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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
or
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 000-27267
I/OMAGIC CORPORATION
(Name of small business issuer as specified in its charter)
NEVADA 88-0290623
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6 AUTRY
IRVINE, CALIFORNIA 92618
(Address of principal executive offices) (Zip code)
(949) 727-7466
(Issuer's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
(None)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $.001 per share
Check whether Registrant (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes /X/ No / /
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
the Form 10-KSB. /X/
Registrant's revenues for its fiscal year ended December 31, 1999, were
$39,917,342. As of March 15, 2000, Registrant had 32,307,039 shares of its $.001
par value Common Stock issued and outstanding with an aggregate market value of
the common stock held by non-affiliates of $88,722,321. This calculation is
based upon the closing sales price of $3.625 per share on March 27, 2000.
Transitional Small Business Disclosure Format (check one). Yes / / No /X/
The following documents are incorporated herein by reference: Registration
Statement on Form 10-SB, filed with the SEC on January 11, 2000 is incorporated
in Part IV, Item 13(a).
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TABLE OF CONTENTS
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PART I PAGE
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Item 1 Description of Business 1
Item 2 Description of Property 8
Item 3 Legal Proceedings 8
Item 4 Submission of Matters to a Vote of Security Holders 8
PART II
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Item 5 Market for Common Equity and Related Stockholder 9
Matters
Item 6 Management's Discussion and Analysis 10
Item 7 Financial Statements 14
Item 8 Changes in and Disagreements with Accountants on 14
Accounting and Financial Disclosure
PART III
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Item 9 Directors, Executive Officers, Promoters and Control Persons; 15
Compliance with Section 16(a) of the Exchange Act
Item 10 Executive Compensation 16
Item 11 Security Ownership of Certain Beneficial Owners and 17
Management
Item 12 Certain Relationships and Related Transactions 18
PART IV
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Item 13 Exhibits and Reports on Form 8-K 19
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PART I
ITEM 1 - 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. ANY BANKRUPTCY, RECEIVERSHIP OR SIMILAR PROCEEDING
Not Applicable.
3. ANY MATERIAL RECLASSIFICATION, MERGER, CONSOLIDATION,
OR PURCHASE OR SALE OF A SIGNIFICANT AMOUNT OF ASSETS NOT IN THE ORDINARY
COURSE OF BUSINESS
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" or
"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 MARKET
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.
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a. OPTICAL STORAGE DRIVES
Approximately 63% of the Company's gross revenues generated from
January 1, 1999 through December 31, 1999 ("calendar 1999") 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 generated during
fiscal 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 to 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 13% of the Company's gross revenues generated during
fiscal 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 calendar 1999,
approximately 14%, 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 to 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
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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.
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
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 34% 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, $829,009 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
$366,486.
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. The
Company is responsible for the shipping costs. 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/OMagic.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
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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.
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 ANY PUBLICLY ANNOUNCED NEW PRODUCT.
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 year 2000, 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 15
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 year 2000, 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.
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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.
(i) TIME TO MARKET.
Consumer demand for particular peripheral upgrade products is
constantly changing. As a result, it is critical that the Company be capable of
quickly addressing this demand. The Company does this in two ways: (a) it
monitors technological developments in the marketplace by consulting with its
retail customers and (b) it then provides this information to its Asian
suppliers. The Company then 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.
(ii) PRODUCT VALUE AND TECHNOLOGY
The Company focuses upon this competitive factor by positioning its
products as an affordable alternative to what the market perceives as the "tier
one" brands such as Creative Labs and S3, Inc. 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. 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.
(iii) MARKET PENETRATION AND AFTER SALES SERVICE
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. This provides
the Company with an expanded presence at these outlets, thereby potentially
improving brand awareness among consumers. The Company has eight employees
dedicated to providing after sales services primarily over the telephone, such
as technical assistance and return and warranty policy information.
As noted above, the Company currently maintains a broad range of
peripheral upgrades for desktop and portable applications. The Company believes
that providing this extensive vertical product mix improves its ability to
maintain critical shelf space at its major retail customers. While a number of
the competitors discussed in this section sell a portion of the Company's
product mix (and clearly, collectively, all of these competitors sell all of the
products sold by the Company), the Company is not aware of any competitor which
provides the broad range of peripheral upgrades currently offered by the
Company.
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.
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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 AND AVAILABILITY 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 34% 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. While it is difficult to project
the extent of this delay, the Company believes that this delay would materially
and adversely effect its position in the marketplace. As a result, if the
Company could no longer obtain supplies from BTC or Lung Hwa it would probably
be required to pay materially more for its products and its product shipments
would be delayed. This would be a material competitive disadvantage for the
Company in the marketplace.
6. DEPENDENCE ON MAJOR CUSTOMERS
In calendar 1999, the Company had sales with three major customers that
each represent approximately 32% (Circuit City, $12,531,457), 26% (CompUSA,
$10,147,978), 17% (Office Max, $6,579,224), and one related party customer that
represented 16% (Digital Research Technology, $6,454,475) of net retail sales.
Similarly, as of December 31, 1999, the Company had three customers that
accounted for 19% (CompUSA, $3,188,635), 17% (Circuit City $2,873,870) and 12%
(OfficeMax, $2,066,953), and had two related party customers that accounted for
23% (Hi Val, Inc. $3,854,250) and 16% (Digital Research Technologies, Inc.,
$2,717,930) of total accounts receivable.
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.
During the fourth quarter of 1998 and all 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 Office Max.
7. INTELLECTUAL PROPERTY
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
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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 two year
period ending December 31, 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.
The Company is not currently subject to direct regulation by any
domestic or foreign governmental agency, other than regulations applicable to
businesses generally.
9. EFFECT OF ANY EXISTING OR PROPOSED GOVERNMENT
REGULATIONS
Not applicable, see discussion in Paragraph 8, Government Approval
above.
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). Typically, the Company identifies a
market or technology trend occurring in the marketplace through consultation
with its large retail customers. The Company then provides its Asian
manufacturers with the technical specifications or market trends which it has
identified. The Asian manufacturers then conduct the actual research and
development (in Asia, at their cost) to determine the technical and financial
feasibility of the proposed product. The Company does conduct limited research
and development in designing driver software providing a user friendly
installation, user manual, installation guides, product packaging, marketing
literature and market and sales research. The Company estimates that it expended
approximately $280,000 in connection with these efforts during the two year
period ending December 31, 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.
12. EMPLOYEES
As of the date hereof, the Company has approximately 57 full-time
employees. While the Company does anticipate a small increase in its number of
employees, it does not anticipate that it will hire more than 10 to 20
additional employees during calendar year 2000. 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.
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ITEM 2 - PROPERTIES
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, 2003, and requires monthly payments of
approximately $15,000 per month.
