SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C 20549 FORM 10-K (Mark one) _X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended________September 30, 2003_____________________________ OR __TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from____________to____________________________________ Commission file number__________________0-10976_________________________________ ______________________Microwave Filter Company, Inc_____________________________ (Exact name of registrant as specified in its charter) __________New York__________________________16-0928443__________________________ (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) _____6743 Kinne Street, East Syracuse, NY________13057_________________________ (Address of principal executive offices) (Zip code) Registrant's telephone number including area code____(315) 438-4700_____________ Securities registered pursuant to Section 12(b) of the Act:_____None____________ Securities registered pursuant to Section 12(g) of the Act: _________________________Common stock, par value $.10 per share_________________ Title of class Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. __ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES ____ NO__X__ 1 <page> The aggregate market value of the voting stock held by non-affiliates of the registrant at the close of business on December 1, 2003 was $2,819,883. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Shares of common stock outstanding at December 1, 2003: 2,904,781 Documents incorporated by reference: None. PART I ITEM 1. BUSINESS. GENERAL DEVELOPMENT OF BUSINESS - ------------------------------- Microwave Filter Company, Inc. (hereinafter referred to as MFC) was incorporated in New York State on September 26, 1967. MFC is the successor of Microwave Filter Company which was founded in April of 1967. On July 1, 1990, MFC acquired Niagara Scientific, Inc. (hereinafter referred to as NSI.) MFC and its subsidiaries are sometimes referred to collectively as the "Company." NARRATIVE DESCRIPTION OF BUSINESS - ---------------------------------- Microwave Filter Company, Inc. (MFC) Established in 1967 in East Syracuse, New York, MFC occupies a modern 40,000 square foot facility with an impressive complement of analytical and design software, test instrumentation, prototype and manufacturing equipment to create passive filters, components and sub systems in the frequency range of 10 MHz to 50 GHz. MFC manufactures filters for eliminating interference and signal processing for such markets as Cable Television, Broadcast, Mobile Communications, Avionics, Radar, Navigation and Defense Electronics. The Company designs waveguide, stripline/ microstrip, transmission line, miniature/subminiature and lumped constant filters in such filter styles as: bandpass, highpass, lowpass, bandstop, multiplexers, tunable notch, tunable bandpass, high power filters, filter networks, amplitude equalized and delay equalized. The Company actively produces over 1,700 standard products and has designed more than 5,000 custom products for specialized applications. A quality plan is developed for each incoming order. Working as a team, engineers, designers, fabricators and technicians identify any potential design or manufacturing challenges before the project begins. With a quality plan, design to shipping time is reduced due to careful resource planning. The manufacturing facility includes a state-of-the-art CAD-CAM system, a test department with automated network analyzers to 50 GHz, a high capacity conveyor soldering oven, a fully compliant finishing operation and a TQM/ISO9000 based quality assurance program to insure the intrinsic quality of the products produced. 2 <page> Efficient simulation, design and analysis software enhanced by proprietary MFC developed software, allow rapid and accurate filter development at reasonable cost. Automated network analyzers provide rigorous product testing and performance data storage on a serial number basis. A network based CAD-CAM system allows the transfer of data and programs to the CNC turning and milling centers for fabrication of machined parts. Prototype PC boards are similarly produced by computer controlled PC board mills. A Grieve high capacity conveyor soldering oven is used for production of large quantity assemblies while smaller production quantities are assembled at hand soldering or brazing stations. ISO-9000 contract and design review procedures coupled with a QA department that is compliant with MIL-I-45208 inspection systems and MIL-STD-45622 calibration system standards assures process and product integrity. A certified staff instructor regularly trains associates to MIL-STD-2000A (now superceded by J-STD-001.) Other in-house testing facilities include three environmental chambers capable of testing products for temperatures of -0 to 200 degrees Celsius and humidity up to 100 percent. Several high power amplifiers are available for power tests up to 2500 watts at 220 MHz and 100 watts at 1,000 MHz. An automated in-house anechoic chamber provides antenna pattern measurement capability in the 2 to 8 GHz frequency range. Facilities are also available for salt spray, sand and dust, shock and vibration, RFI leakage and altitude testing. Niagara Scientific, Inc. (NSI) - ------------------------------ NSI manufactures material handling equipment for suppliers of consumer goods. Such suppliers would include food processors or any other manufacturer of packaged consumer products that need to be moved into shipping cartons at a certain rate of speed. The Schroeder Machines Division (SMD), in existence for over 50 years, is a division of Niagara Scientific. SMD manufactures a number of case packing solutions but is most noted for its Quadnumatic. The Quadnumatic is an automatic case packing machine that performs all the functions of collating, case forming, loading and sealing products into their shipping cartons at packing speeds ranging from 12 to 30 cases per minute. Other products offered by Schroeder include a servo pick-and-place machine for top loading packaging applications and a case erector/bottom taping machine for customers who still hand pack or need to add a case former to an existing case packing machine. 3 <page> MARKETS - ------- Microwave Filter Company, Inc. (MFC) - ------------------------------------ Cable Television (CATV) - MFC serves this market principally with three product groups. One popular area includes standard and custom filters used at the headend to process signals and remove interference. A very popular application involves removing or re-routing channels to organize programming line-ups. A family of trap filters, "Fastrap," is used by cable operators to restrict or permit the viewing of pay per view or other premium programming. The traps can be ordered in small and large quantities, are 100% inspected and delivered overnight. Since all operators initially receive programming via satellite, products from our satellite market cross over into cable television. C-band satellite receive systems are prone to various types of terrestrial interference which are curable in many cases by applying filters. Broadcast - Several areas of broadcast are served by Microwave Filter Company with the most active being Wireless Cable. Wireless Cable is a video delivery service that has attempted to compete with cable television with limited success. This service delivers programming over-the-air using microwave frequencies. Television programming is received via a small rooftop antenna. The signals are then down converted for reception by the television set. At the home, the equipment looks the same as that supplied by a cable television company with the exception of the rooftop antenna. The most significant product sold to this market is our channel combiner used at the broadcast site to reduce tower costs. By combining channels at the transmitter, additional expensive coaxial or waveguide runs up the tower become unnecessary. MFC offers the widest selection of channel combiners to meet a variety of system specifications. Combiners in different configurations and constructed of different materials offer the operator better or best options depending on budget or other system requirements. 4 <page> LPTV - Low Power Television or LPTV is an option in the U.S. as a multichannel subscription television service. A system similar to Wireless Cable can be configured to deliver channels of programming to areas where off air signals cannot be received. The only difference between both services is broadcast frequency and the type of antenna located at the subscriber's home. An LPTV receive antenna would look like any other off air broadcast antenna in contrast to the microwave antenna used for Wireless Cable. LPTV frequencies are easier to obtain and there are more LPTV than Wireless channels available. In fact, due to the limited number of Wireless Cable frequencies, Wireless Cable operators are using a combination of Wireless and LPTV frequencies to increase the number of channels offered to their subscribers. As a broadcaster, LPTV differs from traditional television only in broadcast power. With lower broadcast power, the service has a smaller reception area than high power broadcast stations. Microwave Filter Company provides channel combiners and interference filters for this industry. The channel combiners are used to group channels and eliminate additional coaxial runs to the broadcast tower. Filters are also used in broadcast equipment to eliminate interference. Radio and Television Broadcast - MFC primarily serves these broadcast areas with interference filters to reduce equipment harmonics. Other broadcast areas served also include AML, telemetry and STL/ENG relays. Similar to cable television, the broadcast industry