<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED December 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 001-14001
CUMETRIX DATA SYSTEMS CORP.
(Exact Name of Registrant as Specified in its Charter)
California 95-4574138
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Identification No.)
Organization)
957 Lawson Street, Industry, California 91748
(Address, Including Zip Code, Of Registrant's Principal Executive Offices)
(626) 965-6899
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Security Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the last 90 days. Yes [X] No [_]
As of February 16, 1999, the Registrant had 7,452,500 shares of Common
Stock, without par value, issued and outstanding.
<PAGE>
CUMETRIX DATA SYSTEMS CORP.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
1. Condensed Balance Sheets - December 31, 1998 and March 31, 1998
2. Condensed Statements of Operations - Three Months Ended December
31, 1998 and 1997
3. Condensed Statements of Operations - Nine Months Ended December
31, 1998 and 1997
4. Condensed Statements of Cash Flows - Nine Months Ended December
31, 1998 and 1997
5. Notes to Financial Statements
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
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
________________________________________________________________________________
Page 2
<PAGE>
CUMETRIX DATA SYSTEMS CORP.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS December 31, March 31,
1998 1998
------------ -----------
(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents.......................... $ 9,439,425 $ 4,415,690
Trade receivables, net of allowance for
doubtful accounts of $137,000 and $57,000 at
December 31, 1998 and March 31, 1998,
respectively...................................... 3,951,435 3,885,803
Inventories........................................ 3,580,356 2,001,597
Deferred taxes..................................... 210,848 133,647
Prepaid expenses................................... 186,172 45,983
----------- -----------
Total current assets............................. 17,368,236 10,482,720
----------- -----------
FIXED ASSETS, net................................... 347,623 87,538
DEFERRED OFFERING COSTS............................. - 514,927
CAPITALIZED PURCHASED SOFTWARE COSTS................ 1,100,000 1,100,000
INVESTMENT.......................................... 100,000 -
----------- -----------
Total Assets..................................... $18,915,859 $12,185,185
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................... $ 6,012,887 $ 7,822,652
Accrued expenses................................... 174,380 641,844
Income taxes payable............................... 6,102 717,013
Current portion of long-term debt.................. 3,962 1,203,707
----------- -----------
Total current liabilities........................ 6,197,331 10,385,216
----------- -----------
LONG-TERM DEBT, net of current portion.............. 5,860 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 December 31, 1998 and
March 31, 1998, respectively...................... 12,032,342 1,042,589
Retained earnings.................................. 680,326 748,516
----------- -----------
Total shareholders' equity....................... 12,712,668 1,791,105
----------- -----------
Total liabilities and shareholders' equity....... $18,915,859 $12,185,185
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed balance sheets.
________________________________________________________________________________
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<PAGE>
CUMETRIX DATA SYSTEMS CORP.
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended
December 31,
1998 1997
------------ -----------
(unaudited)
<S> <C> <C>
NET SALES........................................... $16,011,491 $19,799,736
COST OF PRODUCTS.................................... 15 45,340 18,972,036
----------- -----------
Gross profit....................................... 466,151 827,700
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES........ 861,829 418,866
----------- -----------
Income (Loss) from operations...................... (395,678) 408,834
INTEREST EXPENSE.................................... 1,894 12,625
INTEREST INCOME..................................... 101,071 10,082
----------- -----------
Income (loss) before provision (benefit) for
income taxes....................................... (296,501) 406,291
PROVISION (BENEFIT) FOR INCOME TAXES................ (121,822) 162,516
----------- -----------
NET INCOME (LOSS)................................... (174,679) 243,775
=========== ===========
BASIC AND DILUTED EARNINGS PER SHARE................ $ (0.02) $ 0.05
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed statements.
CUMETRIX DATA SYSTEMS CORP.
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Nine Months Ended
December 31,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
(unaudited)
NET SALES........................................... $53,678,126 $49,175,291
COST OF PRODUCTS.................................... 52,245,703 47,100,756
-----------
Gross profit....................................... 1,432,423 2,074,535
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES........ 1,963,524 1,029,504
----------- -----------
Income (Loss) from operations...................... (531,101) 1,045,031
INTEREST EXPENSE.................................... 4,098 13,908
INTEREST INCOME..................................... 421,738 10,723
----------- -----------
Income before provision for income taxes........... (113,461) 1,041,846
PROVISION FOR INCOME TAXES.......................... (45,271) 416,738
----------- -----------
NET INCOME.......................................... (68,190) 625,108
=========== ===========
BASIC AND DILUTED EARNINGS PER SHARE................ $ (0.01) $ 0.13
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed statements.
________________________________________________________________________________
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<PAGE>
CUMETRIX DATA SYSTEMS CORP.
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
December 31,
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................ $ (68,190) $ 625,108
Adjustments to reconcile net income to net
cash and cash equivalents used in operating
activities:
Depreciation and amortization.................. 18,900 2,847
Amortization of deferred financing costs....... - 12,100
Provision for doubtful accounts................ 128,000 56,310
Loss on receivable from director............... - 100,000
Options issued for services.................... 21,000 -
Changes in assets and liabilities:
Trade receivables.............................. (193,632) (2,284,437)
Inventories.................................... (1,578,759) (2,391,716)
Deferred taxes................................. (77,201) (41,788)
Prepaid expenses............................... (174,488) (18,830)
Other.......................................... 34,299 (129,250)
Accounts payable............................... (1,809,765) 5,258,818
Accrued expenses............................... (467,464) 22,450
Income taxes payable........................... (710,911) 393,713
----------- -----------
Net cash provided(used) by operating
activities................................... (4,878,211) 1,605,325
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets......................... (278,985) (8,684)
Receivables from related parties.................. - 39,700
Purchase of Capitalized Software Costs............ - (150,000)
Cash paid for investment.......................... (100,000) -
----------- -----------
Net cash provided (used) in investing
activities................................... (378,985) (118,984)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net........ 11,203,472 -
Payments on bank borrowings....................... - (2,516)
Proceeds from Note................................ - 550,000
Payments on long-term debt........................ (1,202,749) -
Payments on Notes................................. - (300,000)
Proceeds from stock issuance...................... 65,281 749,200
Deferred offering costs........................... 514,927 -
Purchase of Stock from Shareholder................ (300,000) -
----------- -----------
Net cash provided by financing activities..... 10,280,931 996,684
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS.......... 5,023,735 2,483,025
CASH AND CASH EQUIVALENTS, beginning of period..... 4,415,690 479,796
----------- -----------
CASH AND CASH EQUIVALENTS, end of period........... $ 9,439,425 $ 2,962,821
=========== ===========
CASH PAID FOR INTEREST 1,894 1,808
CASH PAID FOR INCOME TAXES 730,000 13,000
</TABLE>
The accompanying notes are an integral part of these condensed statements.
________________________________________________________________________________
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<PAGE>
CUMETRIX DATA SYSTEMS CORP.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998
(Unaudited)
1. Restatement of Prior Financial Statements
The accompanying amended 10-Q for the three months ended December 31, 1998
and nine months ended December 31, 1998 restates previously issued financial
statements due to improper revenue recognition. The restatement decreased sales
and cost of sales by $240,000 for the three months ended December 31, 1998 and
decreased sales and cost of sales by $406,000 for the nine months ended December
31, 1998. Additional expenses of $109,776 were recognized for the three months
ended December 31, 1998 which resulted in an increase in net losses for the
quarter of $64,673. Additional expenses for the nine months ended December 31,
1998 amounted to $124,649 which resulted in an increase in net losses of
$73,326. For further information, refer to the financial statements and notes
thereto for the year ended March 31, 1999.
