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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2002
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From ___________ to __________
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Commission File Number: 0000-27267
I/OMAGIC CORPORATION
(Exact name of registrant as specified in its charter)
NEVADA 88-0290623
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1300 WAKEHAM SANTA ANA, CALIFORNIA 92705
(Address of principal executive office) (Zip Code)
Registrant's Telephone Number, Including Area Code: (714) 953-3000
Indicated 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
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |
As of November 13, 2002, there were 67,930,291 shares of the
registrant's common stock, $.001 par value, outstanding.
================================================================================
I/OMAGIC CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
INDEX
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements
Balance Sheets as of September 30, 2002 (unaudited) and
December 31, 2001....................................................2
Statements of Operations for the three and nine months ended
September 30, 2002 and 2001 (unaudited)..............................4
Statements of Cash Flows for the nine months ended September 30, 2002
and 2001 (unaudited).................................................5
Notes to Financial Statements........................................7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................13
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........28
Item 4. Controls and Procedures..............................................29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................29
Item 2. Changes in Securities and Use of Proceeds............................29
Item 3. Defaults Upon Senior Securities......................................29
Item 4. Submission of Matters to a Vote of Security Holders..................30
Item 5. Other Information....................................................30
Item 6. Exhibits and Reports on Form 8-K.....................................31
Signatures ................................................................32
Exhibits Filed with Report on Form 10-Q.......................................32
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
I/OMAGIC CORPORATION
BALANCE SHEETS
DECEMBER 31, 2001 AND SEPTEMBER 30, 2002 (UNAUDITED)
ASSETS
DECEMBER 31, SEPTEMBER 30,
2001 2002
(unaudited)
------------ ------------
CURRENT ASSETS
Cash and cash equivalents, restricted cash
of $750,000 $ 4,423,623 $ 3,615,938
Accounts receivable, net of allowance for
doubtful accounts of $2,679,118 and 27,844,543 16,663,357
$2,129,248 (unaudited)
Inventory, net of allowance for obsolete
inventory of $558,703 and $297,213 (unaudited) 10,377,287 10,482,399
Inventory in transit 1,634,420 439.790
Income tax receivable 34,311 34,311
Prepaid expenses and other current assets 2,292,424 440,047
Current portion of deferred income taxes 1,556,000 556,000
------------ ------------
TOTAL CURRENT ASSETS 48,162,608 32,231,842
PROPERTY AND EQUIPMENT, NET 1,266,216 1,142,588
TRADEMARK, net of accumulated amortization
of $3,375,976 and $4,147,624 (unaudited) 6,269,703 5,498,055
DEFERRED INCOME TAXES, net of current portion 165,000 165,000
OTHER ASSETS 40,240 40,240
------------ ------------
TOTAL ASSETS $55,903,767 $39,077,725
============ ============
The accompanying notes are an integral part of these financial statements
2
I/OMAGIC CORPORATION
BALANCE SHEETS
DECEMBER 31, 2001 AND SEPTEMBER 30, 2002 (UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, SEPTEMBER 30,
2001 2002
(unaudited)
------------- -------------
CURRENT LIABILITIES
Line of credit $ 9,622,241 $ 5,215,175
Accounts payable and accrued expenses 12,027,498 6,503,711
Accounts payable to related parties 5,521,720 3,142,062
Current portion of capital lease obligation 10,978 1,789
Reserves for customer returns and allowances 2,605,679 1,130,352
------------- -------------
TOTAL CURRENT LIABILITIES 29,788,116 15,993,089
------------- -------------
COMMITMENTS AND CONTINGENCIES
REDEEMABLE CONVERTIBLE PREFERRED STOCK
10,000,000 shares authorized, $0.001 par value
Series A, 1,000,000 shares authorized
875,000 shares issued and outstanding 875 875
Series B, 1,000,000 shares authorized
250,000 shares issued and outstanding 250 250
Additional paid-in capital 8,998,875 8,998,875
------------- -------------
TOTAL REDEEMABLE CONVERTIBLE
PREFERRED STOCK 9,000,000 9,000,000
------------- -------------
STOCKHOLDERS' EQUITY
Class A common stock, $0.001 par value
100,000,000 shares authorized
67,930,291 and 67,930,291 (unaudited) shares
issued and outstanding 67,931 67,931
Additional paid in capital 31,493,957 31,493,957
Treasury stock, 60,396 shares, (unaudited) at cost -- (40,410)
Accumulated deficit (14,446,237) (17,436,842)
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 17,115,651 14,084,636
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 55,903,767 $ 39,077,725
============= =============
The accompanying notes are an integral part of these financial statements
3
I/OMAGIC CORPORATION STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 AND FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (UNAUDITED)
For the Nine Months Ended For the Three Months Ended
September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
(unaudited) (unaudited) (unaudited) (unaudited)
NET SALES $ 61,199,231 $ 41,742,634 $ 20,393,164 $ 23,820,100
COST OF SALES 54,750,691 39,548,635 18,838,477 19,215,140
------------- ------------- ------------- -------------
GROSS PROFIT 6,448,540 2,193,999 1,554,687 4,604,960
------------- ------------- ------------- -------------
OPERATING EXPENSES
Selling, marketing, and advertising 1,147,916 1,125,623 443,953 427,667
General and administrative 6,055,548 4,258,517 1,850,362 1,503,716
Depreciation and amortization 1,000,363 1,672,260 219,136 559,427
------------- ------------- ------------- -------------
Total operating expenses 8,203,827 7,056,400 2,513,451 2,490,810
------------- ------------- ------------- -------------
INCOME (LOSS) FROM OPERATIONS (1,755,287) (4,862,401) (958,764) 2,114,150
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE)
Interest income 1,411 34,953 1,299 1,000
Interest expense (282,818) (345,814) (90,678) (76,430)
Other income 45,221 10,170 6,462 --
Other expense -- -- -- --
------------- ------------- ------------- -------------
Total other income (expense) (236,186) (300,691) (82,917) (75,430)
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE PROVISION
FOR INCOME TAXES (1,991,473) (5,163,092) (1,041,681) 2,038,720
PROVISION FOR INCOME TAXES 999,132 430,091 499,132 600
------------- ------------- ------------- -------------
NET INCOME (LOSS) $ (2,990,605) $ (5,593,183) $ (1,540,813) $ 2,038,120
============= ============= ============= =============
BASIC AND DILUTED INCOME(LOSS)
PER SHARE $ (0.04) $ (0.08) $ (0.02) $ 0.03
============= ============= ============= =============
WEIGHTED-AVERAGE SHARES
OUTSTANDING 67,930,291 67,923,148 67,930,291 67,930,291
============= ============= ============= =============
The accompanying notes are an integral part of these financial statements
4
I/OMAGIC CORPORATION STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001
(UNAUDITED)
For the Nine Months Ended
September 30,
--------------------------------
2002 2001
------------- -------------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (2,990,605) $ (5,593,183)
Adjustments to reconcile net
loss to net cash provided
by operating activities
Depreciation and amortization 228,715 225,417
Amortization of trademark 771,648 1,446,844
Amortization of deferred compensation -- 3,100
Provision for allowance for
doubtful accounts 1,100,000 331,347
Provision for inventory obsolescence 1,425,000 36,260
Net gain from sale of
Property and equipment (38,759) --
Deferred income tax 1,000,000 427,091
Reserves for customer returns
And allowances (1,475,326) 912,673
(Increase) decrease in
Accounts receivable 10,081,186 320,446
Accounts receivable from
related parties -- 39,189
Inventory (335,483) 9,791,410
Prepaid expenses and other
current assets 1,852,377 (1,167,609)
Increase (decrease) in
Accounts payable and accrued expenses (5,523,788) (3,605,197)
Accounts payable to related parties (2,379,658) 2,736,338
------------- -------------
Net cash provided by
operating activities 3,715,307 5,904,126
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Property additions (140,328) (123,401)
Proceeds from sale of
property and equipment 74,000 --
------------- -------------
Net cash used in
investing activities (66,328) (123,401)
------------- -------------
The accompanying notes are an integral part of these financial statements
5
I/OMAGIC CORPORATION STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (UNAUDITED)
For the Nine Months Ended
September 30,
------------------------------
2002 2001
------------ ------------
(unaudited) (unaudited)
CASH FLOWS FROM FINANCING ACTIVITIES
Net payments on line of credit $(4,407,066) $ (301,028)
Payments on capital lease obligations (9,188) (19,972)
Purchase of treasury stock (40,410) --
Proceeds from exercise of warrants -- 625
------------ ------------
Net cash used in financing activities (4,456,664) (320,375)
------------ ------------
Net increase (decrease) in cash (807,685) 5,460,350
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 4,423,623 3,502,546
------------ ------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 3,615,938 $ 8,962,896
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
INTEREST PAID $ 279,757 $ 345,814
============ ============
INCOME TAXES PAID $ 800 $ 1,400
============ ============
The accompanying notes are an integral part of these financial statements
6
I/OMAGIC CORPORATION
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS
I/OMagic Corporation, a Nevada corporation, together with its
subsidiary (collectively, the "Company") develops, manufactures through
subcontractors, markets, and distributes multimedia and communication card
devices for portable and desktop computers. The Company sells its products in
the United States and Canada to distributors and retail customers.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to Form 10-Q and
therefore, do not include all information and notes necessary for a fair
presentation of financial position, results of operations, and cash flows in
conformity with generally accepted accounting principles. The unaudited
condensed financial statements include the accounts of I/OMagic Corporation and
its subsidiary. The operating results for interim periods are unaudited and are
not necessarily an indication of the results to be expected for the full fiscal
year. In the opinion of management, the results of operations as reported for
the interim periods reflect all adjustments which are necessary for a fair
presentation of operating results.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosures of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period.
