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). For the fiscal year ended July 31, 1997.
OR
( ) Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
Commission File Number 1-8342
PICO PRODUCTS, INC.
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(Exact name of registrant as specified in its charter)
NEW YORK 15-0624701
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
12500 Foothill Blvd., Lakeview Terrace, CA 91342
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (818) 897-0028
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
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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
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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. ( )
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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 30, 1997, was $ 6,319,552.
Excluded from this value were shares held by officers and directors of the
Registrant.
The number of the Registrant's common shares outstanding at October 31,
1997, was 4,185,913.
DOCUMENTS INCORPORATED BY REFERENCE:
Definitive Proxy Statement to be filed pursuant to Regulation 14A in
connection with the 1997 annual meeting of shareholders of the Registrant.
Index to Exhibits is at page 58.
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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 and
services that will support high speed internet transmissions. In general, the
Company is a solutions provider to TV system operations and suppliers engaged
in the the convergence of voice, video, text and data transmissions.
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
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,
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processed and amplified 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 a 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 a 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. In Thailand, SMATV and wireless systems are currently being
developed in Bangkok.
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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.
Most of the large CATV companies are currently expanding their systems and
offering more channels.
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, albeit, with some degradation of
picture quality. 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 or their ISDN
service at 128 Kb.
This combination of technological advances and the removal of regulatory
barriers has created substantial opportunities to provide both CATV and other
telecommunications companies with products and services in support of delivering
large amounts of digital data to the home. With more bandwidth available, more
broadband 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.
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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 and consolidations have
occurred such as, the recent $1 billion dollar investments of Microsoft in
Comcast and U.S. West Continental Cablevision Division.
Deregulation has important implications for the cable TV industry. This in
turn presents major potential new opportunities for the Company in the U.S. 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 many metropolitan areas.
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, the largest cable providers and
information technology companies can afford to make this investment. However,
the
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pace of investment in new technology will be determined largely by the
willingness of consumers to pay for new information or interactive services.
MARKETING AND SALES
Prior to January 1997, the Company sold its products through two distinct
sales groups, Pico Macom Inc.(a wholly-owned subsidiary of the Company) and the
CATV Division. In a effort to improve customer service and reduce costs, the
Company consolidated these sales forces into one group in January 1997.
The Company 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. The Company's headend products are manufactured under contract
on an exclusive or OEM 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 the Company's
specifications by a number of subcontract manufacturers in Taiwan. The Company
maintains tight quality control supervision of these manufacturers through on-
site inspections.
Products for the U.S. market are shipped to the Company's warehouse in
California. In some cases, there is additional assembly and tuning or testing
of products before shipment.
The primary business focus for the Company has been on the development and
positioning of its line of headend equipment, 1 GHz product lines and 2 GHz
satellite products. 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 few
years. As the technical needs of the CATV, SMATV and MMDS industries have
grown, the Company's product line has been improved through the use of surface
mount technology (SMT) 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 the Company
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
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components which are used to wire multiple dwelling units. CATV operators
purchase components through a newly created direct sales force.
The Company 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. The Company currently uses industry trade
shows and targeted advertising to market its products.
The Company also 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 Company 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 water or water vapor
migration into the trap.
The Company 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.
The primary market for Pay TV security products is the cable television or
CATV industry in the U.S., although sales to Taiwan and South America have
increased during the past several years. The major customers are the U.S.
multiple system operators (MSO's) such as
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Adelphia, Comcast, Cox, Media One, Time Warner, and TCI. The top 25 MSO's
constitute about 80% of the potential market.
The Company has developed specialized noise blocking filters that the CATV
Industry is using for telephone, Internet and data delivery to customer homes.
These filters incorporate SMT technologies. One version, the HPF-02 mini, has
been very successful in terms of sales volume and technical performance.
Variations of the type of noise blocking filters are anticipated during the
first half of fiscal year 1998 as CATV companies define their unique
requirements.
The Company's sales to American Technology Exporters, Inc. in Miami,
Florida ("Amtech") were approximately 9%, 16% and 20% of consolidated sales for
the years ended July 31, 1997, 1996 and 1995, 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 penalty. The backlog of purchase
orders as of July 31, 1997 and July 31, 1996 was approximately $3,316,000 and
$4,608,000, respectively. These purchase orders were believed to be firm, and
the Company expects to fill the July 31, 1997 backlog within its 1998 fiscal
year.
The largest dollar volume sales are of the Company's active electronic
equipment items used in headend 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-".
FOREIGN OPERATIONS
The Company owns and operates a manufacturing facility on the island of St.
Kitts (St. Christopher and Nevis) in the Caribbean Sea. Pico (St. Kitts)
Limited assembles the circuit boards for the Company's positive, negative and
tier traps, and is a manufacturing source for the HPF-O2 mini filter used in
two-way cable TV systems.
The Company 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 Company opened an office in Thailand in October 1995. In an
effort to better serve the Far East market and reduce costs, the Company has
decided to close its offices in both Hong Kong and Thailand. All sales activity
in Asia will be handled through a new distributor based in Hong Kong.
At July 31, 1997 the assets located outside the United States constituted
less than 10% of the Company's total assets and the
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revenues and operating expenses attributable to the Company's foreign
operations were also less than 10% of the Company's revenues and
expenses.
MANUFACTURERS AND SUPPLIERS
Approximately 58% 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, and Thailand. For
more than ten years, the SMATV electronic components sold by the Company have
been manufactured under contract on an exclusive basis by one subcontractor in
Taiwan and China. 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 and high-pass
filters. 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 21% of products sold are primarily items purchased from
domestic subcontractors for resale.
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.
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PRODUCT DEVELOPMENT
Product development costs are expensed as incurred. Expenses allocated to
product development for the years ended July 31, 1997, 1996 and 1995 totaled
approximately $1,340,000, $1,368,000, and $979,000, 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, $0, and $257,000
during fiscal 1997, 1996 and 1995, 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. In 1997, the Company
was awarded an expanded version of the patent, thus allowing for wider
application in 1 GHz 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 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, 1997, direct costs associated
with the warranties have been minimal.
EMPLOYEES
At July 31, 1997, the Company employed 370 persons, of whom 33 were engaged
in administration and accounting, 14 in engineering and quality control, 27 in
sales and marketing, and the remainder in production, purchasing and shipping.
None of the Company's employees are represented by labor unions.
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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
totaling 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 planned through alliances with Asian-based distributors. 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.
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TABLE OF COMPANY'S SUBSIDIARIES
Name Jurisdiction of Year Incorporated Active (A)
Incorporation Inactive (I)
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Pico Macom, Inc. Delaware 1983 A (1)
Pico Macom Taiwan Taiwan 1987 A (2)
Co. Ltd.
Pico (St. Kitts) St. Christopher 1983 A (1)
Ltd. and Nevis
Pico (Bermuda) Bermuda 1994 A (1)
Ltd.
Pico Products Asia Hong Kong 1994 A (3)
Ltd.
Pico Siam Thailand 1996 A (2)
Company Limited
PicoMacom Brazil 1996 A (2)
Productos de
Telecommunicacao,
Ltda
Pico (St. Vincent) St. Vincent and 1981 I (1)
Ltd. the Grenadines
Pico Satellite, Delaware 1983 I (1)
Inc.
Pico Cargo, Inc. Delaware 1983 I (1)
Pico Korea, Ltd. Korea 1985 I (2)
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Notes: (1) Subsidiary of Pico Products, Inc.
(2) Subsidiary of Pico Macom, Inc.
(3) Subsidiary of Pico (Bermuda) Limited.
Ownership percentage in all cases exceeds 90%.
At July 31, 1997, no operational activities were performed by the following
subsidiaries: Pico (St. Vincent) Ltd., Pico Satellite, Inc., Pico Cargo, Inc.
and Pico Korea, Ltd.
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ITEM 2. PROPERTIES
The Company presently owns or leases an aggregate of approximately 85,000
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 and the Company anticipates
negotiating renewal at this time. 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 in West Conshohocken,
Pennsylvania. The lease expires in October, 2000. The net annual rent is
approximately $43,000. The Company is obligated to provide this office to its
former chairman through December 1997, at which time the Company intends to sub-
lease the office.
