Attached files
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| EX-32.1 - EXHIBIT 32.1 - Microphase Corp | v449387_ex32-1.htm |
| EX-32.2 - EXHIBIT 32.2 - Microphase Corp | v449387_ex32-2.htm |
| EX-31.2 - EXHIBIT 31.2 - Microphase Corp | v449387_ex31-2.htm |
| EX-31.1 - EXHIBIT 31.1 - Microphase Corp | v449387_ex31-1.htm |
| EX-10.17 - EXHIBIT 10.17 - Microphase Corp | v449387_ex10-17.htm |
| EX-10.16 - EXHIBIT 10.16 - Microphase Corp | v449387_ex10-16.htm |
| EX-10.15 - EXHIBIT 10.15 - Microphase Corp | v449387_ex10-15.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE YEAR ENDED JUNE 30, 2016
COMMISSION FILE NO. 000-55382
Microphase Corporation
(Name of issuer in its charter)
| CONNECTICUT | 22-2287503 |
| (State or other jurisdiction of incorporation or organization) |
| 100 TRAP FALLS ROAD EXTENSION SHELTON, CONNECTICUT 06484 |
| (Address of principal executive offices) |
Registrant’s telephone number, including area code: (203) 866-8000
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).
Yes x No o
Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to the Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer o |
| Non-accelerated filer o | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)
Yes o No x
As of June 30, 2016, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $5,149,928 based upon the last sale price at which common equity was sold. As of September 20, 2016, there were 6,200,789 shares of common stock, no par value, outstanding.
Documents Incorporated by Reference
None.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JUNE 30, 2016
TABLE OF CONTENTS
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FORWARD-LOOKING STATEMENTS
This report contains “forward-looking statements.” In some cases, you can identify forward-looking statements by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” or the negative of these terms and similar expressions intended to identify forward-looking statements. These statements reflect the Company’s current views with respect to future events and are based on assumptions and subject to risks and uncertainties. The Company discusses many of these risks and uncertainties in greater detail in Part I, Item 1A of this 10-K under the heading “Risk Factors.” These risks and uncertainties may cause the Company’s actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. You should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent the Company’s estimates and assumptions as of the date of this report. The Company is under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.
The following discussion should be read in conjunction with Microphase Corporation’s financial statements and related notes included elsewhere in this report.
Our Corporate Information
Microphase Corporation was founded in 1955 and is currently a Connecticut corporation. Its predecessors have been in business for over 60 years. Our executive offices are located at 100 Trap Falls Road Extension, Shelton, CT 06484. Our telephone number is (203) 866-8000. Our web site is located at www.microphase.com. The information contained on our website is not incorporated by reference into this Annual Report.
Existing Business
Microphase Corporation is a “design to manufacture” original equipment manufacturer (OEM) providing, primarily as a sub-contractor to prime military contractors, components for radar, electronic warfare (EW) and communication systems. Such components include, radio frequency (RF) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (DLVA) to the military, aerospace and telecommunications industries. Sales to prime contractors of the U.S. Government represent 80% of sales.
Going Concern Opinion
As of June 30, 2016, we had an accumulated deficit of $13,939,651 and a total stockholders’ deficit of $602,207. As of June 30, 2015 we had an accumulated deficit of $12,855,220 and a total stockholders’ deficit of $787,676. A significant amount of capital will be necessary to sustain, grow and advance our business and these conditions raise substantial doubt about our ability to continue as a going concern, as expressed in our Auditor’s report.
Our Business
We design, manufacture and sell microwave electronics components for radar, electronic warfare (“EW”) and communication systems. Such components include radio frequency (“RF”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (“DLVA”). We and our predecessors have been engaged in this business for over 60 years. Our customers are comprised of the U.S. military and allied militaries, and contractors to the U.S. military including prime contractors and sub-contractors. Our recent technology innovations are used in many significant U.S. Government defense programs, including the Polaris submarine, the F-16 aircraft, the F-35 aircraft and the Predator Drone. Other notable programs in which the Company’s products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System (recipient of citation from the Bureau of Naval Weapons), SHRIKE Missile, ARM Missile, Patriot Missile System, THAAD (Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B-1 Bomber, the F-1, EA6B, F-14, F-18, and the Gripen fighter.
Received reflected radar signals are usually weak and require complex components and devices for detection, filtering, conditioning, and amplification. Our sophisticated and proprietary technologies enable the ultra-sensitive detection and high precision video amplification that are necessary in order to accurately recover the signals and facilitate use of the information received.
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Products
Our advanced technology products include:
| • | filters that sort and clarify microwave signals, including multiplexers that are a series of filters combined in a single package; |
| • | solid state amplifiers that amplify microwave signals; |
| • | detectors and limiters that are semiconductor devices for detection of radar signals and protection of receivers from damage from high power signals and jamming; |
| • | detector log video amplifiers that are fully integrated, ruggedized, “mil-spec” signal detection systems; |
| • | integrated assemblies that combine multiple functions from a range of components and devices, including transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction assemblies; |
| • | electronic test and measurement probes; |
| • | universal test and measurement test platforms and fixtures; and |
| • | utility probes and antenna probes. |
Competitive Advantages
We believe that our primary competitive advantages in our core business are our many years of experience in our industry and our many innovative and proprietary advanced technologies. The Company is able to serve customers with product requirements which are highly complex and demand the highest level of precision engineering and manufacturing. Our first diplexer was designed for Lockheed Martin in 1955, and our award-winning multiplexer technology was used on the first Telstar satellite in 1958. Our recent technology innovations are used in significant U.S. Government defense programs, including the F-16 aircraft, the F-35 aircraft and the Predator Drone.
In the test and measurement (“T&M”) market, our primary competitive advantage is a unique and innovative product line which delivers superior performance compared to existing products and solutions at a fraction of the price of the existing products. Our new T&M products enable customers to conduct tests and measurements on electronic components and receive results in minutes instead of days or weeks, which could dramatically reduce the development time of new electronic products.
Recent Developments
On April 19, 2016, the Company issued in a private placement to a single investor, in exchange for an investment of $250,000, 125,000 shares of its common stock and a warrant to purchase 125,000 shares of the Company’s common stock at an exercise price of $2.50 per share.
Our Risks and Challenges
An investment in our common stock involves a high degree of risk, including risks related to the following:
| • | We have not been profitable during the past three fiscal years. |
| • | Our current revenue is largely derived from the U.S. Government and prime defense contractors to the U.S. Government and its allies, and the loss of these relationships, a reduction in U.S. Government funding or a change in U.S. Government spending priorities could have an adverse impact on our business. |
| • | We depend on U.S. Government contracts designated for major defense contractors, which often provide only partial funding, are subject to immediate termination and are heavily regulated and audited. The termination or failure to fund or negative audit findings for one or more of these contracts could have an adverse impact on our business. |
| • | Our business could be negatively impacted by cybersecurity threats and other security threats and disruptions. |
| • | We face certain significant risk exposures and potential liabilities that may not be covered adequately by insurance or indemnities. |
| • | Our auditors have expressed substantial doubt about our ability to continue as a “going concern.” |
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Emerging Growth Company under the JOBS Act
As a company with less than $1.0 billion in revenues during our last fiscal year, we qualify as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. As an emerging growth company, we may take advantage of reduced reporting requirements and are relieved of certain other significant requirements that are otherwise generally applicable to public companies. As an emerging growth company:
| • | we may present only two years of audited financial statements and only two years of related Management’s Discussion and Analysis of Financial Condition and Results of Operations; |
| • | we are exempt from the requirement to obtain an attestation and report from our auditors on whether we maintained effective internal control over financial reporting under the Sarbanes-Oxley Act; |
| • | we are permitted to provide less extensive disclosure about our executive compensation arrangements; and |
| • | we are not required to give our stockholders non-binding advisory votes on executive compensation or golden parachute arrangements. |
We may take advantage of these provisions for up to five years if we continue to be an emerging growth company. We would cease to be an emerging growth company if we have more than $1.0 billion in annual revenues, have more than $700 million in market value of our shares held by non-affiliates or issue more than $1.0 billion of non-convertible debt over a three-year period. We may choose to take advantage of some but not all of these reduced burdens. We have elected to provide two years of audited financial statements.
Additionally, we have elected to take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the “Securities Act”), for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act.
Historical Overview
Microphase Corporation was founded in 1955, by Mr. Necdet F. Ergul, and was originally incorporated in the Commonwealth of Massachusetts and reincorporated under Connecticut law in 1959. As we enter our 61st year, Microphase, now located in Shelton, CT, is engaged in the design and manufacture of Radio Frequency (RF) and microwave electronic components and subsystems, as one of the oldest and most experienced microwave product companies in the industry. The contributions of Microphase to filter and multiplexer technology have been extensive. As discussed below, since our first diplexer designed for Lockheed Martin in 1955, to the use of our multiplexer on the first Telstar satellite, for which we received a letter of achievement from Bell Labs in 1958, and through the use of our components in significant defense programs more recently, including the Polaris Submarine and the F35 Joint Strike Fighter, we have been recognized as a contributor to vital programs that have marked the evolution of RF components.
Microphase Corporation specializes in microwave electronics that provides core technology solutions for radar systems. These solutions include complex components and devices for detection, filtering, conditioning, and amplification of radar signals. Radar signals are bursts of microwave energy that are emitted by a transmitter. When these radar signals come in contact with an object they are reflected back towards the transmitter and are captured by a radar receiver. The received reflected radar signals are usually very weak and buried in noise and require ultra-sensitive detection and high precision video amplification systems in order to accurately recover the signals and facilitate use of the information received.
Microphase Corporation designs and manufactures components and subsystems that carry out these functions. Products include: (1) Filters that sort out and clarify microwave signals; (2) Multiplexers that are a series of filters combined in a single package; (3) Solid State Amplifiers that amplify microwave signals; (4) Detectors and Limiters that are semiconductor devices for detection of radar signals and protection of receivers from damage from high power signals and jamming; (5) Detector Log Video Amplifiers that are fully integrated detection systems ruggedized to meet the most stringent requirements of military environments; and (6) Integrated Assemblies that combine multiple functions from a range of components and devices including transmitters, receivers, filters, amplifiers, detectors, and other functionality into single, efficient, high performance, multifunction assemblies.
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Microwave technology is a well-established and dominant electronics field with a wide range of applications across a diverse mix of military and commercial market sectors. These applications and market sectors cover commercial wireless infrastructure including cell tower, tower-mount, and pole-mount macro-, mini-, and micro-cell base stations; wireless backhaul and enterprise networks comprising point to point and multipoint microwave towers and links; defense & aerospace including radar systems, telemetry transmitters for missile systems, electronic warfare (EW) systems, tactical radio communications systems for ground, sea, and airborne applications; satellite communications; land mobile radio systems for public safety and homeland security communications networks; broadcast systems including digital TV transmitters; electronic test and measurement instruments including high precision RF and microwave signal generators and analyzers; medical instrumentation including MRI and laser systems and RF surgical probe systems; microwave wireless multimedia devices; GPS receivers; automotive sensors; tollway transponders; security scanners; and household appliances including microwave ovens, cordless phones, set-top boxes, cable and Wi-Fi modems.
We have a long history of supplying high power, high frequency, RF and microwave products, including filters, log video amplifiers, detectors and integrated assemblies, to prime contractors that in turn supply government military customers. These prime contractors include, but are not limited to, Lockheed Martin, BAE, Raytheon and Saab, our four largest contractors. Our products have been used in numerous programs dating back to 1956, when Microphase introduced its first diplexer to Lockheed Martin. Continuing its technology leadership, Microphase designed a seven channel multiplexer, now housed in the Smithsonian Institute of Technology, which was onboard the first US piloted space flight, the Mercury Freedom 7 Capsule, on May 5, 1961. Other notable programs in which the Company’s products were used include the Atlas Missile, Vanguard Missile, Polaris Missile System (recipient of citation from Bureau of Naval Weapons), SHRIKE Missile, ARM Missile, the Patriot Missile System, THAAD (Terminal High Altitude Area Defense), the Samos, Tiros, and Currier Space Probes, the B1 Bomber, the F111, EA6B, F14, F16, F18, Gripen fighter, and the F35 joint strike fighter planes, and more recently drone programs including the Predator, the Reaper and the Shadow.
As the need for more secure communications increases, the need for higher powered and higher frequency devices is needed for applications in military, public safety/homeland security, medical, autonomous auto, commercial communications and other fields.
Competition
We operate in highly competitive markets that are sensitive to technological advances. Many of our competitors in each of our markets are larger than we are and maintain higher levels of expenditures for research and development. In each of our markets, we concentrate on the opportunities that our management believes are compatible with our resources, overall technological capabilities and objectives. Principal competitive factors in these markets are product quality and reliability; technological capabilities; service; past performance; ability to develop and implement complex, integrated solutions; ability to meet delivery schedules; the effectiveness of third-party sales channels in international markets; and cost-effectiveness.
In the RF Communications segment, principal competitors for our filter components products include K & L Microwave, a Dover Company located in Salisbury, MD; R S Microwave, a privately held company headquartered in Butler, NJ; Lorch Microwave of Salisbury, MD, a member of the Smith Group, a global technology company listed on the London Stock Exchange; and Delta Diversified Products, a private company based in Arizona.
In the Video amplifier segment, principal competitors for our Detector Log Video Amplifier Sensor products include American Microwave Corporation, a privately held company headquartered in Frederick, MD; Akon Inc., a privately held company based in San Jose, CA; Planar Monolithics Industries (“PMI”), a privately held company based in Frederick, MD; L-3 Narda-Miteq, a subsidiary of L-3 Communications Inc., a publicly-traded company based in New York, NY; and Signal Technology, a subsidiary of Crane Co., a publicly-traded company based in Stamford, CT.
RF/Microwave Industry
The RF/Microwave industry is vast, comprising a wide range of diverse technologies that incorporate everything from tiny components to large integrated systems. The scope of applications for RF/Microwave products is nearly as broad as the number of technologies themselves, with a reach that grows wider with each passing year. RF/Microwave products support a variety of market segments including defense and aerospace; mobile wireless infrastructure networks; multimedia devices; household appliances such as microwave ovens, set top boxes and entertainment systems; public safety/homeland security communications; broadcast systems; automotive sensors; and other markets. These markets have traditionally presented a wide range of opportunities and diverse customers for Microphase’s RF/Microwave products. As a customer-driven global provider of RF/Microwave components, devices, and integrated assemblies we plan to expand market penetration in emerging technology markets including 5th Generation (5G) wireless mobile communications, commercial drone systems, and Internet of Things (IoT), which provides for advanced interconnection of devices, systems, and services within the existing Internet infrastructure and is expected to rely heavily on wireless links to lead in automation in nearly all fields from residential to commercial, healthcare and industrial markets.
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The RF/Microwave components drive annual opportunities that are valued in the billions of dollars. The market segments for Microphase products including filters, detector log video amplifiers, power amplifiers, and integrated assemblies together are valued at more than $4 billion annually as calculated by the Company based on data from CTIA-The Wireless Association, the Microwave Journal, Civitas Group and Transparance Market Research.
Defense Industry
The US Department of Defense (“DoD”) is committed to ensuring a high state of military readiness, with funding priorities focused on the safety and effectiveness of US troops, national defense, homeland security, and battlefield command, control and communication systems. Advanced radar systems, jamming systems, smart munitions, electronic surveillance and communication systems are important DoD capabilities. The Company’s products and technologies are mission-critical components which are supplied to the major US Defense Original Equipment Manufacturers (“OEMs”) that develop and manufacture these systems for the DoD.
Microphase is known in the RF and microwave defense electronics industry for its technical proficiency in high frequency, high power products that support secure communications between military assets, having been an approved contractor and sub-contractor for prime contractors and performing work for the DoD for RF applications since 1963. The Company possesses a high degree of engineering talent and technical expertise in high frequency, high power communications. The Company focuses on more complex and higher performance products with higher technical requirements.
Principal Customers; Government Contracts
The percentage of our revenue that was derived from sales to the U.S. Government and to major defense contractors of advanced weapons systems to U.S. Government customers, including the Military, the DoD and intelligence and civilian agencies, was approximately 87 percent in fiscal 2016 compared with approximately 86 percent in fiscal 2015 and 96 percent in fiscal 2014. Our U.S. Government sales are predominantly derived from contracts with prime military contractors to the U.S. Government.
On U.S. Government firm fixed-price contracts we agree to perform a specific scope of work for a fixed price and, as a result, may benefit from cost savings and may carry the burden of cost overruns. U.S. Government contracts are terminable for the convenience of the U.S. Government, as well as for default based on performance. Companies supplying goods and services to the U.S. Government are dependent on Congressional appropriations and administrative allotment of funds and may be affected by changes in U.S. Government policies resulting from various military, political, economic and international developments. Long-term U.S. Government contracts and related orders are subject to cancellation if appropriations for subsequent performance periods become unavailable. Under contracts terminable for the convenience of the U.S. Government, a contractor is entitled to receive payments for its allowable costs and, in general, the proportionate share of fees or earnings for the work done. Contracts that are terminable for default generally provide that the U.S. Government pays only for the work it has accepted and may require the contractor to pay for the incremental cost of re-procurement and may hold the contractor liable for damages. In many cases, there is also uncertainty relating to the complexity of designs, necessity for design improvements and difficulty in forecasting costs and schedules when bidding on developmental and highly sophisticated technical work. Under many U.S. Government contracts, we are required to maintain facility and personnel security clearances complying with DoD and other Federal agency requirements.
Business the Company Intends to Expand Upon
Global RF/Microwave Test and Measurement Industry
The global RF/microwave test and measurement industry is estimated to reach $4.2 billion in 2016, growing at a compound annual rate of 7% as the increasing complexity of products translates into growth opportunities for RF/microwave test and measurement vendors. This market estimate was calculated by the Company based on data from the US Department of Labor, the Institute of Electrical and Electronics Engineers (“IEEE”), Frost and Sullivan, and Keysight Technologies, Inc. (NYSE:KEYS). Key factors driving the growth include, the growth in wireless and mobile devices, revolving wireless standards, and a focus on Multiple Input Multiple Output (“MIMO”) technology using multiple antennas to make use of reflected signals to provide gains in channel quality. As standards continue to evolve and emerge, there is expected to be a greater demand for state of the art vector network and spectrum analyzers and related accessories.
Subject to available financial resources, Microphase plans to introduce a series of unique and high performance handheld and PC-based electronic test and measurement devices and supporting accessories designed for use with a laptop or desktop computer. These products are intended to provide the most cost effective and most efficient tools for test and characterization of RF/microwave and wireless components, devices, and circuits. Our test and measurement solutions enable board-less, connector-less, solder-less and non-destructive test and measurement of RF/Microwave and wireless packaged and unpackaged devices, components, and circuits. The product line is proprietary and protected by two issued patents and more than 18 patent applications currently in process. The RF/Microwave test and measurement industry is dominated by 5 major global test equipment manufacturers including Keysight Technologies (formerly Agilent Technologies), Anritsu, Rohde & Schwarz, Tektronix (a division of Danaher), and National Instruments. These manufacturers offer a range of vector network and spectrum analyzers which are key electronic test and measurement instruments for test and performance characterization of RF and microwave components, devices, and circuits. In addition to these five major test equipment manufacturers there are several small manufacturers that offer a wide range of test and measurement tools and accessories many of which are designed and intended to work and/or interface with test instruments manufactured by these five major manufacturers. Microphase T&M products include tools and solutions that are intended to interface directly with test instruments from all five test equipment manufacturers as well as test solutions that operate independent of these instruments and in some cases compete with these instruments.
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Growth Strategy
While our core market historically has been the military electronics defense industry, we intend to leverage our high-frequency RF and microwave expertise to expand into high growth sectors of the wireless and RF microwave industries where we believe that we can command significant leadership. Our strategic plan for future growth is to develop and/or acquire proprietary technologies and solutions that will dramatically leapfrog existing solutions and products in the areas of cost, size, weight, reliability and performance.
As a customer-driven global provider of RF/Microwave components, devices, and integrated assemblies, we plan to expand market penetration in emerging technology markets, including fifth generation (5G) wireless mobile communications, commercial drone systems, and the Internet of Things (“IoT”), which provides for advanced interconnection of devices, systems, and services within the existing Internet infrastructure and is expected to rely heavily on wireless links to enable automation in nearly all fields from residential to commercial, healthcare and industrial markets.
The Company is working to develop innovative solutions that we expect will drive our strategic roadmap for long-term growth and profitability. Discussions are underway for collaboration and joint development with certain potential strategic partners as we aggressively pursue access to niche products and solutions with first-to-market opportunities in these high growth market segments. This strategy should enable Microphase to broaden its customer base and reduce risk by spreading its revenue base across multiple market sectors. Acquisitions, if completed successfully, could increase our market share and the technology value of our product lines as well as broaden our product offerings and diversify our customer base. We believe that we are well positioned to capitalize on growth opportunities in the following three key market segments:
| • | test and measurements; |
| • | electronic filters; and |
| • | high power amplifiers. |
Test and Measurements
We believe that there are significant potential opportunities in the RF/Microwave Test and Measurement industry for low-cost high frequency test solutions. We plan to use our core competencies, technologies, and resources to develop, manufacture, and market a unique portfolio of the industry’s first low-cost RF/Microwave and Millimeter-wave test and measurement products as alternative commercial products to conventional expensive custom test solutions.
On January 21, 2016, the Company entered the T&M industry by closing on a purchase agreement with Dynamac, Inc. (“Dynamac”), pursuant to which the Company acquired certain assets in a line of proprietary RF and microwave test and measurement products, as well as related intellectual property. These test and measurement products are designed to test active and passive electronic components, devices and board level systems. The product line includes a unique portfolio of test and measurement products that we expect could reduce the test and measurement time for developers of electronic products from days or weeks to minutes.
According to the U.S. Department of Labor and Frost and Sullivan, the global RF/microwave test and measurement industry is estimated to reach $4.2 billion in 2016, growing at a compound annual rate of 7% as the increasing complexity of products translates into growth opportunities for RF/microwave test and measurement vendors. Key factors include the growth in wireless and mobile devices, constantly changing wireless standards, and a focus on Multiple Input Multiple Output (“MIMO”) technology using multiple antennas to make use of reflected signals to provide gains in channel quality and improved clarity. As standards continue to evolve and emerge, there is expected to be a greater demand for state of the art vector network and spectrum analyzers and related accessories.
The RF/Microwave test and measurement industry is dominated by five major global test equipment manufacturers, including Keysight Technologies (formerly Agilent Technologies), Anritsu, Rohde & Schwarz, Tektronix (a division of Danaher), and National Instruments. These manufacturers offer a range of vector network and spectrum analyzers which are key electronic test and measurement instruments for test and performance characterization of RF and microwave components, devices, and circuits. In addition to these five major test equipment manufacturers, there are several small manufacturers that offer a wide range of test and measurement tools and accessories, many of which are designed and intended to work and/or interface with test instruments manufactured by these five major manufacturers. Our T&M products include tools and solutions that are intended to interface directly with customers’ test instruments purchased from all the five major test equipment manufacturers, as well as to operate independently of these test instruments and, in some cases, compete with these test instruments.
The T&M product portfolio is currently at a transition point. The first group of products consisting of fully tested engineering prototypes for the initial product offering have been completed and production ready units have been produced. Minor design changes are still anticipated to standardize various parts to streamline manufacturing processes and to reduce unit cost for various products for volume production of the first group. The second group of products which is based on several groundbreaking integrated concepts is currently in development phase to produce functional versions for the follow-on product offerings. The Company has been working on and anticipates it will file more than 22 new patent applications in addition to the two patents that were issued in 2011. One of the issued patents is for a universal test fixture for testing and characterization of high power RF and microwave transistors and diodes and the second is for a calibrated passive impedance probe for impedance and performance measurement of RF microwave components, devices and circuits.
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Electronic Filters
An electronic filter provides a fundamental and necessary function in a communication system or device by allowing a band of desired frequencies to pass and attenuating all others. In doing so, the electronic filter eliminates interference and noise to allow communications to take place reliably. Virtually all communications systems, equipment, and devices use electronic filters in one or more places within their network architectures. Electronic filters are vital to the performance and operation of modern commercial, wireless, military and aerospace communications and electronic systems and devices. Electronic filters, which are also widely known as RF & Microwave filters, are designed to operate at radio, microwave, and millimeter-wave frequencies and are also used as building blocks for construction of duplexers, triplexers, quadplexers and the like, allowing two or more receivers and/or transmitters to simultaneously operate using a common single antenna.
Microphase has been developing and manufacturing high value, low volume electronic filters for the aerospace and defense market for over 60 years. Recently, the Company has been collaborating with another company to develop a line of filters based on an innovative new technology being jointly developed. This arrangement is expected to be structured as a joint venture, with such new technology to be owned by the joint venture company. These filters will be designed to be a fraction of the size of current filters, and also be a fraction of the cost. The target markets are defense and aerospace, wireless infrastructure, cellular handsets and other markets. Target customers include existing defense and aerospace customers and new commercial customers. The estimated target market size for the filters is expected to be $3.2 billion in 2016.
High Power Amplifiers
Microphase has been developing low power amplifiers for over 50 years and recently has been working with another company towards developing a new series of high power amplifiers based on a new technology developed by such other company. This arrangement is expected to be structured as a joint venture, with such new technology to be owned by such joint venture company. As proposed, the joint venture partner has developed the two patents and would contribute this intellectual property to the joint venture company and Microphase would commercialize the prototypes and take to market, as well as finishing development, marketing, manufacturing and selling the new amplifier product line. The new technology has been designed to generate multi-kilowatt RF/microwave power and operate at the safety of low DC voltage. It will be designed to be powerful, efficient, light-weight, compact, reliable, tunable, and easily serviceable with low manufacturing cost. The dollar per watt cost is competitive with magnetrons, the lowest price and least reliable source of RF power. The new amplifier will be used in RF/microwave amplifier systems for a wide range of military, commercial and industrial applications. The target market for the high power amplifiers is expected to be $1.7 billion in 2016.
Recent Developments
Pursuant to the Company’s growth strategy, on March 31, 2013 the Company acquired a line of detector log video amplifier (“DLVA”) threat detection products from Microsemi Corporation, a global designer, manufacturer and marketer of analog and mixed-signal integrated circuits and semiconductors. The acquired product line specializes in threat detection assemblies used in many DOD programs. The product line is complementary to Microphase’s existing portfolio of high end Video Amplifier products and has enabled the Company to enhance its market leadership position by allowing it to expand its product offerings. This line of business accounted for 23% of the Company’s 2016 sales.
In July of 2014, Microphase executed a Stock Purchase Agreement with AmpliTech Group, Inc., a publicly-traded provider of RF/Microwave and low-noise amplifiers for critical and high-reliability, wireless and satellite communications applications. Microphase received 8,666,666 shares of common stock of Amplitech Group, Inc. for a $200,000 investment. To date this investment has been a passive investment.
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On January 21, 2016, Microphase Instruments LLC, a wholly-owned subsidiary of the Company entered into a Purchase Agreement with Dynamac, Inc. (the “Seller”), pursuant to which the Company acquired from the Seller a line of proprietary radio frequency (RF) and microwave test and measurement products, together with certain corresponding intellectual property, for an aggregate purchase price of $2,500,000. We believe the products and intellectual property acquired through these acquisitions will enable us to grow sales in accordance with our growth strategy. The Dynamac License was recorded at cost. The Company had previously deposited $50,000 and provided a $300,000 note payable, toward the initial contract during fiscal 2015, which was subsequently revised by the Dynamac agreement of January 21, 2016.
The assets acquired in the Dynamac agreement have been valued at the contract price in our initial measurement, resulting in intangible assets other than goodwill, primarily Intellectual Property consisting of two (2) patents with remaining lives of over 12 years each, a portfolio of product prototypes to be patented, trade secrets, know-how, confidential information and other intellectual property. We expect to incur additional costs to apply for eighteen (18) new patents, in addition to various trademarks and copyrights.
Existing Product Families
Detector Log Video Amplifiers: Microphase DLVA products are complex subsystem modules that are used primarily in radar and electronic warfare (EW) systems to detect and process with high precision and accuracy incoming signals having varying power levels in highly electromagnetic dense and noisy environments to deliver video output signals to advanced early warning radar and control systems.
Detectors and Limiters: These products are used in the receivers of radio and satellite communications, GPS, radar, and electronic countermeasure systems for detection of very low level signals while at the same time protecting high sensitivity receivers from high power interference and jamming sources.
Filters: Microphase’s filter portfolio offers a complete line of bandpass, bandstop, lowpass, and highpass filter products for both transmitter and receiver applications. Microphase filters are used in a wide range of communications, broadcast, radar, and satellite systems, etc. to provide channel selectivity, and to eliminate or mitigate noise, interference and/or spurious emissions.
Switched Filter Banks: A switched filter assembly typically consists of a bank of filters and a controlled high speed switch matrix. Each filter within the filter bank covers a specific frequency band. The filters are selected and switched in nanoseconds by a digital control signal. Microphase offers switched filter assemblies consisting of up to 16 filters or channels for use in EW, military and aerospace, and communications systems.
Duplexers and Multiplexers: Our duplexers consist of two filters which provide a high degree of isolation between transmit and receive signals enabling a transmitter and receiver to operate safely and reliably via a single common antenna. Microphase multiplexers consist of multiple filters designed and arranged in such a way to provide contiguous and non-contiguous channels. Microphase designs and manufactures multiplexers with up to 16 channels using various advanced filter technologies to meet customer-specific requirements.
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Amplifier Solutions: Microphase offers a family of custom designed and manufactured amplifiers covering frequency range up to 18 GHz providing linear amplification of signals for both transmitter and receiver applications for a wide range of military and commercial communications, radar, EW and ECM systems.
Multifunction Assemblies and Integrated Subsystems: Many of Microphase’s products are leveraged, used, and integrated along with other functionality and technologies in the design, development, and manufacture of higher level functionality in smaller and more compact multifunction assemblies offering solutions with substantially reduced risk and complexity when compared to discrete architectures.
Employees
As of June 30, 2016, the Company had 60 full-time employees, 6 part-time employees, 1 paid consultant and 2 contract workers.
