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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2003, or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission File Number 1-11860
Focus Enhancements, Inc.
(Name of Small Business Issuer in its Charter)
Delaware 04-3144936
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1370 Dell Ave
Campbell, CA 95008
(Address of Principal Executive Offices)
(408) 866-8300
(Issuer's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of Act:
Title of Each Class
-------------------
Common Stock, $.01 par value
Name of Exchange on which Registered
------------------------------------
NASDAQ
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such other shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
As of November 7, 2003, there were 42,116,906 shares of the Registrant's
Common Stock Outstanding.
Focus Enhancements, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except per share data)
(unaudited)
September 30, December 31,
2003 2002
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 2,203 $ 1,310
Accounts receivable, net of allowances of $386 and $403 at
September 30, 2003 and December 31, 2002, respectively 4,608 1,628
Inventories 4,225 2,350
Prepaid expenses and other current assets 353 185
-------- --------
Total current assets 11,389 5,473
Property and equipment, net 144 191
Capitalized software development costs -- 40
Other assets 56 86
Intangibles, net 773 1,053
Goodwill 5,191 5,191
-------- --------
Total assets $ 17,553 $ 12,034
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Obligations under capital leases, current portion $ 8 $ 44
Accounts payable 4,540 1,860
Accrued liabilities 2,022 2,018
-------- --------
Total current liabilities 6,570 3,922
Convertible notes payable to stockholder 3,867 3,867
Obligations under capital leases, non-current -- 1
-------- --------
Total liabilities 10,437 7,790
-------- --------
Commitments and contingencies
Stockholders' equity
Preferred stock, $.01 par value; authorized 3,000,000 shares;
1,904 shares issued at September 30, 2003 and December 31, 2002
(aggregate liquidation preference $2,267) -- --
Common stock, $.01 par value; 60,000,000 shares authorized, 41,792,817 and
37,560,537 shares issued at September 30, 2003 and December 31, 2002,
respectively 418 376
Additional paid-in capital 69,979 65,940
Accumulated deficit (62,531) (61,323)
Deferred compensation and price protection -- (49)
Treasury stock at cost, 497,055 and 450,000 shares at September 30, 2003
and December 31, 2002, respectively (750) (700)
-------- --------
Total stockholders' equity 7,116 4,244
-------- --------
Total liabilities and stockholders' equity $ 17,553 $ 12,034
======== ========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
2
Focus Enhancements, Inc.
Condensed Consolidated Statements Of Operations
(in thousands, except per share amounts)
(unaudited)
Three Months ended September 30,
--------------------------------
2003 2002
------------ --------------
Net product revenues $ 10,762 $ 4,091
Contract revenues -- --
-------- --------
Total net revenues 10,762 4,091
Cost of revenues:
Products 7,469 2,659
Contract -- --
-------- --------
Total cost of revenues 7,469 2,659
-------- --------
Gross profit 3,293 1,432
-------- --------
Operating expenses:
Sales, marketing and support 1,103 1,141
General and administrative 417 423
Research and development 1,070 1,042
Amortization expense 132 217
Restructuring expense -- 96
-------- --------
Total operating expenses 2,722 2,919
-------- --------
Income (loss) from operations 571 (1,487)
Interest expense, net (46) (57)
Other income, net 7 --
-------- --------
Net income (loss) $ 532 $ (1,544)
======== ========
Income (loss) per common share:
Basic $ 0.01 $ (0.04)
======== ========
Diluted $ 0.01 $ (0.04)
======== ========
Weighted average common shares outstanding:
Basic 40,159 35,777
======== ========
Diluted 48,755 35,777
======== ========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
3
Focus Enhancements, Inc.
Condensed Consolidated Statements Of Operations
(in thousands, except per share amounts)
(unaudited)
Nine Months ended September 30,
-------------------------------
2003 2002
------------ -------------
Net product revenues $ 19,153 $ 12,602
Contract revenues -- 759
-------- --------
Total net revenues 19,153 13,361
Cost of revenues:
Products 12,312 8,099
Contract -- 499
-------- --------
Total cost of revenues 12,312 8,598
-------- --------
Gross profit 6,841 4,763
-------- --------
Operating expenses:
Sales, marketing and support 3,190 3,857
General and administrative 1,230 1,638
Research and development 3,174 3,007
Amortization expense 436 725
Restructuring (recovery) expense (29) 96
-------- --------
Total operating expenses 8,001 9,323
-------- --------
Loss from operations (1,160) (4,560)
Interest expense, net (150) (174)
Other income, net 104 24
-------- --------
Loss before income taxes (1,206) (4,710)
Income tax expense 2 --
-------- --------
Net loss $ (1,208) $ (4,710)
======== ========
Loss per common share:
Basic $ (0.03) $ (0.13)
======== ========
Diluted $ (0.03) $ (0.13)
======== ========
Weighted average common shares outstanding:
Basic 38,150 35,428
======== ========
Diluted 38,150 35,428
======== ========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
4
Focus Enhancements, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended September 30,
-------------------------------
2003 2002
------------ -------------
Cash flows from operating activities:
Net loss $(1,208) $(4,710)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 571 950
Amortization of deferred compensation expense -- 91
Gain on debt settlement (95) (311)
Warrant issue expense -- 573
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable (2,980) 1,014
Decrease (increase) in inventories (1,875) 1,453
Decrease (increase) in prepaid expenses and other assets (147) 23
Increase (decrease) in accounts payable 2,611 (1,470)
Increase (decrease) in accrued liabilities 168 (364)
Payment of legal judgement -- (2,073)
------- -------
Net cash used in operating activities (2,955) (4,824)
------- -------
Cash flows from investing activities:
Decrease in restricted collateral deposit -- 2,363
Acquisition of developed technology (57) --
Additions to property and equipment (89) (64)
------- -------
Net cash provided by (used in) investing activities (146) 2,299
------- -------
Cash flows from financing activities:
Repayment of convertible notes payable to shareholder -- (145)
Payments under capital lease obligations (37) (31)
Net proceeds from private offerings of common stock 1,924 2,435
Net proceeds from exercise of common stock options/warrants 2,107 537
------- -------
Net cash provided by financing activities 3,994 2,796
------- -------
Net increase in cash and cash equivalents 893 271
Cash and cash equivalents at beginning of period 1,310 449
------- -------
Cash and cash equivalents at end of period $ 2,203 $ 720
======= =======
Supplemental Cash Flow Information:
Interest paid $ -- $ 280
Income taxes paid 2 --
Common stock issued in connection with acquisition of DVUnlimited 50 --
Conversion of accounts payable to common stock -- 23
The accompanying notes are an integral part of the condensed
consolidated financial statements.
5
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
1. Basis of Presentation - Interim Financial Information
The condensed consolidated financial statements of Focus Enhancements, Inc.
("the Company" or "Focus") as of September 30, 2003 and for the three and nine
month periods ended September 30, 2003 and 2002 are unaudited and should be read
in conjunction with the consolidated financial statements and notes thereto for
the year ended December 31, 2002 included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2002.
In the opinion of management, the condensed consolidated financial
statements include all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of its financial position,
operating results and cash flows for interim periods presented. The results of
operations and cash flows for the three and nine month periods ended September
30, 2003 are not necessarily indicative of the results that may be expected for
any future period. All intercompany accounts and transactions have been
eliminated upon consolidation.
Accounting Period
The Company's fiscal year ends on December 31 and the interim quarters end
on the Sunday closest to the end of each calendar quarter. For convenience, the
accompanying interim condensed consolidated financial statements are shown as
ending on September 30.
Stock Compensation Plans
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby compensation
cost is measured at the grant date based on the fair value of the award which is
recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, whereby compensation cost is the excess, if any, of the quoted market
price of the stock at the grant date (or other measurement date) over the amount
an employee must pay to acquire the stock. Stock options issued under the
Company's stock option plans have no intrinsic value at the grant date.
