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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2002 Commission File No. 0-19944
- ---------------------------------------- ---------------------------
M~WAVE, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 36-3809819
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) identification No.)
475 Industrial Drive, West Chicago, Illinois 60185
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (630) 562-5550
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 and 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
The registrant has 4,443,294 shares of common stock outstanding at November 6,
2002.
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
M~WAVE, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
DECEMBER 31 SEPTEMBER 30
2001 2002
------------ -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 2,102,784 $ 1,940,007
Accounts receivable, net of allowance for doubtful accounts,
2001- $100,000: 2002- $100,000 .................................... 8,829,686 2,788,744
Inventories ........................................................ 1,564,008 2,173,249
Refundable income taxes ............................................ 0 2,968,129
Deferred income taxes .............................................. 1,313,644 1,313,644
Prepaid expenses and other ......................................... 105,613 58,383
Restricted cash .................................................... 604,489 346,879
------------ ------------
Total current assets ........................................... 14,520,224 11,589,035
PROPERTY, PLANT AND EQUIPMENT:
Land, buildings and improvements ................................... 7,219,799 5,481,606
Machinery and equipment ............................................ 13,062,860 9,433,479
------------ ------------
Total property, plant and equipment ............................ 20,282,659 14,915,085
Less accumulated depreciation ...................................... (7,836,882) (2,530,234)
------------ ------------
Property, plant and equipment-net .............................. 12,445,777 12,384,851
ASSETS TO BE DISPOSED OF, NET .......................................... 0 842,901
OTHER ASSETS ........................................................... 331,731 334,241
------------ ------------
TOTAL .................................................................. $ 27,297,732 $ 25,151,028
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................... $ 3,112,370 $ 3,798,334
Accrued expenses ................................................... 1,491,547 928,937
Accrued income taxes ............................................... 152,931 0
Current portion of long-term debt .................................. 1,378,767 1,378,767
------------ ------------
Total current liabilities ...................................... 6,135,615 6,106,038
DEFERRED INCOME TAXES .................................................. 663,830 663,830
LONG-TERM DEBT ......................................................... 2,743,527 3,664,836
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; authorized, 1,000,000
shares; no shares issued ......................................... 0 0
Common stock, $.01 par value; authorized, 10,000,000 shares
6,179,112 shares issued and 4,456,294 shares outstanding
at December 31, 2001, 6,179,112 shares issued and 4,443,294
shares outstanding at September 30, 2002 ......................... 30,895 30,895
Additional paid-in capital ......................................... 8,439,072 8,439,072
Retained earnings .................................................. 11,512,072 8,531,527
Treasury stock, at cost, 1,722,815 shares, at December 31, 2001
and 1,735,815 shares at September 30, 2002 ........................ (2,227,279) (2,285,170)
------------ ------------
Total stockholders' equity ..................................... 17,754,760 14,716,324
------------ ------------
TOTAL .................................................................. $ 27,297,732 $ 25,151,028
============ ============
See notes to consolidated financial statements.
2
M~WAVE, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended September 30,
----------------------------------
2001 2002
----------- ------------
Net sales ................................. $ 8,611,111 $ 3,787,531
Cost of goods sold ........................ 6,934,527 6,537,287
----------- -----------
Gross profit (loss) ..................... 1,676,584 (2,749,756)
Operating expenses:
General and administrative .............. 579,071 545,830
Selling and marketing ................... 265,041 394,618
Restructuring expense ................... 0 1,752,108
----------- -----------
Total operating expenses .............. 844,112 2,692,556
----------- -----------
Operating income (loss) ................. 832,472 (5,442,312)
Other income (expense):
Interest income ......................... 25,523 45,817
Interest expense ........................ (102,679) (50,518)
Rental income ........................... 17,000 0
----------- -----------
Total other expense ................... (60,156) (4,701)
----------- -----------
Income (loss) before income taxes ..... 772,316 (5,447,013)
Provision (benefit) for income taxes ...... 293,451 (2,114,422)
----------- -----------
Net income (loss) ......................... $ 478,865 ($3,332,591)
=========== ===========
Weighted average shares outstanding ....... 4,544,689 4,443,294
Basic earnings (loss) per share ........... $0.11 ($0.75)
Diluted shares outstanding ................ 4,570,031 4,443,294
Diluted earnings (loss) per share ......... $0.10 ($0.75)
See notes to consolidated financial statements.
