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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2009
|_| 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 33-0773180
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
4 MARCONI, IRVINE, CALIFORNIA 92618
(Address of principal executive offices) (Zip Code)
(949) 707-4800
(Registrant's telephone number, including area code)
NOT APPLICABLE.
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T (ss.232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files).
Yes | | No | |
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer"
and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer |_| Accelerated filer |_|
Non-accelerated filer |_| Smaller reporting company |X|
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes | | No |X|
As of October 26, 2009, there were 4,540,292 shares of the issuer's
common stock issued and outstanding.
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CAUTIONARY STATEMENT
All statements included or incorporated by reference in this Quarterly
Report on Form 10-Q, other than statements or characterizations of historical
fact, are "forward-looking statements." Examples of forward-looking statements
include, but are not limited to, statements concerning projected net sales,
costs and expenses and gross margins; our accounting estimates, assumptions and
judgments; the demand for our products; the competitive nature of and
anticipated growth in our industry; and our prospective needs for additional
capital. These forward-looking statements are based on our current expectations,
estimates, approximations and projections about our industry and business,
management's beliefs, and certain assumptions made by us, all of which are
subject to change. Forward-looking statements can often be identified by such
words as "anticipates," "expects," "intends," "plans," "predicts," "believes,"
"seeks," "estimates," "may," "will," "should," "would," "could," "potential,"
"continue," "ongoing," similar expressions and variations or negatives of these
words. These statements are not guarantees of future performance and are subject
to risks, uncertainties and assumptions that are difficult to predict.
Therefore, our actual results could differ materially and adversely from those
expressed in any forward-looking statements as a result of various factors, some
of which are set forth in the "Risk Factors" section of our Annual Report on
Form 10-K for the year ended December 31, 2008, which could cause our financial
results, including our net income or loss or growth in net income or loss to
differ materially from prior results, which in turn could, among other things,
cause the price of our common stock to fluctuate substantially. These
forward-looking statements speak only as of the date of this report. We
undertake no obligation to revise or update publicly any forward-looking
statement for any reason, except as otherwise required by law.
-i-
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements...................................................................................1
Condensed Consolidated Balance Sheets as of September 30, 2009 (unaudited) and
December 31, 2008...................................................................................1
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2009 and 2008 (unaudited).............................................................2
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2009 and 2008 (unaudited).............................................................3
Notes to Condensed Consolidated Financial Statements...................................................4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................15
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...........................................24
Item 4. Controls and Procedures ..............................................................................24
Item 4T. Controls and Procedures ..............................................................................24
PART II
OTHER INFORMATION
Item 1. Legal Proceedings ....................................................................................25
Item 1A. Risk Factors .........................................................................................25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ..........................................25
Item 3. Defaults Upon Senior Securities ......................................................................25
Item 4. Submission of Matters to a Vote of Security Holders ..................................................25
Item 5. Other Information ....................................................................................26
Item 6. Exhibits .............................................................................................26
Signatures ......................................................................................................27
Exhibits Filed with this Report
-ii-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
I/OMAGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2009 2008
------------ ------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 650,696 $ 425,495
Accounts receivable, net 442,498 1,039,595
Inventory, net 1,528,870 1,524,719
Prepaid expenses and other current assets 74,979 101,695
------------ ------------
Total current assets 2,697,043 3,091,504
EQUIPMENT, net 150,082 189,719
TRADEMARKS, net -- --
OTHER ASSETS 44,428 41,928
------------ ------------
TOTAL ASSETS $ 2,891,553 $ 3,323,151
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable, accrued expenses and other $ 309,338 $ 852,994
Accounts payable - related party 4,537,753 4,604,138
Deferred revenue -- 26,400
Capital lease obligations - current portion 25,404 54,942
Accrued mail-in rebates 2,215 24,080
------------ ------------
Total current liabilities 4,874,710 5,562,554
------------ ------------
LONG-TERM LIABILITIES
Sub-lease deposit 9,703 --
Capital lease obligations -- 13,704
------------ ------------
Total long-term liabilities 9,703 13,704
------------ ------------
Total liabilities 4,884,413 5,576,258
------------ ------------
STOCKHOLDERS' DEFICIT
Preferred stock, $0.001 par value, 10,000,000 shares authorized
Series A, 1,000,000 shares authorized, no shares issued and outstanding -- --
Series B, 1,000,000 shares authorized, no shares issued and outstanding -- --
Common stock, $0.001 par value, 100,000,000 shares authorized, 4,540,292 and
4,540,292 shares issued and outstanding, respectively 4,541 4,541
Additional paid-in capital 31,858,651 31,842,567
Accumulated deficit (33,856,052) (34,100,215)
------------ ------------
Total stockholders' deficit (1,992,860) (2,253,107)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 2,891,553 $ 3,323,151
============ ============
See accompanying notes to these consolidated financial statements
-1-
I/OMAGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2009 2008 2009 2008
---------------- ---------------- ---------------- ----------------
NET SALES $ 2,341,777 $ 1,528,404 $ 7,931,873 $ 9,265,370
COST OF SALES 1,653,235 1,661,992 5,338,211 10,038,337
---------------- ---------------- ---------------- ----------------
GROSS PROFIT (LOSS) 688,542 (133,588) 2,593,662 (772,967)
---------------- ---------------- ---------------- ----------------
OPERATING EXPENSES
Selling, marketing and advertising 153,951 179,250 515,173 876,948
General and administrative 461,985 624,260 1,798,970 2,152,944
Depreciation and amortization 13,003 31,186 39,637 97,595
---------------- ---------------- ---------------- ----------------
Total operating expenses 628,939 834,696 2,353,780 3,127,487
---------------- ---------------- ---------------- ----------------
INCOME (LOSS) FROM OPERATIONS 59,603 (968,284) 239,882 (3,900,454)
---------------- ---------------- ---------------- ----------------
OTHER INCOME (EXPENSE)
Interest expense (1,169) (4,798) (1,169) (95,546)
Currency transaction loss -- -- (2,762) (446)
Other income 216 1,059 9,012 4,050
---------------- ---------------- ---------------- ----------------
Total other income (expense) (953) (3,739) 5,081 (91,942)
---------------- ---------------- ---------------- ----------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME
TAXES 58,650 (972,023) 244,963 (3,992,396)
PROVISION FOR INCOME TAXES -- -- 800 800
---------------- ---------------- ---------------- ----------------
NET INCOME (LOSS) $ 58,650 $ (972,023) $ 244,163 $ (3,993,196)
================ ================ ================ ================
BASIC AND DILUTED INCOME (LOSS) PER SHARE $ 0.01 $ (0.21) $ 0.05 $ (0.88)
================ ================ ================ ================
BASIC AND DILUTED WEIGHTED-AVERAGE SHARES
OUTSTANDING 4,540,292 4,540,292 4,540,292 4,540,292
================ ================ ================ ================
See accompanying notes to these condensed consolidated financial statements
-2-
I/OMAGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2009 2008
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 244,163 $(3,993,196)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 39,637 45,899
Amortization of trademarks -- 51,696
Allowance for doubtful accounts (1,053) (145,076)
Allowance for product returns 39,945 (167,069)
Reserves for sales incentives 27,399 24,224
Accrued point-of-sale rebates (156,898) (92,490)
Accrued market development funds, cooperative
advertising costs and cross dock fees (33,418) (331,995)
Allowance for obsolete inventory (245,824) (78,333)
Share-based compensation expense 16,084 38,316
Changes in assets and liabilities (net of dispositions
and acquisitions)
Accounts receivable 721,122 6,984,186
Inventory 241,673 3,340,143
Prepaid expenses and other current assets 26,716 40,562
Other assets (2,500) --
Accounts payable, accrued expenses and other (543,656) (340,453)
Accounts payable - related party (66,385) (2,810,074)
Deferred revenue (26,400) --
Sub-lease deposit 9,703 --
Capital leases (43,242) (33,777)
Accrued mail-in rebates (21,865) (193,905)
----------- -----------
Net cash provided by operating activities 225,201 2,338,658
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Restricted cash -- 341,899
----------- -----------
Net cash provided by investing activities -- 341,899
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net payments on line of credit -- (3,864,942)
----------- -----------
Net cash used in financing activities -- (3,864,942)
----------- -----------
Net increase (decrease) in cash and cash equivalents 225,201 (1,184,385)
Cash and cash equivalents at beginning of period 425,495 1,463,122
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 650,696 $ 278,737
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
INTEREST PAID $ 1,169 $ 95,546
=========== ===========
INCOME TAXES PAID $ 800 $ 800
=========== ===========
See accompanying notes to these condensed consolidated financial statements
-3-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS
Nature of Business
------------------
I/OMagic Corporation, a Nevada corporation ("I/OMagic" or the "Company"),
develops, manufactures through subcontractors or obtains from suppliers, markets
and sells data storage products and other consumer electronics products. The
Company sells its products in the United States and Canada to distributors and
retailers.
