-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Gu0NEGnv0ySgtoqeI7ppqyvaTKBefRrd8Y2Ec2JakjHgS531i2dGSN/QWaThZpc5 +/IZ8fQlfR0Gc7rdMx/v2w== 0000003753-05-000004.txt : 20050331 0000003753-05-000004.hdr.sgml : 20050331 20050331134503 ACCESSION NUMBER: 0000003753-05-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050331 DATE AS OF CHANGE: 20050331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLEN ORGAN CO CENTRAL INDEX KEY: 0000003753 STANDARD INDUSTRIAL CLASSIFICATION: MUSICAL INSTRUMENTS [3931] IRS NUMBER: 231263194 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-00275 FILM NUMBER: 05718586 BUSINESS ADDRESS: STREET 1: 150 LOCUST ST STREET 2: PO BOX 36 CITY: MACUNGIE STATE: PA ZIP: 18062 BUSINESS PHONE: 2159662200 MAIL ADDRESS: STREET 1: 150 LOCUST STREET STREET 2: PO BOX 36 CITY: MACUNGIE STATE: PA ZIP: 18062-0036 10-K 1 n10k2004.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K (Mark One) (X) Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 2004 OR ( ) Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 Commission File Number 0-275 Allen Organ Company (Exact name of registrant as specified in its charter) Pennsylvania 23-1263194 (State of Incorporation) (IRS Employer Identification No.) 150 Locust Street, P. O. Box 36, Macungie, Pennsylvania 18062-0036 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code 610-966-2200 Securities registered pursuant to section 12 (b) of the Act: None Securities registered pursuant to section 12 (g) of the Act: Class B Common Shares, par value $1 per share (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. ( ) The Class A voting stock of the registrant is not registered pursuant to the Securities Exchange Act of 1934, is not publicly traded, and, therefore, no market value information exists for such stock held by non-affiliates. The number of shares outstanding of each of the Registrant's classes of common stock, as of the close of business on March 29, 2005: Class A - Voting 83,864 Class B - Non-voting 1,072,302 Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act). Yes No X The aggregate market value of the Class B Common Shares held by non-affiliates of the Registrant as of June 30, 2004: $42,038,347 1 ALLEN ORGAN COMPANY INDEX Item Page No. PART I 1. Business - General developments of business 3 - Industry segments 4 - Description of business 4 - 7 - Financial information about geographic areas 7 - Available information 7 2. Properties 7 3. Legal Proceedings 8 4. Submission of Matters to a Vote of Security Holders 8 PART II 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 8 6. Selected Consolidated Financial Data 9 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 - 17 7A. Quantitative and Qualitative Disclosures About Market Risk 17 8. Financial Statements and Supplemental Data 18 - 39 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 17 9A Controls and Procedures 17 9B Other Information 17 PART III 10. Directors and Executive Officers of the Registrant 40 - 42 11. Executive Compensation 42 - 43 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 43 - 45 13. Certain Relationships and Related Transactions 45 14. Principal Accountant Fees and Services 45 PART IV 15. Exhibits and Financial Statement Schedules 46 Signatures 47 Financial Statement Schedules 48 Exhibits 49 - 53 2 PART I Item 1. Business General developments of business. Incorporated in Pennsylvania in 1945, Allen Organ Company and Subsidiaries ("Company") operate in four industry segments: Musical Instruments, Data Communications, Electronic Assemblies and Audio Equipment. The Musical Instruments segment consists of the manufacture and sale of electronic keyboard musical instruments, primarily digital church organs and accessories. During 2004 the Musical Instruments segment showed improvement in both net sales and operating results. Management attributes this improvement to an improving economy and the introduction of organs containing Quantum(TM) technology in the second quarter of this year, with shipments beginning during the third quarter. Quantum organs offer significant new features and product benefits. Two major benefits of this technology are Quad Suite(TM) and Acoustic PortraitT. Quad Suite allows Quantum organs to supply four complete tonal specifications in one organ console thereby increasing the instrument's versatility. Acoustic Portrait adds low-latency convolution reverberation, currently an exclusive feature for the church organ market. Convolution technology enables the Company to accurately reproduce the response of desired rooms and include them in Quantum organs. The Musical Instruments segment is seeing increasing changes in the type of music used in churches throughout North America, the primary market for this segment's organs. Some churches have changed their music programs from traditional styles that primarily include the use of an organ, to more "contemporary" services where the organ plays a lesser or no role. These changes may negatively impact future sales volume of this segment. The Company recently introduced products to address the changing needs of church music. This includes the Allen EnsembleT that combines traditional organ sounds and more contemporary General MIDI (Musical Instrument Digital Interface) sounds. The Company also introduced EACT (Expanded Audio Capabilities) which allows churches that have both traditional and contemporary programs to utilize their Allen organ's audio capabilities for playing back recorded music or amplifying other musical instruments. The introduction of the Allen Ensemble and EAC are intended to help maintain the organ as the cornerstone of church music programs. Management is hopeful that recent improvement's in the economy and spending patterns of religious institutions, this segment's primary customers, along with the favorable reaction to Quantum organs will continue in 2005. The Data Communications segment designs and markets data networking products. This segment's 2004 annual sales increased approximately $18,958,000 (53%) when compared to 2003. Gross margins and operating income in 2004 also increased significantly when compared to 2003. This improvement in net sales and operating results is attributable to an improvement in the overall data communications market and the timing of completing sales with the Company's larger customers. Sales in this segment have become increasingly dependent on larger sales opportunities that could result in the amount and timing of future net sales being more volatile. The Electronics Assemblies segment provides subcontract manufacture of electronic assemblies for outside customers. Recently, the order rate for this segment has improved and management believes that its efforts to diversify its customer base and recent signs of improvement in the economy may continue to improve this segments order rate in 2005. The Audio Equipment segment designs, manufactures and markets high-quality audio speaker cabinets for hi-fi stereo and home theater applications. This segment's 2004 net sales decreased when compared to 2003. This segment continues its efforts to develop an expanded dealer network, however, adding quality dealers for its products has been slower than expected. 3 Industry segments. Description of business. Musical Instruments. Allen Organ Company is a leading manufacturer of electronic keyboard musical instruments, primarily digital church organs and accessories. This segment accounted for 26%, 34% and 37% of net sales in 2004, 2003 and 2002, respectively. The principal market for the Musical Instruments segment is institutions, primarily churches. Sales to homes make up a smaller portion of this segment's sales. Musical Instruments are distributed mostly through dealers, primarily independent retail music stores throughout the United States, with a lesser percentage distributed through dealers internationally. The segment's business is not seasonal. The principal raw materials used in the segment's products are electronic components and wood, which are readily available from various sources without undue difficulty. Traditionally, organs have longer service requirements than other digital products. As life cycles for electronic components have shortened in recent years the Company has had to redesign some circuit boards to satisfy the needs of current and past customers. At the present time, management does not expect this issue to significantly affect future product shipments. This segment does not engage in any significant amounts of extended payment terms, or lease guarantees. The Company is contingently liable in connection with certain customers' financing arrangements (see Note 11 to the Consolidated Financial Statements). The dollar amounts and number of times the Company has had to honor these repurchase agreements have been negligible. The Musical Instruments segment is not dependent on any single or small group of customers, the loss of which would have a material adverse effect on the business. The dollar amount of the segment's unshipped order backlog at the end of February 2005 and 2004 was $4.9 million and $3.6 million, respectively. All orders are expected to be filled in the current year. The organ industry is competitive involving at least five domestic and foreign manufacturers of digital organs. In addition, there are many small pipe organ companies that serve the institutional organ market. The organ market consists of two basic divisions, institutional (primarily churches) and home or entertainment type instruments. Management believes it is the largest supplier of organs for the institutional market in the United States (largest world market) because of product performance and competitive prices, and has a smaller percentage of the home or entertainment organ market. This segment also markets its organ consoles and control electronics to customers that want to retain their wind-blown pipes and augment them with digital voices. The Company maintains a research and development program to take advantage of the latest in technological developments relating to digital sound generation. Data Communications. The Data Communications segment consists of Eastern Research, Inc. (ERI). This segments operations are headquartered in Moorestown, New Jersey. ERI designs and markets data networking products enabling network service providers to deliver services to their external or internal customers. This segment accounted for 68%, 59% and 54% of the Company's net sales in 2004, 2003 and 2002, respectively. Data Communications products are predominantly sold directly to end-users, to wholesale and retail distributors worldwide and to a smaller extent under OEM agreements. The segment maintains an inventory of in-process and finished goods to allow for rapid fulfillment of orders. 4 The principal raw materials used in the Data Communications products are electronic components, which are readily available from various sources without undue difficulty. As life cycles for electronic components have shortened in recent years, the Company has had to redesign some circuit boards to satisfy the needs of current and past customers. At the present time, management does not expect this to significantly affect future product shipments. The Data Communications segment derived 41% of its 2004 net sales from two customers, 16% of its net sales from one customer in 2003, and 40% of its net sales from two customers in 2002. While there have been significant customers contributing to the revenue growth, some of these customers have changed from year to year. This segment derived approximately 27%, 19% and 28% of its net sales from international markets in 2004, 2003 and 2002, respectively, primarily from Asia Pacific and Europe. ERI will continue to pursue growth opportunities in markets outside the United States. The realization of future business from these opportunities could be affected by currency fluctuations, social and political risks and changes in foreign economies. ERI has a diversified portfolio of customers serving three primary segments: mobile network service providers, fixed network service providers and private networks; both in the domestic and international markets. While each segment continues to grow, the mobile segment has accelerated the most and contributed 41% of 2004 revenues. Applications in the mobile segment involve optimizing and managing the access portion of these networks, which are projected to continue to grow and change. There are many competitors in this market that is dominated by large data communications companies such as Adtran, Tellabs and Alcatel. The Company's strategy has been to target market niches with products that provide desirable features and packaging with attractive pricing. ERI initially built its business in the CSU/DSU market and also developed router technology products. In 1997, ERI introduced its multi-service access concentrator (DNX) family of products. ERI has expanded this product family and broadened its feature set making the DNX its flagship product. The DNX revenues represent approximately 90% of ERI's net sales for 2004. During 2002, ERI introduced the DNX- 1u, which is targeted at wireless service providers. The DNX-1u is the smallest product in the DNX family and includes up to 8 T1 or E1 circuits. This and prior product introductions have strengthened the DNX product line. The largest product in the DNX line is the DNX-88 that can handle as many as 600 T1 circuits and also includes T3 and OC3 (optical) capabilities. While revenues are primarily product sales, service revenues are a smaller, yet growing portion of the business. To properly capitalize on this market's opportunities, ERI has implemented marketing strategies and product development work and will continue to do so in a way that takes into account ERI's needs and the economic environment. On July 24, 2003, ERI purchased the assets of Avail Networks, Inc. (Avail) in exchange for $200,000 in cash and contingent payments based on future revenue related to the sale of Avail products during the 30 months after the acquisition. The resources and technology related to this acquisition have been redeployed and are currently being used in the development of the Company's next generation products. The dollar amount of unshipped order backlog at the end of February 2005 and 2004 was $5.2 million and $7.0 million, respectively. All orders are expected to be filled in the current year. This segment has directed its sales and marketing efforts to focus on markets for which its product line is well suited, including the wireless, enterprise, government and certain international markets. Future sales in this segment have become increasingly dependent on larger sales opportunities that could result in the amount and timing of future revenue being more volatile. 