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 $86,000. The
lease expires in July, 1998. At July 31, 1997, the Company decided to close its
Hong Kong office. This lease was assumed by a third-party on November 1, 1997.
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 1998 and the Company currently anticipates renewing it
at that time.
Management believes that the above-described properties are sufficient for
the Company's present needs.
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ITEM 3. LEGAL PROCEEDINGS
EAGLE LITIGATION
On July 30, 1997, Eagle Comtronics, Inc. ("Eagle") filed a motion in the
United States District Court for the Northern District of New York to amend the
complaint for patent infringement it had filed in 1979 against the Company.
This 1979 action had been settled by Consent Judgment in 1988, pursuant to which
the Company and Eagle entered into a License Agreement providing for specified
royalty payments from Eagle to the Company. Eagle's motion sought the District
Court's permission to proceed against the Company under various legal theories
for breach of the License Agreement, based on Eagle's allegation that the
Company, in violation of the License Agreement's "most favored nation" clause,
granted a license to a third party (Arrow Communication Laboratories, Inc.) on
more favorable terms than those provided to Eagle. Eagle sought damages of
approximately $1,600,000 plus interest and attorneys fees. The Company believed
that Eagle's motion was procedurally improper and that, even if the amended
complaint were allowed by the District Court, it had meritorious defenses to the
claims stated in the amended complaint.
The Company responded to Eagle's motion, and Eagle promptly withdrew the
motion to file an amended complaint. At the same time Eagle filed a complaint
in New York State Supreme Court similar to the proposed amended federal
complaint. Management believes that the Company has meritorious defenses to
Eagle's action and that such suit will not have any material adverse effect on
the Company.
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
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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 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 learned
that the EPA added the Onondaga Lake Site to the Superfund National Priorities
List in December 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 was sold to a third party in 1992, and which
conducted operations within the specified area. 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.
16
In March 1997, the Company received a follow-on request for additional
information in this matter and has provided all information requested.
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, 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
Fiscal Year Ended July 31, 1997:
First Quarter......................... 2 5/16 1 3/4
Second Quarter........................ 2 3/8 1 3/8
Third Quarter......................... 2 1/16 1 1/16
Fourth Quarter........................ 1 1/2 7/8
August 1, 1997 to September 30, 1997... 1 3/4 1 1/8
As of September 30, 1997, there were approximately 2,000 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, 1997. 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, 1997
---------------------------------------------
1997 1996 1995 1994 1993
1) STATEMENT OF OPERATIONS DATA:
Sales $35,448 $36,051 $33,367 $29,886 $23,740
Income (loss) from
operations $(4,502) $ 534 $ 997 $ 799 $ (225)
Net income (loss) $(5,887) $ (400) $ 526 $ 905 $ (277)
Net income (loss) attributable
to common stock $(5,972) $ (400) $ 526 $ 905 $ (277)
Net income (loss) attributable
to common stock per common
and common equivalent share -
primary and fully diluted $ (1.45) $ (0.11) $ 0.12 $ 0.21 $ (0.08)
Weighted average common and common
equivalent shares outstanding -
primary and fully diluted 4,113 3,798 4,240 4,295 3,577
2) BALANCE SHEET DATA:
Working capital $ 3,362 $ 3,124 $ 3,497 $ 3,151 $ 2,180
Total assets $19,896 $17,945 $17,633 $13,853 $11,592
Long-term debt $ 4,915 $ 39 $ 279$ 632 $ 32
Redeemable preferred stock $ 917 $ - $ - $ - $ -
Shareholders' equity (deficiency) $ (817) $ 4,456 $4,513$ 3,961 $ 3,009
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, 1997 were $35.4 million
compared to $36.1 million for the prior year, a decrease of 2%. The
Company's Pico Macom subsidiary recorded a sales decrease of approximately
$449,000, or 2%, compared to the prior year. This decrease was primarily due
to severe competition from U.S.-based distributors of Satellite Master
Antenna Television (SMATV) products in South America. Management is working
diligently to recapture lost market share through competitive pricing and the
customer support of the Company's Brazilian sales and marketing office which
was opened in November 1996. However, management believes that the reduced
level of sales into South America will continue into the first half of fiscal
year 1998. The decrease in Pico Macom's sales into South America during
fiscal year 1997 was partly offset by an increase in sales into the Middle
East of over $1.4 million compared to the prior fiscal year. This included a
contract worth over $1 million to supply components for a cable TV system on
the Seychelles Islands. A majority of the contract was supplied as of July
31, 1997.
The Company's CATV division recorded a sales decrease of approximately
$110,000, or 2%, in fiscal year 1997 compared to the prior year. This
decrease was mainly due to an industry-wide downturn in demand for single
channel pay TV decoders. However, most of this decline was offset by sales
of the Company's new high pass filter used in two-way interactive
communications systems. This product was introduced early in fiscal year
1997, and sales of this product have remained strong into the first quarter
of fiscal year 1998. The Company's Hong Kong subsidiary recorded a slight
sales decrease in fiscal year 1997 compared to the prior year. Based on the
disappointing sales performance of the Hong Kong subsidiary, management
decided to close down its Hong Kong office effective July 31, 1997 and
transition to in-country distribution of its products into the Far East.
Sales for fiscal year 1997 were substantially below the Company's
targeted sales levels. This shortfall has resulted in a continued inventory
buildup at July 31, 1997 which has put a strain on the Company's financial
position. Management is addressing this problem through an expansion of its
sales and marketing efforts and a focused inventory reduction program.
However, management believes that overall sales in the first quarter of
fiscal year 1998 will fall short of the sales level of the first quarter of
fiscal year 1997.
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
20
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.
COST OF SALES
Cost of sales increased by approximately $3.1 million, or 11%, for the
fiscal year ended July 31, 1997 compared to the previous year. Cost of sales
as a percentage of sales increased from 76% in fiscal year 1996 to 86% for
fiscal year 1997. The dollar increase in cost of sales and the increase in
cost of sales as a percentage of sales was primarily due to over $2 million
of reserves for slow moving and obsolete inventory. Additionally, the
Company faced severe price competition both domestically and in South America
which resulted in price reductions for many of the Company's products.
Startup costs related to initial manufacturing of some of the Company's new
products also impacted costs. Finally, cost of sales was impacted unfavorably
by the lower margins generated by the sales of third-party products by the
Company's Hong Kong subsidiary.
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 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.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses increased by approximately $1.3
million, or 16%, in fiscal year 1997 compared to the prior year. The primary
reasons for the increase were an expansion of the Company's sales and
marketing activities worldwide and approximately $900,000 of restructuring
costs recorded at July 31, 1997. The restructuring costs include the closing
of the Company's Hong Kong office and transition to in-country distribution
to sell the Company's products in the Far East, as well as a contract
settlement with the Company's former chairman and chief executive officer.
Management expects selling and administrative expenses to decline in fiscal
year 1998 due to cost savings associated with the closing of the Hong Kong
office.
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
21
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.
PRODUCT DEVELOPMENT
Product development expenditures for fiscal years 1997, 1996, and 1995
were approximately $1,340,000, $1,368,000, and $979,000 respectively. These
amounts are included in the selling and administrative expenses totals
mentioned previously. The product development efforts during fiscal years
1995 through 1997 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 incorporate 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 comparable
levels of product development expenses.
OTHER INCOME
Other income decreased by approximately $9,000, or 39%, for fiscal year
1997 compared to the prior year. The decrease in other income was due to
lower interest income in fiscal year 1997 as most of the Company's short-term
investments were liquidated during the prior year.
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.
INTEREST EXPENSE
Interest expense increased by approximately $443,000, or 46%, for fiscal
year 1997 compared to the prior year. The increase in interest expense was
due to higher borrowing levels on the Company's bank line of credit and
interest on the $5 million subordinated debt financing completed in November
1996. Higher than forecast inventory levels required greater borrowing
levels throughout fiscal year 1997.
22
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.
INCOME TAX PROVISION
No provision for U.S. Federal and state regular income taxes or foreign
income taxes have been recorded for fiscal year 1997, fiscal year 1996 or
fiscal year 1995 due to the Company's U.S. Federal, state and foreign net
operating loss carryforward positions and a tax holiday granted to one of the
Company's foreign subsidiaries. However, a provision for U.S. Federal and
State alternative minimum tax was recorded for fiscal year 1995.