Significant estimates made by management include, but are not limited
to, the provisions for allowance of doubtful accounts and price protection on
accounts receivable, the net realizability of inventory, the evaluation of
potential impairment of furniture and equipment, and the provision for sales
returns and warranties. Actual results could materially differ from those
estimates.
7
STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," establishes
and encourages the use of the fair value based method of accounting for
stock-based compensation arrangements under which compensation cost is
determined using the fair value of stock-based compensation determined as of the
date of grant and is recognized over the periods in which the related services
are rendered. The statement also permits companies to elect to continue using
the current implicit value accounting method specified in Accounting Principles
Bulletin ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," to
account for stock-based compensation issued to employees. The Company has
elected to use the implicit value based method and has disclosed the pro forma
effect of using the fair value based method to account for its stock-based
compensation. For stock-based compensation issued to non-employees, the Company
uses the fair value method of accounting under the provisions of SFAS No. 123.
RECLASSIFICATIONS
Certain amounts included in the September 30, 2001 Statement of
Operations have been reclassified to conform with the current period
presentation. Such reclassifications did not have any effect on the reported net
income(loss).
EARNINGS (LOSS) PER SHARE
The Company calculates earnings (loss) per share in accordance with
SFAS No. 128, "Earnings Per Share." SFAS No. 128 replaced the presentation of
primary and fully diluted earnings per share with the presentation of basic and
diluted earnings (loss) per share. Basic earnings (loss) per share excludes
dilution and is calculated by dividing income (loss) available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings (loss) per share includes the potential dilutive
effects that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock ("potential common stock") that
would then share in the earnings (loss) of the Company.
The Company had potential common stock as follows:
For the Nine Months Ended For the Three Months Ended
September 30, September 30,
2002 2001 2002 2001
(unaudited) (unaudited) (unaudited) (unaudited)
----------- ----------- ----------- -----------
Weighted-average common shares
Outstanding during the period 67,930,291 67,923,148 67,930,291 67,930,291
Incremental shares assumed to be
outstanding since the beginning of the
period related to stock options and warrants
outstanding -- -- -- --
---------- ---------- ---------- ----------
FULLY DILUTED WEIGHTED-AVERAGE COMMON
SHARES AND POTENTIAL COMMON STOCK 67,930,291 67,923,148 67,930,291 67,930,291
---------- ---------- ---------- ----------
8
NOTE 3 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued liabilities consisted of the following:
September 30,
2002
-----------
(unaudited)
Accounts payable $1,801,216
Accrued rebates and marketing 3,666,423
Accrued compensation and related benefits 217,779
Other 818,293
-----------
TOTAL $6,503,711
===========
NOTE 4 - INVENTORY
Inventory consisted of the following:
September 30,
2002
-------------
(unaudited)
Component parts $ 2,222,696
Finished goods 8,556,916
Reserves for inventory (297,213)
-------------
TOTAL $ 10,482,399
=============
NOTE 5 - LINE OF CREDIT
The Company maintains a revolving line of credit with a financial
institution that allows it to borrow a maximum of $14,000,000 with a sub-limit
of $13,000,000. The line of credit expires December 31, 2002. The line is
secured by a UCC filing on substantially all of the Company's assets.
Within the sub-limit, up to $13,000,000 is available for maturities up
to 150 days and up to $3,000,000 is available for maturities up to 60 days
against 30% of inventory. Within the line of credit, a sub-line of $1,000,000 is
available for uncollected funds availability.
The availability of the line of credit is subject to the borrowing
base, which is 65% of eligible receivables. Advances on the line of credit bear
interest at the Wall Street Journal Prime (4.75% as of September 30, 2002) plus
0.75%. As of September 30, 2002, the outstanding balance under the revolving
line of credit was $5,215,175.
9
The line of credit provides for the maintenance of certain financial
covenants and a compensating balance of $750,000, of which the Company was in
compliance at September 30, 2002.
NOTE 6 - TRADE CREDIT ARRANGEMENTS FROM RELATED PARTIES
The Company has the ability to purchase inventory up to $2,000,000
through a stockholder and supplier. Purchases are non-interest bearing and are
due 75 days from the date of receipt. The credit agreement can be terminated or
changed at any time. As of December 31, 2001 and September 30, 2002 (unaudited),
there were $0 and $0, respectively, in trade payables outstanding under this
arrangement.
The Company has the ability to purchase inventory up to $5,000,000
within 75 day terms, as defined by a stockholder and investor. As of December
31, 2001 and September 30, 2002 (unaudited), there were $3,001,926 and
$2,452,062, respectively, in trade payables outstanding under this arrangement.
The Company has the ability to purchase inventory up to $3,000,000 with
net 60 day terms as defined through a stockholder and investor. As of December
31, 2001 and September 30, 2002 (unaudited), there were $1,273,250 and $690,000,
respectively, in trade payables outstanding under this arrangement.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain equipment under operating
lease agreements, expiring through March 2010. The main facility lease is
cancelable as of April 2003; equipment leases are non-cancelable.
Rent expense was $340,966 and $420,438 for the nine months ended
September 30, 2002 and 2001, respectively, and is included in general and
administrative expenses in the accompanying statements of income.
LITIGATION
On August 2, 2001, Mark Vakili and Mitra Vakili filed a complaint in
the Superior Court of the State of California for the County of Orange (Case No.
01CC09894) against Tony Shahbaz. The complaint alleged that Mr. Shahbaz
defrauded the plaintiffs by failing to honor the terms of a contract
("Contract") under which Mr. Shahbaz was to deliver 1,500,000 shares of the
Company's common stock in exchange for an interest in Alex Properties, a general
partnership that held an industrial warehouse rental property. The complaint
later was amended to add Alex Properties and Hi-Val, Inc. as plaintiffs and the
Company, IOM Holdings, Inc. ("IOMH"), which is a corporation that the Company
acquired, Steel Su and Meilin Hsu as defendants. As amended, the complaint seeks
an aggregate of $42,000,000 plus punitive and other damages to be proven at
trial and also seeks rescission of the Contract. The amended complaint alleges
that IOMH, Mr. Shahbaz, Mr. Su and Ms. Hsu fraudulently and negligently made
misrepresentations to induce Hi-Val to enter into an asset purchase agreement in
June 1999 for the purchase and sale of Hi-Val assets to IOMH. The amended
complaint also alleges that IOMH and Mr. Shahbaz breached the terms of the asset
purchase agreement by failing to deliver consideration that included 2,000,000
shares of the Company's common stock and payment of interest on Mr. Vakili's
$1,500,000 loan to Hi-Val that was to be assumed by IOMH under the asset
purchase agreement and by failing to timely replace Mr. Vakili as personal
guarantor of Hi-Val's $25,000,000 credit facility. The $42,000,000 in alleged
damages includes $15,000,000 sought from Mr. Shahbaz in connection with the
Contract and $27,000,000 sought from IOMH, Mr. Shahbaz, Mr. Su and Ms. Hsu in
connection with the asset purchase agreement. The Company intends to vigorously
defend itself in this action.
On September 17, 2002, a settlement was reached between the Company and
Aureal, Inc. The Company paid $280,000 to settle trade payables.
On October 23, 2002, a settlement was reached between the Company and
Staples. The Company received $451,208 for accounts receivable.
10
EMPLOYMENT CONTRACT
In October 2002, the Company entered into a five year employment
contract with one of its officers. The agreement, retroactive to January 1,
2002, calls for a minimum base salary of $198,500 per year, $14,400 auto
allowance per year and provides for certain expense allowances. In addition, the
agreement provides for a 7% bonus based on the "quarterly net income" of the
Company, as defined. If the Company terminates this agreement without cause, the
Company will be obligated to pay all salary owed for the remaining term. No
bonus was paid during the three months ended September 30, 2002, or the three
months ended September 30, 2002. As of September 30, 2001, there was no accrual
under this agreement.
RETAIL AGREEMENTS
In connection with certain retail agreements, the Company has agreed to
pay for certain marketing development and advertising on an ongoing basis.
Marketing development and advertising costs are generally agreed upon at the
time of the event. The Company also records a liability for co-op marketing
based on management's evaluation of historical experience and current industry
and Company trends. During the three months ended September 30, 2002 and 2001,
the Company incurred $954,104 (unaudited) and $3,235,990 (unaudited),
respectively, related to these agreements. Such is netted against sales revenue
in the accompanying statements of operations.
