards and certain German net operating loss carryforwards. Based upon the earnings history of the Company s U.S. and German operations, management has determined that it is more likely than not that these deferred tax assets will be realized during the carryforward period to offset future taxable income from ordinary and recurring operations.
The Company s results of operations may be affected in the future by a variety of factors including: competitive pricing pressures, new product offerings by the Company and its competitors, new technologies, product cost changes, and product mix. In 1996, approximately 36% of the Company s sales were to customers in the telecommunication industry. Accordingly, any significant change in the telecommunication industry s activity level would have a direct impact on the Company s performance.
Liquidity, Capital Resources and Financial Condition
The Company maintains a $6.0 million revolving line of credit with PNC Bank of Erie, Pennsylvania (the Bank ). Under the terms of the line of credit agreement, borrowings and required payments under the revolving credit line are based upon an asset formula involving accounts receivable and inventories. At November 30, 1996 and 1995, the Company had borrowed $2.3 million and $3.6 million, respectively, under the line of credit agreement. The revolving credit line is collateralized by substantially all of the Company s tangible and intangible property, with current interest rates on borrowings below the Bank s prevailing prime rate. At November 30, 1996, the Company had additional borrowing availability of approximately $3.7 million under the asset formula.
The Company s wholly-owned foreign subsidiary maintains unsecured Deutsche Mark lines of credit with German financial institutions aggregating $1.3 million (2.0 million DM) at November 30, 1996, and $1.1 million (1.5 million DM) at November 30, 1995. The Company had borrowed $978,000 (1.5 million DM) at November 30, 1996, and $682,000 (968,000 DM) at November 30, 1995, against these lines of credit. Borrowings under the lines of credit currently bear interest at rates below the prevailing prime rate and are payable upon demand.
The Company s working capital continued to increase in 1996. At November 30, 1996, the Company had net working capital of $12.5 million, compared to $10.0 million at November 30, 1995. The Company s current ratio also improved in 1996, with current assets at 2.20 times current liabilities at November 30, 1996 and 1.89 at November 30, 1995. Current assets increased in 1996, reflected principally in higher accounts receivable and inventories attributable to increased sales. Although accounts receivable and inventories increased, turnover rates improved. Accounts receivable turns were 5.6 in 1996, compared to 5.3 in 1995. Inventory turns improved to 3.3 in 1996 from 2.9 in 1995, primarily reflecting the commencement of the Rapid Response program. Current financial resources, including working capital and existing lines of credit, and anticipated funds from operations are expected to be sufficient to meet cash requirements throughout 1997, including scheduled long-term debt
repayment and planned capital expenditures. The Company's current projection of 1997 cash requirements, however, may be affected in the future by numerous factors including changes in sales volume, operating cost fluctuations and unplanned capital equipment replacement.
The Company s cash expenditures for property, plant and equipment amounted to $3.8 million in 1996, $3.1 million in 1995, and $1.7 million in 1994. These capital expenditures primarily related to manufacturing capacity expansion and improvements. At November 30, 1996, the Company had not entered into any material commitments for capital expenditures.
Income taxes paid during the fiscal years ended November 30, 1996, 1995, and 1994 amounted to $1.2 million, $218,000, and $336,000, respectively. Management expects cash outlays for income taxes to be less than income tax expense for the next three fiscal years.
As a result of increased accounts receivable and inventories, net cash provided by operations decreased in 1996. Net cash provided by operations amounted to $5.0 million in 1996, a decrease of $1.0 million from 1995. In addition to generating $5.0 million of net cash from operations, the Company realized cash proceeds of $1.7 million in 1996 on the sale of certain land and building in Schwabach, Germany. This positive cash flow was utilized for capital additions of $3.8 million and repayment of $2.8 million of bank indebtedness.
In 1995, net cash provided by operations amounted to $6.0 million. In addition to capital expenditures of $3.1 million, this cash flow was utilized to repay $2.9 million in indebtedness.
