<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOCUS AFFILIATES, INC.
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(Exact name of registrant as specified in its charter)
Delaware
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(State or other jurisdiction of incorporation)
1-12571 95-4467726
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(Commission File Number) (I.R.S. Employer Identification No.)
401 East Corporate Drive, Suite 220
Lewisville, Texas 75057
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(Address of principal executive offices) (Zip code)
Issuer's telephone number (214) 222-7979
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
------ -------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest predictable date.
Class Outstanding at June 30, 2000
----------------------------- ----------------------------
Common Stock, $0.01 par value 10,927,789
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PART I - FINANCIAL INFORMATION
FOCUS AFFILIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
(unaudited) (unaudited)
------------------------------ ------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net Sales $ 1,926,000 $ 7,553,000 $ 16,444,000 $ 14,219,000
Cost of Sales 1,259,000 7,196,000 14,969,000 13,397,000
------------ ------------ ------------ ------------
Gross Profit 667,000 357,000 1,475,000 822,000
Selling, General and Administrative Expenses 3,267,000 2,026,000 6,204,000 2,979,000
Restructuring Charges 1,957,000 -- 1,957,000 --
------------ ------------ ------------ ------------
Loss from Operations (4,557,000) (1,669,000) (6,686,000) (2,157,000)
Other Income (expense)
Interest Expense, net (1,533,000) (23,000) (1,835,000) (23,000)
Other Income, net 360,000 11,000 364,000 6,000
------------ ------------ ------------ ------------
Loss Before Provision for Income Taxes
and Extraordinary Item (5,730,000) (1,681,000) (8,157,000) (2,174,000)
Provision for Income Taxes -- -- -- --
------------ ------------ ------------ ------------
Net Loss Before Extraordinary Item (5,730,000) (1,681,000) (8,157,000) (2,174,000)
Extraordinary Item, net of tax effect
of zero (105,000) -- (105,000) --
Net Loss $ (5,835,000) $ (1,681,000) $ (8,262,000) $ (2,174,000)
============ ============ ============ ============
Basic Loss Per Share $ (0.53) $ (0.24) $ (0.76) $ (0.33)
============ ============ ============ ============
Diluted Loss Per Share $ (0.53) $ (0.24) $ (0.76) $ (0.33)
============ ============ ============ ============
Weighted number of common shares outstanding 10,909,189 6,948,782 10,827,858 6,543,636
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
2
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FOCUS AFFILIATES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30,
Assets 2000 December 31,
(unaudited) 1999
------------ ------------
<S> <C> <C>
Current Assets:
Cash and Cash Equivalents $ 148,000 $ 2,495,000
Accounts Receivable, net of allowance of $1,239,000 and $1,000,000,
respectively 1,695,000 9,922,000
Inventories, net of reserves of $690,000 and $1,310,000, respectively 1,480,000 9,488,000
Due from Related Parties 117,000 732,000
Prepaid Expenses and Other Current Assets 252,000 657,000
------------ ------------
Total Current Assets 3,692,000 23,294,000
Property and Equipment, net 1,910,000 4,443,000
Goodwill and Intangible Assets, net 14,608,000 16,423,000
Other 19,000 74,000
------------ ------------
Total $ 20,229,000 $ 44,234,000
============ ============
Liabilities and Shareholders' Equity
Current Liabilities:
Current Maturities of Long-Term Debt $ 2,020,000 $ 500,000
Note Payable 12,000 --
Revolving Credit Facility -- 12,699,000
Accounts Payable 11,028,000 13,190,000
Accrued Expenses 702,000 2,006,000
------------ ------------
Total Current Liabilities 13,762,000 28,395,000
Long-Term Liabilities:
Long-Term Debt -- 1,645,000
Other 321,000 324,000
------------ ------------
Total Long-Term Liabilities 321,000 1,969,000
Shareholders' Equity:
Preferred Stock - $.01 Par Value, 1,000,000 Shares Authorized, none issued -- --
Common Stock - $.01 Par Value, 15,000,000 Shares Authorized, 10,927,789 and
10,737,740 issued and outstanding in 2000 and 1999, respectively 109,000 108,000
Additional Paid-In Capital 28,535,000 27,997,000
Accumulated Deficit (22,498,000) (14,235,000)
------------ ------------
Total Shareholders' Equity 6,146,000 13,870,000
------------ ------------
Total Liabilities and Shareholders' Equity $ 20,229,000 $ 44,234,000
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
3
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FOCUS AFFILIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
(unaudited)
------------------------------
2000 1999
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Loss $ (8,262,000) $ (2,173,000)
Adjustments to Reconcile Net Loss to Net Cash
Used in Operating Activities-
Depreciation and Amortization 1,763,000 83,000
