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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT 1 TO
FORM 10-SB
GENERAL FORM FOR REGISTRATION OF SECURITIES OF
SMALL BUSINESS ISSUERS
Under Section 12(b) or 12(g) of
The Securities Exchange Act of 1934
I/OMAGIC CORPORATION
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(Name of Small Business Issuer in its charter)
Nevada 86-0359523
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(State or Other Jurisdiction (IRS Employer Identification No.)
of Incorporation or Organization)
6 Autry, Irvine, California 92618
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(Address of principal executive offices) (Zip Code)
(949) 727-7466
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(Issuer's Telephone Number, Including Area Code)
Securities to be registered under Section 12(b) of the Act:
Title of each class Name of each exchange on which
to be so registered each class is to be registered
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None None
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Securities to be registered pursuant to section 12(g) of the Act:
Common Stock, par value $.001
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(Title of Class)
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
A. BUSINESS DEVELOPMENT
1. FORM AND YEAR OF ORGANIZATION
I/OMagic Corporation, a California corporation ("I/OMagic California")
was incorporated under the laws of the State of California on September 30,
1993. I/OMagic offers products in both the personal computer and the consumer
electronics marketplace. These products include a variety of peripheral upgrades
for desktop and portable applications. I/OMagic's customers include many of the
largest North American personal computer mass merchants and consumer electronic
retailers, including, but not limited to, Comp USA, Inc., Circuit City and
OfficeMax.
2. ACQUISITION AGREEMENT
I/OMagic California entered into a Plan of Exchange and Acquisition
Agreement (the "Acquisition Agreement") with Silvercrest International, Inc., a
Nevada corporation ("Silvercrest") on March 18, 1996. Pursuant to the
Acquisition Agreement, Silvercrest issued 6,570,583 shares of common stock in
exchange for 6,570,583 shares of common stock of I/OMagic California, which
constituted 100% of the issued and outstanding shares of I/OMagic California.
Prior to the execution of the Acquisition Agreement, Silvercrest was a public
company with dormant operations. Silvercrest's common stock was listed on the
Over-The-Counter Bulletin Board market as of March 1, 1996. Silvercrest changed
its name to I/OMagic Corporation, a Nevada corporation, on March 20, 1996.
Effective as of the date of the Acquisition Agreement, the board of directors of
Silvercrest resigned and I/OMagic's directors were appointed as the new Board of
Directors. As a result of the acquisition, I/OMagic California, became a
wholly-owned subsidiary of I/OMagic Corporation, a Nevada corporation. I/OMagic
is traded publicly on the Over-The-Counter Bulletin Board ("OTC Bulletin Board")
under the symbol "IOMC". Many large brokerage firms do not make a market or
otherwise solicit orders for shares trading on the OTC Bulletin Board. As a
result of the Company trading on the OTC Bulletin Board, investors may
experience difficulty in liquidating some or all of their investment in the
stock market.
Unless otherwise indicated, all references to the "Company" and
I/OMagic include the operations and business of I/OMagic Corporation, a Nevada
corporation, and I/OMagic Corporation, a California corporation.
B. BUSINESS OF ISSUER
1. PRINCIPAL PRODUCTS AND THEIR MARKETS
I/OMagic offers products in both the personal computer and the consumer
electronics marketplace. These products include a variety of peripheral upgrades
for desktop and portable applications. I/OMagic's customers include many of the
largest North American personal computer mass merchants and consumer electronic
retailers, including, but not limited to, Comp USA, Inc., Circuit City and
OfficeMax.
The Company's product mix is constantly adjusted to reflect current
market conditions. Currently, the Company' s products include: CD ROM drives,
CD-Read/Write drives, DVD drives, audio cards, video display cards, modems,
video conferencing cameras, and other peripheral accessories. The Company's
strategy is to constantly monitor market demand and to update its product mix to
reflect after-market conditions. I/OMagic's key suppliers constitute a number of
high volume computer peripheral manufacturers. Two key suppliers of the Company
are also large shareholders of the Company. I/OMagic believes that it is
provided extended interest free trade credit, favorable pricing and early access
to key technologies.
a. OPTICAL STORAGE DRIVES
Approximately 50% of the Company's gross revenues generated from
January 1, 1999 through June 30, 1999
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were generated through the sale of a variety of CD ROM drives. These drives
include CD-Rom playback, CD Readable/Writable ("CDRW") and DVD Playback for DVD
format movies and other applications. The primary function of all of these
products is to provide an interface between reading (playback) and writing
(storing) various data formats that are interfaced with both desktop and
portable computer architecture. These products are sold throughout North America
to virtually all of the Company's customers. This market segment tends to
constantly shift toward greater speed and functionality. The Company believes
that this shift has historically been created due to market opportunities as
consumers constantly search for the most advanced features and standards
available.
b. AUDIO PERIPHERAL UPGRADE CARDS
Approximately 10% of the Company's gross revenues during the first six
months of calendar 1999 were generated through the sale of its audio peripheral
upgrade cards. I/OMagic developed the Tempo PC Card, which was launched during
the fourth quarter of 1993 as one of the first Personal Computer Memory Card
Industry Association ("PCMCIA") audio peripheral upgrade cards to provide audio
upgrade functionality for the portable marketplace. While this product was
discontinued due to technical obsolescence, the Company changed its marketplace
position by introducing a variety of peripheral audio cards for desktop
applications to address specific marketplace demands, including computer games,
business applications and other audio applications. The Company's audio product
mix provides a range of technologies based upon specifications geared too the
specific application. These applications include the basic standard video
conferencing application to a full range of audio intensive gaming features.
c. VIDEO PERIPHERAL UPGRADE CARDS
Approximately 12% of the Company's gross revenues during the first six
months of calendar 1999 were generated through the sale of its video peripheral
upgrade cards and solutions (e.g., video capture cameras). I/OMagic developed
the Focus Video Capture Card, which was launched during the first quarter of
1994 as one of the first PCMCIA video capture cards to address the portable
computer market. While this product was eventually discontinued due to technical
obsolescence, the Company changed its marketplace position by offering a variety
of video display cards addressing the business and gaming market segments. The
Company's product mix currently includes three different video cards addressing
the various technological needs of the end user. In addition, the Company
markets MagicVision which is a camera intended to facilitate video conferencing
and other applications that provide video capture capabilities.
d. MODEMS, FLOPPY DISK DRIVES, SCANNERS,
KEYBOARDS AND OTHER PERIPHERALS
The balance of the Company's gross revenues during the first six months
of calendar 1999 (approximately 28%) were generated through the sale of a
variety of products including modems, floppy disk drives, scanners, keyboards
and other peripherals. As of the date of this filing, the Company is one of the
first distributors of scanners designed specifically for portable computers by
the name of MobileScan. The composition of this product mix varies according to
market demands.
The Company believes that its primary strategic advantage is its
ability to expeditiously identify and adjust to an ever-evolving marketplace.
This ability was evidenced in its quick adjustment to changes in the CD ROM and
the video and audio card markets from 1993-1999. As retail mass merchants
consolidate, the Company believes that its ability to offer a wide assortment of
peripheral products addressing current technological needs provides it with a
competitive advantage. As noted more fully below, the Company's major
shareholders provide substantial manufacturing capacity based in Asia in a
majority of its product lines.
e. INDUSTRY OVERVIEW
The Company believes that the recent emergence of the Internet, coupled
with the ready availability of basic, low priced personal computers and personal
device applications ("PDA") provides consumers with the platform to
technologically improve utilizing, among other things, the products provided by
the Company. In the aggregate, the Company's product mix focuses upon the
enhancement of the functionality of personal computers.
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The lower priced personal computers ("PC") market had a substantial
impact on the U.S. consumer segment, as 50 percent of all U.S. households had a
PC in 1998, according to DataQuest, Inc. The PC industry has made great strides
into the home market. In 1995, just 27 percent of U.S. households had a PC. The
PC industry received a boost in the second quarter of 1999 as worldwide PC
shipments grew 26.4 percent over the second quarter of 1998, primarily because
of lower system prices, economic recovery, and the Internet, according to
DataQuest, Inc.
In 2003, the portable computer market is projected to generate $99.91
billion in worldwide revenues (Frost & Sullivan, Report 5680-71, Publication
Date: June 1997). The total revenues for the market for portable computers, pen
computers, palmtops, peripherals, and PC Cards (the "portables market") was
$33.52 billion in 1996.
2. DISTRIBUTION METHODS
a. MANUFACTURING
All of the Company's products are manufactured in Asia. Two of the
Company's major shareholders, Behavioral Technology Corporation ("BTC") and Lung
Hwa Electronics ("Lung Hwa") provide in excess of 60% of the Company's current
product mix. The combined capacity of these manufacturers is well in excess of
the current needs of the Company. Both of these manufacturers also expend
substantial sums in research and development of new computer peripheral
products. All products distributed by the Company are subject to a minimum
warranty of one year to repair or replace the product. This warranty is provided
by the manufacturer of the product.
BTC has provided a credit line in the amount of $5 million,
non-interest bearing over the initial sixty days, subordinated to any
institutional financing. As of the date of this filing, $531,399 has been
borrowed under this credit line. As of the date of this filing, the Company has
not entered into any institutional debt financing.
Lung Hwa has provided a credit line in the amount of $2 million,
non-interest bearing over the initial sixty days. Both BTC and Lung Hwa have not
encumbered any assets of the Company in connection with the foregoing credit
lines. As of the date of this filing, the balance of the Lung Hwa credit line is
$500,000.
I/OMagic provides less than 10% of the aggregate revenues of each BTC
and Lung Hwa.
b. DISTRIBUTION
Most of the Company's products are shipped directly from the Asian
manufacturer to the Company's warehouse facility in Irvine, California. These
products are then shipped either directly to the customer's retail location or
to centralized distribution centers, where they are then allocated by the
customer. These shipments are made through commercial common carriers such as
United Parcel Service or Federal Express. Most product sales are currently
conducted through purchase orders placed by large retail customers. The Company
has a variety of agreements with a number of these retailers. These agreements
include terms related to pricing and orders, advertising and marketing, returns
and rebates, as applicable. These agreements are considered industry standard
and are not issued by all retailers. The Company believes that it has the
opportunity to build strategic alliances with these and other channels. These
retail customers include Micro Center, Fry's Electronics, Circuit City, COMPUSA,
OfficeMax, ABC Warehouse, Navy Exchange Service Command, PC Mall, and Midwest
Micro.
The Company has completed the initial development of two web sites
(both of which are currently fully operational): (a) www.magicbuys.com ;and
(b)www.I/O Magic.com. www.magicbuys.com is an electronic commerce internet site
which offers various products distributed by the Company. The product mix set
forth in the web site is adjusted from time to time to address perceived market
demands and trends. www.I/OMagic.com is the Company's "flagship" web site which
generally describes the capabilities and business of the Company and directs
internet traffic to www.magicbuys if a consumer is interested in acquiring
products distributed by the Company.. The Company intends that its electronic
commerce facility will provide a wide variety of peripheral applications and
brands. The Company has retained Credit Card Services, Inc. to insure the
encryption and security of all credit card data transmitted in connection with
its e commerce site.
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The Company expended approximately $50,000 in developing these two web
sites. It does not anticipate expending marketing funds focused exclusively upon
the web sites as of the date of this filing. The Company will continue to expend
funds in its general marketing and sales programs to promote its various product
lines.
3. STATUS OF NEW PRODUCTS.
The Company continuously consults with its major retail customers to
identify market trends and developments. This information may include customer
preferences and technological developments which may require a peripheral
product which compliments the Company's existing product line. Once the Company
identifies such a development or trend, the Company consults with its Asian
manufacturers to determine the technical feasibility of manufacturing a
particular technology. The feasibility is then considered in conjunction with
the particular pricing structure which the Company's customers believe will sell
in the retail marketplace. The Company is currently focusing upon the following
market trends:
a. OPTICAL STORAGE DRIVES
The Company anticipates the continued release of higher performance CD
ROM drives incorporating improved functionality. For example, the Company
anticipates during the next 12 months that it will introduce faster DVD drives
with multiple functionality. During this same period, the Company further
intends to release CD read/writable drives capable of writing and rewriting at
an accelerated pace relative to currently available technology. There is no
assurance that the Company will be successful in achieving the foregoing
introduction of products. Further, there is no assurance that in the event the
Company does introduce such technologies that revenues will be generated from
such introductions.
b. AUDIO PERIPHERAL UPGRADE CARDS AND SOLUTIONS
During the 18 month period commencing June 30, 1999 the Company plans
to introduce audio cards supportive of the Dolby digital (AC-3) standard. This
is the standard which has been established for many DVD movie titles for
decoding the five channel audio signal generated by such movies. The Company
believes that this standard will eventually also be adopted by the game software
industry. During this same 18 month period, the Company intends to: (i)
introduce a line of speaker systems that integrate the functionality of audio
cards into the speaker, thereby eliminating the need for a separate audio card
and (ii) introduce MP-3 players allowing end-users to digitally record audio
data over the Internet, such as music titles. There is no assurance that the
Company will be successful in achieving the foregoing introduction of products.
Further, there is no assurance that in the event the Company does introduce such
technologies that revenues will be generated from such introductions.
c. VIDEO PERIPHERAL UPGRADE CARDS AND SOLUTIONS
During the 12 month period commencing June 30, 1999 the Company intends
to introduce a line of digital "still-shot" cameras providing the transportation
of images from a camera to a computer. During this same 12 month period the
Company intends to introduce a number of video display cards addressing specific
marketplace demands. In June, 1999 the Company introduced a 32 megabyte video
display card providing increased speed, resolution and color depth. There is no
assurance that the Company will be successful in achieving the foregoing
introduction of products. Further, there is no assurance that in the event the
Company does introduce such technologies that revenues will be generated from
such introductions.
4. COMPETITION
In general, there are three key competitive factors which impact upon
the success of personal computer peripheral distribution companies: (i) time to
market; (ii) product value and technology and (iii) market penetration typically
measured by retail "shelf-space" and after sales service.
The Company focuses upon these competitive factors by positioning its
products as an affordable alternative
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to what the market perceives as the "tier one" brands such as Creative Labs
and S3, Inc. The Company places multiple orders each month with its Asian
suppliers, thereby assuring that there is a continuous distribution channel
comprised of products reflecting products ordered by its American retail
customers. The Company's products are typically priced below the competing
product distributed by Creative Labs and S3, Inc., while still containing the
same basic functionality and specifications. The Company believes that this
provides consumers with product value, while still sustaining the technology
contained in more expensive brand names. 1999 has been a break-through year
for the Company, allowing its product "sell-through" at the retail level to
provide increasing access to shelf-space at major consumer outlets throughout
North America. In summary, while the Company's marketplace is clearly
extremely price sensitive, there are certain technological specifications
which advanced applications such as video and audio cards for internet
applications require in order to achieve a necessary level of functionality.
These technological requirements typically assure that there is a floor to
pricing in the Company's marketplace.
The Company's competitors include virtually all hardware multi-media
firms selling into North American retail channels. These companies include
Creative Labs (NASDAQ: CREAK) with sales mainly in CD-ROMS, DVD and Sound Cards
and speakers; Haulage (NASDAQ: HAUP) sales mainly in Multimedia cards; 3Com
(NASDAQ: COMS) sales mainly in card LAN; Xircom (NASDAQ: XIRC) sales mainly in
Notebook Netrade Solutions; 3 DFX (NASDAQ: TDFX) sales mainly in Graphics cards;
and Pinnacle Systems, Inc. (NASDAQ: PCLE) sales mainly in Multi Media cards. In
addition, there are private companies, such as Smart and Friendly, Inc., Hi-Val,
Inc., and Digital Research Technologies which directly compete with portions of
the Company's product line.
A number of these companies are better financed and have a longer
operating history then I/OMagic. The market for computer peripherals is
extremely price sensitive and competitive. The composition and identity of
I/OMagic's competitors is constantly changing based upon marketplace conditions
and changes.
While the Company is continuing its development efforts to meet the
requirements of the marketplace, management of the Company believes that the key
to its success will be providing a full line of PC peripheral products,
including those outlined above as well as other products in development.
5. SOURCES OF RAW MATERIAL AND PRINCIPAL SUPPLIERS
The Company does not maintain its own manufacturing or production
facilities, and does not intend to do so in the foreseeable future. The Company
anticipates that its products will be manufactured, and its raw materials and
components will be supplied, by independent companies. Typically, the purchase
order is the Company's "agreement" with the manufacturer. Therefore, any of
these companies could terminate its relationship with the Company at any time.
