<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 001-14001
CUMETRIX DATA SYSTEMS CORP.
(Exact Name of Registrant as Specified in its Charter)
California 95-4574138
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Identification No.)
Organization)
957 Lawson Street, Industry, California 91748
(Address, Including Zip Code, Of Registrant's Principal Executive Offices)
(626) 965-6899
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Security Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the last 90 days. Yes|X| No| |
As of November 13, 1998, the Registrant had 7,452,500 shares of Common
Stock, without par value, issued and outstanding.
<PAGE>
CUMETRIX DATA SYSTEMS CORP.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<C> <S>
ITEM 1. FINANCIAL STATEMENTS
1. Condensed Balance Sheets - September 30, 1998 and March 31, 1998
2. Condensed Statements of Operations - Three Months Ended September
30, 1998 and 1997
3. Condensed Statements of Operations - Six Months Ended September
30, 1998 and 1997
4. Condensed Statements of Cash Flows - Six Months Ended September
30, 1998 and 1997
5. Notes to Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
<CAPTION>
PART II. OTHER INFORMATION
<C> <S>
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. CHANGES IN SECURITIES
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CUMETRIX DATA SYSTEMS CORP.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS September 30, March 31,
1998 1998
----------- -----------
(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents....................................... $11,966,083 $4,415,690
Trade receivables, net of allowance for doubtful accounts of
$107,000 and $57,000 at September 30, 1998 and March 31, 1998,
respectively................................................... 3,532,280 3,885,803
Inventories..................................................... 4,096,706 2,001,597
Deferred taxes.................................................. 98,249 133,647
Prepaid expenses................................................ 151,200 45,983
----------- -----------
Total current assets....................................... 19,844,518 10,482,720
----------- -----------
FIXED ASSETS, net 350,523 87,538
DEFERRED OFFERING COSTS............................................ - 514,927
CAPITALIZED PURCHASED SOFTWARE COSTS............................... 1,100,000 1,100,000
----------- -----------
Total Assets............................................... $21,295,041 $12,185,185
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................................ $ 8,039,536 $ 7,822,652
Accrued expenses................................................ 113,482 641,844
Income taxes payable............................................ 21,545 717,013
Current portion of long-term debt............................... 3,875 1,203,707
----------- -----------
Total current liabilities.................................. 8,178,438 10,385,216
----------- -----------
LONG-TERM DEBT, net of current portion............................. 6,884 8,864
----------- -----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, no par value: Authorized, 2,000,000 shares;
issued and outstanding, none - -
Common stock, no par value: Authorized, 20,000,000 shares; issued
and outstanding, 7,452,500 and 4,750,000 at September 30, 1998
and March 31, 1998, respectively.................................. 12,246,061 1,042,589
Retained earnings.................................................. 863,658 748,516
----------- -----------
Total shareholders' equity................................. 13,109,719 1,791,105
----------- -----------
Total liabilities and shareholders' equity................. $21,295,041 $12,185,185
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed balance sheets.
<PAGE>
CUMETRIX DATA SYSTEMS CORP.
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended
September 30,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
NET SALES...................................... $19,418,109 $18,541,910
COST OF PRODUCTS............................... 18,868,874 17,718,844
----------- -----------
Gross profit.............................. 549,235 823,066
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES... 572,843 298,394
----------- -----------
Income (Loss) from operations............. (23,608) 524,672
INTEREST EXPENSE............................... 323 256
INTEREST INCOME................................ 172,695 91
----------- -----------
Income before provision for income taxes.. 148,764 524,507
PROVISION FOR INCOME TAXES..................... 62,271 209,722
----------- -----------
NET INCOME..................................... 86,493 314,785
=========== ===========
BASIC AND DILUTED EARNINGS PER SHARE........... $ 0.01 $ 0.07
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed statements.
<PAGE>
CUMETRIX DATA SYSTEMS CORP.
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Six Months Ended
September 30,
1998 1997
------------ -------------
(unaudited)
<S> <C> <C>
NET SALES....................................... $37,832,635 $29,389,055
COST OF PRODUCTS................................ 36,851,490 28,142,220
------------ -------------
Gross profit............................... 981,145 1,246,835
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.... 1,101,695 610,638
------------ -------------
Income (Loss) from operations.............. (120,550) 636,197
INTEREST EXPENSE................................ 2,203 1,283
INTEREST INCOME................................. 320,666 641
------------ -------------
Income before provision for income taxes... 197,913 635,555
PROVISION FOR INCOME TAXES...................... 82,771 254,222
------------ -------------
NET INCOME...................................... 115,142 381,333
============ =============
BASIC AND DILUTED EARNINGS PER SHARE............ $ 0.02 $ 0.08
============ =============
</TABLE>
The accompanying notes are an integral part of these condensed statements.
<PAGE>
CUMETRIX DATA SYSTEMS CORP.
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
September 30,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................ $ 115,142 $ 381,333
Adjustments to reconcile net income to net cash and
cash equivalents used in operating activities:
Depreciation and amortization...................... 4,500 1,967
Provision for doubtful accounts.................... 52,000 36,000
Loss on receivable from director................... - 100,000
Changes in assets and liabilities:
Trade receivables.................................. 301,523 (3,998,735)
Inventories........................................ (2,095,109) (1,787,760)
Deferred taxes..................................... 35,398 (20,570)
Prepaid expenses................................... (105,217) (35,827)
Accounts payable................................... 216,884 4,640,280
Accrued expenses................................... (528,362) 13,821
Income taxes payable............................... (695,468) 209,979
----------- -----------
Net cash used by operating activities............ (2,698,709) (459,512)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets............................. (267,485) (8,684)
Receivables from related parties...................... - 39,700
Purchase of Capitalized Software Costs................ - (150,000)
----------- -----------
Net cash provided (used) in investing
activities...................................... (267,485) (118,984)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net............ 11,203,472 -
Payments on bank borrowings........................... - (1,659)
Proceeds from Note.................................... - 150,000
Payments on long-term debt............................ (1,201,812) -
Proceeds from stock issuance.......................... - 300,000
Deferred offering costs............................... 514,927 -
----------- -----------
Net cash provided by financing activities........ 10,516,587 448,341
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.... 7,550,393 (130,155)
----------- -----------
CASH AND CASH EQUIVALENTS, beginning of period.......... 4,415,690 479,796
----------- -----------
CASH AND CASH EQUIVALENTS, end of period................ $11,966,083 $ 349,641
=========== ===========
CASH PAID FOR INTEREST 2,203 1,283
CASH PAID FOR INCOME TAXES 730,000 -
</TABLE>
The accompanying notes are an integral part of these condensed statements.
<PAGE>
CUMETRIX DATA SYSTEMS CORP.
NOTES TO FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
1. Basis of Presentation
The accompanying unaudited financial statements have been prepared in
conformity with generally accepted accounting principles. However, certain
information and footnote disclosures normally included in financial statements
prepared in conformity with generally accepted accounting principles have been
omitted or condensed pursuant to the rules and regulations of the Securities and
Exchanges Commission (SEC). These statements should be read in conjunction with
the Company's March 31, 1998 audited financial statements and notes thereto
included in the Company's Form 10-K dated June 5, 1998, including all amendments
thereto. In the opinion of management, these interim financial statements
reflect all adjustments (consisting of normal recurring adjustments) necessary
for a fair presentation of the financial position and results of operations for
each of the periods presented. The results of operations and cash flows for such
periods are not necessarily indicative of results to be expected for the full
year.
