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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2003, 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 1-11860
Focus Enhancements, Inc.
(Name of Small Business Issuer in its Charter)
Delaware 04-3144936
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1370 Dell Ave
Campbell, CA 95008
(Address of Principal Executive Offices)
(408) 866-8300
(Issuer's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of Act:
Title of Each Class
-------------------
Common Stock, $.01 par value
Name of Exchange on which Registered
------------------------------------
NASDAQ
Securities registered pursuant to Section 12(g) of the Act: None
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 other 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. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
As of August 11, 2003, there were 39,991,009 shares of the Registrant's
Common Stock Outstanding.
Focus Enhancements, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except per share data)
(unaudited)
June 30, December 31,
2003 2002
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 162 $ 1,310
Accounts receivable, net of allowances of $391 and $403 at
June 30, 2003 and December 31, 2002, respectively 2,253 1,628
Inventories 2,420 2,350
Prepaid expenses and other current assets 205 185
-------- --------
Total current assets 5,040 5,473
Property and equipment, net 141 191
Capitalized software development costs -- 40
Other assets 59 86
Intangibles, net 795 1,053
Goodwill 5,191 5,191
-------- --------
Total assets $ 11,226 $ 12,034
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Obligations under capital leases, current portion $ 21 $ 44
Accounts payable 2,522 1,860
Accrued liabilities 2,150 2,018
-------- --------
Total current liabilities 4,693 3,922
Convertible notes payable to stockholder 3,867 3,867
Obligations under capital leases, non-current -- 1
-------- --------
Total liabilities 8,560 7,790
-------- --------
Commitments and contingencies
Stockholders' equity
Preferred stock, $.01 par value; authorized 3,000,000 shares; 1,904 shares
issued at June 30, 2003 and December 31, 2002 (aggregate liquidation
preference $2,267) -- --
Common stock, $.01 par value; 60,000,000 shares authorized, 37,767,397 and
37,560,537 shares issued at June 30, 2003 and December, 2002, respectively 378 376
Additional paid-in capital 66,101 65,940
Accumulated deficit (63,063) (61,323)
Deferred compensation and price protection -- (49)
Treasury stock at cost, 497,055 and 450,000 shares at June 30, 2003 and
December 31, 2002, respectively (750) (700)
-------- --------
Total stockholders' equity 2,666 4,244
-------- --------
Total liabilities and stockholders' equity $ 11,226 $ 12,034
======== ========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
2
Focus Enhancements, Inc.
Condensed Consolidated Statements Of Operations
(in thousands, except per share amounts)
(unaudited)
Three Months ended June 30,
---------------------------
2003 2002
-------- --------
Net product revenues $ 4,301 $ 4,453
Contract revenues -- 59
-------- --------
Total net revenues 4,301 4,512
Cost of revenues:
Products 2,440 2,867
Contract -- 39
-------- --------
Total cost of revenues 2,440 2,906
-------- --------
Gross profit 1,861 1,606
-------- --------
Operating expenses:
Sales, marketing and support 1,089 1,330
General and administrative 436 542
Research and development 1,047 1,043
Amortization expense 132 217
Restructuring recovery (29) --
-------- --------
Total operating expenses 2,675 3,132
-------- --------
Loss from operations (814) (1,526)
Interest expense, net (51) (34)
Other income, net 95 48
-------- --------
Net loss $ (770) $ (1,512)
======== ========
Loss per common share:
Basic $ (0.02) $ (0.04)
======== ========
Diluted $ (0.02) $ (0.04)
======== ========
Weighted average common shares outstanding:
Basic 37,184 35,500
======== ========
Diluted 37,184 35,500
======== ========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
3
Focus Enhancements, Inc.
Condensed Consolidated Statements Of Operations
(in thousands, except per share amounts)
(unaudited)
Six Months ended June 30,
--------------------------
2003 2002
-------- --------
Net product revenues $ 8,391 $ 8,511
Contract revenues -- 759
-------- --------
Total net revenues 8,391 9,270
Cost of revenues:
Products 4,843 5,440
Contract -- 499
-------- --------
Total cost of revenues 4,843 5,939
-------- --------
Gross profit 3,548 3,331
-------- --------
Operating expenses:
Sales, marketing and support 2,087 2,716
General and administrative 813 1,215
Research and development 2,104 1,965
Amortization expense 304 508
Restructuring recovery (29) --
-------- --------
Total operating expenses 5,279 6,404
-------- --------
Loss from operations (1,731) (3,073)
Interest expense, net (102) (117)
Other income, net 95 24
-------- --------
Loss before income taxes (1,738) (3,166)
Income tax expense 2 --
-------- --------
Net loss $ (1,740) $ (3,166)
======== ========
Loss per common share:
Basic $ (0.05) $ (0.09)
======== ========
Diluted $ (0.05) $ (0.09)
======== ========
Weighted average common shares outstanding:
Basic 37,146 35,254
======== ========
Diluted 37,146 35,254
======== ========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
4
Focus Enhancements, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended June 30,
-------------------------
2003 2002
------- -------
Cash flows from operating activities:
Net loss $(1,740) $(3,166)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 405 661
Amortization of deferred compensation expense -- 61
Gain on debt settlement (95) (311)
Warrant issue expense -- 573
Changes in operating assets and liabilities, net of the effects of acquisitions:
Decrease (increase) in accounts receivable (625) 246
Decrease (increase) in inventories (70) 824
Decrease in prepaid expenses and other assets 1 134
Increase (decrease) in accounts payable 593 (1,303)
Increase (decrease) in accrued liabilities 296 (258)
Payment of legal judgement -- (2,073)
------- -------
Net cash used in operating activities (1,235) (4,612)
------- -------
Cash flows from investing activities:
Decrease in restricted collateral deposit -- 2,363
Additions to property and equipment (51) (63)
------- -------
Net cash provided by (used in) investing activities (51) 2,300
------- -------
Cash flows from financing activities:
Repayment of convertible notes payable to shareholder -- (145)
Payments under capital lease obligations (24) (21)
Net proceeds from private offerings of common stock -- 2,435
Net proceeds from exercise of common stock options/warrants 162 186
------- -------
Net cash provided by financing activities 138 2,455
------- -------
Net increase (decrease) in cash and cash equivalents (1,148) 143
Cash and cash equivalents at beginning of period 1,310 449
------- -------
Cash and cash equivalents at end of period $ 162 $ 592
======= =======
The accompanying notes are an integral part of the
condensed consolidated financial statements.
5
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
1. Basis of Presentation - Interim Financial Information
The condensed consolidated financial statements of Focus Enhancements, Inc.
("the Company" or "Focus") as of June 30, 2003 and for the three and six month
periods ended June 30, 2003 and 2002 are unaudited and should be read in
conjunction with the consolidated financial statements and notes thereto for the
year ended December 31, 2002 included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2002.
In the opinion of management, the condensed consolidated financial
statements include all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of its financial position,
operating results and cashflows for interim periods presented. The results of
operations and cashflows for the three and six month periods ended June 30, 2003
are not necessarily indicative of the results that may be expected for any
future period. All intercompany accounts and transactions have been eliminated
upon consolidation.