is also moving towards the digital delivery of both audio and video broadcast. Satellite - Filters and traps for removing interference are provided to both commercial and home C-band TVRO antennas. A variety of products are available that offer protection and or solutions to interference that affects the feedhorn, downconverter, and receiver. A variety of filters are also available for satellite services utilizing higher frequency bands such as 12, 13 and 18 GHz. Direct Broadcast Satellite or DBS is a version of home satellite programming delivered direct to the home. It differs from C-band TVRO by the size of the receive antenna. DBS broadcasts at a higher frequency requiring a smaller satellite dish than C-band TVRO. Both satellite dealers and cable television systems market the service to offer consumers television options. Mobile Radio - MFC provides filters to a variety of mobile radio services such as cellular telephone, two way radio and paging to eliminate interference in transmit or receive equipment. With the number of services increasing and our air waves becoming more congested, filters are increasingly important to many transmit operations. Cellular telephone has been the largest mobile radio growth market. The Cellular market is beginning to level off and now Personal Communications Services (PCS) is an area of mobile radio on the rise. 5 <page> Microwave and RF - This market encompasses both commercial and military applications. Filters in defense applications are used for such purposes as air to ground communications, radar and land communications. In commercial areas, filters are used to protect such equipment as receivers, transmitters, transceivers and any other electronics used for signal processing. In addition to filters, this market is also served with MFC's Ferrosorb product line. Ferrosorb is a microwave absorbing material available in sheets, loads and a variety of other shapes. The product is used to offer protection by shielding signals or absorbing selective bands. In 1992, MFC's acquisition of certain assets of Chesterfield Products added an expanded line of products to enhance the RF filter line. Many of MFC's traditional filters are components added onto a system. Chesterfield provided MFC with the capability to manufacture miniature and subminiature filters which are components built into electronic systems. Another Chesterfield capability has provided us with the resources to expand our filter design range down to 5 KHz. There has been an increased demand for filters in the OEM (Original Equipment Manufacturer) market. In response to this demand, MFC has purchased new design, fabrication and test equipment to design filters up to 50 GHz. OEM orders are larger than those received for other markets and facilities such as a soldering oven have been added in the manufacturing area for large volume production. Niagara Scientific, Inc. (NSI) - ------------------------------ NSI - Like MFC, NSI and its divisions seek niche markets arising from certain demographic changes in the industrial work force which promotes acceptance of automation in both large and small factories. NSI's typical product is customized to the purchaser's operation and is the result of system engineering. The product makes tactical use of precision mechanical movements or sensors of physical characteristics under microprocessor control. These smart machines reduce labor costs through faster operation and increased quality. Typical customers for case packing machines are food processors or makers of cosmetics, pharmaceuticals, candies or hardware whose product must be cased for shipping and storage. Other custom equipment is designed for inspection-rejection, counting, analyzing or otherwise monitoring, reporting or controlling a continuous manufacturing or industrial process. Typical customers are commodity mass producers in the food, drug and paint industries. 6 <page> WORLD TRADE - ----------- Management believes that world marketing is a route to substantial expansion of sales for MFC/NSI. Export opportunities for MFC's communication related products are many - especially in areas of the world such as China, the Pacific Rim and South America. Marketing research reveals that the Company's products are in high demand in these areas of the world. Significant efforts have been made over the last year to identify key international markets and to establish distributors with appropriate technical backgrounds to represent our interests in those regions. NSI products are less suitable for export for a number of reasons, including their large size and complexity, less demand in underdeveloped areas for automation and significant local competition. However, NSI is well qualified to produce and or distribute complementary products under license. SUPPLIERS - --------- The Company depends on outside suppliers for raw materials, components and parts, and services. Although items are generally available from a number of suppliers, the Company purchases certain raw materials and components from a single supplier. If such a supplier should cease to supply an item, the Company believes that new sources could be found to provide the raw materials and components. However, manufacturing delays and added costs could result. The Company has not experienced significant delays of this nature in the past, but there can be no assurance that delays in delivery due to supply shortages will not occur in the future. Substantial periods of lead time for delivery of certain materials are sometimes experienced by the Company, making it necessary to inventory varied quantities of materials. PATENTS AND LICENSES - -------------------- The Company has no patents, trademarks, copyrights, licenses or franchises of material importance. SEASONAL FLUCTUATIONS - --------------------- There are no significant seasonal fluctuations in the Company's business. GOVERNMENT CONTRACTS - -------------------- The Company is not dependent in any material respect on government contracts. 7 <page> BACKLOG - ------- At September 30, 2003, the Company's total backlog of orders was $452,789 compared to $705,578 at September 30, 2002. At September 30, 2003, MFC's backlog of orders was $328,809 compared to $399,640 at September 30, 2002. At September 30, 2003, NSI's backlog of orders was $123,980 compared to $305,938 at September 30, 2002. The total Company backlog at September 30, 2003 is scheduled to ship during fiscal 2004. However, backlog is not necessarily indicative of future sales. Accordingly, the Company does not believe that its backlog as of any particular date is representative of actual sales for any succeeding period. EMPLOYEES - --------- At September 30, 2003, the Company employed 59 full-time permanent employees. RESEARCH AND DEVELOPMENT - ------------------------ The Company maintains and expects to continue to maintain an active research and development program. The Company believes that such a program is needed to maintain its competitive position in existing markets and to provide products for emerging markets. Costs in connection with research and development were $349,203, $376,857 and $362,518 for the fiscal years 2003, 2002 and 2001, respectively. Research and development costs are charged to operations as incurred. COMPETITION - ----------- The principal competitive factors facing both MFC and NSI are price, technical performance, service and the ability to produce in quantity to specific delivery schedules. Based on these factors, the Company believes it competes favorably in its markets. ITEM 2. PROPERTIES. MFC's office and manufacturing facility is located at 6743 Kinne Street, East Syracuse, New York. This facility, which is owned by MFC, consists of 40,000 square feet of office and manufacturing space located on 3.7 acres. MFC presently occupies approximately 35,000 square feet with the balance (approximately 5,000 square feet) occupied by NSI. ITEM 3. LEGAL PROCEEDINGS. There are currently no material pending legal proceedings against the Company or its subsidiaries. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. During the fourth quarter of the fiscal year covered by this Form 10-K, there were no matters submitted to a vote of security holders. 8 <page> PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. MFC's common stock is traded on the NASDAQ over-the-counter market under the symbol MFCO. The information set forth was obtained from statements provided by the NASD. The following table shows the high and low sales prices for MFC's common stock for each full quarterly period within the two most recent fiscal years. The quotations represent prices in the over-the-counter market between dealers in securities. They do not include retail mark-ups, mark-downs or commissions. Fiscal 2003 High Low Oct. 1, 2002 to Dec. 31, 2002 $ 1.53 $ .90 Jan. 1, 2003 to Mar. 31, 2003 1.95 .97 Apr. 1, 2003 to June 30, 2003 1.24 .92 July 1, 2003 to Sept. 30, 2003 1.51 1.04 Fiscal 2002 High Low Oct. 1, 2001 to Dec. 31, 2001 $ 1.45 $ 1.00 Jan. 1, 2002 to Mar. 31, 2002 2.98 1.13 Apr. 1, 2002 to June 30, 2002 2.55 1.50 July 1, 2002 to Sept. 30, 2002 1.81 .94 The approximate number of stockholders on September 30, 2003 was 2,800. On December 18, 2002, the Board of Directors declared a ten cents per share cash dividend to shareholders of record on January 17, 2003 to be distributed on January 31, 2003. On February 13, 2002, the Board of Directors declared a seven cents per share cash dividend to shareholders of record on February 27, 2002 to be distributed on March 13, 2002. 