10-Q 1 c72902e10vq.txt QUARTERLY REPORT DATED 9/30/02 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended September 30, 2002 Commission File No. 0-19944 ---------------------------------------- --------------------------- M~WAVE, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 36-3809819 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) identification No.) 475 Industrial Drive, West Chicago, Illinois 60185 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number including area code: (630) 562-5550 -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 and 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 --- --- The registrant has 4,443,294 shares of common stock outstanding at November 6, 2002. PART I - FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS M~WAVE, INC. CONSOLIDATED BALANCE SHEETS (Unaudited)
DECEMBER 31 SEPTEMBER 30 2001 2002 ------------ ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents .......................................... $ 2,102,784 $ 1,940,007 Accounts receivable, net of allowance for doubtful accounts, 2001- $100,000: 2002- $100,000 .................................... 8,829,686 2,788,744 Inventories ........................................................ 1,564,008 2,173,249 Refundable income taxes ............................................ 0 2,968,129 Deferred income taxes .............................................. 1,313,644 1,313,644 Prepaid expenses and other ......................................... 105,613 58,383 Restricted cash .................................................... 604,489 346,879 ------------ ------------ Total current assets ........................................... 14,520,224 11,589,035 PROPERTY, PLANT AND EQUIPMENT: Land, buildings and improvements ................................... 7,219,799 5,481,606 Machinery and equipment ............................................ 13,062,860 9,433,479 ------------ ------------ Total property, plant and equipment ............................ 20,282,659 14,915,085 Less accumulated depreciation ...................................... (7,836,882) (2,530,234) ------------ ------------ Property, plant and equipment-net .............................. 12,445,777 12,384,851 ASSETS TO BE DISPOSED OF, NET .......................................... 0 842,901 OTHER ASSETS ........................................................... 331,731 334,241 ------------ ------------ TOTAL .................................................................. $ 27,297,732 $ 25,151,028 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable ................................................... $ 3,112,370 $ 3,798,334 Accrued expenses ................................................... 1,491,547 928,937 Accrued income taxes ............................................... 152,931 0 Current portion of long-term debt .................................. 1,378,767 1,378,767 ------------ ------------ Total current liabilities ...................................... 6,135,615 6,106,038 DEFERRED INCOME TAXES .................................................. 663,830 663,830 LONG-TERM DEBT ......................................................... 2,743,527 3,664,836 STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value; authorized, 1,000,000 shares; no shares issued ......................................... 0 0 Common stock, $.01 par value; authorized, 10,000,000 shares 6,179,112 shares issued and 4,456,294 shares outstanding at December 31, 2001, 6,179,112 shares issued and 4,443,294 shares outstanding at September 30, 2002 ......................... 30,895 30,895 Additional paid-in capital ......................................... 8,439,072 8,439,072 Retained earnings .................................................. 11,512,072 8,531,527 Treasury stock, at cost, 1,722,815 shares, at December 31, 2001 and 1,735,815 shares at September 30, 2002 ........................ (2,227,279) (2,285,170) ------------ ------------ Total stockholders' equity ..................................... 17,754,760 14,716,324 ------------ ------------ TOTAL .................................................................. $ 27,297,732 $ 25,151,028 ============ ============
See notes to consolidated financial statements. 2 M~WAVE, Inc. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Three months ended September 30, ---------------------------------- 2001 2002 ----------- ------------ Net sales ................................. $ 8,611,111 $ 3,787,531 Cost of goods sold ........................ 6,934,527 6,537,287 ----------- ----------- Gross profit (loss) ..................... 1,676,584 (2,749,756) Operating expenses: General and administrative .............. 579,071 545,830 Selling and marketing ................... 265,041 394,618 Restructuring expense ................... 0 1,752,108 ----------- ----------- Total operating expenses .............. 844,112 2,692,556 ----------- ----------- Operating income (loss) ................. 832,472 (5,442,312) Other income (expense): Interest income ......................... 25,523 45,817 Interest expense ........................ (102,679) (50,518) Rental income ........................... 17,000 0 ----------- ----------- Total other expense ................... (60,156) (4,701) ----------- ----------- Income (loss) before income taxes ..... 772,316 (5,447,013) Provision (benefit) for income taxes ...... 293,451 (2,114,422) ----------- ----------- Net income (loss) ......................... $ 478,865 ($3,332,591) =========== =========== Weighted average shares outstanding ....... 4,544,689 4,443,294 Basic earnings (loss) per share ........... $0.11 ($0.75) Diluted shares outstanding ................ 4,570,031 4,443,294 Diluted earnings (loss) per share ......... $0.10 ($0.75)
