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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 2
to
FORM 10-SB
GENERAL FORM FOR REGISTRATION OF SECURITIES
OF SMALL BUSINESS ISSUERS
Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934
Pinnacle Data Systems, Inc.
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(Exact name of small business issuer in its charter)
Ohio 31-1263732
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6600 Port Road, Groveport, Ohio 43125
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (614) 748-1150
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Securities to be registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which
registered
None None
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Securities to be registered pursuant to Section 12(g) of the Act:
Common Shares, without par value
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PART I
Item 1. Description of Business...............................................................................1
BACKGROUND.....................................................................................................1
DEVELOPMENT OF THE BUSINESS....................................................................................2
BACKGROUND OF INDUSTRY.........................................................................................3
PRODUCTS.......................................................................................................4
SOFTWARE.......................................................................................................4
SERVICES.......................................................................................................5
CONTRACTUAL RELATIONSHIPS WITH SUN MICROSYSTEMS, INC. AND ITS AFFILIATES.......................................6
SALES AND MARKETING............................................................................................7
COMPETITION....................................................................................................8
EMPLOYEES......................................................................................................8
Item 2. Management's Discussion and Analysis or Plan of Operation.............................................9
RESULTS OF OPERATIONS..........................................................................................9
YEAR 2000 IMPACT ON COMPUTER RESOURCES........................................................................17
Item 3. Description of Property..............................................................................19
Item 4. Security Ownership of Certain Beneficial Owners and Management.......................................19
Item 5. Directors and Executive Officers, Promoters and Control Persons......................................20
Item 6. Executive Compensation...............................................................................22
SUMMARY COMPENSATION TABLE....................................................................................23
OPTION GRANTS IN LAST FISCAL YEAR.............................................................................24
STOCK OPTION EXERCISES AND YEAR END OPTION VALUES.............................................................24
SAVINGS PLAN..................................................................................................25
1995 STOCK OPTION PLAN........................................................................................25
COMPENSATION OF DIRECTORS.....................................................................................26
Item 7. Certain Relationships and Related Transactions.......................................................26
Item 8. Description of Securities............................................................................26
COMMON SHARES.................................................................................................27
. PART II
Item 1. Market price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters......27
Item 2. Legal Proceedings....................................................................................28
Item 3. Changes in and Disagreements With Accountants........................................................28
Item 4. Recent Sales of Unregistered Securities..............................................................29
Item 5. Indemnification of Directors and Officers............................................................32
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PART F/S
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Financial Statements.............................................................................................33
PART III
Item 1. Index to Exhibits....................................................................................57
Item 2. Description of Exhibits..............................................................................57
SIGNATURES.......................................................................................................58
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
BACKGROUND
The Company designs, assembles and sells computer products and provides computer
repair and other related services primarily to Original Equipment Manufacturers
(OEMs) in industries such as telecommunications, medical systems, process
control, and governmental. For the first three quarters of 1999 the Company
reported revenue of approximately $8 Million, net income of approximately
$214,000 and total assets of approximately $5.7 Million. Approximately 70% of
the Company's revenue is generated from product sales and approximately 30% is
generated from services. However, the gross profit from both segments of the
business is approximately equal.
The Company's products are custom designed to meet the needs of its customers.
Often customers have special computer system requirements that can not be met by
off-the-shelf products alone. The Company helps customers by engineering,
designing, assembling and modifying computer equipment to meet customers'
particular needs. The Company takes circuit board type products manufactured by
Sun Microsystems, Inc., one of the world's largest producers of computer
systems, and combines it with technology engineered and developed by the
Company, such as customized circuit boards, enclosures, power supplies and other
engineered computer components requested by customers and assembles them, along
with other off the shelf computer peripherals into finished products for
customers. The Company's products are based upon high performance computer
processor technology from Sun Microsystems, Inc. In a typical system
manufactured by the Company, approximately 50% of the components will be Sun
products, 30% of the components will be off-the-shelf products and 20% will be
products designed and developed by the Company. These percentages will vary from
product to product. By adding its own internally developed products and
engineering capabilities to Sun's off-the-shelf board technology, the Company is
able to offer solutions with minimal non-recurring engineering (product design)
charges. These are turnkey, application-specific computer circuit boards and
entire computer systems that the Company's customer imbeds into the customer's
products. See "Products"
The Company also offers end-of-life management and complete service and support
to OEMs. Many manufacturers will include Sun Microsystems' boards and components
in their own products. If Sun stops manufacturing that board or component, then
the equipment manufacturer is left without a source to supply it with the parts
needed to build its own products. The Company's end of life management allows
the Company's customers to maximize their investment in technology by providing
continued support for products no longer supported by the manufacturer. This
allows OEMs to eliminate or delay the engineering and software development
charges required to integrate new technology.
The Company also provides repair services for advanced technology systems, and
printed circuit board assemblies. The Company's repair services are all depot
repair, which means that the malfunctioning part is sent to the Company for
repair. The Company does not provide any repairs outside of its facilities. The
Company's repair services are focused on UNIX computer equipment and currently
are limited predominantly to equipment manufactured by Sun Microsystems, Inc.
The Company is partnering with Sun Microsystems to provide streamlined
distribution of Sun parts to Sun customers using an online information
management system that connects the two companies. The Company also offers a
repair service whereby it will, overnight, exchange a malfunctioning or broken
electronic component or part for a similar component or part in the Company's
inventory. The Company will then repair the malfunctioning or broken component
and include that part in its inventory as a replacement. The Company also
generates revenue from the sale of spare parts and components.
The Company believes that the services segment of its business provides a
competitive advantage to it in connection with its product sales, because the
Company can offer the purchasers of its products a more complete answer to their
system needs by providing not only products, but also service and support after
the sale. The Company also believes that the product segment of its business
provides it with a competitive advantage in connection with the services it
provides, because product development and engineering activities keeps it
current with the latest technology and how to repair it. The Company considers
its product and services segments to be equally important, not only because of
the synergies they provide to one another, but also because they contribute
relatively equally to the Company's gross profit.
Almost all of the Company's products and services are based on Sun's SPARC
architecture. If for any reason Sun or its products began to experience
significant difficulties in the market place or in operations or otherwise, it
could materially and adversely affect the Company.
The Company believes that its relationship with Sun Microsystems provides
a significant advantage to the Company. The Company has a number of contracts
with Sun under which Sun provides the Company proprietary designs for its
products or which enable the Company to utilize
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and sell Sun circuit board technology and operating systems or other software to
its customers. Additionally, in 1997, the Company was accepted into the Sun
Microelectronics' Partners Program. As a member of this program, Company
personnel make marketing calls on Fortune 500 companies, together with sales
representatives of Sun, to provide complete technology solutions to mutual
customers. In March 1999, the Company entered into a Repair Services Agreement
with Sun Microsystems, Inc. under which the Company provides repair and testing
services on Sun circuit boards and related components, and maintains an
inventory for Sun of repaired boards and components. The Company then provides
streamlined distribution of these components and parts to Sun Enterprise Service
Division's stocking locations, field engineers or customers using an online
information management system that connects the two companies. See "Contractual
Relationships with Sun Microsystems, Inc. and its Affiliates".
The Company is much smaller in size than Sun Microsystems, Inc. In its most
recently completed fiscal year, ending June 30, 1999, Sun reported revenue of
approximately $12 billion, approximately 1,000 times greater than the Company's
current level of annual revenue. While the Company is relatively insignificant
to Sun, the Company is significantly dependent upon its relationship with Sun.
In the first thirty-nine weeks of 1999, approximately 19% of the Company's sales
were services sales made to Sun under a services agreement and approximately 7%
of the Company's sales were product sales to Sun made under purchase orders. In
the same period, approximately 37% of its purchases of inventory were made from
Sun. Additionally, the Company has entered into license agreements with Sun
pursuant to which it sells products and services to third parties which
aggregated to approximately 28% of sales for the first thirty-nine weeks of
1999. For information about the various contracts the Company has with Sun, and
the amount of revenue generated under each agreement, See "Contractual
Relationships with Sun Microsystems, Inc and its Affiliates".
If all of the Company's relationships with Sun were to end, the Company's
operations would be adversely affected, particularly in the short term. However,
the Company would continue to sell products to OEM's, and it would continue to
provide repair and other services to TPM's and end-users. The Company would also
pursue providing repair-related services to other OEM's. The Company's
management believes that a complete severing of all of the various Sun
relationships is unlikely, because those relationships are diverse, and
independent of one another.
Sun could elect to discontinue buying services from the Company, but because of
the size and breadth of the services provided, management believes it would take
several months for Sun to replace the Company with one or more vendors to
provide those services.
DEVELOPMENT OF THE BUSINESS
The Company was incorporated as an Ohio corporation on March 9, 1989. Initially,
the Company focused on providing electronic repair services to universities,
which primarily had installed networks of Sun Microsystems workstations.
Gradually, the Company expanded its services to other users of Sun Microsystems
workstations who were self-maintaining such equipment. In 1992, the Company
began providing engineering and manufacturing services for CPU board designs for
OEMs. In 1994, the Company began engineering and manufacturing computer systems
patterned after Sun Microsystems workstations. In 1995, the Company focused its
product sales efforts on custom-designed circuit boards. Also in 1995, the
Company re-focused its repair marketing efforts from sales to universities and
end users to sales to Third Party Maintainers (TPM's), and Fortune 500
self-maintainers. In 1996, the Company began providing depot repair services to
OEMs. In 1997, the Company began designing and manufacturing custom integrated
computer systems for OEMs and found significant interest for these products in
the growing telecommunications market.
In early 1997, the Company entered into a joint venture as a minority partner of
LogistixPDSi Services in Northern California to provide repair services to the
OEM marketplace. In connection with this venture, the Company established a
repair depot facility within the headquarters of the majority partner in
Fremont, California. The Company also provided services outside of the joint
venture to TPM's from this facility. While the incremental services performed by
the Company for its own TPM customers at that facility was profitable, the level
of business generated by the joint venture entity from OEM customers failed to
meet the Company's expectations. The joint venture entity was not successful and
losses accumulated during 1997.
In November 1997, the company was offered an opportunity to establish a
dedicated depot for Sun Microsystems in California. The Company terminated its
participation in the joint venture, hired the joint venture employees and
established a facility within the distribution center of the Company's customer,
Sun Microsystems. In late 1998, in anticipation of accepting a larger role in
Sun's service business model, the Company closed the California facility and
consolidated its operations in Columbus, Ohio.
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In early 1999 the Company entered into a 10-year lease for 56,000 spare feet of
space for its operations in a building in a free-trade zone in Groveport Ohio, a
suburb of Columbus. In January 2000 the Company amended its lease to expand the
amount of square feet under lease to approximately 113,000. The Company sold the
building in which it previously housed operations.
BACKGROUND OF INDUSTRY
Original equipment manufacturers in the telecommunications, medical systems,
process control and government markets embed advanced technology systems in
their products to enhance functionality and performance. Management believes
that OEMs select a platform for their products based on the performance and
availability required by the application. Management further believes that OEMs
who choose Sun Microsystem's SPARC platform make this decision based on the
speed of Sun Microsystems processor technology and the stability of the UNIX
operating system. The reliability and speed of Sun processors combined with the
stability of Sun's Solaris operating systems provides excellent performance and
system availability.
To fully integrate these systems into their products, OEMs often have special
requirements that cannot be met by off-the-shelf products manufactured by Sun
Microsystems. Traditionally, these companies modified off-the-shelf components
to meet their specific needs, utilizing either in-house engineering resources or
outside engineering firms to create custom system configurations. In doing so,
these OEMs incurred significant non-recurring engineering (NRE) charges to cover
development costs. As the pace of technology has increased and competition has
intensified in these markets, OEMs are now less willing to incur the time and
expense required to develop custom systems. Instead, they are looking for
sources, such as the Company, that can provide application-specific systems and
products with minimal engineering development time and expense. The Company
believes OEMs will continue to look for ways to reduce product development time
and cost without compromising their ability to customize technology to their
application.
At the same time, there is a growing base of OEM products built around
technology that is no longer being supported by the manufacturer. These OEMs are
faced with having to modify software and reconfigure their product to
incorporate new technology that does not enhance their systems' performance
simply because their existing technology is no longer being supported by the
manufacturer. As a result, OEMs are looking for ways to extend the life of their
current technology. Some of these OEM's contract with entities to provide end of
life management, that may include manufacturing and/or repair of the products
not supported or manufactured by the OEM.
In the repair business there has been a trend during the last several years
towards outsourcing in the electronics repair industry which the Company
believes will continue in the future. The Company believes that this is due to:
(1) the desire of OEMs to focus resources on their primary business, (2) the
accelerated pace of new product introductions which is necessary for OEMs to
keep pace with competition, (3) the need to reduce costs, which can be
accomplished by converting fixed costs of an internal service department into
variable costs by outsourcing the service, and (4) the difficulties inherent in
servicing a wide range of equipment produced by
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multiple vendors, as data centers have moved from using predominantly one
company's hardware to using equipment from multiple vendors in many locations.
PRODUCTS
The Company's products include complete systems, specially designed products,
including boards and attach cards, and software. The Company resells some
hardware and software manufactured by Sun Microsystems and other OEM's, as well
as products developed internally by the Company's engineers. Complete systems
bring together hardware and software from multiple sources into fully integrated
systems.
One type of product developed and manufactured by the Company is known as a
"High Availability" system. This includes redundant system components with
sophisticated failover software. This allows systems to continue to operate
despite failure of any component by the instantaneous transfer of system
functions to the redundant backup system. These products have been purchased by
companies primarily in the telecommunications industry that cannot afford a
system failure or even the time delay involved in rebooting a system.
The Company has also developed products that allow OEMs to more fully integrate
SPARC technology into their technology systems. These products include power
supplies, specially modified motherboards, transition cards, and I/O boards.
The Company engages in research and development in connection with designing new
products for customers. This work is done in response to requests from customers
with specific product requirements. Upon completion of design and testing of the
newly developed product, the Company typically receives orders for production of
that product from the customer. During 1998 and 1997 the Company incurred
$191,557 and $144,703 respectively, for research and development. These expenses
were not paid by the Company's customers but are typically recouped over time as
part of the cost of the developed products that are sold to customers.
SOFTWARE
The Company is a SunSoft Master Distributor and is authorized to provide its
customers with the right to use Solaris, Sun Microsystem's UNIX operating
system. The Company also resells failover software as part of its "High
Availability" systems.
SERVICES
The Company repairs products that have been developed, manufactured, marketed
and sold by other companies, and which generally have a well-established
installed base as well as products developed internally. The Company also
designs and manufactures customized modifications to products of other companies
for integration into existing systems. Due in part to the capital costs
necessary to maintain adequate inventory and equipment to service large OEMs and
TPMs, the
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Company has focused its services on products manufactured primarily by Sun
Microsystems, Inc. and has built an inventory of Sun Microsystems components and
parts.
DEPOT REPAIR SERVICES: The Company provides OEMs, TPMs and end users who
maintain their own equipment the opportunity to outsource repairs of their
proprietary products or products produced by third parties. The entity that is
actually providing the maintenance service in the field will place an order with
the Company for the repair of defective components or parts. The time of
completion of the repair will be scheduled, with higher charges being incurred
for shorter time frame repairs. The Company offers its customers a choice of
5-day and 15-day repair and return services. The Company also maintains an
extensive inventory of spare components and offers the ability to provide
replacement components or parts overnight from its existing inventory in
exchange for the defective component or part, which is then repaired and
included in inventory. For repairs not requiring overnight service, the entity
maintaining the equipment in the field sends the defective component or part to
the Company. The Company's electronic technicians then repair the component or
part, test it, and ship it back to the customer. Since inception, the Company
has specialized in the repair of hardware manufactured by Sun Microsystems, Inc.