NET LOSS ATTRIBUTABLE TO COMMON STOCK
The Company recorded a net loss attributable to common stock in fiscal
years 1997 and 1996 of approximately $6 million and $400,000, respectively.
The fiscal year 1997 loss was due to a number of factors, including reserves
for obsolete and slow moving inventory, product sales price reductions to
meet price competition, restructuring costs and a significant shortfall in
sales from targeted levels. Return to profitability in fiscal year 1998 is
contingent upon a resurgence in demand for the Company's products on a
worldwide basis, tight control of operating expenses, and execution of an
effective inventory reduction program to bring stocking levels in line with
Company requirements.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 1997, the Company had working capital of approximately
$3,362,000 and a ratio of current assets to current liabilities of
approximately 1.23 to 1, compared with working capital of approximately
$3,124,000 and a ratio of current assets to current liabilities of
approximately 1.23 to 1 as of July 31, 1996. During fiscal year 1997 the
Company recorded negative cash flow from operating activities primarily as a
result of the net loss from operations and increased inventory purchases to
support the Company's forecasted sales levels.
Sales for fiscal year 1997 were significantly lower than planned,
resulting in higher inventory levels at July 31, 1997. 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 resulting from expanded sales and marketing
efforts.
During the years ended July 31, 1997, 1996 and 1995, cash used for
capital expenditures was approximately $ 283,000, $229,000 and $221,000,
respectively. The Company financed approximately $258,000 for upgrades to its
management
23
information system during fiscal year 1997. Capital expenditures for fiscal
year 1998 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 (8.5% at July 31, 1997) plus 1.25%. 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. The line of credit is subject to
review and renewal on December 31, 1998.
At July 31, 1997, the Company was in violation of several financial
covenants relating to Pico Macom's bank line of credit. These covenants
required a minimum net income for the fiscal year by Pico Macom and limited
certain financial ratios. Pico Macom's bank has issued a waiver of these
violations effective July 31, 1997 and the Company negotiated new, less
restrictive covenants, with which management believes the Company can comply.
At July 31, 1997, Pico Macom had approximately $ 9,425,000 in revolving
loans and approximately $8,000 in letters of credit outstanding, and the
unused portion of the borrowing base was approximately $ 290,000.
In February 1996, the Company was notified by the holders 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.
In February 1997, the Company was notified by the holders of two
outstanding notes payable that they intended to exercise 100,000 warrants to
purchase common stock of the Company, totaling $100,000, against the second
installment payment due on the debt. This transaction was completed in
February 1997.
During the second half of fiscal year 1996, management determined that
the Company's credit arrangements, along with an inventory reduction program
implemented by the Company, would not provide sufficient cash to fund growth
in the Company's sales and planned operations for fiscal year 1997 and
beyond. Consequently, on November 21, 1996 the Company completed a private
placement financing totaling $6 million with two U.S.-based institutional
investors to provide funds for general working capital requirements and
investment in new product development, market development, and upgrade of
facilities. The private placement consisted of $5 million of seven-year 12
percent subordinated debentures sold to Allied Capital Corporation of
Washington, D.C. and certain
24
of its affiliates, and $1 million of seven-year 12 percent redeemable
preferred stock sold to the Sinkler Corporation of Wilmington, Delaware.
In connection with the financing, Allied Capital Corporation and
affiliates received warrants to purchase 779,313 shares of the Company's
common stock. The Sinkler Corporation received warrants to purchase 155,863
of the Company's common stock, and Shipley Raidy Capital Partners, LP, the
Company's investment banker, received warrants to purchase 20,000 shares of
the Company's common stock. Additionally, Allied Capital Corporation and
affiliates and The Sinkler Corporation received warrants to purchase, in the
aggregate, up to 18% of the number of shares of the Company's common stock
resulting from the exercise, from time to time, by holders of options and
warrants previously granted by the Company. The warrants are exercisable at
a price of $1.81 per share, the average closing price of the Company's common
stock for the 30 trading days prior to November 21, 1996.
Various transaction costs totaling $459,443 were incurred in conjunction
with the private placement financing. These costs are being amortized over
the seven-year term of the debt and preferred stock.
The Company has measured the fair value of the warrants issued in
connection with the private placement financing. This value has been
allocated as a discount applied against the related long-term debt and
redeemable preferred stock and will be amortized over the seven-year term of
the financing.
The private placement financing agreements require the Company to meet
certain financial covenants which are very similar to the financial covenants
relating to Pico Macom's bank revolving line of credit. Additionally, these
new agreements prohibit the distribution of cash, stock or other property to
shareholders (whether characterized as dividends or otherwise) or the
redemption or repurchase of the Company's capital stock or similar
securities, subject to limited exceptions.
At July 31, 1997 the Company was in violation of several financial
covenants relating to the private placement. These covenants required a
minimum net income for the fiscal year-end by Pico Macom and limited certain
financial ratios. The holders of the subordinated debt and the redeemable
preferred stock have issued waivers of these violations effective July 31,
1997 and the Company negotiated new, less restrictive covenants, with which
management believes the Company can comply.
In response to the cable TV industry reduction in demand for the
Company's products during fiscal year 1997, management determined in the
fourth quarter of fiscal year 1997 that the existing credit arrangements
along with the ongoing inventory reduction program was not likely to provide
sufficient cash to fund the Company's operations at anticipated levels for
fiscal year 1998 and beyond. Consequently, the Company decided to pursue
other financing alternatives including, but not limited to, additional
subordinated debt financing and adjustments to the availability formula of
Pico Macom's revolving
25
line of credit in order to increase the amount available to borrow against
the credit facility.
On September 12, 1997 the Company completed a private placement
financing totaling $1,650,000 with two U.S.-based institutional investors to
provide funds for general working capital requirements. The private
placement provides for an investment of up to $1,485,000 of three-year 10
percent junior subordinated debentures by Allied Capital Corporation and
affiliates, and an investment of $165,000 of three-year 10 percent redeemable
preferred stock by The Sinkler Corporation. In connection with the
financing, the Company has agreed to issue to the investor's warrants for up
to 1,442,000 shares of its common stock, of which 300,000 Shares are subject
to call provisions. The Company may purchase from the investors up to
300,000 shares of the warrant shares, at $3.00 per share, or if the warrants
have not been exercised, at $3.00 per share less the exercise price.
As of October 31, 1997 the Company had received cash of $985,000 of the
total financing facility, with $500,000 still available to fund the Company's
operating needs. The remaining $150,000 for the private placement facility
represents previously issued subordinated notes payable of the Company which
were purchased by Allied Capital Corporation and affiliates in June 1997.
Additionally, the Company issued to Allied Capital Corporation and affiliates
860,441 warrants to purchase shares of the Company's common stock, and the
Company issued to The Sinkler Corporation 144,200 warrants to purchase shares
of the Company's common stock, of which 209,010 shares are subject to the
above call provision. Warrants to purchase up to 437,359 additional shares
of the Company's common stock will be issued to Allied Capital Corporation
when the balance of the financing is funded.
The warrants issued in conjunction with this financing are exercisable
no later than 6 years from the date of issuance, at a price equal to the
average trading price of the Company's common stock over the 90-day period
commencing 30 days after the Company files its fiscal year 1997 Annual Report
on Form 10-K with the Securities and Exchange Commission.
As a condition to the financing, Allied requested that the Company's
Board of Directors participate in Allied's investment on the same terms and
conditions as Allied. Four members of the Company's Board of Directors have
participated with Allied for an amount up to $335,000.
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 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
26
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 and Thailand (the "Far East"), the Company is
subject to price increases imposed by those vendors to compensate for
currency fluctuations. During fiscal years 1995 through 1997 the U.S. dollar
generally maintained it's 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
the Company's 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 the Company's products, the continuing strength of the markets the
Company serves, competitor pricing, maintenance of the Company's current
momentum and other factors.
