<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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
incorporation of organization) Identification 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 1,672,221
- ------------------------------ --------------------------------
Common Stock -- $.25 par value Outstanding at February 12, 1999
1
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PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
NETWORKS ELECTRONIC CORP.
CONDENSED BALANCE SHEETS
(UNAUDITED)
December 31, 1998 and June 30, 1998
<TABLE>
<CAPTION>
Dec. 31, June 30,
1998 1998
---------- ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 262,594 $ 338,666
Trade accounts receivable, net 1,401,160 1,303,501
Other receivables 6,393 7,787
Due from officer 3,586 15,093
Inventories, net 1,480,988 1,432,781
Prepaid expenses and deposits 64,269 30,576
Deferred income taxes -- current 50,000 65,000
---------- ----------
Total current assets 3,268,990 3,193,404
---------- ----------
PROPERTY AND EQUIPMENT, AT COST:
Land and improvements 146,664 146,664
Building and improvements 3,705,944 3,698,588
Machinery and equipment 4,501,525 4,418,639
---------- ----------
8,354,133 8,263,891
Less accumulated depreciation 5,929,056 5,854,878
---------- ----------
Property and equipment, net 2,425,077 2,409,013
---------- ----------
DEFERRED INCOME TAXES,
NON-CURRENT PORTION 11,701 16,701
DEFERRED CHARGES, NET 49,777 61,387
---------- ----------
Total assets $5,755,545 $5,680,505
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 3
NETWORKS ELECTRONIC CORP.
CONDENSED BALANCE SHEETS
(UNAUDITED)
December 31, 1998 and June 30, 1998
<TABLE>
<CAPTION>
Dec. 31, June 30,
1998 1998
---------- ----------
<S> <C> <C>
ASSETS
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current
maturities of long-term debt $ 208,000 $ 492,000
Note payable, related party --
current portion -- 100,000
Accounts payable 234,796 291,619
Customer advances and deposits -- 238,318
Current portion of pre-petition debt:
Accrued pension liability 160,899 152,157
Other payables 3,316 6,689
Income taxes payable 88,555 232,295
Other accrued expenses 186,274 213,419
---------- ----------
Total current liabilities 881,840 1,726,497
---------- ----------
LONG-TERM DEBT:
Long-term debt, less current
maturities 2,968,567 2,829,329
Accrued pension liability 176,891 179,633
---------- ----------
COMMITMENTS AND CONTINGENCIES -- --
---------- ----------
STOCKHOLDERS' EQUITY:
Common stock, par value $.25 per share;
authorized 10,000,000 shares, issued
and outstanding 1,672,221 and 1,671,221
shares at December 31, 1998 and
June 30, 1998, respectively 418,055 417,805
Additional paid-in capital 280,985 280,985
Stock options exercisable 6,750 6,750
Retained earnings 1,350,649 567,698
Accumulated other comprehensive
income (loss) (328,192) (328,192)
---------- ----------
Total stockholders' equity 1,728,247 945,046
---------- ----------
Total liabilities and stockholders' equity $5,755,545 $5,680,505
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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NETWORKS ELECTRONIC CORP.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
1998 1997 1998 1997
---------------------- ----------------------
<S> <C> <C> <C> <C>
Sales $2,038,390 $1,564,322 $4,081,662 $2,786,764
Cost of sales 1,206,463 1,081,505 2,389,587 1,938,131
---------- ---------- ---------- ----------
Gross profit 831,927 482,817 1,692,075 848,633
Selling, administrative
and other operating exp. 189,994 131,516 367,947 291,924
---------- ---------- ---------- ----------
Operating income 641,933 351,301 1,324,128 556,709
Other income (expense):
Rental income, net 46,597 45,729 92,444 91,319
Interest and non-
operating expenses,
net (56,383) (75,746) (113,421) (142,390)
---------- ---------- --------- ----------
Income before
income taxes 632,147 321,284 1,303,151 505,638
Provision for
income taxes 252,200 64,100 520,200 101,900
---------- ---------- --------- ----------
Net income $ 379,947 $ 257,184 $ 782,951 $ 403,738
========== ========== ========= ==========
Net income
per share -- basic $ .23 $ .15 $ .47 $ .24
========== ========== ========= ==========
Average weighted
number of shares
outstanding -- basic 1,672,221 1,671,221 1,672,221 1,671,221
========== ========== ========= ==========
Net income
per share -- diluted $ .23 $ .15 $ .47 $ .24
========== ========== ========= ==========
Average weighted
number of shares
outstanding -- diluted 1,676,649 1,671,971 1,676,537 1,671,971
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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NETWORKS ELECTRONIC CORP.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
December 31, December 31,
1998 1997
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 782,951 $ 403,738
--------- ---------
Adjustments to reconcile net income
to net cash used in operating
activities:
Non-cash items included