In the event the Company were to have difficulties with its present
manufacturers and suppliers, the Company could experience delays in supplying
products to its customers. The Company has 100% of its products manufactured
overseas. Presently, the Company is dependent upon BTC and Lung Hwa for
manufacture of more than 60% of the Company's products. While the Company has
identified and has commenced utilizing certain alternative sources for its
products, clearly if either of its major suppliers: BTC or Lung Hwa experienced
manufacturing problems, the Company's business, financial condition, and results
of operations would be severely adversely effected, unless the Company could
quickly find a replacement supplier. Management of the Company believes that
should alternative sources be required, the impact would result in a delay of
shipping. The potential impact is that the cost paid to other manufacturers
would not be at the same pricing as BTC and Lung Hwa.
6. DEPENDENCE ON MAJOR CUSTOMERS.
In calendar 1998, the Company had sales with three major customers that
each represent approximately 32% (Fry's, $3,391,785), 26% (CompUSA, $2,769,503)
and 17% (Micro Center, $1,790,257) of net retail sales. Similarly, as of
December 31, 1998, the Company had three customers that accounted for 47%
(CompUSA, $1,810,765), 25% (Fry's $971,555) and 15% (Electronics Boutique,
$556,283) of accounts receivable.
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During the six month period ended June 30, 1999, the Company had
sales with three major customers that each represented 46% (Circuit City,
$5,962,812), 39% (CompUSA, $5,142,864) and 12% (Fry's $1,506,747) of net
retail sales. As of June 30, 1999, the Company had three customers that
accounted for 41% (Circuit City, $2,274,534), 31% (CompUSA, $1,707,522) and
10% (Office Max, $577,556) of accounts receivable. In June, 1999 the Company
engaged Office Max as a national retailer of the Company's products. While
there is no assurance, the Company anticipates that the addition of Office
Max will diversify the Company's gross revenues among its top customers.
During the fourth quarter of 1998 and the first three quarters of
1999, the Company's marketing efforts have focused upon large retail chains
with a national distribution capacity. As a result, the Company anticipates
that its future revenues will be highly dependent upon orders placed by
Circuit City, COMPUSA and OfficeMax
7. PATENTS, TRADEMARKS, LICENSES, FRANCHISES, CONCESSIONS,
ROYALTY AGREEMENTS AND/OR LABOR CONTRACTS .
a. PATENTS.
The Company does not have any issued or pending patents.
There can be no assurance that the Company will in fact apply for
patents and, even if it were to do so, that such patents would be awarded.
Currently, the Company does not hold patents on any of its products or processes
under development. The Company does, however, treat its technical data as
confidential and relies on internal nondisclosure safeguards, as well as on laws
protecting trade secrets, to protect its proprietary information. There can be
no assurance that these measures will adequately protect the confidentiality of
the Company's proprietary information or that others will not independently
develop products or technology that are equivalent or superior to those of the
Company. The Company may receive in the future communications from third parties
asserting that the Company's products infringe the proprietary rights of third
parties. There can be no assurance that any such claims would not result in
protracted and costly litigation. Furthermore, the Company has not filed for
patent law protection in foreign countries.
b. TRADEMARKS
The Company has provided substantial sums to establish its brand
identification in the marketplace. While it is difficult to estimate the
exact amount expended since the Company's inception in 1993, during the 18
month period terminating upon June 30, 1999, the Company expended in excess
of $2 million in supporting its brand identification and market presence.
These expenditures have included, but are not limited to, participation in
industry trade shows such as Comdex, RetailVision and Retail Exchange, rebate
programs, promotional advertisements through national retail outlets,
slotting fees which reserve shelf space for the Company's products and
participation in various customer marketing programs and events. The Company
does not have any registered trademarks at this time.
8. GOVERNMENT APPROVAL.
No government approval is required for any of the Company's current
products or services.
9. EFFECT OF ANY EXISTING OR PROPOSED GOVERNMENT
REGULATIONS.
Other than normal government regulations that any business encounters,
the Company's business is not effected by government regulations.
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10. RESEARCH AND DEVELOPMENT COSTS
The research and development efforts underlying the technology
comprising the eventual products sold by the Company are funded by the
Company's manufacturers (primarily BTC and Lung Hwa). The Company's research
and development efforts focus upon the development of driver software
providing a user friendly installation, user manuals, installation guides,
product packaging, marketing literature and market and sales research. The
Company estimates that it expended approximately $185,000 in connection with
these efforts during the 18 month period ending June 30, 1999.
11. COST AND EFFECTS OF COMPLIANCE WITH ENVIRONMENTAL
LAWS AND REGULATIONS
I/OMagic's business does not involve the use of materials in a
manufacturing process where such materials are likely to result in the violation
of any existing environmental rules and/or regulations. Further, I/OMagic does
not own any real property which would lead to liability as a land owner.
Therefore, I/OMagic does not anticipate any costs associated with the compliance
of environmental laws and regulations.
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12. EMPLOYEES
As of the date hereof, the Company has approximately 50 full-time
employees. The Company has hired independent contractors on an "as needed"
basis, to develop its web site and to fill short-term staffing needs such as
data entry and product assembly. The Company has no collective bargaining
agreements with its employees. The Company believes that its employee
relationships are satisfactory.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
In the event the Company continues with the revenue growth it has
experienced between 1998 and 1999 the Company believes that it will need
additional capital. While there is no assurance that it will be successful in
raising additional capital, the Company is currently actively seeking both
institutional debt, as well as private sources of equity capital in order to
assure that it will be capable of financing such growth. In the event the
Company is unsuccessful in securing such financing, it may be required to
curtail its sales growth. While the Company will continue with its business
plan at least through calendar year 2000 in providing a broad range of desk
top and portable computer peripherals and upgrades, the Company anticipates
that it will increasingly focus upon two aspects of its business: (1)
marketing to national retail chains; the Company believes that such chains
constitute less credit risk than smaller retail operations; and (2) that the
average order from such chains will be substantially larger than smaller
retail chains, thereby allowing the Company to take advantage of the
economies of scale associated with distributing a single product-line in
large volume.
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Year Ended Year Ended Six Months Six Months
December 31, December 31, Ended Ended
1998 1997 June 30, 1999 June 30, 1998
(audited) (audited) (unaudited) (unaudited)
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<S> <C> <C> <C> <C>
Statement of Operations Data
Revenue
(Net Loss)/Net Profit $ 10,714,363 $ 4,034,701 $13,083,869 $ 3,799,971
(Net Loss)/Net Profit (338,018) (1,459,527) 348,429 (15,963)
per share
(0.02) (0.12) 0.01 0.00
- ------------------------------ ---------------- -------------------- ------------------ ----------------
Balance Sheet Data
Current Assets 5,973,859 1,931,750 10,416,986 2,696,475
Total Property &
Equipment, Net 133,231 120,007 171,638 123,907
Total Assets 6,128,250 2,072,917 10,618,512 2,841,542
Total Current Liabilities
Accumulated Deficit 5,344,407 1,197,567 4,414,600 1,734,632
Stockholder's Equity (4,350,541) (4,012,523) (4,002,112) (4,028,489)
(Capital Deficiency) 777,120 (875,350) 6,198,455 (1,098,420)
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</TABLE>
The Company offers rebate programs for various products through its
retail customers. The products offered change from time to time. The purpose
of the rebates is to accelerate the sale of inventory, assist in the
customer's advertising campaign or provide for the joint marketing of related
products. Rebate programs typically last one or two weeks. The rebate concept
is prevalent among the Company's competitors and the Company anticipates that
it will continue indefinitely with different products offered at various
times.
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Periodically, the Company enters into various agreements for
services including, but not limited to, public relations, financial
consulting and manufacturing consulting. The agreements generally are on
going until such time they are terminated, as defined. Compensation for
services is paid either on a fixed monthly rate or based on a percentage, as
specified.
A. SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED) COMPARED TO SIX MONTHS
ENDED JUNE 30, 1998 (UNAUDITED)
Revenues for the period ended June 30, 1999 ("1999") were
$13,083,869, compared to revenues for the period ended June 30, 1998 ("1998")
of $3,799,971. The increase in revenues is primarily attributable to the
addition of COMPUSA in July 1998, Circuit City in April 1999 and Office Max
in June 1999. The Company did not have any sales back-log as of June 30, 1998
and it had a sales back log of $609,014 for the six months ended June 30,
1999.
Cost of sales as a percentage of revenues increased from 73.72%
($2,801,298) in 1998 to 75.70% ($9,905,027) in 1999. Cost of product as a
percentage of revenues decreased from 72.05% in 1998 to 71.45% in 1999. This
was primarily due to decreased product costs from vendors. Freight expenses
as a percentage of revenues increased from 1.67% in 1998 to 4.26% in 1999.
This was primarily due to more expensive air freight of products (as opposed
to ocean freight) due to late production by a major vendor. The Company
believes that this situation has been resolved at this time, and anticipates
lower future freight expenses.
The Company did not "write-down" any of its inventory during the six
months ended June 30, 1998 or 1999. The inventory which was marked down at
the end of a fiscal year (as discussed below) constituted discontinued items
and the Company was responsible for such costs.
Operating expenses as a percentage of revenues decreased from 33.42%
($1,269,964) in 1998 to 21.61% ($2,286,729) in 1999. The decrease is
partially due to the fact that most general and administrative expenses are
indirect, and thus, increase only slightly as revenues increase. Overall,
general and administrative expenses as a percentage of revenues also
decreased from 14.47% ($549,895) in 1998 to 9.84% or ($1,287,818) in 1999.
Expenditures that remained relatively stable from 1998 to 1999 include
outside services, legal expenses, travel expenses and rent which aggregated
$176,162 and $259,653, respectively. As a percentage of revenues these
expenses represented 4.64% in 1998 and 1.98% in 1999. Salaries and related
expenses decreased as a percentage of revenues from 7.64% ($290,379) in 1998
to 4.00% ($523,331) in 1999. The increase in the amount expensed is due
primarily to additional personnel added in 1999, although as a percentage of
revenues the amounts declined. Service agreement expenses as a percentage of
revenues were not significant and amounted to $17,805 in 1998 and $96,839 in
1999. Selling, marketing and advertising as a percentage of revenues
decreased from 18.95% ($720,069) in 1998 to 11.76% ($1,538,911) in 1999. The
decrease is primarily due to a reduction in the number of rebate programs and
the fact that marketing expenses are not a direct function of sales, although
related.
Other income (expense) decreased as a percentage of sales from 6.74%
($256,128 income) to (0.03%) ($3,284). 1998 included one-time other income of
$250,000 from the sale of a modem design.
Income taxes for both periods ended June 30, 1999 and 1998,
represent minimum state income taxes. This is due to the fact the Company has
net operating loss carryforwards expiring though 2018 to offset taxable
income for both federal and state purposes.
Net profits increased from a net loss of $15,963 for the six months
ended June 30, 1998 to a net profit of $348,429. for the six months ended
June 30, 1999.
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B. FISCAL YEAR ENDED DECEMBER 31, 1998 (AUDITED) COMPARED TO FISCAL YEAR
ENDED DECEMBER 31, 1997 (AUDITED)
Revenues for the year ended December 31, 1998 ("1998") were
$10,714,363 compared to revenues for the year ended December 31, 1997
("1997") of $4,034,701. The increase in revenues is attributable to the
increase in sales to: COMPUSA from $0 in 1997 to $2,769,503 in 1998; to Fry's
electronics from $1,051,894 in 1997 to $3,391,785; and to Micro Center from
$1,061,800 in 1997 to $1,790,257 in 1998; and smaller increases in sales to
other existing customers. The Company did not have a sales back log at the
end of 1997 or 1998.
Cost of sales as a percentage of revenues decreased from 84.71%
($3,417,984) to 73.99% ($7,927,553). This was primarily due to decreased
product costs charged by suppliers.
The Company "wrote-down" $93,700 in inventory in 1997 and $54,842 of
its inventory in 1998. Once a product is shipped by the Company to the
customer, then the Company is typically obligated to provide price protection
or accept returned products which are unsold by the retail customer. The
Company then attempts to resell this returned inventory to another customer.
If the Company has not yet accepted delivery of a product from its overseas
manufacturer, then the manufacturer is responsible for all price reductions
and obsolescence of such inventory.
Operating expenses as a percentage of revenues decreased from 51.03%
($3,376,021) in 1997 to 31.51% ($2,059,066) in 1998. This percentage decrease
is primarily due to the fixed cost nature of the majority of operating
expenses. In summary, as revenues increase, the selling, general and
administrative decrease as a percentage of revenues. The increase of $683,045
is primarily a result of commissions paid on a percentage basis of sales.
This increase is also a result of the Company's rebate programs. The Company
did not begin any rebate programs until the end of December 1997, thus 1997
rebate expense is negligible. As of December 31, 1998, the Company incurred
$140,498 in connection with service agreements. Amounts incurred in
connection with service agreements during the year ended December 31, 1997
were insignificant. In addition, bad debt decreased by $227,517 in 1998 from
1997 and audit expense decreased by $151,030 due to replacement of auditors
during the 1997 audit. Both are expected to be one-time non-recurring
expenses.
Other income (expense) increased from (0.41%) ($16,378) expense in
1997 to 2.35% ($251,993) income in 1998. Calendar 1998 revenues included a
non-recurring revenue amount of $250,000 arising from the sale of a modem
design.
Income taxes for both years ended December 31, 1998 and 1997,
represent minimum state income taxes due to the Company's loss position
during both periods.
Although the Company had an increase in revenues and receivables in
1998 compared with 1997, the Company experienced a net loss of $338,018 for
the year ended December 31, 1998 as compared to a net loss of $1,459,527 for
the year ended December 31, 1997. The decrease in the net loss is due to
improved sales, expansion of marketing activities, improved product costs and
the fact that the operating expenses did not increase at the same rate as
sales.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations and
capital expenditures primarily with cash provided by operating activities,
private securities issuances and securities issuances for product (see "Private
Placement Offerings"). The Company believes that working capital generated from
operations is sufficient to meet current activity. However, should the Company
grow significantly in size through additional large customers or acquisitions,
securities issuances or other financing arrangements may be necessary.
For the year ended December 31, 1998 the Company had a net increase in
cash relative to December 31, 1997 in the amount of $689,435. This was primarily
due to cash flow from operating activities of $829,771 being offset by investing
and financing activities of $140,336. While the Company experienced a loss for
1998 of $338,018, cash increased primarily through the utilization of
substantial lines of trade credit provided by the Company's major vendors.
10
<PAGE>
As the Company expands its distribution activities, it may experience
net negative cash flows from operations, pending an increase in gross margins,
and may be required to obtain additional financing to fund operations through
proceeds from offerings, to the extent available, or to obtain additional
financing to the extent necessary to augment its working capital through public
or private issuance of equity or debt securities.
The high technology requirements of the Internet increasingly require
that consumers upgrade their personal computers to take full advantage of audio
and video streaming capabilities. Further, there are increasing Internet
applications for digitally based graphics data, such as pictures taken by
digital cameras. The Company believes that its current distribution channels
currently fulfill and will continue to fulfill these trends in the computer
peripherals marketplace. In the event the Company continues with the revenue
growth it has experienced between 1998 and 1999 the Company believes that it
will need additional capital. While there is no assurance that it will be
successful in raising additional capital, the Company is currently actively
seeking both institutional debt, as well as private sources of equity capital in
order to assure that it will be capable of financing such growth. In the event
the Company is unsuccessful in securing such financing, it may be required to
curtail its sales growth.
PREVIOUS PRIVATE OFFERINGS
(a) SUMMARY OF OFFERINGS.
The proceeds from all of the following offerings were utilized to
acquire inventory and create brand awareness through various marketing and sales
programs. All of the following offerings were offered and sold exclusively to
accredited investors.