Loss on Impairment of Goodwill 765,000 --
Non-Cash Restructuring Charges 1,957,000 --
Non Cash Compensation Expense -- 551,000
Loss on Conversion of Debt 105,000 --
Provision for Doubtful Accounts Receivable 1,539,000 (77,000)
Provision (credit) for Inventory Reserves (118,000) (221,000)
Changes in Operating Assets and
Liabilities-
Accounts Receivable 7,183,000 (962,000)
Inventories, net 8,126,000 104,000
Due from Related Parties 120,000 --
Prepaid Expenses and Other Current
Assets 405,000 (180,000)
Other Assets 55,000 (166,000)
Accounts Payable and Accrued Expenses (3,453,000) 1,948,000
------------ ------------
Net Cash Provided by (used in)
Operating Activities 10,185,000 (1,093,000)
Cash Flows from Investing Activities:
Acquisition of Property and Equipment (137,000) (119,000)
------------ ------------
Net Cash Used in Investing Activities (137,000) (119,000)
Cash Flows from Financing Activities:
Proceeds from Long-Term Debt 804,000 --
Payments of Long-Term Debt (500,000) --
Advances (repayments) Under Credit Facility (12,699,000) 1,376,000
Proceeds from the Sale of Capital Stock -- 1,067,000
------------ ------------
Net Cash (used in) Provided by
Financing Activities (12,395,000) 2,443,000
Net (decrease) Increase in Cash and Cash
Equivalents (2,347,000) 1,231,000
Cash and Cash Equivalents, Beginning of Period 2,495,000 362,000
------------ ------------
Cash and Cash Equivalents, End of Period $ 148,000 $ 1,593,000
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
4
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FOCUS AFFILIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
In the opinion of the Company, the accompanying unaudited consolidated
financial statements contain all adjustments necessary to present fairly
its financial position at June 30, 2000 and December 31, 1999 and its
results of operations for the three and six months ended June 30, 2000 and
1999 and cash flows for the six months ended June 30, 2000 and 1999. All
adjustments are of a normal recurring nature.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with Article 10 of Regulation S-X and therefore do
not include all information and footnotes necessary for a fair presentation
of the financial position, results of operations and cash flow in
conformity with generally accepted accounting principles. The accompanying
financial information should be read in conjunction with the audited
financial statements contained in the Company's Annual Report of Form 10-K,
for the year ended December 31, 1999. Footnote disclosures that
substantially duplicate those in the Company's Form 10-K, including
significant accounting policies, have been omitted.
The results of operations for the six-month period ended June 30, 2000 are
not necessarily indicative of the results to be expected for the full year.
(2) COMMITMENTS, CONTINGENCIES AND OTHER MATTERS
As previously reported in the Company's Form 8-K/A filed on May 11, 2000,
the Company has petitioned the American Arbitration Association seeking to
rescind its acquisition of Cellular Wholesalers, Inc. ("CWI"), or, in the
alternative, seeking monetary damages from the formers CWI stockholders
(including certain members of the former CWI management team) based, in
part, on the misstatements of certain financial information relating to
CWI. There can be no assurance, however, that the Company will be
successful in obtaining a rescission of its acquisition of CWI or monetary
damages from the former CWI stockholders. The arbitration is still ongoing
as of the date of this filing.
On July 12, 2000 the Company was notified by the United States District
Court, Northern District of Illinois, Eastern Division that it and Michael
Hedge, President of the Company, were named as defendants in a lawsuit
filed by Ronald Goldberg, Philip Leavitt, Sherwin Geitner and Cary Maimon.
For further information, see "PART II - OTHER INFORMATION - Legal
Proceedings."
On August 8, 2000, Ben Neman sued the Company in California Superior Court,
Los Angeles County, California. In the complaint, Mr. Neman alleged that
(a) the Company failed to make payments to Mr. Neman aggregating $116,665
as required by an agreement between them and (b) the Company's delay in
removing a legend on shares of stock restricting transfer caused
compensatory and consequential damages to Neman in a sum in excess of
$1,000,000. The Company is evaluating Mr. Neman's claims and believes that
it may have defenses to assert regarding the compensatory and consequential
damages to Neman.
In addition, the Company is a defendant in a number of lawsuits brought by
certain unsecured creditors and former employees. Under the guidelines of
the Statement of Financial Accounting Standards No. 5, "Accounting for
Contingencies", the Company has established a reserve for contingencies in
which the outcome is probable and estimable as of June 30, 2000.
