UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-7336
RELM WIRELESS CORPORATION
(Exact name of registrant as specified in its charter)
Nevada 59-3486297
(State of other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
7100 Technology Drive
West Melbourne, Florida 32904
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (321) 984-1414
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.60
----------------------------
(Title of Class)
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 by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated
filer Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant on February 28, 2003, based on the
closing price at which such stock was sold on the NASDAQ National Market on such
date, was $3,067,163 and on June 30, 2002, was $4,789,105.
As of February 28, 2003, 8,565,088 shares of the registrant's Common
Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the registrant's proxy
statement for its 2003 Annual Shareholders' Meeting are incorporated by
reference in Part III of this report. The registrant's proxy statement will be
filed within 120 days after December 31, 2002.
TABLE OF CONTENTS
PAGE
Part I............................................................................................................1
Item 1. Business..............................................................................................1
Item 2. Properties...........................................................................................11
Item 3. Legal Proceedings....................................................................................11
Item 4. Submission of Matters To A Vote of Security Holders..................................................NA
Part II..........................................................................................................13
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............................13
Item 6. Selected Financial Data..............................................................................14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................16
Item 7A. Quantitative and Qualitative Disclosures About Market Risks..........................................28
Item 8. Financial Statements and Supplementary Data..........................................................39
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................40
Part III.........................................................................................................40
Item 10. Directors and Executive Officers of the Registrant..................................................40
Item 11. Executive Compensation..............................................................................40
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters......41
Item 13. Certain Relationships and Related Transactions......................................................42
Part IV..........................................................................................................42
Item 14. Controls and Procedures.............................................................................43
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................................43
SIGNATURES.......................................................................................................45
i
PART I
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ITEM 1. BUSINESS
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GENERAL
RELM Wireless Corporation designs, manufactures and markets wireless
communications products, principally two-way land mobile radios (LMR) and
related components. We offer products with three distinct brand names, BK Radio,
RELM, and Uniden. These products are sold to:
1) The government and public safety market, which includes fire, rescue,
law enforcement, and emergency medical personnel, as well as the
military and various agencies of federal, state, and local governments.
2) The business and industrial market, which consists of enterprises
requiring fast, inexpensive communication among a discrete group of
users. Examples include hotels, construction companies, schools,
airports, and taxies.
From 1996 through 2000 we significantly restructured the Company. The objective
was to focus the Company on our core business of LMR wireless communications.
The restructuring, largely completed in 1999, consisted of selling or otherwise
discontinuing businesses and product lines that were outside our focus or that
were under-performing. We also significantly reduced the size and costs of our
operations. Consequently, in more recent years, we have been able to
aggressively pursue initiatives in the LMR business designed to improve our
competitive position and ultimately fuel future growth and profitability.
The restructuring program was the key factor behind our profitable year in 2001,
and allowed us to withstand a difficult year in 2002. Diminished sales to our
two largest customers and the deteriorating overall economic conditions were the
principal reasons for a 29% decrease in revenues from 2001 to 2002. We also
incurred several significant non-recurring charges, the largest of which was the
write off of a note receivable from our former paper-manufacturing subsidiary
that was sold in 1997. This charge is unrelated to our present operations.
During the year we continued to expand our utilization of high-quality, low-cost
contract manufacturers. These efforts began to yield margin improvements in
2002, a trend that we expect to continue at an increasing rate in 2003.
We made significant progress on new product development during the year. Most
importantly, we expanded and accelerated our digital product development using
additional capital that was raised in a first quarter public rights offering.
The first model, a digital portable radio that will be added to our BK Radio
line, has been completed and approved by the Federal Communications Commission
(FCC). It is in the process of being added to the contract for the Department of
Interior (DOI). Of all federal government agencies, the DOI is the most
aggressive in implementing plans to purchase digital communications technology.
Late in the year we also introduced a new family of products for business and
industrial users, and completed the development and testing of our ESAS System.
We believe that these new products, and others that will be completed shortly,
serve as a solid foundation on which to grow the business profitably.
Our principal executive offices are located at 7100 Technology Drive, West
Melbourne, Florida 32904 and the telephone number is (321) 984-1414. More
information about our products and us is also available through the Internet at
"RELM.com." The information provided on our website is not incorporated into
this report.
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ITEM 1. BUSINESS-CONTINUED
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HISTORY - REINCORPORATION OF ADAGE, INC. INTO RELM WIRELESS CORPORATION
RELM Wireless Corporation is the surviving corporation in the January 30, 1998
reincorporation merger of Adage, Inc., into RELM Wireless Corporation, its
wholly owned subsidiary.
As a result of the reincorporation, each share of Adage common stock outstanding
immediately prior to the reincorporation was converted, effective as of January
30, 1998, into one share of RELM common stock and the trading symbol for the
shares was changed from "ADGE" to "RELM."
RECENT DEVELOPMENTS
On March 22, 2002, we closed a public rights offering. The purpose of the
offering was to provide working capital, which among other things, we believe
will speed the development of our new APCO Project 25-compliant digital products
and capabilities. The securities offered were "units" priced at $.90 per unit. A
unit was comprised of one share of RELM common stock and one warrant to purchase
one share of RELM common stock, exercisable at $1.08 per share at any time on or
after February 12, 2003 and until February 11, 2006. Units were offered
initially to our equity holders in the form of a rights offering. The "right"
allowed investors in the offering to purchase units at a 10% discount to the
market price of a share of common stock.
Noble International Investments, Inc. was engaged as the standby underwriter for
this offering. The units were offered to the public pursuant to a registration
statement that was declared effective by the Securities and Exchange Commission
(SEC) on February 11, 2002. In accordance with the terms of the offering, the
units were separated on the closing date. The offering resulted in the sale of
2,775,000 shares of common stock and warrants to purchase 2,775,000 shares of
common stock. The offering generated $1.8 million in net proceeds. The warrants
are currently quoted on the OTC Bulletin Board with the symbol "RELMW." Our
common stock is listed on the NASDAQ Small Cap Market under the symbol, "RELM."
On May 17, 2002, Noble exercised its option to purchase 416,250 additional units
at a purchase price of $0.90 per unit to cover over-allotments. We received
approximately $0.3 million in net proceeds from the purchase of these additional
units.
In 2002, we began to introduce a new series of portable radios to be sold under
our RELM brand. This family of portable analogue radios will, upon completion,
be comprised of four models. One model was introduced in the first half of the
year. Two additional models were introduced late in the fourth quarter. The
final model will be available in the second quarter 2003. This radio family
offers a combination of features and affordability that are designed to compete
effectively in business and industrial markets worldwide. We have contracted for
the manufacture of these radios under a previously announced agreement with an
international electronic technology and manufacturing concern. Under the
agreement, we have exclusive distribution rights for these products in North,
Central, and South America. The agreement expires on September 11, 2006 and may
be expanded to include additional products.
On May 1, 2002, we were notified by Nasdaq Listing Qualifications that for the
last 30 consecutive trading days our stock had closed below the minimum $1.00
per share requirement for continued listing under Marketplace Rule 4310(c)(4).
In accordance with Marketplace Rule 4310(c)(8)(d) we had 180 days, until October
28, 2002, to regain compliance. We did not regain compliance by the designated
date. On October 29, 2002 we were granted an additional 180 days, until April
28, 2003, to regain compliance. If at any time before April 28, 2003 the bid
price of our common stock closes at $1.00 per share or more
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ITEM 1. BUSINESS-CONTINUED
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for a minimum of 10 consecutive trading days, the Nasdaq staff will provide
written notification that we comply with the rule. Otherwise the staff will
provide written notification that our securities will be delisted. At that time,
we may appeal the staff's determination to a Listing Qualifications Panel.
LOSS ON NOTES RECEIVABLE
In April 2002, we learned that the purchaser of the assets of the Company's
former paper-manufacturing subsidiary, had ceased operations. The purchaser owed
the Company $900,000 plus accrued interest under the terms of two secured
promissory notes and had defaulted on its obligations to make principal and
interest payments. With guidance from counsel, we evaluated alternatives and
took all prudent actions to maximize the possibility of recovery. However, after
a comprehensive assessment, we believed that the value of the purchaser's assets
and the assets of the guarantor were insufficient to provide any recovery of the
amounts due under the notes. Accordingly, the Company wrote-off the entire
principal amount ($900,000) of the two promissory notes during the first quarter
2002.
During 2002, the purchaser of the assets of our former specialty manufacturing
subsidiary, ceased making payments in accordance with a note receivable. The
initial amount of the note was approximately $355,000. Presently, the amount due
under the note is approximately $175,000 plus accrued interest. This note is
derived from the 1997 agreement for the sale of our specialty manufacturing
operation. Since its inception, the terms of the obligation have been
restructured several times to accommodate the purchaser. The last payment was
received in March 2002. Attempts during the second and third quarters 2002 to
contact the purchaser and collect the past-due installment payments have been
unsuccessful. In February 2003, we started legal proceedings to recover the
remaining amount due under the note plus accrued interest. With guidance from
counsel, we believe that we will prevail in these proceedings. However, we have
been unable to ascertain the financial position of the purchaser or their
ability to pay the debt. Accordingly, we established a collection allowance in
the fourth quarter 2002 for the entire principal amount of the note.
The businesses and events associated with both of the former subsidiaries are
legacies from before 1997. They are not at all related to land mobile radio
(LMR) operations, which have been our focus for the past several years. We have
excluded these obligations from our cash flow projections and operating plans
since 2000. Although the write-off and allowance impacted 2002 earnings, we
anticipate no future impact on the execution of our core LMR business plan
objectives, including our digital product development, which in February 2003
yielded the introduction of our initial APCO Project 25 compliant digital radio.
INVESTMENT BANKING SERVICES AGREEMENT
On May 12, 2000, we engaged Janney Montgomery Scott (JMS) to provide certain
investment banking services. In connection with the engagement, we granted
warrants to JMS, valued at $226,000, to purchase 166,153 shares of our common
stock at an aggregate purchase price of one hundred dollars. The warrants had a
five-year term and an exercise price of $3.25 per share. The value of the
warrants along with $13,083 of associated warrant costs was being amortized on a
straight-line basis over the estimated life of the contract. Accumulated
amortization at December 31, 2002 and 2001 was $120,000 and $76,000
respectively. In the fourth quarter we were notified that JMS had closed its New
York office, and the firm no longer employs the principals who handled our
account. Therefore, we do not anticipate receiving further services under this
agreement. Accordingly, we elected to write-off the remaining value of the
warrants totaling approximately $120,000 during the fourth quarter of 2002.