9 <page> ITEM 6. SELECTED FINANCIAL DATA. The following selected financial information is derived from and should be read in conjunction with the financial statements, including the notes thereto, appearing in Item 8. - "Financial Statements and Supplemental Data." Five Year Summary of Financial Data September 30 2003 2002 2001 2000 1999 Net Sales $ 5,059,520 $ 7,251,732 $ 6,848,191 $ 7,491,853 $ 6,572,949 Net (Loss) Income $ (282,400) $ 434,287 $ 128,752 $ 338,736 $ 160,471 Total Assets $ 3,901,545 $ 4,865,885 $ 4,270,151 $ 5,142,708 $ 4,704,630 Long Term Debt $ 0 $ 0 $ 0 $ 0 $ 0 (Loss) Earnings Per Share $ (.10) $ .15 $ .04 $ .11 $ .05 Weighted Average Number of Common Shares Outstanding 2,904,781 2,904,781 2,946,284 3,169,061 3,283,098 Cash ($) Dividends Paid Per Share $ .10 $ .07 $ .03 $ .05 $ .05 Net (loss) income as a percentage of: 2003 2002 2001 2000 1999 Sales............................. (5.6) 6.0 1.9 4.5 2.4 Assets .................... (7.2) 8.9 3.0 6.6 3.4 Equity............................ (8.9) 11.5 3.6 8.8 4.3 10 <page> ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Microwave Filter Company, Inc. operates primarily in the United States and principally in two industries. The Company extends credit to business customers, including original equipment manufacturers (OEMs), distributors and other end users, based upon ongoing credit evaluations. Microwave Filter Company, Inc. designs, develops, manufactures and sells electronic filters, both for radio and microwave frequencies, to help process signal distribution and to prevent unwanted signals from disrupting transmit or receive operations. Markets served include cable television, television and radio broadcast, satellite broadcast, mobile radio, commercial and defense electronics. Niagara Scientific, Inc., a wholly owned subsidiary, custom designs case packing machines to automatically pack products into shipping cases. Customers are processors of food and other commodity products with a need to reduce labor cost with a modest investment and quick payback. RESULTS OF OPERATIONS - --------------------- The following table sets forth the Company's net sales by major product groups for each of the fiscal years in the three year period ended September 30, 2003. Product group (in thousands) Fiscal 2003 Fiscal 2002 Fiscal 2001 Niagara Scientific $ 704 $ 552 $ 981 Microwave Filter: Cable/Satellite TV 3,138 5,326 4,022 RF/Microwave 1,015 980 1,184 Broadcast TV 202 394 661 Total $5,059 $7,252 $6,848 Sales backlog at 9/30 $ 453 $ 706 $ 466 Fiscal 2003 compared to fiscal 2002 Consolidated net sales for the fiscal year ended September 30, 2003 equaled $5,059,520, a decrease of $2,192,212 or 30.2% when compared to consolidated net sales of $7,251,732 during the fiscal year ended September 30, 2002. Microwave Filter Company, Inc. (MFC) sales decreased $2,344,203 or 35% to $4,355,223 during the fiscal year ended September 30, 2003 when compared to sales of $6,699,426 during the fiscal year ended September 30, 2002. 11 <page> The decrease in MFC sales can primarily be attributed to the decrease in the sales of the Company's standard Cable/Satellite TV product sales, which management attributes to the decrease in demand for the Company's standard filters which suppress strong out-of-band interference caused by military and civilian radar systems. Last year, the Company saw an increase in demand for the Company's filters which suppress strong out-of-band interference caused by military and civilian radar systems, primarily due to the increased security measures that were taken as a result of the September 11th terrorist attacks. That demand decreased during fiscal 2003 resulting in the lower sales and due to the current economic climate, MFC has not seen an increase in sales in other product areas. MFC's Cable/Satellite TV product sales decreased $2,188,365 or 41.1% to $3,137,757 during fiscal 2003 when compared to sales of $5,326,122 for the fiscal year ended September 30, 2002. MFC's RF/Microwave product sales increased $35,415 or 3.6% to $1,015,233 during the fiscal year ended September 30, 2003 when compared to sales of $979,818 during the fiscal year ended September 30, 2002. The Company continues to invest in production engineering and infrastructure development to penetrate OEM (Original Equipment Manufacturer) market segments as they become popular. MFC is concentrating its technical resources and product development efforts toward potential high volume customers as part of a concentrated effort to provide substantial long-term growth. MFC's BTV/Wireless cable sales decreased $191,253 or 48.6% to $202,233 for the fiscal year ended September 30,2003 when compared to sales of $393,486 for the fiscal year ended September 30, 2002, primarily due to the downturn in the telecommunications marketplace. Niagara Scientific, Inc. (NSI) sales increased $151,991 or 27.5% to $704,297 for the fiscal year ended September 30, 2003 when compared to sales of $552,306 for the fiscal year ended September 30, 2002. Sales of NSI related equipment can be impacted by the timing of the shipment of the custom designed equipment and the customer's scheduled delivery dates. Despite the increase in sales, NSI's sales order levels have been negatively impacted by the sluggish economy and reduced capital spending. At September 30, 2003, the Company's total backlog of orders equaled $452,789 compared to $705,578 at September 30, 2002. At September 30, 2003, MFC's backlog of orders equaled $328,809 compared to $399,640 at September 30, 2002. At September 30, 2003, NSI's backlog of orders equaled $123,980 compared to $305,938 at September 30, 2002. The total Company backlog at September 30, 2003 is scheduled to ship during fiscal 2004. However, backlog is not necessarily indicative of future sales. Accordingly, the Company does not believe that its backlog as of any particular date is representative of actual sales for any succeeding period. Gross profit decreased $1,339,186 or 47.3% to $1,490,166 during the fiscal year ended September 30, 2003 when compared to gross profit of $2,829,352 during the fiscal year ended September 30, 2002. The dollar decrease in gross profit during fiscal 2003, when compared to fiscal 2002, can primarily be attributed to the decrease in sales. As a percentage of sales, gross profit equaled 29.5% during the fiscal year ended September 30, 2003 compared to 39.0% during the fiscal year ended September 30, 2002. The decrease in gross profit as a percentage of sales, when compared to the same period last year, can primarily be attributed to the lower sales volume. 12 <page> Selling, general and administrative (SG&A) expenses decreased $309,832 or 13.6% to $1,962,530 during the fiscal year ended September 30, 2003 when compared to SG&A expenses of $2,272,362 during the fiscal year ended September 30, 2002. The reductions were primarily related to decreases in payroll and payroll related expenses and planned reductions in media advertising costs. As a percentage of sales, SG&A expenses increased to 38.8% during the fiscal year ended September 30, 2003 when compared to 31.3% during the fiscal year ended September 30, 2002, primarily due to the decrease in sales during fiscal 2003 when compared to fiscal 2002. Due to the uncertain economic climate, the Company has been emphasizing cost controls and cost cutting measures to minimize operating expenses. Income from operations decreased $1,029,354 to a loss from operations of $472,364 during the fiscal year ended September 30, 2003 when compared to income from operations of $556,990 during the fiscal year ended September 30, 2002 primarily due to the decrease in sales. On an industry segment basis, MFC's income from operations decreased $1,055,779 to a loss from operations of $194,582 for the fiscal year ended September 30, 2003 when compared to income from operations of $861,197 for the fiscal year ended September 30, 2002, due primarily to the lower sales volume. NSI recorded a loss from operations of $204,478 for the fiscal year ended September 30, 2003 compared to a loss from operations of $229,893 for the fiscal year ended September 30, 2002. NSI's loss from operations can partly be attributed to the absorption of fixed overhead expenses. Corporate expenses decreased $1,010 to $73,304 for the fiscal year ended September 30, 2003 when compared to corporate expenses of $74,314 for the fiscal year ended September 30, 2002. The Company recognized an income tax benefit of $163,928, or an effective tax rate of (36.7%), for the fiscal year ended September 30, 2003 compared to income tax expense of $167,080, or an effective tax rate of 27.8%, for the fiscal year ended September 30, 2002, primarily due to the pre-tax loss for the fiscal year ended September 30, 2003. In 2002, the effective tax rate differed from the statutory tax rate primarily due to research and experimentation tax credits recognized. Fiscal 2002 compared to fiscal 2001 Consolidated net sales for the fiscal year ended September 30, 2002 equaled $7,251,732, an increase of $403,541 or 5.9% when compared to consolidated net sales of $6,848,191 during the fiscal year ended September 30, 2001. Microwave Filter Company, Inc. (MFC) sales increased $832,797 or 14.2% to $6,699,426 during the fiscal year ended September 30, 2002 when compared to sales of $5,866,629 during the fiscal year ended September 30, 2001. The increase in MFC sales can primarily be attributed to the increase in the sales of the Company's standard Cable/Satellite TV product sales, which management attributes to the increase in demand for the Company's standard filters which suppress strong out-of-band interference caused by military and civilian radar systems. This increase in demand can primarily be attributed to the increased security measures that were taken as a result of the September 11th terrorist attacks. MFC's Cable/Satellite TV product sales increased $1,304,173 or 32.4% to $5,326,122 during fiscal 2002 when compared to sales of $4,021,949 for the fiscal year ended September 30, 