in net income:
Depreciation and
amortization 85,788 74,232
Deferred income taxes 20,000 99,100
Changes in:
Receivables (84,758) (249,734)
Inventories (48,207) (194,711)
Prepaid expenses and deposits (33,693) (41,032)
Accounts payable and
accrued expenses (87,341) 181,044
Customer advances and deposits (238,318) -
Income taxes payable (143,740) 2,000
Accrued pension liability 6,000 (1,200)
--------- ---------
Total adjustments (524,269) (130,301)
Net cash provided by
operating activities 258,682 273,437
--------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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NETWORKS ELECTRONIC CORP.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
December 31, December 31,
1998 1997
---------------- ----------------
<S> <C> <C>
Cash flows from investing
activities:
Capital expenditures $ (90,242) $(210,142)
--------- ---------
Net cash used in
investing activities (90,242) (210,142)
--------- ---------
Cash flows from financing
activities:
Proceeds from long-term borrowings -- 320,625
Mortgage debt reduction (60,000) (60,000)
Other payments of long-term debt (84,762) (55,165)
Payments on note payable,
related party (100,000) --
Issuance of common stock 250 --
--------- ---------
Net cash provided by (used in)
financing activities (244,512) 205,460
--------- ---------
Net increase (decrease) in
cash and cash equivalents (76,072) 268,755
Cash and cash equivalents
at beginning of period 338,666 185,144
--------- ---------
Cash and cash equivalents
at end of period $ 262,594 $ 453,899
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income taxes paid $ 585,940 $ 800
========= =========
Interest paid $ 123,110 $ 132,244
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
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NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
1. BASIS OF PRESENTATION
In the opinion of the Company, the accompanying unaudited condensed
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 six
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 December 31, 1998 and June 30, 1998 consisted of the
following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1998
------------ ----------
<S> <C> <C>
Raw materials $ 159,257 $ 132,287
Work in process 971,889 629,592
Finished goods and components 754,842 1,045,902
--------- ----------
1,885,988 1,807,781
Less reserve for obsolescence (405,000) (375,000)
---------- ----------
Total $l,480,988 $1,432,781
========== ==========
</TABLE>
7
<PAGE> 8
NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
3. LONG-TERM DEBT
At December 31, 1998 and June 30, 1998, the Company's long-term debt
consisted of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1998
------------- ----------
<S> <C> <C>
Note payable to bank, secured by first 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% (10.00% and 10.75% at
December 31, 1998 and June 30, 1998, respectively). A balloon payment for
$1,342,528 is due in June 2000. $1,522,528 $1,582,528
Note payable to Community Redevelopment Agency, City of Los Angeles
("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 the
remaining 20 years through August 2021. 1,105,000 1,105,000
Notes payable to lessee, secured by assignment of rents, principal payable
in monthly installments totaling $7,663 through March 2002, with interest
payable monthly at annual rates ranging from 7.0% to 10.0% (blended rate
8.88% at December 31, 1998. 298,861 344,840
</TABLE>
8
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NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
3. LONG-TERM DEBT (Continued)
<TABLE>
<CAPTION>
December 31, June 30,
1998 1998
------------- ----------
<S> <C> <C>
Note payable to financial institution, secured by machinery and equipment,
principal payments in monthly installments of $5,667 along with interest at
a reference rate plus 2.75% (10.50% and 11.25% at December 31, 1998 and
June 30, 1998, 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 prior to maturity. 234,500 268,500
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. 5,164 8,259
Note payable to vendor, secured by office equipment, payable in monthly
installments of $395 including interest at an annual rate of approximately
12.4%. Matures in December 2001. 10,514 12,202
---------- ----------
3,176,567 3,321,329
Less current maturities 208,000 492,000
---------- ----------
Total $2,968,567 $2,829,329
========== ==========
</TABLE>
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NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
4. NOTE PAYABLE, RELATED PARTY
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 was subsequently extended through
December 1998, with interest payable monthly. On October 30, 1998 the
Company fully paid back this officer loan along with accrued interest of
$1,104. Interest expense on this loan during the six months ended December
31, 1998 and 1997 amounted to $4,381 and $6,552, respectively.
