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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 JUNE 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 of (I.R.S. Employer
Incorporation or Organization) Identification No.)
957 Lawson Street, Industry, California 91748
---------------------------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (626) 965-6899
NONE
-------------------------------------------------------------------
(Former name, address and fiscal year if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
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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/ /
Indicate the number of shares outstanding of each of the issuer's
classes of stock as of the latest practicable date: 7,452,500 shares of
Common Stock, without par value, as of August 14, 1998.
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CUMETRIX DATA SYSTEMS CORP.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Page
----
<S> <C>
1. Condensed Balance Sheets - June 30, 1998 (unaudited) and
March 31, 1998 3
2. Condensed Statements of Operations - Three Months Ended
June 30, 1998 and 1997 (unaudited) 4
3. Condensed Statements of Cash Flows - Three Months Ended
June 30, 1998 and 1997 (unaudited) 5
4. Notes to Financial Statements (unaudited) 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. 7
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 24
ITEM 2. CHANGES IN SECURITIES 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS 27
ITEM 5. OTHER INFORMATION 27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 27
SIGNATURES 27
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CUMETRIX DATA SYSTEMS CORP.
BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS June 30, March 31,
1998 1998
----------- -----------
(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents. . . . . . . . . . . . $12,129,318 $ 4,415,690
Trade receivables, net of allowance for
doubtful accounts of $84,000 and $57,000
at June 30, 1998 and March 31, 1998, respectively 4,759,814 3,885,803
Inventories. . . . . . . . . . . . . . . . . . . 4,407,368 2,001,597
Deferred taxes . . . . . . . . . . . . . . . . . 65,297 133,647
Prepaid expenses . . . . . . . . . . . . . . . . 196,466 45,983
----------- -----------
Total current assets . . . . . . . . . 21,558,263 10,482,720
----------- -----------
FIXED ASSETS, net. . . . . . . . . . . . . . . . . . 135,614 87,538
DEFERRED OFFERING COSTS. . . . . . . . . . . . . . . - 514,927
CAPITALIZED PURCHASED SOFTWARE COSTS . . . . . . . . 1,100,000 1,100,000
----------- -----------
Total Assets . . . . . . . . . . . . . $22,793,877 $12,185,185
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . $ 9,559,228 $ 7,822,652
Accrued expenses . . . . . . . . . . . . . . . . 172,397 641,844
Income taxes payable . . . . . . . . . . . . . . - 717,013
Current portion of long-term debt. . . . . . . . 3,790 1,203,707
----------- -----------
Total current liabilities . . . . . . . . . . 9,735,415 10,385,216
----------- -----------
LONG-TERM DEBT, net of current portion . . . . . . . 7,885 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 June 30, 1998 and March 31, 1998,
respectively . . . . . . . . . . . . . . . . . . 12,273,412 1,042,589
Retained earnings. . . . . . . . . . . . . . . . . 777,165 748,516
----------- -----------
Total shareholders' equity. . . . . . . . . . 13,050,577 1,791,105
----------- -----------
Total liabilities and shareholders' equity. . $22,793,877 $12,185,185
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
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CUMETRIX DATA SYSTEMS CORP.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
NET SALES. . . . . . . . . . . . . . . . . . . $18,414,526 $10,847,145
COST OF PRODUCTS . . . . . . . . . . . . . . . 17,982,616 10,423,376
----------- -----------
Gross profit . . . . . . . . . . . . . . . 431,910 423,769
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES . 528,852 312,244
----------- -----------
Income (Loss) from operations. . . . . . . (96,942) 111,525
INTEREST EXPENSE . . . . . . . . . . . . . . . (1,880) (1,027)
INTEREST INCOME . . . . . . . . . . . . . . . 147,971 550
----------- -----------
Income before provision for income taxes . 49,149 111,048
PROVISION FOR INCOME TAXES . . . . . . . . . . 20,500 44,500
----------- -----------
NET INCOME . . . . . . . . . . . . . . . . . . 28,649 66,548
----------- -----------
BASIC AND DILUTED EARNINGS PER SHARE . . . . . $ 0.00 $ 0.01
