<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter ended March 31, 1997 COMMISSION FILE NUMBER 0-1817
NETWORKS ELECTRONIC CORP.
- --------------------------------------------------------------------------------
(exact name of registrant as specified in its charter)
CALIFORNIA 95-1770469
------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation of organization) Number)
9750 De Soto Avenue, Chatsworth, California 91311
- --------------------------------------------------------------------------------
(Address or principal executive offices)
(818) 341-0440
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the close of business of
CLASS 1,671,221
----------------------------- --------------------------
Common Stock - $.25 par value Outstanding at May 5, 1997
1
<PAGE> 2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
- -----------------------------
NETWORKS ELECTRONIC CORP.
CONDENSED BALANCE SHEETS
(UNAUDITED)
March 31, 1997 and June 30, 1996
<TABLE>
<CAPTION>
March 31, June 30,
1997 1996
---------- ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 362,340 $ 99,114
Trade accounts receivable - net 535,970 753,159
Other receivables 50,047 68,000
Inventories - net 1,146,351 1,043,256
Prepaid expenses and deposits 50,951 19,577
Deferred income taxes 9,469 9,469
Other assets, current portion 16,383 --
---------- ----------
Total current assets 2,171,511 1,992,575
---------- ----------
PROPERTY AND EQUIPMENT, AT COST:
Land 131,773 131,773
Building and improvements 3,440,660 2,194,703
Machinery and equipment 4,355,306 4,335,926
---------- ----------
7,927,739 6,662,402
Less accumulated depreciation 5,713,765 5,627,847
---------- ----------
Property and equipment, net 2,213,974 1,034,555
---------- ----------
DEFERRED INCOME TAXES,
NON-CURRENT PORTION 161,295 254,795
OTHER ASSETS, NON-CURRENT PORTION 38,250 --
---------- ----------
Total assets $4,585,030 $3,281,925
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 3
NETWORKS ELECTRONIC CORP.
CONDENSED BALANCE SHEETS
(UNAUDITED)
March 31, 1997 and June 30, 1996
<TABLE>
<CAPTION>
March 31, June 30,
1997 1996
---------- -----------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Notes payable and current
maturities of long-term debt $ 188,405 $ 120,000
Notes payable, related parties -
current portion 100,000 50,667
Accounts payable 406,898 535,013
Customer advances and deposits 25,485 --
Current portion of pre-petition debt:
Adjudication award payable 5,472 56,059
Accrued pension liability 182,000 188,800
Other payables 28,842 31,315
Other accrued expenses 195,375 175,840
---------- -----------
Total current liabilities 1,132,477 1,157,694
---------- -----------
LONG-TERM DEBT:
Long-term payables 290,477 --
Long-term debt, less current maturities 2,812,725 1,890,236
Notes payable, related parties -- 29,555
Accrued pension liability 413,948 446,850
Adjudication award payable 37,570 --
---------- -----------
COMMITMENTS AND CONTINGENCIES -- --
---------- -----------
STOCKHOLDERS' DEFICIENCY IN ASSETS:
Common stock, par value $.25 per share;
authorized 10,000,000 shares, issued
and outstanding 1,671,221 shares 417,805 417,805
Additional paid-in capital 280,985 280,985
Accumulated deficit (433,491) (573,734)
Stock subscriptions receivable (14,063) (14,063)
Pension liability adjustment (353,403) (353,403)
----------- ----------
Total stockholders'
deficiency in assets (102,167) (242,410)
----------- ----------
Total liabilities and stockholders'
deficiency in assets $ 4,585,030 $ 3,281,925
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
NETWORKS ELECTRONIC CORP.