See notes to consolidated financial statements. 3 M~WAVE, Inc. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Nine months ended September 30, ---------------------------------- 2001 2002 ------------ ------------ Net sales ........................................... $ 46,586,193 $ 19,397,654 Cost of goods sold .................................. 37,627,062 19,611,629 ------------ ------------ Gross profit (loss) ............................... 8,959,131 (213,975) Operating expenses: General and administrative ........................ 2,044,405 1,678,651 Selling and marketing ............................. 1,193,374 1,227,920 Restructuring expense ............................. 0 1,752,108 ------------ ------------ Total operating expenses ........................ 3,237,779 4,658,679 ------------ ------------ Operating income (loss) ........................... 5,721,352 (4,872,654) Other income (expense): Interest income ................................... 52,858 152,591 Interest expense .................................. (409,991) (151,542) Rental income ..................................... 119,000 ------------ ------------ Total other (expense) income .................... (238,133) 1,049 ------------ ------------ Income (loss) before income taxes .............. 5,483,219 (4,871,605) Provision (benefit) for income taxes ................ 2,155,756 (1,891,060) ------------ ------------ Net income (loss) ................................... $ 3,327,463 ($ 2,980,545) ============ ============ Weighted average shares outstanding ................. 4,562,918 4,449,397 Basic earnings (loss) per share ..................... $0.73 ($0.67) Diluted shares outstanding .......................... 4,597,892 4,449,397 Diluted earnings (loss) per share ................... $0.72 ($0.67)
See notes to consolidated financial statements. 4 M~WAVE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine months ended September 30, ------------------------------ 2001 2002 ----------- ----------- OPERATING ACTIVITIES: Net income (loss) .............................................. $ 3,327,463 ($2,980,545) Adjustments to reconcile net income (loss) to net cash flows from operating activities: Loss on disposal of property, plant and equipment .......... $ 0 $ 986,108 Depreciation and amortization .............................. 1,195,470 1,134,000 Deferred income taxes ...................................... 472,591 0 Changes in assets and liabilities: Accounts receivable-trade .................................. 1,543,471 6,040,942 Inventories ................................................ 6,349,184 (609,241) Income taxes ............................................... (729,911) (3,121,060) Prepaid expenses and other assets .......................... (315,270) 44,720 Restricted cash ............................................ 0 257,610 Accounts payable ........................................... (3,473,278) 685,964 Accrued expenses ........................................... (389,255) (562,610) ----------- ----------- Net cash flows provided by operating activities ......... 7,980,465 1,875,888 ----------- ----------- INVESTING ACTIVITIES: Purchase property, plant and equipment ......................... (5,142,100) (2,902,083) ----------- ----------- Net cash flows used in investing activities ............. (5,142,100) (2,902,083) FINANCING ACTIVITIES: Long term debt ................................................. 3,472,972 2,302,623 Payments on short and long term debt ........................... (5,925,297) (1,381,314) Purchase treasury stock ........................................ (468,376) (57,891) ----------- ----------- Net cash flows (used in) provided by financing activities (2,920,701) 863,418 ----------- ----------- NET DECREASE IN CASH AND CASH EQUIVALENTS ........................ (82,336) (162,777) CASH AND CASH EQUIVALENTS - Beginning of period .................. $ 1,230,999 $ 2,102,784 ----------- ----------- CASH AND CASH EQUIVALENTS - End of period ........................ $ 1,148,663 $ 1,940,007 =========== ===========
