ITEM 1. BUSINESS
GENERAL
Pico Products, Inc. was formed as a corporation in the State of New York on July 31, 1962. Pico and its subsidiaries (the "Company") design, manufacture and distribute products and systems for the pay TV and cable TV industry (CATV), broadband communications and other signal distribution markets. These other distribution markets include "private" cable TV systems such as those found in hotels, schools, hospitals and large apartment complexes. Private cable systems are referred to in the industry as master antenna (MATV) or satellite master antenna (SMATV) systems. These systems receive satellite and "off-air," or broadcast, signals at a single source known as the "headend". The signals are processed and then distributed by coaxial or fiber optic cable to the consumer. Also included in other signal distribution markets are wireless cable or MMDS (multichannel multipoint distribution systems) and business to business or direct-to-home (DTH) communications by satellite. The Company also sells pay TV security products and home satellite market products. Finally, the Company is pursuing development and introduction of broadband communications products that will support high speed internet transmissions with product development in process on cable modem related products and on diplexers used in both fiber-to- the-curb applications and network interface devices. A table listing the Company's subsidiaries is included at the end of Item 1.
BROADBAND COMMUNICATIONS INDUSTRY BACKGROUND
CABLE AND SATELLITE TECHNOLOGY
There are currently five primary methods for the transmission, reception and distribution of TV signals. These include direct "off-air" transmission, cable TV, satellite master antenna TV or SMATV, MMDS or wireless TV, and DBS or direct broadcast satellite transmission. A brief description of each method is shown in the discussion which follows.
The evolution of cable TV and SMATV has been made possible by the development of satellite communications. With a satellite, TV signals are transmitted up to a satellite located in geosynchronous orbit 22,400 miles above the equator. From the satellite, signals are retransmitted to a wide geographic reception area known as a signal "footprint". Many of these signals, and all of the premium programs such as HBO or CNN, are now encoded or scrambled. A special decoding device or descrambler is required to receive these signals. In a cable TV system, the satellite signals are received, processed and amplified
by a cable "headend" located at the cable satellite reception site, before being sent along copper coaxial cable or fiber optic cable through a distribution system to individual subscribers. A small cable system may have several hundred subscribers with several miles of cable, while a large system may have hundreds of thousands of subscribers and thousands of miles of cable.
A SMATV system is essentially a small cable system which has been configured for a single building or building complex such as an apartment building, hotel, hospital or school. Because it is designed to serve a single building complex and fewer subscribers, a SMATV system is significantly less expensive than a cable system. A SMATV system consists of headend and a distribution system to carry the TV signal through the building.
A home satellite system, known as direct-to-home or DTH, consists of a dedicated dish antenna and a satellite receiver installed at every subscriber's house. In the past, DTH received a signal directly from a satellite normally using a large 12 foot dish antenna mounted near the house. However, a new version of DTH was introduced by Hughes in 1994, called DirecTV, which involves a dedicated Hughes Electronics satellite and direct microwave retransmission from the satellite to a small, 18-inch dish at the home. A number of other DTH competitors, including Primestar and Echostar, are now transmitting DTH signals and this market is expected to become very competitive.
MMDS systems, known as a wireless cable, use a headend to receive and process both satellite and local off-air signals. The signals are then modulated and retransmitted at microwave frequencies to a microwave antenna and down converter at the subscriber's home. Wireless cable can also be used to transmit television signals to high-rise apartment buildings where the signals can then be received, processed through an SMATV headend and distributed through the building. The broadcast range of an MMDS system is strictly line-of-sight and reception depends on the terrain and the height of the microwave transmitting antenna.
While cable TV has dominated the U.S. market, SMATV and MMDS have been the primary signal distribution approach in South America, the Middle East and Asia. In cities such as Sao Paulo and Rio de Janeiro, Brazil, most people live in apartment buildings and operators have found that the economics of SMATV or MMDS work much better than cable TV for initial installations. However, a number of cable systems are now being built. In China, cable is being rapidly developed in all major cities. In smaller cities there are plans to develop 3,000 new cable systems. Singapore is developing a state-of-the-art fiberoptic network which would integrate telecommunications and CATV. In Thailand, SMATV and wireless systems are currently being developed in Bangkok.
THE CABLE INDUSTRY
Due to technological and regulatory changes, the traditional cable TV, or CATV, industry is undergoing a major transition. Competition in the form of DTH, MMDS, and SMATV have all enjoyed rapid growth partially at the expense of the CATV industry. DTH is currently growing at levels never envisioned by the CATV experts, and each new DTH customer represents the potential loss of a cable customer. Furthermore, as the regulatory barriers are removed and as digital compression technologies become more cost effective, the Regional Bell operating companies (RBOC's) are seeking opportunities to offer video, information services, and data services to consumers while they protect their local telephony business.
CATV companies, while facing new and strong competition, are making plans to offer telephone services. Additionally, due to the inherent large amount of bandwidth that CATV systems provide, expanding existing services and delivering large amounts of high speed data to the home can be offered by CATV companies.
Technological advances in the broadband communications industry now allow for the delivery of a tremendous amount of information to a consumer's home. In the traditional analog environment, one (1) TV channel requires 6 Mhz of bandwidth. Due to digital compression, it is now possible to transmit in excess of 6 TV channels in the same 6 Mhz bandwidth. Furthermore, when digital technology is used, data services (especially access to the Internet) can be transmitted via the CATV network at speeds of 6 to 10 megabits per second, far faster than the 56 kilobit speed of the RBOC's existing twisted pair wiring used for telephone service.
This combination of technological advances and the removal of regulatory barriers has created substantial opportunities to provide both CATV and RBOC companies products and services in support of delivering large amounts of digital data to the home. With more bandwidth available, more TV services can be offered. With increased bandwidth highly specialized programming can be targeted and offered to specific categories of customers. Additionally, telephony services can be provided by CATV operators and partnerships are being formed among cable companies, long-distance carriers, and RBOC's with alliances to offer telephony services where they have traditionally been prohibited. Finally, creating more bandwidth to the home for Internet connections will allow the Internet to sustain higher growth than it has enjoyed during the last two years.
TRENDS IN THE TELECOMMUNICATIONS INDUSTRY
The recent passage of sweeping legislation to deregulate the telecommunications industry is having a major impact on both the telecommunication and cable industries. The immediate result has been the creation of numerous new partnerships and alliances among companies in the telecommunications, cable TV, cable electronics, computer and programming industries. While the "convergence" of those industries is in an early stage of evolution, a number of major investment commitments have been made, such as the purchase of Continental Cablevision by a division of US West (a RBOC).
Deregulation has important implications for the cable TV industry. This in turn presents major potential new opportunities for the Company in the U.S. In addition, the rapid evolution of the "information highway" is transforming broadband communications in the U.S. The information highway is an open network which permits interactive access to data and information. The highway provides a vast capability to connect users through the Internet, using fiber optic and copper cable links. In the future, this interconnection will also incorporate new wireless and microwave links for both video and data communications. The major technological change that will result is the wide availability of broadband communications involving high-speed digital data transmissions. This will permit the transmission of very large amounts of data at very high speeds over all segments of the network and is making possible, not only video and data links between government agencies, schools, libraries, and research facilities, but also links between businesses and individuals.
It is becoming clear that new technology developments are concentrated on the development of an interactive link with the consumer's home. Within five to ten years, the television set and cable TV converter box will be replaced by smart telecommunications computer systems which will provide interactive access to movies, data, home shopping, video games, video telephone, and teleconferencing, as well as hundreds of channels of television programming. Prototype interactive systems are now operational in Florida and California. Additionally, links to personal computers in consumers' homes will allow direct transmission of high volumes of information to consumers.
The cost to provide connections and hardware to all U.S. households is estimated to be at least $3,000 per household. Assuming a total of 90 million U.S. households, the total cost to implement the new technology could approach $300 billion. The requirement for vast capital expenditures means that only the best capitalized companies, such as the RBOC's, or the largest cable companies can afford to make this investment. However, the pace of new investment in new technology will be determined by the willingness of consumers to pay for new information or interactive services.
PICO MACOM INC.
The Company's Pico Macom, Inc. (PMI) subsidiary, located in Lakeview Terrace, California, sells broadband systems and hardware components, cable TV accessories and passive radio frequency products primarily to the CATV, SMATV, MMDS and DTH industry and related markets. Broadband systems include active headend electronics, such as satellite receivers, signal processors, modulators and amplifiers. PMI's headend products are manufactured under contract on an exclusive basis by one principal subcontractor with facilities in Taiwan and China.
Passive products include splitters, connectors, switches and couplers for coaxial cable installation. Passive products are produced to Pico's specifications by a number of subcontract manufacturers in Taiwan. PMI maintains tight quality control supervision of these manufacturers through on- site inspections by Pico Macom Taiwan employees in the Far East.
Products for the U.S. market are shipped to PMI's warehouse in California. In some cases, there is additional assembly and tuning or testing of products before shipment. Pico Macom employs 100 people in Lakeview Terrace, California and Pico Macom Taiwan employs 6 people in Taiwan who maintain a quality assurance program for the Taiwan subcontractors.
The primary business focus for PMI has been on the development and positioning of its line of headend equipment and 1 GHz product lines. Engineering and production efforts have upgraded various products to ensure that they meet all U.S. regulatory requirements. In addition, the engineering staff has been increased significantly in the last 3 years. As the technical needs of the CATV, SMATV and MMDS industries have grown, PMI's product line has been improved through the use of surface mount technology and computer aided design. Engineering design and product development are done in the U.S. Independent testing and evaluation is completed prior to the introduction of new products. The engineering efforts have resulted in improved quality and features to the point where PMI has been able to introduce low-cost, high-performance products for use by CATV operators.
The second segment of Pico's domestic market is signal distribution systems which use passive components such as splitters, taps and connectors. Private cable TV operators purchase passive components which are used to wire multiple dwelling units. CATV operators purchase passive components through distributors who buy directly from PMI.
Pico Macom sells over 500 different products at prices ranging from under $1 for most passive components to over $20,000 for a complete multiple channel SMATV headend. Products are sold to over 800 distributors, dealers and OEM manufacturers located primarily in the United States. Sales are also made to customers in Canada, Mexico, Central and South America, Europe, the Middle East, and Asia. Sales are primarily made through telemarketing efforts conducted from the Company's Lakeview Terrace, California, facility with some direct sales to major distributors and OEM accounts. PMI currently uses industry trade shows and targeted advertising to market its products.
