NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007
Note 1. Summary of Significant Accounting Policies
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-QSB and
Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. The operating results for the three month
period ended December 31, 2007 are not necessarily indicative of the results
that may be expected for the year ended September 30, 2008. For further
information, refer to the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10KSB for the year ended
September 30, 2007.
Note 2. Industry Segment Data
The Company's primary business segment involves the operations of Microwave
Filter Company, Inc. (MFC) which designs, develops, manufactures and sells
electronic filters, both for radio and microwave frequencies, to help process
signal distribution and to prevent unwanted signals from disrupting transmit
or receive operations. Markets served include cable television, television and
radio broadcast, satellite broadcast, mobile radio, commercial communications
and defense electronics.
Note 3. Inventories
Inventories are stated at the lower of cost determined on the first-in,
first-out method or market.
Inventories net of reserve for obsolescence consisted of the following:
(thousands of dollars) December 31, 2007 September 30, 2007
Raw materials and stock parts $496 $517
Work-in-process 53 55
Finished goods 89 89
---- ----
$638 $661
==== ====
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The Company's reserve for obsolescence equaled $389,726 at December 31,
2007 and September 30, 2007.
Note 4. Income Taxes
The Company adopted FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes - An Interpretation of FASB Statement No. 109 (FIN 48) as of
October 1, 2007. FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in an entity's financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes, and prescribes a recognition
threshold and measurement attributes for financial statement disclosure of tax
position taken or expected to be taken on a tax return. Additionally, FIN 48
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. No adjustments were
required upon adoption of FIN 48. The Company has provided a full valuation
allowance against its deferred tax assets.
The Company is currently open to audit under the statute of limitations by
the Internal Revenue Service for the fiscal years 2004 through 2007. The
Company's state tax returns are open to audit under the statute of limitations
for the fiscal years 2004 through 2007.
Note 5. Stock Options
On April 9, 1998, the Board of Directors and Shareholders of Microwave
Filter Company, Inc. approved the 1998 Microwave Filter Company, Inc.
Incentive Stock Plan (the "1998 Plan"). Under the 1998 Plan, the Company may
grant incentive stock options ("ISOs"), non-qualified stock options ("NQSOs")
and stock appreciation rights to directors, officers and employees of the
Company and its affiliates. The 1998 Plan reserves 150,000 shares for
issuance. The exercise price of the ISOs and NQSOs will be 100% of the fair
market value of the Common Stock on the date the ISOs and NQSOs are granted.
The 1998 Plan will terminate on April 10, 2008. On June 21, 2004, the Board of
Directors granted ISOs totaling 115,000 shares and NQSOs totaling 35,000
shares at an exercise price of $1.47. All options were 100% vested.
We accounted for our incentive stock plan under the recognition and
measurement principles of Accounting Principles Board Opinion No. 25,
Accounting for stock issued to employees. No compensation expense has been
recognized in the accompanying financial statements relative to our stock
option plan.
The Company has adopted the provisions of SFAS No. 123R, "Share-Based
Payment", for the fiscal year beginning October 1, 2007.
A summary of all stock option activity and information related to all options
outstanding follows:
Three months ended
December 31, 2007
------------------
ISOs NQSOs
-------- --------
Exercise Shares Exercise Shares
Price Price
-------- -------- -------- --------
Outstanding at
beginning of period $1.47 108,548 $1.47 30,000
Granted - 0 - 0
Exercised - 0 - 0
Cancelled - 0 - 0
------ -------- ------ --------
Outstanding at
end of period $1.47 108,548 $1.47 30,000
------ -------- ------ --------
Exercisable at
end of period $1.47 108,548 $1.47 30,000
------ -------- ------- --------
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Note 6. Recent Pronouncements
In February 2007, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities, including an amendment
of FASB Statement No. 115". SFAS 159 permits entities to choose to measure
many financial instruments and certain other items at fair value at specified
election dates. This Statement applies to all entities, including not-for-
profit organizations. SFAS 159 is effective as of the beginning of an
entity's first fiscal year that begins after November 15, 2007. As such, the
Company is required to adopt these provisions at the beginning of the fiscal
year ended September 30, 2009. The Company is currently evaluating the impact
of SFAS 159 on its consolidated financial statements.
