UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[ X ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to_______________
Commission file number 1-14072
PEN INTERCONNECT, INC.
(Exact name of small business issuer as specified in its charter)
UTAH 87-0430260
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
2351 South 2300 West, Salt Lake City, UT 84119
(Address of Principal Executive Offices) (Zip Code)
(801) 973-6090
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act:
Common Stock, par value $0.01 per share
Common Stock Warrants
Check whether the issuer (1) filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 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
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. X check
State issuer's revenues for its most recent fiscal year. $17,091,432
As of December 16, 1998, there were 6,068,481 shares of the Issuer's
common stock, par value $0.01, issued and outstanding. The aggregate market
value of the Issuer's voting stock held by non-affiliated of the Issuer was
approximately $8,396,384 computed at the closing quotation for the Issuer's
common stock of $1.563 as of January 11, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement for the Annual Meeting of Shareholders to
be held in 1999. Certain information therein is incorporated into Part III
hereof.
<PAGE>
FORM 10-KSB
PEN INTERCONNECT, INC.
Table of Contents
Page
PART I
1 Description of Business 3
2 Description of Property 10
3 Legal Proceedings 10
4 Submission of Matters to a Vote of Security Holders 10
PART II
5 Market for Common Equity and Related Stockholder Matters 11
6 Management's Discussion and Analysis or Plan of Operation 12
7 Financial Statements 15
8 Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 15
PART III
9 Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act 16
10 Executive Compensation 16
11 Security Ownership of Certain Beneficial Owners and Management 16
12 Certain Relationships and Related Transactions 16
13. Exhibits and Reports on Form 8-K 17
Signatures 18
<PAGE>
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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FORWARD-LOOKING STATEMENTS. This annual report contains certain forward-looking
statements within the meaning of section 27A of the Securities Act of 1933, as
amended, and section 21E of the Securities Exchange Act of 1934, as amended,
that involve risks and uncertainties. In addition, the Company may from time to
time make oral forward-looking statements. Actual results are uncertain and may
be impacted by many factors. In particular, certain risks and uncertainties that
may impact the accuracy of the forward-looking statements with respect to
revenues, expenses and operating results include without limitation; cycles of
customer orders, general economic and competitive conditions and changing
consumer trends, technological advances and the number and timing of new product
introductions, shipments of products and components from foreign suppliers, and
the timing of operating and changes in the mix of products ordered by customers.
As a result, the actual results may differ materially from those projected in
the forward-looking statements.
Because of these and other factors that may affect the Company's operating
results, past financial performance should not be considered an indicator of
future performance, and investors should not use historical trends to anticipate
results or trends in future periods.
(A) BUSINESS DEVELOPMENT
General
Pen Interconnect, Inc. (the "Company" or "Pen"), develops and produces on a
turnkey basis, interconnection and contract manufacturing solutions for original
equipment manufacturers ("OEMs") in the computer, computer peripheral,
telecommunications, instrumentation, medical and testing equipment industries
(See "Business of Issuer"). The Company currently operates four divisions: 1)
the Pen Cable division, located in Salt Lake City, Utah, offers internal and
external custom cable and harness interconnections between electronic equipment
such as computers and various external devices such as video screens, printers,
external disk drives, modems, telephone jacks and other peripheral equipment; 2)
the Incirt division, located in Irvine, California, provides sophisticated ISO
9002-certified assembly and testing services for complex printed circuit boards
and subsystems; 3) the PowerStream division, located in Orem, Utah, designs and
manufactures custom power supplies, battery chargers and uninterruptible power
supply (UPS) systems; and 4) the MotoSat division, located in Salt Lake City,
Utah, manufactures mobile satellite equipment. During fiscal year 1996 and a
portion of fiscal year 1997 the Company operated a division located in San Jose,
California (the "San Jose Division"). The San Jose Division was sold by the
Company on November 12, 1996 (See Note C of Notes to Financial Statements). The
executive offices of the Company are located at 2351 South 2300 West, Salt Lake
City, Utah 84119. The Company was incorporated under the laws of the State of
Utah on September 30, 1985.
<PAGE>
Summary of Current Year Events and Subsequent Events
Since the end of fiscal year 1998, the Company has entered into several
agreements which have had, or will have, a material impact on the Company. To
ensure that the information set forth in this Form 10-KSB is not misleading, it
is necessary to set forth these subsequent events along with a summary of the
prior year.
Over the course of fiscal year 1998, the Company experienced a lower level
of profitability than was anticipated at the beginning of the year and the
Company has consequently experienced continued cash flow problems. The lower
than expected level of profitability has been the result of several delays in
expected contracts with new customers and lower margins realized on a new
contract that yielded significantly higher sales.
For most of the year, the market price of the Company's stock was
sufficient to raise additional cash to support the negative cash flow from
operations. In addition to raising approximately $490,000 from the exercise of
stock warrants, the Company completed private placements of debentures totaling
$2.5 million. Debentures totaling $1,100,000 were issued during December of
1997, $400,000 were issued in April of 1998 and the remaining $1,000,000 were
issued in June of 1998. The debentures carry an interest rate of 3% and a
conversion feature into common stock. The conversion feature allows each $1,000
of debentures to be converted into common shares at a rate of $2.75 or 80% of
the current market price which ever is lower. (See Note P to the Financial
Statements). The difference between the market price of the stock and the price
used in conversion is considered interest expense and must be set up as a
discount against the debenture and expensed as the debentures become convertible
to stock. The offset to the discount is an increase to additional paid in
capital.
The Company signed a Letter of Intent in June of 1998 to enter into merger
discussions with Touche Electronics, Inc. (Touche), a subsidiary of TMCI
Electronics Inc. (TMCI). The intent to merge with Touche was seen by the Board
of Directors of the Company as a means to take advantage of synergies resulting
from the strategic mix of the two companies' products and vertical integration
which would result from the merger. The merger would also supply needed working
capital to help fund the operations of the Company's divisions. As business
valuations were secured by each company, the ratio of stock conversion became
less attractive to the Company and the merger was terminated.
In September of 1998 the Company entered into discussions with a
prospective buyer for the MotoSat and the Pen Technology Cable divisions because
of continued losses generated by these divisions and the lack of capital to
adequately fund and grow the business of these two divisions. Moreover, new
management determined that the MotoSat business and products did not
strategically fit the goals and directions established by the Company. The
Company has entered into a letter of intent with James Pendleton, the Company's
CEO, for the sale of the MotoSat division and anticipates this sale will be
completed in January of 1999. The sale will not generate cash proceeds to the
Company but will eliminate monthly operating losses associated with MotoSat. The
Company has also entered into a contract with Cables To Go Inc. for the sale of
the Pen Technology Cable division. The Company hopes to complete the sale of
this division in January of 1999 and anticipates that it will generate cash
proceeds to the Company in the amount of approximately $1,075,000 but will
result in a loss for financial reportisng purposes on the sale of approximately
$1 million.
In late December, the Company entered into an agreement with Laminating
Technologies, Inc. ("LTI"), whereby a newly formed subsidiary of the Company
will merge into LTI and LTI will become a wholly-owned subsidiary of the
Company. Shareholders of LTI will receive shares of common stock of the Company
in exchange for their shares in LTI. The Company and LTI have commenced
preparation of a registration statement on Form S-4. The merger is subject to
the Form S-4 becoming effective and approval of the shareholders of the
respective companies.
<PAGE>
In December 1998, the Company signed a letter of intent with Transdigiital
Communications Corporation (TCC) to negotiate a possible merger. TCC is a
privately held developer of entertainment and database systems for the
transportation markets which includes narrow bodied commercial aircraft and
cruise ships. The Company believes that its manufacturing capability will
provide vertical integration to TCC as it begins production of these database
systems for their customers while giving the Company the opportunity to
diversify its product offerings.
(B) BUSINESS OF ISSUER
1. Principal Products and Services
The Company focuses on selling products and services to OEMs interested in
utilizing contract manufacturers for some or all components incorporated in OEM
products. OEMs have been increasing their use of contract manufacturers to
provide such components and expertise in order to reduce the capital investment
necessary to manufacture such components thereby enabling the OEMs to focus
their resources on their end products.
Advances in technology of electronic products and increased unit volume
would require OEMs to invest more heavily in internal manufacturing through
increased working capital, capital equipment, labor, systems and infrastructure.
Use of contract manufacturers such as the Company allow OEMs to maintain
advanced manufacturing capabilities while minimizing overall resource
requirements. Contract manufacturers also allow OEMs to focus more sharply on
their own core competencies where they add the greatest value such as product
development and marketing.
The Company markets its products and services to its customers through
in-house salesmen and independent sales representatives. The Company's OEM
customers are located throughout the continental U.S. and Canada and certain
foreign countries.
The following is a summary of the products and markets of each of the
Company's four divisions. While the Pen Technology Cable division used to
contribute the most revenue to the Company, as stated above, the Company has
entered into a letter of intent for the sale of the Cable division.
Consequently, the Company anticipates that the Incirt Division will constitute
the greatest source of revenue for fiscal year 1999. As the primary source of
revenue going forward, the Incert division will be addressed ahead of the Cable
division.
InCirT Division
The Company's InCirT Division (Incirt) is engaged in the Electronic
Manufacturing Services Industry (EMSI) and provides sophisticated ISO
9002-certified assembly and testing services for complex printed circuit boards
and subsystems through advanced surface mount technology (SMT) manufacturing as
well as traditional through-hole assembly. These products are used primarily in
computer instrumentation, testing, and medical equipment.
The Incirt division has experienced a significant increase in sales as a
result of the contract with Alaris Medical Systems (See "Dependence on Major
Customers"). The Alaris contract, while providing a significant increase in
revenue for the Incirt division, provides for lower margins than most contracts
secured by the Incirt division. (See "Management's Discussion and Analysis or
Plan of Operation").
Pen Technology / Cable
The Pen Technology Cable division's sales consist of custom cable
interconnections developed in close collaboration with its customers. The
Company's customers include OEMs of computers including mainframes, desktops,
portables, laptops, notebooks, pens, and palmtops as well as OEMs of computer
peripheral equipment such as modems, memory cards, LAN adapters, cellular
phones, faxes and printers. Other customers include OEMs of telecommunications,
medical, instrumentation and testing equipment.
<PAGE>
Many OEMs in the computer and related industries targeted by the Cable
division increasingly rely upon outsourcing of their manufacturing. Outsourcing
allows OEMs to take advantage of the expertise and capital investments of
contract manufacturers thereby enabling companies to concentrate on their core
activities. The Cable division has extensive in-house technical capabilities and
multiple molding machines which enable the Cable division to assist its OEM
customers by quickly developing and prototyping customized interconnection
assemblies in conjunction with the customers' design staffs. The Cable division
can then efficiently produce the customized interconnections within time frames
and specialized quantities to meet its customers' needs in these rapidly
changing markets. With its U.S. domestic facilities and in-house technical
capabilities, the Company concentrates on higher margin products, which require
customization, rapid production turnaround and constant, real-time client
communication. The Company also has entered into an agreement with lower cost
foreign manufacturers in order to competitively service its customers' needs for
lower margin, high volume standardized products.
As set forth above, the Company has entered into the letter of intent with
Cable To Go, Inc. for the sale of this division. (See "Summary of Current Year
Events and Subsequent Events").