CONDENSED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
1997 1996 1997 1996
---------------------- -----------------------
<S> <C> <C> <C> <C>
Sales $1,066,760 $ 930,536 $2,974,772 $2,955,155
Cost of sales 781,963 672,846 2,202,031 2,029,228
---------- --------- ---------- ----------
Gross profit 284,797 257,690 772,741 925,927
Selling, adminis-
trative and other
operating expenses 245,857 200,546 583,062 530,979
---------- --------- ---------- ----------
Operating income 38,940 57,144 189,679 394,948
Other income (exp.):
Loss on disposition
of property -- -- -- (7,273)
CRA debt forgiveness 45,565 -- 132,735 --
Vendor debt
forgiveness 40,296 -- 40,296 --
Interest and non-
operating expenses,
net (53,585) (55,671) (153,848) (164,443)
Rental income, net 11,586 -- 11,586 --
Insurance proceeds 14,095 -- 14,095 --
---------- --------- ---------- ----------
Income before
income taxes 96,897 1,473 234,543 223,232
Income tax provision
(benefit) 39,100 (300) 94,300 89,500
---------- --------- ---------- ----------
Net income $ 57,797 $ 1,773 $ 140,243 $ 133,732
========== ========= ========== ==========
Net income
per share $ .03 $ .00 $ .08 $ .08
========== ========= ========== ==========
Average weighted
number of shares
outstanding 1,671,221 1,596,221 1,671,221 1,596,221
========== ========= ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
NETWORKS ELECTRONIC CORP.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
March 31, March 31,
1997 1996
------------------ -----------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 140,243 $ 133,732
--------- ---------
Adjustments to reconcile net income
to net cash used in
operating activities:
Non-cash items included
in net income:
Depreciation and
amortization 85,918 93,384
Loss on disposition
of property - 7,273
Deferred income taxes 93,500 87,200
Changes in:
Receivables 235,142 272,625
Inventories (103,095) (201,657)
Prepaid expenses and deposits (31,374) (68,029)
Other assets (54,633) -
Accounts payable and
accrued expenses 166,407 31,316
Customer advances and deposits 25,485 (11,585)
Income taxes - (6,276)
Accrued pension liability (39,702) (26,324)
--------- ---------
Total adjustments 377,648 177,927
Net cash provided by
operating activities 517,891 311,659
--------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 6
NETWORKS ELECTRONIC CORP.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
March 31, March 31,
1997 1996
----------------- -----------------
<S> <C> <C>
Cash flows from investing activities:
Capital expenditures $(1,265,337) $(114,069)
Net proceeds from disposition
of property - 64,627
----------- ---------
Net cash used in
investing activities (1,265,337) (50,342)
----------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings 1,083,239 63,430
Proceeds from notes payable,
related parties 122,000 -
Mortgage debt reduction (90,000) (113,126)
Other payments of long-term debt (2,345)
Payments on notes payable,
related parties (102,222) (38,000)
----------- ---------
Net cash provided by (used in)
financing activities 1,010,672 (87,696)
----------- ---------
Net increase in
cash and cash equivalents 263,226 173,621
Cash and cash equivalents
at beginning of period 99,114 117,494
----------- ---------
Cash and cash equivalents
at end of period $ 362,340 $ 291,115
=========== =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 800 $ 9,500
========= =========
Interest paid $ 156,725 $ 173,040
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE> 7
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1997
1. BASIS OF PRESENTATION
---------------------
In the opinion of the Company, the accompanying unaudited financial
statements contain all adjustments necessary to present fairly its
financial position and the results of its operations and cash flows for
the periods shown.
Certain prior period amounts have been reclassified to conform to the
current period's presentation.
The preparation of the Company's financial statements in conformity with
generally accepted accounting principles necessarily requires management
to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates. The results of operations for the respective
three and nine month periods are not necessarily indicative of the results
to be expected for a full year of operations.
