ITEM 1. BUSINESS
Total Control Products, Inc. designs, develops and markets products and technology for the control segment of the industrial automation market. The Company's broad range of products are used to define, monitor and maintain the operation, sequencing and safety of industrial equipment and machinery on the factory floor. These products range from closed architecture programmable logic controller operator interfaces to open architecture control software and systems, and are sold primarily through an international network of independent distributors with approximately 250 sales locations. End-users of the Company's products include Abbott Laboratories, The Boeing Company, The Coca-Cola Company, The Dow Chemical Company, Eastman Kodak Company, Ford Motor Company, General Motors Corporation, Nabisco, Inc. and USX Corporation. Unless the context otherwise indicates, all references in this filing to "Total Control" or the "Company" refer to Total Control Products, Inc. and its subsidiaries, including wholly-owned subsidiaries Computer Dynamics of Illinois, Inc. and Computer Dynamics Holding Corp. (together "Computer Dynamics, Inc." or "CDI"), SensorPulse Corp. ("SensorPulse" or "SPC") and Taylor Industrial Software, Inc., an Alberta corporation ("Taylor"), a company of which 61.5% of the voting shares are owned by the Company. Subsequent to the Company's fiscal year ended March 31, 1998, the Company acquired the net assets of Deeco Systems, Inc. ("Deeco"), a designer and manufacturer of panel factory automation products.
THE INDUSTRIAL AUTOMATION INDUSTRY
Industrial manufacturing processes have become increasingly complex and difficult to manage, especially at the factory floor level. While trying to respond to such complexities, manufacturers are simultaneously under increased competitive pressures to lower costs, increase quality and efficiency and meet customer delivery deadlines. These pressures are often further complicated by the additional burden of compliance with governmental regulations, safety procedures and internal information reporting needs. To manage the complexity of the manufacturing environment and to satisfy these requirements, manufacturers must collect and analyze large amounts of data concerning their operations on a timely, comprehensive and efficient basis. Industrial automation provides solutions to these challenges.
The industrial automation industry can be divided into three segments: planning, execution and control. Products in the PLANNING segment translate information, such as customer orders and material purchases, into a comprehensive plan for the manufacture of products. Products in the EXECUTION segment schedule and monitor plant resources to ensure that machines produce products in accordance with the production plan. Products in the CONTROL segment, upon which the Company primarily focuses, allow users to define, monitor and maintain the operation, sequencing and safety of industrial equipment and machinery on the factory floor.
Specifically, control segment functions include supervisory controls, which allow individual machines to interact with each other; operator interfaces, which allow a human operator to communicate with an individual machine; and controllers, including programmable logic controllers ("PLCs") and industrial computers, which intelligently control the operation of a machine. The control market is presently dominated by proprietary control products from manufacturers of PLCs such as Allen-Bradley, Siemens Energy and Automation, Inc. and GE Fanuc Automation North America, Inc. Proprietary control products have many inherent limitations, including fixed, vendor-defined functionality and difficulty in programming, integrating and networking with other proprietary products and systems. As manufacturers
benefited from the increasing automation of individual machines, difficulties remained in integrating proprietary control segment products into different parts of the manufacturing process. With little communication ability among these products, multiple "islands of information" within a manufacturing operation resulted as products from one vendor could not easily share information with products from another vendor, forcing a manufacturer to depend upon a single vendor. For the manufacturer, this resulted in a high cost of ownership and the inability to take advantage of the inherent cost and performance benefits associated with standards-based products.
In response to these problems, the Company believes end-users in the control segment of the industrial automation marketplace are beginning to migrate towards open systems-based products. This migration is occurring gradually as manufacturers build new facilities and replace or upgrade existing facilities. By moving to interoperable products, manufacturers can benefit from standard networking protocols which provide enhanced connectivity, intuitive graphical user interfaces, enhanced application software functionality and the continued cost reductions associated with general purpose hardware. The availability of a standardized, easy-to-support operating system, such as Windows NT, allows industrial automation products to be based upon an open architecture platform with widespread market acceptance. In addition, the Company believes the advent of relatively low cost network computers, linked together through Internet or intranet protocols and technologies, will allow manufacturers and end-users greater communication and functionality in automation systems. Eventually, the Company believes these trends may result in the development of network computer systems which combine PLC and operator interface functionality to control the actions of machines on the factory floor.
Distributors are an integral part of the technological evolution occurring in the industrial automation marketplace. Traditionally, a substantial portion of industrial automation products have been sold through the use of independent distributors because they provide vendors with broad geographic and account coverage. Distributors also provide customers with a broad product line and local support and service and generally have well established, long-standing relationships with customers. As competitive pressures force distributors to limit the number of vendors and product lines they represent, the Company believes distributors will seek to represent vendors who offer a comprehensive line of products that will fill the needs of customers who have not migrated towards open systems as well as those who demand a line of products based on interoperable software and hardware. Because distributors base their business on satisfying the demands of their customer base, they need to offer a migration path from traditional industrial automation technology to products based on open systems technology.
The technology shift in the market for control products is similar to the transition in the office environment towards open client/server computing. The Company believes that an opportunity exists for vendors that can offer, through distribution, control segment products which span the range from proprietary, closed architecture products to standards-based open-system products.
STRATEGY
The Company's goal is to become a leading worldwide provider of products and technology in the control segment of the industrial automation market. Key elements of the Company's strategy are as follows:
LEVERAGE THE SUCCESS OF QUICKPANEL. The Company's principal product line, QuickPanel and other similar products, has gained a leadership position in its market. It has been the Company's most successful product line, accounting for 70.7%, 62.4% and 50.3% of net sales in fiscal 1996, 1997 and
1998, respectively. The Company believes that this product line delivers price/performance leadership and has allowed the Company to gain visibility and enhance its reputation both with distributors and with end-users.
DEVELOP PRODUCTS FOR SALE THROUGH INDEPENDENT DISTRIBUTORS. The Company utilizes an international network of independent distributors that specialize in sales of industrial automation products. The Company believes that, because distributors are seeking to make their operations more efficient by reducing the number of approved vendors from which they buy products, they have come to expect that the Company will provide a broad range of products which serve the control segment of the market. The Company is focused on developing industrial automation products that, from price, performance and support perspectives, satisfy the selling requirements of its distributors, and the Company does not currently anticipate designing or marketing products that are not suitable for its existing independent distributors. As the industrial automation industry moves from proprietary systems to open architecture technology, the Company anticipates that a wide variety of new and existing hardware and software technologies will converge, providing a broader range of sales opportunities for both the Company and its distributors.
LEVERAGE THE TREND TOWARDS OPEN SYSTEMS. The Company believes it is positioned to gain a leadership position in the next generation of industrial automation technologies. Because the Company is migrating its products to object-oriented software products that run in the Microsoft operating environment, the Company believes it will be in a position to benefit from the expected rapid acceptance of Microsoft Windows NT on the factory floor. The Company's goal is to provide cost effective distributed client/server products that can improve factory productivity and enhance business management and control.
SEEK PRODUCT PORTFOLIO EXPANSION OPPORTUNITIES. The industrial automation industry continues to be highly competitive and fragmented. The Company believes that this fragmentation will allow it to continue to acquire companies, assets and product lines in this market, although the Company does not currently have any planned acquisitions. This strategy will allow the Company to continue to expand its product portfolio and leverage its distribution channel in order to continue to build market share. The Company's acquisition strategy has been and will continue to be to seek companies, assets and products that are attractive to the Company's current end-user base, require technological understanding similar to the Company's current products, and can be easily marketed through its independent distributors or an already established direct channel.
FOCUS RESOURCES ON STRATEGIC AREAS. The Company's strategy is to maximize flexibility and efficiency in the development of its products in order to quickly and inexpensively bring them to market. The Company seeks to use the most efficient methods available to implement this strategy, including building strategic alliances, such as the Company's relationship with Digital Electronics Corporation, a corporation located in Osaka, Japan ("Digital Electronics"). The Company intends to continue to limit spending in non-strategic areas by using third party suppliers for most of its hardware and manufacturing needs, thereby eliminating the need to build and maintain costly manufacturing infrastructures.
PRODUCTS
The Company's products are used to define, monitor and maintain the operation, sequencing and safety of industrial equipment and machinery on the factory floor. The Company offers a wide range of products, from proprietary PLC operator interfaces to open architecture control software and systems. The Company designs these products to satisfy the price and performance characteristics demanded by its distributors and end-users, and sells products to its distributors at a discount from the end-user list price for such products.
OPERATOR INTERFACE PRODUCTS. The Company's operator interface products are described below:
GRAPHICS-BASED PRODUCTS. These products are easy-to-use displays which allow human machine operators to monitor and program industrial equipment by receiving and inputting information through a display screen. The Company has sold over 30,000 units in this class since 1989, and sales from these graphics-based product lines represented 70.7%, 62.4% and 50.3% of the Company's net sales in fiscal 1996, 1997 and 1998, respectively.
The Company's products in this category consist of monochrome and color graphical displays on either a flat panel or a cathode ray tube ("CRT") based screen. These products offer graphical touchscreen operator interfaces that are cost-effective replacements to a variety of discrete devices, from push buttons to message centers. The trend in this product class is towards smaller, flat panel-based displays as opposed to the more bulky CRT screens. The QuickPanel flat panel product line has eight separate models, while the CRT-based SmartScreen is sold in a variety of screen sizes and configurations. All of these units are designed for single operator stations and include connectivity technology to communicate with proprietary PLCs. The Company's graphics-based operator interface products can communicate with over 35 major PLCs and PLC networks including Allen-Bradley Remote I/O-TM-, Data Highway PLUS-TM-, Modicon Modbus Plus-TM-, and GE Genius I/O-TM-. Consequently, these products are capable of serving as bridges to open systems products and technology.
TEXT-BASED OPERATOR INTERFACES. These products, such as Grey-Line, MessageCenter and QuickMarquee, report on the operation of industrial equipment by sending textual messages to the machine operator through the use of a digital display apparatus, with display sizes ranging from one quarter inch to eight inches. This allows the machine operator to review messages as needed, rather than having to constantly monitor a complicated control panel filled with push buttons, pilot lights and selector switches. These products, although the most basic types of operator interfaces, are still widely popular and allow the Company to provide a broad range of products for the control segment of the industrial automation market.
INDUSTRIAL COMPUTER WORKSTATIONS. With the acquisition of Computer Dynamics, Inc. on October 5, 1997, the Company significantly expanded its product offering into custom designed industrial computer products and monitors. Products offered under the Computer Dynamics brand primarily represent products custom engineered to meet a specific need of an original equipment manufacturer or end-user. The STD Bus product line provides the strong background in board-level products and high-density single board computers which make possible the newer product lines such as the PC-compatible Single Board Computers (SBC line) and flat panel computer systems (DisplayPacs, FP-Kits and VAMPs). These products are primarily sold through a direct sales force.
CONTROL PRODUCTS AND SOFTWARE TOOLS. The Company's control products and software tools are described below:
CONTROL PRODUCTS
WALTZ. The Company's Waltz control software is a PC-based control product that allows a machine operator to have direct PC control over the operation of a machine without the necessity of a PLC. Waltz runs on Windows NT and includes an IEC 1131-3 compatible editor, a controller, communication drivers to various types of input/output systems, and an operator interface based on the Company's ProcessWindow software. By utilizing general purpose computers and high-performance, real-time operating systems, such as Windows NT, this software tool allows manufacturers to reduce dependency on proprietary PLCs and shift their operations to open systems technology.
GRAPHIC LOGIC CONTROLLER. This product is the first generation of graphics-based products to offer the same control and information display functionality currently available in the software tools. Specifically, this product combines the machine control functionality of a PLC and the operator interface functionality of a graphics-based touchscreen. The Company introduced this product in March 1998.
OPERATOR INTERFACE SOFTWARE TOOLS
PROCESSWINDOW. ProcessWindow is a graphical operator interface software program that enhances the man-machine interface ("MMI") that occurs between a human operator and a particular piece of factory equipment. The product provides a variety of information management and display capabilities that can be programed by the user, runs under Windows 3.1 and NT and is capable of communicating with many different control systems. In addition, it can be linked to the Company's ProWorx and Waltz software products.
QUICKDESIGNER. QuickDesigner is a Windows compatible software design tool used with the Company's flat panel operator interface products. This software tool allows users to configure the display features on the graphical flat panel touchscreen to meet their individual needs.
PLC SOFTWARE TOOLS
PROWORX. ProWorx NxT, ProWorxPlus and ProWorx IV are software tools which support the operation of PLCs. These products allow a human operator to easily and efficiently program a PLC to control the parameters of a machine's operation. Each of the products in this class run on DOS- or Windows-compatible PCs, and support PLCs manufactured by Allen-Bradley and Modicon.
SECURWORX. Users of multiple PLCs and other programmable devices may be faced with hundreds of controllers on a particular site, each containing unique application programs, connected by means of a local area network. As human operators make changes to the programming of a particular PLC, the Company's SecurWorx client/server database management software provides version control management as well as password protection. SecurWorx produces an audit trail of the controller program changes and is integrated with the Company's ProWorx software.
SIGNAL CONDITIONING DEVICES. With the acquisition of SensorPulse on December 31, 1997, the Company entered the signal conditioning market. The Company has four types of signal processing modules which standardize a signal for use with an industrial computer or PLC device. The MSC Signal Conditioning Modules are built on an all-digital design, making them one of the smallest, most affordable and highest performing dedicated signal conditioners around. The USC Universal Module can be quickly field configured to accept virtually any analog signal type. The MSP Analog I/O Smart Module is engineered with an all-digital design to provide a stable, state-of-the-art and cost effective solution for allowing analog input and output for any PLC. Finally, the Universal SP Analog I/O Module uses Windows-Registered Trademark--based software to easily and quickly field configurable to work with any input or output signal type.
PRODUCTS UNDER DEVELOPMENT. The Company intends to continue to focus its product development efforts on incorporating the high-end functionality of the Company's software tools into its existing text-based and graphics-based operator interface products. The Company's first product in this effort is the Graphic Logic Controller described above. The next product to be introduced as a result of this development effort is a QuickPanel product that will operate software using a MicroSoft CE operating system. This development would allow the graphics-based products to offer the same control and networking functionality that is currently available in the software tools. The Company believes the resulting products would provide enhanced price/performance leadership, allowing open architecture to be available at the lower end of the product spectrum and providing the end-user the benefit of enhanced flexibility, connectivity and functionality without having to convert its control systems to PC-based systems. In particular, the Company has invested substantial resources in developing future generations of the QuickPanel product line aimed at giving it the functionality of an open standards, interoperable network computer.
SERVICE AND SUPPORT. The Company maintains an inventory of spare parts and service stock. The shipment of spare parts and the performance of repair service on out-of-warranty products is a small, but a high margin part of the Company's business. For its software products, the Company offers annual customer support contracts that entitle the purchaser to free phone support and software upgrades during the length of the contract.
SALES, MARKETING AND SUPPORT
The Company's products are sold in more than 25 countries, primarily through an international network of independent distributors having approximately 250 sales locations. The Company seeks to establish and maintain relationships with the leading industrial automation distributors in each of the geographic market areas in which it competes, and periodically evaluates its distributors' market positions. The Company's distributors typically provide customer training, application engineering and support. The Company believes that its commitment to service and support has been and will continue to be a significant factor in its success. As of March 31, 1998, the Company's sales, marketing and technical support organization consisted of 103 employees and 10 independent sales representatives. This organization is managed by regional sales managers located in Atlanta, Georgia; Cincinnati, Ohio; San Francisco, California; Pittsburgh, Pennsylvania; Melrose Park, Illinois; South Easton, Massachusetts; Edmonton, Alberta; and Birmingham, England. This organization supports the Company's independent distributors and complements their selling efforts by targeting large end-users, system integrators, original equipment manufacturers and others.
In addition to its network of independent distributors, the Company maintains a 40.0%-owned joint venture investment in Pro-face, HMI B.V. ("ProFace"), a distributor located in the Netherlands. ProFace is the European distributor of both the Company's and Digital Electronics' products.
The Company's custom designed industrial computer products, manufactured by CDI, are primarily sold direct through a sales, marketing and support organization of 20 employees located in Greenville, South Carolina.
PRODUCT DEVELOPMENT
The Company maintains an active product development program, including a joint development arrangement with Digital Electronics for certain projects. The Company's strategy is to develop new product offerings and existing product extensions which are responsive to customer demands and satisfy the needs of the Company's distributors. A significant portion of the Company's product development expenses are targeted to developing products that will provide additional functionality requested by the Company's end-users.
As of March 31, 1998, the Company had a product development staff of 87 full-time employees, including software, electronic and mechanical design engineers, product managers, application engineers and directly associated staff members involved in technical documentation and product support. During fiscal 1996, 1997 and 1998, research and development expenses were 7.6%, 9.5% and 8.8 % of net sales, respectively. The Company anticipates that it will continue to commit substantial resources to product development efforts in the future. See Note 1 to the Consolidated Financial Statements included in this Form 10-K for a discussion of the Company's policy regarding capitalization of software development expenses.
SUPPLY RELATIONSHIP WITH DIGITAL ELECTRONICS
Digital Electronics is the Company's sole supplier of the flat panel screens that are the principal hardware component incorporated in its graphics-based operator interface products, the Company's best selling product class. During fiscal 1996, 1997 and 1998, sales from this product class accounted for 70.7%, 62.4% and 50.3%, respectively, of the Company's net sales. The Company has an OEM agreement with Digital Electronics under which Digital Electronics agreed to supply to the Company certain computer hardware products for market and sale on an exclusive basis in North and South America. The agreement expires on January 31, 2005. A disruption in the supply of products from Digital Electronics or a significant price increase could have a material adverse impact on the Company's business, financial condition and results of operations until an alternative source of supply could be established. See "Item 1 - -Risk Factors -- Dependence Upon Digital Electronics Corporation" and "Item 13 - -Other Related Party Transactions."
