<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 the quarterly period ended March 31, 1998 COMMISSION FILE NUMBER 0-1817
NETWORKS ELECTRONIC CORP.
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(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
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(Address or principal executive offices)
(818) 341-0440
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(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 8, 1998
1
<PAGE> 2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
- -----------------------------
NETWORKS ELECTRONIC CORP.
CONDENSED BALANCE SHEETS
(UNAUDITED)
March 31, 1998 and June 30, 1997
<TABLE>
<CAPTION>
March 31, June 30,
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 436,939 $ 185,144
Trade accounts receivable, net 748,218 707,709
Other receivables 180 79,354
Inventories, net 1,437,859 1,189,802
Prepaid expenses and deposits 55,326 39,832
Deferred income taxes 5,000 24,000
---------- ----------
Total current assets 2,683,522 2,225,841
---------- ----------
PROPERTY AND EQUIPMENT, AT COST:
Land and improvements 146,664 131,773
Building and improvements 3,697,667 3,438,250
Machinery and equipment 4,392,142 4,367,555
---------- ----------
8,236,473 7,937,578
Less accumulated depreciation 5,819,688 5,723,480
---------- ----------
Property and equipment, net 2,416,785 2,214,098
---------- ----------
DEFERRED INCOME TAXES,
NON-CURRENT PORTION 3,371 119,571
DEFERRED CHARGES, NET 66,635 81,152
---------- ----------
Total assets $5,170,313 $4,640,662
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 3
NETWORKS ELECTRONIC CORP.
CONDENSED BALANCE SHEETS
(UNAUDITED)
March 31, 1998 and June 30, 1997
<TABLE>
<CAPTION>
March 31, June 30,
1998 1997
------------ ------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Notes payable and current
maturities of long-term debt $ 510,000 $ 220,000
Note payable, related party -
current portion 100,000 100,000
Accounts payable 350,738 479,384
Customer advances and deposits 2,834 2,834
Curr. portion of pre-petition debt:
Adjudication award payable 52,525 41,951
Accrued pension liability 152,157 279,079
Other payables 35,037 29,997
Income taxes payable 34,000 --
Other accrued expenses 252,643 190,262
------------ ------------
Total current liabilities 1,489,934 1,343,507
------------ ------------
LONG-TERM DEBT:
Long-term debt, less current
maturities 2,886,322 3,042,193
Accrued pension liability 233,117 366,209
------------ ------------
Commitments and Contingencies -- --
------------ ------------
STOCKHOLDERS' EQUITY (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
Stock options exercisable 6,750 --
Retained earnings (accumulated deficit) 253,326 (412,111)
Stock subscriptions receivable (14,063) (14,063)
Pension liability adjustment (383,863) (383,863)
------------ ------------
Total stockholders' equity
(deficiency in assets) 560,940 (111,247)
------------ ------------
Total liabilities and stockholders'
equity (deficiency in assets) $ 5,170,313 $ 4,640,662
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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NETWORKS ELECTRONIC CORP.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- --------------------------------
1998 1997 1998 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net sales $ 1,500,737 $ 1,066,760 $ 4,287,501 $ 2,974,772
Cost of sales 1,024,501 781,963 2,962,632 2,202,031
-------------- -------------- -------------- --------------
Gross profit 476,236 284,797 1,324,869 772,741
Selling, adminis-
trative and other
operating expenses 145,464 245,857 437,388 583,062
-------------- -------------- -------------- --------------
Operating income 330,772 38,940 887,481 189,679
Other income (exp.):
CRA debt forgiveness -- 45,565 -- 132,735
Vendor debt forgiveness -- 40,296 -- 40,296
Rental income, net 45,589 11,586 136,908 11,586
Interest and non-
operating expenses,
net (46,562) (53,585) (188,952) (153,848)
