SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
FOR ANNUAL REPORT AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to _________________
COMMISSION FILE NUMBER 0-17521
PACIFIC MAGTRON INTERNATIONAL CORP.
(Exact Name of Registrant as Specified in Its Charter)
Nevada 88-0353141
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization Identification No.)
1600 California Circle, Milpitas, California 95035
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (408) 956-8888
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
n/a n/a
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by checkmark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 126-2). Yes [ ] No [X]
At June 28, 2002 the aggregate market value of common stock held by
non-affiliates of the registrant was approximately $10,485,100.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ] N/A
APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
At March 11, 2003 the number of shares of common stock outstanding was
10,485,062.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement relating to the 2003 Annual
Meeting of Stockholders are incorporated by reference into Part III, Items 10,
11, 12 and 13.
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The following statement is made pursuant to the safe harbor provisions for
forward-looking statements described in the Private Securities Litigation Reform
Act of 1995. Pacific Magtron International Corp. and subsidiaries (the
"Company") may make certain statements in this Annual Report on Form 10-K,
including, without limitation, statements that contain the words "believes,"
"anticipates," "estimates," "expects," and words of similar import, constitute
"forward-looking statements." Forward-looking statements may relate to, among
other items, our future growth and profitability; the anticipated trends in our
industry; our competitive strengths and business strategies; our business
initiatives and our goal of returning to profitability. Further, forward-looking
statements are based on our current expectations and are subject to a number of
risks, uncertainties and assumptions relating to our operations, financial
condition and results of operations. For a discussion of factors that may affect
the outcome projected in such statements, see "Cautionary Factors that May
Affect Future Results," in this Report. If any of these risks or uncertainties
materialize, or if any of the underlying assumptions prove incorrect, actual
results could differ materially from results expressed or implied in any of our
forward-looking statements. We do not undertake any obligation to revise these
forward-looking statements to reflect events or circumstances arising after the
date of this Annual Report on Form 10-K.
PART I
ITEM 1. BUSINESS
SUMMARY OF OUR BUSINESS
As used in this document and unless otherwise indicated, the terms
"Company," "PMIC," "we," "our" or "us" refer to Pacific Magtron International
Corp., a Nevada corporation, and its subsidiaries.
Our primary business is to provide computer and information technology
solutions through our wholly-owned subsidiaries, Pacific Magtron, Inc. ("PMI"),
Pacific Magtron (GA), Inc. ("PMIGA"), Lea Publishing, Inc. ("Lea"),
LiveWarehouse, Inc. ("LiveWarehouse"), PMI Capital Corporation ("PMICC"), and a
majority-owned subsidiary, FrontLine Network Consulting, Inc. ("FNC"). Our
business is organized into five divisions: PMI, PMIGA, FNC, LiveWarehouse and
Lea/LiveMarket.
DEVELOPMENT OF BUSINESS
Our computer products group operates through two wholly-owned subsidiaries,
Pacific Magtron, Inc. and Pacific Magtron (GA), Inc. Our corporate information
systems group operates as a majority-owned subsidiary, FrontLine Network
Consulting, Inc. Our software development and publishing group, Lea Publishing,
Inc., operates as a wholly-owned subsidiary. LiveWarehouse, Inc. provides
consumers a convenient way to purchase computer products via the internet. PMICC
is an investment holding company for the purpose of acquiring companies or
assets deemed suitable for PMIC's organization.
Founded in 1989, PMI fulfills the multimedia hardware needs of system
integrators, value added resellers, retailers, original equipment manufacturers,
software vendors, and internet resellers through the wholesale distribution of
computer related multimedia hardware components and software. In August 2000, we
formed PMIGA to enhance the distribution of PMI's products in the eastern United
States.
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FNC serves as a corporate information services group catering to the
networking and internet infrastructure requirements of corporate clients.
Lea/LiveMarket is engaged in the development and distribution of software
and e-business products and services, as well as integration and hosting
services. In January 1999, we formed Lea, as a California limited liability
company, to develop, sell and license software designed to provide Internet
users, resellers and providers advanced solutions and applications. Prior to the
ownership exchange discussed below, we owned a 62.5% combined direct and
indirect (through our 25% ownership interest in Rising Edge Technology) interest
in Lea, which is a development stage company. Michael Lee, the brother of Hui
Cynthia Lee, one of our officers and directors, is the president and director
and a majority shareholder of Rising Edge. In December 2001, we entered into an
agreement with Rising Edge and its principal owners to exchange Rising Edge's
50% ownership interest in Lea for our 25% interest in Rising Edge. As a
consequence, we now own 100% of Lea and no longer have an ownership interest in
Rising Edge. In the fourth quarter of 2001, certain assets of LiveMarket were
purchased by PMICC and subsequently transferred to Lea. These assets, consisting
primarily of computer equipment, furniture and fixtures, certain Web-hosting
contracts, rights to certain intellectual properties, including LiveSell and
LiveExchange, and non-tangible assets such as domain names and trademarks, were
acquired for $85,000, plus $59,100 in acquisition costs, and the assumption of
$20,000 in accrued vacation obligations (investment of $164,100 in total) and
recorded under the purchase method of accounting as prescribed by FASB Statement
No. 141, Business Combinations. LiveMarket is an internet software development
company which designs and develops online stores (LiveSell) to allow consumers
to purchase products directly via a secured transaction network. It also designs
and develops enterprise document exchange solutions (LiveExchange) for its
client's integration of disparate systems. On May 28, 2002, the Company formed
Lea Publishing, Inc., a California corporation. Effective June 1, 2002, Lea
Publishing, LLC transferred all of its assets and liabilities to Lea Publishing,
Inc.
On October 15, 2001, we formed PMICC as a wholly-owned subsidiary of PMIC,
for the purpose of acquiring companies or assets deemed suitable for PMIC's
organization.
In December, 2001 LiveWarehouse, Inc. was incorporated as a wholly-owned
subsidiary of PMIC, to provide consumers a convenient way to purchase computer
products via the internet.
Financial information for each division for each of the last three fiscal
years is included in the Audited Consolidated Financial Statements.
INDUSTRY OVERVIEW
WHOLESALE MICRO COMPUTER PRODUCTS DISTRIBUTION
The microcomputer products distribution industry consists of suppliers,
wholesalers, resellers, and end-users. Wholesale distributors typically sell
only to resellers and purchase a wide range of products in bulk directly from
manufacturers. Different types of resellers are defined and distinguished by the
end-user market they serve, such as large corporate accounts, small and
medium-sized businesses or home users, and by the level of value that they add
to the basic products they sell.
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INCREASED RELIANCE ON WHOLESALE MICRO COMPUTER PRODUCTS DISTRIBUTION
We believe that the growth of the microcomputer products wholesale
distribution industry exceeds that of the microcomputer industry as a whole
because the wholesale distribution industry serves both the aftermarket upgrade
market as well as system integrators that build new systems. In our view,
suppliers, and resellers are relying to a greater extent on wholesale
distributors for their distribution needs. Suppliers are faced with the
pressures of declining product prices and the increasing costs of selling
directly to a large and diverse group of resellers, and they therefore are
increasingly relying upon wholesale distribution channels for a greater
proportion of their sales. Many suppliers outsource a growing portion of certain
functions, such as distribution, service, technical support, and final assembly,
to the wholesale distribution channel in order to minimize costs and focus on
their core capabilities in manufacturing, product development, and marketing.
Likewise, vendors are finding it more cost efficient to rely on wholesale
distributors that can leverage distribution costs across multiple vendors, each
of whom outsources a portion of its distribution, credit, marketing, and support
services.
On the reseller side, growing product complexity, shorter product life
cycles, an increasing number of microcomputer products, the emergence of open
system architectures, and the recognition of certain industry standards have led
resellers to depend upon wholesale distributors for more of their product,
marketing, and technical support needs. Due to the large number of vendors and
products, resellers often cannot or choose not to establish direct purchasing
relationships with suppliers. Instead, they rely on wholesale distributors that
can leverage purchasing power across multiple resellers to satisfy a significant
portion of their product procurement and delivery, financing, marketing, and
technical support needs. Rather than stocking large inventories themselves, and
maintaining credit lines to finance working capital needs, resellers are also
increasingly relying on wholesale distributors for product availability and
flexible financing alternatives.
OPEN SOURCING
Another apparent reason for the growth of the wholesale distribution
industry is the evolution of open sourcing, a phenomenon specific to the United
States microcomputer products wholesale distribution market. Historically,
branded computer systems from large suppliers were sold in the United States
only through authorized master resellers. Under this single sourcing model,
resellers were required to purchase these products exclusively from one master
reseller. Competitive pressures led some of the major computer suppliers to
authorize second sourcing, in which resellers could purchase a supplier's
product from a source other than their primary master reseller, subject to
certain restrictive terms and conditions. More recently, all major manufacturers
have authorized open sourcing, under which resellers can purchase the supplier's
product from any source on equal terms and conditions. Open sourcing has thus
blurred the distinction between wholesale distributors and master resellers,
which are increasingly able to serve the same reseller base. We believe that
open sourcing enables those distributors of microcomputer products that provide
the highest value through superior service and pricing to be in the best
position to compete for reseller customers.
INTERNET SERVICES
The Internet provides wholesale distributors with an additional method of
serving both suppliers and reseller customers through the development and use of
effective electronic commerce tools. The increasing utilization of electronic
ordering, including the ability to transact business over the World Wide Web,
has had, and is expected to continue to have, a significant impact on the cost
efficiency of the wholesale distribution industry. Distributors with the
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financial and technical resources to develop, implement and operate state of the
art management information systems have been able to reduce both their customers
and their own transaction costs through more efficient purchasing and lower
selling costs. The growing presence and importance of such electronic commerce
capabilities also provides distributors with new business opportunities as new
categories of products, customers, and suppliers develop.
CORPORATE INFORMATION SYSTEMS CONSULTING
Factors similar to those encouraging the increased reliance by target
clients on wholesale distributors are also driving corporations to specialist
service organizations, such as FNC, to support the development and maintenance
of their information technology systems or networks. Accelerating technological
advancement, migration of organizations toward multi-vendor distributed
networks, and increased globalization of corporate activity have contributed to
an increase in the sophistication of information delivery systems and
interdependency of corporate computing systems. The desire by corporations to
focus upon their core activities while enjoying the benefits of such
multi-vendor distributed networks, together with increasing skill shortages
within the information technology industry, have led businesses to outsource the
development and maintenance of their computing systems to network consulting
professionals.
SOFTWARE SOLUTIONS AND PUBLISHING
With increased use of the internet for business transactions and
businesses' growing reliance on their network infrastructure to process data
timely and accurately, the software requirements to accomplish these tasks has
created growth in the software solution provider and consulting segments.
Businesses are looking for Application Service Providers (ASP) and custom
software solution providers such as Lea/LiveMarket to solve their needs and
improve their systems, such as to interface legacy systems with more advanced
applications and control of data flow and communications between disparate
systems. The other area of growth for software providers is the increased need
for B2B or B2C to communicate effectively to other systems on the internet
through a hybrid of communication means.
PACIFIC MAGTRON, INC. AND PACIFIC MAGTRON (GA), INC. - COMPUTER PRODUCTS
Through PMI and PMIGA, we distribute a wide range of computer products,
including components, multimedia and systems networking products. We also
provide vertical solutions for systems integrators and internet resellers by
combining or bundling our products. Our computer products group offers our
customers a broad inventory of more than 1,800 products from approximately 30
manufacturers. We believe this wide assortment of vendors and products meets our
customers' needs for a cost effective link to multiple vendors' products through
a single source. Among the products that we distribute are systems and
networking peripherals, and components such as high capacity storage devices, a
full range of optical storage devices such as CD-ROMS, DVDs, CDR and CDRW, sound
cards, video cards, small computer systems interface components, video phone
solutions, floppy and hard disk drives, and other miscellaneous items such as
audio cabling devices, keyboards, computer mice, and zip drives for desktop and
notebook computers.
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INVENTORY LEVELS AND ASSET MANAGEMENT
Based on historical order levels and our knowledge of the market, we
maintain sufficient quantities of product inventories to achieve high order fill
rates, and believe that price protection and stock return privileges provided by
suppliers substantially mitigate the risks associated with slow moving and
obsolete inventory. We also operate a computerized inventory system that allows
us to look at and deal with slow moving inventory. If a supplier reduces its
prices on certain products we generally receive a credit for such products in
our inventory. In addition, we have the right to return a certain percentage of
purchases, subject to certain limitations. Historically, price protection, stock
return privileges, and inventory management procedures have helped to reduce the
risk of a significant decline in the value of inventory.
However, we have recognized losses due to obsolete inventory in the normal
course of business, but historically we have not experienced any material
losses. Inventory levels may vary from period to period due in part to the
addition of new suppliers or large purchases of inventory in response to
favorable terms offered by suppliers.
CREDIT TERMS
We offer various credit terms, including open account, flooring
arrangements, company and personal checks and credit card payment to qualifying
customers. We closely monitor creditworthiness of our customers, and in most
markets, utilize various levels of credit insurance to control credit risks and
enable us to extend higher levels of credit. We have also established reserves
for estimated credit losses in the normal course of business.
FRONTLINE NETWORK CONSULTING - CORPORATE INFORMATION SYSTEMS
INFORMATION TECHNOLOGY (IT) CONSULTING SERVICES
We assist our end-user corporate clients in identifying solutions that
match available technology, their current IT infrastructure, and
situation-appropriate IT management philosophy to their business needs and
initiatives. We endeavor to understand the client's business and how it relies
on the availability and flow of information from its technology solutions, as
well as assessing the value of that information. We baseline the current IT
infrastructure through network, systems, security and business-continuity
assessments. Subsequently, we assist in quantifying solution benefits in terms
of competitive advantage, better e-commerce transaction efficiency, increased
productivity of personnel and processes, reduced cost of ownership and return on
investment.
IT DESIGN, PLANNING, AND PROJECT MANAGEMENT SERVICES
As part of our specific solution sets, we provide design, planning, and
project management services within the specializations of enterprise
high-availability services, enterprise and network management, advanced
internetworking, LAN engineering, telephony/video/data convergence, systems
engineering, storage and data management, and inter-network/network/systems
security.
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IT IMPLEMENTATION AND CONFIGURATION SERVICES
We provide configuration, testing, troubleshooting, and knowledge-transfer
training to our corporate clients based on their needs and requirements on a per
project basis.
IT PROCUREMENT SERVICES
By taking advantage of the relationships established between manufacturers
and our wholesale distribution business, we are able to provide specialty
procurement services to our corporate customers. Our professionals manage the
details of receiving, configuring, testing, and shipping integrated systems for
our customers, and assist them in dealing with issues such as product
availability forecasting, redeployment and disposal of technology assets,
warehousing, and packaging, tracking, and confirmation of shipments. Our
procurement services afford an additional benefit to our customers by providing
a single source for software and hardware orders, and by making available volume
discounts that might otherwise be unavailable to them.
IT TRAINING SERVICES
We enhance our client's efficiency and productivity through training and
knowledge-transfer. We have the capability to deliver using either
custom-designed or pre-established courseware.
FRONTLINE STRATEGIC PARTNERSHIPS
One of the factors that permits us to provide our corporate customers with
a high level of service is the development of strategic supply partnerships with
leading manufacturers, such as CISCO Systems, Hewlett-Packard, AT&T, Checkpoint,
Microsoft, Nortel, Novell and others. Certification from these manufacturers is
based on their recognition of our expertise at implementing their client
solutions, and allows us to offer our clients the products that they are
currently using, along with continuous education regarding each technology and
the applications for which it is used. We believe that forming relationships
with suppliers is important in providing us with credibility in contacting large
corporate clients.
LEA/LIVEMARKET - SOFTWARE DEVELOPMENT AND PUBLISHING
Lea/LiveMarket provides product and services solutions that connect and
manage consumers, distributors, manufacturers and suppliers by providing a
fully-managed trading network enabled by proven business processes,
state-of-the-art internet technologies, and a network of established partners.
Lea/LiveMarket provides the following products and services.
SYSTEM INTEGRATION & SUPPLY CHAIN CONSULTING SERVICE
Lea/LiveMarket provides business case and recommendations on
business-to-business (B2B) build-out, return on investment analysis, direct and
indirect material spending analysis, inventory reduction analysis and product
cycle time reduction analysis.
INTERNET SOFTWARE DEVELOPMENT AND DEPLOYMENT
Using LiveSell and LiveExchange, Lea/LiveMarket can design and implement
B2B and business-to-customer (B2C) sites expeditiously and bring EDI
capabilities to its client's current environment.
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APPLICATIONS SERVICE PROVIDER AND MANAGED SERVICES
Lea/LiveMarket provides managed hosting services, application monitoring,
application support and help desk support.
CUSTOM PROGRAMMING
Lea/LiveMarket also provides Microsoft Biztalk programming through the use
of LiveExchange, enabling legacy systems to interface with other systems
effectively. All offerings are based on Microsoft.NET architecture and are
marketed under four specific point solutions, as well as general consulting.
Prior to the transfer of LiveMarket's assets to Lea, Lea's only significant
activity consisted of the software development noted above.
LIVEWAREHOUSE - BUSINESS TO CONSUMER E-COMMERCE STORE
In December 2001 we formed LiveWarehouse, Inc., an e-commerce site aimed at
increasing sales and gross profit marginsby selling directly to consumers
through the Internet. LiveWarehouse.com's main focus is consumer computer
electronics for the computer after-market segment as well as storage and related
products for general consumer electronic devices.
SALES AND MARKETING
We generate our sales for our computer products divisions through a
telemarketing sales force, which consisted of approximately 12 people as of
February 28, 2003 in our offices located in Milpitas, California and six people
in our Georgia location.
The sales force is organized in teams generally consisting of a minimum of
three people. We believe that teams provide superior customer service because
customers can contact one of several people. Moreover, we believe that the
long-term nature of our customer relationships is better served by teams that
increase the depth of the relationship and improve the consistency of service.
We provide compensation incentives to our salespeople, thus encouraging
them to increase their product knowledge and to establish long-term
relationships with existing and new customers. Customers can contact their
salespersons using a toll-free number. Salespeople initiate calls to introduce
our existing customers to new products and to solicit orders. In addition,
salespeople seek to develop new customer relationships by using targeted mailing
lists and vendor leads.
The telemarketing salespeople are supported by a variety of marketing
programs. For example, we regularly sponsor promotions for our resellers where
we have new product offerings and discuss industry developments, as well as
regular training sessions hosted by manufacturers. In addition, our in-house
marketing staff prepares catalogs that list available products and routinely
produces marketing materials and advertisements.
Our salespeople are able to analyze our available inventory through a
sophisticated management information system and recommend the most appropriate,
cost-effective systems and hardware for each customer, whether a full-line
retailer or an industry-specific reseller.
We pride ourselves on being service-oriented and have a number of on-going
value-added services intended to benefit both our vendors and their resellers.
We train members of our sales staff through intensive in-house sales training
programs, along with vendor-sponsored product seminars. This training helps our
sales people provide our customers with product information, answer our
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customers questions about important new product considerations, such as
compatibility and capability, and to advise which products meet specific
performance and price criteria. The core competency our sales people develop
about the products that they sell supplements the sophisticated technical
support and configuration services we provide. Salespeople who are knowledgeable
about the products that they sell often can assist in the configuration of
microcomputer systems according to specifications given by the resellers. We
believe that our salespeople's ability to listen to a reseller's needs and
recommend a cost-efficient solution strengthens the relationship between the
salesperson and his or her reseller and promotes customer loyalty to a vendor's
products. In addition, we provide such other value-added services as new product
descriptions and technical education programs for resellers.
We continually evaluate our product mix and the needs of our customers in
order to minimize inventory obsolescence and carrying costs. Our rapid delivery
terms are available to all of our customers, and we seek to pass through our
cost effective shipping and handling expenses to our customers.
FNC sales are generated primarily through its employees and through
referrals from manufacturers and customers. FNC's sales force currently consists
of seven persons.
Lea/LiveMarket currently generates its sales primarily from customer and
direct and online vendor referrals.
LiveWarehouse generates sales primarily through its e-store
(livewarehouse.com) and operates a Yahoo store. Supplemental sales are generated
through Internet auction sites for liquidation electronic products.
LiveWarehouse utilizes a staff of ____ to handle its sales volume and respond to
telephone inquiries.
SUPPLIERS
SOURCES OF SUPPLY
Our financial and industry positions have enabled us to obtain contracts
with many leading manufacturers, including Microsoft Creative Labs, Logitech,
Toshiba, Sony, Network Associates and TEAC. We purchase our products directly
from such manufacturers, generally on a non-exclusive basis. We believe that our
agreements with the manufacturers are in forms customarily used by each
manufacturer. The agreements typically contain provisions allowing termination
by either party without prior notice, and generally do not require us to sell a
specific quantity of products or restrict us from selling products manufactured
by competitors. As a result, we generally have the flexibility to terminate or
curtail sales of one product line in favor of another product line if we
consider it appropriate to do so because of technological change, pricing
considerations, product availability, customer demand or vendor distribution
policies.