5 M~WAVE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation, consisting only of normal recurring adjustments, have been included. For further information, refer to the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2001 filed March 28, 2002. 2. BUSINESS M~Wave, Inc. through its wholly owned subsidiary Poly Circuits, Inc., is a value-added service provider of high performance printed circuit boards used in a variety of digital and high frequency applications for wireless and industrial electronics applications. M~Wave satisfies its customers requirements for wireless and industrial electronics applications by using its 50,000 square foot state-of-the-art prototype and small volume facility located in West Chicago, Illinois and by outsourcing and coordinating the manufacture of such boards by a global base of suppliers located primarily in the Far East ("Virtual Manufacturing"). Virtual Manufacturing contractually supplies all the printed circuit needs of our customers by managing the complete procurement process. We deliver products when the customer needs them through either consignment inventory control or just-in-time programs. The Company began Virtual Manufacturing during 2000 by developing subcontracting relationships with Global manufacturers. The Company typically begins the Virtual Manufacturing process by manufacturing prototypes and pre-production printed circuits at its manufacturing facility. The Company often works closely with customer personnel during this stage to finalize fabrication details and guidelines for circuit boards. As customers' requirements for circuit boards develop into higher volumes, the Company subcontracts the manufacture of the circuit boards to Global manufacturers. The Company continues to monitor the production and quality control of the circuit boards and works with its customers and Global manufacturers throughout the Virtual Manufacturing process. The Company believes that Virtual Manufacturing allows the Company to satisfy a broader range of its 6 customers' printed circuit board requirements without incurring substantial capital expenditures for plant, property and equipment. The Company added new levels of capacity in 2001 with the addition of its new facility in West Chicago, Illinois. The new state-of-the-art 50,000 square foot facility in West Chicago enables the Company to provide quick-turn prototypes to customers and to manufacture pre-production printed circuit boards for specific customer application. These process capabilities are an essential part of the Virtual Manufacturing process and the Company's ability to attract new customers. The Company closed its Bensenville facilities in the third quarter of 2002 and consolidated operations at its West Chicago facility. The Company recorded a one time pre-tax charge of $1,752,000 in the third quarter of 2002 relating to closing and consolidation of the Bensenville facilities into West Chicago. The third quarter 2002 results also included non-recurring events that increased gross loss by approximately $697,000. In addition, the Company produces customer specified bonded assemblies consisting of a printed circuit board bonded in some manner to a metal carrier or pallet. One bonding technique used by the Company is Flexlink(TM), a patented process granted to the Company in 1993. The Company developed an enhanced version called Flexlink II(TM) in 1996. The Company's printed circuit boards and bonded assemblies are used in a variety of telecommunications and industrial electronic applications. Many of the Company's printed circuit boards are Teflon(TM) based and are advantageous for microwave systems because of their extremely low power losses, coupled with stable, predictable electrical characteristics. The production of Teflon(TM) based printed circuit boards and bonded assemblies is technologically demanding due to the precise requirements of their end-use applications and the miniaturization of the microwave frequency components. To meet these technological demands, the Company has developed manufacturing processes and designs, which reduce the cost and increase the manufacturability and reliability of customer systems. Additionally, the Company emphasizes quality engineering and design support for its customers. The Company is subject to stringent technical evaluation and ISO certification by many of its customers. The Company markets its products through regional sales managers supported by independent sales organizations. The Company's base of approximately 100 customers represents a highly sophisticated group of purchasers. 7 M~Wave was incorporated in Delaware in January 1992 in connection with a 100 for 1 share exchange with the former stockholders of Poly Circuits, Inc. The Company's executive offices are located at 475 Industrial Drive, West Chicago, Illinois 60185, and its telephone number is (630) 562-5550. 3. INVENTORIES Inventories are carried at the lower of first-in, first-out (FIFO) cost or market. Substantially all the Company's inventories are in work in process. The Company provides a reserve for slow moving and obsolete inventory. During the second quarter of 2002, the Company negotiated a settlement for previously reserved inventory not expected to be recovered in the amount of $2,500,000. 