UNITED STATES
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
July 31, 1996.
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 1-8342
PICO PRODUCTS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
NEW YORK 15-0624701
- --------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
12500 Foothill Blvd., Lakeview Terrace, CA 91342
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (818) 897-0028
--------------
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
- ---------------------------- -----------------------
Common Stock, par value $.01 American Stock Exchange
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 requirement 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 the Form 10-K or any amendment to this
Form 10-K. ( )
1
The aggregate market value of the Registrant's Voting Stock held by non-
affiliates of the Registrant computed by reference to the closing price of such
stock on the American Stock Exchange at September 20, 1996, was $7,431,899.
Excluded from this value were shares held by officers and directors of the
Registrant.
The number of the Registrant's common shares outstanding at September 20,
1996, was 4,055,246.
DOCUMENTS INCORPORATED BY REFERENCE:
Definitive Proxy Statement to be filed pursuant to Regulation 14A in connection
with the 1996 annual meeting of shareholders of the Registrant.
Index to Exhibits is at page 55.
2
PART I
ITEM 1. BUSINESS
GENERAL
Pico Products, Inc. was formed as a corporation in the State of New York on
July 31, 1962. Pico and its subsidiaries (the "Company") design, manufacture
and distribute products and systems for the pay TV and cable TV industry (CATV),
broadband communications and other signal distribution markets. These other
distribution markets include "private" cable TV systems such as those found in
hotels, schools, hospitals and large apartment complexes. Private cable systems
are referred to in the industry as master antenna (MATV) or satellite master
antenna (SMATV) systems. These systems receive satellite and "off-air," or
broadcast, signals at a single source known as the "headend". The signals are
processed and then distributed by coaxial or fiber optic cable to the consumer.
Also included in other signal distribution markets are wireless cable or MMDS
(multichannel multipoint distribution systems) and business to business or
direct-to-home (DTH) communications by satellite. The Company also sells pay TV
security products and home satellite market products. Finally, the Company is
pursuing development and introduction of broadband communications products that
will support high speed internet transmissions with product development in
process on cable modem related products and on diplexers used in both fiber-to-
the-curb applications and network interface devices. A table listing the
Company's subsidiaries is included at the end of Item 1.
BROADBAND COMMUNICATIONS INDUSTRY BACKGROUND
CABLE AND SATELLITE TECHNOLOGY
There are currently five primary methods for the transmission, reception
and distribution of TV signals. These include direct "off-air" transmission,
cable TV, satellite master antenna TV or SMATV, MMDS or wireless TV, and DBS or
direct broadcast satellite transmission. A brief description of each method is
shown in the discussion which follows.
The evolution of cable TV and SMATV has been made possible by the
development of satellite communications. With a satellite, TV signals are
transmitted up to a satellite located in geosynchronous orbit 22,400 miles above
the equator. From the satellite, signals are retransmitted to a wide geographic
reception area known as a signal "footprint". Many of these signals, and all of
the premium programs such as HBO or CNN, are now encoded or scrambled. A
special decoding device or descrambler is required to receive these signals. In
a cable TV system, the satellite signals are received, processed and amplified
3
by a cable "headend" located at the cable satellite reception site, before being
sent along copper coaxial cable or fiber optic cable through a distribution
system to individual subscribers. A small cable system may have several hundred
subscribers with several miles of cable, while a large system may have hundreds
of thousands of subscribers and thousands of miles of cable.
A SMATV system is essentially a small cable system which has been
configured for a single building or building complex such as an apartment
building, hotel, hospital or school. Because it is designed to serve a single
building complex and fewer subscribers, a SMATV system is significantly less
expensive than a cable system. A SMATV system consists of headend and a
distribution system to carry the TV signal through the building.
A home satellite system, known as direct-to-home or DTH, consists of a
dedicated dish antenna and a satellite receiver installed at every subscriber's
house. In the past, DTH received a signal directly from a satellite normally
using a large 12 foot dish antenna mounted near the house. However, a new
version of DTH was introduced by Hughes in 1994, called DirecTV, which involves
a dedicated Hughes Electronics satellite and direct microwave retransmission
from the satellite to a small, 18-inch dish at the home. A number of other DTH
competitors, including Primestar and Echostar, are now transmitting DTH signals
and this market is expected to become very competitive.
MMDS systems, known as a wireless cable, use a headend to receive and
process both satellite and local off-air signals. The signals are then
modulated and retransmitted at microwave frequencies to a microwave antenna and
down converter at the subscriber's home. Wireless cable can also be used to
transmit television signals to high-rise apartment buildings where the signals
can then be received, processed through an SMATV headend and distributed through
the building. The broadcast range of an MMDS system is strictly line-of-sight
and reception depends on the terrain and the height of the microwave
transmitting antenna.
While cable TV has dominated the U.S. market, SMATV and MMDS have been the
primary signal distribution approach in South America, the Middle East and Asia.
In cities such as Sao Paulo and Rio de Janeiro, Brazil, most people live in
apartment buildings and operators have found that the economics of SMATV or MMDS
work much better than cable TV for initial installations. However, a number of
cable systems are now being built. In China, cable is being rapidly developed
in all major cities. In smaller cities there are plans to develop 3,000 new
cable systems. Singapore is developing a state-of-the-art fiberoptic network
which would integrate telecommunications and CATV. In Thailand, SMATV and
wireless systems are currently being developed in Bangkok.
4
THE CABLE INDUSTRY
Due to technological and regulatory changes, the traditional cable TV, or
CATV, industry is undergoing a major transition. Competition in the form of
DTH, MMDS, and SMATV have all enjoyed rapid growth partially at the expense of
the CATV industry. DTH is currently growing at levels never envisioned by the
CATV experts, and each new DTH customer represents the potential loss of a cable
customer. Furthermore, as the regulatory barriers are removed and as digital
compression technologies become more cost effective, the Regional Bell operating
companies (RBOC's) are seeking opportunities to offer video, information
services, and data services to consumers while they protect their local
telephony business.
CATV companies, while facing new and strong competition, are making plans
to offer telephone services. Additionally, due to the inherent large amount of
bandwidth that CATV systems provide, expanding existing services and delivering
large amounts of high speed data to the home can be offered by CATV companies.
Technological advances in the broadband communications industry now allow
for the delivery of a tremendous amount of information to a consumer's home. In
the traditional analog environment, one (1) TV channel requires 6 Mhz of
bandwidth. Due to digital compression, it is now possible to transmit in excess
of 6 TV channels in the same 6 Mhz bandwidth. Furthermore, when digital
technology is used, data services (especially access to the Internet) can be
transmitted via the CATV network at speeds of 6 to 10 megabits per second, far
faster than the 56 kilobit speed of the RBOC's existing twisted pair wiring used
for telephone service.
This combination of technological advances and the removal of regulatory
barriers has created substantial opportunities to provide both CATV and RBOC
companies products and services in support of delivering large amounts of
digital data to the home. With more bandwidth available, more TV services can
be offered. With increased bandwidth highly specialized programming can be
targeted and offered to specific categories of customers. Additionally,
telephony services can be provided by CATV operators and partnerships are being
formed among cable companies, long-distance carriers, and RBOC's with alliances
to offer telephony services where they have traditionally been prohibited.
Finally, creating more bandwidth to the home for Internet connections will allow
the Internet to sustain higher growth than it has enjoyed during the last two
years.
5
TRENDS IN THE TELECOMMUNICATIONS INDUSTRY
The recent passage of sweeping legislation to deregulate the
telecommunications industry is having a major impact on both the
telecommunication and cable industries. The immediate result has been the
creation of numerous new partnerships and alliances among companies in the
telecommunications, cable TV, cable electronics, computer and programming
industries. While the "convergence" of those industries is in an early stage of
evolution, a number of major investment commitments have been made, such as the
purchase of Continental Cablevision by a division of US West (a RBOC).
Deregulation has important implications for the cable TV industry. This in
turn presents major potential new opportunities for the Company in the U.S. In
addition, the rapid evolution of the "information highway" is transforming
broadband communications in the U.S. The information highway is an open network
which permits interactive access to data and information. The highway provides
a vast capability to connect users through the Internet, using fiber optic and
copper cable links. In the future, this interconnection will also incorporate
new wireless and microwave links for both video and data communications. The
major technological change that will result is the wide availability of
broadband communications involving high-speed digital data transmissions. This
will permit the transmission of very large amounts of data at very high speeds
over all segments of the network and is making possible, not only video and data
links between government agencies, schools, libraries, and research facilities,
but also links between businesses and individuals.
It is becoming clear that new technology developments are concentrated on
the development of an interactive link with the consumer's home. Within five to
ten years, the television set and cable TV converter box will be replaced by
smart telecommunications computer systems which will provide interactive access
to movies, data, home shopping, video games, video telephone, and
teleconferencing, as well as hundreds of channels of television programming.
Prototype interactive systems are now operational in Florida and California.
Additionally, links to personal computers in consumers' homes will allow direct
transmission of high volumes of information to consumers.
The cost to provide connections and hardware to all U.S. households is
estimated to be at least $3,000 per household. Assuming a total of 90 million
U.S. households, the total cost to implement the new technology could approach
$300 billion. The requirement for vast capital expenditures means that only the
best capitalized companies, such as the RBOC's, or the largest cable companies
can afford to make this investment. However, the pace of new investment in new
technology will be determined by the willingness of consumers to pay for new
information or interactive services.
6
PICO MACOM INC.
The Company's Pico Macom, Inc. (PMI) subsidiary, located in Lakeview
Terrace, California, sells broadband systems and hardware components, cable TV
accessories and passive radio frequency products primarily to the CATV, SMATV,
MMDS and DTH industry and related markets. Broadband systems include active
headend electronics, such as satellite receivers, signal processors, modulators
and amplifiers. PMI's headend products are manufactured under contract on an
exclusive basis by one principal subcontractor with facilities in Taiwan and
China.
Passive products include splitters, connectors, switches and couplers for
coaxial cable installation. Passive products are produced to Pico's
specifications by a number of subcontract manufacturers in Taiwan. PMI
maintains tight quality control supervision of these manufacturers through on-
site inspections by Pico Macom Taiwan employees in the Far East.
Products for the U.S. market are shipped to PMI's warehouse in California.
In some cases, there is additional assembly and tuning or testing of products
before shipment. Pico Macom employs 100 people in Lakeview Terrace, California
and Pico Macom Taiwan employs 6 people in Taiwan who maintain a quality
assurance program for the Taiwan subcontractors.
The primary business focus for PMI has been on the development and
positioning of its line of headend equipment and 1 GHz product lines.
Engineering and production efforts have upgraded various products to ensure that
they meet all U.S. regulatory requirements. In addition, the engineering staff
has been increased significantly in the last 3 years. As the technical needs of
the CATV, SMATV and MMDS industries have grown, PMI's product line has been
improved through the use of surface mount technology and computer aided design.
Engineering design and product development are done in the U.S. Independent
testing and evaluation is completed prior to the introduction of new products.
The engineering efforts have resulted in improved quality and features to the
point where PMI has been able to introduce low-cost, high-performance products
for use by CATV operators.
