UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 1, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-11201
Merrimac Industries, Inc.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 22-1642321
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
41 FAIRFIELD PLACE
WEST CALDWELL, NEW JERSEY 07006
(Address of Principal Executive Offices) (Zip Code)
(973) 575-1300
(Registrant's Telephone Number)
Former name, former address and former fiscal year, if changed since last
report: N/A
---
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): Yes No X
----- -----
As of November 11, 2005, there were 3,146,615 shares of Common Stock, par value
$0.01 per share, outstanding.
MERRIMAC INDUSTRIES, INC.
41 Fairfield Place
West Caldwell, NJ 07006
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations and Comprehensive Income
for the Quarters and Nine Months Ended October 1, 2005
and October 2, 2004................................................ 1
Consolidated Balance Sheets as of October 1, 2005
and January 1, 2005................................................ 2
Consolidated Statement of Stockholders' Equity for the Nine Months
Ended October 1, 2005.............................................. 3
Consolidated Statements of Cash Flows for the Nine Months
Ended October 1, 2005 and October 2, 2004.......................... 4
Notes to Consolidated Financial Statements.......................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ......................................... 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk......... 31
Item 4. Controls and Procedures ........................................... 31
PART II. OTHER INFORMATION
Item 6. Exhibits .......................................................... 31
Signatures................................................................... 36
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERRIMAC INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(UNAUDITED)
Quarters Ended Nine Months Ended
----------------------- --------------------
October 1, October 2, October 1, October 2,
2005 2004 2005 2004
---------- ---------- ---------- -----------
OPERATIONS
Net sales ................................... $7,890,033 $7,619,848 $22,717,345 $23,163,720
---------- ---------- ----------- -----------
Costs and expenses:
Cost of sales ............................. 4,639,793 4,457,772 13,164,551 13,345,322
Selling, general and administrative ....... 2,469,693 2,419,450 7,124,979 7,326,984
Research and development .................. 489,602 359,166 1,538,272 1,326,789
---------- ---------- ----------- -----------
7,599,088 7,236,388 21,827,802 21,999,095
---------- ---------- ----------- -----------
Operating income ............................ 290,945 383,460 889,543 1,164,625
Interest and other expense, net ............. (60,532) (53,632) (177,420) (204,880)
Loss on disposition of capital assets........ (6,961) - (42,829) -
---------- ---------- ----------- -----------
Income before income taxes................... 223,452 329,828 669,294 959,745
Provision (benefit) for income taxes......... (5,000) 15,000 25,000 (30,000)
---------- ---------- ---------- -----------
Net income .................................. $ 228,452 $ 314,828 $ 644,294 $ 989,745
========== ========== =========== ===========
Net income per common share-basic............ $ .07 $ .10 $ .21 $ .32
========== ========== =========== ===========
Net income per common share-diluted.......... $ .07 $ .10 $ .20 $ .31
========== ========== =========== ===========
Weighted average number of shares outstanding:
Basic ..................................... 3,144,744 3,131,161 3,141,135 3,125,188
========== ========== =========== ===========
Diluted.................................... 3,179,140 3,154,785 3,175,005 3,151,165
========== ========== =========== ===========
COMPREHENSIVE INCOME
Net income .................................. $ 228,452 $ 314,828 $ 644,294 $ 989,745
Comprehensive income:
Foreign currency translation adjustment.... 345,193 282,421 233,358 139,114
---------- ---------- ----------- -----------
Comprehensive income ........................ $ 573,645 $ 597,249 $ 877,652 $ 1,128,859
========== ========== =========== ===========
See accompanying notes.
1
MERRIMAC INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
October 1, January 1,
2005 2005
---- ----
(UNAUDITED) (AUDITED)
ASSETS
Current assets:
Cash and cash equivalents...................................................... $ 3,384,967 $ 2,166,481
Accounts receivable, net....................................................... 5,958,273 6,472,991
Income tax refunds receivable.................................................. - 97,643
Inventories, net............................................................... 3,503,351 2,931,259
Other current assets........................................................... 866,621 583,029
Deferred tax assets............................................................ 681,000 676,000
----------- -----------
Total current assets......................................................... 14,394,212 12,927,403
----------- -----------
Property, plant and equipment.................................................... 38,761,858 37,988,352
Less accumulated depreciation and amortization................................. 24,500,592 22,404,372
----------- -----------
Property, plant and equipment, net............................................... 14,261,266 15,583,980
Restricted cash.................................................................. 1,500,000 1,500,000
Other assets..................................................................... 639,704 746,714
Deferred tax assets.............................................................. 429,000 439,000
Goodwill......................................................................... 3,517,463 3,377,913
----------- -----------
Total Assets................................................................. $34,741,645 $34,575,010
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt.............................................. $ 955,149 $ 904,940
Accounts payable............................................................... 1,321,943 1,309,132
Accrued liabilities............................................................ 1,698,586 1,930,682
Customer deposits.............................................................. 183,863 233,406
Income taxes payable........................................................... 861 85,131
---------- -----------
Total current liabilities.................................................... 4,160,402 4,463,291
Long-term debt, net of current portion........................................... 2,304,673 2,778,135
Deferred compensation............................................................ 25,095 53,739
Deferred liabilities............................................................. 10,534 33,974
Deferred tax liabilities......................................................... 648,000 648,000
----------- -----------
Total liabilities............................................................ 7,148,704 7,977,139
----------- -----------
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $.01 per share:
Authorized: 1,000,000 shares
No shares issued............................................................. - -
Common stock, par value $.01 per share:
20,000,000 shares authorized; 3,227,715 and 3,215,070 shares issued;
and 3,143,483 and 3,132,970 shares outstanding, respectively................. 32,277 32,151
Additional paid-in capital..................................................... 18,818,002 18,756,710
Retained earnings.............................................................. 8,324,288 7,679,994
Accumulated other comprehensive income......................................... 1,392,240 1,158,882
----------- -----------
28,566,807 27,627,737
Less treasury stock, at cost - 82,100 shares .................................. (573,866) (573,866)
Less loan to officer-stockholder............................................... (400,000) (456,000)
----------- -----------
Total stockholders' equity................................................... 27,592,941 26,597,871
----------- -----------
Total Liabilities and Stockholders' Equity................................... $34,741,645 $34,575,010
=========== ===========
See accompanying notes.
2
MERRIMAC INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED OCTOBER 1, 2005
(UNAUDITED)
Accumulated
Additional Other Loan to
Common Stock Paid-in Retained Comprehensive Treasury Stock Officer-
Shares Amount Capital(A) Earnings Income Shares Amount Stockholder Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 2005.... 3,215,070 $32,151 $18,756,710 $7,679,994 $1,158,882 82,100 $(573,866) $(456,000) $26,597,871
Net income.................. 644,294 644,294
Stock Purchase Plan sales... 7,345 73 39,295 39,368
Exercise of options......... 5,300 53 21,997 22,050
Forgiveness of loan to
Officer-stockholder....... 56,000 56,000
Foreign currency translation 233,358 233,358
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, October 1, 2005.... 3,227,715 $32,277 $18,818,002 $8,324,288 $1,392,240 82,100 $(573,866) $(400,000) $27,592,941
====================================================================================================================================
(A) Tax benefits associated with the exercise of employee stock options are
recorded to additional paid-in capital when such benefits are realized.
See accompanying notes.
3
MERRIMAC INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
-------------------
October 1, October 2,
2005 2004
---- ----
Cash flows from operating activities:
Net income .................................................................. $ 644,294 $ 989,745
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ............................................. 2,363,692 2,418,956
Amortization of deferred financing costs................................... 37,440 37,442
Loss on disposition of assets.............................................. 42,829 -
Deferred and other compensation............................................ 62,818 67,364
Deferred tax benefit....................................................... - (79,968)
Changes in operating assets and liabilities:
Accounts receivable ....................................................... 548,608 700,126
Income tax refunds receivable ............................................. 96,035 44,178
Inventories ............................................................... (559,762) 320,488
Other current assets ...................................................... (281,145) (332,190)
Deferred tax assets........................................................ 18,000 -
Other assets .............................................................. 94,530 28,804
Accounts payable .......................................................... (210,932) 59,653
Accrued liabilities ....................................................... (244,126) 385,733
Customer deposits.......................................................... (49,543) (118,138)
Income taxes payable ...................................................... (83,552) -
Deferred compensation ..................................................... (32,408) (32,749)
Other liabilities ......................................................... (23,440) (10,530)
-------------- --------------
Net cash provided by operating activities ..................................... 2,423,338 4,478,914
-------------- --------------
Cash flows from investing activities:
Purchase of capital assets .................................................. (1,157,287) (847,494)
Proceeds from disposition of capital assets.................................. 300,000 -
-------------- --------------
Net cash used in investing activities ......................................... (857,287) (847,494)
-------------- --------------
Cash flows from financing activities:
Borrowings under revolving credit facility................................... 161,017 -
Borrowings from revolving lease line......................................... 230,753 -
Repayment of borrowings ..................................................... (839,178) (1,276,555)
Proceeds from the exercise of stock options.................................. 22,050 53,950
Proceeds from Stock Purchase Plan sales...................................... 39,368 13,544
-------------- --------------
Net cash used in financing activities ......................................... (385,990) (1,209,061)
-------------- --------------
Effect of exchange rate changes ............................................... 38,425 24,221
-------------- --------------
Net increase in cash and cash equivalents ..................................... 1,218,486 2,446,580
Cash and cash equivalents at beginning of year ................................ 2,166,481 452,633
-------------- --------------
Cash and cash equivalents at end of period .................................... $ 3,384,967 $ 2,899,213
============== ==============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes .............................................................. $ 210,000 $ 2,000
============== ==============
Interest on credit facilities.............................................. $ 216,269 $ 209,590
============== ==============
Non-cash activities-
Purchases of capital assets ............................................... $ 209,000 $ 214,000
============== ==============
See accompanying notes.
4
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and therefore do not include
all information and footnote disclosures otherwise required by generally
accepted accounting principles for a full fiscal year. The financial statements
do, however, reflect all adjustments which are, in the opinion of management,
necessary for a fair presentation of the financial position of the Company as of
October 1, 2005 and its results of operations and cash flows for the periods
presented. Results of operations of interim periods are not necessarily
indicative of results for a full year. These financial statements should be read
in conjunction with the audited consolidated financial statements in the
Company's Annual Report on Form 10-KSB for the year ended January 1, 2005.
2. CONTRACT REVENUE RECOGNITION
The Company recognizes revenue in accordance with the provisions of Staff
Accounting Bulletin No. 104. Contract revenue and related costs on fixed-price
and cost-reimbursement contracts that require customization of products to
customer specifications are recorded when title transfers to the customer, which
is generally on the date of shipment. Prior to shipment, manufacturing costs
incurred on such contracts are recorded as work-in-process inventory.
Anticipated losses on contracts are charged to operations when identified.
Revenue related to non-recurring engineering charges is generally recognized
upon shipment of the related initial units produced or based upon contractually
established stages of completion.
The cost rates utilized for cost-reimbursement contracts are subject to review
by third parties and can be revised, which can result in additions to or
reductions from revenue. Revisions which result in reductions to revenue are
recognized in the period that the rates are reviewed and finalized; additions to
revenue are recognized in the period that the rates are reviewed, finalized,
accepted by the customer, and collectability from the customer is assured. The
Company submits financial information regarding the cost rates on
cost-reimbursement contracts for each fiscal year in which the Company performed
work on cost-reimbursement contracts. The Company does not record any estimates
on a regular basis for potential revenue adjustments, as there currently is no
reasonable basis on which to estimate such adjustments given the Company's very
limited experience with these contracts. During the first nine months of 2004,
the Company recognized a revenue reduction of $12,000 related to a
cost-reimbursement contract. The Company did not recognize any revenue related
to cost-reimbursement contracts in 2005.
3. ACCOUNTING PERIOD
The Company's fiscal year is the 52-53 week period ending on the Saturday
closest to December 31. The Company has quarterly dates that correspond with the
Saturday closest to the last day of each calendar quarter and each quarter
consists of 13 weeks in a 52-week year. Periodically, the additional week to
make a 53-week year (fiscal year 2003 was the last and fiscal year 2008 will be
the next) is added to the fourth quarter, making such quarter consist of 14
weeks.
4. COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a company during a
period from transactions and other events and circumstances from non-owner
sources. Accumulated other comprehensive income at October 1, 2005 and January
1, 2005 was attributable solely to the effects of foreign currency translation.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, SFAS No. 151, "Inventory Costs (An amendment of ARB No. 43,
Chapter 4)," was issued. SFAS No. 151 amends Accounting Research Bulletin
("ARB") No. 43, Chapter 4, to clarify that abnormal amounts of idle facility
expense, freight, handling costs and wasted materials (spoilage) should be
recognized as current-period charges. In addition, SFAS No. 151 requires that
allocation of fixed production overhead to inventory be based on normal capacity
of the production facilities. SFAS No. 151 is effective for the Company for
inventory costs incurred beginning in fiscal 2006. The Company is currently
evaluating the impact that SFAS No. 151 will have on its financial position and
results of operations.
5
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2004, SFAS No. 123R, "Share-Based Payment," a revision of SFAS No.
123, "Accounting for Stock-Based Compensation", was issued. SFAS No. 123R
replaces existing requirements of SFAS No. 123 and APB Opinion No. 25
"Accounting for Stock-Based Compensation", and requires public companies to
recognize the cost of employee services received in exchange for equity
instruments, with limited exceptions. SFAS No. 123R also affects the pattern in
which compensation cost is recognized, the accounting for employee share
purchase plans, and the accounting for income tax effects of share-based payment
transactions. SFAS No. 123R will be effective for the Company as of the
beginning of the 2006 fiscal year. The Company expects the adoption of this
statement will have a non-cash material effect on its financial statements, but
the Company cannot reasonably estimate the amount of the effect resulting from
the adoption because certain assumptions used in the calculation of the value of
share-based payments may change.
