Item 1. Business
The Company
M~Wave, Inc., through its wholly owned subsidiary Poly Circuits, Inc., is a value-added service provider of high performance printed circuit boards used in a variety of digital and high frequency applications for telecommunications and industrial electronics applications. M~Wave satisfies its customers requirements for telecommunications and industrial electronics application by using its 50,000 square foot state-of-the-art prototype and small volume facility located in West Chicago, Illinois and by outsourcing and coordinating the manufacture of such boards by a global base of suppliers located primarily in the Far East ("Virtual Manufacturing"). Virtual Manufacturing contractually supplies all the printed circuit needs of our customers by managing the complete procurement process. We deliver products when the customer needs them through either consignment inventory control or just-in-time programs.
The Company began Virtual Manufacturing during 2000 by developing subcontracting relationships with global manufacturers. The Company typically begins the Virtual Manufacturing process by manufacturing prototypes and pre-production printed circuits at its manufacturing facility. The Company often works closely with customer personnel during this stage to finalize fabrication details and guidelines for circuit boards. As customers' requirements for circuit boards develop into higher volumes, the Company subcontracts the manufacture of the circuit boards to global manufacturers. The Company continues to monitor the production and quality control of the circuit boards and works with its customers and global manufacturers throughout the Virtual Manufacturing process. The Company believes that Virtual Manufacturing allows the Company to satisfy a broader range of its customers' printed circuit board requirements without incurring substantial capital expenditures for property, plant and equipment.
The Company added new levels of capacity in 2001 with the addition of its new facility in West Chicago, Illinois. The new state-of-the-art 50,000 square foot facility in West Chicago enables the Company to provide quick-turn, prototypes to customers and to manufacture pre-production printed circuit boards for specific customer applications. These process capabilities are an essential part of the Virtual Manufacturing process and the Company's ability to attract new customers.
The Company closed its Bensenville facilities in the third quarter of 2002 and consolidated operations at its West Chicago facility. The Company recorded a one time pre-tax charge of $1,752,000 in the third quarter of 2002 relating to closing and consolidation of the Bensenville facilities into West Chicago.
The Company produces customer specified bonded assemblies consisting of a printed circuit board also bonded in some manner to a metal carrier or pallet. One bonding technique used by the Company is Flexlink (TM), a patented process granted to the Company in 1993. The Company developed an enhanced version called Flexlink II(TM) in 1996.
The Company's printed circuit boards and bonded assemblies are used in a variety of telecommunications and industrial electronic applications. Many of the Company's printed
circuit boards are Teflon(TM) based and are advantageous for microwave systems because of their extremely low power losses, coupled with stable, predictable electrical characteristics.
The production of Teflon(TM) based printed circuit boards and bonded assemblies is technologically demanding due to the precise requirements of their end-use applications and the miniaturization of the microwave frequency components. To meet these technological demands, the Company has developed manufacturing processes and designs, which reduce the cost and increase the manufacturability and reliability of customer systems. Additionally, the Company emphasizes quality engineering and design support for its customers. The Company is subject to stringent technical evaluation and ISO certification by many of its customers.
M~Wave, Inc. was incorporated in Delaware in January 1992 in connection with a 100 for 1 share exchange with the former stockholders of Poly Circuits, Inc. The Company's executive offices are located at 475 Industrial Drive, West Chicago, Illinois, 60185, and its telephone number is (630) 562-5550.
Recent Developments
The Company was not in compliance with certain financial covenants for the year ended December 31, 2002 relating to the Company's industrial bond debt. The outstanding balance of the debt is approximately $4,907,000 as of March 14, 2003. On March 31, 2003, the Company entered into a Forbearance Agreement with Bank One, N. A., formerly known as American Bank and Trust Company of Chicago, pursuant to which the Company agreed to comply with all of the terms and conditions contained in the Forbearance Agreement and the Bank agreed to forbear from the date of the agreement to August 31, 2003 from pursuing its rights under the Reimbursement Agreement (including the right to declare the bond immediately due and payable) provided the Company complies with all of the terms and conditions contained in the Forbearance Agreement. A copy of the Forbearance Agreement is filed as Exhibit 10.11 to this Annual Report on Form 10-K and is hereby incorporated by the reference.
Under the terms of the Forbearance Agreement, the Company has agreed to deposit in the Sinking Fund Account for the Industrial Bond Debt:
(i) $1,500,000 on the earlier of (x) receipt by the Borrower of any federal tax refund or (y) April 30, 2003; and
(ii) $500,000 on the earlier of (x) receipt by the Borrower of any state tax refund or (y) June 30, 2003; and
(iii) $300,000 on the earlier of (x) receipt by Borrower of the proceeds of the sale of its real estate located at 215 Park Street, Bensenville, Illinois or (y) August 15, 2003.
The Company expects to satisfy the terms of the Forbearance Agreement by depositing in the Sinking Fund account $1.5 million out of an anticipated Federal tax refund in April of approximately $3.0 million and $500,000 of anticipated state tax refunds during 2003 of approximately $900,000. The Company is also in discussions with third parties concerning the sale of certain fixed assets no longer being used at the Company's Bensenville facility. The Company's ability to comply with the terms of the Forebearance Agreements will depend upon the amount and timing of the aforementioned tax refunds and asset sales, which are subject to factors that are beyond the Company's control. If the Company does not comply with the terms of the Forebearance Agreement, the lender may declare the entire amount of the bond immediately due and payable.
Even if the Company complies with the terms of the Forebearance Agreement, there can be no assurances that the lender and the Company will continue to enter into forbearance agreements beyond August 31, 2003, if necessary, or that the terms of such agreements will not have a material adverse effect on the Company's ability to fund working capital or give the Company sufficient time and flexibility to avoid future defaults under the industrial bond debt. The Company may be required to refinance the industrial bond debt. There can be no assurance that any such refinancing would be available on commercially reasonable terms, if at all. Any such refinancing may require the Company to issue warrants for the Company's common stock, which may result in significant dilution of existing stockholders' ownership interest. See also "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Risk Factors affecting Business and Results of Operations-Default under Industrial Bond Debt and - -Liquidity."
The report of independent auditors accompanying the consolidated financial statements in this Annual Report on Form 10-K states that the foregoing matters raise substantial doubt about the Company's ability to continue as a going concern. See Note 3 in the Notes to the Consolidated Financial Statements. There can be no assurance that the forgoing matters will not adversely impact the Company's relationship with its suppliers and customers.
Industry and Market
There are Commercial and Military-related types of customers within the market for microwave related printed circuit boards and bonded assemblies. Within both customer types there has been an "outsourcing" trend whereby many end users have reduced their internal production of printed circuit boards and bonded assemblies and moved to buying these products from "contract manufacturing" board shops.
One of the most widely recognized high frequency telecommunication systems in commercial use is the cellular telephone. Cellular systems operate at the lower end of the microwave spectrum and use Teflon(TM) based printed circuit boards and bonded assemblies in power amplifier base stations. Approximately 47%, 90% and 94% of the Company's revenues in 2002, 2001, and 2000, respectively, were related to the cellular telephone industry.
The Company also services broadband access suppliers. Broadband access solution companies provide broadband products, service solutions and conferencing solutions for carriers, service providers and business enterprises around the world. Approximately 29% of the Company's 2002 revenue was related to broadband access suppliers.
Customers and Marketing
The Company's customers include microwave system manufacturers with sophisticated technologies and industrial electronic manufacturers. The Company markets its products through regional sales managers supported by independent sales organizations. The Company currently services a customer base of approximately 150.
The sale of microwave printed circuit boards is technical in nature. The Company works with customer personnel who are frequently experts in microwave design and theory with added expertise in fabrication and design techniques for printed circuit boards. Typically, microwave system manufacturers provide the Company fabrication details and guidelines. The Company fabricates the products to customer specifications.
The Company has adopted a program of early supplier involvement as part of its sales strategy. The Company has the opportunity to design-in its manufacturing processes as a
means of reducing the cost of microwave systems. The emphasis upon a partnership underlies the Company's relationship with its customers.
The Company markets its products through regional sales managers supported by approximately 20 independent sales organizations, which are paid a commission to represent the Company. International sales of the Company's products have accounted for less than 5% of revenues in each of 2002, 2001 and 2000.
In 2002, Celestica International, Westell, Inc. and Lucent Technologies accounted for 31%, 29% and 11%, respectively, of the Company's revenues. In 2001, Lucent Technologies accounted for 90% of the Company's revenues. In 2000, Lucent Technologies accounted for 91% of the Company's revenues. On September 1, 2001, Lucent transitioned a segment of their manufacturing operations at Columbus, Ohio to Celestica. Celestica is based in Toronto, Canada. On September 1, 2001 Lucent also transferred most of their open purchase orders with the Company to Celestica. In 2001, Lucent's revenue also includes revenue shipments to Celestica. The loss of, or a substantial reduction in or change in the mix of orders from, Celestica International or Westell, Inc. would have a material adverse effect on the Company's results of operations and financial condition. The Company continues vigorously to pursue a strategy of being a source to a broader base of customers and intends to seek to be one of a few key suppliers rather than the sole supplier. The Company signed eleven Virtual Manufacturing contracts in 2002, which represented approximately $7,000,000 in 2002 revenues.
As of December 31, 2002, the Company had an order backlog of approximately $2,540,000 compared to $3,755,000 at December 31, 2001. Nearly all of the Company's backlog is subject to cancellation or postponement without significant penalty. The backlog at December 31, 2002 does not include expected revenues from Virtual Manufacturing contracts. Accordingly, the Company does not believe that this backlog is necessarily indicative of the Company's future results of operations or prospects.
Products and Production
The Company manufactures high performance printed circuit boards and also bonds microwave related printed circuit boards to metal carriers or pallets using a variety of bonding techniques including a Company patented process called Flexlink II(TM). The use of Teflon(TM) in the manufacturing of printed circuit boards is demanding. This is so because Teflon(TM) is a thermo-plastic which, in a cured state, exhibits a high coefficient of thermal expansion and polymeric molecular cross-linking which makes plating circuitry difficult. Manufacturing microwave-related circuit boards requires tolerances measured in ten thousandths of an inch. Despite these manufacturing complexities, the Company realized a yield of approximately 89% in 2002 compared to 88% in 2001.
Because the Company manufactures a custom, made-to-order product, there is a minimal amount of finished goods inventory. The Company maintains raw material inventory, primarily purchase printed circuits and metal carriers. The Company seeks to balance its labor, materials and backlog to achieve an average of eight weeks lead-time from placement of order to shipment of product. Production can generally be increased rapidly to respond to increases in demand.
The Company is ISO 9002 certified. ISO 9002 is an international standard for compliance with a manufacturing quality system that is recognized through out the world.
During 2002, one manufacturer accounted for approximately 24% of the printed circuit boards supplied to the Company compared to 60% in 2001 and 67% in 2000. There are
numerous manufacturers of printed circuits in the world today. However, a disruption of printed circuits could have an adverse affect on the Company's operation. The Company believes that its relationship with principal suppliers are good.