The second segment of Pico's domestic market is signal distribution systems
which use passive components such as splitters, taps and connectors. Private
cable TV operators purchase passive components which are used to wire multiple
dwelling units. CATV operators purchase passive components through distributors
who buy directly from PMI.
7
Pico Macom sells over 500 different products at prices ranging from under
$1 for most passive components to over $20,000 for a complete multiple channel
SMATV headend. Products are sold to over 800 distributors, dealers and OEM
manufacturers located primarily in the United States. Sales are also made to
customers in Canada, Mexico, Central and South America, Europe, the Middle East,
and Asia. Sales are primarily made through telemarketing efforts conducted from
the Company's Lakeview Terrace, California, facility with some direct sales to
major distributors and OEM accounts. PMI currently uses industry trade shows
and targeted advertising to market its products.
Sales by Pico Macom represented 76%, 83%, and 83% of the Company's
consolidated sales for the fiscal years ended July 31, 1996, 1995 and 1994,
respectively. For the fiscal year ended July 31, 1996 approximately 68% of Pico
Macom's sales revenue was from sales to the television distribution equipment
industry, primarily SMATV systems; the remaining 32% of Pico Macom's sales
revenue was from sales to CATV systems distributors and OEM accounts.
PAY TV SECURITY (CATV) DIVISION
The Company's Pay TV Security (CATV) division designs, manufactures and
sells Pay TV security products for the cable TV industry. These devices include
both negative filters, as well as positive encoders and filters. In the
industry, these are known as "traps". Single channel negative traps block out
an entire channel of a pay service, such as HBO, so that it cannot be viewed by
a non-subscriber. Single channel positive trapping systems use an encoder to
"scramble" a video signal on a pay channel. Installation of a positive trap by
the cable operator allows the subscriber to view the premium channel. Non-
subscribers will only see a scrambled picture.
The CATV division has been making Pay TV security products since HBO
introduced its premium service in 1975. Following a product quality problem in
1988, Pico developed and introduced its PT (Perfect Trap) line of products.
This hermetically sealed product line has two distinct advantages over previous
technologies. The first advantage is highly accurate temperature compensation
which allows the device to operate over a temperature range of -40 degrees to
+60 degrees Celsius in the harshest of environments. The second advantage is
the sealing method used in the device which eliminates any water or water vapor
migration into the trap.
The CATV division also markets a variety of tier traps that block out an
entire tier or group of channels. Business has recently expanded as the result
of new government regulations. These devices can be used to defeat signal theft
by blocking access to groups of premium channels when theft of service is
suspected.
8
The CATV division currently employs over 250 persons, primarily in
manufacturing. In Lakeview Terrace there are 35 hourly manufacturing employees
and approximately 215 employees in St. Kitts. A sales staff of seven persons is
located in East Syracuse, New York. Engineering for the division is done at the
Company's Lakeview Terrace facility.
Sales by the Company's CATV division represented 21%, 17% and 17% of the
Company's consolidated sales for the fiscal years ended July 31, 1996, 1995 and
1994, respectively.
The primary market for CATV division products is the cable television or
CATV industry in the U.S., although sales of traps to Taiwan and South America
have increased significantly during the past two years. The major customers are
the U.S. multiple system operators (MSO's) such as Adelphia, Comcast,
Continental, Cox, Time Warner, and TCI. The top 25 MSO's constitute about 80%
of the potential market. Sales are made primarily through direct sales to MSO's
with telemarketing backup from a sales office in East Syracuse, New York.
Product shipments are made from Pico Macom's distribution center in Lakeview
Terrace, California.
Positive trapping systems are very cost-effective and are widely used in
over half of the cable systems in the U.S. In the past two years, a major
market has began to emerge in Asia where positive traps offer a low cost
alternative to cable system set-top boxes.
The CATV industry estimates that the current market for traps in the United
States is approximately 1 million units per month. Positive and negative traps
typically sell for a unit price of around $3.50, while tier trap unit prices
range from $5.00 to $9.95. Accessory products range from a few cents to a few
dollars per item and encoders sell for between $250 and $300 depending on the
channel configuration required. At an average selling price of $4.00 per unit,
the annual market is approximately $50 million.
The international market for Pay TV security products is in its early
growth as both cable TV and premium services are developing in the different
countries. The Company's CATV division is shipping product to South America,
the Middle East and Asia. The Company is continuing to develop relationships
for the distribution of its products in these emerging markets.
FOREIGN OPERATIONS
In addition to Pico Macom Taiwan discussed above, the Company owns and
operates a manufacturing facility on the island of St. Kitts (St. Christopher
and Nevis) in the Caribbean. Pico (St. Kitts) Limited assembles the circuit
boards for the positive, negative and tier traps
9
sold by the Pay TV Security division. During fiscal year 1994 the Company
established two wholly owned subsidiaries, Pico (Bermuda) Limited and Pico
Products Asia Limited (PPAL).
PPAL opened an office in Hong Kong in September 1995, to provide sales
technical support for Hong Kong, China, Taiwan, the Philippines, and South
Korea. The Hong Kong office also includes a warehouse and distribution center
for products sourced from Taiwan.
The Company opened an office in Thailand in October 1995, and is
establishing a Thai subsidiary, Pico Siam Company Limited. Pico Siam will
concentrate on equipment distribution and technical assistance in the redesign
and rewiring of existing cable and SMATV installations. Pico Siam is also
prepared to set up distributors in Vietnam, Cambodia and Laos.
At July 31, 1996 the assets located outside the United States constituted
less than 10% of the Company's total assets and the revenues and operating
expenses attributable to the Company's foreign operations were also less than
10% of the Company's revenues and expenses.
SALES AND MARKETING
At July 31, 1996, 1995 and 1994, the Company had a sales and marketing
staff of 25 persons, 25 persons, and 21 persons, respectively. Marketing and
promotion of the Company's products are conducted via direct selling and
telemarketing, and to a lesser extent by advertising in trade publications and
participating in trade shows.
Pico Macom sells products to its markets nationally and internationally
through over 800 customers that include cable operators, OEM manufacturers,
cable equipment distributors, and cable installation contractors. The top
fifteen customers generated approximately 58% of Pico Macom's sales in the year
ended July 31, 1996.
Primarily, sales of the CATV division's Pay TV security products are made
directly to cable system operators by the Company's sales group. Some sales are
to national and regional distributors.
The Company's sales to American Technology Exporters, Inc. in Miami,
Florida ("Amtech") were approximately 16%, 20% and 16% of consolidated sales for
the years ended July 31, 1996, 1995, and 1994, respectively.
As is customary in the industries served, the Company's sales are normally
made pursuant to individual purchase orders. Orders are subject to cancellation
by the buyer under certain conditions without
10
penalty. The backlog of purchase orders as of July 31, 1996 and July 31, 1995
was approximately $4,608,000 and $2,600,000, respectively. These purchase
orders were believed to be firm, and the Company expects to fill the July 31,
1996 backlog within its 1997 fiscal year.
The largest dollar volume sales are of the Company's active electronic
equipment items used in head end installations for which unit prices range from
approximately $100 to $500. However, a large volume of the Company's sales is
of low cost components sold at unit prices under $5.00. Since 1982, a large
portion of Pico Macom's passive products have been sold under the trademark,
"Tru-Spec-Registered Trademark-".
MANUFACTURERS AND SUPPLIERS
Approximately 55% of the Company's sales are from products manufactured by
subcontractors according to the Company's design and quality specifications.
These subcontractors are located primarily in Taiwan, China, Malaysia and
Thailand (the "Far East"). For more than ten years, the SMATV electronic
components sold by Pico Macom have been manufactured under contract on an
exclusive basis by one subcontractor in Taiwan. The Company is committed to
procure a minimum of approximately $12,875,000 of products from this
subcontractor through fiscal year 1998. Management believes that the Company's
relationship with this subcontractor is excellent and that the financial
strength of the subcontractor is strong. However, the loss of this
subcontractor could have a material adverse impact on the Company's operations
until the Company could obtain an alternative source of supply. The contract
does not require the subcontractor to maintain a parts inventory, so that from
time-to-time delays are possible in completing customer orders. The current
contract expires in May 1998 and management anticipates renewing the contract
prior to its expiration. Most of the other products obtained from foreign-based
vendors are available from a number of different subcontractors.
Approximately 21% of the Company's sales are from products manufactured by
the Company. These items consist primarily of passive traps. The trap
manufacturing process involves raw materials procured from domestic and foreign-
based sources which are assembled at the Company's manufacturing facility in St.
Kitts. Final assembly and quality control is accomplished at the manufacturing
facility in Lakeview Terrace, California. The raw materials used in the
manufacturing processes are available from a number of different suppliers, both
domestic and foreign-based, and management believes that no one vendor has the
ability to significantly impact the Company's supply of raw materials.
The remaining 24% of products sold are primarily items purchased from
domestic subcontractors for resale.
11
In August 1987, Pico Macom Taiwan was organized as a Taiwanese export
trading company to facilitate procurement of products from vendors who are too
small to export directly. Pico Macom Taiwan serves as a liaison between Pico
Macom and all of its Far East vendors by monitoring quality control of the
products and assisting in new product development.
PRODUCT DEVELOPMENT
Product development costs are expensed as incurred. Expenses allocated to
product development for the years ended July 31, 1996, 1995 and 1994 totaled
approximately $1,368,000, $979,000, and $545,000, respectively.
COMPETITION AND PATENTS
Equipment reliability, diversity of product lines, delivery requirements,
price, customer service and technological competence are the major basis of
competition in the broadband communications equipment industries. The broadband
communications equipment industries are characterized by intense competition and
technological changes. Many companies which provide equipment and services to
these industries are substantially larger in size and in resources than the
Company.
Royalties received on a Company-owned patent were $0, $257,000, and
$607,000 during fiscal 1996, 1995 and 1994, respectively. In February 1995, the
Company's patent for positive trapping systems expired resulting in the
reduction of royalties for fiscal year 1995. In fiscal year 1996 the Company
received a U.S. patent that is used in the new LNDA broadband amplifiers.
However, patent protection is not available for many of the Company's products.
Management believes that its business is dependent upon marketing and product
availability rather than patent protection.
WARRANTIES
The Company warrants its Pay TV Security division products against faulty
materials and workmanship for up to five years. Pico Macom warrants its
products against faulty material and workmanship for two years for its
electronic equipment and one year for its other products. The Company's
warranties are limited to repair or replacement of the defective product.
During the three years ended July 31, 1996, direct costs associated with the
warranties have been minimal.
EMPLOYEES
At July 31, 1996, the Company employed 395 persons of whom 35 were engaged
in administration and accounting, 15 in engineering and quality
12
control, 25 in sales and marketing, and the remainder in production, purchasing
and shipping. None of the Company's employees are represented by labor unions.
GOVERNMENTAL REGULATION
The Company's products are subject to Federal Communications Commission
("FCC") regulation. Certain of the Company's customers also are subject to
regulation by the FCC and by state and local governmental authorities. The
rules, regulations, policies and procedures of the FCC affecting the broadband
communications industry are constantly under review. The likelihood of changes
in such regulation and its effect on the business of the Company cannot be
ascertained.