Reports to Security Holders.
| 1. | The Company files reports with the SEC. The Company is a reporting company and complies with the requirements of the Exchange Act. |
| 2. | The public may read and copy any materials the Company files with the SEC in the SEC’s Public Reference Section, Room 1580, 100 F Street N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Section by calling the SEC at 1-800-SEC-0330. Additionally, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, which can be found at http://www.sec.gov. |
An investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors in evaluating our business. If any of these risks, or other risks not presently known to us or that we currently believe are not significant, develops into an actual event, then our business, financial condition and results of operations could be adversely affected. If that happens, the market price of our common stock could decline.
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Risks Related To Our Business
WE HAVE A HISTORY OF LOSSES AND OUR FUTURE PROFITABILITY ON A QUARTERLY OR ANNUAL BASIS IS UNCERTAIN, WHICH COULD HAVE A HARMFUL EFFECT ON OUR BUSINESS AND THE VALUE OF OUR COMMON STOCK.
During the past three fiscal years we have incurred losses from operations. These losses are attributable to lower volumes of our products sold to major defense contractors partially as a result of the overall reduction in defense spending and sequestration by the U.S. Congress. As of June 30, 2016, we had an accumulated deficit of $13,939,651 and a total stockholders’ deficit of $602,207. Since the financial crisis of 2008, Microphase has been significantly short of capital needed to acquire parts for production of its products to complete orders for such products. At times, the Company has not had the cash available to make advance payments for the purchase of parts, and then, as a consequence, the Company would not receive the parts from its vendors required to finish a customer order. This would then delay the delivery of products to customers, and would also delay recognition of the resulting revenues and the receipt of cash from the customer. Sometimes after experiencing a delay in delivery of an order from Microphase, the customer would not place its next order with the Company, resulting in a loss of business. Although access to the public financial markets could increase our ability to raise capital, no assurances can be given that a significant liquid market will develop for our common stock, and we may not be, therefore, provided with greater access to capital.
Our future profitability depends upon many factors, including several that are beyond our control. These factors include, without limitation:
| · | changes in the demand for our products and services; |
| · | loss of key customers or contracts; |
| · | the introduction of competitive products; |
| · | the failure to gain market acceptance of our new and existing products; and |
| · | the failure to successfully and cost effectively develop, introduce and market new products, services and product enhancements in a timely manner. |
In addition, we are incurring significant legal, accounting, and other expenses related to being a reporting company. As a result of these expenditures, we will have to generate and sustain increased revenue to achieve and maintain future profitability.
OUR CURRENT REVENUE IS ALMOST ENTIRELY DERIVED FROM PRIME DEFENSE CONTRACTORS TO THE U.S. GOVERNMENT AND ITS ALLIES, AND THE LOSS OF THESE RELATIONSHIPS, A REDUCTION IN U.S. GOVERNMENT FUNDING OR A CHANGE IN U.S. GOVERNMENT SPENDING PRIORITIES OR BIDDING PROCESSES COULD HAVE AN ADVERSE IMPACT ON OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS AND CASH FLOWS.
We are highly dependent on sales to major defense contractors of the U.S. military and its allies, including Lockheed Martin, Raytheon, BAE Systems and SAAB. The percentages of our revenue that were derived from sales to these named major defense contractors and directly to the U.S. Government were 66.8% in fiscal 2016, 65.8% in fiscal 2015, 56.1% in fiscal 2014 and 48.4% in fiscal 2013. Therefore, any significant disruption or deterioration of our relationship with any such major defense contractors or the U.S. Government could materially reduce our revenue. In the twelve months ended June 30, 2016 there were two customers which each accounted for more than 10% of sales: Lockheed Martin and BAE Systems at 27.8% and 17.3% respectively. In the twelve months ended June 30, 2015 there were two customers which each accounted for more than 10% of sales: Lockheed Martin and BAE Systems at 30.6% and 14.5% respectively. Our competitors continuously engage in efforts to expand their business relationships with the same major defense contractors and the U.S. Government and will continue these efforts in the future, and the U.S. Government may choose to use other contractors. We expect that a majority of the business that we seek will be awarded through competitive bidding. We operate in highly competitive markets and our competitors may have more extensive or more specialized engineering, manufacturing and marketing capabilities than we do in some areas, and we may not be able to continue to win competitively awarded contracts or to obtain task orders under multi-award contracts. Further, the competitive bidding process involves significant cost and managerial time to prepare bids and proposals for contracts that may not be awarded to us, as well as the risk that we may fail to accurately estimate the resources and costs required to fulfill any contract awarded to us. Following any contract award, we may experience significant expense or delay, contract modification or contract rescission as a result of our competitors protesting or challenging contracts awarded to us in competitive bidding. Major defense contractors to whom we supply components for systems must compete with other major defense contractors (to whom we may not supply components) for military orders from the U.S. Government. In addition, we compete with other policy needs, which may be viewed as more necessary, for limited resources and an ever-changing amount of available funding in the budget and appropriation process. Budget and appropriations decisions made by the U.S. Government are outside of our control and have long-term consequences for our business. U.S. Government spending priorities and levels remain uncertain and difficult to predict and are affected by numerous factors, including sequestration (automatic, across-the-board U.S. Government budgetary spending cuts), and the purchase of our products could be superseded by alternate arrangements. A change in U.S. Government spending priorities or an increase in non-procurement spending at the expense of our programs, or a reduction in total U.S. Government spending, could have material adverse consequences on our future business.
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OUR FEDERAL GOVERNMENT CONTRACTS MAY BE TERMINATED BY THE FEDERAL GOVERNMENT AT ANY TIME PRIOR TO THEIR COMPLETION, WHICH COULD LEAD TO UNEXPECTED LOSS OF SALES AND REDUCTION IN OUR BACKLOG.
Under the terms of our federal government contracts, the federal government may unilaterally:
| · | terminate or modify existing contracts; |
| · | reduce the value of existing contracts through partial termination; and |
| · | delay the payment of our invoices by government payment offices. |
The federal government can terminate or modify any of its contracts with us or its prime contractors either for the federal government’s convenience, or if we or its prime contractors default, by failing to perform under the terms of the applicable contract. A termination arising out of our default could expose us to liability and have a material adverse effect on our ability to compete for future federal government contracts and subcontracts. If the federal government or its prime contractors terminate and/or materially modify any of our contracts or if any applicable options are not exercised, our failure to replace sales generated from such contracts would result in lower sales and could adversely affect our earnings, which could have a material adverse effect on our business, results of operations and financial condition. Our backlog as of March 31, 2016 was approximately $4.8 million. Our backlog could be adversely affected if contracts are modified or terminated.
OUR PRODUCTS WITH MILITARY APPLICATIONS ARE SUBJECT TO EXPORT REGULATIONS, AND COMPLIANCE WITH THESE REGULATIONS MAY BE COSTLY.
We are required to obtain export licenses before filling foreign orders for many of our products that have military or other governmental applications. United States Export Administration regulations control technology exports like our products for reasons of national security and compliance with foreign policy, to guarantee domestic reserves of products in short supply and, under certain circumstances, for the security of a destination country. Thus, any foreign sales of our products requiring export licenses must comply with these general policies. Compliance with these regulations is costly, and these regulations are subject to change, and any such change may require us to improve our technologies, incur expenses or both in order to comply with such regulations.
WE DEPEND ON U.S. GOVERNMENT CONTRACTS ISSUED TO MAJOR DEFENSE CONTRACTORS, WHICH OFTEN ARE ONLY PARTIALLY FUNDED, SUBJECT TO IMMEDIATE TERMINATION, AND HEAVILY REGULATED AND AUDITED. THE TERMINATION OR FAILURE TO FUND, OR NEGATIVE AUDIT FINDINGS FOR, ONE OR MORE OF THESE CONTRACTS COULD HAVE AN ADVERSE IMPACT ON OUR BUSINESS.
Over its lifetime, a U.S. Government program awarded to a major defense contractor may be implemented by the award of many different individual contracts and subcontracts. The funding of U.S. Government programs is subject to Congressional appropriations. Although multi-year contracts may be authorized and appropriated in connection with major procurements, Congress generally appropriates funds on a fiscal year basis. Procurement funds are typically made available for obligations over the course of one to three years. Consequently, programs often receive only partial funding initially, and additional funds are designated only as Congress authorizes further appropriations. The termination of funding for a U.S. Government program with respect to major defense contractors for whom we are a subcontractor would result in a loss of anticipated future revenue attributable to that program, which could have an adverse impact on our operations. In addition, the termination of, or failure to commit additional funds to, a program for which we are a subcontractor could result in lost revenue and increase our overall costs of doing business.
Generally, U.S. Government contracts are subject to oversight audits by U.S. Government representatives. Such audits could result in adjustments to our contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed must be refunded. We have recorded contract revenues based on costs we expect to realize upon final audit. However, we do not know the outcome of any future audits and adjustments, and we may be required to materially reduce our revenues or profits upon completion and final negotiation of audits. Negative audit findings could also result in termination of a contract, forfeiture of profits, suspension of payments, fines and suspension or debarment from U.S. Government contracting or subcontracting for a period of time.
In addition, U.S. Government contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. Government’s convenience upon the payment only for work done and commitments made at the time of termination. We can give no assurance that one or more of the U.S. Government contracts with a major defense contractor under which we provide component products will not be terminated under these circumstances. Also, we can give no assurance that we will be able to procure new contracts to offset the revenue or backlog lost as a result of any termination of our U.S. Government contracts. Because a significant portion of our revenue is dependent on our performance and payment under our U.S. Government contracts, the loss of one or more large contracts could have a material adverse impact on our business, financial condition, results of operations and cash flows.
Our government business also is subject to specific procurement regulations and other requirements. These requirements, although customary in U.S. Government contracts, increase our performance and compliance costs. In addition, these costs might increase in the future, thereby reducing our margins, which could have an adverse effect on our business, financial condition, results of operations and cash flows. Failure to comply with these regulations and requirements could lead to fines, penalties, repayments, or compensatory or treble damages, or suspension or debarment from U.S. Government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various laws, including those related to procurement integrity, export control, U.S. Government security regulations, employment practices, protection of the environment, accuracy of records, proper recording of costs and foreign corruption. The termination of a U.S. Government contract or relationship as a result of any of these acts would have an adverse impact on our operations and could have an adverse effect on our standing and eligibility for future U.S. Government contracts.
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OUR FAILURE TO COMPLY WITH THE OBLIGATIONS SET FORTH IN THE AGREEMENTS ENTERED INTO WITH GERBER FINANCE, INC., INCLUDING FAILURE TO COMPLY WITH FINANCIAL COVENANTS, MAY RESULT IN THE FORECLOSURE OF OUR, INCLUDING OUR SUBSIDIARIES’, PLEDGED ASSETS AND OTHER ADVERSE CONSEQUENCES.
We entered into a revolving credit facility with Gerber Finance, Inc. (“Gerber”) in 2012, as amended, with a maximum borrowing availability of $1,400,000 (the “Gerber Facility”). We have been in non-compliance with certain covenants since 2012 and are currently in discussions with Gerber regarding revising those covenants. Our failure to resolve any non-compliance with respect to the obligations under this credit facility and related documents or the occurrence of certain other specified events could result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of our debt, potential foreclosure on our assets and other adverse consequences. Such obligations include satisfaction of certain financial covenants including those related to our net worth and net income and subordinated debt, with which we may not be able to comply. Any such failure to resolve any non-compliance with respect to such financial covenants could result in an event of default.
OUR BUSINESS COULD BE NEGATIVELY IMPACTED BY CYBERSECURITY THREATS AND OTHER SECURITY THREATS AND DISRUPTIONS.
As a U.S. Government defense contractor, we face certain security threats, including threats to our information technology infrastructure, attempts to gain access to our proprietary or classified information, threats to physical security, and possible domestic terrorism events. Our information technology networks and related systems are critical to the operation of our business and essential to our ability to successfully perform day-to-day operations. We are also involved with information technology systems for certain customers and other third parties, which generally face similar security threats. Cybersecurity threats in particular, are persistent, evolve quickly and include, but are not limited to, computer viruses, attempts to access information, denial of service and other electronic security breaches. We believe we have implemented appropriate measures and controls and we have invested in skilled information technology resources to appropriately identify threats and mitigate potential risks, but there can be no assurance that such actions will be sufficient to prevent disruptions to mission critical systems, the unauthorized release of confidential information or corruption of data. A security breach or other significant disruption involving these types of information and information technology networks and related systems could:
| · | disrupt the proper functioning of these networks and systems and therefore our operations and/or those of certain of our customers; |
| · | result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of, proprietary, confidential, sensitive or otherwise valuable information of ours or our customers, including trade secrets, which others could use to compete against us or for disruptive, destructive or otherwise harmful purposes and outcomes; |
| · | compromise national security and other sensitive government functions; |
| · | require significant management attention and resources to remedy the damages that result; |
| · | subject us to claims for breach of contract, damages, credits, penalties or termination; and |
| · | damage our reputation with our customers (particularly agencies of the U.S. Government) and the public generally. |
Any or all of the foregoing could have a negative impact on our business, financial condition, results of operations and cash flows.
WE ENTER INTO FIXED-PRICE CONTRACTS THAT COULD SUBJECT US TO LOSSES IN THE EVENT OF COST OVERRUNS OR A SIGNIFICANT INCREASE IN INFLATION.
We have a number of fixed-price contracts which allow us to benefit from cost savings but subject us to the risk of potential cost overruns, particularly for firm fixed-price contracts, because we assume all of the cost burden. If our initial estimates are incorrect, we can lose money on these contracts. U.S. Government contracts can expose us to potentially large losses because the U.S. Government can hold us responsible for completing a project or, in certain circumstances, paying the entire cost of its replacement by another provider regardless of the size or foreseeability of any cost overruns that occur over the life of the contract. Because many of these contracts involve new technologies and applications, unforeseen events such as technological difficulties, fluctuations in the price of raw materials, problems with our suppliers and cost overruns, can result in the contractual price becoming less favorable or even unprofitable to us. The U.S. and other countries also may experience a significant increase in inflation. A significant increase in inflation rates could have a significant adverse impact on the profitability of these contracts. Furthermore, if we do not meet contract deadlines or specifications, we may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated damages or suffer major losses if the customer exercises its right to terminate. In addition, some of our contracts have provisions relating to cost controls and audit rights, and if we fail to meet the terms specified in those contracts we may not realize their full benefits. Our results of operations are dependent on our ability to maximize our earnings from our contracts. Cost overruns could have an adverse impact on our financial results.
WE DERIVE A PORTION OF OUR REVENUE FROM INTERNATIONAL OPERATIONS AND ARE SUBJECT TO SOME OF THE RISKS OF DOING BUSINESS INTERNATIONALLY.
We are dependent on sales to customers outside the U.S. The percentage of our total revenue represented by revenue from products and services exported from the U.S. (including foreign military sales) or manufactured or rendered abroad was 13.3% in fiscal 2016, 13.9% in fiscal 2015, 4% in fiscal 2014 and 3% in fiscal 2013. Although we are paid in U.S. dollars for our export products and are therefore not subject to currency fluctuation risks, we are subject to other international business risks including:
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| · | the laws, regulations and policies of foreign governments relating to investments and operations, as well as U.S. laws affecting the activities of U.S. companies abroad, including the Foreign Corrupt Practices Act (“FCPA”); |
| · | changes in regulatory requirements, including business or operating license requirements, imposition of tariffs or embargoes, export controls and other trade restrictions; |
| · | uncertainties and restrictions concerning the availability of funding, credit or guarantees; |
| · | the complexity and necessity of using, and disruptions involving, our international dealers, distributors, sales representatives and consultants; |
| · | import and export licensing requirements and regulations, as well as unforeseen changes in export regulations; |
| · | uncertainties as to local laws and enforcement of contract and intellectual property rights and occasional requirements for onerous contract clauses; and |
| · | rapid changes in government, economic and political policies, political or civil unrest, acts of terrorism or the threat of international boycotts or U.S. anti-boycott legislation. |
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY A NEGATIVE AUDIT OR INVESTIGATORY FINDING BY THE U.S. GOVERNMENT.
As a government contractor, we are subject to audits and investigations by U.S. Government agencies including the Defense Contract Audit Agency (the “DCAA”), the Defense Contract Management Agency (the “DCMA”), the Inspector General of the Department of Defense (the “DoD”) and other departments and agencies, the Government Accountability Office, the Department of Justice (the “DoJ”) and Congressional Committees. From time to time, these and other agencies investigate or conduct audits to determine whether a contractor’s operations are being conducted in accordance with applicable requirements. The DCAA and DCMA also review the adequacy of, and compliance with, a contractor’s internal control systems and policies, including the contractor’s accounting, purchasing, property, estimating, earned value management and material management accounting systems. Our final allowable incurred costs for each year are also subject to audit and have from time to time resulted in disputes between us and the U.S. Government. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded if already reimbursed. If an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. Government. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us.
FUTURE LITIGATION OR ADMINISTRATIVE PROCEEDINGS RELATED TO OUR MILITARY PROJECTS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
In the future, we may be involved in legal proceedings, administrative proceedings, claims and other litigation that arise in the ordinary course of business related to military, aerospace and telecommunications projects. Unfavorable outcomes or developments relating to any such proceedings, such as judgments for monetary damages, injunctions or denial or revocation of permits, could have a material adverse effect on our business, financial condition and results of operations.
OUR OPERATING RESULTS HAVE HISTORICALLY BEEN SUBJECT TO SIGNIFICANT YEARLY AND QUARTERLY FLUCTUATIONS AND ARE EXPECTED TO CONTINUE TO FLUCTUATE.
Our operating results have historically been, and are expected to continue to be, subject to quarterly and yearly fluctuations as a result of a number of factors including:
| · | our reliance on a limited number of customers for a large portion of our revenues; |
| · | our ability to successfully implement programs to stimulate sales by anticipating and offering customized new products and services customers will require in the future to increase the efficiency and profitability of their products; |
| · | our ability to successfully complete programs on a timely basis, to reduce our cost structure, including fixed costs, to streamline our operations and to reduce product costs; |
| · | increased price and product competition in our markets; |
| · | the inherent uncertainties of using forecasts, estimates and assumptions for asset valuations and in determining the amounts of accrued liabilities and other items in our consolidated financial statements; |
| · | our ability to implement our work plan without negatively impacting our relationships with our customers, the delivery of products based on new and developing technologies, the delivery of high quality products at competitive prices, the maintenance of technological leadership, the effectiveness of our internal processes and organizations and the retention of qualified personnel; |
| · | fluctuations in our gross margins; |
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| · | the development, introduction and market acceptance of new technologies; |
| · | variations in sales channels, product costs and the mix of products sold; |
| · | the size and timing of customer orders and shipments; |
| · | our ability to maintain appropriate inventory levels; |
| · | the impact of acquired businesses and technologies; |
| · | the impact of our product development schedules, product quality variances, manufacturing capacity and lead times required to produce our products; |
| · | changes in legislation, regulation and/or accounting rules; |
| · | the impact of higher insurance premiums and deductibles and greater limitations on insurance coverage; and |
| · | acts of terrorism or the outbreak of hostilities or armed conflict between countries. |
THERE ARE A NUMBER OF TRENDS AND FACTORS WHICH AFFECT OUR MARKETS, INCLUDING ECONOMIC CONDITIONS IN THE UNITED STATES, EUROPE AND GLOBALLY, THAT ARE BEYOND OUR CONTROL. THESE TRENDS AND FACTORS MAY RESULT IN REDUCED DEMAND AND PRICING PRESSURE ON OUR PRODUCTS.
There are trends and factors affecting our markets that are beyond our control and may affect our operations. Such trends and factors include:
| · | adverse changes in the public and private equity and debt markets and our ability, as well as the ability of our customers and suppliers, to obtain financing or to fund working capital and capital expenditures; |
| · | reduced capital spending and/or negative economic conditions in the United States, Europe as well as other areas of the world; |
| · | adverse changes in our credit condition or the credit quality of our customers and suppliers; |
| · | adverse changes in demand for our specialized products in the market; |
| · | the trend towards the sale of integrated products that do not require the components we make; |
| · | uncertainty of the actual size and timing of capital expenditures by military customers; |
| · | uncertainty surrounding inventory practices, including the timing of product and service deployment, of our customers; |
| · | policies of our customers regarding utilization of single or multiple vendors for the products they purchase; |
| · | the overall trend toward industry consolidation and rationalization among our customers, competitors and suppliers; |
| · | conditions in the broader market for military and communications products; |
| · | governmental regulation or intervention affecting our products; and |
| · | the effects of war and acts of terrorism, such as disruptions in general global economic activity, and changes in logistics and security arrangements that reduced customer demand for our products and services. |
A NUMBER OF FACTORS COULD NEGATIVELY IMPACT OUR GROSS MARGINS, WHICH IN TURN WOULD NEGATIVELY AFFECT OUR OPERATING RESULTS.
Our gross margins may be negatively affected by a result of a number of factors, including:
| · | increased price competition; |
| · | excess capacity or excess fixed assets; |
| · | customer and contract settlements; |
| · | higher product, material or labor costs; |
| · | increased inventory provisions or contract and customer settlement costs; |
| · | warranty costs; |
| · | obsolescence; |
| · | loss of cost savings on future inventory purchases as a result of high inventory levels; |
| · | introductions of new products and costs of entering new markets; |
| · | increased levels of customer services; |
| · | changes in distribution channels; and |
| · | changes in product and geographic mix. |
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FUTURE CASH FLOW FLUCTUATIONS MAY AFFECT OUR ABILITY TO FUND OUR WORKING CAPITAL REQUIREMENTS OR ACHIEVE OUR BUSINESS OBJECTIVES IN A TIMELY MANNER.
Our working capital requirements and cash flows historically have been, and are expected to continue to be, subject to quarterly and yearly fluctuations, as described above. However, a substantial slow-down in capital spending by our customers may require us to adjust our current business model. As a result, our revenues and cash flows may be materially lower than we expect and we may be required to reduce our capital expenditures and investments or take other measures in order to meet our cash requirements. We may seek additional funds from liquidity-generating transactions and other conventional sources of external financing (which may include a variety of debt, convertible debt and/or equity financings). We cannot provide any assurance that our net cash requirements will be as we currently expect. Our inability to manage cash flow fluctuations resulting from the above factors could have a material adverse effect on our ability to fund our working capital requirements from operating cash flows and other sources of liquidity or to achieve our business objectives in a timely manner.
OUR BUSINESS MAY BE MATERIALLY AND ADVERSELY AFFECTED BY INCREASED LEVELS OF DEBT.
In order to finance our business or to finance possible acquisitions we may incur significant levels of debt compared to historical levels. A high level of debt, arduous or restrictive terms and conditions relating to accessing certain sources of funding, failure to meet the financial and/or other covenants in our credit facility and any significant reduction in, or access to, such facilities, poor business performance or lower than expected cash inflows could have adverse consequences on our ability to fund our business and the operation of our business. Other effects of a high level of debt include the following:
| · | we may have difficulty borrowing money in the future or accessing sources of funding; |
| · | we may need to use a large portion of our cash flow from operations to pay principal and interest on our indebtedness, which would reduce the amount of cash available to finance our operations and other business activities; |
| · | a high debt level, arduous or restrictive terms and conditions, or lower than expected cash flows would make us more vulnerable to economic downturns and adverse developments in our business; and |
| · | if operating cash flows are not sufficient to meet our operating expenses, capital expenditures and debt service requirements as they become due, we may be required, in order to meet our debt service obligations, to delay or reduce capital expenditures or the introduction of new products, sell assets and/or forego business opportunities including acquisitions, research and development projects or product design enhancements. |
THE TESTING OF ELECTRONIC COMMUNICATIONS EQUIPMENT AND THE ACCURATE TRANSMISSION OF INFORMATION ENTAIL A RISK OF PRODUCT LIABILITY CLAIMS BY CUSTOMERS AND OTHERS.
Product liability claims may be asserted against us by end-users of any of our products. We maintain product liability insurance coverage with an aggregate annual liability coverage limit, regardless of the number of occurrences, of $2.0 million. There is no assurance that such insurance will continue to be available at a reasonable cost or will be sufficient to cover all possible liabilities. In the event of a successful suit against us, lack or insufficiency of insurance coverage could result in substantial cost and could have a material adverse effect on our business.
WE CANNOT PREDICT THE CONSEQUENCES OF FUTURE GEO-POLITICAL EVENTS, BUT THEY MAY ADVERSELY AFFECT THE MARKETS IN WHICH WE OPERATE, OUR ABILITY TO INSURE AGAINST RISKS, OUR OPERATIONS OR OUR PROFITABILITY.
Ongoing instability and current conflicts in global markets, including in the Middle East and Asia, and the potential for other conflicts and future terrorist activities and other recent geo-political events throughout the world have created economic and political uncertainties that could have a material adverse effect on our business, operations and profitability. These matters cause uncertainty in the world’s financial and insurance markets and may significantly increase the political, economic and social instability in the geographic areas in which we operate. These matters also may cause our insurance coverages and performance bonds to increase in cost, or in some cases, to be unavailable altogether.
WE PLAN TO CONTINUE TO PURSUE AND CONSUMMATE, STRATEGIC ACQUISITIONS AND DIVESTITURES THAT COULD INVOLVE SIGNIFICANT RISKS AND UNCERTAINTIES.
Strategic acquisitions, joint ventures and divestitures that we plan to continue to pursue and consummate present significant risks and uncertainties, which include:
| · | difficulty in identifying and evaluating potential acquisitions, including the risk that our due diligence does not identify or fully assess valuation issues, potential liabilities or other acquisition risks; |
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| · | difficulty in integrating newly acquired businesses and operations, including combining product and service offerings, and in entering into new markets in which we are not experienced, in an efficient and cost-effective manner while maintaining adequate standards, controls and procedures, and the risk that we encounter significant unanticipated costs or other problems associated with integration; |
| · | difficulty in consolidating and rationalizing IT infrastructure, which may include multiple legacy systems from various acquisitions and integrating software code; |
| · | challenges in achieving strategic objectives, cost savings and other benefits expected from acquisitions; |
| · | risk that our markets do not evolve as anticipated and that the strategic acquisitions and divestitures do not prove to be those needed to be successful in those markets; |
| · | risk that we assume significant liabilities that exceed the limitations of any applicable indemnification provisions or the financial resources of any indemnifying parties; |
| · | potential loss of key employees or customers of the businesses acquired or to be divested; |
| · | risk that we are not able to complete strategic divestitures on satisfactory terms and conditions or within expected timeframes; |
| · | risk of diverting the attention of senior management and other resources from our existing operations; |
| · | risk that the industry may develop in a different direction than anticipated and that the technologies we acquire do not prove to be those we need to be successful in the industry; |
| · | risk that future valuations of acquired businesses may decrease from the price we paid for these acquisitions; |
| · | generation of insufficient revenues by acquired businesses to offset increased operating expenses associated with these acquisitions; |
| · | potential difficulties in completing in-process research and development projects and delivering high quality products to our customers; |
| · | potential difficulties in integrating new products, businesses and operations in an efficient and effective manner; |
| · | risk that our customers or customers of the acquired businesses may defer purchase decisions as they evaluate the impact of the acquisitions on our future product strategy; |
| · | potential loss of key employees, particularly those of the acquired organization; |
| · | risk of entering new markets in which we have limited experience and where competitors may have a stronger market presence; |
| · | problems integrating the purchased operations, personnel or technologies; and |
| · | unanticipated costs. |
Our inability to successfully operate and integrate newly-acquired businesses appropriately, effectively and in a timely manner could have a material adverse effect on our ability to take advantage of further growth in demand for products in our marketplace, as well as on our revenues, gross margins and expenses.
OUR STRATEGY INCLUDES ORGANIC GROWTH, WHICH MAY NOT RESULT IN INCREASED REVENUES OR PROFITABILITY AND MAY DEPLETE OUR LIMITED CASH RESERVES WITHOUT RETURN ON INVESTMENT.
In addition to making acquisitions we intend to grow our business organically, focusing on sales to further increase our revenues and backlog, and ramping up manufacturing to meet the increased demand. This has been especially challenging in the past given our limited success in significantly expanding our product offerings. We may encounter difficulties caused by a number of factors, some of which are out of our control, including: operational or personnel issues; delays in obtaining (or failure to obtain) required parts, supplies, or third-party technology; global recession concerns; and access to credit by our customers, our suppliers, or ourselves. In addition, our competitors may be more successful than we are technologically or in terms of sales generation.
THE OUTCOME OF LITIGATION OR ARBITRATION IN WHICH WE ARE INVOLVED OR MAY BECOME INVOLVED IS UNPREDICTABLE AND AN ADVERSE DECISION IN ANY SUCH MATTER COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION, RESULTS OF OPERATIONS AND CASH FLOWS.
From time to time, we may become defendants in a number of litigation matters and we may become involved in a number of arbitrations. These actions may divert financial and management resources that would otherwise be used to benefit our operations. No assurances can be given that the results of these or new matters will be favorable to us. An adverse resolution of lawsuits or arbitrations could have a material adverse effect on our financial condition, results of operations and cash flows.
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WE FACE CERTAIN SIGNIFICANT RISK EXPOSURES AND POTENTIAL LIABILITIES THAT MAY NOT BE COVERED ADEQUATELY BY INSURANCE OR INDEMNITY.
We are exposed to liabilities that are unique to the products and services we provide. A significant portion of our business relates to designing, developing and manufacturing, components, integrated assemblies and subsystems for advanced defense, technology and communications systems and products. New technologies associated with these systems and products may be untested or unproven. Components of certain of the defense systems and products we develop are inherently dangerous. Failures of satellites, missile systems, air traffic control systems, homeland security applications and aircraft have the potential to cause loss of life and extensive property damage. In most circumstances, we may receive indemnification from the U.S. Government. While we maintain insurance for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and we may be forced to bear substantial costs from an accident or incident. It also is not possible for us to obtain insurance to protect against all operational risks and liabilities. Substantial claims resulting from an incident in excess of U.S. Government indemnity and our insurance coverage would harm our financial condition, results of operations and cash flows. Moreover, any accident or incident for which we are liable, even if fully insured, could negatively affect our standing with our customers and the public, thereby making it more difficult for us to compete effectively, and could significantly impact the cost and availability of adequate insurance in the future.
WE ARE NOT ABLE TO INSURE AGAINST ALL POTENTIAL RISKS AND MAY BECOME SUBJECT TO HIGHER INSURANCE PREMIUMS.
