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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 June 30, 2003 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
----- -----
Indicate by check mark whether the Registrant is an Yes No
accelerated filer(as defined by rule 12b-6 of the Act) [ ] [X]
The registrant has 4,443,294 shares of common stock outstanding at August 12,
2003.
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
M~WAVE, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
DECEMBER 31 JUNE 30
2002 2003
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.................................................... $ 1,514,509 $ 504,342
Accounts receivable, net of allowance for doubtful accounts,
2002- $100,000: 2003- $100,000............................................. 1,901,999 1,693,838
Inventories................................................................. 1,756,641 1,866,749
Refundable income taxes..................................................... 4,446,010 1,744,836
Deferred income taxes....................................................... 748,457 748,457
Prepaid expenses and other.................................................. 31,582 13,236
Restricted cash............................................................. 348,731 2,185,136
----------- -----------
Total current assets.................................................... 10,747,929 8,756,594
PROPERTY, PLANT AND EQUIPMENT:
Land, buildings and improvements............................................ 5,522,765 2,577,238
Machinery and equipment..................................................... 9,248,688 4,015,100
----------- -----------
Total property, plant and equipment..................................... 14,771,453 6,592,338
Less accumulated depreciation............................................... (2,760,441) (122,000)
----------- -----------
Property, plant and equipment-net....................................... 12,011,012 6,470,338
ASSETS TO BE DISPOSED OF, NET................................................... 568,701 568,701
----------- -----------
TOTAL........................................................................... $23,327,642 $15,795,633
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................................ $ 3,707,327 $ 4,605,196
Accrued expenses............................................................ 1,316,579 1,219,289
Current portion of long-term debt........................................... 5,017,629 4,979,365
----------- -----------
Total current liabilities............................................... 10,041,535 10,803,850
DEFERRED INCOME TAXES........................................................... 616,785 616,785
LONG-TERM DEBT.................................................................. 0 0
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 4,443,294 shares outstanding
at December 31, 2002, 6,179,112 shares issued and 4,443,294
shares outstanding at June 30, 2003....................................... 30,895 30,895
Additional paid-in capital.................................................. 8,439,072 8,439,072
Retained earnings .......................................................... 6,484,525 (1,809,799)
Treasury stock, at cost, 1,735,815 shares, at December 31, 2002.............
and 1,735,815 shares at June 30, 2003...................................... (2,285,170) (2,285,170)
----------- -----------
Total stockholders' equity ............................................. 12,669,322 4,374,998
----------- -----------
TOTAL........................................................................... $23,327,642 $15,795,633
=========== ===========
See notes to consolidated financial statements.
2
M~WAVE, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended June 30,
---------------------------
2002 2003
---------- -----------
Net sales........................................... $7,296,369 $4,141,050
Cost of goods sold.................................. 6,376,368 4,338,479
---------- -----------
Gross profit (loss)............................... 920,001 (197,429)
Operating expenses:
General and administrative........................ 539,545 765,728
Selling and marketing............................. 351,245 376,863
Impairment of building and equipment.............. 0 1,600,000
---------- -----------
Total operating expenses........................ 890,790 2,742,591
---------- -----------
Operating income (loss)........................... 29,211 (2,940,020)
Other income (expense):
Interest income................................... 43,880 45,012
Interest expense.................................. (58,759) (45,514)
Gain on disposal of assets........................ 0 17,000
---------- -----------
Total other income (expense) (14,879) 16,498
---------- ----------
Income (loss) before income taxes............... 14,332 (2,923,522)
Provision for income taxes.......................... 5,563 0
---------- -----------
Net income (loss)................................... $ 8,769 ($2,923,522)
========== ===========
Weighted average shares outstanding 4,448,746 4,443,294
Basic earnings (loss) per share $ 0.00 ($0.66)
Diluted shares outstanding 4,467,731 4,443,294
Diluted earnings (loss) per share $ 0.00 ($0.66)
See notes to consolidated financial statements.