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
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CUMETRIX DATA SYSTEMS CORP.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1998 1997
----------- ---------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . $ 28,649 $ 66,548
Adjustments to reconcile net income to net cash
and cash equivalents used in operating activities:
Depreciation and amortization . . . . . . 2,250 950
Provision for doubtful accounts . . . . . 27,000 15,000
Loss on receivable from director . . . . - 100,000
Changes in assets and liabilities:
Trade receivables . . . . . . . . . . . . (901,011) (1,958,044)
Inventories . . . . . . . . . . . . . . . (2,405,771) (409,161)
Deferred taxes. . . . . . . . . . . . . . 68,350 -
Prepaid expenses. . . . . . . . . . . . . (150,483) (5,021)
Accounts payable. . . . . . . . . . . . . 1,736,576 1,966,047
Accrued expenses. . . . . . . . . . . . . (469,447) (4,901)
Income taxes payable. . . . . . . . . . . (717,013) -
----------- ---------
Net cash (used) by operating
activities . . . . . . . . . . . . . (2,780,900) (228,582)
----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets . . . . . . . . . . . . . . . (50,326) (4,101)
Receivables from related parties. . . . . . . . . . . . - 39,700
----------- ---------
Net cash provided (used) in
investing activities . . . . . . . . . (50,326) 35,599
----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net . . . . . . 11,230,823 -
Payments on bank borrowings . . . . . . . . . . . . . . - (821)
Payments on long-term debt . . . . . . . . . . . . . . (1,200,896) -
Proceeds from stock issuance . . . . . . . . . . . . . - 300,000
Deferred offering costs . . . . . . . . . . . . . . . 514,927 -
----------- ---------
Net cash provided by
financing activities . . . . . . . . . 10,544,854 299,179
----------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS. . . . . . . . . 7,713,628 106,196
CASH AND CASH EQUIVALENTS, beginning of period . . . . . . 4,415,690 479,796
----------- ---------
CASH AND CASH EQUIVALENTS, end of period . . . . . . . . . $12,129,318 $ 585,992
----------- ---------
----------- ---------
</TABLE>
The accompanying notes are an integral part of these statements.
5
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CUMETRIX DATA SYSTEMS CORP.
NOTES TO FINANCIAL STATEMENTS
June 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 month periods ended June 30, follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Weighted average number of common shares
outstanding-Basic 7,196,271 4,494,329
Dilutive effect of outstanding stock options 252,021 -
--------- ---------
Weighted average number of common shares
outstanding-Diluted 7,448,292 4,494,329
--------- ---------
--------- ---------
</TABLE>
6
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THIS DISCUSSION SUMMARIZES THE SIGNIFICANT FACTORS AFFECTING THE
OPERATING RESULTS, FINANCIAL CONDITION AND LIQUIDITY/CASH FLOWS OF THE
COMPANY FOR THE QUARTERS ENDED JUNE 30, 1998 AND 1997. EXCEPT FOR THE
HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERS DISCUSSED IN THIS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS ARE FORWARD LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES AND ARE BASED UPON JUDGMENTS CONCERNING VARIOUS FACTORS THAT
ARE BEYOND THE COMPANY'S CONTROL. ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE PROJECTED IN THE FORWARD LOOKING STATEMENTS AS A RESULT OF, AMONG
OTHER FACTORS, THE FACTORS SET FORTH UNDER THE CAPTION "CAUTIONARY STATEMENTS
AND RISK FACTORS" BELOW.
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 ("Computer
Products"). 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 Automated Custom System Assembly Solution (the "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 advanced by an officer of Datatec Systems,
Inc. ("Datatec"), CASI's parent, and evidenced by a promissory note (the
"Datatec Note") of the Company in favor of such officer of Datatec. 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 will continue to sustain pricing pressures at least until fall
of 1998 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
7
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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
operating results, financial condition and liquidity/cash flows of the
Company for the quarters ended June 30, 1998 and 1997. The Company has a
limited history of operations.
Results of Operations
THREE MONTHS ENDED JUNE 30, 1998 AND 1997.
