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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 26, 1998
OR
[X] 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.
(Exact name of Registrant as specified in its charter)
Delaware 33-0238563
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
140 Technology Drive, Suite 500
Irvine, CA 92618
(Address of principal executive offices) (Zip code)
949-789-3000
(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, par value $0.001 per share
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 No X
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of December 26, 1998, 14,500,089 shares of the Registrant's Common Stock were
outstanding. As of December 26, 1998, the aggregate market value of the
Registrant's Common Stock, held by non-affiliates of the Registrant was
approximately $1,132,000 based on the closing sales price of $ 0.078 per share
of the Common Stock as of such date, as reported by the Pink Sheets published by
the National Quotation Service.
Page 1 of 52 pages
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PART I
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This Report contains forward-looking statements within the meaning 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 many factors, including but not limited to the risk factors
stated here and through this Report.
Item 1. Business
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General
Pinnacle Micro, Inc., (the "Company") is a designer, manufacturer, supplier
and reseller of removable optical storage systems. The Company's products read
from and write data to optical media. In 1996, the Company changed its core
business from reselling products manufactured by others to research, development
and manufacturing. During 1997, the Company closed its research and development
capabilities and all personnel associated with just the research and development
activities left the Company. The Company's manufactured products range from the
Vertex 2.6 GB ("GB") drive to its 4.5 terabyte multiple disk optical library
systems ("optical library"). The Company resells under its own brand name
compact disc ("CD") recording systems manufactured by others.
During 1998, the Company began selling its existing products on-line. Online
volume sales have not been significant and have had a negative impact on margins
as a result of competition from other on-line resellers.
The Company was incorporated in California in May 1987 and reincorporated
in Delaware in May 1993. The Company's headquarters and operations are located
at 140 Technology Drive, Suite 500, Irvine, California 92618, and its telephone
number is (949) 789-3000.
Significant Risk Factors
Readers of this Report should carefully consider, in addition to the other
information contained in this Report, the following:
Losses, Liquidity and Capital Resources
As a result of continuing significant losses, the Company has experienced
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 in July 1997.
A committee of the creditors, representing in excess of 50% of the Company's
trade debt, was formed. The committee has agreed to several moratoriums on the
payment of the Company's outstanding unsecured debt. The Company is currently
operating under an informal moratorium with no defined termination date. No
assurance can be given that the creditors' committee will continue the
moratorium. 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
will seek protection under the Federal bankruptcy laws.
Despite the Company's efforts to secure additional funding, the Company has
been unable to secure adequate financing. While the Company continues its search
for financing, 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, the
absence of which will lead the Company to seek protection under the Federal
bankruptcy laws.
There is no forbearance agreement in place with the Company's secured
lender and none is currently expected to be executed, although the Company's
secured lender has continued to provide borrowings to the Company. 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 or that its current lender will continue to provide funding
for the Company's operating needs. 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 thus 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, will be unable to continue to operate as a going
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concern and will seek protection under the Federal bankruptcy laws. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Changes in Management.
The Company has experience turnover of some members of the management team,
however, as of the end of the company's fiscal year, William F. Blum continues
to reside as President and Chief Executive Officer. There can be no assurance
that further management turnover can be prevented, the occurrence of which will
have a negative effect on the Company's operations and financial results..
Technological Competition
The Company's limited working capital resources and acute need for
additional funding are currently preventing the Company from developing its own
new products. Consequently, the Company's revenue is dependent on new product
availability from OEMs. The unwillingness of existing OEM's to continue to sell
through the Company's distribution channel, the announcement, introduction or
market expectation of new products based on new or enhanced technologies, the
emergence of new industry standards, widely accepted operating systems or
significant price reductions on competitors' products will adversely affect the
sales and prices of the Company's products and the Company's results of
operations.
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. There can be no assurance that the
Company will not experience significant delays in the introduction of new
products in the future, as it has in the past, which could have a material
adverse effect on the Company's results of operations.
Fluctuations in Quarterly Operating Results
The Company's quarterly operating results can fluctuate significantly
depending on factors such as timing of product introductions by the Company and
its competitors, market acceptance of new products, changes in pricing policies
by the Company and its competitors, currency fluctuations and the timing of
expenditures on advertising and promotion. In addition, the Company's product
purchases, component purchases, production and spending levels are made based
upon forecasted demand for the Company's products. Any significant shortfall in
forecasted demand will have an immediate adverse impact on the Company's
quarterly results of operations and financial condition. Given the fundamental
changes in the Company's business in 1997 and 1998, there can be no assurance
that the Company will experience revenue growth and profitability in future
periods.
International Trade, Foreign Exchange Dependent Purchases; Currency Fluctuations
The risks of international trade include foreign government regulation, the
difficulties of finding and retaining competent management, miscommunication,
local preferences and changes in taxes and duties. The Company's optical
mechanical storage subassembly ("OMA") suppliers, media suppliers and a number
of the Company's other component suppliers are located in Japan, which subjects
the Company to risks of changes in government policies and regulatory
requirements, transportation delays and the imposition of tariffs and export
controls. In the past the Company experienced losses arising from changes in the
Japanese Yen vs. U.S. dollar exchange rates. Although the Company's purchases
and sales are now dollar denominated, there can be no assurance that the
Company's future results of operations will not be adversely affected by
currency fluctuations.
Products
Magneto Optical Products
The Company's MO drive products combine proprietary firmware, electronics
design, application specific integrated circuits ("ASICs") with optical OMA's
manufactured by a third party. In the 3rd quarter of 1998, the Company
introduced the higher capacity Ultra 5.2 GB drive sold via OEM suppliers.
Despite this product's introduction, the Company's core technology and lead
product continues to be the Apex 4.6 GB 5.25" MO Drive. The Vertex 2.6 GB
product line was discontinued in early 1998. The Company's optical storage
systems are compatible with most personal computer and workstation operating
systems, including Windows NT, Windows 95, Macintosh OS, DOS, Windows and UNIX.
External systems attach to a computer system and include a power supply, OMA,
drive electronics, firmware, software, a SCSI cable and, where necessary, a SCSI
interface card. Internal systems do not include a power supply. The Company
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provides a one year warranty against defects in material and workmanship for all
of its products. The Company's 3.5" 640 MB Tahoe product was discontinued in
1997.
The Apex optical storage systems conform to certain industry standards,
which allow for disk interchangeability among 2.6 GB MO systems and
compatibility with future generations of 3.5" and 5.25" systems, respectively.
The Company's Apex 4.6 GB product also reads 2.0 GB media, but not lower
capacity media.
Network Optical Library Systems
The Company also manufactures and sells a line of optical libraries based
on its Apex technology with storage capacities ranging from 75 GB to 4.5
terabytes. The library mechanisms are obtained from third party suppliers and
are integrated by the Company into its library systems. These library systems
are most often used in client/server or other networked environments and are
free standing, fully enclosed units with robotic arms that move 5.25" optical
disks to and from one or more internally mounted drives. The Company believes
that library sales are a significant potential market for the Company and the
Apex technology.
CD Recorder Systems
The Company distributes compact disc-recorder ("CD-R") systems under its
own brand name and has done so since 1993. The Company's CD-R systems are
comprised of drive assemblies manufactured by third-party suppliers, which the
Company differentiates from products of its competitors through added software
and packaging. The Recordable Compact Disc ("RCD") 4x12 continued to be the
Company's main CD-R line of products. CD-R products are combined with Adaptec's
"EZCD Pro" software for PC environments and Adaptec's "Toast" software for the
Macintosh environment. CD-R systems are used to create custom CDs for low volume
data reproduction and distribution. CDs created in a standardized "ISO 9660"
format can be utilized in most CD-ROM drives and players. The CD-R can be used
with Macintosh, IBM, and Unix compatible personal computers.
The Company's Apex and CD-R product lines provided the primary source of
revenue during 1998. The Company expects the CD-R product line and business to
continue to provide important revenue and product mix contributions to the
Company's business.
"Ready to Store" RTS Program
The Company's independent software vendors ("ISV") program is intended to
assure compatibility between the Company's products and important software
products, in order to increase market acceptance of Apex technology. The Company
improved software compatibility and certification in 1997, as optical library
purchases often depend first on software selection. Participants include Avail
Systems, Dantz, FileNet Corporation, Keyfile, KOM, Micro Design International,
Inc., Optical Technology Group, Inc., Optika Imaging Systems, Inc., Optisys,
Inc., Pegasus Disk Technologies, Inc., Seagate Software, Inc., Software
Architects, Tracer Technologies, Inc., and Watermark Software, Inc.
Optical Storage Media
The Company sells proprietary media for the Apex products as well as
industry standard 2.6 GB media for the Vertex and Apex. The Company also markets
and sells recordable CD media for use with its CD-R products. The Ultra media is
also sold but not proprietary to the Ultra drive.
The Company's 5.25" optical storage system conforms to standards that have
been adopted by the International Standards Organization (ISO), the American
National Standards Institute (ANSI) and the European Computer Manufacturers
Association (ECMA). These standards allow for disk interchangeability among
systems and compatibility with future generation systems based on the same media
dimensions. Company's Apex 4.6 GB drive system and media do not conform to such
standards. The Vertex media is ANSI/ISO compliant, but it is not ECMA compliant.
The Company purchases all media from third party suppliers and resells the media
under Company trademarks.
Sales, Marketing and Distribution
Market and industry trends are toward ever-increasing memory and storage
capacity. The Apex and Ultra technology is a removable, rewritable and reliable
solution, for near on-line and archival storage. Markets for Apex and Ultra
technology include archiving, desk top publishing, multi-media, graphic design,
medical imaging, network storage, near on-line storage and other data-intensive
uses.
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The Company sells its products through distributors, catalogs, value-added
resellers ("VARs"), systems integrators, and direct on-line sales. The Company
also sells to end users directly through its internal sales force. The Company's
distributor channel consists both of one national and one value added
distributor. In addition, The Company sells through many catalogs and through
regional distributors.
In conformance with industry practice, the Company generally provides
distributors with stock balancing and price protection rights. This permits
distributors to return slow moving products to the Company for credit and
provides price adjustments for inventories of the Company's products held by
distributors if the Company subsequently lowers the prices of those products.
The Company's international sales are made through a network of
distributors and resellers, which market and distribute the Company's products
worldwide. The risks of international sales include, among other things, finding
and retaining good customers, local or regional competition, currency
fluctuations that can affect demand for the Company's products, export and
import controls and government regulation and tariffs.
Customer service (order fulfillment) and technical support of the Company's
products are an integral part of the Company's business. The Company continues
to use an out-sourced technical support service for product support. There can
be no assurances given the Company's financial difficulties that the technical
support services will continue on terms that are reasonable for the Company. The
absence of technical and product support will have a material adverse affect on
the Company.
Research and Development
Prior to October 1997, the Company operated a research and development
facility in Colorado Springs, Colorado, which developed proprietary optical
technology, including systems, mechanical, firmware, electronics design and
ASICs. During October and November 1997, the Company closed the Colorado Springs
facility because the Company no longer had the financial resources to invest in
research and development. All personnel associated with just the research and
development activities have left the Company. Prior to closing the Colorado
Springs facility, the Company's research and development efforts were
principally directed towards completing the development of the Apex II product.
The Company's plans were to continue to engineer the Apex II, but due to capital
restrictions were unable to do so and have subsequently dropped all engineering
for that project. The Company intends to continue to source and sell products
manufactured by other companies, as it has always done.
In 1998, 1997, 1996 and 1995 the Company's research and development
expenditures were approximately $0, $2,984,000, $6,006,000 and $4,978,000,
respectively. The expenses prior to 1998 related primarily to the operations of
the Company's engineering team located in Colorado Springs, Colorado until the
latter part of 1997 when that operation was closed.
Since the closure of the Research and Development and Manufacturing
facility in Colorado Springs was closed in October of 1997, the Company has been
manufacturing it products through an outsourced company in California. This
outsource mainly manufactures and fulfills the Apex line, including the library
systems.
The absence of research and development has precluded the Company from
developing new and future product offerings. Consequently, the Company is
dependent on the continued acceptance of legacy products, principally the Apex
product. A change in demand for these legacy products will have a material
adverse impact on the Company and its results of operation.
Suppliers
OMAs, Apex media and certain of the ASICs and other components used in the
Company's products are obtained from single sources. The Company also purchases
from third party suppliers circuit boards, integrated circuits and other
components used in its products. Since October 1997, the Company has outsourced
its manufacturing and fulfillment operations to unrelated companies. The
Company's dependence on third-party suppliers and service providers involves
several risks, including limited bargaining power over pricing, availability,
quality and delivery schedules for components. There is also the risk that a
large supplier may be using the Company to develop a market for later entry by
the supplier. The Company believes that second sources are available for all
components other than OMAs, Apex media and certain integrated circuits. There
can, however, be no assurance that the Company could obtain all required
components from second sources
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on terms as favorable as those in place, if at all. If the Company's ability to
obtain critical components from its sole source suppliers for its products were
impaired or interrupted for any reason, the Company would not be able to
establish alternative sources and integrate replacement components into its
systems without substantial disruption to the Company's operations.
Inventory
During 1998 the Company's inventories decreased significantly. Inventory
values, net of reserves, for 1998 and 1997 were approximately $4,850,000 and
$6,400,000 respectfully, a decline of over 24%. The decrease was a result of the
Company's reduced sales and the establishment of reserves for excess and
obsolescence of component and sub-assembly inventories to amounts consistent
with the Company's current sales levels and expectations for future sales. Spare
parts inventories were reserved to zero value to reflect the relatively short
product life cycles of the Company's products which reduces opportunities for
revenue generating, out of warranty repair service revenues.
Backlog
As is the case with other companies in the electronics industry, the
Company does not believe that backlog amounts are meaningful indicators of
future revenues unless such backlog amounts are caused by new product
introductions. Sales of the newly introduced 5.2 GB Ultra drive did not meet
Company expectations, therefore no significant backlog for that product exist at
the end of 1998.
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Competition
The market for data storage products is competitive and changing,
characterized by price erosion and short product life cycles. The Company's
products compete directly with other optical storage products and removable
storage products. Competition also comes from storage products based on
alternative technologies such as hard disk drives and tape drives. The Company's
optical storage systems compete directly with those manufactured by Sony
Corporation, Hitachi, Ltd., Hewlett-Packard Company, Fujitsu Ltd., Panasonic,
Iomega, Syquest, Nikon, Ricoh, Ltd., Phillips, N.V. and others. All of these
companies have larger technical staffs, greater brand name recognition and
market presence, larger marketing and sales organizations and greater financial
resources than those of the Company. Certain of the Company's suppliers of
mechanical optical storage subassemblies also develop and market optical storage
systems that compete with those of the Company. Potential direct competitors
include certain computer storage peripheral manufacturers and business storage
systems manufacturers or developers, who may introduce optical storage products
or incorporate a competitive product in their own products. The major
competitive factors in the data storage market include product performance,
capacity, price, size and appearance, reliability, as well as the timing of new
product introductions. There can be no assurance that products based on
competing technologies will not have an adverse effect on the market for optical
data storage products.