NOTE 8 - CAPITAL TRANSACTIONS
During the nine months ended September 30, 2002, the Company purchased
60,396 shares of its common stock in the open market for $40,410.
NOTE 9 - RELATED PARTY TRANSACTIONS
During the nine months ended September 30, 2002 and 2001, the Company
had purchases from related parties totaling approximately $13,039,419
(unaudited) and $7,863,562 (unaudited), respectively.
As of September 30, 2002 and December 31, 2001, the Company had
accounts payable to related parties totaling approximately $3,142,062
(unaudited) and $5,521,720, respectively.
The Company leases its Santa Ana facility (57,374 square feet) from a
partnership, of which the Company's President and CEO is a general partner,
which requires initial minimum monthly payment of $28,673 ($0.50 per square
foot) and expires in March 2010. This lease becomes cancelable in April 2003.
For the nine months ended September 30, 2002 and 2001, rent expense was $258,057
and $258,057, respectively, and is included in general and administrative
expenses in the accompanying statements of operations.
King Eagle Enterprises, Inc., a related party, is involved in printing
and packaging services to the Company. King Eagle Enterprises, Inc. is currently
seeking investments in and/or acquisitions of printing and packaging facilities
to better accommodate cost/support to the Company. During the nine months ended
September 30, 2002 and 2001, the Company had purchases of $0 (unaudited) and $0
(unaudited), respectively, from King Eagle Enterprises, Inc.
11
NOTE 10 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit An
Activity (Including Certain Costs Incurred in a Restructuring)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3 a
liability for an exit cost as defined, was recognized at the date of an entity's
commitment to an exit plan. This statement will not have a material impact on
the Company's financial statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." In addition, this statement amends SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include certain financial
institution-related intangible assets. This statement is not applicable to the
Company.
NOTE 11 - SUBSEQUENT EVENTS
On October 25, 2002, the Company repurchased all of its $9 million in
convertible preferred stock for $1 million in cash. The stock consisted of
875,000 of Series A shares and 250,000 of Series B shares. The repurchase and
cancellation will result in an increase to shareholders' equity effective with
the December 31, 2002 statements.
In September 2002, the Board of Directors approved the 2002 Stock
Option Plan, approving the reservation for issuance of 2,000,000 share of Common
Stock. No options have been granted under the plan. The plan was approved at the
Annual Shareholders' Meeting in November 2002.
In September 2002, the Board of Directors approved a one-for-fifteen
reverse stock split to be implemented at the discretion of the Board of
Directors prior to December 31, 2002. The authority of the Board of Directors to
implement a one-for-fifteen reverse stock split was approved at the Annual
Shareholders' Meeting in November 2002.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
I/OMagic Corporation (the "Company") develops, sub-contract
manufactures, markets and distributes products for its optical storage and its
digital entertainment units. These products include CD-Rom drives, CD-RW drives,
DVD-Rom drvies, optical storage media, audio and video adapter cards, video
capture cards, floppy disk drives, keyboards, mice, modems, and MP3 portable
music players. The Company markets its products under some or all of the
following brand names: I/OMagic, Hi-Val and Digital Research Technologies. The
Company sells its products primarily to large retailers of electronic products
such as Office Depot, Office Max, Best Buy, Circuit City, CompUSA, Fred Meyers
and other leading regional retailers.
The following discussion and analysis should be read in conjunction
with the Company's financial statements and notes to financial statements
included elsewhere in this report. This report and the Company's financial
statements and notes to financial statements contain forward-looking statements,
which generally include the plans and objectives of management for future
operations, including plans and objectives relating to our future economic
performance and the Company's current beliefs regarding revenues it might earn
if it is successful in implementing its business strategies. The forward-looking
statements and associated risks may include, relate to or be qualified by other
important factors, including, without limitation:
o the projected growth in the personal computer peripheral and
consumer electronics markets;
o the Company's business strategy for expanding its presence in
these markets;
o anticipated trends in the Company's financial condition and
results of operations; and
o the Company's ability to distinguish itself from its current
and future competitors.
The Company does not undertake to update, revise or correct any
forward-looking statements.
The information contained in this report is not a complete description
of the Company's business or the risks associated with an investment in the
Company's common stock. Before deciding to buy or maintain a position in the
Company's common stock, you should carefully review and consider the various
disclosures the Company made in this report, and in the Company's other
materials filed with the Securities and Exchange Commission that discuss the
Company's business in greater detail and that disclose various risks,
uncertainties and other factors that may affect the Company's business, results
of operations or financial condition.
Any of the factors described above or in the "Risk Factors" section
below could cause the Company's financial results, including the Company's net
income (loss) or growth in net income (loss) to differ materially from prior
results, which in turn could, among other things, cause the price of the
Company's common stock to fluctuate substantially.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including those related to customer programs
13
and incentives, product returns, bad debts, inventories, intangible assets,
income taxes, and contingencies and litigation. The Company bases its estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect
its more significant judgments and estimates used in the preparation of its
consolidated financial statements. The Company records estimated reductions to
revenue for customer programs and incentive offerings including special pricing
agreements, price protection, promotions and other volume-based incentives. If
market conditions were to decline, the Company may take actions to increase
customer incentive offerings possibly resulting in an incremental reduction of
revenue at the time the incentive is offered. The Company maintains allowances
for doubtful accounts for estimated losses resulting from the inability of its
customers to make required payments. If the financial condition of the Company's
customers were to deteriorate, resulting in the impairment of their ability to
make payments, additional allowances may be required.
The Company writes down its inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
the estimated market value based upon assumptions about future demand and market
conditions. If actual market conditions are less favorable than those projected
by management, additional inventory write-downs may be required. The Company
records a valuation allowance to reduce its deferred tax assets in the future in
excess of its net recorded amount, an adjustment to the deferred tax asset would
increase income in the period such determination was made. Likewise, should the
Company determine that it would not be able to realize all or part of its net
deferred tax asset in the future, an adjustment to the deferred tax asset would
be charged to income in the period such determination was made.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2001
Net sales for the three months ended September 30, 2002 decreased by
$3,426,936 (14.4%) to $20,393,164, as compared to $23,820,100 for the three
months ended September 30, 2001. This decrease in net sales primarily was due to
the addition of a new customer in Q3 2001 (which resulted in high initial orders
to stock all the stores), the addition of new products in an existing customer
in Q3 2001 (which resulted in high initial orders to stock all stores), and
supply chain restrictions in Q3 2002.
The Company's net sales include reductions for marketing expenses of
$2,835,307 for the three months ended September 30, 2002 and $5,847,353 for the
three months ended September 30, 2001. These reductions are in accordance with
the Emerging Issues Task Force Issue No. 01-09, "Accounting for Consideration
Given by a Vendor to a Customer or a Reseller of the Vendor's Products" ("EITF
Issue No. 01-09"). EITF Issue No. 01-09 provides that certain consumer and trade
sales promotion expenses are presumed to be a reduction of the selling prices of
the vendor's products and, therefore, should be characterized as a reduction of
revenue as net sales. The provisions of this pronouncement are required for
fiscal years beginning after December 15, 2001. The Company adopted this
pronouncement beginning with its December 31, 2001 statement of operations and
has reclassified its September 30, 2001 statement of operations. The adoption of
this pronouncement has resulted in adjustments to the Company's net sales, gross
margin and selling and marketing expenses. EITF Issue No. 01-09 has no impact on
operating income, net income or earnings per share.
14
Gross profit as a percentage of net sales decreased from approximately
19.3%, representing a gross profit of $4,604,960 for the three months ended
September 30, 2001, to 7.6%, representing a gross profit of $1,554,687 for the
three months ended September 30, 2002. This decrease in gross profit primarily
was due to high gross margin in Q3 2001 due to new products sold and lower gross
margin in Q3 2002 due to greater price competition in a difficult economy and in
part due to supply chain restrictions.
Total operating expenses increased by $22,641 (0.9%) to $2,513,451
during the three months ended September 30, 2002, as compared to $2,490,810 for
the three months ended September 30, 2001, and increased as a percentage of net
sales from 10.46% during the three months ended September 30, 2001 to 12.3%
during the three months ended September 30, 2002. The increase in dollar amount
of these expenses resulted from the following. A $16,286 increase in selling,
marketing, and advertising expenses was primarily due to increased travel
expenses. A $346,646 increase in general and administrative expenses was
primarily due to a $267,587 increase in legal expenses, an $85,638 increase in
salaries and fringe, an $86,390 increase in outside subcontracting, offset by a
$42,864 decrease in rent. A $340,291 decrease in depreciation and amortization
expense resulted from a reduction in monthly trademark amortization effective
April 2002. This reduction in amortization expense was the result of an
independent appraisal of the life of each of the Company's trademarks as
required by FASB No. 142. The increase in total operating expenses as a
percentage of net sales resulted primarily from a 14.4% decrease in net sales as
compared to the prior period.
Other expense during the three months ended September 30, 2002
increased by $7,487 to $82,917 or 0.4% of net sales, from $75,430 or 0.3% of net
sales during the three months ended September 30, 2001. This increase was
primarily due to a $14,248 increase in interest expense as a result of increased
borrowings under the Company's line of credit with ChinaTrust Bank USA.
