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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2002
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission file number: 000-27267
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 EAST WAKEHAM AVENUE 92705
SANTA ANA, CA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (714) 953-3000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers in response
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes | | No |X|
The aggregate market value of the voting common equity held by
nonaffiliates of the registrant computed by reference to the closing sale price
of such stock, was approximately $26,691,360, as of June 28, 2002, the last
business day of the registrant's most recently completed second fiscal quarter.
The registrant has no non-voting common equity.
The number of shares of the registrant's common stock, $.001 par value,
outstanding as of April 8, 2003 was 4,529,670.
DOCUMENTS INCORPORATED BY REFERENCE: None.
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TABLE OF CONTENTS
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Page
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PART I
Item 1. Business 1
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters 11
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 27
Item 8. Financial Statements and Supplementary Data 27
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 27
PART III
Item 10. Directors and Executive Officers of the Registrant 27
Item 11. Executive Compensation 29
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 31
Item 13. Certain Relationships and Related Transactions 32
Item 14. Controls and Procedures 33
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 34
Index To Exhibits 39
Signatures 41
Certifications 42
Exhibits Filed with this Report 44
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
We develop, subcontract manufacture, market and distribute two principal
categories of products:
- optical storageproducts such as CD-ROM playback devices
(CD-ROM), CD-Read/Write devices (CD-RWs), DVD-ROM playback
devices (DVD-ROM), DVD Read/Write devices (DVD RWs), CD-Read/
Write plus DVD Read/Write combination devices (CD-RW + DVD combi),
CD-RW plus multiple-flash card reader devices, and the corresponding
media for such devices; and
- digital entertainment products such as MP3 music players, LCD flat
panel digital TV monitors, digital photo and video storage
devices, audio video adaptor cards, and video capture cards.
We sell our products predominantly through major consumer electronics
retailers that resell our products directly to end-users. These retailers sell
our products in their physical stores and many of these companies also sell our
products over the Internet. These retailers include AAFES, Best Buy, CompUSA,
Circuit City, Fred Meyer Stores, Micro Center Super Stores, Office Depot, Office
Max, Radio Shack, Radio Shack Canada, Target, Tech Data and other leading
retailers throughout the United States and Canada.
We are a Nevada corporation that was formed October 20, 1992 under the name
Silvercrest International, Inc. Following the acquisition of I/OMagic
Corporation, a California corporation, in March 1996, we changed our name to
I/OMagic Corporation.
On December 31, 2000 we acquired all of the outstanding capital stock of
IOM Holdings, Inc., a Nevada corporation, in exchange for shares of our capital
stock. In March 2000, IOM Holdings, Inc. acquired substantially all of the
assets of Hi-Val, Inc., including the "Hi-Val" brand name. At that time, Hi-Val,
Inc. was one of our competitors in the optical storage and media markets.
Through the acquisition of IOM Holdings, Inc. we also obtained the "Digital
Research Technologies" brand name which was owned by IOM Holdings, Inc. At that
time, Digital Research Technologies, Inc. was one of our competitors in
input-output products such as optical storage drives, monitors and keyboards. We
acquired IOM Holdings, Inc. primarily to obtain the Hi-Val and Digital Research
Technologies brand names in order to increase our presence within the markets in
which we compete. This competitive acquisition strategy was developed to secure
a strong North American retail market presence by offering products under the
I/OMagic, Hi-Val, and Digital Research Technologies brand names thereby
providing alternatives for our customers, while consolidating more efficiently,
our back-end operations.
We have expended considerable resources building consumer awareness of our
three brands which, in turn, has resulted in a significant increase in our
market penetration over the last several years.
We sub-contract manufacture and source our products predominantly in East
Asian countries, which allows us to offer products at highly competitive prices
and which we believe permits maximum flexibility in the development of products
and the easy transition and redesign from existing products to new products.
Some of our optical storage and multimedia products are manufactured at times by
Behavior Tech Computer Corp., Citrine Group Limited, an investment arm of Ritek
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Corporation, and Lung Hwa Electronics. These manufacturers, who are also our
shareholders, are some of the largest manufacturers of computer peripherals and
other products in the world. We believe that the relationships we have with
these manufacturers have resulted in significant benefits to our business
including, competitive pricing, time to market advantages, competitive financing
terms, an ability to carefully monitor technological developments in the
marketplace, and the ability to operate with a severely reduced on-site
inventory as compared to our competitors.
We maintain web sites at iomagic.com, hival.com and dr-tech.com. The
purpose of these web sites is to provide customer service and technical support
for end users who have installation or other similar product questions. In
addition, we view our Internet presence as a means of enhancing brand
recognition and consumer loyalty.
INDUSTRY OVERVIEW
Personal computing has extended beyond basic personal computer, or PC,
systems involving a central processing unit, or CPU, a monitor, keyboard and
mouse input devices and data storage devices such as hard drives and disk
drives. Today's state of the art, and even many entry-level, personal computing
solutions now include a wide array of peripheral devices including
communications and consumer electronics peripherals. Specifically, these
peripheral devices include digital cameras, digital video recorders, MP3 digital
audio players, CD and DVD writers, devices that play movies, store pictures,
play music, embedded controls and other instruments that establish the
multimedia after-market arena for companies like ours. The need for
consistently improved functionality, partly as a result of the increasing
demands of new software applications, has led to a greater demand for peripheral
products which improve the capabilities of computer systems.
The computer peripheral and consumer electronics industries are
characterized by rapidly changing technology, evolving industry standards, and
frequent new product introductions which creates an opportunity for the
manufacturers of after-market components. Product life cycles in the computer
peripheral and consumer electronics industries often range from as few as three
to twelve months. We believe that success in the computer peripheral and
consumer electronics industries is substantially dependent upon the ability to
develop and introduce products and technologies on a timely basis with features
and functions that meet changing consumer requirements at competitive prices.
According to NPD Intelect, a leading provider of on-line market data, in
its year 2002 market research report, the North American market for retail sales
of all computer products, accessories and peripherals was approximately $24.3
billion, an increase of approximately 1% from $24.1 billion in 2001. According
to that same report, the North American retail market for data storage, input,
multimedia, and computer connectivity devices was approximately $3.0 billion.
During that same period, however, our net sales within our product categories
increased by approximately 23.2%.
OUR STRATEGY
The computer peripheral and consumer electronics industries continue to
experience rapid innovation and evolution of multimedia, digital entertainment
and wireless connectivity and other devices. Optical storage devices have
become one of the most cost-efficient storage solutions available. According to
NPD Intelect, we were a dominant leader in the sales of optical storage products
for the years 2001 and 2002, with the number one market share in unit sales for
CD ROM and CD-RW drives for 2001 and 2002. We believe that optical storage is
poised for continued growth as the marketplace shifts to video storage.
Although the mainstream users of optical storage have traditionally been driven
by data and audio storage needs, we believe the trend has and will continue to
move towards video storage, DVD RW devices, and digital photo storage devices.
Our business strategy is focused on achieving the number one market share
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presence for all computer data storage products, including video and DVD
devices, and to become a major provider of consumer digital entertainment
devices in North America. The core elements of this strategy include:
- Our commitment to provide our end-users products with the best
performance at the best value in the industry.
- Our three brand strategy that uses our I/OMagic, Digital Research
Technologies and Hi-Val brand names to provide brand identification
for our resellers increasing shelf space and driving revenue.
- On-going collaboration with our strategic sub-contracting manufacturing
partners to develop and provide innovative cost effective products to
the market.
- An incremental addition of higher average selling price products based
on our migration from lower average selling price CD drives to higher
average selling price DVD drives and development of digital
entertainment devices, which creates more revenue for the same number
of unit sales.
- A continuation of our "good, better, best" product strategy allowing us
to often be the first to market and the one of the last to exit a
product life cycle. Based on our "good, better, best" product strategy,
we are able to successfully meet our diverse end-user customers' needs
by offering a variety of products within each of our product lines. We
offer "good" products which provide customers with basic performance and
value. We also offer "better" products which include added-features to
our basic performance and value model. The "best" products that we
offer often include sophisticated proprietary technology with added or
multiple features in addition to basic performance and value. This
strategy allows us to continuously attract new customers while
maintaining our old customers by offering them a selection of products
based on technological sophistication as well as price.
- Financial strategies to utilize our new trade credit agreements to
optimize cash flow and increase inventory turns.
- Operational strategies to consolidate our back-end operations to produce
more units per head count and to strengthen our information technology
systems infrastructure in order to provide improved product delivery
services and product support at reduced operating costs.
OUR PRODUCTS AND SERVICES
We develop, subcontract manufacture, market and distribute two principal
categories of products:
- optical storage and media products and
- digital entertainment products.
We market products within these two categories under some or all of our
I/OMagic, Hi-Val and Digital Research Technologies brand names. Our customers
include major computer and consumer electronics retails, including AAFES, Best
Buy, CompUSA, Circuit City, Fred Meyer Stores, Micro Center Super Stores, Office
Depot, Office Max, Radio Shack, Radio Shack Canada, Target, Tech Data and other
leading retailers throughout the United States and Canada.
Optical Storage and Media Products
- ----------------------------------
Our optical storage products include CD-ROM, DVD-ROM, and CD-RW, CD-RW +
DVD combi, and DVD+RW drives, and optical storage media discs for these types of
drives. These products record and playback general data files, digital images,
digital video and digital music. DVD drives and media are higher density
optical storage products relative to CD drives and media. We offer a full range
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of optical storage media that complement our optical storage drives. Our optical
storage and media products are marketed under our I/OMagic, Hi-Val and Digital
Research Technologies brand names.
Our optical storage and media products business generated approximately
87.8% of our net sales during 2002. These products are sold throughout the
United States and Canada through virtually all of our retailers. According to
NPD Intelect's 2002 market tracking data report, our three principal brand names
ranked among the top ten best selling brands throughout North America in the
data storage product category. Retail sales for data storage products was
estimated to generate nearly $2.0 billion in 2002. NPD Intelect's data storage
category includes various optical and data storage and media.
The marketplace for optical storage products is undergoing a transition in
part to support the growing video storage demands. This new format enables users
to copy and store files in the higher capacity DVD format. We believe that
consumer demand for these optical storage devices is increasing due to several
factors, including an increased usage of data storage, audio storage and
expansion into video storage. Enhanced PC functionality now allows the creation
of higher resolution graphics, audio data, and the storage and playback of high
performance audio-video DVD format data that are critical to business and
consumer applications. We have recently begun shipments of our newest line of
DVD+RW drives. The average selling price of the new DVD RW drives is at least
100% higher than traditional CD-RW drives and is the newest emerging growth
opportunity. We intend to continue to work closely with our manufacturers to
develop more features, and lower cost solutions within this product segment.
Digital entertainment products
- ------------------------------
Based on the success of our optical storage products and the market
penetration that has been developed in North American retailers, we are
expanding our business into a wide variety of digital entertainment products.
The primary focus of our digital entertainment products will be on audio and
video aftermarket sales. These products include solutions for audio, video and
digital imaging, and their related accessories.
Audio solutions
---------------
We have been shipping MP3 players to certain of our national retailer
customers and we plan to introduce new MP3 devices that are more portable,
contain higher memory capacity, greater memory expansion capability and include
many more features that provide cost effective solutions for the end user during
2003.
Video and Digital Imaging Solutions
-----------------------------------
During the fourth quarter of 2002, we introduced our first 15-inch flat
panel LCD TV system through a select retailer. We are currently in the process
of developing larger screen size LCD TV systems which we believe will compete
well in this new and growing sector. During the fourth quarter of 2002, we also
introduced our new Digital Photo Library, a 20 GB external hard disk drive that
facilitates the convenient storage of digital photos and videos. The Digital
Photo Library is a portable, stand-alone (does not require computer
connectivity) system that allows the transfer of digital photos from a memory
card to a hard drive, and thus allows for the repeated use of expensive memory
cards.
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Accessories
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We also offer a variety of accessories that includes keyboards, mice,
floppy disk drives, audio and graphics cards, and modems, all of which
complement our current product line. These products are principally designed
for inputting and transferring data.
MANUFACTURING, DISTRIBUTION AND PRODUCT DEVELOPMENT
We utilize subcontract manufacturing facilities, product development
resources and logistics management to manufacture our products in East Asia.
In addition, we maintain both in-house and subcontract assembly and retail
packaging facilities in Southern California. We also maintain a warehousing,
customer service, and distribution center in Southern California. Three of our
shareholders also serve as subcontract manufacturers. Through these strategic
relationships we believe we are well positioned to provide scalable production
without incurring increased time and expense.
We typically do not have long-term contracts with our sub-contract
manufacturers, instead relying on purchase orders to fulfill our product needs.
As a result, it is conceivable that our manufacturers could refuse to continue
to sell products to us which could cause a substantial disruption in our
business operations.
Our product development efforts, include the development of a new line of
external data storage devices with our own unique proprietary enclosures and
built-in memory card readers. Enclosures are designed for CD-RW, CD-RW + DVD
combi, and DVD RW optical storage devices. In addition, we are working with our
subcontractors to develop new MP3 players and other digital entertainment
devices.
We maintain a subcontract logistics and product development operation in
Taipei, Taiwan in order to better identify new products that we may be
interested in offering for sale and to assist us in qualifying manufacturing
facilities. Our Taiwan operation also coordinates product purchases and product
shipments from our East Asian subcontract manufacturers.
The majority of our products are shipped by our manufacturers to our
packaging, storage and distribution facility in Santa Ana, California. These
products are then shipped either directly to retail locations or to their
centralized distribution centers. Product shipments are primarily made through
major commercial carriers. Each product we distribute is subject to a minimum
warranty of one year. This warranty covers repair or replacement of the product
and is backed by the manufacturer of the product.
Most of our subcontractors are among the largest manufacturers in their
product category in the world and also subcontract manufacture products for
companies such as Hewlett Packard, Dell, and Sony, among others. These
subcontract manufacturers expend substantial resources in research and
development and the design of efficient manufacturing processes. We work closely
with our subcontract manufacturers and our customers to identify existing market
trends and monitor sales performance of our products and predict future market
trends. Following our analysis and our consultation with our subcontract
manufacturers and customers, we determine whether to offer that particular
product.
We maintain our own product development team to develop and coordinate
product solutions that provide user-friendly installation, complete user
manuals, installation guides, product packaging and marketing literature. We
intend to continue to utilize all of our available resources to develop
innovative products, with a great "out of box" experience at the best possible
value.
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SALES AND MARKETING
We believe that our multi-brand optical storage sales and marketing
strategy has proven successful in the North American retail market. According
to NPD Intelect for 2002, we were a dominant leader in the unit sales of optical
storage devices, with the number one market share in unit sales for CD ROM and
CD-RW drives, competing against companies such as Sony, TDK and Yamaha. We plan
to implement a similar strategy for our DVD RW drives. DVD RW drives are the
next logical extension to our optical storage business and by using the same
successful sales strategy from our CD RW business, we believe that the DVD RW's
higher average selling price and better gross margin should produce even greater
success.
We currently sell our products in more than 7,900 retail outlets throughout
North America and Canada. This success has been developed by strategically
focusing on national retailers and creating destination points for our
multi-brand strategy. This effort has been developed over the past six years by
promoting our products through national sales circulars. Our national retailers
currently include, among others, AAFES, Best Buy, CompUSA, Circuit City, Fred
Meyer Stores, Micro Center Super Stores, Office Depot, Office Max, Radio Shack,
Radio Shack Canada, Target and Tech Data. We believe that our products have
matured and the technology standards are widely accepted in the after-market
segment by a greater portion of the population. We are currently planning to
work with other major national retailers that have expressed an interest in
offering PC peripherals to develop more destination points.
We focus on a "good, better, and best" product strategy. Our mission is to
be one of the first to deliver new and exciting products and one of the last to
exit a product life cycle. Based on our "good, better, best" product strategy,
we are able to successfully meet our diverse end-user customers' needs by
offering a variety of products within each of our product lines. We offer
"good" products which provide customers with basic performance and value. We
also offer "better" products which include added-features to our basic
performance and value model. The "best" products that we offer often include
sophisticated proprietary technology with added or multiple features in addition
to basic performance and value. This strategy allows us to continuously attract
new customers while maintaining our old customers by offering them a selection
of products based on technological sophistication as well as price. This
strategy also enables us to manage multiple brands through multiple national
retail channels, maintain the best value, and drive a high frequency of sales
promotions in a coordinated manner.
We regularly participate in industry trade shows such as Comdex, CES, and
RetailVision to develop and maintain our relationship with our national retail
customers.
We have successfully established a significant database of new and repeat
customers. This database represents a powerful marketing tool by which we can
reach potential new customers for our future products.
COMPETITION
We believe that the following three key competitive factors largely
determine the success of companies in the computer peripheral and consumer
electronics industries:
- time-to-market - for new technology;
- product value and performance; and
- market penetration.
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Time-to-Market
- --------------
We believe that time-to-market for new technology is a critical element of
success in the computer peripheral and consumer electronics marketplaces.
Because the market for our products is extremely competitive, with rapid
technological advancements and quick after-market opportunities, the time it
takes us to bring new or enhanced products to market is of utmost importance.
The product life cycle of our products typically ranges from three to
twelve months. During the product life cycle the average sales price for our
products declines. This short life cycle requires that we maintain efficient
supply-chain management through inventory controls and that we quickly respond
to new market and technology trends. For example, during 2002, we transitioned
through five product cycles in our optical storage drive category alone.
We attempt to strategically time our new product introductions by
monitoring market trends and technological developments through consultation
with our retailers and sub-contract manufacturers. We typically place multiple
orders each month with our manufacturers in an attempt to assure a continuous
flow of products reflecting trends in the United States and Canadian
marketplaces. In addition, our strategic relationships with our three
shareholder-manufacturers helps us regularly ship product as it first becomes
available to the market. We believe that our strategies and processes are
designed to ensure rapid time-to-market of our products and are competitive with
other companies in the computer peripheral and consumer electronics industries.
Product Value and Performance
- -----------------------------
We believe that in this challenging economic environment product value and
performance is a critical element of success in the computer peripheral and
consumer electronics marketplaces. We believe that our product value and
performance are the underlying reasons customers purchase our products. We
believe that in order for products to be competitive within the computer
peripheral and consumer electronics marketplaces they typically must offer
technology and features that represent recent developments. Our more technology
savvy customers are rushing towards products with a cost to performance ratio
that is rewarding and certain.
We focus on product value and performance as our most competitive factors
by positioning our products as affordable alternatives to what we believe the
marketplace perceives as "tier one" brands such as Hewlett Packard, Iomega,
Philips, Sony, TDK, and Yamaha. We attempt to compete with these "tier one"
brands by offering similar product performance and features at lower prices. We
believe that our strategy has led us to success in the marketplace. For example,
following the launch of our I/OMagic, Hi-Val and Digital Research Technologies
brand names in the optical store drive marketplace, according to NPD Intelect's
2001 market data report, we achieved, by the end of 2001, the number one market
share position based on sales in the United States. According to NPD Intelect's
2002 market data report, we were among the top leaders in optical storage sales,
maintaining the number one market share position in both CD ROM and CD-RW sales
throughout 2002.
We believe that our products are offered to consumers at competitive prices
and include the performance contained in more expensive brand names. Although
the marketplace for our products is extremely price sensitive, we believe that
we have maintained competitive gross profit margins. Our incremental product
additions shift towards higher average selling prices also improves our current
marketplace advantage by creating comparably higher gross profit margins. While
there can be no assurance that we can maintain our existing gross profit
margins, we believe that we are well positioned with our manufacturers to rely
upon their combined economies of scale to assist us in maintaining these
margins.
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Market Penetration
- ------------------
We believe that market penetration is a critical element of success in the
computer peripheral and consumer electronics marketplaces. Market penetration is
important because most end users purchase products like those we offer from
off-the-shelf retailers such as large computer peripheral and consumer
electronics retailers. Market penetration for a company such as ours is
typically measured by the number of national retailers who resell our products
and the amount of shelf space we are allocated.