2. 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.
3. Earnings Per Common Share
Earnings per share calculations are in accordance with SFAS No. 128,
"Earnings per Share" (SFAS 128). Accordingly, "basic" earnings per share is
computed by dividing net income by the weighted average number of shares
outstanding for the year. "Diluted" earnings per share is computed by dividing
net income by the total of the weighted average number of shares outstanding
plus the dilutive effect of outstanding stock options (applying the treasury
stock method). Earnings per share amounts for 1997 have been restated to reflect
the adoption of SFAS No. 128.
A reconciliation of the basic weighted average number of shares outstanding
and the diluted weighted average number of shares outstanding for each of the
three and nine month periods ended December 31, follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average number
of common shares
outstanding-Basic 7,432,087 4,499,444 7,355,773 4,477,590
Dilutive effect of
outstanding stock
options and warrants - 134,348 226,200 78,394
--------- --------- --------- ---------
Weighted average number
of common shares
outstanding-Diluted 7,432,087 4,633,792 7,581,973 4,555,984
========= ========= ========= =========
</TABLE>
________________________________________________________________________________
Page 6
<PAGE>
4. Reclassifications
Certain amounts in the 1997 Financial Statements have been reclassified to
conform to the 1998 presentation.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Overview
The Company was founded in April 1996, and until December of 1996 operated
entirely as a distributor and value added reseller of computer equipment and
related hardware components and software peripherals. In December of 1996, the
Company entered the system configuration business. This process required certain
organizational and operational changes to effectively position the Company as a
provider of configuration and integration solutions to various levels within the
distribution, integration and end-user markets.
In order to enhance its competitive advantage in the systems integration
market, the Company has entered into a perpetual non-exclusive licensing
agreement with Computer Aided Software Integration, Inc. ("CASI") to license
CASI's Configurator software for use in the development and commercialization of
the Company's ACSA Solution. The Company paid CASI a one-time license fee of
$1.1 million. The payments for the license agreement 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.
Although the Company had anticipated implementing the ACSA Solution by
December 31, 1998, the Company has experienced significant delays in
implementing the ACSA Solution due primarily to a dispute related to the
Reseller Agreement dated September 15, 1997, with CASI and CASI's subsequent
refusal to provide the Company with the necessary training to operate its
Configurator software and related technical support. CASI is obligated to
provide such training and technical support to the Company under the terms of
the License Agreement, dated September 15, 1997, by and between the Company and
CASI, pursuant to which the Company licensed the Configurator software. The
Company is attempting to resolve the delays it is experiencing with CASI. The
delays in implementing the ACSA Solution also result, in part, from staff
turnover. While there can be no assurance, the Company currently anticipates the
availability of the ACSA Solution in the fourth quarter of fiscal year 1999.
Delays in implementing the ACSA Solution have caused the Company to derive its
revenues almost exclusively from the Company's computer products distribution
business, which has gross margins significantly lower than those the Company
believes to be available in the system configuration business. In light of high
legal expenses inherant in litigating the matter, the company opted to negotiate
an amicable resolution with CASI. Based on current discussions, the Company
believes that it will reach an amicable outcome in this matter with CASI.
However, there can be no assurance that the Company will succeed in reaching a
solution to the dispute with CASI that is acceptable to the Company.
Competitive factors in the Computer Products market include price, service
and support, the variety of products offered, and marketing and sales
capabilities. While the Company believes that it competes successfully with
respect to most, if not all of these factors, there can be no assurance that it
will continue to do so in the future. The industry has come to be characterized
by aggressive price cutting which intensified in the first quarter of fiscal
1999 as a result of industry wide pricing pressures resulting from excess
supplies from major manufacturers and reduced demand in the overall personal
computer industry. These factors can in part be traced to the economic slow-down
in Asia and excess worldwide build up of personal computers in the first
calendar quarter of 1998. The Company expects that these factors may continue to
sustain pricing pressures at least until the end of the fourth fiscal quarter
and possibly longer. As a result of these pricing pressures, the Company's
margins have been pressured and the Company has declined to compete for certain
lower margin business. However, the Company will need to continually provide
competitive prices, superior product
________________________________________________________________________________
Page 7
<PAGE>
selection and delivery response time in order to remain competitive. If the
Company were to fail to compete favorably with respect to any of these factors,
the Company's business and operating results may be adversely affected.
Also, the Company's business is subject to certain quarterly influences.
Historically, net sales and operating profits were 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. The Company's lower sales in the
third fiscal quarter ended December 31, 1998 as compared to December 31, 1997,
however, run counter to these quarterly influences, a result the Company
attributes to its unwillingness to compete for low margin business in the
hardware distribution market.
During the third quarter, the Company began the implementation of an
internet strategy designed to give the Company e-commerce and internet auction
capabilities. The Company has begun to form a wholly-owned subsidiary to focus
on the Company's internet initiatives.
In December, 1998, the Company purchased Preferred Stock of Online
Transactions Technologies, Inc., a California corporation ("OTT"), which
develops e-commerce and internet auction websites for $100,000. On February 1,
1999, the Company exercised an option to purchase $900,000 of additional
Preferred Stock in OTT for a 27.8% equity stake in OTT on a fully-diluted basis.
The Company holds an option to purchase up to an aggregate 50% equity stake in
OTT. The Company has begun to work with OTT to develop and implement the
Company's internet strategy, which it expects to include e-commerce and internet
auction websites.
The implementation of the Company's internet strategy will result in the
Company incurring significant expenses in the fourth quarter which will not be
offset by internet-related revenues.
This discussion summarizes the significant factors affecting the operating
results, financial condition and liquidity/cash flows of the Company for the
quarters ended December 31, 1998 and 1997 and nine months ended December 31,
1998 and 1997. The Company has a limited history of operations.
Special Note Regarding Forward-Looking Information
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the 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 and results of operations of the Company and (b) the
business and growth strategies of the Company. The shareholders of the Company
are cautioned not to put undue reliance on such forward-looking statements. Such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties. Actual results may differ materially from those
projected in this Report, for the reasons, among others, discussed in "Future
Operating Results" below and under the caption, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Risk Factors" in
the Company's Annual Report on Form 10-K for Fiscal 1998, filed with the
Securities and Exchange Commission. The Company undertakes no obligation to
publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof. Readers should carefully review
the risk factors referred to above and the other documents the Company files
from time to time with the Securities and Exchange Commission, including the
Company's Annual Report on Form 10-K for the fiscal year 1998, the quarterly
reports on Form 10-Q filed by the Company during the remainder of fiscal 1999,
and any current reports on Form 8-K filed by the Company.
________________________________________________________________________________
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<PAGE>
Results of Operations
Three Months Ended December 31, 1998 and 1997.
Net Sales. Net sales for the quarter ended December 31, 1998 were
$16,011,491 compared to $19,799,736 in the previous year. This decrease of
$3,788,245 or 19.1% in net sales results from sustained industry oversupply,
resulting pricing pressures and the Company's determination to attempt to defend
margins, where the Company has increased gross profits as a percentage of net
sales from 2.8% in the second quarter to 2.9% in the third quarter, rather than
pursue sales growth through low margin sales. Net sales declined from
$19,252,109 in the second quarter to $16,011,491 primarily due to the Company's
unwillingness to compete for lower margin business in the computer products
distribution business. 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 decreased $3,426,696 from $18,972,036 to
$15,545,340 for the quarter ended December 31, 1997 and 1998, respectively. This
decrease is mainly attributable to the decrease in net sales.