During the fourth quarter of 1995, I/OMagic California conducted an
offering of Units (the "Bridge Units"). Each Bridge Unit consisted of a
$25,000 9% secured promissory note (the "Bridge Notes"), 25,000 warrants
containing an exercise price of $0.05 per share (the "A Bridge Warrants"),
and 25,000 warrants containing an exercise price of $0.95 per share (the "B
Bridge Warrants"). The exercise price of the B Bridge Warrants was reduced by
the amount of $0.04 per month for every 30 days after the first six months
that the Bridge Notes were outstanding. The Bridge Notes were due at the
earlier of: (i) one year from issuance or (ii) upon the completion of certain
subsequent offerings of securities. The Bridge Notes were secured by all
tangible and intangible assets of the Company with a first lien, perfected
UCC-1 Financing Statement. The Company raised $805,000 in connection with its
sale of the Bridge Units. As of the date hereof, 255,375 A Bridge Warrants
are outstanding and zero B Bridge Warrants are outstanding having been called
and canceled by the Company on September 11, 1998. The Bridge Notes have been
repaid in full and all UCC filings terminated. The Company relied upon
Section 4(2) of the 1933 Act and this offering was sold to 35 accredited
investors. It was offered only to accredited investors.
On May 6, 1996, the Company entered into a strategic Alliance
Agreement with Lung Hwa Electronics Co., Ltd., whereby for a consideration of
$342,000 from Lung Hwa, the Company issued 1,000,000 shares of restricted
Company common stock. For this agreement, Lung Hwa also agreed to establish a
$1,000,000 line of unsecured credit in favor of I/OMagic, which was later
increased to $2,000,000. As of December 1998 and 1997, there were no
outstanding borrowings under this agreement. As of the date of this filing
there is a balance of $500,000 under this line of credit. The Company relied
upon Section 4(2) of the 1933 Act in connection with this transaction and
Lung Hwa is an accredited investor.
In connection with a March 1996 private placement of units
consisting of common stock and warrants, the Company issued 568,002 shares of
common stock for cash at $1.45 per share and 577,335 warrants for cash at
$.0.05 per warrant, or $1.50 per unit totaling $853,500. Concurrent with this
offering, the Company converted $627,500 of its Bridge Notes into 598,328
shares of common stock at $1 per share and 598,328 warrants at $.0.05 per
warrant. These warrants allow the holder to purchase common stock at $2.50
per share, exercisable for a period of three years from the date of issuance.
The Company is obligated to register the common stock issuable upon exercise
of these warrants in any subsequent Registration Statement filed with the
Securities and Exchange Commission. Through June 30, 1999, none of these
warrants have been exercised. The full amount due on all nonconverted Bridge
Notes has been paid by the Company, and all UCC-1 Financing Statements have
been terminated. The Company relied upon Section 4(2) of
11
<PAGE>
the 1933 Act. There were 35 accredited investors in this offering and offers
were made only to accredited investors.
As consideration for placement agent services rendered in connection
with the March, 1996 private placement, the Company issued to the placement
agents the following warrants: 58,000 warrants to purchase common stock at an
exercise price of $0.70 per share, 131,850 warrants to purchase common stock at
an exercise price of $0.01 per share, and 151,850 warrants to purchase common
stock at an exercise price of $1.65 per share. The term of these warrants is
three years from the date of issuance, and these warrants carry Piggyback
Registration Rights. As of June 30, 1999 none of these warrants have been
exercised.
On December 16, 1996, the Company entered into a private Stock Purchase
Agreement whereby the Company sold 250,000 units at a price of $1.00 per unit.
Each unit consisted of one share of common stock and one warrant to purchase
Company stock exercisable at a price of $1.00 per share for a term of two years.
The warrants were not exercised and have expired. The Company relied upon
Section 4(2) of the 1933 Act and this offering was to a single accredited
investor.
In February 1997, the Company commenced an offering of up to 600,000
units, consisting of one share of restricted common stock for cash at $1.24
per share and one warrant for cash of $0.01 per warrant for a total price of
$1.25 per unit, as amended. The warrants are exercisable in whole or in part
at any time during the three years from date of issuance at an exercise price
of $4.50 and are callable by the Company, as defined. These units carry
piggy-back registration rights and the shares underlying the warrants have
not been registered under the Securities Act of 1933. The offering closed in
September 1997, at which time the Company had sold 364,000 units for total
proceeds of $455,000. Offering costs related to this private placement
totaled approximately $25,000. The Company relied upon Section 4(2) of the
1933 Act and this offering was sold to three accredited investors and was
offered only to accredited investors.
As consideration for placement services rendered in connection with the
February 1997 private placement, the Company issued to a placement agent 13,200
warrants carrying the same terms as the warrants issued in the offering.
On September 19, 1997, the Company entered into a Strategic Alliance
Agreement with Hou Electronics, Inc., a California corporation ("Hou"),
whereby the Company issued two million restricted shares of common stock in
exchange for $250,000 in cash and $1,250,000 of inventory for a total value
of $1,500,000, or $0.75 per share. Of the $1,250,000, $481,260 was credited
toward inventory purchased prior to the agreement. The remaining $768,740 was
to be applied to future inventory purchases. As of December 31, 1998, all of
the inventory had been received by the Company. In connection with this
Agreement, Hou provided the Company with a $1 million line of credit and
provided Hou with a right to designate a single member to the Board of
Directors of the Company. As of June 30, 1999 there are no outstanding
borrowings under this line of credit. The Company relied upon Section 4(2) of
the 1933 Act in connection with this transaction and Hou is an accredited
investor.
On June 1, 1998, the Company offered up to $250,000 worth of units
of its securities with each unit consisting of a $10,000 note bearing
interest at a rate of 10% per annum, repayable in full ninety days after the
declaration of effectiveness of a registration statement, as defined, or
twelve months from the date of sale whichever comes first; and, one warrant
exercisable at $1.00 of 30% of the face value of the note and then divided by
the price per share as set forth in the registration statement, as defined.
Through June 1998, the Company sold units to accredited investors to raise
$250,000. As of June 30, 1999, the Company repaid $205,000 plus accrued
interest. The remaining $45,000, plus interest, was paid in July 1997. All
warrants have expired. The Company relied upon Section 4(2) of the 1933 Act
in connection with this offering and all investors were accredited investors.
Effective February 3, 1999, I/OMagic entered into a Subscription
Agreement with BTC wherein BTC received 16,666,667 shares of restricted
Common Stock valued at $0.30 per share (based on a closing price of $0.31 on
February 3, 1999) in exchange for $5 million in inventory. The Company relied
upon Section 4(2) of the 1933 Securities Act in connection with this
transaction and BTC is an accredited investor.
12
<PAGE>
(b) STATUS OF WARRANT ISSUANCES
As of September 30, 1999 the Company had the following warrants to
purchase common stock outstanding:
(1) 805,000 Class A and 805,000 Class B Warrants were issued in the
October, 1995 private placement. The Class A Warrants have an exercise price
of $0.05 and the Class B Warrants have an exercise price of $0.95. 542,500 of
the Class A Warrants were exercised as of September 30, 1999 and 255,375
Class A Warrants remain outstanding. 25,001 of the Class B Warrants were
exercised and the remainder were called and terminated in September, 1998.
(2) 125,125 Class A Warrants were issued to Pellet Investments, Inc.
as the placement agent in the October, 1995 offering at an exercise price of
$0.10, with an expiration date of October 17, 2000 and 125,125 Class B
Warrants were issued to Pellet investments with an exercise price of $1.10
(these warrants were called and terminated). 33,232 of the Class A Warrants
have been exercised and the balance remain outstanding.
(3) 577,335 warrants with an exercise price of $2.50 were issued in
the March, 1996 offering. None of these warrants were exercised and they all
expired, in accordance with their terms. An additional 598,398 warrants were
issued in the March, 1996 offering arising from the conversion of the Notes
issued in the 1995 Offering. None of these warrants were exercised and all
expired in accordance with their terms.
(4) An aggregate 341,700 warrants were issued to West America
Securities, Inc. as the placement agent for the 1996 Offering at exercise
prices ranging from $0.01 to $1.65. None of these warrants were exercised and
all expired in accordance with their terms.
(5) 70,000 warrants were issued to Redfield Miller, Inc. (between
February and June, 1997) for services associated with the financial
management of the company with an exercise price of $1.65 and an expiration
date of November 1, 2000. None of these warrants have been exercised as of
September 30, 1999.
(6) 15,000 Warrants with an exercise price of $0.01 and 15,000
warrants with an exercise price of $1.00 per share were issued to incentive
Business Channel ("IBC") for public relation services. The warrants expire
between January 1999 and December 1999. As of September 30, 1999, IBC
exercised 20,000 of such warrants. The remaining 10,000 warrants are
exercisable at $1.00 with 5,000 warrants expiring in November, 1999 and 5,000
expiring in December, 1999.
60,000 warrants with an exercise price of $1.12 and 30,000
warrants with an exercise of $2.24 were issued to Marketing Pathways for
public relation services. None of the warrants were exercised and the
warrants expired in August, 1999.
(c) INDEBTEDNESS
The Company issued an 8% convertible promissory note to M.T. Hong in
the principal amount of $345,500, dated March 14, 1995, in consideration for the
purchase by the Company of certain inventory. It is the position of the Company
that this amount is not due and owing as the Company did not receive the
inventory. At no time has any legal cause of action been commenced against the
company in connection with this debt.
YEAR 2000
The Company has developed and acquired its computer systems with an
objective to be Year 2000 compliant. The Company has engaged the services of
qualified technicians to determine the extent to which it may be vulnerable
13
<PAGE>
to third party Year 2000 issues. All computer equipment purchased recently are
Year 2000 compliant. The internal software written by the Company's programmers
is written with the long-date format included and consequently is Year 2000
compliant. The Company uses Microsoft software and has installed all the
available "patches" to up-date this software. Further, Microsoft "patches" will
be installed as they become available from Microsoft in 1999, but this affects
the Company's software and does not impact on the on-going operation of the
Company. The Company has assessed and continues to asses whether its information
and non-information technology systems will be effected by the Year 2000 issues.
The Company has investigated its third party communications suppliers such as
the telephone company and its Internet service provider and found that all are
in the process of becoming Year 2000 compliant in 1999. Based upon current
information, management believes that the necessary modifications have been made
internally to effectively continue the Company into the Year 2000, however,
management is continuing to monitor internal systems, and to assess the
readiness of its systems, to ensure Year 2000 compliance. As a contingency, the
Company has identified other communication suppliers who could provide the
necessary service at a minimal cost to the Company, and a minimal effect on the
operations of the Company. In the event no other communication suppliers can be
found, there could be a material adverse effect on the Company and its
operations. Based upon current information, the Company does not believe that
the costs associated with Year 2000 compliance is material for the Company.
The Company does not distribute any product which maintains a calendar,
therefore all products currently distributed by the Company would be Year 2000
compliant. The worst case scenario for the Company would be an installation of
its peripheral products into a computer system which is not Year 2000 compliant.
The Company believes that if this were to occur, that the functionality of the
computer system and therefore all installed peripherals would be adversely
effected.
ITEM 3. DESCRIPTION OF PROPERTY
As of July 1, 1999 the Company leases approximately 22,000 square feet
located at a facility in Irvine, California, which includes offices, storage,
and package assembly space. All of the Company's operations are conducted from
this facility. The lease expires July 1, 2000, and requires monthly payments of
approximately $15,000 per month.
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<PAGE>
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
<TABLE>
<CAPTION>
PERCENTAGE
NAME NUMBER OF SHARES (1) BENEFICIALLY OWNED
- ---- -------------------- ------------------
<S> <C> <C>
Tony Shahbaz(2) 2,000,000 6%
Lung Hwa Electronics Co., Ltd. 1,000,000 3%
3F, No. 59 Tsao Ti Wei
Shen Keng Shiang
Taipei Hsein, Taiwan
Anthony Andrews(2) 74,999 *
Daniel Hou(3)(2) -0- *
Susha LLC(4) 20,766,667 66%
Hou Electronics Inc.(2) 2,000,000 6%
All officers and directors as a group (3 persons) 2,074,999 6%
</TABLE>
- ---------------
* Less than one percent
1 Except as otherwise indicated, the Company believes that the beneficial
owners of Common Stock listed above, based on information furnished by
such owners, have sole investment and voting power with respect to such
shares, subject to community property laws where applicable. Beneficial
ownership is determined in accordance with the rules of the Securities
and Exchange Commission and generally includes voting or investment power
with respect to securities. Shares of Common Stock subject to options or
warrants currently exercisable, or exercisable within 60 days, are deemed
outstanding for purposes of computing the percentage of the person
holding such options or warrants, but are not deemed outstanding for
purposes of computing the percentage of any other person.
2 c/o Company's address: 6 Autry, Irvine, CA 92618.
3 Pursuant to a written agreement, Hou Electronics, Inc. has a Board seat
on the Board of Directors of the Company.
4 Susha LLC ("Susha") is a California Limited Liability Company which holds
20,766,667 shares of I/OMagic Corporation. Susha was created as a holding
company to hold certain securities contributed by BTC and Mr. Shahbaz.
While Mr. Shahbaz has certain voting powers associated with the shares
held by Susha, 50% of all financial benefits derived from the shares held
by Susha are for the benefit of BTC and 50% of the financial benefits
derived from the shares held by Susha are for the benefit of Mr. Shahbaz.
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of the date of this Statement by: (i)
each stockholder known by the Company to be the beneficial owner of more than
five percent of the outstanding Common Stock, (ii) each director of the Company,
and (iii) all directors and officers as a group.
ITEM 5. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The directors and officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
---------------- --- ---------------------------------
<S> <C> <C>
Tony Shahbaz 37 Chairman, President, Chief Executive Officer
Daniel Hou 50 Director
Anthony Andrews 37 Vice President, Director of Engineering, Director
</TABLE>
Mr. Hou and Mr. Andrews shall serve until the next annual meeting of the
shareholders of the Company which is currently scheduled to occur during
February-April, 2000. Mr. Shahbaz is next scheduled for election in April, 2002
15
<PAGE>
MR. TONY SHAHBAZ, CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER, is the
Company's founder. In addition, he has played a key role in developing the
Company's multimedia strategy. Mr. Shahbaz has a technical background with over
15 years experience in sales and marketing of computer peripheral products. He
was employed by Western Digital Corporation from September 1986 to March 1993.
At Western Digital Corporation, he held several positions including Vice
President of Worldwide Sales for Western Digital Paradise, and Regional Director
of Asia Pacific Sales and Marketing Operations. While at Western Digital
Paradise's business unit, he established a multichannel world wide retail
distribution structure, with a full line of multimedia products. As Regional
Director of Asia Pacific Sales, he managed two of the company's wholly owned
subsidiaries that developed chip sets and peripherals for the marketplace. He
has held other management positions with Tandon Corporation and Lapin
Technology, in the marketing sales divisions of these companies.
DANIEL HOU, DIRECTOR, Mr. Hou is the Founder of Hou Electronic, Inc. a computer
peripheral supplier. The company was formed in 1986 and has continually grown to
have revenues of $45 million in 1998. Mr. Hou is active in related organizations
such as holding the office of President with the Southern California Chinese
Computer Association as well as a membership in American Chemistry Society. Mr.
Hou received his Masters in Science from University of Utah.
MR. ANTHONY ANDREWS, VICE PRESIDENT, DIRECTOR OF ENGINEERING, joined the Company
in February 1994. Mr. Andrews has over 12 years of experience in the computer
industry. His background includes product and software design, with his most
recent position as Principal Engineer at Western Digital Corporation from March
1988 to February 1994. As Principal Engineer, he pioneered the development of
portable notebook designs for companies such as IBM and AST. He also played a
lead role in developing power management features that are being commonly used
in the industry today. Mr. Andrews has his own software design company which has
developed embedded system designs as well as game software. Mr. Andrews works
closely with the Company's sales channels to identify product/market
opportunities for the Company. He is responsible for bringing products from
concept to market launch. This includes sourcing manufacturers for hardware,
developing any necessary software, and packaging designs and specification
sheets. He received a Bachelor of Science in Math and Computer Science from the
University of California at Los Angeles.
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<PAGE>
ITEM 6. EXECUTIVE COMPENSATION
Set forth below is a summary of compensation for the Company's officers for
fiscal years 1999, 1998 and 1997. There are no annuity, pension or retirement
benefits proposed to be paid to officers, directors or employees of the Company
in the event of retirement at normal retirement date pursuant to any presently
existing plan provided or contributed to by the Company or its subsidiary.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term Compensation
----------------------
Annual Compensation Awards Payouts
------------------- ------ -------
Name Other All
and Annual Restricted Other
Principal Position Compen- Stock Options LTIP Compen-
Year Salary Bonus sation Awards SARs Payouts sation
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tony Shahbaz 1999 $140,000 -0- -0- 6,000 (auto)
CEO, President, 1 98 $140,000 -0- 300,000(2) 6,000 (auto)
Secretary & CFO 1997 $140,000 11,5001 -0- 300,000(3) 6,000 (auto)
-0-
-0-
Anthony Andrews 1999 $74,286 -0- -0- -0- -0- -0- -0-
Vice President 1998 $70,269 3,000 -0- -0- -0- -0- -0-
======================= ======== ============ ========= =========== ============= ========== =========== =================
</TABLE>
The Company's By-laws state that Directors of the Company shall not receive
any stated salary for their services, but, by resolution of the Board of
Directors, a fixed sum and expense of attendance, if any, may be allowed for
attendance at each regular and special meeting of the Board of Directors. The
Company maintains directors and officers liability insurance.