We are continuing to implement our brand name strategy throughout the
United States and Canada. This strategy includes the branding of certain of our
products under one or more of our I/OMagic, Hi-Val and Digital Research
Technologies brand names. According to NPD Intelect market data, our three brand
strategy enabled us to achieve the largest market share in North American retail
sales of both CD ROM and CD-RW drives and one of the leaders in total unit sales
for all optical storage products.
Our retailer customer base includes approximately 538 Best Buy stores, 626
Circuit City stores, 225 CompUSA stores, 129 Fred Meyer stores, 833 Office Depot
stores, 1,000 Office Max stores, 4,000 Radio Shack stores, and other leading
regional retailers. In total, our retailer base exceeds 7,900 retail stores.
Over the last five years, we have expended significant resources in developing
brand awareness and creating customer loyalty. In addition, we have invested
heavily in building the support infrastructure necessary to conduct our business
with large computer peripheral and consumer electronics retailers in the United
States and Canada. We believe that providing our extensive mix of computer
peripheral and consumer electronics products improves our ability to obtain
critical shelf space at our retailers which is important to establishing market
penetration.
Many companies have developed computer peripheral and consumer electronics
products. Our products compete on the basis of features, price, quality,
reliability, name recognition, product breadth and technical support and
service. We believe that we generally are competitive in each of these areas.
However, many of our existing and potential competitors have significantly more
financial, engineering, product development, manufacturing and marketing
resources than we have. We cannot assure you that our competitors will not
introduce comparable or superior products incorporating more advanced technology
at lower prices, or that other changes in market conditions or technology will
not adversely affect our ability to compete successfully in the future. We
perceive the following companies as being the principal competition to our
computer peripheral and consumer electronics products:
Hewlett-Packard: Global provider of products, technologies, solutions and
services to consumers and businesses. Hewlett-Packard's
offerings span information technology infrastructure,
personal computing and access devices, global services and
imaging and printing. Competitor in DVD RW drives.
Iomega: Designer, manufacturer and marketer of data management
Solutions, based on removable-media technology for home and
office computers. Competitor in external CD-RW drives.
Memorex: Industry sales and marketing leader of digital media, media
accessories and computer input devices. Competitor in CD
RW and DVD RW drives.
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Philips: Manufacturer and distributor of electronic and electrical
products, systems and equipment, as well as information
technology services. Competitor in CD-RW and DVD RW drives.
Samsung: Manufacturer of a wide range of products from consumer
audio/visual and computer related products, telecommuni-
cations, and home appliances to semiconductors, memory
chips, TFT-LCDs, CDMA mobile phones, monitors and VCRs.
Competitor in CD-ROM, DVD-ROM, and internal CD- RW drives.
Sony: Develops, designs, manufactures, and sells electronic
equipment, instruments and devices for consumer and
industrial markets. Competitor in CD and DVD-ROMs, CD and
DVD RWs, and DVD+/- RW.
INTELLECTUAL PROPERTY
We currently rely on a combination of contractual rights, copyrights,
trademarks and trade secrets to protect our proprietary rights. However,
although our products and their constituent components could benefit from patent
protection, we have chosen to retain any proprietary rights we have that are
associated with our products predominantly as trade secrets. We cannot assure
you that our means of protecting our proprietary rights will be adequate or that
our competitors will not independently develop comparable or superior
technologies or obtain unauthorized access to our proprietary technology.
Our I/OMagic, Hi-Val and Digital Research Technologies brand names are
registered trademarks of I/OMagic Corporation. We own each of these brand names.
We have filed a federal trademark application covering the MyMP3 trademark under
which we sell our MP3 players. There can be no assurance that we will eventually
secure a registered trademark covering the MyMP3 name. We do not have any issued
or pending patents.
We own, license or have otherwise obtained the right to use certain
technologies incorporated in our products. We may receive infringement claims
from third parties relating to our products and technologies. In those cases, we
intend to investigate the validity of the claims and, if we believe the claims
have merit, to respond through licensing or other appropriate actions. To the
extent claims relate to technology included in components purchased from
third-party vendors for incorporation into our products, we would forward those
claims to the appropriate vendor. If we or our product manufacturers are unable
to license or otherwise provide any necessary technology on a cost-effective
basis, we could be prohibited from marketing products containing that
technology, incur substantial costs in redesigning products incorporating that
technology, or incur substantial costs defending any legal action taken against
us.
We have been, and may in the future be, notified of claims asserting that
we may be infringing certain patents, trademarks and other intellectual property
rights of third parties. We cannot predict the outcome of such claims and there
can be no assurance that such claims will be resolved in our favor. An
unfavorable resolution of such claims may have a material adverse effect on our
business, prospects, financial condition and results of operations. The computer
peripheral industry, and in particular, the data storage industry, has been
characterized by significant litigation relating to infringement of patents and
other intellectual property rights. We have in the past been engaged in
infringement litigation, both as plaintiff and defendant. There can be no
assurance that future intellectual property claims will not result in
litigation. If infringement is established, we may be required to pay
substantial damages or we may be enjoined from manufacturing and selling an
infringing product. In addition, the costs of engaging in the prosecution or
defense of intellectual property claims may be substantial regardless of the
outcome.
9
EMPLOYEES
As of April 8, 2003, we had approximately 81 full-time permanent employees
and five full-time temporary employees. We have no collective bargaining
agreements with our employees. We believe that our relationship with our
employees is good.
ITEM 2. PROPERTIES
Our corporate headquarters is located in Santa Ana, California in a leased
production, receiving, shipping and corporate facility consisting of
approximately 57,374 square feet. The lease expires on September 30, 2003;
however, upon 20 days' prior written notice to the landlord, we can terminate
the lease at any time after June 30, 2003.
We are in the process of looking for another facility in Orange County,
California, as our current facility is insufficient in size for our current
sales level. We anticipate moving no later than September 30, 2003.
ITEM 3. 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, our President and Chief Executive Officer. The
plaintiffs alleged that they were defrauded by Mr. Shahbaz because Mr. Shahbaz
failed to honor the terms of a contract under which Mr. Shahbaz was to deliver
1,500,000 shares of our common stock (calculated prior to our recent
one-for-fifteen reverse split of our common stock) in exchange for an interest
in Alex Properties, a general partnership, that holds title to our corporate
headquarters. The complaint later was amended to add Alex Properties and Hi-Val,
Inc. as plaintiffs and I/OMagic Corporation, IOM Holdings, Inc., our
wholly-owned subsidiary ("IOMH"), Steel Su, a director of I/OMagic Corporation,
and Meilin Hsu as defendants. As amended, the complaint sought an aggregate of
$42,000,000 plus punitive and other damages to be proven at trial and also
sought rescission of the contract involving the acquisition of an interest in
Alex Properties. The plaintiffs alleged that IOMH, Mr. Shahbaz, Mr. Su and Ms.
Hsu fraudulently and negligently made misrepresentations to induce Hi-Val, Inc.
to enter into an asset purchase agreement in June 1999 for the purchase and sale
of Hi-Val, Inc. assets to IOMH. The plaintiffs also alleged that IOMH and Mr.
Shahbaz breached the terms of the asset purchase agreement by failing to deliver
consideration that included 2,000,000 pre-split shares of our common stock and
payment of interest on Mr. Valkili's $1,500,000 loan to Hi-Val, Inc. 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, Inc.'s $25,000,000 credit
facility.
Effective on or about March 28, 2003, we, IOMH, and others, entered into a
settlement agreement and general release with Mark Vakili, Mitra Vakili, Hi-Val,
Inc., and others, in connection with the action described above. Under the terms
of the settlement agreement and general release, we paid $3,000,000 on March 31,
2003 and are obligated to pay an additional $1,000,000 on March 15, 2004. The
settlement agreement and general release also provides, among other things, that
Mr. Shahbaz and Mr. Su, each a director of I/OMagic Corporation, will relinquish
any claims held by either of them to any interest in Alex Properties. Pursuant
to the settlement agreement and general release, Mr. Shahbaz and Mr. Su will
also transfer to parties designated by Mark Vakili and Mitra Vakili, an
aggregate of 13,333 post-split shares of our common stock from the 66,667
post-split shares of our common stock being returned by Mark Vakili and Mitra
Vakili to Mr. Shahbaz and Mr. Su. Mr. Shahbaz and Mr. Su had previously
transferred the 66,667 post-split shares to Mark Vakili and Mitra Vakili.
10
In addition, we are involved in certain legal proceedings and claims which
arise in the normal course of business. Management does not believe that the
outcome of these matters will have a material effect on our financial position
or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Our common stock has been traded on the OTC Bulletin Board under the symbol
"IOMG" since December 20, 2002. Prior to that, it traded on the OTC Bulletin
Board under the symbol "IOMC" since March 25, 1996. The table below shows for
each fiscal quarter indicated the high and low closing bid prices for shares of
our common stock. The prices shown reflect inter-dealer prices obtained from
market makers of our stock, without retail mark-up, mark-down, or commission and
may not necessarily represent actual transactions. The prices listed below and
elsewhere within this report reflect the one-for-fifteen reverse split of our
common stock effected December 20, 2002.
PRICE RANGE
-----------
2002: LOW HIGH
---- ------
First Quarter (January 1 - March 31) $ 8.40 $16.50
Second Quarter (April 1 - June 30) 5.25 15.15
Third Quarter (July 1 - September 30) 6.15 10.50
Fourth Quarter (October 1 - December 31) 3.75 11.00
2001:
First Quarter 10.80 16.95
Second Quarter 8.25 15.00
Third Quarter 6.00 11.25
Fourth Quarter 5.25 11.25
As of April 8, 2003, we had 4,529,670 shares of common stock outstanding
held of record by approximately 79 stockholders. Within the holders of record of
our common stock are depositories such as Cede & Co. that hold shares of stock
for brokerage firms which in turn, hold shares of stock for beneficial owners.
We have not paid dividends on our common stock to date. Our line of credit
with ChinaTrust Bank (USA) prohibits the payment of cash dividends on our common
stock. We currently intend to retain future earnings to fund the development and
growth of our business and, therefore, do not anticipate paying cash dividends
on our common stock within the foreseeable future. Any future payment of
dividends on our common stock will be determined by our board of directors and
will depend on our financial condition, results of operations, contractual
obligations and other factors deemed relevant by our board of directors.
11
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated historical financial data should be
read in conjunction with the consolidated financial statements and the notes to
those statements and the section entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
report. The consolidated statements of operations and comprehensive income data
with respect to the years ended December 31, 2002, 2001 and 2000 and the
consolidated balance sheet data at December 31, 2002 and 2001 are derived from,
and are qualified by reference to, the consolidated audited financial statements
included elsewhere in this document. The historical results are not necessarily
indicative of results to be expected for any future periods.
CONSOLIDATED STATEMENTS OF OPERATIONS AND YEARS ENDED DECEMBER 31,
COMPREHENSIVE INCOME DATA: 2002 2001 2000 1999
-------------------------- ------------ ------------ ------------
NET SALES $ 83,529,708 $67,788,959 $60,805,437 $36,661,092
Cost of sales. . . . . . . . . . . . . . . . . . . 74,665,823 62,776,334 53,126,489 31,419,757
-------------------------- ------------ ------------ ------------
Gross profit . . . . . . . . . . . . . . . . . . . 8,863,885 5,012,625 7,678,948 5,241,335
Operating expenses . . . . . . . . . . . . . . . . 10,022,445 10,180,839 10,126,111 3,837,293
-------------------------- ------------ ------------ ------------
Income (loss) from operations. . . . . . . . . . . (1,158,560) (5,168,214) (2,447,163) 1,404,042
Total other income (expense) . . . . . . . . . . . (5,525,033) (376,431) (4,963,286) 30,256
-------------------------- ------------ ------------ ------------
Income (loss) from operations before income taxes. (6,683,593) (5,544,645) (7,410,449) 1,434,298
Income tax (benefit) expense . . . . . . . . . . . 1,663,638 3,000 (999,600) (428,500)
-------------------------- ------------ ------------ ------------
Net income (loss). . . . . . . . . . . . . . . . . (8,347,231) (5,547,645) (6,410,849) 1,862,798
========================== ============ ============ ============
Basic and diluted earnings (loss) per share. . . . (1.84) (1.23) (2.44) 0.86
========================== ============ ============ ============
Weighted average shares outstanding, basic and
diluted . . . . . . . . . . . . . . . . . . . 4,528,894 4,528,341 2,629,894 2,153,954
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME DATA: 1998
------------
NET SALES $ 9,069,994
Cost of sales. . . . . . . . . . . . . . . . . . . 7,927,553
-----------
Gross profit . . . . . . . . . . . . . . . . . . . 1,142,441
Operating expenses . . . . . . . . . . . . . . . . 1,731,652
------------
Income (loss) from operations. . . . . . . . . . . (589,211)
Total other income (expense) . . . . . . . . . . . 251,993
------------
Income (loss) from operations before income taxes. (337,218)
Income tax (benefit) expense . . . . . . . . . . . 800
------------
Net income (loss). . . . . . . . . . . . . . . . . (338,018)
============
Basic and diluted earnings (loss) per share. . . . (0.34)
============
Weighted average shares outstanding, basic and
diluted . . . . . . . . . . . . . . . . . . . 992,120
YEARS ENDED DECEMBER 31,
-------------------------
2002 2001 2000 1999 1998
------------------------- ----------- ----------- ----------- ----------
BALANCE SHEET DATA:
Cash and cash equivalents. . . . . . . $ 7,320,143 $ 4,423,623 $ 3,502,546 $ 1,943,522 $1,402,904
Working capital. . . . . . . . . . . . 11,288,330 18,374,492 21,838,710 7,598,786 629,452
Total assets . . . . . . . . . . . . . 41,757,969 55,903,767 53,098,438 22,916,329 6,128,250
Stockholders' equity . . . . . . . . . 16,726,720 17,115,651 22,659,571 7,875,963 777,120
Redeemable convertible preferred stock - 9,000,000 9,000,000 - -
No cash dividends on our common stock were declared during any of the
periods presented above.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
our audited consolidated financial statements and notes to financial statements
included elsewhere in this document. This report and our audited consolidated
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 our current beliefs regarding revenues we might earn if
we are successful in implementing our business strategies. The forward-looking
statements and associated risks may include, relate to or be qualified by other
important factors, including, without limitation:
- the projected growth or contraction in the computer peripherals and
consumer electronics markets in which we operate;
- our business strategy for expanding, maintaining or contracting our
presence in these markets;
- anticipated trends in our financial condition and results of operations;
and
- our ability to distinguish ourselves from our current and future
competitors.
12
We do not undertake to update, revise or correct any forward-looking
statements.
The information contained in this report is not a complete description of
our business or the risks associated with an investment in our common stock.
Before deciding to buy or maintain a position in our common stock, you should
carefully review and consider the various disclosures we made in this report,
and in our other materials filed with the Securities and Exchange Commission
that discuss our business in greater detail and that disclose various risks,
uncertainties and other factors that may affect our business, results of
operations or financial condition. In particular, you should review the "Risk
Factors" section of this report.
Any of the factors described above or in the "Risk Factors" section of this
report could cause our financial results, including our 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 our common stock to fluctuate
substantially.
OVERVIEW
We offer products in both the personal computer and the consumer
electronics marketplace. These products include a variety of peripheral upgrades
for desktop and portable applications. Our sales are to national and major and
regional retailers in the United States and Canada. We experienced a 23.2%
increase in net sales in 2002 over 2001. While the current economic climate
makes it difficult for us to look forward into 2003, we believe that our
potential for increased sales in 2003 have been strengthened by the addition of
new customers in 2002.
During 2002, our net loss increased by 50.5% over our loss during 2001,
primarily due to the settlement of litigation and related legal expenses and the
write off of deferred tax assets. Our loss from operations decreased by 77.6%,
due to increased sales and gross profit, with operating expenses remaining
relatively constant. During 2002, we wrote down accounts receivables and
inventory relating to the acquisition of IOM Holdings, Inc. in 2000. We believe
that these write downs are complete and we do not expect further write downs in
2003.
We believe that sales may not appreciably increase in 2003 over 2002 due to
the uncertain economic climate. We intend to pursue discussions with additional
large national or regional retailers that are not currently our retail
customers. There is no guarantee that we will be successful in obtaining new
customers. We also plan to discuss with those retailers who carry only a
limited variety of our products, the possibility of expanding the number of our
products which they carry. There is no guarantee that we will be successful in
expanding our product lines within these retail customers. We also plan to
pursue expanding our consumer electronics line; however, there is no guarantee
that we will find any consumer electronics products which will meet our criteria
and our customers' criteria.
We believe that we will show improvement in 2003 over the 2002 net loss,
due to the settlement of a major lawsuit and the complete writeoff of our
deferred tax asset in 2002. There is no guarantee that we will be profitable in
2003, as the economy is still uncertain and there continues to be competitive
pressure on our gross margins.
Any increase in sales or improvement upon our 2002 net loss in 2003 will
also depend on our ability to obtain a new line of credit with a financial
institution before October 15, 2003, when our current line of credit terminates.
While we are currently engaged in discussions with financial institutions
regarding a replacement line of credit, there is no guarantee that we will
obtain one.
13
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of these financial statements requires us 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, we evaluate our estimates, including those
related to customer programs and incentives, product returns, bad debts,
inventories, intangible assets, income taxes, and contingencies and litigation.
We base our 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.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. We record 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, we may take actions to increase customer incentive offerings
possibly resulting in an incremental reduction of revenue at the time the
incentive is offered. We maintain allowances for doubtful accounts for estimated
losses resulting from the inability of our customers to make required payments.
If the financial condition of our customers were to deteriorate, resulting in
the impairment of their ability to make payments, additional allowances may be
required.
We write down our 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. We record a
valuation allowance to reduce its deferred tax assets to the amount that is more
likely than not to be realized. While we have considered future taxable income
and ongoing prudent and feasible tax planning strategies in assessing the need
for the valuation allowance, if we were to determine that we would be able to
realize our deferred tax assets in the future in excess of our net recorded
amount, an adjustment to the deferred tax asset would increase income in the
period this determination was made. Likewise, should we determine that we would
not be able to realize all or part of our net deferred tax asset in the future,
an adjustment to the deferred tax asset would be charged to income in the period
this determination was made.
14
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected
statement of operations data expressed as a percentage of total net sales.
YEARS ENDED DECEMBER 31,
-------------------------
2002 2001 2000
------------------------- ------ -------
Net sales. . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0%
Cost of sales. . . . . . . . . . . . . . . . . 89.4 92.6 87.4
------------------------- ------ -------
Gross profit . . . . . . . . . . . . . . . . . 10.6 7.4 12.6
Selling, marketing and advertising expenses. . 1.7 2.2 3.6
General and administrative expenses. . . . . . 8.8 9.5 10.3
Depreciation and amortization. . . . . . . . . 1.5 3.3 2.7
------------------------- ------ -------
Operating loss . . . . . . . . . . . . . . . . (1.4) (7.6) (4.0)
Net interest expense . . . . . . . . . . . . . (0.4) (0.6) (2.0)
Forgiveness of amounts due from related party. - - (6.3)
Settlement expense and related legal costs . . (6.2) - -
Other income expense . . . . . . . . . . . . . - - 0.1
------------------------- ------ -------
Loss from operations before
provision for income taxes. . . . . . . . . (8.0) (8.2) (12.2)
Income tax provision (benefit) . . . . . . . . 2.0 - (1.7)
------------------------- ------ -------
Net loss . . . . . . . . . . . . . . . . . . . (10.0)% (8.2)% (10.5)%
========================= ====== =======
FISCAL YEAR ENDED DECEMBER 31, 2002 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
2001
Net sales for 2002 were $83,529,708 which is an increase of $15,740,749
(23.2%) as compared to net sales of $67,788,959 for 2001. This increase in net
sales is primarily attributable to the following: (i) a $17,320,353 increase in
sales to consignment customers; (ii) $3,611,863 in sales to new customers; (iii)
a $2,695,258 reduction in product returns; and (iv) a $4,152,212 reduction in
channel promotions; offset by a $8,019,539 decrease in net sales to prior year
customers and a $2,711,090 increase in price protection.