The FASB has issued FASB Staff Position No. 109-1, "Application of FASB
Statement No. 109, Accounting for Income Taxes, for the Tax Deduction Provided
to U.S. Based Manufacturers by the American Jobs Creation Act of 2004." On
October 22, 2004, the American Jobs Creation Act of 2004 (the "Act") was signed
into law by the President. This Act includes tax relief for domestic
manufacturers by providing a tax deduction for up to 9 percent (when fully
phased in) of the lesser of (a) "qualified production activities income," or (b)
taxable income (after the deduction for the utilization of any net operating
loss carryforwards). As a result of this Act, an issue has arisen as to whether
this deduction should be accounted for as a special deduction or a tax rate
reduction under SFAS No. 109. The FASB staff believes that the domestic
manufacturing deduction is based on the future performance of specific
activities, including the level of wages. Accordingly, the FASB staff believes
that the deduction provided for under the Act should be accounted for as a
special deduction in accordance with SFAS No. 109 and not as a tax rate
reduction. The Company will be utilizing its net operating loss carryforwards to
offset domestic taxable income, thus this provision will not have an impact on
its financial position and results of operations in 2005.
6. STOCK-BASED COMPENSATION
The Company accounts for stock options in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation," ("SFAS 123"), which allows companies
an option to either record compensation expense based on the fair value of stock
options granted, as determined by using an option valuation model, or to
continue following the accounting guidance of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for
its stock options and other stock-based employee awards. Because the Company has
elected this treatment, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," ("SFAS No. 123") and Statement of
Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation
- - Transition and Disclosure," ("SFAS No. 148") require disclosure of pro forma
information which provides the effects on net income (loss) and net income
(loss) per share as if the Company had accounted for its employee stock awards
under the fair value method prescribed by SFAS 123. Under APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
market price of the Company's stock at the date of the grant over the amount an
employee must pay to acquire the stock. No stock-based employee compensation
cost is reflected in net income (loss) at the date of grant, as all options
granted under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant.
In accordance with SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," the effect on net income and net income per share if
the Company had applied the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee compensation,
and the related assumptions described below, is as follows:
6
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quarters Ended Nine Months Ended
--------------------------- --------------------------
October 1, October 2, October 1, October 2,
2005 2004 2005 2004
------------ ----------- ------------ ----------
Net income - as reported ............................... $ 228,452 $ 314,828 $ 644,294 $ 989,745
Plus: stock-based compensation
expense included in reported net income .......... - - - -
Less: Stock-based compensation expense
determined using the fair value method ............ (42,000) (28,000) (111,000) (116,000)
----------- ----------- ----------- -----------
Net income - pro forma ............................... $ 186,452 $ 286,828 $ 533,294 $ 873,745
=========== =========== =========== ===========
Basic net income per share:
As reported ......................................... $ .07 $ .10 $ .21 $ .32
Pro forma ........................................... $ .06 $ .09 $ .17 $ .28
Diluted net income per share:
As reported ......................................... $ .07 $ .10 $ .20 $ .31
Pro forma ........................................... $ .06 $ .09 $ .17 $ .28
The fair value of each of the options and purchase plan subscription rights
granted in 2005 and 2004 was estimated on the date of grant using the
Black-Scholes option valuation model.
The following weighted average assumptions were utilized:
2005 2004
---- ----
Expected option life (years)....................... 2.4 2.5
Expected volatility................................ 38.00% 40.00%
Risk-free interest rate............................ 4.00% 2.00%
Expected dividend yield............................ 0.00% 0.00%
7. GOODWILL
The changes in the carrying amount of goodwill for the nine months ended October
1, 2005 and October 2, 2004 are as follows:
2005 2004
---- ----
Balance, beginning of year..................... $3,377,913 $3,122,563
Foreign currency adjustment.................... 139,550 76,044
---------- ----------
Balance, end of period......................... $3,517,463 $3,198,607
========== ==========
8. INVENTORIES
Inventories consist of the following:
October 1, January 1,
2005 2005
---- ----
Finished goods................................. $ 414,034 $ 263,382
Work in process................................ 1,539,343 1,179,606
Raw materials and purchased parts.............. 1,549,974 1,488,271
---------- ----------
Total.......................................... $3,503,351 $2,931,259
========== ==========
Total inventories are net of valuation allowances for obsolescence and cost
overruns of $1,621,000 at October 1, 2005 and $1,942,000 at January 1, 2005, of
which $526,000 and $901,000, respectively, represented cost overruns.
7
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. CURRENT AND LONG-TERM DEBT
The Company was obligated under the following debt instruments at October 1,
2005 and January 1, 2005:
October 1, January 1,
2005 2005
----------- -----------
The CIT Group/Business Credit, Inc. (A):
Revolving line of credit, interest 1/2% above prime ..................... - -
Term loan A, due October 8, 2008, variable interest above LIBOR or prime. $ 850,000 $1,075,000
Term loan B, due October 8, 2010, variable interest above LIBOR or prime. 1,964,288 2,258,930
The Bank of Nova Scotia (B):
Capital leases, interest 8.7%, due June 2005 ............................ - 117,539
Capital leases, interest 7.3%, due April 2006 ........................... 88,288 124,125
Capital leases, interest 5.8%, due May 2006 ............................. 58,576 -
Capital leases, interest 7.9%, due June 2006 ............................ 78,987 107,481
Capital leases, interest 5.8%, due January 2010 ......................... 219,683 -
---------- ----------
3,259,822 3,683,075
Less current portion ....................................................... 955,149 904,940
---------- ----------
Long-term portion .......................................................... $2,304,673 $2,778,135
========== ==========
(A) The financing agreement with CIT consists of a $5,000,000 revolving line of
credit, that is temporarily reduced by $250,000 until certain conditions
are met; a $1,500,000 machinery and equipment term loan ("Term Loan A") and
a $2,750,000 real estate term loan ("Term Loan B"). In connection with this
financing agreement, the Company was required to place, over the life of
the loan, $1,500,000 as restricted cash collateral with CIT. The revolving
line of credit, which expires October 8, 2006, is subject to an
availability limit under a borrowing base calculation (85% of eligible
accounts receivable as defined in the financing agreement plus 100% of the
$1,500,000 restricted cash). At October 1, 2005, the Company had available
borrowing capacity under its revolving line of credit of $4,000,000. The
revolving line of credit bears interest at the prime rate plus 1/2 percent
(currently 7.50%). The principal amount of Term Loan A is payable in 60
equal monthly installments of $25,000 and bears interest at the prime rate
plus one percent (currently 8.0%). The principal amount of Term Loan B is
payable in 84 equal monthly installments of $32,738 and bears interest at
the prime rate plus one percent (currently 8.0%). As of October 1, 2005,
the Company, under the terms of its agreement with CIT, had elected to
convert $850,000 of Term Loan A and $1,950,000 of Term Loan B from their
prime rate base to LIBOR-based interest rate loans. The current LIBOR
interest rate options were renewed on April 11, 2005 for six months at an
interest rate of 6.64% and expired October 11, 2005. The new LIBOR interest
rate options were renewed for six months at 7.54% and will expire April 12,
2006. The revolving line of credit and the term loans are secured by
substantially all of the Company's assets located within the United States
and the pledge of 65% of the stock of the Company's subsidiaries located in
Costa Rica and Canada. The provisions of the financing agreement require
the Company to maintain certain financial and other covenants. The Company
was in compliance with these covenants at October 1, 2005.
(B) Filtran Microcircuits Inc. ("FMI") has a revolving credit agreement in
place with The Bank of Nova Scotia for up to $500,000 (Canadian) at the
prime rate plus 3/4%. No borrowings were outstanding under this agreement
at October 1, 2005.
FMI has a $1,800,000 (Canadian) revolving lease line with the Bank of Nova
Scotia, whereby the Company can obtain funding for previous production
equipment purchases via a sale/leaseback transaction. As of October 1,
2005, $517,000 (Canadian) has been utilized under this facility. Such
leases are payable in monthly installments for up to five years and are
secured by the related production equipment. Interest rates (typically
prime rate plus one percent) are set at the closing of each respective
sale/leaseback transaction. During the first quarter of 2005, FMI obtained
$287,000 (Canadian) ($231,000-US) in connection with the sale/leaseback of
certain production equipment. The related equipment was originally
purchased by the Company in 2004.
Assets securing capital leases included in property, plant and equipment,
net, have a depreciated cost of approximately $712,000 at October 1, 2005
and $611,000 at January 1, 2005.
8
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. INCOME TAXES
The Company's effective tax rate for the nine months ended October 1, 2005
reflects U.S. Federal Alternative Minimum Tax and state income taxes that are
due based on certain statutory limitations on the use of the Company's net
operating loss carryforwards. During the second quarter of 2004 a benefit was
recorded in the amount of $75,000 related to Canadian tax credits.
The Company currently has significant deferred tax assets resulting from net
operating loss carryforwards, tax credit carryforwards and deductible temporary
differences, which should reduce taxable income in future periods. A valuation
allowance is required when it is more likely than not that all or a portion of a
deferred tax asset will not be realized. The Company's 2002 and 2003 net losses
weighed heavily in the Company's overall assessment. As a result of the
assessment, the Company established a full valuation allowance for its remaining
net domestic deferred tax assets at December 28, 2002. This assessment continued
unchanged in 2003, 2004 and the first nine months of 2005. Management believes
that a valuation allowance is not required for FMI's recorded deferred tax
assets as they are more likely than not to be realized.
Internal Revenue Service Code Section 382 places a limitation on the utilization
of net operating loss carryforwards when an ownership change, as defined in the
tax law, occurs. Generally, an ownership change occurs when there is a greater
than 50 percent change in ownership. If such a change should occur, the actual
utilization of net operating loss carryforwards, for tax purposes, would be
limited annually to a percentage of the fair market value of the Company at the
time of such change. The Company does not believe that it may become subject to
these limitations in 2005.
11. BUSINESS SEGMENT DATA
The Company's operations are conducted primarily through two business segments:
(1) electronic components and sub-assemblies and (2) microwave micro-circuitry.
These segments, and the principal operations of each, are as follows:
Electronic components and sub-assemblies: Design, manufacture and sale of
electronic component devices offering extremely broad frequency coverage and
high performance characteristics for communications, defense and aerospace
applications. Of the identifiable assets, 82% are located in the United States
and 18% are located in Costa Rica. Included in such segment are the Multi-Mix(R)
Microtechnology net assets.
Microwave micro-circuitry: Design, manufacture and sale of microstrip, bonded
stripline and thick metal-backed Teflon (R) (PTFE) and mixed dielectric
multilayer circuits for communications, defense and aerospace applications. All
of the identifiable assets are located in Canada.
Information about the Company's operations in different areas of its business
follows. Operating income is net sales less operating expenses. Operating
expenses exclude interest expense, other income and income taxes. Corporate
assets consist principally of cash and corporate expenses are immaterial.
Intersegment sales and the resulting intersegment assets are principally due to
intercompany sales from the microwave micro-circuitry segment to the electronic
components and sub-assemblies segment.
9
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quarters Ended Nine Months Ended
--------------------------- ---------------------------
October 1, October 2, October 1, October 2,
2005 2004 2005 2004
--------- --------- --------- ---------
(In thousands of dollars) (In thousands of dollars)
Industry segments:
Sales to unaffiliated customers:
Electronic components and sub-assemblies $ 5,932 $ 6,188 $ 17,393 $ 18,968
Microwave micro-circuitry 1,974 1,458 5,440 4,319
Intersegment sales (16) (26) (116) (123)
--------- --------- --------- ---------
Consolidated $ 7,890 $ 7,620 $ 22,717 $ 23,164
========= ========= ========= =========
Income before income taxes:
Operating income:
Electronic components and sub-assemblies $ 160 $ 312 $ 604 $ 811
Microwave micro-circuitry 131 71 285 354
Interest and other expense, net (61) (53) (177) (205)
Loss on disposition of assets (7) - (43) -
--------- --------- --------- ---------
Consolidated $ 223 $ 330 $ 669 $ 960
========= ========= ========= =========
Depreciation and amortization:
Electronic components and sub-assemblies $ 731 $ 712 $ 2,163 $ 2,240
Microwave micro-circuitry 68 60 201 179
--------- --------- --------- ---------
Consolidated $ 799 $ 772 $ 2,364 $ 2,419
========= ========= ========= =========
Capital expenditures:
Electronic components and sub-assemblies $ 546 $ 168 $ 1,090 $ 746
Microwave micro-circuitry 51 36 67 101
--------- --------- --------- ---------
Consolidated $ 597 $ 204 $ 1,157 $ 847
========= ========= ========= =========
October 1, October 2,
2005 2004
--------- ---------
Identifiable assets:
Electronic components and sub-assemblies $ 24,609 $ 25,347
Microwave micro-circuitry 6,817 6,164
Corporate 3,385 2,899
Intersegment (69) (29)
--------- ---------
Consolidated $ 34,742 $ 34,381
========= =========
12. NET INCOME PER COMMON SHARE
Basic net income per common share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period.
The calculation of diluted net income per common share is similar to that of
basic net income per common share, except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if all potentially dilutive common shares, principally those issuable under
stock options and warrants, were issued during the reporting period to the
extent they are not anti-dilutive.
10
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the calculation of basic and diluted net income
per share:
Quarters Ended Nine Months Ended
---------------------------- ----------------------------
October 1, October 2, October 1, October 2,
2005 2004 2005 2004
---------------------------- ----------------------------
Net income available to common stockholders ............... $ 228,452 $ 314,828 $ 644,294 $ 989,745
============= ========== ============= ===========
Basic net income per share
- --------------------------------
Weighted average number of shares outstanding for
basic net income per share-
Common stock .............................................. 3,144,744 3,131,161 3,141,135 3,125,188
============= =========== ============= ===========
Net income per common share - basic ....................... $ .07 $ .10 $ .21 $ .32
============= =========== ============= ===========
Diluted net income per share
- -----------------------------------
Weighted average number of shares outstanding for
diluted net income per share:
Common stock .............................................. 3,144,744 3,131,161 3,141,135 3,125,188
Effect of dilutive securities - stock options (1) ......... 34,396 23,624 33,870 25,977
------------- ----------- ------------- -----------
Weighted average number of shares outstanding for
diluted net income per share .............................. 3,179,140 3,154,785 3,175,005 3,151,165
============= =========== ============= ===========
Net income per common share - diluted ..................... $ .07 $ .10 $ .20 $ .31
============= =========== ============= ===========
(1) Represents additional shares resulting from assumed conversion of stock
options less shares purchased with the proceeds therefrom.