5. 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 to
and approved by the shareholders of the Company at the annual meeting of
shareholders held on December 13, 1996. Under the 1996 Plan, 9,000 options
have been issued to officers and other key employees at the Company. These
options were issued at market ($1.58) on November 21, 1997, and have been
valued at approximately $6,750 under the Black-Scholes pricing model. They
become exercisable on a quarterly pro-rata basis over a three-year period
and have an expiration date for exercise of November 21, 2002.
In August 1998, 1,000 fully vested, non-qualified common stock options were
exercised by two officers (500 shares apiece) at an exercise price of $.25
per share.
6. INCOME TAXES
During the six month period ended December 31, 1997, the Company reduced
its income tax provision by approximately $102,000, corresponding to a
reduction in valuation allowance applied against the Company's net deferred
tax benefit. This reduction reflected the increased likelihood of the
Company utilizing its net operating loss carryforward.
10
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NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
7. LEASE AGREEMENT
In March 1997, the Company ("Lessor") leased out approximately 35,000
square feet of its Chatsworth facility. The lease agreement requires
monthly base rent at $17,850, with approximately 2 1/2 months free rent and
a cost of living increase every 18 months over the initial 62-month term of
the lease. Accordingly, the scheduled rent increase in September 1998
incorporated a cost of living increase of approximately 2.4%. 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. Rental income under this agreement, net of
allocated depreciation and amortized deferred lease costs, amounted to
$92,444 and $91,319 for the six month periods ended December 31, 1998 and
December 31, 1997, respectively.
Additionally, the tenant reimbursed the Company $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 agreed to loan the Company $288,000 at an annual interest
rate of 10% to fund additional improvements. In December 1997, the tenant
loaned the Company an additional $130,000 at an annual interest rate of 7%
to fund roof repairs. At December 31, 1998 and June 30, 1998, the
outstanding aggregate balance remaining on the loans was $298,861 and
$344,840, respectively. The loans are being amortized monthly over 5 years
(requiring level principal payments currently totaling $7,663), with the
monthly payment netted against the lessee's rent (See Note 3).
11
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NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
8. NEW ACCOUNTING PRONOUNCEMENT
The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes the
standards for reporting and displaying comprehensive income and its
components (revenues, expenses, gains, and losses) as part of a full set of
financial statements. This statement requires that all elements of
comprehensive income be reported in a financial statement that is displayed
with the same prominence as other financial statements. The Company has
elected to display comprehensive income, which has historically been
attributable to minimum pension liability adjustments, as a component of
the Statement of stockholders' Equity (when presented). In addition, the
equity section of the balance sheet has been reclassified to conform with
this standard.
9. INVESTMENT BANKER
Due to the growth trend the Company has established coupled with a probate
court order requiring that the largest shareholder of the Company ("The
Mihai D. Patrichi Trust", which owns approximately 47% of the Common Stock
of the Company) dispose of its interest in the Company, the Board of
Directors of the Company has created a Special Committee (the "Committee"),
comprised of directors David Wachtel and Glenn Linderman, to retain the
services of an investment banking firm and to investigate measures that
could enhance shareholder value. In November 1998 the Committee engaged the
investment banking firm of The Seidler Companies Incorporated ("TSC") to be
exclusive financial advisor to the Committee and to provide certain
financial advisory and investment banking services with regard to
maximizing the value of the Company's assets in a business transaction. TSC
is to be engaged for an initial period of one year and, upon notice from
the Committee, for additional six-month extension periods, although the
current engagement may be terminated by either the Committee or TSC at any
time and for any reason upon 10 days' written notice from one party to the
other.
For purposes of this engagement, a business transaction is generally one in
which 50% or more of the outstanding shares of the Company effectively
change hands or one in which solely more than 51% of the Trust's current
interest in the Company is sold. In these instances,
12
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NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
9. INVESTMENT BANKER (Continued)
it is anticipated that contractual transaction fees paid to TSC(subject to
certain minimums) will range between 2% and 3% of the aggregate
consideration paid, depending upon the exact nature of the completed
transaction. The Company has paid TSC an initial retainer fee of $25,000,
which will be fully credited against the above transaction fees if a
business transaction is consummated. Additionally, the Company has agreed
to pay TSC a fee of $50,000 if a fairness opinion is rendered by TSC in
connection with a registration statement.
