Item 1. Business
The Company
M~Wave, Inc., operates through its wholly-owned subsidiaries Poly Circuits, Inc. and P C Dynamics Corporation (collectively, the "Company"). In December 1997, the Company announced that the P C Dynamics subsidiary does not have a place in the Company's strategic plans and is actively marketing the P C Dynamics subsidiary. The Company manufactures printed circuit boards using Teflon-based laminates to customers' specifications. In addition, the Company produces customer specified bonded assemblies consisting of a printed circuit board bonded in some manner to a metal carrier or pallet. One bonding technique used by the Company is Flexlink (TM), a patented process granted to the Company in 1993.
The Company's printed circuit boards and bonded assemblies are used in wireless communication systems and in other devices and equipment operating in the microwave frequency spectrum of 800 MHz and above. These devices and equipment include cellular telephones, direct broadcast satellite television, global positioning satellite systems, personal communication networks and military "smart" weapons. The Teflon(TM) based boards and assemblies are advantageous for microwave systems because of their extremely low circuit transmission and power losses; coupled with stable, predictable electrical characteristics.
The production of Teflon(TM) based printed circuit boards and bonded assemblies is technologically demanding due to the precise requirements of their end-use applications and the miniaturization of the microwave frequency components. To meet these technological demands, the Company has developed manufacturing processes and designs which reduce the cost and increase the manufacturability and reliability of customer systems. Additionally, the Company emphasizes quality engineering and design support for its customers. The Company is subject to stringent technical evaluation and certification by many of its customers.
The Company markets its products through Company personnel supported by approximately 20 independent sales organizations. The Company's base of approximately 125 customers represents a highly sophisticated group of purchasers.
Segments within the commercial and military markets have experienced growth in recent years due to: (i) increased efficiency of microwave systems; (ii) a commercial market based upon increasing acceptance of microwave frequency products; (iii) a continuing need to upgrade systems based upon microwave technology; and (iv) crowding of the available frequency spectrum below 800 MHz. The Company's strategy is to increase sales of its products to support the growth of its customers in these industry segments.
M~Wave, Inc. was incorporated in Delaware in January 1992 in connection with a 100 for 1 share exchange with the former stockholders of Poly Circuits, Inc. The Company's executive offices are located at 216 Evergreen Street, Bensenville, Illinois, 60106, and its telephone number is (630) 860-9542.
Industry and Market
There are Commercial and Military-related types of customers within the market for microwave related printed circuit boards and bonded assemblies. Within both customer types there has been an "outsourcing" trend whereby end users have gotten out of internal
production of printed circuit boards and bonded assemblies and moved to buying these products from "contract manufacturing" board shops.
The market for microwave related printed circuit boards and bonded assemblies is expected to grow as wireless communication systems are expanded and improved, and as additional technologies such as global positioning satellites systems; direct broadcast television; advanced avionics systems and missile electronics are brought to market. Although new growth will occur, pricing pressures will also grow thereby depressing margins for printed circuit board manufacturers.
One of the most widely recognized high frequency wireless communication systems in commercial use is the cellular telephone. Cellular systems operate at the lower end of the microwave spectrum and use Teflon(TM) based printed circuit boards and bonded assemblies in signal amplification base assemblies. As cellular telephones increase their market penetration, additional cellular base stations will be constructed to improve geographic coverage and system capacity. Approximately 49%, 39% and 48% of the Company's revenues in 1997, 1996, and 1995, respectively, were related to the cellular telephone industry.
Customers and Marketing
The Company's customers include microwave system manufacturers with sophisticated technologies. The Company currently services a customer base of approximately 125.
The sale of microwave printed circuit boards is technical in nature. The Company works with customer personnel who are frequently experts in microwave design and theory with added expertise in fabrication and design techniques for printed circuit boards. Typically, microwave system manufacturers provide the Company fabrication details and guidelines. The Company fabricates the products to customer specifications. For military microwave system manufacturers, the Company must meet the demanding military and critical weapon specifications.
The Company has adopted a program of early supplier involvement as part of its sales strategy. The Company has the opportunity to design-in its manufacturing processes as a means of reducing the cost of microwave systems. The emphasis upon a partnership underlies the Company's relationship with its customers.
Approximately 20 independent sales organizations are paid a commission to represent the Company in geographical territories. International sales of the Company's products have accounted for less than 5% of revenues in each of 1997, 1996 and 1995.
In 1997, Motorola, Lucent and Spectrian accounted for 19%, 7% and 26%, respectively, of the Company's revenues. In 1996, Motorola, Lucent and Spectrian accounted for 26%, 8% and 10%, respectively, of the Company's revenues. In 1995, Motorola, Lucent and Spectrian accounted for 27%, 16% and 12%, respectively, of the Company's revenues. The loss of, or a substantial reduction in or change in the mix of orders from, any one or more of the Company's major customers could have a material adverse effect on the Company's results of operations and financial condition. The Company continues to vigorously pursue a strategy of being a major source to its customers, but intends to seek to be one of a few key suppliers rather than the sole supplier.
As of December 31, 1997, the Company had an order backlog of approximately $2,626,000 compared to $4,578,000 at December 31, 1996. Nearly all of the Company's backlog is subject to cancellation or postponement without significant penalty. Accordingly the Company does not believe that this backlog is necessarily indicative of the Company's future results of operations or prospects.
Products and Production
The Company produces microwave related Teflon(TM) based printed circuit boards. The Company also bonds microwave related printed circuit boards to metal carriers or pallets using a variety of bonding techniques including a Company patented process called Flexlink(TM). The use of Teflon(TM) in the manufacturing of printed circuit boards is demanding. This is so because Teflon(TM) is a thermo-plastic which, in a cured state, exhibits a high coefficient of thermal expansion and polymeric molecular cross-linking which makes plating circuitry difficult. Manufacturing microwave-related circuit boards requires tolerances measured in ten thousandths of an inch. Despite these manufacturing complexities, the Company realized a yield of approximately 90% in 1997, compared to 80% in 1996. The increase was related to production efficiencies achieved at the Poly Circuits facility. This rate has helped the Company reduce its manufacturing costs, which is particularly important because Teflon(TM) is substantially more expensive than laminates used in low frequency applications.
Because the Company manufactures a custom, made-to-order product, there is a minimal amount of finished goods inventory. The Company maintains raw material inventory, primarily Teflon based laminate. A typical manufacturing cycle time from engineering to shipment is about two weeks. The Company seeks to balance its labor, materials and backlog to achieve an average of eight weeks lead-time from placement of order to shipment of product. Production can generally be increased rapidly to respond to increases in demand.