Product Development
The Company's product development efforts have been an important part of its ongoing activities. The Company has developed the Flexlink(TM) process, the bonding of materials with dissimilar coefficients of thermal expansion, and the fusion bonding of Teflon based laminate for multi-layer circuit fabrication. The Company was granted a patent in 1993 by the United States Patent Office for its Flexlink(TM) process. The Company developed an enhanced version called Flexlink II(TM) in 1996.
The Company relies heavily on its process engineering capabilities to further its corporate objectives. The Company's future results of operations are dependent on its ability to continue to initiate or respond to technical changes and to make the necessary ongoing capital investments. The Company focuses on improving current manufacturing processes and developing new processes in pursuit of its goal to increase quality, offer enhanced systems design flexibility to its customers, and respond to the increasing complexity of its customers' products.
Virtual Manufacturing
The Company out-sources the manufacture of printed circuit boards as part of its Virtual Manufacturing process to unaffiliated manufacturers located primarily in Far East locations. Many of these suppliers are ISO 9000 certified. The Company believes that it maintains good business relationships with its overseas manufacturers.
The Company does not maintain long-term purchase contracts with manufacturers and operates principally on a purchase order basis. The Company believes that it is not currently dependent on any single manufacturer. However, during 2002, one manufacturer accounted for approximately 24% of the printed circuit boards supplied to the Company. In 2001, one manufacturer accounted for approximately 60% of the printed circuit boards supplied to the Company. In 2000, one manufacturer accounted for approximately 67% of the printed circuit boards supplied to the Company. The Company believes that the loss of any one single manufacturer would not have a long-term material adverse effect on the Company because other manufacturers would be able to increase production to fulfill the Company's requirements. However, the loss of a supplier could, in the short term, adversely effect the Company's business until alternative supply arrangements were secured.
The Company's purchase orders are generally made in United States dollars in order to maintain continuity in the Company's pricing structure and to limit exposure to currency fluctuations.
Quality assurance is particularly important to the Company and its product shipments are required to satisfy quality control tests established by its internal product design and engineering department. The Company typically performs quality control inspections prior to shipment of printed circuit boards to its customers. The Company warrants most printed circuit boards to its customers with a money-back guarantee for printed circuit boards and components.
Competition
The market for the Company's products is highly competitive. The Company competes for customers primarily on the basis of quality and on time delivery of its products and the Company's technical support. The Company faces substantial competition from many companies, including many that have greater financial and other resources, broader product lines, greater customer service capabilities and larger and more established customer bases. Alternative methods of manufacturing microwave-related boards exist, including ceramic and thick film technologies. Also, new materials are being introduced that are not Teflon(TM) based and are easier to manufacture. These materials fit within existing manufacturing capabilities of other board shops. Increased competition could cause the Company to lose market share and/or accelerate the decline in the prices of the Company's products. These factors could have a material adverse effect on the Company's results of operations and financial condition.
Environmental Regulations
The Company and the industry in which it operates are subject to environmental laws and regulations concerning, among other things, emissions into the air, discharges into waterways, the generation, handling and disposal of waste materials and certain record-keeping requirements. The Company periodically generates and handles materials that are considered hazardous waste under applicable law and contracts for the off-site disposal of these materials. During the ordinary course of its operations, the Company has received citations or notices from regulatory authorities that such operations may not be in compliance with applicable environmental regulations. Upon such receipt, the Company works with authorities to resolve the issues raised by such citations or notices. The Company's past expenditures relating to environmental compliance have not had a material effect on the financial position or results of operations of the Company. The Company believes that the overall impact of compliance with regulations and legislation protecting the environment will not have a material effect on its future financial position or results of operations, although no assurance can be given.
Based on information available to the Company, which in most cases includes an estimate of liability, legal fees and other factors, a reserve for indicated environmental liabilities has been made in the aggregate amount of approximately $50,000. The Company spent approximately $147,000 in 2002 and approximately $382,000 in 2001 complying with EPA regulations.
Patents
Due to rapidly changing technology, the Company believes its success depends primarily upon the engineering, marketing, manufacturing and support skills of its personnel, rather than upon patent protection. The Company was granted a patent in 1993 by the United States Patent Office for its Flexlink(TM) process. The Company developed an enhanced version called Flexlink II(TM) in 1996.
The Company was granted three patents in 1998. Two patents were granted to the Company for a printed circuit board process using plasma spraying of conductive metal. The plasma spraying process eliminates a significant portion of the wet process currently used to produce printed circuit boards.
Employees
On December 31, 2002, the Company employed approximately 116 persons. The Company closely monitors the number of employees in response to its periodic production requirements
and believes it is positioned appropriately to change the number of employees as changes in production warrant.
None of the Company's employees are represented by a labor union and the Company has never experienced a work stoppage, slowdown or strike. The Company considers its labor relations to be very good.
Executive Officers of the Registrant
The following is a list of Company's executive officers as of March 15, 2003:
Name Age Position ---- --- -------- Joseph A. Turek 45 Chairman and Chief Executive Officer Paul H. Schmitt 56 Secretary and Treasurer Chief Financial Officer Robert F. O'Connell 59 Chief Operating Officer
JOSEPH A. TUREK is the founder of the Company and has acted as Chairman and Chief Executive Officer since June 1993, and has served as director of the Company since 1988. Mr. Turek served for more than five years in various positions at West-Tronics, Inc., a manufacturer of low frequency circuit boards and a contract assembler of electronic products, with his last position as President in 1987 and 1988.
PAUL H. SCHMITT joined the Company in September 1992 as Treasurer. From 1990 to 1992, Mr. Schmitt was with Reynolds Products, a Division of Alco Standard Corporation, where he held the position of Controller. From 1983 to 1990, he served as Controller for Garden City Envelope Company.
ROBERT F. O'CONNELL joined the Company in January 2003 as Chief Operating Officer. From 1993 to January, 2002, Mr. O'Connell served as Vice-President & General Manager of Northrup Grumman Interconnect Technologies, (formerly Litton Interconnect Technologies). From 1986 to 1993, Mr. O'Connell served as Vice-President of Operations at Altron Inc., a division of Sanmina Corporation.
Item 2.
Item 2. Properties
Facilities
The following table lists the manufacturing, administrative, marketing facilities of the Company:
Lease Location Function Square Feet Expiration Date -------- -------- ----------- --------------- Chicago, Illinois Manufacturing 50,000 Owned
Bensenville, Illinois Manufacturing 14,000 Owned
Bensenville, Illinois Administrative 13,000 June 30, 2005 (Subject to option to renew for three years)
The Company purchased the West Chicago facility in the fourth quarter of 200O and began manufacturing at that facility in the fourth quarter of 2001. The Company closed its Bensenville facilities in the third quarter of 2002 and consolidated operations at its West Chicago facility.
The Company also has its corporate headquarters in West Chicago, Illinois. Administration occupies approximately 5,000 square feet.
Item 3.
Item 3. Legal Proceedings
None
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market Price and Dividends on the Registrant's Common Equity and Related Stockholder Matters
The Registrant's common stock is traded on the NASDAQ National Market (trading symbol MWAV). The following table sets forth, for the calendar periods indicated, the range of the high and low last reported sales prices of the common stock from January 1, 2001 through December 31, 2002 as reported by the NASDAQ.
Year Ended December 31 ---------------------------------------- 2001 2002 ----------------- -----------------
Low High Low High --- ---- --- ----
First Quarter $ 7.19 $14.50 $ 5.35 $ 8.10
Second Quarter 4.62 8.78 3.65 6.84
Third Quarter 3.70 7.05 0.77 3.56
Fourth Quarter 3.82 5.15 0.75 2.62
As of December 31, 2002, there were approximately 700 shareholders of record owning the common stock of the Company.
The Company did not pay any dividends on its common stock in 2002 and intends not to pay dividends in the foreseeable future in order to reinvest its future earnings in the business.
Disclosure Regarding the Company's Equity Compensation Plans
The company maintains the 1992 Stock Option Plan ("1992 Plan") pursuant to which the Company may grant equity awards to eligible persons. The material terms of the 1992 Plan are described below.
The following table summarizes information about equity awards under the Company's 1992 Plan as of December 31, 2002.
1992 Stock Option Plan
In 1992, the Company's Board of directors adopted the 1992 Stock Option Plan. The Company's shareholders approved the 1992 Plan in February 1992 and approved amendments to the 1992 Plan in June 1995 and June 1997. See exhibit 10.1 of Form 10-K for reference to the plan document, as amended.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial information with respect to the Company for each of the five years in the period ended December 31, 2002.
On October 24, 2000 the Board of Directors declared a two-for-one split of its common stock, effected in the form of a stock dividend paid on November 28, 2000 to shareholders of record on November 13, 2000. All agreements concerning stock options in shares of the Company's common stock provide for the issuance of additional shares due to the declaration of the stock split. All references to the number of shares, except shares authorized, and to per share information in the consolidated financial statements have been adjusted to reflect the stock split on a retroactive basis.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
M~Wave is a value-added service provider of high performance circuit boards used in a variety of digital and high frequency application for telecommunications and industrial electronics applications.
M~Wave's business has been particularly challenging for the past year, due to the downturn in the telecommunication industry and the resulting decline in customer demand. 2002 was a year of transition for M~Wave as we have seen most of our business move from the telecommunications industry to the industrial electronics industry. Although the industrial electronics industry has also experienced a downturn, this transition has allowed us to broaden our base of customers.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's financial statements, which 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 assumptions that effect: (1) the reported amounts of assets and liabilities; (2) the disclosure of contingent liabilities; and (3) the reported amounts of sales and expenses during the reporting period. On an on-going basis, we evaluate and update our estimates and judgments, including those related to the collectibility of accounts receivable, realizability of inventories, impairment of long-lived assets, and amount of warranty obligations. We base our estimates and judgments on historical experience and on other factors that we believe to be reasonable under the circumstances, the results of which form the basis for our 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 conditions. We believe the following critical accounting policies, among other policies, affect our more significant judgments and estimates used in the preparation of our financial statements.
Revenue Recognition and Accounts Receivable
The Company recognizes revenue upon the shipment of its products to the customer provided that the Company has received a signed purchase order, the price is fixed, title has transferred, product returns are reasonably estimable, collection of resulting receivable is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations. We maintain an allowance for estimated product returns based on historical experience. We also maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This estimate is based on historical experience, current economic and industry conditions and the profile or our customer mix. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventories
Inventories are valued at the lower of cost or market value and include materials, labor and manufacturing overhead. We write down inventory for estimated obsolescence or unmarketability equal to the difference between the cost of the inventory and its estimated market value based on assumptions about future demand and market conditions. If actual future demand or market conditions were to be less favorable than we projected, additional inventory write-downs may be required.
Long-lived Assets
We review long-lived assets for impairment when circumstances indicate that the carrying amount may not be recoverable. Factors which could trigger an impairment review include significant decline in operating results relative to historical or projected future operating results, significant changes in
the manner of our use of assets, changes in technology or significant negative or economic trends. If this review indicates that the value of an asset may be impaired, an evaluation of the recoverability of the net carrying value of the asset over its remaining useful life is made. If this evaluation indicates that the value of the asset is not recoverable, the net carrying value of the asset will be reduced to the fair value and the remaining depreciation period may be adjusted. Any such impairment charge could be significant and could have a material adverse effect on our financial statements if and when an impairment charge is recorded.
