<PAGE> 1
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from ___________ to __________
Commission File Number : 001-11773
PACIFIC RESEARCH AND ENGINEERING CORPORATION
-----------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
California 95-2638420
---------- ----------
(State or other jurisdiction (IRS Employer
of incorporation or organization) identification No.)
2070 Las Palmas Drive, Carlsbad, California, 92009
--------------------------------------------------
(Address of principal executive offices)
(760) 438-3911
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 2,305,500 as of May 13,
1997 Common Stock, No Par Value
<PAGE> 2
PACIFIC RESEARCH & ENGINEERING CORPORATION
FORM 10-QSB
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I: FINANCIAL INFORMATION PAGE
<S> <C>
ITEM 1: FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS AS OF DECEMBER 31, 1996 AND
MARCH 31, 1997 (UNAUDITED) 3
CONDENSED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 (UNAUDITED) 4
CONDENSED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 (UNAUDITED) 5
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 14
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS 20
ITEM 2: CHANGES IN SECURITIES 20
ITEM 3: DEFAULTS UPON SENIOR SECURITIES 20
ITEM 4: SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS 20
ITEM 5: OTHER INFORMATION 20
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K 20
</TABLE>
<PAGE> 3
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
CONDENSED BALANCE SHEETS
AS OF MARCH 31, 1997 AND DECEMBER 31, 1996
<TABLE>
<CAPTION>
ASSETS March 31, December 31,
1997 1996
------------ ------------
CURRENT ASSETS (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 201,517 $ 610,857
Investments 1,000,000 1,000,000
Accounts receivable, net 790,090 695,919
Due from officer 1,047 --
Inventories, net 2,460,294 1,935,501
Prepaid expenses 327,597 250,943
------------ ------------
TOTAL CURRENT ASSETS 4,780,545 4,493,220
PROPERTY AND EQUIPMENT, net 1,039,500 902,251
OTHER ASSETS 1,376,231 1,052,038
------------ ------------
$ 7,196,276 $ 6,447,509
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,034,352 $ 594,258
Accrued expenses 254,882 195,430
Customer advances 637,421 271,710
Line of credit 425,000 500,000
Capital lease obligations - current portion 35,566 34,140
Deferred tax liability, net 13,500 13,500
------------ ------------
TOTAL CURRENT LIABILITIES 2,400,721 1,609,038
CAPITAL LEASE OBLIGATIONS, net of current portion 42,532 37,156
------------ ------------
TOTAL LIABILITIES 2,443,253 1,646,194
SHAREHOLDERS' EQUITY
Common stock, no par value, 25,000,000 shares authorized;
2,305,500 shares issued and outstanding 4,126,392 4,160,905
Additional paid-in capital 50,000 50,000
Retained earnings 576,631 590,410
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 4,753,023 4,801,315
------------ ------------
$ 7,196,276 $ 6,447,509
============ ============
</TABLE>
The accompanying notes are integral part of these financial statements
<PAGE> 4
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
CONDENSED STATEMENTS OF INCOME FOR THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
<TABLE>
<CAPTION>
March 31, 1997 March 31, 1996
-------------- --------------
(unaudited) (unaudited)
<S> <C> <C>
NET SALES $ 2,291,204 $ 1,950,367
COST OF SALES 1,295,938 1,139,233
-------------- --------------
Gross profit 995,266 811,134
OPERATING EXPENSES
General and administrative 395,065 253,572
Selling and marketing 363,565 170,053
Research and development 123,374 98,513
Engineering 59,046 59,772
Depreciation and amortization 59,389 39,308
-------------- --------------
TOTAL OPERATING EXPENSES 1,000,439 621,218
-------------- --------------
INCOME (LOSS) FROM OPERATIONS (5,173) 189,916
OTHER INCOME (EXPENSES)
Interest, net (6,971) (13,303)
Gain on sale of assets -- 16,087
Other (835) 469
-------------- --------------
TOTAL OTHER INCOME (EXPENSE) (7,806) 3,253
-------------- --------------
INCOME (LOSS) BEFORE INCOME TAXES (12,979) 193,169
Income taxes 800 3,000
-------------- --------------
NET INCOME (LOSS) $ (13,779) $ 190,169
============== ==============
Earnings per average common share $ (0.01)
==============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 2,305,500
==============
PRO FORMA FOR MARCH 31, 1996 (NOTE 7)
Income before income taxes $ 193,169
Pro forma income taxes 79,000
--------------
Pro forma net income $ 114,169
==============
Earnings per average common share $ 0.09
==============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 1,320,424
==============
</TABLE>
The accompanying notes are integral part of these financial statements
<PAGE> 5
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
CONDENSED STATEMENTS OF CASH FLOWS FOR THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
<TABLE>
<CAPTION>
March 31, 1997 March 31, 1996
-------------- --------------
(unaudited) (unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (13,779) $ 190,169
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 59,389 39,308
Gain on sale of assets -- 16,087
Changes in operating assets and liabilities:
Accounts receivable (94,171) (18,773)
Inventories (524,793) (138,377)
Prepaid expenses and other assets (400,847) (287,449)
Accounts payable 440,094 247,330
Accrued expenses 59,542 10,378
Customer advances 365,711 (184,967)
-------------- --------------
NET CASH USED IN OPERATING ACTIVITIES (108,854) (126,294)
============== ==============
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (181,752) (83,989)
Due (to) from officer (1,047) --
-------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (182,799) (83,989)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from (payments on) notes payable and lines of credit (75,000) 217,062
Payments under capital lease obligations (8,174) (1,227)
Distributions to shareholders -- (126)
Deferred offering costs, netted against offering proceeds (34,513) --
-------------- --------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (117,687) 215,709
-------------- --------------
NET INCREASE (DECREASE) IN CASH (409,340) 5,426
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 610,857 500
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 210,517 $ 5,926
============== ==============
</TABLE>
The accompanying notes are integral part of these financial statements
5
<PAGE> 6
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations
Pacific Research & Engineering Corporation (the "Company") was
incorporated on October 17, 1969 in the state of California. The
Company's principal operations are the manufacturing and selling of
professional radio studio broadcasting equipment. The Company also
provides technical furniture and studio integration and design services
to radio stations and network facilities. The Company operated under
the name Pacific Recorders & Engineering Corporation until December 21,
1995, at which date the Company changed its name to Pacific Research &
Engineering Corporation.