These systems are typically high end-user workstations able to perform
multi-tasking functions.
SUN MICROSYSTEMS LOGISTICS MANAGEMENT SERVICES: In August 1999, the Company
entered into an agreement with Sun Microsystems, Inc. to provide to Sun's
Enterprise Services Division test and repair services, and inventory and
logistics management services. Under this program, called the Virtual Logistics
Network (VLN), the Company is partnering with Sun Microsystems to provide
streamlined distribution of Sun components and parts to Sun customers using an
online information management system that connects the two companies. The
Company also provides management and logistics services to other
vendors/partners of Sun that participate in the VLN.
SPARE PARTS SALES: Spare parts sales include sales of repaired parts, new parts,
and reclaimed parts. There is a demand in the computer industry for the
necessary parts and components to provide repair services. New components are
often difficult to obtain and costly to purchase. The Company is able to provide
a wide variety of parts at a significant discount compared to the cost of
comparable new parts. The Company's spare parts capabilities enhance the
efficiency of its other service offerings. The Company either supplies the spare
parts from its own inventory when it has a surplus of a particular part or
component, or it acquires the requested parts from brokers or other suppliers of
used equipment. The Company sometimes dismantles used equipment to obtain used
components. The Company maintains an inventory consisting primarily of Sun
Microsystems' spare parts and components.
CONTRACT MANUFACTURING AND ENGINEERING: In certain cases, an OEM will outsource
the design and manufacture of a product to the Company. The outsourcing of
manufacturing enables the OEM to transfer its internal manufacturing
responsibilities to the Company, thereby enabling the OEM to reduce
manufacturing costs and improve its return on assets. The Company's contract
manufacturing services primarily involve products which have high engineering,
technical and test content, and low to medium production requirements. The
Company will also merge technology from a standard workstation to a customer's
product with private labeling. In connection with these services, the Company
will obtain orders for custom engineering and manufacturing services
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from entities which are customers of Sun Microsystems. These customers are using
the Sun operating system software and want to continue to use the sun software
in workstations, data servers or other applications not manufactured and sold by
Sun. The Company will design and engineer modifications to the Sun component
boards to fit the desired customized use and will then build the custom designed
products for the customer. The end product is a component board or computer
system that does not resemble the original Sun Microsystems board or system, but
operates the Sun software and performs the same functions as the Sun board or
system. Each product is unique and custom designed to the customer's
specifications. Some of these products use commercially available parts
configured to produce the desired function. In other cases, the custom-built
product contains components or functions conceived and developed by Company
personnel.
END OF LIFE MANAGEMENT: End of Life Management services bring together the
Company's board design and manufacturing, parts stocking, and repair
capabilities to extend the life of technology that is no longer supported by the
manufacturer. The Company will enter into an end of life service contract with
its customers which may include depot repair of installed technology as well as
acquisition or manufacture of products that have been end-of-lifed by the
manufacturer.
EXTENDED WARRANTY SERVICES. In 1992, the Company began initial marketing efforts
to provide customers with extended warranty support services. Generally, the
Company will extend warranty of the OEM's product for a fixed fee. The Company
is willing to develop warranty programs specifically tailored to meet a
customer's needs with the goal of fulfilling as many of the customer's repair
needs as is required.
CONTRACTUAL RELATIONSHIPS WITH SUN MICROSYSTEMS, INC. AND ITS AFFILIATES
In August 1999, the Company entered into an agreement with Sun Microsystems,
Inc. to provide to Sun's Enterprise Services Division test and repair services,
and inventory and logistics management services. The agreement has a one-year
term and renews automatically for additional one-year terms. In the first
thirty-nine weeks of 1999 the Company generated approximately $1.3 million of
revenue from this agreement, or approximately 19% of total revenue and 61% of
service revenue. These sales represented approximately 90% of the service
segment's operating income of $608,326 for the same period. The Company
considers this agreement to be of critical importance to its future viability,
and considers it to be the basis of its prospects for future growth of the
service segment. See "Services - Sun Microsystems Logistics Management
Services".
The Company designs and sells products under various technology license
agreements with Sun Microsystems. Two of the license agreements are of
material importance to the Company's viability. It is not possible to cite the
respective operating earnings contributions of the products sold under the two
license agreements, as the Company does not allocate labor and overhead costs
to individual products. Consequently, the respective revenue contributions are
cited below. If any of these agreements is terminated it would significantly
impede the Company's ability to perform its design and manufacturing services.
In October 1997, the Company entered into a Development and Manufacturing
License Agreement with Sun Microelectronics, a division of Sun Microsystems,
Inc. pursuant to which the Company has been licensed to develop, manufacture and
sell products based upon and using the Sun PCI card and Open Boot PROM
technology. The Company uses this license in the custom design of products. The
license enables the Company to use the Sun technology and make engineering or
design changes to meet customers' specific needs. The Company generated revenue
from these products of approximately $47,000 in 1997, $92,000 in 1998, and
$478,000 in the first thirty-nine weeks of 1999 (approximately 1%, 2%, and 8% of
total product revenue, respectively). The Company expects the portion of its
products based on this license to increase in future years. Consequently, the
importance of this license to the Company is likely to increase in future years.
Consequently, the importance of this license to the Company is likely to
increase in future years. This license agreement is for a term of three years
expiring in 2000, subject to automatic renewal for one-year periods unless
either party gives notice of non-renewal. The license can be terminated earlier
upon default.
In May 1994, the Company entered into a microprocessor platform design license
agreement with Sun Microsystems Computer Corporation, acting through its SPARC
Technology Business Division, pursuant to which the Company has been licensed to
develop, manufacture and sell products based upon and using the Sun SPARC
microprocessor technology. The Company uses this license in the custom design of
products. The license enables the Company to use Sun technology and make
engineering or design changes to meet customers' specific needs. The Company
generated revenue from these products of approximately $2.3 million in 1997,
$2.7 million in 1998, and $1.1 million in the first thirty-nine weeks of 1999
(approximately 54%, 44%, and 20% of total product revenue, respectively). The
technology of this license is utilized in customer projects that began prior to
1997. It has not been utilized in any new customer projects since before 1997.
The Company does not anticipate that it will develop any new product based on
the technology licensed under this agreement, although it will continue to sell
products that it has developed under this license. Consequently, the importance
of this license to the Company is likely to decline in future years. A license
fee in the amount of $35,000 was paid in full upon execution of the license.
This license agreement is for a term of 7 years expiring in 2001, subject to
automatic renewal for one-year periods unless either party gives notice of
non-renewal. The license can be terminated earlier upon default.
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SALES AND MARKETING
The Company focuses its marketing efforts on large OEMs and on TPMs. Since
marketing is primarily to large OEMs or TPMs, the Company does not maintain a
large field sales organization. The Company currently uses four independent
manufacturers representative firms to generate sales opportunities. The Company
employs three in-house sales representatives, who are focused on targeted
accounts. During the first 39 weeks of 1999 the Company had revenue from three
customers that represented approximately 51% of sales. The Company's largest
customer in 1999, Sun Microsystems, accounted for approximately 26% of sales
during 1999. During 1998, the Company had revenue from three customers that
represented approximately 59% of sales. The Company's largest customer in 1998,
Computer Network Technologies, Inc., accounted for approximately 22% of the
Company's sales. In 1997, the Company's three largest customers represented
approximately 49% of sales. In 1997, the Company was accepted into the Sun
Microelectronics' Partners Program. As a member of this program, Company
personnel make marketing calls on Fortune 500 companies, together with sales
representatives of Sun, to provide complete technology solutions to mutual
customers.
COMPETITION
Competition for the specially designed products of the Company come from two
primary sources: (1) other companies that provide similar products, and (2)
products that are competitive with Sun Microsystem's products.
A number of companies are now targeting the telecommunications industry, due to
the continued growth in this market that is expected in the future. Many of
these companies are more established than the Company and have substantially
greater financial and other resources than the
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Company. The Company believes it can differentiate itself from the competition
through the strength of its close relationship with Sun Microsystems, its
ability to offer a complete turnkey product/service solution, its unique product
set, and its focus on providing off-the-shelf solutions wherever possible.
Primary competition for the Company's products also comes indirectly from
increased performance and acceptance of the "Wintel" platform. OEMs who are
choosing a platform for their products increasingly narrow their choice down to
SPARC-based systems sold by Sun Microsystem and systems using Intel processors
with Windows NT. If the Wintel platform were to gain acceptance in the
telecommunications industry it would erode the Company's potential market as the
Company does not provide products or services to support this platform.
Primary competitive factors in the repair industry are price, scope and quality
of a company's repair services and know-how. The Company competes with the
in-house repair centers of OEMs and TPMs for end-of-life programs and for repair
services. While the Company believes it offers a cost-effective repair solution
to OEMs and TPMs and, therefore, believes these entities are the Company's
primary potential customers, there is no assurance that these entities will
choose to outsource their repair needs and will not become competitors of the
Company. These entities could also choose to compete directly with the Company
for the services of unrelated OEMs and TPMs and for end-users. In addition to
competing with OEMs and TPMs, the Company also competes with a number of
independent organizations similar to the Company.
In the contract manufacturing area, the Company competes against numerous
entities that focus specifically on turnkey contract manufacturing. Many of the
OEMs, TPMs and contract manufacturers with which the Company competes have
significantly greater manufacturing, financial, technical and marketing
resources than the Company. Similarly, some of the independent depot repair
businesses may generate significantly more revenues than the Company and may
have greater manufacturing, financial, technical and marketing resources than
the Company.
EMPLOYEES
As of February 11, 2000, the Company had a total of 79 employees, 74 of whom
were full-time. None of its employees are subject to collective bargaining
agreements, and the Company considers its relationship with its employees to be
good.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion should be read in conjunction with the Financial
Statements and Notes contained herein.
The following sections contain forward-looking statements. These forward-looking
statements involve risks and uncertainties, and the cautionary statements set
forth below identify important factors that could
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cause actual results over the next few quarters to differ materially from those
predicted in any such forward-looking statements. Such factors include, but are
not limited to, adverse changes in general economic conditions, including
adverse changes in the specific markets for the Company's products and services,
adverse business conditions, decreased or lack of growth in the computing
industry, adverse changes in customer order patterns, including any decline or
change in product orders from any of the three customers that make up
approximately 59% of the Company's revenue, increased competition, any adverse
change in Sun Microsystems' business or the Company's relationship with Sun,
around whose operating systems the Company's business is based, lack of
acceptance of new products, pricing pressures, lack of adequate financing to
take advantage of business opportunities that may arise, lack of success in
technological advancements, risks associated with the Company's efforts to
comply with Year 2000 requirements, risks associated with the Company's new
business practices, processes and information systems, and other factors.
RESULTS OF OPERATIONS
The interim financial information contained herein is unaudited. The financial
statements included in this report reflect all adjustments (consisting of normal
recurring accruals) that the Company considers necessary for a fair presentation
of the results of operations for the interim periods covered and of the
financial condition of the Company at the date of the interim balance sheet. The
results for the interim periods are not necessarily indicative of the results
for the entire year.
In 1999 the Company adopted a new fiscal calendar in which each fiscal quarter
consists of four-week periods for the first two fiscal months of the quarter and
a five-week period for the third fiscal month of the quarter. The Company
previously reported on straight calendar quarters.
THIRTY-NINE WEEKS ENDED OCTOBER 1, 1999 (UNAUDITED) COMPARED TO NINE MONTHS
ENDED SEPTEMBER 30, 1998 (UNAUDITED)
SALES
Sales were $7,962,540 for the thirty-nine weeks ended October 1, 1999, an
increase of 26% over sales for the first nine months of 1998.
Product sales were $5,664,507 for the first thirty-nine weeks of 1999, an
increase of 34% over the first nine months of 1998. The 34% increase in product
sales was fully attributable to new customers obtained since September 1998.
Service sales for the first thirty-nine weeks of 1999 were $2,205,310, which was
12% higher than the first nine months in 1998. The increase in service sales
resulted primarily from higher volumes of repairs from the Company's largest OEM
customer. The Company provides repairs and logistics management services for a
specific list of electronic computer circuit boards and other computer
components for one large and several smaller OEM customers. The volumes of those
listed components grew in 1999, more components were added to the list, and the
Company provided services for additional customers. The Company expects sales
volumes to continue to
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<PAGE> 13
grow from each of those three sources. The Company experienced a non-recurring
decline in OEM service revenue early in 1999 as the Company's largest customer
undertook a transition to a new vendor model. The Company believes that the new
model will result in sales growth from the customer in the future.
The relative levels of growth of product and service sales continued a
multi-year trend of an evolution in the mix of the two types of sales. Product
sales, as a percentage of total sales have grown from 56% in 1996, to 65% in
1997, to 68% in 1998, to 71% through the first thirty-nine weeks of 1999.
Service sales, as a percentage of total sales, have gone from 41 %, to 32%, to
30%, to 28% over the same period.
GROSS PROFIT
Total gross margin was 26% for the first thirty-nine weeks of 1999, up from 19%
for the first nine months of 1998.
The gross margin on product sales was 21% for the first thirty-nine weeks of
1999, compared to 18% for the first nine months of 1998. The improvement is
primarily attributable to declines in component costs.
The gross margin on service sales increased to 43% in for the first thirty-nine
weeks of 1999, from 22% for the first nine months of 1998. The predominant
factor in the difference in margins on service sales resulted from an inventory
writedown of $300,000 the Company took in the 3rd quarter of 1998. Without the
writedown, the gross margin on service sales through the first nine months of
1998 would have been 38%. A major factor in the gross margin improving to 43% in
the first thirty-nine weeks of 1999 was a significant reduction in labor and
overhead costs, resulting from the Company's decision to close its depot repair
facility in California. That facility was opened at the request of the Company's
largest service customer in the first quarter of 1998. When that customer
elected in late 1998 to implement its new vendor model that did not require a
West Coast depot, the Company closed the California facility, thereby reducing
labor and overhead costs.
OPERATING EXPENSES
Operating expenses totaled $1,733,057 for the first thirty-nine weeks of 1999,
compared with $1,306,442 for the first nine months of 1998. The 33% increase
from 1998 to 1999 exceeded the rate of growth of sales. The increase came
primarily from higher wages from an expanded professional technical staff,
higher depreciation resulting from fixed asset purchases, facility costs
resulting from the Company's relocation to a larger facility, and higher
professional fees, which included one-time recruiting fees relating to
professional technical staff hiring. As a percentage of sales, operating
expenses increased from 21% in 1998 to 22% in 1999.
Income from operations improved to $346,731 (4% of sales) for the first
thirty-nine weeks of 1999, from a loss of $76,941 for the first nine months of
1998.
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<PAGE> 14
OTHER INCOME AND EXPENSE
In May 1999, the Company sold its building in which it conducted operations, and
relocated to a larger facility, which it leases. The sale of the building
resulted in a gain before taxes of $85,922.
In anticipation of higher sales volumes, the Company entered into a new
financing package with Star (now Firstar) Bank in the first fiscal quarter of
1998. The package included an installment loan of $300,000 and a revolving line
of credit. The two new loans were used to liquidate loans the Company had with
its previous bank, which included a mortgage loan on the Company's building.
After making the initial draw against the line of credit to liquidate the
mortgage loan, the Company made modest drawings against its line of credit for
the remainder of the first nine months of 1998. In July 1998, the Company
obtained another mortgage loan on its building. The Company used the proceeds of
the mortgage loan to pay down the line of credit balance, but then continued to
make draws against the line to support working capital through the last nine
months of 1998 and the first thirty-nine weeks of 1999. At October 1, 1999 the
balance of the line of credit was $1,170,000. Primarily as a result of the
Company's increased use of its line of credit, interest expense in the first
thirty-nine weeks of 1999 grew 14% from the first nine months of 1998.
