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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO 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 000-25277
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)
(408) 956-8888
(Registrant's Telephone Number, Including Area Code)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
Common Stock, $0.001 par value per share:
10,485,062 shares issued and outstanding at July 28, 2003
Part I. - Financial Information
Item 1. - Consolidated Financial Statements
Consolidated balance sheets as of June 30, 2003
and December 31, 2002 (Unaudited) 1-2
Consolidated statements of operations for the three
and six months ended June 30, 2003 and 2002 (Unaudited) 3
Consolidated statements of cash flows for the six
months ended June 30, 2003 and 2002 (Unaudited) 4
Notes to consolidated financial statements 5-14
Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-33
Item 3. - Quantitative and Qualitative Disclosures About
Market Risk 34
Item 4. - Controls and Procedures 34
Part II - Other Information
Item 1. - Legal Proceedings 35
Item 6. - Exhibits and Reports on Form 8-K 35
Signature 36
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2003 2002
----------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,053,100 $ 1,901,100
Restricted cash 500,000 250,000
Accounts receivable, net of allowance for
doubtful accounts of $355,100 and
$305,000 in 2003 and 2002, respectively 4,433,900 5,124,100
Inventories 3,172,300 3,370,500
Prepaid expenses and other current
assets 446,300 459,100
Income tax refund receivable -- 1,472,800
----------- -----------
Total Current Assets 9,605,600 12,577,600
Property and equipment, net 4,288,700 4,495,400
Deposits and other assets 117,600 194,000
----------- -----------
$14,011,900 $17,267,000
=========== ===========
See accompanying notes to consolidated financial statements.
1
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2003 2002
----------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of notes payable $ 63,400 $ 60,800
Floor plan inventory loans 573,300 901,600
Accounts payable 6,129,200 7,781,800
Accrued expenses 717,000 559,100
Warrants 54,900 161,600
----------- -----------
Total Current Liabilities 7,537,800 9,464,900
Notes Payable, less current portion 3,137,200 3,169,500
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 $626,400 as of June 30, 2003) 939,700 190,400
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 2,036,400 2,007,900
Retained earnings 350,300 2,423,800
----------- -----------
Total Shareholders' Equity 2,397,200 4,442,200
----------- -----------
$14,011,900 $17,267,000
=========== ===========
See accompanying notes to consolidated financial statements.
2
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Sales $ 17,275,900 $ 14,298,900 35,401,500 $ 31,196,000
Cost of sales 16,186,800 13,418,500 33,239,000 29,115,800
------------ ------------ ------------ ------------
Gross margin 1,089,100 880,400 2,162,500 2,080,200
Selling, general and
administrative expenses 1,505,000 1,555,200 2,991,200 3,230,300
------------ ------------ ------------ ------------
Loss from continuing operations
before other income (expense)
and income tax benefit
and minority interest (415,900) (674,800) (828,700) (1,150,100)
------------ ------------ ------------ ------------
Other income (expense):
Interest income 600 2,700 1,400 7,500
Interest expense (40,400) (42,300) (79,000) (84,200)
Litigation settlement -- -- (95,000) --
Change in fair value of
warrants issued (8,200) 16,500 106,700 16,500
Other expense, net (16,200) (24,700) (14,600) (22,100)
------------ ------------ ------------ ------------
Total other income (expense) (64,200) (47,800) (80,500) (82,300)
------------ ------------ ------------ ------------
Loss from continuing operations
before income tax benefit
and minority interest (480,100) (722,600) (909,200) (1,232,400)
Income tax benefit -- (233,200) -- (409,300)
------------ ------------ ------------ ------------
Loss from continuing operations
before minority interest (480,100) (489,400) (909,200) (823,100)
Minority interest -- -- -- 2,200
------------ ------------ ------------ ------------
Loss from continuing operations (480,100) (489,400) (909,200) (820,900)
------------ ------------ ------------ ------------
Discontinued operations:
Loss from discontinued
operations of:
Frontline Network Consulting,
Inc. after tax benefit (144,400) (198,000) (279,300) (428,500)
Lea Publishing Inc. after
tax benefit (59,700) (128,200) (106,000) (302,500)
Loss from disposal of:
Frontline Network Consulting,
Inc. after tax benefit (13,700) -- (13,700) --
Lea Publishing Inc. after
tax benefit (16,000) -- (16,000) --
------------ ------------ ------------ ------------
Loss from discontinued
operations (233,800) (326,200) (415,000) (731,000)
------------ ------------ ------------ ------------
Accretion of discount and deemed
dividend related to beneficial
conversion of Series A
Convertible Preferred Stock (6,300) (262,000) (12,300) (262,000)
Accretion of redemption value of
Series A Convertible Preferred
Stock (3,100) -- (737,000) --
------------ ------------ ------------ ------------
Net Loss applicable to
common shareholders $ (723,300) $ (1,077,600) $ (2,073,500) $ (1,813,900)
============ ============ ============ ============
Basic and diluted loss per share:
Loss from continuing operations $ (0.05) $ (0.07) $ (0.16) $ (0.10)
Loss from discontinued
operations (0.02) (0.03) (0.04) (0.07)
------------ ------------ ------------ ------------
Net loss applicable to common
shareholders $ (0.07) $ (0.10) $ (0.20) $ (0.17)
============ ============ ============ ============
Shares used in basic and diluted
per share calculation 10,485,100 10,485,100 10,485,100 10,485,100
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
3
PACIFIC MAGTRON INTERNATIONAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED JUNE 30,
2003 2002
----------- -----------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net loss applicable to common shareholders $(2,073,500) $(1,813,900)
Less: Loss from discontinued operations (415,000) (731,000)
Accretion of discount related to Series
A Convertible Preferred Stock (12,300) (262,000)
Accretion of redemption value of Series
A Convertible Preferred Stock (737,000) --
----------- -----------
Net loss used in continuing operations (909,200) (820,900)
Adjustments to reconcile net loss to net cash (used in) provided by operating
activities:
Deferred income taxes -- 262,700
Depreciation and amortization 158,700 110,600
Provision for doubtful accounts 23,200 --
Gain on disposal of fixed assets -- (8,300)
Change in fair value of warrants (106,700) (16,500)
Minority interest losses -- (2,200)
Changes in operating assets and
liabilities:
Accounts receivable 300,600 391,600
Inventories 399,800 (235,100)
Prepaid expenses and other
current assets (167,000) 17,500
Income taxes receivable 1,472,800 --
Accounts payable (1,374,300) 591,700
Accrued expenses 227,800 15,700
----------- -----------
NET CASH PROVIDED BY CONTINUING OPERATIONS 25,700 306,800
NET CASH USED IN DISCONTINUED OPERATIONS (309,400) (737,500)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (283,700) (430,700)
----------- -----------
CASH FLOWS PROVIDED BY (USED IN) INVESTING
ACTIVITIES:
Acquisition of property and equipment -- (1,500)
Reduction in deposits and other assets -- 24,900
Proceeds from sale of property and equipment -- 36,100
Net investing activities of discontinued
operations 43,700 (105,200)
----------- -----------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES 43,700 (45,700)
----------- -----------
CASH FLOWS PROVIDED BY (USED IN) FINANCING
ACTIVITIES:
Net decrease in floor plan inventory loans (328,300) (546,500)
Principal payments on notes payable (29,700) (27,300)
Net proceeds from issuance of redeemable
convertible preferred stock and warrants -- 477,500
Increase in restricted cash (250,000) --
Net financing activities of discontinued
operations -- 117,600
----------- -----------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES (608,000) 21,300
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (848,000) (455,100)
CASH AND CASH EQUIVALENTS:
Beginning of period 1,901,100 3,110,000
----------- -----------
End of period $ 1,053,100 $ 2,654,900
=========== ===========
See accompanying notes to consolidated financial statements.
4
PACIFIC MAGTRON INTERNATIONAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 and PMIGA's principal activity consists of the importation and wholesale
distribution of electronics products, computer components, and computer
peripheral equipment throughout the United States. LW sells consumer computer
products through the internet.
During the second quarter 2003, the Company sold substantially all the
intangible assets of FNC. The Company also sold all the intangible assets and
certain tangible assets of Lea to certain of Lea's employees. PMICC was formed
in 2001 for the purpose of acquiring companies or assets deemed suitable for
PMIC's organization. During the second quarter 2003, the Company was authorized
to dissolve PMICC.