Gross profit as a percentage of net sales increased from 7.4% ($5,012,625)
in 2001 to 10.6% ($8,863,885) in 2002. This increase was primarily the result
of an increase in gross profit on product costs (resulting from a decrease in
product costs) from 18.6% ($12,565,373) in 2001 to 19.1% ($15,991,419) in 2002
and a smaller decrease in gross profit from inventory shrink/adjustments, from a
5.9% decrease ($3,975,301) in 2001 to a 3.2% decrease ($2,671,787) in 2002. The
decrease in gross profit from freight in/out remained approximately the same
from 5.3% in 2001 ($3,577,443) to 5.3% ($4,455,745) in 2002.
Operating expenses as a percentage of revenues decreased from 15.0%
($10,180,839) in 2001 to 12.0% ($10,022,445) in 2002. This percentage decrease
is primarily due to total operating expenses decreasing slightly while net sales
increased 23.2%. Selling, marketing and advertising expenses decreased by
$50,124 in 2002. General and administrative expenses increased by $899,792 in
2002. Depreciation and amortization expenses decreased by $1,008,062 in 2002.
Selling, marketing and advertising expenses decreased slightly in 2002 to
$1,437,704 as compared to $1,487,828 in 2001. These expenses also declined as a
percentage of net sales from 2.2% in 2001 to 1.7% in 2002. The $50,124 reduction
in selling, marketing and advertising expenses was primarily due to a direct
advertising expense ($120,577) in 2001 not in 2002, $55,825 less customer
product evaluation expenses and $47,063 less payroll in 2002, offset by $135,609
higher outside commissions in 2002 (due to greater sales in 2002).
15
General and administrative expenses in 2002 were $7,360,904 (8.8% of net
sales) and in 2001 were $6,461,112 (9.5% of net sales). General and
administrative expenses increased $899,792 primarily due to $449,063 higher bad
debt expense (Hi-Val accounts receivable acquired in 2000), $197,674 higher
payroll expenses, $149,260 higher insurance expenses, $124,706 increased
warehouse supplies, $117,130 greater financial relations expenses, and $98,095
increased use of subcontracting of product assembly, offset by $153,046 less
rent expense (we moved out of a second facility at the end of April 2002) and
$151,469 decreased expense for consultants in 2002.
Depreciation and amortization expenses in 2002 were $1,223,837 (1.5% of net
sales) and in 2001 were $2,231,899 (3.3% of net sales). The decrease of
$1,008,062 was primarily due to decreased amortization of trademarks. In 2002 we
had an outside valuation service review the value of the trademarks and their
useful lives for us. Based upon the valuation, we determined (with concurrence
of our independent auditors) that there had been no impairment to the value of
the trademarks and that the useful lives of the trademarks should be increased
by ten years due to additional historical information of their value. Therefore,
the amount of annual amortization was decreased.
Other income (expenses) increased to $5,525,033 (6.6% of net sales) expense
in 2002 from $376,431 expense (0.6% of net sales) in 2001. This increase of
$5,148,602 was primarily due to $5,179,891 for the settlement of litigation and
related legal expenses (see footnotes for further discussion). We had a small
gain of $38,759 on the disposal of property and equipment which we sold in
relation to the vacating of a second facility at the end of April 2002. Income
taxes provision for 2002 consisted of $1,755,311 of the deferred tax assets
being written off offset by $91,673 net income tax refund.
Our loss in 2002 was due to four factors. First, we incurred $5,179,891 for
settlement costs and related legal fees for litigation. Second, we wrote off
$1,663,639 in deferred tax assets. Third, we wrote down $2,671,787 in inventory,
primarily related to the 2000 acquisition of IOM Holdings, Inc. assets. Fourth,
we wrote down $1,300,000 in accounts receivable related to the 2000 acquisition
of IOM Holdings, Inc.
FISCAL YEAR ENDED DECEMBER 31, 2001 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
2000
Net sales for 2001 increased $6,983,522 (11.5%) to $67,788,959 from
$60,805,437 for 2000. The re-introduction of the Hi-Val and Digital Research
Technologies brands during 2001 increased net sales by $22,893,606. This
increase resulted mainly from an agreement with Best Buy to sell the Digital
Research Technologies brand on a consignment basis and an agreement with Office
Max in June 2001 to introduce new product lines in large quantities in both the
I/OMagic and Hi-Val brands. Net sales of the I/OMagic brand decreased
$10,983,766. This was primarily the result of several customers moving from an
I/OMagic brand only in 2000 to both an I/OMagic brand and a Hi-Val brand in
2001. The net sales in 2000 are reduced by $1,386,261 from that reported last
year due to the reclassification of COOP expenses from selling and marketing
expenses.
Gross profit as a percentage of revenues decreased from 12.6% ($7,678,948)
in 2000 to 7.4% ($5,012,625) in 2001. This was primarily due to $1,335,398 more
freight in/out in 2001 (5.3% of net sales, due to great air freight in during Q3
and Q4) than in 2000 (3.7% of net sales) and greater inventory write down in
2001. We wrote-down to lower of cost or market $3,975,301 in inventory in 2001
and $1,089,256 of inventory in 2000. In 2000, we wrote-down to lower of cost or
16
market some inventory from the acquisition of IOM Holdings, Inc. and some
inventory received from a related party (Digital Research Technologies) as
payment on accounts receivable. In 2001, we wrote-down to lower of cost or
market such inventory further in anticipation of the sale of such at less than
previously anticipated. Cost of product decreased slightly in 2001.
Operating expenses as a percentage of revenues decreased from 16.7%
($10,126,111) in 2000 to 15.0% ($10,180,839) in 2001. This percentage decrease
is primarily due to total operating expenses increasing only slightly while net
sales increased 11.5%. Selling, marketing and advertising expenses decreased by
$692,857. This was offset by increased general and administrative expenses of
$184,351 and depreciation and amortization expenses of $563,234 in 2001.
Selling, marketing and advertising expenses in 2001 were $1,487,828 (2.2%
of net sales) and in 2000 were $2,180,685 (3.6% of net sales). 2000 expenses
were restated for reclassification of CO-OP expenses against net sales per a new
FASB ruling. Selling, marketing and advertising expenses decreased by $692,857
primarily due to $403,525 less slotting fees in 2001, $273,576 less outside
commissions in 2001 (due to revised commission agreements), and $128,522 less
payroll expenses.
General and administrative expenses in 2001 were $6,461,112 (9.5% of net
sales) and in 2000 were $6,276,761 (10.3% of net sales). General and
administrative expenses increased $184,351 primarily due to $466,052 more bad
debt expense and $347,837 more legal expense in 2001 offset by $647,612 less
payroll expenses in 2001.
Depreciation and amortization expenses in 2001 were $2,231,899 (3.3% of net
sales) and in 2000 were $1,668,665 (2.7% of net sales). The increase was due to
twelve months of trademark amortization in 2001 versus nine months in 2000.
Other income (expenses) decreased from $4,963,286 (8.2% of net sales) expense in
2000 to $376,432 expense (0.6% of net sales) in 2001. This was primarily due to
forgiveness of amounts due from related party (Digital Research Technologies) of
$3,802,917 in 2000 and interest expense of $1,272,079 in 2000 versus $418,381 in
2001.
Income taxes benefit for 2000 is due to prior year loss carryforward.
Income taxes for 2001 are minimum state taxes.
Our loss in 2001 was due to four factors. First, we were affected by the
general economic slowdown in the first six months of the year. Second, we wrote
down nearly $4.0 million in inventory related to the 2000 acquisition of IOM
Holdings. Third, we incurred much higher than planned product promotions
expenses in Q3 and Q4 for the re-introduction of the Hi-Val and Digital Research
Technologies brands. Fourth, we experienced higher expenses due to the effects
of September 11, 2001. Our manufacturers reduced their production after
September 11, 2001 in anticipation of lower world-wide demand. However, demand
for our products did not decrease and therefore, due to product allocation, we
did not realize sales until 2002 for which we had backlog in 2001. In addition,
product allocation resulted in us using more expensive air freight to bring in
product from manufacturers.
LIQUIDITY AND CAPITAL RESOURCES
During 2002, we financed our operations and capital expenditures primarily
through cash provided by operating activities and securities issuances for
product. We believe that working capital generated from operations is
sufficient to meet current activity. However, should we grow significantly in
size through additional large customers or acquisitions, securities issuances or
other financing arrangements may be necessary. We currently have trade credit
17
facilities with our major suppliers. Borrowings under these arrangements provide
us with interest free trade credit.
For the year ended December 31, 2002 we had a net increase in cash relative
to December 31, 2001 in the amount of $2,896,520. This was due to cash provided
by operating activities of $3,260,209 offset by cash used in financing
activities of $302,092 and cash used in investing activities of $61,597. Cash
provided by operations was from a decrease in accounts receivable of $7,489,342,
non-cash entries of $4,470,808, an accrual for settlement payable of $4,000,000,
a decrease in prepaid expenses and other current assets of $2,263,469, a
decrease in inventory of $1,026,227 and a decrease in other assets of $14,288,
offset by a net loss of $8,347,231, a decrease in accounts payable and accrued
expenses of $4,690,892, and a decrease in accounts payable to related parties of
$2,965,802. Cash used for financing activities was primarily for payment on
repurchase of redeemable convertible preferred stock of $1,000,000 offset by net
borrowings on the line of credit of $750,586. Cash used for investing activities
was for leasehold improvements, furniture and computer equipment, offset by
proceeds from the disposal of property and equipment.
Effective January 1, 2002, we obtained a $9 million asset based line of
credit (with a sub-limit of $8 million) with ChinaTrust Bank (USA) which was to
expire December 31, 2003. ChinaTrust Bank (USA) renewed our prior $14 million
line of credit, but reduced the amount to $9 million due to our history of
losses the past three years. Within the sub-limit, up to $8,000,000 is
available for issuance of sight letters of credit, refinancing letters of
credit, local purchase financing against invoice(s), and working capital loans
with maturities up to 150 days. Letters of credit have maturities of up to 60
days. Each advance over a total outstanding line balance of $4,000,000 is
subject to the above maturity periods.
Within the line of credit, a sub-line of $1,000,000 is available for
uncollected funds. 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 (4.25% as of December
31, 2002), plus 0.75%, subject to a minimum interest rate of 5.5%. As of
December 31, 2002, the outstanding balance under the revolving line of credit
was $10,372,827. We are required to maintain a minimum, quarterly, combined
average, cash compensating balance of $750,000.
The line of credit provides for the maintenance of certain financial
covenants. As of December 31, 2002, we were in violation of certain
covenants. On April 11, 2003, we obtained a waiver from ChinaTrustBank (USA) as
to our violation of the covenants. The waiver has an effective date of April
15, 2003. The waiver also modified the original expiration date on the line of
credit from December 15, 2003 to October 15, 2003. Therefore all borrowings
under the line of credit are due and payable no later than October 15, 2003. We
are currently engaged in discussions with financial institutions regarding a
replacement line of credit.
We believe that our failure to either obtain a new bank line of credit or
increased trade credit facilities will require us to reduce our purchase of
products and thus our sales significantly; however, we believe that we can
continue operations at a greatly reduced sales volume. We believe if we are able
to either obtain a new line of credit or increased trade credit facilities, such
lines of credit and our current cash flow from operations will be sufficient to
meet our working capital and capital expenditure requirements at the current
sales volumes for the next 12 months.
In January 2003, we entered into a trade credit facility with Lung Hwa
Electronics Co., Ltd. ("Lung Hwa"), whereby Lung Hwa has agreed to purchase
inventory on our behalf. The agreement allows us to purchase up to $10,000,000,
with payment terms of 120 days following the date of invoice by the supplier.
Lung Hwa will charge us a 5% handling charge on the supplier's unit price. A 2%
discount to the handling fee will be applied if we reach an average running
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monthly purchasing volume of $750,000 a month. Returns made by us, which are
agreed to by the supplier, will result in a credit to us for the handling
charge. As security for the trade facility, we paid Lung Hwa a security deposit
of $1,500,000 in 2003. The agreement will remain in force continuously. Both
parties have the right to terminate the agreement one year following the
inception date by giving the other party 30 days' written notice. Otherwise, the
agreement will remain in force without effecting a new signed agreement. Both
parties have the right to terminate the agreement one year following the
inception date by giving the other party 30 days' written notice of termination.
In February 2003, we entered into an agreement with Behavior Tech Computer
(USA) Corp. ("BTC USA") whereby BTC USA will supply and store at our warehouse
up to $10,000,000 of inventory on a consignment basis. Under the agreement, we
will insure the consignment inventory, store the consignment inventory for no
charge, and furnish BTC USA with weekly statements indicating all products
received and sold and the current consignment inventory level. The agreement
may be terminated by either party upon 60 days' prior written notice.
In the event we continue with the revenue growth we have experienced between
2001 and 2002, we 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 through proceeds from offerings, to the extent
available, or to obtain additional financing to the extent necessary to augment
our working capital through public or private issuance of equity or debt
securities or increased trade credit facilities with vendors. In the event we
are unsuccessful in securing such financing, we may be required to curtail our
sales growth.
We have no firm long-term sales commitments from any of our customers and
enter into individual purchase orders with our customers. We have experienced
cancellations of orders and fluctuations in order levels from period to period
and expect we 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, our business, financial condition and
results of operations will depend upon our ability to obtain orders from new
customers, as well as the financial condition and success of our customers, our
customers products and the general economy.
Our backlog at December 31, 2002 was $12,471,083 as compared to a backlog
at December 31, 2001 of $11,404,292. Based upon the history of the past twelve
months, the December 31, 2002 backlog may be reduced by $1,870,000 (15%) when
recognized as sales, due to returns and price protections.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections." SFAS No. 145 updates,
clarifies, and simplifies existing accounting pronouncements. This statement
rescinds SFAS No. 4, which required all gains and losses from extinguishment of
debt to be aggregated and, if material, classified as an extraordinary item, net
of related income tax effect. As a result, the criteria in Accounting Principles
Board No. 30 will now be used to classify those gains and losses. SFAS No. 64
amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been rescinded.
SFAS No. 44 has been rescinded as it is no longer necessary. SFAS No. 145 amends
SFAS No. 13 to require that certain lease modifications that have economic
effects similar to sale-leaseback transactions be accounted for in the same
manner as sale-lease transactions. This statement also makes technical
corrections to existing pronouncements. While those corrections are not
19
substantive in nature, in some instances, they may change accounting practice.
We do not expect adoption of SFAS No. 145 to have a material impact, if any, on
our financial position or results of operations.
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 EITF 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. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. We do not expect adoption of SFAS No.
146 to have a material impact, if any, on our financial position or results of
operations.
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
I/OMagic Corporation.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," an amendment of SFAS No. 123. SFAS
No. 148 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require more prominent and more frequent disclosures in financial statements
about the effects of stock-based compensation. This statement is effective for
financial statements for fiscal years ending after December 15, 2002. SFAS No.
148 will not have any impact on our financial statements because we do not have
any intention to change to the fair value method.
RISK FACTORS
An investment in our common stock involves a high degree of risk. In
addition to the other information in this report, you should carefully consider
the following risk factors before deciding to invest or maintain an investment
in shares of our common stock. If any of the following risks actually occurs, it
is likely that our business, financial condition and operating results would be
harmed. As a result, the trading price of our common stock could decline, and
you could lose part or all of your investment.
WE HAVE INCURRED SIGNIFICANT LOSSES AND MAY CONTINUE TO INCUR LOSSES. IF WE
CONTINUE TO INCUR LOSSES, WE MAY HAVE TO CURTAIL OUR OPERATIONS.
We have not been profitable the last three years and may not be profitable
in the foreseeable future. Historically, we have relied upon cash from
operations and financing activities to fund all of the cash requirements of our
business and have incurred significant losses. As of December 31, 2002, we had
an accumulated deficit of $14,793,468. During 2002, 2001, and 2000, we incurred
net losses in the amount of $8,347,231, $5,547,645, and $6,410,849,
respectively. We cannot predict when we will become profitable or if we ever
will become profitable, and we may continue to incur losses for an indeterminate
period of time and may never achieve or sustain profitability. An extended
20
period of losses may result in negative cash flow and may prevent us from
operating or expanding our business. We cannot assure you that our business
will ever become profitable or that we will ever generate sufficient revenues to
meet our expenses and support our operations. Even if we are able to achieve
profitability, we may be unable to sustain or increase our profitability on a
quarterly or annual basis.
OUR CURRENT BANK LINE OF CREDIT WILL EXPIRE ON OCTOBER 15, 2003. IF WE ARE
UNABLE TO OBTAIN ANOTHER BANK LINE OF CREDIT, OUR ABILITY TO PURCHASE ADDITIONAL
INVENTORY MAY BE ADVERSELY AFFECTED, WHICH WOULD ADVERSELY AFFECT OUR SALES AND
NET INCOME.
We are in violation of certain financial covenants in our agreement for our
banking line of credit due to the loss incurred in 2002. ChinaTrust Bank USA
has the ability to call our line of credit immediately, which could result in
impairment of the purchase of inventory. However, the bank has provided us a
waiver for violation of such financial covenants and has provided us with six
months to either find another banking facility or to pay off the outstanding
balance. We are currently in discussions with financial institutions for a new
line of credit. If we are unable to obtain a new line of credit then our
ability to expand or sustain our current sales volume will be adversely
affected.
FIERCE COMPETITION IN THE COMPUTER PERIPHERAL AND CONSUMER ELECTRONICS
MARKETPLACE MAY CAUSE A DECLINE IN OUR REVENUES AND FORCE US TO REDUCE PRICES
FOR OUR PRODUCTS.
The market for our products is highly competitive. Our competitors for our
hardware products include Hewlett-Packard, Iomega, Memorex, Phillips, Samsung,
Sony, TDK and Yamaha. Our competitors for our media products include Fuji,
Imation, Maxell, Memorex, PNY, TDK and Verbatim. We also indirectly compete
against original equipment manufacturers such as Dell Computer and
Hewlett-Packard to the extent that they manufacture their own computer
peripheral products or incorporate on personal computer motherboards the
functionalities provided by our products. We believe that the strategy of
certain of our current and potential competitors is to compete largely on the
basis of price, which may result in lower prices and lower margins for our
products or otherwise adversely affect the market for our products. There can be
no assurance that we will be able to continue to compete successfully in the
marketplace.
MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN US. IN ORDER TO COMPETE
SUCCESSFULLY, WE MUST KEEP PACE WITH OUR COMPETITORS IN ANTICIPATING AND
RESPONDING TO RAPID CHANGES IN THE COMPUTER PERIPHERAL AND CONSUMER ELECTRONICS
INDUSTRIES.
Our future success will depend upon our ability to enhance our current
products and services and to develop and introduce new products and services
that keep pace with technological developments, respond to the growth in the
computer peripheral and consumer electronics markets in which we compete,
encompass evolving consumer requirements, provide a broad range of products and
achieve market acceptance of our products. Many of our existing and potential
competitors have larger technical staffs, more established and larger marketing
and sales organizations and significantly greater financial resources than we
do. Our lack of resources relative to our competitors may cause us to fail to
anticipate or respond adequately to technological developments and consumer
requirements or may cause us to experience significant delays in developing or
introducing new products and services. These failures or delays could reduce our
competitiveness, revenues, profit margins and market share.
OUR CONCENTRATION OF SALES TO FOUR MAJOR CUSTOMERS MAY ADVERSELY AFFECT OUR
BUSINESS IF ANY ONE OR MORE OF THEM DECIDES TO DISCONTINUE PURCHASING OUR
PRODUCTS.
During 2002, net sales to our four largest customers represented 27%, 26%,
15%, and 14%, respectively, of total net sales. Our sales and our profitability
21
would be adversely affected if any one or more of these customers ceased
purchasing from us. We would have no guarantee that we would be able to replace
the loss of such sales with existing or new customers or in a timely manner to
avoid an adverse financial impact to our business.
OUR LACK OF LONG-TERM PURCHASE ORDERS OR COMMITMENTS MAY ADVERSELY AFFECT OUR
BUSINESS IF DEMAND DECLINES.
