-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, O7a/X5LUiLOhBa20Xrw8zMrhLCj79lBZLJV3gW4+Kn/B9Uh1//alzjQmpgqfGLvg RVJjm87yhDhlh8x85Kwicw== 0001047469-98-013147.txt : 19980401 0001047469-98-013147.hdr.sgml : 19980401 ACCESSION NUMBER: 0001047469-98-013147 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MACKIE DESIGNS INC CENTRAL INDEX KEY: 0000946815 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 911432133 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26524 FILM NUMBER: 98583530 BUSINESS ADDRESS: STREET 1: 16220 WOOD RED RD NE CITY: WOODINVILLE STATE: WA ZIP: 98072 BUSINESS PHONE: 2064874333 MAIL ADDRESS: STREET 1: 16220 WOOD RED ROAD NE CITY: WOODINVILLE STATE: WA ZIP: 98072 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [Fee Required] For the fiscal year ended December 31, 1997 or / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from to ----------------------- ----------------------- Commission File Number: 0-26524 ------- MACKIE DESIGNS INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Washington 91-1432133 - ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 16220 Wood-Red Road, N.E., Woodinville, Washington 98072 - -------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (425) 487-4333 ---------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered -------------------- ----------------------------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock - no par value --------------------------- (Title of each 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. / / As of March 17, 1998, the aggregate market value of the Registrant's Common Stock held by nonaffiliates of the Registrant was $15,785,888 based on the closing sales price of the Registrant's Common Stock on the Nasdaq National Market. On that date, there were 12,662,650 shares of Common Stock outstanding. Portions of the Registrant's 1997 Annual Report to Shareholders are incorporated by reference into Parts II and IV hereof, and portions of the Registrant's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders are incorporated by reference into Part III hereof. PART I Item 1. Business Introduction Mackie Designs Inc. ("Mackie" or the "Company") develops, manufactures, sells and supports high quality, reasonably priced professional audio equipment. The Company's products are used in a wide variety of sound applications including home and commercial recording studios, multimedia and video production, compact disc, read-only memory ("CD-ROM") authoring, live performances, and public address systems. The Company offers a range of products at suggested retail prices from approximately $400 to $10,000, which generally represents the mid-range price points within the professional audio market. Mackie distributes its products through a network of independent representatives to over 1,000 retail dealers of professional audio equipment in the U.S. and offers its products through local distributors in over 100 other countries. The Company's primary products are mixers and mixer-related products. A mixer serves as the central component of any professional audio system by electronically blending, routing and enhancing sound sources, such as voices, musical instruments, sound effects and audio tape, video tape and other pre-recorded material. For example, using a mixer, a vocalist may be heard above the accompaniment, background singers are combined, and individual instruments are blended into the overall mix. The musician or sound technician accomplishes this task by using the mixer controls to adjust the relative volume of each sound source. Audio mixers are a necessary component of any recording system, whether the system is being used to produce an audio tape, compact disc ("CD"), video soundtrack or multimedia CD-ROM. A mixer is used not only to balance sound inputs when recording initial tracks, but is also often used to further process and edit the tracks prior to duplication and distribution of the recording. Mixers are used in recording applications by commercial and home studios, in film and video post-production, in business presentations and teleconferencing, in the production of television and radio programming and in multimedia productions such as CD-ROM and on-line authoring. Mixers are also used to control relative audio levels in live presentations at locations such as auditoriums, ballrooms, theaters and sports arenas. For example, a typical performing group uses from six to 24 microphones and electronic inputs. Large concert tours and musical road productions often have 60 or more sound inputs, which may include pre-recorded music and sound effects. Many churches use multiple microphones for spoken word and music during their services. In late 1996, the Company introduced power amplifiers, its first line of products that are not directly related to mixers. Power amplifiers are used to amplify the output signals from mixers to a level sufficient to drive loudspeakers. Amplifiers are used with mixers and loudspeakers in a variety of applications, such as private and touring sound reinforcement systems, permanent industrial and commercial installations, recording studios, and theatre/cinema and broadcast facilities. The power amplifier line and future products are distributed through the same channels as the mixers. In August 1997, the Company introduced powered monitor speakers. Powered monitors combine signal processing, power amplifiers, and speakers in one cabinet housing. Enclosing an amplifier in the speaker eliminates one step of the path the sound signal travels, reducing the chance of altering the original signal. This step is very important when recording with highly sensitive professional audio equipment to accurately reproduce sound. Mackie's powered monitors are used in conjunction with a mixer, and are sold through existing mixer distribution channels. 2 The Company's traditional markets have been analog mixers and related products. Recently, digital technologies have been developed by the Company to expand its market base. Mackie's first digital product, Human User Interface (HUI) interface tool for digital audio workstations (DAW), was introduced in late 1997. This digital audio workstation interface targets the rapidly growing digital audio workstation market, and was developed in conjunction with Digidesign for ProTools 4.1. DAWs are used in video, film, multimedia and recording studios. Additionally, the Company plans to introduce digital mixers in 1998. Digital mixers blend, route and enhance sound sources like analog mixers, but have the added capability of recalling all settings and automating them in real-time. Markets include live and recorded sound, such as commercial and home studios, multimedia production, and film and video post-production. Mackie was incorporated in Washington in 1988. The Company's executive offices and manufacturing facilities are located at 16220 Wood-Red Road N.E., Woodinville, Washington 98072, and its telephone number is (206) 487-4333. "MACKIE," the running figure and all of the Company's product names are registered trademarks or trademarks of the Company. This document also contains names and marks of other companies. Products The Company currently offers professional audio mixers and related accessories in four main mixer product lines: compact mixers, 8-Bus consoles, SR series mixers, and digital automation systems. The Company also began offering its line of Fast Recovery Series -TM- power amplifiers in December 1996 and its first active near field studio monitor, the HR824, in August 1997. Compact Mixers. Compact mixers were the Company's first products and are designed to be mounted in 19-inch equipment racks, which are the standard housings for professional audio and video components. The Company offers four basic compact mixers: the CR1604-VLZ, the MS1402-VLZ, the MS1202-VLZ and the LM-3204. The CR1604-VLZ, introduced in February 1996, is a 16-channel mixer that has received wide acceptance for its low noise and high headroom (ability to mix very loud signals without distortion or quiet signals without noise). Applications include recording in project studios, live presentations by major touring bands, video post-production and multimedia. The CR1604-VLZ has been used to produce major label CDs, soundtracks for major motion pictures and on-stage musical instrument mixing for network television shows. The CR1604-VLZ features a two-part design that allows the mixer to be rack-mounted in order to conserve space or to be configured for desk-top use for easy access to the controls. The Company also offers the MixerMixer, an add-on product that expands the capabilities of the CR1604-VLZ and other mixers, by allowing the combination of up to 12 outputs from any three mixers without loss of channels or functionality. The MS1402-VLZ is a 14-channel mixer that the Company introduced in January 1996. It has the same electronic specifications as the CR1604-VLZ but has two fewer channels. It is designed for many of the same applications as the CR1604-VLZ as well as the MS1202-VLZ. The MS1202-VLZ is a 12-channel mixer that occupies less than one square foot of workspace. Designed to be used alone or as a subcomponent of a larger mixing system, the MS1202-VLZ has the same electronic specifications as the CR1604-VLZ and the MS1402-VLZ, but has fewer channels. The success of the product and its predecessor, the MS1202, has been in part due to its relatively low price, flexibility and rugged construction (including solid steel chassis, sealed rotary controls and built-in power supply). This mixer is used for small home studios, on-stage mixing by small lounge acts, off-line 3 video production, multimedia authoring, audiophile acoustic recordings and electronic news gathering and as a supplemental mixer in conjunction with large non-portable studio recording consoles. The LM-3204 is a 32-channel mixer with 16 stereo channels in a compact chassis that occupies just five standard rack spaces. Besides providing all of the control features of the CR1604-VLZ, it includes additional monitor and mixing circuitry that optimizes the mixer's utility for both recording and live presentation applications. The LM-3204 is designed for applications requiring control of a large number of line level inputs such as keyboard submixing, computer sequencing and electronic percussion mixing in stage, sound reinforcement and project studio environments, as well as sound mixing in auditoriums, exhibit halls and other permanent installations. The LM-3204's two microphone preamplifiers extend the mixer's applications to small performing groups such as nightclub single and duo acts and commercial production work where announcer voiceovers are required. The LM-3204 is expandable with one or more optional LM-3204Es, each of which adds 16 stereo channels. 8-Bus Series. The 8-Bus is a larger mixer console designed for multitrack recording and live presentation applications. The Company introduced 8-Bus mixers in 1993. At suggested retail prices from approximately $3,000 to $5,000, the 8-Bus consoles have opened the market to many new users and replaced many larger systems offered by competitors that typically cost over $50,000. The console is available in three basic models: the 32-channel 32-8, the 24-channel 24-8 and the 16-channel 16-8. Each version includes eight submix buses, as well as more elaborate equalization (tone control), signal routing and monitoring capabilities than are found in compact mixers. The 8-Bus console's applications include pre-production and recording of albums for major artists and groups, on-line video production, movie soundtrack mixdown, television dialog editing, on-stage mixing and live sound reinforcement used by touring musical groups, theaters, concert halls, clubs and churches. The 32- and 24-channel versions of the Company's 8-Bus can be expanded with one or more 24-Channel Expander Consoles, each of which adds 24 additional channels. The Company also offers MB-32, MB-24 and MB-16 meter bridges for the 32-channel, 24-channel and 16-channel 8-Bus consoles, respectively; these bridges extend across the width of the mixer and provide a bar-graph meter for each channel strip of the console. SR Series. The SR (Sound Reinforcement) Series are intended as high-quality, low-cost 24-, 32-, 40-, or 56-channel audio mixers for live music applications that compete with consoles selling for several times their retail price. The first product in this line, the SR24-4, was introduced in May 1995, followed by the SR32-4 in August 1995. These retail for approximately $1,600 to $2,300. In December 1996, Mackie introduced the SR40-8, a 40-channel large-format sound reinforcement console, with the SR56-8, a 56-channel console, planned for addition to the line in 1998. The SR40-8 large-format console retails for approximately $10,000. The SR24-4 and SR32-4 are larger than a compact mixer but significantly smaller than Mackie's 8-Bus consoles, and include features necessary for use with digital multitrack recorders. They incorporate much of the advanced technology first introduced in the 8-Bus series, including very-low-impedance circuitry, wide-band equalization and highly sensitive signal presence indicators. The large-format 40-8 incorporates these features plus an UltraMute -TM- computerized system for group and individual sound muting, a built-in meter bridge, and left, right and center master faders. The SR24-4 and 32-4 Series mixers are targeted at bands and other touring musical groups, audio/video rental services and permanent sound reinforcement venues, including churches, clubs, small theaters and auditoriums. The SR40-8 and SR56-8 large-format consoles are intended for use as installed equipment in venues such as churches, auditoriums, or sporting facilities. Digital Automation Systems. The Company's digital automation systems include the UltraMix -Registered Trademark- Universal Automation System, the Human User Interface (HUI), and the Digital 8-Bus (scheduled for introduction in the second quarter of 1998). Because many mixing systems involve controlling specific audio levels on over 100 channels, there is a need for an add-on product to automatically retain and recall a particular range of settings. In 4 September 1995, the Company introduced a digitally controlled automation system to address this need. The Company's UltraMix -Registered Trademark- Universal Automation System, which has a suggested retail price of approximately $2,800, consists of the Ultra-34, a 34-channel external volume control system; the UltraPilot, an external control surface; and UltraMix - -Registered Trademark- Pro automation software. These components, when used in conjunction with a personal computer equipped with Microsoft's Windows 95 or with Apple Computer, Inc.'s Macintosh computer, provide a solution to complex mixing tasks. As with the Company's other products, the UltraMix - -Registered Trademark- is designed to provide much of the functionality of systems prohibitively expensive to all but a limited group of users at a price point attractive to a wide range of potential users. Digital audio workstations (DAWs) are used in commercial, project, and home recording studios, and multimedia authoring such as video production, commercials, and other uses that combine visual and sound effects. Human User Interface, or HUI, was developed in conjunction with Digidesign, a division of Avid Technology, Inc. Digidesign is currently the world leader in the digital audio workstation market. HUI is a hands-on control surface that enhances DAW user productivity with tactile controls and visual displays for mixing and editing functions that were previously controlled by conventional computer controls. HUI, which retails for approximately $3,500, replaces a mouse with a control surface similar to a mixer. The DAW market includes multimedia, film, video, and recording studio professionals. The Company anticipates introducing its first digital console, the Digital 8-Bus (D8B) in spring of 1998. Functions of the D8B are similar to the company's analog 8-Bus. Unlike analog products, digital products store and recall all setting and automate them in real-time, enabling users to more easily and quickly accomplish complicated mixing tasks. Mackie's Digital 8-Bus will allow direct connection to the Internet, with third party software effects available for purchase to download onto the system through software cards. It is designed for multitrack recording and live presentation systems, and will have a suggested retail price of approximately $10,000. Fast Recovery Series -TM- Power Amplifier. Use of a high-quality, professional amplifier is necessary to retain sound integrity in audio production. The Company's FR Series -TM- Power Amplifier is Mackie's first non-mixer related product and became available in December 1996. The M-1400i and M-1400 amplifier models are designed to keep sound quality intact when pushed to extreme levels. Most power amplifiers use technology that can result in distortion from internal feedback. The designs of the M-1400i and M-1400 minimize feedback while improving delivery through the use of high-speed digital circuitry. The M-1400i and M-1400, at suggested retail prices of approximately $600 and $650, respectively, are competitively priced and incorporate the high performance capabilities of the Company's mixer lines. Powered monitor speakers. Powered monitors are an essential tool in accurate sound reproduction, and are used in conjunction with mixer products. Powered monitors pre-process sound through equalization and cross-overs, accurately amplify, then deliver a signal that is perfectly matched to the speaker components. Mackie introduced the first of a family of monitors, the HR824 active near-field studio monitor, in August 1997. Priced at approximately $1,500 a pair, HR824s are primarily designed for studio recording with limited space. These powered monitors are currently being used in a wide variety of applications including home and professional studio recording, video post-production, broadcast post-production, and home stereos. Distribution and Sales In the U.S., the Company uses a network of representatives to sell to over 1,000 retail dealers, some of which have several outlets. In other countries, the Company sells through approximately 70 local distributors, who in turn sell to dealers. Until November 1, 1995, the Company used exclusively 5 the services of MMS, International ("MMS"), a manufacturer's representative, to sell to distributors outside the U.S. and Canada, for which MMS received a commission. Since November 1, 1995, the Company has supervised the international marketing and sales of its products internally. Sales to customers outside of the United States accounted for approximately 38%, 38% and 34% of the Company's net sales in 1997, 1996 and 1995, respectively. The Company carefully selects and reviews its representatives and dealers, including mail order outlets. Representatives and domestic dealers enter into agreements with the Company that govern the terms under which they may sell the Company's products. Agreements with dealers and distributors define an approved territory and set forth the products to be sold. These agreements are reviewed on a six-month basis, and decisions to renew are based on several factors, including sales performance and adequate representation of the Company and its products. The Company's representatives are paid on a commission basis. Dealers retain the difference between their cost and the sale price of products sold. International distributors are selected on the basis of criteria established by the Company. International distributors retain the difference between their cost and the sale price of products sold. In the U.S., the Company's products are sold in musical instrument stores, pro audio outlets and several mail order outlets. Musical instrument stores range from small operations that sell a variety of instruments and equipment to large outlets specializing in rock music equipment such as electric guitars, synthesizers, mixers, drums, amplifiers and speakers. Top U.S. retail dealers in 1997 included Guitar Center, Mar's Music, Musician's Friend, Sweetwater Sound, Thoroughbred Music, Sam Ash Music, Washington Music Center, Full Compass Systems, West LA Music and Manny's Music. These 10 dealers represented approximately 33% of the Company's net sales in the U.S. in 1997. Guitar Center accounted for approximately 12% of domestic net sales in 1997; no other dealer accounted for more than 10% of domestic net sales in this period. Internationally, the Company has distribution in over 100 countries. The top international distributors in 1997 included Musik & Technik Marbury (Germany), SF Marketing Inc. (Canada), Korg Import Division (Japan), Recoton Italia s.r.l. (Italy), Manny's International (Brazil), Hermes International (Mexico), Musikengro (France), Tropical Music Corp. (South America excluding Brazil, Chile and Argentina; Central America and the Caribbean nations), Key Audio Systems (United Kingdom) and A&T Trade, Inc. (former Soviet Union). These 10 distributors represented approximately 62% of the Company's international net sales in 1997. No distributor accounted for more than 10% of international net sales in this period. Marketing The Company's marketing strategy is designed to communicate with end-users directly and to educate them about its products. The Company's in-house marketing and design department creates all its advertising, brochures, video, multimedia and trade show materials. Materials are provided by its marketing department to representatives, distributors and dealers, worldwide, as part of the Company's overall sales strategy. Owner's manuals and sales literature are currently produced in five different languages. These materials are provided as a complement to the Company's direct advertising and customer support follow-up program. To further enhance customer awareness and understanding of its products, the Company advertises in leading trade publications, provides ongoing technical training and education for representatives and distributors, and participates in the primary industry trade shows for the musical instrument, video, recording studio, permanent installation and multimedia markets. Mackie has won several national advertisement awards as a result of this commitment to detail and excellence. Customer Support 6 The Company's customer support program is designed to enhance loyalty by building customer understanding of product use and capabilities. The customer service and support operation also provides the Company with a means of understanding customer requirements for future product enhancements. This understanding comes through direct customer contact, as well as through close analysis of warranty card responses. To encourage return of warranty cards relating to its compact mixers, the Company has established a policy of extending the warranty period for certain products an additional two years to customers returning completed warranty cards. The Company maintains a staff of product support specialists at its headquarters to provide direct technical service and support. Telephone support through a toll-free number is provided during scheduled business hours. Although most calls involve troubleshooting with owners of Mackie products, product support specialists also field calls from inquiring purchasers and thereby may assist in making sales. The Company also relies on its international distributors to support its products in international countries. These distributors are responsible for the costs of carrying inventory required to meet customer needs. Service and repairs on Mackie's products sold in the U.S. are performed at its headquarters and, for certain larger products, at approximately 100 authorized warranty service centers located throughout the U.S. Multiple locations are necessary for customer convenience and to minimize shipping costs. All products shipped outside of the U.S. are serviced by the Company's international distributors. Research and Development The Company's research and development strategy is to develop affordable, high-quality products and related accessories for its targeted markets. On December 31, 1997, the Company's research and development staff consisted of 41 individuals, in addition to Mr. Mackie, who engineer and design all aspects of the Company's new products. The Company's research and development expenses were approximately $5.9 million in 1997, $3.6 million in 1996 and $1.2 million in 1995. Competition The market for professional audio systems in general is highly competitive. The Company must compete with several professional audio manufacturers who have significantly greater development, sales and financial resources than the Company. The Company's major competitors in the mixer market are subsidiaries of Harman International (including Soundcraft Ltd., Allen & Heath Brenell Ltd. and DOD Electronics Corp.), Sony Corporation, Yamaha Corporation, Peavey Electronics Corporation, Teac America, Inc. (Tascam), SoundTracs PLC and Behringer Spezielle Studiotechnik GmbH. Competitors in the amplifier market include Peavey Electronics Corporation, Crown International, QSC Audio Products, Inc. and Crest Audio Inc. Competing speaker manufacturers include Genelec, Inc., Event Electronics, Inc. and Alesis Corporation. The Company competes primarily on the basis of product quality and reliability, price, ease of use, brand name recognition and reputation, ability to meet customers' changing requirements and customer service and support. In order to remain competitive, the Company substantially increased its research and development expenditures in 1997. However, there can be no assurance that the Company will be successful in developing and marketing, on a timely basis, product modifications or enhancements or new products that respond effectively to technological advances by others. Proprietary Technology 7 Mackie has a strong interest in protecting assets of the Company that reflect original research and development of products and product identity. As such, the Company has made extensive filings for the protection of trademarks under domestic and international trademark registrations and applications, for protection of the design of products under domestic and international filing, and for protection of utility aspects of products, domestically and internationally. To date, the Company has 142 issued trademark registrations and 134 additional trademark applications pending in the United States and in multiple foreign countries regarding protection for marks, including: MACKIE. -Registered Trademark-, the running man design, VLZ - -Registered Trademark-, Ultramix -Registered Trademark-, the three dimensional configuration of the 24-8-Bus and 32-8-Bus, HUI and "d8b". Mackie intends to continue filing applications for trademark protection on various marks, as well as identifying other marks as trademarks of the Company. However, there is no assurance that trademark protection will be granted in any or all countries in which Mackie has or will file for registration of trademarks, or any country in which Mackie currently sells or intends to sell products. There can be no assurance that, as regarding these applications, Mackie will be granted the breadth of description of goods or services identified in respective applications. Also, Mackie cannot provide any assurance that any mark, whether or not registered could withstand a challenge as to validity. There is no assurance that its trademarks would not be considered confusingly similar to, or infringing of a third party mark, or that Mackie could successfully defend any of its trademarks. To date, Mackie has 54 issued design patents, in at least 6 countries including the United States, for several products, including: SR24-4, MS1202-VLZ, MS1402-VLZ, CR1604-VLZ, 40-8-Bus, FR Series, HR824 Studio Monitor, HUI and Digital 8-Bus. In addition, the Company has 30 pending design patent applications in at least 5 countries, including the United States. While design patents provide certain legal rights of enforceability, there can be no assurance that the historical legal standards surrounding questions of validity and enforceability will continue to be applied or that current defenses as to issued patents will, in fact, be considered substantial in the future. In addition, there can be no assurance as to the degree and range of protection any design patent will afford, whether patents will issue or the extent to which the Company will not infringe patents granted to others. Mackie has also filed for utility patent protection on selected products, in the United States and/or certain foreign countries, for the HR824 Studio Monitor and the Digital 8-Bus. Along with extensive trademark and patent registration and filings, the Company has filed and will continue to file for copyright registration on various aspects of its technology, products and literature, including filings on: schematics, circuitry, graphics, net lists, bills of material, advertising, brochures, manuals and similar material. While copyrights provide certain legal rights of enforceability, there can be no assurance as to the ability to successfully prevent others from infringing Mackie's copyrights. The Company has never conducted a comprehensive patent search relating to the technology used in its product. The Company believes that its products do not infringe the proprietary rights of others. There can be no assurance, however, that others will not assert infringement claims against the Company in the future or that claims will not be successful. While Mackie pursues patent, trademark and copyright protection for products and various marks, it also relies on trade secrets, know-how and continuing technology advancement, manufacturing capabilities, affordable, high-quality products, brand name recognition, new product introduction and direct marketing efforts to develop and maintain its competitive position. The Company's policy is to have each employee enter into an agreement that contains provisions prohibiting the disclosure of confidential information to anyone outside the Company and to recognize Mackie's ownership of intellectual property developed by employees. Consulting contracts generally provide for the protection of the Company's intellectual property and the requirement of confidentiality. There can be no assurance, however, that these confidentiality agreements will be honored or that the Company can effectively protect its rights to its unpatented trade secrets. Moreover, there can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets. 8 Manufacturing The Company manufactures its products in its facility near Seattle, Washington. Nearly all of the Company's products share many components, which allows for integrated manufacturing of several distinct products and in certain cases significant part purchase volume discounts. Much of the Company's mixer console and power amplifier assembly work is performed on automated component-insertion machines. Currently, the assembly of most of the parts in a circuit board is automated. The Company relies on several vendors to support its product manufacturing and attempts, if possible, to purchase certain materials from multiple sources to allow for competitive pricing and to avoid reliance on one or only a few vendors. The Company relies almost exclusively on one vendor for its potentiometers, but is in contact with other potentiometer manufacturers regularly. Interruption in, or cessation of, the supply of potentiometers from this supplier could adversely affect the Company's production capability, as the qualification process for another manufacturer, from sample submission to production quality and quantity delivery, could take several months. Backlog The Company does not generally track backlog. Generally, orders are shipped within two weeks after receipt. In the case of new product introductions or periods where product demand exceeds production capacity, the Company allocates products to customers on a monthly basis until demand is met. Employees At December 31, 1997, the Company had 585 full-time equivalent employees, including 45 in marketing, sales and customer support, 41 in research and development, 474 in manufacturing and manufacturing support (which includes manufacturing engineering) and 25 in administration and finance. None of the Company's employees is represented by a labor union, and the Company has never experienced a work stoppage. Item 2. Properties The Company's headquarters near Seattle, Washington house its manufacturing, administrative, sales and marketing, research and development and customer support operations. The building, which is occupied pursuant to a lease through December 31, 2004, is a 89,000 square foot manufacturing and office facility, the construction of which was substantially completed in December 1994. The monthly rent is $56,613, adjusted annually for changes in the consumer price index. The Company leases its facility from Mackie Holdings, LLC, an entity owned by three significant shareholders and directors of the Company, on terms the Company believes are at least as favorable to the Company as might have been obtained from unaffiliated parties. In November 1995, the Company entered into a 10-year lease, with an option to extend for an additional 10 years, covering property that is adjacent to the Company's existing facility. The building is approximately 81,250 square feet. The Company is using the building for product shipping, additional vertical integration of manufacturing processes and other manufacturing activities. Initial base monthly rent for the entire building is $43,063; after five years, the base rent increases to $49,563 per month. Item 3. Legal Proceedings 9 In June 1997, the Company filed a lawsuit against certain parties, including one of the Company's major competitors and a major dealer of the Company's products, alleging infringement of its intellectual property rights. Defendants include Behringer Spezielle Studiotechnick GmbH ("Behringer"), Ulrich Bernard Behringer, Sam Ash Music Corporation, Samson Technologies, Richard Ash and Scott Goodman. The suit claims damages in the amount of $327 million. Cases are pending in the United States District Court for the Western District of Washington, the Southern District of New York, and local courts in the United Kingdom and Italy. While the Company intends to vigorously prosecute these lawsuits, there can be no assurance that the Company will prevail in any of the actions. Item 4. Submission of Matters to a Vote of Securities Holders None. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The information required by this Item is included on page 22 of the Financial Statements Section of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1997 under the heading "Common Stock Information and Dividend Policy" and is incorporated herein by reference. Item 6. Selected Financial Data
Year Ended Year Ended Year Ended Year Ended Year Ended 12/31/97 12/31/96 12/31/95 12/31/94 12/31/93 ----------- ---------- ---------- ---------- ---------- (in thousands, except per share data) Statement of Income Data Net Sales $ 74,889 $ 73,236 $ 63,919 $ 49,907 $ 21,934 Gross Profit $ 27,796 $ 28,025 $ 27,163 $ 21,887 $ 9,610 Operating Expenses $ 20,670 $ 17,784 $ 13,627 $ 10,388 $ 5,881 Pro Forma Net Income(a) $ 5,537 $ 7,421 $ 9,026 $ 7,555 $ 2,437 Balance Sheet Data Working Capital $ 35,956 $ 32,020 $ 30,154 $ 7,004 $ 2,850 Total Assets $ 53,372 $ 46,256 $ 38,046 $ 13,592 $ 6,552 Long-Term Debt $ 0 $ 0 $ 0 $ 383 $ 82 Shareholders' Equity $ 46,478 $ 42,283 $ 34,807 $ 8,244 $ 3,624 Per Common Share Data (Diluted Basis) Diluted Income Per Share $ 0.41 $ 0.55 $ 0.73 $ 0.68 $ 0.22 Book Value Per Share $ 3.47 $ 3.11 $ 2.82 $ 0.74 $ 0.33 Shares Used In Diluted Income Per Share 13,401,150 13,611,050 12,361,718 11,139,907 11,139,907
- ------------------------ (a) Through 8/16/95, the Company was taxed as an S Corporation and therefore was not subject to income taxes. The pro forma income statement data includes certain adjustments to reflect a provision for income taxes as if the Company had been subject to income taxes as a C Corporation. (b) Diluted per share amounts for 1997 and 1996 have been restated to comply with Statement of Financial Accounting Standard (SFAS) No. 128, "Earnings per Share," which was adopted in the fourth quarter of 1997. Diluted per share amounts for 1995, 1994, and 1993 have been restated to comply with SFAS No. 128 and new SEC requirements. 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by this Item is included on pages 2 to 7 of the Financial Statements Section of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1997 under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" and is incorporated herein by reference. Item 8. Consolidated Financial Statements and Supplementary Data The report of independent auditors, consolidated financial statements and other information required by this Item are included on pages 8 to 21 of the Financial Statements Section of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1997 and are incorporated herein by reference. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant The information required by this Item is included in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders under the heading "Proposal No. 1: Election of Directors" and is incorporated herein by reference. Item 11. Executive Compensation The information required by this Item is included in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders under the heading "Executive Compensation" and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this Item is included in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders under the heading "Principal Shareholders" and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information required by this Item is included in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders under the heading "Certain Transactions" and is incorporated herein by reference. 11 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Documents filed as part of this report:
Page Number in Financial Statements 1. Consolidated Financial Statements: Section of Annual Report --------------- A. Consolidated Balance Sheets as of December 31, 1997 and December 31, 1996................................................ 8 B. Consolidated Statements of Income for each of the years ended December 31, 1997, December 31, 1996 and December 31, 1995........ 9 C. Consolidated Statements of Cash Flows for each of the years ended December 31, 1997, December 31, 1996 and December 31, 1995........................... 10-11 D. Consolidated Statements of Shareholders' Equity for each of the years ended December 31, 1997, December 31, 1996 and December 31, 1995................................................. 12 E. Notes to Consolidated Financial Statements.......................... 13-20 F. Report of Independent Auditors...................................... 21
2. Financial Statement Schedules: Form 10-K Page Number Schedule II - Valuation and Qualifying Accounts.......................... 14 The independent auditor's report with respect to the financial statement schedule appears in the exhibits to this report (Exhibit 23.1). All other financial statement schedules not listed are omitted either because they are not applicable, not required, or the required information is included in the consolidated financial statements or notes thereto. 3. Exhibits: See Index to Exhibits on page 15.