ITEM 7A. DERIVATIVE EXPOSURE
Not applicable
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, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity (deficiency), and
cash flows for each of the three years in the period ended July 31, 1997. 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, 1997 and 1996, and the results of their operations and
their cash flows for each of the three years in the period ended July 31, 1997
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
November 7, 1997
28
PICO PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
July 31,
------------------------
1997 1996
----------- -----------
ASSETS (Note C):
CURRENT ASSETS:
Cash and cash equivalents $ 22,286 $ 159,669
Accounts receivable (less allowance
for doubtful accounts: July 31, 1997,
$200,000; July 31, 1996, $200,000) 5,621,232 5,289,288
Inventories (Note B) 11,961,229 10,933,244
Prepaid expenses and other current
assets 339,760 191,215
----------- -----------
TOTAL CURRENT ASSETS 17,944,507 16,573,416
----------- -----------
PROPERTY, PLANT AND EQUIPMENT (Note E):
Buildings 217,255 217,255
Leasehold improvements 279,842 345,136
Machinery and equipment 2,900,270 2,637,609
----------- -----------
3,397,367 3,200,000
Less accumulated depreciation
and amortization 2,431,779 2,393,995
----------- -----------
965,588 806,005
----------- -----------
OTHER ASSETS:
Patents and licenses (less accumulated
amortization: July 31, 1997, $68,156;
July 31, 1996, $62,180) 153,054 159,030
Excess of cost over net assets of
businesses acquired (less accumulated
amortization; July 31, 1997, $395,970;
July 31, 1996, $366,930) 181,465 210,505
Deposits and other noncurrent assets 235,614 195,582
Debt issuance costs (less accumulated
amortization; July 31, 1997, $43,760;
July 31, 1996; $-0-) 415,683 -
----------- -----------
985,816 565,117
----------- -----------
$19,895,911 $17,944,538
----------- -----------
----------- -----------
See notes to consolidated financial statements.
29
PICO PRODUCTS, INC.
CONSOLIDATED BALANCE SHEETS
(CONTINUED)
July 31,
--------------------------
1997 1996
------------ -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIENCY)
CURRENT LIABILITIES:
Notes payable (Note C) $ 9,425,299 $ 8,227,776
Current portion of long-term debt
(Note D) 132,902 311,086
Accounts payable 3,348,977 3,921,081
Accrued expenses:
Legal and accounting 212,976 170,497
Payroll and payroll taxes 486,397 506,742
Other accrued expenses 395,552 312,193
Restructuring costs (Note N) 580,035 -
------------ -----------
TOTAL CURRENT LIABILITIES 14,582,138 13,449,375
------------ -----------
LONG-TERM DEBT (Note D) 4,915,286 39,414
------------ -----------
RESTRUCTURING COSTS (Note N) 298,744 -
------------ -----------
COMMITMENTS AND CONTINGENCIES - -
(Notes E and M)
REDEEMBABLE PREFERRED STOCK, $.01 par
value; authorized 500,000 shares;
issued and outstanding 1,000 shares
at July 31, 1997 and -0- shares at
July 31, 1996 (Note D) 917,086 -
------------ -----------
SHAREHOLDERS' EQUITY (DEFICIENCY)
(Notes K and L):
Common shares, $.01 par value;
authorized 15,000,000 shares
issued and outstanding 4,185,913
shares at July 31, 1997 and
4,052,246 shares at July 31, 1996 41,859 40,522
Additional paid-in capital 22,715,292 22,035,178
Stock subscriptions receivable (105,000) (115,000)
Accumulated deficit (23,381,874) (17,409,924)
Cumulative translation adjustment (87,620) (95,027)
------------ -----------
TOTAL SHAREHOLDERS' EQUITY (DEFICIENCY) (817,343) 4,455,749
------------ -----------
$19,895,911 $ 17,944,538
------------ -----------
------------ -----------
See notes to consolidated financial statements.
30
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended July 31,
1997 1996 1995
----------- ----------- -----------
SALES (Note I) $35,448,383 $36,051,304 $33,367,249
COSTS AND EXPENSES
Cost of Sales 30,471,220 27,377,269 25,225,052
Selling and administrative
expenses (Notes H and N) 9,479,008 8,140,285 7,145,472
----------- ----------- -----------
TOTAL COSTS AND EXPENSES 39,950,228 35,517,554 32,370,524
----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS (4,501,845) 533,750 996,725
OTHER INCOME (Note F) 13,496 22,060 281,897
INTEREST EXPENSE (1,398,934) (955,465) (712,921)
----------- ----------- -----------
INCOME (LOSS)
BEFORE INCOME TAXES (5,887,283) (399,655) 565,701
INCOME TAX PROVISION (Note G) - - 40,000
----------- ----------- -----------
NET INCOME (LOSS) (5,887,283) (399,655) 525,701
DIVIDENDS ON PREFERRED STOCK 84,667 - -
----------- ----------- -----------
NET INCOME(LOSS) ATTRIBUTABLE TO
COMMON STOCK $(5,971,950) $ (399,655) $ 525,701
----------- ----------- -----------
----------- ----------- -----------
NET INCOME (LOSS) ATTRIBUTABLE
TO COMMON STOCK PER COMMON
AND COMMON EQUIVALENT SHARE:
Primary $ (1.45) $ (0.11) $ 0.12
----------- ----------- -----------
----------- ----------- -----------
Fully Diluted $ (1.45) $ (0.11) $ 0.12
----------- ----------- -----------
----------- ----------- -----------
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING:
Primary 4,113,229 3,797,972 4,240,241
----------- ----------- -----------
----------- ----------- -----------
Fully Diluted 4,113,229 3,797,972 4,240,241
----------- ----------- -----------
----------- ----------- -----------
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, 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 subscrip- -
tions 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
--------- ---------- ----------- ------------- ------------- ------------- -----------
Cumulative
Translation
Adjustment - - - - 7,407 7,407
Shares issued
under stock
incentive plans 33,667 337 46,664 - - - 47,001
Shares issued
for exercise of
stock warrants 100,000 1,000 99,000 - - - 100,000
Stock subscrip-
tions receivable (10,000) 10,000 - - -
Value of stock
warrants issued
(Note D) - - 544,450 - - - 544,450
Preferred dividends - - - - (84,667) - (84,667)
Net loss - - - - (5,887,283) - (5,887,283)
--------- ---------- ----------- ------------- ------------- ------------- -----------
Balance
July 31, 1997 4,185,913 $ 41,859 $22,715,292 $ (105,000) $(23,381,874) $(87,620) $ (817,343)
--------- ---------- ----------- ------------- ------------- ------------- -----------
See notes to consolidated financial statements.
32
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended July 31,
--------------------------------------
1997 1996 1995
----------- ----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(5,887,283) $ (399,655) $ 525,701
Adjustments to reconcile net
income (loss) to net cash
used in operating activities:
Depreciation and amortization 521,681 362,367 370,176
Provision for losses on
accounts receivable 124,119 143,769 142,897
Provision for inventory
obsolescence 2,200,000 174,900 91,200
Changes in operating assets
and liabilities:
Accounts receivable (456,063) 459,281 (1,617,523)
Inventories (3,220,578) (1,365,108) (2,657,205)
Prepaid expenses and
other current assets (148,545) (7,345) 197,372
Other assets 15,846 (115,074) (3,591)
Accounts payable (572,104) 594,715 1,439,609
Accrued expenses 44,027 100,635 (168,786)
Other liabilities - (466,066) 58,367
Restructuring costs (Note N) 878,779 - -
----------- ----------- ----------
NET CASH USED IN
OPERATING ACTIVITIES (6,500,121) (513,581) (1,621,783)
----------- ----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (283,231) (228,749) (220,532)
------------ ----------- ----------
Continued on next page.
See notes to consolidated financial statements.