2001. Substantially all of this increase was realized during the first six months of the fiscal year. 13 <page> Due to economic conditions, the Company experienced declines in sales in other product areas. MFC's RF/Microwave product sales decreased $204,261 or 17.3% to $979,818 during the fiscal year ended September 30, 2002 when compared to sales of $1,184,079 during the fiscal year ended September 30, 2001. The Company continues to invest in production engineering and infrastructure development to penetrate OEM (Original Equipment Manufacturer) market segments as they become popular. MFC is concentrating its technical resources and product development efforts toward potential high volume customers as part of a concentrated effort to provide substantial long-term growth. MFC's BTV/Wireless cable sales decreased $267,115 or 40.4% to $393,486 for the fiscal year ended September 30, 2002 when compared to sales of $660,601 for the fiscal year ended September 30, 2001, primarily due to the downturn in the telecommunications marketplace. Niagara Scientific, Inc. (NSI) sales decreased $429,256 or 43.7% to $552,306 for the fiscal year ended September 30, 2002 when compared to sales of $981,562 for the fiscal year ended September 30, 2001. Sales of NSI related equipment can be impacted by the timing of the shipment of the custom designed equipment and the customer's scheduled delivery dates. Management attributes the decrease in NSI sales to the downturn in the economy and reduced capital spending. At September 30, 2002, the Company's total backlog of orders equaled $705,578 compared to $466,384 at September 30, 2001. At September 30, 2002, MFC's backlog of orders equaled $399,640 compared to $465,881 at September 30, 2001. At September 30, 2002, NSI's backlog of orders equaled $305,938 compared to $503 at September 30, 2001. Approximately 80% of the total Company backlog at September 30, 2002 is scheduled to ship during fiscal 2003. However, backlog is not necessarily indicative of future sales. Accordingly, the Company does not believe that its backlog as of any particular date is representative of actual sales for any succeeding period. Gross profit increased $538,454 or 23.5% to $2,829,352 during the fiscal year ended September 30, 2002 when compared to gross profit of $2,290,898 during the fiscal year ended September 30, 2001. The dollar increase in gross profit during fiscal 2002, when compared to fiscal 2001, can be attributed to both the improvement in gross profit as a percentage of sales and the increase in sales volume. As a percentage of sales, gross profit equaled 39.0% during the fiscal year ended September 30, 2002 compared to 33.5% during the fiscal year ended September 30, 2001. The improvement in gross profit as a percentage of sales, when compared to the same period last year, can primarily be attributed to a favorable product sales mix experienced in the first six months of the fiscal year and the operational efficiencies and economies of scale gained due to the higher production volume. 14 <page> Selling, general and administrative (SG&A) expenses increased $11,741 or 0.5% to $2,272,362 during the fiscal year ended September 30, 2002 when compared to SG&A expenses of $2,260,621 during the fiscal year ended September 30, 2001. As a percentage of sales, SG&A expenses decreased to 31.3% during the fiscal year ended September 30, 2002 when compared to 33.0% during the fiscal year ended September 30, 2001, primarily due to the increase in sales during fiscal 2002 when compared to fiscal 2001. Due to the uncertain economic climate, the Company has been emphasizing cost controls and cost cutting measures to minimize operating expenses. Income from operations increased $526,713 to $556,990 during the fiscal year ended September 30, 2002 when compared to income from operations of $30,277 during the fiscal year ended September 30, 2001. On an industry segment basis, MFC's income from operations increased $575,283 to $861,197 for the fiscal year ended September 30, 2002 when compared to income from operations of $285,914 for the fiscal year ended September 30, 2001, due primarily to the improved profit margins and higher sales volume. NSI recorded a loss from operations of $229,893 for the fiscal year ended September 30, 2002 compared to a loss from operations of $180,020 for the fiscal year ended September 30, 2001. NSI's loss from operations can be attributed to the lower sales volume and the absorption of fixed overhead expenses. Corporate expenses decreased $1,303 to $74,314 for the fiscal year ended September 30, 2002 when compared to corporate expenses of $75,617 for the fiscal year ended September 30, 2001. The Company's income tax expense equaled $167,080, an effective income tax rate of 27.8%, for the fiscal year ended September 30, 2002 compared to an income tax benefit of $10,436 for the fiscal year ended September 30, 2001, primarily due to the higher levels of pre-tax income for the fiscal year ended September 30, 2002. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- MFC defines liquidity as the ability to generate adequate funds to meet its operating and capital needs. The Company's primary source of liquidity has been funds provided by operations. September 30 2003 2002 2001 Cash & cash equivalents $646,886 $649,196 $373,142 Investments $875,671 $1,377,765 $900,359 Working capital $2,203,072 $2,594,590 $2,288,932 Current ratio 4.09 to 1 3.41 to 1 4.18 to 1 Long-term debt $ 0 $ 0 $ 0 15 <page> Cash and cash equivalents decreased $2,310 to $646,886 at September 30, 2003 when compared to $649,196 at September 30, 2002. The decrease was a result of $167,015 in net cash used in operating activities, $455,183 in net cash provided by investing activities and $290,478 in net cash used in financing activities. The net decrease of $60,285 in accounts receivable at September 30, 2003, when compared to September 30, 2002, can primarily be attributed to the decrease in shipments during the month ended September 30, 2003 when compared to the same period last year. The net decrease of $255,577 in inventories at September 30, 2003, when compared to September 30, 2002, can primarily be attributed to the decrease in the sales order backlog at September 30, 2003, when compared to the last year, and an increase in the inventory valuation reserves. The Company provides for a valuation reserve for certain inventory that is deemed to be obsolete, of excess quantity or otherwise impaired. The Company's inventory valuation reserves equaled $401,974 at September 30, 2003 compared to $345,161 at September 30, 2002. The increase of $56,813 in inventory reserves at September 30, 2003, when compared to the same period last year, can primarily be attributed to the obsolescence of specific inventory items due to product enhancements or the slow movement of certain inventory items due to a decrease in demand. Based on current and expected inventory levels, management believes any change to the inventory valuation reserves will not have a material impact on future results of operations, capital resources or liquidity. All such inventory items are written down to their estimated net realizable value. The decrease of $100,843 in other current liabilities at September 30, 2003, when compared to September 30, 2002, can be attributed to the payment of the Company's discretionary profit sharing contribution for fiscal 2002 during fiscal 2003. Cash used in investing activities during fiscal 2003 consisted of funds provided by the sale of investments of $502,094 and funds used for capital expenditures of $46,911. Cash used in financing activities consisted of funds used to pay a cash dividend of $290,478. At September 30, 2003, the Company had unused aggregate lines of credit totaling $750,000 collateralized by all inventory, equipment and accounts receivable. Management believes that its working capital requirements for the foreseeable future will be met by its existing cash balances, future cash flows from operations and its current credit arrangements. 16 <page> Off-Balance Sheet Arrangements At September 30, 2003 and 2002, the Company did not have any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which might have been established for the purpose of facilitating off-balance sheet arrangements. Critical Accounting Policies The Company's consolidated financial statements are based on the application of accounting principles generally accepted in the United States of America (GAAP). GAAP requires the use of estimates, assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenue and expense amounts reported. The Company believes its use of estimates and underlying accounting assumptions adhere to GAAP and are consistently applied. Valuations based on estimates are reviewed for reasonableness and adequacy on a consistent basis throughout the Company. Primary areas where financial information of the Company is subject to the use of estimates, assumptions and the application of judgment include revenues, receivables, inventories, and taxes. Revenues from product sales are recorded as the products are shipped and title and risk of loss have passed to the customer, provided that no significant vendor or post-contract support obligations remain and the collection of the related receivable is probable. Billings in advance of the Company's performance of such work are reflected as customer deposits in the accompanying consolidated balance sheet. Allowances for doubtful accounts are based on estimates of losses related to customer receivable balances. The establishment of reserves requires the use of judgment and assumptions regarding the potential for losses on receivable balances. The Company's inventories are valued at the lower of cost or market. The Company uses certain estimates and judgments and considers several factors including product demand and changes in technology to provide for excess and obsolescence reserves to properly value inventory. The Company established a warranty reserve which provides for the estimated cost of product returns based upon historical experience and any known conditions or circumstances. Our warranty obligation is affected by product that does not meet specifications and performance requirements and any related costs of addressing such matters. The Company has deferred tax assets that are reviewed for recoverability and valued accordingly. These assets are evaluated by using estimates of future taxable income streams and the impact of tax planning strategies. Valuations related to tax accruals and assets can be impacted by changes to tax codes, changes in statutory tax rates and the Company's future taxable income levels. 