2. INVENTORIES
-----------
Inventories are valued at the lower of cost (FIFO) or market. The
inventories at March 31, 1997 and June 30, 1996 consisted of the
following:
<TABLE>
<CAPTION>
March 31, June 30,
1997 1996
---------- ----------
<S> <C> <C>
Raw materials $ 236,121 $ 133,818
Work in process 636,839 376,998
Finished goods and components 478,391 742,091
--------- ----------
1,351,351 1,252,907
Less progress payments - (49,651)
Less reserve for obsolescence (205,000) (160,000)
--------- ----------
Total $1,146,351 $1,043,256
========== ==========
</TABLE>
7
<PAGE> 8
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1997
3. OTHER ASSETS
------------
Other assets totaling $54,633 at March 31, 1997 consist of deferred
charges related to the lease of space at the Company's facility in
Chatsworth (see Note 9 below) in the amount of $45,300 and loan fees of
$9,333 pertaining to additional financing obtained in March 1997. These
deferred charges are being amortized over periods ranging from
approximately two to five years. At March 31, 1997, the current portion
was $16,383 and the non-current portion was $38,250.
4. LONG-TERM DEBT
--------------
At March 31, 1997 and June 30, 1996, the Company's long-term debt
consisted of the following:
<TABLE>
<CAPTION>
March 31, June 30,
1997 1996
---------- ----------
<S> <C> <C>
Note payable to bank, secured by
deed of trust on land and building,
principal payable in monthly
installments of $10,000 through
June 2000, with interest payable
monthly at a reference rate plus 2.25%
(10.75% at March 31, 1997 and 10.50%
at June 30, 1996, respectively). A
balloon payment is due in June 2000. $1,732,528 $1,822,528
Note payable to Community Redevelopment
Agency ("CRA"), non-interest bearing,
construction loan, secured by second
deed of trust on land and building,
no principal payments required through
April 2001, with level monthly
principal payments applicable
over 20 years through April 2021. 939,872 187,708
</TABLE>
8
<PAGE> 9
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1997
4. LONG-TERM DEBT (Continued)
--------------------------
<TABLE>
<CAPTION>
March 31, June 30,
1997 1996
---------- ----------
<S> <C> <C>
Note payable to lessee, secured by third
deed of trust on land and building
and assignment of rents, principal
payable in monthly installments of
$1,052 through March 2002, with
interest payable monthly at an
annual rate of 10.0%. 63,148 --
Note payable to financial institution,
secured by machinery and equipment,
principal payable in monthly
installments of $4,167 along with
interest at a reference rate plus
2.75% (11.25% at March 31, 1997)
through March 1999. A balloon
payment is due March 1999. 250,000 --
Note payable to finance company, secured
by telephone equipment, payable in
monthly installments of $656
including interest at approximately
18%. Matures in October 2001. 15,582 --
---------- ----------
3,001,130 2,010,236
Less current maturities 188,405 120,000
---------- ----------
Total $2,812,725 $1,890,236
========== ==========
</TABLE>
At March 31, 1997, additional borrowing available on the note payable to
lessee was $224,852 (authorized for building improvements) and on the note
payable to financial institution was $150,000.
9
<PAGE> 10
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1997
5. NOTES PAYABLE, RELATED PARTIES
------------------------------
(a) In January 1995, the Company received a $152,000 loan from the estate
of its former president and chief executive officer, secured by specific
machinery and equipment. The loan was being repaid in equal monthly
principal installments of $4,222 (plus interest at 10%) over a three year
period. A loan fee of $2,000 was charged to consummate the transaction.
The outstanding loan balance at June 30, 1996 was $80,222, of which
$50,667 was the current portion. In March 1997, the Company obtained other
financing and paid off the remaining principal balance of $42,222.
Interest expense on this note during the nine month periods ended March
31, 1997 and 1996 was $4,296 and $8,391, respectively.
(b) In August 1996 the Company's vice president loaned the Company
$100,000 at an annual interest rate of 13%, secured by the Company's
accounts receivable. Interest is payable monthly with the principal fully
due and payable on September 1, 1997. Through March 31, 1997, interest
expense on this loan amounted to $7,835.
(c) In September 1996 a director advanced the Company $22,000 for a fee of
$200. The money was repaid by the Company in October 1996.