3
M~WAVE, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Nine months ended September 30,
----------------------------------
2001 2002
------------ ------------
Net sales ........................................... $ 46,586,193 $ 19,397,654
Cost of goods sold .................................. 37,627,062 19,611,629
------------ ------------
Gross profit (loss) ............................... 8,959,131 (213,975)
Operating expenses:
General and administrative ........................ 2,044,405 1,678,651
Selling and marketing ............................. 1,193,374 1,227,920
Restructuring expense ............................. 0 1,752,108
------------ ------------
Total operating expenses ........................ 3,237,779 4,658,679
------------ ------------
Operating income (loss) ........................... 5,721,352 (4,872,654)
Other income (expense):
Interest income ................................... 52,858 152,591
Interest expense .................................. (409,991) (151,542)
Rental income ..................................... 119,000
------------ ------------
Total other (expense) income .................... (238,133) 1,049
------------ ------------
Income (loss) before income taxes .............. 5,483,219 (4,871,605)
Provision (benefit) for income taxes ................ 2,155,756 (1,891,060)
------------ ------------
Net income (loss) ................................... $ 3,327,463 ($ 2,980,545)
============ ============
Weighted average shares outstanding ................. 4,562,918 4,449,397
Basic earnings (loss) per share ..................... $0.73 ($0.67)
Diluted shares outstanding .......................... 4,597,892 4,449,397
Diluted earnings (loss) per share ................... $0.72 ($0.67)
See notes to consolidated financial statements.
4
M~WAVE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended September 30,
------------------------------
2001 2002
----------- -----------
OPERATING ACTIVITIES:
Net income (loss) .............................................. $ 3,327,463 ($2,980,545)
Adjustments to reconcile net income (loss) to net cash flows
from operating activities:
Loss on disposal of property, plant and equipment .......... $ 0 $ 986,108
Depreciation and amortization .............................. 1,195,470 1,134,000
Deferred income taxes ...................................... 472,591 0
Changes in assets and liabilities:
Accounts receivable-trade .................................. 1,543,471 6,040,942
Inventories ................................................ 6,349,184 (609,241)
Income taxes ............................................... (729,911) (3,121,060)
Prepaid expenses and other assets .......................... (315,270) 44,720
Restricted cash ............................................ 0 257,610
Accounts payable ........................................... (3,473,278) 685,964
Accrued expenses ........................................... (389,255) (562,610)
----------- -----------
Net cash flows provided by operating activities ......... 7,980,465 1,875,888
----------- -----------
INVESTING ACTIVITIES:
Purchase property, plant and equipment ......................... (5,142,100) (2,902,083)
----------- -----------
Net cash flows used in investing activities ............. (5,142,100) (2,902,083)
FINANCING ACTIVITIES:
Long term debt ................................................. 3,472,972 2,302,623
Payments on short and long term debt ........................... (5,925,297) (1,381,314)
Purchase treasury stock ........................................ (468,376) (57,891)
----------- -----------
Net cash flows (used in) provided by financing activities (2,920,701) 863,418
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS ........................ (82,336) (162,777)
CASH AND CASH EQUIVALENTS - Beginning of period .................. $ 1,230,999 $ 2,102,784
----------- -----------
CASH AND CASH EQUIVALENTS - End of period ........................ $ 1,148,663 $ 1,940,007
=========== ===========
5
M~WAVE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States of America for interim financial information and with the
instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments necessary for a fair presentation, consisting only of normal
recurring adjustments, have been included. For further information, refer to
the consolidated financial statements contained in the Annual Report on Form
10-K for the year ended December 31, 2001 filed March 28, 2002.
2. BUSINESS
M~Wave, Inc. through its wholly owned subsidiary Poly Circuits, Inc.,
is a value-added service provider of high performance printed circuit boards
used in a variety of digital and high frequency applications for wireless
and industrial electronics applications. M~Wave satisfies its customers
requirements for wireless and industrial electronics applications by using
its 50,000 square foot state-of-the-art prototype and small volume facility
located in West Chicago, Illinois and by outsourcing and coordinating the
manufacture of such boards by a global base of suppliers located primarily
in the Far East ("Virtual Manufacturing"). Virtual Manufacturing
contractually supplies all the printed circuit needs of our customers by
managing the complete procurement process. We deliver products when the
customer needs them through either consignment inventory control or
just-in-time programs.
