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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, 1999
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)
<TABLE>
<S> <C>
California 95-4574138
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</TABLE>
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
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 [ ] No[X]
Indicate the number of shares outstanding of each of the issuer's classes
of stock as of the latest practicable date: 7,392,500 shares of Common Stock,
without par value, as of August 30, 1999.
The undersigned registrant hereby amends the following items in its
quarterly report on Form 10-Q for the quarter ended June 30, 1999, as set forth
below:
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CUMETRIX DATA SYSTEMS CORP.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
1. Condensed Balance Sheets - June 30, 1999 (unaudited) and
March 31, 1999
2. Condensed Statements of Operations - Three Months Ended June 30,
1999 and 1998 (unaudited)
3. Condensed Statements of Cash Flows - Three Months Ended June 30,
1999 and 1998 (unaudited)
4. Notes to Financial Statements (unaudited)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
PART II. OTHER INFORMATION
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
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CUMETRIX DATA SYSTEMS CORP.
BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS June 30, 1999 March 31, 1999
------------- --------------
(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................................ $ 5,577,751 $ 6,743,198
Time Deposits............................................................ 1,500,000 1,500,000
Trade receivables, net of allowance for doubtful accounts of
$295,000 and $280,000 at June 30, 1999 and March 31, 1999,
respectively............................................................ 1,465,451 1,864,685
Receivables from unauthorized parties.................................... - 87,000
Inventories.............................................................. 1,036,180 2,320,127
Income tax receivable.................................................... 262,430 262,430
Prepaid expenses......................................................... 20,141 149,555
------------- -------------
Total current assets.................................................... 9,861,953 12,926,995
FIXED ASSETS, net 477,956 504,363
OTHER ASSETS:
Investment in Affiliate.................................................. 728,768 878,000
Other.................................................................... 14,429 14,429
------------- -------------
Total Assets........................................................... $11,083,106 $14,323,787
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable......................................................... $ 1,492,692 $ 3,945,595
Accrued expenses......................................................... 561,412 556,964
Income taxes payable..................................................... 800 -
Current portion of long-term debt........................................ 3,743 4,054
------------- -------------
Total current liabilities.............................................. 2,058,647 4,506,613
LONG-TERM DEBT, net of current portion...................................... 4,142 4,810
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, 7,392,500 at June 30, 1999 and March 31, 1999.............. 12,063,414 12,063,414
Deficit.................................................................. (3,043,097) (2,251,050)
------------- -------------
Total shareholders' equity............................................. 9,020,317 9,812,364
------------- -------------
Total liabilities and shareholders' equity............................. $11,083,106 $14,323,787
============= =============
</TABLE>
The accompanying notes are an integral part of these condensed balance sheets.
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CUMETRIX DATA SYSTEMS CORP.
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1999 1998
---------- -----------
(unaudited)
<S> <C> <C>
NET SALES............................................................... $7,056,674 $18,414,526
COST OF PRODUCTS........................................................ 6,909,938 17,982,616
---------- -----------
Gross profit......................................................... 146,736 431,910
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES............................ 862,003 528,852
---------- -----------
Income(loss)from operations.......................................... (715,267) (96,942)
INTEREST INCOME......................................................... 72,645 147,971
INTEREST EXPENSE........................................................ (193) (1,880)
LOSS ON EQUITY INVESTMENT............................................... 149,232 -
---------- -----------
Income (loss) before provision for income taxes...................... (792,047) 49,149
PROVISION (BENEFIT)FOR INCOME TAXES..................................... - 20,500
---------- -----------
NET INCOME (loss)....................................................... (792,047) 28,649
========== ===========
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE............................. $ (0.11) $ 0.00
========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed statements.