Warranty
We provide for the estimated cost of the product warranties at the time revenue is recognized. The warranty obligation includes a provision based on historical experience, as well as reserves for specific issues we identify. To the extent actual warranty charges vary from our historical experience, revisions to the estimated warranty liability may be required.
Other
Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies relating to fair value of financial instruments, depreciation, and income taxes require judgments on complex matters that are often subject to multiple external sources of authoritative guidance such as the Financial Accounting Standards Board, Securities and Exchange Commission, etc. Although no specific conclusions reached by these authorities appear likely to cause a material change in the Company's accounting policies, outcomes cannot be predicted with confidence. Also see Note 2 to the Company's Consolidated Financial Statements, which provide a summary of the Company's significant accounting policies.
Results of Operations
Listed below are the related expenses for 2002, 2001 and 2000, as a percent of sales.
2002 2001 2000 ---- ---- ----
Net sales 100.0% 100.0% 100.0% Cost of goods sold 110.4 81.1 82.8 ------- ------- ------- Gross profit (10.4) 18.9 17.2 ------- ------- -------
Operating expenses: General and administrative 11.0 5.0 4.3 Selling and marketing 6.8 2.8 2.7 Restructuring expense 7.8 0.0 0.0 ------- ------- -------
Total operating expenses 25.6 7.8 7.0 ------- ------- -------
Operating income (loss) (36.0) 11.1 10.2
Interest income (expense) - net (0.6) (0.5) (0.4) Rental income 0.0 0.3 0.4 Insurance settlement 0.0 0.0 0.1 Gain (loss) on disposal of equipment (0.4) 0.5 0.0 ------- ------- ------- Total other income (expense) (1.0) 0.3 0.1 ------- ------- -------
Income (loss) before income taxes (37.0) 11.4 10.3
Income tax expense (benefit) (14.6) 4.5 3.5 ------- ------- -------
Net income (loss) (22.4)% 6.9% 6.8% ======= ======= =======
COMPARISON OF 2002 AND 2001
Net Sales
Net sales for 2002 decreased 59% to $22.5 million from $54.8 million in 2001. The decrease in net sales is related to the telecommunication industry, which saw demands reduced by approximately $39,700,000 from 2001 requirements. The Company was able to offset some of the decrease in demand for telecommunication related products by promoting its "Virtual Manufacturing business model" and entering into the industrial electronics market. Virtual Manufacturing allows the Company to increase its manufacturing capabilities without the brick and mortar by using global suppliers to manufacture all types of high quality printed circuits at much lower costs than domestic suppliers like M~Wave, Inc. The Company developed sub-contracting relationships in 2002 and 2001 with global suppliers to create a "Virtual Manufacturing" business. The Company begins the process by manufacturing prototype and pre-production printed circuits at our wholly-owned subsidiary, Poly Circuits. Then as our customer requirements develop into higher volumes we broaden our capability by sub-contracting printed circuits to our global partners while adding value to our customers for this service. Added value can be in the form of supply chain management, bonding, plating or inventory control. Virtual Manufacturing allows the Company to build a product pipeline for our customers to handle more of their printed circuit requirements without the brick and mortar. The Company signed contracts with eleven new virtual manufacturing customers in 2002. Virtual Manufacturing accounted for approximately 76% of the Company's net sales for 2002 and 90% of the Company's net sales in 2001.
The Company's three largest customers, Celestica, Westell and Lucent, accounted for 72% of the Company's net sales in 2002 compared to 90% in 2001. Net sales to Celestica decreased $4,218,000 to $7,055,000 in 2002. Westell was a new customer in 2002 with sales of $6,580,000. Net sales to Lucent decreased by $35,493,000 to $2,506,000 in 2002, of which most of the sales to Lucent related to an end of life sale. On September 1, 2001, Lucent transitioned a segment of their manufacturing operations at Columbus, Ohio to Celestica. Celestica is based in Toronto, Canada. On September 1, 2001 Lucent also transferred most of their open purchase orders with the Company to Celestica.
Gross Profit (Loss) and Cost of Goods Sold
Gross profit decreased $12,697,000 in 2002 from $10,372,000 in 2001 to $(2,326,000) in 2002. Gross margin decreased to approximately (10%) in 2002 from approximately 19% in 2001. The decrease in gross profit is a result of the decrease in net sales, under utilization of the manufacturing facility, the write-down in inventory, a drop in demand in the telecommunications industry. The closing and consolidation of the Bensenville facility into the West Chicago facility also allowed the Company to reduce personnel from approximately 180 employees during the second quarter of 2002 to approximately 116 employees at year ended December 31, 2002. The reduction included both hourly and salary employees.
During 2002, one manufacturer accounted for approximately 24% of the printed circuit boards supplied to the Company compared to 60% in 2001. The Company has a total reserve for inventory obsolescence of $874,000 at December 31, 2002 and $2,027,000 at December 31, 2001. Substantially all of the reserve for inventory obsolescence is related to specific inventory. The inventory obsolescence reserve requires the use of estimates. The Company believes the techniques and assumptions used in establishing the reserve is appropriate. See Financial Statement Schedules on page 39.
Operating Expenses
General and administrative expenses were $2,471,000 or 11.0% of net sales in 2002, compared to $2,722,000 or 5.0% of net sales in 2001. General and administrative expenses consist primarily of salaries and benefits, professional services, depreciation of office equipment, computer systems and occupancy expenses. Payroll related expenses were down $399,000 due to a reduction in staff and
bonus paid to administrative personnel. Professional services were up approximately $129,000. The Company also expensed $289,000 in 2002 of initial costs related to the Industrial Revenue Bond.
Selling and marketing expenses were $1,528,000 or 6.8% of net sales in 2002, compared to $1,536,000 or 2.8% of net sales in 2001. Selling and marketing expenses include the cost of salaries, advertising and promoting the Company's products and the commissions paid to independent sales organizations. Payroll related expenses were up $352,000 with the addition of two regional sales managers and support staff. Commissions paid to independent sales organizations were down $436,000.
Restructuring expenses were $1,752,000 or 7.8% of net sales in 2002. Restructuring expenses include costs associated with the closing, cleanup and the future disposition of the Bensenville facilities.
Operating Loss
Operating loss was $8,077,000 or 35.9% of net sales in 2002, compared to an operating income of $6,113,000 or 11.1% of net sales in 2001. The change in operating income can be summarized as follows:
Decrease in net sales ($6,122,000) Decrease in gross margin (6,576,000) Decrease in operating expenses (1,492,000) -------------
Decrease in operating income ($14,190,000) =============
Interest Income
Interest income from short-term investments was $195,000 in 2002 compared to $112,000 in 2001.
Interest Expense
Interest expense, primarily related to new borrowings for the West Chicago facility, was $334,000 in 2002 compared to $425,000 in 2001.
Rental income
Rental income, primarily relating to the P C Dynamics facility, was $176,000 in 2001. The Company sold the P C Dynamics facility in the fourth quarter of 2001.
Gain on disposal of fixed assets
The Company recorded a loss of $96,000 in 2002 relating to the sale of assets in the Bensenville facility. The Company recorded a gain of $291,000 relating to the sale of the P C Dynamics facility in the fourth quarter of 2001.
Income Taxes
The Company had an effective tax credit of 39.5% in 2002 compared to an effective tax rate of 39.4% in 2001.
COMPARISON OF 2001 AND 2000
Net Sales
Net sales for 2001 decreased 5% to $54.8 million from $57.6 million in 2000. The small decrease in net sales is related to the telecommunication industry as a whole, which saw demands reduced by up to 50% from 2000 requirements. The Company was able to offset the decrease in demand for telecommunication related products by promoting its "Virtual Manufacturing business model" and entering into the industrial electronics market. Virtual Manufacturing allows the Company to increase its manufacturing capabilities without the brick and mortar by using global suppliers to manufacture all types of high quality printed circuits at much lower costs than domestic suppliers like M~Wave, Inc. The Company developed sub-contracting relationships in 2000 and 2001 with global suppliers to create a "Virtual Manufacturing" business. The Company begins the process by manufacturing prototype and pre-production printed circuits at our wholly-owned subsidiary, Poly Circuits. Then as our customer requirements develop into higher volumes we broaden our capability by sub-contracting printed circuits to our global partners while adding value to our customers for this service. Added value can be in the form of supply chain management, bonding, plating or inventory control. Virtual Manufacturing allows the Company to build a product pipeline for our customers to handle more of their printed circuit requirements without the brick and mortar. The Company has signed contracts with five new virtual manufacturing customers. Virtual Manufacturing accounted for approximately 90% of the Company's net sales for 2001 and 76% of the Company's net sales in 2000.
The Company's three largest customers, Lucent, Honeywell and Spectrian, accounted for 94% of the Company's net sales in 2001 compared to 95% in 2000. Net sales to Lucent related business decreased by $2,836,000 to $49,374,000 in 2001. On September 1, 2001, Lucent transitioned a segment of their manufacturing operations at Columbus, Ohio to Celestica. Celestica is based in Toronto, Canada. On September 1, 2001 Lucent also transferred most of their open purchase orders with the Company to Celestica. In 2001, Lucent's revenue also includes revenue shipments to Celestica. Beginning in 2002, the Company reported these revenues separately.
Gross Profit and Cost of Goods Sold
Gross profit increased $482,000 in 2001 from $9.9 million in 2000 to $10.4 million in 2001. Gross margin increased to approximately 19% in 2001 from approximately 17% in 2000. The increase in gross profit is a result of improved margins and the Company's decision to enter into the industrial electronics market.
During 2001, one manufacturer accounted for approximately 60% of the printed circuit boards supplied to the Company compared to 67% in 2000. The Company has a total reserve for inventory obsolescence of $2,027,000 at December 31, 2001 and December 31, 2000; substantially related to specific inventory. The inventory obsolescence reserve requires the use of estimates. The Company believes the techniques and assumptions used in establishing the reserve is appropriate. Please see Financial Statement Schedules on page 39.
Operating Expenses
General and administrative expenses were $2,722,000 or 5.0% of net sales in 2001, compared to $2,458,000 or 4.3% of net sales in 2000. General and administrative expenses consist primarily of salaries and benefits, professional services, depreciation of office equipment, computer systems and occupancy expenses. Payroll related expenses were down $285,000 due to a reduction in bonus paid to administrative personnel. Depreciation expense was up $142,000 principally relating to the acquisition of the new facility in West Chicago, Illinois. The Company also recorded a reserve of $195,000 relating to the Note Receivable from Performance Interconnect as outlined in Liquidity and Capital Resources.
Selling and marketing expenses were $1,536,000 or 2.8% of net sales in 2001, compared to $1,527,000 or 2.7% of net sales in 2000. Selling and marketing expenses include the cost of salaries, advertising and promoting the Company's products and the commissions paid to independent sales organizations. There was very little change in selling and marketing expenses.
Operating Income
Operating income was $6,112,000 or 11.1% of net sales in 2001, compared to $5,904,000 or 10.3% of net sales in 2000. The change in operating income can be summarized as follows:
Decrease in net sales ($470,000) Increase in gross margin 953,000 Increase in operating expenses (275,000) ----------
Increase in operating income $ 208,000 ==========
Interest Income
Interest income from short-term investments was $112,000 in 2001 compared to $114,000 in 2000.