4. DEBT The Company has an installment loan of $127,000 collateralized by certain fixed assets of the Company. Interest on this loan is at the prime rate. The loan is payable in monthly installments of principal and interest and is due in October 2004. On July 26, 2001, the Company signed an agreement with the Illinois Development Finance Authority to borrow up to a maximum $8,100,000 to finance its facility in West Chicago, Illinois. Borrowings can be disbursed, in accordance with the agreement, to the Company for up to three years. Interest is set on a weekly basis, based upon the interest rates of comparable tax-exempt bonds under prevailing market conditions. The interest rate at September 30, 2002 was 1.99%. The term of the bond is 20 years with the first payment of $1,320,000 due and made in July 2002. Through September 30, 2002 the Company owes $4,916,000. The Company was in default on September 30, 2002 because of its failure to comply with the financial ratios as set forth in the Reimbursement Agreement relating to the bond. On November 8, 2002, the Company entered into a Forbearance Agreement with Bank One, N. A., formerly known as American Bank and Trust Company of Chicago, pursuant to which the Company agreed to comply with all of the terms and conditions contained in the Forbearance Agreement and the Bank agreed to forbear from the date of the agreement to December 31, 2002 from pursuing its rights under the Reimbursement Agreement (including the right to declare the bond immediately due and payable) provided the Company complies with all of the terms and conditions contained in the Forbearance Agreement. See attached exhibit 10.21. 8 The Company had a line of credit agreement, which expired on May 15, 2002. The Company is currently negotiating to replace short and long-term debt. 5. LITIGATION The Company is a party to various actions and proceedings related to its normal business operations. The Company believes that the outcome of this litigation will not have a material adverse effect on the financial position or results of operations of the Company. 9 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS FOR THE QUARTER ENDED SEPTEMBER 30, 2002 COMPARED TO THE QUARTER ENDED SEPTEMBER 30, 2001 NET SALES Net sales were $3,787,000 for the quarter ended September 30, 2002, a decrease of $4,824,000 or 56% below the third quarter of 2001. The decrease in net sales is directly related to a drop in demand in the telecom industry. Virtual Manufacturing accounted for approximately $2,812,000 of net sales or 74% in the third quarter of 2002 compared to $7,660,000 of net sales or 89% in the third quarter of 2001. Net sales to Lucent were $4,779,000 in the third quarter of 2001. There were no sales to Lucent during the third quarter of 2002. Net sales to Celestica were $785,000 in the third quarter of 2002 compared to $2,749,000 in the third quarter of 2001. On September 1, 2001, Lucent transitioned a segment of their manufacturing operations at Columbus, Ohio to Celestica. Celestica is based in Toronto, Canada. On September 1, 2001, Lucent also transferred most of their open purchase orders with the Company to Celestica. The reduction in net sales to Lucent and Celestica reflect the drop in demand in the telecom industry and the end of life of several product lines. Lucent accounted for 56% of the Company's net sales in the third quarter ended September 30, 2001. Celestica accounted for 21% of the Company's net sales for the third quarter ended September 30, 2002 compared to 32% in the third quarter of 2001. RF Power accounted for 9% of the Company's net sales in the third quarter ended September 30, 2002 compared to 1% of the Company's net sales for the third quarter ended September 30, 2001. Westell, a new Virtual Manufacturing customer, accounted for 37% of the Company's net sales for the third quarter ended September 30, 2002. GROSS PROFIT AND COST OF GOODS SOLD The Company's gross loss for the third quarter of 2002 was ($2,750,000) compared to a gross profit of $1,677,000 for the third quarter of 2001. The decrease in gross profit is a result of the decrease in net sales, a drop in demand in the telecom industry and the closing and consolidation of the Bensenville facility. The closing and consolidation also allowed the Company to reduce the staff from approximately 180 employees during the second quarter to approximately 110 employees. The reduction included both hourly and salary employees. Gross Margin was negative in the third quarter of 2002 compared to approximately 20% in the third quarter of 2001. The third quarter 2002 results 10 included non-recurring events that increased gross loss by approximately $697,000. These events were a result of the end of life of several products including products the Company supplied to Celestica. Had these events not occurred, the gross loss for the third quarter would have been a loss of approximately $2,052,000. OPERATING EXPENSES General and administrative expenses were $546,000 or 14.4% of net sales in the third quarter of 2002 compared to $579,000 or 6.7% of net sales in the third quarter of 2001. General and administrative expenses consist primarily of salaries and benefits, professional services, depreciation of office equipment, computer systems and occupancy expenses. Payroll related expenses were down $33,000. Professional services, which include legal and auditing fees, were down $23,000. Selling and marketing expenses were $395,000 or 10.4% of net sales in the third quarter of 2002 compared to $265,000 or 3.1% of net sales in the third quarter of 2001. Selling and