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(3) SUBSEQUENT EVENTS
-RESTRUCTURING COSTS
During the second quarter, the Company discontinued its operations in its
Chatsworth, California and Miami, Florida facilities and began to take
certain steps to reduce the overhead costs related to its CWI operations.
Subsequent to June 30, 2000, the Company discontinued its operations in
Lincolnshire, Illinois and continues to take further steps to reduce its
overhead costs. The Company incurred non-cash restructuring costs of
approximately $1,957,000 during the second quarter. In addition, the
Company incurred a loss on the impairment of goodwill of approximately
$765,000, relating to the acquisition of SourceWireless.com ("Source") in
December 1999. The Company is not currently conducting any activities or
operations through Source.
-RECAPITALIZATION PLAN
On May 8, 2000, the Company received a notice from Critical Capital Growth
Fund L.P. ("Critical Capital") asserting that the Company was in default
with respect to its $1,000,000 subordinated note payable to Critical
Capital. Subsequent to June 30, 2000, Critical Capital became the senior
lender and the Company received an additional loan from Critical Capital in
the amount of $750,000. The aggregate amount, $1,750,000, is due on demand
and bears interest at 18%. See "Item 2 - Management's Discussion and
Analysis of Results of Operations and Changes in Financial Position -
Liquidity and Capital Resources" and "PART II - ITEM 5. Other Information."
As a condition of the Critical Capital additional loan, the Company was
required by Critical Capital to remove all inventory and fixed assets owned
by the Company from its Lincolnshire, Illinois location. This removal was
contested by Leavitt Communications, Inc., an affiliate of one of the
former principal shareholders of CWI ("LCI"). On August 16, 2000, the
parties reached an agreement in principle to resolve this dispute pursuant
to which LCI will acquire various fixed assets of Focus that had been used
at the Lincolnshire, Illinois location for a payment that will total at
least $257,000, with all or a substantial portion of the proceeds to be
applied to pay down part of the Company's outstanding loan from Critical
Capital. In addition, the former principal shareholders of CWI agreed in
principle to pay off the Company's loan from American National Bank & Trust
Company of Chicago ("ANB"), which had an outstanding balance of $1,167,000
at June 30, 2000. The amount paid by the former CWI shareholders to ANB
will be credited and certain other amounts paid by them may be credited
against any amounts that they may be required to pay the Company in
connection with the pending arbitration between the Company and them
relating to the Company's acquisition of CWI.
Subsequent to June 30, 2000, the Company entered into contingent agreements
with unsecured creditors representing approximately $7,000,000 of unsecured
claims against the Company. Not all of the unsecured creditors have agreed
to the terms set forth below. In addition, the Company received an unsigned
term sheet from an investment group indicating the group's interest to
invest $4,000,000 in convertible debt in the Company subject to certain
conditions. The agreements with the unsecured creditors and financial
investors are part of management's effort to restructure the Company's
balance sheet ("Recapitalization Plan"). Pursuant to the Recapitalization
Plan that the Company is seeking to implement, the Company has contingently
agreed with the creditors described above to the summarized terms as
follows:
o Post March 15, 2000 invoices paid in full.
o Pre March 15, 2000 invoices:
o Immediate payment of 12.5% of outstanding payables;
o One year note payable in the principal amount of 12.5% of the
outstanding trade payable with interest at 10% and principal
paid monthly;
o Three year note payable in the principal amount of 6.25% of the
outstanding trade payable with interest at 10% and monthly
payments of interest only in years one and two with level
amortization in year three;
o Common shares of Focus, at $1.00 per share, equal to 12.5% of the
outstanding trade payable, with such issuance subject to required
shareholder and regulatory approvals. If
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required approvals are not granted within one year, common shares
would not be issued. In lieu of common shares, trade creditors
would receive a three-year subordinated note obligation equal to
12.5% of the outstanding trade payable;
o Forgiveness of the outstanding account balance; and
o A contingent payment to all trade creditors on a pro rata basis
of 50% of any net cash proceeds resulting from the CWI
arbitration proceeding.
The Company's ability to complete the Recapitalization Plan will be highly
contingent upon the agreement of substantially all the unsecured creditors to
the terms described above, a restructuring or resolution of the secured
indebtedness owed to Critical Capital and ANB, the Company's timely receipt of
approximately $4,000,000 in proceeds from the investor group, the continued
support of trade vendors and the ability to continue its current operations.
There are no assurances that any of these contingencies referenced above will be
satisfied. The inability of the Company to satisfy any of the aforementioned
conditions may cause the immediate cessation of the Company's business
operations.