5 Electronic Assemblies. Allen Integrated Assemblies (AIA) is the Company's division that provides subcontract manufacture of electronic assemblies for outside customers. The Electronic Assemblies segment is an outgrowth of the technical skills and manufacturing capabilities developed by the Company for its Musical Instruments business. AIA services are supplied out of the Macungie, PA plant, the same plant in which the Company manufactures Musical Instruments and Audio Equipment products. This segment accounted for 4%, 5% and 7% of 2004, 2003 and 2002 net sales, respectively. AIA derived 68% of its 2004 net sales from five customers, 61% of its 2003 net sales from two customers and 73% of its net sales from three customers in 2002. AIA continues to work on diversifying its customer base. The Electronic Assemblies segment is very competitive with numerous companies offering similar services. AIA customers are generally in a geographic area relatively close to the Company's Macungie manufacturing facility. The dollar amount of the segment's unshipped order backlog at the end of February 2005 and 2004 was $1,551,000 and $909,000, respectively. All orders are expected to be filled in the current year. Audio Equipment. The Audio Equipment segment operates mainly through Legacy Audio, Inc. (LAI). LAI designs, manufactures and markets high-quality audio speaker cabinets for hi-fi stereo and home theater applications. This segment accounted for 2% of net sales in 2004, 2003 and 2002, respectively. The principal raw materials used in the segment's products are audio speakers, electronic components and wood, which are readily available from various sources without undue difficulty. LAI derived 12% of its 2004 net sales from one customer, no single customer accounted for greater than 10% of this segments net sales in 2003 or 2002. The principal market for LAI's products is the consumer home market. The segment's products are mainly distributed through independent retail dealers and directly to end-users. This segment's business is not seasonal. LAI historically sold its products through direct marketing. Management determined that this method of distribution limited its ability to penetrate the broader market. The Company has and will continue to add independent retail dealers in a conservative manner to build a quality dealer network in an effort to distribute its products more broadly. LAI has had difficulty adding dealers that are appropriate for its products. The high-end audio market is evolving from the traditional two- channel to the multi-channel market, which is utilized in home theater applications. LAI has developed and markets products specifically for these home theater applications. LAI competes with several other high-end audio speaker cabinet manufacturers including Martin-Logan, Thiel, B&W, Celestion, and others. The dollar amount of the segment's unshipped order backlog at the end of February 2005 and 2004 was $223,000 and $179,000, respectively. All orders are expected to be filled in the current year. General. The Company's working capital is sufficient to meet the normal expansion of inventory and receivables. The Company spent $13,948,340, $8,785,522 and $7,782,571 in 2004, 2003 and 2002, respectively, on research and development. The 2004 and 2003 increases were mainly within the Data Communications segment. The Company maintains an ongoing commitment to new product development and expects future expenditures for these activities to exceed the 2004 level. 6 General. (Continued) The Company monitors its compliance with applicable federal, state, or local provisions with regard to the environment and implements procedures or modifies its equipment as necessary. The Company does not expect any significant capital additions in the coming year to maintain its compliance. The Company and its subsidiaries employ approximately 505 people. None of our employees are covered by a collective bargaining agreement. Management believes that relations with employees are good. Financial information about geographic areas. The Company does not own manufacturing or sales facilities in any foreign countries. See Note 13 to the Consolidated Financial Statements for additional information on export sales. Export sales are all made in US dollars and, based on customer credit information, are made either on open credit terms, under letter of credit or on a prepaid basis. Available information. The Company files annual reports on Form 10-K, quarterly reports of Form 10-Q, current reports on Form 8-K and amendments to those reports pursuant to Section 13(a) or 15(d) of The Securities and Exchange Act of 1934 with the Commission. The public may read and copy any materials filed with the Securities and Exchange Commission at their Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may also obtain this information by calling the Commission at 1-800-SEC-0330. The Securities and Exchange also maintains an Internet site that contains reports and other information statements and other information regarding electronic filers at www.sec.gov. Item 2. Properties The following sets forth the location, approximate square footage and use of the Company's operating locations by segment. Management believes that its Macungie, PA facilities are generally suitable and adequate for the needs of the Musical Instruments, Electronic Assemblies and Audio Equipment segments. The Data Communications segment will need to expand the size of its present facility in New Jersey or relocate to another leased facility during 2005. Approximate Location Square Footage Use Musical Instruments, Audio Equipment and Electronic Assemblies: Macungie, Pennsylvania 242,000 Administrative, research and manufacturing facility. Owned by Allen Organ Company. Operating at approximately 85% capacity. Macungie, Pennsylvania 27,000 International sales, exhibition center, museum and teaching facility. Houses the sales offices for Musical Instruments and Legacy Audio. Owned by Allen Organ Company. Data Communications: Moorestown, New Jersey 46,000 Administrative, sales and research facility. Leased until September 2005. Ann Arbor, Michigan 5,000 Research facility. Leased until July 2005. In October 2002, the Company's subsidiary, Legacy Audio, Inc., sold its manufacturing and sales facility located in Springfield, Illinois. See Note 21 to the Consolidated Financial Statements for additional information. 7 Item 3. Legal Proceedings There is no litigation requiring disclosure pursuant to Item 103 of Regulation S-K. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2004. PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters The Company's Class A voting shares are not registered pursuant to The Securities Exchange Act of 1934 and are not publicly traded. The Company's Class B non-voting stock trades on the NASDAQ Stock Market under the symbol AORGB. The high and low bid quotations for each quarter during the last two years as reported by NASDAQ Market Information System are as follows: 2004 High Low First Quarter $ 48.00 $ 43.15 Second Quarter 54.66 47.50 Third Quarter 64.00 47.74 Fourth Quarter 70.36 53.05 2003 High Low First Quarter $ 40.64 $ 37.00 Second Quarter 42.58 35.46 Third Quarter 44.11 37.97 Fourth Quarter 50.03 43.00 The Company has 6 Class A Stockholders and 232 Class B Stockholders of record as of March 29, 2005. During the past two fiscal years, the Company has declared dividends on both its Class A and B shares as follows: Record of Quarterly Dividends Paid in 2004 Record Date Payable Amount Cash 2/20/2004 3/5/2004 $0.14 Cash 5/14/2004 5/28/2004 $0.14 Cash 8/13/2004 8/27/2004 $0.14 Cash 11/19/2004 12/3/2004 $0.14 Record of Quarterly Dividends Paid in 2003 Record Date Payable Amount Cash 2/14/2003 2/28/2003 $0.14 Cash 5/16/2003 5/30/2003 $0.14 Cash 8/15/2003 8/29/2003 $0.14 Cash 11/14/2003 11/28/2003 $0.14 8 Item 6. Selected Financial Data The selected consolidated financial data presented below has been derived from the Company's consolidated financial statements for each of the periods indicated. The data set forth below is qualified by reference to and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements included as Items 7 and 8 in this Annual Report on Form 10-K. Years Ended December 31, 2004 2003 2002 2001 2000 Net Sales $80,170,788 $60,788,058 $67,739,548 $60,490,513 $72,516,208 Operating Income (Loss) $ 5,729,224 $ 889,497 $ 3,080,022 $(7,113,614) $ 3,784,196 Net Income (Loss) $ 4,709,047 $ 1,396,896 $ 2,685,357 $(4,083,810) $ 3,954,896 Basic earnings (loss) per share $ 4.07 $ 1.20 $ 2.29 $ (3.49) $ 3.38 Diluted earnings (loss) per share $ 4.06 $ 1.20 $ 2.29 $ (3.49) $ 3.38 Cash dividends per share $ 0.56 $ 0.56 $ 0.56 $ 0.56 $ 0.56 At Year End Cash $ 8,949,691 $ 5,907,576 $ 4,515,189 $ 4,449,998 $ 2,712,368 Investments $18,338,350 $17,143,171 $17,176,750 $11,609,416 $24,694,377 Working Capital $46,943,904 $43,917,002 $41,551,690 $38,656,758 $41,648,400 Total Assets $78,472,735 $71,950,276 $73,362,868 $66,472,252 $80,807,742 Long-Term Debt, net of current portion $ 0 $ 0 $ 0 $ 0 $ 0 Stockholders' Equity $59,888,146 $56,364 833 $56,306,332 $56,315,015 $62,434,901 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Business Overview: As discussed in Note 21 of the financial statements, Allen Organ Company and Subsidiaries ("Company") operate in four industry segments: Musical Instruments, Data Communications, Electronic Assemblies and Audio Equipment. Sales for the year ended December 31, 2004 increased $19,382,730 when compared to 2003, primarily due to increased sales in the Company's Data Communications segment. Net income increased $3,312,151 during the year ended December 31, 2004, compared to 2003, primarily due to the higher sales in the Data Communications segment and improved operating results in the Musical Instruments segment. Net sales consist of revenues obtained for the sale of electronic keyboard musical instruments in the Musical Instruments segment; data networking products and support services in the Data Communications Segment; electronic assembly services in the Electronic Assemblies segment; and audio speaker cabinets in the Audio Equipment segment. Sales credits and adjustments are also included in net sales. Cost of sales consist primarily of material costs of products sold, salary and benefit costs related to production and manufacturing support personnel, incoming shipping and facility related costs, such as depreciation and maintenance. Consolidated selling, general and administrative expenses and research and development expenses increased approximately $8,197,000 and $1,554,000 during the years ended December 31, 2004 and 2003, respectively, primarily related to the growth in the Data Communications segment. Selling expenses consist primarily of employee salary and benefit costs, advertising and marketing expenses. General and administrative expenses consist primarily of employee salary and benefit costs, professional services fees and other general corporate expenses. Research and development expenses consist primarily of employee salary and benefit costs for engineering staff, third party contracted development services, product prototyping and compliance costs. 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Liquidity and Capital Resources: The Company continues to maintain a strong financial position and high level of liquidity, which enables it to generate funds internally to meet operating needs, capital expenditures and short-term obligations. Key indicators of the Company's liquidity are presented below: December 31, 2004 2003 Working Capital $46,943,904 $43,917,002 Current Ratio 5.3 to 1 6.5 to 1 Total Liabilities to Equity Ratio 0.31 to 1 0.28 to 1 Cash flows from operating activities increased by approximately $3,718,000 during 2004 when compared to 2003, primarily due to improved operating results in the Musical Instruments, Electronic Assemblies and Data Communications segments. Net income improved by approximately $3,312,000 during the year ended December 31, 2004 as compared to 2003, after reflecting a non-cash charge of approximately $363,000 in 2004 from the write-off of goodwill and intangibles in the Audio Equipment segment. Cash of $454,000 was used to increase working capital components in 2004, versus changes in working capital providing cash of $806,000 and $3,315,000 in 2003 and 2002, respectively. The increase in working capital components in 2004 is primarily attributable to higher levels of inventory ($1,693,000) to support the increased sales activity, payment of estimated income taxes ($1,466,000, net of current year accruals) and payment of pension contributions ($544,000, net of current year accruals), offset by increases in payables and other accruals (total of $3,079,000) and customer deposits ($634,000). Cash flows provided by operating activities decreased during 2003 as compared to 2002, primarily due to operating losses incurred in the Musical Instruments segment. Working capital decreased in 2003 due to decreases in receivables and inventory (total of $2,830,000) primarily from collection of a receivable from a large sales transaction in late 2002 and improved inventory management, offset by a decrease in payables and accruals ($3,238,000) primarily from payment of inventory purchases to fulfill the large sales transaction in late 2002. Working capital decreased in 2002 due to a decrease in inventory ($1,073,000) primarily from improved inventory management, payment of estimated income taxes ($945,000, net of income tax accruals) and an increase in payables and accruals ($3,604,000) primarily from inventory purchases to fulfill a large sales transaction in late 2002, offset by an increase in accounts receivable ($2,237,000) primarily related to a large sales transaction in late 2002. Cash flows used in investing activities during 2004 includes approximately $2,743,000 of property additions, of which approximately $2,320,000 is primarily computer and test equipment purchased for the Data Communications segment and net purchase of investments of approximately $1,268,000. Cash flows used in investing activities during 2003 were used to purchase approximately $160,000 and $900,000 of property and equipment in the Musical Instruments and Data Communications segments, respectively. In addition, the Data Communications segment used $200,000 as payment for the acquisition of Avail Networks. Cash flows used in investing activities during 2002 were used to purchase approximately $1,039,000, $188,000 and $672,000 of property and equipment in the Musical Instruments, Electronic Assemblies and Data Communications segments, respectively and net purchase of investments of approximately $5,376,000. Cash flows from financing activities during 2004 and 2002 were made up primarily of dividend payments to Company shareholders. Cash flows from financing activities during 2003 in addition to dividend payments to Company shareholders, included approximately $505,000 paid for the repurchase of Class B common shares and $449,000 paid for the repurchase of subsidiary company stock. 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Results of Operations: Sales and Operating Income December 31, 2004 2003 2002 Net Sales Musical Instruments Domestic $16,961,307 $17,033,746 $21,694,445 Export 3,925,493 3,348,158 3,248,480 Total 20,886,800 20,381,904 24,942,925 Data Communications Domestic 40,275,770 29,252,691 26,107,275 Export 14,704,274 6,769,565 10,428,899 Total 54,980,044 36,022,256 36,536,174 Electronic Assemblies Domestic 2,822,019 2,819,640 4,750,143 Audio Equipment Domestic 1,227,055 1,390,526 1,441,084 Export 254,870 119,780 69,222 Total 1,481,925 1,564,258 1,510,306 Total $80,170,788 $60,788,058 $67,739,548 Income (Loss) from Operations Musical Instruments $ 613,203 $ (764,639) $ 2,024,144 Data Communications 6,436,161 2,446,213 2,091,520 Electronic Assemblies (124,425) (457,366) (401,165) Audio Equipment (1,195,715) (334,711) (634,477) Total $ 5,729,224 $ 889,497 $ 3,080,022 Consolidated sales for 2004 increased $19,382,730 (32%) when compared to 2003, primarily due to higher sales in the Data Communications segment of approximately $18,958,000. Consolidated sales for 2003 decreased $6,951,490 (10%) when compared to 2002, primarily due to a $4,561,000 decrease in Musical Instruments sales and a $1,930,000 decrease in Electronic Assemblies segment sales. Consolidated gross margins increased to 48% in 2004 compared to 41% in 2003. This was due to the Data Communications segment representing 69% of consolidated net sales in 2004 versus 59% in 2003, which segment provides the highest gross profit percent (58% in 2004). In addition, the Musical Instruments segment gross margins increased by six percentage points to 27.5% in 2004 versus 21.1% in 2003 attributable to cost reduction efforts that were initiated in 2003 to reduce material and other operating costs. Consolidated gross margins in 2003 increased to 41% compared to 38% in 2002 due to a 6% increase in the gross margins in the Data Communications segment attributable to higher sales volume, reductions in product cost and changes in product mix, offset by a 6% decrease in the gross margin in the Musical Instrument segment due to lower sales volume over which to absorb fixed costs. Consolidated selling, administrative and other expenses increased $3,034,102 during the year ended December 31, 2004 when compared to 2003, primarily related to a $2,565,000 increase in the Data Communications segment for increased salaries and commissions related to the higher sales volume and additional sales and marketing efforts implemented in 2004. Consolidated selling, administrative and other expenses increased $503,940 during the year ended December 31, 2003, when compared to 2002, primarily related to an $872,000 increase in the Data Communications segment for increased salaries and benefits related to its increased sales and marketing efforts. 