Accordingly, under APB Opinion No. 25, no compensation cost is recognized. The
Company has elected to continue with the accounting prescribed in APB Opinion
No. 25 and, as a result, must make pro forma disclosures of net income and
earnings per share and other disclosures as if the fair value based method of
accounting had been applied. Had compensation cost for the Company's stock-based
compensation plans and non-plan stock options outstanding been determined based
on the fair value at the grant dates for awards under those plans consistent
with the method prescribed by SFAS No. 123, the Company's net loss and loss per
share would have been adjusted to the pro forma amounts indicated below (in
thousands except per share data):
6
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
Three months ended Nine months ended
September 30, September 30,
-------------------------- ---------------------------
2003 2002 2003 2002
----------- ------------ ------------ ------------
Net income (loss) reported under APB 25 $ 532 $ (1,544) $ (1,208) $ (4,710)
Add: Stock-based employee compensation
expense included in reported net loss -- 30 -- 91
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards (276) (259) (670) (636)
----------- ------------ ------------ ------------
Pro forma net income (loss) $ 256 $ (1,773) $ (1,878) $ (5,255)
=========== ============ ============ ============
Basic income (loss) per share, as reported $ 0.01 $ (0.04) $ (0.03) $ (0.13)
=========== ============ ============ ============
Basic income (loss) per share, pro forma $ 0.01 $ (0.05) $ (0.05) $ (0.15)
=========== ============ ============ ============
Diluted income (loss) per share, as reported $ 0.01 $ (0.04) $ (0.03) $ (0.13)
=========== ============ ============ ============
Diluted income (loss) per share, pro forma $ 0.01 $ (0.05) $ (0.05) $ (0.15)
=========== ============ ============ ============
Common stock equivalents have been excluded from all calculations of loss
per share and pro forma loss per share for the periods presented because the
effect of including them would be anti-dilutive.
2. Management's Plans
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. Although the
Company reported net income of $532,000 for the three months ended September 30,
2003, for the nine months ended September 30, 2003 and the year ended December
31, 2002, the Company incurred a net loss of $1,208,000 and $5,957,000, and net
cash used in operating activities totaled $2,955,000 and $5,004,000,
respectively. These factors indicate that the Company may potentially be unable
to continue as a going concern. Additionally, our auditors have included an
explanatory paragraph in their report on our financial statements for the year
ended December 31, 2002 with respect to uncertainties about our ability to
continue as a going concern.
The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. The Company's continuation as
a going concern is dependent upon its ability to generate sufficient cash flows
to meet its obligations on a timely basis, to obtain additional financing as may
be required, and to achieve sustained profitability and significant positive
cash flows.
The Company has historically met cash needs from the proceeds of debt, the
sale of common stock in private placements, and the exercise of stock options
and warrants. Management continues to assess its product lines in light of
technology trends and economic conditions, to identify how to enhance existing
product lines or create new distribution channels. In addition, the Company is
developing and expects to announce at least one more new product during the
fourth quarter of 2003.
During 2002, management took steps to continue to reduce costs, including
the reduction of its personnel by 9% in April 2002 and the closure of its
Chelmsford, MA office on September 30, 2002, (resulting in a $96,000
restructuring charge). Additionally, in September 2002, the Company furloughed
7% of its personnel and subsequently terminated such personnel in December 2002.
At September 30, 2003, $35,000 of the restructuring reserve remained.
7
Focus Enhancements, Inc.
Notes To Unaudited Consolidated Financial Statements
Even with the reduction in expenses related to the restructuring and an
expected increase in sales, the Company determined late in the second quarter of
2003, that it would need to raise additional funds to support its working
capital needs and meet existing debt obligations. In connection with that need,
on July 2, 2003, the Company raised net proceeds of approximately $1.9 million
in a private placement transaction with independent third parties through the
issuance of 2,200,000 shares of the Company's common stock.
Although the Company reported net income of $532,000 for the three months
ended September 30, 2003 and cash of $2.2 million at September 30, 2003, there
is no assurance that management's plans will be successful or if successful,
that they will result in the Company continuing as a going concern.
3. Recent Accounting Pronouncements
In December 2002, the FASB, issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-an Amendment of FASB Statement No.123,
which provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Effective December 31, 2002, the
Company adopted the amended annual and interim disclosure requirements of SFAS
No. 123.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires that upon
issuance of a guarantee, the guarantor must recognize a liability for the fair
value of the obligation it assumes under that guarantee. The Company has adopted
the disclosure provisions of FIN 45, where applicable, and will apply the
recognition and measurement provision for all material guarantees entered into
or modified after December 31, 2002. The adoption of FIN 45 had no impact on the
Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. This
Statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. The Company currently has no financial
instruments which meet these requirements.
In April 2003 the FASB issued SFAS No. 149, Amendment of Statement No. 133
on Derivative Instruments and Hedging Activities. This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts. The
Statement clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative, clarifies when a derivative
contains a financing component, amends the definition of an underlying
derivative to conform it to language used in FASB Interpretation FIN No. 45, and
amends certain other existing pronouncements. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. All provisions of the Statement,
except those related to forward purchases or sales of "when-issued" securities,
should be applied prospectively. The Company currently has no instruments that
meet the definition of a derivative, and therefore, the adoption of this
Statement will have no impact on the Company's financial position or results of
operations.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which addresses consolidation by
business enterprises of variable interest entities that either: (i) do not have
sufficient equity investment at risk to permit the entity to finance its
activities without additional subordinated financial support, or (ii) the equity
investors lack an essential characteristic of a controlling financial interest.
FIN 46 originally required disclosure of Variable Interest Entities (VIEs) in
financial statements issued after January 31, 2003, if it is reasonably possible
that as of the transition date: (i) the company will be the primary beneficiary
of an existing VIE that will require consolidation, or (ii) the company will
hold a significant variable interest in, or have significant involvement with,
an existing VIE. In October 2003 the FASB elected to defer the effective date
for applying the provisions of FIN 46 for interests held by public entities in
variable interest entities or potential variable interest entities created
before
8
February 1, 2003. A public entity need not apply the provisions of FIN 46 to an
interest held in a variable interest entity until the end of the first interim
or annual period ending after December 31, 2003. The adoption of FIN 46 is not
expected to have an impact on the Company's financial statements.
4. Inventories
Inventories are stated at lower of cost (first-in, first-out) or market (in
thousands):
September 30, December 31,
2002 2003
------ ------
Raw materials $1,856 $1,383
Work in process 98 116
Finished goods 2,271 851
------ ------
Totals $4,225 $2,350
====== ======
5. Intangible Assets
Intangible assets consisted of the following as of (in thousands):
September 30, 2003 December 31, 2002
----------------------------------- -------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
------ ------------ --- ------ ------------ ---
Intangible assets:
Tradename $ 176 $ 119 $ 57 $ 176 $ 86 $ 90
Existing Technology (1) 1,995 1,279 716 1,888 925 963
------- -------- ------ -------- ------ ------
Total $ 2,171 $ 1,398 $ 773 $ 2,064 $1,011 $1,053
======= ======== ====== ======== ====== ======
Estimated Future Amortization Expense:
For the three months ending December 31, 2003 $ 138
Year ending December 31, 2004 552
Year ending December 31, 2005 57
Year ending December 31, 2006 26
------
$ 773
======
(1) In September 2003, the Company acquired the intangible assets of
DVUnlimited, a sole proprietorship, located in Budapest, Hungary.
The total purchase price was $107,000, consisting of cash, common
stock and related legal costs. This amount has been added to
existing technology and will be amortized over a period of three
years.
6. Commitments
Convertible Promissory Notes
Convertible promissory notes payable at September 30, 2003 and December 31,
2002 consists of three promissory notes totaling $3,867,000, payable to Carl
Berg, a Company director and shareholder. These notes were amended on April 28,
2003, to provide for an extension of the maturity dates to November 25, 2004.
The notes bear interest at prime plus 1%, payable quarterly, and are
collateralized by substantially all of the assets of the Company. The Company is
obligated, under certain circumstances, including at the mutual election of Mr.
Berg and the Company, to convert the outstanding balances of the notes, and any
unpaid interest, into shares of Focus common stock or preferred stock, as
specified in the respective note agreements. In September 2003, Mr. Berg agreed
to convert such debt and accrued interest, which totaled approximately $4.3
million at September 30, 2003, into preferred and common stock
9
based on the conversion terms of the respective notes. As of September 30, 2003,
the conversion would result in the issuance of approximately 2,178,433 shares of
common stock and 1,257 shares of preferred stock convertible into 1,257,000
shares of common stock. The conversion is expected to be completed as soon as
practical, but in no event sooner than March 2004.
General
From time to time, the Company is party to certain claims and legal
proceedings that arise in the ordinary course of business which, in the opinion
of management, will not have a material adverse effect on the Company's
financial position or results of operations.
The Company indemnifies its customers from third party claims alleging
patent or copyright infringement relating to the use of the Company's products.
Such indemnification provisions are accounted for in accordance with SFAS No. 5
and are generally limited to the amount paid by the customer. Historically,
costs related to these indemnification arrangements have not been significant.