The Company's operations resulted in a net loss of $1,540,813 for the
three months ended September 30, 2002, as compared to a net income of $2,038,120
for the three months ended September 30, 2001. The reduction in the Company's
net income to a net loss was primarily the result of a reduction in sales and
related gross margin, in part due to supply chain restrictions.
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2001
Net sales for the nine months ended September 30, 2002 increased by
$19,456,597 (46.6%) to $61,199,231, as compared to $41,742,634 for the nine
months ended September 30, 2001. This increase in net sales primarily was due to
the re-introduction of the Company's Hi-Val and Digital Research Technologies
brands during the third and fourth quarters of the fiscal year ended December
31, 2001, which have carried into 2002. The Company's net sales include
reductions for marketing expenses of $6,701,608 for the nine months ended
September 30, 2002 and $8,388,292 for the nine months ended September 30, 2001
in accordance with the EITF Issue No. 01-09.
The Company reported a gross profit of $6,448,540 (10.5% of net sales)
for the nine months ended September 30, 2002, as compared to a gross profit of
$2,193,999 (5.3% of net sales) for the nine months ended September 30, 2001.
This significant improvement primarily was due to a $3,455,762 writedown during
the nine months ended September 30, 2001 of Hi-Val inventory received in the
acquisition of IOM Holdings, Inc., as compared to a $1,425,000 inventory
writedown during the nine months ended September 30, 2002, together with
$1,686,684 less reduction in 2002 due to marketing expenses.
15
Total operating expenses increased by $1,147,427 (16.3%) to $8,203,827
during the nine months ended September 30, 2002, as compared to $7,056,400 for
the nine months ended September 30, 2001, and decreased as a percentage of net
sales from 16.9% during the nine months ended September 30, 2001 to 13.4% during
the nine months ended September 30, 2002. The increase in dollar amount of these
expenses resulted from the following. A $22,293 increase in selling, marketing,
and advertising expenses was primarily due to higher commissions paid to
distributors as a result of greater sales volume, offset by lower salaries and
benefits as result of fewer internal sales and marketing personnel. A $1,797,031
increase in general and administrative expenses was primarily due to a $995,000
increase in bad debt reserve related to the Hi-Val accounts receivable, a
$331,991 increase in legal expenses, a $115,910 increase in outside
subcontracting, a $111,160 increase in insurance premiums and a $99,138 increase
in shipping supplies. A $671,897 decrease in depreciation and amortization
expenses resulted from a reduction in monthly trademark amortization effective
April 2002.
Other expense during the nine months ended September 30, 2002 decreased
by $64,505 to $236,186 or 0.4% of net sales, from $300,691 or 0.7% of net sales
during the nine months ended September 30, 2001. This decrease was primarily due
to a $62,996 decrease in interest expense. This decline in interest expense
stems from a decrease in the average amount of borrowings on the line of credit.
The Company's operations resulted in a net loss of $2,990,605 for the
nine months ended September 30, 2002, as compared to a net loss of $5,593,183
for the nine months ended September 30, 2001. The reduction in the dollar amount
of the Company's net loss was the result of a 46.6% increase in net sales in
2002 over 2001.
The Company's backlog was $25,607,978 on September 30, 2002, as
compared to $5,522,984 on September 30, 2001. The September 30, 2002 backlog
includes significant new orders placed by CompUSA. Based upon the history of the
past nine months, the September 30, 2002 backlog may be reduced by $3,840,000
(15%) when recognized as sales, due to returns and price protection.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2002, the Company funded its
operations primarily through revenue generated from operations. As of December
31, 2001, working capital was $18,374,492 and the accumulated deficit was
$14,446,237. As of that date, the Company had $4,423,623 in cash and cash
equivalents and $27,844,543 of net accounts receivable. As of September 30,
2002, working capital was $16,238,750 and the accumulated deficit was
$17,436,842. As of September 30, 2002, the Company had $3,615,938 in cash and
cash equivalents and $16,663,357 of net accounts receivable.
Cash provided by operations totaled $3,715,307 for the nine months
ended September 30, 2002. This increase resulted primarily from a $10,081,186
decrease in accounts receivable, a $1,852,377 decrease in prepaid expenses and
other current assets, the add back of $1,425,000, $1,100,000, $1,000,000,
$771,648 and $228,715 for non-cash items, provision for inventory obsolescence,
provision for allowance for doubtful accounts, deferred income tax, amortization
of trademark, depreciation and amortization, offset by a $5,523,788 decrease in
accounts payable and accrued expenses, a $2,990,605 net loss, a $2,379,658
decrease in accounts payable to related parties, a $1,475,326 subtraction for
non-cash reserves for customer returns and allowances, and a $335,483 increase
in inventory.
16
Cash used in investing activities totaled $66,328 for the nine months
ended September 30, 2002. $140,328 was used to purchase fixtures and equipment,
offset by the proceeds of $74,000 from the sale of property and equipment.
Cash used in financing activities totaled $4,456,664 for the nine
months ended September 30, 2002 primarily to pay down the line of credit.
The Company maintains a revolving line of credit with ChinaTrust Bank
USA that allows it to borrow a maximum of $14,000,000 with a sub-limit of
$13,000,000. The line of credit expires December 31, 2002. The line is secured
by substantially all of the Company's assets. Within the sub-limit, up to
$13,000,000 is available for maturities up to 150 days and up to $3,000,000 is
available for maturities up to 60 days against 30% of inventory. Within the line
of credit, a sub-line of $1,000,000 is available for uncollected funds
availability. The availability of the line of credit is subject to the borrowing
base, which is 65% of eligible receivables. Advances on the line of credit bear
interest at the WALL STREET JOURNAL prime rate plus 0.75%. As of September 30,
2002, the outstanding balance under the revolving line of credit was $5,215,175.
The line of credit provides for the maintenance of certain financial covenants
and a compensating balance of $750,000, of which the Company was in compliance
at September 30, 2002.
The high technology requirements of the Internet, music, data storage,
gaming and various other applications increasingly require that consumers
upgrade their personal computers to take full advantage of technology
improvements in data storage, audio, video and various input/output devices. The
Company believes that its current distribution channels currently fulfill and
will continue to fulfill these trends in the computer peripherals marketplace.
As the Company expands its distribution activities and in the event the Company
continues with the revenue growth it has experienced since June 2001, it may
experience net negative cash flows from operations pending an increase in gross
margins, and may be required to obtain additional financing to fund operations
or to augment its working capital through pubic or private issuance of equity or
debt securities, or to obtain an increase in the Company's line of credit.
The Company has no firm long-term sales commitments from any of its
customers and enters into individual purchase orders with its customers. The
Company has experienced cancellations of orders and fluctuations in order levels
from period to period and expects it will continue to experience such
cancellations and fluctuations in the future. In addition, customer purchase
orders may be canceled and order volume levels can be changed, canceled or
delayed with limited or no penalties. The replacement of canceled, delayed or
reduced purchase orders with new business cannot be assured. Moreover, the
Company's business, financial condition and results of operations will depend
upon its ability to obtain orders from new customers, as well as the financial
condition and success of its customers, its customers' products and the general
economy. The factors affecting any of the Company's major customers or their
customers could have a material adverse affect on the Company's business,
financial condition and results of operations.
On January 22, 2001 the Company issued 875,000 shares of its Series A
Preferred Stock and 250,000 shares of its Series B Preferred Stock. The original
value of these shares was $9 million in the aggregate. On October 25, 2002, the
Company repurchased and cancelled all Series A Preferred Stock and all Series B
Preferred Stock for a total of $1,000,000 in cash. This will result in the
cancellation of all shares of Preferred Stock and an addition to equity of
$8,000,000 effective with the statements of December 31, 2002.
17
The Company's backlog was $25,607,978 at September 30, 2002, as
compared to $5,522,984 at September 30, 2001. The backlog at September 30, 2002
includes significant new orders placed by CompUSA. Based upon the history of the
past nine months, the September 30, 2002 backlog may be reduced by $3,840,000
(15%) when recognized as sales due to returns and price protection.
The Company believes that current and future available capital
resources, revenues generated from operations, and other existing sources of
liquidity, including the Company's credit facility with ChinaTrust Bank USA,
will be adequate to meet the anticipated working capital and capital expenditure
requirements for at least the next twelve months. If, however, the Company's
capital requirements or cash flow vary materially from the Company's current
projections or if unforeseen circumstances occur, the Company may require
additional financing. Failure to raise such necessary capital could restrict the
Company's growth, limit the Company's development of new products or hinder the
Company's ability to compete.
Should ChinaTrust Bank USA not renew the line of credit at January 1,
2003, the Company would be forced to either seek a line of credit with another
bank or significantly cut back its operations. The Company does not foresee this
problem, based on preliminary discussions with ChinaTrust Bank USA.