MICROWAVE FILTER COMPANY, INC.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Microwave Filter Company, Inc. operates primarily in the United States and
principally in one industry. The Company extends credit to business customers
based upon ongoing credit evaluations. Microwave Filter Company, Inc. (MFC)
designs, develops, manufactures and sells electronic filters, both for radio
and microwave frequencies, to help process signal distribution and to prevent
unwanted signals from disrupting transmit or receive operations. Markets
served include cable television, television and radio broadcast, satellite
broadcast, mobile radio, commercial communications and defense electronics.
Niagara Scientific, Inc. (NSI), a wholly owned subsidiary, custom designs case
packing machines to automatically pack products into shipping cases. Customers
are typically processors of food and other commodity products with a need to
reduce labor cost with a modest investment and quick payback.
Critical Accounting Policies
The Company's consolidated financial statements are based on the application
of generally accepted accounting principles (GAAP). GAAP requires the use of
estimates, assumptions, judgments and subjective interpretations of accounting
principles that have an impact on the assets, liabilities, revenue and expense
amounts reported. The Company believes its use of estimates and underlying
accounting assumptions adhere to GAAP and are consistently applied. Valuations
based on estimates are reviewed for reasonableness and adequacy on a
consistent basis throughout the Company. Primary areas where financial
information of the Company is subject to the use of estimates, assumptions and
the application of judgment include revenues, receivables, inventories, and
taxes. Note 1 to the consolidated financial statements in our Annual Report on
Form 10-KSB for the fiscal year ended September 30, 2007 describes the
significant accounting policies used in preparation of the consolidated
financial statements. The most significant areas involving management
judgments and estimates are described below and are considered by management
to be critical to understanding the financial condition and results of
operations of the Company.
Revenues from product sales are recorded as the products are shipped and
title and risk of loss have passed to the customer, provided that no
significant vendor or post-contract support obligations remain and the
collection of the related receivable is probable. Billings in advance of the
Company's performance of such work are reflected as customer deposits in the
accompanying consolidated balance sheet.
Allowances for doubtful accounts are based on estimates of losses related to
customer receivable balances. The establishment of reserves requires the use
of judgment and assumptions regarding the potential for losses on receivable
balances.
The Company's inventories are stated at the lower of cost determined on the
first-in, first-out method or market. The Company uses certain estimates and
judgments and considers several factors including product demand and changes
in technology to provide for excess and obsolescence reserves to properly
value inventory.
The Company established a warranty reserve which provides for the estimated
cost of product returns based upon historical experience and any known
conditions or circumstances. Our warranty obligation is affected by product
that does not meet specifications and performance requirements and any related
costs of addressing such matters.
The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109. Deferred tax assets and liabilities are
based on the difference between the financial statement and tax basis of
assets and liabilities as measured by the enacted tax rates which are
anticipated to be in effect when these differences reverse. The deferred tax
provision is the result of the net change in the deferred tax assets and
liabilities. A valuation allowance is established when it is necessary to
reduce deferred tax assets to amounts expected to be realized. The Company has
provided a full valuation allowance against its deferred tax assets.
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 2007 vs. THREE MONTHS ENDED DECEMBER 31, 2006.
The following table sets forth the Company's net sales by major product
group for the three months ended December 31, 2007 and 2006.
Product group (in thousands) Fiscal 2008 Fiscal 2007
Microwave Filter (MFC):
Cable TV $ 499 $ 417
RF/Microwave 444 292
Satellite 372 253
Broadcast TV 26 65
Niagara Scientific (NSI) 2 18
------ ------
Total $1,343 $1,045
====== ======
Sales backlog at 12/31 $ 526 $ 782
====== ======
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Net sales for the three months ended December 31, 2007 equaled $1,343,311,
an increase of $298,238 or 28.5% when compared to net sales of $1,045,073 for
the three months ended December 31, 2006.