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ITEM 1. BUSINESS-CONTINUED
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TECHNOLOGY LICENSING AGREEMENT
In March 1998, we entered into an agreement with Racal Communications, Inc.
(presently known as "Thales") which, among other things, licensed us to use
Thales' digital APCO project 25-compliant technology under specified terms and
conditions. The cost of the technology license was $300,000 and was being
amortized over a period of eight years. We have since developed our own APCO
project 25-compliant digital technology, which was completed in the fourth
quarter 2002. Consequently, we do not anticipate utilizing the technology
provided for by our agreement with Racal. Accordingly, we elected to write-off
the remaining value of the technology agreement totaling $211,000 during the
fourth quarter of 2002.
SALES INFORMATION
As an aid to understanding the impact of our decision to focus exclusively on
our LMR business, the following table summarizes sales information by major
product lines and industry:
2002 2001 2000
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(in Millions)
LMR-Gov't & Pub. Safety $12.5 $18.0 $14.7
LMR-Bus./Indus./Comm. 3.4 4.8 6.4
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Total $15.9 $22.8 $21.1
==================================
INDUSTRY OVERVIEW
LMR communications consist of hand-held (portable) and mobile (vehicle mounted)
two-way radios commonly used by the public safety sector (e.g. police, fire, and
emergency medical personnel), businesses (e.g. hotels, airports, farms, taxis,
and construction firms), and government agencies within the United States and
abroad. LMR systems are constructed to meet an organization's specific
communication needs. The cost of a system varies widely, starting at
approximately $60,000 for a basic configuration. Radio sets typically cost
between $250 and $800, depending upon features, and there are no recurring
airtime usage charges. Accordingly, LMR usage patterns are considerably
different from those for cellular and other wireless communications tools. LMR
usage is characterized by frequent calls of short duration. The majority of
users make 20 to 50 calls per day, with most calls lasting less than 30 seconds.
The average useful life is 8 years for a portable radio and 11 years for a
mobile.
LMR systems are the oldest form of wireless dispatch communications used in the
U.S., having been first deployed by the Detroit Police Department in 1921. LMR
is also the most widely used form of dispatch communications in the U.S. with
current users estimated to exceed 16.3 million. Initially, LMR was used almost
exclusively by law enforcement. At that time all radio communications were
transmitted in an analog format. Analog transmissions typically consist of a
voice or other signal modulated directly onto a continuous radio carrier wave.
Over time, advances in technology decreased the cost of LMR
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ITEM 1. BUSINESS-CONTINUED
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products and increased its popularity and usage by businesses and other
agencies. To respond to the growing usage, additional spectrum was allocated for
LMR use.
In recent years LMR has been characterized by slow growth of approximately 2%
annually. This growth rate is a reflection of several factors:
o LMR is a mature industry, having been in existence for over 70 years.
o Some LMR users are in mature industry segments that are themselves
experiencing slow growth rates.
o Most significantly, growth has been hampered by the lack of available radio
spectrum, which has prevented existing users from expanding their systems
and hindered efforts of many potential new users from obtaining licenses
for new systems.
As a result of the lack of available spectrum, the FCC has mandated that new LMR
equipment utilize more spectrum-efficient technology. This will effectively
require LMR users to migrate to digital systems. Responding to the mandate, the
Association of Public Communications Officials (APCO), in concert with several
LMR manufacturers (including RELM), recommended an industry standard for digital
LMR devices that would meet the FCC requirements and provide solutions to
several problems experienced primarily by public safety users. The standard is
called Project 25. The primary objectives of APCO Project 25 are to i) allow
effective, efficient and reliable inter-operability among users, ii) obtain
maximum radio spectrum efficiency, and, iii) to ensure competition among LMR
providers through an open system architecture.
Although the FCC does not require public safety agencies or APCO to purchase
Project 25-compliant equipment or otherwise adopt the standard, we believe that
compliance with the standard is fast becoming the key factor for public safety
purchasers. Furthermore, we believe that the demand for Project 25-compliant
equipment will fuel significant LMR market growth as users upgrade systems to
comply with the FCC mandate. A privately commissioned study by name of study,
estimates the addressable market for APCO Project 25 compliant products will
total approximately $38 billion over the next five years. Roughly half of that
estimate pertains to infrastructure equipment, which is defined as towers,
antennas, controllers, and combiners.
By some estimates, the LMR industry is as large as $5.7 billion in annual sales.
One manufacturer dominates the market, holding an estimated market share in
excess of 70% ($4 billion). The remaining market share is spread among many
small companies, including RELM.
DESCRIPTION OF PRODUCTS
We design, manufacture, and market wireless communications equipment consisting
of land mobile radios and base station components and subsystems. The majority
of our products use analog technology. We are, however, executing a
comprehensive plan to engineer, manufacture, and market digital products that
are compliant with the specifications of the Association of Public Communication
Officials ("APCO") Project 25. The first product from that initiative was
completed at the end of 2002. It was introduced for placement on the Department
of Interior contract in March 2003. Additional products are planned for 2003
through 2005.
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ITEM 1. BUSINESS-CONTINUED
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We sell our products under the "BK RADIO," "UNIDEN," and "RELM" brand names.
Generally, BK Radio-branded products serve the government and public safety
markets, while RELM and Uniden-branded products serve commercial, business, and
industrial market segments.
In September 1993, we purchased the assets of Bendix/King Mobile Communications
Division of Allied Signal. These products, sold under the "BK Radio" (formerly
"Bendix King") brand name, consist of higher-specification land-mobile radios
whose primary market focus is professional radio users in the government and
public safety sectors. The BK Radio products have more extensive features and
capabilities than the products offered in the RELM and Uniden product lines. Our
APCO Project 25-compliant products will be marketed under the BK Radio brand.
In September 2001, we entered into a contract with an electronic and
manufacturing concern for the manufacture of a new family of portable two-way
radios. Under the agreement, such company is manufacturing for RELM, four models
of VHF and UHF portable two-way radio transceivers. The agreement is for a term
of five years and may be expanded to include additional products. Three models
were introduced during 2002. The final model will be introduced in the second
quarter 2003. These products are marketed under the RELM brand.
In 2002, we completed the enhancements of our ESAS system products, and four
systems were installed. ESAS systems offer a comparatively inexpensive
multi-site trunking alternative for two-way communications. There are many areas
of the country, predominantly rural, that lack coverage from other
communications service providers. Enterprises of all types in these areas
continue to have a need for reliable and affordable two-way communications.
Also, in areas that presently have other means of communication, some users are
finding that the cost for their service is higher than anticipated, sometimes
significantly so. ESAS systems are an attractive solution in both of these
circumstances.
In March 2000, we purchased certain private radio communications product lines
from Uniden America Corporation. These products, primarily serving the
commercial, business and industrial segment of the LMR market, broaden and
modernize our offerings there. They are currently sold under the "Uniden" brand
name.
DESCRIPTION OF MARKETS
GOVERNMENT AND PUBLIC SAFETY MARKET
This market includes the military, fire, rescue, law enforcement, emergency
medical personnel, as well as various agencies of federal, state, and local
government. Our sales in this market are made either directly to the end-users,
or through two-way communications dealers. Sales to this market represented
approximately 78% of total sales during 2002 and 79% of total sales for 2001.
We offer products to this market under the BK Radio brand name. This product
line consists of higher-specification land mobile radios with more complex
features and capabilities tailored for professional radio users. The products
include mobile radios for mounting in vehicles, portable (hand-held) radios,
base stations, and repeaters that enable two-way radios to operate over a wider
area. We also manufacture and sell base station components and subsystems which
are installed at radio transmitter sites to improve performance by reducing or
eliminating signal interference and to enable the use of one antenna for both
transmission and reception.
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ITEM 1. BUSINESS-CONTINUED
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Currently, our products and systems for the government and public safety market
use primarily analog technology. We are, however, executing a comprehensive plan
to engineer, manufacture, and market digital products that are compliant with
the specifications of the Association of Public Communication Officials ("APCO")
Project 25. The first product from that initiative was completed at the end of
2002.
It was introduced for placement on the Department of Interior contract in March
2003. Additional products are planned for 2003 through 2005.
BUSINESS, INDUSTRIAL AND COMMERCIAL MARKET
This market includes businesses and enterprises of all sizes that require fast,
push-to-talk communication among a defined group of users such as hotels,
construction companies, schools, taxicab and limousine companies, and airports.
Most of our sales in this market are to dealers and distributors who then resell
the products to end-users. Our sales to this market represented approximately
22% of total sales during 2002 and 21% of total sales for 2001.
We offer products to this market under the RELM and Uniden brand names. The
products include mobile radios, portable radios, base stations, and repeaters.
The acquisition of the private radio communications product lines from Uniden
America Corporation broadened and modernized our product offering in these
segments of the LMR market. These products, which include ESAS systems as well
as additional portable and mobile radios, are presently being sold under the
Uniden brand name.
Under an OEM manufacturing agreement, we have expanded the RELM product lines
with four new models of VHF and UHF portable radios. These radios supplement our
current product lines by providing lower-cost, yet feature rich and reliable
two-way communications for lower-end business and industrial users.
ENGINEERING, RESEARCH AND DEVELOPMENT
Our engineering and development activities are conducted in West Melbourne,
Florida and Lawrence, Kansas. The team in Lawrence is responsible for the
execution of our APCO Project 25 development plan, which was launched in 2001.
During the year, as a result of funding from our public rights offering, we were
able to expand and accelerate this program. As of December 31, 2002, 6 employees
were dedicated to this program. They have completed the first product, an
APCO-compliant digital VHF portable radio, which was introduced in March 2003.
Additional products are planned for 2003 through 2005. Our team based in West
Melbourne, Florida, totaling 7 employees, is responsible for developing design
specifications based on customer requirements and supervising quality assurance
activities. Both teams actively assist in the implementation of product designs,
with primary responsibility for applied engineering, production engineering and
the specification compliance of contract manufacturers.