Sales by Pico Macom represented 76%, 83%, and 83% of the Company's consolidated sales for the fiscal years ended July 31, 1996, 1995 and 1994, respectively. For the fiscal year ended July 31, 1996 approximately 68% of Pico Macom's sales revenue was from sales to the television distribution equipment industry, primarily SMATV systems; the remaining 32% of Pico Macom's sales revenue was from sales to CATV systems distributors and OEM accounts.
PAY TV SECURITY (CATV) DIVISION
The Company's Pay TV Security (CATV) division designs, manufactures and sells Pay TV security products for the cable TV industry. These devices include both negative filters, as well as positive encoders and filters. In the industry, these are known as "traps". Single channel negative traps block out an entire channel of a pay service, such as HBO, so that it cannot be viewed by a non-subscriber. Single channel positive trapping systems use an encoder to "scramble" a video signal on a pay channel. Installation of a positive trap by the cable operator allows the subscriber to view the premium channel. Non- subscribers will only see a scrambled picture.
The CATV division has been making Pay TV security products since HBO introduced its premium service in 1975. Following a product quality problem in 1988, Pico developed and introduced its PT (Perfect Trap) line of products. This hermetically sealed product line has two distinct advantages over previous technologies. The first advantage is highly accurate temperature compensation which allows the device to operate over a temperature range of -40 degrees to +60 degrees Celsius in the harshest of environments. The second advantage is the sealing method used in the device which eliminates any water or water vapor migration into the trap.
The CATV division also markets a variety of tier traps that block out an entire tier or group of channels. Business has recently expanded as the result of new government regulations. These devices can be used to defeat signal theft by blocking access to groups of premium channels when theft of service is suspected.
The CATV division currently employs over 250 persons, primarily in manufacturing. In Lakeview Terrace there are 35 hourly manufacturing employees and approximately 215 employees in St. Kitts. A sales staff of seven persons is located in East Syracuse, New York. Engineering for the division is done at the Company's Lakeview Terrace facility.
Sales by the Company's CATV division represented 21%, 17% and 17% of the Company's consolidated sales for the fiscal years ended July 31, 1996, 1995 and 1994, respectively.
The primary market for CATV division products is the cable television or CATV industry in the U.S., although sales of traps to Taiwan and South America have increased significantly during the past two years. The major customers are the U.S. multiple system operators (MSO's) such as Adelphia, Comcast, Continental, Cox, Time Warner, and TCI. The top 25 MSO's constitute about 80% of the potential market. Sales are made primarily through direct sales to MSO's with telemarketing backup from a sales office in East Syracuse, New York. Product shipments are made from Pico Macom's distribution center in Lakeview Terrace, California.
Positive trapping systems are very cost-effective and are widely used in over half of the cable systems in the U.S. In the past two years, a major market has began to emerge in Asia where positive traps offer a low cost alternative to cable system set-top boxes.
The CATV industry estimates that the current market for traps in the United States is approximately 1 million units per month. Positive and negative traps typically sell for a unit price of around $3.50, while tier trap unit prices range from $5.00 to $9.95. Accessory products range from a few cents to a few dollars per item and encoders sell for between $250 and $300 depending on the channel configuration required. At an average selling price of $4.00 per unit, the annual market is approximately $50 million.
The international market for Pay TV security products is in its early growth as both cable TV and premium services are developing in the different countries. The Company's CATV division is shipping product to South America, the Middle East and Asia. The Company is continuing to develop relationships for the distribution of its products in these emerging markets.
FOREIGN OPERATIONS
In addition to Pico Macom Taiwan discussed above, the Company owns and operates a manufacturing facility on the island of St. Kitts (St. Christopher and Nevis) in the Caribbean. Pico (St. Kitts) Limited assembles the circuit boards for the positive, negative and tier traps
sold by the Pay TV Security division. During fiscal year 1994 the Company established two wholly owned subsidiaries, Pico (Bermuda) Limited and Pico Products Asia Limited (PPAL).
PPAL opened an office in Hong Kong in September 1995, to provide sales technical support for Hong Kong, China, Taiwan, the Philippines, and South Korea. The Hong Kong office also includes a warehouse and distribution center for products sourced from Taiwan.
The Company opened an office in Thailand in October 1995, and is establishing a Thai subsidiary, Pico Siam Company Limited. Pico Siam will concentrate on equipment distribution and technical assistance in the redesign and rewiring of existing cable and SMATV installations. Pico Siam is also prepared to set up distributors in Vietnam, Cambodia and Laos.
At July 31, 1996 the assets located outside the United States constituted less than 10% of the Company's total assets and the revenues and operating expenses attributable to the Company's foreign operations were also less than 10% of the Company's revenues and expenses.
SALES AND MARKETING
At July 31, 1996, 1995 and 1994, the Company had a sales and marketing staff of 25 persons, 25 persons, and 21 persons, respectively. Marketing and promotion of the Company's products are conducted via direct selling and telemarketing, and to a lesser extent by advertising in trade publications and participating in trade shows.
Pico Macom sells products to its markets nationally and internationally through over 800 customers that include cable operators, OEM manufacturers, cable equipment distributors, and cable installation contractors. The top fifteen customers generated approximately 58% of Pico Macom's sales in the year ended July 31, 1996.
Primarily, sales of the CATV division's Pay TV security products are made directly to cable system operators by the Company's sales group. Some sales are to national and regional distributors.
The Company's sales to American Technology Exporters, Inc. in Miami, Florida ("Amtech") were approximately 16%, 20% and 16% of consolidated sales for the years ended July 31, 1996, 1995, and 1994, respectively.
As is customary in the industries served, the Company's sales are normally made pursuant to individual purchase orders. Orders are subject to cancellation by the buyer under certain conditions without
penalty. The backlog of purchase orders as of July 31, 1996 and July 31, 1995 was approximately $4,608,000 and $2,600,000, respectively. These purchase orders were believed to be firm, and the Company expects to fill the July 31, 1996 backlog within its 1997 fiscal year.
The largest dollar volume sales are of the Company's active electronic equipment items used in head end installations for which unit prices range from approximately $100 to $500. However, a large volume of the Company's sales is of low cost components sold at unit prices under $5.00. Since 1982, a large portion of Pico Macom's passive products have been sold under the trademark, "Tru-Spec-Registered Trademark-".
MANUFACTURERS AND SUPPLIERS
Approximately 55% of the Company's sales are from products manufactured by subcontractors according to the Company's design and quality specifications. These subcontractors are located primarily in Taiwan, China, Malaysia and Thailand (the "Far East"). For more than ten years, the SMATV electronic components sold by Pico Macom have been manufactured under contract on an exclusive basis by one subcontractor in Taiwan. The Company is committed to procure a minimum of approximately $12,875,000 of products from this subcontractor through fiscal year 1998. Management believes that the Company's relationship with this subcontractor is excellent and that the financial strength of the subcontractor is strong. However, the loss of this subcontractor could have a material adverse impact on the Company's operations until the Company could obtain an alternative source of supply. The contract does not require the subcontractor to maintain a parts inventory, so that from time-to-time delays are possible in completing customer orders. The current contract expires in May 1998 and management anticipates renewing the contract prior to its expiration. Most of the other products obtained from foreign-based vendors are available from a number of different subcontractors.
Approximately 21% of the Company's sales are from products manufactured by the Company. These items consist primarily of passive traps. The trap manufacturing process involves raw materials procured from domestic and foreign- based sources which are assembled at the Company's manufacturing facility in St. Kitts. Final assembly and quality control is accomplished at the manufacturing facility in Lakeview Terrace, California. The raw materials used in the manufacturing processes are available from a number of different suppliers, both domestic and foreign-based, and management believes that no one vendor has the ability to significantly impact the Company's supply of raw materials.
The remaining 24% of products sold are primarily items purchased from domestic subcontractors for resale.
In August 1987, Pico Macom Taiwan was organized as a Taiwanese export trading company to facilitate procurement of products from vendors who are too small to export directly. Pico Macom Taiwan serves as a liaison between Pico Macom and all of its Far East vendors by monitoring quality control of the products and assisting in new product development.
PRODUCT DEVELOPMENT
Product development costs are expensed as incurred. Expenses allocated to product development for the years ended July 31, 1996, 1995 and 1994 totaled approximately $1,368,000, $979,000, and $545,000, respectively.
COMPETITION AND PATENTS
Equipment reliability, diversity of product lines, delivery requirements, price, customer service and technological competence are the major basis of competition in the broadband communications equipment industries. The broadband communications equipment industries are characterized by intense competition and technological changes. Many companies which provide equipment and services to these industries are substantially larger in size and in resources than the Company.
Royalties received on a Company-owned patent were $0, $257,000, and $607,000 during fiscal 1996, 1995 and 1994, respectively. In February 1995, the Company's patent for positive trapping systems expired resulting in the reduction of royalties for fiscal year 1995. In fiscal year 1996 the Company received a U.S. patent that is used in the new LNDA broadband amplifiers. However, patent protection is not available for many of the Company's products. Management believes that its business is dependent upon marketing and product availability rather than patent protection.
WARRANTIES
The Company warrants its Pay TV Security division products against faulty materials and workmanship for up to five years. Pico Macom warrants its products against faulty material and workmanship for two years for its electronic equipment and one year for its other products. The Company's warranties are limited to repair or replacement of the defective product. During the three years ended July 31, 1996, direct costs associated with the warranties have been minimal.
EMPLOYEES
At July 31, 1996, the Company employed 395 persons of whom 35 were engaged in administration and accounting, 15 in engineering and quality
control, 25 in sales and marketing, and the remainder in production, purchasing and shipping. None of the Company's employees are represented by labor unions.
GOVERNMENTAL REGULATION
The Company's products are subject to Federal Communications Commission ("FCC") regulation. Certain of the Company's customers also are subject to regulation by the FCC and by state and local governmental authorities. The rules, regulations, policies and procedures of the FCC affecting the broadband communications industry are constantly under review. The likelihood of changes in such regulation and its effect on the business of the Company cannot be ascertained.
In October 1992, the U.S. Congress enacted legislation to reregulate certain aspects of the U.S. cable television industry. As part of this legislation, the FCC mandated two separate rollbacks in subscriber rates totalling as much as 17% of the prior rates. This rate reduction adversely impacted the Company's sales of pay TV security devices during fiscal year 1994 as the system operators reduced their capital expenditure budgets to reflect their lowered revenues. During fiscal year 1995, the Company experienced an increase in demand for pay TV security devices as the system operators began to again order products.