33
PICO PRODUCTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Year Ended July 31,
--------------------------------------
1997 1996 1995
----------- ----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under line of
credit agreements $1,197,523 $ 449,121 $1,991,373
Issuance of long-term debt (Note D) 5,000,000 - -
Issuance of preferred stock (Note D) 1,000,000 - -
Private placement financing costs
(Note D) (459,443) - -
Principal payments on long-term
debt (115,911) (134,772) (92,142)
Proceeds from exercise of stock
options 37,800 86,125 3,000
Dividends paid on preferred stock (14,000) - -
----------- ----------- ----------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 6,645,969 400,474 1,902,231
----------- ----------- ----------
NET INCREASE (DECREASE)IN CASH
AND CASH EQUIVALENTS (137,383) (341,856) 59,916
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 159,669 501,525 441,609
----------- ----------- ----------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 22,286 $ 159,669 $ 501,525
----------- ----------- ----------
----------- ----------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Year Ended July 31,
--------------------------------------
1997 1996 1995
----------- ----------- ----------
CASH PAID DURING THE YEAR FOR:
Interest $1,324,731 $ 953,955 $ 681,803
----------- ----------- ----------
----------- ----------- ----------
Income taxes $ 10,234 $ 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 February 1997 the holders of $100,000 of the Company's notes payable
exercised 100,000 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 fiscal year 1997 the Company financed the purchase of computer, office
and test lab equipment totaling approximately $358,000.
In fiscal year 1996 the Company financed the purchase of office and test
lab equipment totaling approximately $94,000.
In March 1996 the holders 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 inter-company
balances and transactions have been eliminated in consolidation.
The Company had net losses of $5,887,263 and $399,655 and negative cash
flows from operating activities of $6,500,121 and $513,581 for the years
ended July 31, 1997 and 1996, respectively. It also was in violation of
certain financial debt covenants at July 31, 1997.
The Company obtained waivers of its debt covenant violations and
negotiated new, less restrictive covenants, with which management believes
the Company can comply. Management has also implemented a plan to reduce its
excess inventories and decrease expenses. This plan includes closing its
Hong Kong and Thailand sales offices and selling products in the Far East
through alliances with local distributors.
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.
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-
36
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 value
of cash equivalents, accounts receivable and accounts payable, 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. It is not practical to estimate
the fair value of the Company's private placement financings due to the lack of
quoted market prices.
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 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.
37
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 years ended July 31, 1997 and 1995, approximately
$342,000 and $878,000, respectively, of cost and the related accumulated
depreciation were 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 of the patents
and trademarks which at July 31, 1997 represented 15 to 26 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.
38
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 years ended July 31, 1997 and 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 1996 and 1995
consolidated financial statements to conform to the classifications used in the
1997 consolidated financial statements.
NEW ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, ("SFAS 128") "Earnings per Share."
SFAS 128 replaces the presentation of primary earnings per share with a
presentation of basic earnings per share based upon the weighted average number
of common shares for the period. It also requires dual presentation of basic
and diluted earnings per share for companies with complex capital structures.
SFAS 128 will be adopted by the Company for the fiscal quarter ending January
31, 1998 and earnings per share for all prior periods will be restated upon
adoption.
B. INVENTORIES
The composition of inventories was as follows:
July 31,
---------------------------
1997 1996
----------- -----------
Raw materials $ 4,634,967 $ 3,485,548
Work in process 606,218 636,072
Finished goods 6,720,044 6,811,624
----------- -----------
$11,961,229 $10,933,244
----------- -----------
----------- -----------
In the fourth quarter, the Company recognized additional write-downs of
inventories of $1,745,000.
C. NOTES PAYABLE
At July 31, 1997, 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 (8.5% at July 31, 1997 and 8.25% at July 31,
1996) 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.
39
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 to borrow at
any one time is based upon various percentages of eligible accounts receivable
and eligible inventories as defined in the agreement. At July 31, 1997, Pico
Macom had $9,425,299 in revolving loans and $7,871 in letters of credit
outstanding, and the unused portion of the borrowing base was $290,471.
The line of credit arrangement is subject to various financial tests and
covenants, 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, 1998.
At July 31, 1997, the Company was in violation of several financial
covenants relating to Pico Macom's bank revolving line of credit. These
covenants required a certain minimum net income for the fiscal year ended
July 31, 1997 for Pico Macom and limited certain financial ratios. Pico
Macom's bank has issued a waiver of these violations effective July 31, 1997
and the Company negotiated new, less restrictive covenants, with which
management believes the Company can comply.
D. LONG-TERM DEBT AND REDEEMABLE PREFERRED STOCK
Long-term debt consisted of the following:
July 31,
----------------------
1997 1996
---------- ----------
Subordinated debentures to domestic invest-
ment funds, payable in installments
beginning in fiscal 2001 through fiscal
2004, with interest at 12.0% $5,000,000 -
Debt discount for valuation of stock
warrants issued to domestic investment
funds (425,202) -
Subordinated notes payable to domestic
Investment funds, payable in fiscal 2001,
with interest at 10.0% 150,000 -
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
Capital lease obligations (Note E) 319,425 93,737
Other loans payable 3,965 6,763
---------- ----------
5,048,188 350,500
40
Less current portion 132,902 311,086
---------- ----------
$4,915,286 $ 39,414
---------- ----------
---------- ----------
In November 1996 the Company completed a private placement financing
totaling $6 million with two U.S.-based institutional investors. The private
placement consisted of $5 million of seven-year 12 percent subordinated
debentures and $1 million of seven-year 12 percent redeemable preferred stock.
In connection with the financing, the Company issued warrants to the investors
and to the Company's investment banker for 955,176 shares of its common stock.
These warrants are exercisable no later than 10 years from the date of issuance,
at a price of $1.81 per share.
Additionally, the Company issued warrants to the investors providing for
the purchase, in the aggregate, of up to 18% of the number of shares of the
Company's common stock resulting from the exercise from time-to-time by holders
of options and warrants previously granted by the Company. These contingent
warrants are exercisable no later than 10 years from the date of issuance, at a
price of $1.81 per share.
Various transaction costs totaling $459,443 were incurred in conjunction
with the private placement financing. These costs are being amortized over the
seven-year term of the debt and preferred stock.
The Company has measured the fair value of the warrants issued in
connection with the private placement financing. This value has been
allocated as a discount applied against the related long-term debt and
redeemable preferred stock and is being amortized over the seven-year term of
the subordinated debentures and preferred stock.
The private placement financing agreements require the Company to meet
certain financial covenants which are very similar to the financial covenants
relating to Pico Macom's bank revolving line of credit. Additionally, these new
agreements prohibit the distribution of cash, stock or other property to
shareholders (whether characterized as dividends or otherwise) or the redemption
or repurchase of the Company's capital stock or similar securities, subject to
limited exceptions.
At July 31, 1997 the Company was in violation of several financial
covenants relating to the private placement. These covenants required a
minimum net income for the fiscal year-end and limited certain financial
ratios. The holders of the subordinated debt and the redeemable preferred
stock have issued waivers of these violations effective July 31, 1997 and the
Company negotiated new, less restrictive covenants, with which management
believes the Company can comply.
In June 1997 the holders of $150,000 of the Company's subordinated notes
payable, with interest at 8%, sold the notes to one of the U.S.-based
institutional investors involved in the November 1996 private placement
financing. As of July 31, 1997, the debt has been converted to subordinated
notes payable due in fiscal year 2001, with interest at 10%.
41
In February 1996, the Company was notified by the holders of 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.
In February 1997, the Company was notified by the holders of two
outstanding notes payable that they intended to exercise 100,000 warrants to
purchase common stock of the Company, totaling $100,000, against the second
installment or payment due on the debt. This transaction was completed in
February 1997.
Long-term debt and redeemable preferred stock at July 31, 1997 are payable
as follow:
Redeemable
Long-Term Debt Preferred Stock
-------------- ---------------
Year ending July 31, 1998 $ 132,902 -
Year ending July 31, 1999 127,085 -
Year ending July 31, 2000 63,404 -
Year ending July 31, 2001 650,000 100,000
Year ending July 31, 2002 500,000 100,000
Thereafter 3,574,757 717,086
-------------- ---------------
$5,048,188 917,086
-------------- ---------------
-------------- ---------------
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 2000 and have interest rates varying from 4% to 12%. The Company has
included the cost of equipment under capital leases of $401,920 and $371,824 in
property, plant and equipment at July 31, 1997 and 1996, respectively.
Accumulated amortization on such assets was $47,279 and $262,412 at July 31,
1997 and 1996, respectively.