In 1994, net cash provided by operations amounted to $3.1 million. Other sources of cash during 1994 included $1.1 million from the sale of certain property, plant and equipment and $351,000 from the issuance of Common Stock upon the exercise of employee stock options. In addition to capital expenditures of $1.7 million, this positive cash flow was utilized to repay $3.0 million of indebtedness.
As indicated above, the Company continued to reduce its bank indebtedness in 1996. The Company s total borrowed funds were $9.7 million at November 30, 1996, $12.7 million at November 30, 1995, and $15.4 million at November 30, 1994. The Company increased total stockholders equity by $3.6 million in 1996, primarily through earnings. Accordingly, the Company s debt to equity ratio continued to improve in 1996. Total liabilities to net worth were 0.58 at November 30, 1996, 0.81 at November 30, 1995, and 1.05 at November 30, 1994.
Environmental Matters
The Company is subject to various laws and governmental regulations concerning environmental matters and employee health and safety. U.S. federal environmental legislation having particular impact on the Company includes the Toxic Substances Control Act; the Resource Conservation and Recovery Act; the Clean Water Act; and the Safe Drinking Water Act. The Company is also subject to the Occupational Safety and Health Administration ( OSHA ) concerning employee safety and health matters. The United States Environmental Protection Agency ( EPA ), OSHA, and other federal agencies have the authority to promulgate regulations that have an impact on the Company operations.
In addition to these federal activities, various states have been delegated certain authority under the aforementioned federal statutes. Many state and local governments have adopted environmental and employee safety and health laws and regulations, some of which are similar to federal requirements. State and federal authorities may seek fines and penalties for violation of these laws and regulations. As part of its continuing environmental program, the Company has been able to comply with such environmental regulations without any materially adverse effect on its business. The Company is not currently involved in any legal proceedings involving environmental matters.
Impact of Recently Issued Accounting Standards
The Company believes that recently issued accounting standards, including Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities , will not have a material impact on the Company s financial position or results of operations.
Impact of Inflation
In recent years, inflation has not had a significant impact on the Company s operations. However, the Company continuously monitors operating price increases, particularly in connection with the supply of precious metals used in the Company s manufacturing of ceramic capacitors. To the extent permitted by competition, the Company passes increased costs on to its customers by increasing sales price over time. Sales increases reported during the last three years in the accompanying financial statements, however, have substantially arisen from increased sales volume, not increases in selling prices.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements of Spectrum Control, Inc. and subsidiaries are included herein:
Page Number
Report of Independent Auditors
Consolidated Balance Sheets as of November 30, 1996 and 1995
Consolidated Statements of Income for the years ended November 30, 1996, 1995, and 1994
Consolidated Statements of Stockholders' Equity for the years ended November 30, 1996, 1995, and 1994
Consolidated Statements of Cash Flows for the years ended November 30, 1996, 1995, and 1994
Notes to Consolidated Financial Statements
Report of Independent Auditors
To the Board of Directors and Shareholders Spectrum Control, Inc.
We have audited the accompanying consolidated balance sheets of Spectrum Control, Inc. and subsidiaries as of November 30, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended November 30, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 consolidated 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 Spectrum Control, Inc. and subsidiaries as of November 30, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended November 30, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for income taxes in the year ended November 30, 1994.
ERNST & YOUNG LLP
Erie, Pennsylvania January 9, 1997
SPECTRUM CONTROL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Spectrum Control, Inc. and its subsidiaries (the "Company"), all of which are wholly-owned, except for Spectrum Polytronics, Inc. which is 96% owned. The fiscal year of the Company's foreign subsidiary, Spectrum Control GmbH, ends October 31 to facilitate timely reporting. All significant intercompany accounts are eliminated upon consolidation.
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable, accounts payable, and accrued liabilities approximate fair value due to the short-term maturities of these assets and liabilities. The interest rates on substantially all of the Company's bank borrowings are adjusted regularly to reflect current market rates. Accordingly, the carrying amounts of the Company's short-term and long-term borrowings also approximate fair value. The Company utilizes letters of credit to collateralize certain long-term borrowings. The letters of credit reflect fair value as a condition of their underlying purpose and are subject to fees competitively determined in the marketplace.