7. Stockholders' Equity
Preferred Stock
The Company is obligated, under certain circumstances, including at the
mutual election of Mr. Berg and the Company, to convert certain of the
outstanding balances of convertible notes payable to Mr. Berg, and any unpaid
interest, into shares of Focus preferred stock. As of September 30, 2003,
approximately 1,257 shares of preferred stock and 2,178,433 shares of common
stock were subject to issuance to Mr. Berg pursuant to the convertible notes
payable agreements. See "Note 6. Commitments - Convertible Promissory Notes."
Common Stock
On January 11, 2002, the Company completed the sale of 2,434,490 shares of
its common stock in a private placement to four independent third parties,
receiving proceeds of approximately $2,435,000, net of offering costs of
$314,000. Additionally, the Company incurred $182,000 of costs during 2001 in
connection with this offering (including costs associated with the subsequent
registration of the shares), resulting in total offering costs of $496,000. The
shares were sold at a 20% discount to the 20-day average closing bid prices of
the Company's common stock as of December 27, 2001, the date an agreement in
principle was reached by the parties. In connection with the private placement,
the Company issued warrants to the four investors to purchase a total of 367,140
shares of common stock at an exercise price of $1.36 per share. Additionally, in
connection with the efforts of vFinance Investments Inc. to find investors in
the private placement, the Company issued warrants to vFinance Investments Inc.
to purchase a total of 123,690 shares of common stock at an exercise price of
$1.36 per share. Tim Mahoney, a member of the Company's Board of Directors is
the Chairman and COO of vFinance, Inc., the parent company of vFinance
Investments Inc.
On July 28, 2000, the Company entered into an equity line of credit
agreement with Euston Investments Holdings Limited ("Euston"), for the future
issuance and purchase of up to 4,000,000 shares of the Company's common stock at
a 10% discount. In lieu of providing Euston with a minimum aggregate drawdown
commitment, the Company issued to Euston a stock purchase warrant to purchase
250,000 shares of common stock with an exercise price of $1.625. The warrant
expires June 12, 2005. The Company had sought to register such shares under a
Registration Statement on Form SB-2. However, before the registration statement
was declared effective, on January 11, 2002, Focus and Euston mutually agreed to
terminate the agreement. As consideration for terminating the agreement, the
exercise price of Euston's warrants to purchase 250,000 shares of Focus common
stock was reduced from $1.625 to $0.75 per share. As a result of the repricing
the Company incurred a $334,000 charge to other expense in the first quarter of
2002. The charge was computed using the Black-Scholes model with assumptions of
a risk-free rate of interest of 2.9%, expected volatility of 130%, a dividend
yield of 0.0% and an expected remaining life of 1.4 years.
On March 1, 2002, the Company issued warrants to purchase 270,000 shares of
common stock as compensation to three unrelated parties for consulting services
in the areas of investment advisory, investor relations and public relation
services. The warrants are exercisable for a period of two to three years at
exercise prices ranging from $1.35 to $1.50
10
per share. The Company recorded charges of approximately $238,000 for the
quarter ended March 31, 2002 based on the fair value of the warrants. Such
amounts were recorded as general and administrative expenses and the fair value
of the warrants were calculated using the Black-Scholes option pricing model
with the following assumptions: contractual term of 2 to 3 years, volatility of
136% to 143%, risk free interest rate of 2.9% to 3.6%, and no dividends during
the term of the warrant.
On November 25, 2002, the Company completed the sale of 800,000 shares of
its common stock in a private placement to two independent third parties,
receiving proceeds of approximately $685,000, net of offering costs of $83,000.
The shares were sold at an approximate 20% discount to the 20-day average
closing bid prices of the Company's common stock as of November 24, 2002, the
date an agreement in principle was reached by the parties. Additionally, in
connection with the efforts of vFinance Investments Inc. to find investors in
the private placement, the Company issued warrants to vFinance Investments Inc.
to purchase a total of 40,000 shares of common stock at an exercise price of
$1.20 per share.
On July 2, 2003, the Company completed the sale of 2,200,000 shares of its
common stock in a private placement to two independent third parties, receiving
proceeds of approximately $1,924,000, net of offering costs of $276,000. The
shares were sold at an approximate 20% discount to the 5-day average closing bid
prices of the Company's common stock prior to closing. In connection with the
private placement, the Company issued warrants to the two investors and a
placement agent to purchase a total of 467,500 shares of common stock at an
exercise price of $1.44 per share.
As of September 30, 2003, the Company was obligated under certain
circumstances, to issue the following additional shares of common stock :
Warrants to purchase common stock 1,157,950
Options to purchase common stock 5,413,267
Notes payable convertible into common stock 2,178,433
Preferred Stock convertible into common stock 1,904,000
----------
Total shares of common stock obligated, under
certain circumstances, to issue 10,653,650
==========
8. Related Party Transactions
In February 2003, the Company engaged vFinance Consulting to assist the
Company with the preparation of a strategic business plan. Tim Mahoney, a member
of the Company's Board of Directors, is the Chairman and COO of vFinance, Inc.,
the parent company to vFinance Consulting. In connection with the preparation of
the business plan, the Company incurred consulting expenses of $50,000 for the
nine months ended September 30, 2003, which is included in general and
administrative expenses.
The Company has also engaged vFinance Consulting, from July 1, 2003 to
September 30, 2003, to act as the Company's exclusive financial advisor, for the
purpose of merger and acquisition services. In connection with such financial
advisory services, the Company incurred consulting expenses of $22,500 for the
three months ended September 30, 2003, which is included in general and
administrative expenses. The consulting agreement was extended, by mutual
agreement, through December 31, 2003. If vFinance Consulting assists in the
successful completion of a qualifying transaction under the engagement, the
Company will pay vFinance Consulting a success fee depending on the total value
of the transaction of (i) no less than $100,000 and up to 2% of the total value
of the transaction; and (ii) no less than 30,000 and up to 80,000 shares of
Focus common stock.
In connection with its efforts to find investors for the Company in the
private placement completed on July 2, 2003, vFinance Investments Inc. received
$137,500 and out-of-pocket expenses, including legal fees, of $27,500. Tim
Mahoney is a principal in vFinance Investments Inc. In connection with its
efforts to find investors in the private placements for the Company completed on
January 11, 2002 and November 25, 2002, vFinance Investments Inc., received
$275,000 in cash and a warrant to purchase 123,690 shares of common stock of
Focus at $1.36 per share and $70,000 in cash and a warrant to purchase 40,000
shares of common stock of Focus at $1.20 per share, respectively. All
11
such cash payments to vFinance Investments Inc., were recorded as reductions of
the proceeds received from the private placements.
Carl Berg, a Company director and shareholder, has provided Samsung
Semiconductor Inc., the Company's contracted ASIC manufacturer, with a personal
guarantee to secure the Company's working capital requirements for ASIC purchase
order fulfillment. See also "Note 6. Commitments - Convertible Promissory
Notes."
9. Significant Customers
For the three and nine month periods ended September 30, 2003, one customer
represented 64% and 36% of the Company's total revenues, respectively. Two
customers accounted for 68% of the Company's accounts receivable balance (54%
and 14% respectively) at September 30, 2003.
No customer accounted for greater than 10% of total revenue for the quarter
ended September 30, 2002. One customer accounted for 11% of total revenue for
the nine months ended September 30, 2002.
As of December 31, 2002, three customers represented approximately 41% of
the Company's accounts receivable balance (21%, 10% and 10% respectively).
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
The following information should be read in conjunction with the
consolidated financial statements and notes thereto in Part I, Item 1 of this
Quarterly Report and with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2002.
Certain Factors That May Affect Future Results
Discussions of certain matters in this Quarterly Report on Form 10-Q may
constitute forward-looking statements within the meaning of the Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act"), and as such, may involve
risks and uncertainties. Forward-looking statements, which are based on certain
assumptions and describe future plans, strategies, and expectations, are
generally identifiable by the use of words or phrases such as "believe", "plan",
"expect", "intend", "anticipate", "estimate", "project", "forecast", "may
increase", "may fluctuate", "may improve" and similar expressions or future or
conditional verbs such as "will", "should", "would", and "could".