MFC sales for the three months ended December 31, 2007 equaled $1,341,537,
an increase of $314,158 or 30.6%, when compared to sales of $1,027,379 for the
three months ended December 31, 2006.
MFC's Cable TV product sales for the three months ended December 31, 2007
equaled $499,587, an increase of $82,620 or 19.8%, when compared to sales of
$416,967 during the same period last year. Despite the increase in Cable TV
product sales, management continues to project a decrease in demand for Cable
TV products due to the shift from analog to digital television. Although the
Company has developed filters for digital television, the demand for these
types of filters is unknown at this time.
MFC's RF/Microwave product sales for the three months ended December 31,
2007 equaled $444,495, an increase of $152,554 or 52.3%, when compared to
RF/Microwave product sales of $291,941 for the three months ended December 31,
2006. The Company's RF/Microwave products are primarily sold to original
equipment manufacturers (OEMs) that serve the mobile radio and commercial and
defense electronics markets. Typical customers include the U.S. Government,
General Dynamics, Motorola, Rockwell Collins, Lockheed Martin, Northrup Gruman
and Raytheon. The Company continues to invest in production engineering and
infrastructure development to penetrate OEM market segments as they become
popular. MFC is concentrating its technical resources and product development
efforts toward potential high volume customers as part of a concentrated
effort to provide substantial long-term growth.
MFC's Satellite product sales for the three months ended December 31, 2007
equaled $371,606, an increase of $118,584 or 46.9%, when compared to sales of
$253,022 during the same period last year. The increase can be attributed to
an increase in demand for the Company's filters which suppress strong out-of-
band interference caused by military and civilian radar systems and other
sources. Management expects demand for these types of filters to continue with
the proliferation of earth stations world wide and increased sources of
interference.
MFC's Broadcast TV/Wireless Cable product sales for the three months ended
December 31, 2007 equaled $25,849, a decrease of $39,600 or 60.5%, when
compared to sales of $65,449 during the same period last year primarily due to
a decrease in demand for UHF Broadcast products.
NSI sales for the three months ended December 31, 2007 equaled $1,774, a
decrease of $15,920 when compared to sales of $17,694 for the three months
ended December 31, 2006. NSI sales consist primarily of field service and
spare part orders. NSI has been concentrating on quoting low risk jobs in an
effort to maintain targeted profit margins. Although this may impact sales
levels, it should improve profit margins and also allow engineering resources
to focus on higher priorities.
The Company's sales order backlog equaled $526,450 at December 31, 2007
compared to sales order backlog of $502,760 at September 30, 2007. However,
backlog is not necessarily indicative of future sales. Accordingly, the
Company does not believe that its backlog as of any particular date is
representative of actual sales for any succeeding period. The total sales
order backlog at December 31, 2007 is scheduled to ship by September 30, 2008.
The Company recorded net income of $37,750, or $.01 per share, for the three
months ended December 31, 2007 compared to a net loss of $130,564, or a loss
of $.04 per share, for the three months ended December 31, 2006. The
improvement can primarily be attributed to the higher sales volume this year
when compared to the same period last year.
Gross profit for the three months ended December 31, 2007 equaled $514,439,
an increase of $178,339 or 53.1%, when compared to gross profit of $336,100
for the three months ended December 31, 2006. As a percentage of sales, gross
profit equaled 38.3% for the three months ended December 31, 2007 compared to
32.2% for the three months ended December 31, 2006. The increases in gross
profit can primarily be attributed to the higher sales volume allowing the
company to absorb fixed manufacturing costs.
