ITEM 1 BUSINESS
BACKGROUND
Golden Systems was incorporated in October 1985 and commenced operating in February 1991. Since then the Company has engaged in the marketing of power supplies to personal computer and peripheral equipment original equipment manufacturers ("OEMs") and to distributors of standard power supply products. During the fiscal year ended March 31, 1992, the Company entered into its first high volume OEM sales arrangement. The engineering, sales and distribution operations of the Company were integrated with the engineering and manufacturing operations of its newly acquired subsidiary, Ultra Tek Devices, Ltd. ("Ultra Tek"), effective on July 1, 1993, in contemplation of the Company's Initial Public Offering. Prior to the integration, Ultra Tek manufactured power supplies for sale primarily to Tandon Corporation or Tandon Associates for use in personal computers and peripheral equipment manufactured by companies affiliated with the Tandon family. J. L. Tandon, a United States resident and citizen, is the Chief Executive Officer and a director of the Company. M. L. Tandon, a resident and citizen of India, has been Chairman of the Board of Ultra Tek since its incorporation on August 9, 1985 and is J. L. Tandon's brother. The Company began doing business as "Cortech Systems" in August 1996.
GENERAL
The Company is in the business of designing, manufacturing and marketing switching power supplies. Historically, its customers have been OEMs of personal computers and peripheral equipment. The Company's principal customers in the past were Compaq Computer Corporation ("Compaq") and International Business Machines Corporation ("IBM"). Sales to Compaq declined significantly during fiscal 1996 and 1997. Although the Company expanded its business activity with IBM during fiscal 1996, IBM ceased to be a customer during fiscal 1997. Since fiscal 1997, the Company's primary customer has been Iomega Corporation ("Iomega"). However, since December 1999, the Company has not received any new orders from Iomega, nor has Iomega provided any explanation for this action.
The Company uses low-cost manufacturing and labor at its manufacturing facilities to produce its products, which it designs specifically to meet the quality requirements and other specifications of its OEM customers. During fiscal 1999, the Company's manufacturing operations were located in a foreign export processing zone in Mumbai (formerly Bombay), India. Manufacturing in two other facilities located in Chennai (formerly Madras), India and Sri Lanka were discontinued in fiscal 1996 and fiscal 1998 as part of the Company's restructuring and cost reduction efforts. During fiscal 1997, the Company relocated its product design and development engineering, along with its self-certifying product safety laboratory, to Scotland. Both were moved back to the Company's headquarters office in California during the fourth quarter of fiscal 1998, as part of the Company's ongoing effort to cut costs, because anticipated sales
volume to support these activities did not develop.
As was previously reported in the Company's annual and quarterly reports filed with the Securities and Exchange Commission (the "Commission") and in timely press releases issued in December 1994, the Company's cash flow was significantly impacted by the product rejection by Compaq, its then-largest customer, that took place in the last few months of fiscal 1995, which cost the Company $4.2 million of lost accounts receivable directly related to the sales of the rejected units and $2.2 million related to other direct costs stemming from the rejection. This additionally placed the Company in an unfavorable position with its raw material vendors due to limited cash, high short-term debt, and a severe deferral of payments to its banking institutions and vendors. Existing and potential new customers were very aware of the significant product return and the unfavorable financial position the Company was experiencing.
In recognition of the unfavorable circumstances created by this event (high short-term debt, limited capital, vendor problems, and negative perception by its existing and potential customer base), the Company was required in fiscal 1996 to develop and implement a strategy to overcome its severe cash difficulties. The strategy included utilization or sale of its raw material inventory, cost reductions, organizational restructuring, price increases, volume growth, and obtaining more favorable payment terms from its existing customers. The Company recognized that these measures would be both difficult to achieve in the very competitive personal computer component market and would be short-term solutions under the best of circumstances and results. Based on this, the Company recognized the necessity, on a longer term basis, of pursuing new equity investment primarily through a merger or acquisition.
The Company was successful in achieving certain portions of its cash recovery strategy as is demonstrated in its fiscal 1996 year-end financial statements. In particular, $2,161,000 in cash was provided by a decrease in accounts receivable as a result of specific customers granting the Company accelerated payment terms and an additional $2,270,000 in cash was provided by a reduction in inventory primarily as a result of using existing raw materials in new power supply products. These same activities resulted in cash in the amounts of $838,000 and $1,046,000, respectively, as reported in the Company's Annual Report on Form 10-K for fiscal 1997. During fiscal 1996, selling, general and administrative expenses were reduced by $1,129,000 resulting from the eventual shut-down of the manufacturing facility located in Chennai, India, staff and cost reductions in the Simi Valley corporate offices, and cost reductions in the England and Singapore sales offices. But, while achieving some success, the Company did not generate the anticipated amounts of cash recovery from inventory reduction, had only limited success in its efforts to resell the reworked, rejected product, and failed to rebuild the volume of its business.
Sales to Compaq decreased significantly in fiscal 1996 and fiscal 1997. Although the Company was successful in increasing its volume with IBM through the third quarter of fiscal 1996, it was not successful in building its sales volumes to other existing customers or to new customers. The Company also was notified by IBM in the latter half of fiscal 1996 that it was reducing its number of vendors for power supplies to those larger and best financially prepared to support its activities and that the Company no longer met its vendor selection criteria. Sales to IBM ceased during fiscal 1997.
The Board of Directors concluded during the fourth quarter of fiscal 1996 that, if the Company were to remain operational, it must evaluate all measures to obtain additional capital from sources outside the Company or, if none were found, that the Company must engage in a transaction that would change its fundamental structure. On February 13, 1996, the Board of Directors established an Independent Directors Committee, made up of non-management directors, to evaluate financing and restructuring options and opportunities available to the Company.
The Independent Directors Committee was unable to identify any outside sources of capital. The Company pursued an equity investment by an outside investment group; discussed strategic alliances with two different companies; considered an acquisition proposal by an investment banker; and explored a merger with another electronics manufacturer. However, the Company found that the following factors made it unattractive to potential investors and traditional lenders: (i) the size of its Indian bank debt relative to the Company's consolidated assets; (ii) the fact that the Indian banks' liens on Ultra Tek's assets are first in priority over all other debt, as well as over shareholders' equity rights; (iii) the Company's
operating losses since the fiscal 1995 product rejection by Compaq; and (iv) the fact that the Company had consumed the totality of its resources simply to survive during the four quarters of fiscal 1996. In May 1996, J. L. Tandon, the Company's CEO, informed the Independent Directors Committee that the Tandon family, which owned approximately 38.2% of the outstanding shares of the Company's common stock (the "Common Stock") and has personally guaranteed Ultra Tek's bank debt in India (amounting to approximately $7.5 million at March 31, 1996), was prepared to invest additional equity in the Company and to support the Company in negotiations with the Indian banks. A number of discussions of terms, amounts and timing took place, leading to an initial proposal from the Tandon family dated July 31, 1996. During August 1996, the Independent Directors Committee informed J. L. Tandon that, in addition to financial terms, an acceptable proposal must include (i) a business plan showing that the investment would be sufficient to restart the Company with new products, and (ii) an organization chart showing that the Company had in place, or had identified, the management and engineering talent necessary to implement the plan.
During September 1996, the Company prepared and delivered a business plan and reviewed personnel issues. The Independent Directors Committee pointed out the weakness in senior financial management as a result of the resignation of Michael D. Thomas, the Company's president and chief financial officer, effective July 1, 1996. Prakash Thanky had become the Company's president, effective that same date, but no senior financial executive was then employed by the Company. The committee directed management to initiate a search for a chief financial officer and indicated its willingness to accept an interim consultant in that position while the search was under way. Harvey Marsh was hired as a part-time interim financial consultant in October 1996 and continued in that capacity until April 6, 1998, at which time he became an employee of the Company. On September 8, 1998, the Board of Directors elected Mr. Marsh a director and appointed him Chief Financial Officer of the Company.
In October 1996, the Tandon family proposed a recapitalization plan (the "Recapitalization Plan") to the Independent Directors Committee. This proposal called for an investment in newly issued shares of the Company's Common Stock in the amount of $2 million by the Tandons, together with a commitment from the Tandon family to obtain a standstill arrangement with Ultra Tek's Indian bank lenders whereby such banks would agree not to demand payment of any interest or principal from the Company or Ultra Tek, or declare a default despite the Company's failure to comply with its debt covenants, for a period of not less than one year. The Company expected that the standstill arrangement would give it enough time to demonstrate its viability as an ongoing business so that it could negotiate a reasonable payment schedule with the Indian banks, rather than having the banks foreclose on Ultra Tek's assets. The Recapitalization Plan did not require that a formal standstill agreement be reached with the Indian Banks. Instead, it required that the Tandon family loan to the Company any funds necessary to meet any payment demands by the Indian Banks. The proposed per-share stock purchase price was $0.15, which exceeded the public bid price of $0.07 and the public asked price of $0.14 at the time of the proposal. The terms presented by the Tandon family would result in Tandon interests in the Company increasing from approximately 38.2% (as of March 1, 1997) to approximately 77.3% of the Company's outstanding shares.
Because implementation of the Recapitalization Plan would cause an increase in ownership by the Tandon family relative to other shareholders, the Recapitalization Plan represents a conflict of interest as a related party equity investment. The Independent Directors Committee, as a result of the Company's lack of success in identifying and consummating a transaction with an unrelated party, concluded that the Company must confront and resolve the conflict of interest. The Committee recognized that the Company's ability to continue its Indian manufacturing operations was dependent upon the involvement of the Tandon family. The Tandon family provided expertise in Indian operations and had personally guaranteed the debts to the Indian banks. As a practical matter, no resolution of the Company's situation would be achievable without the cooperation and participation of the Tandon family. In fact, proposals received from third parties and rejected by the Company (as described above) had provided for separate treatment of the Tandon family and its interests relative to the Indian bank debt. Consequently, the Independent Directors Committee determined that any potential conflict of interest presented by the Recapitalization Plan could be minimized by the function of the Committee itself in reviewing and negotiating the terms of the Recapitalization Plan on the Company's behalf with the Tandon family. Further, the Company appeared to have no practical alternative in order to obtain the cash necessary for it
to continue to exist. Shareholder approval for the Recapitalization Plan would be necessary because of the substantial number of shares issuable under its terms.
On February 21, 1997, the Independent Directors Committee determined to recommend to the Board of Directors that the Recapitalization Plan and the transactions contemplated thereby be approved. On February 27, 1997, the Board of Directors approved the Recapitalization Plan. The Company prepared a proxy statement describing the Recapitalization Plan, which was to be presented to the Company's shareholders for a vote at the 1996 Annual Meeting of Shareholders. The document was filed with the Commission, as required by federal securities law, on April 8, 1997. One month later, the Company received comments from the Commission, which the Company needed to address before the proxy statement could be delivered to the shareholders. As a result of the time taken by the Commission to prepare its comments and the time necessary for the Company to respond to them, the financial information included in the proxy statement became too old to use under federal securities rules. Because the information provided was from the third quarter of fiscal 1997, updating the financial disclosure required the completion of the 1997 fiscal year end audit. Unfortunately, the Company's worsening financial situation prevented it from undertaking this audit for some time and then, upon undertaking the audit, prevented the audit from being completed until June 1998. Having its fiscal 1997 audit in place and having filed the fiscal 1997 year end report with the Commission in June 1998, the Company proceeded to prepare quarterly reports on Form 10-Q for each of the first three quarters of fiscal 1998, which were filed with the Commission in September 1998. Because of the foregoing delays, a change in auditors, and delays in completing the audit in India using Generally Accepted Accounting Principles, the fiscal 1998 audit was not completed until August 1999, which delayed the filing of this fiscal 1999 annual report on Form 10-K with the Commission. Before the Company will be able to solicit the approval of its shareholders for the Recapitalization Plan or any other matters requiring shareholder approval, fiscal 2000 quarterly and annual reports will have to be filed.
In order to ease the Company's worsening cash situation while the shareholder approval process was being pursued, the Tandon family agreed to invest immediately the $2,000,000 contemplated by the Recapitalization Plan. On or about March 31, 1997, the Tandon family contributed $2,000,000 consisting of cash and canceled promissory notes from the Company in exchange for 850,000 shares of the Company's Common Stock that had been authorized for issuance but never issued and a bridging promissory note from the Company in the principal amount of $1,873,000 that would be canceled when the remaining 12,483,333 shares of Common Stock issuable under the terms of the Recapitalization Plan had been authorized by the Company's shareholders and issued to the Tandon family. By its terms, the original bridge note has converted into an 8% per annum demand promissory note. All of the proceeds were used for the Company's working capital. The balance owing under that note as of March 31, 1999, was $2,173,000, including accrued interest. Further, as of that date, the Company had borrowed, net of repayments, an additional $2,234,000 from the Tandon family. This cash allowed the Company to continue operations, but aside from related party financing, the Company currently has no viable source of financing to continue its current revenue growth and achieve profitable operations and positive cash flow. At January 31, 2000, the outstanding balance, including accrued interest, due to the Tandon family was $2,353,000, in addition to $2,298,000 owing on the note payable under the Recapitalization Plan. All additional loaned amounts have either been under the terms of a factoring agreement at a monthly interest rate of 1% on the average outstanding daily balance, or been under the terms of unsecured loans, payable on demand at an interest rate of 15% per annum, commencing April 1, 2000.
In the third quarter of fiscal 1998, the Company began implementing additional cost reductions, including the discontinuance of manufacturing operations at the Sri Lanka facility, in an effort to overcome its negative cash flow. Also, Prakash Thanky resigned and J. L. Tandon assumed the title of President. In the fourth quarter of fiscal 1998, the Company sold its Singapore and Sri Lanka subsidiaries to related parties, closed its Scotland office and initiated additional employee reductions. In addition, the Company commenced discussions with its Indian banks regarding a financial rehabilitation plan pursuant to guidelines established by the Board for Industrial and Financial Reconstruction ("BIFR"), which is an Indian authority that adjudicates all matters of financially distressed companies.
The BIFR appointed an Operating Agency ("OA") to examine the Company's viability and
prepare a viability study report. Accordingly, the Company prepared a draft rehabilitation proposal, which was submitted to the OA. The OA reviewed the proposal and forwarded the same to the BIFR along with the minutes of a joint meeting convened by the OA in March 1999. Based on the minutes of the joint meeting, the BIFR prepared its Draft Rehabilitation Scheme and advised all concerned, inviting suggestions/objections to the scheme. The Draft Scheme is subject to ongoing discussion and envisages restructuring of existing debts (unpaid principal amount of $5,129,047 to banks and financial institutions as of September 30, 1999), conversion of simple interest into a Funded Interest Term Loan amounting to $2,132,801 as of September 30, 1999, infusion of funds by way of contribution by the Tandon family amounting to $938,527 which has already occurred, and additional working capital facilities from the Indian banks of $1,642,421, which would enable the Company to generate enough resources to continue its operations and repay the restructured debts over a period of time. The BIFR held a hearing on August 16, 1999 and, after hearing all interested parties, has advised the Company and the banks to discuss further and modify the Draft Scheme to take into account the various points made at the hearing. The BIFR also instructed the OA to conduct joint meetings with the banks and the Company and to forward a modified scheme. The Company is in the process of discussing with the banks ways to modify the Draft Scheme to take into account a potential conversion of compound interest and liquidated damages into redeemable preference stock. As of January 31, 2000, the debt to the Indian lenders amounted to approximately $11,000,000.