During the year ended December 31, 2002, the sale of our computer
peripheral products accounted for 95.3% of our total net sales, and the sale of
our consumer electronics products accounted for 4.7% of our total net sales. In
many cases we have long-term contracts with our computer peripheral and consumer
electronics retailers that cover the general terms and conditions of our
relationships with them but that do not include long-term purchase orders or
commitments. Rather, our retailers issue purchase orders requesting the
quantities of computer peripheral or consumer electronics products that they
desire to purchase from us, and if we are able and willing to fill those orders,
then we fill them under the terms of the contracts. Accordingly, we cannot rely
on long-term purchase orders or commitments to protect us from the negative
financial effects of a decline in demand for our products that could result from
a general economic downturn, from changes in the computer peripheral and
consumer electronics marketplaces, including the entry of new competitors into
the market, from the introduction by others of new or improved technology, from
an unanticipated shift in the needs of our retailers, or from other causes.
OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO OBTAIN OUR PRODUCTS FROM OUR
SUPPLIERS.
Most of our products are available from multiple sources. However, we
currently obtain most of our products from single or limited sources. We have,
from time to time, experienced difficulty in obtaining some products. We do not
have guaranteed supply arrangements with any of our suppliers, and there can be
no assurance that our suppliers will continue to meet our requirements. If our
existing suppliers are unable to meet our requirements, we could be required to
find other suppliers or even eliminate products from our product line.
Product shortages could limit our sales capacity and also could result in lower
margins due to higher product costs resulting from limited supply or the need to
obtain substitute products which are available only at higher costs. Significant
increases in the prices of our products could adversely affect our results of
operations because our products compete on price and, therefore, we may not be
able to pass along price increases to our retailers. Also, an extended
interruption in the supply of products or a reduction in their quality or
reliability would adversely affect our financial condition and results of
operations by impairing our ability to timely deliver quality products to our
retailers. Delayed product deliveries due to product shortages or other factors
may result in cancellation by our retailers of all or part of their orders. We
cannot assure you that cancellations will not occur.
OUR DEPENDENCE ON SALES OF OUR OPTICAL STORAGE AND OPTICAL MEDIA PRODUCTS COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS IF THE MARKET FOR THOSE PRODUCTS
DECLINES.
Net sales of our optical storage and related media products accounted for
approximately 85.0% of our net sales for 2002. Although we have introduced
products in other segments of the computer peripheral market and in the consumer
electronics market, optical storage and optical media products are expected to
continue to account for a majority of our sales for at least the next year. A
decline in the 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, technological changes, incorporation of the
products' functionality onto personal computer motherboards or otherwise, would
have a material adverse effect on our sales and operating results.
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IF WE FAIL TO KEEP PACE WITH THE RAPID TECHNOLOGICAL CHANGES THAT CHARACTERIZE
THE MARKETPLACE FOR OUR PRODUCTS, WE WILL LIKELY EXPERIENCE A SIGNIFICANT
DECLINE IN OUR COMPETITIVE ADVANTAGE RESULTING IN A MATERIALLY NEGATIVE IMPACT
ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The markets for our products are characterized by rapidly changing
technology, evolving industry standards, frequent new product introductions and
rapid product obsolescence. Product life cycles in the markets for our products
often range from as few as three up to twelve months. We believe that our
success will be substantially dependent upon our ability to continue to develop
and introduce competitive products and technologies on a timely basis with
features and functions that meet changing consumer requirements in a
cost-effective manner. Even if we are successful in the development and market
introduction of new products, we still must correctly forecast consumer demand
for those products to avoid either excessive unsold inventory or excessive
unfilled orders related to our products. The task of forecasting consumer demand
is extremely difficult for new products for which there is little or no sales
history, and for indirect channels, where our customers are not the final
end-users. Moreover, whenever we offer new products, we also must successfully
manage the resulting obsolescence and price erosion of our older products, as
well as any resulting price protection charges and inventory returns from our
retailers. Accordingly, if we are unable to keep pace with the rapid
technological changes within the marketplace for our products, or unable to
manage effectively the introduction of new products, our business, financial
condition and results of operations will be negatively impacted.
OUR FAILURE TO FORECAST SALES IN THE VOLATILE COMPUTER PERIPHERAL AND CONSUMER
ELECTRONICS MARKETPLACES COULD RESULT IN LOST REVENUES AND SIGNIFICANT LOSSES.
We develop and market products in the highly competitive computer
peripheral and consumer electronics marketplaces. Our products are very
susceptible to 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 can materially affect sales volumes. In addition,
new product releases by competitors and accompanying price adjustments to
competing products can materially and adversely affect our revenues and gross
margins.
We sell our products to retailers such as mass merchandisers and large
electronics chains which sell products primarily off-the-shelf directly to end
users. Our reliance on indirect channels of distribution typically results in
little or no ability to predict end user demand. We rely upon sales forecasts
provided by our retailers in order to comply with order placement demands by
these retailers. If these forecasts are inaccurate, we could either have excess
inventory, resulting in significant finance costs and product obsolescence, or
insufficient inventory, resulting in lost revenues due to our inability to
promptly meet consumer demand. Accordingly, our future operating results are
largely dependent on our ability to accurately predict the demand for our
products. Our failure to accurately predict the demand for our products could
result in significant losses from inventory obsolescence and finance charges or
substantial lost revenues.
WE RELY HEAVILY ON OUR MANAGEMENT, AND THE LOSS OF THEIR SERVICES COULD
ADVERSELY AFFECT OUR BUSINESS.
Our success is highly dependent upon the continued services of key members
of our management, including our Chairman of the Board, President, Chief
Executive Officer and Secretary, Tony Shahbaz. Mr. Shahbaz has developed
personal contacts and other skills that we rely upon in connection with our
financing, acquisition and general business strategies. Mr. Shahbaz has also
23
developed key personal relationships with our vendors and frequently is
extensively involved in our sales and promotional efforts with our key
customers. Although we have entered into an employment agreement with Mr.
Shahbaz, that agreement is of limited duration and is subject to early
termination by Mr. Shahbaz under some circumstances. Consequently, the loss of
Mr. Shahbaz or one or more other key members of management could adversely
affect our business.
OUR FAILURE TO MANAGE GROWTH EFFECTIVELY COULD IMPAIR OUR BUSINESS.
Our expansion into new product categories in the computer peripheral and
consumer electronics marketplaces has required and will continue to require
significant investment and management attention to improve our information
systems, product data management, control accounting, telecommunications and
networking systems, coordination of suppliers and distribution channels, and
general business processes and procedures. We are continuing to expand our
product base in the consumer electronics marketplace and expect significant
challenges in coordinating supply and distribution processes in what we hope
will be a rapidly growing product category.
Our strategy envisions a period of rapid growth that may impose a
significant burden on our administrative and operational resources. Our ability
to effectively manage growth will require us to substantially expand the
capabilities of our administrative and operational resources and to attract,
train, manage and retain qualified marketing, technical support, customer
service, sales and other personnel. There can be no assurance that we will be
able to do so. If we are unable to successfully manage our growth, our business,
prospects, results of operations and financial condition could be materially and
adversely affected.
THE EMERGENCE OF NEW SALES CHANNELS AND THE ACCEPTANCE OF EXISTING ALTERNATIVE
SALES CHANNELS MAY RESULT IN FEWER SALES OF OUR PRODUCTS DUE TO OUR INABILITY TO
ADAPT TO THESE SALES CHANNELS.
We are accustomed to conducting business through traditional distribution
and retail sales channels. Traditional computer peripheral and consumer
electronics distribution and retail channels have suffered from the emergence of
alternative sales channels, such as direct mail order, telephone sales by
personal computer manufacturers and Internet commerce. The emergence of
additional alternative sales channels or increased acceptance of existing
alternative sales channels by retailers or consumers may cause a rapid decline
in the sales of our products unless we are able to capitalize on those new or
more widely accepted sales channels. In addition, new products or changes in the
types of products we sell, such as our digital entertainment products, may
require specialized value-added reseller channels, which we have not yet fully
established. We may be unable to effectively compete in a marketplace that
supports numerous alternative sales channels because we do not have experience
in sales channels other than traditional distribution and retail sales channels.
As a result, in a marketplace in which alternative sales channels continue to
emerge, we may suffer from a competitive disadvantage which may have a material
and adverse effect on our business.
POLITICAL AND ECONOMIC INSTABILITY IN EAST ASIA COULD HAVE AN ADVERSE IMPACT ON
THE SUPPLY OF OUR PRODUCTS WHICH COULD MATERIALLY AND ADVERSELY AFFECT OUR
BUSINESS.
We order nearly all of our 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 East Asia, the economic ramifications to our suppliers could be devastating.
As a result, our ability to conduct operations might be materially and adversely
affected. In addition, our suppliers acquire components and raw materials for
the manufacturing of our products from a number of countries, many of which do
not conduct business in United States dollars. Any severe fluctuation in the
value of foreign currencies could materially increase our costs to purchase
24
products. Accordingly, as a result of political or economic instability in East
Asia, our operations could be materially and adversely affected.
THE MIGRATION OF OUR PRODUCTS' FUNCTIONALITIES TO PERSONAL COMPUTER MOTHERBOARDS
COULD MAKE SOME OF OUR COMPUTER PERIPHERAL PRODUCTS OBSOLETE WHICH COULD
ADVERSELY AFFECT OUR BUSINESS.
Many of our products are individual computer peripheral products that
operate in conjunction with personal computers to provide additional
functionalities. Historically, as new functionalities become technologically
stable and widely accepted by personal computer users, the cost of providing
such functionalities declines dramatically by means of large-scale integration
into semiconductor chips, which can be incorporated into personal computer
motherboards. If the migration of the functionalities of our products into
personal computer motherboards occurs, demand for our products will likely
decline significantly. There can be no assurance that the incorporation of new
functionalities into personal computer motherboards will not adversely affect
the market for our products.
IF OUR PRODUCTS FAIL TO COMPLY WITH EVOLVING GOVERNMENT AND INDUSTRY STANDARDS
AND REGULATIONS, WE MAY HAVE DIFFICULTY SELLING OUR PRODUCTS.
Our products are designed to comply with a significant number of industry
standards and regulations, some of which are evolving as new technologies are
deployed. In the United States, our products must comply with various
regulations defined by the United States Federal Communications Commission, or
FCC, Underwriters Laboratories and the Food and Drug Administration as well as
numerous industry standards. The failure of our products to comply, or delays in
compliance, with the various existing and evolving regulations or standards
could negatively impact our ability to sell our products.
BECAUSE WE BELIEVE THAT PROPRIETARY RIGHTS ARE MATERIAL TO OUR SUCCESS,
MISAPPROPRIATION OF THESE RIGHTS COULD ADVERSELY IMPACT OUR FINANCIAL CONDITION.
We are not the licensee or owner of any of the intellectual property
contained in our products other than our I/OMagic, Hi-Val and Digital Research
Technologies brand names, all of which we own. As a result, we do not have a
proprietary interest in any of the software, hardware or related technology
incorporated in our products. We rely primarily on trademark protection for our
I/OMagic, Hi-Val and Digital Research Technologies brand names. There can be no
assurance that our means of protecting our proprietary rights in these brand
names will deter or prevent their unauthorized use. Our financial condition
would be adversely affected if we were to lose our competitive position due to
our inability to adequately protect our proprietary rights in our brand names.
We own, license or have otherwise obtained the right to use certain
technologies incorporated in our products. We may receive infringement claims
from third parties relating to our products and technologies. In those cases, we
intend to investigate the validity of the claims and, if we believe the claims
have merit, to respond through licensing or other appropriate actions. To the
extent claims relate to technology included in components purchased from
third-party vendors for incorporation into our products, we would forward those
claims to the appropriate vendor. If we or our component manufacturers are
unable to license or otherwise provide any necessary technology on a
cost-effective basis, we could be prohibited from marketing products containing
that technology, incur substantial costs in redesigning products incorporating
that technology, or incur substantial costs defending any legal action taken
against us.
25
OUR STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR
INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND IN LITIGATION AGAINST US.
The market prices of securities of technology-based companies have
historically been highly volatile. The market price of our common stock has
fluctuated significantly in the past. In fact, during 2002, the high and low
closing sale prices of a share of our common stock were $16.50 and $3.75
(adjusted for our December 20, 2002 one-for-fifteen reverse stock split),
respectively. The market price of our common stock may continue to fluctuate in
response to the following factors, many of which are beyond our control:
- changes in market valuations of similar companies and stock market price
and volume fluctuations generally;
- economic conditions specific to the computer peripheral and consumer
electronics industries;
- announcements by us or our competitors of new or enhanced products,
technologies or services or significant contracts, acquisitions,
strategic relationships, joint ventures or capital commitments;
- regulatory developments;
- fluctuations in our quarterly or annual operating results;
- additions or departures of key personnel; and
- future sales of our common stock or other securities.
The price at which you purchase shares of common stock may not be
indicative of the price of our stock that will prevail in the trading market.
You may be unable to sell your shares of common stock at or above your purchase
price, which may result in substantial losses to you. Moreover, in the past,
securities class action litigation has often been brought against a company
following periods of volatility in the market price of its securities. We may in
the future be the target of similar litigation. Securities litigation could
result in substantial costs and divert management's attention and resources.
BECAUSE WE ARE SUBJECT TO THE "PENNY STOCK" RULES, THE LEVEL OF TRADING ACTIVITY
IN OUR STOCK MAY BE REDUCED.
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 our common stock, generally are equity
securities with a price of less than $5.00 (other than securities registered on
some national securities exchanges or quoted 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 also must provide the customer with
current bid and offer quotations for the penny stock, the compensation of the
broker-dealer and its salesperson 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 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 our common stock may find it difficult to sell
their shares.
26
BECAUSE OUR STOCK IS NOT LISTED ON A NATIONAL SECURITIES EXCHANGE, YOU MAY FIND
IT DIFFICULT TO DISPOSE OF OR OBTAIN QUOTATIONS FOR OUR COMMON STOCK.
Our common stock trades under the symbol "IOMG" on the OTC Bulletin Board.
Because our stock trades on the OTC Bulletin Board rather than on a national
securities exchange, you may find it difficult to either dispose of, or to
obtain quotations as to the price of, our common stock.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our operations were not subject to commodity price risk during 2002. Our
sales to a foreign country (Canada) were less than 1% of our total sales, and
thus we experienced negligible foreign currency exchange rate risk.
We currently have a line of credit with ChinaTrust Bank in an amount of up to $9
million with a sub-limit of $8 million. The line of credit provides for an
interest rate equal to the prime lending rate plus three-quarters of one
percent, subject to a minimum interest rate of 5.50%. This interest rate is
adjustable upon each movement in the prime lending rate. If the prime lending
rate increases, our interest rate expense will increase on an annualized basis
by the amount of the increase multiplied by the principal amount outstanding
under the ChinaTrust Bank (USA) line of credit.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements included in this report,
which begin at Page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions held by our directors and executive officers
as of April 8, 2003 and their business experience are as follows:
NAME AGE TITLES
- ---- --- ------
Tony Shahbaz(1) 40 Chairman of the Board, President, Chief Executive
Officer, Secretary and Director
Steve Gillings 53 Chief Financial Officer
Anthony Andrews 40 Vice President of Engineering and Product Design
and Director
Steel Su(1) 50 Director
Daniel Hou 53 Director
Young-Hyun Shin 49 Director
Daniel Yao 46 Director
- -------
(1) Member of the compensation committee.
27
TONY SHAHBAZ is a founder of I/OMagic Corporation and has served as our
Chairman of the Board, President, Chief Executive Officer, Secretary and as a
director since September 1993, and as our Chief Financial Officer from September
1993 to October 2002. Prior to founding I/OMagic Corporation, Mr. Shahbaz was
employed by Western Digital Corporation from September 1986 to March 1993.
During his tenure at Western Digital Corporation, Mr. Shahbaz held several
positions including Vice President of Worldwide Sales for Western Digital
Paradise, and Regional Director of Asia Pacific Sales and Marketing Operations.
From 1985 to 1986, Mr. Shahbaz held management positions with Lapin Technology
and from 1979 to 1984, Mr. Shahbaz held management positions with Tandon
Corporation.
STEVE GILLINGS has served as our Chief Financial Officer since October
2002. Prior to that, Mr. Gillings served as our Vice President of Finance from
October 2000 to October 2002 and as our Controller from November 1997 to October
2000. Mr. Gillings earned a B.S. degree in Accounting from the University of
California at Berkeley in 1971 and a Masters degree in Finance from California
State University Fullerton in 1992.
ANTHONY ANDREWS has served as our Vice President of Engineering and Product
Design since he joined I/OMagic Corporation in March 1994 and has served as a
director since October 1995. From 1988 to 1994, Mr. Andrews was a principal
engineer at Western Digital Corporation, where he was involved in product and
software design and played a key role in the development of portable notebook
power management designs that are used by companies such as IBM and AST. Prior
to that, Mr. Andrews was a staff engineer with Rockwell International from 1985
to 1988. Mr. Andrews earned a B.S. degree in Math and Computer Science from the
University of California at Los Angeles in 1985.
STEEL SU has served as a director of I/OMagic Corporation since September
2000 and is a founder of Behavior Tech Corporation and has served as its
Chairman since 1980. Mr. Su has served and continues to serve as a director or
Chairman of the following affiliates of Behavior Tech Corporation: Behavior
Design Corporation (chairman), Behavior Tech Computer (USA) Corp. (chairman),
Behavior Tech Computer Affiliates, N.V. (chairman) and BTC Korea Co., Ltd.
(director). Mr. Su has served as chairman of Gennet Technology Corp., Emprex
Technologies Corp., MaxD Technology Inc. and Maritek Inc. since 1992, 1998, 2000
and 1999, respectively. Mr. Su has also served as a director of Aurora Systems
Corp. and Wearnes Peripherals International (PTE) Limited since 1998 and 2000,
respectively. Mr. Su earned a B.S. degree in Electronic Engineering from Ching
Yuan Christian University in 1974 and an M.B.A. from National Taiwan University
in 2001.
DANIEL HOU has served as a director of I/OMagic Corporation since January
1998. Since 1986, Mr. Hou has served as the President of Hou Electronics, Inc.,
a computer peripheral supplier that he founded. Mr. Hou is a prior President of
the Southern California Chinese Computer Association and is an active member of
the American Chemistry Society. Mr. Hou earned a B.A. degree in Chemistry from
National Chung-Hsing University, Taiwan in 1973 and a Masters degree in Material
Science from the University of Utah in 1978.
YOUNG-HYUN SHIN has served as a director of I/OMagic Corporation since
September 2000 and the Representative Director of BTC Korea Co., Ltd. since
March 1988. Mr. Shin earned a B.S. degree in electronics from Yonsei University
in 1979.
DANIEL YAO has served as a director of I/OMagic Corporation since
February 2001 and has been a Chief Strategy Officer for Ritek Corporation since
July 2000. Prior to joining Ritek, Mr. Yao served as the Senior Investment
Consultant for Core Pacific Securities Capital from July 1998 to July 2000.
Prior to that, Mr. Yao was an Executive Vice President for ABN Amro Bank in
Taiwan from July 1996 to July 1998. Mr. Yao earned a B.A. degree in Business
Management from National Taiwan University in 1978 and a M.B.A. degree from the
University of Rochester in New York.
28
COMPLIANCE WITH BENEFICIAL OWNERSHIP REPORTING RULES
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our executive officers, directors and persons who beneficially own more than 10%
of a registered class of our equity securities to file initial reports of
ownership and reports of changes in ownership with the Securities and Exchange
Commission. These officers, directors and stockholders are required by the
Securities and Exchange Commission regulations to furnish us with copies of all
reports that they file.
Based solely upon a review of copies of the reports furnished to us during
2002 and thereafter, or any written representations received by us from
directors, officers and beneficial owners of more than 10% of our common stock
("reporting persons") that no other reports were required, we believe that all
Section 16(a) filing requirements applicable to our reporting persons were met.