PowerStream Division
The PowerStream division designs custom power supplies, battery chargers
and UPS systems for OEMs and has been able to produce several of those designs
for sale to other companies. It is expected that a major share of the Company's
future business will come from this division and market. Since the Company
acquired the PowerStream division, sales of PowerStream products grew from an
average monthly amount of $42,935 for FY 98 to $270,000_ for the month of
December, 1998. The division has a major contract with L3 Communications which
is expected to yield significant sales in the next fiscal year. (See "Dependence
on Major Customers"). The power supply units being supplied to L3 are being
manufactured in China. Contracts with other customers are manufactured by
domestic contract manufacturers.
PowerStream has no material backlog of orders but suffers instead from
delays by their customers in the projected shipping dates for orders placed.
These delays have resulted from product modifications, testing by the customers
of the products they are purchasing and securing quality approvals from various
customer and independent agencies. Most delays have been remedied and greater
sales are now beginning to materialize.
MotoSat Division
The MotoSat division manufactures satellite receivers for mobile homes and
yachts. This division markets its products primarily to distributors of mobile
homes and boats with a small percentage being sold to electronics distributors.
Marketing projections show that the recreational vehicle business will grow
substantially in the coming years as the "Baby Boom" generation expands
significantly into this consumer market. In addition, many retired persons are
choosing recreational vehicles as their main means of housing in their golden
years which affords low cost and mobility.
<PAGE>
MotoSat has also been developing mobile satellite technology allowing
signals to continue to be received as the mobile home or boat receiving the
signal is in motion. This technology is still in the development stage but will
add to the marketability of MotoSat's products once it is developed. Projected
completion on the continual tracking technology is for fiscal year 1999.
The Company has entered into a letter of intent for the sale of the MotoSat
division. (See "Summary of Current Year Events and Subsequent Events").
2. Distribution Methods
The Company receives orders directly from OEM's and ships the product
directly to them. No other distribution method is employed.
3. Status of Publicly Announced New Products
None
4. Competitive Business Conditions
The Company's primary products and services are sold to OEM's in high
technology industries. The computer industry in particular has been under
intense pressure to provide faster and more powerful products at a lower cost.
Consequently, many contracts calling for large production runs are now being
processed in the Pacific Rim countries due to favorable labor rates. To
compensate for this shift to overseas manufacturing, the Cable division must
focus on short run business with short turnaround times as its strategic focus.
Many other domestic cable companies have also adopted this strategy so
competition remains strong in this area. Sales have declined 44% in the Cable
division over the last year. The drop in business has primarily come from losing
major contracts to overseas producers and from a delay in new contracts
materializing into expected sales.
The remaining sales after the loss of contracts to overseas manufacturers
includes a contract with Unisys, accounting for approximately 40% of the Cable
division's average monthly sales, for various types of cables which are short
production runs in general and will exist over a long period of time.
PowerStream has only a small number of competitors. Furthermore, the
Company has a policy of flexibility in working with customers on product
modifications and the PowerStream products are competitively priced. As a
result, PowerStream has been successful in securing contracts for its products.
The MotoSat division has developed a good reputation among the recreational
vehicle industry. Furthermore, there are not many competitors for this market.
Marketing efforts focus on advertising in industry publications and displays at
RV shows which MotoSat has participated in.
5. Sources and Availability of Raw Material
There are a large number of vendors which provide the raw materials used by
all of the Company's divisions and the Company does not foresee any shortages or
other restrictions on the availability of the necessary raw materials. The
Company's principal suppliers are Arrow Electronics, Praegitzer Industries,
Future Electronics and Winonics which are all associated with the Incirt
Division which contributed 71% of the Company's sales in fiscal year 98.
<PAGE>
The availability of raw materials has been hampered by the lack of cash
flow and the corresponding inability to pay vendors in a timely manner. As a
result of slow or untimely payments to vendors, some vendors have withheld
necessary raw materials until payments have been brought current. The impact of
this is potential delays in meeting customer shipping deadlines, incurring
overtime expenses to comply with customer shipping schedules and more expensive
freight costs to have materials arrive in a timely manner, all of which
negatively impact profitability. Through the divestiture of the Cable and
MotoSat divisions, the merger opportunities with TCC and LTI, and securing new
sales orders through an expanded sales staff, the Company expects to create a
positive cash flow which will allow for timely payment for the raw materials.
6. Dependence on Major Customers
The Company sells its products and services principally to OEMs. Because
the products are not sold at retail to the public, the Company is always
dependent on having supply contracts with OEMs. Consequently, at any given time
the Company can be dependent on one or a few major customers until new contracts
can be secured.
During the past year, sales of the Incirt division's medical application
SMT has grown substantially with the short-term expansion of a contract with
Alaris Medical Systems. This contract expansion generated 24% of the Company's
total revenues for fiscal year 1998. The increase in sales to Alaris will
subside to levels existing before the contract expansion as it expires at the
end of December, 1998. Total sales to Alaris Medical Systems comprised
approximately 59% of the Company's sales in fiscal year 1998 and sales to Alaris
are projected to comprise approximately 47% of the Company's sales in fiscal
year 1999 based on the existing customer base. The loss of this customer would
impair the Company's ability to continue operating. As the contract expansion
winds down, it is critical that Incirt replace the Alaris contract expansion
with other contracts that have higher margins. The Company is currently
investing in efforts to build its marketing and sales force to assist in this
effort.
The Company's PowerStream Division also has significantly increased its
sales as a result of a contract with L3 Communications. Fiscal year 1999
projections for L3 comprise 35% of the total projected revenues for PowerStream.
7. Intellectual Property
The Company, through its PowerStream division, has submitted applications
for patents on various technologies developed by PowerStream. These applications
are pending and are in various stages of evaluation at the end of fiscal year
1998.
The Company does not have any other intellectual property.
8. Need For Governmental Approval
None of the Company's products require governmental approval.
9. Effect of Governmental Regulation on Business
The Company is not aware of any existing governmental regulation and does
not anticipate any governmental regulation which materially affects the
Company's ability to conduct its business operations.
<PAGE>
10. Research and Development
The Company shows an increase in research and development costs in fiscal
year 1998 which is related to an entire years of operations for the PowerStream
division in FY 98 as opposed to six months of operations in FY 97.
11. Compliance with Environmental Laws
The Company has not incurred, and does not presently anticipate incurring,
any material costs in complying with all federal and state environmental laws.
12. Employees
As of September 30, 1998, the Company employed approximately 279 full and
part-time employees. Seven employees were executive personnel, 14 were technical
and engineering personnel, 9 were in marketing and sales, 220 were in
manufacturing, and 29 were administrative, accounting, information systems, and
clerical personnel. The number of employees at September 30, 1998 represents
approximately a 43% increase from September 30, 1997. This increase was
primarily due to the increase in manufacturing employees at the Incirt division
relating to the increase in the Alaris contract. The increase in administrative
and clerical employees represents additional buyers, an accounting clerk and a
receptionist to handle the increased workload from the Alaris contract.
<PAGE>
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ITEM 2. DESCRIPTION OF PROPERTY
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FACILITIES
In July of 1998, the Incirt division moved into a new manufacturing and
office facility in Irvine, California. This new facility consists of 51,400
square feet of which 46,400 is currently being used; 35,000 square feet of
manufacturing space and 16,400 of office space. The expansion capacity can be
converted into both office and manufacturing space as the need arises. The lease
on the property runs until July of 2005.
The Company maintains manufacturing and administrative facilities in Salt
Lake City, Utah under a lease which expired September 30, 1998. The Company is
still in negotiations with the landlord on a new lease agreement. The leased
facilities contains 40,500 square feet of space, of which 3,000 square feet are
utilized for sales and administration and 37,500 square feet are dedicated to
manufacturing, material control, quality control and the machine shop for
prototype development. As part of the negotiations for renewing the lease and
efforts to control costs, the Company will reduce the space it is leasing so as
to permit current and projected production levels and compensate for a projected
increase in the price per square foot to be paid under the new contract. It is
estimated that the net impact of the new lease agreement for the Cable division
will net the same monthly lease expense as the previously expired lease. The
reduced space will primarily involve a realignment of non-manufacturing space
and warehouse space. As previously mentioned, the Company has signed a letter of
intent to sell the Cable and MotoSat divisions which both use this facility. The
sale of these divisions would eliminate the rent on this facility.
The PowerStream division's sales and engineering facilities are located in
Orem, Utah, under a lease which expires in February 2001, which management
intends to extend. The premises contains approximately 5,200 square feet of
space, all of which is utilized for sales, research, development, prototype
production and administration. The annual rental is approximately $29,400.
Management believes that the above properties and their contents are
adequately covered by insurance and that the square footage is sufficient to
meet the Company's needs.
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ITEM 3. LEGAL PROCEEDINGS
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Currently, there are no legal proceedings against the Company of a material
nature.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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The annual shareholder's meeting was held in August of 1998. At the
meeting, the shareholders were asked to vote on the following matters: (i) the
nomination and election of the directors; (ii) to approve the Company's public
accountants; (iii) to ratify the issuance of convertible debentures and
warrants; and (iv) to ratify the issuance and grant of stock options to certain
of the Company's officers and directors entitling such individuals to acquire up
to 675,500 shares of the Company's common stock. All matters put to a vote of
the shareholders were approved. There were no other matters voted on by the
shareholders in the fourth quarter.
<PAGE>
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDERS MATTERS
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The common stock and warrants of the Company are listed on the National
Association of Securities Dealers Automated Quotation system ("NASDAQ"), under
the symbol "PENC" for the common stock and "PENCW" for the warrants. The common
stock and warrants were first publicly traded on November 17, 1995.
The following table sets forth the range of high and low bids for the
common stock of the Company since the Company's common stock and warrants began
active trading on the NASDAQ.
Common Stock Schedule
Fiscal Year 1998 Quarter Ended High Low
------------------------------ ------ -----
September 30, 1998 $ 2.22 $ 0.81
June 30, 1998 3.09 1.88
March 31, 1998 3.19 2.50
December 31, 1997 3.13 1.88
Fiscal Year 1997 Quarter Ended High Low
------------------------------ ----- ------
September 30, 1997 $ 2.50 $ 1.13
June 30, 1997 1.88 1.38
March 31, 1997 2.75 0.88
December 31, 1996 3.38 1.94
On December 16, 1998, the closing quotation for the common stock on NASDAQ
was $1.938 per share. As of December 16, 1998, there were 6,068,481 shares of
common stock issued and outstanding, held by approximately 1135 shareholders of
record, including several holders who are nominees for an undetermined number of
beneficial owners.
The following table sets forth the range of high and low bids for the
warrants of the Company during the periods indicated since the Company's
warrants began trading on the NASDAQ.
Warrants Schedule
Fiscal Year 1998 Quarter Ended High Low
------------------------------ ----- ------
September 30, 1998 $ 0.38 $ 0.13
June 30, 1998 0.44 0.19
March 31, 1998 0.61 0.31
December 31, 1997 0.81 0.25
Fiscal Year 1997 Quarter Ended High Low
------------------------------ ----- ------
September 30, 1997 $ 0.56 $ 0.22
June 30, 1997 0.69 0.38
March 31, 1997 0.81 0.44
December 31, 1996 1.00 0.44
<PAGE>
On December 16, 1998, the closing quotation for the warrants on NASDAQ was
$0.325 per warrant. As of December 16, 1998, there were issued and outstanding
warrants to purchase 5,409,382 shares.