During February 1999, a major customer notified the Company that the plastic housing on approximately 150,000 external power supplies manufactured by the Company is subject to separation under some circumstances. The Company has worked with the customer in their recall of 60,000 units at risk of separation and in the hands of consumers. Through January 31, 2000, the cost of the recall to the Company has been approximately $50,000.
During the second quarter of fiscal 1997, the Company began doing business as "Cortech Systems." Pending shareholder approval of a change in the Company's name, Cortech Systems is a fictitious business name.
UNITED STATES OPERATIONS
The Company's operations in the United States are focused on administration and marketing, product design and development, and the coordination of product engineering and manufacturing between the Company's customers and its Indian manufacturing facilities. The Company markets its products directly to OEMs through its established network of contacts in the electronics industry. Product development and design engineers work closely with OEMs, visiting their facilities and organizing lines of communication (typically through the use of electronic mail). Concurrently, the design engineers communicate with process and manufacturing engineers in India, also via electronic mail, to coordinate the design and manufacture of products. Finally, the Company has a self-certifying product safety laboratory, which allows it to obtain safety certification for its products on an expedited basis.
OFFSHORE OPERATIONS
The electronics industry is extremely competitive, with price being a major competitive factor. The Company seeks a competitive advantage by attempting to offer high-quality, low-cost products to existing and potential customers by capitalizing on lower cost offshore manufacturing capabilities. During fiscal 1999, the Company maintained its manufacturing facility in Mumbai, India. India's large population and high unemployment rate enable the Company to employ relatively well-educated workers at low wages. The Company believes its workers are well educated relative to workers performing similar manufacturing duties in other third world countries. Most of the Company's workers are graduates of secondary school (high school equivalent), which the Company believes enables more extensive and effective worker training, permitting greater productivity. The Company further benefits from these low wages by manufacturing many power supply components in-house. The Company also employs executives who reside in India, thereby minimizing travel expense as well as salary expense.
INDIA OPERATIONS
Ultra Tek currently manufactures all of its power supplies in a leased facility located in the Santa Cruz Electronics Export Processing Zone ("SEEPZ") in Mumbai, India. SEEPZ was established in Mumbai in 1974 as part of a series of incentive programs by the government of India to encourage domestic manufacture of products for export. These programs began in the early 1970s and, to date, the Indian government has created a number of free trade zones. Recent amendments to these programs continue the trend of expanding export incentives. The Company believes that the Indian government will continue to support these export processing zones.
SEEPZ is 100 acres in area and is located in a northern suburb of Mumbai. It is less than five miles away from both Mumbai's domestic and international airports and less than twenty miles from its commercial docks. Almost two hundred companies employing over ten thousand people currently operate in SEEPZ. Under Indian regulations relating to SEEPZ, businesses in SEEPZ are required to export a substantial part of production.
Major benefits provided by the Indian government to businesses operating within SEEPZ include:
INFRASTRUCTURE. In addition to developed land parcels for self-constructed facilities, ready-built space is available in government-constructed Standard Design Factories ("SDFs"). Ultra Tek currently does all of its manufacturing in an SDF. SDFs are typically leased for five-year periods, with the tenant responsible for the construction of all internal improvements, including partitions, air conditioning and internal wiring. The zones are exempt from scheduled electrical power cuts, common in India, and also have on-site telecommunications switching facilities and bank offices. The Indian government typically renews such leases absent unusual circumstances.
INCENTIVES. The Indian government waives licensing and duties on imported capital goods, raw materials, other production materials, office equipment and supplies, and also waives the excise tax applicable on the purchase of goods and materials in India. Sales tax on goods purchased in India is eligible for reimbursement. The government has adopted policies that do not require any domestic ownership to establish and operate a facility within SEEPZ. These policies are intended to encourage the investment of foreign capital. To operate within SEEPZ, all products manufactured by a company therein must be exported, although with prior governmental approval up to 25% of products manufactured may be sold within India. Income derived from export sales is exempt from income tax. Income derived from domestic sales, however, is subject to income tax.
ADMINISTRATIVE SUPPORT. An on-site Development Commissioner is empowered to grant a number of government approvals, widely required in India, including a range of permits and licenses, and is available to coordinate others. Export processing zones also are special customs areas that allow customs clearance on-site, with bonded shipment to nearby harbor and airport facilities.
In addition, restricted access to export processing zones means that the risk of labor unrest from outside organizers is reduced. The businesses in the zones also have the advantage of "public utility" status under Indian law, which restricts the rights of their workers to strike.
STRATEGY
Since fiscal 1996, the Company's strategy has been continued cost control and cash conservation as it seeks to rebuild its manufacturing operations. New credit lines and other sources of working capital are also being explored. Since the fourth quarter of fiscal 1995, the Company has pursued relationships with a broad range of OEMs of electronic products. The Company has sought to shift its product focus away from manufacturers of personal computers and to focus instead on manufacturers of computer peripheral equipment and other electronics products where the Company believes the margins of profit are higher. Manufacturers of these products typically require lower volumes but are not subject to the commodity price pressure that exists in the personal computer market. The Company believes that, with
improved production management, higher margins can be obtained on shorter production runs because these circumstances lower the portion of the customer's price that is represented by the components in the product units. The Company's lower labor and engineering costs should thus provide an opportunity to offer competitive prices while retaining enough margin to allow the Company to generate positive cash flow. Achieving positive cash flow from operations would make the Company more attractive to existing and potential customers and should give the Company a better opportunity to reach a settlement with its Indian banks that will allow the Company to continue to operate.
It is crucial to the Company's prospects that it develop a level of revenues from customers offering sufficient opportunities for positive profit margins that will allow the Company to be cash flow positive on an operating basis and to report operating income. As of January 31, 2000, this has not yet occurred. In addition to the production management, inventory management, customer satisfaction and new business development risks the Company faces in achieving its objectives, the Company also faces national and world economy risks, industry downturn risks and specific customer well-being risks. For example, the economic crisis that began affecting some countries in Asia in 1997 was helpful to some of the Company's competitors and harmful to some of its customers. It also disrupted the supply of raw materials from the affected countries. Further, the slump in business of the Company's largest customer in the first half of fiscal 1998, caused this customer to cut back its orders by approximately 50% from projected levels for the fourth quarter of fiscal 1998. For fiscal 1999, sales to this customer were approximately 17% less than sales for fiscal 1998, and since December 1999 through March 31, 2000, no new orders have been received.
POWER SUPPLIES
Manufacturers of certain types of electronic equipment do not design their products for use with alternating current such as that provided by an electrical outlet. Instead, these products require the use of a power supply to convert the alternating current to a direct current of appropriate voltage. Power supplies are either linear or switching. Linear power supplies are relatively simple devices having low electromagnetic interference and low output ripple, but tend to be large and heavy because the necessary voltage conversion transformers must operate at below the frequency (50 or 60 Hz) of the alternating input current. The scientific and engineering communities use linear power supplies in technical instrumentation where output regulation is extremely important and size and efficiency are of less importance. Linear power supplies also tend to produce a great amount of heat, making them undesirable for many industrial and consumer applications. The Company sells an insignificant number of linear power supplies.
Switching power supplies are more complex devices than linear power supplies and produce greater power in relation to their physical size, described as greater "power density". In a switching power supply, alternating current is first converted to direct current by diodes, and is then reconverted to much higher frequency alternating current before being passed through the voltage conversion transformers, which are therefore much smaller and permit greater power densities. A switching power supply typically consists of a printed circuit board with the appropriate electronic components, an on/off switch, and leads or cables to send power to the electronic equipment. Switching power supplies are much more efficient and therefore produce less heat than equally powerful linear power supplies, making them preferable for a wide array of applications. The Company manufactures three types of switching power supply products--closed frame, open frame and A/C adapters.
CLOSED FRAME. Closed frame power supplies have a case enclosing the power supply components and are used in product applications where end users may need access to the interior of the product and in products requiring greater power than can safely be provided by open frame power supplies. Encasing the power supply minimizes the risk of injury to end users from the high voltage components of the power supply. The Company manufactures closed frame power supplies ranging from 25 watts to 350 watts, with the 200 watt units accounting for a majority of sales. The Company offers these power supplies in a variety of configurations and works closely with its customers to modify or customize the power supplies to adapt them to particular customer specifications. Sales of closed frame power supplies accounted for approximately 21% of the Company's sales in fiscal 1998 and approximately 10% in fiscal 1999.
OPEN FRAME. Open frame power supplies are not enclosed in a case. They tend to be used in
products that require lower wattage and that are unlikely to be opened by end users. For example, open frame power supplies are used in tape and disk drives, monitors, printers and other peripheral equipment. Open frame power supplies tend to be more standardized in configuration than closed frame power supplies. The Company produces open frame power supplies ranging from 25 watts to 200 watts, with the 65 watt unit accounting for a majority of sales. Open frame power supplies accounted for approximately 2% of the Company's sales in fiscal 1998 and approximately 17% in fiscal 1999.
A/C ADAPTERS. A/C adapters are external power supplies that connect electronic products to wall outlets. A/C adapters are used with a variety of products, including notebook and portable computers. The A/C adapters produced by the Company contain a battery recharging circuit. The Company produces A/C adapters ranging from 15 watts to 70 watts, with the 15 watt unit accounting for a majority of sales. Sales of A/C adapters accounted for approximately 75% of the Company's sales in fiscal 1998 and approximately 72% in fiscal 1999.
Parts and License Fees. In addition to providing customers with finished power supplies, the Company has also been selling parts on hand in its efforts to reduce inventories. This activity, along with minor import license fees, accounted for 2% of the Company's sales in fiscal 1998 and approximately 1% in fiscal 1999.
MANUFACTURING
The manufacture of power supplies is labor intensive and will probably remain so in the near future. It necessarily involves relatively large, heavy, or irregularly shaped items such as transformers, heat sinks and high voltage capacitors. Additionally, the manufacture of transformers involves winding wire in complex sequences, involving four or more winding and insulating steps. For this reason, the Company has chosen to manufacture its products in India. The Company believes that the work force there is inexpensive and relatively well-educated. Moreover, because the Company's management team has extensive experience in manufacturing computer components in India, the Company believes that it is well positioned to benefit from the advantages India provides. That being said, however, the largest component of the production cost of a power supply is the materials that go into each unit. The Company's financial condition has made advantageous relationships with the Company's vendors unavailable, which has decreased the Company's ability to produce low-priced products.
The Company uses its low-cost labor to manufacture magnetics, to configure sheet metal, and to mold plastic components, which enables the Company to respond quickly to design changes and reduces the risk of shipping delays. Other purchased parts and raw materials are normally readily available and are supplied to the Company under normal circumstances by various vendors, each of which must be approved by the Company's OEM customers. Many of the Company's purchased components are supplied by manufacturers located in the United States, Japan and Taiwan.
Through fiscal 1996, the Company saw a continuation of price increases and a tightening of supply for purchased parts (components) and other raw material due to a steep growth in world-wide demand for personal computers and other consumer electronics products, as well as the continued strength of the Japanese yen relative to the U.S. dollar. The Company was more severely impacted by this occurrence than its competitors due to its financial condition and extended deferral of payments to its vendors. This unfavorable situation, with its vendors in an already tight market, caused the Company to pay premium costs and to receive poor delivery schedules. The overall effect of these circumstances further reduced the Company's gross margins in an already low margin OEM product and adversely affected the Company's ability to meet its committed delivery schedules to its customers.
During fiscal 1996, the Company placed significant emphasis on improving the control of its manufacturing functions. Because of the significant decline in production in fiscal 1997, primary emphasis was placed on controlling variable expenses and liquidating existing inventories. The Company's strategy to redirect its business to supplying the needs of lower-volume OEMs that offer higher margins means that, if those customers can be secured, the Company would be manufacturing a larger number of product runs, each representing a smaller number of units. As a consequence, effective management of the
manufacturing and inventory control processes is critical if these lower-volume production runs are to generate acceptable gross margins. Since fiscal 1997, the Company began to perform on this strategy. The Company achieved general market acceptance of its product design and production capabilities and began shipping A/C adapters and closed frame power supplies during the second and third quarters of fiscal 1998 to newly acquired customers. Unfortunately, the market for certain customer products began to diminish and other customers began transitioning to new product designs. The Company's limited resources did not allow it to react promptly to those changes, which caused a significant slowdown in sales during the final quarter of fiscal 1998. During fiscal 1999, sales remained soft. However, the Company believes that there is opportunity in the marketplace to obtain orders from newly acquired customers, that offer acceptable margins. Because of an evolving market and the Company's lack of capital resources, there is no assurance that sales volume can be built up to levels that would provide the Company with positive cash flow.
PRODUCT DESIGN AND DEVELOPMENT
In fiscal 1999, the Company maintained engineering departments in Simi Valley, California and Mumbai, India. The California engineering department is principally responsible for the design development of the Company's products, while the Mumbai department is principally responsible for production and manufacturing engineering of the Company's products. The Company's product design development team in California work closely with the OEMs to design products that meet each OEM's specifications for power, price, size, and quality. Typically such a design development will start with one of the Company's standard power supplies, which will then be modified to meet the OEM's requirements. Prototypes of the OEM's product are often sent to the Company so that the Company may test the effectiveness of its proposed power supply design.
Concurrently with the power supply design, the Company's engineers in Bombay develop the manufacturing processes the Company will need for production. These engineers remain in close communication with the Company's design development team and with the OEM's engineering team, typically through the use of electronic mail. Throughout the design process, the manufacturing applications team advises both the design development team and the customer concerning the probable cost, speed of manufacture and ease of quality control of various proposed designs and modifications, suggesting alternatives where appropriate. Development of a prototype typically takes approximately eight weeks from the start of the design process.
Once the OEM approves the product design, the Company subjects a prototype to those testing procedures necessary to obtain product safety certification by Underwriters Laboratories, Canadian Standards Association, T.U.V. Rhineland, and Nemko. This process normally takes approximately twelve weeks. However, the Company has acquired approval to act as a self-certifying laboratory for Nemko, which facilitates the approval process by all these safety agencies, thus reducing the typical approval time required by four to six weeks. The Company's self-certification laboratory, located in Simi Valley, California, is subject to regular inspection and review by each agency. Customers typically pay all new product safety certification costs as incurred.
QUALITY CONTROL
Personal computers, computer peripheral devices and other electronic equipment are precision products requiring each component to function as specified. The Company endeavors to manufacture power supplies to exacting standards and with very high reliability to minimize both return/replacement costs and inspection time.
In pursuit of quality control, the Company tests each product individually at a number of points in the manufacturing process. Completed products are subjected to load tests and burn-ins prior to being packaged and shipped. Because the Company currently inserts electronic components into printed circuit boards manually, one of the more prevalent problems discovered during testing is erroneous component placement. The Company has improved its manufacturing efficiency by installing pin-in-hole equipment, which automates the process of inserting small electronic components into circuit boards. By fiscal 1996, the Company had installed a sufficient number of pin-in-hole units to accommodate its entire production
capacity. This automated process has eliminated most misplacement defects. The Company's manufacturing facilities are regularly inspected by its OEM customers.