marketing expenses include the cost of salaries, advertising and promoting the Company's products, and commissions paid to independent sales organizations. Commissions paid to independent sales organizations were up $19,000. Payroll related expenses were up $97,000 with the addition of regional sales managers and support staff. Restructuring expenses were $1,752,000 or 46.3% of sales in the third quarter of 2002. Restructuring expenses include costs associated with the closing, cleanup and disposition of the Bensenville facilities. These expenses include (1) the net write-down and disposal of approximately $986,000 of specific assets that were not required at the West Chicago facility, (2) cleanup, sale and related expenses of $680,000 for the Bensenville facilities and (3) severance payments of $86,000. OPERATING INCOME Operating loss was ($5,442,000) in the third quarter of 2002 compared to an operating income of $832,000 or 9.7% of net sales in the third quarter of 2001, a decrease of $6,275,000. The changes in operating income reflect primarily the changes in net sales, gross profit and cost of goods sold, operating expenses and the closing and consolidation of the Bensenville facility as discussed above. The change in operating income can be summarized as follows: Decrease in net sales ($939,000) Decrease in gross margin (3,487,000) Increase in operating expenses (1,849,000) ----------- Decrease in operating income ($6,275,000) 11 INTEREST INCOME Interest income from short-term investments was $46,000 in the third quarter of 2002 compared to $26,000 in the third quarter of 2001. Rental income from the P C Dynamics facility was $17,000 in the third quarter of 2001. The Company sold the P C Dynamics facility in the fourth quarter of 2001. INTEREST EXPENSE Interest expense, primarily related to the Industrial Revenue Bond was $51,000 in the third quarter of 2002 compared to $103,000 in the third quarter of 2001. The Company had a mortgage obligation on the P C Dynamics facility in the third quarter of 2001. INCOME TAXES In the third quarter of 2002, the Company had an effective tax credit of 38.8% compared to an effective tax rate of 38.0% in the third quarter of 2001. 12 RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2001 NET SALES Net sales were $19,398,000 for the nine months ended September 30, 2002, a decrease of $27,189,000 or 58% below the first nine months of 2001. The decrease in net sales is directly related to a drop in demand in the telecom industry. Virtual Manufacturing accounted for approximately $15,769,000 of net sales for the first nine months of 2002 compared to $42,630,000 for the first nine months of 2001. The first nine months of 2002 also included two non-recurring events that boosted sales by $3,600,000. These events were the result of the end of life of several products we produced for Lucent and the shipment of inventory we were holding for Westell. Had these events not occurred, the net sales for the first six months of 2002 would have been approximately $15,798,000. Net sales to Lucent were $2,528,000 for the first nine months of 2002 compared to $38,303,000 for the first nine months of 2001. Net sales to Celestica were $6,898,000 for the first nine months of 2002 compared to $4,194,000 for the first nine months of 2001. On September 1, 2001, Lucent transitioned a segment of their manufacturing operations at Columbus, Ohio to Celestica. Celestica is based in Toronto, Canada. On September 1, 2001, Lucent also transferred most of their open purchase orders with the Company to Celestica. Celestica accounted for 36% of the Company's net sales for the first nine months of 2002 compared to 9% for the first nine months of 2001. Lucent accounted for 13% of the Company's net sales for the first nine months of 2002 compared to 82% for the first nine months of 2001. Westell, a new Virtual Manufacturing customer, accounted for 26% of the Company's net sales for the first nine months of 2002. GROSS PROFIT AND COST OF GOODS SOLD The Company's gross loss for the first nine months of 2002 was ($214,000) compared to a gross profit of $8,959,000 for the first nine months of 2001. The decrease in gross profit is a result of the decrease in net sales, a drop in demand in the telecom industry and the closing and consolidation of the Bensenville facility. The closing and consolidation also allowed the Company to reduce the staff from approximately 180 employees during the second quarter to approximately 110 employees. The reduction included both hourly and salary employees. Gross Margin was negative for the first nine months of 2002. Gross margin was 19% for the first nine months of 2001. The first nine months of 2002 included non-recurring events that boosted revenue by $3,600,000 and 13 gross margin by $1,803,000. These events were a result of the end of life of several products including products the Company produced for Lucent and Celestica and the shipment of inventory we were holding for Westell. Had these events not occurred, the gross loss for the first nine months would have been approximately ($2,014,000). OPERATING EXPENSES General and administrative expenses were $1,679,000 or 8.7% of net