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Consolidated research and development expenses increased $5,162,818 during the year ended December 31, 2004 when compared to 2003 primarily related to a $5,292,000 increase in the Data Communications segment. This increase was primarily from salaries and benefits for additional engineering staff, prototype costs and contracted design services associated with the development of the Data Communications segments next generation products. Consolidated research and development expenses increased $1,002,951 during the year ended December 31, 2003, when compared to 2002, primarily related to an $820,000 increase in the Data Communications segment. This increase was made up primarily of salaries and benefits for additional engineering staff. Consolidated costs and expenses for the year ended December 31, 2004 also includes a charge for impairment of goodwill and intangibles of $362,611 related to the write down of the carrying value of Legacy Audio's goodwill and intangibles. Investment income decreased $39,649 and $283,936 during the years ended December 31, 2004 and 2003, respectively, due to lower rates of return available on invested funds. The minority interest in consolidated subsidiaries represents the ERI employee shareholders interest in the net income of Eastern Research after recovering accumulated losses from prior years that were absorbed by the parent company. There was no minority interest in consolidated subsidiaries in 2003 and 2002, as all consolidated subsidiaries had accumulated losses that had been absorbed by the parent and, in the case of Eastern Research, were being recovered by subsequent net income of the subsidiary. The effective tax rate (benefit) was 22.5%, (5.7%) and 29.3% in 2004, 2003 and 2002, respectively. See Note 16 of the Consolidated Financial Statements for a reconciliation of the income tax provision to the statutory rates. The effective tax rate in 2004, 2003 and 2002 is lower than statutory tax rates primarily due to foreign income with the benefit of lower tax rates, research and development credits and non-taxable investment income derived from investment in municipal bond funds. The 2004 rate increased compared to 2003 primarily due to higher levels of taxable income in 2004 offset by higher levels of tax credits and tax exempt income. The 2003 rate decreased when compared to 2002 due to the low level of taxable income which, after deducting tax credits and exempt income, resulted in a small tax benefit. Consolidated net income increased $3,312,151 during the year ended December 31, 2004, compared to 2003, primarily due to the higher sales and operating income in the Data Communications segment and improved operating results in the Musical Instruments segment. Consolidated net income decreased $1,288,461 during the year ended December 31, 2003, compared to 2002, primarily due to operating losses of $765,000 and $457,000 incurred in the Musical Instruments and Electronic Assemblies segments, respectively. The Company is in the process of implementing regulations contained in the Sarbanes-Oxley Act of 2002 applicable to companies with a class of securities registered under the Securities Exchange Act of 1934, in particular Section 404 relating to Management's Assessment of Internal Controls. Compliance with these regulations is estimated to cost in the range of $400,000 to $600,000 for initial implementation. These costs will be incurred over 2005 and 2006. In addition, there will be ongoing compliance costs thereafter which management expects will range from $250,000 to $400,000 annually. Musical Instruments Segment Domestic sales for 2004 were approximately equal to 2003. The 2004 order rate and backlog on December 31, 2004 continue to be higher than the same periods in 2003 reflecting favorable customer reaction to the Company's Quantum organs that include significant new features and product benefits, as well as an improved economic environment. Quantum organs offer Quad SuiteT and Acoustic PortraitT. Quad Suite allows Quantum organs to supply four complete tonal specifications in one organ console increasing the instrument's versatility. Acoustic Portrait adds low- latency convolution reverberation, currently an exclusive feature for the church organ market. Convolution technology enables the Company to accurately reproduce the response of desired rooms and include them in Quantum organs. The domestic sales for 2003 decreased $4,661,000 from 2002 due to lower order volume, which management believed was caused by the economic downturn, declines in financial markets and general global uncertainty caused by the war in Iraq. 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Musical Instruments Segment (Continued) This segment is seeing changes in the type of music used in churches throughout North America, the primary market for this segment's organs, which may negatively impact future sales volume for this segment. Some churches have changed their music programs from traditional styles that primarily use an organ, to more "contemporary" services where the organ plays a lesser or no role. To address the changing needs of church music, the Company recently introduced products including the Allen EnsembleT that combines traditional organ sounds and more contemporary General MIDI (Musical Instrument Digital Interface) sounds. The Company also introduced EACT (Expanded Audio Capabilities) that allows churches that have both traditional and contemporary programs to utilize their Allen organ's audio capabilities for playing back recorded music or amplifying other musical instruments. The introduction of the Allen Ensemble and EAC are intended to help maintain the organ as the cornerstone of church music programs. Export sales increased approximately $577,000 during the year ended December 31, 2004 when compared to 2003, which management believes is attributable to the decreased value of the US dollar compared to certain foreign currencies making the Company's products more affordable in those countries. Export sales were approximately equal in 2003 when compared to 2002. Certain foreign markets continue to be affected by unfavorable economic conditions. Gross profit margins on sales were 27.5%, 21.1% and 29.5% for the years ended December 31, 2004, 2003 and 2002, respectively. The 2004 increase is attributable to the higher sales volume, favorable product mix changes caused by the introduction of Quantum organs and the effect of cost reduction efforts initiated to reduce material and other operating costs. The 2003 decrease in gross profit margins was a result of lower sales volume over which to absorb fixed costs and higher operating costs including employee pension expense, which increased by $597,000 (103%) in 2003 versus 2002. Selling and advertising expenses during 2004 were approximately equal to 2003 and decreased approximately $71,000 during 2003 when compared to 2002, due to lower sales volume. General and administrative expenses increased approximately $108,000 during 2004 when compared to 2003, primarily due to higher fees incurred for professional services including legal and audit services. General and administrative expenses decreased approximately $60,000 in 2003 when compared to 2002. Research and development expenses decreased approximately $152,000 during 2004 compared to 2003 primarily due to lower retirement benefit costs and increased approximately $82,000 during 2003 when compared to 2002. Several of the Company's operating expenses continue to rise at significant rates including business insurances, medical insurance and other employee benefit expenses. As discussed in Note 14 to the financial statements, effective December 31, 2003, the Company froze future benefit accruals in both of its defined benefit pension plans and replaced this benefit with a discretionary contribution to the Allen Organ Company Savings and Profit Sharing Plan. During 2005, management has implemented a profit sharing bonus plan for employees at its Macungie, PA facility which contains its Musical Instrument, Electronic Assemblies and Audio Equipment segments. The Company will contribute 10% of this plants operating income to eligible employees. The plan has been implemented to incent employees to work along with management in lowing costs, improving processes and quality and improving the plants operating results. Data Communications Segment Domestic sales increased $11,023,079 and $3,145,416 in 2004 and 2003, respectively. International sales increased $7,934,709 in 2004 when compared to 2003, and decreased $3,659,334 in 2003 when compared to 2002. The 2004 increases are due to higher order volume which management believes is attributable to an improvement in the overall data communications market and the timing of completing sales with the Company's larger customers. Future sales visibility for this segment has improved, but remains limited throughout the markets served by this segment. The total 2003 sales were approximately equal to 2002. Gross profit margins were 58%, 56% and 50% in 2004, 2003 and 2002, respectively. The 2004 increase is due to higher sales volume, reductions in product costs and changes in product mix. In addition, the 2003 gross margin was reduced by approximately 3% due to an accrual for warranty costs. The 2003 increase is due to favorable product mix changes offset by an $850,000 accrual for warranty costs and also includes $1,400,000 of revenue recognized on product software development for a customer during the second quarter of 2003. Excluding this product software development sale the 2003 gross margin was 54%. While the Company strives to maintain profit margins by developing products that offer desirable features, the industry is very competitive which can negatively affect margins. 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Data Communications Segment (Continued) Selling expenses increased approximately $2,138,000 (28%) in 2004 when compared to 2003, primarily due to increases in ERI's domestic sales force ($983,000), marketing ($344,000) and higher costs associated with international sales efforts ($621,000). Selling expenses increased approximately $823,000 in 2003 when compared to 2002, due to increases in ERI's sales efforts both domestic and international. Administrative expenses increased approximately $426,000 (15%) in 2004 compared to 2003, and increased approximately $50,000 in 2003 compared to 2002. These increases are primarily due to additional management and administrative personnel to support the segment's growth. Research and development expenses were $12,465,063, $7,173,393 and $6,352,909 for the years ended December 31, 2004, 2003 and 2002, respectively. The 2004 increase is due primarily to additional personnel and related costs associated with the development of the Company's next generation products. The products under development are expected to continue to serve emerging segments of the mobile and fixed network service providers, as well as private networks, and may also present the Company with a much broader market opportunity. The 2003 increase was due to increased expenditures incurred in connection with the July 2003 acquisition of Avail Networks and the commencement of work on next generation products. The segment is committed to new product development and expects these expenditures to increase during 2005. The combination of higher sales and higher gross margins resulted in operating income of $6,436,161, $2,446,213 and $2,091,520 during 2004, 2003 and 2002, respectively, for this segment. Future sales in this segment have become increasingly dependent on larger sales opportunities that could result in the amount and timing of future revenue and operating income to be more volatile. In addition, this segment will increase future operating costs, primarily research and development to develop next generation products, which is expected to negatively impact future operating results. Electronic Assemblies Segment Sales for 2004 were approximately equal to 2003, which had decreased $1,930,503 compared to 2002. The segment's order rate decreased in 2003 as a result of the economic slowdown that affected the Company's contract manufacturing customers. Management believes that its efforts to diversify its customer base and recent signs of improvement in the economy may improve this segment's order rate in 2005. The gross profit margin for 2004 was 5% compared to a loss of approximately $(114,000) (4%) and $(61,000) (1%) in 2003 and 2002, respectively. The 2004 increase is due to the Company's efforts initiated in 2003 to reduce its operating costs. Selling, general and administrative expenses in 2004 were approximately equal to 2003 and 2002. This segment continues its efforts to diversify its customer base and to improve its production capabilities to offer state of the art manufacturing services to its customers. Audio Equipment Segment Sales decreased $82,333 in 2004 and increased $53,952 in 2003 when compared to the previous year. Legacy Audio has historically sold its products through a direct marketing program. Management believes that this method of distribution has limited its ability to penetrate the broader market. In 2002, Legacy began distributing its products through a more traditional dealer network. The Company has added independent retail dealers and will continue to do so in a conservative manner to build a quality dealer network. During this period, Legacy has shifted marketing resources to the new method of distribution. Gross profit margins were 20%, 35%, and 22% for the years ended December 31, 2004, 2003 and 2002, respectively. The 2004 decrease is primarily due to changes in products mix and $150,000 in additional inventory reserves recorded. Selling, general and administrative costs increased approximately $217,000 during 2004 when compared to 2003, primarily related to increased marketing and advertising costs associated with the introduction of Legacy's new products. Selling, general and administrative costs decreased approximately $29,000 in 2003 compared to the previous year, as a result of steps taken to reduce operating costs. The Company has taken steps to lower these costs in 2005. As discussed in Note 7 of the Consolidated Financial Statements, 2004 operating expenses includes a charge of $362,611 related to the write down of the carrying value of Legacy's goodwill and intangibles. This write down is attributable to Legacy's past and continuing operating losses and its inability to significantly expand distribution of its products, all of which reduced expectations of future cash flows from Legacy's operations and correspondingly it estimated fair market value. 