2. Earnings Per Common Share
Earnings per share calculations are in accordance with SFAS No. 128,
"Earnings per Share" (SFAS 128). Accordingly, "basic" earnings per share is
computed by dividing net income by the weighted average number of shares
outstanding for the year. "Diluted" earnings per share is computed by dividing
net income by the total of the weighted average number of shares outstanding
plus the dilutive effect of outstanding stock options (applying the treasury
stock method). Earnings per share amounts for 1997 have been restated to reflect
the adoption of SFAS No. 128.
A reconciliation of the basic weighted average number of shares outstanding
and the diluted weighted average number of shares outstanding for each of the
three and six month periods ended September 30, follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
---------------------------- ----------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average number
of common shares
outstanding-Basic 7,452,500 4,499,444 7,304,822 4,521,609
Dilutive effect of
outstanding stock
options 252,021 - 233,043 -
--------- --------- --------- ---------
Weighted average number
of common shares
outstanding-Diluted 7,704,521 4,499,444 7,537,865 4,521,609
========= ========= ========= =========
</TABLE>
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Overview
The Company was founded in April 1996, and until December of 1996 operated
entirely as a distributor and value added reseller of computer equipment and
related hardware components and software peripherals. In December of 1996, the
Company entered the system configuration business. This process required certain
organizational and operational changes to effectively position the Company as a
provider of configuration and integration solutions to various levels within the
distribution, integration and end-user markets.
In order to enhance its competitive advantage in the systems integration
market, the Company has entered into a perpetual non-exclusive licensing
agreement with Computer Aided Software Integration, Inc. ("CASI") to license
CASI's Configurator software for use in the development and commercialization of
the Company's ACSA Solution. The Company paid CASI a one-time license fee of
$1.1 million. The license fee was paid (i) by delivering to CASI a non-interest
bearing promissory note in the principal amount of $950,000 (the "CASI Note"),
and (ii) a cash payment of $150,000 funded by the Datatec Note. The payments
under the CASI Note were capitalized and will be amortized starting when the
configurator software is placed in service over the useful life of the software,
which, for accounting purposes, is currently estimated to be between three and
five years.
Competitive factors in the Computer Products market include price, service
and support, the variety of products offered, and marketing and sales
capabilities. While the Company believes that it competes successfully with
respect to most, if not all of these factors, there can be no assurance that it
will continue to do so in the future. The industry has come to be characterized
by aggressive price cutting which intensified in the first quarter of fiscal
1999 as a result of industry wide pricing pressures resulting from excess
supplies from major manufacturers and reduced demand in the overall personal
computer industry. These factors can in part be traced to the economic slow-down
in Asia and excess worldwide build up of personal computers in the first
calendar quarter of 1998. The Company expects that these factors may continue to
sustain pricing pressures at least until the end of the third fiscal quarter and
possibly longer. As a result of these pricing pressures, the Company's margins
have been pressured and the Company has declined to compete for certain lower
margin business. However, the Company will need to continually provide
competitive prices, superior product selection and delivery response time in
order to remain competitive. If the Company were to fail to compete favorably
with respect to any of these factors, the Company's business and operating
results may be adversely affected.
Also, the Company's business is subject to certain quarterly influences.
Net Sales and operating profits are generally higher in the third fiscal quarter
due to the purchasing patterns of personal computer integrators and resellers
and are generally lower in the first and second fiscal quarters due primarily to
lower industry shipments.
This discussion summarizes the significant factors affecting the
<PAGE>
operating results, financial condition and liquidity/cash flows of the Company
for the quarters ended September 30, 1998 and 1997 and six months ended
September 30, 1998 and 1997. The Company has a limited history of operations.
Special Note Regarding Forward-Looking Information
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Exchange Act and Section
27A of the Securities Act. The words "expect," "estimate," "anticipate,"
"predict," "believe," and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this filing and include statements regarding the intent,
belief or current expectations of the Company, its Directors or Officers with
respect to, among other things (a) trends effecting the financial condition of
results of operations of the Company and (b) the business and growth strategies
of the Company. The shareholders of the Company are cautioned not to put undue
reliance on such forward-looking statements. Such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties. Actual
results may differ materially from those projected in this Report, for the
reasons, among others, discussed in "Future Operating Results" below and under
the caption, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Risk Factors" in the Company's Annual Report on Form
10-K for Fiscal 1998, filed with the Securities and Exchange Commission. The
Company undertakes no obligation to publicly revise these forward-looking
statements to reflect events or circumstances that arise after the date hereof.
Readers should carefully review the risk factors referred to above and the other
documents the Company files from time to time with the Securities and Exchange
Commission, including the Company's Annual Report on Form 10-K for the fiscal
year 1998, the quarterly reports on Form 10-Q filed by the Company during the
remainder of fiscal 1999, and any current reports on Form 8-K filed by the
Company.
Results of Operations
Three Months Ended September 30, 1998 and 1997.
Net Sales. Net sales for the quarter ended September 30, 1998 were $19,418,109
compared to $18,541,910 in the previous year. This increase of $876,199 or 4.7%
in net sales is attributable to growth of the Company's sales force and an
increase in the Company's available combined purchasing credit (including its
vendor credit and the Finova Line), which allowed the Company to increase its
ability to purchase product to fulfill more sales orders. However, as a result
of sustained industry oversupply, resulting pricing pressures and the Company's
determination to attempt to defend margins rather than pursue sales growth
through low margin sales, the Company expects that its historical annual growth
rate for net sales will not be sustained in fiscal 1999 and that these pricing
pressures will continue to affect gross profit.
Cost of Products. Cost of products increased $1,150,030 from $17,718,844 to
$18,868,874 for the quarter ended September 30, 1997 and 1998, respectively.
This increase is mainly attributable to the increase in net sales.
<PAGE>
Gross Profit. Gross profit for the quarter ended September 30, 1998 was
$549,235 compared to $823,066 in the quarter ended September 30, 1997. Gross
profit as a percentage of net sales was 2.8% for the quarter ended September 30,
1998 compared to 4.2% for the quarter ended September 30, 1997. This represents
a 33% decrease in gross profit, and is mainly attributable to industry
oversupply and the resulting pricing pressures facing the industry as a whole.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for quarter ended September 30, 1998 were $572,843
compared to $298,394 for the quarter ended September 30, 1997.
The major components of selling, general and administrative expenses for
the periods include the following:
<TABLE>
<CAPTION>
Three Months Ended
September 30,
1998 1997
-------- --------
<S> <C> <C>
Payroll (including commissions) $332,000 $226,000
Rent 18,000 6,000
Insurance 27,000 5,000
Legal and accounting 57,000 2,000
Other (under 5%) 138,843 59,394
-------- --------
Total $572,843 $298,394
======== ========
</TABLE>
The increase of $274,449 in selling, general and administrative expenses is
attributable to increased staff and overhead to support the higher levels of
sales and marketing activity. The Company's salaries of its executive officers
are at levels the Company believes to be commensurate with current market value
compared to the quarter ended September 30, 1997. In addition, the Company hired
additional personnel in finance and administration to facilitate growth of the
Company's infrastructure and revenue expansion. Other SG&A costs in the quarter
included rent in a larger facility, legal and accounting costs, and costs
related to the development of the automated custom systems assembly solution.