6. GAINS AND LOSSES ON DISPOSITION OF PROPERTY
-------------------------------------------
During the nine months ended March 31, 1996, the Company sold fully
depreciated machinery for $13,500, and sold its Florida condominium
property at a loss of $20,773, resulting in a net loss from disposition of
property of $7,273 during the period.
7. FORGIVENESS OF DEBT
-------------------
During the nine months ended March 31, 1997, the Community Redevelopment
Agency ("CRA") disbursed funds in the amount of approximately $884,899 for
the retrofit and repair of the Company's damaged building at its
Chatsworth site. The damage was sustained as a result of the Northridge
Earthquake in January 1994. Of this commitment, 15% or approximately
$132,735 was a grant and was recorded as forgiveness of debt income for
the period. At March 31, 1997, cumulative funds disbursed by the CRA since
the inception of the loan
10
<PAGE> 11
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1997
7. FORGIVENESS OF DEBT (Continued)
-------------------------------
agreement in April 1996 amounted to approximately $1,105,732, of which
$165,860 has been recognized as forgiveness of debt income and $939,872 as
long-term debt (see Note 4 above). An additional $290,477 in construction
costs for building improvements related to a lease agreement (shown as
long-term payables) have been incurred through March 31, 1997 and have
been submitted to the CRA and the lessee for approval and payment. Of this
amount, approximately $194,268 represents the remaining portion
attributable to the total CRA commitment of $1,300,000. Subsequent
disbursement by the CRA would result in the recognition of another $29,140
in debt forgiveness income. It is anticipated that the balance of the
additional costs in the amount of $96,209 are to be funded by the lessee
(see Note 9 below).
8. STOCK OPTION PLAN
-----------------
The Company's Board of Directors has adopted the Networks Electronic Corp.
1996 Stock Incentive Plan (the "1996 Plan") which provides for the grant
of up to 100,000 shares of the Company's common stock to directors,
officers, employees and consultants of the Company. The 1996 Plan was
submitted to and approved by the shareholders of the Company at the Annual
Meeting of Shareholders held on December 13, 1996.
During the year ended June 30, 1996, the Company's chief executive officer
exercised 75,000 stock options which had been granted outside of the
Company's existing Stock Option Plan, at an exercise price of $.1875 per
share. Accordingly, an outstanding stock subscription receivable in the
amount of $14,063 has been recorded at both the March 31, 1997 and June
30, 1996 balance sheet dates.
9. LEASE AGREEMENT
---------------
The Company has negotiated the lease of approximately 35,000 square feet
of its Chatsworth facility. The commencement date of the tenancy was March
7, 1997. The lease agreement calls for monthly base rent to be
approximately $17,850, with 2 1/2 months free and a cost of living
increase every 18 months over the initial 62 month period. In addition,
the lessee will reimburse the Company for pro rata property taxes,
insurance, and utilities. The lessee has an option to extend the original
lease term for an additional 60 months.
11
<PAGE> 12
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1997
9. LEASE AGREEMENT (Continued)
---------------------------
Additionally, the lessee has contributed $100,000 toward the Company's
cost of constructing improvements to its Chatsworth property and of
negotiating the lease agreement, and is also committed to loan the Company
up to $288,000 at an annual rate of 10% to fund additional improvements.
As of March 31, 1997, the lessee had loaned the Company approximately
$63,148 of the $288,000 commitment. The loan is being repaid over 5 years,
with monthly level principal payments of approximately $1,052 plus
interest being netted against the lessee's rent. Another $96,209 in
construction and lease-related costs (see Note 7 above) has been submitted
to the lessee for payment. Once funded, the Company's expected monthly
level principal payments applied against the lessee's rent will increase
to approximately $2,700.
