The consolidated operating results include those of Bull Run Corporation ("Bull Run") and Datasouth Computer Corporation ("Datasouth", and collectively, with Bull Run, the "Company"), after elimination of intercompany accounts and transactions.
Results of Operations - 1997 as compared to 1996
Total revenue for 1997, primarily from the printer manufacturing operations of Datasouth, was $22,320,000 compared to $24,654,000 in 1996. Revenue from Datasouth's printer operations of $21,639,000 in 1997 represented a 9% decrease from such revenue in 1996 of $23,810,000. Printer sales to the Company's largest customer were approximately $7,200,000 in 1997 and 1996. Sales to two significant distributors were approximately $980,000 lower in 1997 than in 1996, and a product line generating sales of $1,230,000 in 1996 was discontinued in 1997. Short term revenue trends in the Company's printer business fluctuate due to variable ordering patterns of large customers. Gross profit from printer operations of 26.2% for 1997 decreased from the 27.9% realized in 1996, primarily due to a different mix of products sold, initial production costs associated with the introduction of a new printer line, and greater manufacturing overhead efficiencies gained in 1996 as a result of higher unit volumes.
The Company provides consulting services to Gray Communications Systems, Inc. ("Gray") in connection with Gray's acquisitions and acquisition financing. Income on a portion of such fees is deferred and recognized over forty years as a result of the Company's equity investment position in Gray. Consulting fee income of $681,000 was recognized in 1997 compared to $844,000 in 1996. There can be no assurance that the Company will recognize any consulting fees in the future, other than the recognition of currently deferred fees.
The Company's consolidated operating expenses of $6,852,000 in 1997 represented a $597,000, or 9.5%, increase from 1996, due to the cost of research and development efforts incurred for the design of a new printer introduced in the fourth quarter of 1997 and certain general and administrative expenses. Operating expenses include non-cash goodwill amortization associated with the acquisition of Datasouth of $301,000 in 1997 and $292,000 in 1996.
Equity in earnings (losses) of affiliated companies, totaling ($599,000) in 1997 and $1,731,000 in 1996, includes the Company's proportionate share of the earnings of Gray, Host Communications, Inc. ("HCI") and Capital Sports Properties, Inc. ("CSP"), net of goodwill amortization totaling $610,000 and $487,000, respectively. Approximately $975,000 of the decrease from 1996 to 1997 in equity in earnings of affiliated companies can be attributed to Gray's gain on the sale of a television station and HCI's gain on the sale of assets to Universal Sports America, Inc. ("USA") in 1996. Additional decreases in Gray's earnings for 1997 compared to 1996 are attributable to increased interest expense and amortization of goodwill associated with Gray's acquisitions.
Interest and dividend income in 1997 of $1,102,000 was primarily derived from dividends accrued on the Company's investment in Gray's series A and series B preferred stock. Interest expense, totaling $2,716,000 in 1997, was incurred primarily in connection with bank term loans, the proceeds of which were used to finance the Company's investments in Gray, HCI, CSP, USA and Rawlings Sporting Goods Company, Inc. ("Rawlings").
As of December 31, 1997, the Company has an Alternative Minimum Tax ("AMT") credit carryforward of approximately $500,000 to reduce regular Federal tax liabilities in the future. In part resulting from the carryback of the 1997 taxable loss to 1995, the Company has a business credit carryforward of approximately $125,000 to reduce regular Federal tax liabilities in the future. Nondeductible goodwill amortization reduced the Company's tax benefit in 1997 and increased the Company's tax expense in 1996, thereby reducing the Company's effective tax rate from 40.6% in 1996 to 34.5% in 1997.