Each of our directors is in the process of reviewing all filings made prior
to January 1, 2002, pursuant to Section 16(a) in an effort to determine whether
any additional and/or amended filings are required to be made.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS
The following table provides information concerning the annual and
long-term compensation for the years ended December 31, 2002, 2001 and 2000
earned for services in all capacities as an employee by our Chief Executive
Officer and each of our other executive officers who received an annual salary
and bonus of more than $100,000 for services rendered to us during 2002
(collectively, the "named executive officers"):
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
NAME AND PRINCIPAL POSITION ANNUAL COMPENSATION AWARD
- --------------------------- ------------------- ----------------------
SECURITIES
YEAR SALARY BONUS UNDERLYING OTHER
OPTIONS COMPENSATION
------- ------- --------- --------- ------------
2002 $202,259 $89,067 - --
Tony Shahbaz 2001 $140,004 - - $40,853(1)
Chairman, President,
Chief Executive Officer
and Secretary 2000 $140,004 - 74,000(3) $21,231(1)
_______________
(1) Consists of salary earned by Mr. Shahbaz as an employee of IOM Holdings,
Inc., a subsidiary of I/OMagic Corporation.
(2) Includes 667 shares of common stock underlying options granted to Mr.
Shahbaz's wife, Fedra Shahbaz. The options granted to Mr. Shahbaz and Fedra
Shahbaz were immediately exercisable upon the date of grant.
OPTION GRANTS IN LAST FISCAL YEAR
We did not grant any options or stock appreciation rights to Mr. Shahbaz
during 2002.
29
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table provides information regarding the value of unexercised
options held by Mr. Shahbaz as of December 31, 2002. Mr. Shahbaz did not
acquire shares through the exercise of any options during the year ended
December 31, 2002.
NUMBER OF
SECURITIES UNDERLYING VALUE ($) OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 2002 DECEMBER 31, 2002(3)
---------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------- ----------- ------------- ----------- -------------
Tony Shahbaz 64,888 (1) 29,113 (2) $0 $0
______________
(1) Includes 444 shares of common stock underlying options held by Mr.
Shahbaz's wife, Fedra Shahbaz.
(2) Includes 223 shares of common stock underlying options held by Mr.
Shahbaz's wife, Fedra Shahbaz.
(3) Based upon the last reported sale price of our common stock of $8.50 per
share on December 31, 2002 (the last trading day during 2002) as reported on the
OTC Bulletin Board, less the exercise price of the options.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
On October 15, 2002, we entered into an employment agreement with Tony
Shahbaz for Mr. Shahbaz to serve as our President and Chief Executive Officer.
Under the terms of the employment agreement, which are effective as of January
1, 2002, Mr. Shahbaz is entitled to receive an initial annual salary of $198,500
and is eligible to receive quarterly bonuses equal to 7% of our quarterly net
income. Mr. Shahbaz is also entitled to a monthly car allowance equal to $1,200.
The employment agreement terminates on October 15, 2007; however, it is subject
to renewal. Under the terms of the employment agreement, if Mr. Shahbaz is
terminated for cause, Mr. Shahbaz is entitled to receive four times his annual
salary and any and all warrants and options granted to him shall be extended an
additional seven years from date of termination. Pursuant to the employment
agreement, upon termination without cause, Mr. Shahbaz shall be paid his
remaining salary amount for the remaining outstanding term of the agreement.
Mr. Shahbaz's employment agreement further provides that the agreement shall not
be terminated without the prior written consent of Mr. Shahbaz in the event of a
merger, transfer of assets, or dissolution of the I/OMagic Corporation, and that
the rights, benefits, and obligations under the agreement shall be assigned to
the surviving or resulting corporation or the transferee of I/OMagic
Corporation's assets.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No member of the board of directors has a relationship that would
constitute an interlocking relationship with executive officers and directors of
another entity. During 2002, Mr. Shahbaz made salary recommendations to our
compensation committee regarding salary increases for key executives.
COMPENSATION OF DIRECTORS
Our directors do not receive any compensation for their services, however
each director is entitled to reimbursement of his reasonable expenses incurred
in attending board of directors' meetings.
30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
As of April 8, 2003, a total of 4,529,670 shares of our common stock were
outstanding. The following table sets forth information as of that date
regarding the beneficial ownership of our common stock by:
- each person known by us to own beneficially more than five percent, in
the aggregate, of the outstanding shares of our common stock as of the
date of the table;
- each of our directors;
- the named executive officers in the Summary Compensation Table
contained elsewhere in this report; and
- all of our directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Except as indicated in the footnotes to the
table, we believe each security holder possesses sole voting and investment
power with respect to all of the shares of common stock owned by such security
holder, subject to community property laws where applicable. In computing the
number of shares beneficially owned by a security holder and the percentage
ownership of that security holder, shares of common stock subject to options,
warrants or preferred stock held by that person that are currently exercisable
or convertible or are exercisable or convertible into shares of common stock
within 60 days after the date of the table are deemed outstanding. Those shares,
however, are not deemed outstanding for the purpose of computing the percentage
ownership of any other person or group.
AMOUNT AND NATURE
NAME AND ADDRESS OF BENEFICIAL PERCENT
OF BENEFICIAL OWNER(1) TITLE OF CLASS OWNERSHIP OF CLASS OF CLASS
- ------------------------------------------ ----------------- ------------------- ---------
Tony Shahbaz. Common 2,450,013 (2) 54.1%
Steel Su Common 635,121 (3) 14.0%
Young-Hyun Shin Common 375,529 (4) 8.3%
Daniel Yao Common 340,818 (5) 7.5%
Daniel Hou Common 135,047 (6) 3.0%
Anthony Andrews Common 13,179 (7) *
Steve Gillings Common 4,666 (8) *
All executive officers and directors as a
group (7 persons) Common 3,954,373 (9) 87.3%
_______________
* Less than 1.00%
(1) Unless otherwise indicated, the address of each person in this table is
c/o I/OMagic Corporation, 1300 Wakeham Avenue, Santa Ana, California 92705.
Messrs. Shahbaz, Gillings, and Andrews are executive officers of I/OMagic
Corporation. Messrs. Shahbaz, Andrews, Su, Shin and Yao are directors.
(2) Consists of: (i) 541,334 shares of common stock and 50,222 shares of
common stock- underlying options held individually by Mr. Shahbaz; (ii) 493
shares of common stock underlying options held individually by Mr. Shahbaz's
wife, Fedra Shahbaz; (iii) 1,223,757 shares of common stock held by Susha, LLC,
a California limited liability company ("Susha California"); (iv) 550,001 shares
of common stock held by Susha, LLC, a Nevada limited liability company ("Susha
Nevada"); and (v) 84,206 shares of common stock held by King Eagle Enterprises,
Inc., a California corporation. Mr. Shahbaz has sole voting and sole investment
power over the shares held by Susha California, Susha Nevada and King Eagle
Enterprises, Inc.
(3) Consists of 457,334 shares of common stock and 11,120 shares of common
stock underlying options held individually by Mr. Su, and 166,667 shares of
common stock held by Behavior Tech Computer Corp. ("BTC"). Mr. Su is the Chief
31
Executive Officer of BTC and has sole voting and sole investment power over the
shares held by BTC.
(4) Represents 375,529 shares of common stock held by BTC Korea Co., Ltd.
("BTC Korea"). Mr. Shin has sole voting and sole investment power over the
shares held by BTC Korea. The address for Mr. Shin is c/o BTC Korea Co., Ltd.,
160-5, Kajwa-Dong Seo-Ku, Incheon City, Korea.
(5) Represents 340,818 shares of common stock held by Citrine Group Limited,
a wholly owned subsidiary of Ritek Corporation ("Citrine"). Mr. Yao currently
serves as the Chief Strategy Officer of Ritek Corporation. Mr. Yao has sole
voting and sole investment power over the shares held by Citrine Group Limited.
The address for Mr. Yao is c/o Citrine Group Limited, No. 42, Kuanfu N. Road,
30316 R.O.C., HsinChu Industrial Park, Taiwan.
(6) Consists of 1,711 shares of common stock underlying options held
individually by Mr. Hou, and 133,336 shares of common stock held by Hou
Electronics. Mr. Hou has sole voting and sole investment power over the shares
held by Hou Electronics.
(7) Consists of 2,491 shares of common stock and 8,000 shares of common
stock underlying options held individually by Mr. Andrews, and 2,688 shares of
common stock underlying options held individually by Mr. Andrews' wife, Nancy
Andrews.
(8) Consists of 4,666 shares of commons stock underlying options held
individually by Mr. Gillings.
(9) Includes 78,900 shares of common stock underlying options.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information about our common stock that may be
issued upon the exercise of options, warrants, and rights under all of our
existing equity compensation plans as of December 31, 2002.
Number of securities
remaining available
for future issuance
Number of securities to be Weighted-average under equity
issued upon exercise of exercise price of compensation plans
outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
EQUITY COMPENSATION PLANS
APPROVED BY SECURITY HOLDERS. 146,167 $ 29.90 247,298
EQUITY COMPENSATION PLANS NOT
APPROVED BY SECURITY HOLDERS
None. . . . . . . . . . . . . 0 $ 0.00 0
TOTAL . . . . . . . . . . . . 146,167 $ 29.90 247,298
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Citrine, BTC Taiwan, and Behavior Tech Computer (USA) Corp. ("BTC USA"), an
affiliate of BTC Taiwan, in the aggregate, manufacture a significant amount of
the Company's optical storage and related media products. Each of Citrine, BTC
Taiwan, and BTC USA provides us with favorable payment terms in connection with
our purchases of inventory from each of these manufacturers. Citrine has agreed
to allow us to purchase up to $3,000,000 of inventory upon net 60 day terms. BTC
Taiwan and BTC USA, in the aggregate, have agreed to allow us to purchase up to
$5,000,000 of inventory upon net 75 day terms (superceded by a subsequent
agreement in February 2003, described below). In addition, Hou Electronics, one
of our shareholders, has agreed to allow us to purchase up to $2,000,000 of
inventory upon net 75 day terms. As of December 31, 2002, we owed $2,397,800 to
BTC Taiwan. In addition, we purchase some of our consumer electronics products
from BTC Korea. At December 31, 2002, we owed $209,478 to BTC Korea.
In January 2003, we entered into a trade credit facility with one of our
shareholders and manufacturers, Lung Hwa Electronics, whereby they have agreed
to purchase inventory on behalf of us. The agreement allows us to purchase up to
$10,000,000, with payment terms of 120 days following the date of invoice by the
supplier. Lung Hwa Electronics will charge us a 5% handling charge on the
supplier's unit price. A 2% discount to the handling fee will be applied if we
reach an average running monthly purchasing volume of $750,000 a month. Returns
made by us, which are agreed by the supplier, will result in a credit to us for
the handling charge. As security for the trade facility, we paid Lung Hwa
Electronics a security deposit of $1,500,000, in 2003. The agreement will remain
in force continuously. Both parties have the right to terminate the agreement
one year following the inception date by giving the other party 30 days' written
notice of termination.
32
In February 2003, we entered into an agreement with one of our
shareholders, BTC USA, whereby they will supply and store at our warehouse up to
$10,000,000 of inventory on a consignment basis. Under the agreement, we will
insure the consignment inventory, store the consignment inventory for no charge,
and furnish BTC USA with weekly statements, indicating all products received and
sold and the current consignment inventory level. The agreement may be
terminated by either party with 60 days' written notice.
In 2002, we leased our Santa Ana facility from Alex Properties, which was
then owned by Mr. Tony Shahbaz, our President, Chief Executive Officer and
Director, and Mr. Steel Su, a director of I/OMagic Corporation. In 2002, we paid
$344,069 to Alex Properties for rent.
We have entered into indemnification agreements with our directors and
certain officers containing provisions that may in some respects be broader than
the specific indemnification provisions contained in the Nevada Revised
Statutes. These agreements provide, among other things, for indemnification of
these individuals in proceedings brought by third parties and in stockholder
derivative suits. Each agreement also provides for advancement of expenses to
the indemnified party.
We are a party to employment arrangements with related parties, as more
particularly described above under the headings "Compensation of Executive
Officers," "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements" and "Compensation of Directors."
ITEM 14. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of April 14, 2003 ("Evaluation Date"), that the
design and operation of our "disclosure controls and procedures" (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as
amended ("Exchange Act")) are effective to ensure that information required to
be disclosed by us in the reports filed or submitted by us under the Exchange
Act is accumulated, recorded, processed, summarized and reported to our
management, including our principal executive officer and our principal
financial officer, as appropriate to allow timely decisions regarding whether or
not disclosure is required.
There were no significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the Evaluation
Date, nor were there any significant deficiencies or material weaknesses in our
internal controls. As a result, no corrective actions were required or
undertaken.
33
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1), (a)(2) and (d) Financial Statements and Financial Statement
--------------------------------------------
Schedules
-
Reference is made to the financial statements and financial statement
schedule listed on and attached following the Index to Consolidated Financial
Statements and Supplemental Information contained on page F-1 of this report.
(a)(3) and (c) Exhibits
--------
Reference is made to the exhibits listed on the Index to Exhibits that
follows the financial statements and financial statement schedule.
(b) Reports on Form 8-K
-------------------
None.
34
I/OMAGIC CORPORATION
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SUPPLEMENTAL INFORMATION
DECEMBER 31, 2002
================================================================================
Page
INDEPENDENT AUDITOR'S REPORT F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-5
Consolidated Statements of Stockholders' Equity F-6
Consolidated Statements of Cash Flows F-8
Notes to Consolidated Financial Statements F-11
SUPPLEMENTAL INFORMATION
Independent Auditor's Report on Financial Statement Schedule F-38
Valuation and Qualifying Accounts - Schedule II F-39
F-1
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
I/OMagic Corporation and subsidiary
Santa Ana, California
We have audited the accompanying consolidated balance sheets of I/OMagic
Corporation and subsidiary as of December 31, 2002 and 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
I/OMagic Corporation and subsidiary as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
February 14, 2003, except
for the sixth paragraph of
Note 8, as to which the
date is April 11, 2003
F-2
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
================================================================================
ASSETS
2002 2001
----------- -----------
CURRENT ASSETS
Cash and cash equivalents. . . . . . . . . . . . . $ 7,320,143 $ 4,423,623
Accounts receivable, net of allowance for doubtful
accounts of $2,135,660 and $2,679,118. . . . . . 19,055,201 27,844,543
Inventory, net of allowance for obsolete inventory
of $1,046,812 and $558,703 . . . . . . . . . . . 8,240,280 10,377,287
Inventory in transit . . . . . . . . . . . . . . . 675,000 1,634,420
Current portion of deferred income taxes . . . . . - 1,556,000
Income tax receivable. . . . . . . . . . . . . . . - 34,311
Prepaid expenses and other current assets. . . . . 28,955 2,292,424
----------- -----------
Total current assets . . . . . . . . . . . . . 35,319,579 48,162,608
PROPERTY AND EQUIPMENT, net. . . . . . . . . . . . . 1,059,067 1,266,216
TRADEMARK, net of accumulated amortization
of $4,292,308 and $3,375,976 . . . . . . . . . . . 5,353,371 6,269,703
DEFERRED INCOME TAXES, net of current portion. . . . - 165,000
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . 25,952 40,240
----------- -----------
TOTAL ASSETS . . . . . . . . . . . . . . . $41,757,969 $55,903,767
=========== ===========
The accompanying notes are an integral part of these financial statements.
F-3
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
2002 2001
------------- -------------
CURRENT LIABILITIES
Line of credit. . . . . . . . . . . . . . . . . . . $ 10,372,827 $ 9,622,241
Current portion of capital lease obligations. . . . - 10,978
Accounts payable and accrued expenses . . . . . . . 7,285,246 11,976,138
Accounts payable - related parties. . . . . . . . . 2,607,278 5,573,080
Reserves for customer returns and allowances. . . . 765,898 2,605,679
Current portion of settlement payable . . . . . . . 3,000,000 -
------------- -------------
Total current liabilities . . . . . . . . . . . . 24,031,249 29,788,116
SETTLEMENT PAYABLE, net of current portion. . . . . 1,000,000 -
------------- -------------
Total liabilities . . . . . . . . . . . . . . . 25,031,249 29,788,116
------------- -------------
COMMITMENTS AND CONTINGENCIES
REDEEMABLE CONVERTIBLE PREFERRED STOCK
10,000,000 shares authorized, $0.001 par value
Series A, 1,000,000 shares authorized
0 and 875,000 shares issued and outstanding . . - 875
Series B, 1,000,000 shares authorized
0 and 250,000 shares issued and outstanding . . - 250
Additional paid-in capital. . . . . . . . . . . . . - 8,998,875
------------- -------------
Total redeemable convertible preferred stock. - 9,000,000
------------- -------------
STOCKHOLDERS' EQUITY
Class A common stock, $0.001 par value
100,000,000 shares authorized
4,529,670 and 4,528,837 shares issued and
outstanding . . . . . . . . . . . . . . . . . . 4,530 4,529
Additional paid-in capital. . . . . . . . . . . . . 31,557,988 31,557,359
Treasury stock. . . . . . . . . . . . . . . . . . . (42,330) -
Accumulated deficit . . . . . . . . . . . . . . . . (14,793,468) (14,446,237)
------------- -------------
Total stockholders' equity. . . . . . . . . . 16,726,720 17,115,651
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 41,757,969 $ 55,903,767
============= =============
The accompanying notes are an integral part of these financial statements.
F-4
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
====================================================================================
2002 2001 2000
------------ ------------ ------------
NET SALES. . . . . . . . . . . . . . . . . $83,529,708 $67,788,959 $60,805,437
COST OF SALES. . . . . . . . . . . . . . . 74,665,823 62,776,334 53,126,489
------------ ------------ ------------
GROSS PROFIT . . . . . . . . . . . . . . . 8,863,885 5,012,625 7,678,948
------------ ------------ ------------
OPERATING EXPENSES
Selling, marketing, and advertising. . . 1,437,704 1,487,828 2,180,685
General and administrative . . . . . . . 7,360,904 6,461,112 6,276,761
Depreciation and amortization. . . . . . 1,223,837 2,231,899 1,668,665
------------ ------------ ------------
Total operating expenses . . . . . . . 10,022,445 10,180,839 10,126,111
------------ ------------ ------------
LOSS FROM OPERATIONS . . . . . . . . . . . (1,158,560) (5,168,214) (2,447,163)
------------ ------------ ------------
OTHER INCOME (EXPENSE)
Interest income. . . . . . . . . . . . . 2,047 31,780 59,600
Interest expense . . . . . . . . . . . . (385,948) (418,381) (1,272,079)
Forgiveness of amounts due from related
party. . . . . . . . . . . . . . . . . - - (3,802,917)
Settlement expense and related legal
costs. . . . . . . . . . . . . . . . . (5,179,891) - -
Gain on disposal of property and
equipment. . . . . . . . . . . . . . . 38,759 - -
Other income . . . . . . . . . . . . . . - 10,170 52,110
------------ ------------ ------------
Total other income (expense) . . . . (5,525,033) (376,431) (4,963,286)
------------ ------------ ------------
LOSS BEFORE PROVISION FOR
(BENEFIT FROM) INCOME TAXES. . . . . . . (6,683,593) (5,544,645) (7,410,449)
PROVISION FOR (BENEFIT FROM) INCOME
TAXES. . . . . . . . . . . . . . . . . . 1,663,638 3,000 (999,600)
------------ ------------ ------------
NET LOSS . . . . . . . . . . . . . . . . . $(8,347,231) $(5,547,645) $(6,410,849)
============ ============ ============
BASIC AND DILUTED LOSS PER SHARE . . . . . $ (1.84) $ (1.23) $ (2.44)
============ ============ ============
BASIC AND DILUTED WEIGHTED-AVERAGE
SHARES OUTSTANDING . . . . . . . . . . . 4,528,894 4,528,341 2,629,894
============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-5
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31,
=======================================================================================================================
Additional Deferred
Paid-In Compen- Treasury
Class A Common Stock Capital sation Stock
--------------------- ----------- ------------ ------------- -----------
Shares Amount
--------------------- -----------
BALANCE, DECEMBER 31, 1999. . . . . . . . 2,153,954 $ 2,154 $10,542,052 $ (15,500) $ (165,000)
ISSUANCE OF COMMON STOCK IN CONNECTION
WITH THE EXERCISE OF WARRANTS . . . . . . 5,524 6 53,009 - -
COMMON STOCK ISSUED FOR INVENTORY . . . . 757,484 757 12,999,243 - -
COMMON STOCK ISSUED FOR CASH. . . . . . . 42,194 42 1,999,958 - -
COMMON STOCK ISSUED FOR LEGAL SERVICES. . 2,667 3 59,997 - -
COMMON STOCK ISSUED FOR SERVICES RENDERED 2,848 3 39 - -
TREASURY STOCK RETIRED. . . . . . . . . . (36,667) (37) (164,963) - 165,000
COMMON STOCK ISSUED IN CONNECTION WITH
THE ACQUISITION OF IOM HOLDINGS, INC. . . 1,600,000 1,600 5,998,400 - -
AMORTIZATION OF DEFERRED COMPENSATION . . - - - 12,400 -
TAX BENEFIT RELATED TO THE EXERCISE OF
NON-STATUTORY STOCK OPTIONS . . . . . . . - - 69,000 - -
NET LOSS. . . . . . . . . . . . . . . . . _________ _________ __________ _________ _________
Accumulated
Deficit Total
------------ ------------
BALANCE, DECEMBER 31, 1999. . . . . . . . $(2,487,743) $ 7,875,963
ISSUANCE OF COMMON STOCK IN CONNECTION
WITH THE EXERCISE OF WARRANTS . . . . . . - 53,015
COMMON STOCK ISSUED FOR INVENTORY . . . . - 13,000,000
COMMON STOCK ISSUED FOR CASH. . . . . . . - 2,000,000
COMMON STOCK ISSUED FOR LEGAL SERVICES. . - 60,000
COMMON STOCK ISSUED FOR SERVICES RENDERED - 42
TREASURY STOCK RETIRED. . . . . . . . . . - -
COMMON STOCK ISSUED IN CONNECTION WITH
THE ACQUISITION OF IOM HOLDINGS, INC. . . - 6,000,000
AMORTIZATION OF DEFERRED COMPENSATION . . - 12,400
TAX BENEFIT RELATED TO THE EXERCISE OF
NON-STATUTORY STOCK OPTIONS . . . . . . . - 69,000
NET LOSS. . . . . . . . . . . . . . . . . (6,410,849) (6,410,849)
------------ ------------
The accompanying notes are an integral part of these financial statements.
