<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 27, 1997
OR
/ / 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: 0-21892
PINNACLE MICRO, INC.
Delaware 33-0238563
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
PINNACLE MICRO, INC.
19 TECHNOLOGY DRIVE
IRVINE, CALIFORNIA 92618
(714) 789-3000
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 for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No .
As of November 20, 1997, there were outstanding 14,500,089 shares of
Registrant's Common Stock.
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PINNACLE MICRO, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
September 27,
1997 December 28,
(Unaudited) 1996
------------- -------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 572,000 $ 5,455,000
Accounts receivable, net 6,056,000 11,726,000
Income taxes receivable - 1,984,000
Inventories 7,442,000 17,714,000
Prepaid expenses and other current assets 341,000 215,000
------------ ------------
Total current assets 14,411,000 37,094,000
Furniture and equipment, net 578,000 1,739,000
Deferred interest related to convertible debentures - 786,000
Other assets 72,000 619,000
------------ ------------
Total assets $ 15,061,000 $ 40,238,000
------------ ------------
------------ ------------
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Note payable $ 4,527,000 $ 3,276,000
Accounts payable 16,988,000 15,540,000
Accrued expenses 1,162,000 2,922,000
Accrued restructuring 623,000 1,421,000
Payroll related liabilities 357,000 1,225,000
------------ ------------
Total current liabilities 23,657,000 24,384,000
Convertible debentures - 6,422,000
Other liabilities 409,000 929,000
Commitments and contingencies
Stockholders' equity (deficit):
Common stock 15,000 10,000
Additional paid-in capital 34,977,000 28,551,000
Accumulated deficit (43,997,000) (20,058,000)
------------ ------------
Total stockholders' equity (deficit) (9,005,000) 8,503,000
------------ ------------
Total liabilities and stockholders' equity (deficit) $ 15,061,000 $ 40,238,000
------------ ------------
------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED FINANCIAL
STATEMENTS.
2
<PAGE>
PINNACLE MICRO, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
13 Weeks Ended 13 Weeks Ended 39 Weeks Ended 39 Weeks Ended
Sept. 27, 1997 Sept. 28, 1996 Sept. 27, 1997 Sept. 28, 1996
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net sales $ 3,307,000 $ 14,259,000 $ 28,690,000 $ 44,026,000
Cost of sales 12,593,000 11,646,000 34,639,000 36,132,000
------------ ------------ ------------ ------------
Gross profit (loss) (9,286,000) 2,613,000 (5,949,000) 7,894,000
Operating expenses:
Selling, general and administrative 3,550,000 4,451,000 12,454,000 14,132,000
Research and development 736,000 1,494,000 2,983,000 4,522,000
Nonrecurring charges 930,000 4,333,000 930,000 4,584,000
------------ ------------ ------------ ------------
Total operating expenses 5,216,000 10,278,000 16,367,000 23,238,000
Operating loss (14,502,000) (7,665,000) (22,316,000) (15,344,000)
Interest expense (167,000) (142,000) (598,000) (288,000)
Non-cash interest expense related
to convertible debentures - (1,286,000) (786,000) (1,286,000)
------------ ------------ ------------ ------------
Loss before income taxes (14,669,000) (9,093,000) (23,700,000) (16,918,000)
Income tax expense 41,000 - 63,000 3,000
------------ ------------ ------------ ------------
Net loss $(14,710,000) $ (9,093,000) $(23,763,000) $(16,921,000)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net loss per share $ (1.02) $ (1.15) $ (1.88) $ (2.14)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average
common shares outstanding 14,485,000 7,926,000 12,653,000 7,904,000
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED FINANCIAL
STATEMENTS.
3
<PAGE>
PINNACLE MICRO, INC.
CONDENSED STATEMENTS OF CASH FLOWS - PAGE 1 OF 2
(Unaudited)
<TABLE>
<CAPTION>
39 Weeks Ended 39 Weeks Ended
Sept. 27, 1997 Sept. 28, 1996
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(23,763,000) $(16,921,000)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 1,013,000 979,000
Provision for product returns and price protection 1,639,000 831,000
Provision for inventory obsolescence 6,013,000 427,000
Interest on debentures paid in common stock 153,000 -
Non-cash interest expense 786,000 1,286,000
Changes in operating assets and liabilities:
Accounts receivable 4,031,000 (55,000)
Income taxes receivable 1,984,000 36,000
Inventories 4,259,000 (1,331,000)
Prepaid expenses and other current assets (126,000) 256,000
Other assets 547,000 (29,000)
Accounts payable and accrued expenses (65,000) 3,761,000
Payroll related liabilities (868,000) 169,000
Other liabilities (520,000) 829,000
----------- -----------
Net cash used in operating activities (4,917,000) (9,762,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposal of furniture and equipment
30,000 -
Purchase of furniture and equipment (1,384,000) (644,000)
----------- -----------
Net cash provided by (used in) investing activities (1,354,000) (644,000)
----------- -----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED FINANCIAL
STATEMENTS.