Inventories
Inventories are valued at the lower of cost or market, with cost for raw materials, work-in-process and finished goods at standard cost, which approximates the first-in, first-out basis.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the assets using the straight line method. Expenditures for maintenance and repairs are charged against earnings in the year incurred; major replacements, renewals and betterments are capitalized and depreciated over their estimated useful lives. The cost and accumulated depreciation of assets sold or retired are removed from the respective accounts and any gain or loss is reflected in earnings.
Intangibles and Other Assets
Patents and patent rights are amortized to expense on a straight line basis over periods not exceeding 17 years. Technical documentation, consisting primarily of acquired engineering drawings and manufacturing documentation, is stated at cost and amortized on a straight line basis over five years. The carrying
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
value of intangible assets is periodically reviewed by the Company and impairments are recognized when the expected future operating cash flows derived from such intangible assets is less than their carrying value.
Debt issuance costs are amortized to expense on a straight line basis over the term of the related indebtedness.
Income Taxes
Effective December 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly, the Company uses the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, using statutory tax rates in effect for the year in which the differences are expected to reverse.
General business credits are accounted for by the flow through method.
Foreign Currency Translation
The assets and liabilities of the foreign subsidiary are translated into U.S. dollars at current exchange rates. Revenue and expense accounts of these operations are translated at average exchange rates prevailing during the year. These translation adjustments are accumulated in a separate component of stockholders' equity. Foreign currency transaction gains and losses are included in determining net income for the year in which the exchange rate changes.
Revenue Recognition
Product sales are recorded at the time of shipment. Service revenues are recorded when the related services are performed.
Research and Development
Research and development costs are expensed as incurred. For financial statement presentation purposes, these costs are included in selling, general and administrative expense. Research and development expense amounted to $821,000 in 1996, $771,000 in 1995, and $237,000 in 1994.
Stock-Based Compensation
Stock options granted by the Company are accounted for in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). In accordance with APB 25, no stock-based compensation expense has been recognized in the accompanying financial statements, since the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of option grant.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Earnings Per Common Share
Earnings per common share is computed based on the weighted average number of shares of common stock outstanding during the year. The weighted average number of shares was 10,731,000 in 1996, 10,585,000 in 1995, and 10,449,000 in 1994. Although the Company has issued potentially dilutive common stock equivalents in the form of stock options and warrants, the dilutive effect of these securities in the aggregate is less than three percent of earnings per common share.
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 at the date of the financial statements, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2. ACCOUNTING CHANGE
Effective December 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). Previously, the Company had recorded income taxes in accordance with Statement of Financial Accounting Standards No. 96. The changes in accounting for income taxes required by SFAS No. 109 include, among other provisions, changes in the criteria for recognizing deferred tax assets.
The cumulative effect, through November 30, 1993, of adopting the new method of accounting for income taxes amounted to $1,845,000 or $0.18 per share. As permitted by SFAS No. 109, prior period financial statements have not been restated. Accordingly, the cumulative effect of this change in accounting for income taxes has been included in net income in the Company's Consolidated Statement of Income for the year ended November 30, 1994.