Basis of Accounting
The Company's policy is to use the accrual method of accounting and to
prepare and present financial statements which conform to generally
accepted accounting principles. 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 reported
amounts of revenues and expenses during the reporting periods. Actual
results could differ from those estimates.
Basis of Presentation
The accompanying unaudited condensed financial statements and related
notes have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission for Form 10-QSB. Accordingly, they
do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments, consisting
of a normal recurring nature and considered necessary for a fair
presentation, have been included. It is suggested that these financial
statements be read in conjunction with the financial statements and
notes thereto included in the Company's annual report on Form 10-KSB
for the year ended December 31, 1996. The results of operations for the
three month period ended March 31, 1997 are not necessarily indicative
of the operating results for the year ended December 31, 1997. For
further information, refer to the financial statements and notes
thereto included in the Company's Annual Report on Form 10-KSB for the
fiscal year December 31, 1996.
Reclassifications
Certain March 31, 1996 balances have been reclassified to conform to
the March 31, 1997 condensed financial statement presentation.
6
<PAGE> 7
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Investments
The Company maintains excess cash available for operating purposes in a
mutual fund of a financial institution. The fund invests exclusively in
the State of California tax free municipal bonds. There are no
restrictions and the fund shares may be redeemed by the Company at any
time without penalty.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventory costs include material, labor and manufacturing
overhead.
Property and Equipment
Property and equipment is stated at cost, and depreciated using the
straight-line method over the estimated useful lives of the assets,
which range from three to five years. Assets under capital leases are
depreciated by the straight-line method over the shorter of the lease
term or the useful lives of the assets. Maintenance, repairs and minor
renewals are charged to operations as incurred. Major replacements or
upgrade's are capitalized. When properties are retired or otherwise
disposed, the related cost and accumulated depreciation are eliminated
from the respective accounts and any gain or loss on disposition is
reflected as income or expense.
Other Assets
Other assets consist primarily of capitalized software costs and
deferred offering costs.
Capitalized software costs consist of certain costs incurred for the
development of software after technological feasibility has been
established. These expenditures are principally related to new products
which will be sold, leased or otherwise marketed and which have been
capitalized in accordance with the provisions of Statement of Financial
Accounting Standards No. 86. Capitalized software costs are amortized
on a product-by-product basis. Amortization will be computed based upon
the ratio of annual revenues to total anticipated revenues or the
straight-line method over the estimated life of the product (typically
three to five years), whichever provides the greater amortization.
Amortization expense for capitalized software costs have not been
incurred since none of the products are available for sale at December
31, 1996 nor at March 31, 1997.
Deferred offering costs include the costs associated with the initial
public offering. These costs related to the direct incremental costs
associated with the initial public offering and were capitalized and
netted against the amount received from the public offering.
7
<PAGE> 8
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
2. INVENTORIES
Inventories at March 31, 1997 and at December 31, 1996 are summarized
as follows:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
----------- -----------
(unaudited)
<S> <C> <C>
Raw materials $ 1,315,094 $ 969,180
Work-in-process 568,490 516,687
Finished goods 601,710 474,634
----------- -----------
2,485,294 1,960,501
Less reserve for obsolescence (25,000) (25,000)
----------- -----------
Inventories, net $ 2,460,294 $ 1,935,501
=========== ===========
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment at March 31, 1997 and at December 31, 1996 are
summarized as follows:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
----------- -----------
(unaudited)
<S> <C> <C>
Machinery and equipment $ 1,351,017 $ 1,185,798
Furniture and fixtures 823,167 800,550
Leasehold improvements 647,150 638,348
----------- -----------
2,821,334 2,624,696
Less accumulated depreciation and
amortization (1,781,834) (1,722,445)
----------- -----------
Property and equipment, net $ 1,039,500 $ 902,251
=========== ===========
</TABLE>
4. OTHER ASSETS
Other assets at March 31, 1997 and at December 31, 1996 are summarized
as follows:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
------------ ------------
(unaudited)
<S> <C> <C>
Capitalized software costs $ 1,265,291 $ 949,617
Deposits 80,860 93,696
Other 21,842 --
Employee loan 8,238 8,725
------------ ------------
$ 1,376,231 $ 1,052,038
============ ============
</TABLE>
8
<PAGE> 9
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
5. INCOME TAXES
For the tax period ending May 29, 1996 , which includes the period
ended March 31, 1996, the Company elected to be taxed under the
provisions of Subchapter S of the Internal Revenue Code. Under those
provisions, the Company would normally not be subject to federal
corporate taxes since the shareholders are liable for individual
Federal income taxes on their respective shares of the Company's
taxable income.