Interest Income
Interest income of $172,695 for the quarter ended September 30, 1998 is
primarily due to interest income earned on the investment of proceeds from the
initial public offering.
Net Income
Net income for the quarter ended September 30, 1998 was $86,493 compared to
$314,785 for the quarter ended September 30, 1997. The decrease of $228,292 is
mainly attributable to the decrease in gross profit, higher selling, general and
administrative expenses, offset by interest income.
Six Months Ended September 30, 1998 and 1997.
Net Sales. Net sales for the six months ended September 30, 1998 were
<PAGE>
$37,832,635 compared to $29,389,055 in the previous year. This increase of
$8,443,580 or 28.7% in net sales is attributable to growth of the Company's
sales force and an increase in the Company's available combined purchasing
credit (including its vendor credit and the Finova Line), which allowed the
Company to increase its ability to purchase product to fulfill more sales
orders. However, as a result of sustained industry oversupply, resulting pricing
pressures and the Company's determination to attempt to defend margins rather
than pursue sales growth through low margin sales, the Company expects that its
historical annual growth rate for net sales will not be sustained in fiscal 1999
and that these pricing pressures will continue to affect gross profit.
Cost of Products. Cost of products increased $8,709,270 from $28,142,220 to
$36,851,490 for the six months ended September 30, 1997 and 1998, respectively.
This increase is mainly attributable to the increase in net sales.
Gross Profit. Gross profit for the six months ended September 30, 1998 was
$981,145 compared to $1,246,835 in the six months ended September 30, 1997.
Gross profit as a percentage of net sales was 2.6% for the six months ended
September 30, 1998 compared to 4.2% for the six months ended September 30, 1997.
This represents a 21% decrease in gross profit, and is mainly attributable to
industry oversupply and the resulting pricing pressures facing the industry as a
whole.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for six months ended September 30, 1998 were $1,101,695
compared to $610,638 for the six months ended September 30, 1997.
The major components of selling, general and administrative expenses for
the periods include the following:
<TABLE>
<CAPTION>
Six Months Ended
September 30,
1998 1997
---------- --------
<S> <C> <C>
Payroll (including commissions) $ 674,000 $378,000
Rent 36,000 12,000
Write-off of related party receivable - 100,000
Legal and accounting 89,000 4,000
Other (under 5%) 302,695 116,638
---------- --------
Total $1,101,695 $610,638
========== ========
</TABLE>
The increase of $491,057 in selling, general and administrative expenses is
attributable to increased staff and overhead to support the higher levels of
sales and marketing activity. The Company's salaries of its executive officers
are at levels the Company believes to be commensurate with current market value
compared to the six months ended September 30, 1997. In addition, the Company
hired additional personnel in finance and administration to facilitate growth of
the Company's infrastructure and revenue expansion. Other SG&A costs in the
quarter included rent in a larger facility, legal and accounting costs, and
costs related to the development of the automated custom systems assembly
solution.
<PAGE>
Interest Income
Interest income of $320,666 for the six months ended September 30, 1998 is
primarily due to interest income earned on the investment of proceeds from the
initial public offering.
Net Income
Net income for the six months ended September 30, 1998 was $115,142
compared to $381,333 for the six months ended September 30, 1997. The decrease
of $266,191 is mainly attributable to the decrease in gross profit, higher
selling, general and administrative expenses, offset by interest income.
Year 2000 Update
General
The Company has begun a Year 2000 Project (the "Project"). The Project will
address this issue of whether computer programs and imbedded computer chips will
be able to distinguish between the years 1900 and 2000. First, the Company will
evaluate its Year 2000 readiness for both information technology ("IT") and non-
information technology ("non-IT") systems. Non-IT systems typically include
embedded technology in electronic equipment, such as microprocessors, and are
more difficult to assess and repair than IT systems. Second, for both IT and
non-IT systems, the Company will implement any necessary changes it believes
will make the Company ready for the year 2000. Third, the Company will evaluate
the readiness of its major vendors and customers to determine what impact, if
any, their readiness will have on the Company.
Project
To be Year 2000 Compliant, IT and non-IT systems must (a) consistently
handle data information before, during and after January 1, 2000, including
accepting date input, providing date output, and performing calculations on
dates or portions of dates, (b) function accurately and without interruption
before, during and after January 1, 2000, without any change in operations
associated with the turn of the century, and (c) store and provide output of
date information in a manner that is not ambiguous as to the century. The
Company has determined that its present accounting software is not Year 2000
Compliant. The Company has begun the implementation of a new accounting system
that will be Year 2000 Compliant, which the Company expects to complete before
the end of calendar 1998.
The Company will assess the computer systems of customers, vendors and
other outside parties with whom the Company does business. Such an assessment
will be performed during the third and fourth quarters of fiscal 1999. The
Company does not anticipate that such an assessment will reveal significant
potential problems or require the Company to incur substantial costs.
Costs
The total cost associated with required modifications to become Year
<PAGE>
2000 Compliant is not expected to be material to the Company's financial
position. It is estimated that the cost of implementing the new accounting
system will not exceed $150,000. The Company does not expect the costs
associated with the project to be material.
Risks Associated with the Year 2000 Problem
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failure could materially and adversely effect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 Compliance of third party suppliers and customers,
the Company is unable to determine at this time whether the consequences of any
Year 2000 non-Compliance will have a material impact on the Company's results of
operations, liquidity or financial condition. The Project is expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem and, in particular, about the Year 2000 Compliance and readiness of its
material suppliers, customers and other third parties. The Company believes
that, with the implementation of the new accounting system and completion of the
Project as scheduled, the possibility of significant interruptions of normal
operations should be reduced. The Project will not, however, evaluate the
effect of the Year 2000 problem on the computer products industry, the software
configuration industry or related industries within which the Company does
business, or the domestic or global economy. Any industry-wide or economy-wide
effects of the Year 2000 problem may have a material adverse effect on the
Company's results of operations, liquidity or financial condition.
Readers are cautioned that forward-looking statements contained in this
Year 2000 Update should be read in conjunction with the Company's disclosures
under the heading, "Cautionary Statements and Risk Factors" Readers should
understand that the dates on which the Company believes the Project will be
completed are based upon Management's best estimates, which were derived
utilizing numerous assumptions of future events, including the availability of
certain resources, third-party modification plans and other factors. However,
there can be no guarantee that these estimates will be achieved, or that there
will not be a delay in, or increased costs associated with, the implementation
of the Company's Year 2000 Project. A delay in specific factors that might cause
differences between the estimates and actual results include, but are not
limited to, the availability and cost of personnel trained in these areas, the
ability of locating correct all relevant computer code, timely responses to and
corrections by third parties and suppliers, the ability to implement interfaces
between the new systems and the systems not being replaced, and similar
uncertainties. Due to the general uncertainty inherent in the Year 2000 problem,
resulting in part from the uncertainty of the Year 2000 readiness of third
parties and the inter-connection of national and international businesses, the
Company cannot ensure that its ability to timely and cost effectively resolve
problems associated with the Year 2000 issue that may effect its operations and
business, or expose it to third party liability.