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CUMETRIX DATA SYSTEMS CORP.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1999 1998
----------- -----------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)..................................................... $ (792,047) $ 28,649
Adjustments to reconcile net income (loss) to net cash and cash
equivalents provided by (used in) operating activities:
Depreciation and amortization.................................... 54,000 2,250
Provision for doubtful accounts.................................. 15,000 27,000
Loss on equity investment in affiliate........................... 149,232 -
Changes in assets and liabilities:
Trade receivables................................................ 471,234 (901,011)
Inventories...................................................... 1,283,947 (2,405,771)
Deferred taxes................................................... 68,350
Prepaid expenses................................................. 129,414 (150,483)
Accounts payable................................................. (2,452,903) 1,736,576
Accrued expenses................................................. 4,448 (469,447)
Income taxes payable............................................. 800 (717,013)
----------- -----------
Net cash (used in) operating activities........................ (1,136,875) (2,780,900)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets............................................. (27,593) (50,326)
----------- -----------
Net cash used in investing activities.......................... (27,593) (50,326)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net............................ - 11,230,823
Payments on notes..................................................... (979) (1,200,896)
Deferred offering costs............................................... - 514,927
----------- -----------
Net cash provided by (used in) financing activities............ (979) 10,544,854
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................... (1,165,447) 7,713,628
CASH AND CASH EQUIVALENTS, beginning of period.......................... 6,743,198 4,415,690
----------- -----------
CASH AND CASH EQUIVALENTS, end of period................................ $ 5,577,751 $12,129,318
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed statements.
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CUMETRIX DATA SYSTEMS CORP.
NOTES TO FINANCIAL STATEMENTS
June 30, 1999
(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
Exchange Commission (SEC). These statements should be read in conjunction with
the Company's March 31, 1999 audited financial statements and notes thereto
included in the Company's Form 10-K dated August 31, 1999, 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.
Certain balances have been reclassified to conform to the current year
presentation.
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).
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>
1999 1998
---------------------- ----------------------
<S> <C> <C>
Weighted average number of common shares outstanding-Basic 7,392,500 7,196,271
Dilutive effect of outstanding stock options - -
---------------------- ----------------------
Weighted average number of common shares outstanding-Diluted 7,392,500 7,196,271
====================== ======================
</TABLE>
3. Segment Information
At March 31, 1999, Cumetrix has two separately managed business segments,
Computer Products and Computer System Assembly. The accounting policies of the
segments are the same as those described in the significant accounting policies
in the March 31, 1999 Form 10-K; however, the Company evaluates performance
based on revenue only and does not separate assets between segments. Internet
based distribution, an emerging sales channel initiated in April 1999 which
supports both these business segments represents less than 10% of revenues for
the periods presented.
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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, 1999 and 1998. 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 (the "Computer Products Business"). In
December of 1996, the Company entered the system configuration business.
The Company substantially reduced its dependence on its Computer Products
Business at the end of fiscal 1999 as a result of the inability of the Company
to operate the business with gross margins sufficient to avoid recurring losses.
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 overall demand in the personal computer industry. The Company did not
fully anticipate the severity of this issue and did not react adequately. As a
result of these pricing pressures, the Company's margins were pressured and the
Company attempted to shift to higher margin wholesale computer product sales.
The Company was unable to be competitive in this area and business and operating
results were adversely affected.
The Company has also been attempting to implement its ACSA automated custom
software configuration assembly line solution. In this regard, the Company has
invested in fixed assets comprising an assembly line and related computer
equipment. The Company has also 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. However, the Company has not,
as of the date of this filing, implemented the configurator software or made any
significant use of the automated assembly lines installed at the Company's ACSA
Center. The Company has experienced substantial delays in its implementation of
the ACSA solution and although the Company has completed construction of the
first ACSA solution production line ("ACSA Center") located at the Company's
facility, the Company has not commenced use of the licensed custom configuration
software or implemented the ACSA Solution. The Company's initial ACSA strategy
included plans to implement the ACSA Solution through joint ventures, through
multiple ACSA Centers installed at assembly sites and through the resale of
licenses for the ACSA Solution software. The resolution of the Company's
dispute with CASI does not include rights to the Company for the resale of
licenses for the ACSA Solution
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software. Due in part to lengthy delays in implementing ACSA Services, competing
software configuration technologies have had an opportunity to gain market
acceptance and achieve a level of public recognition that may make it more
difficult for the Company to effectively market and sell ACSA services. The
Company does not expect the ACSA Center to be operational at its premises in
Industry, California prior to March 31, 2000 and a launch schedule is dependent
on the results of the Company's evaluation described above. As a result of these
delays, and subject to the evaluation conclusions, the Company will likely incur
additional costs and devote additional time to effect the implementation of the
ACSA Solution. The Company may not generate any revenues from the ACSA Solution.