Selling, general and administrative (SGA) expenses for the three months
ended December 31, 2007 equaled $490,082, an increase of $4,462 or 0.9%, when
compared to SG&A expenses of $485,620 for the three months ended December 31,
2006. As a percentage of sales, SGA expenses decreased to 36.5% for the three
months ended December 31, 2007 compared to 46.5% for the three months ended
December 31, 2006 due to the higher sales volume.
Other income is primarily interest income earned on invested cash balances.
Other income equaled $12,589 for the three months ended December 31, 2007
compared to $18,956 for the three months ended December 31, 2006. The decrease
is primarily due to lower invested cash balances this year compared to last
year. Other income may fluctuate based on market interest rates and levels of
invested cash balances.
The provision (benefit) for income taxes equaled $0 for both the three
months ended December 31, 2007 and 2006. Any benefit for losses have been
subject to a valuation allowance since the realization of the deferred tax
benefit is not considered more likely than not.
Off-Balance Sheet Arrangements
At December 31, 2007 and 2006, the Company did not have any unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which might have been
established for the purpose of facilitating off-balance sheet arrangements.
LIQUIDITY and CAPITAL RESOURCES
December 31, 2007 September 30, 2007
Cash & cash equivalents $1,301,733 $1,266,979
Working capital $1,920,240 $1,876,767
Current ratio 4.85 to 1 4.69 to 1
Long-term debt $ 0 $ 0
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Cash and cash equivalents increased $34,754 to $1,301,733 at December
31,2007 when compared to cash and cash equivalents of $1,266,979 at September
30, 2007. The increase was a result of $47,831 in net cash provided by
operating activities, $12,205 in net cash used for capital expenditures and
$872 in net cash used to purchase treasury stock.
Cash provided by operating activities can primarily be attributed to net
income.
At December 31, 2007, the Company had unused aggregate lines of credit
totaling $750,000 collateralized by all inventory, equipment and accounts
receivable.
Management believes that its working capital requirements for the forseeable
future will be met by its existing cash balances, future cash flows from
operations and its current credit arrangements.
RECENT PRONOUNCEMENTS
In February 2007, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities, including an amendment
of FASB Statement No. 115". SFAS 159 permits entities to choose to measure
many financial instruments and certain other items at fair value at specified
election dates. This Statement applies to all entities, including not-for-
profit organizations. SFAS 159 is effective as of the beginning of an
entity's first fiscal year that begins after November 15, 2007. As such, the
Company is required to adopt these provisions at the beginning of the fiscal
year ended September 30, 2009. The Company is currently evaluating the impact
of SFAS 159 on its consolidated financial statements.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
In an effort to provide investors a balanced view of the Company's current
condition and future growth opportunities, this Quarterly Report on Form 10-
QSB may include comments by the Company's management about future performance.
These statements which are not historical information are "forward-looking
statements" pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. These, and other forward-looking statements,
are subject to business and economic risks and uncertainties that could cause
actual results to differ materially from those discussed. These risks and
uncertainties include, but are not limited to: risks associated with demand
for and market acceptance of existing and newly developed products as to which
the Company has made significant investments; general economic and industry
conditions; slower than anticipated penetration into the satellite
communications, mobile radio and commercial and defense electronics markets;
competitive products and pricing pressures; increased pricing pressure from
our customers; risks relating to governmental regulatory actions in broadcast,
communications and defense programs; as well as other risks and uncertainties,
including but not limited to those detailed from time to time in the Company's
Securities and Exchange Commission filings. These forward-looking statements
are made only as of the date hereof, and the Company undertakes no obligation
to update or revise the forward-looking statements, whether as a result of new
information, future events or otherwise. You are encouraged to review
Microwave Filter Company's 2007 Annual Report and Form 10-KSB for the fiscal
year ended September 30, 2007 and other Securities and Exchange Commission
filings. Forward looking statements may be made directly in this document or
"incorporated by reference" from other documents. You can find many of these
statements by looking for words like "believes," "expects," "anticipates,"
"estimates," or similar expressions.