3
M~WAVE, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Six months ended June 30,
----------------------------
2002 2003
----------- -----------
Net sales......................................... $15,610,123 $ 7,346,095
Cost of goods sold................................ 13,074,341 9,271,350
----------- -----------
Gross profit (loss)............................. 2,535,782 (1,925,255)
Operating expenses:
General and administrative...................... 1,132,821 1,342,875
Selling and marketing........................... 833,303 743,812
Impairment of building and equipment............ 0 5,177,735
----------- -----------
Total operating expenses...................... 1,966,124 7,264,422
----------- -----------
Operating income (loss)......................... 569,658 (9,189,677)
Other income (expense):
Interest income................................. 106,774 85,659
Interest expense................................ (101,024) (95,639)
Gain on disposal of assets...................... 0 17,000
----------- -----------
Total other income 5,750 7,020
----------- -----------
Income (loss) before income taxes............. 575,408 (9,182,657)
Provision (credit) for income taxes............... 223,362 (888,333)
---------- -----------
Net income (loss)................................. $ 352,046 ($8,294,324)
=========== ===========
Weighted average shares outstanding 4,452,499 4,443,294
Basic earnings (loss) per share $0.08 ($1.87)
Diluted shares outstanding 4,477,879 4,443,294
Diluted earnings (loss) per share $0.08 ($1.87)
See notes to consolidated financial statements.
4
M~WAVE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six month ended June 30,
----------------------------
2002 2003
----------- -----------
OPERATING ACTIVITIES:
Net income (loss)................................................. $ 352,046 ($8,294,324)
Adjustments to reconcile net income to net cash flows
from operating activities:
(Gain) on disposal of property, plant and equipment........... 0 (17,000)
Depreciation and amortization................................. 756,000 416,600
Impairment of buildings and equipment......................... 0 5,177,735
Changes in assets and liabilities:
Accounts receivable-trade..................................... 2,202,924 208,161
Inventories................................................... (1,260,070) (110,108)
Income taxes.................................................. (1,006,638) 2,701,174
Prepaid expenses and other assets............................. 90,941 18,346
Restricted cash............................................... (731,980) (1,836,405)
Accounts payable.............................................. 748,989 897,869
Accrued expenses.............................................. (496,462) (97,290)
----------- -----------
Net cash flows provided by (used in) operating activities... 655,750 (935,242)
----------- -----------
INVESTING ACTIVITIES:
Purchase of property, plant and equipment......................... (2,012,648) (53,661)
Proceeds from sale of property, plant and equipment............... 0 17,000
----------- -----------
Net cash flows used in investing activities................ (2,012,648) (36,661)
FINANCING ACTIVITIES:
Long term debt.................................................... 1,465,262 0
Payments on short and long term debt............................. (42,516) (38,264)
Purchase treasury stock........................................... (57,891) 0
----------- -----------
Net cash flows provided by (used in) financing activities... 1,364,855 (38,264)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................ 7,957 (1,010,167)
CASH AND CASH EQUIVALENTS - Beginning of period..................... 2,102,784 1,514,509
----------- -----------
CASH AND CASH EQUIVALENTS - End of period........................... $ 2,110,741 $ 504,342
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest........................ $ 101,024 $ 95,639
Income tax refunds (payments)................................... ($510,000) $ 3,589,507
See notes to consolidated financial statements.
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, 2002 filed March 31,
2003.
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 the printed circuit needs of our
customers by managing the complete procurement process. We deliver products
when the customer needs them through consignment, inventory control or
just-in-time programs.
The Company began Virtual Manufacturing during 2000 by developing
subcontracting relationships with local and 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
6
Company to satisfy a broader range of its 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.
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.
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.
7
3. REALIZATION OF ASSETS
The accompanying financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going concern.