The Company also leases certain of its manufacturing and office facilities
and equipment under operating lease agreements. Minimum rental commitments at
July 31, 1997 for these leases are as follows:
Capital Operating
-------- ----------
Year ending July 31, 1998 $153,138 $ 458,193
Year ending July 31, 1999 137,525 83,291
Year ending July 31, 2000 65,641 69,794
Year ending July 31, 2001 - 35,569
Year ending July 31, 2002 - 15,526
Thereafter - 9,119
-------- ----------
356,304
Less imputed interest 36,879
--------
$319,425 $ 671,492
-------- ----------
-------- ----------
42
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, 1997, 1996 and 1995 was $677,784, $650,175 and $507,739,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,
---------------------------
1997 1996 1995
------- ------- --------
Royalty income $ - $ - $256,657
Interest income 13,496 22,060 25,240
------- ------- --------
$13,496 $22,060 $281,897
------- ------- --------
------- ------- --------
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,
-----------------------------------
1997 1996 1995
----------- --------- ----------
Federal tax (benefit)
based on statutory tax rate $(2,061,000) $(140,000) $ 198,000
Other 101,000 318,000 170,000
Change in valuation
allowance 1,960,000 (178,000) (368,000)
Alternative minimum tax - - 40,000
----------- --------- ----------
$ - $ - $ 40,000
----------- --------- ----------
----------- --------- ----------
At July 31, 1997, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $16.8 million which expire in
varying amounts from the year 2000 through the year 2012. Additionally, the
Company has federal tax credit carryforwards of approximately $367,000 which
expire in varying amounts from the year 1998 through the year 2001.
Neither U.S. nor foreign taxes have been provided on the cumulative
undistributed foreign earnings, as of July 31, 1997, due to an exemption
43
from foreign taxes, which expires in 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, 1997 and 1996. The Company
recognized a valuation allowance to offset the net deferred tax asset since the
future benefit of these assets is not assured
July 31,
-----------------------
1997 1996
----------- -----------
Deferred income tax assets:
Differences between book and
tax basis of property $ 136,000 $ 92,000
Reserves not currently deductible 1,353,000 385,000
Other 64,000 49,000
Operating loss carryforwards 6,765,000 5,730,000
Tax credit carryforwards 367,000 469,000
----------- -----------
8,685,000 6,725,000
Valuation allowance (8,685,000) (6,725,000)
----------- -----------
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, 1997, 1996 and 1995 amounted to approximately
$1,340,000, $1,368,000, and $979,000, respectively.
I. SIGNIFICANT CUSTOMERS
In fiscal 1997, 1996 and 1995 the Company's sales to one customer were
approximately 9%, 16%, and 20%, respectively, of the Company's consolidated
sales.
J. RETIREMENT BENEFITS
The Company maintains a defined contribution pension plan (under Internal
Revenue Code Section 401(k)) covering substantially all of its U.S.-based
employees with more than three months 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 $91,407,
$77,856 and $63,958 for the years ended July 31, 1997, 1996 and 1995,
respectively.
K. OTHER STOCK OPTIONS
During fiscal year 1994, the Board of Directors issued nonqualified, non-
plan 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
44
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 four 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; the 1992
Incentive Stock Plan (1992 Plan), adopted in January, 1993 and amended in July,
1994; and the 1996 Incentive Stock Plan (1996 Plan), adopted in December 1996.
The 1981 Plan reserved 450,000 common shares for issuance, the 1982 Plan
reserved 150,000 shares for issuance, the 1992 Plan reserves 175,000 common
shares for issuances and the 1996 Plan reserves 195,000 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 could 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 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.
45
Under the 1992 plan, 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.
The 1996 Plan provisions are essentially the same as the 1992 Plan,
allowing for grants of ISO's, NSO's, Rights and Awards to eligible persons.
Under the 1996 Plan, Rights may be granted to holders of stock options
outstanding under the 1981 Plan, the 1992 Plan, or the 1996 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 a committee of the Board of Directors.
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.
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.
A SUMMARY OF CHANGES IN SHARES UNDER OPTION FOR THE COMPANY'S FOUR STOCK
INCENTIVE PLANS IS AS FOLLOWS:
Year Ended July 31,
--------------------------------
1997 1996 1995
--------- --------- --------
NON QUALIFIED PLAN (1981):
Outstanding at beginning of year 290,000 410,000 408,500
Options granted - 10,500 6,500
Options expired (33,750) (10,500) -
Options exercised (23,000) (120,000) (5,000)
--------- --------- --------
Outstanding at end of year @ 233,250 * 290,000 410,000
--------- --------- --------
--------- --------- --------
Exercisable at end of year @ 227,083 * 268,670 370,000
--------- --------- --------
--------- --------- --------
Weighted average
exercise price of options -
Outstanding at beginning of year $ 0.95 $ 0.75 $ 0.80
Options granted $ -- $ 1.81 $ 2.50
46
Options expired $ 1.26 $ 1.20 $ --
Options exercised $ 1.12 $ 0.60 $ 0.60
Outstanding at end of year $ 0.89 $ 0.95 $ 0.75
Exercisable at end of year $ 0.86 $ 0.87 $ 0.75
* 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.
@ includes options to acquire 165,000 shares of the Company's common
stock which were exercised in exchange for stock subscription notes
receivable during fiscal year 1996.
INCENTIVE PLAN (1982):
Outstanding at beginning of year - 45,200 45,200
Options exercised - (45,200) -
--------- --------- --------
Outstanding at end of year - - 45,200
--------- --------- --------
--------- --------- --------
Exercisable at end of year - - 45,200
--------- --------- --------
--------- --------- --------
Weighted average
exercise price of options -
Outstanding at beginning of year $ -- $ 0.31 $ 0.31
Options exercised $ -- $ 0.31 $ --
Outstanding at end of year $ -- $ -- $ 0.31
Continued on next page
47
STOCK PLAN (1992) Year Ended July 31,
- ---------------------- --------------------------------
(Nonqualified options) 1997 1996 1995
-------- -------- --------
Outstanding at beginning of year 135,000 114,000 45,000
Options granted 10,000 23,500 69,000
Options expired (17,833) (2,500) --
Options exercised (10,667) -- --
-------- -------- --------
Outstanding at end of year 116,500 135,000 114,000
-------- -------- --------
-------- -------- --------
Exercisable at end of year 76,673 58,832 28,000
-------- -------- --------
-------- -------- --------
Weighted average
exercise price of options -
Outstanding at beginning of year $ 2.19 $ 2.29 $ 1.16
Options granted $ 1.62 $ 1.83 $ 3.03
Options expired $ 2.43 $ 3.19 $ --
Options exercised $ 1.13 $ -- $ --
Outstanding at the end of year $ 2.20 $ 2.19 $ 2.29
Exercisable at end of year $ 2.13 $ .85 $ 1.13
STOCK PLAN (1996) Year Ended July 31,
- ---------------------- --------------------------------
(Nonqualified options) 1997 1996 1995
-------- -------- --------
Outstanding at beginning of year 120,000 -0- -0-
Options granted 7,500 120,000 -0-
Options expired (75,000) -0- -0-
Options exercised -0- -0- -0-
-------- -------- --------
Outstanding at end of year 52,500 120,000 -0-
-------- -------- --------
-------- -------- --------
Exercisable at end of year 14,999 -0- -0-
-------- -------- --------
-------- -------- --------
Weighted average
exercise price of options -
Outstanding at beginning of year $ 2.34 $ -- $ --
Options granted $ 2.09 $ 2.34 $ --
Options expired $ 2.34 $ -- $ --
Options exercised $ -- $ -- $ --
Outstanding at the end of year $ 2.25 $ 2.34 $ -0-
Exercisable at end of year $ 2.28 $ -0- $ -0-
Significant option groups outstanding at July 31, 1997 and related
weighted average price and life information follow:
Weighted Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices at July 31, 1997 Life Price at July 31,1997 Price
- -------- ---------------- ---------------- -------- --------------- --------
$ .60- .80 165,000 # $ .64 165,000 $ .64
1.00-1.50 93,000 1.4 years 1.14 87,668 1.12
1.62-2.34 79,250 4.0 years 2.10 20,581 2.18
2.50-3.38 60,000 2.2 years 3.08 40,506 3.08
3.94 5,000 1.5 years 3.94 5,000 3.94
------- -------
402,250 318,755
------- -------
------- -------
# Options were exercised for stock subscription notes receivables during
fiscal year 1996.