- ------------------------
(1) Mr. Shahbaz received a bonus of $11,500 for Design Sale of a modem
to Hewlett Packard in May 1998.
(2) On January 2, 1997 the Company issued 300,000 warrants to purchase
common stock of the Company at an exercise price of $1.82 for a term of five
years to Mr. Shahbaz under the Company's 1997 Incentive and Nonstatutory Stock
Option Plan.
(3) On January 2, 1998 the Company issued 300,000 warrants to purchase
common stock of the Company at an exercise price of $1.13 for a term of five
years to Mr. Shahbaz under the Company's 1998 Incentive and Nonstatutory Stock
Option Plan.
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<PAGE>
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Tony Shahbaz, its
Chairman, President and Chief Executive Officer on October 25, 1993 pursuant to
which the Company has agreed to pay Mr. Shahbaz an annual salary of $140,000 per
year payable in twelve equal payments on the first day of each month. The
agreement provides for a bonus based on the "net profits" of the Company as
defined. The bonus amount ranges from $20,000 to $70,000 for net profits up to
$%500,000. For net profits in excess of $500,000, the bonus is 7%. No bonuses
were paid under the net profits calculation contained in the employment
agreement.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
THE BTC ACQUISITION
On February 3, 1999, I/OMagic entered into a subscription agreement with
Behavior Technology Corporation (USA), a California corporation ("BTC"). In
this transaction, BTC: (i) contributed $5 million worth of inventory in
exchange for 16,666,667 shares of restricted Common Stock of I/OMAGIC and
(ii) provided a $5 million credit line for the purchase of additional
inventory. Borrowings are non-interest bearing and are due 75 days from the
date of borrowing. As of December 31, 1998, the Company had no debt
outstanding, other than its trade payables generated in the ordinary course
of business.
ITEM 8. DESCRIPTION OF SECURITIES
On February 18, 1999, SUSHA, LLC, a California limited liability company,
was formed. The LLC holds 20,766,667 shares of I/OMagic Corporation. The purpose
of creating this LLC is to provide the President of I/OMagic with more voting
control of the Company.
The authorized capital stock of the company currently consists of
50,000,000 shares of common stock, $0.001 par value, and 10,000,000 shares of
preferred stock. No preferred shares have been issued.
The following summary of certain terms of the common stock does not purport
to be complete and is subject to, and qualified in its entirety by, the
provisions of the company's Articles of Incorporation and By-laws which are
attached to this Statement.
THE EXCHANGE TRANSACTION
I/OMAGIC Corporation, a California corporation ("I/OMAGIC California")
entered into a Plan of Exchange and Acquisition Agreement (the "Acquisition
Agreement") with Silvercrest International, Inc., a Nevada corporation
("Silvercrest") on March 18, 1996. Pursuant to the Acquisition Agreement,
Silvercrest issued 6,570,583 shares of common stock in exchange for 6,570,583
shares of common stock of I/OMAGIC California, which constituted 100% of the
issued and outstanding shares of I/OMAGIC California. Prior to the execution of
the Acquisition Agreement, Silvercrest was a public company with dormant
operations and had 625,000 shares of common stock outstanding. Silvercrest's
common stock was listed on the Over-The-Counter Bulletin Board System as of
March 1, 1996. Silvercrest changed its name to I/OMAGIC Corporation, a Nevada
corporation, on March 20, 1996. Effective as of the date of the Acquisition
Agreement, the board of directors of Silvercrest resigned and I/OMagic's
directors were appointed as the new Board of Directors. As a result of the
acquisition, I/OMAGIC California, became a wholly-owned subsidiary of I/OMAGIC
Corporation, a Nevada corporation.
18
<PAGE>
COMMON STOCK
The Company's Articles of Incorporation authorize the issuance of
50,000,000 shares of Common Stock, $.001 par value per share, of which
31,369,026 shares of are outstanding as of August 6, 1999. In addition, there
are 550,000 treasury shares. As of the date of this filing, assuming the
exercise of all currently outstanding Options and Warrants, 33,673,084 shares
would be outstanding.
Holders of common stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Holders of common
stock are entitled to receive ratably such dividends as may be declared by the
Board of Directors out of funds legally available therefor. In the event of a
liquidation, dissolution or winding up of the Company, holders of Common Stock
are entitled to share ratably in all assets remaining after payment of
liabilities. Holders of Common Stock have no right to convert their Common Stock
into any other securities. The Common Stock has no preemptive or other
subscription rights. There are no redemption or sinking fund provisions
applicable to the Common Stock. All outstanding shares of Common Stock are duly
authorized, validly issued, fully paid and nonassessable.
PREFERRED STOCK
The Company's Articles of Incorporation authorize the issuance of
10,000,000 shares of preferred stock with a par value of $0.001. The
Company's Board of Directors has authority, without action by the
shareholders, to issue all or any portion of the shares of authorized but
unissued preferred stock in one or more series and to determine the voting
rights, preferences as to dividends and liquidation, conversion rights, and
other rights of such series. The preferred stock, if and when issued, may
carry rights superior to those of common stock, however, no preferred stock
may be issued with rights equal or senior to the preferred stock without the
consent of a majority of the holders of preferred stock.
The Company considers it desirable to have preferred stock available to
provide increased flexibility in structuring possible future acquisitions and
financings and in meeting corporate needs which may arise. If opportunities
arise that would make desirable the issuance of preferred stock through either
public offering or private placements, the provisions for preferred stock in the
Company's Certificate of Incorporation would avoid the possible delay and
expense of a shareholder's meeting, except as may be required by law or
regulatory authorities. Issuance of the preferred stock could result, however,
in a series of securities outstanding that will have certain preferences with
respect to dividends and liquidation over the common stock which would result in
dilution of the income per share and net book value of the common stock.
Issuance of additional common stock pursuant to any conversion right which may
be attached to the terms of any series of preferred stock may also result in
dilution of the net income per share and the net book value of the common stock.
The specific terms of any series of preferred stock will depend primarily on
market conditions, terms of a proposed acquisition or financing, and other
factors existing at the time of issuance. Therefore, it is not possible at this
time to determine in what respect a particular series of preferred stock will be
superior to the Company's common stock or any other series of preferred stock
which the Company may issue. The Board of Directors does not have any specific
plan for the issuance of preferred stock at the present time and does not intend
to issue any preferred stock, except on terms which it deems to be in the best
interest of the Company and its shareholders.
The issuance of Preferred Stock could have the effect of making it more
difficult for a third party to acquire a majority of the outstanding voting
stock of the Company. Further, certain provisions of Nevada law could delay or
make more difficult a merger, tender offer or proxy contest involving the
Company. While such provisions are intended to enable the Board of Directors to
maximize stockholder value, they may have the effect of discouraging takeovers
which could be in the best interest of certain stockholders. There is no
assurance that such provisions will not have an adverse effect on the market
value of the Company's stock in the future.
On October 31, 1996, the Board of Directors of the Company authorized
and approved the designation of 1,000,000 shares of Class A Convertible
Preferred Stock and 1,000,000 shares of Class B Convertible Preferred Stock
to be sold in a previous offering. The Class A Convertible Preferred Shares
have a 9% coupon attached, which interest is payable quarterly, and are
convertible into shares of Common Stock of the Company at $2.50 per share.
The Class B Convertible Preferred Shares have a 9% coupon attached, which
interest is payable
19
<PAGE>
quarterly, and are redeemable by the investor only after one year from date
of issuance and convertible into Common Shares at $2.00 per share. The
offering was terminated and there were no sales under the offering and,
therefore, no preferred stock is issued or outstanding.
20
<PAGE>
WARRANTS AND OPTIONS
During the fourth quarter of 1995, the Company conducted an offering of
Units (the "Bridge Units"). Each Bridge Unit consisted of a $25,000 9%
secured promissory note (the "Bridge Notes"), 25,000 warrants to purchase
Common Stock at an exercise price of $0.05 per share (the "A Bridge
Warrants") and 25,000 warrants to purchase Common Stock at an exercise price
of $0.95 per share (the "B Bridge Warrants"). The exercise price of the B
Bridge Warrants was reduced by the amount of $0.04 per month, for every 30
days after the first six months that the Notes were outstanding. As of the
date hereof, 255,375 A Bridge Warrants are outstanding and zero B Bridge
Warrants are outstanding. The Bridge Notes were repaid in full.
As consideration for placement agent services rendered in connection
with the 1995 offering of Bridge Units, the Company issued 125,125 A Bridge
Warrants to purchase shares of the Common Stock of the Company at $0.10 per
share and 125,125 B Bridge Warrants to purchase shares of Common Stock of the
Company at $1.10 per share to Pellet Investments, Inc. The terms of these A
and B Bridge Warrants issued to the placement agents are the same as the A
and B Bridge Warrants issued to the investors. 91,893 A Bridge Warrants
issued to placement agents are currently outstanding. No Bridge Warrants are
outstanding.
On October 30, 1995, the Company entered into a Consulting Agreement
with Redfield Miller, Inc. whereby Redfield Miller earned cash compensation
of $6,000 per month and 5,000 warrants per month, each exercisable for one
share of Common Stock at an exercise price of $1.65 per share for a three
year term, for every month of the Agreement which continues on a
month-to-month basis. As of the date of this Memorandum, Redfield Miller
earned 100,000 warrants under the Consulting Agreement, 30,000 of which were
exercised, leaving Redfield Miller with 70,000 warrants. All shares earned
under the Consulting Agreement may qualify for S-8 Registration Rights.
Edward Hanson, former Chief Financial Officer of the Company, is a principal
of Redfield Miller. The Consulting Agreement was terminated effective June 1,
1997.
During the first half of 1996, the Company conducted an offering of Units
(the "Secondary Units"). Each Secondary Unit consisted of one share of Common
Stock (the "Common Stock") and one Warrant exercisable for one share of Common
Stock at an exercise price of $2.50 per share, subject to adjustment (the
"Secondary Warrants"). The minimum investment was 16,667 Units at $1.50 per Unit
($25,000). The Company raised $853,500 in connection with its sale of the
Secondary Units. In addition, the Company offered each of the holders of the
Bridge Notes the right to exchange their Bridge Notes for Secondary Units at a
price of $1.05 per Unit. $627,500 worth of Bridge Notes were converted, leaving
$177,500 due and payable by the Company on the Bridge Notes by October 31, 1996.
The Bridge Notes were paid in full.
As consideration for placement agent services rendered in connection with
the 1996 Secondary Offering, the Company issued to the placement agents the
following warrants: 58,000 warrants to purchase Common Stock at an exercise
price of $0.70 per share; 131,850 warrants to purchase Common Stock at an
exercise price of $0.01 per share; and 151,850 warrants to purchase Common Stock
at an exercise price of $1.65 per share. The terms of these warrants are the
same as the Secondary Warrants.
On April 1, 1996, the Company enacted the 1996 Incentive and Nonstatutory
Stock Option Plan (the "Plan") which has reserved for issuance 750,000 options
to purchase shares of Common Stock of the Company at an exercise price of $0.01
for key employees and consultants. To date, 750,000 options have been issued
under the plan and 650,000 options have been exercised.
Anthony Andrews, Vice President of the Company, holds 50,000 options, each
exercisable for one share of Common Stock at an exercise price of $0.01 per
share for a period of five years from April 1, 1996, issued pursuant to the
Plan.
Michael Cone, an employee of the Company, holds 50,000 warrants, each
exercisable for one share of Common Stock at an exercise price of $0.01 per
share for a period of five years from April 1, 1996, issued pursuant to the
Plan.
21
<PAGE>
On January 2, 1997, the Company enacted the 1997 Incentive and
Nonstatutory Stock Option Plan (the "Plan") which has reserved for issuance
1,000,000 options to purchase shares of Common Stock of the Company at a
minimum exercise price of $1.65 for key employees and consultants. To date,
300,000 options have been issued under the plan.
In February, 1997 the Company commenced an offering of up to 600,000
units, as amended. Each unit consisted of one share of common stock and one
warrant for cash of $1.25 per unit. The Company sold 364,000 units. The
warrants are exercisable in whole or in part at any time during the three
years from the date of issuance at an exercise price of $4.50 and are
callable by the Company, as defined. As of the date hereof, none of the
warrants have been exercised.
On January 2, 1998, the Company enacted the 1998 Incentive and
Nonstatutory Stock Option Plan (the "Plan") which has reserved for issuance
1,401,976 options to purchase shares of Common Stock of the Company at a
minimum exercise price of $1.03 for key employees and consultants. To date,
300,000 options have been issued under the Plan.
PART II
ITEM 1. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANTS' COMMON EQUITY AND
OTHER STOCKHOLDERS MATTERS
A. MARKET INFORMATION
The Common Stock is currently quoted on the Over-The-Counter Bulletin Board
under the Symbol "IOMC". Set forth below is the trading history of the Company's
Common Stock without retail mark up, mark-down or commissions:
<TABLE>
<CAPTION>
=======================================================================
BID PRICES
--------------------
1997 HIGH LOW
---- ---- ---
<S> <C> <C>
January 1 - January 31 $4 1/4 $2 3/8
February 1 - February 28 $3 3/4 $3 1/4
March 1 - March 31 $3 1/4 $2 1/8
April 1 - April 30 $2 3/4 $2
May 1 - May 31 $2 5/8 $1 5/32
June 1 - June 30 $1 3/8 $1
July 1 - July 31 $0 3/4
August 1 - August 31 $0 13/32
September 1 - September 30 $0 11/16
October 1 - October 31 $1 1/4
November 1 - November 30 $1 7/16
December 1 - December 31 $0 3/4
1998
----
January 1 - January 31 $1 5/8 $0 11/16
February 1 - February 28 1 5/16 0 3/4
March 1 - March 31 1 1/2 0 3/8
April 1 - April 30 1 3/16 0 7/16
May 1 - May 31 0 13/16 0 3/8
June 1 - June 30 1 1/2 0 3/8
July 1 - July 31 1 1/4 5/8
August 1 - August 31 1 1/16 3/8
September 1 - September 30 1 1/16 7/32
=======================================================================
</TABLE>
22
<PAGE>
<TABLE>
=======================================================================================================
<S> <C> <C>
October 1 - October 31 9/16 5/16
November 1 - November 30 1/2 1 1/32
December 1 - December 31 1/2 9/32
1999
----
January 1 - January 31 7/16 1 5/64
February 1 - February 28 1 1/8 0 5/16
March 1 - March 31 3 1/8 0 7/8
April 1 - April 30 2 5/8 1 1/2
May 1 - May 31 2 1/2 1 7/8
June 1 - June 30 2 5/16 1 3/4
July 1 - July 31 1 31/32 1 21/32
=======================================================================================================
</TABLE>
The above quotations are inter-dealer quotations from market makers of
the Company's stock. At certain times the actual closing or opening quotations
may not represent actual trades that took place.
Except for 7,170,807 free trading shares, all shares issued by the
Company are "restricted securities" within the meaning of Rule 144 under the
1933 Act. Ordinarily, under Rule 144, a person holding restricted securities for
a period of one year may, every three months, sell in ordinary brokerage
transactions or in transactions directly with a market maker an amount equal to
the greater of one percent of the Company's then-outstanding Common Stock or the
average weekly trading volume during the four calendar weeks prior to such sale.
Future sales of such shares and sales of shares purchased by holders of options
or warrants could have an adverse effect on the market price of the Common
Stock.
B. HOLDERS
As of August 6, 1999, there were approximately 70 registered holders of
Company's restricted Common Stock, as reported by the Company's transfer agent.
This figure does not include the free trading shareholders.
C. DIVIDENDS
The Company has not paid any dividends on its Common Stock. The Company
currently intends to retain any earnings for use in its business, and therefore
does not anticipate paying cash dividends in the foreseeable future.