Results of Operations - 1996 as compared to 1995
Total revenue for 1996, primarily from the printer manufacturing operations of Datasouth, was $24,654,000 compared to $27,153,000 in 1995. Revenue from Datasouth's printer operations of $23,810,000 in 1996 represented a 10% decrease from such revenue in 1995 of $26,432,000. Printer sales to the Company's largest customer were approximately $7,200,000 in 1996 compared to $7,800,000 in 1995. Sales to a large distributor were approximately $1,500,000 lower in 1996 than in 1995, as a result of a significant printer installation project by the distributor's customer maturing in 1995. Short term revenue trends in the Company's printer business fluctuate due to variable ordering patterns of these and other large customers. Gross profit from printer operations of 27.9% for 1996 decreased from the 29.4% realized in 1995, primarily due to a different mix of products sold and greater manufacturing overhead efficiencies gained in 1995 as a result of higher unit volumes.
The Company provides consulting services to Gray Communications Systems, Inc. ("Gray") in connection with Gray's acquisitions and acquisition financing. Consulting fee income of $844,000 was recognized in 1996 compared to $721,000 in 1995. Due to the reduction in the Company's equity investment from 27.1% to 15.2% of Gray's outstanding common shares (primarily as a result of Gray's public offering of stock in 1996 described below), $174,000 of previously deferred fees were recognized as consulting fee income in 1996. There can be no assurance that the Company will recognize any consulting fees in the future.
The Company's consolidated operating expenses of $6,255,000 in 1996 represented a $509,000, or 7.5%, decrease from 1995, due to reductions in certain project-specific research and development expenses and certain general and administrative expenses. Operating expenses include non-cash goodwill amortization associated with the acquisition of Datasouth of $292,000 in 1996 and $309,000 in 1995.
Equity in earnings of affiliated companies, totaling $1,731,000 in 1996 and $107,000 in 1995 included the Company's proportionate share of the earnings of Gray, Host Communications, Inc. ("HCI") and Capital Sports Properties, Inc. ("CSP"), net of goodwill amortization totaling $487,000 and $378,000, respectively. Approximately $975,000 of the increase from 1995 to 1996 in equity in earnings of affiliated companies can be attributed to Gray's gain on the sale of a television station, and HCI's gain on the sale of assets to Universal Sports America, Inc. ("USA").
In 1996, Gray consummated a public offering of 3.5 million shares of its newly-issued class B common stock at $20.50 per share, resulting in net proceeds of $67.1 million. As a result of this issuance, the Company's common equity ownership of Gray was reduced from 27.1% to 15.2%, resulting in a pretax gain for the Company of approximately $8.2 million (approximately $5.0 million after tax). This offering also reduced the Company's common equity voting power in Gray from 27.1% to 25.1%. There is no assurance that such sales of a material nature will occur in the future.
Interest and dividend income in 1996 of $874,000 was primarily derived from an 8% Subordinated Note due from Gray in the principal amount of $10 million (the "8% Note") and dividends accrued on the Company's investment in Gray's series A and series B preferred stock. Interest expense, totaling $2,124,000 in 1996 was incurred primarily in connection with bank term loans, the proceeds of which were used to finance the Company's investments in Gray, HCI, CSP and USA.
The Company recognizes its equity in earnings of HCI on a six month lag basis, in order to align HCI's fiscal year ending June 30 with the Company's fiscal year. Effective July 1, 1995 (the first day of HCI's 1996 fiscal year), HCI adopted a new accounting policy for the recognition of corporate sponsor license fee revenue and guaranteed rights fee expenses, since the nature of HCI's contracts was changing to include revenue-sharing or net profit split arrangements, rather than guaranteed rights fee payments. As a result, the rights fee expense associated with this type of contract could not be accurately measured until the expiration of each contract period when the revenue-sharing or net profit split amount was determined. Under the new policy, license fee revenue and rights fee expense are recognized on a straight-line basis over the life of the contract, instead of recognizing revenue and expense in their entirety on the effective date of the contract, thereby providing for the uniform matching of revenue and expenses. As a result of such adoption, HCI recognized a $4,559,000 charge against its earnings, representing the after-tax cumulative effect of the accounting change. The Company reported 9.1% of such charge, or $415,000, less a $141,000 deferred tax benefit, as a charge against its 1996 earnings.