sales for the first nine months of 2002 compared to $2,044,000 or 4.4% of net sales for the first nine months of 2001. General and administrative expenses consist primarily of salaries and benefits, professional services, depreciation of office equipment, computer systems and occupancy expenses. Payroll related expenses were down $307,000 due to a reduction in the bonus award. Professional services, which include legal and auditing fees, were down $84,000. IT expenses were up approximately $93,000. Selling and marketing expenses were $1,228,000 or 6.3% of net sales for the first nine months of 2002 compared to $1,193,000 or 2.6% of net sales for the first nine months of 2001. Selling and marketing expenses include the cost of salaries, advertising and promoting the Company's products, and commissions paid to independent sales organizations. Commissions paid to independent sales organizations were down $355,000. Payroll related expenses were up $313,000 with the addition of three regional sales managers and support staff. Restructuring expenses were $1,752,000 or 9.0% of sales for the first nine months of 2002. Restructuring expenses include costs associated with the closing, cleanup and disposition of the Bensenville facilities. These expenses include (1) the net write-down and disposal of approximately $986,000 of specific assets that were not required at the West Chicago facility, (2) cleanup, sale and related expenses of $680,000 for the Bensenville facilities and (3) severance payments of $86,000. OPERATING INCOME Operating loss was ($4,873,000) or (25.1%) of net sales for the first nine months of 2002 compared to an operating income of $5,721,000 or 12.3% of net sales for the first nine months of 2001, a decrease of $10,594,000. The changes in operating income reflect primarily the changes in net sales, gross profit and cost of goods sold, operating expenses and closing and consolidation of the Bensenville facility as discussed above. The change in operating income can be summarized as follows: 14 Decrease in net sales ($5,229,000) Decrease in gross margin (3,944,000) Increase in operating expenses (1,421,000) ------------ Decrease in operating income ($10,594,000) INTEREST INCOME Interest income from short-term investments was $153,000 for the first nine months of 2002 compared to $53,000 for the first nine months of 2001. Rental income from the P C Dynamics facility was $119,000 for the first nine months of 2001. The Company sold the P C Dynamics facility in the fourth quarter of 2001. INTEREST EXPENSE Interest expense, primarily related to the Industrial Revenue Bond was $152,000 for the first nine months of 2002 compared to $410,000 for the first nine months of 2001. The Company had a mortgage obligation on the P C Dynamics facility in the first seven months of 2001. INCOME TAXES For the first nine months of 2002, the Company had an effective tax credit of 38.8% compared to an effective tax rate of 39.3% for the first nine months of 2001. 15 LIQUIDITY AND CAPITAL RESOURCES Net cash flows provided by operations was $1,876,000 for the first nine months of 2002 compared to providing $7,980,000 for the first nine months of 2001. Accounts receivables decreased $6,041,000. Inventories increased $609,000. Accounts payable increased $686,000. Depreciation and amortization was $1,134,000. The loss on disposal of property, plant and equipment was $986,000. Capital expenditures mainly relating to the new West Chicago facility were $2,902,000 for the first nine months of 2002. The Company has limited plans for capital expenditures during the fourth quarter of 2002. The Company has an installment loan of $127,000 collateralized by certain fixed assets of the Company. Interest on this loan is at the prime rate. The loan is payable in monthly installments of principal and interest and is due in October 2004. The Company completed financing of $8,100,000 from the Illinois Development Finance Authority's 2001 maximum limit on tax-exempt private activity bonds to finance its facility in West Chicago, Illinois on July 26, 2001. The bond replaced approximately $2,865,000 of credit line debt, which had an interest rate of 6% at the time. The interest on the bond is set weekly: the current rate for the week ending September 30, 2002 was approximately 1.99%. The outstanding balance, as of September 30, 2002, was $4,916,000. The Company made the first payment of $1,320,000 per the terms of the agreement in the third quarter of 2002. The Company borrowed $837,000 in the third quarter of 2002. The Company also entered into a five-year agreement on September 4, 2001 with American National Bank and Trust Company of Chicago hedging $4,000,000 of the Industrial Bond Debt at a 4.24% rate of interest. The Company's industrial bond debt documents contain a number of significant covenants that, among other things, restrict the Company's ability to dispose of assets, incur additional indebtedness, pay dividends, enter into certain investments, enter into sale and lease-back transactions, make certain acquisitions, engage in mergers and consolidations, create liens, or engage in certain transactions with affiliates, and otherwise restrict