Gross Profit. Gross profit for the quarter ended December 31, 1998 was
$466,151 compared to $827,700 in the quarter ended December 31, 1997. Gross
profit as a percentage of net sales was 2.9% for the quarter ended December 31,
1998 compared to 4.2% for the quarter ended December 31, 1997. This represents a
31.0% decrease in gross profit percentage, and is mainly attributable to
industry oversupply and the resulting pricing pressures facing the industry as a
whole. As discussed under "Net Sales" above, the Company increased gross profits
as a percentage of net sales from 2.8% in the second quarter to 2.9% in the
third quarter.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for quarter ended December 31, 1998 were $861,829
compared to $418,866 for the quarter ended December 31, 1997.
The major components of selling, general and administrative expenses for
the periods include the following:
<TABLE>
<CAPTION>
Three Months Ended
December 31,
1998 1997
------- --------
<S> <C> <C>
Payroll (including commissions) 395,000 327,000
Rent 18,000 11,000
Insurance 27,000 5,000
Advertising/Brochure 18,000 1,000
Legal, Accounting and other professional services 53,000 1,000
Credit and Collection 100,000 38,000
Public Relations 27,000 -
Other (under 5%) 223,829 35,866
------- -------
Total 861,829 418,866
======= =======
</TABLE>
The increase of $442,963 in selling, general and administrative expenses is
attributable to increased staff and overhead to support the higher levels of
sales and marketing activity. In addition, the Company hired additional
personnel in finance and administration to facilitate growth of the Company's
infrastructure and revenue expansion. SG&A costs in the quarter included rent in
a larger facility, D&O insurance costs, legal and accounting costs, an
additional provision for bad debt expense, and other costs related to being a
public company. In addition, in accordance with FAS No. 123, the Company has
included in SG&A a non-cash charge of $21,000 to public relations expense and a
corresponding credit to Paid in Capital upon issuance of options to outside
________________________________________________________________________________
Page 9
<PAGE>
Interest Income
Interest income of $101,071 for the quarter ended December 31, 1998 is
primarily due to interest income earned on the investment of proceeds from the
initial public offering.
Net Income
Net loss for the quarter ended December 31, 1998 was $174,679 compared to
net income of $243,775 for the quarter ended December 31, 1997. The decrease of
$418,454 is mainly attributable to the decrease in sales, gross profit, higher
selling, general and administrative expenses, offset by interest income.
Nine Months Ended December 31, 1998 and 1997.
Net Sales. Net sales for the nine months ended December 31, 1998 were
$53,678,126 compared to $49,175,291 in the previous year. This increase of
$4,502,835 or 9.2% in net sales is attributable to growth of the Company's
sales force and an increase in the Company's available combined purchasing
credit (including its vendor credit and a new credit facility of $25 million,
consisting of a $20 million flooring line of credit and a $5 million revolving
line of credit (together, the "Finova Line"), from Finova Capital Corporation
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 $5,144,947 from $47,100,756 to
$52,245,703 for the nine months ended December 31, 1997 and 1998, respectively.
This increase is mainly attributable to the increase in net sales.
Gross Profit. Gross profit for the nine months ended December 31, 1998 was
$1,432,423 compared to $2,074,535 in the nine months ended December 31, 1997.
Gross profit as a percentage of net sales was 2.7% for the nine months ended
December 31, 1998 compared to 4.2% for the nine months ended December 31, 1997.
This represents a 35.7% decrease in gross profit percentage, and is mainly
attributable to industry oversupply and the resulting pricing pressures facing
the industry as a whole.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for nine months ended December 31, 1998 were $1,963,524
compared to $1,029,504 for the nine months ended December 31, 1997.
The major components of selling, general and administrative expenses for
the periods include the following:
<TABLE>
<CAPTION>
Nine Months Ended
December 31,
1998 1997
--------- ---------
<S> <C> <C>
Payroll (including commissions) 1,069,000 707,000
Rent 54,000 36,000
Insurance 72,000 13,000
Advertising/Brochure 24,000 1,000
Legal, Accounting and other professional services 147,000 5,000
Credit and Collection 190,000 99,000
Public Relations 27,000 -
Write-off of related party receivable - 100,000
Other (under 5%) 380,524 68,504
--------- ---------
Total 1,963,524 1,029,504
========= =========
</TABLE>
________________________________________________________________________________
Page 10
<PAGE>
The increase of $934,020 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 nine months ended December 31, 1997. In addition, the Company
hired additional personnel in finance and administration to facilitate growth of
the Company's infrastructure and revenue expansion. SG&A costs in the period
included rent in a larger facility, D&O insurance costs, legal and accounting
costs, an additional provision for bad debt expense, and other costs related to
being a public company. In addition, in accordance with FAS No. 123, included in
SG&A a non-cash charge of $21,000 to public relations expense and a
corresponding credit to Paid in Capital upon issuance of options to outside
consultants.
Interest Income
Interest income of $421,738 for the nine months ended December 31, 1998 is
primarily due to interest income earned on the investment of proceeds from the
initial public offering.
Net Income
Net loss for the nine months ended December 31, 1998 was $68,190 compared
to net income of $625,108 for the nine months ended December 31, 1997. The
decrease of $693,298 is mainly attributable to the decrease in gross profit,
higher selling, general and administrative expenses, offset by interest income.
Year 2000 Update
General
The Company has begun a Year 2000 Project (the "Project"). The Project
will address this issue of whether computer programs and imbedded computer chips
will be able to distinguish between the years 1900 and 2000. First, the Company
will evaluate its Year 2000 readiness for both information technology ("IT") and
non-information technology ("non-IT") systems. Non-IT systems typically include
embedded technology in electronic equipment, such as microprocessors, and are
more difficult to assess and repair than IT systems. Second, for both IT and
non-IT systems, the Company will implement any necessary changes it believes
will make the Company ready for the year 2000. Third, the Company will evaluate
the readiness of its major vendors and customers to determine what impact, if
any, their readiness will have on the Company.
Project
To be Year 2000 Compliant, IT and non-IT systems must (a) consistently
handle data information before, during and after January 1, 2000, including
accepting date input, providing date output, and performing calculations on
dates or portions of dates, (b) function accurately and without interruption
before, during and after January 1, 2000, without any change in operations
associated with the turn of the century, and (c) store and provide output of
date information in a manner that is not ambiguous as to the century. The
Company has determined that its present accounting software is not Year 2000
Compliant. The Company has begun the implementation of a new accounting system
that will be Year 2000 Compliant, which the Company expects to complete before
the end of fiscal year 1999.
The Company will assess the computer systems of customers, vendors and
other outside parties with whom the Company does business. While the Company
expected to begin this assessment during the third quarter, the Company has
delayed its assessment until the end of the fourth quarter of fiscal 1999 and
the first quarter of fiscal 2000. The Company does not anticipate that such an
assessment will reveal significant potential problems or require the Company to
incur substantial costs.
Costs
The total cost associated with required modifications to become Year 2000
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Compliant is not expected to be material to the Company's financial position. It
is estimated that the cost of implementing the new accounting system will not
exceed $150,000. The Company does not expect the costs associated with the
project to be material.