The public offering discussed in Notes herein resulted in the
termination of the Company's S Corporation status for federal and state
income tax purposes. This resulted in the establishment of a net
deferred tax asset calculated at normal federal and state income tax
rates, causing a one-time non-cash credit to earnings as a reduction of
income tax expense equal to the amount of the net change in deferred
tax benefit. As of March 31, 1996, the amount of the current deferred
tax asset, which would have been recorded had the Company's S
Corporation status terminated on that date, was $93,000. The current
net deferred tax liability comprises primarily temporary differences
relating to inventory valuation, certain reserves, accruals, and
research and development costs capitalized for book purposes, but
expensed for tax purposes.
Pro forma Income Taxes
The accompanying statements of income includes the unaudited pro forma
income tax provision for the three month period ended March 31, 1996,
to reflect the estimated income tax expense of the Company as if it had
been subject to normal federal and state income taxes from the period
presented.
Pro forma earnings per share is calculated using the weighted average
outstanding common and common equivalent shares.
Pro forma income taxes, assuming the Company was subject to C
Corporation income taxes for the entirety of the period, and is
included in the accompanying statements of income.
9
<PAGE> 10
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
6. PROFIT SHARING AND STOCK OPTION PLAN
Profit Sharing Plan
The Company maintains a profit sharing plan (the "Plan") that provides
for tax deferred employee benefits under Section 401(k) of the Internal
Revenue Code. The Plan allows employees to make contributions, a
portion of which will be matched by the Company, up to the lesser of 5%
of an employee's salary or the amount allowed by law, as defined. The
Company may elect to make an additional discretionary contribution in
any Plan year. There were no discretionary Company contributions during
the three month periods ended March 31, 1997 and 1996. Company
contributions vest at a rate of 20% per year, beginning after two years
of employment.
Stock Option Plan
A total of 1,200,000 shares of the Company's Common Stock has been
reserved for issuance under the Company's 1996 Omnibus Stock Plan (the
"Stock Plan"), which expires by its own terms in 2006.
The Stock Plan provides for the grant of "incentive stock options"
within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended, and non-qualified stock options to employees, officer,
directors and consultants of the Company. Incentive stock options may
be granted only to employees. The Stock Plan is administered by the
Board of Directors or a committee appointed by the Board, which
determines the terms of all grants, including the exercise price, the
number of shares subject to grants, and the exercisability and vesting
schedules.
As of December 31, 1996 and March 31, 1997 (unaudited), the following
grants have been made under the Stock Plan:
To each of Messrs. John Robbins and Michael Bosworth, both members of
the Company's Board of Directors, a ten year option to purchase 5,000
shares of Common Stock, exercisable at the initial public offering
price. Additionally, Messrs. Robbins and Bosworth will receive ten year
options to purchase 2,500 shares of common Stock at the then-market
price on the date of the grant on the first three anniversaries of
their election as a director. Each grant is conditioned upon the person
being a director at the time of the grant.
Additionally, options to purchase a total of 750,000 shares of the
Common Stock were granted pro rata, based upon current share ownership,
to Messrs. Williams, Dosch, Eyler and Pollard, executive officers of
the Company and Messrs. Staros and Jackson, key employees of the
Company.
10
<PAGE> 11
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
6. PROFIT SHARING AND STOCK OPTION PLAN (CONTINUED)
These options will vest and become exercisable pursuant to the schedule
set forth below, if the Company achieves the following performance
criteria; (i.) 100,000 shares the first complete fiscal year after the
initial public offering if the Company's earnings per share are at
least $0.25 or the Common Stock achieves a price of at least $6.00 per
share; (ii) 100,000 shares the second year if the Company's earnings
per share are at least $0.30 or the Common Stock achieves a price of at
least $7.20 per share; (iii) 100,000 shares in the third year if the
Company's earnings per share are at least $0.36 or the Common Stock
achieves a price of at least $8.64 per share; (ii) 225,000 shares will
be available in the fourth year if the Company's earnings per share are
at least $0.43 or the Common Stock achieves a price of at least $10.37
per share; (v) 225,000 shares in the fifth year if the Company's
earnings per share are at least $0.52 or the Common Stock achieves a
price of at least $12.44 per share. In the event the Company does not
achieve these performance criteria in any given year, any shares
reserved for issuance but not yet vested will become exercisable in
addition to such subsequent year's shares if the Company achieves the
performance criteria in such subsequent year. In any event, vesting
occurs after year seven for all shares that are reserved for issuance.