Insurance proceeds -- 14,095 -- 14,095
-------------- -------------- -------------- --------------
Income before
income taxes 329,799 96,897 835,437 234,543
Provision for
income taxes 68,100 39,100 170,000 94,300
-------------- -------------- -------------- --------------
Net income $ 261,699 $ 57,797 $ 665,437 $ 140,243
============== ============== ============== ==============
Net income
per share - basic $ .16 $ .03 $ .40 $ .08
============== ============== ============== ==============
Average weighted
number of shares
outstanding - basic 1,671,221 1,671,221 1,671,221 1,671,221
============== ============== ============== ==============
Net income
per share - diluted $ .16 $ .03 $ .40 $ .08
============== ============== ============== ==============
Average weighted
number of shares
outstanding - diluted 1,673,986 1,672,571 1,672,021 1,672,571
============== ============== ============== ==============
</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,
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 665,437 $ 140,243
-------------- --------------
Adjustments to reconcile net income
to net cash used in
operating activities:
Non-cash items included
in net income:
Depreciation and
amortization 112,909 85,918
Deferred income taxes 135,200 93,500
Changes in:
Receivables 38,665 235,142
Inventories (248,057) (103,095)
Prepaid expenses and deposits (15,494) (31,374)
Other assets (2,184) (54,633)
Accounts payable and
accrued expenses (50,651) 166,407
Customer advances and deposits -- 25,485
Income taxes 34,000 --
Accrued pension liability (260,014) (39,702)
-------------- --------------
Total adjustments (255,626) 377,648
Net cash provided by
operating activities 409,811 517,891
-------------- --------------
</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,
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from investing activities:
Capital expenditures $ (298,895) $ (1,265,337)
-------------- --------------
Net cash used in
investing activities (298,895) (1,265,337)
-------------- --------------
Cash flows from financing activities:
Proceeds from long-term borrowings 320,625 1,083,239
Proceeds from notes payable,
related parties -- 122,000
Mortgage debt reduction (90,000) (90,000)
Other payments of long-term debt (96,496) (2,345)
Payments on notes payable,
related parties -- (102,222)
Stock options issued 6,750 --
-------------- --------------
Net cash provided by
financing activities 140,879 1,010,672
-------------- --------------
Net increase in
cash and cash equivalents 251,795 263,226
Cash and cash equivalents
at beginning of period 185,144 99,114
-------------- --------------
Cash and cash equivalents
at end of period $ 436,939 $ 362,340
============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 800 $ 800
============== ==============
Interest paid $ 196,805 $ 156,725
============== ==============
</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, 1998
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, 1998 and June 30, 1997 consisted of the
following:
<TABLE>
<CAPTION>
March 31, June 30,
1998 1997
----------- -----------
<S> <C> <C>
Raw materials $ 92,278 $ 93,843
Work in process 841,552 523,711
Finished goods and components 729,029 752,248
----------- -----------
1,662,859 1,369,802
Less reserve for obsolescence (225,000) (180,000)
----------- -----------
Total $ 1,437,859 $ 1,189,802
=========== ===========
</TABLE>
7
<PAGE> 8
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998
3. DEFERRED CHARGES
Costs associated with the lease of space at the Company's facility in
Chatsworth (see Note 8 below) in the amount of $78,647 and loan fees of
$10,000 pertaining to additional financing obtained in March 1997, plus
an additional $2,184 in loan fees paid in March 1998 are being amortized
over periods ranging from approximately two to five years. Accumulated
amortization of these costs at March 31, 1998 and June 30, 1997 amounted
to $24,196 and $7,495, respectively.