In 1996, Gray retired certain debt with the proceeds from its public offerings of class B common stock and notes, and the sale of its series B preferred stock. As a result, Gray incurred an after-tax extraordinary loss of $3,159,000 related to costs associated with the retired debt. The Company therefore recognized 15.2% of Gray's charge, or $480,000, less a $185,000 deferred tax benefit, as an extraordinary loss.
As of December 31, 1996, the Company had an Alternative Minimum Tax ("AMT") credit carryforward of $341,000 to reduce future regular Federal tax liabilities. As a result of recognizing approximately $79,000 and $58,000 in AMT credits in 1996 and 1995, respectively, and a change in judgment regarding the realizability of the remaining AMT credit carryforward, the valuation allowance on deferred tax assets was reduced in the fourth quarter of 1996, thereby reducing the 1996 income tax provision and goodwill by approximately $47,000 and $131,000, respectively.
Liquidity and Capital Resources
The Company amended all of its long-term debt agreements with two banks subsequent to December 31, 1997. Under an agreement amended February 20, 1998, the Company entered into a $5,000,000 term note, payable to a bank in quarterly installments of $250,000 through December 2002, bearing interest at the London Interbank Offered Rate ("LIBOR") plus 2.75%, and, a revolving bank credit facility for borrowings of up to $5,000,000 expiring February 2001, bearing interest principally at LIBOR plus 2.75%, with a mandatory reduction in February 1999 to $4,000,000 in available borrowings. The $5,000,000 revolving credit facility replaced a previous $5,500,000 facility under which $5,472,000 was outstanding as of December 31, 1997. Under an agreement amended March 20, 1998, the Company has outstanding two term notes for bank borrowings of up to $42,900,000, requiring no principal payments prior to maturity on January 1, 2003, bearing interest at LIBOR plus 1.75%, and, a revolving bank credit facility for borrowings of up to $3,500,000 expiring May 1, 1999, bearing interest at the bank's prime rate, under which $3,183,000 was outstanding as of December 31, 1997. The Company also has a demand bank note for borrowings of up to $2.0 million under which $1,500,000 was outstanding as of December 31, 1997, bearing interest at the bank's prime rate.
In January 1998, the Company executed two interest rate swap agreements, which effectively modify the interest characterics of $24,750,000 of the Company's outstanding long-term debt. The agreements involve the exchange of amounts based on a fixed interest rate for amounts based on variable interest rates over the life of the agreements, without an exchange of the notional amount upon which the payments are based. The differential to be paid or received as interest rates change will be accrued and recognized as an adjustment of interest expense related to the debt. The Company effectively converted $20,000,000 and $4,750,000 of floating rate debt to a fixed rate basis under two separate agreements. Under the first agreement, $20,000,000 of long-term debt is subject to a one-year forward swap arrangement, whereby beginning January 1, 1999 and for the following nine years, the Company will be subject to a fixed rate of 7.83%, instead of LIBOR plus 1.75%, the rate in effect until then. Under the second agreement, $4,750,000 of long-term debt will be subject to a fixed rate of no more than 8.9% beginning March 31, 1998, instead of LIBOR plus 2.75%, the rate in effect until then. The notional amount on the $4,750,000 interest rate swap agreement amortizes $250,000 per quarter through December 31, 2002.
Dividends on the series B preferred stock of Gray owned by the Company are payable in cash at an annual rate of $600 per share or, at Gray's option, payable in additional shares of series B preferred stock. The Company anticipates that dividends on the series B preferred stock will continue to be paid in additional shares of series B preferred stock for the foreseeable future.
The Company has an active stock repurchase program authorized by its Board of Directors for the repurchase of up to 2,000,000 shares of its common stock. Repurchases may be made from time to time in the open market or directly from shareholders at prevailing market prices, and may be discontinued at any time. During 1997, the Company repurchased 706,010 shares at a total cost of $1,751,000. Since the program's inception in November 1994, 1,286,510 shares have been repurchased at an average cost of $2.48 per share.
