U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-KSB
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the fiscal year ended
December 31, 1997.
[ ] Transition report under Section 13 or 15(d) of the
Securities Exchange Act of 1943 for the transition period
from ______________ to ______________.
Commission file number 001-11773
PACIFIC RESEARCH & ENGINEERING CORPORATION
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(Name of small business issuer in its charter)
California 95-2638420
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(State or other jurisdiction of (IRS Employer Identification No.)
Incorporation or organization)
2070 Las Palmas Drive
Carlsbad, California 92009
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(Address of principal executive offices and zip code)
Issuer's telephone number: (760) 438-3911
Securities registered pursuant to Section 12(b) of the Exchange Act:
Common Stock, no par value
Common Stock Purchase Warrants American Stock Exchange
- ------------------------------ ------------------------------
(Title of class) (Name of each exchange on which
registered)
Securities registered pursuant to Section 12(g) of the Exchange Act:
None
Check whether the issuer (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past
90 days. YES_X_ NO___
Check if there is no disclosure of delinquent filers in
response to Item 405 of Regulation S-B is not contained in this
form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Issuers' revenues for the year ended December 31, 1997 were
$12.288 million. The aggregate market value of voting stock held
by nonaffiliates of the registrant is approximately $4,524,750
(based on the last American Stock Exchange reported sales price
on March 30, 1998). This amount was calculated by reducing the
total number of shares of the registrant's common stock
outstanding by the total number of shares of common stock held by
officers, directors, and stockholders owning in excess of 10% of
the registrant's common stock, and multiplying the remainder by
the last reported sales price on March 30, 1998. The information
provided shall in no way be construed as an admission that any
officer, director, or more than 10% stockholder of the registrant
may be deemed an affiliate of the registrant or that such person
is the beneficial owner of the shares reported as being held by
such person, and any such inference is hereby disclaimed. As of
March 30, 1998 there were 2,305,500 shares of the issuers common
stock and warrants to purchase 500,000 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Form 14a - Proxy Statement
is incorporated by reference in Items 9, 10, 11 and 12
PAGE <2>
TABLE OF CONTENTS
PART I
Item 1. Business 3
Item 2. Properties 13
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of
Security Holders 13
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 13
Item 6. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 14
Item 7. Financial Statements and Selected
Financial Data 21
Item 8. Changes in and Disagreements With
Accountants on Accounting and Financial
Disclosure 22
PART III
Item 9. Directors, Executive Officers, Promoters
and Control Persons; Compliance with
Section 16(a) of the Exchange Act 22
Item 10. Executive Compensation 22
Item 11. Security Ownership of Certain Beneficial
Owners and Management 22
Item 12. Certain Relationships and Related
Transactions 22
Item 13. Exhibits, Financial Statements Schedules,
and Reports on Form 8-K 23
PAGE <3>
PART I
ITEM 1. BUSINESS
This Report on Form 10-KSB contains forward-looking
statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results
discussed in the forward-looking statements. Factors that might
cause such a difference include, but are not limited to, those
discussed in Item 1 the section entitled "Business Risks."
Forward-Looking Information - General
This report contains a number of forward-looking
statements which reflect the Company's current views with respect
to future events and financial performance including statements
regarding the Company's strategy, products under development and
plans for expansion. These forward-looking statements are subject
to certain risks and uncertainties that could cause actual
results to differ materially from historical results or those
anticipated. In this report, the words "anticipates," "believes,"
"expects," "intends," "future," "plans," "targets" and similar
expressions identify forward-looking statements. Readers are
cautioned to consider the risk factors described below under the
heading "Business Risks" and not to place undue reliance on the
forward-looking statements contained herein, which speak only as
of the date hereof. The Company undertakes no obligation to
publicly revise these forward-looking statements, to reflect
events or circumstances that may arise after the date hereof.
Additionally, these statements are based on certain
assumptions that may prove to be erroneous and are subject to
certain risks including, but not limited to, the Company's
ability to introduce new products, the concentration of the
Company's current products in a relatively narrow segment of the
professional audio market, technological change and increased
competition in the industry, the Company's ability to manage its
rapid growth, its limited protection of technology and
trademarks, the Company's dependence on limited suppliers,
representatives, distributors, and its dependence on certain key
personnel within the Company. Accordingly, actual results may
differ, possibly materially, from the predictions contained
herein.
The Company
Since its incorporation in 1969, Pacific Research &
Engineering Corporation (PR&E) or (the Company) has produced high
quality audio products and studio design services for the radio
and television broadcasting industry. These include on-air
consoles for radio and television stations, radio production
consoles and workstations, and peripheral products as well as
technical furniture and studio design/integration services for
turnkey systems. The Company has historically targeted the top-
rated radio stations and network facilities in the major United
States (U.S.) broadcast markets, but has recently begun expanding
its product offerings and marketing efforts to target middle and
small market broadcasters in the U.S. as well as abroad.
Industry Overview
According to the Radio Advertising Bureau, an industry
analyst, radio advertisers spent the following for each calendar
year:
1994 1995 1996 1997
$10 billion $11 billion $12 billion $14 billion (est)
Radio continues to be an advertising medium of choice for
targeting specific segments of the consumer marketplace.
Opportunities created by advertising growth and changes in
Federal Communication Commission (FCC) regulations have caused
many changes in radio station ownership and operation, with new
stations, new formats, combined station facilities, local
marketing agreements (LMA) and duopoly, all creating the need for
new studio equipment and services. The Company is planning on
exploiting this need with new products and services designed to
carry the Company into new market segments both domestically and
internationally.
PAGE <4>
The radio broadcasting industry has been in transition since
the advent of television in the early 1950's. Over this period
the industry developed new programming and embraced new
technology to survive and compete effectively with the wide
variety of advertising media. Radio accounts for nearly 7% of the
total spent on advertising nationally. The Company believes that
regulatory changes by the FCC in 1996 regarding multiple station
operation are not only changing the ownership structure of the
radio broadcasting industry, but are also creating additional
applications and opportunities for the Company to introduce new
and more efficient technologies. Following a complex market size
and share formula, an entity may now own up to eight stations in
one market.
The Company's primary market has been the U.S. radio
broadcast industry, which now numbers over 13,000 operating
licensees of the FCC. Additionally, the Company has recently
placed significant focus on the international market, through
increased efforts in sales staff and presence by establishing
distributor relationships abroad and increasing its export staff.
Radio markets are commonly ranked according to data
collected on the 12+ age group population located within the
various Arbitron metro survey areas. Each radio market is
assigned a rank according to the population of the listening
area. For example, the "Top 10 Markets" are New York, Los
Angeles, Chicago, San Francisco, Philadelphia, Dallas, Detroit,
Washington DC, Houston and Boston.
The following table sets forth the Company's customers
according to market share breakdown based on the Arbitron market
ranking as of December 31, 1997.
Number of Percentage of
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Radio Market Stations PR&E Client PR&E Clients Per
Rank Market Rank(1)
1-50 1875 552 29.4%
51-100 1164 181 15.5%
101-150 753 89 11.8%
151-261 1356 90 6.6%
(1) Represents the percentage of radio stations in each Market
Rank to which the Company has sold and/or continues to sell
products. The Company's competitors may also sell products to the
same radio stations. The results set forth in the table are based
on an informal survey conducted by the Company.
Each market's radio stations are rated by Arbitron according
to their market share or listener audience. The Company has
historically targeted those stations in the top 30 markets that
have an audience rating share of 1% or greater. By targeting the
higher rated stations in the top broadcast markets, the Company
was historically able to focus its marketing and product
development efforts on the most affluent segment of the industry.
The Company has recently expanded its product offerings and
marketing efforts to target middle and smaller market stations as
well as lower-rated stations in the top markets.
Strategy
MARKETING CHANNEL DEVELOPMENT. Management plans to market the
Company's products and services worldwide by increasing domestic
and international advertising and promotional activities. The
Company recently reorganized its sales force to improve focus in
the major markets and establish channels for marketing lower-
priced products to less affluent domestic broadcasters. Along
with this reorganization, the Company has increased its
advertising and promotional activities in an effort to more
effectively reach the expanded market target. The Company is also
focusing sales and marketing efforts specifically on the nation's
large broadcast groups in order to better serve these important
corporate clients. Additionally, the Company has increased staff
and promotional activities designed to increase international
business which, until recently, has remained relatively
undeveloped.
PAGE <5>
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 TM Digital Broadcast Console, which was
introduced during the Audio Engineering Society (AES) trade show
in Munich, Germany in 1997 and commercially released during the
third quarter of 1997. Company management believes there is a
market for high technology products and services in this
category, and 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. The Company's recently expanded direct sales
force and select international dealers will sell products for
this market segment. The Company has completed the development of
the AirWave TM; a low cost on-air broadcast console, which began
shipping during March 1997. The Company is also in the final
phase of development of a new line of ready-to-assemble studio
furniture, QuikBilt TM, which offers high quality styling and
craftsmanship at a low price. The Company intends to further
expand these new product lines with other low-cost products as
well as design and integration services aimed at serving the
needs of smaller market broadcasters.
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 TM,
translates sound into data which 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 product opportunities
in the future. Additionally, the audio engine has the potential
for varied applications in the high-end multimedia market as an
audio server engine.
Products & Services
The Company's current line of products and services address
the technical operating requirements of control rooms and studios
in the broadcasting industry. The Company's products and services
are divided into three categories: Audio Control Consoles,
Manufactured Peripheral Equipment and Systems Products and
Services. The Company believes its equipment and services are
ranked among the highest in the industry in quality, reliability,
ease of use and maintenance, and customer service, among others.
1. Audio Control Consoles are audio mixing, routing and
monitoring systems. The Company manufactures a variety of
consoles, covering a wide range of applications designed to meet
the needs of major market radio and television broadcasters as
well as middle and small market radio broadcasters. Approximately
52% and 50% of sales for fiscal years 1997 and 1996, respectively,
was attributable to the console line of business.
2. Manufactured Peripheral Equipment includes
distribution amplifiers, audio switchers, digital audio
workstations, studio turrets and control panels. These products
are sold both independently and as part of system design and
integration. Approximately, 6% and 4% for fiscal years 1997 and
1996, respectively, was attributable to the sales of peripheral
equipment.
3. System Products include design, engineering and
fabrication services, which range from providing a single studio
to a complete broadcast facility. As part of the system
integration business, the Company is a distributor for third-
party manufacturers of supporting peripheral equipment. However,
the Company is not materially dependent on any third-party
manufacturer for which it distributes peripheral equipment.
Approximately 37% and 30% for fiscal years 1997 and 1996,
respectively, was attributable to this line of business.
Audio Control Consoles
Audio control consoles are modular products and are
configured according to customer specifications. Prices vary
according to console features and configuration.
PAGE <6>
INTEGRITY TM DIGITAL BROADCAST CONSOLE. The Integrity is
the Company's newest console. This console features a unique
architecture which provides a high degree of reliability while
giving broadcasters a wide range of new features and benefits as
a result of its computer control and digital signal processing
capabilities. The Integrity is designed for use in major-market
and upper medium-market applications and features an integrated
computer running the console's operating software and a sleek,
intuitive control surface and flat panel display. Integrity's
design allows broadcasters to work with any combination of
digital and analog peripheral equipment.
ABX MULTITRACK PRODUCTION CONSOLE. The ABX was designed to
provide the industry with an integrated broadcast operations
console. The console is equipped with several unique features
designed to accommodate a wide range of tasks, including live on-
air programming, telephone talk-show and stereo, and multitrack
production. The ABX is also the design "master model" for the
AMX and BMX Series III consoles listed below. These designs are
all compatible to each other in terms of key parts, circuitry,
performance and basic features and differ only in the quantity of
facilities offered by each model.
AMX STEREO PRODUCTION CONSOLE. The AMX console was a
"spin-off" of the ABX. The design shares several modules with
the ABX and offers most of the same features in a console
designed for two-channel, stereo, production techniques. The AMX
combines the features of an advanced broadcast on-air console
with a versatile stereo production console. This console is
positioned as the "center" model of the three designs, and
offers the potential client the "safest" purchasing decision
for projects where future flexibility is very important.