For 2002, 2001, and 2000, RELM's research, development and engineering
expenditures were approximately $1.9 million, $1.4 million, and $1.2 million,
respectively. The use of strategic technology partners has enabled us to contain
and, in some instances, even reduce R&D expenditures while concentrating on key
initiatives, such as the APCO Project 25 digital program. In this connection,
costs incurred to date aggregated approximately $0.6 million and we estimate
additional costs of $ 1.2 million over the remaining life of the project.
Products from these research, development and engineering projects will be
completed and introduced at various times through 2005.
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ITEM 1. BUSINESS-CONTINUED
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INTELLECTUAL PROPERTY
We hold patents and patent licenses covering various land-mobile radio products
that are currently marketed. These patents have various expiration dates out to
the year 2004. It is difficult to precisely assess their importance. We hold
several trademarks related to the "RELM" name and our product names. In addition
to intellectual property laws, we also rely on trade secret law and employee and
third party non-disclosure agreements to protect our intellectual property
rights.
MANUFACTURING AND RAW MATERIALS
Our manufacturing strategy is to utilize the highest quality and most cost
effective resources available for every aspect of our manufacturing. Consistent
with that strategy, we have successfully implemented several outside contract
manufacturing arrangements. These arrangements, based primarily in China, have
been instrumental in decreasing our product costs significantly, allowing us to
improve our competitive position and gross margins.
Most recently, in 2002 we started receiving LMR subassemblies manufactured for
us under an agreement with a large and well-established electronics manufacturer
in China. The contract manufacturer purchases raw materials directly from
approved sources and manufactures completed subassemblies to our specifications.
The agreement has a five-year term and may be renewed upon the agreement of both
parties.
We are also currently receiving and selling our recently announced RELM
RP-series products that are manufactured under an OEM manufacturing agreement
with another electronic design and manufacturing concern in China. Under the
agreement, the company is manufacturing for RELM four models of VHF and UHF
portable two-way radio transceivers. These new products will provide a low-cost
yet feature-rich and reliable two-way communication alternative for customers in
these commercial, business, and industrial markets. Three models have been
completed, while the final model will be introduced in the second quarter 2003.
The agreement is for a term of five years and its scope may be expanded to
include additional products.
We continue to utilize the initial two contract manufacturing relationships that
were established in 2000, after restructuring our manufacturing strategy and
operations. One agreement is with a domestic contract manufacturer for the
manufacture of analog two-way subassemblies. The agreement has a five-year term
and is automatically renewed for one-year terms unless either party gives notice
of termination. In connection with the acquisition of the Uniden LMR product
line, we entered into another manufacturing contract with Uniden America
Corporation under which Uniden continues to manufacture that product line. We
are permitted to use the Uniden brand name for the duration of the contract. The
initial term of the Uniden contract was for 18 months. Although the contract
expired in September 2001, both parties continue to operate under its original
terms.
We plan to continue to outsource manufacturing where it furthers our business
objectives. This strategy allows us to focus on our core technological
competencies of research, product design and development, and to reduce the
substantial capital investment required to manufacture our products. We also
believe that our use of experienced, high-volume manufacturers will provide
greater manufacturing specialization and expertise, higher levels of flexibility
and responsiveness, and faster delivery of product. To ensure that products
manufactured by others meet our standards, our West Melbourne production and
engineering team works closely with its ISO9002-qualified contract manufacturers
in all key aspects of
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ITEM 1. BUSINESS-CONTINUED
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the production process. We establish product specifications, select the
components and the suppliers, and negotiate the prices for most of these
components. We retain all document control. We also work with our contract
manufacturers to improve process control and product design, and to conduct
periodic, on-site inspections.
We rely upon a limited number of both domestic and foreign suppliers for several
key products as well as components used in their products. Several are located
in the Pacific-Rim. We place purchase orders from time to time with these
suppliers and have no guaranteed supply arrangements. In addition, we obtain
certain components from a single source. The amount of these components is not
material relative to total component and raw material purchases. During the
years ended December 31, 2002, 2001, and 2000, our operations have not been
impaired due to delays from single source suppliers. However, the absence of a
single source component may delay the manufacture of finished products. We
manage the risk of such delays by securing second sources and redesigning
products in response to component shortages or obsolescence. We strive to
maintain strong relations with all our suppliers.
SEASONAL IMPACT
Demand for our "BK Radio" LMR products is typically the greatest during the
summer season because of the increased forest fire activity during that time of
year.
SIGNIFICANT CUSTOMERS
Sales to the United States Government represented approximately 39%, 44% and 44%
of our total sales for the years ended December 31, 2002 and 2001, and 2000,
respectively. These sales were primarily to the United States Forest Service
(USFS) and the Communications Electronics Command of the United States Army
(CECOM). Sales to the USFS represented approximately 22%, 34%, and 35% of total
sales for the years ended December 31, 2002, 2001, and 2000, respectively. For
the year ended December 31, 2002 we had no sales to CECOM because our contract
expired in 2001. However, sales to CECOM for the years ended December 31, 2001
and 2000 represented approximately 10%, and 9% of total sales, respectively.
In 1998, we were awarded portions of the USFS contract. This contract expired in
September 2001. Earlier in 2001, bids for a new contract were solicited, and we
were awarded the contract for portable radios and base stations. The contract
was for a period of one year with options for three additional years, and did
not specify a minimum purchase. In December 2002, we were awarded a new contract
with similar terms. It continues to include the portable radios and repeaters
that were on the previous contract. Additionally, it includes our GMH mobile
radio that was not on the previous contract. The new contract is for one year
with two additional option years.
In 1996, we were awarded a contract to provide land mobile radios to CECOM. This
contract was for a term of five years with no specified minimum purchase
requirement. The contract expired in 2001. CECOM solicited bids for a new
contract in March 2002, and we submitted proposals. The evaluation of proposals
for this solicitation is in process but has been subjected to delays.
Consequently, the contract has not yet been awarded. CECOM has indicated in
recent communications that the solicitation will be canceled and a contract will
not be awarded. We are currently pursuing avenues for providing our products to
CECOM under other existing contracts.
9
ITEM 1. BUSINESS-CONTINUED
- ---------------------------
BACKLOG
Our order backlog was approximately $1.7 million and $1.6 million as of December
31, 2002 and 2001, respectively.
COMPETITION
The worldwide land mobile radio markets are estimated to be $5.7 billion with
annual growth of less than 5%. We compete with many domestic and foreign
companies in these markets. One competitor holds a share of the market estimated
to exceed 70%. We maintain our competitive advantage in these markets by
capitalizing on our strengths, which include quality, speed, and customer
responsiveness. As we successfully implement low-cost manufacturing
relationships, we are increasingly able to compete on price.
EMPLOYEES
We presently have 73 full-time employees, most of whom are located at our West
Melbourne, Florida facility. 38 of these employees are engaged in direct
manufacturing or manufacturing support, 13 in engineering, 12 in sales &
marketing, and 10 in general and administrative activities. Our employees are
not represented by any collective bargaining agreements, nor has there ever been
a labor-related work stoppage.
INFORMATION RELATING TO DOMESTIC AND EXPORT SALES
The following table summarizes our sales of wireless communications equipment by
location of our customers:
2002 2001 2000
------------------------------------------------------
(in Millions)
United States $14.9 $21.8 $20.4
Europe - - .7
Other International 1.0 1.0 -
------------------------------------------------------
Total $15.9 $22.8 $21.1
======================================================
AVAILABILITY OF REPORTS AND OTHER INFORMATION
Our website is www.Relm.com. We file annual, quarterly and current reports,
proxy statements and other information with the Securities and Exchange
Commission. These filings are available to the public over the Internet at the
SEC's website at www.sec.gov. You may also read and copy any document we file at
the SEC's public reference room located at 450 Fifth Street, NW, Washington,
D.C. 20549. You may obtain more information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330.
10
ITEM 2. PROPERTIES
- -------------------
OWNED
We do not currently own any real estate. In March 2000, we sold our 144,000
square foot office and industrial building located on 20 acres in West
Melbourne, Florida for $5.6 million. The transaction resulted in a gain of
approximately $1.2 million.
LEASED
The majority of our operations are conducted in approximately 54,000 square feet
of leased industrial space at 7100 Technology Drive in West Melbourne, Florida.
The original lease term is five years. Rental, maintenance and tax payments were
approximately $375,000 and $377,856 in 2001 and 2002, respectively. In May 2002,
we rented 3,800 square feet of office space in Lawrence, Kansas, to accommodate
the expansion of our digital engineering team. This lease has a term of two
years. Rental, maintenance and tax payments for 2002 were $20,052.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
In 1993, a civil action was brought against us by a plaintiff to recover losses
sustained on the note of a former affiliate totaling $1.7 million plus interest
at 12% per annum. The plaintiff alleged violations of federal security and other
laws by us in collateral arrangements with the former affiliate. In February
1994, the liquidator of the former affiliate filed a complaint claiming that
intentional and negligent conduct by us and others caused the former affiliate
to suffer millions of dollars of losses leading to its ultimate failure. In
response, we filed motions for summary judgment to dismiss these complaints. On
September 12, 2002, the Court granted in significant part the motions for
summary judgment filed by us and one of our directors. As the result, the lone
remaining claim seeks damages against us for non-payment of the note. We contend
that this note was canceled and released for fair consideration in 1993 and that
there is no basis in law or fact for the liquidator's claim. The Company is
defending this matter vigorously.
In February 12, 1999, we initiated collection and legal proceedings in Sao
Paulo, Brazil, against its Brazilian dealer, Chatral, for failure to pay for
product shipments totaling $1.4 million which has been fully reserved in a prior
year. In April 2001, the Brazilian court ordered us to post security with the
court totaling approximately $300,000 in the form of cash or a bond in order for
the case to proceed. We elected not to post security. Consequently, the case was
involuntarily dismissed. On December 8, 1999, Chatral filed a counter claim
against us alleging damages totaling $8 million as a result of our
discontinuation of shipments to Chatral. On September 11, 2002 we agreed to a
joint stipulation of dismissal under which all claims between the parties were
released.