In October 1992, the U.S. Congress enacted legislation to reregulate
certain aspects of the U.S. cable television industry. As part of this
legislation, the FCC mandated two separate rollbacks in subscriber rates
totalling as much as 17% of the prior rates. This rate reduction adversely
impacted the Company's sales of pay TV security devices during fiscal year 1994
as the system operators reduced their capital expenditure budgets to reflect
their lowered revenues. During fiscal year 1995, the Company experienced an
increase in demand for pay TV security devices as the system operators began to
again order products.
In early 1996, the U.S. Congress enacted sweeping legislation to deregulate
the U.S. telecommunications industry. This legislation is having a major impact
on both the telecommunication and cable industries. The immediate result has
been the creation of numerous new partnerships and alliances among companies in
the telecommunications, cable TV, cable electronics, computer and programming
industries. While the "convergence" of those industries is in an early stage of
evolution, a number of major investment commitments have been made, such as the
purchase of Continental Cablevision by a division of US West (a RBOC).
Deregulation has important implications for the cable TV industry. This in turn
presents major potential new opportunities for Pico in the U.S.
The Company's products are used by broadband communications systems in
foreign countries, especially in Latin America and Asia. Sales to Latin America
are made directly by the Company or through U.S.-based distributors while sales
to Asia are made through the Company's CATV division and through the Company's
Hong Kong subsidiary, PPAL. Regulation of construction, technical character and
operation of the broadband communications system is controlled by each country's
government. The Company cannot predict the impact on its sales due to changes
in regulation or legislation by foreign governments.
13
TABLE OF COMPANY'S SUBSIDIARIES
- --------------------------------------------------------------------------------
Name Jurisdiction of Year Active (A)
Incorporation Incorporated Inactive (I)
- --------------------------------------------------------------------------------
Pico Macom, Inc. Delaware 1983 A (1)
- --------------------------------------------------------------------------------
Pico Macom Taiwan 1987 A (3)
Taiwan Co. Ltd.
- --------------------------------------------------------------------------------
Pico (St. Kitts) Ltd. St. Christopher 1983 A (2)
and Nevis
- --------------------------------------------------------------------------------
Pico (Bermuda) Bermuda 1994 A (1)
Ltd.
- --------------------------------------------------------------------------------
Pico Products Hong Kong 1994 A (4)
Asia Ltd.
- --------------------------------------------------------------------------------
Pico (St. St. Vincent and 1981 I (1)
Vincent) Ltd. the Grenadines
- --------------------------------------------------------------------------------
Pico Satellite, Inc. Delaware 1983 I (1)
- --------------------------------------------------------------------------------
Pico Cargo, Inc. Delaware 1983 I (1)
- --------------------------------------------------------------------------------
Pico Korea, Ltd. Korea 1985 I (3)
- --------------------------------------------------------------------------------
Notes: (1) Subsidiary of Pico Products, Inc.
(2) Subsidiary of Pico (St. Vincent) Ltd.
(3) Subsidiary of Pico Macom, Inc.
(4) Subsidiary of Pico (Bermuda) Limited.
Ownership percentage in all cases exceeds 90%.
At July 31, 1996, no operational activities were performed by the following
subsidiaries: Pico (St. Vincent) Ltd., Pico Satellite, Inc., Pico Cargo, Inc.
and Pico Korea, Ltd.
14
ITEM 2. PROPERTIES
The Company presently owns or leases an aggregate of approximately 86,000
square feet of office, production and warehouse space.
Pico Macom leases 60,000 square feet of space in Lakeview Terrace,
California which is used for corporate headquarters for Pico Products, Inc. and
Pico Macom, Inc., final assembly of Pay TV Security division products and Pico
Macom's administration, sales, engineering and distribution functions. The two-
year facility lease expires in March 1998. The net annual rental for the
current facility is approximately $360,000.
The Company leases approximately 1,700 square feet for its CATV division
sales office in East Syracuse, New York. The lease expires in October, 1998.
The net annual rental is approximately $20,000. The Company also leases
approximately 1,700 square feet of office space for the office of its chairman
and chief executive officer in West Conshohocken, Pennsylvania. The lease
expires in October, 2000. The net annual rent is approximately $43,000.
Pico (St. Kitts) Limited, which manufactures components for the Company's
CATV Security products, owns a 16,000 square foot building and the underlying
ground lease located in Saint Christopher and Nevis, a country in the Caribbean.
The net annual rental of the underlying ground lease is $570 through 2018.
Pico Products Asia Limited leases approximately 4,000 square feet for an
office facility in Hong Kong at an annual rental of approximately $64,000. The
lease expires in July, 1997 with an option to extend the lease term for one
additional year.
Pico Macom Taiwan leases approximately 2,000 square feet for an office
facility in Taipei, Taiwan at an annual rental of approximately $30,000. The
lease expires in January 1997 and the Company anticipates renewing it at that
time.
Management believes that the above described properties are sufficient for
the Company's present needs.
15
ITEM 3. LEGAL PROCEEDINGS
ARCOM LITIGATION
In November 1991, Arrow Communication Laboratories, Inc. (Arcom) of
Syracuse, New York, initiated a lawsuit in the New York Supreme Court, which, as
amended, alleged that Arcom had a paid-up license with respect to the Company's
patent for positive trapping systems and that Arcom was entitled to unspecified
damages based on overpayment of royalty amounts. Arcom also claimed that it was
entitled to compensatory damages in excess of $250,000, plus punitive damages of
$3,000,000, as a result of a Company press release announcing termination of the
license agreement.
The Company initiated a patent infringement suit against Arcom in the United
States District Court for the Northern District of New York, which sought treble
damages for willful infringement plus attorneys fees. The Company requested
that the Court grant a preliminary injunction to prevent Arcom from infringing
its patent. At a Court hearing in February 1994, the parties agreed, and it was
ordered by the Court, that Arcom would post as security amounts equal to the
royalties due to the Company for the manufacture and sale of product covered by
the license agreement from December 15, 1991, the date that the license would
have terminated, until the expiration of the patent in February 1995. Through
July 31, 1995 Arcom had made cash payments of $462,066 covering royalties
through February 14, 1995. The Company did not include these amounts in income
in any fiscal period but recorded a current liability for $462,066 at July 31,
1995. In addition, Arcom agreed to post an irrevocable letter of credit in an
amount deemed sufficient to permit recovery of a significant portion of the
Company's damages if it were to prevail on its willful infringement claim. In
exchange, the Company withdrew its request for a preliminary injunction.
In May, 1996, the Company and Arcom agreed to settle the foregoing
lawsuits, pursuant to which all suits were terminated and dismissed with
prejudice. As part of this agreement, the Company and Arcom, respectively,
granted each other full releases from liability, the Company released certain
deposits and other collateral provided to the Company by Arcom during the
litigation, and the Company reimbursed Arcom approximately $70,000 for certain
fees and expenses.
EPA INFORMATION REQUEST
In March 1995, a subsidiary of the Company received a Joint Request for
Information (the "Information Request") from the United States Environmental
Protection Agency, Region II (the "EPA"), under the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended ("CERCLA"), with
respect to the release and/or
16
threatened release of hazardous substances, hazardous wastes, pollutants or
contaminants into the environment at the Onondaga Lake Site, Syracuse, Onondaga
County, New York. The Company has learned that the EPA added the Onondaga Lake
Site to the Superfund National Priorities List on December 6, 1994, and has
completed an onsite assessment of the degree of hazard. The EPA has indicated
that the Company is only one of 26 companies located in the vicinity of Onondaga
Lake or its tributaries that have received a similar Information Request.
The Information Request related to the activities of the Company's Printed
Circuit Board Division, which conducted operations within the specified area,
and was sold to a third party in 1992. Under the Agreement of Sale with the
buyer, the Company retained liability for environmental obligations which
occurred prior to the sale.
The Company has provided all information requested by the EPA. The
Information Request does not designate the Company as a potentially responsible
party, nor has the EPA indicated the basis upon which it would designate the
Company as a potentially responsible party. The Company is therefore unable to
state whether there is any material likelihood for liability on its part, and,
if there were to be any such liability, the basis of any sharing of such
liability with others.
OTHER
The Company is involved, from time to time, in certain other legal actions
arising in the normal course of business. Management believes that the outcome
of other litigation will not have a material adverse effect on the Company's
consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
17
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's common shares are traded on the American Stock Exchange under
the symbol "PPI". The following table sets forth, for the fiscal periods
indicated, closing prices for the common shares on the American Stock Exchange
as reported by the American Stock Exchange, Inc.
High Low
Fiscal Year Ended July 31, 1995:
First Quarter.................... 3 11/16 2 7/16
Second Quarter................... 2 15/16 2 3/16
Third Quarter.................... 3 3/16 2 1/8
Fourth Quarter................... 2 9/16 1 15/16
Fiscal Year Ended July 31, 1996:
First Quarter.................... 2 1/2 1 5/8
Second Quarter................... 2 1/16 1 1/2
Third Quarter.................... 3 7/16 1 5/8
Fourth Quarter................... 2 3/4 1 3/4
August 1, 1996 to September 20, 1996.. 2 1/4 1 13/16
As of September 20, 1996, there were approximately 2,300 holders of record
of the Company's common shares.
The Company has never paid a cash dividend on its common shares. The
Company's Board of Directors currently intends to retain any future earnings for
use in the Company's business. Payment of cash dividends in the future will be
dependent upon the Company's earnings, financial condition, capital requirements
and other factors deemed relevant by the Company's Board of Directors.
18
ITEM 6. SELECTED FINANCIAL DATA
The following is selected consolidated financial data of the Company for
the five fiscal years ended July 31, 1996. The selected consolidated financial
data should be read in connection with the consolidated financial statements
included as Item 8 of this Annual Report on Form 10-K.
(amounts in thousands,
except per share data) FISCAL YEAR ENDED JULY 31,
------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
1) STATEMENT OF OPERATIONS DATA:
Sales $36,051 $33,367 $29,886 $23,740 $19,520
Income (loss) from
operations $ 534 $ 997 $ 799 $ (225) $ 9
Income (loss) from
continuing operations $ (400) $ 526 $ 905 $ (277) $ 3
Discontinued operations $ - $ - $ - $ - $ 64
Net income (loss) $ (400) $ 526 $ 905 $ (277) $ 67
Income (loss) from
continuing operations per
common and common
equivalent share - primary
and fully diluted $ (0.11) $ 0.12 $ 0.21 $ (0.08) $ -
Net income (loss) per
common and common
equivalent share - primary
and fully diluted $ (0.11) $ 0.12 $ 0.21 $ (0.08) $ 0.02
Weighted average common
and equivalent shares
outstanding - primary
and fully diluted 3,798 4,240 4,295 3,577 3,829
2) BALANCE SHEET DATA:
Working capital $ 3,124 $ 3,497 $ 3,151 $ 2,180 $ 1,849
Total assets $17,945 $17,633 $13,853 $11,592 $10,161
Long-term debt $ 39 $ 279 $ 632 $ 732 $ 392
Shareholders' equity $ 4,456 $ 4,513 $ 3,961 $ 3,009 $ 3,285
19
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
SALES
Sales for the fiscal year ended July 31, 1996 were $36.1 million compared
to $33.4 million for the prior year, an increase of 8%. This was the highest
annual sales total in the Company's history. The Company's CATV division
recorded a sales increase of $1.8 million, or 34%, compared to the prior year.