Liquidity and Capital Resources
<PAGE>
The Company has historically met its working capital and capital
expenditure requirements through a combination of cash flows from operations,
bank financing, vendor credit lines, the sale of equity and the Bridge
Financing.
On April 8, 1998, the Company's initial public offering (the "Initial
Public Offering") of 2,702,500 shares of Common Stock at $5 per share including
overallotment of 352,500 shares provided net proceeds (after deducting issuance
costs) of $11,200,000.
In the third quarter of fiscal year 1998, the Company completed a financing
(the "Bridge Financing") consisting of the sale of 20 units which generated
gross proceeds of $1 million (net proceeds of approximately $678,000). Each unit
was comprised of: (i) an unsecured promissory note of the Company in the
principal amount of $20,000 (ii) 15,000 shares of Common Stock of the Company,
and (iii) 5,000 warrants of the Company, each to purchase one share of Common
Stock of the Company, at an initial exercise price of $3.00 per share, subject
to adjustment, during the 36-month period commencing one year from the date the
Bridge Warrants were issued. The Company repaid $250,000 of the principal amount
of the CASI Note and $50,000 of the Datatec Note out of the proceeds of the
Bridge Financing. The Company paid the remainder of its indebtedness under the
CASI note and the Datatec Note from proceeds of the Initial Public Offering.
In June 1997, the Company obtained credit for inventory purchases through
Finova Capital Corporation ("Finova"). In September 1998, the Company entered
into a new credit facility with Finova, which consists of a $20 million flooring
line of credit, secured by certain inventory and equipment, as well as an
additional $5 million revolving line of credit secured by accounts receivables
and inventory. Unless the Company fails to pay Finova within the agreed upon
period, all finance costs associated with this line are charged by Finova to the
Company's vendors. At September 30, 1998, the Company's Finova line was $7.5
million and the Company had a payable to Finova Capital Corporation of
approximately $7,665,285 included in accounts payable.
Net cash used by operating activities during the six months ended September
30, 1998 was primarily attributable to an increase in inventories, prepaid
expenses and decreases in accrued expenses and income taxes payable offset by an
increase in trade receivables and accounts payable. Net cash provided by
financing activities in the six months ended September 30, 1998 was due
primarily to proceeds from the Company's initial public offering, offset by
payments on notes and deferred offering costs.
The Company believes that current funds and cash generated from operations
will be sufficient to meet its anticipated cash needs for working capital and
capital expenditures for at least the next year. The Company plans to spend
approximately $1,800,000 for its implementation of its Automated Custom System
Assembly Solutions for marketing, salaries and capital expenditures over the
next 12 months. The Company is dependent on the availability of accounts
receivable financing on reasonable terms and at levels that are high relative to
its equity base in order to maintain and increase its sales. No assurance can be
given that additional financing will be available or that, if available, it can
be obtained on terms favorable to
<PAGE>
the Company and its stockholders.
Income Taxes
The Company provides for income taxes using the liability method in
accordance with the Statement of Financial Accounting Standards No. 109 entitled
"Accounting for Income Taxes." The Company provides for federal and state income
taxes based on statutory rates. The provision for income taxes differ from the
amounts computed by applying the statutory federal income tax rate to income
before taxes primarily due to the effect of state income taxes net of the
related federal tax benefit.
Deferred income taxes are provided for income/expense items reported in
different periods for income tax and financial statement purposes. Deferred
income taxes are primarily attributable to temporary differences resulting from
depreciation, state income taxes and various accrued expenses. The Company has
no "tax loss carry forwards."
Inflation
The Company does not believe that inflation has had a material effect on
its results of operations. There can be no assurance, however, that the
Company's business will not be affected by inflation in the future.
Cautionary Statements and Risk Factors
Limited Operating History. The Company commenced operations in April 1996;
therefore, there is only limited financial information in existence upon which
an investment decision may be based. Although the Company has achieved
profitability, the ability of the Company to sustain profitability will depend
in part upon the successful and timely introduction and operation of its ACSA
Centers, continuation of the Company's close relationships with its vendors and
customers, successful marketing of existing products and the Company's ability
to finance inventories and growth and to collect trade receivables in a timely
manner. The likelihood of the success of the Company in implementing its ACSA
Centers must be considered in light of the difficulties and risks inherent in a
new business. There can be no assurance that revenues will increase
significantly in the future or that the Company will ever achieve profitable
operations for the ACSA Center business. There can be no assurance that the
Company will be able to generate and sustain profitability in the future.
Dependence Upon Key Personnel. The Company is highly dependent upon the
services of Max Toghraie and James Ung, its Chief Executive Officer and
President, respectively. Both James Ung and Max Toghraie are employed pursuant
to five year employment agreements. The success of the Company to date has been
in part dependent upon their efforts and abilities, and the loss of the services
of either of them for any reason could have a material adverse effect upon the
Company. In addition, the Company's work force includes executives and employees
with significant knowledge and experience in the Computer Products distribution
industry. The Company's future success will be strongly influenced by its
ability to continue to recruit, train and retain a skilled work force. While the
Company believes that it would be able to locate suitable replacements for its
executives or other personnel if their services were lost
<PAGE>
to the Company, there can be no assurance that the Company would be able to do
so on terms acceptable to the Company. In particular, the location and hiring of
suitable replacements for Mr. Toghraie and Mr. Ung could be very difficult. The
Company maintains a key-man life insurance policy on the lives of Messrs.
Toghraie and Ung with benefits of $1,000,000 each, payable to the Company in the
event of their death. The benefits received under these policies would not be
sufficient to compensate the Company for the loss of the services of Mr.
Toghraie or Mr. Ung should suitable replacements not be employed.
Dependence Upon Relationships with Vendors. A key element of the Company's
past success and future business strategy involves the establishment of
relationships with certain major distributors and Computer Product
manufacturers. Purchases from these vendors account for the majority of the
Company's aggregate purchases for fiscal 1997, for the year ended March 31, 1998
and the present six months ended September 30, 1998. For the year ended March
31, 1998, DSS Technology Distribution Partners, Inc. ("DSS"), a master
distributor of hard drives to the Company, accounted for 64% of the Company's
purchases. Certain of these vendors provide the Company with substantial
incentives in the form of rebates passed through from the manufacturer,
discounts, credits and cooperative advertising. There can be no assurance that
the Company will continue to receive such incentives in the future. Other than
ordinary purchase orders, the Company does not have written supply, distribution
or franchise agreements with any of its Computer Product vendors. Although the
Company believes that it has established close working relationships with its
principal vendors, the Company's success will depend, in large part, on
maintaining these relationships and developing new vendor relationships for its
existing and future product and service lines. Because the Company does not have
written contracts with any of its vendors, there can be no assurance that the
Company will be able to maintain these relationships. Periodically, Computer
Product suppliers consolidate their distribution networks and otherwise
restructure or limit their distribution channels. There can be no assurance that
the Company will continue to be selected to resell products by its principal
vendors. Termination or interruption of such relationships or modification of
the terms the Company receives from these vendors would materially adversely
affect the Company's financial position, operating results, and cash flows.
Certain of the products offered by the Company are subject to manufacturer
allocations, which limit the number of units of such products available to the
Company's vendors, which in turn may limit the number of units available to the
Company. In order to offer the products of most manufacturers, the Company is
required to obtain authorizations from the manufacturers to act as a reseller of
such products, which authorizations may be terminated at the discretion of the
manufacturers at any time. There can be no assurance that the Company will be
able to obtain or maintain authorizations to offer products, directly or
indirectly, from new or existing manufacturers. Termination of the Company's
rights to act as a reseller of the products of one or more significant
manufacturers would have a material adverse effect on the Company's financial
position, operating results, and cash flows.