In particular, statements contained in this document which are not
historical facts (including, but not limited to, statements concerning
anticipated revenues, anticipated operating expense levels, potential new
products and orders, and such expense levels relative to our total revenues)
constitute forward looking statements and are made under the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Our actual
results of operations and financial condition have varied and may in the future
vary significantly from those stated in any forward looking statements. Factors
that may cause such differences include, without limitation, the availability of
capital to fund our future cash needs, reliance on major customers, history of
operating losses, market acceptance of our products, technological obsolescence,
competition, component supply problems and protection of proprietary
information, as well as the accuracy of our internal estimates of revenue and
operating expense levels. For a discussion of these factors and some of the
factors that might cause such a difference see also " - Risks Factors." These
factors should be considered in evaluating the forward-looking statements, and
undue reliance should not be placed on such statements. We do not undertake, and
specifically disclaims any obligation, to update any forward-looking statements
to reflect occurrences or unanticipated events or circumstances after the date
of such statements.
Results of Operations
Net Revenues
Net revenues for the three-months ended September 30, 2003 were $10,762,000
as compared with $4,091,000 for the three-month period ended September 30, 2002,
an increase of $6,671,000, or 163%. Net revenues for the nine-months ended
September 30, 2003 were $19,153,000 as compared with $13,361,000 for the
nine-months ended September 30, 2002, an increase of $5,792,000 or 43%.
For the three-months ended September 30, 2003, net sales of system products
(professional and consumer) to distributors, retailers and VAR's were
approximately $3,355,000 as compared to $3,639,000 for the same period in 2002,
a decrease of $284,000 or 8%. For the nine-months ended September 30, 2003, net
sales of system products (professional and consumer) to distributors, retailers
and VAR's were approximately $10,429,000 as compared to $11,117,000 for the same
period in 2002, a decrease of $688,000 or 6%. The decrease between comparison
periods is primarily the result of a decrease in sales of our consumer products
as a result of reduced educational spending due to budgetary constraints at the
state and local level, offset by increased sales of the Company's newest product
introductions, including FireStore. Consumer product sales decreased
approximately $850,000, between the nine-month comparison periods.
For the three-months ended September 30, 2003, net sales of semiconductor
products to distributors and OEM customers, were approximately $7,407,000, as
compared to $452,000 for the same period in 2002, an increase of $6,955,000 or
1,539%. For the nine-months ended September 30, 2003, net sales of semiconductor
products to distributors and OEM customers, which includes contract revenues,
were approximately $8,724,000 as compared to $2,244,000 for the same period in
2002, an increase of $6,480,000 or 289%. The increase in OEM sales for the
three-
13
month comparison periods is primarily attributable to increased sales of
our semiconductor chips, resulting primarily from the inclusion of our FS454
semiconductor chip in Microsoft's Xbox. The increase in OEM sales for the
nine-month comparison periods is also attributable to the inclusion of our FS454
semiconductor chip in Microsoft's Xbox, and as a result of the Company reporting
contract revenues of $759,000 for the nine-months ended September 30, 2002,
while no contract revenues were reported for the nine-months ended September 30,
2003. Contract revenues related to the development of an Application Specific
Integrated Circuit (ASIC) for a third party that began in June 2001 and finished
in June 2002. Under this development contract the Company recorded total
revenues of $2.1 million.
As of September 30, 2003, the Company had a sales order backlog of
approximately $3,251,000, compared to $6,793,000 as of June 30, 2003, a decrease
of $3,542,000. Backlog for the third quarter of 2002 was $212,000. Backlog
consists primarily of semiconductor chip orders, including FS454 orders from
Microsoft and FireStore orders. The decrease in backlog between the third
quarter and second quarter of 2003, is primarily the result of the seasonality
of Microsoft's ordering. The increase between the third quarter of 2003 and the
third quarter of 2002, is a result of newly introduced products, both, from our
customers, in which our semiconductor chips are included, and new introductions
from us. See Risk Factors - "Backlog should not be construed as indicative of
future revenue or performance".
Cost of Goods Sold
Cost of goods sold were $7,469,000, or 69% of net sales, for the
three-months ended September 30, 2003, as compared with $2,659,000, or 65% of
net sales, for the three-months ended September 30, 2002, an increase of
$4,810,000 or 181%. The Company's gross profit margin for the third quarters of
2003 and 2002 were 31% and 35%, respectively. The majority of the decrease in
the Company's gross profit margin is related to significantly lower than average
gross profit margins (below 30 percent), on the Company's FS454 chip sales to
Microsoft. Cost of goods sold were $12,312,000, or 64% of net sales, for the
nine-months ended September 30, 2003, as compared with $8,598,000, or 64% of net
sales, for the nine months ended September 30, 2002, an increase of $3,714,000
or 43%. The Company's gross profit margin for the nine-month periods of 2003 and
2002 was 36%. The Company's gross profit margins were flat between nine month
comparison periods, as a result of a combination of lower than average gross
profit margins on the Company's FS454 chip sales to Microsoft offset by reduced
manufacturing expenses as the Company reduced its personnel expenditures,
primarily headcount, and as a result of improved pricing on certain of its
products.
Sales, Marketing and Support Expenses
Sales, marketing and support expenses were $1,103,000, or 10% of net
revenues, for the three-months ended September 30, 2003, as compared with
$1,141,000, or 28% of net revenues, for the three-months ended September 30,
2002, a decrease of $38,000 or 3%. Sales, marketing and support expenses were
$3,190,000, or 17% of net revenues, for the nine-months ended September 30,
2003, as compared with $3,857,000, or 29% of net revenues, for the nine-months
ended September 30, 2002, a decrease of $667,000 or 17%. The decrease in sales,
marketing and support expenses in absolute dollars is primarily the result of
lower staffing, and reduced marketing and advertising expenses.
General and Administrative Expenses
General and administrative expenses for the three-months ended September 30,
2003 were $417,000 or 4% of net revenues, as compared with $423,000 or 10% of
net revenues for the three-months ended September 30, 2002, a decrease of $6,000
or 1%. General and administrative expenses for the nine-months ended September
30, 2003 were $1,230,000 or 6% of net revenues, as compared with $1,638,000 or
12% of net revenues for the nine-months ended September 30, 2002, a decrease of
$408,000 or 25%. For the nine-month period, general and administrative expenses
decreased as the nine months ended September 30, 2002 included CEO relocation
expenses of $65,000, a $238,000 charge associated with the issuance of warrants
in connection with consulting services and an additional $54,000 of bad debt
expense.
Research and Development Expenses
Research and development expenses for the three-months ended September 30,
2003 were approximately $1,070,000 or 10% of net revenues, as compared with
$1,042,000 or 25% of net revenues for the three-months ended September 30, 2002,
an increase of $28,000 or 3%. Research and development expenses for the
nine-months ended September 30, 2003 were approximately $3,174,000 or 17% of net
revenues, as compared with $3,007,000 or 23% of
14
net revenues for the nine-months ended September 30, 2002, an increase of
$167,000 or 6%. The increase in research and development expenses between the
nine-month comparison periods is primarily because no engineering work was
performed under contract for the nine months ended September 30, 2003 and, as
such, no research and development personnel expenses were allocated to costs of
sales during such period.
Amortization
Amortization expense for the three-month period ended September 30, 2003
was $132,000 or 1% of net revenues, as compared with $217,000 or 5% of net
revenues, for the three-months ended September 30, 2002, a decrease of $85,000
or 39%. Amortization expense for the nine-month period ended September 30, 2003
was $436,000 or 2% of net revenues, as compared with $725,000 or 5% of net
revenues, for the nine-months ended September 30, 2002, a decrease of $289,000
or 40%. The decrease in the three and nine month comparison periods is primarily
due to the Company's adoption of FAS 142 on January 1, 2002, under which
goodwill is no longer amortized (See also "Note 1. Basis of Presentation -
Interim Financial Information - Stock Compensation Plans") and as a result of
the Company completing amortization of its remaining capitalized software
development expenses.
Restructuring Expenses
The Company reduced its restructuring expense accrual in the nine-month
period ended September 30, 2003, by $29,000 as it was able to settle amounts due
on the closure of its Chelmsford facility for an amount less than originally
estimated. For the three and nine months ended September 30, 2002, the Company
recorded restructuring expenses totaling $96,000 related to the closure of its
Chelmsford, MA, facility.
Interest Expense, Net
Net interest expense for the three-month period ended September 30, 2003 was
$46,000, or less than 1% of net revenues, as compared to $57,000, or 1% of net
revenues, for the three-months ended September 30, 2002, a decrease of $9,000.