MANUFACTURING AND SUPPLY
The Company performs final assembly and testing for substantially all of its operator interface and control products and software tools at its Melrose Park, Illinois and Edmonton, Canada facilities, which are certified under ISO-9001, an international quality standard. The Company's industrial computer workstation products are primarily manufactured at its Greenville, South Carolina facility. The manufacturing process encompasses PC board manufacturing and the assembly of sheet metal parts, keyboards, displays and electronic circuit boards into finished goods and the duplication of software
products on disks or other electronic media. The Company subcontracts the fabrication of sheet metal and some of the assembly of circuit boards and fabrication of front panel bezels. The Company uses a number of firms for these subcontracted services and is not materially dependent upon any third party that performs these services.
Except for the flat panel displays purchased from Digital Electronics, substantially all of the components used in the Company's products are available from multiple sources and the Company maintains more than one source of supply for all material components. However, the Company may experience supply shortages due to various factors, including increases in market demand for certain components and the limited capacity of certain suppliers. Although the Company believes that the partial or complete loss of one or more of its suppliers, other than Digital Electronics, is not likely to have a material long-term impact on its operations, such a loss could in the short term result in significant production delays, require the Company to seek alternative sources of supply and increase its cost of goods sold and, therefore, could have a material adverse effect on the Company's business, financial condition and results of operations.
COMPETITION
Competition in the industrial automation industry is intense and characterized by rapidly advancing technologies. The Company faces substantial competition in all of its product lines and competition may increase if new competitors enter the market or if existing competitors expand their product offerings. Competitors include large PLC manufacturers, including Allen-Bradley (a subsidiary of Rockwell International, Inc.), Eaton Corp., GE Fanuc Automation North America, Inc. (a joint venture between General Electric Corporation and Fanuc Limited), Groupe Schneider S.A. (consisting of Modicon, Inc., Schneider S.A., Square D Co. and Telemechanique, Inc.) and Siemens Energy and Automation, Inc. (the U.S. subsidiary of Siemens A.G.). Competitors also include software developers, such as IDT, Inc. (a subsidiary of Eaton Corp.), Intellution Inc. (a subsidiary of Emerson Electric Corporation), Nematron, Inc. and Wonderware, Inc. Many of these competitors are larger and have significantly greater resources than the Company. These competitors, as well as potential future competitors, may have greater name recognition and a larger installed base than the Company. The Company believes that over time this competition may have the effect of reducing average selling prices of comparable products, and thus, in order to maintain sales, the Company may be forced to increase unit volumes or increase the performance of its products in order to offset or reduce any decreases in selling prices. In the event such price reductions become necessary, the Company's ability to maintain gross margins will depend on its ability to reduce cost of goods sold in an amount sufficient to compensate for any decreases in selling prices. The Company's competitors could in the future introduce products with more features and lower prices than the Company's product offerings, bundle existing or new products with other products or systems to compete with the Company or exert leverage or other competitive pressures on distributors to give priority to their own products at the expense of the Company's products. As the market for industrial automation and process control solutions develops, a number of companies with significantly greater resources than the Company may attempt to increase their presence in the market by acquiring and/or forming strategic alliances with competitors of the Company. The Company competes on the basis of the reliability, price and ease of use of its products, the quality and breadth of its distributor network and its customer service. The Company believes that it competes favorably with respect to these factors.
INTELLECTUAL PROPERTY
The Company's success depends in part on its ability to maintain the proprietary and confidential aspects of its products as they are released. The Company does not own any significant patents, and relies on a combination of copyrights, employee non-disclosure agreements and other means to establish and protect its proprietary rights. There can be no assurance that the precautions taken by the Company adequately protect the Company's technology. In addition, many of the Company's competitors have obtained or developed, and may be expected to obtain or develop in the future, patents, copyrights or other proprietary rights that cover or affect products that perform functions similar to the products offered by the Company. The inability of the Company for any reason to protect existing technology or otherwise acquire necessary technology could prevent distribution or licensing of the Company's products, which would have a material adverse effect on the business, financial condition and results of operations of the Company. The Company licenses its software products primarily under "shrink wrap" license agreements that are not signed by licensees and, therefore, may be unenforceable under the laws of certain foreign jurisdictions. In addition, in some instances the Company licenses its software products under agreements that give licensees limited access to the source code of the Company's products. Accordingly, despite precautions taken by the Company, it may be possible for unauthorized third parties to copy certain portions of the Company's products or to obtain and use information that the Company regards as proprietary.
Certain technology used in the Company's products is licensed from third parties. These licenses generally require the Company to pay royalties and to fulfill confidentiality obligations. In the future, it may be necessary or desirable for the Company to seek additional licenses of intellectual property rights held by third parties. There can be no assurance that such licenses will be available on favorable terms, if at all.
The Company believes that, due to the rapid pace of innovation within its industry, factors such as the technological and creative skills of its personnel are more important to establishing and maintaining a technology leadership position than are the various legal protection of its technology. The Company believes that its products and technology do not infringe any existing proprietary rights of others, although there can be no assurance that third parties will not assert infringement claims in the future.
EMPLOYEES
As of March 31, 1998, the Company had a total of 433 full-time employees, of which 87 were in product development, 123 were in sales and marketing, 169 were in manufacturing and operations and 54 were in general and administrative functions. The Company also hires temporary employees as needed. None of the employees are represented by a labor union or subject to a collective bargaining agreement. The Company believes that its employee relations are good.
YEAR 2000
The Company has conducted a comprehensive review of its computer systems to identify the systems that could be affected by the Year 2000 Issue and is developing an implementation plan to resolve the issue. The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. The Company presently believes that, with modifications to existing
software and converting to new software, the Year 2000 Issue will not pose significant operational problems for the Company's computer systems as so modified and converted. However, if such modifications and conversions are not completed timely, the Year 2000 Issue may have a material impact on the operations of the Company. The Company is currently evaluating the status of significant vendors with respect to Year 2000 compliance status. In the event that any of the Company's significant suppliers does not successfully and timely achieve Year 2000 compliance, the Company's business or operations could be adversely affected.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company cautions readers that certain important factors may affect the Company's actual results and could cause such results to differ materially from forward-looking statements which may be deemed to have been made in this Form 10-K, or which are otherwise made by or on behalf of the Company. Such factors include, but are not limited to, changing market conditions; the availability and cost of supply materials for the Company's products, the timely development and market acceptance of the Company's products; and other risks detailed under the caption "Risk Factors" below or otherwise described herein or detailed from time to time in the Company's Securities and Exchange Commission filings.
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION TO THE OTHER INFORMATION IN THIS REPORT ON FORM 10-K IN EVALUATING THE COMPANY AND ITS BUSINESS.
QUARTERLY VARIATIONS IN OPERATING RESULTS. Results of the Company's operations have fluctuated from quarter to quarter in the past, and may fluctuate significantly in the future. Such fluctuations may result from a variety of factors, including the timing of new product introductions by the Company, its competitors or third parties, the loss of any of its significant distributors, currency fluctuations, disruption in the supply of components for the Company's products, changes in product mix or capacity utilization, the timing of orders from major customers, personnel changes, production delays or inefficiencies, seasonality and other factors affecting sales and results of operations. Such quarterly fluctuations in results of operations may adversely affect the market price of the Company's Common Stock, no par value (the "Common Stock"). A substantial portion of the Company's sales for each quarter results from orders received in that quarter. Consequently, the Company is dependent upon obtaining orders for shipment in a particular quarter to achieve its sales objectives for that quarter. Furthermore, the Company has often recognized a substantial portion of its sales in the last month of a quarter, with sales frequently concentrated in the last weeks or days of a quarter. A substantial portion of the Company's operating expenses are primarily related to personnel, development of new products, marketing programs and facilities. The level of spending for such expenses cannot be adjusted quickly, and is based, in significant part, on the Company's expectations of future revenue. If actual revenue levels are below management's expectations, the Company's business, financial condition and results of operations may be materially adversely affected. The Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance.
DEPENDENCE UPON DIGITAL ELECTRONICS CORPORATION. The Company is substantially dependent upon its relationship with Digital Electronics, which is the Company's sole supplier of the flat panel displays that are the principal hardware component incorporated in the graphics-based operator interface products that represent the Company's best selling product line. For fiscal 1996, 1997 and 1998, sales from this product line accounted for 70.7%, 62.4% and 50.3%, respectively, of the Company's net sales. The inability of the Company to obtain this hardware platform from Digital Electronics, significant delays or shortages in production or significant price increases by Digital Electronics would have a material adverse effect on the Company. The Company currently has no identified alternative supplier for the products supplied by Digital Electronics. At any time, Digital Electronics could become a direct competitor of the Company outside of North and South America and, upon expiration of the distribution agreement in January 2005, Digital Electronics could become a direct competitor of the Company in North America and South America. The Company is also dependent on the ability of Digital Electronics to continue to develop its hardware technology to meet rapidly changing customer requirements and competing technologies. The Company is currently engaged in certain product development efforts with Digital Electronics which are important to the Company's future strategic position. The historic business relationship between the Company and Digital Electronics has been based to a significant extent on personal relationships between members of the management of the two companies and the previous dealings of the entities. If those relationships were to change, or if the management of the Company or Digital Electronics were to change, this could result in a material adverse effect on the relationship between the Company and Digital Electronics and, in turn, on the business, financial condition and results of operations of the Company. The Company believes that the relationship between Digital Electronics and the Company has been and remains good. However, there can be no assurance that the relationship will continue on a satisfactory basis. Digital Electronics is not affiliated with Digital Equipment Corporation. Digital Electronics is also a shareholder of the Company and the Company's majority owned subsidiary, Taylor Industrial Software, Inc. ("Taylor"), and has certain other relationships with the Company. As of March 31, 1998, the Company owned 0.17% of the outstanding common stock of Digital Electronics. See Item 13 - -"Taylor Transaction" and "Other Related Party Transactions."
DEPENDENCE ON DISTRIBUTORS. Prior to October 1997, the Company derived substantially all of its revenue from sales of its products through its network of distributors. Subsequent to October 1997, due to the addition of an inside salesforce at CDI, the Company derived 82% of its revenue from distributors. The Company expects that sales through its distributors will continue to account for a substantial portion of its revenue for the foreseeable future. None of the Company's distributors are under the control of the Company or sell the Company's products on an exclusive basis, and there can be no assurance that future sales by distributors will continue at present levels or increase. Each of the Company's distributors may cease marketing the Company's products with limited notice and with little or no penalty. There can be no assurance that the Company's independent distributors will continue to offer the Company's products, or that the Company will be able to recruit additional or replacement distributors. The loss of one or more of the Company's major distributors could have a material adverse effect on the Company's business, financial condition and results of operations. Many of the Company's distributors offer industrial automation products that compete with products offered by the Company. For example, the Company believes that approximately 20% and 13% of the Company's net sales for fiscal 1997 and 1998, respectively, resulted from sales by distributors that also offer products manufactured by Allen-Bradley Co. ("Allen-Bradley"), a direct competitor of the Company. There can be no assurance that the Company's distributors will give priority to the marketing of the Company's products as compared to competitors' products. Any reduction or delay in sales of the Company's products by its distributors would have a material adverse effect on the business, financial condition and results of operations of the Company.
PRODUCT CONCENTRATION. Sales from the Company's QuickPanel product and similar products represented 70.7%, 62.4% and 50.3% of the Company's net sales in fiscal 1996, 1997 and 1998, respectively. The Company expects that sales of these products will continue to account for a substantial portion of the Company's net sales. Declines in demand for these products, whether as a result of competition, technological change or otherwise, would have a material adverse effect on the Company's business, financial condition and results of operations. See "Item 1 - -Business-Products."
CURRENCY EXCHANGE RATE FLUCTUATIONS. The Company experiences foreign currency exchange gains and losses in the ordinary course of its business due to exchange rate fluctuations among a variety of currencies. Purchases of flat panel screens from Digital Electronics, which constituted 61.6% and 48.4% of the Company's cost of goods sold for fiscal 1997 and 1998, respectively, are transacted in Japanese Yen. As a result, fluctuations in the exchange rate between the U.S. Dollar and the Yen may have a material impact on the ability of the Company to maintain its gross margins. In addition, Taylor is located in Edmonton, Alberta and, although most of its sales are denominated in U.S. Dollars, most of its expenses are incurred in Canadian Dollars. The Company currently attempts to hedge a portion of its potential risk with respect to fluctuations in the Yen, and is investigating hedging Canadian Dollars. While such foreign currency hedging transactions may moderate the overall effect of currency fluctuations, the Company expects that such fluctuations will continue, and there can be no assurance that the Company will be successful in its hedging activities or that exchange rate fluctuations will not otherwise have a material adverse effect on the Company's financial condition or results of operations, or cause significant fluctuations in quarterly results of operations.
EFFECT OF RECENT ACQUISITIONS AND RISKS ASSOCIATED WITH FUTURE ACQUISITIONS. In calendar 1996, the Company acquired Cincinnati Dynacomp, Inc. ("Cincinnati") and a controlling interest in Taylor. In calendar 1997, the Company acquired substantially all of the assets of Computer Dynamics and SensorPulse. Subsequent to the Company's fiscal year ended March 31, 1998, the Company acquired the net assets of Deeco Systems, Inc. (collectively, the "Acquired Businesses"). The Company has no significant history of operations on a combined basis with any of the Acquired Businesses. There can be no assurance that the Company will be successful in integrating the operations and personnel of the Acquired Businesses into its business, incorporating acquired technologies into its product lines, establishing and maintaining uniform standards, controls, procedures and policies, avoiding the impairment of relationships with employees and customers as a result of changes in management or overcoming other problems that may be encountered in connection with the integration of the Acquired Businesses. In connection with the acquisition of the Acquired Businesses, the Company recorded goodwill, which will be amortized over future periods, and recognized certain one-time acquisition-related charges. A part of the Company's business strategy is to continue its growth through strategic acquisitions. Identifying and pursuing future acquisition opportunities and integrating acquired products and businesses will require a significant amount of management time and skill. There can be no assurance that the Company will be able to identify suitable acquisition candidates, consummate any acquisition on acceptable terms or successfully integrate any acquired business into the Company's operations. If the Company were to proceed with one or more significant future acquisitions in which the consideration consists of cash, a substantial portion of the Company's available funds could be necessary in order to consummate the acquisitions. If the Company were to consummate one or more significant acquisitions in which the consideration consists of stock, shareholders of the Company could suffer a significant dilution of their interests in the Company. Many business acquisitions must be accounted for as a purchase. Most of the businesses that might become attractive acquisition candidates for the Company are likely to have significant goodwill and intangible assets, and acquisition of these
businesses, if accounted for as a purchase, would typically result in substantial goodwill amortization charges to the Company. In addition, such acquisitions could involve acquisition-related charges.
EFFECT OF OBLIGATION TO MAKE CONTINGENT PAYMENTS. In accordance with the Taylor transaction, the Company made a payment of contingent consideration of approximately $1.1 million to the former shareholders of Taylor in September 1997. Continuing in fiscal 1999, the Company may become obligated under the terms of the Taylor Transaction, the Computer Dynamics transaction, the SensorPulse transaction and the Deeco transaction to make payments of contingent consideration which could be substantial in amount. The Taylor Transaction requires contingent payments based on Taylor's revenue for the twelve month period ending September 30, 1998, of up to $4.0 million. The Computer Dynamics transaction requires contingent payments for five years ranging from $0 to $3 million each year to the extent that the year over year growth in earnings of CDI exceeds 110% to 125% of the base earnings for each period. Of such contingent payments with respect to the Computer Dynamics transaction, half are payable in shares of the Company's Common Stock valued at its fair market value at such time (up to 347,961 shares), with the remainder payable in cash. The Company intends to seek shareholder approval to amend this agreement to remove the limitation of the number of shares that can be paid under the CDI Transaction. The SensorPulse transaction provides for a four year annual earn-out payment to SensorPulse based on the year over year growth in SensorPulse's earnings before taxes multiplied by: three in calendar 1998; two and three quarters in calendar 1999; two in calendar year 2000; and one and one-half in calendar year 2001,with maximum aggregate payments of $23.25 million. Such earn-out shall be payable 50% in cash and 50% in common stock of the Company at its then fair market value. The Deeco transaction provides for an earn-out of up to $2 million if Deeco attains certain financial targets for the twelve month period ending January 31, 1999. These contingent payments may require the Company to borrow against its existing credit facility or to seek additional equity or debt financing, which could materially adversely affect the Company's business and financial position. There can be no assurance that such capital will be available to the Company on favorable terms, if at all.
RISKS OF SERVING CYCLICAL INDUSTRIES. The end-users of the Company's products include manufacturers in a number of industries which are cyclical in nature, including the automotive and packaging industries. Such industries have historically experienced periodic downturns as well as short-term fluctuations which often have had an adverse effect on the demand for industrial machinery and equipment in those industries and on the related demand for products like those of the Company that are used to control such machinery and equipment. Downturns in these industries could have a material adverse effect on the Company's business, financial condition and results of operations.
EFFECT OF RAPID GROWTH ON EXISTING RESOURCES. The Company has grown rapidly in recent years. A continuing period of rapid growth could place a significant strain on the Company's management, operations and other resources. The Company's ability to manage its growth will require it to continue to invest in its operational, financial and management information systems, and to attract, retain, motivate and effectively manage its employees. The inability of the Company's management to attract such new employees and manage its growth effectively could have a material adverse effect on the business, financial condition and results of operations of the Company.