23
<PAGE>
ITEM 2. LEGAL PROCEEDINGS
In April 1999, the Company filed for an arbitration proceeding
against its former accountants and auditors, Ernst & Young, LLP, for failure
to complete the contracted work in a timely fashion and excessive billing.
Arbitration proceedings are anticipated to take place in Fall 1999. As of the
date of this filing, such arbitration has not commenced.
ITEM 3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
(1) Dismissal of Principal Accountants.
The Company dismissed Ernst & Young LLP, Certified Public
Accountants ("Ernst & Young") as its principal accountants on October 7,
1998. The principal accountants' report on the financial statements for
either of the past two years contained no adverse opinion or a disclaimer of
opinion, nor was qualified nor modified as to uncertainty, audit scope, or
accounting principles. The decision to change principal accountants of the
Company was approved by the Board of Directors of the Company.
During the Company's two most recent fiscal years and any subsequent
interim period preceding such dismissal, there were no disagreements with the
former accountants on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure. There is nothing
to report under Item 304(a)(1)(iv)(B) through (E).
(2) Engagement of New Principal Accountants.
The Company has engaged Singer, Lewak, Greenbaum & Goldstein, LLP,
("SLGG") on October 9, 1998 as its principal accountants. SLGG's business
address is 2700 North Main Street, Suite 200, Santa Ana, California. SLGG
replaces Ernst & Young. SLGG conducted both the 1997 and 1998 audit which are
attached. Neither the Company nor anyone on its behalf has consulted SLGG
during the two most recent past fiscal years regarding any matter for which
reporting is required under Regulation S-B, Item 304(a)(2)(i) or (ii) and the
related instructions. The decision to engage SLGG was approved by the Board
of Directors.
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES
The following information is furnished with regard to all securities
issued by the Company during calendar year 1999 which were not registered under
the Securities Act of 1933, as amended (the "Act"). Each of the following
transactions was exempt from under the Act by virtue of the provisions of
Section 4(2) of the Act. Each purchaser of the securities described below
represented prior to the purchase of the securities that he or she understood
that the securities acquired may not be sold or otherwise transferred absent
registration under the Act or the availability of an exemption from the
registration requirements of the Act, and each certificate evidencing the
securities owned by each purchaser bears or will bear upon issuance the legend
to that effect.
None of the foregoing transactions involved a distribution or public offering.
Effective February 3, 1999, I/OMagic entered into a subscription
agreement with Behavior Technology Corporation, a Taipei, Taiwan corporation
("BTC"). In this transaction, BTC contributed $5 million worth of inventory
in exchange for 16,666,667 shares of restricted Common Stock. The Company
relied upon Section 4(2) of the Securities Act of 1933 as of this transaction
only involved accredited investors.
Effective February 3, 1999, the Company issued 200,000 warrants
valued at the closing price of $0.30 per share on the date of sale to Horwitz
& Beam, the Company's law firm. On April 1, 1999, Horwitz & Beam exercised
all 200,000 warrants for $60,000 cash paid to the Company. The Company relied
upon Section 4(2) of the Securities Act of 1933 as of this transaction only
involved accredited investors.
24
<PAGE>
ITEM 5. TERMS OF INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company has adopted provisions in its Articles of Incorporation and
bylaws that limit the liability of its directors and provide for indemnification
of its directors and officers to the full extent permitted under the Nevada
General Corporation Law. Under the Company's Articles of Incorporation, and as
permitted under the Nevada General Corporation Law, directors are not liable to
the Company or its stockholders for monetary damages arising from a breach of
their fiduciary duty of care as directors. Such provisions do not, however,
relieve liability for breach of a director's duty of loyalty to the Company or
its stockholders, liability for acts or omissions not in good faith or involving
intentional misconduct or knowing violations of law, liability for transactions
in which the director derived as improper personal benefit or liability for the
payment of a dividend in violation of Nevada law. Further, the provisions do not
relieve a director's liability for violation of, or otherwise relieve the
Company or its directors from the necessity of complying with, federal or state
securities laws or affect the availability of equitable remedies such as
injunctive relief or recession.
At present, there is no pending litigation or proceeding involving a
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding that may result in a claim for indemnification by any director or
officer.
25
<PAGE>
PART F/S
FINANCIAL STATEMENTS
The following financial statements are included herein:
Audited Financial Statements for the Years ended December 31, 1998 and 1997
Unaudited Financial Statements for the Six Months Ended June 30, 1999 and
June 30, 1998
PART III
ITEM 1 AND
ITEM 2. INDEX TO EXHIBITS AND DESCRIPTION OF EXHIBITS
Exhibit No. Document Description
3.1 Articles of Incorporation of Asian-Inter American Development
Corporation, dated October 20, 1992
3.2 Certificate of Amendment to Articles of Incorporation of Asian-Inter
American Development Corporation changing name to Silvercrest
International, Inc., dated August 30, 1993
3.3 Restated Articles of Incorporation of Silvercrest International, Inc.,
dated January 10, 1996
3.4 Certificate of Amendment to the Articles of Incorporation of Silvercrest
International, Inc. changing name to I/OMagic Corporation, Inc. dated
March 19, 1996
3.5 Bylaws of Asian-Inter American Development Corporation, dated October 20,
1992, adopted by I/OMagic Corporation, Inc.
3.6 Amendment to the Bylaws of I/OMagic Corporation, Inc. dated November 13,
1996
4.1 Certificate of Designation of Preferred Stock, dated October 31, 1996
10.1 Employment Agreement by and between I/OMagic Corporation, Inc., a
California Corporation, and Tony Shahbaz, dated October 22, 1993
10.2 I/OMagic Corporation 1997 Incentive and Nonstatutory Stock Option Plan
dated January 2, 1997
10.3 Plan of Exchange and Acquisition Agreement by and between Silvercrest
International and I/OMagic Corporation, a California corporation, dated
March 8, 1996
10.4 I/OMagic Corporation 1998 Incentive and Nonstatutory Stock Option Plan,
dated January 2, 1998
10.5 Strategic Alliance Agreement between I/OMagic Corporation and Hou
Electronics, Inc., dated September 19, 1997
10.6 Macola Software Agreement between I/OMagic Corporation and Enterprise
Wide Computing, Inc., dated October 13, 1997
10.7 BTC Acquisition Agreement, dated February 3, 1999
10.8 Lease Agreement by and between I/OMagic Corporation and Autry Properties.
10.9 I/OMagic Corporation 1996 Incentive and Nonstatutory Stock Option Plan
dated February 1, 1996.
23.1 Consent of Horwitz & Beam
23.2 Consent of Singer, Lewak, Greenbaum & Goldstein, LLP
24.1 Power of Attorney (see signature page)
26
<PAGE>
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934,
the Registrant caused this registration statement to be signed on its behalf by
the undersigned, thereunto duly authorized.
Dated: November 15, 1999 I/OMAGIC CORPORATION
/s/ Tony Shahbaz
---------------------------
BY: Tony Shahbaz
ITS: Chief Executive Officer, President
Secretary and Chief Financial Officer
POWER OF ATTORNEY
Each person whose signature appears appoints Tony Shahbaz, as his
agents and attorneys-in-fact, with full power of substitution to execute for him
and in his name, in any and all capacities, all amendments (including
post-effective amendments) to this Registration Statement to which this power of
attorney is attached.
Signature Title Date
- --------- ----- ----
/s/Tony Shahbaz Chief Executive Officer, President November 15, 1999
- ------------------
Tony Shahbaz Secretary and Chief
Financial Officer
/s/ Tony Andrews Vice President November 15, 1999
- ------------------
Anthony Andrews
27
<PAGE>
I/O MAGIC CORPORATION
FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 (UNAUDITED)
IO Magic Corporation Dec98 Aud Rev 3 #3845
<PAGE>
I/O MAGIC CORPORATION
CONTENTS
DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-1
FINANCIAL STATEMENTS
Balance Sheets F-2 to F-3
Statements of Operations F-4
Statements of Stockholders' Equity F-5 to F-7
Statements of Cash Flows F-8 to F-10
Notes to Financial Statements F-11 to F-34
</TABLE>
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
I/O Magic Corporation
We have audited the accompanying balance sheets of I/O Magic Corporation as of
December 31, 1998, and the related statements of operations, stockholders'
equity, and cash flows for each of the two years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of I/O Magic Corporation as of
December 31, 1998, and the results of its operations and its cash flows for each
of the two years then ended in conformity with generally accepted accounting
principles.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
April 28, 1999
<PAGE>
I/O MAGIC CORPORATION
BALANCE SHEETS
DECEMBER 31, 1998 AND JUNE 30, 1999 (UNAUDITED)
- --------------------------------------------------------------------------------
ASSETS
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
--------------- ----------------
(unaudited)
<S> <C> <C>
CURRENT ASSETS
Cash $ 1,402,904 $ 2,894,603
Accounts receivable, net of allowance for doubtful
accounts of $46,372 and $54,906 3,776,413 5,449,384
Inventory 733,834 1,963,832
Prepaid expenses and other current assets 60,708 109,167
--------------- ----------------
Total current assets 5,973,859 10,416,986
FURNITURE AND EQUIPMENT, net 133,231 171,638
OTHER ASSETS 21,160 29,888
--------------- ----------------
TOTAL ASSETS $ 6,128,250 $ 10,618,512
=============== ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
I/O MAGIC CORPORATION
BALANCE SHEETS
DECEMBER 31, 1998 AND JUNE 30, 1999 (UNAUDITED)
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
--------------- ----------------
(unaudited)
<S> <C> <C>
CURRNT LIABILITIES
Notes payable $ 250,000 $ 45,000
Accounts payable and accrued expenses 1,540,643 2,658,774
Current portion of capital lease obligations 208 581
Accounts payable to related parties 2,984,677 1,261,571
Note payable to related party 345,500 -
Reserves for customer returns and allowances 223,379 448,674
--------------- ----------------
Total current liabilities 5,344,407 4,414,600
CAPITAL LEASE OBLIGATIONS, net of current portion 6,723 5,457
--------------- ----------------
Total liabilities 5,351,130 4,420,057
--------------- ----------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $0.001 par value
10,000,000 shares authorized
none issued and outstanding - -
Class A common stock, $0.001 par value
50,000,000 shares authorized
14,879,546 and 31,919,026 (unaudited) shares issued
and outstanding 14,880 31,919
Additional paid-in capital 5,305,681 10,355,348
Deferred compensation (27,900) (21,700)
Treasury stock, 550,000 shares, at cost (165,000) (165,000)
Accumulated deficit (4,350,541) (4,002,112)
--------------- ----------------
Total stockholders' equity 777,120 6,198,455
--------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,128,250 $ 10,618,512
=============== ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended For the Six Months Ended
December 31, June 30,
--------------------------------- ---------------------------------
1998 1997 1999 1998
--------------- ---------------- --------------- ----------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
NET SALES $ 10,714,363 $ 4,034,701 $ 13,083,869 $ 3,799,971
COST OF SALES 7,927,553 3,417,984 9,905,027 2,801,298
--------------- ---------------- --------------- ----------------
GROSS PROFIT 2,786,810 616,717 3,178,842 998,673
--------------- ---------------- --------------- ----------------
OPERATING EXPENSES
Selling, marketing, and advertising 2,112,631 642,274 1,538,911 720,069
General and administrative 1,263,390 1,416,792 1,287,818 549,895
--------------- ---------------- --------------- ----------------
Total operating expenses 3,376,021 2,059,066 2,826,729 1,269,964
--------------- ---------------- --------------- ----------------
INCOME (LOSS) FROM OPERATIONS (589,211) (1,442,349) 352,113 (271,291)
--------------- ---------------- --------------- ----------------
OTHER INCOME (EXPENSE)
Interest income 17,232 6,445 6,000 6,174
Interest expense (16,674) (22,823) (11,384) (1,454)
Other income 251,435 - 2,100 251,408
--------------- ---------------- --------------- ----------------
Total other income (expense) 251,993 (16,378) (3,284) 256,128
--------------- ---------------- --------------- ----------------
INCOME (LOSS) BEFORE PROVISION
FOR INCOME TAXES (337,218) (1,458,727) 348,829 (15,163)
PROVISION FOR INCOME TAXES 800 800 400 800
--------------- ---------------- --------------- ----------------
NET INCOME (LOSS) $ (338,018) $ (1,459,527) $ 348,429 $ (15,963)
=============== ================ =============== ================
BASIC AND DILUTED EARNINGS (LOSS)
PER SHARE $ (0.02) $ (0.12) $ 0.01 $ -
=============== ================ =============== ================
WEIGHTED-AVERAGE SHARES
OUTSTANDING 14,130,105 11,923,028 25,058,544 13,910,534
=============== ================ =============== ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Common Stock Additional
--------------------------------- Paid-In Subscriptions Deferred
Shares Amount Capital Receivable Compensation
--------------- ---------------- --------------- ---------------- -------------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 11,013,010 $ 11,013 $ 3,275,936 $ - $ (105,400)
COMMON STOCK ISSUED FOR
CASH 364,000 364 454,636
OFFERING COSTS (25,000)
COMMON STOCK ISSUED FOR
CASH AND INVENTORY 2,000,000 2,000 1,498,000 (324,240)
COMMON STOCK ISSUED FOR
SERVICES 38,201 38 38,163
COMMON STOCK PURCHASED
FROM CERTAIN OFFICERS FOR
CASH
TREASURY STOCK SOLD BY THE
COMPANY FOR FURNITURE
AND EQUIPMENT 6,158
AMORTIZATION AND ADJUSTMENT
OF DEFERRED COMPENSATION (62,000) 65,100
WARRANTS ISSUED FOR LEGAL AND
MARKETING SERVICES 42,465 (6,495)
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS 338,739 339 16,796
NET LOSS
--------------- ---------------- --------------- ---------------- -----------------
<CAPTION>
Treasury Accumulated
Stock Deficit Total
---------------- ---------------- -------------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 $ - $ (2,552,996) $ 628,553
COMMON STOCK ISSUED FOR
CASH 455,000
OFFERING COSTS (25,000)
COMMON STOCK ISSUED FOR
CASH AND INVENTORY 1,175,760
COMMON STOCK ISSUED FOR
SERVICES 38,201
COMMON STOCK PURCHASED
FROM CERTAIN OFFICERS FOR
CASH (19,800) (19,800)
TREASURY STOCK SOLD BY THE
COMPANY FOR FURNITURE
AND EQUIPMENT 19,800 25,958
AMORTIZATION AND ADJUSTMENT
OF DEFERRED COMPENSATION 3,100
WARRANTS ISSUED FOR LEGAL AND
MARKETING SERVICES 35,970
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS 17,135
NET LOSS (1,459,527) (1,459,527)
-------------- ---------------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Common Stock Additional
--------------------------------- Paid-In Subscriptions Deferred
Shares Amount Capital Receivable Compensation
--------------- ---------------- --------------- ---------------- -------------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 13,753,950 $ 13,754 $ 5,245,154 $ (330,735) $ (40,300)
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS 1,105,596 1,106 24,445
PAYMENT RECEIVED IN 1998 IN
THE FORM OF INVENTORY 324,240
PAYMENT RECEIVED IN 1998 IN
THE FORM OF LEGAL SERVICES 6,495
COMMON STOCK ISSUED FOR
SERVICES 20,000 20 7,480
AMORTIZATION OF DEFERRED
COMPENSATION 12,400
COMMON STOCK PURCHASED
FOR CASH
WARRANTS ISSUED FOR LEGAL AND
CONSULTING SERVICES 28,602
NET LOSS
--------------- ---------------- --------------- ---------------- ------------------ -
BALANCE, DECEMBER 31, 1998 14,879,546 14,880 5,305,681 - (27,900)
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS (unaudited) 372,813 372 66,334
COMMON STOCK ISSUED FOR
INVENTORY (unaudited) 16,666,667 16,667 4,983,333
<CAPTION>
Treasury Accumulated
Stock Deficit Total
--------------- ---------------- ----------------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 $ - $ (4,012,523) $ 875,350
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS 25,551
PAYMENT RECEIVED IN 1998 IN
THE FORM OF INVENTORY 324,240
PAYMENT RECEIVED IN 1998 IN
THE FORM OF LEGAL SERVICES 6,495
COMMON STOCK ISSUED FOR
SERVICES 7,500
AMORTIZATION OF DEFERRED
COMPENSATION 12,400
COMMON STOCK PURCHASED
FOR CASH (165,000) (165,000)
WARRANTS ISSUED FOR LEGAL AND
CONSULTING SERVICES 28,602
NET LOSS (338,018) (338,018)
-------------- ---------------- ---------------
BALANCE, DECEMBER 31, 1998 (165,000) (4,350,541) 777,120
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS (unaudited) 66,706
COMMON STOCK ISSUED FOR
INVENTORY (unaudited) 5,000,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Common Stock Additional
--------------------------------- Paid-In Subscriptions
Shares Amount Capital Receivable
--------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
AMORTIZATION OF DEFERRED
COMPENSATION (unaudited) $ $ $
NET INCOME (unaudited)
--------------- ---------------- --------------- ----------------
BALANCE, JUNE 30, 1999
(UNAUDITED) 31,919,026 $ 31,919 $ 10,355,348 $ -
=============== ================ =============== ================
<CAPTION>
Deferred Treasury Accumulated
Compensation Stock Deficit Total
--------------------------------- ---------------- ---------------
<S> <C> <C> <C> <C>
AMORTIZATION OF DEFERRED
COMPENSATION (unaudited) $ 6,200 $ $ $ 6,200
NET INCOME (unaudited) 348,429 348,429
--------------- --------------- ---------------- ---------------
BALANCE, JUNE 30, 1999
(UNAUDITED) $ (21,700) $ (165,000) $ (4,002,112) $ 6,198,455
=============== =============== ================ ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended For the Six Months Ended
December 31, June 30,
--------------------------------- ---------------------------------
1998 1997 1999 1998
--------------- ---------------- --------------- ----------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (338,018) $ (1,459,527) $ 348,429 $ (15,963)
Adjustments to reconcile net
income (loss) to net cash provided
by operating activities
Depreciation and amortization 38,721 28,670 22,998 18,172
Amortization of deferred
compensation 12,400 12,400 6,200 6,200
Adjustment of deferred
compensation - (9,300) - -
Provision for allowance for
doubtful accounts (192,238) 133,670 8,534 (55,882)
Compensation in connection
with stock options and warrants
granted 28,602 38,201 - -
Note payable to related party - - (240,000) -
Issuance of common stock for
services 7,500 35,970 - -
(Increase) decrease in
Accounts receivable (2,992,319) (377,616) (1,681,505) (436,107)
Inventory 193,733 1,283,718 3,770,002 471,282
Prepaid expenses and other
current assets (31,115) (12,059) (48,459) (57,925)
Other assets - (8,304) (8,728) -
Increase (decrease) in
Accounts payable and accrued
expenses 1,097,481 199,299 1,012,630 491,329
Accounts payable to related
parties 2,984,677 - (1,723,106) 82,537
Reserves for customer returns and
allowances 20,347 203,032 225,295 (124,491)
--------------- ---------------- --------------- ----------------
Net cash provided by operating
activities 829,771 68,154 1,692,290 379,152
--------------- ---------------- --------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of furniture and equipment (51,945) (46,079) (61,405) (22,072)
--------------- ---------------- --------------- ----------------
Net cash used in investing activities (51,945) (46,079) (61,405) (22,072)
--------------- ---------------- --------------- ----------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended For the Six Months Ended
December 31, June 30,
--------------------------------- ---------------------------------
1998 1997 1999 1998
--------------- ---------------- --------------- ----------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on bridge loans $ - $ (177,500) $ - $ -
Payments on capital lease
obligations (5,960) (2,307) (892) (3,820)
Advances due to related parties (192,982) (763,391) - -
Proceeds from issuance of notes
payable 250,000 - - 100,000
Payments on notes payable - - (205,000) -
Proceeds from issuance of common
stock - 705,000 66,706 2,001
Offering costs on issuance of
common stock - (25,000) - -
Purchase of treasury stock (165,000) (19,800) - (99,900)
Proceeds from exercise of warrants 25,551 17,135 - -
--------------- ---------------- --------------- ----------------
Net cash used in financing activities (88,391) (265,863) (139,186) (1,719)
--------------- ---------------- --------------- ----------------
Net increase (decrease) in cash 689,435 (243,788) 1,491,699 355,361
CASH, BEGINNING OF PERIOD 713,469 957,257 1,402,904 713,469
--------------- ---------------- --------------- ----------------
CASH, END OF PERIOD $ 1,402,904 $ 713,469 $ 2,894,603 $ 1,068,830
=============== ================ =============== ================
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
INTEREST PAID $ 2,299 $ 22,823 $ 11,384 $ 1,454
=============== ================ =============== ================
INCOME TAXES PAID $ 800 $ 800 $ - $ 800
=============== ================ =============== ================
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended December 31, 1998, the Company entered into the following
non-cash transactions:
- - Received $324,240 in inventory subscribed during the year ended December
31, 1997.