4. LONG-TERM DEBT
At March 31, 1998 and June 30, 1997, the Company's long-term debt
consisted of the following:
<TABLE>
<CAPTION>
March 31, June 30,
1998 1997
---------- ----------
<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 at a reference rate plus 2.25% (10.75% at both
March 31, 1998 and June 30, 1997, respectively). A balloon payment
is due in June 2000 $1,612,528 $1,702,528
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 August 2001, with level
monthly principal payments of $4,604 applicable over 20 years
through August 2021 1,105,000 1,105,000
</TABLE>
8
<PAGE> 9
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998
4. LONG-TERM DEBT (Continued)
<TABLE>
<CAPTION>
March 31, June 30,
1998 1997
---------- ----------
<S> <C> <C>
Notes payable to lessee, secured by assignment of rents, principal payable
in monthly installments of $7,663 through March 2002, with interest
payable at annual rates ranging from 7.0% to 10.0% (blended rate 9.0% at
March 31, 1998) 367,829 185,635
Note payable to financial institution, secured by machinery and equipment,
principal payable in monthly installments of $5,667 along with interest
at a reference rate plus 2.75% (11.25% at both March 31, 1998 and June
30, 1997, respectively) through March 1999, with a balloon payment for
the balance also due in March 1999. A 7.5% prepayment penalty applies on
the outstanding balance if this loan is refinanced
and paid-off early 285,500 237,500
Note payable to finance company, secured by telephone equipment, payable in
monthly installments of $656 including interest at an annual rate of
approximately 17.3%. Matures in October 1999 9,735 14,453
Note payable to vendor, secured by office equipment, payable in monthly
installments of $395 including interest at an annual rate of 12.4%
Matures in December 2001 15,730 17,077
---------- ----------
3,396,322 3,262,193
Less current maturities 510,000 220,000
---------- ----------
Total $2,886,322 $3,042,193
========== ==========
</TABLE>
9
<PAGE> 10
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998
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. 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 months ended March 31, 1997 (including
remaining loan fee amortization) was $5,314.
(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. The loan maturity date has been extended through
December 1998, with interest payable monthly. Interest expense on this
loan during the nine months ended March 31, 1998 and 1997 amounted to
$9,757 and $7,835, respectively.
(c) In September 1996 a director advanced the Company $22,000 for a fee
of $200. The Company subsequently repaid the money in October 1996.
6. STOCK OPTION PLAN
The Company's Board of Directors adopted the Networks Electronic Corp.
1996 Stock Incentive Plan (the "1996 Plan"), providing 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 and approved by the shareholders of the Company at the annual
meeting of shareholders held on December 13, 1996. Subject to receipt of
a permit from state securities regulators, 9,000 options have been
issued to employees at the Company under the 1996 Plan. These options
were issued at market on November 21, 1997, and have been valued at
approximately $6,750 under the Black-Scholes pricing model.
7. INCOME TAXES
During the nine months ended March 31, 1998, the Company reduced its
income tax provision by approximately $170,000, corresponding to a
reduction in valuation allowance applied against the Company's net
deferred tax benefit. This reduction reflects the increased likelihood
of the Company utilizing its net operating loss carryforwards and tax
credits.
10
<PAGE> 11
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998
8. LEASE AGREEMENT
In March 1997, the Company leased out approximately 35,000 square feet
of its Chatsworth facility. The lease agreement calls for monthly base
rent to be $17,850, with approximately 2 1/2 months free and a cost of
living increase every 18 months over the initial 62 month lease period.
The tenant also reimburses the Company for pro-rata utilities, property
taxes, and insurance. The lessee has an option to extend the original
lease term for an additional 60 months. Net rental income for the nine
months ended March 31, 1998 and 1997 was $136,908 and $11,586,
respectively.
Additionally, the tenant reimbursed the Company for $23,175 in costs
incurred in connection with negotiating the lease arrangement,
contributed $100,000 toward the Company's cost of constructing
improvements to its Chatsworth property, and loaned the Company $288,000
at an annual interest rate of 10% to fund additional improvements. In
December 1997, the tenant loaned the Company another $130,000 at an
annual interest rate of 7% to fund roof repairs. At March 31, 1998 and
June 30, 1997, the outstanding aggregate balance on the loans was
$367,829 and $185,635, respectively. The loans are being amortized
monthly over 5 years (with level principal payments currently totaling
$7,663), with the monthly loan payment netted against the lessee's rent.
9. 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. By June 30, 1997, the entire $1,300,000 CRA commitment was
expended (including a second phase in the amount of $500,000 pertaining
to the tenant lease agreement effective March 1997), resulting in
cumulative forgiveness of debt income of $195,000.
11
<PAGE> 12
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998
10. SUBSEQUENT EVENT
Subsequent to March 31, 1998, the Company was notified by one of its
customers that shipments manufactured with non-conforming material
totaling approximately $244,000 were found to be incompatible with the
customer's system, even though these parts successfully passed
acceptance testing on the customer approved testing equipment. It is
uncertain at this time if any of these parts will be returned. If the
parts are accepted, the Company could be billed for costs incurred by
the customer to make them functional in their designated application.