Net interest expense for the nine-month period ended September 30, 2003 was
$150,000, or 1% of net revenues, as compared to $174,000, or 1% of net revenues,
for the nine-months ended September 30, 2002, a decrease of $24,000. The
decrease in interest expense is primarily attributable to lower interest rates
between comparison periods.
Other Income, Net
Net other income for the three-month period ended September 30, 2003 was
$7,000, or less than 1% of net revenues, as compared to none for the
three-months ended September 30, 2002, an increase of $7,000. Net other income
for the nine-month period ended September 30, 2003 was $104,000, or 1% of net
revenues, as compared to $24,000, or less than 1% of net revenues, for the
nine-months ended September 30, 2002, an increase of $80,000.
Other income for the three and nine months ended September 30, 2003 is
primarily comprised of the settlement of debts for less than original amounts.
Other expense for the nine-months ended September 30, 2002 is primarily
comprised of a charge of $334,000 related to the repricing of warrants
associated with the termination of an equity line of credit offset by gains on
the settlement of debts for less than original amounts of $360,000.
Liquidity and Capital Resources
The accompanying condensed consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. Although
the Company reported net income of $532,000 for the three months ended September
30, 2003, for the nine months ended September 30, 2003 and the year ended
December 31, 2002, the Company incurred net losses of $1,208,000 and $5,957,000,
respectively, and net cash used in operating activities of $2,955,000, and
$5,004,000, respectively. These factors indicate that the Company may
potentially be unable to continue as a going concern.
The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should
15
the Company be unable to continue as a going concern. The Company's continuation
as a going concern is dependent upon its ability to generate sufficient cash
flows to meet its obligations on a timely basis, to obtain additional financing
as may be required, and to achieve sustained profitability and significant
positive cash flows.
Since inception, the Company has financed its operations primarily through
the public and private sale of common stock, proceeds from the exercise of
options and warrants, short-term borrowing from private lenders, and favorable
credit arrangements with vendors and suppliers.
Net cash used in operating activities for the nine-month periods ended
September 30, 2003 and 2002 was $2,955,000 and $4,824,000, respectively. In the
first nine months of 2003, net cash used in operating activities consisted
primarily of a net loss of $1,208,000 adjusted for depreciation and amortization
of $571,000, an increase in accounts payable of $2,611,000 and accrued
liabilities of $168,000 offset by an increase in accounts receivable of
$2,980,000 and inventories of $1,875,000. In the first nine months of 2002, net
cash used in operating activities consisted primarily of a net loss of
$4,170,000 adjusted for depreciation and amortization of $950,000, warrant issue
expense of $573,000 and gain on debt settlement totaling $311,000, a decrease in
accounts payable of $1,470,000 and payment of legal judgment of $2,073,000,
partially offset by an decrease in accounts receivable of $1,014,000 and a
decrease in inventories totaling $1,453,000.
One customer accounted for 64% of the Company's revenue for the quarter
ended September 30, 2003. Two customers accounted for 68% of the Company's
accounts receivable balance (54% and 14% respectively) at September 30, 2003.
See "Risk Factors - We depend on a few customers for a high percentage of our
revenues and the loss of any one of these customers could result in a
substantial decline in our revenues and profits."
We expect that our operating cash flows may fluctuate in future periods as a
result of fluctuations in our operating results, shipment linearity and accounts
receivable collections, inventory management, and the timing of payments among
other factors.
Net cash used by investing activities for the nine-months ended September
30, 2003 was $146,000, as compared to net cash provided by investing activities
for the nine-months ended September 30, 2002 of $2,299,000. For the first nine
months of 2003, net cash used in investing activities was related to the
purchase of property and equipment of $89,000 and the acquisition of intangible
assets from DVUnlimited, which resulted in a net cash outflow of $57,000. For
the first nine months of 2002, net cash provided by investing activities
resulted principally from the decrease in restricted collateral deposit of
$2,363,000, offset by the purchase of property and equipment of $64,000.
Net cash provided by financing activities for the nine-month periods ended
September 30, 2003 and 2002 was $3,994,000 and $2,796,000, respectively. In the
first nine months of 2003, the Company received $1,924,000 in net proceeds from
private offerings of common stock and $2,107,000 from the exercise of common
stock options and warrants, which were partially offset by payments under
capital lease obligations. In the first nine months of 2002, the Company
received $2,435,000 in net proceeds from private offerings of common stock and
$537,000 from the exercise of common stock options which were partially offset
by $145,000 in repayments on convertible notes to a shareholder.
As of September 30, 2003, the Company had working capital of $4,819,000, as
compared to $1,551,000 at December 31, 2002, an increase of $3,268,000.
The Company has incurred losses and negative cash flows from operations for
the nine months ended September 30, 2003 and each of the two years in the period
ended December 31, 2002 and as such has been dependent upon raising money for
short and long-term cash needs through debt, proceeds from the exercise of
options and warrants, and the sale of common stock in private placements. For
the nine months ended September 30, 2003 and the year ended December 31, 2002,
the Company received approximately $1,924,000 and $3,121,000 in net proceeds
from private offerings of common stock, respectively.
At September 30, 2003, the Company owed Mr. Berg approximately $4.3 million
in principal and accrued interest on various notes. In September 2003, Mr. Berg
agreed to convert such debt and accrued interest into preferred and common stock
on conversion terms agreed to more than two years ago. As of September 30, 2003,
the conversion would result in the issuance of approximately 2,178,433 shares of
common stock and 1,257 shares of preferred stock
16
convertible into 1,257,000 shares of common stock. The conversion is expected to
be completed as soon as practical, but in no event sooner than March 2004.
During 2002, management took steps to continue to reduce costs, including
the reduction of its personnel by 9% in April 2002 and the closure of its
Chelmsford, MA office on September 30, 2002, (resulting in a $96,000
restructuring charge). Additionally, in September 2002, the Company furloughed
7% of its personnel and subsequently terminated such personnel in December 2002.
At September 30, 2003, $35,000 of the restructuring reserve remained.
In addition to regularly reviewing its cost structure, management is
continually reviewing its product lines to identify how to enhance existing or
create new distribution channels. During the nine months ended September 30,
2003, the Company released four new products. Additionally, the Company is
developing and expects to announce at least one more new product during the
fourth quarter of 2003. There can be no assurances as to the amount of revenue
these new products will produce. See "Risk Factors."
Ultimate future capital requirements will depend on many factors, including
cash flow from operations, continued progress in research and development
programs, competing technological and market developments, and our ability to
market our products successfully. Even with the reduction in expenses related to
the restructuring and an expected increase in sales, the Company determined late
in the second quarter of 2003, that it would need to raise additional funds to
support its working capital needs and meet existing debt obligations. In
connection with that need, on July 2, 2003, the Company raised net proceeds of
approximately $1.9 million in a private placement transaction with independent
third parties through the issuance of 2,200,000 shares of the Company's common
stock.
Although the Company reported net income of $532,000 for the three months
ended September 30, 2003 and cash of $2.2 million at September 30, 2003, there
is no assurance that management's plans will be successful or if successful,
that they will result in the Company continuing as a going concern.
Effects of Inflation and Seasonality
The Company believes that inflation has not had a significant impact on
the Company's sales or operating results.
Prior to fiscal 2003, the Company's business had not generally
experienced substantial variations in annual revenues or operating income due to
seasonality. The significant increase in our revenues during the nine months
ended September 30, 2003 over the comparable period in 2002 was a result of the
Microsoft's inclusion of our FS454 semiconductor chip in its Xbox product. For
fiscal 2003, a substantial portion of our semiconductor revenues is subject to
risks associated with the sales of certain end products at retail that are
seasonal, with a large majority of retail sales occurring during the period of
September through December. As a result, our 2003 annual operating results will
depend on the successful sales in the relatively brief holiday season of the end
user products in which our in which our semiconductor products are used,
including Microsoft's Xbox. Furthermore, the volume of work for such customers
is likely to vary from year to year and is subject to risks of non-renewal.
Summary of Certain Contractual Obligations as of September 30, 2003
Amount of Commitment Expiration Per Period
(in thousands)
---------------------------------------------------
Less Than After 5
Total 1 year 1-3 Years 4-5 Years Years
------- ------ -------- -------- ------
Notes payable to stockholder $ 3,867 $ -- $3,867 $ -- $ --
Capital leases 8 8 -- -- --
Operating leases 917 139 776 2 --
------- ------ ------ ------ ------
Total $ 4,792 $ 147 $4,643 $ 2 $ --
======= ====== ====== ====== ======
Recent Accounting Pronouncements
In December 2002, the FASB, issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-an Amendment of FASB Statement No.123,
which provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, this
17
Statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. Effective December 31, 2002, the Company
adopted the amended annual and interim disclosure requirements of SFAS No. 123.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires that upon
issuance of a guarantee, the guarantor must recognize a liability for the fair
value of the obligation it assumes under that guarantee. The Company has adopted
the disclosure provisions of FIN 45, where applicable, and will apply the
recognition and measurement provision for all material guarantees entered into
or modified after December 31, 2002. The adoption of FIN 45 had no impact on the
Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. This
Statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. The Company currently has no financial
instruments which meet these requirements.