Heath & Company filed a suit against RELM Wireless Corporation and RELM
Communications, Inc. in the United States District Court for the District of
Massachusetts in early 2001 year for breach of contract, misrepresentation and
unfair trade practices. Pursuant to a Memorandum and Order dated April 24, 2001,
most of Heath's claims were dismissed. The court ruled as a matter of law that a
fact finder must determine whether RELM Communications withheld information it
knew to be essential to the Plaintiff and whether it did so in a bad faith
attempt to withdraw from a brokerage agreement. On March 21, 2002, the parties
settled the matter for payment to Heath of $33,000.
On December 20, 2000, a products liability lawsuit was filed in Los Angeles
Superior Court in Los Angeles, California. Although the Company was not named in
the suit, one of the defendants had purchased all or substantially all of the
assets of a RELM affiliate. As part of the
11
ITEM 3. LEGAL PROCEEDINGS-CONTINUED
- ------------------------------------
asset sale, the asset purchase agreement contained indemnification provisions,
which could result in liability for us. On October 23, 2001, the purchaser of
the assets of our former affiliate served us with a claim for indemnification
under a provision of the asset purchase agreement. In June 2002, we were
released from this matter.
On November 19, 2001, a products liability lawsuit was filed in the 353rd
Judicial District Court of Travis County, Texas. On August 26, 2002, a products
liability lawsuit was filed in the Probate Court of Galveston County, Texas.
RELM Wireless Corporation, RELM Communications, Incorporated, and the purchaser
of the assets of our former specialty-manufacturing subsidiary are named
defendants in these lawsuits. The agreement under which the assets of the former
subsidiary were sold contains indemnification provisions, which could result in
liability for both parties. Counsel for the Company's insurer is vigorously
defending both claims. Counsel believes the Company has meritorious defenses and
the likelihood of an unfavorable outcome in each of these actions is remote.
During 2002, the purchaser of the assets of our former specialty-manufacturing
subsidiary ceased making payments in accordance with a note receivable. The
initial amount of the note was approximately $355,000. Presently, the amount due
under the note is approximately $175,000 plus accrued interest. This note is
derived from the 1997 agreement for the sale of the assets of our
specialty-manufacturing subsidiary. Since its inception, the terms of the
obligation have been restructured several times to accommodate the purchaser.
The last payment was received in March 2002. Attempts to contact the purchaser
and collect the past-due installment payments have been unsuccessful. In
February 2003, we started legal proceedings to recover the remaining amount due
under the note plus accrued interest. With guidance from counsel, we believe
that we will prevail in these proceedings. However, we have been unable to
ascertain the financial position of the purchaser or their ability to pay the
debt. Accordingly we established a collection allowance in the fourth quarter
2002 for the entire principal amount of the note.
In April 2002, we learned that the purchaser of the assets of our former
paper-manufacturing subsidiary had ceased operations. The purchaser owes us
$900,000 plus accrued interest under the terms of two secured promissory notes,
and has defaulted on its obligations to make principal and interest payments.
The Chief Executive Officer of the purchaser personally guaranteed the debt. Our
security interest is subordinated to the security interest granted to the
purchaser's senior lender.
In connection with the sale of the subsidiary in 1997, we took back a secured
promissory note from the purchaser in the initial aggregate principal amount of
$2.4 million. In December 2000, the terms of the original promissory note were
modified and we received a principal payment of $700,000 plus accrued interest
of approximately $166,000. After this payment, the remaining principal amount
due on the original note was $900,000. Also, as part of the modification
agreement, the original note was replaced by two secured promissory notes, one
in the principal amount of $600,000 and the other in the principal amount of
$300,000. The $600,000 note was payable in ten annual installments starting on
April 2, 2002. The $300,000 note was payable in five annual installments
starting on January 1, 2003. Interest on both notes accrued at 2.75% over the
prime rate and was payable, in the case of the $600,000 note, in annual
installments, and, in the case of the $300,000 note, in semi-annual
installments. The $600,000 note was subject to a standby creditor's agreement
under which principal and interest payments on the note were contingent upon the
purchaser achieving a certain debt service coverage ratio and the absence of any
uncured defaults on other loans or agreements of the purchaser. As security for
both notes, the purchaser has granted to us a lien and security interest in
certain collateral. Our security interest, however, is subordinated to the
security interest granted to the purchaser's senior lender. In addition, the
Company was subject to a standstill agreement with the senior lender. A
principal of the purchaser guaranteed
12
ITEM 3. LEGAL PROCEEDINGS-CONTINUED
- ------------------------------------
the prompt and complete payment of both notes when due. Both notes were subject
to forbearance fee payment agreements with both the purchaser and the guarantor
under which additional amounts may be payable to us if there is a merger, sale
or change of control of the purchaser and if the notes are not paid in full by
certain dates.
In December 2002, the purchaser's senior lender notified us that they had sold
the purchaser's assets for $200,000. This amount was not sufficient to provide
any recovery of amounts owed to us under the notes. In February 2003, with the
assistance of counsel, we initiated legal proceedings against the guarantor. We
have not been able to ascertain the financial position of the guarantor or
evaluate his ability to pay the debt. Accordingly, we have maintained the
valuation reserve for the entire principal amount ($900,000) of the two
promissory notes that was established in the first quarter 2002.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS
- ---------------------------------------------------------------------------
MATTERS
- -------
Effective as of July 5, 2001, our common stock began trading on the NASDAQ
SmallCap Market under the symbol "RELM." Prior to trading on the NASDAQ SmallCap
Market our common stock traded on the NASDAQ National Market. The following
table sets forth the high and low closing sale price for our common stock for
the periods indicated, as reported by the NASDAQ SmallCap Market. These
quotations reflect inter-dealer prices, without retail mark-up, markdown, or
commission and may not necessarily represent actual transactions.
2001 QUARTER ENDED HIGH LOW
-----------------------------------------------------------------------
March 31, 2001 $1.56 $0.56
June 30, 2001 1.25 0.80
September 30, 2001 1.59 0.99
December 31, 2001 1.50 1.02
2002 QUARTER ENDED HIGH LOW
-----------------------------------------------------------------------
March 31, 2002 $1.25 $0.83
June 30, 2002 1.01 0.80
September 30, 2002 0.82 0.41
December 31, 2002 0.60 0.39
On February 5, 2003, there were 1,212 holders of record of our common stock.
We have never declared or paid cash dividends on our capital stock. We currently
intend to retain all available funds and any future earnings for use in the
operation and expansion of our business and do not anticipate paying any cash
dividends in the foreseeable future. In addition, our loan agreement with Fleet
Capital prohibits us from paying dividends on our common stock. No cash
dividends were paid with respect to our common stock during the past five years.
13
EQUITY COMPENSATION PLAN INFORMATION
- ------------------------------------------------------------------------------------------------------------------------------------
( a ) ( b ) ( c )
Plan Category Number of securities Weighted average exercise Number of securities remaining
to be issued upon exercise price of outstanding options, available for future issuance
of outstanding options, warrants and rights under equity compensation
warrants, and rights plan (excluding securities
reflected in column (a)
- ------------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 1,418,500 $1.76 281,500
Equity compensation plans not
approved by security holders - 0 -
- ------------------------------------------------------------------------------------------------------------------------------------
Total 1,418,500 $1.76 281,500
====================================================================================================================================
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The following table summarizes selected financial data of RELM and should be
read in conjunction with the Consolidated Financial Statements and notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this report:
14
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
- --------------------------------------------
STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31
2002 2001 2000 1999 1998
----------------------------------------------------------------
Sales $ 15,978 $ 22,809 $ 21,054 $ 22,404 $ 29,530
Income (Loss) From Continuing
Operations (3,631) 122 (1,162) (2,294) (4,907)
Loss From Discontinued Operations
-- -- (266) -- (725)
Extraordinary Gain -- -- -- -- 227
----------------------------------------------------------------
Net Income (Loss) $ (3,631) $ 122 $ (1,428) $ (2,294) $ (5,405)
================================================================
Income (loss) Per Share-Basic and
Diluted:
Income (Loss) Per Share From
Continuing Operations
$ (0.47) $ 0.02 $ (0.22) $ (0.45) $ (0.97)
Income (Loss) Per Share From
Discontinued Operations
-- -- (0.05) -- (0.15)
Income Per Share From Extraordinary
Item -- -- -- -- 0.05
----------------------------------------------------------------
Net Income (Loss) Per Share
$ (0.47) $ 0.02 $ (0.27) $ (0.45) $ (1.07)
================================================================
o 2002 results include, 1) a $900,000 note receivable valuation allowance
related to the purchase of the assets of the Company's former
paper-manufacturing subsidiary in the first quarter, 2) a collection
allowance of $175,333 for a note receivable from the purchaser of the
assets of our former specialty-manufacturing subsidiary, 3) the write-off
of a technology agreement with a book value of $210,981, 4) the write-off
of an investment banking services agreement with a book value of $119,851,
and 5) $185,270 in costs related to the restructuring of our sales and
marketing organization.
o 2000 Results include a $984,000 net gain on the sale of our manufacturing
facility and the sale of certain manufacturing and test equipment.
o Sales for the year ended December 31, 1998 decreased $15.8 million or 34.9%
from the prior year. Of the total decrease, $11.0 million is attributed to
LMR products, $2.2 million to commercial real estate, $1.5 million to
digital data communications, $1.0 million to access controls, and $0.1
million to electronic components. The decreases reflect our strategy to
exit non-LMR businesses and to discontinue products and lines that were
inadequately profitable. Specifically, we sold our digital data
communications business and exited from the access controls, consumer
electronics, and commercial real estate businesses. LMR sales were impacted
by the lack of shipments to the U.S. Army. Throughout the year the U. S.
Army had inventory quantities that were sufficient to meet its users'
requirements.