Diluted net income per share excludes 261,000 and 328,000 shares
underlying stock options for the quarters ended October 1, 2005 and
October 2, 2004, respectively, and 286,000 and 328,000 shares underlying
stock options for the nine months ended October 1, 2005 and October 2,
2004, respectively, as the exercise price of these options was greater
than the average market value of the common shares, resulting in an
anti-dilutive effect on earnings per share.
13. RELATED PARTY TRANSACTIONS
In May 1998, the Company sold 22,000 shares of Common Stock to Mason N. Carter,
Chairman, President and Chief Executive Officer of the Company, at a price of
$11.60 per share, which approximated the average closing price of the Company's
Common Stock during the first quarter of 1998. The Company lent Mr. Carter
$255,000 in connection with the purchase of these shares and combined that loan
with a prior loan to Mr. Carter in the amount of $105,000. The resulting total
principal amount of $360,000 was payable May 4, 2003 and bore interest at a
variable interest rate based on the prime rate. This loan was further amended on
October 19, 2002. Accrued interest of $40,000 was added to the principal,
bringing the new principal amount of the loan to $400,000, the due date was
extended to May 4, 2006, and interest (at the same rate as was previously
applicable) is now payable monthly. Mr. Carter has pledged 33,000 shares of
Common Stock as security for this loan, which is a full-recourse loan.
On August 31, 2000, in connection with an amendment of Mr. Carter's employment
agreement, the Company loaned Mr. Carter an additional $280,000. Interest on the
loan varies and is based on the prime rate, payable in accordance with Mr.
Carter's employment agreement. Each year the Company is required to forgive 20%
of the amount due under this loan and the accrued interest thereon. During 2004,
the Company forgave $56,000 of principal and $4,500 of accrued interest and paid
a tax gross-up benefit of $6,100. $56,000 of principal and $3,000 of accrued
interest were forgiven in 2005, after which this loan was fully satisfied.
During the third quarter and first nine months of 2005, the Company's outside
general counsel Katten Muchin Rosenman LLP was paid $37,000 and $212,000,
respectively, for providing legal services to the Company. During the third
quarter and first nine months of 2004, Katten Muchin Rosenman LLP was paid
$59,000 and $211,000, respectively. A director of the Company is counsel to
Katten Muchin Rosenman LLP but does not share in the fees that the Company pays
to such law firm and his compensation is not based on such fees.
11
MERRIMAC INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During 2005 and 2004 the Company retained Career Consultants, Inc. and SK
Associates to perform executive searches and to provide other services to the
Company. The Company paid an aggregate of $2,000 and $5,000 to these companies
during the third quarter and first nine months of 2005. The Company paid an
aggregate of $1,000 and $18,000 to these companies during the third quarter and
first nine months of 2004, respectively. A director of the Company is the
chairman and chief executive officer of these companies.
During the third quarter and first nine months of 2005, a director of the
Company was paid $9,000 and $27,000, respectively, for providing
technology-related consulting services to the Company. For the third quarter and
first nine months of 2004, such director was paid $9,000 and $27,000,
respectively.
During the third quarter and first nine months of 2005, DuPont Electronic
Technologies ("DuPont"), a stockholder and the employer of a director, was paid
$17,000 and $42,000, respectively, for providing technological and
marketing-related personnel and services on a cost-sharing basis to the Company
under the Technology Agreement dated February 28, 2002. During the third quarter
and first nine months of 2004, DuPont was paid $9,000 and $66,000, respectively.
A director of the Company is an officer of DuPont, but does not share in any of
these payments.
Each director who is not an employee of the Company receives a monthly
director's fee of $1,500, plus an additional $500 for each meeting of the Board
and of any Committees of the Board attended. In addition, the Chair of the Audit
Committee receives an annual fee of $2,500 for his services in such capacity.
The directors are also reimbursed for reasonable travel expenses incurred in
attending Board and Committee meetings. In addition, pursuant to the 2001 Stock
Option Plan, each non-employee director is granted an immediately exercisable
option to purchase 2,500 shares of the Common Stock of the Company on the date
of each Annual Meeting of Stockholders. Each such grant has an exercise price
equal to the fair market value on the date of such grant and will expire on the
tenth anniversary of the date of the grant. On June 21, 2005, non-qualified
stock options to purchase an aggregate of 17,500 shares were issued to seven
directors at an exercise price of $8.95 per share.
On December 13, 2004 Infineon Technologies AG ("Infineon"), at such time the
beneficial owner of approximately 15% of the Company's common stock, sold
475,000 shares of the Company's common stock to four purchasers in a
privately-negotiated transaction. Two purchasers in such transaction, K Holdings
LLC and Hampshire Investments, Limited, each of which is affiliated with Ludwig
G. Kuttner, purchased shares representing an aggregate of approximately 9.6% of
the Company's common stock. Infineon also assigned to each purchaser certain
registration rights to such shares under the existing registration rights
agreements Infineon had with the Company. In connection with the transaction,
the Company and Infineon terminated the Stock Purchase and Exclusivity Letter
Agreement dated April 7, 2000, as amended, which provided that the Company would
design, develop and produce exclusively for Infineon certain Multi-Mix(R)
products that incorporate active RF power transistors for use in certain
wireless base station applications, television transmitters and certain other
applications that are intended for Bluetooth tranceivers.
DuPont and the four purchasers above hold registration rights which currently
give them the right to register an aggregate of 1,003,413 shares of Common Stock
of the Company.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains statements relating to future
results of the Company (including certain projections and business trends) that
are "forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. Actual results may differ materially from those projected as
a result of certain risks and uncertainties. These risks and uncertainties
include, but are not limited to: risks associated with demand for and market
acceptance of existing and newly developed products as to which the Company has
made significant investments, particularly its Multi-Mix(R) products; general
economic and industry conditions; the possibilities of impairment charges to the
carrying value of our Multi-Mix(R) assets, thereby resulting in charges to our
earnings; slower than anticipated penetration into the satellite communications,
defense and wireless markets; the risk that the benefits expected from the
Company's acquisition of Filtran Microcircuits Inc. are not realized; the
ability to protect proprietary information and technology; competitive products
and pricing pressures; failure of our Original Equipment Manufacturer, or OEM,
customers to successfully incorporate our products into their systems; the
emergence of new or stronger competitors as a result of consolidation movements
in the market; the timing and market acceptance of our or our OEM customers' new
or enhanced products; our ability and the ability of our OEM customers to keep
pace with the rapid technological changes and short product life cycles in our
industry and gain market acceptance for new products and technologies; changes
in product mix resulting in unexpected engineering and research and development
costs; delays and increased costs in product development, engineering and
production; reliance on a small number of significant customers; foreign
currency fluctuations between the U.S. and Canadian dollars; risks relating to
governmental regulatory actions in communications and defense programs; and
inventory risks due to technological innovation and product obsolescence, as
well as other risks and uncertainties as are detailed from time to time in the
Company's Securities and Exchange Commission filings. These forward-looking
statements are made only as of the date of the filing of this Form 10-Q, and the
Company undertakes no obligation to update or revise the forward-looking
statements, whether as a result of new information, future events or otherwise.
OVERVIEW
Merrimac Industries, Inc. ("Merrimac" or the "Company") is involved in the
design, manufacture and sale of electronic component devices offering extremely
broad frequency coverage and high performance characteristics, and microstrip,
bonded stripline and thick metal-backed Teflon(R) (PTFE) and mixed dielectric
multilayer circuits for communications, defense and aerospace applications. The
Company's operations are conducted primarily through two business segments: (1)
electronic components and sub-assemblies and (2) microwave micro-circuitry
(through its subsidiary, Filtran Microcircuits Inc.).
The following table provides a breakdown of our sales between these segments for
the quarters and nine months ended October 1, 2005 and October 2, 2004:
Quarters Ended
--------------
October 1, 2005 October 2, 2004
--------------- ---------------
$ % of sales $ % of sales
- ---------- - ----------
Electronic components
and sub-assemblies $ 5,932,000 75.2 % $ 6,188,000 81.2 %
Microwave micro-circuitry(1) $ 1,974,000 25.0 % $ 1,458,000 19.1 %
Intersegment sales $ (16,000) (0.2)% $ (26,000) (0.3)%
----------- ----- ----------- -----
Consolidated $ 7,890,000 100.0 % $ 7,620,000 100.0 %
=========== ===== =========== =====
Nine Months Ended
-----------------
October 1, 2005 October 2, 2004
--------------- ---------------
$ % of sales $ % of sales
- ---------- - ----------
Electronic components
and sub-assemblies $17,393,000 76.6 % $18,968,000 81.9 %
Microwave micro-circuitry(1) $ 5,440,000 23.9 % $ 4,319,000 18.6 %
Intersegment sales $ (116,000) (0.5)% $ (123,000) (0.5)%
----------- ----- ----------- -----
Consolidated $22,717,000 100.0 % $23,164,000 100.0 %
=========== ===== =========== =====
(1) Substantially all conducted by our Canadian subsidiary, Filtran
Microcircuits Inc.
Merrimac is a versatile technologically oriented company specializing in
miniature radio frequency lumped-element components, integrated networks,
microstrip and stripline microwave components, subsystem assemblies and ferrite
attenuators. Of special significance has been
13
the combination of two or more of these technologies into single components to
achieve superior performance and reliability while minimizing package size and
weight. Merrimac components are today found in applications as diverse as
satellites, military and commercial aircraft, radar, cellular radio systems,
medical and dental diagnostic instruments and wireless Internet connectivity.
Merrimac's components range in price from $0.50 to more than $10,000 and its
subsystem assemblies range from $500 to more than $500,000.
Multi-Mix(R)
In 1998, Merrimac introduced Multi-Mix(R) Microtechnology capabilities, an
innovative process for microwave, multilayer integrated circuits and
micro-multifunction module (MMFM)(R) technology and subsystems. This process is
based on fluoropolymer composite substrates, which are bonded together into a
multilayer structure using a fusion bonding process. The fusion process provides
a homogeneous dielectric medium for superior electrical performance at microwave
frequencies. This 3-dimensional Multi-Mix(R) design consisting of stacked
circuit layers permits the manufacture of components and subsystems that are a
fraction of the size and weight of conventional microstrip and stripline
products.
Multi-Mix PICO(R)
In October 2001, Merrimac introduced its Multi-Mix PICO(R) Microtechnology.
Through Multi-Mix PICO(R) technology, Merrimac offers a group of products at a
greatly reduced size, weight and cost that includes hybrid junctions,
directional couplers, quadrature hybrids, power dividers and inline couplers,
filters and vector modulators along with 802.11a, 802.11b, and 802.11g Wireless
LAN (Local Area Network) modules. When compared to conventional multilayer
quadrature hybrids and directional coupler products, Multi-Mix PICO(R) is more
than 84% smaller in size, without experiencing loss of power or performance.
Merrimac has completed the development of integrated inline multi-couplers and
is supplying these Multi-Mix PICO(R) products to major base station customers.
Merrimac's strategy is to be a reliable supplier of high quality, technically
innovative signal processing products. Merrimac coordinates its marketing,
research and development and manufacturing operations to develop new products
and expand its markets. Merrimac's marketing and development activities focus on
identifying and producing prototypes for new military and commercial programs
and applications in aerospace, navigational systems, telecommunications and
cellular analog and digital wireless telecommunications electronics. Merrimac's
research and development efforts are targeted towards providing customers with
more complex, reliable, and compact products at lower costs.
Filtran Microcircuits Inc.
Acquired by Merrimac in February 1999, Filtran Microcircuits Inc. ("FMI") is a
leading manufacturer of microwave micro-circuitry for the high frequency
communications industry. FMI produces microstrip, bonded stripline, and thick
metal-backed Teflon(R) (PTFE) microcircuits for RF applications including
satellite, aerospace, personal communications systems, fiber optic
telecommunications, automotive, navigational and defense applications worldwide.
FMI participates in the market for millimeter-wave applications. FMI also
supplies mixed dielectric multilayer and high speed interconnect circuitry to
meet customer demand for high performance and cost-effective packaging.
For more information regarding our electronics components and sub-assemblies
business and the microwave micro-circuitry business done by FMI, please see Note
11 of the Notes to Consolidated Financial Statements.
The Company markets and sells its products domestically and internationally
through a direct sales force and manufacturers' representatives. Merrimac has
traditionally developed and offered for sale products built to specific customer
needs, as well as standard catalog items.
The Company believes that while its wireless subscriber customer base continues
to grow, the extended economic downturn, resulting in reduced spending by
wireless telecommunications service providers, has caused many wireless
telecommunications equipment manufacturers to delay or forego purchases of the
Company's products. However, the Company expects that its defense and satellite
customers should continue to maintain their approximate current levels of orders
during fiscal year 2005, though there are no assurances they will do so.
Nevertheless, in times of armed conflict or war, military spending is
concentrated on armaments build up, maintenance and troop support, and not on
the research and development and specialty applications that are the Company's
core strengths and revenue generators. Accordingly, defense and military product
14
revenues may decrease and should not be expected to increase, at times of armed
conflicts or war. The Company also anticipates increased levels of orders during
fiscal year 2006 for its Multi-Mix(R) Microtechnology products compared to 2005,
based on inquiries from existing customers, requests to quote from new and
existing customers and market research. The improved telecommunications sector
and the continued efforts to diversify FMI into wireless base stations,
automotive and defense applications has resulted in additional orders for FMI,
which the Company anticipates will continue.