(b) Reports on Form 8-K: None. 12 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MACKIE DESIGNS INC. By: /s/ Greg C. Mackie ------------------------------------- Greg C. Mackie Chairman of the Board, President and Chief Executive Officer Date: March 31, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 31, 1998. Signature Title --------- ----- /s/ Greg C. Mackie Chairman of the Board, President and Chief - --------------------------------- Executive Officer Greg C. Mackie (Principal Executive Officer) /s/ William A. Garrard Vice President, Finance and Chief Financial - --------------------------------- Officer William A. Garrard (Principal Financial and Accounting Officer) /s/ David M. Tully Treasurer and Director - --------------------------------- David M. Tully /s/ Raymond B. Ferguson Director - --------------------------------- Raymond B. Ferguson /s/ Walter Goodman Director - --------------------------------- Walter Goodman /s/ C. Marcus Sorenson Director - --------------------------------- C. Marcus Sorenson 13 SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS MACKIE DESIGNS INC.
- ------------------------------------------------------------------------------------------------------------------ COL. A COL. B COL. C COL. D COL. E - ------------------------------------------------------------------------------------------------------------------ Additions Balance at Charged to Balance at Beginning Costs and Deductions-- End of Description of Period Expenses Describe Period - ------------------------------------------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 1997: Reserve and allowances deducted from asset accounts Allowance for uncollectible accounts $ 808,000 $ -- $ 327,000(1) $ 481,000 Reserve for inventories $ 632,000 $ -- $ 187,000(2) $ 445,000 Reserve and allowances added to liability accounts Reserve for warranty expenses $ 180,000 $ 120,000 $ -- $ 300,000 YEAR ENDED DECEMBER 31, 1996: Reserve and allowances deducted from asset accounts Allowance for uncollectible accounts $ 514,000 $ 471,000 $ 177,000(1) $ 808,000 Reserve for inventories $ 154,000 $ 478,000 $ -- $ 632,000 Reserve and allowances added to liability accounts Reserve for warranty expenses $ 60,000 $ 120,000 $ -- $ 180,000 YEAR ENDED DECEMBER 31, 1995: Reserve and allowances deducted from asset accounts Allowance for uncollectible accounts $ 367,000 $ 196,000 $ 49,000(1) $ 514,000 Reserve for inventories $ -- $ 154,000 $ -- $ 154,000 Reserve and allowances added to liability accounts Reserve for warranty expenses $ 50,000 $ 10,000 $ -- $ 60,000
- ------------------------ (1) Uncollectible accounts written off, net of recoveries, and adjustment to reserves. (2) Inventories written off, net of recoveries, and adjustment to reserves. 14 INDEX TO EXHIBITS
Sequentially Exhibits Description Numbered Page - ---------- ----------- ------------- 3.1 Restated Articles of Incorporation. Incorporated by reference to Exhibit 3.1 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514........................... 3.2 Restated Bylaws. Incorporated by reference to Exhibit 3.2 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514............................................ 4.1 See Articles II, III and IV of Exhibit 3.1 and Sections 1, 5 and 9 of Exhibit 3.2 confirming the rights of the holders of Common Stock.............. *10.1 Mackie Designs Inc. Second Amended and Restated 1995 Stock Option Plan ....... 10.2 Industrial Lease, dated December 15, 1994, by and between Mackie Holdings, L.L.C. and Mackie Designs Inc. Incorporated by reference to Exhibit 10.3 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514............................... 10.3 Industrial Real Estate Lease, dated April 28, 1995, by and between Intrawest Properties Partnership U.S. and Mackie Designs Inc. Incorporated by reference to Exhibit 10.4 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514..... 10.4 Exhibit C to Industrial Real Estate Lease, dated April 28, 1995, by and between Intrawest Properties Partnership U.S. and Mackie Designs Inc. Incorporated by reference to Exhibit 10.4A to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514..................................................... 10.5 Mackie Sales Representative Agreement, dated January 24, 1994, by and between Mackie Designs Inc. and C.M. Sorenson Co. dba Calwest Marketing So. Incorporated by reference to Exhibit 10.5 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514..................................................... 10.6 Exhibit C to Mackie Sales Representative Agreement, dated January 24, 1994, by and between Mackie Designs Inc. and C. M. Sorenson Co. dba Calwest Marketing So. Incorporated by reference to Exhibit 10.5A to 15 Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514................ 10.7 Form of Authorized Dealer Agreement. Incorporated by reference to Exhibit 10.13 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514. ................................................... 10.8 Form of Sales Representative Agreement. Incorporated by reference to Exhibit 10.14 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514......................................... 10.9 Mackie Designs Inc. 401(k) Profit Sharing Plan dated December 20, 1993. Incorporated by reference to Exhibit 10.15 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514..................................................... 10.10 Agreement between A&R Technology and Mackie Designs Inc. for the Development and Publishing of MIDI Mix Automation Software dated December 5, 1993, as amended on August 16, 1994 and June 14, 1995. Incorporated by reference to Exhibit 10.16 to Registrant's Registration Statement filed under the Securities Act of 1933 on Form S-1, as amended, Registration No. 33-93514. .............. 10.11 Software License Agreement among Alexander Hopmann, Robert Tudor and Mackie Designs Inc. dated February 9, 1996. Incorporated by reference to Exhibit 10.22 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1995............................................................. 10.12 Employee Agreement dated April 28, 1997 between Roy D. Wemyss and Mackie Designs Inc. Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1997.............. 10.13 Employee Agreement dated April 28, 1997 between Patric Wiesmann and Mackie Designs Inc. Incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1997.............. 10.14 Employee Agreement dated May 19, 1997 between William A. Garrard and Mackie Designs Inc. Incorporated by reference to Exhibit 10.3 to 16 Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1997................................................................. 10.15 Employee Agreement dated June 20, 1997 between Robert May and Mackie Designs Inc. Incorporated by reference to Exhibit 10.4 to Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1997........................ 10.16 Speaker Design Agreement dated September 18 1997 between Mackie Designs Inc. and Radio Cine Forniture (R.C.F.) S.p.A. Incorporated by reference to Exhibit 10.25 to Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 1997...................................................... *10.17 Business Loan Agreement, dated October 27, 1997, by and between U.S. Bank of Washington, National Association, and Mackie Designs Inc...................... *10.18 Promissory Note made by Mackie Designs Inc. to the order of U.S. Bank of Washington, National Association, in the principal amount of $5,000,000.00 dated October 27, 1997........................................................ ---------- 11.1 Computation of net income per share. Incorporated by reference to the Notes to Consolidated Financial Statements (Footnote 9) in the Annual Report to Shareholders of Mackie Designs Inc. for the year ended December 31, 1997...... *13.1 Annual Report to Shareholders of Mackie Designs Inc. for the year ended December 31, 1997............................................................. ---------- *21.1 Subsidiaries of Mackie Designs Inc............................................ ---------- *23.1 Consent of Ernst & Young LLP, Independent Auditors............................ ---------- *27.1 Financial Data Schedule....................................................... ---------- *27.2 Restated Financial Data Schedules for the periods ended March 31, 1997, June 30, 1997, and September 30, 1997.............................................. ---------- *27.3 Restated Financial Data Schedules for the periods ended March 31, 1996, June 30, 1996, September 30, 1996, and December 31, 1996...........................
- ------------------------------ * Filed herewith 17 EX-10.1 2 EXHIBIT 10-1 Exhibit 10.1 MACKIE DESIGNS INC. SECOND AMENDED AND RESTATED 1995 STOCK OPTION PLAN MACKIE DESIGNS INC. SECOND AMENDED AND RESTATED 1995 STOCK OPTION PLAN 1. Purposes. The purposes of this Mackie Designs Inc. Second Amended and Restated 1995 Stock Option Plan ("Plan") are to: 1.1 Closely associate the interests of the management of Mackie Designs Inc. ("Company") and its subsidiaries with the shareholders of the Company by reinforcing the relationship between participants' rewards and shareholder gains; 1.2 Provide management with an equity ownership in the Company commensurate with the Company's and its subsidiaries' performance as reflected in increased value of the Company's common shares; 1.3 Maintain competitive compensation levels; 1.4 Provide a means whereby the Company can continue to attract, motivate, and retain key employees who can contribute materially to the Company's and its subsidiaries' growth and success; and 1.5 Provide a means whereby the Company and its subsidiaries can continue to attract, motivate and retain the services of selected non-employee agents, consultants, advisors, persons involved in the sale or distribution of the Company's and its subsidiaries' products and independent contractors of the Company and its subsidiaries. 2. Administration. This Plan shall be administered by the Board of Directors of the Company ("Board") or, in the event the Board shall appoint and/or authorize a committee to administer this Plan, by a committee of the Board consisting of at least two (2) non-employee directors ("Committee"). The administrator of this Plan, whether the Board or Committee, shall hereinafter be referred to as the "Plan Administrator." The Plan Administrator shall administer the Plan in accordance with the following: 2.1 Incapacity of Plan Administrator. No member of the Board or the Committee shall vote with respect to the granting of an option created under this Plan ("Option(s)") to himself or herself. Any Option granted to a director for his or her services as such shall not be effective until approved by the full Board. 2.2 Registration Under The Securities Act. If the Company registers any of its equity securities pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934, as amended ("Exchange Act") and any officers or directors are eligible to receive Options, the following provisions shall apply to the administration of this Plan with respect to grants made to directors, officers or other Optionees (as hereinafter defined) affected by Section 16(b) of the Exchange Act. The Plan Administrator shall be Page 1 of 14 - STOCK OPTION PLAN constituted at all times so as to meet the requirements of Section 16(b) of the Exchange Act, as amended from time to time. The members of any committee serving as Plan Administrator shall be appointed by the Board for such term as the Board may determine. The Board may from time to time remove members from, or add members to, the committee. Vacancies on the committee, however caused, may be filled by the Board. Currently, the Plan Administrator is a Committee, of which all members are disinterested. If, at any time, an insufficient number of disinterested non-employee directors is available to serve on such committee, interested non-employee directors may serve on the committee; however, during such time, no Options shall be granted to any person if the granting of such Option would not meet the requirements of Section 16(b) of the Exchange Act. For purposes of this Section 2, a disinterested director shall be a member of the Board who meets the definition of "disinterested person" as set forth in the rules and regulations promulgated under Section 16(b) of the Exchange Act, as amended from time to time (the "16(b) Rules"). Currently, a disinterested director for purposes of this Section 2 is a member of the Board who for one (1) year prior to service as an administrator of this Plan has not been (and during service as a Plan Administrator, will not be) granted or awarded equity securities, including options for equity securities pursuant to this Plan or any other plan of the Company or its affiliates, except for certain exclusions described in Rule 16b-3. For purposes of this Section 2, a non-employee director shall be a member of the Board who meets the definition of "non-employee director" as set forth in the 16(b) Rules. Currently, a non-employee director is a member of the Board who (i) is not currently an officer of the Company or a parent or subsidiary of the Company, or otherwise currently employed by the Company or a parent or subsidiary of the Company; (ii) does not receive compensation, either directly or indirectly, from the Company or a parent or subsidiary of the Company, for services rendered as a consultant or in any capacity other than as a director, except for an amount that does not exceed the dollar amount for which disclosure would be required pursuant to Item 404(a) of Regulation S-K promulgated under the Exchange Act (("S-K"); (iii) does not possess an interest in any other transaction for which disclosure would be required pursuant to Item 404(b) of S-K; and (iv) is not engaged in a business relationship for which disclosure would be required pursuant to Item 404(b) of S-K. 2.3 Procedures. The Board may designate one of the members of the Plan Administrator as chairman. The Plan Administrator may hold meetings at such times and places as it shall determine. The acts of a majority of the members of the Plan Administrator present at meetings at which a quorum exists, or acts reduced to or approved in writing by all Plan Administrator members, shall be valid acts of the Plan Administrator. 2.4 Responsibilities. Except for the terms and conditions explicitly set forth in this Plan, the Plan Administrator shall have the authority, in its discretion, to determine all matters relating to the Options, including selection of the individuals to be granted Options, the number of shares to be subject to each Option, the exercise price for such Option ("Exercise Price"), and all other terms and conditions of the Options. The Page 2 of 14 - STOCK OPTION PLAN interpretation and construction by the Plan Administrator of any terms or provisions of this Plan or any Option, or of any rule or regulation promulgated in connection with this Plan, shall be conclusive and binding on all interested parties, so long as such interpretation and construction with respect to incentive stock options correspond to the requirements of Section 422 of the Internal Revenue Code of 1986, as amended ("Code"), and the regulations issued thereunder, and any amendment or successor sections or regulations. 2.5 Section 16(b) Compliance and Bifurcation of Plan. If the Company registers any of its equity securities pursuant to Sections 12(b) and 12(g) of the Exchange Act, it is the intention of the Company that this Plan then comply in all respects with Rule 16b-3 under the Exchange Act and, if any Plan provision is later found not to be in compliance with such Section, the provision shall be deemed null and void. In all events, the Plan shall be construed in favor of its meeting the requirements of Rule 16b-3. Notwithstanding anything in the Plan to the contrary, the Board, in its absolute discretion, may bifurcate the Plan so as to restrict, limit or condition the use of any provision of the Plan to participants who are officers and directors subject to Section 16(b) of the Exchange Act without so restricting, limiting or conditioning the Plan with respect to other participants. 3. Stock Subject to This Plan. The stock subject to this Plan shall be the Company's common stock ("Common Stock"). The Company shall have authorized and have in reserve for issuance at the time of exercise of any Option a sufficient number of shares of Common Stock to meet the Company's obligation. The maximum number of shares of Common Stock which may be issued under the Plan shall be three million five hundred thousand (3,500,000). If any Option expires or is surrendered, exchanged for another Option, cancelled or terminated for any reason without having been exercised in full, the unpurchased shares subject to such Option shall again be available for purposes of this Plan, including for replacement Options which may be granted in exchange for such expired, exchanged, surrendered, cancelled or terminated Options. 4. Eligibility. An incentive stock option in accordance with Section 422 of the Code ("Incentive Option") may be granted only to an individual who, at the time the option is granted, is an employee of the Company or a related corporation, as defined below, and who the Plan Administrator may from time to time select for participation in this Plan. Members of the Board shall not be eligible for grants of Incentive Options unless they are also employees of the Company or any of its related corporations. At the discretion of the Plan Administrator, employees, officers, directors of the Company or any of its related corporations (including non-employee directors), selected non-employee agents, consultants, advisors, persons involved in the sale or distribution of the Company's or related corporations' products and independent contractors of the Company or any of its related corporations also may receive stock options which are not qualified under Section 422 of the Code ("Nonqualified Option") (Qualified and Nonqualified Options are included collectively within the term "Options" as used in this Plan). Any party to whom an Option is granted shall be referred to as an "Optionee." Page 3 of 14 - STOCK OPTION PLAN As used in this Plan, the term "related corporation," when referring to a subsidiary corporation, shall mean any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company if, at the time of the granting of the Option, each of the corporations other than the last corporation in the unbroken chain owns stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock of one of the other corporations in such chain. When referring to a parent corporation, the term "related corporation" shall mean any corporation (other than the Company) in an unbroken chain of corporations ending with the Company if, at the time of granting of the Option, each of the corporations other than the Company owns stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock of one of the other corporations in such chain. 5. Terms and Conditions of Options. Options granted under this Plan shall be evidenced by written agreements which shall contain such terms, conditions, limitations and restrictions as the Plan Administrator shall deem advisable and which are not inconsistent with this Plan. Notwithstanding the foregoing, Option agreements shall include or incorporate by reference the following terms and conditions: 5.1 Number of Shares. Each Option agreement shall state the number of shares of stock subject to the Option; 5.2 Option Price. The Option agreement shall state the Exercise Price per share, and the Plan Administrator shall act in good faith to establish the Exercise Price as follows: 5.2.1 Incentive Options. Subject to subsection 5.2.3, the Exercise Price of Incentive Options shall be not less than the fair market value per share of the Common Stock at the time the Incentive Option is granted; 5.2.2 Incentive Options to Greater than 10% Shareholders. With respect to Incentive Options granted to shareholders then holding greater than ten percent (10%) of the then-issued and outstanding shares of voting stock of the Company, the Exercise Price shall be as required by Section 6; 5.2.3 Fair Market Value. With respect to Incentive Options, the fair market value per share of the Common Stock shall be determined by the Plan Administrator in good faith at the time the Incentive Option is granted; 5.2.4 Nonqualified Options. The Exercise Price of Nonqualified Options shall be as is determined by the Plan Administrator in good faith at the time of their issuance. 5.3 Term, Maturity and Vesting. Subject to the restrictions contained in Sections 5.8 and 6, the term of each Incentive Option shall be ten (10) years from the date it is granted unless a shorter period of time is established by the Plan Page 4 of 14 - STOCK OPTION PLAN Administrator, but in no event shall the term of any Incentive Option exceed ten (10) years. The term of each Nonqualified Option shall also be ten (10) years from the date it is granted unless a shorter period of time is established by the Plan Administrator. The Plan Administrator shall specify which Options granted hereunder are Incentive Options and which are Nonqualified Options. No Option shall be exercisable until it has vested. The vesting schedule for each Option shall be specified by the Plan Administrator at the time of grant; provided, that if no vesting schedule is specified at the time of grant, the Option shall vest according to the following schedule:
Number of Years Percentage of Following Date of Grant Total Option Vested ----------------------- ------------------- One 25% Two 50% Three 75% Four 100%
The Plan Administrator may specify a vesting schedule for all or any portion of an Option based on the achievement of performance objectives established in advance of the commencement by the Optionee of services related to the achievement of the performance objectives. Performance objectives shall be expressed in terms of one or more of the following: return on equity, return on assets, share price, market share, sales, earnings per share, costs, net earnings, net worth, inventories, cash and cash equivalents, gross margin or the Company's performance relative to its internal business plan. Performance objectives may be in respect of the performance of the Company as a whole (whether on a consolidated or unconsolidated basis), a related corporation, or a subdivision, operating unit, product or product line of either of the foregoing. Performance objectives may be absolute or relative and may be expressed in terms of a progression or a range. An option which is exercisable (in whole or in part) upon the achievement of one or more performance objectives may be exercised only following written notice to the Optionee and the Company by the Plan Administrator that the performance objective has been achieved. 5.4 Exercise. Subject to the limitations on exercise described in subsection 5.3 above and any additional holding period required by applicable law, each Option may be exercised in whole or in part; provided, however, that only whole shares will be issued pursuant to the exercise of any Option. During an Optionee's lifetime, any Options granted under this Plan are personal to him or her and are exercisable solely by such Optionee. Options shall be exercised by delivery to the Company of a written notice of the number of shares with respect to which the Option is to be exercised, together with payment of the Exercise Price in accordance with Section 5.5. Page 5 of 14 - STOCK OPTION PLAN 5.5 Payment of Exercise Price. Payment of the Exercise Price shall be made in full at the time the written notice of exercise of an Option is delivered to the Company, and shall be in cash, bank certified or cashier's check or personal check (unless at the time of exercise the Plan Administrator in a particular case determines not to accept a personal check) for the Common Stock being purchased. The Plan Administrator can determine in its discretion (i) at the time an Incentive Option is granted, or (ii) at any time before exercise of Nonqualified Options, that additional forms of payment will be permitted, including installment payments on such terms and over such period as the Plan Administrator may determine. To the extent permitted by the Plan Administrator and applicable laws and regulations (including, but not limited to, federal tax and securities laws and regulations and state corporate law), an option may be exercised by: 5.5.1 Delivery of Common Stock. Delivery of shares of Common Stock held by an Optionee having a fair market value equal to the Exercise Price, such fair market value to be determined in good faith by the Plan Administrator; 5.5.2 Delivery of Promissory Note. Delivery of a full-recourse promissory note executed by the Optionee; provided that (i) such note if delivered in connection with an Incentive Option shall, and such note if delivered in connection with a Nonqualified Option may, bear interest at a rate specified by the Plan Administrator, but in no case less than the rate required to avoid imputation of interest (taking into account any exceptions to the imputed interest rules) for federal income tax purposes; (ii) the Plan Administrator shall specify the term and other provisions of such note at the time an Incentive Option is granted or at any time prior to exercise of a Nonqualified Option; (iii) the Plan Administrator may require that the Optionee pledge the Optionee's shares to the Company for the purpose of securing the payment of such note, and may require that the certificate representing such shares be held in escrow to perfect the Company's security interest; (iv) the note provides that ninety (90) days following the Optionee's termination of employment with the Company or a related Corporation, the entire outstanding balance under the note shall become due and payable, if not previously due and payable; and (v) the Plan Administrator in its sole discretion may at any time after granting an Option restrict or rescind the right to pay using a promissory note upon written notification to any Optionee; 5.5.3 Delivery of Sale Proceeds. Delivery of a properly executed written exercise notice, together with irrevocable instructions to a broker, all in accordance with the regulations of the Federal Reserve Board, to promptly deliver to the Company the amount of sale or loan proceeds to pay the exercise price and any federal, state or local withholding tax obligations that may arise in connection with the exercise; provided, that the Plan Administrator may at any time determine that this section 5.5.3, to the extent the instructions to the broker call for an immediate sale of the shares, shall not be available to any Optionee Page 6 of 14 - STOCK OPTION PLAN who is subject to Section 16(b) of the Exchange Act if such transaction would result in a violation of Section 16(b), or if such Optionee is not an employee at the time of exercise; 5.5.4 Delivery of Withholding Notice. Delivery of a properly executed written exercise notice together with instructions to the Company to withhold upon exercise, from the shares that would otherwise be issued, that number of shares having a fair market value equal to the Exercise Price. 5.6 Withholding Tax Requirement. The Company or any related entity shall have the right to retain and withhold from any payment of cash or Common Stock under this Plan the amount of taxes required by any government to be withheld or otherwise deducted and paid with respect to such payment. At its discretion, the Company may require an Optionee receiving shares of Common Stock to reimburse the Company for any such taxes required to be withheld by the Company, and may withhold any distribution in whole or in part until the Company is so reimbursed. In lieu of such withholding or reimbursement, the Company shall have the right to withhold from any other cash amounts due or to become due from the Company to the Optionee an amount equal to such taxes or to retain and withhold a number of shares having a market value not less than the amount of such taxes required to be withheld by the Company to reimburse the Company for any such taxes and cancel (in whole or in part) any such shares so withheld. If required by Section 16(b) of the Exchange Act, the election to pay withholding taxes by delivery of shares held by any person who at the time of exercise is subject to Section 16(b) of the Exchange Act, shall be made during the quarterly 10-day window period required under Section 16(b) of the Exchange Act for exercises of stock appreciation rights. 