Possible Additional Financing Required. The Company's business is capital
intensive in that the Company is required to finance the purchase of Computer
Products in order to fill sales orders. In order to obtain necessary capital,
the Company relies primarily on unsecured vendor credit lines and a credit
<PAGE>
facility provided by Finova that is collateralized by equipment, accounts
receivable and inventory. As a result, the amount of credit available to the
Company may be adversely affected by factors such as delays in collection or
deterioration in the quality of the Company's accounts receivable, economic
trends in the computer industry, interest rate fluctuations and the lending or
credit policies of the Company's lenders and vendors. Many of these factors are
beyond the Company's control. Further, the Company must obtain Finova's written
permission prior to arranging other financing, and Finova may require certain
acknowledgments and undertakings from other lenders. There can be no assurance
that Finova will permit additional financing or that other lenders will provide
the acknowledgments and undertakings Finova may require. Any decrease or
material limitation on the amount of capital available to the Company under its
financing arrangements or vendor credit lines will limit the ability of the
Company to fill existing sales orders or expand its sales levels and, therefore,
would have a material adverse effect on the Company's financial position,
operating results, and cash flows. In addition, while the Company does not have
significant exposure to interest rate fluctuations under its current financing,
any significant increases in interest rates will increase the cost of possible
future financing to the Company which would have a material adverse effect on
the Company's financial position, operating results, and cash flows. The Company
is dependent on the availability of accounts receivable financing on reasonable
terms and at levels that are high relative to its equity base in order to
maintain and increase its sales. There can be no assurance that such financing
will be available to the Company in the future. The inability of the Company to
have continuous access to such financing at reasonable costs would severely and
adversely impact the Company's financial position, operating results, and cash
flows.
Risk of Product Returns. As is typical of the computer industry, the Company
incurs expenses as a result of the return of products by customers. Such returns
may result from defective goods, inadequate performance relative to customer
expectations, distributor shipping errors and other causes which are outside the
Company's control. Although the Company's distributors and manufacturers have
specific return policies that enable the Company to return certain types of
goods for credit, to the extent that the Company's customers return products
which are not accepted for return by the distributor or manufacturer of such
products, the Company will be forced to bear the cost of such returns. Any
significant increase in the rate of product returns coupled with the
unwillingness by the Company's distributors or manufacturers to accept goods for
return could have a material adverse effect on the Company's financial position,
operating results, and cash flows.
Product Mix; Risk of Declining Product Margins. As a result of sustained
industry oversupply and resulting pricing pressures, the Company's gross profit
percentage decreased from 4.2% for the six months ended September 30, 1997 to
2.6% for the six months ended September 30, 1998. Given the significant levels
of competition that characterize the Computer Products market especially desktop
hard drive market and recent pricing pressures and oversupply conditions, there
can be no assurance that the Company will maintain the current gross profit
margins or be able to achieve increases in profit margins. From time to time,
product margins will also be reduced as a result of marketing strategies
implemented by the Company. For instance, introductory pricing implemented by
the Company to develop market awareness of product lines, particularly disk
drives, of vendors new to the Company will have an
<PAGE>
adverse effect upon gross profit margins and, potentially, earnings during the
period promotional pricing is offered. Moreover, in order to attract and retain
many of its larger customers, the Company frequently must agree to volume
discounts and maximum allowable mark-ups that serve to limit the profitability
of sales to such customers. Accordingly, to the extent that the Company's sales
to such customers increase, the Company's gross profit margins may be reduced,
and therefore any future increases in net income will have to be derived from
continued sales growth or effective expansion into higher margin business
segments, neither of which can be assured. Furthermore, low margins increase the
sensitivity of the business to increases in costs of financing, because
financing costs to carry a receivable can be very high compared to the low
amount of gross profit on the sale underlying the receivable itself. Any failure
by the Company to maintain or increase its profit margins and sales levels could
have a material adverse effect on the Company's results of operations and
prospects for future growth.
Uncertainty of Commercialization of the ACSA Solution; Importance of ACSA to
Growth. The Company's ability to successfully implement, market and introduce
the ACSA Solution services on a timely basis will be a significant factor in the
Company's ability to improve its operating margins and remain competitive. The
Company's ability to market the ACSA Solution successfully will depend on the
Company convincing potential customers of the benefits of the ACSA Solution. The
Company has only recently commenced marketing the ACSA Solution. The Company
recently completed construction of its first ACSA Center located in Industry,
California. No ACSA Center is currently in operation and the Company currently
has no sales revenue attributable to the ACSA Solution or an ACSA Center. The
first ACSA Center will not be operational until testing is completed and ACSA
dedicated staff are in place. Although the Company is engaged in negotiations
and discussions with a number of potential customers, there can be no assurance
that any such discussions will lead to significant sales of the ACSA Solution,
or that the ACSA Solution will attain market acceptance. There can be no
assurance that the Company will be successful in the implementation, marketing
and sale of ACSA Solution services. Any failure by the Company to anticipate or
respond in a cost-effective and timely manner to market trends or customer
requirements, or any significant delays in introduction of ACSA services, could
have a material adverse effect on the Company's business, operating results and
financial condition.
Lengthy Sales and Implementation Cycles for ACSA. The Company believes that
the purchase of the Company's ACSA Solution services will entail an enterprise-
wide decision by prospective customers and require the Company to engage in a
lengthy sales cycle, estimated at between three and twelve months, as the
Company will be required to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's ACSA
Solution services and products. Also, the purchase of ACSA Solution services
will often depend upon the successful coordination of marketing, system design
and installation efforts by the Company, end-user customers and others with
influence over the purchase decisions of the Company's customers such as
consultants, VARs and SIs. Purchase decisions will generally occur only after
significant internal analysis by each customer and will be subject to
competition with other capital spending priorities of certain customers. As a
result, the sales and customer implementation cycles will be subject to a number
of significant delays over which the Company has little or no control. Delay in
the sale or customer implementation of a limited number of
<PAGE>
transactions could have a material adverse effect on the Company's business and
results of operations and could cause the Company's operating results to vary
significantly from quarter to quarter.
Dependence on CASI for Development and Enhancement of Configuration Software.
