Item 1. Business
General
Blue Wave Systems Inc. (the "Company" or "Blue Wave Systems") designs, develops and markets programmable digital signal processing ("DSP") computing sub-systems that are used in telecommunications, communications analysis, medical imaging, radar, sonar and other systems. The Company's ComStruct(TM) range of products is designed for use in telecommunications infrastructure equipment, and the Company's older product lines (the `legacy' products) are designed for a range of industrial and military applications. The Company's products typically consist of open standards based DSP computing boards (utilizing commercially available DSP microprocessors) optimized for different application groups (e.g. telecommunications, wireless communications, or medical imaging) together with the Company's own software and third party software. This product may act as a complete functional sub-system that is integrated into the customer's product or as enabling technology that the Company's customers will program to build their own sub-system. The Company specializes in products that have a high processing density and are scalable to fit the processing demands of a given system. The Company's products are typically sold to original equipment manufacturers ("OEMs"), systems integrators, research organizations, and military/aerospace contractors who integrate the Company's products into their own products or equipment. The Company was formed in April 1998 upon the combination of Mizar, Inc. ("Mizar") and Loughborough Sound Images Ltd. ("LSI"), a company based in the United Kingdom.
Products and Markets
Beginning in 1999 and accelerating throughout fiscal 2000 the Company has sharpened its strategic direction such that substantially all engineering and marketing resources are directed to telecommunications systems. This focus has generated significant growth in the Company's communications products. In 2000, revenues from commercial communications applications grew to $9,238,000 as compared to $3,048,000 in 1999. Revenues from the Company's legacy line of mil/aero and industrial products grew to $25,590,000 in 2000 as compared to $24,303,000 in 1999. In 2001, the Company expects revenues from the communications products to continue to grow rapidly but the revenues from the legacy products are expected to decline. The Company's products use commercially available DSP microprocessors and general-purpose microprocessors to create DSP computing platforms that contain multiple DSP microprocessors. The Company's products are designed to address those applications that require either many signals to be processed (as is typical in many speech and data applications) or require those applications to impart a large amount of processing power on the signals (as is typical in many new wireless applications). The market for high performance DSP-based sub-systems and components has traditionally experienced rapid technological change, which requires high levels of expenditures for research and development. The Company must continue to introduce DSP-based products in order to retain its competitive position and will be required to constantly enhance its existing products and successfully develop new products.
Communications Products. The Company produces a range of products that are part of the ComStruct(TM) family and include open standards platforms described below and a software product, FACT(TM), that is designed to operate in conjunction with those platforms. These products are designed to meet the needs of customers producing equipment for the telecommunications infrastructure. Specific application areas include the following: voice over internet gateways that interconnect the public telephone network to the internet; high capacity voice archival systems that monitor calls and record them for later reference; wireless transcoders that interface cellular and other wireless systems to the public telephone network; modem pools that require specific non-standard modems to be interfaced to a data network; wireless internet gateways that interconnect cellular wireless systems directly to the internet; telecommunications test equipment and network simulators; 3rd generation wireless systems including demodulation, modulation, and vocoder functions; and; enhanced services platforms that provide value added services to voice networks including hands free dialing, email reading, and voice mail.
FACT (Framework Architecture for Communication Technologies) is a software product that is designed to operate with the ComStruct communications processing platforms. The FACT software runs on both the ComStruct platforms and the host computing system that is controlling those platforms. The FACT software supports a range of
operating systems including Sun Microsystems(TM) Solaris Operating Environment(TM), Microsoft(R) Windows NT(R), and Wind River(R) Systems' VxWorks(R). The main benefit of the FACT software is its management of the DSP sub-system and its ability to dynamically allocate DSP resources within the sub- system to tasks determined by the customer's application. The FACT software is portable across operating environments and is designed to be rapidly and readily adapted to individual customer's systems through a series of open interfaces. The software also provides the customer with an open interface for the DSP algorithms enabling the customer to easily integrate DSP functions supplied by Blue Wave Systems, other 3rd parties, or integrate their own proprietary algorithms and intellectual property. FACT is a key part of the ComStruct product range and not only reduces the customer's time to market but provides a high reliability software framework that is used in deployment to manage the DSP sub-system. Additional versions of the product will continue to be developed, adding to its capabilities and increasing the support for a variety of applications.
The first platforms in the ComStruct range, the PCI/C6400 and CPCI/C6400, were launched in January 1999. These platforms enable between 80 and 120 channels to be processed in applications requiring some form of speech coding (such as voice over internet, voice archival). The second generation of these products was released during fiscal year 2000 and provides for a significant increase (more than double) in the number of channels that can be processed by the platform.
The second platform in the ComStruct range is the VME/C6420. This product provides a high density of processing power and, by virtue of its design and architecture, high bandwidth interconnection between the processor nodes and external systems. This product was designed to target wireless communication applications and has been designed into multiple systems that are being used to trial 3rd generation wireless systems.
During 2000, the Company announced a new series of products, the CPCI/C5421 and PMC/C5421, designed for packet-based voice processing, or VoIP. These products are based on TI's C5000 series of DSP's. These products were first shipped to customers during the second half of fiscal 2000 and the Company has announced some significant design-wins from this new line of products.
Other Products. The Company has a range of general-purpose DSP board products that use open standard interfaces such as PCI and VME to interface to the customer's systems. These products generally contain multiple DSP microprocessors. These products are designed to be general purpose and are applicable to many applications. The Company has design-wins for these products in a variety of applications including government communications, communications test equipment, medical imaging, medical instrumentation, acoustic test equipment, industrial inspection and military/aerospace applications such as radar and sonar. In addition, the Company has variants of these products that are designed to operate in harsh environments where shock, vibration and temperature extremes are present. These products are used in a number of military/aerospace applications. DSP technology moves rapidly and most of these products use earlier generations of DSP microprocessors.
Strategy
Blue Wave Systems has been supplying open standards DSP platforms to a broad range of customers in the communications, defense, industrial and medical industries. The strategy is to build upon its position and skills as a leading supplier of DSP platforms to become the leading supplier of high-density DSP sub-systems for the communications industry. The Company has been using its knowledge of designing and manufacturing high density DSP platforms and its knowledge of the software architectures of high-density DSP sub-systems within telecommunication systems to develop a new product range called ComStruct. The Company intends to continue to exploit the increasing adoption of open standards and the increasing performance of commercially available DSP chips to enhance and expand its solutions for telecommunications, in particular targeting high value applications. The key elements of the Company's strategy include the following:
Target applications within the Telecommunications Industry. Many of the Company's latest generation of products are designed to address the demands of specific application areas such as call recording and screening, speech transcoding, voice over packet (such as VoIP), and 3rd generation wireless. The Company's strategy is to address applications within telecommunications by incorporating relatively unique value-added design and software features that optimize performance for a specific application type. According to third party studies the market for standards-
based board level telecommunications products is expected to experience an annual growth rate of approximately 40% during each of the next several years.
Provide Enabling Technology. The Company has focused its product line on those applications where high performance, product quality, and reliability are the customer's most important product considerations. The Company's products permit customers to decrease the time required developing their products, with the benefit of reduced risk and time to market. The Company will continue to provide solutions that enable its customers to gain the benefits of the latest commercially available DSP technology.
Partnership with Key Technology Providers. The Company's products use DSP chips supplied by the major semiconductor manufacturers. The ComStruct products use DSP chips exclusively from Texas Instruments chosen because of their suitability to the high-density communications applications targeted by the Company. The Company believes that these applications are significant to Texas Instruments and that they will continue to develop their DSP chip product range allowing Blue Wave Systems to further enhance the performance of its products. The Company also builds partnerships with other technology providers that target the same customer base as the Company and have complementary technology to those of the Company.
Global Support. The Company's primary customer base consists of large companies that have operations throughout the world. The Company believes that it has the ability to provide global life cycle support for its customers. For example, a customer may have an application software development group in France which requires intensive local assistance during early portions of the customer's product development cycle. As that product is deployed the Company is capable of providing logistics to supply the DSP sub-system to production facilities throughout the world.
Provide Professional Services. The Company's customers on occasion require modifications or small additions to the standard product in order to integrate it into their own product. The Company believes that the ability to make such modifications rapidly and assist customers with systems integration is a key factor in maintaining a competitive advantage.
Non-DSP Products
In 2000, the Company entered into a contractual agreement to grant manufacturing rights to a series of non-DSP products that was considered by the Company to be obsolete. In exchange, the Company will receive a defined royalty stream which is not expected to be material to the Company's results of operations in the future. Sales of these products were approximately $1,118,000 in 1999 as compared to $3,064,000 in 1998.
Sales and Marketing
The Company uses its own direct sales force and, to a lesser extent, independent manufacturer's representatives and distributors to market its products. The Company's customers frequently require that a product be tailored to their particular requirements. The Company believes that it is advantageous to have its own employees interacting directly with customers on a worldwide basis in order to fully understand their requirements. Blue Wave Systems' sales personnel generally have engineering or technical backgrounds which the Company believes enhances their ability to create relationships with their customer counterparts, who are typically design and systems engineers. The Company maintains its Corporate and North American headquarters in a suburb of Dallas, Texas, USA, and a European headquarters in Loughborough, Leicestershire, England. Regional sales and support staffs are located in Paris, France; Bremen and Munich, Germany; as well as the East Coast, West Coast, and central region of the USA.