INCOME TAXES AND NET INCOME
The improved income from operations, combined with the one-time gain on the sale
of the Company's building, resulted in income before income taxes of $363,596
for the first thirty-nine weeks of 1999, compared to a loss of $137,770 for the
first nine months of 1998. The Company accrued income tax expense at the same
rate in 1999 as it had in 1998. Net income was $214,695 for the first
thirty-nine weeks of 1999, compared to a loss of $80,992 for the first nine
months of 1998.
The Company's basic earnings per share improved from a $0.07 loss for the first
nine months of 1998, to $0.18 for the first thirty-nine weeks of 1999. Fully
diluted earnings per share improved from a $0.07 loss for the first nine months
of 1998, to $0.17 for the first thirty-nine weeks of 1999.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
SALES
Sales of the Company in 1998 increased 38% over 1997, from $6,551,490 in 1997 to
$9,032,332 in 1998. During 1998, the Company achieved a 43% increase in product
sales and a 28% increase in service sales.
The 43% increase in product sales resulted from two primary factors: (1)
obtaining new significant orders from existing customers during the year, and
(2) producing products during the year which were in the design stage at year
end 1997.
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<PAGE> 15
The 28% increase in service sales resulted from management's decision to focus
on increasing sales to OEM's. Sales to this target market increased 234% during
the year. By contrast, repair sales to TPM's and to self-maintainers declined by
45% from the previous year, as management de-emphasized sales to this market
segment.
GROSS PROFIT
Management's decision to direct its marketing efforts toward the OEM marketplace
and away from the TPM marketplace was intended to improve the Company's
long-term prospects for growth and profitability. Management believes the OEM
segment holds greater opportunities for growth than the TPM segment, and also
believes that OEM sales will be more profitable with greater labor efficiencies
and greater returns on investments in inventory and capital equipment.
The transition from a TPM focus to an OEM focus in 1998 had a short-term
negative impact on the Company's financial results. For several years the
Company maintained an inventory of spare parts exclusively for the purpose of
supporting TPM sales. Due to the Company's sharp decline in revenue from the TPM
market segment from 1997 levels, the Company elected to record a writedown of
the value of that segment of its inventory of $300,000 during the third fiscal
quarter of 1998. The writedown was recorded as a charge to cost of goods sold.
The writedown resulted in an operating loss of $126,240 in the third quarter.
For the total of the other three fiscal quarters of 1998 the Company posted
operating income of $126,828.
While some of the inventory items that were written down were sold in the
ordinary course of business during the fourth quarter of 1998, others were
scrapped or sold at reduced prices as part of a specific effort to liquidate
this inventory.
Largely as a result of this inventory writedown, cost of goods sold increased
substantially during 1998, and gross margin was thereby reduced, dropping to 20%
from 27% in 1997. The gross margin on product sales decreased from 23% to 18%.
In addition to providing custom-designed circuit boards, in 1998 the Company
began providing entire custom-designed computer systems, which had lower margins
than the circuit board products. The gross margin on service sales declined from
39% to 29%, due in part to the inventory writedown, and due in part to having
two depot repair facilities open throughout most of 1998. The second repair
facility, located in Northern California, was closed by the Company in late
1998.
Therefore, despite a 38% increase in sales during 1998, the Company's gross
profit increased by only 5.4%. Another factor contributing to the Company's
reduced gross profit margin in 1998 was the fact that product sales grew in 1998
at a higher rate than repair sales. Product sales typically have lower gross
profit margins than repair sales.
OPERATING EXPENSES
During 1998, while the gross profit of the Company remained relatively constant
in total dollars, operating expenses of the Company increased by 31% over 1997
levels, primarily as a result of increased wage and benefit expenses associated
with an expanded work force. However, because
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<PAGE> 16
operating expenses increased by less than the rate of increase of sales during
1998, operating expenses as a percentage of each sales dollar declined from 20%
in 1997 to 19% in 1998.
Because operating expenses increased by more than the relatively modest increase
in gross profit, the Company's income from operations dropped by $322,736, or
78%, from 1997. Income from operations declined from $411,620, or 6% of sales,
in 1997, to $88,885 in 1998, which was 1% of sales.
OTHER INCOME AND EXPENSE
The Company made minimal drawings against its line of credit in 1997, and at
year-end 1997 the balance on the Company's line of credit was zero. During 1998,
the line of credit was used often and extensively by the Company to support the
higher receivables resulting from higher sales volumes and to fund fixed asset
acquisitions. At year-end 1998, the outstanding balance stood at $150,000.
Primarily as a result of the Company's increased use of its line of credit, net
interest expense in 1998 grew by 21% over 1997 levels, from $68,853 in 1997 to
$83,552 in 1998.
The increased interest expense, combined with the Company's reduced income from
operations, resulted in lower income before income taxes during 1998 of $5,333,
compared to $264,819 in 1997.
INCOME TAXES AND NET INCOME
Because its income before income taxes was lower, the Company's income tax
expense was only $4,745 in 1998, compared to $107,580 in 1997.
The Company's net income was $588 in 1998, or 5/100ths of one cent per share,
both basic and diluted, while the 1997 net income was $157,239, or 13 cents per
share, both basic and diluted.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
SALES
Sales of the Company in 1997 were $6,551,490, up from $4,661,261 in 1996.
Product sales increased 64% and service sales increased 11%. Product sales made
up 65% of total sales in 1997, compared to 56% in 1996.
The 64% increase in product sales resulted from two primary factors: (1) winning
new significant product orders from existing customers during the year, and (2)
producing products during the year which were in the design stage at year end
1996.
Most of the service sales growth resulted from marketing efforts directed toward
OEM's.
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<PAGE> 17
GROSS PROFIT
The gross margin on product sales in 1997 was 21%, compared to 26% in 1996. The
product sales margin decreased primarily because new projects were priced more
competitively than older projects. The service sales gross margin declined from
41% to 39%. Because product sales grew in 1997 at a much higher rate than repair
sales, the gross margin of the Company declined to 27% in 1997, compared to 32%
in 1996. However, due to higher sales volume, the gross profit of the Company
(in dollars) grew by 16% in 1997.
OPERATING EXPENSES
Operating expenses of the Company in 1997 were $1,334,156, compared to
$1,401,820 in 1996, a 5% decrease. As a percentage of sales, such expenses were
20% in 1997, compared to 30% in 1996. The decline of operating expenses in 1997
as a percentage of sales was primarily the result of economies of scale and a
restructuring of certain employee compensation arrangements.
In 1997 income from operations increased 303% over 1996. As a percentage of
sales, income from operations was 6% in 1997, compared to 2% in 1996.
OTHER INCOME AND EXPENSE
Net interest expense in 1997 grew by 19% over 1996 levels ($68,853 in 1997 vs.
$57,664 in 1996). The increase was primarily the result of a capital equipment
lease that originated in the fourth quarter of 1996.
Income before income taxes increased to $264,819, or 4% of sales in 1997,
compared to $62,127, or approximately 1% of sales in 1996.
INCOME TAXES AND NET INCOME
The Company incurred significantly higher income tax expense in 1997 than it did
in 1996 ($107,580 in 1997 vs. $12,000 in 1996). Most of the increase was
attributable to higher tax rates on higher income levels.
The Company's income before income taxes was reduced by a loss of approximately
$78,000 from its participation in a joint venture with Software Logistix
Corporation. The Company had approximately a 40% ownership position and reported
results under the equity method of accounting. The Company terminated its
participation in the joint venture as of December 31, 1997.
The Company's 1997 net income was $157,239, compared to $50,127 in 1996. Both
basic and fully diluted earnings per share were $0.13 in 1997. Both per share
calculations were $0.05 in 1996.
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<PAGE> 18
LIQUIDITY AND CAPITAL RESOURCES
During the first thirty-nine weeks of 1999, the Company consumed $816,693 of
cash in its operating activities. In the first nine months of 1998, the Company
used only $476,713 of cash in its operating activities. The foremost use of cash
in 1999 was inventory, which increased by $1,157,857 from the beginning of 1999.
Much of the increase in inventory was attributable to current and anticipated
future sales growth. Another minor factor in the increase in inventory was an
increased number of requests from product customers for delivery of
prototype/evaluation systems. Another factor was the request of some product
customers that the Company hold in stock a quantity of their specific-designed
systems on hand for immediate delivery. In these cases, the customer is
committed to purchase these products within a specified period of time under a
volume purchase agreement. The Company also made some one-time component
purchases, in some cases to take advantage of price discounts, and in other
cases to secure the availability of components that were no longer going to be
manufactured. The Company expects to maintain a substantial investment in
inventory for the foreseeable future in order to support its expected growth in
product sales.
Other asset categories that increased, thereby using cash, were accounts
receivable and prepaid expenses, which increased by $599,772 and $149,656,
respectively. These uses of cash were partially offset by increases in accounts
payable of $521,561, in accrued liabilities and taxes of $177,226, and in
unearned revenues of $26,763.
For the entire year of 1998 the Company consumed $63,622 of cash in its
operating activities. The Company used $34,461 and $391,970 in its operating
activities in 1997 and 1996, respectively. The largest use of cash among
operating activities over the three-year period was an increase in inventory,
which increased by more than $650,000 in both 1996 and 1997. In 1996, the growth
in inventory was fueled primarily by the growth of the TPM repair business, in
which the Company would maintain a stock of replacement computer components in
order to provide an overnight exchange of parts for customers. In 1997, the
inventory growth was driven primarily by the increase in product sales. In 1998,
as a result of the inventory writedown and of efforts by the Company to
liquidate older inventory components, the Company's investment in inventory
declined by approximately $150,000.
The Company's accounts receivable increased in each year from 1996 to 1998. In
1996, the increase was only $55,202, but in both 1997 and 1998, the increase was
greater than $400,000. The rate of increase in accounts receivable from December
31, 1996 to December 31, 1997 was 69%, which was greater than the 40% increase
in annual sales, but far less than the 156% increase in sales from the month of
December 1996 to the month of December 1997. Likewise, accounts receivable
increased 46% from December 31, 1997 to December 31, 1998, which was more than
the 38% increase in annual sales, but was less than the 57% increase in sales
from the month of December 1997 to the month of December 1998.
The Company's investing activities in the first thirty-nine weeks of 1999
consumed $205,088 in cash. Purchases of furniture and computer equipment
consumed $352,704 of cash, but were offset by the Company's sale of its land and
building, which generated $147,615. In the first nine months of 1998 the
Company's investing activities consumed cash of $150,157.
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<PAGE> 19
The Company's investing activities throughout 1997 and 1998 consisted entirely
of purchases of furniture and computer equipment. Total expenditures of capital
assets, all of which were made with cash, were $153,779 in 1997 and $168,664 in
1998.
In April 1996, the Company completed a public offering of 250,000 of its common
shares at $5.00 per share, resulting in gross proceeds of $1,250,000. Five
months earlier (November 1995), the Company sold 100,000 units consisting of 1
share and 1 warrant in a private offering at $2.50 per unit. The warrants, which
were exercised in May 1996 following the public offering, had a striking price
of $2.50 per share. The net proceeds of the three sales of common shares (net of
related expenses) were $1,523,393. The Company also received proceeds of
approximately $77,000 from the exercise of employee incentive stock options.
These proceeds funded the Company's operating activities throughout 1996 and
1997, which consumed approximately $420,000 over the two-year period. The
proceeds also funded approximately $288,000 of capital equipment purchases over
the same period. They were also used to liquidate a note payable to a vendor of
approximately $253,000 and to reduce short-term bank debt of $45,000 and
long-term bank debt of approximately $240,000. As of the end of 1997, these
proceeds were essentially depleted.
Through the last half of 1997, in anticipation of the depletion of the stock
sale proceeds, and in anticipation of higher sales volumes, the Company sought a
new financing package, and in early 1998 completed an agreement with Star (now
Firstar) Bank. The initial package with Star included a revolving line of credit
and a $300,000 term loan requiring 60 monthly payments of $5,000 plus variable
interest. Both instruments had an interest rate of prime. The combined package
had a limit of the lower of $1,500,000, or a percentage of the Company's
eligible accounts receivables. The loan agreements require the Company to meet
certain financial targets and to comply with certain other covenants, including
restrictions on paying dividends, incurring additional indebtedness and liens,
guarantees of other obligations, and reorganizations. The Company's obligations
under these loan agreements are secured by substantially all of the Company's
assets.
The initial draw on the line of credit was approximately $241,000. Combined with
the $300,000 term loan, the proceeds were used to retire a term loan and a
mortgage loan at Huntington Bank. The payoff of those loans were approximately
$180,000 and $361,000, respectively.
In July 1998, the Company obtained a mortgage loan from Firstar Bank on the
Company's building in the amount of $412,500. The mortgage loan had a 5-year
maturity and was amortized on a 15-year basis. The building was sold in May
1999, and the mortgage loan was retired by the proceeds of the sale.
During 1998, the line of credit was used often and extensively by the Company to
support the higher receivables resulting from higher sales volumes and to fund
fixed asset acquisitions. At year-end 1998, the outstanding balance stood at
$150,000. For the year 1998, net of regularly scheduled principal payments, the
Company's bank debt increased by approximately $238,000 to fund operating
activities and capital equipment purchases.
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<PAGE> 20
For the first thirty-nine weeks of 1999 principal payments on the Company's
long-term debt and capital lease totaled $65,974. Those payments were partially
offset by proceeds of $43,500 from the exercise of employee incentive stock
options. However, The Company's principle means of funding its operations in the
first six months of 1999 were draws on its bank line of credit, which totaled
$1,020,000. At October 1, 1999, the balance was $1,170,000.
These draws consumed most of the Company's borrowing capacity under the formulas
of its initial financing package with Firstar. Consequently, in September 1999,
the Company renegotiated its financing agreement with Firstar to increase the
maximum amount available on a revolving basis through September 2000 to
$2,000,000, and to include the Company's inventory as part of the borrowing base
calculation, in addition to its accounts receivable, thereby significantly
increasing the Company's borrowing capacity. The line of credit and the $300,000
term loan are secured by a security interest in substantially all of the
Company's assets and by the collateral assignment of $1,000,000 of coverage of a
$2,000,000 life insurance policy on the life of John Bair. As of October 1,
1999, the Company had approximately $677,000 of unused availability on the line
of credit.
As the Company continues to grow, it will need to obtain additional working
capital, to support higher levels of accounts receivable and inventory and will
need to fund additional investments in capital equipment. The amount for
additional capital needed by the Company will depend, in part, on the relative
growth of the service and product segments. The Company intends to expand its
service sales at a pace greater than or equal to product sales. Service sales
are significantly less capital intensive than product sales, which require a
much greater investment in inventory.
In February 2000 the Company entered into a new loan agreement with Key Bank to
refinance its loan with Firstar. The agreement provides for a line of credit up
to $2.5 million, a $400,000 three-year term loan, both at a variable interest
rate of prime minus 0.25%, and a $250,000 lease line of credit. Differences
between the new loan agreement and the previous agreement will result in
significantly expanded borrowing capacity for the Company. The new term loan
will not reduce the borrowing availability of the line of credit, as was the
case in the old agreement, and amounts owed to Sun Microsystems will not be
deducted from any amounts owed from Sun, in the calculation of the borrowing
availability.