Stock Compensation Plans
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby compensation
cost is measured at the grant date based on the fair value of the award which is
recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, whereby compensation cost is the excess, if any, of the quoted market
price of the stock at the grant date (or other measurement date) over the amount
an employee must pay to acquire the stock. Stock options issued under the
Company's stock option plans have no intrinsic value at the grant date.
Accordingly, under APB Opinion No. 25, no compensation cost is recognized. The
Company has elected to continue with the accounting prescribed in APB Opinion
No. 25 and, as a result, must make pro forma disclosures of net income and
earnings per share and other disclosures as if the fair value based method of
accounting had been applied. Had compensation cost for the Company's stock-based
compensation plans and non-plan stock options outstanding been determined based
on the fair value at the grant dates for awards under those plans consistent
with the method prescribed by SFAS No. 123, the Company's net loss and loss per
share would have been adjusted to the pro forma amounts indicated below (in
thousands except per share data):
Three months ended Six months ended
June 30, June 30,
--------------------- ---------------------
2003 2002 2003 2002
------- ------- ------- -------
Net loss reported under APB 25 $ (770) $(1,512) $(1,740) $(3,166)
Add: Stock-based employee compensation
expense included in reported net loss -- 30 -- 61
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards (188) (186) (396) (375)
------- ------- ------- -------
Pro forma net loss $ (958) $(1,668) $(2,136) $(3,480)
======= ======= ======= =======
Basic and diluted loss per share, as reported $ (0.02) $ (0.04) $ (0.05) $ (0.09)
======= ======= ======= =======
Basic and diluted loss per share, pro forma $ (0.03) $ (0.05) $ (0.06) $ (0.10)
======= ======= ======= =======
Common stock equivalents have been excluded from all calculations of loss
per share and pro forma loss per share for the periods presented because the
effect of including them would be anti-dilutive.
6
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
2. Management's Plans
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. For the six months
ended June 30, 2003 and the year ended December 31, 2002, the Company incurred a
net loss of $1,740,000 and $5,957,000, and net cash used in operating activities
totaled $1,235,000 and $5,004,000, respectively. These factors indicate that the
Company may potentially be unable to continue as a going concern. Additionally,
our auditors have included an explanatory paragraph in their report on our
financial statements for the year ended December 31, 2002 with respect to
uncertainties about our ability to continue as a going concern.
The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. The Company's continuation as
a going concern is dependent upon its ability to generate sufficient cash flows
to meet its obligations on a timely basis, to obtain additional financing as may
be required, and ultimately to return to profitability and significant positive
cash flows.
The Company has historically met cash needs from the proceeds of debt, the
sale of common stock in private placements, and the exercise of stock options
and warrants. Management continues to assess its product lines in light of
technology trends and economic conditions, to identify how to enhance existing
product lines or create new distribution channels. In addition, the Company is
developing and expects to announce at least one more new product during the
second half of 2003.
During 2002, management took steps to continue to reduce costs, including
the reduction of its personnel by 9% in April 2002 and the closure of its
Chelmsford, MA office on September 30, 2002, (resulting in a $96,000
restructuring charge). Additionally, in September 2002, the Company furloughed
7% of its personnel and subsequently terminated such personnel in December 2002.
At June 30, 2003, $44,000 of the restructuring reserve remained.
Even with the anticipated reduction in expenses related to the
restructuring and an expected increase in sales, the Company determined that it
would need to raise additional funds to support its working capital needs and
meet existing debt obligations. In connection with that need, on July 2, 2003,
the Company raised net proceeds of approximately $2.0 million in a private
placement transaction with independent third parties through the issuance of
2,200,000 shares of the Company's common stock. See Note 11 "Subsequent Event -
Private Placement" for further details.
There is no assurance that management's plans will be successful or if
successful, that they will result in the Company continuing as a going concern.
3. Recent Accounting Pronouncements
In December 2002, the FASB, issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-an Amendment of FASB Statement No.123,
which provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Effective December 31, 2002, the
Company adopted the amended annual and interim disclosure requirements of SFAS
No. 123.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires that upon
issuance of a guarantee, the guarantor must recognize a liability for the fair
value of the obligation it assumes under that guarantee. The Company has adopted
the disclosure provisions of FIN 45, where applicable, and will apply the
recognition and measurement provision for all material guarantees entered into
or modified after December 31, 2002. The adoption of FIN 45 had no impact on the
Company's financial statements.
7
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
4. Inventories
Inventories are stated at lower of cost (first-in, first-out) or market (in
thousands):
June 30, December 31,
2003 2002
------ ------
Raw materials $1,452 $1,383
Work in process 292 116
Finished goods 676 851
------ ------
Totals $2,420 $2,350
====== ======
5. Intangible Assets
Intangible assets consisted of the following as of (in thousands):
June 30, 2003 December 31, 2002
------------------------------------- ------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------- ------------ ------ -------- ------------ ------
Intangible assets:
Tradename $ 176 $ 108 $ 68 $ 176 $ 86 $ 90
Existing Technology 1,888 1,161 727 1,888 925 963
------- -------- ------ -------- ------ ------
Total $ 2,064 $ 1,269 $ 795 $ 2,064 $1,011 $1,053
======= ======== ====== ======== ====== ======
Estimated Future Amortization Expense:
For the six months ending December 31, 2003 $ 258
Year ending December 31, 2004 516
Year ending December 31, 2005 21
------
$ 795
======
6. Commitments
Convertible Promissory Notes
Convertible promissory notes payable at June 30, 2003 and December 31, 2002
consists of three promissory notes totaling $3,867,000, payable to Carl Berg, a
Company director and shareholder. These notes were amended on April 28, 2003, to
provide for an extension of the maturity dates to November 25, 2004. The notes
bear interest at prime plus 1%, payable quarterly, and are collateralized by
substantially all of the assets of the Company. The Company is obligated, under
certain circumstances, including at the election of Mr. Berg and Focus, to
convert the outstanding balances of the notes, and any unpaid interest, into
shares of Focus common stock or preferred stock, as specified in the respective
note agreements.
General
From time to time, the Company is party to certain other claims and legal
proceedings that arise in the ordinary course of business which, in the opinion
of management, will not have a material adverse effect on the Company's
financial position or results of operations.
We indemnify our customers from third party claims alleging patent or
copyright infringement relating to the use of our products. Such indemnification
provisions are accounted for in accordance with SFAS No. 5 and are generally
8
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
limited to the amount paid by the customer. Historically, costs related to these
indemnification arrangements have not been significant.
7. Stockholders' Equity
Preferred Stock
The Company is obligated, under certain circumstances, including at the
election of Mr. Berg and Focus, to convert certain of the outstanding balances
of convertible notes payable to Mr. Berg, and any unpaid interest, into shares
of Focus preferred stock. As of June 30, 2003, approximately 1,421 shares of
preferred stock were subject to issuance to Mr. Berg pursuant to the convertible
notes payable agreements. See "See Note 6. Commitments - Convertible Promissory
Notes."