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant on
the Company's financial condition or results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit An
Activity (Including Certain Costs Incurred in a Restructuring)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3 a
liability for an exit cost as defined, was recognized at the date of an entity's
commitment to an exit plan. This statement will not have a material impact on
the Company's financial statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." In addition, this statement amends SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include certain financial
institution-related assets. This statement is not applicable to the Company.
18
RISK FACTORS
AN INVESTMENT IN THE COMPANY'S COMMON STOCK INVOLVES A HIGH DEGREE OF
RISK. IN ADDITION TO THE OTHER INFORMATION IN THIS REPORT, POTENTIAL INVESTORS
SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS BEFORE DECIDING TO INVEST
OR MAINTAIN AN INVESTMENT IN SHARES OF THE COMPANY'S COMMON STOCK. IF ANY OF THE
FOLLOWING RISKS ACTUALLY OCCURS, IT IS LIKELY THAT THE COMPANY'S BUSINESS,
FINANCIAL CONDITION AND OPERATING RESULTS WOULD BE HARMED. AS A RESULT, THE
TRADING PRICE OF THE COMPANY'S COMMON STOCK COULD DECLINE, AND AN INVESTOR COULD
LOSE PART OR ALL OF THE INVESTOR'S INVESTMENT.
COMPETITION
The market for the Company's products is highly competitive.
Competitors for the Company's optical storage products include Acer, Best Data,
Buslink, Hewlett-Packard, Iomega, Phillips, Plextor, Samsung, Sony, TDK and
Yamaha. Competitors for the Company's multimedia products include Fuji, Imation,
Maxell, Memorex, PNY, TDK and Verbatim. The Company also indirectly competes
with personal computer original equipment manufacturers such as Dell Computer
and Compaq to the extent that they manufacture their own add-in subsystems or
incorporate on personal computer motherboards the functionality provided by the
Company's computer peripheral products. In certain markets where the Company is
a relatively new entrant, the Company faces dominant competitors including 3Com
(modems), Creative Technologies, Inc. (sound cards, modems and Internet music
players) and Sony Corp. (consumer electronic music players). In addition, the
Company's markets are expected to become increasingly competitive as multimedia
functions continue to converge and companies that previously supplied products
providing distinct functions (for example, companies today primarily in the
sound, modem, CPU or motherboard markets) emerge as competitors across broader
or more integrated product categories.
The Company also believes that the strategy of certain of its current
and potential competitors is to compete largely on the basis of price, which may
result in lower prices and lower margins for the Company's products or otherwise
adversely affect the market for the Company's products. There can be no
assurance that the Company will be able to continue to compete successfully in
its current and future markets, or will be able to compete successfully against
current and new competitors, as the Company's technology, markets and products
continue to evolve.
19
PROPRIETARY RIGHTS
The Company utilizes subcontractors to manufacture its products.
Further, the Company is not the licensee or owner of any of the technology
comprising its products. As a result, the Company does not have a proprietary
rights in any of the software, hardware or related technology comprising its
various products.
The Company relies primarily on trademarks to protect its I/OMagic,
Hi-Val and Digital Research Technologies brand names. There can be no assurance
that the Company's measures to protect its proprietary rights will deter or
prevent unauthorized use of the Company's brands. In addition, the laws of
certain foreign countries may not protect the Company's proprietary rights to
the same extent, as do the laws of the United States or the European Community.
As is typical in the consumer electronics industry, the Company from time to
time is subject to legal claims asserting that the Company has violated the
proprietary rights of third parties. In the event that a third party was to
sustain a valid claim against the Company, and any required licenses were not
available on commercially reasonable terms, the Company's operating results
could be materially and adversely affected. Litigation, which could result in
substantial cost and diversion of the resources of the Company, may also be
necessary to enforce proprietary rights of the Company or to defend the Company
against claimed infringement of the proprietary rights of others.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
The Company is subject to EITF Issue No. 01-09, which provides that
certain consumer and trade sales promotion expenses are presumed to be a
reduction of the selling prices of the vendor's products and, therefore, should
be characterized as a reduction of revenue as net sales. The provisions of this
pronouncement are required to be applied with fiscal years beginning after
December 15, 2001. The Company has adopted this pronouncement with its December
31, 2001 statement of operations and has restated its March 31, 2001, June 30,
2001 and September 30, 2001 statements of operations. The adoption of this
pronouncement has resulted in adjustments to the Company's net sales, gross
margin and selling and marketing expenses. EITF Issue No. 01-09 has no impact on
the Company's operating income, net income or earnings per share. While the
Company believes that the application of EITF Issue No. 01-09 will not have any
effect upon its cash flow, potential investors may view the impact of EITF Issue
No. 01-09 upon the Company negatively. In the event this does occur, the price
for the Company's stock and as a result its ability to raise capital, may be
adversely affected.
The Company's financial reporting may be subject to other changes in
accounting principles and procedures. In the event these changes negatively
effect the Company's reporting of the results of its operations, its ability to
raise capital and to otherwise utilize its stock to attract key employees and
finance potential acquisitions would be adversely affected.
20
DISTRIBUTION RISKS
The Company's future success is dependent on the continued viability
and financial stability of its customer base. The computer distribution and
retail channels historically have been characterized by rapid change, including
periods of widespread financial difficulties and consolidation and the emergence
of alternative sales channels, such as direct mail order, telephone sales by PC
manufacturers and electronic commerce on the worldwide web. The loss of, or
reduction in, sales to certain of the Company's key customers as a result of
changing market conditions, competition, or customer credit problems could have
a material adverse effect on the Company's operating results. Likewise, changes
in distribution channel patterns, such as increased commerce on the Internet, or
increased use of mail-order catalogues, increased use of consumer-electronics
channels for peripheral product sales, could affect the Company in ways not yet
known. For example, the rapid emergence of Internet-based e-commerce is putting
substantial strain on some of the Company's traditional channels. Moreover,
additions to or changes in the types of products the Company sells, such as the
digital entertainment products, may require specialized value-added reseller
channels, relations with which the Company has only begun to establish.
Aggressive strategies employed by customers to obtain reductions in the charged
purchase price, such as claimed price protections, rebates and advertising
funds, may materially and adversely impact upon the Company's cash flow and
financial results of operations. Finally, the Company's customers frequently
require that the Company expend substantial sums to promote distribution
channels, advertise its products and reserve shelf space for the Company's
products. To the extent the Company's financial resources decline, the Company
might be unable to fulfill its obligations under such programs. Such a failure
might adversely affect the Company's relationship with its customers and as a
result, its financial results of operations.
CAPITAL NEEDS
There can be no assurance that additional capital beyond the amounts
currently forecasted by the Company will not be required or that any required
additional capital will be available on reasonable terms, if at all, at such
time or times as required by the Company. Any shortfall in capital resources
compared to the Company's level of operations or any inability to secure
additional capital as needed could impair the Company's ability to finance
inventory, accounts receivable and other operational needs. Such capital
limitations could also impair the Company's ability to invest in research and
development, improve customer service and support, deploy information technology
systems, and expand marketing and other operations. Failure to keep pace with
competitive requirements in any of these areas could have a material adverse
effect on the Company's business and operating results. Moreover, any need to
raise additional capital through the issuance of equity or debt securities may
result in additional dilution to earnings per share.
LITIGATION
The Company, IOM Holdings, Inc., which is a wholly owned subsidiary of
the Company, Tony Shahbaz, who is the Company's President and Chief Executive
Officer, and two other individuals are defendants in an action in which the
plaintiffs seek, among other relief, $42,000,000 plus punitive and other damages
to be proven at trial in connection with two separate contracts involving the
plaintiffs and the defendants. The $42,000,000 in alleged damages includes
$15,000,000 sought from Mr. Shahbaz and $27,000,000 sought from IOM Holdings,
Inc., Mr. Shahbaz and the other individual defendants. The Company intends to
vigorously defend itself and IOM Holdings, Inc. in this action. However, the
Company cannot predict the outcome of this matter or the extent to which the
resolution of this matter could adversely affect the Company's business and
results of operations.
RISKS ASSOCIATED WITH VERTICAL INTEGRATION
The Company pursues a strategy of continuously identifying and
evaluating potential product vendors. Ideally, the Company prefers a number of
competitive suppliers of each of its products in order to ensure that the
Company is offering leading edge technology in each product line at prices with
which the Company can compete with competitors. In the recent past there have
been instances of Far East manufacturers of computer peripheral products
acquiring distribution divisions in North America or otherwise establishing
21
their own marketing organization in North America. While these expansions in and
of themselves are not material to the operations of the Company, vertical
integration by the Company's suppliers into North American marketing channels
may restrict the vendors available to the Company and thereby may reduce the
likelihood that the Company will have access to leading edge technology at
prices which allow the Company to compete with vertically integrated
competitors.
RECENT FINANCIAL LOSSES
The Company reported net losses in the fiscal years ended December 31,
2000 and 2001 and for the quarter ended September 30, 2002. There is no
assurance that the Company will be able to obtain or maintain profitable
operations in the future. If the Company is unable to do so, there may be a
material adverse affect on the Company's cash flow, which could cause violations
in the covenants under the Company's line of credit and could impede the
Company's ability to raise capital through debt or equity financing to the
extent the Company may need it for continued operations or for planned
expansion. Consequently, future losses may adversely affect the Company's
business, prospects, financial condition, results of operations and cash flows.