The trading volume of the common stock and warrants of the Company is
limited, creating significant changes in the trading price of the common stock
and warrants as a result of relatively minor changes in the supply and demand.
Consequently, potential investors should be aware that the price of the common
stock and warrants in the trading market can change dramatically over short
periods as a result of factors unrelated to the operations, earnings and
business activities of the Company.
The Company has not paid any dividends with respect to its common stock and
does not anticipate paying any dividends in the near future. The Company's
credit facility with its bank prohibits the payment of dividends without the
consent of the bank.
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION
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The following discussion and analysis provides certain information which
the Company's management believes is relevant to an assessment and understanding
of the Company's results of operations and financial condition for the fiscal
years ended September 30, 1998 and 1997. This discussion and analysis should be
read in conjunction with the Company's financial statements and related
footnotes.
Results of Operations
The acquisition of the net assets of PowerStream Technology, Inc.
("PowerStream"), which was effective as of April 1, 1997 has been accounted for
as a purchase. The statement of operations data for the fiscal year ended
September 30, 1997 includes the results of operations of PowerStream since April
1, 1997.
The San Jose Division was acquired on March 24, 1995 and was accounted for
as a purchase. The division was subsequently sold effective November 1, 1996.
The statement of operations data for the fiscal year ended September 30, 1997
includes the results of operations of the San Jose Division for one month.
Net sales. Net sales for the Company decreased $1,147,028 (6.3%) from
$18,238,460 for fiscal year 1997 to $17,091,432 for the fiscal year ended
September 30, 1998. The decrease is primarily the result of continual declines
in sales of the cable division. Sales in 1998 for the Cable division were $3.8
million compared to $6.9 million in 1997. This decline was offset by an increase
in sales for the Incirt division of $2.7 million for the same period. The
decline in sales for the cable division has been a result of delays in expected
contracts for new orders. The decline in sales at the Cable division was offset
by an increase in sales at Incirt as a result of a contract expansion with
Alaris Medical Systems. Monthly sales averaging approximately $700,000 in the
third quarter increased to an average of approximately $1.5 million by the end
of fiscal year 1998. The increased volume at Incirt is not expected to remain
throughout the next year and will return to the level which existed before
unless new orders are obtained.
<PAGE>
Cost of sales. Cost of sales as a percentage of net sales has decreased from
approximately 96% in fiscal year 1997 to 93% in fiscal year 1998. This decrease
in costs was primarily attributable to the Cable Division as a result of
significant reserves for inventory obsolescence booked in fiscal year 97 and the
loss of production contracts which had very low margins due to competitive
pricing.
Operating expenses. Operating expenses increased from $3,659,583 in 1997 to
$4,736,421 in 1998 for a total increase of $1,076,838. This increase resulted
from the following areas: 1) an increase of $290,089 in research and development
costs based on an entire years operations for the PowerStream division in FY 98
vs. six months in FY 97. 2) an increase in general and administrative expenses
totaling $432,165 resulting from an increase in legal and accounting fees
associated with merger and acquisition negotiations as well as the issuance of
the debentures. General and administrative expenses also increased due to
clerical staff increases at Incirt as a result of the higher sales volume
associated with the expanded Alaris contract and a reclassifying of $100,000 in
salaries and benefits from marketing expense in FY 97 to general and
administrative expense in FY 98 3) a decline in sales and marketing expenses of
$242,022 as a result of cash flow restrictions and reclassifying $100,000 of
salaries and benefits from marketing expense in FY 97 to general and
administrative in FY 98 due to a change in assignment. 4) a decrease in
abondoned lease fees of $195,226 which represents a payment made on the sale of
the San Jose division in FY 97 and 5) an increase in depreciation and
amortization expense of $220,867 resulting from normal acquisitions of fixed
assets during the year and a full years amortization of research and development
at PowerStream compared to a partial year for FY 97 when much of the R&D costs
were being incurred. 6). An adjustment for impairment of investment assets
totaling $303,351 and intangible assets totaling $267,414.
Other income and expenses. The Company experienced an increase in other income
and expenses totaling $1,209,240 from ($69,162) in fiscal year 1997 to
$1,140,078 in fiscal year 98. This increase stems from two primary sources: 1)
the fiscal year 1997 statements included a gain on the sale of the San Jose
division totaling $611,912 which is not included in the fiscal year 1998
statements and 2) interest expense totaling $541,052 resulting from the issuance
of debentures. The difference between the market price of the stock and the most
favorable conversion price stated in the debenture at the time the debentures
are issued is considered as additional interest expense and must be recognized
over the period until the debentures are convertible into shares of common stock
Net loss and loss per share. Net losses increased to ($5,445,383) ($1.24) per
share in fiscal year 98 from ($1,735,483) ($0.54) per share in fiscal year 1997
or an increase of ($3,709,900) ($0.70). This increased loss resulted from the
following: the gain on the sale of the San Jose division which was recorded in
fiscal year 1997 for $611,912 with no corresponding entry in FY 98, the
increased interest expense of $541,052 associated with the debentures recorded
in fiscal year 1998, the negative adjustment of $1,071,211 to tax and investment
assets due to impaired value to the Company, the increase in operating expenses
of $1,076,838 and a tax benefit of $1,109,600 recorded in FY 97 which was not
repeated in FY 98. Shares issued during the year total 945,574: 245,000 from the
conversion of warrants, 689,332 from the conversion of debentures and 11,242
from other miscellaneous issues.
<PAGE>
Liquidity and Capital Resources
During fiscal year 1997 and fiscal year 1998, the Company has sustained
losses from operations which has consumed rather than provided cash. The Company
has had to raise working capital through the issuance of stock and debentures to
meet its obligations. In addition to raising approximately $490,000 from the
exercise of stock warrants, the Company completed private placements of
debentures totaling $2.5 million. Debentures totaling $1,100,000 were issued
during December of 1997, $400,000 were issued in April of 1998 and the remaining
$1,000,000 were issued in June of 1998. Of these debentures, $1,000,000 were
converted into shares of common stock in fiscal year 1998 and another $550,000
have been subsequently converted in fiscal year 1999. The conversion of these
debentures increases the shareholder equity and net tangible assets of the
Company and reduces the interest charge.
In signing the Letter of Intent with Touche, the stock price of the
Company's common shares became linked in market perception with the stock price
of Touche's shares. Subsequent to the signing of the Letter of Intent, Touche
experienced a 50% decline in the price of their common stock. The decline had a
similar impact on the price of the Company's common stock which dropped from
$2.12 on June 1, 1998 to $1.00 on September 30, 1998 and $0.81 on October 26.
With the expiration of the Letter of Intent to merge with Touche, the Company's
stock is now independent of Touche's stock price.
The Company received a notice from NASDAQ questioning compliance with a
market capitalization requirement of $4 million of non-affiliated stock holders
for continued NASDAQ listing. The Company subsequently enlisted the help of an
investor relations firm to assist in marketing its stock to the investment
community. The Company believes that it now meets this requirement and, at the
request of NASDAQ, has requested a hearing to confirm this compliance. As of the
date of this report, the hearing has not been scheduled. However, after
completing the analysis in producing the attached financial statements, it
appears that the Company's net tangible assets as of September 30, 1998 will
fall below the amount of $4 million required for continued listing on NASDAQ.
The Company is currently engaged in acquisition and financing activities which
the Company's management believes will restore the required level of net
tangible assets. However, these activities have not been completed as of the
date hereof and there can be no assurance that the Company will acquire
sufficient net tangible assets tomaintain its NASDAQ National Market listing. In
such event, the Company's stock might be listed for trading on the NASDAQ Small
Cap market.
Because of the lower price of the stock it is more difficult for the
Company to raise funds in the capital markets and thus meet its financial
obligations. As a result, the Company has entertained recent proposals for
merger with other companies which should supply needed cash and/or strengthen
the price of the stock. Notwithstanding a strengthening of the Company's stock
price through merger and/or acquisition, the need remains to eliminate the
causes of continual losses from operations and generate cash from operations. To
accomplish this, the Company is in various stages of discussions on selling the
Cable and MotoSat divisions which are considered by management to be the
greatest sources of depletion of working capital and would require the most
investment of working capital and time to transform them into contributors of
positive cash flow.
The Incirt division has recently gone from being a cash supplier to a cash
consumer as a result of the Alaris contract expansion. This contract has low
gross margins built into it yet requires additional overhead to sustain the
higher volumes of sales. With the end of this short-term production expansion,
the Company is directing its efforts to generating new customers. As of the date
of this report, no firm commitments from new customers are in place.
The PowerStream division which has consumed cash since its acquisition in
fiscal year 1997 has now become a cash supplier to the Company due to sales to
L3 which began is December of 1998.
<PAGE>
In summary, the Company continues to incur losses and suffers from
inadequate cash flow. There can be no assurances that the Company will be able
to obtain further funds from issuing equities as in fiscal year 1998. Management
believes that a combination of new and more profitable sales contracts for the
Incirt division, divesting the Company of the Cable and MotoSat divisions,
recognition of sales from the L3 contract with PowerStream and acquisition
and/or merger opportunities with other companies is necessary for the Company to
build a strong financial foundation for future growth. The Company cannot,
however, guarantee that any or all of the factors will occur in a timely manner.
Seasonality of business
None of the segments of the Company is materially impacted by seasonal
fluctuations on sales.
Backlog of orders
The only material backlog of orders exists at the Incirt division in
relation to the Alaris contract. The expansion of the contract with Alaris has
created a backlog position for most of the year. The Company anticipates this
backlog will be eliminated by the end of January, 1999 when the expansion of the
contract will expire and production will be caught up. The cash flow
restrictions mentioned earlier have contributed to the delay in resolving this
backlog.
Year 2000 Readiness
In general, the Year 2000 issue relates to computers and other systems
being unable to distinguish between the years 1900 and 2000 because they use two
digits, rather than four, to define the applicable year. Systems that fail to
properly recognize such information will likely generate erroneous data or cause
a system to fail possibly resulting in a disruption of operations. The Company's
products do not incorporate such date coding so the Company's efforts to address
the Year 2000 issue fall in the following three areas: (i) the Company's
information technology ("IT") systems; (ii) the Company's non-IT systems (i.e.,
machinery, equipment and devices which utilize technology which is "built in"
such as embedded microcontrollers); and (iii) third-party suppliers. Management
has initiated a program to prepare for compliance in these three areas and
expects such program to be implemented and completed by June 1999. Costs will be
expensed as incurred and currently are not expected to be material.
The Company believes its current IT systems, with a few exceptions which
are being addressed, are year 2000 compliant. The Company is currently
conducting an inventory of non-IT systems which may have inadequate date coding
and will commence efforts to remedy any non-compliant systems by the end of the
first quarter of 1999. Third party suppliers and customers present a different
problem in that the Company cannot control the efforts of such third parties.
The Company anticipates requesting confirmations from third party suppliers that
they are year 2000 compliant to avoid disruptions of services and supplies.
However, any failure on the part of such companies with whom the Company
transacts business to be year 2000 compliant on a timely basis may adversely
affect the operations of the Company.
The foregoing statements are based upon management's current assumptions
- - --------------------------------------------------------------------------------
ITEM 7. FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
The financial statements and supplementary data are included beginning at
page F1.