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Significant Accounting Policies The significant accounting policies of the Company are described in Note 1 of the Consolidated Financial Statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United State of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Certain accounting estimates and assumptions are particularly sensitive because of their significance to the consolidated financial statements and the possibility that future events affecting them may differ markedly. Management considers the following accounting estimates to be the most critical in preparing the consolidated financial statements. These critical accounting estimates have been discussed with the Company's audit committee. Allowance for Doubtful Accounts: Management performs ongoing credit evaluations of customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by a review of their current credit information. Management continuously monitors collections and payments from customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. If the financial condition of a specific customer or the Company's general customer base were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Carrying Value of Obsolete and Slow Moving Inventory: The Company values inventory at the lower of cost or market. Management regularly reviews inventory quantities on-hand and records a provision for excess and obsolete inventory based primarily on estimated forecasts of product demand and historical usage, after considering the impact of new products. If actual market conditions and product demand are less favorable than projected, additional inventory write-downs may be required. Carrying Value of Goodwill and Intangible Assets: In assessing the recoverability of goodwill and intangible assets, management is required to make assumptions regarding estimated future cash flows and other factors to determine whether the fair value of the business supports the carrying value of goodwill, intangible assets and net operating assets. This analysis includes assumptions and estimates about future sales, costs, working capital, capital expenditures, and cost of capital. If these assumptions and estimates change in the future, the Company may be required to record an impairment charge related to goodwill and intangible assets. Realization of Deferred Income Tax Benefits: As discussed in Note 16 of the Consolidated Financial Statements, the Company has recorded valuation allowances related to the uncertainty of realizing certain federal and state net operating loss carryforwards and state credit carryforwards. If the estimates and related assumptions relating to the likely utilization of the deferred tax asset change in the future, the valuation allowance may change accordingly. Warranty Reserve: The Company provides warranties on some of its products for varying lengths of time. A warranty liability is recorded at the time of product sale based on estimates that are developed from historical information and certain assumptions about future events. Future warranty obligations are affected by product failure rates, usage and service costs incurred in addressing warranty claims. These factors are impacted by the level of new product introductions and the mix of equipment sold. If actual warranty costs differ from the estimates, adjustments to the warranty liability would be required. 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Contractual Obligations and Commercial Commitments Following is a summary of contractual obligations and other commercial commitments of the Company: Payments Due by Period Less Contractual than 1-3 4-5 After Obligations Total 1 year years years 5 years Operating Leases(a) $341,983 $339,508 $2,475 $0 $0 Purchase Obligations (b) $9,575,186 $9,189,880 $385,306 $0 $0 Amount of Commitment Expiration Per Period Less Other Commercial Total Amounts than 1-3 4-5 After Commitments Committed 1 year years years 5 years Contingent Repurchase Commitments Related to Customer Financing Arrangements (a) $972,676 $972,676 $0 $0 $0 (a) Refer to Note 11 of the Consolidated Financial Statements for more information regarding Operating Leases and Contingent Repurchase Commitments. (b) Purchase Obligations are defined as agreements to purchase goods or services that are enforceable and legally binding and specify all significant terms. The amounts listed above for purchase obligations include contractual commitments for items such as raw materials, supplies, services and capital expenditures. Cancelable purchase obligations that the Company intends to fulfill are also included in the purchase obligations amount listed above. Factors that May Affect Operating Results The statements contained in this report on Form 10-K that are not purely historical are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding the Company's expectations, hopes, intentions or strategies regarding the future. Forward looking statements include: statements regarding future products or product development; statements regarding future research and development spending and the Company's marketing and product development strategy and statements regarding future production capacity. All forward looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which reflect management's opinions only as of the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q to be filed by the Company in fiscal year 2005. It is important to note that the Company's actual results could differ materially from those in such forward looking statements. Some of the factors that could cause actual results to differ materially are set forth below. The Company has experienced and expects to continue to experience fluctuations in its results of operations. Factors that affect the Company's results of operations include the volume and timing of orders received, changes in global economics and financial markets, changes in the mix of products sold, market acceptance of the Company's and its customer's products, competitive pricing pressures, global currency valuations, the availability of electronic components that the Company purchases from suppliers, the Company's ability to meet increasing demand, the Company's ability to introduce new products on a timely basis, the timing of new product announcements and introductions by the Company or its competitors, changing customer requirements, delays in new product qualifications, the timing and extent of research and development expenses and fluctuations in manufacturing yields. As a result of the foregoing or other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis, which would materially and adversely affect the Company's business, financial condition and results of operations. 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) New Accounting Standards During 2004 the Financial Accounting Standards Board issued the following new statements that are applicable to the Company. These statements did not have a material effect on the Company's 2004 financial statements. SFAS 123, (revised), "Share Based Payment" - establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award-the requisite service period (usually the vesting period). This statement is effective as of the beginning of the first interim reporting period that begins after June 15, 2005, which for the Company will be the third quarter of 2005. The Company does not expect that this revised statement will have a material effect on the Company's consolidated financial statements. SFAS 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4" - clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This Statement is effective for the Company for inventory costs incurred on or after January 1, 2006 SFAS 153, "Exchange of Nonmonetary Assets-an amendment of APB Opinion No. 29" - This Statement amends the accounting for the exchange of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This Statement is effective for nonmonetary asset exchanges occurring on or after January 1, 2006. In December 2003, FASB Statement No. 132 (revised), "Employers Disclosures about Pensions and Other Postretirement Benefits", was issued. This Statement prescribes employers' disclosures about pension plans and other postretirement benefit plans; it does not change the measurement or recognition of those plans. The new annual disclosure requirements became effective for the Company as of the year ended December 31, 2004. This additional disclosure is included in Note 14 to the consolidated financial statements. Item 7A Quantitative and Qualitative Disclosures About Market Risk. Financial instruments that potentially subject the Company to market and/or credit risk consist principally of short-term investments and trade receivables. The Company places substantially all of its investments in mutual funds holding federal, state and local government obligations and, by policy, limits the amount of credit exposure in any one investment. The Company's Musical Instruments segment sells most of its products through established dealer networks. The Data Communications segment sells most of their products directly to end-users, to wholesale and retail distributors worldwide and to a smaller extent under OEM agreements with other data communications companies. The market and credit risk associated with related receivables is limited due to the large number of dealers and distributors and their geographic dispersion. The Company has no other material exposure to market risk. Item 8. Financial Statements and Supplemental Data The information required by this Item is set forth on pages 18 through 39 hereto and is incorporated by reference herein. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There were no reportable events as described in Item 304(b) of Regulation S-K. Item 9A. Controls and Procedures The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures, which are designed to insure that the Company records, processes, summarizes and reports in a timely and effective manner the information required to be disclosed in the reports filed with or submitted to the Securities and Exchange Commission. Based upon this evaluation, they concluded that the Company's disclosure controls are effective as of December 31, 2004. There has been no change in the Company's internal control over financial reporting that occurred during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Item 9B. Other Information None 17 KPMG 4905 Tilghman Street Allentown, PA 18104 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders Allen Organ Company: We have audited the accompanying consolidated balance sheets of Allen Organ Company and Subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders' equity and cash flows and the related financial statement schedule for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements and financial statement schedule are the responsibility of the management of Allen Organ Company. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 Allen Organ Company and Subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/KPMG LLP Allentown, Pennsylvania February 24, 2005 18 ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, ASSETS 2004 2003 CURRENT ASSETS Cash $ 8,949,691 $ 5,907,576 Investments including accrued interest 18,338,350 17,143,171 Accounts receivable, net of allowance for doubtful accounts of $ 445,804 in 2004 and $605,496 in 2003 10,993,833 11,652,365 Inventories 15,619,326 13,926,173 Prepaid income taxes 1,466,029 -- Prepaid expenses 532,175 491,444 Deferred income taxes 2,045,087 2,741,167 Total Current Assets 57,944,491 51,861,896 PROPERTY, PLANT AND EQUIPMENT, NET 10,878,469 10,167,004 OTHER ASSETS Note receivable from related party 2,397,291 2,397,291 Cash value of life insurance 2,822,638 2,474,002 Deferred income taxes 3,700,899 3,493,238 Intangible assets, net 682,258 1,347,822 Goodwill, net 24,701 194,523 Other assets 21,988 14,500 Total Other Assets 9,649,775 9,921,376 Total Assets $78,472,735 $71,950,276 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 3,285,659 $ 1,278,535 Accrued income taxes -- 657,941 Accrued expenses 4,882,754 3,811,025 Customer deposits 2,832,174 2,197,393 Total Current Liabilities 11,000,587 7,944,894 NONCURRENT LIABILITIES Deferred and other noncurrent liabilities 1,529,890 1,946,696 Accrued pension costs 6,012,185 5,693,853 Total Noncurrent Liabilities 7,542,075 7,640,549 Total Liabilities 18,542,662 15,585,443 MINORITY INTEREST 41,927 -- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Class A Voting Common stock, $1 par value, 400,000 shares authorized, 127,232 shares issued 127,232 127,232 Class B Non-Voting Common stock, $1 par value, 3,600,000 shares authorized, 1,410,761 shares issued 1,410,761 1,410,761 Additional paid-in capital 13,197,610 13,150,610 Retained earnings 62,076,690 58,015,139 Accumulated other comprehensive loss (4,417,842) (3,832,694) Treasury stock, at cost, 43,368 Class A shares in 2004 and 2003, 338,382 Class B shares in 2004 and 338,380 in 2003 (12,506,305) (12,506,215) Total Stockholders' Equity 59,888,146 56,364,833 Total Liabilities and Stockholders' Equity $78,472,735 $71,950,276 See accompanying notes to Consolidated Financial Statements. 19 ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2004 2003 2002 NET SALES $80,170,788 $60,788,058 $67,739,548 COSTS AND EXPENSES Cost of sales 41,653,317 35,693,613 41,963,839 Selling, administrative and other expenses 18,424,333 15,390,231 14,886,291 Research and development 13,948,340 8,785,522 7,782,571 Other expense 52,963 29,195 26,825 Impairment of goodwill and intangibles 362,611 -- -- Total 74,441,564 59,898,561 64,659,526 INCOME FROM OPERATIONS 5,729,224 889,497 3,080,022 INVESTMENT INCOME 392,750 432,399 716,335 MINORITY INTERESTS IN CONSOLIDATED SUBSIDIARY (41,927) -- -- INCOME BEFORE INCOME TAXES 6,080,047 1,321,896 3,796,357 INCOME TAXES Current 533,000 571,000 1,669,000 Deferred 838,000 (646,000) (558,000) Total 1,371,000 (75,000) 1,111,000 NET INCOME $ 4,709,047 $ 1,396,896 $ 2,685,357 OTHER COMPREHENSIVE LOSS, NET OF TAX Unrealized (loss) gain on investments: Unrealized (loss) gain arising during period $ (47,865) $ (26,898) $ 132,305 Less: reclassified adjustment for gain (loss) included in income 12 2,495 (97,186) Sub-total (47,853) (24,403) 35,119 Minimum pension liability adjustment (537,295) (347,828) (2,121,282) Other comprehensive loss (585,148) (372,231) (2,086,163) COMPREHENSIVE INCOME $ 4,123,899 $ 1,024,665 $ 599,194 EARNINGS PER SHARE OF COMMON STOCK BASIC $ 4.07 $ 1.20 $ 2.29 DILUTED $ 4.06 $ 1.20 $ 2.29 See accompanying notes to Consolidated Financial Statements. 20 ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Common Stock Additional Class A Class B Paid-in Shares Amount Shares Amount Capital Balance-December 31,2001 127,232 $127,232 1,410,761 $1,410,761 $12,903,610 Tax benefit from exercise of subsidiary stock options 58,000 Balance-December 31,2002 127,232 127,232 1,410,761 1,410,761 12,961,610 Tax benefit from exercise ofsubsidiary stock options 189,000 Balance-December 31,2003 127,232 127,232 1,410,761 1,410,761 13,150,610 Tax benefit from exercise of subsidiary stock options 47,000 Balance-December 31,2004 127,232 $127,232 1,410,761 $1,410,761 $13,197,610 Accumulated Other Retained Comprehensive Treasury Stock Earnings Income (Loss) Shares Amount Balance-December 31,2001 $55,237,713 $(1,374,300) 367,672 $(11,990,001) Net income 2,685,357 Reacquired Class B Shares 261 (10,570) Change in unrealized gain (loss) on securities available for sale 35,119 Minimum pension liability adjustment (2,121,282) Cash dividend paid ($0.56 per share) (655,307) Balance-December 31,2002 57,267,763 (3,460,463) 367,933 (12,000,571) Net income 1,396,896 Reacquired Class B Shares 13,815 (505,644) Change in unrealized gain (loss) on securities available for sale (24,403) Minimum pension liability adjustment (347,828) Cash dividend paid ($0.56 per share) (649,520) Balance-December 31,2003 58,015,139 (3,832,694) 381,748 (12,506,215) Net income 4,709,047 Reacquired Class B Shares 2 (90) Change in unrealized loss on securities available for sale (47,853) Minimum pension liability adjustment (537,295) Cash dividend paid ($0.56 per share) (647,496) Balance-December 31,2004 $62,076,690 $(4,417,842) 381,750 $12,506,305 See accompanying notes to Consolidated Financial Statements. 