NET SALES. Net sales for the quarter ended June 30, 1998 were $18,414,526
compared to $10,847,145 in the previous year. This increase of $7,567,381 or
69.8% in net sales is attributable to growth of the Company's sales force
from 6 to 9 individuals at the end of 1997 and 1998, respectively, and an
increase in the Company's available combined purchasing credit (including its
vendor credit and a line of credit from Finova Capital Corporation (the
"Finova Line"), from $3.2 million to $16.5 million (as a 90 day average
available credit for the respective periods) 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 $7,559,240 from $10,423,376 to
$17,982,616 for the quarter ended June 30, 1997 and 1998, respectively. This
increase is mainly attributable to the increase in net sales.
GROSS PROFIT. Gross profit for the quarter ended June 30, 1998 was $431,910
compared to $423,769 in the quarter ended June 30, 1997. Gross profit as a
percentage of net sales was 2.3% for the quarter ended June 30, 1998 compared
to 3.9% for the quarter ended June 30, 1997. This represents a 40% decrease
in gross profit, and is mainly attributable to industry oversupply and the
resulting pricing pressures facing the industry as a whole.
8
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for quarter ended June 30, 1998 were $528,852
compared to $312,244 for the quarter ended June 30, 1997.
The major components of selling, general and administrative expenses for
the periods include the following:
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1998 1997
---------- ---------
<S> <C> <C>
Payroll $ 270,354 $ 147,708
Commissions 48,113 23,402
Write-off of related party receivable - 100,000
Bad debt 27,000 15,000
Rent 37,675 11,904
Other (under 5%) 145,710 14,230
---------- ---------
Total $ 528,852 $ 312,244
---------- ---------
---------- ---------
</TABLE>
The increase of $216,608 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 June 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 $147,971 for the quarter ended June 30, 1998 is
primarily due to interest income earned on the investment of proceeds from
the Bridge Financing and proceeds from the initial public offering.
Net Income
Net income for the quarter ended June 30, 1998 was $28,649 compared to
$66,548 for the quarter ended June 30, 1997. The decrease of $37,899 is
mainly attributable to the decrease in gross profit, higher selling, general
and administrative expenses, offset by interest income.
Impact of Year 2000
The Company's present accounting software is not Year 2000 Compliant.
However, the Company has selected and begun the implementation of a new
accounting system that will be Year 2000 Compliant. The Company does not
believe that the costs associated with the new accounting system will be
material.
The Company has not yet performed an assessment of computer systems
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belonging to customers, vendors, and other outside parties with whom the
Company does business. Such an assessment of significant relationships will
be performed during fiscal 1999. It is not anticipated that such an
assessment will reveal significant potential problems or will require the
Company to incur substantial costs.
Liquidity and Capital Resources
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 (as defined below).
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
generating gross proceeds of $1 million (net proceeds of approximately
$678,000). Each unit was comprised of : (i) an unsecured promissory note (the
"Bridge Notes") of the Company in the principal amount of $20,000 (ii) 15,000
shares of Common Stock of the Company, and (iii) 5,000 Bridge Warrants 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, the Datatec Note and the Bridge Notes from proceeds of
the Initial Public Offering.
In June 1997, the Company obtained credit for inventory purchases
through Finova Capital Corporation. Purchases are collateralized by inventory
and accounts receivable. 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. This arrangement is personally guaranteed
by two officers of the Company. At June 30, 1998, the Company's Finova line
was $7.5 million and the Company had a payable to Finova Capital Corporation
of approximately $7,013,999 included in accounts payable.
Net cash used by operating activities during the quarter ended June 30,
1998 was primarily attributable to an increase in trade receivables,
inventories and decreases in accrued expenses and income taxes payable offset
by an increase in accounts payable. Net cash provided by financing activities
in the quarter ended June 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
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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 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
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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 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.