5.7 Non-assignability of Option. Options and the rights and privileges conferred by this Plan shall not be transferred, assigned or pledged in any manner (whether by operation of law or otherwise) other than by will or by the applicable laws of descent and distribution, except that the Plan Administrator may also in its discretion allow transferability of Nonqualified Options only by gift to members of the Optionee's family, including grandparents, parents, spouses, siblings, children, grandchildren and great-grandchildren, or trusts or partnerships for the benefit of such family members, or to charitable organizations. Options and the rights and privileges conferred by this Plan shall not be subject to execution, attachment or similar process. Any attempt to transfer, assign, pledge or otherwise dispose of any Option or of any right or privilege conferred by this Plan, contrary to the Code or to the provisions of this Plan, or the sale or levy or any attachment or similar process upon the rights and privileges conferred by this Plan shall be null and void. Notwithstanding the foregoing, an Optionee may, during the Optionee's lifetime, designate a person who may exercise the Option after the Optionee's death by giving written notice of such designation to the Plan Administrator. Such designation may be changed from time to time by the Optionee giving written notice to the Plan Administrator revoking any earlier designation and making a new designation. In the event that no such designation is Page 7 of 14 - STOCK OPTION PLAN made, the executor or personal representative of the Optionee's estate shall have any rights then remaining to the Optionee or his estate under this Plan. 5.8 Duration of Option. Vested Options shall terminate, to the extent not previously exercised, upon the occurrence of the first of the following events: (i) the expiration of the Option, as designated by the Plan Administrator in accordance with Section 5.3 above; (ii) the date of an Optionee's termination of employment with the Company or any related corporation for cause (as determined in the sole discretion of the Plan Administrator); (iii) the expiration of ninety (90) days from the date of an Optionee's termination of employment with the Company or any related corporation for any reason whatsoever other than cause, death or Disability (as defined below) unless the exercise period is extended by the Plan Administrator until a date not later than the expiration date of the Option; or (iv) the expiration of one year from (A) the date of death of the Optionee or (B) cessation of an Optionee's employment by reason of Disability (as defined below) unless, the exercise period is extended by the Plan Administrator until a date not later than the expiration date of the Option. If an Optionee's employment is terminated by death, any Option held by the Optionee shall be exercisable only by the person or persons to whom such Optionee's rights under such Option shall pass by the Optionee's will or by the laws of descent and distribution of the state or county of the Optionee's domicile at the time of death. For purposes of the Plan, unless otherwise defined in the Agreement, "Disability" shall mean any physical, mental or other health condition which substantially impairs the Optionee's ability to perform his or her assigned duties for one hundred twenty (120) days or more in any two hundred forty (240) day period or that can be expected to result in death. The Plan Administrator shall determine whether an Optionee has incurred a Disability on the basis of medical evidence acceptable to the Plan Administrator. Upon making a determination of Disability, the Plan Administrator shall, for purposes of the Plan, determine the date of an Opionee's termination of employment. Unless accelerated in accordance with Section 7, unvested Options shall terminate immediately upon termination of employment of the Optionee by the Company for any reason whatsoever, including death or Disability. For purposes of this Plan, transfer of employment between or among the Company and/or any related corporation shall not be deemed to constitute a termination of employment with the Company or any related corporation. For purposes of this subsection with respect to Incentive Stock Options, employment shall be deemed to continue while the Optionee is on military leave, sick leave or other bona fide leave of absence (as determined by the Plan Administrator). The foregoing not withstanding, employment shall not be deemed to continue beyond the first ninety (90) days of such leave, unless the Optionee's re-employment rights are guaranteed by statute or by contract. 5.9 Status of Shareholder. Neither the Optionee nor any party to which the Optionee's rights and privileges under the Option may pass shall be, or shall have any of the rights or privileges of, a shareholder of the Company with respect to any of the Page 8 of 14 - STOCK OPTION PLAN shares issuable upon the exercise of any Option unless and until such Option has been exercised. 5.10 Right to Terminate Employment. Nothing in this Plan or in any Option shall confer upon any Optionee any right to continue in the employ of the Company or of a related entity, or to interfere in any way with the right of the Company or of any related corporation to terminate, at will, his or her employment or other relationship with the Company at any time. 5.11 Modification and Amendment of Option. Subject to the requirements of Code Section 422 with respect to Incentive Options and to the terms, conditions and limitations of this Plan, the Plan Administrator may modify or amend outstanding Options. The modification or amendment of an outstanding Option shall not, without the consent of the Optionee, impair or diminish any of his or her rights or any of the obligations of the Company under such Option. Except as otherwise provided in this Plan, no outstanding Option shall be terminated without the consent of the Optionee. Unless the Optionee agrees otherwise, any changes or adjustments made to outstanding Incentive Options shall be made in such a manner so as not to constitute a "modification" as defined in Code Section 424(h) and so as not to cause any Incentive Option to fail to continue to qualify as an "incentive stock option" as defined in Code Section 422(b). 5.12 Limitation on Value for Incentive Options. As to all Incentive Options, to the extent that the aggregate fair market value of the Common Stock with respect to which Incentive Options are exercisable for the first time by the Optionee during any calendar year (under this Plan and all other incentive stock option plans of the Company, a related corporation or a predecessor corporation) exceeds $100,000, those Options (or the portion of an Option) beyond the $100,000 threshold shall be treated as Nonqualified Options. If the Internal Revenue Service publicly rules, issues a private ruling to the Company, any Optionee, or any legatee, personal representative or distributee of an Optionee or issues regulations changing or eliminating such annual limit, the dollar limitation in the preceding sentence shall be adjusted correspondingly. 6. Greater Than 10% Shareholders. In the case of Incentive Options granted to employees who own at the time of their grant ten percent (10%) or more of the then-issued and outstanding voting stock of the Company, the following rules shall apply: 6.1 Exercise Price and Term of Incentive Options. If Incentive Options are granted to employees who own more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any related corporation, the term of such individual's Incentive Options shall not exceed five (5) years and the Exercise Price shall be not less than one hundred ten percent (110%) of the fair market value of the Common Stock at the time the Incentive Option is granted. This provision shall control notwithstanding any contrary terms contained in an Option agreement or any other document. Page 9 of 14 - STOCK OPTION PLAN 6.2 Attribution Rule. For purposes of subsection 6.1, in determining stock ownership, an employee shall be deemed to own such shares as are owned by those persons or entities defined in Code Section 424. For purposes of this Section 6, stock owned by an employee shall include all stock actually issued and outstanding immediately before the grant of the Incentive Option to the employee. 7. Adjustments Upon Changes in Capitalization. The aggregate number and class of shares for which Options may be granted under this Plan, the number and class of shares covered by each outstanding Option and the Exercise Price per share thereof (but not the total price), and each such Option, shall all be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock of the Company resulting from a split-up or consolidation of shares or any like capital adjustment, or the payment of any stock dividend. 7.1 Effect of Liquidation, Reorganization or Change in Control. 7.1.1 Cash, Stock or Other Property for Stock. Except as provided in subsection 7.1.2, upon a merger (other than a merger of the Company in which the holders of Common Stock immediately prior to the merger have the same proportionate ownership of Common Stock in the surviving corporation immediately after the merger), consolidation, acquisition of property or stock, separation, reorganization (other than a mere reincorporation or the creation of a holding company) or liquidation of the Company, as a result of which the shareholders of the Company receive cash, stock or other property in exchange for or in connection with their shares of Common Stock, any Option granted under this Plan shall terminate, but the Optionee shall have the right immediately prior to any such merger, consolidation, acquisition of property or stock, separation, reorganization or liquidation to exercise such Option in whole or in part, to the extent the vesting requirements set forth in the Option agreement have been satisfied, unless stated otherwise in the Optionee's individual Option agreement. 7.1.2 Conversion of Options on Stock for Stock Exchange. If the shareholders of the Company receive capital stock of another corporation ("Exchange Stock") in exchange for their shares of Common Stock in any transaction involving a merger (other than a merger of the Company in which the holders of Common Stock immediately prior to the merger have the same proportionate ownership of Common Stock in the surviving corporation immediately after the merger), consolidation, acquisition of property or stock, separation or reorganization (other than a mere reincorporation or the creation of a holding company), all Options granted under this Plan shall be converted into options to purchase shares of Exchange Stock unless the Company and the Corporation issuing the Exchange Stock, in their sole discretion, determine that any or all such Options shall not be converted into options to purchase shares of Exchange Stock, but instead shall terminate in accordance with the provisions of subsection 7.1.1. The amount and price of converted options shall be Page 10 of 14 - STOCK OPTION PLAN determined by adjusting the amount and price of the Options in the same proportion as used for determining the number of shares of Exchange Stock the holders of the Common Stock receive in such merger, consolidation, acquisition of property or stock, separation or reorganization. Unless accelerated by the Board, the exercise limitations set forth in the Option agreement and the Plan shall continue to apply for the Exchange Stock. 7.1.3 Change in Control. In the event of a "Change in Control", as defined below, of the Company, unless otherwise determined by the Board prior to the occurrence of such Change in Control, any Options or portions of such Options outstanding as of the date such Change in Control is determined to have occurred that are not yet fully vested on such date shall become immediately exercisable in full. 7.1.4 Definition of "Change in Control". For purposes of this Plan, a "Change in Control" shall mean (a) the first approval by the Board or by the stockholders of the Company of an Extraordinary Event, (b) a Purchase, or (c) a Board Change. For purposes of the Plan such terms shall have the following meanings: 7.1.4.1 an "Extraordinary Event" shall mean any of the following actions: (i) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of Common Stock would be converted into cash, securities or other property, other than a merger of the Company in which the holders of Common Stock immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger; (ii) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of the Company; or, (iii) the adoption of any plan or proposal for liquidation or dissolution of the Company. 7.1.4.2 a "Purchase" shall mean the acquisition by any person (as such term is defined in Section 13(d) of the Exchange Act) of any shares of Common Stock or securities convertible into Common Stock without the prior approval of a majority of the Continuing Directors (as defined below) of the Company, if after making such acquisition such person is the beneficial owner (as such term is defined in Rule 13d-3 under the Exchange Act) directly or indirectly of Securities of the Company representing twenty percent (20%) or more of the combined voting power of the Company's then outstanding securities (calculated as provided in paragraph (d) of such Rule 13d-3). 7.1.4.3 a "Board Change" shall have occurred if individuals who constitute the Board of the Company at the time of adoption of this Plan Page 11 of 14 - STOCK OPTION PLAN (the "Continuing Directors") cease for any reason to constitute at least a majority of the Board, provided that any person becoming a Director subsequent to the date of adoption of this Plan whose nomination for election was approved by a vote of at least a majority of the Continuing Directors (other than a nomination of an individual whose initial assumption of office is in connection with an actual threatened election contest relating to the election of the Directors of the Company, as such terms are used in Rule 14a-11 of Regulation 14A under the Exchange Act) shall be deemed to be a Continuing Director. 7.2 Fractional Shares. In the event of any adjustment in the number of shares covered by any Option, any fractional shares resulting from such adjustment shall be disregarded and each such Option shall cover only the number of full shares resulting from such adjustment. 7.3 Determination of Board to Be Final. All Section 7 adjustments shall be made by the Board, and its determination as to what adjustments shall be made, and the extent of such adjustments, shall be final, binding and conclusive. Unless an Optionee agrees otherwise, any change or adjustment to an Incentive Option shall be made in such a manner so as not to constitute a "modification" as defined in Code Section 424(h) and so as not to cause his or her Incentive Option to fail to continue to qualify as an incentive stock option as defined in Code Section 422(b). 8. Securities Regulation. Shares shall not be issued with respect to an Option unless the exercise of such Option and the issuance and delivery of such shares pursuant to the exercise of such Option shall comply with all relevant provisions of law, including, without limitation, any applicable state securities laws, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance, including the availability of an exemption from registration for the issuance and sale of any shares under this Plan. Inability of the Company to obtain from any regulatory body having jurisdiction, the authority deemed by the Company's counsel to be necessary for the lawful issuance and sale of any shares under this Plan or the unavailability of an exemption from registration for the issuance and sale of any shares under this Plan shall relieve the Company of any liability in respect of the non-issuance or sale of such shares as to which such requisite authority shall not have been obtained. As a condition to the exercise of any Option, the Company may require the Optionee to represent and warrant at the time of any such exercise that the shares are being purchased only for investment and without any present intention to sell or distribute such shares if, in the opinion of counsel for the Company, such a representation is required by any relevant provision of the aforementioned laws. At the option of the Company, a stop-transfer order against any shares of stock may be placed on the official stock books and records of the Company, and a legend indicating that the stock may not be pledged, sold or otherwise Page 12 of 14 - STOCK OPTION PLAN transferred unless an opinion of counsel is provided (concurred in by counsel for the Company) stating that such transfer is not in violation of any applicable law or regulation, may be stamped on stock certificates in order to assure exemption from registration. The Plan Administrator may also require such other action or agreement by the Optionees as may from time to time be necessary to comply with the federal and state securities laws. THIS PROVISION SHALL NOT OBLIGATE THE COMPANY TO UNDERTAKE REGISTRATION OF THE OPTIONS OR STOCK HEREUNDER. Should any of the Company's capital stock of the same class as the stock subject to Options be listed on a national securities exchange, all stock issued under this Plan if not previously listed on such exchange shall be authorized by that exchange for listing on such exchange prior to the issuance of such stock. 9. Amendment and Termination. This Plan may be amended from time to time as follows: 9.1 Board Action. The Board may at any time suspend, amend or terminate this Plan; provided, that except as set forth in Section 7, the approval of the Company's shareholders is necessary within twelve (12) months before or after the adoption by the Board of any amendment which will: 9.1.1 increase the number of shares which are to be reserved for the issuance of Options; 9.1.2 permit the granting of stock options to a class of persons other than those presently permitted to receive Options; or, 9.1.3 require shareholder approval under applicable law, including Section 16(b) of the Exchange Act. Any amendment made to this Plan which would constitute a "modification" to Incentive Options outstanding on the date of such amendment, shall not be applicable to such outstanding Incentive Options, but shall have prospective effect only, unless the Optionee agrees otherwise. 10. Automatic Termination. Unless sooner terminated by the Board, this Plan shall terminate ten (10) years from the earlier of (i) the date on which this Plan is adopted by the Board or (ii) the date on which this Plan is approved by the shareholders of the Company. No Option may be granted after such termination or during any suspension of this Plan. The amendment or termination of this Plan shall not, without the consent of the option holder, alter or impair any rights or obligations under any option previously granted under this Plan. 11. Effectiveness of This Plan. This Plan shall become effective upon adoption by the Board so long as it is approved by the Company's shareholders any time within twelve (12) months before or after the adoption of this Plan. Page 13 of 14 - STOCK OPTION PLAN EX-10.17 3 EXHIBIT 10.17 Exhibit 10.17 BUSINESS LOAN AGREEMENT Borrower: MACKIE DESIGNS INC. 16220 Woodinville Redmond Road Woodinville, WA 98072 Lender: U.S. BANK NATIONAL ASSOCIATION EKC Corporate Bkg. 10800 NE 8th Street, Suite 1000 Bellevue, WA 98004 THIS BUSINESS LOAN AGREEMENT between MACKIE DESIGNS INC. ("Borrower") and U.S. BANK NATIONAL ASSOCIATION ("Lender") is made and executed on the following terms and conditions. Borrower has received prior commercial loans from Lender or has applied to Lender for a commercial loan or loans and other financial accommodations, including those which may be described on any exhibit or schedule attached to this Agreement. All such loans and financial accommodations, together with all future loans and financial accommodations from Lender to Borrower, are referred to in this Agreement individually as the "Loan" and collectively as the "Loans." Borrower understands and agrees that: (a) in granting, renewing, or extending any Loan, Lender is relying upon Borrower's representations, warranties, and agreements, as set forth in this Agreement; (b) the granting, renewing, or extending of any Loan by Lender at all times shall be subject to Lender's sole judgment and discretion; and (c) all such Loans shall be and shall remain subject to the following terms and conditions of this Agreement. TERM. This Agreement shall be effective as of October 21, 1997, and shall continue thereafter until all Indebtedness of Borrower to Lender has been performed in full and the parties terminate this Agreement in writing. DEFINITIONS. The following words shall have the following meanings when used in this Agreement. Terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code. All references to dollar amounts shall mean amounts in lawful money of the United States of America. Agreement. The word "Agreement" means this Business Loan Agreement, as this Business Loan Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Business Loan Agreement from time to time. Borrower. The word "Borrower" means MACKIE DESIGNS INC. The word "Borrower" also includes, as applicable, all subsidiaries and affiliates of Borrower as provided below in the paragraph titled "Subsidiaries and Affiliates." CERCLA. The word "CERCLA" means the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended. Cash Flow. The words "Cash Flow" mean net income after taxes, and exclusive of extraordinary gains and income, plus depreciation and amortization. Collateral. The word "Collateral" means and includes without limitation all property and assets granted as collateral security for a Loan, whether real or personal property, whether granted directly or 20 indirectly, whether granted now or in the future, and whether granted in the form of a security interest, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien, charge, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. Debt. The word "Debt" means all of Borrower's liabilities excluding Subordinated Debt. ERISA. The word "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. Event of Default. The words "Event of Default" mean and include without limitation any of the Events of Default set forth below in the section titled "EVENTS OF DEFAULT." Grantor. The word "Grantor" means and includes without limitation each and all of the persons or entities granting a Security Interest in any Collateral for the Indebtedness, including without limitation all Borrowers granting such a Security Interest. Guarantor. The word "Guarantor" means and includes without limitation each and all of the guarantors, sureties, and accommodation parties in connection with any Indebtedness. Indebtedness. The word "Indebtedness" means and includes without limitation all Loans, together with all other obligations, debts and liabilities of Borrower to Lender, or any one or more of them, as well as all claims by Lender against Borrower, or any one or more of them; whether now or hereafter existing, voluntary or involuntary, due or not due, absolute or contingent, liquidated or unliquidated; whether Borrower may be liable individually or jointly with others; whether Borrower may be obligated as a guarantor, surety, or otherwise; whether recovery upon such Indebtedness may be or hereafter may become barred by any statute of limitations; and whether such Indebtedness may be or hereafter may become otherwise unenforceable. Lender. The word "Lender" means U.S. BANK NATIONAL ASSOCIATION, its successors and assigns. Liquid Assets. The words "Liquid Assets" mean Borrower's cash on hand plus Borrower's readily marketable securities. Loan. The word "Loan" or "Loans" means and includes without limitation any and all commercial loans and financial accommodations from Lender to Borrower, whether now or hereafter existing, and however evidenced, including without limitation those loans and financial accommodations described herein or described on any exhibit or schedule attached to this Agreement from time to time. Note. The word "Note" means and includes without limitation Borrower's promissory note or notes, if any, evidencing Borrower's Loan obligations in favor of Lender, as well as any substitute, replacement or refinancing note or notes therefor. Permitted Liens. The words "Permitted Liens" mean: (a) liens and security interests securing Indebtedness owed by Borrower to Lender; (b) liens for taxes, assessments, or similar charges either not yet due or being contested in good faith; (c) liens of materialmen, mechanics, warehousemen, or carriers, or other like liens arising in the ordinary course of business and securing obligations which are not yet delinquent; (d) purchase money liens or purchase money security interests upon or in any property acquired or held by Borrower in the ordinary course of business to secure indebtedness outstanding on the date of this Agreement or permitted to be incurred under the paragraph of this 21 Agreement titled "Indebtedness and Liens"; (e) liens and security interests which, as of the date of this Agreement, have been disclosed to and approved by the Lender in writing; and (f) those liens and security interests which in the aggregate constitute an immaterial and insignificant monetary amount with respect to the net value of Borrower's assets. Related Documents. The words "Related Documents" mean and include without limitation all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Indebtedness. Security Agreement. The words "Security Agreement" mean and include without limitation any agreements, promises, covenants, arrangements, understandings or other agreements, whether created by law, contract, or otherwise, evidencing, governing, representing, or creating a Security Interest. Security Interest. The words "Security Interest" mean and include without limitation any type of collateral security, whether in the form of a lien, charge, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. SARA. The word "SARA" means the Superfund Amendments and Reauthorization Act of 1986 as now or hereafter amended. Subordinated Debt. The words "Subordinated Debt" mean indebtedness and liabilities of Borrower which have been subordinated by written agreement to indebtedness owed by Borrower to Lender in form and substance acceptable to Lender. Tangible Net Worth. The words "Tangible Net Worth" mean Borrower's total assets excluding all intangible assets (i.e., goodwill, trademarks, patents, copyrights, organizational expenses, and similar intangible items, but including leaseholds and leasehold improvements) less total Debt. Working Capital. The words "Working Capital" mean Borrower's current assets, excluding prepaid expenses, less Borrower's current liabilities. CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make the initial Loan Advance and each subsequent Loan Advance under this Agreement shall be subject to the fulfillment to Lender's satisfaction of all of the conditions set forth in this Agreement and in the Related Documents. Loan Documents. Borrower shall provide to Lender in form satisfactory to Lender the following documents for the Loan: (a) the Note, (b) Security Agreements granting to Lender security interests in the Collateral, (c) Financing Statements perfecting Lender's Security Interests; (d) evidence of insurance as required below; and (e) any other documents required under this Agreement or by Lender or its counsel. Borrower's Authorization. Borrower shall have provided in form and substance satisfactory to Lender properly certified resolutions, duly authorizing the execution and delivery of this Agreement, the Note and the Related Documents, and such other authorizations and other documents and instruments as Lender or its counsel, in their sole discretion, may require. Payment of Fees and Expenses. Borrower shall have paid to Lender all fees, charges, and other expenses which are then due and payable as specified in this Agreement or any Related Document. 22 Representations and Warranties. The representations and warranties set forth in this Agreement, in the Related Documents, and in any document or certificate delivered to Lender under this Agreement are true and correct. No Event of Default. There shall not exist at the time of any advance a condition which would constitute an Event of Default under this Agreement. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as of the date of this Agreement, as of the date of each disbursement of Loan proceeds, as of the date of any renewal, extension or modification of any Loan, and at all times any Indebtedness exists: Organization. Borrower is a corporation which is duly organized, validly existing, and in good standing under the laws of the state of Borrower's incorporation and is validly existing and in good standing in all states in which Borrower is doing business. Borrower has the full power and authority to own its properties and to transact the businesses in which it is presently engaged or presently proposes to engage. Borrower also is duly qualified as a foreign corporation and is in good standing in all states in which the failure to so qualify would have a material adverse effect on its businesses or financial condition. Authorization. The execution, delivery, and performance of this Agreement and all Related Documents by Borrower, to the extent to be executed, delivered or performed by Borrower, have been duly authorized by all necessary action by Borrower; do not require the consent or approval of any other person, regulatory authority or governmental body; and do not conflict with, result in a violation of, or constitute a default under (a) any provision of its articles of incorporation or organization, or bylaws, or any agreement or other instrument binding upon Borrower or (b) any law, governmental regulation, court decree, or order applicable to Borrower. Financial Information. Each financial statement of Borrower supplied to Lender truly and completely disclosed Borrower's financial condition as of the date of the statement, and there has been no material adverse change in Borrower's financial condition subsequent to the date of the most recent financial statement supplied to Lender. Borrower has no material contingent obligations except as disclosed in such financial statements. Legal Effect. This Agreement constitutes, and any instrument or agreement required hereunder to be given by Borrower when delivered will constitute, legal, valid and binding obligations of Borrower enforceable against Borrower in accordance with their respective terms. Properties. Except as contemplated by this Agreement or as previously disclosed in Borrower's financial statements or in writing to Lender and as accepted by Lender, and except for property tax liens for taxes not presently due and payable, Borrower owns and has good title to all of Borrower's properties free and clear of all Security Interests, and has not executed any security documents or financing statements relating to such properties. All of Borrower's properties are titled in Borrower's legal name, and Borrower has not used, or filed a financing statement under, any other name for at least the last five (5) years. Hazardous Substances. The terms "hazardous waste," "hazardous substance," "disposal," "release," and "threatened release," as used in this Agreement, shall have the same meanings as set forth in the "CERCLA," "SARA," the Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq., the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et seq., or other applicable state or Federal laws, rules, or regulations adopted pursuant to any of the foregoing. Except as disclosed to and acknowledged by Lender in writing, Borrower represents and warrants that: (a) During the period of Borrower's ownership of the properties, there has been no use, generation, manufacture, storage, 23 treatment, disposal, release or threatened release of any hazardous waste or substance by any person on, under, about or from any of the properties. (b) Borrower has no knowledge of, or reason to believe that there has been (i) any use, generation, manufacture, storage, treatment, disposal, release, or threatened release of any hazardous waste or substance on, under, about or from the properties by any prior owners or occupants of any of the properties, or (ii) any actual or threatened litigation or claims of any kind by any person relating to such matters. (c) Neither Borrower nor any tenant, contractor, agent or other authorized user of any of the properties shall use, generate, manufacture, store, treat, dispose of, or release any hazardous waste or substance on, under, about or from any of the properties; and any such activity shall be conducted in compliance with all applicable federal, state, and local laws, regulations, and ordinances, including without limitation those laws, regulations and ordinances described above. Borrower authorizes Lender and its agents to enter upon the properties to make such inspections and tests as Lender may deem appropriate to determine compliance of the properties with this section of the Agreement. Any inspections or tests made by Lender shall be at Borrower's expense and for Lender's purposes only and shall not be construed to create any responsibility or liability on the part of Lender to Borrower or to any other person. The representations and warranties contained herein are based on Borrower's due diligence in investigating the properties for hazardous waste and hazardous substances. Borrower hereby (a) releases and waives any future claims against Lender for indemnity or contribution in the event Borrower becomes liable for cleanup or other costs under any such laws, and (b) agrees to indemnify and hold harmless Lender against any and all claims, losses, liabilities, damages, penalties, and expenses which Lender may directly or indirectly sustain or suffer resulting from a breach of this section of the Agreement or as a consequence of any use, generation, manufacture, storage, disposal, release or threatened release occurring prior to Borrower's ownership or interest in the properties, whether or not the same was or should have been known to Borrower. The provisions of this section of the Agreement, including the obligation to indemnify, shall survive the payment of the Indebtedness and the termination or expiration of this Agreement and shall not be affected by Lender's acquisition of any interest in any of the properties, whether by foreclosure or otherwise. Litigation and Claims. No litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Borrower is pending or threatened, and no other event has occurred which may materially adversely affect Borrower's financial condition or properties, other than litigation, claims, or other events, if any, that have been disclosed to and acknowledged by Lender in writing. Taxes. To the best of Borrower's knowledge, all tax returns and reports of Borrower that are or were required to be filed, have been filed, and all taxes, assessments and other governmental charges have been paid in full, except those presently being or to be contested by Borrower in good faith in the ordinary course of business and for which adequate reserves have been provided. Lien Priority. Unless otherwise previously disclosed to Lender in writing, Borrower has not entered into or granted any Security Agreements, or permitted the filing or attachment of any Security Interests on or affecting any of the Collateral directly or indirectly securing repayment of Borrower's Loan and Note, that would be prior or that may in any way be superior to Lender's Security Interests and rights in and to such Collateral. Binding Effect. This Agreement, the Note, all Security Agreements directly or indirectly securing repayment of Borrower's Loan and Note and all of the Related Documents are binding upon Borrower as well as upon Borrower's successors, representatives and assigns, and are legally enforceable in accordance with their respective terms. Commercial Purposes. Borrower intends to use the Loan proceeds solely for business or commercial related purposes. 