DISTRIBUTION
From our central warehouse facilities in Milpitas, California and Atlanta,
Georgia, we distribute microcomputer products principally throughout the United
States. No individual customer or customers in any foreign country account for
more than 10% of our sales. A minority of our distribution agreements are
limited by territory. In those cases, however, North America is usually the
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territory granted to us. We will continue to seek to expand the geographical
scope of our distributor arrangements.
COMPETITION
All aspects of our business are highly competitive. Competition within the
computer products distribution industry is based on product availability, credit
availability, price, speed and accuracy of delivery, effectiveness of sales and
marketing programs, ability to tailor specific solutions to customer needs,
quality and breadth of product lines and services, and the availability of
product and technical support information. We also compete with some
manufacturers that sell directly to resellers and end-users. Principal regional
competitors in the wholesale distribution industry include Asia Source and
Synnex Information Technology, Inc., all of which are privately held companies.
Ingram Micro Inc., Tech Data Corporation Insight.com, yahoo, MSN and AOL
shopping portals are among our principal regional and multi-regional publicly
held competitors. We also compete with manufacturers that sell directly to
resellers and end-users. Nearly all of our competitors are larger and have
greater financial and other resources.
Competition within the corporate information systems industry is based on
technical know-how, breadth of available engineering services, flexibility,
resources in providing customized network solutions and the ability to provide
the right hardware products for integration. Our principal competitors in the
corporate information systems industry varies depending on the project size from
IBM Global Services, SBC and other major consulting groups to local VARs and
network integrators. In some cases we compete with those that have greater
financial and other resources.
Competition within the software solution and publishing industry is based
on the ability to identify, program and deliver efficient and cost-effective
solutions within the scope of the projects, as well as the breadth of knowledge
available through its programmers and consultants necessary to bring any project
to conclusion successfully. Lea/LiveMarket faces competition from such companies
as Manugistics, I2, Compuware, and occasionally local independent consulting
firms.
Competition within the e-commerce space is primarily based on having the
products available and the ability to ship products ordered on our website
expediently and correctly at competitive pricing. Although there are many
smaller competitive e-store websites on the Internet, many of them are
relatively small and the market is quite fragmented. Of the larger e-store
competitors, we face competition from companies such as buy.com, Amazon.com,
tigerdirect.com and other major e-retailers such as Insight.com, Yahoo, MSN and
AOL.
A number of our competitors in the computer distribution industry, and most
of our competitors in the information technology consulting industry the
software solution provider industry, are substantially larger and have greater
financial and other resources than we do.
EMPLOYEES
As of February 28, 2003, we had approximately 90 full time employees, all
of whom are non-union, and three executive officers. We believe that our
employee relations are good.
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CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
OUR REPORT OF INDEPENDENT AUDITORS CONTAINS A GOING CONCERN QUALIFICATION
We have received a going concern opinion from our auditors. The opinion
raises substantial doubts our ability to continue as a going concern. If we fail
to replace our Transamerica floor plan line of credit or if we cannot reverse
our trend of negative earnings an investor could lose his entire investment.
WE HAVE INCURRED OPERATING LOSSES AND DECREASED REVENUES FOR THE LAST TWO FISCAL
YEARS AND WE CANNOT ASSURE YOU THAT THIS TREND WILL CHANGE
We incurred net losses for the year ended December 31, 2002 and 2001 of
$2,835,900 and $2,850,700, respectively, and we may continue to incur losses. In
addition, our revenues decreased 6.2% during the year ended December 31, 2002 as
compared to 2001. Our future ability to execute our business plan will depend on
our efforts to increase revenues, reduce costs and return to profitability. We
have implemented plans to reduce overhead and operating costs, and to build upon
our core business. No assurance can be given, however, that these actions will
result in increased revenues and profitable operations. If we are unable to
return to profitable operations we may be unable to continue as a going concern.
WE CAN PROVIDE NO ASSURANCE THAT WE WILL BE ABLE TO SECURE ADDITIONAL CAPITAL
REQUIRED BY OUR BUSINESS
In the second quarter of 2002, we completed a private placement of 600
shares of our Series A Convertible Preferred Stock at a stated price of $1,000
per share for gross proceeds of $600,000 and net proceeds of $477,500. We also
issued common stock purchase warrants to the same purchaser exercisable to
purchase 400,000 shares of our common stock at $1.20 per share at any time
within three years from the date of issuance.
Based on our projected downsized operations we anticipate that our working
capital, including the $477,500 raised in our second quarter 2002 placement and
a recently received tax refund of $1,427,400, will satisfy our working capital
needs for the next twelve months. However, if we fail to raise additional
working capital prior to that time or if we are unable to replace our
Transamerica Flooring line in a timely fashion, we will be unable to pursue our
business plan. We may give no assurance that we will be able to obtain
additional capital when needed or, if available, that such capital will be
available at terms acceptable to us.
POTENTIAL SALES OFF ADDITIONAL COMMON STOCK AND SECURITIES CONVERTIBLE INTO OUR
COMMON STOCK MAY DILUTE THE VOTING POWER OF CURRENT HOLDERS
We may issue equity securities in the future whose terms and rights are
superior to those of our common stock. Our Articles of Incorporation authorize
the issuance of up to 5,000,000 shares of preferred stock. These are "blank
check" preferred shares, meaning our board of directors is authorized to
designate and issue the shares from time to time without shareholder consent. As
of December 31, 2002 we had 600 shares of Series A Preferred outstanding. The
Series A Preferred are convertible based on a sliding scale conversion price
referenced to the market price of our common stock. As of December 31, 2002, the
Series A Preferred was convertible into 818,900 shares of common stock based on
the floor conversion price of $.75. Any additional shares of preferred stock
that may be issued in the future could be given voting and conversion rights
that could dilute the voting power and equity of existing holders of shares of
common stock and have preferences over shares of common stock with respect to
dividends and liquidation rights. At the time of issuance of the Series A
-12-
Preferred Stock, it was intended that an additional 400 shares be issued to the
same investor; however, the purchaser has not fulfilled its obligations to close
this transaction as of the date of this filing, and we do not anticipate that
such sale will occur.
WE HAVE VIOLATED CERTAIN FINANCIAL COVENANTS CONTAINED IN OUR LOANS AND MAY DO
SO AGAIN IN THE FUTURE
We have a mortgage on our offices with Wells Fargo Bank, under which we
must maintain the following financial covenants:
i) Total liabilities must not be more than twice our tangible net worth;
ii) Net income after taxes must not be less than one dollar on an annual
basis and for no more than two consecutive quarters; and
iii) We must maintain annual EBITDA of one and one half times our debt.
We are currently in violation of covenants (ii) and (iii), but we have
received a waiver for such violation through December 31, 2003. We cannot assure
you that we will be able to meet all of these financial covenants Wells Fargo
Mortgage in the future. If we fail to meet the covenants, Wells Fargo may
declare us in default and accelerate the loan.
On January 7, 2003, Transamerica terminated its credit facility with us
effective April 7, 2003. However, Transamerica will continue its guarantee of
the Letter of Credit Facility through July 25, 2003. Unless we do not perform
our obligations in accordance with the agreement and certain covenants are not
materially worse than the condition at the level on January 7, 2003,
Transamerica will continue to accept payments according to the terms of the
agreement prior to April 7, 2003. The remaining outstanding balance is due and
payable in full on April 7, 2003. As of December 31, 2002, we had an outstanding
balance of $901,600 due under this credit facility. We would be unable to
continue our operations without replacement loans or other alternative
financing. We are in the process of seeking a replacement for the Transamerica
Flooring line with a similar line from Textron Financial. However, we cannot
assure you that we will be able to either secure the Textron flooring line or
maintain it if we continue our losses.
OUR COMMON STOCK DOES NOT CURRENTLY MEET THE REQUIREMENTS FOR CONTINUED LISTING
ON THE NASDAQ SMALLCAP MARKET
Our common stock is currently traded on the Nasdaq SmallCap Market. On
August 19, 2002 we received a letter from the Nasdaq Stock Market informing us
that we did not meet the criteria for continued listing on the Nasdaq SmallCap
Market. The letter stated that Nasdaq will monitor our common stock and if it
closes above $1.00 for a minimum of ten consecutive trading days, Nasdaq will
notify us of our compliance with the continued listing standards. We have also
been notified by Nasdaq that we have not complied with the Marketplace Rule that
requires a minimum bid price of $1.00 per share of common stock. We have until
August 18, 2003 to comply with this Rule.
On February 28, 2003, Nasdaq notified us that our common stock had failed
to comply with the minimum market value of publicly held shares requirement of
Nasdaq Marketplace Rule. Our common stock is, therefore, subject to delisting
from the Nasdaq SmallCap Market. On March 6, 2003 we requested a hearing before
a Listing Qualifications Panel, at which we will seek continued listing. The
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hearing has been scheduled on April 24, 2003. We intend to detail our plan to
comply with both Rules at the hearing referred to above. There can be no
assurance that the Panel will grant our request for continued listing. If our
common stock is delisted, we would seek to have our common stock traded on the
OTC Bulletin Board. In such case, the market for our common stock will not be as
broad as if it were traded on the Nasdaq SmallCap Market and it will be more
difficult to trade in our common stock, which will likely cause a decrease in
the price of our common stock.
OUR FAILURE TO ANTICIPATE OR RESPOND TO TECHNOLOGICAL CHANGES COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS
The market for computer systems and products is characterized by constant
technological change, frequent new product introductions and evolving industry
standards. Our future success is dependent upon the continuation of a number of
trends in the computer industry, including the migration by end-users to
multi-vendor and multi- system computing environments, the overall increase in
the sophistication and interdependency of computing technology, and a focus by
managers on cost-efficient information technology management. These trends have
resulted in a movement toward outsourcing and an increased demand for product
and support service providers that have the ability to provide a broad range of
multi-vendor product and support services. There can be no assurance these
trends will continue in the future. Our failure to anticipate or respond
adequately to technological developments and customer requirements could have a
material adverse effect on our business, operating results and financial
condition.
IF WE ARE UNABLE TO SECURE PRICE PROTECTION PROVISIONS IN OUR VENDOR AGREEMENTS,
THE VALUE OF OUR INVENTORY WOULD QUICKLY DIMINISH
As a distributor, we incur the risk that the value of our inventory will be
adversely affected by industry wide forces. Rapid technology change is
commonplace in the industry and can quickly diminish the marketability of
certain items, whose functionality and demand decline with the appearance of new
products. These changes and price reductions by vendors may cause rapid
obsolescence of inventory and corresponding valuation reductions in that
inventory. We currently seek provisions in the vendor agreements common to
industry practice that provide price protections or credits for declines in
inventory value and the right to return unsold inventory. No assurance can be
given, however, that we can negotiate such provisions in each of our contracts
or that such industry practice will continue.
EXCESSIVE CLAIMS AGAINST WARRANTIES THAT WE PROVIDE COULD ADVERSELY EFFECT OUR
BUSINESS
Our suppliers generally warrant the products that we distribute and allow
us to return defective products, including those that have been returned to us
by customers. We do not independently warrant the products that we distribute,
except that we do warrant services provided in connection with the products that
we configure for customers and that we build to order from components purchased
from other sources. If excessive claims are made against these warranties, our
results of operations would suffer.
WE MAY NOT BE ABLE TO SUCCESSFULLY COMPETE WITH SOME OF OUR COMPETITORS
All aspects of our business are highly competitive. Competition within the
computer products distribution industry is based on product availability, credit
availability, price, speed and accuracy of delivery, effectiveness of sales and
marketing programs, ability to tailor specific solutions to customer needs,
-14-
quality and breadth of product lines and services, and the availability of
product and technical support information. We also compete with manufacturers
that sell directly to resellers and end users.
Competition within the corporate information systems industry is based
primarily on flexibility in providing customized network solutions, resources
and contracts to provide products for integrated systems and consultant and
employee expertise needed to optimize network performance and stability. A
number of our competitors in the computer distribution industry, and most of our
competitors in the information technology consulting industry, are substantially
larger and have greater financial and other resources than we do.
FAILURE TO RECRUIT AND RETAIN TECHNICAL PERSONNEL WILL HARM OUR BUSINESS
Our success depends upon our ability to attract, hire and retain technical
personnel who possess the skills and experience necessary to meet our personnel
needs and the staffing requirements of our clients. Competition for individuals
with proven technical skills is intense, and the computer industry in general
experiences a high rate of attrition of such personnel. We compete for such
individuals with other systems integrators and providers of outsourcing
services, as well as temporary personnel agencies, computer systems consultants,
clients and potential clients. Failure to attract and retain sufficient
technical personnel would have a material adverse effect on our business,
operating results and financial condition.
WE DEPEND UPON CONTINUED CERTIFICATION FROM CERTAIN OF OUR SUPPLIERS
The future success of FNC depends in part on our continued certification
from leading manufacturers. Without such authorizations, we would be unable to
provide the range of services currently offered. There can be no assurance that
such manufacturers will continue to certify us as an approved service provider,
and the loss of one or more of such authorizations could have a material adverse
effect on FNC and thus to our business, operating results and financial
condition.
WE DEPEND ON KEY SUPPLIERS FOR A LARGE PORTION OF OUR INVENTORY, LOSS OF THOSE
SUPPLIERS COULD HARM OUR BUSINESS
One supplier, Sunnyview/CompTronic ("Sunnyview"), accounted for
approximately 11%, 10% and 16% of our total purchases for the years ended
December 31, 2002, 2001 and 2000, respectively. We do not have a supply contract
with Sunnyview, but rather purchase products from it through individual purchase
orders, none of which has been large enough to be material to us. Although we
have not experienced significant problems with Sunnyview or our other suppliers,
and we believe we could obtain the products that Sunnyview supplies from other
sources, there can be no assurance that our relationship with Sunnyview and with
our other suppliers, will continue or, in the event of a termination of our
relationship with any given supplier, that we would be able to obtain
alternative sources of supply on comparable terms without a material disruption
in our ability to provide products and services to our clients. This may cause a
loss of sales that could have a material adversely effect on our business,
financial condition and operating results.
-15-
IF A CLAIM IS MADE AGAINST US IN EXCESS OF OUR INSURANCE LIMITS WE WOULD BE
SUBJECT TO POTENTIAL EXCESS LIABILITY
The nature of our corporate information systems engagements exposes us to a
variety of risks. Many of our engagements involve projects that are critical to
the operations of a client's business. Our failure or inability to meet a
client's expectations in the performance of services or to do so in the time
frame required by such client could result in a claim for substantial damages,
regardless of whether we were responsible for such failure. We are in the
business of employing people and placing them in the workplace of other
businesses. Therefore, we are also exposed to liability with respect to actions
taken by our employees while on assignment, such as damages caused by employee
errors and omissions, misuse of client proprietary information, misappropriation
of funds, discrimination and harassment, theft of client property, other
criminal activity or torts and other claims. Although we maintain general
liability insurance coverage, there can be no assurance that such coverage will
continue to be available on reasonable terms or in sufficient amounts to cover
one or more large claims, or that the insurer will not disclaim coverage as to
any future claim. The successful assertion of one or more large claims against
us that exceed available insurance coverage or changes in our insurance
policies, including premium increases or the imposition of large deductible or
co-insurance requirements, could have a material adverse effect on our business,
operating results and financial condition.
WE ARE DEPENDENT ON KEY PERSONNEL
Our continued success will depend to a significant extent upon our senior
management, including Theodore Li, President, and Hui Cynthia Lee, Executive
Vice President and head of sales operations, and Steve Flynn, general manager of
FrontLine. The loss of the services of Messrs. Li or Flynn or Ms. Lee, or one or
more other key employees, could have a material adverse effect on our business,
financial condition or operating results. We do not have key man insurance on
the lives of any of members of our senior management.
WE CANNOT ASSURE YOU THAT OUR PURSUIT OF NEW BUSINESS THROUGH LIVEMARKET WILL BE
SUCCESSFUL
We plan to enter the proprietary software development business through
Lea/LiveMarket. We have limited experience in developing commercial software
products. We have conducted no independent, formal market studies regarding the
demand for the software currently in development and planned to be developed. We
have, however, conducted informal surveys of our customers and have relied on
business experience in evaluating this market. Further, while we have experience
in marketing computer related products, we have not marketed software or a
proprietary line of our own products. This market is very competitive and nearly
all of the software publishers or distributors with whom Lea/LiveMarket will
compete have greater financial and other resources than Lea/LiveMarket. There
can be no assurance Lea/LiveMarket will be successful in developing commercial
software products, or even if Lea/LiveMarket develops such products, that it
will find market acceptance for them. Finally, there can be no assurance that
Lea/LiveMarket will generate a profit.
-16-
ESTABLISHMENT OF OUR NEW BUSINESS TO-CONSUMER WEBSITE LIVEWAREHOUSE.COM MAY NOT
BE SUCCESSFUL
We have established a new business-to-consumer website, LiveWarehouse.com.
We cannot assure you that we will achieve market acceptance for this project and
achieve a profitable level of operations, that we will be able to hire and
retain personnel with experience in online retail marketing and management, that
we will be able to execute our business plan with respect to this market segment
or that we will be able to adapt to technological changes once operational.
Further, while we have experience in the wholesale marketing of computer-related
products, we have virtually no experience in retail marketing. This market is
very competitive and many of our competitors have substantially greater
resources and experience than we have.
WE ARE SUBJECT TO RISKS BEYOND OUR CONTROL SUCH AS ECONOMIC AND GENERAL RISKS OF
OUR BUSINESS
Our success will depend upon factors that may be beyond our control and
cannot clearly be predicted at this time. Such factors include general economic
conditions, both nationally and internationally, changes in tax laws,
fluctuating operating expenses, changes in governmental regulations, including
regulations imposed under federal, state or local environmental laws, labor
laws, and trade laws and other trade barriers.
ITEM 2. PROPERTIES
We own property located at 1600 California Circle, Milpitas, California
95035, which was subject to mortgages in the amount of $3,230,300 at December
31, 2002. Of this amount, $2,387,500 is subject to bank financing which bears
interest at the bank's 90-day LIBOR rate (1.875% as of December 31, 2002) plus
2.5% and is secured by a deed of trust on the property. The remaining $842,800
is subject to a Small Business Administration loan which bears interest at a
7.569% rate and is secured by the underlying property. This property of 3.31
acres includes a 44,820 square foot building. The building contains our
executive office and warehouse and we believe it is suitable for the current
size and the nature of our operations. We lease a building in Georgia to house
our branch office pursuant to a three-year operating lease which expires October
31, 2003. We have an option to renew this lease for an additional three-year
term. Future minimum lease payments under this non-cancelable operating lease
agreement for 2003 are estimated to be $89,900.
LiveMarket leases an office in Orange County. The term of the lease is
currently on a month-to-month basis at a cost to the company of $1,060 per
month.
Frontline Network Consulting, Inc. leases an office in Tempe, Arizona with
a term expired on February 28, 2003. Currently, the lease is on a month-to-month
basis and requires a monthly payment of $3,069.
ITEM 3. LEGAL PROCEEDINGS
We are not involved as a party to any legal proceeding other than various
claims and lawsuits arising in the normal course of our business, none of which,
in our opinion, is individually or collectively material to our business.
-17-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matter to a vote of our security holders during the
fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Our common stock is listed on the Nasdaq SmallCap Market. It first traded
on the Nasdaq SmallCap Market on January 31, 2000, and prior to such date our
common stock was traded on the OTC Bulletin Board. Our stock first traded on the
OTC Bulletin Board on July 28, 1998. The following table shows the high and low
sale prices in dollars per share for the last two years as reported by the
Nasdaq Small Cap Market and the OTC Bulletin Board. These prices may not be the
prices that you would pay to purchase a share of our common stock during the
periods shown.
HIGH LOW
------ ------
Fiscal Year Ended December 31, 2002
First Quarter $ 2.11 $ 0.86
Second Quarter $ 1.70 $ 0.50
Third Quarter $ 1.25 $ 0.26
Fourth Quarter $ 1.03 $ 0.25
Fiscal Year Ended December 31, 2001
First Quarter $ 2.88 $ 1.00
Second Quarter $ 1.15 $ 0.47
Third Quarter $ 2.00 $ 0.45
Fourth Quarter $ 2.95 $ 1.00
We had 1,260 stockholders of record of our common stock as of February 14,
2003.
DIVIDEND POLICY
We have not paid dividends on our common stock. It is the present policy of
our Board of Directors to retain future earnings to finance the growth and
development of our business. Any future dividends will be at the discretion of
our Board of Directors and will depend upon our financial condition, capital
requirements, earnings, liquidity, and other factors that our Board of Directors
may deem relevant.
-18-
ITEM 6. SELECTED FINANCIAL DATA
The following table contains certain selected financial data and we refer
you to the more detailed consolidated financial statements and the notes thereto
provided in Part II Item 8 of this Form 10-K. The financial data as of and for
the years ended December 31, 2002, 2001, 2000, 1999 and 1998, has been derived
from our consolidated financial statements. Our consolidated financial
statements for the year ended December 31, 2002 were audited by KPMG LLP and the
consolidated financial statements for the years ended December 31, 2001, 2000,
1999 and 1998 were audited by BDO Seidman, LLP.