BMX SERIES III ON-AIR CONSOLE. The Series III console is
the latest version of the BMX Series. The Series III retains the
basic concepts developed in the earlier BMX consoles and enhances
them with features and facilities developed for the ABX and AMX
designs. The console shares many modules and components with the
AMX Model; for example, it is possible to equip a BMX Series III
with input modules from the AMX when the extra facilities of that
design are required.
STX. The STX is the Company's first audio console designed
for television operations. The STX offers several new and unique
features for stereo television audio applications plus the
traditional quality and reliability of the Company's other
console products.
NEWSMIXER TM. The Newsmixer is the Company's first audio
mixing, routing and monitoring system specifically designed for
radio news preparation, assembly and production. The Newsmixer
offers mixing and control facilities required for a news editor
to assemble and produce a news story or "actuality" for
broadcast. The operational design is efficient and provides a
range of features and capabilities in a compact package.
STEREOMIXER TM. The Stereomixer is a compact mixer with most
of the signal and logic control features of the BMX Series III
console. Appearing similar to the Newsmixer, the Stereomixer
combines extensive operational capabilities in an efficient and
easy to use package.
RADIOMIXER TM. The Radiomixer console is the Company's first
full-featured console targeted at the medium-market radio
broadcaster. Radiomixer has the features and performance expected
of the Company's consoles including an easy-to-use telephone mix-
minus system, at a price point targeted at the budget of medium-
market radio broadcasters.
PRODUCTIONMIXER TM. The Productionmixer console is the
stereo/multitrack production console companion to the Radiomixer,
and is designed to meet the production needs of medium-market
radio stations.
AIRWAVE TM. The AirWave console was introduced in 1997 to
meet the operational and budgetary needs of broadcasters in small
to medium domestic and international markets. AirWave contains
many of the same features found in the Company's more
sophisticated consoles in a very attractive and cost effective
package.
PAGE <7>
Manufactured Peripheral Equipment
SDA-8A STEREO DISTRIBUTION AMPLIFIER. The SDA-8A offers
several features not found in competitive designs such as: input
mode switching, input/output metering, very wide input level
accommodation and extensive operating headroom. With its features
and performance the SDA-8A is designed specifically for high-end
applications.
UTILITY SWITCHERS. The Company manufactures three
mechanical switching products that offer the customer a simple
method to accommodate the selection and routing of audio signals.
The three models are the LS-5, LS-10 and LS-20. These switchers
are used to select remote lines for input to a mixing console and
cross connect tape machines for transfer recording. All three of
these items were originally developed to support a particular
custom system requirement and were later developed into products
when the market need demonstrated itself.
ADX DIGITAL WORKSTATION AND MIXSTATION. The ADX is a
multitrack digital audio recording and editing workstation with
an integrated automated mixing control surface. ADX is designed
to help broadcasters improve the speed and efficiency of their
in-house production work by replacing manual tape editing with
the speed and flexibility of computer-based audio systems.
System Products and Services
SYSTEMS DESIGN. This service includes consultation with the
client to determine and design custom systems to meet particular
operational requirements. Recently, broadcasters have begun to
reduce the size of in-house technical staff and have increasingly
turned to the Company for its wide expertise and design
resources. This service is not offered independently, but only as
part of a custom system fabrication project.
CUSTOM ENGINEERING. The sale of custom broadcast systems
often entails the design and manufacture of custom panels,
switchers and other electromechanical components to meet the
client's operating needs. The Company's product engineering and
system design groups work together to develop the custom product,
with a view to future market potential. Historically, several
strong products have emerged from this custom engineering
activity.
CABINETRY FABRICATION. The Company has been designing and
manufacturing custom studio furniture since 1972. The design and
fabrication activity supports both the component level and custom
system sales. The Company manufactures both custom designed
cabinetry and two standard series, PrimeLine and QuikBilt, listed
below.
PRIMELINE TM CABINETRY. The Company introduced a line of
"standard" radio studio cabinetry at the 1990 National
Association of Broadcasters ("NAB") show. This line is designed
to satisfy many of the application requirements of the mid-market
broadcaster who does not need or cannot afford custom designed
and fabricated studio furniture. The series is constructed of
pre-manufactured panels and components to produce attractive and
functional cabinetry. In keeping with the high quality image of
the Company, the price savings are achieved through
standardization and production technology.
QUIKBILT TM CABINETRY. The Company is currently finalizing
design on a new line of ready-to-assemble studio furniture
designed to be shipped inexpensively anywhere in the world and
assembled by the client. The reduced shipping costs and the cost
benefits of pre-fabricated, standard components, will make the
price point for this line of furniture more attractive to smaller
market broadcasters.
WIRING FABRICATION. Audio and logic wiring assembly is part
of custom system services and includes the design, documentation
and fabrication of patch fields, terminal blocks and system
interconnection harnesses. The Company has developed standardized
wiring documentation, components and procedures, which are
efficient in fabrication and offer system flexibility to the
client.
INSTALLATION SERVICES. The Company offers system
installation assistance to broadcasters commissioning large
studio systems projects. Coordination and execution of these
services are typically sold on a cost-plus basis and are
performed by a combination of in-house employees and third-party
contractors under the direction of the Company.
PAGE <8>
Manufacturing
The Company uses an advanced material resource planning
system ("MRP-II") to control inventory and manpower
requirements in manufacturing. This system is fully integrated
with marketing, accounting, engineering and management to provide
information visibility, enabling the Company to forecast and
resolve potential parts and/or manpower shortfalls.
ELECTRO-MECHANICAL ASSEMBLY. The Company manufactures its
products in-house with a trained assembly staff. New production
equipment, tooling and procedures have been installed to support
the quality of the products and improve efficiency. One example
is the recent installation of several semi-automated pick and
place printed circuit assembly machines. These machines have
improved both quality and productivity.
STUDIO CABINETRY AND FURNITURE. The Company brought the production
of system cabinetry in-house during 1988. This enables the
Company to have better control of scheduling and cost compared to
exclusive reliance upon independent shops. Outside shops have
been, and will continue to be, used for accommodating peak
demands and to handle projects for which their capabilities are
better suited than those of the Company.
QUALITY ASSURANCE AND TEST OPERATIONS. The Company's quality
control procedures include source and incoming inspection,
assembly line test and final product test. The Company has
invested in Automatic Test Equipment ("ATE") to provide faster,
more thorough, and efficient testing at both assembly line and
final product levels. All assembly workers are trained in quality
control and are accountable for the high quality standards of the
Company.
METAL FABRICATION. In August 1993, the Company entered into an
agreement to sell various metal fabrication assets used in the
Company's production process to an independent third party,
Pacific Metal Fabrications, Inc. ("PMF"). In connection with
this sale, the Company agreed to allow PMF to bid on all its
future metal fabrication products. So long as PMF satisfies
certain conditions relating to product quality and delivery, and
PMF's bid is not more than 5% higher than other bids, the Company
must accept PMF's bid. During 1997 and 1996, the Company
purchased approximately $517,000 and $562,000 of metal
fabrication products from PMF, respectively. The Company believes
that this arrangement with PMF does not materially adversely
impact the Company.
The Company does not rely on subcontractors in the
manufacture of its products and services. Some manufacturing
processes are outsourced on an as-needed basis when demand
exceeds planned capacity. This outsourcing is not material and is
not dependent on a particular vendor, as the processes are
generic and available from multiple sources. Raw materials used
in the manufacture of the Company's products are also available
from multiple sources of supply. The Company designs its products
so as to not be dependent on the availability and obsolescence of
specialty parts or processes.
Marketing & Distribution
The Company's in-house sales personnel sell the Company's
products and services directly to the domestic market. The
benefits of direct sales as opposed to selling through
distributors are as follows:
Direct access to the final decision makers and end-users,
which can shorten the sales cycle and improve customer
relation.
Accurate sales forecast based on direct customer response
enable the Company to minimize inventories and maximize
inventory turns.
Feedback on upgrades and new products.
Direct management of the customer base to understand
product/market environmental changes as they occur.
Personal support of customers in post-sales and network
enhancement (add-on sales) situations.
Improved factory margins due to the elimination of dealer
commissions.
PAGE <9>
The majority of the Company's domestic sales force is based
at its California facility, and consists of Territorial Sales
Representatives and support staff, all of whom report to the
Sales Manager and the Vice President Sales & Marketing, and are
responsible for the sales of individual products and custom
engineered systems. The Customer Service Representatives and the
System Design Engineers contribute add-on sales. As part of the
growth plan, the Company plans to recruit a number of new
domestic and international sales representatives to supplement
its expanded sales force.
Internationally, the Company's products and services are
sold through selected distributors and dealers located throughout
the world. The Company currently has distributors in Germany,
France, Poland, Italy, China, Singapore/Malaysia, Korea, Mexico,
Canada, and several South American countries. The Company is
continuing to identify, qualify and establish dealer and
distributor organizations in other export markets. Management
believes that a significant portion of future growth will come
from the export markets. The Company has appointed several
international sales positions to focus on cultivating the export
markets.
The Company has solicited and been awarded a United States
General Services Agency ("GSA") contract, which allows various
federal government agencies to purchase products directly from
the Company without the usual bidding and vendor qualification
processes. GSA sales accounted for less than 1.0% of sales during
both 1997 and 1996.
The Company reaches the domestic market through direct
marketing, display advertising in industry trade magazines,
display exhibits at the annual National Association of
Broadcasters ("NAB") conventions and distribution of the
Company's newsletter, Aircheck, which is mailed to approximately
10,000 recipients two to four times per year at no cost to the
recipient. The Company also has brochures and other literature
available for its products and services. The Company has invested
in direct and display advertising, regional trade shows, product
clinics (road shows), and special promotions to improve market
penetration.
Customer Service & Product Support
Management believes customer service, including ongoing
product support, is a critical aspect of maintaining customer
relationships. The Company recognizes that its future sales
success depends upon the quality of support provided to existing
customers. The Company has therefore established a Customer
Service Department that reports directly to the operating
management and, has the ability to promptly resolve any technical
problem that may arise. As the Company grows and develops more
software-based products, the technical support function of the
Customer Service Department will be expanded to offer training
programs, applications support, and cash flow-generating software
maintenance and support agreements. The Company warranties its
products for one year. The Company's warranty claim history has
been less than one half of a percent (0.50%) per year.
Competition
The Company is not aware of any single competitor which
offers the full range of products in addition to systems design
and integration services. The Company however does have
competition in each of the product areas within the target
market, and a number have carved niches selling economy-grade
goods. In the Audio Control Console market, Auditronics,
Wheatstone, Arrakis, and Broadcast Electronics compete against
the Company. Based on an informal Company survey of the "Top 10
Markets" and the top rated radio stations in those markets, the
Company believes that it provides products and/or services to a
significant percentage of the high-end market. See "Business-
Industry Overview."
Harris/Allied is a distributor of broadcast products and
also provides systems integration services to radio and primarily
television broadcasters. Wheatstone introduced a line of studio
cabinetry in 1989 and has recently begun promoting studio
integration services, but Company management is unclear, at this
point, how or if they intend to execute these services. There are
a number of individual contract engineers and small consulting
companies who provide studio design and integration services to
the radio industry.
PAGE <10>
The Company's products have historically competed on the
basis of operating features and quality, not price. To counter-
balance the competitions' offerings and expand its market base,
the Company has introduced lower priced, high-value products,
such as the Radiomixer and more recently, the AirWave low cost
air console and QuikBilt ready-to-assemble studio furniture.
The Company sees a potential competitive threat from a trend
of mergers between, and acquisitions of, broadcast equipment
companies rather than from any one of the existing specialty
manufacturers or general distributors. It is unknown if any of
these firms have ambitions in competing with the Company's
products or system integration services. To date, the Company is
not aware of any erosion of market share as a result of such
mergers.
Technology provides a competitive threat to all companies
addressing this market. The advent of digital audio, satellite
delivered programming, computerized "operator assist" systems
and full automation are all examples of emerging technologies
seeking applications in broadcasting. The Company has products in
development and is planning new products to address the changing
technical needs of this market. There can be no assurance that
the Company will successfully develop new products or that if
developed that such products will achieve acceptance in the
marketplace.