ITEM 3 - LEGAL PROCEEDINGS
In April 1999, the Company filed an arbitration proceeding in Orange
County, California against its former accountants and auditors, Ernst & Young,
LLP, for failure to complete the 1997 audit of the Company in a timely fashion
and for excessive billing in connection with the 1997 audit. Arbitration
proceedings are anticipated to take place during the year 2000.
To the best knowledge of management, there are no legal proceedings
pending or threatened against the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER 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:
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1998 High Low
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Quarter ended
March 31 1 5/8 0 3/8
June 30 1 1/2 0 3/8
September 30 1 1/4 0 7/32
December 31 0 9/16 0 9/32
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1999
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Quarter ended
March 31 3 1/8 0 15/64
June 30 2 5/8 1 1/2
September 30 2 1/16 1 3/8
December 31 1 11/16 0 9/16
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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 7,208,725 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) STOCKHOLDERS
As of March 15, 2000 there are 88 shareholders who currently hold
certificated securities (approximately 60 of these shareholders hold
restricted securities) and approximately 317 shareholders currently listed in
the Depository Trust Company as holding shares in brokerage accounts.
The Company's transfer agent is Transfer Online, 227 S.W. Pine, Suite
300, Portland, OR 97204.
(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.
9
<PAGE>
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS
The discussion and financial statements contained herein are for the
calendar years ended December 31, 1998 and 1999. The following discussion
regarding the financial statements of the Company should be read in
conjunction with the financial statements of the Company included herewith.
OVERVIEW
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.
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, selected financial
information for the Company:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1999 December 31, 1998
- ------------------------------------------------------------------------------
<S> <C> <C>
Statement of Operations Data
Revenue $ 39,917,342 $ 10,714,363
Net Profit/(Net Loss) 1,862,798 (338,018)
Net Profit/(Net Loss) per share 0.06 (0.02)
- -----------------------------------------------------------------------------
Balance Sheet Data
Current Assets 22,639,152 5,973,859
Total Property & Equipment, Net 255,689 133,231
Total Assets 22,916,329 6,128,250
Total Current Liabilities 15,040,366 5,344,407
Accumulated Deficit (2,487,743) (4,350,541)
Stockholder's Equity 7,875,963 777,120
- -----------------------------------------------------------------------------
</TABLE>
CALENDAR YEAR ENDED DECEMBER 31, 1999 COMPARED TO CALENDAR YEAR ENDED
DECEMBER 31, 1998
Revenues for the year ended December 31, 1999 ("1999") were
$39,917,342 compared to revenues for the year ended December 31, 1998
("1998") of $10,714,363. The increase in revenues is primarily attributable
to the increase in sales to: Circuit City (from $0 in 1998 to $12,531,457 in
1999); CompUSA (from $2,769,503 in 1998 to $10,147,978 in 1999); Office Max
(from $0 in 1998 to $6,579,224 in 1999); to Digital Research Technology
(related party OEM sales) (from $0 in 1998 to $6,454,476 in 1999).These
increases were offset by decreases in sales to: Fry's Electronics (from
$3,391,785 in 1998 to $1,984,399 in 1999); to Electronics Boutique (from
$760,691 in 1998 to $88,687 in 1999); and smaller decreases in sales to other
existing customers (from $3,792,382 in 1998 to $2,380,755 in 1999) due to
marketing emphasis on larger national customers. The Company's backlog at
December 31, 1999 was $7,514,583 compared to no backlog at December 31, 1998.
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. These
rebates averaged 5% of gross revenues of the Company during 1999. If the
Company offers a rebate, the amount of the rebate typically ranges between 4%
to 8% of the retail price of the product. The rebate concept is prevalent
among the Company's competitors and the Company anticipates that it will
continue indefinitely with different products
10
<PAGE>
offered at various times.
Cost of sales as a percentage of revenues increased from 73.99%
($7,927,553) in 1998 to 78.71% ($31,419,757) in 1999. This was primarily due
to an increase in lower gross margin OEM sales from $529,946 in 1998 to
$6,454,476 in 1999 and higher freight expenses in 1999.
The Company "wrote-down" $85,644 of its inventory in 1998 and $3,363
of its inventory in 1999. 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 term
"price protection" refers to an agreement between the Company and the
retailer that in the event the market price for a particular item of
inventory declines during a period of time, then the Company shall either
accept a return of this item or reduce the cost charged by the Company to the
retailer in order to allow the retailer to maintain its profit margin. Price
protection is typically not incorporated into any formal agreement between
the Company and the retailer, rather it is an industry method of conducting
business. 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 31.51%
($3,376,021) in 1998 to 17.77% ($7,093,543) in 1999. This percentage decrease
is primarily due to the fixed cost nature of the majority of operating
expenses. In summary, as revenues increase, the general and administrative
expenses decrease as a percentage of revenues. General and administrative
expenses in 1998 were $1,263,390 and in 1999 were $2,542,104. Payroll and
related expenses increased to $1,425,160 in 1999 from $692,888 in 1998 due to
the increase in the number of employees due to the increase in sales.
Temporary help increased to $71,117 in 1999 from $7,118 in 1998 to meet
increases during months for deliveries. Warehouse supplies increased to
$62,600 in 1999 from $1,002 in 1998. Financial relations increased to $93,097
in 1999 from $40,343 in 1998 to promote more visibility in the financial
community. Building rent increased to $119,257 in 1999 from $68,480 in 1998
as the Company leased additional space in mid-year due to the increased in
revenues. Selling expenses in 1998 were $2,112,631 and in 1999 were
$4,551,439. Advertising expenses increased to $1,218,423 in 1999 from
$369,678 in 1998 primarily due to the addition of Circuit City and Office Max
during the year plus increased advertising with prior customers. Rebates
increased to $2,037,828 in 1999 from $1,224,919 in 1998 as revenues
increased, although rebates as a percentage of revenues decreased as
promotions were of a shorter duration. Slotting fees increased to $200,001 in
1999 from $0 in 1998 due to the addition of new customers. Sales
administrative expenses increased to $1,095,187 in 1999 from $518,034 in 1998
primarily due to higher sales commissions
Other income decreased from 2.35% ($251,993) in 1998 to 0.08%
($30,256) in 1999. Calendar 1999 other income included the net impact of
inventory purchased on behalf of a related party totaling $2,382,252. Such
inventory was sold at cost plus handling resulting in other income of
$24,000. Calendar 1998 other income included a non-recurring revenue amount
of $250,000 arising from the sale of a modem design.
