<PAGE> 1
PACIFIC ONLINE COMPUTERS, INC.
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1999 AND 1998
CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
INDEPENDENT AUDITORS' REPORT 1
FINANCIAL STATEMENTS:
Balance Sheets 2
Statements of Operations 3
Statements of Stockholders' Equity (Deficit) 4
Statements of Cash Flows 5
Notes to Financial Statements 6-15
</TABLE>
<PAGE> 2
INDEPENDENT AUDITORS' REPORT
Board of Directors
Pacific Online Computers, Inc.
Irvine, California
We have audited the accompanying balance sheets of Pacific Online Computers,
Inc. as of December 31, 1999 and 1998, and the related statements of operations,
stockholders' equity (deficit) 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 audit.
We conducted our audit 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 audit provides 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 Pacific Online Computers, Inc.
as of December 31, 1999 and 1998, and the results of its operations and its cash
flows for the years then ended, in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern (see Note 1 for management's plans). As
shown in the financial statements, the Company has incurred net losses of
$1,339,152 and $1,073,152 during the years ended December 31, 1999 and 1998,
respectively. As of December 31, 1999 and 1998, the Company had current
liabilities in excess of current assets of $2,716,770 and $1,215,094,
respectively, and had negative cash flows from operations and a net capital
deficiency at December 31, 1999. Also, the Company's financing arrangements for
inventory purchases and cash advances have been on a month-to-month extension
since May 1999. These factors raise substantial doubt about the Company's
ability to continue as a going concern. These financial statements do not
include any adjustments that might be necessary should the Company be unable to
continue as a going concern.
/s/ Stonefield Josephson, Inc.
CERTIFIED PUBLIC ACCOUNTANTS
Santa Monica, California
March 6, 2000, except for Notes 14 and 15,
which are as of April 5, 2000 and March 24, 2000,
respectively
<PAGE> 3
PACIFIC ONLINE COMPUTERS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
ASSETS 1999 1998
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash $ 182,009 $ 172,666
Certificate of deposit 69,629 100,254
Accounts receivable, net of allowance
for doubtful accounts of $102,251 (1999) and
$96,856 (1998) 9,991,080 10,153,597
Income tax refunds receivable -- 778,284
Inventory 1,116,503 1,118,879
Prepaid expenses and other current assets 168,827 90,904
Deferred income taxes 112,000 112,000
------------ ------------
Total current assets 11,640,048 12,526,584
------------ ------------
PROPERTY AND EQUIPMENT, net of
accumulated depreciation and amortization 1,134,273 1,595,003
------------ ------------
OTHER ASSETS:
Receivable from officer 395,251 --
Deposits 114,177 113,832
Long-term accounts receivable 106,825 --
Goodwill 47,005 48,568
Franchise fee and license -- 10,259
------------ ------------
Total other assets 663,258 172,659
------------ ------------
$ 13,437,579 $ 14,294,246
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Loans payable, finance company $ 9,794,334 $ 9,227,254
Accounts payable and accrued expenses 3,354,242 3,418,004
Note payable, stockholder 902,275 902,275
Leases payable, current 23,679 88,361
Deferred revenue, current 282,288 105,784
------------ ------------
Total current liabilities 14,356,818 13,741,678
------------ ------------
LEASES PAYABLE, less current maturities -- 121,312
------------ ------------
DEFERRED REVENUE, less current maturities -- 11,343
------------ ------------
STOCKHOLDERS' DEFICIT:
Common stock; 10,000,000 shares authorized,
152,202 shares issued and outstanding 785,935 785,935
Deficit (1,705,174) (366,022)
------------ ------------
Total stockholders' deficit (919,239) 419,913
------------ ------------
$ 13,437,579 $ 14,294,246
============ ============
</TABLE>
See accompanying independent auditors' report and notes to financial statements.
2
<PAGE> 4
PACIFIC ONLINE COMPUTERS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended Year ended
December 31, 1999 December 31, 1998
----------------- -----------------
<S> <C> <C>
NET SALES $ 61,162,748 $ 80,080,059
COST OF SALES 51,086,675 67,535,722
------------ ------------
GROSS PROFIT 10,076,073 12,544,337
------------ ------------
LABOR COSTS 6,610,025 9,636,160
OPERATING EXPENSES 3,728,699 4,424,000
------------ ------------
10,338,724 14,060,160
------------ ------------
LOSS FROM OPERATIONS (262,651) (1,515,823)
LAWSUIT SETTLEMENT (NOTE 14) (1,076,501) --
------------ ------------
(1,339,152) (1,515,823)
INCOME TAX BENEFIT, NET -- (442,671)
------------ ------------
NET LOSS $ (1,339,152) $ (1,073,152)
============ ============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING -
basic and diluted 152,202 152,202
============ ============
NET LOSS PER SHARE -
basic and diluted $ (8.80) $ (7.05)
============ ============
</TABLE>
See accompanying independent auditors' report and notes to financial statements.