Customers
The Company's customer base consists primarily of OEMs, defense contractors and research organizations which incorporate the Company's products as a part of their systems. Typically, these customers initially purchase a small volume of products for development testing and comparison to competitive products. If upon completion of testing the customer elects to incorporate the Company's product into its design, it frequently purchases the
Company's standard or customized products in higher volumes. Many global companies are users of the Company's DSP sub-systems including:
Motorola Sun Microsystems The Boeing Company Government of Israel Ericsson GDE Systems GE Medical Systems IBM Lockheed Martin Lucent Technologies Nokia Northrop Grumman Nortel Raytheon British Telecom Siemens AG
During the three years in the period ended June 30, 2000, the Company had two customers that comprised at least 10% of its annual revenue in a given year. A secure U.S. Navy communications program represented approximately 22% of revenues in 2000. Raytheon Company represented approximately 13% of the Company's revenues in fiscal 1998. During 1999, no customer individually accounted for more than 10% of revenues.
Backlog
The Company's backlog includes bookings based upon the receipt of a written purchase order. It generally does not include options in contracts for additional quantities not covered by a current purchase order. The Company's backlog for product expected to be delivered within 12 months at June 30, 2000, was $16,800,000 as compared to $17,000,000 as of the end of fiscal 1999. As the blend of the Company's business transitions to a larger proportion of commercial telecommunications, the amount of backlog relative to sales volume is expected to decline as a result of the manner in which the Company's customers prefer to do business. The Company cautions readers who may utilize published bookings and backlog information as tools to forecast the Company's revenue during a given timeframe since certain purchase orders may be subject to cancellation and/or delivery schedule revision.
Product Development
Blue Wave Systems has made a significant investment in its engineering group. The Company's current internal design strengths exist in areas such as DSP computing, software for the deployment of DSP sub-systems in telecommunications equipment, architectures for multiprocessor computing, high speed digital circuit design, application software development tools, harsh environment designs, device driver, and customization of designs.
Over the past year, the most significant investments have been targeted at telecommunications. The telecommunications product development team includes professionals with expertise in telecommunication system architectures, telecommunications application software, algorithms, and radio technology.
A small portion of the Company's investment in new product development is for general purpose DSP sub-systems suitable for a variety of applications and the completion of military/aerospace product development efforts that were started during fiscal 1998.
Blue Wave Systems incurred approximately $5,604,000, $6,236,000, and $7,509,000 in fiscal years 2000, 1999 and 1998, respectively, for product development and engineering expenses. The decrease in 2000 is due primarily to reduced expenses related to the legacy product lines and the continued reduction of spending that began in 1999 as a result of combining Mizar's and LSI's development teams. The reduction in spending for new product development in 1999 is a direct result of merger related synergies created by combining Mizar's and LSI's development teams.
Manufacturing and Quality Control
The quality and reliability of its products are fundamental to the Company's strategy. The Company's quality control systems have been awarded ISO9001 certification. In addition, most of the Company's software development processes have achieved certification under the internationally recognized Tick- IT standard.
The Company relies exclusively upon subcontractors to assemble its products. The Company believes that this enhances its flexibility in product development, as it is not required to invest in specialized capital equipment that may have limited use, but instead can choose subcontractors based upon their capabilities for particular manufacturing tasks. The existence of these outsourcing relationships allows the Company to absorb varying production levels without incurring the costs normally attendant to such fluctuations. The Company has relationships with several contract manufacturers but has no long-term contracts with any of them. The Company believes there are a number of contract manufacturers equipped to meet its needs although there is no assurance of this in the future. Blue Wave Systems' internal manufacturing operations consist primarily of test engineering, material purchasing, incoming inspection, and acceptance testing. The Company's subcontractors perform quality control at their facilities. Blue Wave Systems undertakes subsequent additional quality control procedures.
All of the Company's products incorporate electronic components available from a limited number of sources and in certain instances from a single source. The Company believes that electronic component availability is sufficient to meet the demand for its products.
Competition
The industries and markets in which the Company operates are highly competitive, and the Company believes that competition is likely to intensify. Many of the Company's competitors have substantially greater financial resources, larger engineering and sales staffs, as well as greater name recognition than the Company. The Company has direct competitors which use DSP technology similar to that of the Company. The Company also has competitors offering technologies other than programmable DSPs for signal/image processing applications. These technologies include application-specific integrated circuits ("ASICs"), fixed program DSPs, and programmable non-DSP processors. Often, the Company competes with the in-house design department of its customers. The Company believes that the increasing adoption of open standards by telecommunication equipment manufacturers, the decrease in time to market that these customers are trying to achieve and the shortage of highly skilled development engineers is expanding the market for the Company's products.
New or improved products can be expected from competitors in the future. Market participants must compete on many fronts, including processing capacity, ease of use, product quality, performance, reliability, price, name recognition, financial stability, customer support, development time, engineering expertise, and access to distribution channels.
Intellectual Property
The Company determined that trademark protection for the ComStruct range of telecommunications products, the FACT range of telecommunications software products and the SoftBand(TM) software radio was desirable, however, the majority of its products are referred to by their part numbers rather than by their specific names. The Company believes that due to the rapid pace of innovation within its industry, factors such as product quality, performance and reliability are more important in establishing and maintaining customer relationships than are the various protections afforded by patents.
In January 1997, the Company (LSI) entered into a distribution and manufacturing agreement with Spectrum Signal Processing, whereby Spectrum was appointed a distributor (non-exclusive from May 1, 1997) of certain of the Company's (LSI) products in North America. In addition, Spectrum was granted non-exclusive rights to manufacture certain of the Company's (LSI's) older DSP products in such territory for a period ending December 31, 2003. In return, Spectrum pays the Company at a rate based upon the selling price of the product(s) manufactured under this agreement. The Company retains ownership of its intellectual property rights associated with the products covered by the agreement. This agreement does not include any of the Company's ComStruct line of telecommunications products.
Employees
As of June 30, 2000, the Company employed 129 full-time employees, including 51 in product development, pre-sales engineering, and post-sales technical support; 35 in sales, sales support, and marketing; 23 in operations;
and 20 in finance, IT, general management, and administration. The Company's continued success will depend in large measure on its ability to attract and retain highly skilled employees. None of the Company's employees is represented by a labor union.
Combination of Mizar and LSI, and the Formation of Blue Wave Systems Inc.
Blue Wave Systems Inc. was formed as a result of the combination between Mizar and LSI that occurred in April 1998. The combination was completed via a share exchange whereby Mizar issued 7,876,964 common shares in exchange for all of the outstanding capital stock of LSI. Contemporaneous with completion of the combination, Mizar, Inc. amended its articles of incorporation and changed its name to Blue Wave Systems Inc. The Company's common stock now trades on The Nasdaq Stock Market(R) under the symbol BWSI. Mizar's former trading symbol was MIZR. The combination was accounted for as a pooling of interests and all historical financial information has been retroactively restated to reflect the combination.
Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995.
Certain matters discussed in this Form 10-K, other printed material and in oral presentations are forward-looking statements that involve risks and uncertainties. The following risk factors could affect the Company's actual results and cause actual results to differ materially from those projected in forward-looking statements. The following risk factors should not be construed as exhaustive and the Company disclaims any obligation subsequently to revise forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Technological Change. The market for high performance computer sub-systems and components has traditionally experienced short product life cycles and rapid technological change, requiring high levels of expenditures for research and development. The Company continues to introduce DSP-based products in order to retain its competitive position and will be required to continually enhance its existing products and successfully develop new products. In the event the Company does not continue to incorporate new advances in DSP technology into its products, the Company's business will be adversely affected. To the extent that technologies, other than those offered by the Company, prove to be superior for the high performance applications required by the Company's customers, the Company's business would be significantly impaired.
Quarterly Fluctuations. The Company's quarterly financial results may vary significantly depending upon factors such as the timing of significant orders, the timing and success of new product introductions by the Company and its competitors, and subcontractor delays. In the most recent fiscal years, the Company's business has been increasingly dominated by longer and larger customer contracts. Therefore, the procurement or loss of a single contract, or the change in delivery schedules thereunder, can significantly affect quarterly and annual financial results, including cash flow. Factors such as quarterly variations in financial results could cause the market price of the Company's common stock to fluctuate substantially and cause violations of the Company's debt agreements thereby impacting liquidity.
Dependence upon Suppliers and Subcontractors. All of the Company's products incorporate electronic components available from a limited number of sources and, in certain instances, from a single source. In the event of shortages of any of the single source components, the Company would be severely impacted. Delays on the part of certain key suppliers and subcontractors had a significant adverse effect on the Company's revenues during 1999. In addition, the Company has no internal manufacturing capability. In the event that one or more of the several qualified subcontractors currently used by the Company should cease operations or become unable or unwilling to handle the Company's requirements, the Company's relations with its customer may be adversely affected. In many cases, the Company's contracts with its key customers contain remedial and penalty clauses that could be triggered as a result of non-performance by the Company or one of the Company's suppliers or subcontractors.
Integration of Mizar's and LSI's Operations. The Company may not be able to successfully continue to integrate the operations, facilities and management of Mizar and LSI. Such integration could also have an adverse effect upon the Company's respective relationships with customers, suppliers, and key employees. The diversion of
management time towards such integration may also adversely affect customer support of existing products and the development of new products.
Defense Industry Customer Concentration. The Company's largest single concentration of customers is prime contractors in the United States military and aerospace industry. For several years the United States federal government has significantly reduced overall defense spending and, in certain cases, delayed or deferred funding for defense applications which in turn has, in certain occasions, adversely affected the Company's revenues. The Company believes, however, that reduced defense spending has increased the demand for efficiency and for upgraded electronics in new and existing defense electronics systems. There can be no assurance that continued defense cutbacks would not adversely affect the Company's customers and its business. Additionally, there has been extensive consolidation of companies in the defense industry, and further consolidation is possible in the future. There can be no assurance that such consolidation will not adversely affect the Company.