The Company began Virtual Manufacturing during 2000 by developing
subcontracting relationships with Global manufacturers. The Company
typically begins the Virtual Manufacturing process by manufacturing
prototypes and pre-production printed circuits at its manufacturing
facility. The Company often works closely with customer personnel during
this stage to finalize fabrication details and guidelines for circuit
boards. As customers' requirements for circuit boards develop into higher
volumes, the Company subcontracts the manufacture of the circuit boards to
Global manufacturers. The Company continues to monitor the production and
quality control of the circuit boards and works with its customers and
Global manufacturers throughout the Virtual Manufacturing process. The
Company believes that Virtual Manufacturing allows the Company to satisfy a
broader range of its
6
customers' printed circuit board requirements without incurring substantial
capital expenditures for plant, property and equipment.
The Company added new levels of capacity in 2001 with the addition of
its new facility in West Chicago, Illinois. The new state-of-the-art 50,000
square foot facility in West Chicago enables the Company to provide
quick-turn prototypes to customers and to manufacture pre-production printed
circuit boards for specific customer application. These process capabilities
are an essential part of the Virtual Manufacturing process and the Company's
ability to attract new customers.
The Company closed its Bensenville facilities in the third quarter of
2002 and consolidated operations at its West Chicago facility. The Company
recorded a one time pre-tax charge of $1,752,000 in the third quarter of
2002 relating to closing and consolidation of the Bensenville facilities
into West Chicago. The third quarter 2002 results also included
non-recurring events that increased gross loss by approximately $697,000.
In addition, the Company produces customer specified bonded assemblies
consisting of a printed circuit board bonded in some manner to a metal
carrier or pallet. One bonding technique used by the Company is
Flexlink(TM), a patented process granted to the Company in 1993. The Company
developed an enhanced version called Flexlink II(TM) in 1996.
The Company's printed circuit boards and bonded assemblies are used in
a variety of telecommunications and industrial electronic applications. Many
of the Company's printed circuit boards are Teflon(TM) based and are
advantageous for microwave systems because of their extremely low power
losses, coupled with stable, predictable electrical characteristics.
The production of Teflon(TM) based printed circuit boards and bonded
assemblies is technologically demanding due to the precise requirements of
their end-use applications and the miniaturization of the microwave
frequency components. To meet these technological demands, the Company has
developed manufacturing processes and designs, which reduce the cost and
increase the manufacturability and reliability of customer systems.
Additionally, the Company emphasizes quality engineering and design support
for its customers. The Company is subject to stringent technical evaluation
and ISO certification by many of its customers.
The Company markets its products through regional sales managers
supported by independent sales organizations. The Company's base of
approximately 100 customers represents a highly sophisticated group of
purchasers.
7
M~Wave was incorporated in Delaware in January 1992 in connection with
a 100 for 1 share exchange with the former stockholders of Poly Circuits,
Inc. The Company's executive offices are located at 475 Industrial Drive,
West Chicago, Illinois 60185, and its telephone number is (630) 562-5550.
3. INVENTORIES
Inventories are carried at the lower of first-in, first-out (FIFO) cost
or market. Substantially all the Company's inventories are in work in
process. The Company provides a reserve for slow moving and obsolete
inventory. During the second quarter of 2002, the Company negotiated a
settlement for previously reserved inventory not expected to be recovered in
the amount of $2,500,000.
4. DEBT
The Company has an installment loan of $127,000 collateralized by
certain fixed assets of the Company. Interest on this loan is at the prime
rate. The loan is payable in monthly installments of principal and interest
and is due in October 2004.
On July 26, 2001, the Company signed an agreement with the Illinois
Development Finance Authority to borrow up to a maximum $8,100,000 to
finance its facility in West Chicago, Illinois. Borrowings can be disbursed,
in accordance with the agreement, to the Company for up to three years.
Interest is set on a weekly basis, based upon the interest rates of
comparable tax-exempt bonds under prevailing market conditions. The interest
rate at September 30, 2002 was 1.99%. The term of the bond is 20 years with
the first payment of $1,320,000 due and made in July 2002. Through September
30, 2002 the Company owes $4,916,000.