4
<PAGE>
PINNACLE MICRO, INC.
CONDENSED STATEMENTS OF CASH FLOWS - PAGE 2 OF 2
(Unaudited)
<TABLE>
<CAPTION>
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of convertible debentures $ - $ 10,000,000
Proceeds from note payable to bank 1,251,000 -
Payment of debt issuance costs - (600,000)
Principal payments on long-term debt - (20,000)
Proceeds from exercise of stock options 16,000 56,000
Tax benefit from exercise of stock options 3,000 4,000
Proceeds from issuance of stock through
the employee stock purchase plan 118,000 20,000
----------- -----------
Net cash provided by financing activities 1,388,000 9,460,000
Effect of exchange rate changes on cash - 5,000
----------- -----------
Decrease in cash and cash equivalents (4,883,000) (941,000)
Cash and cash equivalents at beginning of period 5,455,000 3,606,000
----------- -----------
Cash and cash equivalents at end of period $ 572,000 $ 2,665,000
----------- -----------
----------- -----------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 612,000 $ 178,000
----------- -----------
----------- -----------
Income taxes - -
----------- -----------
----------- -----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED FINANCIAL
STATEMENTS.
5
<PAGE>
PINNACLE MICRO, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 27, 1997
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INTERIM PERIOD ACCOUNTING POLICIES
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles.
Certain information normally included in annual financial statements
prepared in accordance with generally accepted accounting principles has
been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission, and these financial statements should
be read in conjunction with the Company's Form 10-K for the year ended
December 28, 1996. In the opinion of management, the accompanying
condensed financial statements reflect all material adjustments which are
necessary for a fair presentation of the financial position and results of
operations and cash flows as of and for the thirty-nine weeks ended
September 27, 1997 and September 28, 1996.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, EARNINGS PER SHARE (SFAS 128).
This pronouncement provides a different method of calculating earnings per
share than is currently used in accordance with APB 15, EARNINGS PER SHARE.
SFAS 128 provides for the calculation of Basic and Diluted earnings per
share. Basic earnings per share includes no dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted earnings per
share reflects the potential dilution of securities that could share in the
earnings of an entity, similar to fully diluted earnings per share. This
pronouncement is effective for fiscal years and interim periods ending
after December 15, 1997; early adoption is not permitted. The Company does
not believe that the adoption of this pronouncement will have a material
impact on the net loss per share presented in the accompanying condensed
statements of operations.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 and 131, REPORTING COMPREHENSIVE
INCOME (SFAS 130) and DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND
RELATED INFORMATION (SFAS 131), respectively (collectively, the
"Statements"). The statements are effective for fiscal years beginning
after December 15, 1997. SFAS 130 establishes standards for reporting of
comprehensive income and its components in annual financial statements.
SFAS 131 establishes standards for reporting financial and descriptive
information about an enterprise's operating segments in its annual
financial statements and selected segment information in interim financial
reports. Reclassification or restatement of comparative financial
statements for earlier periods is required upon adoption of SFAS 130 and
SFAS 131, respectively. Application of the Statements' requirements is not
expected to have a material impact on the Company's financial position,
results of operations or cash flow.
2. INVENTORIES
Inventories consist of the following:
September 27, December 28,
1997 1996
------------- ------------
Components and
work-in-process $ 6,322,000 $ 13,991,000
Finished goods 1,120,000 3,723,000
----------- ------------
$ 7,442,000 $ 17,714,000
----------- ------------
----------- ------------
6
<PAGE>
3. CONVERTIBLE DEBENTURES
In December 1996, the Company completed an offshore placement of $5,000,000
principal amount of convertible subordinated 6% debentures due December
2001. The debenture holders could convert the principal of the 6%
debentures as follows: 30%, 40% and 30%, at discounts from the then market
price of 15%, 17.5% and 20%, in intervals commencing 50, 80 and 110 days
after closing, respectively.
As of September 27, 1997, debentures from both the December placement and
the prior placement made in July, 1996, aggregating $6,422,000 were
converted into 4,367,979 shares of common stock at conversion prices
ranging from $4.16 to $0.53 per share. All of the debentures were
converted prior to September 27, 1997.
4. RESTRUCTURING
During 1996, the Company recorded certain restructuring charges for costs
associated with the Company's planned consolidation and transfer of
manufacturing operations to Colorado Springs, Colorado and the closing of
its branch office in Japan. These restructuring charges principally
reflected the costs associated with early termination of existing leases,
losses from the disposal of assets and severance costs resulting from work
force reductions.