Despite the Company's best efforts, quality problems do arise from time to time. For example, during fiscal 1999 the Company discovered that the plastic housing on approximately 150,000 external power supplies is subject to separation at unacceptably high levels. In these situations, the Company works closely with its customer to determine a course of action and to implement it quickly in order to reduce the risk of a widespread product failure and to resolve the matter while most of the units in question are still in the distribution channel.
MARKETING AND SALES
The Company markets and sells its products directly to OEMs of computers, peripherals, and other electronic equipment primarily through its U.S.-based sales force and manufacturing representatives and distributors with an established network of contacts in the electronics industry. The Company attends several industry trade shows, including the annual COMDEX trade show, as a means of developing customer relationships. Once the Company has established contact with an OEM, the Company targets several departments of the OEM for its sales efforts, usually giving special emphasis to the development engineering department, but with emphasis also on the purchasing and quality control departments.
The Company's strategy for marketing and sales during fiscal 1999 was, and continues to be, directed at lower-volume OEM manufacturers that require more engineering support and smaller product volumes, but offer significantly higher prices and attractive gross margins. At present, the Company has a limited number of customers that fit this profile and there can be no assurance that it will be able to obtain a sufficient number of this type of customer or orders for a sufficient number of units to implement its strategy effectively. Further, because of the Company's precarious financial condition, potential customers have expressed concern regarding the Company's ability to provide on-going support for their product programs.
Historically, the Company has marketed a small portion of its products through distributors. Since fiscal 1998, the Company has retained a contract sales representative, entered into private label agreements, and engaged manufacturing sales representatives and distributors. As of January 31, 2000, sales resulting from these arrangements accounted for approximately 20% of the Company's sales volume.
COMPETITION
The electronics industry is extremely competitive, with price and quality being critical competitive factors. In recent years, price competition has become particularly intense. This competition has affected vendors to OEMs, including those that manufacture power supplies. The Company believes that the primary competitive factors in the power supply industry are price, reliability, and the ability to timely modify and deliver products to meet customer requirements. The Company believes that it has improved its operations management so that it has the ability to compete favorably with respect to these factors. The Company's lack of financial resources, however, has been a major constraint on its ability to compete effectively with its major competitors, many of whom are larger and better financed than the Company. The Company's inability to satisfy the financial strength and stability requirements IBM applied to its vendors was in large part responsible for the loss of IBM as a customer in fiscal 1997. Further, the largest portion of the Company's cost in producing a power supply is the cost of materials. The Company's financial condition has made it very difficult for the Company to obtain advantageous arrangements with its raw material suppliers, which reduces the Company's ability to compete effectively.
The Company's principal competitors also conduct many of their manufacturing operations in countries with low-cost labor forces, but the Company believes its labor costs are competitive. Given India's large population and high unemployment rate, the Company does not anticipate rising labor costs. Moreover, the Company believes it benefits from a relatively well-educated labor force as well as a local process and manufacturing engineering group, thereby minimizing the need for costly expatriate engineers. Although the Company has automated a portion of its manufacturing processes, even with the installation
of the pin-in-hole equipment, the manufacture of power supplies will continue to be labor intensive, requiring the use of skilled workers to install transformers and other components and to wind transformer coils.
The Company's primary competitors in the OEM power supply market include Astec America, Inc., Delta, API, and Lite-on, all of which are privately held and based overseas. Additionally, management believes that many personal computer OEMs that currently purchase power supplies from third party vendors continue to have the capability to manufacture their own power supplies in-house.
BACKLOG
Although the Company's OEM customers provide estimated annual power supply requirements, the Company usually purchases supplies and manufactures its products only against firm orders. Arrangements between the Company and its OEM customers typically provide that the customer must furnish the Company with a purchase order for the customer's power supply requirements for a three-month period. The customer must purchase 100% of the power supplies ordered for delivery within one month of the date of the purchase order. The customer may increase or decrease the number of power supplies estimated to be purchased in the second and third months from the date of the purchase order by no more than 20% and 30%, respectively. The Company's ability to enforce these provisions, however, is limited by the good faith and the market power of the customer. The Company's non-OEM customer orders also generally provide for delivery within a period of three months or less. Therefore, the Company operates without a significant backlog, relying primarily on monthly purchase orders. At January 31, 2000, firm backlog was estimated at approximately $1,000,000. Iomega, the Company's primary customer since fiscal 1997, had only minor orders in backlog at January 31, 2000, and has not provided the Company with any new orders since December 1999.
PATENTS AND PROPRIETARY RIGHTS
The Company believes that patent rights are not significant in the power supply industry. Generally the industry's customer base is more responsive to suppliers that promptly meet its changing needs than to those that offer proprietary technology.
WARRANTIES
The Company generally provides its customers with a one-year warranty on its power supplies and, through the end of fiscal 1999, had not experienced any significant warranty claims, except for the following event. In the fourth quarter of fiscal 1999, a major customer discovered a housing separation issue on one model of external power supply manufactured by the Company. As of January 31, 2000, the Company has spent approximately $50,000 making modifications to all the affected units. No assurances can be given as to future warranty claim levels. The Company ordinarily repairs or replaces defective goods.
EMPLOYEES
At March 31, 1999, the Company employed 10 people in its U.S. operations, including two in engineering and operations, and eight in administration and finance. Approximately 116 people were employed in India, including 73 in manufacturing and planning, 32 in design engineering, and 11 in administration. There were no part-time employees. The Company also contracts for the services of workers through independent agencies in India. At the end of fiscal 1999, there were 379 agency workers who were engaged primarily in manufacturing and planning.
As of January 31, 2000, full-time employees in the United States and India were 13 and 114, respectively, and there were no part-time employees.
None of the Company's employees are represented by a union, and management believes the Company's relations with employees are good. Moreover, under Indian Law, businesses operating in the
duty free export processing zones are considered public utilities, which restricts the rights of their workers to strike.
RISK FACTORS
SIGNIFICANT LOSSES
The Company has incurred significant losses from operations over the past four years. It lost its two largest historical customers in fiscal 1996 and 1997, and has been unsuccessful in rebuilding its base of customer relationships. In addition to the promissory note of $2,298,000 (including accrued interest) outstanding under the terms of the Recapitalization Plan, the Company has additional loan balances of $2,353,000, including accrued interest, with the Tandon family, as of January 31, 2000. The only unrelated party financing available to the Company has been a receivables factoring arrangement at unfavorable rates. The Company has been unsuccessful in its efforts over the last four fiscal years to reestablish its business at levels approaching financial breakeven or approaching positive cash flow. At March 31, 1999, the Company had a shareholders' deficit of $16,737,000. Without a material change in the economics of the Company's business and the viability of its financial position, the Company's prospects as a going concern are limited.
INDIA AND INTERNATIONAL ISSUES
The Company manufactures all of its products in India and sells to OEMs that operate in a number of foreign countries, including countries in Asia. The Company procures a significant amount of raw materials and components from vendors located in Asia. The economic uncertainties that have affected Asia over the last several years have seriously disrupted the Company's ability to deal with its vendors and its customers on an advantageous basis. These events have had an adverse effect on the Company's ability to procure raw materials and components, manufacture its products, and export its products from India to customers in the United States and Western Europe. In general, foreign manufacturing and sales are subject to risks, including changes in governmental policy, economic disruptions, transportation delays and interruptions, political turmoil, protective labor laws, currency restrictions, and the imposition of tariffs and import/export controls. Any disruption of the Company's activities, for example because of international economic sanctions against India, tensions between India and Pakistan, economic uncertainties affecting Japan, Korea and other Asian nations, or political unrest in Indonesia, could adversely affect the Company. The Company's products are not currently subject to any duties upon import to the United States or other countries to which the Company ships. Any change in this duty-free status, as a result, for example, of economic sanctions, could adversely affect the Company.
DEBT IN INDIA
As of January 31, 2000, the Company owed its Indian lenders approximately $11,000,000. While the Company is attempting to restructure its Indian debt, the amount of debt and the cost of servicing that debt is beyond the Company's capability to afford at its current level of operations. If the Company is not able to generate sufficient levels of revenue and positive cash flow from sales to existing and new customers to service its debt, it is within the power of the Indian lenders to seize virtually all of Ultra Tek's assets in India. Further, the level of debt has been a major impediment to disposition of the Company, the sale of Ultra Tek, a business combination, or other restructuring that could change the fundamental prospects of the Company. Because the Company imports a good portion of its raw materials and components into India and exports virtually all of its sales from India, the availability of letter of credit and letter of guarantee facilities and of a positive working relationship with its lenders is more important to the Company than to businesses not so dependent upon international transactions. While the Company's Indian lenders have continued to work with the Company, there can be no assurance that they will continue to do so in the future.
AFFILIATE CONTROL
As of January 31, 2000, the Tandon family beneficially owned approximately 48% of the
Common Stock and has, to a substantial extent, the ability to effectively control substantially all matters requiring approval by the shareholders of the Company. Such matters could include the election of members of the Board of Directors, proxy contests, mergers or the sale of substantially all the assets of the Company, tender offers, open market purchase programs or other transactions that could give shareholders of the Company the opportunity to realize a premium over the then-prevailing market price for their shares of the Common Stock.
SHORT PRODUCT LIFE CYCLES
The personal computer industry in general, and the market for products made by the Company's OEM customers in particular, is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions, and intense price competition, resulting in short product life cycles and regular reductions of unit average selling prices over the life of personal computer products. Products produced by the Company's OEM customers typically have a life cycle of eight to twelve months and dictate the Company's product life cycles. Changes in demand for personal computers, computer peripherals and other electronic products, or other negative factors affecting the electronics industry in general, or any of the Company's OEM customers in particular (including, for example, the recent downturn in the business of Iomega, the Company's largest customer in fiscal 1999), have had in the past and in the future could have a material adverse effect on the Company. The Company's financial position makes it less able than most of its competitors to deal effectively with these issues or to withstand the economic hardships they may entail.
ITEM 2
ITEM 2 PROPERTIES
The Company currently rents on a month-to-month basis its 7,000 square foot California facility for $4,750 per month, including utilities, from SDJ Partners, a related entity. A previous lease was renewed on January 1, 1997, amended July 1, 1997 and expired December 31, 1999. Ultra Tek leases an aggregate of 83,325 square feet of manufacturing space in an SDF in SEEPZ from the Indian government under five-year leases expiring at various dates though December 31, 2000. The Indian government typically renews such leases absent unusual circumstances. Monthly rent for Ultra Tek's SEEPZ facilities aggregates approximately $3,400, but is subject to change at will by the Indian government.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS
During fiscal 1995, the Company's importing of computer components for final assembly and sale into the domestic tariff area ("DTA") of India (i.e., outside the export processing zone) came under investigation by the Indian customs authorities. Subsequently, inventories of $1,088,000 (47,447,000 Indian rupees) were seized by the authorities. On May 30, 1995, the authorities issued a notice to the Company alleging misdeclaration of purported imports of complete computer systems as imports of computer system components. The notice called upon the Company to explain why the authorities should not (a) confiscate all the goods so imported, (b) levy additional duty of $1,121,000 (48,885,000 Indian rupees) on the goods already sold into the DTA, and (c) take penal action against the Company under the law. The Company has paid an advance of $700,000, included in cost of goods sold in its fiscal 1995 financial statements, against customs duty that may ultimately be levied by the authorities. During fiscal 1996, the authorities released the inventories seized earlier.
In September 1997, the Indian customs authorities issued a "show cause" notice alleging that Ultra Tek had not provided valid explanations for shortages of raw material in its inventories. The notice called upon the Company to explain why the authorities should not (a) impose duty of $590,000 (25,725,000 Indian rupees) leviable on imported components which were alleged not accounted for in the terms of bond executed, (b) why penal action should not be initiated against the Company, and (c) why a penalty equal to the duty held to be leviable, $590,000 (25,725,000 Indian rupees), in respect of unaccounted goods should not be imposed.
In fiscal 1997, the Company came under investigation by the Indian Department of Revenue Intelligence ("DRI") in connection with the import and export of certain components and goods used in the
manufacture of power supplies and customer returns. The investigation focused on the alleged discrepancy noted between the physical stock records and books in respect of the work-in-process inventory at March 31, 1996 and 1997, and customer returned product at March 31, 1992 through March 31, 1997. In May 1998, the DRI issued a "show cause" notice requesting that the Company explain why the DRI should not impose duties of $590,000 (25,720,000 Indian rupees). Penalties relating to the investigation, if any, have not yet been determined.
The aggregate of threatened duties and penalties to the Company is approximately $2,442,000 (106,474,000 Indian rupees), using the Indian rupee translation rate at January 31, 2000. The Company is contesting the allegations of the authorities and the outcomes of all of these matters are uncertain. Accordingly, no provisions for any losses that may ultimately result have been made in the Company's financial statements. In addition, penal action under Indian law, which the Company believes is very unlikely, could result in possible monetary fines of up to approximately $16,897,000 at January 31, 2000.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's shareholders during the fourth quarter of the fiscal year ended March 31, 1999.
PART II
ITEM 5
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
STOCK PRICE DATA
The Company's Common Stock is traded in the over-the-counter market under the symbol "CRTSE". On March 31, 1999, the closing bid price for the Company's Common Stock was $.04. The following sets forth the high and low bid prices for the Common Stock over the two most recent fiscal years. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
FISCAL QUARTER HIGH LOW
1999 Fourth quarter $0.109 $0.047 1999 Third quarter N/A 0.016 1999 Second quarter 0.016 0.016 1999 First quarter 0.031 0.016
FISCAL QUARTER HIGH LOW
1998 Fourth quarter $0.031 $0.031 1998 Third quarter 0.047 0.031 1998 Second quarter 0.094 0.031 1998 First quarter 0.219 0.047
The approximate number of holders of record of the Company's Common Stock on January 31, 2000 was 63. The Company has not paid dividends on its Common Stock and has no present intention of doing so in the foreseeable future. Instead, the Company intends to utilize its cash resources in the operation of its business.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
In reviewing this data, please refer to the more detailed financial information disclosed pursuant to Item 8 "Financial Statements and Supplementary Data." Please also refer to the discussions in Item 7
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Since commencing operations in February 1991, the Company has engaged in the marketing of power supplies to personal computer and peripheral equipment OEMs and to distributors of standard power supply products. During the fiscal year ended March 31, 1992, the Company entered into its first high volume OEM sales arrangement. Prior to fiscal 1993, during which it was acquired by the Company, Ultra Tek sold power supplies primarily to Tandon Corporation or Tandon Associates for use in personal computers and peripheral equipment manufactured by companies affiliated with the Tandon family. During fiscal 1993, the Company's net sales increased significantly, due primarily to the commencement of shipments to Compaq. The Company began shipments to IBM in the second quarter of the fiscal year ended March 31, 1994. Net sales continued to increase in fiscal 1994 primarily due to additional sales to Compaq, new sales to IBM, and continued development of additional OEM customers.
The Company's cash flow was significantly impacted by Compaq's product rejection that took place during the third quarter of fiscal 1995. Those returns cost the Company $4,200,000 in uncollected accounts receivable as a result of the issuance of credits for the rejected units and $2,200,000 relating to other direct costs, as well as additional costs for transportation, unutilized capacity, business interruption, reorganization, inventory carrying costs, and interest on short-term borrowings.