PRODUCT MIX; RISK OF DECLINING PRODUCT MARGINS. The Company's gross
profit margins have increased from 3.1% to 4.2% in the years ending March 31,
1997 and 1998, respectively, due to a number of factors, including strong
product demand, the ability of the Company to obtain favorable pricing, and a
sales mix of products with higher profit margins. However, as a result of
sustained industry oversupply and resulting pricing pressures, the Company's
gross profit percentage decreased from 3.9% for the three months ended June
30, 1997 to 2.3% for the three months ended June 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 further
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 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.
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.
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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.
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, and certain of the Company's
vendors are based in Korea, Japan and other Asian countries. The recent turmoil
in the Asian financial markets has not had a material impact on the Company's
sales 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 impacted.
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 quarter ended June 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.
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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 the Finova
Line provided by Finova Capital Corporation ("Finova") that is collateralized
by 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.
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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 is currently constructing 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. 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. Although
the Company will devote a substantial portion of the proceeds of the
Company's April 1998 initial public offering to the implementation and
marketing of ACSA Solution services, there can be no assurance that the
commitment and use of such funds will result in successful implementation,
marketing and sales 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
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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, Value Added Resellers ("VARs") and System Integrators ("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 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 non-exclusive license and reseller agreements
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
Configurator-TM- 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.
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
has used and intends to use a portion of the proceeds of its April 1998
initial public 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
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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 33 at June 30, 1998.
Implementation of the Company's business plan, including implementation of
ACSA Solution services and 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 applied approximately
$120,000 of the net proceeds from the initial public offering to complete
construction of and to equip its first ACSA Center. The first ACSA Center is
expected to be completed by the end of August 1998. Any significant delay
in completion of the 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 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
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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, 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.
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
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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 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 the Company knows of
no operating division or subsidiary of Datatec that 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.
ELECTRONICS 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.
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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.
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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. No shares of Preferred Stock of the Company are
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. The Company does 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
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assurance that a trading market for the Common Stock 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. 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 shareholders 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 of its Common Stock. 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. The Company has applied for
quotation of its Common Stock on the Nasdaq National Market System, which
application is pending. There can be no assurance that the Company will be
approved for quotation on the Nasdaq National Market System or, if approved,
that it will satisfy the criteria for continued quotation on the Nasdaq
National Market System. Elimination 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
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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 includes
"forward-looking statements." All statements other than statements of
historical fact included in this report, including, without limitation, the
statements under "Cautionary Statements and Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
regarding the Company's strategies, plans, objectives and expectations; the
Company's ability to provide custom assembly, configuration and distribution
services of computer equipment and peripherals to technology companies; the
ability of the Company to establish and operate an ACSA Center and to
automate its custom configuration process and systems integration solutions
for its customers; the ability of the Company to successfully market the ACSA
Solution; the ability of the Company to develop processes to position itself
as a low-cost leader for outsourcing system assembly and distribution
services; the Company's future operating results; and other matters are all
forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable at
this time, it can give no assurance that those expectations will prove to be
correct. Important factors that could cause actual results to differ
materially from the Company's expectations are set forth in these "Cautionary
Statements and Risk Factors," as well as elsewhere in this report. All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by these "Cautionary Statements and Risk Factors."
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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
pending action is material to its results of operation or financial condition.
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 $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 June 30, 1998, the Company had used the proceeds from the Offering
as follows: (i) payment of $1,200,000 in satisfaction of the CASI Note, the
Datatec Note and the Bridge Notes and (ii) - $50,000 to purchase fixed
assets. The remaining $9,950,000 of the proceeds from the Offering had not
yet been applied as of June 30, 1998.
RECENT SALES OF UNREGISTERED SECURITIES.
On April 14, 1998, in connection with the Company's April 1998 initial
public offering (the "Offering"), the Company issued five (5) year warrants
(the "Representative's Warrants") to purchase 235,000 shares of Common Stock
to Joseph Stevens & Company, Inc., the managing underwriter of the Offering
of the Common Stock of the Company, for nominal consideration of $23.50, or
$.0001 per warrant. The Representative's Warrants are exercisable at any
time during a period of four (4) years commencing twelve months after the
effective date of the Registration Statement at a price equal to 165% of the
Offering price per share and are restricted from sale, transfer, assignment,
or hypothecation for a period of twelve months from the effective date of the
Registration Statement, except to officers of the underwriters. The issuance
and sale of these securities was exempt from the registration and prospectus
delivery requirements of the Securities Act of 1933, as amended (the "Act"),
pursuant
24
<PAGE>
to Section 4(2) of the Act, as a transaction not involving any public
offering.