The Company maintains in-house capabilities to perform substantially all processes, thereby minimizing the reliance upon outside sources. The Company devotes significant time and attention to quality control and TQA (Total Quality Assurance). The Company operates a SP C (Statistical Process Control) system that is intended to maintain quality at each process stage by reducing the variability of each process. As the Company's business has evolved towards the production of relatively smaller quantities of more complex products, the Company has at times during 1997 and 1996 encountered difficulty in maintaining its past yield standards.
During 1997, 1996 and 1995, one manufacturer accounted for approximately 56%, 46% and 49%, respectively, of the Teflon based laminate supplied to the Company. There are only four U. S. manufacturers of Teflon based laminate. Any disruption or termination of these sources of Teflon based laminate could adversely affect the Company's operations. Moreover, any prolonged disruption or termination of the Company's principal supplier of Teflon based laminate could have a material adverse effect on the Company's business and damage customer relationships. The Company purchases Teflon based laminate pursuant to an ongoing purchase order relationship. The Company believes its relationship with its principal supplier of Teflon based laminate is good.
Product Development
The Company's product development efforts have been a part of its ongoing activities. The Company has developed the Flexlink TM process; the bonding of materials with dissimilar coefficients of thermal expansion, and the fusion bonding of Teflon based laminate for multi-layer circuit fabrication. The Company was granted a patent in 1993 by the United States Patent Office for its Flexlink TM process. The Company developed an enhanced version of Flexlink in 1996.
The Company relies heavily on its process engineering capabilities to further its corporate objectives. The Company's future results of operations are dependent on its ability to
continue to initiate or respond to technical changes and to make the necessary ongoing capital investments. The Company focuses on improving current manufacturing processes and developing new processes in pursuit of its goal to increase quality, offer enhanced systems design flexibility to its customers, and respond to the increasing complexity of its customers' products.
Competition
The market for the Company's products is highly competitive. The Company competes for customers primarily on the basis of quality, reliability and on time delivery of its products and the Company's technical support. The Company faces substantial competition from many companies, including many that have greater financial and other resources, broader product lines, greater customer service capabilities and larger and more established customer bases. Also, some of the smaller "non-Teflon(TM) board shops" are now entering the market for Teflon(TM) boards. Some of these smaller shops are located nearby key customers. This is an advantage they can use.
Alternative methods of manufacturing microwave-related boards exist, including ceramic and thick film technologies. Also, new materials are being introduced that are not Teflon(TM) based and are easier to manufacture. These materials fit within existing manufacturing capabilities of other board shops. Increased competition could cause the Company to lose market share and/or accelerate the decline in the prices of the Company's products. These factors could have a material adverse effect on the Company's results of operations and financial condition.
Environmental Regulations
The Company and the industry in which it operates are subject to environmental laws and regulations concerning, among other things, emissions into the air, discharges into waterways, the generation, handling and disposal of waste materials and certain recordkeeping requirements. The Company periodically generates and handles materials that are considered hazardous waste under applicable law and contracts for the off-site disposal of these materials. During the ordinary course of its operations, the Company has received citations or notices from regulatory authorities that such operations may not be in compliance with applicable environmental regulations. Upon such receipt, the Company works with authorities to resolve the issues raised by such citations or notices. The Company's past expenditures relating to environmental compliance have not had a material effect on the financial position or results of operations of the Company. The Company believes that the overall impact of compliance with regulations and legislation protecting the environment will not have a material effect on its future financial position or results of operations, although no assurance can be given.
Based on information available to the Company, which in most cases includes an estimate of liability, legal fees and other factors, a reserve for indicated environmental liabilities has been made in the aggregate amount of approximately $13,000. The Company spent approximately $21,000 in 1997 complying with EPA regulations.
Patents
Due to rapidly changing technology, the Company believes its success depends primarily upon the engineering, marketing, manufacturing and support skills of its personnel, rather than upon patent protection. The Company was granted a patent in 1993 by the United States Patent Office for its Flexlink(TM) process.
Employees
On December 31, 1997, the Company employed approximately 100 persons. The Company closely monitors the number of employees in response to its periodic production requirements and believes it is positioned appropriately to change the number of employees as changes in production warrant. In February and March 1997, the Company significantly reduced the number of employees in response to lower than anticipated shipments.
None of the Company's employees are represented by a labor union and the Company has never experienced a work stoppage, slowdown or strike. The Company considers its labor relations to be very good.
Executive Officers of the Registrant
The following is a list of Company's executive officers:
JOSEPH A. TUREK is the founder of the Company and has acted as Chairman and Chief Executive Officer since June 1993, and has served as director of the Company since 1988. Mr. Turek served for more than five years in various positions at West-Tronics, Inc., a manufacturer of low frequency circuit boards and a contract assembler of electronic products, with his last position as President in 1987 and 1988.
MICHAEL BAYLES joined the Company in February 1997 as President and Chief Operating Officer. From April, 1991 to February, 1997, Mr. Bayles was with Varlen Instruments, a division of Varlen Corporation, where he held the position of President.
PAUL H. SCHMITT joined the Company in September 1992 as Treasurer. From 1990 to 1992, Mr. Schmitt was with Reynolds Products, a Division of Alco Standard Corporation, where he held the position of Controller. From 1983 to 1990, he served as Controller for Garden City Envelope Company.
Item 2.
Item 2. Properties
Facilities
The following table lists the manufacturing, administrative, marketing facilities of the Company:
The Company began manufacturing at the Company's new 44,000 square foot building in Frisco, Texas during the fourth quarter of 1996. This facility is subject to a mortgage securing the Company's obligation to repay notes totaling $2,576,000 at December 31, 1997. In December 1997, the Company announced that the P C Dynamics facility located in Frisco, Texas does not have a place in the Company" Strategic Plans. As such, the Company is actively marketing P C Dynamics for sale.
Item 3.
Item 3. Legal Proceedings
None
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Registrant's common stock is traded on the NASDAQ National Market (trading symbol MWAV). The following table sets forth, for the calendar periods indicated, the range of the high and low last reported sales prices of the common stock from January 1, 1996 through December 31, 1997 as reported by the NASDAQ. The Company announced that it has been notified by the Nasdaq Stock Market, Inc., that, based on the trading price of M~Wave's common stock for the previous 30 consecutive trading dates, the common stock is not in compliance with the new public float requirement for continued listing on the NASDAQ National Market. Unless M~Wave's common stock trades at a price which causes M~Wave to satisfy the minimum requirement for at least 10-consecutive days on or prior to May 28, 1998, Nasdaq will issue a delisting letter to the Company.
Year Ended December 31 -------------------------------------------- 1997 1996 -------------------- --------------------
Low High Low High
First Quarter $ 2-1/8 $ 4-5/8 $ 5-3/4 $ 8-3/4
Second Quarter 2 3-1/2 4-1/4 6-3/4
Third Quarter 2-7/16 3-15/16 2-1/2 5
Fourth Quarter 3 6-3/8 1-3/4 4-1/4
As of December 31, 1997, there were approximately 1,500 shareholders of record owning the common stock of the Company.