In April 2003 the FASB issued SFAS No. 149, Amendment of Statement No. 133
on Derivative Instruments and Hedging Activities. This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts. The
Statement clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative, clarifies when a derivative
contains a financing component, amends the definition of an underlying
derivative to conform it to language used in FASB Interpretation FIN No. 45, and
amends certain other existing pronouncements. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. All provisions of the Statement,
except those related to forward purchases or sales of "when-issued" securities,
should be applied prospectively. The Company currently has no instruments that
meet the definition of a derivative, and therefore, the adoption of this
Statement will have no impact on the Company's financial position or results of
operations.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which addresses consolidation by
business enterprises of variable interest entities that either: (i) do not have
sufficient equity investment at risk to permit the entity to finance its
activities without additional subordinated financial support, or (ii) the equity
investors lack an essential characteristic of a controlling financial interest.
FIN 46 originally required disclosure of Variable Interest Entities (VIEs) in
financial statements issued after January 31, 2003, if it is reasonably possible
that as of the transition date: (i) the company will be the primary beneficiary
of an existing VIE that will require consolidation, or (ii) the company will
hold a significant variable interest in, or have significant involvement with,
an existing VIE. In October 2003 the FASB elected to defer the effective date
for applying the provisions of FIN 46 for interests held by public entities in
variable interest entities or potential variable interest entities created
before February 1, 2003. A public entity need not apply the provisions of FIN 46
to an interest held in a variable interest entity until the end of the first
interim or annual period ending after December 31, 2003. The adoption of FIN 46
is not expected to have an impact on the Company's financial statements.
Critical Accounting Policies
There have no significant changes to the Company's critical accounting
policies as described in the Company's 2002 Form 10-KSB
Risk Factors
You should carefully consider the following risks relating to our business
and our common stock, together with the other information described elsewhere in
this prospectus. If any of the following risks actually occur, our business,
results of operations and financial condition could be materially affected, the
trading price of our common stock could decline, and you might lose all or part
of your investment.
18
Risks Related to Our Business
We have a long history of operating losses.
As of September 30, 2003, we had an accumulated deficit of $62,531,000. Although
we recorded net income of $532,000 for the three months ended September 30,
2003, we incurred net losses of $1,208,000, $5,957,000 and $6,658,000 for the
nine months ended September 30, 2003 and the years ended December 31, 2002 and
2001, respectively. Although we were profitable for the third quarter of 2003,
there can be no assurance that we will remain profitable in subsequent quarters.
Additionally, our auditors have included an explanatory paragraph in their
report on our financial statements for the year ended December 31, 2002 with
respect to uncertainties about our ability to continue as a going concern. The
financial statements do not include any adjustments that might result from the
outcome of that uncertainty.
A significant portion of our revenues is from products that are designed for
consumer goods that have seasonal sales.
A significant portion of our revenues is subject to risks associated with the
sales of certain end products at retail that are seasonal, with a majority of
retail sales occurring during the period of September through December. As a
result, our annual operating results with respect to sales of our semiconductor
chips designed into newly introduced products, including Microsoft's Xbox
depend, in large part, on sales during the relatively brief holiday season.
We may need to raise additional capital, which will result in further dilution
of existing and future stockholders.
Historically, we have met our short-and long-term extra cash needs through debt
and the sale of common stock in private placements because cash flow from
operations has been insufficient to fund our operations. Set forth below is
information regarding net proceeds received recently:
Private Offerings Of Issuance Exercise of Stock
Common Stock of Debt Options and Warrants
------------ ------- --------------------
First nine months of 2003 $1,924,000 -- $2,108,000
Fiscal 2002 $3,121,000 -- $625,000
Fiscal 2001 -- $2,650,000 $199,000
Future capital requirements will depend on many factors, including cash flow
from operations, continued progress in research and development programs,
competing technological and market developments, and our ability to market our
products successfully. If we require additional equity or debt financing in the
future, there can be no assurance that sufficient funds will be raised.
Moreover, any equity financing or convertible debt would result in dilution to
our then-existing stockholders and could have a negative effect on the market
price of our common stock. Furthermore, any additional debt financing may result
in higher interest expense.
In the event we are unable to raise additional capital, we may not be able to
fund our operations which could result in the inability to execute our current
business plan.
We have a significant amount of convertible securities that will dilute existing
stockholders upon conversion.
At September 30, 2003, we had 41,295,762 and 1,904 shares of common and
preferred shares issued and outstanding, respectively, and 1,157,950 warrants
and 5,413,267 options that are exercisable into shares of common stock. The
1,904 shares of preferred stock are convertible into 1,904,000 shares of our
common stock. Furthermore, we may grant 376,901 additional stock options to our
employees, officers, directors and consultants under our current stock option
plans. We also may issue additional shares in acquisitions. Any additional grant
of options under existing or future plans or issuance of shares in connection
with an acquisition, will further dilute existing stockholders.
In addition, in September 2003, Mr. Carl Berg agreed to convert his approximate
$4.3 million of debt and accrued interest into preferred and common stock on
conversion terms agreed to more than two years ago. As of September 30, 2003,
the conversion would result in the issuance of approximately 2,178,433 shares of
common stock and 1,257 shares of preferred stock convertible into 1,257,000
shares of common stock. Due to a recently negotiated sale of a portion of
19
Mr. Berg's position in FOCUS Enhancements to an institutional investor, the
conversion is expected to be completed as soon as practical, but in no event
sooner than March 2004, which is six months from the date of the recent sale,
the earliest date permitted by SEC Section 16(b) and appropriate securities
laws.
We are dependent upon a significant stockholder to meet our interim financing
needs.
We have relied upon the ability of Carl Berg, a director and significant owner
of our common stock for interim financing needs. As of September 30, 2003, we
had an aggregate of approximately $4.3 million in debt and accrued interest
outstanding to Mr. Berg. Additionally, Mr. Berg has provided Samsung
Semiconductor Inc., the Company's contracted ASIC manufacturer, with a personal
guarantee to secure the Company's working capital requirements for ASIC purchase
order fulfillment. There can be no assurances that Mr. Berg will continue to
provide such interim financing or personal guarantees, should we need additional
funds or increased credit facilities with our vendors.
We rely on certain vendors for a significant portion of our manufacturing.
Over 60% of the components for our products are manufactured on a turnkey basis
by three vendors, Furthertech Company Ltd., Samsung Semiconductor Inc., and
Asemtec Corporation. In addition, certain of our products are assembled by a
single vendor in Mexico. If these vendors experience production or shipping
problems for any reason, we in turn could experience delays in the production
and shipping of our products, which would have an adverse effect on our results
of operations.
We are dependent on our suppliers.
We purchase all of our parts from outside suppliers and from time to time
experience delays in obtaining some components or peripheral devices.
Additionally, we are dependent on sole source suppliers for certain components.
There can be no assurance that labor problems, supply shortages or product
discontinuations will not occur in the future which could significantly increase
the cost, or delay shipment, of our products, which in turn could adversely
affect our results of operations.
We depend on a few customers for a high percentage of our revenues and the loss
or failure to pay of any one of these customers could result in a substantial
decline in our revenues and profits.
For the three and nine months ended September 30, 2003, one customer represented
64% and 36% of our total revenues, respectively. This customer also represents a
significant portion of our backlog and anticipated revenue for the fourth
quarter of 2003. Two customers, one of which is described in the preceding
sentence, represented 68% of our accounts receivable balance (54% and 14%,
respectively) as of September 30, 2003. We presently have no reason to believe
that these customers lack the financial resources to pay us. We do not have
long-term contracts requiring any customer to purchase any minimum amount of
products. There can be no assurance that we will continue to receive orders of
the same magnitude as in the past from existing customers or we will be able to
market our current or proposed products to new customers. However, the loss of
any of these identified or other major customers, the failure of any such
identified customer to pay us, or to continue issuance of additional purchase
orders would have a material adverse effect on our revenues, results of
operation, and business as a whole absent the timely replacement of the
associated revenues and profit margins associated with such business.