Interest Expense
Interest expense, primarily related to new borrowings for the West Chicago facility, was $425,000 in 2001 compared to $339,000 in 2000.
Rental income
Rental income, primarily relating to the P C Dynamics facility, was $176,000 in 2001 compared to $204,000 in 2000. The Company sold the P C Dynamics facility in the fourth quarter of 2001.
Insurance Settlement
The Company recorded a one-time gain of $62,000 in 2000 relating to the fire at the PC Dynamics facility in 1994.
Gain on disposal of fixed assets
The Company recorded a gain of $291,000 in 2001 relating to the sale of the P C Dynamics facility in the fourth quarter of 2001.
Income Taxes
The Company had an effective tax rate of 39.4% in 2001 compared to 33.7% in 2000. The increase relates to the usage of tax credits and net operating loss carry forward in 2000.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided (used) by operations was $1,566,000, $11,410,000 and $(5,673,000) in 2002, 2001 and 2000, respectively. Inventories increased $193,000 at year ended December 31, 2002, due to an increase in Virtual Manufacturing sales. Accounts receivable was down $7,773,000 due to decreased sales in the fourth quarter of 2002 compared to the fourth quarter of 2001. Days of sales outstanding is at 51 days, 58 days and 45 days at December 31, 2002, 2001 and 2000, respectively. Depreciation and amortization in 2002 was $1,446,000, up $79,000 due to the capital equipment purchased for the new facility in West Chicago, Illinois. Accounts Payable was up $595,000 due mainly to increased purchases in the fourth quarter of 2002 compared to the fourth quarter of 2001.
Purchases of property, plant and equipment were $2,997,000, $7,558,000, and $2,421,000 in 2002, 2001 and 2000, respectively. The Company purchased a new facility in 2000 at a cost of approximately $1,600,000. Capital expenditures relating to the new West Chicago Facility were $2,856,000 in 2002 and $6,374,000 in 2001. The Company plans to spend approximately $300,000 in 2003 on capital expenditures mainly relating to the new facility in West Chicago. The expenditures were partially financed through borrowings of approximately $2,320,000 and cash provided by operations.
On November 13, 2001, the Company sold its facility located in Frisco, Texas. The Company received $2,388,000 from the sale of the facility. $1,445,000 was used to satisfy the debt associated with the facility and $943,000 was used to reduce credit line debt at the time of the sale.
The Company completed financing of $8,100,000 from the Illinois Development Finance Authority's 2001 maximum limit on tax-exempt private activity bonds to finance its facility in West Chicago, Illinois on July 26, 2001. The bond replaced approximately $2,865,000 of credit line debt, which had an interest rate of 6% at the time. The interest on the bond is set weekly: the current rate for the week ending February 28, 2003 was approximately 1.39%. The term of the loan is 20 years. The outstanding balance as of December 31, 2002 was $4,910,000. The Company is required to pay $1,320,000 each year through quarterly sinking fund payments of $325,000. The next payment of $1,320,000 is due in the third quarter of 2003. The Company has been making quarterly sinking fund payments of $325,000, except that the December quarterly payment was not made until February 2003. The Company also entered into a five-year agreement on September 4, 2001 with American National Bank and Trust Company of Chicago hedging $4,000,000 of the Industrial Bond Debt at a 4.24% rate of interest.
The Company's industrial bond debt documents contain a number of significant covenants that, among other things, restrict the Company's ability to dispose of assets, incur additional indebtedness, pay dividends, enter into certain investments, enter into sale and lease-back transactions, make certain acquisitions, engage in mergers and consolidations, create liens, or engage in certain transactions with affiliates, and otherwise restrict corporate and business activities. In addition, the Company is required to comply with specified financial ratios and tests, including a minimum tangible net worth test, a minimum interest coverage ratio and a maximum leverage ratio. The Company's ability to comply with these covenants and restrictions may be affected by events beyond the Company's control. A failure by the Company to comply with these covenants and restrictions would result in an event of default under the Company's industrial bond debt documents.
The Company was in default on September 30, 2002 because of its failure to comply with the financial ratios as set forth in the Reimbursement Agreement relating to the bond. On November 8, 2002, the Company entered into a Forbearance Agreement with Bank One, N. A., formerly known as American Bank and Trust Company of Chicago, pursuant to which the Company agreed to comply with all of the terms and conditions contained in the Forbearance Agreement and the Bank agreed to forbear from the date of the agreement to December 31, 2002 from pursuing its rights under the Reimbursement Agreement (including the right to declare the bond immediately due and payable) provided the Company complies with all of the terms and conditions contained in the Forbearance Agreement.
The Company was not in compliance with certain financial covenants for the year ended December 31, 2002 relating to the Company's industrial bond debt. The outstanding balance of the debt is approximately $4,907,000 as of March 14, 2003. On March 31, 2003, the Company entered into a Forbearance Agreement with Bank One, N. A., formerly known as American Bank and Trust Company of Chicago, pursuant to which the Company agreed to comply with all of the terms and conditions contained in the Forbearance Agreement and the Bank agreed to forbear from the date of the agreement to August 31, 2003 from pursuing its rights under the Reimbursement Agreement (including the right to declare the bond immediately due and payable) provided the Company complies with all of the terms and conditions contained in the Forbearance Agreement. A copy of the Forbearance Agreement is filed as Exhibit 10.11 to this Annual Report on Form 10-K and is hereby incorporated by reference.
Under the terms of the Forbearance Agreement, the Company has agreed to deposit in the Sinking Fund Account for the Industrial Bond debt:
(i) $1,500,000 on the earlier of (x) receipt by the Borrower of any federal tax refund or (y) April 30, 2003; and
(ii) $500,000 on the earlier of (x) receipt by the Borrower of any state tax refund or (y) June 30, 2003; and
(iii) $300,000 on the earlier of (x) receipt by Borrower of the proceeds of the sale of its real estate located at 215 Park Street, Bensenville, Illinois or (y) August 15, 2003.
The Company expects to satisfy the terms of the Forbearance Agreement by depositing in the Sinking Fund account $1.5 million out of an anticipated Federal tax refund in April of approximately $3.0 million and $500,000 of anticipated state tax refunds during 2003 of approximately $900,000. The Company is also in discussions with third parties concerning the sale of certain fixed assets no longer being used at the Company's Bensenville facility. The Company's ability to comply with the terms of the Forbearance Agreements will depend upon the amount and timing of the aforementioned tax refunds and asset sales, which are subject to factors that are beyond the Company's control. If the Company does not comply with the terms of the Forbearance Agreement, the lender may declare the entire amount of the bond immediately due and payable.
Even if the Company complies with the terms of the Forbearance Agreement, there can be no assurances that the lender and the Company will continue to enter into forbearance agreements beyond August 31, 2003, if necessary, or that the terms of such agreements will not have a material adverse effect on the Company's ability to fund working capital or give the Company sufficient time and flexibility to avoid future defaults under the industrial bond debt. The Company may be required to refinance the industrial bond debt. There can be no assurance that any such refinancing would be available on commercially reasonable terms, if at all. Any such refinancing may require the Company to issue warrants for the Company's common stock, which may result in significant dilution of existing stockholders' ownership interest.
The report of the independent auditors accompanying the consolidated financial statements of this Annual Report on Form 10-K states that the foregoing matters raise substantial doubt about the Company's ability to continue as a going concern. See Note 3 to Consolidated Financial Statements. There can be no assurances that the forgoing matters will not adversely impact the Company's relationship with its suppliers and customers.
The terms of the Company's long-term bank debt represent the borrowing rates currently available to the Company; accordingly, the fair value of this debt approximates its carrying amount.
The Company had a line of credit agreement, which expired on May 15, 2002. The Company is currently negotiating to replace short and long-term debt.
The Company's ability to make scheduled principal and interest payments on, or to refinance, its indebtedness, or to fund working capital and anticipated capital expenditures will depend on the Company's future performance, which is subject to general economic, financial, competitive and other factors that are beyond its control. The Company's ability to fund operating activities is also dependent upon (a) the Company's anticipated receipt of approximately $3.0 million in Federal tax refunds in April and $900,000 in state tax refunds during 2003, (b) proceeds of anticipated sales of fixed assets no longer required at the Company's Bensenville facility, (c) the Company's ability to refinance the industrial bond debt and/or continue to enter into forbearance agreements beyond August 31, 2003, if necessary relating to such debt, (d) the Company's ability to effectively manage its expenses in relation to revenues and (e) the Company's ability to access external sources of financing. Based upon the current level of operations and anticipated growth, management believes that future cash flow from operations, the anticipated receipt of the aforementioned tax refunds, proceeds from
the sale of certain fixed assets and funds from external sources of debt financing will be adequate to meet its anticipated liquidity requirements over the next 12 months. The Company is currently negotiating additional debt financing. There can be no assurances that such debt financing will be available on commercially reasonable terms, if at all. Any such debt financing may require the Company to issue warrants for the Company's common stock, which may result in significant dilution of existing stockholders' ownership interest. There can be no assurances that the Company's operations and access to external sources of financing will continue to provide resources sufficient to service the Company's indebtedness after satisfying liabilities arising in the ordinary course of business.
The Company has an installment loan of $108,000 collateralized by certain fixed assets of the Company. Interest on this loan is at the prime rate (4.25% at December 31, 2002). The loan is payable in monthly installments of principal and interest and is due October 2004.
On December 18, 1998, the Company repurchased 1,563,928 shares of its common stock owned by First Chicago Equity Corporation (""FCEC") and its affiliates. The aggregate consideration paid by the Company consisted of $781,964 plus warrants to purchase up to 1,563,928 shares of the Company's common stock with an exercise price of $0.50 per share (increasing by $0.025 per share each anniversary date of the warrants). The warrants are exercisable only if the Company engages in an extraordinary transaction (e.g., a merger, a consolidation, combination or dissolution) within five years of the issue date of the warrants.
On March 25, 1999, PC Dynamics Corporation, a wholly owned subsidiary of the Company, sold substantially all of its machinery and equipment, inventory and accounts receivable and assigned substantially all of its outstanding contracts and orders to Performance Interconnect Corp., a Texas Corporation ("PIC"). The purchase price paid by PIC consisted of:
(i) $893,319 Cash
(ii) a promissory note in the principal amount of $773,479, which is payable in nine (9) equal monthly installments commencing on July 1, 1999.
(iii) a promissory note in the principal amount of $293,025, which is payable in monthly installments of $50,000 commencing on May 1,1999 until paid. The Company has collected the full amount of this note.
PC Dynamics and PIC also entered into a royalty agreement which provides for PIC to pay PC Dynamics a royalty equal to 8.5% of the net invoice value of certain microwave frequency components and circuit boards sold by PIC for eighteen months following the closing. PIC shall not be required to pay P C Dynamics in excess of $500,000 in aggregate royalty payments.
In addition, PC Dynamics has leased its facility in Texas to PIC for $17,000 per month for three years. PIC has the right under the lease to purchase the facility from PC Dynamics for $2,000,000 at anytime during the term of the lease. If PIC exercises its right to purchase the facility, the remaining balance due on the royalty agreement is payable in monthly installments of $25,000 until a minimum of $500,000 is paid.