Common Stock
On January 11, 2002, the Company completed the sale of 2,434,490 shares of
its common stock in a private placement to four independent third parties,
receiving proceeds of approximately $2,436,000, net of offering costs of
$314,000. Additionally, the Company incurred $182,000 of costs during 2001 in
connection with this offering (including costs associated with the subsequent
registration of the shares), resulting in total offering costs of $496,000. The
shares were sold at a 20% discount to the 20-day average closing bid prices of
the Company's common stock as of December 27, 2001, the date an agreement in
principle was reached by the parties. In connection with the private placement,
the Company issued warrants to the four investors to purchase a total of 367,140
shares of common stock at an exercise price of $1.36 per share. Additionally, in
connection with the efforts of vFinance Investments Inc. to find investors in
the private placement, the Company issued warrants to vFinance Investments Inc.
to purchase a total of 123,690 shares of common stock at an exercise price of
$1.36 per share. Tim Mahoney, a member of the Company's Board of Directors is
the Chairman and COO of vFinance, Inc., the parent company of vFinance
Investments Inc.
On July 28, 2000, the Company entered into an equity line of credit
agreement with Euston Investments Holdings Limited ("Euston"), for the future
issuance and purchase of up to 4,000,000 shares of the Company's common stock at
a 10% discount. In lieu of providing Euston with a minimum aggregate drawdown
commitment, the Company issued to Euston a stock purchase warrant to purchase
250,000 shares of common stock with an exercise price of $1.625. The warrant
expires June 12, 2005. The Company had sought to register such shares under a
Registration Statement on Form SB-2. However, before the registration statement
was declared effective, on January 11, 2002, Focus and Euston mutually agreed to
terminate the agreement. As consideration for terminating the agreement, the
exercise price of Euston's warrants to purchase 250,000 shares of Focus common
stock was reduced from $1.625 to $0.75 per share. As a result of the repricing
the Company incurred a $334,000 charge to other expense in the first quarter of
2002. The charge was computed using the Black-Scholes model with assumptions of
a risk-free rate of interest of 2.9%, expected volatility of 130%, a dividend
yield of 0.0% and an expected remaining life of 1.4 years.
On March 1, 2002, the Company issued warrants to purchase 270,000 shares of
common stock as compensation to three unrelated parties for consulting services
in the areas of investment advisory, investor relations and public relation
services. The warrants are exercisable for a period of two to three years at
exercise prices ranging from $1.35 to $1.50 per share. The Company recorded
charges of approximately $238,000 for the quarter ended March 31, 2002 based on
the fair value of the warrants. Such amounts were recorded as general and
administrative expenses and the fair value of the warrants were calculated using
the Black-Scholes option pricing model with the following assumptions:
contractual term of 2 to 3 years, volatility of 136% to 143%, risk free interest
rate of 2.9% to 3.6%, and no dividends during the term of the warrant.
On November 25, 2002, the Company completed the sale of 800,000 shares of
its common stock in a private placement to two independent third parties,
receiving proceeds of approximately $685,000, net of offering costs of $83,000.
The shares were sold at an approximate 20% discount to the 20-day average
closing bid prices of the Company's common stock as of November 24, 2002, the
date an agreement in principle was reached by the parties. Additionally, in
connection with the efforts of vFinance Investments Inc. to find investors in
the private placement, the Company issued warrants to vFinance Investments Inc.
to purchase a total of 40,000 shares of common stock at an exercise price of
$1.20 per share.
9
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
As of June 30, 2003, the Company was obligated under certain circumstances,
to issue the following additional shares of common stock :
Warrants to purchase common stock 1,162,140
Options to purchase common stock 6,363,469
Notes payable convertible into common stock 1,963,138
Preferred Stock convertible into common stock 1,904,000
----------
Total shares of common stock obligated, under
certain circumstances, to issue 11,392,747
==========
See also Note 11. "Subsequent Event - Private Placement."
8. Related Party Transactions
In February 2003, the Company engaged vFinance Consulting to assist the
Company in preparing a Strategic Business Plan. Tim Mahoney, a member of the
Company's Board of Directors is the Chairman and COO of vFinance, Inc., the
parent company to vFinance Consulting. For the three and six months ended June
30, 2003 the Company incurred consulting expenses of $35,000 and $50,000
respectively. In connection with its efforts to find investors in the private
placement completed on January 11, 2002, the Company engaged vFinance
Investments Inc. Tim Mahoney is a principal in vFinance Investments Inc. For the
three and six months ended June 30, 2003, vFinance Investments Inc., received
$275,000 in cash and a warrant to purchase 123,690 shares of common stock of
Focus at $1.36 per share.
9. Significant Customers
One customer accounted for 17% of the Company's revenue for the quarter
ended June 30, 2003 and 27% of the Company's accounts receivable balance at June
30, 2003.
Three unrelated customers, each with sales in excess of 10% of the
Company's revenue accounted for 35% of total revenue for the quarter ended June
30, 2002.
As of December 31, 2002, two distributors represented approximately 31% of
the Company's accounts receivable balance (21% and 10% respectively), while a
customer represented an additional 10% of the Company's accounts receivable
balance.
10. Bill and Hold Transaction
For the periods ended June 30, 2003 and 2002, the Company did not have in
its possession any product that had been sold and at the customer's request was
being stored by the Company. However, for the quarter ended March 31, 2003, the
Company had approximately $362,000 of product it was storing for one particular
customer. Such revenue pertained to the sale of product to the Company's
distributor in Asia and was recognized during the first quarter of 2003 as the
product specifications of the purchase contract had been met during the quarter,
the product was accepted by the buyer, title had passed to the buyer, there was
no right of return in the contract, the distributor requested that the product
be stored and, the product was segregated from the Company's regular inventory
and was ready for shipment. Full payment for the product was received in March
2003. In June 2003, in accordance with the customer's instructions, the Company
shipped the product.
10
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
11. Subsequent Event
Private Placement
On July 2, 2003, the Company completed the sale of 2,200,000 shares of its
common stock in a private placement to two independent third parties, receiving
net proceeds of approximately $2.0 million. The shares were sold at an
approximate 20% discount to the 5-day average closing bid prices of the
Company's common stock prior to closing. In connection with the private
placement, the Company issued warrants to the two investors and a placement
agent to purchase a total of 467,500 shares of common stock at an exercise price
of $1.44 per share. The Company has agreed to file a registration statement
covering public resales of the shares issued and the shares issuable in the
future upon the exercise of the warrants.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
The following information should be read in conjunction with the
consolidated financial statements and notes thereto in Part I, Item 1 of this
Quarterly Report and with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2002.
Certain Factors That May Affect Future Results
Discussions of certain matters in this Quarterly Report on Form 10-Q may
constitute forward-looking statements within the meaning of the Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act"), and as such, may involve
risks and uncertainties. Forward-looking statements, which are based on certain
assumptions and describe future plans, strategies, and expectations, are
generally identifiable by the use of words or phrases such as "believe", "plan",
"expect", "intend", "anticipate", "estimate", "project", "forecast", "may
increase", "may fluctuate", "may improve" and similar expressions or future or
conditional verbs such as "will", "should", "would", and "could".