The Company has incurred a net loss applicable to common shareholders of
$2,073,500 for the six months ended June 30, 2003. The Company also incurred a
net loss applicable to common shareholders of $3,110,100 for the year ended
December 31, 2002. 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 upon its ability to achieve profitability and generate
sufficient cash flows to meet its obligations as they come due. Management
believes that recently completed or continued downsizing and disposal of its
subsidiaries, FNC and Lea, and continued cost-cutting measures to reduce
overhead at all of its subsidiaries will enable it to achieve profitability.
Management is also pursuing additional capital and debt financing. However,
there is no assurance that these efforts will be successful.
FINANCIAL STATEMENT PRESENTATION AND PRINCIPLES OF CONSOLIDATION
While the financial information is unaudited, the interim consolidated financial
statements have been prepared on the same basis as the annual financial
statements and, in the opinion of management, reflect all adjustments, which
include only normal recurring adjustments, necessary for a fair presentation of
consolidated financial position and results of operations for the periods
presented. Certain information and footnote disclosures normally included in the
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted. These consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and accompanying notes presented in the Company's Form 10-K
for the year ended December 31, 2002. Interim operating results are not
necessarily indicative of operating results expected for the entire year.
5
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. During the second quarter 2003, the Company
sold substantially all the intangible assets of FNC. The Company also sold all
the intangible assets and certain tangible assets of Lea, to certain of Lea's
employees. During the second quarter 2003, the Company was authorized to
dissolve PMICC. The activities of FNC, Lea and PMICC were reclassified for
reporting purposes as discontinued operations for all periods shown in the
accompanying statements of operations and cash flows.
STOCK-BASED COMPENSATION
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. There
were no options granted for the six months ended June 30, 2003. For the six
months ended June 30, 2002, the Company granted options to purchase 30,000
shares of the Company's common stock to certain members of the Board of
Directors at exercise prices of $0.76 to $1.05 per share. During the six months
ended June 30, 2003 and 2002, no outstanding options were exercised and options
to purchase 6,000 and 66,555 shares, respectively, to the Company's common stock
were cancelled due to employee terminations or expiration of options. Had the
Company adopted the provisions of FASB Statement No. 123, the Company's net loss
would have increased to the pro forma amounts indicated below:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -------------------------------
2003 2002 2003 2002
--------- ----------- ----------- -----------
Net loss applicable to common shareholders:
As reported $(723,300) $(1,077,600) $(2,073,500) $(1,813,900)
Add: total stock based
employee compensation
expense determined
under fair value
based method for all
awards, net of tax (10,800) (37,000) (22,100) (46,400)
--------- ----------- ----------- -----------
Pro forma $(734,100) $(1,114,600) $(2,095,600) $(1,860,300)
--------- ----------- ----------- -----------
Basic and diluted loss per share:
As reported $ (0.07) $ (0.10) $ (0.20) $ (0.17)
Pro forma $ (0.07) $ (0.11) $ (0.20) $ (0.18)
6
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 three months and six months ended June 30,
2003 and 2002, options and warrants to purchase shares of the Company's common
stock and shares of common stock issuable upon conversion of Series A Preferred
Stock were excluded from the calculation of diluted earnings (loss) per share as
their effect would be anti-dilutive.
The following is the computation of the basic and diluted loss per share for
loss from continuing operations:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Loss from continuing operations $ (480,100) $ (489,400) $ (909,200) $ (820,900)
Accretion of discount and deemed
dividend related to beneficial
conversion of Series A
Convertible Preferred Stock (6,300) (262,000) (12,300) (262,000)
Accretion of redemption value of
Series A Convertible Preferred
Stock (3,100) -- (737,000) --
------------ ------------ ------------ ------------
Loss from continuing operations
applicable to common
shareholders $ (489,500) $ (751,400) $ (1,658,500) $ (1,082,900)
============ ============ ============ ============
Basic and diluted loss per share -
Loss from continuing operations $ (0.05) $ (0.07) $ (0.16) $ (0.10)
============ ============ ============ ============
Shares used in basic and diluted
per share calculation 10,485,100 10,485,100 10,485,100 10,485,100
============ ============ ============ ============
7
2. RECENT ACCOUNTING PRONOUNCEMENTS
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 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 adoption of FIN 46 did not have a material effect on the
Company's consolidated financial statements.
In November 2002, the EITF issued Issue No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." This issue addresses determination of
whether an arrangement involving more than one deliverable contains more than
one unit of accounting and how arrangement consideration should be measured and
allocated to the separate units of accounting. EITF Issue No. 00-21 will be
effective for revenue arrangements entered into in fiscal quarters beginning
after June 15, 2003, or the Company may elect to report the change in accounting
as a cumulative-effect adjustment. The Company has reviewed EITF Issue No. 00-21
and has determined it will not have a material impact on its consolidated
financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for classifying and measuring as liabilities certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. SFAS No. 150 is effective for
all financial instruments created or modified after May 31, 2003 and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The Company is currently reviewing the impact, if any, on its
financial position and results of operations upon the adoption of SFAS No. 150.
3. DISCONTINUED OPERATIONS
On June 2, 2003, the Company entered into an agreement to sell substantially all
of FNC's intangible assets for $15,000 payable in five equal installment
payments with no interest. The first payment was due on the closing date and the
remaining four payments are due the last date of each month beginning June 30,
2003. The Company recorded a loss of $13,000 on the sale of these assets.
On June 30, 2003, the Company sold substantially all of Lea's intangible assets
and certain equipment to certain of the Lea's employees. The Company also
entered into a Proprietary Software License and Support Agreement with the
purchaser for providing certain electronic commerce support services to LW for a
term of two years beginning July 1, 2003. The Company received $5,000 on the
closing date and the electronic commerce support services contract valued at
$48,000 which is based on the number of hours of the services to be provided.
The Company recorded a loss of $16,000 on the sale of these assets.
On June 6, 2003 the Board of Directors authorized the dissolution of PMICC.
PMICC had no activities since 2002 and had no assets and liabilities as of June
6, 2003.
8
The operating results, including the loss from disposal of assets, of FNC and
Lea for the three months ended June 30, 2003 and 2002 were as follows:
FNC Lea
Three Months Ended Three Months Ended
June 30, June 30,
------------------------------- ------------------------------
2003 2002 2003 2002
--------- --------- -------- ---------
Net sales $ 342,900 $ 881,500 $ 80,200 $ 197,400
Loss before income tax
benefit (158,100) (290,800) (75,700) (183,700)
Income tax benefit -- (92,800) -- (55,500)
--------- --------- -------- ---------
Net loss $(158,100) $(198,000) $(75,700) $(128,200)
--------- --------- -------- ---------
The operating results, including the loss from disposal of assets, of FNC and
Lea for the six months ended June 30, 2003 and 2002 were as follows:
FNC Lea
Six Months Ended Six Months Ended
June 30, June 30,
----------------------------------- -------------------------------
2003 2002 2003 2002
----------- ----------- --------- ---------
Net sales $ 1,313,500 $ 1,481,100 $ 179,700 $ 333,000
Loss before income tax
benefit (293,000) (637,300) (122,000) (450,000)
Income tax benefit -- (208,800) -- (147,500)
----------- ----------- --------- ---------
Net loss $ (293,000) $ (428,500) $(122,000) $(302,500)
----------- ----------- --------- ---------
4. STATEMENTS OF CASH FLOWS
Cash was paid during the six months ended June 30, 2003 and 2002 for:
SIX MONTHS ENDING JUNE 30, 2003 2002
------- -------
Income taxes $ 6,000 $ 1,200
======= =======
Interest $79,000 $93,100
======= =======
9
The following are the non-cash financing activities for the six months ended
June 30, 2003 and 2002:
SIX MONTHS ENDING JUNE 30, 2003 2002
-------- --------
Accretion of preferred stock dividend $ 12,300 $ 2,000
======== ========
Deemed dividend related to beneficial
conversion of 4% Series A Convertible
Preferred Stock $ -- $260,000
======== ========
Accretion of redemption value of
Series A Convertible Preferred Stock $737,000 $ --
======== ========
On June 30, 2003 the Company entered into an agreement to sell certain assets of
Lea. In addition to $5,000 cash consideration, the Company also received an
electronic commerce support service contract for two years valued at $48,000.