10. SUBSEQUENT EVENTS
(a) On February 1, 1999 the Company received a Real Estate Secured Loan
(the "Term Loan") and a Revolving Line of Credit (the "Revolver")
from City National Bank. The Term Loan for approximately $1,550,000,
covered the amount owed under the existing first trust deed, secured
with Wells Fargo Bank (See Note 3 above) and is secured by a first
trust deed on the Chatsworth facility. The loan is to be fully
amortized over 15 years and is set at an effective annual interest
rate of 2.50% over the rate applicable on Ten Year Treasury Notes at
the time of the execution of the loan documents (approximately 7.27%),
with monthly installments of principal and interest approximating
$14,167 and commencing March 1, 1999. The Revolver allows for advances
not to exceed the lesser of $1,250,000 or 80% of eligible accounts
receivable, and is to be secured by a senior lien and perfected
security interest on all personal property of the Company. The
principal will mature on approximately February 1, 2000, with interest
payable monthly at a variable annual interest rate equivalent to a
bank reference rate plus 1.50% (currently 10.00%). Various financial
covenants pertaining to a minimum level of working capital, net worth,
etc. will apply.
13
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NETWORKS ELECTRONIC CORP.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 1998
10. SUBSEQUENT EVENTS (Continued)
(b) The Community Development Commission of the County of Los Angeles (the
"CDC") has approved a $650,000 business loan to the Company, the
proceeds of which are to be used as working capital. The loan is
expected to be funded in March 1999 and will be fully amortized over a
five-year (60-month) period at a fixed annual interest rate of 7.50%.
Monthly payments will approximate $13,025. The loan is to be
collateralized by a first security interest in all equipment, and by a
junior security interest in all other assets. The Company has agreed
to attain certain employment goals in the 36 months following the
funding of the loan.
14
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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 six months ended December 31, 1998 increased 46% to
$4,082,000 from $2,787,000 for the comparable period of the prior year. Bearing
Division sales, comprising approximately 50% of the current sales mix, increased
by 53% and Ordnance Division sales increased by 40%. Approximately $238,000 of
Ordnance Division revenue pertained to re-shipped parts which had been
previously paid-for and returned by a customer prior to June 30, 1998. For the
quarter ended December 31, 1998, net sales increased by approximately 30% from
the comparable period of the prior year.
The Company's backlog of orders increased by 65% when compared to the same
period a year earlier. At December 31, 1998 the backlog was in excess of
$7,000,000 compared to $4,200,000 at December 31, 1997. Approximately $800,000
of the $7,000,000 backlog is pending contract definitization. While there can be
no assurances, management does not expect any material changes to this contract
following definitization.
Gross profit margins during the six months ended December 31, 1998 improved to
41.5% from 30.5% for the six months ended December 31, 1997 due to both
increased sales volume and operational efficiencies brought about through
overall organizational improvements. The Bearing Division margins increased by
approximately 14 percentage points from the six months ended December 31, 1997,
while the Ordnance Division margins increased by approximately 9 percentage
points from the six month period ended December 31, 1997.
General and administrative expenses increased by 26% (approximately $76,000)
compared to the six month period ended December 31, 1997, due primarily to
higher legal and professional fees associated with a number of additional
disclosures included in this year's Annual Form 10-K and the engagement of an
investment banking firm retained to enhance shareholder value. The possibility
of continued sales growth in the months ahead, along with additional fees to be
paid to the investment banking firm (upon consummation of a business
transaction) could cause G & A expenses to continue to increase through the
remainder of the current fiscal year.
Consistent with the growth trend established by the Company, operating income
increased by more than $767,000 to $1,324,000, when compared with the six months
ended December 31, 1997.
15
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NETWORKS ELECTRONIC CORP.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
- --------------------------------------------------------------------------------
Results of Operations (Continued)
Non-operating income during the six months ended December 31, 1998 was
comparable to the six months ended December 31, 1997 and should remain so for
the foreseeable future. The Company has leased (since March 1997) a portion of
its building to another enterprise, bringing in approximately $180,000 annually
($45,000 quarterly) in net rental income through at least March 2002 (the end of
the initial lease term).
Interest expense declined by about 14% as compared to the prior year's six month
period ended December 31st, with average aggregate borrowing decreasing by
approximately 4%, primarily the result of a pay-off of a $100,000 officer note.
The effective annual interest rate was approximately 7.50% and 8.25% during the
six months ended December 31, 1998 and December 31, 1997 respectively. The
interest rate decline was largely due to a general 0.75% decrease in bank
reference rates last fall.