In early 1996, the U.S. Congress enacted sweeping legislation to deregulate the U.S. telecommunications industry. This legislation is having a major impact on both the telecommunication and cable industries. The immediate result has been the creation of numerous new partnerships and alliances among companies in the telecommunications, cable TV, cable electronics, computer and programming industries. While the "convergence" of those industries is in an early stage of evolution, a number of major investment commitments have been made, such as the purchase of Continental Cablevision by a division of US West (a RBOC). Deregulation has important implications for the cable TV industry. This in turn presents major potential new opportunities for Pico in the U.S.
The Company's products are used by broadband communications systems in foreign countries, especially in Latin America and Asia. Sales to Latin America are made directly by the Company or through U.S.-based distributors while sales to Asia are made through the Company's CATV division and through the Company's Hong Kong subsidiary, PPAL. Regulation of construction, technical character and operation of the broadband communications system is controlled by each country's government. The Company cannot predict the impact on its sales due to changes in regulation or legislation by foreign governments.
TABLE OF COMPANY'S SUBSIDIARIES
- -------------------------------------------------------------------------------- Name Jurisdiction of Year Active (A) Incorporation Incorporated Inactive (I) - --------------------------------------------------------------------------------
Pico Macom, Inc. Delaware 1983 A (1) - --------------------------------------------------------------------------------
Pico Macom Taiwan 1987 A (3) Taiwan Co. Ltd. - --------------------------------------------------------------------------------
Pico (St. Kitts) Ltd. St. Christopher 1983 A (2) and Nevis - --------------------------------------------------------------------------------
Pico (Bermuda) Bermuda 1994 A (1) Ltd. - --------------------------------------------------------------------------------
Pico Products Hong Kong 1994 A (4) Asia Ltd. - --------------------------------------------------------------------------------
Pico (St. St. Vincent and 1981 I (1) Vincent) Ltd. the Grenadines - --------------------------------------------------------------------------------
Pico Satellite, Inc. Delaware 1983 I (1) - --------------------------------------------------------------------------------
Pico Cargo, Inc. Delaware 1983 I (1) - --------------------------------------------------------------------------------
Pico Korea, Ltd. Korea 1985 I (3) - --------------------------------------------------------------------------------
Notes: (1) Subsidiary of Pico Products, Inc. (2) Subsidiary of Pico (St. Vincent) Ltd. (3) Subsidiary of Pico Macom, Inc. (4) Subsidiary of Pico (Bermuda) Limited. Ownership percentage in all cases exceeds 90%.
At July 31, 1996, no operational activities were performed by the following subsidiaries: Pico (St. Vincent) Ltd., Pico Satellite, Inc., Pico Cargo, Inc. and Pico Korea, Ltd.
ITEM 2.
ITEM 2. PROPERTIES
The Company presently owns or leases an aggregate of approximately 86,000 square feet of office, production and warehouse space.
Pico Macom leases 60,000 square feet of space in Lakeview Terrace, California which is used for corporate headquarters for Pico Products, Inc. and Pico Macom, Inc., final assembly of Pay TV Security division products and Pico Macom's administration, sales, engineering and distribution functions. The two- year facility lease expires in March 1998. The net annual rental for the current facility is approximately $360,000.
The Company leases approximately 1,700 square feet for its CATV division sales office in East Syracuse, New York. The lease expires in October, 1998. The net annual rental is approximately $20,000. The Company also leases approximately 1,700 square feet of office space for the office of its chairman and chief executive officer in West Conshohocken, Pennsylvania. The lease expires in October, 2000. The net annual rent is approximately $43,000.
Pico (St. Kitts) Limited, which manufactures components for the Company's CATV Security products, owns a 16,000 square foot building and the underlying ground lease located in Saint Christopher and Nevis, a country in the Caribbean. The net annual rental of the underlying ground lease is $570 through 2018.
Pico Products Asia Limited leases approximately 4,000 square feet for an office facility in Hong Kong at an annual rental of approximately $64,000. The lease expires in July, 1997 with an option to extend the lease term for one additional year.
Pico Macom Taiwan leases approximately 2,000 square feet for an office facility in Taipei, Taiwan at an annual rental of approximately $30,000. The lease expires in January 1997 and the Company anticipates renewing it at that time.
Management believes that the above described properties are sufficient for the Company's present needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
ARCOM LITIGATION
In November 1991, Arrow Communication Laboratories, Inc. (Arcom) of Syracuse, New York, initiated a lawsuit in the New York Supreme Court, which, as amended, alleged that Arcom had a paid-up license with respect to the Company's patent for positive trapping systems and that Arcom was entitled to unspecified damages based on overpayment of royalty amounts. Arcom also claimed that it was entitled to compensatory damages in excess of $250,000, plus punitive damages of $3,000,000, as a result of a Company press release announcing termination of the license agreement.
The Company initiated a patent infringement suit against Arcom in the United States District Court for the Northern District of New York, which sought treble damages for willful infringement plus attorneys fees. The Company requested that the Court grant a preliminary injunction to prevent Arcom from infringing its patent. At a Court hearing in February 1994, the parties agreed, and it was ordered by the Court, that Arcom would post as security amounts equal to the royalties due to the Company for the manufacture and sale of product covered by the license agreement from December 15, 1991, the date that the license would have terminated, until the expiration of the patent in February 1995. Through July 31, 1995 Arcom had made cash payments of $462,066 covering royalties through February 14, 1995. The Company did not include these amounts in income in any fiscal period but recorded a current liability for $462,066 at July 31, 1995. In addition, Arcom agreed to post an irrevocable letter of credit in an amount deemed sufficient to permit recovery of a significant portion of the Company's damages if it were to prevail on its willful infringement claim. In exchange, the Company withdrew its request for a preliminary injunction.
In May, 1996, the Company and Arcom agreed to settle the foregoing lawsuits, pursuant to which all suits were terminated and dismissed with prejudice. As part of this agreement, the Company and Arcom, respectively, granted each other full releases from liability, the Company released certain deposits and other collateral provided to the Company by Arcom during the litigation, and the Company reimbursed Arcom approximately $70,000 for certain fees and expenses.
EPA INFORMATION REQUEST
In March 1995, a subsidiary of the Company received a Joint Request for Information (the "Information Request") from the United States Environmental Protection Agency, Region II (the "EPA"), under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended ("CERCLA"), with respect to the release and/or
threatened release of hazardous substances, hazardous wastes, pollutants or contaminants into the environment at the Onondaga Lake Site, Syracuse, Onondaga County, New York. The Company has learned that the EPA added the Onondaga Lake Site to the Superfund National Priorities List on December 6, 1994, and has completed an onsite assessment of the degree of hazard. The EPA has indicated that the Company is only one of 26 companies located in the vicinity of Onondaga Lake or its tributaries that have received a similar Information Request.
The Information Request related to the activities of the Company's Printed Circuit Board Division, which conducted operations within the specified area, and was sold to a third party in 1992. Under the Agreement of Sale with the buyer, the Company retained liability for environmental obligations which occurred prior to the sale.
The Company has provided all information requested by the EPA. The Information Request does not designate the Company as a potentially responsible party, nor has the EPA indicated the basis upon which it would designate the Company as a potentially responsible party. The Company is therefore unable to state whether there is any material likelihood for liability on its part, and, if there were to be any such liability, the basis of any sharing of such liability with others.
OTHER
The Company is involved, from time to time, in certain other legal actions arising in the normal course of business. Management believes that the outcome of other litigation will not have a material adverse effect on the Company's consolidated financial statements.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common shares are traded on the American Stock Exchange under the symbol "PPI". The following table sets forth, for the fiscal periods indicated, closing prices for the common shares on the American Stock Exchange as reported by the American Stock Exchange, Inc.
High Low Fiscal Year Ended July 31, 1995: First Quarter.................... 3 11/16 2 7/16 Second Quarter................... 2 15/16 2 3/16 Third Quarter.................... 3 3/16 2 1/8 Fourth Quarter................... 2 9/16 1 15/16
Fiscal Year Ended July 31, 1996: First Quarter.................... 2 1/2 1 5/8 Second Quarter................... 2 1/16 1 1/2 Third Quarter.................... 3 7/16 1 5/8 Fourth Quarter................... 2 3/4 1 3/4
August 1, 1996 to September 20, 1996.. 2 1/4 1 13/16
As of September 20, 1996, there were approximately 2,300 holders of record of the Company's common shares.
The Company has never paid a cash dividend on its common shares. The Company's Board of Directors currently intends to retain any future earnings for use in the Company's business. Payment of cash dividends in the future will be dependent upon the Company's earnings, financial condition, capital requirements and other factors deemed relevant by the Company's Board of Directors.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following is selected consolidated financial data of the Company for the five fiscal years ended July 31, 1996. The selected consolidated financial data should be read in connection with the consolidated financial statements included as Item 8 of this Annual Report on Form 10-K.
(amounts in thousands, except per share data) FISCAL YEAR ENDED JULY 31, ------------------------------------------------ 1996 1995 1994 1993 1992 -------- -------- -------- -------- --------
1) STATEMENT OF OPERATIONS DATA:
Sales $36,051 $33,367 $29,886 $23,740 $19,520 Income (loss) from operations $ 534 $ 997 $ 799 $ (225) $ 9 Income (loss) from continuing operations $ (400) $ 526 $ 905 $ (277) $ 3
Discontinued operations $ - $ - $ - $ - $ 64
Net income (loss) $ (400) $ 526 $ 905 $ (277) $ 67
Income (loss) from continuing operations per common and common equivalent share - primary and fully diluted $ (0.11) $ 0.12 $ 0.21 $ (0.08) $ -
Net income (loss) per common and common equivalent share - primary and fully diluted $ (0.11) $ 0.12 $ 0.21 $ (0.08) $ 0.02
Weighted average common and equivalent shares outstanding - primary and fully diluted 3,798 4,240 4,295 3,577 3,829
2) BALANCE SHEET DATA:
Working capital $ 3,124 $ 3,497 $ 3,151 $ 2,180 $ 1,849
Total assets $17,945 $17,633 $13,853 $11,592 $10,161
Long-term debt $ 39 $ 279 $ 632 $ 732 $ 392
Shareholders' equity $ 4,456 $ 4,513 $ 3,961 $ 3,009 $ 3,285
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
SALES
Sales for the fiscal year ended July 31, 1996 were $36.1 million compared to $33.4 million for the prior year, an increase of 8%. This was the highest annual sales total in the Company's history. The Company's CATV division recorded a sales increase of $1.8 million, or 34%, compared to the prior year. This increase was primarily due to strong domestic and international demand for pay TV encoders and decoders. The Company's Hong Kong subsidiary recorded a sales increase of $1.2 million over the prior year, as fiscal year 1996 was its first full year of distributing product into China, Hong Kong and Southeast Asia. Sales for the Company's Pico Macom subsidiary were even with the prior year due to a slowdown in sales in the first half of fiscal year 1996. This sales slowdown was caused by the consolidation of several U.S. multiple cable TV system operators (MSO's) and a resulting slowing of demand in the first half of the year and a slow down of investment by the MSO's in South America in the first half of the year. However, demand for these products increased in the second half of fiscal year 1996. Management believes that the Company's overall sales growth will continue into fiscal year 1997.