3
<PAGE> 5
PACIFIC ONLINE COMPUTERS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
Common stock Total
--------------------------- Accumulated stockholders'
Shares Amount deficit equity/(deficit)
------ ------ ------- ---------------
<S> <C> <C> <C> <C>
Balance at January 1, 1998 152,202 $ 785,935 $ 707,130 $ 1,493,065
Net loss for the year ended
December 31, 1998 (1,073,152) (1,073,152)
----------- ----------- ----------- -----------
Balance at December 31, 1998 152,202 785,935 (366,022) 419,913
Net loss for the year ended
December 31, 1999 (1,339,152) (1,339,152)
----------- ----------- ----------- -----------
Balance at December 31, 1999 152,202 $ 785,935 $(1,705,174) $ (919,239)
=========== =========== =========== ===========
</TABLE>
See accompanying independent auditors' report and notes to financial statements.
4
<PAGE> 6
PACIFIC ONLINE COMPUTERS, INC.
STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
Year ended Year ended
December 31, 1999 December 31, 1998
----------------- -----------------
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED FOR) OPERATING ACTIVITIES:
Net loss $(1,339,152) $(1,073,152)
----------- -----------
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH PROVIDED BY (USED FOR) OPERATING
ACTIVITIES:
Depreciation and amortization 509,221 488,088
Loss on sale of assets 10,227 --
Provision for doubtful accounts 135,000 60,000
CHANGES IN ASSETS AND LIABILITIES:
(INCREASE) DECREASE IN ASSETS:
Certificate of deposit 30,625 (100,254)
Accounts receivable 27,517 4,238,509
Income tax refunds receivable 778,284 (778,284)
Inventory 2,376 810,602
Prepaid expenses and other current assets (77,923) (139,171)
Deferred income taxes -- 158,934
Receivable from officer (395,251) --
Long-term accounts receivable (106,825) --
INCREASE (DECREASE) IN LIABILITIES:
Accounts payable and accrued expenses (63,762) 984,171
Deferred revenue 165,161 (553,847)
Income taxes payable -- (225,021)
----------- -----------
Total adjustments 1,014,650 4,943,727
----------- -----------
Net cash provided by (used for) operating activities (324,502) 3,870,575
----------- -----------
CASH FLOWS PROVIDED BY (USED FOR) INVESTING ACTIVITIES:
Payments to acquire property and equipment (57,155) (487,657)
Deposits 9,914 (15,422)
----------- -----------
Net cash used for investing activities (47,241) (503,079)
----------- -----------
CASH FLOWS PROVIDED BY (USED FOR) FINANCING ACTIVITIES:
Payments on leases payable, net (185,994) (94,784)
Proceeds from loans payable, finance company, net 567,080 (3,397,929)
----------- -----------
Net cash provided by (used for) financing activities 381,086 (3,492,713)
----------- -----------
NET INCREASE (DECREASE) IN CASH 9,343 (125,217)
CASH, beginning of year 172,666 297,883
----------- -----------
CASH, end of year $ 182,009 $ 172,666
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 704,408 $ 932,010
=========== ===========
Income taxes paid $ -- $ 400,000
=========== ===========
Inventory transferred to property and equipment $ -- $ 336,893
=========== ===========
Reclassification of note payable, stockholder to current $ -- $ 902,275
=========== ===========
</TABLE>
See accompanying independent auditors' report and notes to financial statements.
5
<PAGE> 7
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1999 AND 1998
(1) GOING CONCERN:
As shown in the accompanying financial statements, the Company has
incurred a loss from operations and has deficits in working capital. As a
result, approximately $10,697,000 (1999) and $10,130,000 (1998) of debt
is considered to be in default by the respective lenders. These factors
raise substantial doubt about the Company's ability to continue as a
going concern.