This increase was primarily due to strong domestic and international demand for
pay TV encoders and decoders. The Company's Hong Kong subsidiary recorded a
sales increase of $1.2 million over the prior year, as fiscal year 1996 was its
first full year of distributing product into China, Hong Kong and Southeast
Asia. Sales for the Company's Pico Macom subsidiary were even with the prior
year due to a slowdown in sales in the first half of fiscal year 1996. This
sales slowdown was caused by the consolidation of several U.S. multiple cable TV
system operators (MSO's) and a resulting slowing of demand in the first half of
the year and a slow down of investment by the MSO's in South America in the
first half of the year. However, demand for these products increased in the
second half of fiscal year 1996. Management believes that the Company's overall
sales growth will continue into fiscal year 1997.
Sales for the fiscal year ended July 31, 1995 were $33.4 million compared
to $29.9 million for the prior year, an increase of 12%. The sales increase for
Pico Macom was approximately 12% due primarily to continued increasing demand
for Satellite Master Antenna (SMATV) equipment and products by U.S.-based
distributors for resale into South America. The sales increase for the CATV
division was approximately 9% due primarily to increased industry demand for Pay
TV encoders and decoders in both domestic and international markets during the
third and fourth quarters of fiscal year 1995. The growth in sales of Pico
Macom, the CATV division and the Company's St. Kitts operation resulted in a
blended sales growth rate of 12% in fiscal year 1995.
COST OF SALES
Cost of sales for the fiscal year ended July 31, 1996 increased by
approximately $2.2 million, or 8.5%, compared to the previous year. Cost of
sales as a percentage of sales was unchanged at 76% for fiscal year 1996,
compared to the previous year. The dollar increase in cost of sales was
primarily attributable to the increase in sales volume. Manufacturing cost
improvements for the Company's CATV division security products and improved
purchasing power of the U.S. dollar in
20
the Far East resulted in slight product costs reductions in fiscal year 1996.
However, these reductions were offset by startup costs for several of the
Company's new product lines. Management believes that the Company will benefit
from the higher margins on these new products and programs in fiscal year 1997.
Cost of sales for the fiscal year ended July 31, 1995 increased by
approximately $2,430,000, or 11%, compared to the previous year. Cost of sales
as a percentage of sales remained even at 76%. The dollar increase in cost of
sales was primarily attributable to the increase in sales volume. While the
purchasing power of the U.S. dollar in the Far East fluctuated somewhat during
fiscal year 1995 it did not materially affect the Company's profitability in
fiscal year 1995.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses increased by approximately $995,000, or
14%, in fiscal year 1996 compared to the prior year. The primary reasons for
the increase were continuing investment in upgrading and expanding the product
line and expenditures related to development of new markets in Asia. The
Company also expanded its regional office in Hong Kong. During fiscal year 1996
the Company established a sales office in Bangkok, Thailand to market its
products into Thailand, Indonesia, and other markets in Southeast Asia. For
fiscal year 1996 the Company's product development expenses and Asian market
development expenses increased by approximately $389,000 and $654,000,
respectively, when compared with the prior fiscal year. Management believes the
Company will begin to achieve returns on these investments during fiscal year
1997. Management also anticipates that this current level of selling and
administrative expenses will continue throughout fiscal year 1997.
Selling and administrative expenses increased by approximately $853,000, or
14%, in fiscal year 1995 compared to the prior year. The primary reasons for
the increase were increased investment in product development and expenditures
related to development of new markets in Asia, and the opening of a new Asia
regional office in Hong Kong. While product development expenses and marketing
expenses in Asia continued into the fourth quarter at a rate consistent with the
first nine months of the fiscal year, the Company experienced a reduction in
patent amortization, legal and management incentive expenses compared to the
previous year.
PRODUCT DEVELOPMENT
Product development expenditures for fiscal years 1996, 1995, and 1994 were
approximately $1,368,000, $979,000, and $545,000, respectively. These amounts
are included in the selling and administrative expense totals mentioned
previously. The product
21
development efforts during fiscal years 1995 and 1996 were concentrated on
upgrading and expanding Pico Macom's product line to address CATV industry new
products, new features and higher performance specifications. Additionally, new
products were developed for the CATV Division that incorporates 1 GHz capability
in specialized RF filter products for the cable industry. Also, broadband
amplifiers that support 1 GHz with two-way capabilities were designed and
brought into production. Agile headend products, including modulator and
demodulator products, were brought into full manufacturing. Finally,
microprocessor controlled modulators and demodulators were developed and placed
into early deployment.
Management believes that in order to remain competitive in a constantly changing
technological market place, the Company needs to maintain at least the current
level of product development expenses.
OTHER INCOME
Other income decreased by approximately $260,000, or 92%, for fiscal year
1996 compared to the prior year. The decrease in other income was primarily due
to the elimination of royalty income from license holders following the
expiration of the Company's patent for positive encoding and decoding systems in
February 1995.
Other income decreased by approximately $367,000, or 57%, for fiscal year
1995 compared to the prior year. The decrease was primarily related to
decreased royalty income from license holders following the expiration of the
Company's patent for positive encoding and decoding systems in February 1995.
INTEREST EXPENSE
Interest expense increased by approximately $243,000, or 34%, for fiscal
year 1996 compared to the prior year. The increase in interest expense was
primarily due to higher borrowing levels on the Company's bank line of credit to
support the Company's working capital requirements.
Interest expense increased by approximately $170,000, or 31%, for fiscal
year 1995 compared to the prior year. The increase was due primarily to higher
borrowing levels on the Company's bank lines of credit to support the Company's
working capital requirements, and due to several increases in the prime rate.
INCOME TAX PROVISION
No provision for U.S. Federal and state regular income taxes or foreign
income taxes have been provided for fiscal year 1996, fiscal year 1995 or fiscal
year 1994 due to the Company's U.S. Federal and
22
state net operating loss carryforward positions and tax holidays granted the
Company's foreign subsidiaries. However, a provision for U.S. Federal and State
alternative minimum tax was established for fiscal year 1995.
NET LOSS
The Company recorded a net loss of approximately $400,000 in fiscal year
1996. This loss reflects a continued investment in product development and
Asian market development expenses which are key to the future growth of the
Company. Profitability in future periods is contingent upon acceptance of the
new products in the market place, increased sales in Asia and South America, and
continued increases in capital spending by major U.S. cable TV system operators.
OTHER
In fiscal year 1994, the Company's main manufacturing, sales, distribution
and administration facility suffered damage during the January 17, 1994
Northridge earthquake. The Company's office, engineering and manufacturing
areas were damaged primarily from broken high-pressure sprinkler pipes when a
portion of the leased facility's roof collapsed. No employees were injured, and
the Company's inventory and equipment were relatively undamaged. Normal
operations were suspended for one week while the offices, engineering and a part
of the manufacturing operations were moved to a section of the warehouse and
temporary telephone, power and computer cables were installed. Normal
operations resumed on January 24, 1994. Repairs to the damaged portion of the
facility were completed in late May of 1994 and the refurbished offices were
reoccupied. Costs for repairs, replacements and extra expenses were covered by
the Company's insurance policies, and the Company experienced no material
adverse financial impact from the earthquake.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 1996, the Company had working capital of approximately
$3,124,000 and a ratio of current assets to current liabilities of approximately
1.23 to 1, compared with working capital of approximately $3,497,000 and a ratio
of current assets to current liabilities of approximately 1.27 to 1 as of July
31, 1995. During fiscal year 1996 the Company recorded negative cash flow from
operating activities primarily as a result of the net loss from operations,
increased inventory purchases to support the Company's forecasted sales levels,
and reduction of other liabilities partially offset by a reduction in accounts
receivable and increases in accounts payable and accrued expenses.
23
Sales for fiscal year 1996 were lower than planned, resulting in higher
inventory levels at July 31, 1996. The increased investment in inventory has
reduced the Company's borrowing availability on its revolving bank line of
credit. During the year, the Company implemented programs to significantly
reduce inventory levels through improved inventory management and improved sales
from South America and the U.S. in the third and fourth quarters. In addition,
stocks of parts and components for newly developed products were converted into
finished goods for shipment to customers.
During the years ended July 31, 1996, 1995 and 1994, cash used for capital
expenditures was approximately $229,000, $221,000 and $116,000, respectively.
The Company financed approximately $250,000 for the acquisition of a new
management information system during fiscal year 1994. Capital expenditures for
fiscal year 1997 are expected to be under $500,000.
Pico Macom has an $11,000,000 revolving bank line of credit which is
secured by substantially all of Pico Macom's assets, including all trade
accounts receivable and inventories. The line provides for interest at the
prime rate (8.25% at July 31, 1996) plus 1.25%. In December 1995, the bank
increased the line of credit from $10,000,000 to $11,000,000, increased the
borrowing limit against eligible inventories from $4,500,000 to $5,500,000 and
extended the term of the line of credit from May 25, 1996 to December 31, 1996.
The revolving line of credit is used to fund operating expenses, product
purchases and letters of credit for import purchases. The line has a $1,500,000
sublimit for outstanding letters of credit. The amount available to borrow at
any one time is based upon various percentages of eligible accounts receivable
and eligible inventories as defined in the agreement. The credit facility is
subject to certain financial tests and covenants.
At July 31, 1996, the Company was in technical violation of a financial
covenant relating to Pico Macom's bank line of credit. This covenant restricts
the maximum advances to affiliates by Pico Macom. Pico Macom's bank has issued
a waiver of this violation effective July 31, 1996. All other covenants
relating to this line of credit were met as of July 31, 1996.
Management is confident that the bank line of credit will be renewed.
Although failure to obtain such financing would have a material adverse effect
on the Company's working capital requirements, the Company believes that
alternative asset-based financing would be available. At July 31, 1996, Pico
Macom had approximately $8,228,000 in revolving loans and approximately $73,000
in letters of credit outstanding, and the unused portion of the borrowing base
was approximately $347,000.
24
In February 1993, the Company completed private placement financings
totaling $1,000,000. The financings consisted of three notes. The first note
for $500,000 was paid in full in May 1994. The second and third notes totaling
$500,000 provide for interest at 8% and were payable in two equal installments
in February 1996 and in February 1997. In connection with the financings, the
Company issued warrants for 425,000 shares of its common stock, exercisable
through fiscal year 1998 at $1.00 per share.
In February 1996, the Company was notified by the holder of the two
outstanding notes payable that they intended to exercise 250,000 warrants to
purchase common stock of the Company as an offset against the first $250,000
installment payment due on the debt. This transaction was completed by the end
of March 1996.
Management has determined that the Company's current credit
arrangements, along with an inventory reduction program, will not provide
sufficient cash to fund growth in the Company's sales and planned operations
for fiscal year 1997 and beyond. Consequently, the Company has retained an
investment banking firm to assist in obtaining subordinated debt financing
for general working capital requirements and investment in new product
development, market development and upgrade of facilities. The Company has
entered into a non-binding letter of intent with a potential investor with
respect to such a financing, which is subject to satisfactory completion of
the investor's due diligence investigation and negotiation and execution of a
definitive agreement. Although management believes that the Company will
successfully complete a financing on acceptable terms, there can be no
assurance that it will be able to do so. To the extent that the Company were
unable to obtain such additional financing, it would be forced to restrict
and/or postpone its growth plans.