Liquidity and Going Concern
---------------------------
The Company generated net income for the nine months ended September 30, 2009 of
$244,163 but experienced losses for the years ended December 31, 2008, 2007,
2006, 2005 and 2004 of $4,252,412, $4,752,974, $202,042, $1,818,250 and
$8,056,864, respectively. At September 30, 2009, the Company had cash and cash
equivalents of $650,696 and as of October 26, 2009, the Company had $735,967 of
cash and cash equivalents and a credit facility limited to $1,500,000.
Accordingly, the Company is presently experiencing a lack of capital and may
have insufficient liquidity to fund its operations for the next twelve months or
less. The Company's consolidated financial statements as of and for the year
ended December 31, 2008 and the accompanying unaudited condensed consolidated
financial statements as of and for the three and nine months ended September 30,
2009 have been prepared on a going concern basis, which contemplates the
realization of assets and satisfaction of liabilities in the normal course of
business. As discussed in this report, the Company has incurred significant
recurring losses, has serious liquidity concerns and may require additional
financing in the foreseeable future. These factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern.
The condensed consolidated financial statements included in this document do not
include any adjustments that might result from the outcome of this uncertainty.
The Company's plans for correcting these deficiencies include ongoing efforts to
bring new products to market and exploring other products with its suppliers and
retailers to sell through its sales channels, negotiating suitable repayment
terms for outstanding obligations owed to the Company's related-party supplier,
seeking new equity capital and new vendor partnerships, timely collection of
existing accounts receivable, and sell-through of inventory currently in the
Company's sales channels. The Company also needs to restructure its operations
to reduce its operating costs. If the Company's capital requirements or cash
flow vary materially from its current projections, if the Company is unable to
successfully negotiate suitable repayment terms for outstanding obligations owed
to a related-party supplier, if the Company is unable to successfully
restructure its operations and lower its operating costs, if the Company is
unable to timely collect its accounts receivable or unable to sell-through
inventory currently in its sales channels as anticipated, or if unforeseen
circumstances occur, the Company may be unable to increase its liquidity and may
require additional financing. In addition, if the Company is unable to bring
successful new products to market soon, the Company may be forced to
substantially curtail its operations.
If the Company incurs future losses, the Company could experience significant
additional shortages of liquidity and its ability to purchase inventory and to
operate its business may be significantly impaired, which could lead to further
declines in its results of operations and financial condition.
The consolidated financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of assets
or the amounts and classification of liabilities that may result from the
inability of the Company to continue as a going concern.
-4-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of the
Company have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission regarding interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for annual financial statements and
should be read in conjunction with the consolidated financial statements for the
year ended December 31, 2008, and notes thereto included in the Company's Annual
Report on Form 10-K, filed with the Securities and Exchange Commission on April
15, 2009. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments, consisting only of
adjustments of a normal recurring nature, necessary for a fair presentation of
the Company's financial position as of September 30, 2009, and its results of
operations for the periods presented. These unaudited condensed consolidated
financial statements are not necessarily indicative of the results to be
expected for the entire year.
The report of the Company's independent registered public accounting firm dated
April 15, 2009 contained in the Company's financial statements as of and for the
year ended December 31, 2008, includes a paragraph that explains that the
Company has incurred significant recurring losses, has serious liquidity
concerns and may require additional financing in the foreseeable future. The
report concludes that these matters, among others, raise substantial doubt about
the Company's ability to continue as a going concern. Reports of independent
auditors questioning a company's ability to continue as a going concern are
generally viewed unfavorably by analysts and investors. This report may make it
difficult for the Company to raise additional financing necessary to grow or
operate its business. The Company urges potential investors to review this
report before making a decision to invest in I/OMagic.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 revenues and expenses during the
reporting period. Actual results could differ materially from those estimates
and assumptions.
The condensed consolidated financial statements include IOM Holdings, Inc.
Intercompany transactions and balances have been eliminated in consolidation. On
February 26, 2009, Articles of Merger were filed with the State of Nevada to
merge the Company's wholly-owned subsidiary, IOM Holdings, Inc., with and into
the Company.
Certain amounts from prior periods have been reclassified to conform with
current period presentation.
NOTE 3 - CONCENTRATION OF RISK
Retailers and distributors
--------------------------
During the nine months ended September 30, 2009, the Company's most significant
retailer and distributors were Staples, D&H Distributing and Tech Data.
Collectively, this retailer and these distributors accounted for 86.7% of the
Company's net sales in the first nine months of 2009. During the nine months
ended September 30, 2008, the Company's most significant retailers and
distributor were Staples, Target, Tech Data and MicroCenter. Collectively, these
retailers and distributor accounted for 77.4% of the Company's net sales in the
first nine months of 2008.
-5-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2009, one of the Company's retailers and two distributors
represented 87.4% of total accounts receivable. As a result of the substantial
amount and concentration of the Company's accounts receivable, if any of its
major distributors or retailers fails to timely pay the Company amounts owed,
the Company could suffer a significant decline in cash flow and liquidity which
would negatively affect the Company's ability to make payments under its credit
facility with Rexford Funding and which, in turn, could adversely affect the
Company's ability to borrow funds to pay its liabilities and to purchase
inventory and sustain its operations.
Related Party
-------------
During the nine months ended September 30, 2009, the Company did not purchase
any inventory from its related party, Behavior Tech Computer Corp. ("BTC"). As
of September 30, 2009, there were $4,537,753 in trade payables outstanding to
BTC. See Note 10 "Accounts Payable and Trade Credit Facilities - Related Party."
NOTE 4 - ACCOUNTS RECEIVABLE
Accounts receivable as of September 30, 2009 and December 31, 2008 consisted of
the following:
SEPTEMBER 30, DECEMBER 31,
2009 2008
----------- -----------
(unaudited)
Accounts receivable $ 1,132,586 $ 1,853,708
Less:Allowance for doubtful accounts -- (1,053)
Allowance for product returns (354,255) (314,310)
Reserve for sales incentives (84,876) (57,477)
Accrued point-of-sale rebates (141,453) (298,351)
Accrued market development funds, cooperative
advertising costs and cross dock fees (109,504) (142,922)
----------- -----------
TOTAL $ 442,498 $ 1,039,595
=========== ===========
NOTE 5 - INVENTORY
Inventory as of September 30, 2009 and December 31, 2008 consisted of the
following:
SEPTEMBER 30, DECEMBER 31,
2009 2008
----------- -----------
(unaudited)
Component parts $ 53,150 $ 154,697
Finished goods--warehouse 656,964 1,076,194
Finished goods--consigned 875,756 596,652
----------- -----------
1,585,870 1,827,543
Less: Allowance for obsolete and slow-moving inventory (57,000) (302,824)
----------- -----------
TOTAL $ 1,528,870 $ 1,524,719
=========== ===========
Consigned inventory is located at the stores and distribution centers of certain
distributors and retailers with which the Company has consignment agreements.
The inventory is owned by the Company until sold by the distributors or
retailers.
-6-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - EQUIPMENT
Equipment as of September 30, 2009 and December 31, 2008 consisted of the
following:
SEPTEMBER 30, DECEMBER 31,
2009 2008
----------- -----------
(unaudited)
Computer equipment and software $ 977,423 $ 977,423
Warehouse equipment 138,065 138,065
Office furniture and equipment 281,155 281,155
Vehicles 74,742 74,742
Leasehold improvements 106,633 106,633
----------- -----------
1,578,018 1,578,018
Less: Accumulated depreciation (1,427,936) (1,388,299)
----------- -----------
TOTAL $ 150,082 $ 189,719
=========== ===========
For the three and nine months ended September 30, 2009 and 2008, depreciation
and amortization expense was $13,033 and $31,186, and $39,637 and $97,595,
respectively.
NOTE 7 - TRADEMARKS
Trademarks as of September 30, 2009 and December 31, 2008 consisted of the
following:
SEPTEMBER 30, DECEMBER 31,
2009 2008
--------- ---------
(unaudited)
Trademarks $ 499,800 $ 499,800
Less: Amortization (499,800) (499,800)
--------- ---------
TOTAL $ -- $ --
========= =========
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142,
the Company performed its required valuation on its Hi-Val(R) and Digital
Research Technologies(R) trademarks for possible impairment as of December 31,
2008. Based on this valuation, the Company determined that there had been a
significant impairment in the value of the trademarks due to no recent sales of
product under the Hi-Val(R) brand and very limited recent sales under the
Digital Research Technologies(R) brand and no sales forecast by the Company in
subsequent periods. Therefore, the Company recorded an impairment of the total
remaining value of the trademarks of $224,088 as of December 31, 2008.