We will have insurance policies covering certain risks associated with our business. However, any such insurance policies will not cover losses as a result of force majeure, natural disasters, terrorist attacks or sabotage, among other things. We do not expect to maintain insurance for certain environmental risks. In addition, our insurance policies may be subject to annual review by our insurers and may not be renewed at all or on similar or favorable terms. A serious uninsured loss or a loss significantly exceeding the limits of our future insurance policies could have a material adverse effect on our business, financial condition and results of operations.
CHANGES IN FUTURE BUSINESS OR OTHER MARKET CONDITIONS COULD CAUSE BUSINESS INVESTMENTS AND/OR RECORDED GOODWILL OR OTHER LONG-TERM ASSETS TO BECOME IMPAIRED, RESULTING IN SUBSTANTIAL LOSSES AND WRITE-DOWNS THAT WOULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
As part of our overall strategy, we will, from time to time, acquire a minority or majority interest in businesses. These investments are made upon careful analysis and due diligence procedures designed to achieve a desired return or strategic objective. These procedures often involve certain assumptions and judgment in determining acquisition price. After acquisition, unforeseen issues could arise which adversely affect the anticipated returns or which are otherwise not recoverable as an adjustment to the purchase price. Even after careful integration efforts, actual operating results may vary significantly from initial estimates.
IF WE ARE UNABLE TO FULFILL BACKLOG ORDERS DUE TO CIRCUMSTANCES INVOLVING US OR ONE OR MORE OF OUR SUPPLIERS OR CUSTOMERS, OUR ANTICIPATED RESULTS OF OPERATIONS WILL SUFFER.
As of June 30, 2016, we had approximately $3.3 million in backlog orders for our products. Backlog orders represent revenue that we anticipate recognizing in the future, as evidenced by purchase orders and other purchase commitments received from customers, but on which work has not yet been initiated or with respect to which work is currently in progress. Our backlog orders are due, in large part, to the long lead-times associated with our electronic device products, which products generally are custom built to order. We may encounter difficulties in fulfilling these orders and commitments, which could lead to failing to deliver them in a timely manner. We may not ultimately recognize as revenue the amounts reflected as backlog. Factors that could affect our ability to fulfill backlog orders include difficulty we may experience in obtaining raw materials or sub-assemblies from suppliers, whether due to obsolescence, cash limitations, production difficulties on the part of suppliers, including the longer lead times we have recently seen with many suppliers, or customer-induced delays and product holds. If we are required to locate new suppliers or additional sources of supply, we could experience a disruption in our operations or incur additional costs in procuring required materials. Our anticipated results of operations and cash flows will suffer to the extent we are unable to fulfill backlog orders within established timeframes, particularly if delays in fulfilling backlog orders cause our customers to reduce or cancel their orders. Analysts and investors are likely to view us negatively if we fail to recognize as revenue the amounts reflected as backlog, which could lead to a decrease in our common stock price.
We may not sustain these backlog amounts in the future, particularly if we are not successful in continuing to grow our sales or if our investment in technologies and products or acquisitions fails to translate into increased sales.
THE HIGH COSTS OF BEING A U.S. PUBLIC REGISTRANT HAVE INCREASED OUR OPERATING COSTS.
In order to meet the requirements of becoming a public registrant, we hired a Chief Financial Officer and retained two accounting consultants. We have also incurred additional outside accounting and legal expenses and expenses related to filing documents with the SEC. The Company also retained an investor relations firm and acquired D&O insurance. Going forward we expect to reconstitute our Board of Directors by hiring three independent directors and to incur listing and maintenance fees with regard to the quotation of our stock. These additions have increased our operating costs and the expected additions will further increase them.
THE UNCERTAIN GLOBAL ECONOMY MAY NEGATIVELY AFFECT OUR BUSINESS, MARKET SHARE, RESULTS OF OPERATIONS, AND FINANCIAL CONDITION.
The uncertainty and lack of confidence in the global economy since the global financial crisis — which has included, among other things, significant reductions in available capital and liquidity from banks and other providers of credit, substantial reductions and/or fluctuations in equity and currency values worldwide, and concerns that the worldwide economic recession may be prolonged — has had and may continue to have a significant negative effect on our business and operating results. The potential effects of the uncertain global economy are difficult to forecast and mitigate. As a consequence, our operating results for a particular period are difficult to predict, and, therefore, prior results are not necessarily indicative of results to be expected in future periods.
The economic crisis and recession has affected and may continue to affect our direct and indirect customers’ access to capital or willingness to spend capital on our products, and/or their levels of cash liquidity or willingness to pay for products that they will order or have already ordered from us. The effect of the current economic conditions on our customers may therefore lead to decreased demand, including order delays or cancellations, which in turn may result in lower revenue and may materially adversely affect our business, results of operations and financial condition.
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Likewise, the current global economy may negatively affect our suppliers’ access to capital and liquidity with which to maintain their inventories and production levels and could cause them to raise prices or lower production levels, or result in their ceasing operations. The challenges that our suppliers may face in selling their products or otherwise in operating their businesses may lead to our inability to obtain the materials we use to manufacture our products. We have observed a trend among our suppliers to have decreased inventory and therefore longer lead times in obtaining parts, supplies and other goods. These actions could cause us to have longer lead times in producing products for delivery to our customers, reductions in our revenue, increased price competition and increased operating costs, which could materially adversely affect our business, results of operations and financial condition.
WE MUST MAINTAIN REQUIRED DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING AND MEET THE PUBLIC REPORTING AND THE FINANCIAL REQUIREMENTS FOR OUR BUSINESS.
Our management has a legal and fiduciary duty to establish and maintain disclosure controls and control procedures in compliance with the securities laws, including the requirements mandated by the Sarbanes-Oxley Act of 2002. The standards that must be met for management to assess the internal control over financial reporting as effective are complex, and require significant documentation, testing and possible remediation to meet the detailed standards. In addition, our independent registered public accounting firm has not yet performed the attestation process as it was not required, and, if and when it becomes required, we may encounter problems or delays in completing the implementation of any requested improvements and receiving an attestation of our assessment by our independent registered public accounting firm. If our independent registered public accounting firm is unable to provide an unqualified attestation report on such assessment, investor confidence and share value may be negatively impacted.
Under current SEC rules, we are required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, and related rules and regulations of the SEC. We are required to review on an annual basis our internal control over financial reporting, and on a quarterly and annual basis to evaluate and disclose changes in our internal control over financial reporting. This process also results in a diversion of management’s time and attention. In the event that we are unable to maintain compliance with the applicable provisions of Section 404 of the Sarbanes-Oxley Act and related rules, we and the market price of our common stock may be adversely affected.
COMPETITION WITHIN OUR MARKETS MAY REDUCE OUR REVENUES AND MARKET SHARE.
We operate in highly competitive markets and our competitors may have more extensive or more specialized engineering, manufacturing and marketing capabilities than we do in some areas. We anticipate increasing competition in our core markets as a result of continued defense industry consolidation, including cross-border consolidation of competition, which has enabled companies to enhance their competitive position and ability to compete against us. We are also facing heightened competition in our domestic and international markets from foreign and multinational firms. In addition, as discussed in more detail above, increased pressure to limit U.S. defense spending and changes in the U.S. Government procurement environment may limit certain future market opportunities. For example, the DoD increasingly is awarding contracts through competitive bidding and relying on competitive contract award types. Additionally, some customers, including the DoD, are increasingly turning to commercial contractors, rather than traditional defense contractors, for information technology and other support work. If we are unable to continue to compete successfully against our current or future competitors, we may experience declines in revenues and market share which could negatively impact our results of operations, financial condition or liquidity. In addition, due to the current competitive environment, we continue to see an increase in bid protests from unsuccessful bidders on new program awards. Generally, a bid protest will delay the start of contract activities, delay earnings, and could result in the award decision being overturned, requiring a re-bid of the contract. Our direct competitors include: Akon, American Microwave, LabTec (England), Miteq, Genesis Microwave, Planar Microwave, Teledyne Microwave, Herotech, Skyworks, K & L Microwave, Filtronetics, Anatech Electronics, Delta Microwave, Eastern Wireless TeleComm Inc., Lark Engineering, Lorch Microwave, Narda Microwave East, and Spectrum Microwave.
ESTIMATES IN ACCOUNTING FOR MANY OF OUR PROGRAMS ARE ESPECIALLY CHALLENGING IN OUR INDUSTRY AND CHANGES IN OUR ESTIMATES COULD ADVERSELY AFFECT OUR FUTURE FINANCIAL RESULTS.
Contract accounting in our industry requires especially difficult judgments relative to assessing risks, including risks associated with customer directed delays and reductions in scheduled deliveries, unfavorable resolutions of claims and contractual matters, judgments associated with estimating contract revenues and costs, and assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total revenues and cost at completion is complicated and subject to many variables. For example, we must make assumptions regarding the length of time to complete the contract because costs also include expected increases in wages and prices for materials; consider whether the intent of entering into multiple contracts was effectively to enter into a single project in order to determine whether such contracts should be combined or segmented; consider incentives or penalties related to performance on contracts in estimating sales and profit rates, and record them when there is sufficient information for us to assess anticipated performance; and use estimates of award fees in estimating sales and profit rates based on actual and anticipated awards. Because of the significance of the judgments and estimation processes described above, it is likely that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Changes in underlying assumptions, circumstances or estimates may adversely affect our future results of operations and financial condition.
IF WE CANNOT EFFECTIVELY MANAGE OUR INTERNAL GROWTH, OUR POTENTIAL BUSINESS PROSPECTS, REVENUES AND PROFIT MARGINS MAY SUFFER.
If we fail to effectively manage our internal growth in a manner that minimizes strains on our resources, we could experience disruptions in our operations and ultimately be unable to generate revenues or profits. We expect that we will need to significantly expand our operations to successfully implement our business strategy. As we add manufacturing, marketing, sales and installation and build our infrastructure, we expect that our operating expenses and capital requirements will increase. To effectively manage our growth, we must continue to expend funds to improve our operational, financial and management controls, and our reporting systems and procedures. In addition, we must effectively expand, train and manage our employee base. If we fail in our efforts to manage our internal growth, our prospects, revenue and profit margins may suffer.
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RAPID GROWTH ESSENTIAL TO OUR BECOMING PROFITABLE COULD RESULT IN A STRAIN ON OUR RESOURCES.
Because of our size, growth will likely place a significant strain on our financial, technical, operational and management resources. The failure to continue to upgrade our technical, administrative, operating and financial control systems or the occurrence of unexpected expansion difficulties, including difficulties associated with the recruitment and retention of experienced managers and engineers, could have a material adverse effect on our business, financial condition and results of operations and our ability to timely execute this aspect of our business plan.
WE DEPEND ON MANUFACTURING LINES FOR CERTAIN OF OUR PRODUCTS, AND ANY SIGNIFICANT DISRUPTION IN PRODUCTION COULD IMPAIR OUR ABILITY TO DELIVER OUR PRODUCTS.
We currently manufacture and assemble our products at our facilities using production lines. Every product is hand assembled by our skilled and uniquely trained employees. Once a product is assembled it goes to a test area for testing, tuning and troubleshooting where every piece is tested and checked to make sure it meets customer specification requirements. Testing includes environmental testing for temperature and vibration tolerance. Some products are sent out to third parties for testing for additional parameters including altitude, shock and acceleration. Once products are tested most are solder-sealed in house but some are sent out to third parties to be laser-sealed. After the products are sealed, they are painted, marked with an identification number, and then shipped. Any significant disruption to one of these production lines will require time either to reconfigure and equip an alternative production line or to restore the original line to full capacity. Some of our production processes are complex, and we may be unable to respond rapidly to the loss of the use of any production line. This could result in delayed shipments, which could result in customer dissatisfaction, loss of sales and damage to our reputation.
WE DESIGN CUSTOM PRODUCTS TO MEET SPECIFIC REQUIREMENTS OF OUR CUSTOMERS. THE UNCERTAIN NATURE OF THE DEVELOPMENT CYCLE FOR CUSTOM PRODUCTS CAN RESULT IN VARIABILITY IN THE TIMING OF OUR RECEIPT OF REVENUE FROM SUCH PRODUCTS.
The design and sales cycle for our custom products, from initial contact by our sales force to the commencement of shipments of those products, may be lengthy. In this process, our engineers work closely with the customer to analyze the customer’s system requirements and establish a technical specification for the custom product. We then select a process, evaluate components, and establish assembly and test procedures before manufacturing can begin. The length of this cycle is influenced by many factors, including the difficulty of the technical specification, the novelty and complexity of the design and the customer’s procurement processes. Our customers typically do not commit to purchase significant quantities of the custom product until they are ready to commence volume shipments of their own system or equipment. Our receipt of substantial revenue from sales of a custom product often depends on that customer’s commercial success in manufacturing and selling its system or equipment that incorporates our custom product. As a result, a significant period may elapse between our investment of time and resources in designing and developing a custom product and our receipt of substantial revenue from sales of that custom product. The length of this process may increase the risk that a customer will decide to cancel or change its plans related to its system or equipment. Such a cancellation or change in plans by a customer could cause us to lose anticipated sales. In addition, our business, results of operations and financial condition could be materially adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle, chooses not to release its system or equipment that contains our custom products, or is not successful in the sale and marketing of its system or equipment that contains our custom products.
WE DEPEND ON COMPONENT AVAILABILITY, SUBCONTRACTOR PERFORMANCE AND OUR KEY SUPPLIERS TO MANUFACTURE AND DELIVER OUR PRODUCTS AND SERVICES.
We are dependent upon the delivery by suppliers of materials and the assembly by subcontractors of major components and subsystems used in our products in a timely and satisfactory manner and in full compliance with applicable terms and conditions. Some products require relatively scarce raw materials. We also are subject to specific procurement requirements that may, in effect, limit the suppliers and subcontractors we may utilize, including requirements for genuine original equipment manufacturer parts.
In some instances, we are dependent on sole-source suppliers. If any of these suppliers or subcontractors fails to meet our needs or becomes insolvent, we may not have readily available alternatives. While we enter into long-term or volume purchase agreements with certain suppliers and take other actions, such as accelerating supplier payments commensurate with value delivered, to ensure financial viability and the availability of needed materials, components and subsystems, we cannot be sure that such items will be available in the quantities we require, if at all. In addition, some of our suppliers or subcontractors, especially smaller entities, may continue to be impacted by global economic conditions, which could impair their ability to meet their obligations to us. If we experience a material supplier or subcontractor problem, our ability to satisfactorily and timely complete our customer obligations could be negatively impacted which could result in reduced sales, termination of contracts and damage to our reputation and relationships with our customers. We could also incur additional costs in addressing such a problem. Any of these events could have a negative impact on our results of operations, financial condition or liquidity. In addition, we must comply with other procurement requirements, including restrictions on the use of certain chemicals in the European Union and conducting diligence and providing disclosure regarding the use of certain minerals, known as conflict minerals, which may impact our procurement practices and increase our costs.
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IF WE CANNOT ESTABLISH AND MAINTAIN RELATIONSHIPS WITH DISTRIBUTORS, WE MAY NOT BE ABLE TO INCREASE REVENUE.
In order to increase our revenues and successfully commercialize our systems, we must establish and maintain relationships with potential distributors, sales representatives or other resellers. A reduction, delay or cancellation of orders from one or more significant customers could significantly reduce our revenues and could damage our reputation among our potential customers.
IF WE EXPERIENCE QUALITY CONTROL PROBLEMS OR SUPPLIER SHORTAGES FROM POTENTIAL SUPPLIERS, OUR REVENUES AND PROFIT MARGINS MAY SUFFER.
Our dependence on third-party suppliers for components involves several risks, including limited control over pricing, availability of materials, quality and delivery schedules. Any quality control problems or interruptions in supply with respect to one or more components or increases in component costs could materially adversely affect our potential customer relationships, revenues and profit margins.
OUR FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO DEVELOP NEW OFFERINGS AND TECHNOLOGIES FOR OUR CURRENT AND FUTURE MARKETS.
To achieve our business strategies and continue to grow our revenues, we must successfully develop new offerings and technologies or adapt or modify our existing offerings and technologies for our current core defense markets and our future markets, including new growth and emerging markets. Accordingly, our future performance depends on a number of factors, including our ability to:
| · | identify emerging technological trends in our current and target markets; |
| · | identify additional uses for our existing technology to address customer needs in our current and future markets; |
| · | enhance our offerings by adding innovative features that differentiate our offerings from those of our competitors; |
| · | develop and manufacture and bring solutions to market quickly at cost-effective prices; and |
| · | effectively structure our businesses, through the use of joint ventures, collaborative agreements and other forms of alliances, to reflect the competitive environment. |
We believe that, in order to remain competitive in the future, we will need to continue to invest significant financial resources to develop new offerings and technologies or to adapt or modify our existing offerings and technologies, including through internal research and development, acquisitions and joint ventures or other teaming arrangements. These expenditures could divert our attention and resources from other projects, and we cannot be sure that these expenditures will ultimately lead to the timely development of new offerings and technologies or identification of and expansion into new markets. Due to the design complexity of our products, we may in the future experience delays in completing the development and introduction of new products. Any delays could result in increased costs of development or deflect resources from other projects. In addition, there can be no assurance that the market for our offerings will develop or continue to expand or that we will be successful in newly identified markets as we currently anticipate. The failure of our technology to gain market acceptance could significantly reduce our revenues and harm our business. Furthermore, we cannot be sure that our competitors will not develop competing technologies which gain market acceptance in advance of our products.
Additionally, the possibility exists that our competitors might develop new technology or offerings that might cause our existing technology and offerings to become obsolete. If we fail in our new product development efforts or our products or services fail to achieve market acceptance more rapidly than our competitors, our ability to procure new contracts could be negatively impacted, which would negatively impact our results of operations and financial condition.
THIRD PARTIES MAY CLAIM IN THE FUTURE THAT WE ARE INFRINGING DIRECTLY OR INDIRECTLY UPON THEIR INTELLECTUAL PROPERTY RIGHTS, AND THIRD PARTIES MAY INFRINGE UPON OUR INTELLECTUAL PROPERTY RIGHTS.
Many of the markets we serve are characterized by vigorous protection and pursuit of intellectual property rights, which may result in protracted and expensive litigation. Third parties may claim in the future that we are infringing directly or indirectly upon their intellectual property rights, and we may be found to be infringing or to have infringed directly or indirectly upon those intellectual property rights. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements, and we may not be able to obtain royalty or license agreements on terms acceptable to us, or at all. We also may be subject to significant damages or injunctions against development and sale of certain of our products, services and solutions. Our success depends in large part on our proprietary technology. We rely on a combination of patents, copyrights, trademarks, trade secrets, know-how, confidentiality provisions and licensing arrangements to establish and protect our intellectual property rights. If we fail to successfully protect and enforce these rights, our competitive position could suffer. Our prospective patent and trademark registration applications may not be allowed, or competitors may challenge the validity or scope of our patents or trademark registrations. In addition, our patents may not provide us a significant competitive advantage. We may be required to spend significant resources to monitor and police our intellectual property rights. We may not be able to detect infringement and our competitive position may be harmed before we do so. In addition, competitors may design around our technology or develop competing technologies.
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WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD AFFECT OUR ABILITY TO COMPETE.
There can be no assurance that trade secrets and other intellectual property will not be challenged, invalidated, misappropriated or circumvented by third parties. In some instances, we have augmented our technology base by licensing the proprietary intellectual property of others. In the future, we may not be able to obtain necessary licenses on commercially reasonable terms. We enter into confidentiality and invention assignment agreements with our employees and enter into non-disclosure agreements with our suppliers and appropriate customers so as to limit access to and prevent disclosure of our proprietary information. These measures may not suffice to deter misappropriation or third party development of similar technologies. Moreover, the laws concerning intellectual property vary among nations and the protection provided to our intellectual property by the laws and courts of foreign nations may not be as advantageous to us as the remedies available under U.S. law. In order to maintain strict confidentiality, we do not file patents to protect our intellectual property.
MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN WE DO. IF WE ARE UNABLE TO KEEP PACE WITH OUR COMPETITORS IN ANTICIPATING AND RESPONDING TO THE RAPID CHANGES INVOLVING THE MILITARY INDUSTRIES, WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY WITH THEM, AND OUR STOCK PRICE MAY DECLINE.
Our future success depends, in part, upon our ability to enhance our current products and services and to develop and introduce new products and services that keep pace with technological developments, respond to the growth in the military, aerospace and telecommunications equipment markets in which we compete, encompass evolving customer requirements, and provide a broad range of products and achieve market acceptance of our products. Most of our existing and potential competitors have larger technical staffs, more established and larger marketing and sales organizations and significantly greater financial resources than we do. Our lack of resources relative to our competitors may cause us to fail to anticipate or respond adequately to technological developments and customer requirements or to experience significant delays in developing or introducing new products and services. These failures or delays could reduce our competitiveness, revenues, profit margins or market share, cash flow and stock price.
BECAUSE WE DEPEND ON COMPUTER AND TELECOMMUNICATIONS SYSTEMS WE DO NOT OWN OR CONTROL, WE ARE POTENTIALLY SUBJECT TO THE ADVERSE EFFECTS OF THIRD PARTY OPERATIONAL SYSTEM FAILURES.
We have entered into licenses and other agreements with third parties for hardware, software, telecommunications and database services in connection with the operation of our facilities. We may be subject to disruptions of our operational systems arising from events that are wholly or partially beyond our control (for example, natural disasters, acts of terrorism, epidemics, computer viruses and telecommunications outages). These third party systems and licenses on which we rely could also suffer operational system failure. Any interruptions to our arrangements with third parties, to our computing and communications infrastructure, or our information systems could significantly disrupt our business operations and result in potential liability or reputational damage or otherwise have an adverse impact on our financial results.
TECHNOLOGICAL CHANGE COULD AFFECT OUR OPERATIONS.
The military, aerospace, and telecommunications industries are characterized by rapid and significant technological advancements and introductions of new products and services utilizing new technologies. As others use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement such new technologies at substantial costs. In addition, other companies in our industries have greater financial, technical and personnel resources that may allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. We may be unable to respond to such competitive pressures and implement such technologies on a timely basis or at an acceptable cost. One or more of the technologies that we currently use or may implement in the future may become obsolete.
WE DO NOT HAVE A FORMAL SUCCESSION PLAN.
Mr. Necdet F. Ergul, our Chief Executive Officer and President, is 92 years old. His age creates the risk of the loss of his services, either permanently or for an indeterminate period of time. In such circumstances, we would be obligated to find a replacement for him and during the period of the search for a replacement, our operating results might be adversely affected. We do not have a formal succession plan and cannot assure you that we will establish one in a timely fashion or at all.
WE MAY NOT BE ABLE TO ATTRACT OR RETAIN THE SPECIALIZED TECHNICAL AND MANAGERIAL PERSONNEL NECESSARY TO ACHIEVE OUR BUSINESS OBJECTIVES.
Competition for certain key positions and specialized technical personnel in the high-technology industry is strong. We believe that our future success depends in part on our continued ability to train, hire, assimilate, and retain qualified personnel in a timely manner, particularly our Chief Executive Officer, other senior executives and other key positions in our areas of potential growth.
We may find it difficult to attract or retain qualified employees because of our size. In addition, if we do not properly size our workforce and retain those employees with the appropriate skills, our ability to compete effectively may be adversely affected. If we are not successful in attracting and retaining qualified employees, we may not have the necessary personnel to effectively compete in the highly dynamic, specialized and volatile industry in which we operate or to achieve our business objectives.
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OUR REPUTATION AND ABILITY TO DO BUSINESS MAY BE IMPACTED BY THE IMPROPER CONDUCT OF OUR EMPLOYEES, AGENTS OR BUSINESS PARTNERS.
We have implemented compliance controls, policies and procedures designed to prevent reckless or criminal acts from being committed by our employees, agents or business partners that would violate the laws of the jurisdictions in which we operate, including laws governing payments to government officials (such as the FCPA), and to detect any such reckless or criminal acts committed. We cannot ensure, however, that our controls, policies and procedures will prevent or detect all such reckless or criminal acts. If not prevented, such reckless or criminal acts could subject us to civil or criminal investigations and monetary and non-monetary penalties and could have a material adverse effect on our ability to conduct business, our results of operations and our reputation.
THE LOSS OF ONE OR MORE MEMBERS OF OUR SENIOR MANAGEMENT TEAM OR KEY PERSONNEL MAY ADVERSELY AFFECT OUR ABILITY TO IMPLEMENT OUR STRATEGY.
Our success depends to a significant extent upon the continued services of Mr. Necdet F. Ergul, Mr. James Ashman, Mr. Michael Ghadaksaz and Mr. Brian Kelly. The loss of the services of Messrs. Ergul, Ashman, Ghadaksaz or Kelly could have a material adverse effect on our growth, revenues, and prospective business. In particular, the departure of Mr. Kelly, a consultant currently acting as the Company’s General Manager from the Company could result in an event of default under the Gerber Facility. These individuals are committed to the Company and willing to devote their full time and energy to the Company; however, any of these persons could terminate their employment with us with little or no prior notice. We do not have “key person” life insurance policies covering any of our employees. Additionally, there are a limited number of qualified technical personnel with significant experience in the design, development, manufacture, and sale of our products, and we may face challenges hiring and retaining these types of employees.
We depend on our experienced management team and the loss of one or more key executives could have a negative impact on our business. We also depend on our ability to retain and motivate key employees and attract qualified new employees. If we lose a member of the management team or a key employee, we may not be able to replace him or her. Integrating new employees into our management team and training new employees with no prior experience in our industry could prove disruptive to our operations, require a disproportionate amount of resources and management attention and ultimately prove unsuccessful. An inability to attract and retain sufficient technical and managerial personnel could limit or delay our development efforts, which could have a material adverse effect on our business, financial condition and results of operations.
Risks Related To Our Common Stock
WE CURRENTLY DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK. AS A RESULT, YOUR ONLY OPPORTUNITY TO ACHIEVE A RETURN ON YOUR INVESTMENT IS IF THE PRICE OF OUR COMMON STOCK APPRECIATES.
We currently do not expect to declare or pay dividends on our common stock. In addition, in the future we may enter into agreements that prohibit or restrict our ability to declare or pay dividends on our common stock. As a result, your only opportunity to achieve a return on your investment will be if the market price of our common stock appreciates and you sell your shares at a profit.
YOU MAY EXPERIENCE DILUTION OF YOUR OWNERSHIP INTEREST DUE TO THE FUTURE ISSUANCE OF ADDITIONAL SHARES OF OUR COMMON STOCK.
While we expect to have sufficient funds to execute our business plan for at least 12 months, assuming completion of the public offering contemplated in the Company’s second fiscal quarter of 2017, we may need additional funds in the future to execute additional prospective joint ventures or acquisitions or due to changed business conditions or other future developments.. As a result, we may require additional funds from future equity or debt financings, including sales of preferred shares or convertible debt, to complete the development of new projects and pay the general and administrative costs of our business. We may in the future issue our previously authorized and unissued securities, resulting in the dilution of the ownership interests of holders of our common stock. We are currently authorized to issue 7,800,000 shares of common stock and 200,000 shares of preferred stock. Additionally, assuming completion of reincorporation in Delaware, which is currently contemplated, we will be authorized to issue 110,000,000 shares, of which 100,000,000 are for shares of common stock, $0.0001 par value per share, 200,000 are for shares of preferred stock, par value $100 per share, all of which have been designated as Series A Convertible Preferred Stock and 9,800,000 are for shares of “blank check” preferred stock, having such designations, rights and preferences as the Board of Directors may determine, in its sole discretion, from time to time. The potential issuance of such additional shares of common stock or preferred stock or convertible debt may create downward pressure on the trading price of our common stock. We may also issue additional shares of common stock or other securities that are convertible into or exercisable for common stock in future public offerings or private placements for capital raising purposes or for other business purposes. The future issuance of a substantial number of common shares into the public market, or the perception that such issuance could occur, could adversely affect the prevailing market price of our common shares. A decline in the price of our common shares could make it more difficult to raise funds through future offerings of our common shares or securities convertible into common shares.
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OUR AMENDED AND RESTATED CERTIFICATE OF INCORPORATION ALLOWS FOR OUR BOARD OF DIRECTORS TO CREATE NEW SERIES OF PREFERRED STOCK WITHOUT FURTHER APPROVAL BY OUR STOCKHOLDERS, WHICH COULD HAVE AN ANTI-TAKEOVER EFFECT AND COULD ADVERSELY AFFECT HOLDERS OF OUR COMMON STOCK.
Our authorized capital includes preferred stock issuable in one or more series. Our board of directors has the authority to issue preferred stock and determine the price, designation, rights, preferences, privileges, restrictions and conditions, including voting and dividend rights, of those shares without any further vote or action by stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of holders of any preferred stock that may be issued in the future. The issuance of additional preferred stock, while providing desirable flexibility in connection with possible financings and acquisitions and other corporate purposes, could make it more difficult for a third party to acquire a majority of the voting power of our outstanding voting securities, which could deprive our holders of common stock of a premium that they might otherwise realize in connection with a proposed acquisition of the Company.
TWO OF OUR STOCKHOLDERS OWN A SIGNIFICANT PERCENTAGE OF OUR STOCK AND WILL BE ABLE TO EXERT SIGNIFICANT CONTROL OVER MATTERS SUBJECT TO STOCKHOLDER APPROVAL.
Currently, assuming conversion of preferred stock, 57.77% of our outstanding common stock will be owned by Microphase Holding Company, LLC and separately 36.84% by the RCKJ Trust and 25.33% by the Ergul Family Limited Partnership.
Microphase Holding is owned 50% by RCKJ Trust and 50% by the Ergul Family Limited Partnership. Decisions with respect to the voting and disposition of the Company shares owned by Microphase Holding are required to be made by a unanimous vote of the members. The beneficial owners for economic purposes of the Ergul Family Limited Partnership are Necdet Ergul, Eda Peterson, Berrin Snyder and Ergul Corporation. Ronald A. Durando, who was the Company’s chief operating officer until his resignation in January 2015 and who is currently employed by the Company as Strategic Advisor, assigned all his direct and indirect interests in the capital stock of the Company to the RCKJ Trust. Decisions with respect to the voting and disposition of such shares are made by the trustee, Dennis Durando, Ronald A. Durando’s brother.
These two stockholders may be able to substantially determine the outcome of all matters requiring stockholder approval. For example, these stockholders may be able to substantially control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders. The interests of these stockholders may not always coincide with your interests or the interests of other stockholders and they may act in a manner that advances their best interests and not necessarily those of other stockholders, including seeking a premium value for their common stock, and might affect the prevailing market price for our common stock.