F-6
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31,
================================================================================================================================
Additional Deferred
Paid-In Compen- Treasury Accumulated
Class A Common Stock Capital sation Stock Deficit Total
--------------------- ----------- ----------- --------- -------------- ----------
Shares Amount
---------------------
BALANCE, DECEMBER 31, 2000 . . . . . . 4,528,004 $ 4,528 $31,556,735 $(3,100) $ - $ (8,898,592) $22,659,571
ISSUANCE OF COMMON STOCK IN CONNECTION
WITH THE EXERCISE OF WARRANTS. . . . . 833 1 624 - - - 625
AMORTIZATION OF DEFERRED COMPENSATION. - - - 3,100 - - 3,100
NET LOSS . . . . . . . . . . . . . . . - - - - - (5,547,645) (5,547,645)
----------- ------------
BALANCE, DECEMBER 31, 2001 . . . . . . 4,528,837 4,529 31,557,359 - - (14,446,237) 17,115,651
PURCHASE OF TREASURY STOCK . . . . . . - - - - (42,330) - (42,330)
REDEMPTION OF SERIES A - REDEEMABLE
CONVERTIBLE PREFERRED STOCK . . . . - - - - - 6,222,222 6,222,222
REDEMPTION OF SERIES B - REDEEMABLE
CONVERTIBLE PREFERRED STOCK . . . . - - - - - 1,777,778 1,777,778
ISSUANCE IN COMMON STOCK IN CONNECTION
WITH THE EXERCISE OF WARRANTS . . . 833 1 629 - - - 630
NET LOSS . . . . . . . . . . . . . . . - - - - - (8,347,231) (8,347,231)
------------- ----------
BALANCE, DECEMBER 31, 2002. . . . . 4,529,670 $ 4,530 $31,557,988 $ - $(42,330) $(14,793,468) $16,726,720
=========== ============ =========== ======== ========= ============= ============
The accompanying notes are an integral part of these financial statements.
F-7
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
===============================================================================================
2002 2001 2000
------------ ------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss). . . . . . . . . . . . . . . . . . $(8,347,231) $ (5,547,645) $(6,410,849)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation and amortization. . . . . . . . . . . . 307,505 302,775 221,813
Gain on disposal of property and equipment . . . . . (38,759) - -
Amortization of trademark. . . . . . . . . . . . . . 916,332 1,929,124 1,446,852
Amortization of deferred compensation. . . . . . . . - 3,100 12,400
Allowance for doubtful accounts. . . . . . . . . . . 1,300,000 850,937 2,420,210
Reserves for customer returns and allowances . . . . (1,839,781) 373,592 1,086,519
Reserves for obsolete inventory. . . . . . . . . . . 2,070,200 410,000 2,716,303
Forgiveness of amounts due from related party. . . . - - 3,802,917
Interest imputed on notes payable. . . . . . . . . . - - 477,181
Deferred income taxes. . . . . . . . . . . . . . . . - - (1,070,000)
Impairment of deferred income taxes. . . . . . . . . 1,755,311 - -
Tax effect of exercised options. . . . . . . . . . . - - 69,000
(Increase) decrease in
Accounts receivable. . . . . . . . . . . . . . . . . 7,489,342 (10,585,686) (7,427,017)
Accounts receivable - related parties. . . . . . . . - 84,710 4,342,607
Inventory. . . . . . . . . . . . . . . . . . . . . . 1,026,227 7,373,008 1,712,635
Prepaid expenses and other current assets. . . . . . 2,263,469 (2,107,901) (135,403)
Due from related party . . . . . . . . . . . . . . . - - (2,108,220)
Other assets . . . . . . . . . . . . . . . . . . . . 14,288 - (18,752)
Increase (decrease) in
Accounts payable and accrued expenses. . . . . . . . (4,690,892) 6,442,547 3,774,351
Accounts payable - related parties . . . . . . . . . (2,965,802) (1,065,041) (4,898,948)
Income taxes payable . . . . . . . . . . . . . . . . - - (140,311)
Settlement payable . . . . . . . . . . . . . . . . . 4,000,000 - -
------------ ------------- ------------
Net cash provided by (used in) operating activities. 3,260,209 (1,536,480) (126,712)
------------ ------------- ------------
The accompanying notes are an integral part of these financial statements.
F-8
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
============================================================================================
2002 2001 2000
------------ ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposal of property and equipment . . $ 74,000 $ - $ -
Purchase of property and equipment . . . . . . . . . (135,597) (141,219) (220,242)
------------ ----------- -----------
Net cash used in investing activities. . . . . . . . (61,597) (141,219) (220,242)
------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on line of credit . . . . . . . . . . 750,586 2,625,272 118,634
Payments on capital lease obligations. . . . . . . . (10,978) (27,121) (17,804)
Payments on notes payable. . . . . . . . . . . . . . - - (247,909)
Purchase of treasury stock . . . . . . . . . . . . . (42,330) - -
Payments on redemption of redeemable
convertible preferred stock . . . . . . . . . . . (1,000,000) - -
Proceeds from issuance of common stock . . . . . . . - - 2,000,000
Proceeds from exercise of warrants . . . . . . . . . 630 625 53,057
------------ ----------- -----------
Net cash provided by (used in) financing activities. (302,092) 2,598,776 1,905,978
------------ ----------- -----------
Net increase in cash and cash equivalents. . . . . . 2,896,520 921,077 1,559,024
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR . . . . 4,423,623 3,502,546 1,943,522
------------ ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR . . . . . . . $ 7,320,143 $4,423,623 $3,502,546
============ =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INTEREST PAID. . . . . . . . . . . . . . . . . . . $ 363,171 $ 396,868 $ 794,888
============ =========== ===========
INCOME TAXES PAID (REFUNDED). . . . . . . . . . . . $ (91,055) $ 3,000 $ 27,500
============ =========== ===========
The accompanying notes are an integral part of these financial statements.
F-9
I/OMAGIC CORPORATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
================================================================================
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended December 31, 2002, the Company entered into the following
non-cash transactions:
- Paid $1,000,000 to redeem 875,000 shares of Series A redeemable
convertible preferred stock and 250,000 shares of Series B redeemable
convertible preferred stock, valued at $7,000,000 and $2,000,000,
respectively. The gain on redemption of $8,000,000 was netted against
accumulated deficit in the consolidated balance sheet.
The Company did not have any non-cash transactions during the year ended
December 31, 2001.
During the year ended December 31, 2000, the Company entered into the following
non-cash transactions:
- Received $5,000,000 in inventory for 416,667 shares of common stock.
- Received $8,000,000 in inventory for 340,817 shares of common stock.
- Received $5,011,000 in inventory and a reduction in accounts payable of
$989,000 for 125,000 shares of IOM Holdings, Inc., which were later
converted into 320,000 shares of I/OMagic Corporation.
- Received $1,003,413 in inventory in exchange for a reduction in accounts
receivable of the same amount.
- Issued 1,125,000 shares of preferred stock in exchange for $9,000,000 of
debt.
- Received $60,000 in legal services for 2,667 shares of common stock.
- Cancelled 36,667 shares of treasury stock outstanding totaling $165,000.
- Issued 1,600,000 shares of common stock in exchange for 100% of the
issued and outstanding shares of IOM Holdings, Inc.
The accompanying notes are an integral part of these financial statements.
F-10
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 1 - ORGANIZATION AND BUSINESS
I/OMagic Corporation ("I/OMagic"), a Nevada corporation, and its subsidiary
(collectively, the "Company") develop, manufacture through subcontractors,
market, and distribute optical storage and media, multimedia, input-output
peripheral products and solutions for the desktop and mobile computing markets,
and digital entertainment products for the consumer electronics market. The
Company sells its products in the United States and Canada to distributors and
retail customers.
In March 1996, I/OMagic Corporation, a California corporation ("I/OMagic
California"), originally incorporated on September 30, 1993, entered into a Plan
of Exchange and Acquisition Agreement (the "Acquisition Agreement") with
Silvercrest International, Inc. ("Silvercrest"), a Nevada corporation.
Silvercrest subsequently changed its name to I/OMagic Corporation, a Nevada
corporation.
Acquisitions
- ------------
Hi-Val, Inc.
On March 29, 2000, IOM Holdings, Inc. ("IOMH") acquired certain assets of
Hi-Val, Inc. ("Hi-Val") from Development Specialists, Inc., the assignee of
Hi-Val's assets pursuant to a general assignment executed by Hi-Val pursuant to
Section 493.010 of the California Code of Civil Procedure. The stated purchase
price for the assets was $15,878,335; however, total consideration was adjusted
to $15,401,154, based on imputed interest. The purchase price was paid by IOMH
as follows: (i) $6,878,335 in cash, (ii) $7,000,000 in the form of a promissory
note at 0% interest (imputed to $6,522,819 based on 9.5% interest), and (iii)
$2,000,000 in the form of a promissory note at prime (9.5% as of December 31,
2000). In connection with the transaction, IOMH paid $712,681 to its lender,
Finova Capital Corporation. IOMH recorded $9,645,679 in excess of cost over
fair value of net assets acquired, identified as the trademarks, which were
being amortized on a straight-line basis over five years. During the year
ended December 31, 2001, the term was changed to 10 years. The acquisition was
accounted for by the purchase method.
For financial statement purposes, the acquisition occurred on April 1, 2000.
The assets acquired were as follows:
Accounts receivable $ 2,987,637
Inventory 1,890,818
Due from related party 563,689
Property and equipment 1,173,654
Liabilities assumed (860,323)
Trademark 9,645,679
---------
TOTAL $ 15,401,154
==========
The accompanying notes are an integral part of these financial statements.
F-11
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 1 - ORGANIZATION AND BUSINESS (CONTINUED)
Acquisitions(Continued)
- ------------
IOM Holdings, Inc.
On December 31, 2000, I/OMagic acquired 100% of the issued and outstanding
shares of IOM Holdings, Inc., a Nevada corporation, for 24,000,000 restricted
shares (pre-reverse stock split, or 1,600,000 post-reverse stock split) of
common stock. The entities were under common control; therefore, the
acquisition has been accounted for in a manner similar to a
pooling-of-interests.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
- -----------------------------
The consolidated financial statements include the accounts of I/OMagic and its
subsidiary, IOMH. All material intercompany accounts and transactions have been
eliminated.
Revenue Recognition
- --------------------
For transactions satisfying the conditions for revenue recognition under
Statement of Financial Accounting Standards ("SFAS") No. 48, "Revenue
Recognition when Right of Return Exists," product revenue is recorded at the
time of shipment, net of estimated allowances and returns. For transactions not
satisfying the conditions for revenue recognition under SFAS No. 48, product
revenue is deferred until the conditions are met, net of an estimate for cost of
sales. For the years ended December 31, 2002, 2001, and 2000, the Company had
reserves for sales returns totaling $367,626, $861,831, and $315,015,
respectively.
The Company performs periodic credit evaluations of its customers and maintains
allowances for potential credit losses based on management's evaluation of
historical experience and current industry trends. Although the Company expects
to collect amounts due, actual collections may differ.
The accompanying notes are an integral part of these financial statements.
F-12
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Comprehensive Income
- ---------------------
The Company utilizes SFAS No. 130, "Reporting Comprehensive Income." This
statement establishes standards for reporting comprehensive income and its
components in a financial statement. Comprehensive income as defined includes
all changes in equity (net assets) during a period from non-owner sources.
Examples of items to be included in comprehensive income, which are excluded
from net income, include foreign currency translation adjustments and unrealized
gains and losses on available-for-sale securities. For the years ended December
31, 2002, 2001, and 2000, comprehensive income is not presented in the Company's
financial statements since the Company did not have any of the items of
comprehensive income in any period presented.
Cash and Cash Equivalents
- ----------------------------
For purposes of the statements of cash flows, the Company considers all highly
liquid investments purchased with original maturities of three months or less to
be cash equivalents.
Inventory
- ---------
Inventory is stated at the lower of cost, using the weighted-average method,
which approximates the first-in, first-out method or market.
Property and Equipment
- ------------------------
Property and equipment are recorded at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using the
straight-line method over estimated useful lives as follows:
Computer equipment and software 5 years
Warehouse equipment 7 years
Office furniture and equipment 5 to 7 years
Equipment under capital leases 5 years
Vehicles 5 years
Leasehold improvements Estimated useful life
or lease term whichever is shorter
Expenditures for major renewals and betterments that extend the useful lives of
property and equipment are capitalized. Expenditures for maintenance and
repairs are charged to expense as incurred. Depreciation expense on assets
acquired under capital leases is included with depreciation expense on owned
assets.
The accompanying notes are an integral part of these financial statements.
F-13
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Trademarks
- ----------
The trademarks are being amortized over a 10-year period. The Company
continually evaluates whether events or circumstances have occurred that
indicate the remaining estimated value of the trademarks may not be recoverable.
When factors indicate that the value of the trademarks may be impaired, the
Company estimates the remaining value and reduces the trademarks to that amount.
Accounting for the Impairment of Long-Lived Assets
- --------------------------------------------------------
The Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." SFAS No. 121 requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount.
Management determined that there was not any impairment of long-lived assets
during the years ended December 31, 2002, 2001, and 2000.
Fair Value of Financial Instruments
- ---------------------------------------
For certain of the Company's financial instruments, including cash and cash
equivalents, accounts receivable, deferred income taxes, income tax receivable,
prepaid expenses and other current assets, trademarks, other assets, line of
credit, capital lease obligations, accounts payable and accrued expenses,
accounts payable - related parties, reserve for customer returns and allowances,
and settlement payable, the carrying amounts approximate fair value due to their
short maturities.
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.
The accompanying notes are an integral part of these financial statements.
F-14
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Advertising Costs
- ------------------
The Company expenses advertising costs as incurred. For the years ended
December 31, 2002, 2001, and 2000, advertising costs were $3,500, $120,577, and
$218,956, respectively.
Income Taxes
- -------------
Deferred income taxes are recognized for the tax consequences in future years of
differences between the tax basis of assets and liabilities and their financial
reporting amounts at each period end, based on enacted tax laws and statutory
tax rates applicable to the periods in which the differences are expected to
affect taxable income. Valuation allowances are established, when necessary, to
reduce deferred tax assets to the amount expected to be realized. The provision
for income taxes represents the tax payable for the period, if any, and the
change during the period in deferred tax assets and liabilities.
Loss Per Share
- ----------------
The Company calculates loss per share in accordance with SFAS No. 128, "Earnings
Per Share." Basic loss per share is computed by dividing the net loss available
to common stockholders by the weighted-average number of common shares
outstanding. Diluted loss per share is computed similar to basic loss per share,
except that the denominator is increased to include the number of additional
common shares that would have been outstanding if the potential common shares
had been issued and if the additional common shares were dilutive. Because the
Company had net losses for the years ended December 31, 2002, 2001, and 2000,
basic and diluted loss per share are the same.
The following potential common shares have been excluded from the computations
of diluted net loss per share for the years ended December 31, 2002, 2001, and
2000 because the effect would have been anti-dilutive:
2002 2001 2000
---------- ---------- ----------
Stock options outstanding 146,167 166,500 179,000
Warrants outstanding - 8,000 63,633
Redeemable convertible
Preferred stock - 240,000 240,000
------- ------- -------
TOTAL 146,167 414,500 482,633
======= ======= =======
The accompanying notes are an integral part of these financial statements.
F-15
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Estimates
- ---------
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Recently Issued Accounting Pronouncements
- --------------------------------------------
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." SFAS No. 145 updates, clarifies,
and simplifies existing accounting pronouncements. This statement rescinds SFAS
No. 4, which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net of related
income tax effect. As a result, the criteria in Accounting Principles Board No.
30 will now be used to classify those gains and losses. SFAS No. 64 amended
SFAS No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS
No. 44 has been rescinded as it is no longer necessary. SFAS No. 145 amends
SFAS No. 13 to require that certain lease modifications that have economic
effects similar to sale-leaseback transactions be accounted for in the same
manner as sale-lease transactions. This statement also makes technical
corrections to existing pronouncements. While those corrections are not
substantive in nature, in some instances, they may change accounting practice.
The Company does not expect adoption of SFAS No. 145 to have a material impact,
if any, on its financial position or results of operations.
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 EITF 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. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. The Company does not expect adoption
of SFAS No. 146 to have a material impact, if any, on its financial position or
results of operations.
The accompanying notes are an integral part of these financial statements.
F-16
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recently Issued Accounting Pronouncements (Continued)
- --------------------------------------------
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.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," an amendment of SFAS No. 123. SFAS
No. 148 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require more prominent and more frequent disclosures in financial statements
about the effects of stock-based compensation. This statement is effective for
financial statements for fiscal years ending after December 15, 2002. SFAS No.
148 will not have any impact on the Company's financial statements as management
does not have any intention to change to the fair value method.
Reclassifications
- -----------------
Certain amounts included in the prior years' financial statements have been
reclassified to conform with the current year presentation. Such
reclassifications did not have any effect on reported net loss.
NOTE 3 - RISKS AND UNCERTAINTIES
Technological Obsolescence
- ---------------------------
The computer industry is characterized by rapid technological advancement and
change. Should demand for the Company's products prove to be significantly less
than anticipated, the ultimate realizable value of such products could be
substantially less than the amounts reflected in the accompanying balance
sheets.
The accompanying notes are an integral part of these financial statements.
F-17
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 3 - RISKS AND UNCERTAINTIES (CONTINUED)
Reliance on Independent and Related Party Manufacturers/Subcontractors
- ----------------------------------------------------------------------------
The Company does not maintain its own manufacturing or production facilities and
does not intend to do so in the foreseeable future. The Company anticipates
that its products will be manufactured, and independent companies, some of which
are stockholders of the Company, will supply its raw materials and components.