This agreement was amended in the third quarter of 1999 whereas the Company agreed to revise the payment schedule for Promissory Note I from 9 equal monthly installments to 30 equal monthly installments in return for not pursuing the purchase of the facility in Texas. The Company has collected $133,000 through December 31, 2000. The royalty agreement was also revised to $500,000 payable in equal monthly installments of $25,000 until paid. The Company collected $145,000 through December 31, 2000.
On November 8, 2001, Performance Interconnect (PIC) exercised its right and purchased the facility located in Frisco, Texas per the terms of the agreement dated March 25, 1999. The Company also amended the Promissory Note with Performance Interconnect whereas PIC agreed to pay the
Company $711,649 in 29 equal monthly installments of principal and interest (prime plus 1%) of $10,140.69 commencing December 15, 2001 with the entire unpaid balance of principal and interest due May 15, 2004. As of December 31, 2002, the Company collected approximately $142,000 per the terms of the new agreement.
Inflation
Management believes inflation has not had a material effect on the Company's operation or on its financial position.
NEW ACCOUNTING STANDARDS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 addresses a variety of accounting practices. Its provisions related to the rescission of SFAS No. 4 (Reporting Gains and Losses from Extinguishment of Debt) are effective for fiscal years beginning after May 15, 2002. Its provisions related to SFAS No. 13 (Accounting for Leases) are effective for transactions occurring after May 15, 2002. All other provisions are effective for financial statements issued on or after May 15, 2002. SFAS No. 44 was titled "Accounting for Intangible Assets of Motor Carriers." SFAS No. 64 was titled "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements."
The Company adopted the provisions of SFAS No. 145 that were effective as of May 15, 2002. This adoption did not have a material effect on the Company's results of operations or financial position. The Company does not expect adoption of the provisions that are effective for fiscal years beginning after May 15, 2002, to have a material effect on its results of operations or financial position.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." It requires recognition of costs associated with exit or disposal activities at the time they are incurred rather than at the date of a commitment to an exit or disposal plan. The statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not expect adoption of this statement to have a material effect on its results of operations or financial position.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." It is an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize at the inception of a guarantee a liability for the fair value of the obligation undertaken in issuing the guarantee. Initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. Disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company does not expect adoption of this interpretation to have a material effect on its results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure." It amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported amounts. The amendments to SFAS No. 123 in paragraphs 2(a)-2(e) were effective for financial statements for fiscal years ending after December 15, 2002, and were adopted by the Company in 2002. This adoption did not have a material effect on the Company's results of operations or financial position. The amendment to SFAS No. 123 in paragraph 2(f) and the amendment to Opinion 28 in paragraph 3 are effective for financial reports containing condensed
financial statements for interim periods beginning after December 15, 2002. The Company does not expect adoption of these portions of the statement to have a material effect on its results of operations or financial position.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities." It is an interpretation of Accounting Research Bulletin No. 51 and revises the requirements for consolidation by business enterprises of variable interest entities. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest acquired before February 1, 2003. FIN 46 applies to public enterprises as of the beginning of the applicable interim or annual period and to nonpublic enterprises as of the end of the applicable annual period. It may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The Company is not party to any variable interest entity. It does not expect adoption of this interpretation to have a material effect on its results of operations or financial position.
Foreign Currency Transactions
All of the Company's foreign transactions are negotiated, invoiced and paid in United States dollars.
RISK FACTORS AFFECTING BUSINESS AND RESULTS OF OPERATIONS
You should carefully consider the following factors that may affect our business, future operating results and financial condition, as well as other information included in this Annual Report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.
Default Under Industrial Bond Debt
The Company was not in compliance with certain financial covenants for the year ended December 31, 2002 relating to the Company's industrial bond debt. The outstanding balance of the debt is approximately $4,907,000 as of March 14, 2003. On March 31, 2003, the Company entered into a Forbearance Agreement with Bank One, N. A., formerly known as American Bank and Trust Company of Chicago, pursuant to which the Company agreed to comply with all of the terms and conditions contained in the Forbearance Agreement and the Bank agreed to forbear from the date of the agreement to August 31, 2003 from pursuing its rights under the Reimbursement Agreement (including the right to declare the bond immediately due and payable) provided the Company complies with all of the terms and conditions contained in the Forbearance Agreement. A copy of the Forbearance Agreement is filed as Exhibit 10.11 to this Annual Report on From 10-K and is hereby incorporated by reference.
Under the terms of the Forbearance Agreement, the Company has agreed to deposit in the Sinking Fund Account for the Industrial Bond Debt:
(i) $1,500,000 on the earlier of (x) receipt by the Borrower of any federal tax refund or (y) April 30, 2003; and
(ii) $500,000 on the earlier of (x) receipt by the Borrower of any state tax refund or (y) June 30, 2003; and
(iii) $300,000 on the earlier of (x) receipt by Borrower of the proceeds of the sale of its real estate located at 215 Park Street, Bensenville, Illinois or (y) August 15, 2003
The Company expects to satisfy the terms of the Forbearance Agreement by depositing in the sinking fund account $1.5 million out of an anticipated Federal tax refund in April of approximately $3.0 million and $500,000 of anticipated state tax refunds during 2003 of approximately $900,000. The
Company is also in discussions with third parties concerning the sale of certain fixed assets no longer being used at the Company's Bensenville facility. The Company's ability to comply with the terms of the Forbearance Agreements will depend upon the amount and timing of the aforementioned tax refunds and asset sales, which are subject to factors that are beyond its control. If the Company does not comply with the terms of the Forbearance Agreement, the lender may declare the entire amount of the bond immediately due and payable.
Even if the Company complies with the terms of the Forbearance Agreement, there can be no assurances that the lender and the Company will continue to enter into forbearance agreements beyond August 31, 2003, if necessary, or that the terms of such agreements will not have a material adverse effect on the Company's ability to fund working capital or give the Company sufficient time and flexibility to avoid future defaults under the industrial bond debt. The Company may be required to refinance the industrial bond debt. There can be no assurance that any such refinancing would be available on commercially reasonable terms, if at all. Any such refinancing may require the Company to issue warrants for the Company's common stock, which may result in significant dilution of existing stockholders' ownership interest. See also "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Risk Factors affecting Business and Results of Operations-Default under Industrial Bond Debt and - -Liquidity."
The report of independent auditors accompanying the consolidated financial statements in this Annual Report on Form 10-K states that the foregoing matters raise substantial doubt about the Company's ability to continue as a going concern. See Note 3 in the Notes to the Consolidated Financial Statements. There can be no assurances that the forgoing matters will not adversely impact the Company's relationship with its suppliers and customers.
Liquidity
The Company's ability to make scheduled principal and interest payments on, or to refinance, its indebtedness, or to fund working capital and anticipated capital expenditures will depend on the Company's future performance, which is subject to general economic, financial, competitive and other factors that are beyond its control. The Company's ability to fund operating activities is also dependent upon (a) the Company's anticipated receipt of approximately $3.0 million in Federal tax refunds in April and $900,000 in state tax refunds during 2003, (b) proceeds of anticipated sales of fixed assets no longer required at the Company's Bensenville facility, (c) the Company's ability to refinance the industrial bond debt and/or continue to enter into forbearance agreements beyond August 31, 2003, if necessary relating to such debt, (d) the Company's ability to effectively manage its expenses in relation to revenue shortfalls and (e) the Company's ability to access external sources of financing. Based upon the current level of operations and anticipated growth, management believes that future cash flow from operations, the anticipated receipt of the aforementioned tax refunds, proceeds from the sale of certain fixed assets and funds from external sources of debt financing will be adequate to meet its anticipated liquidity requirements over the next 12 months. The Company is currently negotiating additional debt financing. There can be no assurances that such debt financing will be available on commercially reasonable terms, if at all. Any such debt financing may require the Company to issue warrants for the Company's common stock, which may result in significant dilution of existing stockholders' ownership interest. In addition, the Company's ability to incur additional indebtedness is limited by covenants in the Company's industrial bond debt. There can be no assurances that the Company's operations and access to external sources of financing will continue to provide resources sufficient to service the Company's indebtedness after satisfying liabilities arising in the ordinary course of business.
Dependence on Major Customers
The Company's three largest customers accounted for 72% of the Company's net sales in 2002. The Company expects that a small number of customers will continue to account for a substantial majority of its sales and that the relative dollar amount and mix of products sold to any of these customers can change significantly from year to year. There can be no assurance that the Company's major customers will continue to purchase products from the Company at current levels,
or that the mix of products purchased will be in the same ratio. The loss of the Company's largest customer or a change in the mix of product sales would have a material adverse effect on the Company.
Competition: Ability to Respond to Technical Advances
The Company's future success is highly dependent upon its ability to manufacture products that incorporate new technology and are priced competitively. The market for the Company's products is characterized by rapid technology advances and industry-wide competition. This competitive environment has resulted in downward pressure on gross margins. In addition, the Company's business has evolved towards the production of relatively smaller quantities of more complex products, the Company expects that it will at times encounter difficulty in maintaining its past yield standards. There can be no assurance that the Company will be able to develop technologically advanced products or that future-pricing actions by the Company and its competitors will not have a material adverse effect on the Company's results of operations.
Dependence on Overseas Manufactures
The Company is dependent upon unaffiliated foreign companies for the manufacture of printed circuit boards as part of its Virtual Manufacturing process. The Company's arrangements with manufacturers are subject to the risks of doing business abroad, such as import duties, trade restrictions, production delays due to unavailability of parts or components, transportation delays, work stoppages, foreign currency fluctuations, political instability and other factors which could have an adverse effect on the Company's business, financial condition and results of operations. The Company believes that the loss of any one or more of its suppliers would not have a long term material adverse effect on its business, financial condition and results of operations because other manufacturers would be able to increase production to fulfill its requirements. However, the loss of certain suppliers, could, in the short term adversely affect its business until alternative supply arrangements were secured.
Fluctuations in Quarterly Operating Results
Our quarterly results of operations are subject to significant variation for a variety of reasons, including the following:
The timing and volume of our customers' orders; o Price and product competition; o Changes in mix of products we sell; o The levels at which we utilize our manufacturing capacity; o Our level of experience in manufacturing a particular product; o Manufacturing process yields; and o Raw material availability.
Each of these factors has had in the past, and may have in the future, an adverse effect on our quarterly operating results. In addition, a significant portion of our operatng expenses are relatively fixed in nature and planned expenditures are based in part on anticipated orders. Any inability to adjust spending quickly enough to compensate for any revenue shortfalls may magnify the adverse impact of such revenue shortfalls of our results of operations. As a result, our operating results may vary significantly from one quarter to the next.
Environmental Laws
We are required to comply with all federal, state, county and municipal regulations regarding protection of the environment. Printed circuit board manufacturing requires the use of a variety of materials, including metals and chemicals. Water used in the printed circuit board manufacturing process must be treated to remove metal particle and other contaminants before it can be discharged
into the municipal sanitary sewer system. As a result, we are subject to various federal, state, local and foreign environmental laws and regulations, including those governing storage, use, discharge and disposal of hazardous substances in the ordinary course of our manufacturing processes. Although we believe our current manufacturing operations comply in all material respects with applicable environmental laws and regulations, environmental legislation has been enacted and may in the future be enacted or interpreted to create environmental liability with respect to our facilities or operations. We may be responsible for the cleanup of any contamination discovered at our current and former manufacturing facilities and could be subject to revocatin of permits necessary to conduct business. Further, we cannot guaranty that additional environmental matters will not arise in the future at sites where no problem is currently known or at sites that we may acquire in the future.