While the Company believes that its optical storage products should compete
favorably for applications that require removable, reliable, random access
storage, certain other products such as hard disk drives, tape drives or other
alternative storage technologies, separately or together in various
combinations, may compete more favorably for other applications. Hard disk
drives and tape drives may be less costly alternatives where removable storage
and data security are not required. The optical storage market is still
developing. Hard disk drives compete in cost per megabyte. In the optical media
market, the Company competes as a reseller with a number of other companies,
primarily on the basis of price/performance and purchasing convenience. Optical
media manufacturing is limited to a few companies whose future decisions may
affect the Company's media business. The Company's single source supplier of
optical media for the Apex product also competes against the Company by selling
comparable products. There can be no assurance that the Company will be able to
compete successfully with manufacturers and other resellers of optical storage
products and media or that competition will not have a material adverse effect
on the Company's results of operations.
Intellectual Property and Proprietary Rights
The Company seeks to obtain the appropriate proprietary rights protection
for new technology it develops. The Company attempts to protect its trade
secrets and other proprietary information through agreements with customers and
suppliers, proprietary information agreements with employees and consultants and
other security measures. There can be no assurance that the Company will be
successful in protecting its proprietary technology. Actual protection and its
assumed benefits may differ materially from Company goals as a result of the
intellectual property rights and licensing strategies of the Company's
competitors and of other licensors.
Certain of the Company's products are subject to patents or intellectual
property rights held by third parties. The Company seeks and obtains license
rights, including indemnification against infringement of such patents or
intellectual property rights, as necessary. The high technology industry,
including the data storage industry, has seen a great increase in patent and
related litigation in the past decade. Other entities may hold patents or have
applications on file, which, if valid or enforced, could adversely affect the
Company's use of certain of its technologies and processes. There can be no
assurance that the Company will be successful in obtaining acceptable license
rights and terms if in fact licenses are necessary. The Company anticipates that
it may have continuing obligations and expenses related to licensing third party
technology. There can be no assurance that third parties will not assert
infringement claims against the Company in the future or that any such assertion
may not require the Company to enter into royalty arrangements or costly
litigation.
The Company has patent applications pending in the United States and
intends to file additional patent applications relating to the designs employed
within certain of its products, both hardware and software. There can, however,
be no assurance that any patents applied for will be granted.
Employees
As of December 26, 1998, the Company employed 21 full-time employees. The
Company's current employees are engaged in sales and administrative activities
and management of the Company's outsourced activities. The Company's employees
are not represented by any collective bargaining agreements, and the Company has
never experienced a work stoppage. There can be no assurances that further
turnover of key employees will not occur. The loss of the remaining key
employees will have a material adverse impact on the Company.
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Item 2. Properties
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The Company leases and occupies an 11,180 square foot facility in Irvine,
California. The lease for this facility was renewed in November 30, 1998 for one
year.
Item 3. Legal Proceedings
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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. During 1998, it was determined that the company will
not achieve certain positive financial results and therefore reversed the
amounts included in 1997. 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. The Company's
portion of the settlement, which totaled $232,000, had been included in the
results of operations for the fourth quarter ended December 27, 1997.
The Company and certain members and former members of its senior management
were the subject of an investigation by the Securities and Exchange Commission
(the "SEC") relating principally to the restatement of the Company's previously
reported financial results for 1993 and 1994. During the fourth quarter of 1997,
the investigation conducted by the SEC 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 former officers and a
permanent injunction barring future violations of certain accounting provisions
against a third former officer, who was also fined $25,000.
The resignation of the Company's prior independent public accountants on
February 20, 1996, led to additional inquiries by the SEC. These inquiries
related principally to the accounting matters discussed in Note 13 of Notes to
Financial Statements (1995 adjustments). The inquiries by the SEC were concluded
as part of the resolution of the SEC's investigation as described in the
previous paragraph.
Numerous judgments have been obtained by certain creditors demanding
payment of past due obligations. In the opinion of counsel for the Company,
attempts to collect against these judgments would not be successful because of
prior lien recorded by the Company's secured lender and by the Credit Managers
Association of California on behalf of all of the Company's unsecured creditors.
The Company is also subject to other legal proceedings and claims that
arise in the normal course of business. While the outcome of these proceedings
cannot be predicted with certainty, the Company does not believe that the
outcome of these other legal matters will have a material adverse effect on the
Company's financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders, through the solicitation
of proxies or otherwise.
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PART II
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Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
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The Company's common stock is traded on the Pink Sheets published by the
National Quotation Service under the symbol PNCL. From July 1, 1993 until
February 4, 1998, the Company's common stock was traded on the NASDAQ National
Market System. On February 4, 1998, the company's common stock was delisted from
the NASDAQ National Market System because of non-compliance with NASDAQ's
listing criteria. The following table sets forth, for the periods indicated, the
range of high and low bid prices for the Company's common stock. These prices do
not include adjustments for retail mark-ups, mark-downs or commissions.
<TABLE>
<CAPTION>
High Low
<S> <C> <C> <C>
1996: 1st Quarter 16.500 $7.250
2nd Quarter 12.000 6.625
3rd Quarter 9.000 4.875
4th Quarter 8.750 2.000
1997: 1st Quarter 7.813 2.375
2nd Quarter 2.750 .969
3rd Quarter 1.531 .594
4th Quarter .938 .125
1998: 1st Quarter .563 .156
2nd Quarter .250 .156
3rd Quarter .313 .156
4th Quarter .391 .063
</TABLE>
There were 1,009 security holders of record as of January 7, 1999. Other
than S Corporation distributions to the Company's existing stockholders in
connection with the termination of the Company's S Corporation status on July 1,
1993, the Company has not paid cash dividends and intends to retain earnings, if
any, for use in the business for the foreseeable future. Under the terms of the
Company's revolving line of credit agreement (see Note 5 of the Notes to
Financial Statements), the Company is contractually restricted from paying cash
dividends.
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Item 6. Selected Financial Data
-----------------------
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
- ----------------------------------------------------------------------------
STATEMENTS AND NOTES THERTO FOR THE YEARS 1997 AND 1998 FROM ITS INDEPENDENT
- ----------------------------------------------------------------------------
AUDITOR PRINCIPALLY AS A RESUULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER THE
- ------------------------------------------------------------------------------
ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE
- ------------------------------------------------------------------------
FINANCIAL STATEMENTS AND NOTES THERETO, SELECTED FINANCIAL DATA, AND
- --------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
- --------------------------------------------------------------------------
OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS UNAUDITED FOR THE YEARS 1997 AND
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1998. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL DATA,
- -----------------------------------------------------------------------------
AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
- ------------------------------------------------------------------------------
OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT AUDITORS
- ------------------------------------------------------------------------
ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY
- -------------------------------------------------------------------------------
FOR DECEMBER 27, 1997 AND DECEMBER 26, 1998 PRESENTED IN THIS FORM 10-K.
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The following selected financial data should be read in conjunction with
the Financial Statements and the accompanying notes and the management's
discussion and analysis of financial condition and results of operations
appearing elsewhere herein. The statement of operations data and the balance
sheet for the years ended December 26, 1998 and December 27, 1997 are derived
from unaudited results as more fully described above. The statement of
operations data for the years ended December 28, 1996 and December 30, 1995, and
the balance sheet data at December 28, 1996, is derived from, and should be read
in conjunction with, the audited financial statements for each of those years
The statement of operations data set forth below with respect to 1994 and the
balance sheet data at December 30, 1995 and December 31, 1994 is derived from
unaudited financial statements not included in this Form 10-K.
<TABLE>
<CAPTION>
Fiscal Year Ended Dec. 26, Dec 27, Dec. 28, Dec. 30, Dec. 31,
In thousands except per share data -------- ------- -------- -------- --------
1998 1997 1996 1995 1994
---- ---- ----- ----- ----
UNAUDITED UNAUDITED
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net Sales $ 10,554 $ 31,124 $ 59,921 $ 81,844 $ 65,382
Gross Profit (loss) 1,073 (8,763) 11,829 21,952 19,784
Income (loss) from Operations (3,912) (28,579) (18,463) (3,274) 4,231
Net Income (loss) (4,556) (30,229) (20,833) (2,459) 2,793
Net Income (loss) per share (1) (0.31) (2.32) (2.52) (0.31) 0.35
Pro Forma Statement of Operations Data (2):
Pro forma net income $ - $ - $ - $ - $ -
Supplementary pro forma net income per share (1) - - - - -
<CAPTION>
In thousands Dec. 26, Dec. 27, Dec. 28, Dec. 30, Dec. 31,
1998 1997 1996 1995 1994
UNAUDITED UNAUDITED
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital (deficiency) $ (20,215) $ (15,928) $ 12,710 $ 15,527 $ 17,105
Total Assets 4,979 12,544 40,238 32,005 28,855
Notes Payable and Long-term debt 5,507 6,166 9,698 - 1,439
Shareholders' equity (deficit) (20,025) (15,470) 8,503 16,741 18,911
</TABLE>
(1) The net income (loss) per share and the supplementary pro forma net income
per share have been retroactively restated to reflect the 1995 stock
dividend. (See Note 7 of Notes to Financial Statements).
(2) Effective May 1, 1989, the Company elected to be taxed as an S Corporation.
Accordingly, the provisions for income taxes for the periods from May 1989
to June 30, 1993 were computed by applying the California franchise tax
rate for S Corporations of 2.5% to pretax earnings. The pro forma data are
unaudited and reflect provisions for federal and state income taxes
(assuming an effective tax rate of 36.3% for the year ended December 31,
1993) as if the Company had not elected to be treated as an S Corporation
during that period. In accordance with a regulation of the SEC, the pro
forma net income per share for the year ended December 31, 1993 reflects
the effect of an assumed issuance of 301,352 average shares at the initial
public offering price of $7.00 per share, which would have generated
sufficient cash to pay an S Corporation distribution in an amount equal to
retained earnings at June 30, 1993.
10
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
This Section contains forward-looking statements within the meaning 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
in the forward-looking statements as a result of many factors, including but not
limited to the risk factors stated here and throughout this Report.
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
- ----------------------------------------------------------------------------
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR PRINCIPALLY AS A RESULT
- --------------------------------------------------------------------------------
OF THE INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO CONTINUE
- --------------------------------------------------------------------------------
AS A GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES THERETO,
- -----------------------------------------------------------------------------
SELECTED FINANCIAL DATA, AND MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------------------------------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS
- ----------------------------------------------------------------------
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
- ----------------------------------------------------------------------------
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -------------------------------------------------------------------------
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT
- --------------------------------------------------------------------------
AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE
- --------------------------------------------------------------------------------
COMPANY FOR DECEMBER 27, 1997 AND DECEMBER 26, 1998 PRESENTED IN THIS FORM 10-K.
- --------------------------------------------------------------------------------
General
In 1998, the Company incurred a net loss of $4,555,000 on net sales of
$10,554,000. During the years 1997 and 1998 the company incurred significant and
critically serious problems, which continue to the date of this Form 10-K. The
Company continues to incur significant losses and quarterly sales remain
significantly below historical levels and those levels required for
profitability. As of December 26, 1998, the Company's liabilities exceeded its
assets by $20,025,000. The Company's liquidity position continues to be severely
constrained. As of December 26, 1998, the Company's working capital deficiency
was $20,215,000. The Company was unsuccessful in its attempt to transition from
a reseller of OEM products to an engineering and manufacturing company and it
was, accordingly, forced to abandon its research and development and
manufacturing capabilities during 1997. The Company's revised strategy is to
return to its original concept as a reseller of OEM products. The Company's
future now depends upon its ability to obtain and sell state of the art products
developed and manufactured by OEMs. There can be no assurances that the Company
will be successful in its strategy, the absence of which will require the
Company to seek protection under the Federal bankruptcy laws.
Significant events affecting the Company in 1998 included:
During 1998, the Company incurred significant losses each quarter. These
results did not allow the company to pay any amounts to its unsecured creditors.
The Company continues to operate out of compliance with the terms of the secured
lender.
As a result of the Company's severe liquidity problems, the Company was
unable to pay its trade debt on a timely. Consequently, the Company sought the
cooperation of its creditors in a restructuring of its trade debt in July, 1997.
The Company held a meeting with its trade creditors and 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 were subsequent extensions of the
moratorium. During 1998, the Company's creditors voted to reject the
reorganization plan. During late 1998 a final vote was taken to approve the
informal reorganization plan. The plan was rejected by a majority vote of the
creditors forcing the Company to continue operations without the satisfaction of
the creditors. In the event the Company is unable to obtain some sort of
agreement with the secured and/or unsecured creditors, it may be unable to
operate as a going concern and will seek protection under the Federal bankruptcy
laws.
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. 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 Company frequently has exceeded the maximum available under the
line of credit. At December 26, 1998, the Company had borrowed in excess of its
available credit under the line.
11
<PAGE>
There is no forbearance agreement in place with the Company's secured
lender, although the Company's secured lender has continued to provide
borrowings to the Company. 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. The Company is also in default
under other provisions of the agreement relating to 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 then be unable to
continue to operate as a going concern and will seek protection under the
Federal bankruptcy laws.
During August 1998, three creditors filed an involuntary bankruptcy
petition against the Company. In October 1998, the bankruptcy court dismissed
the petition. The company made no payments to the petitioning creditors,
provided no financial inducements to the petitioning creditors, nor provided any
other consideration to the petitioning creditors. Although no material damages
were awarded to the creditors, the Company did experience severe negative press
in relation to the petition. There can be no assurance that other creditors will
not file petitions against the Company and cause the Company to be liquidated.
During 1998, two of the four remaining board members resigned as directors
of the Company. In late 1998 Hans Imhoff and James Roszak resiged. During 1999,
Bruce Bastl resigned as a board member. As of the filing of this Form 10K,
William F. Blum is the sole remaining board member.
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 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. The Company's
portion of the settlement which totaled $232,000 has been included in the
results of operations for the fourth quarter ended December 27, 1997. In
September 1998, the Company concluded that they would not achieve positive
financial results and reversed the adjustment made in December 1997.