Cost of sales for the Company consists of materials, salaries and related
expenses, and outside services for manufacturing and certain engineering
personnel and manufacturing overhead. Our products are designed and manufactured
in the Company's facilities. The Company's manufacturing and production
facilities infrastructure overhead are relatively fixed and are based on its
expectations of future net revenues. Should the Company experience a reduction
in net revenues in a quarter, it could have difficulty adjusting short-term
expenditures and absorbing any excess capacity expenses. If this were to occur,
the Company's operating results for that quarter would be negatively impacted.
In order to remain competitive, the Company must continually reduce its
manufacturing costs through design and engineering innovations and increases in
manufacturing efficiencies. There can be no assurance that the Company will be
able to reduce its manufacturing costs.
The Company anticipates that depreciation and amortization expenses will exceed
capital expenditures in fiscal year 2005 by approximately $1,200,000. The
Company intends to issue up to $700,000 of purchase order commitments for
capital equipment from various vendors. The Company anticipates that such
equipment will be purchased and become operational during the fourth quarter of
2005 and first quarter of 2006.
Selling general and administrative expenses consist of personnel costs for
administrative, selling and marketing groups, sales commissions to employees and
manufacturing representatives, travel, product marketing and promotion costs, as
well as legal, accounting, information technology and other administrative
costs. The Company expects to continue to make significant and increasing
expenditures for selling, general and administrative expenses, especially in
connection with implementation of its strategic plan for generating and
expanding sales of Multi-Mix(R) products.
Research and development expenses consist of materials, salaries and related
expenses of certain engineering personnel, and outside services related to
product development projects. The Company charges all research and development
expenses to operations as incurred. The Company believes that continued
investment in research and development is critical to the Company's long-term
business success. The Company intends to continue to invest in research and
development programs in future periods, and expects that these costs will
increase over time, in order to develop new products, enhance performance of
existing products and reduce the cost of current or new products.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The Company's management makes certain assumptions and estimates that impact the
reported amounts of assets, liabilities and stockholders' equity, and revenues
and expenses. The management judgments that are currently the most critical are
related to the accounting for the Company's investments in Multi-Mix (R)
Microtechnology, contract revenue recognition, inventory valuation, valuation of
goodwill and valuation of deferred tax assets.
IMPAIRMENT OF LONG-LIVED ASSETS
Following is a summary of the carrying amounts of the Multi-Mix (R)
Microtechnology net assets included in the Company's consolidated financial
statements at October 1, 2005 and the related future planned purchases and lease
obligation commitments through January 2006.
Net assets:
Property, plant and equipment, at cost.............................. $14,104,000
Less accumulated depreciation and amortization...................... 6,313,000
-----------
Property, plant and equipment, net.................................. 7,791,000
Inventories......................................................... 403,000
Other assets, net................................................... 195,000
-----------
Total net assets at October 1, 2005................................. $ 8,389,000
-----------
15
Commitments:
Planned equipment purchases for the remainder of 2005............... $ 100,000
Lease obligations through January 2006.............................. 175,000
-----------
Total commitments................................................... $ 275,000
-----------
Total net assets and commitments.................................... $ 8,664,000
===========
Approximately 32% of the property, plant and equipment may be utilized in other
areas of our electronic components and sub-assemblies operations.
The Company anticipates receiving additional orders during 2006 for its
Multi-Mix(R) Microtechnology products, for which substantial research and
development costs have also been incurred. Due to economic and market conditions
in the wireless industry over the past several years, telecommunications system
service providers substantially reduced their capital equipment purchases from
the Company's customers. While these circumstances have resulted in the delay or
cancellation of Multi-Mix(R) Microtechnology product purchases that had been
anticipated from certain specific customers or programs, the Company has
implemented a strategic plan utilizing product knowledge and customer focus to
expand specific sales opportunities. However, continued extended delay or
reduction from planned levels in new orders expected from customers for these
products could require the Company to pursue alternatives related to the
utilization or realization of these assets and commitments, the net result of
which could be materially adverse to the financial results and position of the
Company. In accordance with the Company's evaluation of Multi-Mix(R) under SFAS
No. 144, the Company has determined no provision for impairment is required at
this time. Management will continue to monitor the recoverability of the
Multi-Mix(R) assets.
CONTRACT REVENUE RECOGNITION
The Company recognizes revenue in accordance with the provisions of Staff
Accounting Bulletin No. 104. Contract revenue and related costs on fixed-price
and cost-reimbursement contracts that require customization of products to
customer specifications are recorded when title transfers to the customer, which
is generally on the date of shipment. Prior to shipment, manufacturing costs
incurred on such contracts are recorded as work-in-process inventory.
Anticipated losses on contracts are charged to operations when identified.
Revenue related to non-recurring engineering charges is generally recognized
upon shipment of the related initial units produced or based upon contractually
established stages of completion.
The cost rates utilized for cost-reimbursement contracts are subject to review
by third parties and can be revised, which can result in additions to or
reductions from revenue. Revisions which result in reductions to revenue are
recognized in the period that the rates are reviewed and finalized; additions to
revenue are recognized in the period that the rates are reviewed, finalized,
accepted by the customer, and collectability from the customer is assured. The
Company submits financial information regarding the cost rates on
cost-reimbursement contracts for each fiscal year in which the Company performed
work on cost-reimbursement contracts. The Company does not record any estimates
on a regular basis for potential revenue adjustments, as there currently is no
reasonable basis on which to estimate such adjustments given the Company's very
limited experience with these contracts. During the first nine months of 2004,
the Company recognized a revenue reduction of $12,000 related to a
cost-reimbursement contract. The Company did not recognize any revenue related
to cost-reimbursement contracts in 2005.
INVENTORY VALUATION
Inventories are valued at the lower of average cost or market. Inventories are
periodically reviewed for their projected manufacturing usage utilization and,
when slow-moving or obsolete inventories are identified, a provision for a
potential loss is made and charged to operations. Total inventories are net of
valuation allowances for obsolescence and cost overruns of $1,621,000 at October
1, 2005 and $1,942,000 at January 1, 2005, of which $526,000 and $901,000,
respectively, represented cost overruns.
Procurement of inventory is based on specific customer orders and forecasts.
Customers have certain rights of modification with respect to these orders and
forecasts. As a result,
16
customer modifications to orders and forecasts affecting inventory previously
procured by us and our purchases of inventory beyond customer needs may result
in excess and obsolete inventory for the related customers. Although the Company
may be able to use some of these excess components and raw materials in other
products it manufactures, a portion of the cost of this excess inventory may not
be recoverable from customers, nor may any excess quantities be returned to the
vendors. The Company also may not be able to recover the cost of obsolete
inventory from vendors or customers.
Write offs or write downs of inventory generally arise from:
- - declines in the market value of inventory;
- - changes in customer demand for inventory, such as cancellation of orders; and
- - our purchases of inventory beyond customer needs that result in excess
quantities on hand and that we are not able to return to the vendor or charge
back to the customer.
VALUATION OF GOODWILL
With the adoption of SFAS No. 142 by the Company on December 30, 2001, goodwill
is no longer subject to amortization over its estimated useful life. However,
goodwill is subject to at least an annual assessment for impairment and more
frequently if circumstances indicate a possible impairment. The Company
performed the annual assessment during the fourth quarter of 2004 and determined
there was no impairment. The Company will perform its annual assessment for 2005
during the fourth quarter of 2005.
VALUATION OF DEFERRED TAX ASSETS
The Company currently has significant deferred tax assets resulting from net
operating loss carryforwards, tax credit carryforwards and deductible temporary
differences, which should reduce taxable income in future periods. A valuation
allowance is required when it is more likely than not that all or a portion of a
deferred tax asset will not be realized. The Company's 2002 and 2003 net losses
weighed heavily in the Company's overall assessment. As a result of the
assessment, the Company established a full valuation allowance for its remaining
net domestic deferred tax assets at December 28, 2002. This assessment continued
unchanged in 2003 and 2004 and the first nine months of 2005. Management
believes that a valuation allowance is not required for FMI's recorded deferred
tax assets as they are more likely than not to be realized.
CONSOLIDATED STATEMENTS OF OPERATIONS SUMMARY
(UNAUDITED)
The following table reflects the percentage relationships of items from the
Consolidated Statements of Operations as a percentage of net sales.
Percentage of Net Sales Percentage of Net Sales
------------------------ ------------------------
Quarters Ended Nine Months Ended
------------------------ ------------------------
October 1, October 2, October 1, October 2,
2005 2004 2005 2004
------ ------ ------ -------
Net sales.................................... 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
Costs and expenses:
Cost of sales.............................. 58.8 58.5 57.9 57.6
Selling, general and administrative........ 31.3 31.8 31.4 31.6
Research and development................... 6.2 4.7 6.8 5.7
------ ------ ------ ------
96.3 95.0 96.1 94.9
------ ------ ------ ------
Operating income ............................ 3.7 5.0 3.9 5.1
Interest and other expense, net.............. (.8) (.7) (.8) (.9)
Loss on disposition of assets................ (.1) - (.2) -
------ ------ ------ ------
Income before income taxes................... 2.8 4.3 2.9 4.2
Provision (benefit) for income taxes......... (.1) .2 .1 (.1)
------ ------ ------ ------
Net income .................................. 2.9% 4.1% 2.8% 4.3%
====== ====== ====== ======
17
THIRD QUARTER AND FIRST NINE MONTHS OF 2005 COMPARED TO THE THIRD QUARTER AND
FIRST NINE MONTHS OF 2004
Net sales.
Consolidated results of operations for the third quarter of 2005 reflect an
increase in net sales from the third quarter of 2004 of $270,000 or 3.5% to
$7,890,000. This increase was attributable to a $256,000 decrease in net sales
of electronic components and sub-assemblies offset by a $516,000 increase in
sales of microwave micro-circuitry products from the Company's wholly-owned
subsidiary Filtran Microcircuits Inc. ("FMI"). Consolidated results of
operations for the first nine months of 2005 reflect a decrease in net sales
from the nine months of 2004 of $446,000 or 1.9% to $22,717,000. This decrease
was attributable to a $1,575,000 decrease in net sales of electronic components
and sub-assemblies offset by a $1,121,000 increase in net sales of microwave
micro-circuitry products from FMI. The decrease in net sales for the electronic
components and sub-assemblies segment for third quarter and first nine months of
2005 is due to reduced orders from delays in space and defense programs.
The increase in net sales of the microwave micro-circuitry segment for the third
quarter and first nine months of 2005 was due to new orders from existing
customers resulting from the Company's successful continued efforts to diversify
FMI into wireless base station, automotive and defense applications. FMI
anticipates much of this new order volume to renew in future periods.
Backlog represents the amount of orders the Company has received that have not
been shipped as of the end of a particular fiscal period. The orders in backlog
are a measure of future sales and determine the Company's upcoming material,
labor and service requirements. The book-to-bill ratio for a particular period
represents orders received for that period divided by net sales for the same
period. The Company looks for this ratio to exceed 1.0, indicating the backlog
is being replenished by new orders at a higher rate than the sales being removed
from the backlog.
The following table presents key performance measures that we use to monitor our
operating results for the nine months ended October 1, 2005 and October 2, 2004:
2005 2004
--------------------- ------------------------
Beginning backlog $ 12,945,000 $ 12,395,000
Plus bookings $ 21,511,000 $ 23,290,000
Less net sales $ 22,717,000 $ 23,164,000
Ending backlog $ 11,739,000 $ 12,521,000
Book-to-bill ratio 0.95 1.01
Orders of $5,176,000 were received during the third quarter of 2005, a decrease
of $2,592,000 or 33.4% compared to $7,768,000 in orders received during the
third quarter of 2004. Orders of $21,511,000 were received during the first nine
months of 2005, a decrease of $1,779,000 or 7.6% compared to $23,290,000 in
orders received during the first nine months of 2004. The reduction in orders
for the third quarter and nine months was due to delays in expected satellite
and defense programs. The delayed satellite and defense programs, which resulted
in lower orders for the third quarter, may result in lower fourth quarter sales
and slightly lower fiscal 2005 sales as compared to 2004. Backlog decreased by
$1,206,000 to $11,739,000 at the end of third quarter of 2005 compared to
$12,945,000 at year-end 2004.
18
Cost of sales and Gross profit.
The following table provides comparative gross profit information, by product
segment, between the quarters and nine months ended October 1, 2005 and October
2, 2004.
Quarter ended October 1, 2005 Quarter ended October 2, 2004
------------------------------------------------- ----------------------------------------------------
$ Increase/ % of $ Increase/ % of
--------- --------- ----- --------- --------- -----
(Decrease) (Decrease)
----------- -----------
from prior Segment from prior Segment
----------- ------- ----------- -------
period Net Sales period Net Sales
------ --------- ------ ---------
Electronic Components
and Sub-assemblies gross $ 2,708,000 $(41,000) 45.6% $ 2,749,000 $ 873,000 44.4%
profit
Microwave
Micro-Circuitry
gross profit $ 542,000 $ 129,000 27.5% $ 413,000 $ 88,000 28.3%
Consolidated $ 3,250,000 $ 88,000 41.2% $ 3,162,000 $ 961,000 41.5%
gross profit
Nine Months ended October 1, 2005 Nine Months ended October 2, 2004
------------------------------------------------- ----------------------------------------------------
$ Increase/ % of $ Increase/ % of
--------- --------- ----- --------- --------- -----
(Decrease) Segment (Decrease) Segment
----------- ------- ----------- -------
from prior Net Sales from prior Net Sales
---------- --------- ---------- ---------
period period
------ ------
Electronic Components
and Sub-assemblies gross
profit $ 8,152,000 $ (350,000) 46.9% $ 8,502,000 $ 2,008,000 44.8%
Microwave
Micro-Circuitry $ 1,401,000 $ 84,000 25.8% $ 1,317,000 $ 603,000 30.5%
gross profit
Consolidated $ 9,553,000 $ (266,000) 42.1% $ 9,819,000 $ 2,611,000 42.4%
gross profit
The decrease in gross profit for the third quarter of 2005 as compared to the
third quarter of 2004 for the electronic components and sub-assemblies segment
was due to the overall decrease in segment sales. The increase in gross profit
percent for the third quarter of 2005 for the electronic components and
sub-assemblies segment was due to a stronger product mix and production
efficiencies. The decrease in gross profit for the first nine months of 2005 for
the electronic components and sub-assemblies segment was due to the overall
decrease in segment sales. The improvement in gross profit percent to 46.9% in
the first nine months of 2005 from 44.8% in the first nine months of 2004 for
the electronic components and sub-assemblies segment was due to a stronger
product mix, higher yields and lower fixed costs.
