Item 1. Business --------
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
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
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.
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
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.
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.
Item 2.
Item 2. Properties ----------
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.
Item 3. Legal Proceedings -----------------
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.
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.
PART II -------
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ---------------------------------------------------------------------
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.
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.
Item 6.
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 - ------------------------------------------------------------------------------ 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. - ------------------------------------------------------------------------
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.
(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.
Item 7.
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.
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.
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:
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.
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
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
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.
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,
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.
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.
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.
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 -----------------------------
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.
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.
PART IV -------
Item 14.
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 --------------------------------
(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.
__________________ (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.
(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
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
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. - --------------------------------------------------------------------------------
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. - -------------------------------------------------------------------------------
PINNACLE MICRO, INC.
BALANCE SHEETS
ASSETS
The accompanying notes are an integral part of these financial statements.
PINNACLE MICRO, INC.
STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
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)
The accompanying notes are an integral part of these financial statements.
PINNACLE MICRO, INC. STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
PINNACLE MICRO, INC.
STATEMENTS OF CASH FLOWS (continued)
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.
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.
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
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.
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.
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.
3. Inventories
Inventories consist of the following:
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:
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
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
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:
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:
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.
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:
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.
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).
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. Income Taxes
Income tax expense (benefit) consists of the following:
Income tax expense (benefit) differs from the amount that would result from applying the federal statutory rate as follows:
PINNACLE MICRO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. Income Taxes (continued)
The components of the deferred income tax assets are as follows:
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).
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.
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:
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:
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.
Schedule II
PINNACLE MICRO, INC.
VALUATION AND QUALIFYING ACCOUNTS
December 26, 1998 (UNAUDITED)
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* Doubtful accounts written off. ** Disposal of obsolete inventory.