12
<PAGE>
Results of Operations
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
- ----------------------------------------------------------------------------
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR PRINCIPALLY AS A
- -------------------------------------------------------------------------
RESUULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO
- -------------------------------------------------------------------------------
CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES
- -----------------------------------------------------------------------------
THERETO, SELECTED FINANCIAL DATA, AND MAMANEMENT'S DISCUSSION AND ANALYSIS OF
- -----------------------------------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS
- --------------------------------------------------------------------------------
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
- ----------------------------------------------------------------------------
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -------------------------------------------------------------------------
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT
- --------------------------------------------------------------------------
AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE
- --------------------------------------------------------------------------------
COMPANY FOR DECEMBER 27, 1997 AND DECEMBER 26, 1998 PRESENTED IN THIS FORM 10-K.
- --------------------------------------------------------------------------------
The following table sets forth certain statement of operations data as a
percentage of net sales for the fiscal years indicated:
<TABLE>
<CAPTION>
1998 1997 1996
UNAUDITED UNAUDITED
<S> <C> <C> <C>
Net Sales:
- -Optical storage devices 100.0% 100.0% 100.0%
- -Components - - -
---------------------------------------------------
Total Net Sales 100.0 100.0 100.0
Cost of Sales:
- -Optical storage devices 90.0 128.1 80.3
- -Components - - -
---------------------------------------------------
Total Cost of Sales 90.0 128.1 80.3
Gross Profit (Loss) 10 (28.1) 19.7
Operating Expenses:
- -Selling, general and administrative 47.2 47.4 32.6
- -Research and development 0.0 9.6 10.0
- -Non recurring charges 0.0 6.7 7.9
---------------------------------------------------
Total operating expenses 47.2 63.7 50.5
Operating Loss (37.1) (91.8) (30.8)
Interest income 0.1 0.1 0.1
Interest expense (6.2) (2.6) (0.9)
Non-cash interest expense (6.2) (2.6) (0.9)
Loss before income taxes (43.2) (96.8) (34.5)
Income tax expense (benefit) - 0.2 (.3)
---------------------------------------------------
Net Loss (43.2)% (97.0)% (34.8)%
===================================================
</TABLE>
Comparison of 1998 to 1997
Net Sales. Net sales of optical storage devices decreased 66.0% to
$10,554,000 in 1998. The decrease was primarily attributable to the very
significant decrease in the 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.. Returns as a percentage of sales decreased from
19.4% to 9.0% in 1997 and 1998 respectfully. The product returns in 1997 and
1998 were the result of initial product quality problems with the Company's Apex
and Vertex drives, stock rotation returns by the distributor channel and general
returns.
Gross Profit (Loss). The Company realized a gross profit of $1,048,000 or
10.2% in 1998 compared to a gross loss of $6,203,000 for 1997. The gross margin
loss in the prior year was principally the result of increased inventory
reserves taken for component parts of the Apex and Vertex lines of inventory
which were deemed excess or obsolete based upon sales projections. In addition,
the Company incurred significant costs associated with the move of the Research
and Development and production facilities to Colorado and back all in 1997. The
gross margin realized in 1998 is principally attributable to the sale of lower
cost legacy products.
13
<PAGE>
Inventory reserves were taken in the 4th quarter of 1998 to reserve for excess
and obsolete inventory. Obsolescence reserves amounting to $1,100,000 were taken
for the Vertex line that was discontinued in early 1998. All Vertex components
and service parts inventory were fully reserved. In addition, inventory reserves
were taken to recognize diminished values of Apex 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 year 1998.
Selling, general and administrative. Selling, general and administrative
expenses decreased 86.3% to $3,912,000 and decreased as a percentage of net
sales to 37.1% in 1998 from 47.4% in 1997. The decreased absolute dollars of
Selling, General and Administrative expenses can be attributed to the Company's
need to decrease overall expenditures due to increased cash flow restraints. The
Company continued to decrease promotional and advertising expenses along with
sales and administrative staffing. The decrease as a percentage of sales is
attributed to the significant decline in operating expenses that decreased at a
faster pace than the decrease in gross sales.
Research and development. Research and development expenses decreased
100.0% to zero in 1998. Due to cash funding restraints and the switch to
Reseller and OEM Sales, the Company has discontinued virtually all the Research
and Development activities in 1998.
Nonrecurring Charges. Nonrecurring charges were $0 and $2,087,000 for the years
1998 and 1997, respectively. Nonrecurring charges for 1997 include $857,000
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 1997 also include
$807,000, principally for the establishment of employee severance accruals and
$577,000 for accrued class action settlement and legal costs. For 1998, no
nonrecurring charges were incurred. The $577,000 accrual in 1997 was reversed in
1998 as the class action settlement was resolved and the Company had no
obligations pertaining to that settlement.
Interest Income and Interest Expense. Interest income was $1,100 and
$84,000 and interest expense was $654,000 and $824,000 in 1998 and 1997,
respectively. The Company borrowed on its line of credit consistently during
1998 and 1997. Additionally, the Company incurred interest expenses relating to
a guarantee made on behalf of Pinnacle Micro, Inc. by William F. Blum. This
guarantee amounted to $225,000 and carries an interest rate of 5% per annum.
Non-cash Interest Expense Related to Convertible Debentures. NONE
Income Taxes. Income tax expense/(income) was $(12,000) for 1998 and
$57,000 for 1997. During 1998 the company recorded a refund of $12,000 from the
Franchise Tax Board of California.
Comparison of 1997 to 1996
Net Sales. Net Sales of optical storage devices decreased 48.1% to
$31,124,000 in 1997. The decrease was primarily attributable to the very
significant decrease in unit sales and average sales price 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.
Gross Profit. The company incurred a gross loss in 1997 totaling $6,203,000
compared to a gross profit in 1996 of $11,829,000. This gross loss is attributed
to the write-off of a portion of the Company's service inventories and the
establishment of substantial additional inventory excess and obsolescence
reserves. An aggregate of $6,893,000 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
year 1997.
Selling, General and Administrative. Selling, general and administrative
expenses decreased 24.5% to $14,772,000 and increased as a percentage of net
sales to 47.4% in 1997 from 32.6% in 1996. The decrease in absolute dollars in
selling, general and administrative expenses can be attributed to the Company's
need to decrease advertising and promotional expenditures and decreased sales
and administrative staffs during the latter half of 1997 in response to the
Company's reduced sales and its severe financial condition. The increase in
percentage of net sales is attributable to the significant decline in net sales
that decreased at a faster rate then the decrease in selling, general and
administrative expenses.
Research and Development. Research and development expenses decreased 50.3%
to $2,984,000 in 1997, and decreased as a percentage of net sales to 9.6% in
1997 from 10.0% in 1996. The decrease in absolute dollars spent on
14
<PAGE>
research and development 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 fourth quarter of 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.
Nonrecurring charges. Nonrecurring charges were $2,087,000 and $4,721,000
for the years 1997 and 1996, respectively. Nonrecurring charges for 1997 include
$857,000 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 1997 also
include $807,000, principally for the establishment of employee severance
accruals and $577,000 for accrued class action settlement and legal costs.
Nonrecurring charges for 1996 included $3,028,000 for costs associated with the
Company's then planned consolidation and transfer of manufacturing operations to
Colorado Springs, Colorado and the closing of its branch office in Japan. These
charges principally reflect the costs associated with early termination of
existing leases, losses from the disposal of assets and severance costs
resulting from work force reductions. Additional nonrecurring charges in 1996
included $1,602,000 primarily for changes to major component contracts with two
key suppliers. As of December 27, 1997, $568,000 of the 1996 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 year ended
December 27, 1997. (See Notes 8 and 10 of Notes to Financial Statements).
Interest Income and Interest Expense. Interest income was $17,000 and
$84,000 and interest expense was $824,000 and $549,000 in 1997 and 1996,
respectively. The Company borrowed on its line of credit consistently during
1997 and frequently during 1996. Additionally, the Company issued convertible
debentures in amounts of $10,000,000 in July 1996 and $5,000,000 in December
1996, which accrued interest at 8% and 6%, respectively. (See Notes 5 and 6 of
Notes to Financial Statements).
Non-cash Interest Expense Related to Convertible Debentures. Non-cash
interest expense results from issuing debentures which are convertible at a
discount from market price of the common stock. The non-cash interest recorded
on the convertible debentures was amortized over the periods during which the
debentures first became convertible and have no effect on stockholders' equity.
During 1996 the Company recorded a non-cash interest charge of $1,721,000.
During 1997 the Company incurred an additional non-cash interest charge of
$786,000 to record the effect of the deferred interest expense in 1997. (See
Note 6 of Notes to Financial Statements).
Income Taxes. Income tax expense was $57,000 for 1997 and $184,000 for
1996. (See Note 9 of Notes to Financial Statements).
Liquidity and Capital Resources
Cash and cash equivalents at December 26, 1998 decreased by $132,000 from
the December 27, 1997 balance. This decrease in available cash balances at
December 26, 1998 occurred principally as a result of losses incurred and a
decrease in overall liabilities offset by a decrease in accounts receivable and
inventory. Operating activities provided/(used) cash and cash equivalents of
$664,000, $(6,545,000), and $(14,889,000) in 1998, 1997 and 1996, respectively.
Inventories decreased by $2,812,000 in 1998. The 1998 decrease in
inventories was primarily attributable to the write-off of a portion of the
Company's service inventories and the establishment of substantial additional
inventory excess and obsolescence reserves. An aggregate of $1,100,000 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 year. Also, inventory has decreased as
inventory parts are being utilized as the life span of the Apex drives have been
extended beyond original sales estimates.
The $4,111,000 decrease in accounts receivable from 1998 to 1997 was caused
by the significant decline in sales in 1998 from 1997 levels and the collection
of amounts owed along with additional reserves for uncollectable accounts.
The Company currently has a revolving line of credit agreement with a
lender which, is collateralized by substantially all assets of the Company. The
Company has a maximum availability of $10,000,000 under the line of credit based
on a percentage of eligible accounts receivable and inventories. Interest is
payable monthly at the lender's reference
15
<PAGE>
rate (8.5% at December 26, 1998) plus 1.75%. As of December 26, 1998 through
March 27, 1999, the Company was not in compliance with the terms of this line of
credit. Although the Company has the maximum availability of $10,000,000 under
the line of credit based on a percentage of eligible accounts receivable 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 accounts
receivable are also lower than expected and the Company frequently has exceeded
the maximum available under the line of credit. At December 26, 1998 and March
27, 1999, the Company had borrowed in excess of its available credit under the
line.
Borrowings under the line of credit totaled $5,503,000 at December 26, 1998
and $5,170,000 at March 27, 1999. (See Note 5 of Notes to Financial Statements).
As a result of the Company's severe liquidity problems, the Company was
unable to pay its trade debt in a timely basis. Consequently, the Company sought
the cooperation of its creditors in a restructuring of its trade debt in July,
1997. In late 1998, a vote was taken by the unsecured creditors to approve an
informal reorganization plan. The creditors rejected that vote and the plan was
dropped. In the event that the Company is unable to agree on a plan with the
creditors, the Company will be unable to continue as a going concern and will
seek protection under the Federal bankruptcy laws.
There is no forbearance agreement in place with the Company's secured
lender, although the Company's secured lender has continued to provide
borrowings to the Company. 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. The Company is also in default
under other provisions of the agreement relating to 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 then be unable to
continue to operate as a going concern and will seek protection under the
Federal bankruptcy laws.
16
<PAGE>
1999 Trends
The Company has continued to incur significant losses, continues to suffer
serious liquidity constraints and has been unable to secure appropriate sources
of additional funding. Consequently, absent a significant increase in revenue or
the availability of other sources of funding, the Company will seek protection
under the Federal bankruptcy laws.
The Company intends to continue selling its Apex drive and the optical
libraries that use the Apex technology. New competing products utilizing newer
technologies are, however, being introduced for sale in the first quarter of
1999, which will provide greater storage capacities. The Company intends to sell
those new products that the Company is able to acquire from OEMs. There can be
no assurance, however, that the Company will be successful in obtaining such
products. The absence of new products will have a material adverse impact on the
Company and its ability to continue as a going concern which will cause the
Company to seek protection under the Federal bankruptcy laws.
The Company faces the following critical challenges in 1999:
Adequate Liquidity to Fund Operations. The Company incurred a net loss of
$752,000 for the first quarter of 1999 ended March 27, 1999. The Company cannot
continue to offset operating losses with asset reductions. Furthermore, the
Company is severely restricted as to the amount of borrowings its secured lender
will permit. There can be no assurance that the Company will be able to operate
profitably or that its secured lender will continue to provide funds to operate
the business. The inability to achieve profitability or secure additional
financing will result in the Company seeking protection under the Federal
bankruptcy laws.
Utilization of Inventories. The Company has significant investments in
component parts and sub-assemblies for its Apex product. To utilize the
components and subassemblies in inventory the Company must continue to sell the
Apex product throughout 1999.. There can be no assurances that the Company will
be successful in its efforts to sell the Apex product or in utilizing the
related components and subassemblies inventories. The inability of the Company
to sell the Apex line of products will have a material adverse impact on the
Company and its results of operations.
Plan of Reorganization With Unsecured Creditors. The Company must reach an
agreement with its unsecured creditors that will provide the Company sufficient
time to repay the amounts owed to the creditors. If no plan is reached, the
Company will be forced to seek protection under the Federal bankruptcy laws.
Retention of Key Employees. With funding restrictions from the Company's
secured lender and the Company's poor financial condition, the Company faces the
task of retaining key employees.
Inflation and Foreign Currency Exchange
Inflation has not had a significant impact on the Company's operating
results. The Company has from time-to-time attempted to reduce its anticipated
exposure to currency fluctuations by negotiating price and other cost
concessions from its suppliers, and by entering hedging transactions, including
the purchase of forward contracts for foreign currencies. Currently, the
Company's product and component purchases are denominated in U. S. Dollars, as
are its sales to international customers. Accordingly, the Company does not
expect to be impacted directly by currency fluctuations. There can be no
assurance, however, that the Company's results of operations will not be
adversely affected by currency fluctuations.
Risk Management
The Company has not used any derivative financial instrument. Company policy
restricts the concentration of credit risk in any one institution and requires
management approval of any hedging strategies and derivative financial
instrument transactions.
This Section and this entire Report on Form 10-K contain forward-looking
statements and include assumptions concerning the Company's operations,
future results and prospects. These forward-looking statements are based on
current expectations and are subject to a number of risks,
17
<PAGE>
uncertainties and other factors. In connection with the Private Securities
Litigation Reform Act of 1995, the Company provides the cautionary
statements included in this Report identifying important factors which,
among other things, could cause the actual results and events to differ
materially from those set forth in or implied by the forward-looking
statements and related assumptions contained in this Section and in this
entire Report.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The financial statements and supplementary data of the Company required by
this item are set forth at the pages indicated at Item 14(a)(1).