NOTE 8 - LINES OF CREDIT
Silicon Valley Bank
-------------------
On January 29, 2007, the Company entered into a Loan and Security Agreement with
Silicon Valley Bank which provided for a credit facility that was initially used
to pay off the Company's outstanding loan balance as of January 29, 2007 with
GMAC Commercial Finance, which balance was approximately $5.0 million, and was
also used to pay $62,000 of the Company's closing fees in connection with
securing the credit facility.
-7-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On April 18, 2008, the Company entered into a new Loan and Security Agreement
with Silicon Valley Bank which provided for a credit facility based on the
Company's accounts receivable. The Loan and Security Agreement served to amend
and restate the Company's prior Loan and Security Agreement dated January 29,
2007 with Silicon Valley Bank. On April 18, 2008, the Company also entered into
an Amendment to Loan Documents with Silicon Valley Bank, which provided that the
ancillary loan documents executed in connection with the Company's prior credit
facility with Silicon Valley Bank would apply to the new Loan and Security
Agreement.
The new credit facility allowed the Company to finance its accounts receivable
and borrow up to a maximum aggregate amount of $7.0 million; provided, that the
Company could only borrow up to a limit of 60% of each eligible account or such
other percentage as Silicon Valley Bank established. The credit facility was to
expire on January 29, 2009. Advances under the credit facility bore interest at
a floating rate equal to the prime rate published from time to time by Silicon
Valley Bank plus 2.5%. The credit facility required that the Company pay a
collateral handling fee of $2,000 per month and other customary fees and
expenses.
The Company's obligations under the Loan and Security Agreement were secured by
substantially all of its assets and were guaranteed by IOM Holdings, Inc. under
a Cross-Corporate Continuing Guaranty. The Company's obligations and the
guarantee obligations of IOM Holdings, Inc. were also secured under Intellectual
Property Security Agreements executed by the Company and IOM Holdings, Inc.
On July 31, 2008, the Company paid off its obligations owed under its Loan and
Security Agreement dated April 18, 2008 with Silicon Valley Bank and terminated
the Loan and Security Agreement.
Rexford Funding
---------------
On October 29, 2008, the Company entered into a Sale of Accounts and Security
Agreement (the "Agreement") dated as of October 24, 2008 with Rexford Funding,
LLC ("Lender"), which provides for an accounts receivable-based credit facility.
The credit facility allows the Company to sell accounts receivable to Lender
subject to a maximum advance amount equal to $1.5 million. The purchase price
for each purchased account is to equal the net invoice amount less Lender's
commission. Lender is entitled to a factoring commission equal to 0.033% of the
gross invoice amount of each purchased account receivable and an additional
0.033% for each day the account receivable remains outstanding and unpaid.
Lender, in its sole and absolute discretion, may from time to time advance the
Company funds against the purchase price of the accounts receivable in an amount
of up to 75% (except as to accounts receivable of Staples which shall be up to
60%) of the aggregate purchase price of the purchased accounts receivable,
subject to customary reductions, including those based on (i) disputed accounts
receivable, (ii) any accounts receivable from a customer whom Lender deems not
credit worthy, (iii) any accounts receivable unpaid in excess of 60 days, (iv)
any accounts receivable from a past-due customer when 25% or more accounts
receivable from that customer are unpaid in excess of 60 days, (v) any accounts
receivable which Lender deems, in its sole and absolute discretion, are
ineligible, and (vi) any fees, actual or estimated, that are chargeable to the
Company's reserve account as to the credit facility. Lender is entitled to
interest charges on all advances at a rate equal to the Prime Rate plus 1.00%,
but in no case less than 5.50%.
The Agreement had an initial term through April 30, 2009 and had automatic six
month extensions unless either party terminated the Agreement at least 60 but
not more than 90 days prior to the end of the initial term or any renewal term.
At all times Lender had the right to terminate the Agreement upon 30 days prior
notice. In August 2009, the Company agreed with Lender that the Agreement would
have a month-to-month term.
-8-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
If the Company terminates the Agreement prior to the end of the term, it will be
subject to an early termination fee equal to Lender's average monthly commission
and/or deficiency charges for the preceding term, pro rated for the time
remaining in the term.
The obligations of the Company under the Agreement are secured by the Company's
accounts receivable and all proceeds thereof and, with respect thereto, all
chattel paper, commercial tort claims, deposit accounts, documents, general
intangibles, goods, letters of credit, letter of credit rights and all
supporting obligations. The Agreement also contains other customary
representations, warranties, covenants and terms and conditions.
NOTE 9 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses as of September 30, 2009 and December 31,
2008 consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2009 2008
--------------- ---------------
(unaudited)
Trade accounts payable $ 209,955 $ 565,804
Accrued compensation and related benefits 75,375 121,998
Other 24,008 165,192
--------------- ---------------
TOTAL $ 309,338 $ 852,994
=============== ===============
NOTE 10 - ACCOUNTS PAYABLE AND TRADE CREDIT FACILITIES - RELATED PARTY
In February 2003, the Company entered into a Warehouse Services and Bailment
Agreement with BTC USA. Under the terms of the agreement, BTC USA agreed to
supply and store at the Company's warehouse up to $10.0 million of inventory on
a consignment basis. The Company was responsible for insuring the consigned
inventory, storing the consigned inventory for no charge, and furnishing BTC USA
with weekly statements indicating all products received and sold and the current
level of consigned inventory. The agreement also provided the Company with a
trade line of credit of up to $10.0 million with payment terms of net 60 days,
without interest. The agreement could be terminated by either party upon 60
days' prior written notice to the other party. BTC USA is a subsidiary of BTC,
one of the Company's significant stockholders. Mr. Steel Su, a former director
of I/OMagic, is the Chief Executive Officer of BTC. For the nine months ended
September 30, 2009, the Company made no purchases under this arrangement. As of
September 30, 2009, there were $4.5 million in trade payables outstanding under
this arrangement. As of October 26, 2009, the Company was out of compliance with
the payment terms of its agreement with BTC and the Company is in continued
negotiations with BTC USA to satisfy its obligations on a basis that is
acceptable to both parties. The Company does not currently utilize this trade
credit facility as BTC USA is either not able to supply certain products the
Company currently sells, or in some cases, the Company is able to source certain
products at better prices directly from other third-party manufacturers.
Additionally, due to substantial outstanding obligations owed to BTC, it is
highly unlikely that the Company will be able to obtain additional inventory
supplies from BTC unless, and at least until, the Company is able to negotiate
repayment terms acceptable to BTC. Even if the Company is able to negotiate
repayment terms acceptable to BTC, the Company may be unable to obtain
additional inventory supplies from BTC on the same terms as before, on
satisfactory terms, or at all.
-9-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
---------------------------
The Company leases its facilities under non-cancelable operating lease
agreements expiring through December 31, 2012. The Company has the right to
extend the lease for one three-year period under the same terms and conditions,
except that the base rent for each year during the option period is to increase
at the rate of three percent per annum.
On July 6, 2009, the Company executed a sub-lease for approximately 30% of its
facility to a sub-tenant for a period of 18 months with an option to renew for
an additional 22 months. The total amount of minimum rentals to be received
under the sub-lease for the initial 18 month period is $160,578. In addition to
the base rent, the sub-tenant also pays its proportionate share of the monthly
operating expenses related to the facilities.
Capital Lease Obligations
-------------------------
The Company entered into various lease agreements during 2007 to acquire certain
equipment.
Other Contractual Obligations
-----------------------------
During its normal course of business, the Company has made commitments under
which it will or may be required to make payments in relation to certain
transactions. These include lease, service and retail agreements and employment
contracts. See "Note 11--Commitments and Contingencies" in the Company's Annual
Report on Form 10-K for the year ended December 31, 2008.
Financial Agreements
--------------------
The Company entered into a Loan and Security Agreement in January 2007 which
provided for a loan commitment fee of $50,000, a monthly collateral monitoring
fee of $1,250 and an anniversary fee of $50,000. In April 2008, the Company
entered into a new Loan and Security Agreement. The Loan and Security Agreement
was terminated in July 2008.
On October 29, 2008, the Company entered into a Sale of Accounts and Security
Agreement dated as of October 24, 2008 with Rexford Funding, LLC which provides
for an accounts receivable-based credit facility.
Service Agreements
------------------
Periodically, the Company enters into various agreements for services including,
but not limited to, public relations, financial consulting, sales consulting and
manufacturing consulting. The agreements generally are ongoing until such time
as they are terminated. Compensation for services is paid either on a fixed
monthly rate or based on a percentage, as specified. These expenses are included
in operating expenses in the accompanying consolidated statements of operations.