15
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
- --------------------------------------------
BALANCE SHEET (IN THOUSANDS)
DECEMBER 31
2002 2001 2000 1999 1998
--------------------------------------------------------------------------------
Working Capital $5,734 $9,262 $7,679 $5,676 $6,573
Total Assets 12,856 17,623 18,422 22,853 26,827
Long-Term Debt 3,150 6,998 6,353 9,072 8,755
Total Shareholders Equity 4,872 6,482 6,360 6,377 8,671
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
RESULTS OF OPERATIONS
- ---------------------
GENERAL
Diminished sales to our two largest customers and the deteriorating overall
economic conditions were instrumental in a reduction of revenues by
approximately 29% in 2002 compared to 2001. Further details regarding the
decrease in revenues are reported in the Net Sales section of Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Gross margins for 2002 were approximately 26.4% compared to 29.2% in 2001. Due
to the lower volumes, we did not fully absorb our manufacturing overhead costs,
which adversely impacted gross margins. However, during the year we continued to
expand our utilization of high-quality, low-cost contract manufacturers. Also,
responding to lower production volumes, during the fourth quarter we reduced
manufacturing support staffing and expenses. These efforts began to yield
product cost reductions and improved margins in 2002, a trend that we expect to
continue at an increasing rate in 2003. Further details regarding gross margins
are reported in the Cost of Sales & Gross Margins section of Management's
Discussion and Analysis of Financial Condition and Results of Operations.
We made significant progress on new product development during the year.
Spending on product engineering and development in 2002 increased compared to
2001. This was made possible by the capital derived from the successful
completion of our public rights offering in the first quarter 2002. The offering
provided us with approximately $2.0 million of additional working capital. The
additional engineering and development expenditures were related primarily to
the development of our digital products and ESAS systems. We believe that this
investment has yielded new products that will drive revenue growth starting in
2003. The first digital product is complete and is in the process of being
approved by the U. S. Department of Interior (DOI) for immediate use. The DOI is
the most aggressive
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
of all federal government agencies in implementing plans to purchase digital
communications technology. The first four ESAS system installations are complete
and set the stage for additional systems sales in the near-term. Late in the
year we also introduced a new family of products, the RP Series, for business
and industrial users. We believe that all these new products, and others that
will be completed shortly, serve as a solid foundation on which to grow the
business profitably. Our financial results for the year, and the fourth quarter
in particular, include several significant charges unrelated to our current
operations. These charges totaled approximately $1.6 million of which $0.7
million was incurred in the fourth quarter 2002.
We established allowances totaling approximately $1.1 million for two notes
receivable from the purchasers of our former paper manufacturing and
specialty-manufacturing subsidiaries. The businesses and events associated with
these charges are legacies from before 1997. They are not at all related to land
mobile radio (LMR) operations, which have been our focus for the past several
years. Although the write-off and allowance impacted earnings, we anticipate no
impact on the execution of our core LMR business plan objectives. In addition to
the notes, we wrote-off the remaining book value (approximately $331,000) of
certain technology and investment banking agreements. Lastly, we incurred
severance and other expenses (approximately $195,000) associated with the
restructuring of our sales and marketing organization. Each of these charges is
discussed in greater detail in the recent events section of this report.
RESULTS OF OPERATIONS
As an aid to understanding our operating results, the following table shows
items from our consolidated statement of operations expressed as a percent of
sales:
PERCENT OF NET SALES
FOR YEAR ENDED DECEMBER 31
2002 2001 2000
-------------------------------------------------
Sales 100.0% 100.0% 100.0%
Cost of Sales 73.6 70.8 74.4
-------------------------------------------------
Gross Margin 26.4 29.2 25.6
Selling, General, and Administrative
Expenses (40.5) (26.0) (33.0)
Loss on notes receivable (6.7) - -
Interest Expense (2.9) (2.5) (4.4)
Gain on Sale of Facility and Equipment - - 4.7
Other Income 1.0 - 1.6
-------------------------------------------------
Pretax Income (loss) from Continuing
Operations (22.7) 0.7 (5.5)
Income Tax Expense - - -
-------------------------------------------------
Income (loss) from Continuing Operations
(22.7)% 0.7% (5.5%)
=================================================
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
FISCAL YEAR 2002 COMPARED WITH FISCAL YEAR 2001
- -----------------------------------------------
SALES
Total sales for the year ended December 31, 2002 decreased $6.8 million (30.0%)
to $15.9 million from $22.8 million for the year 2001.
Revenues for BK Radio products, sold primarily to the government and public
safety segment of the LMR market, decreased $5.1 million (29.0%) compared to the
prior year. This decrease was attributed primarily to a decrease in revenues
derived from the U. S. Forest Service (USFS) and the Communications Electronics
Command of the U. S. Army (CECOM).
We did not ship any products to CECOM during 2002. During the prior fiscal year,
revenues from product shipments to CECOM totaled approximately $2.4 million. The
contract under which those shipments were made expired in October 2001. CECOM
solicited bids for a new contract in March 2002 and we submitted proposals.
Numerous delays have been encountered by CECOM, and the contract has not yet
been awarded. CECOM has indicated in recent communications that the solicitation
will be canceled and a contract will not be awarded. Accordingly, we are
currently pursuing avenues for providing our products to CECOM under other
existing contracts. Our shipments to CECOM during the years 1999 through 2001
averaged approximately $2.3 million annually.
During 2002, budget constraints and contract delays combined to reduce shipments
to the USFS by $3.4 million compared to the prior year. The USFS is our largest
customer representing revenues of approximately $3.5 million and $6.9 million
for the years ended December 31, 2002 and 2001, respectively. Due to an
extraordinarily active forest fire season, USFS experienced a decrease in the
funding available for new two-way communications equipment. Additionally, the
USFS contract expired in September 2002, and a new contract was not awarded
until December 2002. Revenues from the USFS also decreased because our mobile
radio was not included on the contract for most of 2002. We had been awarded the
mobile portion of the contract in prior years. The mobile radio has again been
awarded to us on the new contract that was issued in December 2002. We were also
awarded the portions of the contact for portable radios, base stations, and
repeaters. We anticipate that the margins that will be realized under this
contract will be consistent with or better than those realized under the
previous contract. The contract does not specify definite delivery dates or
quantities.
For the year ended December 31, 2002, sales in the business and industrial
market segment, served by RELM-branded and Uniden-branded products, decreased
approximately $1.7 million (50.3%) when compared to the same period of the prior
year. Customer demand in this market segment continued to be weak, reflecting
the lack of a sustained economic recovery. Also, due to engineering delays, our
new family of portable radios, the RP Series, was ready for sale later in the
year than originally anticipated. The RP series is designed as a quality,
full-featured, low-cost line to compete effectively in the business and
industrial market. We anticipate that the margins that will be realized from
these products will be consistent with or better than those realized from the
previous contract.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
In response to declining revenues, we recently hired a new executive sales
management team and restructured our sales and marketing organization. This team
brings to RELM a history of sales and marketing success with another large LMR
manufacturer and with other wireless industries as well. We also re-deployed
other resources within the company to achieve a strong focus on critical new
product introductions. These organizational changes combined with new products
that have recently been completed and introduced (e.g. The digital portable
radio, RP Series portable radios, and ESAS systems), we believe position us for
revenue growth in 2003.
COST OF SALES AND GROSS MARGINS
Cost of sales as a percentage of sales for the year ended December 31, 2002 was
73.6% compared to 70.8% for the same period last year. Due to the lower volumes,
we did not fully absorb our manufacturing overhead costs, which adversely
impacted cost of sales and gross margins. Responding to lower production
volumes, starting in the fourth quarter we reduced manufacturing support
staffing and expenses. Also related to lower volumes, during the year we
increased reserves for slow moving inventory by approximately $283,000.
Excluding the impact of under-absorption, we continued to decrease direct
product costs (i.e. material and labor). Direct product costs for the year ended
December 31, 2002 were 55.3% compared to 58.2% for the same period last year. We
achieved this improvement by continuing to expand our utilization of
high-quality, low-cost contract manufacturers. We presently have agreements with
six contract manufacturers, five of which are offshore. By the end of 2002 all
of our products were partially or entirely manufactured by these contract
manufacturers. These arrangements, combined with our deductions in manufacturing
infrastructure expenses, began impact margins in 2002. With a full year of
manufacturing under these arrangements in 2003, we expect that trend to continue
at an increasing rate for all of our product lines.
We continuously evaluate new manufacturing alternatives to further reduce our
product costs. We anticipate that the current relationships or comparable
alternatives will be available to the company in the future.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general, and administrative expenses (SG&A) include commissions,
marketing, sales, sustaining engineering, product development, management
information, accounting, and headquarters. For the year ended December 31, 2002,
SG&A expenses totaled $6.5 million or 40.5% of sales compared with $5.9 million
or 26.0% for the prior year.
This increase of $550,000 is attributable to the following: (1) the expansion of
our product development initiatives ($321,000) for APCO Project 25-compliant
digital products and ESAS systems. (2) charges unrelated to our current LMR
operations, all of which pertained to old business lines of the company. These
charges pertained to a) writing-off the unamortized cost ($211,000) of a digital
technology license that we will no longer utilize, b) writing-off the
unamortized cost ($120,000) of an investment banking agreement, and c) severance
and other expenses ($195,000) associated with restructuring our sales and
marketing organization.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
The aforementioned increases were partially offset by decreases in marketing and
selling ($94,000) and general and administrative expenses ($203,000). Marketing
and selling expenses decreased as a result of lower selling commission expenses,
which was driven by lower revenues. General and administrative expenses were
reduced as certain information systems functions ($121,000) were outsourced and
several pending legal matters ($82,000) were resolved.
Bringing products to market that will comply with the APCO 25 standard, and
achieving a significant share of the market for these products will continue to
require substantial investment to complete research and development and to
achieve market penetration. We estimate that these costs will total
approximately $393,000 in 2003, and will be funded from existing cash reserves
and working capital from operations.
LOSS ON NOTES RECEIVABLE
In April 2002, we learned that the purchaser of the assets of the Company's
former paper-manufacturing subsidiary, had ceased operations. The purchaser owed
the Company $900,000 plus accrued interest under the terms of two secured
promissory notes and had defaulted on its obligations to make principal and
interest payments. With guidance from counsel, we evaluated alternatives and
took all prudent actions to maximize the possibility of recovery. However, after
a comprehensive assessment, we believed that the value of the purchaser's assets
and the assets of the guarantor were insufficient to provide any recovery of the
amounts due under the notes. Accordingly, the Company wrote-off the entire
principal amount ($900,000) of the two promissory notes in the first quarter
2002.