Item 9. Changes in and Disagreements With Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
- --------------------
BDO Seidman, LLP
As noted in the Company's Form 8-K dated January 6, 1998, the engagement of
BDO Seidman LLP, the former independent accountants of the Company, was
terminated by the resignation of BDO Seidman LLP.
Coopers & Lybrand L.L.P.
As noted in the Company's Form 8-K dated February 20, 1996, the engagement
of Coopers & Lybrand L.L.P., the former independent accountants of the Company,
was terminated by the resignation of Coopers & Lybrand L.L.P. on February 20,
1996.
Ernst & Young LLP
As noted in the Company's Form 8-K dated March 30, 1995, the engagement of
Ernst & Young LLP, the former independent accountants of the Company, was
terminated by the resignation of Ernst & Young LLP on March 30, 1995.
18
<PAGE>
PART III
--------
Executive Officer Compensation
The following table sets forth compensation received for the fiscal years
ended December 26, 1998, December 27, 1997, and December 28, 1996 by the
Company's Chief Executive Officers and other executive officers whose salary and
bonus exceeded $100,000 for the fiscal year ended December 26, 1998
(collectively, the "Named Executive Officers"):
Summary Compensation Table
--------------------------
Long Term Compensation Trends
-----------------------------
<TABLE>
<CAPTION>
Name and Principal Position Year Salary ($) Bonus ($)
--------------------------- ---- ---------- ---------
<S> <C> <C> <C>
Kenneth Campbell 1998 -- --
President/1/ 1997 $ 278, 670 --
1996 $ 157,740 --
William F. Blum 1998 $ 156,000 --
President, Chief Executive Officer, 1997 $ 141,538/2/ --
Chief Financial Officer/3/ 1996 $ 153,615 --
Roger Hay 1998 -- --
Executive Vice President and Chief 1997 $ 170,697 --
Financial Officer/4/ 1996 $ 94,062 $ 20,000
James G. Hanley 1998 -- --
Vice President of Sales/5/ 1997 $ 122,717 $ 32,938
1996 $ 183,971 --
Charles R. McGee 1998 $ 100,000 --
Vice President Human Resources and 1997 $ 128,093 --
Administration 1996 $ 86,563 $ 3,750
Jamey L. Robbins 1998 -- --
Vice President Research and 1997 $ 113,059 --
Development/6/ 1996 $ 105,803 $ 10,000
</TABLE>
Employment Agreements and Severance Payments
NONE
- ----
Stock Options
The following table sets forth certain information regarding options
granted to the Named Executive Officers during the fiscal year ended December
26, 1998:
_______________________
/1/ Effective September 30, 1997, Mr. Kenneth C. Campbell resigned from his
position as President of the Company.
/2/ Includes $87,500 in payments Mr. William F. Blum received prior to his
return to the Company as President, Chief Executive Officer and Chief Financial
Officer.
/3/ Effective August 21, 1997, Mr. William F. Blum was rehired as President,
Chief Executive Officer and Chief Financial Officer.
/4/ Effective August 28, 1997, Mr. Roger Hay resigned from his position as
Executive Vice President and Chief Financial Officer
/5/ Effective August 25, 1997, Mr. James G. Hanley resigned from his position as
Vice President of Sales of the Company.
/6/ Effective August 22, 1997, Mr. Bernard J. Wu resigned from his position as
Vice President of Marketing of the Company.
19
<PAGE>
Option Grants in Last Fiscal Year
NONE
- ----
The following table sets forth the number and value of unexercised vested
options held by each of the Name Executive Officers on December 26, 1998:
Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values
NONE
- ----
Compensation of Directors
Compensation for non-employee directors remained at $12,000 per year through
1998 based upon the vote taken in early 1997. At that time the board reduced
compensation to non-employee directors from $40,000 to $12,000.
20
<PAGE>
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
----------------------------------------------------------------
(a) The following documents are filed as a part of this Report:
Financial Statements.
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE
-------------------------------------------------------------
FINANCIAL STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR FOR
----------------------------------------------------------------------
THE YEARS ENDED 1997 AND 1998 PRINCIPALLY AS A RESUULT OF THE
-------------------------------------------------------------
INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO
----------------------------------------------------------------
CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS
--------------------------------------------------------------------
AND NOTES THERETO, SELECTED FINANCIAL DATA, AND MAMANEMENT'S
------------------------------------------------------------
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
-------------------------------------------------------------
OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS UNAUDITED. THE READER
---------------------------------------------------------------------
OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL DATA, AND
----------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN
--------------------------------------------------------------
INDEPENDENT AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS OF THE COMPANY FOR DECEMBER 27, 1997 AND
--------------------------------------------------------------
DECEMBER 26, 1998, PRESENTED IN THIS FORM 10-K.
-----------------------------------------------
Indexing to Financial Statements
--------------------------------
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Comment on the Report of Independent Certified Public Accountants 26
Report of Independent Certified Public Accountants - 1996 and 1995 Financial Statements 27
Balance Sheets - December 26, 1998 and December 27, 1997 28
UNAUDITED Statements of Operations - Years Ended December 26, 1998, December 27, 1997,
and December 28, 1996. 29
UNAUDITED Statements of Stockholders' Equity - Years Ended December 26, 1998, December 27, 1997,
and December 28, 1996. 30
UNAUDITED Statements of Cash Flows - Years Ended December 26, 1998, December 27, 1997,
and December 28, 1996. 31,32
Notes to Financial Statements 36
</TABLE>
(2) Financial Statement Schedule. The following financial statement
schedule of Pinnacle Micro, Inc., is filed as part of this Report and
should be read in conjunction with the Financial Statements of
Pinnacle Micro, Inc.:
Index to Financial Statement Schedule
-------------------------------------
Page No.
--------
Schedule II - Valuation and Qualifying Accounts 49
All other schedules are omitted because they are not required or the
required information is included in the financial statements or notes thereto.
<TABLE>
<CAPTION>
<C> <S> <C>
(3) Exhibits:
Exhibit No. Description Location
----------- ----------- --------
<S> <C> <C>
3.1 Certificate of Incorporation of the Company. (1)
3.2 Bylaws of the Company, as currently in effect. (1)
4.1 Specimen Certificate of Common Stock. (1)
10.1* Pinnacle Micro, Inc. Incentive Stock Option, Nonqualified Stock Option
and Restricted Stock Purchase Plan -- 1989 (the "1989 Plan"). (1)
10.2* Form of Incentive Stock Option Agreement pertaining to the 1989 Plan. (1)
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
10.3* Pinnacle Micro, Inc. Incentive Stock Option, Nonqualified Stock Option
Exhibit No. Description Location
----------- ----------- --------
<S> <C> <C>
and Restricted Stock Purchase Plan -- 1993 (the "1993 Plan"). (1)
10.4* Form of Incentive Stock Option Agreement pertaining to the 1993 Plan. (1)
10.5* Form of Nonqualified Stock Option Agreement pertaining to the 1993 Plan. (1)
10.6* Form of Restricted Stock Purchase Agreement pertaining to the 1993 Plan. (1)
10.7 Pinnacle Micro, Inc. Employee Stock Purchase Plan. (1)
10.8 Distributor Agreement, dated June 14, 1991, by and between the Company
and Merisel Inc., together with Amendment dated June 14, 1991
and Addendum dated February 11, 1993. (1)
10.9 Distributor Agreement, dated July 30, 1991, by and between
the Company and Tech Data Corporation, together with Addendum No. 1
to Distributor Agreement dated July 30, 1991. (1)
10.10 Distributor Agreement, dated August 18, 1989, by and between the
Company and Ingram Micro D Inc., together with Addenda Nos. 1, 2, 3, 4 and 5. (1)
10.11 Peripherals OEM Purchase Agreement, dated May 1, 1991, by and
between the Company and Hewlett-Packard Company, together with
Amendment to Peripherals OEM Agreement No. A509M, effective May 12, 1992. (1)
10.12 Computer Peripheral Products Company Peripheral Systems Products Agreement,
dated April 1, 1992, by and between the Company and Computer Peripheral
Products Company, Sony Corporation of America. (1)
10.13 Basic Agreement, dated April 1, 1992, by and between the Company and Sony
Corp. in Japan. (1)
10.14 Agreement, effective October 28, 1991, by and between the Company
and Olympus Optical Co., Ltd., together with Memorandum dated February 19,
1992, Addendum dated August 1, 1992, Memorandum dated September 9, 1992 and
letter dated October 15, 1992. (1)
10.15+ OKI Semiconductor Standard Products Volume Purchase Agreement,
dated August 17, 1992, by and between the Company and OKI Semiconductor. (1)
10.16+ Nippon Pinnacle Micro, Pinnacle Micro and Ricoh Company Ltd.
Purchase Agreement, dated October 1, 1992, by and among the Company, Nippon
Pinnacle Micro and Ricoh Company Ltd. (1)
10.17 Agreement on Sale and Purchase, dated January 1, 1993, by and between the
Company and Victor Company of Japan, Limited, together with Addenda Nos. I,
II and III. (1)
10.19 Lease, dated January 6, 1993, by and between the Company and Webb/Colorado
Ventures, Ltd. (1)
10.20 Lease, dated February 5, 1991, by and between the Company and The Irvine
Company, together with Amendment Nos. 1, 2, 3 and 4. (1)
10.21 Form of Indemnification Agreement for officers and directors of the Company. (1)
10.22* Form of Nonqualified Stock Agreement pertaining to the 1989 Plan. (1)
10.23 Business Loan Agreement, dated August 4, 1994, by and between the Company
and Bank of America, together with Amendment No. One, dated October 4, 1994
and Amendment No. Two, dated February 2, 1995. (2)
10.24(a) Amendment No. Three, dated August 31, 1995, to Business Loan Agreement, dated
August 4, 1994, by and between the Company and Bank of America. (3)
10.24(b) Amendment No. Four, dated October 10, 1995, to Business Loan Agreement, dated
August 4, 1994, by and between the Company and Bank of America. (3)
10.24(c) Amendment No. Five, dated January 24, 1996, to Business Loan Agreement, dated
August 4, 1994, by and between the Company and Bank of America. (3)
10.24(d) Amendment No. Six, dated March 28, 1996, to Business Loan Agreement, dated
August 4, 1994, by and between the Company and Bank of America. (3)
10.25++ Development, Manufacturing and Purchasing Agreement dated June 30, 1995, by
and between the Company and Asahi Optical Co., LTD. (3)
10.26* Employment Agreement dated December 15, 1995, by and
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
between the Company and James G. Hanley. (3)
Exhibit No. Description Location
----------- ----------- --------
<S> <C> <C>
10.27* First Amendment to the 1993 Equity Incentive Plan of Pinnacle Micro,
Inc. (the "1993 Plan"). (3)
10.28* First Amendment to the 1989 Equity Incentive Plan of Pinnacle Micro,
Inc. (the "1989 Plan"). (3)
10.29++ Development and Manufacturing Agreement dated October 6, 1994, by and
between the Company and Advanced Hardware Architectures, Inc. (3)
10.30++ Computer 2000 Purchase Agreement dated September 13, 1995, by and
between the Company and Computer 2000. (3)
10.31 Stipulation of settlement - Class action - Kurtz, et al. vs. Blum, et al.;
Case No. SAC-94-1043-GLT(EEx). (3)
10.32 Form of Offshore Subscription Agreement. (4)
10.33 Form of Convertible Debentures. (4)
10.34 Form of Registration Rights Agreement. (4)
10.35 Loan and Security Agreement with Coast Business Credit dated September 18,
1996. (5)
10.36* 1996 Long-Term Incentive Plan. (6)
10.37* 1996 Non-Employee Directors Stock Option Plan. (6)
10.38* Employment Agreement for Kenneth Campbell as of December 1, 1996. (6)
10.39 Employment Agreement for Roger Hay as of December 1, 1996. (6)
10.40* Employment Agreement for Jonathan B. Eddison as of December 1, 1996. (6)
10.41* Employment Agreement for Kevin Lehnert as of December 1, 1996. (6)
10.42* Employment Agreement for David Ooley as of December 1, 1996. (6)
10.43* Stand-still and Voting Rights Agreement dated December 8, 1996. (6)
10.44* Scott Blum - Severance Agreement and Release of February 13, 1997. (6)
10.45* Employment Agreement for Bernard Wu dated as of March 26, 1997 (7)
10.46* Employment Agreement for David Nesbit dated as of March 26, 1997 (7)
23.1 Comment on the Consent of Independent Auditor
23.2 Comment on the Consent of BDO Seidman, LLP.
27.1 Financial Data Schedule.
</TABLE>
__________________
(1) Incorporated by reference to the referenced exhibit number to the Company's
Registration Statement on Form S-1, Reg. No. 33-62614.
(2) Incorporated by reference to exhibit filed with the Company's Report on
Form 10-K for the fiscal year ended December 31, 1994.
(3) Incorporated by reference to exhibit filed with the Company's Report on
Form 10-K for the fiscal year ended December 30, 1995.
(4) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-Q for the period ended June 29, 1996.
(5) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-Q for the period ended September 28, 1996.
(6) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-K for the fiscal year ended December 28, 1996.
(7) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-Q for the period ended March 29, 1997.
__________________
* Denotes applicable executive compensation plans and arrangements of the
Company.
+ Confidential treatment has been granted by the Commission. The copy filed
as an exhibit omits the information subject to the confidentiality grant.
++ Confidentiality treatment has been requested. The copy filed as an exhibit
omits the information subject to the confidentiality request.
23
<PAGE>
(b) Reports on Form 8-K
January 6, 1998 Resignation of BDO Seidman, LLP as independent
auditors.
February 4, 1998 Delisting of the Company's common stock from trading on
the NASDAQ National Market.
August 22, 1998 Response to vote of unsecured creditors and filing of
involuntary petition of Bankruptcy.
February 12, 1999 Hans Imhoff and James Roszack resignation from Board of
Directors
24
<PAGE>
SIGNATURES
- ----------
Pursuant to the requirements of Section 13 or 15(d) 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.
PINNACLE MICRO, INC.