Results of Investigation
On July 13, 1999 the Company announced the preliminary results of an
internal investigation into certain improprieties and record-keeping
irregularities. In connection with this investigation, James Ung, the President
of the Company and a director, and Mei Yang, the Secretary and Treasurer of the
Company and a director, have been relieved from all executive officer and
employment responsibilities held by them. The Company intends not to nominate
Mr. Ung and Ms. Yang for election as directors at the Company's next annual
meeting.
Additionally, the Audit Committee of the Company's Board of Directors
directed counsel to retain a special investigative unit of the Company's outside
auditors, Arthur Andersen LLP, to assist it in the investigation.
As a result of the investigation, the Company was not able to timely file
its Annual Report on Form 10-K. The Company has contacted the staff of the
Securities and Exchange Commission to provide complete details of the
preliminary results of the internal investigation.
Subject to its review of final conclusions of the investigation, the
Company will take appropriate actions to mitigate any damages to the Company
resulting from events giving rise to the investigation.
The record-keeping irregularities and other improprieties reported in the
conclusions of the investigation resulted in a reduction of reported revenues
and cost of products during the second and third quarters of fiscal 1999 of
$166,000 and $240,000, respectively, from previously reported revenues of
$19,418,109 and $16,251,491, respectively. Other record-keeping errors also
resulted in a reduction of reported net income during the second and third
quarters of $14,873 and $109,776 respectively, from previously reported net
income (loss) of $86,493 and ($110,006), respectively. As a result, the Company
has restated the financial statements set forth it in its Quarterly Reports on
Form 10-Q for the applicable periods.
Results of Operations
Three months ended June 30, 1999 and 1998
Net Sales. Net sales for the quarter ended June 30, 1999 were $7,056,674
compared to $18,414,526 for the quarter ended June 30, 1998. This decrease of
$11,357,852 in net sales is attributable to the Company's earlier decision to
reduce its dependence on the Computer Products business (specifically,
distribution of hard drives) as a response to a change in market conditions
which resulted in reduced gross margins and operating losses from this segment
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of the business.
Cost of Products. Cost of products decreased $11,072,678 from $17,982,616 to
$6,909,938 for the quarter ended June 30, 1999. This decrease is mainly
attributable to the reduction in net sales volumes as noted above.
Gross Profit. Gross profit for the quarter ended June 30, 1999 was $146,736
compared to $431,910 for the quarter ended June 30, 1998. Gross profit as a
percentage of net sales was 2.1% for the quarter ended June 30, 1999 compared to
2.3% for the quarter ended June 30, 1998. This represents a 9% decrease in gross
profit ratios, and is mainly attributable to current market conditions with
regard to pricing pressures facing the industry as a whole.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for quarter ended June 30, 1999 were $862,003 compared
to $528,852 for the quarter ended June 30, 1998.
The major components of selling, general and administrative expenses for
the periods include the following:
<TABLE>
<CAPTION>
June 30, June 30,
1999 1998
-------------------- --------------------
<S> <C> <C>
Payroll (including commissions) $ 430,000 $ 342,000
Rent 22,625 18,837
Legal, accounting and other 100,000 36,600
Credit and collection (including bad debt expense) 48,160 39,045
Depreciation & amortization 54,000 2,250
Outside services 75,040 11,056
Other (under 5%) 132,178 79,064
-------------------- --------------------
Total $ 862,003 $ 528,852
==================== ====================
</TABLE>
The increase of $333,151 in selling, general and administrative expenses is
attributable to increased staff and overhead to support the marketing activity
of the Company. SG&A costs in the period included higher insurance, legal and
accounting costs, costs related to the investigations, marketing costs related
to the start up of internet sales and distribution activities, and other costs
related to being a public company.
Interest Income
Interest income of $72,546 for the quarter ended June 30, 1999 is primarily
due to interest income earned on the investment of proceeds from the Initial
Public Offering.