The Registrant did not pay any dividends on its common stock in 1997 and intends not to pay dividends in the foreseeable future in order to reinvest its future earnings in the business.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial information with respect to the Company for each of the five years in the period ended December 31, 1997.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Listed below are the related expenses for 1997, 1996 and 1995 as a percent of sales.
COMPARISON OF 1997 AND 1996
Net Sales
Net sales for 1997 decreased 26% to $16.7 million from $22.6 million in 1996. The decrease in sales was due to several factors including a Company decision to exit low margin commodity business; shifts by customers to alternate materials and suppliers; and the tapering off of specific customer program business as it enters the later stages in its life cycle. 1996 net sales also included $741,000 of sales relating to the Assembly Division and the Asian based distribution entity (Vortex). These divisions were sold in December 1996. Net sales to Motorola decreased by $2,776,000 or 47% to $3,120,000. The products produced for Motorola are maturing and their requirements have been reduced. Net sales to Lucent decreased by $708,000 or 40% to $1,080,000. The products produced for Lucent are maturing and their requirements have been reduced. Net sales to LK Products decreased by $2,233,000 or 71% to $926,000. LK Products has shifted their product to an alternative material.
The foregoing decreases in net sales were partially offset by an increase in net sales to Spectrian, the Company's largest customer, of $2,158,000 or 97% to $4,375,000.
The Company's three largest customers accounted for 52% of the Company's net sales in 1997 compared to 45% in 1996.
The Company is taking steps to increase its sales by visiting key customers to inform them of the positive changes at the Company; however, the Company expects its sales to decline in the first quarter of 1998.
Gross Profit and Cost of Goods Sold
Gross profit increased $3.4 million in 1997 from a negative $0.7 million in 1996 to $2.7 million in 1997. Gross margin increased to approximately 16% in 1997 from approximately negative 3% in 1996. The improvement is due to many factors. In 1996, the Company incurred sales adjustments for pricing and returns of $1,201,000 and inventory writedowns of $2,719,000 and $747,000 relating to manufacturing scrap and rework and inventory obsolescence, respectively. A total of $301,000 of the inventory writedowns related to the Assembly Division that was sold in December 1996. These charges did not reoccur in 1997. Also, the Bensenville facility made good progress in improving productivity and reducing costs in 1997.This includes moving to one shift from two while improving on time delivery. The Texas facility has not achieved the same magnitude of manufacturing improvements and is hindered by the type of business (small lot sizes) it produces. The Company has made operational changes designed to enhance its quality control and ability to manufacture highly complex products; however, there can be no assurance as to when, or if, these changes will result in improved manufacturing processes. Future production problems would continue to adversely impact the Company's gross margins and profitability, which would also result in decreased liquidity and adversely affect the Company's financial position.
The adjusted gross profit was $3,966,000 or 17.5% in 1996 compared to $2,704,000 or 16.2% in 1997. The adjusted gross profit for 1996 is calculated by adding back the sales adjustments and inventory write-downs of $4,667,000 to the reported gross loss. The adjusted gross profit declined due to a decrease in sales and manufacturing inefficiencies related to the P C Dynamics facility.
Teflon based laminate is the largest single component of the Company's cost of goods sold, representing 15.4% and 27.5% of net sales during 1997 and 1996, respectively. The Company did not experience significant changes in the cost of Teflon based laminate during 1997 and 1996. During 1997 and 1996, one manufacturer accounted for approximately 56% and 46%, respectively, of the Teflon based laminate supplied to the Company.
Operating Expenses
General and administrative expenses were $2,297,000 or 13.8% of net sales in 1997, compared to $3,233,000 or 14.3% of net sales in 1996. General and administrative expenses consist primarily of salaries and benefits, professional services, depreciation of office equipment, computer systems and occupancy expenses. The net decrease was due to a reduction in professional and legal fees of $748,000 and the final settlement of the Comptek litigation of $170,000. 1996 expenses also included $93,000 of administrative expenses relating to the Assembly Division and the Asian based distribution entity (Vortex). On April 15, 1996, the Company engaged a consulting firm to provide consulting services with respect to the Company's operations, which services resulted in additional expenses of $696,000. The consultants completed their work with the Company in February 1997.
Selling and marketing expenses were $1,021,000 or 6.1% of net sales in 1997, compared to $1,678,000 or 7.4% of net sales in 1996. Selling and marketing expenses include the cost of salaries, advertising and promoting the Company's products and the commissions paid to independent sales organizations. The decrease in selling and marketing expenses was primarily attributable to a reduction in staff and reduced commissions paid as a result of a decease in sales.
1996 expenses also included $223,000 of selling and marketing expenses relating to the Assembly Division and the Asian based distribution entity (Vortex).
Research and development expenses related to the Assembly Division were $357,000 or 1.6% of net sales for 1996. The Company sold the Assembly Division in December 1996.
During the fourth quarter of 1997, the Company decided to reposition the P C Dynamics subsidiary located in Frisco, Texas. Management decided the P C Dynamics subsidiary did not have a future place in the Company's strategic plans. As such, management is actively marketing P C Dynamics for sale. In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company recorded a goodwill impairment charge of $670,000. The Company also recorded a $2,604,448 impairment of building and equipment for the write down the P C Dynamics building and equipment to an estimate of market value. The building and equipment are recorded in the December 31, 1997 balance sheet as building and equipment to be disposed of at market value less an estimate of selling costs. The market value was determined based on appraisals.
For the year ended December 31, 1997, 1996 and 1995 P C Dynamics' financial results included $4,192,303, $4,786,726 and $4,172,403 of net sales and operating losses of $4,422,128, $1,377,584 and $353,474, respectively. Until the P C Dynamics business is sold, the Company estimates incurring monthly pre-tax losses in the range of $75,000 to $100,000 per month. If the decision was made to cease P C Dynamic's business, the Company estimates incurring approximately $200,000 in severance and shutdown costs. If P C Dynamics' business were to cease, the Company estimates incurring expenses of approximately $84,000 each month for real estate taxes, utilities and security until the building and equipment can be disposed of.
In May 1995, the Company established a division which performed contract assembly work for the Company's customers. Effective December 13, 1996, the Company sold substantially all of the assets, subject to certain liabilities, of this division to Marquis Microwave Products for a promissory note of $1,122,000, which approximated the net book value of the assets sold to Marquis Microwave Products. In 1996, the Company recorded a valuation allowance of $250,000 on the note.
Effective December 19, 1997, the Company consented to the transfer of assets of Marquis Microwave Products to TRL Technologies, Inc. provided Marquis Microwave Products pay the Company $400,000. As further consideration, the Company entered into a Royalty agreement that entitles the Company to receive royalties of 3% of net sales of products developed by Marquis Microwave Products, subject to a maximum of $700,000. The Company also agreed that the Promissory Note and the prior royalty agreements dated December 13, 1996 issued by Marquis Microwave Products are null and void. In connection with this transaction the Company recorded a write-off of Note Receivable of $472,000.