Income taxes for 1998 represent minimum state income taxes due to
the Company's loss position during the year. Income taxes for 1999 are
comprised of $106,000 current federal and state tax liabilities offset by the
recognition of net deferred tax assets totaling $651,000. In addition, income
taxes includes the tax impact related to the exercise of certain
non-qualified stock options which totaled $116,500 for 1999. The deferred tax
asset recorded for 1999 is comprised of future tax benefits related to
primarily reserves, allowances for doubtful accounts, sales returns, and
price protection; and accrued compensation. The deferred tax assets is
recorded net of deferred liabilities, net of a valuation allowance for
certain assets that are not expected to be realized.
The Company experienced net income of $1,862,798 for the year ended
December 31, 1999 as compared to a net loss of $338,018 for the year ended
December 31, 1998. The change to profitability is due to the addition of
Circuit City and Office Max in 1999 and increased sales to CompUSA in 1999
over 1998, expansion of marketing activities, improved product costs and the
fact that the operating expenses did not increase at the same rate as sales.
11
<PAGE>
CALENDAR YEAR ENDED DECEMBER 31, 1998 COMPARED TO CALENDAR YEAR ENDED
DECEMBER 31, 1997
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 primarily 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 in 1998); 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.
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. These rebates
averaged 11% of gross revenues of the Company during the year ended December
31, 1998. If the Company offers a rebate, the amount of the rebate typically
ranges between 4% to 8% of the retail price of the product. 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.
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 of inventory in 1997 and $85,644 of
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 term "price
protection" refers to an agreement between the Company and the retailer that
in the event the market price for a particular item of inventory declines
during a period of time, then the Company shall either accept a return of
this item or reduce the cost charged by the Company to the retailer in order
to allow the retailer to maintain its profit margin. Price protection is
typically not incorporated into any formal agreement between the Company and
the retailer, rather it is an industry method of conducting business. 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%
($2,059,066) in 1997 to 31.51% ($3,376,021) 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 general and administrative
expenses decrease as a percentage of revenues. General and administrative
expenses in 1997 were $1,416,792 and in 1998 were $1,263,390. Bad debt
increased by $227,517 in 1998 from 1997 and audit expense decreased by
$151,030 in 1998 from 1997 due to replacement of auditors during the 1997
audit. Both are expected to be one-time non-recurring expenses. In 1998 the
Company incurred $140,498 in connection with service agreements. Amounts
incurred in connection with service agreements in 1997 were insignificant.
Selling expenses in 1997 were $642,274 and in 1998 were $2,112,631. Rebates
increased to $1,224,919 in 1998 from $24,117 in 1997, as rebates were not
initiated until late December 1997. Advertising expenses increased to
$369,678 in 1998 from $287,398 in 1997. Sales administrative expenses
increased to $518,034 in 1998 from $330,759 in 1997 primarily due to higher
sales commissions
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
12
<PAGE>
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. The Company currently has two lines of credit
with its major suppliers: $5 million with BTC and $2 million with Lung Hwa.
Borrowings under these arrangements provided the Company interest free for up
to 75 days as defined. The Company has an outstanding balance with BTC of
$829,009 and with Lung Hwa of $366,486 as of December 31, 1999.
In January 2000, the Company issued 4,444,445 shares of restricted
common stock to BTC valued at $1.13 per share for $5,000,000 of inventory.
In March 2000, the Company sold 632,912 shares of restricted common
stock to an affiliate of BTC for cash at $3.16 per share or $2,000,000 in
aggregate.
In March 2000, the Company entered into an asset based lending
agreement for up to $15,000,000 with IBM Credit in order to continue its
growth. The Company believes that its current cash flow from operations and
the amounts available under its existing vendor lines of credit are
sufficient to meet its working capital and capital expenditure requirements
at the current sales volume for the next twelve months.
For the year ended December 31, 1999 the Company had a net increase
in cash in the amount of $540,618. This was due to cash used for investing
activities of $174,290 and cash used for financing activities of
$148,642 offset by cash provided from operations of $863,550. Cash used for
investing activities was for leasehold improvements, furniture and computer
equipment. Cash used for financing activities was primarily for payment on
notes payable ($250,000) offset by proceeds from exercise of warrants
($107,145).
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 activities of $51,945 and financing activities of $88,391. While
the Company experienced a loss for 1998 of $338,018, cash from operating
activities increased primarily through the utilization of substantial lines
of trade credit provided by the Company's major vendors. Cash used for
investing activities was for furniture and computer equipment. Cash used for
financing activities was primarily for advances to related parties ($192,982)
and purchase of treasury stock ($165,000) offset by proceeds from issuance of
notes payable ($250,000).
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
13
<PAGE>
securing such financing, it may be required to curtail its sales growth.
The Company has no firm long-term sales commitments from any of its
customers and enters into individual purchase orders with its customers. The
Company has experienced cancellations of orders and fluctuations in order
levels from period to period and expects it will continue to experience such
cancellations and fluctuations in the future. In addition, customer purchase
orders may be canceled and order volume levels can be changed, canceled or
delayed with limited or no penalties. The replacement of canceled, delayed or
reduced purchase orders with new business cannot be assured. Moreover, the
Company's business, financial condition and results of operations will depend
upon its ability to obtain orders from new customers, as well as the
financial condition and success of its customers, its customers products and
the general economy. The factors affecting any of the Company's major
customers or their customers could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company can indefinitely finance its current level of sales
through its own internal resources, as well as the credit lines provided by
BTC and Lung Hwa. In the event the Company continues with the revenue growth
it has experienced between 1998 and 1999 the Company believes that it may
need additional capital during the year ended December 31, 2000 which is
expected to come from the IBM Credit Corp. facility discussed in the
preceding paragraphs. This additional capital would be utilized to acquire
additional inventory to be resold by the Company and to increase marketing
and sales efforts toward national retail chains. In the event the Company is
unsuccessful in securing needed 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.
PART II - OTHER INFORMATION
ITEM 7. FINANCIAL STATEMENTS
The Financial Statements that constitute Item 7 are included at the
end of this report beginning on Page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
(1) DISMISSAL OF PRINCIPAL ACCOUNTANTS.
The Company dismissed Ernst & Young LLP, Certified Public
Accountants ("Ernst & Young") as its principal accountants on October 7,
1998. Ernst & Young only performed an audit for the year ended December 31,
1996. Ernst & Young's report of independent auditors for the year ended
December 31, 1996 contained no adverse opinion or a disclaimer of opinion,
nor was qualified nor modified as to uncertainty, audit scope, or accounting
principles. The principal accountant's 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 year ended December 31, 1996, and through the
dismissal of Ernst & Young on October 7, 1998, there were no disagreements
with Ernst & Young on any matter of accounting principles or practices,
financial statement disclosures, or auditing scope or procedure. There is
nothing further to report under Item 304 (a) (1) or (iv) (B) through (E).
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 further to report under Item 304(a)(1) or (iv)(B) through (E).