24 Employee Benefit Plans. Each employee benefit plan as to which Borrower may have any liability complies in all material respects with all applicable requirements of law and regulations, and (i) no Reportable Event nor Prohibited Transaction (as defined in ERISA) has occurred with respect to any such plan, (ii) Borrower has not withdrawn from any such plan or initiated steps to do so, (iii) no steps have been taken to terminate any such plan, and (iv) there are no unfunded liabilities other than those previously disclosed to Lender in writing. Location of Borrower's Offices and Records. Borrower's place of business, or Borrower's Chief executive office, if Borrower has more than one place of business, is located at 16220 Woodinville Redmond Road, Woodinville, WA 98072. Unless Borrower has designated otherwise in writing this location is also the office or offices where Borrower keeps its records concerning the Collateral. Information. All information heretofore or contemporaneously herewith furnished by Borrower to Lender for the purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all information hereafter furnished by or on behalf of Borrower to Lender will be, true and accurate in every material respect on the date as of which such information is dated or certified; and none of such information is or will be incomplete by omitting to state any material fact necessary to make such information not misleading. Survival of Representations and Warranties. Borrower understands and agrees that Lender, without independent investigation, is relying upon the above representations and warranties in extending Loan Advances to Borrower. Borrower further agrees that the foregoing representations and warranties shall be continuing in nature and shall remain in full force and effect until such time as Borrower's Indebtedness shall be paid in full, or until this Agreement shall be terminated in the manner provided above, whichever is the last to occur. AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, while this Agreement is in effect, Borrower will: Litigation. Promptly inform Lender in writing of (a) all material adverse changes in Borrower's financial condition, and (b) all existing and all threatened litigation, claims, investigations, administrative proceedings or similar actions affecting Borrower or any Guarantor which could materially affect the financial condition of Borrower or the financial condition of any Guarantor. Financial Records. Maintain its books and records in accordance with generally accepted accounting principles, applied on a consistent basis, and permit Lender to examine and audit Borrower's books and records at all reasonable times. Financial Statements. Furnish Lender with, as soon as available, but in no event later than one hundred twenty (120) days after the end of each fiscal year, Borrower's balance sheet and income statement for the year ended, audited by a certified public accountant satisfactory to Lender, and, as soon as available, but in no event later than forty five (45) days after the end of each fiscal quarter, Borrower's balance sheet and profit and loss statement for the period ended, prepared and certified as correct to the best knowledge and belief by Borrower's chief financial officer or other officer or person acceptable to Lender. All financial reports required to be provided under this Agreement shall be prepared in accordance with generally accepted accounting principles, applied on a consistent basis, and certified by Borrower as being true and correct. Additional Information. Furnish such additional information and statements, lists of assets and liabilities, agings of receivables and payables, inventory schedules, budgets, forecasts, tax returns, and other reports with respect to Borrower's financial condition and business operations as Lender may request from time to time. 25 Financial Covenants and Ratios. Comply with the following covenants and ratios: Tangible Net Worth. Maintain a minimum Tangible Net Worth of not less than $28,000,000.00. Net Worth Ratio. Maintain a ratio of Total Liabilities to Tangible Net Worth of less than 0.50 to 1.00. Working Capital. Maintain Working Capital in excess of $20,000,000.00. The following provisions shall apply for purposes of determining compliance with the foregoing financial covenants and ratios: Borrower understands and agrees with Lender that all covenants and ratios will be monitored quarterly for compliance. Except as provided above, all computations made to determine compliance with the requirements contained in this paragraph shall be made in accordance with generally accepted accounting principles, applied on a consistent basis, and certified by Borrower as being true and correct. Insurance. Maintain fire and other risk insurance, public liability insurance, and such other insurance as Lender may require with respect to Borrower's properties and operations, in form, amounts, coverages and with insurance companies reasonably acceptable to Lender. Borrower, upon request of Lender, will deliver to Lender from time to time the policies or certificates of insurance in form satisfactory to Lender, including stipulations that coverages will not be cancelled or diminished without at least ten (10) days' prior written notice to Lender. Each insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Borrower or any other person. In connection with all policies covering assets in which Lender holds or is offered a security interest for the Loans, Borrower will provide Lender with such loss payable or other endorsements as Lender may require. Insurance Reports. Furnish to Lender, upon request of Lender, reports on each existing insurance policy showing such information as Lender may reasonably request, including without limitation the following: (a) the name of the insurer; (b) the risks insured; (c) the amount of the policy; (d) the properties insured; (e) the then current property values on the basis of which insurance has been obtained, and the manner of determining those values; and (f) the expiration date of the policy. In addition, upon request of Lender (however not more often than annually), Borrower will have an independent appraiser satisfactory to Lender determine, as applicable, the actual cash value or replacement cost of any Collateral. The cost of such appraisal shall be paid by Borrower. Other Agreements. Comply with all terms and conditions of all other agreements, whether now or hereafter existing, between Borrower and any other party and notify Lender immediately in writing of any default in connection with any other such agreements. Loan Proceeds. Use all Loan proceeds solely for Borrower's business operations, unless specifically consented to the contrary by Lender in writing. Taxes, Charges and Liens. Pay and discharge when due all of its indebtedness and obligations, including without limitation all assessments, taxes, governmental charges, levies and liens, of every kind and nature, imposed upon Borrower or its properties, income, or profits, prior to the date on which penalties would attach, and all lawful claims that, if unpaid, might become a lien or charge upon any of Borrower's properties, income, or profits. Provided however, Borrower will not be required to pay and discharge any such assessment, tax, charge, levy, lien or claim so long as (a) the legality of the same shall be contested in good faith by appropriate proceedings, and (b) Borrower shall have established on its books adequate reserves with respect to such contested assessment, tax, charge, levy, lien, or claim in 26 accordance with generally accepted accounting practices. Borrower, upon demand of Lender, will furnish to Lender evidence of payment of the assessments, taxes, charges, levies, liens and claims and will authorize the appropriate governmental official to deliver to Lender at any time a written statement of any assessments, taxes, charges, levies, liens and claims against Borrower's properties, income, or profits. Performance. Perform and comply with all terms, conditions, and provisions set forth in this Agreement and in the Related Documents in a timely manner, and promptly notify Lender if Borrower learns of the occurrence of any event which constitutes an Event of Default under this Agreement or under any of the Related Documents. Operations. Maintain executive and management personnel with substantially the same qualifications and experience as the present executive and management personnel; provide written notice to Lender of any change in executive and management personnel; conduct its business affairs in a reasonable and prudent manner and in compliance with all applicable federal, state and municipal laws, ordinances, rules and regulations respecting its properties, charters, businesses and operations, including without limitation, compliance with the Americans With Disabilities Act and with all minimum funding standards and other requirements of ERISA and other laws applicable to Borrower's employee benefit plans. Inspection. Permit employees or agents of Lender at any reasonable time to inspect any and all Collateral for the Loan or Loans and Borrower's other properties and to examine or audit Borrower's books, accounts, and records and to make copies and memoranda of Borrower's books, accounts, and records. If Borrower now or at any time hereafter maintains any records (including without limitation computer generated records and computer software programs for the generation of such records) in the possession of a third party, Borrower, upon request of Lender, shall notify such party to permit Lender free access to such records at all reasonable times and to provide Lender with copies of any records it may request, all at Borrower's expense. Compliance Certificate. Unless waived in writing by Lender, provide Lender (not required) and at the time of each disbursement of Loan proceeds with a certificate executed by Borrower's chief financial officer, or other officer or person acceptable to Lender, certifying that the representations and warranties set forth in this Agreement are true and correct as of the date of the certificate and further certifying that, as of the date of the certificate, no Event of Default exists under this Agreement. Environmental Compliance and Reports. Borrower shall comply in all respects with all environmental protection federal, state and local laws, statutes, regulations and ordinances; not cause or permit to exist, as a result of an intentional or unintentional action or omission on its part or on the part of any third party, on property owned and/or occupied by Borrower, any environmental activity where damage may result to the environment, unless such environmental activity is pursuant to and in compliance with the conditions of a permit issued by the appropriate federal, state or local governmental authorities; shall furnish to Lender promptly and in any event within thirty (30) days after receipt thereof a copy of any notice, summons, lien, citation, directive, letter or other communication from any governmental agency or instrumentality concerning any intentional or unintentional action or omission on Borrower's part in connection with any environmental activity whether or not there is damage to the environment and/or other natural resources. Additional Assurances. Make, execute and deliver to Lender such promissory notes, mortgages, deeds of trust, security agreements, financing statements, instruments, documents and other agreements as Lender or its attorneys may reasonably request to evidence and secure the Loans and to perfect all Security Interests. 27 RECOVERY OF ADDITIONAL COSTS. If the imposition of or any change in any law, rule, regulation or guideline, or the interpretation or application of any thereof by any court or administrative or governmental authority (including any request or policy not having the force of law) shall impose, modify or make applicable any taxes (except U.S. federal, state or local income or franchise taxes imposed on Lender), reserve requirements, capital adequacy requirements or other obligations which would (a) increase the cost to Lender for extending or maintaining the credit facilities to which this Agreement relates, (b) reduce the amounts payable to Lender under this Agreement or the Related Documents, or (c) reduce the rate of return on Lender's capital as a consequence of Lender's obligations with respect to the credit facilities to which this Agreement relates, then Borrower agrees to pay Lender such additional amounts as will compensate Lender therefor, within five (5) days after Lender's written demand for such payment, which demand shall be accompanied by an explanation of such imposition or charge and a calculation in reasonable detail of the additional amounts payable by Borrower, which explanation and calculations shall be conclusive in the absence of manifest error. NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this Agreement is in effect, Borrower shall not, without the prior written consent of Lender: Indebtedness and Liens. (a) Except for trade debt incurred in the normal course of business and indebtedness to Lender contemplated by this Agreement, create, incur or assume indebtedness for borrowed money, including capital leases, (b) except as allowed as a Permitted Lien, sell, transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber any of Borrower's assets, or (c) sell with recourse any of Borrower's accounts, except to Lender. Continuity of Operations. (a) Engage in any business activities substantially different than those in which Borrower is presently engaged, (b) cease operations, liquidate, merge, transfer, acquire or consolidate with any other entity, change ownership, change its name, dissolve or transfer or sell Collateral out of the ordinary course of business, (c) pay any dividends on Borrower's stock (other than dividends payable in its stock), provided, however that notwithstanding the foregoing, but only so long as no Event of Default has occurred and is continuing or would result from the payment of dividends, if Borrower is a "Subchapter S Corporation" (as defined in the Internal Revenue Code of 1986, as amended), Borrower may pay cash dividends on its stock to its shareholders from time to time in amounts necessary to enable the shareholders to pay income taxes and make estimated income tax payments to satisfy their liabilities under federal and state law which arise solely from their status as Shareholders of a Subchapter S Corporation because of their ownership of shares of stock of Borrower, or (d) purchase or retire any of Borrower's outstanding shares or alter or amend Borrower's capital structure. Loans, Acquisitions and Guaranties. (a) Loan, invest in or advance money or assets, (b) purchase, create or acquire any interest in any other enterprise or entity, or (c) incur any obligation as surety or guarantor other than in the ordinary course of business. CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to Borrower, whether under this Agreement or under any other agreement, Lender shall have no obligation to make Loan Advances or to disburse Loan proceeds if: (a) Borrower or any Guarantor is in default under the terms of this Agreement or any of the Related Documents or any other agreement that Borrower or any Guarantor has with Lender; (b) Borrower or any Guarantor becomes insolvent, files a petition in bankruptcy or similar proceedings, or is adjudged a bankrupt; (c) there occurs a material adverse change in Borrower's financial condition, in the financial condition of any Guarantor, or in the value of any Collateral securing any Loan; (d) any Guarantor seeks, claims or otherwise attempts to limit, modify or revoke such Guarantor's guaranty of the Loan or any other loan with Lender; or (e) Lender in good faith deems itself insecure, even though no Event of Default shall have occurred. 28 ACCESS LAWS. Without limiting the generality of any provision of this agreement requiring Borrower to comply with applicable laws, rules, and regulations, Borrower agrees that it will at all times comply with applicable laws relating to disabled access including, but not limited to, all applicable titles of the Americans with Disabilities Act of 1990. STATUTE OF FRAUDS DISCLOSURE. ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO FORBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW. CAPITAL EXPENDITURES. Borrower covenants and agrees with Lender that, while this Agreement is in effect, Borrower shall not make or contract to make capital expenditures, including leasehold improvements, in any fiscal year in excess of $10,000,000.00 or incur liability for rental of property (including both real and personal property) in an amount which, together with capital expenditures, shall in any fiscal year exceed such sum. Capital expenditures shall be measured at each fiscal year end. MULTIPLE PARTIES, CORPORATE AUTHORITY. All obligations of Borrower under this Agreement shall be jointly and several, and all references to Borrower shall mean each and every Borrower. This means that each of the persons signing below is responsible for all obligations in this Agreement. RIGHT OF SETOFF. Borrower grants to Lender a contractual possessory security interest in, and hereby assigns, conveys, delivers, pledges, and transfers to Lender all Borrower's right, title and interest in and to, Borrower's accounts with Lender (whether checking, savings, or some other account), including without limitation all accounts held jointly with someone else and all accounts Borrower may open in the future, excluding however all IRA and Keogh accounts, and all trust accounts for which the grant of a security interest would be prohibited by law. Borrower authorizes Lender, to the extent permitted by applicable law, to charge or setoff all sums owing on the Indebtedness against any and all such accounts. EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: Default on Indebtedness. Failure of Borrower to make any payment when due on the Loans. Other Defaults. Failure of Borrower or any Grantor to comply with or to perform when due any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents, or failure of Borrower to comply with or to perform any other term, obligation, covenant or condition contained in any other agreement between Lender and Borrower. Default in Favor of Third Parties. Should Borrower or any Grantor default under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's or any Grantor's ability to repay the Loans or perform their respective obligations under this Agreement or any of the Related Documents. False Statements. Any warranty, representation or statement made or furnished to Lender by or on behalf of Borrower or any Grantor under this Agreement or the Related Documents is false or misleading in any material respect at the time made or furnished, or becomes false or misleading at any time thereafter. Defective Collateralization. This Agreement or any of the Related Documents ceases to be in full force and effect (including failure of any Security Agreement to create a valid and perfected Security Interest) at any time and for any reason. 29 Insolvency. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower. Creditor or Forfeiture Proceedings. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self-help, repossession or any other method, by any creditor of Borrower, any creditor of any Grantor against any collateral securing the Indebtedness, or by any governmental agency. This includes a garnishment, attachment, or levy on or of any of Borrower's deposit accounts with Lender. Events Affecting Guarantor. Any of the preceding events occurs with respect to any Guarantor of any of the Indebtedness or any Guarantor dies or becomes incompetent, or revokes or disputes the validity of, or liability under, any Guaranty of the Indebtedness. Change In Ownership. Any change in ownership of twenty-five percent (25%) or more of the common stock of Borrower. Adverse Change. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the Indebtedness is impaired. Insecurity. Lender, in good faith, deems itself insecure. EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where otherwise provided in this Agreement or the Related Documents, all commitments and obligations of Lender under this Agreement or the Related Documents or any other agreement immediately will terminate (including any obligation to make Loan Advances or disbursements), and, at Lender's option, all Indebtedness immediately will become due and payable, all without notice of any kind to Borrower, except that in the case of an Event of Default of the type described in the "Insolvency" subsection above, such acceleration shall be automatic and not optional. In addition, Lender shall have all the rights and remedies provided in the Related Documents or available at law, in equity, or otherwise. Except as may be prohibited by applicable law, all of Lender's rights and remedies shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Borrower or of any Grantor shall not affect Lender's right to declare a default and to exercise its rights and remedies. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Agreement: Amendments. This Agreement, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to this Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. Applicable Law. This Agreement has been delivered to Lender and accepted by Lender in the State of Washington. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of King County, the State of Washington. Subject to the provisions on arbitration, this Agreement shall be governed by and construed in accordance with the laws of the State of Washington. Arbitration. Lender and Borrower agree that all disputes, claims and controversies between them, whether individual, joint, or class in nature, arising from this Agreement or otherwise, 30 including without limitation contract and tort disputes, shall be arbitrated pursuant to the Rules of the American Arbitration Association, upon request of either party. No act to take or dispose of any Collateral shall constitute a waiver of this arbitration agreement or be prohibited by this arbitration agreement. This includes, without limitation, obtaining injunctive relief or a temporary restraining order; invoking a power of sale under any deed of trust or mortgage; obtaining a writ of attachment or imposition of a receiver; or exercising any rights relating to personal property, including taking or disposing of such property with or without judicial process pursuant to Article 9 of the Uniform Commercial Code. Any disputes, claims, or controversies concerning the lawfulness or reasonableness of any act, or exercise of any right, concerning any Collateral, including any claim to rescind, reform, or otherwise modify any agreement relating to the Collateral, shall also be arbitrated, provided however that no arbitrator shall have the right or the power to enjoin or restrain any act of any party. Judgment upon any award rendered by any arbitrator may be entered in any court having jurisdiction. Nothing in this Agreement shall preclude any party from seeking equitable relief from a court of competent jurisdiction. The statute of limitations, estoppel, waiver, laches, and similar doctrines which would otherwise be applicable in an action brought by a party shall be applicable in any arbitration proceeding, and the commencement of an arbitration proceeding shall be deemed the commencement of an action for these purposes. The Federal Arbitration Act shall apply to the construction, interpretation, and enforcement of this arbitration provision. Caption Headings. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement. Consent to Loan Participation. Borrower agrees and consents to Lender's sale or transfer, whether now or later, of one or more participation interests in the Loans to one or more purchasers, whether related or unrelated to Lender. Lender may provide, without any limitation whatsoever, to any one or more purchasers, or potential purchasers, any information or knowledge Lender may have about Borrower or about any other matter relating to the Loan, and Borrower hereby waives any rights to privacy it may have with respect to such matters. Borrower additionally waives any and all notices of sale of participation interests, as well as all notices of any repurchase of such participation interests. Borrower also agrees that the purchasers of any such participation interests will be considered as the absolute owners of such interests in the Loans and will have all the rights granted under the participation agreement or agreements governing the sale of such participation interests. Borrower further waives all rights of offset or counterclaim that it may have now or later against Lender or against any purchaser of such a participation interest and unconditionally agrees that either Lender or such purchaser may enforce Borrower's obligation under the Loans irrespective of the failure or insolvency of any holder of any interest in the Loans. Borrower further agrees that the purchaser of any such participation interests may enforce its interests irrespective of any personal claims or defenses that Borrower may have against Lender. Costs and Expenses. Borrower agrees to pay upon demand all of Lender's expenses, including without limitation attorneys' fees, incurred in connection with the preparation, execution, enforcement, modification and collection of this Agreement or in connection with the Loans made pursuant to this Agreement. Lender may pay someone else to help collect the Loans and to enforce this Agreement, and Borrower will pay that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses, whether or not there is a lawsuit, including attorneys' fees for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Borrower also will pay any court costs, in addition to all other sums provided by law. Notices. All notices required to be given under this Agreement shall be given in writing, may be sent by telefacsimile (unless otherwise required by law), and shall be effective when actually delivered or when deposited with a nationally recognized overnight courier or deposited in the United States mail, 31 first class, postage prepaid, addressed to the party to whom the notice is to be given at the address shown above. Any party may change its address for notices under this Agreement by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. To the extent permitted by applicable law, if there is more than one Borrower, notice to any Borrower will constitute notice to all Borrowers. For notice purposes, Borrower will keep Lender informed at all times of Borrower's current address(es). Severability. If a court of competent jurisdiction finds any provision of this Agreement to be invalid or unenforceable as to any person or circumstance, such finding shall not render that provision invalid or unenforceable as to any other persons or circumstances. If feasible, any such offending provision shall be deemed to be modified to be within the limits of enforceability or validity; however, if the offending provision cannot be so modified, it shall be stricken and all other provisions of this Agreement in all other respects shall remain valid and enforceable. Subsidiaries and Affiliates of Borrower. To the extent the context of any provisions of this Agreement makes it appropriate, including without limitation any representation, warranty or covenant, the word "Borrower" as used herein shall include all subsidiaries and affiliates of Borrower. Notwithstanding the foregoing however, under no circumstances shall this Agreement be construed to require Lender to make any Loan or other financial accommodation to any subsidiary or affiliate of Borrower. Successors and Assigns. All covenants and agreements contained by or on behalf of Borrower shall bind its successors and assigns and shall inure to the benefit of Lender, its successors and assigns. Borrower shall not, however, have the right to assign its rights under this Agreement or any interest therein, without the prior written consent of Lender. Survival. All warranties, representations, and covenants made by Borrower in this Agreement or in any certificate or other instrument delivered by Borrower to Lender under this Agreement shall be considered to have been relied upon by Lender and will survive the making of the Loan and delivery to Lender of the Related Documents, regardless of any investigation made by Lender or on Lender's behalf. Waiver. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Borrower, or between Lender and any Grantor, shall constitute a waiver of any of Lender's rights or of any obligations of Borrower or of any Grantor as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent in subsequent instances where such consent is required, and in all cases such consent may be granted or withheld in the sole discretion of Lender. BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN AGREEMENT, AND BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF OCTOBER 21, 1997. BORROWER: MACKIE DESIGNS INC. 32 By: /s/ William A. Garrard ------------------------------- Title: CFO ---------------------------- LENDER: U.S. BANK NATIONAL ASSOCIATION By: /s/ Ann B. Caldwell ------------------------------- Authorized Officer 33 EX-10.18 4 EXHIBIT 10.18 Exhibit 10.18 ALTERNATIVE RATE OPTIONS PROMISSORY NOTE (PRIME RATE, LIBOR) $5,000,000.00 Dated as of: OCTOBER 21, 1997 MACKIE DESIGNS, INC. ("Borrower") U.S. BANK NATIONAL ASSOCIATION ("Lender") 1. TYPE OF CREDIT. This note is given to evidence Borrower's obligation to repay all sums which Lender may from time to time advance to Borrower ("Advances") under a: / / single disbursement loan. Amounts loaned to Borrower hereunder will be disbursed in a single Advance in the amount shown in Section 2. /X/ revolving line of credit. No Advances shall be made which create a maximum amount outstanding at any one time which exceeds the maximum amount shown in Section 2. However, Advances hereunder may be borrowed, repaid and reborrowed, and the aggregate Advances loaned hereunder from time to time may exceed such maximum amount. / / non-revolving line of credit. Each Advance made from time to time hereunder shall reduce the maximum amount available shown in Section 2. Advances loaned hereunder which are repaid may not be reborrowed. 2. PRINCIPAL BALANCE. The unpaid principal balance of all Advances outstanding under this note ("Principal Balance") at one time shall not exceed $5,000,000.00. 3. PROMISE TO PAY. For value received Borrower promises to pay to Lender or order at 10800 NORTHEAST 8TH STREET, SUITE 1000, BELLEVUE, WA 98004 the Principal Balance of this note, with interest thereon at the rate(s) specified in Sections 4 and 11 below. 4. INTEREST RATE. The interest rate on the Principal Balance outstanding may vary from time to time pursuant to the provisions of this note. Subject to the provisions of this note, Borrower shall have the option from time to time of choosing to pay interest at the rate or rates and for the applicable periods of time based on the rate options provided herein; provided, however, that once Borrower notifies Lender of the rate option chosen in accordance with the provisions of this note, such notice shall be irrevocable. The rate options are the Prime Borrowing Rate and the LIBOR Borrowing Rate, each as defined herein. (a) Definitions. The following terms shall have the following meanings: "Business Day" means any day other than a Saturday, Sunday, or other day that commercial banks in Seattle, Washington, Portland, Oregon or New York City are authorized or required by law to close; provided, however that when used in connection with a LIBOR Rate, LIBOR Amount or LIBOR Interest Period such term shall also exclude any day on which dealings in U.S. dollar deposits are not carried on in the London interbank market. "LIBOR Amount" means each principal amount for which Borrower chooses to have the LIBOR Borrowing Rate apply for any specified LIBOR Interest Period. 34 "LIBOR Interest Period" means as to any LIBOR Amount, a period of 1, 2, 3, 6, 9 OR 12 months commencing on the date the LIBOR Borrowing Rate becomes applicable thereto; provided, however, that: (i) the first day of each LIBOR Interest Period must be a Business Day; (ii) no LIBOR Interest Period shall be selected which would extend beyond APRIL 30, 1998; (iii) no LIBOR Interest Period shall extend beyond the date of any principal payment required under Section 6 of this note, unless the sum of the Prime Rate Amount, plus LIBOR Amounts with LIBOR Interest Periods ending on or before the scheduled date of such principal payment, plus principal amounts remaining unborrowed under a line of credit, equals or exceeds the amount of such principal payment; (iv) any LIBOR Interest Period which would otherwise expire on a day which is not a Business Day, shall be extended to the next succeeding Business Day, unless the result of such extension would be to extend such LIBOR Interest Period into another calendar month, in which event the LIBOR Interest Period shall end on the immediately preceding Business Day; and (v) any LIBOR Interest Period that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such LIBOR Interest Period) shall end on the last Business Day of a calendar month. "LIBOR Rate" means, for any LIBOR Interest Period, the rate per annum (computed on the basis of a 360-day year and the actual number of days elapsed and rounded upward to the nearest 1/16 of 1%) established by Lender as its LIBOR Rate, based on Lender's determination, on the basis of such factors as Lender deems relevant, of the rate of interest at which U.S. dollar deposits would be offered to U. S. Bank National Association in the London interbank market at approximately 11 a.m. London time on the date which is two Business Days prior to the first day of such LIBOR Interest Period for delivery on the first day of such LIBOR Interest Period for the number of months therein; provided, however, that the LIBOR Rate shall be adjusted to take into account the maximum reserves required to be maintained for Eurocurrency liabilities by banks during each such LIBOR Interest Period as specified in Regulation D of the Board of Governors of the Federal Reserve System or any successor regulation. "Prime Rate" means the rate of interest which Lender from time to time establishes as its prime rate and is not, for example, the lowest rate of interest which Lender collects from any borrower or class of borrowers. When the Prime Rate is applicable under Section 4(b) or 11(b), the interest rate hereunder shall be adjusted without notice effective on the day the Prime Rate changes, but in no event shall the rate of interest be higher than allowed by law. "Prime Rate Amount" means any portion of the Principal Balance bearing interest at the Prime Borrowing Rate. (b) The Prime Borrowing Rate. (i) The Prime Borrowing Rate is a per annum rate equal to the Prime Rate plus 0.00% per annum. (ii) Whenever Borrower desires to use the Prime Borrowing Rate option, Borrower shall give Lender notice orally or in writing in accordance with Section 15 of this note, which notice shall specify the requested effective date (which must be a Business Day) and principal amount of the Advance or increase in the Prime Rate Amount, and whether Borrower is requesting a new Advance under a line of credit or conversion of a LIBOR Amount to the Prime Borrowing Rate. (iii) Subject to Section 11 of this note, interest shall accrue on the unpaid Principal Balance at the Prime Borrowing Rate unless and except to the extent that the LIBOR Borrowing Rate is in effect. (c) The LIBOR Borrowing Rate. (i) The LIBOR Borrowing Rate is the LIBOR Rate plus 1.50% per annum. 35 (ii) Borrower may obtain LIBOR Borrowing Rate quotes from Lender between 8:00 a.m. and 10:00 a.m. (Portland, Oregon time) on any Business Day. Borrower may request an Advance, conversion of any portion of the Prime Rate Amount to a LIBOR Amount or a new LIBOR Interest Period for an existing LIBOR Amount, at such rate only by giving Lender notice in accordance with Section 4(c)(iii) before 10:00 a.m. (Portland, Oregon time) on such day. iii) Whenever Borrower desires to use the LIBOR Borrowing Rate option, Borrower shall give Lender irrevocable notice (either in writing or orally and promptly confirmed in writing) between 8:00 a.m. and 10:00 a.m. (Portland, Oregon time) two (2) Business Days prior to the desired effective date of such rate. Any oral notice shall be given by, and any written notice or confirmation of an oral notice shall be signed by, the person(s) authorized in Section 15 of this note, and shall specify the requested effective date of the rate, LIBOR Interest Period and LIBOR Amount, and whether Borrower is requesting a new Advance at the LIBOR Borrowing Rate under a line of credit, conversion of all or any portion of the Prime Rate Amount to a LIBOR Amount, or a new LIBOR Interest Period for an outstanding LIBOR Amount. Notwithstanding any other term of this note, Borrower may elect the LIBOR Borrowing Rate in the minimum principal amount of $1,000,000.00 and in multiples of $500,000.00 above such amount; provided, however, that no more than THREE separate LIBOR Interest Periods may be in effect at any one time. (iv) If at any time the LIBOR Rate is unascertainable or unavailable to Lender or if LIBOR Rate loans become unlawful, the option to select the LIBOR Borrowing Rate shall terminate immediately. If the LIBOR Borrowing Rate is then in effect, (A) it shall terminate automatically with respect to all LIBOR Amounts (i) on the last day of each then applicable LIBOR Interest Period, if Lender may lawfully continue to maintain such loans, or (ii) immediately if Lender may not lawfully continue to maintain such loans through such day, and (B) subject to Section 11, the Prime Borrowing Rate automatically shall become effective as to such amounts upon such termination. (v) If at any time after the date hereof (A) any revision in or adoption of any applicable law, rule, or regulation or in the interpretation or administration thereof (i) shall subject Lender or its Eurodollar lending office to any tax, duty, or other charge, or change the basis of taxation of payments to Lender with respect to any loans bearing interest based on the LIBOR Rate, or (ii) shall impose or modify any reserve, insurance, special deposit, or similar requirements against assets of, deposits with or for the account of, or credit extended by Lender or its Eurodollar lending office, or impose on Lender or its Eurodollar lending office any other condition affecting any such loans, and (B) the result of any of the foregoing is (i) to increase the cost to Lender of making or maintaining any such loans or (ii) to reduce the amount of any sum receivable under this note by Lender or its Eurodollar lending office, Borrower shall pay Lender within 15 days after demand by Lender such additional amount as will compensate Lender for such increased cost or reduction. The determination hereunder by Lender of such additional amount shall be conclusive in the absence of manifest error. If Lender demands compensation under this Section 4(c)(v), Borrower may upon three (3) Business Days' notice to Lender pay the accrued interest on all LIBOR Amounts, together with any additional amounts payable under Section 4(c)(vi). Subject to Section 11, upon Borrower's paying such accrued interest and additional costs, the Prime Borrowing Rate immediately shall be effective with respect to the unpaid principal balance of such LIBOR Amounts. (vi) Borrower shall pay to Lender, on demand, such amount as Lender reasonably determines (determined as though 100% of the applicable LIBOR Amount had been funded in the London interbank market) is necessary to compensate Lender for any direct or indirect losses, expenses, liabilities, costs, expenses or reductions in yield to Lender, whether incurred in connection with liquidation or re-employment of funds or otherwise, incurred or sustained by Lender as a result of: (A) Any payment or prepayment of a LIBOR Amount, termination of the LIBOR Borrowing Rate or conversion of a LIBOR Amount to the Prime Borrowing Rate on a day other than the last day of the applicable LIBOR Interest 36 Period (including as a result of acceleration or a notice pursuant to Section 4 (c) (v)); or (B) Any failure of Borrower to borrow, continue or prepay any LIBOR Amount or to convert any portion of the Prime Rate Amount to a LIBOR Amount after Borrower has given a notice thereof to Lender. (vii) If Borrower chooses the LIBOR Borrowing Rate, Borrower shall pay interest based on such rate, plus any other applicable taxes or charges hereunder, even though Lender may have obtained the funds loaned to Borrower from sources other than the London interbank market. Lender's determination of the LIBOR Borrowing Rate and any such taxes or charges shall be conclusive in the absence of manifest error. (viii) Notwithstanding any other term of this note, Borrower may not select the LIBOR Borrowing Rate if an event of default hereunder has occurred and is continuing. (ix) Nothing contained in this note, including without limitation the determination of any LIBOR Interest Period or Lender's quotation of any LIBOR Borrowing Rate, shall be construed to prejudice Lender's right, if any, to decline to make any requested Advance or to require payment on demand. 5. COMPUTATION OF INTEREST. All interest under Section 4 and Section 11 will be computed at the applicable rate based on a 360-day year and applied to the actual number of days elapsed. 6. PAYMENT SCHEDULE. (a) Principal. Principal shall be paid: / / on demand. /X/ on demand, or if no demand, on APRIL 30, 1998. / / on , / / subject to Section 8, in installments of / / each, plus accrued interest, beginning on and on the same day of each thereafter until when the entire Principal Balance plus interest thereon shall be due and payable. / / each, including accrued interest, beginning on and on the same day of each thereafter until when the entire Principal Balance plus interest thereon shall be due and payable. (b) Interest. (i) Interest on the Prime Rate Amount shall be paid: /X/ on the LAST day of NOVEMBER, 1997, and on the same day of each MONTH thereafter prior to maturity and at maturity. / / at maturity. / / at the time each principal installment is due and at maturity. / / (ii) Interest on all LIBOR Amounts shall be paid: / / on the last day of the applicable LIBOR Interest Period, and if such LIBOR Interest Period is longer than three months, on the last day of each three month period occurring during such LIBOR Interest Period, and at maturity. 37 /X/ on the LAST day of NOVEMBER, 1997, and on the same day of each MONTH thereafter prior to maturity and at maturity. / / at maturity. / / at the time each principal installment is due and at maturity. / / 7. PREPAYMENT. (a) Prepayments of all or any part of the Prime Rate Amount may be made at any time without penalty. (b) Except as otherwise specifically set forth herein, Borrower may not prepay all or any part of any LIBOR Amount or terminate any LIBOR Borrowing Rate, except on the last day of the applicable LIBOR Interest Period. (c) Principal prepayments will not postpone the date of or change the amount of any regularly scheduled payment. At the time of any principal prepayment, all accrued interest, fees, costs and expenses shall also be paid. 8. CHANGE IN PAYMENT AMOUNT. Each time the interest rate on this note changes the holder of this note may, from time to time, in holder's sole discretion, increase or decrease the amount of each of the installments remaining unpaid at the time of such change in rate to an amount holder in its sole discretion deems necessary to continue amortizing the Principal Balance at the same rate established by the installment amounts specified in Section 6(a), whether or not a "balloon" payment may also be due upon maturity of this note. Holder shall notify the undersigned of each such change in writing. Whether or not the installment amount is increased under this Section 8, Borrower understands that, as a result of increases in the rate of interest the final payment due, whether or not a "balloon" payment, shall include the entire Principal Balance and interest thereon then outstanding, and may be substantially more than the installment specified in Section 6. 9. ALTERNATE PAYMENT DATE. Notwithstanding any other term of this note, if in any month there is no day on which a scheduled payment would otherwise be due (e.g. February 31), such payment shall be paid on the last banking day of that month. 10. PAYMENT BY AUTOMATIC DEBIT. /X/ Borrower hereby authorizes Lender to automatically deduct the amount of all principal and interest payments from account number at 2087-029847. If there are insufficient funds in the account to pay the automatic deduction in full, Lender may allow the account to become overdrawn, or Lender may reverse the automatic deduction. Borrower will pay all the fees on the account which result from the automatic deductions, including any overdraft and non-sufficient funds charges. If for any reason Lender does not charge the account for a payment, or if an automatic payment is reversed, the payment is still due according to this note. If the account is a Money Market Account, the number of withdrawals from that account is limited as set out in the account agreement. Lender may cancel the automatic deduction at any time in its discretion. Provided, however, if no account number is entered above, Borrower does not want to make payments by automatic debit. 11. DEFAULT. 38 (a) Without prejudice to any right of Lender to require payment on demand or to decline to make any requested Advance, each of the following shall be an event of default: (i) Borrower fails to make any payment when due. (ii) Borrower fails to perform or comply with any term, covenant or obligation in this note or any agreement related to this note, or in any other agreement or loan Borrower has with Lender. (iii) Borrower defaults under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's ability to repay this note or perform Borrower's obligations under this note or any related documents. (iv) Any representation or statement made or furnished to Lender by Borrower or on Borrower's behalf is false or misleading in any material respect either now or at the time made or furnished. (v) Borrower dies, becomes insolvent, liquidates or dissolves, a receiver is appointed for any part of Borrower's property, Borrower makes an assignment for the benefit of creditors, or any proceeding is commenced either by Borrower or against Borrower under any bankruptcy or insolvency laws. (vi) Any creditor tries to take any of Borrower's property on or in which Lender has a lien or security interest. This includes a garnishment of any of Borrower's accounts with Lender. (vii) Any of the events described in this default section occurs with respect to any general partner in Borrower or any guarantor of this note, or any guaranty of Borrower's indebtedness to Lender ceases to be, or is asserted not to be, in full force and effect. (viii) There is any material adverse change in the financial condition or management of Borrower or Lender in good faith deems itself insecure with respect to the payment or performance of Borrower's obligations to Lender. If this note is payable on demand, the inclusion of specific events of default shall not prejudice Lender's right to require payment on demand or to decline to make any requested Advance. (b) Without prejudice to any right of Lender to require payment on demand, upon the occurrence of an event of default, Lender may declare the entire unpaid Principal Balance on this note and all accrued unpaid interest immediately due and payable, without notice. Upon default, including failure to pay upon final maturity, Lender, at its option, may also, if permitted under applicable law, increase the interest rate on this note to a rate equal to the Prime Borrowing Rate plus 5%. The interest rate will not exceed the maximum rate permitted by applicable law. In addition, if any payment of principal or interest is 15 or more days past due, Borrower will be charged a late charge of 5% of the delinquent payment. 12. EVIDENCE OF PRINCIPAL BALANCE; PAYMENT ON DEMAND. Holder's records shall, at any time, be conclusive evidence of the unpaid Principal Balance and interest owing on this note. Notwithstanding any other provisions of this note, in the event holder makes Advances hereunder which result in an unpaid Principal Balance on this note which at any time exceeds the maximum amount specified in Section 2, Borrower agrees that all such Advances, with interest, shall be payable on demand. 13. LINE OF CREDIT PROVISIONS. If the type of credit indicated in Section 1 is a revolving line of credit or a non-revolving line of credit, Borrower agrees that Lender is under no obligation and has not committed to make any Advances hereunder. Each Advance hereunder shall be made at the sole option of Lender. 14. DEMAND NOTE. If this note is payable on demand, Borrower acknowledges and agrees that (a) Lender is entitled to demand Borrower's immediate payment in full of all amounts owing hereunder and (b) neither anything to the contrary contained herein or in any other loan documents (including but not limited to, provisions relating to defaults, rights of cure, default rate of interest, installment payments, late charges, periodic review of Borrower's financial condition, and covenants) nor any act of Lender pursuant to any such provisions shall limit or impair Lender's right or ability to require Borrower's payment in full of all amounts owing hereunder immediately upon Lender's demand. 15. REQUESTS FOR ADVANCES. 39 (a) Any Advance may be made or interest rate option selected upon the request of Borrower (if an individual), any of the undersigned (if Borrower consists of more than one individual), any person or persons authorized in subsection (b) of this Section 15, and any person or persons otherwise authorized to execute and deliver promissory notes to Lender on behalf of Borrower. (b) Borrower hereby authorizes any ONE of the following individuals to request Advances and to select interest rate options: GREG C. MACKIE, ROY WEMYSS AND WILLIAM A GARRARD unless Lender is otherwise instructed in writing. (c) All Advances shall be disbursed by deposit directly to Borrower's account number 0287-029847 at a branch of Lender, or by cashier's check issued to Borrower. (d) Borrower agrees that Lender shall have no obligation to verify the identity of any person making any request pursuant to this Section 15, and Borrower assumes all risks of the validity and authorization of such requests. In consideration of Lender agreeing, at its sole discretion, to make Advances upon such requests, Borrower promises to pay holder, in accordance with the provisions of this note, the Principal Balance together with interest thereon and other sums due hereunder, although any Advances may have been requested by a person or persons not authorized to do so. 16. PERIODIC REVIEW. Lender will review Borrower's credit accommodations periodically. At the time of the review, Borrower will furnish Lender with any additional information regarding Borrower's financial condition and business operations that Lender requests. This information may include but is not limited to, financial statements, tax returns, lists of assets and liabilities, agings of receivables and payables, inventory schedules, budgets and forecasts. If upon review, Lender, in its sole discretion, determines that there has been a material adverse change in Borrower's financial condition, Borrower will be in default. Upon default, Lender shall have all rights specified herein. 17. NOTICES. Any notice hereunder may be given by ordinary mail, postage paid and addressed to Borrower at the last known address of Borrower as shown on holder's records. If Borrower consists of more than one person, notification of any of said persons shall be complete notification of all. 18. ATTORNEY FEES. Whether or not litigation or arbitration is commenced, Borrower promises to pay all costs of collecting overdue amounts. Without limiting the foregoing, in the event that holder consults an attorney regarding the enforcement of any of its rights under this note or any document securing the same, or if this note is placed in the hands of an attorney for collection or if suit or litigation is brought to enforce this note or any document securing the same, Borrower promises to pay all costs thereof including such additional sums as the court or arbitrator(s) may adjudge reasonable as attorney fees, including without limitation, costs and attorney fees incurred in any appellate court, in any proceeding under the bankruptcy code, or in any receivership and post-judgment attorney fees incurred in enforcing any judgment. 19. WAIVERS; CONSENT. Each party hereto, whether maker, co-maker, guarantor or otherwise, waives diligence, demand, presentment for payment, notice of non-payment, protest and notice of protest and waives all defenses based on suretyship or impairment of collateral. Without notice to Borrower and without diminishing or affecting Lender's rights or Borrower's obligations hereunder, Lender may deal in any manner with any person who at any time is liable for, or provides any real or personal property collateral for, any indebtedness of Borrower to Lender, including the indebtedness evidenced by this note. Without limiting the foregoing, Lender may, in its sole discretion: (a) make secured or unsecured loans to Borrower and agree to any number of waivers, modifications, extensions and renewals of any length of such loans, including the loan evidenced by this note; (b) impair, release (with or without substitution of new collateral), fail to perfect a security interest in, fail to preserve the value of, fail to 40 dispose of in accordance with applicable law, any collateral provided by any person; (c) sue, fail to sue, agree not to sue, release, and settle or compromise with, any person. 20. JOINT AND SEVERAL LIABILITY. All undertakings of the undersigned Borrowers are joint and several and are binding upon any marital community of which any of the undersigned are members. Holder's rights and remedies under this note shall be cumulative. 21. SEVERABILITY. If any term or provision of this note is declared by a court of competent jurisdiction to be illegal, invalid or unenforceable for any reason whatsoever, such illegality, invalidity or unenforceability shall not affect the balance of the terms and provisions hereof, which terms and provisions shall remain binding and enforceable, and this note shall be construed as if such illegal, invalid or unenforceable provision had not been contained herein. 22. ARBITRATION. (a) Either Lender or Borrower may require that all disputes, claims, counterclaims and defenses, including those based on or arising from any alleged tort ("Claims") relating in any way to this note or any transaction of which this note is a part (the "Loan"), be settled by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association and Title 9 of the U.S. Code. All Claims will be subject to the statutes of limitation applicable if they were litigated. This provision is void if the Loan, at the time of the proposed submission to arbitration, is secured by real property located outside of Oregon or Washington, or if the effect of the arbitration procedure (as opposed to any Claims of Borrower) would be to materially impair Lender's ability to realize on any collateral securing the Loan. (b) If arbitration occurs and each party's Claim is less than $100,000, one neutral arbitrator will decide all issues; if any party's Claim is $100,000 or more, three neutral arbitrators will decide all issues. All arbitrators will be active Washington State Bar members in good standing. All arbitration hearings will be held in Seattle, Washington. In addition to all other powers, the arbitrator(s) shall have the exclusive right to determine all issues of arbitrability. Judgment on any arbitration award may be entered in any court with jurisdiction. (c) If either party institutes any judicial proceeding relating to the Loan, such action shall not be a waiver of the right to submit any Claim to arbitration. In addition, each has the right before, during and after any arbitration to exercise any number of the following remedies, in any order or concurrently: (i) setoff; (ii) self-help repossession; (iii) judicial or non-judicial foreclosure against real or personal property collateral; and (iv) provisional remedies, including injunction, appointment of receiver, attachment, claim and delivery and replevin. 23. GOVERNING LAW. This note shall be governed by and construed and enforced in accordance with the laws of the State of Washington without regard to conflicts of law principles; provided, however, that to the extent that Lender has greater rights or remedies under Federal law, this provision shall not be deemed to deprive Lender of such rights and remedies as may be available under Federal law. 24. DISCLOSURE. Oral agreements or oral commitments to loan money, extend credit, or to forbear from enforcing repayment of a debt are not enforceable under Washington law. EACH OF THE UNDERSIGNED HEREBY ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THIS DOCUMENT. 