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THERE CAN BE NO ASSURANCES THAT OUR SHARES WILL BE LISTED ON THE NASDAQ CAPITAL MARKET AND, IF THEY ARE, OUR SHARES WILL BE SUBJECT TO POTENTIAL DELISTING IF WE DO NOT MEET OR CONTINUE TO MAINTAIN THE LISTING REQUIREMENTS OF THE NASDAQ CAPITAL MARKET.
We intend to apply to list the shares of our common stock on the NASDAQ Capital Market, or NASDAQ. An approval of our listing application by NASDAQ will be subject to, among other things, our fulfilling all of the listing requirements of NASDAQ. In addition, NASDAQ has rules for continued listing, including, without limitation, minimum market capitalization and other requirements. Failure to obtain or maintain our listing, or de-listing from NASDAQ, would make it more difficult for shareholders to dispose of our common stock and more difficult to obtain accurate price quotations on our common stock. This could have an adverse effect on the price of our common stock. Our ability to issue additional securities for financing or other purposes, or otherwise to arrange for any financing we may need in the future, may also be materially and adversely affected if our common stock is not traded on a national securities exchange.
THERE IS CURRENTLY NO PUBLIC MARKET FOR OUR COMMON STOCK. FAILURE TO DEVELOP OR MAINTAIN A TRADING MARKET COULD NEGATIVELY AFFECT ITS VALUE AND MAKE IT DIFFICULT OR IMPOSSIBLE FOR YOU TO SELL YOUR SHARES.
There is currently no public market for our common stock and an active public market for our common stock may not develop. Failure to develop or maintain an active trading market could make it difficult for you to sell your shares or recover any part of your investment in us. Even if a market for our common stock does develop, the market price of our common stock may be highly volatile. In addition to the uncertainties relating to future operating performance and the profitability of operations, factors such as variations in interim financial results or various, as yet unpredictable, factors, many of which are beyond our control, may have a negative effect on the market price of our common stock.
“PENNY STOCK” RULES MAY MAKE BUYING OR SELLING OUR COMMON STOCK DIFFICULT.
If the market price for our common stock is below $5.00 per share, trading in our common stock may be subject to the “penny stock” rules. The SEC has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions. These rules would require that any broker-dealer that would recommend our common stock to persons other than prior customers and accredited investors, must, prior to the sale, make a special written suitability determination for the purchaser and receive the purchaser’s written agreement to execute the transaction. Unless an exception is available, the regulations would require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated with trading in the penny stock market. In addition, broker-dealers must disclose commissions payable to both the broker-dealer and the registered representative and current quotations for the securities they offer. The additional burdens imposed upon broker-dealers by such requirements may discourage broker-dealers from effecting transactions in our common stock, which could severely limit the market price and liquidity of our common stock.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable
Corporate Offices
We maintain our current principal office at 100 Trap Falls Road Extension, Shelton, Connecticut 06484. Our telephone number at this office is (203) 866-8000. In November 2013 the Company sold its headquarters building in Norwalk, CT to 587 Connecticut Avenue LLC. From November 27, 2013 through April 20th, 2015 the Company leased back a portion of the building, approximately 15,000 sq. ft., for $10,103 per month. Under the terms of the lease, either party could terminate the lease with 90 days’ prior notice. The Company moved to Shelton, Connecticut on April 21, 2015, to a facility with 15,000 square feet with monthly rent of $15,000, for a 7-year term with annual escalations of 3%.
In connection with the acquisition of selected assets from Microsemi the Company signed a lease for 4,000 square feet of space at Microsemi Corp’s facility in Folsom, California. The initial terms of the lease were $8,400 per month rent with a term of one year. The lease was renegotiated in April of 2014 with a new rent of $7,000 per month beginning in June 2014. The lease was renegotiated again in February 2015 with new rent of $8,500 per month from February 1, 2015 to June 30, 2015, then $10,000 per month from July 1, 2015 to December 31, 2015, and then $12,000 per month from January 1, 2016 to June 30, 2016. The end of the lease was June 2016, but it was extended for one month to July 31, 2016. The expense for fiscal 2015 was $91,500. The expense for fiscal 2016 was $132,000. The expense for fiscal 2017 is $12,000.
There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of our Company or any of our subsidiaries, pending or threatened against or affecting our Company, our common stock, any of our subsidiaries or of our Company’s or our Company’s subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
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ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) Market Information.
There is no established public trading market for our common stock.
The ability of individual stockholders to trade their shares in a particular state may be subject to various rules and regulations of that state. A number of states require that an issuer’s securities be registered in their state or appropriately exempted from registration before the securities are permitted to trade in that state. Presently, we have no plans to register our securities in any particular state. Further, our shares may be subject to the provisions of Section 15(g) and Rule 15g-9 of the Exchange Act, commonly referred to as the “penny stock” rule. Section 15(g) sets forth certain requirements for transactions in penny stocks and Rule 15g-9(d)(1) incorporates the definition of penny stock as that used in Rule 3a51-1 of the Exchange Act.
The SEC generally defines penny stock to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. Rule 3a51-1 provides that any equity security is considered to be a penny stock unless that security is: registered and traded on a national securities exchange meeting specified criteria set by the SEC; authorized for quotation on The NASDAQ Stock Market; issued by a registered investment company; excluded from the definition on the basis of price (at least $5.00 per share) or the issuer’s net tangible assets; or exempted from the definition by the SEC. Broker-dealers who sell penny stocks to persons other than established customers and accredited investors (generally persons with assets in excess of $1,000,000 or annual income exceeding $200,000 by an individual, or $300,000 together with his or her spouse), are subject to additional sales practice requirements.
For transactions covered by these rules, broker-dealers must make a special suitability determination for the purchase of such securities and must have received the purchaser’s written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the first transaction, of a risk disclosure document relating to the penny stock market. A broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, and current quotations for the securities. Finally, monthly statements must be sent to clients disclosing recent price information for the penny stocks held in the account and information on the limited market in penny stocks. Consequently, these rules may restrict the ability of broker-dealers to trade and/or maintain a market in our common stock and may affect the ability of stockholders to sell their shares.
We have not previously filed a registration statement that is effective under the Securities Act. Shares sold pursuant to exemptions from registration are deemed to be “restricted” securities as defined by the Securities Act. As of June 30, 2016, out of a total of 6,200,789 shares outstanding, 6,200,789 shares are restricted securities and can only be sold or otherwise transferred pursuant to a registration statement under the Securities Act or pursuant to an available exemption from registration. Of such restricted shares, 3,625,825 (58.5%) shares are held by affiliates (directors, officers and 10% holders), with the balance of 2,574,964 (41.5%) shares being held by non-affiliates. In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated) who has beneficially owned restricted shares of a reporting company for at least six months, including any person who may be deemed to be an “affiliate” of the company (as the term “affiliate” is defined under the Securities Act), is entitled to sell, within any three-month period, an amount of shares that does not exceed the greater of (i) the average weekly trading volume in the company’s common stock, as reported through the automated quotation system of a registered securities association, during the four calendar weeks preceding such sale or (ii) 1% of the shares then outstanding. In order for a stockholder to rely on Rule 144, adequate current public information with respect to the company must be available. A person who is not deemed to be an affiliate of the company and has not been an affiliate for the most recent three months, and who has held restricted shares for at least six months is entitled to sell such shares without regard to the various resale limitations under Rule 144. Under Rule 144, the requirements of paragraphs (c), (e), (f), and (h) of such Rule do not apply to restricted securities sold for the account of a person who is not an affiliate of an issuer at the time of the sale and has not been an affiliate during the preceding three months, provided the securities have been beneficially owned by the seller for a period of at least one year prior to their sale. For purposes hereof, a controlling stockholder is considered to be a person who owns 10% or more of the company’s total outstanding shares, or is otherwise an affiliate of the Company. No individual person owning shares that are considered to be not restricted owns more than 10% of the Company’s total outstanding shares.
(b) Holders
As of June 30, 2016, we had 170 holders of record of common stock per the shareholder list provided by the Company’s transfer agent.
As of June 30, 2016, we had 6 holders of record of the Company’s preferred stock as maintained by the Company’s Secretary and Treasurer.
(c) Dividends
The Registrant has not paid any cash dividends on common stock to date and does not anticipate or contemplate paying any dividends in the foreseeable future. It is the present intention of management to utilize all available funds for the growth of the Registrant’s business.
(d) Securities Authorized for issuance under Equity Compensation Plans
We currently do not have an equity compensation plan. The Board of Directors authorized the implementation of a stock option plan referred to as the 2015 Microphase Stock Option Plan with an initial reserve of 250,000 shares of common stock. The Board awarded 75,000 options to an officer in September 2016.
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Recent Sales of Unregistered Securities
Common Stock Transactions
During the Fiscal Year ended June 30, 2013, the Company issued 447,742 shares of its common stock for services and charged $895,484 to selling general and administrative expense, valuing the shares based upon the value of concurrent private placements. The Company also issued 294,641 shares of its common stock to accredited investors in private placements of its common stock to accredited investors pursuant to Rule 504 of regulation D and Section 4(2) of the Securities Act of 1933, as amended, which included 57,141 shares to finders and $35,625 of offering costs, generating $439,375 net proceeds to the Company.
During the Fiscal Year ended June 30, 2014, the Company issued 225,000 shares of its common stock for services and charged $450,000 to selling general and administrative expense, valuing the shares based upon the value of concurrent private placements. The Company also issued 756,725 shares of its common stock to accredited investors in private placements of its common stock to accredited investors pursuant to Rule 504 of regulation D and Section 4(2) of the Securities Act of 1933, as amended, which included 196,725 shares to finders and $102,750 of offering costs, generating $1,019,551 net proceeds to the Company.
During the Fiscal Year ended June 30, 2015, the Company issued 435,000 shares of its common stock for services and charged $790,000 to selling general and administrative expense and $80,000 to engineering and research expenses, respectively, valuing the shares based upon the value of concurrent private placements. The Company also issued 311,782 shares of its common stock to accredited investors in private placements of its common stock to accredited investors pursuant to Rule 504 of regulation D and Section 4(2) of the Securities Act of 1933, as amended, which included 68,782 shares to finders and $31,450 of offering costs, generating $447,050 net proceeds to the Company.
Also during the Fiscal Year ended June 30, 2015, the Company recorded the conversion of $320,000 of related party loans, including $21,043 accrued interest thereon, into 213,333 shares of common stock with beneficial conversion feature interest of $106,666, charged to loss on debt settlements and the conversion of $10,000 of strategic payables into common stock with beneficial conversion feature interest expense of $5,000.
During the Fiscal Year ended June 30, 2016, the Company issued 80,000 shares of its Common Stock to two consultants pursuant to consulting agreements and 210,000 shares to two Officers and Directors for services, respectively, valued at $580,000, which was charged to selling general and administrative expense for this period. Also during the fiscal year ended June 30, 2016, the Company granted options to an Officer and Director for services to purchase 75,000 shares of Common Stock, with an exercise price of $2.00, with a term of 7 years, and which rights vest over the next three years. The total value of these options was estimated to be $106,200 using the Black Scholes method, based on an assumed volatility of 112.5% and an interest rate of .09% resulting in a $35,400 charge to selling general and administrative expense for the fiscal year ended June 30, 2016, deferring the balance of which $35,400 will be charged each October 1 of 2016 and 2017 for fiscal 2017 & 2018, as vested.
During the Fiscal Year ended June 30, 2016, the Company completed a private placement of its common stock to an accredited investor pursuant to Rule 504 of regulation D and Section 4(2) of the Securities Act of 1933, as amended. The Company issued 125,000 shares of its common stock at $2.00 per share together with a 5 year warrant to purchase up to 125,000 additional shares of our common stock at $2.50 to the investor and 25,000 shares to the placement agent, and received net proceeds of $225,000 after deducting $25,000 of cash costs, which was used for working capital.
Also during the Fiscal Year ended June 30, 2016, the Company’s President converted $252,815 of unpaid compensation into 168,550 shares of Common Stock resulting in a loss on the settlement of liabilities of $84,271. The President also converted $69,310 of related party loans, including $39,366 of accrued interest, into 46,200 shares of Common Stock resulting in a loss on the settlement of liabilities of $23,103. In total the Company settled $322,125 of related liabilities and recorded a $107,375 loss on the settlement of liabilities with related parties for a total of 214,750 shares of Common Stock valued at $429,500.
During the Fiscal Year ended June 30, 2016, the Company issued 770,733 shares of the Company’s Common Stock pursuant to the conversion of 11,561 shares of the Company’s Series A Convertible Preferred Stock (the “Preferred Stock”) held by the RCKJ Trust. The issuance did not result in any proceeds to the Company as the conversion to common shares effectively cancelled 11,561 shares of Preferred Stock previously acquired by the holder.
Preferred Stock Transactions
During the fiscal year ended June 30, 2013 the Company issued 10,000 shares of preferred stock, $100 par value per share, in connection with the acquisition of the building at 587 Connecticut Avenue in Norwalk, CT from a related party and 500 shares of preferred stock to two officers in connection with the cancelation of $50,000 of debt owed to these officers. The building was disposed of in fiscal 2014 as discussed in Item 13 Certain transactions.
During the Fiscal Year ended June 30, 2015, the Company recorded the Conversion of $180,000 of related party loans into 1,800 shares of preferred stock with beneficial conversion feature interest of $59,400 and the conversions of $160,000 of unpaid compensation into 1,600 shares of preferred stock with beneficial conversion feature interest of $52,800.
During the Fiscal Year ended June 30, 2016, the Company issued 770,733 shares of the Company’s Common Stock pursuant to the conversion of 11,561 shares of the Company’s Series A Convertible Preferred Stock (the “Preferred Stock”) held by the RCKJ Trust. The issuance did not result in any proceeds to the Company as the conversion to common shares effectively cancelled 11,561 shares of Preferred Stock previously acquired by the holder.
The preferred stock, with respect to dividends, liquidation payments, and liquidation rights, ranks senior to the common stock and of the Company. Holders of Preferred Stock are entitled to receive, when and as declared by the Board of Directors, dividends, at the annual rate of 6% of the stated par value, or $100 per share. Dividends are cumulative and accrue from the effective date of issuance of the Preferred Stock until declared.
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Preferred stock dividends
The Board of Directors had not declared a dividend on the preferred stock through the fiscal year ended June 30, 2014. As of June 30, 2014, 23,543 preferred shares have been issued and the cumulative dividends undeclared were approximately $459,400. In December 2014, the Board of Directors declared $494,735 of dividends on preferred shares outstanding as of September 30, 2014 and authorized the payment in 329,825 shares common stock using a conversion rate of $1.50 per share, charging an additional $164,193 to retained deficit for the loss on the settlement of the dividend payable.
As of June 30, 2015, 26,943 preferred shares are outstanding and cumulative undeclared dividends on preferred stock total $115,759.
As of June 30, 2016, 15,382 preferred shares are outstanding and cumulative undeclared dividends on preferred stock total $243,788.
Conversions of Debt
Effective December 31, 2014, Mr. Durando and a former employee converted $150,000 and $170,000, respectively, or a total of $320,000 of related party loans into 213,333 shares of the Company’s common stock. Mr. Ergul converted $180,000 of related party loans into 1,800 shares of the Company’s preferred stock. Messrs. Ergul and Durando each converted $80,000, or a total of $160,000 of unpaid compensation into a total of 1,600 shares of the Company’s preferred stock. A strategic vendor converted $15,000 of accounts payable into 10,000 shares of the Company’s common stock.
Shareholders meeting and approval of amendments
On October 4, 2014 at a special meeting of the shareholders of the Company the shareholders approved amendments to the Certificate of Incorporation of the Company to:
(1) Increase its authorized common stock from 4,800,000 shares of common stock without par value to 50,000,000 shares of common stock without par value for economic reasons the Board of Directors has implemented an increase to 7,800,000 shares;
(2) Increase its authorized preferred stock from 200,000 shares, $100 par value per share, to 2,000,000 shares of 6% convertible preferred stock, for economic reasons this has yet to be implemented, $100 par value per share. Each outstanding and hereafter issued share of the preferred stock will:
i) be entitled to a cash dividend, payable quarterly on the last business day of each fiscal quarter of the Company, commencing with the fiscal quarter ended December 31, 2014, if and when declared by the Company’s board of directors. These dividends will be cumulative, will accrue if not declared by the directors, and must be paid before any dividends or other distributions are made to the common shareholders.
ii) be entitled, on liquidation of the Company, to receive $100 per share plus accrued dividends before any distributions are made to the common shareholders.
iii) be convertible at the option of the holder into common stock of the Company at a price agreeable to the holders of the preferred stock.
(3) Enter into agreements for the conversion of at least $660,000 of shareholder/note holder loans which together with accrued interest are estimated to total $1,160,000 of debt at September 30, 2014 into shares of common stock of the Company.
Effective December 31, 2014 the Board of Directors approved the implementation of the 2015 stock option plan, reserving 250,000 shares of common stock for this plan, but no action has been taken to implement this plan.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical financial statements and notes included in this annual report. The statement of operations data for the years ended June 30, 2016, 2015, 2014 and 2013 and the balance sheet data as of June 30, 2016, 2015, 2014 and 2013 are derived from financial statements that have been audited by Rosenberg, Rich, Baker, Berman & Company.
SUMMARY OPERATING DATA
| Fiscal Years Ended June 30, | ||||||||||||||||
| 2016 | 2015 | 2014 | 2013 | |||||||||||||
| Total Revenues | $ | 9,121,307 | $ | 8,176,352 | $ | 7,198,816 | $ | 5,473,756 | ||||||||
| Cost of Sales | (5,294,017 | ) | (4,557,285 | ) | (4,285,313 | ) | (3,625,158 | ) | ||||||||
| Gross Profit | 3,827,290 | 3,619,067 | 2,913,503 | 1,848,598 | ||||||||||||
| General and administrative | (3,413,733 | ) | (3,678,133 | ) | (2,573,984 | ) | (2,693,692 | ) | ||||||||
| Research and Development | (979,461 | ) | (943,084 | ) | (717,847 | ) | (681,632 | ) | ||||||||
| Other income (expense) net | (186,792 | ) | (212,143 | ) | (59,854 | ) | (14,222 | ) | ||||||||
| Interest income (expense) | (331,735 | ) | (264,015 | ) | (421,597 | ) | (374,640 | ) | ||||||||
| Realized Gain on Sale of Building | - | - | 2,355,904 | - | ||||||||||||
| Net (Loss) Income | (1,084,431 | ) | (1,478,308 | ) | 1,496,125 | (1,915,588 | ) | |||||||||
| Preferred dividends declared | - | (659,649 | ) | - | - | |||||||||||
| Net ( Loss) Income available to common shareholders | $ | (1,084,431 | ) | $ | (2,137,957 | ) | $ | 1,496,125 | $ | (1,915,588 | ) | |||||
| Basic & Diluted Net income (loss) per share: | $ | (0.20 | ) | $ | (0.51 | ) | $ | 0.53 | $ | (0.96 | ) | |||||
| Weighted Average shares outstanding | 5,337,519 | 4,233,158 | 2,844,806 | 1,991,791 | ||||||||||||
BALANCE SHEET DATA
Year Ended June 30,
| 2016 | 2015 | 2014 | 2013 | |||||||||||||
| Cash and cash equivalents | $ | 81,224 | $ | 127,093 | $ | 445,080 | $ | - | ||||||||
| Working capital (deficit) | $ | (2,301,573 | ) | $ | (1,468,082 | ) | $ | (1,127,954 | ) | $ | (2,537,807 | ) | ||||
| Total assets | $ | 5,534,385 | $ | 2,939,174 | $ | 2,770,056 | $ | 2,686,319 | ||||||||
| Long-term obligations, net of current portion | $ | 1,611,073 | $ | 331,488 | $ | 891,552 | $ | 3,236,130 | ||||||||
| Total stockholders’ (deficit) | $ | (602,207 | ) | $ | (787,676 | ) | $ | (1,525,284 | ) | $ | (4,529,596 | ) | ||||
Selected Quarterly Financial Information
The statement of operations data as of the quarterly periods indicated below are derived from unaudited financial statements from the Company’s general ledger for the September quarters for fiscal 2013 & 2014 & the quarterly information for the December information for fiscal 2013 & 2014, from Form 10 Filings. The remaining quarterly information, from March 2015 through June 30, 2016, is taken from our Form 10Q filings and include all adjustments (consisting of normal recurring items) that management considers necessary for a fair presentation of the financial statements.
| FISCAL YEAR ENDED JUNE 30, 2016 QUARTERLY | Three Months Ended, | |||||||||||||||
| STATEMENT OF OPERATIONS DATA: | September 30, | December 31, | March 31, | June 30, | ||||||||||||
| Total revenues | $ | 2,451,855 | $ | 2,598,219 | $ | 1,952,817 | $ | 2,118,416 | ||||||||
| Cost of sales | 1,415,183 | 1,347,348 | 1,374,194 | 1,157,292 | ||||||||||||
| Gross Profit | 1,036,672 | 1,250,871 | 578,623 | 961,124 | ||||||||||||
| General and administrative | (703,000 | ) | (1,067,780 | ) | (825,650 | ) | (817,303 | ) | ||||||||
| Research and development | (206,314 | ) | (261,150 | ) | (258,410 | ) | (253,587 | ) | ||||||||
| Interest expense, Net | (58,171 | ) | (59,287 | ) | (98,832 | ) | (115,445 | ) | ||||||||
| Other Income (expense) | 1,200 | (45,335 | ) | (112,607 | ) | (30,050 | ) | |||||||||
| Net ( Loss) Income | $ | 70,387 | $ | (182,681 | ) | $ | (716,876 | ) | $ | (255,261 | ) | |||||
| Preferred dividends declared | ||||||||||||||||
| Net ( Loss) Income available to common shareholders | $ | 70,387 | $ | (182,681 | ) | $ | (716,876 | ) | $ | (255,261 | ) | |||||
| Basic Net income (loss) per share: | $ | 0.015 | $ | (0.04 | ) | $ | (0.13 | ) | $ | (0.04 | ) | |||||
| Diluted Net income (loss) per share: | 0.011 | NA | NA | NA | ||||||||||||
| Basic Weighted Average shares outstanding | 4,775,306 | 4,935,433 | 5,696,039 | 6,130,789 | ||||||||||||
| Diluted Weighted Average shares outstanding | 6,122,456 | NA | NA | NA | ||||||||||||
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| FISCAL YEAR ENDED JUNE 30, 2015 QUARTERLY | Three Months Ended, | |||||||||||||||
| STATEMENT OF OPERATIONS DATA: | September 30, | December 31, | March 31, | June 30, | ||||||||||||
| Total revenues | $ | 1,929,183 | $ | 1,849,895 | $ | 2,305,665 | $ | 2,091,609 | ||||||||
| Cost of sales | (1,105,055 | ) | (1,138,463 | ) | (1,245,837 | ) | (1,067,930 | ) | ||||||||
| Gross Profit | 824,128 | 711,432 | 1,059,828 | 1,023,679 | ||||||||||||
| General and administrative | (683,230 | ) | (1,234,908 | ) | (834,923 | ) | (925,072 | ) | ||||||||
| Research and development | (207,243 | ) | (293,386 | ) | (223,564 | ) | (218,891 | ) | ||||||||
| Interest expense, Net | (62,688 | ) | (62,547 | ) | (71,235 | ) | (67,545 | ) | ||||||||
| Other Income (expense) | 2,250 | (219,702 | ) | 2,742 | 2,567 | |||||||||||
| Net ( Loss) Income | $ | (126,783 | ) | $ | (1,099,111 | ) | $ | (67,152 | ) | $ | (185,262 | ) | ||||
| Preferred dividends declared | - | (659,649 | ) | - | - | |||||||||||
| Net ( Loss) Income available to common shareholders | $ | (126,783 | ) | $ | (1,758,760 | ) | $ | (67,152 | ) | $ | (185,262 | ) | ||||
| Basic & Diluted Net income (loss) per share: | $ | (0.04 | ) | $ | (0.45 | ) | $ | (0.01 | ) | $ | (0.04 | ) | ||||
| Weighted Average shares outstanding | 3,510,033 | 3,930,679 | 4,679,545 | 4,755,306 | ||||||||||||
| FISCAL YEAR ENDED JUNE 30, 2014 QUARTERLY | Three Months Ended | |||||||||||||||
| STATEMENT OF OPERATIONS DATA: | September 30, | December 31, | March 31, | June 30, | ||||||||||||
| Total revenues | $ | 1,375,953 | $ | 1,548,490 | $ | 2,058,685 | $ | 2,215,688 | ||||||||
| Cost of sales | (894,055 | ) | (997,744 | ) | (1,120,394 | ) | (1,273,120 | ) | ||||||||
| Gross Profit | 481,898 | 550,746 | 938,291 | 942,568 | ||||||||||||
| General and administrative | (448,364 | ) | (487,946 | ) | (944,411 | ) | (693,263 | ) | ||||||||
| Research and development | (165,384 | ) | (156,077 | ) | (191,338 | ) | (205,048 | ) | ||||||||
| Interest expense, Net | (108,265 | ) | (127,905 | ) | (86,294 | ) | (99,133 | ) | ||||||||
| Other Income (expense) | - | (7,543 | ) | 1,154 | (53,465 | ) | ||||||||||
| Realized Gain on Sale of Building | - | 2,355,904 | - | - | ||||||||||||
| Net ( Loss) Income | $ | (240,115 | ) | $ | 2,127,179 | $ | (282,598 | ) | $ | (108,341 | ) | |||||
| Basic & Diluted Net income (loss) per share: | $ | (0.10 | ) | $ | 0.81 | $ | (0.10 | ) | $ | (0.03 | ) | |||||
| Weighted Average shares outstanding | 2,493,641 | 2,612,734 | 2,847,937 | 3,345,533 | ||||||||||||
| FISCAL YEAR ENDED JUNE 30, 2013 QUARTERLY | Three Months Ended | |||||||||||||||
| STATEMENT OF OPERATIONS DATA: | September 30, | December 31, | March 31, | June 30, | ||||||||||||
| Total revenues | $ | 1,775,373 | $ | 1,397,755 | $ | 1,277,773 | $ | 1,022,855 | ||||||||
| Cost of sales | (1,039,244 | ) | (905,752 | ) | (930,113 | ) | (750,050 | ) | ||||||||
| Gross Profit | 736,129 | 492,003 | 347,660 | 272,805 | ||||||||||||
| General and administrative | (455,420 | ) | (390,071 | ) | (1,248,927 | ) | (599,274 | ) | ||||||||
| Research and development | (212,880 | ) | (184,407 | ) | (171,243 | ) | (113,102 | ) | ||||||||
| Interest expense, Net | (52,345 | ) | (55,780 | ) | (110,010 | ) | (156,505 | ) | ||||||||
| Other Income (expense) | (3,265 | ) | (949 | ) | (556 | ) | (9,452 | ) | ||||||||
| Net ( Loss) Income | $ | 12,219 | $ | (139,204 | ) | $ | (1,183,076 | ) | $ | (605,528 | ) | |||||
| Basic & Diluted Net income (loss) per share: | $ | 0.01 | $ | (0.08 | ) | $ | (0.53 | ) | $ | (0.25 | ) | |||||
| Weighted Average shares outstanding | 1,752,258 | 1,752,258 | 2,245,833 | 2,406,547 | ||||||||||||
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis (“MD&A”) is intended to assist in an understanding of our financial condition and results of operations. This MD&A is provided as a supplement to, and should be read in conjunction with, the accompanying financial statements, financial data and related notes. Except for the historical information contained herein, the discussions in MD&A contain forward-looking statements that involve risks and uncertainties. All forward-looking statements included in this report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements. Our future results could differ materially from those discussed herein.
RESULTS OF OPERATIONS
OVERVIEW
Microphase Corporation designs and manufactures custom RF (radio frequency) and microwave products from DC to 40 GHz. Our products include components, subsystems and multi-function assemblies for the military and commercial markets. The Company has been in business for over 60 years and is one of the oldest and most established RF and microwave products companies in the industry.
The Company’s RF and microwave products enable the transmission, reception and processing of high frequency signals in defense electronics, homeland security systems and telecommunication networks. Our RF products are typically used in high frequency applications and include filters, switch filters, diplexers, multiplexers, detectors, detector logarithmic video amplifiers (DLVA) and multi-function assemblies. The end products in which the Company’s products are used include fighter planes, missiles, submarines, ships, drones, and IED jammers. Customers include Lockheed Martin, Raytheon, Saab, Rockwell Collins, L3 Communications and Northrup Grumman. Sales to the military markets comprised 100% of sales for 2015 and 2016.
Many years of deficit spending have caused U.S. Government budgets to come under significant pressure in recent years. In particular, the Budget Control Act of 2011 resulted in automatic spending reductions known as sequestration, through budget caps for both defense and non-defense spending. According to usgovernmentspending.com spending on Military Defense has gone from $693.5 billion in the government fiscal year 2010 (ending September 30) to $705.6 billion in 2011, $677.9 billion in 2012, $633.4 billion in 2013, $603.5 in 2014, $597.5 in 2015 and $604.5 in 2016. This decrease has had a significant negative impact on Microphase’s customers, with a resultant negative impact on Microphase’s results during and prior to the past three fiscal years.
The Company is responding to the decrease in the defense budget by pursuing the acquisition of companies and product lines which are similar and/or related to the Company’s existing product lines and which may provide the Company with opportunities to expand beyond military markets. On March 27, 2013, the Company acquired the assets of a DLVA manufacturing business in Folsom, California from Microsemi Corp. pursuant to a purchase agreement (the “Microsemi Agreement”) for a purchase price comprised of $100,000 in cash plus a $650,000 note, which was paid in full prior to its maturity in December 2014 (the “Microsemi Transaction”). The assets acquired pursuant to the Microsemi Agreement, which we operated as a division and refer to as “Microphase West,” Until July 16, 2016.
On July 9, 2014, the Company executed a securities purchase agreement with AmpliTech Group Inc. of Bohemia, New York (“AmpliTech”), which was subsequently amended (as amended, the “AmpliTech Agreement) to purchase 8,666,666 shares of AmpliTech common stock at $0.023 per share for a total purchase price of $200,000. We paid the purchase price in two equal installments of $100,000 on July 31, 2014 and on August 31, 2014. AmpliTech designs, engineers and assembles amplifiers for microwave components primarily for communication systems. As of May 12, 2016, we owned 18.8% of the outstanding shares of AmpliTech common stock. To date, this has been a passive investment.