During the first two quarters of 1997, charges totaling $655,000 were
incurred in connection with this restructuring, including employee
severance and lease terminations and for the write-off of leasehold
improvements and other assets. During the third quarter of 1997, charges
totaling $283,000 were incurred in connection with this restructuring
liability, including $254,000 for facilities terminations and $29,000 in
employee severance costs. In addition, the Company recorded a new amount
of $188,000 for restructuring charges associated with the personnel
reductions associated with the closing of its Colorado Springs, Colorado
manufacturing and engineering facility, and the reductions in force in its
Irvine, California facility. As of September 27, 1997, $568,000 of the
restructuring liability was considered to be no longer required principally
as a result of more favorable lease terminations than estimated. The
$568,000 excess restructuring liability was reversed and is reflected, net,
as a reduction to nonrecurring charges in the condensed statement of
operations for the thirteen and thirty-nine week periods ended September
27, 1997. The remaining balance of the1996 restructuring liability as of
September 27, 1997 was $844,000 of which $759,000 related to longer-term
severance agreements.
5. TRANSACTIONS WITH STOCKHOLDERS
Subsequent to the conversion from an S Corporation to a C Corporation, the
Company paid dividends to the S Corporation stockholders for the previously
taxed undistributed S Corporation earnings as of June 30, 1993. As of
December 31, 1994, these stockholders were estimated to have overpaid by
$130,000. This $130,000 estimated overpayment, plus an additional $80,000,
which was also determined to be an overpayment, were repaid to the Company
during 1995.
During 1997, upon finalization of an IRS audit of both the S Corporation
and the C Corporation, it was determined that the overpayment referred to
above was not as great as previously estimated. Accordingly, $151,000,
plus interest, of the associated refund received by the Company was
distributed to the S Corporation stockholders as an adjustment to the
previously recorded S Corporation dividends.
6. CONTINGENCIES
On March 15, 1996, a complaint was filed against the Company and certain of
its current and then directors and executive officers in a securities class
action lawsuit which alleges that Company management engaged in improper
accounting practices and made certain false and misleading statements. The
complaint was filed in the United States District Court for the Central
District of California under the case name Wills, Cohen, et al. v. William
Blum et al., Case No. SACV96-261GLT. On or about November 10, 1997, the
Company reached an agreement in principle with the plaintiffs to settle the
lawsuit. Plaintiffs have agreed to accept payment of $2,325,000 in
exchange for a complete release of all claims arising from the allegations
set forth in the plaintiffs' complaint. All of the terms of the settlement
are not final, and the settlement is subject to preliminary and final
approval by the Court as well as approval by the members of the class. The
Company's insurers have agreed to advance all settlement and defense costs,
including the Company's attorneys' fees and expenses, subject to the
Company's agreement to reimburse the insurers for
7
<PAGE>
up to approximately $577,000 of those settlement and defense costs if
the Company achieves certain positive financial results prior to the
federal Court's final approval of the settlement. Although the Company
does not concede that any portion of the class action settlement is
allocable to the Company, the Company has agreed to the terms of the
settlement to avoid further costs. Because of the uncertainties relating
to the final amount of the obligation, if any, the Company may
ultimately incur, no accrual for any portion of the Company's portion of
the settlement has been made in the accompanying condensed financial
statements as of September 27, 1997.
8
<PAGE>
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANINGS OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934. ACTUAL RESULTS AND EVENTS COULD DIFFER MATERIALLY
FROM THOSE PROJECTED AS A RESULT OF THE RISK FACTORS SET FORTH IN THIS
REPORT AS WELL AS IN THE COMPANY'S ANNUAL REPORT ON
FORM 10 - K.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company has continued to incur significant losses associated with
substantially reduced net sales, the development of a follow on product to
the APEX product and the manufacture of its VERTEX and APEX products. The
Company made significant investments in its Colorado Springs, Colorado
manufacturing and engineering facility and relocated, with the exception of
sales and marketing activities, a significant portion of its personnel and
functions to that facility. Because sales declined significantly and were
not expected to increase significantly in the future, during the third
quarter ended September 27, 1997, the Company's management concluded that the
Colorado Springs facility was in excess of the Company's needs. In addition,
the Company's weakened financial condition required it to consolidate
facilities and to reduce all costs to those minimum levels consistent with
the reduced sales outlook. As a result of these factors, the Company
undertook a restructuring which included significant workforce reductions in
both its Irvine, California and Colorado Springs facilities. As of November
20, 1997, the Company employed 27 full-time persons. The Company has
outsourced certain operations such as assembly, fulfillment, technical
support, repair services, and financial management and accounting. Marketing
responsibilities were outsourced to a firm owned by co-founder Scott A. Blum.