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
PEN INTERCONNECT, INC
Report of Independent Certified Public Accountants 1
Financial Statements
Balance Sheets as of September 30, 1998 and 1997 3
Statements of Operations for the Years Ended
September 30, 1998 and 1997 4
Statement of Stockholders' Equity for the Years Ended
September 30, 1998 and 1997 5
Statements of Cash Flows for the Years Ended
September 30, 1998 and 1997 6
Notes to Financial Statements 10
<PAGE>
REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Pen Interconnect, Inc.
We have audited the accompanying balance sheets of Pen Interconnect, Inc. (a
Utah Corporation), as of September 30, 1998 and 1997, and the related statements
of operations, stockholders' equity, and cash flows for the years then ended.
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 audits 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 financial position of Pen Interconnect, Inc., as of
September 30, 1998 and 1997, and the results of its operations and its cash
flows for the years then ended, in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note B to the
financial statements, the Company has suffered recurring losses from operations
and as of September 30, 1998, the Company's current liabilities exceeded its
current assets by $1,714,606. These factors, among others, as discussed in Note
B to the financial statements, raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note B. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
Grant Thornton LLP
Salt Lake City, Utah
January 12, 1999
F-2
<PAGE>
Pen Interconnect, Inc.
BALANCE SHEETS
September 30,
ASSETS
1998 1997
-------------- --------------
CURRENT ASSETS
Cash and cash equivalents ........................ $ 657,777 $ 272,148
Receivables (Notes D and I)
Trade accounts, less allowance for doubtful
accounts of $108,575 in 1998 and $137,058
in 1997 ..................................... 3,350,970 2,093,056
Current maturities of notes receivable
(Notes C and E) ............................. 35,675 357,006
Inventories (Notes F and I) ...................... 3,680,169 3,355,871
Investments (Note C) ............................. 242,739 400,000
Prepaid expenses and other current assets ........ 261,375 289,991
Deferred income taxes (Note L) ................... 41,324 141,324
----------- -----------
Total current assets ...................... 8,270,029 6,909,396
----------- -----------
PROPERTY AND EQUIPMENT, AT COST
(Notes I, J and K)
Production equipment ........................... 2,624,513 2,418,368
Furniture and fixtures ........................... 837,594 834,971
Transportation equipment ......................... 83,522 69,217
Leasehold improvements ........................... 613,248 368,137
----------- -----------
4,158,877 3,690,693
Less accumulated depreciation .................... 1,680,266 1,303,063
----------- -----------
2,478,611 2,387,630
OTHER ASSETS
Notes receivable, less current maturities
(Notes C and E) ................................ 3,989 607,524
Deferred income taxes (Note L) ................... 725,667 1,392,658
Goodwill and other intangibles, net of accumulated
amortization (Note Q) .......................... 2,031,685 2,287,146
Investments (Note C) ............................. 482,220 --
Other ............................................ 98,455 322,630
----------- -----------
3,342,016 4,609,958
----------- -----------
$14,090,656 $13,906,984
=========== ===========
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
Pen Interconnect, Inc.
BALANCE SHEETS - CONTINUED
September 30,
LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997
-------------- --------------
CURRENT LIABILITIES
Notes payable (Note G) ....................... $ -- $ 641,505
Bridge loan (Note H) ......................... -- 100,000
Line of credit (Note I) ...................... 4,064,361 2,237,690
Subordinated debentures (Note P) ............. 1,401,429 --
Current maturities of long-term
obligations (Notes I and J) ................ 1,132,538 263,255
Current maturities of capital leases (Note K) 69,621 66,464
Accounts payable ............................. 2,926,797 2,053,348
Accrued liabilities .......................... 389,889 481,356
------------ ------------
Total current liabilities ............. 9,984,635 5,843,618
LONG-TERM OBLIGATIONS, less current
maturities (Notes I and J) .................... 51,965 681,722
CAPITAL LEASE OBLIGATIONS,
less current maturities (Note K) .............. 22,333 70,889
DEFERRED INCOME TAXES (Note L) ................... 165,755 165,755
------------ ------------
Total liabilities ..................... 10,224,688 6,761,984
COMMITMENTS AND CONTINGENCIES (Notes K, M and N) . -- --
STOCKHOLDERS' EQUITY (Notes C, I, M and P)
Preferred stock, $0.01 par value,
authorized 5,000,000 shares, none issued .... -- --
Common stock,$0.01 par value,
authorized 50,000,000 shares; issued and
outstanding 5,018,437 shares in 1998
and 4,072,863 shares in 1997 ................ 50,184 40,729
Additional paid-in capital ................... 10,890,022 8,733,126
Accumulated deficit .......................... (7,074,238) (1,628,855)
------------ ------------
Total stockholders' equity ............ 3,865,968 7,145,000
============ ============
$ 14,090,656 $ 13,906,984
============ ============
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
Pen Interconnect, Inc.
STATEMENTS OF OPERATIONS
Year ended September 30,
1998 1997
--------------- ---------------
Net sales (Note D) ............................. $ 17,091,432 $ 18,238,460
Cost of sales .................................. 15,892,456 17,493,122
------------ ------------
------------ ------------
Gross profit ........................ 1,1,98,976 745,338
Operating expenses
Sales and marketing ........................ 565,185 807,207
Research and development ................... 550,843 260,554
General and administrative ................. 2,357,875 1,925,710
Abandoned lease fees (Note C) .............. 16,000 211,226
Asset impairment charges (Notes Q and R) ... 570,765 --
Depreciation and amortization .............. 675,753 454,886
------------
------------
Total operating expenses ............ 4,736,421 3,659,583
------------ ------------
Operating loss ...................... (3,537,445) (2,914,245)
Other income (expense)
Interest expense (Note P) .................. (1,100,717) (612,143)
Gain on sale of division (Note C) .......... -- 611,912
Other income (expense) net ................. (39,361) 69,393
------------ ------------
(1,140,078) 69,162
------------ ------------
Loss before income taxes ............ (4,677,523) (2,845,083)
Income tax expense (benefit) (Note L) .......... 767,860 (1,109,600)
------------ ------------
NET LOSS ............................ $ (5,445,383) $ (1,735,483)
============ ============
Loss per common share (Note O)
Basic ...................................... $ (1.24) $ (0.54)
Diluted .................................... (1.24) (0.54)
Weighted-average common and dilutive
common equivalent shares outstanding
Basic .................................... 4,397,490 3,213,089
Diluted .................................... 4,397,490 3,213,089
The accompanying notes are an integral part of these statements.
F-5
<TABLE>
<CAPTION>
<PAGE>
Pen Interconnect, Inc.
STATEMENT OF STOCKHOLDERS' EQUITY
Years ended September 30, 1998 and 1997
Retained
earnings
Common Stock Additional (accumu-
--------------------------
Number paid-in lated
of shares Amount capital deficit) Total
------------ ----------- -------------- -------------- ---------------
------------ ----------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Balances at October 1, 1996 ................ 3,033,407 $ 30,334 $ 7,431,669 $ 106,628 $ 7,568,631
Common stock issued in acquisition
(Note C)................................... 150,000 1,500 223,500 - 225,000
Contingent common stock issued in
acquisition (Note C)...................... 55,568 556 82,796 - 83,352
Common stock issued in payment of notes
payable.................................. 88,888 889 103,111 - 104,000
Common stock issued upon exercise of
warrants (Note M)........................ 745,000 7,450 892,050 - 899,500
Net loss.................................... - - - (1,735,483) (1,735,483)
------------ ----------- -------------- --------------- ---------------
Balances at September 30, 1997............ 4,072,863 40,729 8,733,126 (1,628,855) 7,145,000
Common stock issued as
compensation........................... 10,833 108 28,953 - 29,061
Common stock issued upon
conversion of subordinated
debentures (Note P)...................... 689,332 6,893 993,107 - 1,000,000
Common stock issued upon exercise of
warrants (Note M)....................... 245,000 2,450 487,549 - 489,999
Favorable conversion feature of
subordinated debentures (Note P)........ - - 639,623 - 639,623
Common stock issued as interest on
subordinated debentures (Note P)........ 409 4 7,664 - 7,668
Net loss................................... - - - (5,445,383) (5,445,383)
============ =========== ============== ============== ===============
Balances at September 30, 1998............. 5,018,437 $ 50,184 $ 10,890,022 $ (7,074,238) $ 3,865,968
============ =========== ============== ============== ===============
The accompanying notes are an integral part of this statement.
F-8
</TABLE>
<PAGE>
Pen Interconnect, Inc.
STATEMENTS OF CASH FLOWS
Year ended September 30,
1998 1997
-------------- --------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities
Net loss ................................. $ (5,445,383) $ (1,735,483)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization ........ 675,753 454,886
Amortization of favorable conversion feature
on subordinated debentures charged to
interest expense .................. 541,052 --
Allowance for bad debts .............. (28,482) (118,339)
Allowance for obsolete inventory ..... 634,497 16,641
Deferred income taxes ................ 766,991 (1,068,227)
Loss on disposal of property and equipment (2,779) --
Asset impairment charges ............. 570,765 --
Stock issued in payment of compensation 29,061 --
Stock issued in payment of interest .. 7,668 --
Gain on sale of division ............. -- (611,912)
Changes in assets and liabilities
Trade accounts receivable ........ (1,269,432) 1,624,593
Inventories ...................... (958,795) 1,187,444
Prepaid expenses and other current asset (168,165) 62,929
Other assets ..................... 30,760 (240,362)
Accounts payable ................. 873,449 (793,139)
Accrued liabilities .............. (91,467) (722,971)
Income taxes ..................... -- 228,341
---------- ----------
Total adjustments ............. 1,610,876 19,884
---------- ----------
Net cash used in
operating activities ........ (3,834,507) (1,715,599)
---------- ----------
Cash flows from investing activities
Purchase of property and equipment ....... (449,814) (243,097)
Issuance of notes receivable ............. -- (49,730)
Collection on notes receivable ........... 24,866 5,616
Proceeds from sale of investments ........ 395,690 --
---------- ----------
Net cash used in
investing activities ........ (29,258) (287,211)
---------- ----------
<PAGE>
(Continued)
Pen Interconnect, Inc.
STATEMENTS OF CASH FLOWS - CONTINUED
Year ended September 30,
1998 1997
-------------- -------------
Cash flows from financing activities
Proceeds from notes payable ................. -- 902,469
Principal payments on notes payable ......... (641,505) (144,244)
Principal payments on bridge loans .......... (100,000) --
Proceeds from issuance of subordinated
debentures................................. 2,500,000 --
Net change in line of credit ................ 1,826,671 (2,732,174)
Proceeds from long-term obligations ......... 500,000 1,000,000
Principal payments on long-term obligations . (260,474) (128,390)
Principal payments on capital leases ........ (65,297) --
Proceeds from sale of division .............. -- 2,000,000
Exercise of warrants ........................ 489,999 899,500
Stock issued in acquisition of assets ....... -- 308,352
----------- -----------
Net cash provided by
financing activities ........... 4,249,394 2,105,513
----------- -----------
----------- -----------
Net increase in cash
and cash equivalents ........... 385,629 102,703
Cash and cash equivalents at beginning of year ..... 272,148 169,445
=========== ===========
Cash and cash equivalents at end of year ........... $ 657,777 $ 272,148
=========== ===========
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest .................................... $ 605,627 $ 627,522
Income taxes ................................ 869 800
Noncash investing and financing activities
Favorable conversion feature of subordinated debentures
As discussed in Note P - Subordinated Debentures, the Company recognized charges
related to the favorable conversion feature of the subordinated debentures
issued during fiscal 1998. The favorable conversion feature was recognized as a
deferred charge against the subordinated debenture balance with an offset to
additional paid-in capital. The deferred charge is being amortized over a period
corresponding to the time restrictions on conversion of the debentures into
stock. The amortization of the favorable conversion feature is recognized as
interest expense. At September 30, 1998, recognition of the favorable conversion
feature and subsequent amortization has resulted in a $541,052 increase in
interest expense, a $98,571 decrease in subordinated debentures, and a $639,623
increase in additional paid-in capital.