Sales for the fiscal year ended July 31, 1995 were $33.4 million compared to $29.9 million for the prior year, an increase of 12%. The sales increase for Pico Macom was approximately 12% due primarily to continued increasing demand for Satellite Master Antenna (SMATV) equipment and products by U.S.-based distributors for resale into South America. The sales increase for the CATV division was approximately 9% due primarily to increased industry demand for Pay TV encoders and decoders in both domestic and international markets during the third and fourth quarters of fiscal year 1995. The growth in sales of Pico Macom, the CATV division and the Company's St. Kitts operation resulted in a blended sales growth rate of 12% in fiscal year 1995.
COST OF SALES
Cost of sales for the fiscal year ended July 31, 1996 increased by approximately $2.2 million, or 8.5%, compared to the previous year. Cost of sales as a percentage of sales was unchanged at 76% for fiscal year 1996, compared to the previous year. The dollar increase in cost of sales was primarily attributable to the increase in sales volume. Manufacturing cost improvements for the Company's CATV division security products and improved purchasing power of the U.S. dollar in
the Far East resulted in slight product costs reductions in fiscal year 1996. However, these reductions were offset by startup costs for several of the Company's new product lines. Management believes that the Company will benefit from the higher margins on these new products and programs in fiscal year 1997.
Cost of sales for the fiscal year ended July 31, 1995 increased by approximately $2,430,000, or 11%, compared to the previous year. Cost of sales as a percentage of sales remained even at 76%. The dollar increase in cost of sales was primarily attributable to the increase in sales volume. While the purchasing power of the U.S. dollar in the Far East fluctuated somewhat during fiscal year 1995 it did not materially affect the Company's profitability in fiscal year 1995.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses increased by approximately $995,000, or 14%, in fiscal year 1996 compared to the prior year. The primary reasons for the increase were continuing investment in upgrading and expanding the product line and expenditures related to development of new markets in Asia. The Company also expanded its regional office in Hong Kong. During fiscal year 1996 the Company established a sales office in Bangkok, Thailand to market its products into Thailand, Indonesia, and other markets in Southeast Asia. For fiscal year 1996 the Company's product development expenses and Asian market development expenses increased by approximately $389,000 and $654,000, respectively, when compared with the prior fiscal year. Management believes the Company will begin to achieve returns on these investments during fiscal year 1997. Management also anticipates that this current level of selling and administrative expenses will continue throughout fiscal year 1997.
Selling and administrative expenses increased by approximately $853,000, or 14%, in fiscal year 1995 compared to the prior year. The primary reasons for the increase were increased investment in product development and expenditures related to development of new markets in Asia, and the opening of a new Asia regional office in Hong Kong. While product development expenses and marketing expenses in Asia continued into the fourth quarter at a rate consistent with the first nine months of the fiscal year, the Company experienced a reduction in patent amortization, legal and management incentive expenses compared to the previous year.
PRODUCT DEVELOPMENT
Product development expenditures for fiscal years 1996, 1995, and 1994 were approximately $1,368,000, $979,000, and $545,000, respectively. These amounts are included in the selling and administrative expense totals mentioned previously. The product
development efforts during fiscal years 1995 and 1996 were concentrated on upgrading and expanding Pico Macom's product line to address CATV industry new products, new features and higher performance specifications. Additionally, new products were developed for the CATV Division that incorporates 1 GHz capability in specialized RF filter products for the cable industry. Also, broadband amplifiers that support 1 GHz with two-way capabilities were designed and brought into production. Agile headend products, including modulator and demodulator products, were brought into full manufacturing. Finally, microprocessor controlled modulators and demodulators were developed and placed into early deployment.
Management believes that in order to remain competitive in a constantly changing technological market place, the Company needs to maintain at least the current level of product development expenses.
OTHER INCOME
Other income decreased by approximately $260,000, or 92%, for fiscal year 1996 compared to the prior year. The decrease in other income was primarily due to the elimination of royalty income from license holders following the expiration of the Company's patent for positive encoding and decoding systems in February 1995.
Other income decreased by approximately $367,000, or 57%, for fiscal year 1995 compared to the prior year. The decrease was primarily related to decreased royalty income from license holders following the expiration of the Company's patent for positive encoding and decoding systems in February 1995.
INTEREST EXPENSE
Interest expense increased by approximately $243,000, or 34%, for fiscal year 1996 compared to the prior year. The increase in interest expense was primarily due to higher borrowing levels on the Company's bank line of credit to support the Company's working capital requirements.
Interest expense increased by approximately $170,000, or 31%, for fiscal year 1995 compared to the prior year. The increase was due primarily to higher borrowing levels on the Company's bank lines of credit to support the Company's working capital requirements, and due to several increases in the prime rate.
INCOME TAX PROVISION
No provision for U.S. Federal and state regular income taxes or foreign income taxes have been provided for fiscal year 1996, fiscal year 1995 or fiscal year 1994 due to the Company's U.S. Federal and
state net operating loss carryforward positions and tax holidays granted the Company's foreign subsidiaries. However, a provision for U.S. Federal and State alternative minimum tax was established for fiscal year 1995.
NET LOSS
The Company recorded a net loss of approximately $400,000 in fiscal year 1996. This loss reflects a continued investment in product development and Asian market development expenses which are key to the future growth of the Company. Profitability in future periods is contingent upon acceptance of the new products in the market place, increased sales in Asia and South America, and continued increases in capital spending by major U.S. cable TV system operators.
OTHER
In fiscal year 1994, the Company's main manufacturing, sales, distribution and administration facility suffered damage during the January 17, 1994 Northridge earthquake. The Company's office, engineering and manufacturing areas were damaged primarily from broken high-pressure sprinkler pipes when a portion of the leased facility's roof collapsed. No employees were injured, and the Company's inventory and equipment were relatively undamaged. Normal operations were suspended for one week while the offices, engineering and a part of the manufacturing operations were moved to a section of the warehouse and temporary telephone, power and computer cables were installed. Normal operations resumed on January 24, 1994. Repairs to the damaged portion of the facility were completed in late May of 1994 and the refurbished offices were reoccupied. Costs for repairs, replacements and extra expenses were covered by the Company's insurance policies, and the Company experienced no material adverse financial impact from the earthquake.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 1996, the Company had working capital of approximately $3,124,000 and a ratio of current assets to current liabilities of approximately 1.23 to 1, compared with working capital of approximately $3,497,000 and a ratio of current assets to current liabilities of approximately 1.27 to 1 as of July 31, 1995. During fiscal year 1996 the Company recorded negative cash flow from operating activities primarily as a result of the net loss from operations, increased inventory purchases to support the Company's forecasted sales levels, and reduction of other liabilities partially offset by a reduction in accounts receivable and increases in accounts payable and accrued expenses.
Sales for fiscal year 1996 were lower than planned, resulting in higher inventory levels at July 31, 1996. The increased investment in inventory has reduced the Company's borrowing availability on its revolving bank line of credit. During the year, the Company implemented programs to significantly reduce inventory levels through improved inventory management and improved sales from South America and the U.S. in the third and fourth quarters. In addition, stocks of parts and components for newly developed products were converted into finished goods for shipment to customers.
During the years ended July 31, 1996, 1995 and 1994, cash used for capital expenditures was approximately $229,000, $221,000 and $116,000, respectively. The Company financed approximately $250,000 for the acquisition of a new management information system during fiscal year 1994. Capital expenditures for fiscal year 1997 are expected to be under $500,000.
Pico Macom has an $11,000,000 revolving bank line of credit which is secured by substantially all of Pico Macom's assets, including all trade accounts receivable and inventories. The line provides for interest at the prime rate (8.25% at July 31, 1996) plus 1.25%. In December 1995, the bank increased the line of credit from $10,000,000 to $11,000,000, increased the borrowing limit against eligible inventories from $4,500,000 to $5,500,000 and extended the term of the line of credit from May 25, 1996 to December 31, 1996. The revolving line of credit is used to fund operating expenses, product purchases and letters of credit for import purchases. The line has a $1,500,000 sublimit for outstanding letters of credit. The amount available to borrow at any one time is based upon various percentages of eligible accounts receivable and eligible inventories as defined in the agreement. The credit facility is subject to certain financial tests and covenants.
At July 31, 1996, the Company was in technical violation of a financial covenant relating to Pico Macom's bank line of credit. This covenant restricts the maximum advances to affiliates by Pico Macom. Pico Macom's bank has issued a waiver of this violation effective July 31, 1996. All other covenants relating to this line of credit were met as of July 31, 1996.
Management is confident that the bank line of credit will be renewed. Although failure to obtain such financing would have a material adverse effect on the Company's working capital requirements, the Company believes that alternative asset-based financing would be available. At July 31, 1996, Pico Macom had approximately $8,228,000 in revolving loans and approximately $73,000 in letters of credit outstanding, and the unused portion of the borrowing base was approximately $347,000.
In February 1993, the Company completed private placement financings totaling $1,000,000. The financings consisted of three notes. The first note for $500,000 was paid in full in May 1994. The second and third notes totaling $500,000 provide for interest at 8% and were payable in two equal installments in February 1996 and in February 1997. In connection with the financings, the Company issued warrants for 425,000 shares of its common stock, exercisable through fiscal year 1998 at $1.00 per share.
In February 1996, the Company was notified by the holder of the two outstanding notes payable that they intended to exercise 250,000 warrants to purchase common stock of the Company as an offset against the first $250,000 installment payment due on the debt. This transaction was completed by the end of March 1996.