- - Received $6,495 in legal services subscribed during the year ended
December 31, 1997.
The accompanying notes are an integral part of these financial statements.
F-9
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES (CONTINUED)
During the year ended December 31, 1997, the Company entered into the following
non-cash transactions:
- - Issued 9,000 shares of common stock for software valued at $25,958.
- - Issued 2,000,000 shares of common stock for a $324,240 subscription
receivable, $925,760 in inventory, and $250,000 in cash.
- - Issued common stock for a subscription receivable valued at $6,495 for
legal services to be provided.
- - Purchased certain furniture and equipment under a capital lease
obligation totaling $15,198.
During the six months ended June 30, 1999, the Company entered into the
following non-cash transactions:
- - Received $5,000,000 (unaudited) in inventory for 16,666,667 (unaudited)
shares of common stock.
- - Reflected the reduction of a related party as a reduction to cost of
sales of $240,000 (unaudited) and increased reserves of $154,388
(unaudited) (see Note 9).
During the six months ended June 30, 1998, the Company entered into the
following non-cash transactions:
- - Received $330,735 (unaudited) in inventory subscribed during the six
months ended June 30, 1998.
The accompanying notes are an integral part of these financial statements.
F-10
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND BUSINESS
I/O Magic Corporation (the "Company"), a Nevada corporation, develops,
manufactures through subcontractors, markets, and distributes
multimedia and communication card devices for portable and desktop
computers. The Company sells its products in the United States to
distributors and retail customers.
In March 1996, I/O Magic Corporation, a California corporation ("I/O
Magic California"), originally incorporated on September 30, 1993
entered into a Plan of Exchange and Acquisition Agreement (the
"Acquisition Agreement") with Silvercrest International, Inc.
("Silvercrest"), a Nevada corporation. Pursuant to the Acquisition
Agreement, Silvercrest acquired all of the outstanding stock of I/O
Magic California totaling 6,570,583 shares in exchange for an aggregate
6,570,583 shares of newly-issued common stock. In connection with the
Acquisition Agreement, the Company issued 624,704 shares of common
stock. For accounting purposes, the acquisition has been treated as a
recapitalization of I/O Magic California, with I/O Magic California as
the accounting acquirer (reverse acquisition). The reverse acquisition
was recorded at the historical cost of I/O Magic California. Prior to
the execution of the Acquisition Agreement, Silvercrest was a public
company listed on NASDAQ's over-the-counter market with dormant
operations and no assets or liabilities. Silvercrest subsequently
changed its name to I/O Magic Corporation, a Nevada corporation.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and the disclosures of contingent assets and liabilities at
the date of the financial statements, as well as the reported amounts
of revenues and expenses during the reporting period. Significant
estimates made by management include, but are not limited to, the
provisions for allowance of doubtful accounts and price protection on
accounts receivable, the net realizability of inventory, the evaluation
of potential impairment of furniture and equipment, and the provision
for sales returns and warranties. Actual results could materially
differ from those estimates.
F-11
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company measures its financial assets and liabilities in accordance
with generally accepted accounting principles. For certain of the
Company's financial instruments, including cash, accounts receivable,
and accounts payable and accrued expenses, the carrying amounts
approximate fair value due to their short maturities. The amounts shown
for capital lease obligations also approximate fair value because
interest rates offered to the Company for capital lease obligations of
similar maturities are substantially the same.
INVENTORY
Inventory is stated at the lower of cost, using the weighted-average
method, which approximates the first-in, first-out method or market.
FURNITURE AND EQUIPMENT
Furniture and equipment are recorded at cost, less accumulated
depreciation and amortization. Depreciation and amortization are
provided using the straight-line method over estimated useful lives as
follows:
<TABLE>
<S> <C>
Computer equipment and software 5 years
Warehouse equipment 7 years
Office furniture and equipment 5 to 7 years
Equipment under capital lease 5 years
Leasehold improvements Estimated useful life or lease term
whichever is shorter
</TABLE>
Maintenance and minor replacements are charged to expense as incurred.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of." SFAS No. 121 requires
impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount. Management determined that there
was no impairment of long-lived assets for all periods presented.
F-12
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," establishes
and encourages the use of the fair value based method of accounting for
stock-based compensation arrangements under which compensation cost is
determined using the fair value of stock-based compensation determined
as of the date of grant and is recognized over the periods in which the
related services are rendered. The statement also permits companies to
elect to continue using the current implicit value accounting method
specified in Accounting Principles Bulletin ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," to account for stock-based
compensation issued to employees. The Company has elected to use the
implicit value based method and has disclosed the pro forma effect of
using the fair value based method to account for its stock-based
compensation. For stock-based compensation issued to non-employees, the
Company uses the fair value method of accounting under the provisions
of SFAS No. 123.
REVENUE RECOGNITION
For transactions satisfying the conditions for revenue recognition
under SFAS No. 48, "Revenue Recognition when Right of Return Exists,"
product revenue is recorded at the time of shipment, net of estimated
allowances and returns. For transactions not satisfying the conditions
for revenue recognition under SFAS No. 48, product revenue is deferred
until the conditions are met, net of an estimate for cost of sales. As
of December 31, 1998 and June 30, 1999, the Company had reserves for
sales returns totaling $69,146 and $86,326 (unaudited), respectively.
EARNINGS (LOSS) PER SHARE
The Company calculates earnings (loss) per share in accordance with
SFAS No. 128, "Earnings Per Share." SFAS No. 128 replaced the
presentation of primary and fully diluted earnings (loss) per share
with the presentation of basic and diluted earnings (loss) per share.
Basic earnings (loss) per share excludes dilution and is calculated by
dividing income (loss) available to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted earnings (loss) per share includes the potential dilutive
effects that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock ("potential
common stock") that would then share in the earnings (loss) of the
Company.
F-13
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Net Loss per Share (Continued)
As of June 30, 1999, the Company had potential common stock as follows:
<TABLE>
<CAPTION>
<S> <C>
Weighted-average common shares outstanding during the
period (unaudited) 25,058,544
Incremental shares assumed to be outstanding since the
beginning of the period related to stock options and warrants
outstanding (unaudited) 549,709
----------
FULLY DILUTED WEIGHTED-AVERAGE COMMON SHARES AND
POTENTIAL COMMON STOCK
(UNAUDITED) 25,608,253
==========
</TABLE>
As of December 31, 1998 and 1997 and June 30, 1998, the Company had
potential common stock including options and warrants. The effects of
such potential common stock were not included in diluted earnings per
share as their effects would have been anti-dilutive.
INCOME TAXES
The Company accounts for its income taxes under the provisions of SFAS
No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred
income taxes are recognized for the tax consequences in future years of
differences between the tax basis of assets and liabilities and their
financial reporting amounts at each period end, based on enacted tax
laws and statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances
are established, when necessary, to reduce deferred tax assets to the
amount expected to be realized. The provision for income taxes
represents the tax payable for the period, if any, and the change
during the period in deferred tax assets and liabilities.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income." This statement is not
applicable to the Company.
F-14
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information," is effective for financial
statements with fiscal years beginning after December 15, 1997. This
statement establishes standards for the way that public entities report
selected information about operating segments, products and services,
geographic areas, and major customers in interim and annual financial
reports. During the years ended December 31, 1998 and 1997 and the six
months ended June 30, 1999 and 1998, the Company operated in one
segment.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." This statement is
not applicable to the Company.
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement is not applicable
to the Company.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This
statement is not applicable to the Company.
In February 1999, the FASB issued SFAS No. 135, "Recession of FASB
Statement No. 75 and Technical Corrections." This statement is not
applicable to the Company.
NOTE 3 - RISKS AND UNCERTAINTIES
TECHNOLOGICAL OBSOLESCENCE
The computer industry is characterized by rapid technological
advancement and change. Should demand for the Company's products prove
to be significantly less than anticipated, the ultimate realizable
value of such products could be substantially less than the amounts
reflected in the accompanying balance sheet.
F-15
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 3 - RISKS AND UNCERTAINTIES (CONTINUED)
RELIANCE ON INDEPENDENT AND RELATED PARTY MANUFACTURERS/SUBCONTRACTORS
The Company does not maintain its own manufacturing or production
facilities and does not intend to do so in the foreseeable future. The
Company anticipates that its products will be manufactured and its raw
materials and components will be supplied by independent companies,
some of which are stockholders of the Company. Many of these
independent companies may manufacture and supply products for the
Company's existing and potential competitors. As is customary in the
manufacturing industry, the Company does not have any material ongoing
licensing or other supply agreement with its manufacturers and
suppliers. Typically, the purchase order is the Company's "agreement"
with the manufacturer. Therefore, any of these companies could
terminate its relationship with the Company at any time. In the event
the Company were to have difficulties with its present manufacturers
and suppliers, the Company could experience delays in supplying
products to its customers.
RELIANCE ON ORIGINAL EQUIPMENT MANUFACTURING ("OEM") CUSTOMERS AND
RETAIL DISTRIBUTORS
The Company's success will depend to a significant extent upon the
ability to develop and maintain a multi-channel distribution system
with OEM customers and retail distributors to sell the Company's
products in the marketplace. There can be no assurance that the Company
will be successful in obtaining and retaining the OEM customers and
retail distributors it requires to continue to grow and expand its
marketing and sales efforts.
LISTING AND MAINTENANCE CRITERIA FOR NASDAQ SECURITIES
The Company intends to apply for listing of its common stock on NASDAQ
for the Small-Cap Market. The initial listing standards for the NASDAQ
Small-Cap Market require that the Company have total assets of at least
$4,000,000, total stockholders' equity of at least $2,000,000, a public
float of at least 100,000 shares with a market value of at least
$1,000,000, at least 300 stockholders, a minimum bid price for its
common stock of $3 per share, and at least two market makers. To
maintain its listing on the NASDAQ Small-Cap Market, the Company must
continue to be registered under Section 12(g) of the Securities and
Exchange Act of 1934 and have total assets of at least $2,000,000,
total stockholders' equity of at least $1,000,000, a public float of at
least 100,000 shares with a market value of at least $200,000, at least
300 stockholders, a minimum bid price for its common stock of $1 per
share, and at least two market makers. There is no assurance that the
Company will be able to obtain or maintain the standards for NASDAQ
Small-Cap Market listing.
F-16
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 4 - CONCENTRATIONS OF RISK
CASH
As of December 31, 1998 and June 30, 1999, the Company maintained cash
balances with a national bank totaling $1,398,596 and $2,907,464
(unaudited), respectively, in excess of federally insured amounts of
$100,000.
CUSTOMERS
During the year ended December 31, 1998, the Company had sales to three
major customers that represented approximately 32%, 26%, and 17% of net
sales. As of December 31, 1998, the Company had three customers that
accounted for 47%, 25% and 15% of accounts receivable.
During the year ended December 31, 1997, the Company had sales to two
major customers that each represented approximately 27% of net sales.
During the six months ended June 30, 1999, the Company had sales to
three major customers that represented approximately 46% (unaudited),
39% (unaudited), and 12% (unaudited) of net sales. As of June 30, 1999,
the Company had three customers that accounted for 41% (unaudited), 31%
(unaudited) and 10% (unaudited) of accounts receivable.
During the six months ended June 30, 1998, the Company had sales to two
major customers that each represented approximately 36% (unaudited) and
15% (unaudited) of net sales.
SUPPLIERS
During the year ended December 31, 1998, the Company purchased
inventory from three related party vendors that represented
approximately 42%, 27%, and 11% of purchases. As of December 31, 1998,
no one supplier represented 10% or more of accounts payable.
During the year ended December 31, 1997, the Company purchased
inventory from one related party vendor that represented approximately
33% of purchases.
During the six months ended June 30, 1999, the Company purchased
inventory from two related-party vendors that represented approximately
60% (unaudited) and 20% (unaudited) of purchases. As of June 30, 1999,
two suppliers represented 37% (unaudited) and 25% (unaudited) of
accounts payable.