Common Stock: Possible De-listing
The market value of our publicly held shares has fallen below the minimum market value of $5.0 million as required by the Nasdaq National Market on which our common stock is currently listed. If the minimum market value of our publicly held shares remains below $5.0 million, the Company may be delisted from the Nasdaq National Market which could reduce the liquidity of our common stock, further decrease the market price of our common stock and negatively impact our ability to obtain additional capital. The Company has until April 28, 2003 to comply with the Nasdaq National Market listing requirements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company entered into a five-year agreement on September 4, 2001 with American National Bank and Trust Company of Chicago, hedging $4,000,000 of the Company's industrial bond debt at a 4.24% rate of interest.
Item 8.
Item 8. Financial Statements and Supplementary Data
Consolidated financial statements and the related notes for each of the three years in the period ended December 31, 2002 are filed in response to this Item pursuant to Item 14.
The supplementary data regarding quarterly results of operations, set forth under the caption "Selected Quarterly Financial Data (Unaudited)" following the aforementioned consolidated financial statements, are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information required by this Item with respect to Executive Officers of the Company is set forth in Part I, Item 4 and is incorporated herein by this reference. Information required by this Item with respect to members of the Board of Directors of the Company will be contained in the Proxy Statement for the Annual Meeting of Stockholders (the "2003 Proxy Statement"), and is incorporated herein by this reference.
Item 11.
Item 11. Executive Compensation
Information required by this Item will be contained in the 2003 Proxy Statement and is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this Item will be contained in the 2003 Proxy Statement and is incorporated herein by this reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information required by this Item will be contained in the 2003 Proxy Statement and is incorporated herein by this reference.
PART IV
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES. - ----------------------------------
(a) Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer and its Chief Financial Officer, have reviewed and evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of a date within 90 days of the filing date of this annual report on Form 10-K (the "Evaluation Date"). Based on their review and evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities in a timely manner, particularly during the period in which this annual report on Form 10-K was being prepared, and that no changes are required at this time.
(b) Changes in Internal Controls
There were no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's internal controls subsequent to the Evaluation Date, or any significant deficiencies or material weaknesses in such internal controls requiring corrective actions. As a result, no corrective actions were taken.
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements
Page in the Form 10-K --------- Independent Certified Public Accountants Report 33
Consolidated Balance Sheets December 31, 2002 and 2001 35
Consolidated Statements of Operations Years Ended December 31, 2002, 2001 and 2000 36
Consolidated Statements of Stockholders' Equity Years Ended December 31, 2002, 2001 and 2000 37
Consolidated Statements of Cash Flows Years Ended December 31, 2002, 2001 and 2000 38-39
Notes to Consolidated Financial Statements 40-51
Selected Quarterly Financial Data (Unaudited) 52
Subsidiaries 61
(a) 2. Financial Statement Schedules
Allowance for Doubtful Accounts 53 Inventory Obsolescence 53
(a) 3. Exhibits
The exhibits filed herewith are set forth on the Index to Exhibits filed as part of this report.
(b) Reports on Form 8-K o A current report on Form 8-K was filed on October 4, 2002, disclosing under item 5, expected third quarter 2002 revenues and other matters o A current report on Form 8-K was filed on October 31, 2002, disclosing under item 5, third quarter 2002 results and other matters o A current report on Form 8-K was filed on January 10, 2003, disclosing under item 5, expected fourth quarter 2002 revenues and other matters
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACOUNTANTS
Board of Directors M~Wave, Inc.
We have audited the accompanying consolidated balance sheets of M~Wave, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the management of M~Wave, Inc. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of M~Wave, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule II of M~Wave, Inc.,and Subsidiaries for the years ended December 31, 2002, 2001 and 2000. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therin.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, as of December 31, 2002, the Company was in default of certain debt covenants under its Industrial Revenue Bond Agreement. On March 26, 2003, the Company entered into a Forbearance Agreement where the Company agreed to comply with all the terms and conditions and the Bank agreed to forbear on its rights to call the debt from the date of the agreement through August 31, 2003. The Company's business plan for 2003, which is also described in Note 3, contemplates reduced operating losses, obtaining additional working capital, and the refinancing its long-term debt. The Company's ability to achieve the foregoing elements of its business, which may be necessary to permit the realization of assets and satisfaction of liabilities in the ordinary course of business, is uncertain and raises substantial doubt about its ability to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of this uncertainty.
GRANT THORNTON LLP
Chicago, Illinois January 30, 2003 (except for footnote No. 3 and 7, as of March 31, 2003)
M~WAVE, Inc. and Subsidiaries - -----------------------------
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries - -----------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries - -----------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries - -----------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See notes to consolidated financial statements.
M~WAVE, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 - --------------------------------------------------------------------------------
1. ORGANIZATION AND OPERATIONS
M~Wave, Inc. ("M~Wave"), a Delaware corporation, was formed on January 31, 1992. On January 31, 1992, Poly Circuits, Inc. ("Poly Circuits") became a wholly owned subsidiary of M~Wave through an exchange in which the former stockholders of Poly Circuits received 100 shares of M~Wave common stock for each outstanding share of Poly Circuits.
M~Wave, Inc., currently operating through its wholly-owned subsidiary Poly Circuits, Inc. (the "Company"), is a value-added service provider of high performance printed circuit boards used in a variety of telecommunications applications for wireless and internet communications and digital applications. M~Wave satisfies its customers needs for high performance printed circuit boards by using its 50,000 square foot state-of-the-art facility located in West Chicago, Illinois and by outsourcing and coordinating the manufacture of such boards by unaffiliated manufacturers located primarily in the Far East ("Virtual Manufacturing")
2. SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Principles of Consolidation - The consolidated financial statements include the accounts of M~Wave and its wholly owned subsidiaries. Significant intercompany transactions and account balances have been eliminated.
Revenue Recognition - The Company recognizes revenue when product is shipped to customers. The Company recognizes revenue for consignment inventory products when the Customer uses the Consigned inventory.
Cash and Cash Equivalents - Cash and cash equivalents comprise cash in banks and highly liquid investments that are both readily convertible to known amounts of cash or purchased with a maturity of three months or less.
Accounts Receivable - The majority of the Company's accounts receivable are due from companies in the telecommunications industries. Credit is extended based on evaluation of a customers' financial condition and, generally, collateral is not required. Accounts receivable are due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.
Inventories - Inventories are carried at the lower of first-in, first-out (FIFO) cost or market. Substantially all the Company's inventories are work-in-process.
Restricted Cash - In connection with the Industrial Revenue Bond the Company is required to make quarterly sinking fund payments of $325,000 per quarter. Beginning September 2002, and continuing each quarter thereafter, the balance in the sinking fund is disbursed to the bondholders.
Derivative Instruments - In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," which was later amended by Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133" and by statement No. 138, "Accounting for Certain Derivatives Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133" (collectively, "SFAS No., 133"). SFAS No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities measured at fair value. The accounting treatment of gains and losses resulting from changes in the value of derivatives depends on the use of the derivatives and whether they qualify for hedging accounting. The Company has adopted SFAS No. 133 as of January 1, 2001. Adoption of SFAS No. 133 is recorded as a cumulative effect of a change in accounting principles and would not result in restatement of previously issued financial statements. However, the effect of adoption of SFAS No. 133 was not material.
The Company has entered into a $4,000,000 interest rate swap agreement as a means of managing its interest rate exposure under its Industrial Revenue Bond. The agreement has the effect of converting the variable rate to a fixed rate. The interest rate swap agreement is not designated as a hedging instrument. This contract is accounted for by adjusting the carrying amount of the contract to market and recognizing the gain or loss in interest expense. In 2002, 2001 and 2000 mark to market interest expense was $92,723, $20,308 and $0, respectively.
Property, Plant and Equipment - Property, plant and equipment are recorded at cost. The Company calculates depreciation using the straight-line method at annual rates as follows:
Building and improvements 3% to 20% Machinery and equipment 10% to 20%
Fair Value of Financial Instruments - The fair value of financial instruments are not materially different from their carrying values.
Income Taxes - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax basis at enacted tax rates when such amounts are supposed to be realized or settled.
Stock Incentive Plans - The Company maintains a stock incentive plan. See Note 11 for additional information regarding this plan. The Company accounts for this plan under the recognition and measurement principles of Accounting Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No compensation cost is recognized for stock option grants. All options granted under the Company's plans had an exercise price equal to the market value of the underlying common stock on the date of the grant. The following table illustrates the effect of net income and earnings per share if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," to Stock-Based compensation. The following table also provides the amount of Stock-Based compensation cost included in net income as reported.
Shipping and Handling Fees and Costs - In September 2000, the Emerging Issues Task Force ("EITF") released Issue No.00-10, "Accounting for Shipping and Handling Fees and Costs". The Issue requires that shipping and handling costs be classified as costs of goods sold, and shipping and handling fees billed to customers be classified as revenues. Previously, the Company had netted its revenues from shipping and handling fees billed to customers against the related costs, and included the net amount as a component of cost of goods sold.
Effective for the year ended December 31, 2000, the Company has classified all shipping and handling fees billed to customers as net sales for all periods presented.
Net Earnings (Loss) Per Share - The Company's basic net earnings (loss) per share amounts have been computed by dividing net earnings (loss) by the weighted average number of outstanding common shares. The Company's diluted net earnings (loss) per share is computed by dividing net earnings (loss) by the weighted average number of outstanding common shares and common share equivalents relating to stock options, when dilutive, based on cumulative year-to-date net earnings or losses.
New Accounting Standards - In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 addresses a variety of accounting practices. Its provisions related to the rescission of SFAS No. 4 (Reporting Gains and Losses from Extinguishment of Debt) are effective for fiscal years beginning after May 15, 2002. Its provisions related to SFAS No. 13 (Accounting for Leases) are effective for transactions occurring after May 15, 2002. All other provisions are effective for financial statements issued on or after May 15, 2002. SFAS No. 44 was titled "Accounting for Intangible Assets of Motor Carriers." SFAS No. 64 was titled "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements."
The Company adopted the provisions of SFAS No. 145 that were effective as of May 15, 2002. This adoption did not have a material effect on the Company's results of operations or financial position. The Company does not expect adoption of the provisions that are effective for fiscal years beginning after May 15, 2002, to have a material effect on its results of operations or financial position.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." It requires recognition of costs associated with exit or disposal activities at the time they are incurred rather than at the date of a commitment to an exit or disposal plan. The statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not expect adoption of this statement to have a material effect on its results of operations or financial position.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." It is an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize at the inception of a guarantee a liability for the fair value of the obligation undertaken in issuing the guarantee. Initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. Disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company does not expect adoption of this interpretation to have a material effect on its results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure." It amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported amounts. The amendments to SFAS No. 123 in paragraphs 2(a)-2(e) were effective for financial statements for fiscal years ending after December 15, 2002, and were adopted by the Company in 2002. This adoption did not have a material effect on the Company's results of operations or financial position. The amendment to SFAS No. 123 in paragraph 2(f) and the amendment to Opinion 28 in paragraph 3 are effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The Company does not expect adoption of these portions of the statement to have a material effect on its results of operations or financial position.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities." It is an interpretation of Accounting Research Bulletin No. 51 and revises the requirements for consolidation by business enterprises of variable interest entities. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest acquired before February 1, 2003. FIN 46 applies to public enterprises as of the beginning of the applicable interim or annual period and to nonpublic enterprises as of the end of the applicable annual period. It may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The Company is not party to any variable interest entity. It does not expect adoption of this interpretation to have a material effect on its results of operations or financial position.