Management is working with its primary lender to monitor the status of
its indebtedness and is currently evaluating methods to reduce costs,
improve results of operations, and obtain additional capital infusions.
There can be no assurance that the Company will be successful in its
efforts to not have the payment of debt accelerated. The Company's main
lender notified them as to termination effective May 31, 1999 and has
been extending the agreement for 30-day periods throughout 1999. There's
no guarantee that the lender will continue to grant the extensions. If
the Company is unsuccessful in its efforts, it may be necessary to
undertake such other actions as may be appropriate to preserve asset
value. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BUSINESS ACTIVITY:
The Company sells computer hardware and software and offers
installation, consulting and repair services to its customers
throughout the United States.
REVENUE RECOGNITION:
The Company recognizes revenues from the sale of computer hardware
related products upon shipment of the products.
The Company provides and recognizes computer consulting and
technical support revenues on an hourly basis as services are
rendered and over the term of the service contract as determined
on an individual contract basis. The Company recognizes consulting
and technical support revenues only when no further contingencies
or material performance obligations are warranted, and thereby
would have earned the right to receive and retain payments for
services performed and billed.
DEFERRED REVENUE RELATING TO SERVICE CONTRACTS:
The Company sells warranty contracts which, in most instances,
cover a period of more than one year. The amount of deferred
revenue, as presented in the financial statements, represents
warranty contracts which have not yet been fulfilled.
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 and disclosure of contingent 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.
See accompanying independent auditors' report.
6
<PAGE> 8
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
CASH EQUIVALENTS:
For purposes of the statement of cash flows, cash equivalents
include all highly liquid debt instruments with original
maturities of three months or less which are not securing any
corporate obligations.
INVENTORY:
Inventory is valued at the lower of cost (first-in, first-out) or
market. Inventory consists of computer equipment and service
supplies.
PROPERTY AND EQUIPMENT:
Property and equipment are valued at cost. Additions and
betterments are capitalized. Maintenance and repairs are charged
directly to expense as incurred. When assets are disposed, the
related cost and accumulated depreciation are removed from the
accounts and any resulting gains or losses are included in the
statements of operations. Depreciation is being provided using the
straight-line method over the following estimated useful lives:
Building and improvements 39 years
Office furniture and equipment 5-7 years
Machinery and equipment 5-7 years
Computer software and hardware 5-7 years
The Company estimates depreciation on property and equipment based
on estimated useful lives. The actual useful lives and
recoverability of values of property and equipment may vary from
the Company's estimates. In the event that future facts and
circumstances indicate that the cost of property and equipment may
be impaired, an evaluation of recoverability would be performed.
If an evaluation is required, the estimated future undiscounted
cash flows associated with the asset would be compared to the
asset's carrying amount to determine if a write-down to market
value or discounted cash flow value is required.
NET LOSS PER SHARE:
The Company computes net loss per share following SFAS No. 128,
"Earnings Per Share". Under the provisions of SFAS No. 128, basic
net income (loss) per share is computed by dividing the net income
(loss) available to common shareholders for the period by the
weighted average number of common shares outstanding during the
period. Diluted net income (loss) per share is computed by
dividing the net income (loss) for the period by the weighted
average number of common and common equivalent shares outstanding
during the period. Common equivalent shares are not included in
the computation of diluted loss per share for the periods
presented because the effect would reduce net loss per share.
See accompanying independent auditors' report.
7
<PAGE> 9
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
NET OPERATING LOSS CARRYFORWARD:
The Company has a net operating loss carryforward of approximately
$74,000 (federal) and $763,000 (state) at December 31, 1999 which
can be used to offset future taxable income. The lawsuit
settlement disclosed in Note 14 will be deductible for tax
purposes in the corporation's year 2000 tax return (year of
payment).
GOODWILL:
Goodwill represents the excess of the cost to acquire the Company
over the fair value of its net assets at the date of acquisition,
and is being amortized over 40 years by use of the straight-line
method.
(3) CASH:
Credit Risk for Cash Deposits
-----------------------------
The Company maintains its cash in bank deposit accounts which, at times,
may exceed federally insured limits. The Company has not experienced any
losses in such accounts.
Certificate of Deposit
----------------------
The certificate of deposit is held as collateral for a standby letter of
credit. The letter of credit, as well as equipment with a cost of
approximately $218,000, collateralizes a lessor's position with respect
to a lease which for financial statement purposes is treated as an
operating lease by the Company.