F-17
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
During the six months ended June 30, 1998, the Company purchased
inventory from two related-party vendors that represented approximately
73% (unaudited) and 23% (unaudited) of purchases.
F-18
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 5 - INVENTORY
Inventory consisted of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
--------------- ----------------
(unaudited)
<S> <C> <C>
Raw materials $ 440,887 $ 457,921
Finished goods 292,947 1,505,911
--------------- ----------------
TOTAL $ 733,834 $ 1,963,832
=============== ================
NOTE 6 - FURNITURE AND EQUIPMENT
Furniture and equipment consisted of the following:
December 31, June 30,
1998 1999
(unaudited)
Computer equipment and software $ 120,082 $ 166,080
Warehouse equipment 20,893 36,549
Office furniture and equipment 66,655 62,135
Equipment under capital lease 15,198 15,198
Leasehold improvements 16,679 20,949
--------------- ----------------
239,507 300,911
Less accumulated depreciation and amortization 106,276 129,273
--------------- ----------------
TOTAL $ 133,231 $ 171,638
=============== ================
</TABLE>
Depreciation and amortization expense for the years ended December 31,
1998 and 1997 and the six months ended June 30, 1999 and 1998 was
$38,721, $28,160, $22,998 (unaudited), and $18,171 (unaudited),
respectively.
F-19
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 7 - NOTES PAYABLE
In May 1998, the Company engaged an agent to assist in a private
placement (the "1998 Private Placement") to sell up to $250,000 of
units, as amended. Each unit consists of a $10,000 note (the "Note")
bearing interest at 10% per annum, repayable in full 90 days after the
declaration of effectiveness of a Registration Statement, as defined,
or 12 months from the date of issue, whichever comes first, and one
warrant, exercisable at $1 for 30% of the face value of the Note, and
then divided by the price per share as set forth in the Registration
Statement, as defined. As the number of warrants to be issued and the
exercise price were not determinable until such time the Company
effects a Registration Statement, relative fair value of the warrants
was not determinable. Accordingly, no portion of the proceeds was
allocated to the warrants. Through June 1998, the Company sold 25 units
for proceeds of $250,000. As of December 31, 1998 and June 30, 1999,
accrued interest totaled $14,375 and $4,500 (unaudited), respectively,
and is included in accounts payable and accrued expenses on the
accompanying balance sheets.
No expense was recorded for these warrants as such were issued with an
exercise price greater than fair market value (see Note 11). In
addition, the Company paid $25,000 to the agent for services provided.
Such is included in prepaid expenses and other current assets on the
accompanying balance sheet and is being amortized over the term of the
Notes.
NOTE 8 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued liabilities consisted of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
--------------- ----------------
(unaudited)
<S> <C> <C>
Accounts payable $ 278,337 $ 621,356
Accrued rebates and marketing 868,113 1,592,108
Accrued compensation and related benefits 142,906 163,935
Other 251,287 281,375
--------------- ----------------
TOTAL $ 1,540,643 $ 2,658,774
=============== ================
</TABLE>
F-20
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 9 - CREDIT LINES FROM RELATED PARTIES
The Company has available a $2,000,000 credit line from a stockholder
and supplier for inventory purchases. Borrowings are non-interest
bearing and are due 60 days from the date of borrowing. Borrowings are
subordinated to bank financings. The credit agreement can be mutually
terminated at any time. As of December 31, 1998, no borrowings were
outstanding under this agreement. During the six months ended June 30,
1999 (unaudited), such agreement was mutually terminated.
In connection with a 1997 Strategic Alliance Agreement (the "1997
Strategic Alliance Agreement") (see Notes 10 and 11), the Company also
has available a second line of credit through another stockholder and
supplier for borrowings up to $2,000,000. Borrowings are non-interest
bearing and are due 75 days from the date of borrowing. The credit
agreement can be mutually terminated at any time. As of December 31,
1998 and June 30, 1999 (unaudited), there were no outstanding
borrowings under this arrangement.
In connection with an April 1999 subscription agreement, the Company
also has available an additional line of credit through a stockholder
and vendor that provides a trade credit facility of up to $5,000,000
carrying net 75 day terms, as defined (see Note 11).
NOTE 10 - NOTE PAYABLE TO RELATED PARTY
As of December 31, 1998, the note payable to related party represents a
convertible promissory note to a stockholder for inventory purchases.
The note bore interest at 8% and matured March 1, 1997. Accrued
interest related to this note totaling $48,888 is included in accounts
payable and accrued expenses on the accompanying balance sheet as of
December 31, 1998. As of December 31, 1998, the Company was in default
under the agreement and disputes any obligation as no consideration was
received. The Company ceased accruing interest as of August 1997. In
March 1999, the statute of limitations for collection on this note
expired.
During the six months ended June 30, 1999, the Company has reflected as
a reduction to cost of sales $240,000 (unaudited) of the total debt and
related interest. The remaining $154,388 (unaudited) is included as a
reserve for any potential litigation that may arise from this matter.
Management does not believe any litigation will arise and has had no
contact with the counter-party.
Pursuant to the terms of the note payable, in the event the Company or
its assets are sold or the Company commences an offering of common
stock, as defined, the note holder had the right to convert the
outstanding balance, including all accrued interest thereon, into
shares of the Company's common stock. The conversion factor was
F-21
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
defined as either the price per share in the event of sale or the
initial public offering price, as defined, divided by 1.5.
F-22
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain equipment under
non-cancelable, operating lease agreements, expiring through May 2003.
The Company also leases certain manufacturing equipment under a capital
lease obligation expiring January 2001.
Future aggregate minimum annual lease payments under capital and
operating lease arrangements are as follows as of December 31, 1998:
<TABLE>
<CAPTION>
Year Ending Capital Operating
December 31, Leases Leases
------------ --------- ------------
<S> <C> <C>
1999 $ 5,247 $ 126,728
2000 5,247 171,456
2001 437 171,456
2002 - 171,456
2003 - 71,440
--------- ------------
10,931 $ 712,536
============
Less amount representing interest 4,000
---------
Present value of minimum lease payments 6,931
Less current portion 208
---------
TOTAL $ 6,723
========
</TABLE>
Interest expense was insignificant for the years ended December 31,
1998 and 1997 and for the six months ended June 30, 1999 (unaudited)
and 1998 (unaudited).
Rent expense was $68,480, $64,069, $48,677 (unaudited), and $34,160
(unaudited) for the years ended December 31, 1998 and 1997 and the six
months ended June 30, 1999 and 1998, respectively, and is included in
general and administrative expenses in the accompanying statements of
operations.
F-23
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
SERVICE AGREEMENTS
Periodically, the Company enters into various agreements for services
including, but not limited to, public relations, financial consulting,
and manufacturing consulting. The agreements generally are ongoing
until such time they are terminated, as defined. Compensation for
services is paid either on a fixed monthly rate or based on a
percentage, as specified. As of December 31, 1998, the Company was
party to one such agreement. During the year ended December 31, 1998,
the Company incurred $140,498 in connection with such arrangements.
Amounts incurred during the year ended December 31, 1997 were
insignificant. During the six months ended June 30, 1999 and 1998, the
Company incurred $96,839 (unaudited) and $17,805 (unaudited),
respectively, in connection with such agreements.
EMPLOYMENT CONTRACT
The Company has entered into an employment contract with one of its
officers which expires upon written termination. The agreement calls
for a minimum base salary and provides for certain expense allowances.
In addition, the agreement provides for a bonus based on the "net
profits" of the Company, as defined. The bonus amount ranges from
$20,000 to $70,000 for net profits up to $500,000. For net profits in
excess of $500,000, the bonus is 7% of such excess. No bonus amounts
were paid during the years ended December 31, 1998 and 1997 or during
the six months ended June 30, 1999 (unaudited) and 1998 (unaudited)
under the terms of this agreement.
RETAIL AGREEMENTS
In connection with certain retail agreements, the Company has agreed to
pay for certain marketing development and advertising on an ongoing
basis. Marketing development and advertising costs are generally agreed
upon at the time of the event. The Company also records a liability for
co-op marketing based on management's evaluation of historical
experience and current industry and Company trends. During the years
ended December 31, 1998 and 1997 and the six months ended June 30, 1999
and 1998, the Company incurred $369,679, $287,398, $172,955
(unaudited), and $184,950 (unaudited), respectively, related to these
agreements. Such is included in selling, marketing, and advertising in
the accompanying statements of operations.
RELATED PARTY LICENSE AND DISTRIBUTION AGREEMENT
In connection with the 1997 Strategic Alliance Agreement (see Notes 8
and 11), the Company entered into a definitive license agreement with a
stockholder and lender, whereby the Company will license all of its
current and future products for nonexclusive distribution into all
countries other than the United States and Canada and to mutually
agreed-upon OEM's for royalties, as defined. During the years ended
December 31,
F-24
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
1998 and 1997 and during the six months ended June 30, 1999
(unaudited), the Company earned no royalties under the terms of this
agreement.
F-25
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
RELATED PARTY LICENSE AND DISTRIBUTION AGREEMENT (CONTINUED)
In addition, the Company had two-year exclusive rights through retail
channels and select OEMs, as defined, in the North American market to
sell products purchased from such stockholder and supplier. This
agreement expired May 1998 and was renewable by written agreement. The
agreement was not renewed.
NOTE 12 - CAPITAL TRANSACTIONS
1996 PRIVATE PLACEMENT OF COMMON STOCK
In connection with a March 1996 private placement of units consisting
of common stock and warrants whereby the minimum investment was 16,667
units at $1.50 per unit, or $25,000, the Company issued 568,002 shares
of common stock for cash at $1.45 per share and 577,335 warrants for
cash at $0.05 per warrant. The Unit price was allocated between common
stock and warrants based on management's determination of relative fair
market value. The Company raised $853,500 in connection with this
offering. Concurrent with this offering, the Company converted $627,500
of notes payable into 598,328 shares of common stock at $1 per share
and 598,328 warrants at $0.05 per warrant. These warrants allow the
holder to purchase common stock at $2.50 per share, exercisable for a
period of three years from the date of issuance. The Company is
obligated to register the common stock issuable upon exercise of these
warrants in any subsequent Registration Statement filed with the
Securities and Exchange Commission ("Piggyback Registration Rights").
These units also carry demand registration rights, as defined. Through
December 31, 1998, none of these warrants have been exercised.
As consideration for placement agent services rendered in connection
with the March 1996 private placement, the Company issued to the
placement agents the following warrants: 58,000 warrants to purchase
common stock at an exercise price of $0.70 per share, 131,850 warrants
to purchase common stock at an exercise price of $0.01 per share, and
151,850 warrants to purchase common stock at an exercise price of $1.65
per share. The term of these warrants is three years from the date of
issuance, and these warrants carry Piggyback Registration Rights. As of
December 31, 1998 and 1997, none of these warrants have been exercised.
On December 16, 1996, the Company entered into a private Stock Purchase
Agreement with an officer whereby the Company sold 250,000 units at
$1.00 per unit, or $250,000. Each unit consisted of one share of common
stock and one warrant to purchase Company stock exercisable at a price
of $1.00 per share for a term of two years. The fair market value of
the common stock and the warrants was deemed by management to be $1.45
and $0.05, respectively, based on relative fair market value.
Accordingly, the
F-26
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
Company recorded $125,000 of compensation expense related to this
transaction. The warrants were not exercised and have expired.
F-27
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
1997 PRIVATE PLACEMENT OF COMMON STOCK
In February 1997, the Company commenced an offering of up to 600,000
units, consisting of one share of restricted common stock for cash at
$1.24 per share and one warrant for cash of $0.01 per warrant for a
total price of $1.25 per unit ("Unit"), as amended. The Unit price was
allocated between common stock and warrants based on management's
determination of relative fair market value. The warrants are
exercisable in whole or in part at any time during the three years from
date of issuance at an exercise price of $4.50 and are callable by the
Company, as defined. The Units carry registration rights, as defined,
as the common stock and the common stock underlying the warrants have
not been registered under the Securities Act of 1933. The offering
closed in September 1997, at which time the Company had sold 364,000
Units for total proceeds of $455,000. Offering costs related to this
private placement totaled approximately $25,000.
As consideration for placement services rendered in connection with the
February 1997 private placement, the Company issued to a placement
agent 13,200 warrants carrying the same terms as the warrants discussed
in the preceding paragraph.
COMMON STOCK ISSUED FOR CASH
Through December 31, 1996, the Company issued an aggregate 6,809,998 of
shares of common stock for cash totaling $1,186,384, or ranging from
$0.01 to $1.00 per share, net of costs of $55,216. Such issuances are
net of a 1995 buyback and retirement of 15,783,392 shares of common
stock at $0.03 per share, or $459,000 in aggregate.
COMMON STOCK ISSUED FOR SERVICES
Through December 31, 1996, the Company issued 16,666 restricted shares
of common stock for consulting services valued at $166, or $0.01 per
share. No compensation expense was charged to operations as the value
of the shares and the services was insignificant. In addition, expense
was not deemed appropriate by management as the value of the Company
was nominal prior to the effective date of the Acquisition Agreement,
the consummation of which was not assured.
In February and June 1997, the Company issued an aggregate 38,201
restricted shares of common stock for services to a consultant valued
at $38,201, or $1 per share. The fair value of the services received
was determined by management to be the value of such services had the
Company paid cash.
During the year ended December 31, 1998, the Company issued 20,000
restricted shares of common stock to an officer in exchange for 20,000
freely tradable shares. The freely tradable shares were issued to a
consultant for public relations services valued at the fair market
value of the services received totaling $7,500, or $0.375 per share.
The fair market value of the services received was determined by
management to be the value of such services had the Company paid cash.
Management of the Company determined the value of the freely tradable
shares compared to the value of the restricted shares was nominal.
Accordingly, no contribution or expense was recorded by the Company.
The freely tradable shares issued carried a 90-day lock-up.
F-28
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
COMMON STOCK ISSUED IN CONNECTION WITH THE EXERCISE OF WARRANTS
Through December 31, 1996, the Company issued an aggregate of 1,395,312
restricted shares of common stock in connection with the exercise of
warrants for cash totaling $100,566, or at a per share price ranging
from $0.01 to $0.25 per share.
During the year ended December 31, 1997, the Company issued an
aggregate of 338,739 restricted shares of common stock in connection
with the exercise of warrants for cash of $17,135, or at a per share
price of $0.05 or $0.10 per share.
During the year ended December 31, 1998, the Company issued an
aggregate of 1,105,596 restricted shares of common stock in connection
with the exercise of warrants for cash of $25,551, or at a per share
price ranging from $0.05 to $0.55 per share.
During the six months ended June 30, 1999, the Company issued an
aggregate of 372,813 (unaudited) restricted shares of common stock in
connection with the exercise of warrants for cash totaling $66,706
(unaudited), or at a per share price ranging from $0.01 (unaudited) to
$0.30 (unaudited) per share.
OTHER COMMON STOCK TRANSACTIONS
In March 1996, in connection with the Acquisition Agreement, the
Company issued 624,704 shares of common stock (see Note 1).
In December 1997, the Company purchased from three officers an
aggregate 9,000 freely tradable shares of common stock for cash of
$19,800, or at $2.20 per share. Such treasury shares were sold to an
outside third party pursuant to an October 1997 agreement for software
valued at $25,958, or at $2.88 per share.
STRATEGIC ALLIANCE AGREEMENTS
On May 6, 1996, the Company entered into a strategic alliance agreement
with an electronics manufacturer whereby for consideration of $342,000
the Company issued 1,000,000 shares of restricted Company common stock.
In connection with this agreement, the electronics manufacturer agreed
to establish a $1,000,000 unsecured line of credit in favor of the
Company, later increased to $2,000,000. No value was assigned to the
establishment of the line of credit as such line was deemed to not
carry any market value. As of December 31, 1998 and June 30, 1999,
there were no outstanding borrowings under this agreement.
F-29
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STRATEGIC ALLIANCE AGREEMENTS (CONTINUED)
On September 19, 1997, the Company entered into a strategic alliance
agreement with an electronics manufacturer, whereby the Company issued
2,000,000 restricted shares of common stock in exchange for $250,000 in
cash and $1,250,000 of inventory (valued at transferor's cost basis)
for a total value of $1,500,000, or $0.75 per share. Of the $1,250,000,
$481,260 was credited toward inventory purchased prior to the
agreement. The remaining $768,740 was to be applied to future inventory
purchases. As of December 31, 1998, all of the inventory had been
received by the Company. These shares carry registration rights, as
defined. In connection with this agreement, this electronics
manufacturer has established a line of credit for the Company and has
certain license and distribution agreements (see Notes 8 and 10).