The Company had sustained operating losses on the Assembly Division of $1.1 million in 1996 and $400,000 in 1995 on revenues of $463,000 and $91,000, respectively.
Operating loss
Operating income was negative $4.4 million or negative 26.1% of net sales in 1997, compared to a negative $6.2 million or negative 27.5% of net sales in 1996. The change in operating income can be summarized as follows:
Decrease in net sales $184,000 Increase in gross margin 3,221,000 Impairment of building and equipment (2,604,000) Goodwill impairment charge (670,000)
Write off of note receivable (222,000) Decrease in operating expenses 1,950,000 ---------- Decrease in operating loss $1,859,000 ==========
Interest Income
Interest income from short-term investments was $180,000 in 1997 compared to $39,000 in 1996.
Interest Expense
Interest expense, primarily related to the Company's mortgage obligation on its P C Dynamics facility, was $250,000 in 1997 compared to $224,000 in 1996.
Loss on disposal of fixed assets
The Company recorded a loss of $93,000 in 1997 and $417,000 in 1996 relating to the disposal of fixed assets which are no longer usable in the Company's business.
Income Taxes
The Company had an effective tax credit rate of 30.1% in 1997,and an effective tax credit rate of 36.1% in 1996.
Earnings per share
In 1997, the Company adopted Statement of Financial Accounting Standards No. 128 - - "Earnings per Share" ("SFAS 128"). As required by SFAS 128, all current and prior year earnings (loss) per share data have been restated to conform to the provisions of SFAS 128.
COMPARISON OF 1996 AND 1995
Net Sales
Net sales for 1996 decreased 23% to $22.6 million from $29.5 million in 1995. This decrease was primarily attributable to production problems. Net sales to Motorola decreased by $1,826,000 or 24% to $5,896,000. Net sales to Spectrian decreased by $1,280,000 or 37% to $2,218,000. Net sales to AT&T decreased by $2,759,000 or 61% to $1,788,000. Net sales to Glenayre decreased by $1,873,000 or 95% to $90,000.
The foregoing decreases in net sales were partially offset by an increase in net sales to L K Products and Rockwell, two of the Company's larger customers, of $3,069,000 or 26%.
The Company's three largest customers accounted for 50% of the Company's net sales in 1996 compared to 55% in 1995.
Gross Profit and Cost of Goods Sold
Gross profit decreased $7.7 million in 1996 from $7.0 million in 1995 to negative $0.7 million in 1996. Gross margin decreased to approximately negative 3% in 1996 from approximately 24% in 1995. This reduction is attributable to reduced shipments to certain of the Company's largest customers, a shift in product mix, and production problems. The decrease in gross profit includes sales adjustments for pricing and returns of $1,201,000 and inventory writedowns of $2,719,000 and $747,000 relating to manufacturing scrap and rework and inventory obsolescence, respectively.
The Company has made operational changes designed to enhance its quality control and ability to manufacture highly complex products; however, there can be no assurance as to when, or if, these changes will result in improved manufacturing processes. Future production problems would continue to adversely impact the Company's gross margins and profitability, which would also result in decreased liquidity and adversely affect the Company's financial position.
Teflon based laminate is the largest single component of the Company's cost of goods sold, representing 27.5% and 18.6% of net sales during 1996 and 1995, respectively. The Company did not experience significant changes in the cost of Teflon based laminate during 1996 and 1995. During 1996 and 1995, one manufacturer accounted for approximately 46% and 49% , respectively, of the Teflon based laminate supplied to the Company.
Operating Expenses
General and administrative expenses were $3,233,000 or 14.3% of net sales in 1996, compared to $2,327,000 or 7.9% of net sales in 1995. On April 15, 1996, the Company engaged a consulting firm to provide consulting services with respect to the Company's operations, which services resulted in additional expenses of $609,000. The consultants completed their work with the Company in February 1997. General and administrative expenses for 1996 also include a valuation provision of $250,000 against a promissory note of $1.1 million received by the Company in December 1996 in connection with the sale of its Assembly Division. General and administrative expenses consist primarily of salaries and benefits, professional services, depreciation of office equipment, computer systems and occupancy expenses.
Selling and marketing expenses were $1,678,000 or 7.4% of net sales in 1996, compared to $2,009,000 or 6.8% of net sales in 1995. The decrease in selling and marketing expenses was primarily attributable to reduced commissions paid as a result of a decrease in sales. Selling and marketing expenses include the cost of salaries, advertising and promoting the Company's products and the commissions paid to independent sales organizations.
Research and development expenses were $357,000 or 1.6% of net sales in 1996, compared to $412,000 or 1.4% of net sales in 1995. Research and development expenses were related to the Assembly Division, which was sold in December 1996.
Operating Income
Operating income was negative $6.2 million or negative 27.5% of net sales in 1996, a decrease of $8.4 million from 1995. The change in operating income can be summarized as follows:
Decrease in net sales ($1,622,000) Decrease in gross margin (6,033,000) Write off of note receivable (250,000) Increase in operating expenses (538,000) ------------ Decrease in operating income ($8,443,000) ===========
Interest Income
Interest income from short-term investments was $39,000 in 1996 compared to $294,000 in 1995.
Interest Expense
Interest expense, primarily related to the Company's mortgage obligation on its P C Dynamics facility, was $224,000 in 1996 compared to $88,000 in 1995.
Loss on disposal of fixed assets
The Company recorded a loss of $417,000 in 1996 relating to the disposal of fixed assets which are no longer usable in the Company's business.
Litigation settlement
On May 13, 1994, Comptek Research, Inc., Comptek Telecommunications, Inc. and Industrial Systems Service, Inc. (together "Comptek") filed a six-count complaint against M~Wave, Inc. and Poly Circuits, Inc. alleging contractual, Uniform Commercial Code and tortious violations arising out of Poly Circuits' sale of printed circuit boards.
On September 29, 1995 the Company reached settlement with Comptek. The settlement included a cash payment of $300,000, the issuance of 20,000 shares of the Company's common stock to Comptek and an agreement to supply goods and services to Comptek on a long-term basis. The settlement resulted in a non-recurring pre-tax charge in the third quarter of 1995 of $561,000 or $0.11 per share after tax.