Dependence on Key Personnel. The Company is highly dependent on their key sales and technical personnel. There is a well-published acute market shortage of skilled technical personnel that are critical to the Company's success. The Company's future success will depend on its ability to attract and retain highly qualified personnel, which are in high demand in the job marketplace. There can be no assurance that the Company will be successful in hiring or retaining qualified personnel. The loss of key personnel, or inability to hire and retain qualified personnel, could have an adverse effect on the Company's business, financial condition and results of operations.
Competition. The Company participates in a highly competitive industry, which is subject to rapid and innovative technological change. There can be no assurance that future technological changes or the development of new or competitive products by others will not render the Company's current or planned products less competitive or obsolete. Additionally, many of the companies with which the Company competes have significantly greater financial and other resources than the Company.
Historical and Potential Future Operating Losses. The Company incurred net losses of $2,023,000 and $9,942,000 (inclusive of a $8,426,000 merger and realignment provisions) in fiscal 1999 and 1998, respectively. Additionally, the Company may generate an operating loss if its legacy lines of business begin a more rapid decline than expected. Further, should the Company successfully sell or otherwise dispose of its legacy products during fiscal 2001, the Company would likely begin to generate operating losses. The loss incurred in fiscal 1999 is primarily the result of production-related problems involving the Company's military/aerospace product line. The loss incurred in 1998 is due primarily to a decrease in the Company's revenues and, to a lesser extent, increased spending for product and market development. Many of the Company's potential customers, including those involved in the telecommunications and military/aerospace industries, are evaluating new DSP microprocessor technology for their next generation products, which appear to have dramatic performance enhancements as compared to current, widely available DSP microprocessors. Since many customers are in an evaluation stage, and availability of certain components, including new DSP microprocessors, is quite limited, the Company's ability to generate significant revenues from new DSP products is currently limited. If demand for the Company's new products is below that currently forecasted, or supply of components is less than forecasted, or the Company continues to experience production problems the Company could incur an operating loss during fiscal 2001. In the event the Company experiences an operating loss in 2001 and consumes working capital, the financial institutions which currently provide the Company with credit facilities might alter such facilities. In this situation, the Company may seek alternative sources of working capital.
Item 2.
Item 2. Properties
The Company's general corporate offices and North American headquarters are located in Carrollton, Texas (a suburb of Dallas) where it leases approximately 21,000 square feet at an annual rate of approximately $135,000. This lease expires in 2004 and contains a 5 year renewal option. In North America, the Company also leases offices for regional sales operations on the East Coast, West Coast, and central region of the USA. The Company's European headquarters are located in Loughborough, Leicestershire, England. This 44,000 square foot facility is leased at an annual rate of approximately $850,000.
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 Stockholders Matters
The Company's common stock trades on The Nasdaq Stock Market(R) under the symbol BWSI. Prior to the combination and name change in April 1998, it traded under the symbol MIZR. The following table lists the high and low price for each quarter.
Fiscal Year 2000 High Low ---------------- ---- --- First quarter $ 4.50 $2.56 Second quarter 10.75 3.69 Third quarter 22.91 9.56 Fourth quarter 14.50 7.00
Fiscal Year 1999 ---------------- First quarter 3.63 2.63 Second quarter 3.50 2.25 Third quarter 4.75 3.38 Fourth quarter 4.56 3.25
On August 24, 1999, the Company completed a private placement of common stock and warrants for consideration of $3,000,000 with an existing institutional shareholder of the Company. The Company issued 1,200,000 shares of common stock and two warrants convertible, in the aggregate, into 1,000,002 common shares. The first warrant, for 500,001 common shares at an exercise price of $3.50 per share, and the second warrant, also for 500,001 common shares, at an exercise price of $4.50 per share, were exercised in December 1999 resulting in total proceeds to the Company of $4,000,000. The agreements governing the placement contained anti-dilution and SEC registration requirements, as defined. The Company has used the proceeds from the placement and the warrant exercise for general working capital purposes.
As of September 25, 2000, the approximate number of beneficial stockholders was 1,400.
The Company has not declared or paid any dividends on its common stock, and does not anticipate paying any dividends in the foreseeable future.
Item 6.
Item 6. Selected Financial Data (Fiscal Years 1996-1997 have been restated to give effect to the combination) -----------------------------------------------------------------------------
(1) The accompanying restated consolidated statements of operations, stockholders' equity and cash flows combine Blue Wave's historical statements of operations, stockholders' equity and cash flows for the periods ended June 30, 1997 and 1996 with the corresponding Loughborough Sound Images Ltd. ("Sub") historical statements of operations, stockholders' equity and cash flows for the periods ended September 30, 1997 and 1996. The restated consolidated statements of stockholders' equity for the periods ended June 30, 1997 and 1996 reflect the exchange of each Sub common share for 94.632 shares of Blue Wave common stock (see Note 3 to the Consolidated Financial Statements).
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Year Ended June 30, 2000 Compared to Year Ended June 30, 1999
Net Sales. Net sales in 2000 were $34,828,000, an increase of $7,477,000, or 27% from the $27,351,000 reported in 1999. This increase is attributable to the Company's new line of telecommunications products. In 2000, revenues derived from the ComStruct line of telecommunications products were $9,238,000, or 27% of net sales, a 203% increase from 1999. Since its introduction in January 1999, ComStruct has achieved design-wins in a number of key application areas including 3G wireless communications, enhanced services, and VoIP. The product line consists of a variety of open-architecture hardware and software products which are used to perform signal processing functions with a telecommunications platform. There is a trend to outsource the procurement of signal processing platforms. As a result, the Company is forecasting further growth in 2001 for its ComStruct product range. Revenues derived from the Company's broad range of "legacy" products that are sold into the military, aerospace, test, and instrumentation markets were $25,590,000, or 73% of net sales, a 5% increase from 1999. Beginning in 2000, the Company began to allocate substantially all of its engineering and marketing efforts to the telecommunications marketplace. Therefore, the Company is forecasting a decline in revenues from its legacy products in 2001. On a geographic basis net sales in North America were $16,015,000 in 2000 as compared to $9,667,000 in 1999. Net sales to customers outside North America were $18,813,000 in 2000 as compared to $17,684,000 in 1999. The significant increase in North American sales is attributable to the ComStruct line of telecommunications products and a major program with the U.S. Navy that generated revenues of $7,690,000, or 22% of total revenues. The Company expects to continue to derive a significant portion of its revenues from this U.S. Navy program in 2001 but it is expected to decline in 2001 relative to 2000. The increase in net sales outside the U.S. is also due to the ComStruct line of telecommunications products, somewhat offset by an expected decline in net sales to the test/instrumentation marketplace. Order backlog as of June 30, 2000, was $16,800,000 as compared to $17,000,000 as of June 30, 1999.
Gross Margin. Gross margin as a percentage of revenues was 54.7% in 2000, as compared to 53.4% in fiscal 1999. The increase in 2000 is the result of the benefit of leveraging the Company's operations personnel over a larger revenue base. The Company's gross margin percentage has varied each year, and each quarter, in both a positive and negative fashion due to a variety of factors including customer and specific product mix, inventory provisions, and volume related efficiencies. Such variations will continue to impact gross margin percentages in future reporting periods
Product Development and Engineering. Engineering expenses decreased 10% to $5,604,000, or 16% of net sales in 2000, as compared to $6,236,000, or 23% of net sales in 1999. The decrease is due primarily to reduced expenses related to the legacy product lines and the continued reduction of spending that began in 1999 as a result of combining Mizar's and LSI's development teams. The Company's telecommunications product development efforts now comprise approximately 75% of new product development effort. The Company believes that the focus on this vertical market will greatly expand its available served market during 2001 and beyond.
Sales and Marketing. Sales and marketing expenses decreased 10% to $6,475,000, or 19% of net sales, in 2000, as compared to $7,157,000, or 26% of net sales, in 1999. The decrease is primarily due to a restructuring of the sales and marketing teams in line with the reduced emphasis on legacy products. The Company has continued to invest in new market development for its ComStruct line of telecommunications products and for related application and technical support personnel.
General and Administrative. General and administrative expenses increased 15% to $3,868,000, or 11% of net sales, in 2000, as compared to $3,375,000, or 12% of net sales, in 1999. The increase in absolute spending is the result of a number of factors including: a provision for the separation agreement with the Company's former chief executive officer, bonuses, higher average compensation, a commitment fee for a new line of credit agreement, and higher legal and professional fees.
Interest Income. Interest income increased to $102,000 in fiscal 2000, as compared to $84,000 in 1999. The slight increase is primarily due to the proceeds received from the Company's private placement of common stock completed during fiscal 2000.
Interest Expense. Interest expense decreased to $77,000 in fiscal 2000, as compared to $199,000 in 1999. The decrease is due to the elimination of short- term borrowings made possible by the proceeds received from the Company's private placement of common stock completed during fiscal 2000.
Provision for Income Taxes. The provision for income taxes was $317,000 in 2000, as compared to $106,000 in 1999. The Company's effective income tax rate is impacted by the utilization of operating loss carryforwards in both the United States and the United Kingdom. Pursuant to Section 382 of the Internal Revenue Code, a change in ownership of the Company greater than 50%, as defined, within a three-year period occurred twice, once in 1995 and once due to the combination with LSI in 1998. The Company's US annual utilization limitation related to its NOL carryforward is now $1,373,000.