The Company was in default on September 30, 2002 because of its failure
to comply with the financial ratios as set forth in the Reimbursement
Agreement relating to the bond. On November 8, 2002, the Company entered
into a Forbearance Agreement with Bank One, N. A., formerly known as
American Bank and Trust Company of Chicago, pursuant to which the Company
agreed to comply with all of the terms and conditions contained in the
Forbearance Agreement and the Bank agreed to forbear from the date of the
agreement to December 31, 2002 from pursuing its rights under the
Reimbursement Agreement (including the right to declare the bond immediately
due and payable) provided the Company complies with all of the terms and
conditions contained in the Forbearance Agreement. See attached exhibit
10.21.
8
The Company had a line of credit agreement, which expired on May 15,
2002. The Company is currently negotiating to replace short and long-term
debt.
5. LITIGATION
The Company is a party to various actions and proceedings related to
its normal business operations. The Company believes that the outcome of
this litigation will not have a material adverse effect on the financial
position or results of operations of the Company.
9
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS FOR THE QUARTER ENDED SEPTEMBER 30, 2002 COMPARED TO THE QUARTER ENDED
SEPTEMBER 30, 2001
NET SALES
Net sales were $3,787,000 for the quarter ended September 30, 2002, a
decrease of $4,824,000 or 56% below the third quarter of 2001. The decrease in
net sales is directly related to a drop in demand in the telecom industry.
Virtual Manufacturing accounted for approximately $2,812,000 of net sales or 74%
in the third quarter of 2002 compared to $7,660,000 of net sales or 89% in the
third quarter of 2001.
Net sales to Lucent were $4,779,000 in the third quarter of 2001. There
were no sales to Lucent during the third quarter of 2002. Net sales to Celestica
were $785,000 in the third quarter of 2002 compared to $2,749,000 in the third
quarter of 2001. On September 1, 2001, Lucent transitioned a segment of their
manufacturing operations at Columbus, Ohio to Celestica. Celestica is based in
Toronto, Canada. On September 1, 2001, Lucent also transferred most of their
open purchase orders with the Company to Celestica. The reduction in net sales
to Lucent and Celestica reflect the drop in demand in the telecom industry and
the end of life of several product lines.
Lucent accounted for 56% of the Company's net sales in the third
quarter ended September 30, 2001. Celestica accounted for 21% of the Company's
net sales for the third quarter ended September 30, 2002 compared to 32% in the
third quarter of 2001. RF Power accounted for 9% of the Company's net sales in
the third quarter ended September 30, 2002 compared to 1% of the Company's net
sales for the third quarter ended September 30, 2001. Westell, a new Virtual
Manufacturing customer, accounted for 37% of the Company's net sales for the
third quarter ended September 30, 2002.
GROSS PROFIT AND COST OF GOODS SOLD
The Company's gross loss for the third quarter of 2002 was ($2,750,000)
compared to a gross profit of $1,677,000 for the third quarter of 2001. The
decrease in gross profit is a result of the decrease in net sales, a drop in
demand in the telecom industry and the closing and consolidation of the
Bensenville facility. The closing and consolidation also allowed the Company to
reduce the staff from approximately 180 employees during the second quarter to
approximately 110 employees. The reduction included both hourly and salary
employees. Gross Margin was negative in the third quarter of 2002 compared to
approximately 20% in the third quarter of 2001. The third quarter 2002 results
10
included non-recurring events that increased gross loss by approximately
$697,000. These events were a result of the end of life of several products
including products the Company supplied to Celestica. Had these events not
occurred, the gross loss for the third quarter would have been a loss of
approximately $2,052,000.
OPERATING EXPENSES
General and administrative expenses were $546,000 or 14.4% of net sales
in the third quarter of 2002 compared to $579,000 or 6.7% of net sales in the
third quarter of 2001. General and administrative expenses consist primarily of
salaries and benefits, professional services, depreciation of office equipment,
computer systems and occupancy expenses. Payroll related expenses were down
$33,000. Professional services, which include legal and auditing fees, were down
$23,000.