Fiscal Year Ended December 31
----------------------------------------------------------------------------
Statement of Operations Data 2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
Net Sales ......................... $ 70,328,700 $ 75,011,700 $ 88,872,700 $104,938,700 $105,431,200
Income (Loss) from Operations ..... (4,176,000) (3,829,500) 10,200 1,682,100 3,080,000
Net Income (Loss) ................. (2,835,900) (2,850,700) 121,800 827,300 1,775,700
Net Income (Loss) applicable to
Common Shareholders ............. (3,110,100) (2,850,700) 121,800 827,300 1,775,700
Net Income (Loss) per share to
Common Shareholders - Basic and
Diluted ......................... (0.30) (0.28) 0.01 0.08 0.19
Fiscal Year Ended December 31
----------------------------------------------------------------------------
Balance Sheet Data 2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
Current Assets .................... $ 12,577,600 $ 12,501,600 $ 15,335,200 $ 15,221,100 $ 16,886,600
Current Liabilities ............... 9,464,900 6,766,700 7,710,800 7,614,400 8,955,100
Total Assets ...................... 17,267,000 17,323,300 20,861,100 20,689,000 21,108,400
Long-Term Debt .................... 3,169,500 3,230,300 3,286,200 3,337,600 3,377,100
Redeemable Convertible Preferred
Stock ........................... 190,400 -- -- -- --
Long-Term Obligations and
Redeemable Convertible
Preferred Stock ................. 3,359,900 3,230,300 3,286,200 3,337,600 3,377,100
Shareholders' Equity .............. 4,442,200 7,289,900 9,857,800 9,736,000 8,744,700
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The accompanying discussion and analysis of financial condition and results
of operations is based on our consolidated financial statements, which are
included elsewhere in this Form 10-K. The following discussion and analysis
should be read in conjunction with the accompanying financial statements and
related notes thereto. This discussion contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Our actual
results could differ materially from those set forth in the forward-looking
statements. Forward-looking statements, by their very nature, include risks and
uncertainties. Accordingly, our actual results could differ materially from
those discussed in this Report. A wide variety of factors could adversely impact
revenues, profitability, cash flows and capital needs, including our objective
of returning to profitabiltiy. Such factors, many of which are beyond our
control include, but are not limited to, technological changes, our need for
additional capital, insurance and potential excess liability, diminished
marketability of inventory, increased warranty costs, competition, recruitment
-19-
and retention of technical personnel, dependence on continued OEM certification,
dependence on certain suppliers, risks associated with the projects in which we
are engaged to complete, and dependence on key personnel.
GENERAL
We provide solutions to customers in several synergetic and rapidly growing
segments of the computer industry. Our operating business is organized into five
divisions: PMI, PMIGA, FNC, Lea/LiveMarket, and LiveWarehouse (LW). We also use
PMICC as an investment vehicle for the purpose of acquiring companies or assets
deemed suitable for our operations.
Our subsidiaries, PMI and PMIGA, provide the wholesale distribution of
computer multimedia and storage peripheral products and provide value-added
packaged solutions to a wide range of resellers, vendors, OEMs and systems
integrators. PMIGA commenced operations in October 2000 and distributes PMI's
products in the eastern United States market.
To capture the expanding corporate IT infrastructure market, we established
the FrontLine Network Consulting division in 1998 to provide professional
services to mid-market companies focused on consulting, implementation and
support services of Internet technology solutions. During 2000, this division
was incorporated as FNC. On September 30, 2001, FNC acquired certain assets of
Technical Insights, Inc., a computer technical support company, in exchange for
$20,000 worth of PMIC common stock (16,142 shares). This acquired business unit,
Technical Insights, enables FNC to provide computer technical training services
to corporate clients.
We also invested in a 50%-owned joint software venture, Lea Publishing, LLC
(Lea Publishing), in 1999 to focus on Internet-based software application
technologies to enhance corporate IT services. Lea Publishing was a development
stage company. In June 2000, we increased our direct and indirect interest in
Lea Publishing to 62.5% by completing our purchase of 25% of the outstanding
common stock of Rising Edge Technologies, Ltd., the other 50% owner of Lea
Publishing. In December 2001, we entered into an agreement with Rising Edge and
its principal owners to exchange the 50% Rising Edge ownership in Lea Publishing
for our 25% interest in Rising Edge. As a consequence, PMIC owns 100% of Lea
Publishing and no longer has an interest in Rising Edge. Certain assets acquired
and liabilities assumed originated from the acquisition of LiveMarket that were
initially purchased through PMICC, were transferred to Lea Publishing in the
fourth quarter of 2001 to further assist in the development of internet
software. In May 2002, the Company formed Lea, a California corporation.
Effective June 1, 2002, Lea Publishing transferred all of its assets and
liabilities to Lea.
In December, 2001 LiveWarehouse, Inc. was incorporated as a wholly-owned
subsidiary of PMIC, to provide consumers a convenient way to purchase computer
products via the internet.
As used herein and unless otherwise indicated, the terms "Company," "we"
and "our" refer to Pacific Magtron International Corp. and each of our
subsidiaries.
-20-
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 1 to the
consolidated financial statements included as Part II Item 8 to this Form 10-K.
The following are our critical accounting policies:
REVENUE RECOGNITION
The Company recognizes sales of computer and related products upon delivery
of goods to the customer, provided no significant obligations remain and
collectibility is probable. A provision for estimated product returns is
established at the time of sale based upon historical return rates, which have
typically been insignificant, adjusted for current economic conditions. The
Company generally does not provide volume discounts or rebates to its customers.
Revenues relating to services performed by FNC are recognized upon completion of
the contracts. Software and service revenues relating to software design and
installation performed by FNC and Lea, are recognized upon completion of the
installation and customer acceptance.
LONG-LIVED ASSETS
The Company periodically reviews its long-lived assets for impairment. When
events or changes in circumstances indicate that the carrying amount of an asset
group may not be recoverable, the Company adjusts the asset group to its
estimated fair group value. The fair value of an asset group is determined by
the Company as the amount at which that asset could be bought or sold in a
current transaction between willing parties or group the present value of the
estimated future cash flows from the asset. The asset value recoverability test
is performed by the Company on an on-going basis.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company grants credit to its customers after undertaking an
investigation of credit risk for all significant amounts. An allowance for
doubtful accounts is provided for estimated credit losses at a level deemed
appropriate to adequately provide for known and inherent risks related to such
amounts. The allowance is based on reviews of loss, adjustment history, current
economic conditions, level of credit insurance and other factors that deserve
recognition in estimating potential losses. While management uses the best
information available in making its determination, the ultimate recovery of
recorded accounts receivable is also dependent upon future economic and other
conditions that may be beyond management's control.
INVENTORY
Our inventories, consisting primarily of finished goods, are stated at the
lower of cost (moving weighted average method) or market. We regularly review
inventory quantities on hand and record a provision, if necessary, for excess
and obsolete inventory based primarily on our estimated forecast of product
demand. Due to a relatively high inventory turnover rate and vendor agreements
common in industry practice that provide price protections or credits for
declines in inventory value and the right to return unsold inventory, we believe
that our risk for a decrease in inventory value is minimized. No assurance can
be given, however, that we can continue to turn over our inventory as quickly in
the future or that we can negotiate such provisions in each of our vendor
contracts or that such industry practice will continue.
-21-
INCOME TAXES
The Company reports income taxes in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, ACCOUNTING FOR INCOME TAXES, which requires
an asset and liability approach. This approach results in the recognition of
deferred tax assets (future tax benefits) and liabilities for the expected
future tax consequences of temporary differences between the book carrying
amounts and the tax basis of assets and liabilities. The deferred tax assets and
liabilities represent the future tax consequences of those differences, which
will either be deductible or taxable when the assets and liabilities are
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. Future tax benefits are subject to a valuation allowance when
management believes it is more likely than not that the deferred tax assets will
not be realized.
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 materially from those estimates.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain selected
financial data as a percentage of sales:
Year Ended December 31,
----------------------------
2002 2001 2000
------ ------ ------
Sales .......................................... 100.0% 100.0% 100.0%
Cost of Sales .................................. 93.4 92.9 92.1
------ ------ ------
Gross Margin ................................... 6.6 7.1 7.9
Operating Expenses ............................. 12.5 12.2 7.9
------ ------ ------
(Loss) Income from operations .................. (5.9) (5.1) 0.0
Other income (expense) ......................... 0.0 (0.2) 0.2
Income Tax Benefit (expense) ................... 1.9 1.5 (0.1)
Minority Interest in FNC and PMIGA ............. 0.0 0.0 0.0
------ ------ ------
Net Income (loss) .............................. (4.0) (3.8) 0.1
Accretion and deemed dividend relating to
beneficial conversion of 4% Series A
Convertible Preferred Stock .................. (0.4) 0.0 0.0
------ ------ ------
Net income (loss) applicable to Common
shareholders ................................. (4.4)% (3.8)% 0.1%
====== ====== ======
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Consolidated sales for the year ended December 31, 2002 were $70,328,700, a
decrease of $4,683,000, or approximately 6.2%, compared to $75,011,700 for the
year ended December 31, 2001. Approximately $65,862,100, or 93.6% of total sales
recognized by us for the year ended December 31, 2002 was attributable to PMI
and PMIGA, our wholesale computer distribution business. For the year ended
December 31, 2001, the combined sales of PMI and PMIGA were $71,738,800, or
95.7% of total sales. Sales generated by FNC and Lea in 2002 were $2,378,300 and
$496,600, respectively, as compared to $3,022,200 and $250,700, respectively, in
2001. Sales from FNC, Lea, and LW as a percent of total sales were 3.4%, 0.7%,
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and 2.3%, respectively, for the year ended December 31, 2002. Sales from FNC and
Lea as a percent of total sales were 4.0% and 0.3%, respectively, for the year
ended December 31, 2001. LW was incorporated in December 2001 and generated
$1,591,700 sales in 2002.
The combined sales of PMI and PMIGA, our computer products segments, were
$65,862,100 for the year ended December 31, 2002, a decrease of $5,876,700, or
approximately 8.2%, compared to $71,738,800 for the year ended December 31,
2001. Sales recognized by PMIGA were approximately $9,374,200 in 2002, a
decrease of $2,071,100, compared to $11,445,300 in 2001. Sales for PMI decreased
by $3,805,600, or 6.3% from $60,293,500 for the year ended December 31, 2001 to
$56,487,900 for the year ended December 31, 2002. The decrease in PMI and PMIGA
sales was primarily due to a continuing decline in the computer component market
and the intense competition in pricing in the computer component market in 2002.
In addition, we believe that the continued slow down in the economy depressed
our sales in 2002.
Total sales generated by FNC for the year ended December 31, 2002 were
$2,378,300 of which $1,904,700 was from products sales and $473,600 was from
service sales. For the year ended December 31, 2001, total sales generated by
FNC were $3,022,200, of which $2,907,200 was from products sales and $115,000
was from service sales. The total sales in 2002 decreased by $643,900, or 21.3%,
compared to 2001. Products sales in 2002 decreased by $1,002,500, or 34.5%,
compared to 2001 and service sales in 2002 increased by $358,600, or 311.8%,
compared to 2001. The decrease in FNC's products sales was primarily due to a
continued slow and stagnant U.S. economy and the over-capacity built by our
existing and potential customers in the past few years. In September 2001, FNC
purchased certain assets of Technical Insights, a computer technical support
company which provides computer technical training for its customers. The
increase in service sales for 2002 was primarily due to three months of sales
for Technical Insights that were included in FNC's service sales for 2001
compared to twelve months of sales that were included in FNC's service sales in
2002.
In the fourth quarter of 2001 PMICC acquired certain assets of an internet
software development company, LiveMarket. Subsequently, these assets were
transferred to Lea. During the fourth quarter of 2001, Lea/LiveMarket generated
$250,700 in revenues which related entirely to the newly acquired LiveMarket
operations. For the year ended December 31, 2002, Lea/LiveMarket generated
$496,600 in revenue.
In December 2001, LW was incorporated as a wholly-owned subsidiary of PMIC
to provide consumers a convenient way to purchase computer products via the
internet. Sales generated by LW were $1,591,700 for the year ended December 31,
2002. There were no sales generated by LW in 2001.
Consolidated gross margin for the year ended December 31, 2002 was
$4,610,300, a decrease of $691,800, or 13.0%, compared to $5,302,100 for the
year ended December 31, 2001. The consolidated gross margin as a percentage of
consolidated sales decreased from 7.1% for the year ended December 31, 2001 to
6.6% for year ended December 31, 2002.
The combined gross margin for PMI and PMIGA was $3,723,700, or 5.7% for the
year ended December 31, 2002 compared to $4,687,000, or 6.5%, for the year ended
December 31, 2001. PMI's gross margin for the year ended December 31, 2002 was
$3,266,900, or 5.8% of PMI's sales compared to $4,066,400, or 6.7% of PMI's
sales for the year ended December 31, 2001. PMIGA's gross margin for the year
ended December 31, 2002 was $456,800, or 4.9% of PMIGA's sales compared to
-23-
$620,600, or 5.4% of PMIGA's sales for the year ended December 31, 2001. The
decrease in PMI and PMIGA sales was primarily due to a continuing decline in the
computer component market and the intense competition in pricing in the computer
component market in 2002 compared to 2001. We believe that there was an excess
supply of computer products in 2002 resulting in intense pricing pressure that
adversely affected the gross margin.
Gross margin related to FNC for the year ended December 31, 2002 was
$430,900, or 18.1% of total FNC's sales, compared to $391,800, or 13.0% of FNC's
sales for the year ended December 31, 2001. The higher gross margin in 2002
compared to 2001 was primarily due to a higher mix of service sales in 2002.
FNC's service revenue was $473,600, or 19.9% of total FNC's sales, compared to
$115,000, or 3.8% of total FNC's sales in 2001. FNC has a higher gross margin on
service sales than product sales as part of the consulting and implementation
and training services. Since FNC's sales accounted for only 3% and 4% of our
consolidated sales that occurred in 2002 and 2001, respectively, the gross
margin percentage earned by FNC had only a minor effect on our overall
consolidated gross margin in 2002 and 2001.
The gross margin for Lea was $229,700, or 46.3% of Lea's revenues for the
year ended December 31, 2002, compared to $214,900, 85.7% of Lea's revenues from
October 2001 (acquisition date for LiveMarket) to December 2001. The decrease in
gross margin was primarily due to the increase in labor time and labor costs in
servicing fixed fee maintenance contracts for the year ended December 31, 2002.
LiveWarehouse experienced a gross margin of $226,000, or 14.2% of
LiveWarehouse's sales in 2002.
Consolidated operating expenses, including selling, general,
administrative, and research and development expenses, for the year ended
December 31, 2002 were $8,786,300, a decrease of $345,300, or 3.8%, compared to
$9,131,600 for the year ended December 31, 2001. The decrease in consolidated
operating expenses was primarily due to our implementation of cost-cutting
measures, such as reducing our employee count from 104 as of December 31, 2001
to 96 as of December 31, 2002, and expenses relating to 2001 acquisitions that
were not incurred in 2002. The decrease in payroll in 2002 also resulted from a
bonus of $171,400 paid to certain officers in 2001 which did not recur in 2002.
Proceeds received by the officers for these bonuses in 2001 were used to repay
the officer notes receivable during 2001. Consolidated professional service
expense was reduced by $172,100 in 2002 compared to 2001. The Company also
experienced a lower level of bad debt write-offs in 2002. The consolidated bad
debt expense decreased from $450,500 in 2001 to $348,200 in 2002. The decrease
was also due to the write-offs of our investment in TargetFirst Inc. and Rising
Edge Technologies, Ltd. in 2001. During the year ended December 31, 2001, as
result of our ongoing evaluation of the net realizable value of our investments,
we wrote off our investments in TargetFirst Inc. and Rising Edge Technologies,
Ltd., resulting in an impairment loss of $250,000 and $468,000, respectively.
The decreases in consolidated operating expenses were partially offset by the
inclusion of operating expenses of $980,700 and $392,100 for Lea and
LiveWarehouse, respectively, for the year ended December 31, 2002. LiveMarket
was acquired in October 2001 and incurred an operating expense of $424,500 for
the three months ended December 31, 2001. LiveWarehouse was incorporated in
December 2001 and did not incur operating expenses in 2001. As a percentage of
consolidated sales, consolidated operating expenses was 12.5% for the year ended
December 31, 2002 compared to 12.2% for the year ended December 31, 2001. During
2002 the Company continued to implement its cost-cutting measures as the
consolidated sales declined.
-24-
PMI's operating expenses were $4,604,200 for the year ended December 31,
2002 compared to $5,448,800 for the year ended December 31, 2001. The decrease
of $844,600, or 15.5%, was mainly due to a decrease in our labor costs of
$652,500 and a decrease in our professional service expense of $112,500. PMI
also experienced a lower level of bad debt write-offs in 2002. The consolidated
bad debt expense decreased by $246,900 in 2002 compared to 2001.
PMIGA's operating expenses were $1,242,400 for the year ended December 31,
2002, a decrease of $42,900, or 3.3%, compared to $1,285,300 for the year ended
December 31, 2001. The decrease was mainly due to a decrease in our labor costs
of $167,500, which was partially offset by an increase in bad debt expense of
$104,300.
FNC's operating expenses were $1,566,900 for the year ended December 31,
2002, an increase of $180,600, or 13.0%, compared to $1,386,300 for the year
ended December 31, 2001. The increase in FNC's operating expenses was primarily
due to an increase in labor costs and rent expense of $107,400 and $27,100,
respectively, mainly as a result of our Technical Insights acquisition in the
fourth quarter 2001. The increase was partially offset by a decrease in
professional service expenses of $63,500.
Consolidated loss from operations for the year ended December 31, 2002 was
$4,176,000 as compared to $3,829,500 for the year ended December 31, 2001. As a
percentage of sales, loss from consolidated operations increased to 5.9% for the
year ended December 31, 2002, compared to 5.1% for the year ended December 31,
2001. This consolidated operating loss was mainly due to the 13.0% decrease in
consolidated operating expenses and the 6.2% decrease in consolidated sales
experienced during the year ended December 31, 2002. Loss from operations for
the year ended December 31, 2002, including allocations of PMIC corporate
expenses, for PMI, PMIGA, FNC, Lea, and LW was $1,337,300, $785,600, $1,135,900,
$751,100, and $166,100, respectively. Loss from operations for the year ended
December 31, 2001, including allocations of PMIC corporate expenses, for PMI,
PMIGA, FNC, and Lea was $1,416,700, $624,700, $878,400, and $191,700,
respectively. LW was not operating in 2001.
Consolidated interest income was $18,100 for the year ended December 31,
2002, compared to $125,100 for the year ended December 31, 2001. Interest income
for the year ended December 31, 2002 for PMI, PMIGA, and FNC was $13,500, $700,
and $3,900, respectively. Interest income for the year ended December 31, 2001
for PMI, PMIGA, and FNC was $85,500, $5,500, and $34,100, respectively. The
decrease in PMI's interest income was principally due to a decline in funds
available to earn interest and lower interest rates available for short-term
investments in cash and cash equivalents.
Consolidated interest expense for the year ended December 31, 2002 was
$183,700, a decrease of $72,100, or 28.2%, compared to $255,800 for the year
ended December 31, 2001. Interest expense for the year ended December 31, 2002
for PMI, PMIGA, FNC and LW was $164,400, $700, $17,600, and $1,000,
respectively. For the year ended December 31, 2001, interest expense for PMI,
PMIGA and FNC was $230,700, $600 and $24,500, respectively. LW was not operating
in 2001. This decrease in PMI's interest expense was due to a decrease in the
floating interest rate charged on our mortgage loans for our office building
located in Milpitas, California.
We reported income tax benefits of $1,322,300 for the year ended December
31, 2002 and $1,078,200 for the year ended December 31, 2001 arising from the
loss incurred in those years. In March 2002, the Job Creation and Worker
Assistance Act of 2002 ("the Act") was enacted. The Act extended the general
-25-
federal net operating loss carryback period from 2 years to 5 years for net
operating losses incurred for any taxable year ending in 2001 and 2002. As a
result, we did not record a valuation allowance on the portion of the deferred
tax assets relating to unutilized federal net operating loss of $1,906,800 for
the year ended December 31, 2001. On June 12, 2002, the Company received a
federal income tax refund of $1,034,700 attributable to 2001 net operating loss
carried back. The tax benefits recorded for 2002 primarily reflect potential
federal income tax refund attributable to the 2002 net operation loss carryback.
On March 20, 2003, the Company received a federal income tax refund of
$1,427,400.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Consolidated sales for the year ended December 31, 2001 were $75,011,700, a
decrease of $13,861,000, or approximately 15.6%, compared to $88,872,700 for the
year ended December 31, 2000.
Approximately $3,022,200 of the sales recognized by us for the year ended
December 31, 2001 was attributable to the FNC subsidiary, a decrease of
$5,083,300, or approximately 62.7%, compared to $8,105,500 for the year ended
December 31, 2000. The decrease in FNC sales was due to a weak U.S. economy
combined with a reduction of capital expenditures by our existing and potential
future customers. The Frontline division was spun off as a separate subsidiary
effective October 1, 2000 to better serve the networking and personal computer
requirements of corporate customers.