TECHNOLOGICAL CHANGE; DIFFICULTIES AND RISKS ASSOCIATED WITH NEW PRODUCT DEVELOPMENT AND INTRODUCTION. The market for the Company's products is characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. The Company's near-term success and future growth are substantially dependent upon continuing market acceptance of its existing products, and on the Company's ability to develop new products to meet changing customer requirements and
emerging industry standards. In addition, the Company's growth is in part dependent on the ability of Digital Electronics to maintain its development and supply of advanced hardware platforms for the Company's graphics-based operator interface products. There can be no assurance that products or technologies of the Company's competitors will not render the Company's products or technologies noncompetitive or obsolete. The Company's future success is dependent to a significant degree on its ability to develop products in a timely manner that operate in an open architecture environment. There can be no assurance that the Company will be successful in developing new products or product extensions, that unanticipated problems or delays in future development and production will not be encountered, or that, once developed, the Company's products will meet the requirements of its customers or gain market acceptance.
SIGNIFICANCE OF DEVELOPING MARKET. The market for standards-based, interoperable software tools and products in the industrial automation industry is new and rapidly evolving. The Company's future success is dependent to a significant degree upon broad market acceptance of the type of open architecture products on which the Company is focusing its development efforts. There can be no assurance that the market for such products will continue to develop or grow, that the Company's product offerings will gain market acceptance, that the Company will be able to offer in a timely manner, if at all, further product developments utilizing open architecture technology or that the Company's end-users will choose the Company's products for use. The failure of any of these events to occur would have a material adverse effect on the business, financial condition and results of operations of the Company.
PARTIALLY OWNED SUBSIDIARY. The Company owns 61.5% of the Class A Shares of Taylor (the "Taylor Class A Shares"), and Digital Electronics owns the remaining 38.5% of such shares. Digital Electronics, as the minority shareholder of Taylor, will be entitled to a portion of the economic benefits of the business operated by Taylor and will have influence over the business and operations of Taylor, including certain fundamental corporate transactions requiring supermajority shareholder approval. Both the Company and Digital Electronics pay a royalty to Taylor based on their sales of Taylor software products. Although the Company owns a majority interest of the outstanding Taylor Class A Shares, and although Taylor's financial results are consolidated with those of the Company, the Company will not receive the full economic benefit from Taylor's sales and operations. Moreover, the Company may not be able to unilaterally control decisions regarding the conduct of Taylor's business and affairs. A unanimous vote of shareholders is required for the following: change in business purpose of Taylor; dissolution or liquidation of Taylor; the amalgamation, merger, consolidation or other similar capital integration of Taylor with a third party; the acquisition of an interest in any other company by Taylor which competes with the business of either the Company or Digital Electronics; or the making of any loan over $500,000 or offering guarantees, securities, or mortgages in favor of any person other than Taylor itself by Taylor.
DEPENDENCE ON OUTSIDE SUPPLIERS. The Company is dependent on outside vendors to manufacture many of the components and subassemblies used in the Company's products. Although substantially all of the components used in the Company's products are available from multiple sources (other than the flat panel screens supplied by Digital Electronics), the Company may experience shortages in supply from its suppliers due to various factors, including increases in market demand for certain components which occur from time to time and the limited capacity of certain suppliers. The Company believes that the partial or complete loss of one or more of its suppliers is not likely to have a material long-term impact on its operations. Such a loss, however, could in the short term result in significant production delays, require the Company to seek alternative sources of supply and increase its cost of goods sold and,
therefore, could have a material adverse effect on the Company's business, financial condition and results of operations.
COMPETITION. Competition in the industrial automation industry is intense and characterized by rapidly advancing technologies. The Company faces substantial competition in all of its product lines and competition may increase if new competitors enter the market or if existing competitors expand their product offerings. The Company believes that over time this competition may have the effect of reducing average selling prices of comparable products offered by competitors, and thus, in order to maintain sales, the Company may be forced to increase unit volumes or increase the performance of its products in order to offset or reduce any decreases in selling prices. In the event such price reductions become necessary, the Company's ability to maintain gross margins will depend on its ability to reduce its cost of goods sold in an amount sufficient to compensate for any decreases in selling prices. Certain of the Company's competitors and potential competitors have substantially greater name recognition and financial, technical, marketing and other resources than the Company. Such competitors or potential competitors may be able to exert leverage or other competitive pressures on distributors to give priority to their own products at the expense of the Company's products. To the extent the Company is unable to compete effectively against its competitors, its business, financial condition and results of operations could be materially adversely affected. The Company believes its ability to effectively compete in the industrial automation market depends on factors both within and outside its control, including the ability of the Company to meet evolving market requirements, the timing and success of new products developed by the Company and its competitors, product performance and price, distribution and customer support, product reputation, customers' assessment of the Company's financial resources and its technical and service expertise. There can be no assurance that the Company will be able to compete successfully with respect to these and other factors, and such competitive pressures could adversely affect the Company's business, financial condition and results of operations.
PRODUCT LIABILITY EXPOSURE. The use of the Company's products in systems that interact directly on the factory floor, where the failure of the system could cause substantial property damage or personal injury, could expose the Company to significant product liability claims. Although the Company has not experienced product liability claims to date, the sale and support of its products may entail the risk of such claims. A successful product liability claim brought against the Company, or product recall involving the Company's products, could have a material adverse effect upon the Company's business, financial condition and results of operations. The Company maintains product liability insurance, but there can be no assurance that such insurance will be sufficient to cover any claims or that it will continue to be available on reasonable terms, if at all. The Company's contracts typically contain limitations of liability, disclaimers of warranties, damage limitations, and indemnifications against third party claims, which provisions may not be effective in all circumstances and jurisdictions. Taylor's software license agreements with its customers typically contain similar limitations and provisions but consist of "shrink wrap" licenses that are not signed by licensees and, therefore, it is possible that such licenses may be unenforceable under the laws of certain jurisdictions.
DEPENDENCE ON CHIEF EXECUTIVE OFFICER AND OTHER EXECUTIVE OFFICERS. The Company depends to a significant degree on its senior management and other officers and key employees, especially its Chief Executive Officer, Nicholas Gihl. The loss of Mr. Gihl's services, the loss of service of one or more of the Company's other executive officers or the inability to hire or retain qualified personnel could adversely affect the Company's business, financial condition and results of operations. See "Directors and Executive Officers of the Registrant."
PROPRIETARY TECHNOLOGY AND PRODUCT PROTECTION; POTENTIAL INFRINGEMENT. The Company's success depends in part on its ability to maintain the proprietary and confidential aspects of its products. The Company does not own any significant patents, and relies on a combination of copyrights, non-disclosure agreements with certain employees and other means to establish and protect its proprietary rights. There can, however, be no assurance that the precautions taken by the Company adequately protect the Company's technology. In addition, many of the Company's competitors have obtained or developed, and may be expected to obtain or develop in the future, patents, copyrights or other proprietary rights that cover or affect products that perform functions similar to those performed by products offered by the Company. The inability of the Company for any reason to protect existing technology or otherwise acquire necessary technology could prevent distribution or licensing of the Company's products, which would have a material adverse effect on the business, financial condition and results of operations of the Company. In addition, although the Company believes that its products do not infringe patents, copyrights, or other proprietary rights of third parties, there can be no assurance that the Company is aware of all patents, copyrights or other proprietary rights that may be infringed by the Company's products, that infringement does not exist or that infringement may not be alleged by third parties in the future. If infringement is alleged, there can be no assurance that the necessary licenses would be available on acceptable terms, if at all, or that the Company would prevail in any related litigation. Intellectual property litigation can be extremely protracted and expensive even if the Company ultimately prevails, and involvement in such litigation could have a material adverse effect on the business, financial condition and results of operations of the Company.
PREFERRED STOCK; STAGGERED BOARD AND ANTI-TAKEOVER EFFECTS OF CORPORATE PROVISIONS. The Board of Directors of the Company (the "Board of Directors") has the authority to issue, without vote or action of the shareholders, 1,000,000 shares of Preferred Stock, no par value ("Preferred Stock"), in one or more series; to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption, redemption prices and liquidation preferences; and to determine the designation and the number of shares constituting any series. The issuance of any Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company and may adversely affect the voting and other rights of the holders of Common Stock. At present, the Company has no plans to issue any Preferred Stock. The Company has also implemented a staggered Board of Directors consisting of three three-year classes. These and other provisions in the Company's Articles of Incorporation and By-laws and of Illinois law could delay or make more difficult a merger, tender offer or proxy contest involving the Company.
ITEM 2.
ITEM 2. PROPERTIES
The Company's headquarters and principal manufacturing for operator interface products facilities are located in Melrose Park, Illinois, in a 39,000 square foot leased facility, of which approximately 24,000 square feet is used for manufacturing and storage. The facility is owned by a partnership which is controlled by officers and major shareholders of the Company. See "Item 13 - -Other Related Party Transactions." This facility is leased through April 2002. Also, the Company leases a 22,000 square foot facility in Edmonton, Alberta. The Company also leases sales offices. As part of the acquisition of Cincinnati, the Company became the primary obligor of a 29,670 square foot facility in Cincinnati, Ohio. The Company is currently seeking a sublessor of this facility through the remainder of the original lease term, which expires in August 2000. The Company believes that its facilities are adequate for its current needs.
The Company also leases a 97,000 square foot manufacturing facility for its industrial computer workstation products located in Greenville, South Carolina, of which 75,000 square feet is used for manufacturing and storage. The facility is owned by a limited liability corporation controlled by an officer/shareholder of the Company. See "Item 13 - --Other Related Party Transactions". This facility is leased through September 30, 2002. The Company is currently subletting 32,000 square feet of this facility through February 28, 2001. The Company has the right request the sublessee vacate the space within 60 days.
The Company also leases a 9,100 square foot facility for its signal conditioning operation in South Easton, Massachusetts, of which 5,000 square feet is used for manufacturing and storage. The facility is leased through December 31, 1998, and the Company has the right for two one year renewals at the current rate plus an increase equal to the adjustment in the consumer price index.
In conjunction with the Deeco transaction, the Company is subleasing a 33,750 square foot facility in Hayward, California, of which approximately 17,000 square feet is used for manufacturing and storage. The facility is sublet through January 31, 1999.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In 1996, Wesco Distribution Incorporated ("Wesco"), a former distributor of Cincinnati, initiated litigation against one of its customers, Joslyn Sterilizer, Inc. ("Joslyn") to collect approximately $50,000 of invoices for computer software and equipment purchased by the customer, including equipment supplied by Cincinnati. The customer then filed a counterclaim against Wesco alleging that the software and equipment contained defects and seeking damages in the amount of approximately $1.6 million. On February 14, 1997, Wesco impleaded Tara Products, Inc. ("Tara"), the Company's wholly-owned subsidiary which is the successor to Cincinnati, seeking indemnification from Tara for damages suffered by Wesco resulting from any product defects. This suit (the "Lawsuit") was filed in the New York Supreme Court for Monroe County. On May 23, 1997, the New York Supreme Court for Monroe County dismissed Wesco's third-party complaint against Tara without prejudice on the grounds that under a distribution agreement between Wesco and Tara's predecessor, any litigation between the two companies must be brought in the Court of Common Pleas for Claremont County, Ohio. Wesco may still seek indemnification from Tara in Ohio. While the Company has not conducted any formal investigation or taken any discovery, it believes that Tara would have a meritorious defense to such an action.
On May 7, 1997, Joslyn filed a complaint against Tara, the Company and Tara's predecessors, Cincinnati Electrosystems Inc., and Cincinnati Dynacomp, Inc., in the Supreme Court for Monroe County, New York, alleging substantially the same facts against those defendants as it did against Wesco in the counterclaim. In response to Joslyn's complaint, the defendants filed a motion for summary judgement which was granted in part and denied in part. With respect to such matters that it was unsuccessful, the Company filed a response on January 19, 1998. Again, while this action is in the preliminary stages and no formal discovery has been initiated, the Company believes that it and the other defendants have meritorious defenses, and the Company intends to vigorously defend this action. There can be no assurance, however, that the defendants will prevail in this action. If the defendants do not prevail, or if they settle the action, the Company could be required to make payments to Joslyn. The Company does not, however, believe that any such payments, if required to be made, would have a material adverse effect on the Company's financial condition or results of operations.
The Company is not involved in any other material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters have been submitted to a vote of security holders since the effective date of the Company's initial public offering on March 11, 1997.
With respect to the scheduled Annual Meeting of Shareholders of the Company to be held on August 27, 1998, the Company intends to submit the following items to a vote of the shareholders:
1. Considering and acting upon a proposal to amend Article Fifth of the Company's Amended and Restated Articles of Incorporation to provide that the number of directors of the Company shall not be less than three nor more than eleven directors;
2. Electing two persons to the Board of Directors of the Company to serve until the annual meeting of the Company in 2001 and until their respective successors have been elected and qualified and, if the charter amendment described in subparagraph 1 is adopted, electing one additional person to the Board of Directors of the Company to serve until the annual meeting of the Company in 1999 and until his respective successor has been elected and qualified;
3. Considering and acting upon a proposal to amend the Company's 1996 Employee Stock Option Plan in order to increase the number of reserved shares of Common Stock for option grants under such Plan from 550,000 to 1,100,000;
4. Considering and acting upon a proposal to approve, pursuant to Nasdaq Rule 4460(I), an amendment to the asset purchase agreement in which the Company acquired substantially all of the assets of KP One, Inc. (f/k/a Computer Dynamics), a South Carolina corporation, to allow the Company to issue in excess of 347,961 shares of Common Stock as contingent consideration thereunder; and
5. Ratifying the appointment of Arthur Andersen LLP as auditors of the Company for fiscal 1999.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET INFORMATION
Total Control's Common Stock is traded on the Nasdaq National Market under the symbol "TCPS." Trading in Total Control's stock commenced on March 11, 1997, the effective date of its initial public offering. The initial public offering price of Total Control's Common Stock was $8.00 per share.
The following table sets forth the reported high and low sale prices for Total Control's Common Stock for each fiscal quarter during the fiscal year ended March 31, 1998. Quotations are as reported by Nasdaq for National Market System issues.
As of June 1, 1998, there were approximately 1,600 holders of record of Total Control's Common Stock (including individual participants in security position listings) and the closing bid price of the Common Stock was $8.375 per share.
The transfer agent and registrar for Total Control's Common Stock is Norwest Bank Minnesota, N.A., Stock Transfer Department, P.O. Box 64854, St. Paul, MN 55164-0854, telephone: 1-800-468-9716.
DIVIDENDS
Total Control presently intends to retain future earnings for its operations and expansion of its business. Total Control has never declared or paid any dividends on its Common Stock and has no plans to do so in the foreseeable future. Any determination to pay cash dividends in the future will be at the discretion of Total Control's Board of Directors and will be dependent upon Total Control's results of operations, financial condition and other factors deemed relevant at the time by its Board of Directors.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated statement of operations data for each of the three years in the period ended March 31, 1998 and balance sheet data at March 31, 1997 and 1998 have been derived from the consolidated financial statements of the Company included elsewhere in this Form 10-K and have been audited by Arthur Andersen LLP, independent public accountants, as indicated by their report thereon contained elsewhere herein. The selected consolidated statement of operations data for the two years in the period ended March 31, 1995 and balance sheet data as of March 31, 1994, 1995 and 1996 has been derived from consolidated financial statements of the Company not included in this Form 10-K that have been audited by Arthur Andersen LLP, independent public accountants. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Form 10-K.
__________________
(1) Computed on the basis described in Note 1 of Notes to Consolidated Financial Statements.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company designs, develops and markets products and technology for the control segment of the industrial automation market. The Company's broad range of products are used to define, monitor and maintain the operation, sequencing and safety of industrial equipment and machinery on the factory floor. These products include closed architecture control and PLC operator interface devices, industrial computers and flat panel monitors and open architecture control software and systems, and are sold primarily through an international network of independent distributors with approximately 250 sales locations.
The Company's net sales include revenues from sales of products, software license fees, software maintenance and services. The Company's principal operator interface product line, QuickPanel, accounted for 70.7%, 62.4% and 50.3% of net sales in fiscal 1996, 1997 and 1998, respectively.
A key element of the Company's strategy has been to expand the breadth of its factory floor automation products offered through its distributor network in order to provide innovative solutions for automation to end users. In September 1996, the Company acquired a controlling interest in Taylor, an Edmonton, Alberta-based developer of PC-control software, client/server program management software, graphical operator interface software and PLC configuration and support software. In October 1997, the Company acquired substantially all of the net assets of CDI, a South Carolina-based manufacturer of industrial computers. Also, on December 31, 1997, the Company acquired substantially all of the net assets of SensorPulse, a Massachusetts-based designer and developer of industrial signal conditioning products and networked input/output (I/O) devices. Subsequent to the Company's fiscal year ended March 31, 1998, the Company acquired the net assets of Deeco Systems, Inc., a designer and manufacturer of flat
panel factory automation products. These acquisitions expanded the Company's product line, allowing it to capitalize on the growing trends towards interoperable technology products, and gave the Company a platform from which to develop new products incorporating these new technologies into the Company's traditional products.
In connection with these acquisitions, the Company may become obligated to make payments of contingent consideration which could be substantial in amount. See "--Liquidity and Capital Resources." All of these acquisitions were accounted for as a purchase in accordance with Accounting Principles Board Opinion No. 16. In connection with the SensorPulse and Taylor Transactions, approximately $200,000 ($120,000 net of related income tax benefit) and $4.9 million were charged as an expense at the acquisition date related to the purchase of incomplete research and development projects and other acquisition costs. In connection with the Company's acquisitions, the Company recorded approximately $25.8 million of goodwill (which will be increased in the event any future contingent consideration is paid), which is being amortized on a straight-line basis over 7 to 17 years.