Management has recently obtained improved financing, to refinance its building
loan and provide a working capital line of credit, while reducing the Company's
effective borrowing rate.
Liquidity and Capital Resources
The Company's working capital at December 31, 1998 was $2,385,000 compared to
$1,465,000 at June 30, 1998. The $920,000 improvement in working capital was
largely the result of net income earned in the six months ended December 31,
1998 of $783,000, less approximately $90,000 in capital expenditures, plus the
reclassification of approximately $224,000 in debt from short-term to long-term
(due to a pending re-finance). The short-term operating liquidity is expected to
be enhanced by the current growth trend in sales established by the Company,
along with the new revolving line-of-credit with expected availability in the
range of $1,000,000. This anticipated improvement is expected by the Company to
be sufficient to meet the Company's near and mid-term capital requirements,
namely, the funding of its pension plan obligation and the maturity of
additional debt.
16
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NETWORKS ELECTRONIC CORP.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
- --------------------------------------------------------------------------------
Year 2000 Issue
The Year 2000 readiness issue, which is common to most businesses, arises from
the inability of information systems, and other time and date sensitive products
and systems, to properly recognize and process date-sensitive information or
system failures. Assessments of the potential cost and effects of Year 2000
issues vary significantly among businesses, and it is extremely difficult to
predict the actual impact. Recognizing this uncertainty, management is
continuing to actively analyze, assess and plan for various Year 2000 issues
across its businesses.
The Year 2000 issue has an impact on both information technology ("IT") systems
and non-IT systems, such as its manufacturing systems and physical facilities
including, but not limited to, security systems and utilities. Although
management believes that a majority of the Company's IT systems are Year 2000
ready, such systems still have to be tested for Year 2000 readiness. The Company
is replacing or upgrading those systems that are identified as non-Year 2000
compliant. Certain IT systems previously identified as non-Year 2000 compliant
are being upgraded or replaced which should be complete by June 30, 1999. Non-IT
system issues are more difficult to identify and resolve. The Company is
actively identifying non-IT Year 2000 issues concerning its products and
services, as well as its physical facility locations. As non-IT areas are
identified, management formulates the necessary actions to ensure minimal
disruption to its business processes. Although management believes that its
efforts will be successful and the costs will be immaterial (i.e., less than
$10,000) to its consolidated financial position and results of operations, it
also recognizes that any failure or delay could cause a potential impact.
The Company has initiated efforts to ensure Year 2000 readiness of its products
and services. The Company is currently migrating to a Year 2000 compliant
Network Operating System, and its key financial, manufacturing and other
in-house systems are already materially compliant.
The Year 2000 readiness of its customers varies, and the Company is encouraging
its customers to evaluate and prepare their own systems. These efforts by
customers to address Year 2000 issues may affect the demand for certain products
and services; however, the impact to the revenue of any change in revenue
patterns is highly uncertain.
The Company has also initiated efforts to assess the Year 2000 readiness of its
key suppliers and business partners. The Company's direction of this effort is
to ensure the adequacy of resources and supplies to minimize any potential
business interruptions. Management plans to complete this part
17
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NETWORKS ELECTRONIC CORP.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
- --------------------------------------------------------------------------------
Year 2000 Issue (Continued)
of its Year 2000 readiness plan in the early part of calendar 1999. The Year
2000 issue presents a number of other risks and uncertainties that could impact
the Company, such as public utilities failures, potential claims against it for
damages arising from products and services that are not Year 2000 compliant, and
the response ability of certain government commissions of the various
jurisdictions where the Company conducts business. While the Company continues
to believe the Year 2000 issues described above will not materially affect its
consolidated financial position or results of operations, it remains uncertain
as to what extent, if any, the Company may be impacted.
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 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 has recorded operating profits during the years ended June 30,
1996, 1997, and 1998 in the amounts of approximately $175,000, $235,000, and
$1,326,000, 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 past 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.
Continued 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, develop and introduce new products or to
create new markets for its existing products
18
<PAGE> 19
NETWORKS ELECTRONIC CORP.
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)
- --------------------------------------------------------------------------------
History of Losses; Variability of Operating Results (Continued)
as well as 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.
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
Advances in technology characterize the markets for specialized bearings and
ordnance products. 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 six-month periods ended December 31, 1998 and 1997, sales to Textron
Systems accounted for approximately 19% and 26%, respectively, of the Company's
sales. Sales to the Department of Defense constituted approximately 21% of the
Company's sales during the six-month period ended December 31, 1998. A
significant decline in sales to any key customers could adversely affect the
Company.