Legal Matters
-------------
On or about May 30, 2003, the Company and IOM Holdings, Inc. filed a complaint
for breach of contract and legal malpractice against Lawrence W. Horwitz,
Gregory B. Beam, Horwitz & Beam, Inc., Lawrence M. Cron, Horwitz & Cron, Kevin
J. Senn and Senn Palumbo Meulemans, LLP, the Company's former attorneys and
their respective law firms, in the Superior Court of the State of California for
the County of Orange. The complaint sought damages of $15.0 million arising out
of the defendants' representation of the Company and IOM Holdings, Inc. in an
acquisition transaction and in a separate arbitration matter. On or about
November 6, 2003, the Company filed its First Amended Complaint against all
defendants. Defendants responded to the First Amended Complaint denying the
-10-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company's allegations. Defendants Lawrence W. Horwitz and Lawrence M. Cron also
filed a Cross-Complaint against I/OMagic for attorneys' fees in the approximate
amount of $79,000. The Company denied the allegations in the Cross-Complaint.
Trial began on February 6, 2006 and on March 10, 2006, the jury ruled in the
Company's favor against Lawrence W. Horwitz, Horwitz & Beam, Inc., Lawrence M.
Cron, Horwitz & Cron and Senn Palumbo Meulemans, LLP, and awarded the Company
$3.0 million in damages. Judgment was entered on or about April 5, 2006.
Thereafter, defendants filed a motion for new trial and a motion for judgment
notwithstanding the verdict. On May 31, 2006, the Court denied the motion for
new trial in its entirety, denied the motion for judgment notwithstanding the
verdict as to Lawrence W. Horwitz, Horwitz & Beam, Inc. and Lawrence M. Cron,
but granted the motion for judgment notwithstanding the verdict as to Horwitz &
Cron and Senn Palumbo Meulemans, LLP. An Amended Judgment Notwithstanding, the
Verdict based upon the Court's ruling on the motion for judgment notwithstanding
the verdict was entered on or about July 7, 2006. Thereafter, appeals were filed
as to both the original Judgment and the Amended Judgment. On March 27, 2008,
the Court of Appeal issued an opinion against the Company as to all defendants,
which reversed the Judgments in the Company's favor as to Lawrence W. Horwitz,
Horwitz & Beam, Inc. and Lawrence M. Cron. The Court of Appeal also ordered that
the Company was to pay defendants' costs on appeal. The Company paid the
defendants' claim for costs.
In addition to the matter described above, the Company may be 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, results of
operations or cash flows.
NOTE 12 - SHARE-BASED COMPENSATION
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), SHARE-BASED
PAYMENT, which requires the measurement and recognition of compensation expense
for all share-based payment awards made to employees and directors based on
estimated fair values. SFAS No. 123(R) supersedes the Company's previous
accounting under Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES. In March 2005, the Securities and Exchange Commission
issued Staff Accounting Bulletin ("SAB") No. 107 relating to SFAS No. 123(R).
The Company has also applied the provisions of SAB No. 107 in its adoption of
SFAS No. 123(R).
The Company has a 2002 Stock Option Plan (the "2002 Plan") and a 2003 Stock
Option Plan (the "2003 Plan"). The 2002 Plan and 2003 Plan are collectively
referred to as the "Plans." The total number of shares of the Company's common
stock authorized for issuance under the 2002 Plan and the 2003 Plan are 133,334,
and 400,000, respectively. The Plans are more fully described in the Company's
Annual Report on Form 10-K for the year ended December 31, 2008.
As of September 30, 2009, there were options to acquire 133,325 shares of common
stock issued to employees and directors that were outstanding under the Plans.
-11-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The weighted-average exercise prices, remaining contractual lives and aggregate
intrinsic values for options and warrants granted, exercisable, and expected to
vest under the Plans as of September 30, 2009 were as follows:
WEIGHTED-
WEIGHTED- AVERAGE
AVERAGE REMAINING
NUMBER OF EXERCISE CONTRACTUAL INTRINSIC
OPTIONS SHARES PRICE LIFE (YEARS) VALUE(1)
--------------------- ------------- ------------- ------------ -----------------
Outstanding 133,325 $ 2.77 1.01 $ 368,888
Expected to vest 133,325 $ 2.77 1.01 $ 368,888
Exercisable 133,325 $ 2.77 1.01 $ 368,888
----------
(1) Awards that are expected to vest take into consideration estimated
forfeitures for awards not yet vested.
There were no options granted during the nine months ended September 30, 2009
and 2008. No cash was received from the exercise of stock options for the nine
months ended September 30, 2009 and 2008. As of September 30, 2009, there was no
unrecognized compensation costs related to non-vested share-based compensation
arrangements.
Share-based compensation expense was $16,084 and $38,316 for the nine months
ended September 30, 2009 and 2008, respectively. There was no tax deduction for
share-based compensation expense during those periods. When options are
exercised, the Company's policy is to issue new shares to satisfy share option
exercises.
The Company expenses share-based compensation in cost of goods sold or operating
expenses depending on the job function of the employee.
NOTE 13 - INCOME TAXES
The Company is required to file federal and state income tax returns in the
United States. The preparation of these tax returns requires the Company to
interpret the applicable tax laws and regulations in effect in such
jurisdictions, which could affect the amount of tax paid by the Company. The
Company, in consultation with its tax advisors, bases its tax returns on
interpretations that are believed to be reasonable under the circumstances. The
tax returns, however, are subject to routine reviews by the various federal and
state taxing authorities in the jurisdictions in which the Company files its
returns. As part of these reviews, a taxing authority may disagree with respect
to the tax positions taken by the Company ("uncertain tax positions") and
therefore require the Company to pay additional taxes. The Company prepares an
accrual for uncertain tax positions as more definitive information becomes
available from taxing authorities, completion of tax audits, expiration of
statute of limitations, or upon occurrence of other events. With few exceptions,
the Company is no longer subject to United States federal, state or local, or
non-United States income tax examination by tax authorities for tax years before
2001.
Prior to January 1, 2007, the Company analyzed and determined no accrual was
required for uncertain tax positions based upon SFAS No. 5, ACCOUNTING FOR
CONTINGENCIES, which requires the Company to accrue for the estimated additional
amount of taxes for the uncertain tax positions if it was probable the Company
would be required to pay such additional taxes. Effective January 1, 2007, the
Company adopted and implemented the provisions of Financial Accounting Standards
Board ("FASB") Interpretation No. ("FIN") 48, ACCOUNTING FOR UNCERTAINTY IN
-12-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INCOME TAXES, which requires the Company to accrue for the estimated additional
amount of taxes for the uncertain tax positions if it is more likely than not
that the Company would be required to pay such additional taxes. As a result of
the implementation of FIN 48, the Company recognized no charge for uncertain tax
positions.
SFAS No. 109, ACCOUNTING FOR INCOME TAXES, requires that a valuation allowance
be established when it is more likely than not that its recorded net deferred
tax asset will not be realized. In determining whether a valuation allowance is
required, a company must take into account all positive and negative evidence
with regard to the utilization of a deferred tax asset. SFAS No. 109 further
states that it is difficult to conclude that a valuation allowance is not needed
when there is negative evidence such as cumulative losses in recent years. As of
September 30, 2009 and December 31, 2008, the valuation allowance for deferred
tax assets totaled approximately $16,443,000 and $16,543,000, respectively. For
the nine month periods ended September 30, 2009 and 2008, the net change in the
valuation allowance was approximately $100,000 (decrease) and $1,836,000
(increase), respectively.
The Company plans to continue to provide a full valuation allowance on future
tax benefits until it can sustain an appropriate level of profitability and
until such time, the Company would not expect to recognize any significant tax
benefits in its future results of operations.
As of September 30, 2009, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $38,566,000 and
$27,750,000, respectively, that expire through 2028 and 2018, respectively. The
utilization of net operating loss carryforwards may be limited under the
provisions of Internal Revenue Code Section 382 and similar state provisions due
to the change in ownership.
FIN 48 not only impacts the amount of the Company's accrual for uncertain tax
positions but it also impacts the manner in which such accruals should be
classified in the Company's financial statements. In connection with the
implementation of FIN 48, and if an accrual is recorded, the Company will record
the aggregate accrual for uncertain tax positions as a component of current or
non-current income tax payable and the offsetting amounts as a component of the
Company's net deferred tax assets and liabilities.
The Company's continuing practice is to recognize interest and/or penalties
related to income tax matters in income tax expense. As of September 30, 2009
and December 31, 2008, the Company had no accrual for the payment of interest
and penalties
NOTE 14 - LOSS PER SHARE
Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. Options with an exercise price in excess of the average
market value of the Company's common stock during the period have been excluded
from the calculation as their effect would be antidilutive. Additionally,
potentially dilutive securities are excluded from the computation of earnings
per share in periods in which a net loss is reported as their effect would be
antidilutive. Thus, both basic and diluted weighted-average shares outstanding
are the same in all periods presented.
NOTE 15 - SEGMENT INFORMATION
The Company currently operates in one business segment, consumer electronics.
All fixed assets are located at the Company's headquarters in the United States.
All sales for the nine months ended September 30, 2009 were in the United
States.