Management has determined that the Company's current credit arrangements, along with an inventory reduction program, will not provide sufficient cash to fund growth in the Company's sales and planned operations for fiscal year 1997 and beyond. Consequently, the Company has retained an investment banking firm to assist in obtaining subordinated debt financing for general working capital requirements and investment in new product development, market development and upgrade of facilities. The Company has entered into a non-binding letter of intent with a potential investor with respect to such a financing, which is subject to satisfactory completion of the investor's due diligence investigation and negotiation and execution of a definitive agreement. Although management believes that the Company will successfully complete a financing on acceptable terms, there can be no assurance that it will be able to do so. To the extent that the Company were unable to obtain such additional financing, it would be forced to restrict and/or postpone its growth plans.
Profitability of operations is subject to various uncertainties including general economic conditions and the actions of actual or potential competitors and customers. The Company's future depends on the growth of the cable TV market in the United States and internationally. In the United States, a number of factors could affect the future profitability of the Company, including changes in the regulatory climate for cable TV, changes in the competitive structure of the cable and telecommunications industries or changes in the technology base of the industry. Internationally, the Company's profitability depends on its ability to penetrate new markets in the face of competition from other United States and foreign companies.
OTHER
IMPACT OF TECHNOLOGICAL OBSOLESCENCE
The Company's products are subject to technological obsolescence as government regulations, competition or the nature of the broadband communications industry could require changes in the current product
lines. The rapid changes in all sectors of the communications industry and the entry of new technology could significantly impact the sale of the Company's products. While management is not aware of any specific products, regulations or requirements that would create significant obsolescence in the next fiscal year, technological obsolescence could materially affect the operating results of the Company in any fiscal period.
IMPACT OF INFLATION AND CHANGING PRICES
Although the Company cannot accurately determine the precise effect of inflation, the Company has experienced some increased costs of materials, supplies, salaries and benefits due to inflation. The Company attempts to pass on increased costs and expenses by increasing selling prices, when possible, and by developing more useful and economical products that can be sold at favorable profit margins.
FOREIGN OPERATIONS
Because a substantial portion of the Company's products are purchased from vendors in Taiwan, China, Malaysia and Thailand (the "Far East"), the Company is subject to price increases imposed by those vendors to compensate for currency fluctuations. During fiscal years 1994 through 1996 the U.S. dollar generally maintained its purchasing power against the currencies of the countries from which the Company purchases most of its products. If the U.S. dollar were to weaken, the Company would consider setting price increases for its products. Continued weakening of the U.S. dollar could cause the Company to lose its competitive costing edge to U.S.-based manufacturers which could adversely affect operating results. Restrictive foreign government regulations or political instability could also materially affect the operating results of the Company. As discussed above, foreign economic and financial uncertainties could also materially affect sales levels to foreign customers which could materially affect the operating results of the Company.
FORWARD LOOKING STATEMENTS
Statements which are not historical facts, including statements about our confidence, strategies and expectations, technologies and opportunities, industry and market segment growth, demand and acceptance of new and existing products, and return on investments in products and markets, are forward looking statements that involve risks and uncertainties, including without limitation, the effect of general economic and market conditions, industry market conditions caused by changes in the supply and demand for our products, the continuing strength of the markets we serve, competitor pricing, maintenance of our current momentum and other factors.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of Pico Products, Inc.:
We have audited the accompanying consolidated balance sheets of Pico Products, Inc. and its subsidiaries as of July 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended July 31, 1996. Our audits also included the financial statement schedule listed at Item 14a(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pico Products, Inc. and its subsidiaries at July 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, such 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.
DELOITTE & TOUCHE LLP Los Angeles, California
October 24, 1996
PICO PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
July 31, -------------------------- 1996 1995 ----------- ----------- ASSETS (Note C):
CURRENT ASSETS:
Cash and cash equivalents $ 159,669 $ 501,525 Accounts receivable (less allowance for doubtful accounts: July 31, 1996, $200,000; July 31, 1995, $290,000) 5,289,288 5,892,338 Inventories (Note B) 10,933,244 9,760,164 Prepaid expenses and other current assets 191,215 183,870 ----------- -----------
TOTAL CURRENT ASSETS 16,573,416 16,337,897 ----------- -----------
PROPERTY, PLANT AND EQUIPMENT (Note E):
Buildings 217,255 217,255 Leasehold improvements 345,136 259,277 Machinery and equipment 2,637,609 2,428,605 ----------- ----------- 3,200,000 2,905,137 Less accumulated depreciation and amortization 2,393,995 2,121,382 ----------- ----------- 806,005 783,755 ----------- -----------
OTHER ASSETS: Patents and licenses (less accumulated amortization: July 31, 1996, $62,180; July 31, 1995, $56,204) 159,030 165,006 Excess of cost over net assets of businesses acquired (less accumulated amortization; July 31, 1996, $366,930; July 31, 1995, $337,890) 210,505 239,545 Deposits and other noncurrent assets 195,582 107,147 ----------- ----------- 565,117 511,698 ----------- -----------
$17,944,538 $17,633,350 ----------- ----------- ----------- -----------
See notes to consolidated financial statements.
PICO PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED) July 31, -------------------------- 1996 1995 ----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable (Note C) $ 8,227,776 $ 7,778,655 Current portion of long-term debt (Note D) 311,086 362,239 Accounts payable 3,921,081 3,326,366 Accrued expenses: Legal and accounting 170,497 90,443 Payroll and payroll taxes 506,742 484,854 Other accrued expenses 312,193 336,450 Other current liabilities (Note M) - 462,066 ----------- -----------
TOTAL CURRENT LIABILITIES 13,449,375 12,841,073 ----------- -----------
LONG-TERM DEBT (Note D) 39,414 278,820 ----------- -----------
COMMITMENTS AND CONTINGENCIES - - (Notes E and M)
SHAREHOLDERS' EQUITY (Notes K and L): Preferred shares, $.01 par value; authorized 500,000 shares; no shares issued - - Common shares, $.01 par value; authorized 15,000,000 shares issued and outstanding 4,052,246 shares at July 31, 1996 and 3,637,046 shares at July 31, 1995 40,522 36,370 Additional paid-in capital 22,035,178 21,565,255 Stock subscriptions receivable (115,000) - Accumulated deficit (17,409,924) (17,010,269) Cumulative translation adjustment (95,027) (77,899) ----------- -----------
TOTAL SHAREHOLDERS' EQUITY 4,455,749 4,513,457 ----------- -----------
$17,944,538 $17,633,350 ----------- ----------- ----------- -----------
See notes to consolidated financial statements.
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended July 31, ----------------------------------------- 1996 1995 1994 ----------- ----------- -----------
SALES (Note I) $36,051,304 $33,367,249 $29,886,482
COSTS AND EXPENSES Cost of Sales 27,377,269 25,225,052 22,795,447 Selling and administrative expenses (Note H) 8,140,285 7,145,472 6,292,002 ----------- ----------- -----------
TOTAL COSTS AND EXPENSES 35,517,554 32,370,524 29,087,449 ----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS 533,750 996,725 799,033
OTHER INCOME (Note F) 22,060 281,897 649,314 INTEREST EXPENSE (955,465) (712,921) (543,332) ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (399,655) 565,701 905,015 INCOME TAX PROVISION (Note G) - 40,000 - ----------- ----------- -----------
NET INCOME (LOSS) $ (399,655) $ 525,701 $ 905,015 ----------- ----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE: Primary $ (0.11) $ 0.12 $ 0.21 ----------- ----------- ----------- ----------- ----------- -----------
Fully Diluted $ (0.11) $ 0.12 $ 0.21 ----------- ----------- ----------- ----------- ----------- -----------
WEIGHTED AVERAGE COMMON AND EQUIVALENT SHARES OUTSTANDING: Primary 3,797,972 4,240,241 4,294,784 ----------- ----------- ----------- ----------- ----------- -----------
Fully Diluted 3,797,972 4,240,241 4,294,784 ----------- ----------- ----------- ----------- ----------- -----------
See notes to consolidated financial statements.
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See notes to consolidated financial statements.
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended July 31, ---------------------------------------- 1996 1995 1994 ------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (399,655) $ 525,701 $ 905,015
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization 362,367 370,176 536,269 Provision for losses on accounts receivable 143,769 142,897 246,602 Provision for inventory obsolescence 174,900 91,200 184,515 Changes in operating assets and liabilities: Accounts receivable 459,281 (1,617,523) (409,784) Inventories (1,365,108) (2,657,205) (2,251,036) Prepaid expenses and other current assets (7,345) 197,372 (138,509) Other assets (115,074) (3,591) (54,922) Accounts payable 594,715 1,439,609 38,205 Accrued expenses 100,635 (168,786) 306,865 Other liabilities (462,066) 58,367 403,699 ------------ ------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (513,581) (1,621,783) (233,081) ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (228,749) (220,532) (115,664) ------------ ------------ ------------
Continued on next page.
See notes to consolidated financial statements.
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year Ended July 31, ---------------------------------------- 1996 1995 1994 ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under line of credit agreements $ 449,121 $1,991,373 $1,177,059 Principal payments on long-term debt (134,772) (92,142) (854,113) Change in restricted cash - - 209,993 Proceeds from exercise of stock options 86,125 3,000 48,000 ----------- ----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 400,474 1,902,231 580,939 ----------- ----------- -----------
NET INCREASE (DECREASE)IN CASH AND CASH EQUIVALENTS (341,856) 59,916 232,194
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 501,525 441,609 209,415 ----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 159,669 $ 501,525 $ 441,609 ----------- ----------- ----------- ----------- ----------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Year Ended July 31, ---------------------------------------- 1996 1995 1994 ------------ ------------ ------------
CASH PAID DURING THE YEAR FOR: Interest $ 953,955 $ 681,803 $ 529,605 ----------- ----------- ----------- ----------- ----------- -----------
Income taxes $ 28,950 $ 15,138 $ - ----------- ----------- ----------- ----------- ----------- -----------
Continued on next page.
See notes to consolidated financial statements.
PICO PRODUCTS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In fiscal year 1994 the Company financed its new management information system, totaling approximately $248,000.
In fiscal year 1996 the Company financed the purchase of office and test lab equipment totaling approximately $94,000.
In March 1996 the holder of $250,000 of the Company's notes payable exercised 250,000 warrants to purchase common stock of the Company at $1.00 per share. The proceeds from the exercise of the warrants offset the payment due on the debt.
In April 1996 an officer of the Company exercised options to acquire 125,000 shares of the Company's common stock in exchange for a stock subscription note receivable.
In June 1996 several officers and employees of the Company exercised options to acquire 50,000 shares of the Company's common stock in exchange for stock subscription notes receivable.
See notes to consolidated financial statements.