21 ALLEN ORGAN COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2004 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES Net income $4,709,047 $1,396,896 $2,685,357 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 2,480,881 2,518,612 2,801,512 Minority interest in consolidated subsidiary 41,927 -- -- Loss from impairment of goodwill and intangibles 362,611 -- -- (Gain) loss on sale of property, plant and equipment (378) 16,554 55,184 Loss (gain) on sale of investments -- 4,000 (156,248) Tax benefit from exercise of stock options 47,000 189,000 58,000 Deferred income taxes 838,000 (624,135) (518,984) Change in assets and liabilities Accounts receivable 658,532 532,199 (2,236,722) Inventories (1,693,153) 2,297,509 1,073,475 Prepaid income taxes (1,466,029) 161,071 945,143 Prepaid expenses (40,731) (172,501) 67,478 Other assets (7,488) 1,592 -- Accounts payable 2,007,124 (4,410,432) 2,938,716 Accrued income taxes (657,941) 657,941 -- Accrued expenses 1,071,729 1,172,769 665,104 Customer deposits 634,781 (496,587) (284,043) Accrued pension costs (544,045) 144,349 (175,071) Deferred and other noncurrent liabilities (416,806) 917,911 321,016 Net Cash Provided by Operating Activities 8,025,061 4,306,748 8,239,917 CASH FLOWS FROM INVESTING ACTIVITIES Cash proceeds from sale of investments classified as available for sale 791,464 526,866 30,633,381 Cash paid for purchase of investments classified as available for sale (2,058,995) (521,690) (36,009,348) Increase in cash value of life insurance (348,636) (200,839) (99,597) Increase in note receivable -- -- (400,184) Payment for acquisition of business -- (200,000) -- Cash proceeds from sale of property, plant and equipment 7,000 5,100 319,155 Cash paid for purchase of property, plant and equipment (2,743,457) (1,063,231) (1,898,586) Net Cash Used In Investing Activities (4,352,624) (1,453,794) (7,455,179) CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid in cash (647,496) (649,520) (655,307) Reacquired Class B common shares (90) (505,644) (10,570) Subsidiary company stock reacquired from minority stockholders (24,939) (448,659) (89,386) Proceeds from sale of subsidiary stock 42,203 143,256 35,716 Net Cash Used in Financing Activities (630,322) (1,460,567) (719,547) NET INCREASE IN CASH 3,042,115 1,392,387 65,191 CASH, JANUARY 1 5,907,576 4,515,189 4,449,998 CASH, DECEMBER 31 $8,949,691 $5,907,576 $4,515,189 SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION Cash paid (refunded) for income taxes $2,619,970 $ (439,012) $ 750,008 Cash paid for interest $ -- $ -- $ -- The above changes in assets and liabilities excludes the following adjustments related to the minimum pension liability. Accumulated other comprehensive income $ 537,295 $ 347,828 $2,121,282 Deferred income tax benefits 325,082 195,128 1,312,295 Accrued pension costs (862,377) (542,956) (3,433,577) See accompanying notes to Consolidated Financial Statements. 22 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 Background and Significant Accounting Policies Background: Allen Organ Company and Subsidiaries (Company) operate in four industry segments: Musical Instruments, Data Communications, Electronic Assemblies, and Audio Equipment. See Note 21 for additional information on the operating activities of each segment. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries (Allen Diversified, Inc. and Legacy Audio, Inc.) and majority-owned (91%) subsidiary (Eastern Research, Inc.). In addition, the Company has other inactive, wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Cash Equivalents: Cash equivalents of $5,861,878 and $1,556,578 at December 31, 2004 and 2003, respectively, consist of money market funds. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months of less to be cash equivalents. Investments: Investment securities at December 31, 2004 and 2003 consist of U.S. Treasury and equity securities. The Company classifies its debt securities in one of three categories: trading, available for sale, or held to maturity and its equity securities into trading or available for sale. Trading securities are bought and held principally for the purpose of selling them in the near term. Held to maturity debt securities are those securities in which the Company has the ability and intent to hold the security until maturity. All other securities not included in trading or held to maturity are classified as available for sale. The Company has no trading or held to maturity securities. Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, on available-for- sale securities are excluded from earnings and are reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis. A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year-end, and forecasted performance of the investee. Premiums and discounts are amortized or accreted over the life of the related available-for-sale security as an adjustment to yield using the effective-interest method. Dividend and interest income are recognized when earned. Accounts Receivable Allowance: The Company records an allowance for uncollectible accounts receivable based on historical loss experience, customer payment patterns and current economic trends. Management reviews the adequacy of the allowance for uncollectible accounts receivable on a quarterly basis and, if necessary, increases or decreases the allowance. 23 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 Background and Significant Accounting Policies (Continued) Inventories: Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first- out (FIFO) method for all inventories. Property, Plant and Equipment: Property, plant and equipment are stated at cost. Depreciation is computed over the estimated useful asset lives using both straight-line and accelerated methods for financial reporting and accelerated methods for tax reporting purposes. Goodwill and Intangible Assets: Goodwill represents the excess of costs over fair value of assets of businesses acquired. The Company accounts for its goodwill and intangible assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets". Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". Intangible assets represent identifiable assets such as customer lists, developed technology and trademarks acquired in connection with the purchase of the Company's subsidiaries. Intangible assets are amortized on a straight-line basis over various periods, generally from 5 - 15 years, and are presented net of accumulated amortization on the consolidated balance sheets. The carrying value of goodwill and intangible assets for each business is continually reviewed to assess its recoverability from future operations, based on future cash flows (undiscounted) expected to be generated by such operations. Any impairment in value indicated by the assessment would be computed based on discounted cash flows and charged against current operations. Revenue Recognition: The Company recognizes revenue when products are shipped and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. Service revenues are recognized when the services are performed. Service revenues are derived from providing extended warranties to customers, equipment maintenance and repairs, engineering and hardware support, and subcontract assembly services. Deferred revenues represent cash received from customers in advance of revenues being recognized for the related payment. Sales are recorded net of anticipated product returns. The estimated product returns are based on a historical analysis and are recorded when the associated product revenue is recognized. Research and Development and Advertising: Research and development and advertising expenditures are charged to expense as incurred. Research and development expenses are separately disclosed in the consolidated statements of operations while advertising costs were $459,812, $278,327, and $333,695 in 2004, 2003 and 2002, respectively. Income Taxes: Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 24 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 1 Background and Significant Accounting Policies (Continued) Financial Instruments: Financial instruments that potentially subject the Company to credit risk consist principally of short-term investments and trade receivables. The Company places substantially all of its investments in mutual funds holding federal, state and local government obligations and, by policy, limits the amount of credit exposure in any one investment. The Company's Musical Instruments segment sells most of its products through established dealer networks. The Data Communications segment sells most of its products direct to customers, to distributors worldwide and to a lesser extent under OEM agreements with other data communications companies. The credit risk associated with related receivables is limited due to the large number of customers and their geographic dispersion. Reclassifications: Certain amounts in the 2003 and 2002 financial statements have been reclassified to conform to the 2004 presentation. New Accounting Standards: During 2004 the Financial Accounting Standards Board issued the following new statements that are applicable to the Company. These statements did not have a material effect on the Company's 2004 financial statements. SFAS 123, (revised), "Share Based Payment" - establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award-the requisite service period (usually the vesting period). This statement is effective as of the beginning of the first interim reporting period that begins after June 15, 2005, which for the Company will be the third quarter of 2005. The Company does not expect that this revised statement will have a material effect on the Company's consolidated financial statements. SFAS 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4" - clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This Statement is effective for the Company for inventory costs incurred on or after January 1, 2006 SFAS 153, "Exchange of Nonmonetary Assets-an amendment of APB Opinion No. 29" - This Statement amends the accounting for the exchange of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This Statement is effective for nonmonetary asset exchanges occurring on or after January 1, 2006. In December 2003, FASB Statement No. 132 (revised), "Employers Disclosures about Pensions and Other Postretirement Benefits", was issued. This Statement prescribes employers' disclosures about pension plans and other postretirement benefit plans; it does not change the measurement or recognition of those plans. The new annual disclosure requirements became effective for the Company as of the year ended December 31, 2004. This additional disclosure is included in Note 14. 25 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 1 Background and Significant Accounting Policies (Continued) Stock-Based Compensation: The Company accounts for its stock-based compensation plans using the accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Since the Company is not required to adopt the fair value based recognition provisions prescribed under Statement of Financial Accounting Standards No. 123, as amended by SFAS No. 148, "Accounting for Stock-Based Compensation", only the disclosure requirements set forth in the Statements are presented. Had compensation cost been determined on the basis of fair value pursuant to SFAS No. 123, as amended by SFAS No. 148, net income and earnings per share would have been as follows: 2004 2003 2002 Net income As reported $4,709,047 $1,396,896 $2,685,357 Stock-based employee compensation expense included in reported net income, net of tax 71,693 90,402 35,661 Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (653) (121,859) (105,035) Pro forma $4,780,087 $1,365,439 $2,615,983 Earnings per share As reported Basic $4.07 $1.20 $2.29 Diluted $4.06 $1.20 $2.29 Pro forma Basic $4.13 $1.18 $2.23 Diluted $4.12 $1.18 $2.23 The fair value of each option granted is estimated on the grant date using the Black-Scholes option pricing model. The following assumptions were made in estimating the fair value of options granted under the Allen Organ Company stock option plan in 2004 and 2002; there were no option grants under the Allen Organ Company stock option plan in 2003. 2004 2002 Dividend yield 1.40% 1.40% Risk-free interest rate 2.25% 2.50% Expected life 6 years 7 years Expected volatility 25% 10% NOTE 2 Business Acquisition On July 24, 2003, the Company's subsidiary, Eastern Research, Inc. (ERI), purchased the assets of Avail Networks, Inc. (Avail) in exchange for $200,000 in cash and contingent payments of 5% of net revenues related to the sale of Avail products in excess of $1,500,000 during the first 30 months after the acquisition. ERI has not paid any royalties in connection with this acquisition and does not expect that revenue related to the sales of Avail products during the 30 months following the acquisition will exceed $1,500,000, the amount after which any royalty would be due. Avail's sales prior to the acquisition date were minimal. As such, pro-forma financial information is not required for this acquisition. The purchase price was allocated $114,300 to property and equipment and $85,700 to intangibles. 26 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 3 Investments The cost and fair value of investments in debt and equity securities are as follows: Gross Gross Fair Amortized Unrealized Unrealized Value Cost Gains Losses December 31, 2004 Available for sale Equity securities $ 29,310 $ -- $ 50 $ 29,260 Mutual Funds Short Term Gov't Funds 3,318,087 -- 72,088 3,245,999 Municipal Bond Funds 15,049,871 -- 46,056 15,003,815 Equity Funds 57,213 2,063 -- 59,276 Totals $18,454,481 $ 2,063 $118,194 $18,338,350 December 31, 2003 Available for sale Equity securities $ 29,310 $ -- $ 50 $ 29,260 Mutual Funds Short Term Gov't Funds 2,281,775 -- 36,422 2,245,353 Municipal Bond Funds 14,840,033 -- 6,593 14,833,440 Equity Funds 35,832 -- 714 35,118 Totals $17,186,950 $ -- $ 43,779 $17,143,171 Marketable debt securities have an average contractual maturity of approximately 1 year or less. Realized gains and losses are determined based on the original cost of these investments using a first-in, first-out method. During 2004, 2003 and 2002, sales proceeds and gross realized gains and losses on securities classified as available for sale were: 2004 2003 2002 Sales proceeds $ 791,464 $ 526,866 $30,633,381 Gross realized losses $ -- $ 4,000 $ 379,804 Gross realized gains $ -- $ -- $ 536,052 The change in net unrealized holding (loss) gain on securities available for sale of $(72,352) $(36,537), and $55,961, net of deferred tax (benefit) expense of $(24,499), $(12,134), and $20,842, has been included in accumulated other comprehensive loss in stockholders' equity for the years ended December 31, 2004, 2003, and 2002, respectively. 