41 BORROWER: MACKIE DESIGNS, INC. BY: /s/ William A. Garrard ----------------------------------- TITLE: CFO ----------------------------------- - ------------------------------------------------------------------------------- For valuable consideration, Lender agrees to the terms of the arbitration provision set forth in this note. Lender Name: U.S. Bank National Association By: /s/ Ann B. Caldwell -------------------------------------- Title: Vice President -------------------------------------- 42 EX-13.1 5 EXHIBIT 13.1 Exhibit 13.1 MACKIE DESIGNS GOES DIGITAL 1997 ANNUAL SHAREHOLDERS' REPORT Cover: a) Photo of Mackie Digital 8-Bus with computer attachments. 43 Page 1: We make electronic systems used in professional audio applications. In fact, when you hear sound, you're probably hearing Mackie Designs. We make products that are absolutely essential to creating electronic media: TV, radio, film, albums, Internet sound-plus every possible kind of live event from concerts to conferences, from Broadway musicals to church services. With leading-edge product design and aggressive marketing, we've won a significant market share in the United States and a respectable share overseas. Our potential market is as big as the world demand for DVDs, compact discs, cassettes, broadcast media, CD-ROMs, video games, streaming web audio & every sort of live event. 44 Page 2: Our core products are mixers. a) Photo of studio This is a typical media studio for producing TV soundtracks, commercials, pop albums, rock videos and CD-ROM motion graphics. Note the presence of two Mackie Designs mixers. b) Photo of SR32-4 and SR24-4. The looming, upside down mixers are our SR32-4 and SR24-4. Although designed for live performances, they are also popular for recording projects. c) Graph of Mackie's Core Products, the Non-Powered Mixer Market d) Graph of Mackie's New and Future Markets in Millions e) Graph of Current and New Products Market Growth in Millions Source: 1997 Statistical Review of the U.S. Music Products Industry. Published by NAMM International Music Products Association. f) Photo of two awards won by the CR1604VLZ mixer: the 1997 Music & Sound Retailer magazine award for Best New Mixer/Console of the Year, and Musician Magazine's Editor's pick award. Above: Although our workhorse CR1604-VLZ mixer is not a new product, it keeps gaining in popularity. Above are two of the four awards it won in 1997 alone. One of them is especially coveted because it is nominated and selected by balloting among U.S. pro audio retailers. g) Photo of Butch Vig Above right: If you don't recognize the rock star posed with his 8-Bus in the top photo, your kids probably do. He's Butch Vig, producer extraordinaire and member of the band Garbage. Our analog 8-Bus was one of the first affordable consoles to produce top pop albums by famous groups. It's a mainstay in recording studios all over the world. h) Photo of Mackie's CR1604-VLZ, MS1402VLZ, and MS1202-VLZ. At right: Our compact mixer line. Our CR1604-VLZ, MS1402-VLZ, and MS1202-VLZ primarily differ by the number of microphones and other sound devices that you can plug into them. Suggested U.S. retail prices range from $429 to $1,199. These are the mixers that you find everywhere from middle schools and corporate boardrooms to network football feeds and Olympic broadcasts. They are ubiquitous in video editing suites, and produce a surprising number of the music soundtracks you hear on major TV shows. Other less obvious users include NASA, Jet Propulsion Laboratory, dozens of U.S. embassies, the Reagan Library, MIT and Cal Tech. Most importantly, they can be readily purchased by anyone who wishes to do their own recording or public performing. This vast audience of aspiring composers and performers dwarfs all other markets. 45 Page 3: For Mackie Designs, 1997 was a pretty good year. It wasn't a complete success, but it wasn't a failure either. Our decision to invest a much-higher-than-usual portion of our revenues in Research & Development was a good one, but the resulting new products did not ship when we had planned. Moving forward, we are better equipped to deal with new product development intricacies and how they relate to intended delivery dates. At this time we are shipping four new products. A fifth new product is due in the second quarter of 1998. In 1997, we spent considerable time analyzing the pro audio market. We have determined the areas we believe Mackie Designs can successfully expand into, and we will do so with greater wisdom and, we expect, rewards. 46 Page 4: 1997's new products were... a) Graph of Mackie's revenues in millions, 1993-1997. b) Graph of Mackie's investment in R&D in millions, 1993-1997. c) Graph of Mackie's operating income in millions, 1993-1997. d) Photo of SR40-8 SR40-8 large-format console for theaters, auditoriums, and large churches. e) Photo of 1997 TEC Award for Mackie's SR40-8 console f) Photo of Electronic Musician's 1998 Editors Choice award. g) Photo of EQ magazine's 1996 Blue Ribbon award for Mackie's HR824 monitors. Above: Our HR824 Studio Monitor has won accolades from major pro audio trade journals. The SR40-8 large-format console won the industry's most coveted prize for technical achievement, the TEC Award. h) Photo of HR824 Active 2-Way Studio Monitor i) Photo of HR824 Certificate of Calibration. Above: the HR824 Active 2-Way Studio Monitor is already on its way to becoming a standard in major recording studios and media production facilities. The HR824 is the only studio monitor that comes with its own individual, signed certificate of accuracy. j) Photo of FR Series M-1400. FR Series M-1400 power amplifier for live-sound reinforcement applications. k) Photo of HUI Human User Interface. HUI Human User Interface is designed to boost the productivity of digital audio workstations (including Digidesign's Pro Tool 4.1.) HUI gives users a hands-on control interface. 47 Page 5: President's message to our shareholders: From its inception, a large part of Mackie Designs' success has been in the introduction of ground-breaking new professional audio products. Our success is also in how well we have marketed and, above all, supported those products with world-class customer service. We have built a great reputation in the industry. While we believe that 1997 was a year in which we built upon those strengths, we were not very satisfied with the year's financial results. There were several factors that contributed to our monetary shortcomings. First, we incurred a significant increase in Research & Development expenditures as compared to prior years, committing a considerable amount of capital to ambitious product development plans. Second, we established aggressive product release dates. Unfortunately, "aggressive" amounted to "unrealistic." We did not deliver on these release dates because we were adamant about not compromising product quality. This resulted in fewer new product introductions than had been planned, lower sales, and a lack of synchronization of launch costs, inventory levels, and manufacturing capacity. While we didn't get the financial results we had hoped for, we do not intend to back off on our R&D commitment. It is part of a deliberate strategy to broaden our sales base by identifying markets and families of products that complement our core business, in order to leverage our brand name successfully for the future. In 1997, our talented product development and engineering team completed several exciting new products. Among them is our HR824 Active Near Field Studio Monitor, our first entry into the speaker market. The HR824 is winning worldwide industry acclaim as one of a) Photos of Greg Mackie in action at Mackie Designs Inc. headquarters. 48 Page 6: the most accurate professional loudspeakers available, and is fast becoming the monitor of choice for some of the world's top recording engineers and producers. The endorsements of these opinion leaders--and some extremely glowing reviews appearing in pro-audio industry publications--confirm that Mackie is able to enter new audio markets successfully. We also shipped our first professional power amplifiers, the M-1200 and M-1400. Used in permanent installations such as public auditoriums, clubs, theaters, churches, and by touring groups of all types, our amplifiers combine excellent value with exclusive, innovative Mackie features. These amplifiers are considered to be very competitively-priced and are currently being sold at major professional audio retailers throughout the U.S. and around the world. Finally, we began manufacturing our HUI -Registered Trademark- digital audio workstation controller late in the fourth quarter. Developed in conjunction with Digidesign -Registered Trademark-, an Avid Technologies -Registered Trademark- company, HUI (Human User Interface) does for digital audio workstation users what the mouse did for computer users. HUI boosts productivity and creativity during film, video, radio, and music recording post-production, with a unique set of features and capabilities. I believe it has a strong future in the rapidly-growing electronic media production market. While we're now seeing the fruits of investing almost $6,000,000 in Engineering and Research & Development during 1997, the short-term effect was a deep cut into our per-share earnings. Coupled with the fact that we had difficulty in meeting planned release dates, Mackie Designs did not perform up to its potential. 49 Page 7: If a goal is to learn from our mistakes, I think we have achieved it. By identifying and understanding last year's setbacks, we will be able to leverage our R&D investment into many new product introductions in the future. There were other positives for Mackie during 1997. Our expanded executive management team has now been in place for almost a year, and in that time we devoted significant energies to the strategic and visionary direction of the company. We have an extremely strong, vertically-integrated manufacturing operation with the management expertise and manufacturing capacity to handle significant growth. Additionally, we took steps to protect Mackie's intellectual property by filing a lawsuit in June. As of this date, this matter is proceeding to trial. Though this might prove costly in the short-term, we believe in the long run that this decision will both protect our core products and better protect future Mackie intellectual property. We are also aggressively pursuing strategies to improve our sales in international markets. In closing, I'd like to share with you something else I'm very excited about-we are poised to ship our Digital 8-Bus console, a new product that some industry observers feel will revolutionize the professional audio console product category. In my opinion, it has strong sales potential in virtually every market we serve. All of this, along with the exciting concepts currently incubating in our R&D/Engineering group, points to a promising 1998 for Mackie Designs. Sincerely, Greg C. Mackie President a) Photo of Greg Mackie at work in his office. 50 Page 8: a) Photo of most of Mackie's engineering group. At right is a shot of most of our engineers (the software programmers keep weird hours and were still asleep). Aside from our Digital development team, we have engineering teams working on a wide range of acoustic products including enhancements to our core product line of mixing consoles. b) Excerpt from Puget Sound Business Journal article, dated Feb. 13-19, 1998. EXCERPT FROM THE PUGET SOUND BUSINESS JOURNAL, Feb. 13-19, 1998. For a complete reprint, contact Investor Relations. c) Side shot of Digital 8-Bus console. Above: The culprit that "put us behind the curve," to paraphrase the above-mentioned Puget Sound Business Journal article. Yes, our Digital 8-Bus has taken longer to develop than we anticipated. But throughout its development, it has gained a number of what we believe to be highly competitive features that should set it apart from its competition. d) Photo of HR824 Active Studio Monitors production line. At right: Production of HR824 Active Studio Monitors. Like all Mackie products, they are made at our 170,000-square-foot complex in Woodinville, Washington. e) Photo of FR Series power amplifier. Below right: One of our FR Series power amplifiers displayed in one of those artful poses that in-house advertising departments feel compelled to come up with on a regular basis. f) Photo of Acoustic Development Laboratory. g) Photo of the HR824 Active Monitor development team. More of the engineers and technicians we've recruited in 1997. Top left: part of our Acoustic Development Laboratory; Above: the HR824 Active Monitor development team, including Greg Mackie. h) Photos of management team. At right: Our management team--in no particular pecking order except that we felt that the photo of (1) Peter Watts, Director of Engineering and R&D, should be up next to some of his myriad staff, (2) Roy Wemyss, COO, (3) Dave Firestone, V.P. Product Development, (4) Bill Garrard, CFO, (5) Patric Wiesmann, V.P. Marketing, (6) Bob May, V.P. Manufacturing. 51 Page 9: What isn't going digital these days? For audio recording, digital mixing makes especially good sense. First, more entertainment and information media are being delivered digitally ... Digital Video Discs (DVDs), streaming Internet audio, satellite TV, and FM broadcasts, not to mention the now-venerable compact disc. Second, digital mixing automation does for audio production what the word processor and spreadsheet did for writing and financial planning--it lets users store, recall, and edit their work... and perform functions that would be next-to-impossible manually. In typical Mackie fashion, the Digital 8-Bus embodies all leading-edge technology required to create first-to-mind position. We've written our own code and incorporated more features than anything out in the market. One reason we think that our new Digital 8-Bus stands out is that it provides users with 52 Page 10: a familiar analog interface. a) Photo of audio signal processors. Above is a rendering of the conventional pro audio signal processors that are replaced by the Digital 8-Bus' powerful computer system. You don't have to know what they are ... just that saving this much money on extra stuff is significant to the Digital 8-Bus' target audience. Moreover, the conventional processors require constant manual adjustments, while the same functions inside the D8-B can be automated--stored, recalled, and edited. The Digital 8-Bus includes its own Pentium processor, 16 megabytes of RAM, hard disk, floppy disk drive, SVGA monitor card, and high-speed modem for downloading additional software from Mackie Designs. b) Front shot of Mackie's Digital 8-Bus console with computer set-up. What's different about the Digital 8-Bus? The most obvious is that it has moving faders (those slots with the square white knobs on `em). These are the mixers' "volume controls." On both analog and digital mixers, the recording engineer first manually moves the faders to adjust relative levels of various sound. However, on an analog mixer, any subsequent changes must also be made manually. Even a simple 30-second commercial has dozens of level changes in it--but an engineer only has two hands to make all the adjustments ... and then probably can't make the same moves more than once. On our Digital 8-Bus, the faders "remember" their settings and move on cue at the right times during mixing. Until recently, "mix automation" was only found on recording consoles costing half a million dollars and up. c) Photo of some of the software screens of the Digital 8-Bus. At right are some of the software screens. They are designed to exactly simulate the look and feel of the actual Digital 8-Bus console and include a familiar "desktop" environment for file management. d) Photo of Digital 8-Bus logo. e) Photo of plug-in cards for the Digital 8-Bus. The Digital 8-Bus features an "open" architecture with plug-in cards to customize the console for various applications. 53 Page 11: When we claim that pros prefer Mackie, we have some potent proof. You'd be hard-pressed to find a cable or broadcast network, video post production facility, film studio, or superstar concert tour that isn't using our products. Our current endorsees' list reads like a "Who's Who" of the entertainment and news media. The Mackie users that aren't as obvious are in the hundred-thousand-plus "semi-pro" and hobbyist recording studios in basements, spare bedrooms, and remodeled garages. Aspiring composers and performers are able to afford the same studio-quality mixers, amplifiers and monitor speakers used day-in and day-out by many of the world's 54 Page 12: top engineers and producers. a) Photos of product users. 1. Mick Guzauski's credits read like a "Who's Who" of pop luminaries -Babyface, Toni Braxton, Eric Clapton, LeAnn Rimes, and a new single for the blockbuster movie, Titanic, just to name a few. 2. You know Pop/R&B Producer Rhett Lawrence from his work with Bebe and Cece Winans, Whitney Houston, Mariah Carey, Samantha Cole, etc., etc. ... 3. Nick Milo plays Hammond B3 and synths for perhaps the definitive musician's band in America, Tower of Power. 4. Aimee Cain runs LA's most frequented songwriter hang, called, simply, Largo. Erik Gavriluk is the guy who advised Largo to buy a Mackie SR24-4. Eric has access to possibly the world's largest collection of vintage keyboards--all routed through Mackie mixers. 5. Sheila E, of the legendary Escovedo percussion family, is not only a monster percussionist, she'll be the band leader for a new late-night show starting soon. 6. Rick Ruggieri designs and installs recording studios. He's seen monitor trends come and go and believes that the Mackie HR824's accuracy may put an end to speakers as fashion statements. 7. The Tonight Show's custodian of musical theme-scapes, Kevin Eubanks. 8. Butch Vig has built a reputation and a career producing and engineering ground-breaking recordings for the likes of Nirvana, Smashing Pumpkins, Soul Asylum, and his amalgamation, Garbage. 9. Scott Weiland is known to most as the lead singer of Stone Temple Pilots. He is also a talented songwriter and eager student of recording and mixing techniques. 10. The musical team currently-known-as-Wendy & Lisa initially rose to prominence as members of the-artist-then-known-as-Prince's band. 11. Charles Dye is Studio Manager and Chief Mix Engineer for Gentlemen's Club, a high-end, ProTools-based recording studio in Miami Beach, Florida. 12. Johnny Caswell's Burbank rehearsal facility Center Staging has so many Mackie products moving between rehearsal rooms and TV sets like the Tonight Show, VIBE, and awards shows, that he just shrugs when you ask him for a total product count. He's pictured here with his good friend Sheila E. 13. Wayne Sharpe has been profiled in both Keyboard and Post magazines. His IMAX surround-sound "signatures,' film scores, and themes for TV shows and sports events are heard by virtually everyone. 14. Tim Alexander--The "put-him-in-a-cage-and-feed-him-raw-meat" drummer formerly with the radical, mega-hip band Primus. 15. Among stick-users, John "JR" Robinson is "Mr. Studio Drummer." To those of you relying on mere fingers, you can pick out JR's recorded work by simply turning on the radio. 16. Shawn Pelton's booked solid these days for sessions, tours, and album projects with artists like Hall & Oates, Billy Joel, and Celine Dion. For the past six years he's been holding down the drum throne for the comedy variety show, Saturday Night Live. 55 Page 13: One way that Mackie maintains a competitive edge is by taking advantage of advanced manufacturing technologies in our 170,000-square-foot complex in Woodinville, Washington. Here, we deploy the latest automated insertion and surface-mount assembly equipment. To control costs, we've invested in a fully-automated, state-of-the-art metal fabrication, painting, and screening facility. Vertically integrated manufacturing is admittedly at odds with out-sourcing (the current trend du jour). But, as implemented by over 550 Mackie employees, our methods have enabled us to respond quickly to market demand, achieve more constant production rates and 56 Page 14: maintain better quality control. a) Photo of employee. The obligatory photo of an employee driving a forklift. b) Photo of production area. One of our two main production areas. We still have room for considerable growth. c) Photo of HUI production HUI (Human User Interface) production. d) Photo of surface-mount area. Part of our high-speed surface-mount area. These incredible machines, which run three shifts per day, "shoot" more than 21,000 miniaturized parts per hour. The benefits: faster production, better reliability and the ability to pack more product features into less space on our mixers and power amplifiers. e) Photo of production line. Looking down our amp production line. f) Photo of paint plant Mackie's automated paint production plant. g) Photo of metal plant. In the metal plant. These incredible machines work round-the-clock turning steel sheets into high-tech swiss cheese. h) Photo of Dave Trudeau Above: Dave Trudeau, Director of Materials, managed multiple plants and a global distribution system prior to joining Mackie. His manufacturing discipline expertise has been gained from 20 years of experience. 57 Page 15: Ask anybody in the pro audio industry and they'll tell you that a fair part of Mackie's success can be attributed to our marketing communications. Instead of a confusing plethora of conventional product brochures, we pack every Mackie product, our unique technology stories, employee photos, our latest awards and at least one image of P.D., the Corporate Chihuahua, into a huge tabloid with the same dimensions as this report (but at least 40 pages thicker). Our ads-appearing in over 30 industry publications-are equally as dense and info-packed. They build a strong brand image and help us share our relaxed corporate culture. For a quick sample, visit 58 Page 16: our website at www.mackie.com. a) Photo of Mackie advertisement for CR1604-VLZ mixer. An actual page from our product literature. CR1604-VLZ Mix Section 1. 12V BNC lamp connector 2. Aux Sends 1 & 2 master gain controls 3. Aux Send master Solo switches 4. Aux Send master Solo LED indicators 5. Aux Returns 1 & 2 6. Effects Returns to Monitor controls (from Aux Returns 1 & 2 to Aux Sends 1 & 2) 7. Aux Returns 3 & 4 8. Aux Return 3 Assign (to Main Mix or Subs) switch 9. Aux Return 3 Assign (to Subs 1-2 or 3-4) switch 10. Aux Return 4 Assign (to Control Room/Phones only) switch 11. Global Aux Return solo switch 12. Aux Return Solo LED 13. Phantom power & main power LED indicators 14. Control Room/Phones level control 15. Control Room/Phones source switches 16. Tape input (tape return) volume control 17. Tape to Main Mix assign switch 18. Global Solo level control 19. AFL/PFL global solo mode switch 20. Left/Right LED meters 21. Level Set indicator and LED 22. Our famous Rude Solo Light 23. Assign to Left Main Mix switches for Subs 1-4 24. Assign to Right Main Mix switches for Subs 1-4 25. Submaster faders 26. Main Left/Right Mix fader 27. Headphone output Only Mackie Designs could improve the classic CR-1604. First introduced in 1990, the CR-1604 literally defined the modern compact mixer in terms of features and sonic quality. It's been used on more feature films, more network TV shows and commercials, more world tours, and more major-label albums than any other compact mixer. But we didn't let success go to our heads. For years we'd been collecting warranty card comments and user suggestions about how to improve the CR-1604; the CR1604-VLZ includes almost everything anybody ever asked for. For sheer density of tasty features, there's never been more mixer in a rack-mount configuration. We avoided "sequel-itus," too. All too often, a manufacturer forgets what made the first version of a product successful when it comes out with a "new improved" model. Not us. The CR1604-VLZ maintains the original's sound quality, musical EQ, rugged construction, and unique 3-way physical configuration with rotating input/output pod. But we also added an astonishingly long list of features and additions, many of which descended from our 8-Bus consoles and SR Series. The official channel strip tour. 59 Right off, you'll notice the Trim control is located where you can get at it, no matter how the CR1604-VLZ input/output pod is rotated. It also has a whopping 60dB of gain range. Then comes our 6-Aux-Sends-In-4-Knobs section. Auxes 1 & 2 are switchable, per channel, pre- or post-fader. A Shift switch to the right of the next two knobs lets you select between Aux Sends 3 & 4 or 5 & 6 (all four of which are post-fader). High (12kHz) and low frequency (80Hz) shelving equalization are two classic CR-1604 characteristics that received jillions of warranty card raves. Of course we didn't change `em. However, about a jillion more warranty cards asked for sweepable midrange EQ. We dipped into the SR Series data bank and came up with a nice wide 1.5-octave midrange bandwidth and an incredible 6.5-octave sweep range--from 8kHz all the way down to 100Hz. Each channel features our sharp 18dB/octave Lo Cut (high-pass) filter that cuts undesirable frequencies without diminishing audible bass. Next is our signature constant-loudness pan control. When you pan a signal from side to side--even hard right or hard left--its apparent loudness stays the same as when it's dead center. This is important for precise video and CD production. The CR1604-VLZ pan also has far more L/R separation than other compact mixers' pan controls critical when assigning a signal hard right or left to odd or even submix buses. Then there's the mute button. What can we say? It mutes. Well. The red channel Overload LED is actually dual-purpose. It blinks when the channel strip's amplifiers are being driven into overload ... AND it stays on constantly when you mute a channel. The -20 signal present LED is so sensitive that you can actually tell what's on a channel (drums, keyboards, vocals, etc.) by its flashing vigor. This LED also has a dual purpose: It stays on constantly when you solo a channel. Below the LEDs is the Solo button. Globally switchable from PFL (Pre-Fader Listen) to AFL (After Fader Listen, or Solo In-Place) via the Master Section. Finally, a silky-smooth, ultra-accurate 60mm fader. Mackie's log-taper faders are built for long life and--just as important--beautiful fades. Our faders are usable over the entire fader length (instead of dropping off to silence halfway down), are extremely linear-sounding, and have a tight lip seal and long-life wiper material; for years of durability. Each channel can be assigned to Subs 1-2, Subs 3-4, or L/R Main Mix with switches to the right of the fader. 60 Page 17: Our products are sold through a network of over 1,000 dealers in the United States and more than 4,000 dealers in 100 foreign countries. These outlets range from pro audio superstores to small music shops, from national broadcast supply houses to sound installation contractors. In an effort to reduce the cost of our products in the important European market, we have opened a distribution center in Rotterdam, Netherlands. In conjunction with a network of in-country distributors and Mackie factory technical sales representatives, we believe that we can increase our market share in key countries. 