Under the Company's License Agreement with Computer-Aided Software Integration,
Inc. ("CASI"), CASI retains the source code of the Configurator software
required to operate the automated software configuration functions of the
Company's planned ACSA Solution and ACSA Centers, and retains all rights to
modify and enhance the ConfiguratorO software. CASI has agreed to provide the
Company with all enhancements and upgrades to the Configurator software used
internally or distributed by CASI to its customers, and to develop additional
enhancements requested by the Company at the Company's sole expense. Any
enhancements requested by the Company and implemented by CASI at CASI's expense
may be incorporated in the generally distributed version of CASI's software. If
CASI determines not to fund development of an enhancement then CASI must prepare
the enhancement at pre-agreed rates and ownership of the requested enhancement
will belong to the Company. Failure by CASI to promptly and adequately perform
its obligations under its license agreement with the Company would have a
material adverse effect on the Company. Furthermore, there can be no assurance
that CASI will fully comply with its contractual obligations to the Company,
that CASI will dedicate sufficient software development capacity to satisfy the
Company's requirements, or that the Company's remedies in the event CASI does
not perform its obligations will be adequate. The Company has no capability to
internally develop any enhancements or upgrades. Failure or delay by CASI to
fulfill the Company's anticipated needs for enhancement and upgrading of the
Configurator software would adversely affect the Company's ability to market
ACSA services and to become and remain competitive in the software configuration
market. In the event that CASI fails to meet its obligations under the license,
the Company has, among other rights, the contractual right to the source code
underlying the software, but there can be no assurance that the Company will be
able to obtain the source code in a timely manner, if at all, because CASI is in
possession of the only copies of the source code. Even if the Company is able to
obtain the source code under such circumstances, internal maintenance and
enhancement of the source code could place a significant financial burden on the
Company. See "Legal Proceedings."
Limited Marketing Capabilities. The Company's operating results will depend
to a large extent on its ability to successfully market the ACSA Solution
services to personal computer manufacturers and multi-user system buyers. The
Company currently has limited marketing capability. The Company intends to use a
portion of the proceeds of the Offering to hire additional sales and marketing
personnel and outside consultants to market the ACSA Solution. There can be no
assurance that any marketing efforts undertaken by the Company will be
successful or will result in any significant sales of the ACSA Solution.
Management of Growth. The Company has grown rapidly since inception in April
1996, with net sales reaching $25,940,203 in the Company's first fiscal year and
reaching $72,495,474 for the year ended March 31, 1998, and employees increasing
from 3 at inception to 24 at March 31, 1998. Implementation of the Company's
business plan, including implementation of ACSA Solution services and
<PAGE>
the general strains of the Company's growth will require that the Company
significantly expand its operations in all areas. This growth in the Company's
operations and activities will place a significant strain on the Company's
management, operational, financial and accounting resources. Successful
management of the Company's operations will require the Company to continue to
implement and improve its financial and management information systems. The
Company's ability to manage its future growth, if any, will also require it to
hire and train new employees, including management and technical personnel, and
motivate and manage its new employees and integrate them into its overall
operations and culture. The Company's failure to manage implementation of its
business plan would have a material adverse effect on the Company's business,
operating results and financial condition.
Risk of Potential Joint Ventures or Acquisitions. In the future, the Company
may acquire complementary companies, products or technologies, although no
specific acquisitions currently are pending or under negotiation. Acquisitions
involve numerous risks, including adverse short-term effects on the combined
business' reported operating results, impairments of goodwill and other
intangible assets, the diversion of management's attention, the dependence on
retention, hiring and training of key personnel, the amortization of intangible
assets and risks associated with unanticipated problems or legal liabilities. A
portion of the net proceeds of the initial public offering may be used to fund
such acquisitions at the broad discretion of the Board of Directors. The Board
of Directors may consummate such acquisitions, if any, without permitting
shareholders to review or vote on such transactions, unless required under
applicable law.
Construction of First ACSA Center. The Company has used approximately
$200,000 of the net proceeds from the Initial Public Offering to complete
construction of and to equip its first ACSA Center. It is expected that the
construction will require a substantial time commitment of certain members of
management. The first ACSA Center has been constructed, and is expected to be
operational by the end of the third quarter. Any delay in completion of the
first ACSA Center could result in delays in the commencement of sales of
assembly and custom software configuration services and adversely affect the
Company's business, operating results and financial condition. There can be no
assurance that the Company will be able to complete the ACSA Center at the
budgeted price. Additionally, there can be no assurance that the ACSA Center
will be available on time or that the Company will be successful in timely
hiring and training engineers and technicians necessary to commence operations
of the ACSA Center. Any such delay would delay the Company's ability to commence
offering the ACSA Solution and have a material adverse effect upon the Company's
business, operating results and financial condition.
Rapid Technological Change; New Product Introductions. The market for the
Company's ACSA technology is characterized by rapidly changing technology and
frequent new product introductions. Even if the Company's ACSA Solution services
using its licensed Configurator software gains initial market acceptance, the
Company's success will depend, among other things, upon its ability to enhance
the ACSA Solution services and to develop and introduce new products and
services that keep pace with technological developments, respond to evolving
customer requirements and achieve continued market acceptance. There can be no
assurance that the Company will be able to identify, develop, manufacture,
market or support new products or offer new services successfully,
<PAGE>
that such new products or services will gain market acceptance, or that the
Company will be able to respond effectively to technological changes or product
announcements by competitors. Any failure by the Company to anticipate or
respond adequately to technological developments and customer requirements or
any significant delays in product development or introductions could result in a
loss of market share or revenues.
Industry Evolution and Price Reductions; Changing Methods of Distribution.
The personal computer industry is undergoing significant change. The industry
has become more accepting of large volume, cost-effective channels of
distribution such as computer superstores, consumer electronics and office
supply superstores, national direct marketers and mass merchants. In addition,
many traditional computer resellers are consolidating operations and acquiring
or merging with other resellers to increase efficiency. This current industry
reconfiguration has resulted in increased pricing pressures. Decreasing prices
of Computer Products require the Company to sell a greater number of products to
achieve the same level of net sales and gross profit. The continuation of such
trend would make it more difficult for the Company to maintain or to increase
its net sales and net income. In addition, it is possible that the historically
high rate of growth of the personal computer industry may slow at some point in
the future. If the growth rate of the personal computer industry were to
decrease, the Company's financial position, operating results, and cash flows
could be materially adversely affected. Furthermore, new methods of distribution
and sales of Computer Products, such as on-line shopping services and catalogs
published on CD-ROM, may emerge in the future. Computer Products and software
manufacturers have sold, and may in the future intensify their efforts to sell,
their products directly to end users. From time to time, certain vendors have
instituted programs for the direct sale of large orders of Computer Products and
software to certain major corporate accounts. These types of programs may
continue to be developed and used by various vendors. While the Company attempts
to anticipate future distribution trends, any of these distribution methods or
competitive programs, if expanded, could have a material adverse effect on the
Company's financial position, operating results, and cash flows.
Availability of Components. The computer component and computer assembly
businesses have from time to time experienced periods of extreme shortages in
product supply, generally as the result of demand exceeding available supply.
When these shortages occur, suppliers tend either to slow down shipments or
place their customers "on allocation," reducing the number of units sold to each
customer. While the Company believes that it has well-established relationships
with vendors and that it has not been adversely affected by recent shortages in
certain storage and other computer components, no assurance can be given that
future shortages will not adversely impact the Company.