Income Taxes
The Company had an effective tax credit rate of 36.1% in 1996,and an effective tax provision rate of 32.4% in 1995.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided/(used) by operations was $2,645,000, ($181,000) and ($740,000) in 1997, 1996 and 1995, respectively. The Company reduced its Accounts Payable in 1997 by $711,000, which was partially offset by a reduction of inventories in 1997 of $455,000. Cash generated and cash on hand has been primarily used for the purchase of property, plant and equipment. Purchases of property, plant and equipment were $544,000, $4,723,000, and $4,528,000 in 1997, 1996 and 1995, respectively. The capital expenditures for 1996 include $3.6 million for the new P C Dynamics facility in Texas. The expenditures were partially financed through mortgage borrowings of $2.9 million. Except for expenditures required to improve the manufacturing processes, the Company presently has no plans for additional capital expenditures.
In January and March 1996, the Company obtained construction loans from American National Bank and Trust Company of Chicago to finance the rebuilding of the P C Dynamics facility in Frisco, Texas. The loans are payable in monthly installments of principal and interest which began in October 1996 and end with a balloon payment of $1,440,000 in October 2001.
The Company has a line of credit from American National Bank and Trust Company of Chicago which provides for a maximum borrowings of $2,000,000 based on 80% of eligible account receivables through May 1998 at an interest rate of prime plus 0.5%. At December 31, 1997, no amounts were outstanding on this line.
As of December 31, 1997, the Company has $2,576,000 of debt and $3.5 million of cash and cash equivalents. Management believes that funds generated from operations, coupled with the Company's cash balance and its capacity for debt will be sufficient to fund current business operations.
The sale of the P C Dynamics subsidiary will have no material effect on liquidity and capital resources because the value of the assets are reflected at net realizable value.
Inflation
Management believes inflation has not had a material effect on the Company's operation or on its financial position.
New Accounting Pronouncements
Statement of Financial Standard 125 and 127 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This new Statement will have no material effect on the Company.
Statement of Financial Standard 129 - Disclosures of Information about Capital Structure. This new Statement should have no material effect on the Company.
Statement of Financial Standard 130 - Reporting Comprehensive income. This new Statement should have no material effect on the Company.
Statement of Financial Standard 131 - Disclosure about Segments of an Enterprise and Related Information. This new Statement will be adopted in December 1998.
Year 2000 Compliance
The company is presently updating its operating software at a cost of approximately $75,000 to be in compliance with year 2000 requirements.
Foreign Currency Transactions
All of the Company's foreign transactions are negotiated, invoiced and paid in United States dollars.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
As a supplier to microwave manufacturers, the Company is dependent upon the success of its customers in developing and successfully marketing end-user microwave systems. The Company is currently working on several development programs for its customers. The development of commercial applications for microwave systems and the timing and size of production schedules for these programs is uncertain and beyond the control of the Company. There can be no assurance that these development programs will have a favorable impact on the Company's operating results. Although management believes some of these products and programs may ultimately develop into successful commercial applications, such developments could result in periodic fluctuations in the Company's operating results. As a result of these considerations, the Company has historically found it difficult to project operating results.
The Company expects that a small number of customers will continue to account for a substantial majority of its sales and that the relative dollar amount and mix of products sold to any of these customers can change significantly from year to year. There can be no assurance that the Company's major customers will continue to purchase products from the Company at current levels, or that the mix of products purchased will be in the same ratio. The loss of one or more of the Company's major customers or a change in the mix of product sales could have a material adverse effect on the Company.
In addition, future results may be impacted by a number of other factors, including the Company's dependence on suppliers and subcontractors for components; the Company's ability to respond to technical advances; successful award of contracts under bid; design and production delays; cancellation or reduction of contract orders; the Company's effective utilization of existing and new manufacturing resources; and pricing pressures by key customers.
The Company's future success is highly dependent upon its ability to manufacture products that incorporate new technology and are priced competitively. The market for the Company's products is characterized by rapid technology advances and industry-wide competition. This competitive environment has resulted in downward pressure on gross margins. In addition, the Company's business has evolved towards the production of relatively smaller quantities of more complex products, the Company expects that it will at times encounter difficulty in maintaining its past yield standards. There can be no assurance that the Company will be able to develop technologically advanced products or that future-pricing actions by the Company and its competitors will not have a material adverse effect on the Company's results of operations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
Consolidated financial statements and the related notes for each of the three years in the period ended December 31, 1997 are filed in response to this Item pursuant to Item 14.
The supplementary data regarding quarterly results of operations, set forth under the caption "Selected Quarterly Financial Data (Unaudited)" following the aforementioned consolidated financial statements, are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
The Company filed a report on Form 8K dated August 11, 1997 announcing the Company had engaged Grant Thornton LLP as the Company's accountants replacing Deloitte & Touche LLP
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information required by this Item with respect to Executive Officers of the Company is set forth in Part I, Item 4 and is incorporated herein by this reference. Information required by this Item with respect to members of the Board of Directors of the Company will be contained in the Proxy Statement for the Annual Meeting of Stockholders (the "1998 Proxy Statement"), and is incorporated herein by this reference.
Item 11.
Item 11. Executive Compensation
Information required by this Item will be contained in the 1998 Proxy Statement and is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this Item will be contained in the 1998 Proxy Statement and is incorporated herein by this reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information required by this Item will be contained in the 1998 Proxy Statement and is incorporated herein by this reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements PAGE IN THE FORM 10-K ---------
Independent Auditors' Report 23
Independent Auditors' Report 24
Consolidated Balance Sheets December 31, 1997 and 1996 25
Consolidated Statements of Operations Years Ended December 31, 1997, 1996 and 1995 26
Consolidated Statements of Stockholders' Equity Years Ended December 31, 1997, 1996 and 1995 27
Consolidated Statements of Cash Flows Years Ended December 31, 1997, 1996 and 1995 28-29
Notes to Consolidated Financial Statements 30-37
Selected Quarterly Financial Data (Unaudited) 38
Subsidiaries 41
(a) 2. Financial Statement Schedules None
(a) 3. Exhibits
The exhibits filed herewith are set forth on the Index to Exhibits filed as part of this report.
(b) The Company filed a report on Form 8-K dated December 22, 1997 announcing fourth quarter 1997 charges for restructuring and asset writedowns.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors M~Wave, Inc.
We have audited the accompanying consolidated balance sheets of M~Wave, Inc. and Subsidiaries as of December 31, 1997 and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the management of M~Wave, Inc. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of M-Wave, Inc. and subsidiaries for the years ended December 31, 1996 and December 31, 1995 were audited by other auditors whose report dated February 17, 1997 expressed an unqualified opinion on those statements.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of M~Wave, Inc. and Subsidiaries as of December 31, 1997, and the consolidated results of their operations and their consolidated cash flows for the year then ended, in conformity with generally accepted accounting principles.
We also audited the adjustments that were applied to restate the 1996 and 1995 earnings per share information to give retroactive effect to the adoption of Statement of Financial Accounting Standards No. 128, as described in Note 2. In our opinion, such adjustments are appropriate and have been properly applied.