corporate and business activities. In addition, the Company is required to comply with specified financial ratios and tests, including a minimum tangible net worth test, a minimum interest coverage ratio and a maximum leverage ratio. The Company's ability to continue to comply with these covenants and restrictions may be affected by events beyond the Company's control. A failure by the Company to comply with these covenants and restrictions would result in an event of default under the Company's industrial bond debt documents. The 16 Company was in default on September 30, 2002 because of its failure to comply with the financial ratios as set forth in the Reimbursement Agreement relating to the bond. On November 8, 2002, the Company entered into a Forbearance Agreement with Bank One, N. A., formerly known as American Bank and Trust Company of Chicago, pursuant to which the Company agreed to comply with all of the terms and conditions contained in the Forbearance Agreement and the Bank agreed to forbear from the date of the agreement to December 31, 2002 from pursuing its rights under the Reimbursement Agreement (including the right to declare the bond immediately due and payable) provided the Company complies with all of the terms and conditions contained in the Forbearance Agreement. See attached exhibit 10.21. The terms of the Company's long-term bank debt represent the borrowing rates currently available to the Company; accordingly, the fair value of this debt approximates its carrying amount. The Company had a line of credit agreement, which expired on May 15, 2002. The Company is currently negotiating to replace short and long-term debt. The Company's ability to make scheduled principal and interest payments on, or to refinance, its indebtedness, or to fund planned capital expenditures will depend upon its future performance, which is subject to general economic, financial, competitive and other factors that are beyond its control. The Company's ability to fund operating activities is also dependent upon its rate of growth, ability to effectively manage its inventory, the terms under which the Company extends credit to customers and its ability to collect under such terms and its ability to access external sources of financing. Based upon the current level of operations and anticipated growth, management believes that future cash flow from operations, together with other sources of debt fundings and issuance of additional equity securities, will be adequate to meet its anticipated requirements for capital expenditures, working capital, interest payments and scheduled principal payments over the next 12 months. There can be no assurance, however, that its business will continue to generate sufficient cash flow from operations in the future to service its debt and make necessary capital expenditures after satisfying certain liabilities arising in the ordinary course of business. If unable to do so, the Company may be required to refinance all or a portion of its existing debt, to sell assets or to obtain additional financing. There can be no assurance that any such refinancing would be available or that any such sale of assets or additional financing could be obtained. 17 INFLATION Management believes inflation has not had a material effect on the Company's operation or on its financial position. FOREIGN CURRENCY TRANSACTIONS All of the Company's foreign transactions are negotiated, invoiced and paid in United States dollars. ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS As a supplier to microwave manufacturers, the Company is dependent upon the success of its customers in developing and successfully marketing end-user microwave systems. The Company is currently working on several development programs for its customers. The development of commercial applications for microwave systems and the timing and size of production schedules for these programs is uncertain and beyond the control of the Company. There can be no assurance that these development programs will have a favorable impact on the Company's operating results. Although management believes some of these products and programs may ultimately develop into successful commercial applications, such developments could result in periodic fluctuations in the Company's operating results. As a result of these considerations, the Company has historically found it difficult to project operating results. The Company expects that a small number of customers will continue to account for a substantial majority of its sales and that the relative dollar amount and mix of products sold to any of these customers can change significantly from year to year. There can be no assurance that the Company's major customers will continue to purchase products from the Company at current levels, or that the mix of products purchased will be in the same ratio. The loss of the Company's largest customer or a change in the mix of product sales would have a material adverse effect on the Company. In addition, future results may be impacted by a number of other factors, including the failure of the Telecom market to improve; the Company's ability to secure additional sources of funds that it may require; the Company's dependence on suppliers and subcontractors for components; the Company's ability to respond to technical advances; successful award of contracts under bid; design and production delays; cancellation or reduction of contract orders; the Company's effective utilization of existing and new manufacturing resources and the "Virtual Manufacturing" process; and pricing pressures by key customers. 