In fiscal 1996, the Company implemented a program to overcome its cash difficulties through inventory reduction, organizational restructuring, price increases, volume growth and more favorable payment terms from the Company's existing customers. While a number of elements of that program were successfully implemented, the Company has not been able to generate anticipated amounts of cash from inventory reduction and, through the end of fiscal 1999, was unsuccessful in its efforts to resell the reworked rejected product. In addition, the Company has not yet been successful in significantly building its sales volumes to its existing customers or to new customers. While the Company has implemented a
plan to transition its business focus to power supplies for products that are less price sensitive and therefore provide a greater opportunity to develop positive profit margins, it has not been successful in doing so. There can be no assurance that the Company will have sufficient resources to carry out its plan in the future or, even if the resources are available, that the Company will be able to successfully develop the necessary customer relationships and obtain enough product contracts to allow it to continue to operate its business. As of December 31, 1999, the Company has received orders for power supplies that yield an average gross margin of approximately 28%. Assuming gross margins remain at that level, it is estimated that the Company will need to achieve approximately $7 million in annual net sales to achieve a break-even from operations (before interest expense and other income/expense).
In fiscal 1997, the Tandon family invested $2,000,000 as part of the Recapitalization Plan. As of March 31, 1999, the Company had borrowed, net of repayments, an additional $2,234,000 from the Tandon family. This cash has allowed the Company to continue operations, but aside from related party financing, the Company currently has no viable source of financing to continue its current revenue growth and achieve profitable operations and positive cash flow. At January 31, 2000, the outstanding balance, including accrued interest, due the Tandon family was $2,353,000, exclusive of the $2,298,000 demand promissory note payable under the Recapitalization Plan.
In light of these facts, and the operating results discussed below, the Company continues to look at opportunities to obtain additional capital from sources outside the Company and at transactions that would change its fundamental structure.
RESULTS OF OPERATIONS
Results of operations for fiscal 1999 have been determined assuming that the Company will continue as a going concern. However, the Company is currently facing significant issues which raise substantial doubt that the Company has the ability to continue as a going concern. These issues are summarized as follows:
- At March 31, 1999, the Company had outstanding amounts due to four separate Indian lenders in the amount of $9,579,000, all of which are currently in default. Of that amount, three banks have issued notices to the Company demanding immediate repayment of $8,617,000. At January 31, 2000, the amounts due to the four separate Indian lenders was approximately $11,000,000, including accrued interest. The Company has insufficient funds available to repay the lenders. Because the Indian debt is secured by the assets of Ultra Tek, alternatives available to the lenders include closing the operations of Ultra Tek and forcing Ultra Tek into liquidation.
- In fiscal 1995, Ultra Tek's importing of computer components into India came under investigation by the Indian customs authorities. In September 1997, the Indian customs authorities issued a separate "show cause" notice alleging that Ultra Tek has not provided valid explanations for shortages of imported raw material in its inventories. In fiscal 1997, Ultra Tek came under the investigation of the Indian Department of Revenue Intelligence concerning the import and export of certain components used in the manufacture of power supplies and customer returned product. Subsequently, a separate "show cause" notice was issued requesting explanation of why duties should not be assessed. The above governmental allegations and investigations could lead to additional duty and penalties being assessed against Ultra Tek in the amount of approximately $2,500,000 (106,474,000 Indian rupees), using the Indian rupee translation rate at January 31, 1999. In addition, penal action under Indian law, which the Company believes is very unlikely, could result in possible monetary fines of up to approximately $16,897,000. The Company is contesting these allegations, but currently, the matters remain unresolved and the outcomes uncertain.
- The Company has incurred significant losses from operations over the past four years; has lost its two main historical customers, which has significantly impacted its revenues; and at March 31, 1999, had a shareholders' deficit of $16,737,000. During fiscal 2000, the Company continued to incur significant losses, and management has not successfully executed on its efforts to achieve profitable operations and positive cash flows. Outside of related party financing, the Company has identified no viable source of financing.
Due to the significance of these factors in the Company's financial statements at March 31, 1999, all assets have been stated at their estimated realizable values. Costs of resolving the contingencies noted above or settling amounts due to Indian banks or Company creditors have not been recorded as management is currently unable to estimate these amounts. Accounts receivable and inventories were valued at their subsequently realized amounts (inventories at cost), and property, plant and equipment were valued based on estimates by management and in accordance with the guidelines of Statement of Financial Accounting Standards No. 121 "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). The estimated realizable values and settlement amounts may be different from the proceeds ultimately received or payments made.
NET SALES. The Company records substantially all sales of finished goods in the United States. Sales originating outside of the United States were not material during fiscal 1997, 1998 and 1999. During fiscal 1997, 1998 and 1999, export sales from the United States were 11%, 12%, and 35% of total sales, respectively, representing sales to foreign subsidiary companies of United States companies located primarily in Europe and Asia. All product shipments to fill customer orders are made from the Company's manufacturing facility in India. Until manufacturing was discontinued there in the third quarter of fiscal 1998, certain components were produced at the Company's facility in Sri Lanka and sent to India for the final assembly of the finished power supply units.
Sales in fiscal 1997 were $2,568,000, an 85% decrease from fiscal 1996 sales. The Company essentially lost its two major customers, Compaq and IBM, during fiscal 1997. The primary reasons were the fiscal 1995 product rejection by Compaq and the Company's ineligibility for new programs under IBM's vendor selection criteria. Net sales to Compaq and IBM were 19% and 36% of net sales, respectively, with Nexar, a new customer, accounting for an additional 21%.
Fiscal 1998 sales were $4,581,000, a 78% increase over fiscal 1997 sales. This increase was due almost entirely to shipments to Iomega, a new customer in fiscal 1998. Net sales to Iomega and Nexar were 65% and 15% of net sales, respectively. There were no sales to Compaq or IBM.
Sales in fiscal 1999 were $3,935,000, a 14% decrease from fiscal 1998 sales. This decrease was due almost entirely to the Company's decision to no longer do business with Nexar, and a decline in the volume of shipments to Iomega. These declines in sales were partially offset by sales to one new customer and increased sales to two existing customers, none of which were major customers of the Company during fiscal 1999.
GROSS PROFIT. Gross loss for fiscal 1997 was $4,537,000 compared to a gross profit of $45,000 in fiscal 1996. As a consequence of not selling certain inventory, including $1,300,000 (47,447,000 Indian rupees using the translation rate at March 31, 1997) of inventory of computers previously seized and subsequently released by Indian customs authorities, and declining sales volumes in fiscal 1997, the Company reduced the carrying value of inventories by $4,325,000, which charge is included in cost of goods sold. Partially offsetting the negative impact of this charge on gross profit was the sale of 38,000 reworked units for $628,000, which had been written off after the fiscal 1995 product rejection. The only cost associated with these sales was $144,000 for rework.
Gross profit for fiscal 1998 was $249,000 compared to a gross loss of $4,537,000 in fiscal 1997. The improved gross margin in fiscal 1998 over fiscal 1997 is due primarily to the reduction in carrying value of inventories in fiscal 1997 in the amount of $4,325,000, which charge was included in cost of goods sold. The Company achieved only a slight gross profit on increased sales because of low overall gross margins and unabsorbed production overhead due to excess plant capacity and inefficient production runs
resulting from small monthly orders.
Fiscal 1999 gross profit was $1,301,000 compared to $249,000 in fiscal 1998. The improved gross margin in fiscal 1999 on a 14% decrease in sales is due to significantly improved sales margins resulting in part from the use of slow moving inventory, the carrying value of which was reduced in fiscal 1997, a reduction in production start-up costs, and a decrease in unabsorbed indirect manufacturing overhead due to cost reductions and the sale of the manufacturing facility in Sri Lanka in the fourth quarter of fiscal 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses were $3,348,000 in fiscal 1997 compared to $3,435,000 in fiscal 1996. These expenses did not change significantly from the prior year due principally to cost containment actions and employee attrition in the United States, India and Sri Lanka.
Selling, general and administrative expenses were $2,246,000 in fiscal 1998 compared to $3,348,000 in fiscal 1997, or a 33% decrease. This decrease resulted from several factors, the most significant of which includes a restructure of the Company's marketing strategy that resulted in the use of sales representatives and the elimination of salaried employees, and other cost containment actions in fiscal 1998, as well as the nonrecurrence of expenses relating to the Recapitalization Plan in fiscal 1997.
Selling, general and administrative expenses were $1,525,000 in fiscal 1999 compared to $2,246,000 for fiscal 1998. This 32% decrease in expenses was due to the Company's continuing actions to reduce costs, the most significant of which were the decision to restructure its marketing strategy resulting in the use of sales representatives, the elimination of salaried employees, and the sale of the Sri Lanka subsidiary.
RESEARCH AND DEVELOPMENT. Research and development expenses were $865,000 in fiscal 1997 compared to $430,000 in fiscal 1996. This 101% increase resulted from the establishment of a research and product development facility in Scotland during the second quarter of fiscal 1997. This action was part of the Company's strategy to develop higher gross margin power supplies for OEMs of electronic equipment other than personal computers.
Research and development expenses were $976,000 in fiscal 1998 compared to $865,000 in fiscal 1997. The 13% increase in these expenses was due to the Company's research and product development facility in Scotland being fully staffed for the first nine months of fiscal 1998. During the prior year, the facility began staffing during the second fiscal quarter and did not become fully operational until the final quarter of fiscal 1997. Because of a lack of funding, this facility was discontinued in December 1997, and the research and development engineering was relocated to the United States at a much reduced level.
Research and development expenses for fiscal 1999 were $341,000 compared to $976,000 in fiscal 1998, a 65% decrease. This significant decrease resulted from the Company's decision during the third quarter of fiscal 1998 to shut down its product research and development facility in Scotland and relocate the research and product engineering to Simi Valley, California at a significantly reduced level.
PROPERTY, PLANT AND EQUIPMENT IMPAIRMENT LOSS. Because of the continuing decline in sales volume and the difficulties encountered during fiscal 1997 by the Company in implementing its marketing strategies, it was determined that an impairment of the value of property, plant and equipment may exist. Accordingly, a charge of $2,495,000 was taken as of March 31, 1997 to record the assets at estimated current value.
EXTINGUISHMENT OF ACCOUNTS PAYABLE. In fiscal 1999, the Company decided to credit income for certain accounts payable aggregating $2,174,000 for which no demand has been made against the Company. Creditors owed on those accounts became barred in fiscal 1999 under the Indian Limitation Act from making any future demand on the Company to make payment on these obligations.
INTEREST EXPENSE. Interest expense in fiscal 1997 was $1,585,000 compared to $1,253,000 in
fiscal 1996. The 26% increase is primarily due to the higher interest rates being charged by the Company's Indian banks on short-term debt that is currently delinquent.
Interest expense in fiscal 1998 was $1,998,000 compared to $1,585,000 in fiscal 1997. The 26% increase over the prior year was due to interest accrued on the demand promissory note payable to the Tandon family under the Recapitalization Plan, entered into in March 1997, interest on other related party financing that was implemented in order to continue the operations of the Company, and accounts receivable factoring with a United States bank at monthly interest rates ranging from 2.25% to 1.75%, plus administration fees ranging from 1% to .75%.
Interest expense in fiscal 1999 was $1,828,000 compared to $1,998,000 in fiscal 1998. The 9% decrease was due principally to the change in the value of the Indian rupee, which affected the translation of interest expense on the debt in India.
LITIGATION SETTLEMENT. During the third quarter of fiscal 1995, the Company experienced a product rejection by Compaq, its then largest customer, which cost the Company $4,200,000 of lost accounts receivable directly related to the sales of the rejected units and $2,200,000 related to other direct costs stemming from the rejections. The Company engaged the services of an outside contractor to address the customer complaint and rework the rejected product. After rework, the product was again rejected as a result, in the Company's view, of poor workmanship in the rework process. In fiscal 1996, the Company filed a complaint against the rework contractor alleging, among other things, that the contractor improperly performed rework services and thereby breached the contract with the Company. The Company sought damages in excess of $3,000,000. Also, in fiscal 1996, the contractor filed a cross-complaint against the Company alleging breach of contract by the Company for failure to pay for rework services rendered. The contractor sought $108,000 and unspecified damages. In April 1996, the Company settled the lawsuits with the contractor. Under the agreement terms, the Company received a cash settlement of $592,000, of which $163,000 related to the reimbursement of legal expenses incurred in fiscal 1996. Accordingly, $163,000 was recorded as a reduction of legal expenses in fiscal 1996 and the balance of the settlement was recorded in fiscal 1997.
OTHER INCOME. Other income of $224,000 in fiscal 1997 increased approximately 22% over the prior year, due to product development fees and scrap sales in fiscal 1997, offset in part by a decline in interest income on lower restricted cash deposits required to secure letters of credit and letters of guarantee.
For fiscal 1998, substantially all of the Company's other income of $285,000, an increase of 27% over 1997, resulted from the sale of property and equipment, which had been recorded at estimated fair value in fiscal 1997, as determined by applying SFAS 121.
Other income in fiscal 1999 was $164,000 or approximately 42% lower than the prior year. This decrease was due to a significant reduction in the sale of property and equipment.
NET INCOME (LOSS). For fiscal 1997, 1998 and 1999 the Company's net income (loss) was $(12,627,000), $(3,700,000), and $113,000, respectively. Before giving effect to the $2,174,000 extinguishment of accounts payable in fiscal 1999, net income (loss) from operations was ($2,061,000).
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES
During fiscal 1997 the Company used cash of $2,461,000 in operating activities compared to $1,461,000 of cash used in fiscal 1996. While the fiscal 1997 balance sheet includes non-cash reserves to record assets at estimated realizable values pursuant to the guidelines of SFAS 121, actual cash of $1,046,000 was generated by sale of inventories and of $838,000 through collection of accounts receivable. Cash was also generated by reducing prepaid expenses and other current assets by $459,000 and increasing accrued liabilities by $416,000.
During fiscal 1998, the Company used cash of $4,194,000 in operating activities compared to $2,461,000 of cash used in fiscal 1997. Unlike fiscal 1997, there were no substantial non-cash valuation reserves recorded for inventories and property, plant and equipment. In addition, cash was consumed by an increase in accounts receivable resulting from an increase in sales volume.
During fiscal 1999, cash used in operating activities was $1,947,000 compared to $4,194,000 of cash used in fiscal 1998. This reduction in cash consumed in fiscal 1999 was due primarily to a reduction in the net loss to $2,061,000 (before giving effect to a $2,174,000 extinguishment of accounts payable) for the current year versus a loss of $3,700,000 in fiscal 1998. During fiscal 1999, the Company also generated cash from a decrease in accounts receivable because of the decline in sales, whereas in fiscal 1998, there was an increase in accounts receivable resulting from an increase in sales.
INVESTING ACTIVITIES
In fiscal 1997, cash generated by investing activities was $795,000, compared to $92,000 in cash used by investing activities in fiscal 1996. This increase in cash was due to the decrease in restricted cash as a consequence of the continuing decline in manufacturing and shipping activity in India, which resulted in lower restricted cash deposits required to secure letters of credit and letters of guarantee. As of March 31, 1997 there was virtually no activity in India requiring deposits on letters of credit and letters of guarantee. Purchases of property, plant and equipment were also severely curtailed.
In fiscal 1998, cash provided by investing activities was $319,000 compared to $795,000 provided in fiscal 1997. The primary source of this cash in fiscal 1998 was from the sale of property and equipment.