The Company believes that if it continues with steady growth, then the new loan
agreement will be sufficient to meet its immediate financing needs. However,
the Company's management believes that it would need to raise additional debt
and/or equity capital in order to fund larger product sales opportunities that
may arise. The Company is currently investigating several alternatives. One
alternative is specific bank financing for customer sales projects, and for
fixed asset acquisitions. The Company is pursuing expanded credit terms from
its suppliers for specific projects. For the longer term the Company will
consider additional debt or equity financing.
YEAR 2000 IMPACT ON COMPUTER RESOURCES
A potential problem exists for all companies that rely on computers as the year
2000 approaches. The "Year 2000" problem is the result of the past practice in
the computer industry of using two digits rather than four to identify the
applicable year. This practice could result in incorrect results when the
Company's computers or those of the third parties with which it deals perform
arithmetic operations, comparisons or data field sorting involving years later
than 1999.
The Company believes that all of its product offerings are Year 2000 compliant,
in that its products will not produce errors in the processing of date data
related to the year change from December 31, 1999 to January 1, 2000. The
Company believes its products are Year 2000 compliant in large part because its
products incorporate hardware and software products and technology that are
produced by Sun Microsystems, Inc., and that have been warranted by Sun to be
Year 2000 compliant. However, if the Company's products are embedded into or
otherwise combined with other hardware or software products that are not Year
2000 compliant, the Company's products may fail to function properly.
The Company cannot be sure that its products or Sun's products do not contain
undetected errors or defects associated with Year 2000-related operations that
may result in material costs to the Company. Nor can the Company be sure that
its products will not be combined with other products that contain undetected
errors or defects. The Company's operations and financial condition could be
adversely affected if its customers become dissatisfied with its products and
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<PAGE> 21
services as a result of Year 2000 issues, or if customers are unable to pay the
Company for services rendered or products sold because of their own year 2000
issues.
The Company has assessed the Year 2000 readiness of those third parties that
could have a material impact on the Company's operations. The Company has sent
Year 2000 questionnaires to these third parties with the intent to evaluate the
steps these parties have taken to assess their preparedness for the Year 2000.
The Company is in the process of evaluating these questionnaires. The areas in
which the Company is most dependent on third parties is in the supply of
electronic components and accounts receivable. Most of the Company's purchases
and most of its sales are from and to large companies who have already made
assurances of Year 2000 compliance. Nonetheless, the Company is continuing to
evaluate the readiness of these organizations. The Company's operations and
financial condition could be adversely affected if any of its suppliers cannot
timely provide products or services which are critical to the Company.
The Company has partially assessed the potential operational and financial
effects that it may encounter with respect to its internal information systems
as a result of the "Year 2000" issue, and believes that these will be material.
The Company has replaced its management information/accounting system with a
Year 2000-compliant system at a cost of approximately $30,000 in the past year.
The Company has completed all phases except for the installation of a business
management system, which has been purchased. The Company's operations and
financial condition could likewise be adversely affected if any of its internal
systems fail to achieve Year 2000 compliance.
The Company will utilize both internal and external resources to reprogram or
replace and test all of its software. The Company expects to incur costs up to
$40,000 to replace its existing business management system.
Such costs are being financed through a lease with the Company's bank.
ITEM 3. DESCRIPTION OF PROPERTY
The Company leases approximately 56,000 square feet of office, warehouse,
laboratory and production space in a building located at 6600 Port Road,
Groveport, Ohio. The Company entered into a ten-year lease commencing May 1,
1999. In January 2000 the Company amended its lease to expand the amount of
square feet under lease to approximately 113,000, effective February 1, 2000.
The Company has the option to extend the term of the lease for an additional
five years. The building is in good condition. The Company believes that this
space is adequate for the foreseeable future and that additional space could be
obtained within its existing building if additional space became necessary. See
Item 2, Management Discussion and Analysis.
In May 1999, the Company sold a 19,200 square foot building in which it formerly
conducted its operations. The sale resulted in a gain of $85,922 to the Company.
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<PAGE> 22
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of February 11, 2000, with
respect to the Shares held of record by (a) the Company's chief executive
officer and the three persons serving as its other executive officers during
1999, (b) each of the directors of the Company, (c) all executive officers and
directors as a group, and (d) each shareholder known to the Company to own more
than 5% of the Company's common shares, including Shares subject to outstanding
Options or Warrants that can be exercised within a 60 day period:
NAME AND NUMBER OF PERCENT
ADDRESS OF OWNER SHARES OWNED (1) (2) (3) OF CLASS
---------------- ------------------------ --------
John D. Bair 359,431 24.2 %
6600 Port Road
Groveport, OH 43125
C. Robert Hahn 31,831 2.1 %
6600 Port Road
Groveport, OH 43125
Thomas J. Carr 38,031 2.6 %
6600 Port Road
Groveport, OH 43125
Thomas M. O'Leary 15,500 1.0 %
868 Paisley Place
Worthington, OH 43085
Robert V.R. Ostrander 14,500 1.0 %
1585 Bethel Road
Columbus, OH 43220
Executive officers and directors 453,631 30.6 %
as a group (_6_ persons)
-
The following table sets forth certain information as of February 11, 2000, with
respect to the Shares held of record by any other shareholder known to the
Company to own more than 5% of the Company's common shares, including Shares
subject to outstanding Options or Warrants:
David J. Richards 111,320 7.5 %
765 North Hamilton Rd.
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<PAGE> 23
Columbus, Ohio 43230
- ----------------------------------------------------------
(1) The persons listed in the foregoing two tables have the sole right to vote
and to dispose of the common shares of the Company listed in that person's
name.
(2) As trustees of the Pinnacle Data Systems, Inc. 401(K) Profit Sharing Plan,
Messrs. Bair, Hahn and Carr have the power to vote the Pinnacle shares held
in the plan. Each of these individuals is shown as beneficially owning the
2,831 shares in the Plan due to their shared voting power. However, they
have no investment power with respect to such shares.
(3) The shares set forth in the foregoing two tables include the following
numbers of Shares which may be acquired by the following persons upon the
exercise of stock options, which are exercisable within the next 60 days:
John D. Bair 35,000 2.4 %
C. Robert Hahn 29,000 1.9 %
Thomas J. Carr 34,000 2.3 %
Thomas M. O'Leary 15,000 1.0 %
Robert V.R. Ostrander 14,500 1.0 %
David J. Richards 37,000 2.5 %
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The directors, executive officers and key personnel of the Company are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION DIRECTOR
---- --- -------- SINCE
-----
<S> <C> <C> <C>
John D. Bair 33 Chairman, President, Chief 1989
Executive Officer and Director
C. Robert Hahn 47 Chief Operating Officer, Vice 1995
President and Director
Thomas J. Carr 45 Treasurer, Chief Financial Officer 1996
and Director
John C. Kniley 51 Vice President of Sales and
Marketing
Michael L. Antill 38 Vice President of Engineering
Joy Bair 29 Secretary
</TABLE>
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<PAGE> 24
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Thomas M. O'Leary 55 Director 1996
Robert V.R. Ostrander 53 Director 1997
</TABLE>
John D. Bair, one of the founders of the Company, currently serves as Chief
Executive Officer and President of the Company. He has served as a director
since inception, as the Chairman of the Board and Chief Executive Officer since
May 1996, and as President since 1998. He served as Secretary from inception
until October 1998. Mr. Bair holds a Bachelor of Science Degree in Computer and
Information Science from the College of Engineering from the Ohio State
University.
C. Robert Hahn is an executive officer and has served as Chief Operating Officer
and Vice President of the Company since June 1998. He served as President of the
Company from June 1996 to June 1998, and as Vice President of Sales and
Marketing from October 1994 to June 1996. He has served as a director since
December 1995. Mr. Hahn previously worked for six years as general manager of
Cranel, Inc., a distributor of computer peripheral products. Mr. Hahn holds a
Bachelor Degree in Business Administration and a Master of Business
Administration degree, both from Ohio University, and has been certified as a
Certified Production and Inventory Manager by the American Production and
Inventory Control Society.
Thomas J. Carr is an executive officer and has served as Treasurer and Chief
Financial Officer and as a director of the Company since May 1996. He joined the
Company as Controller in September 1995. Previously, Mr. Carr was President for
three years of Celtic Resources, a business consulting firm. Mr. Carr taught
general computer courses at Columbus State Community College for two years. He
served as Controller and Director of Financial Planning for six years at
CompuServe Incorporated of Columbus, Ohio. Mr. Carr holds a Bachelor Degree in
Accounting and a Master of Business Administration degree, both from The Ohio
State University.
John C. "Skip" Kniley is an executive officer and has served as Vice President
of Sales and Marketing since March 1999. Mr. Kniley has 27 years of experience
in various sales and marketing positions, the most recent five years with the
Bucci-Augustyn group of companies, a medical technology firm, as Director of
Sales and Marketing. Mr. Kniley holds a Bachelor of Science in Marketing from
the University of Connecticut.
Michael L. Antill is an executive officer and has served as Vice President of
Engineering since August 1999. Mr. Antill has 17 years experience in various
engineering and engineering management positions, including the last 11 years as
Manager of Electronic Systems at Chiron Diagnostics Corp., a medical technology
company. Mr. Antill holds a Bachelor of Electrical Engineering Technology from
The Ohio Institute of Technology and a Masters of Electrical Engineering degree
from Cleveland State University.
Joy S. Bair has served as Secretary of the Company since October 1998. From
October 1997 until October 1998 she served as Assistant Secretary. Ms. Bair was
previously employed with the Company from June 1990 until April 1993, serving in
several positions including Accounting
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<PAGE> 25
Manager. Ms. Bair holds a Bachelor of Science Degree in Actuarial Science and a
Master of Education Degree in Mathematics, both from The Ohio State University.
Thomas M. O'Leary has served as a director of the Company since September 1996.
Mr. O'Leary retired from ATT/Lucent after 30 years of service in 1996. While
employed by ATT/Lucent, Mr. O'Leary acquired extensive experience in the areas
of management of manufacturing operations, engineering, product development,
project management, product repair and support and sales. He is currently on the
school board of the Worthington City School system and served as President in
1998. He is also a board member of Liberty Communications Services, Inc. in
Gahanna, Ohio. Mr. O'Leary now serves as a private consultant for a number of
local companies in areas related to his accumulated experience.
Robert V.R. Ostrander has served as a director of the Company since July 1997.
Mr. Ostrander is currently serving as Chairman of Manex Financial Management,
Inc. and President of Manex Risk Management, Inc., Manex Management Services,
Inc., Manex Advisors, Inc. and Omni Financial Securities, Inc., which positions
he has held for more than five years. He is a Certified Financial Planner, a
licensed securities principal, and is licensed to sell several forms of
insurance by the State of Ohio. He was the founding president of The Central
Ohio Chapter of Society for Certified Financial Planners. He is also the author
of Omni's Business Navigator, and has been involved in numerous business
start-ups.
ITEM 6. EXECUTIVE COMPENSATION
The following table sets forth for the fiscal years ended December 31, 1999,
1998, and 1997, the compensation of the Company's Chief Executive Officer and
the only other executive officer whose compensation exceeded $100,000 during
1999. No other executive officer of the Company received salary and bonus
compensation in excess of $100,000 in the most recent completed fiscal year.
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<PAGE> 26
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
----------------------
(***)
SECURITIES ALL
ANNUAL COMPENSATION UNDER- OTHER
------------------- LYING COMPEN-
NAME AND FISCAL SALARY BONUS OPTIONS/ SATION
POSITIONS YEAR ($) ($) SAR's ($)
- --------------------------------------------------------------------------------
John D. Bair 1999 148,500 17,413(**) 4,000 2,498
Chairman of the 1998 135,520 7,370 35,000(*) 3,000
Board of Directors, 1997 100,000 5,181 30,000 3,000
President, and Chief
Executive Officer
- --------------------------------------------------------------------------------
C. Robert Hahn 1999 137,500 17,413(**) 4,000 3,000
Chief Operating 1998 125,481 7,370 24,000(*) 3,000
Officer, Vice 1997 120,000 5,181 20,000 3,000
President
- --------------------------------------------------------------------------------
* In 1998, 30,000 of the options granted to Mr. Bair, and 20,000 of the options
granted to Mr. Hahn were replacement grants for options grunted to them in 1997,
which were re-priced to reflect then-current market values.
** Estimated. The actual 1999 bonuses cannot be calculated until completion of
the Company's 1999 year-end audit.
*** Amounts in this column reflect matching contributions made by the Company to
its 401 (k) plan.
- --------------------------------------------------------------------------------
The Company has entered into an employment agreement with John D. Bair, its
President and Chief Executive Officer. The agreement is for a term of three
years ending on September 1, 2000, and provides for an annual salary of $100,000
or such higher amount as shall be determined by the Board of Directors plus a
bonus of 3% of pre-tax net income, and provides for those benefits generally
available to other employees. If the Company terminates Mr. Bair's employment
without cause, he is entitled to a severance payment equal to one year's base
salary.
The Company has entered into an employment agreement with C. Robert Hahn, its
Vice President and Chief Operating Officer. The agreement is for a term of three
years ending on September 1, 2000, and provides for an annual salary of $120,000
or such higher amount as shall be determined by the Board of Directors plus a
bonus of 3% of pre-tax net income, and provides for those benefits generally
available to other employees. If the Company terminates Mr. Hahn's employment
without cause, he is entitled to a severance payment equal to one year's base
salary.
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<PAGE> 27
OPTION GRANTS IN LAST FISCAL YEAR
The following table indicates information about stock options granted to the
Company's chief executive officer and the other officers named in the summary
compensation table during 1999:
<TABLE>
<CAPTION>
NUMBER PERCENT OF
OF SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO EXERCISE OR
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION
NAME GRANTED(#) FISCAL YEAR ($/SH) DATE
---- ---------- ----------- ------ ----
<S> <C> <C> <C> <C>
John D. Bair 4,000 shares 5.4% $4.54 2004
C. Robert Hahn 4,000 shares 5.4% $4.13 2009
</TABLE>
STOCK OPTION EXERCISES AND YEAR END OPTION VALUES
The following table indicates stock option exercises during 1999 by the
Company's chief executive officer and the other officers named in the summary
compensation table, and the value, as of December 31, 1999, of in-the-money
stock options held by them.
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
SHARES 12/31/99(#) 12/31/99(#)
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE (#) REALIZED(1) UNEXERCISABLE UNEXERCISABLE(2)
---- ------------ ----------- ------------- ----------------
<S> <C> <C> <C> <C>
John D. Bair 0 0 35,000/4,000 $30,500/$0
C. Robert Hahn 0 0 29,000/4,000 $31,500/$0
</TABLE>
(1) Aggregate market value of the shares covered by the option less the
aggregate price paid by such person.
(2) The value of in-the-money options was determined by subtracting the
exercise price from the average of the closing bid and asked prices of
the shares on December 31, 1999.
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<PAGE> 28
SAVINGS PLAN
The Company has adopted the Pinnacle Data Systems, Inc. 401(k) Savings and
Profit Sharing Plan (the "Savings Plan"). The Savings Plan is a defined
contribution plan (within the meaning of the Employee Retirement Income Security
Act of 1974) and is intended to be a qualified plan under Sections 401(a) and
401(k) of the Internal Revenue Code of 1986, as amended (the "Code"). Under the
Savings Plan, each participant is eligible to enter into a written salary
reduction agreement with the Company whereby the participant's salary will be
reduced by up to 12%, as elected by the participant, in accordance with the
rules governing cash or deferred arrangements under Section 401(k) of the Code.