On November 26, 1997, the Company issued warrants to purchase 35,000
shares of Common Stock to Joseph Stevens & Company, Inc. (the "Placement
Agent Warrants"). The Placement Agent's Warrants were sold for a nominal
purchase price of $3.50, or $0.001 per warrant, and were exercisable at $3.00
per share during the period commencing November 26, 1998 and ending November
26, 2001. The Placement Agent's Warrants were cancelled on March 6, 1998. In
December 1997, the Company issued warrants to purchase 45,000 shares of
common stock of the Company to Troop Meisinger Steuber & Pasich, LLP
("TMSP"). The warrants issued to TMSP were issued for nominal consideration
of $45.00 and for legal services provided in connection with the Bridge
Financing (as defined below). These warrants are exercisable beginning
December 23, 1997 and ending December 31, 2002 at an exercise price of $3.00
per share. Each of Joseph Stevens & Company, Inc. and TMSP, represented that
(i) it acquired the warrants for its own account with the present intention
of holding such warrants for investment purposes only and not with a view to,
or for sale in connection with, any distribution of such warrants (other than
a distribution in compliance with all applicable federal and state securities
laws); (ii) it is an experienced and sophisticated investor and has such
knowledge and experience in financial and business matters that it is capable
of evaluating the relative merits and the risks of an investment in the
warrants and of protecting its own interest in connection with the
transaction at issue; (iii) it is willing to bear and is capable of bearing
the economic risk of an investment in the warrants; and (iv) the Company made
available, prior to the date of its warrant agreement, to it the opportunity
to ask questions of the Company and its officers, and to receive from the
Company and its officers information concerning the terms and conditions of
the warrant and the warrant agreement and to obtain any additional
information with respect to the Company, its business, operations and
prospects, as reasonably requested by it; and (v) it is an "accredited
investor" as that term is defined under Rule 501(a)(8) of Regulation D
promulgated by the Commission under the Securities Act. The issuance and sale
of these securities was exempt from the registration and prospectus delivery
requirements of the Securities Act pursuant to Section 4(2) of the Securities
Act (in accordance with Rule 506 of Regulation D and Rule 152 promulgated by
the Commission under the Securities Act) as a transaction not involving any
public offering.
On December 23, 1997, prior to the filing of the Registration Statement
with respect to the Offering, the Company completed a financing (the "Bridge
Financing") consisting of the sale of 20 units (the "Units"), each unit
comprised of: (i) an unsecured promising note (each a "Bridge Note") of the
Company in the principal amount of $20,000, bearing interest at a rate of 10%
per annum payable upon the earlier of the closing of the Offering or 18
months form the date of issuance; (ii) 15,000 shares of Common Stock of the
Company, and (iii) 5,000 warrants of the Company, each warrant exercisable to
purchase one share of Common Stock 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 warrants are issued (the "Bridge Warrants"). Each Unit was
sold for $50,000 generating gross proceeds to the Company of $1,000,000 and
net proceeds of $678,184. 60,000 of the Bridge Warrants are exercisable
during the period beginning November 26, 1998 and ending November 26, 2001.
37,500 of the Bridge Warrants are exercisable during the period beginning
December 16, 1998
25
<PAGE>
and ending December 16, 2001. 2,500 of the Bridge Warrants are exercisable
during the period beginning December 23, 1998 and ending December 23, 2001.