July 27, 1999 By: \s\ William F. Blum
- ------------- -------------------
William F. Blum
Date Chairman, President, Chief Executive Officer and
Chief Financial Officer and Chief Accounting
Officer and a Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
July 27, 1999 By: \s\ William F. Blum
- ------------- -------------------
William F. Blum
Date Chairman, President, Chief Executive Officer and
Chief Financial Officer and Chief Accounting
Officer and a Director
25
<PAGE>
Report of Independent Certified Public Accountants
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
-----------------------------------------------------------------------
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR FOR THE YEARS ENDED
- ----------------------------------------------------------------------------
1997 AND OPINION ON THE FINANCIAL1998 PRINCIPALLY AS A RESUULT OF THE
- ----------------------------------------------------------------------
INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO CONTINUE AS A
- ------------------------------------------------------------------------------
GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES THERETO,
- -------------------------------------------------------------------------
SELECTED FINANCIAL DATA, AND MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------------------------------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS
- ----------------------------------------------------------------------
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
- -----------------------------------------------------------------------------
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -------------------------------------------------------------------------
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT
- --------------------------------------------------------------------------
AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE
- --------------------------------------------------------------------------------
COMPANY FOR DECEMBER 27, 1997 AND DECEMBER 26, 1998 PRESENTED IN THIS FORM 10-K.
- --------------------------------------------------------------------------------
26
<PAGE>
Report of Independent Certified Public Accountants
THE COMPANY HAS BEEN UNABLE TO OBTAIN THE NECESSARY CONSENT FROM THE COMPANY'S
- ------------------------------------------------------------------------------
PREDECCESOR INDEPENDENT AUDITORS FOR THE FINANCIAL STATEMENTS, NOTES, SELECTED
- ------------------------------------------------------------------------------
FINANCIAL DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- -------------------------------------------------------------------------------
AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 28, 1996, PRINCIPALLY AS A
- --------------------------------------------------------------------------------
RESULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO
- ------------------------------------------------------------------------------
CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES
- ------------------------------------------------------------------------------
THERETO, SELECTED FINANCIAL DATA, AND MAMANEMENT'S DISCUSSION AND ANALYSIS OF
-----------------------------------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED, ALTHOUGH
-------------------------------------------------------------------------
UNCHANGED FROM THE PRIOR YEAR FORM 10-K, ARE PRESENTED AS UNAUDITED. THE
-------------------------------------------------------------------------
READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL DATA, AND
-----------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
--------------------------------------------------------------------------
OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF A CONSENT FROM THE PREDECCESOR
- -------------------------------------------------------------------------------
AUDITORS TO REISSUE THEIR AUDIT OPINION ON THE FINANCIAL CONDITION AND RESULTS
- ------------------------------------------------------------------------------
OF OPERATIONS OF THE COMPANY FOR DECEMBER 28, 1996 PRESENTED IN THIS FORM 10-K.
- -------------------------------------------------------------------------------
<PAGE>
PINNACLE MICRO, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
December 26, December 28,
1998 1997
UNAUDITED UNAUDITED
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 322,000 $ 454,000
Accounts Receivable, net of allowance of $771,000 At December 26, 1998 742,000 4,853,000
and $2,906,000 at December 28, 1997
Inventories 3,592,000 6,404,000
Prepaid expenses and other current assets 134,000 374,000
------------ ------------
Total current assets 4,790,000 12,085,000
Furniture and equipment, net 46,000 447,000
Other assets 143,000 11,000
Total assets $ 4,979,000 $ 12,544,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Note Payable $ 5,503,000 $ 6,166,000
Accounts Payable $ 17,366,000 18,581,000
Accrued expenses 535,000 1,641,000
Accrued Restructuring 1,501,000 1,501,000
Payroll related liabilities 99,000 125,000
------------ ------------
Total current liabilities 25,004,000 28,014,000
Stockholders' equity
Preferred stock, $.001 par value:
Authorized shares-5,000,000
Issued and outstanding-none
Common Stock, $.001 par value:
Authorized shares-30,000,000
Issued and outstanding-14,500,089 at December 26, 1998 and 15,000 15,000
14,500,089 at December 28, 1997
Additional paid in capital 34,977,000 34,977,000
Retained earnings (55,017,000) (50,462,000)
------------ ------------
Total stockholders' equity (deficit) (20,025,000) (15,470,000)
Total liabilities and stockholders' equity $ 4,979,000 $ 12,544,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
PINNACLE MICRO, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended
-----------
December 26, December, 28, December 28,
1998 1997 1996
UNAUDITED UNAUDITED SEE EXHIBIT 23.2
<S> <C> <C> <C>
Net sales:
Optical storage devices $ 10,554,000 $ 31,124,000 $ 59,921,000
Components -- -- --
------------ ------------ ----------------
Total net sales 10,554,000 31,124,000 59,921,000
Cost of sales:
Optical storage devices 9,481,000 39,860,000 49,092,000
Components -- -- --
------------ ------------ ----------------
Total cost of sales 9,481,000 39,860,000 49,092,000
------------ ------------ ----------------
Gross profit (loss) 1,073,000 (8,736,000) 11,829,000
Operating expenses:
Selling, general and administrative 4,985,000 14,772,000 19,565,000
Research and development -- 2,984,000 6,006,000
Nonrecurring charges -- 2,087,000 4,721,000
------------ ------------ ----------------
Total operating expenses 4,985,000 19,843,000 30,292,000
------------ ------------ ----------------
Operating loss (3,912,000) (28,579,000) (18,463,000)
Interest income 1,000 17,000 84,000
Interest expense (644,000) (824,000) (549,0000
Non-cash interest expense related to convertible debentures -- (786,000) (1,721,000)
------------ ------------ ----------------
Loss before income taxes (4,555,000) (30,172,000) (20,833,000)
Income tax expense (benefit) -- 57,000 184,000
------------ ------------ ----------------
Net loss $ (4,555,000) (30,229,000) $ (20,833,000)
============ ============ ================
Net loss per share $ (0.31) $ (2.32) $ (2.52)
============ ============ ================
Weighted average common shares outstanding 14,500,000 13,039,000 8,272,000
============ ============ ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
The accompanying notes are an integral part of these financial statements.
PINNACLE MICRO, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(unaudited as to the years ended December 26, 1998 and December 27, 1997 and see
exhibit 23.2 for the year ended December 28, 1996)
<TABLE>
<CAPTION>
Retained
Additional Earnings Foreign
Three Years Ended Dec. 26, 1998 Common Stock Paid-in (Accumulated Currency
-------------------
Shares Amount Capital Deficit) Translation Total
---------- ------- ----------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 30, 1995.............. 7,867,599 8,000 16,158,000 775,000 (200,000) 16,741,000
Exercise of stock options................. 15,010 - 63,000 - - 63,000
Tax benefit of employee stock options..... - - 11,000 - - 11,000
Purchases through the employee
stock purchase plan...................... 19,737 - 98,000 - - 98,000
Shares issued for settlement of
stockholder lawsuit...................... 190,084 - 1,400,000 - - 1,400,000
Shares issued upon conversion of
convertible debentures................... 1,801,381 2,000 8,083,000 - - 8,085,000
Shares issued for interest on
convertible debentures................... 41,783 - 191,000 - - 191,000
Additional paid-in capital related to
debenture embedded interest.............. - - 2,507,000 - - 2,507,000
Foreign currency translation.............. - - - - 200,000 200,000
Warrants issued in connection with
convertible debentures................... - - 31,000 - - 31,000
Non-employee stock option
compensation............................. - - 9,000 - - 9,000
Net loss for the year ended
December 28, 1996........................ - - - (20,833,000) - (20,833,000)
---------- ------- ----------- ------------ ----------- ------------
Balances at December 28, 1996.............. 9,935,594 10,000 28,551,000 (20,058,000) - 8,503,000
Dividend for S Corporation tax refund..... - - - (175,000) - (175,000)
Exercise of stock options................. 1,500 - 1,000 - - 1,000
Tax benefit of employee stock options..... - - 4,000 - - 4,000
Non-employee stock option compensation - - 72,000 - - 72,000
Purchases through the employee
stock purchase plan...................... 83,906 - 118,000 - - 118,000
Shares issued upon conversion of
convertible debentures................... 4,367,979 5,000 6,063,000 - - 6,068,000
Shares issued for interest on
convertible debentures................... 108,110 - 153,000 - - 153,000
Shares issued for settlement of vendor
dispute................................. 3,000 - 15,000 - - 15,000
Net loss for the year ended
December 27, 1997........................ - - - (30,229,000) - (30,229,000)
---------- ------- ----------- ------------ ----------- ------------
Balances at December 27, 1997.............. 14,500,089 $15,000 $34,977,000 $(50,462,000) $ - $(15,470,000)
Dividend for S Corporation tax refund..... - - - - -
Exercise of stock options................. - - - - -
Tax benefit of employee stock options..... - - - - -
Non-employee stock option compensation.... - - - - -
Purchases through the employee stock
Purchase plan............................ - - - - -
Shares issued upon conversion of
Convertible debentures................... - - - - -
Shares issued for settlement of vendor
Dispute.................................. - - - - -
Net loss for the year ended
December 26, 1998........................ - - - $ (4,555,000) - $ (4,555,000)
---------- ------- ----------- ------------ ----------- ------------
Balances at December 26, 1998.............. 14,500,089 $15,000 $34,977,000 $(55,017,000) $ - $(20,025,000)
</TABLE>
30
<PAGE>
The accompanying notes are an integral part of these financial statements.
PINNACLE MICRO, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended
------------------
December 26, 1998 December 27, 1997 December 28, 1996
------------------ ------------------ ------------------
UNAUDITED UNAUDITED SEE EXIBIT 23.2
<S> <C> <C> <C>
Cash flow from operations
Net Income (loss) $(4,555,000) $(30,229,000) $(20,833,000)
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Depreciation 402,000 1,148,000 1,323,000
Provision for doubtful accounts -- 122,000 369,000
Provision for product returns and price protection -- 7,492,000 999,000
Provision for inventory obsolescence 1,100,000 9,274,000 866,000
Settlement for vendor dispute paid in common stock -- 15,000 --
Non-cash interest expense -- 786,000 1,721,000
Interest on debentures paid in common stock -- 153,000 191,000
Compensation related to stock options and warrants -- 72,000 40,000
Loss on disposal of assets -- 741,000 --
Furniture and equipment reserve -- 696,000 --
Changes in operating assets and liabilities:
Accounts Receivable 4,111,000 (740,000) (1,740,000)
Income taxes receivable -- 1,984,000 (985,000)
Inventories 2,812,000 2,035,000 (7,167,000)
Prepaid expenses and other current assets 242,000 (160,000) 746,000
Other assets (132,000) 254,000 31,000
Accounts payable and accrued expenses (1,215,000) 1,840,000 7,081,000
Payroll related liabilities (25,000) (1,100,000) 269,000
Other liabilities (1,106,000) (928,000) 929,000
---------------- ---------------- ----------------
Net cash provided by (used in) operating activities 532,000 (6,545,000) (14,889,000)
---------------- ---------------- ----------------
Cash flow from Investing Activities
Purchase of furniture and equipment -- (1,320,000) (904,000)
Proceeds from the sales of furniture and equipment -- 27,000 --
---------------- ---------------- ----------------
Net cash provided by (used in) investing activities -- (1,293,000) (904,000)
---------------- ---------------- ----------------
Cash flow from Financing Activities
Proceeds from note payable -- 2,890,000 8,276,000
Principal payments on note payable to bank (663,000) -- (5,000,000)
Proceeds from issuance of debentures -- -- 15,000,000
Payment of debt issuance costs -- -- (900,000)
Dividends -- (175,000) --
Proceeds from exercise of stock options -- 1,000 63,000
Tax benefit from exercise of stock options -- 3,000 11,000
Proceeds from issuance of stock through the employee stock purchase
plan -- 118,000 98,000
---------------- ---------------- ----------------
Net cash provided by (used in) financing activities (663,000) 2,837,000 17,548,000
---------------- ---------------- ----------------
Effect of exchange rate changes in cash -- -- 94,000
---------------- ---------------- ----------------
Increase (decrease) in cash and cash equivalents (131,000) (5,001,000) 1,849,000
Cash and cash equivalents at beginning of year 454,000 5,455,000 3,606,000
---------------- ---------------- ----------------
Cash and cash equivalents at end of year 322,000 454,000 5,455,000
================ ================ ================
</TABLE>
31
<PAGE>
The accompanying notes are an integral part of these financial statements.
PINNACLE MICRO, INC.
STATEMENTS OF CASH FLOWS (continued)
<TABLE>
<CAPTION>
Years Ended
-----------------
December 26, 1998 December 27, 1997 December 28, 1996
------------------ ----------------- -----------------
UNAUDITED UNAUDITED SEE EXHIBIT 23.2
<S> <C> <C> <C>
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest $ 654,000 $ 642,000 $ 306,000
Income taxes paid/(refunded) (12,000) $ 1,000 $ 15,000
Supplemental disclosure of non cash investing and financing
activities:
Common Stock issued upon conversion of debentures, net -- $6,068,000 $8,085,000
Common Stock issued for settlement of stockholder lawsuit -- -- $1,400,000
Additional paid-in capital related to debenture embedded interest -- -- $2,507,000
</TABLE>
32
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS
December 26, 1998
(UNAUDITED)
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
-----------------------------------------------------------------------
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR FOR THE YEARS ENDED
- ----------------------------------------------------------------------------
1997 AND 1998 PRINCIPALLY AS A RESUULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER
- --------------------------------------------------------------------------------
THE ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE
- -----------------------------------------------------------------------------
FINANCIAL STATEMENTS AND NOTES THERETO, SELECTED FINANCIAL DATA, AND
- --------------------------------------------------------------------
MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
- --------------------------------------------------------------------------
OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS UNAUDITED. THE READER OF THE
- ---------------------------------------------------------------------------
FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL DATA, AND MANAGEMENT'S
- ----------------------------------------------------------------------
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD
- -------------------------------------------------------------------------------
CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT AUDITORS ATTESTATION TO THE
- -------------------------------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY FOR DECEMBER 26,
- -----------------------------------------------------------------------------
1998 AND DECEMBER 27, 1997 PRESENTED IN THIS FORM 10-K.
- -------------------------------------------------------
1. Summary of Significant Accounting Policies
Organization
Pinnacle Micro, Inc., (the "Company") acquires, manufactures and markets optical
storage systems for data intensive applications for use both with stand-alone
and networked personal computers and workstations. The financial statements
include the accounts of Pinnacle Micro, Inc., and its foreign branches, Nippon
Pinnacle Micro and Euro Pinnacle Micro. Euro Pinnacle Micro was closed during
1997 and Nippon Pinnacle Micro was closed during 1996 (see Note 8).
This summary of the Company's significant accounting policies is presented to
assist in understanding the Company's financial statements. The financial
statements and notes are representations of the Company's management, who are
responsible for their integrity and objectivity. These accounting policies
conform to generally accepted accounting principles. Management uses estimates
and assumptions in preparing financial statements in accordance with generally
accepted accounting principles. Those estimates and assumptions affect the
amounts reported in the financial statements. Actual results could vary for the
estimates that were used.