F-11
<PAGE>
(Continued)
Pen Interconnect, Inc.
STATEMENTS OF CASH FLOWS - CONTINUED
Years ended September 30, 1998 and 1997
Noncash investing and financing activities - continued
Conversion of subordinated debentures and notes payable
During fiscal 1998, convertible debentures in the amount of $1,000,000 were
converted into 689,332 shares of common stock.
During fiscal 1997, 88,888 shares of common stock were issued in payment of
notes.
Notes receivable and investments
During fiscal 1998, the Company received stock in another company with a
guaranteed value of $1,024,000 as satisfaction for $900,000 of notes receivable,
$84,000 of accrued interest, and $40,000 of accounts receivable.
Acquisition of PowerStream Technology, Inc.
Effective April 1, 1997, the Company acquired substantially all of the assets
and assumed certain liabilities of PowerStream Technology, Inc., in exchange for
150,000 shares of the Company's common stock, valued at $1.50 per share (Note
C). Assets acquired and liabilities assumed in conjunction with this acquisition
were as follows:
Accounts receivable, net ...................................... $ 20,432
Inventories, net ....................................... 5,900
Prepaid expenses and other current assets .............. 603
Furniture and equipment ................................ 53,325
Account payable ........................................ (169,315)
Accrued liabilities .................................... (402,861)
Long-term obligations .................................. (32,198)
---------
Liabilities assumed, net ............................... (524,114)
Plus stock issued (150,000 shares
@ $1.50 per share) ..................................... 225,000
=========
Excess purchase price over net assets
acquired allocated to goodwill
$ 749,114
=========
F-12
<PAGE>
(Continued)
Pen Interconnect, Inc.
STATEMENTS OF CASH FLOWS - CONTINUED
Years ended September 30, 1998 and 1997
Noncash investing and financing activities - continued
Sale of Division
On November 1, 1996, the Company sold substantially all of the assets and
liabilities of its San Jose Division (Note C). Assets and liabilities sold were
as follows:
Accounts receivable, net ...................... $ 680,420
Inventories ................................... 1,644,336
Prepaid expenses .............................. 34,177
Other assets .................................. 26,099
Property and equipment ........................ 638,373
Accounts payable .............................. (277,429)
Accrued liabilities ........................... (35,373)
Capital leases ................................ (22,515)
---------
Assets sold, net .............................. 2,688,088
Less noncash consideration received
Notes ..................................... $ 900,000
Stock ..................................... 400,000 1,300,000
Cash received ................................. 2,000,000
=========
Gain on sale of division ...................... $ 611,912
=========
Pro forma data. The following unaudited pro forma summary represents the results
of operations as if the disposition of the San Jose Division had occurred at the
beginning of the period presented, and does not purport to be indicative of what
would have occurred had the transaction actually occurred on that date, or of
results which may occur in the future. The pro forma weighted shares are
reported as if outstanding at the beginning of the period.
Fiscal year
ended
September 30, 1997
(in thousands
except per share
amount)
-------------------
Net sales $ 17,955
Operating income (loss) (2,931)
Net loss (2,347)
Loss per share - basic (0.73)
Weighted shares outstanding 3,213
The accompanying notes are an integral part of these statements.
F-11
<PAGE>
Pen Interconnect, Inc.
NOTES TO FINANCIAL STATEMENTS
September 30, 1998 and 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the
preparation of the accompanying financial statements follows:
1. Business activity
Pen Interconnect, Inc. (the Company) was incorporated on September 30,
1985, in the State of Utah. The Company is a total interconnection
solution provider offering internal and external custom cable and harness
interconnections, mobile satellite equipment, electronic manufacturing
services industry (EMSI) manufacturing (circuit board assembly) and
custom design and manufacturing of battery chargers, power supplies and
uniterrupted power supply (UPS) systems for original equipment
manufacturers ("OEMs") in the computer, peripherals, telecommunications,
instrumentation, medical and testing equipment industries. The Company's
products connect electronic equipment, such as computers, to various
external devices (such as video screens, printers, external disk drives,
modems, telephone jacks, peripheral interfaces and networks) and connect
devices to one another within the equipment (such as power supplies,
computer hard drives and PC cards). Most of the Company's sales consist
of custom cable interconnections and printed circuit boards. The
Company's customers include OEMs of computers including mainframes,
desktops, notebooks, pens and palmtops, as well as, OEMs of computer
peripheral equipment such as modems, memory cards, LAN adapters, cellular
phones, faxes and printers. Other customers include OEMs of
telecommunications, instrumentation and testing equipment.
2. Inventories
Inventories consist primarily of cable, components, and boards and are
valued at the lower of cost or market (first-in, first-out basis). Costs
include materials, labor, and overhead.
3. Property and equipment
Property and equipment are recorded at cost. Expenditures for additions
and major improvements are capitalized. Expenditures for repairs and
maintenance and minor improvements are charged to expense as incurred.
Gains or losses from retirements and disposals are recorded as other
income or expense.
Property and equipment are depreciated over their estimated useful lives.
Leasehold improvements and assets financed under capital leases are
amortized over their estimated useful lives or the lease term, whichever
is shorter. Depreciation and amortization are calculated using
straight-line and accelerated methods over the following estimated useful
lives:
Years
-------------
Production equipment 5-10
Furniture and fixtures 7
Transportation equipment 5-10
Leasehold improvements 7-10
<PAGE>
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
4. Goodwill and other intangibles
The Company capitalized as goodwill, the excess acquisition costs over
the fair value of net assets acquired, in connection with business
acquisitions, which costs are being amortized on a straight-line method
over 15 years. The carrying value of goodwill is reviewed periodically
based on the undiscounted cash flows of the entities acquired over the
remaining amortization period. Should this review indicate that goodwill
is impaired, the Company's carrying value of the goodwill will be reduced
by the estimated shortfall of undiscounted cash flows.
5. Income taxes
The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases
of assets and liabilities and are measured using the enacted tax rates
and laws that will be in effect when the differences are expected to
reverse. An allowance against deferred tax assets is recorded when it is
more likely than not that such tax benefits will not be realized.
6. Revenue recognition
Revenue is recognized when products are shipped.
7. Cash and cash equivalents
For financial statement purposes, the Company considers all highly liquid
investments with an original maturity of three months or less when
purchased to be cash equivalents.
8. Warranties
The Company's standard warranty is one year on parts and labor. Warranty
costs are accrued and expensed when revenue is recognized based upon the
Company's experience with such costs. Returns have been insignificant to
date.
9. Research and development
Research and development costs are expensed as incurred.
<PAGE>
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
10. Earnings (loss) per common share
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 128 "Earnings Per Share" (SFAS No. 128). SFAS
No. 128 established new standards for computing and presenting earnings
per share (EPS). SFAS No. 128 requires the presentation of basic and
diluted EPS. Basic EPS are calculated by dividing earnings (loss)
available to common stockholders by the weighted-average number of common
shares outstanding during each period. Diluted EPS are similarly
calculated, except that the weighted-average number of common shares
outstanding includes common shares that may be issued subject to existing
rights with dilutive potential. The EPS for prior periods have been
restated as required by SFAS No. 128.
11. Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses during the reporting period. Estimates also affect
the disclosure of contingent assets and liabilities at the date of the
financial statements. Actual results could differ from those estimates.
Such estimates of significant accounting sensitivity include the
allowance for doubtful accounts and the allowance for inventory overstock
or obsolescence, and the estimated useful lives of goodwill and other
intangibles.
On an ongoing basis, management reviews such estimates, and if necessary,
makes changes to them. The effect of changes in estimates are reflected
in the financial statements in the period of the change. Management
believes the estimates used in determining carrying values of assets as
of the respective balance sheet dates were reasonable at the dates the
estimates were made. During 1998 adjustments to certain estimates were
recognized.
12. Accounting standards not yet adopted
Comprehensive income
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130 (SFAS No. 130), "Reporting Comprehensive Income." SFAS No. 130
requires entities presenting a complete set of financial statements to
include details of comprehensive income that arise in the reporting
period. Comprehensive income consists of net earnings or loss for the
current period and other comprehensive income, which consists of revenue,
expenses, gains, and losses, that bypass the statement of operations and
are reported directly in a separate component of equity. Other
comprehensive income includes, for example foreign currency items,
minimum pension liability adjustments, and unrealized gains and losses of
certain investment securities. SFAS No. 130 requires that components of
comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. This
statement is effective for fiscal years beginning after December 15,
1997, and requires restatement of prior period financial statements
presented for comparative purposes. Adoption of SFAS No. 130 is not
expected to have a material effect on the Company's financial statements.
<PAGE>
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
12. Accounting standards not yet adopted - continued
Disclosure of segments
Also in June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131 (SFAS No. 131), "Disclosures about Segments of the
Enterprise and Related Information." This statement requires an entity to
report financial and descriptive information about their reportable
operating segments. An operating segment is a component of an entity for
which financial information is developed and evaluated by the entity's
chief operating decision maker to assess performance and to make
decisions about resource allocation. Entities are required to report
segment profit or loss, certain specific revenue and expense items and
segment assets based on financial information used internally for
evaluating performance and allocating resources. This statement is
effective for fiscal years beginning after December 15, 1997, and
requires restatement of prior period financial statements presented for
comparative purposes. Adoption of SFAS No. 131 will not have an effect on
the Company's financial position or results of operations, but will
result in disclosures about the Company's products and services not
previously required.
13. Fair value of financial instruments
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments,"
requires certain disclosures regarding the fair value of financial
instruments. Cash and cash equivalents, accounts receivable, accounts
payable and accrued liabilities are reflected in the financial statements
at fair value because of the short-term maturity of these instruments.
Because of the unique aspects of the subordinated debentures and
long-term debt fair values cannot readily be determined.
14. Stock options
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options rather than
adopting the alternative fair value accounting provided for under FASB
No. 123 "Accounting for Stock-Based Compensation" (SFAS No. 123). Under
APB 25, because the exercise price of the Company's options equals or
exceeds the market price of the underlying shares on the date of grant,
the Company does not recognize any compensation expense.
15. Reclassifications
Certain reclassifications have been made to the 1997 financial statements
to conform with the 1998 presentation.
<PAGE>
NOTE B - FINANCIAL RESULTS AND LIQUIDITY
The Company has incurred net losses of $5,445,383, $1,735,483, and
$709,010 in 1998, 1997, and 1996, respectively. In addition, the Company
has a working capital deficit of $1,714,606 as of September 30, 1998.
These factors, among others, raise substantial doubt about the Company's
ability to continue as a going concern.
Although net sales of the Cable division had been declining over the last
few years, the Company believed that these declines would stabilize.