The amount deferred by a participant is contributed by the Company to a trust
fund for the Savings Plan and invested by the trustee in accordance with the
investment guidelines established under the Savings Plan. Participants have the
right to direct the trustee to invest such participant's deferred amounts in the
investment funds the administrator directs the trustee to make available for the
Savings Plan. Mr. Bair, Mr. Carr and Mr. Hahn serve as the trustees of the
Savings Plan. Certified Pension Services serves as the administrator of the
Savings Plan, and McDonald & Company serves as investment advisor.
During 1997, the Savings Plan was amended to provide that if the Company is
profitable, the Company will match 100% of employee contributions up to 6% of
wages deferred with a maximum contribution of $3,000 per employee. Contributions
of $48,630, $24,520, $28,665 have been accrued for 1999, 1998 and 1997,
respectively. The amounts contributed on behalf of Mr. Bair and the other
executive officers are reflected in the "All Other Annual Compensation" column
of the foregoing Summary Compensation Table. While a participant is always
vested in his or her own salary reduction contributions, contributions by the
Company become fully vested only after five years.
Upon retirement or other termination of employment, vested benefits are
disbursed in a single lump sum to the participant. The amounts payable to a
participant will be determined by the amount credited to his bookkeeping account
in the trust fund, including his allocable share of trust fund earnings or
losses.
1995 STOCK OPTION PLAN
On December 19, 1995, the Company adopted the Pinnacle Data Systems, Inc. Stock
Option Plan (the "Plan"). Under the Plan the Company has reserved 300,000 common
shares for issuance pursuant to which options may be granted to employees of the
Company or its subsidiaries. On February 16, 2000 the Board of Directors amended
the Plan, subject to shareholder approval, to increase the number of shares
reserved for issuance to 600,000 common shares. The purpose of the Plan is to
attract and retain qualified individuals to serve on behalf of the Company. The
Plan is currently administered by the Board of Directors. Options granted under
the plan can qualify as incentive stock options under ss.422 of the Code, or at
the option of the directors, be non-qualified options. Directors of the Company
who are not employees of the Company or its subsidiaries are not eligible to
participate in the Plan.
Subject to the requirement that the price per share of any common shares to be
received upon the exercise of any incentive option will not be less than the
fair market value of the common shares at the time the option is granted, the
board or committee administering the Plan has the exclusive
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<PAGE> 29
authority, consistent with law and the terms of such Plan, to designate
recipients of options to be granted thereunder and to determine the number and
type of options and the number of common shares subject thereto. As of October
1, 1999 all options under the Plan have been granted. See Note 7 of Notes to
Financial Statements.
COMPENSATION OF DIRECTORS
Directors who are officers of the Company receive no separate compensation for
their services as directors. Compensation of the outside directors is determined
by the whole Board after receiving the recommendations of the President.
Currently, outside directors receive a fee of $250.00 for each Board Meeting
attended. In 1996, upon his initial election to the Board of Directors, Mr.
O'Leary received options for 5,000 shares of the Company's common stock that are
exercisable at $4.13 per share until October 1, 2006. Mr. O'Leary also received
options for 10,000 shares in September 1997 that are exercisable at $3.00 per
share until September 2007, and received options for 4,000 shares in June 1999
that are exercisable at $4.13 per share until September 2009. Mr. Ostrander
received options for 14,500 shares in September 1997 that are exercisable at
$3.00 per share until September 2007. Mr. Ostrander also received options for
4,000 shares in June 1999 that are exercisable at $4.13 per share until
September 2009.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
In 1998, the Company refinanced three loans aggregating $540,585 in principal
amount. In addition to being collateralized by the Company's land, building,
rents, leases, general business assets and profits thereof, these loans were
guaranteed by two shareholders of the Company, one of whom was John Bair, the
President and principal shareholder of the Company. These guarantees were
released at the time of the refinancing.
On July 22, 1998, the Company entered into an agreement with David J. Richards,
an advisor who is a shareholder, but otherwise unrelated to a director or
executive officer, to provide to the Company consulting and advisory services
with respect to the Company's communications with its stockholders and with
members of the financial community. The agreement expired on July 22, 1999. In
exchange for his services, the advisor was granted options to purchase 37,000
shares of common stock at the then market price.
ITEM 8. DESCRIPTION OF SECURITIES.
COMMON SHARES
The aggregate number of shares of capital stock that the Company has authority
to issue is 5,000,000 shares, all of which are common shares, without par value.
Holders of the common shares are entitled to receive such dividends as may be
declared by the board of directors out of funds legally available therefor. Upon
dissolution and liquidation of the Company, holders of the common shares are
entitled to a ratable share of the net assets of the
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<PAGE> 30
Company remaining after payments to creditors of the Company. All outstanding
common shares are validly issued, fully paid and nonassessable.
The holders of common shares are entitled to one vote per share for the election
of directors and on all other matters submitted to a vote of shareholders.
Holders of common shares are not entitled to preemptive rights or to cumulative
voting for the election of directors. The absence of cumulative voting, together
with the ownership of approximately 24% of the common shares by Mr. Bair
(approximately 30% when included with shares owned by all directors and
executive officers), has enabled him to control the affairs and policies of the
Company and could have the effect of delaying, averting or preventing a change
in control or management of the Company unless Mr. Bair is in favor of such
change.
PART II
ITEM 1. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.
(a) MARKET INFORMATION. Since April 1996, the Shares have been traded
on the over-the-counter market and since April 1996, the Shares have been
included on the NASDAQ OTC Bulletin Board under the trading symbol PNDS. Prior
to April 1996, there was no established trading market in the Shares. Set forth
below is the range of high and low bid prices for the Shares for each quarterly
period since January 1996, as reported by National Quotation Bureau. These
quotations reflect interdealer prices, without retail markup, markdown or
commission and may not necessarily represent actual transactions.
BID PRICES
----------
HIGH LOW
---- ---
Fiscal Year 1999
First quarter (ended March 31)......................... $5.50 $2.25
Second quarter (ended June 30)......................... 5.375 2.75
Third quarter (ended September 30)..................... 5.25 3.00
Fourth quarter (ended December 31)..................... 4.375 3.625
Fiscal Year 1998
First quarter (ended March 31)......................... $5.25 $3.75
Second quarter (ended June 30)......................... 5.25 3.375
Third quarter (ended September 30)..................... 3.75 0.875
Fourth quarter (ended December 31)..................... 2.75 0.875
Fiscal Year 1997
First quarter (ended March 31)......................... $8.75 $5.50
Second quarter (ended June 30)......................... 5.625 4.00
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<PAGE> 31
Third quarter (ended September 30)..................... 9.00 5.00
Fourth quarter (ended December 31)..................... 7.25 3.625
(b) HOLDERS. On February 11, 2000, there were 72 holders of record
of the Shares. Most of the Shares not held by officers and directors of the
Company are held in street name.
(c) DIVIDENDS. During the past three years, the company has not
paid any cash dividends. Payments of dividends are within the discretion of the
Company's board of directors and depend upon the earnings, capital requirements,
and operating and financial condition of the Company, among other factors. The
Company currently expects to retain its earnings to finance the growth and
development of its business and does not expect to pay cash dividends in the
foreseeable future. In addition, under the terms of a loan agreement with a
bank, the Company is prohibited from declaring or paying dividends to common
shareholders and from redeeming stock from shareholders.
ITEM 2. LEGAL PROCEEDINGS.
The Company is not currently a party to any legal proceedings.
ITEM 3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS .
None.
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES.
The following is information about all securities that the Company sold within
the past three years without registration under the Securities Act of 1933, as
amended:
(a) On April 23, 1996, the Company sold 250,000 common shares,
without par value, to the public at a price of $5.00 per share. The aggregate
offering price was $1,250,000 and the total underwriting commissions were
$100,000, plus underwriters warrants for 25,000 common shares exercisable at a
price of $5.50 per share, plus a $10,000 nonaccountable expense allowance. Corna
Securities, Inc. acted as the underwriter in the sale of the shares. The shares
were sold pursuant to the exemption from registration under the Securities Act
of 1933, as amended, set forth in Regulation A. In addition, the shares were
registered for sale in the State of Ohio.
(b) On May 23, 1996, the Company issued 100,000 common shares,
without par value, to Microcap, Ltd. upon exercise by Microcap of warrants to
purchase such shares at $2.50 per share. The shares were sold at a price of
$2.50 per share and an aggregate of $250,000. The
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<PAGE> 32
shares were issued pursuant to the exemption from registration under the
Securities Act of 1933, as amended, set forth in Regulation A. In addition, the
issuance of such shares was registered in the State of Ohio.
(c) On August 7, 1996, 10,000 common shares, without par value,
were issued to Robert Henkel, a former officer and principal shareholder of the
Company, upon his exercise of stock options at $2.75 per share. The aggregate
amount received by the Company in connection therewith was $27,500, which it
received in the form of 4,400 common shares of the Company valued at market
price at the time of the transaction. The 10,000 shares were issued pursuant to
Section 4(2) of the Securities Act of 1933, as amended, and Rule 701. The
Company recorded the receipt of the 4,400 shares as treasury shares.
(d) On October 1, 1996, the Company granted an option for 5,000
common shares to Thomas M. O'Leary, upon his election as a director of the
Company. The Company received no consideration for the grant of the option. The
exercise price of the option was $7.00 per share and the option expires on
October 1, 2006. The option was issued pursuant to Section 4(2) of the
Securities Act of 1933, as amended, and Rule 701 promulgated thereunder. On June
23, 1999, the option was re-priced at $4.13 per share.
(e) On May 16, 1997, the Company granted options pursuant to the
Pinnacle Data Systems, Inc. 1995 Stock Option Plan for 77,800 common shares,
without par value, to employees of the Company. Options for 10,000 of the shares
were issued to John D. Bair at an exercise price of $6.60 per share, and the
exercise price for the remainder of 67,800 shares was $6.00 per share. The
Company received no consideration for the grant of the options. The options were
issued pursuant to the exemption from registration under the Securities Act of
1933, as amended, set forth in Regulation D, Rule 504. In addition, the shares
underlying such options were registered with the state of Ohio and a filing was
made with the Securities and Exchange Commission on Form D under Rule 504. On
July 30, 1998, 61,750 of the options were re-priced at $3.00 per share. The
10,000 options issued to John D. Bair were re-priced at $3.30 per share. Prior
to the re-pricing, 6,050 of the options originally issued in 1997 had been
forfeited by terminated employees. The repriced options were issued pursuant to
the exemption from registration under the Securities Act of 1933, as amended,
set forth in Rule 701.
(f) On June 4, 1997, the Company issued 9,500 common shares,
without par value, to Corsair Associates, Ltd., an advisor to the Company. On
October 13, 1995, the Company had entered into an agreement with the advisor to
assist the Company in its efforts to fund the growth of its business. A
provision in the agreement required the Company to retain the advisor for two
additional years if the Company received at least $1 million in equity capital
in 1996. In exchange, the advisor would receive 19,000 shares of common stock of
the Company in two annual installments of 9,500 shares. The first installment
was made in 1997 and the second installment of 9,500 shares was made in 1998.
The shares were issued pursuant to Regulation D, Rule 504, and a Form D was
filed with the Securities and Exchange Commission. In addition, the shares were
registered under Ohio law. The value of the services received by the Company
and paid by the 1997 installment of shares was $3,750.
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<PAGE> 33
(g) During 1997, the Company issued 29,600 common shares, without
par value, to employees of the Company pursuant to their exercise of stock
options previously granted to them. The aggregate amount received by the Company
upon such exercise was $77,475. The shares were registered under Ohio law and
were the subject of a Form D filing under Rule 504 with the Securities and
Exchange Commission.
(h) On September 12, 1997, under separate Stock Option Agreements,
the Company granted an option for 10,000 common shares to Thomas M. O'Leary, a
director of the Company, and 14,500 options to Robert V.R. Ostrander, another
director of the Company. The Company also granted options for 50,000 common
shares to three employees who are also directors. Options for 20,000 of the
shares were issued to John D. Bair at an exercise price of $6.53 per share.
Options for 10,000 shares were granted to Robert Hahn and options for 20,000
shares were granted to Thomas Carr at an exercise price of $5.94 per share. The
Company received no consideration for the grant of the options. The options were
issued pursuant to Section 4(2) of the Securities Act of 1933, as amended, and
Rule 701 promulgated thereunder. On July 30, 1998, all of the options were
re-priced. The 20,000 options issued to John D. Bair were re-priced at $3.30 per
share. The remaining options of O'Leary, Ostrander Hahn and Carr were repriced
at $3.00 per share. The repriced options were issued pursuant to the exemption
from registration under the Securities Act of 1933, as amended, set forth in
Rule 701.
(i) On May 20, 1998, the Company issued 9,500 common shares,
without par value, to Corsair Associates, Ltd., an advisor to the Company. On
October 13, 1995, the Company had entered into an agreement with the advisor to
assist the Company in its efforts to fund the growth of its business. A
provision in the agreement required the Company to retain the advisor for two
additional years if the Company received at least $1 million in equity capital
in 1996. In exchange, the advisor would receive 19,000 shares of common stock of
the Company in two annual installments of 9,500 shares. The first installment
was made in 1997 and the second installment of 9,500 shares was made in 1998.
The shares were issued pursuant to Regulation D, Rule 504 and a Form D was filed
with the Securities and Exchange Commission. The shares were also registered
under Ohio law. The value of the services received by the Company and paid by
the 1998 installment of shares was $12,938.
(j) On July 30, 1998, the Company granted options pursuant to the
Pinnacle Data Systems, Inc. 1995 Stock Option Plan for 74,500 common shares,
without par value, to employees of the Company. Options for 5,000 of the shares
were issued to John D. Bair at an exercise price of $3.30 per share and the
exercise price for the remainder of 69,500 shares was $3.00 per share The
Company received no consideration for the grant of the options. The options were
issued pursuant to the exemption from registration under the Securities Act of
1933, as amended, set forth in Rule 701. In addition, the shares underlying such
options were registered with the State of Ohio and a filing was made with the
Securities and Exchange Commission on Form D under Rule 504.
(k) On June 23, 1999, the Company granted options pursuant to the
Pinnacle Data Systems, Inc. 1995 Stock Option Plan for 67,450 common shares,
without par value, to employees of the Company. Options for 4,000 of the shares
were issued to John D. Bair and 2,000 of the shares to Joy Bair at an exercise
price of $4.54 per share. The exercise price for the
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<PAGE> 34
remainder of 61,450 shares was $4.125 per share. The Company received no
consideration for the grant of the options. The options were issued pursuant to
the exemption from registration under the Securities Act of 1933, as amended,
set forth in Rule 701.
(l) On June 23, 1999, under separate Stock Option Agreements, the
Company granted options for 4,000 common shares to both Thomas M. O'Leary and to
Robert V.R. Ostrander, directors of the Company, at an exercise price of $4.13
per share. The Company received no consideration for the grant of the options.
The options were issued pursuant to Section 4(2) of the Securities Act of 1933,
as amended, and Rule 701 promulgated thereunder.
(m) On August 12, 1999, the Company granted options pursuant to
the Pinnacle Data Systems, Inc. 1995 Stock Option Plan for 3,000 common shares,
without par value, to employees of the Company. The exercise price was $4.625
per share. The Company received no consideration for the grant of the options.
The options were issued pursuant to the exemption from registration under the
Securities Act of 1933, as amended, set forth in Rule 701.
(n) During 1999, the Company has issued 14,500 common shares,
without par value, to employees of the Company pursuant to their exercise of
stock options previously granted to them. The aggregate amount received by the
Company upon such exercise was $43,500. The shares were registered under Ohio
law, and were the subject of a Form D filing under Rule 504 with the Securities
and Exchange Commission.
ITEM 5. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 1701.13(E) of the Ohio Revised Code sets forth conditions and
limitations governing the indemnification of officers, directors, and other
persons.