Fiscal Years
The Company operates and reports financial results on a fiscal year of 52 or 53
weeks ending on the Saturday closest to December 31. Accordingly, fiscal 1998
ended on December 26, 1998, fiscal 1997 ended on December 27, 1997, fiscal 1996
ended on December 28, 1996, and fiscal 1995 ended on December 30, 1995. Prior to
1995 all fiscal years ended on December 31.
Revenue Recognition
The Company recognizes product sales revenue at the time of shipment and records
a reserve for estimated sales returns and price adjustments. The Company has
agreements with its resellers which, under certain circumstances, provide for
stock rotation for slow-moving items and price protection for inventories held
by the resellers at the time of published price reductions. It is reasonably
possible that the Company's estimates of sales returns and price adjustments may
change.
Cash and Cash Equivalents
For purposes of the Statements of Cash Flows, the Company considers all highly
liquid investments with an original maturity of three months or less when
purchased to be cash equivalents. The amount of cash equivalents reported in the
financial statements approximates fair value. The Company invests its cash and
cash equivalents with high credit quality financial institutions. At times such
investments may be in excess of the FDIC insurance limit.
33
<PAGE>
Accounts Receivable
Accounts receivable (less allowance for doubtful accounts) are recorded at net
realizable value. The amount of accounts receivable reported in the financial
statements approximates fair value. Company management has estimated the
allowance for doubtful accounts. It is reasonably possible that the Company's
estimate of the collectibility of accounts receivable will change.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or
market (net realizable value). It is reasonably possible that the Company's
estimate of market will change.
34
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies (continued)
Furniture and Equipment
Furniture and equipment is stated at cost, less accumulated depreciation and
amortization. Depreciation is determined using the straight-line method for all
assets based on the estimated useful lives of the assets, which range from one
to five years. Leasehold improvements are amortized using the straight-line
method over the shorter of their estimated useful lives or the term of the
related leases.
The Company's policy is to evaluate the remaining life and recoverability of
furniture and equipment in light of current conditions. It is reasonably
possible that the Company's estimate to recover the carrying amount of property,
plant and equipment will change.
Debt Issuance Costs
The costs related to the issuance of the convertible debentures are capitalized
and amortized over the terms of the related debt.
Notes Payable
The amount of the notes payable reported in the financial statements
approximates fair value because of the short maturity of those instruments.
Advertising
The Company expenses advertising costs when incurred. Advertising expense
totaled $553,000, $2,622,000, and $5,916,000 for the years ended December 26,
1998, December 27, 1997, and December 28, 1996, respectively.
Income Taxes
Deferred income taxes are recorded for the temporary differences between the
Company's financial statements and tax returns in accordance with Statement of
Financial Accounting Standards No. 109 (FAS 109), Accounting for Income Taxes.
FAS 109 is an asset and liability approach that requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been recognized in the Company's financial statements or tax
returns. In estimating future tax consequences, FAS 109 generally considers all
expected future events other than enactments of changes in the law or rates.
Stock-Based Compensation
The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees,"
and related interpretations in accounting for its stock-based compensation
plans. Accordingly, no compensation cost is recognized for its employee stock
option plans, unless the exercise price of options granted is less than fair
market value on the date of grant. The Company has adopted the disclosure
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" (see Note 7).
Foreign Currency Transactions
On January 1, 1995, the Company changed the functional currency of its branch
located in Japan (Nippon Pinnacle Micro) to the local functional currency and,
accordingly, the foreign currency denominated assets and liabilities were
translated to U.S. dollars at the year-end exchange rate. The effects of
translation are recorded as a separate component of stockholders' equity through
the date that Nippon Pinnacle Micro was closed during 1996 (see Note 8).
Exchange gains and losses arising from
35
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies (continued)
Foreign Currency Transactions (continued)
transactions denominated in foreign currencies are translated at average
exchange rates. The effects of translation are recorded as a separate component
of stockholders' equity through the date that Nippon Pinnacle Micro was closed
during 1996 (see Note 8). Exchange gains and losses arising from transactions
denominated in foreign currencies are translated at average exchange rates. Net
foreign currency transaction gains of $478,000 and losses of $473,000 were
realized in 1996 and 1995, respectively, and are included in selling, general
and administrative expenses in the accompanying statements of operations. There
were no foreign currency transaction gains or losses in 1997.
Substantially all of the transactions of the Company's branch in the Netherlands
(Euro Pinnacle Micro) are denominated in U.S. dollars and accordingly no
remeasurement of foreign currency is necessary as the accounts are maintained in
U.S. dollars. Euro Pinnacle Micro was closed in 1997.
Foreign currency forward contracts are entered into from time to time to offset
the effects of exchange rate changes on transactions denominated in foreign
currencies. These contracts generally have maturity dates that do not exceed
three months. Gains and losses on contracts which effectively hedge foreign
currency transactions are deferred and included in income as part of those
transactions. The aggregate contract value of instruments used to buy U. S.
dollars in exchange for Japanese Yen was approximately $3,204,000 at December
30, 1995. There were no such contracts entered into at December 26, 1998,
December 27, 1997 or December 28, 1996. The carrying value of the foreign
currency contracts approximated their fair market value. The counter parties to
these transactions were major international financial institutions.
Software Development Costs
Research and development costs resulting from the design, development and
testing of new software for use in products are expensed as incurred until
technological feasibility has been established. Certain costs incurred
thereafter, such as coding and testing, are capitalized until the product is
available for general release to customers. Such amounts were not material for
the years presented.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, accounts
payable and accrued expenses are reasonable estimates of their fair value
because of the short maturity of those items. The Company believes the carrying
amounts of the Company's notes payable and convertible debentures approximate
fair value because the interest rates on these instruments are subject to change
with, or approximate, market interest rates.
Net Income (Loss) Per Share
In February 1997, The Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128 ("FAS-128"), Earnings Per
Share. FAS-128 replaces the presentation of primary and fully diluted earnings
per share with the presentation of basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Basic income (loss) per
share is computed by dividing net income available to common shareholders by the
weighted average common shares outstanding for the period. Diluted income (loss)
per share is computed giving effect to all potentially dilutive common shares.
Potentially dilutive common shares may consist of incremental shares issuable
upon the exercise of stock options or in connection with convertible securities.
In periods in which a net loss has been incurred, all potentially dilutive
common shares are considered antidilutive and therefore excluded from the
calculation. The weighted average number of shares outstanding is adjusted to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued. All income (loss) per
share amounts for all prior periods have been restated to conform to the
requirements of FAS-128.
36
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies (continued)
Net Income (Loss) Per Share (continued)
The weighted average common shares outstanding used in the computation of income
(loss) per share have been retroactively restated to reflect the 1995 stock
dividend (see Note 7).
Estimated Accrual for Warranty Claims
The Company sells the majority of its products to customers along with
unconditional repair or replacement warranties. The accompanying financial
statements for the years ended December 26, 1998, December 27, 1997, and
December 28, 1996 include provisions of $104,000, $225,000, and $100,000 for
estimated warranty claims based on the Company's experience relative to the
amount of claims actually made. It is reasonably possible that the Company's
estimate of the accrued warranty claims will change.
Reclassifications
Certain reclassifications have been made to the 1995 financial statements to be
consistent with the 1996 and 1997 presentation.
New Accounting Pronouncements
In June 1997, the FASB issued FAS-130, Reporting Comprehensive Income. FAS-130
establishes reporting and display requirements with respect to comprehensive
income and its components. This Statement requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This statement requires that
an enterprise (a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance of other
compressive income separately from retained earnings and additional paid-in
capital in the equity section of the balance sheet. This Statement is effective
for fiscal years beginning after December 15, 1997 and requires reclassification
of financial statements for prior periods for comparative purposes. The Company
does not expect adoption of FAS-130 to have a material effect, if any, on its
financial condition or results of operations.
In February 1997 FAS-129, Disclosure of Information about Capital Structure, was
issued by the FASB and is effective for fiscal years beginning after December
15, 1997. The new standard reinstates various securities disclosure requirements
previously in effect under Account Principles Board ("APB") 15, which has been
superseded by FAS-128. The Company does not expect adoption of FAS-129 to have a
material effect, if any, on its financial condition or results of operations.
In June 1997, the FASB issued FAS-131, Disclosures about Segments of an
Enterprise and Related Information. FAS-131 establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements, and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. FAS-131 was
effective for fiscal years which began after December 15, 1997. The adoption of
FAS-131 had no impact on the Company's results of operations, financial position
or cash flows.
During October 1997, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants issued State of Position
("SOP") 07-2, Software Revenue Recognition. The SOP is effective for
transactions entered into in fiscal years beginning after December 15, 1997.
Different informal and unauthoritative interpretations of certain provisions of
SOP 97-2 have arisen. AcSEC is already deliberating amendments to SOP 97-2,
including deferral of the effective date of certain provisions of the SOP so
AcSEC can develop and issue an interpretation regarding the applicability and
the method of application of those provisions. Because of the uncertainties
related to the outcome of these amendments, the impact on the future financial
results of the Company is not currently determinable.
37
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. Going Concern Issues
The Company faces severe operating and financial difficulties. For the year
ended December 26, 1998, the Company incurred a net loss of $4,555,000. As of
December 26, 1998, The Company had a working capital deficiency of $20,214,000,
and a stockholders' deficit of $20,025,000. Realization of the carrying values
of the assets included in the balance sheet as of December 26, 1998, is
dependent upon the Company's successful future operations.
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
- -----------------------------------------------------------------------
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR FOR THE YEARS ENDED
- ----------------------------------------------------------------------------
1997 AND 1998 PRINCIPALLY AS A RESUULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER
- --------------------------------------------------------------------------------
THE ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE
- -----------------------------------------------------------------------------
FINANCIAL STATEMENTS AND NOTES THERETO, SELECTED FINANCIAL DATA, AND
- --------------------------------------------------------------------
MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
- --------------------------------------------------------------------------
OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS UNAUDITED. THE READER OF THE
- ---------------------------------------------------------------------------
FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL DATA, AND MANAGEMENT'S
- ----------------------------------------------------------------------
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD
- -------------------------------------------------------------------------------
CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT AUDITORS ATTESTATION TO THE
- -------------------------------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY FOR DECEMBER 27,
- -----------------------------------------------------------------------------
1997 AND DECEMBER 26, 1998 PRESENTED IN THIS FORM 10-K.
- ------------------------------------------------------
As a result of the Company's severe liquidity problems, the Company was unable
to pay its trade debt in a timely basis. Consequently, the Company sought the
cooperation of its creditors in a restructuring of its trade debt in July,
1997.In late 1998, a vote was taken by the unsecured creditors to approve an
informal reorganization plan. That vote was rejected by the creditors and the
plan was dropped. In the event that the Company is unable to agree on a plan
with the creditors, the Company will be unable to continue as a going concern
and will seek protection under the Federal bankruptcy laws.
There is no forbearance agreement in place with the Company's secured lender,
although the Company's secured lender has continued to provide borrowings to the
Company. 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. The Company is also in default under other provisions
of the agreement relating to 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 then be unable to continue to
operate as a going concern and will seek protection under the Federal bankruptcy
laws.
The Company incurred a net loss of $752,000 for the first quarter of 1999 ended
March 27, 1999. The Company cannot continue to offset operating losses with
asset reductions. Furthermore, the Company is severely restricted as to the
amount of borrowings its secured lender will permit. There can be no assurance
that the Company will be able to operate profitably or that its secured lender
will continue to provide funds to operate the business, the absence of which
will result in the Company seeking protection under the Federal bankruptcy laws.
Because of the significant facts and uncertainties described in the preceding
paragraphs, there can be no assurance that the Company will be able to continue
as a going concern. The inability of the Company continuing as a going concern
will result in the Company seeking protection under the Federal bankruptcy laws.
Accordingly, the accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
38
<PAGE>
3. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
1998 1997
----------------------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Components and work-in-process $ 11,204,000 $ 12,210,000
Finished Goods 845,000 2,182,000
Reserve for excess inventory and obsolescence (8,457,000) (7,988,000)
----------------------------
$ 3,592,000 $ 6,404,000
============================
</TABLE>
39
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. Inventories (continued)
Management has determined the reserve for excess inventory and obsolescence by
reviewing expected product life cycles, assessing current inventory levels and
analyzing projected sales levels. Inventory in excess of expected sales
requirements and inventory expected to become obsolete has been fully reserved.
4. Furniture and Equipment
Furniture and equipment consists of the following:
<TABLE>
<CAPTION>
1998 1997
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Furniture and equipment $ 2,662,000 $ 2,662,000
Computers 1,661,000 1,661,000
Tooling - -
Leasehold improvements - -
Gross furniture and equipment 4,323,000 4,323,000
Accumulated depreciation and amortization (7,903,000) (3,179,000)
Reserve for furniture and equipment disposition (697,000) (697,000)
--------------------------------
Net furniture and equipment $ 46,000 $ 447,000
================================
</TABLE>
The reserve for furniture and fixture disposition has been estimated by
management based upon the Company's current utilization of computers and
furniture and equipment. All computers or furniture and equipment which are not
being utilized have been reserved for any amounts in excess of their market
value. Assets that cannot be located have been fully reserved.
5. Note Payable
The Company has a $10,000,000 revolving line of credit agreement with a lending
institution which is collateralized by substantially all assets of the Company
and which expires on September 30, 1999. Outstanding borrowings on this line of
credit were $5,503,000 and $6,166,000 at December 26, 1998 and December 27,
1997, respectively. The total unused amount available at December 26, 1998 was
zero and at December 27, 1997 was zero. Borrowings on this line credit are based
on a percentage of eligible accounts receivable and inventories. As of December
26, 1998, the Company was not in compliance with the terms of the line of credit
and had borrowed in excess of its available credit under the eligibility
formulas. If it is in compliance with the terms of the line of credit, the
Company can obtain up to $3,500,000 in letters of credit pursuant to this
agreement; there were no such obligations under standby letters of credit at
December 26, 1998 or December 27, 1997. Interest is payable monthly at the
institution's reference rate (8.50% at December 26, 1998 and 8.50% at December
27, 1997) plus 1.75%. At December 26, 1998, the Company was not in compliance
with the principal terms of the line of credit agreement. At December 28, 1996,
the Company was in compliance with all terms of the line of credit agreement.
The current line of credit replaced a prior $5,000,000 line of credit with a
different lending institution, which had no amounts outstanding at December 30,
1995.
6. Convertible Debentures
In July 1996, the Company completed its first offshore placement of $10,000,000
principal amount of convertible subordinated 8% debentures due July 2001. The
$10,000,000 placement yielded aggregate net proceeds of $9,400,000 after
commissions and fees to First Bermuda Securities Limited ("First Bermuda").