27 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 4 Inventories December 31, 2004 2003 Finished goods $5,685,024 $3,945,007 Work in process 5,535,795 5,525,106 Raw materials 4,398,507 4,456,060 Total $15,619,326 $13,926,173 Inventory is net of allowance for obsolete and slow moving items of $3,134,223 and $3,851,749 at December 31, 2004 and 2003, respectively. Finished goods consist primarily of completed organs, speaker cabinets and completed data communications products. NOTE 5 Property, Plant and Equipment Estimated December 31, Useful 2004 2003 Lives Land and improvements $ 2,369,298 $ 2,369,298 10 yrs Buildings and improvements 9,502,949 9,085,523 2 - 40 yrs Machinery and equipment 12,411,711 11,263,861 5 - 10 yrs Office furniture and equipment 6,480,353 5,385,231 3 - 8 yrs Vehicles 212,453 179,369 4 yrs Sub-total 30,976,764 28,283,282 Less accumulated depreciation 20,098,295 18,116,278 Total $10,878,469 $10,167,004 Depreciation expense charged to operations was $2,025,370, $1,846,367 and $2,158,302 in 2004, 2003 and 2002, respectively. NOTE 6 Note Receivable The Company has entered into two split-dollar life insurance agreements with its President, who is the insured and owner of the policies. The policy owner is required to pay the portion of the premiums equal to the value of the economic benefit determined in accordance with applicable IRS Revenue Rulings. Due to rules included in the Sarbanes-Oxley Act of 2002 prohibiting the payment of these types of premiums, the Company did not pay any insurance premiums in 2004 or 2003 related to these split-dollar agreements. In the past, the Company paid the balance of the net premiums, which approximates $450,000 annually. The agreements provide that the Company shall be entitled to recover the amount of premiums paid out of the built-up cash value upon termination of the agreement or out of the proceeds upon the death of the insured. As security for repayment, the Company is a collateral assignee of the policy to the extent of any such unreimbursed premiums. The note receivable is also secured by the personal obligation of its President. The note receivable exceeds the cash surrender value of these policies by approximately $457,000 and $431,000 at December 31, 2004 and 2003, respectively. However, the Company's President has an adequate level of personal net assets to cover these amounts. 28 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 7 Intangible Assets Intangible assets subject to amortization are as follows: December 31, 2004 December 31, 2003 Weighted Gross Gross Average Carrying Accumulated Carrying Accumulated Amortization Amount Amortization Amount Amortization Period Customer Lists $ 105,679 $ 105,679 $ 105,679 $ 87,583 7 years Developed Technology 4,643,246 3,960,988 4,660,509 3,515,220 5 years Trademark 278,396 278,396 278,396 93,959 20 years Total $5,027,321 $4,345,063 $5,044,584 $3,696,762 Amortization expense was $455,511, $672,245 and $643,210 in 2004, 2003 and 2002, respectively. Estimated amortization expense for the next five years is as follows: 2005 $224,856 2006 167,605 2007 136,356 2008 87,875 2009 65,566 As discussed in Note 2, in July 2003, ERI acquired the assets of Avail Networks for $200,000, which included $85,700 of intangible assets allocated to developed technology and will be amortized over five years. In addition, intangible assets of $(17,264), $305,403 and $53,670 were recorded in 2004, 2003 and 2002, respectively, in connection with stock transactions with minority stockholders of ERI. During June 2004, the Company recorded a charge to operating expenses of $362,611 related to the impairment in the carrying value of goodwill ($169,822) and intangibles ($192,789) which arose in connection with the acquisition of Legacy Audio, Inc. This write down is attributable to Legacy's past and continuing operating losses and its inability to significantly expand distribution of its products, all of which reduced expectations of future cash flows from Legacy's operations and correspondingly its estimated fair market value. NOTE 8 Accrued Expenses December 31, 2004 2003 Accrued salaries and commissions $2,279,036 $1,876,287 Accrued warranty costs 555,000 970,000 Deferred revenue 535,113 405,959 Accrued profit sharing contribution 826,640 248,349 Other 686,965 310,430 Total $4,882,754 $3,811,025 29 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 9 Deferred and Other Noncurrent Liabilities December 31, 2004 2003 Deferred compensation (see Note 14 and 18) $ 925,157 $1,190,549 Deferred revenue 254,940 516,147 Accrued warranty costs 349,793 240,000 Total $1,529,890 $1,946,696 NOTE 10 Warranty Costs The Musical Instruments segment provides a 10 year warranty on its organs, the Data Communications segment provides a 2 year warranty on all of its data communication products, the Electronic Assemblies segment provides a 1 year warranty on assemblies manufactured for outside customers and the Audio Equipment segment provides a 5 year warranty of its line of home audio speakers. The Company's policy is to accrue the estimated cost of warranty coverage at the time the sale is recorded. The activity in the warranty accrual is summarized as follows: December 31, 2004 2003 Accrual at beginning of year $1,210,000 $ 300,000 Revision to prior year estimate (298,105) -- Additions charged to warranty expense 315,000 1,080,357 Claims paid and charged against the accrual (322,102) (170,357) Accrual at end of year $ 904,793 $1,210,000 NOTE 11 Commitments and Contingencies As of December 31, 2004, the Company is contingently liable for a maximum amount of approximately $973,000 in connection with the financing arrangements of certain customers. Under the terms of an agreement with the wife of the late Chairman and principal stockholder of the Company, the Company may be required to purchase within eight months of her death, at the option of her personal representative, an amount of Class A and/or B Common Shares then owned by her or includable in her estate for Federal Estate Tax purposes sufficient to pay estate taxes and costs, subject to the limitations of Section 303 of the Internal Revenue Code. At December 31, 2004, the stockholder owned or would have includable in her estate 81,531 Class A shares and 267,429 Class B shares. The Company's obligation under this agreement is limited to the insurance proceeds to be received by the Company on life insurance purchased on the life of the stockholder, which policy has a face value of $6,000,000. In connection with the purchase of Avail Networks (see Note 2), ERI agreed to pay royalties of 5% of total net sales of qualifying products through January 2006 in excess of $1,500,000. The royalties are payable quarterly. There were no royalty payments made during 2004 and 2003. ERI leases its offices and production facility under non-cancelable operating leases which expire at various dates through March 2006. Rent expense for all Company operating leases was $571,851, $453,414, and $413,733 in 2004, 2003 and 2002, respectively. Minimum annual rent payments for the operating leases are $339,508 and $2,475 in 2005 and 2006, respectively. At December 31, 2004, the Company had open purchase obligations with expected payment obligations of $9,575,186 in 2005 and $385, 306 in 2006. 30 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 12 Accumulated Other Comprehensive Loss December 31, 2004 2003 Unrealized loss on investments, net $ (76,720) $ (28,867) Minimum pension liability adjustment (4,341,122) (3,803,827) Total $(4,417,842) $(3,832,694) NOTE 13 Export Sales Export sales are all made in US dollars and based on the customers credit information are made either on open credit terms, under letter of credit or on a prepaid basis In 2004, 2003 and 2002, net sales by the Musical Instruments segment include export sales, principally to Canada, Europe and the Far East, of $3,925,493, $3,348,158, and $3,248,480, respectively. Net sales by the Data Communications segment include export sales principally to South Africa, Europe and Asia Pacific of $14,704,274 for 2004, $6,769,565 for 2003, and $10,428,899 for 2002. Included in the export sales of the Data Communications segment are sales to Australia of $6,622,621, $2,321,937 and $6,979,993 in 2004, 2003 and 2002, respectively. Net sales by the Audio Equipment segment include export sales principally to Russia of $254,870 for 2004, $119,780 for 2003, and $69,222 for 2002. NOTE 14 Retirement Plans The Company sponsors two noncontributory defined benefit pension plans which cover substantially all of its employees. Salaried plan benefits are generally based on the employee's years of service and compensation levels. Hourly plan benefits are based on various monthly amounts for each year of credited service. The Company's funding policy is to contribute amounts to the plans sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as the Company may determine to be appropriate from time to time. Effective December 31, 2003, the Company froze future benefit accruals under both the salaried and hourly defined benefit pension plans. The Company will continue to fund the plans and may terminate the plans in the future. The Company has replaced the retirement benefit previously provided to its employees under the defined benefit pension plan with a discretionary contribution to the Allen Organ Company Saving and Profit Sharing Plan. The discretionary contribution will be allocated to employee accounts based on their salary. The measurement date used to calculate the benefit obligations is December 31. 31 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 14 Retirement Plans (Continued) Following are reconciliations of the pension benefit obligation and the value of plan assets: 2004 2003 2002 Pension benefit obligation Balance, beginning of year $17,945,952 $17,468,426 $16,112,915 Service cost -- 436,305 393,927 Interest cost 1,016,079 1,089,526 1,085,299 Benefits paid to participants (1,142,374) (1,112,879) (1,117,494) Actuarial loss 862,985 -- -- Increase due to changes in data/assumptions -- 64,574 993,779 Balance, end of year $18,682,642 $17,945,952 $17,468,426 Plan assets Fair value, beginning of year $12,252,099 $11,514,344 $13,398,564 Actual investment returns 560,732 820,634 (1,663,508) Company contributions 1,000,000 1,030,000 852,041 Benefits paid to participants (1,142,374) (1,112,879) (1,072,753) Fair value, end of year $12,670,457 $12,252,099 $11,514,344 The funded status of the plans is as follows: December 31, 2004 2003 2002 Excess of the benefit obligation over the value of plan assets $(6,012,185) $(5,693,853) $(5,954,082) Unrecognized net actuarial loss 6,967,646 6,105,269 6,509,847 Adjustment to recognize minimum liability (6,967,646) (6,105,269) (5,562,313) Accrued benefit cost $(6,012,185) $(5,693,853) $(5,006,548) The adjustment to recognize the minimum pension liability of $6,967,646, net of deferred tax benefit of $2,626,524, has been included in accumulated other comprehensive loss in stockholders' equity at December 31, 2004. The following weighted-average rates were used in determining the above plan information: 2004 2003 2002 Discount rate on the benefit obligation 5.50% 5.75% 6.25% Discount rate on net periodic benefit cost 5.75% 6.25% 6.75% Expected long-term rate of return on plan assets 7.00% 7.00% 7.00% Rate of long-term compensation increase N/A 5.00% 5.00% The expected long-term rate of return is based on the portfolio that management expects to maintain as a whole and not on the sum of the returns on individual asset categories. The return is based exclusively on historical returns, without adjustments. The expected rate of long- term compensation is not applicable as accrued benefits in the plans have been frozen. Pension expense is comprised as follows: 2004 2003 2002 Service cost $ -- $ 436,305 $ 393,927 Interest cost 1,016,079 1,089,526 1,085,299 Expected return on plan assets (868,347) (768,716) (1,036,157) Amortization of net gain from prior service cost -- -- 133,903 Amortization of net loss 308,223 417,234 -- Net pension cost $ 455,955 $1,174,349 $ 576,972 32 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 14 Retirement Plans (Continued) The allocation of the fair value of plan assets of the Company's pension plans at December 31, 2004, 2003 and 2002 were as follows: December 31, 2004 2003 2002 Equity Security Funds 33% 20% -- Stable Asset Fund 34% 34% -- Cash and Equivalents Fund 33% 46% 100% Total 100% 100% 100% The Company's investment policies and strategies for the pension benefit plans do not use target allocations for the individual asset categories. Management expects to increase its allocation to Equity Security Funds to approximately 40%, with the balance being invested in the Stable Asset Fund. Management will continue to monitor market conditions and make changes in asset allocation that it feels are appropriate to balance the risk and return on plan investments. The Company's investment goals are to maximize returns subject to specific risk management policies. Its risk management policies permit investments in mutual funds and prohibit direct investments in debt and equity securities and derivative financial instruments. The Company addresses diversification by the use of mutual fund investments whose underlying investments are in domestic and international fixed income securities and domestic and international equity securities. These mutual funds are readily marketable and can be sold to fund benefit payment obligations as they become payable. The Company expects to contribute a total of $1,000,000 to its pension plans in 2005. Future benefit payments are estimated as follows: 2005 $1,165,633 2006 1,188,586 2007 1,274,828 2008 1,330,150 2009 1,318,210 2010-2014 6,277,407 The Company provides a 401(k) deferred compensation and profit sharing plan for the benefit of eligible employees. The plan allows eligible employees to defer a portion of their annual compensation, pursuant to Section 401(k) of the Internal Revenue Code. Profit-sharing contributions to the plan are discretionary as determined by the Company's Board of Directors. Expenses related to this plan were $826,640, $248,349 and $58,325 in 2004, 2003 and 2002, respectively. The Company provides supplemental executive retirement plans (deferred compensation) for several of its officers and key employees of the Company. These plans provide for discretionary Company contributions, which vest over a five year period, accrue interest at the prime rate, not to exceed 9%, and are payable upon the executive's death or retirement. Expense related to these arrangements was $159,647, $138,760 and $143,512 in 2004, 2003 and 2002, respectively. The accrued benefits were $629,157 and $667,549 at December 31, 2004 and 2003, respectively. NOTE 15 Investment Income December 31, 2004 2003 2002 Interest Income $ 377,753 $ 429,440 $ 550,697 Dividend Income 14,997 6,959 9,390 Gain (Loss) on Sale of Investments -- (4,000) 156,248 Total $ 392,750 $ 432,399 $ 716,335 33 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 16 Income Taxes The provision for income taxes consists of the following: 2004 2003 2002 Currently Currently Currently Payable Deferred Payable Deferred Payable Deferred Federal $ 432,000 $ 783,000 $ 439,000 $ (448,000) $1,252,000 $ (456,000) State 101,000 55,000 132,000 (198,000) 417,000 (102,000) Total $533,000 $ 838,000 $ 571,000 $ (646,000) $1,669,000 $ (558,000) A reconciliation of the provision for income taxes with the statutory rate follows: 2004 2003 2002 Statutory provision for federal income tax $2,081,000 34.0% $ 449,000 34.0% $1,291,000 34.0% State taxes, net of federal tax benefits 203,000 3.3 106,000 8.0 143,000 3.8 Tax credits for research and development (510,000) (8.3) (347,000) (26.3) (311,000) (8.2) Tax-exempt income (71,000) (1.1) (56,000) (4.2) (64,000) (1.7) Extraterritorial income exclusion (309,000) (5.1) (104,000) (7.9) (136,000) (3.6) Other items, net 77,000 1.3 27,000 2.0 18,000 0.5 Effect of change in valuation allowance of deferred tax assets: Federal -- -- -- -- 105,000 2.8 State (100,000) (1.6) (150,000) (11.3) 65,000 1.7 Total $1,371,000 22.5% $ (75,000) (5.7)% $1,111,000 29.3% The following temporary differences give rise to the net deferred tax asset at December 31, 2004 and 2003. 