61 Page 18: a) Artist's computer rendering of a map of the world. b) Photo of synth player/producer Simon Franglen with Mackie products. A final, titanic success story. One person who has taken Mackie to heart is British-born synth player/producer Simon Franglen. You may not know his name, but you most certainly know his work. Simon Franglen's curriculum vitae includes work with Grammy winners Eric Clapton, Celine Dion, and Madonna, rockers Yes and Crash Test Dummies, and legendary performers such as Michael Jackson and Barbara Streisand. Simon's done work in the movies, too, including Titanic, The Client, Dances With Wolves, Mission Impossible, Seven, and Contact. He's won seven Clio Awards for his work in television commercials, where his clients have included Nike and Lee Jeans. His talents as a session synth player and programmer as well as producer, are well-known throughout the entertainment world. With such credits, you'd think the guy was using incredibly esoteric, expensive gear. How else could he get such award-winning results? Well, Simon will be the first to say you don't have to spend wads of money to get tough, quality sound gear. Not with Mackie. Last year Simon began working on the soundtrack to what would become the costliest and highest-grossing motion picture of all time, Titanic. The film's original score was written by James Horner, and Simon was called in to produce the theme song for the film and soundtrack (written by Horner with Will Jennings and sung by Celine Dion), "My Heart Will Go On." Simon also spent considerable time programming the synths for the movie's score with fellow synthman Ian Underwood (and later Randy Kerber). With his experience in both analog and digital realms, it's no wonder Simon can't wait to get his hands on a prototype of Mackie's upcoming digital mixer. Until then he'll spend his time working on various projects, including new records for Tina Arena (1997's "Sorrento Moon") and singer Edyta, as well as early work for the theme song to Zorro (written by Horner and Jennings), a Columbia film starring Antonio Banderas. Having recently finished remixes for Jon Bon Jovi and Simply Red on his HR824s, you can be reasonably assured that Simon Franglen will continue working with--and on--Mackie products. "I do genuinely like the stuff," he says about his near-decade of Mackie use. "If I wanted to put a bigger-format desk [into my home studio] I probably could do it, but I prefer to spend the money in other areas." Thanks Simon. We couldn't have said it better. c) Mackie product photos UltraPilot automation interface works with Mackie's UltraMix Universal Automation system. HR824 Active Near Field Monitor 32-8 8-Bus Mixing Console with 24-E Expander HUI" Human User Interface for digital audio workstations Product Photography: Dave Crosier. People and Facilities: Richard McNamee and Peter Figen (C)1998 Mackie Designs Inc. All rights reserved. Product specifications subject to change. "Mackie.," "Running Man" figure, VLZ, UltraMix, FR Series, HR Series, and HUI are trademarks or registered trademarks of Mackie Designs Inc. 62 Financial statements cover (page 1): MACKIE DESIGNS INC. FINANCIAL STATEMENTS DECEMBER 31, 1997 63 Financial statements page 2: Management's Discussion and Analysis of Financial Condition and Results of Operations General The following information contains certain forward-looking statements that anticipate future trends or events. These statements are based on certain assumptions that may prove to be erroneous and are subject to certain risks including, but not limited to, the Company's ability to introduce new products, the concentration of the Company's current products in a relatively narrow segment of the professional audio market, technological change and increased competition in the industry, the Company's ability to manage its rapid growth, its limited protection of technology and trademarks, various factors that impact the Company's international operations including economic conditions in various countries, customs and tariff regulations, currency fluctuations and lower gross margins, the Company's dependence on a limited number of suppliers and on its network of representatives and distributors, and its dependence on certain key personnel within the Company. Accordingly, actual results may differ, possibly materially, from the predictions contained herein. The Company derives its operating revenue from worldwide sales of audio mixers and other professional audio equipment. Sales outside the U.S. account for a significant portion of the Company's total sales. International sales volumes have historically been affected by foreign currency fluctuations relative to the U.S. dollar. The Company prices its products in U.S. dollars worldwide. When weaknesses of local currencies have made the Company's products more expensive, sales to those countries have declined. The Company's gross margins are also affected by its international sales. Typically, gross margins from exported products are lower than from those sold in the U.S. due to discounts offered to the Company's foreign distributors. These discounts are given because the international distributor typically incurs certain expenses, including technical support, product service, and in-country advertising, that the Company normally incurs for domestic sales. The Company offered its international distributors a weighted average discount of approximately 14.8% in 1997, 12.7% in 1996, and 8.1% in 1995. The increase in discounts is attributable to the fact that the Company increased its discounts to international distributors after it terminated the services of its exclusive representative for sales to international distributors in 1995 and began supervising international marketing and sales internally. The increase in discounts in 1997 is also attributable to additional discounts offered on certain products. In conjunction with the increase in discounts, the Company also eliminated the commissions it was paying to its international representative. While the Company has eliminated these commissions, the Company has incurred and will continue to incur additional expenses associated with managing the international marketing and sales of its products. Sales outside the U.S. represented approximately 38%, 38%, and 34% of the Company's net sales in 1997, 1996, and 1995, respectively. The Company's gross margins are also affected by the purchase of some components abroad. As a result of fluctuations in the value of local currencies relative to the U.S. dollar, some of the Company's international 64 Financial statements page 3: component suppliers have increased prices and may further increase prices. The Company currently does not employ any foreign exchange hedging strategies, but may employ such strategies in the future. The Company's gross margins have fluctuated from time to time due primarily to inefficiencies related to the introduction and manufacture of new products and the integration of equipment into the Company's manufacturing processes. Historically, fluctuations have also resulted from increases in overhead associated with each of the Company's several relocations, varying prices of components, and competitive pressures. The Company plans to introduce new products and product revisions at a more rapid rate than it has in the past. Some anticipated new products will require the implementation of manufacturing practices with which the Company is not familiar. This could result in lower margins as the Company becomes more familiar with new manufacturing procedures. As a result of its election to be treated as an S Corporation, the Company was exempt from the payment of federal income taxes through August 16, 1995. Accordingly, the Company's financial statements do not contain a provision for income tax expense for periods through that date. Pro forma income statement information is provided to reflect a provision for income taxes as if the Company had been subject to federal income taxes as a C Corporation for all periods presented. Results of Operations Year Ended December 31, 1997 as Compared with Year Ended December 31, 1996 Net Sales The Company's net sales increased 2.3% to $74.9 million in 1997 from $73.2 million in 1996. The increase in sales was primarily attributable to sales from new products (the SR40-8, FR Series -TM- power amplifiers, and the HR824 active studio monitor), partially offset by a decrease in sales in two mixer product lines (the 8-Bus Series mixers and compact mixers). Sales of the SR40-8 (which became available in December 1996), FR Series -TM- power amplifiers (which became available in December 1996), and the HR824 active studio monitor (which became available in August 1997) accounted for 20% of net sales in 1997. Sales of the 8-Bus Series mixers decreased to 16% of net sales in 1997 from 25% in 1996. Sales of compact mixers were 47% of net sales in 1997 compared with 53% in 1996. Sales outside the United States represented 38% of the Company's net sales in both 1997 and 1996. Cost of Sales Gross profit was $27.8 million in 1997 compared with $28.0 million in 1996. Gross profit as a percentage of net sales decreased to 37.1% in 1997 from 38.3% in 1996. The decrease in gross margin percentage was due to start-up costs associated with initial production of the SR40-8 and the FR Series -TM- power amplifier, both of which were shipped in significant quantities for the first time in the first quarter of 1997. The gross margin percentage decrease was also due to a higher weighted average discount offered to international distributors. Additionally, the decrease in gross margin percentage was due to a difference in product mix in 1997 compared with 1996 as sales of certain product lines provided lower gross margins than other product lines. Marketing and Sales Marketing and sales expenses increased to $9.9 million in 1997 from $9.2 million in 1996. This increase was due primarily to increased marketing and sales staff and increased advertising expenses. 65 The primary components of marketing and sales expenses include salaries ($2.0 million in 1997 and $1.7 million in 1996), independent representatives' 66 Financial statements page 4: commissions ($2.7 million in 1997 and $2.9 million in 1996), and advertising ($3.0 million in 1997 and $2.7 million in 1996). Marketing and sales expenses as a percentage of net sales were 13.3% in 1997 compared with 12.6% in 1996. Administrative Administrative expenses decreased to $4.8 million in 1997 from $5.0 million in 1996. This decrease was due primarily to a reallocation of rent expense from administrative expenses to manufacturing overhead as additional space was utilized in the manufacturing process, partially offset by an increase in various other expenditures. Administrative expenses as a percentage of net sales were 6.5% in 1997 compared with 6.8% in 1996. Research and Development Research and development expenses increased to $5.9 million in 1997 from $3.6 million in 1996. As a percentage of net sales, these expenses increased to 7.9% in 1997 from 4.9% in 1996. This increase was due primarily to increases in R&D staff and expenditures as the Company expanded its product line into other pro-audio categories. Interest Income Interest income decreased to $791,000 in 1997 from $863,000 in 1996 due to a lower average cash balance. Income Tax Provision The provision for income taxes for 1997 of $2.4 million represents an overall effective rate of 30.0%. The provision for income taxes for 1996 of $3.7 million represented an overall effective rate for 1996 of 33.1%. The decrease in the overall effective rate in 1997 compared with 1996 is due to the increased benefits provided by the Company's foreign sales corporation and the research and development tax credit. Year Ended December 31, 1996 as Compared with Year Ended December 31, 1995 Net Sales The Company's net sales increased 14.6% to $73.2 million in 1996 from $63.9 million in 1995. The increase in sales was primarily attributable to an increase in sales of two product lines: the compact mixers and the SR Series mixers. Sales of compact mixers increased to 53% of net sales in 1996 from 35% in 1995. Sales of the SR Series mixers increased to 20% of net sales in 1996 from 17% in 1995. Sales outside the United States represented 38% and 34% of the Company's net sales in 1996 and 1995, respectively. Cost of Sales Gross profit was $28.0 million in 1996 compared with $27.2 million in 1995. Gross profit as a percentage of net sales decreased to 38.3% in 1996 from 42.5% in 1995. The decrease was due to increases in discounts offered to international distributors following the Company's decision, effective November 1, 1995, to terminate the services of its exclusive representative for sales to distributors 67 outside the U.S. and Canada. Since then, the Company has supervised the international marketing and sales of its products internally. The decrease in gross margin percentage was also due to a difference in product mix in 1996 compared with 1995, as sales of the MS1202-VLZ -Registered Trademark- (successor to the MS-1202) and the CR1604-VLZ -Registered Trademark- (successor to the CR-1604), both of which were introduced in the first quarter of 1996, provided lower gross margin percentages than their predecessors. As the Company has introduced new versions of existing products, it has added more features to them without significant price increases. Additionally, the gross margin decreased due to labor and overhead inefficiencies caused by a lower-than-anticipated sales volume in the third and fourth quarters of 1996. 68 Financial statements page 5: Marketing and Sales Marketing and sales expenses increased to $9.2 million in 1996 from $9.0 million in 1995. The increase was due primarily to increases in marketing staff. The primary components of marketing and sales expenses include salaries ($1.7 million in 1996 and $1.2 million in 1995), independent representatives' commissions ($2.9 million in 1996 and $3.9 million in 1995), and advertising ($2.7 million in 1996 and $2.6 million in 1995). Marketing and sales expenses as a percentage of net sales were 12.6% in 1996 compared with 14.1% in 1995. Administrative Administrative expenses increased to $5.0 million in 1996 from $3.4 million in 1995. Administrative expenses as a percentage of net sales were 6.8% in 1996 compared with 5.3% in 1995. The increase was due to an increase in staff and expenditures related to the Company's increased business volume and various expenses associated with being a publicly-held company. Research and Development Research and development expenses increased to $3.6 million in 1996 from $1.2 million in 1995. As a percentage of net sales, these expenses increased to 4.9% in 1996 from 1.9% in 1995. The increase was due primarily to increases in R&D staff and expenditures related to the creation of two new engineering groups (Digital Product Group and Acoustic Product Group) as the Company expanded its product line into other professional audio categories. Interest Income, Interest Expense, and Other Income Interest income increased to $863,000 in 1996 from $346,000 in 1995 due to higher overall cash balances stemming from the Company's initial public offering of common stock ("IPO") in August 1995. Interest expense decreased to zero in 1996 compared with $318,000 in 1995 due to the repayment of all interest-bearing debt following the IPO. The interest expense in 1995 was related primarily to shareholder notes entered into in April 1995. These notes, which represented the undistributed S Corporation earnings as of December 31, 1994 that had not been paid as of April 3, 1995, were paid in full following the IPO. Other expense of $11,000 in 1996 (compared with other income of $70,000 in 1995) resulted primarily from losses on the sale of capital equipment. Income Tax Provision The provision for income taxes for 1996 of $3.7 million represents an overall effective rate of 33.1%. The income tax provision for 1995 of $2.0 million represented an overall effective rate for the year applied to pre-tax income from August 17, 1995 (the first day following the termination of the Company's S Corporation status) through December 31, 1995. The pro forma provision for income taxes for 1995 reflects the federal income tax expense the Company would have recognized had the Company been subject to income taxes for the year ended December 31, 1995. The pro forma income tax provision for 1995 is based upon an overall effective rate of 33.8%. The decrease in the expected overall effective rate in 1996 from 1995 is due to the benefit provided by the Company's foreign sales corporation formed in September 1995 and the research and development tax credit. Liquidity and Capital Resources 69 The Company used internally generated cash to finance its operations during 1997 and 1996. The Company's operating activities generated cash of $2.6 million in 1997 and $6.9 million in 1996. Accounts receivable, net of allowances, at December 31, 1997 increased slightly to $10.6 million from 70 Financial statements page 6: $9.7 million at December 31, 1996. Inventory levels increased to $17.8 million at December 31, 1997 from $10.3 million at December 31, 1996 due to a lower-than-anticipated sales volume in the fourth quarter of 1997 and increased inventory quantities for new products. Net cash used in investing activities decreased to $2.6 million in 1997 from $8.4 million in 1996, attributable to a decrease in capital expenditures and a decrease in net purchases of marketable securities. The Company had no significant capital expenditure commitments at December 31, 1997. The Company intends to finance its 1998 capital expenditures from cash provided by operations and current cash reserves. Net cash used in financing activities in 1997 was $1.3 million compared with $55,000 in cash generated in 1996. The cash used in financing activities in 1997 was due to the repurchase of 207,600 shares of the Company's common stock totaling $1.7 million, partially offset by $316,000 received from the exercise of common stock options. In October 1997, the Company renewed a business loan agreement with a bank. The agreement provides three credit facilities to the Company, including a $5.0 million unsecured line of credit to finance any unexpected working capital requirements. The line of credit bears interest at the bank's prime rate, or at a specified IBOR rate plus 1.5%, whichever the Company chooses. The agreement also provides a $2.5 million credit facility for capital equipment purchases or general corporate purposes. Certain terms under this facility, such as interest rate, repayment period, and collateral, will be determined at the time advances are made to the Company. The Company also has a $1.75 million line of credit for the purchase of foreign exchange contracts. There were no borrowings outstanding on any of the bank credit facilities at December 31, 1997. These credit facilities expire April 30, 1998. Under the terms of the business loan agreement, the Company must maintain certain financial ratios and tangible net worth. The Company is in compliance with all such covenants. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, and acquisitions. The agreement also imposes an annual capital expenditure limit of $10 million. The Company has granted options to various individuals to purchase shares of the Company's common stock. As of December 31, 1997, options to purchase 2,852,200 shares of common stock at exercise prices of $5.55 per share to $13.88 per share are outstanding and 1,766,575 of these options are exercisable. The exercise of these options would provide additional cash to the Company. The Company believes that existing cash and cash equivalent balances together with cash generated from operations and cash available from credit facilities will be sufficient to finance the Company's operations at least through 1998. Although the Company cannot accurately anticipate the effects of inflation, the Company does not believe inflation has had or is likely to have a material effect on its results of operations or liquidity. The Company's present policy is to retain earnings to finance the Company's business. Any future dividends will be dependent upon the Company's financial condition, results of operations, current and anticipated cash requirements, acquisition plans, plans for expansion, and any other factors which the Company's Board of Directors deems relevant. Under its bank loan agreement, the Company is prohibited from paying any dividends without prior approval from the bank. The Company has no present intention of paying dividends on its common stock in the foreseeable future. 71 Financial statements page 7: The Company has developed a plan to assess and address Year 2000 compliance issues and has begun converting its critical data processing systems. The Company's total Year 2000 project cost and estimates to complete include the estimated costs and time associated with the impact of third-party Year 2000 issues based on presently available information. However, there can be no guarantee that the systems of other companies on which the Company relies will be converted on a timely basis and will not have an adverse effect on the Company's systems. The Company currently expects the project to be substantially complete by early 1999 and to cost between $50,000 and $100,000. This estimate includes internal costs, but excludes the costs to upgrade and replace systems in the normal course of business. The Company does not expect this project to have a significant effect on operations. As of December 31, 1997, no significant expenditures had been made. The Company will, as it deems necessary, continue to implement systems with strategic value. 72 Financial statements page 8: Consolidated Balance Sheets
December 31, 1997 1996 ------------------------- ASSETS Current assets: Cash and cash equivalents ..................... $ 975,180 $ 2,366,184 Securities available-for-sale ................. 10,864,401 11,688,513 Accounts receivable, less allowance of $481,000 in 1997 and $808,000 in 1996 .. 10,614,515 9,693,035 Inventories ................................... 17,761,462 10,316,940 Income taxes receivable ....................... -- 182,627 Deferred taxes ................................ 670,000 685,000 Prepaid expenses and other current assets ..... 1,287,311 673,585 ----------- ----------- Total current assets .............................. 42,172,869 35,605,884 Furniture and equipment, net ...................... 10,605,164 10,246,118 Other assets ...................................... 594,390 403,948 ----------- ----------- Total assets ...................................... $53,372,423 $46,255,950 ----------- ----------- ----------- ----------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable .............................. $ 3,822,239 $ 2,053,079 Commissions payable ........................... 664,983 627,374 Accrued salaries and bonus .................... 480,180 226,498 Accrued vacation .............................. 305,350 217,097 Accrued warranty .............................. 300,000 180,000 Income taxes payable .......................... 348,173 -- Other accrued liabilities ..................... 296,227 281,662 ----------- ----------- Total current liabilities ......................... 6,217,152 3,585,710 Deferred rent ..................................... 81,250 42,250 Deferred taxes .................................... 596,000 345,000 Commitment Shareholders' equity: Preferred stock, no par value: Authorized shares--5,000,000 Outstanding shares--none Common stock, no par value: Authorized shares--40,000,000 Issued and outstanding shares--12,733,650 & 12,885,000 in 1997 & 1996, respectively ............................ 29,657,210 30,998,830 Retained earnings ............................. 16,820,811 11,284,160 ----------- ----------- Total shareholders' equity ........................ 46,478,021 42,282,990 ----------- ----------- Total liabilities and shareholders' equity ........ $53,372,423 $46,255,950 ----------- ----------- ----------- -----------
See accompanying notes. 73 Financial statements page 9: Consolidated Statements of Income
Year Ended December 31, 1997 1996 1995 -------------------------------------------- Net sales ............................ $ 74,889,420 $ 73,235,925 $ 63,918,999 Cost of sales ........................ 47,093,131 45,210,585 36,755,638 ------------ ------------ ------------ Gross profit ......................... 27,796,289 28,025,340 27,163,361 Operating expenses: Marketing and sales .............. 9,938,507 9,202,448 9,021,819 Administrative ................... 4,839,780 4,979,320 3,400,355 Research and development ......... 5,892,178 3,602,727 1,204,739 ------------ ------------ ------------ Total operating expenses ............. 20,670,465 17,784,495 13,626,913 ------------ ------------ ------------ Operating income ..................... 7,125,824 10,240,845 13,536,448 Interest income ...................... 790,687 862,518 346,494 Interest expense ..................... -- -- (318,038) Other income (expense) ............... (7,060) (11,104) 70,141 ------------ ------------ ------------ Income before income taxes ........... 7,909,451 11,092,259 13,635,045 Provision for income taxes ........... 2,372,800 3,671,600 1,972,700 ------------ ------------ ------------ Net income ........................... $ 5,536,651 $ 7,420,659 $ 11,662,345 ------------ ------------ ------------ ------------ Basic income per share ............... $ 0.43 $ 0.58 ------------ ------------ ------------ ------------ Diluted income per share ............. $ 0.41 $ 0.55 ------------ ------------ ------------ ------------ Pro forma data (unaudited) : Income before pro forma provision for income taxes ............... $ 13,635,045 Pro forma provision for income taxes ............... 4,608,700 ------------ Pro forma net income ............. $ 9,026,345 ------------ ------------ Pro forma basic income per share ...................... $ 0.82 ------------ ------------ Pro forma diluted income per share ...................... $ 0.73 ------------ ------------
See accompanying notes. 74 Financial statements page 10: Consolidated Statements of Cash Flows
Year Ended December 31, 1997 1996 1995 ---------------------------------------------- OPERATING ACTIVITIES Net income ..................................... $ 5,536,651 $ 7,420,659 $ 11,662,345 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .............. 3,160,237 1,969,131 1,051,086 (Gain) loss on asset dispositions .......... -- 11,104 (65,407) Deferred income taxes ...................... 266,000 (136,000) 131,800 Changes in operating assets and liabilities: (Increase) decrease in accounts receivable ............................. (921,480) 10,892 (2,841,481) Decrease in due from related parties ..... -- -- 1,020,174 Increase in inventories .................. (7,444,522) (2,674,048) (3,971,395) (Increase) decrease in income taxes receivable ....................... 182,627 196,473 (379,100) Increase in prepaid expenses and other current assets ......................... (613,726) (65,738) (499,178) Increase in other assets ................. (257,114) (341,059) (112,893) Increase in accounts payable and accrued expenses ....................... 2,245,660 567,300 185,690 Increase (decrease) in commissions payable 37,609 (109,816) 235,694 Increase in income taxes payable ......... 348,173 -- -- Increase in deferred rent ................ 39,000 42,250 -- ------------ ------------ ------------ Net cash provided by operating activities ...... 2,579,115 6,891,148 6,417,335 INVESTING ACTIVITIES Purchases of securities ........................ (20,422,495) (45,287,047) (22,040,686) Proceeds from sales of securities .............. 6,311,193 6,362,768 4,522,137 Proceeds from maturities of securities ......... 14,935,414 38,011,708 6,742,607 Purchases of equipment ......................... (3,452,611) (7,611,708) (4,090,447) Proceeds from asset dispositions ............... -- 86,630 75,797 ------------ ------------ ------------ Net cash used in investing activities .......... (2,628,499) (8,437,649) (14,790,592)
(continued on next page) 75 Financial statements page 11: Consolidated Statements of Cash Flows (continued)
Year Ended December 31, 1997 1996 1995 --------------------------------------------- FINANCING ACTIVITIES Net proceeds from sale of common stock .............................. 316,188 55,500 31,589,788 Repurchase and retirement of common stock ........................... (1,657,808) -- -- Payments on notes payable to related parties ........................ -- -- (9,150,586) Payments on long-term debt and capital leases ....................... -- -- (643,490) Payments of dividends ............................................... -- -- (9,872,488) ------------ ------------ ------------ Net cash provided by (used in) financing activities ................. (1,341,620) 55,500 11,923,224 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents ................ (1,391,004) (1,491,001) 3,549,967 Cash and cash equivalents at beginning of year ...................... 2,366,184 3,857,185 307,218 ------------ ------------ ------------ Cash and cash equivalents at end of year ............................ $ 975,180 $ 2,366,184 $ 3,857,185 ------------ ------------ ------------ ------------ ------------ ------------ SUPPLEMENTAL DISCLOSURES Non-cash financing and investing activities: Dividends paid in exchange for shareholders' notes .............. $ -- $ -- $ 8,469,309 ------------ ------------ ------------ ------------ ------------ ------------ Cash paid for interest .............................................. $ -- $ -- $ 329,755 ------------ ------------ ------------ ------------ ------------ ------------ Cash paid for income taxes .......................................... $ 1,576,000 $ 3,611,127 $ 2,220,000 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying notes. 76 Financial statements page 12: Consolidated Statements of Shareholders' Equity
Common Stock -------------------------- Retained Shares Amount Earnings Total ---------------------------------------------------------- Balance at December 31, 1994 .... 10,000,000 29,781 8,213,897 8,243,678 Recognition of deferred tax assets ................ -- 335,800 -- 335,800 Reclassification of accumulated deficit due to termination of S Corporation status ...... -- (1,012,039) 1,012,039 -- Issuance of common shares in initial public offering, net of issuance costs of $705,212 ............... 2,875,000 31,589,788 -- 31,589,788 Net income .................. -- -- 11,662,345 11,662,345 Dividends declared .......... -- -- (17,024,780) (17,024,780) ---------- ------------ ------------ ------------ Balance at December 31, 1995 .... 12,875,000 30,943,330 3,863,501 34,806,831 Issuance of common shares upon exercise of stock options .......... 10,000 55,500 -- 55,500 Net income .................. -- -- 7,420,659 7,420,659 ---------- ------------ ------------ ------------ Balance at December 31, 1996 .... 12,885,000 $ 30,998,830 $ 11,284,160 $ 42,282,990 Issuance of common shares upon exercise of stock options .......... 56,250 316,188 -- 316,188 Repurchase of common shares .................... (207,600) (1,657,808) (1,657,808) Net income .................. -- -- 5,536,651 5,536,651 ---------- ------------ ------------ ------------ Balance at December 31, 1997 .... 12,733,650 $ 29,657,210 $ 16,820,811 $ 46,478,021 ---------- ------------ ------------ ------------ ---------- ------------ ------------ ------------