The combined sales of PMI and PMIGA, our computer products segments, were
$71,738,800 for the year ended December 31, 2001, a decrease of $9,028,400 or
approximately 11.2%, compared to $80,767,200 for the year ended December 31,
2000. Sales recognized by PMIGA, which commenced operations in October 2000,
were approximately $11,445,300 in 2001 as compared to $1,156,900 in 2000. Sales
for PMI decreased by $19,316,800, or 24.3% from $79,610,300 for the year ended
December 31, 2000 to $60,293,500 for the year ended December 31, 2001. The
decrease in PMI sales was due to the overall decline in the computer component
market and the lack of any new and innovative high-demand products in the
multimedia arena during a period of economic slowdown. In addition, we believe
that the continuous uncertainty regarding the economy depressed sales during
2001 as customers were delaying their buying decisions.
In the fourth quarter of 2001, PMICC acquired certain assets of an internet
software development company, LiveMarket. Subsequently, these assets were
transferred to Lea Publishing (Lea). During the last quarter of 2001,
Lea/LiveMarket generated $250,700 in revenue which related entirely to the
newly-acquired LiveMarket operations.
Consolidated gross margin for the year ended December 31, 2001 was
$5,302,100, a decrease of $1,749,900 or 24.8%, compared to $7,052,000 for the
year ended December 31, 2000. The consolidated gross margin as a percentage of
consolidated sales decreased from 7.9% for the year ended December 31, 2000 to
7.1% for the year ended December 31, 2001.
Gross margin relating to FNC for the year ended December 31, 2001 was
$391,800, or 13% of FNC's sales during the same period as compared to $962,700,
or 12% of FNC's sales during the year ended December 31, 2000. The slightly
higher gross margin percentage experienced by FNC in 2001 was attributed to more
service revenues earned as a percent of total sales in 2001 compared to 2000.
FNC's service revenues were $115,000, or 3.8% of FNC's total revenues in 2001 as
compared to $275,400, or 3.4% of FNC's total revenues in 2000. In general, FNC
-26-
has a higher gross margin on service revenues than products sales as part of the
consulting and implementation services. Since FNC's sales levels accounted for
only 4% and 9% of our consolidated sales in 2001 and 2000, respectively, the
gross margin percentage earned by FNC had only a minor effect on our overall
consolidated gross margin in both years.
The combined gross margin for PMI and PMIGA, our computer products
segments, was $4,687,000, or 6.5% for the year ended December 31, 2001 compared
to $5,917,800, or 7.3% of the combined sales of PMI and PMIGA, for the year
ended December 31, 2000. PMI's gross margin for the year ended in December 31,
2001 was $4,066,400, or 6.7% of PMI's sales compared to $5,858,900 or 7.4% of
PMI's sales, for the year ended December 31, 2000. Because our major
manufacturers focused on lower margin products, PMI sold more lower margin
products during 2001. Additionally, PMI experienced pricing pressures in selling
its products. We believe that because of the economic slowdown, there was an
excess supply of computer products throughout 2001 which reduced demand and
increased pressure on gross margins. Thirdly, vendors also reduced rebates and
product advertising funding to minimize their costs. Finally the lower gross
margin is further compounded by an increase in freight costs. Gross margin
relating to PMIGA in 2001 was $620,600, or 5.4% of PMIGA's sales as compared to
year 2000 gross margin percentage in the amount of $58,900 or 5.1% of PMIGA's
sales. The increase in PMIGA 2001 gross margin was due to more products with
higher margin being sold in 2001.
Lea experienced a gross margin of $214,900, or 85.7% of Lea's sales in
2001.
Consolidated operating expenses, including selling, general,
administrative, and research and development expense, for the year ended
December 31, 2001 were $9,131,600, an increase of $2,089,800, or 29.7%, compared
to $7,041,800 for the year ended December 31, 2000. Although we implemented cost
cutting measures in anticipation of the economic slowdown, such as reducing our
employee count from 114 as of December 31, 2000 to 104 as of December 31, 2001,
expenses increased primarily due to the continued establishment of our FNC and
PMIGA operations, including among other things, additional expenses associated
with our new distribution facility in Georgia. During 2001, we also increased
spending for consulting and accounting services to assist in the formation of an
acquisition strategy. Consolidated consulting and accounting expenses were
$217,000 and $115,400, in 2001 and 2000, respectively. During 2001, we had a
higher level of bad debt write-offs and increased the allowance for doubtful
accounts. As such, the consolidated bad debt expense increased from $182,200 in
2000 to $450,500 in 2001. During the year ended December 31, 2001, as a result
of our ongoing evaluation of the net realized value of our investments in
TargetFirst Inc. and Rising Edge Technologies, Ltd, we wrote off these
investments resulting in an impairment loss of $250,000 and $468,000,
respectively. We also increased our advertising spending for promoting our
Company, products and services. Consolidated advertising expense was $178,000 in
2001 compared to $3,600 in 2000. Additionally, $171,400 in officer bonuses was
paid in 2001. Proceeds received by the officers for these bonuses were used to
repay the officer notes receivable during 2001. There were no officer bonuses in
2000. As a percentage of consolidated sales, consolidated operating expenses
increased to 12.2% for the year ended December 31, 2001 as compared to 7.9% for
the year ended December 31, 2000 resulting from an increase in our consolidated
fixed operating expenses during a period of decreased sales.
PMI's operating expenses were $5,448,800 for the year ended December 31,
2001, compared to $5,608,700 for the year ended December 31, 2000, a decrease of
$159,900, or 2.9%. The decrease in PMI's operating expenses was primarily due to
the reduction in payroll expense of $368,900, a cost reduction of $129,900 in
professional services, and was partially offset by an increase in bad debt
-27-
expense of $206,800 and repair and maintenance and internet service expense of
$132,100. PMIGA's operating expenses were $1,285,300 for the year ended December
31, 2001. PMIGA began business in October 2000 and its operating expenses for
the three months in 2000 were $197,000.
FNC's operating expenses for the year ended December 31, 2001 were
$1,386,400 compared to $1,105,200 for the year ended December 31, 2000. The
increase in FNC's operating expenses was primarily due to an increase in payroll
expense, from our Technical Insights acquisition, of $108,600, professional
services expense of $73,500, and insurance expense of $24,200. Although FNC had
14 employees as of December 31, 2001 compared to 15 as of December 31, 2000, FNC
recruited and retained employees with higher qualifications in 2001. The
increase in FNC's professional services expense in 2001 was due to the increase
in the search for acquisition opportunities.
Lea's newly-acquired LiveMarket operations began in October 2001. Operating
expenses were $424,500, including research and development expense of $68,500,
for the three months in 2001. Lea's research and development expense for the
year ended December 31, 2000 was $100,000.
As a result of an ongoing evaluation of the net realizable value of its
investments, PMIC recognized an impairment loss totaling $718,000 during 2001,
of which $250,000 related to the cost investment in Target First and was
recorded in the second quarter and $468,000 (including the equity in the loss in
the investment of $14,500 during 2001) related to the equity investment in
Rising Edge and was recorded in the fourth quarter. These impairment losses were
due to a change in the focus of the investees' business and current period
operating losses combined with a projection of the future continuing losses on
those investments.
Consolidated loss from operations for the year ended December 31, 2001 was
$3,829,500 as compared to consolidated income from operations of $10,200 for the
year ended December 31, 2000. As a percentage of sales, loss from consolidated
operations increased to 5.1% for the year ended December 31, 2001 as compared to
0.0% of consolidated income from operations for the year ended December 31,
2000. This consolidated operating loss was mainly due to the 28.7% increase in
consolidated operating expenses and the 15.6% decrease in consolidated sales
experienced during the year ended December 31, 2001. Loss from operations for
the year ended December 31, 2001, including allocations of PMIC corporate
expenses, for PMI, PMIGA, FNC, and Lea was $1,416,700, $624,700, $878,400, and
$191,700, respectively. For the year ended December 31, 2000, PMI and FNC had an
income from operations of $390,400 and $56,300, respectively, and PMIGA and Lea
had an operating loss of $137,800 and $100,800, respectively.
Consolidated interest income was $125,100 for the year ended December 31,
2001 compared to $227,300 for the year ended December 31, 2000. Interest income
for the year ended December 31, 2001 for PMI, PMIGA, and FNC was $85,500,
$5,500, and $34,100, respectively. For the year ended December 31, 2000, PMI,
PMIGA and FNC had interest income of $226,800, $500 and $0, respectively. The
decrease in PMI's interest income was principally due to a decline in funds
available to earn interest and lower interest rates available for short-term
investments in cash and cash equivalents.
Consolidated interest expense for the year ended December 31, 2001 was
$255,800, a decrease of $40,200 or 13.6%, compared to $296,000 for the year
ended December 31, 2000. Interest expense for the year ended December 31, 2001
for PMI, PMIGA, and FNC was $230,700, $600, and $24,500, respectively. For the
year ended December 31, 2000, interest expense for PMI, PMIGA and FNC was
-28-
$295,000, $200 and $0, respectively. This decrease in PMI's interest expense was
due to a decrease in the floating interest rate charged on our mortgages on our
office building facility located in Milpitas, California and the allocation of
$24,500 of interest expense to FNC for the year ended December 31, 2001.
In March 2002, legislation was enacted to extend the general Federal net
operating loss carryback period from 2 years to 5 years for net operating losses
incurred in 2001 and 2002. As a result, we did not record a valuation allowance
on the portion of the deferred tax assets relating to Federal net operating loss
carryforward of $1,906,800 as we believed that it was more likely than not that
this deferred tax asset will be realized as of December 31, 2001.
UNAUDITED QUARTERLY FINANCIAL DATA
Summarized quarterly financial data for 2002 and 2001 is as follows:
2002 (2) Quarter
------------------------------------------------------------
First Second Third Fourth
------------ ------------ ------------ ------------
Sales $ 17,632,300 $ 15,377,800 $ 18,231,100 $ 19,087,500
Gross Profit 1,311,700 1,143,800 1,052,100 1,102,700
Net Loss (736,300) (815,600) (715,900) (567,300)
Accretion and deemed dividend related to
beneficial conversion of convertible
preferred stock -- (262,000) (6,100) (6,100)
Net (loss) applicable to Common
Shareholders (736,300) (1,077,600) (722,000) (573,400)
Basic and diluted (loss) per common share (1) (0.07) (0.10) (0.07) (0.05)
2001 Quarter
------------------------------------------------------------
First Second Third Fourth
------------ ------------ ------------ ------------
Sales $ 19,956,500 $ 14,961,400 $ 20,840,200 $ 19,253,600
Gross Profit 1,380,000 979,700 1,465,200 1,597,600
Net Loss (473,600) (1,211,800) (370,000) (795,300)
Basic and diluted (loss) per common share (1) (0.05) (0.12) (0.04) (0.08)
(1) (Loss) per share are computed independently for each of the quarters
presented. The sum of the quarterly loss per share in 2002 and 2001 does
not equal the total computed for the year due to rounding.
(2) Certain amounts reported in our previously filed Form 10-Q's were restated.
The restated financial information is included in our Form 10-Q/A's for the
quarters ended June 30, 2002 and September 30, 2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company incurred a net loss of $2,835,900 and a net loss applicable to
common shareholders of $3,110,100 for the year ended December 31, 2002. The
Company also incurred a net loss applicable to common shareholders of $2,850,700
for the year ended December 31, 2001. These recurring losses combined with
existing levels of working capital and existing commitments raise substantial
doubt about the Company's ability to continue as a going concern. The Company's
ability to continue as a going concern is dependent upon its ability to achieve
profitability and generate sufficient cash flows to meet its obligations as they
come due, which management believes it will be able to do. In addition,
management has continued to implement cost-cutting measures to reduce overhead
at all of its subsidiaries with a goal to achieve profitability. The Company is
also exploring the possibility of obtaining additional debt financing. However,
there is no assurance that these efforts will be successful.
As described below, the Company's Flooring line with Transamerica has been
terminated and all amounts owed under that line are due and payable on April 7,
2003. If we are unable to replace this line, we will have to pay such amounts
out of currently available assets including a recently received tax refund of
$1,427,400 and a possible refinancing of the Company's headquarters building. If
we fail to downsize in a timely manner or if we fail to replace the flooring
line, we will not have sufficient liquidity to operate for Fiscal 2003.
At December 31, 2002, the Company had consolidated cash and cash equivalents of
$1,901,100 (excluding $250,000 in restricted cash) and working capital of
$3,112,700. At December 31, 2001, we had consolidated cash and cash equivalents
totaling $3,110,000 and working capital of $5,734,900.
-29-
Net cash used in operating activities for the year ended December 31, 2002 was
$898,000, which principally reflected the net loss of $2,835,900 incurred during
the year, an increase in accounts receivable of $439,000, inventories of
$418,500, and income taxes refunds receivable of $1,073,600, which was partially
offset by a decrease in deferred income taxes of $778,800 and an increase in
accounts payable of $2,995,200.
Net cash used in investing activities was $89,100 for the year ended December
31, 2002, primarily resulting from the payment for acquisition of equipment and
property of $126,200 and an increase in deposits and other assets of $24,000,
which were partially offset by the proceeds of $61,100 received from sales of
equipment.
Net cash used in financing activities was $221,800 for the year ended December
31, 2002, primarily resulting from the decrease in floor plan inventory loans of
$643,400 and principal repayment of $55,900 on notes payable, which were offset
by the proceeds of $477,500 from issuance of redeemable convertible preferred
stock.
On July 13, 2001, PMI and PMIGA (the Companies) obtained a $4 million (subject
to credit and borrowing base limitations) accounts receivable and inventory
financing facility from Transamerica Commercial Finance Corporation
(Transamerica). This credit facility has a term of two years, subject to
automatic renewal from year to year thereafter. The credit facility can be
terminated under certain conditions and the termination is subject to a fee of
1% of the credit limit. The facility includes an up to $3 million inventory line
(subject to a borrowing base of up to 85% of eligible accounts receivable plus
up to $1,500,000 of eligible inventories), that includes a sub-limit of $600,000
working capital line, and a $1 million letter of credit facility used as
security for inventory purchased on terms from vendors in Taiwan. Borrowing
under the inventory loans is subject to 30 to 45 days repayment, at which time
interest begins to accrue at the prime rate, which was 4.25% at December 31,
2002. Draws on the working capital line also accrue interest at the prime rate.
The credit facility is guaranteed by both PMIC and FNC available capacity.
Under the accounts receivable and inventory financing facility from
Transamerica, the Companies are required to maintain certain financial
covenants. As of December 31, 2001, the Companies were in violation of the
minimum tangible net worth covenant. On March 6, 2002, Transamerica issued a
waiver of the default retroactively to September 30, 2001 and revised the
covenants under the credit agreement. The revised covenants require the
Companies to maintain certain financial ratios and to achieve certain levels of
profitability. As of December 31, 2001 and March 31, 2002, the Companies were in
compliance with these revised covenants. As of June 30, 2002, the Companies did
not meet the revised minimum tangible net worth and profitability covenants,
giving Transamerica, among other things, the right to call the loan and
immediately terminate the credit facility.
On October 23, 2002, Transamerica issued a waiver of the default occurring on
June 30, 2002 and revised the terms and covenants under the credit agreement.
Under the revised terms, the credit facility includes FNC as an additional
borrower and PMIC continues as a guarantor. Effective October 2002, the new
credit limit was $3 million in aggregate for inventory loans and the letter of
credit facility. The letter of credit facility is limited to $1 million. The
credit limits for PMI and FNC are $1,750,000 and $250,000, respectively. As of
December 31, 2002 and September 30, 2002, the Companies did not meet the
covenants as revised on October 23, 2002 relating to profitability and tangible
-30-
net worth. This constituted a technical default and gave Transamerica, among
other things, the right to call the loan and immediately terminate the credit
facility.
On January 7, 2003, Transamerica elected to terminate the credit facility
effective April 7, 2003. However, Transamerica will continue its guarantee of
the letter of credit facility through July 25, 2003. Unless the Companies do not
perform their obligations in accordance with the agreement and the Indebtedness
to tangible net worth covenant is materially worse than the condition at the
level on January 7, 2003, Transamerica will continue to accept payments
according to the terms of the agreement prior to April 7, 2003. The remaining
outstanding balance is due and payable in full on April 7, 2003. As of December
31, 2002, the Companies had an outstanding balance of $901,600 due under this
credit facility. The Company is in the process of seeking a replacement for the
Transamerica Flooring line with a similar line from Textron Financial. However,
the Company cannot assure you that it will be able to either secure the line or
maintain it if we continue to incur operating losses.
Pursuant to one of our bank mortgage loans with a $2,387,500 balance at December
31, 2002, we are required to maintain a minimum debt service coverage, a maximum
debt to tangible net worth ratio, no consecutive quarterly losses, and to
achieve net income on an annual basis. During 2002 and 2001, the Company was in
violation of two of these covenants which constituted an event of default under
the loan agreement and gives the bank the right to call the loan. A waiver of
these loan covenant violations was obtained from the bank in March 2002,
retroactive to September 30, 2001, and through December 31, 2002. In March 2003,
the bank extended the waiver through December 31, 2003. As a condition for this
waiver, the Company transferred $250,000 to a restricted account as a reserve
for debt servicing. This amount has been reflected as restricted cash in the
accompanying consolidated financial statements.
On May 31, 2002 we received net proceeds of $477,500 from the issuance of 600
shares of 4% Series A Preferred Stock. An additional 400 shares can be issued
after the completion of the required registration of the underlying common
stock. Even though we completed the required registration of the underlying
common stock in October 2002, there is no assurance that the remaining 400
shares will be sold or that we will be able to obtain additional capital beyond
the issuance of the 1,000 shares of Preferred stock. Upon the occurrence of a
Triggering Event, such as if the Company were a party in a "Change of Control
Transaction," among others, as defined, the holder of the preferred stock has
the rights to require us to redeem its preferred stock in cash at a minimum of
1.5 times the Stated Value. As of December 31, 2002, the redemption value of the
Series A Preferred Stock, if the holder had required us to redeem the Series A
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Preferred Stock as of that date, was $921,300. Even though we do not expect that
a Triggering Event will occur, there is no assurance that one will not occur. In
the event we are required to redeem our Series A Preferred Stock in cash, we
might experience a reduction in our ability to operate the business at its
current level.
We are actively seeking additional capital to augment our working capital and to
finance our business. However, there is no assurance that we can obtain such
capital, or if we can obtain capital that it will be on terms that are
acceptable to us.
The Company's common stock is currently traded on the Nasdaq SmallCap Market. On
August 19, 2002 the Company received a letter from the Nasdaq Stock Market
informing it that the Company's common stock did not meet the criteria for
continued listing on the Nasdaq SmallCap Market. The letter stated that Nasdaq
will monitor the Company's common stock and if it closes above $1.00 for a
minimum of ten consecutive trading days, Nasdaq will notify the Company of its
compliance with the continued listing standards. The Company has also been
notified by Nasdaq that it does not comply with the Marketplace Rule that
requires a minimum bid price of $1.00 per share of common stock. The Company
have until August 18, 2003 to comply with this Rule.
On February 28, 2003, Nasdaq notified the Company that its common stock had
failed to comply with the minimum market value of publicly held shares
requirement of the Nasdaq Marketplace Rules. The Company's common stock is,
therefore, subject to delisting from the Nasdaq SmallCap Market. On March 6,
2003 the Company requested a hearing before a Listing Qualifications Panel, at
which it will seek continued listing. The hearing has been scheduled on April
24, 2003. The Company intends to detail its plan to comply with both Rules at
the hearing referred to above. There can be no assurance that the Panel will
grant the Company's request for continued listing. If the Company's common stock
is delisted, it would seek to have its common stock traded on the OTC Bulletin
Board. In such case, the market for the Company's common stock will not be as
broad as if it were traded on the Nasdaq SmallCap Market and it will be more
difficult to trade in the Company's common stock, which will likely cause a
decrease in its price.
FUTURE CONTRACTUAL OBLIGATIONS
The Company leases office space, equipment, and vehicles under various operating
leases. The leases for office space provide for the payment of common area
maintenance fees and the Company's share of any increases in insurance and
property taxes over the lease term.
Future minimum obligations under these non-cancelable operating leases are as
follows:
YEAR ENDING DECEMBER 31, Amount
------------------------ --------
2003 $132,700
2004 31,800
2005 26,300
2006 2,000
--------
$192,800
========
Total rent expense associated with all operating leases for the years ended
December 31, 2002, 2001 and 2000 was $232,100, $136,000, and $16,700,
respectively.
RELATED PARTY TRANSACTIONS
At December 31, 1999, the Company had unsecured notes receivable from two
officer/shareholders with interest at 6%. In December 2000, the repayment terms
of these notes were renegotiated to require monthly principal payments, without
interest, to pay off the loan by December 31, 2001. Additionally, accrued
interest receivable of $43,600 pertaining to these notes as of December 31,
1999, was forgiven by the Company and charged to expense during 2000. As of
December 31, 2000, notes receivable from these two officer/shareholders
aggregated $171,400 and were repaid in full during 2001.