The Company believes it is more likely than not that it will realize the net deferred tax asset of $1,085,000 recorded in the balance sheet as of June 30, 2000 and accordingly no valuation allowance has been provided on this portion of the asset. This conclusion is based on (1) changes in operations that have recently occurred, including the acquisition of LSI, which management believes has expanded its product capabilities and customer base, (2) cost reductions or synergies gained from the combination of Mizar and LSI, (3) the realignment of the Company including its strategy to expand its markets in the telecommunications industry, (4) the introduction of systems based upon the C6x technology, (5) limitation of the net operating loss carryforwards, as described above, related to the LSI merger, and (6) projections of sufficient taxable US income to fully realize the net recognized deferred tax asset by the end of calendar year 2001. Management continually evaluates the realizability of the net deferred tax assets and the need for a valuation allowance on such assets.
Year Ended June 30, 1999 Compared to Year Ended June 30, 1998
Net Sales. Net sales in 1999 were $27,351,000, a decrease of $5,328,000, or 16%, from the $32,679,000 reported in 1998. This decline in revenue is attributable to 1) production delays on three large military/aerospace programs and, 2) the technology transition created by the introduction of a revolutionary new family of DSP microprocessors from Texas Instruments. Historically, the Company has supplied complex products to the military/aerospace industry. This complexity is necessitated by environmental conditions, space and weight constraints, and processing demands. Products of this nature inherently involve greater production risks since many components are only available from one supplier and relatively few subcontractors are available for final assembly. Specifically, during the second half of 1999 the Company experienced supplier delays from vendors of printed circuit boards and memory devices. Additionally, production scheduled at one assembly contractor was also delayed by factors outside the Company's immediate control. All of these factors contributed to approximately $3 million of shipment delays which impacted net sales in 1999. The Company's focus on telecommunications products, which were not impacted by these production delays, will greatly reduce the Company's dependence on complex military/aerospace product sales. As mentioned above, the second factor that led to the decline in net sales was the introduction in 1997 of the C6000 family of DSP microprocessors from Texas Instruments (TI). Historically, the majority of the Company's products incorporate DSP's from TI. The Company believes the first release of the C6000 DSP represented a 10x improvement in performance over the existing widely available DSP's. Commercial OEMs and defense contractors are continuing to develop products that utilize these next generation DSPs which, in turn, creates tremendous opportunities for the Company in a number of emerging application areas such as wireless communications and internet telephony. The Company's strong order flow from customers in the
second half of 1999 coupled with the deferment of the delayed product shipments into 2000 led to a 50% annual increase in order backlog as of June 30, 1999. Order backlog as of June 30, 1999, was $17,000,000 as compared to $11,298,000 as of June 30, 1998. On a geographic basis net sales in North America were $9,667,000 in 1999 as compared to $13,332,000 in 1998. Net sales to customers outside North America were $17,684,000 in 1999 as compared to $19,347,000 in 1998. The decline in North American sales is mostly attributable to the production delays described above and, to a lesser extent, the technology transition. The decline in sales to customers outside North America can be attributed to the technology transition. Net sales from the Company's non-DSP products have continued to decline steadily and represented $1,118,000, or 4% of net sales in 1999, as compared to $3,064,000, or 9% of net sales in 1998.
Gross Margin. Gross margin as a percentage of revenues was 53.4% in 1999, as compared to 52.5% in fiscal 1998. The increase in 1999 is the result of inventory provisions taken in 1998 related to product scrap and obsolescence. A significant portion of the provision for product obsolescence in 1998 is related to the technology transition discussed above. The Company's gross margin percentage has varied each year, and each quarter, in both a positive and negative fashion due to factors mentioned above, and changes in customer and specific product mix. Such variations will continue to impact gross margin percentages in future reporting periods
Product Development and Engineering. Engineering expenses decreased 17% to $6,236,000, or 23% of net sales in 1999, as compared to $7,509,000, or 23% of net sales in 1998. The decline in absolute spending is the result of implementing the Company's post-merger organization plan immediately after the merger between Mizar and Loughborough Sound Images was completed in April 1998. Duplicate development efforts were eliminated and the use of external contractors was reduced. The post-merger plan for the Company also reflected a reduced level of new product development for the military/aerospace industry and more stringent cost controls for discretionary spending items.
Sales and Marketing. Sales and marketing expenses decreased 4% to $7,157,000, or 26% of net sales, in 1999, as compared to $7,434,000, or 23% of net sales, in 1998. The Company continued to invest in new market development for its ComStruct line of telecommunications products. The Company also employed additional sales personnel in the United States during 1999.
General and Administrative. General and administrative expenses decreased 14% to $3,375,000, or 12% of net sales, in 1999, as compared to $3,938,000, or 12% of net sales, in 1998. The reduction in absolute spending is the result of implementing the Company's post-merger organization plan immediately after the merger was closed in April 1998. The implementation of this plan included the elimination of duplicate functions and activities as well as stringent cost controls. Exclusive of a nonrecurring charge for separation agreements in 1999, general and administrative expenses were reduced by 17% from fiscal 1998.
Merger and Realignment Expenses. In 1998, the Company provided for estimated costs and expenses associated with completing the merger and implementing the post-merger organization plan. As of the end of fiscal 1999 the Company evaluated the adequacy of the original provision and determined that the estimate of the original provision should be reduced by $277,000, or 3% of merger and realignment expenses. Accordingly, this revision in estimate, primarily related to non-cash charges, was reflected as a nonrecurring reduction in operating expenses in 1999.
Interest Income. Interest income decreased to $84,000 in fiscal 1999, as compared to $506,000 in 1998. Cash reserves available for investment were greatly reduced near the end of 1998 and throughout 1999 as a result of the merger and realignment expenses and operating losses incurred in 1999. With respect to the merger, nonrecurring merger and realignment related expenses and the net cash used to redeem outstanding preference shares consumed over $8 million in cash. Operating losses incurred in 1999 also contributed to the decline in the level of cash available for investment.
Interest Expense. Interest expense increased to $199,000 in fiscal 1999, as compared to $109,000 in 1998. The increase in interest expense is the result of increased borrowings during 1999. The credit facilities utilized were with a commercial bank in the United Kingdom and a commercial bank in the United States. The increase in the average borrowing level was necessitated by the cash consumed by merger-related expenses and transactions as well as the operating loss incurred in 1999.
Provision for Income Taxes. The provision for income taxes was $106,000 in 1999, as compared to $255,000 in 1998. Despite reported net losses the Company did incur income related taxes in 1999 for state tax due in the U.S. and federal tax due in France. The 1998 provision relates to state tax due in the US and tax due in the UK. The Company recorded a valuation allowance on 100% of the losses in 1999 due to the recent unfavorable operating results. As a result of the significant net losses incurred in previous years, the Company has accumulated a net operating loss ("NOL") carryforward, a portion of which was used to reduce the Company's US federal income tax liability in fiscal years 1992 through 1997. Pursuant to Section 382 of the Internal Revenue Code, a change in ownership of the Company greater than 50%, as defined, within a three-year period occurred twice, once in 1995 and once due to the merger with LSI in 1998. The Company's US annual utilization limitation related to its NOL carryforward is now $1,373,000.
Liquidity and Capital Resources
The Company's cash flow provided (used) by operations was $141,000, $(2,423,000) and $(2,655,000) in fiscal 2000, 1999 and 1998, respectively. Net working capital was $15,690,000, $4,618,000 and $5,936,000 as of the end of fiscal 2000, 1999 and 1998, respectively. Cash flow from operations increased primarily as a result of income from operations offset by investments in inventory and higher accounts receivable due to higher revenues. The improved liquidity resulted from a private placement of stock and warrants in August of 1999. Under the private placement, the Company received total net proceeds of $6,926,000 from common stock and the subsequent exercise (in full) of warrants for common stock. The Company also received net proceeds aggregating $757,000 from the exercise of stock options, and an additional amount of approximately $300,000 of option proceeds that were used to pay down the debt related to the ESOP from which shares were issued upon the exercise of options. Merger related transactions had a significant negative impact upon the Company's working capital and cash flow from operations during 1998 and 1999 as did the Company's operating losses. Merger and realignment related expenses consumed approximately $1,700,000 of cash during 1999.
The Company's investment in capital equipment was $630,000, $701,000, and $1,233,000 in fiscal 2000, 1999 and 1998, respectively. Capital equipment generally consists of design engineering tools, simulation tools, production and design test equipment, and computers for general use.
The Company has utilized credit facilities to support its operations although at June 30, 2000 no short-term borrowings on facilities were outstanding. The Company maintains a $1,500,000 credit facility agreement with a commercial bank in the United Kingdom. This facility is collateralized by the assets of the Company's European operations, guaranteed by the U.S. parent company, bears interest at the bank's base rate plus 1.75% and is due on demand. The Company also has a $3,500,000 credit facility agreement with a commercial bank in the United States which is collateralized by the assets of the Company's U.S. operations and bears interest at the bank's prime rate plus 1%.
On August 24, 1999, the Company completed a private placement of common stock and warrants for consideration of $3,000,000 with an existing institutional shareholder of the Company. The Company issued 1,200,000 shares of common stock and two warrants convertible, in the aggregate, into 1,000,002 common shares. The first warrant, for 500,001 common shares at an exercise price of $3.50 per share, and the second warrant, also for 500,001 common shares, at an exercise price of $4.50 per share, were exercised in December 1999 resulting in total proceeds to the Company of approximately $4,000,000. The agreements governing the placement contained anti-dilution and SEC registration requirements, as defined. The Company has used the proceeds from the placement and the warrant exercise for general working capital purposes.