For purposes of calculating earnings per share under the above formula,
earnings per share will be calculated without taking into account any
compensation expense required under generally accepted accounting
principles due to recognition of any expense as a result of the
exercisability of the performance shares.
7. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures of cash flow information for the three month
periods ended March 31, 1997, and 1996 are summarized as follows:
<TABLE>
<CAPTION>
Quarter Ended Quarter Ended
March 31, 1997 March 31, 1996
(unaudited) (unaudited)
------------- -------------
<S> <C> <C>
Cash paid for interest and income taxes:
Interest $ 10,215 $ 13,303
Income taxes $ -- $ --
Non cash investing and financing activities:
Capital lease obligations $ 14,799 $ --
</TABLE>
11
<PAGE> 12
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
8. INITIAL PUBLIC OFFERING
Effective May 28, 1996, the Company sold 500,000 equity units (Unit) to
the general public. Each Unit sold for $11.00 and consisted of two
shares of common stock and one redeemable common stock purchase
warrant. The common stock and the warrant were detachable and
separately transferable immediately after the closing of the offering.
Each warrant entitles the registered holder to purchase, at any time
over a five year period commencing on the date of the initial public
offering (Offering), one share of common stock at 120% of the initial
public offering price per share. Commencing from the date of the
Offering, the warrants are subject to redemption at $0.10 per warrant
on thirty days written notice if the closing bid price of the common
stock is in excess of 150% of the then current exercise price of the
warrants for a period of ten consecutive trading days.
9. SHAREHOLDERS' EQUITY
S Corporation Distributions
For the year ended December 31, 1996 the Company distributed $694,722
to its shareholders. These amounts represented a portion of the S
Corporation earnings through December 31, 1996 and were distributed
from retained earnings to the shareholders. The Company's status as an
S Corporation automatically terminated following the initial public
offering. No further distributions were made.
Common Stock
During December 1995, the Board of Directors and shareholders voted to
amend the Company's Articles of Incorporation and By-laws. The effect
of the restatement is (i) to change the authorized capital from 1,500
shares of common stock to 25,000,000 shares of common stock, no par
value and (ii) to effect a 12,433.33-for-1 stock split of the Company's
common stock. In April 1996, the Board of Directors and shareholders
voted to effect a .7-for-1 stock split of the Company's stock. Common
stock has been retroactively restated for the stock splits.
Warrants
Warrants outstanding in addition to those discussed in Note 8 above at
December 31, 1996 and March 31, 1997 (unaudited) consists of warrants
granted to a former director of the Company. These warrants provide for
the purchase of 100,100 shares of common stock, exercisable at $4.68
per share, which was an amount in excess of the fair market value at
the date of grant. At the closing of the Offering, the Company issued
to the Underwriter the Representative's Warrant to purchase for
investment a maximum of 50,000 Units of the Company, each Unit
consisting of two shares of common stock and one warrant, but which may
be exercised separately by the Underwriter at an exercise price of 120%
of the public offering price of the securities being offered.
12
<PAGE> 13
PACIFIC RESEARCH & ENGINEERING CORPORATION
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
9. SHAREHOLDERS' EQUITY (CONTINUED)
As of December 31, 1996 and March 31, 1997 (unaudited), no warrants had
been exercised in connection with these issuance's.
10. EARNINGS PER SHARE
Options and warrants outstanding as of March 31, 1997(unaudited) are
antidilutive for purposes of calculating primary and fully diluted
earnings per share and are, therefore, not included in the earnings per
share calculation. For the three month periods ended March 31, 1997 and
1996, the calculation was based on the weighted number of shares
outstanding, since the options and warrants were antidilutive.
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD LOOKING STATEMENTS
Forward-looking statements used in this Form 10-QSB are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that all forward-looking statements involve risks and
uncertainty, including without limitation risks of dependence on third-party
suppliers, intellectual property rights and litigation, market acceptance of and
demand for the Company's products as well as general market conditions,
competition and pricing, and development of technology and manufacturing
capabilities. This Form 10-QSB contains forward-looking statements that involve
risks and uncertainties relating to future events. Actual events or the
Company's results may differ materially from the results discussed in the
forward-looking statements.
OVERVIEW
Since incorporation in October 1969, Pacific Research & Engineering, a
California corporation, ("PR&E," the "Company") has produced high quality studio
products and services including audio control and mixing consoles, cartridge
machines, digital workstations, and a wide range of peripheral products for the
radio broadcasting industry. The Company also provides technical furniture and
offers studio integration and design services for turnkey systems projects. The
Company's primary customers are the nation's top rated radio stations and
network facilities. The Company believes it had developed a solid reputation in
supplying quality products and services to the broadcast industry. The Company
recently introduced, on a limited basis, products for the television broadcast
industry which has not generated any significant revenues to date, however it is
expected to increase in the future.