In particular, statements contained in this document which are not
historical facts (including, but not limited to, statements concerning
anticipated revenues, anticipated operating expense levels, potential new
products and orders, and such expense levels relative to our total revenues)
constitute forward looking statements and are made under the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Our actual
results of operations and financial condition have varied and may in the future
vary significantly from those stated in any forward looking statements. Factors
that may cause such differences include, without limitation, the availability of
capital to fund our future cash needs, reliance on major customers, history of
operating losses, market acceptance of our products, technological obsolescence,
competition, component supply problems and protection of proprietary
information, as well as the accuracy of our internal estimates of revenue and
operating expense levels. For a discussion of these factors and some of the
factors that might cause such a difference see also " - Risks Factors." These
factors should be considered in evaluating the forward-looking statements, and
undue reliance should not be placed on such statements. We do not undertake, and
specifically disclaims any obligation, to update any forward-looking statements
to reflect occurrences or unanticipated events or circumstances after the date
of such statements.
Results of Operations
Net Revenues
Net revenues for the three-months ended June 30, 2003 were $4,301,000 as
compared with $4,512,000 for the three-month period ended June 30, 2002, a
decrease of $211,000, or 5%. Net revenues for the six-months ended June 30, 2003
were $8,391,000 as compared with $9,270,000 for the six-month period ended June
30, 2002, a decrease of $879,000 or 9%.
For the three-months ended June 30, 2003, net sales of system products
(professional and consumer) to distributors, retailers and VAR's were
approximately $3,513,000 as compared to $3,952,000 for the same period in 2002,
a decrease of $439,000 or 11%. For the six-months ended June 30, 2003, net sales
of system products (professional and consumer) to distributors, retailers and
VAR's were approximately $7,161,000 as compared to $7,478,000 for the same
period in 2002, an increase of $317,000 or 4%. The decrease between comparison
periods is the result of a decrease in business to business sales as a result of
the continued slowdown in the economy and as a result of a reduction of
nationwide computer sales and decreased educational spending.
For the three-months ended June 30, 2003, net sales of semiconductor
products to distributors and OEM customers, which includes contract revenues,
were approximately $788,000 as compared to $560,000 for the same period in 2002,
an increase of $228,000 or 40%. For the six-months ended June 30, 2003, net
sales of semiconductor products to distributors and OEM customers, which
includes contract revenues, were approximately $1,230,000 as compared to
$1,792,000 for the same period in 2002, a decrease of $562,000 or 31%. The
increase in OEM sales for the three
12
months comparison period is primarily attributable to increased sales of our
semiconductor chips as we have been designed into newly introduced products. The
decrease in OEM sales for the six months comparison period is primarily
attributable to a decrease in contract revenues as the Company reported contract
revenues of $759,000 for the six-months ended June 30, 2002, while no contract
revenues were reported for the six-months ended June 30, 2003. Contract revenues
related to the development of an Application Specific Integrated Circuit (ASIC)
for a third party that began in June 2001 and finished in June 2002. Under this
development contract the Company recorded total revenues of $2.1 million.
As of June 30, 2003, the Company had a sales order backlog of approximately
$6,793,000, an increase of $5,567,000 when compared to the first quarter of
2003. The growth in backlog is a result of increased semiconductor chip and
FireStore orders. See Risk Factors - "The substantial increase in our backlog in
recent periods should not be construed as indicative of future revenue or
performance".
Cost of Goods Sold
Cost of goods sold were $2,440,000, or 57% of net sales, for the
three-months ended June 30, 2003, as compared with $2,906,000, or 64% of net
sales, for the three-months ended June 30, 2002, a decrease of $466,000 or 16%.
The Company's gross profit margin for the second quarters of 2003 and 2002 were
43% and 36%, respectively. Cost of goods sold were $4,843,000, or 58% of net
sales, for the six-months ended June 30, 2003, as compared with $5,939,000, or
64% of net sales, for the six months ended June 30, 2002, a decrease of
$1,096,000 or 18%. The Company's gross profit margin for the six-month periods
of 2003 and 2002 were 42% and 36%, respectively. The majority of the increase in
gross profit margin for the three and six month comparison periods is primarily
attributable to reduced manufacturing expenses as the Company reduced its
personnel expenditures, primarily headcount, and as a result of product mix and
improved pricing on certain of its products.
Sales, Marketing and Support Expenses
Sales, marketing and support expenses were $1,089,000, or 25% of net
revenues, for the three-months ended June 30, 2003, as compared with $1,330,000,
or 29% of net revenues, for the three-months ended June 30, 2002, a decrease of
$241,000 or 18%. Sales, marketing and support expenses were $2,087,000, or 25%
of net revenues, for the six-months ended June 30, 2003, as compared with
$2,716,000, or 29% of net revenues, for the six-months ended June 30, 2002, a
decrease of $629,000 or 23%. The decrease in sales, marketing and support
expenses in absolute dollars is primarily the result of lower staffing, and
reduced marketing and advertising expenses.
General and Administrative Expenses
General and administrative expenses for the three-months ended June 30,
2003 were $436,000 or 10% of net revenues, as compared with $542,000 or 12% of
net revenues for the three-months ended June 30, 2002, a decrease of $106,000 or
20%. General and administrative expenses for the six-months ended June 30, 2003
were $813,000 or 10% of net revenues, as compared with $1,215,000 or 13% of net
revenues for the six-months ended June 30, 2002, a decrease of $402,000. The
decrease in general and administrative expense for the three-month period ended
June 30, 2003 is primarily attributable to a decrease in bad debt expense. For
the six-month period, general and administrative expenses decreased as the six
months ended June 30, 2002 included a $238,000 charge associated with the
issuance of warrants in connection with consulting services and included an
additional $61,000 of bad debt expense.
Research and Development Expenses
Research and development expenses for the three-months ended June 30, 2003
were approximately $1,047,000 or 24% of net revenues, as compared with
$1,043,000 or 23% of net revenues for the three-months ended June 30, 2002, an
increase of $4,000 or less than 1%. Research and development expenses for the
six-months ended June 30, 2003 were approximately $2,104,000 or 25% of net
revenues, as compared with $1,965,000 or 21% of net revenues for the six-months
ended June 30, 2002, an increase of $139,000 or 7%. The increase in research and
development expenses between the six-month comparison periods is due primarily
to a reduction in engineering work performed under contract and as such less
research and development personnel expenses were allocated to costs of sales
than in the prior year.
13
Amortization
Amortization expenses for the three-month period ended June 30, 2003 were
$132,000 or 3% of net revenues, as compared with $217,000 or 5% of net revenues,
for the three-months ended June 30, 2002, a decrease of $85,000 or 39%.
Amortization expenses for the six-month period ended June 30, 2003 were $304,000
or 5% of net revenues, as compared with $508,000 or 5% of net revenues, for the
six-months ended June 30, 2002, a decrease of $204,000 or 40%. The decrease in
the three and six month comparison periods is primarily due to the Company's
adoption of FAS 142 on January 1, 2002, under which goodwill is no longer
amortized (See also "Basis of Presentation - Interim Financial Information -
Stock Compensation Plans") and as a result of the Company completing
amortization of its remaining capitalized software development expenses.
Restructuring Expenses
The Company reduced its restructuring expense accrual in the three-month
period ended June 30, 2003, by $29,000 as it was able to settle amounts due on
the closure of its Chelmsford facility for an amount less than originally
estimated.