Selling and marketing expenses were $395,000 or 10.4% of net sales in
the third quarter of 2002 compared to $265,000 or 3.1% of net sales in the third
quarter of 2001. Selling and marketing expenses include the cost of salaries,
advertising and promoting the Company's products, and commissions paid to
independent sales organizations. Commissions paid to independent sales
organizations were up $19,000. Payroll related expenses were up $97,000 with the
addition of regional sales managers and support staff.
Restructuring expenses were $1,752,000 or 46.3% of sales in the third
quarter of 2002. Restructuring expenses include costs associated with the
closing, cleanup and disposition of the Bensenville facilities. These expenses
include (1) the net write-down and disposal of approximately $986,000 of
specific assets that were not required at the West Chicago facility, (2)
cleanup, sale and related expenses of $680,000 for the Bensenville facilities
and (3) severance payments of $86,000.
OPERATING INCOME
Operating loss was ($5,442,000) in the third quarter of 2002 compared
to an operating income of $832,000 or 9.7% of net sales in the third quarter of
2001, a decrease of $6,275,000. The changes in operating income reflect
primarily the changes in net sales, gross profit and cost of goods sold,
operating expenses and the closing and consolidation of the Bensenville facility
as discussed above. The change in operating income can be summarized as follows:
Decrease in net sales ($939,000)
Decrease in gross margin (3,487,000)
Increase in operating expenses (1,849,000)
-----------
Decrease in operating income ($6,275,000)
11
INTEREST INCOME
Interest income from short-term investments was $46,000 in the third quarter
of 2002 compared to $26,000 in the third quarter of 2001. Rental income from the
P C Dynamics facility was $17,000 in the third quarter of 2001. The Company sold
the P C Dynamics facility in the fourth quarter of 2001.
INTEREST EXPENSE
Interest expense, primarily related to the Industrial Revenue Bond was
$51,000 in the third quarter of 2002 compared to $103,000 in the third quarter
of 2001. The Company had a mortgage obligation on the P C Dynamics facility in
the third quarter of 2001.
INCOME TAXES
In the third quarter of 2002, the Company had an effective tax credit of
38.8% compared to an effective tax rate of 38.0% in the third quarter of 2001.
12
RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE NINE MONTHS
ENDED SEPTEMBER 30, 2001
NET SALES
Net sales were $19,398,000 for the nine months ended September 30, 2002, a
decrease of $27,189,000 or 58% below the first nine months of 2001. The decrease
in net sales is directly related to a drop in demand in the telecom industry.
Virtual Manufacturing accounted for approximately $15,769,000 of net sales for
the first nine months of 2002 compared to $42,630,000 for the first nine months
of 2001. The first nine months of 2002 also included two non-recurring events
that boosted sales by $3,600,000. These events were the result of the end of
life of several products we produced for Lucent and the shipment of inventory we
were holding for Westell. Had these events not occurred, the net sales for the
first six months of 2002 would have been approximately $15,798,000.
Net sales to Lucent were $2,528,000 for the first nine months of 2002
compared to $38,303,000 for the first nine months of 2001. Net sales to
Celestica were $6,898,000 for the first nine months of 2002 compared to
$4,194,000 for the first nine months of 2001. On September 1, 2001, Lucent
transitioned a segment of their manufacturing operations at Columbus, Ohio to
Celestica. Celestica is based in Toronto, Canada. On September 1, 2001, Lucent
also transferred most of their open purchase orders with the Company to
Celestica.
Celestica accounted for 36% of the Company's net sales for the first nine
months of 2002 compared to 9% for the first nine months of 2001. Lucent
accounted for 13% of the Company's net sales for the first nine months of 2002
compared to 82% for the first nine months of 2001. Westell, a new Virtual
Manufacturing customer, accounted for 26% of the Company's net sales for the
first nine months of 2002.
GROSS PROFIT AND COST OF GOODS SOLD
The Company's gross loss for the first nine months of 2002 was ($214,000)
compared to a gross profit of $8,959,000 for the first nine months of 2001. The
decrease in gross profit is a result of the decrease in net sales, a drop in
demand in the telecom industry and the closing and consolidation of the
Bensenville facility. The closing and consolidation also allowed the Company to
reduce the staff from approximately 180 employees during the second quarter to
approximately 110 employees. The reduction included both hourly and salary
employees. Gross Margin was negative for the first nine months of 2002. Gross
margin was 19% for the first nine months of 2001. The first nine months of 2002
included non-recurring events that boosted revenue by $3,600,000 and
13
gross margin by $1,803,000. These events were a result of the end of life of
several products including products the Company produced for Lucent and
Celestica and the shipment of inventory we were holding for Westell. Had these
events not occurred, the gross loss for the first nine months would have been
approximately ($2,014,000).