The Company's manufacturing and development activities are conducted in four
principal areas: audio control consoles, digital recording equipment, peripheral
equipment and system products and services. Some of the Company's customers
include Capital Cities/ABC, Disney, Infinity Broadcasting and Bonneville
International ("Bonneville").
One family of audio control consoles which the Company manufactures (the
"X-Class") are mainframes with both on-air and production capabilities
configured with various accessory modules affording flexible add-on-features.
Modules for high-end consoles may include the capacity to: handle a talk show
with four independent telephone feeds, equalize and/or process the inputs,
record a stereo feed for later broadcast and work with two separate studios and
a remote all at the same time. The Radiomixer console (part of the
"Mixer-Class") was developed by the Company as a lower-priced on-air console
targeted at price sensitive domestic and international markets. The Radiomixer
can perform several jobs simultaneously handling up to two telephones.
Digital recording equipment is manufactured and sold as part of the ADX
workstation line with one of the more popular versions termed the ADX Ensemble.
The Ensemble is a stand alone digital audio workstation featuring automated
digital recording and mixing, incorporating an Apple Macintosh 6100/66 for
display and control. Like a word processor for audio, Ensemble has the ability
to cut, copy, paste and move audio segments around to create sophisticated audio
productions. An optical backup drive feature, similar to a recordable compact
disc, allows the user to read and write directly to an optical drive without
having to load individual projects onto the hard drive.
The needs of a broadcast studio vary depending upon the requirements and budgets
of the broadcast facility. The Company custom builds integrated turnkey systems
to meet each studio's objective providing custom cabinetry, audio and logic
wiring, as well as installation services. Each customized system is fully
documented and thoroughly tested in the Company's manufacturing facility prior
to shipment.
14
<PAGE> 15
The fourth quarter of 1996, and to a lesser extent the first quarter of 1997,
experienced the financial impact of the Company's significant investment in its
future. Over this period of time, the Company has (i) established product market
representation and penetration in Europe and Asia, (ii) hired qualified account
managers for the previously untapped middle markets in the United States, and
(iii) incurred significant development costs associated with the releases of its
three new products. These investment efforts impacted operating income
significantly, since it takes time for these growth initiatives, once
implemented, to generate revenues for the Company. There can be no assurance
that these growth initiatives will be successful or generate revenues for the
Company.
Strategy for Future Product releases
- Marketing Channel Development. Management plans to market the Company's
existing products and services worldwide by significantly increasing domestic
and international advertising and promotional activities. The Company is
reorganizing its sales force to improve focus in the major markets and establish
a channel for marketing lowered priced products for less affluent domestic and
international broadcasters. Both the enhancements of the Company's direct sales
efforts and the increased promotional activities will place an emphasis on
international business that, until now, has remained relatively undeveloped.
- Horizontal Expansion for Top-Market Broadcasters. The Company intends to
develop a range of new technology products and services for the Company's
primary market segment, such as computer controlled air and production consoles
and digital audio processing and interfacing devices. The first product in this
category is the Integrity Digital Broadcast Console introduced at the Audio
Engineering Society (AES) trade show in Munich, Germany during March, 1997, with
a commercial release and sales during the second quarter of 1997. Company's
management believes there is a market for high technology products and services
in this category, and that maintaining dominance in its existing market segment
is vital to future success in other markets.
- Middle Market Products and Services. The Company plans to develop
products and services for the broadcasters in somewhat less affluent markets
than those to which the Company has historically sold. Products for this market
segment will be sold by the Company's direct sales force and a few select
international dealers. The Company has just completed the development of the
AirWave J, a low cost broadcast console, and will begin shipping to clients
during the second quarter of 1997. The Company is also in the final phase of
development of a new line of ready-to-assemble studio furniture named QuickBiltJ
which offers high quality styling and craftsmanship at a very low price point.
- Development of OEM Audio Engine. The Company is developing a high
quality, digital audio engine to be marketed as original equipment ("OEM") to
manufacturers of computer-based digital audio recording/playback systems. This
device, named Soundfire J, translates sound into data that can be manually or
automatically processed by computer. This engine will employ much of the digital
signal processing ("DSP") technology being applied to the Company's other
digital audio products, and will provide a vehicle for establishing OEM
relationships with other manufacturers, which could lead to further products in
the future. Additionally, the audio engine has the potential for varied
applications in the highend multimedia market as an audio server engine.
15
<PAGE> 16
RESULTS OF OPERATIONS
The following table sets forth the percentage of revenue represented by certain
items in the Company's Condensed Statements of Operations for the periods
indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31
--------------------------------------------
1997 1996 PERCENT
(UNAUDITED) (UNAUDITED) INCR.
(DECR.)