14
<PAGE>
Subsequent to the completion of the audit by Ernst & Young, and as
of December 31, 1996, the Company recorded the valuation of certain options
and warrants as compensation expense resulting in an increase to additional
paid-in-capital and an increase to the accumulated deficit totaling $136,833.
Ernst & Young has not expressed any opinion on the December 31, 1996
financial statements, as restated, as they have not performed any procedures
with respect to the adjustments recorded by the Company. The financial
statements and financial information included herein reflect these entries.
These entries are not part of the arbitration proceedings discussed above
(Item 2 - Legal Proceedings).
(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 the 1998 and 1999 audits 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.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
(a) DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth the names and ages of the current
directors and executive officers of the Company and the principal offices and
positions with the Company held by each person. The executive officers of the
Company are elected annually by the Board of Directors. Each year the
stockholders elect the board of directors. The executive officers serve terms
of one year or until their death, resignation or removal by the Board of
Directors. There was no arrangement or understanding between any executive
officer and any other person pursuant to which any person was elected as an
executive officer.
<TABLE>
<CAPTION>
NAME AGE POSITION
--------------- --- --------------------------------------------
<S> <C> <C>
Tony Shahbaz 37 Chairman, President, Chief Executive
Officer, Secretary, Chief Financial Officer
Daniel Hou 50 Director
Anthony Andrews 37 Vice President, Director of Engineering,
Director
</TABLE>
MR. TONY SHAHBAZ, CHAIRMAN, PRESIDENT, CHIEF EXECUTIVE OFFICER, SECRETARY,
CHIEF FINANCIAL 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. Since 1993 Mr. Shahbaz has been the
president of I/O Magic Corporation. Prior to his positions with Western
Digital, he held management positions with Tandon Corporation and Lapin
Technology, in the marketing and sales divisions of these companies.
15
<PAGE>
MR. DANIEL HOU, DIRECTOR, Mr. Hou is the Founder of Hou Electronics, Inc. a
computer peripheral supplier. This company was formed in 1986 and has
continually grown to have revenues of $45 million in 1998. Mr. Hou has been
the president of Hou Electronics from 1986 through the present. He is
responsible for all business activities associated with Hou Electronics. 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.
(b) COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE
ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than ten percent
of the Company's Common Stock, to file reports of ownership and changes in
ownership with the Securities and Exchange Commission ("SEC"). Officers,
directors and greater than ten percent stockholders are required by SEC
regulations to furnish the Company with copies of all Section 16(a) forms
they file. Based solely on its review of the copies of such forms received by
it, or written representations from certain reporting persons, the Company
believes that during its 1999 fiscal year, all such filing requirements
applicable to its officers, directors, and greater than 10% beneficial owners
were complied with.
ITEM 10 - EXECUTIVE COMPENSATION
(a) SUMMARY 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>
- --------------------------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG TERM COMPENSATION
AWARDS PAYOUTS
Name Other Restricted
and Annual Stock Options LTIP All Other
Principal Position Year Salary Bonus Compensation Awards SARs Payouts Compensation
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tony Shahbaz 1999 $140,000 105,000 -0- 6,000 (auto)
CEO, President, 1998 $140,000 11,500(1) -0- 300,000 (2) 6,000 (auto)
Secretary & CFO 1997 $140,000 -0- 300,000 (3) 6,000 (auto)
- --------------------------------------------------------------------------------------------------------------------------
16
<PAGE>
- --------------------------------------------------------------------------------------------------------------------------
Anthony Andrews 1999 $74,286 -0- -0- -0- -0- -0- -0-
Vice President 1998 $70,269 3,000 -0- -0- -0- -0- -0-
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Mr. Shahbaz received a bonus of $11,500 for the design sale of a
modem to Hewlett-Packard in May 1998.
(2) On January 2, 1997 the Company issued 300,000 options 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 options 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.
(b) EMPLOYMENT AGREEMENTS
The Company entered into an employment agreement with Tony Shahbaz, its
President, Chief Executive Officer, Secretary, and Chief Financial 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 have been paid under the net profits
calculation contained in the employment agreement. As of December 31, 1999, a
bonus totaling $105,000 has been accrued pursuant to the terms of this
agreement.
(c) COMPENSATION OF DIRECTORS
Directors of the Company do not receive any cash compensation, but
are entitled to reimbursement of their reasonable expenses incurred in
attending directors' meetings.
ITEM 11- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of the date of this Report 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.
<TABLE>
<CAPTION>
PERCENTAGE BENEFICIALLY
NAME NUMBER OF SHARES (1) OWNED
- ---- -------------------- -----
<S> <C> <C>
Tony Shahbaz(2) 26,348,862(3) 79%
Anthony Andrews(2) 116,666(4) *
Daniel Hou(2) -0- *
All officers and directors as a group (3 persons) 26,465,528 79%
Hou Electronics Inc.(2) 2,000,000 6%
Susha, LLC(2) 26,348,862(3) 79%
</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
17
<PAGE>
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) 26,348,862 of these shares are held in the name of Susha, LLC. 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. Also includes 600,000 options to
purchase Common Stock.
(4) Includes 50,000 options to purchase Common Stock.
- ---------------
ITEM 12-CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
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, 1999, the Company had $829,009
outstanding in trade payables generated in the ordinary course of business.
Effective January 4, 2000, the Company issued to BTC 4,444,445
shares of restricted common stock valued at $1.13 per share for $5,000,000 of
inventory, as defined (valued at transferor's cost basis).
In March 2000, the Company sold 632,912 shares of restricted common
stock to an affiliate of BTC for cash at $3.16 per share or $2,000,000 in
aggregate, which includes a 20% discount.
All shares issued to BTC and its affiliate are held by Susha LLC as
noted in footnote 3 above.
18
<PAGE>
PART IV
ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
<TABLE>
<S> <C>
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/O Magic 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.*
27.1 Financial Data Schedule
</TABLE>
- ---------------------------
*Incorporated by reference from Registration Statement on Form 10-SB filed by
the Company on January 11, 2000.
(b) REPORTS ON FORM 8-K
None.
19
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act") the Registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
I/OMAGIC CORPORATION
/s/ TONY SHAHBAZ
--------------------------------------
By: Tony Shahbaz
Its: Chief Executive Officer,
President Secretary Chief
Financial Officer, Director
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/TONY SHAHBAZ Chief Executive Officer, President March 28, 2000
- -------------------- Secretary, Chief Financial Officer,
Tony Shahbaz Director
/s/ TONY ANDREWS Vice President, Director March 28, 2000
- --------------------
Anthony Andrews
/s/ DANIEL HOU Director March 28, 2000
- --------------------
Daniel Hou
</TABLE>
20
<PAGE>
I/O MAGIC CORPORATION
CONTENTS
DECEMBER 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-1
FINANCIAL STATEMENTS
Balance Sheet F-2 - F-3
Statements of Income F-4
Statements of Stockholders' Equity F-5
Statements of Cash Flows F-6 - F-7
Notes to Financial Statements F-8 - F-29
</TABLE>
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
I/O Magic Corporation
We have audited the accompanying balance sheet of I/O Magic Corporation as of
December 31, 1999, and the related statements of income, 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, 1999, 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.
/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
March 16, 2000
<PAGE>
I/O MAGIC CORPORATION
BALANCE SHEET
AS OF DECEMBER 31,
- --------------------------------------------------------------------------------
ASSETS
<TABLE>
<S> <C>
CURRENT ASSETS
Cash $ 1,943,522
Accounts receivable, net of allowance for doubtful
accounts of $71,193 10,115,350
Accounts receivable from related parties 6,561,738
Inventory 3,318,422
Deferred income taxes 651,000
Prepaid expenses and other current assets 49,120
----------------
Total current assets 22,639,152
FURNITURE AND EQUIPMENT, net 255,689
OTHER ASSETS 21,488
----------------
TOTAL ASSETS $ 22,916,329
================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
I/O MAGIC CORPORATION
BALANCE SHEET
AS OF DECEMBER 31,
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<S> <C>
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 9,067,600
Income taxes payable 106,000
Current portion of capital lease obligation 1,144
Due to related parties 4,720,054
Reserves for customer returns and allowances 1,145,568
----------------
Total current liabilities 15,040,366
----------------
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
32,307,039 shares issued and outstanding 32,309
Additional paid-in capital 10,511,897
Deferred compensation (15,500)
Treasury stock, 550,000 shares, at cost (165,000)
Accumulated deficit (2,487,743)
----------------
Total stockholders' equity 7,875,963
----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 22,916,329
================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
---------------- ----------------
<S> <C> <C>
NET SALES $ 39,917,342 $ 10,714,363
COST OF SALES 31,419,757 7,927,553
---------------- ----------------
GROSS PROFIT 8,497,585 2,786,810
---------------- ----------------
OPERATING EXPENSES
Selling, marketing, and advertising 4,551,439 2,112,631
General and administrative 2,542,104 1,263,390
---------------- ----------------
Total operating expenses 7,093,543 3,376,021
---------------- ----------------
INCOME (LOSS) FROM OPERATIONS 1,404,042 (589,211)
---------------- ----------------
OTHER INCOME (EXPENSE)
Interest income 16,087 17,232
Interest expense (13,994) (16,674)
Income from related party 24,000 -
Other income 4,163 251,435
---------------- ----------------
Total other income (expense) 30,256 251,993
---------------- ----------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES 1,434,298 (337,218)
(BENEFIT) PROVISION FOR INCOME TAXES (428,500) 800
----------------- ----------------
NET INCOME (LOSS) $ 1,862,798 $ (338,018)
================ ================
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE $ 0.06 $ (0.02)
================ ================
BASIC WEIGHTED-AVERAGE SHARES OUTSTANDING 31,757,039 14,130,105
================ ================
DILUTED WEIGHTED-AVERAGE SHARES OUTSTANDING 31,880,921 14,130,105
================ ================
</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, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Common Stock Additional
-------------------- Paid-In Subscriptions Deferred Treasury Accumulated
Shares Amount Capital Receivable Compensation Stock Deficit Total
---------- -------- ----------- ------------- ------------ --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 13,753,950 $ 13,754 $ 5,245,154 $ (330,735) $ (40,300) $ -- $(4,012,523) $ 875,350
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS 1,105,596 1,106 24,445 -- -- -- -- 25,551
PAYMENT RECEIVED IN 1998 IN
THE FORM OF INVENTORY -- -- -- 324,240 -- -- -- 324,240
PAYMENT RECEIVED IN 1998 IN
THE FORM OF LEGAL SERVICES -- -- -- 6,495 -- -- -- 6,495
COMMON STOCK ISSUED FOR
SERVICES 20,000 20 7,480 -- -- -- -- 7,500
AMORTIZATION OF DEFERRED
COMPENSATION -- -- -- -- 12,400 -- -- 12,400
COMMON STOCK PURCHASED
FOR CASH -- -- -- -- -- (165,000) -- (165,000)
WARRANTS ISSUED FOR LEGAL AND
CONSULTING SERVICES -- -- 28,602 -- -- -- -- 28,602
NET LOSS -- -- -- -- -- -- (338,018) (338,018)
---------- -------- ----------- ----------- ------------- --------- ----------- ----------
BALANCE, DECEMBER 31, 1998 14,879,546 14,880 5,305,681 -- (27,900) (165,000) (4,350,541) 777,120
ISSUANCE OF COMMON STOCK IN
CONNECTION WITH THE EXERCISE
OF WARRANTS 760,826 762 106,383 -- -- -- -- 107,145
COMMON STOCK ISSUED FOR
INVENTORY 16,666,667 16,667 4,983,333 -- -- -- -- 5,000,000
AMORTIZATION OF DEFERRED
COMPENSATION -- -- -- -- 12,400 -- -- 12,400
TAX BENEFIT RELATED TO THE
EXERCISE OF NON-STATUTORY
STOCK OPTIONS -- -- 116,500 -- -- -- -- 116,500
NET INCOME -- -- -- -- -- -- 1,862,798 1,862,798
---------- -------- ----------- ----------- ------------- --------- ----------- ----------
BALANCE, DECEMBER 31, 1999 32,307,039 $ 32,309 $10,511,897 $ -- $ (15,500) $(165,000) $(2,487,743) $7,875,963
========== ======== =========== =========== ============ ========= =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
--------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 1,862,798 $ (338,018)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation and amortization 51,832 38,721
Amortization of deferred compensation 12,400 12,400
Provision for allowance for doubtful accounts 24,821 (192,238)
Provision for obsolete inventory 3,363 85,644
Provision for deferred income taxes (651,000) -
Compensation in connection with stock options and
warrants granted - 28,602
Note payable to related party (345,500) -
Issuance of common stock for services - 7,500
Tax effect of exercised options 116,500 -
(Increase) decrease in
Accounts receivable (6,363,758) (2,992,319)
Accounts receivable from related parties (6,561,738) -
Inventory 2,412,050 108,089
Prepaid expenses and other current assets 11,588 (31,115)
Other assets (328) -
Increase (decrease) in
Accounts payable and accrued expenses 7,526,956 1,097,481
Income taxes payable 106,000 -
Due to related parties 1,735,377 2,984,677
Reserves for customer returns and allowances 922,189 20,347
--------------- ----------------
Net cash provided by operating activities 863,550 829,771
--------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of furniture and equipment (174,290) (51,945)
--------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on capital lease obligations (5,787) (5,960)
Advances due to related parties - (192,982)
(Payments) proceeds on notes payable (250,000) 250,000
Purchase of treasury stock - (165,000)
Proceeds from exercise of warrants 107,145 25,551
--------------- ----------------
Net cash used in financing activities (148,642) (88,391)
--------------- ----------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
I/O MAGIC CORPORATION
STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
--------------- ----------------
<S> <C> <C>
Net increase in cash 540,618 689,435
CASH, BEGINNING OF YEAR 1,402,904 713,469
--------------- ----------------
CASH, END OF YEAR $ 1,943,522 $ 1,402,904
=============== ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
INTEREST PAID $ 13,994 $ 2,299
=============== ================
INCOME TAXES PAID $ 800 $ 800
=============== ================
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended December 31, 1999, the Company entered into the following
non-cash transactions:
- - Received $5,000,000 in inventory for 16,666,667 shares of common stock.
- - Reflected the reduction of a related party note payable as a reduction
to cost of sales of $345,500 (see Note 9).
- - Tax effect of exercise of nonqualified stock options totaling $116,500.
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-7
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
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.
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 notes payable and 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.
F-8
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 during 1999 and 1998.
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.
F-9
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, 1999 and 1998, the Company had reserves for sales
returns totaling $191,326 and $69,146, respectively.
The Company performs periodic credit evaluations of its customers and
maintains allowances for potential credit losses based on management's
evaluation of historical experience and current industry trends.
Although the Company expects to collect amounts due, actual collections
may differ.
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 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.
As of December 31, 1999, the Company had potential common stock as
follows:
<TABLE>
<S> <C>
Weighted-average common shares outstanding during the period 31,757,039
Incremental shares assumed to be outstanding since the
beginning of the period related to stock options and
warrants outstanding 123,882
-------------
FULLY DILUTED WEIGHTED-AVERAGE COMMON SHARES AND
POTENTIAL COMMON STOCK 31,880,921
=============
</TABLE>
As of 1998, the Company had common potential common stock including
options and warrants. The effects of such potential common stock were
not included in diluted loss per share as their effects would have been
anti-dilutive.
F-10
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
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.
COMPREHENSIVE INCOME
For the year ended December 31, 1999, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income." This statement establishes standards
for reporting comprehensive income and its components in a financial
statement. Comprehensive income as defined includes all changes in
equity (net assets) during a period from non-owner sources. Examples of
items to be included in comprehensive income, which are excluded from
net income, include foreign currency translation adjustments and
unrealized gains and losses on available-for-sale securities.
Comprehensive income is not presented in the Company's financials
statements since the Company did not have any of the items of
comprehensive income in any period presented.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1999, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 136, "Transfer of Assets to a Not-for-Profit Organization or
Charitable Trust that Raises or Holds Contributions for Others." This
statement is not applicable to the Company.
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of
SFAS No. 133." This statement is currently not applicable to the
Company.
RECLASSIFICATIONS
Certain amounts have been reclassified in the 1998 balances to conform
to the 1999 presentation.
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-11
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
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.
NOTE 4 - CONCENTRATIONS OF RISK
CASH
As of December 31, 1999, the Company maintained cash balances with a
national bank totaling $2,203,479 in excess of federally insured
amounts of $100,000.
F-12
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 4 - CONCENTRATIONS OF RISK (CONTINUED)
CUSTOMERS
During the year ended December 31, 1999, the Company had net sales to
three major customers that represented approximately 32%, 26%, and 17%
of net sales. During the year ended December 31, 1999, the Company had
sales to one related party that represented approximately 16% of net
sales. As of December 31, 1999, the Company had three customers that
accounted for approximately 39%, 37% and 24% of accounts receivable.
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 approximately 47%, 25% and 15% of accounts receivable.
SUPPLIERS
During the year ended December 31, 1999, the Company purchased
inventory from two related party vendors that represented approximately
28% and 20% of purchases. As of December 31, 1999, there were two
suppliers that represented approximately 11% and 14% of accounts
payable.
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.
NOTE 5 - INVENTORY
Inventory as of December 31, 1999 consisted of the following:
<TABLE>
<S> <C>
Component parts $ 2,400,837
Finished goods 917,585
-------------
TOTAL $ 3,318,422
=============
</TABLE>
F-13
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 6 - FURNITURE AND EQUIPMENT
Furniture and equipment as of December 31, 1999 consisted of the
following:
<TABLE>
<S> <C>
Computer equipment and software $ 204,650
Warehouse equipment 57,534
Office furniture and equipment 92,358
Equipment under capital lease 15,198
Leasehold improvements 44,057
------------
413,797
Less accumulated depreciation and amortization 158,108
------------
TOTAL $ 255,689
============
</TABLE>
Depreciation and amortization expense for the years ended December 31,
1999 and 1998 was $51,832 and $38,721, respectively.
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 consisted 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, which shall expire thirty days after the declaration of
effectiveness of a Registration Statement of the Company registering
the shares underlying the warrants or twelve months from the date of
issue, whichever comes first. The warrants entitled the holder to
purchase that certain number of shares which was equal to one third of
the note amount divided by the price per share of common stock
registered in the Registration Statement, all at the aggregate exercise
price of $1.00. The warrants were deemed by management to be contingent
consideration based on the requirement of an effective Registration
Statement. As no Registration Statement was effected, none of these
warrants were exercisable at any time prior to their expiration in May
and June 1999. Under the provisions of APB 12, management determined
the relative fair value of the warrants to be nominal due to the
contingent nature of the warrants. Accordingly, none of the proceeds
were allocated to these warrants which expired in May and June 1999.
The Company sold 25 units for proceeds of $250,000. In July 1999 all
principal and interest had been paid.
F-14
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 7 - NOTES PAYABLE (CONTINUED)
No expense was recorded for these warrants as such were issued with an
exercise price greater than fair market value (see Note 12). In
addition, the Company paid $25,000 to the agent for services provided.
Such was capitalized in current assets and was amortized over the term
of the Notes.
NOTE 8 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued liabilities as of December 31, 1999
consisted of the following:
<TABLE>
<CAPTION>
<S> <C>
Accounts payable $ 5,509,415
Accrued rebates and marketing 2,802,664
Accrued compensation and related benefits 427,430
Other 328,091
-------------
TOTAL $ 9,067,600
=============
</TABLE>
NOTE 9 - CREDIT LINES FROM RELATED PARTIES
The Company had available a $2,000,000 credit line from a stockholder
and supplier for inventory purchases. Borrowings were non-interest
bearing and were due 60 days from the date of borrowing. Borrowings
were subordinated to bank financings. The credit agreement could be
mutually terminated at any time. During the year ended December 31,
1999, such agreement was mutually terminated.