5. RELATED PARTY TRANSACTIONS
During the first quarter of 2002, the Company made short-term salary advances to
a shareholder/officer totaling $30,000, without interest. These advances were
recorded as a salary paid to the shareholder/officer during the second quarter
ended June 30, 2002.
The Company sells 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. For the three and six months ended June 30, 2003, and 2002,
the Company recognized the following sales revenues from this customer:
THREE MONTHS SIX MONTHS
ENDING ENDING
JUNE 30, JUNE 30,
------------ -----------
Year 2003 $ 41,300 $100,600
============ ===========
Year 2002 $234,700 $371,400
============ ===========
Included in accounts receivable as of June 30, 2003 and 2002 is $32,200 and
$125,400, respectively, due from this related customer.
10
6. INCOME TAXES
In March 2002, the Job Creation and Worker Assistance Act of 2002 ("the Act")
was enacted. The Act extended 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, for the year ended December 31, 2001
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. On
June 12, 2002, the Company received a federal income tax refund of $1,034,700
attributable to 2001 net operating losses carried back. The income tax benefits
of $409,300 recorded for the six months ended June 30, 2002 primarily reflects
the federal income tax refund attributable to the net operating loss incurred
for the six months ended June 30, 2002. The Company does not expect to receive a
tax benefit for losses incurred in 2003 which are not covered by the Act. As a
result, no tax benefits were recorded for the six months ended June 30, 2003 as
management does not believe it is more likely than not that the benefit from
such assets will be realized. On March 20, 2003, the Company received a federal
income tax refund of $1,427,400 attributable to its 2002 net operating loss
carryback.
7. 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 had a term of two years and was subject to
automatic renewal from year to year thereafter. The credit facility could be
terminated by Transamerica. Under certain conditions, the termination was
subject to a fee of 1% of the credit limit. The facility included 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 included
a sub-limit of $600,000 for working capital and a $1 million letter of credit
facility used as security for inventory purchased on terms from vendors in
Taiwan. Borrowings under the inventory loans were subject to 30 to 45 days
repayment, at which time interest accrued at the prime rate. Draws on the
working capital line also accrued interest at the prime rate. The credit
facility was guaranteed by both PMIC and FNC.
Under the accounts receivable and inventory financing facility from
Transamerica, the Companies were required to maintain certain financial
covenants and to achieve certain levels of profitability. As of June 30, 2002,
the Companies did not meet the revised 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 continued 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 was limited to $1 million. The
credit limits for PMI and FNC were $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 agreed to continue its guarantee
of the Letter of Credit Facility through July 25, 2003 and to continue to accept
payments according to the terms of the agreement. The Letter of Credit Facility
was discontinued in June 2003. As of June 30, 2003, the Companies had repaid the
entire outstanding balance.
11
In May 2003, PMI obtained a $3,500,000 inventory financing facility which
includes a $1 million letter of credit facility used as security for inventory
purchased on terms from vendors in Taiwan from Textron Financial Corporation
(Textron). The credit facility is guaranteed by PMIC, PMIGA, FNC, Lea, LW and
two shareholders/officers of the Company. Borrowings under the inventory loans
are subject to 30 days repayment, at which time interest accrues at the prime
rate plus 6% (10% at June 30, 2003). The Company is required to maintain
collateral coverage equal to 120% of the outstanding balance. A prepayment is
required when the outstanding balance exceeds the sum of 70% of the eligible
accounts receivables and 90% of the Textron-financed inventory and 100% of any
cash assigned or pledged to Textron. PMI and PMIC are required to meet certain
financial ratio covenants and levels of profitability. As of June 30, 2003, the
Company is in compliance with these covenants. The Company is also required to
maintain $250,000 in a restricted account as a pledge to Textron. This amount
has been reflected as restricted cash in the accompanying consolidated financial
statements. As of June 30, 2003, the outstanding balance of this loan was
$573,300.
8. NOTES PAYABLE
In 1997, 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 (1.375% as of June 30, 2003) 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% per annum, and is secured by the underlying property.
Under the bank loan for the purchase of the Company's office and warehouse
facility, the Company is required, among other things, to maintain a minimum
debt service coverage, a maximum debt to tangible net worth ratio, no
consecutive quarterly losses, and net income on an annual basis. During 2002,
the Company was in violation of two of these covenants which is an event of
default under the loan agreement that gives the bank the right to call the loan.
While a waiver of the loan covenant violations was obtained from the bank
through December 31, 2003, the Company is required to maintain $250,000 in a
restricted account as a reserve for debt servicing. This amount has been
reflected as restricted cash in the accompanying consolidated financial
statements.
9. SEGMENT INFORMATION
The Company has five reportable segments: PMI, PMIGA, LW, FNC and Lea.
PMI imports and distributes electronic products, computer components, and
computer peripheral equipment to various distributors and retailers throughout
the United States. PMIGA imports and distributes similar products focusing on
customers located in the east coast of the United States. LW sells similar
products as PMI to end-users through a website.
FNC provides professional services to mid-market companies focused on
consulting, implementation and support services of Internet technology solutions
and computer technical training services to corporate clients. Lea is engaged
the development and distribution of software and e-business products and
services, as well as integration and hosting services. During the second quarter
2003, the Company sold substantially all the intangible assets FNC. The Company
also sold all the intangible assets and certain tangible assets of Lea, to
certain of the Lea's employees. The activities of FNC and Lea for all periods
were reclassified for reporting purposes as discontinued operations.
12
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies presented in the Company's Form 10-K.
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 separate strategic business units. They are
managed separately because each business requires different technology and/or
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 continuing segment
profit or loss for the three months and six months ended June 30, 2003 and 2002:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues from external customers:
PMI $ 14,323,000 $ 11,960,000 $ 29,067,100 $ 25,390,700
PMIGA 1,650,000 2,222,600 3,652,500 5,667,600
LW 1,302,900 116,300 2,681,900 137,700
------------ ------------ ------------ ------------
TOTAL $ 17,275,900 $ 14,298,900 $ 35,401,500 $ 31,196,000
============ ============ ============ ============
Segment loss before income taxes and minority interest:
PMI $ (289,000) $ (424,400) $ (665,700) $ (721,900)
PMIGA (106,900) (229,300) (219,900) (371,300)
LW (68,000) (85,400) (114,300) (155,700)
------------ ------------ ------------ ------------
Total loss before
income taxes and
minority interest for
reportable segments (463,900) $ (739,100) (999,900) $ (1,248,900)
Change in fair value of
warrants issued (8,200) 16,500 106,700 16,500
Amortization of warrant
issuance costs (8,000) -- (16,000) --
------------ ------------ ------------ ------------
Consolidated loss before
income taxes and
minority interest $ (480,100) $ (722,600) $ (909,200) $ (1,232,400)
============ ============ ============ ============
13
10. ACCOUNTS RECEIVABLE FACTORING AGREEMENT
Pursuant to a non-notification accounts receivable factoring agreement, the
Company factored certain of its accounts receivable with GE Capital Commercial
Services, Inc. (GE) on a pre-approved non-recourse basis. The factoring
commission charge was 0.375% and 2.375% of specific approved domestic and
foreign receivables, respectively. The agreement, which expired February 28,
2003 and was renewed through March 31, 2003, provided for the Company to pay a
minimum of $200,000 (pro-rated for March 2003) in annual commission to GE. The
Company's obligations to GE were collateralized by the related accounts
receivable sold and assigned to GE and the underlying inventory. However, any
collateral assigned to GE was subordinated to the collateral rights held by
Transamerica, the Company's floor plan inventory lender. GE agreed to remit to
Transamerica, on behalf of the Company, any collections on assigned accounts to
repay amounts due Transamerica under the Company's inventory floor line of
credit.
Beginning April 1, 2003, the Company purchased a credit insurance policy from
American Credit Indemnity covering certain accounts receivable up to $2,000,000
of losses. In April 2003, the Company entered into a financing agreement with
ENX, Inc. for its accounts receivables for one year beginning April 7, 2003.
Under the agreement, the Company factors its accounts receivable on pre-approved
customers with pre-approved credit limits under certain conditions. The
commission is 0.5% of the approved invoice amounts with a minimum annual
commission of $50,000. For the quarter ended June 30, 2003, accounts receivable
that were approved amounted to $1,825,000 and no receivables were factored.