PICO PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Pico Products, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
DESCRIPTION OF BUSINESS
Pico Products, Inc. and its subsidiaries (the "Company") design, manufacture and distribute products and systems for the pay TV and cable TV industry (CATV), broadband communications and other signal distribution markets. These other distribution markets include "private" cable TV systems such as those found in hotels, schools, hospitals and large apartment complexes. Private cable systems are referred to in the industry as master antenna (MATV) or satellite master antenna (SMATV) systems. These systems receive satellite and "off-air" (or broadcast) signals at a single source known as the "headend". The signals are processed and then distributed by coaxial or fiber optic cable to the consumer. Also included in other signal distribution markets are wireless cable or MMDS (multichannel multipoint distribution systems) and business to business or direct-to-home (DTH) communications by satellite. The Company also sells pay TV security products and home satellite market products. Finally, the Company is pursuing development and introduction of broadband communications products that will support high speed internet transmissions.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash equivalents, accounts receivable, accounts payable, and debt instruments. The carrying values of all financial instruments, other than the revolving line of credit, are representative of their fair values due to their short maturities. The estimated fair value of the revolving bank line of credit approximates fair value because of its variable interest rate.
CONCENTRATION OF CREDIT RISK
Financial instruments which subject the Company to credit risk consist primarily of accounts receivable. Concentration of credit risk with respect to accounts receivable is generally diversified due to the
large number of entities comprising the Company's customer base and their geographic dispersion. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventory costs consist of material, direct labor and overhead.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation and amortization are provided for on the straight-line method over the estimated useful lives of the assets as follows:
Buildings 20 years Leasehold improvements Term of lease Machinery and equipment 3 to 10 years
During the fiscal year ended July 31, 1995, approximately $878,000 of cost and the related accumulated depreciation was removed from the accounting records for fully depreciated assets no longer in use.
Repairs and maintenance costs not extending the useful life of the assets are expensed in the year incurred. Betterments are capitalized.
PATENTS AND TRADEMARKS
Patents and trademarks are amortized on the straight-line method over the shorter of their estimated useful lives or the remaining lives
of the patents and trademarks which at July 31, 1996 represented 16 to 27 years.
EXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED
The excess of the Company's purchase price of subsidiaries over the fair market value of net assets acquired is being amortized on the straight-line method over twenty years. The Company reviews the carrying value of all intangible assets on a regular basis, and if the undiscounted future cash flows are believed insufficient to recover the remaining carrying value of an intangible asset, the carrying value is written down to its estimated fair value in the period the impairment is identified.
REVENUE RECOGNITION
Revenue from sale of products or services is recognized when goods are delivered or services performed. Reserves for estimated product returns are provided at the time of sale.
DEBT ISSUANCE COSTS
Debt issuance costs are included in other noncurrent assets and are amortized over the term of the related debt.
INCOME TAXES
Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss and tax credit carryforwards.
INCOME (LOSS) PER SHARE
Income (loss) per common and common equivalent share is based upon the weighted average number of common shares outstanding during each year, assuming exercise of dilutive outstanding stock options and warrants under the treasury stock method. For the year ended July 31, 1996, common stock equivalents and warrants were not included in the computations since their inclusion would be anti-dilutive.
CERTAIN RECLASSIFICATIONS
The Company has made certain reclassifications to the 1995 and 1994 consolidated financial statements to conform to the classifications used in the 1996 consolidated financial statements.
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of." This statement, which is effective for the Company's fiscal year ending July 31, 1997, requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review of recoverability, the Company estimates the future cash flows expected to result from the use of the asset and its eventual disposition. Management does not expect the adoption of this new accounting standard to have a material impact on the Company's financial statements.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS 123) which will be effective for the Company in its fiscal year ending July 31, 1997. SFAS 123 requires expanded disclosures of stock- based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB Opinion No. 25 to its stock-based compensation awards to employees and will disclose the required pro forma effect on net income and earnings per share. See Note L to these financial statements for disclosures regarding the Company's Stock Incentive Plans.
B. INVENTORIES
The composition of inventories was as follows:
July 31, ------------------------- 1996 1995 ----------- ----------
Raw materials $ 3,485,548 $3,350,435 Work in process 636,072 319,386 Finished goods 6,811,624 6,090,343 ----------- ----------
$10,933,244 $9,760,164 ----------- ---------- ----------- ----------
C. NOTES PAYABLE
At July 31, 1996, the Company's Pico Macom, Inc. subsidiary (Pico Macom) had a $11,000,000 revolving bank line of credit with HSBC Business Loans, a member of the Hongkong and Shanghai Banking Corporation Group, which provides for interest at the prime rate (8.25%
at July 31, 1996 and 8.75% at July 31, 1995) plus 1.25%. The bank line of credit is used to fund operating expenses, product purchases and letters of credit for import purchases. The line of credit is secured by substantially all of Pico Macom's assets, including all trade accounts receivable and inventories.
The line is structured as a $11,000,000 line of credit with a sublimit of $1,500,000 for outstanding letters of credit. The amount available is based on various percentages of eligible accounts receivable and inventories as defined in the agreement. At July 31, 1996, Pico Macom had $8,227,776 in revolving loans and $72,677 in letters of credit outstanding, and the unused portion of the borrowing base was $346,843.
The line of credit arrangement is subject to various terms and conditions, including but not limited to, tangible net worth, working capital and current ratio requirements; and contains certain restrictions on acquisitions, capital expenditures and payment of dividends or purchases of stock. The line of credit is subject to review and renewal on December 31, 1996.
At July 31, 1996, the Company was in technical violation of a financial covenant relating to Pico Macom's bank revolving line of credit. This covenant restricts the maximum advances to affiliates by Pico Macom. Pico Macom's bank has issued a waiver of this violation effective July 31, 1996. All other covenants relating to this line of credit were met as of July 31, 1996.
D. LONG-TERM DEBT
Long-term debt consisted of the following: July 31, -------------------------- 1996 1995 ----------- ----------
Notes payable to Bermuda-based and Jersey- based investment funds, payable in equal installments in fiscal 1996 and 1997, with interest at 8.0% $ 250,000 $ 500,000
Capital lease obligations (Note E) 93,737 130,151
Other loans payable 6,763 10,908 ----------- ---------- 350,500 641,059
Less current portion 311,086 362,239 ----------- ----------
$ 39,414 $ 278,820 ----------- ---------- ----------- ----------
In February 1993, the Company completed private placement financings totaling $1,000,000. The financings consisted of three notes. The first note for $500,000 was paid in full in May 1994. The second and third notes totaling $500,000 provide for interest at 8% and were payable in two equal installments in February 1996 and 1997. In connection with the financings, the Company issued warrants for 425,000 shares of its common stock, exercisable through fiscal year 1998 at $1.00 per share.
In February 1996, the Company was notified by the holder of the two outstanding notes payable that they intended to exercise 250,000 warrants to purchase common stock of the Company as an offset against the first $250,000 installment payment due on the debt. This transaction was completed in March 1996.
Long-term debt at July 31, 1996 is payable as follow:
Year ending July 31, 1997 $311,086 Year ending July 31, 1998 29,007 Year ending July 31, 1999 10,407 -------- $350,500 -------- --------
E. LEASE COMMITMENTS
The Company leases manufacturing, computer and office equipment under lease agreements, some of which have been capitalized. These capitalized lease obligations are payable in monthly and quarterly installments through fiscal year 1999 and have interest rates varying from 10% to 18%. The Company has included the cost of equipment under capital leases of $465,492 and $371,824 in property, plant and equipment at July 31, 1996 and 1995, respectively. Accumulated depreciation on such assets was $262,412 and $185,523 at July 31, 1996 and 1995, respectively.
The Company also leases certain of its manufacturing and office facilities and equipment under operating lease agreements. Minimum rental commitments at July 31, 1996 for these leases are as follows:
Capital Operating --------- ----------- Year ending July 31, 1997 $ 65,340 $ 564,328 Year ending July 31, 1998 28,161 318,033 Year ending July 31, 1999 9,632 52,821 Year ending July 31, 2000 - 44,463 Year ending July 31, 2001 - 13,135 Thereafter - 9,690 --------- ----------- 103,133 $1,002,470 Less imputed interest 9,396 ----------- --------- ----------- $ 93,737 --------- ---------
Renewal options exist on certain of the operating leases for additional periods at increased rental rates. Total rental expense for the years ended July 31, 1996, 1995 and 1994 was $650,175, $507,739, and $461,656, respectively. The Company is also required to pay real estate taxes and other occupancy costs of the facilities in addition to the above rentals.
F. OTHER INCOME
Other income consisted of the following:
Year Ended July 31, -------------------------------- 1996 1995 1994 -------- -------- --------
Royalty income $ - $256,657 $606,985 Interest income 22,060 25,240 15,771 Miscellaneous income - - 26,558 -------- -------- -------- $ 22,060 $281,897 $649,314 -------- -------- -------- -------- -------- --------
The Company's patent for positive trapping systems expired in fiscal year 1995. Licenses issued for use of this patented technology generated the Company's royalty income. At July 31, 1995, the Company had fully written off the patent's cost and the related accumulated amortization from its books and records.
G. INCOME TAXES
A reconciliation of the Company's income tax provision to that computed using the Federal statutory rate is as follows:
Year Ended July 31, ----------------------------------- 1996 1995 1994 --------- --------- ---------
Federal tax (benefit) based on statutory tax rate $(140,000) $ 198,000 $ 317,000 Nontaxable foreign (income) loss 317,000 139,000 (63,000) Other 1,000 31,000 20,000 Change in valuation allowance (178,000) (368,000) (274,000) Alternative minimum tax - 40,000 - --------- --------- ---------
$ - $ 40,000 $ - --------- --------- --------- --------- --------- ---------
At July 31, 1996, the Company had net operating loss carryforwards for federal income tax purposes of approximately $14,696,000 which expire in varying amounts from the year 2000 through the year 2008. Additionally, the Company had federal tax credit carryforwards of
approximately $469,000 which expire in varying amounts from the year 1997 through the year 2001.
Neither U.S. nor foreign taxes have been provided on the cumulative undistributed foreign earnings, $67,000 at July 31, 1996, due to exemptions from foreign taxes, which expire in 1997 and 1998, and the intention of the Company to permanently reinvest earnings in the operations of foreign subsidiaries.