On January 21, 2016, Microphase Instruments LLC, a wholly-owned subsidiary of the Company, entered into a purchase agreement with Dynamac, Inc. (“Dynamac”), pursuant to which the Company acquired from Dynamac a suite of proprietary RF and microwave test and measurement products, together with certain corresponding intellectual property (“the Test and Measurement Business”), for an aggregate purchase price of $2,500,000. We believe the products and intellectual product acquired through these acquisitions will enable us to grow sales revenue in accordance with our growth strategy
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TWELVE MONTHS ENDED JUNE 30, 2016 VS. JUNE 30, 2015
Revenues. Total revenues for the year ended June 30, 2016 were $9,121,307, up from $8,176,352, in 2015, an increase of 12%. 92% of the $944,955 revenue increase was due to an increase in sales to domestic customers.
Cost of Sales. Cost of sales increased $736,732 for the year ended June 30, 2016 from $4,557,285 in 2015 to $5,294,017 an increase of 16%. This increase in cost of sales is in line with the increase in revenues. The gross profit margin for 2015 was 44% and for 2016 was 42%. This margin decrease reflects a slightly less profitable mix of products shipped.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $3,413,733 for the year ended June 30, 2016 compared to $3,678,133 for the year ended June 30, 2015, a decrease of $264,400 or 7%. SG&A expenses in 2016 included $615,400 of non-cash charges relating to stock-based compensation and consulting fees paid by the issuance of common stock and that amount in 2015 was $790,000, a decrease of $174,600. 2016 SG&A expenses were less than 2015 SG&A expenses since 2015 SG&A expenses also included $108,000 for the move from Norwalk to Shelton and increased compensation expenses for two new senior executives and incentive compensation for key employees and consultants.
Engineering and Research Expenses. Engineering and research expenses were $979,461 in 2016 compared to $943,084 in 2015, an increase of 4%. Engineering and research expenses slightly increased for fiscal 2016 due to continued engineering and research expenses applicable to the acquisition of the product line from Microsemi Corp.
Other Income (Loss). Non-operating loss was ($28,250) in 2016, down from $19,023 in 2015, a decrease of $47,273. This decrease was due to the termination in 2016 of vehicle lease revenue from a related party and an additional $25,000 accrued expense in moving Folsom CA operations back to the Shelton, CT plant.
Interest (Expense and Credit costs) net. Interest expense and credit costs were $331,735 in 2016, up from $264,015 in 2015, an increase of 26%. The higher interest costs in 2016 versus 2015 reflect the higher debt levels in 2016.
Net Income (Loss). Microphase recorded a net loss of ($1,084,431) for the year ended June 30, 2016 as compared to a net loss of ($1,478,308) for 2015, a decrease of $393,877. The decrease in net loss in 2016 was due to improved revenues for 2016 as compared to 2015, as well as reduced non-cash charges from $1,093,866 in 2015 to $722,774 in 2016, which included $615,400 in stock-based compensation and $107,375 for losses on debt settlements in our current fiscal 2016 compared to $ 870,000 and $223,866 in fiscal 2015.
This represents a loss per share of $ (0.20) in 2016 as compared to loss per common share of $(0.51) in 2015, based upon weighted average common shares outstanding during the periods ending June 30, 2015 and June 30, 2016 of 4,233,158 and 5,337,519 respectively.
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LIQUIDITY AND CAPITAL RESOURCES
Through the fiscal year ended June 30, 2016, the Company reported a net loss of ($1,084,431) and had cash and cash equivalents of $81,224. At June 30, 2016 Microphase had a working capital deficit of $2,301,573 as compared to a working capital deficit of $1,468,082 as of June 30, 2015, an increase of $833,491 in the deficit. The primary sources of the increase in the working capital deficit in fiscal 2016 compared to fiscal 2015 was a result from our cash investment in the acquisition from Dynamac, which in turn contributed to an increase in the balance of Gerber financing, plus from the Note Payable commitment on the acquisition increased the current portion of debt obligations. Our financial condition raises substantial doubt that we will be able to continue as a “going concern”, and our independent auditors included an explanatory paragraph regarding this uncertainty in their report on our financial statements as of June 30, 2016. As of June 30, 2016, we had an accumulated deficit of $13,939,651 compared to $12,855,220 as of June 30, 2015.
Cash used in operating activities was $156,112 during the twelve months ended June 30, 2016 and $87,125 for 2015.
During the 2016 fiscal year the cash used in operating activities consisted principally of the net loss of $1,084,431, reduced by non-cash expenses for depreciation and amortization of $97,893, stock-based compensation and debt settlement fees aggregating $722,775; and changes in assets and liabilities of an increase in accounts receivable of $211,261, an increase in other current assets of $24,836, an increase of $5,250 in the Due to/from affiliates account balances, reduced by an increase in trade payables of 131,416, and an increase of $38,592 in other accrued expenses. Cash used in operating activities was decreased by a decrease in inventory of $19,999, by increases in customer deposits of $117,800 and $81,189 in the deferred long term rent liability.
The terms and conditions of the purchase agreement with Dynamac requires semi-annual payments due in August 2016 & 2017 and February 2017 & 2018 of $550,000, which the Company imputed interest at 7%, its most favorable credit line rate, and as such is valued at $2,020,425.
During the 2015 fiscal year the cash used in operating activities consisted principally of the net loss of $1,478,308 reduced by depreciation and amortization of $89,977, by stock based compensation and fees of 1,093,866, by a decrease in accounts receivable of $21,979, by a decrease in other current assets of $105,927, by an increase in accrued payroll liabilities of $50,000, by an increase in other accrued expenses of $270,731 and by an increase in accrued interest on related party loans of $21,083. Cash used in operating activities was decreased by a gain on sale of property of $11,010, by an increase in inventory of $94,333, by a decrease in customer deposits of $113,910 and by an increase in security deposits of $43,479.
The terms and conditions of the purchase agreement with Dynamac require semi-annual payments due in August 2016 and 2017 and February 2017 and 2018 of $550,000, which the Company imputed interest at 7%, its most favorable credit line rate, and as such is valued at $2,020,425. The payment owed to Dynamac in August 2016 has a grace period until October 22, 2016. The Company intends to make such payment on or before October 22, 2016 with proceeds from private equity and/or debts bridge financings.
The amounts owed by the Company pursuant to the related party notes are three months in arrears.
The Company has material Debt Service commitments at June 30, 2016 summarized as follows:
| Related Party Loans |
Other
Termed Debt |
Equity
Lines of Credit |
Acquisition Notes | Total | ||||||||||||||||
| EFFECTIVE
INTEREST RATE FISCAL YEAR ENDED JUNE 30, 2016 |
4.1 | % | 5.5 | % | 3.3 | % | 7.0 | % | ||||||||||||
| Fiscal Years: | ||||||||||||||||||||
| 2017 | $ | 137,150 | $ | 13,714 | $ | 38,132 | $ | 975,345 | $ | 1,164,341 | ||||||||||
| 2018 | 118,645 | 14,410 | 39,363 | 1,045,080 | 1,217,498 | |||||||||||||||
| 2019 | 104,112 | 12,565 | 241,798 | - | 358,475 | |||||||||||||||
| 2020 | 35,100 | - | - | - | 35,100 | |||||||||||||||
| Total | $ | 395,007 | $ | 40,689 | $ | 319,293 | $ | 2,020,425 | $ | 2,775,414 | ||||||||||
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The Company has financed its operations in recent years primarily through a debt facility with a financial firm, from loans from officers and related parties, and since April of 2013, from the private placement of common stock to accredited investors. The Company has also financed its operations utilizing capital stock conversions to settle debts, primarily with related parties.
The Company entered into a revolving credit facility with Gerber Finance, Inc. (“Gerber”) in 2012 with a maximum for this line of $1,500,000. The maximum line was reduced to $1,150,000 in connection with the sale of the headquarters building in November 2013. As of June 30, 2016, this line has a limit of $1,400,000 and the interest is currently at the rate of 7.25%. The outstanding balance as of June 30, 2016 was $1,474,129, This excess utilization was corrected in July 2016, and as of June 30, 2015 was $1,013,406. Under this agreement the Company receives funds based on a borrowing base which consists of various percentages of certain assets. The effective interest rate for 2016 was 11.54 % and for 2015 was 15.29%, including the annual facility fee of 1.75% plus monthly collateral monitoring fees of $1,500 and other fees. During Fiscal 2016 our higher credit balances incurred higher interest costs. Although the Company is currently non-compliant with regard to certain covenants under such credit agreement with Gerber, no defaults have been declared, and such non-compliance has not triggered any cross-defaults under any other debt instruments.
During the Fiscal Year ended June 30, 2016, the Company completed a private placement of its common stock to an accredited investor pursuant to Rule 504 of Regulation D and Section 4(2) of the Securities Act of 1933, as amended. The Company issued 125,000 shares of its common stock at $2.00 per share together with a 5 year warrant to purchase up to 125,000 additional shares of our common stock at $2.50 to the investor and 25,000 shares to the placement agent, and received net proceeds of $225,000 after deducting $25,000 of cash costs, which was used for working capital.
During the 12 month period ended June 30, 2015 the Company completed transactions in private placements of its common stock to accredited investors pursuant to Rule 504 of Regulation D and Section 4(2) of the Securities Act of 1933, as amended. The Company issued 311,782 shares of its common stock at $2.00 per share, including 68,782 shares to finders and received net proceeds of $447,050, after deducting $31,450 of cash costs, which was used for working capital. The Company also paid the remaining $360,000 on its acquisition note with Microsemi Corp. in full and invested $200,000 in a securities purchase agreement with AmpliTech Group Inc. of Bohemia, N.Y.
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Preferred stock dividend
Effective December 31, 2014 the Board of Directors approved and declared payable all cumulative dividends in arrears for preferred shares of Microphase outstanding at September 30, 2014, under the original terms for preferred shares commencing with preferred shares issued since March 31, 2010. The Board also authorized the conversion of the liability for the preferred dividend payable into common shares at $1.50 consistent with the conversion rate for debt conversions approved by shareholders at the October 4th special meeting, resulting in the issuance of 329,825 shares of the Company’s common stock as payment of $494,735 and a loss on the settlement of $164,954, totaling $659,689.
Capital stock conversions
During the Fiscal Year ended June 30, 2016, the Company’s President converted $252,815 of unpaid compensation into 168,550 shares of Common Stock resulting in a loss on the settlement of liabilities of $84,271. The President also converted $69,310 of related party loans, including $39,366 of accrued interest, into 46,200 shares of Common Stock resulting in a loss on the settlement of liabilities of $23,103. In total the Company settled $322,125 of related liabilities and recorded a $107,375 loss on the settlement of liabilities with related parties for a total of 214,750 shares of Common Stock valued at $429,500.
During the Fiscal Year ended June 30, 2015, an officer and a former employee converted $150,000 and $170,000, respectively, or a total of $320,000 of related party loans into 213,333 shares of the Company’s common stock. Another officer converted $180,000 of related party loans into 1,800 shares of the Company’s preferred stock. Two officers each converted $80,000, or a total of $160,000 of unpaid compensation into a total of 1,600 shares of the Company’s preferred stock. A strategic vendor converted $15,000 of accounts payable into 10,000 shares of the Company’s common stock.
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CURRENT STATUS AND MANAGEMENT’S PLANS
The Company has been seeking to diversify its market focus beyond its legacy products. By utilizing our current capability together and positioning ourselves through targeted acquisitions, strategic alliances and product partnering we believe we can augment our current product offerings and will further enable us to continue to introduce a mix of Military Electronic Defense, Department of Homeland Security and commercial products for the wireless telecom, autonomous auto, test & measurements, and medical instrumentation markets. This strategy should enable Microphase to broaden its customer base and reduce risk by spreading its revenue base across multiple market sectors. Targeted strategic acquisitions should increase our market share and the technology value of our product lines as well as broaden our product offering and diversify our customer base.
The Company plans on continuing financing operations through its debt facility with Gerber Financial, the issuance of debt to management and to bridge debt investors, the settlement of debts for equity, and the sale of common and preferred securities through private placements, until such time it can complete its initial public offering, when and if declared effective, as described in its registration statement and impending amendment(s) on Form S-1, during the second quarter of fiscal 2017. The Company also continues to boost efforts to increase the sales of its traditional RF and DLVA business and anticipates the product growth plan to include the launch of its initial T&M products by the later portion of fiscal 2017 implementing the assets acquired from Dynamac in January 2016. Management has also taken steps in fiscal 2016 to contain operating expenses, including a reduction in the number of employees, primarily by consolidating all of its traditional design to manufacture RF and DLVA business into the Shelton, Connecticut location. The Company has expanded its facility in square footage and utility as such to house both our traditional RF and DLVA business, and enable the launch and delivery of its initial T&M products.
Management believes that these steps will permit the Company to maintain the continuation of our traditional operations, and should we become further capitalized, allow us to implement our product growth plan, which we believe will enable the Company to achieve and maintain a level of operations which generates sustainable profitability and to continue as a going concern. However there can be no assurance that this will be the case.
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CRITICAL ACCOUNTING POLICIES, ESTIMATES AND ASSUMPTIONS
The SEC defines critical accounting policies as those that are, in management’s view, most important to the portrayal of our financial condition and results of operations and those that require significant judgments and estimates.
The discussion and analysis of our financial condition and results of operations is based upon our financial statements that have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities. On an on-going basis, we evaluate our estimates including the allowance for doubtful accounts, the salability and recoverability of inventory, income taxes and contingencies. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We cannot predict what future laws and regulations might be passed that could have a material effect on our results of operations. We assess the impact of significant changes in laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when we deem it necessary.
Basis of Accounting
The accompanying consolidated financial statements have been prepared using the accrual basis of accounting.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated.
Cash and Cash Equivalents
The Company considers deposits that can be redeemed on demand and investments that have original maturities of less than three months, when purchased, to be cash equivalents. Company’s cash and cash equivalents were deposited primarily in two financial institutions.
Allowance for Doubtful Accounts
The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Company’s estimate is based on historical collection experience and a review of the current status of Accounts Receivable. It is reasonably possible that the Company’s estimate of the allowance for doubtful accounts will change in the future.
Depreciation and Amortization
Property and equipment are recorded at cost. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. The Company uses other depreciation methods (generally, accelerated depreciation methods) for tax purposes where appropriate. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements.
Income Taxes
The Company accounts for income taxes under the provisions of Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 740 “Income Tax”. ASC 740 requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and tax bases of certain assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The deferred tax assets and liabilities are classified according to the financial statement classification of the assets and liabilities generating the differences. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company has adopted the provisions of FASB ASC 740-10-05 “Accounting for Uncertainty in Income Taxes”. The ASC clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The ASC prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The ASC provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Earnings (Loss) Per Share
Basic earnings (loss) per share (“EPS”) is determined by dividing the net earnings (loss) by the weighted-average number of shares of common shares outstanding during the period. Diluted EPS is determined by dividing net earnings (loss) by the weighted average number of common shares used in the basic EPS calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive securities (such as stock options, preferred stock subsequent to October 4, 2014, and convertible securities) outstanding under the treasury stock method. There were no dilutive financial instruments issued or outstanding for the periods presented. On October 4, 2014 the shareholders approved a convertible feature in preferred stock, such preferred stock at par value convertible into common shares at agreed upon market value.
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Inventory Obsolescence
Inventory quantities and related values are analyzed at the end of each fiscal quarter to determine those items that are slow moving or obsolete. An inventory reserve is recorded for those items determined to be slow moving with a corresponding charge to cost of goods sold. Inventory items that are determined obsolete are written off currently with a corresponding charge to cost of goods sold.
Revenue Recognition
Revenues and costs of revenues are recognized during the period in which the products are shipped. The Company applies the provisions of FASB Accounting Standards Codification (“ASC”) 605-10, Revenue Recognition in Financial Statements ASC 605-10, which provides guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. ASC 605-10 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, the Company recognizes revenue for sale of products when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, and (iv) the collectability is reasonably assured.
The Company’s sources of revenue are from the sale of various component amplifiers and filters. Revenue is recognized upon shipment of such products, FOB shipping point. The Company offers a 100% satisfaction guarantee against defects for 90 days after the sale of their product except for a few circumstances. There are no maintenance or service contracts related to any product sale.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. Actual results could differ from those estimates.
OFF BALANCE SHEET TRANSACTIONS
As of June 30, 2016, we did not have any off-balance sheet arrangements.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company is not exposed to changes in interest rates as the Company has no floating rate debt arrangements and no investments in certain held-to-maturity securities. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical 100 basis point adverse move in interest rates along the interest rate yield curve would not materially affect the fair value of any financial instruments at June 30, 2016. We believe that interest rate risks for our accounts receivable are insignificant. Sales to customers are denominated in dollars. Accordingly, we are not directly exposed to market risks from currency fluctuations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See pages beginning page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
There have been no changes in or disagreements with accountants on accounting or financial disclosure matters.
ITEM 9A. CONTROLS AND PROCEDURES
Assessment of Internal Controls Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer (our principal financial and accounting officer) to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-15(e).
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with participation of management, including our Chief Executive Officer and our Chief Financial Officer (our principal financial and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and our Chief Financial officer have concluded that our disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Management evaluated the effectiveness of the Company’s internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission in Internal Control — Integrated Framework of 2013.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2016. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Our evaluation concluded that the company had no material weakness which would result in the reasonable possibility of a material misstatement described above.
This report does not include an attestation report of our registered public accounting firm regarding our internal controls over financial reporting. The disclosure contained under this Item 9A was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only the disclosure under this Item 9A in this annual report.
Management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2016 and concluded that it is effective.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the fiscal year ended June 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
None.
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table contains information with respect to our directors and executive officers. To the best of our knowledge, none of our directors or executive officers have an arrangement or understanding with any other person pursuant to which he or she was selected as a director or officer. There are no family relationships between any of our directors or executive officers, other than Jeffrey Peterson, who is the son-in-law of Necdet Ergul. Directors serve one year terms. Our executive officers are appointed by and serve at the pleasure of the board of directors.
| Name | Age | Position | ||
| Necdet F. Ergul | 93 | Chief Executive Officer, President and Chairman of the Board of Directors | ||
| Paul H. DeCoster | 82 | Director | ||
| James Ashman | 62 | Chief Financial Officer and Director | ||
| Michael Ghadaksaz | 60 | Chief Technology Officer, Chief Marketing Officer and Director | ||
| Jeffrey Peterson | 58 | Chief Administrative Officer, Secretary, Treasurer and Director |
Necdet F. Ergul, age 93, Chairman of the Board of Directors, Chief Executive Officer and President.
Mr. Ergul has guided the development of Microphase Corporation, which he founded in 1955, since inception to become a leading developer of military electronic defense and telecommunications technology. In addition to his management responsibilities at Microphase, he is active in engineering design and related research and development. Under Mr. Ergul’s direction, Microphase has achieved its current position in the industry with respect to the design and physical miniaturization of passive Multiplexers.
Mr. Ergul holds a Masters Degree in Electrical Engineering from the Polytechnic Institute of Brooklyn, New York.
Mr. Paul H. DeCoster, age 82, Director.
Mr. DeCoster combines over 50 years experience as an attorney working on corporate matters. Presently Mr. DeCoster has a limited practice for corporate clients and their respective owners and family members. Mr. DeCoster was a Partner in Jackson & Nash, LLP, where he worked for over 27 years through 1999, Mr. DeCoster received a bachelor of arts in history from Yale in 1955, and he received an LLB from Yale Law School in 1958, and was admitted to the New York Bar in 1959.
James Ashman, age 62, Chief Financial Officer and Director.
Mr. Ashman has more than 20 years experience as a senior finance executive in the technology, telecommunications, software and advanced materials industries. Prior to that he spent 11 years as an investment banker, primarily at Prudential Securities, and executed public offerings of debt and equity, private placements and merger and acquisition advisories for companies in a wide range of industries. From 2013 to 2014 he was the Chief Financial Officer of DefenCall Inc., an emergency communication company in New Canaan, CT. From 2009 to 2013, he was the Chief Financial Officer of Axxun Inc., a software development company in Stamford, CT. From 2001 to 2008 Mr. Ashman was a member of the Board of Directors and Chairman of the finance committee and the compensation committee of Starfire Systems, Inc., a Malta, N.Y.-based developer and manufacturer of nano-structured ceramic materials and finished products. From 2005 to 2006 Mr. Ashman was the Chief Financial Officer of Phone Labs Technology Corporation, a New York City-based designer and manufacturer of cell phone docking stations. From 2003 to 2004 Mr. Ashman was the Interim Chief Financial Officer of SMART System technologies, Inc., an RFID payment company in NYC. From 1999 to 2002 he was a partner in TechOne Group LLC, an early stage venture capital firm based in Albany, N.Y. From 1994 to 1999 Mr. Ashman was Executive Vice President, Chief Financial Officer and a Director of CAI Wireless Systems, Inc., a publicly traded wireless telecommunications company acquired by MCI/WorldCom.
In addition to his position at Microphase he is also currently Chairman of the Board of SouthWest NanoTechnologies, Inc., a manufacturer of advanced materials based in Norman, Oklahoma. He has an undergraduate degree in economics from Columbia University and an MBA from Columbia Business School.
Michael Ghadaksaz, age 60, Chief Technology Officer, Chief Marketing Officer & Director.
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Mr. Ghadaksaz combines over 29 years of experience in RF/Microwave, wireless technology, test & measurements, defense, and venture capital industries senior technology and executive management. Previously, he had been involved in 10 companies in RF/Microwave and Millimeter-wave products, wireless technology, electronic test & measurements, public safety land mobile radio, telecom, and military communications industries holding positions including President and Chief Technical Officer, Vice President of Business Development and Corporate Officer, Director of Technology Planning and Business Strategy, Director of Technology Strategy, Senior Scientist, Senior Member of Technical Staff, and Technical Manager. He had also served as a senior technology and business consultant to venture capital firms and technology investment banks. From 2010 to 2013, Mr. Ghadaksaz was the President and Chief Technical Officer of AES Technologies, Inc., an electronic test & measurement technology start-up company. From 2008 to 2010, he was Director of North America Technology Planning and Business Strategy for Huawei Technologies, a leading global and China’s largest telecom equipment manufacturer. From 2003 to 2008, he was Vice President of Business development, Corporate Officer, and Member of Board of Directors’ Technical Committee of Merrimac Industries (now Crane Aerospace), a leading manufacturer of integrated RF, Microwave, and Millimeter-wave products and solutions. From 1999 to 2002, he was Director of Technology Strategy of Motorola, the leading global manufacturer of land mobile radio products for Public Safety and Homeland Security markets. From 1995 to 1999, he was Senior Scientist and Director of Applications of Hughes Aircraft Company (now Raytheon), a leading defense and aerospace system manufacturer. Prior to his employment at Hughes Aircraft, Mr. Ghadaksaz held engineering and management positions at GTE Laboratories (now Verizon), General Electric Mobile Communications Business (now Harris), Canadian Marconi Defense Communications Division and Bell Canada Enterprises. Mr. Ghadaksaz holds several patents and was recipient of 2012 Illinois 10 th Congressional District Community Leadership Award for Entrepreneurial Excellence. He has an undergraduate degree from University of Ottawa and a Master’s degree in Microwave Electronics from Carleton University in Ottawa, Canada.
Jeffrey Peterson, 58, Chief Administrative Officer, Secretary, Treasurer and Director.
Mr. Peterson has over 14 years of accounting department and operations experience with the Company in Norwalk, CT, with various roles including recently returning as the Company’s controller. He also has 14 years of operations experience as assistant vice president with the Industrial Bank of Japan, New York Bank in New York, New York.
He has an undergraduate degree in Asian Studies from Vassar College, 1979, and an MBA from Pace University, 1983, and a bachelors’ degree in accounting from Pace University, 2003. He attained the CPA accreditation in 2005.
Brian Kelly, 55, General Manager (Contractor)
Mr. Kelly joined Microphase in 2008. He has over 30 years of experience in operations management, including manufacturing process improvement, material control, inventory control (APICS certified), and lean manufacturing (Six Sigma, Black Belt certified in MFG). Mr. Kelly has worked most of his career for major defense contractors including United Technologies, Westinghouse, Northrop Grumman and Dover Corp. in various material and operations management positions. In addition to participation in several M&A transactions in his career, Mr. Kelly has relocated and set up several state of the art factories in the U.S.
Mr. Kelly received an A.S. degree in general studies from Housatonic Technical-Community College in 1987.
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Family Relationships.
There are no family relationships between any of our directors or executive officers, other than Jeffrey Peterson, who is the son in law of Necdet Ergul.
Involvement in Certain Legal Proceedings.
There have been no events under any bankruptcy act, any criminal proceedings and any judgments, injunctions, orders or decrees material to the evaluation of the ability and integrity of any director, executive officer, promoter or control person of Registrant during the past ten years.
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ITEM 11. EXECUTIVE COMPENSATION
The following table provides each element of compensation paid or granted to each Executive officer and director, for service rendered during the fiscal years ended June 30, 2016, 2015 & 2014.
Summary Compensation Table
| All Other | ||||||||||||||||||||||
| Salary | Bonus | Option Awards | Compensation | Total | ||||||||||||||||||
| Year | ($) | ($) | ($) | ($) | ($) | |||||||||||||||||
| Necdet F. Ergul-Chairman of the Board, Chief Executive Officer | FYE June 30, 2016 | $ | 225,000 | $ | - | $ | - | $ | - | $ | 225,000 | |||||||||||
| FYE June 30, 2015 | $ | 239,904 | $ | - | $ | - | $ | - | $ | 239,904 | ||||||||||||
| FYE June 30, 2014 | $ | 250,000 | $ | - | $ | - | $ | - | $ | 250,000 | ||||||||||||
| Ronald A. Durando—Strategic Consultant 2015 Chief Operating Officer, Director 2014(1) | FYE June 30, 2016 | $ | 225,000 | $ | - | $ | - | $ | - | $ | 225,000 | |||||||||||
| FYE June 30, 2015 | $ | 240,865 | $ | 25,000 | $ | - | $ | - | $ | 265,865 | ||||||||||||
| FYE June 30, 2014 | $ | 250,000 | $ | 26,900 | $ | - | $ | - | $ | 276,900 | ||||||||||||
| Brian Kelly-Consultant/General Manager | FYE June 30, 2016 | $ | - | $ | - | $ | - | $ | 195,692 | $ | 195,692 | |||||||||||
| FYE June 30, 2015 | $ | - | $ | - | $ | - | $ | 195,692 | $ | 195,692 | ||||||||||||
| FYE June 30, 2014 | $ | - | $ | - | $ | - | $ | 199,038 | $ | 199,038 | ||||||||||||
| Mr. Michael Ghadaksaz, Chief Marketing and Technical Officer | FYE June 30, 2016 | $ | 169,596 | $ | - | $ | - | $ | 240,000 | $ | 409,596 | |||||||||||
| FYE June 30, 2015 | $ | 131,827 | $ | - | $ | - | $ | - | $ | 131,827 | ||||||||||||
| Mr. James Ashman, Chief Financial Officer and Director | FYE June 30, 2016 | $ | 158,558 | $ | - | $ | 35,400 | $ | 180,000 | $ | 373,958 | |||||||||||
| FYE June 30, 2015 | $ | 99,499 | $ | - | $ | - | $ | - | $ | 99,499 | ||||||||||||
| Mr. Jeffrey Peterson, Secretary and Director | FYE June 30, 2016 | $ | 92,558 | $ | - | $ | - | $ | - | $ | 92,558 | |||||||||||
| FYE June 30, 2015 | $ | 77,114 | $ | - | $ | - | $ | - | $ | 77,114 | ||||||||||||
(1) Mr. Durando resigned as Chief Operating Officer and Director on January 22, 2015.
Currently, the Company has employment agreements with Necdet Ergul, James Ashman, Michael Ghadaksaz and Ronald Durando.
Mr. Necdet Ergul, Chief Executive Officer, is presently compensated at an annualized rate of approximately $225,000 during fiscal 2016.
Mr. James Ashman, Chief Financial Officer and Director, joined the Company in August of 2014 and is presently compensated at an annualized rate of approximately $150,000 during fiscal 2016.
Mr. Michael Ghadaksaz, Chief Marketing and Technical Officer and Director, joined the Company in April of 2014 and is presently compensated at an annualized rate of approximately $165,000 during fiscal 2016.
Mr. Jeffrey Peterson, Chief Administrative Officer, Secretary and Treasurer, re-joined the Company in July of 2014 and is presently compensated at an annualized rate of approximately $100,000 during fiscal 2016.
Mr. Ronald Durando, Strategic consultant, re-joined the company in February of 2015 and is presently compensated at an annualized rate of approximately $225,000 during fiscal 2016.