Profitability of operations is subject to various uncertainties including
general economic conditions and the actions of actual or potential competitors
and customers. The Company's future depends on the growth of the cable TV
market in the United States and internationally. In the United States, a number
of factors could affect the future profitability of the Company, including
changes in the regulatory climate for cable TV, changes in the competitive
structure of the cable and telecommunications industries or changes in the
technology base of the industry. Internationally, the Company's profitability
depends on its ability to penetrate new markets in the face of competition from
other United States and foreign companies.
OTHER
IMPACT OF TECHNOLOGICAL OBSOLESCENCE
The Company's products are subject to technological obsolescence as
government regulations, competition or the nature of the broadband
communications industry could require changes in the current product
25
lines. The rapid changes in all sectors of the communications industry and the
entry of new technology could significantly impact the sale of the Company's
products. While management is not aware of any specific products, regulations
or requirements that would create significant obsolescence in the next fiscal
year, technological obsolescence could materially affect the operating results
of the Company in any fiscal period.
IMPACT OF INFLATION AND CHANGING PRICES
Although the Company cannot accurately determine the precise effect of
inflation, the Company has experienced some increased costs of materials,
supplies, salaries and benefits due to inflation. The Company attempts to pass
on increased costs and expenses by increasing selling prices, when possible, and
by developing more useful and economical products that can be sold at favorable
profit margins.
FOREIGN OPERATIONS
Because a substantial portion of the Company's products are purchased from
vendors in Taiwan, China, Malaysia and Thailand (the "Far East"), the Company is
subject to price increases imposed by those vendors to compensate for currency
fluctuations. During fiscal years 1994 through 1996 the U.S. dollar generally
maintained its purchasing power against the currencies of the countries from
which the Company purchases most of its products. If the U.S. dollar were to
weaken, the Company would consider setting price increases for its products.
Continued weakening of the U.S. dollar could cause the Company to lose its
competitive costing edge to U.S.-based manufacturers which could adversely
affect operating results. Restrictive foreign government regulations or
political instability could also materially affect the operating results of the
Company. As discussed above, foreign economic and financial uncertainties could
also materially affect sales levels to foreign customers which could materially
affect the operating results of the Company.
FORWARD LOOKING STATEMENTS
Statements which are not historical facts, including statements about our
confidence, strategies and expectations, technologies and opportunities,
industry and market segment growth, demand and acceptance of new and existing
products, and return on investments in products and markets, are forward looking
statements that involve risks and uncertainties, including without limitation,
the effect of general economic and market conditions, industry market conditions
caused by changes in the supply and demand for our products, the continuing
strength of the markets we serve, competitor pricing, maintenance of our current
momentum and other factors.
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
27
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of
Pico Products, Inc.:
We have audited the accompanying consolidated balance sheets of Pico Products,
Inc. and its subsidiaries as of July 31, 1996 and 1995, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended July 31, 1996. Our audits also
included the financial statement schedule listed at Item 14a(2). These
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Pico Products, Inc. and its
subsidiaries at July 31, 1996 and 1995, and the results of their operations and
their cash flows for each of the three years in the period ended July 31, 1996
in conformity with generally accepted accounting principles. Also, in our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Los Angeles, California
October 24, 1996
28
PICO PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
July 31,
--------------------------
1996 1995
----------- -----------
ASSETS (Note C):
CURRENT ASSETS:
Cash and cash equivalents $ 159,669 $ 501,525
Accounts receivable (less allowance
for doubtful accounts: July 31, 1996,
$200,000; July 31, 1995, $290,000) 5,289,288 5,892,338
Inventories (Note B) 10,933,244 9,760,164
Prepaid expenses and other current
assets 191,215 183,870
----------- -----------
TOTAL CURRENT ASSETS 16,573,416 16,337,897
----------- -----------
PROPERTY, PLANT AND EQUIPMENT (Note E):
Buildings 217,255 217,255
Leasehold improvements 345,136 259,277
Machinery and equipment 2,637,609 2,428,605
----------- -----------
3,200,000 2,905,137
Less accumulated depreciation
and amortization 2,393,995 2,121,382
----------- -----------
806,005 783,755
----------- -----------
OTHER ASSETS:
Patents and licenses (less accumulated
amortization: July 31, 1996, $62,180;
July 31, 1995, $56,204) 159,030 165,006
Excess of cost over net assets of
businesses acquired (less accumulated
amortization; July 31, 1996, $366,930;
July 31, 1995, $337,890) 210,505 239,545
Deposits and other noncurrent assets 195,582 107,147
----------- -----------
565,117 511,698
----------- -----------
$17,944,538 $17,633,350
----------- -----------
----------- -----------
See notes to consolidated financial statements.
29
PICO PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
(CONTINUED)
July 31,
--------------------------
1996 1995
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable (Note C) $ 8,227,776 $ 7,778,655
Current portion of long-term debt
(Note D) 311,086 362,239
Accounts payable 3,921,081 3,326,366
Accrued expenses:
Legal and accounting 170,497 90,443
Payroll and payroll taxes 506,742 484,854
Other accrued expenses 312,193 336,450
Other current liabilities (Note M) - 462,066
----------- -----------
TOTAL CURRENT LIABILITIES 13,449,375 12,841,073
----------- -----------
LONG-TERM DEBT (Note D) 39,414 278,820
----------- -----------
COMMITMENTS AND CONTINGENCIES - -
(Notes E and M)
SHAREHOLDERS' EQUITY (Notes K and L):
Preferred shares, $.01 par value;
authorized 500,000 shares;
no shares issued - -
Common shares, $.01 par value;
authorized 15,000,000 shares
issued and outstanding 4,052,246
shares at July 31, 1996 and 3,637,046
shares at July 31, 1995 40,522 36,370
Additional paid-in capital 22,035,178 21,565,255
Stock subscriptions receivable (115,000) -
Accumulated deficit (17,409,924) (17,010,269)
Cumulative translation adjustment (95,027) (77,899)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 4,455,749 4,513,457
----------- -----------
$17,944,538 $17,633,350
----------- -----------
----------- -----------
See notes to consolidated financial statements.
30
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended July 31,
-----------------------------------------
1996 1995 1994
----------- ----------- -----------
SALES (Note I) $36,051,304 $33,367,249 $29,886,482
COSTS AND EXPENSES
Cost of Sales 27,377,269 25,225,052 22,795,447
Selling and administrative
expenses (Note H) 8,140,285 7,145,472 6,292,002
----------- ----------- -----------
TOTAL COSTS AND EXPENSES 35,517,554 32,370,524 29,087,449
----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS 533,750 996,725 799,033
OTHER INCOME (Note F) 22,060 281,897 649,314
INTEREST EXPENSE (955,465) (712,921) (543,332)
----------- ----------- -----------
INCOME (LOSS)
BEFORE INCOME TAXES (399,655) 565,701 905,015
INCOME TAX PROVISION (Note G) - 40,000 -
----------- ----------- -----------
NET INCOME (LOSS) $ (399,655) $ 525,701 $ 905,015
----------- ----------- -----------
----------- ----------- -----------
NET INCOME (LOSS) PER
COMMON AND COMMON
EQUIVALENT SHARE:
Primary $ (0.11) $ 0.12 $ 0.21
----------- ----------- -----------
----------- ----------- -----------
Fully Diluted $ (0.11) $ 0.12 $ 0.21
----------- ----------- -----------
----------- ----------- -----------
WEIGHTED AVERAGE COMMON AND
EQUIVALENT SHARES OUTSTANDING:
Primary 3,797,972 4,240,241 4,294,784
----------- ----------- -----------
----------- ----------- -----------
Fully Diluted 3,797,972 4,240,241 4,294,784
----------- ----------- -----------
----------- ----------- -----------
See notes to consolidated financial statements.
31
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
Number of Common Additional Stock Accumulated Cumulative Total
Common Shares - Paid-In Subscriptions Deficit Translation
Shares Par Value Capital Receivable Adjustment
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE
August 1, 1993 3,577,246 $35,772 $21,505,604 $0 $(18,440,985) $(90,985) $3,009,406
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative
translation
adjustment - - - - - (10,129) (10,129)
Shares issued
under stock
incentive plans 54,800 548 55,951 - - - 56,499
Net income - - - - 905,015 - 905,015
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE
July 31, 1994 3,632,046 36,320 21,561,555 0 (17,535,970) (101,114) 3,960,791
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative
translation
adjustment - - - - - 23,215 23,215
Shares issued
under stock
incentive plans 5,000 50 3,700 - - - 3,750
Net income - - - - 525,701 - 525,701
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE
July 31, 1995 3,637,046 36,370 21,565,255 0 (17,010,269) (77,899) 4,513,457
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative
translation
adjustment - - - - - (17,128) (17,128)
Shares issued
under stock
incentive plans 165,200 1,652 107,423 - - - 109,075
Shares issued
for exercise of
stock warrants 250,000 2,500 247,500 - - - 250,000
Stock subscriptions
receivable - - 115,000 (115,000) - - -
Net loss - - - - (399,655) - (399,655)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE
July 31, 1996 4,052,246 $40,522 $22,035,178 $(115,000) $(17,409,924) $(95,027) $4,455,749
- ------------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
32
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended July 31,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (399,655) $ 525,701 $ 905,015
Adjustments to reconcile net
income (loss) to net cash
used in operating activities:
Depreciation and amortization 362,367 370,176 536,269
Provision for losses on
accounts receivable 143,769 142,897 246,602
Provision for inventory
obsolescence 174,900 91,200 184,515
Changes in operating assets
and liabilities:
Accounts receivable 459,281 (1,617,523) (409,784)
Inventories (1,365,108) (2,657,205) (2,251,036)
Prepaid expenses and
other current assets (7,345) 197,372 (138,509)
Other assets (115,074) (3,591) (54,922)
Accounts payable 594,715 1,439,609 38,205
Accrued expenses 100,635 (168,786) 306,865
Other liabilities (462,066) 58,367 403,699
------------ ------------ ------------
NET CASH USED IN
OPERATING ACTIVITIES (513,581) (1,621,783) (233,081)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (228,749) (220,532) (115,664)
------------ ------------ ------------
Continued on next page.
See notes to consolidated financial statements.
33
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Year Ended July 31,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under line of
credit agreements $ 449,121 $1,991,373 $1,177,059
Principal payments on long-term
debt (134,772) (92,142) (854,113)
Change in restricted cash - - 209,993
Proceeds from exercise of stock
options 86,125 3,000 48,000
----------- ----------- -----------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 400,474 1,902,231 580,939
----------- ----------- -----------
NET INCREASE (DECREASE)IN CASH
AND CASH EQUIVALENTS (341,856) 59,916 232,194
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 501,525 441,609 209,415
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 159,669 $ 501,525 $ 441,609
----------- ----------- -----------
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Year Ended July 31,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
CASH PAID DURING THE YEAR FOR:
Interest $ 953,955 $ 681,803 $ 529,605
----------- ----------- -----------
----------- ----------- -----------
Income taxes $ 28,950 $ 15,138 $ -
----------- ----------- -----------
----------- ----------- -----------
Continued on next page.