GRANT THORNTON LLP
Chicago, Illinois January 30, 1998
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders M~Wave, Inc. Bensenville, Illinois
We have audited the accompanying consolidated balance sheet of M~Wave, Inc. and subsidiaries as of December 31, 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1996 and 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of M~Wave, Inc. and subsidiaries as of December 31, 1996, and the results of their operations and their cash flows for the years ended December 31, 1996 and 1995 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Chicago, Illinois February 17, 1997
M~WAVE, Inc. and Subsidiaries
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. ORGANIZATION AND OPERATIONS
M~Wave, Inc. ("M~Wave"), a Delaware corporation, was formed on January 31, 1992. On January 31, 1992, Poly Circuits, Inc. ("Poly Circuits") became a wholly-owned subsidiary of M~Wave through an exchange in which the former stockholders of Poly Circuits received 100 shares of M~Wave common stock for each outstanding share of Poly Circuits.
M~Wave, through its wholly-owned subsidiaries, Poly Circuits, Inc. and P C Dynamics Corporation (collectively, the "Company"), manufactures microwave frequency components and high frequency circuit boards on Teflon-based laminates for commercial and military wireless communication applications.
2. SIGNIFICANT ACCOUNTING POLICIES
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.
Principles of Consolidation - The consolidated financial statements include the accounts of M~Wave and its wholly-owned subsidiaries. Significant intercompany transactions and account balances have been eliminated.
Revenue Recognition - The Company recognizes revenue when product is shipped to customers.
Cash and Cash Equivalents - Cash and cash equivalents comprise cash in banks and highly liquid investments that are both readily convertible to known amounts of cash and so near maturity that they present insignificant risk of change in value.
Inventories - Inventories are carried at the lower of first-in, first-out (FIFO) cost or market. Substantially all the Company's inventories are work-in-process.
Property, Plant and Equipment - Property, plant and equipment are recorded at cost. The Company calculates depreciation using the straight-line method at annual rates as follows:
Building and improvements 3% to 20% Machinery and equipment 10% to 20%
Goodwill - Goodwill arising from the acquisition of P C Dynamics Corporation was being amortized on a straight-line basis over 10 years. In 1997, in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company wrote down the goodwill in the fourth quarter of 1997 after assessing its recoverability, as well as the book value of the building and equipment of the P C Dynamics facility. The goodwill and building and equipment of the P C Dynamics were determined to be impaired based upon P C Dynamics' estimated net realizable value.
Assets to be Disposed of, Net - The Company has recorded the building and equipment of the P C Dynamics facility as Assets to be Disposed of, Net and valued these items at market less an estimate of selling costs.
Fair Value of Financial Instruments - The fair value of financial instruments are not materially different from their carrying values.
Income Taxes - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax basis at enacted tax rates when such amounts are supposed to be realized or settled.
Net Earnings (Loss) Per Share - In 1997, the Company adopted Statement of Financial Accounting Standards No. 128 - "Earnings per Share" ("SFAS 128"). As required by SFAS 128, all current and prior year earnings (loss) per share data have been restated to conform to the provisions of SFAS 128.
The Company's basic net earnings (loss) per share amounts have been computed by dividing net earnings (loss) by the weighted average number of outstanding common shares. The Company's diluted net earnings (loss) per share is computed by dividing net earnings (loss) by the weighted average number of outstanding common shares and common share equivalents relating to stock options, when dilutive based on cumulative year-to-date losses. There is no difference in the Company's calculation of basic and fully diluted earnings per share for 1997 and 1996. For the year ended December 31, 1995, 79,935 shares of common stock equivalents were included in the computation of diluted earnings per share. Options to purchase 155,000 shares of common stock with a weighted average exercise price of $14.69 were outstanding at December 31, 1995, but were excluded from the computation of common share equivalents because their exercise prices were greater than the average market price of common shares.
Reclassifications - Certain reclassifications of 1996 and 1995 amounts have been made to conform to the presentation in the current year.
3. SALE OF ASSEMBLY DIVISION
In May 1995, The Company established a division which performed contract assembly work for the Company's customers. Effective December 13, 1996, the Company sold substantially all of the assets, subject to certain liabilities, of this division for a promissory note of $1,122,000, which approximated the net book value of the assets sold to Marquis Microwave Products. In 1996, the Company recorded a valuation allowance of $250,000 on the note.
Effective December 19, 1997, the Company consented to the transfer of assets of Marquis Microwave Products, Inc. to TRL Technologies, Inc. provided Marquis Microwave Products pay the Company $400,000. As further consideration, the Company will be entitled to royalties of 3% of net sales of Marquis Microwave Products, subject to a maximum of $700,000. The Company also agreed that the Promissory Note and the prior royalty agreements dated December 13, 1996 issued by Marquis Microwave Products are null and void. In connection with this transaction the Company recorded a write-off of Note Receivable of $472,000.
The Company had sustained operating losses on the Assembly Division of $1.1 million in 1996 and $400,000 in 1995 on revenues of $463,000 and $91,000, respectively.
4. ACCRUED EXPENSES
Accrued expenses at December 31, 1997 and 1996 were comprised of:
1997 1996 ---- ----
Salaries and wages $284,694 $242,720 Commissions 94,094 109,494 Professional fees 250,000 445,764 Property and other taxes 118,756 109,104 Other 281,494 347,354 -------- --------
Total accrued expenses $1,029,038 $1,254,436 =========== ==========
5. LONG-TERM DEBT
The Company has a bank credit agreement which includes a revolving line of credit and the mortgage loan described below.
Line of credit availability is based on 80% of eligible accounts receivable, with a borrowing limit of $2,000,000. Interest is at the prime rate (8.5% at December 31, 1997) plus 1/2%. The agreement expires May 31, 1998 and is renewable annually at the mutual consent of the Company and the lender. No balance was outstanding under the line at December 31, 1997.
Long-term debt is comprised of the following at December 31, 1997 and 1996:
1997 1996 ----- ----
Mortgage notes payable, 1/2% over prime rate, payable in monthly installments of $25,233 due October 2001, collateralized by P C Dynamics facility $2,575,505 $2,903,534
Obligations under capital leases, due through 1998 128 8,536 ---------- ---------- 2,575,633 2,912,070
Less current portion 307,605 307,606 ---------- ----------
Total long-term debt $2,268,028 $2,604,464 ========== ==========
Scheduled future maturities of long-term debt are as follows at December 31, 1997:
1998 307,605 1999 302,796 2000 302,796 2001 1,662,436 ---------- $2,575,633 ==========
The terms of the Company's long-term bank debt represent the borrowing rates currently available to the Company; accordingly, the fair value of this debt approximates its carrying amount.
Revolving credit borrowings and the mortgage notes are cross-defaulted and cross-collateralized. The credit agreement, as amended May 31, 1997 requires the Company to maintain a stipulated amount of tangible net worth, as defined.