In October 1997, the Colorado Springs facility was closed. The current
Irvine facility will be vacated in December 1997 for a smaller facility
appropriate to the Company's revised business plan. These restructuring
actions resulted in significant one-time charges which are included in the
results of operations for the quarter ended September 27, 1997.
Subsequent to September 27, 1997, the Company terminated its remaining
consultants and employees associated with its European sales office. The
Company intends to reach an arrangement with a European distributor to become
the master distributor for the Company's products throughout Europe.
Subsequent to September 27, 1997, the Company discontinued its development
efforts for the follow-on product to the APEX drive, the APEX II. All
personnel associated with that development project have left the Company's
employ. It is the Company's intention to reconstitute a development team for
the APEX II with the assistance of outside investors or partners and to bring
that product to completion. There can be no assurance, however, that the
Company will be successful in attracting outside investors or partners or
that the Company will have sufficient resources to restart the development
efforts on its own behalf. The inability to have a follow-on product for the
APEX could have a materially negative effect on the Company's ability to sell
its current inventory of the APEX product and could require significant
write-downs of its inventories, further impairing the Company's ability to
obtain financing. See "Liquidity and Capital Resources" below for more
information concerning the Company's capital needs.
During the quarter ended September 27, 1997, the Company significantly
changed its senior management. William F. Blum, co-founder, was named
Chairman and Chief Executive Officer in August 1997. Roger Hay, Executive
Vice President and Chief Financial Officer and a director resigned from both
positions in August 1997 and William F. Blum added the position of Chief
Financial Officer to his responsibilities. Kenneth C. Campbell resigned in
September 1997 as President and a director and William F. Blum was appointed
the Company's President.
During October 1997, Bruce P. Bastl and James B. Roszak joined the Company's
board of directors to fill existing vacancies on the board.
Subsequent to September 27, 1997, the investigation conducted by the
Securities and Exchange Commission relating principally to the restatement of
the Company's previously reported financial results for 1993 and 1994 and for
certain interim periods for 1995 involving the Company and certain former
members of its senior management was concluded. The Commission instituted a
cease and desist order against the Company and two
9
<PAGE>
former officers and a permanent injunction barring future violations of
certain accounting provisions against a third former officer, who was also
fined $25,000.
NET SALES
Net sales were $3,307,000 and $14,259,000 for the thirteen weeks ended
September 27, 1997 and September 28, 1996, respectively, representing a year
to year decrease of approximately 77%. Net sales were $28,690,000 and
$44,026,000 for the thirty-nine weeks ended September 27, 1997 and September
28, 1996, respectively, representing a decrease of 35%. These significant
decreases are primarily attributable to decreased unit sales and average
sales prices of all of the Company's products. The decreased unit sales can
be attributed to increased competition, the Company's inability to acquire
products for sale because of the Company's lack of financial resources and
the discontinuance of certain of the Company's products. Virtually all of the
Company's vendors will only sell to the Company on a prepay basis. The third
quarter of 1997 was adversely affected by a seasonal downturn experienced by
the disk drive industry in general, uncertainty among customers created by
the news of the Company's operational and financial difficulties, and the
Company's inability to purchase product because of its financial condition.
In addition, the Company reduced the selling prices of its APEX and VERTEX
drives by an average of 33% in an attempt to reach a wider market and
increase sales of these drives. These price reductions were reversed in
October. In addition, the Company experienced unusually high product returns.
GROSS PROFIT (LOSS)
Gross profit decreased from $2,613,000 for the thirteen weeks ended September
28, 1996, to a gross loss of $9,286,000 for the thirteen weeks ended
September 27, 1997. Gross profit decreased from $7,894,000 for the
thirty-nine weeks ended September 28, 1996, to a gross loss of $5,949,000 for
the thirty-nine weeks ended September 27, 1997. The gross loss for the
quarter ended September 27, 1997 was primarily attributable to the write-off
of a portion of the Company's service inventories and the establishment of
substantial additional inventory reserves. An aggregate of $4,387,000 in
additions to inventory reserves were made to recognize diminished values of
component parts and service parts inventories, consistent with the Company's
revised estimates of future inventory utilization as a result of the
experiences and knowledge obtained during the third quarter of 1997. The
substantial quarter to quarter reduction in net sales was a major contributor
to the revised estimates of future inventory values. As noted above, the
Company has observed increased competition in the recordable CD market for
its current products and this competition placed additional pressures on
selling prices and gross margins during the first three quarters of 1997, and
is expected to continue placing pressure on gross margins in future periods
for existing recordable CD products.
In addition, the significantly high costs associated with the Company's
Colorado Springs manufacturing facility and the excess manufacturing capacity
increased the costs of the Company's APEX and VERTEX products significantly.