3. INVENTORIES
Inventories by major classification are as follows:
11/30/96 11/30/95 (in thousands)
Finished goods $ 2,631 $ 1,876 Work-in-process 5,549 6,075 Raw materials 3,897 3,371
$12,077 $11,322
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
11/30/96 11/30/95 (in thousands)
Land and improvements $ 1,161 $ 1,578 Buildings and improvements 8,669 10,719 Machinery and equipment 28,774 25,186 Construction in progress 144 166 38,748 37,649
Less accumulated depreciation 22,731 20,897
$16,017 $16,752 5. OTHER ASSETS
Other assets consist of the following:
11/30/96 11/30/95 (in thousands)
Patents and patent rights $ 549 $ 526 Technical documentation 2,260 2,260 Debt issuance costs 384 384 3,193 3,170 Less accumulated amortization 2,478 1,969
715 1,201
Deferred income taxes 281 332 Deferred charges 205 98
$ 1,201 $ 1,631
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. SHORT-TERM DEBT
At November 30, 1996 and 1995, short-term debt included $2,300,000 and $3,570,000, respectively, of borrowings under a Line of Credit Agreement between the Company and its principal lending institution (the "Bank"). Borrowings and required payments under the revolving credit line are based upon an asset formula involving accounts receivable and inventories, with maximum borrowings limited to $6,000,000. At November 30, 1996, the Company had additional borrowing availability of $3,700,000 under the asset formula. Weighted average borrowings under the revolving credit line amounted to $4,261,000 in 1996, and $3,210,000 in 1995, with average interest rates of 7.50% in 1996 and 8.45% in 1995. The maximum amount of borrowings under the revolving credit line at the end of any month was $5,164,000 in 1996 and $3,893,000 in 1995. The revolving credit line is collateralized by substantially all of the Company's tangible and intangible property, with current interest rates on borrowings below the Bank's prevailing prime rate. The Line of Credit Agreement is subject to bi-annual renegotiation and renewal.
The Company's wholly-owned foreign subsidiary maintains unsecured Deutsche Mark lines of credit with German financial institutions aggregating $1,325,000 (2,000,000 DM) at November 30, 1996, and $1,056,000 (1,500,000 DM) at November 30, 1995. The Company had borrowed $978,000 (1,477,000 DM) at November 30, 1996 and $682,000 (968,000 DM) at November 30, 1995, against these lines of credit. Weighted average borrowings under the lines of credit amounted to $437,000 (661,000 DM) in 1996 and $311,000 (442,000 DM) in 1995, with average interest rates of 6.85% in 1996 and 8.00% in 1995. The maximum amount of borrowings under the lines of credit at the end of any month was $1,034,000 (1,561,000 DM) in 1996 and $682,000 (968,000 DM) in 1995. Borrowings currently bear interest at rates below the prevailing prime rate and are payable upon demand.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. LONG-TERM DEBT Long-term debt consists of the following:
11/30/96 11/30/95 (in thousands)
Industrial development authority notes at variable interest rate (3.65% at 11/30/96 and 3.85% at 11/30/95)(1) $2,500 $2,800
Industrial development authority notes at variable interest rate (3.95% at 11/30/96 and 4.29% at 11/30/95)(2) 1,900 2,300
Notes payable to foreign bank at an interest rate of 6.38%(3) 1,658 2,068
Industrial development authority notes and related bank mortgage notes at interest rates ranging from 4.00% to 7.75%, collateralized by certain land and buildings, and requiring monthly principal and interest payments of $13,000 through the year 1999 406 531
Term loan payable to bank at an interest rate of 8.30% -- 715
Total 6,464 8,414 Less current portion 2,392 1,845 Long-term debt $4,072 $6,569
(1) The industrial development authority notes are collater- alized by certain land, building and equipment and an irrevocable letter of credit issued by the Company, through its principal lending institution. The notes bear interest at approximately 50% of the prevailing prime rate and require annual principal payments ranging from $200,000 to $300,000 through the year 2007.
(2) The industrial development authority notes are collater- alized by an irrevocable letter of credit issued by the Company, through its principal lending institution. The notes bear interest at approximately 50% of the prevailing prime rate and require annual principal payments of $400,000 through the year 2000 with a final principal payment of $300,000 due in the year 2001.
(3) The notes payable are collateralized by an irrevocable letter of credit issued by the Company, through its principal lending institution. The notes require quarterly principal payments of $71,000 (108,000 DM) through June 15, 1997, with a final principal payment of $1,445,000 (2,180,000 DM) due September 15, 1997.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Each of the above irrevocable letters of credit is collateralized by substantially all of the Company's tangible and intangible assets.
The aggregate maturities of all long-term debt during each of the five years ending November 30, 2001 are: $2,392,000, $743,000, $830,000, $600,000 and $500,000.