However, the Company has sustained substantial losses from operations in
2002, and such losses have continued through the unaudited quarter ended
June 30, 2003. As of December 31, 2002, the Company was in default of
certain debt covenants under its Industrial Revenue Bond Agreement. On
March 26, 2003, the Company entered into a Forbearance Agreement where the
Company agreed to comply with all the terms and conditions and the Bank
agreed to forbear on its rights to call the debt from the date of the
agreement through August 31, 2003.
Under the terms of the Forbearance Agreement, the Company has agreed
to deposit in the Sinking Fund Account for the Industrial Bond Debt:
(i) $1,500,000 on the earlier of (x) receipt by the Borrower of any
federal tax refund or (y) April 30, 2003; and
(ii) $500,000 on the earlier of (x) receipt by the Borrower of any
state tax refund or (y) June 30, 2003; and
(iii) $300,000 on the earlier of (x) receipt by Borrower of the
proceeds of the sale of its real estate located at 215 Park
Street, Bensenville, Illinois or (y) August 15, 2003.
The Company received its federal tax refund on March 31, 2003 and
deposited $1,500,000 in the sinking fund in April 2003 as required. As of
June 30, 2003, the Company had not received the expected refund from the
state and the Company has not sold the real estate located at 215 Park
Street, Bensenville, Illinois.
The Company defaulted under the Forbearance Agreement dated March 26,
2003 due to its failure to make certain required payments.
In view of the matters described in the preceding paragraph,
recoverability of a major portion of the recorded asset amounts shown in
the accompanying balance sheet is dependent upon continued operations of
the Company, which in turn is dependent upon the Company's ability to
obtain additional working capital, refinance its long-term debt and to
succeed in its future operations.
4. 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.
5. DEBT
The Company has an installment loan of $78,000 collateralized by
certain fixed assets of the Company. Interest on this loan is at the prime
rate. The
8
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 August 7, 2003 was 1.04%. The term of the bond is 20 years
with the first payment of $1,320,000 due and made in July 2002 and payments
are due annually thereafter.
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.
See Footnote Number 7, Debt, in the Company's Annual Report Form 10-K,
for fiscal year ended December 31, 2002, filed March 31, 2003.
The Company was in default with the covenants at June 30, 2003. The
Company had a line of credit agreement, which expired on May 15, 2002.
6. RESTRUCTURING ACTIVITIES
The Board of Directors of the Company engaged Credit Support
International, LLC of Texas, and specifically its Managing Member, Jim
Mayer, April 15, 2003 to assist in implementing a corporate restructuring
that includes financial, operating and strategic re-positioning to stem
operating and financial losses. As of June 30, 2003 a plan of restructuring
was in development including, but not limited to: 1.) A plan to partner
with a printed circuit board company to co-manufacture or outsource certain
aspects of Company's operations and reduce operating costs therein; 2.)
Negotiate the $2,800,000 of debt with Bank One; 3.) Liquidate un-needed
assets to supplement liquidity and fund the restructuring; and 4.) Develop
a plan to eliminate, renegotiate or retire delinquent trade debt within the
remaining calendar year.
7. 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.
8. IMPAIRMENT OF LONG-LIVED ASSETS TO BE HELD AND USED
The Company recorded impairment of building charges in the second
quarter of 2003 of $1,600,000. The Company estimated the fair value of the
real estate at $4,000,000 in the first quarter of 2003. This amount was
estimated in the first quarter of 2003 because the final appraisal was not
received until June 3, 2003. The final appraisal of the real estate was
$2,400,000. The additional charge was recorded to comply with FASB
statement No. 144, which requires the Company to (a) recognize an
impairment loss when the carrying amount of a long-lived asset is not
recoverable from its undiscounted cash flows and (b) measure the impairment
losses as the difference between the carrying amount and the fair value of
the asset. Since the revised fair value of the real estate was $2,400,000,
this resulted in an additional write-down of the assets of $1,600,000 in
the second quarter of 2003.
9
9. STOCK-BASED COMPENSATION
Effective for fiscal 2003, the Company adopted the disclosure
requirements under SFAS No. 148, "Accounting for Stock-Based Compensation
-- Transition and Disclosure," as an amendment to SFAS No. 123.