During the quarter ended September 27, 1997, the Company maintained
manufacturing facilities in both California and Colorado, both of which were
underutilized. The overhead costs associated with those facilities
contributed to the Company's gross loss in the thirteen-week period ended
September 27, 1997. In October 1997, the Company outsourced all
manufacturing operations to an unrelated company in California. The Colorado
operation was closed and virtually all personnel associated with the facility
have left the Company. Also, in October 1997, the Company reached agreement
with the lessor of its California operation to permit the Company to vacate
its current California facility by December 31, 1997. The Company has
obtained a substantially smaller facility (approximately 11,000 square feet)
which is sufficient for its current needs in Irvine, California into which it
will relocate during the month of December 1997. (See Note 4 of Notes to
Condensed Financial Statements).
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses were $3,550,000 and $4,451,000 in
the thirteen weeks ended September 27, 1997 and September 28, 1996,
respectively, and represented 107.4% and 31.2% of net sales. Selling, general
and administrative expenses were $12,454,000 and $14,132,000 in the thirty-nine
weeks ended September 27, 1997 and September 28, 1996, respectively, and
represented 43.4% and 32.1% of net sales. The decreases in expenditures for the
thirteen weeks ended September 27, 1997 compared to the comparable period for
the prior year resulted primarily from decreased advertising and promotional
expenditures and decreased sales and administrative staffs. The increase for
the thirty-nine week period ended September 27, 1997 compared to the
10
<PAGE>
comparable period for the prior year resulted primarily from increased
advertising and promotional expenditures and increases to sales and
administrative staffs during the first two quarters of 1997 as compared to
the prior year comparable period.
RESEARCH AND DEVELOPMENT
Research and development expenses were $736,000 and $1,494,000 for the
thirteen weeks ended September 27, 1997 and September 28, 1996, respectively,
or 22.2% and 10.5% of net sales. Research and development expenses were
$2,983,000 and $4,522,000 for the thirty-nine weeks ended September 27, 1997
and September 28 1996, respectively, or 10.4% and 10.3% of net sales. These
decreases resulted from decreased staffing at the Company's research and
development facility, along with decreased expenses for APEX and VERTEX
prototypes and for ASIC development fees paid to third parties. During the
months of October and November 1997, the Company closed its research and
development capabilities in Colorado and all personnel associated with the
research and development activities of the Company have left the Company.
Because of the Company's financial condition it was unable to continue to
fund its development efforts for the APEX II product. It is the Company's
current objective to reconstitute its development activities with the
assistance of other companies and/or investors who would assume primary
ownership of the APEX II technology, but there can be no assurance that such
participants can be identified and committed or that the APEX II program can
be restarted. The Company believes, however, that alternative products
developed and manufactured by others can be located that will permit the
Company to continue to serve its customer base. There can be no assurance,
however, that such products can be identified and this alternative program
implemented. The APEX products account for the majority of the Company's
current sales.
NONRECURRING CHARGES
Nonrecurring charges were $930,000 and $4,333,000 in the thirteen weeks ended
September 27, 1997 and September 28, 1996, respectively. Nonrecurring
charges were $930,000 and $4,584,000 in the thirty-nine weeks ended September
27, 1997 and September 28, 1996, respectively. Nonrecurring charges for the
current period include $506,000 representing the net book value of certain
fixed assets the ownership of which was transferred to the Company's Colorado
Springs facility lessor in exchange for lease termination concessions.
Nonrecurring charges for the thirteen weeks ended September 28, 1996 included
$2,731,000 for costs associated with the Company's planned restructuring and
$1,602,000 primarily for changes to major component contracts with two key
suppliers. (See Note 4 to Condensed Financial Statements).
NON-CASH INTEREST EXPENSE RELATED TO CONVERTIBLE DEBENTURES
Non-cash interest expense, which was $1,286,000 for the thirteen weeks ended
September 28, 1996, resulted from issuing debentures which were convertible
at a discount from the market price of the common stock. The non-cash
interest recorded on the convertible debentures was amortized over the period
which the debentures were first convertible and had no effect on
stockholders' equity. The remaining deferred interest related to convertible
debentures and totaled $380,000 at September 28, 1996 and was fully amortized
during the fourth quarter of 1996.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents of $572,000 at September 27, 1997 were $4,883,000
lower than the $5,455,000 balance at December 28, 1996. The decline in cash
balances can be directly attributed to the significant losses incurred by the
company for the 39 weeks ended September 27, 1997. Cash was also used for
payment of certain expenses and capital costs related to the relocation to
Colorado Springs in the first quarter 1997. Partially offsetting the cash
lost through operating losses and payments was collections of customer
accounts receivable, income taxes receivable and decreased inventories. Cash
was also received from increased borrowings on the Company's line of credit.
In the second quarter the Company wrote-off $1,200,000 of excess inventory
and end-of-life products. During the third quarter of 1997, similar
write-offs, including write-offs of service inventories aggregated
$1,600,000. In addition, $2,610,000 was added to reserves for excess and
obsolete inventories.