However, the Company's 1998 results produced weaker than anticipated
results, including disappointing sales performance for the Cable and
MOTO-SAT divisions. The Company's operations continued to generate
operating losses and to use rather than provide cash flow. This has
caused the Company to be in violation of certain of its debt covenants.
The Company has issued debentures and increased other borrowings to
provide working capital to help meet current obligations. However, the
Company still currently does not generate enough cash to fund operations,
and opportunities to supplement cash from capital markets are
diminishing.
The Company has formulated plans to satisfy its cash flow requirements.
Management's plans include the following:
1. Taking advantage of opportunities to divest of unprofitable
divisions.
2. Pursuing possibilities to obtain new and more profitable sales
contracts.
3. Negotiating acquisition and/or merger opportunities with other
companies.
4. Aggressively reducing corporate overhead costs.
5. Renegotiating its credit facility with its primary lender.
In connection with their plans, the Company and its major lender have
agreed to restructure its loan agreement, including the loan covenants.
In addition, management has secured new contracts for the PowerStream and
InCirT divisions.
Management has also negotiated with various individuals and companies for
the sale of the MOTO-SAT and Cable divisions. Management has also
actively negotiated mergers and/or acquisitions with other companies to
help bring additional financing resources, new and more profitable sales
contracts, and additional profitable sales from existing contracts to the
Company. (Note R)
There can be no assurance that the Company will be successful in its
attempt to consummate any of the above strategic alternatives.
<PAGE>
NOTE C - ACQUISITIONS/DISPOSITIONS
PowerStream Technology
Effective April 1, 1997, the Company acquired substantially all of the
assets, and assumed certain liabilities and the operations, of
PowerStream Technology, Inc. ("PowerStream") by issuing 150,000 shares of
common stock valued at $1.50 per share. PowerStream is a research and
development company specializing in power recharging devices and power
supply products. In addition, the Company entered into a five year
Employment Agreement with the President of PowerStream who, the Company
believes, is an expert in the area of power recharging devices and power
supply products. This transaction was accounted for using the purchase
method of accounting. Accordingly, the purchased assets and liabilities
have been recorded at their fair value at the date of acquisition and the
excess purchase price over fair value of net tangible assets acquired of
$749,114 is being amortized over 15 years. The results of operations of
the acquired business have been included in the financial statements
since the effective date of acquisition.
Sale of San Jose Division
Effective November 1, 1996, the Company sold substantially all of the net
assets used by the San Jose Division ("Division") to Touche Electronics,
Inc. ("Touche"), a subsidiary of TMCI Electronics, Inc. ("TMCI"). The
sale price for the net assets of the Division was $3,300,000; consisting
of $2,000,000 in cash, $900,000 in promissory notes, and 53,669 shares of
TMCI common stock with an agreed upon guaranteed value of $400,000. In
addition, the Company had the right to receive up to $700,000 in
contingent earnouts for a potential total sale price of $4,000,000. The
Company originally purchased the Division in March 1995, for
approximately $2,100,000. As part of the transaction, Touche and TMCI
also assumed certain liabilities associated with the operations of the
Division.
In February 1997, TMCI filed a notice of demand for rescission of the
purchase and sale of the Division. The Company filed a counterclaim
against TMCI in May 1997, alleging that TMCI had defaulted in its
obligations under the promissory notes. The disputes were subsequently
submitted to arbitration in August 1997. In December 1997, the Company
and TMCI entered into a Settlement and Release Agreement (the "Settlement
Agreement"), releasing each other of any and all respective claims the
parties may have had against each other. The Settlement Agreement
provided, in part, that TMCI issue to the Company, 137,390 shares of
TMCI's common stock (the "Settlement Stock"). The Settlement Stock is
guaranteed to have a minimum value of $7.4532 per share. In the event the
Settlement Stock is sold at less than that amount, TMCI is obligated to
pay to the Company the difference between the sales price and the
guaranteed value. During 1998, the Company sold shares of settlement
stock at a price below the minimum value. TMCI reimbursed the Company for
the difference between the sales price and the guaranteed value. At
September 30, 1998, TMCI stock had a quoted market price of $2.25 per
share. Based upon the market price of TMCI stock and consideration of
realizability of the guaranteed minimum value per share, the carrying
value of the investment was reduced by approximately $300,000 as of
September 30, 1998.
<PAGE>
NOTE C - ACQUISITIONS/DISPOSITIONS - CONTINUED
Sale of San Jose Division - continued
In addition, the Company entered into a long-term building lease
agreement several months prior to the sale of the San Jose Division with
the intention of relocating the operations. This lease was not sold as
part of the above sale and required fees of $227,226 for abandonment of
the lease. Abandoned lease fees of $16,000 and $211,226 were recognized
in fiscal years 1998 and 1997, respectively.
NOTE D - MAJOR CUSTOMERS AND CREDIT CONCENTRATION
Financial instruments, which potentially subject the Company to credit
risk, consist primarily of trade accounts receivable. The Company sells
to customers in the computer, computer peripheral, telecommunications,
instrumentation, and medical and testing equipment industries located
throughout the United States. Sales have historically been concentrated
with several large original equipment manufacturers (OEMs) on a turnkey
basis. To reduce credit risk the Company performs ongoing credit
evaluations of its customers' financial condition and generally does not
require collateral. The majority of its trade receivables are unsecured.
Allowances are maintained for potential credit losses. The resulting
losses have been insignificant to date and have been within management's
expectations.
Revenue from shipments to the largest customers (representing over ten
percent of sales in fiscal 1998) were 59 percent and 24 percent of sales
(15 percent, 14 percent and 12 percent of sales in fiscal 1997).
At September 30, 1998, the Company had accounts receivable due from the
above largest customers representing approximately 75 percent of trade
receivables (50 percent at September 30, 1997). Remaining trade accounts
receivable at September 30, 1998, were due from a variety of other
customers under normal credit terms.
NOTE E - NOTES RECEIVABLE
Notes receivable consist of the following:
1998 1997
------------- ------------
10% note receivable from a company,
due in monthly payments of $1,500
including interest, collateralized by
inventory, accounts receivable,
machinery, and equipment $33,377 $35,775
10% note receivable from a company,
due in monthly payments of $1,297
including interest, collateralized by
inventory, accounts receivable,
machinery, and equipment 6,287 8,124
12% notes receivable from two companies,
due in monthly payments aggregating
$1,000 including interest -- 5,882
<PAGE>
<TABLE>
<CAPTION>
NOTE E - NOTES RECEIVABLE - CONTINUED
1998 1997
------------- ------------
<S> <C> <C>
Note receivable from a company at prime plus .5% (9% at September 30,
1998), due in monthly payments of $10,417 including interest, with a
balloon payment on October 31, 1999, secured by security agreement
and the personal guaranty of the owner and principal stockholder of
the company. This note was exchanged for shares of stock
during 1998 (Note C) - 500,000
Note receivable from a company at prime plus .5% (9% at September 30,
1998), due in monthly payments of $16,667 including interest,
secured by security agreement and the personal guaranty of the owner
and principal stockholder of the company. This note was exchanged
for shares of
stock during 1998 (Note C) - 400,000
10% note receivable from officers/stockholders,
due in monthly payments of $1,500 including interest - 14,749
------------- ------------
39,664 964,530
Less current maturities 35,675 357,006
------------- ------------
============= ============
$ 3,989 $ 607,524
============= ============
NOTE F - INVENTORIES
Inventories consist of the following:
1998 1997
------------- -------------
Raw material $ 3,070,958 $ 2,714,763
Work-in-process 1,391,664 736,928
Finished goods 35,572 87,708
------------- -------------
4,498,194 3,539,399
Less allowance for obsolete inventory (818,025) (183,528)
------------- -------------
============= =============
$ 3,680,169 $ 3,355,871
============= =============
</TABLE>
<PAGE>
<TABLE>
NOTE G - NOTES PAYABLE
Notes payable at September 30, 1997, consisted of trade payables to
vendors converted to notes totaling $641,505, payable in semi-monthly
amounts of approximately $147,000, with interest at 9.5 percent per
annum. The notes were paid in full during fiscal 1998.
NOTE H - BRIDGE LOAN
At September 30, 1997, the Company had one note payable to an individual
for $100,000 with interest at 8 percent per annum, which was due and paid
in full in November 1997.
NOTE I - CREDIT FACILITY
On September 4, 1997, the Company completed a four year financing
agreement with a bank for $6,300,000. The agreement consists of a
$5,000,000 revolving credit line and two term loans for $800,000 ("Loan
A") and $500,000 ("Loan B"), respectively. The revolving credit loan is
at prime plus 1.75 percent (10 percent at September 1998) and is
collateralized by accounts receivable and inventory. Loan A is at a fixed
rate of 10.16 percent and is collateralized by machinery and equipment.
Loan B is at a fixed rate of 10.32 percent and is collateralized by
machinery and equipment of the Company and personal guarantees of certain
officers of the Company. This agreement requires that the Company
maintain certain financial ratios, meet specific minimum levels of
earnings and net worth; restricts employee advances, capital
expenditures, compensation, and additional indebtedness; and restricts
the payment of dividends. This new line of credit replaced the previous
$6,000,000 revolving line of credit. The Company has borrowed $4,064,361
under the new line of credit at September 30, 1998 ($2,237,690 at
September 30, 1997).
At times, including at September 30, 1998, the Company has been in
violation of certain of the covenants of this credit facility. At
September 30, 1998, the Company has notified the lender of the violations
and is negotiating modifications to the loan agreement with the lender.
As of September 30, 1998, the Company has not received a waiver from the
lender and all obligations under this credit facility are payable on
demand of the lender and are classified as current liabilities in the
balance sheet.
NOTE J - LONG-TERM OBLIGATIONS
Long-term obligations consist of the following:
1998 1997
------------- ------------
Note to an individual with interest imputed at 10% per
<S> <C> <C>
annum, payable in monthly payments of $2,500 $ 80,104 $ 100,604
<PAGE>
NOTE J - LONG-TERM OBLIGATIONS - CONTINUED
1998 1997
------------- ------------
10.16% note to a financial institution, payable in 48 monthly
installments of $16,667 plus interest, maturing on August 1, 2001,
collateralized by substantially all of
the Company's property and equipment (Note I) 599,996 800,000
10.32% note to a financial institution, payable in 48 monthly
installments of $10,417 plus interest, maturing on August 1, 2002,
collateralized by substantially all of the Company's property and
equipment and personal
guarantees of certain officers of the Company (Note I) 489,583 -
11.25% note to a financial institution, payable in monthly installments
of $375, including interest, collateralized by personal residence of
the president of the PowerStream
Division 3,100 31,653
Noninterest-bearing note to a parts vendor, payable in
monthly installments of $1,000, past due 11,720 12,720
------------- ------------
1,184,503 944,977
Less current maturities 1,132,538 263,255
------------- ------------
============= ============
$ 51,965 $ 681,722
============= ============
Maturities of long-term obligations are as follows:
Year ending September 30,
1999 $ 1,132,538
2000 25,972
2001 25,993
Thereafter -
=============
$ 1,184,503
=============
</TABLE>
<PAGE>
<TABLE>
NOTE K - LEASES
1. Operating leases
The Company conducts a portion of its operations in leased facilities
under noncancelable operating leases expiring through 2003. In addition,
the Company leases equipment under noncancelable operating leases
expiring through 2000. The minimum future rental commitments under
operating leases are as follows:
Year ending September 30, Facilities Equipment Total
------------- --------------- -------------
<S> <C> <C> <C> <C>
1999 $ 367,083 $ 191,410 $ 558,493
2000 367,083 47,380 414,463
2001 349,933 - 349,933
2002 337,683 - 337,683
2003 337,683 - 337,683
Thereafter - - -
============= =============== =============
$ 1,759,465 $ 238,790 $ 1,998,255
============= =============== =============
The leases generally provide that property taxes, insurance and
maintenance expenses are obligations of the Company. It is expected that
in the normal course of business, operating leases that expire will be
renewed or replaced by leases on other properties. Rental expense for all
operating leases was $565,490 and $570,486 for the years ended September
30, 1998 and 1997, respectively.