Long Lived Assets - In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets." SFAS No. 144 is effective for fiscal years beginning after December 15, 2001, and addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequent Occurring Events and Transactions," for the disposal of a segment of a business. The Company adopted SFAS No 144 in connection with its Bensenville plant and facilities.
Basis of Presentation - Certain prior year amounts have been reclassified to conform with the 2002 presentation.
3 REALIZATION OF ASSETS
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the company as a going concern. However, the Company has sustained substantial losses from operations in 2002, and such losses have continued through the unaudited quarter ended March 31, 2003. As of December 31, 2002, the Company was in default of certain debt covenants under its Industrial Revenue Bond Agreement. On March 26, 2003, the Company entered into a Forbearance Agreement where the Company agreed to comply with all the terms and conditions and the Bank agreed to forbear on its rights to call the debt from the date of the agreement through August 31, 2003. A copy of the Forbearance Agreement is filed as Exhibit 10.11 to this Annual Report on Form 10-K and is hereby incorporated by reference.
Under the terms of the Forbearance Agreement, the Company has agreed to deposit in the Sinking Fund Account for the Industrial Bond Debt:
(i) $1,500,000 on the earlier of (x) receipt by the Borrower of any federal tax refund or (y) April 30, 2003; and
(ii) $500,000 on the earlier of (x) receipt by the Borrower of any state tax refund or (y) June 30, 2003; and
(iii) $300,000 on the earlier of (x) receipt by Borrower of the proceeds of the sale of its real estate located at 215 Park Street, Bensenville, Illinois or (y) August 15, 2003.
In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the company, which in turn is dependent upon the company's ability to obtaining additional working capital, and the refinancing its long-term debt and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the company be unable to continue in existence.
Management has taken and/or plans to take the following action to revise its operating and financial requirements, which it believes are sufficient to provide the Company with the ability to continue in existence:
o Refinance its long-term debt o Obtain working capital financing o Hired a COO with over 25 years experience in the printed circuit market to oversee the operations of the Company to improve efficiencies and on time deliveries. o Sign additional supply chain agreements with new customers in 2003 o Hired an RF sales manager to focus on the RF business of the Company which the Company believes will add approximately $5 to $10 million of annual revenue o Froze the wages of all employees effective January 1, 2003 o Reduce the purchase cost of raw materials, supplies and repairs.
However, there can be no assurances that the Company will be able to complete the aforementioned steps.
4. INVENTORY
Inventories consisted of the following: 2002 2001 ---- ----
Raw Materials $ 543,094 $ 377,205 Work in Process 2,088,013 3,214,041 ---------- ----------- Total Inventory 2,631,107 3,591,246 Less reserve for obsolete inventory (874,466) (2,027,238) ---------- ----------- Net Inventory 1,756,641 1,564,008
Inventories are valued at the lower of cost or market value and include materials, labor and manufacturing overhead. The Company writes down inventory for estimated obsolescence or unmarketability equal to the difference between the cost of the inventory and its estimated market value based on assumptions about future demand and market conditions. If actual future demand or market conditions were to be less favorable than projected, additional inventory write-downs may be required.
5. SALE OF P C DYNAMICS CORPORATION
On March 25, 1999, PC Dynamics Corporation, a wholly owned subsidiary of the Company, sold substantially all of its machinery and equipment, inventory and accounts receivable and assigned substantially all of its outstanding contracts and orders to Performance Interconnect Corp., a Texas Corporation ("PIC"). The purchase price paid by PIC consisted of:
(i) $893,319 Cash
(ii) a promissory note in the principal amount of $773,479, payable in nine (9) equal monthly installments commencing on July 1, 1999.
(iii) a promissory note in the principal amount of $293,025, payable in monthly installments of $50,000 commencing on May 1, 1999 until paid. The Company has collected the full amount of this note.
PC Dynamics and PIC also entered into a royalty agreement which provides for PIC to pay PC Dynamics a royalty equal to 8.5% of the net invoice value of certain microwave frequency components and circuit boards sold by PIC for eighteen months following the closing. PIC shall not be required to pay P C Dynamics in excess of $500,000 in aggregate royalty payments.
In addition, PC Dynamics has leased its facility in Texas to PIC for $17,000 per month for three years. PIC has the right under the lease to purchase the facility from PC Dynamics for $2,000,000 at anytime during the term of the lease. If PIC exercises its right to purchase the facility, the remaining balance due on the royalty agreement is payable in monthly installments of $25,000 until a minimum of $500,000 is paid.
This agreement was amended in the third quarter of 1999 whereas the Company agreed to revise the payment schedule for Promissory Note I from 9 equal monthly installments to 30 equal monthly installments in return for not pursuing the purchase of the facility in Texas. The Company has collected $133,000 through December 31,2000. The royalty agreement was also revised to $500,000 payable in equal monthly installments of $25,000 until paid. The Company has collected $145,000 through December 31,2000.
On November 8, 2001, Performance Interconnect (PIC) exercised its right and purchased the facility located in Frisco, Texas per the terms of the agreement dated March 25, 1999. The Company also amended the Promissory Note with Performance Interconnect whereas PIC agreed to pay the Company $711,649 in 29 equal monthly installments of principal and interest (prime plus 1%) of $10,140.69 commencing December 15, 2001 with the entire unpaid balance of principal and interest due May 15, 2004. As of December 31, 2002, the Company collected approximately $142,000 per the terms of the new agreement.
6. ACCRUED EXPENSES
Accrued expenses at December 31, 2002 and 2001 were comprised of:
2002 2001 ---- ---- Reserve for sales returns $ 300,000 $ 844,986
Salaries and wages 282,073 684,205 Commissions 63,662 115,187 Professional fees 140,952 206,713 Property and other taxes 179,705 164,030 Other 350,187 321,412 ---------- ----------
Total accrued expenses $1,316,579 $2,336,533 ========== ==========
7. DEBT
The Company has debt as described below.
Long-term debt is comprised of the following at December 31, 2002 and 2001:
On July 26, 2001, the Company signed an agreement with the Illinois Development Finance Authority to borrow up to a maximum $8,100,000 to finance its facility in West Chicago, Illinois. Borrowings were disbursed, in accordance with the agreement, to the Company. Interest is set on a weekly basis, based upon the interest rates of comparable tax-exempt bonds under prevailing market conditions. The interest rate at December 31, 2002 was 1.49%. The term of the bond is 20 years with the first payment of $1,320,000 made in July 2002 and payments are due annually thereafter.
The terms of the Company's long-term bank debt represent the borrowing rates currently available to the Company; accordingly, the fair value of this debt approximates its carrying amount.
The mortgage notes are cross-defaulted and cross-collateralized. The credit agreement, as amended May 15, 2001 requires the Company to maintain a stipulated amount of tangible net worth and cash flow coverage ratio, as defined. The Company was in default with the covenants at December 31, 2002. On March 31, 2003, the Company entered into a Forbearance Agreement with Bank One, N. A., formerly known as American National Bank and Trust Company of Chicago, pursuant to which the Company agreed to comply with all the terms and conditions contained in the Forbearance Agreement and the Bank agreed to forbear from the date of the agreement to August 31, 2003 from pursuing its rights under the Reimbursement Agreement (including the right to declare the bond immediately due and payable) provided the Company complies with all the terms and conditions contained in the Forbearance Agreement. See attached Exhibit 10.11. As the Forbearance Agreement terminated on August 31, 2003, the balance of debt outstanding is presented as current.
8. INCOME TAXES
The provision (benefit) for income taxes consists of:
2002 2001 2000 ---- ---- ----
Current $(3,801,948) $2,525,820 $2,196,288 Deferred 518,142 (54,165) (190,982) ----------- ---------- ----------
Total $(3,283,806) $2,471,655 $2,005,306 =========== ========== ==========
The primary components comprising the net deferred tax assets (liabilities) are as follows:
2002 2001 2000 ---- ---- ---- Deferred tax assets Receivable reserves $ 39,000 $368,544 $117,000 Inventory reserves 341,042 790,623 790,623 Accrued expenses and other 368,415 154,477 210,619 ---------- ---------- ----------- Deferred tax assets 748,457 1,313,644 1,118,242
Valuation Allowance 0 0 0
Deferred tax liabilities Depreciation (616,785) (543,961) (522,593) Prepaid bond costs (0) (119,869) 0 ---------- ---------- ----------- Deferred tax (616,785) (663,830) (522,593) ---------- ---------- ----------- Net deferred tax asset $ 131,672 $ 649,814 $ 595,649 ========== ========== ===========
The effective tax (benefit) rate differs from the Federal statutory tax rate for the following reasons:
2002 2001 2000 ---- ---- ---- Federal statutory rate 34.0% 34.0% 34.0% State income taxes, net of Federal benefit 2.5 2.5 2.5 Other adjustments 2.9 (2.9) (2.8) ----- ----- ----- Effective rate (39.5)% 39.4% 33.7% ====== ====== ======
9. SIGNIFICANT CUSTOMERS AND SUPPLIERS
The percentages of net sales attributable to major customers by year were as follows:
2002 2001 2000 ---- ---- ---- Customer A 31% 90% 91% Customer B 29 2 0 Customer C 11 2 2
The loss of, or a substantial reduction in or change in the mix of orders from, any one of the Company's major customers could have a material adverse effect on the Company's results of operations and financial condition.
Approximately 47%, 94% and 64% of the Company's revenues in 2002, 2001 and 2000 respectively, were related to the cellular telephone industry.
During 2002, the largest single component of the Company's cost of goods sold was purchased printed circuit boards that accounted for approximately 43% of net sales and one manufacturer accounted for approximately 24% of the purchased printed circuit boards. In 2001, the largest single component of the Company's cost of goods sold was purchased printed circuit boards that
accounted for approximately 29% of net sales and one manufacturer accounted for approximately 60% of the purchased printed circuit boards.
During 2002, 2001 and 2000, one manufacturer accounted for approximately 45%, 54% and 41%, respectively, of the Teflon-based laminates ("Teflon based laminate") supplied to the Company. Teflon based laminate is a significant cost component of the Company's cost of goods sold representing approximately 4.9%, 3.6%, and 4.3% of net sales during 2002, 2001 and 2000, respectively. There are only four U. S. manufacturers of Teflon based laminate. Any disruption or termination of these sources of Teflon based laminate could adversely affect the Company's operations.
10. COMMON STOCK EQUITY
On October 24, 2000 the Board of Directors declared a two-for-one split of its common stock, effected in the form of a stock dividend paid on November 28, 2000 to shareholders of record on November 13, 2000. All agreements concerning stock options in shares of the Company's common stock provide for the issuance of additional shares due to the declaration of the stock split. All references to the number of shares, except shares authorized, and to per share information in the consolidated financial statements have been adjusted to reflect the stock split on a retroactive basis.