Many of these independent and related party manufacturers/subcontractors may
manufacture and supply products for the Company's existing and potential
competitors. As is customary in the manufacturing industry, the Company does
not have any material ongoing licensing or other supply agreements with its
manufacturers and suppliers. Typically, the purchase order is the Company's
"agreement" with the manufacturer. Therefore, any of these companies could
terminate their relationships with the Company at any time. In the event the
Company were to have difficulties with its present manufacturers and suppliers,
the Company could experience delays in supplying products to its customers.
Reliance on Retail Distributors
- ----------------------------------
The Company's success will depend to a significant extent upon the ability to
develop and maintain a multi-channel distribution system with retail
distributors to sell the Company's products in the marketplace. There cannot be
any assurance that the Company will be successful in obtaining and retaining the
retail distributors it requires to continue to grow and expand its marketing and
sales efforts.
NOTE 4 - CONCENTRATIONS OF RISK
Cash and Cash Equivalents
- ----------------------------
The Company maintains its cash and cash equivalent balances in several banks
located in Southern California and a financial institution that from time to
time exceed amounts insured by the Federal Deposit Insurance Corporation up to
$100,000 per bank and by the Securities Investor Protection Corporation up to
$500,000 per financial institution. As of December 31, 2002 and 2001, balances
totaling $7,453,045 and $4,904,747, respectively, were uninsured. The Company
has not experienced any losses in such accounts and believes it is not exposed
to any significant credit risk on cash.
In connection with the Company's revolving line of credit, the Company is
required to maintain a minimum, quarterly, combined average, cash compensating
balance of $750,000 at December 31, 2002 and 2001.
The accompanying notes are an integral part of these financial statements.
F-18
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 4 - CONCENTRATIONS OF RISK (CONTINUED)
Customers
- ---------
During the year ended December 31, 2002, the Company had net sales to four major
customers that represented 27%, 26%, 15%, and 14% of net sales. As of December
31, 2002, the Company had four customers that accounted for 28%, 25%, 17%, and
16% of accounts receivable.
During the year ended December 31, 2001, the Company had net sales to four major
customers that represented 36%, 20%, 15%, and 14% of net sales. As of December
31, 2001, the Company had four customers that accounted for 25%, 23%, 18%, and
15% of accounts receivable.
During the year ended December 31, 2000, the Company had net sales to four major
customers that represented 27%, 19%, 15%, and 14% of net sales. As of December
31, 2000, the Company had three customers that accounted for 27%, 19%, and 18%
of accounts receivable.
Suppliers
- ---------
During the year ended December 31, 2002, the Company purchased inventory from
two related party vendors that represented 47% and 18% of purchases. As of
December 31, 2002, there were two suppliers that represented 60% and 12% of
accounts payable and accounts payable - related parties.
During the year ended December 31, 2001, the Company purchased inventory from
two related party vendors that represented 26% and 14% of purchases. As of
December 31, 2001, there were two suppliers that represented 51% and 42% of
accounts payable and accounts payable - related parties.
During the year ended December 31, 2000, the Company purchased inventory from
one related party vendor that represented 47% of purchases. As of December 31,
2000, there was one supplier that represented 32% of accounts payable and
accounts payable - related parties.
The accompanying notes are an integral part of these financial statements.
F-19
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 5 - INVENTORY
Inventory as of December 31, 2002 and 2001 consisted of the following:
2002 2001
---------------- ----------------
Component parts $ 3,098,085 $ 5,243,285
Finished goods 6,189,007 5,692,705
Reserves for inventory (1,046,812) (558,703)
--------------- ----------------
TOTAL $ 8,240,280 $ 10,377,287
=============== ================
NOTE 6 - PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2002 and 2001 consisted of the
following:
2002 2001
---------------- ----------------
Computer equipment and software $ 988,666 $ 957,079
Warehouse equipment 58,570 78,465
Office furniture and equipment 241,557 161,339
Equipment under capital leases - 94,136
Vehicles 91,304 6,707
Leasehold improvements 631,129 651,187
--------------- ----------------
2,011,226 1,948,913
Less accumulated depreciation
and amortization 952,159 682,697
--------------- ----------------
TOTAL $ 1,059,067 $ 1,266,216
=============== ================
For the years ended December 31, 2002, 2001, and 2000, depreciation and
amortization expense was $307,505, $302,775, and $221,813, respectively.
The accompanying notes are an integral part of these financial statements.
F-20
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 7 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses as of December 31, 2002 and 2001 consisted
of the following:
2002 2001
---------------- -------------
Accounts payable $ 1,709,736 $ 311,832
Accrued rebates and marketing 4,041,126 10,395,995
Accrued compensation and related benefits 301,851 452,517
Other 1,232,533 815,794
---------------- -------------
TOTAL $ 7,285,246 $ 11,976,138
================ =============
NOTE 8 - LINE OF CREDIT
The Company maintains a revolving line of credit with a financial institution
that allows it to borrow a maximum of $9,000,000 with a sub-limit of $8,000,000.
The line of credit expires December 31, 2003 and is secured by a UCC filing on
substantially all of the Company's assets.
Within the sub-limit, up to $8,000,000 is available for issuance of sight
letters of credit, refinancing letters of credit, local purchase financing
against invoice(s), and working capital loans with maturities up to 150 days.
Letters of credit have maturities of up to 60 days. Each advance over a total
outstanding line balance of $4,000,000 is subject to the above maturity periods.
Within the line of credit, a sub-line of $1,000,000 is available for uncollected
funds.
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 (4.25% as of December 31, 2002), plus 0.75%,
subject to a minimum interest rate of 5.5%. As of December 31, 2002, the
outstanding balance under the revolving line of credit was $10,372,827.
The Company is required to maintain a minimum, quarterly, combined average, cash
compensating balance of $750,000.
The accompanying notes are an integral part of these financial statements.
F-21
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 8 - LINE OF CREDIT (CONTINUED)
The line of credit provides for the maintenance of certain financial covenants.
The Company was not in compliance with certain covenants at December 31, 2002.
The line of credit is included in current liabilities in the accompanying
consolidated balance sheet. The Company received a waiver from the financial
institution for six months from April 2003. The waiver stipulates that if the
defaults are not cured within 15 days, the bank is willing to forbear from
enforcing the defaults, provided that the Company pays in full the outstanding
amounts under the line of credit by October 15, 2003. This agreement will be
subject to the Company entering into a forbearance agreement with the bank on
terms and conditions satisfactory to the bank, at its sole discretion.
NOTE 9 - CREDIT FACILITIES FROM RELATED PARTY
In connection with a 1997 Strategic Alliance Agreement, the Company also has
available a trade credit facility through a stockholder and supplier for
borrowings up to $2,000,000. Borrowings are non-interest-bearing and are due 75
days from the date of the borrowing. The credit agreement can be mutually
terminated at any time. As of December 31, 2002 and 2001, the trade credit
facility was unused.
In connection with an April 1999 subscription agreement, the Company also has
available a trade credit facility through a stockholder and supplier that
provides a trade credit facility of up to $5,000,000 carrying net 75 day terms,
as defined. As of December 31, 2002 and 2001, there was $2,607,278 and
$2,993,578, respectively, outstanding under this arrangement, which is included
in accounts payable - related parties in the accompanying balance sheets.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
Leases
- ------
The Company leased its warehouse and office space from a related party that was,
prior to March 2003, under the control of an officer of the Company. It also
leases certain equipment under non-cancelable, operating lease agreements. All
of the leases require initial, minimum, monthly, aggregate payments of $31,423
and expire through March 2005.
The accompanying notes are an integral part of these financial statements.
F-22
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Leases (Continued)
- ------
In March 2003, in connection with the settlement of the Vakili lawsuit (see
Litigation), an officer of the Company relinquished control, to the Vakilis, of
the entity that owns the warehouse and office space that is being leased by the
Company. Under the terms of the settlement agreement, the lease dated April 1,
2000, as amended on June 1, 2000 and which originally expired in March 2010, was
terminated and replaced with a new lease. The new lease requires monthly
payments of $28,687 and expires on September 30, 2003. It may be terminated
prior to the expiration date, but only after June 30, 2003, upon 20 days'
written notice to the landlord.
Future minimum lease payments under these non-cancelable operating lease
obligations at December 31, 2002 were as follows:
Year Ending
December 31,
-------------
2003 $ 289,263
2004 26,211
2005 18,927
-------------
TOTAL $ 334,401
=============
For the years ended December 31, 2002, 2001, and 2000, rent expense was
$431,590, $557,530, and $491,340, respectively.
Service Agreements
- -------------------
Periodically, the Company enters into various agreements for services including,
but not limited to, public relations, financial consulting, and manufacturing
consulting. The agreements generally are ongoing until such time they are
terminated, as defined. Compensation for services is paid either on a fixed
monthly rate or based on a percentage, as specified, and may be payable in
shares of the Company's common stock. During the years ended December 31, 2002,
2001, and 2000, the Company incurred expenses of $349,056, $383,395, and
$350,457, respectively, in connection with such arrangements. Such is included
in general and administrative expenses in the accompanying statements of
operations.
The accompanying notes are an integral part of these financial statements.
F-23
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Employment Contract
- --------------------
The Company entered into an employment contract with one of its officers on
October 15, 2002, which expires on October 15, 2007. The agreement, which is
effective as of January 1, 2002, calls for a minimum base salary, as reported,
and provides for certain expense allowances. In addition, the agreement
provides for a quarterly bonus equal to 7% of the Company's quarterly net
income. For the years ended December 31, 2002, 2001, and 2000, bonuses totaling
$89,067, $0, and $165,396, respectively, were paid under the terms of this
agreement. As of December 31, 2002 and 2001, the accrued bonuses were
approximately $0 and $98,000, respectively, which are included in accounts
payable and accrued expenses in the accompanying balance sheets.
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.
In May 2001, the Company entered into an agreement to provide marketing and
promotional funds to a customer up to 10% of the net sales to this customer for
a 24-month period, which was temporarily adjusted to 17% for a period during the
year ended December 31, 2001. During the year ended December 31, 2001, the
Company paid $6,068,479, of which $2,193,535 and $3,874,944 was expensed during
the years ended December 31, 2002 and 2001, respectively. At December 31, 2002
and 2001, $0 and $2,193,535 was included in prepaid expenses and other current
assets in the accompanying consolidated balance sheets.
For the years ended December 31, 2002, 2001, and 2000, the Company incurred
$3,388,570, $2,890,502, and $1,386,261, respectively, related to its retail
agreements with its customers. These amounts are netted against revenue in the
accompanying statements of operations.
The accompanying notes are an integral part of these financial statements.
F-24
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Litigation
- ----------
Effective on or about March 28, 2003, the Company, among others, entered into a
settlement agreement and general release with Mark Vakili, Mitra Vakili, Hi-Val,
and others, in connection with a complaint filed in the Superior Court of the
State of California for the County of Orange (Case No. 01CC09894). Under the
terms of the settlement agreement and general release, the Company paid
$3,000,000 on March 31, 2003 and is obligated to pay an additional $1,000,000 on
March 15, 2004. The settlement agreement also provides, among other things,
that Mr. Shahbaz and Mr. Su, each a director of the Company, will each
relinquish any claims held by either of them to any interest in Alex Properties,
a California general partnership that holds title to the Company's corporate
headquarters and warehouse.
Pursuant to the settlement agreement and general release, Mr. Shahbaz and Mr. Su
will also transfer to parties designated by Mark and Mitra Vakili, an aggregate
of 13,333 shares of the Company's common stock from the 66,667 shares of the
Company's common stock being returned by Mark and Mitra Vakili to Mr. Shahbaz
and Mr. Su. Mr. Shahbaz and Mr. Su had previously transferred the 66,667 shares
to Mark and Mitra Vakili.
In addition, the Company is involved in certain legal proceedings and claims
which arise in the normal course of business. Management does not believe that
the outcome of these matters will have a material effect on the Company's
financial position or results of operations.
NOTE 11 - REDEEMABLE CONVERTIBLE PREFERRED STOCK
During December 2000, the Company amended its Articles of Incorporation to
authorize 10,000,000 shares of preferred stock, of which 1,000,000 shares are
designated as Series A preferred stock. Preferred stockholders of the Series A
preferred stock do not have voting powers and are entitled to receive dividends
on an equal basis with the holders of common stock of the Company.
In addition, the Company designated 1,000,000 shares as Series B preferred
stock. The Series B stockholder has the same rights as the Series A holders,
except the Company will be obligated to redeem any issued shares which have been
outstanding for two years.
The accompanying notes are an integral part of these financial statements.
F-25
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 11 - REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
On January 22, 2001, the Company issued 875,000 shares of Series A preferred
stock to its financial institution for $7,000,000 in exchange for amounts owed
under long-term debt. As of December 31, 2000, the shares were presented as
outstanding on the balance sheet, and the related debt was eliminated.
On January 22, 2001, the Company issued 250,000 shares of Series B preferred
stock to its financial institution for $2,000,000 in exchange for amounts owed
under long-term debt. As of December 31, 2000, the shares were presented as
outstanding on the balance sheet, and the related debt was eliminated.
On October 25, 2002, the Company redeemed all of the issued Series A and Series
B redeemable convertible preferred stock totaling 875,000 and 250,000 shares,
respectively, for a payment of $1,000,000. The gain on redemption of $8,000,000
was netted against accumulated deficit in the accompanying consolidated balance
sheet.
NOTE 12 - COMMON STOCK
Amendment to Articles of Incorporation
- ------------------------------------------
On January 12, 2001, the Company amended its Articles of Incorporation to
increase the number of authorized common shares from 50,000,000 to 100,000,000.
On December 6, 2002, the Company amended its Articles of Incorporation to effect
a 1-for-15 reverse stock split as of December 20, 2002.
Common Stock Issued for Legal Services
- -------------------------------------------
During the year ended December 31, 2000, the Company issued 2,667 shares of
common stock for $60,000 in legal services, which represented the fair market
value of the services rendered.
Common Stock Issued in Connection with the Exercise of Warrants
- ------------------------------------------------------------------------
During the year ended December 31, 2002, the Company issued an aggregate of 833
shares of common stock in connection with the exercise of warrants for cash of
$630 or at a per share price of $0.75.
During the year ended December 31, 2001, the Company issued an aggregate of 833
shares of common stock in connection with the exercise of warrants for cash of
$625, or at a per share price of $0.75.
During the year ended December 31, 2000, the Company issued an aggregate of
5,524 restricted shares of common stock in connection with the exercise of
warrants for cash of $53,015, or at a per share price ranging from $0.75 to $30
per share.
The accompanying notes are an integral part of these financial statements.
F-26
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 12 - COMMON STOCK (CONTINUED)
Common Stock Issued in Exchange for Inventory
- ---------------------------------------------------
On January 4, 2000, the Company issued 416,667 shares of restricted common stock
to a stockholder and vendor, valued at $12 per share, for $5,000,000 of
inventory, as defined (valued at transferor's cost basis).
On December 10, 2000, the Company issued 340,817 shares of restricted common
stock to a stockholder and vendor, valued at $23.40 per share, for $8,000,000 of
inventory, as defined (valued at transferor's cost basis).
Common Stock Issued for Cash
- --------------------------------
On March 7, 2000, the Company issued 42,194 shares of restricted common stock to
a stockholder and vendor, valued at $47.40, for $2,000,000 in cash. This
issuance of common stock made by the Company carries registration rights.
Treasury Stock
- ---------------
On February 12, 2002, the Company announced the approval by the Board of
Directors of the Company to redeem its own stock in open market transactions of
up to $500,000. During the year ended December 31, 2002, the Company purchased
4,226 shares of common stock for $42,330 on the open market. It is the
Company's intention to cancel these shares.
Stock Split
- ------------
In December 2002, the Company effectuated a 1-for-15 reverse stock split. All
share and per share data have been retroactively restated to reflect this
reverse stock split.
NOTE 13 - WARRANTS AND STOCK OPTIONS
Warrants
- --------
In connection with an October 1995 private placement of notes payable and
warrants, the Company issued 53,667 A Warrants to purchase common stock for
$0.75 per share, exercisable for five years from the date of issuance, and
53,667 B Warrants to purchase common stock for $14.25 per share, exercisable for
five years from the date of issuance. For every 30 days the B Warrants were
outstanding, commencing six months from the date of issuance, the B Warrant
holders were entitled to a $0.60 discount on the exercise price per month to a
minimum exercise price of $7.50 per share.
The accompanying notes are an integral part of these financial statements.
F-27
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 13 - WARRANTS AND STOCK OPTIONS (CONTINUED)
Warrants (Continued)
- --------
Interest expense ascribed to the warrants was deemed to be insignificant and
recording such was not deemed appropriate by management as the value of the
Company was nominal prior to the effective date of the Acquisition Agreement,
the consummation of which was not assured. During the years ended December 31,
2001 and 2000, A Warrants aggregating 833 and 1,667, respectively, have been
exercised. Through December 31, 2001, A Warrants aggregating 53,534 have been
exercised. As of December 31, 2001, the remaining 133 outstanding A warrants
expired. Through December 31, 2001, B warrants aggregating 1,667 have been
exercised. As of December 31, 2001, the remaining 52,000 outstanding B warrants
expired.
In connection with an October 1995 private placement for placement agent
services, the Company issued 8,342 A Warrants to purchase common stock for $1.50
per share exercisable for five years from the date of issue and 8,342 B Warrants
to purchase common stock for $16.50 per share, exercisable for five years from
the date of issuance. During the year ended December 31, 2000, 1,191 of these A
Warrants were exercised. Through December 31, 2000, 6,381 of these A Warrants
were exercised. As of December 31, 2000, the remaining 1,961 outstanding A
warrants and 8,342 outstanding B warrants expired.
In October 1995, the Company issued to an officer 22,667 warrants to purchase
restricted shares of common stock for $0.15 per share exercisable for five years
from the date of grant. No compensation expense was charged to operations as
the fair value of the shares and services received was nominal. Fair value was
determined by management to be the amount that would have been paid had the
Company paid cash for such services. In addition, expense was not deemed
appropriate by management as the value of the Company was nominal prior to the
effective date of the Acquisition Agreement, the consummation of which was not
assured. These warrants carried piggyback registration rights, as defined. As
of December 31, 2000, none of the warrants had been exercised, and such warrants
expired.
Through December 31, 1996, the Company issued an aggregate 6,667 warrants to
purchase restricted shares of common stock for $24.75 per share, exercisable
five years from the date of grant, to a consultant for services provided.
Compensation expense related to these warrants, as determined by management to
be the fair value of services received had the Company paid cash, was
insignificant. As of December 31, 2001, none of the warrants had been exercised,
and such warrants expired.
The accompanying notes are an integral part of these financial statements.
F-28
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 13 - WARRANTS AND STOCK OPTIONS (CONTINUED)
Warrants (Continued)
- --------
During the years ended December 31, 2001 and 2000, the Company issued warrants
to purchase 8,000 and 2,667 shares, respectively, of restricted common stock to
the Company's prior law firm and a consultant, respectively. The warrants were
exercisable at prices ranging from $4.50 to $30 (fair market value or higher)
per share for one year. Management of the Company determined that no additional
amounts would have been paid to such law firm for services as invoiced services
are paid in cash. Accordingly, the Company did not record legal or consulting
expense. During the years ended December 31, 2001 and 2000, 0 and 2,667
warrants, respectively, were exercised. As of December 31, 2002, none of the
remaining warrants were exercised, and such warrants expired.
During the year ended December 31, 2000, the Company issued warrants to purchase
10,000 shares of common stock to a public relations firm. The warrants were
exercisable at prices ranging from $30 to $60 (fair market value or higher).
Warrants for 4,000 of these shares were restricted. The warrants expired
between six and 12 months from the date of grant. During the years ended
December 31, 2001 and 2000, 4,000, and 6,000 warrants, respectively, expired.