First Bermuda also received additional compensation in the form of 73,846
warrants exercisable for five years at a price of $8.125 which was 125% of the
closing bid price on the closing date. First Bermuda received customary
piggyback registration rights beginning 90 days from the closing date and demand
rights after two years. The debenture holders may convert the principal of the
8% debentures in thirds, at discounts from the then market price of 15%, 17.5%
and 20%, in intervals commencing 60, 90 and 120 days after the closing,
respectively.
In December 1996, the Company completed a second offshore placement of
$5,000,000 principal amount of convertible subordinated 6% debentures due
December 2001. The $5,000,000 placement yielded aggregate net proceeds of
$4,700,000 after commission and fees to First Bermuda. First Bermuda also
received additional compensation in the form of 65,076 warrants exercisable for
five years at a price of $4.61 which was 125% of the closing bid price on the
closing date. First
40
<PAGE>
Bermuda received customary piggyback registration rights beginning 90 days from
the closing date and demand rights after two years. The debenture holders
received an aggregate of 32,538 of warrants with terms similar to those of First
Bermuda, except that such warrants are exercisable for one year. The debenture
holders may 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.
According to the views of certain members of the Staff of the SEC, convertible
debt instruments which are convertible at a discount to market should be
accounted for by treating such discount as additional interest expense. The
Company has computed the amount of the discount based on the difference between
the conversion price and fair value of the underlying common stock on the date
the debentures were issued. The Company conformed to those views and recorded
$2,507,000 as additional paid-in capital for the discount related to the
embedded interest in the convertible debentures. Of this amount, $786,000 and
$1,721,000, in 1997 and 1996, respectively, has been amortized and is included
in the caption "Non-cash interest expense related to convertible debentures" in
the accompanying statements of operations (see Note 13).
As of December 28, 1996, debentures aggregating $8,578,000 had been converted
into 1,801,381 shares of common stock at conversion prices ranging from $3.15 to
$6.44 per share. Stockholders' equity was increased by the full amount of the
debentures converted less the unamortized debt issuance costs. In addition,
41,783 shares of common stock were issued for $191,000 of interest payable on
the converted debentures.
As of December 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. Stockholders' equity was increased by the full amount of the
debentures converted less the unamortized debt issuance costs. In addition,
108,110 shares of common stock were issued for $153,000 of interest payable on
the converted debentures. All of the debentures were converted during 1997.
For the year ended December 26, 1998, the Company had no debenture activity.
7. Stockholders' Equity
Dividends to Stockholders
Subsequent to the conversion from an S Corporation to a C Corporation, the
Company paid dividends for the previously taxed undistributed S Corporation
earnings as of June 30, 1993. As of December 31, 1994, these stockholders were
estimated to have been overpaid by $130,000, which was included as a receivable
in the 1994 balance sheet. This $130,000 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.
The Company anticipates any future earnings will be retained for use in the
business. The Company paid a 50% stock dividend on December 15, 1995, to
stockholders of record as of December 1, 1995. A total of 2,622,518 shares and
less than $1,000 of cash for fractional shares were distributed as part of this
stock dividend. All references in the financial statements to share amounts, per
share amounts and stock plan data have been restated to reflect this stock
dividend. The Company does not anticipate paying cash dividends on the common
stock in the foreseeable future. In addition, the Company's line of credit
agreement restricts the Company's ability to pay cash dividends on its capital
stock.
Stock Options and Stock Purchase Plans
Under terms of the Company's stock option plans (the "Plans"), 3,605,000 shares
of the Company's common stock are reserved for the granting of incentive stock
options and nonqualified stock options, and the sale of restricted common stock
to the Company's key employees and non-employee directors. Options may not be
granted at a price that is less than fair market value on the date of grant, as
determined by the Company's Board of Directors, while restricted common stock
may be sold at any price. Options generally vest over 36 months and must be
exercised within 10 years from the date of grant. During 1996, the Company
adopted the 1996 Non-Employee Directors Stock Option Plan under which eligible
directors will automatically receive initial option grants to purchase 25,000
shares upon joining the Company's board of directors and additional option
grants to purchase 10,000 shares after each subsequent annual meeting of the
Company's stockholders. For
41
<PAGE>
financial reporting purposes, compensation expense, representing the excess of
the deemed value for accounting purposes of the stock issuable upon exercise of
the options over the aggregate exercise price of such options, amounting to
$50,000, was deferred in 1992 and was amortized over the vesting periods of the
respective option grants. This compensation expense was fully amortized at
December 30, 1995. During 1997 and 1996, the Company recognized $72,000 and
$9,000, respectively, of compensation expense related to the issuance of stock
options to non-employees. There was no such expense for the year 1995.
The following is a summary of the activity under the Company's stock option
plans:
<TABLE>
<CAPTION>
Number of Shares Option Price
Under Option per Share
---------- -------------
<S> <C> <C>
Options outstanding at December 31, 1994 288,816 $. 33 - 12.00
Granted 737,700 6.41 - 15.17
Exercised (24,055) .87 - 8.83
Canceled (95,007) 6.41 - 11.17
---------- -------------
Options outstanding at December 30, 1995 907,454 .33 - 15.17
Granted 1,841,175 3.69 - 15.00
Exercised (15,010) .33 - 6.59
Canceled (1,080,886) .33 - 15.17
---------- -------------
Options outstanding at December 28, 1996 1,652,733 .33 - 15.17
Granted 958,450 .75 - 4.81
Exercised (1,500) .88
Canceled (1,891,326) .88 - 15.17
---------- -------------
Options outstanding at December 27, 1997 718,357 $ .33 - 14.25
Granted -- --
Exercised -- --
Canceled -- --
---------- -------------
Options outstanding at December 26, 1998 718,357 $ .33-14.25
</TABLE>
The weighted average option price per share was $4.77, $4.77, $6.40 and $7.15
for options outstanding at December 26, 1998, December 27, 1997, December 28,
1996 and December 30, 1995, respectively.
Information relating to stock options at December 27, 1997 summarized by
exercise price is as follows:
<TABLE>
<CAPTION>
Range of Options Outstanding Options Exercisable
-------- ------------------------------------------------ ------------------------------
Exercise Prices Weighted Average Weighted Average
--------------- ---------------- ----------------
Per Share Shares Life (Year) Exercise Price Shares Exercise Price
--------- ------------ ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 0.33 to $ 5.50 325,691 8.54 $ 2.63 167,524 $ 2.64
$ 6.00 to $ 6.00 260,166 8.73 6.00 234,499 6.00
$ 6.25 to $ 6.25 25,000 8.77 6.25 8,333 6.25
$ 6.41 to $ 6.41 9,000 7.02 6.41 6,000 6.41
$ 6.59 to $ 8.83 91,500 7.17 7.76 85,000 7.85
$11.00 to $11.00 4,250 7.61 11.00 4,000 11.00
$14.25 to $14.25 2,750 8.11 14.25 916 14.25
------- -------
$ 0.33 to $14.25 718,357 8.42 $ 4.77 506,272 $ 5.26
======= =======
</TABLE>
In addition, the Company has an employee stock purchase plan which allows
employees to purchase directly from the Company shares of the Company's common
stock at a 15% discount from the market price, and to pay the purchase price in
installments by payroll deductions. The Company has reserved 150,000 shares for
granting under the employee stock purchase plan. During 1997, 83,906 shares of
common stock were purchased under this plan at an average price of $1.41. During
1996 and 1995, 19,737 and 14,938 shares of common stock were purchased under
this plan at average prices of $4.95 and $9.04, respectively, prior to
considering the impact of the stock dividend. As of December 28, 1996, the
Company's employee stock purchase plan liability (included under the caption
"Payroll Related Liabilities" in the accompanying balance sheets) totaled
$230,000. There was no such liability as of December 26, 1998 or December 27,
1997.
42
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. Stockholders' Equity (continued)
Stock Options and Stock Purchase Plans (continued)
Statement of Financial Accounting Standards No. 123 ("FAS 123"), "Accounting for
Stock-Based Compensation," requires the Company to provide pro forma information
regarding net income and earnings per share as if such compensation cost for the
Company's stock option and purchase plans had been determined in accordance with
the fair value based method prescribed in FAS 123. The Company estimates the
fair value of each stock option at the grant date by using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants in 1997, 1996 and 1995, respectively: 0% dividend yield; expected
volatility of 30%, 19% and 19%; respectively, risk free interest rates of 5.45%,
6.37% and 6.92%; respectively, and expected lives of 3 years. For purpose of
calculating compensation cost in 1997, the offsetting effect of significant
cancellations of options granted in prior years would have resulted in a
decrease in the net loss and a decrease in the net loss per share on a pro forma
basis. This is because the effect of actual forfeitures are recognized as they
occur. Accordingly, the actual net loss and pro forma net loss for 1997 are the
same. There were no grants in 1998.
Under the accounting provisions of FAS 123, the Company's net loss and net loss
per share for 1997 would remain unchanged and the net loss and net loss per
share for 1996 would have been increased to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
Net Loss: For the Years
------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
As Reported $(4,555,000) $(30,229,000) $(20,833,000)
Pro forma $(4,555,000) $(30,229,000) $(21,187,000)
Net Loss per share:
As reported $ (0.31) $ (2.32) $ (2.52)
Pro forma $ (0.31) $ (2.32) $ (2.56)
</TABLE>
8. Nonrecurring Charges
Restructuring - 1996
- --------------------
During 1996, the Company recorded restructuring charges of $3,028,000 for costs
associated with the Company's then planned consolidation and transfer of
manufacturing operations to Colorado Springs, Colorado and the closing of its
branch office in Japan, Nippon Pinnacle Micro. 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 1996, the Japanese branch office was closed and the Irvine, California
manufacturing facility was relocated to Colorado Springs, Colorado. During 1996,
charges totaling $678,000 were incurred in connection with this restructuring,
including: $421,000 for the write-off of the foreign currency translation upon
closing of the Japanese branch office; $107,000 for severance related to the
termination of employees who worked in manufacturing and marketing functions;
$150,000 for facility and lease terminations. The remaining balance of the
restructuring liability as of December 28, 1996 was $2,350,000.
During 1997, charges totaling $806,000 were incurred in connection with the 1996
restructuring for employee severance and lease terminations and $713,000 was
recorded for write-offs of leasehold improvements and other assets. As of
December 27, 1997, $568,000 of the 1996 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 year ended December 27, 1997.
43
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. Nonrecurring Charges (continued)
Restructuring - 1997
- --------------------
During 1997, the Company recorded an amount of $2,665,000 for restructuring
charges associated with the closing of the Colorado Springs, Colorado facility
and the related personnel and additional reductions in force at its Irvine,
California facility.
The remaining balance of the combined 1997 and 1966 restructuring liability as
of December 27, 1997 was $1,501,000 which related principally to longer-term
severance agreements.
Contract Termination
- --------------------
In 1996, the Company recorded $1,200,000 for estimated costs associated with
changes to a major component contract with a key supplier.
Litigation Settlement and Professional Fees
- -------------------------------------------
During 1998, 1997, 1996, and 1995 the Company incurred $0, $11,000, $493,000 and
$732,000, respectively, for certain professional fees related to litigation and
SEC related matters. In addition, the Company incurred $478,000, $577,000 and
$1,400,000 for litigation settlement expenses in 1998, 1997 and 1995,
respectively. (See Note 10).
44
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. Income Taxes
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
UNAUDITED UNAUDITED SEE EXHIBIT 23.2
<S> <C> <C> <C>
Current:
State -- $ 41,000 $ (1,103,000)
Foreign -- 19,000 1,000
------------- ------------- ----------------
-- 57,000 (1,087,000)
Deferred:
State -- -- 971,000
Federal -- -- 300,000
------------- ------------- ----------------
-- -- 1,271,000
------------- ------------- ----------------
-- $ 57,000 $ 184,000
============= ============= ================
</TABLE>
Income tax expense (benefit) differs from the amount that would result from
applying the federal statutory rate as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Tax at U.S. Federal statutory rate $ (1,481,000) $ (10,258,000) $ (7,002,000)
State Income taxes (335,000) (2,314,000) 1,000
Nondeductible expenses 200,000 276,000 595,000
Tax exempt income - - (1,000)
Adjustment to deferred tax assets valuation allowance - 13,194,000 1,271,000
Net operating loss carryforward for which no tax benefit (7,033,000) (7,033,000) 5,396,000
Has been recognized
Effect of graduated rates 8,649,000 6,304,000 --
Other -- (112,000) (57,000)
------------- ------------- --------------
$ -- $ 57,000 $ 184,000
============= ============= ==============
</TABLE>
45
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. Income Taxes (continued)
The components of the deferred income tax assets are as follows:
<TABLE>
<CAPTION>
1998 1997
(UNAUDITIED) (UNAUDITED
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ 13,643,000 $ 12,505,000
Accrued restructuring cost and other accruals not currently -- 643,000
Deductible
Inventory obsolescence reserve 8,457,000 3,422,000
Furniture and equipment 696,000 562,000
Sales returns and allowances for doubtful accounts 771,000 1,245,000
Research and development credit carryforward 400,000 400,000
Other -- (601,000)
------------ ------------
Total deferred tax assets 23,967,000 18,176,000
Valuation allowance (23,967,000 (18,176,000)
------------ ------------
Net deferred tax asset $ -- $ --
============ ============
</TABLE>
A valuation allowance is provided when it is more likely than not that some
portion or all of the deferred tax assets will be realized. As a result of the
Company's significant losses in 1998, 1997 and 1996 and uncertainties
surrounding the realization of the net operating loss carryforwards which were
generated during 1998, 1997 and 1996, management has determined that the
realization of the deferred tax assets is not more likely than not. Accordingly,
100% valuation allowances have been recorded. The net change in the total
valuation allowances for the years ended December 26, 1998, December 27, 1997
and December 28, 1996, were increases of $1,138,000, $11,196,000 and $6,980,000,
respectively. There was no change in the valuation allowance during 1995. The
amount of the valuation allowance could be reduced if estimates of the future
taxable income are increased.
10. Commitments and Contingencies
Legal Proceedings
- -----------------
In the fourth quarter of 1995, the Company reached a settlement agreement with
the plaintiffs who filed the November 20, 1994, class action complaint against
the Company, certain of its officers and directors and the Company's then
independent auditors, Ernst & Young LLP. This complaint resulted from the
Company's restatement of prior financial statements which, most significantly,
required approximately $2,400,000 of revenue, $1,400,000 of cost of good sold
and $70,000 of selling, general and administrative expenses previously reported
as earned or incurred in the quarter ended December 31, 1993 to be reported
instead as being earned or incurred in the quarter ended March 31, 1994. The
complaint alleged various violations of Federal Securities Laws and claimed
unspecified compensatory damages and related fees and costs. The complaint was
filed in the United States District Court for the Central District of California
under the case name of Kurtz, et al. v. Blum, et al., Case No. SACV94-1043-GLT.