8. OTHER INCOME AND EXPENSE
Other income and expense consist of the following (in thousands):
1996 1995 1994
Patent licensing fees $ - $ - $ 303 Investment income - - 16 Gain(loss) on foreign currency transactions 38 (45) (80) Gain(loss) on sale of property, plant and equipment (18) 3 125
$ 20 $ (42) $ 364
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. INCOME TAXES
For the years ended November 30, 1996, 1995, and 1994, income before income taxes consists of the following (in thousands):
1996 1995 1994
U.S. operations $3,605 $3,140 $1,607 Foreign operations 1,132 955 1,050
$4,737 $4,095 $2,657
For the years ended November 30, 1996, 1995 and 1994, the provision for income taxes consists of the following (in thousands): 1996 1995 1994
Current Federal $ 806 $ 200 $ 30 State 111 235 53 Deferred 402 676 519
$1,319 $1,111 $ 602
The difference between the provision for income taxes and the amount computed by applying the U.S. federal income tax rate in effect for the years ended November 30, 1996, 1995, and 1994 consists of the following (in thousands):
1996 1995 1994
Statutory federal income tax $1,611 $1,392 $ 903 State income taxes, net of federal tax benefit 73 155 35 Subpart F income, U.S. property investment 166 -- -- Foreign tax rates 181 153 168 Decrease in deferred tax asset valuation allowance (987) (399) (311) Other items 275 (190) (193)
$1,319 $1,111 $ 602
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Significant components of the Company's net deferred tax assets and liabilities are as follows (in thousands):
Deferred tax assets: 11/30/96 11/30/95
Net operating loss carryforwards $1,561 $3,507 Tax credit carryforwards 1,280 577 Investment in subsidiaries 689 857 Intangible assets 579 483 Accrued expenses 214 274 Property, plant and equipment 116 119 Other 194 142 Sub-total 4,633 5,959 Valuation allowance (principally related to certain net operating loss carryforwards) 1,256 2,243
Deferred tax assets 3,377 3,716
Deferred tax liabilities:
Property, plant and equipment 2,463 2,530 Investment in subsidiaries 838 815
Deferred tax liabilities 3,301 3,345
Net deferred tax assets and liabilities $ 76 $ 371
Net deferred tax assets:
Current $ 96 $ 39 Noncurrent 281 332
Net deferred tax liabilities:
Noncurrent (301) --
$ 76 $ 371
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company has not recorded deferred income taxes on the undistributed earnings of its foreign subsidiary because of management's intent to indefinitely reinvest such earnings. At November 30, 1996, the undistributed earnings of the foreign subsidiary amounted to $1,010,000 (1,525,000 DM). Upon distribution of these earnings in the form of dividends or otherwise, the Company may be subject to U.S. income taxes and foreign withholding taxes. It is not practical, however, to estimate the amount of taxes that may be payable on the eventual remittance of these earnings.
During the years ended November 30, 1996, 1995, and 1994, the decrease in valuation allowance for deferred tax assets principally related to the utilization of certain foreign net operating loss carryforwards. During the year ended November 30, 1996, the valuation allowance also decreased as a result of changes in the expected future realization of remaining foreign net operating loss carryforwards. Income tax expense for the years ended November 30, 1996, 1995, and 1994, includes $108,000, $49,000, and $118,000, respectively, relating to tax benefits associated with the exercise of stock options.
At November 30, 1996, the Company had U.S. general business tax credit carryforwards of $234,000 expiring at varying dates through the year 2006 and minimum tax credits of $1,001,000 which may be carried forward indefinitely. At November 30, 1996, the Company's foreign subsidiary had approximately $2,431,000 (3,671,000 DM) of tax net operating loss carryforwards available to be carried forward indefinitely.
10. SUPPLEMENTAL CASH FLOW INFORMATION
The Company incurred obligations of $553,000 in 1994 in connection with the acquisition of certain intangible assets under an asset purchase agreement.