The Company's liquidity position continues to be severely constrained. The
Company currently has a revolving line of credit agreement with a lender,
collateralized by substantially all assets of the Company, which expires on
September 30, 1998. Although the Company has a maximum availability of
$10,000,000 under the line of credit based on a percentage of eligible accounts
receivables and inventories, its ability to borrow against the revolving line of
credit is largely dependent upon its level of eligible accounts receivable.
Because of its lower than expected level of shipments, the Company's eligible
account receivables are also lower than expected and the
11
<PAGE>
Company frequently has exceeded the maximum available under the line of
credit. Borrowings under the line of credit totaled $3,276,000 at December
28, 1996, $4,527,000 at September 27, 1997, and $6,162,000 at November 20,
1997. At November 20, 1997, the Company had borrowed in excess of its
available credit under the line.
As a result of the Company's difficulty in paying its trade debt on a timely
basis, the Company sought the cooperation of its creditors in a restructuring
of its trade debt. As previously disclosed, in July 1997, the Company held a
meeting with its trade creditors. A committee of the creditors, representing
in excess of 50% of the Company's trade debt, was formed. The committee
initially agreed to a 60-day moratorium on the payment of the Company's
outstanding trade debt. There have been three subsequent extensions of the
moratorium and the current extension expires December 15, 1997. No assurance
can be given that the moratorium will be extended. In the event the Company
is unable to obtain additional extensions of the moratorium it may be unable
to continue to operate as a going concern and may be required to seek
protection under the Federal Bankruptcy laws.
During the second quarter of 1997 the Company retained a turnaround and
management consulting firm and a law firm to assist the Company in dealing
with various creditors and related matters. The Company also engaged an
investment banking firm to assist the Company in evaluating its alternatives,
including the possibility of locating a financial or industry partner or
other transaction. The Company has continued to retain the services of the
law firm but the turnaround and management consulting firm is no longer
retained by the Company. The investment banking firm was not successful in
its efforts to locate a financial or industry partner nor was it successful
in identifying other transactions that could materially benefit the Company.
Concurrent with the change in management that occurred on August 21, 1997,
the Company retained a new financial management and consulting firm to assist
it in restructuring the Company and identifying sources of financing and in
providing supplemental support to the Company's financial management and
accounting functions. There can be no assurance that sources of financing
can be identified or that any financing transaction can be consummated under
terms which will allow the Company to continue to operate as a going concern.
There is no forbearance agreement in place with the Company's secured lender
and none is expected to be executed, although the Company's secured lender
has continued to provide borrowings to the Company. The Company has been
advised by its secured lender, however, that the secured lender expects the
Company to find a replacement lender in the very near future. The Company
has been actively soliciting the involvement of alternative lenders. There
can be no assurance, however, that the Company will be successful in finding
a replacement lender. The Company has borrowed amounts from its secured
lender that exceed the amounts permitted as calculated using the Company's
eligible borrowing base under its line of credit. While the lender has
cooperated so far with the Company's efforts to meet its ongoing working
capital requirements, there can be no assurance that such cooperation will
continue. In the event the Company is declared in default under the line of
credit by the lender and demand for payment is made, the Company would be
unable to make such payment.
In the event that the Company is unable to locate other sources of funding to
meet its current cash needs, it may be unable to continue to operate as a
going concern and may be required to seek protection under the Federal
Bankruptcy laws.
GENERAL AND RISK FACTORS
CHANGES IN MANAGEMENT
The Company has experienced significant turnover in its senior management in
the last year. Although the Company's founder, William F. Blum, has returned
to active management of the Company and has directed a complete restructuring
of the Company, there can be no assurance that the cumulative effects of
management turnover will not have a negative effect on the Company's
operations and financial results.
SALES AND MARKETING
During the second quarter of 1997, the Company reduced the prices of APEX by
33% in an effort to broaden its market base and increase sales in the third
quarter 1997. The Company subsequently made the determination that the
previous price reduction was unwarranted and prices were increased
accordingly. The Company is also moving aggressively to focus on the
optical library market. The critical tasks facing the Company in future
quarters are managing liquidity and building demand for APEX technology (and
applications of that technology such as optical libraries). Although
management believes that the demand for optical libraries indicates market
acceptance of the APEX 4.6 GB capacity point, if demand for APEX-based
optical library solutions cannot be
12
<PAGE>
developed to satisfactory levels and sustained at those levels, the Company
will have further significant liquidity constraints.
Marketing efforts are being directed at optical libraries and mid-range
($10,000-$100,000 systems) computer systems, medical imaging, near on-line
storage, video on demand and document imaging markets. The Company also
sells its products through the major distribution and catalog channels. The
Company is seeking to have its products certified as compatible by additional
leading software vendors in the belief that such certification may generate
additional sales of APEX.