Loss on Equity Investment
Loss on equity investment for the quarter ended June 30, 1999 was $149,232
which relates to the Company's investment in Online Transaction Technologies.
The Company's investment provided substantially all of OTT's working capital.
Net Loss
Net loss for the quarter ended June 30, 1999 was $792,047 compared to net
income of $28,649 for the quarter ended June 30, 1998. The increase in the net
loss of $820,696 is mainly attributable to the decrease in gross profit
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margins, the loss on equity investment, and higher selling, general and
administrative expenses, including charges relating to the investigations,
offset by interest income.
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.
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 March 31, 1999, the Company's Finova line was $20 million
and the Company had a payable to Finova Capital Corporation of approximately
$1,285,659 included in accounts payable. The Company has not provided audited
year end financial statements to Finova by June 29, 1999, and thus is not in
compliance with their agreement. Finova has waived this covenant until October
31, 1999.
Net cash used by operating activities during the quarter ended June 30,
1999 was primarily attributable to a loss from operations and decreases in
accounts payable, inventories and trade receivables.. Net cash used in
investing activities was due to purchases of fixed assets.
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 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 the Company and its
stockholders.
Risks Associated with the Year 2000 Problem
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General
The Company has undertaken a Year 2000 Project (the "Project"). The
Project addresses the issue of whether computer programs and imbedded computer
chips will be able to distinguish between the years 1900 and 2000.
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 completed the implementation of a new accounting system that is Year
2000 Compliant.
The Company continues to assess the computer systems of customers, vendors
and other outside parties with whom the Company does business. The Company
began this assessment during the third quarter of fiscal 1999. This assessment
to date has not revealed significant potential problems requiring the Company to
incur substantial costs.
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 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 and correcting 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
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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.
The Company has been informed that its telephone system is not Year 2000
Compliant. The Company has determined to purchase a new phone system that is
Year 2000 Compliant in the current quarter and does not believe the costs
associated with this purchase will be more than $15,000.
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
Delisting
The Company's stock has been delisted from Nasdaq and the Boston Stock
Exchange for failure to meet their standards--primarily due to the Company's
failure to keep current its reports to the Securities Exchange Commission,
pursuant to the Securities Exchange Act of 1934.
Delisting will materially adversely affect the trading market for the
Common Stock and the Company's access to the capital markets. It will be
necessary for the Company to re-apply for initial listing once it determines
that it can meet the initial listing requirements. The Company currently cannot
qualify for initial listing with Nasdaq and it may never meet those
qualifications.
The closing sale price of our Common Stock on August 30, 1999 was $2.25 per
share. Because the Common Stock is delisted from trading on Nasdaq and the
Boston Stock Exchange and the trading price is less than $5.00 per share,
trading in it is subject to the requirements of Rule 15g-9 promulgated under the
Securities Exchange Act of 1934. Under this rule, broker/dealers who recommend
these 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 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 with the penny stock market. These requirements
would likely severely limit the market liquidity of our Common Stock and the
ability of our shareholders to dispose of their shares, particularly in a
declining market.
We face significant litigation risks resulting from our internal investigation.
In connection with the Audit Committee's investigation into certain
improprieties and record-keeping irregularities, James Ung, our President, a
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Director and a significant shareholder, and Mei Yang, our Secretary, a Director
and a significant shareholder, were relieved of all executive officer and
employment responsibilities. During the course of the investigation, our Audit
Committee uncovered evidence of the unauthorized resale of certain software.
Mr. Ung and Ms. Yang each were party to employment agreements with the
Company. A termination of James Ung without "cause" (as defined in the
employment agreement), would require the payment to Mr. Ung of an amount equal
to 6 months of his then current base salary. Ms. Yang was not entitled to any
payments upon a termination without cause. Based on the information uncovered
during the investigation, we elected to treat Mr. Ung's and Ms. Yang's relief of
their executive officer and employment responsibilities as terminations for
"cause" (as defined in the employment agreements). Mr. Ung and Ms. Yang may
allege breach of their employment agreements or other injury resulting from
alleged wrongful termination of employment, libel, slander, or other alleged
wrongful or tortious acts.
In addition, due to our unauthorized resale of certain software, we face a
risk of litigation alleging damages, including punitive damages, resulting from
these unauthorized sales.