If and when the Recapitalization Plan is completed and the aforementioned
agreements with unsecured creditors are consummated, the Company will reflect a
reduction in these liabilities, which are currently reflected in accounts
payable. The reduction in liabilities will increase the Company's net income and
related shareholders' equity at the date the Recapitalization Plan is completed.
On April 11, 2000, a note in the amount of approximately $417,500 plus accrued
interest of approximately $8,000 was exchanged for 169,263 shares of common
stock at an agreed value of $2.50 per share. Because the market value of the
shares on the date of the transaction was $3.13 per share, the Company recorded
a loss on the extinguishment of debt of approximately $105,000. This loss is
reflected as an extraordinary item on the statements of operations.
Item 2. Management's Discussion and Analysis of Results of Operations and
Changes in Financial Position
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: THE STATEMENTS CONTAINED IN THIS REPORT WHICH ARE NOT HISTORICAL FACTS ARE
FORWARD LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, INCLUDING BUT
NOT LIMITED TO, THE NEED FOR ADDITIONAL WORKING CAPITAL, POSSIBLE DELAYS IN THE
COMPANY'S EXPANSION EFFORTS, CHANGES IN THE WIRELESS COMMUNICATIONS MARKETS AND
TECHNOLOGIES, THE NATURE OF POSSIBLE SUPPLIER OR CUSTOMER ARRANGEMENTS WHICH MAY
BECOME AVAILABLE TO THE COMPANY IN THE FUTURE, POSSIBLE PRODUCT OBSOLESCENCE,
UNCOLLECTIBLE ACCOUNTS RECEIVABLE, SLOW MOVING INVENTORY, LACK OF ADEQUATE
FINANCING, INCREASED COMPETITION, UNFAVORABLE GENERAL ECONOMIC CONDITIONS AND
THE EXPENSE OF POTENTIAL DAMAGES ARISING FROM LITIGATION. THE COMPANY'S ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN ANY FORWARD LOOKING
STATEMENT.
Due to the Company's negative working capital position and its continuing
operating losses, the Company will need to restructure its existing trade debt
and secure substantial additional capital in the immediate future or be forced
to immediately terminate its operations. The Company has obtained contingent
agreements from the holders of most of its outstanding trade debt to restructure
the debt pursuant to the Recapitalization Plan provided, in part, that the
Company receives additional financing. Although the Company recently received a
preliminary commitment for a convertible debt financing from an investor group,
this indication of interest is subject to various conditions. The Company has
been unable to satisfy at least one of these conditions and has been unable to
date to enter into a definitive agreement with the investor group to finalize
the terms under which that group would provide financing to the Company, if at
all. The investor group also has advised the Company that one of the conditions
to its providing financing to the Company will be that Ben Neman, who has
recently sued the Company for the Company's breach of an agreement with Mr.
Neman, waive certain of his claims against the Company. Mr. Neman has been
unwilling to date to waive those claims and is continuing to prosecute his
lawsuit against the Company. The Company has no alternative commitment or
arrangements for any such financing, and there can be no assurance whether, or
on what terms, such capital may be available if at all.
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Results of Operations
Second Quarter 2000 Compared to Second Quarter 1999
Net sales were $1,926,000 in the second quarter of 2000 compared to $7,553,000
in the second quarter of 1999. Of the total sales approximately $491,000 or
25.5% was represented by the Company's fulfillment services that commenced
operations in May 2000. The decrease of $5,627,000 or (74.5)% is attributable to
the Company's lack of working capital, the inability of the Company to access
trade credit from its vendors to purchase inventory and the elimination of the
Company's sales staff in its Chatsworth, Miami and Lincolnshire locations during
the second quarter.
Gross profit for the second quarter of 2000 was $667,000 representing an 86.8%
increase over the $357,000 in 1999. The gross margin was 34.6% of net sales in
2000 versus 4.7% of net sales in 1999. The increase in the gross margin is due
primarily to the sale of previously written down inventory.
Selling, general and administrative expenses increased by $1,241,000 or 61.3%
from $2,026,000 or 26.8% of net sales in the second quarter of 1999 to
$3,267,000 or 169.6% of net sales in the second quarter of 2000. The increase in
selling, general and administrative expenses and the higher expense rate was
attributable to the higher costs associated with the CWI operations, the
amortization of goodwill for the acquisitions in late 1999, the write down of
the goodwill attributable to the Source acquisition and costs related to the
Company's effort to modify and enhance its information technology system to
better meet current business needs. The loss on the impairment of goodwill
associated with Source was approximately $765,000.