The Company's marketing and advertising expenditures were reduced in the
third quarter as compared to the average for the previous two quarters.
CONVERSION OF CONVERTIBLE DEBENTURES
In December 1996, the Company sold an additional $5,000,000 principal amount
of 6% convertible debentures pursuant to an offshore private placement. The
proceeds from this offering were used entirely for the Company's liquidity
needs at the end of the fourth quarter of 1996 and during the first quarter
of 1997.
As of August 1, 1997, all of the debentures had been converted into 3,675,973
shares of common stock at conversion prices ranging from $0.53 to $4.16 per
share. Stockholders' equity was increased by the full amount of the
debentures converted less the unamortized debt issuance costs. In addition,
78,101 shares of common stock were issued for $94,341 of interest payable on
the converted debentures.
BACKGROUND RISKS
The Company's quarterly operating results fluctuate significantly depending
on factors such as timing of product introductions by the Company and its
competitors, market acceptance of new products and enhanced versions of the
Company's existing products, changes in pricing policies by the Company and
its competitors, and the timing of expenditures on advertising, promotion and
research and development.
The Company's component purchases, production and spending levels are made
based upon forecasted demand for the Company's products. Accordingly, any
inaccuracy in forecasting could adversely affect the Company's results of
operations. As is common in many high technology companies, the Company's
shipments tend to be disproportionately higher in the latter part of each
quarter. Past results are not necessarily indicative of future performance
for any particular period.
The computer industry in general, and the market for the Company's products
in particular, is characterized by rapidly changing technology, evolving
industry standards, frequent new product introductions and significant price
competition, resulting in short product life cycles and reductions in unit
selling prices over the life of a specific product. The Company faces
competition from much larger magnetic and optical storage device developers,
including Fujitsu, Sony and Philips. These competitors have engineering and
manufacturing experience greater than the Company, and may be able to bring
comparable or superior products to market which could negatively impact the
results of the Company. The Company faces increasing competition in the "3R"
or removable, rewritable and random access storage market from companies such
as Syquest and Iomega.
There can be no assurance that there will be continued acceptance of the
Company's existing products or that the Company's future products will
achieve market acceptance at acceptable margins.
The market price for shares of f the Company's common stock has been
volatile. The Company's common stock has experienced substantial market price
degradation, which may be attributable to the Company's losses and distressed
financial condition. Factors such as announcements of technological
innovations or new products by the Company or its competitors, variations in
the Company's quarterly operating results, continued high levels of short
selling of the Company's common stock and general economic and stock market
conditions may have material adverse effects on the market price of the
Company's common stock. In addition, as of September 27, 1997 the Company
did not meet the minimum tangible net worth requirement for continued listing
on NASDAQ by a substantial margin. Further, NASDAQ has advised the Company
that due to its late filing of this Form 10-Q it will be delisted on December
1, 1997. Should the Company be unable to obtain approval from NASDAQ for the
late filing of this Form 10-Q or if the Company is unable to find sufficient
financing to enable it to meet the NASDAQ minimum tangible net worth
requirement within whatever time periods permitted by NASDAQ, the Company's
common stock will no longer trade on NASDAQ. Such inability to trade on
NASDAQ could add
13
<PAGE>
further volatility to the market price of the Company's common stock and
could limit the liquidity of a shareholder's investment.
There is no forbearance agreement in place with the Company's secured lender
and none is expected to be executed, although the Company's secured lender
has continued to provide borrowings to the Company. The Company has been
advised by its secured lender, however, that the secured lender expects the
Company to find a replacement lender in the very near future. The Company
has been actively soliciting the involvement of alternative lenders. There
can be no assurance, however, that the Company will be successful in finding
a replacement lender. The Company has borrowed amounts from its secured
lender that exceed the amounts permitted as calculated using the Company's
eligible borrowing base under its line of credit. While the lender has
cooperated so far with the Company's efforts to meet its ongoing working
capital requirements, there can be no assurance that such cooperation will
continue. In the event the Company is declared in default under the line of
credit by the lender and demand for payment is made, the Company would be
unable to make such payment.
In the event that the Company is unable to locate other sources of funding to
meet its current cash needs, it may be unable to continue to operate as a
going concern and may be required to seek protection under the Federal
Bankruptcy laws.
As a result of the Company's difficulty in paying its trade debt on a timely
basis, the Company sought the cooperation of its creditors in a restructuring
of its trade debt. As previously disclosed, in July 1997, the Company held a
meeting with its trade creditors. A committee of the creditors, representing
in excess of 50% of the Company's trade debt, was formed. The committee
initially agreed to a 60-day moratorium on the payment of the Company's
outstanding trade debt. There have been three subsequent extensions of the
moratorium and the current extension expires December 15, 1997. No assurance
can be given that the moratorium will be extended. In the event the Company
is unable to obtain additional extensions of the moratorium it may be unable
to continue to operate as a going concern and may be required to seek
protection under the Federal Bankruptcy laws.