Competition. The Company faces intense competition, both in its selling
efforts and purchasing efforts, from the significant number of companies that
configure and/or assemble personal computers, manufacture or distribute disk
drives and offer software configuration services. Many of these companies, such
as CompuCom Systems, Inc., CDW Computer Centers, Inc., Vanstar Corp. and Inacom,
Inc. in the Computer Products distribution market, large computer manufacturers
such as IBM Corp. and Compaq Computer Corporation, which provide custom
configuration and automated software configuration for standardized systems,
large distributors such as Ingram Micro Inc., Vanstar Corp., En Point
<PAGE>
Technologies, Inc., Microwarehouse, Inc. and CompuCom Systems, Inc. in the
systems integration and network services market, have substantially greater
assets and possess substantially greater financial and personnel resources than
those of the Company and may develop software, or services or products which are
comparable to the ACSA Solution. Many competing distributors also carry or offer
brands or product lines which the Company does not carry. Generally, large disk
drive and personal computer component manufacturers and large distributors do
not focus their direct selling efforts on small to medium sized OEMs and
distributors, which constitute the vast majority of the Company's customers;
however, as the Company's customers increase in size, disk drive and component
manufacturers may find it cost effective to focus direct selling efforts on
those customers, which could result in the loss of customers or pressure on
margins. In addition, CASI and/or Datatec Systems Inc. ("Datatec"), formerly
known as Glasgal Communications, Inc., the parent corporation of CASI, may
directly enter into the Company's integration and configuration markets using
the software the Company has licensed from CASI. While no operating division or
subsidiary of Datatec is currently competing in the Company's markets, there can
be no assurance that Datatec will not decide to directly compete with the
Company in the future. Further, the terms of the Company's license agreement
with CASI allows CASI to license the software used in the ACSA Solution and the
ACSA Centers to new or existing direct competitors of the Company. There can be
no assurance that the Company will be able to continue to compete effectively
with existing or potential competitors.
Industry Cyclicality. The personal computer component distribution industry
has been affected historically by general economic downturns, which have had an
adverse economic effect upon manufacturers and corporate end users of personal
computers, as well as component distributors such as the Company. In addition,
the life cycle of existing personal computer products and the timing of new
product development and introduction can affect demand for disk drives and other
personal computer components. Any downturns in the personal computer component
distribution industry, or the personal computer industry in general, could
adversely affect the Company's business and results of operations.
Asian Market Instability. Economies and financial markets in Asia have
recently experienced significant turmoil. A non-material portion of the
Company's revenues are derived from sales to businesses which primarily export
Computer Products to Asian customers. Also certain of the Company's vendors are
based in Korea, Japan and other Asian countries. Asian financial market
instability may adversely impact customer orders or the Company's ability to
obtain products from its Asian vendors. The financial instability in these
regions has had an adverse impact on the financial position of end-users in the
region which has been a contributing factor to the oversupply condition and
pricing pressures currently impacting the Company (because Asian vendors have
channeled excess inventory into the North American market at reduced prices and
have reduced component demand from domestic manufacturers who export to Asia)
and could also impact future orders from the Company's customers and/or the
ability of such end users to pay the Company's customers, which could also
impact the ability of such customers to pay the Company. If the Company's
customers who export into Asia are unable to maintain export sales or current
margins on such export sales, the Company's sales and/or sales margins may be
adversely affected. Additionally, if the Company's vendors in these regions are
unable to continue to supply the Company, the Company may be adversely
<PAGE>
impacted.
Foreign Trade Regulation. A significant number of the products distributed
by the Company are manufactured in Taiwan, China, Korea, Japan and the
Philippines. The purchase of goods manufactured in foreign countries is subject
to a number of risks, including economic disruptions, transportation delays and
interruptions, foreign exchange rate fluctuations, imposition of tariffs and
import and export controls and changes in governmental policies, any of which
could have a material adverse effect on the Company's business and results of
operations. The ability to remain competitive with respect to the pricing of
imported components could be adversely affected by increases in tariffs or
duties, changes in trade treaties, strikes in air or sea transportation,
fluctuation in currency and possible future United States legislation with
respect to pricing and import quotas on products from foreign countries. For
example, it is possible that political or economic developments in China, or
with respect to the United States' relationship with China, could have an
adverse effect on the Company's business. The Company's ability to remain
competitive could also be affected by other governmental actions related to,
among other things, anti-dumping legislation and international currency
fluctuations. While the Company does not believe that any of these factors
adversely impact its business at present, there can be no assurance that these
factors will not materially adversely affect the Company in the future. Any
significant disruption in the delivery of merchandise from the Company's
suppliers, substantially all of whom are foreign, would also have a material
adverse impact on the Company's business and results of operations.
Fluctuations in Quarterly Earnings. The Company's business is subject to
certain quarterly influences. Net sales and operating profits are generally
higher in the fiscal third quarter due to the purchasing patterns of personal
computer integrators and resellers and are generally lower in the first and
second fiscal quarter due primarily to lower industry shipments. Quarterly
results may also be adversely affected by a variety of other factors, including
the timing of acquisitions and related costs, the release of new products,
promotions, and component pricing and availability.
Possible Issuance of Preferred Stock; Barriers to Takeover. The Company's
Articles of Incorporation authorize the issuance of up to 2,000,000 shares of
Preferred Stock. Following the Offering, no shares of Preferred Stock of the
Company will be outstanding, and the Company has no present intention to issue
any shares of Preferred Stock. However, because the rights and preferences for
any series of Preferred Stock may be set by the Company's Board of Directors in
its sole discretion, the rights and preferences of any such Preferred Stock are
likely to be superior to those of the Common Stock and thus could adversely
affect the rights of the holders of Common Stock. The Company currently has no
commitments or contracts to issue any additional securities. Any securities
issuances might result in a reduction in the book value or market price of the
outstanding shares. Further, any new issuances could be used for anti-takeover
purposes or might be used as a method of discouraging, delaying or preventing a
change of control of the Company. Additionally, certain provisions of the
Company's Articles of Incorporation and Bylaws could delay or make more
difficult a merger, tender offer or proxy contest involving the Company.
No Dividends Anticipated. The Company has never declared or paid dividends
on its Common Stock. After the consummation of this Offering, the Company does
<PAGE>
not intend for the foreseeable future to declare or pay any cash dividends and
intends to retain earnings, if any, for the future operation and expansion of
the Company's business.
Delisting from The Nasdaq SmallCap Market; Potential Penny Stock
Classification. The Company's Common Stock is quoted on The Nasdaq SmallCap
Market and listed on the Boston Stock Exchange. However, there can be no
assurance that a trading market for the Common Stock will develop, or if
developed, that it will be maintained. No assurance can be given that the
Company will be able to satisfy the criteria for continued quotation on The
Nasdaq SmallCap Market or the criteria for continued listing on the Boston Stock
Exchange following this Offering. Failure to meet the maintenance criteria in
the future may result in the Common Stock not being eligible for quotation or
listing. If the Company were removed from The Nasdaq SmallCap Market and the
Boston Stock Exchange, trading, if any, in the Common Stock would thereafter
have to be conducted in the over-the-counter market in so-called "pink sheets"
or, if then available, the OTC Bulletin Board. As a result, holders of the
Common Stock would find it more difficult to dispose of, or to obtain accurate
quotations as to the market value of, the Common Stock.
In addition, if the Common Stock is delisted from trading on Nasdaq and the
Boston Stock Exchange and the trading price of the Common Stock is less than
$5.00 per share, trading in the Common Stock would also be subject to the
requirements of Rule 15g-9 promulgated under the Securities Exchange Act of
1934, as amended (the "Exchange Act"). Under such rule, broker/dealers who
recommend such low-priced securities to persons other than established customers
and accredited investors must satisfy special sales practice requirements,
including a requirement that they make an individualized written suitability
determination for the purchaser and receive the purchaser's written consent
prior to the transaction. The Securities Enforcement Remedies and Penny Stock
Reform Act of 1990 also requires additional disclosure in connection with any
trades involving a stock defined as a penny stock (generally, according to
regulations adopted by the Securities Exchange Commission (the "Commission"),
any equity security not traded on an exchange or quoted on Nasdaq that has a
market price of less than $5.00 per share, subject to certain exceptions),
including the delivery, prior to any penny stock transaction, of a disclosure
schedule explaining the penny stock market and the risks associated therewith.