11. LITIGATION SETTLEMENT
In April 2003, the Company settled a lawsuit relating to a counterfeit products
claim for $95,000 which was included in other expense in the first quarter 2003.
12. CAPITAL STOCK
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. On March 6, 2003 the Company requested a
hearing before a Listing Qualifications Panel, at which it would seek continued
listing. The hearing was held on April 24, 2003. The Company was also notified
by Nasdaq that the Company did not comply with the Marketplace Rule that
requires a minimum bid price of $1.00 per share of common stock. Subsequent to
the hearing on April 24, 2003, Nasdaq notified the Company that its common stock
would be delisted from the Nasdaq SmallCap Market effective and such delisting
took place on April 30, 2003. The Company's common stock is eligible to be
traded on the Over the Counter Bulletin Board (OCTBB). The delisting of the
Company's common stock enables the holder of the Company's Series A Redeemable
Convertible Preferred Shares to request the repurchase of such shares 60 days
after the delisting date. As of June 30, 2003, 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 $939,700. The Company has
increased the carrying value of the Series A Redeemable Convertible Preferred
Stock to its redemption value and has recorded an increase in loss applicable to
common shareholders of $737,000 in the accompanying consolidated statement of
operations.
14
ITEM 2. 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 the consolidated financial statements, which are included
elsewhere in this Quarterly Report. 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. Such factors, many of
which are beyond our control, include, but are not limited to, those identified
in the Company's Form 10-K for the fiscal year ended December 31, 2002 under the
heading "Cautionary Factors That May Affect Future Results", such as our ability
to reverse our trend of negative earnings, the diminished marketability of
inventory, the need for additional capital, the delisting of our common stock
from the Nasdaq SmallCap Market, increased warranty costs, competition,
dependence on certain suppliers and dependence on key personnel.
GENERAL
As used herein and unless otherwise indicated, the terms "Company," "we," and
"our" refer to Pacific Magtron International Corp. and each of our subsidiaries.
We provide solutions to customers in several segments of the computer industry.
Our business is organized into five divisions: PMI, PMIGA, FNC, Lea and LW. Our
subsidiaries, PMI and PMIGA, provide for 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 distributes PMI's products in the southeastern United States market. 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. FNC provides professional services to mid-market companies focused on
consulting, implementation and support services of Internet technology solutions
and computer technical training services to corporate clients. Lea is engaged
the development and distribution of software and e-business products and
services, as well as integration and hosting services. During the second quarter
2003, the Company sold substantially all the intangible assets FNC. The Company
also sold all the intangible assets and certain tangible assets of Lea, to
certain of the Lea's employees. The activities of FNC and Lea for all periods
were reclassified for reporting purposes as discontinued operations.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 1 to the consolidated
financial statements included as Part II Item 8 to the Form 10-K for the year
ended December 31, 2002. The following are our critical accounting policies:
15
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. 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 value. The fair value of an asset group is determined by the
Company as the amount at which that asset group 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.
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 the inclusion of
provisions in the vendor agreements common to industry practice that provide us
price protections or credits for declines in inventory value and the right to
return certain 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.
16
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. 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.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain selected
financial data of the continuing operations as a percentage of sales:
Three Months Ended Six Months Ended
June 30, June 30,
---------------- ----------------
2003 2002 2003 2002
----- ----- ----- -----
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 93.7 93.8 93.9 93.3
----- ----- ----- -----
Gross margin 6.3 6.2 6.1 6.7
Operating expenses 8.7 10.9 8.4 10.4
----- ----- ----- -----
(2.4) (4.7) (2.3) (3.7)
Other income (expense), net (0.4) (0.3) (0.2) (0.3)
Income tax benefit -- (1.6) -- (1.4)
Minority interest 0.0 0.0 0.0 0.0
----- ----- ----- -----
Loss from continuing
operations (2.8)% (3.4)% (2.5)% (2.6)%
===== ===== ===== =====
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
Sales for the three months ended June 30, 2003 were $17,275,900, an increase of
$2,977,000, or approximately 20.8%, compared to $14,298,900 for the three months
ended June 30, 2002. The combined sales of PMI and PMIGA were $15,973,000 for
the three months ended June 30, 2003, an increase of $1,790,400 or approximately
12.6%, compared to $14,182,600 for the three months ended June 30, 2002. Sales
for PMI increased by $2,363,000 or 19.8% from $11,960,000 for the three months
ended June 30, 2002 to $14,323,000 for the three months ended June 30, 2003.
PMIGA's sales decreased by $572,600 or 25.8% from $2,222,600 for the three
months ended June 30, 2002 to $1,650,000 for the three months ended June 30,
2003. The increase in PMI sales was due to improved computer component market
conditions since the first quarter of 2003 compared to the same period last
year. The decrease in PMIGA's sales was due to the intense competition and a
continuing decrease in market share on the U.S. east coast.
Sales generated by LW were $116,300 for the three months ended June 30, 2002,
compared to $1,302,900 for the three months ended June 30, 2003, an increase of
$1,186,600. LW was an operating entity during the three months ended June 30,
2003, whereas it was in a development stage during the three months ended June
30, 2002.
17
Consolidated gross margin for the three months ended June 30, 2003 was
$1,089,100, or 6.3% of sales, compared to $880,400, or 6.2% of sales for the
three months ended June 30, 2002. The combined gross margin for PMI and PMIGA
was $963,800, or 6.0% of sales for the three months ended June 30, 2003,
compared to $855,600 or 6.0% of sales for the three months ended June 30, 2002.
PMI's gross margin was $829,500 or 5.8% of sales for the three months ended June
30, 2003, compared to $763,800 or 6.4% for the three months ended June 30, 2002.
The increase in gross margin for PMI was due to a 19.8% increase in sales for
the three months ended June 30, 2003 compared to the same period in 2002. The
decrease in gross margin as a percent of sales for PMI was due to the continuing
intense price competition in the market for products sold by PMI. We anticipate
the intense price competition will continue but stabilize at this level in the
computer component products market in the next 12 months.
PMIGA's gross margin was $134,600 or 8.2% of sales for the three months ended
June 30, 2003, compared to $91,700 or 4.1% of sales for the three months ended
June 30, 2002. Even though PMIGA's sales decreased by 25.8% for the three months
ended June 30, 2003 compared to the same period in 2002, the gross margin
increased by $65,700. The increase in gross margin both in amount and as a
percent of sales for the three months ended June 30, 2003 compared to the same
period in 2002 was due to management's focus on higher profit products and an
improvement in product management.
Gross margin for LW was $125,400 or 9.6% of sales for the three months ended
June 30, 2003, compared to $22,800, or 19.6% of sales for the three months ended
June 30, 2002. LW was in a development stage during the three months ended June
30, 2002.
Consolidated operating expenses, which consists of selling, general and
administrative expenses, were $1,505,000 for the three months ended June 30,
2003, a decrease of $50,200, or 3.2%, compared to $1,555,200 for the three
months ended June 30, 2002. Employee count was 80 at June 30, 2003 compared to
77 at June 30, 2002. The increase in employee count was due to additional
employees hired by LW during 2003. LW was in a development stage during the
three months ended June 30, 2002. Consolidated payroll expense increased by
$41,600 for the three months ended June 30, 2003, compared to the same period in
2002. Consolidated expenses related to E-commerce incurred by LW increased by
$18,800 for the three months ended June 30, 2003 compared to the same period
last year when LW was in a development stage. Offsetting such increased expenses
was an overall lower level of bad debt write-offs. The consolidated bad debt
expense decreased by $67,000 for the three months ended June 30, 2003 compared
to the same period in 2002. Consolidated promotional expenses for our Company's
stock, products and services and communication expense decreased by $47,200 and
$23,000, respectively, for the three months ended June 30, 2003, compared to the
same period in 2002. We expect certain expenses, such as promotional expense and
communication expense, will continue to be reduced in 2003 compared to 2002.
PMI's operating expenses were $1,085,300 for the three months ended June 30,
2003, compared to $1,119,400 for the three months ended June 30, 2002. The
decrease of $34,100 or 3.0%, was mainly due the decrease in bad debt expense of
$45,600 and promotional expenses of $34,300 and communication expense of
$23,100. These decreases were partially offset by an increase in payroll
expenses of approximately $58,000 resulting from an increase in worker's
compensation insurance costs, further, for the three months ended June 30, 2002,
the Company recorded a short-term salary advance to a shareholder/officer in the
first quarter 2002 as a salary expense thus increasing payroll expense for that
quarter.