In fiscal 1999, $78,000 in cash was used in investing activities, compared to $319,000 in cash being provided during fiscal 1998. As previously stated, the fiscal 1998 cash resulted from the sale of property, plant and equipment, whereas such sales during fiscal 1999 were significantly reduced.
FINANCING ACTIVITIES
Cash provided by financing activities for fiscal year 1997 was $2,003,000 compared to $760,000 in fiscal 1996. This increase is due principally to the infusion of $2,000,000 in cash during fiscal 1997 by the Tandon family pursuant to the terms of the Recapitalization Plan. This Plan resulted in the issuance of 850,000 Common Stock shares and a note payable in the amount of $1,873,000, which is convertible into an additional 12,483,333 shares of Common Stock upon approval of the Recapitalization Plan by the Company's shareholders.
Cash provided by financing activities for fiscal 1998 was $3,168,000 compared to $2,003,000 in fiscal 1997. This increase was due principally to loans received from Tandon Associates, Inc., a related party, to provide the Company with working capital and to the transfer of bank debt as a result of the sale of the Company's subsidiary in Sri Lanka. During November and December 1997, the Company factored a total of $713,000 of its accounts receivable to provide working capital. Subsequently, the borrowings were repaid and there was no outstanding balance at March 31, 1998.
Cash provided by financing activities for fiscal 1999 was $2,300,000 compared to $3,168,000 in fiscal 1998. This decrease is due primarily to the reduction in working capital loans being made to the Company by related party entities.
In summary, the Company has suffered a considerable decline in cash flow over the last three years for the aforementioned reasons. At March 31, 1999, the Company had negative working capital of $14,766,000 and a retained deficit of $16,737,000. While current actions are being taken to implement a viable operating plan to increase sales, renegotiate the terms of short-term obligations with the Indian banks, and raise additional capital, there can be no assurance that any of these actions will be successfully completed.
Since March 31, 1996, the Company has been negotiating with its Indian banks for an extension of
payment terms of existing debt as well as an extension of credit to support planned production and sales. In July 1997, the banks' legal counsel issued notices to Ultra Tek and the Company calling upon them to pay the outstanding amounts due. The banks have not initiated any legal action against the Company for non-payment of the amounts due, since Ultra Tek has been declared a sick company by the Board of Industrial and Financial Reconstruction ("BIFR") of the Government of India.
The BIFR appointed an Operating Agency ("OA") to examine the Company's viability and prepare a viability study report. Accordingly, the Company prepared a draft rehabilitation proposal, which was submitted to the OA. The OA reviewed the proposal and forwarded the same to the BIFR along with the minutes of a joint meeting between the Indian banks and the Company convened by the OA in March 1999. Based on the minutes of the joint meeting, the BIFR prepared its Draft Rehabilitation Scheme and advised all concerned inviting suggestions/objections to the scheme. The Draft Scheme is subject to ongoing discussion and envisages restructuring of existing debts (unpaid principal amount of $5,129,047 to banks and financial institutions as of September 30, 1999), conversion of simple interest into a Funded Interest Term Loan amounting to $2,132,801 as of September 30, 1999, infusion of funds by way of contribution by the Tandon family amounting to $938,527 which has already occurred, and additional working capital facilities from the Indian banks of $1,642,421, which would enable the Company to generate enough resources to continue its operations and repay the restructured debts over a period of time. The BIFR held a hearing on August 16, 1999 and after hearing all interested parties, has advised the Company and the banks to discuss further and modify the Draft Scheme to take into account the various points made at the hearing. The BIFR also instructed the OA to conduct joint meetings with the banks and the Company and to forward a modified scheme. The Company is in the process of discussing with the banks ways to modify the Draft Scheme to take into account a potential conversion of compound interest and liquidated damages into redeemable preference stock. Essentially all of the Ultra Tek short-term borrowing agreements and facilities are secured by the assets of Ultra Tek and are covered by corporate guarantees from the Company, Fairplay Group, Inc. ("Fairplay"), an intermediate holding company, and Tandon Associates, a related party. They are also covered by the personal guarantee of the Chairman and Managing Director of Ultra Tek for the amount of approximately $10,030,000.
Subsequent to the fiscal year ended March 31, 1999, the Company continues to experience negative cash flow as a result of continuing losses and sporadic ramp-ups of production in India. In order to obtain the necessary cash to operate, the Company has a factoring agreement with a United States bank at a monthly financing fee of 1.75% and an administration fee applied to the total of factored accounts of .75%. Under the terms of the agreement, the bank may purchase up to $1,333,333 in accounts receivable from the Company in return for cash equal to 80% of the face value of the purchased accounts receivable. At January 31, 2000, the Company had factored accounts receivable invoices totaling $240,000.
YEAR 2000 COMPLIANCE
The Company has in place a plan to address Year 2000 readiness of its internal computer systems and key suppliers. It is not anticipated that the Company's products will affect its customers' Year 2000 compliance. The Year 2000 readiness team consists entirely of internal personnel, as the Company's lack of resources does not permit the use of external consultants. The team's activities are directed to ensure that there will be no material adverse effects on the Company's business operations and that transactions with customers and suppliers will not be materially interrupted by the advent of Year 2000. The Company estimates costs to assure Year 2000 compliance will approximate $50,000. It is expected that some of these costs will be financed, to the extent that suppliers offer financing arrangements, and the balance will come either from cash from operations or accounts receivable financing.
The Company has upgraded its accounting and telecommunications software to ensure Year 2000 compliance in the United States. In India, personal computers have been upgraded to allow for software upgrades.
While the Company believes its planning efforts have been adequate to address known Year 2000 concerns, there can be no assurance that all internal systems, as well as those of third parties upon which the Company relies, will be Year 2000 compliant on a timely basis and will not have a material affect on
the Company's operations, especially those located in a third-world country. As of January 31, 2000 the Company has not experienced any significant computer failures due to the advent of Year 2000.
ITEM 8
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this item is included in Part IV of this report.
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On October 5, 1998, the Company received the written resignation of Arthur Andersen LLP, as its auditors, effective immediately.
For each of the fiscal years ended March 31, 1996 and March 31, 1997, the accountant's report on the financial statements was qualified as to the uncertainty of the Company's ability to continue as a going concern. This uncertainty was based on (1) the Company's default on payments due lenders in the amount of $8,306,000, as of March 31, 1997 (2) Indian Customs and Department of Revenue Intelligence allegations and investigations that could lead to additional duty and penalties against the Company's Indian subsidiary in an amount then believed to be approximately $8,400,000 (since revised to approximately $2,442,000) and possible penal action, (3) continuing significant losses from operations, which resulted in a shareholder deficit of $14,168,000 at March 31, 1997 and (4) a lack of a viable source of financing, other than from a related party.
Because of the resignation of the Company's former auditors, the Company engaged Farber & Hass LLP as its new independent accountants. This engagement for the audit of the financial statements for the fiscal year ended March 31, 1998, was effective October 8, 1998.
For the same reasons referred to above, the accountant's reports on the Company's financial statements for the fiscal year ended March 31, 1998 and 1999 were qualified as to the uncertainty of the Company's ability to continue as a going concern.
The Audit Committee of the Board of Directors was advised of the former accountant's resignation and approved the engagement of the new independent accountant, Farber & Hass LLP, on October 8, 1998.
PART III
ITEM 10
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning each person who is an executive officer, director or significant employee of the Company:
*Member of the Audit Committee, Compensation Committee, Subsidiary Securities Committee and Independent Directors Committee
J. L. Tandon has been Chief Executive Officer and a director of the Company since February 1991 and served as President from February 1991 to April 1995, and again from November 1997 to October 1999. On October 11, 1996, J.L. Tandon was elected Chief Financial Officer of the Company and served in that position until September 1998. From December 1978 to July 1993, J. L. Tandon was President of Tandon Associates, an affiliate of the Company. From March 1992 to August 1993, J. L. Tandon was President of Tantec, Inc., an affiliated company. From 1983 to present, J. L. Tandon has been President and a director of Clady International Corporation, Fairplay and Lunenburg S. A., all affiliated companies. J. L. Tandon is M. L. Tandon's brother.
M. L. Tandon served as a director of the Company from August 1993 through April 1995. M. L. Tandon has been a director and Chairman of Ultra Tek, a subsidiary of the Company, since October 1985. From June 1988 to March 1995, M.L. Tandon was Managing Director of Ultra Tek. M. L. Tandon was Managing Director of Tandon Motors P. Ltd., an affiliated company, from June 1982 to August 1989. M. L. Tandon is J. L. Tandon's brother.
Naren Bansal became President and Chief Operating Officer of the Company on October 15, 1999. Mr. Bansal has been an employee of the Company since 1990 and most recently held the position Vice President, Operations and Sales.
Harvey A. Marsh became Vice President, Chief Financial Officer, Secretary and director in September 1998. From October 1996 to April 1998, Mr. Marsh acted as a financial consultant to the Company and other Tandon affiliated companies and joined the Company as an employee in April 1998. From January 1993 to June 1996, Mr. Marsh was Vice President, Finance and Chief Financial Officer of FACT Retirement Services. Mr. Marsh is also a director of Bender Growth Fund.
R. D. Middlebrook, Ph.D. joined the Company as a director in August 1993. From 1955 to present, Dr. Middlebrook has been a professor of Electrical Engineering at California Institute of Technology.
Robert Sherburne joined the Company as a director in August 1993. From January 1992 to present, Mr. Sherburne has been a merger and acquisition consultant. From November 1990 to December 1991, Mr. Sherburne was the Chairman of the Board of Everest & Jennings International and remained a director until December 1996.
All directors are elected annually and serve until the next annual meeting of shareholders or until
the election and qualification of their successors. Executive officers of the Company are elected by and serve at the discretion of the Board of Directors.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Naren Bansal became President of the Company on October 21, 1999, and a Form 3 was not filed on Mr. Bansal's behalf on a timely basis.
ITEM 11
ITEM 11 EXECUTIVE COMPENSATION
COMPENSATION
The following table sets forth information concerning the annual and long-term compensation for services in all capacities to the Company paid or accrued by the Company to the Chief Executive Officer and to each of the four other most highly compensated officers of the Company for each of the fiscal years in the three-year period ended March 31, 1999.
(1) Includes compensation deferred at the officer's election. J.L. Tandon has deferred compensation of $96,500 in fiscal 1999.
(2) Represents supplemental income bonus, automobile allowance, club dues and payments made toward medical and group life insurance on behalf of executive officers.
(3) Mr. Marsh became an employee of the Company on April 6, 1998 and was appointed Chief Financial Officer on September 8, 1998.
(4) Messrs. Barton and Thomas resigned from the Company in July 1996.
(5) Mr. Thanky resigned from the Company in November 1997. His salary includes vacation and salary continuation pay through December 31, 1997.
EMPLOYMENT AGREEMENT
In April 1995, the Company hired Michael D. Thomas as President, Chief Operating Officer, Chief Financial Officer, and Secretary at an annual salary of $105,000 pursuant to a letter agreement. Additionally, the Company agreed to grant Mr. Thomas an option to purchase 100,000 shares of Common Stock which was to vest over five years and have a ten-year term. The Company also agreed to grant Mr. Thomas an additional option to purchase 50,000 shares which would vest and become exercisable if the Company's fiscal 1996 performance substantively conformed to a financial and cash management plan prepared by Mr. Thomas and approved by the Board of Directors. However, these performance targets were not met and, consequently, Mr. Thomas' right to purchase the additional 50,000 shares did not vest.
Mr. Thomas' agreement called for him to receive deferred compensation at the end of each fiscal year he remained an executive of the Company in the amount of $50,000. Mr. Thomas also was entitled to an annual bonus, not to exceed $50,000, if the Company had met certain sales and profitability targets. Those targets were not met for fiscal 1996 and no bonus was paid. Mr. Thomas' letter agreement with the Company had no term and was terminable by either party at any time. Mr. Thomas resigned in July 1996 and received six months of severance pay and the pro rata portion of his deferred compensation. His 100,000 share stock option expired without exercise.
CHANGE IN CONTROL ARRANGEMENTS
Under the terms of his employment letter agreement, Mr. Thomas was entitled to treat a termination of his employment in connection with a change in control of the Company as a termination without cause. His agreement terminated upon his resignation in July 1996.
Under the terms of the Company's 1994 Stock Option Plan (the "1994 Plan"), upon a change in control or liquidation of the Company, the Compensation Committee, in its discretion, may allow each person holding an option (who did not receive a replacement stock option from the Company's successor entity) to exercise that option without regard to its vesting provisions.
DIRECTOR COMPENSATION
Each outside director receives $1,500 for each board meeting attended and $1,000 for each committee meeting attended; provided, however, that if two committee meetings are held on the same day, outside directors in attendance only receive $1,000. In August 1993, the Board of Directors established an Audit Committee, a Compensation Committee and a Subsidiary Securities Committee, each comprised of the outside directors.
In September 1993, the Board of Directors granted each outside director an option to purchase 20,000 shares of Common Stock at the initial offering price to the public of $7.00. The Company's policy through fiscal 1996 was to issue its outside directors options to purchase 20,000 shares upon election to the Board and options to purchase 5,000 additional shares after each two years of subsequent service. A proposal to adopt a formula grant amendment to the Company's 1994 Plan implementing this policy was approved by the Company's shareholders at the 1995 Annual Meeting of Shareholders. All such grants would be at fair market value. No options have been granted since fiscal 1996.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None.
1994 STOCK OPTION PLAN
Key employees, including Directors who are key employees, who are chosen by the Compensation Committee are eligible to participate in the 1994 Plan. Messrs. J. L. Tandon and M. L. Tandon have agreed that they will not be eligible to receive grants of options under the 1994 Plan.
There were no stock options granted or exercised during the fiscal year ended March 31, 1999, nor were there any unexercised stock options at March 31, 1999, held by any executive officer.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee of the Board for fiscal 1999 was comprised of Messrs. Middlebrook and Sherburne. The Compensation Committee establishes the general compensation policies of the Company, establishes the compensation plans and specific compensation levels for executive officers, and administers the 1994 Plan.
As required by Commission rules designated to enhance the disclosure of the Company's executive compensation policies and practices, the following is the Compensation Committee's report submitted to the Board of Directors addressing the compensation of the Company's executive officers for fiscal 1999.
REPORT OF THE COMPENSATION COMMITTEE
The Compensation Committee of the Board of Directors establishes the general compensation policies of the Company, establishes the compensation plans, establishes the specific compensation of Mr. J.L. Tandon, the Company's Chief Executive officer, reviews the Chief Executive Officer's recommendations as to the specific compensation levels for the other executive officers, and administers the Company's incentive plans. The Compensation Committee is composed of two independent non-employee directors who have no interlocking relationships as defined by the Securities and Exchange Commission.
COMPENSATION POLICY AND PROGRAMS. The Compensation Committee's responsibility is to ensure that a strong and direct link exists among shareholder values, Company performance, and executive compensation through its oversight of the design and implementation of a sound compensation program that will attract and retain highly qualified personnel. Compensation programs are intended to complement the Company's short- and long-term business objectives and to focus executive efforts on the fulfillment of these objectives.