(4) CONCENTRATION OF CREDIT RISK AND ACCOUNTS RECEIVABLE:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade receivables. In
the normal course of business, the Company extends unsecured credit to
customers who principally operate in California. The Company's ability to
generate future profitability will be dependent upon the economics within
the regions it sells to as well as its ability to maintain competitive
pricing and service capabilities.
Included in accounts receivable at December 31, 1999 and 1998 is
approximately $818,000 and $1,700,000, respectively, due from one and
three customers, respectively. Sales to one customer amounted to
approximately $8,095,000 for the year ended December 31, 1999. In
addition, there are six customers, including this one, which make up
approximately 49% of open accounts receivable.
During the year ended December 31, 1998, sales to three customers
amounted to approximately $32,405,000.
See accompanying independent auditors' report.
8
<PAGE> 10
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(4) CONCENTRATION OF CREDIT RISK AND ACCOUNTS RECEIVABLE, CONTINUED:
Included in accounts receivable are amounts due from vendors for rebates
and for merchandise where a right of return exists. Approximately $85,000
(1999) and $246,000 (1998) of this balance is due from a stockholder (see
Note 10).
Supplemental Information - Schedule II - Valuation Accounts
-----------------------------------------------------------
A summary of the valuation accounts is as follows:
a. Allowance for doubtful accounts: As of December 31, 1999, 1998 and
1997, the allowance for doubtful accounts amounted to $102,251,
$96,856 and $74,562, respectively. During the years ended December
31, 1999 and 1998, the Company charged $135,000 and $60,000 to
expense, respectively.
b. Allowance for inventory markdowns: As of December 31, 1999, 1998
and 1997, the allowance for inventory markdowns amounted to
$261,362, $144,162 and $120,000, respectively.
(5) PREPAID EXPENSES AND OTHER CURRENT ASSETS:
A summary is as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Prepaid purchases $ 110,347 $ 82,536
Prepaid insurance 38,992 -
Other 19,488 8,368
----------- ----------
$ 168,827 $ 90,904
=========== ==========
</TABLE>
See accompanying independent auditors' report.
9
<PAGE> 11
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(6) PROPERTY AND EQUIPMENT:
A summary is as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Computer hardware $ 1,713,772 $ 1,580,303
Computer software 451,023 395,810
Furniture and fixtures 286,247 285,300
Machinery and equipment 199,235 195,754
Internally developed computer
software available for sale 114,104 114,104
Building 95,200 95,200
Leasehold improvements 66,394 61,151
Vehicles 41,554 263,842
------------ ------------
2,967,529 2,991,464
Less accumulated depreciation and amortization 1,833,256 1,396,461
------------ ------------
$ 1,134,273 $ 1,595,003
============ ============
</TABLE>
(7) INCOME TAXES:
The Company uses the asset and liability approach to measure temporary
differences in accounting for income taxes. Temporary differences arise
from differences in the timing of revenue and expense recognition for
financial reporting and income tax return purposes and are measured using
the currently enacted tax rates and laws. Two of the major temporary
differences relate to the federal net operating loss carryforward of
approximately $74,000 and the California State net operating loss
carryforward of approximately $763,000. Additionally, a deferred asset
was created by the lawsuit settlement referred to in Note 14, which is
only deductible in the year paid (2000). Deferred assets related to net
operating loss carryforwards and the lawsuit settlement have been
provided and completely offset by a valuation allowance, because its
utilization does not appear to be reasonably assured. Available federal
and state net operating loss carryforwards start to expire on December
31, 2018 and December 31, 2003, respectively. In the event of a change in
control in ownership of the Company, the utilization of the available net
operating loss carryforward may be significantly limited.
The deferred tax asset, as shown on the balance sheet, relates primarily
to the difference in the treatment of deferred revenues for tax and
financial statement purposes.
See accompanying independent auditors' report.