Restructuring costs incurred in the second quarter of 2000 associated with the
closure of the three facilities were approximately $1,957,000 for the writedown
of fixed assets.
Interest charges changed from $23,000 in the second quarter of 1999 to
$1,533,000 in the second quarter of 2000 as a result of additional borrowing
necessary to finance the increased working capital requirement of the CWI
acquisition, the interest costs associated with the subordinated debt utilized
to finance a portion of the acquisition and the bank charges related to the
prepayment and minimum loan fees associated with the working capital line of
credit.
First Half 2000 Compared to First Half 1999
Net sales were $16,444,000 in the first half of 2000 compared to $14,219,000 in
the first half of 1999. The increase of $2,225,000 or an increase of 15.6% is
principally attributable to the inclusion of operations related to CWI.
Gross profit for the first half of 2000 was $1,475,000 representing an increase
of 79.4% over the $822,000 in 1999. The gross margin was 9.0% of net sales in
2000 versus 5.8% of net sales in 1999. The increase in the gross margin is due
largely to the mix of products sold which included greater sales of accessory
items at higher margins.
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Selling, general and administrative expenses increased by $3,225,000 or 108.3%
from $2,979,000 or 21.0% of net sales in the first half of 1999 to $6,204,000 or
37.7% of net sales in the first half of 2000. The increase in selling, general
and administrative expenses and the higher expense rate was attributable to the
higher costs associated with the CWI operations, the amortization of goodwill
for the acquisitions in late 1999, the write down of the goodwill attributable
to the Source acquisition, and costs related to the Company's effort to
establish and develop its information technology system. The loss on the
impairment of goodwill associated with Source was approximately $765,000.
Restructuring costs incurred in the first half of 2000 associated with the
closure of the three facilities were approximately $1,957,000 for the writedown
of fixed assets.
Interest charges changed from $23,000 in the first half of 1999 to $1,835,000 in
the first half of 2000 as a result of additional borrowing necessary to finance
the increased working capital requirement of the CWI acquisition, the interest
costs associated with the subordinated debt utilized to finance a portion of the
acquisition and the bank charges related to the prepayment and minimum loan fees
associated with the working capital line of credit.
Liquidity and Capital Resources
Losses incurred in 1999, particularly during the fourth quarter of 1999, and in
the first half of 2000, as well as additional working capital requirements
associated with the merger of CWI have had a significant negative impact on cash
flow, working capital and the liquidity of the Company. At December 31, 1999,
the Company's working capital position was a deficit of $5,101,000 compared to a
working capital deficit of $10,070,000 at June 30, 2000. The Company's
continuing losses in the first half of 2000 severely restricted the Company's
ability to manage its on-going operations, absorbed practically all of the
Company's liquidity and have caused the Company to operate on restricted terms
with its vendors.
Given the lack of working capital available and the inability of the Company to
attract permanent capital, the Company was forced to secure an additional loan
from Critical Capital. This $750,000 loan was funded in two separate tranches
during July 2000. Given the Company's cost structure, the proceeds of the
additional loan provided sufficient cash for the Company to maintain its
operations until early August 2000. Thereafter, the Company's ability to
continue current operations can not be assured.
Cash provided by operating activities was $10,185,000 for the first half of
2000, as compared to cash used in operating activities of $1,093,000 for the
comparable period in 1999. The primary cause for the increase in cash provided
by operating activities for the first half of 2000 compared to first half of
1999 was the inclusion of CWI's former operations for a full half year,
management's conversion of accounts receivable and inventory to cash, greater
depreciation and amortization charges, an increase in the provision for doubtful
accounts and restructuring charges.
Cash used in investing activities increased from $119,000 in the first half of
1999 to $137,000 in 2000 and are related to additions to property and equipment.
Cash flows from financing activities decreased from an increase in cash of
$2,443,000 in the first half of 1999 to a use of cash in financing activities of
$12,395,000 in 2000. During the first half of 2000, cash was utilized to repay
obligations due under the Company's revolving line of credit and other long-term
debt.
During 1999 and the first half of 2000, the Company continued to incur
significant losses. Due to the Company's negative working capital position and
its continuing operating losses, the Company will need to restructure its
existing trade debt and secure substantial additional capital in the immediate
future or be forced to immediately
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terminate its operations. The Company has obtained contingent agreements from
the holders of most of its outstanding trade debt to restructure the debt
pursuant to the Recapitalization Plan provided, in part, that the Company
receives additional financing. Although the Company recently received a
preliminary commitment for a convertible debt financing from an investor group,
this indication of interest is subject to various conditions. The Company has
been unable to satisfy at least one of these conditions and has been unable to
date to enter into a definitive agreement with the investor group to finalize
the terms under which that group would provide financing to the Company, if at
all. The investor group also has advised the Company that one of the conditions
to its providing financing to the Company will be that Ben Neman, who has
recently sued the Company for the Company's breach of an agreement with Mr.