Stock-based employee compensation, including stock options, for the
six months ended June 30, 2003 and 2002 was accounted for under the
intrinsic value-based method as prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Therefore, no compensation
expense was recognized for those stock options that had no intrinsic value
on the date of grant.
If the Company were to recognize compensation expense over the
relevant service period under the fair-value method of SFAS No. 123 net
earnings would have decreased, resulting in pro forma net earnings (loss)
and EPS as presented below:
SIX MONTHS
ENDED JUNE 30,
---------------------------
2003 2002
----------- --------
Net earnings (loss), as reported $(8,294,324) $352,046
Deduct: Stock-based employee
compensation expense, net of
related tax effects, determined
under fair-value method for all
awards (149,306) (127,713)
----------- --------
Pro forma net earnings (loss) $(8,443,630) $224,333
=========== ========
EPS, as reported
Basic $ (1.87) $ 0.08
Diluted (1.87) 0.08
Pro forma EPS
Basic $ (1.90) $ 0.05
Diluted (1.90) 0.05
10
10. SUBSEQUENT EVENTS
After the Company defaulted under the Forbearance Agreement dated
March 26, 2003, the Bank, under the Industrial Bond Debt, notified the
Trustee under such debt of the default, the Trustee accelerated the Bonds
and the Trustee drew on the Letter of Credit to pay the Bondholders.
As a result of the Company's defaults and the Trustee's draw on the
Letter of Credit, the Company is indebted to the Bank in the principal
amount of approximately $2,800,000.
The Bank is entitled to be subrogated to the rights of the Trustee
under the Issuer Loan Agreement and the Issuer Promissory.
The Company is negotiating the terms of such indebtedness with the
Bank.
On August 7, 2003, the Company received the state income tax refund of
approximately $940,000.
11
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS FOR THE QUARTER ENDED JUNE 30, 2003 COMPARED TO THE QUARTER ENDED JUNE
30, 2002
NET SALES
Net sales were $4,141,000 for the quarter ended June 30, 2003, a decrease
of $3,155,000 or 43% below the second quarter of 2002. The decrease in net sales
is related to a drop in demand in the telecom industry. Virtual Manufacturing
accounted for approximately $3,129,000 of net sales or 76% in the second quarter
of 2003 compared to $2,964,000 of net sales or 41% in the second quarter of
2002. The second quarter of 2002 also included two non-recurring events that
boosted net sales by $3,600,000. These events were the result of (1) a
cancellation charge of approximately $2.5 million paid by Lucent related to the
discontinuation of several products and (2) a one-time shipment of inventory for
approximately $1.0 million that the Company was holding for Westell. Had these
events not occurred, the net sales for the second quarter 2002 would have been
approximately $3,696,000.
Net sales to Westell were $1,763,000 in the second quarter of 2003 compared
to $3,057,000 in the second quarter of 2002. The net sales in 2002 to Westell
included a shipment of inventory of approximately $1,000,000. Net sales to
Lucent were $2,502,000 in the second quarter of 2002, which was a cancellation
charge paid by Lucent related to the discontinuation of several products. Net
sales to Federal Signal were $319,000 in the second quarter of 2003 compared
to $7,000 in the second quarter of 2002. Federal Signal first signed a contract
with the Company in February 2002.
GROSS PROFIT AND COST OF GOODS SOLD
The Company's gross loss for the second quarter of 2003 was ($197,000)
compared to a gross profit of $920,000 for the second quarter of 2002. The
second quarter of 2002 include two non-recurring events that boosted revenue by
$3,600,000 and gross margin by $2,500,000. These events were a result of the end
of life of several products we produced for Lucent and shipment of inventory we
were holding for Westell. Had these events not occurred, the gross loss for the
second quarter of 2002 quarter would have been approximately $1,580,000. The
gross loss for the second quarter of 2003 is a result of under utilization of
the manufacturing facility and a drop in demand in the telecom industry.