Following the Taylor Transaction, the Company engaged a broker to commence the sale of Taylor's labor scheduling software product line. The revenues, expenses and resulting net loss associated with this product line since the date of acquisition have not been reflected in the Company's statement of operations. On September 26, 1997, Taylor completed the sale of this product line to an entity principally owned by Neil R. Taylor ("Mr. Taylor"). Mr. Taylor, the former principal shareholder of Taylor, is a member of the Company's board of directors. The sale price was approximately $4 million.
In connection with the transaction, the Company loaned Mr. Taylor $2 million pursuant to a promissory note dated September 25, 1997. The note bears interest at 8% per annum, due annually, and is payable in five equal installments beginning on September 25, 1999 and ending on September 25, 2003. The note is secured by 250,000 shares of Class C exchangeable common stock of Taylor currently held by Mr. Taylor. As a result of this transaction, the purchase price associated with the Taylor acquisition was re-allocated. The carrying value of the goodwill previously recorded by the Company related to the Taylor acquisition increased by approximately $2.5 million, which related to the after tax difference between the estimated sales price of the product line, previously recorded as an asset held for sale, and the actual sales price. This additional goodwill is being amortized over the remaining useful life of the goodwill (six years from the date of the transaction).
All of the Company's purchases of QuickPanel operator interface hardware devices are from Digital Electronics and are transacted in Japanese Yen, while substantially all of the Company's sales are in U.S. Dollars. These purchases from Digital Electronics accounted for 61.6% and 49.8%, respectively, of the Company's total cost of goods sold for fiscal 1997 and 1998. The Company's financial performance, including its gross margin, may be substantially impacted by changes in the Yen/Dollar exchange rate. The Company attempts to hedge a portion of this exchange rate risk, but there can be no assurance that the Company will be successful in its hedging activities or that certain exchange rate fluctuations will not otherwise have a material adverse effect on the Company's financial condition or results of operations, or cause significant fluctuations in results of operations.
To the extent statements in this Item 7 may be considered forward looking, readers are cautioned to read the "Safe Harbor Statement" and "Risk Factors" contained in Item 1 hereof.
FISCAL YEARS ENDED MARCH 31, 1998 AND MARCH 31, 1997
NET SALES. Net sales increased 48.6% to $60.6 million for fiscal 1998 compared to $40.8 million for fiscal 1997. This increase resulted primarily from the sales of products acquired as a result of the CDI Transaction of approximately $10.8 million for the six months ended March 31, 1998 and the growth in sales of the Company's graphics-based operator interface products of approximately $5.8 million. Additionally, the increase reflects the results of Taylor for the entire period in 1998 versus six months in the period ended March 31, 1997 of approximately $2.9 million.
GROSS PROFIT. Cost of goods sold consists primarily of expenses for components and subassemblies, subcontracted labor, direct labor, manufacturing overhead, and provisions for excess and obsolete inventory. Gross profit increased 62.7% to $32.8 million for fiscal 1998 from $20.2 million for fiscal 1997. Gross margin increased to 54.1% for fiscal 1998 from 49.4% in fiscal 1997. Of this increase, 1.7 percentage points related to a reduction in the material cost primarily in the QuickPanel product line due to favorable Yen fluctuations, 2.5 percentage points was related to lower manufacturing overhead costs as a result of integrating the Cincinnati Dynacomp operation acquired in January 1996 into the Total Control operation during the latter part of fiscal 1997. An additional improvement of .7 percentage points related to an increase in higher margin Taylor sales as a percentage of total sales for the year, offset by a 0.5 percentage point reduction related to the inclusion of lower margin CDI and SensorPulse sales in fiscal 1998.
SALES AND MARKETING. Sales and marketing expenses consist primarily of personnel costs, sales commissions paid to the Company's independent sales representatives, advertising, product literature, trade shows, distributor promotions and depreciation on equipment used for sales related activities. Sales and marketing expenses increased 43.1% to $13.0 million for fiscal 1998 from $9.1 million for fiscal 1997. Approximately $1.5 million of the increase resulted from costs associated with the operations of Taylor for an entire period versus six months in 1997 and $725,000 of the increase resulted from the operations CDI. Approximately $1.0 million of the increase resulted from increased direct sales headcount. Finally, commissions due to external sales representative increased as a result of higher sales volume by approximately $460,000.
RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of personnel costs, engineering supplies, development equipment, depreciation and overhead costs. Research and development expenses increased 37.2% to $5.3 million for fiscal 1998 from $3.9 million in fiscal 1997. Approximately $1.0 million of the increase related to the inclusion of the costs related to Taylor for the entire period in fiscal 1998 versus six months in fiscal 1997 and $550,000 of costs related to the operations of CDI for the period from acquisition to March 31, 1998. The increase also resulted from an increase in outside development costs of approximately $100,000 and increases in prototype supplies and product liability insurance totaling approximately $100,000. These increases were offset by a reduction in payroll and related costs of approximately $350,000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of personnel costs related to finance, information systems, and general management functions, as well as professional fees related to legal, audit and tax services. General and administrative expenses increased 25.4% to $4.7 million for fiscal 1998 from $3.7 million for fiscal 1997. Approximately $400,000 of the increase related to the inclusion of Taylor for the entire period in fiscal 1998 versus six months in fiscal 1997 and approximately $650,000 related to the inclusion of the CDI operation.
AMORTIZATION OF GOODWILL. Amortization of goodwill relates to the Cincinnati, Taylor, CDI and SensorPulse acquisitions, which are being amortized over seven to seventeen years from the date of acquisition. Amortization expense increased to $1.2 million for fiscal 1998 from $320,000 for fiscal 1997 due to a full period of amortization for Taylor and an increase in total Taylor goodwill related to the $1.1 million earnout payment to the former Taylor shareholders in fiscal 1998 and the approximately $2.5 million increase related to the sale of the Company's labor scheduling product line in September 1997. The remaining increase related to the inclusion of CDI and SensorPulse from the date of their respective acquisitions.
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. Purchased research and development and other acquisition expenses relating to the acquisition of Taylor totaled approximately $4.9 million and were charged to expense at the acquisition date in September 1996. Of this expense, $4.7 million represents the estimated fair value of Taylor's incomplete research and development projects as determined by independent appraisal. In fiscal 1998, an additional charge was recorded relating to the acquisition of SensorPulse of $200,000 related to the estimated value of incomplete research and development at acquisition as determined by independent appraisal.
CHARGE FOR RESTRUCTURING. During the fourth quarter of fiscal 1998, the Company's board of directors approved a restructuring plan consisting of a reorganization of the Company's management and sales channel primarily driven by the recent expansion of the Company's product offerings, which resulted in a $1.3 million pre-tax charge to earnings. This restructuring charge included termination provisions for certain employees of approximately $944,000, termination costs related to certain manufacturer's representatives of $155,000 and a further reduction in the utilization of the Company's Cincinnati facility resulting in a charge for exit costs of $238,000.
INTEREST EXPENSE AND OTHER, NET. Interest expense and other, net decreased to $387,000 for fiscal 1998 from $561,000 in fiscal 1997. The decrease primarily related to a decrease in average debt outstanding as a substantial portion of the Company's debt that was outstanding during fiscal 1997 was repaid with a portion of the proceeds from the Company's initial public offering.
PROVISION FOR INCOME TAXES. Provision for income taxes increased to $2,940,000 for fiscal 1998 from $1,040,000 in fiscal 1997. The effective tax rate for fiscal 1998 was 44.4% as compared to the effective tax rate of approximately 44.8% in fiscal 1997, after giving effect to the impact on taxable income of the charge for purchased research and development of approximately $4.7 million. This decrease was primarily due to a decrease in the percentage of the non-deductible portion of goodwill amortization as a percentage of total income for fiscal 1998 as compared to fiscal 1997.
MINORITY INTEREST IN LOSS OF SUBSIDIARY. A minority interest representing Digital Electronic's 38.5% (39.0% prior to September 30, 1997) share of the net income or loss of Taylor is recorded on the Company's statements of operations. The Company's ownership of Taylor Class A Shares may increase by up to an additional 2.0% based on the amount of contingent consideration paid by the Company in connection with the acquisition. To the extent the equity interest of the Company in Taylor increases, the percentage applied to calculate minority interest will be reduced by a corresponding amount. The minority interest benefit of $380,000 recorded for fiscal 1998 represents the minority interest share of the loss recorded by Taylor from its operations in fiscal 1998. In fiscal 1997, a minority interest benefit of approximately $1.9 million was recorded. The minority interest loss for fiscal 1997 primarily resulted from the charge for purchased research and development of $4.7 million recorded at Taylor's acquisition date in September 1996.
FISCAL YEARS ENDED MARCH 31, 1997 AND MARCH 31, 1996
NET SALES. Net sales increased 58.6% to $40.8 million for fiscal 1997 compared to $25.7 million for fiscal 1996. This increase resulted primarily from the growth in sales of the Company's graphics-based operator interface products of approximately $6.6 million and from sales of products acquired as a result of the Cincinnati Transaction of approximately $3.9 million. Additionally, the increase reflects the results of Taylor for the six months ended March 31, 1997 of approximately $4.1 million.
GROSS PROFIT. Gross profit increased 94.3% to $20.2 million for fiscal 1997 from $10.4 million for fiscal 1996. Gross margin increased to 49.4% for fiscal 1997 from 40.3% in fiscal 1996. Of this increase, approximately 7 percentage points were attributable to a reduction in the material cost primarily in the QuickPanel product line due to favorable Yen fluctuations, partially offset by increases in direct labor and manufacturing overhead costs as a percentage of sales related to the Cincinnati Transaction which reduced gross margin by approximately 3 percentage points. In addition, gross margin increased by 5 percentage points from six months sales of higher gross margin Taylor software products.
SALES AND MARKETING. Sales and marketing expenses increased 82.8% to $9.1 million for fiscal 1997 from $5.0 million for fiscal 1996. Approximately $1.6 million of the increase resulted from increased commissions due to higher sales volume, and increased advertising and distributor promotional programs. Approximately $1.75 million of the increase resulted from costs associated with the operations of Cincinnati and Taylor and the remaining increase was due to increased salary, benefits and related costs attributable to increased sales support personnel.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 99.5% to $3.9 million for fiscal 1997 from $2.0 million in fiscal 1996. The increase resulted primarily from increased salary, related benefits and employee procurement expenses due to increases in personnel headcount, including approximately $1.2 million of product development costs related to Cincinnati and Taylor.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased 154.1% to $4.1 million for fiscal 1997 from $1.6 million for fiscal 1996. Approximately $1.6 million of the increase related primarily to additional personnel and facility costs and goodwill amortization resulting from the operations of Cincinnati and the six month's operating results of Taylor, with the remaining increase resulting from higher personnel and associated overhead costs necessary to support the growth of the Company.
AMORTIZATION OF GOODWILL. Amortization of goodwill relates to the Cincinnati and Taylor acquisitions, which are being amortized over seven to fifteen years from the date of acquisition. Amortization expense increased to $320,000 for fiscal 1997 from $23,000 for fiscal 1996 due to a full period of amortization for Cincinnati. The remaining increase related to the inclusion of six months of goodwill amortization related to the Taylor Transaction.
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. Purchased research and development and other acquisition expenses relating to the acquisition of Taylor totaled approximately $4.9 million and were charged to expense at the acquisition date in September 1996. Of this expense, $4.7 million represents the estimated fair value of Taylor's incomplete research and development projects as determined by independent appraisal.
INTEREST EXPENSE AND OTHER, NET. Interest expense and other, net increased to $561,000 for fiscal 1997 from $169,000 in fiscal 1996. The increase primarily related to an increase in average debt outstanding used to fund the acquisitions of Cincinnati and Taylor and increased working capital needs.
PROVISION FOR INCOME TAXES. Provision for income taxes increased to $1,040,000 for fiscal 1997 from $665,000 in fiscal 1996. The effective tax rate for fiscal 1997 was 44.8%, after giving effect to the impact on taxable income of the charge for purchased research and development of approximately $4.7 million, as compared to the effective tax rate of approximately 40.0% in fiscal 1996. This increase was primarily due to non-deductible goodwill amortization.
MINORITY INTEREST IN LOSS OF SUBSIDIARY. The minority interest benefit of $1.9 million recorded for fiscal 1997 represents the minority interest share of the loss recorded by Taylor, primarily incurred as a result of the charge for purchased research and development of $4.7 million recorded at the acquisition date in September 1996.
ACCRETION TO REDEMPTION VALUE OF COMMON STOCK. The Company previously issued redeemable Common Stock and Taylor issued redeemable Taylor Exchangeable shares. The Company recorded these redeemable shares at their estimated redemption values at the date of issuance and subsequent changes in such redemption value in each reporting period were accreted. The redemption rights automatically terminated upon the closing of the Company's initial public offering and as a result, the Company is not required to record a non-cash charge in the future. The accretion to redemption value of Common Stock increased to $9.1 million for fiscal 1997 from $1.6 million in fiscal 1996. Approximately $8.9 million of the accretion recorded for fiscal 1997 was attributable to an increase in the estimated fair value of the Common Stock from $2.33 per share to $9.00 per share. The remaining accretion was due to the increase in redemption value using the effective interest method for the 767,112 redeemable Taylor Exchangeable Shares issued in connection with the Taylor Transaction. The accretion recorded for fiscal 1996 is based on the increase in the estimated fair market value of the Common Stock from $1.00 per share to $2.33 per share.
LIQUIDITY AND CAPITAL RESOURCES
In March 1997, the Company completed an initial public offering of its Common Stock. Net proceeds of $11.0 million from this offering were used to repay certain indebtedness, primarily borrowings under the Company's bank lines of credit and certain acquisition indebtedness.
At March 31, 1998, the Company had bank lines of credit aggregating $19.0 million. Prior to the acquisition of CDI on October 5, 1997, the Company had bank lines of credit aggregating $10.0 million. The amount that the Company is entitled to borrow under such lines of credit is based on 80.0% to 85.0% of eligible trade accounts receivable and 50.0% of eligible inventory, up to $8.0 million, of its respective operations. Based on this formula, the Company would have had approximately $850,000, $7.2 million and $8.4 million of available borrowings under its line of credit at March 31, 1996, 1997 and 1998, respectively. All funds advanced pursuant to the lines of credit are secured by substantially all of the assets of the Company, and such lines of credit expire in July 1999. The interest rate on borrowings under the lines of credit varies based on certain financial ratios from LIBOR plus 1.5% to LIBOR plus 2%, or in the case of a $1.0 million the line of credit related to Taylor, the bank's prime lending rate (See Note 5 to Consolidated Financial Statements).
In connection with the acquisition of CDI, the Company also entered into a $4.0 million term
note with its bank. Interest is calculated at the bank's prime rate and is payable monthly. Principal of $250,000 is paid quarterly beginning March 31, 1998, and commencing September 30, 1998, all cash flow in excess of the debt service coverage, as defined, shall be applied to pay down the outstanding principal balance on the note. The note is secured by substantially all of the Company's assets (See Note 5 to Consolidated Financial Statements).
The Company is substantially dependent upon its relationship with Digital Electronics, the sole supplier of the flat panel displays that are the principal hardware component incorporated in the graphics-based operator interface products that represent the Company's best selling product line. For fiscal year 1997 and 1998, sales from this product line accounted for 62.4% and 50.3%, respectively, of the Company's net sales. The inability of the Company to obtain this hardware platform from Digital Electronics would have a material adverse effect upon the operating results and liquidity of the Company.
Cash (used in) provided by operating activities was $(411,000) in fiscal 1996, $(2.1) million for fiscal 1997 and $6.5 million for fiscal 1998. In fiscal 1996 and 1997 the Company experienced increases in receivables and inventory as a result of increases in the Company's sales volume, and a decrease in accounts payable and accrued expenses which were repaid with a portion of the proceeds from the Company's initial public offering in fiscal 1997. In fiscal 1998, the Company's cash flow from operations related primarily to increased income for the period and non-cash charges related to fixed asset depreciation and the amortization of acquisition-related goodwill. Additionally, the Company experienced a sales volume related increase in accounts receivable, offset by an increase in accounts payable and accrued expenses.
Net cash used in investing activities totaled $1.9 million, $6.4 million and $14.7 million for fiscal 1996, 1997 and 1998, respectively. In 1996 and 1997, the activities consisted primarily of the purchase of Cincinnati and Taylor, respectively, for cash and stock. Additional activities consisted primarily of purchases of property and equipment. In 1998, cash was generated from the sale of the Company's production scheduling software product line, TESS (discussed below), offset by the acquisitions of CDI and SensorPulse for cash and common stock, purchases of property and equipment and other assets and cash paid for an investment in marketable securities.
Under the terms of the Taylor acquisition, the Company paid approximately $1.1 million of contingent consideration for the first earn-out period ended September 30, 1997, on January 2, 1998. The Company recorded this contingent consideration payment as additional goodwill at September 30, 1997. As a result of the payment of this contingent consideration, the Company's ownership interest in Taylor increased by approximately 0.5%.
On September 26, 1997, Taylor completed the sale of its TESS software product to an entity principally owned by Mr. Neil Taylor. Mr. Taylor, the former principal shareholder of Taylor, is a member of the Company's board of directors. The sale price was approximately $4 million.
In connection with the transaction, the Company loaned Mr. Taylor $2 million pursuant to a promissory note from Mr. Taylor dated September 25, 1997. The note bears interest at 8% per annum (due annually) and is payable in five equal annual installments beginning on September 25, 1999 and ending on September 25, 2003. The note is secured by 250,000 shares of Class C exchangeable common stock of Taylor currently held by Mr. Taylor.