Interest Expense, Net
Net interest expense for the three-month period ended June 30, 2003 was
$51,000, or 1% of net revenues, as compared to $34,000, or 1% of net revenues,
for the three-months ended June 30, 2002, an increase of $17,000. Net interest
expense for the six-month period ended June 30, 2003 was $102,000, or 1% of net
revenues, as compared to $117,000, or 2% of net revenues, for the six-months
ended June 30, 2002, a decrease of $15,000.
Other Income, Net
Net other income for the three-month period ended June 30, 2003 was
$95,000, or 2% of net revenues, as compared to $48,000, or 1% of net revenues,
for the three-months ended June 30, 2002, an increase of $47,000. Net other
income for the six-month period ended June 30, 2003 was $95,000, or 2% of net
revenues, as compared to $24,000, or 1% of net revenues, for the six-months
ended June 30, 2002, an increase of $71,000.
Other income for the three months ended June 30, 2003 and 2002 is primarily
comprised of the settlement of debts for less than original amounts. Other
income for the six months ended June 30, 2003 is primarily comprised of the
settlement of debts for less than original amounts. Other income for the six
months ended June 30, 2002 is primarily comprised of a charge of $334,000
related to the repricing of warrants associated with the termination of an
equity line of credit offset by gains on the settlement of debts for less than
original amounts of $360,000
Liquidity and Capital Resources
The accompanying condensed consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. For the
six months ended June 30, 2003 and the year ended December 31, 2002, the Company
incurred net losses of $1,740,000 and $5,957,000, respectively, and net cash
used in operating activities of $1,235,000, and $5,004,000, respectively. These
factors indicate that the Company may potentially be unable to continue as a
going concern.
The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. The Company's continuation as
a going concern is dependent upon its ability to generate sufficient cash flows
to meet its obligations on a timely basis, to obtain additional financing as may
be required, and ultimately to return to profitability and significant positive
cash flows.
Since inception, the Company has financed its operations primarily through
the public and private sale of common stock, proceeds from the exercise of
options and warrants, short-term borrowing from private lenders, and favorable
credit arrangements with vendors and suppliers.
14
Net cash used in operating activities for the six-month periods ended June
30, 2003 and 2002 was $1,235,000 and $4,612,000, respectively. In the first six
months of 2003, net cash used in operating activities consisted primarily of a
net loss of $1,740,000 adjusted for depreciation and amortization of $405,000,
an increase in accounts payable of $593,000 and accrued liabilities of $296,000
offset by an increase in accounts receivable of $625,000 and inventories of
$70,000. In the first six months of 2002, net cash used in operating activities
consisted primarily of a net loss of $3,166,000 adjusted for depreciation and
amortization of $661,000, warrant issue expense of $573,000 and gain on debt
settlement totaling $311,000, a decrease in accounts payable of $1,303,000 and
payment of legal judgement of $2,073,000, partially offset by an decrease in
inventories totaling $824,000.
One customer accounted for 17% of the Company's revenue for the quarter
ended June 30, 2003 and 27% of the Company's accounts receivable balance at June
30, 2003.
We expect that our operating cash flows may fluctuate in future periods as
a result of fluctuations in our operating results, shipment linearity and
accounts receivable collections, inventory management, and the timing of
payments among others.
Net cash used by investing activities for the six-months ended June 30,
2003 was $51,000 compared to net cash provided by investing activities for the
six-months ended June 30, 2002 of $2,300,000. For the first six months of 2003,
cash used in investing activities was related to the purchase of property and
equipment of $51,000. For the first six months of 2002, cash provided in
investing activities was principally from the decrease in restricted collateral
deposit of $2,363,000, offset by the purchase of property and equipment of
$63,000.
Net cash provided by financing activities for the six-month periods ended
June 30, 2003 and 2002 was $138,000 and $2,455,000, respectively. In the first
six months of 2003, the Company received $162,000 from the exercise of common
stock options, which were partially offset by payment under capital lease
obligations. In the first six months of 2002, the Company received $2,435,000 in
net proceeds from private offerings of common stock and $186,000 from the
exercise of common stock options, which were partially offset by repayment of
convertible notes payable to shareholder of $145,000.
As of June 30, 2003, the Company had working capital of $347,000, as
compared to $1,551,000 at December 31, 2002, a decrease of $1,204,000.
The Company has incurred losses and negative cash flows from operations for
the six months ended June 30, 2003 and each of the two years in the period ended
December 31, 2002 and as such has been dependent upon raising money for short
and long-term cash needs through debt, proceeds from the exercise of options and
warrants, and the sale of common stock in private placements. For the year ended
December 31, 2002, the Company received approximately $3,121,000 in net proceeds
from private offerings of common stock.
At June 30, 2003, the Company owed Mr. Berg approximately $4.3 million in
principal and accrued interest on various notes.
During 2002, management continued to take steps to reduce costs, including
a 9% reduction in personnel in April of 2002. Additionally, in September 2002,
the Company closed its Chelmsford, MA office (resulting in a $96,000
restructuring charge) and furloughed 7% of its personnel. In December 2002, the
Company terminated those furloughed employees and recorded a severance accrual
of $26,000. At June 30, 2003, $44,000 of the restructuring reserve remained.
In addition to regularly reviewing its cost structure, management is
continually reviewing its product lines to identify how to enhance existing or
create new distribution channels. During 2002, the Company released four new
products. Many of these new products are expected to take hold in their
respective markets and provide additional revenue to the Company in 2003.
Additionally, the Company expects to announce at least one more new product in
the second half of 2003. There can be no assurances as to the amount of revenue
these new products will produce. See "Risk Factors."
There is no assurance that management's plans will be successful or if
successful, that they will result in the Company continuing as a going concern.
15
Ultimate future capital requirements will depend on many factors, including
cash flow from operations, continued progress in research and development
programs, competing technological and market developments, and our ability to
market our products successfully. Even with the anticipated reduction in
expenses related to the restructuring and an expected increase in sales, the
Company determined that it would need to raise additional funds to support its
working capital needs and meet existing debt obligations. In connection with
that need, on July 2, 2003, the Company raised net proceeds of approximately
$2.0 million in a private placement transaction with independent third parties
through the issuance of 2,200,000 shares of the Company's common stock. It is
expected that additional costs will be incurred by the Company to register such
shares during the third quarter of 2003 pursuant to a registration rights
agreement. See Note 11 "Subsequent Event - Private Placement" for further
details.
Effects of Inflation and Seasonality
The Company believes that inflation has not had a significant impact on the
Company's sales or operating results. The Company's business does not experience
substantial variations in revenues or operating income during the year due to
seasonality.
Summary of Certain Contractual Obligations as of June 30, 2003
Amount of Commitment Expiration Per Period (in thousands)
---------------------------------------------------------
Less Than After 5
Total 1 year 2-3 Years 4-5 Years Years
----- ------ --------- --------- -----
Notes payable to stockholder $ 3,867 $ -- $3,867 $ -- $ --
Capital leases 21 21 -- -- --
Operating leases 1,039 261 776 2 --
------- ------ ------ ----- -----
Total $ 4,927 $ 282 $4,643 $ 2 $ --
======= ====== ====== ===== =====
Recent Accounting Pronouncements
In December 2002, the FASB, issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-an Amendment of FASB Statement No.123,
which provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Effective December 31, 2002, the
Company adopted the amended annual and interim disclosure requirements of SFAS
No. 123.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires that upon
issuance of a guarantee, the guarantor must recognize a liability for the fair
value of the obligation it assumes under that guarantee. The Company has adopted
the disclosure provisions of FIN 45, where applicable, and will apply the
recognition and measurement provision for all material guarantees entered into
or modified after December 31, 2002. The adoption of FIN 45 had no impact on the
Company's financial statements.