48
The weighted average fair value of the stock options granted from the 1981
Plan, the 1992 Plan, and the 1996 Plan during fiscal years 1997 and 1996 was
$1.53 and $ 1.39 respectively. The fair value of each stock option grant is
estimated on the date of grant using the Black-Scholes option pricing model with
the following weighted average assumptions used:
Year Ended July 31,
1997 1996
--------- ---------
Expected life 5.0 years 5.0 years
Risk-free interest rate 6.23% 6.32%
Volatility 83% 83%
Dividend yield - -
The Company has applied the provisions of APB Opinion 25 to account for
stock options, under which no compensation cost has been recognized for stock
option awards. Had compensation costs for the Company's stock incentive
plans been determined consistent with the provisions of Statement of
Financial Accounting Standards Number 123, the Company's pro-forma net income
(loss) attributable to common stock and earnings (loss) per share for fiscal
years 1997 and 1996 would have been as follows:
Year Ended July 31,
1997 1996
----------- ---------
Net income (loss)
Attributable to Common Stock $(5,988,898) $(406,892)
----------- ---------
----------- ---------
Net income (loss) attributable
to common stock per common
share:
Primary $ (1.46) $ (0.11)
----------- ---------
----------- ---------
Fully Diluted $ (1.46) $(0.11)
----------- ---------
----------- ---------
Because options vest over several years and additional options may be granted
each year, the effects on pro forma net loss and related per share amounts
presented above are not representative of the effects for future years.
49
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
$6,000,000 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.
EAGLE LITIGATION
On July 30, 1997, Eagle Comtronics, Inc. ("Eagle") filed a motion in the
United States District Court for the Northern District of New York to amend the
complaint for patent infringement it had filed in 1979 against the Company.
This 1979 action had been settled by Consent Judgment in 1988, pursuant to which
the Company and Eagle entered into a License Agreement providing for specified
royalty payments from Eagle to the Company. Eagle's motion sought the District
Court's permission to proceed against the Company under various legal theories
for breach of the License Agreement, based on Eagle's allegation that the
Company, in violation of the License Agreement's "most favored nation" clause,
granted a license to a third party (Arrow Communication Laboratories, Inc.) on
more favorable terms than those provided to Eagle. Eagle sought damages of
approximately $1,600,000 plus interest and attorneys fees. The Company believed
that Eagle's motion was procedurally improper and that, even if the amended
complaint were allowed by the District Court, it had meritorious defenses to the
claims stated in the amended complaint.
The Company responded to Eagle's motion, and Eagle promptly withdrew the
motion to file an amended complaint. At the same time Eagle filed a complaint
in New York State Supreme Court similar to the proposed amended federal
complaint. Management believes that the Company has meritorious defenses to
Eagle's action and that such suit will not have any material adverse effect on
the Company.
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
50
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 In-
fringement 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 learned
that the EPA added the Onondaga Lake Site to the Superfund National Priorities
List in December 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 was sold to a third party in 1992,
51
and which conducted operations within the specified area. 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.
In March 1997 the Company received a follow-on request for additional
information in this matter and has provided all information requested.
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.
N. RESTRUCTURING COSTS
The Company has recorded restructuring expenses of approximately $900,000
in the fourth quarter of fiscal year 1997 related to the realignment of its
operations and a contract settlement with the Company's former chairman and
chief executive officer. The Company has decided to pursue product distribution
in the Far East through alliances with local distributors, and therefore will
incur the costs of closing down its Hong Kong office.
SUBSEQUENT EVENT
On September 12, 1997 the Company completed a private placement
financing totaling $1,650,000 with two U.S.-based institutional investors to
provide funds for general working capital requirements. The private
placement provides for an investment of up to $1,485,000 of three-year 10
percent junior subordinated debentures and $165,000 of three-year 10 percent
redeemable preferred stock. In connection with the financing, the Company
has agreed to issue to the investors warrants for up to 1,442,000 shares of
its common stock, of which 300,000 shares are subject to call provisions. The
Company may purchase from the investors up to 300,000 shares of the warrant
shares, at $3.00 per share, or if the warrants have not been exercised, at
$3.00 per share less the exercise price.
As of October 31, 1997 the Company had received cash of $985,000 of the
total financing facility, with $500,000 still available to fund the Company's
operating needs. The remaining $150,000 of the private placement facility
represents previously issued subordinated notes payable of the Company which
were purchased by one of the institutional investors in June 1997.
Additionally, the Company issued to the investors warrants for 1,004,641
shares of its common stock, of which 209,010 shares are subject to the above
call provision. Warrants to purchase an
52
additional 437,359 shares will be issued to the investors when the balance of
the financing is funded.
The warrants issued in conjunction with this financing are exercisable no
later than 6 years from the date of issuance, at a price equal to the average
trading price of the Company's common stock over the 90-day period commencing 30
days after the Company files its fiscal year 1997 Annual Report on Form 10-K
with the Securities and Exchange Commission.
As a condition to the financing, Allied requested that the Company's Board
of Directors participate in Allied's investment on the same terms and conditions
as Allied. Four members of the Company's Board of Directors have participated
with Allied for an amount up to $335,000.
53
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, 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
Fiscal Year Ended July 31, 1997:
Allowance for
doubtful accounts $200,000 $124,119 $124,119 $200,000
* Write-off of uncollectible accounts receivable and other adjustments.
54
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
55
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 1997 annual meeting of shareholders which will
be filed prior to November 28, 1997.
ITEM 11. EXECUTIVE COMPENSATION.
The information called for by this item is incorporated by reference to the
Company's Proxy Statement for its 1997 annual meeting of shareholders which will
be filed prior to November 28, 1997.
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 1997 annual meeting of shareholders which will
be filed prior to November 28, 1997.
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 1997 annual meeting of shareholders which will
be filed prior to November 28, 1997.
56
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, 1997 and 1996
Consolidated Statements of Operations for the Years Ended July 31,
1997, 1996 and 1995
Consolidated Statements of Shareholders' Equity for the Years Ended
July 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended July 31,
1997, 1996 and 1995
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.
57
(C) INDEX TO EXHIBITS
3(a) Complete copy of the Certificate of Incorporation of the Company, as
amended on November 19, 1996.
3(b)e By-Laws of the Company, as amended on December 17, 1987.
4(a)b 1981 Non-Qualified Stock Option Plan.
4(b)a 1982 Incentive Stock Option Plan.
4(c)i 1992 Incentive Stock Plan.
4(d)j Warrant Certificates issued to Scimitar Development Capital Fund and
Scimitar Development Capital "B" Fund, dated February 10, 1993.
4(e)k Warrant Certificate issued to City National Bank, dated February 10,
1993.
4(f)m Amendment to 1992 Incentive Stock Plan.
4(g)r Amendment to 1981 Non-Qualified Stock Option Plan.
4(h)s Investment Agreement between the Company and certain of its
subsidiaries, and Allied Capital Corporation and certain of its
affiliated companies, dated November 21, 1996.
4(i)s Subordinated Secured Debenture issued by the Company and certain of
its subsidiaries, payable to Allied Capital Corporation, dated
November 21, 1996. The Company has issued subordinated secured
debentures in substantially the same form as this debenture to the
following parties for the following amounts:
Holder Amount
----------------------------- ----------
Allied Investment Corporation $2,300,000
Allied Investment Corporation II $1,450,000
Allied Capital Corporation II $ 550,000
4(j)s Letter Agreement covering the issuance and sale by the
Company of Preferred Stock to The Sinkler Corporation, dated
November 21, 1996.
4(k)s Stock Purchase Warrant issued by the Company to Allied
Capital Corporation, dated November 21, 1996. The Company
has issued warrants in substantially the same form as this
warrant to the following parties for the following number of
shares:
See page 62 for Key to Index of Exhibits Incorporated by Reference.