The Company sold computer products to a company owned by a member of the
Board of Directors and Audit Committee of the Company. Management believes that
the terms of these sales transactions are no more favorable than those given to
unrelated customers. During 2002, 2001 and 2000, the Company recognized
$527,400, $476,200, and $1,476,100 in sales revenues from this company. Included
in accounts receivable as of December 31, 2002 and 2001 is $27,000 and $200,
respectively, due from this related customer.
In 2001 FNC acquired certain assets of Technical Insights in exchange for
16,100 shares of PMIC common stock. Under the purchase agreement, among other
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terms, FNC was required to pay $126,000 to the sellers upon completion and full
settlement of a sale transaction as specified in the agreement. On October 2001
the sellers became employees of FNC. As a result of this profit sharing
arrangement, the $126,000 payment due to the sellers was recorded as
compensation expense by the Company. In January 2002, this balance was paid to
the sellers/employees under the terms of the purchase agreement.
Prior to June 13, 2000, the Company and Rising Edge each owned a 50%
interest in Lea Publishing, LLC. The brother of a director, officer, and
principal shareholder of the Company is a director, officer and the majority
shareholder of Rising Edge. See Note 15 in the consolidated financial statements
for a description of the related party transactions between the Company and
Rising Edge.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board finalized SFAS No.
141, BUSINESS COMBINATIONS, and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS.
SFAS No. 141 requires the use of the purchase method of accounting and prohibits
the use of the pooling-of-interests method of accounting for business
combinations initiated after June 30, 2001. SFAS No. 141 also requires that the
Company recognize acquired intangible assets apart from goodwill if the acquired
intangible assets meet certain criteria. SFAS No. 141 applies to all business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, upon adoption
of SFAS No. 142 that the Company reclassify the carrying amounts of intangible
assets and goodwill based on the criteria in SFAS No. 141. The Company recorded
its acquisition of Technical Insights and LiveMarket in September and October
2001 in accordance with SFAS No. 141 and did not recognize any goodwill relating
to these transactions. However, certain intangibles totaling $59,400, including
intellectual property and vendor reseller agreements, were identified and
recorded in the consolidated financial statements in deposits and other assets.
These intangible assets are being amortized over a 3-year period using the
straight-line method. As of December 31, 2002, a total of $24,300 has been
amortized.
SFAS No. 142 requires, among other things, that companies no longer
amortize goodwill, but instead test goodwill for impairment at least annually.
In addition, SFAS No. 142 requires that the Company identify reporting units for
the purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
were initially recognized. SFAS No. 142 requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption. The
Company is also required to reassess the useful lives of other intangible assets
within the first interim quarter after adoption of SFAS No. 142. The adoption of
SFAS No. 142 did not have a material effect on the Company's financial position,
results of operations or cash flows.
In August 2001, the FASB issued SFAS No. 143 Accounting for Obligations
associated with the Retirement of Long-Lived Assets. SFAS No. 143 addresses
financial accounting and reporting for the retirement obligation of an asset.
SFAS No. 143 states that companies should recognize the asset retirement cost,
at its fair value, as part of the asset cost and classify the accrued amount as
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a liability in the balance sheet. The asset retirement liability is then
accreted to the ultimate payout as interest expense. The initial measurement of
the liability would be subsequently updated for revised estimates of the
discounted cash outflows. SFAS No. 143 was effective for fiscal years beginning
after June 15, 2002. The Company believes the adoption of SFAS No. 143 will not
have a material effect on the Company's financial position, results of
operations, or cash flows.
In October 2001, the FASB issued SFAS No. 144 Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 supersedes the SFAS No. 121 by
requiring that one accounting model to be used for long-lived assets to be
disposed of by sale, whether previously held and used or newly acquired, and by
broadening the presentation of discontinued operation to include more disposal
transactions. SFAS No. 144 was effective for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 144 did not have a material effect
on the Company's financial position, results of operations, or cash flows.
SFAS No. 145, "Rescission of SFAS Statements No. 4, 44, and 64, Amendment
of SFAS Statement No. 13, and Technical Corrections" ("SFAS 145"), updates,
clarifies and simplifies existing accounting pronouncements. SFAS 145 rescinds
SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt." SFAS 145
amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. The provisions of SFAS 145 related to
SFAS No. 4 and SFAS No. 13 are effective for fiscal years beginning and
transactions occurring after May 15, 2002, respectively. The adoption of SFAS
No. 145 did not have a material effect on it's the Company's financial position,
results of operations, or cash flows.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," (SFAS 146), requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS 146 replaces Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of SFAS 146 are to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company does not expect the adoption of
SFAS No. 146 to have a material effect on its financial position, results of
operations, or cash flows.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires a guarantor to
(i) include disclosure of certain obligations and (ii) if applicable, at the
inception of the guarantee, recognize a liability for the fair value of other
certain obligations undertaken in issuing a guarantee. The disclosure provisions
of the Interpretation are effective for financial statements of interim or
annual reports that end after December 15, 2002. The adoption of FIN 45 had no
impact on the Company's disclosures as of December 31, 2002. The recognition and
measurement provisions of FIN 45 are effective for guarantees issued or modified
after December 29, 2002. The Company does not expect FIN 45 to have a material
effect on the Company's financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure--an Amendment of FASB Statement No. 123.
SFAS No. 148 amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for an entity that
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chooses to change to the fair-value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
statement to require prominent disclosure about the effects that accounting for
stock-based employee compensation using the fair-value-based method would have
on reported net income and earnings per share and to require prominent
disclosure about the entity's accounting policy decisions with respect to
stock-based employee compensation. Certain of the disclosure requirements are
required for all companies, regardless of whether the fair value method or
intrinsic value method is used to account for stock-based employee compensation
arrangements. The Company accounts for its stock option plan in accordance with
the recognition and measurement principles of Accounting Principles Opinion No.
25, Accounting for Stock Issued to Employees. The amendments to SFAS No. 123 are
effective for financial statements for fiscal years ended after December 15,
2002 and for interim periods beginning after December 15, 2002. The adoption of
the disclosure requirements of SFAS No. 148 did not have a material effect on
the Company's financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). This interpretation of Accounting Research
Bulletin No. 51, Consolidated Financial Statements, addresses consolidation by
business enterprises of variable interest entities. Under current practice,
enterprises generally have been included in the consolidated financial
statements of another enterprise because the one enterprise controls the others
through voting interests. FIN 46 defines the concept of "variable interests" and
requires existing unconsolidated variable interest entities to be consolidated
into the financial statements of their primary beneficiaries if the variable
interest entities do not effectively disperse risks among the parties involved.
This interpretation applies immediately to variable interest entities created
after January 31, 2003. It applies in the first fiscal year or interim period
beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
If it is reasonably possible that an enterprise will consolidate or disclose
information about a variable interest entity when FIN 46 becomes effective, the
enterprise must disclose information about those entities in all financial
statements issued after January 31, 2003. The interpretation may be applied
prospectively with a cumulative-effect adjustment as of the date on which it is
first applied or by restating previously issued financial statements for one or
more years, with a cumulative-effect adjustment as of the beginning of the first
year restated. The Company does not expect the adoption of FIN 46 to have a
material effect on its consolidated financial statements.
INFLATION
Inflation has not had a material effect upon our results of operations to
date. In the event the rate of inflation should accelerate in the future, it is
expected that to the extent resulting increased costs are not offset by
increased revenues, our operations may be adversely affected.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to one of our bank loans with a $2,387,500 balance at December 31, 2002 which
bears fluctuating interest based on the bank's 90-day LIBOR rate. We believe
that fluctuations in interest rates in the near term would not materially affect
our consolidated operating results, financial position or cash flow. We are not
exposed to material risk based on exchange rate fluctuation or commodity price
fluctuation.
-35-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This information appears in a separate section of this report following
Part IV.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
On December 20, 2002, the Company's board of directors passed a resolution
dismissing BDO Seidman, LLP ("BDO") as its independent accountant for the fiscal
year ended December 31, 2002. On the same date, the Company appointed KPMG LLP
("KPMG") to replace BDO as the Company's independent auditor for the current
fiscal year.
The report of BDO for the fiscal years ended December 31, 2000 and 2001
contained no adverse opinions, disclaimer of opinion or qualification or
modification as to uncertainty, audit scope or accounting principles.
Except for the disagreement discussed below, during the Company's two most
recent fiscal years and subsequent interim periods through the date of
dismissal, December 20, 2002, there were no other disagreements with BDO
Seidman, LLP on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedures or any other matters
considered reportable events as contemplated by Regulation S-K 304 (a)(1)(iv)(A)
and (B).
In accounting for the issuance of its preferred stock in May 2002, the
Company recorded a deemed dividend of $303,000 associated with the beneficial
conversion feature as a charge against retained earnings and an increase in
Additional Paid-in Capital. BDO reviewed the Company's Form 10-Q for the quarter
ended June 30, 2002, and advised the Company that an additional deemed dividend
of $148,300 associated with 300,000 common stock warrants issued to the investor
should be recorded as a charge against retained earnings and an increase in the
carrying amount of preferred stock. After further research and consultation with
BDO, the Company agreed to record this additional deemed dividend. However, the
Company's management believed it was proper to increase Additional Paid-in
Capital for both of these deemed dividends and reflected such presentation in
the Company's Form 10-Q for the quarter ended June 30, 2002. BDO reviewed the
Company's Form 10-Q for the quarter ended September 30, 2002, and at the
conclusion of further research and consultation, advised the Company that the
$148,300 deemed dividend relating to the common stock warrants issued to the
investor should be reclassified from Additional Paid-in Capital to the carrying
amount of the preferred stock. Management did not concur with the proposed
reclassification. BDO discussed the basis for their position, and the proposed
adjustment with the Chairman of the Audit Committee on November 7, 2002. On
November 12, 2002, after discussion of the above matter with BDO, the Audit
Committee Chairman recommended that the Company not reclassify this deemed
dividend to the carrying amount of the preferred stock until the Audit Committee
could analyze the issue closely during the fourth quarter of 2002. On November
13, 2002, BDO notified the Audit Committee Chairman and management of the
Company that there was an unresolved reportable disagreement regarding the
accounting treatment of this deemed dividend. On November 14, 2002 BDO had a
telephone conversation with the Company's outside counsel to discuss the issue.
Following that conversation, the Company elected to reclassify the credit
associated with the deemed dividend to the preferred stock in accordance with
the advice of BDO.
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The Company did not consult with KPMG during the fiscal years ended
December 31, 2000 and 2001, and the interim period from January 1, 2002 through
December 20, 2002, on any matter which was the subject of any disagreement,
including the disagreement reported herein, or any reportable event or on the
application of accounting principles to a specified transaction, either
completed or proposed. Further, the Company has consented to the free
consultation of KPMG with BDO, including the disagreement with management noted
above and other matters.
PART III
The information required to be presented in Part III is, in accordance with
General Instruction G(3) to Form 10-K, incorporated herein by reference to the
information contained in our definitive Proxy Statement for our 2003 Annual
Meeting which will be filed with the Securities and Exchange Commission not
later than 120 days after December 31, 2002.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation
was carried out under the supervision and with the participation of our
management, including our Chief Executive Officer/Chief Financial Officer, of
the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of
1934). Based upon that evaluation, our Chief Executive Officer/Chief Financial
Officer concluded that the design and operation of these disclosure controls and
procedures were effective.
No significant changes were made in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Financial Statements
(a) (1) Report of KPMG, LLP and report of BDO Seidman, LLP
(2) Consolidated Financial Statements and Notes thereto of the
Company including Consolidated Balance Sheets as of December 31, 2002 and 2001
and related Consolidated Statements of Operations, Shareholders' Equity, and
Cash Flows for each of the years in the three year period ended December 31,
2002.
(b) Reports on Form 8-K
(1) Form 8-K filed on March 7, 2003 to report that the Company issued
a press release announcing that Nasdaq informed us that our shares would be
subject to delisting from the SmallCap Market for failure to comply with
Nasdaq's Marketplace Rules regarding minimum value of publicly held shares and
minimum bid price per share. The delisting has been suspended until a hearing is
held on these matters.
(2) Form 8-K filed on December 24, 2002 to report that the Company's board
of directors passed a resolution dismissing BDO Seidman, LLP as our independent
accountant for the fiscal year ended December 31, 2002, and to report that the
Company appointed KPMG LLP to replace BDO Seidman, LLP as our independent
auditor for the current fiscal year. The Form 8-K also discussed a disagreement
between the Company and BDO Seidman, LLP.
(3) Form 8-K filed on June 13, 2002 to report that the Company
completed a private placement of $1 million of its Series A Convertible
Preferred Stock and a warrant exercisable to purchase 300,000 shares of common
stock with Stonestreet L.P., a private Canadian based investor, as of May 31,
2002.
(c) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Stock Purchase Agreement, dated July 17, 1998, by and between
Pacific Magtron, Inc., the Shareholders of Pacific Magtron, Inc.,
and Wildfire Capital Corporation (filed as an exhibit to our Form
10-12G, File No. 000-25277).
3.1 Articles of Incorporation, as Amended and Restated (filed as an
exhibit to our Form 10-12G, File No. 000-25277).
3.2 Bylaws, as Amended and Restated (filed as an exhibit to our Form
10-12G, File No. 000-25277).
10.1 1998 Stock Option Plan (filed as an exhibit to our Form 10-12G,
File No. 000-25277).
10.2 Sony Electronics Inc. Value Added Reseller Agreement, dated May
1, 1996 (filed as an exhibit to our Form 10-12G, File No.
000-25277).
-38-
10.3 Logitech, Inc. Distribution and Installation Agreement, dated
March 26, 1997 (filed as an et our Form 10-12G, File No.
000-25277).
10.4 Wells Fargo Term Note, dated February 4, 1997 (filed as an
exhibit to our Form 10-12G, File No. 000-25277).
10.5 Limited Liability Company Operating Agreement for Lea Publishing
L.L.C. dated February 1, 1999 between Pacific Magtron
International Corp. and Rising Edge Technology (filed as an
exhibit to our Report on Form 10-K for fiscal year ended December
31, 2000).
10.6 Accounts Receivable and Inventory Financing Agreement between
Transamerica Commercial Finance Corporation, Pacific Magtron,
Inc. and Pacific Magtron (GA), Inc. dated July 13, 2001 (filed as
an exhibit to our Report on Form 10-Q for quarter ended June 30,
2001).
10.7 Amendment No. 2 to Accounts Receivable and Inventory Financing
Agreement by and between Transamerica Commercial Finance
Corporation and Pacific Magtron, Inc. and Pacific Magtron (GA),
Inc. (filed herewith).
10.8 Amendment No. 1 to Accounts Receivable and Inventory Financing
Agreement by and between Transamerica Commercial Finance
Corporation and Pacific Magtron, Inc. and Pacific Magtron (GA),
Inc. (filed herewith).
21.1 Subsidiaries (filed herewith).
23.1 Consent of KPMG LLP (filed herewith).
23.2 Consent of BDO Seidman, LLP (filed herewith)
99.1 Sarbanes-Oxley Certification
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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 on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, this 31st
day of March, 2003.
PACIFIC MAGTRON INTERNATIONAL CORP.,
a Nevada corporation
BY /s/ Theodore S. Li
-------------------------------------
THEODORE S. LI
President and Chief Financial Officer
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Pursuant to the requirements of the Securities Exchange Act of 1934, this
report on Form 10-K has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Theodore S. Li President, Chief Executive March 31, 2003
------------------------------ Officer Treasurer and
THEODORE S. LI Director
/s/ Hui Cynthia Lee Director and Secretary March 31, 2003
------------------------------
HUI CYNTHIA LEE
/s/ Jey Hsin Yao Director March 31, 2003
------------------------------
JEY HSIN YAO
/s/ Hank C. Ta Director March 31, 2003
------------------------------
HANK C. TA
/s/ Limin Hu, Ph.D Director March 31, 2003
------------------------------
LIMIN HU, Ph.D.
/s/ Raymond Crouse Director March 31, 2003
------------------------------
RAYMOND CROUSE
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CERTIFICATION
I, Theodore Li, certify that:
1. I have reviewed this annual report on Form 10-K of Pacific Magtron
International Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
By: /s/ Theodore S. Li Date: March 31, 2003
------------------------------
Theodore S. Li, Chief Executive
Officer/Chief Financial Officer
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
CONTENTS
INDEPENDENT AUDITORS' REPORT F-2
REPORT OF BDO SEIDMAN LLP, INDEPENDENT AUDITORS F-3
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets F-4
Consolidated statements of operations F-6
Consolidated statements of shareholders' equity F-7
Consolidated statements of cash flows F-8
Notes to consolidated financial statements F-9
SUPPLEMENTAL SCHEDULE
Schedule II - Valuation and Qualifying Accounts F-27
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Pacific Magtron International Corp.
We have audited the accompanying consolidated balance sheet of Pacific Magtron
International Corp. and subsidiaries as of December 31, 2002, and the related
consolidated statements of operations, shareholders' equity and cash flows for
the year then ended. In connection with our audit of the consolidated financial
statements, we have also audited the 2002 financial information in the related
financial statement schedule. These consolidated financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and the financial statement schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pacific Magtron
International Corp. and subsidiaries as of December 31, 2002, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion the 2002 financial information in the related financial statement
schedule, when considered in relation to the consolidated financial statements
taken as a whole, presents fairly, in all material respects, the information set
forth therein.
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
consolidated financial statements, the Company has suffered recurring losses
from operations. This matter raises substantial doubt about its ability to
continue as a going concern. Management's plans in regard to this matter is also
described in Note 1. The accompanying consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
/s/ KPMG LLP
Mountain View, California
February 21, 2002
F-2
REPORT OF BDO SEIDMAN LLC, INDEPENDENT AUDITORS
To the Board of Directors and Shareholders Pacific Magtron International Corp.
We have audited the accompanying consolidated balance sheet of Pacific Magtron
International Corp. and subsidiaries (the Company) as of December 31, 2001, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the years in the two-year period ended December 31, 2001.
We have also audited Schedule II - Valuation and Qualifying Accounts for the
years ended December 31, 2001 and 2000. These consolidated financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform our audits to obtain reasonable assurance about whether the consolidated
financial statements and schedule are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements and schedule. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement and schedule
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Pacific
Magtron International Corp. and subsidiaries as of December 31, 2001, and the
results of their operations and their cash flows for each of the years in the
two-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
Also, in our opinion, the schedule referred to above presents fairly, in
all material respects, the information set forth therein for the years ended
December 31, 2001 and 2000.
/s/ BDO SEIDMAN, LLP
San Francisco, California
March 6, 2002
F-3
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31,
----------------------------
2002 2001
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,901,100 $ 3,110,000
Restricted cash 250,000 250,000
Accounts receivable, net of allowance for
doubtful accounts of $305,000 in 2002
and $400,000 in 2001 5,124,100 4,590,100
Inventories 3,370,500 2,952,000
Prepaid expenses and other current
assets 459,100 387,300
Income tax refunds receivable 1,472,800 399,200
Deferred income taxes -- 813,000
------------ ------------
Total Current Assets 12,577,600 12,501,600
Property and Equipment, net 4,495,400 4,711,500
Deposits and Other Assets 194,000 110,200
------------ ------------
$ 17,267,000 $ 17,323,300
============ ============
See accompanying notes to consolidated financial statements.
F-4
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31,
----------------------------
2002 2001
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of notes payable $ 60,800 $ 55,900
Floor plan inventory loans 901,600 1,545,000
Accounts payable 7,781,800 4,786,600
Accrued expenses 559,100 379,200
Warrants 161,600 --
------------ ------------
Total Current Liabilities 9,464,900 6,766,700
Notes Payable, less current portion 3,169,500 3,230,300
Deferred Tax Liabilities -- 34,200
Commitments and Contingencies
Minority Interest -- 2,200
Preferred Stock, $0.001 par value; 5,000,000
Shares authorized;
4% Series A Redeemable Convertible Preferred
Stock; 1,000 shares designated; 600 shares
issued and outstanding (liquidation value
of $614,200 as of December 31, 2002) 190,400 --
Shareholders' Equity:
Common stock, $0.001 par value; 25,000,000
shares authorized; 10,485,100 shares
issued and outstanding 10,500 10,500
Additional paid-in capital 2,007,900 1,745,500
Retained earnings 2,423,800 5,533,900
------------ ------------
Total Shareholders' Equity 4,442,200 7,289,900
------------ ------------
$ 17,267,000 $ 17,323,300
============ ============
See accompanying notes to consolidated financial statements.