12
OPERATING EXPENSES
General and administrative expenses were $766,000 or 18.5% of net sales in
the second quarter of 2003 compared to $540,000 or 7.4% of net sales in the
second quarter of 2002, an increase of $226,000. General and administrative
expenses consist primarily of salaries and benefits, professional services,
depreciation of office, equipment and computer systems and occupancy expenses.
Payroll related expenses were up $80,000. Professional services, which include
legal, auditing fees, and consulting fees were up $167,000.
Selling and marketing expenses were $377,000 or 9.1% of net sales in the
second quarter of 2003 compared to $351,000 or 4.8% of net sales in the second
quarter of 2002. Selling and marketing expenses include the cost of salaries,
advertising and promotion of the Company's products, and commissions paid to
independent sales organizations. Commissions paid to independent sales
organizations were up $62,000. Payroll-related expenses were up $17,000 with the
hiring of a regional sales manager in the second quarter of 2003. Advertising
expenses were down $38,000.
The Company recorded impairment of building charges in the second quarter
of 2003 of $1,600,000. The Company estimated the fair value of the real estate
at $4,000,000 in the first quarter of 2003. This amount was estimated in the
first quarter of 2003 because the final appraisal was not received until June 3,
2003. The final appraisal of the real estate was $2,400,000. The additional
charge was recorded to comply with FASB statement No. 144, which requires the
Company to (a) recognize an impairment loss when the carrying amount of a
long-lived asset is not recoverable from its undiscounted cash flows and (b)
measure the impairment losses as the difference between the carrying amount and
the fair value of the asset. Since the revised fair value of the real estate was
$2,400,000, this resulted in an additional write-down of the assets of
$1,600,000 in the second quarter of 2003.
OPERATING INCOME
Operating loss was ($2,940,000) in the second quarter of 2003 compared to
an operating income of $29,000 in the second quarter of 2002, a decrease of
$2,969,000. The changes in operating income reflect primarily the changes in net
sales, gross profit and cost of goods sold, impairment charges and operating
expenses as discussed above, which can be summarized as follows:
Decrease in net sales ($398,000)
Decrease in gross margin (720,000)
Impairment of building and equipment (1,600,000)
Increase in operating expenses (251,000)
----------
13
Decrease in operating income ($2,969,000)
INTEREST INCOME
Interest income from short-term investments was $45,000 in the second
quarter of 2003 compared to $44,000 in the second quarter of 2002.
INTEREST EXPENSE
Interest expense, primarily related to the Industrial Revenue Bond was
$46,000 in the second quarter of 2003 compared to $59,000 in the second quarter
of 2002.
INCOME TAXES
In the second quarter of 2003, the Company had an effective tax rate of
0.0% compared to an effective tax rate of 38.8% in the second quarter of 2002.
The Company's tax credit is limited to expected tax refunds of approximately
$888,000 for 2003, which were recorded in the first quarter of 2003.
14
RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX MONTHS ENDED
JUNE 30, 2002
NET SALES
Net sales were $7,346,000 for the six months ended June 30, 2003, a
decrease of $8,264,000 or 53% below the first six months of 2002. The decrease
in net sales is directly related to a drop in demand in the telecom industry.
Virtual Manufacturing accounted for approximately $5,643,000 of net sales or 77%
in the first six months of 2003 compared to $3,754,000 of net sales or 24% in
the first six months of 2002. The first six months of also included two
non-recurring events that boosted sales net sales by $3,600,000. These events
were the result of (1) a cancellation charge of approximately $2.5 million paid
by Lucent related to the discontinuation of several products and (2) a one-time
shipment of inventory for approximately $1.0 million that the Company was
holding for Westell. Had these events not occurred the net sales for the first
six months of 2002 would have been approximately $12,010,000.