10
<PAGE> 12
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(7) DEFERRED INCOME TAXES, CONTINUED:
A reconciliation of the differences between the statutory federal income
tax rate and the Company's effective income tax rate applied to income
(loss) before income taxes are as follows for the years ending:
<TABLE>
<CAPTION>
December 31,
------------
1999 1998
---- ----
<S> <C> <C>
Statutory federal tax (benefit) rate 34% 34%
State income tax provision, net of federal benefit - -
Net operating loss for which no benefit is available (34)% (34)%
Effective tax rate 0% 0%
</TABLE>
(8) ACCOUNTS PAYABLE AND ACCRUED EXPENSES:
A summary is as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Purchases and services $ 1,193,370 $ 2,062,256
Lawsuit settlement (Note 14) 1,076,501 -
Salaries payable 427,849 488,313
Sales tax payable 342,464 291,241
Non-compensated absences due
to employees 201,598 227,807
401(k) contributions payable 63,521 176,918
Payroll taxes payable 32,439 166,953
Other 16,500 4,516
----------- ------------
$ 3,354,242 $ 3,418,004
=========== ============
</TABLE>
The Company purchased approximately $32,000,000 and $43,000,000 from two
suppliers (one of them also a stockholder, see Note 10) during the years
ended December 31, 1999 and 1998, respectively. The supplier who is not a
stockholder has received the unlimited personal guarantee of a
stockholder of the Company and the limited guaranties of an officer and
certain employees. The respective guarantors have subordinated their
right to receive payment on debt owed to them by the Company (none
outstanding at December 31, 1999 and 1998) to the debt owed by the
Company to the supplier. These amounts were financed according to the
terms indicated in Note 11. Included in accounts payable and accrued
expenses is approximately $1,686,000 and $1,144,000 due to these
suppliers at December 31, 1999 and 1998, respectively.
See accompanying independent auditors' report.
11
<PAGE> 13
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(9) 401(K) CONTRIBUTORY PROFIT SHARING PLAN:
The Company initiated a contributory 401(k) profit sharing plan effective
October 1, 1992, whereby eligible employees can make contributions. The
employer may make annual discretionary contributions. Total contributions
payable at December 31, 1999 and 1998 amounted to $63,521 and $72,516,
respectively, which is included in accounts payable and accrued expenses.
Contribution expense amounted to $50,252 and $77,537 during the years
ended December 31, 1999 and 1998, respectively.
(10) NOTE PAYABLE, STOCKHOLDER:
The note payable is due to a stockholder who is also a major supplier of
the Company (see Note 8). This same supplier was issued 33,102 shares of
stock for $500,000 during the year ended December 31, 1994 and an
additional 13,837 shares in February 1996 in consideration for backing an
appellate bond (see Note 14). The Company can pay down the note, but if
it decides to repay the entire note, it is required to repurchase all of
the shares for an amount equal to $500,000, compounded annually at a rate
of 12.5%, and obtain the unconditional release of the appellate bond
referred to in Note 14. Interest on the note is payable on the first of
each month at a rate equal to prime plus 1% per annum on the unpaid
principal (if in default, the rate is prime plus 2% per annum). The note
is presently being extended by the stockholder on a month-to-month basis.
The note has a conversion clause which, depending upon the results of
operations and the maintenance of purchase commitments (Note 13 -
purchase commitments were not met), allows the note holder the right to
convert the principal due into stock. If the stockholder elects to
convert the note, the net book value of the Company is recalculated to
assume that all of the issued stock options are exercised at their option
price. As a note covenant, the Company is limited to $500,000 of losses
for any 12 consecutive month period (violated at December 31, 1999 and
1998).
The note is subordinated to the finance company described in note 11 and
to IBM (a supplier of the Company). The note is personally guaranteed by
an officer-stockholder of the Company and 100,000 shares of the Company's
stock have been pledged as security.
(11) CREDIT FACILITY:
The Company has a revolving line of credit with a finance company which
is used for cash advances and inventory financing. Interest is paid on
borrowings at a rate of prime (not less than 6.0%) plus 1.0% per annum.
The finance company holds as security substantially all assets of the
Company, as well as the personal guarantee and specific assets of an
officer-stockholder.
Based on notifications received, the finance company agreed to finance
the Company's inventory acquisitions and make advances only through May
31, 1999 (termination date) due to covenant violations. Since that date,
the finance company has been operating on 30-day extensions.
See accompanying independent auditors' report.
12
<PAGE> 14
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(11) CREDIT FACILITY, CONTINUED:
The Company must maintain the following financial ratios and covenants,
which it was not in compliance with at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Covenant Requirement
-------- -----------
<S> <C>
Tangible net worth and subordinated debt => $2,300,000
Debt to tangible net worth and subordinated debt <= 9.0 : 1.0
</TABLE>
Interest expense amounted to $704,408 and $932,010 for the years ended
December 31, 1999 and 1998, respectively. Approximately $81,000 and
$131,000 was paid to a stockholder during the years ended December 31,
1999 and 1998, respectively.