F-5
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
Sales:
Products $ 69,358,500 $ 74,853,100 $ 88,597,300
Services 970,200 158,600 275,400
------------ ------------ ------------
Total Sales 70,328,700 75,011,700 88,872,700
------------ ------------ ------------
Cost of Sales:
Products 65,234,300 69,660,600 81,691,100
Services 484,100 49,000 129,600
------------ ------------ ------------
Total Cost of Sales 65,718,400 69,709,600 81,820,700
------------ ------------ ------------
Gross Margin 4,610,300 5,302,100 7,052,000
Research and Development -- 68,500 100,000
Selling, General and
Administrative Expenses 8,786,300 8,345,100 6,941,800
Impairment Loss on Investment -- 718,000 --
------------ ------------ ------------
Income (Loss) from Operations (4,176,000) (3,829,500) 10,200
------------ ------------ ------------
Other Income (Expense):
Interest income 18,100 125,100 227,300
Interest expense (183,700) (255,800) (296,000)
Equity loss on investment -- -- (32,000)
Litigation settlement -- -- 300,000
Change in fair value of warrants issued 235,700 -- --
Other expense, net (54,500) (1,600) (33,400)
------------ ------------ ------------
Total Other Income (Expense) 15,600 (132,300) 165,900
------------ ------------ ------------
Income (Loss) Before Income Tax Benefit
and Minority Interest (4,160,400) (3,961,800) 176,100
Income Tax Benefit (Expense) 1,322,300 1,078,200 (104,600)
------------ ------------ ------------
Income (Loss) Before Minority Interest (2,838,100) (2,883,600) 71,500
Minority Interest in FNC and PMIGA Loss 2,200 32,900 50,300
------------ ------------ ------------
Net Income (Loss) (2,835,900) (2,850,700) 121,800
Accretion and deemed dividend related to
Series A Convertible Preferred Stock (274,200) -- --
------------ ------------ ------------
Net income (loss) applicable to common
shareholders $ (3,110,100) $ (2,850,700) $ 121,800
============ ============ ============
Basic and diluted earnings (loss) per share $ (0.30) $ (0.28) $ 0.01
============ ============ ============
Shares used in computing per share amounts:
Basic 10,485,100 10,280,100 10,100,000
Potential common shares-stock options -- -- 54,700
------------ ------------ ------------
Diluted 10,485,100 10,280,100 10,154,700
============ ============ ============
See accompanying notes to consolidated financial statements.
F-6
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Shareholders' Equity
---------------------------------------------------------------------------
Common Stock Additional
---------------------------- Paid-in Retained
Shares Amount Capital Earnings Total
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1999 10,100,000 $ 10,100 $ 1,463,100 $ 8,262,800 $ 9,736,000
Net income -- -- -- 112,800 121,800
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2000 10,100,000 10,100 1,463,100 8,384,600 9,857,800
Issuance of Common Stock in
exchange for advertising
services 333,400 300 199,700 -- 200,000
Purchase of assets in
exchange for stock 16,100 -- 20,000 -- 20,000
Exercise of stock options 56,000 100 55,200 -- 55,300
Tax benefit of stock
options exercised -- -- 22,100 -- 22,100
Repurchase and retirement
of treasury stock (20,400) -- (14,600) -- (14,600)
Net Loss -- -- -- (2,850,700) (2,850,700)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2001 10,485,100 10,500 1,745,500 5,533,900 7,289,900
Deemed dividend
associated with
beneficial conversion
feature of convertible
preferred stock -- -- 260,000 (260,000) --
Vesting portion of 300,000
common stock warrants issued
as payment of consulting
services -- -- 2,400 -- 2,400
Preferred stock accretion -- -- -- (14,200) (14,200)
Net Loss -- -- -- (2,835,900) (2,835,900)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 10,485,100 $ 10,500 $ 2,007,900 $ 2,423,800 $ 4,442,200
============ ============ ============ ============ ============
See accompanying notes to consolidated financial statements.
F-7
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (2,835,900) $ (2,850,700) $ 121,800
Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating activities:
Depreciation and amortization 325,000 279,000 215,100
Gain on disposal of property and equipment (5,200) (1,400) --
Provision (benefit) for doubtful accounts (95,000) 450,500 182,200
Deferred income taxes 778,800 (682,700) 21,600
Equity in loss in investment -- -- 32,000
Impairment loss on investments -- 718,000 --
Change in value of warrants (235,700) -- --
Minority interest losses (2,200) (32,900) --
Changes in operating assets and liabilities:
Accounts receivable (439,000) 588,600 797,200
Inventories (418,500) 965,900 (106,700)
Prepaid expenses and other current assets (71,800) 259,200 (347,400)
Income tax refunds receivable (1,073,600) (183,500) --
Accounts payable 2,995,200 (1,002,000) (23,000)
Accrued expenses 179,900 (142,000) 268,700
------------ ------------ ------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (898,000) (1,634,000) 1,161,500
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (126,200) (96,100) (341,500)
Proceeds from sale of property and equipment 61,100 -- --
Notes receivable from shareholders -- 171,400 52,200
Investments in Rising Edge and TargetFirst -- -- (750,000)
Deposits and other assets (24,000) (4,600) 536,400
Payment for business acquisitions and
related costs -- (170,700) --
------------ ------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (89,100) (100,000) (502,900)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in floor plan
inventory loans (643,400) 215,500 (153,400)
Principal payments on note payable (55,900) (51,400) (47,300)
Restricted cash -- (250,000) --
Issuance of Common Stock under stock option plan -- 55,300 --
Net proceeds from issuance of redeemable
convertible preferred stock and warrants 477,500 -- --
Repurchase of common stock -- (14,600) --
Proceeds from sale of PMIGA stock to
minority shareholder -- 15,000 --
------------ ------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (221,800) (30,200) (200,700)
------------ ------------ ------------
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS (1,208,900) (1,764,200) 457,900
CASH AND CASH EQUIVALENTS:
Beginning of year 3,110,000 4,874,200 4,416,300
------------ ------------ ------------
End of year $ 1,901,100 $ 3,110,000 $ 4,874,200
============ ============ ============
See accompanying notes to consolidated financial statements.
F-8
PACIFIC MAGTRON INTERNATIONAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
The consolidated financial statements of Pacific Magtron International Corp.
(the Company or PMIC) include its subsidiaries, Pacific Magtron, Inc. (PMI),
Pacific Magtron (GA) Inc. (PMIGA), Frontline Network Consulting, Inc. (FNC), Lea
Publishing, Inc. (Lea), PMI Capital Corporation (PMICC), and LiveWarehouse, Inc.
(LW).
PMI's principal activity consists of the importation and wholesale distribution
of electronics products, computer components, and computer peripheral equipment
throughout the United States.
In May 1998, PMI formed its Frontline Network Consulting (Frontline) division, a
corporate information systems group that serves the networking and personal
computer requirements of corporate customers. In July 2000, the Company formed
FNC, a California corporation. Effective October 1, 2000, PMI transferred the
assets and liabilities of Frontline to FNC. Concurrently, FNC issued 20,000,000
shares of common stock to the Company and became a wholly-owned subsidiary. On
January 1, 2001, FNC issued 3,000,000 shares of its common stock to three key
FNC employees for past services rendered pursuant to certain Employee Stock
Purchase Agreements. As a result of this transaction, the Company's ownership
interest in FNC was reduced to 87%. In August 2001 and in March 2002, FNC
repurchased and retired a total of 2,000,000 of its shares from former employees
at $0.01 per share, resulting in an increase in the Company's ownership of FNC
from 87% to 95%.
In May 1999, the Company entered into a Management Operating Agreement which
provided for a 50% ownership interest in Lea Publishing, LLC, a California
limited liability company formed in January 1999 to develop, sell and license
software designed to provide internet users, resellers and providers with
advanced solutions and applications. In June 2000, the Company increased its
direct and indirect interest in Lea to 62.5% by purchasing 25% of the
outstanding common stock of Rising Edge Technologies, Ltd. (Rising Edge), the
other 50% owner of Lea, which was a development stage company. In December 2001,
the Company entered into an agreement with Rising Edge and its principal owners
to exchange the 50% Rising Edge ownership interest in Lea for the Company's 25%
ownership interest in Rising Edge. As a consequence, PMIC owns 100% of Lea and
no longer has an ownership interest in Rising Edge. No amounts were recorded for
the 50% Rising Edge ownership interest in Lea received in this exchange because
of the write-down of the Rising Edge investment to zero in the fourth quarter of
2001. In May 2002, the Company formed Lea, a California corporation. Effective
June 1, 2002, Lea Publishing, LLC transferred all of its assets and liabilities
to Lea.
In August 2000, PMI formed PMIGA, a Georgia corporation whose principal activity
is the wholesale distribution of PMI's products in the eastern United States
market. During 2001, PMIGA sold 15,000 shares of its common stock to an employee
for $15,000. In June 2002, PMIGA repurchased the 15,000 employee owned shares.
As a result, PMIGA is 100% owned by PMI.
On October 15, 2001, the Company formed an investment holding company, PMICC, a
wholly owned subsidiary of the Company, for the purpose of acquiring companies
or assets deemed suitable for PMIC's organization. In October 2001, the Company
acquired through PMICC certain assets and assumed the accrued vacation of
certain employees of Live Market, Inc. in exchange for $85,000. The LiveMarket
assets were then transferred to Lea.
In December 2001, the Company incorporated LW, a wholly-owned subsidiary of the
Company, to provide consumers a convenient way to purchase computer products
over the internet.
BASIS OF ACCOUNTING
The Company has incurred a net loss of $2,835,900 and a net loss applicable to
common shareholders of $3,110,100 for the year ended December 31, 2002. The
Company also incurred a net loss of $2,850,700 for the year ended December 31,
2001. These conditions raise doubt about the Company's ability to continue as a
going concern. The Company's ability to continue as a going concern is dependent
F-9
upon its ability to achieve profitability and generate sufficient cash flows to
meet its obligations as they come due, which management believes it will be able
to do. Management believes that the downsizing of its subsidiaries, FNC and Lea
and continued cost-cutting measures to reduce overhead at all of its
subsidiaries would enable it to achieve profitability. The Company is also
pursuing additional capital and debt financing. However, there is no assurance
that these efforts will be successful. The accompanying consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
USE OF ESTIMATES IN THE PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS
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 materially from those estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of PMIC
and its wholly-owned subsidiaries, PMI, PMIGA, Lea, PMICC and LW and its
majority-owned subsidiary, FNC. All inter-company accounts and transactions have
been eliminated in consolidation.
RECLASSIFICATIONS
Certain 2001 and 2000 financial statement amounts have been reclassified to
conform to the 2002 financial statement presentation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original maturities of
90 days or less to be cash equivalents.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company grants credit to its customers after undertaking an investigation of
credit risk for all significant amounts. An allowance for doubtful accounts is
provided for estimated credit losses at a level deemed appropriate to adequately
provide for known and inherent risks related to such amounts. The allowance is
based on reviews of loss, adjustment history, current economic conditions,
credit insurance levels, and other factors that deserve recognition in
estimating potential losses. While management uses the best information
available in making its determination, the ultimate recovery of recorded
accounts receivable is also dependent upon future economic and other conditions
that may be beyond management's control.
INVENTORIES
Inventories, consisting primarily of finished goods, are stated at the lower of
cost (weighted average cost method) or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the assets, as
follows:
Building and improvements 39 years
Furniture and fixtures 5 to 7 years
Computers and equipment 5 years
Automobiles 5 years
Software 3 years
REVENUE RECOGNITION
The Company recognizes sales of computer and related products upon delivery of
goods to the customer (generally upon shipment), provided no significant
obligations remain and collectibility is probable. A provision for estimated
product returns is established at the time of sale based upon historical return
rates, which have typically been insignificant, adjusted for current economic
conditions. Revenues relating to services performed by FNC are recognized upon
completion of the contracts. Software and service revenues relating to software
design and installation performed by FNC and Lea are recognized upon completion
of the installation and customer acceptance.
F-10
ADVERTISING COSTS
Advertising costs, except for certain radio advertising credits, are expensed
when incurred. Radio advertising credits are expensed when utilized and are
included in other selling, general and administrative expenses in the
accompanying consolidated statements of operations. Included in prepaid expenses
and other current assets as of December 31, 2002 and 2001 are $150,000 and
$200,000, respectively, representing the outstanding balance of radio
advertising credits. Advertising expense was $71,400, $178,000, and $3,600, in
2002, 2001, and 2000, respectively.
WARRANTY REPAIRS
The Company is principally a distributor of numerous electronics products, for
which the original equipment manufacturer is responsible and liable for product
repairs and service. However, the Company does warrant its services with regards
to products configured for its customers and products built to order from
purchased components, and provides for the estimated costs of fulfilling these
warranty obligations at the time the related revenue is recorded. Historically,
warranty costs have been insignificant.
INCOME TAXES
The Company reports income taxes in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, ACCOUNTING FOR INCOME TAXES, which requires
an asset and liability approach. This approach results in the recognition of
deferred tax assets (future tax benefits) and liabilities for the expected
future tax consequences of temporary differences between the book carrying
amounts and the tax basis of assets and liabilities. The deferred tax assets and
liabilities represent the future tax consequences of those differences, which
will either be deductible or taxable when the assets and liabilities are
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized as income in the period that includes the
enactment date. Future tax benefits are subject to a valuation allowance when
management believes it is more likely than not that the deferred tax assets will
not be realized.
LONG-LIVED ASSETS
The Company periodically reviews its long-lived assets for impairment. When
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable, the Company adjusts the asset to its estimated fair
value. The fair value of an asset is determined by the Company as the amount at
which that asset could be bought or sold in a current transaction between
willing parties or the present value of the estimated future cash flows from the
asset. The asset value recoverability test is performed by the Company on an
on-going basis. As further discussed in Note 15, the Company recorded an
impairment loss in 2001 related to the write-down of its investments in Rising
Edge and TargetFirst to zero. The impairment loss recognized for Rising Edge was
based on operations history, projections and a change in focus of the investee's
business. The impairment loss recognized for Target First resulted from an
analysis of the investee's recurring operating losses and cash available for use
in operations.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair value of long-term debt and floor plan inventory loans is estimated
based on current interest rates available to the Company for debt instruments
with similar terms and remaining maturities. At December 31, 2002 and 2001, the
fair value of long-term debt, which consisted of a bank loan and an SBA loan
relating to the Company's facility in Milpitas, California, was approximately
$3,346,300 and $3,487,700, respectively. The bank loan had an outstanding
balance of $2,387,500 and $2,411,700 as of December 31, 2002 and 2001,
respectively. The carrying value of the bank loan, which contains an adjustable
interest rate provision based on the market interest rate, approximates its fair
value. The SBA loan had an outstanding amount of $842,800 and $874,500 at
December 31, 2002 and 2001, respectively. The estimated fair value of the SBA
loan was $958,800 and $1,076,000 as of December 31, 2002 and 2001, respectively.
The fair value of the SBA loan was estimated based on the present value of the
future payments discounted by the market interest rate for similar loans at
December 31, 2002 and 2001. The fair value of floor plan inventory loans
approximates their carrying value because of the short maturity of this
instrument.
F-11
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed by dividing income (loss) available
to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflect the potential
dilution of securities, using the treasury stock method that could share in the
earnings of an entity. During the year ended December 31, 2002, options and
warrants to purchase 1,302,800 shares of the Company's common stock and 818,900
shares of common stock issuable upon conversion of Series A Preferred Stock were
excluded from the calculation of diluted loss per share as their effect would be
anti-dilutive. During the year ended December 31, 2001, options to purchase
794,600 shares of the Company's common stock were excluded from the calculation
of diluted loss per share as their effect would be anti-dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
BUSINESS COMBINATIONS, and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS
No. 141 requires the use of the purchase method of accounting and prohibits the
use of the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS No. 141 also requires that the Company
recognize acquired intangible assets apart from goodwill if the acquired
intangible assets meet certain criteria. SFAS No. 141 applies to all business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, upon adoption
of SFAS No. 142 that the Company reclassify the carrying amounts of intangible
assets and goodwill based on the criteria in SFAS No. 141. The Company recorded
its acquisition of Technical Insights and LiveMarket in September and October
2001 in accordance with SFAS No. 141 and did not recognize any goodwill relating
to these transactions. However, certain intangibles totaling $59,400, including
intellectual property and vendor reseller agreements, were identified and
recorded in the consolidated financial statements in deposits and other assets.
These intangible assets are being amortized over a 3-year period using the
straight-line method. As of December 31, 2002, a total of $24,300 has been
amortized.
SFAS No. 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS No. 142 requires that the Company identify reporting units for
the purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
were initially recognized. SFAS No. 142 requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption. The
Company is also required to reassess the useful lives of other intangible assets
within the first interim quarter after adoption of SFAS No. 142. The adoption of
SFAS No. 142 did not have a material effect on the Company's financial position,
results of operations or cash flows.
In August 2001, the FASB issued SFAS No. 143, ACCOUNTING FOR OBLIGATIONS
ASSOCIATED WITH THE RETIREMENT OF LONG-LIVED ASSETS. SFAS No. 143 addresses
financial accounting and reporting for the retirement obligation of an asset.
SFAS No. 143 states that companies should recognize the asset retirement cost,
at its fair value, as part of the asset cost and classify the accrued amount as
a liability in the balance sheet. The asset retirement liability is then
accreted to the ultimate payout as interest expense. The initial measurement of
the liability would be subsequently updated for revised estimates of the
discounted cash outflows. SFAS No. 143 was effective for fiscal years beginning
after June 15, 2002. The Company believes the adoption of SFAS No. 143 will not
have a material effect on the Company's financial position, results of
operations, or cash flows.
In October 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144 supersedes the SFAS No. 121 by
requiring that one accounting model to be used for long-lived assets to be
disposed of by sale, whether previously held and used or newly acquired, and by
broadening the presentation of discontinued operation to include more disposal
transactions. SFAS No. 144 was effective for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 144 did not have a material effect
on the Company's financial position, results of operations, or cash flows.
F-12
SFAS No. 145, "Rescission of SFAS Statements No. 4, 44, and 64, Amendment of
SFAS Statement No. 13, and Technical Corrections" ("SFAS 145"), updates,
clarifies and simplifies existing accounting pronouncements. SFAS 145 rescinds
SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt." SFAS 145
amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. The provisions of SFAS 145 related to
SFAS No. 4 and SFAS No. 13 are effective for fiscal years beginning and
transactions occurring after May 15, 2002, respectively. The adoption of SFAS
No. 145 did not have a material effect on the Company's financial position,
results of operations, or cash flows.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS 146 requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS 146 replaces
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." The provisions of SFAS
146 are to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The Company does not expect the adoption of SFAS No.
146 to have a material effect on its financial position, results of operations,
or cash flows.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45). FIN 45 requires a guarantor to (i) include
disclosure of certain obligations and (ii) if applicable, at the inception of
the guarantee, recognize a liability for the fair value of other certain
obligations undertaken in issuing a guarantee. The disclosure provisions of the
Interpretation are effective for financial statements of interim or annual
reports that end after December 15, 2002. The adoption of FIN 45 had no impact
on the Company's disclosures as of December 31, 2002. The recognition and
measurement provisions of FIN 45 are effective for guarantees issued or modified
after December 29, 2002. The Company does not expect Interpretation No. 45 to
have a material effect on the Company's financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure--an Amendment of FASB Statement No. 123.
SFAS No. 148 amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for an entity that
chooses to change to the fair-value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
statement to require prominent disclosure about the effects that accounting for
stock-based employee compensation using the fair-value-based method would have
on reported net income and earnings per share and to require prominent
disclosure about the entity's accounting policy decisions with respect to
stock-based employee compensation. Certain of the disclosure requirements are
required for all companies, regardless of whether the fair value method or
intrinsic value method is used to account for stock-based employee compensation
arrangements. The Company accounts for its stock option plan in accordance with
the recognition and measurement principles of Accounting Principles Opinion No.
25, Accounting for Stock Issued to Employees. The amendments to SFAS No. 123 are
effective for financial statements for fiscal years ended after December 15,
2002 and for interim periods beginning after December 15, 2002. The adoption of
the disclosure requirements of SFAS No. 148 did not have a material effect on
the Company's financial position or results of operations.
FASB Statement No. 123 requires the Company to provide pro forma information
regarding net income and earnings per share as if compensation cost for the
Company's stock option plan had been determined in accordance with the fair
value based method prescribed in SFAS No. 123 as amended by SFAS No. 148. The
Company estimates the fair value of stock options at the grant date by using the
Black-Scholes option pricing-model with the following weighted-average
assumptions use for grants in 2002, 2001, and 2000: no yield; expected
volatility of 311%, 152%, and 112%, risk-free interest rates of 4%, 5.0%, and
6.2% and expected lives of four years for all plan options.
Had the Company adopted the provisions of FASB Statement No. 123, the Company's
net income (loss) and earnings (loss) per share would have been reduced
(increased) to the pro forma amounts indicated below:
F-13
YEAR ENDING DECEMBER 31, 2002 2001 2000
------------------------ ----------- ----------- -----------
Net (loss) income:
As reported $(3,110,100) $(2,850,700) $ 121,800
Deduct: Stock based compensation
expense determined under fair value
based method for all awards $ (71,200) $ (627,400) $ (118,600)
Pro forma $(3,181,300) $(3,478,100) $ 3,200
----------- ----------- -----------
Basic and diluted (loss) earnings per share:
As reported $ (0.30) $ (0.28) $ 0.01
Pro forma $ (0.30) $ (0.34) $ 0.00
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). This interpretation of Accounting Research
Bulletin No. 51, Consolidated Financial Statements, addresses consolidation by
business enterprises of variable interest entities. Under current practice,
enterprises generally have been included in the consolidated financial
statements of another enterprise because the one enterprise controls the others
through voting interests. FIN 46 defines the concept of "variable interests" and
requires existing unconsolidated variable interest entities to be consolidated
into the financial statements of their primary beneficiaries if the variable
interest entities do not effectively disperse risks among the parties involved.