James Ung and Mei Yang continue to serve on the Board of Directors and are
significant shareholders.
We face significant risks resulting from our recent changes in high-level
management personnel and anticipated director changes.
The Board of Directors has indicated that it does not intend to nominate
James Ung or Mei Yang to serve as directors at our 1999 Annual Meeting of
Shareholders. We may be unable to locate qualified individuals to accept the
nomination of director or, if nominated, our shareholders may not elect such
individuals. The management and Board of Director changes may cause significant
disruption to our operations and relationships with vendors and customers.
These disruptions could have a material adverse affect on the Company's
business.
We operated at a loss during the year ended March 31, 1999, and we anticipate
continuing to operate at a loss for the foreseeable future.
For the year ended March 31, 1999, our net loss was $2,999,566 compared to
net income of $723,152 for the year ended March 31, 1998. Further, due to the
significant development and marketing costs we have and will incur in the
implementation of our internet strategy, we foresee operating at a loss for the
foreseeable future. If, other than in the short run, we continue to operate at
a loss and are unable to finance our operations through additional sales of our
securities, we risk our ability to continue as a going concern.
We have only limited experience with Internet and e-commerce operations.
We have only been selling products via our suredeals.com website since
-------------
April 1999 and have not yet provided products via sureauctions.com, our auctions
----------------
website. While we have attempted to consult with experienced Internet
professionals in the development of these websites, we have only limited
knowledge and experience with Internet and e-commerce operations. We can give
no assurance that our Internet strategy will achieve market acceptance, or that
our Internet websites will ever achieve profitability.
-xiii-
<PAGE>
We face intense competition in the Internet e-commerce industry.
We face intense competition in the Internet e-commerce industry from other
e-commerce businesses, many of whom have significantly greater access to
capital, significantly greater name or brand recognition in the market, and
greater experience in the Internet e-commerce industry. In the computer
products e-commerce business, these competitors include Valueamerica, Buy.com,
Onsale, Dell, Gateway, etc. We can give no assurance that we will be able to
compete successfully against these or other Internet e-commerce competitors.
Further, due to the relatively low cost of developing and implementing an e-
commerce website, we are likely to encounter competition from additional
companies other than those set forth above.
We have only a limited operating history.
We commenced operations in April 1996. Therefore, there is only limited
financial information in existence upon which an investment decision may be
based. Although we were profitable as of March 31, 1998, we did not achieve
profitability for our fiscal year 1999. The Company's ability to regain
profitability will depend in part upon its ability to compete successfully in
the Internet e-commerce industry. Our likelihood of success in competing in the
Internet e-commerce industry must be considered in light of our inexperience in
the industry and the relative strength of our competitors. Our likelihood of
success in implementing our ACSA Centers must be considered in light of the
difficulties and risks inherent in a new business. Revenues may not increase
significantly in the future and the Company may never achieve profitable
operations from its Internet e-commerce business or its ACSA Center business.
The Company may never be profitable again.
Our future operating results may fluctuate and are unpredictable. If we fail to
meet the expectations of public market analysts and investors, the market price
of our common stock may decline significantly.
Our limited operating history and the recent change in the focus of our
business make it difficult to forecast accurately our revenues, operating
expenses and operating results. As a result, we may be unable to adjust our
spending in a timely manner to compensate for any unexpected revenue shortfall.
We may also be unable to increase our spending and expand our operations in a
timely manner to meet customer demand should it exceed our expectations.
Our future operating results may fluctuate significantly due to a variety of
factors, many of which are outside of our control. These factors include, but
are not limited to:
. our ability to retain existing customers, attract new customers and
maintain customer satisfaction;
. the introduction of new or enhanced Web pages, services and products;
price competition or higher wholesale prices; our ability to manage inventory
levels;
. decreases in the number of visitors to our Web sites or our inability to
convert visitors to our Web sites into customers;
. the termination of existing, or failure to develop new, strategic
marketing relationships through which we receive exposure to traffic on third-
party Web sites; increases in the cost of online or offline advertising;
. our ability to attract new personnel in a timely and effective manner or
retain existing personnel; unexpected increases in shipping costs or
-xiv-
<PAGE>
delivery times; government regulations related to use of the Internet for
commerce;
. our ability to maintain, upgrade and develop our Web sites, transaction
processing systems or network infrastructure; technical difficulties, system
downtime or Internet brownouts;
. the amount and timing of operating costs and capital expenditures
relating to expansion of our business, operations and infrastructure;
. and the timing of promotions and sales programs.