Critical Accounting Policies
There have no significant changes to the Company's critical accounting
policies as described in the Company's 2002 Form 10-KSB
Risk Factors
You should carefully consider the following risks relating to our business
and our common stock, together with the other information described elsewhere in
this prospectus. If any of the following risks actually occur, our business,
results of operations and financial condition could be materially affected, the
trading price of our common stock could decline, and you might lose all or part
of your investment.
16
Risks Related to Our Business
We have a long history of operating losses.
As of June 30, 2003, we had an accumulated deficit of $63,063,000. We incurred
net losses of $1,740,000, $5,597,000 and $6,658,000 for the six months ended
June 30, 2003 and the years ended December 31, 2002 and 2001, respectively.
There can be no assurance that we will become profitable. Additionally, our
auditors have included an explanatory paragraph in their report on our financial
statements for the year ended December 31, 2002 with respect to uncertainties
about our ability to continue as a going concern. The financial statements do
not include any adjustments that might result from the outcome of that
uncertainty.
We may need to raise additional capital, which will result in further dilution
of existing and future stockholders.
Historically, we have met our short-and long-term extra cash needs through debt
and the sale of common stock in private placements because cash flow from
operations has been insufficient to fund our operations. Set forth below is
information regarding net proceeds received recently:
Private Offerings Of Issuance of Exercise of Stock
Common Stock Debt Options and Warrants
------------ ---- --------------------
First six months of 2003 -- -- $162,000
Fiscal 2002 $3,121,000 -- $625,000
Fiscal 2001 -- $2,650,000 $199,000
See also Note 11 "Subsequent Event - Private Placement." Future capital
requirements will depend on many factors, including cash flow from operations,
continued progress in research and development programs, competing technological
and market developments, and our ability to market our products successfully. If
we require additional equity or debt financing in the future, there can be no
assurance that sufficient funds will be raised. Moreover, any equity financing
or convertible debt would result in dilution to our then-existing stockholders
and could have a negative effect on the market price of our common stock.
Furthermore, any additional debt financing may result in higher interest
expense.
In the event we are unable to raise additional capital, we may not be able to
fund our operations which could result in the inability to execute our current
business plan.
We have a significant amount of convertible securities that will dilute existing
stockholders upon conversion.
At June 30, 2003, we had 37,270,342 and 1,904 shares of common and preferred
shares issued and outstanding, respectively, and 1,162,140 warrants and
6,363,469 options that are exercisable into shares of common stock. The 1,904
shares of preferred stock are convertible into 1,904,000 shares of our common
stock. Furthermore, we may grant 1,134,092 additional stock options to our
employees, officers, directors and consultants under our current stock option
plans. We also may issue additional shares in acquisitions. Any additional grant
of options under existing or future plans or issuance of shares in connection
with an acquisition, will further dilute existing stockholders. See also Note 11
"Subsequent Event - Private Placement."
In addition, at June 30, 2003, the Company was obligated under certain
circumstances, to issue up to 1,963,138 shares of common stock and 1,421 shares
of preferred stock convertible into 1,421,000 shares of common stock upon the
conversion of $4.3 million in debt and accrued interest outstanding to Mr. Carl
Berg.
We are dependent upon a significant stockholder to meet our interim financing
needs.
We have relied upon the ability of Carl Berg, a director and significant owner
of our common stock for interim financing needs. As of June 30, 2003, we had an
aggregate of approximately $4.3 million in debt and accrued interest outstanding
to Mr. Berg. Additionally, Mr. Berg has provided Samsung Semiconductor Inc., the
Company's contracted ASIC manufacturer, with a personal guarantee to secure the
Company's working capital requirements for ASIC purchase order fulfillment.
There can be no assurances that Mr. Berg will continue to provide such interim
financing or personal guarantees, should we need additional funds or increased
credit facilities with our vendors.
17
We rely on certain vendors for a significant portion of our manufacturing.
Over 40% of the components for our products are manufactured on a turnkey basis
by three vendors, Furthertech Company Ltd., Samsung Semiconductor Inc., and
Asemtec Corporation. In addition, certain of our products are assembled by a
single vendor in Mexico. If these vendors experience production or shipping
problems for any reason, we in turn could experience delays in the production
and shipping of our products, which would have an adverse effect on our results
of operations.
We are dependent on our suppliers.
We purchase all of our parts from outside suppliers and from time to time
experience delays in obtaining some components or peripheral devices.
Additionally, we are dependent on sole source suppliers for certain components.
There can be no assurance that labor problems, supply shortages or product
discontinuations will not occur in the future which could significantly increase
the cost, or delay shipment, of our products, which in turn could adversely
affect our results of operations.
We rely on sales to a few major customers for a large part of our revenues.
As of June 30, 2003, one distributor represented approximately 27% of the
Company's accounts receivable. We do not have long-term contracts requiring any
customer to purchase any minimum amount of products. There can be no assurance
that we will continue to receive orders of the same magnitude as in the past
from existing customers or we will be able to market our current or proposed
products to new customers. Loss of any major customer would have a material
adverse effect on our business as a whole. Furthermore, many of our products are
dependent upon the overall success of our customer's product, over which we
often have no control.
Our products may become obsolete very quickly.
The computer peripheral markets are characterized by extensive research and
development and rapid technological change resulting in short product life
cycles. Development by others of new or improved products, processes or
technologies may make our products or proposed products obsolete or less
competitive. We must devote substantial efforts and financial resources to
enhance our existing products and to develop new products. There can be no
assurance that we will succeed with these efforts.
We may not be able to protect our proprietary information.
As of June 30, 2003, we had been issued five patents and filed five provisional
patent applications in the United States. Certain of these patents have also
been filed and issued in countries outside the United States. We treat our
technical data as confidential and rely on internal non-disclosure safeguards,
including confidentiality agreements with employees, and on laws protecting
trade secrets, to protect our proprietary information. There can be no assurance
that these measures will adequately protect the confidentiality of our
proprietary information or prove valuable in light of future technological
developments.
Delays in product development could adversely affect our market position or
customer relationships.
We have experienced delays in product development in the past and may experience
similar delays in the future. Given the short product life cycles in the markets
for our products, any delay or unanticipated difficulty associated with new
product introductions or product enhancements could cause us to lose customers
and damage our competitive position. Prior delays have resulted from numerous
factors, such as:
* changing product specifications; difficulties in hiring and retaining
necessary personnel;
* difficulties in reallocating engineering resources and other resource
limitations;
* difficulties with independent contractors;
* changing market or competitive product requirements;
* unanticipated engineering complexity;
* undetected errors or failures in software and hardware; and
* delays in the acceptance or shipment of products by customers.