18
PMIGA's operating expenses were $239,900 for the three months ended June 30,
2003, a decrease of $66,100, or 21.6%, compared to $306,000 for the three months
ended June 30, 2002. The decrease was primarily due to a decrease in payroll
expense, bad debt expense and promotional expense of $19,400, $24,600 and
$18,600, respectively.
LW's operating expenses were $188,500 for the three months ended June 30, 2003,
an increase of $80,900, or 75.2%, compared to $107,600 for the three months
ended June 30, 2002. LW was in a development stage during the three months ended
June 30, 2002. The increase was mainly due to the increase in payroll expenses,
bank charges, and e-commerce service fees of approximately $15,400, $12,200, and
$18,800, respectively.
Consolidated loss from operations for the three months ended June 30, 2003 was
$415,900, compared to $674,800 for the three months ended June 30, 2002, a
decrease of $258,900 or 38.4%. As a percent of sales, consolidated loss from
operations was 2.4% for the three months ended June 30, 2003, compared to 4.7%
for the three months ended June 30, 2002. The decrease in consolidated loss from
operations was primarily due to a 23.7% increase in gross margin and a 3.2%
decrease in consolidated operating expenses. Loss from operations for the three
months ended June 30, 2003, including allocations of PMIC corporate expenses,
for PMI, PMIGA and LW was $368,800, $47,900 and $81,600, respectively. Loss from
operations for the three months ended June 30, 2002, including allocations of
PMIC corporate expenses, for PMI, PMIGA and LW was $496,800, $89,200 and
$76,300, respectively.
Consolidated interest expense was $40,400 for the three months ended June 30,
2003, compared to $42,300 for the three months ended June 30, 2002. The decrease
in interest expense was largely due to a rate decrease on the floating interest
rate charged on one of our mortgages for our office building facility located in
Milpitas, California.
Other income and expenses for the three months ended June 30, 2003 included an
$8,200 expense, compared to $16,500 income for the same period in 2002, related
to the change in fair value of the warrants issued to a preferred stock investor
and a broker on May 31, 2002.
In March 2002, the Job Creation and Worker Assistance Act of 2002 ("the Act")
was enacted. The Act extended 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, for the year ended December 31, 2001
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. On
June 12, 2002, the Company received a federal income tax refund of $1,034,700
attributable to 2001 net operating losses carried back. The income tax benefits
of $233,200 recorded for the three months ended June 30, 2002 primarily reflects
the federal income tax refund attributable to the net operating loss incurred
for the three months ended June 30, 2002. The Company does not expect to receive
a tax benefit for losses incurred in 2003 which are not covered by the Act. As a
result, no tax benefits were recorded for the three months ended June 30, 2003
as management does not believe it is more likely than not that the benefit from
such assets will be realized. On March 20, 2003, the Company received a federal
income tax refund of $1,427,400 attributable to its 2002 net operating loss
carryback.
19
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. On March 6, 2003 the Company requested a
hearing before a Listing Qualifications Panel, at which it would seek continued
listing. The hearing was held on April 24, 2003. The Company was also notified
by Nasdaq that the Company did not comply with the Marketplace Rule that
requires a minimum bid price of $1.00 per share of common stock. Subsequent to
the hearing on April 24, 2003, Nasdaq notified the Company that its common stock
would be delisted from the Nasdaq SmallCap Market effective and such delisting
took place on April 30, 2003. The Company's common stock is eligible to be
traded on the Over the Counter Bulletin Board (OCTBB). The delisting of the
Company's common stock enables the holder of the Company's Series A Redeemable
Convertible Preferred Shares to request the repurchase of such shares 60 days
after the delisting date. As of June 30, 2003, 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 $939,700. The Company has
increased the carrying value of the Series A Redeemable Convertible Preferred
Stock to its redemption value and has recorded an increase in loss applicable to
common shareholders of $3,100 and $737,000 for the three months and six months
ended June 30, 2003, respectively, in the accompanying consolidated statement of
operations.
On June 2, 2003, the Company entered into an agreement to sell substantially all
of FNC's intangible assets for $15,000 payable in five equal installment
payments with no interest. The first payment was due on the closing date and the
remaining four payments are due the last date of each month beginning June 30,
2003. The Company recorded a loss of $13,700 on the sale of these assets.
On June 30, 2003, the Company sold substantially all of Lea's intangible assets
and certain equipment to certain of the Lea's employees. The Company also
entered into a Proprietary Software License and Support Agreement with the
purchaser for providing certain electronic commerce support services to LW for a
term of two years. The Company received $5,000 on the closing date and will
receive the electronic commerce support services valued at $48,000. The Company
recorded a loss of $16,000 on the sale of these assets.
The operating results, including the loss from disposal of assets, of FNC and
Lea for the three months ended June 30, 2003 and 2002 were as follows:
FNC Lea
Three Months Ended Three Months Ended
June 30, June 30,
------------------------------- ------------------------------
2003 2002 2003 2002
--------- --------- -------- ---------
Net sales $ 343,000 $ 881,500 $ 80,100 $ 197,400
Loss before income tax benefit (158,100) (290,800) (75,700) (183,700)
Income tax benefit -- (92,800) -- (55,500)
--------- --------- -------- ---------
Net loss $(158,100) $(198,000) $(75,700) $(128,200)
--------- --------- -------- ---------
20
FNC's sales decreased from $881,500 for the three months ended June 30, 2002 to
$343,000 for the three months June 30, 2003. Loss before income taxes also
reduced from $290,800 for the three months ended June 30, 2002 to $158,100 for
the three months ended June 30, 2003. FNC disposed of its assets and
discontinued its operations on June 2, 2003. The sales and operating loss for
the quarter ended June 30, 2003 were for the operations through June 2, 2003
(the date of the assets disposal).
Lea generated $80,100 in sales for the three months ended June 30, 2003, a
decrease of $117,300, compared to $197,400 for the three months ended June 30,
2002. The decrease in sales was due to the pricing pressure on our services and
less web-site development work demanded in the second quarter of 2003. Loss
before income taxes for Lea reduced from $183,700 for the three months ended
June 30, 2002 to $75,700 for the three month ended June 30, 2003. The decrease
in loss before income taxes was primarily due to a reduction in expenses of all
levels.
The income tax benefits recorded for the three months ended June 30, 2002
primarily reflects the federal income tax refund attributable to the net
operating loss incurred for the three months ended June 30, 2002. The Company
does not expect to receive a tax benefit for losses incurred in 2003
On May 31, 2002 the Company issued 600 shares of its 4% Series A Redeemable
Convertible Preferred Stock and a warrant for 300,000 shares of common stock to
an investor. The value of the beneficial conversion option of these 600 shares
of 4% Series A Redeemable Convertible Preferred Stock was $260,000. The
accretion of the 4% Series A Preferred Stock was $2,000 from the issuance date
(May 31, 2002) to June 30, 2002. The value of the beneficial conversion option
and the accretion of the preferred stock were included in the loss applicable to
the common shareholders in the calculation of the loss per common share. In
connection with the sales of preferred stock, we recorded the $$99,300 fair
value of the warrant issued to the broker who facilitated the transaction and
$298,000 fair value of the warrants issued to the preferred stock investor as a
current liability. The fair values of the warrants are revalued at the end of
each quarter and the change in fair value of the warrants is recorded as income
or expense for the period of the change.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
Sales for the six months ended June 30, 2003 were $35,401,500, an increase of
$4,205,500, or approximately 13.5%, compared to $31,196,000 for the six months
ended June 30, 2002. The combined sales of PMI and PMIGA were $32,719,600 for
the six months ended June 30, 2003, an increase of $1,661,300 or approximately
5.3%, compared to $31,058,300 for the three months ended June 30, 2002. Sales
for PMI increased by $3,676,400 or 14.5% from $25,390,700 for the six months
ended June 30, 2002 to $29,067,100 for the six months ended June 30, 2003.
PMIGA's sales decreased by $2,015,100 or 35.6% from $5,667,600 for the six
months ended June 30, 2002 to $3,652,500 for the six months ended June 30, 2003.
The increase in PMI sales was due to improved computer component market
conditions compared to the same period last year. The decrease in PMIGA's sales
was due to the intense competition and a continuing decrease in market share on
the U.S. east coast.