The following represents the tax effects of significant items comprising the Company's deferred income taxes as of July 31, 1996 and 1995. The Company recognized a valuation allowance to offset the net deferred tax asset since the future benefit of these assets is not assured. The valuation allowance decreased $178,000 and $368,000 in the years ended July 31, 1996 and 1995, respectively, primarily due to the use of net operating losses to offset each year's taxable income.
July 31, -------------------------- 1996 1995 ------------ ------------
Deferred income tax assets: Differences between book and tax basis of property $ 92,000 $ 48,000 Reserves not currently deductible 385,000 493,000 Other 49,000 59,000 Operating loss carryforwards 5,730,000 5,773,000 Tax credit carryforwards 469,000 530,000 ------------ ------------
6,725,000 6,903,000 Valuation allowance (6,725,000) (6,903,000) ------------ ------------
Net deferred income taxes $ -0- $ -0- ------------ ------------ ------------ ------------
H. PRODUCT DEVELOPMENT COSTS
Product development costs are expensed as incurred and are included as part of selling and administrative expenses. Expenses related to product development for the years ended July 31, 1996, 1995 and 1994 amounted to approximately $1,368,000, $979,000, and $545,000, respectively.
I. SIGNIFICANT CUSTOMERS
In fiscal 1996, 1995 and 1994 the Company's sales to one customer were approximately 16%, 20%, and 16%, respectively, of the Company's consolidated sales.
J. RETIREMENT BENEFITS
During fiscal year 1994, the Company established a defined contribution pension plan (under Internal Revenue Code Section 401(k)) covering substantially all of its U.S. -based employees with more than one year of service. Company contributions are determined at 50% of each employee's voluntary contribution (up to 6% of compensation) to the plan. The Company's contribution expense totaled $77,856, $63,958 and $37,385 for the years ended July 31, 1996, 1995 and 1994, respectively.
K. OTHER STOCK OPTIONS
During fiscal year 1994, the Board of Directors issued nonqualified, nonplan options to two individuals. These options were issued in November 1993 and became exercisable in November 1994. A total of 30,000 options were issued at an average exercise price of $1.29 per share. The Company recognized compensation expense of $12,292 and $33,958 during fiscal year 1995 and fiscal year 1994, respectively, for the difference between the fair value of the stock options at the date of the grant and the exercise price of the options.
L. STOCK INCENTIVE PLANS
The Company has three stock incentive plans; the 1981 Non-Qualified Stock Option Plan (1981 Plan) amended in December, 1991 and in December 1995; the 1982 Incentive Stock Option Plan (1982 Plan) adopted in April 1982; and the 1992 Incentive Stock Plan (1992 Plan), adopted in January, 1993 and amended in July, 1994. The 1981 Plan reserved 450,000 common shares for issuance, the 1982 Plan reserved 150,000 shares for issuance, and the 1992 Plan reserves 175,000 common shares for issuance. Each plan is administered by the Board of Directors, or a special committee thereof, which has the authority to determine the persons, the shares and the related terms and provisions of the incentives which may be granted.
Under the 1981 Plan, the option exercise price could not be less than 80% of the fair market value of the shares at the date of grant. Under the 1982 Plan, the option exercise price could not be less than 100% (or 110% if the optionee owned 10% or more of the Company's outstanding voting securities) of the fair market value of the shares at the date of grant. Options under the 1981 Plan and the 1982 Plan could not be exercised more than five years and ten years, respectively, from the date of grant. The 1982 Plan provided limitations on the number of option shares which may be granted to officers and directors. In both plans, options became exercisable as specified in the option agreement, subject to the limitation that no option could be exercised within twelve months after the date it is granted. The 1982 Plan provided that no incentive stock options could
be granted after April 28, 1992, and the 1981 Plan provided that no non- qualified stock options could be granted after May 31, 1996.
Under the 1992 Plan, incentive stock options ("ISO"), nonqualified stock options ("NSO"), stock appreciation rights ("Rights") and stock awards ("Awards") may be granted to eligible persons. The Board of Directors, or a committee thereof, determines the option prices and vesting periods for all options granted; however, options may not be exercised less than one nor more than ten years from the date of grant. The option exercise prices for ISO's must be at 100% of the fair market value of the shares at the date of grant to comply with tax regulations. The 1992 Plan specified that each director who is not also an employee of the Company or any of its affiliates would be awarded an annual grant of 5,000 NSO's at an option price equal to 80% of the fair market value on the date of grant. During fiscal year 1994, the Board of Directors amended the plan by reducing the annual grant to directors to 2,000 NSO's with option prices and vesting provisions consistent with all other plan options. During fiscal year 1994, the Board of Directors also determined that NSO's would be granted at 100% of the fair market value of the shares at the date of grant.
Rights may be granted to holders of stock options outstanding under the 1981 Plan, the 1982 Plan, or the 1992 Plan, whereby the holder of such options, in exchange for the surrender of the options to the Company, will receive from the Company an amount equal to the excess of the fair market value of the related shares over the option price of the options surrendered. Awards may be granted to selected recipients, without payment therefore, as additional compensation for their services to the Company or its affiliates. Any awards will be subject to various terms and conditions as determined by the committee.
In June 1996, the Board of Directors of the Company rescinded the amendment to the 1981 Plan which provided for extending the expiration date from five years to ten years for options granted under the Plan. This amendment had been approved by the shareholders in December 1995. At the same time the Board, subject to shareholder approval in December 1996, established a 1996 Incentive Stock Option Plan covering 195,000 shares of common stock. The proposed 1996 Plan is identical in substance to 1992 Plan. At the same time 120,000 non-qualified option grants were approved by the compensation committee subject to approval of the 1996 Plan by the shareholders. Each option granted has an exercise price equal to the fair market value of the stock as of the grant date and vests ratably over a three-year period and is conditioned upon achievement of an $8.00 level in the price of the Company's common stock over a consecutive 20 trading-day period.
In April 1996 an officer of the Company exercised options to acquire 125,000 shares of the Company's common stock in exchange for a stock subscription note receivable. In June 1996 several officers and employees of the Company exercised options to acquire 50,000 shares of
the Company's common stock in exchange for stock subscription notes receivable.
A summary of changes in shares under option for the Company's three stock incentive plans is as follows: Year Ended July 31, ------------------------------- 1996 1995 1994 --------- --------- --------- NON QUALIFIED PLAN (1981): Outstanding at beginning of year 410,000 408,500 417,000 Options granted 10,500 6,500 31,500 Options expired (10,500) - (5,000) Options exercised (120,000) (5,000) (35,000) --------- --------- --------- Outstanding at end of year * 290,000 410,000 408,500 --------- --------- --------- --------- --------- ---------
Exercisable at end of year * 268,670 370,000 351,000 --------- --------- --------- --------- --------- ---------
Average exercise price of outstanding options $ 0.95 $ 0.83 $ 0.80 --------- --------- --------- --------- --------- ---------
Average exercise price of exercisable options $ 0.87 $ 0.75 $ 0.71 --------- --------- --------- --------- --------- ---------
INCENTIVE PLAN (1982): Outstanding at beginning of year 45,200 45,200 60,000 Options exercised (45,200) - (14,800) --------- --------- --------- Outstanding at end of year - 45,200 45,200 --------- --------- --------- --------- --------- ---------
Exercisable at end of year - 45,200 45,200 --------- --------- --------- --------- --------- ---------
Average exercise price of outstanding options $ - $ 0.31 $ 0.31 --------- --------- --------- --------- --------- ---------
Average exercise price of exercisable options $ - $ 0.31 $ 0.31 --------- --------- --------- --------- --------- ---------
STOCK PLAN (1992) (Nonqualified options) Outstanding at beginning of year 114,000 45,000 15,000 Options granted 23,500 69,000 35,000 Options expired (2,500) - - Options exercised - - (5,000) --------- --------- --------- Outstanding at end of year 135,000 114,000 45,000 --------- --------- --------- --------- --------- ---------
Exercisable at end of year 58,832 28,000 10,000 --------- --------- --------- --------- --------- ---------
Average exercise price of outstanding options $ 2.19 $ 2.29 $ 1.16 --------- --------- --------- --------- --------- ---------
Average exercise price of exercisable options $ 1.85 $ 1.13 $ 1.00 --------- --------- --------- --------- --------- ---------
* Includes options to acquire 175,000 shares of the Company's common stock which were exercised in exchange for stock subscription notes receivable during fiscal year 1996.
M. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
The majority of the SMATV electronic components sold by Pico Macom are manufactured under contract on an exclusive basis by one subcontractor in Taiwan. The Company is committed to procure a minimum of approximately $12,875,000 of products from this subcontractor through fiscal year 1998. Management believes that the Company's relationship with this subcontractor is excellent and that the financial strength of the subcontractor is strong. However, the loss of this subcontractor could have a material adverse impact on the Company's operations until the Company could obtain an alternative source of supply. The contract does not require the subcontractor to maintain a parts inventory, so that from time-to-time delays are possible in completing customer orders. The current contract expires in May 1998 and management anticipates renewing the contract prior to its expiration. Most of the other products obtained from foreign-based vendors are available from a number of different subcontractors.
ARCOM LITIGATION
In November 1991, Arrow Communication Laboratories, Inc. (Arcom) of Syracuse, New York initiated a lawsuit in the New York Supreme Court, which, as amended, alleged that Arcom had a paid-up license with respect to the Company's patent for positive trapping systems and that Arcom was entitled to unspecified damages based on overpayment of royalty amounts. Arcom also claimed that it was entitled to compensatory damages in excess of $250,000, plus punitive damages of $3,000,000, as a result of a Company press release announcing termination of the license agreement.
The Company initiated a patent infringement suit against Arcom in the United States District Court for the Northern District of New York, which sought treble damages for willful infringement plus attorneys fees. The Company requested that the Court grant a preliminary injunction to prevent Arcom from infringing its patent. At a Court hearing in February 1994, the parties agreed, and it was ordered by the Court, that Arcom would post as security amounts equal to the royalties due to the Company for the manufacture and sale of product covered by the license agreement from December 15, 1991, the date that the license would have terminated, until the expiration of the patent in February 1995. Through July 31, 1995 Arcom had made cash payments of $462,066 covering royalties through February 14, 1995. The Company did not include these amounts in income in any fiscal period but recorded a current liability for $462,066 at July 31, 1995. In addition, Arcom agreed to post an irrevocable letter of credit in an amount deemed sufficient to permit recovery of a significant portion of the Company's
damages if it were to prevail on its willful infringement claim. In exchange, the Company withdrew its request for a preliminary injunction.