18
If we are unable to respond to rapid technological change in a timely manner,
then we may lose customers to our competitors.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our products. Our industry is
characterized by rapid technological change, changes in user and customer
requirements and preferences and frequent new product and service introductions.
If competitors introduce products and services embodying new technologies, or if
new industry standards and practices emerge, then our existing proprietary
technology and systems may become obsolete. Our future success will depend on
our ability to do the following:
* both license and internally develop leading technologies useful in our
business;
* enhance our existing technologies;
* develop new services and technology that address the increasingly
sophisticated and varied needs of our prospective customers; and
* respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
To develop our proprietary technology entails significant technical and business
risks. We may use new technologies ineffectively, or we may fail to adapt our
proprietary technology and transaction processing systems to customer
requirements or emerging industry standards. If we face material delays in
introducing new services, products and enhancements, then our customers may
forego the use of our services and use those of our competitors.
The substantial increase in our backlog in recent periods should not be
construed as indicative of future revenue or performance.
In the past we have experienced quarterly fluctuations in operating results due
to the contractual nature of our business and the consequent timing of product
orders. In addition, we have historically operated with a small amount of
backlog and accordingly our revenues in any quarter have been substantially
dependent upon orders booked in that quarter. However, as of June 30, 2003, our
total backlog was approximately $6.8 million compared to $223,000 at December
31, 2002. There can be no assurance that the rate of growth in backlog will
continue. Furthermore, only a small portion of our backlog is fully-funded and
many of our customers have the ability to delay delivery or cancel contracts,
therefore, there can be no assurance that orders comprising the backlog will be
realized as revenue. In any event, quarterly sales and operating results will be
continue to be affected by the volume and timing of contracts received and
performed within the quarter, which are difficult to forecast. Any significant
deferral or cancellation of a contract could have a material adverse effect on
our operating results in any particular period. Because of these factors, we
believe that period-to-period comparisons of our operating results are not
necessarily indicative of future performances.
Our quarterly financial results are subject to significant fluctuations.
We have been unable in the past to accurately forecast our operating expenses or
revenues. Our revenues currently depend heavily on volatile customer purchasing
patterns. If actual revenues are less than projected revenues, we may be unable
to reduce expenses proportionately, and our operating results, cash flows and
liquidity would likely be adversely affected.
Recently, our common stock did not meet the minimum bid price requirement to
remain listed on the Nasdaq SmallCap Market. If we were to be delisted, it could
make trading in our stock more difficult.
Our common stock is traded on the Nasdaq SmallCap Market. There are various
quantitative listing requirements for a company to remain listed on the Nasdaq
SmallCap Market.
We are required to maintain a minimum bid price of $1.00 per share for
our common stock. Between January 1, 2003 and June 30, 2003, our stock
closed below $1.00 a share on 64 of 124 trading days. On March 18, 2003, we
were notified by the Nasdaq that our common stock did not meet the minimum
bid price requirement to remain listed on the Nasdaq SmallCap Market.
However, on May 21, 2003, we received notification from Nasdaq that the
Company had regained compliance and the matter was now closed.
19
We must maintain stockholders' equity of $2,500,000. At June 30, 2003, we
had total stockholders' equity of $2,666,000 million. To the extent we
continue to incur net losses and do not raise additional capital, our
stockholders' equity will be reduced. See however, Note 11 - Subsequent
Event - Private Placement.
If we fail these Nasdaq SmallCap requirements, our common stock could be
delisted, eliminating the only established trading market for shares of our
common stock. Any sales of our common stock at a discount to market may reduce
the trading price of our common stock to a level below the Nasdaq minimum bid
price requirement.
In the event we are delisted from Nasdaq, we would be forced to list our shares
on the OTC Electronic Bulletin Board or some other quotation medium, such as
pink sheets, depending on our ability to meet the specific listing requirements
of those quotation systems. As a result an investor might find it more difficult
to dispose of, or to obtain accurate price quotations for, our shares. Delisting
might also reduce the visibility, liquidity, and price of our common stock.
Our common stock price is volatile.
The market price for our common stock is volatile and has fluctuated
significantly to date. For example, between July 1, 2002 and June 30, 2003, the
per share price of our stock has fluctuated between $0.45 and $2.20 per share,
closing at $1.87 at August 11, 2003. The trading price of our common stock is
likely to continue to be highly volatile and subject to wide fluctuations in
response to factors including the following:
* actual or anticipated variations in our quarterly operating results;
* announcements of technological innovations, new sales formats or new
products or services by us or our competitors;
* changes in financial estimates by the Company or securities analysts;
* changes in the economic performance and/or market valuations of other
multi-media, video scan companies;
* announcements by us of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
* additions or departures of key personnel; and
* sales of common stock or issuance of other dilutive securities.
In addition, the securities markets have experienced extreme price and volume
fluctuations, and the market prices of the securities of technology companies
have been especially volatile. These broad market and industry factors may
adversely affect the market price of our common stock, regardless of our actual
operating performance. In the past, following periods of volatility in the
market price of stock, many companies have been the object of securities class
action litigation, including us. If we are sued in a securities class action,
then it could result in additional substantial costs and a diversion of
management's attention and resources.
Risks Related to Our Industry
International sales are subject to significant risk.
Our revenues from outside the United States are subject to inherent risks
related thereto, including currency rate fluctuations, the general economic and
political conditions in each country. There can be no assurance that the
economic crisis and currency issues currently being experienced in certain parts
of the world will not reduce demand for our products and therefore have a
material adverse effect on our revenue or operating results.
Our business is very competitive.
The computer peripheral markets are extremely competitive and are characterized
by significant price erosion over the life of a product. We currently compete
with other developers of video conversion products and with video-graphic
integrated circuit developers. Many of our competitors have greater market
recognition and greater financial, technical, marketing and human resources.
Although we are not currently aware of any announcements by our competitors that
would have a material impact on its operations, there can be no assurance that
we will be able to compete successfully against existing companies or new
entrants to the marketplace.
The video production equipment market is highly competitive and is characterized
by rapid technological change, new
20
product development and obsolescence, evolving industry standards and
significant price erosion over the life of a product. Competition is fragmented
with several hundred manufacturers supplying a variety of products to this
market. We anticipate increased competition in the video post-production
equipment market from both existing manufacturers and new market entrants.
Increased competition could result in price reductions, reduced margins and loss
of market share, any of which could materially and adversely affect our
business, financial condition and results of operations. There can be no
assurance that we will be able to compete successfully against current and
future competitors in this market.
Often our competitors have greater financial, technical, marketing, sales and
customer support resources, greater name recognition and larger installed
customer bases than we possess. In addition, some of our competitors also offer
a wide variety of video equipment, including professional video tape recorders,
video cameras and other related equipment. In some cases, these competitors may
have a competitive advantage based upon their ability to bundle their equipment
in certain large system sales.
We are exposed to general economic conditions that have resulted in
significantly reduced sales levels. If such adverse economic conditions were to
continue or worsen, our business, financial condition and operating results
could be adversely impacted.