To respond to increasingly complex products driven by
advances in technology, the Company plans to develop its new
products so that they can be used by non-technical personnel
while containing the most recent technological advances.
Research and Development and Engineering
During 1997 and 1996 the Company spent approximately
$482,000 and $433,000, respectively, on internally funded
research and development and approximately $520,000 and $155,000,
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 required for the
development of the new digital products. 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.
See "Business--Research and Development and Engineering," and
Notes A and E of Notes to Financial Statements. The amount of
research and engineering expenses capitalized for the years ending
December 31, 1997 and 1996 were approximately $1,078,000 and
$911,000, respectively. The Company has begun to amortize these
costs over a sixty-month period, of which $169,000 and $0 were
expensed for the year ending December 31, 1997 and 1996,
respectively.
Proprietary Rights, Patents, Trademarks & Copyrights
The Company holds no patents at this time. The Company has
developed several proprietary circuit design and construction
techniques that yield both measured and subjective (listening)
performance improvements. The Company also has considerable
expertise in the area of radio frequency interference ("RFI")
problems and has developed advanced construction techniques to
enable the use of high performance circuitry in the severe
environments often encountered at radio and television
transmission sites.
The Company holds registered trademarks for the name of its
industry newsletter, Aircheck as well as for several of its
products including: Radiomixer, Newsmixer, Stereomixer and
others.
Regulation
The U.S. "on-the-air" broadcast industry is regulated by
the FCC which establishes the rules and regulations for issues
ranging from license qualification and technical standards to
attempts at defining "indecent" programming. In 1996 the FCC
changed the ownership rules regarding both the total number of
broadcast properties which one entity may own, and the number of
stations owned in one market. Following a complex market size and
share formula, an entity may own up to eight stations in one
market. The Company's major customers have been in the lead in
prospecting for and acquiring additional stations in their
established markets. The "off-air" broadcast industry is not
subject to FCC regulation. These include the broadcast networks,
independent program producers and syndicators, and commercial
production houses. Current legislative proposals in Congress, if
enacted, could materially alter the rules as to station ownership
and may have other consequences for the radio and television
industries. The impact on the Company cannot be determined at
this time from the passage of such legislation.
PAGE <11>
Employees
As of December 31, 1997, the Company employed 142 persons on a
full-time basis and an additional 3 on a part-time basis. Of the
145 total employees, 89 were engaged in manufacturing and
operational support, 25 in engineering and design/drafting and 31
in marketing and administration. The Company's employees are not
represented by a union and the Company believes its relations
with its employees are excellent.
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 will be
successfully developed by the Company or if developed, that they
will achieve market acceptance.
Competition
The Company is not aware of any 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.
Furthermore, in order to remain competitive, the Company
substantially increased its research and development expenditures
in 1997. The Company is currently developing new products
incorporating digital technology, new analog technology and
Internet products for audio transmission. However, there can be
no assurance that the Company will be successful in developing
and marketing, on a timely basis, product modifications or
enhancements or new products that respond effectively to
technological advances by others.
Management of Growth
If the Company is successful in implementing its continued
growth strategy, the Company believes it could undergo a period
of 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.
PAGE <12>
Executive Officers of the Registrant
The following table sets forth the name, age and position of
each person who is an executive officer of the Company:
Name Age Position
Jack Williams 56 Chairman of the Board, Chief Executive
Officer and President
Michael Dosch 35 Vice President, Chief Operating
Officer and Director
Larry Eyler 44 Vice President, Finance, Chief Financial
Officer, Corporate Secretary & Director
David Pollard 45 Vice President, Engineering and Director
Randy Jackson 50 Vice President, Manufacturing
Susan Dingethal 44 Vice President, Sales and Marketing
Jack Williams has served as Chief Executive Officer, President
and Chairman of the Board of Directors since October 1969. Prior
to founding the Company, Mr. Williams was a professional
recording engineer and an audio and video systems designer at the
University of California, San Diego.
Michael Dosch has been a Director of the Company since
December 1995. Mr. Dosch has served in a number of positions
since he joined the Company in July 1984. Mr. Dosch was promoted
to General Manager in June of 1992 to oversee the Company's day-
to-day operations and was promoted to Vice President, Chief
Operating Officer in 1995.
Larry Eyler joined the Company in July of 1992 as the Chief
Financial Officer, and was elected a Director in December 1995.
Prior to joining the Company, Mr. Eyler was Director of Finance,
Real Estate, for The Price Company from October 1987 to July 1989,
and Chief Financial Officer for Club Merchandising from July 1989
to July 1992. Mr. Eyler also has experience with Peat, Marwick,
Mitchell & Co., CPA's and Dixieline Lumber Company.
David Pollard has been a Director of the Company since May
1996. Mr. Pollard has served as Vice President, Engineering of
the Company since December 1995, and as manager of various
operating functions since September 1985, including product
engineering, systems engineering/manufacturing as well as sales.
Mr. Pollard now oversees the technical staff responsible for
research & development, product design, and documentation.
Randy Jackson has served as Vice President, Manufacturing of
the Company since January 1997, and has served as the Company's
Production Manager since March 1993. From 1990 to 1993 Mr.
Jackson worked with Solid State Stamping as its material manager.
Mr. Jackson has many years of experience in manufacturing systems
and materials management.
Susan Dingethal has served as Vice President, Sales and
Marketing of the Company since July 1997. Prior to this Ms.
Dingethal served as Director of National Sales for Broadcast
Electronics, Inc.. During her many years of experience in
management and marketing for radio broadcasting, Ms. Dingethal
was employed by The Arbitron Company PK Network Communications Inc.
and Nationwide Communications, Inc..
PAGE <13>
ITEM 2. PROPERTIES
The Company leases two buildings of approximately 40,000 total
square feet in Carlsbad, California. The buildings house the
Company's corporate offices as well as manufacturing operations
and technical cabinet fabrication facilities. PMF, a sheet metal
fabrication company and supplier to the Company, sub-leases a
portion of one of the buildings. The buildings are approximately
eleven years old. The lease terms for the facilities are 10
years: the rental rate is approximately $22,000 per month, net of
$8,250 sublease income. The Company subsequent to year end
entered into an agreement to lease a build-to-suit property
within the same vicinity. This lease will provide a considerable
increase in space for the manufacturing and corporate
headquarters. The Company expects to occupy the new facility
during the fourth quarter of 1998.
ITEM 3. LEGAL PROCEEDINGS
As of March 30, 1998, there were no pending legal
proceedings involving the Company which, in the opinion of
management, after discussion with legal counsel, were of a
material nature.
During January 1998, the Company received a letter regarding
a claim for unlawful discharge. The Company has investigated the
factual allegations and has found no basis for the claims in the
letter. There can be no assurance, however, that the Company will
not incur significant expense in defending itself against the
claims made in the letter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's common stock and common stock purchase warrants
are traded on the American Stock Exchange (the "AMEX") Market
under the symbol "PXE;" "PXEW."
For the periods indicated below, the following table sets
forth the high and low sales prices of the Company's common stock
and common stock warrants as reported on AMEX, rounded to the
nearest tenth of a dollar. These prices do not include retail
markups, markdowns or commissions.
Common Stock Common Stock
Purchase Warrants
Year ended December 31, 1997 High Low High Low
Jan. 1 - March 31 $2.63 $2.00 $0.44 $0.19
Apr. 1 - June 30 $3.63 $2.00 $0.50 $0.25
July 1 - Sept. 30 $3.50 $2.69 $0.63 $0.25
Oct. 1 - Dec. 31 $4.75 $2.63 $0.81 $0.31
Year ended December 31, 1996 High Low High Low
May 29 - June 30 $4.13 $3.13 $0.63 $0.25
July 1 - Sept. 30 $3.88 $2.38 $0.94 $0.19
Oct. 1 - Dec. 31 $3.00 $2.00 $0.75 $0.19
As of March 30, 1998, there were approximately 997,000
shares of common stock and 500,000 redeemable common stock
purchase warrants held in account by 45 brokerage houses. The
Company believes that there are numerous "beneficial" owners of
its Common Stock who hold shares and/or common stock purchase
warrants in "street name," of which it is believed that there are
more than 400 shareholders to date.
Prior to May 28, 1996, the Company was being treated as an S
Corporation for income tax purposes under Subchapter S of the
Internal Revenue Code of 1986, as amended. As a result, the
income of the Company was not subject to federal taxation, except
for certain built-in gains tax, and was subject to state taxation
on income at a reduced rate. See Note H of Notes to Financial
Statements. The shareholders are liable for individual federal
and state income taxes on their allocated portions of the
Company's taxable income. The Company's status as an S
Corporation was automatically terminated as a result of the
Company's initial public offering. The Company during the year
ended December 31, 1997 made a final distribution to its
shareholders of certain previously taxed and undistributed S
Corporation earnings. For the years ended December 31, 1997 and
1996, the Company distributed approximately $36,000 and $695,000,
respectively, to its shareholders.
PAGE <14>
The Company's present policy is to retain earnings to
finance the Company's business. Any future dividends will be
dependent upon the Company's financial condition, results of
operations, current and anticipated cash requirements,
acquisition plans and plans for expansion, and any other factors
that the Company's Board of Directors deems relevant. The Company
has no present intention of paying dividends on its common stock
in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company derives its operating revenue from worldwide sales
of professional audio equipment. Sales outside the U.S. account
for a small portion of the Company's total sales. International
sales volumes have historically been affected by foreign currency
fluctuations relative to the U.S. dollar. The Company prices its
products in U.S. dollars worldwide. When weaknesses of local
currencies have made the Company's products more expensive, sales
to those countries have declined or may have not reached goals
placed internally by the Company.
The Company's gross margins are affected by its international
sales. Typically, gross margins from exported products are lower
than from those sold in the U.S. due to discounts offered to the
Company's international distributors. The Company expects to
increase the percentage of sales to its international markets.
This trend may have a negative effect on gross margins as sales
increase. While the Company has eliminated the commissions it was
paying to its international representative, the Company has
incurred and will continue to incur additional expenses
associated with managing international marketing and sales
internally.
The Company's gross margins are also affected by the purchase
of some components abroad. As a result of fluctuations in the
value of local currencies relative to the U.S. dollar, some of
the Company's foreign component suppliers have increased prices
and may further increase prices. The Company currently does not
employ any foreign exchange hedging strategies, but may employ
such strategies in the future.
Generally, orders are shipped within a short period of time
after receipt. In the case of new product introductions or
periods where product demand exceeds production capacity, the
Company allocates products based on contractual agreements.
Backlog has increased substantially from the prior year and is
expected to increase during 1998. Backlog is measured by the
total of in-hand firm contracts which are in-process and have not
yet invoiced by the reporting date.
The Company's gross margins have fluctuated from time to
time due primarily to inefficiencies related to the introduction
and manufacturing of new products and inefficiencies associated
with integrating new equipment into the Company's manufacturing
processes. Historically, fluctuations have also resulted from
increases in overhead, varying prices of components and
competitive pressures.
The Company plans to introduce new products and revisions
at a more rapid rate than it has in the past. Some anticipated
new products would require the implementation of manufacturing
practices with which the Company is not familiar. This could
result in lower margins, as the Company becomes more familiar
with these new manufacturing procedures. There can be no
assurance that the Company will successfully introduce new
products.
Although the Company cannot accurately anticipate the effect
of inflation, the Company does not believe inflation has had or
is likely to have a material effect on its results of operations
or liquidity.
The Company's quarterly operating results vary significantly
depending on the timing of new product introductions and
enhancements by the Company and its competitors and on the volume
and timing of orders, which are difficult to forecast. Customers
generally order on an as-needed basis, and the Company normally
ships' products within a short period of time after receipt of an
order. The results of operations for any quarter are not
necessarily indicative of the results to be expected for any
future period. A disproportionate percentage of the Company's
quarterly net revenue is typically generated in the last few
weeks of the quarter. A significant portion of the Company's
operating expenses is relatively fixed, and planned expenditures
are based primarily on sales forecasts. As a result, if revenue
generated in the last few weeks of a quarter does not meet the
Company's forecast, operating results may be materially adversely
affected.