In connection with the establishment of an employee stock ownership plan ("ESOP"), which provides for the issuance of stock options for the benefit of employees of the Company's UK subsidiary, the Company has guaranteed the debt of the ESOP. The guarantee required the Company to place cash in escrow in an amount equal to the debt. Such cash has been reflected as restricted cash in the accompanying consolidated balance sheets. The guarantee is reflected as long- term debt in the accompanying consolidated balance sheets. This debt consists of a note payable to a commercial bank with interest at the bank's base rate (6.00% at June 30, 2000) plus 1.50%, for a total rate of 7.5% at June 30, 2000. The note is subject to renewal annually. The debt agreements related to this note contain warranties and covenants and require maintenance of certain financial ratios. Default on any warranty or
covenant could, if not waived or corrected, accelerate the maturity of any borrowings outstanding. Management believes the Company is in compliance with such warranties and covenants. In December 1999, proceeds aggregating $290,000 from eligible stock option exercises were used to reduce the balance of the note payable. The associated restricted cash balance was reduced in the third quarter of fiscal 2000 by an equivalent amount.
Management believes that through its current cash resources and currently available credit facilities it will have adequate resources to fund the Company's 2001 operating plan. If the Company incurs losses during fiscal year 2001, liquidity could be significantly impaired if the Company's debt facilities are materially altered or cancelled. In the event this occurred, the Company may find it necessary to secure other sources of working capital.
The Company will, from time to time, evaluate potential strategic transaction opportunities including acquisitions and joint ventures. In order to fund such a transaction the Company may find it necessary to seek additional working capital via a borrowing transaction or consider raising additional funds through an equity offering. The Company is also considering selling or otherwise disposing of its non-strategic legacy product lines. Should this occur during fiscal 2001, the Company currently anticipates that it may begin generating operating losses.
Recently Issued Accounting Pronouncements
In June 1998, Financial Accounting Standards Board Statement 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") was issued. SFAS 133 requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and measured at fair value. In addition, SFAS 133 specifies the accounting for changes in the fair value of a derivative based on the intended use of the derivative and the resulting designation. The Company does not have any derivatives and SFAS 133 does not have a material impact on the Company's financial position or disclosures. SFAS 133, as amended by SFAS 137 and SFAS 138, is effective for all quarters beginning in fiscal year 2001.
In December 1999, the SEC staff issued SAB 101 "Revenue Recognition in Financial Statements". SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. SAB 101 is effective in our fourth fiscal quarter of 2001. Management does not believe the adoption of SAB 101 will have a material impact on the Company's financial position or results of operations.
Item 7A.
Item 7A. Qualitative Disclosures about Market Risk
Interest Rate Risk. The Company generally invests cash balances in excess of operating requirements in money market funds. The Company's investments in these funds are subject to interest rate fluctuations, but management believes this risk is immaterial due to the nature of these investments. If the Company were to experience a 1% decrease in the effective interest rate, the effect on annual interest income would be a decrease of approximately $50,000. The carrying value of the funds would not be affected. The Company's lines of credit provide for borrowings which bear interest at a variable rate equal to the prime rates of the lenders. As of June 30, 2000, the Company did not have any borrowings outstanding under the credit agreements. The Company has a note payable which bears interest at a variable rate equal to the prime rate of the lender. If the Company were to experience a 5% increase in the variable rate of interest, the effect on interest expense would be an increase of approximately $25,000 annually. The Company believes that the effects, if any, of possible near-term changes in interest rates on the Company's financial position, results of operations and cash flows should not be material.
Foreign Currency Risk. The operations of the Company's international subsidiaries are primarily conducted in their respective local currencies. The Company is exposed to foreign exchange rate fluctuations since the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability and financial position. If the Company were to have experienced a 10% decrease in the United Kingdom pound sterling to US dollar foreign exchange rate, the impact on the results of operations for fiscal 2000 would have been a decrease of approximately $100,000. The effect of foreign exchange rate fluctuations on the Company's operations in fiscal 2000 was not material. The Company, to date, has not attempted to hedge foreign currency exposures. The Company does not enter into financial instrument transactions for trading or other speculative purposes.
Item 8.
Item 8. Financial Statements and Supplementary Data
See Financial Statements beginning on page.
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The directors and executive officers of the Company are as follows:
(1) Member of the Compensation Committee. (2) Member of the Audit Committee.
Rob N. Shaddock joined LSI in October 1992 as Technical Director, when LSI merged with Data Beta Ltd. He served as Marketing Director of LSI from 1997 until the time of the combination. In April 1998, he was named as Executive Vice President and a director of Blue Wave Systems. In November 1999, he was appointed Chief Executive Officer.
John R. Forrest, a director of LSI since 1996, was elected as a director of the Company on the date of the combination. He was a Professor of Electronic Engineering from 1970 to 1984 at University College London, following which he joined Marconi Defense Systems as Technical Director. Between 1986 and 1991, he was Director of Engineering at the Independent Broadcasting Authority. In 1991, he was appointed Chief Executive of National Transcommunications Limited ("NTL") from which he resigned in 1994. Since leaving NTL, Mr. Forrest has been engaged in the management of investments and continues to serve as director of several entities based in the United Kingdom. In February 2000, he was elected as Chairman of the Board of Directors.
Lynn J. Davis was appointed as a director of the Company in November 1999. He is a senior vice president of ADC Telecommunications Inc. and serves as President of ADC's Broadband Connectivity Group. He has headed the ADC Broadband Connectivity Group since 1990.
John L. Rynearson has been a director since 1982. Mr. Rynearson co-founded Mizar in 1982 and held a variety of technical and managerial positions with Mizar until 1991. He has served as the Technical Director of VITA (VME International Trade Association) since 1993. From 1992 to 1993, he served as President of Rystar, Inc., a VME training company. He is a director of Open Systems Service Corporation, a subsidiary of VITA.
Richard J. Thompson was appointed as a director of the Company in February 2000. He has served as the Vice President - Finance, Chief Financial Officer and Secretary of Artesyn Technologies, Inc. since June 1990.
Malcolm Brownsell was appointed as Chief Operating Officer of the Company in August 2000. He was VP of Operations of Integrated Micro Products beginning in 1988, and subsequent to the acquisition of Integrated Micro Products by Sun Microsystems in 1996, was appointed as General Manager and served in that position until 1997. He served as the Operations Director of Welwyn Systems from 1997 to 1998. From 1998 to August 2000, he served as Manufacturing Director for Psion Computing Ltd. and continued to serve in that position after the acquisition of the Psion manufacturing facility by Flextronics International.
M. Keith Burgess joined Mizar in September 1989 and has served in a variety of engineering and technical marketing management positions. He was named Vice President-Advanced Technology of Mizar in January 1997, and in April 1998, was named Chief Technology Officer for the Company.
Donald B. Crosbie was appointed as Chief Financial Officer and President of North American Operations of the Company in September 2000. He was President, COO and CFO of Ypay.com from September 1999 to July 2000. He was the founder of ComVest Partners Inc., an institutional research firm from 1995 to 1996.
Kevin Parslow joined LSI in October 1992 when LSI merged with Data Beta, where he was Sales and Marketing Director. In 1994, he was appointed as Sales Director of LSI, and in April 1998, was named the Vice President of Worldwide Sales for the Company. In March 2000, he was named Executive Vice President, Worldwide Sales and Marketing for the Company.
Each of the Company's directors holds office until the next annual meeting of stockholders and until their respective successors shall have been elected and qualified or until their earlier death, resignation or removal. The Company's officers are elected annually by, and serve at the discretion of, the Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
The information required by this item is incorporated by reference to the Company's Proxy Statement for the Annual Meeting of Stockholders' which will be filed on or before October 28, 2000.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated by reference to the Company's Proxy Statement for the Annual Meeting of Stockholders' which will be filed on or before October 28, 2000.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference to the Company's Proxy Statement for the Annual Meeting of Stockholders' which will be filed on or before October 28, 2000.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference to the Company's Proxy Statement for the Annual Meeting of Stockholders' which will be filed on or before October 28, 2000.
Part IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. and 2. Financial Statements and Financial Statement Schedules
These documents are filed with this report and are listed in the Index to Financial Statements on page.
3. Exhibits
A list of exhibits required to be filed as a part of this 10-K is set forth in the Exhibit Index.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K dated September 7, 1999 related to the private placement of common stock.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Blue Wave Systems Inc.
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.
BLUE WAVE SYSTEMS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Blue Wave Systems Inc.:
We have audited the accompanying consolidated balance sheets of Blue Wave Systems Inc. (formerly Mizar, Inc.) and subsidiaries (the "Company") as of June 30, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 2000. The consolidated financial statements give retroactive effect to the merger with Blue Wave Systems Ltd. (formerly Loughborough Sound Images Limited) on April 27, 1998, which has been accounted for as a pooling of interests as described in Note 1. These consolidated financial statements and Supplemental Schedule II are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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, based upon our audit, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 2000 and 1999, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2000, after giving retroactive effect to the merger with Blue Wave Systems Ltd. as described in Note 1, all in conformity with accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Schedule II listed in the index to consolidated financial statements is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not a part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas August 11, 2000
Blue Wave Systems Inc.
Consolidated Balance Sheets As of June 30, 2000 and 1999 (in thousands, except par value per share)
The accompanying notes are an integral part of these consolidated financial statements.
Blue Wave Systems Inc.
Consolidated Statements of Operations
For the Fiscal Years Ended June 30, 2000, 1999, and 1998 (in thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Blue Wave Systems Inc.
Consolidated Statements of Changes in Stockholders' Equity
For the Fiscal Years Ended 2000, 1999 and 1998 (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Blue Wave Systems Inc.