During 2002, the purchaser of our former specialty-manufacturing subsidiary
ceased making payments in accordance with a note receivable. The initial amount
of the note was approximately $355,000. Presently, the amount due under the note
is approximately $175,000 plus accrued interest. This note is derived from the
1997 agreement for the sale of our specialty manufacturing operation. Since its
inception, the terms of the obligation have been restructured several times to
accommodate the purchaser. The last payment was received in March 2002. Attempts
during the second and third quarters 2002 to contact the purchaser and collect
the past-due installment payments have been unsuccessful. In February 2003, we
started legal proceedings to recover the remaining amount due under the note
plus accrued interest. With guidance from counsel, we believe that we will
prevail in these proceedings. However, we have been unable to ascertain the
financial position of the purchaser or their ability to pay the debt.
Accordingly we established a collection allowance in the fourth quarter 2002 for
the entire principal amount of the note.
The businesses and events associated with the purchasers of the assets of our
former subsidiaries are legacies from before 1997. They are not at all related
to land mobile radio (LMR) operations, which have been our focus for the past
several years. We have excluded these obligations from our cash flow projections
and operating plans since 2000. Although the write-off and allowance impacted
2002 earnings, we anticipate no future impact on the execution of our core LMR
business plan objectives, including our digital product development, which in
February 2003 yielded the introduction of our initial APCO Project 25 compliant
digital radio.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
INTEREST EXPENSE
For the year ended December 31, 2002, interest expense totaled approximately
$456,000 compared to $579,000 for 2001. We incur interest expense on our
revolving line of credit and on the subordinated convertible notes. The interest
rate on our revolving line of credit is variable and fluctuated with the prime
lending rate. The interest rate on the convertible notes is 8% per annum. The
effective interest rate on our revolving line of credit was lower during 2002 as
a result of the reductions in the prime lending rate. Also, primarily as a
result of improved accounts receivable collections, the principal balance on the
revolver as of December 31, 2002 decreased by $780,000 compared to the balance
at the same time in 2001.
INCOME TAXES
Income taxes represented effective tax rates of 0% for the years ended December
31, 2002 and 2001. These tax rates are made up of a 34% effective tax rate, the
respective state tax rates where we do business, and changes in valuation
allowances related to deferred tax assets. For tax purposes, as of December 31,
2002 and 2001, we have federal and state net operating loss carryforwards of
approximately $35.0 million and $29.3 million, respectively. These net operating
loss carryforwards begin to expire, for federal and state purposes, in 2010.
In accordance with SFAS Statement No. 109, Accounting for Income Taxes,
valuation allowances are provided against deferred tax assets if, based on the
weight of available evidence, it is more likely than not that some or all of the
deferred tax assets will not be realized. We have evaluated the realizability of
the deferred tax assets on our balance sheet and do not believe that we have met
the more likely than not criteria; therefore we have established a valuation
allowance in the amount of approximately $14.4 and $12.2 million against our net
deferred tax assets at December 31, 2002 and 2001, respectively.
The federal and state net operating loss and tax credit carryforwards could be
subject to limitation if, within any three year period prior to the expiration
of the applicable carryforward period, there is a greater than 50% change in
ownership of RELM.
FISCAL YEAR 2001 COMPARED WITH FISCAL YEAR 2000
- -----------------------------------------------
SALES
Total sales for the year ended December 31, 2001 increased $1.8 million (8.3%)
to $22.8 million from $21.1 million for the year 2000. Sales from core LMR
products in 2001 increased $2.6 million (12.8%) to $22.8 million from $20.2
million for the prior year.
Revenues for BK Radio products, sold primarily to the government and public
safety segment of the LMR market, increased $2.6 million (17.8%) compared to the
prior year. This increase was largely driven by sales of our GMH mobile radios
that were introduced in the fourth quarter of 2000, and by strong demand from
the United States Forest Service and the Army as a result of significant forest
fires and recent world events.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
Revenues for Uniden products, sold principally to the business and industrial
segment of the LMR market, increased approximately $2.0 million (117.5%)
compared to the prior year. This increase was the result of a complete year of
marketing and sales initiatives that yielded domestic and international growth,
and included ESAS systems sales. Also, the acquisition of the Uniden product
line was not completed until the end of the first quarter in 2000, and the
entire line of products was not available until the fourth quarter of 2000.
Revenues for RELM products, sold principally to the low-end business and
industrial segment of the LMR market, decreased approximately $1.9 million
(66.7%) compared to the prior year. During the year, aged product designs with
minimal profit potential were discontinued and plans for a new family of
portable radios were finalized.
COST OF SALES
Cost of sales as a percentage of sales for the year ended December 31, 2001 was
70.8% compared to 74.4% for the same period in the prior year. The overall
improvement in cost of sales and gross margins was the result of reductions in
manufacturing staff and expenses that were implemented starting in the fourth
quarter 2000, combined with increased manufacturing volumes, which allowed for
more effective use of manufacturing overhead resources.
We also realized cost improvements by employing a strategy to outsource certain
manufacturing operations and products. In March 2000, we entered into a contract
manufacturing agreement for the manufacture of certain LMR subassemblies for a
period of five years. Also, in connection with our acquisition in March 2000 of
certain Uniden product lines, we entered into a manufacturing contract with
Uniden Corporation pursuant to which Uniden Corporation manufactures our LMR
products branded under the "Uniden" name. Although the contract expired in
September 2001, both parties continue to operate in accordance with its terms
and conditions. In September 2001, we entered into a contract with an electronic
design and manufacturing concern in China for the manufacture of a new family of
portable two-way radios. Under the agreement, this company will manufacture for
RELM, four models of VHF and UHF portable two-way radio transceivers, and we
will have exclusive distribution rights for these products in North, Central,
and South America. The agreement is for a term of five years and may be expanded
to include additional products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general, and administrative expenses (SG&A) include commissions,
marketing, sales, sustaining engineering, product development, management
information, accounting, and headquarters. For the year ended December 31, 2001,
SG&A expenses totaled $5.9 million or 26.0% of sales compared with $6.9 million
or 33.0% for the prior year.
This decrease was the result of our restructuring and cost reduction actions.
Selling and marketing staff and expenses, particularly those related to the
Uniden product line, were significantly reduced. Likewise, staff and expenses
pertaining to general and administrative functions such as finance, information
systems, human resources and headquarters were also reduced. Engineering
expenses increased by approximately $184,000 (15.7%). This reflected our
development of multi-site dispatch capability for our Uniden ESAS systems. These
systems were introduced in the second quarter of 2001.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
INTEREST EXPENSE
For the year ended December 31, 2001, interest expense totaled approximately
$579,000 compared to $933,000 for the same period last year. Revenue growth and
expense reductions throughout the year generated working capital and enabled us
to reduce the amount outstanding on our revolving line of credit. Also, the
effective interest rate on our revolving line of credit was lower during 2001 as
a result of the reductions in the prime lending rate. Other long-term debt was
satisfied at various times during 2000, including the mortgage on our facility,
which was sold, and capital leases associated with certain manufacturing and
computer equipment.
GAIN ON SALE OF FACILITY AND EQUIPMENT
On March 24, 2000, we completed the sale of our 144,000 square foot facility
located in West Melbourne, Florida for $5.6 million. The transaction resulted in
a gain of approximately $1.2 million and provided approximately $1.6 million in
cash after related expenses and the satisfaction of the mortgage on the
property. We now lease approximately 54,000 square feet of comparable space at a
nearby location.
INCOME TAXES
Income taxes represented effective tax rates of 0% for the years ended December
31, 2001 and 2000. These tax rates are made up of a 34% effective tax rate, the
respective state tax rates where we do business, and changes in valuation
allowances related to deferred tax assets. For tax purposes, at December 31,
2001 and 2000, we have federal and state net operating loss carryforwards of
approximately $29.3 million and $30.8 million, respectively. These net operating
loss carryforwards begin to expire, for federal and state purposes, in 2010.
In accordance with SFAS Statement No. 109, Accounting for Income Taxes,
valuation allowances are provided against deferred tax assets if, based on the
weight of available evidence, it is more likely than not that some or all of the
deferred tax assets will not be realized. We have evaluated the realizability of
the deferred tax assets on our balance sheet and do not believe that we have met
the more likely than not criteria; therefore we have established a valuation
allowance in the amount of $12.2 million against our net deferred tax assets at
December 31, 2001 and 2000.
The net change in total valuation allowance for the period ended December 31,
2001 was $18,000 and relates to our expectations regarding utilization of our
net deferred tax assets, including available net operating loss and tax credit
carryforwards. The federal and state net operating loss and tax credit
carryforwards could be subject to limitation if, within any three year period
prior to the expiration of the applicable carryforward period, there is a
greater than 50% change in ownership of RELM.
INFLATION AND CHANGING PRICES
- -----------------------------
Inflation and changing prices for the years ended December 31, 2002, 2001, and
2000 have contributed to increases in wages, facilities, and raw material costs.
These inflationary effects were partially offset by increased prices to
customers and reduced manufacturing costs associated our initiatives to utilized
low-cost contract manufacturers.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
DIVIDENDS
- ---------
No cash dividends have been paid with respect to our common stock during the
past five years. We intend to retain our earnings to fund growth and, therefore,
do not intend to pay dividends in the foreseeable future. In addition, our
revolving credit line restricts our ability to pay dividends.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Net cash provided by operating activities for the year ended December 31, 2002
increased by $1,242,000 to $1,534,000 compared to net cash provided by operating
activities of $292,000 for the prior year. The increase is attributable
primarily to collection of trade receivables ($2,832,000), decreases in
inventory ($1,099,000), partially offset by losses on notes receivable
($1,075,000) pertaining to former subsidiaries (see "Loss On Notes Receivable in
Management's Discussion and Analysis) and by the payment of trade payables
($1,043,000). Additionally, depreciation and amortization decreased for the year
ended December 31, 2002 by $269,000 to $787,000 compared to $1,056,000 for the
previous year.