11. COMMON STOCK OPTIONS AND WARRANTS
The Company has several plans which provide for granting to officers, directors, key employees and advisors options to purchase shares of the Company's Common Stock. Under the plans, option prices are not less than the market price of the Company's Common Stock on the date of the grant. The options become exercisable at varying dates and generally expire five years from the date of grant. At November 30, 1996, options to purchase 1,076,850 shares of Common Stock were available for grant under the Company's stock option plans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
During the year ended November 30, 1996, the weighted average fair value of options granted amounted to $0.95 per share. At November 30, 1996, the weighted average remaining contractual life of outstanding options was 3.1 years.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related Interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") requires use of option valuation models that were not developed for use in valuing employee stock options.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Pro forma information regarding net income and earnings per share, required by SFAS No. 123, has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value for options granted in 1996 was estimated at the date of grant using a Black- Scholes option pricing model with the following assumptions: risk-free interest rate of 6.00%; volatility factor of the expected market price of the Company's Common Stock of 0.30; a weighted average expected option life of five years; and a 2.00% dividend yield. For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the options' vesting period. For the year ended November 30, 1996, the Company's reported and pro forma net income and earnings per share are as follows:
As reported: Net income $3,418,000 Earnings per common share $ 0.32
Pro forma: Net income $3,396,000 Earnings per common share $ 0.32
In 1993, in connection with restructuring certain industrial development authority bond indebtedness, the Company granted stock warrants that entitled the former bondholders to purchase an aggregate of 275,000 shares of the Company's Common Stock through February 28, 1996, at exercise prices ranging from $4.00 to $5.00 per share. On February 28, 1996, all of the warrants expired unexercised.
12. EMPLOYEE SAVINGS PLAN
The Company has an employee savings plan which permits participants to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code. The Company matches contributions up to a maximum of 2.5% of compensation and may, at its discretion, make additional contributions to the plan. In connection with the required match, the Company's contribution to the plan was $182,000 in 1996, $161,000 in 1995, and $130,000 in 1994.
13. BUSINESS SEGMENTS AND CONCENTRATION OF CREDIT RISK
The Company currently operates exclusively in a single industry as manufacturer of electronic components and a consultant in the field of electromagnetic compatibility. At November 30, 1996 and 1995, approximately 36% and 40%, respectively, of the Company's accounts receivable were from customers in the telecommunication industry. The Company performs periodic credit evaluations of its customers and generally does not require advance payments or collateral. Credit losses to customers dealing in the tele- communication industry have not been material.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. OPERATING LEASES
The Company has entered into several operating lease agreements, primarily relating to sales office facilities and computer equipment. These leases are noncancelable and expire on various dates through 2006. Leases that expire generally are expected to be renewed or replaced by other leases. Future minimum rental payments for succeeding years under all operating leases are as follows:
1997 $ 215,000 1998 199,000 1999 161,000 2000 84,000 2001 73,000 Later Years 325,000
$1,057,000
Total rent expense under all operating leases amounted to $397,000 in 1996, $314,000 in 1995 and $377,000 in 1994.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under "Election of Directors" and "Directors of the Company" on pages 3 and 4 of the registrant's Proxy Statement for the annual meeting of shareholders to be held April 7, 1997 (the "Proxy Statement") is incorporated herein by reference.
The following information is provided with respect to the executive officers of the Company:
NAME OF OFFICER AGE POSITION
John P. Freeman 42 Vice President, Chief Financial Officer
Joseph J. Gaynor 46 Vice President, General Manager of Spectrum Control Technology, Inc.
James A. Siegel 55 Treasurer
Richard A. Southworth 54 Vice President, General Manager of Filter Products Group
James F. Toohey 62 Secretary
Richard E. Zaday 57 Vice President of Sales
As a result of the untimely death on December 27, 1996, of President and Chief Executive Officer, John L. Johnston, the Board of Directors has created an Executive Committee to act in lieu of, and to exercise all of the powers of the President and Chief Executive Officer until a successor has been appointed. The members of this Committee are: John P. Freeman, Chairman; Joseph J. Gaynor; Gerald A. Ryan; and Richard A. Southworth.