OPERATING EXPENSES
General and administrative expenses were $1,679,000 or 8.7% of net sales for
the first nine months of 2002 compared to $2,044,000 or 4.4% of net sales for
the first nine months of 2001. General and administrative expenses consist
primarily of salaries and benefits, professional services, depreciation of
office equipment, computer systems and occupancy expenses. Payroll related
expenses were down $307,000 due to a reduction in the bonus award. Professional
services, which include legal and auditing fees, were down $84,000. IT expenses
were up approximately $93,000.
Selling and marketing expenses were $1,228,000 or 6.3% of net sales for the
first nine months of 2002 compared to $1,193,000 or 2.6% of net sales for the
first nine months of 2001. Selling and marketing expenses include the cost of
salaries, advertising and promoting the Company's products, and commissions paid
to independent sales organizations. Commissions paid to independent sales
organizations were down $355,000. Payroll related expenses were up $313,000 with
the addition of three regional sales managers and support staff.
Restructuring expenses were $1,752,000 or 9.0% of sales for the first nine
months of 2002. Restructuring expenses include costs associated with the
closing, cleanup and disposition of the Bensenville facilities. These expenses
include (1) the net write-down and disposal of approximately $986,000 of
specific assets that were not required at the West Chicago facility, (2)
cleanup, sale and related expenses of $680,000 for the Bensenville facilities
and (3) severance payments of $86,000.
OPERATING INCOME
Operating loss was ($4,873,000) or (25.1%) of net sales for the first nine
months of 2002 compared to an operating income of $5,721,000 or 12.3% of net
sales for the first nine months of 2001, a decrease of $10,594,000. The changes
in operating income reflect primarily the changes in net sales, gross profit and
cost of goods sold, operating expenses and closing and consolidation of the
Bensenville facility as discussed above. The change in operating income can be
summarized as follows:
14
Decrease in net sales ($5,229,000)
Decrease in gross margin (3,944,000)
Increase in operating expenses (1,421,000)
------------
Decrease in operating income ($10,594,000)
INTEREST INCOME
Interest income from short-term investments was $153,000 for the first nine
months of 2002 compared to $53,000 for the first nine months of 2001. Rental
income from the P C Dynamics facility was $119,000 for the first nine months of
2001. The Company sold the P C Dynamics facility in the fourth quarter of 2001.
INTEREST EXPENSE
Interest expense, primarily related to the Industrial Revenue Bond was
$152,000 for the first nine months of 2002 compared to $410,000 for the first
nine months of 2001. The Company had a mortgage obligation on the P C Dynamics
facility in the first seven months of 2001.
INCOME TAXES
For the first nine months of 2002, the Company had an effective tax credit
of 38.8% compared to an effective tax rate of 39.3% for the first nine months of
2001.
15
LIQUIDITY AND CAPITAL RESOURCES
Net cash flows provided by operations was $1,876,000 for the first nine
months of 2002 compared to providing $7,980,000 for the first nine months of
2001. Accounts receivables decreased $6,041,000. Inventories increased $609,000.
Accounts payable increased $686,000. Depreciation and amortization was
$1,134,000. The loss on disposal of property, plant and equipment was $986,000.
Capital expenditures mainly relating to the new West Chicago facility were
$2,902,000 for the first nine months of 2002. The Company has limited plans for
capital expenditures during the fourth quarter of 2002.
The Company has an installment loan of $127,000 collateralized by certain
fixed assets of the Company. Interest on this loan is at the prime rate. The
loan is payable in monthly installments of principal and interest and is due in
October 2004.
The Company completed financing of $8,100,000 from the Illinois Development
Finance Authority's 2001 maximum limit on tax-exempt private activity bonds to
finance its facility in West Chicago, Illinois on July 26, 2001. The bond
replaced approximately $2,865,000 of credit line debt, which had an interest
rate of 6% at the time. The interest on the bond is set weekly: the current rate
for the week ending September 30, 2002 was approximately 1.99%. The outstanding
balance, as of September 30, 2002, was $4,916,000. The Company made the first
payment of $1,320,000 per the terms of the agreement in the third quarter of
2002. The Company borrowed $837,000 in the third quarter of 2002. The Company
also entered into a five-year agreement on September 4, 2001 with American
National Bank and Trust Company of Chicago hedging $4,000,000 of the Industrial
Bond Debt at a 4.24% rate of interest.