As a result of the factors listed above, our quarterly or annual results of
operations in future periods may not meet the expectations of securities
analysts or investors. This could result in a decline in the value of our
common stock.
We face risks related to a shift in our business strategy.
As described in the section entitled "Business," above, we have shifted
away from the computer products distribution business to an Internet e-commerce
and system configuration businesses, and we intend to focus our marketing and
development efforts into the Internet e-commerce and systems configuration
businesses in the future. However, if we are not successful in our efforts to
generate significant revenues from our Internet e-commerce and system
configuration businesses, our revenues will decrease significantly. There can
be no assurance that we will be successful in our efforts to generate
significant revenues from our Internet e-commerce and system configuration
businesses.
We are dependent upon key personnel.
On September 8, 1999, the Board of Directors of the Company elected John L.
Davidson as its President and Chief Executive Officer. Although we have
recently reassigned Max Toghraie, formerly our Chief Executive Officer, and Jeff
Toghraie, formerly our Chief Operating Officer to the positions of Executive
Vice President and Vice President Marketing, respectively we continue to be
dependent upon each for their services. Our success to date has been in part
dependent upon their efforts and abilities, and the loss of their services for
any reason could have a material adverse effect. In addition, while we have
historically employed executives and employees with knowledge and experience in
the computer products distribution industry, we are attempting to employ
executives and employees with significant knowledge and abilities in the
Internet e-commerce and system configuration industries. Our future success
will be strongly influenced by our ability to continue to recruit, train and
retain a skilled work force. While we believe that we would be able to locate
suitable replacements for our executives or other personnel if their services
were lost to us, there can be no assurance that we would be able to do so on
terms acceptable to us. We maintain a key-man life insurance policy on the life
of Max Toghraie with benefits of $1,000,000, payable to us in the event of his
death. We do not believe that any benefits received under this policy would be
sufficient to compensate us for the loss of Max Toghraie's services should a
suitable replacement not be employed. We do not maintain a key-man life
insurance policy on the life of Jeff Toghraie.
We may be required to seek additional financing to fund continued operations.
Our Internet e-commerce business is capital intensive, because we are
required to finance the purchase of Computer Products in order to fill sales
orders. In order to obtain necessary capital, we rely primarily on unsecured
-xv-
<PAGE>
vendor credit lines and a line of credit provided by Finova Capital Corporation.
Our line of credit with Finova is collateralized by accounts receivable and
inventory. We are currently in breach of one of our financial covenants to
Finova. As a result, the amount of credit available to us may be adversely
affected by factors such as delays in collection or deterioration in the quality
of our accounts receivable, economic trends in the Internet e-commerce or
computer industries, interest rate fluctuations and the lending or credit
policies of the Company's lenders and vendors. Many of these factors are beyond
our control.
Further, we must obtain Finova's written permission prior to arranging
other financing, and Finova may require certain acknowledgments. 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 us under
our financing arrangements or vendor credit lines will limit our ability to fill
existing sales orders or expand our sales levels and, therefore, could have a
material adverse effect on the Company's financial position, operating results,
and cash flows. In addition, while we do not have significant exposure to
interest rate fluctuations under our current financing, any significant
increases in interest rates will increase the cost of possible future financing
which could have a material adverse effect on our financial position, operating
results, and cash flows.
We face risks of product returns.
As is typical of Internet e-commerce retailers, we incur expenses as a
result of the return of products by customers. Further, we may continue to
incur expenses from the return of products sold through our computer products
distribution business. Returns may result from defective goods, inadequate
performance relative to customer expectations, shipping errors and other causes,
many of which are outside of our control.
We face risks related to our attempts to implement ACSA, which has been faced
with numerous delays.