The decreases in trade receivable and inventory were the result of lower sales
volumes and shipments from existing inventory during 2002. Depreciation
decreased due to as certain assets reached the end of their depreciation cycle
and capital expenditures remained low ($157,000). Net cash used in investing
activities for the year ended December 31, 2002 was $ 271,000, an increase of
$199,000, as compared to $72,000 net cash used during the prior year,
substantially all of this change related to capital expenditures for property
and equipment totaling $157,000 and the purchase of DVSI technology for
$125,000. These expenditures were primarily for engineering test equipment
required for the development of our new digital products. No significant capital
expenditures are planned for 2003. Capital expenditures are expected to increase
in 2004 when we commence production of our new generation of digital radios. The
current revolving line of credit contains restrictions on our capital
expenditures. We believe that these restrictions will not impact the execution
of our capital investment plans. We anticipate that capital expenditures will be
funded through existing cash balances, operating cash flow, and our revolving
line of credit.
Net cash provided by (used in) financing activities increased $126,000 to
$33,000 for the year ended December 31, 2002 compared to ($93,000) used in
previous year. On March 22, 2002, the Company closed a public rights offering,
which resulted in net cash to us of $2,021,000. The purpose of the offering was
to provide working capital, which will, among other things, be utilized to
continue the development of our APCO Project 25-compliant digital product line.
The securities offered were "units" priced at $.90 per unit. A unit was
comprised of one share of RELM common stock and one warrant to purchase one
share of RELM common stock, exercisable at $1.08 per share at any time on or
after February 12, 2003 and until February 11, 2006.
The offering resulted in the sale of 2,775,000 shares of common stock and
warrants to purchase 2,775,000 shares of common stock. The offering generated
$1.8 million in net proceeds. The warrants are currently quoted on the OTC
Bulletin Board with the symbol RELMW.
On May 17, 2002, the underwriter exercised its option to purchase 416,250
additional units at a purchase price of $0.90 per unit to cover over-allotments.
The Company received approximately $326,000 in net proceeds from the purchase of
these additional units.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
We have a $7 million revolving line of credit with Fleet Business Credit. As of
December 31, 2002, the amount outstanding on the line was approximately $2.0
million, a decrease of $1,978,000 compared to the prior year. The reduction was
funded through the cash provided from operating activities combined with
proceeds from the public rights offering. The formula under the terms of the
agreement supported a borrowing base of approximately $2.2 million, of which
approximately $0.2 million was available at December 31, 2002. As of December
31, 2002 we were in violation of certain financial covenants in the line of
credit agreement. Accordingly, we have reclassified all amounts due under this
agreement from long-term debt to current liabilities. Although no definitive
agreement has been executed, based upon discussions with the lender, we
anticipate entering into a forbearance agreement. We believe that this agreement
will have a term of 90 days and will increase the current interest rate (prime
rate plus 1.25%) by 2%. Also, the lender will likely charge a one-time fee of
$20,000 for the forbearance agreement. The agreement will be reviewed for
renewal at the end of its term. It is our intent to seek new financing
arrangements during 2003.
In their report on our consolidated financial statements for the year ended
December 31, 2002, our independent auditors have included an explanatory
paragraph which states "there is substantial doubt about the Company's ability
to continue as a going concern". This paragraph is included because we suffered
a substantial net loss from operations and were in violation of certain
financial covenants in our revolving line of credit agreement. As shown in the
accompanying consolidated financial statements, we incurred a net loss of
approximately $3.6 million during the year ended December 31, 2002. The
violation of financial covenants is an event of default under our agreement with
the lender. Accordingly, under the terms of the agreement, the lender may demand
immediate payment of all amounts owed. If the lender were to demand payment, we
presently would not have sufficient resources to satisfy this obligation and
continue with our normal ongoing business activities. The lender has not made
such a demand. Based upon discussions with the lender, we anticipate entering
into a forbearance agreement, the likely terms of which are disclosed in the
previous paragraph. We are seeking a replacement line of credit to fund our
working capital demands.
We believe existing cash funds combined with funds generated from operations and
our credit facility, assuming a satisfactory forbearance agreement, are
sufficient to meet our current working capital requirements for the next twelve
months. If sales volumes increase substantially, additional sources of working
capital may be required to fulfill the demand.
The following table sets forth the Company's future contractual obligations and
off balance sheet arrangements as of December 31, 2002:
(IN THOUSANDS)
- ----------------------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007
- ----------------------------------------------------------------------------------------------------------------------
Future minimum lease commitments $ 410 $ 410 $ 189 $ - $ -
- ----------------------------------------------------------------------------------------------------------------------
Convertible subordinate notes $ - $ 3,150 $ - $ - $ -
- ----------------------------------------------------------------------------------------------------------------------
Revolving credit facility $ 1,970 $ - $ - $ - $ -
- ----------------------------------------------------------------------------------------------------------------------
Standby letters of credit $ 21 $ - $ - $ - $ -
- ----------------------------------------------------------------------------------------------------------------------
At December 31, 2002, the Company has $223,000 in unused line of credit.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
In March 2000, we leased a 54,000 square feet facility in West Melbourne,
Florida. The lease has a term of five years. Rental, maintenance and tax
payments were approximately $375,000 and $377,856 in 2001 and 2002,
respectively. In May 2002, we rented 3,800 square feet of office space in
Lawrence, Kansas, to accommodate the expansion of our digital engineering team.
This lease has a term of two years. Rental, maintenance and tax payments for
2002 were $20,052. We anticipate that current leases will be renewed at the time
of their expiration dates.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
Statement 145 amends Statement of Financial Accounting Standards No. 13 to
require that certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. This amendment is consistent with the FASB's goal
of requiring similar accounting treatment for transactions that have similar
economic effects. Statement 145 also makes technical corrections to existing
pronouncements. While those corrections are not substantive in nature, in some
instances, they may change accounting practice. The Company has adopted the
provisions of Statement 145 for fiscal 2002, which did not result in a material
impact to the its financial position.
In July 2002, the FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities,"
("Statement 146"). Statement 146 addresses financial accounting and reporting
for costs associated with exit or disposal activities and nullifies Emerging
Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)" ("Issue 94-3"). The principal
difference between Statement 146 and Issue 94-3 relates to Statement 146's
requirements for recognition of a liability for a cost associated with an exit
or disposal activity. Statement 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. Under Issue 94-3, a liability for an exit cost as generally defined in
Issue 94-3 was recognized at the date of an entity's commitment to an exit plan.
A fundamental conclusion reached by the FASB in this Statement is that an
entity's commitment to a plan, by itself, does not create an obligation that
meets the definition of a liability. Therefore, this Statement eliminates the
definition and requirements for recognition of exit costs in Issue 94-3. This
Statement also establishes that fair value is the objective for initial
measurement of the liability. The provisions of this Statement are effective for
exit or disposal activities that are initiated after December 31, 2002. The
Company is assessing whether the adoption of Statement 146 will have a material
impact on its consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and are not
expected to have a material effect on the Company's consolidated financial
statements.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS-CONTINUED
- -----------------------
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation, Transition and Disclosure, an amendment of FASB Statement No.
123." SFAS No. 148 provides alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-
based employee compensation. It also amends the disclosure provisions of SFAS
No. 123 to require prominent disclosure about the effects on reported net income
of an entity's accounting policy decisions with respect to stock-based employee
compensation. Finally, this Statement amends APB Opinion No. 28, "Interim
Financial Reporting," to require disclosure about those effects in the interim
financial information. The amendments to SFAS No. 123 that provide alternative
methods of transition for an entity that voluntarily changes to the fair value
based method of accounting for stock-based employee compensation are effective
for financial statements for fiscal years ending after December 15, 2002. The
amendment to SFAS No. 123 relating to disclosure and the amendment to Opinion 28
is effective for financial reports containing condensed financial statements for
interim periods beginning after December 15, 2002. Early application is
encouraged. Management currently believes that the adoption of SFAS No. 148 will
not have a material impact on the financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 (" FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities ("VIE's") created after January 31, 2003, and to VIE's in which an
enterprise obtains an interest after that date. It applies in the first fiscal
year or interim period beginning after June 15, 2003, to VIE's in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
FIN 46 applies to public enterprises as of the beginning of the applicable
interim or annual period. The adoption of FIN 46 is not expected to have a
material impact on the Company's consolidated financial position, liquidity, or
results of operations.
FORWARD-LOOKING STATEMENTS
- --------------------------
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities Exchange Act
of 1934, as amended, and is subject to the safe-harbor created by such sections.
Such forward-looking statements concern the Company's operations, economic
performance and financial condition. Such statements involve known and unknown
risks, uncertainties and other factors that may cause the actual results,
performance or achievements of the Company, or industry results, to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following: general economic and business conditions; changes
in customer preferences; competition; changes in technology; the integration of
any acquisitions; changes in business strategy; the indebtedness of the Company;
quality of management, business abilities and judgment of the Company's
personnel; the availability, terms and deployment of capital; and various other
factors referenced in this Report. The words "believe," "estimate," "expect,"
"intend," "anticipate" and similar expressions and variations thereof identify
certain of such forward-looking statements. The forward-looking statements are
made as of the date of this Report, and the Company assumes no obligation to
update the forward-looking statements or to update the reasons why actual
results could differ from those projected in the forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements.
27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
- ---------------------------------------------------------------------
We are subject to the risk of fluctuating interest rates in the ordinary course
of business for borrowings under our revolving line of credit. The lender
presently charges interest at the 1.25% over the prime rate. As a result of
defaults under the credit agreement, the lender has indicated their intent to
increase the interest rate to 3.25% over the prime rate. No definitive agreement
regarding the increase has yet been executed.
The Company's primary exposure to market risk is to changes in interest rates.
The Company has both fixed and variable rate debt. The Company has $5.1million
of debt outstanding as of December 31, 2002, of which $3.1 million, or 61.52%,
has been borrowed at a fixed rate of 8.0% with maturity through December 2004.
The Company also has $1.9 million of variable rate debt at December 31, 2002. As
these debt instruments mature, the Company typically refinances such debt at
their existing market interest rates which may be more or less than interest
rates on the maturing debt. Changes in interest rates have different impacts on
the fixed and variable rate portions of the Company's debt portfolio. A change
in interest rates impacts the net market value of the Company's fixed rate debt,
but has no impact on interest incurred or cash flows on the Company's fixed rate
debt. Interest rate changes on variable debt impacts the interest incurred and
cash flows but does not impact the net market value of the debt instrument.