19
<PAGE> 20
NETWORKS ELECTRONIC CORP.
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 that sustained damage from 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.
20
<PAGE> 21
NETWORKS ELECTRONIC CORP.
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 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 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.
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, the court has
ruled that the Trust must dispose of all of its shares in the Company. Sale by
the Trust of its interest in the Company would effect a change in the control of
the Company.
The Board of Directors of the Company has established a special committee (the
"Special Committee") to examine and make a recommendation to the Board of
Directors, as to what actions the Company should take in connection with the
Trust's sale of all of its interest in the Company. The Special Committee has
engaged an investment banking firm (The Seidler Companies Incorporated) to
determine the course of conduct to be adopted by the Company and to investigate
methods of enhancing shareholder value, including the possible sale of the
Company, merger or consolidation of the Company with complimentary businesses,
acquisition and recapitalizations.
The Company believes that there is a significant possibility that the Special
Committee may recommend to the Board of Directors that the Company pursue one or
more transactions that may result in a change of control, and that absent any
action by the Board of Directors, a change of control would likely occur in
connection with a sale by the Trust of its interest in the Company.
There can be no assurance that such a change of control would be accomplished
smoothly or that the Company will be successful in retaining key members of
management. The ability of the Company to make the change of control
successfully will depend on its capability to make the transition in an
efficient, effective and timely manner and on its ability to retain key
management, marketing and production personnel. Making the change in control an
efficient and timely process will also require the dedication of management
resources, which may temporarily distract management's attention from the
day-to-day business of the Company. The
21
<PAGE> 22
NETWORKS ELECTRONIC CORP.
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 (Continued)
inability of management to make the change of control smoothly could have an
adverse effect on the business and operational results of the Company. In
addition, there can be no assurance that the present and potential customers of
the Company will continue their current utilization patterns without regard to a
change of control. A loss of key members of management could affect business
relations with the Company's customers. Any significant reduction in utilization
patterns by the Company's customers could have an adverse effect on the
near-term business and results of operations of the Company's business.
The Company expects that the costs related to the retention of investment
bankers, as well as additional legal and accounting fees expected to be
incurred, will impact the Company's earnings during the fiscal year.
Also, 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 Company's Common Stock and could
impair the Company's 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.
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
22
<PAGE> 23
NETWORKS ELECTRONIC CORP.
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 (Continued)
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.
23
<PAGE> 24
NETWORKS ELECTRONIC CORP.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company generally has export sales ranging between 5% and 15% of total sales
during the period. These transactions are denominated in U.S. dollars,
effectively protecting the Company against foreign currency fluctuations.
At December 31, 1998, the Company had a mortgage note payable of approximately
$1,525,000 and a promissory note payable of approximately $235,000 that were
both indexed to reference rates. Accordingly, a 1% increase in the applicable
reference rates would result in additional interest expense of $17,600 per year,
assuming no change in the level of borrowing.
24
<PAGE> 25
NETWORKS ELECTRONIC CORP.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
(a) Through January 4, 1993, Networks Electronic Corp.'s common 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 common stock of Networks Electronic Corp. was removed from
trading on the NASDAQ national market system. The common stock is currently
traded on the OTC Electronic Bulletin Board.
(c) During the six months ended December 31, 1998, the Company issued an
aggregate of 1,000 shares of its common stock upon exercise of non-qualified
stock options granted to two key employees. The shares (500 each) were issued in
exchange for an aggregate of $250 in cash. These shares were acquired for
investment and without a view to the public distribution or resale thereof, and
the issuance thereof was exempt from the registration requirements under the
Securities Act of 1933, as amended, under Section 4(2) thereof as transactions
not involving a public offering.
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
25
<PAGE> 26
NETWORKS ELECTRONIC CORP.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
3.1 Articles of Incorporation of the Registrant*
3.2 By-Laws of the Registrant*
27.1 Financial Data Schedule
* Incorporated by reference to Registrant's Annual Report on Form-10K for the
year ended June 30, 1998.
b. Reports on Form 8-K:
There were no reports on Form 8-K filed for the three months ended December
31, 1998.
26
<PAGE> 27
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: February 12, 1999
27
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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.
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<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
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<INVENTORY> 1,480,988
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<CGS> 1,206,463
<TOTAL-COSTS> 1,396,457
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<INCOME-PRETAX> 632,147
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