Mr. Freeman is a graduate of Gannon University in Accounting and is a Certified Public Accountant and Certified Management Accountant. He joined the Company in 1988 as Controller. Prior to that time, he was a principal in a public accounting firm. In January, 1990, he was named Vice President and Chief Financial Officer.
Mr. Gaynor is a graduate of the Georgia Institute of Technology with a bachelors degree in Mechanical Engineering. He joined the Company in 1991 as Vice President and General Manager of Spectrum Control Technology, Inc. Mr. Gaynor's prior work experience includes various engineering and manufacturing positions in specialty glass and electronic components.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (Continued)
Mr. Siegel is a graduate of Gannon University in Accounting. He joined the Company as Corporate Controller in 1974, was appointed Assistant Treasurer in 1975, and Treasurer in 1984.
Mr. Southworth is a graduate of Gannon University in Mechanical Engineering and Mathematics. He joined the Company in 1991 as Vice President and General Manager of the Electromagnetic Division. Prior to joining the Company, Mr. Southworth held executive positions with National Water Specialties, Philips Components, Murata-Erie North America, and Erie Technological Products. In 1996, Mr. Southworth was named General Manager of the Company's Filter Products Group.
Mr. Toohey is a graduate of Gannon University and Dickinson School of Law and is a practicing member of the Erie County Bar Association. He is a member of the law firm of Quinn, Buseck, Leemhuis, Toohey & Kroto, Inc., general counsel to the Company, and has been a Director and Secretary of the Company since its organization.
Mr. Zaday is a graduate of Cal State - LA in electronic engineering. He joined the Company in 1990 as Distribution Sales Manager and was named Vice President of Sales in 1994. Prior to joining the Company, Mr. Zaday held sales positions with Spectrol Electronics, Alpha Wire, and Triad-Utrad.
All executive officers are elected by the Board of Directors and serve at the discretion of the Board.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under "Executive Compensation" on pages 6 through 11 of the Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under "Securities Ownership" on pages 4 and 5 of the Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Schedules
(1) Financial Statements - The following consolidated financial statements of Spectrum Control, Inc. and subsidiaries are included in Part II, Item 8:
PAGE NO.
Report of Independent Auditors
Consolidated Balance Sheets as of November 30, 1996 and 1995
Consolidated Statements of Income for the Years Ended November 30, 1996, 1995, and 1994
Consolidated Statements of Stockholders' Equity for the Years Ended November 30, 1996, 1995, and 1994
Consolidated Statements of Cash Flows for the Years Ended November 30, 1996, 1995, and 1994
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules - The following financial statement schedule is submitted herewith for the periods indicated therein.
Schedule II - Valuation and Qualifying Accounts
All other schedules are not submitted because they are not required or are not applicable, or the required information is shown in the consolidated financial statements or notes thereto. Columns omitted from the schedule filed have been omitted because the information is not applicable.
(3) Exhibits - The following is the index to exhibits for Spectrum Control, Inc. and subsidiaries.
Description of Exhibit Page No.
Articles of Incorporation of registrant, as amended, previously filed on February 25, 1981, as Exhibit 3.1 to Form S-1 registration and incorporated herein by reference
By-laws of registrant, as amended, previously filed on February 25, 1981, as Exhibit 3.2 to Form S-1 registration and incorporated herein by reference
Subsidiaries of the registrant (21)
Consent of Independent Auditors(23)
(b) Reports on Form 8-K
None
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.
SPECTRUM CONTROL, INC
By: /s/John P. Freeman February 17, 1997 John P. Freeman, Chairman of Executive Committee
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/Edwin R. Bindseil Director February 17, 1997
/s/John P. Freeman Director, Principal February 17, 1997 Executive Officer, Chief Financial r Officer and Principal Accounting Officer
/s/Gerald A. Ryan Director February 17, 1997
/s/James F. Toohey Director February 17, 1997