PAGE <15>
General Overview
During 1996 and 1997, the Company achieved several significant
milestones. Immediately after completing its initial public
offering early in 1996, the Company launched a number of
strategic initiatives designed to broaden its product offerings
and to expand its market focus. Between May 1996 and December 31,
1997 the Company expanded its domestic and international sales
and marketing staff, engaged in new promotional activities,
developed and launched new technology products, and implemented
infrastructure improvements throughout the Company to support the
increased business requirements. The rapid growth in sales from
1996 to 1997 exerted pressure on the Company's management and
financial resources, but management believes that the investments
made in infrastructure and personnel will position the Company for
the foreseeable future.
Results of Operations
The following table sets forth for the periods indicated,
comparatives and percentages which certain items in Selected
Operating Data bear to total revenue.
Year to Year
Increase (Decrease)
Percentage of Sales 1997 1996
Year Ended December 31, Compared Compared
1997 1996 1995 to 1996 to 1995
----- ----- ----- ----- -----
Net sales 100.0 100.0 100.0 59.7 10.8
Cost of sales 57.1 59.1 59.8 54.2 9.5
----- ----- ----- ----- -----
Gross profit 42.9 40.9 40.2 67.5 12.8
General and administration
(including depreciation/
amortization) 17.8 19.7 16.3 43.3 34.5
Selling and marketing 15.0 14.0 11.2 70.6 39.2
Research, development &
engineering 8.1 7.6 7.8 70.5 8.8
----- ----- ----- ----- -----
Operating (loss) income 2.0 (0.4) 4.9 ** **
Interest, net (0.2) (0.0) (0.9) ** **
Other expense (income) 0.3 0.7 (0.1) (50.7) **
----- ----- ----- ----- -----
Income before income
taxes 2.1 0.3 3.9 ** (88.6)
----- ----- ----- ----- -----
** - greater than 100% or immaterial
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Sales increased approximately $4,592,000 or 59.7%, from
$7,696,000 in 1996 to $12,288,000 in 1997. The Company
experienced a nearly 49% increase in sales of its console
products from $5,515,000 in 1996 to $8,194,000 in 1997, as well
as an 118% increase in its custom systems and cabinetry business
from $1,304,000 in 1996 to $2,844,000 in 1997. These increases
are directly attributable to the strong market acceptance of the
Integrity digital console and AirWave analog console, both
introduced in 1997 and the continued demand for the Company's
goods and services created by the consolidation in the radio
industry. Additionally, the Company has invested heavily in sales
and marketing since going public in May 1996 and believes much of
its sales growth is attributable to these expanded marketing
efforts. See "Management's Discussion and Analysis-Selling and
Marketing Expenses." The Company ended the year with a backlog of
nearly $3.5 million.
PAGE <16>
Cost of sales increased $2,466,000 or 54.2%, from $4,547,000
in 1996 to $7,013,000 in 1997, due largely in part to the
increase in revenues. However, cost of sales, as a percentage of
revenue, decreased 2.0%, from 59.1% in 1996 to 57.1% in 1997.
This margin improvement reflects a shift in product mix, to
higher margin products, as well as a reduction in fixed costs,
through enhanced inventory procurement and handling, and improved
manufacturing processes. The Company believes that as the sales
volume increases, the gross margin will increase incrementally as
fixed costs inherent in its manufacturing processes are amortized
over a broader sales base.
General and administrative expenses (including depreciation
and amortization) increased approximately $657,000 or 43.3%, to
$2,176,000 in 1997 from $1,519,000 in 1996. This increase was due
to additional personnel, expenditures related to the Company's
increased business volume and an increase in depreciation and
amortization expenses from $188,000 in 1996 to $413,000 in 1997.
The Company amortized approximately $169,000 in capitalized
software development costs in 1997 per SFAS 86 compared to none
in 1996. See Notes A and E of Notes to Financial Statements for
further discussion of the Company's policy of capitalization and
amortization of software development costs. General and
administrative expenses, as a percentage of sales, decreased 1.9%
(from 19.7% to 17.8%), largely due to the increase in revenues
for 1997.
Selling and marketing expenses increased approximately
$762,000 or 70.6%, from $1,079,000 in 1996 to $1,841,000 in 1997.
A majority of the increase focused on trade shows and general
advertising as the Company introduced new products, increased its
internal sales staff and developed new collateral marketing
materials. Additionally, the Company hired a vice-president of
sales & marketing, and invested in the growth of its
international business. The Company believes that its investment
in these areas is largely responsible for the sales increase
discussed above. Selling and marketing expenses as a percentage
of sales increased slightly (14.0% to 15.0%) during 1997.
Research, development and engineering expenses increased
approximately $414,000 or 70.5%, from $587,000 in 1996 to
$1,001,000 in 1997, due primarily to the additions of software
and mechanical engineers to support the development and
maintenance of the company's new digital and analog products.
Additionally, the Company has capitalized certain 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. See "Business--Product Development
Status," and Notes A and E of Notes to Financial Statements.
Total costs capitalized during the year ended December 31, 1997
amounted to $1,078,000 compared to $911,000 in 1996 and
amortization of such costs amounted to $169,000 for the year
ended December 31, 1997 compared to none for the year ending
December 31, 1996. Research, development and engineering, as a
percentage of sales, increased 0.5% from 7.6% in 1996 to 8.1% in
1997.
Income from operations increased approximately $292,000, from
a loss of $36,000 in 1996 to operating income of $256,000 in
1997, primarily due to the increased volume of sales noted above
and efficiencies created in the manufacturing processes. For the
same reason, operational income as a percentage of sales
increased to 2.0% in 1997 compared to a loss of 0.4% in 1996.
"Interest, net" increased approximately $27,000 or 924.0%
from $3,000 in 1996 to $30,000 in 1997. Of the two components
from which it is derived, interest expense decreased
approximately $3,000 or 3.8%, from $78,000 in 1996 to $75,000 in
1997. Although bank debt increased from $500,000 in 1996 to
$1,300,000 in 1997, the Company was able to negotiate more
favorable interest rates in 1997 versus 1996, thus reducing
overall interest expense. The increase in debt was due to the
increased draws on the line of credit for working capital
purposes. See Note G to Financial Statements for further
discussion of the Company's bank credit facilities.
The remaining component, interest income decreased
approximately $30,000 or 40.1%, from $75,000 in 1996 to $45,000
in 1997. The Company during the year 1997 liquidated a
significant portion of the investment account, approximately
$815,000 for 1997. See "Liquidity and Capital Resources" for a
discussion on Company financing.
Net income before taxes increased approximately $230,000 or
730.3%, from $31,000 in 1996 to $261,000 in 1997. As a percentage
of sales, net income before income taxes increased 1.72% from
0.41% in 1996 to 2.13% in 1997.
An income tax benefit of $38,200 was recognized for the year
ending December 31, 1997. This income tax benefit was based upon
an overall effective benefit rate of (15.0%) applied to temporary
timing differences, which consisted of various items of income
recognized for tax purposes and not for financial reporting
purposes. The income tax provision for the year ending December
31, 1996 of $20,700 was based upon an overall effective rate of
66.0%. This rate was caused by various items of income being
recognized for financial reporting purposes and not for tax
purposes. The decrease in the overall effective rate from 1996 to
1997 was due to various income tax benefits and credits provided
by an increase in financial reporting inventory value, which for
tax purposes includes certain additional costs and the reduction
of research and development expenditures and credits available
for tax purposes. This accounts for a significant amount of the
Company's deferred tax asset base and current years income tax
benefit.
PAGE <17>
The effective tax rate for the years ending December 31,
1997 and 1996 differ substantially from the federal statutory
rate of 34%, due to differences between accounting rules and tax
laws causing differences between the bases of certain assets and
liabilities for financial reporting purposes and tax purposes.
The tax effects of these differences, to the extent they are
temporary, are recorded as deferred tax assets and liabilities
under SFAS 109. See Note H to Financial Statements for further
discussion of the Company's income tax provision and deferred
taxes. The Company believes that the effective tax rate will be
more reflective of the federal statutory rates for future years
as the amount of unrecognized deferred tax assets and liabilities
are reduced.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Sales increased $751,000 or 10.8%, from $6,945,000 in 1995 to
$7,696,000 in 1996. The Company believes the sales increase was
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 caused a number of the existing,
well established, broadcasting companies to aggressively acquire
radio stations throughout the United States and has inspired some
mergers of large broadcasting companies and several new ventures
which has increased purchases and retrofitting of broadcasting
equipment.
Additionally, radio advertising revenues grew, providing the
capital broadcasters need to consolidate and upgrade their
facilities, which generally translated into increased demand for
the Company's goods and services.
Cost of sales increased nearly $394,000 or 9.5%, from
$4,153,000 in 1995 to $4,547,000 in 1996, due to the sales
increase, but remained essentially unchanged as a percent of
revenues for 1996 compared to 1995. The Company continually
evaluated its inventory purchasing and handling policies, as well
as its manufacturing processes, to ensure the maintenance of, and
improvement to gross margins. Accordingly, gross margin increased
by $358,000 or 12.8% from $2,791,000 in 1995 to $3,149,000 in
1996 due primarily to the increase in sales, but increased
slightly as a percentage of revenues from 40.2% in 1995 to 40.9%
in 1996.
General and administrative expenses (including depreciation
and amortization) increased by $390,000 or 34.5% to $1,519,000 in
1996 from $1,129,000 in 1995. As a percentage of revenue, general
and administrative expenses increased by 3.4%, from 16.3% in 1995
to 19.7% in 1996.
This increase was due, primarily, to additional expenses
incurred in connection with the Company's initial public offering
completed in May 1996. The Company also incurred increased
payroll costs and benefits, professional services, and expenses
associated with the donation of radio equipment to a public radio
broadcast facility early in 1996. Additionally, the Company's
annual depreciation expense increased by $128,000 pursuant to the
Company's increase in capital assets purchased during the year
ended December 31, 1997.
Selling and marketing expenses increased nearly $304,000 or
39.2%, from $775,000 in 1995 to $1,079,000 in 1996. The increase
reflects the hiring of a sales manager and staffing of an
expanded sales department as well as increased spending on
advertising and marketing materials for new product releases.
Selling and marketing expenses as a percentage of revenue
increased 2.8% from 11.2% in 1995 to 14.0% in 1996.
Research, development and engineering expenses increased
$47,000 or 8.8%, from $540,000 in 1995 to $587,000 in 1996. The
primary reasons for the increase were 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. The Company capitalized certain development costs relating
to the coding, testing and other expenditures related to new
products that were to be sold, leased or otherwise marketed, in
accordance with the provisions of Statement of Financial
Accounting Standards No. 86. See "Business--Research and Deveopment
and Engineering," and Notes A and E of Notes to Financial Statements.
The amount of capitalized research and engineering expenses for 1996
was approximately $911,000. Research and engineering, as a
percentage of sales, decreased 0.2% from 7.8% in 1995 to 7.6% in
1996.
PAGE <18>
Income from operations decreased by $383,000 or 110.4% from
$347,000 in 1995 to a loss of $36,000 in 1996, primarily due to
the increase in sales and marketing expenses and general and
administrative expenses since the Company's initial public
offering in May of 1996. The Company invested significantly in
infrastructure and personnel in the implementation of its growth
initiatives as outlined in its initial public offering
registration statement. Operating income in the fourth quarter of
1996 was adversely affected by this investment of capital.
Operating income, as a percentage of revenue, decreased by 5.3%,
from 4.9% in 1995 to (0.4%) in 1996.
Interest expense increased by $14,000 from $64,000 in 1995
to $78,000 in 1996. The Company earned interest income of $75,000
on its surplus cash compared to zero during 1995. See Notes A and
G of Notes to Financial Statements for further discussion of the
Company's bank credit facilities and cash investment activities.
The Company incurred a gain of approximately $16,000
resulting from an upgrade to an enhanced CAD/Engineering software
package. The gain has been classified as other income in the
financial statements.
Net income before taxes decreased by $245,000 or 88.6%, from
$276,000 in 1995 to $31,000 in 1996, primarily due to the
increased expenditures for sales and marketing and general and
administrative expenses.