17 <page> NEW PRONOUNCEMENTS - ------------------ SFAS No. 147, "Acquisitions of Certain Financial Institutions", SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FAS 123", SFAS No. 149 " Amendment of Statement 133 on Derivative Instruments and Hedging Activities", SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity", and FIN 46, "Consolidation of Variable Interest Entities - an interpretation of ARB No. 51" have been issued. The adoption of these statements has no impact on the financial statements of the Company. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 - -------------------------------------------------------------------------------- Any statements contained in this report which are not historical facts are forward looking statements; and, many important factors could cause actual results to differ materially from those in the forward looking statements. Such factors include, but are not limited to, changes (legislative, regulatory and otherwise) in the MMDS, LPTV or Cable industry, demand for the Company's products (both domestically and internationally), the development of competitive products, competitive pricing, market acceptance of new product introductions, technological changes, general economic conditions, litigation and other factors, risks and uncertainties which may be identified in the Company's Securities and Exchange Commission filings. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company has limited exposure to market risk as the Company has no long term debt as of September 30, 2003. The Company's available line of credit is based on a factor of the prime rate; however, there are no outstanding borrowings under the line of credit. The Company does not trade in derivative financial instruments. Investments generally consist of commercial paper, government backed obligations and other guaranteed commercial debt that have an original maturity of more than three months and a remaining maturity of less than one year. Investments are carried at cost which approximates market. The Company's policy is to hold investments until maturity. The Company's practice is to invest cash with financial institutions that have acceptable credit ratings. 18 <page> ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Financial Statements and Financial Statement Schedules called for by this item are submitted as a separate section of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ITEM 9A. CONTROLS AND PROCEDURES The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures performed within 90 days of the filing date of this report, the Chief Executive and Chief Financial Officers of the Company concluded that the Company's disclosure controls and procedures were adequate. The Company made no significant changes in its internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation of those controls by the Chief Executive and Chief Financial Officers. There were no significant deficiencies or material weaknesses identified in the evaluation and, therefore, no corrective actions were taken. While the Chief Executive and Chief Financial Officers of the Company believe that the Company's existing disclosure controls and procedures have been effective to accomplish its objectives, the Chief Executive and Chief Financial Officers of the Company intend to examine, refine and formalize our disclosure controls and procedures and monitor ongoing developments. Notwithstanding the foregoing, there can be no assurance that the Company's disclosure controls and procedures will detect or uncover all failures of persons within the Company and its consolidated subsidiaries to disclose material information otherwise required to be set forth in the Company's periodic reports. 19 <page> PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The names of, and certain information with respect to, the directors of MFC is set forth below: Common Shares Actually or Percent Beneficially of Director Principal occupation Owned 12/1/03 Class TRUDI B. ARTINI Mrs. Artini is an independent 82,435 2.8% (a)(b)(d) investor in MFC and various other Age 81 business enterprises in Syracuse, Director since 1974 New York. DAVID B. ROBINSON MD Dr. Robinson is Emeritus Professor 58,571 2.0% (a)(b)(d) of Psychiatry at Upstate Medical Age 79 University, State University of New Director since 1977 York at Syracuse. He was a faculty member from 1958 until his retirement in 1985 and served as Acting Chairman of the Dept. of Psychiatry for six of those years. He was elected to serve as a Skaneateles Town Councilman from 1990 to 1998. In 1980, he was a founding member of the Skaneateles Festival of Chamber Music. LOUIS MISENTI President and Principal 264,814 9.1% Age 76 shareholder of SCI Corp., Director since 1976 Syracuse, New York since 1984. SCI manufactures polishing compounds for the automobile and silverware industries. Mr. Misenti is also the managing partner of Northern Pines Golf Course, Cicero, New York which was founded in 1970. He was elected Chairman of the Board of Directors of MFC on March 27, 1993. 20 <page> Common Shares Actually or Percent Beneficially of Director Principal occupation Owned 12/1/03 Class CARL F. FAHRENKRUG PE Mr. Fahrenkrug was appointed 132,598 4.6% (a)(d) President and Chief Executive Age 61 Officer of MFC on October 7, Director since 1984 1992. He has also served as President and Chief Executive Officer of NSI since prior to 1986. He served as Vice President of Engineering at Microwave Systems, Inc., Syracuse, N.Y. from 1972-1976. Mr. Fahrenkrug has a B.S. and M.S. in Engineering and an MBA from Syracuse University. MILO PETERSON Mr. Peterson has served as 80,000 2.8% (a)(d) Executive Vice President and Age 63 Corporate Secretary of NSI since Director since 1990 January 1, 1992. Mr. Peterson graduated from programs at Yale University and Syracuse University. He served as Vice President of Manufacturing of Microwave Systems, Inc., Syracuse, N.Y. from 1970-1976. He was elected Vice President And Corporate Secretary of MFC On March 27, 1993. FRANK S. MARKOVICH Mr. Markovich is a consultant in 4,340 * (c)(d) the manufacturing operations Age 58 and training field. Prior to that Director since 1992 he was the Director of the Manufacturing Extension Partnership at UNIPEG Binghamton. He held various high level positions in operations, quality and product management in a 20 year career with BF Goodrich Aerospace, Simmonds Precision Engine Systems of Norwich, New York. He completed US Navy Electronics and Communications Schools and received an MBA from Syracuse University. 21 <page> Common Shares Actually or Percent Beneficially of Director Principal occupation Owned 12/1/03 Class ROBERT R. ANDREWS Mr. Andrews is the President and 1,214 * (a)(c) Principal shareholder of Morse Age 62 Manufacturing Co., Inc., East Director since 1992 Syracuse, N.Y. which produces specialized material handling equipment and has served in that capacity since prior to 1985. He received a B.A degree from Arkansas University and has served as Vice President and a director of the Manufacturers' Association of Central New York, President of the Citizens Foundation, a Trustee of Dewitt Community Church, director of the Salvation Army and Chairman of the Business and Industry Council of Onondaga Community College. SIDNEY CHONG Mr. Chong is a corporate 3,335 * (a)(b)(c) accountant for Carrols Corp. in Age 62 Syracuse. Prior to joining Carrols Director since 1995 Corp., he was a Senior Accountant with Price Waterhouse and Co. in New York City. Mr. Chong has a Bachelor of Science degree in accounting from California State University. Daniel Galbally Mr. Galbally is an accountant 1,489 * (b)(c) for Nucor Steel Auburn, Inc. Age 56 in Auburn, New York. Prior to Director since 1995 joining Nucor Steel Auburn, he was the controller of Diamond Card Exchange, Inc. in Syracuse, New York. He was the controller of Evaporated Metal Films (EMF) in Ithaca, N.Y. Before joining EMF, he worked as controller and acting vice president of finance at Philips Display Components Co. He has a bachelor's degree in accounting and an MBA from Syracuse University. (a)Member of Executive Committee (b)Member of Compensation Committee (c)Member of Finance and Audit Committee (d)Member of Nominating Committee * Denotes less than one percent of class. 