The Company's industrial bond debt documents contain a number of significant
covenants that, among other things, restrict the Company's ability to dispose of
assets, incur additional indebtedness, pay dividends, enter into certain
investments, enter into sale and lease-back transactions, make certain
acquisitions, engage in mergers and consolidations, create liens, or engage in
certain transactions with affiliates, and otherwise restrict corporate and
business activities. In addition, the Company is required to comply with
specified financial ratios and tests, including a minimum tangible net worth
test, a minimum interest coverage ratio and a maximum leverage ratio. The
Company's ability to continue to comply with these covenants and restrictions
may be affected by events beyond the Company's control. A failure by the Company
to comply with these covenants and restrictions would result in an event of
default under the Company's industrial bond debt documents. The
16
Company was in default on September 30, 2002 because of its failure to comply
with the financial ratios as set forth in the Reimbursement Agreement relating
to the bond.
On November 8, 2002, the Company entered into a Forbearance Agreement with
Bank One, N. A., formerly known as American Bank and Trust Company of Chicago,
pursuant to which the Company agreed to comply with all of the terms and
conditions contained in the Forbearance Agreement and the Bank agreed to forbear
from the date of the agreement to December 31, 2002 from pursuing its rights
under the Reimbursement Agreement (including the right to declare the bond
immediately due and payable) provided the Company complies with all of the terms
and conditions contained in the Forbearance Agreement. See attached exhibit
10.21.
The terms of the Company's long-term bank debt represent the borrowing rates
currently available to the Company; accordingly, the fair value of this debt
approximates its carrying amount.
The Company had a line of credit agreement, which expired on May 15, 2002.
The Company is currently negotiating to replace short and long-term debt.
The Company's ability to make scheduled principal and interest payments on,
or to refinance, its indebtedness, or to fund planned capital expenditures will
depend upon its future performance, which is subject to general economic,
financial, competitive and other factors that are beyond its control. The
Company's ability to fund operating activities is also dependent upon its rate
of growth, ability to effectively manage its inventory, the terms under which
the Company extends credit to customers and its ability to collect under such
terms and its ability to access external sources of financing. Based upon the
current level of operations and anticipated growth, management believes that
future cash flow from operations, together with other sources of debt fundings
and issuance of additional equity securities, will be adequate to meet its
anticipated requirements for capital expenditures, working capital, interest
payments and scheduled principal payments over the next 12 months. There can be
no assurance, however, that its business will continue to generate sufficient
cash flow from operations in the future to service its debt and make necessary
capital expenditures after satisfying certain liabilities arising in the
ordinary course of business. If unable to do so, the Company may be required to
refinance all or a portion of its existing debt, to sell assets or to obtain
additional financing. There can be no assurance that any such refinancing would
be available or that any such sale of assets or additional financing could be
obtained.
17
INFLATION
Management believes inflation has not had a material effect on the Company's
operation or on its financial position.
FOREIGN CURRENCY TRANSACTIONS
All of the Company's foreign transactions are negotiated, invoiced and paid
in United States dollars.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
As a supplier to microwave manufacturers, the Company is dependent upon the
success of its customers in developing and successfully marketing end-user
microwave systems. The Company is currently working on several development
programs for its customers. The development of commercial applications for
microwave systems and the timing and size of production schedules for these
programs is uncertain and beyond the control of the Company. There can be no
assurance that these development programs will have a favorable impact on the
Company's operating results. Although management believes some of these products
and programs may ultimately develop into successful commercial applications,
such developments could result in periodic fluctuations in the Company's
operating results. As a result of these considerations, the Company has
historically found it difficult to project operating results.
The Company expects that a small number of customers will continue to
account for a substantial majority of its sales and that the relative dollar
amount and mix of products sold to any of these customers can change
significantly from year to year. There can be no assurance that the Company's
major customers will continue to purchase products from the Company at current
levels, or that the mix of products purchased will be in the same ratio. The
loss of the Company's largest customer or a change in the mix of product sales
would have a material adverse effect on the Company.