On October 5, 1997, the Company acquired substantially all of the assets of CDI, and certain
other related entities. Subject to certain adjustments, the consideration paid by the Company in connection with the Transaction consisted of approximately $12.3 million in cash, 932,039 shares of common stock of the Company and a Warrant to purchase 100,000 shares of Common Stock. The Warrant is immediately exercisable at a price of $12.875 per share and shall remain outstanding for a period of ten years.
Additionally, subject to certain adjustments, for five years after the closing, the Company shall pay CDI an annual payment ranging from $0 to $3.0 million for each year in which the year over year earnings of the acquired company exceed 110% to 125% of the base earnings for each twelve month period. Each such payment shall be made 50% in cash and 50% in Common Stock; provided however, that not more than 347,961 shares of Common Stock may be issued in connection with the payment of such consideration, and once such number of shares have been issued, all remaining payments shall be made in cash. The Company intends to seek shareholder approval to amend this agreement to remove the limitation of the number of shares that can be paid under the CDI Transaction. Each share of Common Stock shall be valued at the then fair market value of the Common Stock at the end of each Earn Out Period.
On December 31, 1997, the Company acquired substantially all of the assets of SensorPulse for 41,667 shares of common stock of the Company and $1.25 million in cash. Additionally, the purchase agreement provides for a four year annual earn-out payment to SensorPulse based upon the year over year growth in SensorPulse's earnings multiplied by: three in calendar year 1998; two and three quarters in calendar year 1999; two in calendar year 2000; and one and one-half in calendar year 2001, with a maximum aggregate payment of $23.25 million. Such earn-out shall be payable 50% in cash and 50% in common stock of the Company at its then fair market value.
Subsequent to March 31, 1998, the Company acquired substantially all of the net assets of Deeco, a designer and manufacturer of flat panel factory automation products, for $5.5 million in cash and an earn out of up to $2 million if Deeco meets certain financial targets for the twelve month period ending January 31, 1999. The Company utilized available borrowings under its existing line of credit arrangement (See Notes 5 and 12 to Consolidated Financial Statements) to finance the acquisition.
Net cash provided by financing activities totaled $2.3 million, $8.7 million and $9.9 million for fiscal 1996, 1997 and 1998, respectively. In fiscal 1996, the Company increased borrowings to finance the Cincinnati acquisition. In fiscal 1997, the Company received $11.6 million in net proceeds from its initial public offering and an additional $4 million related to the sale of a minority interest in Taylor. These funds were used to repay substantially all of the outstanding debt obligations of the Company. In fiscal 1998, the Company increased borrowings to finance the acquisitions of CDI and SensorPulse.
Management believes funds generated from operations and borrowings available under the existing bank credit facilities or replacement facilities will be sufficient to finance the Company's operations for at least the next 12 months. In the event the Company acquires one or more businesses or products, the Company's capital requirements could increase substantially, and there can be no assurance that additional capital will be available on terms acceptable to the Company, if at all.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued Statement No. 128, "Earnings Per Share." This statement is effective for fiscal years and interim periods ending after December 15, 1997. This statement establishes standards for computing and presenting earnings per share (EPS) and simplifies the standards for computing EPS previously found in APB Opinion No. 15. The Company adopted this statement effective April 1, 1997.
In February 1997, the FASB issued Statement No. 129, "Disclosure of Information about Capital Structure." This statement expands the capital structure disclosure requirements and requires that companies disclose pertinent rights and privileges of all securities other than common stock. The Company adopted this statement for the year ended March 31, 1998 with no material impact on the consolidated financial statement disclosures.
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive Income." This statement defines comprehensive income as net income plus non-owner changes in equity. This statement requires that items of comprehensive income previously included in equity be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement is effective for the quarter ended June 30, 1998 with restatement of prior years required. The Company expects that this statement will not have a material impact on the consolidated financial statements.
In June 1997, the FASB issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement introduces an approach to defining the Company's segments for financial reporting purposes on a basis consistent with how the Company's management evaluates the operations of the business. This statement is effective for the Company's fiscal year ended March 31, 1999 with restatement of prior years required. The Company is currently evaluating the impact that this standard will have upon its financial statement disclosures.
In February 1998, the FASB issued Statement No. 132, "Employers' Disclosures About Pensions and Other Post-Retirement Benefits." This statement revises and standardizes the required financial statement disclosures with respect to pension plans and other post-retirement benefit plans. This statement is effective for the Company's fiscal year ended March 31, 1999. The Company expects that this statement will not have a material impact on the consolidated financial statements.
ITEM 7a.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Public Accountants Consolidated Balance Sheets as of March 31, 1997 and 1998 Consolidated Statements of Operations for the Years Ended March 31, 1996, 1997 and 1998 Consolidated Statements of Shareholders' Equity for the Years Ended March 31, 1996, 1997 and 1998 Consolidated Statements of Cash Flows for the Years Ended March 31, 1996, 1997 and 1998 Notes to Consolidated Financial Statements
To the Shareholders of Total Control Products, Inc.:
We have audited the accompanying consolidated balance sheets of Total Control Products, Inc. (an Illinois Corporation) and Subsidiaries as of March 31, 1997 and 1998 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended March 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Total Control Products, Inc. and Subsidiaries as of March 31, 1997 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1998 in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP - ----------------------- ARTHUR ANDERSEN LLP
Chicago, Illinois May 8, 1998
TOTAL CONTROL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31, 1997 AND 1998
The accompanying notes are an integral part of these consolidated financial statements
TOTAL CONTROL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31, 1997 AND 1998 (Continued)
The accompanying notes are an integral part of these consolidated financial statements
TOTAL CONTROL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED MARCH 31, 1996, 1997 AND 1998
The accompanying notes are an integral part of these consolidated financial statements.
TOTAL CONTROL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) DESCRIPTION OF BUSINESS
Total Control Products, Inc., an Illinois corporation, together with its wholly-owned subsidiaries and its majority-owned subsidiary (collectively the "Company"), designs, develops and markets products and technology for the control segment of the industrial automation marketplace.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Total Control Products, Inc. and its wholly-owned subsidiary, Tara Products, Inc. d/b/a Total Control - Cincinnati, an Illinois corporation, since its acquisition on January 29, 1996; its majority-owned subsidiary, Taylor Industrial Software, Inc., an Alberta corporation ("Taylor"), since its acquisition on September 26, 1996; its wholly-owned subsidiaries Computer Dynamics, Inc. and Computer Dynamics Holding Company (together "Computer Dynamics" or "CDI"), Illinois corporations, d/b/a Computer Dynamics, Inc., since their acquisition on October 5, 1997 and its wholly-owned subsidiary SensorPulse Corp. ("SensorPulse" or "SPC"), an Illinois corporation, since its acquisition on December 31, 1997. In connection with the Taylor transaction, the Company sold 39% of the Taylor Class A Shares to Digital Electronics Corporation ("Digital Electronics") located in Osaka, Japan, which is the Company's largest supplier (see Note 10), for an aggregate purchase price of $4.0 million. Under the terms of the purchase agreement (see Note 2), the minority interest ownership percentage decreased to 38.5% effective October 1, 1997. As a result, minority interest for 38.5% to 39% of the net income or loss of Taylor was recorded in the Company's statement of operations. The Company's ownership may be further increased by up to 2% effective October 1, 1998 based on the amount of contingent consideration paid by the Company related to the Taylor transaction in the future. All intercompany items and transactions have been eliminated in consolidation. Effective March 31, 1998, the Company terminated its wholly-owned subsidiary, Tara Products, Inc., and merged that entity into Total Control Products, Inc.
Additionally, the Company accounts for its 40% ownership interest in a foreign joint venture on the equity method.
(c) REVENUE RECOGNITION
Net sales include revenues from operator interface and industrial computer products, software license fees, software maintenance and services. Revenue from product sales and software licenses are recognized upon shipment of the product to customers, provided that there are no significant obligations remaining and collectibility of the revenue is probable. The Company provides for estimated product returns upon shipment of the products. Revenue from software maintenance contracts is recognized ratably as it is earned over the term of the contract, generally one year. Unearned software maintenance revenue is included in deferred revenue. Service revenue is recognized as the service is provided. The Company recognizes revenue from software license fees, services and maintenance in accordance with the provisions of the American Institute of Certified Public Accountants, Statement of Position NO. 97-2 (SOP 97-2), SOFTWARE REVENUE RECOGNITION.
(d) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include all highly liquid investments (with original maturities of three months or less), principally time deposits and other short term securities which are stated at cost, which approximates fair value.
(e) TRADE RECEIVABLES
The following summarizes trade receivables allowance activity for fiscal 1996, 1997 and 1998:
(f) INVENTORY
Inventory is stated at the lower of first-in, first-out cost or market. Inventory at March 31, 1997 and 1998 consisted of the following:
(g) PROPERTY AND EQUIPMENT
Property and equipment are as follows:
Expenditures for maintenance and repairs are expensed as incurred. Property and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives as follows:
(h) INTANGIBLE ASSETS
Intangible assets relating to acquired businesses consist primarily of the cost of purchased businesses in excess of the fair value of net assets acquired ("goodwill"). Such goodwill is being amortized on a straight-line basis over periods ranging from seven to seventeen years. The accumulated amortization of intangible assets amounted to $343,000 and $1.7 million as of March 31, 1997 and 1998, respectively.
The Company reviews goodwill for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. To date, no such events or changes in circumstances have occurred. If such events or changes in circumstances occur, the Company will recognize an impairment loss if the undiscounted future cash flows expected to be generated by the acquired business are less than the carrying value of the related goodwill. The impairment loss in such circumstances would adjust the goodwill to its fair value.
(i) FOREIGN CURRENCY TRANSLATION ADJUSTMENTS
The Company follows the translation principles established by Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation". The net assets of the Company's majority-owned subsidiary and the Company's investment in its foreign joint venture are translated at the exchange rate in effect at the end of the periods presented. The revenues and expenses of the Company's majority-owned subsidiary and the Company's ownership percentage of the
foreign joint venture's net income are translated at the average rates in effect during the period. The Company's foreign joint venture had no significant activity for the year ended March 31, 1996. Included in other income is the Company's 40% share of the earnings of the foreign joint venture for the years ended March 31, 1997 and 1998 of $79,425 and $97,489, respectively. See Note 6 for a discussion of the Company's policy regarding certain foreign currency hedging transactions.
(j) RESEARCH AND DEVELOPMENT
The Company records its software development costs in accordance with SFAS No. 86. Accordingly, these costs are expensed until the technological feasibility of the software has been established. Thereafter, all significant software development costs are capitalized until the product is available for general release to customers. Subsequently, these costs are reported at the lower of unamortized cost or net realizable value. As a result of market and other business conditions, the time between establishment of technological feasibility and general release is not significant. Accordingly, the Company has not capitalized any internal software development costs during this time.
(k) INCOME TAXES
The Company accounts for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes." Deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities under the provisions of the enacted tax laws.
(l) MANAGEMENT'S 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 sales and expenses during the period. Actual results could differ from those estimates.
(m) FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The carrying value for current assets and current liabilities reasonably approximates fair value due to the short maturity of these items. Since the Company's receivables from officers and long-term debt are not publicly quoted, fair value estimates are based on each obligation's characteristics, including remaining maturities, interest rate, credit rating, collateral, amortization schedule and liquidity. The carrying amounts for receivables from officers, long-term debt and notes payable to bank approximate fair value principally due to the Company's variable interest rates on the underlying obligations.
Included in other assets is approximately $250,000 of marketable equity securities in a related party (see Note 10), all of which are classified as available-for-sale as defined by Statement of Financial Accounting Standards No. 115. As such, these securities are stated at market value, based on the available quoted market prices and the unrealized gains and losses on such securities are reflected, net of tax, as a component of shareholders' equity.
Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash investments and trade receivables. The Company has cash investment policies that limit cash investments to short-term low risk investments. With respect to trade receivables, the Company grants unsecured credit to its customers. In doing so, the Company performs ongoing credit evaluations of its customers' financial condition. A substantial portion of accounts receivable are from customers located throughout the United States. One customer accounted for approximately 10% of the Company's net sales for the year ended March 31, 1996. No customer accounted for 10% or greater of Company sales for fiscal years 1997 and 1998. Additionally, the Company establishes accounts receivable allowances based upon factors relating to the credit risk of specific customers, historical trends and other information.
A significant portion of the Company's raw material purchases are transacted in Japanese Yen (see Notes 6 and 10).
(n) ACCRETION TO REDEMPTION VALUE OF COMMON STOCK
Accretion to redemption value of redeemable common stock represents the change in redemption value of outstanding redeemable common stock in each period. The redmemption values for certain common shares have been based upon (i) fair market values of the class of stock or (ii) fixed amounts. Although management did not obtain an appraisal of the fair market value of the Common Stock of the Company, certain equity transactions occurred upon which management based its estimate of the potential redemption value of the aforementioned shares. The estimated redemption values per share for the shares with redemption values equal to fair market value, were $0.83/share, $1.00/share and $2.33/share at March 31 1994, 1995 and 1996, respectively and $9.00/share at December 31, 1996. As the redemption features for these shares of common stock terminated automatically upon the completion of the Company's initial public offering on March 10, 1997, no further accretion was required after December 31, 1996. (See Note 7).
(o) STOCK SPLIT
In December 1996, the Company's Board of Directors declared a three-for-one split of the Company's Common Stock, which has been retroactively reflected in the accompanying consolidated
financial statements. In December 1996, Taylor's Board of Directors declared a three-for-one split of Taylor's Class C Exchangeable Common Stock, which has been retroactively reflected in the accompanying consolidated financial statements.
(p) NET INCOME (LOSS) PER SHARE AVAILABLE TO COMMON SHAREHOLDERS
The Company adopted Statement of Financial Accounting Standards No. 128, ("SFAS 128") "Earnings Per Share" during the fiscal year ended March 31, 1998. In accordance with SFAS 128, all previously presented earnings per share information has been calculated under the provisions of SFAS 128. Due to the nature of the Company's capital structure, there was no difference between diluted earnings per share calculated under SFAS 128 and earnings per share previously reported.
Basic earnings per share has been computed by dividing net income by the weighted average number of common shares outstanding.
Diluted earnings per share has been computed by dividing net income by the weighted average number of common and equivalent shares outstanding. Common stock equivalents included in the computation represent shares issuable upon exercise of stock options or warrants which would have a dilutive effect in periods where there are earnings. Common stock equivalents also include the Class C Exchangeable shares of Taylor, as they are convertible on a one-for-one basis for common stock of the Company at any time at the option of the holder. Common stock equivalents were anti-dilutive for the fiscal years ended March 31, 1996 and 1997.
2. CORPORATE DEVELOPMENT
On January 29, 1996, Total Control Products, Inc. acquired 100% of the outstanding common stock of Cincinnati Dynacomp, Inc. ("Cincinnati"), a manufacturer and distributor of text based operator interface products, for $499,990 and 150,003 shares of the Company's Common Stock (which was assigned a fair value of $500,010) and merged Cincinnati into its wholly-owned subsidiary. To the extent calendar year 1998, 1999 and 2000 sales of the Company exceed approximately $32.0 million in any of those years, the former majority shareholder of Cincinnati receives 1.25% of such excess of which 50% shall be paid in cash and 50% shall be paid in shares of the Company valued at their then fair market value, with the agreement providing the Company a buy-out option related to this contingent consideration ranging from $1.0 million to $2.0 million depending on the timing of such prepayment. All contingent consideration is due 90 days after the respective calendar years on which such consideration was based.
This acquisition was accounted for under the purchase method. Accordingly, the purchase price was allocated to the net assets acquired based on their estimated fair values. This treatment resulted in approximately $1.98 million of cost in excess of net
assets acquired at the date of acquisition. In fiscal 1997, goodwill increased by approximately $970,000, primarily as a result of the Company revising its estimate of the costs to exit the Cincinnati facility in connection with the Company's integration plan established at the acquisition date. Such excess (which will increase for any future contingent consideration paid) is being amortized on a straight-line basis over 15 years. Cincinnati's results of operations have been included in the consolidated results of operations since the date of acquisition.
In fiscal 1996, the Company made an investment in a foreign joint venture, which distributes industrial automation tools, including the Company's products. The Company owns 40% of this joint venture, which is located in the Netherlands and sells products throughout Europe, with the remaining 60% owned by the Company's largest vendor (see Notes 6 and 10) and the distributor of this vendor's product (see Note 6). This investment is accounted for under the equity method.
On September 19, 1996 the Company entered into an agreement to acquire a controlling interest in Taylor, a developer and marketer of industrial automation software products located in Edmonton, Alberta. The transaction was consummated on September 26, 1996 and the results of operations have been included since that date. In exchange for 100% of the outstanding voting shares of common stock of Taylor, the Company paid $7,389,817, which included $2.2 million in the form of a note payable to the former principal shareholder and 767,112 shares of Class C Exchangeable common stock of Taylor (convertible into 767,112 shares of the Company's Common Stock; see Note 7 for a description of the features of the stock). A $4.65 million value was assigned to the 767,112 shares of Class C Exchangeable common stock based on management's estimate of fair value, primarily based on the present value of the potential redemption of the security as well as recent equity transactions. Under the terms of the Taylor acquisition, the Company may become obligated to make payments of contingent consideration based on future revenues of Taylor. The first contingent payment period ended on September 30, 1997, for which the Company paid contingent consideration of approximately $1.1 million. The Company recorded this contingent consideration obligation as additional goodwill at September 30, 1997 and this goodwill is being amortized over the remaining useful life of the goodwill of six years from the date recorded. To the extent the revenues of Taylor exceed $8.0 million in the 12 month period ended September 30, 1998, the Taylor shareholders will receive $1.0 million due 90 days after that 12 month period. Additionally, the Taylor shareholders will receive cash consideration in the amount of 50% of the revenue of Taylor in excess of $10.6 million for the 12 month period ended September 30, 1998, with the cumulative contingent consideration capped at $3.0 million. The Company also incurred approximately $600,000 in direct expenses related to the acquisition. The acquisition was accounted for using the purchase method. Accordingly, the purchase price was allocated to assets acquired based on their estimated fair values.