The Compensation Committee has conducted a full review of the Company's executive compensation program and will repeat this review annually. It is the Compensation Committee's practice to establish target levels of compensation for senior officers consistent with that of companies comparable in size and complexity to the Company, as well as companies that are direct business competitors of the Company. Actual compensation of the Company's executive officers is subject to increase or decrease by the Compensation Committee from targeted levels according to the Company's overall performance and the individual's efforts and contributions. A significant portion of executive compensation is directly related to the Company's financial performance and is therefore at risk. Total compensation for the Company's senior management is composed of base salary, near-term incentive compensation in the form of bonuses, and long-term incentive compensation in the form of stock options. The Compensation Committee retains the discretion to adjust the formula for certain items of compensation so long as total compensation reflects overall corporate performance and individual achievement.
BASE SALARY. In establishing base salary levels for senior officer positions, the Compensation Committee and Mr. J.L. Tandon consider levels of compensation at other similarly situated companies and at direct competitors, levels of responsibility, and internal issues of consistency and fairness. In determining the base salary of a particular executive, the Compensation Committee and Mr. J.L. Tandon consider individual performance, including the accomplishment of short- and long-term objectives, and various subjective criteria including initiative, contribution to overall corporate performance, and leadership ability.
In the fiscal year ended March 31, 1999, the annual base salary of Mr. J.L. Tandon was unchanged at $198,000, a level determined to be appropriate by the Compensation Committee based on comparable chief executive salaries of a peer group of companies and of direct competitors referred to above, the
Company's overall performance in the prior fiscal year, and Mr. J.L. Tandon's efforts and contributions to the Company.
BONUSES. The Company's executive officers are eligible for annual bonuses based upon recommendations made by Mr. J.L. Tandon (as to the other executive officers) and the Compensation Committee (as to Mr. J.L. Tandon) as to individual performance and the Company's achievement of certain operating results.
Amounts of individual awards are based principally upon the results of the Company's financial performance during the prior fiscal year. The amount of awards for senior officers are within guidelines established by the Compensation Committee and Mr. J.L. Tandon as a result of their review of total compensation for senior management of peer companies and competitors. The actual amount awarded, within these guidelines, will be determined principally by the Compensation Committee's and Mr. J.L. Tandon's assessment of the individual's contribution to the Company's overall financial performance. Consideration is also given to factors such as the individual's successful completion of a special project, any significant increase or decrease in the level of the participant's executive responsibility and the Compensation Committee's and Mr. J.L. Tandon's evaluation of the individual's overall efforts and ability to discharge the responsibilities of his position. In fiscal 1999, in light of the Company's financial results, no bonuses were paid to any of the executive officers named in the Summary Compensation Table.
Mr. J.L. Tandon received no bonus with respect to the March 31, 1999 fiscal year. In determining bonuses in future years, the Compensation Committee will give particular consideration to the following factors: (1) the Company's progress toward break-even financial results and sustainable positive cash flow; (2) the narrowing of losses and the trend toward positive earnings growth of the Company during the fiscal year; (3) the efforts and contributions made by Mr. J.L. Tandon in discharging his responsibilities as Chief Executive Officer; and (4) the efforts and contributions by the other executives of the Company.
STOCK OPTIONS. During fiscal 1994, the Compensation Committee adopted the Company's 1994 Stock Option Plan. The purpose of the 1994 Plan is to provide incentives and reward the contributions of key employees and officers for the achievement of long-term Company performance, as measured by earnings per share and the market value of the Common Stock. The Compensation Committee, working with the Option Committee (which, prior to being disbanded in fiscal 1996, consisted of Mr. J.L. Tandon and Mr. M.L. Tandon), set guidelines for the number and terms of stock option awards based on factors similar to those considered with respect to the other components of the Company's compensation program, including comparison with the practices of peer group companies and direct competitors. In the event of unsatisfactory corporate performance, the Compensation Committee may decide not to award stock options or restricted stock in any given fiscal year although exceptions to this policy may be made for individuals who have assumed substantially greater responsibilities and other similar factors. The awards under the 1994 Plan are designed to align the interests of executives with those of the shareholders. Generally, stock options become exercisable in cumulative installments over a period of five years, but the individual forfeits any installment that has not vested during the period of his employment.
In light of the Company's financial performance during fiscal 1998 and 1999, the Compensation Committee has tabled its review of any necessary revisions to the Company's executive compensation policy or plans due to the provisions of the Omnibus Budget Reconciliation Act of 1993. This legislation amended Section 162 of the Internal Revenue Code by limiting to $1,000,000 the deductibility of compensation paid to certain executives. The Company's 1994 Plan was amended by the Board of Directors to conform with new rules on Section 162 compliance and those amendments were approved at the Company's 1995 Annual Meeting of Shareholders. It is the current policy of the Compensation Committee to maximize, to the extent reasonably possible, the Company's ability to obtain a corporate tax deduction for compensation paid to executive officers of the Company to the extent consistent with the best interests of the Company and its stockholders.
THE COMPENSATION COMMITTEE R. D. Middlebrook, Ph.D. Robert Sherburne
COMPANY PERFORMANCE
The following graph shows a comparison of cumulative total returns for the Company, the NASDAQ Stock Market-U.S. Index, and a peer group index comprised of the NASDAQ Computer Index (as described below) for the period during which the Company's Common Stock has been registered under Section 12 of the Exchange Act. The NASDAQ Computer Index includes approximately 170 companies, all of which are manufacturers of computer hardware or software. The Company believes that the companies included in the NASDAQ Computer Index are reasonably representative of companies in the Company's industry.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* AMONG GOLDEN SYSTEMS, INC., THE NASDAQ STOCK MARKET (U.S.) INDEX AND THE NASDAQ COMPUTER MANUFACTURER INDEX
[GRAPH]
* Specified ending dates or ex-dividends dates. ** All Closing Prices and Dividends are adjusted for stock splits and stock dividends. ***'Begin Shares' based on $100 investment.
ITEM 12
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial ownership of the Company's capital stock as of January 31, 2000 by (i) each person who is known by the Company to be the beneficial owner of more than 5% of any class of the Company's capital stock, (ii) each Director, and certain executive officers of the Company, individually, and (iii) all Directors and executive officers as a group:
- ---------------------------------- *Less than one percent (1) Except as otherwise indicated below, the persons named have sole voting power and investment power with respect to all shares of capital stock shown as beneficially owned by them, subject to community property laws where applicable.
(2) The address for J. L. Tandon is 2125-C Madera Road, Simi Valley, California 93065.
(3) Includes 2,125,000 shares owned by Clady, a Panamanian corporation of which J. L. Tandon is the President.
(4) The address for Clady is c/o J. L. Tandon, 2125-C Madera Road, Simi Valley, California 93065.
(5) D. L. Tandon is an officer and director of Clady. He expressly disclaims beneficial ownership of any shares owned by Clady for the purposes of Sections 13(d) and 13(g) of the Exchange Act.
(6) M. L. Tandon and S. L. Tandon expressly disclaim beneficial ownership of any shares owned by Clady for the purposes of Section 13(d) and 13(g) under the Exchange Act.
(7) Includes 7,500 shares issuable upon exercise of stock options excercisable.
(8) Includes 24,000 shares issuable upon exercise of stock options exercisable within sixty days of January 31, 2000.
(9) For purposes of this calculation, all shares beneficially owned by any member of the Tandon family are included in the amount beneficially owned.
ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Tandon family has been involved in the manufacture of a wide range of personal computer components and of personal computers for many years. Since its formation, the Company and its subsidiaries have been operated in conjunction with other privately held operations of the Tandon family.
In order to support the continuing operations of the Company, Tandon Associates loaned the Company $1,525,000, net of repayments, during fiscal 1998. The March 31, 1998 loan balance, including interest at 1% per month on the average daily balance, was $1,607,000. The total due Tandon Associates, including accrued interest, at March 31, 1999 was $1,334,000. Payments on the loan balance during fiscal 1999 were $432,000.
In fiscal 1997 the Company entered into a renewed lease agreement with SDJ Partners, a general partnership, whose partners are certain members of the Tandon family. The lease was for the Company's headquarters facility, which includes office and warehouse space. The facility lease was at the cost of comparable space at the time the lease was negotiated and utilities are charged at $250 per month, which approximates estimated usage and cost. During fiscal 1998, SDJ Partners agreed to amend the lease agreement, which allowed the Company to reduce the amount of leased space because of the contraction of its business. On December 31, 1999, the lease expired and the Company is currently renting space on a month-to-month basis. For fiscal 1999, total facilities cost was $57,000.
Eastern Peripherals Ltd., a Tandon family-affiliated company that had shared common facilities with and had purchased power supplies from Ultra Tek, owed Ultra Tek $96,000 at March 31, 1998. Eastern Peripherals Ltd. ceased operations in 1995, and since then has been liquidating its assets to pay its obligations to Ultra Tek and other creditors. During fiscal 1999, it was determined that all the assets of Eastern Peripherals Ltd. had been liquidated and that no further payments would be forthcoming. Consequently, the balance due of $84,000 was written off as being uncollectible.
During fiscal 1999, J.T. Holdings Pvt. Ltd. loaned $806,000 to the Company for needed working capital. The loan is unsecured, payable on demand at an interest rate of 15% per annum commencing April 1, 2000.
PART IV
ITEM 14
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
(a) 1. Financial Statements:
Reports of Independent Public Accountants
Consolidated Balance Sheets as of March 31, 1998 and 1999: Assets Liabilities and Shareholders' Deficit
Consolidated Statements of Operations for each of the three years in the period ended March 31, 1999
Consolidated Statements of Shareholders' Equity for each of the three years in the period ended March 31, 1999
Consolidated Statements of Cash Flows for each of the three years in the period ended March 31, 1999
Notes to Consolidated Financial Statements
2. Financial Statement Schedules:
Reports of Independent Public Accountants on Supplemental Schedule Schedule II - Valuation and Qualifying Accounts for the three fiscal years ended March 31, 1999
All other schedules are omitted because they are not applicable, not required, or the required information is shown in the Financial Statements or notes thereto.
3. Exhibits:
See Item 14(c) below.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the fiscal year ended March 31, 1999.
(c) Exhibits
The exhibits listed on the accompanying index immediately following the signature page are filed as part of this report.
(d) Financial Statement Schedules
See Item 14(a) above
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, on May 9, 2000.
GOLDEN SYSTEMS, INC.
/s/ JAWAHAR L. TANDON ----------------------------------- Jawahar L. Tandon Chairman of the Board of Directors and Chief Executive Officer
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 so indicated.
EXHIBIT INDEX
1 Incorporated by reference to the Company's Registration Statement on Form S-1 dated September 9, 1993. 2 Incorporated by reference to Amendment No. 1 to the Company's Registration Statement on Form S-1 dated October 20, 1993. 3 Incorporated by reference to the Company's Form 10K for the Fiscal Year Ended March 31, 1994. 4 Incorporated by reference to the Company's Preliminary Proxy Materials, filed April 1, 1997. - -------------------------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE
We have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Golden Systems, Inc. and its subsidiaries as of March 31, 1999 and for each of the two years then ended, and have issued our qualified report thereon, qualified with respect to the Company's ability to continue as a going concern, dated September 17, 1999. Our audit was made for the purpose of forming an opinion on the statements taken as a whole. The supplemental schedule is presented for purposes of complying with the Securities and Exchange Commission's Rules and Regulations and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements, and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ FARBER & HASS LLP ---------------------------------- Farber & Hass LLP
Oxnard, California September 17, 1999
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE
We have audited in accordance with generally accepted auditing standards, the consolidated statement of operations, shareholders equity and cash flows of Golden Systems, Inc. and subsidiaries for the year ended March 31, 1997, and have issued our qualified report thereon, qualified with respect to the Company's ability to continue as a going concern, dated June 2, 1998. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. Supplemental Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements referred to above, and, in our opinion, fairly states in all material respects the financial data required to be set forth therein for the year ended March 31, 1997 in relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP ---------------------------------- ARTHUR ANDERSEN LLP
Los Angeles, California June 2, 1998
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED MARCH 31, 1997, 1998 AND 1999 (IN THOUSANDS)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Golden Systems, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Golden Systems, Inc. and its subsidiaries (the "Company") as of March 31, 1998 and 1999 and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of the Company at March 31, 1998 and 1999 and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company is currently facing significant financial and operational issues which raise substantial doubt that the Company has the ability to continue as a going concern. These issues are summarized in the paragraphs that follow. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
At March 31, 1999, the Company had outstanding amounts due to four separate Indian lenders in the amount of $9,579,000, all of which are currently in default. Of that amount, three of the banks have issued notices to the Company demanding immediate repayment of $8,617,000. The Company has insufficient funds available to repay the banks. Because the Indian debt is secured by the assets of the Company's subsidiary, Ultra Tek, alternatives available to the banks include closing its operations and forcing it into liquidation (see Note 4). In the event of such action by the lenders, liquidation of assets may result in amounts less than amounts shown in the attached financial statements.
In fiscal 1995 and 1997, Ultra Tek came under investigation by the Indian custom authorities and the Indian Department of Revenue Intelligence regarding alleged improprieties in their inventories and in the import and export of certain components. The government's allegations and investigations could lead to additional duty and penalties being assessed against Ultra Tek in the amount of $2,450,000 at September 17, 1999. In addition, penal action which could be taken under Indian law could result in possible fines up to approximately $16,923,000 at September 17, 1999. The Company is contesting these allegations, but currently, the matters are unresolved and the outcomes uncertain (see Note 11).
The Company has incurred significant losses from operations over the past four years and has lost its two largest customers, which has significantly impacted its revenues. At March 31, 1999, the Company had a shareholders' deficit of $16,737,000. During fiscal 2000, the Company has continued to incur significant losses and management has not successfully executed its efforts to achieve profitable operations and positive cash flows. Outside of related party financing, the Company has identified no viable source of financing.
/s/FARBER & HASS LLP ---------------------- Farber & Hass LLP Oxnard, California September 17, 1999
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Golden Systems, Inc.:
We have audited the consolidated statement of operations, shareholders' equity (deficit) and cash flows of GOLDEN SYSTEMS, INC. (a California corporation) and subsidiaries for the year ended March 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of their operations and their cash flows for the year ended March 31, 1997, in conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company is currently facing significant financial and operational issues which raise substantial doubt that the Company has the ability to continue as a going concern. These issues are summarized in the paragraphs that follow. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.
At March 31, 1997, the Company had outstanding amounts due to four separate Indian lenders in the amount of $8,306,000, all of which are currently in default. Of that amount, three of the banks have issued notices to the Company demanding immediate repayment of $7,392,000. The Company has insufficient funds available to repay the banks. Because the Indian debt is secured by the assets of Ultra Tek, alternatives available to the banks include closing the operations of Ultra Tek and forcing Ultra Tek into liquidation (see Notes 4 and 5). In the event of such action by the lenders, liquidation of assets may result in amounts less than amounts shown in the attached financial statements and related inability to pay liabilities.
In fiscal 1995, Ultra Tek's importing of computer components into India came under investigation by the Indian customs authorities. In September 1997, the Indian customs authorities issued a separate "show cause" notice alleging that Ultra Tek has not provided valid explanations for shortages of imported raw material in its inventories. In fiscal 1997, Ultra Tek came under the investigation of the Indian Department of Revenue Intelligence concerning the import and export of certain components used in the manufacture of power supplies. The above governmental allegations and investigations could lead to additional duty and penalties being assessed against Ultra Tek in the amount of $2.4 million and penal action being initiated against Ultra Tek estimated at $16.9 million. Penalties relating to the Indian Department of Revenue Intelligence investigation, if any, have not yet been finalized. The Company is contesting these allegations, but currently, the matters are unresolved and the outcomes uncertain (see Note 11).