Article 8 of the Amended and Restated Code of Regulations of the Company, a copy
of which is filed as Exhibit 3(b), contains certain indemnification provisions
adopted pursuant to authority contained in Section 1701.13(E) of the Ohio
Revised Code. The Company's Code of Regulations provides for the indemnification
of its officers, directors, employees, and agents, or persons who are serving or
have served at the request of the Corporation as a director, trustee, officer,
employee, or agent of another corporation, domestic or foreign, nonprofit or for
profit, partnership, joint venture, trust, or other enterprise, against all
expenses with respect to any judgements, fines, and amounts paid in settlement,
or with respect to any threatened, pending, or completed action, suit, or
proceeding to which they were or are parties or are threatened to be made
parties by reason of acting in such capacities, provided that it is determined,
either by a majority vote of a quorum of disinterested directors of the Company
or by the shareholders of the Company or otherwise as provided in Section
1701.13(E) of the Ohio Revised Code, that: (a) they acted in good faith and in a
manner they reasonably believed to be in or not opposed to the best interests of
the Company; (b) in any action, suit, or proceeding by or in the right of the
Company, they were not, and have not been adjudicated to have been, negligent or
guilty of misconduct in the performance of their duties to the Company; (c) with
respect to any criminal
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<PAGE> 35
action or proceeding, that they had no reasonable cause to believe that their
conduct was unlawful. Section 1701.13(E) provides that expenses, including
attorneys' fees, incurred in defending any action, suit, or proceeding, may be
paid by the Company in advance of the final disposition of such action, suit, or
proceeding, upon receipt of an undertaking by the indemnified person to repay
such amount in the event that indemnification shall be deemed improper.
The Company maintains directors and officers liability insurance.
At present, there are no claims, actions, suits, or proceedings pending where
indemnification would be required under these provisions, and the Company does
not know of any threatened claims, actions, suits, or proceedings which may
result in a request for such indemnification.
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<PAGE> 36
PART F/S
FINANCIAL STATEMENTS.
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<PAGE> 37
TABLE OF CONTENTS
<TABLE>
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
<CAPTION>
Page
----
<S> <C>
INDEPENDENT AUDITORS' REPORT..........................................................35
FINANCIAL STATEMENTS
Balance Sheets as of December 31, 1997 and 1998 and
October 1, 1999 (Unaudited).........................................................36
Statements of Income for the Years Ended December 31, 1997 and 1998 and for
the Nine Months Ended September 30, 1998 (Unaudited) and the Thirty-nine Weeks
ended October 1, 1999 (Unaudited)...................................................38
Statements of Changes in Stockholders' Equity For the Years Ended December 31,
1997 and 1998 and for the Thirty-nine Weeks Ended October 1, 1999 (Unaudited).......39
Statements of Cash Flows For the Years Ended December 31, 1997 and 1998 and
for the Nine Months Ended September 30, 1998 (Unaudited) and the Thirty-nine
Weeks Ended October 1, 1999 (Unaudited).............................................40
Notes to Financial Statements.......................................................42
</TABLE>
-34-
<PAGE> 38
To the Board of Directors
Pinnacle Data Systems, Inc. (dba PDSi)
Columbus, Ohio
Independent Auditors' Report
We have audited the accompanying balance sheets of Pinnacle Data
Systems, Inc. (dba PDSi) as of December 31, 1997 and 1998, and the related
statements of income, changes in 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 audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Pinnacle Data
Systems, Inc. (dba PDSi) as of December 31, 1997 and 1998, and the results of
its operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ Hausser & Taylor LLP
Columbus, Ohio
February 23, 1999
-35-
<PAGE> 39
PINNACLE DATA SYSTEMS, INC.
(DBA PDSi)
BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
December 31, December 31, October 1,
1997 1998 1999
---- ---- ----
ASSETS
------
<S> <C> <C> <C>
CURRENT ASSETS
Cash $ 16,149 $ 35,101 $ 10,846
Accounts receivable, net of allowance for doubtful
accounts of $10,000, $9,000 and $18,000, respectively 1,008,807 1,469,674 2,060,446
Inventory 1,730,185 1,427,792 2,591,241
Prepaid software costs (Note 2) 56,456 - 29,739
Other prepaid expenses 17,299 115,017 234,935
Deferred income taxes (Note 10) 72,420 97,675 97,675
---------- ---------- ----------
2,901,316 3,145,259 5,024,882
---------- ---------- ----------
PROPERTY AND EQUIPMENT (Note 8)
Land 13,230 13,230 -
Building and improvements 522,179 522,179 -
Leasehold improvements - - 24,566
Furniture and fixtures 95,728 117,396 214,013
Computer equipment 546,080 675,414 880,418
Shop equipment 207,675 265,366 277,819
Vehicle 21,846 21,846 21,846
---------- ---------- ----------
1,406,738 1,615,431 1,418,662
Less accumulated depreciation 309,515 556,013 702,118
---------- ---------- ----------
1,097,223 1,059,418 716,544
---------- ---------- ----------
OTHER ASSETS
Product design costs, less accumulated amortization
of $12,124, $12,825 and $13,175, respectively (Note 3) 1,401 700 175
---------- ---------- ----------
$3,999,940 $4,205,377 $5,741,601
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-36-
<PAGE> 40
PINNACLE DATA SYSTEMS, INC.
(DBA PDSi)
BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
December 31, December 31, October 1,
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Line of credit (Note 5) $ - $ 150,000 $1,170,000
Current portion of long-term debt (Note 6) 120,727 79,148 64,182
Current portion of capital lease obligation (Note 8) 19,112 20,635 7,614
Accounts payable 962,994 1,054,942 1,348,331
Accounts payable - joint venture (Note 14) 18,892 - -
Accrued expenses:
Wages and payroll taxes 72,296 105,738 77,215
Vacation 28,628 33,197 50,197
Profit sharing plan (Note 9) 29,165 21,865 36,377
Property taxes 24,709 4,539 -
Income taxes 102,425 25,401 138,034
Other 89,121 37,760 332,075
Unearned software revenue (Note 4) 15,250 - -
Unearned service revenue (Note 13) 15,481 45,130 71,893
---------- ---------- ----------
1,498,800 1,578,355 3,295,918
---------- ---------- ----------
LONG-TERM LIABILITIES
Long-term debt, less current portion (Note 6) 439,463 586,500 146,965
Capital lease obligation, less current portion (Note 8) 18,681 - -
Deferred income taxes (Note 10) 37,000 21,000 21,000
---------- ---------- ----------
495,144 607,500 167,965
---------- ---------- ----------
1,993,944 2,185,855 3,463,883
---------- ---------- ----------
STOCKHOLDERS' EQUITY (Note 7)
Common stock; no par value; 5,000,000 shares authorized;
1,194,701, 1,204,201 and 1,218,701 shares issued
and outstanding, respectively 1,559,200 1,572,138 1,615,638
Additional paid-in capital 214,506 214,506 214,506
Retained earnings 232,290 232,878 447,573
---------- ---------- ----------
2,005,996 2,019,522 2,277,717
---------- ---------- ----------
$3,999,940 $4,205,377 $5,741,601
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-37-
<PAGE> 41
PINNACLE DATA SYSTEMS, INC.
(DBA PDSi)
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited)
-----------------------------
Nine Months Thirty-nine
Years Ended Ended Weeks Ended
--------------------------- ------------- --------------
December 31, December 31, September 30, October 1,
1997 1998 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
SALES
Service sales $ 2,122,096 $ 2,721,388 $ 1,962,371 $ 2,205,310
Product sales 4,286,577 6,141,722 4,227,201 5,664,507
Other sales 142,817 169,222 139,505 92,723
----------- ----------- ----------- -----------
6,551,490 9,032,332 6,329,078 7,962,540
----------- ----------- ----------- -----------
COST OF SALES
Service sales 1,296,944 1,936,882 1,522,351 1,263,621
Product sales 3,380,609 5,017,652 3,456,258 4,498,879
Other sales 128,161 237,700 120,967 120,252
----------- ----------- ----------- -----------
4,805,714 7,192,234 5,099,576 5,882,753
----------- ----------- ----------- -----------
GROSS PROFIT 1,745,776 1,840,098 1,229,502 2,079,788
----------- ----------- ----------- -----------
OPERATING EXPENSES
Selling, general and administrative 1,334,156 1,751,213 1,306,442 1,733,057
----------- ----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS 411,620 88,885 (76,941) 346,731
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Loss on investment in joint venture (Note 14) (77,948) - - -
Gain on sale of building - - - 85,922
Interest expense (68,853) (83,552) (60,829) (69,057)
----------- ----------- ----------- -----------
(146,801) (83,552) (60,829) 16,865
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 264,819 5,333 (137,770) 363,596
INCOME TAXES (Note 10) 107,580 4,745 (56,778) 148,901
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 157,239 $ 588 $ (80,992) $ 214,695
=========== =========== =========== ===========
BASIC EARNINGS (LOSS) PER COMMON SHARE (Note 11) $ 0.13 $ - $ (0.07) $ 0.18
=========== =========== =========== ===========
DILUTED EARNINGS (LOSS) PER COMMON SHARE (Note 11) $ 0.13 $ - $ (0.07) $ 0.17
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-38-
<PAGE> 42
<TABLE>
<CAPTION>
PINNACLE DATA SYSTEMS, INC.
(DBA PDSi)
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 1997 and 1998 and Thirty-nine Weeks Ended October 1,
1999 (Unaudited)
Common Stock
------------------------- Total
Outstanding Paid-In Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
----------- ----------- ----------- --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE - December 31, 1996 1,155,601 $ 1,505,475 $ 214,506 $ 75,051 $(27,500) $ 1,767,532
Issuance of common stock
(Note 12) 9,500 3,750 - - - 3,750
Net income - - - 157,239 - 157,239
Options exercised 29,600 77,475 - - - 77,475
Treasury stock retired - (27,500) - - 27,500 -
----------- ----------- ----------- ----------- ----------- -----------
BALANCE - December 31, 1997 1,194,701 1,559,200 214,506 232,290 - 2,005,996
Issuance of common stock
(Note 12) 9,500 12,938 - - - 12,938
Net income - - - 588 - 588
----------- ----------- ----------- ----------- ----------- -----------
BALANCE - December 31, 1998 1,204,201 1,572,138 214,506 232,878 - 2,019,522
Net income (unaudited) - - - 214,695 - 214,695
Options exercised 14,500 43,500 - - - 43,500
----------- ----------- ----------- ----------- ----------- -----------
BALANCE - October 1, 1999 (unaudited) 1,218,701 $ 1,615,638 $ 214,506 $ 447,573 $ - $ 2,277,717
=========== =========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-39-
<PAGE> 43
PINNACLE DATA SYSTEMS, INC.
(DBA PDSi)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
----------------------------------
Nine Months Thirty-nine
Years Ended Ended Weeks Ended
------------------------------ -------------- ---------------
December 31, December 31, September 30, October 1,
1997 1998 1998 1999
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 157,239 $ 588 $ (80,992) $ 214,695
------------- ------------- ------------- --------------
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 187,809 268,129 196,029 232,862
Provision for doubtful accounts (6,750) (1,000) 3,205 9,000
Inventory reserves 43,000 90,921 300,000 (5,593)
Provision for deferred taxes (28,420) (41,255) (123,255) -
Gain on sale of property and equipment - - - (85,922)
(Increase) decrease in assets:
Accounts receivable (428,576) (459,867) (210,340) (599,772)
Inventory (677,074) 150,513 (106,334) (1,157,857)
Prepaid expenses 55,118 (41,262) 23,148 (149,656)
Increase (decrease) in liabilities:
Accounts payable 527,360 73,056 (380,825) 521,561
Accrued expenses and taxes 162,712 (117,844) (77,135) 177,226
Unearned revenues (26,879) 14,399 (20,214) 26,763
-------------- -------------- -------------- ---------------
Total adjustments (191,700) (64,210) (395,721) (1,031,388)
-------------- -------------- -------------- ---------------
Net cash used in operating activities (34,461) (63,622) (476,713) (816,693)
-------------- -------------- -------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (153,779) (168,664) (150,157) (338,640)
Proceeds from sale of property and equipment - - - 133,552
-------------- -------------- -------------- ---------------
Net cash used in investing activities (153,779) (168,664) (150,157) (205,088)
-------------- -------------- -------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from line of credit - 321,915 666,180 1,020,000
Principal payments on long-term debt (118,440) (66,457) (46,831) (52,953)
Principal payments on capital lease obligation (16,052) (17,158) (12,817) (13,021)
Net proceeds from sale of stock 81,225 12,938 12,938 43,500
-------------- -------------- -------------- ---------------
Net cash provided by (used in) financing activities (53,267) 251,238 619,470 997,526
-------------- -------------- -------------- ---------------
INCREASE (DECREASE) IN CASH (241,507) 18,952 (7,400) (24,255)
CASH - Beginning of year 257,656 16,149 16,149 35,101
-------------- -------------- -------------- ---------------
CASH - End of year $ 16,149 $ 35,101 $ 8,749 $ 10,846
============== ============== ============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
-40-
<PAGE> 44
PINNACLE DATA SYSTEMS, INC.
(DBA PDSi)
STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
(Unaudited)
-------------------------------
Nine Months Thirty-nine
Years Ended Ended Weeks Ended
---------------------------------- -------------- ------------
December 31, December 31, September 30, October 1,
1997 1998 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Interest paid $ 72,144 $ 85,358 $ 69,354 $62,932
=============== =============== =============== =======
Income taxes paid, net of refunds $ 43,975 $ 118,261 $ 125,004 $36,268
=============== =============== =============== =======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING TRANSACTIONS
During 1997, the Company purchased a vehicle by directly
financing the purchase price of $21,846.
During 1997, the Company capitalized $239,208 of
inventory as computer equipment.
During 1997, the Company applied $23,249 of accounts
receivable from a customer against accounts payable for the
purchase of shop equipment from the same customer.
During 1997, the Company retired $27,500 shares of treasury
stock purchased at cost.
During 1997 and 1998, 9,500 shares of common stock in each year were
issued for advisory services of $3,750 and $12,938, respectively.
During 1998, the Company capitalized $75,413 of inventory
as computer equipment. Also, computer equipment with a
net book value of $14,454 was transferred to saleable inventory.
During 1998, the Company refinanced mortgage and long-term
debt totaling $540,585 with a $300,000 term note and line of
credit draws of $240,585. Later in 1998, $412,500 of
outstanding line of credit was refinanced via term debt.
In May 1999, the Company sold its land, building and
improvements. Of the proceeds, $401,197 was used to pay off
the remaining mortgage balance.
The accompanying notes are an integral part of these financial statements.
-41-
<PAGE> 45
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. Nature of Business - Pinnacle Data Systems, Inc. (dba PDSi)
(the Company) is an independent provider of component-level
depot repair services for electronic equipment such as
computers, peripherals and printed circuit board assemblies.
The Company's repair services are focused on UNIX/RISC
workstations for original equipment manufacturers (OEM's). The
Company also designs and manufactures custom printed circuit
boards and provides custom integration of standard computing
equipment for OEM's.
B. Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual
results could differ from those estimates.
C. Interim Financial Data (Unaudited) - The unaudited financial
information as of October 1, 1999 and for the nine months
ended September 30, 1998 and the thirty-nine weeks ended
October 1, 1999 has been prepared on the same basis as the
audited financial statements and, in the opinion of the
Company's management, reflects all adjustments necessary for a
fair presentation of the financial position and the results of
operations for such interim periods in accordance with
generally accepted accounting principles.