Stock Option Plans
- --------------------
The Company has the following six stock option plans:
- 1996 Incentive and Non-Statutory Stock Option Plan (the "1996 Plan")
- 1997 Incentive and Non-Statutory Stock Option Plan (the "1997 Plan")
- 1998 Incentive and Non-Statutory Stock Option Plan (the "1998 Plan")
- 1999 Incentive and Non-Statutory Stock Option Plan (the "1999 Plan")
- 2000 Incentive and Non-Statutory Stock Option Plan (the "2000 Plan")
- 2002 Stock Option Plan (the "2002 Plan")
The total number of shares of the Company's common stock authorized for issuance
under the 1996 Plan, 1997 Plan, 1998 Plan, 1999 Plan, 2000 Plan (collectively,
the "Prior Plans") and the 2002 Plan are 50,000, 66,667, 93,465, 100,000,
66,667, and 133,333, respectively.
The accompanying notes are an integral part of these financial statements.
F-29
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 13 - WARRANTS AND STOCK OPTIONS (CONTINUED)
Stock Option Plans (Continued)
- --------------------
Under the Prior Plans and the 2002 Plan (collectively, the "Company Plans")
options granted may be either "incentive stock options," within the meaning of
Section 422 of the Internal Revenue Code, or "nonqualified options." Incentive
options granted under the Company Plans must have an exercise price of not less
than the fair market value of a share of common stock on the date of grant
unless the optionee owns more than 10% of the total voting securities of the
Company. In this case, the exercise price will not be less than 110% of the
fair market value of a share of common stock on the date of grant. Incentive
stock options may not be granted to an optionee under any of the Company Plans
if the aggregate fair market value, as determined on the date of grant, of the
stock with respect to which incentive stock options are exercisable by such
optionee in any calendar year under the Company Plans, exceeds $100,000.
Nonqualified options granted under the Prior Plans must have an exercise price
of not less than the fair market value of a share of common stock on the date of
grant. Nonqualified options granted under the 2002 Plan must have an exercise
price of not less than 85% of the fair market value of a share of common stock
on the date of grant.
Under the Prior Plans, options become exercisable over a period of three to five
years from the date of grant, and none of the options granted may be exercisable
prior to one year from the date of grant unless approved by the Board of
Directors. Under the 2002 Plan, options may be exercised during a period of
time fixed by the committee administering the 2002 Plan (which could include the
entire Board of Directors). Options granted under the Company Plans must vest
at a rate not less than 20% per year over a consecutive five-year period. No
option granted under any of the Company Plans may be exercised more than 10
years after the date of grant. Under the 1996 Plan, 1997 Plan, 1998 Plan, and
2002 Plan, incentive stock options granted to an optionee who owns more than 10%
of the voting securities of the Company may not be exercised more than five
years after the date of grant.
In April 1996, the Company issued options to purchase restricted shares of
common stock at $0.15 per share, which was below market, to two employees,
resulting in the Company recording deferred compensation of $124,000, which was
being amortized over five years, the vesting period of the options. During the
year ended December 31, 1997, one of the employees left the Company and
forfeited his options. Accordingly, the Company reversed the deferred
compensation relating to this employee. During the year ended December 31,
2001, 3,333 of these options were exercised.
As of December 31, 2002, 2001, and 2000, the balance of deferred compensation
totaled $0, $0, and $3,100, respectively.
The accompanying notes are an integral part of these financial statements.
F-30
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 13 - WARRANTS AND STOCK OPTIONS (CONTINUED)
Stock Option Plans (Continued)
- --------------------
The following summarizes options and warrants granted and outstanding through
December 31, 2002:
Weighted-
Number of Shares Average
--------------------------- Exercise
Non- Price
Employee Employee Total
---------- ---------- ---------- ----------
Outstanding,
December 31, 1999 40,000 38,572 78,572 $ 34.50
Granted 109,833 37,833 147,666 $ 32.70
Exercised - (5,523) (5,523) $ 9.60
Expired, cancelled - (41,715) (41,715) $ 48.30
---------- ---------- ----------
Outstanding,
December 31, 2000 149,833 29,167 179,000 $ 30.55
Exercised - (833) (833) $ 0.75
Expired, cancelled (7,667) (4,000) (11,667) $ 45.96
---------- ---------- ----------
Outstanding,
December 31, 2001 142,166 24,334 166,500 $ 29.62
Expired, cancelled (20,333) - (20,333) $ 27.59
---------- ---------- ----------
OUTSTANDING,
DECEMBER 31, 2002 121,833 24,334 146,167 $ 29.90
========== ========== ==========
EXERCISABLE,
DECEMBER 31, 2002 83,722 14,556 98,278 $ 28.66
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
F-31
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 13 - WARRANTS AND STOCK OPTIONS (CONTINUED)
Stock Option Plans (Continued)
- --------------------
The following table is a summary of the stock options and warrants as of
December 31, 2002:
Weighted- Weighted-
Average Average
Weighted- Exercise Exercise
Average Price of Price of
Range of Stock Options Remaining Options and Options and
Exercise and Warrants Contractual Warrants Warrants
Prices Outstanding Exercisable Life
- ------------ ----------- ----------- ----------- ----------- ------------
$15.00-29.99 20,000 20,000 0.39 years $ 16.95 $ 16.95
$30.00-44.99 116,500 71,834 2.29 years $ 30.40 $ 30.41
$45.00-52.50 9,667 6,444 2.29 years $ 45.39 $ 45.39
------- -------
146,167 98,278
======= =======
Pro forma information regarding net loss and loss per share is required by SFAS
No. 123 and has been determined as if the Company had accounted for its employee
stock options under the fair value method of SFAS No. 123. The fair value for
these options was estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions for the year ended
December 31, 2000: risk free interest rate of 6.4%, dividend yield of and 0%,
expected volatility of 70%, and expected life of four years. For the year ended
December 31, 2000, 147,666 options were granted. For the years ended December
31, 2002 and 2001, options were not granted.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The accompanying notes are an integral part of these financial statements.
F-32
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 13 - WARRANTS AND STOCK OPTIONS (CONTINUED)
Stock Option Plans (Continued)
- --------------------
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options vesting period. Adjustments are made
for options forfeited prior to vesting. The effect on net loss and basic and
diluted loss per share had compensation costs for the Company's stock option
plans been determined based on a fair value at the date of grant consistent with
the provisions of SFAS No. 123 for the years ended December 31, 2002, 2001, and
2000 is as follows:
2002 2001 2000
---------- ----------- -----------
Net loss
As reported $ (8,347,231) $ (5,547,645) $ (6,410,849)
Pro forma $ (8,656,867) $ (5,789,317) $ (6,790,152)
Basic and diluted loss per share
As reported $ (1.84) $ (1.23) $ (2.44)
Pro forma $ (1.19) $ (1.28) $ (2.58)
NOTE 14 - INCOME TAXES
The components of the income tax provision (benefit) for the years ended
December 31, 2002, 2001, and 2000 were as follows:
2002 2001 2000
---------- ----------- --------------
Current $ (57,362) $ 3,000 $ 2,400
Deferred 1,721,000 - (1,002,000)
---------- ----------- --------------
TOTAL $1,663,638 $ 3,000 $ (999,600)
========== ============ ==============
The accompanying notes are an integral part of these financial statements.
F-33
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 14 - INCOME TAXES (CONTINUED)
Income tax expense (benefit) for the years ended December 31, 2002, 2001, and
2000 differed from the amounts computed applying the federal statutory rate of
34% to pre-tax income as a result of:
2002 2001 2000
------------- -------------- ------------
Computed "expected"
tax benefit $ (2,272,000) $ (1,885,000) $ (2,520,000)
Income in income taxes
resulting from
Expenses not deductible
for tax purposes 12,000 18,000 12,000
Change in beginning of
the year balance of
the valuation allowance
for deferred tax assets
allocated to income tax
expense 4,261,000 2,090,000 1,789,000
State and local income
taxes, net of tax benefit (277,000) (220,000) (280,600)
Other (60,362) - -
------------- -------------- ------------
TOTAL $ 1,663,638 $ 3,000 $ (999,600)
============= =============== =============
Significant components of the Company's deferred tax assets and liabilities for
federal income taxes at December 31, 2002 and 2001 consisted of the following:
2002 2001
------------- -----------
Deferred tax assets
Net operating loss carryforward $ 5,271,000 $ 3,833,000
Allowance for doubtful accounts 134,000 367,000
Allowances for sales returns 157,000 369,000
Allowances for price protection 171,000 747,000
Accrued compensation 86,000 91,000
Amortization of trademarks 1,081,000 964,000
Settlement payable and related accrued
legal expenses 1,971,000 -
Inventory 576,000 423,000
Other 10,000 4,000
Valuation allowance (8,947,000) (4,709,000)
------------- -----------
Total deferred tax assets 510,000 2,089,000
------------- -----------
(continued)
The accompanying notes are an integral part of these financial statements.
F-34
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 14 - INCOME TAXES (CONTINUED)
(continued)
2002 2001
------------- -----------
Deferred tax liabilities
State tax $ 495,000 $ 353,000
Other 15,000 15,000
------------- -----------
Total deferred tax liabilities 510,000 368,000
------------- -----------
- 1,721,000
Less current portion - 1,556,000
------------- -----------
LONG-TERM PORTION $ - $ 165,000
============= ===========
As of December 31, 2002 and 2001, the valuation allowance for deferred tax
assets, totaled approximately $8,947,000 and $4,709,000, respectively. For the
years ended December 31, 2002, 2001, and 2000, the net change in the valuation
allowance was $4,238,000 (increase), $2,129,000 (increase), and $2,270,000
(increase), respectively.
As of December 31, 2002, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $13,750,000. The net operating
loss carryforwards expire through 2022. The utilization of net operating loss
carryforwards may be limited due to the ownership change under the provisions of
Internal Revenue Code Section 382 and similar state provisions.
NOTE 15 - RELATED PARTY TRANSACTIONS
During the years ended December 31, 2002, 2001, and 2000, the Company made
purchases from related parties totaling $12,705,232, $22,031,190, and
$31,004,756, respectively.
Until March 28, 2003, the Company leased its warehouse and office space from a
related party under the control of an officer of the Company. During the years
ended December 31, 2002, 2001, and 2000, the Company made rental payments
totaling $376,607, $529,653, and $667,572, respectively, to this related party.
The accompanying notes are an integral part of these financial statements.
F-35
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
NOTE 16 - SUBSEQUENT EVENTS
Credit Facility
- ----------------
In January 2003, the Company entered into a trade credit facility with a related
party, whereby the related party has agreed to purchase inventory on behalf of
the Company. The agreement allows the Company to purchase up to $10,000,000,
with payment terms of 120 days following the date of invoice by the supplier.
The third party will charge the Company a 5% handling charge on the supplier's
unit price. A 2% discount to the handling fee will be applied if the Company
reaches an average running monthly purchasing volume of $750,000 a month.
Returns made by the Company, which are agreed by the supplier, will result in a
credit to the Company for the handling charge.
As security for the trade facility, the Company will pay the related party a
security deposit of $1,500,000, payable at a rate of $250,000 a week for six
weeks, commencing one week from the date of the agreement. The agreement is for
12 months. At the end of the 12-month period, either party may terminate the
agreement upon 30 days' written notice. Otherwise, the agreement will remain
continuously valid without effecting a new signed agreement. Both parties have
the right to terminate the agreement one year following the inception date by
giving the other party 30 days' written notice of termination.
In February 2003, the Company entered into an agreement with a related party,
whereby the related party will supply and store at the Company's warehouse up to
$10,000,000 of inventory on a consignment basis. Under the agreement, the
Company will insure the consignment inventory, store the consignment inventory
for no charge, and furnish the related party with weekly statements indicating
all products received and sold and the current consignment inventory level. The
agreement may be terminated by either party with 60 days' written notice.
Settlement Agreement
- ---------------------
In March 2003, the Company entered into a settlement agreement with the Vakilis
and others (see Note 10).
The accompanying notes are an integral part of these financial statements.
F-36
I/OMAGIC CORPORATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED STATEMENTS
DECEMBER 31, 2002
================================================================================
SUPPLEMENTAL INFORMATION
F-37
INDEPENDENT AUDITOR'S REPORT ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
I/OMagic Corporation and subsidiary
Santa Ana, California
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The consolidated
supplemental schedule II is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not a part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in our audits of the basic consolidated financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic consolidated financial statements taken as a whole.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
February 14, 2003
F-38
I/O MAGIC CORPORATION
AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNTS - SCHEDULE II
FOR THE YEARS ENDED DECEMBER 31,
================================================================================
Additions Additions
Balance, (Deductions) (Deductions) Balance,
Beginning Charge to from End
of Year Operations Reserve of Year
---------- ---------- ----------- -----------
ALLOWANCE FOR DOUBTFUL ACCOUNTS
DECEMBER 31, 2002 $ 2,679,118 $ 1,300,000 $ (1,843,458) $ 2,135,660
============= ============= ============== ===========
DECEMBER 31, 2001 $ 2,106,518 $ 850,937 $ (278,337) $ 2,679,118
============= ============== =============== ===========
DECEMBER 31, 2000 $ 71,193 $ 2,420,210 $ (384,885) $ 2,106,518
============= ============== =============== ===========
RESERVES FOR OBSOLETE INVENTORY
DECEMBER 31, 2002 $ 558,703 $ 2,070,200 $ (1,582,091) $ 1,046,812
============== ============= =============== ===========
DECEMBER 31, 2001 $ 1,834,427 $ 410,000 $ (1,685,724) $ 558,703
============== ============= =============== ===========
DECEMBER 31, 2000 $ 138,007 $ 2,716,303 $ (1,019,883) $ 1,834,427
============== ============= ============== ===========
F-39
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1 Restated Articles of Incorporation dated January 10, 1996 (1)
3.2 Certificate of Amendment to the Articles of Incorporation dated March
19, 1996 (1)
3.3 Certificate of Designation of Preferred Stock dated October 31, 1996 (1)
3.4 Amended and Restated Certificate of Designation of Series A Cumulative
Preferred Stock dated December 29, 2000 (2)
3.5 Certificate of Designation of Series B Preferred Stock dated January 12,
2001 (2)
3.6 Certificate of Amendment of Articles of Incorporation dated January 12,
2001 (2)
3.7 Amended and Restated Bylaws dated July 25, 2002 (4)
10.1 Employment Agreement by and between I/OMagic Corporation, a California
Corporation, and Tony Shahbaz dated October 22, 1993 (#) (1)
10.2 I/OMagic Corporation 1997 Incentive and Nonstatutory Stock Option
Plan (#) (1)
10.3 Plan of Exchange and Acquisition Agreement by and between Silvercrest
International and I/OMagic Corporation, a California corporation, dated
March 8, 1996 (1)
10.4 I/OMagic Corporation 1998 Incentive and Nonstatutory Stock Option
Plan (#) (1)
10.5 Strategic Alliance Agreement between I/OMagic Corporation and Hou
Electronics, Inc. dated September 19, 1997 (1)
10.7 BTC Acquisition Agreement dated February 3, 1999 (1)
10.8 I/OMagic Corporation 2001 Incentive and Nonstatutory Stock Option
Plan (#) (3)
10.9 Commercial Lease Agreement dated April 1, 2000 between Alex Properties,
a California partnership and IOM Holdings, Inc., a Nevada corporation(4)
10.10 Business Loan Agreement dated April 9, 2002 between I/OMagic
Corporation and ChinaTrust Bank (USA) (4)
10.11 Rider to Business Loan Agreement dated April 9, 2002 between I/OMagic
Corporation and ChinaTrust Bank (USA) (4)
10.12 Change in Terms Agreement dated April 9, 2002 between I/OMagic
corporation and ChinaTrust Bank (USA) (4)
10.13 Employment Agreement dated October 15, 2002 between I/OMagic
Corporation and Tony Shahbaz (#) (5)
10.14 Business Loan Agreement dated December 31, 2002 between I/OMagic
Corporation and ChinaTrust Bank (USA) (4)
10.15 Rider to Business Loan Agreement dated December 31, 2002 between
I/OMagic Corporation and ChinaTrust Bank (USA) (4)
10.16 Change in Terms Agreement dated December 31, 2002 between I/OMagic
Corporation and ChinaTrust Bank (USA) (4)
10.17 Commercial Lease Agreement dated March __, 2003 between I/OMagic
Corporation and Alex Properties, a California partnership
10.18 Agreement dated January 23, 2003 between I/OMagic Corporation and Lung
Hwa Electronics Co., Ltd.
10.19 Agreement dated February 3, 2003 between I/OMagic Corporation and
Behavior Tech Computer Corp. (USA).
10.20 Amended and Restated Settlement and Mutual Release Agreement dated
effective November 5, 2000 between IOM Holdings, Inc. and DRT
Holdings, Inc.
10.21 I/OMagic Corporation 2002 Stock Option Plan (6)
21.1 List of subsidiaries of the Registrant (3)
99.1 Section 906 Certifications of CEO and CFO
___________________________
(#) Management contract or compensatory plan, contract or arrangement
required to be filed as an exhibit.
(1) Incorporated by reference to the Registrant's initial registration
statement on Form 10-SB filed by the Registrant with the Securities and Exchange
Commission on September 8, 1999 (File No. 000-27267).
(2) Incorporated by reference to the Registrant's annual report on Form 10-K
for the year ended December 31, 2000 (File No. 000-27267).
(3) Incorporated by reference to the Registrant's annual report on Form 10-K
for the year ended December 31, 2001 (File No. 000-27267).
(4) Incorporated by reference to the Registrant's quarterly report on Form
10-Q for the quarterly period ended June 30, 2002 (File No. 000-27267).
(5) Incorporated by reference to the Registrant's quarterly report on Form
10-Q for the quarterly period ended September 30, 2002 (File No. 000-27267).
(6) Incorporated by reference to Registrant's definitive proxy statement for
the annual meeting of stockholders to be held November 4, 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act
of 1934, the Registrant has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized on this 15th day of April, 2003.
I/OMAGIC CORPORATION
/s/ Tony Shahbaz
Tony Shahbaz
Chief Executive Officer, President and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ---------------------------------- ----------
/s/ Tony Shahbaz Chief Executive Officer, President April 15, 2003
and Secretary (Principal Executive
Officer)
Tony Shahbaz
/s/ Steve Gillings Chief Financial Officer (Principal April 15, 2003
Accounting and Financial Officer)
Steve Gillings
/s/ Anthony Andrews Director April 15, 2003
Anthony Andrews
/s/ Daniel Hou Director April 14, 2003
Daniel Hou
/s/ Daniel Yao Director April __, 2003
Daniel Yao
- ---------------
Steel Su Director
- ---------------
Young-Hyun Shin Director
CERTIFICATIONS
I, Tony Shahbaz, certify that:
1. I have reviewed this annual report on Form 10-K of I/OMagic Corporation.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 14, 2003
/s/ Tony Shahbaz
Tony Shahbaz,
Chief Executive Officer (principal executive officer)
I, Steve Gillings, certify that:
1. I have reviewed this annual report on Form 10-K of I/OMagic Corporation.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 15, 2003
/s/ STEVE GILLINGS
Steve Gillings,
Chief Financial Officer (principal financial officer)
EXHIBITS FILED WITH THIS REPORT
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.14 Business Loan Agreement dated December 31, 2002 by and between
I/OMagic Corporation and ChinaTrust Bank (USA) (4)
10.15 Rider to Business Loan Agreement dated December 31, 2002 by and
between I/OMagic Corporation and ChinaTrust Bank (USA) (4)
10.16 Change in Terms Agreement dated December 31, 2002 by and between
I/OMagic corporation and ChinaTrust Bank (USA) (4)
10.17 Commercial Lease Agreement dated March __, 2003 between I/OMagic
Corporation and Alex Properties, a California partnership
10.18 Agreement dated January 23, 2003 between I/OMagic Corporation and Lung
Hwa Electronics Co., Ltd.
10.19 Agreement dated February 3, 2003 between I/OMagic Corporation and
Behavior Tech Computer Corp. (USA).
10.20 Amended and Restated Settlement and Mutual Release Agreement dated
effective November 5, 2000 between IOM Holdings, Inc. and DRT
Holdings, Inc.
99.1 Section 906 Certifications of CEO and CFO