See notes to consolidated financial statements.
34
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In fiscal year 1994 the Company financed its new management information
system, totaling approximately $248,000.
In fiscal year 1996 the Company financed the purchase of office and test
lab equipment totaling approximately $94,000.
In March 1996 the holder of $250,000 of the Company's notes payable
exercised 250,000 warrants to purchase common stock of the Company at $1.00 per
share. The proceeds from the exercise of the warrants offset the payment due on
the debt.
In April 1996 an officer of the Company exercised options to acquire
125,000 shares of the Company's common stock in exchange for a stock
subscription note receivable.
In June 1996 several officers and employees of the Company exercised
options to acquire 50,000 shares of the Company's common stock in exchange for
stock subscription notes receivable.
See notes to consolidated financial statements.
35
PICO PRODUCTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Pico
Products, Inc. and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
DESCRIPTION OF BUSINESS
Pico Products, Inc. and its subsidiaries (the "Company") design,
manufacture and distribute products and systems for the pay TV and cable TV
industry (CATV), broadband communications and other signal distribution markets.
These other distribution markets include "private" cable TV systems such as
those found in hotels, schools, hospitals and large apartment complexes.
Private cable systems are referred to in the industry as master antenna (MATV)
or satellite master antenna (SMATV) systems. These systems receive satellite
and "off-air" (or broadcast) signals at a single source known as the "headend".
The signals are processed and then distributed by coaxial or fiber optic cable
to the consumer. Also included in other signal distribution markets are
wireless cable or MMDS (multichannel multipoint distribution systems) and
business to business or direct-to-home (DTH) communications by satellite. The
Company also sells pay TV security products and home satellite market products.
Finally, the Company is pursuing development and introduction of broadband
communications products that will support high speed internet transmissions.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash equivalents,
accounts receivable, accounts payable, and debt instruments. The carrying
values of all financial instruments, other than the revolving line of credit,
are representative of their fair values due to their short maturities. The
estimated fair value of the revolving bank line of credit approximates fair
value because of its variable interest rate.
CONCENTRATION OF CREDIT RISK
Financial instruments which subject the Company to credit risk consist
primarily of accounts receivable. Concentration of credit risk with respect to
accounts receivable is generally diversified due to the
36
large number of entities comprising the Company's customer base and their
geographic dispersion. The Company performs ongoing credit evaluations of its
customers and maintains an allowance for potential credit losses.
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 and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventory costs consist of material, direct labor and overhead.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation and
amortization are provided for on the straight-line method over the estimated
useful lives of the assets as follows:
Buildings 20 years
Leasehold improvements Term of lease
Machinery and equipment 3 to 10 years
During the fiscal year ended July 31, 1995, approximately $878,000 of cost
and the related accumulated depreciation was removed from the accounting records
for fully depreciated assets no longer in use.
Repairs and maintenance costs not extending the useful life of the assets
are expensed in the year incurred. Betterments are capitalized.
PATENTS AND TRADEMARKS
Patents and trademarks are amortized on the straight-line method over the
shorter of their estimated useful lives or the remaining lives
37
of the patents and trademarks which at July 31, 1996 represented 16 to 27 years.
EXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED
The excess of the Company's purchase price of subsidiaries over the fair
market value of net assets acquired is being amortized on the straight-line
method over twenty years. The Company reviews the carrying value of all
intangible assets on a regular basis, and if the undiscounted future cash flows
are believed insufficient to recover the remaining carrying value of an
intangible asset, the carrying value is written down to its estimated fair value
in the period the impairment is identified.
REVENUE RECOGNITION
Revenue from sale of products or services is recognized when goods are
delivered or services performed. Reserves for estimated product returns are
provided at the time of sale.
DEBT ISSUANCE COSTS
Debt issuance costs are included in other noncurrent assets and are
amortized over the term of the related debt.
INCOME TAXES
Deferred income taxes reflect the net tax effects of (a) temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, and (b) operating loss
and tax credit carryforwards.
INCOME (LOSS) PER SHARE
Income (loss) per common and common equivalent share is based upon the
weighted average number of common shares outstanding during each year, assuming
exercise of dilutive outstanding stock options and warrants under the treasury
stock method. For the year ended July 31, 1996, common stock equivalents and
warrants were not included in the computations since their inclusion would be
anti-dilutive.
CERTAIN RECLASSIFICATIONS
The Company has made certain reclassifications to the 1995 and 1994
consolidated financial statements to conform to the classifications used in the
1996 consolidated financial statements.
38
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of." This statement,
which is effective for the Company's fiscal year ending July 31, 1997, requires
that long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In performing the review of
recoverability, the Company estimates the future cash flows expected to result
from the use of the asset and its eventual disposition. Management does not
expect the adoption of this new accounting standard to have a material impact on
the Company's financial statements.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" (SFAS 123) which will be effective for the Company in its fiscal
year ending July 31, 1997. SFAS 123 requires expanded disclosures of stock-
based compensation arrangements with employees and encourages (but does not
require) compensation cost to be measured based on the fair value of the equity
instrument awarded. Companies are permitted, however, to continue to apply APB
Opinion No. 25, which recognizes compensation cost based on the intrinsic value
of the equity instrument awarded. The Company will continue to apply APB
Opinion No. 25 to its stock-based compensation awards to employees and will
disclose the required pro forma effect on net income and earnings per share.
See Note L to these financial statements for disclosures regarding the Company's
Stock Incentive Plans.
B. INVENTORIES
The composition of inventories was as follows:
July 31,
-------------------------
1996 1995
----------- ----------
Raw materials $ 3,485,548 $3,350,435
Work in process 636,072 319,386
Finished goods 6,811,624 6,090,343
----------- ----------
$10,933,244 $9,760,164
----------- ----------
----------- ----------
C. NOTES PAYABLE
At July 31, 1996, the Company's Pico Macom, Inc. subsidiary (Pico Macom)
had a $11,000,000 revolving bank line of credit with HSBC Business Loans, a
member of the Hongkong and Shanghai Banking Corporation Group, which provides
for interest at the prime rate (8.25%
39
at July 31, 1996 and 8.75% at July 31, 1995) plus 1.25%. The bank line of
credit is used to fund operating expenses, product purchases and letters of
credit for import purchases. The line of credit is secured by substantially all
of Pico Macom's assets, including all trade accounts receivable and inventories.
The line is structured as a $11,000,000 line of credit with a sublimit of
$1,500,000 for outstanding letters of credit. The amount available is based on
various percentages of eligible accounts receivable and inventories as defined
in the agreement. At July 31, 1996, Pico Macom had $8,227,776 in revolving
loans and $72,677 in letters of credit outstanding, and the unused portion of
the borrowing base was $346,843.
The line of credit arrangement is subject to various terms and conditions,
including but not limited to, tangible net worth, working capital and current
ratio requirements; and contains certain restrictions on acquisitions, capital
expenditures and payment of dividends or purchases of stock. The line of credit
is subject to review and renewal on December 31, 1996.
At July 31, 1996, the Company was in technical violation of a financial
covenant relating to Pico Macom's bank revolving line of credit. This covenant
restricts the maximum advances to affiliates by Pico Macom. Pico Macom's bank
has issued a waiver of this violation effective July 31, 1996. All other
covenants relating to this line of credit were met as of July 31, 1996.
D. LONG-TERM DEBT
Long-term debt consisted of the following:
July 31,
--------------------------
1996 1995
----------- ----------
Notes payable to Bermuda-based and Jersey-
based investment funds, payable in equal
installments in fiscal 1996 and 1997,
with interest at 8.0% $ 250,000 $ 500,000
Capital lease obligations (Note E) 93,737 130,151
Other loans payable 6,763 10,908
----------- ----------
350,500 641,059
Less current portion 311,086 362,239
----------- ----------
$ 39,414 $ 278,820
----------- ----------
----------- ----------
40
In February 1993, the Company completed private placement financings
totaling $1,000,000. The financings consisted of three notes. The first note
for $500,000 was paid in full in May 1994. The second and third notes totaling
$500,000 provide for interest at 8% and were payable in two equal installments
in February 1996 and 1997. In connection with the financings, the Company
issued warrants for 425,000 shares of its common stock, exercisable through
fiscal year 1998 at $1.00 per share.
In February 1996, the Company was notified by the holder of the two
outstanding notes payable that they intended to exercise 250,000 warrants to
purchase common stock of the Company as an offset against the first $250,000
installment payment due on the debt. This transaction was completed in March
1996.
Long-term debt at July 31, 1996 is payable as follow:
Year ending July 31, 1997 $311,086
Year ending July 31, 1998 29,007
Year ending July 31, 1999 10,407
--------
$350,500
--------
--------
E. LEASE COMMITMENTS
The Company leases manufacturing, computer and office equipment under lease
agreements, some of which have been capitalized. These capitalized lease
obligations are payable in monthly and quarterly installments through fiscal
year 1999 and have interest rates varying from 10% to 18%. The Company has
included the cost of equipment under capital leases of $465,492 and $371,824 in
property, plant and equipment at July 31, 1996 and 1995, respectively.
Accumulated depreciation on such assets was $262,412 and $185,523 at July 31,
1996 and 1995, respectively.
The Company also leases certain of its manufacturing and office facilities
and equipment under operating lease agreements. Minimum rental commitments at
July 31, 1996 for these leases are as follows:
Capital Operating
--------- -----------
Year ending July 31, 1997 $ 65,340 $ 564,328
Year ending July 31, 1998 28,161 318,033
Year ending July 31, 1999 9,632 52,821
Year ending July 31, 2000 - 44,463
Year ending July 31, 2001 - 13,135
Thereafter - 9,690
--------- -----------
103,133 $1,002,470
Less imputed interest 9,396 -----------
--------- -----------
$ 93,737
---------
---------
41
Renewal options exist on certain of the operating leases for additional
periods at increased rental rates. Total rental expense for the years ended
July 31, 1996, 1995 and 1994 was $650,175, $507,739, and $461,656, respectively.
The Company is also required to pay real estate taxes and other occupancy costs
of the facilities in addition to the above rentals.
F. OTHER INCOME
Other income consisted of the following:
Year Ended July 31,
--------------------------------
1996 1995 1994
-------- -------- --------
Royalty income $ - $256,657 $606,985
Interest income 22,060 25,240 15,771
Miscellaneous income - - 26,558
-------- -------- --------
$ 22,060 $281,897 $649,314
-------- -------- --------
-------- -------- --------
The Company's patent for positive trapping systems expired in fiscal year
1995. Licenses issued for use of this patented technology generated the
Company's royalty income. At July 31, 1995, the Company had fully written off
the patent's cost and the related accumulated amortization from its books and
records.
G. INCOME TAXES
A reconciliation of the Company's income tax provision to that computed
using the Federal statutory rate is as follows:
Year Ended July 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
Federal tax (benefit)
based on statutory tax rate $(140,000) $ 198,000 $ 317,000
Nontaxable foreign
(income) loss 317,000 139,000 (63,000)
Other 1,000 31,000 20,000
Change in valuation
allowance (178,000) (368,000) (274,000)
Alternative minimum tax - 40,000 -
--------- --------- ---------
$ - $ 40,000 $ -
--------- --------- ---------
--------- --------- ---------
At July 31, 1996, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $14,696,000 which expire in
varying amounts from the year 2000 through the year 2008. Additionally, the
Company had federal tax credit carryforwards of
42
approximately $469,000 which expire in varying amounts from the year 1997
through the year 2001.