Liquidity and Capital Resources
The Company's principal capital requirements during 1997 and
1996 were to fund the expansion of its internal sales department,
increase advertising and marketing, increase engineering and
development of new products and the development and penetration
of worldwide markets. The Company has historically satisfied its
cash requirements through cash flows from operations and bank
borrowings. Under some project contracts, the Company requires
deposits upon project acceptance, then invoices the customer
based upon the completion of specified conditions and/or
milestones. Depending upon the stage of completion and the size
of the contract, it may be necessary for the Company, from time
to time, to finance a portion of its working capital needs until
the realization of income from the milestones has been achieved.
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 years
ending December 31, 1997 and 1996.
The Company completed its initial public offering May 28, 1996
and realized net proceeds of approximately $4.1 million after
underwriting discounts and offering expenses. As of December 31,
1997 the Company had no cash or cash equivalents and had incurred
a overdraft of approximately $145,000.
The Company's current ratio at December 31, 1997 was 1.4
compared to 2.8 at December 31, 1996. The decrease was
attributable, primarily, to the Company's borrowings on its line
of credit and an increase in accounts payable. For the same
reasons, the Company experienced a decrease in working capital of
approximately $1,312,000 from $2,795,000 at December 31, 1996 to
$1,483,000 at December 31, 1997.
The Company's operating activities consumed cash of $542,000
for the year ended December 31,1997, primarily due to an increase
in inventory ($1,267,000), an increase in unrealized revenue
recognized on the percentage of completion basis ($456,000) and
an increase in prepaid expense and other assets ($322,000),
primarily a result of capitalized engineering expenses in
accordance with Statement of Financial Accounting Standards No.
86. The Company received cash from customer deposits totaling
$589,000 in 1997, offsetting the cash uses detailed above.
Cash used in investing activities for the year ended
December 31, 1997 totaled $955,000. Such investing activities
involved purchases of property and equipment necessary to support
the manufacturing and testing of the new digital and analog product
offerings introduced in 1997. The Company had no significant
capital expenditure commitments at December 31, 1997. The
Company intends to finance its 1998 capital expenditures from
cash provided by operations and cash reserves.
Cash provided by financing activities was $887,000 for the
year ended December 31, 1997, consisting primarily, of the
proceeds from borrowings on the Company's line of credit of
$1,519,000, offset by payments toward the line of $719,000,
capital leases of $22,000 and shareholder distributions (of
previously taxed income from the Subchapter S income years) of
$36,000.
As a result of the above the Company experienced a decrease
in cash and cash equivalents from $611,000 as of December 31, 1996
to none for the year ended December 31, 1997.
PAGE <19>
As of December 31, 1997 the Company had drawn down a
significant portion of its revolving line of credit in the
amount of $1,300,000. Additionally, the Company was in violation
with respect to certain of its loan convenants. The Company's loan
convenants as of December 31, 1997 were as follows: a tangible
net worth in excess of $3,750,000 as of the end of each fiscal
quarter and $4,000,000 as of the end of the fiscal year; a quick
ratio of 1.25 to 1.00; a minimum balance of cash and marketable
securities of $1,000,000; and total liabilities to tangible net
worth of not greater than .60 to 1.00. The Company, as of
December 31, 1997, was out of covenant with respect to two of the
four covenants. The Company's lending institution agreed to
waive, in all respects, the convenant violations, and the Company
has renegotiated and modified, subsequent to year end, its credit
facility and loan covenants as follows: on March 11, 1998 the
Company secured a fully amortizing term loan in the principal
amount of $750,000, the proceeds from which will be used to pay
down the $1,500,000 revolving line. The term loan is for a
duration of 36 months and carries an interest rate of LIBOR plus
three percent. The revolving line remains at $1,500,000, with a
one year renewal option and interest at LIBOR plus two percent.
The convenants have been modified as follows: minimum tangible
net worth of $3,500,000; a current ratio of 1.50 to 1.00; cash
flow to debt service ratio of 1.50 to 1.00; and total liabilities
to tangible net worth not greater than 1.25 to 1.00. The Company
expects to remain in compliance with the covenants as proposed
for this new debt facility. See Note G of Notes to Financial
Statements for further explanation to the loan covenants and
credit facility. The above loans are secured by substantially all
of the assets of the Company.
The Company's current ratio at December 31, 1996 was 2.8
compared to 1.5 at December 31, 1995. The increase was
attributable, primarily, to the proceeds from the Company's
initial public offering less costs incurred completing the
offering. For the same reasons, the Company experienced an
increase in working capital of approximately $2,093,000 from
$702,000 at December 31, 1995 to $2,795,000 at December 31, 1996.
The Company experienced a net increase in cash of $610,000
during the year ended December 31, 1996 compared to a net
decrease of $146,000 for the year ended December 31, 1995. The
primary uses of cash in 1995 were for development of new products
($227,000), and an increase in accounts receivable ($133,000).
Cash flows from investing activities used $447,000, while
financing activities provided $114,000.
Although the Company cannot accurately anticipate the effects
of inflation, the Company does not believe inflation has had or
is likely to have a material effect on its results of operations
or liquidity.
S Corporation Distributions
Prior to May 28, 1996, the Company was being treated as an
S Corporation for income tax purposes under Subchapter S of the
Internal Revenue Code of 1986, as amended. As a result, the
income of the Company was not subject to federal taxation, except
for certain built-in gains tax, and was subject to state taxation
on income at a reduced rate. See Note G of Notes to Financial
Statements. The shareholders are liable for individual federal
and state income taxes on their allocated portions of the
Company's taxable income. The Company's status as an S
Corporation was automatically terminated as a result of the
Company's initial public offering.
The Company during the year ended December 31, 1997 made final
distributions to its shareholders of certain previously taxed and
undistributed S Corporation earnings. For the years ended
December 31, 1997 and 1996, the Company distributed approximately
$36,000 and $695,000, respectively, to its shareholders. The
Company made the final distribution during the first quarter of
1997 from cash on hand.
Impact Of Year 2000.
The Year 2000 Issue is the result of computer programs being
written using two digits rather than four to define the
applicable year. Any of the Company's computer programs that have
time-sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000. This could result in a
system failure or miscalculations causing disruption of normal
business activities.
Based on a recent and ongoing assessment, the Company has
determined that it will be required to modify or replace portions
of its software and software that has been sold to customers so
that computer systems will function properly with respect to
dates in the year 2000 and thereafter. The Company presently
believes that with modifications to existing software or
conversions to new software, the Year 2000 Issue will not pose
significant operational problems and will not materially affect
future financial results.
PAGE <20>
The Company has initiated communications with its significant
suppliers and major customers to determine the extent to which
the Company is vulnerable to any third party's failure to remedy
their own Year 2000 issues.
The Company will utilize both internal and external resources
to modify, or replace, and test software for Year 2000
compliance. The Company currently anticipates completing the Year
2000 project within one year, but not later than March 31, 1999,
which is prior to any anticipated impact on its operating
systems.
The costs of the project, which at the current time are
projected to be immaterial, and the date on which the Company
believes it will complete Year 2000 modifications are based on
management's best estimates, which were derived utilizing
numerous assumptions of future events, including the continued
availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these
estimates will be achieved and actual results could materially
differ from those anticipated.
Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), and Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 130
establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains and losses)
in a full set of general purpose financial statements. SFAS 131
establishes standards for the way that public business
enterprises report information about operating segments in annual
financial statements and requires that those enterprises report
selected information about operating segments in interim
financial reports. It also establishes standards for related
disclosures about products and services, geographic areas and
major customers. Both standards must be adopted in 1998 and are
not expected to have a significant impact on the Company's
disclosures.
PAGE <21>
ITEM 7. FINANCIAL STATEMENTS AND SELECTED FINANCIAL DATA.
The financial Statements together with the report thereon of
Harlan & Boettger, LLP are included in this report commencing at
Page F-1.
SELECTED FINANCIAL DATA
The data set forth below is qualified by reference to, and
should be read in conjunction with, the financial statements and
notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere
in this report. The following selected financial data of the
Company as of December 31, 1997 and 1996 and for the years ended
December 31, 1997, 1996 and 1995, are derived from the financial
statements of the Company audited by Harlan & Boettger, LLP,
independent accountants. This information should be read in
conjunction with the financial statements and notes thereto and
"Management's Discussion and Analysis of Financial Condition and
Results of Operations," set forth elsewhere in this report.
Balance sheets at December 31, 1997 and 1996 and the related
statements of income and cash flow for the three years ended
December 31, 1997 and notes thereto appear elsewhere in this
report. The pro forma income statement data for the periods shown
below is unaudited.
Year Ended December 31
1997 1996 1995
----------- ----------- -----------
Statement of Income Data:
Net sales $12,287,973 $ 7,696,160 $ 6,944,737
Cost of sales 7,013,069 4,547,132 4,153,472
Gross profit 5,274,904 3,149,028 2,791,265
General and administrative 1,763,602 1,331,438 1,069,774
Selling and marketing 1,840,711 1,079,137 775,281
Research and development 481,694 432,657 397,813
Engineering 519,749 154,552 142,092
Depreciation and amortization 412,828 187,588 59,228
Total operating expenses 5,018,584 3,185,372 2,444,188
Income (loss) from operations 256,320 (36,344) 347,077
Other income (expense), net 4,824 67,796 (70,653)
Income before income taxes 261,144 31,452 276,424
Income taxes (benefit) (38,200) 20,700 7,400
Net income 299,344 10,752 269,024
Net income per share 0.13 0.01
Weighted average common
shares outstanding 2,305,500 1,888,833
Statement of Income Data: (1)
Pro forma income before income taxes $276,424
Pro forma provision for income taxes 116,000
Pro forma net income 160,424
Pro forma net income per share 0.12
Weighted average common shares outstanding 1,305,500
December 31,
1997 1996 1995
Balance Sheet Data: ----------- ----------- -----------
Working capital $ 1,483,139 $ 2,797,384 $ 702,196
Total assets 8,669,852 6,535,324 3,022,396
Total long-term debt and
capital lease obligations 18,968 37,156 370,155
Total shareholders' equity 5,048,177 4,804,030 1,355,560
(1) Prior to May 28, 1996 the Company was exempt from payment of
federal income taxes and paid certain state income taxes at a
reduced rate as a result of an S Corporation election made by the
Company. Pro forma income statement data reflect the income tax
expense that would have been recorded had the Company not been
exempt from paying taxes under the S Corporation election. As a
result of terminating the Company's S Corporation status upon
completion of the initial public offering, the Company was
required to record a one-time non-cash credit to earnings as a
reduction of income tax expense for additional deferred tax
benefit based upon the increase in the effective tax rates from
the Company's S Corporation status to C Corporation status. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operation" and Note H of Notes to Financial
Statements. See Note Q of Notes to Financial Statements for
weighted average shares outstanding for previous periods.
PAGE <22>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
None.
PART III
Certain information required by Part III is omitted from this
Report, in that the Company will file its Proxy Statement
pursuant to Regulation 14A not later than 120 days after the end
of the fiscal year covered by this Report, and certain
information included therein is incorporated by reference.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The information relating to the directors of the Company is
incorporated by reference from the Company's Proxy Statement
filed in connection with the Company's Annual Meeting of
Stockholders to be held on May 21, 1998 (the "Proxy Statement")
as set forth under the caption "Election of Directors."
Information relating to the executive officers of the Company is
set forth in Part I of this Report under the caption "Executive
Officers of the Registrant." Information with respect to
compliance with Section 16(a) of the Exchange Act is incorporated
by reference to the Proxy Statement as set forth under the
caption "Section 16(a) Beneficial Ownership Reporting
Compliance."
ITEM 10. EXECUTIVE COMPENSATION
The information relating to executive compensation is
incorporated by reference to the Proxy Statement under the
caption "Executive Compensation and Other Matters."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information relating to ownership of equity securities
of the Company by certain beneficial owners and management is
incorporated by reference to the Proxy Statement as set forth
under the caption "General Information--Stock Ownership of
Certain Beneficial Owners and Management."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related
transactions is incorporated by reference to the Proxy Statement
under the caption "Certain Transactions."