Our ability to successfully implement, market and introduce the ACSA
Solution services on a timely basis will be a significant factor in our ability
to improve our operating margins and remain competitive. Our ability to market
the ACSA Solution successfully will depend on our ability to convince potential
customers of the benefits of the ACSA Solution. While we have completed the
physical construction of an ACSA Center at our offices in Industry, California,
no ACSA Center is currently operational and we currently have no sales revenue
attributable to ACSA. Although we have had general discussions with a number of
potential customers, there can be no assurance that these discussions will lead
to significant sales of the ACSA Solution, or that the market will accept the
ACSA Solution. There can be no assurance we will successfully implement, market
and sell ACSA Solution services. If we fail to anticipate or respond in a cost-
effective and timely manner to market trends or customer requirements, or
further delay significantly the introduction of ACSA services, our business,
operating results and financial condition could suffer.
The success of ACSA is partially dependent upon the assistance and cooperation
of a third party vendor.
Under our 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 ACSA, and retains all
rights to modify and enhance the Configurator software. CASI has agreed to
provide us with all enhancements and upgrades to the
-xvi-
<PAGE>
Configurator software used internally or distributed by CASI to its customers,
and to develop additional enhancements requested by us at our expense. If CASI
fails to promptly and adequately perform its obligations under its license
agreement with us, our ability to exploit fully the ACSA Solution would likely
suffer. Because we have no capability to develop internally any enhancements or
upgrades to the software, if CASI fails or delays to fulfill our anticipated
needs for enhancement and upgrading of the Configurator software, it will be
significantly more difficult for us to market ACSA services and to become and
remain competitive in the software configuration market.
We have only a limited ability to market our products.
Our operating results will depend to a large extent on our ability to
successfully market our Internet e-commerce and auction websites and our ACSA
services to personal computer manufacturers and multi-user system buyers. We
currently have limited marketing capability. While we intend to market
aggressively our Internet e-commerce and auction websites and our ACSA services,
there can be no assurance that our marketing efforts will be successful.
We face risks from rapidly changing technology.
The market for ACSA technology is characterized by rapidly changing
technology and frequent new product introductions. Even if ACSA gains initial
market acceptance, our long term success will depend, among other things, upon
our ability to enhance ACSA services and to develop and introduce new products
and services that keep pace with technological developments.
Further, due to our lengthy delays in implementing ACSA services, competing
software configuration technologies have had an opportunity to gain market
acceptance and achieve a level of public recognition that may make it more
difficult for us to effectively market and sell ACSA services. There can be no
assurance that we 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 we will be able to respond
effectively to technological changes or product announcements by competitors.
If we fail to anticipate or respond adequately to technological developments and
customer requirements or delay significantly product development or
introductions, we could lose market share and revenues.
We face risks arising from seasonality.
A significant portion of our business is expected to be derived from the
consumer market, which is characterized by seasonality. Sales tend to be higher
in the back-to-school period and pre-holiday period. As a result, sales tend to
be lower in other periods, particularly in the summer months. Because our
expenses are to a large extent fixed, this results in generally weaker operating
results in the summer months.
We face risks arising from industry cyclicality.
The personal computer industry has been affected historically by general
economic downturns, which have had an adverse economic effect upon resellers and
manufacturers of personal computers 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 personal computers. Any
downturns in the personal computer component distribution industry, or the
personal computer industry in general, could adversely affect our business and
results of operations.
-xvii-
<PAGE>
We do not anticipate declaring dividends in the foreseeable future.
We have never declared or paid dividends on our Common Stock and we do not
intend in the foreseeable future to declare or pay any cash dividends. Instead,
we intend to retain earnings, if any, for the future operation and expansion of
our business.
Disclosure regarding forward-looking statements.
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934 and Section 27A of the Securities Act of 1933. 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 Filing, 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 1999, 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 1999, the quarterly
filings on Form 10-Q filed by the Company during the remainder of fiscal 2000,
and any current filings on Form 8-K filed by the Company.
-xviii-
<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 pending
action is material to its results of operation or financial condition.
ITEM 2. CHANGES IN SECURITIES
None.
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: October 8, 1999 /s/ Carl L. Wood
Chief Financial Officer
-xix-
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