Consolidated Statements of Cash Flows
For the Fiscal Years Ended 2000, 1999 and 1998 (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
BLUE WAVE SYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEARS 2000, 1999, AND 1998
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Blue Wave Systems Inc. (formerly Mizar, Inc.) (a Delaware corporation) (the "Company", "Blue Wave" or "BWS Inc.") designs, develops and markets programmable Digital Signal Processing ("DSP") computing sub-systems that are used in telecommunications, communications analysis, medical imaging, radar, sonar and other systems. The Company's ComStruct(TM) range of products is designed for use in telecommunications infrastructure equipment, and the Company's older product lines (the `legacy' products) are designed for a range of industrial and military applications. The Company's products are typically sold to original equipment manufacturers, systems integrators, research organizations, and military/aerospace contractors who integrate the Company's products into their own products or equipment. The Company was formed in April 1998 upon the combination of Mizar, Inc. ("Mizar") and Loughborough Sound Images Limited ("LSI"), a company based in the United Kingdom.
Blue Wave Systems Limited ("Blue Wave Sub" or "Sub") (formerly Loughborough Sound Images Limited or "LSI") was incorporated in England in 1983 and is registered as a private limited company. Blue Wave Sub, and its wholly owned subsidiaries, are collectively referred to herein as "Sub" or "LSI".
Certain previously reported amounts have been reclassified to conform with current year presentation.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The accompanying consolidated financial statements of the Company have been prepared in accordance with United States generally accepted accounting principles. They give retroactive effect, for all periods presented, to the combination with Sub on April 27, 1998, which has been accounted for as a pooling of interests (see Note 3). The restated consolidated statement of stockholders' equity for the beginning of fiscal year 1998 reflects the exchange of each Sub common share for 94.632 shares of Blue Wave common stock (see Note 3).
Foreign Currency Translation
The functional currency of Sub is the United Kingdom pound sterling ("pound sterling") and the functional currency of BWS Inc. is the US dollar.
The historical financial statements of Sub have been translated into US dollars ("$") from pound sterling ("Pounds" or "(Pounds)") using the exchange rate at each balance sheet date for assets and liabilities, average exchange rate for each period for net sales, costs, expenses and other income and expenses, and at historical rates for stockholders' equity. Translation adjustments have been recorded as a component of other accumulated comprehensive income (loss) in the accompanying consolidated statement of stockholders' equity.
Cash and Cash Equivalents
Cash and cash equivalents include cash placed in money market funds or investments in highly liquid securities with original maturities of three months or less.
Restricted Cash
In connection with the establishment of an employee stock ownership plan ("ESOP"), Sub has guaranteed the debt of the ESOP. The guarantee required Sub to place cash in escrow in an amount equal to the debt. Such cash has been reflected as restricted cash in the accompanying consolidated financial statements (see Note 13).
Inventories
Inventories are stated at the lower of cost (including direct materials, labor, and applied overhead) or market using the first-in, first-out method (FIFO). The Company periodically reviews inventory items on hand and provides allowances, if necessary, to reduce inventory to its estimated realizable value.
Property, Plant, and Equipment
Property, plant and equipment, including assets under capital lease, are carried at cost and depreciated using the straight-line method over the estimated economic lives of the assets as follows:
Buildings/leasehold improvements 4 - 25 years Equipment 3 - 5 years Furniture and fixtures 2 - 5 years Software 1 - 3 years
Repair and maintenance expenditures are charged to expense as incurred, and expenditures for major renewals and betterments are capitalized.
When property, plant and equipment are sold or otherwise retired, the cost and accumulated depreciation applicable to such assets are eliminated from the accounts, and any resulting gain or loss is reflected in current operations.
The Company assesses the realizability of long-lived assets in accordance with Statement of Financial Accounting Standard (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. This statement 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.
Revenue Recognition
Revenue from product sales is recorded only when the earnings process is completed, which is principally when the product is shipped. The Company may receive advance payments on progress billings for certain long-term contracts. The Company defers revenue on progress billings until the product is shipped and the earnings process is substantially complete. At June 30, 2000, the Company has deferred $431,000 of progress billings on long-term contracts.
Research and Development
Research and development costs are included in and inseparable from product development and engineering expenses and are charged to expense as incurred. No research and development costs are capitalized.
Income Taxes
The Company uses the liability method to determine deferred taxes. Deferred tax assets and liabilities are based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of enacted tax law. Management continually evaluates the realizability of the net deferred tax assets and the need for additional valuation allowances on such assets.
Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average common shares outstanding. Diluted net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average common shares outstanding, including dilutive securities if net income exists.
Stock Compensation
The Company has elected to follow the proforma disclosure requirements promulgated by SFAS No. 123, Accounting for Stock-based Compensation, and has opted to continue to account for the stock option plan under APB Opinion No. 25, under which no compensation cost has been recognized in the accompanying consolidated statements of operations. The proforma disclosure can be found in Note 13 to the consolidated financial statements.
Warrant
On September 28, 1995, the Company completed an initial public offering ("IPO") of 918,000 shares of common stock. The Company sold John G. Kinnard and Company, Incorporated, as an underwriter of the IPO, a five-year warrant to purchase up to 15,000 shares of the Company's common stock, exercisable at $10.20 per share. As of June 30, 2000, this warrant had not been exercised.
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.
Fair Value of Financial Instruments
Management believes the recorded values of financial instruments approximate their current fair values as such items are current in nature and/or generally bear variable interest rates which adjust yield to derive current market value.
Recently Issued Accounting Pronouncements
In June 1998, Financial Accounting Standards Board Statement 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") was issued. SFAS 133 requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and measured at fair value. In addition, SFAS 133 specifies the accounting for changes in the fair value of a derivative based on the intended use of the derivative and the resulting designation. The Company does not have any derivatives and SFAS 133 does not have a material impact on the Company's financial position or disclosures. SFAS 133, as amended by SFAS 137 and SFAS 138, is effective for all quarters beginning in fiscal year 2001.
In December 1999, the SEC staff issued SAB 101 "Revenue Recognition in Financial Statements". SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. SAB 101 is effective in our fourth fiscal quarter of 2001. Management does not believe the adoption of SAB 101 will have a material impact on the Company's financial position or results of operations.
2. HISTORICAL OPERATING LOSSES AND OPERATING ENVIRONMENT:
Although the Company had net income in 2000, it incurred net losses of $2,023,000 and $9,942,000 (inclusive of a $8,426,000 merger and realignment provision) in fiscal 1999 and 1998, respectively. The loss in 1999 was primarily the result of production related problems involving the Company's military/aerospace product line, and technological changes impacting the Company's served markets which decreased the Company's revenues.
The Company operates in an environment which is subject to rapid technological change requiring high levels of expenditures for research and development, dependence on components that may be available from a limited number of suppliers, subcontractor manufacturing firm scheduling since the Company has no internal manufacturing capability, and quarterly fluctuations as the result of the timing of significant orders and new product introductions.
3. COMBINATION WITH SUB:
On April 27, 1998, Mizar, Inc. and Sub completed the combination announced in November 1997. The combination was completed via a share exchange with the Company issuing 7,876,964 common shares of the Company (the "Common Stock") to Sub shareholders in exchange for all outstanding Sub shares. BWS Inc. also issued options exercisable for approximately 564,000 shares of Common Stock in exchange for the outstanding Sub options. The foregoing issuances were based upon the exchange ratio of 94.632 shares of Common Stock for each ordinary share of Sub transferred to the Company, including shares issuable under options. The Company incurred significant costs and expenses to consummate this complex, cross-border transaction. Also, in conjunction with the merger, the Company realigned its business operations in order to better meet the needs of its customers, capitalize on the synergy between Blue Wave and LSI and to strategically focus the Company on the growing telecommunications market.
In fiscal 1998, the Company recorded an $8,426,000 nonrecurring charge for merger and strategic realignment related costs and expenses. In broad terms this provision includes all professional and statutory fees relating to the combination, a non-cash charge related to LSI stock options, and the cost necessary to execute the plan to streamline operations and reduce the Company's cost base from that of two independent companies. Approximately $4,800,000 of the total charge resulted in a cash outlay and approximately $3,600,000 of the charge was non-cash. The $3,600,000 non-cash portion provided for the vesting of stock options at LSI as well as duplicate and excess assets that occurred as a result of merging the two companies. The amount associated with the stock option provision was approximately $2,700,000 and relates to the establishment of a vesting date for LSI options as a result of the combination. Although reflected as a charge against income this provision had no net impact on shareholders' equity since it also increased paid-in-capital. Professional and statutory fees included legal, accounting, investment banking, and printing fees for both companies as well as a statutory transaction based tax in the UK, and SEC expenses in the US totaling approximately $2,500,000. Other cash outlays, which include travel, excess lease space, and employment severance, aggregated approximately $2,300,000. Of the total provision that resulted in cash outlay, approximately $2,700,000 was paid in fiscal 1998 and an additional $1,700,000 was paid in fiscal 1999. Approximately $213,000 was paid in fiscal year 2000 and approximately $60,000 will be paid in fiscal year 2001.
In fiscal 1999, the Company revised its estimate of certain merger and realignment charges. This resulted in a reduction of certain accruals. This change in estimate is reflected as a reduction to the merger and realignment costs of $277,000, primarily consisting of non-cash charges, in the accompanying consolidated statement of operations. As of June 30, 2000, approximately $117,000 of reserves for excess facilities is recorded in the accompanying consolidated balance sheet. The following table presents a summary of the remaining reserves for these expenses, as of June 30, 2000 and 1999, respectively.
Balance Sheet Classification 2000 1999 ---------------------------- ---- ---- Reserves included in other accrued liabilities $ 74,000 $249,000 Reserves included in other noncurrent liabilities 43,000 104,000
The table below presents a reconciliation of revenues and net income, as reported in the consolidated statements of income with those previously reported by the Company. The references to Blue Wave in this table are to the Company's historical operating results prior to the acquisition of Sub (amounts in table are in thousands).