Risks Associated with the Year 2000 Problem
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failure could materially and adversely effect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 Compliance of third party suppliers and customers,
the Company is unable to determine at this time whether the consequences of any
Year 2000 non-Compliance will have a material impact on the Company's results of
operations, liquidity or financial condition. The Project is expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem and, in particular, about the Year 2000 Compliance and readiness of its
material suppliers, customers and other third parties. The Company believes
that, with the implementation of the new accounting system and completion of the
Project as scheduled, the possibility of significant interruptions of normal
operations should be reduced. The Project will not, however, evaluate the effect
of the Year 2000 problem on the computer products industry, the software
configuration industry or related industries within which the Company does
business, or the domestic or global economy. Any industry-wide or economy-wide
effects of the Year 2000 problem may have a material adverse effect on the
Company's results of operations, liquidity or financial condition.
Readers are cautioned that forward-looking statements contained in this
Year 2000 Update should be read in conjunction with the Company's disclosures
under the heading, "Special Note on Forward-looking Statements," beginning on
page 8 above. Readers should understand that the dates on which the Company
believes the Project will be completed are based upon Management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the availability of certain resources, third-party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved, or that there will not be a delay in, or increased costs associated
with, the implementation of the Company's Year 2000 Project. A delay in specific
factors that might cause differences between the estimates and actual results
include, but are not limited to, the availability and cost of personnel trained
in these areas, the ability of locating correct all relevant computer code,
timely responses to and corrections by third parties and suppliers, the ability
to implement interfaces between the new systems and the systems not being
replaced, and similar uncertainties. Due to the general uncertainty inherent in
the Year 2000 problem, resulting in part from the uncertainty of the Year 2000
readiness of third parties and the inter-connection of national and
international businesses, the Company cannot ensure that its ability to timely
and cost effectively resolve problems associated with the Year 2000 issue that
may effect its operations and business, or expose it to third party liability.
Liquidity and Capital Resources
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,
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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 December 31, 1998, the Company's Finova line was $20
million and the Company had a payable to Finova Capital Corporation of
approximately $762,000 included in accounts payable.
Net cash used by operating activities during the nine months ended December
31, 1998 was primarily attributable to an increase in inventories, prepaid
expenses, trade receivables, deferred taxes and decreases in accounts payable,
accrued expenses and income taxes payable. Net cash provided by financing
activities in the nine months ended December 31, 1998 was due primarily to
proceeds from the Company's initial public offering, offset by payments on notes
and deferred offering costs, and the repurchase of stock from a Shareholder.
The Company believes that current funds and cash generated from operations
will be sufficient to meet its anticipated cash needs for working capital and
capital expenditures for at least the next year. The Company plans to spend
approximately $1,800,000 for its implementation of its Automated Custom System
Assembly Solutions for marketing, salaries and capital expenditures over the
next 12 months. The Company is dependent on the availability of accounts
receivable financing on reasonable terms and at levels that are high relative to
its equity base in order to maintain and increase its sales. No assurance can be
given that additional financing will be available or that, if available, it can
be obtained on terms favorable to 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 had periods of
profitability, the ability of the Company to sustain profitability will depend
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in part upon the successful and timely introduction and operation of its ACSA
Centers, market acceptance of its internet strategy, 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 and its internet
strategy 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 or internet related businesses. There can be no
assurance that the Company will be able to generate and sustain profitability in
the future.
Dependence Upon Key Personnel. The Company is highly dependent upon the
services of Max Toghraie and James Ung, its Chief Executive Officer and
President, respectively. Both James Ung and Max Toghraie are employed pursuant
to five year employment agreements. The success of the Company to date has been
in part dependent upon their efforts and abilities, and the loss of the services
of either of them for any reason could have a material adverse effect upon the
Company. In addition, the Company's work force includes executives and employees
with significant knowledge and experience in the Computer Products distribution
industry. The Company's future success will be strongly influenced by its
ability to continue to recruit, train and retain a skilled work force. While the
Company believes that it would be able to locate suitable replacements for its
executives or other personnel if their services were lost to the Company, there
can be no assurance that the Company would be able to do so on terms acceptable
to the Company. In particular, the location and hiring of suitable replacements
for Mr. Toghraie and Mr. Ung could be very difficult. The Company maintains a
key-man life insurance policy on the lives of Messrs. Toghraie and Ung with
benefits of $1,000,000 each, payable to the Company in the event of their death.
The benefits received under these policies would not be sufficient to compensate
the Company for the loss of the services of Mr. Toghraie or Mr. Ung should
suitable replacements not be employed.
Dependence Upon Relationships with Vendors. A key element of the Company's
past success and future business strategy involves the establishment of
relationships with certain major distributors and Computer Product
manufacturers. Purchases from these vendors account for the majority of the
Company's aggregate purchases for fiscal 1997, for the year ended March 31, 1998
and the present nine months ended December 31, 1998. For the year ended March
31, 1998, DSS Technology Distribution Partners, Inc. ("DSS"), a master
distributor of hard drives to the Company, accounted for 64% of the Company's
purchases. Certain of these vendors provide the Company with substantial
incentives in the form of rebates passed through from the manufacturer,
discounts, credits and cooperative advertising. There can be no assurance that
the Company will continue to receive such incentives in the future. Other than
ordinary purchase orders, the Company does not have written supply, distribution
or franchise agreements with any of its Computer Product vendors. Although the
Company believes that it has established close working relationships with its
principal vendors, the Company's success will depend, in large part, on
maintaining these relationships and developing new vendor relationships for its
existing and future product and service lines. Because the Company does not have
written contracts with any of its vendors, there can be no assurance that the
Company will be able to maintain these relationships. Periodically, Computer
Product suppliers consolidate their distribution networks and otherwise
restructure or limit their distribution channels. There can be no assurance that
the Company will continue to be selected to resell products by its principal
vendors. Termination or interruption of such relationships or modification of
the terms the Company receives from these vendors would materially adversely
affect the Company's financial position, operating results, and cash flows.
Certain of the products offered by the Company are subject to manufacturer
allocations, which limit the number of units of such products available to the
Company's vendors, which in turn may limit the number of units available to the
Company. In order to offer the products of most manufacturers, the Company is
required to obtain authorizations from the manufacturers to act as a reseller of
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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 that is collateralized by equipment, accounts receivable and inventory. As
a result, the amount of credit available to the Company may be adversely
affected by factors such as delays in collection or deterioration in the quality
of the Company's accounts receivable, economic trends in the computer industry,
interest rate fluctuations and the lending or credit policies of the Company's
lenders and vendors. Many of these factors are beyond the Company's control.
Further, the Company must obtain Finova's written permission prior to arranging
other financing, and Finova may require certain acknowledgments and undertakings
from other lenders. There can be no assurance that Finova will permit additional
financing or that other lenders will provide the acknowledgments and
undertakings Finova may require. Any decrease or material limitation on the
amount of capital available to the Company under its financing arrangements or
vendor credit lines will limit the ability of the Company to fill existing sales
orders or expand its sales levels and, therefore, would have a material adverse
effect on the Company's financial position, operating results, and cash flows.
In addition, while the Company does not have significant exposure to interest
rate fluctuations under its current financing, any significant increases in
interest rates will increase the cost of possible future financing to the
Company which would have a material adverse effect on the Company's financial
position, operating results, and cash flows. The Company is dependent on the
availability of accounts receivable financing on reasonable terms and at levels
that are high relative to its equity base in order to maintain and increase its
sales. There can be no assurance that such financing will be available to the
Company in the future. The inability of the Company to have continuous access to
such financing at reasonable costs would severely and adversely impact the
Company's financial position, operating results, and cash flows.