The Company has incurred significant losses from operations and has lost major customers, which has significantly impacted its revenues. Management has not successfully executed on its efforts to achieve profitable operations and positive cash flows.
/s/ ARTHUR ANDERSEN LLP --------------------------- ARTHUR ANDERSEN LLP
Los Angeles, California June 2, 1998
GOLDEN SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 1998 AND 1999 (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated statements.
GOLDEN SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 1998 AND 1999 (IN THOUSANDS)
LIABILITIES AND SHAREHOLDERS' DEFICIT
The accompanying notes are an integral part of these consolidated statements.
GOLDEN SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED MARCH 31, 1997, 1998 AND 1999 (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
The accompanying notes are an integral part of these consolidated statements.
The accompanying notes are an integral part of these consolidated statements.
The accompanying notes are an integral part of these consolidated statements.
GOLDEN SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
1. BASIS OF PRESENTATION, BACKGROUND, AND PRINCIPLES OF CONSOLIDATION
BASIS OF PRESENTATION
The accompanying financial statements include the accounts of Golden Systems, Inc. (GSI) and Fairplay Group, Inc. (Fairplay), collectively hereafter referred to as "the Company".
The accompanying financial statements at March 31, 1999 have been prepared assuming that the Company will continue as a going concern. However, the Company is currently facing significant issues which raise substantial doubt that the Company has the ability to continue as a going concern. These issues are summarized as follows:
- - At March 31, 1999, the Company had outstanding amounts due to four separate Indian lenders in the amount of $9,579,000, all of which are currently in default. Of that amount, three banks have issued notices to the Company demanding immediate repayment of $8,617,000. The Company has insufficient funds available to repay the lenders. Because the Indian debt is secured by the assets of Ultra Tek, alternatives available to the lenders include closing the operations of Ultra Tek and forcing Ultra Tek into liquidation (see Note 4).
- - In fiscal 1995, Ultra Tek's importing of computer components into India came under investigation by the Indian customs authorities. In September 1997, the Indian customs authorities issued a separate "show cause" notice alleging that Ultra Tek has not provided valid explanations for shortages of imported raw material in its inventories. In fiscal 1997, Ultra Tek came under the investigation of the Indian Department of Revenue Intelligence concerning the import and export of certain components used in the manufacture of power supplies and returned customer product. Subsequently, a separate "show cause" notice was issued requesting explanation of why duties should not be assessed. The above governmental allegations and investigations could lead to additional duty and penalties being assessed against Ultra Tek in the amount of $2,450,000 using the Indian rupee translation rate at September 17, 1999, and penal action being initiated against Ultra Tek. In addition, penal action under Indian law, which the Company believes is very unlikely, could result in possible monetary fines of up to a maximum of $16,923,000 using the Indian rupee translation rate at September 17, 1999. The Company is contesting these allegations, but currently, the matters are unresolved and the outcomes uncertain (see Note 11).
- - The Company has incurred significant losses from operations over the past four years; has lost its two main customers, which has significantly impacted its revenues; and at March 31, 1999, had a shareholders' deficit of $16,737,000. During fiscal 2000, the Company has continued to incur significant losses, and management has not successfully executed on its efforts to achieve profitable operations and positive cash flows. Outside of related party financing, the Company has identified no viable source of financing.
Due to the significance of these factors in the accompanying financial statements at March 31, 1999, all assets have been stated at their estimated realizable values. Costs of resolving the contingencies noted above or settling amounts due to Indian banks or Company creditors have not been reflected in the accompanying financial statements as management is currently unable to estimate these amounts. Accounts receivable and inventories were valued at their subsequently realized amounts (inventories at cost), and property, plant and equipment were valued based on estimates by management and in accordance with the guidelines of Statement of Financial Accounting Standards No. 121 "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS 121). The estimated realizable values and settlement amounts may be different from the proceeds ultimately received or payments made.
BACKGROUND
Fairplay, a Panamanian corporation, is solely a holding company and conducts its business through Ultra Tek Devices Limited (Ultra Tek), an Indian corporation and wholly owned subsidiary of Fairplay.
The Company is principally in the business of the manufacture and export of switching mode power supplies and adapters, primarily for incorporation by original equipment manufacturers (OEMs) of personal computers and computer peripheral
devices into their products. The Company's power supplies convert alternating current electrical power from a primary source, such as a wall outlet, into the direct current, stable voltages required to power the OEMs' various products.
The manufacturing facilities of Ultra Tek are primarily located in Bombay, India, in the Santa Cruz Electronics Export Processing Zone (SEEPZ). Under the regulations of the SEEPZ, Ultra Tek is required to export a substantial part of its production. Ultra Tek imports substantially all of its raw materials from East Asia, Europe and the United States of America. Ultra Tek exports substantially all of its production to GSI and its customers in the United States of America, Asia and Europe.
GSI was incorporated in October 1985, but began its operations in February 1991. GSI, a California corporation, designs and markets the power supplies manufactured by Ultra Tek. The power supplies are primarily drop shipped by Ultra Tek directly to GSI's customers.
The Company began using the fictitious name "Cortech Systems" during the second quarter of fiscal 1997.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the accounts of the Company presented on a consolidated basis. All significant intercompany balances and transactions have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
FOREIGN CURRENCY TRANSLATION
The financial statements of Ultra Tek and the Company's subsidiaries in Sri Lanka and England have been prepared in their local currencies and have been translated into U.S. dollars in accordance with the Statement of Financial Accounting Standards No. 52. The functional currency is the local currency. Assets and liabilities are translated from the local currencies into U.S. dollars at the exchange rate at the balance sheet date. Revenues, expenses and cash flows are translated at weighted average exchange rates for the period to approximate translation at the exchange rates prevailing at the dates those elements are recognized in the financial statements. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are not included in determining net income or loss but are accumulated and reported as a separate component of shareholders' deficit in the accompanying balance sheets.
STOCK-BASED COMPENSATION PLAN
The Company accounts for its stock-based compensation plan (see Note 6) under the provisions of APB Opinion No. 25. The Company has elected to follow the disclosure provisions of Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation", beginning April 1, 1995 for employee awards. See Note 7 for disclosure of pro forma loss and loss per common share amounts for the years ended March 31, 1997, 1998 and 1999, as required by SFAS 123. The Company has adopted SFAS 123 for all non-employee awards beginning April 1, 1996.
REVENUE RECOGNITION
Revenues on product sales are recognized at the time of shipment from India.
The Company accounts for potential product returns by reserving for the potential loss of sales and accounts receivable in the period in which the original sale occurred based on historical results. Historically, product returns have been relatively insignificant, except for in fiscal 1995 when the Company's most significant customer returned approximately $4.2 million of product to the Company. These significant returns only occurred in fiscal 1995 and, through fiscal 1999, the Company has incurred relatively insignificant product returns in every other year of its operations since its inception. The Company's management believes that the fiscal 1995 level of returns was of a non-recurring nature, and as such, only reserves relating to an estimated recurring level of returns were recorded as of March 31, 1998 and 1999 and are included in the accounts receivable allowance.
Sales to countries other than the United States approximated 20, 18 and 36 percent of the Company's revenues in fiscal years 1997, 1998 and 1999, respectively.
RESEARCH AND DEVELOPMENT
Costs associated with developing and testing new concepts and designs are expensed as incurred. All research and development costs have been expensed through March 31, 1999.
WARRANTIES
The Company generally provides its customers with a one to three-year warranty on its power supplies. A provision for estimated future costs relating to warranty expense is recorded when products are shipped.
SIGNIFICANT GROUP CONCENTRATION OF CREDIT RISK
In fiscal 1997, sales to two customers accounted for approximately 19 and 36 percent, respectively, of the Company's net sales. As of March 31, 1997, these customers accounted for approximately 85 percent of the Company's accounts receivable balance. In fiscal 1998, sales to these customers were not material because they were replaced with two new customers which accounted for approximately 15% and 65%, respectively, of the Company's net sales. At March 31, 1998, the accounts receivable balance to these newly acquired customers was approximately 93 percent of the total accounts receivable balance. In fiscal 1999, the customer obtained in 1998, which accounted for the smaller percentage of sales, was replaced. Sales to the new customer and the existing customer accounted for approximately 12 and 64 percent, respectively, of the Company's net sales. As of March 31, 1999, these customers accounted for approximately 76 percent of the Company's accounts receivable balance.
The Company's strategy of selling to OEMs anticipates that the Company will be relying on high sales volumes to a relatively small number of customers. Although there can be no assurance that the major customers will continue to utilize the Company's products at current levels, if at all, the Company expects to continue to depend upon such customers for a significant percentage of its net sales. The Company has no long-term contracts with major customers. A decline in demand for computer peripheral equipment and other electronic products, or other factors affecting the electronics industry in general, or major customers in particular, could have a material adverse effect on the Company's results of operations (see Note 1).
INVENTORIES
Inventories are valued at the lower of cost (first in, first out) or market. Cost includes cost of material, freight and manufacturing overhead. Inventories consist of the following (in thousands):
The Company reviews its inventories on a periodic basis (generally quarterly) for slow-moving, excess and obsolete items. A reserve is recorded against the cost of items identified as such. The amounts shown at March 31, 1998 and 1999 are presented net of a reserve of $5,671,000 and $4,943,000, respectively, which records the inventories at their estimated net realizable values.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at acquisition cost, net of accumulated depreciation and amortization, which is computed using straight-line and accelerated methods over three to fifteen years. The amounts presented below are shown net of accumulated depreciation and amortization as the amounts are presented at their fair value (as determined by applying SFAS 121).
Property, plant and equipment consists of the following (in thousands):
Costs of normal maintenance and repairs are charged to expense as incurred. Major replacements or betterments of property and equipment are capitalized. When items are sold or otherwise disposed of, the cost and related accumulated depreciation and reserve for impairment loss are removed from the accounts and any resulting gain or loss is included in operations.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original maturity of 90 days or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Based on borrowing rates currently available to the Company for bank loans with similar terms and maturities, the fair value of the Company's long-term debt approximates the carrying value. Furthermore, the carrying value of all other financial instruments potentially subject to valuation risk (principally consisting of cash equivalents, accounts receivable and accounts payable) also aproximates fair value.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes was $800 in 1997, 1998 and 1999. Cash paid for interest was approximately $308,000, $302,000 and $223,000 in 1997, 1998 and 1999, respectively.
BASIC INCOME (LOSS) PER SHARE
The Company adopted the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share," that established standards for the computation, presentation and disclosure of earnings per share ("EPS"), replacing the presentation of Primary EPS with a presentation of Basic EPS. It also requires dual presentation of Basic EPS and Diluted EPS on the face of the income statement for entities with complex capital structures. Basic EPS is based on the weighted average number of common shares outstanding during the period, which totaled 5,300,000, 5,300,000 and 4,452,000 for 1999, 1998 and 1997, respectively. The Company did not present Diluted EPS since the result was anti-dilutive in 1997 and 1998 and immaterial in 1999.
NEW ACCOUNTING PRONOUNCEMENTS
The Company adopted the provisions of Statement of Financial Account Standards ("SFAS") No. 130, "Reporting Comprehensive Income", in fiscal year 1999. The impact of SFAS No. 130, which establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements, was not significant.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year presentation.
3. RECAPITALIZATION PLAN
In February 1997, the Company's Board of Directors approved a proposal (the "Recapitalization Plan" or the "Plan") from the Company's President on behalf of the Tandon family, the Company's principal shareholders, pursuant to which the
Tandon family would contribute $2,000,000 in cash in exchange for 13,333,333 shares of the Company's common stock. In February 1997, the Company received a fairness opinion from an investment bank which stated the Plan was fair to the Company's shareholders from a financial point of view. In March 1997, the Company issued 850,000 of its common shares, which represented all of the shares available to be issued by the Company under its current capital structure, to the Tandon family. The Company's authorized shares will be increased, if approved by the Company's shareholders, at which time the remaining 12,483,333 shares will be issued to the Tandon family. In connection with the Plan (due to not all of the shares being issued), the Company entered into an agreement with the Tandon family under which $1,873,000 of the $2,000,000 contributed would be set up as a note payable with the remaining $127,000 recorded as an increase to equity in fiscal 1997. Borrowings under the note payable agreement bear interest at 8 percent, are convertible into 12,483,333 shares of common stock upon approval by the Company's shareholders and are secured by essentially all assets of GSI.
4. SHORT-TERM BORROWINGS
GSI FACTORING AGREEMENT
The Company has a factoring agreement with a United States bank. Under the agreement, the Company may sell its accounts receivable to the bank, at the bank's option, at the value of 60 percent in fiscal 1998 and 80% as of September 14, 1998, of the face amount of each receivable the bank desires to purchase. The total amount of "unpaid advances" by the bank cannot exceed $1,333,333. The Company must pay a monthly finance charge (1.75 percent) on the outstanding unpaid advances in addition to a one-time administration fee (.75 percent) on each purchased receivable. The unpaid advances are secured by essentially all of the assets of the Company. The term of the factoring agreement is on a year-to-year basis unless terminated in writing by Buyer or Seller. Through March 31, 1997, the Company had not sold any of its accounts receivable under the agreement. During November and December 1997, the Company factored a total of $713,000 of its accounts receivable to provide working capital. Subsequently, the borrowings were repaid and there was no outstanding balance at March 31, 1998. During fiscal 1999, the Company factored a total of $264,608 of its accounts receivable to provide working capital. Subsequently, the borrowings were repaid and there was no outstanding balance at March 31, 1999.
During fiscal 1995, the Company issued the bank a warrant to purchase 24,000 shares of its common stock at the price of $.50 per share. The warrants may be exercised beginning in December 1994 and expire in December 1999.
ULTRA TEK FINANCING AGREEMENTS
The Company has entered into borrowing agreements with three banks in India, which are denominated in Indian Rupees. The agreements provide for borrowings based upon qualifying intercompany accounts receivable which relate to export sales. At March 31, 1998 and 1999, $7,437,000 and $8,191,000 of principal and accrued interest (295,461,000 and 349,102,000 in Indian rupees), respectively, were outstanding under these agreements and no amounts were available to borrow. Borrowings bear interest at varying rates prescribed by the Reserve Bank of India for such borrowings. At March 31, 1998 and 1999, the normal rate of interest was 13 percent per annum, with interest on overdue amounts increasing to a maximum of 25 percent. These agreements are secured by accounts receivable, property, plant and equipment, and inventories.
The Company has also entered into additional credit agreements with the same three banks, which are denominated in Indian rupees. These agreements provide for borrowings based upon qualifying inventories which relate to export sales. At March 31, 1998 and 1999, $467,000 and $425,595 (18,495,000 and 18,139,000 in Indian rupees), respectively, were outstanding under these agreements and no amounts were available to borrow. Borrowings bear interest at varying rates prescribed by the Reserve Bank of India for such borrowings. At March 31, 1998 and 1999, the normal rate of interest was 13 percent per annum, with interest on overdue amounts increasing to a maximum of 25 percent. These credit agreements are secured by inventories and accounts receivable.
The above agreements and facilities were due for renewal at various dates and amounts prior to March 31, 1998, and as such, effective June 1996, the consortium of banks "froze" all credit facilities available to the Company. In July 1997, the banks' legal counsel issued notices to Ultra Tek and the Company calling upon them to pay the outstanding amounts due. The banks have not initiated any legal action against the Company for non-payment of the amounts due, since Ultra Tek has been declared a sick company by the Board of Industrial and Financial Reconstruction (BIFR) of the Government of India.