Sales generated by LW were $2,681,900 for the six months ended June 30, 2003,
compared to $137,700 for the six months ended June 30, 2002, an increase of
$2,544,200. LW was an operating entity during the six months ended June 30,
2003, whereas it was in a development stage during the six months ended June 30,
2002.
21
Consolidated gross margin for the six months ended June 30, 2003 was $2,162,500,
or 6.1% of sales, compared to $2,080,200, or 6.7% of sales for the six months
ended June 30, 2002. The combined gross margin for PMI and PMIGA was $1,903,800,
or 5.8% of sales for the six months ended June 30, 2003, compared to $2,052,900
or 6.6% of sales for the six months ended June 30, 2002.
PMI's gross margin was $1,645,300 or 5.7% of sales for the six months ended June
30, 2003, compared to $1,788,700 or 7.0% for the six months ended June 30, 2002.
The increase in gross margin for PMI was due to a 14.5% increase in sales for
the six months ended June 30, 2003 compared to the same period in 2002. The
decrease in gross margin as a percent of sales for PMI was due to the continuing
intense price competition in the market for products sold by PMI. We anticipate
the intense price competition will continue but stabilize at this level in the
computer component products market in the next 12 months.
PMIGA's gross margin was $258,600 or 7.1% of sales for the six months ended June
30, 2003, compared to $264,100 or 4.7% of sales for the six months ended June
30, 2002. Even though PMIGA's sales decreased by 35.6% for the six months ended
June 30, 2003 compared to the same period in 2002, the gross margin decreased
only by $5,500. The increase in gross margin as a percent of sales for the six
months ended June 30, 2003 compared to the same period in 2002 was due to
management's focus on higher profit products and an improvement in product
management.
Gross margin for LW was $258,700 or 9.6% of sales for the six months ended June
30, 2003, compared to $27,300, or 19.8% of sales for the six months ended June
30, 2002. LW was in a development stage during the six months ended June 30,
2002.
Consolidated operating expenses, which consists of selling, general and
administrative expenses, were $2,991,200 for the six months ended June 30, 2003,
a decrease of $239,100, or 7.4%, compared to $3,230,300 for the six months ended
June 30, 2002. Employee count was 80 at June 30, 2003 compared to 77 at June 30,
2002. The increase in employee count was due additional employees hired by LW
which was in a development stage during the six months ended June 30, 2002.
Consolidated payroll expenses for the six months ended June 30, 2003 decreased
by $11,300 compared to the six months ended June 30, 2002. The decrease in
consolidated payroll expenses was due to the salary and employee count reduction
in PMI and PMIGA which was partially offset by the increase in employee count in
LW. Consolidated expenses related to E-commerce and bank charges for credit card
transactions incurred by LW increased by $37,400 and 20,700, respectively, for
the six months ended June 30, 2003 compared to the same period last year when LW
was in a development stage. Offsetting such increased expenses was an overall
lower level of bad debt write-offs. The consolidated bad debt expense decreased
by $161,000 for the six months ended June 30, 2003 compared to the same period
in 2002. Consolidated promotional expenses for our Company's stock, products and
services, receivables collection expense and communication expense decreased by
$84,900, $42,100 and $40,100, respectively, for the six months ended June 30,
2003, compared to the same period in 2002. We expect certain expenses, such as
promotional expense and communication expense, will continue to be reduced in
2003 compared to 2002.
PMI's operating expenses were $2,152,000 for the six months ended June 30, 2003,
compared to $2,427,000 for the six months ended June 30, 2002. The decrease of
$275,000 or 11.3%, was mainly due to the decrease in payroll expenses, bad debt
expense, promotional expenses and communication expense of approximately
$29,000, $158,500, $63,700 and $41,700, respectively.
22
PMIGA's operating expenses were $475,800 for the six months ended June 30, 2003,
a decrease of $144,900, or 23.3%, compared to $620,700 for the three months
ended March 31, 2002. The decrease was primarily due to a decrease in expenses
for accounts receivable collection, payroll expense, promotional expense and bad
debt expense of approximately $18,800, $31,600, $35,100 and $30,300,
respectively.
LW's operating expenses were $363,400 for the six months ended June 30, 2003, an
increase of $181,300, or 99.6%, compared to $182,100 for the six months ended
June 30, 2002. LW was in a development stage during the six months ended June
30, 2002. The increase was mainly due to the increase in payroll expenses, bad
debt expense, bank charges, and e-commerce service fees of approximately
$49,300, $27,900, $25,800, and $37,400, respectively.
Consolidated loss from continuing operations for the six months ended June 30,
2003 was $828,700, compared to $1,150,100 for the six months ended June 30,
2002, a decrease of $321,400 or 27.9%. As a percent of sales, consolidated loss
from operations was 2.3% for the six months ended June 30, 2003, compared to
3.7% for the six months ended June 30, 2002. The decrease in consolidated loss
from operations was primarily due to a 4.0% increase in gross margin and a 7.4%
decrease in consolidated operating expenses. Loss from operations for the six
months ended June 30, 2003, including allocations of PMIC corporate expenses,
for PMI, PMIGA and LW was $759,600, $103,900 and $144,200, respectively. Loss
from operations for the six months ended June 30, 2002, including allocations of
PMIC corporate expenses, for PMI, PMIGA and LW was $1,085,600, $198,500 and
$112,000, respectively.
Consolidated interest expense was $79,000 for the six months ended June 30,
2003, compared to $84,200 for the six months ended June 30, 2002. The decrease
in interest expense was largely due to a rate decrease on the floating interest
rate charged on one of our mortgages for our office building facility located in
Milpitas, California.
Other income and expenses for the three months ended June 30, 2003 included
$106,700 income compared to $16,500 income for the same period in 2002, related
to the change in fair value of the warrants issued to a preferred stock investor
and a broker on May 31, 2002. Other expense for the six months ended June 30,
2003 included $95,000 for the settlement of a lawsuit relating to a counterfeit
products claim.
In March 2002, the Job Creation and Worker Assistance Act of 2002 ("the Act")
was enacted. The Act extended 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, for the year ended December 31, 2001
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. On
June 12, 2002, the Company received a federal income tax refund of $1,034,700
attributable to 2001 net operating losses carried back. The income tax benefits
of $409,300 recorded for the six months ended June 30, 2002 primarily reflects
the federal income tax refund attributable to the net operating loss incurred
for the six months ended June 30, 2002. The Company does not expect to receive a
tax benefit for losses incurred in 2003 which are not covered by the Act. As a
result, no tax benefits were recorded for the three months ended June 30, 2003
as management does not believe it is more likely than not that the benefit from
such assets will be realized. On March 20, 2003, the Company received a federal
income tax refund of $1,427,400 attributable to the 2002 net operating loss
carryback.
23
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. On March 6, 2003 the Company requested a
hearing before a Listing Qualifications Panel, at which it would seek continued
listing. The hearing was held on April 24, 2003. The Company was also notified
by Nasdaq that the Company did not comply with the Marketplace Rule that
requires a minimum bid price of $1.00 per share of common stock. Subsequent to
the hearing on April 24, 2003, Nasdaq notified the Company that its common stock
would be delisted from the Nasdaq SmallCap Market effective and such delisting
took place on April 30, 2003. The Company's common stock is eligible to be
traded on the Over the Counter Bulletin Board (OCTBB). The delisting of the
Company's common stock enables the holder of the Company's Series A Redeemable
Convertible Preferred Shares to request the repurchase of such shares 60 days
after the delisting date. As of June 30, 2003, 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 $939,700. The Company has
increased the carrying value of the Series A Redeemable Convertible Preferred
Stock to its redemption value and has recorded an increase in loss applicable to
common shareholders of $737,000 for the six months ended June 30, 2003 in the
accompanying consolidated statement of operations.
On June 2, 2003, the Company entered into an agreement to sell substantially all
of FNC's intangible assets for $15,000 payable in five equal installment
payments with no interest. The first payment was due on the closing date and the
remaining four payments are due the last date of each month beginning June 30,
2003. The Company recorded a loss of $13,700 on the sale of these assets.
On June 30, 2003, the Company sold substantially all of Lea's intangible assets
and certain equipment to certain of the Lea's employees. The Company also
entered into a Proprietary Software License and Support Agreement with the
purchaser for providing certain electronic commerce support services to LW for a
term of two years. The Company received $5,000 on the closing date and will
receive the electronic commerce support services valued at $48,000. The Company
recorded a loss of $16,000 on the sale of these assets.