Net sales to Westell were $3,270,000 for the first six months of 2003
compared to $3,690,000 for the first six months of 2002. The net sales in 2002
to Westell included a shipment of inventory of approximately $1,000,000. Net
sales to Celestica were $358,000 for the first six months of 2003 compared to
$6,114,000 for the first six months of 2002. The reduction in net sales with
Celestica is related to the completion of a specific project. Net sales to
Federal Signal were $553,000 for the first six months of 2003 compared to $7,000
for the first six months of 2002. Federal Signal first signed a contract with
the Company in February 2002. Net sales to Lucent were $2,528,000 for the first
six months of 2002, which was a cancellation charge paid by Lucent related to
the discontinuation of several products.
GROSS PROFIT AND COST OF GOODS SOLD
The Company's gross loss for the first six months of 2003 was ($1,925,000)
compared to a gross profit of $2,536,000 for the first six months of 2002. The
first six months of 2002 include two non-recurring events that boosted revenue
by $3,600,000 and gross margin by $2,500,000. These events were a result of the
end of life of several products we produced for Lucent and shipment of inventory
we were holding for Westell. Had these events not occurred, the gross profit for
the first six months of 2002 would have been approximately $36,000. The gross
loss for the first six months of 2003 is a result of under-utilization of the
manufacturing facility and a drop in demand in the telecom industry.
15
OPERATING EXPENSES
General and administrative expenses were $1,343,000 or 18.3% of net sales
for the first six months of 2003 compared to $1,133,000 or 7.3% of net sales for
the first six months of 2002. General and administrative expenses consist
primarily of salaries and benefits, professional services, depreciation of
office, equipment and computer systems and occupancy expenses. Payroll-related
expenses were up $120,000. Professional services, which include legal, auditing
and consulting fees were up $137,000.
Selling and marketing expenses were $744,000 or 10.1% of net sales for the
first six months of 2003 compared to $833,000 or 5.3% of net sales for the first
six months of 2002. Selling and marketing expenses include the cost of salaries,
advertising and promotion of the Company's products, and commissions paid to
independent sales organizations. Commissions paid to independent sales
organizations were up $17,000. Payroll-related expenses were down $12,000 and
advertising expenses were down $54,000.
The Company recorded impairment of building, plant and equipment charges in
the first six months of 2003 of $5,178,000. The charge was recorded to comply
with FASB statement No. 144, which requires the Company to (a) recognize an
impairment loss when the carrying amount of a long-lived asset is not
recoverable from its undiscounted cash flows and (b) measure the impairment
losses as the difference between the carrying amount and the fair value of the
asset. The fair value of the real estate was estimated at $2,400,000 and the
machinery and equipment at $4,014,000. This resulted in a write-down of the
assets of $5,178,000.
OPERATING INCOME
Operating loss was ($9,190,000) for the first six months of 2003 compared
to an operating income of $570,000 or 3.6% of net sales for the first six months
of 2002, a decrease of $9,760,000. The changes in operating income reflect
primarily the changes in net sales, gross profit and cost of goods sold,
impairment charges and operating expenses as discussed above which can be
summarized as follows:
Decrease in net sales ($1,342,000)
Decrease in gross margin (3,119,000)
Impairment of building and equipment (5,178,000)
Increase in operating expenses (121,000)
-----------
Decrease in operating income ($9,760,000)
16
INTEREST INCOME
Interest income from short-term investments was $86,000 for the first six
months of 2003 compared to $107,000 for the first six months of 2002.
INTEREST EXPENSE
Interest expense, primarily related to the Industrial Revenue Bond was
$96,000 for the first six months of 2003 compared to $101,000 for the first six
months of 2002.
INCOME TAXES
In the first six months of 2003, the Company had an effective tax credit of
9.7% compared to an effective tax rate of 38.8% in the first six months of 2002.
The Company's tax credit is limited to expected tax refunds of approximately
$888,000 for 2003.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operations was $935,000 for the first six months of 2003
compared to $656,000 provided by operations for the first six months of 2002.