Inventories as of December 31, 1997 increased to $3,757,000 from $3,315,000 as of December 31, 1996, due to an increase in raw materials on hand associated with the initial production of a new printer beginning in December 1997. As of December 31, 1997, the Company had open purchase commitments totaling approximately $8,000,000 primarily for raw materials inventories. The Company's total working capital of $2,513,000 as of December 31, 1997 decreased from $3,990,000 as of December 31, 1996, as a result of borrowings under the bank demand notes and a $1,000,000 increase in the current portion of long-term debt, net of the increase in inventories.
Effective January 2, 1998, the Company acquired all of the outstanding common stock of CodeWriter Industries, Inc. ("CodeWriter") and all of the outstanding membership interests of CodeWriter's affiliate, CW Technologies, LLC ("CWT"), in a transaction valued at approximately $6,200,000, of which $5,000,000 million was paid at closing in the form of $2,500,000 in cash and $2,500,000 in the Company's common stock. In addition, the Company is obligated to pay quarterly to the members of CWT, a specified percentage of revenue generated by the Company from CodeWriter and CWT products and services during each calendar quarter through December 31, 2001, but in no event will the aggregate amount of such payments exceed $1,200,000. The cash acquisition price was financed under the $5,000,000 term note previously described.
In 1997, the Company entered into an Investment Purchase Agreement with Rawlings. Pursuant to this agreement, the Company acquired warrants to purchase 925,804 shares of Rawlings' common stock, and has the right, under certain circumstances, to purchase additional warrants. The Company's total cost to purchase the warrants pursuant to this agreement (excluding the additional warrants) was $2,842,000. Fifty percent of the purchase price, or $1,421,000, was paid to Rawlings in 1997. The remaining fifty percent of the purchase price, plus interest at 7% per annum from November 21, 1997 until the date of payment, will be due on the earlier of the date of exercise and the date of expiration of the warrants. In the event of a partial exercise of the warrants, a pro rata portion of the purchase price with interest accrued thereon will be payable. The warrants have a four year term and an exercise price of $12.00 per share, but are exercisable only if Rawlings' common stock closes at or above $16.50 for twenty consecutive trading days during the four year term. In addition, under the terms of the agreement, the Company purchased 10.4% of the outstanding shares of Rawlings' common stock in the open market from November 1997 through January 1998 (of which, 5.0% was acquired as of December 31, 1997 at a cost of $4,382,000). Investments in Rawlings were financed with borrowings under the $42,900,000 term loans previously described.
Capital spending for 1998, excluding assets acquired from CodeWriter and CWT, is expected to be approximately $600,000. The Company anticipates that its current working capital, funds available under its revolving credit facilities, quarterly cash dividends on the Gray series A preferred stock and Gray class A common stock, and cash flow from operations will be sufficient to fund its debt service, working capital requirements and capital spending requirements for at least the next twelve months. Any capital required for potential additional business acquisitions would have to be funded by issuing additional securities or by entering into other financial arrangements.
Impact of Year 2000
Some of the Company's older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs have time-sensitive software that recognize a date using "00" as the year 1900 rather than the year 2000. This could cause a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
The Company has completed an assessment and will have to modify or replace portions of its software so that its computer systems will function properly with respect to dates in the year 2000 and thereafter. The total Year 2000 project cost is estimated to be less than $200,000, including the cost of upgraded computer hardware and software. Most of this cost will be realized over the estimated useful lives of the new hardware and software. To date, the Company has not incurred significant expenses associated with the Year 2000 issue.
The project is estimated to be completed not later than December 31, 1998, which is prior to any anticipated impact on its operating systems. The Company believes that with modifications to existing software and conversions to new software, the Year 2000 issue will not pose significant operational problems for its computer systems. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 issue could have a material impact on the operations of the Company.
The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties.