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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSBA
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended March 31, 1998
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to _________.
Commission file number 0-16055
PHOTOMATRIX, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3267788
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(State or other jurisdiction of incorporation or organization) (IRS Employer
Identification No.)
1958 KELLOGG AVE., CARLSBAD, CALIFORNIA 92008
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(Address of principal executive offices)
(Zip Code)
(760) 431-4999
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(Registrant'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
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or 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
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information statement
incorporated hereby by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.
[ X ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 18, 1998, based on the average of the highest and lowest
prices of such stock on that date was $10,238,861. The number of shares of
common stock of Photomatrix, Inc. outstanding as of June 18, 1998, was
9,931,000.
DOCUMENTS INCORPORATED BY REFERENCE
None
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PART I
THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THESE STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS RELATING
TO THE COMPANY'S PLANS AND OBJECTIVES FOR FUTURE OPERATIONS, ASSUMPTIONS AND
STATEMENTS RELATING TO THE COMPANY'S FUTURE ECONOMIC PERFORMANCE, MANAGEMENT'S
OPINIONS ABOUT THE COMPETITIVE POSITION OF THE COMPANY'S PRODUCTS, THE ABILITY
OF THE COMPANY TO COMPETE SUCCESSFULLY AND OTHER NON-HISTORICAL INFORMATION. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HEREIN.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, WITHOUT
LIMITATION, THOSE RISKS DISCUSSED IN ITEM 7 UNDER THE HEADING "ADDITIONAL RISK
FACTORS" AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS ANNUAL REPORT.
ITEM 1. BUSINESS
OVERVIEW
Photomatrix, Inc. (the "Company," or "Photomatrix,") is a value added
engineering, design and manufacturing company specializing in document scanning,
digital video imaging and related technology. On June 5, 1998, the shareholders
of Photomatrix approved a merger ("Merger") with I-PAC Manufacturing, Inc.
("I-PAC"). Effective as of June 5, 1998, Photomatrix is comprised of I-PAC and
Photomatrix Imaging Corporation ("PMX").
I-PAC is a value added contract manufacturer, specializing in the
manufacture of electrical and mechanical assemblies. PMX develops, manufactures,
sells and services high-performance document and aperture-card scanners for
legal, financial, government and commercial enterprises.
PMX operates in the electronic imaging segment of the information and
image management industry as a supplier of quality, high-value electronic
image-processing hardware and software products and services. During the past
four years, PMX has evolved from being a computer output microfilm ("COM")
duplicator manufacturer with primarily one major customer to a document scanner
manufacturer with many customers. Over the past four years, revenue from COM
products and services has steadily declined, while scanner product and services
revenue has increased.
CORPORATE HISTORY
Photomatrix was incorporated in California in 1978 under the name
Xscribe Corporation. On July 31, 1996, the Company sold substantially all the
assets and the business of its wholly- owned subsidiary, Xscribe Legal Systems,
Inc. In October, 1996, the Company changed its name from Xscribe Corporation to
Photomatrix, Inc. In December, 1996, the Board of Directors of the Company
approved a plan to discontinue the operations of another wholly-owned
subsidiary, Lexia Systems, Inc., and the Company is currently in the process of
winding down and closing this operation. The financial position and results of
operations of Xscribe Legal Systems, Inc. and Lexia Systems, Inc. have been
shown in the consolidated financial statements of the Company as discontinued
operations. In May, 1998, the Company consolidated and relocated its United
States continuing operations to 1958 Kellogg Avenue, Carlsbad, California. The
Company's phone number is (760) 431-4999.
PRINCIPAL PRODUCTS
In fiscal year 1998, the Company derived its consolidated revenue
primarily from sales and service of its Photomatrix document scanners and
aperture card scanners, as more fully described below. Additionally, a portion
of the Company's consolidated revenue was obtained by servicing its discontinued
COM product line.
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DOCUMENT SCANNERS
PMX offers a line of medium and high-speed paper document scanners that
serve as input devices for image management systems used in office automation
and service bureau environments. All Photomatrix scanners are constructed for
rugged, high volume use, offering higher duty cycles and reliability than most
competitive models.
The complete image capture system among the Photomatrix document
scanner line is the newly introduced Vision Series 9600, a high-speed (up to 200
dual-sided pages per minute at 200 dots per inch [dpi] resolution), rugged,
single or dual-sided, 200 to 400 dpi, automatic feeding document scanning
system. The Vision Series 9600 includes the scanner, a Pentium PC, high
resolution display, a video interface card, Windows NT application software and
Vision Image Capture Software ("VICS"), which operates in Microsoft Windows NT.
VICS controls the scanning and PC hardware, displays images and manages the work
flow of the image capture process (including indexing, scanning and formatting)
and its customizable work flow features enable users to use VICS as the
front-end of a larger document management software system. Because the Series
9600 scanner, computer and VICS were designed to work as one tightly integrated
system, this configuration is the most efficient of the Photomatrix products.
The Vision Series 9600 replaces the Company's earlier generation Series 6000
scanners.
PMX has primarily sold the Vision Series 5000 ("Series 5000"), a
duplex, high resolution, 5000 element scanner which captures double-sided
documents at speeds in excess of 150 dual sided pages per minute. These machines
differ from the Vision Series 9600 and Vision Series 6000, in that the Series
5000 is not bundled with the Photomatrix image processing board, compression
board, or VICS. Instead, the Series 5000 is plug compatible with interface
(processing and compression) boards from Kofax, Xionics and Seaport Imaging.
Because of this compatibility, PMX sold a higher volume of the Series 5000
scanners. During the fourth quarter of fiscal 1998, the Company began selling
the next generation of plug-compatible document scanners, the Series 9000, which
features improved ergonomics of the top document stacker output bin, SCSI (Small
Computer Systems Interface) capabilities and increased speeds up to 200
dual-sided pages per minute.
APERTURE CARD SCANNERS
Photomatrix aperture card scanners are used to scan microfilm images of
engineering drawings for storage in a digital format. In addition to crisper
images, the digital format permits users to electronically store, retrieve,
distribute and print engineering documents in a local or enterprise wide
environment. Photomatrix aperture card scanners offer a wide range of
automation, throughput speed and image enhancement features. PMX sells aperture
card scanners primarily to corporate in-house and third party service bureaus
which scan microfilmed engineering drawings for the end users of those drawings.
PMX also sells a limited number of aperture card scanners under subcontracts to
provide electronic imaging systems to the Department of Defense.
MAINTENANCE SERVICES
The Company provides 24 hour service for its installed base through
field engineers in 10 major cities throughout the United States ("US") and in
England. The Company also has relationships with various third party maintenance
organizations, including a nationwide relationship with IBM, to maintain
document scanners, and Kodak, to provide COM duplicator spare parts. PMX field
engineers average nine ( 9) years of experience with the Company.
The Company views maintenance contracts and related revenue as a
significant revenue opportunity and profit center in fiscal year 1999.
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COMPETITION
DOCUMENT SCANNERS. PMX competes in the high-end of the industry with
Kodak, Bell and Howell, and BancTec where speed, throughput and duty cycle are
important product features. Competition in this segment is based upon price,
image quality, paper handling capabilities, throughput speeds, ease of use,
reliability and quality and speed of maintenance services. Kodak has utilized
its strengths of name recognition, reputation, distribution channels, good
performance, service capabilities, and a strong financial capital base to become
the market share leader in this segment. However, Kodak 500 and 900 model
scanners, which are comparable to the Company's Vision Series 5000 and 9000
scanners, sell for higher prices than the Photomatrix scanners.
In the document scanner market, PMX believes that its Vision Series
5000, 9000 and 9600 compare favorably with their product counterparts at BancTec
and Kodak. PMX believes that its primary competitive advantage in this segment
of the market is the price -performance relationship of its products, including
their relative speed, image quality, reliability and rugged build. PMX maintains
the leading price-performance ratios in its market segment and retains this
status by continually improving on speed and throughput and also pricing below
BancTec's and Kodak's products. All of its primary competitors, however, have
substantially greater resources than PMX for marketing and distribution and for
purchasing and maintaining market share. PMX's ability to increase its market
share may be reduced should Kodak significantly reduce its prices. Although
management expects some general downward pressure on price in the next two to
three years, management does not expect intense price competition in the
foreseeable future. However, there is no assurance that the Company will not
experience intense price competition or that it will be able to maintain a
competitive position in this market.
PMX has entered into an original equipment manufacturer ("OEM")
contract with Bell & Howell to supply Series 5000 and 9000 scanners under the
Bell & Howell label. PMX scanners operate at speeds higher than scanners
manufactured by Bell & Howell, and the Company's OEM relationship with Bell &
Howell represents a strategic corporate partnering that should be beneficial to
both parties. Management does not currently view Bell & Howell as a competitor
in the high-end market assuming PMX continually improves the features and speed
of Photomatrix scanners such that they are perpetually superior to Bell &
Howell's product offering and Bell & Howell adequately markets and sells
Photomatrix scanners in large volumes. Management believes PMX has the
engineering talent and resources to stay ahead of Bell & Howell technologically,
thereby fostering an OEM relationship. In December, 1997, PMX entered into an
addendum to its OEM agreement with Bell & Howell, whereby Bell & Howell became
an exclusive agent, with certain specifically identified exceptions, to sell
Photomatrix peripheral document scanners to distributors and value added
resellers ("VARs") in the United States and Canada. As a part of this agreement,
PMX received a commitment from Bell & Howell to purchase a minimum quantity of
Vision Series 5000 document scanners, valued at $1.5 million, over a period of
seven months, beginning in December, 1997. Bell & Howell purchased $924,000
under this commitment agreement during the period from December, 1997 through
May, 1998. In June, 1998, this commitment agreement was modified, whereby Bell &
Howell agreed to purchase a minimum quantity of Vision Series 9000 scanners,
valued at approximately $600,000, over a period of nine months beginning in
July, 1998. There is no assurance that the existing OEM agreement with Bell &
Howell will continue to be beneficial to both parties.
APERTURE CARD SCANNERS. The market for scanning engineering drawings is
large and growing steadily. According to industry studies, in the US alone it is
estimated that more than 40,000 companies each have more than 100,000
engineering drawings, with a total estimated value of more than $1.5 trillion.
Companies are dedicating significant resources to, and establishing significant
budgets for, the conversion, storage, distribution and retrieval of these
engineering drawings. Problems with document and revision control, document
distribution and deterioration and loss of documents are pervasive. Aperture
cards, which contain microfilm images of these drawings, have been widely used
since World War II to improve the storage and security of these documents. The
need to electronically manage this data has become critical, as the volume of
paper documents continues to increase, and companies are increasingly seeking
methods to increase the efficiency of the storage and retrieval of these
documents.
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PMX developed much of its technology and related application of
aperture card scanners in the mid 1980's when it introduced its aperture card
scanner product. PMX's primary competitors in the aperture card scanning market
are Wicks & Wilson, a United Kingdom company, Microbox, a German company, and
SunRise Imaging, a US based company. PMX is not able to estimate the size of
this market but believes that it is currently limited due to the cost of
converting engineering back files of aperture cards and the related systems into
electronic storage and retrieval systems. PMX's products are high-end products
and are priced higher than other currently marketed products. In the Company's
opinion, its aperture card scanner product exceeds the quality and duty cycle
statistics of the products of any of its competitors.
MARKETING AND DISTRIBUTION
PMX markets Series 9600 image capture systems to service bureaus and
end-users through its direct sales force. In contrast, PMX markets its Series
5000 and 9000 document scanners via indirect distribution channels, primarily as
a consequence of its OEM agreement with Bell & Howell and to VAR's service
bureaus and end-users. In April 1997, PMX entered into a distribution agreement
with IBM. Under the agreement, which contains no minimum requirements, IBM is
granted the right to sell Photomatrix document scanners. To date there have been
no significant sales under the IBM agreement.
PMX distributes its aperture card scanning products primarily to
systems integrators and VARs who package the Photomatrix scanners with other
software and hardware products for sale to end-users. Because Photomatrix
aperture card scanners are peripheral products which must be integrated with
other products for end users, PMX maintains close working relationships with
major systems integrators and VARs. PMX relies heavily on the sales efforts of
systems integrators and VARs to generate sales of aperture card scanners. PMX
also sells aperture card scanning systems through its direct sales force to
service bureaus which provide scanning services to engineering drawing end
users.
PMX generally provides a 90-day warranty on its products and offers,
for sale, annual maintenance contracts thereafter. The warranty and maintenance
work is typically provided through PMX field service employees who are located
throughout the United States and in England. PMX also performs repair services
for, and supplies replacement parts to, Kodak (which previously sold PMX
products under a private label agreement).
RAW MATERIALS AND MANUFACTURING
PMX manufactures its aperture card scanners and document scanners at
its manufacturing facilities in Carlsbad, California. PMX's operations consist
of procurement, kit packaging, assembly of circuit boards, wiring and assembly
and quality control testing of all parts, components, subassemblies and final
assemblies of all products. PMX manufactures some of its own boards; however,
many of its printed circuit boards ("PCBs") have been manufactured by outside
vendors. In anticipation of the Merger, PMX recently began utilizing I-PAC as
its principal PCB vendor. Now that the Merger has occurred, the Company expects
to realize additional cost savings as a result of I-PAC's expertise in PCB
manufacturing and wiring and assembly.
PMX's products incorporate electronic, imaging and mechanical
components purchased from various vendors. The electronic components, including
computer chips, are generally available from multiple sources. PMX currently
uses Fairchild, Kodak and Sony CCDs (Charged Coupled Devices) in the PMX cameras
in its aperture card and document scanning products. However, other commercially
available CCD cameras could be substituted if necessary. PMX copies, labels and
packages its software products.
PMX's products contain numerous mechanical components that are machined
specially for PMX's products. PMX relies upon several vendors for its custom
machined parts. Although many vendors can provide this machine work, tools and
molds needed for this process are in the possession of (and in some cases, owned
by) its machine shop vendors, and PMX could experience a supply disruption if
any of these vendors failed to meet its supply obligations.
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PMX also bundles its aperture card scanners and document scanners with
commercially available personal computers, work stations, high resolution
monitors, optical disk drives and other compatible peripherals and with
Microsoft Windows and NT, Novell NetWare and other commercially available
software.
INTELLECTUAL PROPERTY RIGHTS AND LICENSES
PMX relies upon copyright and trade secret laws to protect its software
and firmware used in its aperture card scanner and document scanner products.
PMX has registered design documents for its document scanner and certain of its
product maintenance manuals, operations manuals and parts catalogues under
federal copyright law.
PMX is a party to a nonexclusive reseller agreement with Image Machines
Corporation for a Windows driver for Photomatrix's aperture card scanners and
for viewing and editing software. Under the reseller agreement, PMX purchases
the software for resale on a per copy basis. The Image Machines software is not
bundled with aperture card scanners sold through PRC or Intergraph who have
developed their own software for use with the scanners. PMX offers with its
scanners a SCSI developers' tool kit for developing a Photomatrix scanner
driver.
PMX also purchases and resells as part of the Series 9600 document
scanner a board manufactured by Kodak Image Products that enables the scanning
of bar codes and bundles its Series 9600 document scanner with Microsoft NT
which it purchases on a per copy basis.
SEASONAL BUSINESS
The second and third quarters of the Company's fiscal year have
typically shown higher revenue volumes than its first and fourth quarters.
SIGNIFICANT CUSTOMERS
One customer (Bell & Howell) accounted for 17 percent of the Company's
total revenue for fiscal year 1997 and two customers Bell & Howell and Kodak,
accounted for 26 and 13 percent, respectively, of its revenue for fiscal year
1998. No other customer accounted for more than 10 percent of the Company's
total revenue during fiscal years 1998 or 1997. (See "Additional Risk Factors")
BACKLOG
PMX generally does not have a material order backlog at any time
because PMX normally fills orders within the delivery schedules requested by
customers (generally within 30 days).
GOVERNMENT SALES
The Company has had no government sales.
RESEARCH AND DEVELOPMENT
During the last three fiscal years, the Company expended $1,098,000
(fiscal year 1998), $969,000 (fiscal year 1997), and $1,018,000 (fiscal year
1996) on company-sponsored research and development projects, including projects
performed by consultants for the Company and capitalized software development
costs. Management expects that research and development expenditures (including
capitalized software development costs) will total approximately $1 million for
the coming year.
The Company works closely with its customers to develop enhancements
and new products in response to customer needs. In fiscal years 1998 and 1997,
the Company has been engaged in the development of competitive enhancements to
the Photomatrix line of scanners, including a faster scanner, a "smart"
automatic
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document feeder, a top loading stacker, and the next generation of both the
Series 5000 and 6000 document scanners and a new aperture card scanner line.
There is no assurance that the Company will successfully complete current or
planned development projects or that it will do so within the time parameters
and budgets established by the Company, and there is no assurance that a market
will develop for any product that is developed.
ENVIRONMENTAL LAWS
Compliance with federal, state and local laws enacted for the
protection of the environment has not had a material effect upon the Company's
capital expenditures, earnings or competitive position to date. The Company does
not anticipate that it will have to incur any material expenses in the future in
order to comply with such laws because of the nature of its products and
manufacturing operations.
EMPLOYEES
At May 31, 1998 (before the merger with I-PAC), the Company had 47
full-time and one part-time employee, excluding three employees associated with
the discontinued Lexia operation, none of whom are subject to a collective
bargaining agreement. The Company considers its relationship with its employees
to be good.
FOREIGN AND DOMESTIC OPERATIONS
The Company derived approximately 18.5% of its revenue for the year
ended March 31, 1998, and approximately 21.8% of its revenue for the year ended
March 31, 1997, from foreign sales made by Photomatrix, Ltd., a wholly owed
subsidiary located in the United Kingdom.
PROPERTY
Subsequent to March 31, 1998, the Company relocated its corporate
headquarters to the I-PAC facility in Carlsbad, California. The Company leases a
facility located in San Diego, California, consisting of approximately 23,400
square feet, which previously housed the Company's corporate offices and its
manufacturing, sales and administrative functions. The lease expires in
September 2002. The Company has entered into an assignment of this lease,
effective June 15, 1998. Management anticipates that related costs of lease
assignment and the write-off of leasehold improvements will be less than
$50,000.
The Company also leases facilities in Chandler, Arizona and London,
England. These facilities house the Photomatrix product development and
Photomatrix European operations, respectively. The Chandler facility consists of
5,100 square feet, and the lease expires in June 2000. The London facility
consists of 2,400 square feet, and the lease expires in May 2013.
The Company also leases 880 square feet in Herndon, Virginia for the
Lexia operation (which operation has been discontinued). This lease expires in
November 1998.
LEGAL PROCEEDINGS
The Company has been a defendant in three product liability cases pending
in the United States District Court, Eastern District of New York (BERNHART V.
XSCRIBE ET AL. (92 Civ. 3931), GALFIN V. XSCRIBE (92 Civ. 2582), and HAGIPADELIS
V. XSCRIBE (95 Civ. 1977)). Both BERNHART V. XSCRIBE and GALFIN V. XSCRIBE have
now been or are in the process of being dismissed. Xscribe has tendered the
HAGIPADELIS V. XSCRIBE claim to its insurance carriers, St. Paul Fire ("St.
Paul") and Marine Insurance and Federal Insurance Company ("Federal"). St. Paul
has assumed the Company's defense without reservation of right, and Federal has
agreed to share defense costs, subject to a reservation of rights. The insurance
carriers have prevailed in all judgements rendered to date. It may take several
years before this litigation is ultimately resolved. The Company believes
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that this remaining case is without merit and further believes that if any
liability results from these claims, the liability (excluding punitive damages,
if any) will be covered by its insurance policies.
ACQUIRED OPERATIONS
I-PAC is a value added custom contract manufacturer of electrical and
mechanical assemblies, including complex, multi-layer printed circuit board
assemblies, wire and cable harnesses, molded cables, and complete system and
subsystem assemblies. I-PAC specializes in providing value added electronic
manufacturing services in connection with the manufacture of surface mount and
hybrid printed circuit boards used in high value industrial and commercial
products which require an exceptionally high level of quality control, a
critical emphasis on delivery schedules, and intensive customer support.
All of I-PAC's printed circuit boards are designed by the customer and
manufactured to its specifications. Using computer controlled manufacturing and
test machinery and equipment, I-PAC provides manufacturing services employing
surface mount technology ("SMT") and pin-through-hole ("PTH") interconnection
technologies. I-PAC offers a wide range of manufacturing and management
services, either on a turnkey or consignment basis, including material
procurement and control, manufacturing and test engineering support, and quality
assurance. I-PAC's strategy is to develop long-term manufacturing relationships
with established and emerging original equipment manufacturers ("OEMs").
CORPORATE HISTORY
I-PAC was organized under the laws of the State of California in 1990.
In January 1997, I-PAC purchased the facility it had been leasing, a 40,000
square foot, two story concrete building located in Carlsbad, California.
Subsequent to March 31, 1998, the Company relocated its corporate headquarters
and manufacturing operations into this facility.
In February 1997, I-PAC acquired I-PAC Express Assembly, Inc. ("I-PAC
Express"). I-PAC Express is a custom contract manufacturer specializing in quick
turn printed circuit board prototypes incorporating surface mount and hybrid
technologies. It is located in Santa Ana, California. I-PAC Express supports
prototyping requirements for new electronic products during their design phase,
allowing those products to then migrate to the main I-PAC facility when
production quantities are required. I-PAC intends to open additional I-PAC
Express locations in Southern California.
I-PAC's facilities are located at 1958 Kellogg Avenue, Carlsbad,
California 92009. Its phone number is (760) 438-1529.
CONTRACT ELECTRONICS MANUFACTURING INDUSTRY
OVERVIEW
The contract electronics manufacturing industry provides the program
management, technical and administrative support, and manufacturing expertise
required to take a product from the early design and prototype stages through
volume production and distribution. Over the past two decades electronic systems
have become smaller, lighter and more reliable, while demands for performance at
lower costs have increased. The use of a contract manufacturer allows an OEM to
avoid large capital investments in plant, equipment and staff and to concentrate
instead on the areas of its greatest strength: innovation, design and marketing.
OEMs use contract manufacturers to:
Reduce Production Costs. Contract manufacturers generally are
able to manufacture specialized products at a lower cost than OEMs
because of efficiencies associated with specialization and higher
production volumes.
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Accelerate Time to Market. Rapid technological advances and
shorter product life cycles require OEMs to reduce the time required to
bring a product to market. Delays in bringing a product to market can
result in obsolescence of the product before or shortly after it
becomes available. By providing an established infrastructure and
manufacturing expertise, contract manufacturers can help OEMs shorten
their product introduction cycles.
Access Advanced Manufacturing Capabilities. As electronic
products have become smaller and more technologically advanced,
manufacturing processes have become more automated and complex, making
it more difficult for OEMs to maintain the manufacturing expertise
required to remain competitive. Using contract manufacturers affords
OEMs access to advanced manufacturing technology and processes.
Improve Manufacturing Quality. Because of their focus on their
specialized area of expertise, contract manufacturers generally can
provide services of higher quality than OEMs can provide in-house.
Focus Resources. In the rapidly changing, increasingly
competitive electronics industry, most OEMs must focus their attention
and resources properly. The use of contract manufacturers enables OEMs
to focus on their core competencies.
Reduce Investment. As the electronics industry has become more
technologically advanced, manufacturing requirements have resulted in
increased investments in inventory, equipment, labor and
infrastructure. Contract manufacturers enable OEMs to achieve high
technological capabilities at a lower capital investment level than
required for internal manufacturing.
Improve Inventory Management and Purchasing Power. The
experience of contract manufacturers in inventory procurement and
management can reduce OEM production and inventory costs.
INDUSTRY SIZE
According to the Institute for Interconnecting and Packaging
Electronics Circuits ("IPC"), the U.S. market for contract electronics
manufacturing services was approximately $36 billion in 1996 and was growing at
an annual rate of approximately 25%. The domestic contract electronics
manufacturing market includes passive components ($15 billion), actual assembly
($13 billion), PCBs ($7.2 billion) and flexible circuits ($0.7 billion).
PRINTED CIRCUIT BOARDS
PCBs are the basic platform used in virtually all advanced electronic
equipment to direct, sequence and control electronic signals between
semiconductor devices (such as microprocessors, memory chips and logic devices)
and passive components (such as resistors and capacitors). PCBs consist of one
or more layers of circuitry laminated into rigid insulating material composed of
fiberglass epoxy. Multi-layer PCBs provide a three dimensional system with
electronic signals traveling along horizontal planes of multiple layers of
circuitry patterns as well as along the vertical plane through plated holes or
vias.
SMT is an assembly process which allows the placement of a large number
of components in a dense array directly on both sides of a PCB. SMT is a recent
advance over the more mature PTH technology, which permits electronic components
to be attached to only one side of a PCB by inserting the component into holes
drilled through the board. The SMT process allows OEMs to use advanced
circuitry, while at the same time permitting the placement of a greater number
of components on a PCB without having to increase the size of
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the board. By allowing increasingly complex circuits to be packaged with the
components in closer proximity to each other, SMT enhances circuit processing
speed and board and system performance.
Lead times for PCBs generally fall into two categories, "quick turn"
and "standard." Quick turn lead times range from one to 15 days for prototype
and preproduction quantities. Standard lead times typically run from six to
twelve weeks and are generally associated with larger volumes.
According to the IPC, the U.S. market for PCBs was estimated at
approximately $7.2 billion in 1996, an increase of 10% from 1995. Also according
to the IPC, Multi-layer PCBs, the fastest growing segment (14% growth from 1995
to 1996) accounted for approximately 74% of all PCBs shipped in 1996. Despite
its large size, the PCB market is fragmented. In 1996, only eight of
approximately 700 independent PCB manufacturers had annual sales in excess of
$100 million.
SYSTEM AND SUBSYSTEM ASSEMBLY
According to the IPC, the United States value added contract
manufacturing market was approximately $13 billion in 1996 and is growing at a
rate of approximately 20% per year. I-PAC believes that OEMs are increasingly
relying upon independent contract manufacturers for the manufacture of complex
electronic interconnect products rather than on in-house production.
BUSINESS STRATEGY
In response to these industry trends, I-PAC has positioned itself as a
specialist in the manufacture of complex, multi-layer PCBs, wire and cable
harnesses, molded cables, and complete system and subsystem assemblies including
value added electronic manufacturing services. I-PAC's strategy is to emphasize
its experience with surface mount and hybrid printed circuit boards used in high
value industrial and commercial products which require an exceptionally high
level of quality, a critical emphasis on delivery schedules, and intensive
customer support. Further, its strategy includes the following elements:
Establish and Maintain Long-term Relationships. One of I-PAC's
primary objectives is to pursue opportunities whereby it becomes an
integral part of an OEM's manufacturing operations. In this regard,
I-PAC strives to work closely with its customers in all phases of
design and production in an attempt to establish itself as the sole or
primary source for its customers' specialized manufacturing
requirements. I-PAC believes that this effort to develop close,
reliable, long-term relationships builds customer loyalty that is
difficult for competitors to overcome. I-PAC specifically targets
turnkey manufacturing opportunities because such business offers
increased profit margin, greater control over all variables of the
manufacturing process and greater reliance upon I-PAC by the OEM
associated with the turnkey operation.
Target and Maintain Balance Among Selected OEM Industries and
Customers. I-PAC markets its services to industries and customers that
have strict quality control standards for their products and that have
service intensive manufacturing requirements. I-PAC focuses on complex
assemblies in low and medium volumes for commercial and industrial
customers. I-PAC has not been, and does not intend to become, a
manufacturer of high volume PCB assemblies for personal computers or
other consumer related products, which typically have relatively low
margins. I-PAC instead focuses on a variety of industries that produce
products that generally have longer life cycles, higher engineering
content, higher customer margins, more stable demand and less price
pressure.
Provide Comprehensive and Reliable Manufacturing Services. I-PAC
believes that its ability to attract and retain customers depends on
its ability to offer a broad range of specialized services. I-PAC
provides its customers with services ranging from prototype
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production to the manufacture of PCB assemblies, material procurement
and management, post-production testing, and final product assembly.
I-PAC also strives to provide the highest level of reliability in
connection with these services and has an ongoing program of investing
in sophisticated machinery and equipment to enable it to achieve this
objective on a continuing basis. I-PAC's ability to provide electrical
mechanical assembly, wire and cable assembly and harnessing, molded
cable processing and other related services allows it to offer a
broader range of value added services to its customers than is
typically offered by a PCB assembly manufacturer.
Pursue Opportunities for Growth. Although it has not currently
identified any candidate for acquisition, I-PAC is committed to
pursuing opportunities to increase the scope of its operations through
acquisition. Its strategy is to attempt to acquire privately-held
technology product companies where the manufacturing requirements can
be met by I-PAC at significant cost reductions and economies of scale.
In addition, I-PAC intends to attempt to increase its contract
manufacturing business through growth of its customer base, vertical
and horizontal acquisition of other contract manufacturers and
expansion of its I-PAC Express operations to additional locations.
Maintain Flexibility. Many of I-PAC's customers are leaders in
their respective industries. As such, these customers often require
that their products be routinely reengineered. I-PAC has organized its
operations so that it can respond rapidly to design changes and provide
value added services where needed.
SERVICES PROVIDED BY I-PAC
I-PAC manufactures over 200 different assemblies which are incorporated
in over 60 different products. I-PAC provides contract manufacturing services
primarily with regard to advanced industrial and commercial products in the
industrial controls, process control equipment, commercial broadcast, video and
instrumentation markets.
During the year ended December 31, 1997, I-PAC provided contract
services to more than 30 different customers, including ITT, Lockheed Martin,
Disney, Hughes JVC, Coyote Technologies, Sanyo, Schumacher, Standard
Communications, Triconex (a Siebe company) and Palomar Products. I-PAC's
services can be categorized as follows:
Prototype Manufacture. Through its wholly-owned subsidiary,
I-PAC Express, I-PAC offers quick turn, PCB prototype manufacturing
capabilities, incorporating SMT and hybrid technologies. I-PAC Express
supports new OEM products in their design phase and then attempts to
migrate these products to I-PAC's main manufacturing facility when
production quantities are required.
Product Manufacture. I-PAC manufactures electronic products
and assemblies for use in a variety of industries and applications. Its
manufacturing operations include product assembly, testing, and
assembly into final product housings. While I-PAC has automated various
aspects of many processes, the assembly of components into electronic
products is a labor intensive process generally requiring a high degree
of precision and dexterity, together with multiple quality control
steps prior to shipment. In addition to PCB assembly, I-PAC
manufactures various interconnect products, including molded cables.
Product Testing. The increasingly complex design and assembly
techniques required for products manufactured by I-PAC, as well as the
reliability demanded by its customers, has required I-PAC to engage
extensive testing of its products. These tests include in-circuit
component measurement testing, manufacturing defect analysis, and
functional tests.
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Value Added Services. I-PAC provides value added electronic
manufacturing services to enhance the quality and reduce the cost of
OEM products. I-PAC primarily solicits the manufacturer of high
engineering content OEM products and offers close working relationships
with its customers and flexibility to meet customer engineering needs.
MANUFACTURING AND SUPPLIES
The principal materials used by I-PAC in the manufacture of its
products are electronic components such as memory chips, microprocessing units,
integrated circuits, resistors, capacitors, transformers, switches, connectors,
wire and related items purchased as stock items from a variety of manufacturers
and distributors. While I-PAC purchases most of these materials from outside
sources, I-PAC is not dependent upon a single source of supply for any materials
essential to its business. I-PAC has generally been able to obtain adequate
supplies of such materials, and no shortage of such materials is currently
anticipated. However, notwithstanding the foregoing, there can be no assurance
that I-PAC will continue to be able to procure such components in the future
without material delay or other restrictions.
I-PAC believes that it is currently operating in accordance with ISO
9000 manufacturing quality control requirements, which specify standards,
processes, procedures and documentation to be implemented and maintained in all
applicable functions. I-PAC expects to receive formal certification for such
compliance by an outside third party in 1998.
MARKETING
Senior management of I-PAC and a manufacturers' representative
organization owned by the shareholders of I-PAC are currently primarily
responsible for marketing I-PAC's services. The manufacturers' representative
organization receives variable commissions based on orders received by I-PAC. As
part of its marketing strategy, I-PAC attempts to work closely with its
customers in all phases of design and production in an attempt to establish
itself as the sole or primary source for its customers' specialized
manufacturing requirements. I-PAC believes that this effort to develop close,
reliable, long-term relationships builds customer loyalty that is difficult for
competitors to overcome. As a result, I-PAC is continually striving to develop
new negotiated business with existing customers. I-PAC also expects that I-PAC
Express will assist in marketing the services of I-PAC, in that customers of the
quick turn prototyping services of I-PAC Express may turn to I-PAC for
manufacturing services when production quantities of the products prototyped by
I-PAC Express are required.
COMPETITION
The contract manufacturing industry is highly fragmented and is
characterized by intense competition. The contract manufacturing services
provided by I-PAC are available from many independent sources as well as the
in-house manufacturing capabilities of current and potential customers of I-PAC.
Many of I-PAC's competitors and potential competitors are significantly larger
and have significantly more capital, direct buying power and management
resources than I-PAC. Management believes that the principal competitive factors
in its targeted markets are flexible value added services, product quality and
reliability, flexibility and timeliness in responding to design and schedule
changes, reliability in meeting product delivery schedules, pricing and
geographical location. I-PAC believes that it competes favorably with respect to
these factors. However, I-PAC also expects that competition in its markets will
continue to be intense, and there can be no assurance that I-PAC will compete
successfully.
LICENSES
I-PAC has acquired licenses for the manufacture, marketing and sale of
proprietary video capture, storage and transmission software technology that has
on-going development potential and possible application in a wide range of
existing and new markets. The ongoing development is not capital intensive, in
that the
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technology can be applied to products in different markets without significant
modification. Following the Merger, I-PAC plans to begin entering new markets,
possibly including telemedicine, video editing, video teleconferencing, video
surveillance and various broadcast markets.
In May, 1998, the Company and I-PAC entered into a letter of intent
with the licensor to jointly develop, manufacture and sell a series of products
which incorporate the licensor's proprietary video compression, storage and
transmission technology. Under terms of this new agreement, Photomatrix will
provide various mechanical, hardware and packaging engineering services to
finalize the design of three of the licensor's products: a Digital VCR, a video
monitoring product which will initially be used in automated teller machines,
and video controller to be used with the licensor's primary products. I-PAC will
also provide value engineering services for these products. In return, I-PAC
will be granted exclusive rights to manufacture all three products for the
licensor on a cost-plus basis. In addition, the licensor will enter into a
licensing agreement with Photomatrix granting Photomatrix the right to private
label and sell the Digital VCR and a new surveillance product which will utilize
the video controller. Photomatrix and the licensor also agreed to jointly
develop "Video Instruction of Demand" software, which in combination with the
Digital VCR product, will enable the transmission and reception of a wide range
of "video instruction" products over the Internet, as well as other transmission
mediums.
SEASONALITY
I-PAC has historically experienced its strongest sales volume in the
first and second quarters of each calendar year, but its business is not
considered seasonal. It is, however, subject to the business cycles that impact
its customers.
BACKLOG
As of March 8, 1998, I-PAC's backlog was approximately $500,000,
compared to $700,000 as of December 31, 1997. I-PAC defines backlog as hard copy
purchase orders for which I-PAC has firm delivery dates within the next twelve
months.
EMPLOYEES
As of June 4, 1998, I-PAC had approximately 61 full time employees, of
which 4 were engaged in program management, 40 were engaged in manufacturing and
the remainder were engaged in management, engineering or administration, and 2
part time employees. None of its employees is represented by a labor union.
I-PAC believes its relations with its employees are good.
PROPERTY
I-PAC maintains its executive offices and manufacturing facilities in a
40,000 square foot, two story concrete building located at 1958 Kellogg Ave.,
Carlsbad, California. I-PAC owns these facilities.
I-PAC Express leases a 5,000 square foot facility located at 1415 East
McFadden Avenue, Santa Ana, California. The lease for this facility provides for
annual rent of $22,600 and expires in April 2000.
GOVERNMENT REGULATION
I-PAC's operations are subject to certain federal, state and local
regulatory requirements related to environmental, waste management, health and
safety matters. While there can be no assurance that material costs and
liabilities will not be incurred or that past or future operations will not
result in exposure to claims
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of injury by employees or the public, I-PAC management believes that its
business is operated in substantial compliance with such regulations.
I-PAC periodically generates and temporarily handles limited amounts of
materials that are considered hazardous wastes under applicable law. The Company
contracts for the offsite disposal of these materials and has implemented a
waste management program to address related regulatory issues.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which I-PAC or any
of its subsidiaries is a party or of which any of their properties is the
subject. I-PAC is not aware of any such proceedings known to be contemplated by
governmental authorities.
RELATED PARTY TRANSACTIONS
The former shareholders of I-PAC currently own interests in several
entities with which I-PAC does business. Evergreen Investments (Evergreen), a
company owned by Mr. Moore and Mr. Grivas, provides management and legal
services to I-PAC. I-PAC incurred expenses of approximately $205,500 and
$235,600 for services provided by Evergreen for the years ended December 31,
1997 and 1996, respectively. For the year ended December 31, 1997, I-PAC
purchased approximately $6,600 of merchandise from MGS Interconnect ("MGS"), a
company owned by Mr. Moore and Mr. Grivas. During 1996, I-PAC subcontracted out
$57,400 of sub-assembly and other production work to MGS. I-PAC also recorded
sales to MGS of approximately $47,900 and $88,100 for the years ended December
31, 1997 and 1996, respectively. During 1997 and 1996, I-PAC incurred expenses
of approximately $136,700 and $147,000, respectively, for commissions to MGM
Tech Rep ("MGM"), an outside sales representative firm owned primarily by the
three stockholders of I-PAC. I-PAC received approximately $4,600 of rental
income from MGM for the year ended December 31, 1997. I-PAC also incurred
expenses of approximately $28,400 and $39,900 for legal services provided by a
law firm in which Mr. Hill is a partner, for the years ended December 31, 1997
and 1996, respectively. In addition, I-PAC also incurred expenses of
approximately $27,500 and $39,700 for general business consulting services
provided by Mr. Hill for the years ended December 31, 1997 and 1996,
respectively. Following the Merger, any related party transactions will be
reviewed and approved by the Audit Committee of Photomatrix' Board of Directors.
DISCONTINUED OPERATIONS
The following represents a brief history of the discontinued operations
of Photomatrix:
SALE OF XSCRIBE LEGAL SYSTEM, INC. In July 1996, the Company sold
certain assets and liabilities related to its computer-aided transcription
business to its primary competitor for $2.2 million. The Company retained
certain liabilities.
LEXIA SYSTEMS, INC. In October 1993, the Company acquired the North
American Sales Division of International Computers Limited, Inc. ("ICL"), a
developer of groupware (office automation) software and manufacturer of
Unixbased hardware, and formed Lexia Systems, Inc. ("Lexia"). Lexia and ICL
entered into a strategic alliance whereby Lexia was to distribute ICL's
groupware products in the United States and support the domestic installed base
of ICL customers. However, the business partnering efforts between the Company
and ICL and its sister company, Fujitsu ICL Computers Ltd. ("Fujitsu") have
proved to be ineffective primarily because of a difficult working relationship
between ICL, Fujitsu and Lexia, combined with the fact that Lexia did not own
the applicable software or proprietary rights and was not able to control the
marketing or product management of ICL and Fujitsu products. Consequently, in
December, 1996, the Board of Directors of the Company approved a plan to
discontinue Lexia Systems, Inc. The Company is currently in the process of
winding down and closing this operation. Further, as of March 31, 1998 , Lexia
had recorded accounts payable and unpaid rent claims of ICL and Fujitsu in the
amount of approximately $786,000. Lexia disputes these
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liabilities. Lexia is attempting to resolve these disputes through
negotiations. There is no assurance that Lexia will be successful in
resolving these disputed amounts.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 5, 1998, a Special Meeting of Shareholders of Photomatrix,
Inc., was held and the following matters were approved:
1. The proposed merger with I-PAC Manufacturing, Inc.
2. The election of six directors of the Company.
3. The adoption of the Photomatrix 1998 Stock Option Plan whereby
1,500,000 shares of Photomatrix Common Stock were reserved for issuance
to officers, directors and employees of the Company under incentive
stock options or nonqualified stock options to be granted by the
Compensation Committee of the Board of Directors.
4. The ratification of the appointment by the Company's Board of Directors
of KPMG Peat Marwick LLP as the independent auditors of the Company for
the 1998 fiscal year.
PART II
MARKET PRICES OF PHOTOMATRIX COMMON STOCK
Photomatrix, Inc. is traded in the NASDAQ Stock Market Small Cap Tier under the
symbol PHRX. On May 31, 1998, there were 5,083,000 shares outstanding, and there
were approximately 3,000 shareholders of record. On June 11, 1998, and effective
as of June 5, 1998, an additional 4,848,000 shares were issued under the terms
of the Merger Agreement, resulting in 9,931,000 shares outstanding as of that
date. Following is information regarding Photomatrix, Inc. common stock market
prices:
<TABLE>
<CAPTION>
FISCAL YEAR 1998 FISCAL YEAR 1997 FISCAL YEAR 1996
---------------- ---------------- ----------------
Quarter Ended Low Bid High Bid Low Bid High Bid Low Bid High Bid
- ------------- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
June 30 - 1st 5/16 5/8 11/16 1-7/16 7/8 1-1/2
September 30 - 2nd 9/32 9/16 17/32 1-1/16 13/16 1-1/2
December 31 - 3rd 1/4 29/32 3/8 13/16 3/4 1-1/16
March 31 - 4th 3/8 15/16 3/8 15/16 9/16 1-3/64
</TABLE>
The Company has not paid a cash dividend on its common stock, and it is not
anticipated that the Company will pay any dividends in the foreseeable future.
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<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PHOTOMATRIX SELECTED HISTORICAL FINANCIAL DATA
The following selected financial data is derived from financial statements as of
and for the years ended March 31, 1998, 1997, 1996, 1995 and 1994 (000's have
been omitted). Certain reclassifications have been made to prior year amounts to
be consistent with current year. Discontinued operations were reclassified for
all periods presented, and the remaining operations consist of Photomatrix
Imaging Corp. and Photomatrix, Ltd., which were acquired in fiscal 1994. The
data set forth below should be read in conjunction with the consolidated
financial statements and the related notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations," both appearing
elsewhere herein.
<TABLE>
<CAPTION>
For the years ended March 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
OPERATING DATA
REVENUE $ 8,595 $ 8,694 $ 9,092 $ 9,712 $ 9,742
GROSS PROFIT PERCENT 31.5% 26.3% 32.3% 31.5% 34.8%
LOSS FROM CONTINUING
OPERATIONS $(1,696) $(2,290) $(1,368) $ (791) $ (194)
NET INCOME (LOSS) $(1,482) $(2,407) $(1,704) $ (133) $ 1,222
LOSS PER SHARE
FROM CONTINUING OPERATIONS $ (0.33) $ (0.44) $ (0.24) $ (0.13) $ (0.04)
NET INCOME (LOSS) PER SHARE $ (0.29) $ (0.46) $ (0.30) $ (0.02) $ 0.23
DIVIDENDS PER SHARE - - - - -
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
BALANCE SHEET DATA
WORKING CAPITAL $ 2,304 $ 2,432 $ 5,624 $ 6,991 $ 7,617
CURRENT RATIO 1.76 1.92 2.96 4.10 5.35
TOTAL ASSETS $ 7,303 $ 8,565 $12,581 $13,202 $12,844
TOTAL LONG-TERM DEBT AND $ 239 $ 415 $ 1,148 $ 699 $ 827
OBLIGATIONS
</TABLE>
Management's discussion and analysis of financial condition and results of
operations should be read in conjunction with the selected financial data and
consolidated financial statements and notes thereto included elsewhere
therein.
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<PAGE>
RESULTS OF OPERATIONS
Following is a comparative discussion by fiscal year of the results of
continuing operations for the last three fiscal years ended March 31, 1998. The
Company believes that inflation has not had a material effect on its operations
to date.
FISCAL YEAR 1998 ENDED MARCH 31, 1998 COMPARED TO FISCAL YEAR 1997 ENDED
MARCH 31, 1997
Consolidated revenue for the year ended March 31, 1998 decreased by
$99,000 (1.1%) to $8,595,000 from $8,694,000 for the year ended March 31, 1997.
This decrease was due to decreases in scanner revenue of $593,000 (10.8%) and
COM duplicator revenue of $185,000 (52.1%) offset by increases in spare parts
revenue of $488,000 (51.0%) and service revenue of $191,000 (9.8%). The Company
anticipates that scanner sales will decline significantly in the first quarter
of fiscal 1999, as a result of a modification of a purchase commitment from Bell
& Howell, but that on a consolidated basis, revenue will increase significantly
in fiscal 1999 as a result of the acquisition of I-PAC.
Consolidated gross margins for the year ended March 31, 1998 increased
$412,000 (18.0%) to $2,706,000 from $2,294,000. This excludes the effect of the
$366,000 write-off of capitalized software, as more fully discussed below. Gross
margin as a percent of sales increased 5.1% to 31.5% from 26.4% in the year
ended March 31, 1998. This increase was due to a more favorable product mix, as
well as the cost reductions gained as a result of production efficiencies
resulting from improved production methods, product modularization and the
consolidation of the San Diego, California and Culver City, California
operations in March, 1997. Management believes that costs may be reduced further
as a result of the merger with I-PAC as described elsewhere, although there is
no assurance that these additional cost reductions will be achieved. These
improvements were somewhat offset by the write-off of $165,000 of inventory and
an increase in the Company's reserve for obsolete inventory by $475,000 as a
result of new product introductions, together with a significant decrease in
sales of aperture card scanners.
Selling, general and administrative ("SG&A") expenses decreased
$113,000 to $3,198,000 from $3,311,000 in the prior year. As a percent of
revenue SG&A decreased 0.9% to 37.2% from 38.1% in the prior year. These
reductions are attributable primarily due to cost reduction efforts in both the
sales and marketing and the general and administrative areas of the Company
which were implemented during the current fiscal year.
Research and development expenses increased $188,000 (23.3%) to
$995,000 from $807,000 in the year ended March 31, 1997. Software development
expenditures that were capitalized because they related to technologically
feasible projects were $103,000 in the current year compared to $162,000 in the
prior year. Total development spending increased $129,000 to $1,098,000 from
$969,000 in the prior year primarily because of increased scanner development
activity, including the development of new models.
Fiscal year 1998 includes a write-off of capitalized software in the
amount of $366,000. Fiscal year 1997 includes a charge for facility
consolidation and relocation in the amount of $520,000. The Company has recently
relocated its operations into the I-PAC facility located in Carlsbad,
California. The costs related to this move approximate $81,000, including
$77,000 paid to I-PAC before consummation of the merger, and will be reflected
in the Company's consolidated statement of operations for the first quarter of
fiscal 1999.
Interest expense decreased $51,000 to $41,000 from $92,000 in the prior
year. This decrease was due to the elimination of borrowings under the Company's
credit facility during fiscal 1998. The Company anticipates that debt service
expenses will increase as a result of the Merger. Other income decreased $47,000
to $203,000 from $250,000 in 1997. This reduction is the result of a one-time
sale of an unused trademark in the amount of $100,000 in the current year
together with various other transactions which were non-recurring in nature,
compared to a $250,000 non-recurring payment from a major customer under a
minimum quantity purchase contract during the prior year.
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<PAGE>
The Company's provisions for income taxes were $5,000 and $104,000 in
the years ended March 31, 1998 and 1997, respectively. These amounts are
substantially different from provisions calculated using the statutory rates
because of the Company's inability to recognize the effect of net operating
losses and related carry-forwards. The prior year's provision was significantly
greater than that of the current year as a result of an increase in the
Company's valuation allowance relating to deferred tax assets.
The increases in gross margin and decreases in SG&A expenses, interest
expense and income tax expense, offset slightly by the increase in product
development expenses and reduction in other income, resulted in a loss from
continuing operations of $1,696,000 ($0.33 per share) for the year ended March
31, 1998. This is an improvement of $594,000 (25.9%) over the loss from
continuing operations of $2,290,000 ($0.44 per share) for the year ended March
31, 1997.
During fiscal 1997, the Company sold its court reporting business
(Xscribe Legal Systems, Inc.) and discontinued Lexia Systems, Inc., as more
fully described in Note 2 of the Consolidated Financial Statements contained
elsewhere herein. The Company booked a net loss from discontinued operations in
fiscal 1997 of $117,000. This loss included accruals for indemnifications
related to the discontinued operations of Xscribe Legal Systems. During the
current year, the indemnification period lapsed and the Company determined that
the remaining accruals were no longer necessary. The accruals were reversed,
resulting in income from discontinued operations of $214,000 in the current
year. Including the income from discontinued operations, the net loss for the
year ended March 31, 1998 was $1,482,000 ($0.29 per share), an improvement of
$925,000 (38.4%) over the net loss for the year ended March 31, 1997 of
$2,407,000 ($0.46 per share).
FISCAL YEAR 1997 ENDED MARCH 31, 1997 COMPARED TO FISCAL YEAR 1996 ENDED
MARCH 31, 1996
Consolidated revenue for the year ended March 31, 1997 decreased by
$398,000 (4.4 %) to $8,694,000 from $9,092,000 for the year ended March 31,
1996. This decrease was due to a 35.4 % ($803,000) expected decrease in COM
duplicator revenue offset by a 5.9 % ($405,000) increase in scanner product and
service revenue.
Consolidated gross margins for the year ended March 31, 1997 decreased
$639,000 (21.8 %) to $2,294,000 from $2,933,000 and gross margin as a percent of
sales decreased from 32.3 % to 26.4 % in the year ended March 31, 1997 due to
significant price concessions made by the Company in connection with the
establishment of its new OEM relationship with a major document scanner
customer, as well as certain cost inefficiencies caused by the relocation of its
manufacturing operations from Culver City to San Diego, including an inventory
obsolescence writeoff of approximately $127,000.
Selling, general and administrative ("SG&A") expenses decreased
$281,000 (7.8 %) from $3,592,000 in 1996 to $3,311,000 in 1997. The net decrease
is primarily attributable to cost reductions made both in the sales and
marketing as well as the general and administrative areas of the Company. As a
percent of sales, SG&A decreased from 39.5% in the 1996 to 38.1% in 1997,
primarily due to the cost reduction efforts implemented during 1997.
Product development expenses increased $322,000 (66.4 %) from $485,000
in the year ended March 31, 1996 to $807,000 in the year ended March 31, 1997.
Product development expenditures that were capitalized because they related to
technologically feasible projects were $162,000 in 1997 compared to $533,000 in
1996. Total development spending decreased $49,000 from $1,018,000 in 1996 to
$969,000 in 1997 primarily because of increased scanner development activity at
Photomatrix, including the development of new models which feature increased
speed (150 and 200 page per minute duplex models), as well as new options such
as a "smart" automatic document feeder, a top loading stacker and an NT version
of the Company's PICS software.
During fiscal 1997, the Company relocated and consolidated its
operations to San Diego. The cost incurred in connection with this activity
totaled $520,000, and has been shown as a separate line item.
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<PAGE>
Interest expense decreased $136,000 from $228,000 in 1996 to $92,000 in
1997. This decrease was due to decreased borrowings under the Company's credit
facility in 1997. Other income increased $239,000, from $11,000 in 1996 to
$250,000 in 1997 as a result of nonrecurring payment from a major customer under
a minimum quantity purchase contract.
The Company's provisions for income taxes were $104,000 and $7,000 in
the years ended March 31, 1997 and 1996, respectively. These amounts are
substantially different from provisions calculated using the statutory rates
because of the Company's inability to recognize the effects of net operating
losses and related carry forwards. The 1997 provision reflects an increase in
the Company's valuation allowance relating to a deferred tax asset.
The decreases in revenue and gross margin, and the increased product
development and relocation expenses, offset slightly by the reduction in SG&A
costs and interest expense and the increase in other income, resulted in a loss
from continuing operations of $2,290,000 ($0.44 per share) for the year ended
March 31, 1997. This compares to the loss from continuing operations of
$1,368,000 ($0.24 per share) for the year ended March 31, 1996.
During 1997, the Company sold its court reporting business (Xscribe
Legal Systems, Inc.) and discontinued Lexia Systems, Inc., as more fully
described in Note 2 of the Consolidated Financial Statements contained elsewhere
herein. Including the loss from discontinued operations of $336,000 in the prior
year and $251,000 in the current year, less gain of $134,000 from the sale of
Xscribe Legal Systems, the net loss increased from $1,704,000 ($0.30 per share)
in the year ended March 31, 1996 to $2,407,000 ($0.46 per share) in the year
ended March 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Following is a discussion of Photomatrix's recent and future sources of and
demands on liquidity as well as an analysis of liquidity levels.
RECENT AND FUTURE SOURCES OF AND DEMANDS ON LIQUIDITY AND CAPITAL RESOURCES
During fiscal year 1998, the Company's primary sources of liquidity
were from discontinued operations ($875,000), reductions to inventory ($349,000)
and prepaid expenses ($51,000), an increase in accrued liabilities ($264,000),
retirements of property and equipment ($420,000), and the effects of exchange
rates on cash ($7,000). Primary uses of liquidity in the year ended March 31,
1998 were a loss from continuing operations net of noncash charges ($448,000),
increases to accounts receivable ($131,000), other assets ($42,000), reduction
to long term liabilities ($14,000), accounts payable ($342,000), customer
deposits ($204,000), capitalized software additions ($103,000), and repayments
of notes payable to related parties ($152,000). In the year ended March 31,
1998, the Company's cash increased $530,000 from $812,000 to $1,342,000.
In September, 1997, the Company amended and renewed a line of credit
with a bank which allows for borrowings under the line of credit limited to the
lesser of $750,000 or 70% of eligible accounts receivable (as defined). The line
of credit accrues interest on all outstanding borrowings at the rate of prime
plus 2% per annum. The Company is now required to 1) maintain a minimum tangible
net worth of $2,800,000, 2) maintain a ratio of total liabilities to tangible
net worth of not greater than 1.1 to 1.0, 3) maintain working capital of
$1,750,000, and 4) maintain a current ratio of at least 1.7 to 1.0. Outstanding
borrowings are collateralized by all of the Company's assets. The line of credit
expires in September, 1998. As of March 31, 1998, there was no outstanding
balance on the line of credit and the Company was not in compliance with certain
loan covenants. The Company's bank has waived compliance with these
requirements. The Company is currently in the process of negotiating a $1.5
million line of credit with its bank.
18
<PAGE>
The Company is obligated under a series of unsecured notes payable to a
related party totaling $375,000 as of March 31, 1998. These notes bear interest
at a rate of 8% per annum and mature in April 2000. Interest and principal
payments totaling approximately $16,000 are due monthly. All payments were
current as of March 31, 1998.
The Company's discontinued operation, Lexia, has recorded accounts
payable and unpaid rent claims of ICL and related entities in the amount of
$786,000. Lexia disputes these liabilities. Lexia is attempting to resolve these
disputes through negotiations. While the Company believes ICL claims against
Lexia will be settled with ICL at a discount, there is no assurance that Lexia
will be successful in resolving these disputed amounts.
The Company's assured sources of future short-term liquidity as of
March 31, 1998 are its cash and cash equivalents of $1,342,000 and the unused
portion of its line of credit of $750,000. Availability under the line of credit
can be further limited based upon the balance of eligible accounts receivable as
described above.
The Company is currently obligated as a guarantor under an assignment
agreement of a lease in the amount of approximately $20,000 per month through
September, 2002. In June 1998, the Company entered into a commitment to purchase
$400,000 of equipment for its manufacturing operation. Aside from these
commitments, the Company has not made any material capital commitments.
The Company is concentrating on increasing its sales and improving its
gross margins. If it is successful, then it should have sufficient liquidity to
fund its operations during the next twelve months. Management believes that the
Company has sufficient liquidity to fund the costs associated with the recent
Merger and relocation and consolidation of its operations into the I-PAC
facility, as well as the operations of the combined company. In addition,
management intends to structure any future acquisitions in a manner that will be
neutral or positive to its liquidity and accretive to its future earnings per
share.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS
130, REPORTING COMPREHENSIVE INCOME. This Statement established standards for
reporting and display of comprehensive income and its components (revenue,
expenses, gains and losses) in a full set of general-purpose financial
statements. This Statement shall be effective for fiscal years beginning
after December 15, 1997. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. This statement,
requiring additional informational disclosures, is effective for the
Company's fiscal year ending March 31, 1999.
In June 1997, the Financial Accounting Standards Board issued SFAS 131,
DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. This
accounting statement established standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that enterprises report selected information about
operating segments in interim financial reports issued to shareholders. This
accounting statement shall be effective for fiscal years beginning after
December 15, 1997. In the initial year of application, comparative information
for earlier years in to be restated. At this time, the Company does not believe
that this accounting statement will have a significant impact on the financial
position or results of operations for the year ending March 31, 1999.
Statement of Position 97-2 Software Revenue Recognition, (SOP 97-2)
issued by the Accounting Standards Executive Committee, is effective for fiscal
years beginning after December 15, 1997. Earlier application is permitted. SOP
97-2 provides guidance on when revenue should be recognized and in what amounts
for licensing, selling, leasing, or other wise marketing computer software. The
Company does not expect adoption of SOP 97-2 to have a material effect, if any,
on its financial position or results of operations.
19
<PAGE>
ADDITIONAL RISK FACTORS
Photomatrix's business is subject to the following risks and
uncertainties in addition to those described above.
ABILITY TO SUCCESSFULLY MARKET DOCUMENT SCANNERS
The Company's growth strategy has been dependent upon its ability to
market successfully its document scanners. In this regard, Photomatrix is
currently focusing on utilizing I-PAC's manufacturing expertise to create new
OEM arrangements, whereby the Company will provide value-added engineering and
manufacturing services to other scanner manufacturers. At this time, the
indirect distribution channels are not well developed, and there is no assurance
that these channels will lead to increased sales. There is no assurance that
Photomatrix's marketing efforts will be successful. Competitors of Photomatrix
have substantially greater resources and may be able to compete more effectively
on technology, price or product features. Photomatrix is also constrained by
limits on its marketing budget and ability to create brand recognition. Further,
PMX's products are relatively high-priced durable goods, and economic conditions
that adversely affect the market for durable goods could have an adverse effect
on PMX's orders. The Company believes that its acquisition of I-PAC
significantly reduces its dependence on its ability to successfully market its
document scanners.
COMPETITIVE ENVIRONMENT
In the past, the Company has competed primarily in the high-end of the
imaging marketplace. The Company believes the critical success factors within
this market segment include engineering quality, price reasonableness,
distribution channels, production volume, name recognition, and access to a
strong financial-capital base. The Company's primary competitors in the
high-performance document-scanner marketplace include Kodak and BancTec, both of
which have access to a substantially greater financial-capital base than the
Company. In addition, the Company estimates that Kodak has the leading market
share in this market segment, and Kodak has substantially broader name
recognition and greater sales and marketing resources than the Company. There
can be no assurance that Photomatrix will be able to overcome competitive forces
and reactions in order to increase revenue in an amount necessary to return to
profitability.
The Company's ability to increase its revenue is partially dependent
upon successfully developing additional OEM relationships and upon expanding its
indirect and direct sales. The Company's ability to improve its sales is in part
dependent upon its marketing and research and development expenditures. The
Company's liquidity constraints may limit these expenditures.
Further, Bell & Howell, with whom the Company has an OEM relationship
to sell the Company's document scanners, has recently introduced a document
scanner with speed and features overlapping the lower end of many of the
scanners sold by the Company via this OEM channel. Although the Company believes
it has been able to enhance its scanner technology to stay ahead of some of its
competitors' products, there can be no assurance that Bell & Howell or another
competitor will not introduce products into the Company's future market niche
that will be of equal or superior performance. During the period from July, 1997
through June, 1998, Bell & Howell sales of Photomatrix scanners have
significantly declined.
I-PAC also operates in a highly competitive industry and faces
competition from a number of domestic and foreign electronic manufacturing
services companies, some with financial and manufacturing resources greater than
the Company's. The Company also faces competition in the form of current and
prospective customers that have the capabilities to develop and manufacture
products internally. In order to maintain a viable alternative, the Company must
continue to enhance its total engineering and manufacturing technologies.
20
<PAGE>
REQUIRED REVENUE INCREASES
In order to reduce operating losses, management has reduced operating
costs over the past eighteen months on a consolidated basis by an aggregate of
approximately $1,200,000 annually (including continuing and discontinued
operations). The majority of these cost reductions have been realized through
headcount reductions and the consolidation of the operations and employees at
the former Photomatrix facility in Culver City, California and the corporate
headquarters in San Diego, California into a single facility. At current revenue
levels, these cost reductions will not, in and of themselves, return the Company
to profitability. Therefore, the Company is focused on increasing its revenue
through the pursuit of OEM opportunities in the scanner industry in order to
return the Company to profitable operations. Management believes that the
acquisition of I-PAC enhances the likelihood that the Company will return to
profitability. There is no assurance, however, that the Company will be
profitable.
LEXIA SYSTEMS, INC.
Relative to the discontinuation of Lexia Systems, Inc. ("Lexia"), and
to the protracted nature of the negotiations and the disagreements with ICL and
Fujitsu, there is no assurance that Lexia and ICL/Fujitsu will settle their
current disagreements.
Lexia carries on its books accounts payable and unpaid rent claims of
ICL and related entities in the amount of $786,000. Lexia disputes these
liabilities. Lexia is attempting to resolve these disputes through negotiations.
While the Company believes the ICL claims against Lexia will be settled at a
discount, there is no assurance that Lexia will be successful in this regard.
Further, there is no assurance that existing Lexia customers will not assert
claims against Lexia and that such actions would not be defended successfully.
RETENTION OF KEY EMPLOYEES
The Company is highly dependent upon the principal members of its
management, engineering and field service staff and key individuals in all areas
of the Company. The Company has implemented certain programs which it believes
will help in retaining these key employees. There can be no assurance that the
Company will be able to retain all key personnel or attract new qualified
personnel on acceptable terms.
CONTINUED LISTING ON NASDAQ SMALL CAP MARKET
On August 22, 1997, the Securities and Exchange Commission approved new
listing standards for companies listed on The NASDAQ Stock Market. These new
requirements became effective on February 23, 1998. On February 27, 1998, NASDAQ
notified the Company that it was not in compliance with the new requirement
regarding the minimum bid price of its Common Stock. Under the new Small Cap
Market listing maintenance requirements, the minimum bid price of the Company's
Common Stock must be at least $1.00 per share. On May 18, 1998, NASDAQ notified
the Company that it was in compliance with this same minimum bid price
requirement. Notwithstanding the fact that the Company believes that the Merger
provides investors with new data which supports a stock price in excess of $1.00
per share, it is possible that the market will not reflect such a valuation over
a prolonged period and that a reverse stock split may be necessary in the future
to increase the likelihood that the Common Stock of the Company will trade at a
price higher than $1.00 per share and that the Company will therefore be in
compliance with the new NASDAQ rules and thereby avoid delisting. There is no
assurance that the Company will avoid delisting.
RETAINING AVAILABILITY OF LINE OF CREDIT
The Company has not yet achieved a critical-mass level of revenue
sufficient to reach a financial break-even point. The Company is currently
negotiating with its bank for a new line of credit subsequent to the acquisition
of I-PAC. Assuming that the Company is successful in obtaining the new line of
credit, cash
21
<PAGE>
flow forecasts suggest that the Company's line of credit will be adequate to
finance the Company's growth in the year ending March 31, 1999. However, there
can be no assurance that the Company will be successful in negotiating the new
line. Furthermore, as discussed above, if the Company cannot increase revenue
levels sufficiently to return to profitability, the Company could be in default
of its bank covenants in the near future and possibly lose its line of credit.
YEAR 2000 CONTINGENCIES
The Company recognizes the need to ensure that its operations will not
be adversely impacted by Year 2000 software and hardware failures. The Company
is addressing Year 2000 risks and believes it will resolve any such risks in a
timely manner. The currently estimated costs associated with these changes are
not material in any year and are not material to the Company's financial
position. However, the Company could be adversely impacted if its suppliers and
customers do not make the necessary changes to their own systems and products
successfully and in a timely manner.
CUSTOMER CONCENTRATION
Many companies in the electronic manufacturing services industry,
including the Company, have a high percentage of their revenues concentrated in
a small customer base. The greatest risk facing these companies is possible
weakening of a major customer or a slow-down in the industry. It may take
several quarters to replace significant customers.
INTERNAL GROWTH
Start-up costs and the management of labor and equipment efficiencies
for new manufacturing services programs and new customers can have the effect of
reducing the Company's gross margins. Due to these and other factors, gross
margins can be negatively impacted early on in the life cycle of new programs.
In addition, labor efficiency and equipment utilization rates ultimately
achieved and maintained by the Company for new and current programs impact the
Company's gross margins.
ACQUISITION STRATEGY
Geographical expansion and growth by acquisition can have an effect on
the Company's operation. The successful operation of an acquired business will
require communication and cooperation among key managers, along with the
transition of customer relationships. There can be no assurance the Company will
successfully manage the integration of new locations or acquired operations and
may experience certain inefficiencies which could negatively impact the results
of operations. Additionally, no assurance can be given that any past or future
acquisition by the Company will enhance the Company's business.
Other factors that could adversely affect forward-looking statements
include the Company's ability to maintain and expand its customer base, gross
margin pressures, the effect of start-up costs related to new facilities, the
overall economic conditions affecting the electronics industry, and other
factors and risks detailed herein and in the Company's other Securities and
Exchange Commission filings.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedule filed herewith are set forth in
the Index to Consolidated Financial Statements and the Index to Consolidated
Financial Statement Schedule and are incorporated herein by reference.
22
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
Mr. WILLIAM L. GRIVAS assumed the duties of Chairman of the Board effective as
of June 5, 1998. He has served as the Chief Executive Officer of I-PAC since
1990. Prior to that time, Mr. Grivas was the sole owner of Southwest General
Industries (SGI), a $25 million per year contract manufacturer which he founded
in the 1970's. After selling SGI to SCI Manufacturing, Inc., Mr. Grivas joined
with Mr. Moore and Mr. Hill to found I-PAC in 1990. Mr. Grivas also serves as a
Director on the Boards of I-PAC Express Assembly, Inc., MGS Interconnect, Inc.,
MGM Techrep, Inc., Evergreen Investments, Inc., Universal Cable Products, Inc.
and Vantage Manufacturing Services, Inc ("Vantage"). Vantage, a company which is
solely owned by Mr. Grivas, filed for protection under Federal Bankruptcy laws
in 1996. Mr. Grivas served in the Marine Corps as a Drill Instructor and a
special weapons expert, with extensive training in electronic and radar
technologies. Mr. Grivas is 43 years of age.
Mr. PATRICK W. MOORE assumed the duties of Chief Executive Officer of the
Company effective as of June 5, 1998. Mr. Moore has been a Director of the
Company since January 1991. Mr. Moore, who has served as the President of I-PAC
since 1990, has significant business experience in both the private and public
sectors. Mr. Moore also serves as a Director on the Boards of I-PAC Express
Assembly, Inc., MGS Interconnect, Inc., MGM Techrep, Inc., Evergreen
Investments, Inc., Universal Cable Products, Inc. and Keystone Gaming, Inc. Mr.
Moore has served on the National Commission on Employment Policy, committees of
the National Academy of Science, and as the national president of various trade
organizations based in Washington, D.C. From 1981 to 1986, Mr. Moore served as
President of the San Diego Private Industry Council and as Executive Director of
the San Diego Regional Employment and Training Consortium. Mr. Moore is 50 years
of age.
Mr. SUREN G. DUTIA has been a Director of the Company and has served as the
President and Chief Executive Officer of the Company from January 1989 through
June 5, 1998. He was elected to be the Chairman of the Board of the Company in
September 1990. Effective June 5, 1998, Mr. Dutia resigned as Chief Executive
Officer and Chairman of the Board and retained his position as President of the
Company. Prior to January 1989, Mr. Dutia was associated from 1981 to December
1988 with Dynatech Corporation, a diversified high-technology company
headquartered in Burlington, Massachusetts. From 1986 to 1988, Mr. Dutia was a
Division Manager and Vice President. Mr. Dutia was responsible for several
subsidiaries, including one operating subsidiary for which he acted as
President. He directed turn-around/divestiture activities for Dynatech and
handled investor relations. Mr. Dutia is 55 years of age.
Mr. IRA H. SHARP has been a Director of the Company since January 1990. Mr.
Sharp has been the owner, Chief Executive Officer and General Counsel of
Alderson Reporting Company, Inc., a court-reporting and litigation-support
services firm in Washington, D.C., since 1984. Mr. Sharp also served in the same
capacities for Alderson from 1977 until 1983. During the period of his absence
from Alderson, Mr. Sharp was a lawyer in private practice. Mr. Sharp is 55 years
of age.
Mr. JOHN F. STALEY has been a Director of the Company since January 1989. From
1972 to the present, Mr. Staley has been a partner in Staley, Jobson and
Wetherell, a law firm Mr. Staley founded, located in Pleasanton, California. Mr.
Staley was also the founder and a director of Lab Sales of California and P.M.
America, which were corporations involved in the manufacture, sale and
distribution of blood-analyzing
23
<PAGE>
machines and which were sold to Dynatech Corporation in 1982. In 1982, Mr.
Staley co-founded the Bank of Livermore, California. Mr. Staley is 54 years of
age.
Mr. JAMES P. HILL became a director of the Company effective as of June 5, 1998.
For the last five years Mr. Hill has been, a partner specializing in bankruptcy
law, commercial law and civil litigation in the San Diego law firm of Sullivan,
Hill, Lewin, Rez, Engel & LaBazzo. Mr. Hill was a Director of the San Diego
Bankruptcy Forum from 1991 through 1994 and the Chairman of the Commercial Law
Section of the San Diego County Bar Association from 1985 through 1987. Mr. Hill
also serves as a director on the Board of MGM Techrep, Inc. Mr. Hill is 45 years
of age.
EXECUTIVE OFFICERS
Set forth below is information about certain executive officers of Photomatrix
and its subsidiaries effective as of June 5, 1998.
MR. ROY L. GAYHART joined Photomatrix as Chief Financial Officer and Secretary
on April 18, 1997. From 1994 to 1997, Mr. Gayhart was President of
Sutherland-Gayhart, Inc., a private investment company which specialized in
small start-up and bridge financing investments. From 1992 to 1994 he served as
Chief Financial Officer, and later Vice President of International Operations,
for Lottery Enterprises, Inc. Mr. Gayhart has also served as Chief Financial
Officer and Chief Operating Officer for the Shorebreak Division of South
Carolina Tees, Inc. (from 1991 to 1992), Jacks Incorporated (from 1988 to 1991)
and Nu-Ear Electronics, Inc. (from 1984 to 1988). Mr. Gayhart previously was an
audit manager with Arthur Andersen LLP. Mr. Gayhart is 48 years of age.
MR. CHARLES H. FRADY has served as Controller and Assistant Treasurer of the
Company since January, 1997. Mr. Frady joined Photomatrix in 1995 as Division
Controller. From 1993 to 1995, he served as Senior Cost Accountant for Eaton
Leonard Corporation. From 1990 to 1993, Mr. Frady was Accounting Manager for
PacOrd, Inc. From 1987 to 1990, he was Controller for Bell Industries, Inc. Mr.
Frady is 56 years of age.
Set forth below is certain information about significant employees of the
Company as of June 5, 1998.
MR. DEL GLOVER joined Photomatrix in February 1996 as Vice President of Sales
and Marketing. For the eight years prior to that, Mr. Glover was the Director of
the Peripheral Products Division of Ricoh Corporation.
MR. WILLIAM SHEPPARD joined Photomatrix in July 1985 as Vice President of
Engineering. Prior to that, Mr. Sheppard served in various engineering
management positions with Planning Research Corporation and the U.S. Naval Ocean
Systems Center and as President of Saguaro Systems Corporation, a consulting
firm.
MR. ROGER BURTON joined Photomatrix in 1986 as the Managing Director of
Photomatrix, Ltd., its wholly owned United Kingdom-based subsidiary. Prior to
joining Photomatrix, Mr. Burton was Co-Director of Rosstech Designs, Ltd.,
specializing in electro-mechanical design consulting and prototype
manufacturing.
ITEM 10. EXECUTIVE COMPENSATION
The following table shows, for the most recent three fiscal years, the cash
compensation paid by the Company, as well as all other compensation paid or
accrued for those years, to the Chief Executive Officer
24
<PAGE>
of the Company. No other current officer of the Company earned more than
$100,000 in any of the years identified.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
LONG TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
------------------------------------------------ ---------------------
NAME AND SECURITIES UNDERLYING
PRINCIPAL POSITION YEAR SALARY BONUS OTHER(1) OPTIONS/SARS (#)
- ------------------ ---- ------ ----- -------- ---------------------
<S> <C> <C> <C> <C> <C>
Suren G. Dutia 1998 $140,000 - $11,200 -
President and Chief 1997 $154,400 $30,000 $15,000 -
Executive Officer 1996 $165,000 - $13,900 191,667
</TABLE>
(1) Includes Company matching contributions to the Photomatrix Savings and
Investment Plan ($4,900, $4,800, and $4,400) and supplemental life and medical
premiums ($7,400, $10,200, and $9,500) for 1998, 1997 and 1996, respectively.
EMPLOYMENT AGREEMENTS. Mr. Dutia and Mr. Gayhart are employed under employment
agreements that expire on July 31, 1999 and April 30, 1999, respectively. If
either Mr. Dutia's or Mr. Gayhart's employment is terminated by the Company
without cause, then he will be entitled to receive his base salary, stock option
vesting and health insurance benefits for the remainder of the term.
OFFICERS SEVERANCE POLICY. In 1988, the Company's Board of Directors adopted an
Officers Severance Policy that was modified in November 1990 and February 1997.
Under the policy, Mr. Dutia is to receive twelve weeks' compensation upon
termination of employment by the Company, in addition to amounts due him under
his employment contract, Mr. Gayhart is to receive eight (8) weeks' compensation
upon termination, in addition to amounts payable for the remaining term of his
employment agreement, and Mr. Frady is to receive eight weeks' compensation upon
termination of employment by the Company.
STOCK OPTION GRANTS
There were no options granted to the named executive officer in fiscal
1998.
AGGREGATED STOCK OPTION EXERCISES AND FISCAL YEAR-END STOCK OPTION VALUE TABLE
The following table sets forth certain information regarding the number
and value of specified unexercised options held by the Chief Executive Officer
as of March 31, 1998:
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED IN-THE-MONEY
NUMBER OF UNEXERCISED OPTIONS(1) OPTIONS(2)
----------------------------------------------------------------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Suren G. Dutia 100,000 166,667 $72,000 $0
</TABLE>
(1) No options were exercised in fiscal year 1998.
(2) The value is calculated as the total market value of stock subject
to the options on June 18, 1998 ($1.03 per share), less the total
of the option exercise prices.
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<PAGE>
TEN YEAR OPTION REPRICING TABLE
In July 1997 the Compensation Committee offered to reprice a portion of
the option shares previously granted to Mr. Dutia which had an original exercise
price in excess of the market value of the Company's common stock at that time.
This offer was made in conjunction with identical offers to most employees. The
following table sets forth the specified information concerning all options
repriced for all executive officers of the Company for the period August 1987
(initial public offering) through June 1998.
<TABLE>
<CAPTION>
LENGTH OF
NUMBER OF ORIGINAL
SHARES MARKET PRICE OPTION TERM
UNDERLYING OF STOCK AT EXERCISE REMAINING AT
OPTIONS TIME OF PRICE AT TIME NEW EXERCISE DATE OF
NAME DATE REPRICED REPRICING OF REPRICING PRICE REPRICING
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
S. Dutia, CEO November 1990 200,000 $0.18 $3.75 $0.18 8 years
S. Dutia, CEO June 1995 25,000 $1.25 $4.13 $1.69 9 years
S. Dutia, CEO November 1995 166,667 $0.88 $1.31-$2.91 $0.88 6-9 years
S. Dutia, CEO July 1997 166,667 $0.37 $0.88 $0.37 4-7 years
B. Myers, November 1995 100,000 $0.18 $1.50-$3.48 $0.18 8 years
Former CFO
B. Myers, June 1995 16,667 $1.25 $4.13 $1.69 9 years
Former CFO
B. Myers, November 1995 116,667 $0.88 $1.31-$2.91 $0.88 6-9 years
Former CFO
</TABLE>
REPORT ON STOCK OPTION REPRICING
In connection with the July 1997 option repricing, the Compensation
Committee issued the following report:
While the Committee believes that the Company's Stock Option Plans have
been instrumental in attracting and retaining quality executive officers,
employees and Directors, the incentive feature of such programs may become lost
when options are granted at fair market value and subsequently the market price
of the Company's common stock falls substantially below the exercise price of
stock options granted under such programs. In 1997, the market price for the
Company's common stock fell substantially. As a result of the drop in market
price of the common stock, the optionees have exercise prices substantially
higher than the current market value, and therefore hold options which are out
of the money. After careful consideration of the relevant factors, including (1)
the decline in the market price of the common stock, (2) the reasons for the
decline in the market price of the common stock, (3) the large percentage of the
Company's employees and Directors holding out of the money options, and (4) the
importance of equity incentive to the Company's overall compensation program for
executive officers and employees at all levels and Directors, the Committee
approved the cancellation of the existing options and the reissue of said
options pursuant to the Company's Stock Option Plans.
COMPENSATION COMMITTEE
Ira H. Sharp
Patrick W. Moore
John F. Staley
26
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
As of June 11, 1998, Aundir Trust Company Ltd., was the only shareholder
(other than certain of its executive officers) known by the Company to be the
beneficial owner of more than five percent of its outstanding Common Stock. As
of that date, Aundir Trust Company, Ltd. was the beneficial owner of 1,054,002
shares, representing approximately 10.6 percent of the Company's outstanding
stock. These shares are beneficially owned by Aundir Trust Company, Ltd. as
trustee of the Bulldog Trust and the Pitkin Trust, irrevocable trusts
established by Sam Wyly and Charles J. Wyly, Jr., respectively. The record
holders are Tensas, Ltd. and Roaring Creek, Ltd., which are corporations wholly-
owned by such trusts. Sam Wyly and Charles J. Wyly, Jr. disclaim beneficial
ownership of these shares. The address of Aundir Trust Company is Castle Town,
Isle of Man, British Isles.
The following table sets forth certain information regarding the ownership of
Photomatrix common stock by Directors and Executive Officers of the Company:
<TABLE>
<CAPTION>
PERCENT OF SHARES OF
SHARES OF COMMON STOCK COMMON STOCK
NAME OF BENEFICIAL BENEFICIALLY OWNED OUTSTANDING
OWNER OR GROUP AS OF JUNE 11, 1998(1) AS OF JUNE 11, 1998(1)
- ------------------ ---------------------- ----------------------
<S> <C> <C>
William L. Grivas, Chairman of the Board 1,609,057 16.20%
Patrick W. Moore, CEO and Director 1,599,227 16.10%
Suren G. Dutia, President and Director 291,033 2.80%
Roy L. Gayhart 20,000 *
Chief Financial Officer and Secretary
Charles H. Frady 5,000 *
Controller, Treasurer
James P. Hill, Director 1,579,176(2) 15.90%
Ira H. Sharp, Director 43,333 *
John F. Staley, Director 100,033 *
All directors and executive officers as a 5,246,859 52.83%
group
</TABLE>
(1) Includes and reflects the ownership by the named director or officer of
shares of Common Stock issuable pursuant to options exercisable within 60 days
of June 11, 1998.
(2) Includes 168,824 shares owed by Loma Services Corporation, of which Mr. Hill
is a principal shareholder, and 1,410,352 shares owned by Mr. Hill as Trustee of
the Hill Family Trust.
* less than 1%
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<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In connection with the acquisition of PMX, Photomatrix restructured outstanding
indebtedness to members and affiliates of the Wyly family into non-negotiable
seven-year term notes bearing interest at the rate of eight percent per annum.
The total principal amount of the notes payable to members of the Wyly family
and their affiliates as of March 31, 1998 was $375,000.
Claudia Fullerton, who is the wife of Patrick W. Moore, is employed by the
Company as its Director of Administration at an annual salary of $47,900.
During the quarter ended June 30, 1998, the Company entered into an agreement
with I-PAC, whereby I-PAC provided manufacturing and administrative services to
the Company prior to the consummation of the merger. In addition, under this
agreement, the Company agreed to pay I-PAC rent for use of I-PAC facilities. The
total amount paid to I-PAC during this period was $116,000.
28
<PAGE>
PART IV
ITEM 13. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULE AND REPORTS ON FORM 8-K
A. FINANCIAL STATEMENTS, SCHEDULE AND EXHIBITS
The following consolidated financial statements are filed herewith:
Consolidated Balance Sheets as of March 31, 1998 and 1997
Consolidated Statements of Operations for the years ended March 31, 1998,
1997 and 1996
Consolidated Statements of Shareholders' Equity for the years ended
March 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended March 31, 1998,
1997 and 1996.
Notes to Consolidated Financial Statements
The schedule filed herewith is set forth in the Index to Financial Statement
Schedule. Other financial statement schedules, for which provision is made in
the applicable accounting regulations of the Securities and Exchange Commission,
are not required under the related instructions and, therefore, have been
omitted.
B. REPORTS ON FORM 8-K.
The Company filed no reports on Form 8-K during the quarter ended March 31,
1998.
C. EXHIBITS
The exhibits listed under Item 13(c) are filed as part of this Annual Report on
Form 10-KSB.
<TABLE>
<S> <C> <C>
3.1 Amended and Restated Articles of Incorporation (ix)
3.3 Bylaws (ix)
3.3.1 Amendment to Bylaws dated June 5, 1998 *
10.2 Settlement Agreement dated January 11, 1993 between Photomatrix Corporation (iv)
and Scan-Graphics, Inc.
10.4 Lease Agreement between Photomatrix and EVB Limited Partnership-I dated (iv)
December 17, 1987
10.5 Lease Agreement between Photomatrix Limited and Bermer Limited dated May (iv)
31, 1989
10.6 Promissory Notes dated April 30, 1993 in the aggregate principal amount of (iv)
$776,607 payable to the following members of the Wyly family and affiliates:
Sam Wyly, Charles Wyly, Jr., Evan Wyly, Donald Miller, First Dallas
International, Ltd., and Premier Partners
10.7 Subcontract dated March 31, 1991 between PRC, Inc. and Photomatrix (iv)
10.8 1992 Xscribe Stock Option Plan and Sample Agreement (iv)
10.11 Executive Employment Agreement between the Company and Suren G. Dutia (i)
dated December 20, 1988
10.11.1 Amendment to Executive Employment Agreement between the Company and
Suren G. Dutia *
10.24 Description of executive bonus arrangements and executive severance plan (iv)
29
<PAGE>
10.25 1994 Xscribe Stock Option Plan and Sample Agreements (vii)
10.30 Security and Loan Agreement between Imperial Bank and Xscribe Corporation (ix)
dated June 17, 1996 and related documents
10.30.1 Amendment No. 1 to Security and Loan Agreement with Imperial Bank *
10.30.2 Amendment No. 2 to Security and Loan Agreement with Imperial Bank *
10.30.3 Amendment No. 3 to Security and Loan Agreement with Imperial Bank *
10.31 OEM Purchase Agreement for Photomatrix Scanners dated February 8, 1996 (ix)
between Bell & Howell Limited and Photomatrix Corporation (Non-public
information has been filed with the Securities and Exchange Commission)
10.32 OEM Purchase Agreement for Photomatrix Scanners dated June 12, 1996 (ix)
between Bell & Howell Operating Company and Photomatrix Corporation
(Non-public information has been filed with the Securities and Exchange
Commission)
10.33 Facilities Lease Agreement between Photomatrix and Manufacturers Life dated (x)
November 7, 1996
10.33.1 Consent by Lessor to Assignment of Facilities Lease Agreement *
10.35 Business Agreement with Bell & Howell dated December 29, 1997 *
10.35.1 Addendum to Business Agreement with Bell & Howell dated January 5, 1998 *
10.36 Agreement and Plan of Reorganization and Merger, dated as of March 16, 1998, (xi)
by and among Photomatrix, Inc., Photomatrix Acquisition Corp., and I-PAC
Manufacturing, Inc.
10.37 Executive Employment Agreement, dated as of June 5, 1998, between the
Company and Patrick W. Moore *
10.38 Executive Employment Agreement dated as of June 5, 1998, between the
Company and William L. Grivas *
10.39 1998 Photomatrix, Inc. Stock Option Plan and Sample Agreements (xi)
21.1 Subsidiaries of the registrant as of March 31, 1998: *
- Photomatrix Imaging, Inc., Nevada
- Lexia Systems, Inc., California
- Xscribe Imaging, Inc., California
- Xscribe Legal Systems, Inc. California
23.2 Independent Auditors' Consent from KPMG Peat Marwick LLP *
24.1 Power of Attorney (see signature pages)
(d) Schedule
Schedule II Valuation and Qualifying Accounts
</TABLE>
30
<PAGE>
- ---------
(i) Incorporated by reference to exhibits filed with the Company's
Combined Annual Report to Shareholders and Annual Report on Form 10-K for the
fiscal year ended March 31, 1991, filed with the Securities and Exchange
Commission on June 26, 1991.
(ii) Incorporated by reference to exhibits filed with the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1992, filed with
the Securities and Exchange Commission on June 26, 1992.
(iii) Incorporated by reference to exhibits filed with the Company's
Post Effective Amendment No. 2 to its Registration Statement on Form S-2 (No.
33-43036) filed with the Securities and Exchange Commission on June 14, 1993.
(iv) Incorporated by reference to exhibits filed with the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1993, filed with
the Securities and Exchange Commission on June 29, 1993.
(v) Incorporated by reference to exhibits filed with the Company's
Current Report on Form 8-K dated October 25, 1993, filed with the Securities and
Exchange Commission on November 5, 1993.
(vi) Incorporated by reference to exhibits filed with the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1994, filed with
the Securities and Exchange Commission on June 29, 1994.
(vii) Incorporated by reference to exhibits filed with Company's
Registration Statement on Form S-8 with the Securities and Exchange Commission
on August 18, 1995.
(viii) Incorporated by reference to exhibits filed with the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1995, filed with
the Securities and Exchange Commission on June 29, 1995.
(ix) Incorporated by reference to exhibits filed with the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1996, filed with
the Securities and Exchange Commission on June 25, 1996.
(x) Incorporated by reference to exhibits filed with the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1997, filed with
the Securities and Exchange Commission on June 30, 1997.
(xi) Incorporated by reference to exhibits to definitive proxy
materials filed on Schedule 14A on May 13, 1998.
* Previously filed with Form 10-KSB in June 1998.
31
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and
Shareholders of Photomatrix, Inc.
We have audited the accompanying consolidated balance sheets of Photomatrix,
Inc. and subsidiaries as of March 31, 1998 and 1997, and the related
consolidated statements of operations, shareholders' equity, and cash flows
for each of the years in the three-year period ended March 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Photomatrix, Inc. and subsidiaries as of March 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended March 31, 1998, in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
San Diego, California
May 29, 1998
F-1
<PAGE>
PHOTOMATRIX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,342,000 $ 812,000
Accounts receivable, net of allowance
of $142,000 and $111,000 1,733,000 1,602,000
Inventories 2,171,000 2,520,000
Prepaid expenses and other 98,000 149,000
------------ ------------
Total current assets 5,344,000 5,083,000
------------ ------------
Property and equipment, at cost 1,174,000 1,986,000
Less accumulated depreciation and amortization (627,000) (640,000)
------------ ------------
Net property and equipment 547,000 1,346,000
------------ ------------
Intangible assets, net of accumulated amortization of
$1,437,000 and $1,512,000 (Note 1) 1,287,000 2,053,000
Other assets 125,000 83,000
------------ ------------
$ 7,303,000 $ 8,565,000
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 502,000 $ 844,000
Accrued liabilities and other (Note 8) 854,000 590,000
Customer deposits (Note 8) 409,000 613,000
Current maturities of notes payable to related parties
(Note 5) 162,000 152,000
Net current liabilities of discontinued operation (Note 2) 1,113,000 452,000
------------ ------------
Total current liabilities 3,040,000 2,651,000
------------ ------------
Notes payable to related parties, less current portion (Note 5) 213,000 375,000
Other non-current liabilities 26,000 40,000
Commitments and contingencies (Note 10)
Shareholders' equity (Note 4):
Preferred Stock, no par value; 3,173,000 shares
authorized, -- --
no shares issued and outstanding
Common stock, no par value; 30 million shares
authorized, 5,083,000 shares issued and
outstanding 19,351,000 19,351,000
Accumulated deficit (15,480,000) (13,998,000)
Cumulative translation adjustment 153,000 146,000
------------ ------------
Total shareholders' equity 4,024,000 5,499,000
------------ ------------
$ 7,303,000 $ 8,565,000
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-2
<PAGE>
PHOTOMATRIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Equipment and software $ 6,464,000 $ 6,730,000 $ 6,979,000
Services 2,131,000 1,964,000 2,113,000
----------- ----------- -----------
Total revenues 8,595,000 8,694,000 9,092,000
----------- ----------- -----------
Cost of revenues:
Equipment and software 4,746,000 5,180,000 4,881,000
Services 1,143,000 1,220,000 1,278,000
----------- ----------- -----------
Total cost of revenues 5,889,000 6,400,000 6,159,000
----------- ----------- -----------
Gross profit 2,706,000 2,294,000 2,933,000
----------- ----------- -----------
Operating costs and expenses:
Selling, general and administrative 3,198,000 3,311,000 3,592,000
Research and development 995,000 807,000 485,000
Write off capitalized software 366,000 -- --
Facility consolidation and relocation -- 520,000 --
----------- ----------- -----------
Total operating costs and expenses 4,559,000 4,638,000 4,077,000
----------- ----------- -----------
Operating loss (1,853,000) (2,344,000) (1,144,000)
----------- ----------- -----------
Other income (expense), net:
Interest expense (Notes 5 and 6) (41,000) (92,000) (228,000)
Other, net 203,000 250,000 11,000
----------- ----------- -----------
Net other income (expense) 162,000 158,000 (217,000)
----------- ----------- -----------
Loss from continuing operations before
taxes (1,691,000) (2,186,000) (1,361,000)
Provision for income taxes (Note 7) 5,000 104,000 7,000
----------- ----------- -----------
Loss from continuing operations (1,696,000) (2,290,000) (1,368,000)
Income (loss) from discontinued operations
(Note 2) 214,000 (251,000) (336,000)
Gain on sale of discontinued operation
(Note 2) -- 134,000 --
----------- ----------- -----------
Net loss $(1,482,000) $(2,407,000) $(1,704,000)
----------- ----------- -----------
----------- ----------- -----------
Basic and diluted net income (loss) per share:
Continuing operations
Discontinued operations $ (0.33) $ (0.44) $ (0.24)
----------- ----------- -----------
----------- ----------- -----------
Net loss $ 0.04 $ (0.02) $ (0.06)
----------- ----------- -----------
----------- ----------- -----------
$ (0.29) $ (0.46) $ (0.30)
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
<PAGE>
PHOTOMATRIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
COMMON STOCK CUMULATIVE
--------------------------------- ACCUMULATED TRANSLATION
SHARES AMOUNT DEFICIT ADJUSTMENT TOTAL
--------------- ----------------- ------------------ ----------------- ---------------
<S> <C> <C> <C> <C>
Balance, March 31, 1995 5,719,000 $ 20,132,000 $ (9,887,000) $ 4,000 $ 10,249,000
Other (4,000) (39,000) -- 59,000 20,000
Net loss -- -- (1,704,000) --
------------ ------------ ------------ ------------ ------------
Balance, March 31, 1996 5,715,000 20,093,000 (11,591,000) 63,000 8,565,000
Common stock cancelled to settle
disagreements with ICL (Note 2) (666,000) (748,000) -- -- (748,000)
Exercise of options (Note 4) 34,000 6,000 -- -- 6,000
Other -- -- -- 83,000 83,000
Net loss -- -- (2,407,000) (2,407,000)
------------ ------------ ------------ ------------ ------------
Balance, March 31, 1997 5,083,000 19,351,000 (13,998,000) 146,000 5,499,000
Other -- -- -- 7,000 7,000
Net loss -- -- (1,482,000) (1,482,000)
------------ ------------ ------------ ------------ ------------
Balance, March 31, 1998 5,083,000 $ 19,351,000 $(15,480,000) $ 153,000 $ 4,024,000
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
<PAGE>
PHOTOMATRIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Loss from continuing operations: $(1,696,000) $(2,290,000) $(1,368,000)
Adjustments:
Depreciation and amortization 878,000 903,000 809,000
Write off capitalized software 366,000 -- --
Loss on disposal of property and equipment 4,000 27,000 --
Changes in assets and liabilities:
Accounts receivable (131,000) 302,000 179,000
Inventories 349,000 573,000 (848,000)
Prepaid expenses and other 51,000 7,000 58,000
Accounts payable (342,000) (301,000) 412,000
Accrued liabilities and other 264,000 264,000 (96,000)
Customer deposits (204,000) (223,000) 343,000
----------- ----------- -----------
Cash used in continuing operations (461,000) (738,000) (511,000)
Cash provided by discontinued operations 875,000 508,000 971,000
----------- ----------- -----------
Cash provided by (used in) operations 414,000 (230,000) 460,000
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sale of discontinued operation -- 2,000,000 --
Sale (purchase) of property and equipment 420,000 (267,000) (276,000)
Capitalized software (additions) and retirements (103,000) (162,000) (533,000)
Decrease (increase) in other assets (42,000) 94,000 (78,000)
----------- ----------- -----------
Cash provided by (used in) investing activities 275,000 1,665,000 (887,000)
----------- ----------- -----------
Cash flows from financing activities:
Issuance of common stock -- 6,000 26,000
(Repayment of) proceeds from credit facility, net (Note 6) -- (826,000) 524,000
Repayment of notes payable to related parties (Note 5) (152,000) (141,000) (108,000)
Other (14,000) -- (8,000)
----------- ----------- -----------
Cash provided by (used in) financing activities (166,000) (961,000) 434,000
----------- ----------- -----------
Effects of exchange rates on cash 7,000 83,000 59,000
----------- ----------- -----------
Increase in cash and cash equivalents 530,000 557,000 66,000
Cash and cash equivalents, beginning of year 812,000 255,000 189,000
----------- ----------- -----------
Cash and cash equivalents, end of year $ 1,342,000 $ 812,000 $ 255,000
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
<PAGE>
PHOTOMATRIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial statements of
Photomatrix, Inc. and its wholly-owned subsidiaries (the consolidated entity
referred to as the "Company"). All significant intercompany accounts and
transactions have been eliminated in consolidation.
BUSINESS
The Company primarily develops, manufactures, sells and services
high-performance document and aperture card scanners to legal, financial,
government and commercial enterprises.
CASH EQUIVALENTS
Cash equivalents include all highly liquid investments with an original maturity
of three months or less.
INTANGIBLE ASSETS (INCLUDE SOFTWARE DEVELOPMENT COSTS)
Intangible assets are comprised of software development costs and costs in
excess of net assets acquired (goodwill).
Software development costs incurred to establish technological feasibility are
expensed when incurred. Subsequent software development costs are capitalized
and amortized beginning when the related product is available for general
release to customers. The amortization recorded for such products each year
equals the greater of (i) the amount computed using the ratio that current
revenue bear to total current and anticipated revenue, or (ii) the amount
computed using the straight-line method over the remaining useful life of the
product not to exceed a total life of five years. Unamortized computer software
costs, included in intangible assets were $154,000 and $647,000 as of March 31,
1998 and 1997, respectively. Amortization expense for capitalized software costs
were $273,000, $261,000, $279,000, $139,000 for fiscal years 1998, 1997, and
1996, respectively.
The goodwill, net of accumulated amortization of $1,103,000 and $830,000,
amounting to $1,133,000 and $1,406,000 as of March 31, 1998 and 1997,
respectively, is related to the acquired Photomatrix technology and is being
amortized over a period of 10 years.
The Company evaluates the recoverability of its capitalized software development
costs by comparing the unamortized software development costs to the estimated
net realizable value on a product by product basis. Any excess of the carrying
amount over the net realizable value of capitalized software development costs
is written off. In the year ended March 31, 1998, the Company recorded a
write-off of capitalized software of $366,000 related to a discontinued product
line.
F-6
<PAGE>
FOREIGN CURRENCY TRANSLATION
The accounts of the Company's foreign subsidiary are measured using local
currency as the functional currency; assets and liabilities are translated into
U.S. dollars at period-end exchange rates, and income and expense accounts are
translated at average monthly exchange rates. Net gains or losses resulting from
such translation are excluded from operations and accumulated in a separate
component of shareholders' equity ("cumulative translation adjustment"). Gains
and losses from foreign currency transactions are not significant and are
included in selling, general and administrative expenses in the consolidated
statements of operations.
INVENTORIES
Inventories include material, labor and overhead valued at the lower of costs
(first-in, first-out) or market, and consist of the following as of March 31,
1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Raw materials $1,705,000 $1,715,000
Work in process 247,000 375,000
Finished goods 219,000 430,000
---------- ----------
$2,171,000 $2,520,000
---------- ----------
---------- ----------
</TABLE>
REVENUE RECOGNITION
Equipment and software sale revenue are recognized upon transfer of the risk of
ownership to the customer which typically occurs upon shipment from either the
Company's or its agent's distribution location. The Company has no significant
obligations related to software sales subsequent to delivery and subsequent to
management's assessment that the collectibility of the related receivable is
probable. Service revenue is recognized over the related contract period for
maintenance contracts, or as the services are rendered.
PROPERTY AND EQUIPMENT
Substantially all property and equipment is demonstration equipment,
manufacturing equipment and personal computers used in the Company's assembly,
product development, sales and administrative activities. These items are stated
at cost. Depreciation is provided over the estimated useful lives, typically
three-to-five years, using the straight-line method.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company adopted the provisions of SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,
effective April 1, 1996. This Statement requires that long-lived assets and
certain identifiable intangibles be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. Adoption of this Statement did not have a material impact on the Company's
financial position, results of operations, or liquidity.
INCOME TAXES
F-7
<PAGE>
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
computed using enacted tax rates expected to apply to taxable income in the
years in which temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities from a change in tax rates is
recognized in income in the period that includes the enactment date.
BASIC AND DILUTED INCOME (LOSS) PER SHARE
In December 1997, the Company adopted the provisions of SFAS No. 128, "Earnings
per Share." SFAS No. 128 supersedes APB No. 15 and replaces "primary" and "fully
diluted" earnings per share ("EPS") under Accounting Principles Board ("APB")
Opinion No. 15 with "basic" and "diluted" EPS. Unlike primary EPS, basic EPS
excludes the dilutive effects of options, warrants and other convertible
securities. The weighted average number of common shares outstanding used in
computing basic EPS was 5,083,000, 5,219,000 and 5,742,000 in fiscal years 1998,
1997 and 1996, respectively. Diluted EPS reflects the potential dilution of
securities that could share in the earnings of the Company, similar to fully
diluted EPS. Options and warrants representing approximately 886,000, 855,000
and 933,000 shares were excluded from the computations of net loss per common
share for the years ended March 31, 1998, 1997 and 1996, respectively, as their
effect is antidilutive. The adoption of SFAS No. 128 did not have a material
effect on the Company's net loss per common share.
STOCK OPTIONS
Prior to April 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. As such, compensation expense
would be recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. On April 1, 1996, the Company
adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which permits
entities to recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows
entities to continue to apply the provisions of APB Opinion No. 25 and provide
pro forma net loss and pro forma loss per share disclosures for employee stock
option grants made in fiscal 1996 and future years as if the fair-value based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
SIGNIFICANT CUSTOMERS
Two customers (Bell & Howell and Kodak) accounted for 26% and 13%, respectively,
of the Company's total revenue for fiscal year 1998. One customer (Bell &
Howell) accounted for 17% of the Company's total revenue for fiscal 1997. One
customer (Bell & Howell) accounted for 12% of the outstanding accounts
receivable at March 31, 1998. No other customer accounted for more than 10% of
the Company's total revenue or accounts receivable during the years presented.
PRODUCT WARRANTY COSTS
The Company provides product warranties and software support services to
customers as part of its standard sales agreement. The warranties cover the
service costs associated with hardware and software defects and range in term
from 90 days to one year from date of sale. The Company accrues for warranty
costs at the time of sale.
SUPPLEMENTAL CASH FLOW INFORMATION
F-8
<PAGE>
Interest and income taxes paid approximate the amounts expensed in the years
ended March 31, 1998 and 1996. Interest paid approximates the amount expensed
for the year ended March 31, 1997. However, in the year ended March 31, 1997,
income tax expense of $104,000 exceeds income tax payments of $5,000 due to the
increase in the valuation allowance related to the deferred tax assets. Refer to
Note 7 below for a detailed discussion of income taxes.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments," requires that the fair values be disclosed for
the Company's financial instruments. The carrying amount of cash and cash
equivalents, accounts receivable, accounts payable, accrued liabilities and
other, and customer deposits approximate their fair values because of the
short-term nature of these instruments. The carrying amounts reported for notes
payable to related parties, and other non-current liabilities approximate fair
value because the underlying instruments bear interest at rates that are
comparable to rates available to the Company for similar debt instruments.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements and
the reported amounts of revenue and expenses during the reporting period to
prepare these consolidated financial statements in conformity with generally
accepted accounting principles. Actual results could differ from those
estimates.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. DIVESTITURE AND DISCONTINUATION
XSCRIBE LEGAL SYSTEMS, INC.
On July 31, 1996, the Company sold substantially all of the assets and the
business of its wholly-owned subsidiary, Xscribe Legal Systems, Inc. ("Legal
Systems"), to Stenograph Corporation ("Stenograph") in exchange for $2 million
cash paid at closing, a $180,000 note delivered at closing, and the assumption
by Stenograph of substantially all of the current liabilities ($844,000) of
Legal Systems (excluding certain contingent liabilities). The contingent
liabilities retained by the Company consist primarily of all income, property,
sales and employment tax contingencies of Legal Systems, if any, and all
products liability contingencies of Legal Systems for product sold prior to July
31, 1996.
The Company recognized a gain on the sale of Legal Systems of $134,000 and also
recorded a net loss from discontinued operations in fiscal 1997 of $117,000.
This loss included accruals for indemnifications related to the discontinued
operations of Legal Systems. During the current year, the indemnification period
lapsed and the Company determined that the remaining accruals were no longer
necessary. The accruals were reversed, resulting in income from discontinued
operations of $214,000 in the current year. The discontinued business accounted
for 33% of the Company's revenue for the year ended March 31, 1996. Current and
prior period balances have been reclassified to present Legal Systems as a
discontinued operation.
LEXIA SYSTEMS, INC.
In December 1996, the Board of Directors of the Company approved a plan to
discontinue the operations of Lexia Systems, Inc. ("Lexia"). The Company is
currently in the process of winding down and closing
F-9
<PAGE>
this operation. Lexia's operational results have been reclassified as
discontinued operations for the respective years presented herein. Lexia's
balance sheets have similarly been reclassified as net current liabilities of
discontinued operations as of March 31, 1998 and 1997, respectively.
Previously, the Company had certain disagreements with the seller of the assets
and operations which comprised Lexia. Under the terms of a settlement reached in
August, 1996, the Company relinquished certain rights, including its exclusive
reselling rights, in exchange for cancellation of 666,000 shares of the
Company's common stock previously owned by the seller. Currently, Lexia carries
on its books accounts payable and unpaid rent claims of ICL and related entities
in the amount of $786,000. Lexia disputes these liabilities. Lexia is attempting
to resolve these disputes through negotiations. There is no assurance that Lexia
will be able to resolve this matter.
OTHER DISCONTINUED OPERATIONS
In fiscal year 1996, the Company discontinued its imaging service bureau. The
accompanying consolidated financial statements reflect this business as a
discontinued operations. Revenue from this discontinued business was $51,000 in
fiscal year 1996.
Net current liabilities of all discontinued operations as of March 31, 1998 and
1997 totaled $1,113,000 and $452,000, respectively, and was primarily comprised
of accounts receivable, accounts payable, accrued liabilities and customer
deposits.
3. SEGMENT INFORMATION
Photomatrix operates predominantly in a single industry as a manufacturer of
document and aperture card scanners. The Company's operations are located in the
United States and the United Kingdom. Geographical segment information follows
for 1998, 1997 and 1996.
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
REVENUE:
United States $ 6,999,000 $ 6,797,000 $ 6,917,000
Inter-area Domestic and
export customers 796,000 923,000 1,399,000
------------ ------------ ------------
Total United States 7,795,000 7,720,000 8,316,000
Foreign 1,596,000 1,897,000 2,175,000
Eliminations (796,000) (923,000) (1,399,000)
------------ ------------ ------------
Total $ 8,595,000 $ 8,694,000 $ 9,092,000
------------ ------------ ------------
------------ ------------ ------------
OPERATING INCOME (LOSS):
United States $ (1,603,000) $ (2,006,000) $ (978,000)
Foreign 24,000 (348,000) (97,000)
Eliminations (274,000) 10,000 (69,000)
------------ ------------ ------------
Total $ (1,853,000) $ (2,344,000) $ (1,144,000)
------------ ------------ ------------
------------ ------------ ------------
IDENTIFIABLE ASSETS:
United States $ 6,475,000 $ 7,189,000 $ 10,619,000
Foreign 958,000 1,366,000 2,031,000
Eliminations (130,000) 10,000 (69,000)
------------ ------------ ------------
Total $ 7,303,000 $ 8,565,000 $ 12,581,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
4. SHAREHOLDERS' EQUITY
The Company has two existing common stock option plans under which an aggregate
of 699,999 shares
F-10
<PAGE>
of the Company's common stock may be issued through qualified incentive stock
options or non-qualified stock options. The Company has a third plan which
expired in fiscal 1994 with approximately 100,000 options still outstanding.
Under the terms of the existing plans, incentive stock options are granted at an
exercise price which is not less than 100% of the fair market value of the
Company's common stock at the date of grant; non-qualified options are granted
at not less than 85% of the fair value at the date of grant. Options are
exercisable within the period and in the increments as determined by the
Company's Board of Directors or plan administration committee appointed by the
Board of Directors. In conjunction with the merger discussed in note 11, the
Board of Directors has unanimously adopted and the Company's shareholder
approved a fourth plan, the Photomatrix, Inc. 1998 Stock option Plan, that
authorizes the grant of incentive and non-qualified stock options covering an
aggregate of 1,500,000 shares of Common Stock to officers, directors and
employees of the Company and its subsidiaries.
At March 31, 1998, there were 21,667 additional shares available for grant under
the Plans. The per share weighted-average fair value of stock options granted
during 1998, 1997 and 1996 was $0.33, $0.62 and $0.63, respectively, on the date
of grant using the Black Scholes option-pricing model with the following
weighted-average assumptions: 1998 - expected dividend yield 0.0%, volatility of
88.2%, risk-free interest rate of 6.0%, and an expected life of 10 years; 1997 -
expected dividend yield 0.0%, volatility of 75.8%, risk-free interest rate of
6.0%, and an expected life of 5 years; 1996 - expected dividend yield 0.0%,
volatility of 75.8%, risk-free interest rate of 6.0%, and an expected life of 5
years.
The Company applied APB Opinion No. 25 in accounting for its Plans and,
accordingly, no compensation cost has been recognized for its stock options in
the consolidated financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under SFAS
No. 123, the Company's net loss would have been increased to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Net loss, as reported $ (1,482,000) $ (2,407,000) $ (1,704,000)
Pro forma $ (1,566,000) $ (2,578,000) $ (1,771,000)
Loss per share, as reported $ (0.29) $ (0.46) $ (0.30)
Pro forma loss per share $ (0.31) $ (0.49) $ (0.31)
</TABLE>
Pro forma net loss reflects only options granted in 1998, 1997 and 1996.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the pro forma net loss amounts presented
above because compensation cost is reflected over the options' vesting period of
2-3 years and compensation cost for options granted prior to April 1, 1995 is
not considered.
Additional information with respect to the options under the plans follows:
F-11
<PAGE>
<TABLE>
<CAPTION>
RANGE OF EXERCISE
SHARES PRICE
------ -----------------
<S> <C> <C>
Options outstanding, March 31, 1995 716,867 $0.18 - $4.13
Options granted 760,665 $0.69 - $1.25
Options exercised - -
Options canceled (649,034) $0.88 - $4.13
--------- -------------
Options outstanding, March 31, 1996 828,498 $0.18 - $3.56
Options granted 195,000 $0.44 - $0.94
Options exercised (33,333) $0.18
Options canceled (242,833) $0.38 - $3.56
--------- -------------
Options outstanding March 31, 1997 747,332 $0.18 - $1.25
Options granted 683,331 $0.35 - $0.38
Options exercised - -
Options canceled (652,330) $0.44 - $1.25
------- -------------
Options outstanding, March 31, 1998 778,333 $0.18 - $0.47
--------- -------------
--------- -------------
Options exercisable, March 31, 1998 100,000 $0.18 - $ 0.47
--------- -------------
--------- -------------
</TABLE>
As of March 31, 1998, the Company has 778,333 options outstanding with a
weighted average exercise price of $0.37 per share and a weighted average
remaining contractual life of 8.7 years.
In June 1995, the Company canceled employee stock options to acquire 41,667
shares at an exercise price of $4.13 per share and granted new replacement
options to acquire 41,667 shares at an exercise price of $1.69 per share. In
November 1995, the Company canceled stock options to acquire 628,999 shares
(including options to acquire 85,000 shares held outside the Plans described
above) at exercise prices ranging from $1.31 to $2.91 per share and granted new
replacement options to acquire 628,999 shares at an exercise price of $0.88 per
share. In July, 1997, the Company canceled stock options to acquire 579,331
shares at exercise prices ranging from $0.44 to $1.25 per share and granted new
replacement options to acquire 579,331 shares at an exercise price of $0.38 per
share, its then fair market value.
In addition to the options described above, the Company had outstanding warrants
and other options to acquire common shares as of March 31, 1998 as follows:
<TABLE>
<CAPTION>
SHARES EXERCISE PRICE EXPIRATION
------ -------------- ----------
<S> <C> <C>
33,333 $0.42 December, 2003
75,000 $0.44 April, 2002
</TABLE>
Subsequent to March 31, 1998, the Company granted options to purchase 100,000
shares at an exercise price of $0.75 per share with an expiration date of April,
2001.
The Company is authorized to issue 3,173,000 shares of its preferred stock. No
preferred shares were outstanding as of March 31, 1998 and 1997.
F-12
<PAGE>
5. RELATED PARTY TRANSACTIONS
In connection with the acquisition of Photomatrix in the year ended March 31,
1994, $777,000 of amounts due to affiliates of Photomatrix's then-majority
shareholders (presently shareholders of the Company) were converted into
seven-year notes payable which mature in April 2000. These notes bear interest
at a rate of 8% per annum. Interest-only payments were due monthly during the
first two years. Interest and principal are due in equal monthly installments
(beginning in May 1995) for years three-through-seven. Interest expense related
to these notes was $37,000, $48,000 and $59,000 in the years ended March 31,
1998, 1997 and 1996, respectively. As of March 31, 1998 and 1997, $375,000 and
$527,000, respectively, were outstanding under these notes.
6. LINE OF CREDIT
The Company has a line of credit with a bank to borrow a total of $750,000 of
which zero was outstanding at March 31, 1998. This line of credit accrues
interest on outstanding borrowings at prime plus 2% per annum. Total borrowings
under the line of credit are limited to the lesser of $750,000 or 70% of
eligible accounts receivable (as defined). The Company is required to 1)
maintain a minimum tangible net worth of $2,800,000; 2) maintain a ratio of
total liabilities to tangible net worth of not greater than 1.1 to 1.0, 3)
maintain working capital of $1,750,000; and 4) maintain a current ratio of at
least 1.7 to 1.0. As of March 31, 1998, the Company was not in compliance with
certain of these covenants; however, the Company obtained a waiver of these
requirements. The line of credit expires in September 1998 and is subject to a
1% non-utilization fee charged on the average daily unused portion of the line,
payable quarterly in arrears. Outstanding borrowings under this line of credit
are collateralized by all of the Company's assets.
F-13
<PAGE>
As part of the credit facility which the Company maintained during a portion of
the years ended March 31, 1997 and 1996, the Company also had a term loan with
outstanding balances of zero as of March 31, 1998 and 1997. Interest on this
term loan accrued at a rate of prime plus 1-1/2% per annum. Interest expense on
the term note during the years ended March 31, 1998, 1997 and 1996 was $0,
$23,000 and $61,000, respectively.
7. INCOME TAXES
The components of loss before income taxes are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
LOSS BEFORE INCOME TAXES
U.S. continuing operations $(1,410,000) $(1,820,000) $(1,258,000)
U.S. discontinued operations 214,000 (117,000) (336,000)
Foreign (281,000) (366,000) (103,000)
----------- ----------- -----------
$(1,477,000) $(2,303,000) $(1,697,000)
----------- ----------- -----------
----------- ----------- -----------
PROVISION FOR TAXES
Current:
Federal $ -- $ -- $ --
State 5,000 1,000 7,000
Foreign -- -- --
----------- ----------- -----------
$ 5,000 $ 1,000 $ 7,000
Deferred -- 103,000 --
----------- ----------- -----------
$ 5,000 $ 104,000 $ 7,000
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
RECONCILIATION STATUTORY TO EFFECTIVE RATES
A reconciliation from the federal income tax provision computed at the statutory
rate to the actual provision for taxes on loss from continuing operations for
fiscal year 1998, 1997 and 1996 is as follows:
<TABLE>
<S> <C> <C> <C>
Tax at statutory federal tax rate $(575,000) $(744,000) $(463,000)
State income taxes (net of federal benefit) 4,000 -- 5,000
Federal impact on continuing operations
from change in valuation allowance 576,000 848,000 465,000
--------- --------- ---------
$ 5,000 $ 104,000 $ 7,000
--------- --------- ---------
--------- --------- ---------
</TABLE>
DEFERRED TAX ASSETS/LIABILITIES
Deferred tax assets and liabilities result from differences between the
financial statement carrying amounts and the tax bases of existing assets and
liabilities. The significant components of the deferred income tax assets and
deferred income tax liabilities as of March 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
---------- -----------
<S> <C>
Deferred tax assets:
Tax operating loss carryforward $4,998,000 $ 4,624,000
Inventory and other reserves 428,000 256,000
Tax basis of intangible assets greater
than book basis - 193,000
Other 61,000 145,000
----------- ------------
5,487,000 5,218,000
Less valuation allowance (5,029,000) (4,488,000)
----------- ------------
458,000 $ 730,000
----------- ------------
Deferred tax liabilities:
Book basis of intangible assets
greater than tax basis (458,000) $ (461,000)
Software capitalization - (239,000)
Other - ( 30,000)
----------- ------------
$ (458,000) $ (730,000)
----------- ------------
Net deferred tax asset $ - $ -
----------- ------------
----------- ------------
</TABLE>
F-14
<PAGE>
The Company has recorded net tax assets in an amount approximately equal to net
tax liabilities because management believes that these items will offset in
future periods, considering statutory carryforward periods and limitations.
Subject to future reassessment of future income potential, the Company has fully
reserved for all deferred tax assets in excess of deferred tax liabilities.
As of March 31, 1998, the Company has available for federal income tax purposes
a net operating loss ("NOL") carryforward of approximately $14,700,000 which can
offset future consolidated taxable income and which begins to expire in fiscal
year 2000. The utilization of this NOL may be subject to an annual limitation
under Section 382 of the Internal Revenue Code.
8. ACCRUED LIABILITIES AND CUSTOMER DEPOSITS
Accrued liabilities and other consist of the following as of March 31, 1998 and
1997:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Compensation and related items $309,000 $210,000
Other 545,000 380,000
-------- --------
$854,000 $590,000
-------- --------
-------- --------
</TABLE>
In December 1997 and 1996, Kodak advanced to the Company $250,000 and $500,000,
respectively (the entire respective calendar year shortfall) as a prepayment
against future spare parts purchases. Of the total prepayments made in the years
ended March 31, 1998 and 1997, $0 and $273,000 remained as of March 31, 1998 and
1997, respectively, and are included in customer deposits in the accompanying
consolidated balance sheets. In fiscal year 1997, the Company recognized
$250,000 for minimum annual guaranty purchase level requirements, which was
classified as other income in the consolidated statements of operations.
9. EMPLOYEE BENEFIT PLANS
The Company maintains defined contribution savings and investment plans for the
benefit of all full-time employees. The Company's expense related to the plans
was $55,000, $39,000 and $54,000 in 1998, 1997 and 1996, respectively. The
Company has no significant post-employment or post-retirement obligations that
would require accrual under SFAS 106 or 112.
10. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company's operations are conducted in facilities which are occupied under
operating leases. The leases require payment of taxes, maintenance expenses and
insurance. Rental expense (net of rents under sublease of $0, $187,000 and
$150,000 in 1998, 1997 and 1996, respectively) incurred under operating leases
(including leases which have expired) was $306,000, $246,000 and $232,000, in
1998, 1997 and 1996, respectively.
Future minimum lease commitments as of March 31, 1998, are as follows:
<TABLE>
<S> <C>
1999 $ 94,000
2000 96,000
2001 73,000
2002 52,000
2003 46,000
2004 and thereafter 464,000
--------
$825,000
--------
--------
</TABLE>
F-15
<PAGE>
Subsequent to March 31, 1998, the Company moved its corporate headquarters,
assigned the lease of its former principal operating facility, and provided the
lessor with a guarantee of the lease through its expiration in September 2002.
LEGAL PROCEEDINGS
The Company has been a defendant in three product liability cases pending in the
United States District Court, Eastern District of New York (BERNHART V. XSCRIBE
ET AL. (92 Civ. 3931), GALFIN V. XSCRIBE (92 Civ. 2582), and HAGIPADELIS V.
XSCRIBE (95 Civ. 1977)). Both BERNHART V. XSCRIBE and GALFIN V. XSCRIBE has now
been or are in the process of being dismissed. Xscribe has tendered the
HAGIPADELIS V. XSCRIBE claim to its insurance carriers, St. Paul Fire ("St.
Paul") and Marine Insurance and Federal Insurance Company ("Federal"). St. Paul
has assumed the Company's defense without reservation of right, and Federal has
agreed to share defense costs, subject to a reservation of rights. The insurance
carriers have prevailed in all judgments rendered to date. It may take several
years before this litigation is ultimately resolved. The Company believes that
this remaining case is without merit and further believes that if any liability
results from these claims, the liability (excluding punitive damages, if any)
will be covered by its insurance policies.
11. SUBSEQUENT EVENTS (Unaudited)
On March 16, 1998, the Company entered into an Agreement and Plan of Merger and
Reorganization with I-PAC Manufacturing, Inc. The Agreement was approved by the
shareholders of the Company on June 5, 1998, and the transaction closed on June
11, 1998. As a result of the Merger, the 8,500 outstanding shares of I-PAC
Common Stock were exchanged for 4,848,000 shares (adjusted proportionately in
the event of the exercise of dissenters' rights) of Photomatrix Common Stock and
possibly additional shares of Photomatrix Common Stock in the event that I-PAC
achieves certain performance milestones during a twelve month period commencing
on July 1, 1998 or outstanding options to purchase Photomatrix Common Stock are
exercised.
If the I-PAC transaction had been consummated at the beginning of fiscal year
1997, the Company's consolidated revenues, net loss and net loss per share would
have been:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Revenues $ 14,037,000 $ 13,883,000
Net Loss $ (1,071,000) $ (2,709,000)
Net Loss per share, basic and
diluted $ ( 0.11) $ (0.27)
</TABLE>
On June 5, 1998 the Company's shareholders also approved the 1998 Photomatrix
Stock Option Plan, which authorizes the grant of incentive and non-qualified
stock options covering an aggregate of 1,500,000 shares of common stock to
officers, directors and employees of the Company and its subsidiaries.
F-16
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and
Shareholders of Photomatrix, Inc.
Under date of May 29, 1998, we reported on the consolidated balance sheets of
Photomatrix, Inc. and subsidiaries as of March 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the years in the three-year period ended March 31, 1998, which
are included in the Form 10-KSB. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the related
consolidated financial statement schedule in the Form 10-KSB. This consolidated
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion on this consolidated financial
statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
San Diego, California
May 29, 1998
F-17
<PAGE>
PHOTOMATRIX, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE DEDUCTIONS BALANCE
BEGINNING AND END
DESCRIPTION OF YEAR EXPENSE ACQUIRED WRITE-OFFS OF YEAR
- ---------------------------- --------- ------- -------- ---------- -------
<S> <C> <C> <C> <C> <C>
FISCAL YEAR 1998
- ----------------------------
Allowance for Uncollectible
Accounts Receivable $ 111,000 63,000 -- 32,000 142,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Inventory Excess and
Obsolescence Reserve $ 150.000 629,000 -- 154,000 625,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Warranty Reserve $ 51,000 157,000 -- 148,000 60,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
FISCAL YEAR 1997
- ----------------------------
Allowance for Uncollectible
Accounts Receivable $ 76,000 46,000 -- 11,000 111,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Inventory Excess and
Obsolescence Reserve $ 592,000 130,000 -- 572,000 150,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Warranty Reserve $ 35,000 16,000 -- -- 51,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
FISCAL YEAR 1996
- ----------------------------
Allowance for Uncollectible
Accounts Receivable $ 61,000 75,000 -- 60,000 76,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Inventory Excess and
Obsolescence Reserve $ 368,000 179,000 -- (45,000) 592,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Warranty Reserve $ 35,000 15,000 -- 15,000 35,000
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
</TABLE>
F-18