The operating results, including the loss from disposal of assets, of FNC and
Lea for the six months ended June 30, 2003 and 2002 were as follows:
FNC Lea
Six Months Ended Six Months Ended
June 30, June 30,
--------------------------------- -----------------------------
2003 2002 2003 2002
----------- ----------- --------- ---------
Net sales $ 1,313,500 $ 1,481,100 $ 179,700 $ 333,000
Loss before income tax benefit (293,000) (637,300) (122,000) (450,000)
Income tax benefit -- (208,800) -- (147,500)
----------- ----------- --------- ---------
Net loss $ (293,000) $ (428,500) $(122,000) $(302,500)
----------- ----------- --------- ---------
24
FNC's sales decreased from $1,481,100 for the six months ended June 30, 2002 to
$1,313,500 for the six months June 30, 2003. Loss before income taxes also
reduced from $637,300 for the six months ended June 30, 2002 to $293,000 for the
six months ended June 30, 2003. FNC disposed of its assets and discontinued its
operations on June 2, 2003. The sales and operating loss for the six months
ended June 30, 2003 were for the operations through June 2, 2003 (the date of
the assets disposal).
Lea generated $179,700 in sales for the six months ended June 30, 2003, a
decrease of $153,300, compared to $333,000 for the six months ended June 30,
2002. The decrease in sales was due to the pricing pressure on our services and
less web-site development work demanded in 2003. Loss before income taxes for
Lea reduced from $450,000 for the six months ended June 30, 2002 to $122,000 for
the six month ended June 30, 2003. The decrease in loss before income taxes was
primarily due to a reduction in expenses of all levels.
The income tax benefits recorded for the six months ended June 30, 2002
primarily reflects the federal income tax refund attributable to the net
operating loss incurred for the six months ended June 30, 2002. The Company does
not expect to receive a tax benefit for losses incurred in 2003
On May 31, 2002 the Company issued 600 shares of its 4% Series A Redeemable
Convertible Preferred Stock and a warrant for 300,000 shares of common stock to
an investor. The value of the beneficial conversion option of these 600 shares
of 4% Series A Redeemable Convertible Preferred Stock was $260,000. The
accretion of the 4% Series A Preferred Stock was $2,000 from the issuance date
(May 31, 2002) to June 30, 2002. The value of the beneficial conversion option
and the accretion of the preferred stock were included in the loss applicable to
the common shareholders in the calculation of the loss per common share. In
connection with the sales of preferred stock, we recorded the $99,300 fair value
of the warrant issued to the broker who facilitated the transaction and $298,000
fair value of the warrants issued to the preferred stock investor as a current
liability. The fair values of the warrants are revalued at the end of each
quarter and the change in fair value of the warrants is recorded as income or
expense for the period of the change.
LIQUIDITY AND CAPITAL RESOURCES
On June 2, 2003, the Company entered into an agreement to sell substantially all
of FNC's intangible assets for $15,000 payable in five equal installment
payments with no interest. The first payment was due on the closing date and the
remaining four payments are due the last date of each month beginning June 30,
2003. The Company recorded a loss of $13,700 on the sale of these assets.
On June 30, 2003, the Company sold substantially all of Lea's intangible assets
and certain equipment to certain of the Lea's employees. The Company also
entered into a Proprietary Software License and Support Agreement with the
purchaser for providing certain electronic commerce support services to LW for a
term of two years beginning July 1, 2003. The Company received $5,000 on the
closing date and the electronic commerce support services contract valued at
$48,000. The Company recorded a loss of $16,000 on the sale of these assets.
25
The Company has incurred a loss of $909,200 on continuing operations and a net
loss applicable to common shareholders of $2,073,500 for the six months ended
June 30, 2003. The Company also incurred a net loss applicable to common
shareholders of $3,110,100 for the year ended December 31, 2002. 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 upon
its ability to achieve profitability and generate sufficient cash flows to meet
its obligations as they come due. Management believes that recently completed or
continued downsizing and disposal of its subsidiaries, FNC and Lea, and
continued cost-cutting measures to reduce overhead at all of its subsidiaries
will enable it to achieve profitability. Management is also pursuing additional
capital and debt financing. However, there is no assurance that these efforts
will be successful.
At June 30, 2003, we had consolidated cash and cash equivalents totaling
$1,053,100 (excluding $500,000 in restricted cash) and working capital of
$2,067,800. At December 31, 2002, we had consolidated cash and cash equivalents
of $1,901,100 (excluding $250,000 in restricted cash) and working capital of
$3,112,700.
Net cash used by operating activities for the six months ended June 30, 2003 was
$283,700, which principally reflected a decrease in accounts payable of
$1,374,300 and a net loss from continuing operations of $909,200 which was
partially offset by the decrease in income tax receivable of $1,472,800. Net
cash used in operating activities during the six months ended June 30, 2002 was
$430,700, which principally reflected the net loss from continuing operations of
$820,900 incurred during the period and an increase inventories and net cash
used in discontinued operations of $737,500, which was partially offset by an
increase in accounts payable and a decrease in accounts receivable.
Net cash provided by investing activities was $43,700 for the six months ended
June 30, 2003 resulting from the net investing activities of the discontinued
operations. Net cash used by investing activities during the six months ended
June 30, 2002 was $45,700, primarily resulting from the net investing activities
of the discontinued operations, which was partially offset by the proceeds of
sales of property and equipment and reduction in deposits and other assets.
Net cash used in financing activities was $608,000 for the six months ended June
30, 2003, primarily resulting from a decrease in floor plan inventory loans of
$328,300 and a pledge of $250,000 cash with Textron as required by the floor
plan inventory loan agreement. Net cash provided by financing activities was
$21,300 for the six months ended June 30, 2002, primarily from the net proceeds
of $477,500 from the issuance of preferred stock and the net financing
activities of discontinued operations of 117,600, which was partially offset by
a decrease in the floor plan inventory loans of $546,500.
On March 20, 2003, the Company received a federal income tax refund of
$1,427,400 attributable to the 2002 net operating loss carryback.
In April 2003, the Company settled a lawsuit relating to a counterfeit products
claim for $95,000 which was paid in the second quarter of 2003.
26
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 had a term of two years and was subject to
automatic renewal from year to year thereafter. The credit facility could be
terminated by Transamerica. Under certain conditions, the termination was
subject to a fee of 1% of the credit limit. The facility included 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 included
a sub-limit of $600,000 for working capital and a $1 million letter of credit
facility used as security for inventory purchased on terms from vendors in
Taiwan. Borrowings under the inventory loans were subject to 30 to 45 days
repayment, at which time interest accrued at the prime rate. Draws on the
working capital line also accrued interest at the prime rate. The credit
facility was guaranteed by both PMIC and FNC.
Under the accounts receivable and inventory financing facility from
Transamerica, the Companies were required to maintain certain financial
covenants and to achieve certain levels of profitability. As of June 30, 2002,
the Companies did not meet the revised 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 was $3 million in aggregate for inventory loans and the letter of
credit facility. The letter of credit facility was limited to $1 million. The
credit limits for PMI and FNC were $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 agreed to continue its guarantee
of the Letter of Credit Facility through July 25, 2003 and to continue to accept
payments according to the terms of the agreement. The Letter of Credit Facility
was discontinued in June 2003. As of June 30, 2003, the Companies had repaid the
entire outstanding balance.
In May 2003, PMI obtained a $3,500,000 inventory financing facility which
includes a $1 million letter of credit facility used as security for inventory
purchased on terms from vendors in Taiwan from Textron Financial Corporation
(Textron). The credit facility is guaranteed by PMIC, PMIGA, FNC, Lea, LW and
two shareholders/officers of the Company. Borrowings under the inventory loans
are subject to 30 days repayment, at which time interest accrues at the prime
rate plus 6% (10% at June 30, 2003). The Company is required to maintain
collateral coverage equal to 120% of the outstanding balance. A prepayment is
required when the outstanding balance exceeds the sum of 70% of the eligible
accounts receivables and 90% of the Textron-financed inventory and 100% of any
cash assigned or pledged to Textron. PMI and PMIC are required to meet certain
financial ratio covenants and levels of profitability. As of June 30, 2003, the
Company is in compliance with these covenants. The Company is also required to
maintain $250,000 in a restricted account as a pledge to Textron. As of June 30,
2003, the outstanding balance of this loan was $573,300.