-13-
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - RECENT ACCOUNTING PRONOUNCEMENTS
In April 2008, the FASB issued FASB Staff Position ("FSP") SFAS 142-3,
DETERMINATION OF THE USEFUL LIFE OF INTANGIBLE ASSETS ("FSP SFAS 142-3"), which
amends the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under FASB Statement No. 142 GOODWILL AND OTHER INTANGIBLE ASSETS. FSP SFAS
142-3 is effective for fiscal years beginning on or after December 15, 2008,
which for the Company is the first quarter of fiscal year 2009. The Company has
determined that the adoption of FSP SFAS 142-3 had no impact on its consolidated
financial statements.
In March 2008, the FASB issued SFAS No. 161, DISCLOSURES ABOUT DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES-AN AMENDMENT OF FASB STATEMENT NO. 133 ("SFAS
161"). SFAS 161 updates guidance regarding disclosure requirements for
derivative instruments and hedging activities. SFAS 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, which for the Company is the first quarter of fiscal year
2009. The adoption of SFAS No. 161 will change the Company's accounting
treatment for disclosure of derivative instruments and hedging activities on a
prospective basis beginning January 1, 2009.
In December 2007, the FASB issued SFAS No. 141 (R), BUSINESS COMBINATIONS. SFAS
No. 141(R) requires an entity to recognize the assets acquired, liabilities
assumed, contractual contingencies, and contingent consideration at their fair
value on the acquisition date. It also requires acquisition-related costs to be
expensed as incurred, restructuring costs to generally be expensed in periods
subsequent to the acquisition date, and changes in accounting for deferred tax
asset valuation allowances and acquired income tax uncertainties after the
measurement period impact income tax expense. The adoption of SFAS No. 141(R)
will change the Company's accounting treatment for business combinations on a
prospective basis beginning January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, NONCONTROLLING INTERESTS IN
CONSOLIDATED FINANCIAL STATEMENTS. SFAS No. 160 changes the accounting and
reporting for minority interests, which will be characterized as non-controlling
interests and classified as a component of equity. SFAS No. 160 is effective for
the Company on a prospective basis in the first quarter of fiscal year 2009. The
Company has determined that the adoption of SFAS No. 160 had no impact on its
consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, THE FAIR VALUE OPTION FOR
FINANCIAL ASSETS AND FINANCIAL LIABILITIES. SFAS No. 159 permits entities to
choose to measure, on an item-by-item basis, specified financial instruments and
certain other items at fair value. Unrealized gains and losses on items for
which the fair value option has been elected are required to be reported in
earnings at each reporting date. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007, the provisions of which are required to be
applied prospectively. The Company adopted SFAS No. 159 in the first quarter of
2008. The adoption of SFAS No. 159 did not have a material effect on the
Company's financial position, results of operations or cash flows for the first
nine months of 2009 and the Company has made no election under SFAS No. 159.
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS, which
defines the fair value, establishes a framework for measuring fair value and
expands disclosures about fair value measurements. This statement is effective
for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. In February 2008, the FASB
issued FASB Staff Position 157-2, EFFECTIVE DATE OF FASB STATEMENT 157, which
deferred the effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008 for nonfinancial assets and nonfinancial liabilities. Early
adoption is encouraged, provided that the Company has not yet issued financial
statements for that fiscal year, including any financial statements for an
interim period within that fiscal year. The Company adopted SFAS No. 157
effective January 1, 2008. The adoption of SFAS No. 157 had no material impact
on the Company's accounting or disclosure as to its assets and liabilities at
September 30, 2009 and did not materially affect the Company's financial
position, results of operations or cash flows for the first nine months of
2009. The Company will continue to make an evaluation of the fair value of its
assets and liabilities as of the end of each future reporting period.
-14-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 2009 AND THE RELATED NOTES AND THE OTHER FINANCIAL
INFORMATION INCLUDED ELSEWHERE IN THIS REPORT. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS REGARDING THE DATA STORAGE AND DIGITAL ENTERTAINMENT
INDUSTRIES AND OUR EXPECTATIONS REGARDING OUR FUTURE PERFORMANCE, LIQUIDITY AND
FINANCIAL RESOURCES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
EXPRESSED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF ANY NUMBER OF
FACTORS, INCLUDING THOSE SET FORTH UNDER THE "RISK FACTORS" SECTION OF OUR
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2008 AND ELSEWHERE IN
THIS REPORT.
OVERVIEW
We sell data storage products and other consumer electronics products.
We also sold televisions, most of which were high-definition televisions, or
HDTVs, utilizing liquid crystal display, or LCD, technology, in the first
quarter of 2008. Our data storage products collectively accounted for
approximately 99% of our net sales for the first nine months of 2009 and our
other consumer electronics products collectively accounted for approximately 1%
of our net sales in the first nine months of 2009.
Our data storage products consist of a range of products that store
traditional personal computer data as well as movies, music, photos, video games
and other multi-media content. Our other consumer electronics products consist
of a range of products that focus on digital movies, music and photos.
We sell our products through computer, consumer electronics and office
supply superstores, wholesale clubs, distributors, and other major North
American retailers. Our network of retailers enables us to offer products to
consumers across North America, including every major metropolitan market in the
United States. During the first nine months of 2009, our most significant
retailer and distributors were Staples, D&H Distributing and Tech Data.
Collectively, this retailer and these distributors accounted for 86.7% of our
net sales for the first nine months of 2009, or 45.7%, 31.8% and 9.2%,
respectively. During the first nine months of 2008, our most significant
retailers and distributor were Staples, Target, Tech Data and MicroCenter.
Collectively, these retailers and distributor accounted for 77.4% of our net
sales during that period.
We market our products primarily under our I/OMagic(R) brand name, but
from time to time, we also market products under our Digital Research
Technologies(R) and Hi-Val(R) brand names. We sell our data storage products
primarily under our I/OMagic(R) brand name, bundling various hardware devices
with different software applications to meet a range of consumer needs.
We do not directly manufacture any of the components incorporated into
products that we sell. We subcontract the manufacturing of the majority of our
products or source our products from Asia, predominantly from China and Taiwan,
which allows us to offer products at highly competitive prices. Most of our
subcontract manufacturers and suppliers have substantial product development
resources and facilities, and are among the major component manufacturers and
suppliers in their product categories, which we believe affords us substantial
flexibility in offering new and enhanced products.
-15-
RECENT DEVELOPMENTS
As of October 26, 2009, we had $735,967 of cash and cash equivalents.
Accordingly, we continue to experience a lack of liquidity and may have
insufficient capital to fund our operations for the next twelve months or less.
If our capital requirements or cash flow vary materially from our current
projections, if we are unable to timely collect our accounts receivable or
unable to sell-through inventory currently in our sales channels as anticipated,
or if unforeseen circumstances occur, we may be unable to increase our
liquidity. If we are unable to increase our liquidity, we will experience a
material adverse effect on our ability to operate our business. These factors,
among others, raise substantial doubt about our ability to continue as a going
concern and our independent registered public accounting firm has issued a
report expressing substantial doubt about our ability to continue as a going
concern.
Sales of our magnetic data storage products continue to decline and we
are no longer developing new magnetic data storage products because of the
intense price competition from major competitors such as Western Digital and
Seagate Technology/Maxtor who are original equipment manufacturers of hard disk
drives. Due to this intense price competition, we may not be able to sell our
remaining inventory of magnetic data storage products at positive gross margins.
We are unable to predict whether the market for and selling prices of magnetic
data storage products will stabilize, increase or further decline in the future,
or whether we will develop new magnetic data storage products. In response to
these market conditions, and also as part of our ongoing efforts to bring new
products to market, we are currently exploring other products with our suppliers
and retailers to sell through our sales channels.
Behavior Tech Computer Corp. and its affiliated companies, or BTC, one
of our significant stockholders, provided us with significantly preferential
trade credit terms. These terms included extended payment terms, a substantial
trade line of credit and other preferential buying arrangements. We believe that
these terms were substantially better terms than we could likely obtain from
other subcontract manufacturers or suppliers. We do not currently utilize this
trade credit facility as BTC is either not able to supply certain products we
currently sell, or in some cases, we are able to source certain products at
better prices directly from other third-party manufacturers. Additionally, due
to substantial outstanding obligations owed to BTC, it is highly unlikely that
we will be able to obtain additional inventory supplies from BTC unless, and at
least until, we are able to negotiate repayment terms acceptable to BTC. Even if
we are able to negotiate repayment terms acceptable to BTC, we may be unable to
obtain additional inventory supplies from BTC on the same terms as before, on
satisfactory terms, or at all. See "--Liquidity and Capital Resources."