Depreciation expense included in consolidated cost of sales for the third
quarter of 2005 was $729,000, an increase of $13,000 compared to the third
quarter of 2004. Depreciation expense included in consolidated cost of sales for
the first nine months of 2005 was $2,145,000, a decrease of $38,000 compared to
the third quarter of 2004. For the third quarter and first nine months of 2005,
approximately $418,000 and $1,214,000, respectively, of depreciation expense was
associated with Multi-Mix(R) Microtechnology capital assets. For the third
quarter and first nine months of 2004, approximately $476,000 and $1,453,000,
respectively of depreciation expense was associated with Multi-Mix(R)
Microtechnology capital assets.
FMI sales include intersegment sales of $16,000 and $26,000 in the third quarter
of 2005 and 2004, respectively. The increase in gross profit for the third
quarter and first nine months of 2005 was due to the overall increase in segment
sales. The decrease in gross profit percent for the third quarter and first nine
months of 2005 is due to higher direct labor and manufacturing costs,
attributable to the strengthening of the Canadian dollar, related to defense
orders booked in 2004 and 2005. These higher costs for such defense orders may
continue into future periods. FMI sales include intersegment sales of $116,000
and $123,000 in the first nine months of 2005 and 2004, respectively.
19
Selling, general and administrative expenses.
Selling, general and administrative expenses of $2,470,000 for the third quarter
of 2005 increased by $51,000 or 2.1%, and when expressed as a percentage of net
sales, decreased by 0.5 percentage points to 31.3% compared to the third quarter
of 2004. The increase in such expenses for the third quarter of 2005 was due to
higher administrative and proposal costs in the third quarter of 2005 offset by
lower commissions, selling and marketing costs. Selling, general and
administrative expenses of $7,125,000 for the first nine months of 2005
decreased by $202,000 or 2.8%, and when expressed as a percentage of net sales,
decreased by 0.2 percentage points to 31.4% compared to the first nine months of
2004. The decrease in such expenses for the first nine months of 2005 was due to
lower commissions related to the lower sales level in the first nine months of
2005.
Research and development expenses.
Research and development expenses for new products were $490,000 for the third
quarter of 2005, an increase of $130,000 or 36.3%, and when expressed as a
percentage of net sales, an increase of 1.5 percentage points to 6.2% compared
to the third quarter of 2004. Except for $40,000 of expenses at FMI,
substantially all of the research and development expenses were related to
Multi-Mix(R) Microtechnology and Multi-Mix PICO(R) products. Research and
development expenses for new products were $1,538,000 for the first nine months
of 2005, an increase of $211,000 or 15.9%, and when expressed as a percentage of
net sales, an increase of 1.1 percentage points to 6.8% compared to the first
nine months of 2004. Except for $120,000 of expenses at FMI, (a decrease of
$45,000 from such FMI expenses in the first nine months of 2004) substantially
all of the research and development expenses were related to Multi-Mix(R)
Microtechnology and Multi-Mix PICO(R) products. The Company anticipates that
these expenses will increase in future periods in connection with implementation
of our strategic plan for Multi-Mix(R).
Operating income.
Consolidated operating income for the third quarter of 2005 was $291,000
compared to consolidated operating income of $384,000 for the third quarter of
2004. The decrease in consolidated operating income for the third quarter of
2005 was due to the increase in research and development costs to support new
Multi-Mix(R) products.
Consolidated operating income for the first nine months of 2005 was $890,000
compared to consolidated operating income of $1,165,000 for the first nine
months of 2004. The decrease in consolidated operating income for the first nine
months of 2005 was due to a reduction of gross profit resulting from decreased
sales and the increase in research and development costs to support new
Multi-Mix(R) products.
For the third quarter of 2005, the Company's operating income for its electronic
components and sub-assemblies segment was $160,000 compared to operating income
of $312,000 for the third quarter of 2004. The lower operating income for the
electronic components and sub-assemblies segment was due to a reduction of gross
profit resulting from decreased sales compared to the third quarter of 2004 and
the increase in research and development costs to support new Multi-Mix(R)
products for the refined implementation of the Company's strategic plan. For the
third quarter of 2005, operating income for the microwave micro-circuitry
segment was $131,000 compared to operating income of $71,000 for the third
quarter of 2004. The higher operating income for the microwave micro-circuitry
segment was due to the segment's higher gross margin offset by higher
administrative expenses compared to the third quarter of 2004.
For the first nine months of 2005, the Company's operating income for its
electronic components and sub-assemblies segment was $604,000 compared to
operating income of $811,000 for the first nine months of 2004. The lower
operating income for the electronic components and sub-assemblies segment was
due to the segment's lower gross profit from lower sales, partially offset by
lower operating expenses compared to the first nine months of 2004. For the
first nine months of 2005, operating income for the microwave micro-circuitry
segment was $285,000 compared to operating income of $353,000 for the first nine
months of 2004. The lower operating income for the microwave micro-circuitry
segment was due to the segment's higher commissions and higher administrative
expenses compared to the first nine months of 2004.
20
Interest and other expense, net.
Interest and other expense, net was $61,000 for the third quarter of 2005
compared to interest and other expense, net of $54,000 for the third quarter of
2004. Interest and other expense, net was $177,000 for the first nine months of
2005 compared to interest and other expense, net of $205,000 for the first nine
months of 2004. Interest expense for the third quarter and first nine months of
2005 was principally incurred on borrowings under the term loans which the
Company consummated during the fourth quarter of 2003. Interest expense for the
third quarter and first nine months of 2004 was principally incurred on
borrowings under the Company's revolving line of credit and the term loans
described above. Despite the general rise in interest rates from 2004 to 2005,
the reduction of interest and other expense was due to lower outstanding debt
balances during the first nine months of 2005 as the Company repaid
approximately $1,500,000 throughout 2004.
Income taxes.
The Company's effective tax rate for the nine months ended October 1, 2005
reflects U.S. Federal Alternative Minimum Tax and State income taxes that are
due based on certain statutory limitations on the use of the Company's net
operating loss carryforwards. During the first nine months of 2004 a benefit was
recorded in the amount of $75,000 related to Canadian tax credits.
Internal Revenue Service Code Section 382 places a limitation on the utilization
of net operating loss carryforwards when an ownership change, as defined in the
tax law, occurs. Generally, an ownership change occurs when there is a greater
than 50 percent change in ownership. If such a change should occur, the actual
utilization of net operating loss carryforwards, for tax purposes, would be
limited annually to a percentage of the fair market value of the Company at the
time of such change. The Company does not believe that it may become subject to
these limitations in 2005.
Net income.
Net income for the third quarter of 2005 was $228,000 compared to net income of
$315,000 for the third quarter of 2004. Net income per diluted share for the
third quarter of 2005 was $.07 compared to net income of $.10 per diluted share
for the third quarter of 2004.
Net income for the first nine months of 2005 was $644,000 compared to net income
of $990,000 for the first nine months of 2004. Net income per diluted share for
the first nine months of 2005 was $.20 compared to net income of $.31 per
diluted share for the nine months of 2004. Net income for the first nine months
of 2004 included a tax benefit of $75,000 or $.02 per share related to certain
Canadian tax credits.
LIQUIDITY AND CAPITAL RESOURCES
The Company had liquid resources comprised of cash and cash equivalents totaling
approximately $3,400,000 at the end of the first nine months of 2005 compared to
approximately $2,200,000 at the end of 2004. The Company's working capital was
approximately $10,200,000 and its current ratio was 3.4 to 1 at the end of the
third quarter of 2005 compared to $8,500,000 and 2.9 to 1, respectively, at the
end of 2004. At October 1, 2005, the Company had available borrowing capacity
under its revolving line of credit of $4,000,000.
The Company's operating activities generated positive cash flows of $2,423,000
during the first nine months of 2005 compared to $4,479,000 of positive cash
flows during the first nine months of 2004. The primary sources of operating
cash flows for the first nine months of 2005 were the year-to-date net income of
$644,000 which was reduced by depreciation and amortization of $2,364,000; a
decrease in accounts receivable of $549,000, offset by an increase in
inventories of $560,000, an aggregate decrease in accounts payable, customer
deposits and accrued liabilities of $505,000 and the reduction of income taxes
payable of $84,000. The primary sources of operating cash flows for the first
nine months of 2004 were net income of $990,000 which was reduced by
depreciation and amortization of $2,419,000, the reduction of accounts
receivable of $700,000, a reduction in inventories of $320,000,and an aggregate
increase in accounts payable and accrued liabilities of $445,000 partly offset
by a reduction of customer deposits of $118,000 and an increase in other current
assets of $332,000.
The Company made net cash investments in property, plant and equipment of
$1,157,000 during the first nine months of 2005 compared to net cash investments
made in property, plant and equipment of $847,000 during the first nine months
of 2004. These capital expenditures are related to new production and test
equipment capabilities in connection with the introduction of new products
21
and enhancements to existing products. The depreciated cost of capital equipment
associated with Multi-Mix(R) Microtechnology was $7,791,000 at the end of the
third quarter of 2005, a decrease of $1,082,000 compared to $8,873,000 at the
end of fiscal year 2004.
The Company's planned equipment purchases and other commitments are expected to
be funded through cash resources and cash flows expected to be generated from
operations, and supplemented by the Company's $5,000,000 revolving credit
facility, which expires October 8, 2006.
The financing agreement with CIT consists of a $5,000,000 revolving line of
credit, that is temporarily reduced by $250,000 until certain conditions are
met; a $1,500,000 machinery and equipment term loan ("Term Loan A") and a
$2,750,000 real estate term loan ("Term Loan B"). In connection with this
financing agreement, the Company was required to place, over the life of the
loan, $1,500,000 as restricted cash collateral with CIT. The revolving line of
credit, which expires October 8, 2006, is subject to an availability limit under
a borrowing base calculation (85% of eligible accounts receivable as defined in
the financing agreement plus 100% of the $1,500,000 restricted cash). At October
1, 2005, the Company had available borrowing capacity under its revolving line
of credit of $4,000,000. The revolving line of credit bears interest at the
prime rate plus 1/2 percent (currently 7.50%). The principal amount of Term Loan
A is payable in 60 equal monthly installments of $25,000 and bears interest at
the prime rate plus one percent (currently 8.0%). The principal amount of Term
Loan B is payable in 84 equal monthly installments of $32,738 and bears interest
at the prime rate plus one percent (currently 8.0%). As of October 1, 2005, the
Company, under the terms of its agreement with CIT, had elected to convert
$850,000 of Term Loan A and $1,950,000 of Term Loan B from their prime rate base
to LIBOR-based interest rate loans. The current LIBOR interest rate options were
renewed on April 11, 2005 for six months at an interest rate of 6.64% and
expired October 11, 2005. The new LIBOR interest rate options were renewed for
six months at 7.54% and will expire April 12, 2006. The revolving line of credit
and the term loans are secured by substantially all of the Company's assets
located within the United States and the pledge of 65% of the stock of the
Company's subsidiaries located in Costa Rica and Canada. The provisions of the
financing agreement require the Company to maintain certain financial and other
covenants. The Company was in compliance with these covenants at October 1,
2005.
Filtran Microcircuits Inc. ("FMI") has a revolving credit agreement in place
with The Bank of Nova Scotia for up to $500,000 (Canadian) at the prime rate
plus 3/4%. No borrowings were outstanding under this agreement at October 1,
2005.
FMI has a $1,800,000 (Canadian) revolving lease line with the Bank of Nova
Scotia, whereby the Company can obtain funding for previous production equipment
purchases via a sale/leaseback transaction. As of October 1, 2005, $517,000
(Canadian) has been utilized under this facility. Such leases are payable in
monthly installments for up to five years and are secured by the related
production equipment. Interest rates (typically prime rate plus one percent) are
set at the closing of each respective sale/leaseback transaction. During the
first quarter of 2005, FMI obtained $287,000 (Canadian) ($231,000-US) in
connection with the sale/leaseback of certain production equipment. The related
equipment was originally purchased by the Company in 2004.
Assets securing capital leases included in property, plant and equipment, net,
have a depreciated cost of approximately $712,000 at October 1, 2005 and
$611,000 at January 1, 2005.
Depreciation and amortization expenses exceeded capital expenditures for
production equipment during the first nine months of 2005 by approximately
$1,200,000, and the Company anticipates that depreciation and amortization
expenses will exceed capital expenditures in fiscal year 2005 by approximately
$1,200,000. The Company intends to issue commitments to purchase $700,000 of
capital equipment from various vendors. The Company anticipates that such
equipment will be purchased and become operational during the fourth quarter of
2005 and first quarter of 2006.
The functional currency for the Company's wholly-owned subsidiary FMI is the
Canadian dollar. The change in accumulated other comprehensive income for the
first nine months of 2005 and 2004 reflect the changes in the exchange rates
between the Canadian dollar and the United States dollar for those respective
periods. The functional currency for the Company's Costa Rica operations is the
United States dollar.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, SFAS No. 151, "Inventory Costs (An amendment of ARB No. 43,
Chapter 4)," was issued. SFAS No. 151 amends Accounting Research Bulletin
("ARB") No. 43, Chapter 4, to clarify that abnormal amounts of idle facility
expense, freight, handling costs and wasted materials (spoilage) should be
recognized as current-period charges. In addition, SFAS No. 151 requires
22
that allocation of fixed production overhead to inventory be based on normal
capacity of the production facilities. SFAS No. 151 is effective for the Company
for inventory costs incurred beginning in fiscal 2006. The Company is currently
evaluating the impact that SFAS No. 151 will have on its financial position and
results of operations.