Risk of Product Returns. As is typical of the computer industry, the
Company incurs expenses as a result of the return of products by customers. Such
returns may result from defective goods, inadequate performance relative to
customer expectations, distributor shipping errors and other causes which are
outside the Company's control. Although the Company's distributors and
manufacturers have specific return policies that enable the Company to return
certain types of goods for credit, to the extent that the Company's customers
return products which are not accepted for return by the distributor or
manufacturer of such products, the Company will be forced to bear the cost of
such returns. Any significant increase in the rate of product returns coupled
with the unwillingness by the Company's distributors or manufacturers to accept
goods for return could have a material adverse effect on the Company's financial
position, operating results, and cash flows.
Product Mix; Risk of Declining Product Margins. As a result of sustained
industry oversupply and resulting pricing pressures, the Company's gross profit
percentage decreased from 4.2% for the nine months ended December 31, 1997 to
2.8% for the nine months ended December 31, 1998. Given the significant levels
of competition that characterize the Computer Products market especially desktop
hard drive market and recent pricing pressures and oversupply conditions, there
can be no assurance that the Company will maintain the current gross profit
margins or be able to achieve increases in profit margins. From time to time,
product margins will also be reduced as a result of marketing strategies
implemented by the Company. For instance, introductory pricing implemented by
the Company to develop market awareness of product lines, particularly disk
drives, of vendors new to the Company will have an adverse effect upon gross
profit margins and, potentially, earnings during the period promotional pricing
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is offered. Moreover, in order to attract and retain many of its larger
customers, the Company frequently must agree to volume discounts and maximum
allowable mark-ups that serve to limit the profitability of sales to such
customers. Accordingly, to the extent that the Company's sales to such customers
increase, the Company's gross profit margins may be reduced, and therefore any
future increases in net income will have to be derived from continued sales
growth or effective expansion into higher margin business segments, neither of
which can be assured. Furthermore, low margins increase the sensitivity of the
business to increases in costs of financing, because financing costs to carry a
receivable can be very high compared to the low amount of gross profit on the
sale underlying the receivable itself. Any failure by the Company to maintain or
increase its profit margins and sales levels could have a material adverse
effect on the Company's results of operations and prospects for future growth.
Uncertainty of Commercialization of the ACSA Solution; Importance of ACSA
to Growth. The Company's ability to successfully implement, market and introduce
the ACSA Solution services on a timely basis will be a significant factor in the
Company's ability to improve its operating margins and remain competitive. The
Company's ability to market the ACSA Solution successfully will depend on the
Company convincing potential customers of the benefits of the ACSA Solution. The
Company has only recently commenced marketing the ACSA Solution. The Company
recently completed construction of its first ACSA Center located in Industry,
California. No ACSA Center is currently in operation and the Company currently
has no sales revenue attributable to the ACSA Solution or an ACSA Center. The
first ACSA Center will not be operational until the dispute with CASI is
resolved, testing is completed and ACSA dedicated staff are in place. Although
the Company is engaged in negotiations and discussions with a number of
potential customers, there can be no assurance that any such discussions will
lead to significant sales of the ACSA Solution, or that the ACSA Solution will
attain market acceptance. There can be no assurance that the Company will be
successful in the implementation, marketing and sale of ACSA Solution services.
Any failure by the Company to anticipate or respond in a cost-effective and
timely manner to market trends or customer requirements, or any significant
delays in introduction of ACSA services, could have a material adverse effect on
the Company's business, operating results and financial condition.
Lengthy Sales and Implementation Cycles for ACSA. The Company believes that
the purchase of the Company's ACSA Solution services will entail an enterprise-
wide decision by prospective customers and require the Company to engage in a
lengthy sales cycle, estimated at between three and twelve months, as the
Company will be required to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's ACSA
Solution services and products. Also, the purchase of ACSA Solution services
will often depend upon the successful coordination of marketing, system design
and installation efforts by the Company, end-user customers and others with
influence over the purchase decisions of the Company's customers such as
consultants, VARs and SIs. Purchase decisions will generally occur only after
significant internal analysis by each customer and will be subject to
competition with other capital spending priorities of certain customers. As a
result, the sales and customer implementation cycles will be subject to a number
of significant delays over which the Company has little or no control. Delay in
the sale or customer implementation of a limited number of transactions could
have a material adverse effect on the Company's business and results of
operations and could cause the Company's operating results to vary significantly
from quarter to quarter.
Dependence on CASI for Development and Enhancement of Configuration
Software. Under the Company's License Agreement with Computer-Aided Software
Integration, Inc. ("CASI"), CASI retains the source code of the Configurator
software required to operate the automated software configuration functions of
the Company's planned ACSA Solution and ACSA Centers, and retains all rights to
modify and enhance the Configurator 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
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the enhancement at pre-agreed rates and ownership of the requested enhancement
will belong to the Company. Although the Company had anticipated implementing
the ACSA Solution by December 31, 1998, the Company has experienced significant
delays in implementing the ACSA Solution due primarily to a dispute related to
the Reseller Agreement dated September 15, 1997, with CASI and CASI's subsequent
refusal to provide the Company with the necessary training to operate its
Configurator software and related technical support. CASI is obligated to
provide such training and technical support to the Company under the terms of
the License Agreement, dated September 15, 1997, by and between the Company and
CASI, pursuant to which the Company licensed the Configurator software. The
Company is attempting to resolve the delays it is experiencing with CASI. The
delays in implementing the ACSA Solution also result, in part, from staff
turnover. While there can be no assurance, the Company currently anticipates the
availability of the ACSA Solution in the fourth quarter of fiscal year 1999.
Delays in implementing the ACSA Solution have caused the Company to derive its
revenues almost exclusively from the Company's computer products distribution
business, which has gross margins significantly lower than those the Company
believes to be available in the system configuration business. In light of high
legal expenses inherant in litigating the matter, the company opted to negotiate
an amicable resolution with CASI. Based on current discussions, the Company
believes that it will reach an amicable outcome in this matter with CASI.
However, there can be no assurance that the Company will succeed in reaching a
solution to the dispute with CASI that is acceptable to the Company. Further
failure by CASI to promptly and adequately perform its obligations under its
license agreement with the Company would have a material adverse effect on the
Company.
Furthermore, there can be no assurance that CASI will fully comply with its
contractual obligations to the Company, that CASI will dedicate sufficient
software development capacity to satisfy the Company's requirements, or that the
Company's remedies in the event CASI does not perform its obligations will be
adequate. The Company has no capability to internally develop any enhancements
or upgrades. Failure or delay by CASI to fulfill the Company's anticipated needs
for enhancement and upgrading of the Configurator software would adversely
affect the Company's ability to market ACSA services and to become and remain
competitive in the software configuration market. In the event that CASI fails
to meet its obligations under the license, the Company has, among other rights,
the contractual right to the source code underlying the software, but there can
be no assurance that the Company will be able to obtain the source code in a
timely manner, if at all, because CASI is in possession of the only copies of
the source code. Even if the Company is able to obtain the source code under
such circumstances, internal maintenance and enhancement of the source code
could place a significant financial burden on the Company. See "Legal
Proceedings."
Limited Marketing Capabilities. The Company's operating results will depend
to a large extent on its ability to successfully market the ACSA Solution
services to personal computer manufacturers and multi-user system buyers. The
Company currently has limited marketing capability. The Company intends to use a
portion of the proceeds of the Offering to hire additional sales and marketing
personnel and outside consultants to market the ACSA Solution. There can be no
assurance that any marketing efforts undertaken by the Company will be
successful or will result in any significant sales of the ACSA Solution.