Fiscal Year Ended ----------------- --------- REVENUES: Blue Wave $12,111 Sub 20,568 ------- Total consolidated revenues $32,679 =======
NET LOSS: Blue Wave $(5,677) Sub (4,265) ------ Total consolidated net loss $(9,942) ======
Included in the net loss of Sub for fiscal year 1998 are losses from discontinued operations of $137,000 (net of income tax benefits of $62,000). See Note 10.
4. INVENTORIES:
Net inventories at fiscal year-end 2000 and 1999, consisted of the following (in thousands):
2000 1999 ------ ------- Raw materials $3,135 $ 2,326 Work-in-process 2,636 2,185 Finished goods 1,258 1,705 Reserves (798) (1,097) ------ ------- Inventories, net $6,231 $ 5,119 ====== =======
5. OTHER ACCRUED LIABILITIES:
At fiscal year-end 2000 and 1999, other accrued liabilities consisted of the following (in thousands):
2000 1999 ---- ---- Sales representative commissions $ 330 $ 383 Property tax 42 38 Warranties 176 207 Accrued franchise tax and income tax payable 176 161 Professional services and other 227 185 Merger and realignment 74 249 Taxes payable, other than income 278 376 Other current liabilities 492 104 ------ ------ $1,795 $1,703 ====== ====== 6. ROYALTIES:
During fiscal years 2000 and 1999, the Company paid royalties of $96,000 and $90,000, respectively. The royalties paid in 2000 were related to sales of non-DSP products covered by a contractual agreement to grant manufacturing rights of those products and an agreement with an engineering service provider. The royalties paid in 1999 were primarily related to an agreement with an engineering service provider which provided for royalties to be paid upon sales of a specific product.
7. DEBT:
Lines of Credit
The Company utilizes credit facilities to support its operations. As of June 30, 2000, there were no loans outstanding under a facility with a commercial bank in the United Kingdom, with approximately $1,500,000 in aggregate availability under such credit facility. This facility is collateralized by the assets of the Company's European operations, guaranteed by the U.S. parent company, bears interest at the bank's base rate plus 1.75% and is due on demand. As of June 30, 2000, there were no loans outstanding under a $3,500,000 facility with a commercial bank in the United States. This facility is collateralized by the assets of the Company's U.S. operations, bears interest at the bank's base rate plus 1% and contains financial covenants. As of June 30, 1999 there was a total of $1,707,000 outstanding under credit facilities. As of June 30, 2000, the Company was in compliance with all its financial covenants under its agreements with both banks.
Long-term Debt
Long-term debt consists of the following (in thousands):
The debt agreements related to this note contain warranties and covenants and require maintenance of certain financial ratios. Default on any warranty or covenant could, if not waived or corrected, accelerate the maturity of any borrowings outstanding. Management believes the Company is in compliance with such warranties and covenants.
8. INCOME PER SHARE:
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, Earnings per Share. The Statement establishes standards for computing and presenting earnings per share ("EPS"). It replaces the presentation of primary EPS with a presentation of basic earnings per share. Additionally, it requires presentation of diluted EPS which is similar to fully diluted EPS, pursuant to APB Opinion No. 15.
Basic net income (loss) per share for each of the three fiscal years ended 2000 were computed by dividing net income (loss) applicable to common stock by the weighted average number of shares of common stock outstanding during the periods presented, as adjusted, on a historical basis, for the exchange ratio in the combination (Note 3). Diluted net income per share for fiscal 2000 was computed by dividing net income by the weighted average number of shares of common stock outstanding, including dilutive securities. Diluted net loss per share for fiscal years 1999 and 1998 were computed by dividing net loss applicable to common stock by the weighted average number of shares of common stock outstanding. Other dilutive securities outstanding during fiscal 1999 and 1998 were anti-dilutive to the net loss per share calculation. Other dilutive securities included in diluted net income per share are stock options and warrants calculated under the treasury stock method using the prevailing average market price for the period presented. Shares used in basic and diluted net income (loss) per share calculations for the fiscal years 2000, 1999, and 1998 are presented below (in thousands):
Dilutive securities equivalent to 646,000 and 990,000 shares of common stock were outstanding during 1999 and 1998, respectively, but were not included in the computation of diluted EPS because the Company incurred net losses attributable to common shareholders. The inclusion of these options would have been anti-dilutive to diluted EPS.
9. COMMITMENTS AND CONTINGENCIES:
The Company leases certain buildings and equipment under operating leases. Rent expense applicable to operating leases was $1,245,000, $1,316,000, and $1,337,000 for the fiscal years 2000, 1999, and 1998, respectively. At fiscal year-end 2000, the future minimum lease payments required by operating leases were as follows (in thousands):
2001 $ 1,215 2002 1,185 2003 1,051 2004 970 2005 835 Thereafter 12,668 -------- Total $ 17,924 --------
In prior periods, the Company has been party to certain legal proceedings incidental to its business. The Company accrues for claims that are both probable and for which expected loss can be reasonably estimated. Currently, there are no known claims pending against the Company.
10. DISCONTINUED OPERATIONS:
In April 1997, Sub adopted a plan to discontinue its Video Multimedia Group ("VMG") operations in order to focus resources on its digital signal processing products. The VMG operations principally designed, manufactured, and sold products for the video conferencing industry. These activities operated as a distinct business segment, the results of which have been separately disclosed as discontinued operations in the accompanying consolidated statements of operations. The VMG operations were fully abandoned by September 30, 1997. There were no sales of VMG in fiscal 2000, 1999 or 1998.
11. SIGNIFICANT CUSTOMERS, RECEIVABLES, AND CONCENTRATION OF CREDIT RISK:
The following table summarizes sales by major customer group for the fiscal years 2000, 1999, and 1998 and gross accounts receivable by major customer group at fiscal year-end 2000 and 1999 (in thousands):
2000 1999 1998 ------- ------- -------- SALES BY CUSTOMER GROUP: Commercial and other $22,489 $20,327 $25,135 Prime contractors to the US government 12,339 7,024 7,544 ------- ------- -------- $34,828 $27,351 $32,679 ======= ======= ========
2000 1999 ------- ------- ACCOUNTS RECEIVABLE BY CUSTOMER GROUP: Commercial and other $ 6,803 $ 4,418 Prime contractors to the US government 1,950 1,713 ------- ------- $ 8,753 $ 6,131 ======= =======
During 2000, one customer represented approximately 22% of net sales. During 1999, no customer individually accounted for more than 10% of net sales. During 1998, one customer accounted for 13% of net sales.
12. OPERATING SEGMENTS:
SFAS 131, Disclosure About Segments of an Enterprise and Related Information, requires companies to identify their operating segments based upon the internal financial information reported to the Company's chief operating decision-maker. Financial information is reported to the CEO by geographical region and reflects two business segments: North America and Outside of North America. The CEO
evaluates the performance of these segments based upon operating income. The accounting policies of these segments are the same as those described in Note 1 to the consolidated financial statements.
Revenues in North America are derived from all of the Company's customer groups. Revenues outside of North America are derived primarily from telecommunications and other commercial customers.
The Company's net sales, merger and realignment costs, operating income, capital expenditures, depreciation and identifiable assets by operating segment were as follows (in thousands):
The percentages of net sales by country of origination that were in excess of 10% of total net sales in fiscal 2000, 1999 and 1998 were: the United States with 46%, 35% and 41%, respectively, and the United Kingdom with 48%, 51% and 47%, respectively.
13. EMPLOYEE BENEFIT PLANS:
SFAS No. 123 Disclosure
The Company accounts for its stock option plan and its employee stock ownership plan in accordance with APB Opinion No. 25, under which no compensation cost has been recognized in the accompanying consolidated statements of operations. Had compensation cost been determined pursuant to the fair value recognition provisions of SFAS No. 123, the cost would have been $391,000, $195,000 and $250,000 for fiscal 2000, 1999 and 1998, respectively. The Company's proforma net income (loss) applicable to common stock for fiscal 2000, 1999 and 1998 would have been $2,446,000, $(2,218,000) and $(11,704,000) respectively, resulting in a diluted net income (loss) per share of $0.15, $(0.17) and $(0.92), respectively. The fair value of each option grant is estimated on the date of grant using the Black Scholes option pricing model with the following weighted-average assumptions used for options granted in fiscal 2000, 1999 and 1998: risk-free interest rate of 6.12%, 4.59% and 5.64%, respectively; expected volatility of 78.27%, 65.49% and 67.09%, respectively; expected dividend yield of zero and expected lives of 3 years.
Stock Option Plan
The Company has a stock option plan, which includes nonqualified and incentive stock options, for directors and employees. The total number of shares underlying options is approximately 2,500,000 and the options are granted at fair value as determined by the Board of Directors. Options are exercisable on a schedule determined by the Board of Directors and expire 10 years after the date of grant or earlier, in accordance with the terms of the plan.