Based on the variable rate debt of the Company as of December 31, 2002, it is
estimated that a 100 basis point increase in interest rates on the Company's
revolving line of credit would result in an additional $20,000 in interest
incurred per year on its line of credit and a 100 basis point decline would
lower interest incurred by $20,000 per year. To ameliorate the risk of interest
rate increases, the Company attempts to minimize borrowings.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
In response to the SEC's financial reporting release, FR-60, Cautionary Advice
Regarding Disclosure About Critical Accounting Policies, we have selected our
more subjective accounting estimation processes for purposes of explaining the
methodology used in calculating the estimate in addition to the inherent
uncertainties pertaining to the estimate and the possible effects on the
Company's financial conditions. The two accounting estimation processes
discussed below are the allowance for collection on trade receivables and
reserves for excess or obsolete inventory. These estimation processes affect
current assets and are therefore critical in assessing the financial and
operating status of the Company. These estimates involve certain assumption that
if incorrect could create an adverse impact on the Company's operations and
financial position.
The allowance for collection losses was $69,000 on gross trade receivables of
$834,000 as of December 31, 2002. This allowance is used to state trade
receivables at a net realizable value or the amount that we estimate will be
collected on our gross receivables as of December 31, 2002. Because the amount
that we will actually collect on the receivables outstanding as of December 31,
2002 cannot be known with certainty as of this document's effective date, we
rely on prior experience. Our historical collection losses have typically been
infrequent with write-offs of trade receivables being less than 1% of sales. We
maintain a general allowance of approximately 2 to 5% of a gross trade
receivable balance in order to allow for future collection losses that arise
from customer accounts that do not indicate the inability to pay but turn out to
have such an inability. Currently, our allowance on trade receivables is 8.25%
of gross receivables. The increase in percentage is strictly related to the
decrease of account receivable balance, is not the result of any particular
doubtful account and is appropriate in view of the current economic downturn. We
believe that revenues and the receivable balance will increase during 2003, and
accordingly, we may experience an increase in this allowance balance. We also
maintain a specific allowance for customer accounts that we know may not be
collectible due to various reasons such as bankruptcy and other customer
liquidity issues. We analyze our trade receivable portfolio based on the
28
CRITICAL ACCOUNTING POLICIES-CONTINUED
- --------------------------------------
age of each customer's invoice. In this way, we can identify those accounts that
are more likely than not to have collection problems. We then reserve a portion
or all of the customer's balance.
The reserve for slow-moving, excess, or obsolete inventory was $2.6 million at
December 31, 2002 as compared to $2.3 million in 2001. The reserve for excess or
obsolete inventory is used to state our inventories at the lower of cost or
market. Because the amount of inventory that we will actually recoup through
sales of our inventory as of December 31, 2002 can not be known with certainty
as of this document's effective date, we rely on past sales experience, future
sales forecasts, and our strategic business plans. Generally, in analyzing our
inventory levels, we classify inventory as having been used or unused during the
past year. For raw material inventory with no usage in the past year, we reserve
85% of its cost which takes into account a 15% scrap value while for finished
goods inventory with no usage in the past year we reserve 80% of its costs. For
inventory with usage in the past year, we review the average annual usage over
the past three years, project that amount over the next seven years, and then
reserve 25% of the excess amount (in which the excess amount equals inventory on
hand less a seven year projected usage amount). We believe that 25% represents
the value of excess inventory we would not be able to recover due to our new
product introductions and other technological advancements over the next seven
years.
RISK FACTORS
- ------------
OUR INDEPENDENT AUDITORS, IN THEIR REPORT REGARDING OUR FINANCIAL STATEMENTS AS
OF DECEMBER 31, 2002, HAVE INDICATED THAT THERE IS SUBSTANTIAL DOUBT ABOUT OUR
ABILITY TO CONTINUE AS A GOING CONCERN
Our independent auditors, have reported that substantial doubt exists about our
ability to continue as a going concern because we suffered a substantial net
loss from operations for the year ended December 31, 2002 and because we are in
default under the terms of our credit agreement, because of our violation of
certain financial covenants. We incurred a net loss of approximately $3.6
million during the year ended December 31, 2002. Additionally, because we are in
default, under the terms of our credit agreement, the lender may demand
immediate payment of all amounts owed. If the lender were to demand payment, we
presently would not have sufficient resources to satisfy this obligation and
continue with our normal ongoing business activities. The lender has not made
such a demand. Based upon discussions with the lender, we anticipate entering
into a forbearance agreement. We believe that this agreement will have a term of
90 days and will increase the current interest rate (prime rate plus 1.25%) by
2%. Also, the lender will likely charge a one-time fee of $20,000 for the
forbearance agreement. The agreement may be reviewed for renewal at the end of
its term. We will need to renew the agreement, refinance our loan, or raise
additional funds from new sources. If we are unable to borrow sufficient amounts
under the Fleet Capital loan agreement or are unable to refinance it, or find
alternate lenders, we may be required to significantly curtail or even cease our
operations. We are seeking a replacement line of credit to fund our working
capital demands.
WE HAVE INCURRED SUBSTANTIAL LOSSES IN THE PAST
We have a history of substantial losses. We incurred a loss, totaling $3.6
million for the year ended December 31, 2002. For the fiscal year ended December
31, 2001 we reported net income of $0.1 million. As of December 31, 2002, we had
an accumulated deficit of approximately $21.8 million. While we have taken steps
to improve operations, we cannot assure that we will achieve or sustain
profitable operations in the future.
29
RISK FACTORS-CONTINUED
- ----------------------
WE HAVE A VARIED OPERATING HISTORY ON WHICH INVESTORS CAN EVALUATE OUR FUTURE
PROSPECTS
The size and structure of our Company changed significantly from 1997 to 2000.
During that time we shifted our focus to the LMR business by selling or
discontinuing our non-LMR businesses as well as LMR products that were
performing poorly. Accordingly, operating results prior to 2000 may not be
useful in projecting our future results.
In light of the nature of our LMR products, our operating results are difficult
to forecast, because they generally depend on the volume and timing of the
orders we receive. As a result, we may be unable to adjust our expenses in a
timely manner to compensate for an unexpected revenue shortfall. A shortfall in
revenues will significantly harm our business and operating results. In
addition, we are and will continue to be subject to numerous risks,
uncertainties, expenses, delays, and difficulties in our attempt to concentrate
our efforts on the LMR business due to a variety of factors, including:
o Availability of products;
o Our dependence upon orders placed by the United States Federal Government
and its agencies;
o The timing and amount of orders we receive from our customers, which may be
tied to seasonal demand;
o Cancellations or delays of customer product orders, or the loss of a
significant customer;
o Reductions in consumer demand for our customers' products generally or for
our products in particular;
o A reduction in the average selling price for our products as a result of
competitive factors;
o The timing and amount of research and development expenditures;
o General business conditions in our markets;
o Any new product introductions, or delays in product introductions, by us or
our competitors;
o Increased costs charged by our suppliers or changes in the delivery of
products to us; and
o Increased competition or reductions in the prices that we are able to
charge.
As a result of these and other factors, we believe that period-to-period
comparisons for years prior to 2000, of our historical results of operations may
not be a good predictor of our future performance.
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RISK FACTORS-CONTINUED
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WE RELY ON OUR LINE OF CREDIT TO FINANCE OPERATIONS
Our loan agreement contains numerous financial and operating covenants. We have
defaulted on some of these covenants as of December 31, 2002. Based upon
discussions with the lender, we anticipate entering into a forbearance
agreement. We believe that this agreement will have a term of 90 days and will
increase the current interest rate (prime rate plus 1.25%) by 2%. Also, the
lender will likely charge a one-time fee of $20,000 for the forbearance
agreement. The agreement will be reviewed for renewal at the end of its term. It
is our intent to seek new financing arrangements during 2003. There can be no
assurance that we will not cause an event of default in the future or that such
defaults will be cured or waived. These covenants place restrictions on our
ability to incur additional indebtedness, to pay dividends and other
distributions, to repay other obligations, to create liens or other
encumbrances, to make investments, to engage in transactions with affiliates, to
sell or otherwise dispose of assets and to merge or consolidate with other
entities, and will otherwise restrict our corporate activities.
Our failure to comply with the ratios and tests contained in the Fleet Business
Capital loan agreement could result in acceleration of the indebtedness to
Fleet. To secure our obligations under the agreement, we have granted to Fleet
Capital a first priority pledge of, and security interest in, substantially all
of our assets. If the maturity of our indebtedness were accelerated, we might
not have sufficient assets to repay such indebtedness in full.
When our Fleet Business Capital loan agreement expires, we will need to renew
the agreement, refinance our loan, or raise additional funds from new sources.
If we are unable to borrow sufficient amounts under the Fleet Capital loan
agreement or are unable to refinance it, or find alternate lenders, we may be
required to significantly curtail or even cease our operations.
We will continue to need significant capital to fund our operations and finance
our growth, and we may not be able to obtain it on terms acceptable to us or at
all. In addition, our capital requirements in connection with the development,
marketing and sale of our LMR products are, and will continue to be,
significant.
We believe, based upon our current plans and assumptions relating to our
operations, that our existing line of credit, reserves and expected cash
receipts will provide the funds necessary to satisfy our cash requirements for
the foreseeable future.
OUR INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND LIMIT OUR
ABILITY TO FINANCE FULL OPERATIONS AND PLANNED GROWTH BECAUSE OF DEBT SERVICE
OBLIGATIONS
At December 31, 2002, our total liabilities and debt were approximately $7.9
million and shareholders' equity was approximately $5.0 million. Our leverage
could have important consequences to you. For example, it could:
. make it more difficult for us to satisfy our obligations with respect
to our indebtedness;
. increase our vulnerability to general adverse economic and industry
conditions;
. limit our ability to fund future working capital, capital expenditures,
acquisitions and other general corporate requirements;
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RISK FACTORS-CONTINUED
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. require us to dedicate a substantial portion of our cash flow from
operations to repaying indebtedness, thereby reducing the availability
of our cash flow to fund working capital, capital expenditures,
acquisitions and other general corporate purposes;
. limit