2004 2003 Deferred Tax Assets Excess of book depreciation/amortization over tax depreciation/amortization $ 352,792 $ 375,529 Excess of book over tax pension expense 1,881,358 1,766,324 Loss on investments not recognized for tax purposes 39,414 14,913 Deferred compensation not recognized for tax purposes 316,157 447,759 Net operating loss and credit carryforwards 1,729,610 1,872,221 Other liabilities 659,323 646,331 Reserve for bad debts 167,560 227,846 Warranty reserve 340,852 454,989 Inventory reserve 1,178,920 1,448,493 Sub-total 6,665,986 7,254,405 Valuation Allowance (920,000) (1,020,000) Total Deferred Tax Assets $5,745,986 $6,234,405 Deferred taxes are included in the Company's financial statements as follows: 2004 2003 Current deferred tax asset $2,045,087 $2,741,167 Non-current deferred tax asset 3,700,899 3,493,238 Total deferred tax asset $5,745,986 $6,234,405 34 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 16 Income Taxes (Continued) At December 31, 2004, the Company has available approximately $2,337,000 of unused federal and $13,886,000 of unused state net operating loss carryforwards that may be applied against future taxable income and that expire in various years from 2007 to 2024. In addition, the Company has $872,000 in state tax credit carryforwards that expire in various years from 2008 to 2019. The Company has a valuation allowance of $920,000 for the deferred tax assets related to the uncertainty of realizing state net operating loss carryforwards, state credit carryforwards and federal net operating losses generated by a subsidiary prior to inclusion in the consolidated federal income tax return. The decrease in the 2004 valuation allowance is primarily related to state net operating losses that were reduced due to state apportionment. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance at December 31, 2004. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. NOTE 17 Earnings Per Share The following shows the amounts used in computing earnings per share and the effect on weighted average number of shares for dilutive potential common stock. 2004 2003 2002 Weighted average number of common shares used in basic earnings per share 1,156,243 1,160,008 1,170,191 Effect of stock options 2,576 473 -- Weighted average number of common shares used in diluted earnings per share 1,158,819 1,160,481 1,170,191 Outstanding stock options to purchase 12,000 shares of common stock were not included in computing earnings per share for 2002 because the effect was antidilutive. 35 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 18 Stock Option Plans In July 2002, the Company established an employee stock-based compensation plan to assist in attracting and retaining personnel. The maximum number of the Company's Class B shares that may be issued under the plan approximates a 9% interest in the Company. Options are issued at the fair market value on the date of grant. The maximum term of the options is ten years, and generally vest equally over four years. As of December 31, 2004, total options issued represent 1.40% of the shares currently outstanding. Vested options represent 0.75% of the currently outstanding shares. Following is a summary of the activity under the plan: December 31, 2004 2003 2002 Weighted Weighted Weighted Average Average Average Number of Exercise Number of Exercise Number of Exercise Shares Price Shares Price Shares Price Outstanding at beginning of year 12,000 $39.00 12,000 $39.00 -- $ -- Granted 4,500 43.15 -- -- 12,000 39.00 Exercised -- -- -- -- -- -- Forfeited -- -- -- -- -- -- Outstanding at end of year 16,500 $40.13 12,000 $39.00 12,000 $39.00 Weighted average fair value of options granted during the year $10.32 $ -- $ 5.03 Following is a summary of the status of options outstanding at December 31, 2004: Options Outstanding Options Exercisable Weighted Avg. Remaining Weighted Avg. Weighted Avg Exercise Number Contractual Exercise Number Exercise Price Outstanding Life Price Exercisable Price $39.00 12,000 7.56 years $39.00 7,200 $39.00 43.15 4,500 9.08 years 43.15 1,500 43.15 Total 16,500 7.98 years $40.13 8,700 $39.72 ERI also provides an employee stock-based compensation plan to assist in attracting and retaining personnel. The maximum number of subsidiary shares that may be issued under the plan approximates a 15% interest in the subsidiary. Options are generally issued at the estimated fair market value. The maximum term of the options is six years, and generally vest equally over four years. As of December 31, 2004, total options issued and outstanding represents 8% of the ERI shares currently outstanding. Vested options consist of 5% of the currently outstanding shares of ERI. ERI recognized compensation expense of $115,188 in 2004, $144,875 in 2003, and $59,375 in 2002 related to options granted with an exercise price less than the fair market value on the date of grant. Deferred compensation relating to these option grants is $296,000 and $523,000 at December 31, 2004 and 2003, respectively. See Note 1 for the pro forma effects on net income and earnings per share had compensation cost been determined on the basis of fair value pursuant to SFAS No. 123, as amended by SFAS No. 148. 36 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 19 Related Party Transactions The Company maintains two classes of stock, Class A voting common stock and Class B non-voting common stock. The majority (97%) of the Class A voting common stock is held by a Trust for the benefit of the family of company founder Jerome Markowitz. Accordingly, the Markowitz family has the ability to elect all board of directors and control the vote on substantially all matters without the approval of other stockholders. A member of the Company's Board of Directors is a principal in firms providing legal and financial advisory services. Legal fees paid were $265,447, $153,149 and $45,851 in 2004, 2003 and 2002, respectively. Financial advisory fees paid were $6,000 in both 2003 and 2002. There were no related party financial advisory fees paid in 2004. NOTE 20 Major Customers The Company derived 20% of its consolidated net sales from one customer in 2004. Receivables from this customer represented 41% of total consolidated accounts receivable at December 31, 2004. No single customer represented 10% or more of consolidated net sales in 2003 or 2002. NOTE 21 Industry Segment Information The Company's operations are classified into four industry segments: Musical Instruments, Data Communications, Electronic Assemblies and Audio Equipment. The Musical Instruments segment is comprised of operations principally involved in the design, manufacture, sale and distribution of electronic keyboard musical instruments, primarily digital organs and related accessories. Musical instruments are sold primarily to retail dealers worldwide. The Data Communications segment is involved in the design, sale and distribution of data communications equipment. Data communications products are sold direct to customers, to distributors worldwide and to a smaller extent under OEM agreements with some customers. The Electronic Assemblies segment is involved in the manufacture, sale and distribution of electronic assemblies for outside customers used primarily as control devices and other circuitry in their products. Subcontract assembly services are provided primarily to industrial concerns in Pennsylvania and New Jersey. The Audio Equipment (Legacy Audio, Inc.) segment is involved in the design, manufacture, sale and distribution of high quality speaker cabinets for hi-fi stereo and home theater applications. Legacy's products are sold worldwide primarily through independent retail dealers and, to a lesser extent, directly to individual customers. Intersegment sales are generally priced at cost plus a percentage mark- up, and are generally marginally less than prices which would be charged for the same product to unaffiliated customers. Intersegment sales are excluded from net sales reported in the accompanying consolidated statements of income. Identifiable assets by segment are those assets that are used in the Company's operations within that segment. General corporate assets consist principally of cash and short-term investments. The Electronic Assemblies segment derived 68% of its 2004 net sales from five customers, 61% of its 2003 net sales from two customers and 73% of its 2002 net sales from three customers. The Data Communications segment derived 41% of its 2004 net sales from two customers, 16% of its net sales from one customer in 2003 and 40% of its net sales from two customers in 2002. The Audio Equipment segment derived 12% of its 2004 net sales from one customer. The Company's Musical Instruments segment is not dependent on any single customer. In October 2002, Legacy Audio, Inc. sold its manufacturing plant located in Springfield, Illinois for $285,000 (net of selling expenses) and recognized a gain on the sale of approximately $7,000. Legacy ceased operations at this facility effective August 31, 2002 and consolidated all of its production into the Company's manufacturing facility in Macungie, PA. 37 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 21 Industry Segment Information (Continued) Following is a summary of segmented information for 2004, 2003 and 2002. December 31, 2004 2003 2002 Net Sales to Unaffiliated Customers Musical Instruments $20,886,800 $20,381,904 $24,942,925 Data Communications 54,980,044 36,022,256 36,536,174 Electronic Assemblies 2,822,019 2,819,640 4,750,143 Audio Equipment 1,481,925 1,564,258 1,510,306 Total $80,170,788 $60,788,058 $67,739,548 Intersegment Sales Musical Instruments $ 905,340 $ 823,199 $ 435,915 Data Communications -- 84,418 -- Electronic Assemblies 951,919 344,553 131,540 Audio Equipment 31,411 88,205 88,909 Total $ 1,888,670 $ 1,340,375 $ 656,364 Income (Loss) from Operations Musical Instruments $ 613,203 $ (764,639) $ 2,024,144 Data Communications 6,436,161 2,446,213 2,091,520 Electronic Assemblies (124,425) (457,366) (401,165) Audio Equipment (1,195,715) (334,711) (634,477) Total $ 5,729,224 $ 889,497 $ 3,080,022 Identifiable Assets Musical Instruments $16,474,486 $16,762,054 $17,301,133 Data Communications 30,152,927 26,164,502 25,868,894 Electronic Assemblies 1,850,634 2,065,776 2,373,162 Audio Equipment 1,015,729 1,541,238 1,623,546 Sub-total 49,493,776 46,533,570 47,166,735 General corporate assets 28,978,959 25,416,706 26,196,133 Total $78,472,735 $71,950,276 $73,362,868 Capital Expenditures Musical Instruments $ 423,417 $ 155,195 $ 1,037,338 Data Communications 2,320,040 904,861 670,320 Electronic Assemblies -- -- 188,487 Audio Equipment -- 3,175 2,441 Total $ 2,743,457 $ 1,063,231 $ 1,898,586 Depreciation and Amortization Musical Instruments $ 712,558 $ 765,196 $ 759,689 Data Communications 1,640,861 1,596,862 1,864,921 Electronic Assemblies 104,184 120,679 126,321 Audio Equipment 23,278 35,875 50,581 Total $ 2,480,881 $ 2,518,612 $ 2,801,512 Income Tax Expense (Benefit) Musical Instruments $ 521,000 $ (20,000) $ 1,240,000 Data Communications 1,303,000 312,000 138,000 Electronic Assemblies (25,000) (204,000) (152,000) Audio Equipment (428,000) (163,000) (115,000) Total $ 1,371,000 $ (75,000) $ 1,111,000 38 ALLEN ORGAN COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 22 Quarterly Financial Data (Unaudited) First Second Third Fourth Quarter Quarter Quarter Quarter Total 2004 Net Sales $16,718,716 $19,747,048 $21,353,653 $22,351,371 $80,170,788 Gross Profit 7,879,016 9,857,983 10,553,944 10,226,528 38,517,471 Net Income 682,674 1,199,172 1,607,432 1,219,769 4,709,047 Earnings per Share Basic 0.59 1.04 1.39 1.05 4.07 Diluted 0.59 1.04 1.39 1.05 4.06 2003 Net Sales $13,874,464 $12,725,880 $14,932,091 $19,255,623 $60,788,058 Gross Profit 5,274,954 5,222,827 6,588,075 8,008,589 25,094,445 Net Income (Loss) (19,808) (149,898) 200,923 1,365,679 1,396,896 Earnings (Loss) per Share Basic (0.02) (0.13) 0.17 1.18 1.20 Diluted (0.02) (0.13) 0.17 1.18 1.20 2002 Net Sales $15,977,488 $17,403,733 $15,705,708 $18,652,619 $67,739,548 Gross Profit 6,628,428 7,158,583 5,755,644 6,233,054 25,775,709 Net Income 931,539 1,009,634 528,362 215,822 2,685,357 Earnings per Share Basic 0.80 0.86 0.45 0.18 2.29 Diluted 0.80 0.86 0.45 0.18 2.29 39 PART III Item 10. Directors and Executive Officers of the Registrant. (a) Identification of Directors Time Period Date Term Position Name Expires Age Position Held Steven Markowitz Next Annual 51 Director Since 1980 Meeting in 2005 Eugene Moroz (1) Next Annual 81 Director Since 1968 Meeting in 2005 Leonard W. Helfrich Next Annual 75 Director 1964-1968 and Meeting in 2005 1972 to present Orville G. Hawk (1) Next Annual 87 Director Since 1989 Meeting in 2005 Albert F. Schuster Next Annual 85 Director Since 1989 Meeting in 2005 Martha Markowitz Next Annual 83 Director Since 1991 Meeting in 2005 Jeffrey L. Schucker (1) Next Annual 50 Director Since 1996 Meeting in 2005 Ernest Choquette Next Annual 51 Director Since 1998 Meeting in 2005 Michael F. Doyle Next Annual 50 Director Since 2001 Meeting in 2005 (1) Audit Committee member. (b) Identification of Executive Officers. Date Term Time Period Name Expires Age Position Position Held Steven Markowitz Next Annual 51 President 1990 to present Meeting in 2005 Barry J. Holben Next Annual 52 Vice President-Sales October 1995 to Meeting in 2005 present Dwight A. Beacham Next Annual 58 Vice President- October 1995 to Meeting in 2005 Product Development present Nathan S. Eckhart Next Annual 41 Vice President- May 1996 to Meeting in 2005 Finance, Treasurer, present Secretary (c) Identification of Certain Significant Employees. Not applicable. (d) Family Relationships. Except for Martha Markowitz and Steven Markowitz, who are mother and son, there is no family relationship between any officers or directors of the Company. 