The settlement agreement with the plaintiffs concerning this litigation required
a cash payment of $925,000 and the issuance of shares of the Company's common
stock with a value of $1,400,000. Pursuant to this settlement, the Company's
insurance carrier paid $925,000 in cash in December 1995, in connection with a
Directors and Officers liability policy purchased by the Company. The Company
issued 190,084 shares of common stock valued at $1,400,000 to the plaintiff
class and its attorneys during 1996. A provision for this $1,400,000 litigation
settlement was included as part of nonrecurring charges in the accompanying 1995
statement of operations (see Note 8).
46
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. Commitments and Contingencies (continued)
The Company and certain members or former members of its senior management have
been the subject of an investigation by the Securities and Exchange Commission
(the "SEC") relating principally to the restatement of the Company's previously-
reported financial results. The Company and its management have been cooperating
fully with the investigation.
The resignation of the Company's prior independent public accountants on
February 20, 1996, led to additional inquiries by the SEC. These inquiries
relate principally to the 1995 accounting adjustment matters discussed in Note
13. The Company and its management continue to cooperate fully with the SEC.
On March 15, 1996, a complaint was filed against the Company and certain of its
officers and directors 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. The Company denies
all allegations and intends to vigorously contest the suit. The ultimate outcome
of this matter cannot presently be determined. Accordingly, no provision for any
liability that may result has been made in the accompanying financial
statements. However, any adverse determination with respect to the pending
lawsuit could have a material adverse effect on the Company's financial
statements. The Company may incur significant legal costs relating to this suit
in 1997.
The Company is also subject to other legal proceedings and claims which arise in
the normal course of business. While the outcome of these proceedings cannot be
predicted with certainty, the Company does not believe that the outcome of these
other legal matters will have a material adverse effect on the Company's
financial statements.
Operating Leases
- ----------------
The Company leases its facilities and equipment under various noncancellable
operating leases for terms of up to four years. Future minimum lease payments
under these leases as of December 26, 1998 are as follows:
(UNAUDITED)
1999 $ 47,000
2000 35,000
2001 35,000
2002 35,000
--------
$152,000
--------
Rent expense for 1998 and 1997 was approximately $194,000 and $2,297,000,
respectfully. Rent in 1997 included $721,000 in costs associated with lease
terminations, which costs are included in nonrecurring charges in the Statements
of Operations. Rent expense was approximately $1,650,000 and $1,531,000 for 1996
and 1995, respectively.
11. Employee Benefits
The Company maintains an elective retirement savings plan which is intended to
qualify under Section 401(k) of the Internal Revenue Code. Participating
employees are allowed to contribute up to 15% of their cash compensation. The
Company can make contributions to the plan at the discretion of management.
There were no contributions to the plan in 1998,1997 or 1996. The year 1996 was
the first year of the plan.
47
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. Major Customers, Export Sales and Geographic Segment Information
For 1997, 1996 and 1995, the Company had product sales to one distributor of
approximately $7,190,000, $10,847,000 and $10,965,000 or 23%, 18% and 15%,
respectively, of the Company's net sales. The accounts receivable balances from
this distributor were $735,000 and $2,820,000 or 10% and 24% of total accounts
receivable at December 27, 1997 and December 28, 1996, respectively. In late
1997 this distributor became a credit risk to the Company, therefore shipments
were ceased.
In 1998, the Company's sales were spread over various customers and no one
customer made up more than 10% of net sales.
The Company's United States operations include export sales of $4,068,000,
$6,568,000 and $10,589,000 for 1997, 1996 and 1995, respectively. The Company
exports products direct from the United States to its international customers.
Prior to the fourth quarter of 1997, foreign operations were comprised of sales
offices in the Netherlands and Japan which were branches of the Company and
which were closed in 1997 and 1996, respectively. Inventory was transferred to
each of these sales offices at the Company's manufacturing cost. A summary of
the Company's operations by geographic region is as follows:
<TABLE>
<CAPTION>
1998 1997 1996 1995
UNAUDITED UNAUDITED SEE EXHIBIT 23.2
<S> <C> <C> <C> <C>
Net sales:
United States $ 9,400,000 $ 27,057,000 $ 48,489,000 $64,142,000
Europe 1,154,000 4,067,000 9,838,000 15,543,000
Japan 0 0 1,594,000 2,159,000
- ----------------------------------------------------------------------------------------------------------------------
Total net sales $10,554,000 $ 31,124,000 $ 59,921,000 $81,844,000
Operating income (loss):
United States $(4,786,000) $(30,066,000 $(17,571,000 $(3,761,000
Europe 231,000 (163,000) (221,000) 1,096,000
Japan 0 0 (671,000) (609,000)
- ----------------------------------------------------------------------------------------------------------------------
Total operating income (loss) $(4,555,000) $(30,229,000) $(18,463,000) $(3,274,000)
Identifiable assets:
United States 4,979,000 $ 12,544,000 $ 37,990,000 $26,912,000
Europe 0 0 1,955,000 3,062,000
Japan 0 0 293,000 2,031,000
- ----------------------------------------------------------------------------------------------------------------------
Total Assets 4,979,000 $ 12,544,000 $ 40,238,000 $32,005,000
</TABLE>
48
<PAGE>
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
13. Fourth Quarter Adjustments
1996 Adjustments
- ----------------
The Company originally accounted for its convertible debentures (see Note 5) in
accordance with APB 14, "Accounting for Convertible Debentures and Debt Issued
with Stock Purchase Warrants." According to the views of certain members of the
Staff of the SEC, which the Company learned in December 1996, convertible debt
instruments which are convertible at a discount to market should be accounted
for by treating such discount as additional interest expense. The Company
conformed to those views and computed the amount of the discount based on the
difference between the conversion price and fair value of the underlying common
stock on the date the debentures were issued. In the fourth quarter of 1996, the
Company recorded $1,721,000 of non-cash interest expense related to the embedded
interest in the convertible debentures. Of this amount, $1,286,000 should have
been recorded as interest expense in the third quarter. If this amount had been
properly recorded, net loss would have increased by $1,286,000 ($0.16 per share)
in the third quarter and decreased by $1,286,000 ($0.14 per share) in the fourth
quarter. The Company considers these amounts to be material and therefore has
restated its financial statements for the quarterly period ended September 28,
1996 on Form 10-Q/A for that period.
1995 Adjustments
- ----------------
The Company previously capitalized certain non-recurring engineering
expenditures for 1994 and the quarters ended April 1, July 1 and September 30,
1995, which expenditures primarily related to design and development of
components incorporated into certain of the Company's products. The Company
since determined the capitalization of these amounts was not appropriate. The
amounts should have been accounted for as research and development and expensed
as incurred. The aggregate amount of capitalized expenditures for 1994 and 1995
were $138,000 and $429,000, respectively.
The amounts capitalized in 1995 and the aggregate effect of such amounts if they
had been properly expensed are as follows:
<TABLE>
<CAPTION>
Quarter Amount Aggregate Effect on
----------------------------------
Ended Capitalized Net Income Net Income Per Share
------- ----------- ----------- ---------------------
<S> <C> <C> <C>
April 1 $ 38,000 $ (23,000) $ -
July 1 69,000 (42,000) -
September 30 322,000 (198,000) (.03)
--------
Total $429,000
========
</TABLE>
The Company considers the $322,000 for the quarter ended September 30, 1995 to
be material and restated the financial statements in the Form 10-Q/A for that
period. The Company considers the $38,000 for the quarter ended April 1, 1995,
the $69,000 for the quarter ended July 1, 1995 and the $138,000 for 1994 to be
immaterial and therefore has not restated the financial statements for those
periods. For the aforementioned periods which have not been restated, the total
amount of $245,000 was charged to research and development expense for the
quarter ended December 30, 1995. The aggregate effect of such adjustments in the
quarter ended December 30, 1995 was to increase the net loss by $151,000 or $.02
per share.
14. Related Party Transaction
The Company has a month to month consulting contract for marketing and
advertising services with an entity owned by the son of the Company's Chairman
of the Board, President, Chief Executive Officer and Chief Financial Officer.
This other entity also subleased space from the Company on a month to month
basis through July 1998. Total marketing and advertising expense incurred for
these services in 1998 and 1997 were $143,000 and $66,000, respectfully. Total
rental income earned under the sublease was $14,000.
49
<PAGE>
Schedule II
PINNACLE MICRO, INC.
VALUATION AND QUALIFYING ACCOUNTS
December 26, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Balance at Charged to Balance at
Description Beginning Costs and End of
-----------
of Period Expenses Deductions Period
----------- ----------- ---------- ------
<S> <C> <C> <C> <C>
Year ended December 26, 1998:
Deducted from asset accounts:
Allowance for doubtful accounts $ 451,000 $ 300,000 $ (523,000)* 228,000
Allowance for product returns and price protection 2,455,000 0 (1,912,000) 543,000
Inventory obsolescence reserve 7,988,000 1,100,000 (631,000)** 8,457,000
Deferred valuation allowance 18,176,000 6,791,000 - 24,967,000
Year ended December 27, 1997:
Deducted from asset accounts:
Allowance for doubtful accounts $ 336,000 $ 122,000 $ ( 7,000)* 451,000
Allowance for product returns and price protection 412,000 7,492,000 (5,449,000) 2,455,000
Inventory obsolescence reserve 1,095,000 9,274,000 (2,381,000)** 7,988,000
Deferred valuation allowance 6,980,000 11,196,000 - 18,176,000
Year ended December 27, 1996: (SEE EXHIBIT 23.2)
Deducted from asset accounts:
Allowance for doubtful accounts $ 350,000 $ 369,000 $ ( 383,000)* $ 336,000
Allowance for product returns and price protection 828,000 999,000 (1,415,000) 412,000
Inventory obsolescence reserve 783,000 866,000 (554,000)** 1,095,000
Deferred valuation allowance - 6,980,000 - 6,980,000
Year ended December 30, 1995:
Deducted from asset accounts:
Allowance for doubtful accounts $ 287,000 $ 230,000 $ (167,000)* $ 350,000
Allowance for product returns and price protection 700,000 128,000 - 828,000
Inventory obsolescence reserve 683,000 871,000 (771,000)** 783,000
Deferred valuation allowance - - - -
</TABLE>
___________________________
* Doubtful accounts written off.
** Disposal of obsolete inventory.
50
<PAGE>
Exhibit 23.1
Consent of Independent Certified Public Accountants
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
-------------------------------------------------------------
STATEMENTS AND NOTES THERTO FOR THE YEAR ENDED DECEMBER 26, 1998 AND DECEMBER
- -----------------------------------------------------------------------------
27, 1997 FROM ITS INDEPENDENT AUDITOR PRINCIPALLY AS A RESUULT OF THE
- ---------------------------------------------------------------------
INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO CONTINUE AS A
- ------------------------------------------------------------------------------
GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES THERETO,
- -------------------------------------------------------------------------
SELECTED FINANCIAL DATA, AND MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------------------------------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS
- ----------------------------------------------------------------------
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
- -----------------------------------------------------------------------------
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -------------------------------------------------------------------------
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT
- --------------------------------------------------------------------------
AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE
- --------------------------------------------------------------------------------
COMPANY FOR DECEMBER 27, 1997 AND DECEMBER 26, 1998 PRESENTED IN THIS FORM 10-K.
- --------------------------------------------------------------------------------
<PAGE>
Exhibit 23.2
Consent of Independent Certified Public Accountants
THE COMPANY HAS BEEN UNABLE TO OBTAIN THE NECESSARY CONSENT FROM THE
--------------------------------------------------------------------
COMPANY'S PREDECCESOR INDEPENDENT AUDITORS FOR THE FINANCIAL STATEMENTS, NOTES,
- -------------------------------------------------------------------------------
SELECTED FINANCIAL DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------------------------------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 28, 1996,
- -------------------------------------------------------------------------
PRINCIPALLY AS A RESULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF
- --------------------------------------------------------------------------------
THE COMPANY TO CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE FINANCIAL
- ------------------------------------------------------------------------
STATEMENTS AND NOTES THERETO, SELECTED FINANCIAL DATA, AND MAMANEMENT'S
- -----------------------------------------------------------------------
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, HEREIN
- --------------------------------------------------------------------------------
CONTAINED, ALTHOUGH UNCHANGED FROM THE PRIOR YEAR FORM 10-K, ARE PRESENTED AS
- -----------------------------------------------------------------------------
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
- -----------------------------------------------------------------------------
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -------------------------------------------------------------------------
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF A CONSENT FROM THE
- ------------------------------------------------------------------------------
PREDECCESOR AUDITORS TO REISSUE THEIR AUDIT OPINION ON THE FINANCIAL CONDITION
- ------------------------------------------------------------------------------
AND RESULTS OF OPERATIONS OF THE COMPANY FOR DECEMBER 28, 1996 PRESENTED IN THIS
- --------------------------------------------------------------------------------
FORM 10-K
- ---------
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 12 MOS 12 MOS
<FISCAL-YEAR-END> DEC-26-1998 DEC-27-1997
<PERIOD-START> DEC-28-1997 DEC-29-1996
<PERIOD-END> DEC-26-1998 DEC-27-1997
<CASH> 322,218 454,003
<SECURITIES> 0 0
<RECEIVABLES> 513,000 7,759,000
<ALLOWANCES> 771,000 2,906,000
<INVENTORY> 3,592,208 6,403,826
<CURRENT-ASSETS> 4,789,903 12,085,795
<PP&E> 45,940 447,254
<DEPRECIATION> 402,000 1,148,000
<TOTAL-ASSETS> 4,978,844 12,544,000
<CURRENT-LIABILITIES> 25,004,098 28,014,000
<BONDS> 0 0
0 0
0 0
<COMMON> 34,991,756 34,991,756
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 4,978,844 12,544,000
<SALES> 10,554,000 31,124,000
<TOTAL-REVENUES> 10,554,000 31,124,000
<CGS> 9,481,300 37,328,000
<TOTAL-COSTS> 5,032,000 20,561,000
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 654,000 824,000
<INCOME-PRETAX> (4,544,000) (27,772,000)
<INCOME-TAX> (12,000) 57,000
<INCOME-CONTINUING> (4,556,000) (30,229,000)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (4,556,000) (30,229,000)
<EPS-BASIC> (0.314) (2.32)
<EPS-DILUTED> (0.314) (2.32)
</TABLE>