Neman, waive certain of his claims against the Company. Mr. Neman has been
unwilling to date to waive those claims and is continuing to prosecute his
lawsuit against the Company.
During 1999 and the six months ended June 30, 2000, the Company continued to
incur significant losses, the continuation of which could have a materially
adverse impact on its cash flow, liquidity and financial position. At June 30,
2000, the Company was not in compliance with the covenants of its debt facility
with BancAmerica, which restricted its ability to draw any further amounts under
the facility. At June 30, 2000, there was a credit balance of approximately
$99,000 in restricted deposits under this facility due to the Company. Effective
July 2000, the Company's debt facility with BancAmerica was terminated and
BancAmerica was no longer a creditor of the Company. Although the Company is
current in all of its payments to Critical Capital, the Company continues to be
in default of a number of the covenants under the loan agreement, including
without limitation, the satisfaction of certain net worth and other financial
requirements. Critical Capital and the Company subsequently entered into an
Amended and restated Loan Agreement dated as of July 14, 2000 (the "Amended
Critical Loan Agreement") pursuant to which the parties amended the prior loan
agreement and Critical Capital advanced an additional $750,000 to the Company.
The Company is required under the Amended Critical Loan Agreement to apply all
of its revenues and proceeds from the sale of assets to pay down at least
$1,000,000 of the outstanding loan from Critical Capital, and the loan now
accrues interest at 18% per annum and is payable on demand. As of August 11,
2000, the outstanding balance of the Critical Capital loan was approximately
$1,500,000.
In May 2000, the Company defaulted on a $42,000 installment payment on the
subordinated, secured loan made to it in October 1999 by ANB. ANB has
accelerated the entire amount of this loan, which had an outstanding balance of
$1,167,000 at June 30, 2000. However, ANB may not receive any payments from the
Company with respect to this loan since Critical Capital, as the Company's
senior lender, has effected a payment blockage against ANB pursuant to the terms
of an intercreditor and subordination agreement between Critical Capital and
ANB.
Although the Company has been extended trade credit through one key vendor,
there is no assurance that existing or additional trade credit will be available
to the Company or that such credit will be sufficient to maintain the current
level of its operations, even if the Company is able to restructure its trade
debt and obtain additional debt or equity financing proceeds. In addition, the
lack of borrowing capability further inhibits the Company's ability to finance
new business initiatives including the relationships with network operators and
manufacturers that would require additional working capital.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company believes that its exposure to market risk to changes in foreign
rates, interest rate fluctuations and trade accounts receivable is immaterial.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As previously reported in the Company's Form 10-Q for the quarter ended March
31, 2000, the Company petitioned the American Arbitration Association on April
24, 2000 seeking to rescind its acquisition of Cellular Wholesalers, Inc.
("CWI") or, in the alternative, seeking monetary damages from the former CWI
stockholders (Ronald Goldberg,
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Philip Leavitt, Sherwin Geitner and Cary Maimon) based, in part, on the
misstatements of certain financial information relating to CWI. On June 30,
2000, Ronald Goldberg, Philip Leavitt, Sherwin Geitner and Cary Maimon filed a
lawsuit against the Company, its subsidiary, Intellicell Merger Sub, Inc., and
Michael Hedge, the Company's Chief Executive Officer, in the United States
District Court for the Northern District of Illinois, Eastern Division. The
plaintiffs in this action allege that in connection with the Company's
acquisition of CWI, the defendants misrepresented the status of the Company's
business relationship with a prospective customer and that the Company breached
a covenant made to the former CWI shareholders by allegedly changing the focus
of the Company's operations following completion of the acquisition of CWI by
the Company. The plaintiffs are seeking $9,000,000 in consequential damages,
together with punitive damages, from the defendants in this action. The Company
believes that the plaintiffs' claims in this action are without merit and is
seeking to dismiss or stay this lawsuit pending resolution of the related
arbitration action brought by the Company against these plaintiffs. There can be
no assurance, however, that the Company will be successful in obtaining a
rescission of its acquisition of CWI or monetary damages from the former CWI
stockholders, that the Company will be successful in dismissing or staying the
lawsuit brought against it by the former principal CWI stockholders or that
these stockholders will not prevail in their action against the Company. An
adverse ruling regarding either of the two matters with the former CWI
stockholders could materially and adversely impact the Company's business
operations and cause a cessation of the Company's business operations.