40 (e) Business Experience. (1) Steven Markowitz, Barry Holben, Dwight Beacham and Nathan Eckhart, have been employees of the Company in executive capacities for at least the last five years. Mr. Moroz was employed by the Company for over 50 years, having last held the position of Vice President. He retired from active employment in May 1998 and continues to serve on the Board of Directors. Mr. Helfrich was employed by the Company for nearly 40 years as Vice President-Finance and Secretary before retiring in March 2000 and continues to serve on the Board of Directors. Mr. Hawk, who has been retired more than five (5) years, was formerly Chairman of the Board and President of First National Bank of Allentown. Mr. Schuster is a church director of music and prior to his retirement more than five (5) years ago was a supervisor at Bethlehem Steel Corporation. Mrs. Markowitz is the widow of Jerome Markowitz, the Company's founder, and she represents the family's interest in the Company. Mr. Schucker is a Vice President at National Penn Bank. Prior to joining the bank, he worked as an investment banker at various firms including Managing Director with Griffin Financial Group, President of Middle Market Capital Advisors, L.L.C. (MMCA) and Vice President of Meridian Capital Markets. Mr. Choquette has been a member of the law firm of Stevens & Lee, Reading PA, for over 20 years and currently serves as Co-Chairman of their Corporate Group. Stevens & Lee serves as general counsel to the Company. Mr. Doyle is President of the Company's subsidiary, Eastern Research, Inc. Prior to joining ERI in May of 1997, Mr. Doyle had 20 years experience in the data communications industry including positions at Infotron Systems, Inc., Dowty Communications, Inc., Teleos Communications, Inc. and Madge Networks, Inc. (f) Involvement in Certain Legal Proceedings by Directors or Officers. None. (g) Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of the Securities Exchange Act of 1934 requires that Company Directors, Executive Officers and greater-than-ten-percent Share Owners file with the Securities and Exchange Commission and the Company an initial statement of beneficial ownership and certain statements of changes in beneficial ownership of Common Stock of the Company. Based solely on its review of such forms received by the Company, Martha Markowitz and Steven Markowitz both individually and as trustees of the Jerome Markowitz Trust inadvertently failed to timely report the following share transactions in December 2004 due to a failure of the transfer agent to timely notify the filer of the date the shares were transferred. The Company is unaware of any other instances of noncompliance with such filings during the year ended December 31, 2004. Name Transaction Number and Class of Type Shares Martha Markowitz Purchase 1,047 Class B shares Steven A. Markowitz Sale 869 Class B Shares Jerome Markowitz Trust, Martha & Steven Markowitz Trustees Purchase 3,000 Class B Shares 41 (h) Audit Committee Financial Expert The Company's Board of Directors has determined that Jeffrey L. Schucker is a financial expert serving on the Company's audit committee and that he is independent within the meanings of the NASDAQ listing standards and the Exchange Act. (i) Code of Ethics. The Company has adopted a Code of Business Conduct and Ethics that applies to all employees including its principal executive and financial officers. A copy of the Code of Business Conduct and Ethics is incorporated by reference to Exhibit 14 of the 2003 Form 10-K. Item 11. Executive Compensation. Deleted paragraphs and/or columns are not applicable. (b) SUMMARY COMPENSATION TABLE: Long Term Compensation Annual Compensation Securities All Other Name and Salary Bonus Underlying Compensation Principal Position Year $ $ Options(#) $ Steven A. Markowitz, President 2004 155,027 - - 39,995 (1) (Chief Executive Officer) 2003 151,675 - - 38,886 2002 147,855 - - 20,969 Dwight A. Beacham, 2004 107,438 - - 27,994 (2) Vice President - 2003 104,850 - - 17,052 Product Development 2002 101,918 - 4,000 12,049 Barry J. Holben, 2004 107,642 - - 27,994 (2) Vice President-Sales 2003 106,628 - - 17,052 2002 104,008 - 4,000 12,049 Nathan S. Eckhart, 2004 112,313 - - 22,142 (2) Vice President-Finance, 2003 107,630 - - 13,533 (Treasurer and Secretary) 2002 102,823 - 4,000 9,527 (1)-Value of split dollar life insurance policy. See Note 6 to the accompanying Consolidated Financial Statements for additional information on this arrangement. (2)-Value of vested deferred compensation earned under supplemental executive retirement plans. See Note 14 to the accompanying Consolidated Financial Statements for additional information on these arrangements. (c) OPTION GRANTS IN LAST FISCAL YEAR: There were no stock options granted to or exercised by the above named executive officers of the Company during 2004 under the Allen Organ Company stock option plan. 42 (d) AGGREGATE OPTIONS EXERCISED IN LAST YEAR AND DECEMBER 31, 2004 OPTION VALUE: Number of Securities Value of Underlying Unexercised In-The Unexercised Options Money Options at Shares at December 31, 2004(#) December 31, 2004($) Name Acquired on Value exercise Realized (1) (1) (#) ($) Exercisable Unexercisable Exercisable Unexercisable Dwight A. Beacham 0 0 2,400 1,600 $72,000 $48,000 Barry J. Holben 0 0 2,400 1,600 $72,000 $48,000 Nathan S. Eckhart 0 0 2,400 1,600 $72,000 $48,000 (1) Based on market value of $69.00 per share for Allen Organ Company Class B common stock at December 31, 2004. (f) Defined Benefit or Actuarial Plan Disclosure. As discussed in Note 14 to the Company's consolidated financial statements included in Item 8, future benefit accruals under the Company's defined benefit pension plan were frozen as of December 31, 2003. Based on the 2004 actuarial report for the Plan the estimated annual retirement benefit under the Plan to each of the named executive officers are as follows: Steven A. Markowitz (age 51) - $33,890; Dwight A. Beacham (age 58) - $21,378; Barry J. Holben (age 52) - $15,742; Nathan S. Eckhart (age 41) - $13,870. (g) Compensation of Directors: Non-employee directors receive $450 for each Board and committee meeting attended plus reasonable expenses in connection with attendance. Employee directors receive no additional compensation for their services as a director. (h) Employment Contracts and Termination of Employment and Change in Control Arrangements: There are no employment contracts between the Company and any of the Company's executive officers. The Company has established an Executive Bonus Program in the form of executive supplemental retirement plans for the benefit of Mr. Beacham, Mr. Holben and Mr. Eckhart. These plans provide for discretionary Company contributions which vest over a five year period, accrue interest at the prime rate, not to exceed 9%, and are payable upon the executives death or retirement. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters (a) Voting securities of the registrant owned of record or beneficially by each person who owns of record, or is known by the registrant to own beneficially, more than five percent of any class of such securities. Class A Common Shares constitute the only securities with voting rights. Information as of February 29, 2005. Amount and Nature of Names and Title of Beneficial % of Addresses Class Ownership Class Jerome Markowitz A 81,531 97.22% Trust (2) (1) 821 N. 30th St. Allentown, PA (1) Sole voting and investment power (2) The shares are held by Trustees under an Inter Vivos Trust established by Mr. Markowitz, who died in February 1991, for the benefit of his family, principally his widow, Martha Markowitz. The Trustees are Steven Markowitz, President and a Director of the Company, and Martha Markowitz, a Director of the Company. 43 (b) Each class of equity securities of the registrant beneficially owned directly or indirectly by all directors naming them and directors and officers of the registrant, as a group, without naming them. Directors not named in the following table do not beneficially own any equity securities of the registrant. Information as of December 31, 2004. Percent Percent Nature of of of Class Class Beneficial Class Class Directors A B Ownership A B Steven Markowitz 58 (1) (3) .07 % 12,693 (1) (3) 1.18% 81,531* (2) (4) 97.22 % 245,016* (2) (4) 22.85% Eugene Moroz 6,290 (1) (3) as to 6,290 6,000 (2) (4) as to 6,000 1.15% Leonard W. Helfrich 258 (2) (4) .02% Orville G. Hawk 50 (2) (4) .005% Martha Markowitz 22,413 (1) (3) 2.09% 81,531* (2) (4) 97.22 % 245,016* (2) (4) 22.85% Percent Percent All Directors of of and Officers Class Class Class Class as a Group A B A B 12 81,589** 292,720** 97.29%** 27.30% (1) Sole voting power (2) Shared voting power (3) Sole investment power (4) Shared investment power * Shares owned by the Jerome Markowitz Trust for which Martha Markowitz and Steven Markowitz, Co- Trustees, have shared voting and investment power, and of which Martha Markowitz is the primary beneficiary and Steven Markowitz is one of the residuary beneficiaries. ** The shares held by the Jerome Markowitz Trust are not duplicated in the totals for the Class A and Class B Shares. (c) Changes in Control. Not applicable. 44 (d) Securities authorized for issuance under equity compensation plans: Plan category Number of Weighted-average Number of securities to be exercise price of securities issued upon outstanding remaining exercise of options, warrants available for outstanding and rights future issuance options, warrants under equity and rights compensation plans (excluding securities reflected in column (a)) (a) (b) (c) Equity compensation plans approved by security holders 16,500 $40.13 83,500 Equity compensation plans not approved by security holders -- -- -- Total 16,500 $40.13 83,500 Item 13. Certain Relationships and Related Transactions See Note 11 to the Consolidated Financial Statements concerning an agreement between the Company and Martha Markowitz, a Director of the Company. Ernest Choquette, a member of the Company's Board of Directors, is a principal in firms providing legal and financial advisory services. Legal fees paid were $265,447, $153,149 and $45,851 in 2004, 2003 and 2002, respectively. Financial advisory fees paid were $6,000 in both 2003 and 2002, none were paid in 2004. Item 14. Principal Accountant Fees and Services 2004 2003 (1) Audit Fees $185,000 $116,000 (2) Audit-Related Fees 14,100 13,500 (3) Tax Fees 92,200 116,200 (4) All Other Fees -- -- Total Fees $291,300 $245,700 (1) Audit Fees represent the fees to complete the annual audit and quarterly reviews. (2) Audit-Related Fees include assurance services provided for the Company's retirement plans in 2003 and other miscellaneous services in 2004. (3) Tax Fees include fees for compliance services, assistance with compliance documentation and various other tax issues that arise from time to time. (4) No other fees paid in 2004 and 2003. The audit committee of the Board of Directors pre-approves all audit and permissible non-audit services provided by the Company's independent registered public accounting firm. All of the services provided by the Company's independent registered public accounting firm set forth above were pre- approved by the audit committee. 45 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) (1) Financial Statements The following consolidated financial statements of Allen Organ Company and its subsidiaries are included in Part II, Item 8: Report of Independent Registered Public Accounting Firm. Consolidated Balance Sheets as of December 31, 2004 and 2003. Consolidated Statements of Income for the years ended December 31, 2004, 2003, and 2002. Consolidated Statements of Stockholders' Equity for the years ended December 31, 2004, 2003, and 2002. Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and 2002. Notes to Consolidated Financial Statements. The individual financial statements of the Registrant's subsidiaries have been omitted, as they are all included in the Consolidated Financial Statements referred to above. (a) (2) Financial Statement Schedules Schedule II. Valuation and Qualifying Accounts for the three years ended December 31, 2004. Schedules other than those listed above are omitted because they are either not required, are not applicable or the required information is presented in the Consolidated Financial Statements. (a) (3) Exhibits Exhibit No. Description 3.1(1) Articles of Incorporation, as amended 3.2(2) Bylaws, as amended 10.1(7) Allen Organ Company Stock Option Plan 10.2(3) Agreement of Amendment between the Company and Martha Markowitz 10.3(5) Executive Bonus Program and Endorsement Split Dollar Life Insurance Agreements between the Company and Dwight A. Beacham, Nathan S. Eckhart and Barry J. Holben 14(8) Code of Business Conduct and Ethics 21 Subsidiaries of the registrant 23.1 Consent of KPMG LLP 31.1 Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer 31.2 Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer 32 Section 1350 Certifications 99.1(6) Audit Committee Charter 1. Incorporated by reference to the exhibit filed with the Registrants Annual Report on Form 10-K for the year ended December 31, 1984. 2. Incorporated by reference to the exhibit filed with the Registrants Annual Report on Form 10-K for the period ended December 31, 1991. 3. Incorporated by reference to the exhibit filed with the Registrants Annual Report on Form 10-K for the year ended December 31, 1992. 4. Incorporated by reference to the exhibit filed with the Registrants Quarterly Report on Form 10-Q for the period ended September 30, 1999. 5. Incorporated by reference to the exhibit filed with the Registrants Annual Report on Form 10-K for the year ended December 31, 2000. 6. Incorporated by reference to the exhibit filed with the Registrants Quarterly Report on Form 10-Q for the period ended September 30, 2002. 7. Incorporated by reference to the exhibit filed with the Registrants Annual Report on Form 10-K for the year ended December 31, 2003. 46 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ALLEN ORGAN COMPANY Date: March 31, 2005 /s/STEVEN A. MARKOWITZ Steven A. Markowitz Chief Executive Officer, President and Director Date: March 31, 2005 /s/NATHAN S. ECKHART Nathan S. Eckhart Vice President-Finance, Chief Financial and Principal Accounting Officer Date: March 31, 2005 /s/LEONARD W. HELFRICH Leonard W. Helfrich Director Date: March 31, 2005 /s/MARTHA MARKOWITZ Martha Markowitz Director Date: March 31, 2005 /s/ERNEST CHOQUETTE Ernest Choquette Director Date: March 31, 2005 /s/MICHAEL F. DOYLE Michael F. Doyle Director 47 Allen Organ Company and Subsidiaries Schedule II - Valuation and Qualifying Accounts For the Years Ended December 31, 2004, 2003 and 2002 Balance Additions Charged Reductions, Balance at Charged to Write Offs at Description Beginning to Other And End Of Year Expense Accounts Recoveries Of Year Year Ended December 31, 2004 Allowance for Doubtful Accounts $ 605,496 $ (119,078) $ - $ (40,614) $ 445,804 Allowance for Obsolete and slow moving inventory 3,851,749 744,323 - (1,461,849) 3,134,223 Valuation Allowance Deferred Tax Asset 1,020,000 - - (100,000) 920,000 Year Ended December 31, 2003 Allowance for Doubtful Accounts $ 502,209 $ 174,614 $ - $ (71,328) $ 605,496 Allowance for Obsolete and slow moving inventory 3,497,436 890,391 - (536,078) 3,851,749 Valuation Allowance Deferred Tax Asset 1,170,000 - - (150,000) 1,020,000 Year Ended December 31, 2002 Allowance for Doubtful Accounts $ 350,492 $ 234,117 $ - $ (82,400) $ 502,209 Allowance for Obsolete and slow moving inventory 3,178,050 974,251 - (654,865) 3,497,436 Valuation Allowance Deferred Tax Asset 1,000,000 170,000 - - 1,170,000 48 EX-21 2 ex21.txt ALLEN ORGAN COMPANY Exhibit 21 - Subsidiaries of the Registrant Subsidiaries Name Trade Name (if different) State of Incorporation Allen Audio, Inc. Pennsylvania Allen Diversified, Inc Delaware Allen Organ International, Inc. Virgin Islands US VIR, Inc. VIR Linear Switch Pennsylvania Eastern Research, Inc. New Jersey Linear Switch Corporation New Jersey Legacy Audio, Inc. Illinois EX-23 3 ex23.txt Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors Allen Organ Company: We consent to the incorporation by reference in the registration statement (No. 333-116002) on Form S-8 of Allen Organ Company of our report dated February 24, 2005, with respect to the consolidated balance sheets of Allen Organ Company and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2004, which report appears in the December 31, 2004 annual report on Form 10-K of Allen Organ Company. /s/KPMG LLP Allentown, Pennsylvania March 30, 2005 EX-31 4 sm302cert.txt ALLEN ORGAN COMPANY AND SUBSIDIARIES Exhibit 31.1 Section 302 Certification I, Steven Markowitz, certify that: 1. I have reviewed this annual report on Form 10-K of Allen Organ Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b)Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c)Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/STEVEN MARKOWITZ Steven Markowitz Chief Executive Officer March 31, 2005 EX-31 5 nse302cert.txt ALLEN ORGAN COMPANY AND SUBSIDIARIES Exhibit 31.2 Section 302 Certification I, Nathan S. Eckhart, certify that: 1. I have reviewed this annual report on Form 10-K of Allen Organ Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b)Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c)Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/NATHAN S. ECKHART Nathan S. Eckhart Chief Financial Officer March 31, 2005 EX-32 6 smnsecom.txt ALLEN ORGAN COMPANY Exhibit 32 Section 1350 Certifications In connection with the Annual Report of Allen Organ Company (the "Company") on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we certify, pursuant to 18 U.S.C. 1350 as adopted pursuant to 906 of the Sarbanes- Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: March 31, 2005 /s/STEVEN MARKOWITZ /s/NATHAN S. ECKHART Steven Markowitz Nathan S. Eckhart Chief Executive Officer Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----