In December 2004, SFAS No. 123R, "Share-Based Payment," a revision of SFAS No.
123, "Accounting for Stock-Based Compensation", was issued. SFAS No. 123R
replaces existing requirements of SFAS No. 123 and APB Opinion No. 25
"Accounting for Stock-Based Compensation", and requires public companies to
recognize the cost of employee services received in exchange for equity
instruments, with limited exceptions. SFAS No. 123R also affects the pattern in
which compensation cost is recognized, the accounting for employee share
purchase plans, and the accounting for income tax effects of share-based payment
transactions. SFAS No. 123R will be effective for the Company as of the
beginning of the 2006 fiscal year. The Company expects the adoption of this
statement will have a non-cash material effect on its financial statements, but
the Company cannot reasonably estimate the impact of the adoption because
certain assumptions used in the calculation of the value of share-based payments
may change.
The FASB has issued FASB Staff Position No. 109-1, "Application of FASB
Statement No. 109, Accounting for Income Taxes, for the Tax Deduction Provided
to U.S. Based Manufacturers by the American Jobs Creation Act of 2004." On
October 22, 2004, the American Jobs Creation Act of 2004 (the "Act") was signed
into law by the President. This Act includes tax relief for domestic
manufacturers by providing a tax deduction for up to 9 percent (when fully
phased in) of the lesser of (a) "qualified production activities income," or (b)
taxable income (after the deduction for the utilization of any net operating
loss carryforwards). As a result of this Act, an issue has arisen as to whether
this deduction should be accounted for as a special deduction or a tax rate
reduction under SFAS No. 109. The FASB staff believes that the domestic
manufacturing deduction is based on the future performance of specific
activities, including the level of wages. Accordingly, the FASB staff believes
that the deduction provided for under the Act should be accounted for as a
special deduction in accordance with SFAS No. 109 and not as a tax rate
reduction. The Company will be utilizing its net operating loss carryforwards to
offset domestic taxable income, thus this provision will not have an impact on
its financial position and results of operations in 2005.
INVESTMENT CONSIDERATIONS
You should carefully consider the matters described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Our business operations may be impaired by
additional risks and uncertainties of which we are unaware or that we currently
consider immaterial.
Our business, results of operations or cash flows may be adversely
affected if any of the following risks actually occur. In such case, the trading
price of our common stock could decline, and you may lose part or all of your
investment.
The market for our products, in particular our Multi-Mix(R) products, is new and
rapidly evolving. If we are not able to develop or enhance our products, or to
respond to customer needs, our net revenues will suffer.
Our future success depends in large part on our ability to develop and
market our new line of Multi-Mix(R) modules, filters, couplers and delay lines
products, particularly to the wireless base station and defense sectors. We will
also need to continually enhance our existing core products (passive RF and
microwave component assemblies, power dividers and other micro circuitry
products), lower product cost and develop new products that maintain
technological competitiveness. Our core products must meet changing customer,
regulatory and particular technological requirements and standards, and our
Multi-Mix(R) products especially must respond to the changing needs of our
customers, particularly our OEM customers. These customer requirements might or
might not be compatible with our current or future product offerings. We might
not be successful in modifying our products and services to address these
requirements and standards and our business could suffer.
Multi-Mix(R) Microtechnology and Multi-Mix PICO(R) Products.
We have made capital investments of approximately $14 million in our
proprietary line of Multi-Mix(R) Microtechnology products.
23
While we have generated revenues and developed a customer base for our
Multi-Mix (R) products, if a competitive product or decreased consumer demand
for our Multi-Mix (R) products resulted in significant decrease in those
revenues, our ability to recover our investment in our Multi-Mix (R)
Microtechnology product assets could be negatively impacted and result in a
reduction of the carrying value of these assets and an impairment charge to our
earnings.
In addition, we have invested significant engineering, research and
development, personnel and other resources in developing our new Multi-Mix
Zapper(R) product line, introduced in June 2004. While revenues to date have not
been material, we intend to incur significant additional expenses, including
sales and marketing costs, in implementing our strategic plan to commercialize
various applications of our Multi-Mix(R) technologies. These products are direct
drop-in replacements for competing technologies used in virtually all wireless
base stations. There are competing technologies already in the marketplace, and
in order to obtain market share we will have to convince customers to convert to
our products from those that are already in use.
We may seek to enter into joint ventures, research and development,
distribution and other arrangements with third party OEM's, defense contractors,
universities and research institutions and others in order to successfully
market our Multi-Mix(R) products. In fact, we may find it necessary to enter
into such arrangements if our own resources are inadequate to develop recurring
revenues and a sustained commercial market for these products. There can be no
assurance we will be able to enter into such arrangements, or do so on
commercially attractive terms, if necessary.
Our business plan anticipates significant future revenues from our
Multi-Mix(R) products. Due to economic and market conditions in the wireless
industry over the past several years, telecommunications system service
providers substantially reduced their capital equipment purchases from our
customers. While these circumstances have resulted in the delay or cancellation
of Multi-Mix(R) Microtechnology product purchases that had been anticipated from
certain specific customers or programs, the Company has implemented a strategic
plan utilizing product knowledge and customer focus to expand specific sales
opportunities. However, continued extended delay or reduction from planned
levels in new orders expected from customers for these products could require
the Company to pursue alternatives related to the utilization or realization of
these assets and commitments. If we are unable to generate significant future
revenues from these Multi-Mix(R) products or identify alternative uses,
sufficient to recover our investment, we could have to write down the carrying
value of these assets, thereby incurring an impairment charge to earnings, which
would significantly harm our operations and financial condition.
Our products are intended for use in various sectors of the satellite, defense
and telecommunications industries, which produces technologically advanced
products with short life cycles.
Factors affecting the satellite, defense and telecommunications
industries, in particular the short life cycle of certain products, could
seriously harm our customers and reduce the volume of products they purchase
from us. These factors include:
- the inability of our customers to adapt to rapidly changing
technology and evolving industry standards that result in short
product life cycles;
- the inability of our customers to develop and market their
products, some of which are new and untested; and
- the potential that our customers' products may become obsolete or
the failure of our customers' products to gain widespread
commercial acceptance.
The expenses relating to our products might increase, which could reduce our
gross margins.
In the past, developing engineering solutions, meeting research and
development challenges and overcoming production and manufacturing issues have
resulted in additional expenses and cost overruns. These expenses create
pressure on our average selling prices and may result in decreased margins of
our products. We expect that this will continue. In the future, competition
could increase, and we anticipate this may result in additional pressure on our
pricing. We also may not be able to increase the price of our products in the
event that the cost of components or overhead increase. Changes in exchange
rates between the United States
24
and Canadian dollars, and other currencies, might result in further disparity
between our costs and selling price and hurt our ability to maintain gross
profits.
We carry inventory and there is a risk we may be unable to dispose of certain
items.
We procure inventory based on specific customer orders and forecasts.
Customers have certain rights of modification with respect to these orders and
forecasts. As a result, customer modifications to orders and forecasts affecting
inventory previously procured by us and our purchases of inventory beyond
customer needs may result in excess and obsolete inventory for the related
customers. Although we may be able to use some of these excess components and
raw materials in other products we manufacture, a portion of the cost of this
excess inventory may not be recoverable from customers, nor may any excess
quantities be returned to the vendors. We also may not be able to recover the
cost of obsolete inventory from vendors or customers.
Write offs or write downs of inventory generally arise from:
- declines in the market value of inventory;
- changes in customer demand for inventory, such as cancellations of
orders; and
- our purchases of inventory beyond customer needs that result in
excess quantities on hand and that we are not able to return to the
vendor or charge back to the customer.
Our products and therefore our inventories are subject to technological
risk. At any time either new products may enter the market or prices of
competitive products may be introduced with more attractive features or at lower
prices than ours. There is a risk we may be unable to sell our inventory in a
timely manner and avoid it becoming obsolete. As of October 1, 2005, our
inventories, including raw materials, work-in-process and finished goods, were
valued at $3.5 million and we had valuation allowances for obsolescence and cost
overruns of $1.6 million against these inventories. In the event we are required
to substantially discount our inventory or are unable to sell our inventory in a
timely manner, we would be required to increase our reserves and our operating
results could be substantially harmed.
We generally do not obtain long-term volume purchase commitments from customers,
and, therefore, cancellations, reductions in production quantities and delays in
production by our customers could adversely affect our operating results.
We generally do not obtain firm, long-term purchase commitments from
our customers. Customers may cancel their orders, choose not to exercise options
for further product purchases, reduce production quantities or delay production
for a number of reasons. In the event our customers experience significant
decreases in demand for their products and services, our customers may cancel
orders, delay the delivery of some of the products that we manufactured or place
purchase orders for fewer products than we previously anticipated. Even when our
customers are contractually obligated to purchase products from us, we may be
unable or, for other business reasons, choose not to enforce our contractual
rights. Cancellations, reductions or delays of orders by customers would:
- adversely affect our operating results by reducing the volumes of
products that we manufacture for our customers;
- delay or eliminate recoupment of our expenditures for inventory
purchased in preparation for customer orders; and
- lower our asset utilization, which would result in lower gross
margins.
Products we manufacture may contain design or manufacturing defects that could
result in reduced demand for our services and liability claims against us.
We manufacture products to our customers' specifications that are
highly complex and may at times contain design or manufacturing defects. Defects
have been discovered in products we manufactured in the past and despite our
quality control and quality assurance efforts, defects may occur in the future.
Defects in the products we manufacture, whether caused by design, manufacturing
or component defects, may result in delayed shipments to customers or reduced or
cancelled customer orders. If these defects occur in large quantities or
frequently, our business reputation may also be tarnished. In addition, these
defects may result in liability
25
claims against us. Even if customers are responsible for the defects, they may
or may not be able to assume responsibility for any costs or payments.
We are subject to risks of currency fluctuations.
A portion of our business is conducted in currencies other than the
U.S. dollar. Changes in exchange rates among other currencies and the U.S.
dollar will affect our cost of sales, operating margins and revenues. Our
Canadian operations were adversely impacted in fiscal 2004 as a result of
changes in the Canadian and U.S. Dollar exchange rates. We cannot predict the
impact of future exchange rate fluctuations. In addition, certain of our
subsidiaries that have non-U.S. dollar functional currencies transact business
in U.S. dollars.
We rely on a small number of customers for a substantial portion of our net
sales, and declines in sales to these customers could adversely affect our
operating results.
Sales to our five largest customers accounted for 45.6% of our net
sales in the fiscal year ended January 1, 2005 and our two largest customers,
Raytheon Company and Northrop Grumman Corporation, accounted for 13.9%, and
11.9%, respectively, of our net sales for that period. We depend on the
continued growth, viability and financial stability of our customers,
substantially all of which operate in an environment characterized by rapid
technological change, short product life cycle, consolidation, and pricing and
margin pressures. We expect to continue to depend upon a relatively small number
of customers for a significant percentage of our revenue. Consolidation among
our customers may further concentrate our business in a limited number of
customers and expose us to increased risks relating to dependence on a small
number of customers. In addition, a significant reduction in sales to any of our
large customers or significant pricing and margin pressures exerted by a key
customer would adversely affect our operating results. In the past, including as
recently as the third quarter of 2005, some of our large customers have
significantly reduced or delayed the volume of products ordered from us as a
result of government and defense program timing changes, changes in their
business, consolidation or divestitures or for other reasons. We cannot be
certain that present or future large customers will not terminate their
arrangements with us or significantly change, reduce or delay the amount of
products ordered from us, any of which would adversely affect our operating
results.
A substantial portion of our revenues is related to the defense and
military communications sectors. However, in times of armed conflict or war,
military spending is concentrated on armaments build up, maintenance and troop
support, and not on the research and development and specialty applications that
are the Company's core strengths and revenue generators. Accordingly, our
defense and military product revenues may decrease, and should not be expected
to increase, at times of armed conflicts or war.
Variations in our quarterly operating results could occur due to factors
including changes in demand for our products, the timing of shipments and
changes in our mix of net revenues.
Our quarterly net revenues, expenses and operating results have varied
in the past and might vary significantly from quarter to quarter in the future.
Quarter-to-quarter comparisons of our operating results are not a good
indication of our future performance, and should not be relied on to predict our
future performance. Our short-term expense levels and manufacturing and
production facilities infrastructure overhead are relatively fixed and are based
on our expectations of future net revenues. If we were to experience a reduction
in net revenues in a quarter, we could have difficulty adjusting our short-term
expenditures and absorbing our excess capacity expenses. If this were to occur,
our operating results for that quarter would be negatively impacted. Other
factors that might cause our operating results to fluctuate on a quarterly basis
include:
- changes in the mix of net revenues attributable to higher-margin
and lower-margin products;
- customers' decisions to defer or accelerate orders;
- timing of shipments of orders for our products;
- changes in product mix which could cause unexpected engineering or
research and development costs;
- changes in demand for our products;
- announcements or introductions of new products by our competitors;
26
- engineering or production delays due to product defects or quality
problems and production yield issues; and
- defense budgets are very dynamic which could cause military program
delays or cancellations.
Competition.
The microwave component and subsystems industry continues to be highly
competitive. The Company competes against many companies, both foreign and
domestic, many of which are larger and have greater financial and other
resources. Direct competitors for Merrimac in the commercial market are Anaren,
Sirenza, Vari-L, Radiall and Sochen. Major competitors for Merrimac in the
military market are Anaren, M/A Com, L-3 Communications (Narda), Sage, TRM and
KW Microwave. Major competitors for Filtran in the microwave micro-circuitry
market are Labtech, MPC and Precision Instruments. As a direct supplier to OEMs,
the Company also faces significant competition from the in-house capabilities of
its customers. However, the current trend in the wireless marketplace has been
for the OEMs to outsource more design and production work, thereby freeing up
their internal resources for other use. Thus, the Company believes that internal
customer competition exists predominantly in its space and defense and satellite
businesses.