Mr. Brian Kelly, General Manager, entered into a consulting agreement with the Company in June, 2008, and is compensated at an annualized rate of $192,000 during fiscal 2016.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth as of September 20, 2016 certain information regarding the beneficial ownership of our shares:
| 1. | by each person who is known by us to be the beneficial owner of at least five percent (5%) of our outstanding common stock; |
| 2. | by each of our directors; |
| 3. | by each executive officer named in the compensation table: and |
| 4. | by all of our directors and executive officers as a group |
| Warrants/ | ||||||||||||||||||
| conversion | Percent of | |||||||||||||||||
| Class of Stock | AFFILIATES (1)(2)(11) | Shares | rights | TOTAL | Common | |||||||||||||
| Common | Necdet Ergul, Chief Executive Officer and Director (3)(4) | 1,133,169 | 585,867 | 1,719,036 | 25.33 | % | ||||||||||||
| Common | James Ashman, Chief Financial Officer and Director (5) | 110,000 | 50,000 | 160,000 | 2.56 | % | ||||||||||||
| Common | Michael Ghadaksaz, Chief Technology Officer and Director (6) | 140,000 | - | 140,000 | 2.26 | % | ||||||||||||
| Common | Jeffrey Peterson, Chief Administrative Officer and Director | 10,000 | - | 10,000 | 0.16 | % | ||||||||||||
| Common | Paul H. DeCoster, Director (7) | - | - | - | 0.00 | % | ||||||||||||
| Common | All Officers and Directors as a group (5 persons) | 1,591,169 | 635,867 | 2,029,036 | 33.50 | % | ||||||||||||
| Common | RCKJ Trust (3)(8) | 2,034,656 | 395,867 | 2,430,523 | 36.84 | % | ||||||||||||
| Common | Microphase Holding Company LLC (3)(9) | 3,167,825 | 981,734 | 4,149,559 | 57.77 | % | ||||||||||||
| Common | All Officers, Directors and 5% holders as a group (7 persons) (10) | 3,427,825 | 1,031,734 | 4,459,559 | 57.04 | % | ||||||||||||
| (1) | Unless otherwise indicated, the address of each beneficial owner is 100 Trap Falls Road Ext., Shelton, Connecticut 06484. |
| (2) | Unless otherwise indicated, Microphase believes that all persons named in the table have sole voting and investment power with respect to all shares of the Company beneficially owned by them. The percentage for each beneficial owner listed above is based upon 6,200,789 shares outstanding on September 20, 2016 and, with respect to each person holding options, warrants or similar conversion rights to purchase shares that are exercisable to within 60 days of September 20, 2016, the number of options and warrants or similar conversion rights are deemed to be outstanding and beneficially owned by the person for the purpose of computing such person’s percentage ownership, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person. |
| (3) | Includes 50% of the 1,833,702 shares of Common Stock and 11,876 shares of Series A Preferred Stock (convertible into 791,734 shares of common stock) owned by Microphase Holding Company, LLC, a limited liability company in which RCKJ Trust holds 50% of the membership interests and the Ergul Family Limited Partnership holds 50% of the membership interests and a unanimous vote of the members is required to determine the voting or conversion of such company’s shares of the Company. The beneficial owners for economic purposes of the Ergul Family Limited Partnership are Necdet Ergul, Eda Peterson, Berrin Snyder and Ergul Corporation, as well as Paul DeCoster, who owns an option to purchase an interest in such partnership. |
| (4) | Includes 2,850 shares of Series A Convertible Preferred Stock, which are convertible into 190,000 shares of Common Stock. |
| (5) | Includes 50,000 of 75,000 options held by Mr. Ashman. This amount does not include 10,000 shares of common stock that is issuable to Mr. Ashman pursuant to a deferred share grant for September 2016. |
| (6) | This amount does not include 55,000 shares of common stock that is issuable to Mr. Ghadaksaz pursuant to a deferred share grant for September 2016. |
| (7) | Paul H. DeCoster does not directly own any shares of Microphase. Mr. DeCoster owns an option to purchase an interest of 3% in the Ergul Family Limited Partnership, which expires on September 21, 2021, and has an exercise price of $38,500, or $0.50 per unit for the 76,233 units presently covered by such option. The Ergul Family Limited Partnership is a Connecticut limited partnership which has four limited partners, with ownership interests as follow: Necdet Ergul (19.3%); Eda Peterson (39.88%); Berrin Snyder (39.88%); and Ergul Corporation (0.94%). Ergul Corporation is the general partner. Mr. DeCoster owns 5% of Ergul Corporation. As described above, the Ergul Family Limited Partnership holds 50% of the membership interests in Microphase Holding Company, LLC. |
| (8) | On February 9, 2015 Ronald A. Durando, who was the Company’s chief operating officer until his resignation on January 22, 2015, assigned all his interests in the common stock and Series A Convertible Preferred Stock of the Company held by Microphase Holding Company, LLC, Durando Investments, LLC and by him individually to the RCKJ Trust. The beneficial owners for economic purposes are Mr. Durando’s children, Ryan C. Durando and Korinne J. Durando. Decisions with respect to the voting and disposition of such shares shall be made by the trustee, Mr. Dennis Durando, Ronald A. Durando’s brother, who disclaims beneficial ownership of such shares in his individual capacity. |
| (9) | Pursuant to the operating agreement of Microphase Holding Company, LLC, a unanimous vote of the members is required to determine the voting or conversion of such company’s shares of the Company. This total Includes: (i) 1,833,702 shares of Common Stock and 11,876 shares of Series A Preferred Stock, convertible into 791,734, shares of Common Stock, held by MHC; (ii) 1,117,805 shares of Common Stock held by the RCKJ Trust and (iii) 134,902 shares of Common Stock and 2,850 shares of Series A Preferred Stock, convertible into 190,000 shares of Common Stock held by the Ergul Family Limited Partnership. |
| (10) | The totals for Microphase Holding Company, LLC are not included in the above total for affiliates because such shares have been included in the amounts indicated for the RCKJ Trust and Mr. Ergul. Microphase Holding Company, LLC, is a limited liability company in which RCKJ Trust holds 50% of the membership interests and the Ergul Family Limited Partnership holds 50% of the membership interests. Pursuant to the operating agreement of Microphase Holding Company, LLC, a unanimous vote of the members is required to determine the voting or conversion of such company’s shares of the Company. |
| (11) | This total does not include 198,000 shares of common stock owned by Brian Kelly, the Company’s general manager, who is a contractor. Mr. Kelly’s shares comprise 3.19% of the amount of common stock currently outstanding. |
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Common and Preferred Stock
The Company is authorized by its Certificate of Incorporation and Certificate of Designation to issue an aggregate of 8,000,000 shares of capital stock, of which 7,800,000 are shares of common stock, no par value per share (the “Common Stock”) and 200,000 are shares of Series A Convertible Preferred Stock, par value $100.00 per share (the “Preferred Stock”). As of June 30, 2016 6,200,789 shares of Common Stock and 15,382 shares of Preferred Stock were issued and outstanding, respectively.
Common Stock
The holders of our Common Stock (i) have equal ratable rights to dividends from funds legally available therefore, when, as and if declared by our Board of Directors; (ii) are entitled to share ratably in all of our assets available for distribution to holders of common stock upon liquidation, dissolution or winding up of our affairs; (iii) do not have pre-emptive, subscription or conversion rights and there are no redemption or sinking fund provisions or rights; and (iv) are entitled to one non-cumulative vote per share on all matters on which shareholders may vote.
The shares of our Common Stock are not subject to any future call or assessment and all have equal voting rights. There are no special rights or restrictions of any nature attached to any of the shares of our Common Stock and they all rank at equal rate or “pari passu”, each with the other, as to all benefits, which might accrue to the holders of the shares of our Common Stock. All registered shareholders are entitled to receive a notice of any general annual meeting to be convened.
At any general meeting, subject to the restrictions on joint registered owners of shares of our Common Stock, on a showing of hands every shareholder who is present in person and entitled to vote has one vote, and on a poll every shareholder has one vote for each share of our Common Stock of which he is the registered owner and may exercise such vote either in person or by proxy. Holders of shares of our Common Stock do not have cumulative voting rights, which means that the holders of more than 50% of the outstanding shares, voting for the election of directors, can elect all of the directors to be elected, if they so choose, and, in such event, the holders of the remaining shares will not be able to elect any of our directors.
Preferred Stock
As of June 30, 2016, 200,000 shares of our Preferred Stock shares are authorized of which 15,382 were issued and outstanding, held by six shareholders. MHC holds 11,876 preferred shares. The Ergul Family Limited Partnership holds 2,850 preferred shares. Four other shareholders hold 656 preferred shares.
Dividends
The preferred stock, with respect to dividends ranks senior to the common stock of the Company. Holders of Preferred Stock are entitled to receive, when and as declared by the Board of Directors, dividends, at the annual rate of 6% of the stated par value, or $100 per share. Dividends are cumulative and accrue from the effective date of issuance of the Preferred Stock until declared.
Liquidation
In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Company, the holders Preferred Stock shall be entitled to be paid the full par value of such Preferred Stock, plus the dividends accumulated thereon up to the date of such liquidation, dissolution, or winding up of the
Company (whether or not the Company shall have a surplus or earnings available for dividends), and no more. After payment to the holders of the Preferred Stock of the full amount payable to them as aforesaid, the remaining assets of the Company shall be payable to and distributed pro rata among the holders of record of the Common Stock. For purposes of this Subsection (b), the consolidation or merger of the Company with or into another corporation or entity shall not constitute, nor shall the sale, lease or conveyance of all or substantially all of the assets of the Company as an entity in and of itself, constitute, a liquidation, dissolution or winding up of affairs of the Company.
Conversion
The preferred shares are convertible into common shares at any time at the option of the holders of the preferred shares, on notice to the Company. The conversion price is to be agreed upon by the board of directors and the holder at the time of each Conversion. 3,400 of the presently issued and outstanding 26,943 preferred shares are convertible into common stock at $1.50 per share, until the earlier of October 4, 2015 or the date the Company’s common stock becomes quoted in an established public trading market.
Voting Rights
The holders of Preferred Stock, voting together with the holders of Common Stock, have one vote per share for the election of directors and on all other matters.
Transfer Agent and Registrar
The transfer agent and registrar for our Common Stock is:
Jersey Stock Transfer, LLC
TEL: (973) 814-7004
FAX: (973) 215-2740
PO BOX 606
1250 SUSSEX TURNPIKE, #606
MOUNT FREEDOM,
NJ 07970-0606
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The Company had activities with related parties during the fiscal years 2016, 2015, 2014, 2013 and 2012 as follows:
Effective March 6, 2013 the Company received title to the corporate headquarters and production facility in Norwalk, CT in an exchange transaction intended to be tax free under IRC sec 351 from Microphase Holding Company, LLC, (“MHC”), an 82% shareholder of the Company at the time. Title to the building had originally been held by Edson Realty, Inc. (Edson), a related party which had transferred the building to MHC together with 2,532 preferred shares of the Company and 1,280,543 common shares of the Company for the assumption of $2,268,975 of mortgage and mortgage related obligations by MHC for a like amount of preferred and common shares of the Company, on the same date. The Company also issued 10,000 shares of its $100 par value preferred stock to MHC to complete the transaction. MHC is owned 50% by Mr. Ergul and 50% by the RCJK Trust since February 9, 2015 when such was assigned to the trust by Mr. Ronald Durando. The historical carrying value of the building and underlying land as held by Edson and then MHC, $500,247, was recorded as the historical cost on the Company’s books as of March 6, 2013. The Company recorded liabilities in excess of basis of $2,268,729 in connection with this transfer treated for accounting purposes as a contribution of property, which is shown as a reduction of equity in the Statement of Changes in Stockholders’ Deficit during the fiscal year ended June 30, 2013.
Prior to March 6, 2013 the Company was a guarantor of the mortgage note by Edson to Capital One Bank as part of the terms of its former lease with Edson. The balance of this note at June 30, 2012 was $2,289,268 plus any adjustments for swap differences. The Company assumed this mortgage in connection with the transfer of the building to the Company treated for accounting purposes as a contribution of property discussed above and the balance at June 30, 2013 was $2,270,187. On November 22, 2013 this mortgage was satisfied together with all mortgage related obligations including adjustments for swap differences, when the building was sold to an unrelated third party. Amortization of deferred finance costs included in interest expense for this mortgage was $20,192 and $1,524 in 2014 and 2013, respectively.
The Company has some common management and common significant shareholders with mPhase Technologies, Inc. (“mPhase”) and had owned a total of 42,793,354 shares of this publicly traded company. Mr. Ergul had been the Chairman of the Board of mPhase from 1997 through 1999. Mr. Durando is the Chief Operating Officer and a Director of mPhase and has held those positions since 1997. These shares were valued at $38,514 as of June 30, 2012. These shares were valued at $55,632 as of June 30, 2013 and effective June 30, 2014 the shares were transferred to Mr. Ergul and Mr. Durando as partial payment of loans due to them by the Company. The transfer was valued at $34,235 based upon the closing trading price for these shares on that date. The Company realized a $60,033 loss on the disposition of these shares, $38,636 of which had previously been reserved for market value declines through June 30, 2013 and $21,397 was attributable to the year ended June 30, 2014.
Since July 1, 2014 the Company held no interest in any shares of mPhase common stock.
The Company sublet office space until March 31, 2015 and a vehicle in fiscal 2015 to mPhase. In fiscal 2015 the rent recorded was $13,500 for the office space and $9,000 for the vehicle. In fiscal 2014 the rent received was $20,090 for the office space.
As of June 30, 2016, 2015 and 2014 mPhase owed the Company $33,295, $28,045 and $16,183, respectively.
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Employment and Consulting Agreements
The Company has entered into employment and consulting contracts with Messrs. Ergul, Ashman, Ghadaksaz, Durando and Kelly.
Mr. Ergul entered into an employment agreement with the Company dated as of February 6, 2015 (the “Ergul Agreement”), pursuant to which Mr. Ergul will receive $225,000 per year in base compensation, in addition to certain benefits, for serving as the Company’s Chief Executive Officer. The term of the Ergul Agreement shall continue through February 1, 2018, and Mr. Ergul may receive severance for terminations under circumstances other than for Cause (as such term is defined therein). The Ergul Agreement contains provisions regarding indemnification, confidentiality and non-competition, among others.
Mr. Ashman entered into an employment agreement with the Company dated as of February 6, 2015, which was subsequently revised as of July 1, 2016 (the “Ashman Agreement”), pursuant to which Mr. Ashman will receive $165,000 per year in base compensation, in addition to certain benefits, for serving as the Company’s Chief Financial Officer. Mr. Ashman’s employment is “at will,” but Mr. Ashman would receive twelve months’ severance upon termination, subject to compliance with obligations there under. The Ashman Agreement contains provisions regarding indemnification, confidentiality and non-competition, among others.
Mr. Ghadaksaz entered into an employment agreement with the Company dated as of February 6, 2015 which was subsequently revised as of July 1, 2016 (the “Ghadaksaz Agreement”), pursuant to which Mr. Ghadaksaz will receive $175,000 per year in base compensation, in addition to certain benefits, for serving as the Company’s Chief Technology Officer and Chief Marketing Officer. Mr. Ghadaksaz’s employment is “at will,” but Mr. Ghadaksaz would receive twelve months’ severance upon termination, subject to compliance with obligations thereunder. The Ghadaksaz Agreement contains provisions regarding indemnification, confidentiality and non-competition, among others.
Mr. Durando entered into an employment agreement with the Company dated as of February 6, 2015 (the “Durando Agreement”), pursuant to which Mr. Durando will receive $225,000 per year in base compensation, in addition to certain benefits, for serving as the Company’s Strategic Advisor. The term of the Durando Agreement shall continue through February 1, 2018 and Mr. Durando may receive twelve months’ severance for terminations under circumstances other than for Cause (as such term is defined therein). The Durando Agreement contains provisions regarding indemnification, confidentiality and non-competition, among others.
The Company owed $80,000, $332,815, $503,471 and $415,552 to Mr. Ergul and to its former chief operating officer, Mr. Durando, as of June 30, 2016, 2015, 2014 and 2013, respectively.
Mr. Kelly entered into a consulting agreement with the Company dated as of June 8, 2008 (the “Kelly Agreement”), pursuant to which Mr. Kelly receives $192,000 per year in base compensation, in addition to certain benefits, for serving as the Company’s Contractual General Manager. The term of the Kelly Agreement was until September 30, 2017. The Kelly Agreement contains provisions regarding indemnification, confidentiality and non-competition, among others. Effective July 1, 2016 the Company entered into a modification of the consulting contract with Mr. Kelly through July 1, 2019. The updated contract includes base compensation of $192,000 per year with contract termination fees, comparable to the severance provisions for officers, and non-competition covenants.
Equity Lines of Credit
The Company has guaranteed to Edson, and Messrs. Durando and Ergul, its majority shareholders, the repayment of loan origination costs, interest charges and the principal in full, for an Equity Line of Credit with Wells Fargo Bank totaling up to $250,000, the proceeds of which the Company received a concurrent loan from Edson when the credit line was funded on August 15, 2008. Edson incurred approximately $3,200 loan origination costs. The credit line was secured by residential real estate owned by Edson at that time and payment has been guaranteed by Messrs. Durando and Ergul. In June 2010 the Company issued 2,532 shares of its preferred stock to Edson to secure repayment of the $250,000 plus costs incurred, agreeing to continue to pay interest charges and committing to repay the principal by March 2012. This agreement was extended through March 2013, and again through June 2014. On June 30, 2013 the balance was $244,362 which is shown as a reduction of equity in the Statement of Changes in Stockholders’ Deficit for the fiscal years ended June 30, 2013. In March, 2013 the Company agreed to assume the remaining balance owing by Edson and, effective June 30, 2014, indemnified Messrs. Durando and Ergul from any liability pertaining to this note, of $243,296 for the cancellation of 2,433 shares of its $100 par value preferred stock. The shares were reflected as not outstanding since March, 2010. The original proceeds under this credit line were $250,000 and the loan balance at 2014 was $243,296. As of June 30, 2016 & 2015 this line of credit has $250,000 available, secured by residential real estate owned by a former COO of the Company, of which $218,290 and $232,466 was outstanding, respectively, with an interest rate of 3.35%. Interest expense charged to operations on this loan amounted to $7,608 and $7,924 for the years ended June 30, 2016 and 2015 respectively.
Effective June 30, 2014 the Company has guaranteed to Mr. Ergul, the repayment of a second Equity Line of Credit, totaling $131,545, with Wells Fargo Bank, secured by his principal residence. The proceeds of this home equity loan were primarily used to fund loan advances to the Company by Mr. Ergul in recent fiscal years. The Company committed to pay interest charges and the principal in full for this obligation and recorded the assumption as a $100,000 reduction of loans and a $31,545 reduction of unpaid compensation due to Mr. Ergul. The original proceeds under this credit line were $150,000 and the balance at June 30, 2014 was $131,545. As of June 30, 2016 & 2015 this line of credit has $150,000 available, secured by the president’s principal residence, of which $101,003 and $119,531 is outstanding respectively, with an interest rate of 3.0%. The Company charged operations $3,332 and $4,105 for the years ended June 30, 2016 and 2015.
| 49 |
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Audit Fees
| (a) | The audit fees billed by our accounting firm of Rosenberg Rich Baker Berman & Company during fiscal years ended June 30, 2016 and June 30, 2015 were $65,000 and $92,120, respectively. |
Audit Related Services
| (b) | There were no fees for audit related services billed during the fiscal year ended June 30, 2016 and 2015, respectively. |
Tax Fees
| (c) | The aggregate fees billed by Rosenberg Rich Baker Berman & Company for tax compliance, advice and planning were $0 for the fiscal year ended June 30, 2016 and $0 for the fiscal year ended June 30, 2015. |
All other fees
| (d) | Rosenberg Rich Baker Berman & Company did not bill the Company for any products and services other than the foregoing during the fiscal years ended June 30, 2016 and June 30, 2015, respectively. |
| 50 |
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Form 10-K
(1)
MICROPHASE CORPORATION
INDEX TO FINANCIAL STATEMENTS
(2) Financial Statement Schedules None.
(3) The Exhibits filed with this Form 10-K or, where so indicated by footnote in the case of previously filed exhibits, incorporated by reference are as set forth below:
| 51 |
| Exhibit | ||
| Number | Description | |
| 3.1 | Amended and Restated Certificate of Incorporation, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 3.2 | Bylaws, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.1 | Loan and Security Agreement dated as of February 3, 2012, by and between Microphase Corporation and Gerber Finance, Inc., as amended, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.2 | Strategic Partnership between Microphase Corporation and Dynamac, Inc., incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.3 | Assumption of Mortgage Debt entered into as of January 22, 2015, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.4 | Employment Agreement by and between the Company and Necdet Ergul, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.5 | Employment Agreement by and between the Company and James Ashman, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.6 | Employment Agreement by and between the Company and Michael Ghadaksaz , incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.7 | Employment Agreement by and between the Company and Ron Durando, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.8 | Consulting Agreement by and between the Company and Brian Kelly, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.9 | Third Amendment to Condo Agreement, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.10 | Second Amendment to Condo Agreement, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.11 | Lease for 100 Trap Falls Lease Extension, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.12 | Amplitech Amendment Agreement, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.13 | Agreement with Dynamac, incorporated by reference to the Company’s Amendment No. 1 to Form 10, filed with the SEC on April 30, 2015 | |
| 10.14 | Purchase Agreement – Acquisition of Dynamac’s Proprietary Line of RF and Microwave Test & Measurement Products, entered into January 21, 2016, by and between Microphase Instruments, LLC and Dynamac, Inc., incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on January 27, 2016 | |
| 10.15 | Employment Agreement by and between the Company and James Ashman, dated July 1, 2016* | |
| 10.16 | Employment Agreement by and between the Company and Michael Ghadaksaz, dated July 1, 2016* | |
| 10.17 | Modification Agreement between the Company and Brian Kelly, dated June 30, 2016* | |
| 31.1 | Certification by the Principal Executive Officer of Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a) or Rule 15d-14(a)).* | |
| 31.2 | Certification by the Principal Financial Officer of Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a) or Rule 15d-14(a)).* | |
| 32.1 | Certification by the Principal Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* | |
| 32.2 | Certification by the Principal Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* | |
| 101.INS* | XBRL Instance Document | |
| 101.SCH* | XBRL Taxonomy Extension Schema Document | |
| 101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
| 101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document | |
| 101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |
| 101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
* Filed Herewith.
| 52 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Microphase Corporation
We have audited the accompanying consolidated balance sheets of Microphase Corporation as of June 30, 2016 and 2015, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for each of the years in the two year period ended June 30, 2016. Microphase Corporation’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Microphase Corporation as of June 30, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the two year period ended June 30, 2016, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that Microphase Corporation will continue as a going concern. As more fully described in the notes to the financial statements, the Company has suffered recurring losses from operations and has a working capital deficit as of June 30, 2016. These conditions raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Rosenberg Rich Baker Berman & Company
Somerset, New Jersey
October 3, 2016
| F-1 |
Consolidated Balance Sheets
| June 30, 2016 | June 30, 2015 | |||||||
| ASSETS | ||||||||
| CURRENT ASSETS | ||||||||
| Cash | $ | 81,224 | $ | 127,093 | ||||
| Accounts receivable, net of allowance of $5,000 June 30, 2016 and 2015 | 1,092,482 | 881,221 | ||||||
| Inventory | 872,014 | 852,015 | ||||||
| Due from related parties | 33,295 | 28,045 | ||||||
| Prepaid and other current assets | 63,742 | 38,906 | ||||||
| TOTAL CURRENT ASSETS | 2,142,757 | 1,927,280 | ||||||
| Property and equipment, net | 158,979 | 194,160 | ||||||
| OTHER ASSETS | ||||||||
| Cash – restricted | 100,000 | 100,000 | ||||||
| Intangible assets | 2,629,170 | 474,255 | ||||||
Marketable securities | 200,000 | 200,000 | ||||||
Deferred offering costs | 260,000 | — | ||||||
| Other assets-lease deposit | 43,479 | 43,479 | ||||||
| TOTAL OTHER ASSETS | 3,232,649 | 817,734 | ||||||
| TOTAL ASSETS | $ | 5,534,385 | $ | 2,939,174 | ||||
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||
| CURRENT LIABILITIES | ||||||||
| Credit Facility – Revolving Loan | $ | 1,474,129 | $ | 1,013,406 | ||||
| Accounts payable | 553,331 | 421,915 | ||||||
| Accrued expenses | 1,134,729 | 1,105,943 | ||||||
| Deferred Revenue & Customer Deposits | 117,800 | — | ||||||
| Notes Payable – Related Parties, current portion | 137,150 | 169,447 | ||||||
| Asset Acquisition Note Payable-current portion | 975,345 | 300,000 | ||||||
| Equity Lines of Credit-current portion | 38,132 | 351,997 | ||||||
| Other termed debts – current portion | 13,714 | 32,654 | ||||||
| TOTAL CURRENT LIABILITIES | 4,444,330 | 3,395,362 | ||||||
| Other termed debts, net of current portion | 26,975 | 40,689 | ||||||
| Notes Payable – Related Parties, net of current portion | 257,857 | 290,799 | ||||||
| Asset Acquisition Note Payable, net of current portion | 1,045,080 | — | ||||||
| Equity Lines of Credit, net of current portion | 281,161 | — | ||||||
| Deferred Lease Obligation | 81,189 | — | ||||||
| COMMITMENTS AND CONTINGENCIES | ||||||||
| STOCKHOLDERS’ DEFICIT | ||||||||
| 6% cumulative preferred stock, $100 par value, 200,000 shares authorized, 15,382, and 26,943 shares issued and outstanding on June 30, 2016 and 2015, respectively | 1,538,200 | 2,694,300 | ||||||
| Common stock, no par value 7,800,000 shares authorized, 6,200,789 and 4,775,306 shares issued and outstanding at June 30, 2016 and 2015, respectively | 9,367,133 | 6,976,533 | ||||||
| Additional Paid In Capital | 2,432,111 | 2,396,711 | ||||||
| Accumulated Deficit | (13,939,651 | ) | (12,855,220 | ) | ||||
| TOTAL STOCKHOLDERS’ DEFICIT | (602,207 | ) | (787,676 | ) | ||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT | $ | 5,534,385 | $ | 2,939,174 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-2 |
Consolidated Statements of Operations
| For the Fiscal Year Ended | ||||||||
| June 30, | ||||||||
| 2016 | 2015 | |||||||
| Revenues | $ | 9,121,307 | $ | 8,176,352 | ||||
| Cost of Sales | 5,294,017 | 4,557,285 | ||||||
| Gross Profit | 3,827,290 | 3,619,067 | ||||||
| Selling, General and Administrative Expenses (including non-cash stock related charges of $615,400 and $870,000 in Fiscal 2016 and 2015) | 3,413,733 | 3,678,133 | ||||||
| Engineering and Research expenses (including non-cash stock related charges of $0 and $80,000 in Fiscal 2016 and 2015) | 979,461 | 943,084 | ||||||
| Other Income (Loss) | (28,250 | ) | 19,023 | |||||
| Interest (Expense and Credit costs) net | (331,735 | ) | (264,015 | ) | ||||
| Loss From Operations | (925,889 | ) | (1,247,142 | ) | ||||
| (Loss) on Settlement of Liabilities (including $107,375 and $218,836 loss on settlement of liabilities with related parties in Fiscal 2016 and 2015) | (107,375 | ) | (223,866 | ) | ||||
| Net Income (Loss) before Income Taxes | (1,033,264 | ) | (1,471,008 | ) | ||||
| Income Taxes | (51,167 | ) | (7,300 | ) | ||||
| Net Income (Loss) | $ | (1,084,431 | ) | $ | (1,478,308 | ) | ||
| Preferred dividends declared and settled in common stock, including $164,913 loss on settlement of dividend payable | — | (659,649 | ) | |||||
| Net Income (Loss) available to common shareholders | $ | (1,084,431 | ) | $ | (2,137,957 | ) | ||
| Basic & Diluted Net income (loss) per share: | $ | (0.20 | ) | $ | (0.51 | ) | ||
| Weighted Average Number of Shares Outstanding: | ||||||||
| Basic & Diluted | 5,337,519 | 4,233,158 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-3 |
Consolidated Statement of Changes in Stockholders’ Deficit
For the Two Years Ended June 30, 2016
| Additional | |||||||||||||||||||||||||||
| Preferred Stock | Common Stock | Paid In | Accumulated | ||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Deficit | Amount | |||||||||||||||||||||
| Balance, June 30, 2014 | 23,543 | $ | 2,354,000 | 3,475,366 | $ | 4,553,168 | $ | 2,284,511 | $ | (10,717,263 | ) | $ | (1,525,284 | ) | |||||||||||||
| Issuance of Common Stock in Private Placements, including 68,782 of finder shares and net of $31,450 costs | 311,782 | 447,050 | 447,050 | ||||||||||||||||||||||||
| Conversion of strategic payables into common stock including loss on settlement of liabilities of $5,000 | 10,000 | 20,000 | 20,000 | ||||||||||||||||||||||||
| Conversion of related party loans into common stock including loss on settlement of liabilities of $106,666 | 213,333 | 426,666 | 426,666 | ||||||||||||||||||||||||
| Conversion of related party loans into preferred stock including loss on settlement of liabilities of $59,400 | 1,800 | 180,000 | 59,400 | 239,400 | |||||||||||||||||||||||
| Conversion of unpaid compensation into preferred stock including loss on settlement of liabilities of $52,800 | 1,600 | 160,000 | 52,800 | 212,800 | |||||||||||||||||||||||
| Issuance of Common Stock for Services | 435,000 | 870,000 | 870,000 | ||||||||||||||||||||||||
| Preferred stock dividend declared on preferred shares held through September 30, 2014 paid in common stock including loss on settlement of dividend payable of $164,913 | 329,825 | 659,649 | (659,649 | ) | — | ||||||||||||||||||||||
| Net Loss For the Year Ended June 30, 2015 | (1,478,308 | ) | (1,478,308 | ) | |||||||||||||||||||||||
| Balance, June 30, 2015 | 26,943 | $ | 2,694,300 | 4,775,306 | $ | 6,976,533 | $ | 2,396,711 | $ | (12,855,220 | ) | $ | (787,676 | ) | |||||||||||||
| Conversion of preferred stock into Common Stock | (11,561 | ) | 1,156,100 | 770,733 | 1,156,100 | — | |||||||||||||||||||||
| Issuance of common stock and options for services | 290,000 | 580,000 | 35,400 | 615,400 | |||||||||||||||||||||||
| Conversion of loans and unpaid compensation to president into common stock including loss on settlement of liabilities with related party of $107,375 | 214,750 | 429,500 | 429,500 | ||||||||||||||||||||||||
| Issuance of Common Stock and warrants in Private Placements, including 25,000 of finder shares valued at $50,000 and net of $25,000 costs | 150,000 | 225,000 | 225,000 | ||||||||||||||||||||||||
| Net Loss For the Year Ended June 30, 2016 | (1,084,431 | ) | (1,084,431 | ) | |||||||||||||||||||||||
| Balance, June 30, 2016 | 15,382 | $ | 1,538,200 | 6,200,789 | $ | 9,367,133 | $ | 2,432,111 | $ | (13,939,651 | ) | $ | (602,207 | ) | |||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-4 |
Consolidated Statements of Cash Flows
| For The Years Ended | ||||||||
| June 30, | ||||||||
| 2016 | 2015 | |||||||
| Cash Flow Used In Operating Activities: | ||||||||
| Net Loss From Operations | $ | (1,084,431 | ) | $ | (1,478,308 | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Depreciation and amortization | 97,893 | 89,977 | ||||||
| Non-cash charges relating to issuance of common stock for services | 615,400 | 870,000 | ||||||
| Realized loss from the sale of fixed assets | — | (11,010 | ) | |||||
| Loss on Settlement of Liabilities | 107,375 | 223,866 | ||||||
| Changes in assets and liabilities: | ||||||||
| Accounts receivable | (211,261 | ) | 21,979 | |||||
| Inventories | (19,999 | ) | (94,333 | ) | ||||
| Other current assets | (24,836 | ) | 105,927 | |||||
| Other assets-lease deposit | — | (43,479 | ) | |||||
| Deferred Rent | 81,189 | - | ||||||
| Accounts payable | 131,416 | (2,343 | ) | |||||
| Accrued Expenses | 38,592 | 347,515 | ||||||
| Customer deposits | 117,800 | (113,910 | ) | |||||
| Due to/from related parties mPhase & Edson Realty | (5,250 | ) | (3,006 | ) | ||||
| Net cash used in operating activities | $ | (156,112 | ) | $ | (87,125 | ) | ||
| Cash Flow Used in Investing Activities: | ||||||||
| Investments in common stock | — | (200,000 | ) | |||||
| Purchase of intangible assets | (450,000 | ) | (50,000 | ) | ||||
| Purchase of fixed assets | (47,202 | ) | (14,170 | ) | ||||
| Proceeds from the sale of fixed assets | — | 11,010 | ||||||
| Net Cash used in investing activities | $ | (497,202 | ) | $ | (253,160 | ) | ||
| Cash Flow Provided by Financing Activities: | ||||||||
| Proceeds from issuance of common stock | 225,000 | 447,050 | ||||||
| Proceeds from revolving credit facility (net) | 460,723 | 88,102 | ||||||
| Payments of equity lines of credit | (32,704 | ) | (22,844 | ) | ||||
| Payments of long-term debt | (12,623 | ) | (9,191 | ) | ||||
| Payments on acquisition notes | — | (360,000 | ) | |||||
| Payments of capital lease obligations | (12,061 | ) | (17,245 | ) | ||||
| Payments to related parties | (37,920 | ) | (95,992 | ) | ||||
| Advances from related parties | 25,000 | — | ||||||
| Payments of extended term arrangement | (7,970 | ) | (7,582 | ) | ||||
| Net cash provided by financing activities | $ | 607,445 | $ | 22,298 | ||||
| Net decrease in cash | $ | (45,869 | ) | $ | (317,987 | ) | ||
| CASH, beginning of period | $ | 127,093 | $ | 445,080 | ||||
| CASH, end of period | $ | 81,224 | $ | 127,093 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-5 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 1 — RECENT LOSSES AND MANAGEMENTS PLANS:
The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern. However as of June 30, 2016 and 2015 and for the years then ended, the Company reported a net loss from operations of $925,889 and $1,247,142 respectively and net cash used in operations totaled $156,112 and $87,125 respectively. The Company also had negative working capital of $2,301,573 and $1,468,082 at June 30, 2016 and 2015 respectively. Further, the Company anticipates that it will experience negative cash flows from operations for fiscal 2017. These matters raise substantial doubt about the Company’s ability to continue as a going concern.