LACK OF LONG TERM PURCHASE ORDERS
The Company does not have any long term purchase orders from its
customers. The Company's product orders are typically received with one to three
weeks lead time to deliver the products. Accordingly, the Company cannot rely on
long-term purchase orders or commitments to protect it from the negative
financial effects of a reduced demand for it's products that could result from,
among other things, a general economic downturn, from changes in the personal
computer peripheral and consumer electronics markets, including the entry of new
competitors into those markets, from the introduction by others of new or
improved technology and from an unanticipated shift in the needs of the
Company's customers.
DEPENDENCE ON MAJOR CUSTOMERS
During the three and nine months ended September 30, 2002, the Company
had four major customers which accounted for approximately 82% and 79%,
respectively, of the Company's net sales.
The amounts due from these major customers on September 30, 2002
amounted to approximately $16,510,539. The Company's strategy is to constantly
attempt to sign new major retail customers in order to both increase the
Company's growth and to reduce the impact of any one customer.
The Company does not have any contract with any of these customers
requiring that any amount of product be purchased in the future. In the event
any of these major customers were to cease ordering products from the Company or
to reduce the level of their orders, the Company's financial performance could
be materially and adversely affected.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS
The Company develops and markets products in the highly competitive
optical storage, multimedia and input-output segments of the personal computer
peripheral market and the digital entertainment segment of the consumer
electronic market. These products are very susceptible to product obsolescence
and typically exhibit a high degree of volatility of shipment volumes over
relatively short product life cycles. The timing of introductions of new
products in one calendar quarter as opposed to an adjacent quarter can
materially affect the relative sales volumes in those quarters. In addition,
product releases by competitors and accompanying pricing actions can materially
and adversely affect the Company's revenues and gross margins.
22
The Company sells its products to retail customers such as mass
merchandisers and large chains who sell products primarily off-the-shelf
directly to end users. Reliance on indirect channels of distribution means that
the Company typically has little or no direct visibility into end user customer
demand. The Company must rely upon sales forecasts provided by its retail
customers in order to comply with lead times required by these customers. If
these forecasts prove inaccurate, the Company could either have excess inventory
(resulting in potential finance costs and obsolescence) or insufficient
inventory (resulting in an inability to meet customer demands promptly).
Accordingly, this means that future operating results are dependent on the
Company accurately predicting in advance the demand for various product segments
from its customers.
REVENUE VOLATILITY AND DEPENDENCE ON ORDERS RECEIVED AND SHIPPED IN A
QUARTER
The volume and timing of orders received during a quarter are difficult
to forecast. Retail customers generally order with only limited or no forecast
data on an as-needed basis. Moreover, the Company has emphasized its ability to
respond quickly to customer orders as part of its competitive strategy. This
strategy, combined with current industry supply and demand conditions as well as
the Company's emphasis on minimizing inventory levels, has resulted in customers
placing orders with relatively short delivery schedules and increased demand on
the Company to carry inventory for its customer base, particularly for large
national retail chains. This has the effect of increasing short lead-time orders
as a portion of the Company's business and reducing the Company's ability to
accurately forecast net sales. Because retail customers' orders are at times
difficult to predict, there can be no assurance that the combination of these
orders, and backlog in any quarter will be sufficient to achieve either
sequential or year-over-year growth in net sales during that quarter. If the
Company does not achieve a sufficient level of retail orders in a particular
quarter, the Company's revenues and operating results would be materially
adversely affected.
MANAGEMENT OF GROWTH
In recent years, the Company has experienced a significant expansion in
the overall level of its business and the scope of its operations, including
marketing, technical support, customer service, sales and logistics. This
expansion in scope has resulted in a need for significant investment in
infrastructure, process development and information systems. This requirement
includes, without limitation: securing adequate financial resources to
successfully integrate and manage the growing businesses and acquired companies;
retention of key employees; integration of management information, product data
management, control, accounting, telecommunications and networking systems;
establishment of a significant worldwide web and e-commerce presence;
coordination of suppliers and distribution channels; establishment and
documentation of business processes and procedures; and integration of various
functions and groups of employees. Each of these requirements poses significant,
material challenges.
During the year 2000, the Company acquired the Hi-Val brand name and
became the world-wide exclusive licensee of the Digital Research Technologies
brand name. In addition to managing the growing business of the Company and its
previous acquisitions, the Company will be required to integrate and manage
these brands. The Company faces significant challenges in terms of sales,
marketing, and logistics with respect to integrating the products and businesses
of Hi-Val and Digital Research Technologies into the procedures and operations
of the Company. There can be no assurance that the Company will be able to
successfully integrate these operations. If the Company fails to successfully
integrate these brand names into the operations of the Company, there will
likely be a material adverse impact on the operating results of the Company.
Even if the integration is successfully achieved, there can be no assurance that
the cost of such integration will not materially and adversely affect the
Company's operating results, or that the Company will be able to make a
satisfactory return on such costs.
23
In the fourth quarter of 2001, the Company commenced shipping its first
digital entertainment product, a portable MP3 player distributed under the name
"MyMP3." The Company has recently filed a trademark application for the name
"MyMP3." These products will pose new design, manufacturing and customer support
issues to the Company and there can be no assurance that the Company can
successfully meet these challenges, generate customer demand for such products
or satisfy customer demand for the products. There can also be no assurance that
the cost associated with meeting such challenges and satisfying demand will not
have a material adverse impact on the Company's operating results in future
periods.
PRODUCT SHORTAGES; RELIANCE ON SOLE OR LIMITED SOURCE SUPPLIERS
The Company is dependent on sole or limited source suppliers for
certain key products. If any of these suppliers were to experience a disruption
in their manufacturing capacity, the financial performance of the Company could
be materially adversely affected. There can be no assurances that the Company
can obtain adequate inventory of each of its product categories, or that such
shortages or the costs of these products will not adversely affect future
operating results. The Company's dependence on sole or limited source suppliers,
and the risks associated with any delay or shortfall in supply, can be
exacerbated by the short life cycles that characterize the Company's product
mix. Although the Company maintains ongoing efforts to identify new suppliers of
its products, shortages may continue to exist from time to time, and there can
be no assurances that the Company can continue to obtain adequate supplies or
obtain such supplies at their historical or competitive cost levels. In its
attempt to counter actual or perceived shortages, the Company may over-purchase
certain products or pay expediting or other surcharges, resulting in excess
inventory or inventory at higher than normal costs and reducing the Company's
liquidity, or in the event of unexpected inventory obsolescence or a decline in
the market value of such inventory, causing inventory write-offs or sell-offs
that adversely affect the Company's gross margin and profitability.
DEPENDENCE ON OPTICAL STORAGE AND OPTICAL MEDIA MARKET
Sales of optical storage and related media products accounted for
approximately 78% of the Company's net sales in 2001 and 89% of net sales for
the nine months ended September 30, 2002. Although the Company has introduced
products in the digital entertainment segment of the consumer electronics
market, optical storage and optical media devices are expected to continue to
account for a majority of the Company's sales for the foreseeable future. A
decline in demand or average selling prices for optical storage or optical media
products, whether as a result of new competitive product introductions, price
competition, excess supply, widespread cost reduction, technological change,
incorporation of the products' functionality onto personal computer motherboards
or otherwise, would have a material adverse affect on the Company's sales and
operating results.
MIGRATION TO PERSONAL COMPUTER MOTHERBOARDS
Many of the Company's products are peripheral products that function
within personal computers to provide additional functionality. Historically, as
a given functionality becomes technologically stable and widely accepted by
personal computer users, the cost of providing this functionality is typically
reduced by means of large scale integration into semiconductor chips, which can
be subsequently incorporated onto personal computer motherboards. The Company
recognizes that this migration could occur with respect to the functionality
provided by some of the Company's current products. While the Company believes
that a market will continue to exist for add-in subsystems that provide advanced
or multiple functions and offer flexibility in systems and connectivity, such as
audio and video upgrade cards, there can be no assurance that the incorporation
of new multimedia functions onto personal computer motherboards or into CPU
microprocessors, will not adversely affect the future market for the Company's
products.
24
DEPENDENCE ON KEY PERSONNEL
The Company's future success will depend to a significant extent upon
the efforts and abilities of its senior management and professional, technical,
sales and marketing personnel, including the Company's president Tony Shahbaz.
Mr. Shahbaz has been instrumental in virtually all aspects of the Company's
operations. He has developed the key personal relationships with principals of
the Company's vendors and frequently is extensively involved in the Company's
sales and promotional efforts with its key customers. The loss of his services
would certainly severely and adversely affect the financial results of
operations of the Company. The competition for such personnel is intense,
particularly in the Orange County, California area. There can be no assurance
that the Company will be successful in retaining its existing key personnel or
in attracting and retaining the additional key personnel that it requires. The
loss of services of one or more of its key personnel or the inability to add or
replace key personnel could have a material adverse effect on the Company. The
salary, performance bonus and stock option packages necessary to recruit or
retain key personnel, may significantly increase the Company's expense levels or
result in dilution to the Company's earnings per share. The Company does not
carry "key person" life insurance on any of its employees.