<S> <C> <C> <C>
NET SALES 100.0% 100.0% 17.5%
COST OF SALES 56.5% 58.4% 13.8%
---------- ---------- ----------
GROSS PROFIT 43.5% 41.6% 22.7%
EXPENSES:
GENERAL AND ADMINISTRATIVE 17.3% 13.0% 56.4%
SELLING AND MARKETING 15.9% 8.7% NA
RESEARCH AND ENGINEERING 7.9% 8.1% 15.2%
DEPRECIATION AND AMORTIZATION 2.6% 2.0% 51.1%
---------- ---------- ----------
TOTAL OPERATING EXPENSES 43.7% 31.8% 61.3%
INCOME FROM OPERATIONS (0.2%) 9.8% NA
OTHER INCOME (EXPENSES):
INTEREST INCOME (EXPENSE) (0.2%) (0.7%) (48.4%)
GAIN ON SALE OF ASSET 0.0% 0.8% NA
OTHER 0.0% 0.0% NA
---------- ---------- ----------
TOTAL OTHER INCOME (EXPENSE) (0.2%) 0.1% NA
INCOME BEFORE INCOME TAXES (0.4%) 9.9% NA
PROVISION FOR INCOME TAXES 0.1% 0.2% NA
NET INCOME (0.5%) 9.7% NA
</TABLE>
NA = NOT MEANINGFUL OR IN EXCESS OF 100%
THREE MONTHS ENDED MARCH 31, 1997 COMPARED TO THREE MONTHS ENDED MARCH 31, 1996.
Sales increased $341,000 or 17.5%, from $1,950,000 for the three months ended
March 31, 1996 to $2,291,000 for the three months ended March 31, 1997. The
Company believes the sales increase to be the result of the continuing wave of
consolidation, merger and acquisition activity triggered by the signing of the
Telecommunications Bill in February of 1996 allowing entities to own as many as
eight radio stations in each market. The relaxation of ownership rules has
caused a number of the existing, well established, broadcasting companies to
aggressively acquire radio stations throughout the United States and has also
inspired some mergers of large broadcasting companies and several new ventures.
The Company believes all this activity will continue to favorably impact sales
as broadcast companies stabilize their acquisition activities and begin to
concentrate on operating more efficiently. The Company feels there will be a
strong market for its products and services to these broadcasting companies.
16
<PAGE> 17
Additionally, radio advertising revenues continue to grow, providing the capital
broadcasters need to consolidate and upgrade their facilities, which generally
translates into increased demand for the Company's goods and services.
Cost of sales increased $156,000 or 13.8% from $1,139,000 to $1,295,000 due to
the sales increase, and decreased slightly as a percent of revenues for the
three months ended March 31, 1997 compared to the same period in 1996.
The Company continually evaluates its inventory purchasing and handling
policies, as well as its manufacturing processes, to ensure the maintenance of,
or improvement to, gross margins. Accordingly, gross profit increased $184,000
(from $811,000 to $995,000) or 22.7% due primarily to the increase in sales, but
increased slightly as a percent of revenue from 41.6% to 43.5% for the three
months ended March 31, 1996 compared to the three months ended March 31, 1997.
General and administrative expenses increased approximately $141,000, or 56.4%
for the comparable periods ($254,000 during the three months ended March 31,
1996, compared to $395,000 during the three months ended March 31, 1997). The
increase was due, primarily, to additional expenses incurred in ramping up the
infrastructure and costs in connection with the Company's public filing
requirements, additional payroll costs, and other expenses associated with the
public offering. As a percent of revenue, general and administrative expenses
increased 4.3%, from 13.0% during the three months ended March 31, 1996 to 17.3%
during the three months ended March 31, 1997.
Selling and marketing expenses increased $193,000 or 113.8% from $170,000 during
the three months ended March 31, 1996 to $363,000 during the three months ended
March 31, 1997 due, primarily, to the addition of a Sales Manager as well as
additional sales professionals, expansion costs for entry into Europe, Asia and
middle market accounts and new product launches. The Company expects to take
advantage of the growing radio market generated by the Telecommunication Bill
(see overview, above) and will continue to invest prudently in this area to
maximize market penetration. Selling and marketing expenses as a percentage of
revenue increased 7.2% from 8.7% during the three months ended March 31, 1996 to
15.9% during the three months ended March 31, 1997.
Research and engineering expenses increased $24,000 or 15.2% from $158,000 for
the three months ended March 31, 1996 to $182,000 for the three months ended
March 31, 1997. The primary reason for the increase is that, during the three
months ended March 31, 1997, the Company has begun to decrease its overall
capitalization of certain development costs relating to the coding, testing and
other expenditures related to new products that will be sold, leased or
otherwise marketed, in accordance with the provisions of Statement of Financial
Accounting Standards No. 86.
Capitalized research and engineering costs, pursuant to Statement of Financial
Accounting Standards No. 86, for the three months ended March 31, 1997 was
approximately $315,000. The Company capitalized research and engineering costs
in the amount of $370,000 for the comparable period during 1996. The Company has
incurred and expects to continue to incur research and engineering payroll
expenses as it recruits and hires the engineering staff necessary to develop and
launch new products. The Company will also continue to invest in
state-of-the-art computer equipment and CAD products to enable its engineering
team to manage product development as radio migrates from analog to digital.
Research and engineering expenses decreased, as a percent of revenue, from 8.1%
for the three months ended March 31,1996 to 7.9% for the three months ended
March 31, 1997 due to primarily the increase in sales.