Accounts receivable decreased $208,000. Inventories increased $110,000. The
Company received approximately $3,589,000 in income tax refunds. Accounts
payable increased $898,000. Depreciation and amortization was $417,000.
Capital expenditures were $54,000 in the first six months of 2003 compared
to $2,013,000 in the first six months of 2002. The Company has limited plans for
capital expenditures in 2003.
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 August 7, 2003 was approximately 1.04%. The term of the loan
is 20 years. The outstanding balance as of June 30, 2003 was $4,901,000. The
Company is required to pay $1,320,000 each year through quarterly sinking fund
payments of $325,000. The next payment of $1,320,000 is due in the third quarter
of 2003. The Company has been making quarterly sinking fund payments of
$325,000, except that the December quarterly payment was not made until February
2003. The Company deposited $325,000 in the first quarter of 2003 and an
additional $1,500,000 in April
17
2003 into the sinking fund for the Company's outstanding industrial bond debt
account per the terms of its Forbearance Agreement with Bank One. The
outstanding balance of the industrial bond debt was approximately $2,794,000 net
of the sinking fund. The Company's cash balance was approximately $504,000 as of
June 30, 2003
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 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 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 Footnote Number 3, Realization of Assets, in the Company's Annual
Report Form 10-K, for fiscal year ended December 31, 2002, filed March 31, 2003.
Even if the Bank complies and converts the indebtedness to a Promissory
Note, there can be no assurances that the terms of Note will not have a material
adverse effect on the Company's ability to fund working capital or give the
Company sufficient time and flexibility to avoid future defaults under the Note.
18
There can be no assurances that the forgoing matters will not adversely
impact the Company's relationship with its suppliers and customers.
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's ability to make scheduled principal and interest payments on,
or to refinance, its indebtedness, or to fund working capital and anticipated
capital expenditures will depend on the Company's 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 (a) the Company's anticipated receipt of $900,000 in state tax
refunds during 2003, (b) proceeds of anticipated sales of fixed assets no longer
required at the Company's Bensenville facility, (c) the Company's ability to
effectively manage its expenses in relation to revenues and (d) the Company's
ability to access external sources of financing. The Company has been unable to
date to secure additional financing.
There can be no assurances that the steps being taken by the Company, even
if successfully completed, will enable the Company to comply with the terms of
the Promissory Note and/or fund the Company's working capital requirements.
Moreover, even if the Company is able to comply with the terms of the Promissory
Note, there can be no assurance that the Company will be able to fund its
working capital needs.
The Company has an installment loan of $78,000 collateralized by certain
fixed assets of the Company. Interest on this loan is at the prime rate (4.25%
at June 30, 2003). The loan is payable in monthly installments of principal and
interest and is due October 2004.
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.
19
SIGNIFICANT EVENTS
The Company continues to take the following steps to reposition the
Company and improve its liquidity:
o reducing staff mainly in the production segment of the Company's
business;
o pursuing the sale of certain fixed assets no longer being used at
the Company's Bensenville facility;
o engaging Jim Mayer, the managing member of Credit Support
International, LLC of Texas to assist the Company's management.
RISK FACTORS AFFECTING BUSINESS AND RESULTS OF OPERATIONS
This report, as well as our other reports filed with the SEC and our press
releases and other communications, contain forward-looking statements made
pursuant to the safe harbor provisions of the Securities Litigation Reform Act
of 1995. Forward-looking statements include all statements regarding our
expected financial position, results of operations, cash flows, dividends,
financing plans, strategy, budgets, capital and other expenditures, competitive
positions, growth opportunities, benefits from new technology, plans and
objectives of management, and markets for stock. These forward-looking
statements are based largely on our expectations and, like any other business,
are subject to a number of risks and uncertainties, many of which are beyond our
control. The risks include those stated in the section entitled "Risk Factors
Affecting Business and Results of Operations" in Item 7 of our Annual Report on
Form 10-K and economic, competitive and other factors affecting our operations,
markets, products and services, expansion strategies and other factors discussed
elsewhere in this report, our Annual Report on Form 10-K and the other documents
we have filed with the Securities and Exchange Commission. In light of these
risks and uncertainties, there can be no assurance that the forward-looking
information contained in this report will in fact prove accurate, and our actual
results may differ materially from the forward-looking statements.