Such requirements could severely limit the market liquidity of the Common Stock
and the ability of purchasers in this Offering to sell their securities in the
secondary market. There can be no assurance that the Common Stock will not be
delisted or treated as a penny stock.
Elimination of Cumulative Voting. The Articles of Incorporation of the
Company provide that at such time as the Company has (i) shares listed on the
New York Stock Exchange or the American Stock Exchange, or (ii) securities
designated for trading as a national market security on the National Association
of Securities Dealers Automatic Quotation System (or any successor national
market system) if the Company has at least 800 or more holders of its Common
Stock as of the record date of the Company's most recent annual meeting of
shareholders, the cumulative voting rights of shareholders will cease. The
Company believes that it has more than 800 holders. If the Company has shares
listed on the New York Stock Exchange or the American Stock Exchange, or
designated for trading as national market securities on The Nasdaq National
Market System, cumulative voting rights of shareholders will cease. Elimination
<PAGE>
of cumulative voting will have the effect of making it more difficult for
minority shareholders to obtain representation on the Board of Directors.
Limitation of Liability and Indemnification. The Company's Articles of
Incorporation, as amended, (the "Articles") include a provision that eliminates
the personal liability of its directors to the Company for monetary damages for
breach of their fiduciary duties (subject to certain limitations) as a director
to the fullest extent permissible under California law. The Company's Articles
and Bylaws allow the Company to provide for indemnification of its Directors the
fullest extent permitted by law. The Bylaws allow the Company to enter into
indemnity agreements with individual directors, officers, employees and other
agents. The Company has entered into indemnification agreements designed to
provide the maximum indemnification permitted by law with all the directors of
the Company. These agreements, together with the Company's Bylaws and Articles,
may require the Company, among other things, to indemnify these directors
against certain liabilities that may arise by reason of their status or service
as directors (other than liabilities resulting from willful misconduct of a
culpable nature), to advance expenses to them as they are incurred, provided
that they undertake to repay the amount advanced if it is ultimately determined
by a court that they are not entitled to indemnification, and to obtain
directors' and officers' insurance if available on reasonable terms. The Company
has purchased and does maintain directors' and officers' liability insurance. As
a result of the provisions in the Company's Articles and in the indemnification
agreements, it may be more difficult for shareholders to obtain relief against a
director for breaches of such director's fiduciary duty than if these provisions
were not included in the Company's Articles and Bylaws.
No Earthquake Insurance. The Company's executive office, warehouse and
assembly facility is located in a Company-leased facility in Industry,
California, an area which experienced damage in the 1994 Northridge, California
earthquake. The Company does not currently carry insurance against earthquake-
related risks.
Disclosure Regarding Forward-Looking Statements. This Report contains
statements that constitute "forward-looking statements" within the meaning of
Section 21E of the Exchange Act and Section 27A of the Securities Act. The
words "expect," "estimate," "anticipate," "predict," "believe," and similar
expressions and variations thereof are intended to identify forward-looking
statements. Such statements appear in a number of places in this filing and
include statements regarding the intent, belief or current expectations of the
Company, its Directors or Officers with respect to, among other things (a)
trends effecting the financial condition of results of operations of the Company
and (b) the business and growth strategies of the Company. The shareholders of
the Company are cautioned not to put undue reliance on such forward-looking
statements. Such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties. Actual results may differ
materially from those projected in this Report, for the reasons, among others,
discussed in "Future Operating Results" below and under the caption,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Risk Factors" in the Company's Annual Report on Form 10-K for
Fiscal 1998, filed with the Securities and Exchange Commission. The Company
undertakes no obligation to publicly revise these forward-looking statements to
reflect events or circumstances that arise after the date hereof. Readers
should carefully review the risk factors
<PAGE>
referred to above and the other documents the Company files from time to time
with the Securities and Exchange Commission, including the Company's Annual
Report on Form 10-K for the fiscal year 1998, the quarterly reports on Form 10-Q
filed by the Company during the remainder of fiscal 1999, and any current
reports on Form 8-K filed by the Company.
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is periodically subject to legal actions which arise in the
ordinary course of its business. The Company does not believe that any such
action is material to its results of operation or financial condition.
The Company has been involved in a disagreement with CASI concerning the
interpretation of certain provisions of the Reseller Agreement, dated September
15, 1997, between CASI and the Company (the "Reseller Agreement"). By letter
dated November 9, 1998, attorneys for CASI purported to terminate the Reseller
Agreement on behalf of CASI.
The Company strongly disagrees with CASI's right to terminate the Reseller
Agreement and is currently evaluating its legal options.
It should be noted that there is no disagreement between the Company and
CASI concerning the License Agreement, dated September 15, 1997, between CASI
and the Company (the "License Agreement"). The Company has no reason to believe
that CASI will not fulfill all its obligations under the License Agreement to
provide the Company with its Configurator software and certain technical
support.
ITEM 2. CHANGES IN SECURITIES
Use of Proceeds
The Company's Registration Statement on Form S-1 (File No. 333-43151)
relating to the offer and sale (the "Offering") of an aggregate of 2,350,000
shares (the "Firm Shares") of Common Stock, without par value (the "Common
Stock"), of the Company was declared effective by the Securities and Exchange
Commission (the "Commission") on April 7, 1998. The managing underwriter for
the Offering was Joseph Stevens & Company, Inc. (the "Managing Underwriter").
The Offering commenced on April 8, 1998 and the sale of 2,350,000 shares
closed on April 14, 1998, with the sale of an additional 352,500 shares (the
"Option Shares" and, together with the Firm Shares, the "Shares") closing on
April 23, 1998 (which were sold by the Company upon the exercise of the over-
allotment option granted to the underwriters). All the Shares were sold in the
Offering at an aggregate price of $5.00 per share, for aggregate proceeds of
$13,512,500. After deducting underwriting discounts and commissions of $0.4625
per share, and other issuance costs, the Company received net proceeds of
approximately $11,200,000. On April 14, 1998, the Company also received $0.001
per warrant, for an aggregate of $23.50, in consideration of unregistered 5-year
warrants to purchase 235,000 shares of Common Stock at an initial exercise price
of 165% of the Offering price, exercisable one year after the effective date of
the Registration Statement, granted to the Managing Underwriter in connection
with the Offering. See "Recent Sales of Unregistered Securities."
As of September 30, 1998, the Company had used the proceeds as follows: (i)
payments on notes payable of $1,200,000 and (ii) purchases of fixed assets -
$267,000. The remaining proceeds of $9,733,000 are available to fund the
<PAGE>
construction of the First ACSA Center and for working capital.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit 27 Financial Data Schedule
SIGNATURE
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 thereto duly authorized.
CUMETRIX DATA SYSTEMS CORP.
Date: November 13, 1998 /s/ Carl L Wood
Chief Financial Officer
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<PAGE>
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10-Q AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
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<PERIOD-END> SEP-30-1998 SEP-30-1998
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<RECEIVABLES> 3,532,280 0
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