Neither U.S. nor foreign taxes have been provided on the cumulative
undistributed foreign earnings, $67,000 at July 31, 1996, due to exemptions from
foreign taxes, which expire in 1997 and 1998, and the intention of the Company
to permanently reinvest earnings
in the operations of foreign subsidiaries.
The following represents the tax effects of significant items comprising
the Company's deferred income taxes as of July 31, 1996 and 1995. The Company
recognized a valuation allowance to offset the net deferred tax asset since the
future benefit of these assets is not assured. The valuation allowance
decreased $178,000 and $368,000 in the years ended July 31, 1996 and 1995,
respectively, primarily due to the use of net operating losses to offset each
year's taxable income.
July 31,
--------------------------
1996 1995
------------ ------------
Deferred income tax assets:
Differences between book and
tax basis of property $ 92,000 $ 48,000
Reserves not currently deductible 385,000 493,000
Other 49,000 59,000
Operating loss carryforwards 5,730,000 5,773,000
Tax credit carryforwards 469,000 530,000
------------ ------------
6,725,000 6,903,000
Valuation allowance (6,725,000) (6,903,000)
------------ ------------
Net deferred income taxes $ -0- $ -0-
------------ ------------
------------ ------------
H. PRODUCT DEVELOPMENT COSTS
Product development costs are expensed as incurred and are included as part
of selling and administrative expenses. Expenses related to product development
for the years ended July 31, 1996, 1995 and 1994 amounted to approximately
$1,368,000, $979,000, and $545,000, respectively.
I. SIGNIFICANT CUSTOMERS
In fiscal 1996, 1995 and 1994 the Company's sales to one customer were
approximately 16%, 20%, and 16%, respectively, of the Company's consolidated
sales.
43
J. RETIREMENT BENEFITS
During fiscal year 1994, the Company established a defined contribution
pension plan (under Internal Revenue Code Section 401(k)) covering substantially
all of its U.S. -based employees with more than one year of service. Company
contributions are determined at 50% of each employee's voluntary contribution
(up to 6% of compensation) to the plan. The Company's contribution expense
totaled $77,856, $63,958 and $37,385 for the years ended July 31, 1996, 1995 and
1994, respectively.
K. OTHER STOCK OPTIONS
During fiscal year 1994, the Board of Directors issued nonqualified,
nonplan options to two individuals. These options were issued in November 1993
and became exercisable in November 1994. A total of 30,000 options were issued
at an average exercise price of $1.29 per share. The Company recognized
compensation expense of $12,292 and $33,958 during fiscal year 1995 and fiscal
year 1994, respectively, for the difference between the fair value of the stock
options at the date of the grant and the exercise price of the options.
L. STOCK INCENTIVE PLANS
The Company has three stock incentive plans; the 1981 Non-Qualified Stock
Option Plan (1981 Plan) amended in December, 1991 and in December 1995; the 1982
Incentive Stock Option Plan (1982 Plan) adopted in April 1982; and the 1992
Incentive Stock Plan (1992 Plan), adopted in January, 1993 and amended in July,
1994. The 1981 Plan reserved 450,000 common shares for issuance, the 1982 Plan
reserved 150,000 shares for issuance, and the 1992 Plan reserves 175,000 common
shares for issuance. Each plan is administered by the Board of Directors, or a
special committee thereof, which has the authority to determine the persons, the
shares and the related terms and provisions of the incentives which may be
granted.
Under the 1981 Plan, the option exercise price could not be less than 80%
of the fair market value of the shares at the date of grant. Under the 1982
Plan, the option exercise price could not be less than 100% (or 110% if the
optionee owned 10% or more of the Company's outstanding voting securities) of
the fair market value of the shares at the date of grant. Options under the
1981 Plan and the 1982 Plan could not be exercised more than five years and ten
years, respectively, from the date of grant. The 1982 Plan provided limitations
on the number of option shares which may be granted to officers and directors.
In both plans, options became exercisable as specified in the option agreement,
subject to the limitation that no option could be exercised within twelve months
after the date it is granted. The 1982 Plan provided that no incentive stock
options could
44
be granted after April 28, 1992, and the 1981 Plan provided that no non-
qualified stock options could be granted after May 31, 1996.
Under the 1992 Plan, incentive stock options ("ISO"), nonqualified stock
options ("NSO"), stock appreciation rights ("Rights") and stock awards
("Awards") may be granted to eligible persons. The Board of Directors, or a
committee thereof, determines the option prices and vesting periods for all
options granted; however, options may not be exercised less than one nor more
than ten years from the date of grant. The option exercise prices for ISO's
must be at 100% of the fair market value of the shares at the date of grant to
comply with tax regulations. The 1992 Plan specified that each director who is
not also an employee of the Company or any of its affiliates would be awarded an
annual grant of 5,000 NSO's at an option price equal to 80% of the fair market
value on the date of grant. During fiscal year 1994, the Board of Directors
amended the plan by reducing the annual grant to directors to 2,000 NSO's with
option prices and vesting provisions consistent with all other plan options.
During fiscal year 1994, the Board of Directors also determined that NSO's would
be granted at 100% of the fair market value of the shares at the date of grant.
Rights may be granted to holders of stock options outstanding under the
1981 Plan, the 1982 Plan, or the 1992 Plan, whereby the holder of such
options, in exchange for the surrender of the options to the Company, will
receive from the Company an amount equal to the excess of the fair market
value of the related shares over the option price of the options surrendered.
Awards may be granted to selected recipients, without payment therefore, as
additional compensation for their services to the Company or its affiliates.
Any awards will be subject to various terms and conditions as determined by
the committee.
In June 1996, the Board of Directors of the Company rescinded the
amendment to the 1981 Plan which provided for extending the expiration date
from five years to ten years for options granted under the Plan. This
amendment had been approved by the shareholders in December 1995. At the
same time the Board, subject to shareholder approval in December 1996,
established a 1996 Incentive Stock Option Plan covering 195,000 shares of
common stock. The proposed 1996 Plan is identical in substance to 1992 Plan.
At the same time 120,000 non-qualified option grants were approved by the
compensation committee subject to approval of the 1996 Plan by the
shareholders. Each option granted has an exercise price equal to the fair
market value of the stock as of the grant date and vests ratably over a
three-year period and is conditioned upon achievement of an $8.00 level in
the price of the Company's common stock over a consecutive 20 trading-day
period.
In April 1996 an officer of the Company exercised options to acquire
125,000 shares of the Company's common stock in exchange for a stock
subscription note receivable. In June 1996 several officers and employees of
the Company exercised options to acquire 50,000 shares of
45
the Company's common stock in exchange for stock subscription notes receivable.
46
A summary of changes in shares under option for the Company's three stock
incentive plans is as follows:
Year Ended July 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
NON QUALIFIED PLAN (1981):
Outstanding at beginning of year 410,000 408,500 417,000
Options granted 10,500 6,500 31,500
Options expired (10,500) - (5,000)
Options exercised (120,000) (5,000) (35,000)
--------- --------- ---------
Outstanding at end of year * 290,000 410,000 408,500
--------- --------- ---------
--------- --------- ---------
Exercisable at end of year * 268,670 370,000 351,000
--------- --------- ---------
--------- --------- ---------
Average exercise price of
outstanding options $ 0.95 $ 0.83 $ 0.80
--------- --------- ---------
--------- --------- ---------
Average exercise price of
exercisable options $ 0.87 $ 0.75 $ 0.71
--------- --------- ---------
--------- --------- ---------
INCENTIVE PLAN (1982):
Outstanding at beginning of year 45,200 45,200 60,000
Options exercised (45,200) - (14,800)
--------- --------- ---------
Outstanding at end of year - 45,200 45,200
--------- --------- ---------
--------- --------- ---------
Exercisable at end of year - 45,200 45,200
--------- --------- ---------
--------- --------- ---------
Average exercise price of
outstanding options $ - $ 0.31 $ 0.31
--------- --------- ---------
--------- --------- ---------
Average exercise price of
exercisable options $ - $ 0.31 $ 0.31
--------- --------- ---------
--------- --------- ---------
STOCK PLAN (1992)
(Nonqualified options)
Outstanding at beginning of year 114,000 45,000 15,000
Options granted 23,500 69,000 35,000
Options expired (2,500) - -
Options exercised - - (5,000)
--------- --------- ---------
Outstanding at end of year 135,000 114,000 45,000
--------- --------- ---------
--------- --------- ---------
Exercisable at end of year 58,832 28,000 10,000
--------- --------- ---------
--------- --------- ---------
Average exercise price of
outstanding options $ 2.19 $ 2.29 $ 1.16
--------- --------- ---------
--------- --------- ---------
Average exercise price of
exercisable options $ 1.85 $ 1.13 $ 1.00
--------- --------- ---------
--------- --------- ---------
47
* Includes options to acquire 175,000 shares of the Company's common stock
which were exercised in exchange for stock subscription notes receivable
during fiscal year 1996.
48
M. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
The majority of the SMATV electronic components sold by Pico Macom are
manufactured under contract on an exclusive basis by one subcontractor in
Taiwan. The Company is committed to procure a minimum of approximately
$12,875,000 of products from this subcontractor through fiscal year 1998.
Management believes that the Company's relationship with this subcontractor is
excellent and that the financial strength of the subcontractor is strong.
However, the loss of this subcontractor could have a material adverse impact on
the Company's operations until the Company could obtain an alternative source of
supply. The contract does not require the subcontractor to maintain a parts
inventory, so that from time-to-time delays are possible in completing customer
orders. The current contract expires in May 1998 and management anticipates
renewing the contract prior to its expiration. Most of the other products
obtained from foreign-based vendors are available from a number of different
subcontractors.
ARCOM LITIGATION
In November 1991, Arrow Communication Laboratories, Inc. (Arcom) of
Syracuse, New York initiated a lawsuit in the New York Supreme Court, which, as
amended, alleged that Arcom had a paid-up license with respect to the Company's
patent for positive trapping systems and that Arcom was entitled to unspecified
damages based on overpayment of royalty amounts. Arcom also claimed that it was
entitled to compensatory damages in excess of $250,000, plus punitive damages of
$3,000,000, as a result of a Company press release announcing termination of the
license agreement.
The Company initiated a patent infringement suit against Arcom in the United
States District Court for the Northern District of New York, which sought treble
damages for willful infringement plus attorneys fees. The Company requested
that the Court grant a preliminary injunction to prevent Arcom from infringing
its patent. At a Court hearing in February 1994, the parties agreed, and it was
ordered by the Court, that Arcom would post as security amounts equal to the
royalties due to the Company for the manufacture and sale of product covered by
the license agreement from December 15, 1991, the date that the license would
have terminated, until the expiration of the patent in February 1995. Through
July 31, 1995 Arcom had made cash payments of $462,066 covering royalties
through February 14, 1995. The Company did not include these amounts in income
in any fiscal period but recorded a current liability for $462,066 at July 31,
1995. In addition, Arcom agreed to post an irrevocable letter of credit in an
amount deemed sufficient to permit recovery of a significant portion of the
Company's
49
damages if it were to prevail on its willful infringement claim. In exchange,
the Company withdrew its request for a preliminary injunction.