This interpretation applies immediately to variable interest entities created
after January 31, 2003. It applies in the first fiscal year or interim period
beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
If it is reasonably possible that an enterprise will consolidate or disclose
information about a variable interest entity when FIN 46 becomes effective, the
enterprise must disclose information about those entities in all financial
statements issued after January 31, 2003. The interpretation may be applied
prospectively with a cumulative-effect adjustment as of the date on which it is
first applied or by restating previously issued financial statements for one or
more years, with a cumulative-effect adjustment as of the beginning of the first
year restated. The Company does not expect the adoption of FIN 46 to have a
material effect on its consolidated financial statements.
2. RELATED PARTY TRANSACTIONS
The Company had notes receivable from two officer/shareholders which bore
interest at 6% and were unsecured. In December 2000, the repayment terms of the
notes were renegotiated to require monthly principal payments, without interest,
to pay off the notes by December 31, 2001. Additionally, accrued interest
receivable of $43,600 pertaining to the notes was forgiven by the Company and
charged to expense during 2000. As of December 31, 2000, notes receivable from
the two officer/shareholders aggregated $171,400 and were repaid in full during
2001 using proceeds from officer bonuses declared and paid by the Company during
the period.
The Company sold computer products to a company owned by a member of the Board
of Directors and Audit Committee of the Company. Management believes that the
terms of the sales transactions are no more favorable than those given to
unrelated customers. During 2002, 2001 and 2000, the Company recognized
$527,400, $476,200, and $1,476,100 in sales revenues from this company. Included
in accounts receivable as of December 31, 2002 and 2001 is $27,000 and $200,
respectively, due from this related party.
In 2001 FNC acquired certain assets of Technical Insights in exchange for 16,100
shares of PMIC common stock. Under the purchase agreement, among other terms,
FNC was required to pay $126,000 to the sellers upon completion and full
settlement of a sale transaction as specified in the agreement. On October 2001
the sellers became employees of FNC. As a result of the profit sharing
arrangement, the $126,000 payment due to the sellers was accrued as compensation
expense by the Company. In January 2002, this balance was paid to the
sellers/employees under the terms of the purchase agreement.
Prior to June 2000, the Company and Rising Edge each owned a 50% interest in Lea
Publishing, LLC. The brother of a director, officer, and principal shareholder
of the Company is a director, officer and the majority shareholder of Rising
Edge. See Note 15 for the related party transactions between the Company and
Rising Edge.
F-14
3. ACCOUNTS RECEIVABLE FACTORING AGREEMENT
Pursuant to a non-notification accounts receivable factoring agreement, the
Company factors certain of its accounts receivable with a financial institution
(the Factor) on a pre-approved non-recourse basis. The factoring commission
charge is 0.375% and 2.375% of specific approved domestic and foreign
receivables (Approved Accounts), respectively. The agreement, which expired on
February 28, 2003, was automatically renewed for one year under the provisions
of the agreement. The agreement requires the Company to pay a minimum of
$200,000 in annual commission to the Factor and to maintain the receivable
records and make reasonable collection efforts on the Approved Accounts. The
Company recognizes the commission expense based on the cumulative amount of
approved accounts or the prorated cumulative minimum annual fee, which is the
greater. Approved Accounts are transferred to the Factor as assigned accounts
(Assigned Accounts) when the receivables are not collected within 120 days from
the due date or the customers become insolvent. The title of the receivable is
transferred to the Factor when it becomes an Assigned Account. As a purchaser of
the Assigned Accounts, the Factor has title to the Assigned Accounts and has
unilateral rights, such as to demand and collect payments from customers on the
Assigned Accounts, compromise, sue for, and foreclose. The Company has no
further obligations or control over the receivable when it becomes an Assigned
Account. The Factor is obligated to pay the Company for the Assigned Accounts
within 15 days after the receivable becomes an Assigned Account. Security
interests in the Assigned Accounts are granted to the Factor when the accounts
become assigned. In accordance with SFAS 140 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," the Company
accounts for the factored receivables as sales of financial assets when they
become Assigned Accounts. The total amount of receivables approved by the Factor
as Approved Accounts was $23,382,700 during the year ended December 31, 2002.
The amount of receivables assigned to the Factor during the year ended December
31, 2002 was $101,800. There were no receivables assigned to the Factor prior to
the quarter ended June 30, 2002 and as of December 31, 2002, there were no
Assigned Accounts included in accounts receivable. As of December 31, 2002, the
commission amount due to the Factor was $37,700 and was included in accrued
liabilities.
4. PROPERTY AND EQUIPMENT
A summary of property and equipment as of December 31, 2002 and 2001 follows:
DECEMBER 31, 2002 2001
------------ ---------- ----------
Building and improvements $3,274,400 $3,266,900
Land 1,158,600 1,158,600
Furniture and fixtures 393,300 394,500
Computers and equipment 795,100 703,900
Automobiles 116,500 190,400
---------- ----------
5,737,900 5,714,300
Less accumulated depreciation 1,242,500 1,002,800
---------- ----------
$4,495,400 $4,711,500
========== ==========
5. NOTES PAYABLE
The Company obtained financing of $3,498,000 for the purchase of its office and
warehouse facility. Of the amount financed, $2,500,000 was in the form of a
10-year bank loan utilizing a 30-year amortization period. This loan bears
interest at the bank's 90-day LIBOR rate (1.875% as of December 31, 2002) plus
2.5%, and is secured by a deed of trust on the property. The balance of the
financing was obtained through a $998,000 Small Business Administration (SBA)
loan due in monthly installments through April 2017. The SBA loan bears interest
at 7.569%, and is secured by the underlying property.
Under the bank loan, the Company is required, among other things, to maintain a
minimum debt service coverage, a maximum debt to tangible net worth ratio, and
have no consecutive quarterly losses. In addition, the Company is required to
achieve net income on an annual basis. During 2001, the Company was in violation
of two of these covenants which constituted an event of default under the loan
agreement and gave the bank the right to call the loan. A waiver of the loan
covenant violations was obtained from the bank that extends through December 31,
2003. As a condition for this waiver, the Company transferred $250,000 to a
restricted account as a reserve for debt servicing. This amount has been
reflected as restricted cash in the accompanying consolidated balance sheet.
F-15
Notes payable as of December 31, 2002 and 2001 are as follows:
2002 2001
----------- -----------
Bank loan $ 2,387,500 $ 2,411,700
SBA loan 842,800 874,500
----------- -----------
3,230,300 3,286,200
Less current portion 60,800 55,900
----------- -----------
$ 3,169,500 $ 3,230,300
=========== ===========
The aggregate amount of future maturities for notes payable are as follows:
YEARS ENDING DECEMBER 31, Amount
------------------------- -----------
2003 $ 60,800
2004 66,100
2005 71,900
2006 78,200
2007 2,310,600
Thereafter 642,700
-----------
$ 3,230,300
===========
6. FLOOR PLAN INVENTORY LOANS AND LETTER OF CREDIT
On July 13, 2001, PMI and PMIGA (the Companies) obtained a $4 million (subject
to credit and borrowing base limitations) accounts receivable and inventory
financing facility from Transamerica Commercial Finance Corporation
(Transamerica). This credit facility has a term of two years and is subject to
automatic renewal from year to year thereafter. The credit facility can be
terminated by Transamerica under certain conditions and the termination is
subject to a fee of 1% of the credit limit. The facility includes up to a $3
million inventory line (subject to a borrowing base of up to 85% of eligible
accounts receivable plus up to $1,500,000 of eligible inventories) that includes
a sub-limit of $600,000 working capital line and a $1 million letter of credit
facility used as security for inventory purchased on terms from vendors in
Taiwan. Borrowing under the inventory loans are subject to 30 to 45 days
repayment, at which time interest begins to accrue at the prime rate, which was
4.25% at December 31, 2002. Draws on the working capital line also accrue
interest at the prime rate. The credit facility is guaranteed by both PMIC and
FNC.
Under the accounts receivable and inventory financing facility from
Transamerica, the Companies are required to maintain certain financial
covenants. However, at June 30, 2002, the Companies did not meet the minimum
tangible net worth and profitability covenants.
On October 23, 2002, Transamerica issued a waiver of the default occurring on
June 30, 2002 and revised the terms and covenants under the credit agreement.
Under the revised terms, the credit facility includes FNC as an additional
borrower and PMIC continues as a guarantor. Effective October 2002, the new
credit limit is $3 million in aggregate for inventory loans and the letter of
credit facility. The letter of credit facility is limited to $1 million. The
credit limits for PMI and FNC are $1,750,000 and $250,000, respectively. At
December 31, 2002 and September 30, 2002, the Companies did not meet the
covenants as revised on October 23, 2002 relating to profitability and tangible
net worth. This constituted a technical default and gave Transamerica, among
other things, the right to call the loan and immediately terminate the credit
facility.
On January 7, 2003, Transamerica elected to terminate the credit facility
effective April 7, 2003. However, Transamerica will continue its guarantee of
the Letter of Credit Facility through July 25, 2003. Unless the Companies do not
perform its obligations in accordance with the agreement and the indebtedness to
tangible net worth covenant is materially worse than the condition at the level
on January 7, 2003, Transamerica will continue to accept payments according to
the terms of the agreement prior to April 7, 2003. The remaining outstanding
balance is due and payable in full on April 7, 2003. As of December 31, 2002,
the Companies had an outstanding balance of $901,600 due under this credit
facility.
F-16
In March 2001, FNC obtained a $2 million discretionary credit facility from
Deutsche Financial Services Corporation (Deutsche) to purchase inventory. To
secure payment, Deutsche obtained a security interest in all of FNC's inventory,
equipment, fixtures, accounts, reserves, documents, general intangible assets
and all judgments, claims, insurance policies, and payments owed or made to FNC.
Under the loan agreement, all draws matured in 30 days. Thereafter, interest
accrued at the lesser of 16% per annum or at the maximum contract rate of
interest permitted under applicable law FNC was required to maintain certain
financial covenants to qualify for the Deutsche bank credit line, and was not in
compliance with certain of the covenants as of June 30, 2002 and December 31,
2001. On April 30, 2002, Deutsche elected to terminate the credit facility
effective July 1, 2002. FNC repaid the outstanding balance in full in October
2002.
7. INCOME TAXES
For the years ended December 31, 2002, 2001 and 2000, income tax benefit
(expense) comprises:
2002 Current Deferred TOTAL
---- ------------ ------------ ------------
Federal $ 1,459,000 (131,000) $ 1,328,000
State (5,700) -- (5,700)
------------ ------------ ------------
$ 1,453,300 (131,000) $ 1,322,300
============ ============ ============
2001 Current Deferred TOTAL
---- ------------ ------------ ------------
Federal $ 378,700 $ 698,500 $ 1,077,200
State (5,300) 6,300 1,000
------------ ------------ ------------
$ 373,400 $ 704,800 $ 1,078,200
============ ============ ============
2000 Current Deferred TOTAL
---- ------------ ------------ ------------
Federal $ (56,000) $ (22,500) $ (78,500)
State (27,000) 900 (26,100)
------------ ------------ ------------
$ (83,000) $ (21,600) $ (104,600)
============ ============ ============
The following summarizes the differences between the income tax (benefit)
expense and the amount computed by applying the Federal income tax rate of 34%
in 2002, 2001 and 2000 to income before income taxes:
YEAR ENDING DECEMBER 31, 2002 2001 2000
------------------------ ---------- ---------- ----------
Federal income tax benefit (expense)
at statutory rate $1,414,300 $1,347,000 $ (59,900)
State income taxes benefit (expense),
net of federal benefit (5,700) 230,100 (10,600)
Other non-taxable income and
non-deductible expenses 55,100 (96,000) (34,100)
Change in deferred tax assets (432,500) -- --
Change in valuation allowance (380,500) (402,900) --
Benefits recognized due to changes
in tax laws 648,000 -- --
Others 23,600 -- --
---------- ---------- ----------
Income tax benefit (expense) $1,322,300 $1,078,200 $ (104,600)
========== ========== ==========
California limits the amount that could be carried forward to 60% of the losses
incurred in 2001 and 2002. As of December 31, 2002, the Company had California
state net operating loss (NOL) carry forwards of approximately $4,011,000 to
offset future taxable income. The net operating loss carry forwards expire in
2014.
F-17
Deferred tax assets and liabilities as of December 31, 2002 and 2001 were
comprised of the following:
2002 2001
----------- -----------
Deferred tax assets:
Reserves (primarily the allowance for
doubtful accounts) not currently
deductible $ 132,400 $ 272,800
Accrued compensation and benefits 23,900 8,400
Capital loss carryover 335,700 186,400
NOL carryover 354,600 746,500
Others 12,400 1,800
Accumulated depreciation (75,600) --
----------- -----------
783,400 1,215,900
Valuation allowance (783,400) (402,900)
----------- -----------
Net deferred tax assets $ -- $ 813,000
=========== ===========
Deferred tax liabilities - accumulated
depreciation $ -- $ 34,200
=========== ===========
At December 31, 2002 and 2001, the Company has recorded a valuation allowance,
relating principally to the capital loss carryover and California net operating
loss carryover and reserves not currently deductible, against the net deferred
tax assets to reduce them to amounts that are more likely than not to be
realized. The net increase in the total valuation allowance for the year ended
December 31, 2002 and 2001 was $380,500 and $402,900, respectively.
During 2001, the Company recorded a $22,100 tax benefit of stock options
exercised as a credit to additional paid-in-capital.
The Company reported income tax benefits of $1,322,300 for the year ended
December 31, 2002 and $1,078,200 for the year ended December 31, 2001 arising
from the loss incurred in those years. In March 2002, the Job Creation and
Worker Assistance Act of 2002 ("the Act") was enacted. The Act extends the
general federal net operating loss carryback period from 2 years to 5 years for
net operating losses incurred for any taxable year ending in 2001 and 2002. As a
result, the Company did not record a valuation allowance on the portion of the
deferred tax assets relating to unutilized federal net operating loss of
$1,906,800 for the year ended December 31, 2001. On June 12, 2002, the Company
received a federal income tax refund of $1,034,700 attributable to 2001 net
operating loss carried back. The tax benefits recorded for 2002 primarily
reflect potential federal income tax refund attributable to the 2002 net
operation loss carryback.
8. LEASE COMMITMENTS
The Company leases office space, equipment, and vehicles under various operating
leases. The leases for office space provide for the payment of common area
maintenance fees and the Company's share of any increases in insurance and
property taxes over the lease term.
Future minimum obligations under these non-cancelable operating leases are as
follows:
YEAR ENDING DECEMBER 31, Amount
------------------------ --------
2003 $132,700
2004 31,800
2005 26,300
2006 2,000
--------
$192,800
========
Total rent expense associated with all operating leases for the years ended
December 31, 2002, 2001 and 2000 was $232,100, $136,000, and $16,700,
respectively.
9. MAJOR VENDORS
One vendor accounted for approximately 11%, 10%, and 16% of the total purchases
for the years ended December 31, 2002, 2001, and 2000, respectively. No other
vendors accounted for more than 10% of purchases for any period presented.
F-18
Management believes other vendors could supply similar products on comparable
terms as those provided by the major vendors. A change in suppliers, however,
could cause a delay in availability of products and a possible loss of sales,
which could adversely affect operating results.
10. EMPLOYEE BENEFIT PROGRAM-401(k) PLAN
The Company has a 401(k) plan (the Plan) for its employees. The Plan is
available to all employees who have reached the age of twenty-one and who have
completed three months of service with the Company. Under the Plan, eligible
employees may defer a portion of their salaries as their contributions to the
Plan. Company contributions are discretionary, subject to statutory maximum
levels. Company contributions to the Plan totaled $3,400 and $24,100 for the
years ended December 31, 2001 and 2000, respectively. There were no
contributions by the Company in 2002.
11. CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to concentration of
credit risk consist principally of cash and cash equivalents and trade
receivables. The Company places its cash and cash equivalents with what it
believes are reputable financial institutions. As of December 31, 2002 and 2001,
the Company had deposits at one financial institution which aggregated
$1,665,900 (including restricted cash of $250,000) and $3,083,900, respectively.
As of December 31, 2002 and 2001, the Company had deposits amounting to $482,700
and $274,200, respectively, at two other financial institutions. Such funds are
insured by the Federal Deposit Insurance Company up to $100,000.
A significant portion of the Company's revenues and accounts receivable are
derived from sales made primarily to unrelated companies in the computer
industry and related fields located throughout the United States. For the years
ended December 31, 2002, 2001 and 2000, no individual customer or customers
accounted for more than 10% of sales. The Company believes any risk of credit
loss is significantly reduced due to the use of various levels of credit
insurance, diversity in customers, geographic sales areas and extending credit
based on established limits or terms. The Company performs credit evaluations of
its customers' financial condition whenever necessary, and generally does not
require collateral for sales on credit.
12. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Company is authorized to issue up to 5,000,000 shares of its $0.001 par
value preferred stock that may be issued in one or more series and with such
stated value and terms as may be determined by the Board of Directors. The
Company has designated 1,000 shares as 4% Series A Redeemable Convertible
Preferred Stock (the "Series A Preferred Stock") with a stated value per share
of $1,000 plus all accrued and unpaid dividends.
On May 31, 2002 the Company entered into a Preferred Stock Purchase Agreement
with an investor (Investor). Under the agreement, the Company agreed to issue
1,000 shares of its Series A Preferred Stock at $1,000 per share. On May 31,
2002, the Company issued 600 shares of the Series A Preferred Stock to the
Investor, and the remaining 400 shares would be issued when the registration
statement that registers the common stock underlying the Series A Preferred
Stock became effective. As part of the Preferred Stock Purchase Agreement, the
Company issued a common stock purchase warrant to the Investor. The warrant may
be exercised at any time within 3 years from the date of issuance and entitles
the Investor to purchase 300,000 shares of the Company's common stock at $1.20
per share and includes a cashless exercise provision. The Company also issued a
common stock purchase warrant with the same terms and conditions for the
purchase of 100,000 shares of the Company's common stock to a broker who
facilitated the transaction as a commission.
The holder of the Series A Preferred Stock is entitled to cumulative dividends
at the rate of 4% per annum, payable on each Conversion Date, as defined, in
cash or by accretion of the stated value. The amount recorded as accretion of
the stated value for the year ended December 31, 2002 was $14,200. Dividends
must be paid in cash, if among other circumstances, the number of the Company's
authorized common shares is insufficient for the conversion in full of the
Series A Preferred Stock, or the Company's common stock is not listed or quoted
on Nasdaq, NYSE or AMEX. Each share of Series A Preferred Stock is non-voting
and entitled to a liquidation preference of the stated value plus accrued and
unpaid dividends. A sale or disposition of 50% or more of the assets of the
Company, or completion of a transaction in which more than 33% of the voting
power of the Company is disposed of, would constitute liquidation. At any time
and at the option of the holder, each share of Series A Preferred Stock is
convertible into shares of common stock at the Conversion Ratio, which is
F-19
defined as the stated value divided by the Conversion Price. The Conversion
Price is the lesser of (a) 120% of the average of the 5 Closing Prices
immediately prior to the Closing Date on which the preferred stock was issued
(the Set Price), and (b) 85% of the average of the 5 lowest VWAPs (the daily
volume weighted average price as reported by Bloomberg Financial L.P. using the
VAP function) during the 30 trading days immediately prior to the Conversion
Date but not less than $0.75 (Floor Price). The Set Price and Floor Price are
subject to certain adjustments, such as stock dividends.
The Company has the right to redeem the Series A Preferred Stock for cash at a
price equal to 115% of the Stated Value plus accrued and unpaid dividends if (a)
the Conversion Price is less than $1 during the 5 trading days prior to the
redemption, or (b) the Conversion price is greater than 175% of the Set Price
during the 20 trading days prior to the redemption. Upon the occurrence of a
Triggering Event, such as failure to register the underlying common shares among
other events as defined, the holder of the Series A Preferred Stock has the
right to require the Company to redeem the Series A Preferred Stock in cash at a
price equal to the sum of (a) the redemption amount (the greater of (i) 150% of
the Stated Value or (ii) the product of the Per Share Market Value and the
Conversion Ratio) plus other costs, and (b) the product of the number of
converted common shares and Per Market Share Value. As of December 31, 2002, the
liquidation value of the Series A Preferred Stock was $614,200. As the Series A
Preferred Stock has conditions for redemption that are not solely within the
control of the Company, such Series A Preferred Stock has been excluded from
shareholders' equity. As of December 31, 2002, the redemption value of the
Series A Preferred Stock, if the holder had required the Company to redeem the
Series A Preferred Stock as of that date, was $921,300.