In connection with a 1997 Strategic Alliance Agreement (the "1997
Strategic Alliance Agreement") (see Notes 11 and 12), 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,
1999, there was $336,486 outstanding under this arrangement. As of
December 31, 1998, there were no outstanding borrowings under this
arrangement included in due to related parties in the accompanying
balance sheet.
In connection with an April 1999 subscription agreement, the Company
also has available an additional line of credit through a stockholder
and supplier that provides a trade credit facility of up to $5,000,000
carrying net 75 day terms, as defined (see Note 12). As of December 31,
1999, there was $829,009 of outstanding borrowings under this
arrangement included in due to related parties in the accompanying
balance sheet.
F-15
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 10 - NOTE PAYABLE TO RELATED PARTY
The Company had a note payable to a related party that represented 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.
As of December 31, 1999, the Company has reflected as a reduction to
cost of sales $394,388 of the total debt and related interest.
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 were sold or the Company commenced 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 defined
as either the price per share in the event of sale or the initial
public offering price, as defined, divided by 1.5.
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 totaling $1,144, expiring January 2001.
Future aggregate minimum annual lease payments under operating lease
arrangements are as follows as of December 31, 1999:
<TABLE>
<CAPTION>
Year Ending
December 31,
------------
<S> <C>
2000 $ 171,456
2001 171,456
2002 71,440
2003 -
-----------
$ 414,352
===========
</TABLE>
F-16
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASES (Continued)
Interest expense was insignificant for the years ended December 31,
1999 and 1998.
Rent expense was $119,257 and $68,480 for the years ended December 31,
1999 and 1998, respectively, and is included in general and
administrative expenses in the accompanying statements of income.
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 and may be payable in shares of the Company's
common stock. As of December 31, 1999, the Company was party to one
such agreement. During the years ended December 31, 1999 and 1998, the
Company incurred $217,167 and $140,498, respectively, in connection
with such arrangements. Such is included in general and administrative
expenses in the accompanying statements of income.
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, 1999 and 1998 under the
terms of this agreement. As of December 31, 1999, the accrued bonus was
approximately $105,000 and is included in accounts payable and accrued
expenses in the accompanying balance sheet.
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, 1999 and 1998, the Company incurred $1,218,423 and
$369,679, respectively, related to these agreements. Such is included
in selling, marketing, and advertising expenses in the accompanying
statements of income.
F-17
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
RELATED PARTY LICENSE AND DISTRIBUTION AGREEMENT
In connection with the 1997 Strategic Alliance Agreement (see Notes 9
and 12), 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, 1999 and 1998, the Company earned no royalties under the
terms of this agreement.
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.
YEAR 2000 ISSUE
The issue whether computer systems would properly recognize
date-sensitive information when the year changed to 2000 resulted in no
system failures to the Company. The Company is dependent on computer
processing in the conduct of its business activities.
While the Company has taken steps to communicate with outside
suppliers, it cannot guarantee that they have all taken the necessary
steps to prevent any service interruption that may affect the Company.
Based on the current operations of the Company's computer systems,
management believes there will not be any additional costs related to
this issue.
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, 1999, none of these warrants were exercised and such
warrants expired.
F-18
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
1996 PRIVATE PLACEMENT OF COMMON STOCK (Continued)
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.
Through December 31, 1999, none of these warrants have been exercised
and such warrants expired.
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 Company recorded $125,000 of compensation expense
related to this transaction. The warrants were not exercised and have
expired.
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. Through December 31,
1999, none of these warrants have been exercised. In January 2000, such
warrants expired.
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. Through December 31, 1999, none of these
warrants have been exercised. In January 2000, such warrants expired.
F-19
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
COMMON STOCK ISSUED FOR SERVICES
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.
COMMON STOCK ISSUED IN CONNECTION WITH THE EXERCISE OF WARRANTS
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 year ended December 31, 1999, the Company issued an
aggregate of 760,826 restricted shares of common stock in connection
with the exercise of warrants for cash totaling $107,145, or at a per
share price ranging from $0.01 to $0.70 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 (see Note 9).
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 9 and 11).
F-20
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STRATEGIC ALLIANCE AGREEMENTS (Continued)
Effective February 3, 1999, the Company issued 16,666,667 shares of
restricted common stock to a stockholder and supplier 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 9). 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, 1999 and 1998, A
Warrants aggregating 360,513 and 25,000, respectively, have been
exercised. Through December 31, 1997, A Warrants aggregating 380,000
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.
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.
F-21
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
WARRANTS (Continued)
In connection with an October 1995 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, 1999, 5,313 of these A Warrants
were exercised. During the year ended December 31, 1998, no A or B
Warrants were exercised. Through December 31, 1997, 27,919 of these
A Warrants were exercised.
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 years ended December 31, 1999 and 1998,
warrants totaling 140,000 and 200,000, respectively, were exercised.
Through December 31, 1996, 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. Through December 31,
1999, none of the remaining warrants were exercised. These warrants
carry registration rights, as defined.
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. During the years ended December 31, 1999 and 1998, warrants
totaling 127,465 and 35,000, respectively, expired.
F-22
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
WARRANTS (Continued)
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. During the year ended December 31, 1999,
warrants to purchase 5,000 shares of common stock were exercised and
warrants to purchase 5,000 shares of common stock expired.
In February 1999, the Company issued options to purchase 200,000 shares
of restricted common stock to the Company's law firm. The options are
exercisable at $0.30 (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 recorded by the
Company. During the year ended December 31, 1999, such options were
exercised.
STOCK OPTION PLANS
The Company has had incentive stock option and non-qualified stock
option plans, as amended, (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.
F-23
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STOCK OPTION PLANS (Continued)
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 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. During
the year ended December 31, 1999, 50,000 of these options were
exercised.
The balance of deferred compensation as of December 31, 1999 and 1998
totaled $15,500 and $27,900, 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.
During the year ended December 31, 1999, 50,000 of options expired.
The following summarizes options and warrants granted and outstanding
through December 31, 1999:
<TABLE>
<CAPTION>
Number of Shares Weighted-
--------------------------- Average
Non- Exercise
Employee Employee Total Price
----------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
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, cancelled - (1,190,124) (1,190,124) $ 1.11
----------- ------------ ------------
Balance, December 31, 1998 700,000 2,744,234 3,444,234 $ 1.80
Granted - 200,000 200,000 $ 0.30
Exercised (50,000) (710,826) (760,826) $ 0.11
Expired, cancelled (50,000) (1,654,828) (1,704,828) $ 2.10
----------- ------------ ------------
BALANCE, DECEMBER 31, 1999 600,000 578,580 1,178,580 $ 2.30
=========== ============ ============
</TABLE>
F-24
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
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, 1999:
<TABLE>
<CAPTION>
Weighted-
Number of Average
Options and Remaining
Exercise Prices Warrants Contractual Life
--------------- -------------- ----------------
<S> <C> <C>
$ 0.05 39,487 0.75 years
$ 0.10 91,893 0.82 years
$ 1.13 300,000 3.09 years
$ 1.65 70,000 0.84 years
$ 1.82 300,000 2.00 years
$ 4.50 377,200 0.08 years
-------------
1,178,580
=============
</TABLE>
Pro forma information regarding net loss and 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 year ended December 31, 1998: risk
free interest rates of 5.25%, respectively; dividend yields of 0%,
respectively; expected life of five years; and expected volatility of
92%. For the year ended December 31, 1999, no options were granted.
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.
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 loss and net 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 year ended December 31, 1998 are as
follows:
F-25
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL TRANSACTIONS (CONTINUED)
STOCK OPTION PLANS (Continued)
<TABLE>
<S> <C>
Net income (loss)
As reported $ (338,018)
Pro forma $ (569,014)
Basic and diluted loss per common share
As reported $ (0.02)
Pro forma $ (0.04)
</TABLE>
There was no effect on compensation expense for the year ended
December 31, 1999.
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 - RELATED PARTY TRANSACTIONS
During the year ended December 31, 1999, the Company had sales totaling
$6,943,495 to related parties. During the year ended December 31, 1998,
sales to related parties were insignificant.
During the years ended December 31, 1999 and 1998, the Company had
purchases from related parties totaling $15,870,093 and $7,842,862,
respectively.
During the year ended December 31, 1999, the Company purchased
inventory totaling $2,382,252 on behalf of a related party. Such
inventory was sold at cost plus handling expenses resulting in other
income to the Company of $24,000.
NOTE 15 - INCOME TAXES
The components of the income tax provision for the years ended December
31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
--------------- ----------------
<S> <C> <C>
Current $ 222,500 $ 800
Deferred (651,000) -
--------------- ----------------
TOTAL $ (428,500) $ 800
=============== ================
</TABLE>
F-26
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 15 - INCOME TAXES (CONTINUED)
Income tax expense (benefit) for the years ended December 31, 1999 and
1998 differed from the amounts computed applying the federal statutory
rate of 34% to pre-tax income as a result of:
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
Computed "expected" tax expense (benefit) $ 488,000 $ (114,700)
Income in income taxes resulting from
Expenses not deductible for tax purposes 4,000 18,000
Expenses deductible for tax purposes (116,000) -
Change in beginning of the year balance of the
valuation allowance for deferred tax assets
allocated to income tax expense (986,000) 97,000
State and local income taxes, net of tax benefit 65,000 500
------------ -----------
TOTAL $ (545,000) $ 800
============ ===========
</TABLE>
Significant components of the Company's deferred tax assets and
liabilities for federal income taxes for the year ended December 31,
1999 consisted of the following:
<TABLE>
<S> <C>
Deferred tax assets
Net operating loss carryforward $ 310,000
Allowance for doubtful accounts 28,000
Allowances for sales returns 76,000
Allowances for price protection 382,000
Accrued compensation 81,000
Other 154,000
Valuation allowance (310,000)
-----------
Total deferred tax assets 721,000
Deferred tax liabilities
State tax 70,000
-----------
TOTAL $ 651,000
===========
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1998
totaled approximately $1,306,000. The net change in the valuation
allowance for the years ended December 31, 1999 and 1998 was $996,000
(decrease) and $88,000 (increase), respectively.
F-27
<PAGE>
I/O MAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
- -------------------------------------------------------------------------------
NOTE 16 - SUBSEQUENT EVENTS
CAPITAL TRANSACTIONS
In January 2000, the Company executed a consulting agreement for cash
and warrants for common stock. The agreement calls for aggregate
warrants for 150,000 common shares with exercise prices ranging from
$2.00 to $4.00. Warrants for 60,000 of these shares are restricted. The
warrants expire between six and twelve months from the date of grant.
Effective January 2000, the Company granted non-qualified and incentive
stock options to purchase a total of 1,412,000 shares of common stock
to officers and employees and certain consultants under the Company's
stock option plans (see Note 12). The stock options vest either
immediately or ratably over five years. Exercise prices range from
$2.00 to $3.00 and the options expire five years from the date of
grant.
Effective January 4, 2000, the Company issued 4,444,445 shares of
restricted common stock to a stockholder and supplier valued at $1.13
per share for $5,000,000 of inventory, as defined (valued at
transferor's cost basis).
In March 2000, the Company sold 632,912 shares of restricted common
stock to an affiliate of a major shareholder and supplier for cash at
$3.16 per share or $2,000,000 in aggregate, which includes a 20%
discount.
LINE OF CREDIT
Effective March 2000, the Company obtained a revolving line of credit
(the "Line") from a financial institution for borrowings up to
$15,000,000. Borrowings can be for inventory purchases from specified
approved vendors plus .50% of eligible accounts receivable, as defined.
Borrowings will bear interest at the referenced prime rate plus 0.50%.
The Company will be required to maintain various financial covenants
and ratios. The Line matures one year from the effective date and is
secured by substantially all assets of the Company.
F-28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> DEC-31-1999 DEC-31-1998
<CASH> 1,943,522 0
<SECURITIES> 0 0
<RECEIVABLES> 16,748,281<F1> 0
<ALLOWANCES> 71,193 0
<INVENTORY> 3,318,422 0
<CURRENT-ASSETS> 22,639,152 0
<PP&E> 255,689<F2> 0
<DEPRECIATION> 158,108 0
<TOTAL-ASSETS> 22,916,329 0
<CURRENT-LIABILITIES> 15,040,366 0
<BONDS> 0 0
0 0
0 0
<COMMON> 32,309 0
<OTHER-SE> 7,843,654 0
<TOTAL-LIABILITY-AND-EQUITY> 22,916,329 0
<SALES> 39,917,342 10,714,363
<TOTAL-REVENUES> 39,961,159 10,965,798
<CGS> 31,419,757 7,927,553
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 7,093,543 3,376,021
<LOSS-PROVISION> 24,821<F3> (198,238)<F3>
<INTEREST-EXPENSE> 13,994 16,674
<INCOME-PRETAX> 1,434,298 (337,218)
<INCOME-TAX> (428,500) 800
<INCOME-CONTINUING> 1,862,798 (338,018)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,862,798 (338,018)
<EPS-BASIC> 0.06 (0.02)
<EPS-DILUTED> 0.06 (0.02)
<FN>
<F1> BEFORE ALLOWANCE FOR DOUBTFUL ACCOUNTS
<F2> NET OF ACCUMULATED DEPRECIATION AND AMORTIZATION
<F3> BRACKETS REPRESENT INCOME
</FN>
</TABLE>