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
20
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.
21
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
None
22
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification pursuant to 18 U.S.C. Section 135O, as adopted
pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification pursuant to 18 U.S.C. Section 135O, as adopted
pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
(1) none
23
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: August 12, 2003 /s/ PAUL H. SCHMITT
-----------------------
Paul H. Schmitt
Chief Financial Officer
24
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION PAGE
- ------- ------------------------------------------------------------ -----------
2.1 Exchange Agreement, dated as of January 31, 1992, among
Poly Circuits, Inc., Joel S. Dryer, Joseph A. Turek and the
Company *
3.1 Certificate of Incorporation of the Company *
3.2 Bylaws of the Company *
10.1 Amended and restated M~Wave, Inc. 1992 Stock Option Plan ***
10.2 Construction Loan Note, dated January 10, 1996, by
and among the Company, P C Dynamics and American
National Bank and Trust Company. ***
10.3 Stock Purchase Agreement dated December 18, 1998 by and
between the Company and First Chicago Equity Corporation. *****
10.4 Stock Purchase Agreement dated December 18, 1998 by and
between the Company and Cross Creek Partners II. *****
10.5 Warrant dated December 18, 1998 issued to First Chicago Equity *****
10.6 Warrant dated December 18, 1998 issued to Cross Creek
Partners II *****
10.7 Employment Agreement dated January 29, 2001 between
the Company and Joseph A. Turek ******
10.8 Employment Agreement dated January 29, 2001 between
the Company and Paul H. Schmitt ******
10.9 Loan Agreement dated July 1, 2001 between the Illinois
Development Finance Authority and the Company *******
10.10 Forbearance Agreement dated November 8, 2002 between
the Company and Bank One, N.A., formerly known as
American National Bank & Trust Company of Chicago ********
25
EXHIBIT
NO. DESCRIPTION PAGE
- ------- ------------------------------------------------------------ -----------
10.11 Forbearance Agreement dated March 31, 2003 between
the Company and Bank One, N.A., formerly known as
American National Bank & Trust Company of Chicago *********
10.12 Employment Agreement dated January 7, 2003 between
the Company and Robert O'Connell *********
10.13 Employment Agreement dated January 29, 2003 between
the Company and Paul H. Schmitt *********
21 Subsidiaries *********
24.1 Consent of Grant Thornton LLP *********
31.1 Certification of CEO Pursuant to Section 302 of the
Sarbanes-Oxley Act 27
31.2 Certification of CFO Pursuant to Section 302 of the
Sarbanes-Oxley Act 28
32.1 Certification pursuant to 18 U.S.C. Section 135O,
as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002. 29
32.2 Certification pursuant to 18 U.S.C. Section 135O,
as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002. 30
*Incorporated herein by reference to the applicable exhibit to Registrants
Registration Statement on Form S-1 (Registration No. 33-45499)
***Incorporated herein by reference to the applicable exhibit to the
Registrant's Annual Report on Form 10-K for year ended December 31, 1995.
*****Incorporated herein by reference to the applicable exhibit report on Form
8-K dated December 18, 1998.
******Incorporated herein by reference to the applicable exhibit report to the
Registrant's quarterly report on form 10-Q for the quarter ended March 31,
2001.
*******Incorporated herein by reference to the applicable exhibit report to the
Registrant's quarterly report on form 10-Q for the quarter ended
June 30, 2001
********Incorporated herein by reference to the applicable exhibit report to the
Registrant's quarterly report on form 10-Q for the quarter ended
September 30, 2002
********Incorporated herein by reference to the applicable exhibit report to the
Registrant's annual report on form 10-K for the year ended December 31,
2002
26