In the wireless market, increased price pressure from the Company's
customers is a continuing challenge. It is anticipated that this pricing
pressure will continue indefinitely.
The principal competitive factors are technical performance,
reliability, ability to produce in volume, on-time delivery and price. Based on
these factors, the Company believes that it competes favorably in its markets.
The Company believes that it is particularly strong in the areas of technical
performance and on-time delivery in the wireless marketplace. The Company
believes that it competes favorably on price as well.
The RF and microwave components industry is highly competitive and has
become more so as defense spending has changed program spending profiles.
Furthermore, current Department of Defense efforts are shifting funds to support
troops engaged in existing hostilities around the world. We compete against
numerous U.S. and foreign providers with global operations, as well as those who
operate on a local or regional basis. In addition, current and prospective
customers continually evaluate the merits of manufacturing products internally.
Changes in the industries and sectors we service could significantly harm our
ability to compete, and consolidation trends could result in larger competitors
that may have significantly greater resources with which to compete against us.
We may be operating at a cost disadvantage compared to manufacturers
who have greater direct buying power from component suppliers, distributors and
raw material suppliers or who have lower cost structures. Our manufacturing
processes are generally not subject to significant proprietary protection, and
companies with greater resources or a greater market presence may enter our
market or increase their competition with us. Increased competition could result
in price reductions, reduced sales and margins or loss of market share.
Intellectual Property.
Substantial litigation regarding intellectual property rights exists in
our industry. We do not believe our intellectual properties infringe those of
others, and are not aware that any third party is infringing our intellectual
property rights. A risk always exists that third parties, including current and
potential competitors, could claim that our products, or our customers'
products, infringe on their intellectual property rights or that we have
misappropriated their intellectual property. We may discover that a third party
is infringing upon our intellectual property rights, or has been issued an
infringing patent.
Infringement suits are time consuming, complex, and expensive to
litigate. Such litigation could cause a delay in the introduction of new
products, require us to develop non-infringing technology, require us to enter
into royalty or license agreements, if available, or require us to pay
substantial damages. We have agreed to indemnify certain customers for
infringement of third-party intellectual property rights. We could incur
substantial expenses and costs in case of a successful indemnification claim. If
a successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed
27
or similar technology on a timely and cost-effective basis, our business could
be significantly negatively impacted.
The Company's success depends to a significant degree upon the
preservation and protection of its product and manufacturing process designs and
other proprietary technology. To protect its proprietary technology, the Company
generally limits access to its technology, treats portions of such technology as
trade secrets, and obtains confidentiality or non-disclosure agreements from
persons with access to the technology. The Company's agreements with its
employees prohibits employees from disclosing any confidential information,
technology developments and business practices, and from disclosing any
confidential information entrusted to the Company by other parties. Consultants
engaged by the Company who have access to confidential information generally
sign an agreement requiring them to keep confidential and not disclose any
non-public confidential information.
The Company currently has 14 active patents and has filed 3 other
patent applications that are currently pending before the United States Patent
and Trademark Office to protect both the design and manufacture of its products.
The Company plans to pursue intellectual property protection in foreign
countries, primarily in the form of international patents, in instances where
the technology covered is considered important enough to justify the added
expense. By agreement, Company employees who initiate or contribute to a
patentable design or process are obligated to assign their interest in any
potential patent to the Company.
Our executive officers, engineers, research and development and technical
personnel are critical to our business, and without them we might not be able to
execute our business strategy.
Our financial performance depends substantially on the performance of
our executive officers and key employees. We are dependent in particular on
Mason N. Carter, who serves as our Chief Executive Officer, Reynold K. Green,
our Chief Operating Officer, Robert V. Condon, who serves as our Chief Financial
Officer and James J. Logothetis, our Chief Technology Officer. We are also
dependent upon our other highly skilled engineering, research and development
and technical personnel, due to the specialized technical nature of our
business. If we lose the services of any of our key personnel and are not able
to find replacements in a timely manner, our business could be disrupted, other
key personnel might decide to leave, and we might incur increased operating
expenses associated with finding and compensating replacements. Key Man
insurance is maintained on certain executives of the Company.
Government Regulation.
The Company's products are incorporated into telecom and wireless
communications systems that are subject to regulation domestically by various
government agencies, including the Federal Communications Commission and
internationally by other government agencies. In addition, because of its
participation in the satellite and defense industry, the Company is subject to
audit from time to time for compliance with government regulations by various
governmental agencies. The Company is also subject to a variety of local, state
and federal government regulations relating to environmental laws, as they
relate to toxic or other hazardous substances used to manufacture the Company's
products. The Company believes that it operates its business in material
compliance with applicable laws and regulations. However, any failure to comply
with existing or future laws or regulations could have a material adverse effect
on the Company's business, financial condition and results of operations.
Export controls.
The Company's products are subject to the Export Administration
Regulations ("EAR") administered by the U.S. Department of Commerce and may, in
certain instances, be subject to the International Traffic in Arms Regulations
("ITAR") administered by the U.S. Department of State. EAR restricts the export
of dual-use products and technical data to certain countries, while ITAR
restricts the export of defense products, technical data and defense services.
The Company believes that it has implemented internal export procedures and
controls in order to achieve compliance with the applicable U.S. export control
regulations. However, the U.S. government agencies responsible for administering
EAR and ITAR have significant discretion in the interpretation and enforcement
of these regulations, and it is possible that these regulations could adversely
affect the Company's ability to sell its products to non-U.S. customers.
28
Risks of International Operations.
A significant percentage of the Company's revenues is derived from the
operations of its wholly-owned subsidiaries in Costa Rica and Canada. These
revenues are subject to the risks normally associated with international
operations which include, without limitation, fluctuating currency exchange
rates, changing political and economic conditions, difficulties in staffing and
managing foreign operations, greater difficulty and expense in administering
business abroad, complications in complying with foreign laws and changes in
regulatory requirements, and cultural differences in the conduct of business.
While the Company believes that current political and economic
conditions in Canada and Costa Rica are relatively stable, such conditions may
adversely change so as to effect underlying business assumptions about the
current opportunities which exist for doing business in those countries. In
particular, the government in Costa Rica could change, the currency exchange
rate between the U.S. and Canadian dollars may change adversely (as occurred in
2004), or the cost of labor and/or goods and services necessary to the
operations of the Company may increase.
Recently enacted changes in the Securities Laws and Regulations are likely to
increase costs.
The Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") has required
changes in some of our corporate governance, securities disclosure and
compliance practice. In response to the requirements of the Sarbanes-Oxley Act,
the SEC and the American Stock Exchange have promulgated new rules in a variety
of subjects. Compliance with these new rules has increased our legal and
accounting costs, and we expect these increased costs to continue indefinitely.
These developments may also make it more difficult for us to attract and retain
qualified members of our board of directors or qualified executive officers.
If we receive other than an unqualified opinion on the adequacy of our internal
control over financial reporting as of December 29, 2007 and future year-ends as
required by Section 404 of the Sarbanes-Oxley Act, investors could lose
confidence in the reliability of our financial statements, which could result in
a decrease in the value of our common stock.
As required by Section 404 of the Sarbanes-Oxley Act, the SEC adopted
rules requiring public companies to include a report of management on the
company's internal control over financial reporting in their annual reports on
Form 10-K or 10-KSB that contains an assessment by management of the
effectiveness of the Company's internal control over financial reporting. In
addition, the public accounting firm auditing a company's financial statements
must attest to and report on both management's assessment as to whether the
company maintained effective internal control over financial reporting and on
the effectiveness of the company's internal control over financial reporting.
We are currently undergoing a comprehensive effort to comply with
Section 404 of the Sarbanes-Oxley Act. If we are unable to complete our
assessment in a timely manner or if our independent auditors issue other than an
unqualified opinion on the design, operating effectiveness or management's
assessment of internal control over financial reporting, this could result in an
adverse reaction in the financial markets due to a loss of confidence in the
reliability of our financial statements, which could cause the market price of
our shares to decline.
RELATED PARTY TRANSACTIONS
In May 1998, the Company sold 22,000 shares of Common Stock to Mason N. Carter,
Chairman, President and Chief Executive Officer of the Company, at a price of
$11.60 per share, which approximated the average closing price of the Company's
Common Stock during the first quarter of 1998. The Company lent Mr. Carter
$255,000 in connection with the purchase of these shares and combined that loan
with a prior loan to Mr. Carter in the amount of $105,000. The resulting total
principal amount of $360,000 was payable May 4, 2003 and bore interest at a
variable interest rate based on the prime rate. This loan was further amended on
October 19, 2002. Accrued interest of $40,000 was added to the principal,
bringing the new principal amount of the loan to $400,000, the due date was
extended to May 4, 2006, and interest (at the same rate as was previously
applicable) is now payable monthly. Mr. Carter has pledged 33,000 shares of
Common Stock as security for this loan, which is a full-recourse loan.
29
On August 31, 2000, in connection with an amendment of Mr. Carter's employment
agreement, the Company loaned Mr. Carter an additional $280,000. Interest on the
loan varies and is based on the prime rate, payable in accordance with Mr.
Carter's employment agreement. Each year the Company is required to forgive 20%
of the amount due under this loan and the accrued interest thereon. During 2004,
the Company forgave $56,000 of principal and $4,500 of accrued interest and paid
a tax gross-up benefit of $6,100. $56,000 of principal and $3,000 of accrued
interest were forgiven in 2005, after which this loan was fully satisfied.
During the third quarter and first nine months of 2005, the Company's outside
general counsel Katten Muchin Rosenman LLP was paid $37,000 and $212,000,
respectively, for providing legal services to the Company. During the third
quarter and first nine months of 2004, Katten Muchin Rosenman LLP was paid
$59,000 and $211,000, respectively. A director of the Company is counsel to
Katten Muchin Rosenman LLP but does not share in the fees that the Company pays
to such law firm and his compensation is not based on such fees.
During 2005 and 2004 the Company retained Career Consultants, Inc. and SK
Associates to perform executive searches and to provide other services to the
Company. The Company paid an aggregate of $2,000 and $5,000 to these companies
during the third quarter and first nine months of 2005. The Company paid an
aggregate of $1,000 and $18,000 to these companies during the third quarter and
first nine months of 2004, respectively. A director of the Company is the
chairman and chief executive officer of these companies.
During the third quarter and first nine months of 2005, a director of the
Company was paid $9,000 and $27,000, respectively, for providing
technology-related consulting services to the Company. For the third quarter and
first nine months of 2004, such director was paid $9,000 and $27,000,
respectively.
During the third quarter and first nine months of 2005, DuPont Electronic
Technologies ("DuPont"), a stockholder and the employer of a director, was paid
$17,000 and $42,000, respectively, for providing technological and
marketing-related personnel and services on a cost-sharing basis to the Company
under the Technology Agreement dated February 28, 2002. During the third quarter
and first nine months of 2004, DuPont was paid $9,000 and $66,000, respectively.
A director of the Company is an officer of DuPont, but does not share in any of
these payments.
Each director who is not an employee of the Company receives a monthly
director's fee of $1,500, plus an additional $500 for each meeting of the Board
and of any Committees of the Board attended. In addition, the Chair of the Audit
Committee receives an annual fee of $2,500 for his services in such capacity.
The directors are also reimbursed for reasonable travel expenses incurred in
attending Board and Committee meetings. In addition, pursuant to the 2001 Stock
Option Plan, each non-employee director is granted an immediately exercisable
option to purchase 2,500 shares of the Common Stock of the Company on the date
of each Annual Meeting of Stockholders. Each such grant has an exercise price
equal to the fair market value on the date of such grant and will expire on the
tenth anniversary of the date of the grant. On June 21, 2005, non-qualified
stock options to purchase an aggregate of 17,500 shares were issued to seven
directors at an exercise price of $8.95 per share.
On December 13, 2004 Infineon Technologies AG ("Infineon"), at such time the
beneficial owner of approximately 15% of the Company's common stock, sold
475,000 shares of the Company's common stock to four purchasers in a
privately-negotiated transaction. Two purchasers in such transaction, K Holdings
LLC and Hampshire Investments, Limited, each of which is affiliated with Ludwig
G. Kuttner, purchased shares representing an aggregate of approximately 9.6% of
the Company's common stock. Infineon also assigned to each purchaser certain
registration rights to such shares under the existing registration rights
agreements Infineon had with the Company. In connection with the transaction,
the Company and Infineon terminated the Stock Purchase and Exclusivity Letter
Agreement dated April 7, 2000, as amended, which provided that the Company would
design, develop and produce exclusively for Infineon certain Multi-Mix(R)
products that incorporate active RF power transistors for use in certain
wireless base station applications, television transmitters and certain other
applications that are intended for Bluetooth tranceivers.
DuPont and the four purchasers above hold registration rights which currently
give them the right to register an aggregate of 1,003,413 shares of Common Stock
of the Company.
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Interest on the Company's borrowings under its financing agreement with CIT
fluctuates with the prime rate and LIBOR. A variation of 1% in the prime rate
and LIBOR during the year ended January 1, 2005 would have affected the
Company's earnings by approximately $38,000.
Foreign Currency Risk
The Company is subject to currency exchange rate risk for the assets,
liabilities and cash flows of its subsidiary that operates in Canada. The
Company does not utilize financial instruments such as forward exchange
contracts or other derivatives to limit its exposure to fluctuations in the
value of foreign currencies. There are costs associated with our operations in
Canada which require payments in the local currency and payments received from
customers for goods sold in Canada are typically in the local currency. We
partially manage our foreign currency risk related to those payments by
maintaining operating accounts in Canada.
A significant portion of the Company's revenues and receivables (including those
of its Canadian subsidiary) are denominated in U.S. dollars. A strengthening of
the U.S. dollar could make the Company's products less competitive in foreign
markets. Alternatively, if the U.S. dollar were to weaken, it would make the
Company's products more competitive in foreign markets, but could result in
higher costs from its Canadian operations.