6. INCOME TAXES
The provision (benefit) for income taxes consists of:
1997 1996 1995 ---- ---- ----
Current $(1,004,219) $(2,197,726) $556,478 Deferred (355,777) (265,750) 48,993 ----------- ---------- --------
Total $(1,359,996) $(2,463,476) $605,471 =========== =========== ========
The primary components comprising the net deferred tax assets (liabilities) are as follows:
1997 1996 ---- ---- Deferred tax assets Impairment of fixed assets to be disposed of $1,015,735 $ 0 Impairment and amortization of goodwill 296,104 0 Accounts receivable reserves 37,540 61,827 Inventory reserves 218,769 411,672 Accrued expenses and other 117,952 330,589 Tax credits 36,154 0 ---------- ---------- Deferred tax assets 1,722,254 804,088
Deferred tax liabilities Depreciation (1,669,175) (1,106,786) ---------- ---------- Net deferred tax assets (liabilities) $ 53,079 $ (302,698) ========== ==========
The Company believes no valuation allowance is required due to the availability of net operating loss carrybacks and the expectation of future taxable income.
The effective tax rate differs from the from the Federal statutory tax rate for the following reasons:
1997 1996 1995 ---- ---- ----
Federal statutory rate 34.0% 34.0% 34.0% State income taxes, net of Federal benefit 2.5 4.8 4.2 Tax exempt interest 0 0 (5.5) Other, net (6.4) (2.7) (0.3) ----- ------ -----
Effective rate 30.1% 36.1% 32.4% ===== ===== =====
7. SIGNIFICANT CUSTOMERS AND SUPPLIERS
The percentages of net sales attributable to major customers by year were as follows:
1997 1996 1995 ---- ---- ----
Customer A 7% 8% 16% Customer B 19 26 27 Customer C 26 10 12 Customer D 7 14 6
The loss of, or a substantial reduction in or change in the mix of orders from, any one of the Company's major customers could have a material adverse effect on the Company's results of operations and financial condition.
Approximately 49%, 39% and 48% of the Company's revenues in 1997,1996 and 1995 respectively, were related to the cellular telephone industry.
During 1997, 1996 and 1995, one manufacturer accounted for approximately 56%, 46% and 49%, respectively, of the Teflon-based laminates ("Teflon based laminate") supplied to the Company. Teflon based laminate is the largest single component of the Company's cost of goods sold representing approximately 15.4%, 27.5%, and 18.6% of net sales during 1997, 1996 and 1995, respectively. There are only four U. S. manufacturers of Teflon based laminate. Any disruption or termination of these sources of Teflon based laminate could adversely affect the Company's operations.
8. STOCK OPTION PLAN
In February 1992, the Board of Directors and stockholders of the Company approved a non-qualified Stock Option Plan (the "Stock Option Plan") under which 300,000 shares of common stock are reserved for issuance upon exercise of stock options. The Stock Option Plan is designed as an incentive for retaining key employees and directors.
In June 1995, the Board of Directors and stockholders of the Company approved an amendment and restatement of the Company's 1992 Stock Option Plan. The principal changes that resulted from the amendment are (1) an increase in the aggregate number of shares of Common Stock of the Company available for the exercise of options granted under the plan from 300,000 to 500,000; (2) a limit on the number of shares as to which options may be granted to any grantee in any calendar year to 75,000; (3) a grant of discretion to the Compensation Committee to extend the exercisability of options after a grantee's termination of employment (other than for Cause, as defined in the Plan) from 30 days to any longer period up to the full remaining term of the option; and (4) a provision for the acceleration of the exercisability of all outstanding options (regardless of when granted) in the event of a Change of Control of the Company.
In June 1997 the Board of Directors and stockholders of the Company approved an amendment and restatement of the Company's 1992 Stock Option Plan. The principal changes that resulted from the amendment are (1) to increase the aggregate number of shares of Common Stock of the Company available for the exercise of options granted under the plan from 500,000 to 750,000 and (2) to increase the limit on the number of shares as to which options may be granted to any grantee in any calendar year from 75,000 to 215,000.
The exercise price of each non-qualified stock option granted to employees of the Company under the Stock Option Plan must equal at least 80% of the fair market value of the underlying shares of common stock on the date of the grant, and the maximum term of such an option may not exceed 10 years. For all options granted to date, except for 75,000 options granted in 1995 and 210,000 shares granted in 1997, exercise price has equaled fair market value at the date of grant, the term of the option has been 10 years, and the options vest as to 25% on each of the first four anniversary dates of the grant. Exercise prices, as a percentage of fair market value at date of grant, on 75,000 options granted in 1995 are 110% as to 25,000 options, 120% as to 25,000 options and 130% as to 25,000 options. These options vest as to 33 1/3% on December 31, 1995, December 31, 1996, December 31, 1997 and the term is ten years. Exercise prices for the 210,000 shares granted in 1997 are 50,000 shares at $2.75 (fair market value), 70,000 at $7.50 and 90,000 shares at $10.00. These options vest at 40% on February 3, 1998, 35% on February 3, 1999 and 25% on February 3, 2000, and the term is ten years.
Stock option activity under the Plan was as follows:
Exercisable at year-end:
1995 127,125 $ 8.39 1996 175,875 9.30 1997 137,125 10.97
The weighted average exercise price of the options granted in 1997 were $7.27. The weighted average exercise price of the options granted in 1995 were $ 14.50. The range of exercise prices of the 360,875 options outstanding at December 31, 1997 is $2.75 to $15.93 and the weighted average remaining contractual life is 7 years. At December 31, 1997, 337,500 shares were available for grant.
The Company applies Accounting Principles Board Opinion No. 25 in accounting for stock options. Accordingly, no compensation cost has been recognized for options granted. Had compensation cost for options granted in 1997 and 1995 been determined based on the fair value at the grant date, consistent with the method prescribed by Financial Accounting Standards Board Statement No. 123, the Company's net income (loss) and related per share amounts would have been adjusted to the following pro forma amounts:
Diluted (1.04) (1.44) 0.41
Pro forma Basic (1.21) (1.51) 0.37 Diluted (1.21) (1.51) 0.36
Options outstanding and exercisable at December 31, 1997, by price range:
The weighted average fair value of options granted in 1997, and 1995 was $4.70 and $10.50, respectively, and was estimated at the grant date using the Black-Scholes options pricing model with the following weighted average assumptions: expected volatility of 178% and 81%, respectively: risk free interest rate of 6.6% and 7.2 %, respectively; expected life of 9 years; and no dividend yield.
9. EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution retirement plan covering substantially all full-time employees. The plan allows for employees to defer up to 10% of their pretax annual compensation, as defined in the plan. The Company will match up to 25% of the first 4% of base compensation that a participant contributes. Additionally, discretionary amounts may be contributed by the Company. There were no Company's contributions for 1997, 1996 and 1995.