14
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDING
On March 15, 1996, a complaint was filed against the Company and certain of
its current and then directors and executive officers in a securities class
action lawsuit which alleges that Company management engaged in improper
accounting practices and made certain false and misleading statements. The
complaint was filed in the United States District Court for the Central
District of California under the case name Wills, Cohen, et al. v. William
Blum et al., Case No. SACV96-261GLT. On or about November 10, 1997, the
Company reached an agreement in principle with the plaintiffs to settle the
lawsuit. Plaintiffs have agreed to accept payment of $2,325,000 in exchange
for a complete release of all claims arising from the allegations set forth
in the plaintiffs' complaint. All of the terms of the settlement are not
final, and the settlement is subject to preliminary and final approval by
Court as well as approval by the members of the class. The Company's
insurers have agreed to advance all settlement and defense costs, including
the Company's attorneys' fees and expenses, subject to the Company's
agreement to reimburse the insurers for up to approximately $577,000 of those
settlement and defense costs if the Company achieves certain positive
financial results prior to the federal Court's final approval of the
settlement. Although the Company does not concede that any portion of the
class action settlement is allocable to the Company, the Company has agreed
to the terms of the settlement to avoid further costs.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
There is no forbearance agreement in place with the Company's secured lender
and none is expected to be executed, although the Company's secured lender
has continued to provide borrowings to the Company. The Company has been
advised by its secured lender, however, that the secured lender expects the
Company to find a replacement lender in the very near future. The Company
has been actively soliciting the involvement of alternative lenders. There
can be no assurance, however, that the Company will be successful in finding
a replacement lender. The Company has borrowed amounts from its secured
lender that exceed the amounts permitted as calculated using the Company's
eligible borrowing base under its line of credit. While the lender has
cooperated so far with the Company's efforts to meet its ongoing working
capital requirements, there can be no assurance that such cooperation will
continue. In the event the Company is declared in default under the line of
credit by the lender and demand for payment is made, the Company would be
unable to make such payment.
In the event that the Company is unable to locate other sources of funding to
meet its current cash needs, it may be unable to continue to operate as a
going concern and may be required to seek protection under the Federal
Bankruptcy laws.
As a result of the Company's difficulty in paying its trade debt on a timely
basis, the Company sought the cooperation of its creditors in a restructuring
of its trade debt. As previously disclosed, in July 1997, the Company held a
meeting with its trade creditors. A committee of the creditors, representing
in excess of 50% of the Company's trade debt, was formed. The committee
initially agreed to a 60-day moratorium on the payment of the Company's
outstanding trade debt. There have been three subsequent extensions of the
moratorium and the current extension expires December 15, 1997. No assurance
can be given that the moratorium will be extended. In the event the Company
is unable to obtain additional extensions of the moratorium it may be unable
to continue to operate as a going concern and may be required to seek
protection under the Federal Bankruptcy laws.
15
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit Number Description
- -------------- -----------
27 Financial Data Schedule
(b) Reports on Form 8-K:
None.
16
<PAGE>
SIGNATURES
PINNACLE MICRO, INC.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 26, 1997 By: \s\ William F. Blum
-------------------------------
William F. Blum
Chairman, President, Chief
Executive Officer and
Chief Financial Officer
(Duly Authorized Officer)
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED BALANCE SHEET AS OF SEPTEMBER 27, 1997 AND THE UNAUDITED
CONDENSED STATEMENT OF OPERATIONS FOR THE THIRTY-NINE WEEK PERIOD ENDED
SEPTEMBER 27, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-27-1997
<PERIOD-START> DEC-28-1996
<PERIOD-END> SEP-27-1997
<CASH> 572
<SECURITIES> 0
<RECEIVABLES> 6,218
<ALLOWANCES> 162
<INVENTORY> 7,442
<CURRENT-ASSETS> 14,411
<PP&E> 4,319
<DEPRECIATION> 3,741
<TOTAL-ASSETS> 15,061
<CURRENT-LIABILITIES> 23,657
<BONDS> 0
0
0
<COMMON> 15
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 15,061
<SALES> 28,690
<TOTAL-REVENUES> 28,690
<CGS> 34,639
<TOTAL-COSTS> 34,639
<OTHER-EXPENSES> 16,367
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,384
<INCOME-PRETAX> (23,700)
<INCOME-TAX> 63
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (23,763)
<EPS-PRIMARY> (1.88)
<EPS-DILUTED> (1.88)
</TABLE>