On August 8, 2000, Ben Neman sued the Company in California Superior Court, Los
Angeles County, California. In the complaint, Mr. Neman alleged that (a) the
Company failed to make payments to Mr. Neman aggregating $116,665 as required by
an agreement between them and (b) the Company's delay in removing a legend on
shares of stock restricting transfer caused compensatory and consequential
damages to Neman in a sum in excess of $1,000,000. The Company is evaluating Mr.
Neman's claims and believes that it may have defenses to assert regarding the
compensatory and consequential damages to Neman.
In addition to the litigation described above, the Company is a defendant in a
number of lawsuits brought by certain vendors and former employees. The amount
of damages sought by the plaintiffs in each of these cases is individually not
material; however, the expense and the diversion of Company management time to
defend these suits could have a materially adverse effect on the Company.
Item 2. Change in Securities and Use of Proceeds
On April 11, 2000 the Company issued 169,263 shares of its common stock to
Carroll Edwards in cancellation of a note with an outstanding balance of
approximately $425,000, including accrued interest of $8,000, that
evidenced a loan previously made by him in January 2000. Carroll Edwards is an
accredited investor and the Company relied on an exemption from registration for
the foregoing issuance provided by Section 4(2) of the Securities Act of 1933.
Item 3. Defaults Upon Senior Securities
On May 8, 2000 Critical Capital advised the Company that it was in default of
certain covenants in the loan agreement pursuant to which Critical Capital had
made a senior subordinated secured loan of $1,000,000 to the Company in October
1999. Critical Capital and the Company subsequently entered into the Amended
Critical Loan Agreement pursuant to which the parties amended the prior loan
agreement and Critical Capital advanced an additional $750,000 to the Company.
Although the Company is current in all of its payments to Critical Capital, the
Company continues to be in default of a number of the covenants under the loan
agreement, including without limitation, the satisfaction of certain net worth
and other financial requirements. The Company is required under the Amended
Critical Loan Agreement to apply all of its revenues and proceeds from the sale
of assets to pay down at least $1,000,000 of the outstanding loan from Critical
Capital, and the loan now accrues interest at 18% per annum and is payable on
demand. As of August 11, 2000, the outstanding balance of the Critical Capital
loan was approximately $1,500,000.
In May 2000, the Company defaulted on a $42,000 installment payment on the
subordinated, secured loan made to it in October 1999 by ANB. ANB has
accelerated the entire amount of this loan, which had an outstanding balance of
$1,167,000 at June 30, 2000. However, ANB may not receive any payments from the
Company with respect to this loan since Critical Capital, as the Company's
senior
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lender, has effected a payment blockage against ANB pursuant to the terms of an
intercreditor and subordination agreement between Critical Capital and ANB.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
In connection with its continuing efforts to reduce its operating costs, the
Company has initiated discussions with Michael Hedge and James Krohn concerning
the termination of their employment with the Company. Although these
arrangements have not yet been finalized, the Company anticipates that Michael
Hedge's employment as the Company's President and CEO and James Krohn's
employment as the Company's Chief Financial Officer may be ending in the near
future.
Since late last year, the Company has been in the process of transitioning from
a traditional wholesaler of wireless goods to a value-added fulfillment service
enterprise. Pursuant to this transition, the Company has established a
fulfillment service center in the Dallas, Texas area and has ceased operations
in its Chatsworth, California, Miami, Florida and Lincolnshire, Illinois
facilities. The Company presently has eight full-time employees.
Commencing in May 2000, the Company began shipping products pursuant to its plan
to provide value-added fulfillment services to mobile virtual network operators.
These shipments to date have been limited in amount and there can be no
assurance that the Company's fulfillment services will generate significant
revenues or cash flow in the future. In order to expand its fulfillment
operations, the Company will need to secure profitable contracts from more
customers, modify and enhance its information technology system to better meet
current business needs, hire and retain skilled operations, marketing, customer
care and administrative personnel. The Company is dependent upon selected
suppliers to provide adequate inventories of products on a timely basis and on
favorable credit terms. The operations of the Company will require vendors to
extend customary trade credit and will require the Company to obtain additional
capital to meet its operating objectives. In addition, the Company will require
a working capital loan from a financial institution to fund payments to vendors
and other creditors. See "Management's Discussion and Analysis of Results of
Operations and Changes in Financial Position Liquidity and Capital Resources."