18 The Company's future success is highly dependent upon its ability to manufacture products that incorporate new technology and are priced competitively. The market for the Company's products is characterized by rapid technology advances and industry-wide competition. This competitive environment has resulted in downward pressure on gross margins. In addition, the Company's business has evolved towards the production of relatively smaller quantities of more complex products, the Company expects that it will at times encounter difficulty in maintaining its past yield standards. There can be no assurance that the Company will be able to develop technologically advanced products or that future-pricing actions by the Company and its competitors will not have a material adverse effect on the Company's results of operations. The Company is dependent upon unaffiliated foreign companies for the manufacture of printed circuit boards as part of its Virtual Manufacturing process. The Company's arrangements with manufacturers are subject to the risks of doing business abroad, such as import duties, trade restrictions, production delays due to unavailability of parts or components, transportation delays, work stoppages, foreign currency fluctuations, political instability and other factors which could have an adverse effect on the Company's business, financial condition and results of operations. The Company believes that the loss of any one or more of its suppliers would not have a long term material adverse effect on its business, financial condition and results of operations because other manufacturers would be able to increase production to fulfill its requirements. However, the loss of certain suppliers, could, in the short term adversely affect its business until alternative supply arrangements were secured. The market value of our publicly held shares has fallen below the minimum market value of $5 million as required by the Nasdaq National Market on which our common stock is currently listed. In addition, the closing bid price per share of our common stock has fallen below the minimum closing bid price of $1.00 required under the listing requirements of the Nasdaq National Market. If the minimum market value of our publicly held shares remains below $5 million or the per share closing bid price for our common stock remains below the $1.00 minimum bid price, we may be delisted from the Nasdaq National Market which could reduce the liquidity of our common stock, further decrease the market price of our common stock and negatively impact our ability to obtain additional capital. The Company has until December 23, 2002 to comply with the Nasdaq National Market listing requirements. 19 ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act")) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. (b) Changes in internal controls. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 20 PART II - OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS None 21 ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.21 Forbearance Agreement dated November 8, 2002 between the Company and Banc One, N.A., formerly known as American National Bank & Trust Company of Chicago. (b) Reports on Form 8-K (1) A current report on Form 8-K was filed on August 13, 2002, under item 9, the execution by the Company's chief executive officer and chief financial officer of the certification required by Section 906 of the Sarbanes-Oxley Act of 2002. (2) A current report on Form 8-K was filed on August 28, 2002 reporting, under item 5, the Company's reduction in workforce. 22 SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. M~WAVE, INC. Date: November 11, 2002 /s/ PAUL H. SCHMITT ------------------------- Paul H. Schmitt Chief Financial Officer 23 CERTIFICATIONS I, Joseph A. Turek, Chairman and Chief Executive Officer of M-Wave, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of M-Wave, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 24 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 8, 2002 By: /s/ Joseph A. Turek ------------------------------------ JOSEPH A. TUREK CHAIRMAN AND CHIEF EXECUTIVE OFFICER 25 CERTIFICATIONS I, Paul H. Schmitt, Chief Financial Officer of M-Wave, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of M-Wave Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 26 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 8, 2002 By: /s/ Paul H. Schmitt --------------------------------------- PAUL H. SCHMITT CHIEF FINANCIAL OFFICER 27 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION PAGE ------- ----------- ---- 10.21 Forbearance Agreement dated November 8, 2002 between the Company and Banc One, N.A., formerly known as American National Bank & Trust Company of Chicago. 29-32 28