See accompanying notes. 77 Financial statements page 13: Notes to Consolidated Financial Statements 1. SIGNIFICANT ACCOUNTING POLICIES Description of Business Mackie Designs Inc. (the Company) develops, manufactures, sells, and supports high-quality, reasonably priced professional audio equipment. The Company operates as a single business segment. The Company sells to retailers and distributors throughout the world, generally on open credit terms. Sales to distributors outside of the United States approximated 38%, 38%, and 34% of net sales in 1997, 1996, and 1995, respectively. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Mackie Sales Corporation. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Revenue Recognition Generally, revenues from sales of products are recognized when products are shipped. Cash Equivalents The Company considers all highly-liquid investments purchased with an initial maturity of three months or less to be cash equivalents. Inventories Inventories are carried at the lower of cost, using the first-in, first-out method, or market. Furniture and Equipment Furniture and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets of three to nine years. Income Taxes The shareholders of the Company elected to be treated until August 16, 1995 as an S Corporation under the Internal Revenue Code. As a result, taxable income until that date was included in the taxable income of the individual shareholders and no income tax provision was recorded. As an S Corporation, it was the Company's practice to make cash distributions to shareholders in amounts sufficient for them to meet their personal income tax obligations resulting from the Company's S Corporation status. 78 The Company terminated its S Corporation status on August 16, 1995 and implemented Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," upon becoming a taxable entity. Under SFAS No. 109, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and are measured using the tax rates that will be in effect when the differences are expected to reverse. A deferred tax asset of $335,800 was recorded for the temporary differences between recognition of income and expense for financial reporting and tax as of August 16, 1995. On the date of termination of the Company's S Corporation status, S Corporation distributions in excess of financial reporting income were reclassified on the accompanying balance sheet to common stock. 79 Financial statements page 14: A pro forma income tax adjustment has been included in the statements of income as if the Company had been a taxable entity during those periods presented. Warranty Costs The Company provides an accrual for future warranty costs at the time of sale of products. The warranty for the Company's products generally covers defects in materials and workmanship for a period of one to five years. Advertising Costs The cost of advertising is expensed as incurred. For the years ended December 31, 1997, 1996, and 1995, the Company incurred advertising expenses of $3.0 million, $2.7 million, and $2.6 million, respectively. Stock Compensation The Company has elected to apply the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." Accordingly, the Company accounts for stock-based compensation using the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Compensation expense for stock options is measured as the excess, if any, of the fair value of the Company's common stock at the date of grant over the stock option exercise price. Concentrations of Credit Risk The Company is subject to concentrations of credit risk from its holdings of cash, cash equivalents, and securities. The Company's credit risk is managed by investing its cash in high-quality money market instruments, securities of the U.S. Government and its agencies, and high-quality corporate issues. In addition, a significant portion of the Company's accounts receivable are due from sales outside of the U.S. No international country accounted for more than 10% of net sales in any of the periods presented. Net Income Per Share In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." SFAS No. 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. Basic earnings per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of common and common stock equivalent shares outstanding during the period. Common equivalent shares are excluded from the computation if their effect is antidilutive. Net income per share amounts for all periods, where necessary, have been restated to conform to SFAS No. 128 requirements. The Securities and Exchange Commission (SEC) previously had requirements for common and common stock equivalent shares issued during the 12-month period prior to the filing of an initial public 80 Financial statements page 15: offering to be included in the calculation of earnings per share as if they were outstanding for all periods presented using the treasury stock method assuming the initial public offering price. In 1998, the SEC issued new requirements for dilutive common stock equivalent shares to be included in the calculation of diluted earnings per share at the fair market value of common stock outstanding during the period. In 1995, pro forma net income per share is based on the weighted average number of common and common stock equivalent shares outstanding. To calculate pro forma net income per share, net proceeds from the sale of 1,139,907 shares of common stock from the Company's initial public offering were assumed to repay the shareholder notes and to pay distributions to existing shareholders equal to the Company's undistributed S Corporation earnings through the termination of the Company's S Corporation status on August 16, 1995. These shares have been included in the calculation as if they were outstanding for all periods presented prior to the initial public offering. As a result of the adoption of SFAS No. 128, the Company's previously reported net income per share changed from $0.54 to $0.55 for the year ended December 31, 1996. As a result of the adoption of SFAS No. 128 and the new SEC requirements, the Company's previously reported pro forma net income per share changed from $0.71 to $0.73 for the year ended December 31, 1995. New Accounting Pronouncements In June 1997, Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." The Company will adopt SFAS No. 130 and 131 in the first quarter of 1998. The Company does not expect the impact of SFAS No. 130 or 131 to be material. 2. SECURITIES AVAILABLE-FOR-SALE The amortized cost of securities available-for-sale approximated fair market value and was as follows:
December 31, 1997 1996 ----------- ----------- U.S. corporate securities $6,680,463 $ 7,618,609 U.S. Government securities 4,183,938 4,069,904 ----------- ----------- $10,864,401 $11,688,513 ----------- ----------- ----------- -----------
As of December 31, 1997, the securities available-for-sale have contractual maturities of one year or less. 3. INVENTORIES Inventories consisted of the following:
December 31, 1997 1996 ----------- ----------- Raw materials $10,987,890 $ 8,003,941 Work in process 2,901,785 1,331,199 Finished goods 3,871,787 981,800 ----------- ----------- $17,761,462 $10,316,940 ----------- ----------- ----------- -----------
4. FURNITURE AND EQUIPMENT Furniture and equipment consisted of the following: 81
December 31, 1997 1996 ----------- ----------- Machinery and equipment ...................... $10,115,125 $ 8,667,873 Furniture and fixtures ....................... 5,211,871 3,666,366 Leasehold improvements ....................... 1,834,954 1,375,100 ----------- ----------- 17,161,950 13,709,339 Less accumulated depreciation and amortization ............................... 6,556,786 3,463,221 ----------- ----------- $10,605,164 $10,246,118 ----------- ----------- ----------- -----------
5. INCOME TAXES Deferred tax assets and liabilities consisted of the following at December 31, 1997 and 1996:
December 31, 1997 1996 --------- --------- Deferred tax liabilities: Depreciation ...... $(596,000) $(345,000) --------- --------- Deferred tax assets: Accrued expenses... 406,000 382,000 Inventory ......... 175,000 287,000 Other ............. 89,000 16,000 --------- --------- Total deferred tax assets... 670,000 685,000 --------- --------- --------- --------- Net deferred tax assets .... $ 74,000 $ 340,000 --------- ---------
82 Financial statements page 16: The provision for income taxes as of December 31, 1995 represents taxes on earnings for the period subsequent to August 16, 1995 (termination of S Corporation status) through December 31, 1995, which earnings aggregated $5,866,201. Components of the provision are as follows:
Year Ended Year Ended Aug. 17, 1995 to Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995 ------------- ------------- ------------- Federal income taxes: Current provision ................. $ 2,106,800 $ 3,807,600 $ 1,840,900 Deferred provision ................ 266,000 (136,000) 131,800 ----------- ----------- ----------- $ 2,372,800 $ 3,671,600 $ 1,972,700 ----------- ----------- -----------
A reconciliation between the statutory federal income tax rate and the actual provision for income taxes is shown below:
Year Ended December 31, 1997 1996 1995 ------------------------------------------------------------------------- Tax at the statutory rate........ $ 2,689,200 34.0% $ 3,771,400 34.0% $ 1,994,500 34.0% Effect of research and development tax credit........ (280,000) (3.6%) (111,400) (1.0%) -- -- Effect of foreign sales corporation .................. (357,900) (353,000) (3.2%) (149,300) (2.6%) Other ........................... 321,500 4.1% 364,600 3.3% 127,500 2.2% ----------- ---- ----------- ---- ------------ ---- $ 2,372,800 30.0% $ 3,671,600 33.1% $ 1,972,700 33.6% ----------- ---- ----------- ---- ------------ ---- ----------- ---- ----------- ---- ------------ ----
S Corporation Tax Adjustment (Unaudited) As a result of terminating its S Corporation election, the Company became subject to corporate federal income taxes subsequent to August 16, 1995. The statements of operations present, on a pro forma basis, the impact on net income and net income per share as if the Company had been subject to federal income taxes for all of 1995. The pro forma tax provisions is as follows:
Year Ended December 31, 1995 ----------------- Income before pro forma provision for income taxes .......................... $13,635,045 ----------- Current pro forma income tax provision....... $ 4,300,800 Deferred pro forma income tax provision...... 307,900 ----------- Pro forma provision for income taxes ........ $ 4,608,700 ----------- Effective tax rate .......................... 33.8% ----------- -----------
6. BANK LOAN AGREEMENT In October 1997, the Company renewed a business loan agreement with a bank. The agreement provides three credit facilities to the Company including a $5.0 million unsecured line of credit to finance any unexpected working capital requirements. The line of credit bears interest at the bank's prime rate, or at a specified IBOR rate plus 1.5%, whichever the Company chooses. The agreement also provides a $2.5 million credit facility for capital equipment purchases or general corporate purposes. Certain terms under this facility, such as interest rate, repayment period, and collateral, will be 83 determined at the time advances are made to the Company. The Company also has a $1.75 million line of credit for the purchase of foreign exchange contracts. There were no borrowings outstanding on any of the bank credit facilities at December 31, 1997. These credit facilities expire April 30, 1998. Under the terms of the business loan agreement, the Company must maintain certain financial ratios and tangible net worth. The Company is in compliance with all such covenants. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, and acquisitions. The agreement also imposes an annual capital expenditure limit of $10 million. 84 Financial statements page 17: 7. RELATED-PARTY TRANSACTIONS The Company has an agreement to receive marketing and sales services from an entity affiliated with a shareholder of the Company. Transactions are summarized as follows:
Year Ended December 31, 1997 1996 1995 -------- -------- -------- Commissions expense ...... $294,609 $371,968 $379,632 -------- -------- -------- Commissions payable at end of year ............ $ 38,090 $ 35,102 $ 31,823 -------- -------- --------
EMPLOYEE BENEFIT PLANS The Company has a qualified profit-sharing plan (the Plan) under the provisions of Internal Revenue Code Section 401(k). The Plan is available to all employees meeting the eligibility requirements. Contributions by the Company are based on a matching formula as defined in the Plan. Additional contributions are at the discretion of the Board of Directors. The Company made contributions of $51,000, $32,000, and $28,000 to the Plan in 1997, 1996, and 1995, respectively. The Company insures health care costs for its eligible employees and dependents. The Company has obtained an insurance policy to cover claims incurred during the policy year in excess of $30,000 per person. Estimated costs of all incurred claims that are not covered by insurance are recognized in the financial statements. 9. INCOME PER SHARE The following table sets forth the computation of basic and diluted income per share (pro forma income per share in 1995):
Year ended December 31, 1997 1996 1995 ----------- ----------- ----------- Numerator: Numerator for basic income per share--net income $ 5,536,651 $ 7,420,659 $ 9,026,345 ----------- ----------- ----------- Denominator: Denominator for basic income per share--weighted average common shares ........................... 12,825,949 12,881,038 11,038,356 ----------- ----------- ----------- Effect of dilutive securities: Stock options, net ................................ 575,201 730,012 608,187 Sales of common stock from the IPO assumed to repay amounts due to pre-IPO shareholders for undistributed S Corporation earnings............. -- -- 715,175 ----------- ----------- ----------- Dilutive potential common shares ..................... 575,201 730,012 1,323,362 ----------- ----------- ----------- Denominator for diluted income per share ............. 13,401,150 13,611,050 12,361,718 ----------- ----------- ----------- Basic income per share ............................ $0.43 $0.58 $0.82 ----------- ----------- ----------- ----------- ----------- ----------- Diluted income per share .......................... $0.41 $0.55 $0.73 ----------- ----------- ----------- ----------- ----------- -----------
85 10. SHAREHOLDERS' EQUITY Stock Options In April 1995, the Company established a stock option plan for the granting of incentive and non-qualified stock options (the Plan). The 86 Financial statements page 18: exercise price of incentive stock options granted under the Plan may not be less than the fair market value of the common stock on the date of grant. The exercise price of non-qualified stock options granted under the Plan may be greater or less than the fair market value of the common stock on the date of grant, as determined by the stock option committee of the Company's Board of Directors at its discretion. The Company has reserved 3,000,000 shares of common stock for issuance under the Plan. The options vest over a period determined by the Plan administrator and expire no later than 10 years after the date of grant. The following table summarizes the Company's stock option activity:
WEIGHTED SHARES SUBJECT OPTION AVERAGE TO OPTION PRICE RANGE EXERCISE PRICE -------------- ------------- -------------- Options outstanding at Jan. 1, 1995 -- Granted 1,784,700 $5.55 - 13.88 $5.64 --------- ------------- ----- Options outstanding at Dec. 31, 1995 1,784,700 $5.55 - 13.88 $5.64 Granted 367,000 $6.63 - 10.00 $8.78 Canceled (141,000) $5.55 - 10.00 $8.24 Exercised (10,000) $ 5.55 $5.55 --------- ------------- ----- Options outstanding at Dec. 31, 1996 2,000,700 $5.55 - 13.88 $6.04 Granted 1,093,000 $5.55 - 6.88 $6.32 Canceled (185,250) $5.55 - 13.88 $7.78 Exercised (56,250) $5.55 - 8.75 $5.62 --------- ------------- ----- Options outstanding at Dec. 31, 1997 2,852,200 $5.55 - 13.88 $6.04 --------- ------------- -----
At December 31, 1997, 81,550 shares of common stock were available for future grants. The following table summarizes information about options outstanding and exercisable at December 31, 1997:
Options Outstanding ------------------- WEIGHTED WEIGHTED RANGE OF OPTIONS AVERAGE REMAINING AVERAGE EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE - ------------- ----------- ----------------- -------------- $5.55 - 8.00 2,719,700 8.19 $5.89 $8.01 - 13.88 132,500 8.04 $9.14 - ------------- --------- ---- ----- $5.55 - 13.88 2,852,200 8.19 $6.04 - ------------- --------- ---- -----
Options Exercisable ------------------- WEIGHTED RANGE OF OPTIONS AVERAGE EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ------------- ------------ -------------- $5.55 - 8.00 1,730,950 $5.59 $8.01 - 13.88 35,625 $9.47 - ------------- --------- ----- $5.55 - 13.88 1,766,575 $5.67 - ------------- --------- -----
87 The Company follows the intrinsic value method in accounting for its stock options. Had compensation costs been recognized based on the fair value at the date of grant for options awarded under the Plan, the pro forma amounts of the Company's net income and net income per share for the years ended December 31, 1997, 1996, and 1995 would have been as follows:
1997 1996 1995 --------------------------------------- Net income--as reported $ 5,536,651 $ 7,420,659 $ 9,026,345 Net income--pro forma $ 4,869,064 $ 7,157,908 $ 5,236,709 Basic income per share--as reported $ 0.43 $ 0.58 $ 0.82 Basic income per share--pro forma $ 0.38 $ 0.56 $ 0.47 Diluted income per share--as reported $ 0.41 $ 0.55 $ 0.73 Diluted income per share--pro forma $ 0.36 $ 0.53 $ 0.42
88 Financial statements page 19: The fair value of each option grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: risk-free interest rates of 5.0% to 7.2%; expected option life of three years for qualified options and six years for non-qualified stock options; expected volatility of 0.45% to 0.48%; and no expected dividends. The weighted-average fair value of options granted during the years 1997, 1996, and 1995 was $2.43, $3.46, and $3.68, respectively. Initial Public Offering On August 18, 1995, the Company sold 2,500,000 shares of its common stock in an initial public offering at a price of $12.00 per share. In addition, the underwriters of the IPO exercised an option to purchase 375,000 additional shares of the Company's common stock at the same price per share. 11. COMMITMENT In December 1994, the Company entered into a lease for office and manufacturing facilities with Mackie Holdings, LLC, an entity owned by three significant shareholders and directors of the Company. The lease commenced on December 31, 1994 and expires December 31, 2004. The monthly rent under this lease is $56,613, adjusted annually for changes in the Consumer Price Index. Taxes, insurance, utilities, and maintenance are the responsibility of the Company. Future minimum rental payments under this lease and two additional leases for facilities at December 31, 1997 are as follows: 1998 $ 1,260,000 1999 1,260,000 2000 1,261,000 2001 1,274,000 2002 1,274,000 Thereafter 3,093,000 ------------ $ 9,422,000
Total rent expense for the years ended December 31, 1997, 1996, and 1995 was $1,328,000, $1,313,000, and $833,000, respectively. 89 Financial statements page 20: 12. QUARTERLY FINANCIAL DATA (UNAUDITED) In thousands, except per share data
1997 First Second Third Fourth - --------------------------------------- ------- ------- ------- ------- Net sales ............................. $16,768 $18,684 $21,596 $17,841 - --------------------------------------- ------- ------- ------- ------- Gross profit .......................... $ 6,391 $ 7,122 $ 7,850 $ 6,433 - --------------------------------------- ------- ------- ------- ------- Net income ............................ $ 1,140 $ 1,413 $ 1,818 $ 1,166 - --------------------------------------- ------- ------- ------- ------- Basic income per share ................ $ 0.09 $ 0.11 $ 0.14 $ 0.09 - --------------------------------------- ------- ------- ------- ------- Diluted income per share .............. $ 0.09 $ 0.11 $ 0.13 $ 0.09 - --------------------------------------- ------- ------- ------- -------
1996 First Second Third Fourth - --------------------------------------- ------- ------- ------- ------- Net sales ............................. $19,504 $20,779 $16,093 $16,861 - --------------------------------------- ------- ------- ------- ------- Gross profit .......................... $ 7,784 $ 7,993 $ 5,978 $ 6,269 - --------------------------------------- ------- ------- ------- ------- Net income ............................ $ 2,315 $ 2,443 $ 1,346 $ 1,316 - --------------------------------------- ------- ------- ------- ------- Basic income per share ................ $ 0.18 $ 0.19 $ 0.10 $ 0.10 - --------------------------------------- ------- ------- ------- ------- Diluted income per share .............. $ 0.17 $ 0.18 $ 0.10 $ 0.10 - --------------------------------------- ------- ------- ------- -------
1995 First Second Third Fourth - --------------------------------------- ------- ------- ------- ------- Net sales ............................. $14,270 $16,084 $16,897 $16,668 - --------------------------------------- ------- ------- ------- ------- Gross profit .......................... $ 6,437 $ 6,690 $ 7,037 $ 6,999 - --------------------------------------- ------- ------- ------- ------- Net income ............................ $ 3,398 $ 3,019 $ 2,877 $ 2,368 - --------------------------------------- ------- ------- ------- ------- Pro forma net income .................. $ 2,236 $ 1,986 $ 2,436 $ 2,368 - --------------------------------------- ------- ------- ------- ------- Pro forma basic income per share ...... $ 0.22 $ 0.20 $ 0.22 $ 0.18 - --------------------------------------- ------- ------- ------- ------- Pro forma diluted income per share .... $ 0.20 $ 0.17 $ 0.19 $ 0.17 - --------------------------------------- ------- ------- ------- -------
The 1996 and the first three quarters of 1997 basic and diluted income per share amounts have been restated to comply with SFAS No. 128, which was adopted in the fourth quarter of 1997. Pro forma basic and diluted income per share amounts for 1995 have been restated to comply with SFAS No. 128 and new SEC requirements. 90 Financial statements page 21: Report of Ernst & Young LLP Independent Auditors The Board of Directors and Shareholders Mackie Designs Inc. We have audited the accompanying consolidated balance sheets of Mackie Designs Inc. as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended DecemberE31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Mackie Designs Inc. at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Seattle, Washington February 10, 1998 Ernst & Young LLP 91 Financial statements page 22: Common Stock Information and Dividend Policy The Company's Common Stock is traded on the NASDAQ National Market System under the symbol "MKIE." The following table sets forth the high and low sale prices as reported on NASDAQ for the periods indicated. These prices do not include retail markups, markdowns or commissions.
Common Stock -------------- HIGH LOW ------ ----- Year Ended December 31, 1996 First Quarter ..... $12.25 $7.00 Second Quarter .... $12.75 $9.75 Third Quarter ..... $11.75 $6.39 Fourth Quarter .... $ 8.88 $6.00 Year Ended December 31, 1997 First Quarter ..... $ 8.00 $5.88 Second Quarter .... $ 8.88 $5.63 Third Quarter ..... $ 9.88 $7.75 Fourth Quarter .... $10.25 $6.00
As of March 6, 1998, there were 12,662,650 shares of Common Stock outstanding held by approximately 90 holders of record. The number of holders does not include individual participants in security position listings. In 1996 and 1997, the Company paid no dividends on its common stock. The Company's present policy is to retain earnings to finance the Company's business. Any future dividends will be dependent upon the Company's financial condition, results of operations, current and anticipated cash requirements, acquisition plans and plans for expansion, and any other factors that the Company's Board of Directors deems relevant. Under its bank loan agreement, the Company is prohibited from paying any dividends without prior approval from the bank. The Company has no present intention of paying dividends on its common stock in the foreseeable future. 92 Financial statements page 23: BOARD OF DIRECTORS Greg C. Mackie Chairman of the Board and Chief Executive Officer David M. Tully Secretary/Treasurer President, SMB Corporation, Issaquah, Washington Raymond B. Ferguson Consultant, Seattle, Washington Walter Goodman Consultant, Great Neck, New York C. Marcus Sorenson Partner, Blacker Sorenson Audio Group Los Alamitos, California CORPORATE OFFICERS Roy D. Wemyss Executive Vice President and Chief Operating Officer William A. Garrard Vice President Finance and Chief Financial Officer Patric L. Wiesmann Vice President Marketing and Business Development David E. Firestone Vice President Product Development Robert A. May Vice President Manufacturing SHAREHOLDER SERVICES You are invited to contact us for a variety of shareholder services or to request more information about Mackie Designs. Following are suggestions on how to contact us: Transfer Agent Our transfer agent can help you with a variety of shareholder-related services, including change of address, lost stock certificates, transfer of stock to another person, and other administrative services. Call ChaseMellon Shareholder Services, LLC at 800/522-6645, TDD (for the hearing impaired) 800/231-5469, or visit their website at www.chasemellon.com. Investor Relations You can contact Mackie's Investor Relations department any time to order an investor pack which includes this annual report, the latest Form 10-K, and other financial information. Call toll-free 800/258-6883 (Outside the United States call 425/487-4333,)send a fax to 425/487-4337, Attn: Investor Relations, or send an e-mail to investor@mackie.com. Common Stock Mackie's common stock trades on The Nasdaq Stock Market under the symbol MKIE. Independent Auditors Ernst & Young LLP Seattle, Washington Corporate Counsel Weiss, Jensen, Ellis & Howard Seattle, Washington and Portland, Oregon 93 Notice of Annual Meeting Mackie's shareholders are invited to attend our annual meeting, which will be held on Tuesday, May 19, 1998, 9:00 am, at the Columbia Winery, 14030 N.E. 145th Street, Woodinville, Washington. Other Mackie Information If you would like to receive other information about Mackie Designs such as the 80-page product catalog, accessory catalog, or other product information, please call toll-free 800/898-3211 or 425/487-4333, fax a request to 425/487-4337, or send an e-mail to LitRequest@mackie.com. Mackie Designs Inc. 16220 Wood-Red Road NE Woodinville, WA 98072, USA (425)487-4333 (Y) Fax (425)487-4337 Internet: www.mackie.com 94 Back Cover: a) Photo of temple holy man holding Mackie compact mixer. We can't speak for others in our industry, but Mackie has a very loyal following among the audio professionals who rely on our equipment--which can lead to receiving unsolicited photos like the one at right. Jimmy Waldo and D. Kendall Jones of Waterbone, a new-age format group, went to Nepal to record exotic sound effects for their new album recently released on WorldDisc Records. Naturally, they brought with them a Mackie Designs MS1402-VLZ mixer, which survived weeks of dust, humidity, smoke and the sort of general hard use that occurs when you try to run a recording studio out of your backpack. Now we get to the loyal following part. For no other reason than, "... the folks at Mackie might get a kick out of this," they posed their trusty mixer with this temple holy man. Luckily, their translator and traveling buddy was National Geographic photographer and field guide Gordon Wiltsie, who shot this magnificent photo. Then two members of the group sought us out at a trade show and gave us the photos free of charge. Just to say "thank you" for making such a dependable recording tool. 16220 Wood-Red Road NE Woodinville, WA 98072, U.S.A. Phone 425/487-4333 -Fax 425/487-4337 Internet: www.mackie.com -NASDAQ: MKIE 95 EX-21.1 6 EXHIBIT 21.1 Exhibit 21.1 SUBSIDIARIES OF MACKIE DESIGNS INC. As of December 31, 1997 State of Incorporation or Country Subsidiary in which Organized - ------------------------------------- ----------------------------------- Mackie Sales Corporation Barbados 96 EX-23.1 7 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Mackie Designs Inc. of our report dated February 10, 1998 included in the 1997 Annual Report to Shareholders of Mackie Designs Inc. Our audits also included the financial statement schedule of Mackie Designs Inc. listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-98720) pertaining to the 1995 Stock Option Plan of Mackie Designs Inc. of our report dated February 10, 1998 with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) of Mackie Designs Inc. Ernst & Young LLP Seattle, Washington March 31, 1998 97 EX-27.1 8 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MACKIE DESIGNS, INC.'S CONSOLIDATED BALANCE SHEETS AND RELATED CONSOLIDATED STATEMENTS OF INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 975,180 10,864,401 11,095,515 (481,000) 17,761,462 42,172,869 17,161,950 6,556,786 53,372,423 6,217,152 0 0 0 29,657,210 16,820,811 53,372,423 74,889,420 74,889,420 47,093,131 47,093,131 20,670,465 0 0 7,909,451 2,372,800 5,536,651 0 0 0 5,536,651 .43 .41
EX-27.2 9 EXHIBIT 27.2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MACKIE DESIGNS, INC.'S CONSOLIDATED BALANCE SHEETS AND RELATED CONSOLIDATED STATEMENTS OF INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 9-MOS 6-MOS 3-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 JAN-01-1997 JAN-01-1997 JAN-01-1997 SEP-30-1997 JUN-30-1997 MAR-31-1997 1,119,372 3,259,494 1,751,152 10,463,213 11,460,440 13,434,415 15,421,814 12,581,465 12,172,705 (995,843) (932,393) (878,023) 15,819,757 11,877,761 10,059,563 43,741,556 39,784,131 38,127,015 16,128,733 15,390,159 14,640,100 (5,753,867) (4,931,181) (4,183,074) 54,530,293 50,655,408 48,989,064 7,964,752 5,981,501 5,080,438 0 0 0 0 0 0 0 0 0 30,211,693 30,248,830 30,998,830 15,655,348 13,837,327 12,423,796 54,530,293 50,655,408 48,989,064 57,048,825 35,452,340 16,767,951 57,048,825 35,452,340 16,767,951 35,885,130 21,939,391 10,376,833 35,885,130 21,939,391 10,376,833 15,369,399 9,992,857 4,826,309 172,801 124,269 69,899 0 0 0 6,445,388 3,810,667 1,701,036 2,074,200 1,257,500 561,400 4,371,188 2,553,167 1,139,636 0 0 0 0 0 0 0 0 0 4,371,188 2,553,167 1,139,636 .34 .20 .09 .33 .19 .09 Reflects adoption in fourth quarter 1997 of FAS 128, a new standard of computing and presenting both basic and diluted net income per share.
EX-27.3 10 EXHIBIT 27.3
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MACKIE DESIGNS, INC.'S CONSOLIDATED BALANCE SHEETS AND RELATED CONSOLIDATED STATEMENTS OF INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR 9-MOS 6-MOS 3-MOS DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 DEC-31-1996 SEP-30-1996 JUN-30-1996 MAR-31-1996 2,366,184 2,779,565 3,870,830 7,486,315 11,688,513 10,995,493 11,981,442 7,742,609 10,501,035 11,824,989 14,723,229 13,983,712 (808,000) (761,089) (761,744) (625,606) 10,316,940 10,403,652 6,611,660 6,747,713 35,605,884 36,717,572 37,447,665 36,083,648 13,709,339 12,624,752 10,974,380 7,607,866 (3,463,221) (3,122,005) (2,503,119) (2,014,265) 46,255,950 46,600,435 46,304,161 41,807,605 3,585,710 5,600,836 6,660,632 4,672,281 0 0 0 0 0 0 0 0 0 0 0 0 30,998,830 30,998,830 30,998,830 30,943,330 11,284,160 9,968,269 8,621,949 6,178,994 46,255,950 46,600,435 46,304,161 41,807,605 73,235,925 56,375,346 40,282,746 19,504,089 73,235,925 56,375,346 40,282,746 19,504,089 45,210,585 34,619,414 24,505,095 11,719,629 45,210,585 34,619,414 24,505,095 11,719,639 17,324,599 12,906,252 8,843,784 4,440,263 471,000 378,844 247,303 111,164 0 0 0 0 11,092,259 9,125,668 7,113,048 3,461,393 3,671,600 3,020,900 2,354,600 1,145,900 7,420,659 6,104,768 4,758,448 2,315,493 0 0 0 0 0 0 0 0 0 0 0 0 7,420,659 6,104,768 4,758,448 2,315,493 .58 .47 .37 .18 .55 .45 .35 .17 Reflects adoption in fourth quarter 1997 of FAS 128, a new standard of computing and presenting both basic and diluted net income per share.
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