Pursuant to one of our bank mortgage loans, with a $2,374,500 balance at June
30, 2003, we are required to maintain a minimum debt service coverage, a maximum
debt to tangible net worth ratio, no consecutive quarterly losses, and 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 gave the bank the right to call the loan. A waiver of the
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.
27
On May 31, 2002 we received net proceeds of $477,500 from the sale of 600 shares
of 4% Series A Preferred Stock. An additional 400 shares were to be sold after
the completion of the registration of the underlying common stock. Even though
we completed the required registration of the underlying common stock in October
2002, the remaining 400 shares were not sold. There is no assurance that we will
able to obtain additional capital financing other than the issuance of these
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.
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. On March 6, 2003 the Company requested a
hearing before a Listing Qualifications Panel, at which it would seek continued
listing. The hearing was held on April 24, 2003. The Company was also notified
by Nasdaq that the Company did not comply with the Marketplace Rule that
requires a minimum bid price of $1.00 per share of common stock. Subsequent to
the hearing on April 24, 2003, Nasdaq notified the Company that its common stock
would be delisted from the Nasdaq SmallCap Market effective and such delisting
took place on April 30, 2003. The Company's common stock is eligible to be
traded on the Over the Counter Bulletin Board (OCTBB). The delisting of the
Company's common stock enables the holder of the Company's Series A Redeemable
Convertible Preferred Shares to request the repurchase of such shares 60 days
after the delisting date. As of June 30, 2003, 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 $939,700. During 2003 the Company
has increased the carrying value of the Series A Redeemable Convertible
Preferred Stock to its redemption value and has recorded an increase in loss
applicable to common shareholders of $737,000 in the accompanying consolidated
statement of operations. 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.
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.
RELATED PARTY TRANSACTIONS
During the first quarter of 2002, the Company made short-term salary advances to
a shareholder/officer totaling $30,000, without interest. These advances were
recorded as a salary paid to the shareholder/officer during the second quarter
ended June 30, 2002.
The Company sells 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. For the three and six months ended June 30, 2003, and 2002,
the Company recognized the following sales revenues from this customer:
THREE MONTHS SIX MONTHS
ENDING ENDING
JUNE 30, JUNE 30,
------------ ------------
Year 2003 $ 41,300 $100,600
============ ============
Year 2002 $234,700 $371,400
============ ============
28
Included in accounts receivable as of June 30, 2003 and 2002 is $32,200 and
$125,400, respectively, due from this related customer.
RECENT ACCOUNTING PRONOUNCEMENTS
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 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 adoption of FIN 46 did not have a material effect on the
Company's consolidated financial statements.
In November 2002, the EITF issued Issue No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." This issue addresses determination of
whether an arrangement involving more than one deliverable contains more than
one unit of accounting and how arrangement consideration should be measured and
allocated to the separate units of accounting. EITF Issue No. 00-21 will be
effective for revenue arrangements entered into in fiscal quarters beginning
after June 15, 2003, or the Company may elect to report the change in accounting
as a cumulative-effect adjustment. The Company has reviewed EITF Issue No. 00-21
and has determined it will not have a material impact on its consolidated
financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for classifying and measuring as liabilities certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. SFAS No. 150 is effective for
all financial instruments created or modified after May 31, 2003 and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The Company is currently reviewing the impact, if any, on its
financial position and results of operations upon the adoption of SFAS No. 150.
29
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
OUR REPORT OF INDEPENDENT AUDITORS CONTAINS A GOING CONCERN QUALIFICATION
We received a going concern opinion from our auditors for the financial
statements for the year ended December 31, 2002. The opinion raises substantial
doubts our ability to continue as a going concern. If we cannot reverse our
trend of negative earnings an investor could lose his/her 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 have incurred a net loss applicable to common shareholders of $2,073,500 for
the six months ended June 30, 2003. We also have 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 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, 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.
30
OUR COMMON STOCK IS NOT CURRENTLY LISTED ON THE NASDAQ 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 was,
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
would seek continued listing. The hearing was 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. Subsequent to the hearing on April 24, 2003, Nasdaq notified the
Company that its common stock had been delisted from the Nasdaq SmallCap Market
effective April 30, 2003. The Company's common stock is eligible to be traded on
the Over the Counter Bulletin Board (OCTBB). The market for our common stock is
not as broad as if it were traded on the Nasdaq SmallCap Market and it is more
difficult to trade in our common stock.
POTENTIAL SALES OF 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 June 30,
2003 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 June 30, 2003, the Series A Preferred
was convertible into 835,200 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 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 in the future. If we
fail to meet the covenants, Wells Fargo may declare us in default and accelerate
the loan.
In May 2003 we obtained a $3,500,000 inventory financing facility and a $1
million letter of credit facility used as security for inventory purchased on
terms from vendors in Taiwan from Textron Financial Corporation. Under this
financing facility, we are required to meet certain financial ratio covenants
and levels of profitability. We were in compliance with these financial
requirements as of June 30, 2003. However, we cannot assure you that we will be
able to comply with these financial requirements or to maintain the Textron
flooring line if we continue our losses.
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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 were 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,
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. A number of our competitors in
the computer distribution industry are substantially larger and have greater
financial and other resources than we do.
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
23.4% and 10.5% of our total purchases for the six months ended June 30, 2003
and 2002, 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 adverse effect on our business,
financial condition and operating results.
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. The loss of the services of Messrs.
Li 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.
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ESTABLISHMENT AND MAINTENANCE OF OUR BUSINESS-TO-CONSUMER WEBSITE
LIVEWAREHOUSE.COM MAY NOT BE SUCCESSFUL
We have established a business-to-consumer website, LiveWarehouse.com. We cannot
assure you that we will 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. Further, while we have experience in the wholesale marketing of
computer-related products, we have limited 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.
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 increased costs are not offset by increased
revenues, our operations may be adversely affected.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily to
our bank mortgage loan with a $2,374,500 balance at June 30, 2003 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. We are not exposed to material risk based on
exchange rate fluctuation or commodity price fluctuation.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
Our management, with the participation of our principal executive officer and
principal financial officer, has evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended)
as of the end of the period covered by this quarterly report. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that these disclosure controls and procedures are effective and
designed to ensure that the information required to be disclosed in our reports
filed or submitted under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the requisite time periods.
(b) Changes in Internal Controls.
There was no change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d- 15(f) under the Securities Exchange Act of 1934, as
amended) identified in connection with the evaluation of our internal control
performed during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
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PART II
ITEM 1. - LEGAL PROCEEDINGS
Adaptec, Inc. filed a lawsuit against the Company and thirteen other defendants,
claiming amongst other things, copyright and trademark infringement, and unfair
business practices. The Company denied these allegations. On April 4, 2003
Pacific Magtron, Inc. agreed to a out-of-court settlement of this claim with
Adaptec, Inc. for $95,000 after giving consideration to the on-going legal
costs.
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Description Reference
- ------- ----------- ---------
3.1 Articles of Incorporation (1)
3.2 Bylaws, as amended and restated (1)
10.1 Asset Purchase Agreement with Sable Computer,Inc.
dated as of May 31, 2003 (2)
10.2 Asset Purchase Agreement with LiveCSP, Inc.
dated as of June 30, 2003 (3)
10.3 Credit Line for Inventory Financing with Textron Financial *
31.1 Certificate of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 *
32.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 *
(1) Incorporated by reference from the Company's registration statement on
Form 10SB-12G filed January 20, 1999.
(2) Filed as an exhibit to our Form 8-K dated June 2, 2003.
(3) Filed as an exhibit to our Form 8-K dated July 15, 2003.
* Filed herewith
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K on June 2, 2003 under Item 2
reporting the sale of substantially all of the intangible assets of its
Frontline Network Consulting, Inc. subsidiary.
The Company filed a current report on Form 8-K on July 15, 2003 under Item 2
reporting the sale of substantially all of the intangible assets and certain
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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.
PACIFIC MAGTRON INTERNATIONAL CORP.,
a Nevada corporation
Date: August 14, 2003 By /s/ Theodore S. Li
--------------------------------
Theodore S. Li
President and Chief Financial Officer
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