22 <page> The Directors listed above and executive officers as a group own 630,682 shares or approximately 22% of the outstanding common shares of the Company. The Board of Directors of Microwave Filter Company, Inc. has determined that Mr. Chong and Mr. Galbally, both members of the Audit Committee, are "audit committee financial experts" as defined by the SEC's regulations. IDENTIFICATION OF EXECUTIVE OFFICERS Name Age Position Carl F. Fahrenkrug 61 President and Chief Executive Officer Richard L. Jones 55 Vice President and Chief Financial Officer Milo J. Peterson 63 Vice President and Corporate Secretary Paul W. Mears 44 Vice President of Engineering All of the officers serve at the pleasure of the Board of Directors. Carl F. Fahrenkrug was elected President and Chief Executive Officer of MFC on October 7, 1992. Prior to that date, he had been Executive Vice President and Chief Operating Officer of MFC. Prior to January 1, 1992, he was President and CEO of NSI and Vice President of Corporate Development for MFC. Richard L. Jones joined MFC in August 1983 as controller. In February 1985, he was appointed Vice President and Treasurer of MFC. On October 7, 1992, he was appointed Vice President and Chief Financial Officer. Milo J. Peterson was elected Vice President and Corporate Secretary of MFC on March 27, 1993. Mr. Peterson has served as Executive Vice President and Corporate Secretary of NSI. He served as Vice President of Manufacturing of Microwave Systems, Inc., Syracuse, NY, from 1970 - 1976. Paul W. Mears began his association with MFC as a Co-op while attending RIT in 1981. He became a full time employee in 1984 when he began his duties as an Electrical Engineer in Research and Development. In 1988 he became a Senior Design and Quotation Engineer and in 1989, he was promoted to Assistant Chief Engineer, Manager of Engineering of the Filter Division and in April of 1998, Was appointed Vice President of Engineering. The Company has adopted a Code of Ethics and Business Conduct for all of our employees and directors, including our Chief Executive Officer and Chief Financial Officer. A copy of our Code of Ethics and Business Conduct is available free of charge on our Company web site at www.microwavefilter.com. 23 <page> ITEM 11. EXECUTIVE COMPENSATION. The following table sets forth for the fiscal years ended September 30, 2003, 2002 and 2001, compensation paid by MFC to the named executive officers in all capacities in which they served. SUMMARY COMPENSATION TABLE Annual Compensation Salary Bonus Name and principal position Year ___$___ ___$___ Carl F. Fahrenkrug 2003 119,019 - President and CEO 2002 127,274 - 2001 126,832 - PROFIT SHARING - -------------- MFC has a profit sharing plan for all employees over the age of 21 with one year of service. Annual contributions are determined by the Board of Directors and are made from current or accumulated net income. Allocation of contributions to plan participants are based upon annual compensation. Participants vest on the basis of 20% after 3 years of service, 40% at 4 years, 60% at 5 years, 80% at 6 years and 100% at 7 years. MFC also has a voluntary 401-K plan. Eligibility is the same as the Profit Sharing Plan. Contributions to the 401-K plan are currently matched at a rate of 100% of an employee's first 3% of contributions and 50% of an employee's next 2% of contributions. The maximum corporate match is 4% of an employee's compensation. MFC's contributions to the plans for the years ended September 30, 2003, 2002 and 2001 amounted to $80,017, $187,488 and $112,461, respectively. STOCK OPTIONS - ------------- On April 9, 1998, the Board of Directors and Shareholders of Microwave Filter Company, Inc. approved the 1998 Microwave Filter Company, Inc. Incentive Stock Plan (the "1998 Plan"). Under the 1998 Plan, the Company may grant incentive stock options ("ISOs"), non-qualified stock options ("NQSOs") and stock appreciation rights to directors, officers and employees of the Company and its affiliates. The 1998 Plan reserves 150,000 shares for issuance. The exercise price of the ISOs and NQSOs will be 100% of the fair market value of the Common Stock on the date the ISOs and NQSOs are granted. The 1998 Plan will terminate on April 10, 2008. There were no stock options or stock appreciation rights granted or outstanding at September 30, 2003 or 2002. 24 <page> COMPENSATION OF DIRECTORS - ------------------------- Non-officer directors receive fees of $400.00 per board and committee meetings. MFC also reimburses directors for reasonable expenses incurred in attending meetings. The Chairman of the Board and Officer members receive no compensation for their attendance at meetings. During fiscal 2003, the Company paid Louis S. Misenti $23,542 in compensation for his services as Chairman of the Board of Directors of Microwave Filter Company, Inc. ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth information as to the only persons known by the Company to own beneficially more than 5% of the Common Stock of the Company on December 1, 2003. % of Outstanding Number of shares Common Name of Beneficial Owner Address Beneficially Owned ____Stock____ Frederick A. Dix & 209 Watson Rd. 244,007 8.4% Marjorie Dix N. Syracuse, NY 13212 Louis S. Misenti 140 Clearview Rd. 264,814 9.1% Dewitt, NY 13214 The information relating to the ownership of common stock held by the directors and executive officers of the corporation is set forth in item 10 of this report. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. None 25 <page> PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) 1. and 2. Financial Statements and Schedules: Reference is made to the list of Financial Statements and the Financial Statement Schedule submitted as a separate section of this report. (b) Reports On Form 8-K: There are no reports on Form 8-K for the three months ended September 30, 2003. (C) Exhibits: Reference is made to the List of Exhibits submitted as a separate section of this report. 26 <page> SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Microwave Filter Company, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MICROWAVE FILTER COMPANY, INC. |S| Carl F. Fahrenkrug - -------------------------- By: Carl F. Fahrenkrug (President and Chief Executive Officer) |S| Richard Jones - --------------------- By: Richard Jones (Vice President and Chief Financial Officer) Dated: December 19, 2003 Pursuant to the requirements Of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated: |S| Louis S. Misenti |S| Carl F. Fahrenkrug - ------------------------ -------------------------- Louis S. Misenti Carl F. Fahrenkrug (Director) (Director) |S| Milo J. Peterson |S| Robert R. Andrews - ------------------------ ----------------------- Milo J. Peterson Robert R. Andrews (Director) (Director) |S| Sidney Chong - -------------------- Sidney Chong (Director) Dated: December 19, 2003 27 <page> ANNUAL REPORT ON FORM 10-K MICROWAVE FILTER COMPANY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE ITEM 8, ITEM 15(a)(1) and (2) CONSOLIDATED FINANCIAL STATEMENTS: Page Independent Auditors' Report.....................................29 Consolidated Balance Sheets as of September 30, 2003 and 2002....30 Consolidated Statements of Operations for the Years Ended September 30, 2003, 2002 and 2001 .......................31 Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 2003, 2002 and 2001 .......................32 Consolidated Statements of Cash Flows for the Years Ended September 30, 2003, 2002 and 2001 .......................33 Notes to Consolidated Financial Statements.......................34-40 SCHEDULE FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001: II-Valuation and Qualifying Accounts.............................42 All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. 28 <page> Report of Independent Auditors To the Board of Directors and Shareholders of Microwave Filter Company, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a) (1) present fairly, in all material respects, the financial position of Microwave Filter Company, Inc. and Subsidiaries at September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a) (2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Syracuse, New York December 11, 2003 29 <page> Microwave Filter Company and Subsidiaries Consolidated Balance Sheets September 30 Assets 2003 2002 - ------ ---- ---- Current assets: Cash and cash equivalents $ 646,886 $ 649,196 Investments 875,671 1,377,765 Accounts receivable-trade, net of allowance for doubtful accounts of $65,000 and $49,000 318,351 378,636 Federal and state income tax recoverable 39,485 0 Inventories 707,590 963,167 Deferred tax asset - current 235,492 179,779 Prepaid expenses and other current assets 92,666 120,579 --------- --------- Total current assets 2,916,141 3,669,122 Property, plant and equipment, net 974,519 1,196,763 Deferred tax asset - noncurrent 10,885 0 ---------- ---------- Total Assets $3,901,545 $4,865,885 ========== ========== Liabilities and Stockholders' Equity - ------------------------------------ Current liabilities: Accounts payable $ 171,837 $ 179,686 Customer deposits 144,390 139,466 Accrued federal and state income taxes 0 233,846 Accrued payroll and related expenses 96,069 126,352 Accrued compensated absences 255,301 248,867 Other current liabilities 45,472 146,315 --------- --------- Total current liabilities 713,069 1,074,532 Deferred tax liability - noncurrent 0 29,999 --------- --------- Total liabilities 713,069 1,104,531 --------- --------- Commitments (Note 6) Stockholders' equity: Common stock, $.10 par value. Authorized 5,000,000 shares Issued 4,317,688 in 2003 and 2002 431,769 431,769 Additional paid-in capital 3,239,867 3,239,867 Retained earnings 1,022,554 1,595,432 Common stock in treasury, at cost, 1,412,907 shares in 2003 and 2002 (1,505,714) (1,505,714) --------- --------- Total stockholders' equity 3,188,476 3,761,354 --------- --------- Total Liabilities and Stockholders' Equity $3,901,545 $4,865,885 ========== ========== The accompanying notes are an integral part of the consolidated financial statements. 