The Company plans on continuing financing operations through its debt facility with Gerber Financial, the issuance of debt to management, the settlement of debts for equity, and the sale of common and preferred securities though private placements, until such time it can complete its initial public offering, when and if declared effective, as described in its registration statement and impending amendment(s) on Form S-1, during the second quarter of fiscal 2017. The Company also continues to boost efforts to increase the sales of its traditional RF and DLVA business and anticipates the product growth plan to include the launch of its initial T&M products by the later portion of fiscal 2017 implementing the assets acquired from Dynamac in January 2016. Management has also taken steps in fiscal 2016 to contain operating expenses, including a reduction in the number of employees, primarily by consolidating all of its traditional design to manufacture RF and DLVA business into the Shelton, Connecticut location. The Company has expanded its facility in square footage and utility as such to house both our traditional RF and DLVA business, and enable the launch and delivery of its initial T&M products.
Management believes that these steps will permit the Company to maintain the continuation of our traditional operations, and should we become further capitalized, allow us to implement our product growth plan, which we believe will enable the Company to achieve and maintain a level of operations which generates sustainable profitability and to continue as a going concern. However there can be no assurance that this will be the case.
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(A) Microphase Corporation is a design to manufacture original equipment manufacturer (OEM) industry leader delivering world-class radio frequency (RF) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (DLVA) to the military, aerospace and telecommunications industries. Sales to military markets represent 100% of sales. The Company had two manufacturing facilities, one in Shelton, Connecticut and one in Folsom, California during Fiscal 2016 and 2015. Effective August 2016, the Company consolidated all of its operations to the Shelton, Connecticut location. See Note 13 for further details.
(B) PROPERTY AND EQUIPMENT — Stated at cost. Provision for depreciation and amortization is made by annual charges to operations principally under the following methods and estimated useful lives:
| Method | Years | ||
| Property held under capital leases | Straight Line | 5 | |
| Furniture and fixtures | Straight Line | 7 | |
| Machinery and equipment | Straight Line | 5 | |
| Computer equipment | Straight Line | 3 | |
| Transportation equipment | Straight Line | 5 | |
| Leasehold improvements | Straight Line | 7 |
MAINTENANCE AND REPAIRS — Charged to expenses as incurred. Cost of major replacements and renewals are capitalized. Upon retirement or other disposition of equipment and improvements, the cost and related depreciation is removed from the accounts, and any gain or loss is recognized in income.
| F-6 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: – (continued)
(C) OTHER LONG LIVED ASSETS — The Company reviews long-term assets for impairment whenever events or circumstances indicate that the carrying amount of those assets may not be recoverable. The Company also assesses these assets for impairment based on their future cash flows. Management has determined that there was no impairment charge to be recorded for the years ended 2016 and 2015.
(D) INVENTORIES — are stated at the lower of average cost or market under the first-in, first-out method. The Company regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory to insure that the net realizable value exceeds the carrying cost of the inventory.
(E) ACCOUNTS RECEIVABLE — Management records receivables at net realizable value and they generally do not bear interest. This value includes an allowance for estimated uncollectible accounts to reflect any loss anticipated on the accounts receivable balances which is charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, level of past due accounts and economic status of the customers. We consider a receivable delinquent if it is unpaid after 180 days after it is due.
(F) ACCOUNTING ESTIMATES — Management uses estimates and assumptions in preparing financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could vary from the estimates that were assumed in preparing the financial statements.
(G) COMPENSATED ABSENCES — Employees of the Company are entitled to vacation pay depending on length of service and current salary. Vacation days accrued in a given year are available in the following year. A limit of 5 days of unused vacation may be carried over to a subsequent following year. The Company has provided for vacation liabilities in the accompanying financial statements.
(H) RESEARCH AND DEVELOPMENT EXPENSES — The Company charges the cost of research and development to operations.
(I) REVENUE RECOGNITION — The Company recognizes revenues when persuasive evidence of an arrangement exists, the product has been shipped, the price is fixed and collectability is reasonably assured, and title passes to the customer. Revenue is recognized net of estimated sales returns and allowances.
(J) PRINCIPLES OF CONSOLIDATION — The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries which include Microphase West LLC, as of June 27, 2013, and Microphase Instruments, LLC, as of October 23, 2015. All intercompany accounts and transactions have been eliminated.
(K) EARNINGS (LOSS) PER SHARE — Basic earnings (loss) per share (“EPS”) is determined by dividing the net earnings (loss) by the weighted-average number of shares of common shares outstanding during the period. Diluted EPS is determined by dividing net earnings (loss) by the weighted average number of common shares used in the basic EPS calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive securities (such as stock options, preferred stock subsequent to October 4, 2014, and convertible securities) outstanding under the treasury stock method.
As of June 30, 2016 we have outstanding (i) options to purchase 75,000 shares, (ii) 15,382 shares of preferred stock convertible into 1,025,467 shares, (iii) $395,007 of debts to related parties convertible into 263,338 shares, and (iv) warrants to purchase 125,000 shares of our Common stock. In periods reporting a loss, the inclusion of warrants and potential common shares to be issued in connection with convertible debt and convertible securities, which would have an anti-dilutive effect on diluted loss per share, have been omitted in such computation.
| F-7 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: – (continued)
(L) BUSINESS CONCENTRATIONS AND CREDIT RISK — The Company’s customers are predominately prime contractors in the military, aerospace and telecommunications industries. The Company has material sales and accounts receivable with Major Customers (see note 15).Throughout the year, cash balances that the Company maintains at financial institutions may exceed the Federal Deposit Insurance Corporation insurance limitation of up to $250,000. Cash balances did not exceed FDIC insured limits throughout the years ended June 30 2016 and 2015.
(M) MARKETABLE SECURITIES AND OTHER INVESTMENTS — Marketable equity securities included in marketable securities (current) and other investments (non-current) are stated at the lower of cost or market in the aggregate. Other marketable securities included in marketable securities (current) are stated at the lower of cost or market in the aggregate and investments other than marketable equity securities in other investments (non-current) are stated at cost less any significant decline in fair value assessed to be other than temporary. Realized gains and losses on the sale of securities are based on the average cost of all the units of a particular security held at the time of sale.
(N) RECLASSIFICATIONS — Certain prior year amounts have been reclassified in our Condensed Consolidated Financial Statements to conform to current year classifications
(O) Deferred Offering Costs - At June 30, 2016 the Company has $260,000 in deferred offering costs directly associated with its impending initial public offering. At June 30, 2015 the Company had $0 deferred costs.
(P) RECENT ACCOUNTING PRONOUNCEMENTS
The Company is evaluating several pronouncements issued by the FASB which may result in the adoption by the Company of these standards in upcoming accounting periods as follows:
ADOPTION OF NEW ACCOUNTING STANDARDS —
In April 2014, the FASB issued an accounting standards update that raises the threshold for disposals to qualify as discontinued operations and allows companies to have significant continuing involvement and continuing cash flows with discontinued operations. This standard also requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. This standard is to be applied prospectively and is effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2014, which for us is our fiscal 2016. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The adoption of this standard for Fiscal Year Ended June 30, 2016 did not have a material impact on our financial position, results of operations or cash flows.
In the first quarter of fiscal 2016, we adopted an accounting standard issued by the Financial Accounting Standards Board (“FASB”) that eliminates the requirement for an acquirer in a business combination to retrospectively account for measurement-period adjustments. Instead, the new guidance requires that the cumulative impact of a measurement-period adjustment (including the impact on prior periods) be recognized in the reporting period in which the adjustment is identified. This standard is to be applied prospectively. The adoption of this standard for Fiscal Year Ended June 30, 2016 did not have a material impact on our financial position, results of operations or cash flows.
In the second quarter of fiscal 2016, we adopted an accounting standard issued by the FASB that simplifies the presentation of deferred income taxes by requiring entities to classify all deferred tax assets and liabilities as non-current in a classified statement of financial position instead of separating deferred tax assets and liabilities into current and non-current amounts. Consequently, entities may no longer allocate valuation allowances between current and non-current deferred tax assets because those allowances also will be classified as non-current. This standard was applied retrospectively, and as a result, no reclassifications were required.
| F-8 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: – (continued)
ACCOUNTING STANDARDS ISSUED BUT NOT YET EFFECTIVE —
The Company is evaluating several pronouncements issued by the FASB which may result in the adoption by the Company of these standards in upcoming accounting periods as follows:
On April 7, 2015, the FASB issued Accounting Standards Update 2015-03, Interest — Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires entities to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability. The guidance in Update 2015-03 (see below) does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. Given the absence of authoritative guidance within Update 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement to be effective for Fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015; which for us is our fiscal 2017. We are currently evaluating the impact this standard, if any, will have on our financial position, results of operations and cash flows.
Compensation Stock-Compensation (Topic 718): Accounting for Share Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) to be effective for Annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2015; which for us would be our fiscal 2017. We are currently evaluating the impact this standard, if any, will have on our financial position, results of operations and cash flows.
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date-In May 2014, the FASB issued a comprehensive new revenue recognition standard that supersedes nearly all revenue recognition guidance under U.S. GAAP and supersedes some cost guidance for construction-type and production-type contracts. The guidance in this standard is principles-based, and accordingly, entities will be required to use more judgment and make more estimates than under prior guidance, including identifying contract performance obligations, estimating variable consideration to include in the contract price and allocating the transaction price to separate performance obligations. The guidance in this standard is applicable to all contracts with customers, regardless of industry-specific or transaction-specific fact patterns. Additionally, this standard provides guidance for transactions that were not previously addressed comprehensively (e.g., service revenue, contract modifications and licenses of intellectual property) and modifies guidance for multiple-element arrangements. The core principle of this standard is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. To help financial statement users better understand the nature, amount, timing and potential uncertainty of the revenue that is recognized, this standard requires significantly more interim and annual disclosures. This standard allows for either “full retrospective” adoption (application to all periods presented) or “modified retrospective” adoption (application to only the most current period presented in the financial statements, as well as certain additional required footnote disclosures). On July 9, 2015, the FASB approved a one-year deferral of the effective date, while permitting entities to elect to adopt one year earlier on the original effective date. As a result, this standard is now effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2017, which for us is our fiscal 2019. We are currently evaluating the impact this standard, if any, will have on our financial position, results of operations and cash flows.
| F-9 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: – (continued)
ASU 2015-11 — Inventory (Topic 330): Simplifying the Measurement of Inventory. For public business entities, the pending content that links to this paragraph shall be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, which for us is our fiscal 2018. We are currently evaluating the impact this standard will have on our financial position, results of operations and cash flows.
In February 2016, the FASB issued a new lease standard that supersedes existing lease guidance under GAAP. This standard requires lessees to record most leases on their balance sheets but recognize expenses on their income statements in a manner similar to existing lease guidance under GAAP. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, with the option to use certain relief. Full retrospective application is prohibited. This standard is effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2018, which for us is our fiscal 2020. We are currently evaluating the impact this standard will have on our financial position, results of operations and cash flows.
ASU 2014-15 — Presentation of Financial Statements Going Concern (Subtopic 20540): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern to be effective for Annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016; which for us would be our fiscal 2017 and although early adoption is permitted for this standard, the Company has not adopted nor determined its applicability.
In March 2016, the FASB issued an accounting standards update making final targeted amendments to the accounting for employee share-based payments. These amendments will require entities to recognize the income tax effects of awards when the awards vest or are settled, will change an employer’s accounting for an employee’s use of shares to satisfy the employer’s statutory income tax withholding obligation and will require entities to elect whether to account for forfeitures of share-based payments by either recognizing forfeitures of awards as they occur or estimating the number of awards expected to be forfeited as is currently required. The required method of adoption varies by amendment. This accounting standards update is effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2016, which for us is our fiscal 2018. Early adoption is permitted in any annual or interim period, but all of the guidance is required to be adopted in the same period and any adjustments must be reflected as of the beginning of the fiscal year. We are currently evaluating the impact this accounting standards update will have on our financial position, results of operations and cash flows.
| F-10 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: – (continued)
SUPPLEMENTAL CASH FLOW INFORMATION
| For The Years Ended | ||||||||
| June 30, | ||||||||
| 2016 | 2015 | |||||||
| Statement of Operation Information: | ||||||||
| Cash paid for state taxes | $ | 45,661 | $ | 7,050 | ||||
| Interest Paid (net interest income) | $ | 270,600 | $ | 249,333 | ||||
| Non Cash Investing and Financing Activities: | ||||||||
| Assets acquired with debt financing | $ | 1,720,425 | $ | 300,000 | ||||
| Conversion of $15,000 of strategic payables into common stock with beneficial conversion feature interest of $5,000 | $ | — | $ | 20,000 | ||||
| Conversion of $320,000 of related party loans, including $21,043 accrued interest thereon, into 213,333 shares of common stock with beneficial conversion feature interest of $106,666 | $ | — | $ | 426,666 | ||||
| Conversion of $180,000 of related party loans into 1,800 shares of preferred stock with beneficial conversion feature interest of $59,400 | $ | — | $ | 239,400 | ||||
| Conversions of $160,000 of unpaid compensation into 1,600 shares of preferred stock with beneficial conversion feature interest of $52,800 | $ | — | $ | 212,800 | ||||
| Preferred stock dividend, declared on preferred shares held through September 30, 2014, of $494,736 paid through the issuance of 329,825 shares of common stock with beneficial conversion feature interest of $164,913 | $ | — | $ | 659,649 | ||||
| Conversion of 11,516 shares of preferred stock into 770,733 shares of common stock | $ | 1,156,100 | $ | — | ||||
| Conversion of $252,815 of unpaid compensation into 168,550 shares of common stock with beneficial conversion feature interest of $84,272 | $ | 337,087 | $ | — | ||||
| Conversion of $69,310 of related party loans, including $39,366 accrued interest thereon, into 46,200 shares of common stock with beneficial conversion feature interest of $23,103 | $ | 92,413 | $ | — | ||||
| Accrued Deferred Offering Costs | $ | 260,000 | $ | — | ||||
NOTE 3 — INVENTORIES
Inventories consist of the following:
| June 30, | ||||||||
| 2016 | 2015 | |||||||
| Amount | Amount | |||||||
| Raw materials | $ | 423,670 | $ | 402,761 | ||||
| Work-in-process | 485,344 | 486,254 | ||||||
| Reserve | (37,000 | ) | (37,000 | ) | ||||
| Total | $ | 872,014 | $ | 852,015 | ||||
The inventory reserve remained at $27,000 in our west division during the years ended June 30, 2016 and 2015. The inventory reserve remained at $10,000 in our east division during the years ended June 30, 2016 and 2015.
| F-11 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
Note 4 — PROPERTY AND EQUIPMENT:
Property and equipment was comprised of the following:
| June 30, | ||||||||
| 2016 | 2015 | |||||||
| Amount | Amount | |||||||
| Leasehold Improvements | $ | 40,288 | $ | 8,290 | ||||
| Computers, machinery & equipment | 3,210,147 | 3,194,943 | ||||||
| Furniture and fixtures | 122,350 | 122,350 | ||||||
| Transportation equipment | 40,438 | 40,438 | ||||||
| Property held under capital leases | 56,013 | 56,013 | ||||||
| 3,469,236 | 3,422,034 | |||||||
| Less: accumulated depreciation and amortization | (3,310,257 | ) | (3,227,874 | ) | ||||
| Total | $ | 158,979 | $ | 194,160 | ||||
Depreciation expense was $82,382 and $74,466 in 2016 and 2015, respectively.
NOTE 5 — ACCRUED EXPENSES:
Accrued expenses were comprised of the following:
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
| Salaries, wages and other compensation, including $80,000 and $332,815 to related parties at June 30, 2016 and 2015. | $ | 470,273 | $ | 678,729 | ||||
| Royalties | 146,449 | 190,924 | ||||||
| Professional fees | 372,500 | 135,000 | ||||||
| Commissions | 37,936 | 37,936 | ||||||
| Interest | 47,144 | 0 | ||||||
| Other miscellaneous accruals | 60,427 | 63,354 | ||||||
| $ | 1,134,729 | $ | 1,105,943 | |||||
401 (K) Employee Benefit Plan:
The Company sponsors a 401(K) plan for all eligible employees. Employee contributions are based on a percentage of compensation. Employer contributions for both matching and profit sharing are discretionary and determined annually by management. For the years ended June 30, 2016 and 2015, there were no employer contributions to the plan. At June 30, 2016 & 2015 the Company owed no amounts to the 401 K Plan.
Deferred Lease Obligation
At June 30, 2016 the Company has $81,189 of deferred lease obligation associated with the amendment in May of 2016 for its long term lease on the Shelton Connecticut facility.
| F-12 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 6 — FAIR VALUE OF FINANCIAL INSTRUMENTS:
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Quoted market prices are used to establish fair value when they are available and other valuation techniques are utilized to estimate the fair value of financial instruments that do not have quoted market prices.
The Company has long term debt with fixed interest rates, the carrying amount of which may be different from fair value as of June 30, 2016 and 2015. The Company decided that it is not practical to estimate the fair value of these financial instruments on the basis that they are held-to-maturity debts which have no immediately available market information on the fair value and the cost of making assumptions and applying estimation methodologies to assess the fair value estimates exceeds the benefit. Information pertinent to estimating the fair value such as carrying amount, effective interest rate, maturity and repayment term are disclosed in Notes 7 through 11 and summarized in Note 13.
The Company has applied the fair value concepts to its available-for-sale securities. As such, the valuation techniques used to measure fair value is based on the source of the data used to develop the prices. The priority of these sources is defined as follows:
Level 1 — quoted prices in active markets.
Level 2 — other than quoted prices that are directly or indirectly observable.
Level 3 — unobservable inputs for the asset or liability.
Marketable securities, classified as available-for-sale securities, are measured at the lower of original cost or fair market value’ which we consider at this time to fall into (Level 1); on a recurring basis:
As of June 30, 2016 and 2015, this amounted to $200,000 and $200,000.
These are the result of our investment in AmpliTech Group Inc. On July 9, 2014 Microphase executed a securities purchase agreement with AmpliTech Group Inc. of Bohemia, N.Y. to purchase, as amended, 8,666,666 AmpliTech common shares at $0.023 per share for a total purchase price of $200,000.
| F-13 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 7 — REVOLVING CREDIT LINE:
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
The Company entered into a revolving loan agreement with Gerber Finance, Inc. (Gerber) in February of 2012 for a maximum of $1,500,000, which was amended to $1,150,000 in November of 2013 and then increased to $1,400,000 in September 2015. Under this agreement, the Company can receive funds based on a borrowing base, which consists of various percentages of accounts receivable, inventory, a restricted cash account held by Gerber, and equipment., In connection with this agreement, the Company is subject to an annual facility fee (1.75%) on each anniversary, monthly collateral monitoring fees of $1,500 and other fees, plus interest at the rate of 7% through June 30, 2015. As of June 30, 2016 this line has a limit of $1,400,000 and the interest is currently at the base rate of 7.25%. For the months of March through June 2016, we incurred an additional 2.5% interest charge on over-advance amounts that exceeded the collateral borrowing base and briefly (less than one week) a separate additional interest charge of 2.5% for exceeding the line limit of $1,400,000. This excess utilization was eliminated in early July 2016. | $ | 1,474,129 | $ | 1,013,406 | ||||
The interest expense for 2016 and 2015 was $168,237 and $128,772, and the fees for 2016 and 2015 were $41,734 and $26,385, respectively. The effective interest rate for 2016 and 2015 was 11.54% & 15.29%, respectively.
There are financial covenants set forth in the Gerber agreement of February 3, 2012 and as amended on February 24, 2012. As of June 30, 2016 the Company was not in compliance with three financial covenants regarding minimum levels of net worth, net income and subordinated debt. The Company has not received a notice of default from Gerber regarding these covenants.
Approximate Value of collateral at balance sheet dates —
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
| Amount | Amount | |||||||
| Inventories | $ | 872,014 | $ | 852,015 | ||||
| Accounts Receivable | 1,092,482 | 881,221 | ||||||
| Total Collateral | $ | 1,964,496 | $ | 1,733,236 | ||||
| F-14 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 8 — NOTES PAYABLE — RELATED PARTIES:
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
| Officers and Stockholders: | ||||||||
| Payable in monthly payments of $2,000 as revised, including interest at 6% through September, 2017, of which $180,000 was converted into 1,800 shares of preferred stock during Fiscal Year Ended June 30, 2015. On March 31, 2016, the balance together with accrued interest which totaled $69,421 was converted into 46,280 common stock shares at a $1.50 per share conversion rate. | $ | — | $ | 44,258 | ||||
| Former Employee: | ||||||||
| Note payable to a Note Holder formerly employed by the Company, payable in monthly payments of $7,600 as revised in November, 2015, with interest at 6% until paid in full. This Note Holder subordinated his debts to the revolving line discussed in Note 7, in February 2012, and converted $170,000 of his debt into 113,333 shares of common stock during the Fiscal Year Ended June 30, 2015. During the current fiscal year the Company has sought to revise the payment schedule with Note Holder and to date the parties have not agreed to a revised repayment schedule and the note is in arrears. In May 2016, this lender initiated a Notice of Default and Demand for Payment, and in July 2016 the Note Holder initiated litigation to collect this debt in full. While the Company still seeks a mutually agreeable settlement on amicable terms the Company believes this debt will be settled for an amount substantially the same as recorded in the financial statement. | $ | 152,434 | $ | 168,599 | ||||
| Stockholders: | ||||||||
| Two notes previously payable to individuals with monthly payments of $2,715 and $2,750 as revised, including interest at 6% through September, 2017. In January 2016, these two notes and loan amortization schedules were revised with monthly payments of $910 and $980 respectively, including interest at 3% through August 2019. The monthly payment amounts increase by $130 and $140 respectively every 4 months, per the revised schedule. | $ | 118,762 | 121,140 | |||||
| Other Related Parties: | ||||||||
| Previously payable to this individual in monthly payments of $875 as revised, including interest at 6% through September, 2017. In January 2016, this note & loan amortization schedule was revised with a monthly payment of $280, including interest at 3% through August 2019. The monthly payment amount increases by $40 every 4 months, per the revised schedule. | $ | 18,754 | 19,058 | |||||
| Two notes previously payable to two individuals with identical monthly payments of $2,425 each as revised, including interest at 6% through April, 2017. In January 2016, these two notes & loan amortization schedules were revised with monthly payments of $840 each, including interest at 3% through August 2019. The monthly payment amount increases by $120 every 4 months, per the revised schedule. | $ | 105,057 | 107,191 | |||||
| Total | 395,007 | 460,246 | ||||||
| Less: current portion | (137,150 | ) | (169,447 | ) | ||||
| Long-term portion | $ | 257,857 | 290,799 | |||||
At June 30, 2016 the maturities of notes payable — related parties for each of the next five years & thereafter are as follows:
| June 30, | ||||
| 2017 | $ | 137,150 | ||
| 2018 | 118,645 | |||
| 2019 | 104,112 | |||
| 2020 | 35,100 | |||
| Total | $ | 395,007 | ||
Interest expense charged to operations on these loans amounted to $21,662 and $36,085 for the years ended June 30, 2016 and 2015, respectively. The Company and the note holders (except for the former employee as discussed above) have agreed to revised repayment schedules for 42 months commencing December 2015. As of June 30, 2016, the Company is in arrears on one payment of the revised repayment schedules for each of the note holders.
| F-15 |
MICROPHASE
CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 9 — OTHER TERMED DEBTS:
Other termed debts consist of: (i) Long-term Debt, (ii) Capital Leases, & (iii) Extended Payment Arrangements.
| Long-term Debt: | June 30, | June 30, | ||||||
| 2016 | 2015 | |||||||
| People’s General Bank | ||||||||
| Overdraft protection credit line loan; up to $20,000 available at June 30, 2015, with minimum payments based upon a twenty four month payout from most recent utilization, or $215 plus interest at June 30, 2015. Microphase paid this loan off in the 2nd quarter of fiscal 2016. | $ | — | $ | 7,542 | ||||
| Ford Credit Company: | ||||||||
| Payable in monthly payments of $499, including interest at 4.90% through April, 2019 secured by transportation equipment. | $ | 15,823 | $ | 20,904 | ||||
| $ | 15,823 | $ | 28,446 | |||||
| Less: current portion | (5,336 | ) | (12,623 | ) | ||||
| Total | $ | 10,487 | $ | 15,823 | ||||
The Company charged operations $1,309 and $2,612 in interest on these loans for the years ended June 30, 2016 and 2015, respectively.
Capital Leases:
The Company is the lessee of equipment under capital leases expiring through March, 2016. The assets are recorded at the fair market value as of the date of the leases. The assets are amortized over their estimated productive lives. Amortization is included in depreciation expense.
| The following is a summary of property held under capital leases: | June 30, | June 30, | ||||||
| 2016 | 2015 | |||||||
| Property held under capital leases | $ | 56,013 | $ | 56,013 | ||||
| Less: accumulated amortization | (49,478 | ) | (38,276 | ) | ||||
| Net property under capital leases | $ | 6,535 | $ | 17,737 | ||||
| The following is a summary of balances due under capital leases: | June 30, | June 30, | ||||||
| 2016 | 2015 | |||||||
| Total minimum lease payments | $ | - | $ | 12,510 | ||||
| Less: amount representing interest | - | (449 | ) | |||||
| Present value of net minimum lease payments | - | 12,061 | ||||||
| Less: current portion | - | (12,061 | ) | |||||
| Long-term portion | $ | — | $ | — | ||||
Interest expense charged to operations under capital leases was $567 and $2,215 for the years ended June 30, 2016 and 2015, respectively.
| F-16 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 9 — OTHER TERMED DEBTS: – (continued)
Extended Payment arrangements:
The Company is responsible for paying a former employee, disability benefits under a prior self-insured plan, through April, 2019. The plan requires monthly payments until the participant attains age 65. Interest has been imputed on this obligation at 5%.
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
| Total of extended disability benefits | $ | 26,327 | $ | 36,152 | ||||
| Less: amount representing interest | (1,461 | ) | (3,316 | ) | ||||
| Present value of disability benefits | 24,866 | 32,836 | ||||||
| Less: current portion | (8,378 | ) | (7,970 | ) | ||||
| Long-term portion | $ | 16,488 | $ | 24,866 | ||||
Interest expense charged to operations for the extended disability payments was $1,461 and $1,849 in 2016 and 2015, respectively.
| Summary totals for Other termed debts consisting of: | ||||||||
| (i) Long-term Debt, (ii) Capital Leases, & (iii) Extended Payment Arrangements. | ||||||||
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
| Total minimum long term debt, capital lease & extended disability payments | $ | 40,689 | $ | 73,343 | ||||
| Less: current portion | (13,714 | ) | (32,654 | ) | ||||
| Long-term portion | $ | 26,975 | $ | 40,689 | ||||
At June 30, 2016 the maturities of all other termed debts for each of the next five years & thereafter are as follows:
| June 30, | ||||
| 2017 | 13,714 | |||
| 2018 | 14,410 | |||
| 2019 | 12,565 | |||
| Total minimum long term debt, capital lease & extended disability payments | $ | 40,689 | ||
NOTE 10 — EQUITY LINES OF CREDIT:
The Company had previously guaranteed the payment of an Equity Line of Credit with Wells Fargo Bank totaling up to $250,000, the proceeds of which the Company received from a concurrent loan from Edson when the credit line was funded on August 15, 2008 discussed further in Note 14. In June 2014 the Company agreed to assume the remaining balance of $243,257 for the cancellation of 2,433 shares of its $100 par value preferred stock. As of June 30, 2016 & 2015 this line of credit has $250,000 available, secured by residential real estate owned by a former COO of the Company, of which $218,290 and $232,466 was outstanding, respectively, with an interest rate of 3.35%. Interest expense charged to operations on this loan amounted to $7,608 and $7,924 for the years ended June 30, 2016 and 2015 respectively.