(12) INCENTIVE STOCK PLAN:
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under FASB Statement No.
123, "Accounting for Stock-Based Compensation," requires use of option
valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the fair market value of the underlying
stock on the date of grant, no compensation expense is recognized.
Proforma information regarding net income and earnings per share under
the fair value method has not been presented as the amounts are
immaterial.
Under the terms of its stock option plan, options to purchase shares of
the Company's common stock are granted at a price equal to the fair
market value of the stock at the date the option is granted. At December
31, 1999, the Company had reserved and outstanding 45,660 shares for
issuance under its incentive stock plan. At December 31, 1998, the
Company had reserved 45,660 shares for issuance under its incentive stock
plan, of which 45,457 options were outstanding.
The number and weighted average exercise prices of options granted for
the years ended December 31, 1999 and 1998 are as follow:
<TABLE>
<CAPTION>
Average
Exercise
Number Price
------ -----
<S> <C> <C>
Outstanding at beginning of the year, 1998 27,143 $ 14.39
Cancelled during the year 7,747 15.10
Granted during the year 26,061 15.10
Outstanding at beginning of the year, 1999 45,457 14.69
Cancelled during the year 24,273 15.10
Granted during the year 24,476 15.10
Outstanding at end of the year 45,660 14.69
Exercisable at end of the year 42,129 14.66
</TABLE>
See accompanying independent auditors' report.
13
<PAGE> 15
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(13) COMMITMENTS:
Leases
------
The following is a schedule by years of future minimum rental payments
required under facility and equipment operating leases that have
noncancellable lease terms in excess of one year as of December 31, 1999:
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
2000 $ 316,502
2001 266,898
2002 165,053
2003 127,204
-----------
$ 75,657
</TABLE>
Rent expense under all facility leases amounted to $520,877 and $525,013
and payments under non-facility leases included above amounted to $90,474
and $136,252 for the years ended December 31, 1999 and 1998,
respectively.
Buy-Sell Agreement
------------------
A stockholders agreement has been entered into by the major stockholders
of the Company. Upon death or the occurrence of specific events as
outlined in the agreement, the Company may purchase from the stockholder
or the stockholder's estate the shares then owned at a value outlined in
the agreement.
Purchases
---------
The Company has a purchase commitment to buy at least $9,000,000 worth of
products from a stockholder who is also a supplier (the stockholder
referred to in notes 4, 8 and 10) for each of the four quarters during
the years ended December 31, 1999 and 1998. Per the agreement with that
stockholder, if the Company does not meet this commitment, the
stockholder has the right to convert the note (referred to in note 10)
into shares of common stock of the Company. The Company was not in
compliance with this commitment as of December 31, 1999 and 1998.
See accompanying independent auditors' report.
14
<PAGE> 16
PACIFIC ONLINE COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1999 AND 1998
(14) LAWSUIT SETTLEMENT AND SUBSEQUENT EVENT:
In October 1994, a group of former employees filed suit against the
Company alleging they were wrongfully terminated and improperly denied
stock benefits by the Company. They sought compensatory and general
damages. The Company and one of its stockholders filed a cross-complaint
asserting causes of action for breach of contract and related business
torts. The Company has spent the last several years appealing the
judgement entered against them. On February 25, 2000, the Court of Appeal
issued a written opinion affirming the judgement for $760,000 plus 10%
simple interest. On April 3, 2000, the judgement became final. The
accrual, totaling $1,076,501, is included in accounts payable and accrued
expenses at December 31, 1999 (Note 8) and was paid on April 5, 2000 by
the stockholder referred to in Note 10 and a demand note was entered into
between them and the Company.
An appellate bond, as required by statute for cases on appeal, had been
posted by the stockholder referred to in note 10 and in consideration
thereof, the Company issued 13,837 shares to that stockholder in February
1996 (non-cash financing transaction). The bond should be released
pending verification by the courts of payment in full.
(15) SUBSEQUENT EVENT:
Effective March 24, 2000, the President (majority stockholder) of the
Company resigned. The President and the Company agreed to forgive the
receivable from officer for $395,251 (arising from cash advances) as full
and complete payment for the outstanding shares to be purchased from him.
The consideration given will be effective upon the subsequent sale or
liquidation of the Company.
See accompanying independent auditors' report.
15