12
<PAGE> 13
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Results of Operations
- ---------------------
Overall sales for the quarter ended March 31, 1997 increased by about 15% from
the prior year, reflecting the general pick-up in orders occurring throughout
the aerospace industry. Bearing Division shipments actually decreased 18%, while
Ordnance Division sales increased by 78%. The dramatic change in sales mix which
occurred during the quarter reflected the fact that shipments of some Bearing
Division parts were delayed from the March 1997 to the June 1997 quarter and
that several large Ordnance Division orders previously in production over a long
period of time were finally completed.
Sales for the nine months ended March 31, 1997 were relatively flat, increasing
by 0.7% to approximately $2,975,000 from $2,955,000 for the comparable period of
the prior year. The prior year's figures included sales revenue of approximately
$239,000 from a non-recurring time and materials contract in the Ordnance
Division. Bearing Division sales (comprising 53% of total sales) decreased by
approximately 10%, while Ordnance Division revenue was up 17%.
Company backlogs as of April 30, 1997 have increased to approximately $2,850,000
from the combined divisions. The Bearings Division backlog is approximately
$2,450,000 and the Ordnance Division backlog is approximately $400,000. This
represents a total increase of approximately $150,000 from just three months
ago. Bookings for the Company continue to show a positive growth trend. Total
backlogs have more than doubled since June 30, 1996, reflecting the results of
the rebuilding plan to market and sell the Company's products and services. The
book to bill ratio for the three month period ending March 31, 1997 was
approximately 1.73 compared to approximately 0.88 for the same period last year.
Orders, when compared to the same period last year, increased significantly from
approximately $764,000 to $1,800,000. This positive trend in bookings will
translate into increased sales for the Company in the forthcoming months.
The Company's gross profit margins decreased to approximately 26% during the
nine months ended March 31, 1997, from approximately 31% during the nine months
ended March 31, 1996, due in large measure to ongoing competitive price
pressures throughout the industry, preventing the Company from passing on
increased labor costs (as part of the Company's wage normalization policy) to
its customers.
While gross margins are down from the similar period last year, the Company
continues to improve its operating efficiencies. This positive trend is shown by
the return on revenue ratio (operating income as a percentage of sales), which
has climbed steadily since the Company's return to profitability. For the fiscal
year ending June 1995, the Company's return on revenue ratio was 1.6%,
13
<PAGE> 14
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Results of Operations (Continued)
- ---------------------------------
for fiscal year ending June 1996 it was 4.4%, and for the current nine-month
reporting period it was 6.4%.
General, administrative and selling expenses increased by 10% (approximately
$52,000) compared to the nine month period ended March 31, 1996. The increase
was due primarily to higher wages paid to administrative personnel, as well as
to increased fees for professional services associated with corporate legal,
administrative and management matters. Expectations that selling and G & A
expenses will level off in the months ahead should be tempered somewhat by the
possibility that the Company may undergo a period of more sustained sales
growth, calling for the hiring of additional personnel.
Net interest expense declined by 6% (approximately $11,000) compared to the nine
months ended March 31, 1996. Although average aggregate borrowings climbed by
about $500,000 compared to a year ago, the fact that the CRA loan is
non-interest bearing served to reduce the effective annual interest rate to
approximately 8.1% during the nine month period ended March 31, 1997 from
approximately 10.9% for the nine month period ended March 31, 1996. Excluding
the possible effects of terms applicable to a loan refinance or a new credit
line, the effective interest rate should continue to decline in the months
ahead, due to additional CRA construction financing at 0%.
Liquidity and Capital Resources
- -------------------------------
The Company had working capital of approximately $1,040,000 at March 31, 1997,
as compared to approximately $835,000 at June 30, 1996. The increase of
approximately $205,000 was due primarily to pre-tax income for the nine month
period of $188,000 (excluding CRA debt forgiveness and depreciation), plus
$250,000 in loan proceeds from a new funding source, less the net
reclassification of $23,000 from long to short-term debt, less $38,000 in
deferred charges, less approximately $183,000 in payments made on pension and
long-term debt. With the Community Redevelopment Agency loan commitment, plus an
additional commitment of $400,000 from a financial institution (of which
$250,000 has been utilized as of March 31, 1997), and the commencement of a 5
year tenant lease for a portion of the Chatsworth facility, management believes
that the Company can continue to generate enough earnings to meet both its short
and medium-term financing needs. The tenant lease began March 7, 1997, and
should provide the Company with close to $200,000 annually over at least the
next five years. The Company plans to use these revenues to enhance productivity
through the purchase of machinery and equipment and, if needed, to pay down its
pension liability.