In May, 1996, the Company and Arcom agreed to settle the foregoing lawsuits, pursuant to which all suits were terminated and dismissed with prejudice. As part of this agreement, the Company and Arcom, respectively, granted each other full releases from liability, the Company released certain deposits and other collateral provided to the Company by Arcom during the litigation, and the Company reimbursed Arcom approximately $70,000 for certain fees and expenses.
EPA INFORMATION REQUEST
In March 1995, a subsidiary of the Company received a Joint Request for Information (the "Information Request") from the United States Environmental Protection Agency, Region II (the "EPA"), under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended ("CERCLA"), with respect to the release and/or threatened release of hazardous substances, hazardous wastes, pollutants or contaminants into the environment at the Onondaga Lake Site, Syracuse, Onondaga County, New York. The Company has learned that the EPA added the Onondaga Lake Site to the Superfund National Priorities List on December 6, 1994 and has completed an onsite assessment of the degree of hazard. The EPA has indicated that the Company is only one of 26 companies located in the vicinity of Onondaga Lake or its tributaries that have received a similar Information Request.
The Information Request related to the activities of the Company's Printed Circuit Board Division, which conducted operations within the specified area, and was sold to a third party in 1992. Under the Agreement of Sale with the buyer, the Company retained liability for environmental obligations which occurred prior to the sale.
The Company has provided all information requested by the EPA. The Information Request does not designate the Company as a potentially responsible party, nor has the EPA indicated the basis upon which it would designate the Company as a potentially responsible party. The Company is therefore unable to state whether there is any material likelihood for liability on its part, and, if there were to be any such liability, the basis of any sharing of such liability with others.
OTHER
The Company is involved, from time to time, in certain other legal actions arising in the normal course of business. Management believes that the outcome of other litigation will not have a material adverse effect on the Company's consolidated financial statements.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Additions Balance charged to Balance beginning cost and end of Description of period expenses Deduction* Period - ----------- --------- -------- ---------- ------
Fiscal Year Ended July 31, 1994: Allowance for doubtful accounts $250,000 $246,602 $201,602 $295,000
Fiscal Year Ended July 31, 1995: Allowance for doubtful accounts $295,000 $142,897 $147,897 $290,000
Fiscal Year Ended July 31, 1996: Allowance for doubtful accounts $290,000 $143,769 $233,769 $200,000
* Write-off of uncollectible accounts receivable and other adjustments.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information called for by this item is incorporated by reference to the Company's Proxy Statement for its 1996 annual meeting of shareholders which will be filed prior to November 28, 1996.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information called for by this item is incorporated by reference to the Company's Proxy Statement for its 1996 annual meeting of shareholders which will be filed prior to November 28, 1996.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information called for by this item is incorporated by reference to the Company's Proxy Statement for its 1996 annual meeting of shareholders which will be filed prior to November 28, 1996.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for by this item is incorporated by reference to the Company's Proxy Statement for its 1996 annual meeting of shareholders which will be filed prior to November 28, 1996.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. The following consolidated financial statements are included in Part II Item 8:
Independent Auditors' Report
Consolidated Balance Sheets as of July 31, 1996 and 1995
Consolidated Statements of Operations for the Years Ended July 31, 1996, 1995 and 1994
Consolidated Statements of Shareholders' Equity for the Years Ended July 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years Ended July 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
2. The following consolidated financial statement schedule should be read in conjunction with the consolidated financial statements set forth in Part II Item 8:
Valuation and Qualifying Accounts
All other schedules called for under Regulation S-X are not submitted because they are not applicable or not required or because the required information is not material or is included in the consolidated financial statements or notes thereto.
3. See Index to Exhibits for a list of exhibits to this Annual Report.
(b) Reports on Form 8-K.
None.
(c) INDEX TO EXHIBITS
3(a)e Restated Articles of Incorporation of the Company, as amended on December 17, 1987
(b)e By-Laws of the Company, as amended on December 17, 1987 and as currently in effect
4(a)b 1981 Non-Qualified Stock Option Plan
(b)a 1982 Incentive Stock Option Plan
(c)i 1992 Incentive Stock Plan
(d)j Warrant Certificates issued to Scimitar Development Capital Fund and Scimitar Development Capital "B" Fund, dated February 10, 1993
(e)k Warrant Certificate issued to City National Bank, dated February 10, 1993
(f)m Amendment to 1992 Incentive Stock Plan
(g)r Amendment to 1981 Non-Qualified Stock Option Plan
10(a)f The Company's product warranties
(b)c Pico (St. Kitts) Limited lease on Pond Pasture Industrial Estate, Basseterre, St. Christopher and Nevis
(c)d Pico Macom, Inc. lease on approximately 60,000 square feet of building at 12500 Foothill Blvd., Lakeview Terrace, California
(d)g Amendment to Pico Macom, Inc. lease of building at 12500 Foothill Blvd., Lakeview Terrace, California
(e)e Lease on office of Pico Macom Taiwan Co. Ltd.
(f)g Exclusive Manufacturing Agreement between Pico Macom, Inc. and Good Mind Industries, dated April 26, 1989
(g)h Employment Agreement between Pico Macom, Inc. and George M. Knapp, dated June 19, 1992
See page 57 for Key to Index for Exhibits.
(c) INDEX TO EXHIBITS (continued)
(h)k Pico Products, Inc. 8% Subordinated Notes Payable to Scimitar Development Capital Fund and Scimitar Development Capital "B" Fund, dated February 10, 1993
(i)k Amendment to Exclusive Manufacturing Agreement between Pico Macom, Inc. and Good Mind Industries (dated April 26, 1989) - amendment dated April 27, 1993
(j)l Loan and Security Agreement between Pico Macom, Inc. and Marine Midland Business Loans, Inc. dated May 25, 1994
(k)n Employment Agreement between Pico Products, Inc. and Joseph T. Kingsley, dated January 1, 1995.
(l)o Employment Agreement between Pico Macom, Inc. and Norman Reinhardt, dated March 22, 1995.
(m)o Amendment to the Exclusive Manufacturing/Marketing Agreement between Pico Macom, Inc. and Goodmind Industries (dated April 26, 1989) - amendment dated April 10, 1995.
(n)p Amendments to the Loan and Security Agreement between Pico Macom, Inc. and Marine Midland Business Loans, Inc. dated May 25, 1994 - amendments dated April 27, 1995 and May 18, 1995.
(o)p Employment Agreement between Pico Products, Inc. and Everett T. Keech, dated September 22, 1995.
(p)q Amendment to Pico Macom, Inc. lease of building at 12500 Foothill Boulevard, Lakeview Terrace, California - amendment dated November 9, 1995.
(q)r Amendment No. 3 to the Loan and Security Agreement between Pico Macom, Inc. and Marine Midland Business Loans, Inc. dated May 25, 1994 - amendment dated December 20, 1995.
11.1 Computation of Per Share Earnings.
22(a) Subsidiaries of the Company are listed in the Table at the end of Item 1
24(a) Independent Auditors' Consent
27 Financial Data Schedule (included only in the EDGAR filing).
See next page for Key to Index of Exhibits.
KEY TO INDEX OF EXHIBITS
a Previously filed by the Company as an exhibit to the Company's Registration Statement on Form S-1, File No. 2-77439 and incorporated by reference.
b Previously filed by the Company as an exhibit to the Company's Registration Statement on Form S-18, File No. 2-72318 and incorporated by reference.
c Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1983 and incorporated by reference.
d Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1985 and incorporated by reference.
e Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1988 and incorporated by reference.
f Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1990 and incorporated by reference.
g Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1991 and incorporated by reference.
h Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1992 and incorporated by reference.
i Previously filed by the Company as an exhibit to the Company's Form 10-Q for the fiscal quarter ended January 31, 1993 and incorporated by reference.
j Previously filed as exhibits to Schedule 13D, dated February 16, 1993, filed by Standard Chartered Equitor Trustee CI Limited, Scimitar Development Capital Fund and Scimitar Development Capital "B" Fund, and incorporated by reference.
k Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1993 and incorporated by reference.
KEY TO INDEX OF EXHIBITS (continued)
l Previously filed by the Company as an exhibit to the Company's Form 10-Q for the fiscal quarter ended April 30, 1994 and incorporated by reference.
m Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1994 and incorporated by reference.
n Previously filed by the Company as an exhibit to the Company's Form 10-Q for the fiscal quarter ended January 31, 1995 and incorporated by reference.
o Previously filed by the Company as an exhibit to the Company's Form 10-Q for the fiscal quarter ended April 30, 1995 and incorporated by reference.
p Previously filed by the Company as an exhibit to the Company's Form 10-K for the fiscal year ended July 31, 1995 and incorporated by reference.
q Previously filed by the Company as an exhibit to the Company's Form 10-Q for the fiscal quarter ended October 31, 1995 and incorporated by reference.
r Previously filed by the Company as an exhibit to the Company's Form 10-Q for the fiscal quarter ended January 31, 1996 and incorporated by reference.
Copies of all exhibits incorporated by reference are available at no charge by written request to Assistant Corporate Secretary, Pico Products, Inc., 12500 Foothill Blvd., Lakeview Terrace, California 91342.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Pico Products, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: October 24, 1996
PICO PRODUCTS, INC.
By: /s/ Everett T. Keech By: /s/ Joseph T. Kingsley --------------------------------- --------------------------------- Everett T. Keech Joseph T. Kingsley Chairman of the Board Principal Financial & (Principal Executive Officer) Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Pico Products, Inc. and in the capacities and on the dates indicated.
/s/ Everett T. Keech /s/ Charles G. Emley, Jr. - --------------------------------- --------------------------------- Everett T. Keech Charles G. Emley, Jr. Chairman of the Board Director October 24, 1996 October 24, 1996
/s/ David Heenan /s/ George M. Knapp - --------------------------------- --------------------------------- David Heenan George M. Knapp Director Director October 24, 1996 October 24, 1996
/s/ E.B. Leisenring, Jr. /s/ Pierson G. Mapes - --------------------------------- --------------------------------- E.B. Leisenring, Jr. Pierson G. Mapes Director Director October 24, 1996 October 24, 1996
/s/ William W. Mauritz /s/ J. Michael Sills - --------------------------------- --------------------------------- William W. Mauritz J. Michael Sills Director Director October 24, 1996 October 24, 1996
FORM 10-K
YEAR ENDED JULY 31, 1996
EXHIBITS
- --------------------------------------------------------------------------------
11.1 Computation of Per Share Earnings
24(a) Independent Auditors' Consent
27 Financial Data Schedule (included only in the EDGAR filing).