10. LEASE COMMITMENTS
The Company rents manufacturing and administrative space under operating leases. Rent expense under these leases for the years ended December 31, 1997, 1996 and 1995 was $93,600, $236,401, and $142,534, respectively.
Future minimum annual lease commitments at December 31, 1997 are as follows:
Year 1998 $109,060 1999 57,600 2000 28,800 --------- Total $195,460 ========
11. LITIGATION
The Company is a party to various actions and proceedings related to its normal business operations. The Company believes that the outcome of this litigation will not have a material adverse effect on the financial position or results of operations of the Company.
On May 13, 1994, Comptek Research, Inc., Comptek Telecommunications, Inc. and Industrial Systems Service, Inc. (together "Comptek") filed a suit against M~Wave, Inc. and Poly Circuits,
Inc. alleging contractual, Uniform Code and tortious violations arising out of Poly Circuits' sale of printed circuits boards. On September 29, 1995, the Company reached settlement with Comptek. The settlement included a cash payment of $300,000, the issuance of 20,000 shares of the Company's common stock to Comptek and an agreement to supply goods and services to Comptek on a long-term basis. The settlement resulted in a non-recurring pre-tax charge in the third quarter of 1995 of approximately $561,000, or $0.11 per share after tax.
The Company and Joseph Turek have been named as defendants in Lionheart Partners, Inc., as general partner of Lionheart USA Micro Cap Value, L.P. v. M~Wave, Inc. and Joseph Turek, which was filed on or about November 17, 1995 in the United States District Court for the Northern District of Illinois. The case was filed as a purported class action on behalf of all persons who purchased common stock of the Company between August 8, 1995 and October 18, 1995. The complaint alleges that the defendants made materially false and misleading statements and failed to correct public representations which had become materially false and misleading regarding the Company's revenues and earnings. The complaint asserts claims under Sections 10(b) and 20 of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and seeks compensatory damages in an unspecified amount.
On April 25, 1997, the plaintiffs and the defendants entered into a settlement agreement which resolves all of the claims arising out of this action, except as to claims of class members who opt out of the settlement. This settlement received court approval on July 8, 1997. The settlement provides for a $150,000 payment to the plaintiff class plus administrative fees not to exceed $20,000. The Company's contribution to the settlement would be approximately $85,000 and is recorded in accrued liabilities on the December 31, 1997 balance sheet.
12. ENVIRONMENTAL MATTERS
The Company periodically generates and handles materials that are considered hazardous waste under applicable law and contracts for the off-site disposal of these materials. During the ordinary course of its operations, the Company has on occasion received citations or notices from regulatory authorities that such operations may not be in compliance with applicable environmental regulations. Upon such receipt, the Company works with such authorities to resolve the issues raised by such citations or notices. The Company's past expenditures relating to environmental compliance have not had a material effect on the financial position of the Company. The Company believes the overall impact of compliance with regulations and legislation protecting the environment will not have a material effect on its future financial position or results of operations, although no assurance can be given.
Based on information available to the Company, which in most cases includes an estimate of liability, legal fees and other factors, a reserve for indicated environmental liabilities has been recorded in accrued liabilities section of the December 31, 1997 Balance Sheet, the aggregate amount is approximately $13,000.
13. IMPAIRMENT OF GOODWILL AND LONG-LIVED ASSETS TO BE DISPOSED OF
During the fourth quarter of 1997, the Company decided to reposition the P C Dynamics subsidiary located in Frisco, Texas. Management decided the P C Dynamics division did not have a future place in the Company's strategic plans. As such, management is actively marketing P C Dynamics for sale. In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of," the Company recorded a goodwill impairment charge of $670,000. The Company also recorded a $2,604,448 impairment of building and equipment for the write down of the P C Dynamics building and equipment to an estimate of market value. The building and equipment are recorded in the December 31, 1997 balance sheet as building and
equipment to be disposed of at market value less an estimate of selling costs. The market value was determined based on appraisals.
For the year ended December 31, 1997, 1996 and 1995 P C Dynamics' financial results included $4,192,303, $4,786,726 and $4,172,403 of net sales and operating losses of $4,422,128, $1,377,584 and $353,474, respectively. Until the P C Dynamics business is sold, the Company estimates incurring monthly pre-tax losses in the range of $75,000 to $100,000 per month. If the decision was made to cease P C Dynamic's business, the Company estimates incurring approximately $200,000 in severance and shutdown costs. If P C Dynamics' business were to cease, the Company estimates incurring expenses of approximately $84,000 each month for real estate taxes, utilities and security until the building and equipment can be disposed of.
* * * * * *
M~WAVE, Inc. and Subsidiaries
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below is a summary of the Company's unaudited quarterly results for each quarter during 1997 and 1996. In management's opinion, these results have been prepared on the same basis as the audited financial statements contained elsewhere herein and include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information for the periods when read in conjunction with the financial statements and notes thereto.
During the three months ended December 31, 1997, the Company recorded expenses of $2,604,448 for impairment of building and equipment, $670,000 for goodwill impairment and $471,718 for a writeoff of a note receivable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
M~WAVE, Inc.
By: /s/ Joseph A. Turek ----------------------- Joseph A. Turek Chairman of the Board, Chief Executive Officer March 15, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Joseph A. Turek /s/ Michael Bayles - --------------------- ----------------------- Joseph A. Turek Michael Bayles Director President and Chief March 15, 1998 Operating Officer March 15, 1998
/s/ Lavern D. Kramer /s/ Timothy A. Dugan - --------------------- ----------------------- Lavern D. Kramer Timothy A. Dugan Director Director March 15, 1998 March 15, 1998
/s/ Eric Larson /s/ Rick Mathes - --------------------- ----------------------- Eric Larson Rick Mathes Director Director March 15, 1998 March 15, 1998
/s/ Paul H. Schmitt - ------------------------ Paul H. Schmitt Treasurer and Secretary (Principal Accounting and Financial Officer) March 15, 1998
EXHIBIT INDEX
*Incorporated herein by reference to the applicable exhibit to the Registrant's Registration Statement on Form S-1 (Registration No. 33-45499).
**Incorporated herein by reference to the applicable exhibit to the Registrant's Annual Report on Form 10-K for year ended December 31, 1993 (Registration No. 0-19944).
***Incorporated herein by reference to the applicable Report on Form 8-K dated August 5, 1994.
****Incorporated herein by reference to the applicable exhibit to the Registrants quarterly report on form 10-Q for the quarter ended June 30, 1995.
*****Incorporated herein by reference to the applicable exhibit to the Registrant's Annual Report on Form 10-K for year ended December 31, 1995.
******Incorporated herein by reference to the applicable exhibit to the Registrants quarterly report on form 10-Q for the quarter ended March 31, 1997.