In connection with the transaction, the Company sold 39% of the Class A voting shares of Taylor for $4.0 million to Digital Electronics. The $4.0 million investment in Taylor by Digital was greater than 39% of the equity of the subsidiary, and this difference of approximately $600,000 was reflected as a reduction of goodwill to properly reflect the Company's cost of the Taylor acquisition. To the extent the contingent consideration described in the paragraph above is earned, the Company is required to contribute as equity into Taylor a portion of the earnout payment and receive additional equity interest in Taylor up to a maximum of 4% based on a formula outlined in a shareholder agreement between the Company and Digital. In connection with this provision, the Company's ownership interest in Taylor increased from 61% to 61.5% effective September 30, 1998. A maximum of 2% additional equity interest is still contingent based upon the earn-out payment which may be due from the Company for the twelve month period ending September 30, 1998.
In connection with the acquisition of Taylor, the Company engaged a broker to commence the sale of one of the developed software product lines acquired. On September 26, 1997, Taylor completed the sale of its TESS software product line operation (which had previously been classified as "asset held for sale") to an entity principally owned by Neil R. Taylor ("Mr. Taylor"). Mr. Taylor, the former principal shareholder of Taylor, a member of the Company's board of directors. The sale price was approximately $4 million.
In connection with the transaction, the Company loaned Mr. Taylor $2 million pursuant to a promissory note dated September 25, 1997. The note bears interest at 8% per annum, due annually, and is payable in five equal annual installments beginning on September 25, 1999 and ending on September 25, 2003. The note is secured by 250,000 shares of Class C Exchangeable common stock of Taylor currently held by Mr. Taylor. As a result of this transaction, the purchase price associated with the Taylor acquisition was re-allocated. The carrying value of the goodwill previously recorded by the Company related to the Taylor acquisition increased by approximately $2.5 million, which related to the after tax difference between the estimated sales price of the TESS product line, previously recorded as an asset held for sale, and the actual sales price. This additional goodwill will be amortized over the remaining useful life of the goodwill of six years from the date of the transaction.
Purchased research and development expense and other related acquisition expenses relating to the acquisition of Taylor totaled $4.9 million and was charged to expense at the acquisition date in September, 1996. Of this expense, approximately $4.7 million was allocated to incomplete research and development that had not yet reached technological feasibility and did not have a future alternative use, and therefore was charged to expense at the acquisition date. The amount allocated to the purchased incomplete research and development projects represents the estimated fair value related to those projects determined by an independent appraisal. Proven valuation procedures and techniques were utilized in determining the fair market value of each intangible asset. The
purchased research and development projects were individually identified and were valued based on estimates of discounted future income. Consideration was given to the stage of development, the time and resources required for completion, as well as the market potential and associated risks. To bring these projects to technological feasibility, high-risk developmental and testing issues needed to be resolved, which required substantial additional effort and testing.
The remaining excess purchase price over the estimated fair value of identified net assets (which will increase for any future contingent consideration) of approximately $2.5 million was assigned to goodwill and is being amortized over 7 years.
On October 5, 1997, the Company acquired substantially all of the assets of CDI, a South Carolina corporation, and certain other related entities pursuant to the terms of an Asset Purchase Agreement dated October 5, 1997. The consideration paid by the Company in connection with the purchase of CDI, which was accounted for as a purchase, consisted of approximately $12.3 million in cash, 932,039 shares of common stock of the Company and a warrant to purchase 100,000 shares of common stock of the Company. The warrant is immediately exercisable at a price of $12.875 per share and shall remain outstanding for a period of ten years. The excess of purchase price over the fair value of identified net assets acquired of approximately $15.6 million has been recorded as goodwill and is being amortized over seventeen years from the date of acquisition based upon independent appraisal.
Additionally, subject to certain adjustments, for five years after the closing, the Company shall pay CDI an annual payment ranging from $0 to $3.0 million for each year in which the year over year earnings of the acquired company exceed 110% to 125% of the base earnings for each period. Each such payment shall be made 50% in cash and 50% in common stock of the Company; provided however, that not more than 347,961 shares may be issued in connection with the payment of such consideration, and once such number of shares have been issued, all remaining payments shall be made in cash. Each of the common shares shall be valued based on their then fair market value at the end of each earn out period. Future payments of contingent consideration, if any, will be recorded as additional goodwill and will be amortized over the remaining goodwill amortization period.
On December 31, 1997, the Company acquired substantially all of the assets of SensorPulse, a designer and developer of industrial signal conditioning products and networked input/output (I/O) devices located in South Easton, Massachusetts, for 41,667 shares of common stock of the Company and $1.25 million in cash in a transaction that was accounted for as a purchase. At the date of acquisition, the Company recorded a charge related to the purchase of incomplete research and development of $200,000 ($120,000 net of related tax benefit). The amount allocated to the purchased incomplete research and development projects represents the estimated fair value related to those projects determined by independent appraisal. Proven
valuation procedures and techniques were utilized in determining the fair market value of each intangible asset. The purchased research and development projects were individually identified and were valued based on estimates of discounted future income. Consideration was given to the stage of development, the time and resources required for completion, as well as the market potential and associated risks. To bring these projects to technological feasibility, high-risk developmental and testing issues needed to be resolved, which required substantial additional effort and testing.
The excess purchase price over the fair value of identified net assets (which will increase for any future contingent consideration) of approximately $975,000 was assigned to goodwill and is being amortized over fifteen years.
Additionally, the purchase agreement provides for a four year annual earn-out payment to the former shareholders of SensorPulse based upon the year over year growth in SensorPulse's earnings before taxes multiplied by: three in calendar year 1998; two and three quarters in calendar year 1999; two in calendar year 2000; and one and one-half in calendar year 2001, with maximum aggregate payments of $23.25 million. Such earn-out shall be payable 50% in cash and 50% in common stock of the Company at its then fair market value.
The following unaudited pro forma results of operations data for fiscal 1996, 1997 and 1998 assume the Cincinnati acquisition and the Taylor acquisition occurred as of April 1, 1995 and the CDI and SPC acquisitions occurred as of April 1, 1996 (in thousands except per share amounts):
3. CHARGE FOR RESTRUCTURING
During the fourth quarter of fiscal year 1998, the Company's board approved a restructuring plan, for which the Company recognized a $1.3 million pre-tax charge to earnings. The restructuring charge is the result of a reorganization of the Company's management structure and sales channel primarily driven by the expansion of the Company's product offerings in connection with the acquisitions of Computer Dynamics in October 1997 and SensorPulse in December 1997. This restructuring charge included the recognition of involuntary termination provisions for certain management employees of approximately $944,000. All of the planned employee terminations occurred by March 31, 1998. Additionally, included in the restructuring charge were termination costs related to certain manufacturer's representatives of $155,000 and a charge for exit costs of $238,000, primarily made up of the remaining non-cancelable lease obligation for office space and related utilities.
During fiscal year ended 1998, approximately $249,000 was paid related to the restructuring charge, resulting in $618,000 and $470,000 recorded in accrued other in current liabilities and other long-term liabilities, respectively, on the accompanying March 31, 1998 balance sheet.
4. INCOME TAXES
The components of the provision for income taxes for fiscal 1996, 1997 and 1998 are as follows:
The provision for income taxes differs from the amounts which would result by applying the applicable Federal income tax rate before income taxes for fiscal 1996, 1997 and 1998 and are reconciled as follows:
In conjunction with the Company's acquisition of Cincinnati, the Company acquired net deferred tax assets of $795,000. A portion of the acquired deferred tax assets relates to net operating loss carry forwards ("NOLs") of approximately $430,000, which begin to expire in 2006. These NOLs will be limited to approximately $56,000 per year, and, at such level, it is management's opinion that these NOLs will not expire without being fully utilized.
Components of the net deferred income tax assets which are included in current deferred tax assets and other long term assets on the accompanying consolidated balance sheets, at March 31, 1997 and 1998 are as follows:
Generally, undistributed earnings of foreign subsidiaries will not be subject to U.S. tax until distributed as dividends. Since the earnings have been or are intended to be indefinitely reinvested in foreign operations, no provision has been made for any U.S. taxes on the Company's portion of undistributed earnings. Furthermore, any taxes paid to foreign goverments on those earnings may be used, in whole or in part, as credits against U.S. tax on any dividends distributed from such earnings. The Company's share of cumulative undistributed earnings of its foreign joint venture recorded as of
March 31, 1997 and 1998 is approximately $79,000 and $176,000, respectively. There were no undistributed earnings from the Company's foreign subsidiary.
Because management believes that the deferred tax asset will be fully realized based on current estimates of future taxable income, future reversals of existing taxable temporary differences or available tax planning strategies, no valuation allowance has been recorded against the deferred tax asset.
5. NOTES PAYABLE TO BANK
At March 31, 1997, the Company had a revolving line-of-credit agreement with a bank which allowed for borrowings up to $9.0 million (approximately $7.03 million was available at March 31, 1997) based on 85% of eligible accounts receivable and 50% of eligible inventory up to a maximum of $4.5 million as specified in the agreement. Interest was at LIBOR plus 1.5% or prime, at the Company's option, and was due monthly. In September 1997, the Company amended this line of credit agreement with its bank. The amended line of credit agreement allows for borrowings of up to $18.0 million (approximately $7.9 million was available at March 31, 1998), subject to borrowing base restrictions consistent with the previous agreement, with interest at prime (8.5% at March 31, 1998) or varying based on certain financial ratios from LIBOR plus 1.5% to LIBOR plus 2% (effectively 7.49% at March 31, 1998), at the Company's option, payable monthly. The weighted average interest on all short-term borrowing at March 31, 1998 was 7.6%. Additionally, the Company entered into a $4.0 million term note with its bank ($3.75 million outstanding at March 31, 1998). Interest is calculated at the bank's prime rate (8.5% at March 31, 1998) and is payable monthly. Principal of $250,000 is payable quarterly beginning March 31, 1998, and commencing September 30, 1998, all cash flow in excess of the debt service coverage, as defined, shall be applied to pay down the outstanding principal balance on the note. As the principal due over the next twelve months can be paid with available funds from the Company's long-term line of credit, the total amount of the term note has been reflected as long-term in the accompanying consolidated financial statements. The note is secured by substantially all of the Company's assets. The amended line of credit agreement and term note expire July 31, 1999.
The Company also has a term note for 32,300,000 Japanese Yen ($242,729 translated at March 31, 1998) with this bank. This note is bears interest at 2.87%. Principal and interest are due July 31, 1999.
Additionally, in conjunction with the acquisition of Taylor the Company entered into a line-of-credit agreement with a bank allowing for borrowings up to $1.0 million (approximately $494,000 available at March 31, 1998) based on 80% of eligible
accounts receivable of its majority-owned subsidiary. This revolving credit line expires July 31, 1999 and bears interest at prime (8.5% at March 31, 1998) which is due monthly. All amounts under this line are secured by the general assets of the Company's majority-owned subsidiary.
All amounts outstanding under these agreements are secured by inventory, receivables and all other general assets of the Company. Among other things, the agreements require compliance with specific financial covenants related to tangible net worth and debt to tangible net worth ratio. As of March 31, 1998, the Company was in compliance with these covenants.
6. COMMITMENTS AND CONTINGENCIES
The Company has an operating lease for an office and manufacturing facility with a partnership owned by the principal shareholder and a shareholder/officer. Monthly rental payments of $12,000 plus property taxes, insurance and utilities are due through April 2002, with provisions for rent increases tied to increases in the consumer price index.
The Company also has an operating lease with a limited liability corporation controlled by an officer for an office and manufacturing facility. Monthly rental payments of $33,542 plus property taxes, insurance and utilities are due through September 2002. These payments were offset during the period from the acquisition of CDI to March 31, 1998 by sublease income of approximately $64,000 which was offset against the related rent expense in the accompanying consolidated financial statements. The sublease arrangement expires February 28, 2001 and is cancellable at the Company's option upon sixty day notice. The current sublease arrangement calls for the Company to receive $8,667 monthly.
The Company leases various other office space and office equipment under operating leases that expire in various years through 2000. Rent expense for fiscal 1996, 1997 and 1998 was approximately $243,000, $588,000 and $740,000, respectively. Included in the table below on a net basis is sublease income of approximately $131,000 for fiscal 1999, $104,000 for fiscal 2000 and $95,000 for fiscal 2001 for a portion of the Greenville facility and for two office locations that were leased by Cincinnati.
Minimum future lease payments under noncancelable operating leases as of March 31, 1998 are as follows:
Certain officers and employees of the Company have employment contracts through calendar year 2001. The Company's total obligation under these contracts in the event of termination without cause as of March 31, 1998 was approximately $1,920,000.
Under the terms of various agreements, the Company is obligated to pay royalties on product sales at rates from 3.5% to 5.0%. The Company has made certain advance payments in respect of future royalties. Prepaid royalties are amortized to earnings based on actual sales over the term of the applicable royalty agreement.
To manage its foreign currency risk related to its purchases of inventory from a Japanese vendor (see Note 10), the Company hedges firm inventory purchase commitments by entering into forward contracts to purchase Japanese Yen, as well as call options. This hedging minimizes the impact of foreign exchange rate movements on the Company's operating results. Gains and losses on the hedge positions are deferred and included as a component of the transaction when it is completed for forward contracts. The cost of call options is amortized over the option period. At March 31, 1998, the Company had outstanding forward contracts for the purchase of Japanese Yen through July 29,1998 of approximately $4.0 million and call option unamortized premiums of $30,724 for the purchase of $1,500,000 of Japanese Yen through June 26, 1998 to hedge equivalent outstanding commitments transacted in Yen.
The holders of certain shares of common stock have certain rights to cause the Company to register those shares under the Securities Act of 1933, as amended (the "Securities Act"). By separate agreements, these registration rights apply to holders of 1,804,767 shares of Common Stock of the Company and the 737,112 shares issuable to the former shareholder of Taylor upon the conversion of Taylor Class C Exchangeable common stock (collectively, the "Rights Holders"). All of such registration rights agreements provide that the Rights Holders' registration rights are subject to certain notice requirements and to the condition that, in the case of any piggyback registration rights, the underwriters of any offering have the right to limit the number of shares included in such registration. The Company has agreed to bear the expenses of all registrations under these registration rights agreements, except for underwriting discounts, selling commissions and underwriters' expense allowances, which are to be paid by the respective rights holders. Additionally, 973,706 shares of common stock have certain piggyback registration rights.
In 1996, a former distributor of Cincinnati initiated litigation against one of its customers. The customer then filed a counterclaim against the former distributor alleging that the equipment contained defects and seeking damages. On February 14, 1997, the former distributor filed a third party complaint against Tara, the Company's wholly-owned subsidiary which is the successor to Cincinnati, seeking indemnification from Tara for damages resulting from any product defects. This suit was filed in the New York Supreme Court for Monroe County. On May 23, 1997, the New York Supreme Court for
Monroe County dismissed the former distributor's third-party complaint against Tara without prejudice on the grounds that under a distribution agreement between the former distributor and Tara's predecessor, any litigation between the two companies must be brought in the Court of Common Pleas for Claremont County, Ohio. The former distributor may still seek indemnification from Tara in Ohio. While the Company has not conducted any formal investigation or taken any discovery, it believes that Tara would have a meritorious defense to such an action.
On May 7, 1997, the customer of the former distributor ("End User") filed a complaint against the Company and Tara in the Supreme Court for Monroe County, alleging substantially the same facts against those defendants as it did against the former distributor in the counterclaim. In response to End User's complaint, the Company filed a motion for summary judgement which was granted in part and denied in part. With respect to such matters that it was unsuccessful, the Company filed a response on January 19, 1998. Again, while this action is in the preliminary stages and no formal discovery has been initiated, the Company believes that it and the other defendants have meritorious defenses, and the Company intends to vigorously defend this action. There can be no assurance, however, that the defendants will prevail in this action. If the defendants do not prevail, or if they settle the action, the Company could be required to make payments to End User. The Company does not, however, believe that any such payments, if required to be made, would have a material adverse effect on the Company's financial condition or results of operations.
The Company is not involved in any other material legal proceedings.
7. COMMON STOCK RIGHTS
In previous years, the Company issued shares of Common Stock and the Class C Exchangeable shares of Taylor with the right to put the shares to the Company at fair market value, as defined in the agreements. These put rights automatically terminated upon the closing of the Company's initial public offering in March 1997.
In connection with the acquisition of Taylor, a portion of the consideration exchanged by the Company was 767,112 shares of Class C Exchangeable common stock of Taylor to the former holders of the voting common stock of Taylor. This common stock is convertible at the holders' option into shares of the Company's Common Stock on a one to one basis. This Class C Exchangeable common stock has no rights in the assets or earnings of Taylor, has no voting rights and does not have the right to the dividends of the Taylor Class A common stock outstanding. As a result, this stock is not considered minority interest in Taylor; rather the stock is treated as an equity security of the Company.
8. STOCK OPTION PLANS
The Company has four fixed option plans which reserve shares of common stock for issuance to management, employees, directors and advisors of the Company. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation"("SFAS No. 123".) Accordingly, no compensation cost has been recognized for the stock option plans. Consistent with the provisions of SFAS No. 123, compensation cost for the Company's four stock option plans has been determined based on the fair value at the grant date for awards. In fiscal 1996, 1997 and 1998, the Company's pro forma net income (loss) and net income (loss) per share using the fair value approach provided by SFAS No. 123 would have been as follows:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for grants during fiscal 1996, 1997 and 1998: dividend yield of 0%; expected volatility of 60% in 1996 and
1997 and 100% in 1998; risk-free interest rate of 6% in 1996 and 1997 and 5% in 1998; and expected lives of 3 years.