GOVERNMENT REGULATION AND INDUSTRY STANDARDS
The Company frequently jointly designs its products with its
manufacturing suppliers. These products are sometimes subject to various
government regulations and industry standards, such as Underwriters Laboratories
compliance. It is difficult to predict the direction of evolution of these
regulations and standards and what, if any impact they might have upon the
operations of the Company. For example, the Federal Drug Administration has
inspected Company products containing laser components for potential health
risks. The Company's failure to comply with the various existing and evolving
standards and regulations could adversely affect its ability to sell its
products.
DECLINING SELLING PRICES AND OTHER FACTORS AFFECTING GROSS MARGINS
The Company's markets are characterized by intense ongoing competition
coupled with a history, as well as a current trend, of declining average selling
prices. A decline in selling prices may cause the net sales in a quarter to be
lower than those of a preceding quarter or corresponding prior year's quarter
even if more units were sold during such quarter than in the preceding or
corresponding prior year's quarter. Accordingly, it is possible that the
Company's average selling prices will decline, and that the Company's net sales
and margins may decline in the future, from the levels experienced to date (See
also "- Short Product Life Cycles; Dependence on New Products"). The Company's
gross margins may also be adversely affected by shortages of, or higher prices
for, key components for the Company's products. The availability of new products
is sometimes restricted in volume early in a product's life cycle and, should
customers choose to wait for the new version of a product rather than to
purchase the current version, the ability of the Company to procure sufficient
volumes of such new products to meet higher customer demand is limited. Such a
failure to meet demand for new products may have a material adverse effect on
the revenues and operating margins of the Company.
CHANNEL PROMOTIONS
The Company engages in various channel promotions throughout its
customer base throughout the entire year. However, there can be no assurance
that any estimates, accruals or reserves will be sufficient to support the
extent of the channel promotions. Excessive promotion costs could have a
material adverse effect on the operations of the Company.
ASIAN POLITICAL AND ECONOMIC CLIMATE
The Company is dependent upon political and economic stability in the
Far East. Specifically, the Company orders virtually all of its products from
large manufacturing facilities located primarily in Taiwan, Korea and the
People's Republic of China. In the event of a severe political disruption in the
governments of any country located in the Far East, the economic ramifications
for the Company's supplier base could be devastating. As a result, the Company's
ability to conduct profitable operations may be materially and adversely
25
affected. The Company's suppliers acquire components and raw materials for the
manufacturing of the Company's products from a number of countries, many of
which do not conduct operations in United States dollars. Any severe fluctuation
in the value of such currencies could materially increase the cost to the
Company's suppliers of manufacturing the Company's products. Upon such an
occurrence, the Company's operations could be severely and adversely affected.
SEASONALITY
The Company believes that, due to industry seasonality, demand for its
products is strongest during the fourth quarter of each year and is generally
slower in the period from April through August. This seasonality may become more
pronounced and material in the future to the extent that a greater proportion of
the Company's sales consist of sales of more consumer-oriented or
entertainment-driven products. These seasonal fluctuations may be exaggerated by
general economic conditions and other factors outside the control of the
Company. A failure by the Company to accurately forecast seasonal fluctuations
may have a material adverse affect on the revenues and operating margins of the
Company.
SHORT PRODUCT LIFE CYCLES; DEPENDENCE ON NEW PRODUCTS
The market for the Company's products is characterized by frequent new
product introductions and rapid product obsolescence. These factors typically
result in short product life cycles, frequently ranging from three to six
months. The Company must develop and introduce new products in a timely manner
that compete effectively on the basis of price and performance and that address
customer requirements. To do this, the Company must continually monitor industry
trends and make difficult choices regarding the selection of new technologies
and features to incorporate into its new products, as well as the timing of the
introduction of such new products, all of which may impair the orders for or the
prices of the Company's existing products. The success of new product
introductions depends on various factors, some of which are outside the
Company's direct control. Such factors may include: selection of new products;
selection of controller or memory chip architectures; implementation of the
appropriate standards or protocols; timely completion and introduction of new
product designs; trade-offs between the time of first customer shipment and the
optimization of software drivers and hardware for speed, stability and
compatibility; development and production of collateral product literature;
ability to rapidly ramp manufacturing volumes to meet customer demand in a
timely fashion; and coordination of advertising, press relations, channel
promotion and evaluation programs with the availability of new products. For
example, selection of the appropriate standards and protocols will be a key
factor in determining the future success of the Company's digital entertainment
products.
MARKET ANTICIPATION OF NEW PRODUCTS, NEW TECHNOLOGIES OR LOWER PRICES
Because the business environment in which the Company operates is
characterized by rapid new product and technology introductions and generally
declining prices for existing products, the Company's customers may from time to
time postpone purchases in anticipation of new product introductions or lower
prices. If the anticipated changes are viewed as significant by the market, such
as the introduction of a data storage format change, then this may have the
effect of temporarily slowing overall market demand and negatively affecting the
Company's operating results. For example, during the fourth quarter of 2001 the
Company initially introduced a 32 megabyte version of its "MyMP3" portable
digital music system. As technology quickly advanced, the Company's customers
immediately demanded expanded memory capability. In response, the Company is
developing a 64 megabyte version of the same product. This demand for more
technologically advanced products took place within a period of three months.
26
PRODUCT RETURNS; PRICE PROTECTION
The Company frequently grants limited rights to customers to return
certain unsold inventories of the Company's products in exchange for new
purchases ("Stock Rotation"), as well as price protection on unsold inventory.
Moreover, certain of the Company's retail customers will readily accept returned
products from their own retail customers, and these returned products are, in
turn, returned to the Company for credit. The Company estimates returns and
potential price protection on unsold channel inventory. The Company accrues
reserves for estimated returns, including warranty returns, and price
protection. The Company may be faced with further significant price protection
charges as the Company and its competitors move to reduce channel inventory
levels of current products, as new product introductions are made. However,
there can be no assurance that any estimates, reserves or accruals will be
sufficient or that any future returns or price reductions will not have a
material adverse affect on operating results, including through the mechanisms
of Stock Rotation or price protection, particularly in light of the rapid
product obsolescence which often occurs during product transitions.
RAPID TECHNOLOGICAL CHANGE
The markets for the Company's products are characterized by rapidly
changing technology, evolving industry standards, frequent new product
introductions and rapid product obsolescence. Product life cycles in the
Company's markets frequently range from three to six months. The Company's
success will be substantially dependent upon its ability to continue to develop
and introduce competitive products and technologies on a timely basis with
features and functions that meet changing customer requirements in a
cost-effective manner. Further, if the Company is successful in the development
and market introduction of new products, it must still correctly forecast
customer demand for such new products so as to avoid either excessive unsold
inventory or excessive unfilled orders related to the products. The task of
forecasting such customer demand is unusually difficult for new products, for
which there is little sales history, and for indirect channels, where the
Company's customers are not the final end customers. Moreover, whenever the
Company launches new products, it must also successfully manage the corollary
obsolescence and price erosion of those of its older products that are affected
by such new products, as well as any resulting price protection charges and
Stock Rotations from its distribution channels.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT INTEREST RATE RISK
The Company is exposed to financial market risks due primarily to
changes in interest rates. As the Company continues to grow, it is finding that
many of its vendors are increasingly refusing to provide credit. As a result,
the Company frequently is required to draw down upon its line of credit in order
to finance its operations. Fluctuations in interest rates may increase the cost
of the Company drawing down upon its line of credit. The Company does not use
derivatives to alter the interest characteristics of its debt instruments. The
Company has no holdings of derivative or commodity instruments and does not
conduct business in foreign currencies.
"PENNY STOCK" RULES
Broker-dealer practices in connection with transactions in "penny
stocks" are regulated by penny stock rules adopted by the Securities and
Exchange Commission. Penny stocks, like shares of the Company's common stock,
generally are equity securities with a price of less than $5.00 (other than
securities registered on some national securities exchanges or quote on Nasdaq).
The penny stock rules require a broker-dealer, prior to a transaction in a penny
stock not otherwise exempt from the rules, to deliver a standardized risk
disclosure document that provides information about penny stocks and the nature
and level of risks in the penny stock market. The broker-dealer must also
provide current bid and offer quotations for the penny stock, the compensation
27
of the broker-dealer and its sales person in the transaction, and if the
broker-dealer is the sole market maker, the broker dealer must disclose this
fact and the broker dealer's presumed control over the market, and the monthly
account statements showing the market value of each penny stock held in the
customer's account. In addition, broker-dealers who sell these securities to
persons other than established customers and "accredited investors" must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser's written agreement to the transaction.
Consequently, these requirements may have the effect of reducing the level of
trading activity, if any, in the secondary market for a security subject to the
penny stock rules, and investors in the Company's common stock may find it
difficult to sell their shares.