2. Capital leases
Maturities of capital lease obligations are as follows:
Year ending September 30,
1999 $ 76,165
2000 23,916
Thereafter -
-------------
Total minimum lease payments 100,081
Less amount representing interest 8,127
-------------
Present value of net minimum lease payments 91,954
Less current portion 69,621
-------------
=============
$ 22,333
=============
</TABLE>
Included in property and equipment is $295,637 of equipment under capital
leases at September 30, 1998. The related accumulated amortization is
$203,683.
<PAGE>
<TABLE>
<CAPTION>
NOTE L - INCOME TAXES (BENEFIT)
Income tax expense (benefit) consists of the following:
1998 1997
------------- --------------
Current
<S> <C> <C>
Federal $ (36,106) $ (36,067)
State 20,748 (5,306)
------------- --------------
(15,358) (41,373)
Deferred
Federal 387,584 (931,233)
State 229,010 (136,994)
------------- --------------
616,594 (1,068,227)
------------- --------------
$ 601,236 $ (1,109,600)
============= ==============
Reconciliation of income taxes (benefit) computed at the federal statutory rate
of 34 percent is as follows:
1998 1997
------------- -------------
Federal income taxes at statutory rate $ 635,999 $ (967,300)
State income taxes, net of federal tax benefit (34,763) (142,300)
============= =============
Income taxes $ 601,236 $ (1,109,600)
============= =============
Deferred tax assets and liabilities consist of the following:
1998 1997
------------- -------------
Deferred tax assets (liabilities)
Accumulated depreciation $ (171,852) $ (165,755)
Net operating loss 3,183,720 1,392,658
Reserve for inventory obsolescence 316,731 71,576
Allowance for doubtful accounts 138,411 53,453
Reserve for warranties - 10,182
Write off of goodwill 37,833 -
Impairment of investment 117,454 -
Amortization of intangibles (2,910) -
Reserve for vacation 12,785 6,113
------------- -------------
Deferred tax asset 3,632,172 1,368,227
Valuation allowance (3,030,936) -
============= =============
Net deferred tax asset $ 601,236 $ 1,368,227
============= =============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NOTE L - INCOME TAXES (BENEFIT) - (CONTINUED)
The Company has sustained net operating losses in each of the periods
presented. Deferred tax assets or income tax benefits were recorded in
both 1998 and 1997 for net deductible temporary differences or net
operating loss carryforwards. The likelihood of realization of the
related tax benefits cannot be fully established. A valuation allowance
has been recorded in 1998 to reduce the 1997 net deferred tax asset. The
decrease in the valuation allowance was $601,236 and $0 for the years
ended September 30, 1998 and 1997, respectively.
As of September 30, 1998, the Company had net operating loss
carryforwards for tax reporting purposes of approximately $7,737,000
expiring in various years through 2019.
NOTE M - STOCK OPTION PLAN
The Company has a Stock Option Plan (the Plan). The Plan provides for the
granting of both Incentive Stock Options (ISOs) or NonQualified Options
(NQOs) to purchase shares of common stock. ISOs are granted at not less
than market value on the date of grant whereas NQOs may be granted at not
less than 85 percent of market value on the date of the grant. Options
may be granted under the Plan to all officers, directors, and employees
of the Company. In addition, NQOs may be granted to other parties who
perform services for the Company.
The Company also issues warrants in conjunction with various transactions
with third parties.
The Company accounts for the Plan under APB 25 and related
interpretations. Accordingly, since all options granted under the Plan
were granted at or in excess of fair market value of the stock on the
date of the grant, no compensation costs have been recognized in the
accompanying financial statements for options granted under the Plan. Had
compensation cost for the Plan been determined based on the fair value of
the options at the grant dates for awards under the Plan consistent with
the method prescribed by FAS No. 123, the Company's net loss and loss per
common share would have been increased to the pro forma amounts indicated
below:
Fiscal Year ended September 30, 1998 1997
-------------------------------
---------------- ---------------
Net loss
<S> <C> <C>
As reported $ (5,445,383) $ (1,735,483)
Pro forma (6,112,600) (3,185,595)
Loss per common share
As reported - basic $ (1.24) $ (0.54)
Pro forma - basic (1.39) (0.99)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NOTE M - STOCK OPTION PLAN - CONTINUED
The fair value of these options and warrants was estimated at the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions for 1998 and 1997, respectively: expected
volatility of 79.07 and 68.08 percent; risk-free interest rate of 5.26
and 6.35 percent; and expected life equal to the actual life for both
periods. The weighted-average fair value of options and warrants granted
was $0.83 for both 1998 and 1997.
The following is a summary of the activity relating to options and
warrants through September 30, 1998:
Weighted-average
Warrants and exercise
stock options Exercise price
price
------------ -------------- -------------
<S> <C> <C> <C>
Outstanding at October 1, 1996 3,105,000 $ 6.00-6.50 $ 6.46
Granted 3,668,000 1.38-3.00 1.87
Canceled (154,000) 6.00 6.00
Exercised (550,000) 1.75-2.00 1.88
------------
Outstanding at September 30, 1997 6,069,000 1.38-6.50 4.18
Granted 2,305,000 1.45-6.00 1.83
Canceled (59,000) 1.38-6.00 1.83
Exercised (245,000) 2.00 2.00
------------
Outstanding at September 30, 1998 8,070,000 1.38-6.50 3.55
============
Exercisable at September 30, 1998 7,745,800 $ 1.38-6.50 $ 3.60
============
The following table summarizes information concerning currently
outstanding options and warrants:
Options and Warrants Outstanding:
Weighted-Average
Range of Remaining Contractual
Exercise Prices Number Life (Years) Weighted-Average
Outstanding Exercise Price
----------- --------------
<S> <C> <C> <C> <C>
$ 1.38-1.45 1,895,500 4.35 $ 1.42
2.00-2.75 3,195,000 5.55 2.12
3.00 32,500 3.64 3.00
6.00-6.50 2,947,000 2.17 6.48
---------
8,070,000
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
NOTE M - STOCK OPTION PLAN - CONTINUED
The following table summarizes information concerning currently
exercisable options and warrants:
Options and Warrants Exercisable:
Weighted-Average
Range of Remaining Contractual
Exercise Prices Number Life (Years) Weighted-Average
Exercisable Exercise Price
----------- --------------
<S> <C> <C> <C> <C>
$ 1.38-1.45 1,707,500 4.45 $ 1.42
2.00-2.75 3,143,000 5.56 2.12
3.00 6,500 3.64 3.00
6.00-6.50 2,888,800 2.17 6.49
---------
7,745,800
</TABLE>
NOTE N - COMMITMENTS AND CONTINGENCIES
1. Employment agreements
The Company has entered into agreements with eight key employees and
officers which provide for annual salaries and incentive bonuses.
Incentive bonuses are calculated as a percentage of gross profits and/or
sales of the Company.
Annual salaries under these employment agreements, in the aggregate, are
as follows:
Year ending September 30,
1999 $ 548,000
2000 515,000
2001 485,000
2002 295,000
2003 170,000
Thereafter -
============
$ 2,013,000
============
2. Litigation
From time to time the Company is engaged in various lawsuits or disputes
as plaintiff or defendant arising in the normal course of business. In
the opinion of management, based upon advice of counsel, the ultimate
outcome of these matters will not have a material impact on the Company's
financial position or results of operations.
<PAGE>
NOTE O - EARNINGS (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 128, "Earnings per Share"
(SFAS No. 128). SFAS No. 128 is effective for financial statements for
periods ending after December 15, 1997, and requires companies to report
both "basic" and "diluted" earnings per share. "Basic" earnings per share
do not include the addition of common stock equivalents to the shares
outstanding. "Diluted" earnings per share require the addition of common
stock equivalents to the shares outstanding. Average shares outstanding
is the denominator used in "basic" earnings per share calculations.
Accordingly, "basic" earnings per share will be higher than "diluted"
earnings per share. This statement replaces Accounting Principles Board
("APB") Opinion No. 15, "Earnings per Share." The effect of adopting SFAS
No. 128 did not materially effect the Company's earnings per share. The
following data show the amounts used in computing earnings (loss) per
common share, including the weighted-average number of shares and
dilutive potential common shares.
Year ended September 30,
----------------------------
1998 1997
============== ===========
Loss applicable to common stock ................ $(5,445,383) $(1,735,483)
=========== ===========
Common shares outstanding during the
entire period ............................... 4,072,863 3,033,407
Weighted-average common shares issued
during the period ........................... 324,627 179,682
----------- -----------
Weighted-average number of common
shares used in basic EPS .................... 4,397,490 3,213,089
Dilutive effect of stock options
and warrants ................................ -- --
=========== ===========
Weighted-average number of common
shares and dilutive potential common
stock used in diluted EPS ................... 4,397,490 3,213,089
=========== ===========
For the years ended September 30, 1998 and 1997, all of the options and
warrants that were outstanding, as described in Note M, were not included
in the computation of diluted EPS because to do so would have been
anti-dilutive.
<PAGE>
NOTE P - SUBORDINATED DEBENTURES
On June 16, 1998, the Board of Directors of the Company approved the
issuance of up to $1,000,000 of three percent convertible debentures (the
"Debentures") with a maximum term of 24 months. The Debentures will
mature, unless earlier converted by the holders, into shares of common
stock of the Company. The Company has agreed to file a registration
statement with the United States Securities and Exchange Commission with
respect to the common stock of the Company into which the Debentures may
be converted.
The Debentures are convertible by the holders thereof into the number of
shares of common stock equal to the face amount of the Debentures being
converted divided by the lesser of (i) eighty percent (80 percent) of the
closing bid price of the Company's common stock as reported on the NASDAQ
Small Cap market on the day of conversion, or (ii) $2.75. The Debentures
may be converted in three equal installments beginning on the earlier of
(i) the 75th day of their issuance, and continuing through the 135th day
of their issuance, or (ii) the day following the effective date of the
Registration Statement, through the 60th day following the effective date
of the Registration Statement. The Company may cause the Debentures to be
converted into shares of common stock after the 110th day following the
effective date of the Registration Statement, if the common stock has
traded at or above $5.50 per share for 20 consecutive days.
As of September 30, 1998, the Company had issued all $1,000,000 of these
convertible Debentures and none have been converted.
On October 22, 1997, the Board of Directors of the Company approved the
issuance of up to $1,500,000 of 3 percent convertible Debentures with a
maximum term of 24 months. The Debentures will mature, unless earlier
converted by the holders, into shares of common stock of the Company. The
Company has agreed to file a registration statement with the United
States Securities and Exchange Commission with respect to the common
stock of the Company into which the Debentures may be converted.