Furthermore, many of our products are dependent upon the overall success of our
customers' products, over which we often have no control.
Backlog should not be construed as indicative of future revenue or performance.
In the past we have experienced quarterly fluctuations in operating results due
to the contractual nature of our business and the consequent timing of product
orders. In addition, we have historically operated with a small amount of
backlog and accordingly our revenues in any quarter have been substantially
dependent upon orders booked in that quarter. However, as of September 30, 2003,
our total backlog was approximately $3.3 million compared to $223,000 at
December 31, 2002. There can be no assurance that the rate of growth in backlog
will continue. Furthermore, only a small portion of our backlog is fully funded
and many of our customers have the ability to delay delivery or cancel
contracts, therefore, there can be no assurance that orders comprising the
backlog will be realized as revenue. In any event, quarterly sales and operating
results will be continue to be affected by the volume and timing of contracts
received and performed within the quarter, which are difficult to forecast. Any
significant deferral or cancellation of a contract could have a material adverse
effect on our operating results in any particular period. Because of these
factors, we believe that period-to-period comparisons of our operating results
are not necessarily indicative of future performances.
20
Our quarterly financial results are subject to significant fluctuations.
We have been unable in the past to accurately forecast our operating expenses or
revenues. Our revenues currently depend heavily on volatile customer purchasing
patterns. If actual revenues are less than projected revenues, we may be unable
to reduce expenses proportionately, and our operating results, cash flows and
liquidity would likely be adversely affected.
Our products may become obsolete very quickly.
The computer peripheral markets are characterized by extensive research and
development and rapid technological change resulting in short product life
cycles. Development by others of new or improved products, processes or
technologies may make our products or proposed products obsolete or less
competitive. We must devote substantial efforts and financial resources to
enhance our existing products and to develop new products. There can be no
assurance that we will succeed with these efforts.
We may not be able to protect our proprietary information.
As of September 30, 2003, we had been issued five patents and filed five
provisional patent applications in the United States. Certain of these patents
have also been filed and issued in countries outside the United States. We treat
our technical data as confidential and rely on internal non-disclosure
safeguards, including confidentiality agreements with employees, and on laws
protecting trade secrets, to protect our proprietary information. There can be
no assurance that these measures will adequately protect the confidentiality of
our proprietary information or prove valuable in light of future technological
developments.
Delays in product development could adversely affect our market position or
customer relationships.
We have experienced delays in product development in the past and may experience
similar delays in the future. Given the short product life cycles in the markets
for our products, any delay or unanticipated difficulty associated with new
product introductions or product enhancements could cause us to lose customers
and damage our competitive position. Prior delays have resulted from numerous
factors, such as:
* changing product specifications;
* difficulties in hiring and retaining necessary personnel;
* difficulties in reallocating engineering resources and other resource
limitations;
* difficulties with independent contractors;
* changing market or competitive product requirements;
* unanticipated engineering complexity;
* undetected errors or failures in software and hardware; and
* delays in the acceptance or shipment of products by customers.
If we are unable to respond to rapid technological change in a timely manner,
then we may lose customers to our competitors.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our products. Our industry is
characterized by rapid technological change, changes in user and customer
requirements and preferences and frequent new product and service introductions.
If competitors introduce products and services embodying new technologies, or if
new industry standards and practices emerge, then our existing proprietary
technology and systems may become obsolete. Our future success will depend on
our ability to do the following:
* both license and internally develop leading technologies useful in our
business;
* enhance our existing technologies;
* develop new services and technology that address the increasingly
sophisticated and varied needs of our prospective customers; and
21
* respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
To develop our proprietary technology entails significant technical and business
risks. We may use new technologies ineffectively, or we may fail to adapt our
proprietary technology and transaction processing systems to customer
requirements or emerging industry standards. If we face material delays in
introducing new services, products and enhancements, then our customers may
forego the use of our services and use those of our competitors.
Recently, our common stock did not meet the minimum bid price requirement to
remain listed on the Nasdaq SmallCap Market. If we were to be delisted, it could
make trading in our stock more difficult.
Our common stock is traded on the Nasdaq SmallCap Market. There are various
quantitative listing requirements for a company to remain listed on the Nasdaq
SmallCap Market.
We are required to maintain a minimum bid price of $1.00 per share for our
common stock. Between January 1, 2003 and September 30, 2003, our stock closed
below $1.00 a share on 64 of 186 trading days. On March 18, 2003, we were
notified by the Nasdaq that our common stock did not meet the minimum bid price
requirement to remain listed on the Nasdaq SmallCap Market. However, on May 21,
2003, we received notification from Nasdaq that the Company had regained
compliance and the matter was now closed.
We must maintain stockholders' equity of $2,500,000. At September 30, 2003, we
had total stockholders' equity of $7,116,000. To the extent we incur net losses
and do not raise additional capital, our stockholders' equity will be reduced.
If we fail these Nasdaq SmallCap requirements, our common stock could be
delisted, eliminating the only established trading market for shares of our
common stock. Any sales of our common stock at a discount to market may reduce
the trading price of our common stock to a level below the Nasdaq minimum bid
price requirement.
In the event we are delisted from Nasdaq, we would be forced to list our shares
on the OTC Electronic Bulletin Board or some other quotation medium, such as
pink sheets, depending on our ability to meet the specific listing requirements
of those quotation systems. As a result an investor might find it more difficult
to dispose of, or to obtain accurate price quotations for, our shares. Delisting
might also reduce the visibility, liquidity, and price of our common stock.
Our common stock price is volatile.
The market price for our common stock is volatile and has fluctuated
significantly to date. For example, between October 1, 2002 and September 30,
2003, the per share price of our stock has fluctuated between $0.50 and $2.76
per share, closing at $2.72 at November 7, 2003. The trading price of our common
stock is likely to continue to be highly volatile and subject to wide
fluctuations in response to factors including the following:
* actual or anticipated variations in our quarterly operating results;
* announcements of technological innovations, new sales formats or new
products or services by us or our competitors;
* cyclical nature of consumer products using our technology;
* changes in financial estimates by the Company or securities analysts;
* changes in the economic performance and/or market valuations of other
multi-media, video scan companies;
* announcements by us of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
* additions or departures of key personnel; and
* sales of common stock or issuance of other dilutive securities.
In addition, the securities markets have experienced extreme price and volume
fluctuations, and the market prices of the securities of technology companies
have been especially volatile. These broad market and industry factors may
adversely affect the market price of our common stock, regardless of our actual
operating performance. In the past,
22
following periods of volatility in the market price of stock, many companies
have been the object of securities class action litigation, including us. If we
are sued in a securities class action, then it could result in additional
substantial costs and a diversion of management's attention and resources.
Risks Related to Our Industry
International sales are subject to significant risk.
Our revenues from outside the United States are subject to inherent risks
related thereto, including currency rate fluctuations, the general economic and
political conditions in each country. There can be no assurance that the
economic crisis and currency issues currently being experienced in certain parts
of the world will not reduce demand for our products and therefore have a
material adverse effect on our revenue or operating results.
Our business is very competitive.
The computer peripheral markets are extremely competitive and are characterized
by significant price erosion over the life of a product. We currently compete
with other developers of video conversion products and with video-graphic
integrated circuit developers. Many of our competitors have greater market
recognition and greater financial, technical, marketing and human resources.
Although we are not currently aware of any announcements by our competitors that
would have a material impact on its operations, there can be no assurance that
we will be able to compete successfully against existing companies or new
entrants to the marketplace.
The video production equipment market is highly competitive and is characterized
by rapid technological change, new product development and obsolescence,
evolving industry standards and significant price erosion over the life of a
product. Competition is fragmented with several hundred manufacturers supplying
a variety of products to this market. We anticipate increased competition in the
video post-production equipment market from both existing manufacturers and new
market entrants. Increased competition could result in price reductions, reduced
margins and loss of market share, any of which could materially and adversely
affect our business, financial condition and results of operations. There can be
no assurance that we will be able to compete successfully against current and
future competitors in this market.
Often our competitors have greater financial, technical, marketing, sales and
customer support resources, greater name recognition and larger installed
customer bases than we possess. In addition, some of our competitors also offer
a wide variety of video equipment, including professional video tape recorders,
video cameras and other related equipment. In some cases, these competitors may
have a competitive advantage based upon their ability to bundle their equipment
in certain large system sales.