Prior to filing the Registration Statement with respect to the Offering, the
purchasers in the Bridge Financing had entered into binding agreements for
the purchase of the Units. 12 of the Units were sold on November 26, 1997,
7.5 of the Units were sold December 16, 1997, and 0.5 of the Units were sold
on December 23, 1997. The obligations of the purchasers were not subject to
any conditions within the control of the purchasers or any right of
renegotiation. All purchasers of Units in the Bridge Financing were brokerage
customers of Joseph Stevens & Company, Inc., the managing underwriter of the
Offering, who acted as placement agent and there was no public solicitation
or advertising in connection with the Bridge Financing. The transaction was
exempt from the registration requirements of the Securities Act of 1933 (the
"Act") under Section 4(2) of the Act (in accordance with Rule 506 of
Regulation D and Rule 152 promulgated by the Commission under the Act) as a
transaction not involving any public offering. The proceeds were used by the
Company for working capital, to repay indebtedness and to commence
construction of the Company's first ACSA Center.
On April 12, 1996, the Company sold 2,192,118 shares of its Common Stock
to Nancy Hundt for $200,000. On November 12, 1997, Ms. Hundt signed an
investment representation which states that she purchased the shares for her
own account and not with a view to resale or distribution. On April 12, 1996,
Ms. Hundt was appointed, and she accepted as a director of the Company. There
were no underwriters involved in the sale of these securities and there was
no public solicitation or advertisement by the Company in connection with the
sale of these securities. This transaction was exempt form the registration
requirements of the Act under section 4(2) of the Act and section 25102(f) of
the California Securities Law. The proceeds were used by the Company as
working capital to cover general start-up costs.
On April 12, 1996, the Company sold 1,096,059 shares of its Common Stock
each to James Ung and Mei Yang, who are married, each of whom paid $25,000 in
consideration therefor. On November 12, 1997, each of Mr. Ung and Ms. Yang
signed an investment representation which states that each of Mr. Ung and Ms.
Yang purchased the shares for their own accounts and not with a view to
resale or distribution. On April 12, 1996, Mr. Ung and Ms. Yang were
appointed, and they each accepted their appointment as a director of the
Company. There were no underwriters involved in the sale of these securities
and there was no public solicitation or advertisement by the Company in
connection with the sale of these securities. This transaction was exempt
from the registration requirements of the Act under section 4(2) of the Act
and section 25102(f) of the California Securities Law. The proceeds were used
by the Company as working capital to cover general start-up costs.
On April 7, 1997, the Company sold 65,764 shares of its Common Stock and
an option to purchase an additional 372,659 shares, which option expired
October 7, 1997, to Vince Yiang, the brother of Mei Yang, who paid $300,000
in consideration therefor. On November 12, 1997, Mr. Yiang signed an
investment representation in which Mr. Yiang represents that he purchased the
shares for his own account and not with a view to resale or distribution, and
that he has an individual net worth greater than $1.0 million. There were no
underwriters involved in the sale of these securities and there was no public
solicitation or advertisement by the Company in connection with the sale of
these securities. The transaction was exempt from the registration
requirements of
26
<PAGE>
the Act under section 4(2) of the Act. The proceeds were used by the Company
as general 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: August 14, 1998 /s/ Carl L Wood
Chief Financial Officer
27
<PAGE>
EXHIBIT INDEX
ITEM EXHIBIT PAGE
- ---- ------- ----
27 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 12,129,318
<SECURITIES> 0
<RECEIVABLES> 4,843,664
<ALLOWANCES> (83,850)
<INVENTORY> 4,407,368
<CURRENT-ASSETS> 21,558,263
<PP&E> 151,932
<DEPRECIATION> (16,318)
<TOTAL-ASSETS> 22,793,877
<CURRENT-LIABILITIES> 9,735,415
<BONDS> 0
0
0
<COMMON> 12,273,412
<OTHER-SE> 777,165
<TOTAL-LIABILITY-AND-EQUITY> 22,793,877
<SALES> 18,414,526
<TOTAL-REVENUES> 18,414,526
<CGS> 17,982,616
<TOTAL-COSTS> 528,852
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 27,000
<INTEREST-EXPENSE> 1,880
<INCOME-PRETAX> 49,149
<INCOME-TAX> 20,500
<INCOME-CONTINUING> 28,649
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 28,649
<EPS-PRIMARY> .00
<EPS-DILUTED> .00
</TABLE>