All options are granted at fair value on the date of grant. There have been no grants of equity instruments other than options in the periods presented. The following summarizes the activity under the plan (number of shares in thousands):
The following table summarizes information about the outstanding and exercisable stock options at fiscal year-end 2000 (number of shares in thousands):
Employee Stock Ownership Plan
In April 1997, Sub established an employee stock ownership plan (the "ESOP") for the benefit of employees of Sub. The ESOP borrowed (Pounds)500,000 ($788,000) from a commercial bank and used the proceeds to purchase 2,358 shares (approximately 223,000 equivalent Blue Wave shares) of Sub's ordinary shares from a director of Sub at (Pounds)212 (approximately $343) per share which was estimated to be the fair value of Sub's ordinary shares. Sub has guaranteed the debt of the ESOP and has placed in escrow cash in an amount equal to the debt. Sub has reflected the guaranteed ESOP debt and a corresponding amount of guaranteed ESOP obligations as a reduction of stockholders' equity in the consolidated balance sheet at fiscal year-end 2000 and 1999. In fiscal 2000, proceeds aggregating $290,000 from eligible stock option exercises were used to reduce the balance of the debt. The associated restricted cash balance was reduced by an equivalent amount. Interest payments in 2000, 1999 and 1998 were $50,000, $72,000 and $76,000, respectively.
Under the terms of the ESOP, there were originally 223,000 shares available for the grant of stock options. The options are granted at fair value and are exercisable on a schedule as determined by the Board of Directors. These options expire 10 years after the date of grant or earlier, in accordance with the terms of the stock option agreements. Substantially all of the shares acquired have been allocated as stock option grants to employees of Sub, as shown in the table below (number of shares in thousands):
The following table summarizes information about the outstanding and exercisable stock options at fiscal year-end 2000 (number of shares in thousands):
Bonus Plan
Key full-time employees of the Company are eligible to participate in a bonus program in which yearly bonus amounts are calculated on predetermined performance formulas. There were $165,000, $0 and $26,000 of bonuses earned in 2000, 1999 and 1998, respectively, related to this program. Bonuses, if earned, are included in accrued compensation in the accompanying consolidated financial statements.
Defined Contribution Plan and Employee Savings Plan
The Company maintains a defined contribution profit sharing and retirement plan for substantially all US employees. Participants may elect to contribute up to the lesser of the statutory maximum or 20% of total compensation. The Company made total contributions to this plan of $28,000, $36,000 and $35,000 in 2000, 1999 and 1998, respectively.
Other
Certain officers of the Company, including its Chief Executive Officer, have employment contracts with the Company. These agreements define, among other items, the terms of employment, remuneration, and notice periods for termination.
14. INCOME TAXES:
At fiscal year-end 2000, Blue Wave had federal and foreign net operating loss (NOL) carryforwards of approximately $12,000,000 and $2,000,000, respectively, which begin to expire in 2002. Research and development tax credit carryforwards of approximately $41,000 at fiscal year ended 2000, were also available to reduce future federal income taxes. Pursuant to Section 382 of the Internal Revenue Code, a change in ownership occurred in 1995. As a result, Blue Wave was subject to a $2,300,000 annual net operating loss utilization limitation. A change in ownership pursuant to Section 382 also occurred with the combination in 1998. As a result, Blue Wave will be subject to a $1,373,000 annual net operating loss utilization limitation. Blue Wave had net deferred tax assets of $1,085,000 and $545,000 at fiscal year ended 2000 and 1999, respectively.
The components of the income tax provisions in the accompanying consolidated statements of operations consisted of the following (in thousands):
The US and foreign components of income (loss) from continuing operations before income taxes are as follows (in thousands):
2000 1999 1998 -------- ---------- ---------- US $1,798 $(1,789) $(5,646) Foreign 1,356 (128) (3,904) ------ -------- -------- Income (loss) from continuing operations $3,154 $(1,917) $(9,550) ====== ======== ======== The difference between the federal statutory tax rate and the effective tax rate for continuing operations is reconciled as follows (in thousands):
Deferred taxes are determined based on the estimated future tax effects of differences between the financial reporting and tax bases of assets and liabilities given the provisions of the enacted tax laws. The net deferred tax asset (liability) is comprised of the following (in thousands):
The Company believes it is more likely than not that it will realize the net deferred tax asset of $1,085,000 recorded in the balance sheet as of June 30, 2000 and accordingly no valuation allowance has been provided on this portion of the asset. This conclusion is based on (1) changes in operations that have recently occurred, including the acquisition of LSI, which management believes will expand its product capabilities and customer base, (2) cost reduction or synergies to be gained from the combination of Mizar and LSI, (3) the realignment of the Company including its strategy to expand its markets in the telecommunications industry, (4) the introduction of systems based upon the C6000 technology, (5) limitation of the net operating loss carryforwards, as described above, related to the LSI merger, and (6) projections of sufficient taxable US income to fully realize the net recognized deferred tax asset by the end of calendar year 2001. Management continually evaluates the realizability of the net deferred tax assets and the need for a valuation allowance on such assets.
15. CAPITAL STOCK
Common stock
In May 1997, Blue Wave announced a plan to repurchase up to $1,000,000 worth of the common stock outstanding. As of fiscal year-end 1997, 144,400 shares had been repurchased for a total of $509,000. In August 1997, Blue Wave announced a $1,000,000 expansion to its common stock repurchase plan. As of September 12, 1997, a total of 281,900 shares had been repurchased for a total of $1,081,000 since the commencement of the program in May. In the second quarter of fiscal 1998, the Board of Directors canceled the stock repurchase plan.
The combination was completed via a share exchange whereby Mizar issued 7,876,964 common shares in exchange for all of the outstanding capital stock of LSI.
On August 24, 1999, the Company completed a private placement of common stock and warrants for consideration of $3,000,000 with an existing institutional shareholder of the Company. The Company issued 1,200,000 shares of common stock and two warrants convertible, in the aggregate, into 1,000,002 common shares. The first warrant, for 500,001 common shares at an exercise price of $3.50 per share, and the second warrant, also for 500,001 common shares, at an exercise price of $4.50 per share, were exercised in December 1999 resulting in total proceeds to the Company of $4,000,000. The agreements governing the placement contained anti-dilution and SEC registration requirements, as defined. The anti-dilution provisions generally were triggered if the Company
completed an offering or warrant issuance below the price levels of this placement within defined time periods. The Company has used the proceeds from the placement and the warrant exercise for general working capital purposes.
Preference Shares
On April 10, 1997, Sub entered into an agreement with Boston Holdings Limited ("BHL"), a subsidiary of BancBoston Capital Limited, to sell to BHL at a subscription price of (Pounds)5,500,000 (approximately $8,914,000), 5,500,000 preference shares, one "B" ordinary share, and warrants to acquire an additional 20,115 "B" ordinary shares. The warrants were exercisable in whole or in part through March 31, 2012, at a price determined by a formula, which at the time of the combination was (Pounds)165 per share. Under the terms of Sub's Articles of Association, any proceeds resulting from the exercises of the warrants was to be used to redeem the preference shares. Contemporaneously with the combination, this warrant was exercised for (Pounds)3,318,975 (or approximately $5,571,000) and was converted into 1,903,522 common shares of Blue Wave Systems; and the preference shares were redeemed for approximately $10,023,000, inclusive of accrued dividends.
The preference shares accrued first preference cumulative dividends of 6% per annum beginning on April 1, 1998, such dividends being payable in cash biannually on March 31 and September 30. The preference shares also accrued a second preference cumulative dividend of 8% per annum until March 31, 1998, and 2% per annum thereafter, and such dividends were paid as one additional preference share for each pound sterling 1 in dividends due on March 31 and September 30. Dividends accrued between March 31, 1998 and April 27, 1998 (the date of redemption) were paid in cash.
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
A summary of the unaudited quarterly results of operations follows (in thousands, except per share amounts):
(1) The loss from continuing operations before taxes includes a merger and realignment benefit of $277,000 in the quarter ended June 30, 1999.
Schedule II
BLUE WAVE SYSTEMS INC.
VALUATION AND QUALIFYING ACCOUNTS
JUNE 30, 2000, 1999 AND 1998 (in thousands)
(1) As of the end of fiscal 1999 the Company evaluated the adequacy of the original provision for merger and realignment costs and determined that the estimate of the original provision should be reduced by $277,000. Accordingly, this revision in estimate was reflected as a nonrecurring reduction in operating expenses in 1999.
(2) Merger and realignment expenses in fiscal 1998 include a $2,700,000 non- cash charge related to variable stock options of LSI, other non-cash charges of $900,000 and cash payments of $2,700,000.
EXHIBIT INDEX
2.1 Share Purchase Agreement, dated November 17, 1997, between the Company and Loughborough Sound Images Limited (formerly Loughborough Sound Images plc). (2) 2.2 Letter Agreement dated March 24, 1998, between the Company and Loughborough Sound Images Limited. (2) 2.3 Securities Purchase Agreement, dated August 20, 1999, between the Company and the each of the purchasers of common stock and warrants. (5) 3.1 Certificate of Incorporation of the Company, as amended. (1) 3.2 Bylaws, as amended, of the Company. (3) 10.1 Loan and Security Agreement by and between Silicon Valley Bank and the Company dated March 1, 2000. (6) 10.2 Advice of Borrowing Terms by and between National Westminster Bank plc and the Company dated July 28, 1999. (4) 10.3 Form of Indemnification and Hold Harmless Agreement. (3) 10.4 Employment Agreement between the Company and Rob Shaddock. (6) 11 Computation of per share net income (loss). (6) 23.1 Consent of Arthur Andersen LLP. (6) 27 Financial Data Schedule. (6)
(1) Incorporated by reference to Exhibits in the Company's Registration Statement on Form S-3. (2) Incorporated by reference to Exhibits in the Company's Current Report on Form 8-K dated May 12, 1998. (3) Incorporated by reference to Exhibits in the Company's Registration Statement on Form S-1. (4) Incorporated by reference to Exhibits filed with the Company's Form 10-K filed for the year ended June 30, 1999. (5) Incorporated by reference to the Exhibit in the Company's Current Report on Form 8-K dated September 7, 1999. (6) Filed herewith.