Management of Growth. Implementation of the Company's business plan,
including implementation of ACSA Solution services and the Company's internet
strategy 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
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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 and,
although no specific acquisitions currently are pending the Company has been
negotiating possible joint ventures to further its internet strategy.
Acquisitions and joint ventures 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
or joint ventures, if any, without permitting shareholders to review or vote on
such transactions, unless required under applicable law.
Construction of First ACSA Center. The Company has used approximately
$200,000 of the net proceeds from the Initial Public Offering to complete
construction of and to equip its first ACSA Center. It is expected that the
construction will require a substantial time commitment of certain members of
management. Although the first ACSA Center has been constructed, it is not
expected to be operational until the end of the fourth quarter 1999. Any delay
in completion of the first ACSA Center could result in delays in the
commencement of sales of assembly and custom software configuration services and
adversely affect the Company's business, operating results and financial
condition. There can be no assurance that the Company will be able to complete
the ACSA Center at the budgeted price. Additionally, there can be no assurance
that the ACSA Center will be available on time or that the Company will be
successful in timely hiring and training engineers and technicians necessary to
commence operations of the ACSA Center. Any such delay would delay the Company's
ability to commence offering the ACSA Solution and have a material adverse
effect upon the Company's business, operating results and financial condition.
Rapid Technological Change; New Product Introductions. The markets for the
Company's ACSA technology and its internet strategy are characterized by rapidly
changing technology and frequent new product introductions. Even if the
Company's ACSA Solution services using its licensed Configurator software and
its internet strategy gain initial market acceptance, the Company's success will
depend, among other things, upon its ability to enhance the ACSA Solution
services and its internet strategy 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.
Uncertainty of Commercial Acceptance of Internet Strategy. The Company has
developed, and is in the early stages of implementing, an internet strategy that
is intended to give the Company, among other things, e-commerce and internet
auction capabilities. The Company's ability to market its internet strategy will
depend on the Company convincing potential customers of the benefits of
transacting business with the Company using its internet capabilities. To date,
the Company's e-commerce and internet auction websites are not operational, and
the Company has not begun to market an e-commerce or internet auction capability
to its existing and potential customers. There can be no assurance that the
Company will be able to convince existing and potential customers to transact
business with the Company over its e-commerce and internet auction websites.
Failure by the Company to convince existing and potential customers to utilize
e-commerce and internet auction websites to transact business with the Company
will have a material adverse effect on the Company's internet strategy.
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Reliance On Third Parties To Develop And Service E-commerce and Internet
Auction Websites. The Company depends on OTT to develop and service the
e-commerce and internet auction websites which the Company expects to develop in
connection with its internet strategy and, therefore, is only partially able to
control the development of and implementation of its internet strategy. The
ability of the Company to timely develop an internet capability is dependent, to
a significant degree, on OTT. If the Company's relationship with OTT is
terminated, the Company would be forced to either enter into a relationship with
another third party provider or undertake to develop and service its internet
strategy internally. This would likely require the Company to incur additional
expenses in connection with such conversion and result in a significant delay in
the implementation of the Company's internet strategy.
Success of Internet Strategy Dependent Upon The Continued Growth Of Online
Commerce. The long-term viability of the Company's internet strategy depends
upon widespread consumer acceptance and use of the Internet as a medium of
commerce. Use of the Internet e-commerce is at an early stage of development,
and demand and market acceptance for recently introduced services and products
over the Internet is very uncertain. The Company cannot predict the extent to
which consumers will be willing to shift their purchasing habits to the online
medium.
The Internet may not become a viable commercial marketplace for a number of
reasons, including potentially inadequate development of the necessary network
infrastructure, delayed development of enabling technologies and inadequate
performance improvements. In addition, the Internet's viability as a commercial
marketplace could be adversely affected by increased government regulation.
Changes in or insufficient availability of telecommunications services or other
services to support the Internet also could result in slower response times and
adversely affect usage of the Internet generally. Also, negative publicity and
consumer concern about the security of transactions conducted on the Internet
and the privacy of users may also inhibit the growth of commerce on the
Internet.
Industry Evolution and Price Reductions; Changing Methods of Distribution.
The personal computer industry is undergoing significant change. The industry
has become more accepting of large volume, cost-effective channels of
distribution such as computer superstores, consumer electronics and office
supply superstores, national direct marketers and mass merchants. In addition,
many traditional computer resellers are consolidating operations and acquiring
or merging with other resellers to increase efficiency. This current industry
reconfiguration has resulted in increased pricing pressures. Decreasing prices
of computer products require the Company to sell a greater number of products to
achieve the same level of net sales and gross profit. The continuation of such
trend would make it more difficult for the Company to maintain or to increase
its net sales and net income. In addition, it is possible that the historically
high rate of growth of the personal computer industry may slow at some point in
the future. If the growth rate of the personal computer industry were to
decrease, the Company's financial position, operating results, and cash flows
could be materially adversely affected. Furthermore, new methods of distribution
and sales of Computer Products, such as on-line shopping services and catalogs
published on CD-ROM, may emerge in the future. Computer Products and software
manufacturers have sold, and may in the future intensify their efforts to sell,
their products directly to end users. From time to time, certain vendors have
instituted programs for the direct sale of large orders of Computer Products and
software to certain major corporate accounts. These types of programs may
continue to be developed and used by various vendors. While the Company attempts
to anticipate future distribution trends, any of these distribution methods or
competitive programs, if expanded, could have a material adverse effect on the
Company's financial position, operating results, and cash flows.
Availability of Components. The computer component and computer assembly
businesses have from time to time experienced periods of extreme shortages in
product supply, generally as the result of demand exceeding available supply.
When these shortages occur, suppliers tend either to slow down shipments or
place their customers "on allocation," reducing the number of units sold to each
customer. While the Company believes that it has well-established relationships
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with vendors and that it has not been adversely affected by recent shortages in
certain storage and other computer components, no assurance can be given that
future shortages will not adversely impact the Company.
Competition. The Company faces intense competition, both in its selling
efforts and purchasing efforts, from the significant number of companies that
configure and/or assemble personal computers, manufacture or distribute disk
drives and offer software configuration services. Many of these companies, such
as CompuCom Systems, Inc., CDW Computer Centers, Inc., Vanstar Corp. and Inacom,
Inc. in the Computer Products distribution market, large computer manufacturers
such as IBM Corp. and Compaq Computer Corporation, which provide custom
configuration and automated software configuration for standardized systems,
large distributors such as Ingram Micro Inc., Vanstar Corp., En Point
Technologies, Inc., Microwarehouse, Inc. and CompuCom Systems, Inc. in the
systems integration and network services market, have substantially greater
assets and possess substantially greater financial and personnel resources than
those of the Company and may develop software, or services or products which are
comparable to the ACSA Solution. Many competing distributors also carry or offer
brands or product lines which the Company does not carry. Generally, large disk
drive and personal computer component manufacturers and large distributors do
not focus their direct selling efforts on small to medium sized OEMs and
distributors, which constitute the vast majority of the Company's customers;
however, as the Company's customers increase in size, disk drive and component
manufacturers may find it cost effective to focus direct selling efforts on
those customers, which could result in the loss of customers or pressure on
margins. In addition, CASI and/or Datatec Systems Inc. ("Datatec"), formerly
known as Glasgal Communications, Inc., the parent corporation of CASI, may
directly enter into the Company's integration and configuration markets using
the software the Company has licensed from CASI. While no operating division or
subsidiary of Datatec is currently competing in the Company's markets, there can
be no assurance that Datatec will not decide to directly compete with the
Company in the future. Further, the terms of the Company's license agreement
with CASI allows CASI to license the software used in the ACSA Solution and the
ACSA Centers to new or existing direct competitors of the Company. There can be
no assurance that the Company will be able to continue to compete effectively
with existing or potential competitors.