During the six months ended June 30, 1999, the Company issued
16,666,667 shares of restricted common stock to a stockholder and
vendor valued at $0.30 per share for $5,000,000 of inventory, as
defined (valued at transferor's cost basis). In connection with this
transaction, the stockholder and vendor established a $5,000,000 line
of credit (see Note 8). No value was assigned to the establishment of
the line of credit as such line was deemed to not carry any market
value.
Generally, all new issuances of common stock made by the Company carry
registration rights.
WARRANTS
In connection with an October 1995 private placement of notes payable
and warrants, the Company issued 805,000 A Warrants to purchase common
stock for $0.05 per share exercisable for five years from the date of
issuance, and 805,000 B Warrants to purchase common stock for $0.95 per
share exercisable for five years from the date of issuance. For every
30 days the B Warrants were outstanding, commencing six months from the
date of issuance, the B Warrant holders were entitled to a $0.04
discount on the exercise price per month to a minimum exercise price of
$0.50 per share. Interest expense ascribed to the warrants was deemed
to be insignificant and recording such was not deemed appropriate by
management as the value of the Company was nominal prior to the
effective date of the Acquisition Agreement, the consummation of which
was not assured. During the years ended December 31, 1998 and 1997, A
Warrants aggregating 25,000 and 316,132, respectively, have been
exercised. Through December 31, 1996, A Warrants aggregating 63,868
have been exercised. During the year ended December 31, 1998, B
Warrants aggregating 25,001 were exercised for cash of $0.55 per share,
as adjusted. These units carry Piggyback Registration Rights, as
defined.
F-30
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
WARRANTS (Continued)
In September 1998, the Company effected the B Warrant call. Pursuant to
the terms of the private placement, the B Warrants were callable at the
option of the Company, on or after the date that its common stock is
registered, in the event its common stock market price equals or
exceeds $2.00 per share for 30 consecutive days. The B Warrant holders
had the option to either exercise their B Warrants or have their B
Warrants terminated. The common stock of the Company has not been
registered. The B Warrant holders who elected to exercise their
warrants were given freely-tradable shares held by an
officer/stockholder. The Company issued restricted shares to the
officer/stockholder to replace the shares transferred in connection
with the exercise of the B Warrants. Management of the Company
determined the value of the freely tradable shares compared to the
value of the restricted shares was nominal. Accordingly, no
contribution or expense was recorded by the Company.
In connection with an October 1995 debt private placement, for
placement agent services, the Company issued 125,125 A Warrants to
purchase common stock for $0.10 per share exercisable for five years
from the date of issue and 125,125 B Warrants to purchase common stock
for $1.10 per share exercisable for five years from the date of issue.
During the year ended December 31, 1998, no A or B Warrants were
exercised. During the years ended December 31, 1997 and 1996, 25,107
and 2,812 A Warrants were exercised, respectively.
In October 1995, the Company issued to an officer 340,000 warrants to
purchase restricted shares of common stock for $0.01 per share
exercisable for five years from the date of grant. No compensation
expense was charged to operations as the fair value of the shares and
services received was nominal. Fair value was determined by management
to be the amount that would have been paid had the Company paid cash
for such services. In addition, expense was not deemed appropriate by
management as the value of the Company was nominal prior to the
effective date of the Acquisition Agreement, the consummation of which
was not assured. These warrants carry Piggyback Registration Rights, as
defined. During the year ended December 31, 1998, 200,000 of these
warrants were exercised.
During the years ended December 31, 1996 and 1995, the Company issued
an aggregate 100,000 warrants to purchase restricted shares of common
stock for $1.65 per share exercisable five years from date of grant to
a consultant for services provided. Compensation expense related to
these warrants, as determined by management to be the fair value of
services received had the Company paid cash, was insignificant. Through
December 31, 1998, 30,000 of these warrants have been exercised. These
warrants carry registration rights, as defined.
F-31
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
WARRANTS (Continued)
During the year ended December 31, 1996, the Company issued to an
outside consultant for services received 7,500 warrants to purchase
restricted shares of common stock for a per share price of $0.75
exercisable for five years from the date of grant. The Company recorded
$2,250 of consulting expense to reflect the fair value of the services
received. Fair value was determined by management to be the value of
such services had the Company paid cash. During the year ended December
31, 1997, such warrants expired.
During the year ended December 31, 1996, the Company issued to an
officer 190,000 warrants to purchase restricted shares of common stock
for $0.01 per share exercisable for five years from the date of grant.
Compensation expense was charged to operations totaling $9,500,
representing the value of the bonus for additional services rendered to
the Company had the Company paid cash for such services. These warrants
carry Piggyback Registration Rights, as defined. During the year ended
December 31, 1998, all of these warrants were exercised.
During the year ended December 31, 1997, the Company issued to outside
parties 162,465 warrants to purchase restricted shares of common stock
at a per share price ranging from $1.00 to $2.24 per share exercisable
up to five years from the date of grant. These warrants carry
registration rights, as defined. The Company recorded $42,465 of legal
and consulting expense to reflect the fair value of the services
received had the Company paid cash for such services. During the year
ended December 31, 1998, warrants to purchase 35,000 shares of common
stock at $1.68 per share expired.
None of these warrants have been exercised.
During the year ended December 31, 1998, the Company issued to outside
consultants 30,000 warrants to purchase restricted shares of common
stock at a per share price of $0.01 or $1.00 per share exercisable up
to five years from the date of grant. These warrants carry registration
rights, as defined. The Company recorded $20,163 of consulting expense
to reflect the fair value of the services received, of which $5,163
represents the difference between the fair market value of the
underlying common shares and the exercise price of the warrants and the
remaining $15,000 represents the fair value of the services received
had the Company paid cash for such services. During the year ended
December 31, 1998, warrants to purchase 15,000 shares of common stock
at $0.01 were exercised.
In February 1999, the Company issued options to purchase 200,000
(unaudited) shares of restricted common stock to the Company's law
firm. The options are exercisable at $0.30 (unaudited fair market
value) per share for one year. Management of the Company determined
that no additional amounts would have been paid to such law firm for
services, as invoiced services are paid in cash. Accordingly, no legal
expense was
F-32
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
recorded by the Company. During the six months ended June 30, 1999,
such options were exercised.
F-33
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STOCK OPTION PLANS
The Company has incentive stock option and non-qualified stock option
plans (the "Plans") for directors, officers, key employees, and
consultants. The Plans provide for the granting of options for common
shares at exercise prices equal to or exceeding the fair market value
at the date of grant, as determined by the Board of Directors. Options
generally become exercisable over a period of up to five years from the
date of grant and no less than 20% shall become exercisable annually,
as determined by the Board of Directors.
None of the options granted are exercisable prior to one year from the
date of grant, unless specified by the Board of Directors. In no event
are options to be exercisable after 10 years from the date of grant.
The Board of Directors has authorized a total of 3,751,976 shares to be
available for grant under the Company's stock option Plans.
Options granted under the Plans may be either "incentive stock
options," within the meaning of Section 422 of the Internal Revenue
Code, or "non-qualified stock options," as determined by the Committee
at the time of grant. No incentive stock option may be granted to any
person who owns stock possessing more than 10% of the combined voting
power of all classes of the Company's stock or of its parent ("10%
Stockholders") unless the exercise price is at least equal to 110% of
fair market value on the date of grant. Options may be granted under
the Plans for terms of up to 10 years, except for incentive stock
options granted to 10% Stockholders, which are limited to five-year
terms.
The exercise price in the case of incentive stock options granted under
the Plans must be at least equal to the fair market value of the common
stock as of the date of grant. No incentive stock options may be
granted to an optionee under the Plans if the aggregate fair market
value (determined on the date of grant) of the stock with respect to
which incentive stock options are exercisable by such optionee in any
calendar year under all such plans of the Company and its affiliates
exceeds $100,000.
In February 1996, the Company issued options to an officer to purchase
650,000 restricted shares of common stock at $0.01 per share
exercisable five years from the date of grant. Compensation expense was
charged to operations totaling $6,500, representing the fair value of a
bonus for additional services rendered to the Company. These options
vested on the date of grant. Additional compensation expense was not
deemed appropriate by management as the value of the Company was
nominal prior to the effective date of the Acquisition Agreement, the
consummation of which was not assured.
F-34
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STOCK OPTION PLANS (Continued)
In April 1996, the Company issued options to purchase restricted shares
of common stock at $0.01 per share to two employees below market,
resulting in the Company recording deferred compensation of $124,000,
which was being amortized over five years, the vesting period of the
options. During the year ended December 31, 1997, one of the employees
left the Company and forfeited his options. Accordingly, the Company
reversed the deferred compensation relating to this employee.
The balance of deferred compensation as of December 31, 1998 and 1997
and as of June 30, 1999 and 1998 totaled $27,900 and $40,300,
respectively, and $21,700 (unaudited) and $34,100 (unaudited),
respectively.
During the years ended December 31, 1998 and 1997, the Board of
Directors granted options to purchase 350,000 and 300,000,
respectively, shares of common stock to an officer and to an employee
at exercise prices ranging from $1.13 to $1.82. The options vested
immediately and expire over two to five years.
The following summarizes options and warrants granted and outstanding
through June 30, 1999:
<TABLE>
<CAPTION>
Weighted-
Number of Shares Average
Non- Exercise
Employee Employee Total Price
--------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C>
Balance, December 31,
1996 750,000 4,181,633 4,931,633 $ 0.99
Granted 350,000 526,465 876,465 $ 2.74
Exercised - (341,239) (341,239) $ 0.05
Expired, cancelled (50,000) (7,500) (57,500) $ 0.11
--------------- ---------------- ---------------
Balance, December 31,
1997 1,050,000 4,359,359 5,409,359 $ 1.31
Granted 300,000 30,000 330,000 $ 1.07
Exercised (650,000) (455,001) (1,105,001) $ 0.03
Expired, called - (1,190,124) (1,190,124) $ 1.11
--------------- ---------------- ---------------
Balance, December 31,
1998 700,000 2,744,234 3,444,234 $ 1.80
Granted (unaudited) - 200,000 200,000 $ 0.30
Exercised (unaudited) (50,000) (322,813) (372,813) $ 0.18
Expired, cancelled
(unaudited) - (1,517,363) (1,517,363) $ 2.13
--------------- ---------------- ---------------
</TABLE>
F-35
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1999
(UNAUDITED) 650,000 1,104,058 1,754,058 $ 1.70
=============== ================ ===============
</TABLE>
F-36
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STOCK OPTION PLANS (Continued)
The following table sets forth the exercise prices, the number of
warrants and stock options exercisable and outstanding and the
remaining contractual lives of such warrants and stock options as of
December 31, 1998:
<TABLE>
<CAPTION>
Weighted-
Number of Average
Range of Options and Remaining
Exercise Prices Warrants Contractual Life
---------------- ------------------ -----------------
<S> <C> <C>
$ 0.01 to 0.50 869,056 1.5 years
$ 0.51 to 1.00 105,465 1.2 years
$ 1.13 to 1.25 360,000 3.4 years
$ 1.65 to 1.82 521,850 0.6 years
$ 2.24 to 2.50 1,210,663 0.2 years
$ 4.50 377,200 1.1 years
------------------
3,444,234
==================
</TABLE>
Pro forma information regarding net income (loss) and earnings (loss)
per share is required by SFAS No. 123 and has been determined as if the
Company had accounted for its employee stock options under the fair
value method of SFAS No. 123. The fair value for these options was
estimated at the date of grant using the Black-Scholes option pricing
model with the following weighted-average assumptions for the years
ended December 31, 1998 and 1997: risk free interest rate of 5.25%;
dividend yield of 0%; expected life of five years; and expected
volatility of 92%.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion,
the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
F-37
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STOCK OPTION PLANS (Continued)
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options vesting period.
Adjustments are made for options forfeited prior to vesting. The effect
on compensation expense, net income (loss) and net income (loss) per
common share had compensation costs for the Company's stock option
plans been determined based on a fair value at the date of grant
consistent with the provisions of SFAS No. 123 for the years ended
December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
--------------- ----------------
<S> <C> <C>
Net loss
As reported $ (338,018) $ (1,459,527)
Pro forma $ (569,014) $ (1,845,027)
Basic and diluted loss per common share
As reported $ (0.02) $ (0.12)
Pro forma $ (0.04) $ (0.16)
</TABLE>
NOTE 13 - SETTLEMENT AGREEMENT
In March 1998, the Company entered into a Modem Card Settlement
Agreement with an outside company whereby the Company assigned
exclusive property rights of a specified product in exchange for
$250,000. In connection with this agreement, an officer and stockholder
was paid a bonus totaling $11,500.
NOTE 14 - INCOME TAXES
The components of the income tax provision were as follows:
<TABLE>
<CAPTION>
For the Years Ended For the Six Months Ended
December 31, June 30,
--------------------------------- ---------------------------------
1998 1997 1999 1998
--------------- ---------------- --------------- ----------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Current $ 800 $ 800 $ 400 $ 800
Deferred - - - -
--------------- ---------------- --------------- ----------------
TOTAL $ 800 $ 800 $ 400 $ 800
=============== ================ =============== ================
</TABLE>
F-38
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 14 - INCOME TAXES (CONTINUED)
Income tax expense (benefit) for the years ended December 31, 1998 and
1997 differed from the amounts computed applying the federal statutory
rate of 34% to pre-tax income as a result of:
<TABLE>
<CAPTION>
1998 1997
--------------- ----------------
<S> <C> <C>
Computed "expected" tax benefit $ (114,654) $ (495,967)
Income (reduction) in income taxes resulting from
Expenses not deductible for tax purposes 17,999 9,062
Change in beginning of the year balance of the
valuation allowance for deferred tax assets
allocated to income tax expense 96,927 487,177
State and local income taxes, net of tax benefit 528 528
--------------- ----------------
TOTAL $ 800 $ 800
=============== ================
Significant components of the Company's deferred tax assets and
liabilities for federal income taxes for the year ended December 31,
1998 and the six months ended June 30, 1999 consisted of the following:
<CAPTION>
December 31, June 30,
1998 1999
--------------- ----------------
(unaudited)
<S> <C> <C>
Deferred tax assets
Net operating loss $ 1,259,000 $ 1,716,000
Allowance for doubtful accounts 19,000 22,000
Allowances for sales returns 28,000 34,000
Allowances for price protection 62,000 145,000
Other 13,000 20,000
Valuation allowance (1,306,000) (1,816,000)
--------------- ----------------
Total deferred tax assets 75,000 121,000
Deferred tax liabilities
State tax 75,000 121,000
--------------- ----------------
TOTAL $ - $ -
=============== ================
</TABLE>
F-39
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE SIX MONTHS ENDED
JUNE 30, 1999 AND 1998 IS UNAUDITED.)
- --------------------------------------------------------------------------------
NOTE 14 - INCOME TAXES (CONTINUED)
The valuation allowance for deferred tax assets as of December 31, 1998
and 1997 totaled approximately $1,306,000 and $1,218,000, respectively.
The net change in the valuation allowance for the years ended December
31, 1998 and 1997 was an increase of approximately $88,000 and
$411,000, respectively.
As of December 31, 1998, the Company had net tax operating loss
carryforwards of approximately $3,142,000 available to offset future
federal taxable income and tax liabilities. The federal carryforwards
expire in varying amounts from 2008 to 2018. The Company also had net
tax operating loss carryforwards of approximately $2,157,000 available
to offset future California taxable income and tax liabilities. The
state carryforwards expire in 2003 and 2009.
NOTE 15 - YEAR 2000 ISSUE
The Company is conducting a comprehensive review of its computer
systems, is inquiring of its major customers and suppliers to identify
systems that could be affected by the Year 2000 Issue, and is
developing an implementation plan to resolve the Issue.
The Issue is whether computer systems will properly recognize
date-sensitive information when the year changes to 2000. Systems that
do not properly recognize such information could generate erroneous
data or cause a system to fail. The Company is dependent on computer
processing in the conduct of its business activities.
Based on the review of the computer systems, management does not
believe the cost of implementation will be material to the Company's
financial position and results of operations.
F-40