In addition, future results may be impacted by a number of other factors,
including the failure of the Telecom market to improve; the Company's ability to
secure additional sources of funds that it may require; the Company's dependence
on suppliers and subcontractors for components; the Company's ability to respond
to technical advances; successful award of contracts under bid; design and
production delays; cancellation or reduction of contract orders; the Company's
effective utilization of existing and new manufacturing resources and the
"Virtual Manufacturing" process; and pricing pressures by key customers.
18
The Company's future success is highly dependent upon its ability to
manufacture products that incorporate new technology and are priced
competitively. The market for the Company's products is characterized by rapid
technology advances and industry-wide competition. This competitive environment
has resulted in downward pressure on gross margins. In addition, the Company's
business has evolved towards the production of relatively smaller quantities of
more complex products, the Company expects that it will at times encounter
difficulty in maintaining its past yield standards. There can be no assurance
that the Company will be able to develop technologically advanced products or
that future-pricing actions by the Company and its competitors will not have a
material adverse effect on the Company's results of operations.
The Company is dependent upon unaffiliated foreign companies for the
manufacture of printed circuit boards as part of its Virtual Manufacturing
process. The Company's arrangements with manufacturers are subject to the risks
of doing business abroad, such as import duties, trade restrictions, production
delays due to unavailability of parts or components, transportation delays, work
stoppages, foreign currency fluctuations, political instability and other
factors which could have an adverse effect on the Company's business, financial
condition and results of operations. The Company believes that the loss of any
one or more of its suppliers would not have a long term material adverse effect
on its business, financial condition and results of operations because other
manufacturers would be able to increase production to fulfill its requirements.
However, the loss of certain suppliers, could, in the short term adversely
affect its business until alternative supply arrangements were secured.
The market value of our publicly held shares has fallen below the minimum
market value of $5 million as required by the Nasdaq National Market on which
our common stock is currently listed. In addition, the closing bid price per
share of our common stock has fallen below the minimum closing bid price of
$1.00 required under the listing requirements of the Nasdaq National Market. If
the minimum market value of our publicly held shares remains below $5 million or
the per share closing bid price for our common stock remains below the $1.00
minimum bid price, we may be delisted from the Nasdaq National Market which
could reduce the liquidity of our common stock, further decrease the market
price of our common stock and negatively impact our ability to obtain additional
capital. The Company has until December 23, 2002 to comply with the Nasdaq
National Market listing requirements.
19
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation as of a date within 90 days of the filing date of this Quarterly
Report on Form 10-Q, the Company's principal executive officer and principal
financial officer have concluded that the Company's disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934 (the "Exchange Act")) are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.
(b) Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
20
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
None
21
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.21 Forbearance Agreement dated November 8, 2002 between the
Company and Banc One, N.A., formerly known as American
National Bank & Trust Company of Chicago.
(b) Reports on Form 8-K
(1) A current report on Form 8-K was filed on August 13, 2002,
under item 9, the execution by the Company's chief executive
officer and chief financial officer of the certification
required by Section 906 of the Sarbanes-Oxley Act of 2002.
(2) A current report on Form 8-K was filed on August 28, 2002
reporting, under item 5, the Company's reduction in
workforce.
22
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
M~WAVE, INC.
Date: November 11, 2002 /s/ PAUL H. SCHMITT
-------------------------
Paul H. Schmitt
Chief Financial Officer
23
CERTIFICATIONS
I, Joseph A. Turek, Chairman and Chief Executive Officer of M-Wave,
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of M-Wave, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
24
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 8, 2002
By: /s/ Joseph A. Turek
------------------------------------
JOSEPH A. TUREK
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
25
CERTIFICATIONS
I, Paul H. Schmitt, Chief Financial Officer of M-Wave, Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of M-Wave Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
26
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 8, 2002
By: /s/ Paul H. Schmitt
---------------------------------------
PAUL H. SCHMITT
CHIEF FINANCIAL OFFICER
27
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION PAGE
- ------- ----------- ----
10.21 Forbearance Agreement dated November 8, 2002 between the
Company and Banc One, N.A., formerly known as American
National Bank & Trust Company of Chicago. 29-32
28