The financial statements reflect an allowance against sales of
approximately $54,000. This amount represents the gross profit on the
shipments. The Company is working with the customer on a correction to
ensure the parts will function as required, and also has completed
customer requested modifications to the item and the testing environment
to ensure future deliveries will be compatible with the customer's
system.
12
<PAGE> 13
NETWORKS ELECTRONIC CORP.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Company net sales for the nine months ended March 31, 1998 increased 44% to
$4,288,000 from $2,975,000 for the comparable period of the prior year. Both
Divisions participated equally in the percentage increase, with Bearing Division
sales comprising approximately 53% of the current year's sales mix. For the
latest quarterly period, net sales were approximately $1,501,000, up about 41%
from the quarter ended March 31, 1997. The Company believes that based on
existing backlogs and increased capacity this higher level of sales activity as
compared to the same period for the prior year is likely to be sustained
throughout the remainder of the current fiscal year.
The increase in sales volume now being achieved is reflected in the overall
backlog of orders at May 1, 1998, which at approximately $4,700,000, is up
approximately $1,800,000 from year ago levels and $2,800,000 from two years ago.
Gross profits during the nine months ended March 31, 1998 improved to 30.9% from
26.0% during the nine months ended March 31, 1997. Margins in the Ordnance
Division increased significantly as a result of efficiencies in production,
while Bearings margins, under pressure from cost increases incurred as a result
of capacity limitations caused by increased demand, were down when compared to
the same period a year before. Bearings margins have recently improved as
production schedules have been optimized and production capacity significantly
enhanced. During the quarter ended March 31, 1998 overall gross margins were
approximately 31.7% as opposed to 26.7% during the year-ago quarter.
Selling, administrative and other costs declined by 25% (approximately $146,000)
compared to the nine month period ended March 31, 1997, due mostly to a decrease
in legal and professional fees and an increased allocation of resources to the
manufacturing process. The March 1998 quarter also benefited from a
non-recurring reduction in vendor payables, contributing to a year-to-year
quarterly decline of 41% in selling, administrative and other costs. However,
the possibility of continued sales growth in the coming quarters, along with the
Company's ongoing wage normalization policy, could serve to push general &
administrative expenses higher in the months ahead.
Operating income during the nine months ended March 31, 1998 exceeded $887,000,
an increase of $698,000 from the prior year. The current figure represents a
return on revenue of approximately 21% as compared to approximately 6% for the
nine month period ended March 31, 1997. For the latest quarter, the return on
revenue was approximately 22% versus approximately 4% for the quarter ended
March 31, 1997. This positive trend, complemented by the growth in new orders,
provides further evidence
13
<PAGE> 14
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
that the Company has exited its stabilization phase and has entered its growth
phase, in keeping with Management's long-range reorganization plan.
Other income derived from the lease of a portion of the Chatsworth building
amounted to $137,000 during the nine months ended March 31, 1998 (as compared to
$12,000 during the start-up month of March 1997), and based on continued
performance by the tenant of its obligations under the lease, it is expected to
approximate $180,000 annually through at least March 2002. $133,000 in
non-recurring income from debt forgiveness during the nine months ended March
31, 1997 arose from the Community Redevelopment Agency's commitment to fund
earthquake repairs.
Interest expense was significantly higher (about 28%) for the nine month period
ended March 31, 1998 as compared to the prior year, reflecting additional
borrowing required to cover increased raw material purchases, outside production
and facility improvements. However, the increase was only about 11% when
comparing the quarterly period ended March 31, 1998 to the quarterly period
ended March 31, 1997. Average aggregate borrowing (including an increase in
non-interest bearing funding from the Community Redevelopment Agency of
approximately $500,000 to a total of $1,105,000) was up by approximately
$860,000 (33%) during the nine months ended March 31, 1998 as compared to the
prior year. Despite the increase in debt, the effective annual interest rate
actually declined from 8.1% to 7.8%. Management is attempting to obtain improved
financing, through refinancing the building loans or obtaining a working capital
line of credit.