ITEM 4. CONTROLS AND PROCEDURES
As of October 1, 2005 (the end of the period covered by this report), the
Company's management carried out an evaluation, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the Company's disclosure controls and procedures. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that, as of October 1, 2005, the Company's disclosure controls and
procedures were effective.
In designing and evaluating the Company's disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of
1934), management recognized that any controls and procedures, no matter how
well designed and operated, can provide only reasonable assurances of achieving
the desired control objectives, as ours are designed to do, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. At the time of our evaluation,
we believe that our disclosure controls and procedures provide such reasonable
assurance.
Subsequent to the end of the Company's second fiscal quarter and the evaluation
of our disclosure controls conducted as of July 2, 2005, two adjustments were
identified in the Company's accounting for certain contracts where specified
shipment, delivery, customer inspection and acceptance revenue recognition
criteria had not been satisfied. The adjustments, aggregating $301,000 of
revenue recognition were recorded in the second quarter, and the sale of the
affected products was concluded in the third quarter, at which time the related
revenue was recognized. The need for these adjustments indicated a deficiency in
the design and operation of the Company's cut off procedures at the end of
accounting periods, and in the application and documentation of revenue
recognition policies and SEC/GAAP accounting requirements. This deficiency
constituted a material weakness in the Company's internal controls over
financial reporting.
To address such material weakness, during the third quarter of 2005 management,
with the oversight of the Audit Committee, implemented enhanced procedures to
examine each quarter all contracts in excess of a specified dollar amount to
ensure that revenue is appropriately recognized in the proper period. This
examination includes, among other steps, a comparison of each selected sale's
characteristics to the specific revenue recognition requirements of the
Company's accounting policy based on the SEC's SAB 101 and SAB 104 (Revenue
Recognition) and other relevant authoritative revenue recognition accounting
literature that may become available from time to time. Management also created
a standard documentation template to support the timing of revenue recognition
for those selected sales that meet the review criteria. In addition, members of
the Company's financial department including our Chief Financial Officer
undertook additional training with respect to GAAP and SEC reporting
requirements for accounting matters, including regarding revenue recognition
issues and contract fulfillment administration. Management believes that, with
the addition of these enhanced procedures, the Company's internal controls over
financial reporting is effective.
31
Other than the foregoing, no change occurred in the Company's internal controls
concerning financial reporting during the Company's third quarter of 2005 that
has materially affected, or is reasonably likely to materially affect, the
Company's internal controls over financial reporting.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibits:
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
3(a) Certificate of Incorporation of Merrimac is hereby
incorporated by reference to Exhibit 3(i)(b) to Post-Effective
Amendment No. 2 to the Registration Statement on Form S-8 (No.
33-68862) of Merrimac dated February 23, 2001.
3(b) By-laws of Merrimac are hereby incorporated by reference to
Exhibit 3(ii)(b) to Post-Effective Amendment No. 2 to the
Registration Statement on Form S-8 (No. 33-68862) of Merrimac
dated February 23, 2001.
4(a) Stockholder Rights Agreement dated as of March 9, 1999,
between Merrimac and ChaseMellon Stockholder Services, L.L.C.,
as Rights Agent, is hereby incorporated by reference to
Exhibit 1 to Merrimac's Current Report on Form 8-K filed with
the Securities and Exchange Commission on March 9, 1999.
4(b) Amendment No. 1 dated as of June 9, 1999, to the Stockholder
Rights Agreement dated as of March 9, 1999, between Merrimac
and ChaseMellon Stockholder Services, L.L.C., as Rights Agent,
is hereby incorporated by reference to Exhibit 1 to Merrimac's
Current Report on Form 8-K filed with the Securities and
Exchange Commission on June 9, 1999.
4(c) Amendment No. 2 dated as of April 7, 2000, to the Stockholder
Rights Agreement dated as of March 9, 1999, between Merrimac
and ChaseMellon Stockholder Services, L.L.C., as Rights Agent,
is hereby incorporated by reference to Exhibit 1(b) to
Merrimac's Current Report on Form 8-K filed with the
Securities and Exchange Commission on April 10, 2000.
4(d) Amendment No. 3 dated as of October 26, 2000, to the
Stockholder Rights Agreement dated as of March 9, 1999,
between Merrimac and ChaseMellon Stockholder Services, L.L.C.,
as Rights Agent, is hereby incorporated by reference to
Exhibit 2 to Merrimac's Current Report on Form 8-K filed with
the Securities and Exchange Commission on October 27, 2000.
4(e) Amendment No. 4 dated as of February 21, 2001, to the
Stockholder Rights Agreement dated as of March 9, 1999,
between Merrimac and Mellon Investor Services, L.L.C.
(formerly known as ChaseMellon Stockholder Services, L.L.C.),
as Rights Agent, is hereby incorporated by reference to
Exhibit 1(d) to Merrimac's Current Report on Form 8-K filed
with the Securities and Exchange Commission on February 21,
2001.
4(f) Amendment No. 5, dated February 28, 2002, to the Rights
Agreement, between Merrimac and Mellon Investor Services LLC
(f.k.a. ChaseMellon Shareholder Services, L.L.C.), as Rights
Agent is hereby incorporated by reference to Exhibit 99.4 to
Merrimac's Form 8-K filed with the Securities and Exchange
Commission on March 6, 2002.
4(g) Amendment No. 6, dated September 18, 2002, to the Rights
Agreement, between Merrimac and Mellon Investor Services LLC,
as Rights Agent is hereby incorporated by reference to Exhibit
99.3 to Merrimac's Form 8-K filed with the Securities and
Exchange Commission on October 10, 2002.
4(h) Amendment No. 7, dated December 13, 2004, to the Rights
Agreement, between
32
Merrimac and Wachovia Bank, National Association, as successor
Rights Agent, is hereby incorporated by reference to Exhibit
4.1 to Merrimac's Form 8-K filed with the Securities and
Exchange Commission on December 13, 2004.
10(a) Registration Rights Agreement dated as of April 7, 2000,
between Merrimac and Ericsson Holding International, B.V. is
hereby incorporated by reference to Exhibit 10(b) to
Merrimac's Quarterly Report on Form 10-QSB for the period
ending July 1, 2000.
10(b) Registration Rights Agreement dated October 26, 2000, between
Merrimac and Ericsson Holding International, B.V. is hereby
incorporated by reference to Exhibit 10(u) to Merrimac's
Annual Report on Form 10-KSB dated for the year ending
December 30, 2000.
10(c) Registration Rights Agreement, dated February 28, 2002 between
Merrimac and DuPont Chemical and Energy Operations, Inc., a
subsidiary of E.I. DuPont de Nemours and Company is hereby
incorporated by reference to Exhibit 99.3 to Merrimac's Form
8-K filed with the Securities and Exchange Commission on March
6, 2002.
10(d) Profit Sharing Plan of Merrimac is hereby incorporated by
reference to Exhibit 10(n) to Merrimac's Registration
Statement on Form S-1 (No. 2-79455).*
10(e) 1993 Stock Option Plan of Merrimac effective March 31, 1993,
is hereby incorporated by reference to Exhibit 4(c) to
Merrimac's Registration Statement on Form S-8 (No. 33-68862)
dated September 14, 1993.*
10(f) 1997 Long-Term Incentive Plan of Merrimac is hereby
incorporated by reference to Exhibit A to Merrimac's Proxy
Statement filed with the Securities and Exchange Commission on
April 11, 1997.*
10(g) Resolutions of the Stock Option Committee of the Board of
Directors of Merrimac adopted June 3, 1998, amending the 1983
Key Employees Stock Option Plan of Merrimac, the 1993 Stock
Option Plan of Merrimac and the 1997 Long-Term Incentive Plan
of Merrimac and adjusting outstanding awards thereunder to
give effect to Merrimac's 10% stock dividend paid June 5,
1998, are hereby incorporated by reference to Exhibit 10(f) to
Merrimac's Annual Report on Form 10-KSB for the year ending
March 30, 1999.*
10(h) 1995 Stock Purchase Plan of Merrimac is hereby incorporated by
reference to Exhibit A to Merrimac's Proxy Statement filed
with the Securities and Exchange Commission on March 27,
1995.*
10(i) Resolutions of the Stock Purchase Plan Committee of the Board
of Directors of Merrimac adopted June 3, 1998, amending the
1995 Stock Purchase Plan of Merrimac and adjusting outstanding
awards thereunder to give effect to Merrimac's 10% stock
dividend paid June 5, 1998, are hereby incorporated by
reference to Exhibit 10(g)(2) to Merrimac's Annual Report on
Form 10-KSB for the year ending January 2, 1999.*
10(j) 1996 Stock Option Plan for Non-Employee Directors of Merrimac
is hereby incorporated by reference to Exhibit 10(d) to
Merrimac's Annual Report on Form 10-KSB dated for the year
ending December 28, 1996.*
10(k) Resolutions of the Board of Directors of Merrimac, adopted
June 3, 1998, amending the 1996 Stock Option Plan for
Non-Employee Directors of Merrimac and adjusting outstanding
awards thereunder to give effect to Merrimac's 10% stock
dividend paid June 5, 1998, are hereby incorporated by
reference to Exhibit 10(h)(2)to Merrimac's Annual Report on
Form 10-KSB for the year ending January 2, 1999.*
10(l) Amended and Restated Employment Agreement dated as of January
1, 1998, between Merrimac and Mason N. Carter is hereby
incorporated by reference to Exhibit 10(a) to Merrimac's
Quarterly Report on Form 10-QSB for the period ending July 4,
1998.*
10(m) Amendment dated August 31, 2000 to the Amended and Restated
Employment Agreement
33
dated January 1, 1998, between Merrimac and Mason N. Carter is
hereby incorporated by reference to Exhibit 10(a) to
Merrimac's Quarterly Report on Form 10-QSB for the period
ending September 30, 2000.*
10(n) Amended and Restated Pledge Agreement dated as of May 4, 1998,
between Merrimac and Mason N. Carter is hereby incorporated by
reference to Exhibit 10(c) to Merrimac's Quarterly Report on
Form 10-QSB for the period ending July 4, 1998.*
10(o) Amended Promissory Note dated as of May 4, 1998, executed by
Mason N. Carter in favor of Merrimac is hereby incorporated by
reference to Exhibit 10(l) to Merrimac's Annual Report on Form
10-KSB for the year ending January 2, 1999.*
10(p) Registration Rights Agreement dated as of May 4, 1998, between
Merrimac and Mason N. Carter is hereby incorporated by
reference to Exhibit 10(e) to Merrimac's Quarterly Report on
Form 10-QSB for the period ending July 4, 1998.*
10(q) Consulting Agreement dated as of January 1, 1998, between
Merrimac and Arthur A. Oliner is hereby incorporated by
reference to Exhibit 10 to Merrimac's Quarterly Report on Form
10-QSB for the period ending April 4, 1998.*
10(r) Separation Agreement dated as of December 31, 1998, between
Merrimac and Eugene W. Niemiec is hereby incorporated by
reference to Exhibit 10(p) to Merrimac's Annual Report on Form
10-KSB for the year ending January 2, 1999.*
10(s) Stockholder's Agreement dated as of October 30, 1998, between
Merrimac and Charles F. Huber II is hereby incorporated by
reference to Exhibit 10 to Merrimac's Quarterly Report on Form
10-QSB for the period ending October 3, 1998.
10(t) Shareholder's Agreement dated as of June 3, 1999, among
Merrimac, William D. Witter, Inc. and William D. Witter is
hereby incorporated by reference to Exhibit 10 to Merrimac's
Quarterly Report on Form 10-QSB for the period ending July 3,
1999.
10(u) 2001 Key Employee Incentive Plan is hereby incorporated by
reference to Exhibit 4.01 to Merrimac's Form S-8 (No.
333-63434) dated June 20, 2001.*
10(v) 2001 Stock Option Plan is hereby incorporated by reference to
Exhibit 4.01 to Merrimac's Form S-8 (No. 333-63436) dated June
20, 2001.*
10(w) 2001 Stock Purchase Plan is hereby incorporated by reference
to Exhibit 4.01 to Merrimac's Form S-8 (No. 333-63438) dated
June 20, 2001.*
10(x) 2001 Amended and Restated Stock Option Plan is hereby
incorporated by reference to Exhibit 4(i) to Merrimac's
Quarterly Report on Form 10-QSB for the period ending June 30,
2001.*
10(y) Financing Agreement, dated October 8, 2003, between Merrimac
and The CIT Group/Business Credit, Inc. is hereby incorporated
by reference to Exhibit 10(qq) to Merrimac's Form 10-QSB for
the period ending September 27, 2003.
10(z) Trademark and Patent Security Agreement, dated October 8,
2003, between Merrimac and The CIT Group/Business Credit, Inc.
is hereby incorporated by reference to Exhibit 10(rr) to
Merrimac's Form 10-QSB for the period ending September 27,
2003.
10(aa) Mortgage and Security Agreement, dated October 8, 2003, by
Merrimac in favor of The CIT Group/Business Credit, Inc. is
hereby incorporated by reference to Exhibit 10(ss) to
Merrimac's Form 10-QSB for the period ending September 27,
2003.
10(bb) Merrimac Severance Plan, as adopted September 17, 2003, is
hereby incorporated by reference to Exhibit 10(tt) to
Merrimac's Form 10-QSB for the period ending September 27,
2003.*
31.1+ Chief Executive Officer's Certificate, pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
34
31.2+ Chief Financial Officer's Certificate, pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1+ Chief Executive Officer's Certificate, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2+ Chief Financial Officer's Certificate, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Indicates that exhibit is a management contract or compensatory plan or
arrangement.
+ Indicates that exhibit is filed as an exhibit hereto.
35
SIGNATURES
In accordance with the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
MERRIMAC INDUSTRIES, INC.
Date: November 15, 2005 By: /s/ Mason N. Carter
-------------------
Mason N. Carter
Chairman, President and
Chief Executive Officer
Date: November 15, 2005 By: /s/ Robert V. Condon
--------------------
Robert V. Condon
Vice President, Finance and
Chief Financial Officer
36