If the adverse economic conditions in the State of California, the United States
and throughout the world economy continue or worsen, we may experience a
material adverse impact on our business, operating results, and financial
condition. We continue to take actions and charges to reduce our cost of sales
and operating expenses in order to address these adverse conditions. A prolonged
continuation or worsening of sales trends may require additional actions and
charges to reduce cost of sales and operating expenses in subsequent quarters.
We may be unable to reduce cost of sales and operating expenses at a rate and to
a level consistent with such a future adverse sales environment. If we must
undertake further expense reductions, we may incur significant incremental
special charges associated with such expense reductions that are
disproportionate to sales, thereby adversely affecting our business, financial
condition and operating results. Continuing weakness in the economy could
decrease demand for our products, increase delinquencies in payments and
otherwise have an adverse impact on our business.
Recent corporate bankruptcies, accounting irregularities, and alleged insider
wrong doings have negatively affected general confidence in the stock markets
and the economy, further depressing the stock market and causing the U.S.
Congress to enact sweeping legislation.
In an effort to address these growing investor concerns, the U.S. Congress
passed, and on July 30, 2002, President Bush signed into law, the Sarbanes-Oxley
Act of 2002. This sweeping legislation primarily impacts investors, the public
accounting profession, public companies, including corporate duties and
responsibilities, and securities analysts. Some highlights include establishment
of a new independent oversight board for public accounting firms, enhanced
disclosure requirements for public companies and their insiders, required
certification by CEO's and CFO's of SEC financial filings, prohibitions on
certain loans to offices and directors, efforts to curb potential securities
analysts' conflicts of interest, forfeiture of profits by certain insiders in
the event financial statements are restated, enhanced board audit committee
requirements, whistleblower protections, and enhanced civil and criminal
penalties for violations of securities laws. Such legislation and subsequent
regulations will increase the costs of securities law compliance for publicly
traded companies such as us.
Continued terrorism threats and hostilities in the Middle East have had a
negative impact on the U.S. economy.
The adverse consequences of war and the effects of terrorism have had a negative
affect on the U.S. economy. Further conflicts in the Middle East could
negatively impact our ability to raise additional funds if needed and our
revenues will be adversely affected if consumers and businesses continue to cut
back spending.
The spread of severe acute respiratory syndrome may have a negative impact on
our business and results of operations.
The recent outbreak of severe acute respiratory syndrome, or SARS, which has had
particular impact in China, Hong Kong, and Singapore, could continue to have a
negative effect on our operations. Our operations may be impacted by a number of
SARS-related factors, including, among other things, disrupting operations at
our turnkey manufacturer and certain of our distributors and customers located
in those areas. If the number of SARS cases continues to spread to other areas,
our international and domestic sales and operations could be harmed.
21
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At June 30, 2003 we did not hold any short-term investments that would be
exposed to market risk from adverse movements in interest rates.
At June 30, 2003, we had three promissory notes payable to Carl Berg, a
Company director and shareholder, totaling $3,867,000, bearing interest at prime
plus 1%. If short-term interest rates were to increase 100 basis points (100
basis points equals 1%), the increased interest expense associated with these
promissory notes would not have a material impact on our net loss and cash
flows.
Item 4. Controls and Procedures
In accordance with Section 302 of the Sarbanes-Oxley Act of 2002 and the
Securities Exchange Act of 1934 Section 13(a) or Section 15(d), we implemented
disclosure controls and procedures pursuant to which management under the
supervision and with the participation of the chief executive officer ("CEO")
and chief financial officer ("CFO") carried out, as of the quarter ended June
30, 2003, a review and evaluation of the effectiveness of these controls and
procedures. Based on this review, our CEO and CFO have concluded that our
disclosure controls and procedures are effective in timely alerting them to
material changes in information required to be included in our periodic
Securities and Exchange Commission filings.
There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the
date of the evaluation referred to above.
22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
General
From time to time, the Company is party to certain other claims and legal
proceedings that arise in the ordinary course of business of which, in the
opinion of management, do not have a material adverse effect on the Company's
financial position or results of operation.
Item 2. Changes in Securities and Use of Proceeds
(a) (None)
(b) (None)
(c) (None - However, See Note 11. Subsequent Event - Private Placement)
(d) Use of Proceeds. On November 25, 2002, the Company completed the sale
of 800,000 shares of its common stock in a private placement to two independent
third parties, receiving proceeds of approximately $685,000, net of offering
costs of $83,000. The shares were sold at an approximate 20% discount to the
20-day average closing bid prices of the Company's common stock as of November
24, 2002, the date an agreement in principle was reached by the parties.
Additionally, in connection with the efforts of vFinance Investments Inc. to
find investors in the private placement, the Company issued warrants to vFinance
Investments Inc. to purchase a total of 40,000 shares of common stock at an
exercise price of $1.20 per share. The shares were sold to accredited investors
pursuant to an exemption from registration under the federal securities laws. We
used the funds from the sale of the 800,000 shares of common stock for general
corporate purposes.
The shares, including the underlying warrants, were subsequently registered on a
Registration Statement on Form S-3 deemed effective on April 25, 2003. We did
not receive any proceeds from the sale of shares by the selling stockholders
pursuant to the Form S-3. However, we will receive funds from the exercise of
warrants held by selling stockholders who pay the exercise price in cash. The
warrants entitle the selling shareholders to purchase up to an aggregate of
40,000 shares of our common stock at a conversion price of $1.20 per share. We
will receive the proceeds of any exercise of the warrants, which we will use for
general corporate purposes. If all warrants are exercised, we will receive gross
proceeds of $48,000. There can be no assurances that any of the warrants will be
exercised. As of June 30, 2003, no warrants registered pursuant to the Form S-3
had been exercised.
Item 3. Defaults Upon Senior Securities
(None)
Item 4. Submission of Matters to a Vote of Security Holders
(None)
Item 5. Other Information
(None)
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 31.1 - Rule 13a-14(a) Certification of CEO
Exhibit 31.2 - Rule 13a-14(a) Certification of CFO
23
Exhibit 32.1 - CEO Certification Pursuant to the 18 U.S.C. Section
1350
Exhibit 32.2 - CFO Certification Pursuant to the 18 U.S.C. Section
1350
(b) Reports on Form 8-K
On May 5, 2003, Focus Enhancements, Inc. issued a press release
announcing it first quarter 2003 results.
On July 7, 2003, Focus Enhancements, Inc. issued a press release
announcing that it had closed an private placement of 2.2 million
shares of Focus Enhancements common stock for gross proceeds of
$2,200,000. In addition, Focus issued warrants for an additional
467,500 shares of common stock. Proceeds will be used to fund
working capital and for general corporate purposes. vFinance
Investments, Inc. and TN Capital Equities, Ltd. acted as placement
agents in the transaction. In a separate development, on July 7,
2003, Focus Enhancements, Inc. issued a press release announcing
that it had raised its revenue guidance for the remainder of 2003.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
August 12, 2003 Focus Enhancements, Inc.
- -------------------- ---------------------------
Date Registrant
By: /s/ Brett A. Moyer
----------------------------
Brett A. Moyer
Chief Executive Officer and President
(Principal Executive Officer)
By: /s/ Gary L. Williams
----------------------------
Gary L. Williams
Vice President of Finance,
Chief Financial Officer
(Principal Accounting Officer)