Industry Cyclicality. The personal computer component distribution industry
has been affected historically by general economic downturns, which have had an
adverse economic effect upon manufacturers and corporate end users of personal
computers, as well as component distributors such as the Company. In addition,
the life cycle of existing personal computer products and the timing of new
product development and introduction can affect demand for disk drives and other
personal computer components. Any downturns in the personal computer component
distribution industry, or the personal computer industry in general, could
adversely affect the Company's business and results of operations.
Asian Market Instability. Economies and financial markets in Asia have
recently experienced significant turmoil. A non-material portion of the
Company's revenues are derived from sales to businesses which primarily export
Computer Products to Asian customers. Also certain of the Company's vendors are
based in Korea, Japan and other Asian countries. Asian financial market
instability may adversely impact customer orders or the Company's ability to
obtain products from its Asian vendors. The financial instability in these
regions has had an adverse impact on the financial position of end-users in the
region which has been a contributing factor to the oversupply condition and
pricing pressures currently impacting the Company (because Asian vendors have
channeled excess inventory into the North American market at reduced prices and
have reduced component demand from domestic manufacturers who export to Asia)
and could also impact future orders from the Company's customers and/or the
ability of such end users to pay the Company's customers, which could also
impact the ability of such customers to pay the Company. If the Company's
customers who export into Asia are unable to maintain export sales or current
margins on such export sales, the Company's sales and/or sales margins may be
adversely affected. Additionally, if the Company's vendors in these regions are
unable to continue to supply the Company, the Company may be adversely impacted.
________________________________________________________________________________
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<PAGE>
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.
Possible Issuance of Preferred Stock; Barriers to Takeover. The Company's
Articles of Incorporation authorize the issuance of up to 2,000,000 shares of
Preferred Stock. Following the Offering, no shares of Preferred Stock of the
Company will be outstanding, and the Company has no present intention to issue
any shares of Preferred Stock. However, because the rights and preferences for
any series of Preferred Stock may be set by the Company's Board of Directors in
its sole discretion, the rights and preferences of any such Preferred Stock are
likely to be superior to those of the Common Stock and thus could adversely
affect the rights of the holders of Common Stock. The Company currently has no
commitments or contracts to issue any additional securities. Any securities
issuances might result in a reduction in the book value or market price of the
outstanding shares. Further, any new issuances could be used for anti-takeover
purposes or might be used as a method of discouraging, delaying or preventing a
change of control of the Company. Additionally, certain provisions of the
Company's Articles of Incorporation and Bylaws could delay or make more
difficult a merger, tender offer or proxy contest involving the Company.
No Dividends Anticipated. The Company has never declared or paid dividends
on its Common Stock. After the consummation of this Offering, the Company does
not intend for the foreseeable future to declare or pay any cash dividends and
intends to retain earnings, if any, for the future operation and expansion of
the Company's business.
Delisting from The Nasdaq SmallCap Market; Potential Penny Stock
Classification. The Company's Common Stock is quoted on The Nasdaq SmallCap
Market and listed on the Boston Stock Exchange. However, there can be no
assurance that a trading market for the Common Stock will develop, or if
developed, that it will be maintained. No assurance can be given that the
Company will be able to satisfy the criteria for continued quotation on The
Nasdaq SmallCap Market or the criteria for continued listing on the Boston Stock
Exchange following this Offering. Failure to meet the maintenance criteria in
the future may result in the Common Stock not being eligible for quotation or
listing. If the Company were removed from The Nasdaq SmallCap Market and the
Boston Stock Exchange, trading, if any, in the Common Stock would thereafter
have to be conducted in the over-the-counter market in so-called "pink sheets"
or, if then available, the OTC Bulletin Board. As a result, holders of the
Common Stock would find it more difficult to dispose of, or to obtain accurate
quotations as to the market value of, the Common Stock.
In addition, if the Common Stock is delisted from trading on Nasdaq and the
Boston Stock Exchange and the trading price of the Common Stock is less than
$5.00 per share, trading in the Common Stock would also be subject to the
requirements of Rule 15g-9 promulgated under the Securities Exchange Act of
________________________________________________________________________________
Page 21
<PAGE>
1934, as amended (the "Exchange Act"). Under such rule, broker/dealers who
recommend such low-priced securities to persons other than established customers
and accredited investors must satisfy special sales practice requirements,
including a requirement that they make an individualized written suitability
determination for the purchaser and receive the purchaser's written consent
prior to the transaction. The Securities Enforcement Remedies and Penny Stock
Reform Act of 1990 also requires additional disclosure in connection with any
trades involving a stock defined as a penny stock (generally, according to
regulations adopted by the Securities Exchange Commission (the "Commission"),
any equity security not traded on an exchange or quoted on Nasdaq that has a
market price of less than $5.00 per share, subject to certain exceptions),
including the delivery, prior to any penny stock transaction, of a disclosure
schedule explaining the penny stock market and the risks associated therewith.
Such requirements could severely limit the market liquidity of the Common Stock
and the ability of purchasers in this Offering to sell their securities in the
secondary market. There can be no assurance that the Common Stock will not be
delisted or treated as a penny stock.
Elimination of Cumulative Voting. The Articles of Incorporation of the
Company provide that at such time as the Company has (i) shares listed on the
New York Stock Exchange or the American Stock Exchange, or (ii) securities
designated for trading as a national market security on the National Association
of Securities Dealers Automatic Quotation System (or any successor national
market system) if the Company has at least 800 or more holders of its Common
Stock as of the record date of the Company's most recent annual meeting of
shareholders, the cumulative voting rights of shareholders will cease. The
Company believes that it has more than 800 holders. If the Company has shares
listed on the New York Stock Exchange or the American Stock Exchange, or
designated for trading as national market securities on The Nasdaq National
Market System, cumulative voting rights of shareholders will cease. Elimination
of cumulative voting will have the effect of making it more difficult for
minority shareholders to obtain representation on the Board of Directors.
Limitation of Liability and Indemnification. The Company's Articles of
Incorporation, as amended, (the "Articles") include a provision that eliminates
the personal liability of its directors to the Company for monetary damages for
breach of their fiduciary duties (subject to certain limitations) as a director
to the fullest extent permissible under California law. The Company's Articles
and Bylaws allow the Company to provide for indemnification of its Directors the
fullest extent permitted by law. The Bylaws allow the Company to enter into
indemnity agreements with individual directors, officers, employees and other
agents. The Company has entered into indemnification agreements designed to
provide the maximum indemnification permitted by law with all the directors of
the Company. These agreements, together with the Company's Bylaws and Articles,
may require the Company, among other things, to indemnify these directors
against certain liabilities that may arise by reason of their status or service
as directors (other than liabilities resulting from willful misconduct of a
culpable nature), to advance expenses to them as they are incurred, provided
that they undertake to repay the amount advanced if it is ultimately determined
by a court that they are not entitled to indemnification, and to obtain
directors' and officers' insurance if available on reasonable terms. The Company
has purchased and does maintain directors' and officers' liability insurance. As
a result of the provisions in the Company's Articles and in the indemnification
agreements, it may be more difficult for shareholders to obtain relief against a
director for breaches of such director's fiduciary duty than if these provisions
were not included in the Company's Articles and Bylaws.