Income from operations decreased $195,000 or 103.6% from $190,000 for the three
months ended March 31, 1996 to a loss of $5,000 for the three months ended March
31, 1997 reflecting a 22.7% increase in gross profit and a 61.3% increase in
operating expenses for the comparable period.
17
<PAGE> 18
Operating income, as a percent of revenue, decreased 10.0% from 9.8% for the
three months ended March 31, 1996 to a loss of 0.2% for the three months ended
March 31, 1997.
Net interest expense decreased overall by $6,000 or 48.4% from $13,000 for the
three months ended March 31, 1996 to $7,000 for the three months ended March 31,
1997, reflecting a decrease in borrowing on the line of credit, as well as an
offset by the interest earned on invested funds.
The Company incurred a gain of approximately $16,000 for the three months ended
March 31, 1996, resulting from an upgrade to an enhanced CAD/engineering
software package. The gain has been properly classified as other income in the
financial statements. The Company had no other income of this nature for the
three months ended March 31, 1997.
The combined results, as discussed above, yielded a net loss before taxes of
$13,000 for the three months ended March 31, 1997 compared to net income of
approximately $193,000 for the three months ended March 31, 1996, or an
approximately 107.3% decrease in net income before taxes.
Research and Development and Engineering
During the three month periods ended March 31, 1997 and 1996 the Company spent
approximately $123,000 and $98,000, respectively on internally funded research
and development and approximately $59,000 and $60,000, respectively in
engineering.
The main costs associated with research and engineering are expenditures related
to licenses, permits and CE (European Conformity) certification for existing
products marketed overseas, increased research and development activities and
the hiring of additional engineering staff incurred in the development of the
new digital products. These expenditures would have been significantly more if
not for the fact that the Company has capitalized certain development costs
relating to the coding, testing and other expenditures related to new products
that will be sold, leased or otherwise marketed, in accordance with the
provisions of Statement of Financial Accounting Standards No. 86.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital requirements are to fund the expansion of its
internal sales department, increase advertising and marketing, increase
engineering and development of new products and development of worldwide markets
and penetration. The Company has historically satisfied its cash requirements
through cash flows from operations and bank borrowings. Under some project
contracts, the Company requires customer advances upon project acceptance, then
invoices based upon the completion of specified conditions and milestones.
Depending upon the stage of completion, it may be necessary for the Company,
from time to time, to finance a portion of its working capital needs.
Additionally, developing and launching new products exerts additional pressure
on the working capital requirements of the Company. The Company through the use
of its offering proceeds was able to fulfill these capital requirements during
the previous year and to initiate its expansion plans to take advantage of the
expected growth in the market.
The Company completed its initial public offering May 28, 1996 and realized net
proceeds of approximately $4.2 million after underwriting discounts and offering
expenses. As of December 31, 1996 and March 31, 1997 the Company had $1.6 and
$1.2 million in cash and cash equivalents, respectively.
The Company's current ratio at March 31, 1997 was 2.0 compared to 2.8 at
December 31, 1996. The decrease was attributable, primarily, to the decrease in
cash and cash equivalents, and increase in accounts payables, customer advances
and accrued expenses. For the same reasons, the Company experienced a decrease
in working capital of approximately $504,000 from $2,884,000 at December 31,
1996 to $2,380,000 at March 31, 1997.
18
<PAGE> 19
The Company's operating activities consumed cash of $109,000 for the three
months ended March 31, 1997. Cash used in operations for the three months ended
March 31, 1997 was the result, primarily, of an increase in inventory
($524,000), an increase in accounts receivable ($94,000), an increase in prepaid
expense and other assets ($401,000) (which was primarily a result of capitalized
engineering expenses in accordance with Statement of Financial Accounting
Standards No. 86), offset by an increase in accounts payable of $440,000, and an
increase in customer advances of $366,000 which was related to deposits on
projects expected to be completed during the second and third quarters of 1997.
Cash used in investing activities for the three month period ended March 31,
1997 was $183,000. Such investing activities involved purchases of property and
equipment ($182,000) and borrowings from an officer on a short term basis
($1,000).
Cash used in financing activities was $118,000 for the three months ended March
31, 1997, consisting primarily of payments on the Company's line of credit
($75,000) and the offset of additional deferred offering costs associated with
the Company's initial public offering of $35,000 and payments of $8,000 relative
to the Company's capital lease obligations.
As a result of the above the Company experienced an overall decrease in cash and
cash equivalents from $611,000 at December 31, 1996 to $211,000 for the three
month period ended March 31, 1997.
The Company believes that the net proceeds from its initial public offering
completed May 28, 1996, together with its line of credit facility, capital
leases and cash flows generated by operations should be adequate to meet its
operating and working capital needs for the foreseeable future.