CRITICAL ACCOUNTING POLICIES
The preparation of our financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America, requires us to make judgments and estimates that may have a
significant impact upon the portrayal of our financial condition and results of
operations. We believe that of our significant accounting policies, the
following require estimates and assumptions that require complex, subjective
judgments by management that can materially impact the portrayal of our
financial condition and results of operations: going concern assumption, revenue
recognition; sales incentives; market development funds and cooperative
advertising costs, rebate promotion costs and slotting fees; inventory
obsolescence allowance; lower-of-cost-or-market reserve; accounts receivable and
allowance for doubtful accounts; and product returns. These significant
accounting principles are more fully described in "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Critical Accounting
Policies" in our Annual Report on Form 10-K for the year ended December 31,
2008.
-16-
RESULTS OF OPERATIONS
The tables presented below, which compare our results of operations
from one period to another, present the results for each period, the change in
those results from one period to another in both dollars and percentage change
and the results for each period as a percentage of net sales. The columns
present the following:
o The first two data columns in each table show the dollar
results for each period presented.
o The columns entitled "Dollar Variance" and "Percentage
Variance" show the change in results, both in dollars and
percentages. These two columns show favorable changes as
positive and unfavorable changes as negative. For example,
when our net sales increase from one period to the next, that
change is shown as a positive number in both columns.
Conversely, when expenses increase from one period to the
next, that change is shown as a negative in both columns.
o The last two columns in each table show the results for each
period as a percentage of net sales.
THREE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2008 (UNAUDITED)
Three Months Ended Percentage Results as a
September 30, Dollar Variance Variance Percentage of
---------------------- Favorable Favorable Net Sales
2009 2008 (Unfavorable) (Unfavorable) 2009 2008
------- -------- --------------- ------------- -------- --------
(in thousands)
Net sales $ 2,342 $ 1,528 $ 814 53.3% 100.0% 100.0%
Cost of sales 1,653 1,662 9 0.5% 70.6% 108.8%
------- ------- ------- -------- -------- --------
Gross profit (loss) 689 (134) 823 614.2% 29.4% (8.8)%
Selling, marketing and
advertising expenses 154 179 25 14.0% 6.6% 11.7%
General and administrative
expenses 462 624 162 26.0% 19.7% 40.8%
Depreciation and amortization 13 31 18 58.1% 0.5% 2.0%
------- ------- ------- -------- -------- --------
Operating income (loss) 60 (968) 1,028 106.2% 2.6% (63.4)%
Net interest expense (1) (5) 4 80.0% --% 0.3%
Other income -- 1 (1) 100.0% --% 0.1%
------- ------- ------- -------- -------- --------
Income (loss) from operations
before provision for income
taxes 59 (972) 1,031 106.1% 2.5% (63.6)%
Income tax provision -- -- -- --% --% --%
------- ------- ------- -------- -------- --------
Net income (loss) $ 59 $ (972) $ 1,031 106.1% 2.5% (63.6)%
======= ======= ======= ======== ======== ========
NET SALES. Net sales increased by $814,000, or 53%, to $2,342,000 in
the third quarter of 2009 as compared to $1,528,000 in the third quarter of
2008. A combination of factors caused the increase in our net sales, including
an increase in sales of our optical data storage products by 60% to $2.2
million, or 94% of net sales, for the third quarter of 2009, as compared to $1.4
million, or 89% of net sales, for the third quarter of 2008, while the average
unit net sales price of our optical drives for the third quarter of 2009
increased by 18% to $56.27 compared to $47.78 for the third quarter of 2008 and
-17-
our net units sold increased by 36% in the third quarter of 2009 compared to the
third quarter of 2008. These increases were offset by a $34,000, or 20%,
decrease in sales of our magnetic data storage products across the same periods.
Sales of our magnetic data storage products totaled $137,000, or 6% of net
sales, for the third quarter of 2009, as compared to $171,000, or 11% of net
sales, for the third quarter of 2008.
In addition, our overall product return rate was 13.7% in the third
quarter of 2009 compared to 16.5% in the third quarter of 2008. The decrease in
our overall product return rate is a result of no returns of HDTVs in the third
quarter of 2009 compared to the number of HDTVs returned in the third quarter of
2008. Also, sales incentives, point-of-sale rebates, market development funds,
cooperative advertising costs and cross-dock fees, rebate promotion costs and
slotting fees, collectively as a percentage of gross sales, decreased to 7%, all
of which were offset against gross sales, in the third quarter of 2009, as
compared to 19% in the third quarter of 2008. The decrease in our overall rate
of sales incentives, point-of-sale rebates, market development funds,
cooperative advertising costs and cross-dock fees, rebate promotion costs and
slotting fees resulted primarily from a decrease in sales incentives associated
with our optical data storage products due to better market positioning for
these products in the third quarter of 2009 as compared to the third quarter of
2008.
GROSS PROFIT (LOSS). Gross profit increased by $823,000, or 614%, to
$689,000 in the third quarter of 2009 as compared to a gross loss of $134,000
in the third quarter of 2008. The increase in gross profit primarily resulted
from increased operating margins on our optical data storage products and from
lower cost of sales for our magnetic data storage products resulting from
inventory valuation write-downs in prior periods. Our gross profit margin as a
percentage of net sales increased to 29% in the third quarter of 2009 as
compared to a gross loss margin of 9% in the third quarter of 2008.
SELLING, MARKETING AND ADVERTISING EXPENSES. Selling, marketing and
advertising expenses decreased by $25,000, or 14%, to $154,000 in the third
quarter of 2009 as compared to $179,000 in the third quarter of 2008. This
decrease was primarily due to decreases of $31,000 in personnel costs, $9,000 in
shipping and handling costs which resulted from shipment consolidations, $5,000
in sales expenses, $5,000 in system support costs and $3,000 in customer
refunds, all of which were partially offset by increases of $17,000 in outside
commissions, $9,000 in trade show expenses, $1,000 in supplies and $1,000 in
travel and entertainment expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses decreased by $162,000, or 26%, to $462,000 in the third quarter of 2009
as compared to $624,000 in the third quarter of 2008. This decrease was
primarily due to decreases of $72,000 in personnel costs, $36,000 in facilities
costs, $17,000 in insurance costs, $17,000 in legal fees, $14,000 in directors'
fees, $8,000 in temporary staffing costs, $8,000 in financial relations
expenses, $5,000 in travel and entertainment expenses, $4,000 in audit fees,
$4,000 in bank charges, $3,000 in technical support costs and $1,000 in system
support costs, all of which were partially offset by increases of $15,000 in
outside services costs, $8,000 in miscellaneous income, $3,000 in finance and
bank charges and $1,000 in supplies costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
decreased in the third quarter of 2009 as compared to the third quarter of 2008
as a result of the impairment of trademarks at December 31, 2008.
NET INTEREST EXPENSE. Net interest expense decreased by $1,000, or
100%, in the third quarter of 2009 as compared to the third quarter of 2008.
This decrease primarily resulted from the termination of our prior line of
credit on July 31, 2008. Financing charges related to the credit facility with
Rexford Funding are included as finance charges in general and administrative
expenses.
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OTHER INCOME. Other income decreased by $1,000, or 100%, in the third
quarter of 2009 as compared to the third quarter of 2008.
NINE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2008 (UNAUDITED)
Nine Months Ended Percentage Results as a
September 30, Dollar Variance Variance Percentage of
---------------------- Favorable Favorable Net Sales
2009 2008 (Unfavorable) (Unfavorable) 2009 2008
------- -------- --------------- ------------- -------- --------
Net sales $ 7,932 $ 9,265 $ (1,333) (14.4)% 100.0% 100.0%
Cost of sales 5,338 10,038 4,700 46.8% 67.3% 108.3%
-------- -------- -------- -------- -------- --------
Gross profit (loss) 2,594 (773) 3,367 435.6% 32.7% (8.3)%
Selling, marketing and
advertising expenses 515 877 362 41.3% 6.5% 9.5%
General and administrative
expenses 1,799 2,153 354 16.4% 22.7% 23.2%
Depreciation and amortization 40 97 57 58.8% 0.5% 1.0%
-------- -------- -------- -------- -------- --------
Operating income (loss) 240 (3,900) 4,140 106.2% 3.0% (42.1)%
Net interest expense (1) (96) 95 99.0% --% 1.0%
Other income 6 4 2 50.0% 0.1% --%
-------- -------- -------- -------- -------- --------
Income (loss) from operations
before provision for income
taxes 245 (3,992) 4,237 106.1% 3.1% (43.1)%
Income tax provision 1 1 -- --% --% --%
-------- -------- -------- -------- -------- --------
Net income (loss) $ 244 $ (3,993) $ 4,237 106.1% 3.1% (43.1)%
======== ======== ======== ======== ======== ========
NET SALES. Net sales decreased by $1,133,000, or 14%, to $7,932,000 in
the first nine months of 2009 as compared to $9,265,000 in the first nine months
of 2008. A combination of factors caused the decrease in our net sales,
including a $2.5 million, or 81%, decrease in sales of our magnetic data storage
products. Sales of our magnetic data storage products totaled $602,000, or 8% of
net sales, for the first nine months of 2009, as compared to $3.1 million, or
34% of net sales, for the first nine months of 2008. In addition, sales of our
HDTVs decreased by 100% from $1.4 million in the first nine months of 2009
compared to the first nine months of 2008. However, sales of our optical data
storage products increased 58% to $7.3 million, or 92% of net sales, for the
first nine months of 2009, as compared to $4.6 million, or 50% of net sales, for
the first nine months of 2008, and the average unit net sales price of our
optical drives for the first nine months of 2009 decreased by 1% to $56.06
compared to $59.85 for the first nine months of 2008 and our net units sold
increased by 42% in the first nine months of 2009 compared to the first nine
months of 2008.