Subsequent to June 30, 2000, the Company entered into contingent agreements with
unsecured creditors representing approximately $7,000,000 of unsecured claims
against the Company. Not all of the unsecured creditors have agreed to the terms
set forth below. In addition, the Company received an unsigned term sheet from
an investment group indicating the group's interest to invest $4,000,000 in
convertible debt in the Company subject to certain conditions. The agreements
with the unsecured creditors and financial investors are part of management's
effort to restructure the Company's balance sheet ("Recapitalization Plan").
Pursuant to the Recapitalization Plan that the Company is seeking to implement,
the Company has contingently agreed with the creditors described above to the
summarized terms as follows:
o Post March 15, 2000 invoices paid in full.
o Pre March 15, 2000 invoices:
o Immediate payment of 12.5% of outstanding payables;
o One year note payable in the principal amount of 12.5% of the
outstanding trade payable with interest at 10% and principal
paid monthly;
o Three year note payable in the principal amount of 6.25% of the
outstanding trade payable with interest at 10% and monthly
payments of interest only in years one and two with level
amortization in year three;
o Common shares of Focus, at $1.00 per share, equal to 12.5% of the
outstanding trade payable, with such issuance subject to required
shareholder and regulatory approvals. If required approvals are
not granted within one year, common shares would not be issued.
In lieu of common shares, trade creditors would receive a
three-year subordinated note obligation equal to 12.5% of the
outstanding trade payable;
o Forgiveness of the outstanding account balance; and
o A contingent payment to all trade creditors on a pro rata basis
of 50% of any net cash proceeds resulting from the CWI
arbitration proceeding.
The Company's ability to complete the Recapitalization Plan will be highly
contingent upon the agreement of substantially all the unsecured creditors to
the terms described above, a restructuring or resolution of the secured
indebtedness owed to Critical Capital and ANB, the Company's timely receipt of
approximately $4,000,000 in proceeds from the investor group, the continued
support of trade vendors and the ability to continue its current operations.
There are no assurances that any of these contingencies referenced above will be
satisfied. The inability of the Company to satisfy any of the aforementioned
conditions may cause the immediate cessation of the Company's business
operations.
As a condition of the Critical Capital additional loan under the Amended
Critical Loan Agreement, the Company was required by Critical Capital to remove
all inventory and fixed assets owned by the Company from its Lincolnshire,
Illinois location. This removal was contested by Leavitt Communications, Inc.,
an affiliate of one of the former principal shareholders of CWI ("LCI"). On
August 16, 2000, the parties reached an agreement in principle to resolve this
dispute pursuant to which LCI will acquire various fixed assets of Focus that
had been used at the Lincolnshire, Illinois location for a payment that will
total at least $257,000, with all or a substantial portion of the proceeds to be
applied to pay down part of the Company's outstanding loan from Critical
Capital. In addition, the former principal shareholders of CWI agreed in
principle to pay off the Company's loan from ANB, which had an outstanding
balance of $1,167,000 at June 30, 2000. The amount paid by the former CWI
shareholders under the Amendment Critical Loan Agreement to ANB will be credited
and certain other amounts paid by them may be credited against any amounts that
they may be required to pay the Company in connection with the pending
arbitration between the Company and them relating to the Company's acquisition
of CWI.
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The Company's ability to complete the Recapitalization Plan will be highly
contingent upon the Company's timely receipt of approximately $4,000,000 in
proceeds from the investor group, the continued support of unsecured creditors
and the ability to continue its current operations.
The Company is not currently in compliance with the net worth and minimum share
price requirements for maintaining its listing on the Nasdaq SmallCap Market.
Nasdaq advised the Company on August 17, 2000 that in light of this
non-compliance, the Company's common stock will be delisted from the Nasdaq
Stock Market on August 28, 2000. The delisting will be delayed in the event the
Company files an appeal with Nasdaq of Nasdaq's delisting decision and the
Company is reviewing the advisability of filing this appeal.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed herewith:
10.1 Amended and Restated Loan and Security Agreement dated as of July 14,
2000 between Critical Capital and the Company
27 Financial Data Schedule
(b)(1) Current Report on Form 8-K/A dated May 11, 2000 (Item 5 - Other Events
and Item 7 - Financial Statements & Exhibits)
(b)(2) Current Report on Form 8-K dated June 23, 2000 (Item 5 - Other Events
and Item 7 - Financial Statements & Exhibits)
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Focus Affiliates, Inc.
Date: August 21, 2000 By: /s/ JAMES E. KROHN
-------------------------------- --------------------------------
Title: Chief Financial Officer
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INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
10.1 Amended and Restated Loan and Security Agreement dated as of July 14,
2000 between Critical Capital and the Company
27 Financial Data Schedule
</TABLE>