No Earthquake Insurance. The Company's executive office, warehouse and
assembly facility is located in a Company-leased facility in Industry,
California, an area which experienced damage in the 1994 Northridge, California
earthquake. The Company does not currently carry insurance against earthquake-
related risks.
Disclosure Regarding Forward-Looking Statements. This Report contains
statements that constitute "forward-looking statements" within the meaning of
Section 21E of the Securities Exchange Act of 1934 and Section 27A of the
Securities Act of 1933. The words "expect," "estimate," "anticipate,"
________________________________________________________________________________
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<PAGE>
"predict," "believe," and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this filing and include statements regarding the intent,
belief or current expectations of the Company, its Directors or Officers with
respect to, among other things (a) trends effecting the financial condition of
results of operations of the Company and (b) the business and growth strategies
of the Company. The shareholders of the Company are cautioned not to put undue
reliance on such forward-looking statements. Such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties. Actual
results may differ materially from those projected in this Report, for the
reasons, among others, discussed in "Future Operating Results" below and under
the caption, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Risk Factors" in the Company's Annual Report on Form
10-K for Fiscal 1998, filed with the Securities and Exchange Commission. The
Company undertakes no obligation to publicly revise these forward-looking
statements to reflect events or circumstances that arise after the date hereof.
Readers should carefully review the risk factors referred to above and the other
documents the Company files from time to time with the Securities and Exchange
Commission, including the Company's Annual Report on Form 10-K for the fiscal
year 1998, the quarterly reports on Form 10-Q filed by the Company during the
remainder of fiscal 1999, and any current reports on Form 8-K filed by the
Company.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is periodically subject to legal actions which arise in the
ordinary course of its business. The Company does not believe that any such
action is material to its results of operation or financial condition.
The Company has been involved in a disagreement with CASI concerning the
interpretation of certain provisions of the Reseller Agreement, dated September
15, 1997, between CASI and the Company (the "Reseller Agreement"). By letter
dated November 9, 1998, attorneys for CASI purported to terminate the Reseller
Agreement on behalf of CASI.
The Company strongly disagrees with CASI's right to terminate the Reseller
Agreement and is currently evaluating its legal options.
CASI is obligated to provide training and technical support to the Company
under the terms of the License Agreement, dated September 15, 1997, by and
between the Company and CASI, pursuant to which the Company licensed the
Configurator software. To date, CASI has failed to provide such training and
technical support to the Company, which has resulted in the delays of the
implementation of the ACSA Solution. The Company has opted to resolve the CASI
matter amicably and is attempting to reach an agreement with CASI. However, the
Company will keep it's legal options open pending final resolution of this
matter. However, there can be no assurance that the Company will succeed in
reaching a solution to the dispute with CASI that is acceptable to the Company.
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
In October, 1998, the Company issued to 8607 Colonial Group, Inc.
("Colonial") an option (the "Colonial Option") to purchase up to 50,000 shares
of the Company's Common Stock at an initial exercise price of $5.00 per share.
Colonial provides public relations consulting services to the Company. The
Colonial Option vested as to 5,000 shares immediately upon issuance and vests,
as to the remaining 45,000 shares, monthly beginning October 1998 and ending
June 1999.
Use of Proceeds
The Company's Registration Statement on Form S-1 (File No. 333-43151)
________________________________________________________________________________
Page 23
<PAGE>
relating to the offer and sale (the "Offering") of an aggregate of 2,350,000
shares (the "Firm Shares") of Common Stock, without par value (the "Common
Stock"), of the Company was declared effective by the Securities and Exchange
Commission (the "Commission") on April 7, 1998. The managing underwriter for
the Offering was Joseph Stevens & Company, Inc. (the "Managing Underwriter").
The Offering commenced on April 8, 1998 and the sale of 2,350,000 shares
closed on April 14, 1998, with the sale of an additional 352,500 shares (the
"Option Shares" and, together with the Firm Shares, the "Shares") closing on
April 23, 1998 (which were sold by the Company upon the exercise of the over-
allotment option granted to the underwriters). All the Shares were sold in the
Offering at an aggregate price of $5.00 per share, for aggregate proceeds of
$13,512,500. After deducting underwriting discounts and commissions of $0.4625
per share, and other issuance costs, the Company received net proceeds of
approximately $11,200,000. On April 14, 1998, the Company also received $0.001
per warrant, for an aggregate of $23.50, in consideration of unregistered 5-year
warrants to purchase 235,000 shares of Common Stock at an initial exercise price
of 165% of the Offering price, exercisable one year after the effective date of
the Registration Statement, granted to the Managing Underwriter in connection
with the Offering. See "Recent Sales of Unregistered Securities."
As of December 31, 1998, the Company had used the proceeds as follows: (i)
payments on notes payable of $1,200,000, (ii) purchases of fixed assets -
$279,000, (iii) repurchase of stock from shareholder for $300,000 and (iv)
investment in OTT of $100,000. The remaining proceeds of $9,321,000 are
available to fund the construction of the First ACSA Center, payment to OTT for
$900,000, and for working capital.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
The Annual Meeting of Shareholders of Cumetrix Data Systems Corp. (the
"Annual Meeting") took place on Monday, October 5, 1998, at the offices of the
Company.
The Company's six directors, namely Max Toghraie, James Ung, Mei Yang,
Nancy Hundt, David Tobey and Philip Alford were re-elected and will continue to
act in their same capacities in the ensuing year. Actual votes cast at the
meeting were as follows:
Max Toghraie 7,044,866 votes for and 16,100 withheld.
James Ung 7,044,866 votes for and 16,100 withheld
Mei Yang 7,043,866 votes for and 17,100 withheld
Nancy Hundt 7,044,866 votes for and 16,100 withheld
David Tobey 7,044,866 votes for and 16,100 withheld
Philip Alford 7,044,866 votes for and 16,100 withheld
Also approved at the Annual Meeting was the increase of the maximum number
of shares of Common Stock that may be issued pursuant to awards granted under
the Company's 1997 Stock Plan from 500,000 shares to 1,000,000 shares. Actual
votes cast at the meeting were as follows: 4,777,166 votes for, 139,650 against
and 10,250 abstaining. 2,133,900 shares did not vote on the proposal.
No other matters were voted on by the shareholders of the Company at the
Annual Meeting.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
________________________________________________________________________________
Page 24
<PAGE>
10.1* Loan and Security Agreement, dated as of October 22, 1998, by
and between the Company and Finova Capital Corporation
10.2* Schedule to Loan and Security Agreement, dated October 22, 1998
10.3* Secured Revolving Credit Note, dated as of October 22, 1998, by
the Company in favor of Finova Capital Corporation
10.4* Preferred Stock Purchase Agreement, dated as of December 15,
1998, by and between the Company and Online Transaction
Technologies, Inc.
10.5* First Stock Option Agreement, dated as of December 30, 1998, by
and between the Company and Online Transaction Technologies,
Inc.
Exhibit 27 Financial Data Schedule
* as previously filed with the Securities and Exchange Commission on 2/16/1999.
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: March 7, 2000 /s/ Herbert H. Tom
Chief Financial Officer
________________________________________________________________________________
Page 25
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