30 <page> Microwave Filter Company and Subsidiaries Consolidated Statements of Operations For the Years Ended September 30 2003 2002 2001 ---- ---- ---- Net sales $5,059,520 $7,251,732 $6,848,191 Cost of goods sold 3,569,354 4,422,380 4,557,293 --------- --------- --------- Gross profit 1,490,166 2,829,352 2,290,898 Selling, general and administrative expenses 1,962,530 2,272,362 2,260,621 --------- --------- --------- (Loss) income from operations (472,364) 556,990 30,277 Non-operating Income (Expense) Interest income 24,634 37,513 56,519 Interest expense 0 0 (229) Miscellaneous 1,402 6,864 31,749 --------- --------- --------- (Loss) income before income taxes (446,328) 601,367 118,316 (Benefit) provision for income taxes (163,928) 167,080 (10,436) --------- --------- --------- NET (LOSS) INCOME ($282,400) $434,287 $128,752 ========= ========= ========= (Loss) Earnings Per Common Share ($.10) $0.15 $0.04 ========= ========= ========= Weighted average number of common shares outstanding 2,904,781 2,904,781 2,946,284 ========= ========= ========= The accompanying notes are an integral part of the consolidated financial statements. 31 <page> Microwave Filter Company and Subsidiaries Consolidated Statements of Stockholders' Equity For the Years Ended September 30, 2003, 2002 and 2001 ----------------------------------------------------- Additional Total Common Stock Paid-in Retained Treasury Stock Stockholders' Shares Amt Capital Earnings Shares Amt Equity ------ --- ------- -------- ------ --- ------ Balance, September 30, 2000 4,317,688 $431,769 $3,239,867 $1,322,871 1,153,502 ($1,124,180) $3,870,327 Net income 128,752 128,752 Purchase of treasury stock 259,400 (381,534) (381,534) Donated capital 5 Cash dividend paid ($.03 per share) (87,144) (87,144) --------- -------- ---------- -------- ------- ---------- ---------- Balance, September 30, 2001 4,317,688 431,769 3,239,867 1,364,479 1,412,907 (1,505,714) 3,530,401 Net income 434,287 434,287 Cash dividend paid ($.07 per share) (203,334) (203,334) ---------- --------- ---------- ---------- ------- ---------- ---------- Balance September 30, 2002 4,317,688 431,769 3,239,867 1,595,432 1,412,907 (1,505,714) 3,761,354 Net (loss) (282,400) (282,400) Cash dividend paid ($.10 per share) (290,478) (290,478) ---------- --------- ---------- ---------- ------- ---------- ---------- Balance September 30, 2003 4,317,688 $431,769 $3,239,867 $1,022,554 1,412,907 ($1,505,714) $3,188,476 ========== ======== ========== ========== ========= =========== ========== The accompanying notes are an integral part of the consolidated financial statements. 32 <page> Microwave Filter Company and Subsidiaries Consolidated Statements of Cash Flows Increase (Decrease) in Cash and Cash Equivalents ------------------------------------------------ For the Years Ended September 30 -------------------------------- 2003 2002 2001 ---- ---- ---- Cash flows from operating activities: Net (loss) income ($282,400) $434,287 $128,752 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation 269,155 280,072 300,950 Provision for doubtful accounts 15,675 18,469 0 Inventory obsolescence provision 56,813 50,000 0 Deferred income taxes (96,597) (4,090) (16,065) Changes in assets and liabilities: Accounts receivable-trade, net 44,610 202,982 296,734 Federal and state income taxes (273,331) 173,224 (128,147) Inventories 198,764 (129,188) 219,851 Other assets 27,913 (33,630) (9,494) Accounts payable and customer deposits (2,925) 104,167 (332,505) Accrued payroll, compensated absences and related expenses (23,849) 1,011 6,824 Other current liabilities (100,843) 75,618 (49,765) --------- -------- ------- Net cash (used in) provided by operating activities (167,015) 1,172,922 417,135 --------- -------- ------- Cash flows from investing activities: Investments 502,094 (477,406) 24,708 Capital expenditures (46,911) (216,128) (225,500) -------- -------- -------- Net cash provided by (used in) investing activities 455,183 (693,534) (200,792) -------- -------- ---------- Cash flows from financing activities: Purchase of treasury stock 0 0 (381,534) Cash dividend paid (290,478) (203,334) (87,144) -------- -------- -------- Net cash used in financing activities (290,478) (203,334) (468,678) -------- -------- -------- Net (decrease) increase in cash and cash equivalents (2,310) 276,054 (252,335) Cash and cash equivalents at beginning of year 649,196 373,142 625,477 -------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $646,886 $649,196 $373,142 ======== ======== ========== Supplemental disclosures of cash flows: Cash paid during the year for (approximately): Interest $0 $0 $200 Income taxes $206,000 $0 $128,800 The accompanying notes are an integral part of the consolidated financial statements. 33 <page> Microwave Filter Company and Subsidiaries Notes to Consolidated Financial Statements ------------------------------------------ 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a. Nature of Business Microwave Filter Company, Inc. operates primarily in the United States and principally in two industries. The Company extends credit to business customers, including original equipment manufacturers (OEMs), distributors and other end users, based upon ongoing credit evaluations. Microwave Filter Company, Inc. designs, develops, manufactures and sells electronic filters, both for radio and microwave frequencies, to help process signal distribution and to prevent unwanted signals from disrupting transmit or receive operations. Markets served include cable television, television and radio broadcast, satellite broadcast, mobile radio, commercial and defense electronics. Niagara Scientific, Inc. custom designs case packing machines to automatically pack products into shipping cases. Customers are processors of food and other commodity products with a need to reduce labor cost with a modest investment and quick payback. b. Basis of Consolidation The consolidated financial statements include the accounts of Microwave Filter Company, Inc. (MFC) and its wholly-owned subsidiaries, Niagara Scientific, Inc. (NSI) and Microwave Filter International, LTD. (MFI); located in Syracuse, New York. All significant intercompany balances and transactions have been eliminated in consolidation. c. Revenue Recognition The Company recognizes revenue at the time products are shipped to customers and title and risk of loss have passed to the customer. The Company is not required to install any of its products. Payments received from customers in advance of products shipped are recorded as customer advance payments until earned. d. Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of 90 days or less to be cash equivalents. The carrying value at September 30, 2003 and September 30, 2002 approximates fair value. Substantially all cash balances were invested at one financial institution at September 30, 2003 and 2002. e. Investments Investments generally consist of commercial paper, government backed obligations and other guaranteed commercial debt that have an original maturity of more than three months and a remaining maturity of less than one year. Investments are carried at cost which approximates market. The Company's policy is to hold investments until maturity. The Company's practice is to invest cash with financial institutions that have acceptable credit ratings. 34 <page> f. Inventories Inventories are stated at the lower of cost determined on the first-in, first- out method or market. g. Research and Development Costs in connection with research and development, which amount to $349,203, $376,857 and $362,518 for the fiscal years 2003, 2002 and 2001, respectively, are charged to operations as incurred. h. Property, Plant and Equipment Property, plant and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets. Buildings and building improvements are depreciated over an estimated service life of 20 to 30 years. Machinery and equipment are depreciated over an estimated useful life of 3 to 10 years. Office equipment and fixtures are depreciated over an estimated useful life of 3 to 10 years. At the time of sale or retirement, the cost and accumulated depreciation are removed from the respective accounts and the resulting gain or loss is recognized in income. i. Income Taxes The Company accounts for income taxes under Statement of Financial Accounting Standards (SFAS) No. 109. Deferred tax assets and liabilities are based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates which are anticipated to be in effect when these differences reverse. The deferred tax provision is the result of the net change in the deferred tax assets and liabilities. A valuation allowance is established when it is necessary to reduce deferred tax assets to amounts expected to be realized. j. Earnings Per Share The Company presents basic earnings per share ("EPS"), computed based on the weighted average number of common shares outstanding for the period, and when applicable diluted EPS, which gives the effect to all dilutive potential shares outstanding (i.e. options) during the period after restatement for any stock dividends. The Company had no dilutive potential common shares outstanding for the years ended September 30, 2003, 2002 or 2001. Income used in the EPS calculation is net income for each year. k. Fair Value of Financial Instruments The carrying values of the Company cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of those instruments. The Company currently does not trade in or utilize derivative financial instruments. 35 <page> l. Miscellaneous Non-operating Income Miscellaneous non-operating income generally consists of sales of scrap material, stock transfer fees, the forfeiture of non-refundable deposits and other incidental items. m. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. n. Warranty Costs The Company established a warranty reserve which provides for the estimated cost of product returns based upon historical experience and any known conditions or circumstances. Our warranty obligation is affected by product that does not meet specifications and performance requirements and any related costs of addressing such matters. 