We are exposed to general economic conditions that have resulted in
significantly reduced sales levels. If such adverse economic conditions were to
continue or worsen, our business, financial condition and operating results
could be adversely impacted.
If the adverse economic conditions in the State of California, the United States
and throughout the world economy continue or worsen, we may continue to
experience a material adverse impact on our business, operating results, and
financial condition. We continue to take actions and charges to reduce our cost
of sales and operating expenses in order to address these adverse conditions. A
prolonged continuation or worsening of sales trends may require additional
actions and charges to reduce cost of sales and operating expenses in subsequent
quarters. We may be unable to reduce cost of sales and operating expenses at a
rate and to a level consistent with such a future adverse sales environment. If
we must undertake further expense reductions, we may incur significant
incremental special charges associated with such expense reductions that are
disproportionate to sales, thereby adversely affecting our business, financial
condition and operating results. Continuing weakness in the economy could
decrease demand for our products, increase delinquencies in payments and
otherwise have an adverse impact on our business.
Recent corporate bankruptcies, accounting irregularities, and alleged insider
wrong doings have negatively affected general confidence in the stock markets
and the economy, further depressing the stock market and causing the U.S.
Congress to enact sweeping legislation.
In an effort to address these growing investor concerns, the U.S. Congress
passed, and on July 30, 2002, President Bush signed into law, the Sarbanes-Oxley
Act of 2002. This sweeping legislation primarily impacts investors, the public
accounting profession, public companies, including corporate duties and
responsibilities, and securities analysts. Some
23
highlights include establishment of a new independent oversight board for public
accounting firms, enhanced disclosure requirements for public companies and
their insiders, required certification by CEO's and CFO's of SEC financial
filings, prohibitions on certain loans to offices and directors, efforts to curb
potential securities analysts' conflicts of interest, forfeiture of profits by
certain insiders in the event financial statements are restated, enhanced board
audit committee requirements, whistleblower protections, and enhanced civil and
criminal penalties for violations of securities laws. Such legislation and
subsequent regulations will increase the costs of securities law compliance for
publicly traded companies such as us.
Continued terrorism threats and hostilities in the Middle East have had a
negative impact on the U.S. economy.
The adverse consequences of war and the effects of terrorism have had a negative
affect on the U.S. economy. Further conflicts in the Middle East could
negatively impact our ability to raise additional funds if needed and our
revenues will be adversely affected if consumers and businesses continue to cut
back spending.
The spread of severe acute respiratory syndrome may have a negative impact on
our business and results of operations.
The recent outbreak of severe acute respiratory syndrome, or SARS, which has had
particular impact in China, Hong Kong, and Singapore, could continue to have a
negative effect on our operations. Our operations may be impacted by a number of
SARS-related factors, including, among other things, disrupting operations at
our turnkey manufacturer and certain of our distributors and customers located
in those areas. If SARS re-emerges in the future, our international and domestic
sales and operations could be harmed.
24
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At September 30, 2003 we did not hold any short-term investments that would
be exposed to market risk from adverse movements in interest rates.
At September 30, 2003, we had three promissory notes payable to Carl Berg, a
Company director and shareholder, totaling $3,867,000, bearing interest at prime
plus 1%. If short-term interest rates were to increase 100 basis points (100
basis points equals 1%), the increased interest expense associated with these
promissory notes would not have a material impact on our net loss and cash
flows.
Item 4. Controls and Procedures
In accordance with Section 302 of the Sarbanes-Oxley Act of 2002 and
the Securities Exchange Act of 1934 Section 13(a) or Section 15(d), we
implemented disclosure controls and procedures pursuant to which management
under the supervision and with the participation of the chief executive officer
("CEO") and chief financial officer ("CFO") carried out, as of the end of the
period covered by this filing, a review and evaluation of the effectiveness of
these controls and procedures. Based on this review, our CEO and CFO have
concluded that our disclosure controls and procedures are effective in timely
alerting them to material changes in information required to be included in our
periodic Securities and Exchange Commission filings.
During the Company's most recent quarter, there were no significant changes
in our internal controls or in other factors that could significantly affect
these controls.
25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
General
From time to time, the Company is party to certain other claims and legal
proceedings that arise in the ordinary course of business of which, in the
opinion of management, do not have a material adverse effect on the Company's
financial position or results of operation.
Item 2. Changes in Securities and Use of Proceeds
(a) (None)
(b) (None)
(c) and (d) On November 25, 2002, the Company completed the sale of 800,000
shares of its common stock in a private placement to two
independent third parties, receiving proceeds of approximately
$685,000, net of offering costs of $83,000. The shares were
sold at an approximate 20% discount to the 20-day average
closing bid prices of the Company's common stock as of November
24, 2002, the date an agreement in principle was reached by the
parties. Additionally, in connection with the efforts of
vFinance Investments Inc. to find investors in the private
placement, the Company issued warrants to vFinance Investments
Inc. to purchase a total of 40,000 shares of common stock at an
exercise price of $1.20 per share. The shares were sold to
accredited investors pursuant to an exemption from registration
under the federal securities laws. We used the funds from the
sale of the 800,000 shares of common stock for general
corporate purposes.
The shares, including the underlying warrants, were
subsequently registered on a Registration Statement on Form S-3
deemed effective on April 25, 2003. We did not receive any
proceeds from the sale of shares by the selling stockholders
pursuant to the Form S-3. However, we will receive funds from
the exercise of warrants held by selling stockholders who pay
the exercise price in cash. The warrants entitle the selling
shareholders to purchase up to an aggregate of 40,000 shares of
our common stock at a conversion price of $1.20 per share. We
will receive the proceeds of any exercise of the warrants,
which we will use for general corporate purposes. As of
September 30, 2003, the 40,000 warrants registered pursuant to
the Form S-3 had been exercised.
On July 2, 2003, the Company completed the sale of 2,200,000
shares of its common stock in a private placement to two
independent third parties, receiving net proceeds of
approximately $1.9 million. The shares were sold at an
approximate 20% discount to the 5-day average closing bid
prices of the Company's common stock prior to closing. In
connection with the private placement, the Company issued
warrants to the two investors and a placement agent to purchase
a total of 467,500 shares of common stock at an exercise price
of $1.44 per share. The shares were sold to accredited
investors pursuant to an exemption from registration under the
federal securities laws. We used the funds from the sale of the
2,200,000 shares of common stock for general corporate
purposes.
The shares, including the underlying warrants, were
subsequently registered on a Registration Statement on Form S-3
deemed effective on October 7, 2003. We did not receive any
proceeds from the sale of shares by the selling stockholders
pursuant to the Form S-3. However, we will receive funds from
the exercise of warrants held by selling stockholders who pay
the exercise price in cash. We will receive the proceeds of any
exercise of the warrants, which we will use for general
corporate purposes. As of September 30, 2003, none of the
warrants registered pursuant to the Form S-3 had been
exercised.
26
Item 3. Defaults Upon Senior Securities
(None)
Item 4. Submission of Matters to a Vote of Security Holders
(None)
Item 5. Other Information
(None)
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 31.1 - Rule 13a-14(a) Certification of CEO
Exhibit 31.2 - Rule 13a-14(a) Certification of CFO
Exhibit 32.1 - CEO Certification Pursuant to the 18 U.S.C.
Section 1350
Exhibit 32.2 - CFO Certification Pursuant to the 18 U.S.C.
Section 1350
(b) Reports on Form 8-K
On July 7, 2003, Focus Enhancements, Inc. issued a press release
announcing that it had closed a private placement of 2.2 million
shares of Focus Enhancements common stock for gross proceeds of
$2,200,000. In addition, Focus issued warrants for an additional
467,500 shares of common stock. Proceeds will be used to fund working
capital and for general corporate purposes. vFinance Investments, Inc.
and TN Capital Equities, Ltd. acted as placement agents in the
transaction. In a separate development, on July 7, 2003, Focus
Enhancements, Inc. issued a press release announcing that it had
raised its revenue guidance for the remainder of 2003.
On August 7, 2003, Focus Enhancements, Inc. issued a press release
announcing it second quarter 2003 results.
27
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.
November 12, 2003 Focus Enhancements, Inc.
-------------------------------------
Date Registrant
By: /s/ Brett A. Moyer
----------------------------------
Brett A. Moyer
Chief Executive Officer and President
(Principal Executive Officer)
By:/s/ Gary L. Williams
----------------------------------
Gary L. Williams
Vice President of Finance,
Chief Financial Officer
(Principal Accounting Officer)