BUSINESS RISKS
Risks Associated with the Development of New Products and Technological Change
The markets for the Company's products are characterized by rapidly
changing technology and new product introductions. Accordingly, the Company
believes its future prospects depend on its ability to develop and introduce in
a timely fashion new and complementary products that achieve market acceptance
based on continuing technological innovations. The Company invests significant
time and resources in research and development of new products and system
configurations. The Company anticipates diversifying it product line in response
to new market opportunities some of which are expected to be created or
accelerated by federal government initiatives. There can be no assurance that
new products or product enhancements developed by the Company will achieve
market acceptance.
Competition
The Company does not have direct across the board competitors, but does
have competition in its individual product categories. The high performance
broadcast market is intensely competitive and is characterized by rapid
technological advances, evolving industry standards and technological
obsolescence. Although the Company believes it is one of the more significant
competitors in the audio custom system design and fabrication services market,
many of the Company's competitors have greater financial, technical, sales,
marketing and other resources than the Company. The Company believes that the
principal competitive factors in the market for high end broadcasting equipment
and services are offering customers a range of high end products, custom system
design and fabrication services. Although the Company believes that it competes
favorably with respect to certain of these factors, there can be no assurance
that other present or potential competitors will not develop additional products
or alternative technologies which make the Company's products obsolete.
Management of Growth
If the Company is successful in implementing its growth strategy, the
Company believes it could
19
<PAGE> 20
undergo a period of rapid growth which could place a significant strain on its
management, financial and other resources. The Company's ability to manage its
growth will require it to continue to improve its operational and financial
systems and to motivate and effectively manage its employees. If the Company
grows, it will have to implement new financial, budgeting, management
information and internal control systems. The success of the Company will depend
in the ability of management to effectively implement these changes and to
manage the Company's operations over the long term. The Company's success also
will depend in large part upon its ability to attract and retain highly skilled
technical personnel to provide technological depth and support, to complete and
enhance its products and to develop new products. In addition, marketing and
sales personnel will be needed. Competition for highly skilled management,
technical, marketing and sales personnel is intense. There can be no assurance
that the Company will be successful in attracting and retaining key management,
technical, marketing and sales personnel, and its failure to do so would
materially and adversely affect the Company's business and results of
operations.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Default Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Securities Holders
Schedule Form 14 (a) Proxy Statement, dated
May 9, 1997
Annual Shareholders Meeting, June 5, 1997
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(a) Exhibits
4.1 Articles of Incorporation of the Company (1)
4.2 Bylaws of the Company (1)
4.3 Warrant Agreement (1)
4.4 Warrant Certificate (1)
4.5 Stock Certificate (1)
4.6 Unit Certificate (1)
5.1 Opinion re legality of S-8 filing (2)
10.1 Lease Agreement dated May 9, 1995 (1)
10.2 Sublease Agreement dated May 9, 1995 by and between the
Registrant and Pacific Metal Fabricators (1)
10.3 Employment Contract by and between the Registrant and Jack
Williams (1)
10.4 Employment Contract by and between the Registrant and Michael
Dosch (1)
20
<PAGE> 21
10.5 Employment Contract by and between the Registrant and Larry
Eyler (1)
10.6 Employment Contract by and between the Registrant and David
Pollard (1)
10.7 1996 Omnibus Stock Plan and form of Stock Option Agreement
thereunder (1)
10.8 Asset Purchase Agreement between the Registrant and Pacific
Metal Fabricators, Inc. (1)
24.1 Power of Attorney (included in signature pages to this
registration statement)
26.1 Form S-8 filing, dated February 29, 1997 (2)
27 Financial Data Schedules
(1) Previously filed as an exhibit to the Company's Form SB-2, file no.
333-858-LA, and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Form S-8, file no.
333-22407, and incorporated herein by reference.
(b) Reports on From 8-K None
21
<PAGE> 22
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PACIFIC RESEARCH & ENGINEERING CORP.
By: /s/ Larry Eyler
-----------------------------
Larry Eyler
Chief Financial Officer
22
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 1,201,517
<SECURITIES> 0
<RECEIVABLES> 790,090
<ALLOWANCES> 0
<INVENTORY> 2,460,294
<CURRENT-ASSETS> 4,780,545
<PP&E> 2,821,334
<DEPRECIATION> 1,781,834
<TOTAL-ASSETS> 7,196,276
<CURRENT-LIABILITIES> 2,400,721
<BONDS> 0
0
0
<COMMON> 4,126,392
<OTHER-SE> 626,631
<TOTAL-LIABILITY-AND-EQUITY> 4,753,023
<SALES> 2,291,204
<TOTAL-REVENUES> 2,291,204
<CGS> 1,295,938
<TOTAL-COSTS> 1,000,439
<OTHER-EXPENSES> 835
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,971
<INCOME-PRETAX> (12,979)
<INCOME-TAX> 800
<INCOME-CONTINUING> (13,779)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,779)<F1>
<EPS-PRIMARY> (0.01)
<EPS-DILUTED> (0.01)
<FN>
<F1>OPTIONS AND WARRANTS OUTSTANDING AS OF MARCH 31, 1997 ARE ANTIDILUTIVE FOR
PURPORSES OF CALCULATING PRIMARY AND FULLY DILUTED EARNINGS PER SHARE AND ARE,
THEREFORE, IGNORED.
</FN>
</TABLE>