14
<PAGE> 15
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Liquidity and Capital Resources (Continued)
- -------------------------------------------
The Company's cash position increased by approximately $263,000 from June 30,
1996 levels, to about $362,000 at the March 31, 1997 balance sheet date. The
increase was largely due to net proceeds of approximately $198,000 from a new
loan taken out in March 1997, and to the Company's continuing diligence in the
collection of its accounts receivable. Management is continuing to seek the
refinance of its mortgage and the establishment of an additional line of credit
to support its operating requirements, the largest of which is a defined benefit
pension plan contribution of approximately $182,000 due within the coming year.
15
<PAGE> 16
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition
- ---------------------------------------------------------------
Potential risks and uncertainties that could affect the Company's future
operating results and financial condition include, without limitation, the
following factors:
HISTORY OF LOSSES; VARIABILITY OF OPERATING RESULTS
The Company is in the process of emerging from bankruptcy protection. Despite
historical losses, the Company experienced its first operating profit in four
years during the year ended June 30, 1995, in the amount of approximately
$47,000, and a second consecutive operating profit during the year ended June
30, 1996 in the amount of approximately $175,000. The Company's revenues and
operating results have varied substantially from period to period. There can be
no assurance that the Company will be profitable in the future or that future
revenues and operating results will not also vary substantially. New management
has expended and continues to expend substantial time and resources in
attempting to resolve problems arising from the Company's financial condition
and to restore confidence in the Company. Although the research and development
expenditures of the Company have increased, its financial condition limits its
ability to engage in large scale research and development. Also, the Company's
financial condition has limited the ability of the Company to modernize its
plant and equipment which hinders the Company's marketing efforts. Future
revenues and profits, if any, will depend upon various factors, including, but
not limited to, management's ability to restore confidence in the Company,
continued market acceptance of the Company's current products, the ability of
the Company to develop distribution and marketing channels and develop and
introduce new products or to develop new markets for its existing products and
the successful implementation of its planned marketing strategies. If the
Company is not able to achieve its operating objectives, the Company may find it
necessary to reduce its expenditures for sales, marketing, and research and
development, or undertake other such actions as may be appropriate, and may be
otherwise unable to achieve its goals or continue its operations.
16
<PAGE> 17
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition (Continued)
- --------------------------------------------------------------------------
COMPETITION
Certain of the Company's existing and potential competitors have substantially
greater financial, marketing and other resources than the Company. These
competitors have also been able to market their products successfully to the
Company's existing and potential customers in the defense and aerospace
industries. Increased competition could result in price reductions, reduced
margins and loss of market share, all of which could materially adversely affect
the Company. The Company has determined to follow a strategy of continuing
product development to the extent permitted by the financial resources of the
Company to protect its competitive position to the extent practicable. There can
be no assurance that the Company will be able to maintain its position in the
field or continue to compete successfully against current and future sources of
competition or that the competitive pressures faced by the Company will not
adversely affect its profitability or financial performance.
TECHNOLOGICAL CHANGE
The markets for specialized bearings and ordnance products are characterized by
advances in technology. Accordingly, the Company's ability to compete in those
markets may depend in large part on its success in enhancing its existing
products and in developing new products. There can be no assurance that the
Company will succeed in such efforts or that any of its products will not be
rendered obsolete or uneconomical by technological advances made by others.