PAGE <23>
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.
a) The following documents are filed as part of this report:
1) The following financial statements of the Company are filed
as a part of this report.
Page
Independent Auditors' Report F-1
Balance Sheets as of December 31, 1997 and 1996 F-2
Statements of Income for the years ended
December 31, 1997, 1996 and 1995 F-3
Statement of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995 F-4
Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 F-5
Notes to Financial Statements F-6
All other schedules are omitted because they are not
applicable or the required information is shown in the
financial statements or notes thereto.
2) Exhibits. The Exhibits listed in the accompanying Exhibit
index are filed or incorporated by reference as part of this
Report.
b) Reports on Form 8-K.
The Company filed no reports on Form 8-K during fiscal 1997.
PAGE <F-1>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
PACIFIC RESEARCH & ENGINEERING CORPORATION:
We have audited the accompanying balance sheets of Pacific
Research & Engineering Corporation (a California corporation) as
of December 31, 1997 and 1996, and the related statements of
income, shareholders' equity and cash flows for the years ended
December 31, 1997, 1996 and 1995. These financial statements are
the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial
statements 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, the financial statements referred to above
present fairly, in all material respects, the financial position
of Pacific Research & Engineering Corporation as of December 31,
1997 and 1996, and the results of its operations and its cash
flows for the years ended December 31, 1997, 1996 and 1995, in
conformity with generally accepted accounting principles.
/S/Harlan & Boettger, LLP
San Diego, California
February 25, 1998, except for
Note U, as to which, the date
is March 11, 1998
PAGE <F-2>
PACIFIC RESEARCH & ENGINEERING CORPORATION
BALANCE SHEETS
<TABLE>
December 31,
1997 1996
---------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ - $ 610,857
Investment in securities (Note O) 185,251 1,002,715
Accounts receivable, less allowance for doubtful
accounts of $15,000 for 1997 and 1996 844,048 620,919
Contracts in progress (Note B) 456,139 75,000
Inventories, net (Note C) 3,014,183 1,747,388
Deferred taxes (Note H) 128,000 85,100
Prepaid expenses (Note T) 402,225 250,943
---------- ----------
TOTAL CURRENT ASSETS 5,029,846 4,392,922
---------- ----------
PROPERTY AND EQUIPMENT, net (Note D) 1,352,857 902,251
---------- ----------
OTHER ASSETS
Intangibles, net (Note E) 2,046,773 1,137,730
Other (Note F) 240,376 102,421
---------- ----------
2,287,149 1,240,151
---------- ----------
TOTAL ASSETS $8,669,852 $6,535,324
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Overdraft $ 144,701 $ -
Line of credit (Note G) 1,300,000 500,000
Accounts payable 882,155 594,258
Accrued expenses (Note S) 328,724 195,430
Customer advances 860,593 271,710
Capital lease obligations - current
portion (Note I) 30,534 34,140
---------- ----------
TOTAL CURRENT LIABILITIES 3,546,707 1,595,538
DEFERRED TAXES (Note H) 56,000 98,600
CAPITAL LEASE OBLIGATIONS, net of
current portion (Note I) 18,968 37,156
---------- ----------
TOTAL LIABILITIES 3,621,675 1,731,294
---------- ----------
COMMITMENTS AND CONTINGENCIES (Notes I and L) - -
SHAREHOLDERS' EQUITY (Note M)
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 853,347 590,410
Net unrealized gain on investment in
securities (Note O) 18,438 2,715
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 5,048,177 4,804,030
---------- ----------
$8,669,852 $6,535,324
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
PAGE <F-3>
PACIFIC RESEARCH & ENGINEERING CORPORATION
STATEMENTS OF INCOME
<TABLE>
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
NET SALES (Note N) $12,287,973 $ 7,696,160 $ 6,944,737
COST OF SALES 7,013,069 4,547,132 4,153,472
----------- ----------- -----------
GROSS PROFIT 5,274,904 3,149,028 2,791,265
----------- ----------- -----------
OPERATING EXPENSES
General and administrative 1,763,602 1,331,438 1,069,774
Selling and marketing 1,840,711 1,079,137 775,281
Research and development 481,694 432,657 397,813
Engineering 519,749 154,552 142,092
Depreciation and amortization 412,828 187,588 59,228
----------- ----------- -----------
TOTAL OPERATING EXPENSES 5,018,584 3,185,372 2,444,188
----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS 256,320 (36,344) 347,077
----------- ----------- -----------
OTHER INCOME (EXPENSES)
Interest and dividend income 44,877 74,933 -
Interest expense (74,952) (77,870) (64,362)
Gain on sale of assets - 16,087 250
Gain on sales of investment in securities 13,878 - -
Other 21,021 54,646 (6,541)
----------- ----------- -----------
TOTAL OTHER INCOME (EXPENSES) 4,824 67,796 (70,653)
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 261,144 31,452 276,424
Income tax benefit (expense) (Note H) 38,200 (20,700) (7,400)
----------- ----------- -----------
NET INCOME $ 299,344 $ 10,752 $ 269,024
=========== =========== ===========
BASIC EARNINGS PER SHARE (Note Q)
Net income $ 299,344 $ 10,752 $ 269,024
=========== =========== ===========
Earnings per average basic common share $ 0.13 $ 0.01
=========== ===========
WEIGHTED AVERAGE BASIC SHARES
OUTSTANDING 2,305,500 1,888,833
=========== ===========
FULLY DILUTED EARNINGS PER SHARE
(Note Q)
Net income $ 299,344 $ 10,752
=========== ===========
Earnings per average fully diluted
common share $ .13 $ .01
=========== ===========
WEIGHTED AVERAGE FULLY DILUTED SHARES
OUTSTANDING 2,331,769 1,888,833
=========== ===========
PRO FORMA FOR 1995 (UNAUDITED) (Notes A and H)
Income before income taxes $ 276,424
Pro forma income taxes (116,000)
-----------
Pro forma net income $ 160,424
===========
Earnings per average basic and fully diluted common share $ 0.12
===========
WEIGHTED AVERAGE BASIC AND FULLY DILUTED
COMMON SHARES OUTSTANDING 1,305,500
===========
</TABLE>
The accompanying notes are an integral part of these financial
statements.
PAGE <F-4>
PACIFIC RESEARCH & ENGINEERING CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
Additional Unrealized
Common Stock Paid-in Retained Gain(Loss)
Shares Amounts Capital Earnings on Securities Total
---------- ---------- ---------- ---------- ---------- ----------
(Note M)
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 1,305,500 $ 81,179 - $1,049,887 $ - $1,131,066
Net income - - - 269,024 - 269,024
Distributions to shareholders (Note M) - - - (44,530) - (44,530)
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 1995 1,305,500 81,179 - 1,274,381 - 1,355,560
Net proceeds from initial
public offering 1,000,000 4,079,726 - - - 4,079,726
Proceeds from sale of common
stock warrants - - 50,000 - - 50,000
Net income - - - 10,752 - 10,752
Distributions to shareholders (Note M) - - - (694,723) - (694,723)
Net unrealized gain on
investment in securities (Note O) - - - - 2,715 2,715
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 1996 2,305,500 4,160,905 50,000 590,410 2,715 4,804,030
Adjustments to proceeds from
initial public offering (Note L) - (34,513) - - - (34,513)
Net income - - - 299,344 - 299,344
Distributions to shareholders (Note M) - - - (36,407) - (36,407)
Net unrealized gain on
investment in securities (Note O) - - - - 15,723 15,723
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 1997 2,305,500 $4,126,392 $ 50,000 $ 853,347 $ 18,438 $5,048,177
========== ========== ========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial
statements.
PAGE <F-5>
PACIFIC RESEARCH & ENGINEERING CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
Year Ended December 31,
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 299,344 $ 10,752 $ 269,024
Adjustments to reconcile net income to
net cash used in operating activities:
Depreciation and amortization 412,828 187,588 149,112
Deferred income taxes (85,500) 23,640 (202)
Gain on sale of assets - 16,087 250
Gain on sale of investment in securities 13,878 - -
Changes in operating assets and liabilities:
Accounts receivable (223,129) (46,137) (132,674)
Contracts in progress (381,139) (75,000) -
Inventories (1,266,795) (637,952) (59,943)
Prepaid expenses and other assets (321,881) (28,951) (190,068)
Accounts payable 287,897 36,033 296,605
Accrued expenses 133,294 9,452 21,802
Customer advances 588,883 (57,671) (166,481)
----------- ----------- -----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (542,320) (562,159) 187,425
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (694,036) (514,282) (219,531)
Purchases of investments (30,358) (1,000,000) -
Proceeds from sales of investments in securities 845,107 - -
Purchases of software development costs (1,075,750) (722,448) (227,168)
----------- ----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (955,037) (2,236,730) (446,699)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Overdraft 144,701 - -
Net proceeds on line of credit 800,000 500,000 780,908
Payments on notes payable - (496,468) (595,747)
Payments under capital lease obligations (21,794) (29,289) (27,059)
Distributions to shareholders (36,407) (694,723) (44,530)
Proceeds from initial public offering - 4,079,726 -
Proceeds from common stock warrants - 50,000 -
----------- ----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 886,500 3,409,246 113,572
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH (610,857) 610,357 (145,702)
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 610,857 500 146,202
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ - $ 610,857 $ 500
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
PAGE <F-6>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
A. Organization and 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.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with
maturities of three months or less to be cash equivalents.
INVESTMENT IN SECURITIES
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. The Company's marketable securities are
categorized as available for sale securities, as defined by
Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity
Securities." Unrealized gains and losses are reported as a
separate component within the shareholders' equity section
of the balance sheet. Realized gains and losses on all
marketable securities are determined using the average cost
method and are charged or credited to current earnings.
ACCOUNTS RECEIVABLE
The Company sells and grants credit to broadcast companies,
primarily located throughout the United States, during
normal course of business (See Note N). The Company
performs ongoing credit evaluations of its customers'
financial condition and collateral is generally not
required.
PAGE <F-7>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
A. Organization and Summary of Significant Accounting Policies:
(continued)
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. The Company's policy is to evaluate
the remaining lives and recoverability in light of current
conditions. It is at least reasonably possible that the
Company's estimates of lives and recoverability will change.
INTANGIBLE ASSETS
Intangible assets consist of capitalized software costs
incurred for the development of software after technological
feasibility has been established. These expenditures are
principally related to new products, and whose costs were
capitalized in accordance with the provisions of Statement
of Financial Accounting Standards No. 86, "Accounting for
the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed." Capitalized software costs are being
amortized on a product-by-product basis using the straight-
line method over the remaining estimated economic useful
life of the products which as been established as five
years. It is at least reasonably possible that the
Company's estimate of the useful lives will change.
CUSTOMER ADVANCES
Advance payments received from customers are deferred and
recognized as revenue upon shipment.
REVENUE RECOGNITION
Revenue from product sales is generated primarily from the
manufacture and sale of radio studio broadcasting equipment.
The period of time from initial order to final shipment of
the product typically ranges from two to six weeks. Revenue
is recognized when the equipment is shipped.
Revenues from fixed-price and modified fixed-price contracts
are recognized on the percentage-of-completion method,
measured by the percentage of actual costs incurred to date
to estimated total costs for each contract. This method
(costs-to-cost) is used because management considers
expended actual costs to be the best available measure of
progress on these contracts.
Contract costs include all direct material and labor costs
and those indirect costs related to contract performance,
such as indirect labor, supplies, tools, repairs, and
depreciation costs. Selling, general and administrative
costs are charged to expense as incurred. Provisions for
estimated losses on uncompleted contracts are made in the
period in which such losses are determined. Changes in job
performance, job conditions, and estimated profitability,
including those arising from contract penalty provisions,
and final contract settlements may result in revisions to
costs and income and are recognized in the period in which
the revisions are determined. An amount equal to contract
costs attributable to claims is included in revenues when
realization is probable and the amount can be reliably
estimated. It is at least reasonably possible that these
estimates will change.
The asset, "contracts in progress," represents revenues
recognized in excess of amounts billed.