OTC BULLETIN BOARD LISTING
Currently, the Company's common stock is traded on the OTC Bulletin
Board under the symbol "IOMC.OB." As a result, accurate current quotations as to
the value of the Company's common stock are unavailable, making it more
difficult for investors to dispose of the Company's common stock. The lack of
current quotations and liquidity can cause the Company's stock price to decline
or trade lower than the prices which might prevail if the Company's securities
were listed or quoted on an exchange or on Nasdaq.
STOCK PRICE VOLATILITY
The trading price of the Company's Common Stock has been subject to
significant fluctuations to date, and could be subject to wide fluctuations in
the future in response to quarter-to-quarter variations in operating results,
announcements of technological innovations, new product introductions by the
Company or its competitors, general conditions in the markets for the Company's
products or the computer industry, the price and availability of the Company's
products, general financial market conditions, market conditions for personal
computer or semiconductor stocks, changes in earnings estimates by analysts, or
other events or factors. In this regard, the Company does not endorse and
accepts no responsibility for the estimates or recommendations issued by stock
research analysts from time to time. In addition, the public stock markets in
general, and technology stocks in particular, have experienced extreme price and
trading volume volatility. This volatility has significantly affected the market
prices of securities of many high technology companies for reasons frequently
unrelated to the operating performance of the specific companies. These broad
market fluctuations may adversely affect the market price of the Company's
Common Stock.
WEST COAST PORTS STRIKE/LOCKOUT
The west coast ports experienced a lockout at the end of September
2002. The Taft Hartley Act was invoked in early October 2002 to remedy the
situation for eighty days. However, the week and a half lockout caused massive
disruption of goods from the Far East and thus has had an adverse effect on the
Company. The Company expects to experience higher freight in expenses in Q4 2002
and possibly into early 2003, which will adversely affect its net income. In
addition, if the port situation is not resolved before expiration of the Taft
Hartley Act cooling off period, then the Company may experience even higher
freight-in expenses or the inability to bring in sufficient inventory to meet
its backlog. This may further adversely affect the Company's net income for Q4
2002 and Q1 and Q2 2003.
TERRORISM
Terrorist attacks may adversely affect the Company's business and
operating results. The terrorist attacks of September 11, 2001, the continued
threat of terrorist activity and other acts of war or hostility have created
uncertainty in the financial markets and in consumer confidence. Future acts of
terrorism could result in disruption or delay in the manufacture or shipment of
the Company's products. The Company's operating results may be adversely
affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Approximately 1% of the Company's operations were subject to foreign
currency exchange or commodity price risk during the nine months ended September
30, 2002. Effect on the Company's statement of operations was negligible.
The Company has a line of credit with ChinaTrust Bank USA in the amount
of up to $14,000,000. The interest rate under the line of credit is equal to the
WALL STREET JOURNAL prime rate plus 0.75%. If the prime rate increases, the
Company's interest expense will increase which, in turn, will expose the Company
to risk of earnings loss.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On August 2, 2001, Mark Vakili and Mitra Vakili filed a complaint in
the Superior Court of the State of California for the County of Orange (Case No.
01CC09894) against Tony Shahbaz. The complaint alleged that Mr. Shahbaz
defrauded the plaintiffs by failing to honor the terms of a contract
("Contract") under which Mr. Shahbaz was to deliver 1,500,000 shares of the
Company's common stock in exchange for an interest in Alex Properties, a general
partnership that held an industrial warehouse rental property. The complaint
later was amended to add Alex Properties and Hi-Val, Inc. as plaintiffs and the
Company, IOM Holdings, Inc. ("IOMH"), which is a corporation that the Company
acquired, Steel Su and Meilin Hsu as defendants. As amended, the complaint seeks
an aggregate of $42,000,000 plus punitive and other damages to be proven at
trial and also seeks rescission of the Contract. The amended complaint alleges
that IOMH, Mr. Shahbaz, Mr. Su and Ms. Hsu fraudulently and negligently made
misrepresentations to induce Hi-Val to enter into an asset purchase agreement in
June 1999 for the purchase and sale of Hi-Val assets to IOMH. The amended
complaint also alleges that IOMH and Mr. Shahbaz breached the terms of the asset
purchase agreement by failing to deliver consideration that included 2,000,000
shares of the Company's common stock and payment of interest on Mr. Vakili's
$1,500,000 loan to Hi-Val that was to be assumed by IOMH under the asset
purchase agreement and by failing to timely replace Mr. Vakili as personal
guarantor of Hi-Val's $25,000,000 credit facility. The $42,000,000 in alleged
damages includes $15,000,000 sought from Mr. Shahbaz in connection with the
Contract and $27,000,000 sought from IOMH, Mr. Shahbaz, Mr. Su and Ms. Hsu in
connection with the asset purchase agreement. The Company intends to vigorously
defend itself and IOMH in this action.
On September 17, 2002, a settlement was reached between the Company and
Aureal, Inc. The Company paid $280,000 to settle trade payables.
On October 23, 2002, a settlement was reached between the Company and
Staples. The Company received $451,208 for accounts receivable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Dividends
---------
To date the Company has not paid dividends on its common stock. The
Company's line of credit with ChinaTrust Bank USA prohibits the payment of cash
dividends on common stock unless specifically approved by the bank. The Company
currently intends to retain future earnings to fund the development and growth
of its business and, therefore, does not anticipate paying cash dividends on its
common stock within the foreseeable future. Any future payment of dividends on
common stock will be determined by the board of directors and will depend on the
Company's financial condition, results of operations, contractual obligations
and other factors deemed relevant by the board of directors.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 4, 2002, the Company held its Annual Meeting of
Shareholders. Up for consideration by the shareholders at the meeting were five
proposals submitted by the Company's Board of Directors.
(1) The first proposal involved the election of the Company's Board of
Directors. Set forth below is the name of each director elected at
the meeting and the number of votes cast for their election, the
number of votes against their election, the number of votes
abstained and the number of non-votes:
Number of Number of Number of Number of
Name Votes "For" Votes "Against" Votes "Abstain" "Non-Votes"
------------------ ----------- --------------- --------------- ----------
Tony Shahbaz 51,368,409 0 35,150 16,526,732
Daniel Hou 51,368,409 0 35,150 16,526,732
Anthony Andrews 51,368,409 0 35,150 16,526,732
Steel Su 51,368,409 0 35,150 16,526,732
Young-Hyun Shin 51,368,409 0 35,150 16,526,732
Daniel Yao 51,368,409 0 35,150 16,526,732
------------------ ----------- --------------- --------------- -----------
(2) The second proposal up for consideration involved the approval and
ratification of the Company's 2002 Stock Option Plan. Set forth
below are the number of votes for, against, abstain and non-votes
for this proposal:
Number of Number of Number of Number of
Votes "For" Votes "Against" Votes "Abstain" "Non-Votes"
----------- --------------- --------------- -----------
51,318,676 68,178 16,705 16,526,732
----------- --------------- --------------- -----------
(3) Proposal Three involved the approval of a One-for-Fifteen Reverse
Common Stock Split to be implemented at the discretion of the Board
of Directors prior to December 31, 2002. Set forth below are the
number of votes for, against, abstain and non-votes for this
proposal:
Number of Number of Number of Number of
Votes "For" Votes "Against" Votes "Abstain" "Non-Votes"
----------- --------------- --------------- -----------
51,253,061 135,393 15,105 16,526,732
----------- --------------- --------------- -----------
(4) The fourth proposal involved the approval of the Amended and
Restated Articles of Incorporation to modernize and conform to
current Nevada law. Set forth below are the number of votes for,
against, abstain and non-votes for this proposal:
Number of Number of Number of Number of
Votes "For" Votes "Against" Votes "Abstain" "Non-Votes"
----------- --------------- --------------- -----------
51,258,961 124,293 20,305 16,526,732
----------- --------------- --------------- -----------
(5) Proposal five involved ratifying the appointment of Singer Lewak
Greenbaum & Goldstein LLP as independent auditors of the Company for
the fiscal year ending December 31, 2002. Set forth below are the
number of votes for, against, abstain and non-votes for this
proposal:
Number of Number of Number of Number of
Votes "For" Votes "Against" Votes "Abstain" "Non-Votes"
----------- --------------- --------------- -----------
51,356,254 28,000 19,305 16,526,732
----------- --------------- --------------- -----------
As a majority of the shareholders attending the meeting, either in
person or by proxy, voted in favor of the above proposals, the proposals were
duly approved and authorized by the shareholders of the Company.
ITEM 5. OTHER INFORMATION.
None.
30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Employment Agreement by and between I/OMagic Corporation, a California
Corporation, and Tony Shahbaz dated October 15, 2002
(b) Reports on Form 8-K
On August 2, 2002, the Company filed a report on Form 8-K,
under Item 5, Other Events, announcing a change in the date
for the Company's Annual Shareholders' Meeting.
31
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
I/OMAGIC CORPORATION
Dated: November 14, 2002 By:/S/ Tony Shahbaz
----------------------------
Tony Shahbaz, President, Chief
Executive Officer
By: /S/ STEPHEN C. GILLINGS
---------------------------
Chief Financial Officer
32