In May, 1996, the Company and Arcom agreed to settle the foregoing
lawsuits, pursuant to which all suits were terminated and dismissed with
prejudice. As part of this agreement, the Company and Arcom, respectively,
granted each other full releases from liability, the Company released certain
deposits and other collateral provided to the Company by Arcom during the
litigation, and the Company reimbursed Arcom approximately $70,000 for certain
fees and expenses.
EPA INFORMATION REQUEST
In March 1995, a subsidiary of the Company received a Joint Request for
Information (the "Information Request") from the United States Environmental
Protection Agency, Region II (the "EPA"), under the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended ("CERCLA"), with
respect to the release and/or threatened release of hazardous substances,
hazardous wastes, pollutants or contaminants into the environment at the
Onondaga Lake Site, Syracuse, Onondaga County, New York. The Company has
learned that the EPA added the Onondaga Lake Site to the Superfund National
Priorities List on December 6, 1994 and has completed an onsite assessment of
the degree of hazard. The EPA has indicated that the Company is only one of 26
companies located in the vicinity of Onondaga Lake or its tributaries that have
received a similar Information Request.
The Information Request related to the activities of the Company's Printed
Circuit Board Division, which conducted operations within the specified area,
and was sold to a third party in 1992. Under the Agreement of Sale with the
buyer, the Company retained liability for environmental obligations which
occurred prior to the sale.
The Company has provided all information requested by the EPA. The
Information Request does not designate the Company as a potentially responsible
party, nor has the EPA indicated the basis upon which it would designate the
Company as a potentially responsible party. The Company is therefore unable to
state whether there is any material likelihood for liability on its part, and,
if there were to be any such liability, the basis of any sharing of such
liability with others.
OTHER
The Company is involved, from time to time, in certain other legal actions
arising in the normal course of business. Management believes that the outcome
of other litigation will not have a material adverse effect on the Company's
consolidated financial statements.
50
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Additions
Balance charged to Balance
beginning cost and end of
Description of period expenses Deduction* Period
- ----------- --------- -------- ---------- ------
Fiscal Year Ended July 31, 1994:
Allowance for
doubtful accounts $250,000 $246,602 $201,602 $295,000
Fiscal Year Ended July 31, 1995:
Allowance for
doubtful accounts $295,000 $142,897 $147,897 $290,000
Fiscal Year Ended July 31, 1996:
Allowance for
doubtful accounts $290,000 $143,769 $233,769 $200,000
* Write-off of uncollectible accounts receivable and other adjustments.
51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
52
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information called for by this item is incorporated by reference to the
Company's Proxy Statement for its 1996 annual meeting of shareholders which will
be filed prior to November 28, 1996.
ITEM 11. EXECUTIVE COMPENSATION.
The information called for by this item is incorporated by reference to the
Company's Proxy Statement for its 1996 annual meeting of shareholders which will
be filed prior to November 28, 1996.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information called for by this item is incorporated by reference to the
Company's Proxy Statement for its 1996 annual meeting of shareholders which will
be filed prior to November 28, 1996.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for by this item is incorporated by reference to the
Company's Proxy Statement for its 1996 annual meeting of shareholders which will
be filed prior to November 28, 1996.
53
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. The following consolidated financial statements are included in
Part II Item 8:
Independent Auditors' Report
Consolidated Balance Sheets as of July 31, 1996 and 1995
Consolidated Statements of Operations for the Years Ended
July 31, 1996, 1995 and 1994
Consolidated Statements of Shareholders' Equity for the Years Ended
July 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years Ended
July 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
2. The following consolidated financial statement schedule should be read
in conjunction with the consolidated financial statements set forth in
Part II Item 8:
Valuation and Qualifying Accounts
All other schedules called for under Regulation S-X are not submitted
because they are not applicable or not required or because the
required information is not material or is included in the
consolidated financial statements or notes thereto.
3. See Index to Exhibits for a list of exhibits to this Annual Report.
(b) Reports on Form 8-K.
None.
54
(c) INDEX TO EXHIBITS
3(a)e Restated Articles of Incorporation of the Company, as amended on
December 17, 1987
(b)e By-Laws of the Company, as amended on December 17, 1987 and as
currently in effect
4(a)b 1981 Non-Qualified Stock Option Plan
(b)a 1982 Incentive Stock Option Plan
(c)i 1992 Incentive Stock Plan
(d)j Warrant Certificates issued to Scimitar Development Capital Fund and
Scimitar Development Capital "B" Fund, dated February 10, 1993
(e)k Warrant Certificate issued to City National Bank, dated
February 10, 1993
(f)m Amendment to 1992 Incentive Stock Plan
(g)r Amendment to 1981 Non-Qualified Stock Option Plan
10(a)f The Company's product warranties
(b)c Pico (St. Kitts) Limited lease on Pond Pasture Industrial Estate,
Basseterre, St. Christopher and Nevis
(c)d Pico Macom, Inc. lease on approximately 60,000 square feet of building
at 12500 Foothill Blvd., Lakeview Terrace, California
(d)g Amendment to Pico Macom, Inc. lease of building at 12500 Foothill
Blvd., Lakeview Terrace, California
(e)e Lease on office of Pico Macom Taiwan Co. Ltd.
(f)g Exclusive Manufacturing Agreement between Pico Macom, Inc. and Good
Mind Industries, dated April 26, 1989
(g)h Employment Agreement between Pico Macom, Inc. and George M. Knapp,
dated June 19, 1992
See page 57 for Key to Index for Exhibits.
55
(c) INDEX TO EXHIBITS (continued)
(h)k Pico Products, Inc. 8% Subordinated Notes Payable to Scimitar
Development Capital Fund and Scimitar Development Capital "B" Fund,
dated February 10, 1993
(i)k Amendment to Exclusive Manufacturing Agreement between Pico Macom,
Inc. and Good Mind Industries (dated April 26, 1989) - amendment dated
April 27, 1993
(j)l Loan and Security Agreement between Pico Macom, Inc. and Marine
Midland Business Loans, Inc. dated May 25, 1994
(k)n Employment Agreement between Pico Products, Inc. and Joseph T.
Kingsley, dated January 1, 1995.
(l)o Employment Agreement between Pico Macom, Inc. and Norman Reinhardt,
dated March 22, 1995.
(m)o Amendment to the Exclusive Manufacturing/Marketing Agreement between
Pico Macom, Inc. and Goodmind Industries (dated April 26, 1989) -
amendment dated April 10, 1995.
(n)p Amendments to the Loan and Security Agreement between Pico Macom, Inc.
and Marine Midland Business Loans, Inc. dated May 25, 1994 -
amendments dated April 27, 1995 and May 18, 1995.
(o)p Employment Agreement between Pico Products, Inc. and Everett T. Keech,
dated September 22, 1995.
(p)q Amendment to Pico Macom, Inc. lease of building at 12500 Foothill
Boulevard, Lakeview Terrace, California - amendment dated
November 9, 1995.
(q)r Amendment No. 3 to the Loan and Security Agreement between Pico Macom,
Inc. and Marine Midland Business Loans, Inc. dated May 25, 1994 -
amendment dated December 20, 1995.
11.1 Computation of Per Share Earnings.
22(a) Subsidiaries of the Company are listed in the Table at the
end of Item 1
24(a) Independent Auditors' Consent
27 Financial Data Schedule (included only in the EDGAR filing).
See next page for Key to Index of Exhibits.
56
KEY TO INDEX OF EXHIBITS
a Previously filed by the Company as an exhibit to the Company's Registration
Statement on Form S-1, File No. 2-77439 and incorporated by reference.
b Previously filed by the Company as an exhibit to the Company's Registration
Statement on Form S-18, File No. 2-72318 and incorporated by reference.
c Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1983 and incorporated by reference.
d Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1985 and incorporated by reference.
e Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1988 and incorporated by reference.
f Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1990 and incorporated by reference.
g Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1991 and incorporated by reference.
h Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1992 and incorporated by reference.
i Previously filed by the Company as an exhibit to the Company's Form 10-Q
for the fiscal quarter ended January 31, 1993 and incorporated by
reference.
j Previously filed as exhibits to Schedule 13D, dated February 16, 1993,
filed by Standard Chartered Equitor Trustee CI Limited, Scimitar
Development Capital Fund and Scimitar Development Capital "B" Fund, and
incorporated by reference.
k Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1993 and incorporated by reference.
57
KEY TO INDEX OF EXHIBITS (continued)
l Previously filed by the Company as an exhibit to the Company's Form 10-Q
for the fiscal quarter ended April 30, 1994 and incorporated by reference.
m Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1994 and incorporated by reference.
n Previously filed by the Company as an exhibit to the Company's Form 10-Q
for the fiscal quarter ended January 31, 1995 and incorporated by
reference.
o Previously filed by the Company as an exhibit to the Company's Form 10-Q
for the fiscal quarter ended April 30, 1995 and incorporated by reference.
p Previously filed by the Company as an exhibit to the Company's Form 10-K
for the fiscal year ended July 31, 1995 and incorporated by reference.
q Previously filed by the Company as an exhibit to the Company's Form 10-Q
for the fiscal quarter ended October 31, 1995 and incorporated by
reference.
r Previously filed by the Company as an exhibit to the Company's Form 10-Q
for the fiscal quarter ended January 31, 1996 and incorporated by
reference.
Copies of all exhibits incorporated by reference are available at no charge
by written request to Assistant Corporate Secretary, Pico Products, Inc., 12500
Foothill Blvd., Lakeview Terrace, California 91342.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Pico Products, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: October 24, 1996
PICO PRODUCTS, INC.
By: /s/ Everett T. Keech By: /s/ Joseph T. Kingsley
--------------------------------- ---------------------------------
Everett T. Keech Joseph T. Kingsley
Chairman of the Board Principal Financial &
(Principal Executive Officer) Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of Pico Products, Inc.
and in the capacities and on the dates indicated.
/s/ Everett T. Keech /s/ Charles G. Emley, Jr.
- --------------------------------- ---------------------------------
Everett T. Keech Charles G. Emley, Jr.
Chairman of the Board Director
October 24, 1996 October 24, 1996
/s/ David Heenan /s/ George M. Knapp
- --------------------------------- ---------------------------------
David Heenan George M. Knapp
Director Director
October 24, 1996 October 24, 1996
/s/ E.B. Leisenring, Jr. /s/ Pierson G. Mapes
- --------------------------------- ---------------------------------
E.B. Leisenring, Jr. Pierson G. Mapes
Director Director
October 24, 1996 October 24, 1996
/s/ William W. Mauritz /s/ J. Michael Sills
- --------------------------------- ---------------------------------
William W. Mauritz J. Michael Sills
Director Director
October 24, 1996 October 24, 1996
59
FORM 10-K
YEAR ENDED JULY 31, 1996
EXHIBITS
- --------------------------------------------------------------------------------
11.1 Computation of Per Share Earnings
24(a) Independent Auditors' Consent
27 Financial Data Schedule (included only in the EDGAR filing).