The BIFR appointed an Operating Agency ("OA") to examine the Company's viability and prepare a viability study report. Accordingly, the Company prepared a draft rehabilitation proposal, which was submitted to the OA. The OA reviewed the proposal and forwarded the same to the BIFR along with the minutes of a joint meeting between the banks and the Company convened by the OA in March 1999. Based on the minutes of the joint meeting, the BIFR prepared its Draft Rehabilitation Scheme and advised all concerned inviting suggestions/objections to the scheme. The Draft Scheme is subject to ongoing discussion and envisages restructuring of existing debts (unpaid principal amount of $5,129,047 to banks and financial institutions as of September 30, 1999), conversion of simple interest into a Funded Interest Term Loan amounting to
$2,132,801 as of September 30, 1999, infusion of funds by way of contribution by the Tandon family amounting to $938,527 which has already occurred, and additional working capital facilities from the Indian banks of $1,642,421, which would enable the Company to generate enough resources to continue its operations and repay the restructured debts over a period of time. The BIFR held a hearing on August 16, 1999 and after hearing all interested parties, has advised the Company and the banks to discuss further and modify the Draft Scheme to take into account the various points made at the hearing. The BIFR also instructed the OA to conduct joint meetings with the banks and the Company and to forward a modified scheme. The Company is in the process of discussing with the banks ways to modify the Draft Scheme to take into account a potential conversion of compound interest and liquidated damages into redeemable preference stock.
Essentially all of the above agreements and facilities are covered by corporate guarantees from GSI, Fairplay and Tandon Associates, a related party. They are also covered by the personal guarantee of the Chairman of Ultra Tek for the amount of approximately $10,030,000.
5. NOTES PAYABLE
In fiscal 1995, the Company entered into borrowing agreements with an Indian lending institution (which are denominated in U. S. dollars) to finance the purchase of certain property and equipment. At March 31, 1998 and 1999, $834,000 and $962,000, respectively, was owed under these agreements. The borrowings are repayable in five equal installments beginning on April 1, 1997 and ending on April 1, 1998. Interest on outstanding amounts are payable annually at a rate equal to the London Inter Bank Offer Rate (LIBOR) plus 2.75 percent. For overdue amounts, the rate of interest was 20.4 percent per annum. At March 31, 1998, the rate was 8.7 percent. The borrowings are secured by the property and equipment. The Company currently has defaulted on all payments due subsequent to April 1, 1997. Currently, there has been no legal action taken by the lender nor has the lender called for repayment of outstanding amounts due.
6. EQUITY TRANSACTIONS
STOCK OPTION PLAN
During fiscal 1994, the Company adopted a stock option plan (the "1994 Plan") that provides for the granting of options to purchase up to 455,000 shares of common stock, consisting of both incentive stock options and non-qualified options. Incentive stock options are issuable only to employees, while non-qualified stock options may be issued to non-employee directors, consultants and others, as well as to employees. All stock options must be granted at prices equal to the fair market value of the common stock on the grant date. All options granted expire ten years from the date of grant and vest in 20 percent increments over five years.
The Company accounts for the 1994 Plan under APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost for this plan been determined consistent with SFAS 123, the Company's net income (loss) and income (loss) per common share amounts would have been adjusted to the following pro forma amounts for the years ended March 31, 1997, 1998 and 1999 (net income/loss amounts are in thousands):
Because the SFAS 123 method of accounting has not been applied to options granted prior to April 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years.
A summary of the status of the Company's outstanding stock options at March 31, 1997, 1998 and 1999 and changes during the years then ended is presented in the table and narrative below (shares are in thousands):
The fair value of each option grant is estimated on the date of grant using an option pricing model with the following weighted-average assumptions used for grants in 1997; a risk-free interest rate of seven percent; no expected dividend yield; expected lives of 5 years; expected volatility of 50% to 60%.
COMMON STOCK PURCHASE WARRANTS
A summary of warrant activity is as follows:
No warrants were issued, exercised or redeemed in fiscal years 1997, 1998 and 1999.
STOCK PURCHASE PLAN
The Company has established an Employee Stock Purchase Plan (the Purchase Plan), which allows eligible employees to purchase shares of the Company at the price of 85 percent of the fair market value of the shares on the first or last day of an option period. The maximum number of shares which may be issued under the Purchase Plan is 300,000. The Purchase Plan became effective on September 1, 1994. No shares have been issued under this Plan.
7. LITIGATION SETTLEMENT
During the third quarter of fiscal year 1995, the Company experienced a product rejection by its then-largest customer, which cost the Company $4.2 million of lost accounts receivables directly related to the sales of the rejected units and $2.2 million related to other direct costs stemming from the rejections. The Company engaged the services of an outside contractor to address the customer complaint and rework the rejected product. After rework, the product was again rejected by the customer as a result, in the Company's view, of poor workmanship in the rework process.
In fiscal year 1996, the Company filed a complaint against the contractor alleging, among other things, that the contractor improperly performed rework services and thereby breached the contract with the Company. The Company sought damages in excess of $3 million. Also, in fiscal year 1996, the contractor filed a cross-complaint against the Company alleging breach of contract by the Company for failure to pay for rework services rendered. The contractor sought $108,000 and unspecified damages.
In April 1996, the Company settled the lawsuits with the contractor. Under the agreement terms, the Company received a cash settlement of $592,000, of which $163,000 related to the reimbursement of legal expenses incurred in fiscal year 1996.
Accordingly, $163,000 was recorded as a reduction of legal expenses in fiscal year 1996 and the balance of the settlement has been recorded in fiscal year 1997.
8. EXTINGUISHMENT OF ACCOUNTS PAYABLE
In 1994, the Company attempted to develop a product line, which failed to materialize. Inventory related to this product line was previously reserved for, however certain accounts payable amounts aggregating $1,775,000 payable since 1994 had been retained in the financial statements pending any possible demand for payment. Since demand for payment has not been made and any future demand will be barred under the Indian Limitation Act, the Company has credited operating income for the balance due. Similarly, there are other accounts payable amounts aggregating $399,000 that have not been paid for which no demand has been made against the Company and which are currently barred under the Indian Limitation Act. These amounts have also been credited to operating income.
9. INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109).
Under SFAS 109, deferred income tax assets or liabilities are computed based on the temporary difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal income tax rate in effect for the year in which the differences are expected to reverse. Deferred income tax expenses or credits are based on the changes in the deferred income tax assets or liabilities from period to period. The valuation allowance decreased $624,000 in 1999.
The components of the net deferred income tax asset at March 31, 1999 are as follows (in thousands):
The provision for income taxes for the years ended March 31, 1997, 1998 and 1999 are as follows (in thousands):
Differences between the provision for income taxes and income taxes at the statutory federal income tax rate for the years ended March 31, 1997, 1998 and 1999 are as follows (in thousands):
In 1997, the pre-tax losses relating to U.S. and foreign operations were $1,551,100 and $12,147,000, respectively. In 1998, the pre-tax losses relating to U.S. and foreign operations were $1,561,000 and $2,138,000, respectively. In 1999, the pre-tax loss relating to U.S. operations was $816,000 and the pre-tax profit relating to foreign operations was $929,000.
Ultra Tek's manufacturing facilities are located in an export processing zone. Under the Indian Income-tax Act of 1961, the entire profits of a company situated in a free trade zone are exempt from income tax for a period of five consecutive years within the first eight years of operations at the option of the Company. Ultra Tek elected to claim the exemption for the five years ended March 31, 1992. Consequently, Ultra Tek did not have any income tax liability up to March 31, 1992. Under another provision of the Indian Income-tax Act of 1961, Ultra Tek will continue to be exempt from income tax to the extent of profits attributable to its export sales. For the years ended March 31, 1997, 1998 and 1999, no provision for income taxes was recorded as Ultra Tek incurred losses for tax purposes.
The Company does not provide for U. S. federal income taxes on the undistributed earnings of its foreign operations. The Company's policy is to leave the income permanently invested in the country of origin. Such amounts will only be distributed to the United States to the extent any federal income tax can be fully offset by foreign tax credits. Currently, this policy is still in effect due to the limited foreign funds available for repatriation to the U.S.
Net operating loss carryforwards as of March 31, 1999 for federal and state tax purposes are approximately $11.6 million and $6.1 million, respectively, and begin expiring in fiscal years 2010 and 2000, respectively.
10. MINORITY INTEREST
On September 7, 1993, the holders of notes payable due from Ultra Tek in the amount of approximately $2.6 million contributed such amounts to Ultra Tek in exchange for Ultra Tek redeemable preference shares. The preference shares exchanged for the debt are non-voting shares, with an aggregate annual dividend amount of $25 ($0.00003 per share) per year, are mandatorily redeemable in 20 years and have a liquidation preference of approximately $2.6 million. Due to an agreement with the preference shareholders, these shares are redeemable at the option of the Company but do not have to be redeemed for 20 years. Early redemption of the shares prior to maturity can be accomplished only with the approval of a majority of the Company's outside directors. The full redemption amount is shown in the accompanying balance sheets as of March 31, 1998 and 1999 as minority interest.
11. COMMITMENTS AND CONTINGENCIES
A) LEASES
GSI leases its corporate headquarters from a related party under a three year operating lease which expired in December 1999. Ultra Tek leases certain factory premises from the Indian Government under operating leases which expire at various dates through December 2000. Future minimum payments under these and other various operating leases are as follows (in thousands):
Gross rental expense for the years ended March 31, 1997, 1998 and 1999 was approximately $214,000, $222,000 and $98,000, respectively.
b) LITIGATION
The Company is subject to lawsuits in the normal course of business. In the opinion of management and legal counsel to the Company, pending litigation will not result in a material loss to the Company.
c) CONTINGENCIES
During fiscal year 1995, the Company's imports of computer components for final assembly and sale into the domestic tariff area (DTA) of India (outside the SEEPZ) came under investigation by the Indian customs authorities. As a result, Company inventories of $1,090,000 (47,447,000 in Indian rupees) were seized by the authorities. On May 30, 1995, the authorities issued a notice to the Company alleging misdeclaration of purported imports of complete computer systems as imports of computer system components. The notice calls upon the Company to explain why the authorities should not (a) confiscate all the goods so imported, (b) levy additional duty of $1,123,000 (48,885,000 in Indian rupees) on the goods already sold into the DTA, and (c) take penal action against the Company under the law. The Company paid an advance of $700,000 (20,000,000 in Indian rupees) against customs duty that may ultimately be levied by the authorities and recorded this amount in "cost of goods sold" in the accompanying statement of operations for the year ended March 31, 1995. During fiscal 1996, the authorities released the seized goods. However, because of difficulties encountered in re-exporting the goods and technological obsolescence, the entire amount of the seized goods was included in the inventory reserve amounts discussed in Note 2 at March 31, 1997 (Inventories). No other penalties or expenses related to this government action have been incurred by the Company.
In September 1997, the Indian customs authorities issued a "show cause" notice alleging that Ultra Tek has not provided valid explanations for shortages of raw material in its inventories. The notice called upon the Company to explain why the authorities should not (a) impose duty of $591,000 (25,725,000 in Indian rupees) leviable on imported components which were alleged not accounted for in the terms of bond executed, (b) why penal action should not be initiated against the Company, and (c) why a penalty equal to the duty held to be leviable, $591,000 (25,725,000 in Indian rupees), in respect of unaccounted goods should not be imposed.
In fiscal 1997, the Company came under investigation by the Indian Department of Revenue Intelligence (DRI) in connection with the import and export of certain components and goods used in the manufacture of power supplies and customer returns. The investigation focused on the alleged discrepancy noted between the physical stock records and books, in respect of the work-in-process inventory at March 31, 1996 and 1997 and customer returned product at March 31, 1992 through March 31, 1997. In May 1998, the DRI issued a "show cause" notice requesting that the Company explain why the DRI should not impose duties of approximately $591,000 (25,720,000 in Indian rupees). Penalties relating to the investigation, if any, have not yet been determined.
The aggregate of threatened duties and penalties to the Company is approximately $2,450,000 (106,474,000 in Indian rupees), using the Indian rupee translation rate at September 17, 1999. Although the Company is contesting the allegations of the authorities, the outcomes of these matters are uncertain at this time. Accordingly, no additional provisions for any losses that may ultimately result have been made in these financial statements. In addition, penal action under Indian law, which the Company believes is very unlikely, could result in possible monetary fines of up to $16,923,000 at September 17, 1999.
12. RELATED PARTY TRANSACTIONS
The Company has substantial dealings with the following entities which are owned by or affiliated with Company shareholders. The amount of loans, sales, purchases, transfers and sharing of expenses during the years ended March 31, 1997, 1998 and 1999 with each party are as follows (in thousands):
During fiscal 1999, it was determined that the balance of $84,000 due from Eastern Peripherals Ltd. was not collectible. Eastern Peripherals ceased operations in 1995 and has liquidated all of its assets to pay down its outstanding obligations.
During fiscal 1999, J. T. Holdings Pvt. Ltd. loaned $806,000 to the Company for needed working capital. The loan is unsecured, payable on demand at an interest rate of 15% per annum commencing April 1, 2000.
During fiscal 1998, Tandon Associates loaned the Company $1,525,000, net of repayments, to support continuing operations. The loan, which is secured by a factoring agreement, is at a monthly interest rate of 1% on the average daily outstanding balance.
The Company believes that related party transactions are at amounts and terms which approximate market. The headquarters facility lease is at the cost of comparable office and warehouse space at the time the lease was negotiated and utilities are at estimated usage and cost. Charges and credits for common expenses and administrative services are at approximate cost and the transfer of assets is at net book value which approximates market value. The purchase of travel services is at competitive prices and the purchase of computer supplies is at cost plus a five percent mark-up to cover administrative costs. The sale of Company product is at estimated market price.
In addition, during fiscal 1998, the Company sold its manufacturing subsidiary located in Sri Lanka to Cortex, Limited, a Tandon family affiliate, which transaction resulted in a gain to the Company of approximately $590,000. In connection with the sale, Cortex, Limited, agreed to assume all of the bank debt in Sri Lanka, the facility lease, and all the obligations to employees. The Company also entered into an agreement with an affiliated part of Tandon Associates to sell its Singapore operation. The Company recorded a gain of approximately $38,000 on this transaction.
13. FOREIGN OPERATIONS
The Company operates principally in three geographic areas: the United States, Europe, and Asia. The following is a summary of information by areas as of and for the years ended March 31, 1997, 1998 and 1999 (in thousands):
The Company exported approximately 11 percent, 13 percent, and 35 percent, of its total sales in the years ended 1997, 1998 and 1999, respectively. These exports are primarily to foreign subsidiaries of U. S. companies.
DOMESTIC VERSUS EXPORT SALES
14. 401K PLAN
The Company maintains a 401K plan for the benefit of its domestic employees. The Plan covers substantially all of these employees, subject to certain participation requirements. Participants may contribute from 1% to 15% of their eligible earnings, subject to certain restrictions. The Plan provides that the Company may make additional contributions to the Plan but it is not required to contribute on behalf of the participants. The Company did not incur expenses related to this Plan during fiscal years 1997, 1998 and 1999.