In addition, our overall product return rate was 14.2% in the first
nine months of 2009 compared to 20.9% in the first nine months of 2008. The
decrease in our overall product return rate resulted from a decrease in sales of
our HDTVs which experienced a 36% return rate in the first nine months of 2008.
Also, sales incentives, point-of-sale rebates, market development funds,
cooperative advertising costs and cross-dock fees, rebate promotion costs and
slotting fees, collectively as a percentage of gross sales, decreased to 8.0%,
all of which were offset against gross sales, in the first nine months of 2009,
as compared to 9.4% in the first nine months of 2008. The decrease in our
overall rate of sales incentives, point-of-sale rebates, market development
funds, cooperative advertising costs and cross-dock fees, rebate promotion costs
and slotting fees resulted primarily from a decrease in sales incentives
associated with our optical data storage products due to better market
positioning for these products in 2009 as compared to 2008.
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GROSS PROFIT (LOSS). Gross profit increased by $3.4 million, or 436%,
to $2.6 million in the first nine months of 2009 as compared to a gross loss
of $773,000 in the first nine months of 2008. The increase in gross profit
primarily resulted from increased operating margins on our optical data storage
products and positive operating margins on our magnetic data storage products
due to lower cost of sales resulting from inventory valuation write-downs in
prior periods, while our HDTVs had negative gross margins in 2008. Our gross
profit margin as a percentage of net sales increased to 33% in the first nine
months of 2009 as compared to a gross loss margin of 8% in the first nine
months of 2008.
SELLING, MARKETING AND ADVERTISING EXPENSES. Selling, marketing and
advertising expenses decreased by $362,000, or 41%, to $515,000 in the first
nine months of 2009 as compared to $877,000 in the first nine months of 2008.
This decrease was primarily due to decreases of $181,000 in shipping and
handling costs related to lower sales volumes and consolidation of shipments,
$61,000 in personnel costs, $37,000 in customer penalties, $34,000 in trade show
expenses, $25,000 in system support costs, $16,000 in outside commissions,
$8,000 in sales expenses, and $2,000 in outside services costs, all of which
were partially offset by an increase of $2,000 in operating supplies costs.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses decreased by $354,000, or 16%, to $1.8 million in the first nine months
of 2009 as compared to $2.2 million in the first nine months of 2008. This
decrease was primarily due to decreases of $223,000 in personnel costs, $66,000
in bad debt expense, $52,000 in insurance costs, $38,000 in outside services
costs, $38,000 in facilities costs, $32,000 in temporary staffing costs, $24,000
in directors fees, $23,000 in bank charges, $22,000 in financial relations
expenses, $12,000 in system support costs, $8,000 in travel and entertainment
expenses, and $2,000 in miscellaneous expenses, all of which were partially
offset by increases of $73,000 in finance charges related to our credit
facility, $64,000 in legal fees and $49,000 in audit fees.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
decreased in the first nine months of 2009 as compared to the first nine months
of 2008 as a result of the impairment of trademarks at December 31, 2008.
NET INTEREST EXPENSE. Net interest expense decreased by $95,000, or
99%, in the first nine months of 2009 as compared to the first nine months of
2008. This decrease primarily resulted from the termination of our prior line of
credit on July 31, 2008. Financing charges related to the credit facility with
Rexford Funding are included as finance charges in general and administrative
expenses.
OTHER INCOME. Other income increased by $2,000, or 50%, in the first
nine months of 2009 as compared to the first nine months of 2008 primarily as a
result of miscellaneous income.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Our principal sources of liquidity have been cash provided by
operations and borrowings under our bank and trade credit facilities. Our
principal uses of cash have been to provide working capital, finance capital
expenditures and to satisfy our debt service requirements. We anticipate that
these sources and uses will continue to be our principal sources and uses of
cash for the foreseeable future. As of September 30, 2009, we had a working
capital deficit of $2.2 million, an accumulated deficit of $33.9 million,
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$650,696 in cash and cash equivalents and $442,498 in net accounts receivable.
This compares with a working capital deficit of $2.5 million, an accumulated
deficit of $34.1 million, $425,495 in cash and cash equivalents and $1.0 million
in net accounts receivable as of December 31, 2008. For the nine months ended
September 30, 2009, our cash increased by $225,201, or 53%, from $425,495.
As of October 26, 2009, we had approximately $735,967 of cash and cash
equivalents and we continue to experience a lack of liquidity and may have
insufficient liquidity to fund our operations for the next twelve months or
less.
Our condensed consolidated financial statements as of and for the three
and nine months ended September 30, 2009 have been prepared on a going concern
basis, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. As discussed in this report and in
Note 1 to our condensed consolidated financial statements included elsewhere in
this report, we have incurred significant recurring losses, have serious
liquidity concerns and may require additional financing in the foreseeable
future. These factors, among others, raise substantial doubt about our ability
to continue as a going concern. The condensed consolidated financial statements
included in this report do not include any adjustments that might result from
the outcome of this uncertainty.
Our plans for correcting these deficiencies include ongoing efforts to
bring new products to market and exploring other products with our suppliers and
retailers to sell through our sales channels, negotiating suitable repayment
terms for outstanding obligations owed to a related-party supplier, seeking new
equity capital and new vendor partnerships, timely collection of existing
accounts receivable, and sell-through of inventory currently in our sales
channels. We also need to restructure our operations to reduce our operating
costs. If our capital requirements or cash flow vary materially from our current
projections, if we are unable to successfully negotiate suitable repayment terms
for outstanding obligations owed to a related-party supplier, if we are unable
to successfully restructure our operations and lower our operating costs, if we
are unable to timely collect our accounts receivable or unable to sell-through
inventory currently in our sales channels as anticipated, or if unforeseen
circumstances occur, we may be unable to increase our liquidity and may require
additional financing. In addition, if we are unable to bring successful new
products to market soon, we may be forced to substantially curtail our
operations.
If we incur future losses, we could experience significant additional
shortages of liquidity and our ability to purchase inventory and to operate our
business may be significantly impaired, which could lead to further declines in
our results of operations and financial condition.
CASH FLOWS
Cash provided by our operating activities totaled $225,201 during the
nine months ended September 30, 2009, as compared to $2.3 million during the
nine months ended September 30, 2008, and resulted primarily from the following
combination of factors:
o net income of $244,000;
o a $721,000 decrease in accounts receivable;
o a $242,000 decrease in inventory;
o a $40,000 increase in depreciation and amortization;
o a $40,000 increase in our allowance for product returns;
o a $27,000 decrease in prepaid expenses and other current
assets;
o a $27,000 increase in our reserves for sales incentives;
o a $16,000 increase in share-based compensation; and
o a $10,000 increase in sub-lease deposit.
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These increases in cash were partially offset by:
o a $544,000 decrease in accounts payable, accrued expenses and
other;
o a $246,000 decrease in allowance for obsolete inventory;
o a $157,000 decrease in point-of-sale accruals;
o a $66,000 decrease in accounts payable - related party,
resulting from return of products;
o a $43,000 decrease in our capital leases;
o a $33,000 decrease in market development funds, cooperative
advertising costs and cross-dock fees accruals;
o a $26,000 decrease in deferred revenue;
o a $22,000 decrease in mail-in rebates accruals;
o a $3,000 increase in other assets; and
o a $1,000 decrease in allowance for doubtful accounts.
Cash provided by our investing activities totaled $0 during the nine
months ended September 30, 2009 as compared to $342,000 during the nine months
ended September 30, 2008.
Cash used in our financing activities totaled $0 during the nine months
ended September 30, 2009 as compared to $3.9 million for the nine months ended
September 30, 2008.
CREDIT FACILITY -- SILICON VALLEY BANK
On January 29, 2007, we entered into a Loan and Security Agreement with
Silicon Valley Bank which provided for a new credit facility. Our credit
facility with Silicon Valley Bank was initially used to pay off our outstanding
loan balance with GMAC Commercial Finance in the approximate amount of $5.0
million. On April 18, 2008, we entered into a new Loan and Security Agreement
with Silicon Valley Bank which provided for a credit facility based on our
accounts receivable. The Loan and Security Agreement amended and restated our
prior Loan and Security Agreement dated January 29, 2007 with Silicon Valley
Bank. On April 18, 2008, we also entered into an Amendment to Loan Documents
with Silicon Valley Bank, which provided that the ancillary loan documents
executed in connection with our prior credit facility with Silicon Valley Bank
would apply to the new Loan and Security Agreement.