D. Concentration of Credit Risk -- Financial instruments, which
potentially subjects the Company to a concentration of credit
risk principally consist of accounts receivable. The Company
grants credit to its customers, which are varied in terms of
size, geographic location and financial strength. Customer
balances are continually monitored to minimize the risk of
loss.
For 1997, the Company had three customers that generated
revenues of approximately $878,000, $1,393,000, and $929,000
or 13%, 22% and 14% respectively, of total revenue. In the
Statement of Income, approximately $878,000 is included in
service sales and $2,322,000 is included in product sales. In
addition, these customers represented 12% 44% and 0% of
accounts receivable at December 31, 1997.
For 1998, the Company had three customers that generated
revenues of approximately $1,933,000, $1,978,000, and
$1,063,000 or 21%, 22%, and 12%, respectively, of total
revenue. In the Statement of Income, approximately $1,839,000
is included in service sales and $3,135,000 is included in
product sales. In addition, these customers represented 5%,
37%, and 20% of accounts receivable at December 31, 1998.
For the nine months ended September 30, 1998, the Company had
three customers that generated revenues of approximately
$1,431,000, $1,301,000, and $581,000 or 23%, 21%, and 10%,
respectively, of total revenue. In the Statement of Income,
approximately $94,000 is included in service sales and
$3,219,000 is included in product sales.
For the thirty-nine weeks ended October 1, 1999, the Company
had three customers that generated revenues of approximately
$2,079,000, $761,000, and $1,223,000 or 26%, 10%, and 15%,
respectively, of total revenue, In the Statement of Income,
approximately $1,536,000 is included in service sales and
$2,527,000 is included in product sales. In addition, these
customers represented 34%, 12%, and 13% of accounts receivable
at October 1, 1999.
E. Revenue Recognition - Revenue from product sales is recognized
upon shipment to customers. Revenue from service sales is
generally recognized as the service is provided which consists
of: (1) repairing products produced by third parties, (ii)
earning a fee by exchanging with a customer a replacement
component or part for a defective component or part; and (iii)
servicing contracts to certain customers generally for six to
twelve months; for which, revenue is deferred and recognized
in income on a straight-line basis over the contract period.
F. Inventories - Inventories are valued at average cost, not in
excess of market.
Inventory was comprised of the following:
December 31, October 1,
------------ ----------
1997 1998 1999
---- ---- ----
Component parts -
(raw materials) $ 606,755 $ 594,062 $ 909,248
Work-in-process 156,012 220,297 1,141,959
Finished goods 967,418 613,433 540,034
---------- ---------- ----------
$1,730,185 $1,427,792 $2,591,241
========== ========== ==========
-42-
<PAGE> 46
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The carrying values of component parts and finished goods
represent management's estimate of their net realizable value.
Such value is based on forecasts of repair/trade-in activity
in the ensuing years. Such forecasts are based on historical
information, known contracts, and management's expertise in
computer hardware life cycles. The computer hardware industry
is characterized by rapid technological advancement and
change. Should demand for repair/trade-in hardware prove to be
significantly less than anticipated, the ultimate realizable
value of such products could be substantially less than the
amount shown in the balance sheet.
G. Property and Equipment - Property and equipment are recorded
at cost. Depreciation is provided on the straight-line method
for financial reporting purposes over the estimated useful
lives of the respective assets. Expenditures for maintenance
and repairs are charged to operations as incurred, while
expenditures for additions and improvements are capitalized.
The vehicle is depreciated over 3 years. Furniture, fixtures,
and equipment are depreciated over useful lives of 5 and 7
years. The building is depreciated over a useful life of 40
years, while building improvements are depreciated over 10
years. Leasehold improvements are being amortized over 10
years. Depreciation expense amounted to $187,108 and $267,429
for the years ended December 31, 1997 and 1998, respectively.
H. Advertising - All of the Company's advertising costs are of
the nondirect-response type. The Company expenses all
advertising costs as incurred or at the time the advertising
takes place. Total advertising costs incurred during the years
ended December 31, 1997 and 1998 were $14,282 and $7,930,
respectively.
I. Life Insurance - The Company has purchased, and is the
beneficiary, of three term life insurance policies on key
employees of the Company. The total amount of coverage at
December 31, 1998 and 1997 was $3,250,000. Subsequent to
December 31, 1998, in conjunction with refinancing of
long-term debt, $1,000,000 of the coverage was assigned to the
new lender.
J. Stock-Based Compensation - The Company adopted
Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation" in the year ended
December 31, 1996. This standard encourages the adoption of
the fair value-based method of accounting for employee stock
options or similar equity instruments, but continues to allow
the Company to measure compensation cost for those equity
instruments using the intrinsic value-based method of
accounting prescribed by Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." Under the
fair value-based method, compensation cost is measured at the
grant date based on the value of the award. Under the
intrinsic value-based method, compensation cost is the excess,
if any, of the quoted market price of the stock at the grant
date or other measurement date over the amount the employee
must pay to acquire the stock. The Company intends to continue
the use of the intrinsic value-based method.
-43-
<PAGE> 47
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
As a result, adoption of this standard will not have any
effect to the Company's financial statements other than to
require disclosure of the pro forma effect on net income of
using the fair value-based method of accounting. However, due
to the Company's stock price at December 31, 1998 being below
the strike price of all outstanding options, management deems
it unlikely that the options will be exercised. However, as a
result of improved performance of the Company's stock price
during the thirty-nine week period ended October 1, 1999,
management now deems it likely all outstanding options will be
exercised. Accordingly, the Company has made the disclosures
required by SFAS 123 as of October 1, 1999 (see Note 7).
K. Reclassifications - Certain 1997 amounts have been
reclassified to conform to the 1998 presentation.
NOTE 2. PREPAID SOFTWARE COSTS
The Company has entered into an agreement with Sunsoft, Inc.,
which allows it to distribute certain Sunsoft software and
documentation. Until 1998, the Company was required to make
noncancellable prepayments for master media. Royalties were
charged against the prepayments as sales were made. During
1998, the Company sold the remaining prepaid software and the
related royalties were expensed.
NOTE 3. INTANGIBLE ASSETS
Intangible assets are summarized as follows:
December 31, October 1,
------------ ----------
1997 1998 1999
---- ---- ----
Product design costs $ 13,500 $ 13,500 $ 13,500
Less accumulated
amortization 12,099 12,800 13,350
---------- ---------- ----------
$ 1,401 $ 700 $ 150
========== ========== ==========
Product design costs, incurred in the design of custom circuit boards to be sold
in current and future years, are being amortized using the straight-line method
over five years. Amortization expense charged to operations during the years
ended December 31, 1997 and 1998 amounted to $700 and $701, respectively.
-44-
<PAGE> 48
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 4. UNEARNED SOFTWARE REVENUE
The Company entered into an agreement with a customer wherein
the customer prepaid for certain software products which were
installed on circuit boards designed and built by the Company.
Under this agreement, the Company's customer received the
software at the Company's purchase price. The Company prepaid
the manufacturer of the software products (see Note 2). During
1998, the Company installed the remaining prepaid software and
the related revenue was recognized.
NOTE 5. SHORT-TERM DEBT
In January 1998, the Company entered into an agreement to
establish a $1,500,000 revolving line of credit that matured
on June 30, 1999 and carries an interest rate of prime (7.75%
and 8.5% at December 31, 1998 and October 1, 1999,
respectively). The amount available under the line of credit
is subject to a borrowing base as outlined in the agreement.
The line is collateralized by substantially all assets of the
Company and is subject to various covenants described further
in Note 6. In September 1999, the line of credit was extended
through September 2000, with an increase in the maximum
borrowing amount to $2,000,000.
NOTE 6. LONG-TERM DEBT
Following is a summary of long-term debt:
December 31, October 1,
------------ ----------
1997 1998 1999
---- ---- ----
3.9% vehicle loan, payable in
monthly installments of $401,
including interest through
January 2002. $ 18,152 $ 14,150 $ 11,147
Prime plus .5% (9% at
December 31, 1997)
note payable in
monthly installments of $8,167
plus interest through October
1999;collateralized by assets
of the Company;guaranteed
by two stockholders. During
1998, the Company refinanced
this note. 179,406 - -
-45-
<PAGE> 49
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 6. LONG-TERM DEBT (CONTINUED)
December 31, October 1,
------------ ----------
1997 1998 1999
---- ---- ----
3 Year Treasury Constant
Maturities Rate plus 2.5%
(8.875% at December 31, 1997
and 1998) mortgage note payable
in monthly installments of $1,254
including interest through
June 2009;collateralized by the
Company's land, building,
rents, leases and profits thereof
and the fixtures associated
therewith;guaranteed by two
stockholders. During 1998,
the Company refinanced this
note. 108,830 - -
Prime rate (7.75% and 8.5%
at December 31, 1998 and
October 1, 1999, respectively)
note payable in monthly
installments of $5,000 plus
interest through January 2003;
collateralized by substantially
all assets of the Company. - 245,000 200,000
8.35% mortgage note payable
in monthly installments of
$4,054 including interest through
July 2003; collateralized by
Company's land, building and
other personal property. The
real estate was sold and the
mortgage paid off during the
period ended July 2, 1999. - 406,498 -
-46-
<PAGE> 50
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 6. LONG-TERM DEBT (CONTINUED)
<TABLE>
<CAPTION>
December 31, October 1,
------------------- ----------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
9.37% mortgage note (guaranteed
by the Small Business Admin-
istration); payable in monthly
installments of $3,012 including
interest through June 2009;
collateralized by the Company's
land, building, rents, leases
and profits thereof and the
fixtures associated therewith;
guaranteed by two stockholders.
During 1998, the Company
refinanced this note. 253,802 - -
----------- ---------- -----------
Total long-term debt 560,190 665,648 211,147
Less current portion 120,727 79,148 64,182
----------- ---------- -----------
$ 439,463 $ 586,500 $ 146,965
=========== ========== ===========
</TABLE>
The line of credit (Note 5) and long-term notes above are subject to a loan and
security agreement which contains numerous covenants which require the Company
to maintain specific financial performance ratios, restrict payment of
dividends, and report various financial information to the lender on a monthly
basis. At December 31, 1997 and 1998, the Company was in compliance with these
covenants.
Aggregate maturities on long-term debt for the five years ending after December
31, 1998 is as follows:
1999 $ 79,148
2000 81,384
2001 82,622
2002 80,056
2003 342,438
----------
$ 665,648
==========
-47-
<PAGE> 51
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 7. STOCKHOLDERS' EQUITY
A. Common Stock - In April 1996, the Company completed an
offering of 250,000 shares of its no par value common stock at
$5.00 per share. All 250,000 shares were sold in 1997. Also,
as part of the same offering, 100,000 shares of common stock
were issued in exchange for the exercise of previously issued
warrants to purchase shares at $2.50 per share.
B. Additional Paid-In Capital - On May 2, 1996, the Board of
Directors passed a resolution authorizing the transfer of
undistributed earnings accumulated while an S corporation of
$214,506 to additional paid-in capital. This transaction was
recorded in the Company's financial statements as of December
31, 1995.
C. Treasury Stock - In August 1996, an agreement was executed
whereby 4,400 shares of common stock were returned to the
Company at the then fair market value of $6.25 per share in
exchange for permitting a stockholder to exercise 10,000
options at $2.75 per share in advance of the stated exercise
date of December 20, 1997. During 1997, the Company retired
all 4,400 shares of treasury stock.
D. Stock Options - The Company adopted the Pinnacle Data Systems,
Inc. 1995 Stock Option Plan (the Plan) on December 19, 1995.
Any employee who has been granted a discretionary option may
purchase Company common stock over a ten year period, at the
fair market value at time of grant. (If the grantee owns more
than 10% of the Company's stock at the time of the grant, the
purchase price shall be at least 110% of the fair market value
and the options expire five years from the date of grant.) The
aggregate number of common shares of the Company which may be
granted under the plan is 300,000 shares. All incentive
options available under the plan shall be granted by December
19, 2005.
<TABLE>
<CAPTION>
Stock Option Plan December 31 1997 December 31, 1998
----------------- ---------------- -----------------
Weighted Average Weighted Average
Number Exercise Price Number Exercise Price
------ -------------- ------ --------------
<S> <C> <C> <C> <C>
Outstanding, beginning of year 41,200 $ 2.56 138,000 $ 5.58
Granted 127,800 $ 6.00 147,250 $ 3.03
Exercised 29,600 $ 2.58 None
Canceled 1,400 $ 2.50 89,300 $ 5.58
------ ----------------- ------- ------------
Outstanding, end of year 127,800 $ 5.58 195,950 $ 3.05
====== ================= ======= ============
Exercise price range of options
outstanding $2.50 to $6.00 $3.00 to $5.50
Director Stock Option Agreements
Outstanding, beginning of year 5,000 $ 7.00 29,500 $ 3.27
Granted 24,500 $ 3.02 None
Exercised None None
Canceled None None
------ ----------------- ------ ------------
Outstanding, end of year 29,500 $ 3.27 29,500 $ 3.27
====== ================= ====== ============
Exercise price range of options
outstanding $3.00 to $7.00 $3.00 to $7.00
</TABLE>
--------------------------------------------------------------
On June 23, 1999, the Company cancelled the 5,000
Director Stock Options at $7.00 and reissued the 5,000
options at $4.13.
As noted in Note 1.J., the Company is continuing to
utilize the intrinsic value-based method for accounting
for employee stock Options or similar equity instruments;
therefore, the Company not recorded any compensation cost
in the Statement of Operations for stock-based employee
compensation awards.
The options outstanding at December 31, 1999 are
exercisable through periods ranging from May 2006 through
September 2008.
On July 22, 1998 the Board granted options for 37,000
shares to an advisor of the Company at an option price of
$3.50 per share. The options are exercisable for a period
commencing on the grant date and continuing for two years
Based on the average market price, either being below or
approximating the option price, the Company has
determined that these options would not be exercised
during the two year period and have not recorded an
expense at December 31, 1998 or October 1, 1999.
-48-
<PAGE> 52
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 7. STOCKHOLDERS' EQUITY (CONTINUED)
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of
that Statement. At December 31, 1998 and 1997 and for the nine month
period ended September 30, 1998, the Company's stock price was below
the exercise price for the options. Therefore, management deems it
unlikely that the options would be exercised over these periods and the
disclosure required by SFAS 123 is not applicable. The fair value for
these options was estimated at the date of grant using a Black-Shole's
option pricing model with the following weighted average assumptions
for October 1, 1999.
Risk-free interest rate 6%
Dividend yield 0%
Volatility factor 92.74%
Weighted average expected life in years 5
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma income and earnings per share are as follows:
Net income - as reported $ 214,695
Net income - pro forma $ 183,350
Basic earnings per common share-as reported $ 0.18
Basic earnings per common share-pro forma $ 0.15
Diluted earnings per common share - as reported $ 0.14
Diluted earnings per common share - pro forma $ 0.12
Weighted average fair value of options granted
during the year $ 4.16
-49-
<PAGE> 53
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 7. STOCKHOLDERS' EQUITY (CONTINUED)
E. Stock Warrants - As part of the April 1996 offering circular,
the underwriter was granted warrants to purchase 25,000 shares
of common stock at $5.50 per share. The warrants became
exercisable in May 1997 and expire in April 2001.
NOTE 8. LEASES
OPERATING
The Company leases office equipment under operating leases
expiring in 1999 and 2002.
Minimum future lease payments under operating leases as of
December 31, 1998 are as follows:
1999 $ 11,132
2000 5,462
2001 5,462
2002 1,933
--------------
$ 23,989
==============
Total lease payments charged to operations for the years ended
December 31, 1997 and 1998 amounted to $5,747 and $14,800,
respectively.