PAGE <F-8>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
A. Organization and Summary of Significant Accounting Policies:
(continued)
FAIR VALUE
The Company has cash for which the carrying value
approximates fair value due to the short term nature of
these instruments. The carrying amount of the line of
credit approximates fair value since the interest rate
fluctuates with the lending bank's prime rate.
RECLASSIFICATION
Certain prior period amounts have been reclassified to
conform with the current year's presentation. These
reclassifications have no effect on previously reported net
income.
ADVERTISING
Advertising costs are generally charged to operations in the
year incurred and totaled $305,519, $223,591 and $150,889
for the years ended December 31, 1997, 1996 and 1995,
respectively.
RESEARCH AND DEVELOPMENT
Research and development costs, consisting principally of
engineering, design and development costs devoted to
creating new products or improving existing products, are
expensed as incurred.
INCOME TAXES
Income taxes, including pro forma computations, are provided
in accordance with Statement of Financial Accounting
Standards No. 109 (SFAS 109), "Accounting for Income Taxes."
Deferred taxes are recognized for temporary differences in
the basis of assets and liabilities for financial statement
and income tax reporting. A provision has been made for
income taxes due on taxable income and for the deferred
taxes on the temporary differences. The components of the
deferred tax asset and liability are individually classified
as current and non-current based on their characteristics.
Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will
not be realized. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on
the date of enactment.
STOCK OPTION PLAN
Effective January 1, 1996, the Company adopted a method of
accounting for stock-based compensation plans as required by
Statement of Financial Accounting Standard No. 123 (FAS No.
123) "Accounting for Stock-Based Compensation." FAS No. 123
allows for two methods of valuing stock-based compensation.
The first method allows for the continuing application of
APB No. 25 in measuring stock-based compensation, while
complying with the disclosure requirements of FAS No. 123.
The second method uses an option pricing model to value
stock compensation and record as such within the financial
statements. The Company will continue to apply APB No. 25,
while complying with FAS No. 123 disclosure requirements
(see Note R).
PAGE <F-9>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
A. Organization and Summary of Significant Accounting Policies:
(continued)
EARNINGS PER SHARE
Earnings per share are provided in accordance with Statement
of Financial Accounting Standard No. 128 (FAS No. 128)
"Earnings Per Share." Basic earnings per share are computed
by dividing earnings available to common stockholders by the
weighted average number of common shares outstanding during
the period. Diluted earnings per share reflect per share
amounts that would have resulted if dilutive potential
common stock had been converted to common stock. As
required by FASB No. 128, prior year earnings per share
amounts have been restated. Earnings per share for the
years ended December 31, 1996 and 1995 did not change as a
result of this restatement.
B. Contracts in Progress:
The following is a summary of contracts in progress as of
December 31, 1997 and 1996:
1997 1996
----------- -----------
Costs incurred on uncompleted
contracts $ 224,547 $ 36,921
Estimated earnings 231,592 38,079
----------- -----------
456,139 75,000
Less: Billings to date - -
----------- -----------
$ 456,139 $ 75,000
=========== ===========
Included in the accompanying balance sheets are the following:
Contracts in progress $ 456,139 $ 75,000
=========== ===========
C. Inventories:
Inventories at December 31, 1997 and 1996 are summarized as
follows:
1997 1996
----------- -----------
Raw materials $ 1,666,885 $ 969,180
Work-in-process 676,630 328,574
Finished goods 695,668 474,634
----------- -----------
3,039,183 1,772,388
Less reserve for obsolescence (25,000) (25,000)
----------- -----------
Inventories, net $ 3,014,183 $ 1,747,388
=========== ===========
PAGE <F-10>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
D. Property and Equipment:
Property and equipment at December 31, 1997 and 1996 are
summarized as follows:
1997 1996
----------- -----------
Machinery and equipment $ 1,520,981 $ 1,185,798
Furniture and fixtures 830,189 800,550
Leasehold improvements 667,749 638,348
----------- -----------
3,018,919 2,624,696
Less accumulated depreciation and
amortization (1,965,875) (1,722,445)
Self-constructed assets not placed
in service 299,813 -
----------- -----------
Property and equipment, net $ 1,352,857 $ 902,251
=========== ===========
Depreciation expense was $243,430, $187,588 and $59,228 for
the years ended December 31, l997, 1996 and 1995 respectively.
E. Intangible Assets:
Intangible assets at December 31, 1997 and 1996 are
summarized as follows:
1997 1996
----------- -----------
Capitalized software costs $ 2,216,171 $ 1,137,730
Less accumulated amortization (169,398) -
----------- -----------
Intangible assets, net $ 2,046,773 $ 1,137,730
=========== ===========
Amortization of software costs were $169,398, $0, $0, for the
years ended December 31, 1997, 1996 and 1995, respectively.
F. Other Assets:
Other assets at December 31, 1997 and 1996 are summarized as
follows:
1997 1996
----------- -----------
Deposits $ 203,876 $ 93,696
Employee loan 6,500 8,725
Architectural design 30,000 -
----------- -----------
$ 240,376 $ 102,421
=========== ===========
PAGE <F-11>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
G. Line of Credit:
The Company has a line of credit facility with a bank which
expires in May 1998. The line bears interest at the bank's
LIBOR rate plus 2.00%, 8% at December 31, l997. The line of
credit provides for maximum borrowings of $1,500,000, and is
secured by substantially all assets of the Company. At
December 31, 1997, the Company had $200,000 of available
credit under the line. This facility contains certain
covenants, as defined, for which, as of December 31, 1997
the Company was in violation. Financial covenants and
ratios are as follows: minimum tangible net worth of at
least $4,000,000, a ratio of total liabilities to tangible
net worth of not greater than 0.60 to l.00 and a ratio of
current assets to current liabilities of at least 1.50 to
1.00. Management received a waiver from the financial
institution for certain covenant violations as of
December 31, 1997. In January 1998, the Company amended
the line of credit and extended the maturity date. The
above information reflects the amended terms of this facility.
H. Income Taxes:
For the tax period ended May 29, 1996 and the year ended
December 31, 1995, 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 Note L 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 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 December 31, 1995, 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.
Deferred taxes are comprised primarily of temporary
differences relating to inventory valuation, certain
reserves, accruals, and software development costs
capitalized for book purposes, but expensed for tax
purposes.
The Company has research and development and manufacturer's
credit carryforwards of approximately $19,000 and $41,000,
respectively. The credit carryforwards will expire in
fifteen (15) years, if not utilized.
The components of the provision for income taxes are as
follows:
1997 1996 1995
----------- ----------- -----------
Current:
Federal $ (46,500) $ - $ -
State (800) (800) (7,602)
----------- ----------- -----------
(47,300) (800) (7,602)
----------- ----------- -----------
Deferred:
Federal 19,000 17,000 -
State 66,500 (36,900) 202
----------- ----------- -----------
85,500 (19,900) 202
----------- ----------- -----------
$ 38,200 $ (20,700) $ (7,400)
=========== =========== ===========
PAGE <F-12>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
H. Income Taxes: (continued)
PRO FORMA INCOME TAXES
The accompanying statements of income includes the unaudited
pro forma income tax provision for 1995, 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 income taxes, assuming the Company was subject to
C Corporation income taxes for the entirety of the period,
are as follows:
Pro forma
1995
(Unaudited)
----------
Federal $ 89,500
States taxes, net of federal benefits 26,500
----------
$ 116,000
==========
The reconciliation of the federal statutory rate for income
taxes is as follows:
Pro forma
1995
1997 1996 (Unaudited)
------ ------ ------
Statutory federal rate 34% 34% 34%
State taxes, net of federal
benefits 6 6 6
Adjustment for prior year
deferred taxes calculated
as an S-corporation - 32 -
Benefit of tax adjustments (55) (6) 2
------ ------ ------
(15%) 66% 42%
====== ====== ======
The components of deferred tax assets (liabilities) as of
December 31, 1997 and 1996 are as follows:
Deferred tax assets:
1997 1996
----------- -----------
Credit carryforwards $ 67,000 $ 214,000
Nondeductible reserves 32,000 16,400
Nondeductible accruals 16,000 11,900
Inventory 195,000 56,800
Valuation allowance (115,000) -
----------- -----------
Total deferred tax assets $ 195,000 $ 299,100
=========== ===========
PAGE <F-13>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
H. Income Taxes: (continued)
Deferred tax liabilities:
1997 1996
----------- -----------
Property and equipment $ (71,000) $ (36,200)
Software development costs (52,000) (276,400)
----------- -----------
Total deferred tax liabilities (123,000) (312,600)
----------- -----------
Net deferred tax asset (liability) $ 72,000 $ (13,500)
=========== ===========
These amounts have been presented in the Company's financial
statements as follows:
1997 1996
----------- -----------
Deferred tax assets, Current $ 128,000 $ 85,100
Deferred tax liabilities, Noncurrent (56,000) (98,600)
----------- -----------
$ 72,000 $ (13,500)
=========== ===========
The Company's valuation allowance for the years ended
December 31, 1997 and 1996 increased $115,000 and $0,
respectively. It is at least reasonably possible that the
estimated valuation allowance will change.
I. Commitments and Contingencies:
OPERATING LEASES
The Company leases its facilities under a noncancelable
operating lease which expires in May 2005. The
noncancelable operating lease provides that the Company pays
for property taxes, insurance and certain other operating
expenses applicable to the leased premises. Rent expense for
the years ended December 31, 1997, 1996 and 1995 was
$377,077, $383,440 and $221,375, respectively. The Company
subleases space in one of the buildings to an unrelated
third party and received rent of $99,000, $99,000 and
$63,525 for the years ended December 31, 1997, 1996 and
1995, respectively. The sublease agreement will be assigned
to the lessor in October 1998, releasing the Company from
any future responsibility or liability as set forth in the
lease agreement.
At December 31, 1997, minimum annual rent payable and
sublease income under the noncancelable leases are as
follows:
Rent Payable Sublease Income
--------------- ---------------
1998 $ 368,573 $ 74,250
1999 292,559 -
2000 304,261 -
2001 316,433 -
2002 330,156 -
Thereafter 821,040 -
--------------- ---------------
Total $ 2,433,022 $ 74,250
=============== ===============
PAGE <F-14>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
I. Commitments and Contingencies: (continued)
The Company has paid a nonrefundable deposit as part of an
agreement to enter into a lease for a build-to-suit
property. This property will provide a considerable
increase in space for the manufacturing and corporate
headquarters. The Company expects to occupy the new
facility during the fourth quarter of 1998.
CAPITAL LEASES
The Company leases equipment under capital leases. The
economic substance of the capital lease agreements is that
the Company finances the acquisition of equipment, and
accordingly, they are recorded as a capital lease
obligation and the asset as a component of property and
equipment. The following is an analysis of the book value
of the leased assets included in property and equipment as
of December 31, 1997 and 1996.
1997 1996
----------- -----------
Cost $ 170,274 $ 155,297
Accumulated depreciation (118,043) (84,737)
----------- -----------
$ 52,231 $ 70,560
=========== ===========
The future minimum lease payments under capitalized leases
and the present value of the net minimum lease payments as
of December 31, 1997 are as follows:
1998 $ 34,207
1999 15,192
2000 4,623
2001 771
-----------
54,793
Less amount representing interest (5,291)
-----------
Present value of net minimum lease payments 49,502
Less current portion of capital lease obligations (30,534)
-----------
$ 18,968
===========
PAGE <F-15>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
I. Commitments and Contingencies: (continued)
PURCHASE COMMITMENTS
During August 1993, the Company entered into an agreement to
sell certain assets and certain liabilities associated with
the Company's former sheet metal fabrication process to an
unrelated third party (the "Buyer"). In connection with
the sale, the Company agreed to allow the Buyer to bid on
all of the Company's future metal fabrication orders, if the
Buyer can satisfy certain quality control and delivery
schedule requirements. Under this agreement, the Company is
obligated to accept the Buyer's bid if the bid does not
exceed 8% of other bids through August 1994, and 5% for bids
thereafter. The Company purchased approximately $516,862,
$562,561, and $454,700 of metal fabrication from the Buyer
for the years ended December 31, 1997, 1996 and 1995,
respectively.