The new credit facility allowed us to finance our accounts receivable
and borrow up to a maximum aggregate amount of $7.0 million; provided, that we
could only borrow up to a limit of 60% of each eligible account or such other
percentage as Silicon Valley Bank established. The credit facility was to expire
on January 29, 2009. Advances under the credit facility bore interest at a
floating rate equal to the prime rate of interest published from time to time by
Silicon Valley Bank plus 2.5%. The credit facility required that we pay a
collateral handling fee of $2,000 per month and other customary fees and
expenses.
Our obligations under the new Loan and Security Agreement were secured
by substantially all of our assets and were guaranteed by our subsidiary under a
Cross-Corporate Continuing Guaranty. Our obligations and the guarantee
obligations of our subsidiary were also secured under Intellectual Property
Security Agreements executed by us and our subsidiary.
On July 31, 2008, we paid off our obligations under the Loan and
Security Agreement dated April 18, 2008 with Silicon Valley Bank and terminated
the Loan and Security Agreement.
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CREDIT FACILITY -- REXFORD FUNDING
On October 29, 2008, we entered into a Sale of Accounts and Security
Agreement, or the Agreement, dated as of October 24, 2008 with Rexford Funding,
LLC, which provides for an accounts receivable-based credit facility.
The credit facility allows us to sell accounts receivable to Rexford
Funding subject to a maximum advance amount equal to $1.5 million. The purchase
price for each purchased account is to equal the net invoice amount less Rexford
Funding's commission. Rexford Funding is entitled to a factoring commission
equal to 0.033% of the gross invoice amount of each purchased account receivable
and an additional 0.033% for each day the account receivable remains outstanding
and unpaid.
Rexford Funding, in its sole and absolute discretion, may from time to
time advance us funds against the purchase price of the accounts receivable in
an amount of up to 75% (except as to accounts receivable of Staples which shall
be up to 60%) of the aggregate purchase price of the purchased accounts
receivable, subject to customary reductions, including those based on (i)
disputed accounts receivable, (ii) any accounts receivable from a customer whom
Rexford Funding deems not credit worthy, (iii) any accounts receivable unpaid in
excess of 60 days, (iv) any accounts receivable from a past-due customer when
25% or more accounts receivable from that customer are unpaid in excess of 60
days, (v) any accounts receivable which Rexford Funding deems, in its sole and
absolute discretion, are ineligible, and (vi) any fees, actual or estimated,
that are chargeable to our reserve account as to the credit facility. Rexford
Funding is entitled to interest charges on all advances at a rate equal to the
Prime Rate plus 1.00%, but in no case less than 5.50%.
The Agreement had an initial term through April 30, 2009 and had
automatic six month extensions unless either party terminated the Agreement at
least 60 but not more than 90 days prior to the end of the initial term or any
renewal term. At all times Rexford Funding had the right to terminate the
Agreement upon 30 days prior notice. In August 2009, we agreed with Rexford
Funding that the Agreement would have a month-to-month term.
If we terminate the Agreement prior to the end of the term, we will be
subject to an early termination fee equal to Rexford Funding's average monthly
commission and/or deficiency charges for the preceding term, pro rated for the
time remaining in the term.
Our obligations under the Agreement are secured by our accounts
receivable and all proceeds thereof and, with respect thereto, all chattel
paper, commercial tort claims, deposit accounts, documents, general intangibles,
goods, letters of credit, letter of credit rights and all supporting
obligations.
TRADE CREDIT FACILITY
In February 2003, we entered into a Warehouse Services and Bailment
Agreement with BTC USA. Under the terms of the agreement, BTC USA agreed to
supply and store at our warehouse up to $10.0 million of inventory on a
consignment basis. We were responsible for insuring the consigned inventory,
storing the consigned inventory for no charge, and furnishing BTC USA with
weekly statements indicating all products received and sold and the current
level of consigned inventory. The agreement also provided us with a trade line
of credit of up to $10.0 million with payment terms of net 60 days, without
interest. We believe that these terms were substantially better terms than we
could likely obtain from other subcontract manufacturers or suppliers. The
agreement could be terminated by either party upon 60 days' prior written notice
to the other party. BTC USA is a subsidiary of BTC, one of our significant
stockholders. Mr. Steel Su, a former director of I/OMagic, is the Chief
Executive Officer of BTC. During the nine months ended September 30, 2009, we
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made no purchases under this arrangement. As of September 30, 2009, there were
$4,537,753 in trade payables outstanding under this arrangement. As of October
26, 2009, we were out of compliance with the payment terms of the agreement with
BTC and we are in continued negotiations with BTC USA to satisfy our obligations
on a basis that is acceptable to both parties. We do not currently utilize this
trade credit facility as BTC USA is either not able to supply certain products
we currently sell, or in some cases, we are able to source certain products at
better prices directly from other third-party manufacturers. Additionally, due
to substantial outstanding obligations owed to BTC, it is highly unlikely that
we will be able to obtain additional inventory supplies from BTC unless, and at
least until, we are able to negotiate repayment terms acceptable to BTC. Even if
we are able to negotiate repayment terms acceptable to BTC, we may be unable to
obtain additional inventory supplies from BTC on the same terms as before, on
satisfactory terms, or at all.
LIQUIDITY IMPACT OF CONSIGNMENT INVENTORY MODEL
We retain most risks of ownership of our consignment inventory. These
products remain our inventory until their sale by our retailers. For example,
both Office Depot and OfficeMax returned substantial consigned inventory in the
fourth quarter of 2007 and the first quarter of 2008, respectively, each in
anticipation of discontinuing sales of our products. The return of this
inventory resulted in significant inventory valuation adjustments caused by the
declining value of the inventory, principally, our magnetic data storage
products. In addition, the turnover frequency of our inventory on consignment is
critical to generating regular cash flow in amounts necessary to keep financing
costs to targeted levels and to purchase additional inventory. If this inventory
turnover is not sufficiently frequent, our financing costs may exceed targeted
levels and we may be unable to generate regular cash flow in amounts necessary
to purchase additional inventory to meet the demand for other products. In
addition, as a result of our products' short life-cycles, which generate lower
average selling prices as the cycles mature, low inventory turnover levels may
force us to reduce prices and accept lower margins to sell consigned products.
If we fail to select high turnover products for our consignment inventory model,
our sales, profitability and financial resources will likely decline.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
The disclosure requirements and impacts of new accounting
pronouncements are described in "Note 16--Recent Accounting Pronouncements" of
the notes to condensed consolidated financial statements contained elsewhere in
this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4. CONTROLS AND PROCEDURES
Not applicable.
ITEM 4T. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and
Acting Chief Financial Officer of the effectiveness of the design and operation
of our disclosure controls and procedures. The term "disclosure controls and
procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
and Exchange Act of 1934, as amended ("Exchange Act"), means controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by the company in the reports it files or submits under the
-24-
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures also include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by a
company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the company's management, including its
principal executive and principal financial officers, or persons performing
similar functions, as appropriate, to allow timely decisions regarding required
disclosure. Based on this evaluation, our Chief Executive Officer and Acting
Chief Financial Officer concluded as of September 30, 2009 that our disclosure
controls and procedures were effective at the reasonable assurance level.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no change during our most recently completed fiscal quarter
that has materially affected or is reasonably likely to materially affect, our
internal control over financial reporting, as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to legal proceedings, claims and litigation arising in
the ordinary course of business. While the amounts claimed may be substantial,
the ultimate liability cannot presently be determined because of considerable
uncertainties that exist. Therefore, it is possible that the outcome of those
legal proceedings, claims and litigation could adversely affect our quarterly or
annual operating results or cash flows when resolved in a future period.
However, based on facts currently available, management believes such matters
will not adversely affect our financial position, results of operations or cash
flows.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you
should carefully consider the factors discussed under "Risk Factors" in our
Annual Report on Form 10-K for the year ended December 31, 2008, which could
materially affect our business, financial condition and results of operations.
The risks described in our Annual Report on Form 10-K for the year ended
December 31, 2008 are not the only risks we face. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, financial
condition and results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit
Number Description
------ -----------
31.1 Certification Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (*)
31.2 Certification Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (*)
32.1 Certification of President and Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (*)
-------------------
(*) Filed herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
I/OMAGIC CORPORATION
Dated: October 29, 2009 By: /s/ TONY SHAHBAZ
-------------------------------------------
Tony Shahbaz
Acting Chief Financial Officer
(principal financial and accounting officer)
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EXHIBITS FILED WITH THIS REPORT
Exhibit
Number Description
------ -----------
31.1 Certification Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of President and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
-28