(a) 1993 STOCK OPTION PLAN
The Company's 1993 Stock Option Plan (the "1993 Plan") provides for the grant of common stock options.
Under the 1993 Plan, incentive stock options ("ISOs") may be granted to any officer or employee of the Company. Nonqualified stock options may be granted to any officer, employee, consultant, director or other agent of the Company. In the case of ISOs, the exercise price paid shall be at least 100% (110% in certain cases) of the fair market value of the Common Stock on the date of grant. Options become exerciseable generally over three years or as determined by the Board. Certain acceleration provisions exist related to a change in control of the Company. In December 1996, the Board determined that no additional options will be granted under this plan.
(b) 1996 STOCK OPTION PLAN
In December 1996, the Company adopted the 1996 Stock Option Plan under which options may be granted to purchase up to 550,000 shares of Common Stock to management, employees and advisors of the Company. This Plan provides for the grant of ISOs and non-qualified stock options. Options become exerciseable generally over three years or as determined by the Board. Certain acceleration provisions exist related to a change in control of the Company.
The following summarizes option activity related to the 1993 and 1996 Stock Option plans:
Subject to certain exceptions defined under the stock plans related to an employee's death, disability or termination,
options expire ten years from the date of grant. At March 31, 1998, options to purchase 308,315 shares were exerciseable.
(c) 1996 NON-EMPLOYEES DIRECTORS' STOCK OPTION PLAN
In December 1996, the Company adopted the 1996 Non-Employees Directors' Stock Option Plan under which 120,000 shares of Common Stock have been authorized for issuance. All non-employee directors receive a stock option to purchase 12,000 shares of Common Stock on the day after each annual meeting of shareholders of the Company, provided they are then serving as a director of the Company. All grants are non-qualified stock options. Options granted under this Plan are exerciseable six months after the date of grant. No options were issued under this plan through March 31, 1997. In fiscal 1998, the Company granted options under this plan to three non-employee directors totaling 36,000 shares at a price equal to $8.00 per share all of which were exercisable at March 31, 1998.
(d) 1996 DISCOUNT STOCK PURCHASE PLAN
In December 1996, the Company adopted the 1996 Discount Stock Purchase Plan under which 250,000 shares of Common Stock have been reserved for issuance. Eligible employees of the Company may purchase Common Stock of the Company on a quarterly basis. Eligible employees participate in this Plan by authorizing payroll deductions of up to 10% of their base compensation. The purchase price per share is the lesser of (i) 85% of the fair market value of a share of Common Stock on the date of the commencement of the applicable offering period, or (ii) 85% of the fair market value of a share of Common Stock on the date of the end of such period. In fiscal 1998, the Company issued 25,441 shares for $92,081 under the plan. There were no issuances under this plan during fiscal 1997.
9. BENEFIT PLANS
The Company has a 401(k) plan covering all domestic employees of the Company. Employees must complete one month of service to participate. Employee contributions are supplemented by Company contributions as defined in the plan agreement. Company contributions to the plan totaled approximately $29,000, $95,000 and $183,000 for fiscal 1996, 1997 and 1998, respectively. Additionally, the Company can make discretionary profit-sharing contributions. The Company did not make a discretionary profit-sharing contribution in fiscal 1996, 1997 or 1998.
The Canadian employees of the Company's subsidiary, Taylor, may contribute on a pre-tax basis to a benefit plan, which does not provide for employer sponsored contributions.
10. SIGNIFICANT VENDOR
A significant portion of the Company's purchases are made from a related party, Digital Electronics. During fiscal 1996, 1997 and 1998, approximately 67%, 56%, and 49%, respectively, of the Company's total raw material purchases were made from this vendor. The raw material component of cost of sales for fiscal 1996, 1997 and 1998 was approximately 91%, 84%, and 85%, respectively. Additionally, in 1998, the Company's majority-owned subsidiary sold approximately $142,000 of software and software related services to this vendor.
11. INITIAL PUBLIC OFFERING
In December 1996, the Company's Board of Directors authorized an amendment to the Company's Articles of Incorporation increasing the number of authorized shares of Common Stock to 22,500,000. The Company completed an initial public offering of its common stock on March 10, 1997. The Company issued 1,650,000 shares of common stock for net proceeds of $10,998,589.
12. UNAUDITED SUBSEQUENT EVENT
Subsequent to March 31, 1998, the Company acquired substantially all of the net operating assets of Deeco Systems, Inc., a designer and manufacturer of flat panel factory automation products. The consideration paid by the Company in conjunction with the acquisition consisted of $5.5 million cash funded by the Company's existing line of credit facility. Additionally, the Company shall pay an earn-out of up to $2 million if certain financial targets are attained for the twelve month period ending January 31, 1999. As a result of this transaction, the Company's bank amended the covenants related to the Company's existing line of credit agreement (Note 5). The Company was in compliance with these covenants as of the date of acquisition.
13. UNAUDITED SUPPLEMENTAL STATEMENTS OF OPERATIONS DATA
The following table sets forth certain unaudited consolidated quarterly statement of operations data for each of the eight quarters ending with the quarter ended March 31, 1998. In the opinion of management, this information has been prepared on the same basis as the audited consolidated financial statements contained herein and includes all adjustments, consisting only of normal recurring adjustments, that the Company considers necessary to present fairly this information in accordance with generally accepted accounting practices. The Company's operating results for any one quarter are not necessarily indicative of the results to be expected for any future period.
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 following table sets forth the name, age as of March 31, 1998, and position of the executive officers and directors of the Company:
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(1) Member of the Executive Committee. (2) Member of the Compensation Committee. (3) Member of the Audit Committee. (4) Effective July 1, 1998, Mr. Taylor is resigning as an executive officer. Mr. Taylor will continue as an employee of the Company and serve as a consultant to Mr. Gihl on corporate matters.
Mr. Gihl co-founded the Company in 1982, along with Mr. Sparacino, and has served as President of the Company since April 1994. From the Company's founding in 1982 to March 1994, Mr. Gihl served as Executive Vice President. Mr. Gihl has served as a director of the Company since the Company's founding. Mr. Gihl became Chairman in December 1996. Prior to co-founding the Company, from October 1979 to November 1982, Mr. Gihl served in several design engineering and electronic development positions and as a Design Supervisor at Mark Controls, a manufacturer of energy management systems. Mr. Gihl is married to the daughter of Mr. Sparacino.
Mr. Nicholson has served as Senior Vice President and Chief Financial Officer, Treasurer and Secretary of the Company since June 1996. From June 1995 to May 1996, Mr. Nicholson served as Vice President
of Finance of Mama Tish's Italian Specialties, Inc., a manufacturer and marketer of frozen dessert products. From July 1985 to May 1995, Mr. Nicholson was employed by Arthur Andersen LLP, most recently as a manager in the audit and business advisory practice area. Mr. Nicholson is a Certified Public Accountant.
Mr. O'Connor has served as the General Manager - Control Division since March 1997. Mr. O'Connor served as the Company's Senior Vice President of Sales from February 1996 to March 1997. Mr. O'Connor served as the Company's Vice President of Sales and Marketing from March 1994 to February 1996 and as a regional sales manager from December 1992 to March 1994. From August 1983 to December 1992, Mr. O'Connor served as a Regional Sales Engineer for McNaughton-McKay Electric Company, a distributor of industrial automation products.
Mr. Potach has served as Senior Vice President of Sales since March 1997. He served as Total Control Products' Vice President of North American Sales from January 1997 to March 1997 and as the Southeast Regional Sales Manager from February 1992 to January of 1997. From February 1988 to February 1992, he served as a Systems Sales Engineer for PC Design Inc., a factory automation systems integrator. He also served as a Sales Engineer for the Allen Bradley Company from June 1984 to February 1988.
Mr. Priester founded Computer Dynamics, Inc., a manufacturer of flat panel display systems and board-level computer products, in 1981. Following Computer Dynamics' acquisition by Total Control Products in October 1997, Mr. Priester has remained as Computer Dynamics' President.
Mr. Roach has served as President of SensorPulse since it's acquisition by Total Control Products in December of 1997. Mr. Roach founded SensorPulse Corp. in December of 1989 and served as President and CEO. From October 1982 to November 1989, Mr. Roach served as Director of Automation for TW Kutter, Inc., a manufacturer and marketer of automated packaging, assembly and food processing systems.
Mr. Taylor has served as Senior Vice President of Software Development and a director of the Company since the consummation of the Taylor Transaction in September 1996. Mr. Taylor founded Taylor, a developer and marketer of industrial automation software products, in 1979. Mr. Taylor served as the Chairman of the Board of Taylor from inception to September 1996, and President of Taylor from inception to September 1991. Mr. Taylor is resigning as an executive officer of the Company effective July 1, 1998, but will continue as an employee and serve as a consultant on corporate matters and as well as a director.
Mr. Wood has served as General Manager - Operator Interface Division since March 1997. Mr. Wood served as Senior Vice President of Product Development and Marketing of the Company from February 1996 to March 1997. From September 1995 to February 1996, and May 1993 to July 1993, Mr. Wood served as a consultant in the industrial automation market. From August 1993 to September 1995, Mr. Wood served as Vice President of Sales and Marketing of Promise Systems Corp., a developer and marketer of manufacturing execution systems software. From October 1988 to April 1993, Mr. Wood served as Vice President of Marketing for AEG Modicon, Inc., a developer, manufacturer and marketer of programmable logic controllers and other industrial automation products.
Mr. Sparacino co-founded the Company in 1982 and has served as a director since that time. Mr. Sparacino served as the Chairman from 1982 to December 1996. From 1982 to April 1994, Mr. Sparacino served as President of the Company.
Mr. Siemer has served as a director of the Company since December 1993. Mr. Siemer has been the President of Desco Corporation, an industrial and manufacturing holding company, for over thirty years.
Mr. Hurd became a director in March 1997. From 1990 to February 1995, Mr. Hurd was President of Industrial Control, a division of Honeywell Inc., a worldwide supplier of automation and control products, systems and services, and served as Executive Vice President of Honeywell Inc. from February 1995 to April 1996. Mr. Hurd has been an independent consultant since April 1996. Mr. Hurd is also the Chairman of the Board of Moore Products Co., a manufacturer of industrial products for the process control industry.
Mr. Kramer became a director in March 1997. From January 1990 to March 1996, Mr. Kramer was a Special Limited Partner of TA Associates, a venture capital investing firm, and was a general partner of TA Associates for the five years preceding January 1990. Since March 1996, Mr. Kramer has been a private investor. Mr. Kramer is also a director of Robotic Vision Systems, Inc., a designer, manufacturer and installer of machine vision-based products, and Micro Component Technology, Inc., a supplier of semi-conductor handling equipment.
Executive officers of the Company are appointed by the Board of Directors and serve, subject to their removal or resignation, until their successors have been duly elected and qualified.
EMPLOYMENT AGREEMENTS
The Company entered into written employment agreements with Mr. Gihl on December 19, 1996, with Mr. Nicholson effective June 1, 1996, with Mr. Taylor as of September 19, 1996 , with Mr. Wood effective February 9, 1996, with Mr. Priester effective October 5, 1997 and with Mr. Roach effective January 1, 1998. The employment agreement for Mr. Wood provides for an initial term of one year, while the initial term under Mr. Gihl's employment agreement is approximately 54 weeks, the initial employment term for each of Mr. Taylor, Mr. Priester and Mr. Roach is three years and Mr. Nicholson's initial employment term under his employment agreement is nineteen months. After the expiration of the initial term, the employment agreements automatically renew for successive one year periods unless either party delivers written notice of its desire to terminate the agreement at least 90 days prior to the expiration of the term. The base salaries for Messrs. Gihl, Nicholson, Taylor, Priester and Wood under their respective employment agreements is $200,000, $125,000, $125,000, $125,000, and $125,000, respectively. The base salary for Mr. Roach under his employment agreement is $90,000 for calendar year 1998, $110,000 for calendar year 1999 and $125,000 for calendar year 2000.
Each of the employment agreements contains a noncompetition covenant whereby the employee agrees that for a period lasting from the date of the agreement to one year after the termination of his employment with the Company (Mr. Taylor's extends for two years from the date of termination), he will not engage in any business that competes with the Company anywhere in the United States. In addition, each employee has agreed to be bound by the terms of a confidentiality provision requiring the employee to hold the Company's confidential information in the strictest confidence for the longest period permitted by law. Under the terms of these agreements, the employee's employment with the Company may be terminated prior to the expiration of the term for "cause," as defined in the agreements. In the event of termination for cause or if the employee
voluntarily terminates his employment, the Company's obligations under the agreement cease and the employee forfeits all his rights to receive any compensation or benefits, except for salary and benefits for services already performed as of the date of termination. In addition, if the Company terminates an employee's employment under certain circumstances the Company must pay the employee designated severance amounts. In particular, in the event the Company terminates Mr. Gihl's employment for any reason other than death, disability or cause, including the decision not to renew the term of his employment agreement, Mr. Gihl will be entitled to receive in one lump sum payment an amount equal to two years compensation, based upon his highest monthly salary during the twelve months immediately preceding the termination, plus two times the bonus paid Mr. Gihl for the most recent fiscal year. In addition, all of Mr. Gihl's unvested stock options shall vest and become immediately exerciseable and the Company shall continue his medical insurance benefits for a period of two years. Under the terms of Mr. Taylor's employment agreement, if Mr. Taylor's employment is terminated by the Company for any reason other than death, disability or cause, Mr. Taylor shall be entitled to receive his salary for the longer of the remainder of the employment term, or twelve months from the date of termination. In the event the Company terminates Mr. Wood's employment for any reason other than death, disability or cause, including the decision not to renew the term of his employment agreement, the Company shall pay Mr. Wood his base salary for a period of one year following such termination and will continue his medical insurance benefits during such period to the extent Mr. Wood is not entitled to receive similar benefits from a subsequent employer. If the Company terminates Mr. Nicholson's employment for any reason other than cause, death, disability or within one year after certain circumstances defined as a "change of control," but including upon the decision of the Company not to renew the term of Mr. Nicholson's employment, the Company shall pay Mr. Nicholson in one lump sum an amount equal to six times the greater of his monthly salary as of the date of termination or his highest monthly salary during the prior twelve month period and continue Mr. Nicholson's medical insurance benefits during such six month period to the extent Mr. Nicholson is not entitled to receive similar benefits from a subsequent employer. Finally, if the Company terminates Mr. Priester's or Mr. Roach's employment pursuant to the terms of his respective employment agreement for any reason other than death, disability or cause, then the Company will pay such officer all unpaid salary through the remainder of his employment term in accordance with the Company's practices for salaried employees. In addition to the payment of the amounts set forth above, if the Company terminates Mr. Nicholson's employment within one year after a change of control (other than for cause) or Mr. Nicholson terminates his employment for good reason (as defined in such agreement), the Company is obligated to pay Mr. Nicholson in one lump sum an additional amount equal to $25,000. In the case of Messrs. Gihl and Nicholson, the employee may also become entitled to severance under other designated circumstances involving his decision to terminate his employment with the Company. Effective June 1, 1998, Mr. Nicholson's employment agreement was amended, subject to Compensation Committee approval, whereby if Mr. Nicholson terminates his employment for good reason or the Company terminates Mr. Nicholson's employment within one year after a change of control, the Company shall pay Mr. Nicholson in one lump sum an amount equal to the sum of twelve times the greater of his monthly salary as of the date of termination or his highest monthly salary during the prior twelve months, plus $50,000. In the event of Mr. Nicholson's termination without cause, the Company shall pay Mr. Nicholson in one lump sum an amount equal to the sum of twelve times the greater of his monthly salary as of the date of termination or his highest monthly salary during the prior twelve months.
Under the terms of these agreements, the employees are entitled to bonus amounts based upon the Company meeting certain financial targets. Mr. Gihl's agreement provides for a minimum bonus of $5,000 per quarter and Mr. Wood's agreement provides for a minimum bonus of $4,000 per quarter.
STAGGERED BOARD OF DIRECTORS
Pursuant to the Company's Articles of Incorporation, the Board of Directors is divided into three classes of directors serving staggered three-year terms. The terms of Class I directors (Messrs. Siemer and Taylor)
expire in 1998; the terms of Class II directors (Messrs. Sparacino and Kramer) expire in 1999; and the terms of Class III directors (Messrs. Gihl and Hurd) expire in 2000. All directors of each class hold their positions until the annual meeting of shareholders held during the year in which the terms of the directors in such class expire, or until their respective successors are elected and qualified.
COMPENSATION OF DIRECTORS
Non-Employee directors are paid $1,500 for their attendance of each face-to-face board meeting and $250 for their attendance at any committee meeting of the board or telephonic board meeting, plus reimbursement for their out of pocket expenses incurred to attend each committee or board meeting, up to a total amount not to exceed $10,000 per director per year. In addition, non-employee directors participate in the 1996 Non-Employee Directors' Stock Option Plan, and options to purchase 12,000 shares of the Company's Common Stock were granted to each non-employee director effective June 1, 1997, and all such options vested on December 1, 1997.
DIRECTOR COMMITTEES
The Board of Directors has established an Audit Committee, a Compensation Committee and an Executive Committee.
The functions of the Audit Committee are to recommend annually to the Board of Directors the appointment of the independent public accountants of the Company, to discuss and review the scope and the fees of the prospective annual audit and to review the results thereof with the Company's independent public accountants, to review and approve non-audit services of the independent public accountants, to review compliance with existing major accounting and financial policies of the Company, to review the adequacy of the financial organization of the Company and to review management's procedures and policies relative to the adequacy of the Company's internal accounting controls. Messrs. Kramer and Siemer serve on the Audit Committee.