11. STOCK OPTION PLAN
In February 1992, the Board of Directors and stockholders of the Company approved a non-qualified Stock Option Plan (the "Stock Option Plan") under which 600,000 shares of common stock are reserved for issuance upon exercise of stock options. The Stock Option Plan is designed as an incentive for retaining key employees and directors.
In June 1995, the Board of Directors and stockholders of the Company approved an amendment and restatement of the Company's 1992 Stock Option Plan. The principal changes that resulted from the amendment are (1) an increase in the aggregate number of shares of Common Stock of the Company available for the exercise of options granted under the plan from 600,000 to 1,000,000; (2) a limit on the number of shares as to which options may be granted to any grantee in any calendar year to 150,000; (3) a grant of discretion to the Compensation Committee to extend the exercisability of options after a grantee's termination of employment (other than for Cause, as defined in the Plan) from 30 days to any longer period up to the full remaining term of the option; and (4) a provision for the acceleration of the exercisability of all outstanding options (regardless of when granted) in the event of a Change of Control of the Company.
In June 1997 the Board of Directors and stockholders of the Company approved an amendment and restatement of the Company's 1992 Stock Option Plan. The principal changes that resulted from the amendment are (1) to increase the aggregate number of shares of Common Stock of the Company available for the exercise of options granted under the plan from 1,000,000 to 1,500,000 and (2) to increase the limit on the number of shares as to which options may be granted to any grantee in any calendar year from 150,000 to 430,000.
The exercise price of each non-qualified stock option granted to employees of the Company under the Stock Option Plan must equal at least 80% of the fair market value of the underlying shares of common stock on the date of the grant, and the maximum term of such an option may not exceed 10 years. For all options granted to date, except for 150,000 options granted in 1995 and 420,000 shares granted in 1998, exercise price has equaled fair market value at the date of grant, the term of the option has been 10 years, and the options vest as to 25% on each of the first four anniversary dates of the grant. Exercise prices, as a percentage of fair market value at date of grant, on 150,000 options granted in 1995 are 110% as to 50,000 options, 120% as to 50,000 options and 130% as to 50,000 options. These options vest as to 33 1/3% on December 31, 1995, December 31, 1996, December 31, 1997 and the term is ten years. Exercise prices for the 420,000 shares granted in 1998 are 100,000 shares at $2.75, 140,000 at $6.10 and 180,000
shares at $8.80. These options vest at 40% on May 1, 1998, 35% on May 1, 1999 and 25% on May 1, 2000, and the term is ten years.
Stock option activity under the Plan was as follows:
-------------------------------------------------------------------------- Number of Shares Weighted Average Under Option Exercise Price -------------------------------------------------------------------------- Balance, January 1, 2000 275,500 $5.30
Granted 20,000 13.78
Forfeited (20,000) 0.66
Exercised (39,500) (2.29) --------------------------------------------------------------------------
Balance, December 31, 2000 236,000 $ 6.92
Granted 235,000 7.50
Forfeited (69,375) 7.44
Exercised 0 0 --------------------------------------------------------------------------
Balance, December 31, 2001 401,625 $ 7.17
Granted 92,000 4.50
Forfeited (81,050) 3.99
Exercised 0 0 --------------------------------------------------------------------------
Balance, December 31, 2002 412,575 $ 7.20
Exercisable at year-end:
2000 216,000 $ 4.40 2001 221,000 6.45 2002 191,894 9.84
The weighted average exercise price of the options granted in 2002 were $4.50.The weighted average exercise price of the options granted in 2001 were $7.50. The weighted average exercise prices of the options granted in 2000 were $13.78. The range of exercise prices of the 412,575 options outstanding at December 31, 2002 is $4.50 to $13.78 and the weighted average remaining contractual life is 6 years. At December 31, 2002, 1,087,425 shares were available for grant.
The Company applies Accounting Principles Board Opinion No. 25 in accounting for stock options. Accordingly, no compensation cost has been recognized for options granted. Had compensation cost for options granted been determined based on the fair value at the grant date, consistent with the method prescribed by Financial Accounting Standards Board Statement No. 123, the Company's net income (loss) and related per share amounts would have been adjusted to the following pro forma amounts:
2002 2001 2000 ---- ---- ---- Net income(loss) As reported $(5,027,547) $3,796,789 $3,939,962 Pro forma (5,494,595) 3,567,112 3,895,958
Basic net income (loss) per share As reported Basic $(1.13) $0.84 $0.86 Diluted (1.13) 0.83 0.85
Pro forma Basic (1.24) 0.79 0.85 Diluted (1.24) 0.78 0.84
Options outstanding and exercisable at December 31, 2002, by price range:
The weighted average fair value of options granted in 2002, and 2001 was $4.50 and $7.50, respectively, and was estimated at the grant date using the Black-Scholes options pricing model with the following weighted average assumptions: expected volatility of 131% and 136%, respectively: risk free interest rate of 4.39% and 4.92%, respectively; expected life of 10 and 10 years respectively; and no dividend yield.
12. EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution retirement plan covering substantially all full-time employees. The plan allows for employees to defer up to 15% of their pretax annual compensation, as defined in the plan. The Company will match up to 25% of the first 4% of base compensation that a participant contributes. The Company matching contributions were $18,993, $17,967 and $15,711 for 2002, 2001 and 2000. Additionally, the Company may contribute discretionary amounts. There were no discretionary contributions for 2002 and 1999. The Company discretionary contribution for 2001 was $104,531.
13. LEASE COMMITMENTS
The Company rents manufacturing and administrative space under operating leases. Rent expense under these leases for the years ended December 31, 2002, 2001 and 2000 was $71,600, $100,200, and $96,000, respectively.
Future minimum annual lease commitments at December 31, 2002 are as follows:
Year ---- 2003 $ 60,000 2004 $ 60,000 2005 $ 30,000
14. LITIGATION
The Company is a party to various actions and proceedings related to its normal business operations. The Company believes that the outcome of this litigation will not have a material adverse effect on the financial position or results of operations of the Company.
15. ENVIRONMENTAL MATTERS
The Company periodically generates and handles materials that are considered hazardous waste under applicable law and contracts for the off-site disposal of these materials. During the ordinary course of its operations, the Company has on occasion received citations or notices from regulatory authorities that such operations may not be in compliance with applicable environmental regulations. Upon such receipt, the Company works with such authorities to resolve the issues raised by such citations or notices. The Company's past expenditures relating to environmental compliance have not had a material effect on the financial position of the Company. The Company believes the overall impact of compliance with regulations and legislation protecting the environment will not have a material effect on its future financial position or results of operations, although no assurance can be given.
16. RESTRUCTURING CHARGES
In September 2002, the Company moved its entire operations, including its headquarters, from its Bensenville, Illinois location to West Chicago, Illinois. In September, 2002 the Company recorded restructuring expenses of $1,752,000. Restructuring expenses include costs associated with the closing, cleanup and disposition of the Bensenville facilities. These expenses include (1) the net write-down and disposal of approximately $986,000 of specific assets that were not required at the West Chicago facility, (2) cleanup, sale and related expenses of $680,000 for the Bensenville facilities and (3) severance payments of $86,000.
* * * * * *
M~WAVE, Inc. and Subsidiaries
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) - --------------------------------------------------------------------------------
Set forth below is a summary of the Company's unaudited quarterly results for each quarter during 2002 and 2001. In management's opinion, these results have been prepared on the same basis as the audited financial statements contained elsewhere herein and include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information for the periods when read in conjunction with the financial statements and notes thereto.
On October 24, 2000 the Board of Directors declared a two-for-one split of its common stock, effected in the form of a stock dividend paid on November 28, 2000 to shareholders of record on November 13, 2000. All agreements concerning stock options in shares of the Company's common stock provide for the issuance of additional shares due to the declaration of the stock split. All references to the number of shares, except shares authorized, and to per share information in the consolidated financial statements have been adjusted to reflect the stock split on a retroactive basis.
FINANCIAL STATEMENT SCHEDULES Schedule II
M~Wave, Inc. and Subsidiaries Schedule II - Reserve for Inventory Obsolescence For the years ended December 31, 2002, 2001 and 2000
Balance at Charged to Balance at Year Beginning of costs and end of period expenses Deductions period ------ -------- ---------- ------ 2002 $2,027,000 $ 662,000 $1,815,000 $ 874,000 2001 2,027,000 758,290 758,290 2,027,000 2000 137,000 1,890,000 0 2,027,000
M~Wave, Inc. and Subsidiaries Schedule II - Allowance for Doubtful Accounts For the years ended December 31, 2002, 2001 and 2000
Balance at Charged to Balance at Year Beginning of costs and end of period expenses Deductions(a) period ------ -------- ------------- ------ 2002 $100,000 $ 5,048 $ 5,048 $100,000 2001 $100,000 $ 0 $ 0 $100,000 2000 $ 10,000 $ 90,000 $ 0 $100,000
(a) Accounts charged off as uncollectable, less recovery
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
M~WAVE, Inc.
By: /s/ Joseph A. Turek ----------------------------- Joseph A. Turek Chairman of the Board, Chief Executive Officer March 31, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Joseph A. Turek /s/ Gregory E. Meyer - -------------------------- ------------------------- Joseph A. Turek Gregory E. Meyer Director Director March 31, 2003 March 31, 2003
/s/ Lavern D. Kramer /s/ Gary Castagna - -------------------------- ------------------------- Lavern D. Kramer Gary Castagna Director Director March 31, 2003 March 31, 2003
/s/ Paul H. Schmitt /s/ Don Lepore - -------------------------- ------------------------- Paul H. Schmitt Don Lepore Treasurer and Secretary Director (Principal Accounting and March 31, 2003 Financial Officer) March 31, 2003
CERTIFICATIONS
I, Joseph A. Turek, Chairman and Chief Executive Officer of M-Wave, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of M-Wave, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: /s/ Joseph A. Turek -------------------------------------- JOSEPH A. TUREK CHAIRMAN AND CHIEF EXECUTIVE OFFICER
CERTIFICATIONS
I, Paul H. Schmitt, Chief Financial Officer of M-Wave, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of M-Wave Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: /s/ Paul H. Schmitt ------------------------------------- PAUL H. SCHMITT CHIEF FINANCIAL OFFICER
EXHIBIT INDEX
*Incorporated herein by reference to the applicable exhibit to Registrants Registration Statement on Form S-1 (Registration No. 33-45499)
***Incorporated herein by reference to the applicable exhibit to the Registrant's Annual Report on Form 10-K for year ended December 31, 1995.
*****Incorporated herein by reference to the applicable exhibit report on Form 8-K dated December 18, 1998.
******Incorporated herein by reference to the applicable exhibit report to the Registrants quarterly report on form 10-Q for the quarter ended March 31, 2001.
*******Incorporated herein by reference to the applicable exhibit report to the Registrants quarterly report on form 10-Q for the quarter ended June 30, 2001
********Incorporated herein by reference to the applicable exhibit report to the Registrants quarterly report on form 10-Q for the quarter ended September 30, 2002