Liquidity and Capital Resources
The Company's working capital at March 31, 1998 was $1,190,000 compared to
$880,000 at June 30, 1997. The $310,000 improvement in working capital was
largely the result of pre-tax income earned (excluding depreciation and
amortization) in the nine month period ended March 31, 1998 of approximately
$950,000, net of capital expenditures of approximately $300,000 and the
reclassification of an additional $370,000 in debt and pension liabilities from
long-term to current. The Company made a payment of approximately $260,000 on
its pension plan obligation in March 1998 from cash on hand. Although this
disbursement impacted liquidity, Management expects the cash generated from the
rental for a full year and increased gross profit from higher sales to be
sufficient to meet its obligations and short to mid-term capital requirements.
Longer term, the company may require additional capital to support future
growth. There can be no assurance that this financing will be available at terms
acceptable to the company. As the Company expects its federal net operating loss
carryforward to be fully utilized during the current fiscal year, a federal
income tax liability of $100,000 could become due and payable for the tax year
ended June 30, 1998.
14
<PAGE> 15
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)
Factors That May Affect Future Results and Financial Condition
The Company continues to work on refinancing the building and replacing the
existing term loan with Wells Fargo. Management expects that transaction to
yield sufficient funds to meet the Company's working capital needs for the
medium term.
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 emerged from bankruptcy protection in November 1994. 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 recorded operating profits during the years ended June 30, 1996 and
1997 in the amounts of approximately $175,000 and $235,000, respectively. 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.
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.
Future 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 Company's ability to
successfully manufacture its 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 and business 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.
15
<PAGE> 16
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)
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. Although
in recent years the Company has shown increases in revenue, 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 month period ended March 31, 1998, sales to Textron Systems
constituted approximately 16% and sales to Eagle Picher Industries approximately
15% of the Company's sales. Sales to the Department of Defense accounted for
approximately 11% and 17% of Company sales for the nine month periods ended
March 31, 1998 and March 31, 1997, respectively. A significant decline in sales
of any of these key customers could adversely affect the Company. Additionally,
export sales (denominated in U.S. dollars) accounted for approximately 10% of
sales revenue by the Company for the nine months ended March 31, 1998.
16
<PAGE> 17
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)
Factors That May Affect Future Results and Financial Condition
(Continued)
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 of decreases or shifts in defense appropriations for programs in which
the Company's products are incorporated.
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 both general
liability insurance and limited 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 key members of staff. The loss of services of Mr.
Wachtel or any of these key members could have a material adverse effect on the
Company. The company does not maintain key man life insurance on Mr. Wachtel or
any other employee.
17
<PAGE> 18
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)
Factors That May Affect Future Results and Financial Condition
(Continued)
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 as a
practical matter, able to control the election of a majority of the directors,
and, therefore, the business and affairs of the Company and to 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.
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.
18
<PAGE> 19
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)
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.
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, and limitations on or banning 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.
19
<PAGE> 20
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, 1998.
20
<PAGE> 21
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 12, 1998
-----------------------
21
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AND STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 436,939
<SECURITIES> 0
<RECEIVABLES> 748,398
<ALLOWANCES> 5,000
<INVENTORY> 1,437,589
<CURRENT-ASSETS> 2,683,522
<PP&E> 8,236,473
<DEPRECIATION> 5,819,688
<TOTAL-ASSETS> 5,170,313
<CURRENT-LIABILITIES> 1,489,934
<BONDS> 3,119,439
0
0
<COMMON> 417,805
<OTHER-SE> 143,135
<TOTAL-LIABILITY-AND-EQUITY> 5,170,313
<SALES> 1,500,737
<TOTAL-REVENUES> 1,546,326
<CGS> 1,024,501
<TOTAL-COSTS> 1,169,965
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 46,562
<INCOME-PRETAX> 329,799
<INCOME-TAX> 68,100
<INCOME-CONTINUING> 261,699
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 261,699
<EPS-PRIMARY> 0.16
<EPS-DILUTED> 0.16
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