DEPENDENCE ON KEY CUSTOMERS
During the nine months ended March 31, 1997, sales to the Department of Defense
constituted approximately 17% of Company sales. Sales to the Department of
Defense and Hughes Missile Systems accounted for approximately 19% and 15%,
respectively, of Company sales for the nine months ended March 31, 1996. A
significant decline in sales to any of the aforementioned key customers could
adversely affect the Company.
DEPENDENCE UPON DEFENSE INDUSTRY
The Company has been supplying components for United States defense programs for
over forty years. Reliance upon defense programs has certain inherent risks,
including the uncertainty of economic conditions, dependence on Congressional
appropriations and administrative allotment of funds, changes in governmental
policies that may reflect military and political developments and other factors
characteristic of the defense industry. The Company is unable to predict the
impact on defense appropriations for programs in which the Company's products
are incorporated.
17
<PAGE> 18
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition (Continued)
- --------------------------------------------------------------------------
PRODUCT LIABILITY AND RISK MANAGEMENT
As a manufacturer of ordnance products and specialized bearings for the defense
and aerospace industries, the Company is subject to the risk of claims arising
from injuries to persons or property. The Company maintains general liability
insurance but does not maintain product liability insurance. Although the
Company has instituted quality control procedures that it believes produce
products of the highest quality, the Company may become subject to future
proceedings alleging defects in its products.
NO EARTHQUAKE INSURANCE
The Company's principal executive offices are located in a facility owned by the
Company in Chatsworth, California - an area which was damaged in the 1994
Northridge, California earthquake. The Company does not currently carry
insurance against earthquake-related risks. The Company suffered approximately
$1.2 million in damages, costs and renovations to its facility resulting from
that earthquake, and recovered only approximately $384,000 from insurers as a
result of insured flood damage caused by the earthquake.
KEY PERSONNEL
The Company's success is highly dependent on the efforts and abilities of its
Chairman, David Wachtel and a number of key employees. The loss of services of
Mr. Wachtel or these key employees could have material adverse effect on the
Company.
CONTROL OF COMPANY
The Mihai D. Patrichi Trust (the "Trust") presently owns of record approximately
47.3% of the Company's outstanding voting stock. Accordingly, the Trust is able
to control the election of a majority of the directors, and, therefore, the
business and affairs of the Company and approve or disapprove any corporate
action submitted to a vote of the Company's shareholders, in each case
regardless of how other shareholders of the Company may vote. The provisions of
the Trust provide that the trustees act in a prudent manner to dispose of the
Trust's interest in the Company. In the matter of In Re: Mihai D. Patrichi Trust
(Case No. BP03796), now pending in the Superior Court of California for the
county of Los Angeles, Michael Patrichi, one of the beneficiaries of the Trust,
is attempting to remove and replace the co-trustees of the Trust, Ileana Wachtel
and Rodica Patrichi. Sale by the Trust of its interest in the Company would
effect a change in the control of the Company. Sales of substantial amounts of
Common Stock in the public market under Rule 144 or otherwise, or even the
potential for such sales, could adversely affect the prevailing market prices
for the Common Stock and could impair the ability to raise capital through the
sale of its equity securities.
18
<PAGE> 19
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition (Continued)
- --------------------------------------------------------------------------
CONTRACTS
The Company generates substantially all of its revenues pursuant to procurement
contracts for custom designed or manufactured bearings or ordnance products. The
ability of the Company to generate additional revenues will depend upon its
ability to obtain additional contracts. Substantially all of the Company's
contracts are on a fixed-fee basis. Accordingly, the Company is subject to the
risk of cost overruns. Because the Company manufactures ordnance and specialized
bearings for the defense and aerospace industries, the Company is subject to
extremely stringent quality control standards and testing. These standards are
implemented through internal operational quality control procedures of the
Company and through customer audits. Furthermore, lot acceptance test procedures
("LATs") are required by the Company's customers. These LATs include
environmental testing and detonation and non-detonation tests. Generally, the
Company's ordnance products are manufactured in batches and then subjected to
LATs under standards that result in rejection of an entire manufactured batch if
a single unit fails. From time to time, the Company has experienced LATs
failures resulting from human error or technical problems. Occurrence of LATs
failures of this type on large contracts could adversely impact the revenues of
the Company and no assurance can be given that such failures will not occur in
the future.