2. INVENTORIES Inventories net of provision for obsolescence consisted of the following: September 30 2003 2002 ---- ---- Raw materials and stock parts $426,698 $635,930 Work-in-process 201,807 256,970 Finished goods 79,085 70,267 -------- --------- $707,590 $963,167 ======== ========== The Company's reserve for obsolescence equaled $401,974 at September 30, 2003 and $345,161 at September 30, 2002. 3. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following: September 30 2003 2002 ---- ---- Land $143,000 $143,000 Building and improvements 1,818,633 1,818,633 Machinery and equipment 3,068,256 3,042,103 Office equipment and fixtures 1,534,024 1,513,266 --------- --------- 6,563,913 6,517,002 Less: Accumulated depreciation 5,589,394 5,320,239 --------- --------- $974,519 $1,196,763 ========== ========== 36 <page> 4. CREDIT FACILITIES The Company has unused aggregate lines of credit totaling $750,000 collateralized by inventory, equipment and accounts receivable. 5. PROFIT SHARING AND 401-K PLANS The Company maintains both a non-contributory profit sharing plan and a contributory 401-K plan for all employees over the age of 21 with one year of service. Annual contributions to the profit sharing plan are determined by the Board of Directors and are made from current or accumulated earnings, while contributions to the 401-K plan are currently matched at a rate of 100% of an employee's first 3% of contributions and 50% of an employee's next 2% of contributions. The maximum corporate match is 4% of an employee's compensation. The Company's matching contributions to the 401-K plan for the years ended September 30, 2003, 2002 and 2001 were $80,017, $87,488 and $92,461, respectively. Additionally, the Company may make discretionary contributions to the non-contributory profit sharing plan. These contributions were $0, $100,000 and $20,000 in 2003, 2002 and 2001, respectively. 6. OBLIGATIONS UNDER OPERATING LEASES The Company leases equipment under operating lease agreements expiring at various dates through September 30, . Rental expense under these leases for the years ended September 30, 2003, 2002 and 2001 amounted to $13,711, $14,888 and $14,410, respectively. Minimum rental commitments at September 30, 2003 for these leases are: Year Ended Lease September 30 Payments ------------ -------- 2004 $11,219 2005 7,486 2006 6,242 2007 6,242 2008 4,682 ------- $35,871 ======= 37 <page> 7. INCOME TAXES The provision for income taxes consisted of the following: Year Ended September 30 2003 2002 2001 Currently payable: Federal ($70,831) $162,170 $4,629 State 3,500 9,000 1,000 Deferred (credit) (96,597) (4,090) (16,065) ------- ------- ------- ($163,928) $167,080 ($10,436) ======== ======== ======= A reconciliation of the statutory federal income tax rate and the Company's effective income tax rate is as follows: Year ended September 30 ______2003______ ______2002______ ______2001______ Amount % Amount % Amount % Statutory tax rate ($151,752) (34.0)% $204,465 34.0% $40,227 34.0% Surtax exemption (7,995) (6.8%) State income tax net of: Federal benefit 2,310 0.5% 5,940 1.0% 660 0.6% Foreign sales benefit 0 .0% (3,973) (0.7%) (7,912) (6.7%) Research and experimentation tax credits 0 .0% (31,158) (5.2%) (31,860) (26.9%) Other (14,486) (3.2%) (8,194) (1.3%) (3,556) (3.0%) -------- ------ ------- ------ ------- ------ ($163,928) (36.7%) $167,080 27.8% ($10,436) (8.8%) ======== ===== ======== ===== ======= ==== The temporary differences which give rise to deferred tax assets and liabilities at September 30 are as follows: 2003 2002 ---- ---- Inventory $142,912 $106,444 Accrued vacation 70,480 59,031 Accounts receivable 22,100 14,304 ------- ------- Net deferred tax assets - current $235,492 $179,779 ======== ======== Accelerated depreciation ($88,871) ($94,523) Research and experimentation tax credit carry forward 60,357 25,125 AMT credit carry forward 39,399 39,399 ------ -------- Net deferred tax assets (liabilities) - noncurrent $10,885 ($29,999) ======= ======= Based on the Company's history of taxable earnings and its expectations for the future, management has determined that operating income will more likely than not be sufficient to recognize its deferred tax assets. Research and experimentation tax credit carry forwards expire in 2022. At September 30, 2003, the Company's federal AMT credit can be carried forward indefinitely. 38 <page> 8. INDUSTRY SEGMENT DATA The Company's primary business segments involve (1) operations of Microwave Filter Company, Inc. (MFC) which manufactures electronic filters used for preventing interference or signal processing in cable television, satellite, broadcast, aerospace and government markets; and (2) operations of Niagara Scientific, Inc. (NSI) which manufactures industrial automation equipment. Information by industry segment is as follows: (thousands of dollars) 2003 2002 2001 Net Sales (Unaffiliated): MFC $4,356 $6,700 $5,867 NSI 704 552 981 Total $5,060 $7,252 $6,848 Operating Profit (Loss): (a) MFC ($195) $861 $286 NSI (204) (230) (180) Corporate (73) (74) (76) Total ($472) $557 $30 Identifiable Assets: (b) MFC $3,033 $3,907 $3,696 NSI 222 310 201 Subtotal 3,255 4,217 3,897 Corporate Assets-Cash and Cash Equivalents 647 649 373 Total $3,902 $4,866 $4,270 Depreciation Expense: MFC $264 $275 $296 NSI 5 5 5 Total $269 $280 $301 Capital Expenditures: MFC $ 47 $216 $226 NSI 0 0 0 Total $ 47 $216 $226 Significant Export Sales: MFC $366 $339 $554 (a) Operating profit (loss) is total revenue less operating expenses. In computing operating profit, none of the following items have been added or deducted: general corporate expenses, interest expense, income taxes and miscellaneous income. Expenses incurred on behalf of both Companies are allocated based upon estimates of their relationship to each entity. (b) Identifiable assets by industry are those assets that are used in the Company's operations in each industry. 39 <page> 9. STOCK OPTIONS On April 9, 1998, the Board of Directors and Shareholders of Microwave Filter Company, Inc. approved the 1998 Microwave Filter Company, Inc. Incentive Stock Plan (the "1998 Plan"). Under the 1998 Plan, the Company may grant incentive stock options ("ISOs"), non-qualified stock options ("NQSOs") and stock appreciation rights to directors, officers and employees of the Company and its affiliates. The 1998 Plan reserves 150,000 shares for issuance. The exercise price of the ISOs and NQSOs will be 100% of the fair market value of the Common Stock on the date the ISOs and NQSOs are granted. The 1998 Plan will terminate on April 10, 2008. There were no stock options or stock appreciation rights granted or outstanding at September 30, 2003, 2002 or 2001. 10. LEGAL MATTERS There are currently no material pending legal proceedings against the Company or its subsidiaries. 11. SELECTED QUARTERLY FINANCIAL DATA (Unaudited) The following table sets forth certain unaudited quarterly financial information For the years ended September 30, 2003 and 2002: 2003 Quarter Ended ----------------------------------------------------- Dec. 31 March 31 June 30 Sept. 30 ------------ ------------ ------------ ----------- Net sales $1,489,157 $1,013,892 $1,322,546 $1,233,925 Cost of sales $1,039,471 $ 762,205 $1,011,981 $ 755,697 Net (loss) income $ (86,168) $ (179,076) $ (76,552) $ 59,396 (Loss) earnings per common share: $ (.03) $ (.06) $ (.03) $ .02 2002 Quarter Ended ----------------------------------------------------- Dec. 31 March 31 June 30 Sept. 30 ------------ ------------ ------------ ----------- Net sales $2,390,460 $2,110,951 $1,517,312 $1,233,009 Cost of sales $1,220,369 $1,317,345 $1,104,293 $ 780,373 Net income (loss) $ 375,492 $ 158,781 $ (80,194) $ (19,792) Earnings (loss) per common share: $ .13 $ .05 $ (.03) $ .00 40 <page> EXHIBIT INDEX Page Exhibit No. Description Number 3.1 MFC Certificate of Corporation, as amended. * 3.2 MFC Amended and Restated Bylaws. * 10.1 Bond Purchase Agreement dated as of February 22,1984 * among MFC, Onondaga County Industrial Development Agency ("OCIDA") and Key Bank of Central New York ("Bondholder"). 10.2 Lease Agreement dated as of February 22, 1984 between MFC and OCIDA. * 10.3 Mortgage and Security Agreement dated as of February 22, 1984 from * MFC and OCIDA to the Bondholder. 10.4 Guaranty Agreement dated as of February 22, 1984 from MFC to OCIDA * and the Bondholder. 31.1 Section 13a-14(a)/15d-14(a) Certification of Carl F. Fahrenkrug 31.2 Section 13a-14(a)/15d-14(a) Certification of Richard L. Jones 32.1 Section 1350 Certification of Carl F. Fahrenkrug 32.2 Section 1350 Certification of Richard L. Jones * Previously filed 41 <page> Microwave Filter Company and Subsidiaries Schedule II - VALUATION AND QUALIFYING ACCOUNTS SEPTEMBER 30, 2003, 2002 and 2001 Col. A Col. B Col. C Col. D Col. E Additions Balance at Charged to Charged to Balance Beginning Costs and Other at End Description of Period Expenses Accounts Deductions of Period - ----------- --------- ----------------------- ---------- ---------- Year ended September 30, 2003 Allowance for doubtful accounts $49,325 $15,675 $65,000 Inventory valuation reserves 345,161 56,813 401,974 -------- -------- ------- ------- -------- $394,486 $72,488 $0 $0 $466,974 ======== ======== ======= ======== ======== Year ended September 30, 2002 Allowance for doubtful accounts $41,155 $18,469 $10,299 $49,325 Inventory valuation reserves 297,634 50,000 2,473 345,161 -------- -------- ------- ------- -------- $338,789 $68,469 $0 $12,772 $394,486 ======== ======== ======= ======== ======== Year ended September 30, 2001 Allowance for doubtful accounts $44,023 $2,868 $41,155 Inventory valuation reserves 323,101 25,467 297,634 -------- -------- ------- ------- -------- $367,124 $0 $0 $28,335 $338,789 ======== ======== ======= ======== ======== 42