The functions of the Compensation Committee are to review and approve annual salaries and bonuses for all executive officers, to review, approve and recommend to the Board of Directors the terms and conditions of all employee benefit plans or changes thereto and to administer the Company's various stock plans. Messrs. Hurd and Kramer serve on the Compensation Committee.
The Executive Committee is empowered to act with all authority granted to the Board of Directors between board meetings, except with respect to those matters required by Illinois law or by the Company's Bylaws to be subject to the power and authority of the Board of Directors as a whole. Messrs. Gihl, Siemer and Sparacino are the current members of the Executive Committee.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth a summary of all compensation paid by the Company for the past three fiscal years to the Company's Chief Executive Officer and the Company's four most highly compensated executive officers other than the CEO (the "Named Executive Officers")
(1) Other compensation consists of matching contributions under the Company's 401(k) plan and amounts paid for car allowance.
OPTION GRANTS IN LAST FISCAL YEAR INDIVIDUAL GRANTS
The following table provides certain specified information concerning the grant of options under the 1996 Plan during fiscal 1998 to the Named Executive Officers.
OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following stock table provides certain specified information concerning fiscal year option exercises and unexercised options at March 31, 1998.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial ownership of Common Stock as of June 1, 1998 by (i) each executive officer of the Company, (ii) each director of the Company and (iii) all executive officers and directors as a group. Other than as set forth below, there are no persons known by the Company to own beneficially more than 5.0% of the outstanding Common Stock.
- ------------------- * Less than one percent.
(1) Unless otherwise indicated, address is c/o Total Control Products, Inc., 2001 North Janice Avenue, Melrose Park, Illinois 60160. (2) Unless otherwise indicated in the footnotes to this table, the Company believes the individuals named in this table have sole voting and investment power with respect to all shares of Common Stock reflected in this table. (3) Includes 575,700 shares held directly by Mr. Gihl, 72,000 shares held directly by Mr. Gihl's spouse, and 16,666 shares issuable upon the exercise of stock options, all of which are currently exercisable. (4) Includes 21,666 shares issuable upon the exercise of options, all of which are currently exercisable. (5) Represents 513,966 shares issuable upon the conversion of Mr. Taylor's Taylor Exchangeable Shares, 61,368 shares issuable upon the conversion of Taylor Exchangeable Shares owned by Mr. Taylor's spouse and 1,666 shares issuable upon the exercise of options, all of which are currently exercisable. Also includes 85 shares of Common Stock owned by Mr. Taylor's son. Mr. Taylor disclaims beneficial ownership of the shares issuable upon the conversion of Taylor Exchangeable Shares owned by his spouse. (6) Represents 54,466 shares issuable upon the exercise of options, all of which are currently exercisable. (7) Does not include shares owned by Mr. Sparacino's children, all of whom are adults who do not reside with Mr. Sparacino. Mr. Sparacino disclaims beneficial ownership of all such shares. (8) Includes 233,010 shares owned by Mr. Priester's wife. Mr. Priester is the President of the Company's wholly-owned subsidiary, Computer Dynamics, Inc. Includes a warrant to purchase 100,000 shares of Common Stock of the Company, exercisable immediately. (9) Includes 5,666 shares issuable upon the exercise of options, all of which are currently exercisable. (10) Includes 12,000 shares issuable upon the exercise of options, all of which are currently exercisable. (11) Includes the shares identified in Notes (3) through (10) above. (12) Includes 18,000 shares owned by Mr. Keizo Wada, the President of Digital Electronics Corporation. Digital Electronic's address is 8-2-52 Nanko-Higashi, Suminoe-ku, Osaka, 559, Japan. (13) The Capital Group Companies' address is 333 South Hope Street, 52nd Floor, Los Angeles, CA 90071.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and officers, and persons who own more than 10% of a registered class of the Company's equity securities, to file with the Securities and Exchange Commission ("SEC") reports of ownership and changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater-than-10% shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.
Based solely on review of the copies of such reports furnished to the Company or written representations that no other reports were required, the Company believes that, during the 1998 fiscal year, all filing requirements applicable to its officers, directors and greater-than-10% beneficial owners were complied with, except that Mr. Dennis Marrano, the former Senior Vice President of Operations, was late with a single Form 4 filing.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TAYLOR TRANSACTION
In September 1996, the Company completed a series of transactions resulting in its holding 61.0% of the Class A Shares of Taylor. In the first step of this transaction, the Company acquired all of the voting stock of Taylor in exchange for aggregate consideration of $7.4 million, the right to receive contingent consideration as described below and 767,112 Taylor Exchangeable Shares. Of the $7.4 million, $2.2 million was in the form of a promissory note from Taylor to Neil R. Taylor, the former majority shareholder of Taylor, which was repaid in full with a portion of the proceeds of the Company's initial
public offering, and the remainder was paid in cash at the closing. The 767,112 Taylor Exchangeable Shares are convertible into 767,112 shares of Common Stock of the Company at any time at the election of the holders of such shares.
Mr. Taylor and the former shareholders of Taylor also hold certain registration rights with respect to their shares of Common Stock issuable upon conversion of their Taylor Exchangeable Shares.
Under the Taylor Transaction, the former shareholders of Taylor are also entitled to receive certain contingent consideration pursuant to an earn-out formula. Under such formula, Taylor paid the former shareholders an aggregate amount of approximately $1.1 related to the year ended September 30, 1997. For the period between October 1, 1997 and September 30, 1998, if Net Revenues exceed $8.0 million, Taylor will pay to the former shareholders an aggregate amount equal to $1.0 million, and to the extent that Net Revenues during such period exceed $10.6 million, the Company will pay to the former shareholders an aggregate amount, not to exceed $3.0 million, equal to 50.0% of such excess. The Company has guaranteed the payment of all amounts of contingent consideration by Taylor to the former shareholders of Taylor.
Digital Electronics originally loaned the Company an aggregate of $5.0 million in order to consummate the Taylor Transaction. Immediately thereafter, $4.0 million of the loan was converted into 3,900 Taylor Class A Shares, representing 39.0% of the aggregate amount of such shares. The remaining $1.0 million of indebtedness was repaid in full with a portion of the proceeds from the Company's initial public offering.
Pursuant to an arrangement with Digital Electronics, the Company agreed that to the extent Taylor is required to make any payment of contingent consideration to the former shareholders of Taylor, the Company will transfer funds to Taylor in an amount equal to such contingent consideration. To the extent the Company funds a portion of a contingent payout, the Company is permitted to cause Taylor to issue additional Taylor Class A Shares to the Company in order to increase the Company's ownership interest in the outstanding Taylor Class A Shares by the following percentage: 2.0% multiplied by a fraction, the numerator of which is the entire contingent consideration payable to the shareholders and the denominator of which is $4.0 million. If the entire amount of contingent consideration is paid to the former Taylor shareholders, Digital Electronics' ownership interest in Taylor will be decreased to 36.5% and the Company's interest will be increased to 63.5%.
In connection with the payment of contingent consideration for the period ended September 30, 1997, the Company's ownership interest in Taylor increased from 61.0% to 61.5% and Digital Electronics ownership percentage decreased from 39.0% to 38.5%.
TESS TRANSACTION
On September 25, 1997, the Company's majority-owned subsidiary, Taylor Industrial Software, Inc. completed the sale of its TESS software product line operation (which had previously been classified as "asset held for sale") to an entity principally owned by Mr. Taylor.
Mr. Taylor, the former principal shareholder of Taylor, is a member of the Company's board of directors. The sale price was approximately $4 million.
In connection with this transaction, the Company loaned Mr. Taylor $2 million (U.S.) pursuant to a promissory note (the "Taylor Note") dated September 25, 1997. The Taylor Note bears interest at 8% per annum and is payable in five equal annual installments beginning on September 25, 1999 and ending on September 25, 2003. The Taylor Note is secured by 250,000 Taylor Exchangeable Shares currently held by Mr. Taylor.
CDI TRANSACTION
On October 5, 1997, the Company acquired substantially all of the assets of Computer Dynamics and certain other related entities pursuant to the terms of an Asset Purchase Agreement (the "Agreement") dated October 5, 1997 (the "CDI Transaction"). The consideration paid by the Company in connection with the CDI Transaction consisted of approximately $12.3 million in cash, 932,039 shares of common stock of the Company and a warrant (the "Warrant") to purchase 100,000 shares of common stock of the Company. The Warrant is immediately exercisable at a price of $12.875 per share and shall remain outstanding for a period of ten years.
Additionally, subject to certain adjustments, for five years after the closing, the Company shall pay CDI an annual payment ranging from $0 to $3.0 million for each year in which the year over year earnings of the acquired company exceed 110% to 125% of the base earnings for each period (each an "Earn Out Period"). Each such payment shall be made 50% in cash and 50% in common stock of the Company; provided however, that not more than 347,961 shares may be issued in connection with the payment of such consideration, and once such number of shares have been issued, all remaining payments shall be made in cash. The Company intends to seek shareholder approval to amend this agreement to remove the limitation of the number of shares that can be paid under the CDI Transaction. Each of the shares of Common Stock shall be valued based on their then fair market value at the end of each Earn Out Period.
Furthermore, the Company entered into a Registration Rights Agreement with CDI and its former majority shareholder, Mr. Kurt Priester, pursuant to which the portion of the shares of common stock of the Company issued to Mr. Priester and CDI in connection with the Transaction or issued pursuant to the Warrant are subject to certain piggy-back registration rights.
SENSORPULSE TRANSACTION
On December 31, 1997 the Company acquired substantially all of the assets of SensorPulse pursuant to the terms of an Asset Purchase Agreement among SensorPulse, Kevin Roach, Charles Harlfinger, and the Company. Subject to certain adjustments, the consideration paid by the Company consisted of 41,667 shares of Common Stock, approximately $1.25 million in cash and a four year earn out based upon income growth in the business conducted by SensorPulse prior to the closing.
OTHER RELATED PARTY TRANSACTIONS
The Company is party to a lease agreement, dated March 26, 1992, as amended in December, 1996, with J&N Partnership, an Illinois general partnership owned by Messrs. Sparacino and Gihl and Mr. Sparacino's sons and daughter (Mr. Gihl's spouse), pursuant to which the Company leases its principal 39,000 square foot office and manufacturing facility located in Melrose Park, Illinois. Annual rent under the lease is $144,000 plus property taxes, insurance and utilities, and the lease terminates in April 2002. The Company has also agreed pursuant to the terms of the lease agreement to pay all expenses relating to occupancy and maintenance of the leased premises.
The Company is party to a lease agreement, dated October 5, 1997, with Pelham Capital LLC, a limited liability corporation controlled by Kurt Priester, an officer/shareholder of the Company, pursuant to which the Company leases a 97,000 square foot manufacturing facility for its industrial computer workstation products located in Greenville, South Carolina. Annual rent under the lease is approximately $400,000, plus property taxes, insurance and utilities, and the lease terminates in September 2002. The Company currently subleases 32,000 square feet of this facility to a third party for approximately $100,000 annually through February 28, 2001. The Company has the right to request the sublessee vacate the space upon 60 days notice.
At March 31, 1998, Mr. Gihl, an executive officer and significant shareholder of the Company, was indebted to the Company in the amount of $203,327 pursuant to two promissory notes bearing interest at a rate per annum equal to 1.0% above the prime rate, maturing on December 16, 1998. Interest is being accrued quarterly under these notes, and all amounts outstanding under these notes are secured by a pledge of Mr. Gihl's shares of Common Stock.
The Company purchases all of the flat panel display screens that are the principal hardware component incorporated in its graphics-based operator interface product line from Digital Electronics, which owns 380,001 shares of Common Stock, representing 5.0% of the outstanding Common Stock, and owns 38.5% of the Taylor Class A Shares. Keizo Wada, the President and Chairman of Digital Electronics, owns 18,000 shares of the Common Stock of the Company. Hardware purchases by the Company from Digital Electronics totaled $8.8 million, $10.2 million and $14.6 million for fiscal 1996, 1997 and 1998, respectively. Mr. Gihl is a member of the Board of Directors of Digital Electronics since June of 1996. Digital Electronics is permitted to have a representative present at all regularly scheduled quarterly board meetings of the Company. Such representative does not vote, and receives $2,500 for each board meeting attended plus reimbursement for all out-of-pocket costs and expenses. The Company has nominated this representative of Digital Electronics for election to the Company's Board of Directors for fiscal 1999.
In November 1996, Taylor entered into a two-year consulting agreement with Digital Electronics whereby Digital Electronics has agreed to provide certain product development and marketing consulting services to Taylor in exchange for compensation of $200,000 per year. This agreement terminates in October 1998.
On September 12, 1997, the Company entered into an Original Equipment Manufacturer's Purchase Agreement (the "OEM Agreement"), dated as of April 1, 1997, with Digital Electronics, Moritani America, Inc. and Inde Electronics, Inc. The Agreement modifies the terms of the Original Equipment Manufacturer's Purchase Agreement among the same parties dated January 1, 1991. Pursuant to the OEM Agreement, Digital Electronics, the Company's principal hardware supplier, agreed to supply to the Company certain computer hardware products for market and sale on an exclusive basis in North and
South America. The Agreement extends the arrangement between the Company and Digital Electronics until January 31, 2005. Effective April 1, 1997, The Company and Digital Electronics also entered into an agreement regarding the operation and conduct of Taylor's business.
In March 1997, the Company acquired 10,000 shares of the outstanding common stock of Digital Electronics (1,000 of which the transaction to acquire the shares closed on April 1, 1998), or 0.17% of the outstanding common stock. Mr. Gihl individually owns 10,000 shares of Digital Electronics' common stock, or 0.17% of the outstanding common shares. The Company has accounted for this investment using the cost method of accounting and included in the Company's consolidated balance sheet as of March 31, 1998 is an investment of Digital Stock of approximately $250,000.
In November 1995, the Company purchased a 40% interest in ProFace, a joint venture among the Company, Digital Electronics and Moritani America, Inc. ("Moritani America"). Moritani America (which, together with its parent, Moritani & Co., owns an aggregate of 291,501 shares of the Company's Common Stock) acts as the import broker of Digital Electronics' products on behalf of the Company. ProFace, an industrial automation products distributor located in the Netherlands, distributes the Company's and Digital Electronics' products in Europe. This investment is accounted for by the Company under the equity method. ProFace did not have significant operations during fiscal 1996. For fiscal 1997 and 1998, respectively, the Company's share of net earnings of the joint venture was $79,425 and $97,489.
Neil Taylor, a director of the Company, together with his wife, received a $2.2 million note (which was repaid with a portion of the proceeds of the initial public offering), $3.7 million in cash, 575,334 Taylor Exchangeable Shares and the right to receive certain contingent consideration in connection with the Taylor Transaction. Prior to the Taylor Transaction, Neil Taylor and his wife loaned Taylor an aggregate of $230,000. This loan was repaid in full during fiscal 1998.
The Company's Board of Directors has adopted a policy that any future transactions between the Company and its officers, directors, affiliates or controlling shareholders will be on terms which are considered to be no less favorable to the Company than those obtainable in arm's length transactions with unaffiliated third parties and must be approved by a majority of the disinterested directors.
PART IV.
ITEM 14.
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents Filed With This Report:
1. Financial Statements. The financial statements filed as a part of this report are listed in Item 8, "Financial Statements and Supplementary Data," herein.
2. Financial Statement Schedules. There are no financial statement schedules filed as part of this report, since the required information is included in the financial statements, including notes thereto, or the circumstances requiring inclusion of such schedules are not present.
3. Exhibits. See Item (c) below.
(b) Reports of Form 8-K.
The Company filed a Current Report on Form 8-K (date of report, August 4, 1997), covering item 5 to report the execution of a letter of intent regarding the sale of the TESS product line.
The Company filed a Current Report on Form 8-K (date of report, September 22, 1997), covering item 5 to report the execution of a letter of intent regarding the CDI transaction.
The Company filed a Current Report on Form 8-K (date of report, September 12, 1997), covering item 5 to report the OEM Agreement with Digital.
The Company filed a Current Report on Form 8-K (date of report, September 25, 1997), covering item 5 to report the consummation of the sale of the sale of the TESS product line.
The Company filed a Current Report on Form 8-K (date of report, October 5, 1997), covering item 2 to report the consummation of the acquisition of CDI.
The Company filed an Amendment to its Current Report on Form 8-K (date of report, October 5, 1997), covering item 7 which included audited financial statements of CDI and unaudited pro forma financial information regarding the Company and CDI.
The Company filed a Current Report on Form 8-K (date of report, December 31, 1997), covering item 5 to report the consummation of the acquisition of certain assets of SensorPulse Corp.
Subsequent to the end of the period covered by this Report, the Company filed a Current Report on Form 8-K (date of report, June 8, 1998), covering item 5 to report the consummation of the acquisition of certain assets constituting the Deeco Systems division of Lucas Automation and Control Engineering, Inc.
(c) Exhibits
The following exhibits are filed herewith or incorporated by reference as indicated. Exhibit numbers refer to Item 601 of Regulation S-K. As used in the list of Exhibits below, "Registrant" and the "Company" refers to Total Control.
- ----------------------- * Incorporated by reference to Total Control's Registration Statement on Form S-1, File No. 333-18539.
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.
TOTAL CONTROL PRODUCTS, INC. (Registrant)
By: /s/ Nicholas T. Gihl ------------------------------------- Nicholas T. Gihl Chairman and Chief Executive Officer (Principal Executive Officer)
By: /s/ Peter A. Nicholson ------------------------------------- Peter A. Nicholson Senior Vice President and Chief Financial Officer (Principal Accounting and Financial Officer)
Date: June 26, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.