VOLATILITY OF WORKLOAD
To remain profitable, the Company is highly dependent on its ability to maintain
a suitably sized staff of qualified technical personnel commensurate with a
fluctuating volume of work. New contracts often arise at unscheduled or
unanticipated times. The Company endeavors to maintain adequate staff to respond
to these unscheduled opportunities. If the Company overestimates its projected
workload, the resulting financial burden can reduce profitability. Occasionally,
the Company is faced with the opposite problem - a shortage of suitable
technical personnel - or the funds to pay premium rates to obtain the necessary
skilled labor that is in short supply, and is unable to timely perform
contracts, potentially resulting in cost overruns or late delivery penalties.
19
<PAGE> 20
NETWORKS ELECTRONIC CORP.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition (Continued)
- --------------------------------------------------------------------------
GOVERNMENTAL REGULATION
The Company's operations are subject to, and substantially affected by,
extensive federal, state and local laws, regulations, orders and permits, which
govern environmental protection, health and safety, zoning and other matters.
These regulations may impose restrictions on the Company's operations that could
adversely affect the Company's results, such as limitations on the expansion of
metals plating facilities of the Company, limitations on or banning disposal of
certain categories of waste, or mandates regarding the disposal of hazardous
waste generated by the Company's operations. Because of heightened public
concern, companies in the metals plating business, including the Company, may
become subject to judicial and administrative proceedings involving federal,
state or local agencies. These governmental agencies may seek to impose fines on
the Company or to revoke or deny renewal of the Company's waste generation and
disposal permits or licenses for violations of environmental laws or regulations
or to require the Company to remediate environmental problems resulting from its
operations, all of which could have a material adverse effect on the Company.
The Company may also be subject to actions brought by individuals or community
groups in connection with the permitting or licensing of its operations, any
alleged violations of such permits and licenses, or other such matters.
PREMISES BUILD-OUT
The Company has commenced retrofitting and repairing of the north building of
its Premises which was damaged in the Northridge Earthquake. This project is
being funded by loans and grants from the Community Redevelopment Agency of the
City of Los Angeles. The Company has entered into a construction contract to
accomplish the retrofit and repair of the north building and anticipates that
the funding procured from the Community Redevelopment Agency will be sufficient
to fund all anticipated costs under the contract. However, the Company will be
required to fund any unanticipated cost overruns from operating reserves or with
additional financing. There can be no assurance that additional financing would
be available on terms acceptable to the Company. If the Company is required to
fund construction with its cash reserves, resulting cash constraints could limit
the Company's ability to improve the remainder of its plant and equipment and to
fund other operating requirements of the Company.
20
<PAGE> 21
NETWORKS ELECTRONIC CORP.
PART II
OTHER INFORMATION
Item 2. Shareholders Stock Information
- ---------------------------------------
Through January 4, 1993, Networks Electronic Corp.'s stock was traded in NASDAQ
OVER-THE-COUNTER MARKETS and was listed in NATIONAL MARKET ISSUES under NWRK.
Subsequent to that date, due to certain size and activity requirements, the
stock of Networks Electronic Corp. was removed from trading on the NASDAQ
national market system. The stock is currently traded on the OTC Electronic
Bulletin Board.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
None
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
Reports on Form 8-K: There were no reports on Form 8-K filed for the three
months ended March 31, 1997.
21
<PAGE> 22
NETWORKS ELECTRONIC CORP.
Signatures
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORKS ELECTRONIC CORP.
(Registrant)
BY: DAVID WACHTEL
---------------------------
DAVID WACHTEL
Chairman of the Board,
Chief Executive Officer,
President, Chief Financial
Officer
Date: May 9, 1997
-----------------------
22
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