Effective June 30, 2014 the Company also has guaranteed to its President and a general member of MHC, the repayment of a second Equity Line of Credit with Wells Fargo Bank as also discussed further in Note 14. As of June 30, 2016 & 2015 this line of credit has $150,000 available, secured by the president’s principal residence, of which $101,003 and $119,531 is outstanding respectively, with an interest rate of 3.0%. Interest expense charged to operations on this loan amounted to $3,332 and $4,105 for the years ended June 30, 2016 and 2015.
| F-17 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 11 — ACQUIRED INTANGIBLE ASSETS & ACQUISITION NOTES PAYABLE:
The Company acquired certain assets including specific inventory and fixed assets from a RF services provider, Microsemi Corp-RF Integrated Solutions (“Microsemi”); which had eliminated providing certain RF services similar to that of the Company for approximately 10 customers. The acquisition was pursuant to a contract, originally dated March 27, 2013, which provided for a $100,000 down payment and a note payable for $650,000, with payments through December, 2014 as amended. The total purchase price of $750,000 was allocated to tangible assets inventory and fixed assets associated with these specific RF services, and $155,277 intangible assets consisting of a customer list, non-compete clause and an exclusive license. The Contract also provided for 5% royalty on certain RF services we will provide to the specified 10 customers.
On August 8, 2014 the Company signed a strategic partnership agreement with Dynamac, Inc. to develop, manufacture and market a portfolio of low cost RF/Microwave and Millimeter-wave calibrated test probes and related universal test platforms. Microphase agreed to pay a one-time licensing and rights fee of $350,000 of which $50,000 was paid in the first quarter of fiscal 2015, and the remaining $300,000 was originally due in the second quarter. As of June 30, 2015 the Company was renegotiating repayment terms as well as the expected delivery date of the initial proto-type products.
On January 21, 2016, Microphase Instruments LLC, a wholly-owned subsidiary of Microphase Corporation (the “Company”) entered into a Purchase Agreement (the “Agreement”) with Dynamac, Inc. (the “Seller”), pursuant to which the Company acquired from the Seller an entire line of proprietary radio frequency (RF) and microwave test and measurement products, together with certain corresponding intellectual property, for an aggregate purchase price of $2,500,000 (the “Purchase Price”). The Agreement replaces all previous agreements and arrangements between the Company and the Seller, including, without limitation, that certain strategic partnership agreement dated August 8, 2014.
Asset allocation on Acquisition date
The Exclusive License associated with the Microsemi Inc. (“Microsemi”) asset acquisition was valued at $56,861, was ascribed a perpetual life and is subject to evaluation annually for impairment. Management has determined that there was no impairment charge to be recorded for the years ended June 30, 2016 and 2015. Customer Lists and Non-Compete agreements associated with the Microsemi asset acquisition were ascribed useful lives of 7 and 5 years respectively. The consideration paid for this portion of business was allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. We assigned $155,277 to identifiable intangible assets, which consist of a customer list, non-compete clause and an exclusive license. The acquired intangible assets will be amortized over their estimate lives, which range from 5 to 10 years, primarily using accelerated amortization methods based on the cash flow streams used to value those assets. The exclusive license has a contractual indefinite life and will be reviewed annually for impairment. There was no excess of the purchase price over the estimated fair value of the net assets acquired and as such no goodwill was recorded. Amortization expense recorded for these intangible assets was $15,511 and $15,511 for the years ended June 30, 2016 and 2015, respectively.
The Dynamac License was recorded at cost. The Company deposited $50,000 and provided a $300,000 note payable toward the initial contract during fiscal 2015 which was subsequently revised by the Dynamac agreement of January 21, 2016.
The assets acquired in the Dynamac agreement have been valued at the contract price in our initial measurement, resulting in intangible assets other than goodwill, primarily Intellectual Property consisting of two (2) patents with remaining lives of over 12 years each, a portfolio of product prototypes to be patented, trade secrets, know-how, confidential information and other intellectual property. We expect to incur additional costs to apply for eighteen (18) new patents, in addition to various trademarks and copyrights.
Our accounting for the allocation of the relative fair value of the intangible assets, other than goodwill, acquired in the Dynamac acquisition is still preliminary. The fair value estimates for the assets acquired were based on preliminary calculations, and our estimates and assumptions of the allocation of the relative fair value of these assets to possibly amortizable components, and if any, what period of amortization would be appropriate, are subject to change as we obtain additional information for our estimates during the measurement period (up to one year from the acquisition date). These assets will be subject to periodic evaluation and at a minimum will be reviewed annually for impairment. The Company assesses these assets for impairment based on their future cash flows.
| F-18 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 11 — ACQUISITION OF ASSETS & NOTE PAYABLE: – (continued)
Our Acquisitions have resulted in the following Asset allocation:
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
| Intellectual Property | $ | 2,520,425 | $ | 350,000 | ||||
| Customer List | 73,017 | 73,017 | ||||||
| Non-Compete Clause | 25,399 | 25,399 | ||||||
| Exclusive License | 56,861 | 56,861 | ||||||
| Total | 2,675,702 | 505,277 | ||||||
| Accumulated Amortization | (46,532 | ) | (31,022 | ) | ||||
| Net Total | $ | 2,629,170 | $ | 474,255 | ||||
Asset Acquisition Note Payable is comprised of the following:
| June 30, | June 30, | |||||||
| 2016 | 2015 | |||||||
| Asset Acquisition Note Payable-current portion | ||||||||
| - Microsemi | $ | — | $ | — | ||||
| - Dynamac agreement | 975,345 | 300,000 | ||||||
| Asset Acquisition Note Payable, net of current portion | ||||||||
| - Dynamac agreement | 1,045,080 | |||||||
| Total Asset acquisition note payable | $ | 2,020,425 | $ | 300,000 | ||||
The acquisition of Microsemi- on March 27, 2013, provided for a $100,000 down payment and a note payable for $650,000, with payments through December, 2014 and was repaid in full during Fiscal 2015.
The Dynamac agreement, as revised, of January 21, 2016 was funded by the $50,000 original deposit paid in connection with the previous agreement, $350,000 paid at closing, $100,000 paid in February 2016, and a series of four $550,000 payments payable on the note semi-annually, due in August 2016 & 2017 and February 2017 & 2018. The Company imputed interest at 7%, its most favorable credit line rate, and as such is valued at $2,020,425.
| F-19 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 12 — INCOME TAXES AND DEFERRED TAXES:
There is no provision for federal income tax and state income tax is provided for at the minimum statutory amount. The Company has available at June 30, 2016 approximately $7,655,000 and $6,950,000 in federal and state unused operating loss carry-forwards that expire in various years from 2019 to 2036. The Company also has available at June 30, 2016 approximately $3,400,000 capital loss carry-forwards.
The provisions for current and deferred income taxes are summarized as follows:
| 2016 | 2015 | |||||||
| Amount | Amount | |||||||
| Current: | ||||||||
| United States | $ | (338,321 | ) | $ | (788,153 | ) | ||
| State and local | (51,231 | ) | (119,349 | ) | ||||
| (389,552 | ) | (907,502 | ) | |||||
| Deferred: | ||||||||
| United States | 215,390 | 304,500 | ||||||
| State and local | 32,616 | 46,110 | ||||||
| 248,006 | 350,610 | |||||||
| Valuation reserve | (192,713 | ) | (564,192 | ) | ||||
| $ | 51,167 | $ | 7,300 | |||||
The elements is the tax provision consist of the following:
| 2016 | 2015 | |||||||
| Amount | Amount | |||||||
| Domestic tax loss and credit carryforwards | $ | (437,026 | ) | $ | (900,093 | ) | ||
| Deferred revenue | 47,473 | (45,906 | ) | |||||
| Share-based compensation | 248,006 | 350,610 | ||||||
| Capital loss carryforwards | - | 38,496 | ||||||
| All other — net | - | - | ||||||
| (141,546 | ) | (556,892 | ) | |||||
| Valuation allowance | (192,713 | ) | (564,192 | ) | ||||
| $ | 51,167 | $ | 7,300 | |||||
Deferred income tax assets and liabilities result from differences in reporting of income and expenses and operating loss carry-forwards. No deferred income tax assets have been recorded due to the fact that it is unlikely the Company will derive any tax benefit, until such time it attains profitability, from these factors. There were no material unrecorded taxes at the years ending June 30, 2016 or 2015.
The Company is subject to routine audits by taxing jurisdictions, however, there are currently no audits in progress. The Company remains subject to examinations by U.S. Federal and various state authorities for years ending after June 30, 2013.
NOTE 13 — COMMITMENTS AND CONTINGENCIES:
The Company sublet office space until March 31, 2015 and a vehicle in fiscal 2015 to mPhase Technologies, Inc. (mPhase), a related company. In Fiscal 2015 the rent recorded was $13,500 for the office space and $9,000 for the vehicle. As of June 30, 2016 and 2015, mPhase owed the Company $33,295 and $28,045.
In March of 2013 the Company acquired a division of Microsemi Inc. for $750,000 plus 5% royalty of gross sales. There were payments of $360,000 in 2015 which completed the acquisition. There were no payments in 2016.
The Company leases four vehicles under operating leases expiring in 2016 through 2018. As of June 30, 2016, the future minimum rental payments for fiscal 2017 are $34,909.
The Company has employment contracts with three officers and one employee and one consulting contract discussed in note 14 below.
The Company also has guaranteed to Edson, and its majority shareholders individually as signatories, the repayment of loan origination costs, interest charges and the principal in full, for an Equity Line of Credit with Wells Fargo Bank totaling up to $250,000, the proceeds of which the Company received a concurrent loan from Edson when the credit line was funded on August 15, 2008. Edson incurred approximately $3,200 loan origination costs (see note 14). The Company is a guarantor of a $243,296 note to Wells Fargo secured by real estate of one of the officers. As of June 30, 2016 & 2015 this line of credit had $250,000 available, secured by residential real estate owned by the vice president, of which $218,290 and $232,466 was outstanding, respectively, with an interest rate of 3.35%. Interest expense charged to operations on this loan amounted to $7,608 and $7,924 for the years ended June 30, 2016 and 2015 respectively.
The Company is also a guarantor of a $131,545 note to Wells Fargo secured by real estate of another officer. As of June 30, 2016 & 2015 this line of credit had $150,000 available, secured by the president’s principal residence, of which $101,003 and $119,531 was outstanding respectively, with an interest rate of 3.0%. Interest expense charged to operations on this loan was $3,332 and $4,105 for the years ended June 30, 2016 and 2015. These notes were assumed by the Company effective June 30, 2013 and 2014, respectively.
| F-20 |
MICROPHASE
CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 13 — COMMITMENTS AND CONTINGENCIES: – (continued)
On January 21, 2016, Microphase Instruments LLC, a subsidiary of Microphase Corporation (the “Company”) entered into a Purchase Agreement (the “Agreement”) with Dynamac, Inc. (the “Seller”), pursuant to which the Company acquired from the Seller an entire line of proprietary radio frequency (RF) and microwave test and measurement products, together with certain corresponding intellectual property, for an aggregate purchase price of approximately $2,500,000 (the “Purchase Price”). The Purchase Price was funded by the $50,000 original deposit paid in connection with the previous agreement, $350,000 paid at closing, $100,000 paid in February 2016, and a series of four $550,000 payments payable on the note semi-annually, due in August 2016 & 2017 and February 2017 & 2018. The Company imputed interest at 7%, its most favorable credit line rate, and as such is valued at $2,020,425.
The Agreement replaces all previous agreements and arrangements between the Company and the Seller, including, without limitation, that certain strategic partnership agreement dated August 8, 2014.
The Company has material Debt Service commitments at June 30, 2016 as discussed in Notes 8 through 11 summarized as follows:
| Related Party Loans-SEE NOTE 8 | Other Termed Debt-SEE NOTE 9 | Equity Lines of Credit-SEE NOTE 10 | Acquisition Notes-SEE NOTE 11 | Total | ||||||||||||||||
| EFFECTIVE
INTEREST RATE FISCAL YEAR ENDED JUNE 30, 2016 | 4.1 | % | 5.5 | % | 3.3 | % | 7.0 | % | ||||||||||||
| Fiscal Years: | ||||||||||||||||||||
| 2017 | $ | 137,150 | $ | 13,714 | $ | 38,132 | $ | 975,345 | $ | 1,164,341 | ||||||||||
| 2018 | 118,645 | 14,410 | 39,363 | 1,045,080 | 1,217,498 | |||||||||||||||
| 2019 | 104,112 | 12,565 | 241,798 | - | 358,475 | |||||||||||||||
| 2020 | 35,100 | - | - | - | 35,100 | |||||||||||||||
| Total | $ | 395,007 | $ | 40,689 | $ | 319,293 | $ | 2,020,425 | $ | 2,775,414 | ||||||||||
| F-21 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 13 — COMMITMENTS AND CONTINGENCIES: – (continued)
In connection with the acquisition of a specific product line of Microsemi’s, the Company signed a lease for 4,000 square feet of space at Microsemi’s facility in Folsom, CA. The initial terms of the lease were $8,400 per month rent with a term of one year. The lease was renegotiated in April of 2014 with a new rent of $7,000 per month beginning in June 2014 through June 2016, extended to July. The rent expense for fiscal 2015 was $91,500. The rent expense for fiscal 2016 was $132,000. The Company did not renew this lease. The Company moved all of the inventory and equipment from the facility in Folsom, CA into our facility in Shelton, Connecticut in August of 2016.
In November 2013 the Company sold the headquarters building to 587 Connecticut Avenue LLC. Beginning November 27, 2013 through April 17, 2015 the Company leased back a portion of the building for $10,103 per month. Under the terms of the lease, either party could terminate the lease with 90 days prior notice.
The Company moved to Shelton, Connecticut on April 21, 2015, to a facility with 15,000 square feet with monthly rent of $15,000, for a 7-year term with annual escalations of 3%. In December 2015 the Company committed to rent additional space in connection with the acquisition of the Dynamac proprietary line. In June 2016 the monthly rent became $18,400 and in August 2016 $24,740.
Under the terms of the Shelton lease minimum premises lease commitments for the next five years and thereafter at June 30, 2016 is as follows:.
| Total | ||||
| Fiscal Years: | ||||
| 2017 | 302,511 | |||
| 2018 | 304,989 | |||
| 2019 | 314,051 | |||
| 2020 | 323,351 | |||
| 2021 | 332,890 | |||
| Thereafter | 708,362 | |||
| Total | $ | 2,286,154 | ||
Rent Expense for Fiscal Years Ended June 30, 2016 and 2015 was $334,060 and $240,532, respectively.
We are subject to the possibility of legal proceedings and other claims arising out of the conduct of our business, including proceedings and claims relating to commercial and financial transactions; government contracts and sub-contracts; alleged lack of compliance with applicable laws and regulations; production partners; product liability; patent and trademark infringement; employment disputes; and environmental, safety and health matters. Some potential legal proceedings and claims could seek damages, fines or penalties in substantial amounts or remediation of environmental contamination. As a government sub-contractor, we are subject to audits, reviews and investigations to determine whether our operations are being conducted in accordance with applicable regulatory requirements. Under federal government procurement regulations, certain claims brought by the U.S. Government could result in our suspension or debarment from U.S. Government contracting for a period of time. On the basis of information presently available, we do not believe that there are any existing proceedings or potential claims that would have a material effect on our financial position or results of operations.
| F-22 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 14 — RELATED PARTY TRANSACTIONS:
The Company had activities with related parties during the fiscal years 2016 and 2015.
The Company sublet office space until March 31, 2015 and a vehicle in fiscal 2015 to mPhase. In Fiscal 2016 the rent recorded was $0 for the office space and $9,000 for the vehicle. In Fiscal 2015 the rent recorded was $13,500 for the office space and $9,000 for the vehicle.
As of June 30, 2016 and 2015 mPhase owed the Company $33,295 and $28,045, respectively.
| F-23 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 14 — RELATED PARTY TRANSACTIONS: – (continued)
Employment and Consultant Contracts:
The Company had previously entered into employment contracts with two long term officers through 2015 that provided for a stated salary of $250,000 per year, plus company benefits. These contracts were subject to other items and included a non-compete covenant. In Fiscal 2015 the Company entered into updated three year employment agreements with these two workers, one as an officer, currently the Company’s president and a director, and one as a strategic consultant upon his resignation as an officer and director. These updated contracts include base compensation of $225,000 per year plus company benefits, severance provisions and non-competition covenants for both individuals. As of June 30, 2016 and 2015, the Company owed $80,000 and $332,815 to these individuals, respectively.
In Fiscal 2015 the Company also entered into three year employment contracts with two new officers for at will employment with base compensation of $160,000 and $150,000 per year plus company benefits, respectively. Effective July 1, 2016 the Company revised these agreements with these two officers. These updated contracts include base compensation of $175,000 and $165,000 per year plus company benefits, severance provisions and non-competition covenants for both officers.
Effective July 1, 2016 the Company executed a modification to the consulting contract with the general manager through February 1, 2019. The updated contract includes base compensation of $192,000 per year with contract termination fees, comparable to the severance provisions for officers, and non-competition covenants.
Equity Lines of Credit:
The Company also has guaranteed to Edson, and its majority shareholders individually as signatory’s, the repayment of loan origination costs, interest charges and the principal in full, for an Equity Line of Credit with Wells Fargo Bank totaling up to $250,000, the proceeds of which the Company received a concurrent loan from Edson when the credit line was funded on August 15, 2008. Edson incurred approximately $3,200 loan origination costs. The credit line was secured by residential real estate owned by Edson at that time. In June 2010 the Company issued 2,532 shares of its $100 par value preferred stock to Edson to secure repayment of the $250,000 plus costs incurred, by the Company for the concurrent loan made to the Company, agreeing to continue to pay interest charges and committing to repay the principal by March 2012. This agreement was extended through March 2013, and again through June 2014. On June 30, 2013 the balance was $244,362 which is shown as a reduction of equity in the Statement of Changes in Stockholders’ Deficit for the fiscal years ended June 30, 2013. In March, 2013 the Company agreed to assume the remaining balance from Edson and then effective June 30, 2014, indemnified the officers from any liability pertaining to this note, of $243,296 for the cancellation of 2,433 shares of its $100 par value preferred stock.
Effective June 30, 2014 the Company also has guaranteed to its president, and a general member of MHC, the majority shareholder, individually as signatory’s, the repayment of a second Equity Line of Credit with Wells Fargo Bank, secured by the president’s principal residence, totaling $131,545 at that date. The proceeds of this home equity loan were primarily used to fund loan advances to the Company by the president in recent fiscal years. The Company committed to pay interest charges and the principal in full for this obligation and recorded the assumption as a $100,000 reduction of loans and a $31,545 reduction of unpaid compensation due to the president. (ALSO SEE NOTE-10)
| F-24 |
MICROPHASE
CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 15 — MAJOR CUSTOMERS AND SEGMENTS:
The Company had two customers in 2016 and two customers in 2015 which each accounted for more than 10% of sales.
The Company recorded sales of $4,123,408 with the two customers during the year ended June 30, 2016. These sales represent 45% of total sales for the year. At June 30, 2016, these customers owed $322,376 to the Company.
The Company recorded sales of $3,689,132 with the two customers during the year ended 2015. These sales represent 45% of total sales for the year. At June 30, 2015 these customers owed $383,464 to the Company.
Sales to U.S. customers were $7,921,939 and $7,047,074 which represented 87% and 86% of sales for the year ended June 30, 2016 and 2015, respectively.
NOTE 16 — STOCKHOLDERS’ EQUITY:
Microphase Corporation has, as amended, authorized capital of 7,800,000 shares of common stock with no par value and 200,000 shares of preferred stock, convertible into common stock subsequent to October 4, 2014, $100 par value per share, with 6% cumulative dividends when declared.
Common Stock Transactions
During the Fiscal Year ended June 30, 2016, the Company issued 80,000 shares of its Common Stock to two consultants pursuant to consulting agreements and 210,000 shares to two Officers and Directors for services, respectively, valued at $580,000, which was charged to selling general and administrative expense for this period. Also during the fiscal year ended June 30, 2016, the Company granted options to an Officer and Director for services to purchase 75,000 shares of Common Stock, with an exercise price of $2.00, with a term of 7 years, and which rights vest over the next three years. The total value of these options was estimated to be $106,200 using the Black Scholes method, based on an assumed volatility of 112.5% and an interest rate of .09% resulting in a $35,400 charge to selling general and administrative expense for the fiscal year ended June 30, 2016, deferring the balance of which $35,400 will be charged quarterly as it vests.
During the Fiscal Year ended June 30, 2016, the Company completed a private placement of its common stock to an accredited investor pursuant to Rule 504 of regulation D and Section 4(2) of the Securities Act of 1933, as amended. The Company issued 125,000 shares of its common stock at $2.00 per share together with a 5 year warrant to purchase up to 125,000 additional shares of our common stock at $2.50 to the investor and 25,000 shares to the placement agent, and received net proceeds of $225,000 after deducting $25,000 of cash costs, which was used for working capital.
During the Fiscal Year ended June 30, 2016, the Company’s President converted $252,815 of unpaid compensation into 168,550 shares of Common Stock resulting in a loss on the settlement of liabilities of $84,271. The President also converted $69,310 of related party loans, including $39,366 of accrued interest, into 46,200 shares of Common Stock resulting in a loss on the settlement of liabilities of $23,103. In total the Company settled $322,125 of related liabilities and recorded a $107,375 loss on the settlement of liabilities with related parties for a total of 214,750 shares of Common Stock valued at $429,500.
| F-25 |
MICROPHASE CORPORATION
Notes to
Financial Statements
June 30, 2016
NOTE 16 — STOCKHOLDERS’ EQUITY: – (continued)
During the Fiscal Year ended June 30, 2015, the Company issued 435,000 shares of its common stock for services and charged $790,000 to selling general and administrative expense and $80,000 to engineering and research expenses, respectively, valuing the shares based upon the value of concurrent private placements.
During the Fiscal Year ended June 30, 2015, the Company also issued 311,782 shares of its common stock to accredited investors in private placements of its common stock to accredited investors pursuant to Rule 504 of regulation D and Section 4(2) of the Securities Act of 1933, as amended, which included 68,782 shares to finders and $31,450 of offering costs, generating $447,050 net proceeds to the Company.
Also during the Fiscal Year ended June 30, 2015, the Company recorded the conversion of $320,000 of related party loans, including $21,043 accrued interest thereon, into 213,333 shares of common stock with beneficial conversion feature interest of $106,666, charged to loss on debt settlements and the conversion of $15,000 of strategic payables into common stock with beneficial conversion feature interest expense of $5,000.
Preferred Stock Transactions
During the Fiscal Year ended June 30, 2016, the Company issued 770,733 shares of the Company’s Common Stock pursuant to the conversion of 11,561 shares of the Company’s Series A Convertible Preferred Stock (the “Preferred Stock”) held by a private investor. The issuance did not result in any proceeds to the Company as the conversion to common shares effectively cancelled 11,561 shares of Preferred Stock previously acquired by the holder.
During the Fiscal Year ended June 30, 2015, the Company recorded the Conversion of $180,000 of related party loans into 1,800 shares of preferred stock with beneficial conversion feature interest of $59,400 and the conversions of $160,000 of unpaid compensation into 1,600 shares of preferred stock with beneficial conversion feature interest of $52,800.
The preferred stock, with respect to dividends, liquidation payments, and liquidation rights, ranks senior to the common stock and of the Company. Holders of Preferred Stock are entitled to receive, when and as declared by the Board of Directors, dividends, at the annual rate of 6% of the stated par value, or $100 per share. Dividends are cumulative and accrue from the effective date of issuance of the Preferred Stock until declared.
As of June 30, 2014, 23,543 preferred shares were issued and the cumulative dividends undeclared were approximately $459,400. In December 2014, the Board of Directors declared $494,735 of dividends on preferred shares outstanding as of September 30, 2014 and authorized the payment in 329,825 shares common stock using a conversion rate of $1.50 per share, charging an additional $164,193 to retained deficit for the loss on the settlement of the dividend payable. As of June 30, 2015, 26,943 preferred shares are outstanding and cumulative undeclared dividends on preferred stock are $115,769. As of June 30, 2016, 15,382 preferred shares were outstanding and cumulative undeclared dividends on preferred stock were $243,788.
| F-26 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 16 — STOCKHOLDERS’ EQUITY: – (continued)
Shareholders meeting and approval of amendments
On October 4, 2014 at a special meeting of the shareholders of the Company the shareholders approved amendments to the Certificate of Incorporation of the Company to:
| (1) | Increase its authorized common stock from 4,800,000 shares of common stock without par value to 50,000,000 shares of common stock without par value for economic reasons the Board of Directors has implemented an increase to 7,800,000 shares; |
| (2) | Increase its authorized preferred stock from 200,000 shares, $100 par value per share, to 2,000,000 shares of 6% convertible preferred stock, for economic reasons this has yet to be implemented, $100 par value per share. Each outstanding and hereafter issued share of the preferred stock will: |
| i) | be entitled to a cash dividend, payable quarterly on the last business day of each fiscal quarter of the Company, commencing with the fiscal quarter ended December 31, 2014, if and when declared by the Company’s board of directors. These dividends will be cumulative, will accrue if not declared by the directors, and must be paid before any dividends or other distributions are made to the common shareholders. |
| ii) | be entitled, on liquidation of the Company, to receive $100 per share plus accrued dividends before any distributions are made to the common shareholders. |
| iii) | be convertible at the option of the holder into common stock of the Company at a price agreeable to the holders of the preferred stock. |
| (3) | Enter into agreements for the conversion of at least $660,000 of shareholder/note holder loans which together with accrued interest are estimated to total $1,160,000 of debt at September 30, 2014 into shares of common stock of the Company. |
Capital stock conversions
During the fiscal year ended June 30, 2016, the Company’s President converted $252,815 of unpaid compensation into 168,550 shares of Common Stock resulting in a loss on the settlement of liabilities of $84,271. The President also converted $69,310 of related party loans, including $39,366 of accrued interest, into 46,200 shares of Common Stock resulting in a loss on the settlement of liabilities of $23,103. In total the Company settled $322,125 of related liabilities and recorded a $107,375 loss on the settlement of liabilities with related parties for a total of 214,750 shares of Common Stock valued at $429,500.
The Company recorded a loss on the settlement of liabilities of $223,866 which was charged to operations in the fiscal year ended June 30, 2015, in connection with the conversion of $675,000 of debts, $660,000 of which were with related parties representing $218,836 of the loss on the settlement of liabilities, into 233,333 shares of common stock and 3,400 shares of $100 preferred stock convertible into common stock at $1.50 per share, based upon the difference between the conversion value of $1.50 and $2.00, the value of shares issued in recent private placements.
| F-27 |
MICROPHASE CORPORATION
Notes to Financial Statements
June 30, 2016
NOTE 16 — STOCKHOLDERS’ EQUITY: – (continued)
Reserved Shares
Stock Options
The Board approved the implementation of a stock option plan in January 2015, for which the Company will not seek ratification by the shareholders, reserving 250,000 shares of Common Stock for this plan; however, such plan has not yet been set forth in a formal document adopted by the board. During the fiscal year ended June 30, 2016, the Company granted options, as part of this plan, to an Officer and Director for services to purchase 75,000 shares of Common Stock, with an exercise price of $2.00, with a term of 7 years, and which rights vest over the next three years as follows; 25,000 shares were exercisable immediately and 25,000 shares vest each October 1 of 2016 and 2017. The total value of these options was estimated to be $106,200 using the Black Scholes method, based on an assumed volatility of 112.5% and an interest rate of .09%. $35,400 was charged to operations in the during the fiscal year ended June 30, 2016 deferring the balance of which $35,400 will be charged each October 1 of 2016 and 2017 for fiscal 2017 & 2018.
Series A Preferred Shares currently convertible
As of June 30, 2016, 15,382 preferred shares were outstanding and cumulative undeclared dividends on preferred stock were $243,788. The preferred shares are convertible into 1,025,467 shares of the Company’s common stock at $1.50, and the dividends, if declared, are convertible into 162,525 common shares stock also at $1.50, until such time the Company’s common stock begins trading.
Certain Debts currently convertible
As of June 30, 2016, $395,007 of loans from related parties and $80,000 of unpaid compensation are convertible into 263,338 and 53,334 shares of the Company’s common stock at $1.50, respectively, until such time the Company’s common stock begins trading.
Deferred Common Stock Awards
The Board approved additional stock compensation for the Company’s Chief Financial Officer and a Director of the Company and the Company’s Chief Technology Officer, Chief Marketing Officer, and a Director of the Company whereby they will receive an additional 100,000 and 175,000 shares of common stock each as follows: 30,000 and 40,000 shares per quarter for the next three quarters, beginning December 31, 2015, and then 10,000 and 55,000 shares in the quarter ending September 30, 2016.
NOTE 17 — SUBSEQUENT EVENTS:
The Company was awarded a grant and a loan pursuant to the State of Connecticut Small Business Express Program which closed in August 2016. The terms include the following:
| A) | Small Business Express Matching Grant in an amount of $100,000. State grant funding requires a dollar for dollar match on behalf of the Company, and |
| B) | Small Business Express Job Creation Incentive loan in an amount of $300,000 at an interest rate of 3.0 % for a term of 10 years. Principal and Interest will be deferred for the first year of the loan. |
| F-28 |
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Date: October 3, 2016 | MICROPHASE CORPORATION | |
| By: | /s/ Necdet F. Ergul | |
Name: Necdet F. Ergul Title: Chief Executive Officer, Chairman of the Board of Directors | ||
| By: | /s/ James Ashman | |
Name: James Ashman Title: Chief Financial Officer, Director | ||
| By: | /s/ Michael Gadakhasz | |
| Name: Michael Gadakhasz | ||
| Title: Director | ||
| By: | /s/ Jeffrey Peterson | |
| Name: Jeffrey Peterson | ||
| Title: Director | ||
| By: | /s/ Paul H. DeCoster | |
| Name: Paul H. DeCoster | ||
| Title: Director |
| 51 |