The Company has accounted for the sale of preferred stock and related warrants
in accordance with Emerging Issues Task Force (EITF) 00-27 "Application of Issue
No. 98-5 to Certain Convertible Instruments" and EITF 00-19 "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Owned Stock." Proceeds of $477,500 (net of $80,500 cash issuance
costs) were received of which $222,500 (net of allocated issuance costs of
$37,500) was allocated to the Series A Preferred Stock and $255,000 (net of
allocated issuance costs of $43,000) was allocated to the detachable warrant
based upon its fair value as computed using the Black-Scholes option pricing
model. The $260,000 value of the beneficial conversion option on the 600 shares
of Series A Preferred Stock was recorded as a deemed dividend on the date of
issuance. The allocated $46,300 value (net of $53,000 allocated issuance costs)
of the warrant issued to the broker who facilitated the transaction was recorded
as a stock issuance cost relating to the sale of preferred stock. As a result, a
total amount of $397,300 was as allocated to the warrants and was included in
the current liabilities. The related issuance costs of $96,000 allocated to the
warrants were included in deposits and other assets and are being amortized over
a 3-year period using a straight-line method. As of December 31, 2002, issuance
costs of $16,000 have been amortized to expense. As of December 31, 2002, the
carrying amount of the warrants was adjusted to the fair value of $161,600. The
change in fair value of the warrants from the issuance date (May 31, 2002) to
December 31, 2002 was $235,700 and is included as other income. As of December
31, 2002, 818,900 shares of common stock could have been issued if the Series A
Preferred Stock were converted into common stock.
13. CAPITAL STOCK
TREASURY STOCK
On May 7, 2001, the Company's Board of Directors authorized a share repurchase
program whereby, up to $100,000 worth of the Company's common stock may be
repurchased at a maximum price of $1.25 per share and held in treasury or
retired. During 2001, the Company acquired 20,400 shares of its common stock at
a cost of $14,600. On November 8, 2001, this treasury stock was retired.
INVESTMENT BANKING SERVICES
On December 16, 2002, the Company issued warrants for the purchase of up to
300,000 shares of its common stock under terms of an agreement for investment
banking services. Warrants to purchase 100,000 shares of the Company's common
F-20
stock were to vest immediately and warrants to purchase 200,000 shares were to
vest 50% on June 16, 2003 and 50% on December 16, 2003. The Company accounted
for this transaction in accordance with EITF No. 96-18, ACCOUNTING FOR EQUITY
INSTRUMENTS THAT ARE ISSUED TO OTHER THAN EMPLOYEES FOR ACQUIRING, OR IN
CONJUNCTION WITH SELLING, GOODS OR SERVICES. In 2002, the Company recorded
$2,400 in expense related to this transaction and increased additional paid-in
capital for the same amount.
STOCK ISSUED FOR SERVICES
On June 14, 2001, the Company issued 333,400 shares of its common stock to an
unrelated party in exchange for radio advertising services to be received over a
three-year period. All of the shares vested upon issuance and are
non-forfeitable, resulting in a measurement date and final valuation of shares
in the amount of $200,000 based upon the market price of the Company's common
stock on the date of issuance. Under the terms of the agreement, one-third of
the radio advertising service credits expire in two years. Radio advertising
service credits are expensed when utilized and are included in other selling,
general and administrative expenses in the accompanying consolidated statements
of operations. Included in prepaid expenses and other current assets as of
December 31, 2002 and 2001 are $150,000 and $200,000, respectively, representing
the outstanding balance of the radio advertising credits.
STOCK OPTION PLAN
On July 16, 1998 the Company adopted the 1998 Stock Option Plan and
reserved 1,000,000 shares of Common Stock for issuance under the Plan. Activity
under the Plan is as follows:
Weighted
Weighted Weighted Average
Shares Average Average Remaining
Available Options Exercise Fair Contractual
for Grant Outstanding Price Value Life
--------- ----------- -------- -------- ---------
DECEMBER 31, 1999 802,700 197,300 $ 3.67 $ 2.73 3.9 Years
Options granted (136,000) 136,000 1.50 1.15 --
Options forfeited 40,000 (40,000) 2.78 2.34 --
--------- ----------- -------- --------
DECEMBER 31, 2000 706,700 293,300 2.78 2.05 3.6 Years
Options granted (660,000) 660,000 0.94 0.80 --
Options forfeited 102,700 (102,700) 2.65 2.22 --
Options exercised -- (56,000) 0.99 0.87 --
--------- ----------- -------- --------
DECEMBER 31, 2001 149,400 794,600 1.40 1.08 3.8 Years
Options granted (30,000) 30,000 0.95 0.85 --
Options forfeited 172,600 (172,600) 2.41 2.24 --
--------- ----------- -------- --------
DECEMBER 31, 2002 292,000 652,000 $ 1.11 $ 0.76 3.1 Years
========= =========== ======== ========
The following table summarizes information about stock options outstanding as of
December 31, 2002:
Options Outstanding Options Exercisable
-------------------------------------- ----------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Exercise as of Contractual Exercise as of Exercise
Price 12/31/2002 Life Price 12/31/2002 Price
----- ---------- ---------- ----- ---------- -----
$0.76 10,000 4.5 Years $0.76 10,000 $0.76
$0.88 323,800 3.3 Years $0.88 323,800 $0.88
$0.97 206,200 3.3 Years $0.97 206,200 $0.97
$1.05 20,000 4.6 Years $1.05 20,000 $1.05
$1.50 72,000 1.7 Years $1.50 28,800 $1.50
$5.00 20,000 0.9 Years $5.00 14,000 $5.00
-------- -------
652,000 3.1 Years $1.11 602,800 $1.04
======== =======
Under the terms of the Plan, options are exercisable on the date of grant and
expire from four to five years from the date of grant as determined by the Board
of Directors. The Company applies Accounting Principles Board (APB) No. 25,
F-21
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations in
accounting for the plan. Under APB Opinion No. 25, because the exercise price of
the Company stock options equals or exceeds the estimated fair value of the
underlying stock on the measurement date, no compensation cost is recognized.
FASB Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires the
Company to provide pro forma information regarding net income and earnings per
share as if compensation cost for the Company's stock option plan had been
determined in accordance with the fair value based method prescribed in SFAS No.
123 as amended by SFAS No. 148. The Company estimates the fair value of stock
options at the grant date by using the Black-Scholes option pricing-model with
the following weighted-average assumptions use for grants in 2002, 2001, and
2000: no yield; expected volatility of 311%, 152%, and 112%, risk-free interest
rates of 4%, 5.0%, and 6.2% and expected lives of four years for all plan
options.
Had the Company adopted the provisions of FASB Statement No. 123, the Company's
net income (loss) and earnings (loss) per share would have been reduced
(increased) to the pro forma amounts indicated below:
YEAR ENDING DECEMBER 31, 2002 2001 2000
------------------------ ----------- ----------- -----------
Net (loss) income:
As reported $(3,110,100) $(2,850,700) $ 121,800
Deduct: Stock based compensation
expense determined under fair value
based method for all awards $ (71,200) $ (627,400) $ (118,600)
Pro forma $(3,181,300) $(3,478,100) $ 3,200
----------- ----------- -----------
Basic and diluted (loss) earnings per share:
As reported $ (0.30) $ (0.28) $ 0.01
Pro forma $ (0.30) $ (0.34) $ 0.00
On July 24, 2002, the Company entered into a service agreement with a consultant
for a term of 180 days. The consultant was paid by granting options to purchase
an aggregate of 200,000 shares of the Company's common stock. On August 26, 2002
the Company terminated the agreement and cancelled the outstanding stock
options.
14. SUPPLEMENTAL DISCLOSURE OF CASH FLOWS
Cash was paid during the years ended December 31, 2002, 2001 and 2000 for:
YEAR ENDED DECEMBER 31,
----------------------------------
2002 2001 2000
-------- -------- --------
Income taxes $ 5,700 $ 1,500 $203,700
======== ======== ========
Interest $183,700 $255,800 $296,000
======== ======== ========
During 2001, the Company issued 333,400 shares of its common stock to an
unrelated party in exchange for radio advertising services to be received over
three-year period. All of the shares vested upon issuance and are
non-forfeitable, resulting in a non-cash transaction of $200,000 based upon the
market price of the Company's common stock on the date of issuance.
FNC acquired certain assets of a computer technical support company in September
2001 in exchange or 16,100 PMIC shares, resulting in a non-cash investing
transaction of $20,000 based upon the average market price of the Company's
common stock.
On May 31, 2002, the Company issued warrants to purchase 400,000 shares of the
Company's common stock to the preferred stock investor and the broker in
connection with the issuance of preferred stock. In connection with the issuance
of the preferred stock, the Company recorded a non-cash deemed dividend of
relating to the beneficial conversion feature of the preferred stock of $260,000
and an accretion of the stated value of the preferred stock of $14,200.
In December 2002, the Company issued warrants to purchase up to 300,000 shares
of the Company's common stock at $1.20 per share for consulting services.
F-22
15. INVESTMENTS
The Company and Rising Edge Technologies, Ltd., a corporation based in Taiwan
(Rising Edge), entered into an Operating Agreement to form Lea in January 1999.
The objective of Lea is to provide internet users, resellers and providers
advanced software solutions and applications. Prior to June 13, 2000, the
Company and Rising Edge each owned a 50% interest in Lea. The brother of a
director, officer and principal shareholder of the Company is a director,
officer and the majority shareholder of Rising Edge (Rising Edge Majority
Holder). On June 13, 2000, the Company purchased a 25% ownership interest in
Rising Edge common stock for $500,000 from the Rising Edge Majority Holder. As
such, the Company had a 62.5% combined direct and indirect ownership interest in
Lea, which required the consolidation of Lea with the Company. The Company
accounted for its investment in Rising Edge by the equity method whereby 25% of
the equity interest in the net income or loss of Rising Edge (excluding Rising
Edge's portion of the results of Lea and all inter-company transactions) flows
through to the Company. During the year ended December 31, 2001, Lea incurred a
$191,700 net loss and the equity in the loss in the investment in Rising Edge
was $14,500. During the year ended December 31, 2000, Lea incurred a $100,800
net loss and the equity in the loss in the investment in Rising Edge was
$32,000. During the year ended December 31, 2001, Rising Edge had $9,800 in
revenues and incurred a net loss of $58,100. During the period from June 13,
2000 to December 31, 2000, Rising Edge had $101,100 in revenues and incurred a
net loss of $78,200. At December 31, 2000, Rising Edge had total assets of
$1,092,200.
In November 1999, Lea entered into a software development contract with Rising
Edge which called for the development of certain internet software for a
$940,000 fee. Of this amount the contract specified that $440,000 shall be
applied to services performed in 1999 (of which $220,000 represented the
Company's portion), and the Company and Rising Edge were each responsible for
$470,000 of the fee. During 1999, the Company paid $470,000 for its portion of
the total fee due under the contract. During the year ended December 31, 2000,
Rising Edge performed $100,000 worth of services, of which $50,000 represented
the Company's portion. In January 2001, the contract was terminated by mutual
agreement of the parties, and the Company's remaining portion of the software
development fees prepaid under the contract, totaling $200,000, was refunded.
In December 2001, the Company entered into an agreement with Rising Edge
Technology (Rising Edge) and its principal owners to exchange the 50% Rising
Edge ownership interest in Lea for the Company's 25% ownership interest in
Rising Edge. As a result, as of December 31, 2001 PMIC owned 100% of Lea and no
longer had an ownership interest in Rising Edge.
In connection with the Company's on-going evaluation of the net realizable value
of this investment, during the fourth quarter of 2001, based on the operating
history, projections and a change in focus of the investee's business, the
Company believed the value of its investment was impaired and wrote off its
investment in Rising Edge prior to the exchange of the Rising Edge shares for
Lea ownership resulting in an impairment loss of $468,000 (including the equity
in the loss in the investment of $14,500 during 2001). Because of the write-down
of the Rising Edge investment to zero in the fourth quarter of 2001, no amounts
were recorded for the 50% Rising Edge ownership interest in Lea received in this
exchange.
INVESTMENT IN TARGETFIRST
On January 20, 2000, the Company acquired, in a private placement, 485,900
shares of convertible preferred stock of a nonpublic company, TargetFirst, Inc.
(formerly ClickRebates.com), for approximately $250,000. The Company's
investment in TargetFirst, Inc., which represented approximately 8% of the
preferred stock offering, was being accounted for using the cost method. In
connection with the Company's ongoing evaluation of the net realizable value of
this investment based on its operating history and projections, the Company
determined that its investment was impaired and recorded an impairment loss of
$250,000 in the second quarter 2001.
16. ACQUISITIONS
On September 30, 2001, FNC acquired certain assets, consisting principally
of furniture and fixtures, computers and certain vendor reseller agreements, of
a computer technical support company, Technical Insights (TI), in exchange for
$20,000 worth of PMIC common stock (16,100 shares). TI has expertise in computer
technical training which enables FNC to better serve its corporate customers in
the field of technical training. The total purchase price of the TI acquisition
F-23
of $46,600, including acquisition costs of $26,600, was allocated pro rata to
the assets acquired based upon estimates of their fair values. Under the
purchase agreement, among other terms, FNC was required to pay $126,000 to the
sellers upon completion and full settlement of a sale transaction as specified
in the agreement. On October 2001 the sellers became employees of FNC. As a
result of this profit sharing arrangement, the $126,000 payment to the sellers
was recorded as compensation expense by the Company. As of December 31, 2001,
$126,000 was owed to these employees and was included in accounts payable. In
January 2002, the amount was paid to the sellers/employees under the terms of
the purchase agreement.
In October 2001, PMICC paid $85,000 cash to acquire certain assets,
including fixed assets and intellectual property, and assumed a $20,000 accrued
vacation liability of LiveMarket, Inc. The LiveMarket assets were then
transferred to Lea. The total investment of $164,100, including acquisition
costs of $59,100 relating to the LiveMarket acquisition, has been allocated pro
rata to the assets acquired based upon estimated fair values.
The acquisitions of certain assets of TI and LiveMarket were accounted for
under the purchase method of accounting as prescribed by SFAS No. 141 and not
material individually and in the aggregate to the Company's consolidated results
of operations. As such, pro forma consolidated results of operations of the
Company assuming the acquisitions took place on January 1, 2001 have not been
presented. The Company's consolidated financial statements include the
operations of TI and LiveMarket since their respective dates of acquisition.
Included in deposits and other assets at December 31, 2002 are intangible
assets relating to intellectual property and reseller agreements acquired in the
TI and LiveMarket acquisitions with a cost basis of $59,400 and accumulated
amortization of $24,300. The Company is amortizing the intangible assets over a
three-year period. Amortization expense for the year ended December 31, 2002 and
2001 was approximately $19,800 and $4,500 respectively.
17. SEGMENT INFORMATION
The Company has five reportable segments: PMI, PMIGA, FNC, Lea and LW. PMI
imports and distributes electronic products, computer components, and computer
peripheral equipment to various distributors and retailers throughout the United
States, with PMIGA focusing on the east coast area. FNC serves the networking
and personal computer requirements of corporate customers. Lea designs and
installs advanced software solutions and applications for internet users,
resellers and providers. LW sells similar products as PMI to the end-users
through a website. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies. The Company
evaluates performance based on income or loss before income taxes and minority
interest, not including nonrecurring gains or losses. Inter-segment transfers
between reportable segments have been insignificant. The Company's reportable
segments are strategic business units that offer different products and
services. They are managed separately because each business requires different
technology and marketing strategies. PMI and PMIGA are comparable businesses
with different locations of operations and customers. Sales to foreign countries
have been insignificant for the Company.
The following table presents information about reported segment profit or loss
and segment assets for the years ended December 31, 2002, 2001 and 2000:
Year Ended December 31, 2002:
PMI PMIGA FNC LEA LW Totals
------------ ------------ ------------ ------------ ------------ ------------
Revenues from
external customers $ 56,487,900 $ 9,374,200 $ 2,378,300(1) $ 496,600(2) $ 1,591,700 $ 70,328,700
Interest income 13,500 700 3,900 -- -- 18,100
Interest expense 164,400 700 17,500 -- 1,100 183,700
Depreciation and
amortization 190,800 28,000 46,300 43,100 800 309,000(3)
Segment loss
before income
taxes and
minority interest (1,701,800) (796,200) (964,500) (751,000) (166,600) (4,380,100)
Segment assets 21,442,300 842,200 1,123,400 239,700 412,300 24,059,900
Expenditures for
segment assets 58,900 800 -- 65,000 1,500 126,200
F-24
Year Ended December 31, 2001:
PMI PMIGA FNC LEA LW Totals
------------ ------------ ------------ ------------ ------------ ------------
Revenues from
external customers $ 60,293,500 $ 11,445,300 $ 3,022,200(1) $ 250,700(2) -- $ 75,011,700
Interest income 85,500 5,500 34,100 -- -- 125,100
Interest expense 230,700 600 24,500 -- 255,800
Depreciation and
amortization 222,600 27,500 25,400 3,500 -- 279,000
Segment loss
before income
taxes and
minority interest (1,563,500) (619,800) (868,800) (191,700) (3,243,800)
Segment assets 19,102,200 1,549,800 1,500,600 256,400 22,409,000
Expenditures for
segment assets 126,200 32,600 23,000 85,000 266,800
Year Ended December 31, 2000:
PMI PMIGA FNC LEA LW Totals
------------ ------------ ------------ ------------ ------------ ------------
Revenues from
external customers $ 79,610,300 $ 1,156,900 $ 8,105,500(1) -- -- $ 88,872,700
Interest income 226,800 500 -- -- -- 227,300
Interest expense 295,800 200 -- -- 296,000
Depreciation and
amortization 192,800 4,200 18,100 -- -- 215,100
Segment income (loss)
before income
taxes and
minority interest 390,400 (137,800) 56,300 (100,800) -- 208,100
Segment assets 18,528,700 1,573,600 2,575,000 -- -- 22,677,300
Expenditures for
segment assets 205,500 102,800 33,200 -- -- 341,500
(1) Includes service revenues of $473,600, $115,000, and $275,400 in 2002,
2001, and 2000, respectively.
(2) Primarily generated from service and maintenance contracts.
(3) The total of reportable segment depreciation and amortization does not
include $16,000 of amortization expense related to the warrant issuance
costs.
The following is a reconciliation of reportable segment income before income
taxes and total assets to the Company's consolidated totals:
2002 2001 2000
------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES
Income (loss) before income taxes and
minority interest for reportable segments $ (4,380,100) $ (3,243,800) $ 208,100
Equity in loss in investment in Rising Edge -- -- (32,000)
Impairment loss on investments -- (718,000)(1) --
Change in fair value of warrants 235,700 -- --
Amortization of warrants issuance costs (16,000) -- --
------------ ------------ ------------
Consolidated income (loss) before income taxes
and minority interest $ (4,160,400) $ (3,961,800) $ 176,100
============ ============ ============
Assets:
Total assets for reportable segments $ 24,059,900 $ 22,409,000 $ 22,677,300
Other assets 918,300 714,100 720,400
Elimination of inter-company receivables (7,711,200) (5,799,800) (2,536,600)
------------ ------------ ------------
Consolidated total assets $ 17,267,000 $ 17,323,300 $ 20,861,100
============ ============ ============
(1) Amount includes the equity in the loss in the investment in Rising Edge of
$14,500 during 2001.
F-25
18. LITIGATION SETTLEMENT AND CONTINGENCIES
The Company was a plaintiff in a lawsuit involving a number of claims against a
competitor. On September 27, 2000, this dispute was settled for $300,000, which
is included in other income in 2000.
There are various claims, lawsuits, and pending actions against the Company such
as counterfeit products and other matters incidental to the Company's
operations. It is the opinion of management that the ultimate resolution of
these matters will not have a material adverse effect on the Company's
consolidated financial position or results of operations.
19. SUBSEQUENT EVENTS
The Company's common stock is currently traded on the Nasdaq SmallCap Market. On
August 19, 2002 the Company received a letter from the Nasdaq Stock Market
informing the Company that the Company did not meet the criteria for continued
listing on the Nasdaq SmallCap Market. The letter stated that Nasdaq will
monitor the Company's common stock and if it closes above $1.00 for a minimum of
ten consecutive trading days, Nasdaq will notify Company of its compliance with
its continued listing standards. If the Company does not meet the continued
listing standards by February 18, 2003, Nasdaq would evaluate whether the
Company meet the initial listing criteria of the SmallCap Market. On February
28, 2003, Nasdaq notified the Company that its common stock had failed to comply
with the minimum market value of publicly held shares requirement of Nasdaq
Marketplace Rule. The Company's common stock is, therefore, subject to delisting
from the SmallCap Market. On March 6, 2003 the Company requested a hearing
before a Listing Qualifications Panel, at which it will seek continued listing.
The hearing has been scheduled on April 24, 2003. The Company has also been
notified by Nasdaq that the Company has not complied with Marketplace Rule,
which requires a minimum bid price of $1.00 per share of common stock. The
Company has until August 18, 2003 to comply with this Rule. The Company will
detail its plan to comply with both Rules at the hearing referred to above.
There can be no assurance that the Panel will grant the Company's request for
continued listing.
F-26
SUPPLEMENTAL SCHEDULE
PACIFIC MAGTRON INTERNATIONAL CORP.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Charged to
Beginning Costs Write-offs Ending
Allowance for Doubtful Accounts Balance and Expense of Accounts Balance
------------------------------- --------- ----------- ----------- ---------
Year ended December 31, 2000 $150,000 $182,200 $(157,200) $175,000
Year ended December 31, 2001 175,000 450,500 (225,500) 400,000
Year ended December 31, 2002 400,000 348,200 $(443,200) $305,000
F-27