58
(c) INDEX TO EXHIBITS (CONTINUED)
Holder Shares
----------------------------- -------
Allied Investment Corporation 358,484
Allied Investment Corporation II 226,001
Allied Capital Corporation II 85,724
The Sinkler Corporation 155,863
Shipley Raidy Capital Partners, LP 20,000
4(l)s Stock Purchase Warrant issued by the Company to Allied
Capital Corporation, dated November 21, 1996. The Company
has issued warrants in substantially the same form as this
warrant to the following parties for the following
percentage of shares:
Percentage of
Holder Shares
----------------------------- -----------
Allied Investment Corporation 6.9%
Allied Investment Corporation II 4.35%
Allied Capital Corporation II 1.65%
The Sinkler Corporation 3.0%
4(m)s Registration Rights Agreement between the Company, Allied
Capital Corporation and certain of its affiliated companies,
Scimitar Development Capital Fund and Scimitar Development
Capital "B" Fund, Shipley Raidy Capital Partners, LP, and
The Sinkler Corporation, dated November 21,1996.
4(n)t Amended and Restated 1996 Incentive Stock Plan.
4(o) Investment Agreement between the Company and certain of its
subsidiaries, and Allied Capital Corporation and certain of its
affiliated companies, dated September 12, 1997.
4(p) Junior Subordinated Secured Debenture issued by the Company and
certain of its subsidiaries, payable to Allied Capital
Corporation, dated September 12, 1997. The Company has issued
subordinated secured debentures in substantially the same form as
this debenture to the following parties for the following
amounts:
Holder Amount
----------------------------- -------
Allied Investment Corporation $374,300
Allied Capital Corporation II $394,000
See page 62 for Key to Index of Exhibits Incorporated by Reference.
59
4(q) Letter Agreement covering the issuance and sale by the
Company of Preferred Stock to The Sinkler Corporation, dated
September 12, 1997.
4(r) Stock Purchase Warrant issued by the Company to Allied
Capital Corporation, dated September 12, 1997. The Company
has issued warrants in substantially the same form as this
warrant to the following parties for the following number of
shares:
Holder Shares
----------------------------- -------
Allied Investment Corporation 258,944
Allied Capital Corporation II 272,572
The Sinkler Corporation 114,200
4(s) Stock Purchase Warrant Subject to Call issued by the Company
to Allied Capital Corporation, dated September 12, 1997.
The Company has issued warrants in substantially the same
form as this warrant to the following parties for the
following number of shares:
Holder Shares
----------------------------- -------
Allied Investment Corporation 68,024
Allied Capital Corporation II 71,604
The Sinkler Corporation 30,000
4 (t) First amendment to Investment Agreement between the Company
and certain of its subsidiaries, and Allied Capital
Corporation and certain of its affiliated Companies, dated
September 12, 1997.
10(a)f The Company product warranties
10(b)c Pico (St. Kitts) Limited lease on Pond Pasture Industrial
Estate, Basseterre, St. Christopher and Nevis
10(c)d Pico Macom, Inc. lease on approximately 60,000 square feet
of building at 12500 Foothill Blvd., Lakeview Terraace,
California.
10(d)g Amendment to Pico Macom, Inc. lease of building at 12500
Foothill Blvd., Lakeview Terrace, California.
10(e)e Lease on office of Pico Macom Taiwan Co., Ltd.
See page 62 for Key to Index of Exhibits Incorporated by Reference.
60
(c) INDEX TO EXHIBITS (continued):
10(f)g Exclusive Manufacturing Agreement between Pico Macom, Inc.
and Goodmind Industries, dated April 26, 1989.
10(g)k Amendment to Exclusive Manufacturing Agreement between Pico
Macom, Inc. and Good Mind Industries (dated April 26, 1989) -
amendment dated April 27, 1993
10(h)l Loan and Security Agreement between Pico Macom, Inc. and Marine
Midland Business Loans, Inc. dated May 25, 1994
10(i)o Employment Agreement between Pico Macom, Inc. and Norman
Reinhardt, dated March 22, 1995.
10(j)o Amendment to Exclusive Manufacturing/Marketing Agreement between
Pico Macom, Inc. and Goodmind Industries (dated April 26, 1989) -
amendment dated April 10, 1995.
10(k)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.
10(l)p Employment Agreement between Pico Products, Inc. and Everett
T. Keech, dated September 22, 1995.
10(m)q Amendment to Pico Macom, Inc. lease of building at 12500 Foothill
Boulevard, Lakeview Terrace, California - amendment dated
November 9, 1995.
10(n)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.
10(o)s Amendment No. 4 to the Loan and Security Agreement between Pico
Macom, Inc. and HSBC Business Loans, Inc., as successor to Marine
Midland Business Loans, Inc. (original agreement dated May 25,
1994) - amendment dated November 25, 1996.
10(p)u Employment Agreement between Pico Products, Inc. and Robert G.
Cunningham, dated December 12, 1996.
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 Incorporated by Reference.
61
KEY TO INDEX OF EXHIBITS INCORPORATED BY REFERENCE
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.
62
KEY TO INDEX OF EXHIBITS INCORPORATED BY REFERENCE (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.
s Previously filed by the Company as an exhibit to the Company's Form
10-Q for the fiscal quarter ended October 31, 1996 and
incorporated by reference.
t Previously filed by the Company as an amendment to the Company's
definitive proxy statement dated December 4, 19965 and
incorporated by reference.
u Previously filed by the Company as an exhibit to the Company's Form
10-Q for the fiscal quarter ended January 31, 1997 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.
63
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: November 13, 1997
PICO PRODUCTS, INC.
By: /s/ Charles G. Emley, Jr. By: /s/ Jack Brucker
-------------------------- ---------------------
Charles G. Emley, Jr. Jack Brucker
Chairman of the Board Executive Vice President,
(Principal Executive Officer) Operations and Chief
Financial Officer
(Principal Financial 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/ Charles G. Emley, Jr. /s/ David Heenan
- -------------------------- ---------------------
Charles G. Emley, Jr. David Heenan
Chairman of the Board Director
November 13, 1997 November 13, 1997
/s/ E.B. Leisenring, Jr. /s/ Pierson G. Mapes
- -------------------------- ---------------------
E.B. Leisenring, Jr. Pierson G. Mapes
Director Director
November 13, 1997 November 13, 1997
/s/ William W. Mauritz
- --------------------------
William W. Mauritz
Director
November 13, 1997
FORM 10-K
YEAR ENDED JULY 31, 1997
NEW EXHIBITS
- ------------------------------------------------------------------------------
3(a) Complete copy of Certificate of Incorporation of the Company, as amended on
November 19, 1996.
4(o) Investment Agreement between the Company and certain of its subsidiaries,
and Allied Capital Corporation and certain of its affiliated companies,
dated September 12, 1997.
4(p) Junior Subordinated Secured Debenture issued by the Company and certain of
its subsidiaries, payable to Allied Capital Corporation, dated September
12, 1997. The Company has issued subordinated secured debentures in
substantially the same form as this debenture to the following parties for
the following amounts:
Holder Amount
----------------------------- --------
Allied Investment Corporation $374,300
--------
Allied Capital Corporation II $394,000
--------
4(q) Letter Agreement covering the issuance and sale by the
Company of Preferred Stock to The Sinkler Corporation, dated
September 12, 1997.
4(r) Stock Purchase Warrant issued by the Company to Allied
Capital Corporation, dated September 12, 1997. The Company
has issued warrants in substantially the same form as this
warrant to the following parties for the following number of
shares:
Holder Shares
----------------------------- ----------
Allied Investment Corporation 258,944
Allied Capital Corporation II 272,572
The Sinkler Corporation 114,200
List of New Exhibits Continued on Next Page.
FORM 10-K
YEAR ENDED JULY 31, 1997
NEW EXHIBITS (CONTINUED)
- ------------------------------------------------------------------------------
4(s) Stock Purchase Warrant Subject to Call issued by the Company to Allied
Capital Corporation, dated September 12, 1997. The Company has issued
warrants in substantially the same form as this warrant to the following
parties for the following number of shares:
Holder Shares
----------------------------- -------
Allied Investment Corporation 68,024
Allied Capital Corporation II 71,604
The Sinkler Corporation 30,000
4(t) First Amendment to Investment Agreement between the Company and certain of
its subsidiaries, and Allied Capital Corporation and
certain of its affiliated Companies, dated September
12, 1997.
11.1 Computation of Per Share Earnings
24(a) Independent Auditors' Consent
27 Financial Data Schedule (included only in the EDGAR filing).