Additionally, commencing March 9, 1999, the Company entered
into a lease for its new operating facility that has a term
through 2009.
The minimum annual rental commitments as of October 1, 1999
are as follows:
2000 $ 202,066
2001 202,066
2002 202,066
2003 202,066
2004 202,066
Thereafter 1,163,150
------------
$ 2,173,480
============
-50-
<PAGE> 54
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 8. LEASES (CONTINUED)
CAPITAL
The Company also leases certain diagnostic and schematic
equipment under a capital lease through September 1999. The
future minimum lease payments by year with the present value
of such payments, as of December 31, 1998 is as follows:
1999 $ 22,173
-----------
Total minimum lease payments 22,173
Less amount representing interest 1,538
-----------
Present value of minimum lease payments 20,635
Less current portion 20,635
-----------
Long-term capital lease obligation $ -
===========
The equipment under capital lease is included in the
accompanying balance sheet under the following captions:
December 31,
------------
1997 1998
---- ----
Shop equipment $ 57,000 $ 57,000
Less accumulated depreciation 17,100 28,500
--------- ---------
Net book value $ 39,900 $ 28,500
========= =========
These assets are depreciated over five years using the
straight-line method.
NOTE 9. PROFIT SHARING AND 401(K) SAVINGS PLAN
The Company maintains a qualified cash or deferred
compensation plan under section 401(k) of the Internal Revenue
Code. The plan covers all employees age 21 or over with one
year of service. Under the plan, employees may elect to defer
from 1% to 12% of their salary, subject to Internal Revenue
Code limits.
The Company, at its discretion, may match 100% of employee
contributions up to 6% of wages deferred with a maximum
contribution of $3,000 per employee. Matching contribution
expense of $29,165 and $21,865 has been accrued for 1997 and
1998, respectively.
-51-
<PAGE> 55
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 10. INCOME TAXES
Deferred income taxes arise from temporary differences resulting from
income and expense items reported for financial accounting and tax
reporting purposes in different periods. Deferred taxes are classified
as current or long-term, depending on the classification of the assets
and liabilities to which they relate. Deferred taxes arising from
temporary differences that are not related to an asset or liability are
classified as current or long-term depending on the periods in which
the temporary differences are expected to reverse.
The components of the deferred tax asset (liability) consist
of the following:
December 31,
------------
1997 1998
---- ----
Current:
Federal $ 56,000 $ 92,800
State 12,900 -
City 3,520 4,875
---------- --------
$ 72,420 $ 97,675
========== ========
Noncurrent:
Federal $ (28,000) $(20,000)
State (7,000) -
City (2,000) (1,000)
---------- --------
$ (37,000) $(21,000)
========== ========
Net deferred tax assets in the accompanying balance sheets include the
following components:
December 31,
------------
1997 1998
---- ----
Deferred tax liabilities arising from
depreciation and state tax benefit
temporary differences $ (37,000) $ (21,000)
Deferred tax assets arising from allowance
for doubtful accounts, inventory reserves
and vacation and bonus accrual temporary
differences 72,420 97,675
--------- ---------
$ 35,420 $ 76,675
========= =========
-52-
<PAGE> 56
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 10. INCOME TAXES (CONTINUED)
The components of the tax expense (benefit) were as follows:
December 31,
------------
1997 1998
---- ----
Current:
Federal $ 117,000 $ 43,000
State 12,000 -
City 7,000 3,000
----------- ----------
136,000 46,000
----------- ----------
Deferred:
Federal (24,400) (38,400)
State (2,600) -
City (1,420) (2,855)
----------- ----------
(28,420) (41,255)
----------- ----------
Total $ 107,580 $ 4,745
=========== ==========
A reconciliation of the total provision for income taxes with amounts
determined by applying the statutory U.S. federal income tax rate to
income tax provision is as follows:
December 31,
------------
1997 1998
---- ----
Income tax provision at statutory rate $ 88,580 $ 1,745
Add:
Tax effect of permanent differences 5,000 4,000
State income taxes, net of federal
income tax provision 11,000 -
Other, net 3,000 (1,000)
------------ ---------
Total income tax provision $ 107,580 $ 4,745
============ =========
-53-
<PAGE> 57
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 11. EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
Earnings per common and common equivalent share were computed
by dividing net income by the weighted average number of
shares of common stock outstanding during the year. At
December 31, 1997 and 1998, September 30, 1998 and October 1,
1999, the number of common shares was increased by the number
of shares issuable on the exercise of outstanding stock
options and warrants when the market price of the common stock
exceeds the exercise price of the options and warrants. This
increase in the number of common shares was reduced by the
number of common shares that are assumed to have been
purchased with the proceeds from the exercise of the options;
those purchases were assumed to have been made at the average
price of the common stock during that part of the year when
the market price of the common stock exceeded the exercise
price of the options.
The following data show the amounts used in computing earnings
per share (EPS) and the effect on income and the weighted
average number of shares of dilutive potential common stock.
<TABLE>
<CAPTION>
December 31, September 30, October 1,
------------ ------------------------
1997 1998 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income available to common
stockholders used in basic
EPS and diluted EPS $ 157,239 $ 588 $ (80,993) $ 214,695
=========== ========== ========== ===========
Weighted average number
of common shares used in
basic EPS 1,191,734 1,199,451 1,199,979 1,215,034
Effect of dilutive securities:
Stock options and warrants 13,419 - - 64,986
----------- ---------- ---------- -----------
Weighted number of common
shares and dilutive potential
common stock used in diluted
EPS 1,205,153 1,199,451 1,199,971 1,280,020
=========== ========== ========== ==========
</TABLE>
Options and warrants on 182,300, 292,450, 187,450, and 1,000
shares, respectively, of common stock were not included in
computing diluted EPS for the years ended December 31, 1997
and 1998 and the nine months ended September 30, 1998 and the
thirty-nine weeks ended October 1, 1999 because their effects
were antidilutive.
-54-
<PAGE> 58
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 12. COMMITMENT RELATED TO 1996 PUBLIC OFFERING
On October 13, 1995, the Company entered into an agreement with an
advisor to assist the Company in its efforts to fund the growth of its
business. A provision in the agreement required the Company to retain
the advisor to perform future services, for two additional years since
the Company received at least one million dollars in equity capital in
1996. In exchange, the advisor would be paid by the issuance of 19,000
shares of common stock of the Company in two annual installments of
9,500 shares. The first installment was made in 1997 and the second
installment was made in 1998.
The common shares issued in 1997 and 1998 were accounted for at the
fair market value of the consulting services provided which amounted to
$3,750 and $12,938 which represented the accumulated unpaid amounts at
the date of issuance of the common stock. These expenses were recorded
in the Statements of Income for 1997 and 1998 as the services were
performed which amounted to $16,050 and $638, respectively. Previously,
the issuance of these shares had been reported as a reduction of the
equity capital raised in 1996. The effect of this adjustment is to
reduce net income and basic earnings and diluted earnings per share as
follows:
<TABLE>
<CAPTION>
Basic Diluted
Earnings Earnings
Net (Loss) Per (Loss) Per
Income Common Common
(Loss) Share Share
--------- -------- --------
<S> <C> <C> <C>
Year Ended December 31, 1997
As previously reported $ 166,869 $ 0.14 $ 0.14
Adjustment (9,630) (0.01) (0.01)
--------- -------- --------
As restated $ 157,239 $ 0.13 $ 0.13
========= ======== ========
Year Ended December 31, 1998
As previously reported $ 971 $ - $ -
Adjustment (383) - -
--------- -------- --------
As restated $ 588 $ - $ -
========= ======== ========
Nine Months Ended September 30, 1998
As previously reported $ (80,609) $ (0.07) S (0.07)
Adjustment (383) - -
--------- -------- --------
As restated $ (80,992) $ (0.07) $ (0.07)
========= ======== ========
</TABLE>
NOTE 13. JOINT VENTURE AGREEMENT
On December 5, 1996, the Company entered into an agreement to form a
joint venture with Software Logistics Corporation (Logistix). The new
company, named Logistix PDSi Services and located in Fremont,
California, was formed to provide depot repair services for computer
original equipment manufacturers. The Company had a 40% ownership
position and reported results under the equity method of accounting.
As of December 31, 1997, the joint venture agreement was terminated and
the Company's share of the 1997 operating loss was $77,948. At December
31, 1997, the Company had a net payable to the joint venture of $18,892
resulting from services rendered during 1997.
-55-
<PAGE> 59
PINNACLE DATA SYSTEMS, INC.
(DBA PDSI)
NOTES TO FINANCIAL STATEMENTS
NOTE 14. OPERATING SEGMENTS
The Company's reportable segments include Service Sales and Product
Sales which are explained in Item 1 of this Form 10SB, including a
discussion of principle markets and distribution. The other income
reflected below is composed of consulting services and freight charged
to customers on shipments.
The Company evaluates performance based on operating earnings of the
reportable segments.
Segment information for the years ended December 31, 1997 and 1998,
and for the nine months ended September 30, 1998 and the thirty-nine
weeks ended October 1, 1999 was as follows:
<TABLE>
<CAPTION>
1997
----------------------------------------------------------------------------
Service Product
Sales Sales Other Total
----- ----- ----- -----
<S> <C> <C> <C> <C>
Sales $ 2,122,096 $ 4,286,577 $ 142,817 $ 6,551,490
Gross profit 825,152 905,968 14,656 1,745,776
Operating earnings 392,481 540,656 (521,517) 411,620
Depreciation and
amortization 94,518 33,174 60,119 187,811
Total assets 2,049,816 1,607,466 342,658 3,999,940
Capital expenditures 112,805 31,243 9,731 153,779
1998
----------------------------------------------------------------------------
Service Product
Sales Sales Other Total
----- ----- ----- -----
Sales $ 2,721,388 $ 6,141,222 $ 169,222 $ 9,032,332
Gross profit 784,506 1,124,070 (68,478) 1,840,098
Operating earnings 254,483 461,987 (627,585) 88,885
Depreciation and
amortization 135,780 47,110 85,238 268,128
Total assets 1,773,363 2,194,267 237,747 4,205,377
Capital expenditures 124,405 12,728 31,531 168,664
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
---------------------------------------------------------------
Service Product
Sales Sales Other Total
------- ------- ----- -----
<S> <C> <C> <C> <C>
Sales $ 1,962,371 $ 4,227,201 $ 139,505 $ 6,329,077
Gross profit 440,020 770,943 18,538 1,229,502
Operating earnings 82,499 255,742 (415,182) (76,941)
Depreciation and
amortization 109,912 23,653 62,464 196,029
Total assets 2,403,110 2,402,037 265,144 5,070,291
Capital expenditures 124,405 12,728 13,024 150,157
</TABLE>
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED OCTOBER 1, 1999
---------------------------------------------------------------
Service Product
Sales Sales Other Total
------- ------- ----- -----
<S> <C> <C> <C> <C>
Sales $ 2,205,310 $ 5,664,507 $ 92,723 $ 7,962,540
Gross profit 941,689 1,165,628 (27,529) 2,079,788
Operating earnings 608,326 318,623 (580,218) 346,731
Depreciation and
amortization 117,775 36,793 78,294 232,862
Total assets 1,337,080 4,079,065 325,456 5,741,601
Capital expenditures 67,028 183,038 102,637 352,703
</TABLE>
NOTE 15. RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations when incurred
and are included in operating expenses. The amounts charged for the
years ended December 31, 1998 and 1997 were $191,557 and $144,703,
respectively.
-56-
<PAGE> 60
PART III
ITEM 1. INDEX TO EXHIBITS.
3 (a) Amended and restated articles of incorporation
3 (b) Amended and restated code of regulations
4 Instruments defining the rights of security holders, including
indentures
10 (a) Technology license agreement between Pinnacle Data Systems, Inc. and
Sun Microsystems, Inc. dated May 12, 1994
10 (b) Development and manufacturing license agreement between Pinnacle Data
Systems, Inc. and Sun Microsystems, Inc. dated October 27, 1997
10 (c) Technology license and distribution agreement between Pinnacle Data
Systems, Inc. and Sun Microsystems, Inc. dated January 15, 1999
10 (d) Repair services agreement between Pinnacle Data Systems, Inc. and Sun
Microsystems, Inc. dated March 29, 1999
10 (e)* Employment agreement between Pinnacle Data Systems, Inc. and John D.
Bair dated October 29, 1997
10 (f)* Employment agreement between Pinnacle Data Systems, Inc. and C. Robert
Hahn dated October 29, 1997
10 (g)* Employment agreement between Pinnacle Data Systems, Inc. and Thomas J.
Carr dated October 29, 1997
10 (h)* Employment agreement between Pinnacle Data Systems, Inc. and Michael L.
Antill dated September 20, 1999
10 (i)* Standard form Director stock option agreement between Pinnacle Data
Systems, Inc. and individual members of the Board of Directors
10 (j)* Employment agreement and stock option agreement between Pinnacle Data
Systems, Inc. and David J. Richards dated July 22, 1998
10 (k)* Pinnacle Data Systems, Inc. 1995 stock option plan
10 (l) Real estate contract on sale of building, dated March 17, 1999
10 (m) Lease agreement between Pinnacle Data Systems, Inc. and Duke Realty
Limited Partnership dated March 9, 1999
10 (n) Loan and security agreement between Pinnacle Data Systems, Inc. and
Firstar Bank, N.A. dated September 30, 1999
- --------------------------------------------------------------------------------
* Employee benefit plan arrangement
ITEM 2. DESCRIPTION OF EXHIBITS.
See Item 1 above.
-57-
<PAGE> 61
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934, the
registrant caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized.
PINNACLE DATA SYSTEMS, INC.
Date : December 13, 1999 By: /s/ John D. Bair
-----------------------
John D. Bair, President
-58-
<PAGE> 62
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBITS
- ----------- -----------------------
3 (a) Amended and restated articles of incorporation
3 (b) Amended and restated code of regulations
4 Instruments defining the rights of security holders, including
indentures
10 (a) Technology license agreement between Pinnacle Data Systems, Inc. and
Sun Microsystems, Inc. dated May 12, 1994
10 (b) Development and manufacturing license agreement between Pinnacle Data
Systems, Inc. and Sun Microsystems, Inc. dated October 27, 1997
10 (c) Technology license and distribution agreement between Pinnacle Data
Systems, Inc. and Sun Microsystems, Inc. dated January 15, 1999
10 (d) Repair services agreement between Pinnacle Data Systems, Inc. and Sun
Microsystems, Inc. dated March 29, 1999
10 (e)* Employment agreement between Pinnacle Data Systems, Inc. and John D.
Bair dated October 29, 1997
10 (f)* Employment agreement between Pinnacle Data Systems, Inc. and C. Robert
Hahn dated October 29, 1997
10 (g)* Employment agreement between Pinnacle Data Systems, Inc. and Thomas J.
Carr dated October 29, 1997
10 (h)* Employment agreement between Pinnacle Data Systems, Inc. and Michael L.
Antill dated September 20, 1999
10 (i)* Standard form Director stock option agreement between Pinnacle Data
Systems, Inc. and individual members of the Board of Directors
10 (j)* Employment agreement and stock option agreement between Pinnacle Data
Systems, Inc. and David J. Richards dated July 22, 1998
10 (k)* Pinnacle Data Systems, Inc. 1995 stock option plan
10 (l) Real estate contract on sale of building, dated March 17, 1999
10 (m) Lease agreement between Pinnacle Data Systems, Inc. and Duke Realty
Limited Partnership dated March 9, 1999
10 (n) Loan and security agreement between Pinnacle Data Systems, Inc. and
Firstar Bank, N.A. dated September 30, 1999
- --------------------------------------------------------------------------------
* Employee benefit plan arrangement