OTHER
The Company is subject to numerous federal, state, and local
environmental laws and regulations. Management believes
that the Company is in material compliance with such laws
and regulations and that potential environmental
liabilities, if any, are not material to the financial
statements.
J. 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 all employees with at least one year employment with
the Company to make contributions, 20% of which will be
matched by the Company, up to 14% 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 periods ended December 31, 1997,
1996 and 1995. Company contributions vest at a rate of 20%
per year, beginning after two years of employment. The
Company has made matching contributions to the Plan of
approximately $44,232 for the year ended December 31, 1997.
The Company pays the administrative costs of the Plan,
which approximates $5,000.
K. Supplemental Cash Flow Information:
Supplemental disclosures of cash flow information for the
years ended December 31, 1997, 1996 and 1995 are summarized
as follows:
1997 1996 1995
----------- ----------- -----------
Cash paid for:
Interest $ 74,952 $ 77,870 $ 64,362
Income taxes $ 16,000 $ 800 $ 21,000
PAGE <F-16>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
L. Initial Public Offering:
Effective May 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 transferrable
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 Prospectus,
one share of common stock at $8.00 per share. Commencing
from the date of the Prospectus, 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. In 1997, the Company
determined that proceeds from the initial public offering
were overstated by $34,513 due to an increase in Directors &
Officers insurance expense directly attributable to the
Company's public offering.
M. Shareholders' Equity:
S CORPORATION DISTRIBUTIONS
For the years ended December 31, 1997, 1996 and 1995, the
Company distributed $36,407, $694,723, and $44,530,
respectively, to its shareholders. Distributions to
shareholders were paid on previous years earnings. The
Company's status as an S Corporation automatically terminated
following the initial public offering (the "S Corporation
Termination Date").
COMMON STOCK
In 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 stated for the
stock splits.
WARRANTS
Warrants outstanding in addition to those discussed in Note L
above at December 31, 1997 and 1996 consist of warrants
granted to a director/officer 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. A summary of
warrants outstanding at December 31, 1997 and 1996 is as
follows:
1997 1996
----------- -----------
Officer/director warrants $ 100,100 $ 100,100
IPO Unit warrants 500,000 500,000
Representatives warrants 50,000 50,000
----------- -----------
$ 650,100 $ 650,100
=========== ===========
As of December 31, 1997 and 1996, no warrants had been
exercised in connection with these issuances.
PAGE <F-17>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
N. Segment and Geographic Data:
The Company is engaged in one line of business, the
manufacturing and selling of professional radio studio
broadcasting equipment. The Company does not have any
employees, capital expenditures or other assets that are
permanently located outside of the United States.
The Company's operations consist primarily of sales of
products to both domestic and foreign markets. Information
about the sales of the Company by geographical markets is
presented below for the years ended December 31, 1997 and
1996. For the year ended December 31, 1995 foreign sales
were immaterial to the financial statements and, therefore,
are not presented.
1997 1996
----------- -----------
Europe $ 152,976 $ 164,218
Central America 137,554 40,345
Canada 136,096 27,693
Middle East - 191,287
Southeast Asia 34,635 1,926
Mexico 14,916 13,802
South Africa 27,785 -
Caribbean 6,534 -
Australia 2,152 -
Other foreign countries 4,281 -
----------- -----------
Total foreign sales 516,929 439,271
Total domestic sales 11,771,044 7,256,889
----------- -----------
$12,287,973 $ 7,696,160
=========== ===========
O. Investment in Securities:
Cost and fair value of securities available for sale at
December 31, 1997 are as follows:
Unrealized Unrealized
Cost Gains Losses Fair Value
---------- --------- --------- ----------
Debt Securities $ 166,813 $ 18,438 $ - $ 185,251
Cost and fair value of securities available for sale at
December 31, 1996 are as follows:
Unrealized Unrealized
Cost Gains Losses Fair Value
---------- --------- --------- ----------
Debt Securities $1,000,000 $ 2,715 $ - $1,002,715
The unrealized gain on marketable securities, which is
included as a separate component of shareholders' equity in
the accompanying balance sheets, increased by $16,353 during
1997.
PAGE <F-18>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
P. Major Customer:
For the year ended December 31, 1997 the Company had a major
customer, sales to which exceeded 10% of the Company's
revenues. Sales to this customer were approximately
$1,464,000, or 12% of net sales, for the year ended December
31, 1997. The related accounts receivable balance from this
customer as of December 31, 1997, was approximately $78,000.
Q. Earnings Per Share:
The following reconciles amounts reported in the financial
statements for the years ended December 31, 1997 and 1996,
respectively.
<TABLE>
1997 1996
------------------------------------ ------------------------------------
Income Shares Per-Share Income Shares Per-Share
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Income available to
common stockholders
basic earnings per share $ 299,344 2,305,500 $ .13 $ 10,752 1,888,833 $ .01
========== ==========
Effect of dilutive securities
options - 26,269 - -
---------- ---------- ---------- ----------
Income available to common
stockholders diluted earnings
per share $ 299,344 2,331,769 $ .13 $10,752 1,888,833 $ .01
========== ========== ========== ========== ========== ==========
</TABLE>
During 1997 and 1996, the corporation had 650,100 warrants
outstanding, each convertible into one share of common stock.
In addition, the Company had outstanding stock options in
1997 and 1996 issued and available to officers and employees
of the Company. These warrants and stock options were not
included in the computation of diluted earnings per share
because the coverage market price of common stock during the
respective periods was lower than the exercise prices.
R. Stock Options:
The Company has granted stock options pursuant to its Omnibus
Stock Plan adopted in 1996, which can be exercised to
purchase one share of common stock each at the option price.
Options that have been granted and are outstanding generally
expire 10 years from the date of grant and become exercisable
at the rate of 20% per year based on the number of full years
the options are held from the date of grant (with the
exception of 760,000 options granted in 1996 to certain key
persons which will become vested December 31, 2003 at a price
of $5.50 a share). At December 31, 1997, a total of
1,015,000 options were outstanding, of which 57,000 were
exercisable. Options granted under the plan in 1997 had
exercise prices ranging from $2.25 to $3.00 per share. Stock
option transactions are summarized as follows:
PAGE <F-19>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
R. Stock Options: (continued)
Weighted Average
Stock Options Price Per Share
----------- -----------
Outstanding, December 31, 1995
Granted 760,000 $ 5.50
Exercised -
Canceled -
-----------
Outstanding, December 31, 1996 760,000 $ 5.50
Granted 255,000 $ 2.60
Exercised -
Canceled -
-----------
Outstanding, December 31, 1997 1,015,000 $ 4.77
===========
Exercisable, December 31, 1996 -
===========
Exercisable, December 31, 1997 57,000
===========
Had compensation cost for options granted in 1997 and 1996
been determined based on the fair values at the grant dates,
as prescribed in FAS 123, the Company's pro forma net
income/(loss) and pro forma net income/(loss) per share would
have been as follows:
1997 1996
----------- -----------
Net income
As reported $ 299,344 $ 10,752
Pro forma $ 261,731 $ 455
Net income per share
As reported $ .13 $ .01
Pro forma $ .11 $ .00
The above referenced calculations to estimate the fair value
of options were made using the Black-Scholes pricing model
which required making significant assumptions. These
assumptions include the expected life of the options, which
was determined to be the vesting period, the expected
volatility, which was based on fluctuations of the stock
price over a 12 month period and the risk free interest rate,
which was estimated using the bond equivalent yield at
December 31, 1997.
PAGE <F-20>
PACIFIC RESEARCH & ENGINEERING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Continued)
S. Accrued Expenses:
Accrued expenses at December 31, 1997 and 1996 consists of
the following:
1997 1996
----------- -----------
Accrued payroll $ 139,123 $ 101,860
Accrued payroll taxes and
benefits 103,224 79,915
Warranty reserve 40,679 -
Accrued sales tax 14,641 13,655
Property tax 6,057 -
Other 25,000 -
----------- -----------
$ 328,724 $ 195,430
=========== ===========
T. Prepaid Expenses:
Prepaid expenses at December 31, 1997 and 1996 consists of
the following:
1997 1996
----------- -----------
Trade show fees $ 162,611 $ 42,567
Product brochures 144,956 97,360
Technical manuals 57,198 -
Insurance 14,053 32,272
Trademark registration 12,239 -
Maintenance contracts 6,624 5,891
Property tax 4,544 3,653
Income tax - 69,200
----------- -----------
$ 402,225 $ 250,943
=========== ===========
U. Subsequent Event:
On March 11, 1998, the Company secured a $750,000 note
payable bearing interest at the bank's LIBOR plus 3.00%. The
note is secured by property and equipment. The note is to be
repaid in monthly principal installments of $20,833, plus
interest, and is due in full on March 15, 2001.
The following is a summary of principal maturities of this
debt:
Year ending December 31,
------------------------
1998 $ 187,500
1999 250,000
2000 250,000
2001 62,500
----------
$ 750,000
==========
PAGE <F-21>
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use of our report included in the Registrant's
Form 10-KSB dated February 25, 1998 relating to the financial statements
of Pacific Research & Engineering Corporation.
Harlan & Boettger, LLP
San Diego, California
March 30, 1998
CONSENT OF HARLAN & BOETTGER, LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement on Form S-8 pertaining to the 1996 Omnibus Stock Plan
of Pacific Research & Engineering Corporation of our report dated
February 25, 1998, with respect to the consolidated financial
statements and schedule of Pacific Research & Engineering
Corporation for the year ended December 31, 1997 included in its
annual report on Form 10-KSB filed with the Securities and Exchange
Commission.
Harlan & Boettger, LLP
San Diego, California
March 30, 1998
PAGE <25>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act of
1934, the registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 30, 1998
Pacific Research & Engineering Corporation
By: /S/Jack Williams
Jack Williams
President, Chief Executive Officer, Chairman of the Board
PAGE <26>
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in
the capacities and on the date indicated.
Title Date
/S/ Jack Williams Director, President, March 30, 1998
Chief Executive
Officer, and Chairman
of the Board
/S/ Larry Eyler Director, Secretary, March 30, 1998
Chief Financial
Officer, and Vice
President of Finance
(Principal Financial
Officer)
/S/ Michael Dosch Director, Chief March 30, 1998
Operating Officer,
and Vice President
/S/ David Pollard Director, March 30, 1998
Engineering-Vice
President
/S/ John Lane Director March 30, 1998
/S/ Michael Bosworth Director March 30, 1998
/S/ John Robbins Director March 30, 1998
/S/ Herb McCord Director March 30, 1998
PAGE <27>
Exhibit Index
3.1 Articles of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
4.1 Warrant Agreement (1)
4.2 Warrant Certificate (1)
4.3 Stock Certificate (1)
4.4 Unit Certificate (1)
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)(3)
10.4 Employment Contract by and between the Registrant and
Michael Dosch (1)(3)
10.5 Employment Contract by and between the Registrant and
Larry Eyler (1)(3)
10.6 Employment Contract by and between the Registrant and
David Pollard (1)(3)
10.7 1996 Omnibus Stock Plan and form of Stock Option
Agreement thereunder (1)(3)
10.8 Asset Purchase Agreement between the Registrant and
Pacific Metal Fabricators, Inc. (1)
10.9 Employment Contract by and between the Registrant and
Susan Dingethal (2)(3)
23.1 Consent of Harlan & Boettger, LLP, Independent Auditors
23.2 Consent of Harlan & Boettger, LLP, Independent Auditors
27.1 Financial Data Schedule.
(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 10-QSB,
September 30, 1997, and incorporated herein by reference.
(3) Executive Compensation Plans and Agreements.
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<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 0
<SECURITIES> 185,251
<RECEIVABLES> 859,048
<ALLOWANCES> (15,000)
<INVENTORY> 3,014,183
<CURRENT-ASSETS> 5,029,846
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<DEPRECIATION> (1,965,875)
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<CURRENT-LIABILITIES> 3,546,707
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0
0
<COMMON> 4,126,392
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<TOTAL-LIABILITY-AND-EQUITY> 5,048,177
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<INCOME-PRETAX> 261,144
<INCOME-TAX> (38,200)
<INCOME-CONTINUING> 299,344
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<EXTRAORDINARY> 299,344
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