As of September 30, 1998, the Company had issued all $1,500,000 of these
convertible Debentures and $1,000,000 had been converted to 689,332
shares of common stock.
Because of the favorable conversion feature of the Debentures, the
Company has recognized interest expense relating to the price below
market at which the Debentures can be converted into common shares of
stock. The interest is initially set up as a deferred charge against the
subordinated debenture balance with an offset to additional paid-in
capital. The deferred interest is amortized over a period corresponding
to time restrictions as to when the Debentures can be converted into
stock. The resulting charge to interest expense increases the effective
interest rate of the Debentures. Deferred interest expense of $250,032
was recorded on the $1,000,000 in Debentures relative to the favorable
conversion feature and is being amortized over four months and charged to
interest expense. As of September 30, 1998, $151,461 of the $250,032
deferred charge had been amortized. This interest along with the stated 3
percent interest rate in the Debentures results in an inherent interest
rate of 31 percent.
<PAGE>
NOTE P - SUBORDINATED DEBENTURES - CONTINUED
In connection with the $1,500,000 in Debentures, the Company recorded
$389,591 of deferred interest expense related to the beneficial
conversion feature. The entire deferred charge has been amortized and
charged to interest expense at September 30, 1998. This interest when
added to the stated 3 percent interest rate of the Debenture results in
an inherent interest rate of 28 percent over the Debentures life of two
years.
NOTE Q - GOODWILL AND INTANGIBLES
Goodwill and intangibles consist primarily of goodwill acquired in the
purchase of the InCirT, MOTO-SAT, and PowerStream divisions. Intangibles
other than goodwill consist of product development costs. The long-term
value of the product development costs is connected to the application of
technologies to viable products which management believes can be
successfully marketed by the Company. On an ongoing basis, management
reviews the valuation and amortization of intangible assets to determine
possible impairment by comparing the carrying value to the undiscounted
estimated future cash flows of the related assets and necessary
adjustments, if any, are recorded. During 1998, the carrying values of
goodwill and intangibles were adjusted in the amount of $267,414 to
better reflect management's current expectations for the realizablility
of these assets. The adjustments relate to goodwill and intangibles of
the MOTO-SAT division. Management believes current and projected sales
levels of its existing and planned products will support the carrying
costs of assets, as adjusted.
The following is a summary of goodwill and intangible assets:
Fiscal Year ended September 30, 1998 1997
-------------------------------
------------ ------------
Goodwill $ 2,287,894 $ 2,393,685
Other intangibles 71,150 221,285
------------ ------------
2,359,044 2,614,970
Less accumulated amortization (327,359) (327,824)
============ ============
$ 2,031,685 $ 2,287,146
============ ============
NOTE R - SUBSEQUENT EVENTS
In December, 1998, the Company entered into a letter of intent with the
Company's CEO for the sale of the MotoSat division. The Company
anticipates the sale will be completed in January 1999. The proposed sale
provides for the acquisition of substantially all of the assets,
assumption of all liabilities and the operations of the division. The
proposed sale will not generate cash proceeds to the Company. The Company
expects to recognize a gain of approximately $20,000 on the sale.
<PAGE>
NOTE R - SUBSEQUENT EVENTS - CONTINUED
Subsequent to year-end, the Company negotiated a contract with a company
for the sale of the Cable division. The sale is subject to the completion
of due diligence and the execution of a definitive agreement. The Company
anticipates completion of the sale in January 1999. Based on terms of the
contract agreed to during November and December, 1998, the Company
expects to receive cash proceeds of approximately $1,075,000 and to
recognize a loss upon completion of the sale of approximately $1,000,000.
On December 21, 1998, the Company entered into an agreement with a
laminating company whereby a proposed newly formed subsidiary of the
Company will merge into the laminating company and the laminating company
will become a wholly-owned subsidiary of the Company. Stockholders of the
laminating company will receive shares of common stock of the Company in
exchange for their shares. The parties have commenced preparation of a
Registration Statement on Form S-4. The merger is subject to Form S-4
becoming effective and approval of the stockholders of the respective
companies.
In December 1998, the Company signed a letter of intent with a company to
negotiate a possible merger. The letter of intent serves as a basis for
the parties to negotiate formal, definitive agreements, memorializing all
the terms of the merger.
The Company has an investment in the publicly traded stock of another
company (Note C). The stock was received in satisfaction of notes
receivable and has a guaranteed minimum value of $7.4532 per share. At
September 30, 1998, the market value of the stock was approximately $2.25
per share. At January 1999, the quoted market value of the stock
decreased to approximately $0.66 per share.
<PAGE>
<PAGE>
- - --------------------------------------------------------------------------------
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
- - --------------------------------------------------------------------------------
Not applicable.
- - --------------------------------------------------------------------------------
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND
CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE
EXCHANGE ACT
- - --------------------------------------------------------------------------------
The information required is set forth under the captions "Election of
Directors, Directors and Executive Officers; Compliance with Section 16(a) of
Securities Exchange Act of 1934" in the Company's definitive proxy statement to
be filed pursuant to Regulation 14A and is incorporated herein by reference.
- - --------------------------------------------------------------------------------
ITEM 10. EXECUTIVE COMPENSATION
- - --------------------------------------------------------------------------------
The information required is set forth under the caption "Compensation of
Executive Officers" in the Company's definitive proxy statement to be filed
pursuant to Regulation 14A and is incorporated herein by reference.
- - --------------------------------------------------------------------------------
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
- - --------------------------------------------------------------------------------
The information required is set forth under the caption "Security Ownership
of Certain Beneficial Owners and Management" in the Company's definitive proxy
statement to be filed pursuant to Regulation 14A and is incorporated herein by
reference.
- - --------------------------------------------------------------------------------
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- - --------------------------------------------------------------------------------
The information required is set forth under the caption "Election of
Directors - Certain Relationships and Related Transaction" in the Company's
definitive proxy statement to be filed pursuant to Regulation 14A and is
incorporated herein by reference.
<PAGE>
- - --------------------------------------------------------------------------------
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- - --------------------------------------------------------------------------------
(a) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the three months
ended September 30, 1998.
(b) INDEX OF EXHIBITS
Exhibit No. Description
1. Form of Underwriter's Warrant Agreement including Form of
Underwriter's Warrant, incorporated by reference to the
Company's Registration Statement filed on Form SB-2, SEC File
No. 33-96444.
3. Articles of incorporation and By-laws, incorporated by reference
to the Company's Registration Statement filed on Form SB-2, SEC
File No. 33-96444.
10.1 Asset Purchase Agreement for the purchase of InCirT Technology
from the Cerplex Group, Inc. See Exhibit to Report on Form
10-QSB dated June 30, 1996.
10.2 Employment Agreement between James S. Pendleton and the Company.
See Exhibit to Report on Form 10-QSB dated June 30, 1996.
10.3 Employment Agreement between Wayne R. Wright and the Company.
See Exhibit to Report on Form 10-QSB dated June 30, 1996.
10.4 Employment Agreement between Robert D. Deforest Sr. and the
Company. See Exhibit to Report 10-QSB dated June 30, 1996.
10.5 Employment Agreement between Lewis Carl Rasmussen and the
Company. See Exhibit to Report on Form 10-QSB dated June 30,
1996.
<PAGE>
INDEX OF EXHIBITS - CONTINUED
Exhibit No. Description
10.6 Employment Agreement between Alan L. Weaver and the Company. See
Exhibit to Report on Form 10-QSB dated June 30, 1996.
10.7 Loan and Security Agreement dated February 29, 1996 between
National Bank of Canada and the Company. See 10-KSB dated
September 30, 1996.
10.8 Form of Warrant between the Registrant and JW Charles
Securities, Inc., BMC Bach International Ltd., Gordon Mundy,
Louis Centofanti and Heracles Holdings, See Registration
Statement filed on Form S-3, SEC File No. 333-60451
10.9 Asset Purchase Agreement dated March 22, 1995 between
Registratant, Insulectro, Quality Interconnect Systems, Quintec
Interconnect Systems, Quintec Industries and QIS Electronics.
See Registration Statement filed on Form SB-2, SEC File No.
33-96444.
10.10 Real Estate Lease dated June 2, 1993 between Registrant and The
Equitable Life Insurance Society. See Registration Statement
filed on Form SB-2, SEC File No. 33-96444.
10.11 Form of 1995 Stock Option Plan. See Registration Statement filed
on Form SB-2, SEC File No. 33-96444.
10.12 Asset Purchase Agreement dated November 12, 1996 for the sale of
the San Jose Division between Touche Electronics, Inc. a
subsidiary of TMCI Electronics, Inc. and the Company. See
Exhibit to Report on Form 10-QSB dated December 31, 1996.
10.13 Loan and Security Agreement between FINOVA and the Company. See
Exhibit to Report on Form 10-KSB, dated September 30, 1997.
10.14 Employment Agreement between Stephen J. Fryer and the Company.
See Exhibit to Report on Form 10-KSB, dated September 30, 1997.
10.15 Employment Agreement between Daniele Reni and the Company. See
Exhibit to Report on Form 10-KSB, dated September 30, 1997.
10.16 Agreement and Plan of Reorganization through Acquisition dated
April 1, 1997 between PowerStream Technology, Inc. and the
Company. See Exhibit to Report on Form 10-KSB, dated September
30, 1997.
10.17 Finder's Agreement between the Registrant and JW Charles
Securities, Inc., dated June 2, 1998. See Registration Statement
filed on Form S-3, SEC File No. 333-60451
11. Statement re: computation of per share earnings. See Exhibit to
Report on Form 10-KSB, dated September 30, 1998.
23.1. Consent of Grant Thornton LLP. This filing page ___.
27. Financial Data Schedule
<PAGE>
Signatures
In accordance with Section 13 or 15(d) of the Exchange Act, the Company
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: January 13, 1999 PEN INTERCONNECT, INC.
By:/s/Stephen Fryer
-------------------
Stephen Fryer
President and Director
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Company and in the capacities and on the
dates indicated below.
Date: January 13, 1999 By:/s/James Pendleton
----- ---------------- ---------------------
James Pendleton
CEO and Director
Date: January 13, 1999 By:/s/Stephen Fryer
----- ---------------- -------------------
Stephen Fryer
President and Director
Date: January 13, 1999 By:/s/Robert Albrecht
----- ---------------- ---------------------
Robert Albrecht
CFO and Principal Accounting Officer
Date: January 13, 1999 By:/s/Wayne R. Wright
----- ---------------- ---------------------
Wayne R. Wright
Director
Date: January 13, 1999 By:/s/Milton Haber
----- ---------------- -------------------
Milton Haber
Director
Date: January 13, 1999 By:/s/C. Reed Brown
----- ---------------- -------------------
C. Reed Brown
Director
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Schedule contains summary financial information extracted from Pen
Interconnect, Inc., September 30, 1997 financial statements and is qualified in
its entirety by reference to such financial statments.
</LEGEND>
<CIK> 0001000266
<NAME> Pen Interconnect, Inc.
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> SEP-30-1997
<PERIOD-END> SEP-30-1998
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<CASH> 657,777
<SECURITIES> 252,739
<RECEIVABLES> 3,459,545
<ALLOWANCES> (108,575)
<INVENTORY> 3,680,169
<CURRENT-ASSETS> 8,270,029
<PP&E> 4,158,877
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