FORM 10-QSB/A
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report Under Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For Quarter Ended September 30, 1999
Commission file number 27267
I/O Magic Corporation
(Exact name of Registrant as specified in its charter)
Nevada 88-0290623
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6 Autry
Irvine, California 92618
(Address of principal executive offices) (Zip Code)
(949) 727-7466
(registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes No X
--- ---
The number of shares of the Registrant's common stock outstanding as of December
6, 1999: 32,307,039
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Form 10-SB and its Amendments 1,2, 3 and 4 are incorporated in
Part I and in Part II Items 1 and 2.
FINANCIAL INFORMATION
PART 1 - ITEM 1
I/O MAGIC CORPORATION
BALANCE SHEETS
DECEMBER 31, 1998 AND SEPTEMBER 30, 1999 (UNAUDITED)
ASSETS
DECEMBER 31, 1998 SEPTEMBER 30, 1999
----------------- ------------------
CURRENT ASSETS
Cash $1,402,904 $1,203,804
Accounts receivable, net of allowance for doubtful
accounts of $46,372 and $76,097 3,776,413 8,016,969
Accounts receivable from related parties - 767,228
Inventory 733,834 2,224,938
Prepaid expenses and other current assets 60,708 140,969
----------------- ------------------
TOTAL CURRENT ASSETS 5,973,859 12,353,908
PROPERTY AND EQUIPMENT, NET 133,231 197,577
OTHER ASSETS 21,160 19,988
----------------- ------------------
TOTAL ASSETS $6,128,250 $12,571,473
================= ==================
The accompanying notes are an integral part of these financial statements
I/O MAGIC CORPORATION
BALANCE SHEETS
DECEMBER 31, 1998 AND SEPTEMBER 30, 1999 (UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, 1998 SEPTEMBER 30, 1999
----------------- ------------------
CURRENT LIABILITIES
Notes payable $250,000 $ -
Accounts payable and accrued expenses 1,540,643 3,974,631
Current portion of capital lease obligations 208 581
Accounts payable to related parties 2,984,677 1,102,036
Note payable to related party 345,500 -
Reserves for customer returns and allowances 223,379 848,515
----------------- ------------------
TOTAL CURRENT LIABILITIES 5,344,407 5,925,763
CAPTIAL LEASE OBLIGATIONS, NET OF CURRENT PORTION 6,723 2,281
----------------- ------------------
TOTAL LIABILITIES 5,351,130 5,928,044
----------------- ------------------
STOCKHOLDERS' EQUITY
Preferred stock, $0.001 par value
10,000,000 shares authorized
none issued and outstanding - -
Class A common stock, $0.001 par value
50,000,000 shares authorized
14,879,546 and 32,091,151 (unaudited) shares
issued and outstanding 14,880 32,091
Additional paid in capital 5,305,681 10,358,180
Deferred compensation (27,900) (18,600)
Treasury stock, 550,000 shares, at cost (165,000) (165,000)
Accumulated deficit (4,350,541) (3,563,242)
----------------- ------------------
TOTAL STOCKHOLDERS' EQUITY 777,120 6,643,429
----------------- ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $6,128,250 $12,571,473
================= ==================
The accompanying notes are an integral part of these financial statements
I/O MAGIC CORPORATION
STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS AND THREE MONTHS ENDED
SEPTEMBER 30, 1999 (UNAUDITED) AND 1998 (UNAUDITED)
Nine Months Ended Three Months Ended
September 30, September 30,
------------------------------- ------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Net sales $ 21,569,160 $ 6,180,170 $ 8,485,291 $ 2,380,199
Cost of sales 16,244,908 4,426,379 6,339,881 1,625,081
------------ ------------ ------------ ------------
Gross profit 5,324,252 1,753,791 2,145,410 755,118
------------ ------------ ------------ ------------
Operating expenses
Selling, marketing and advertising 2,983,691 1,210,801 1,236,037 490,732
General and administrative 1,574,647 804,220 495,572 254,325
------------ ------------ ------------ ------------
Total operating expenses 4,558,338 2,015,021 1,731,609 745,057
------------ ------------ ------------ ------------
Income (loss) from operations 765,914 (261,230) 413,801 10,061
------------ ------------ ------------ ------------
Other income (expense)
Interest income 9,587 10,235 3,587 4,061
Interest expense (12,786) (10,300) (1,402) (8,846)
Income from related party 21,938 0 21,938 0
Other income 3,446 251,435 1,346 27
------------ ------------ ------------ ------------
Total other income (expense) 22,185 251,370 25,469 (4,758)
------------ ------------ ------------ ------------
Income (loss) before provision
for income taxes 788,099 (9,860) 439,270 5,303
------------ ------------ ------------ ------------
Provision for income taxes 800 800 400 0
------------ ------------ ------------ ------------
Net income (loss) $ 787,299 ($ 10,660) $ 438,870 $ 5,303
============ ============ ============ ============
Basic and diluted earnings (loss)
per share $ 0.03 ($ 0.00) $ 0.02 $ 0.00
============ ============ ============ ============
Weighted-average shares outstanding 29,778,974 13,940,492 25,058,544 13,910,534
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
I/O MAGIC CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS AND THREE MONTHS ENDED
SEPTEMBER 30, 1999 (UNAUDITED) AND 1998 (UNAUDITED)
Nine Months Ended Three Months Ended
September 30, September 30,
----------------------------- -----------------------------
1999 1998 1999 1998
----------- ------------ ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations $ 787,299 ($ 10,660) $ 438,870 $ 5,303
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 36,026 28,125 13,028 9,953
Amortization of deferred compensation 9,300 9,300 3,100 3,100
Provision for allowance for doubtful accounts 29,725 0 21,191 (116,420)
Note payable to related party (345,500) 0 0 0
Increase (decrease) in cash due to changes in:
Accounts receivable (4,270,281) (1,186,494) (2,588,776) (578,085)
Accounts receivable from related parties (767,228) (49,374) (767,228) (49,374)
Inventory 3,508,896 462,279 (366,606) (9,003)
Prepaid expenses and other current assets (80,261) (50,048) (31,802) 7,877
Other assets 1,172 0 9,900 0
Accounts payable and accrued expenses 2,433,988 985,781 1,421,358 494,452
Accounts payable to related parties (1,882,641) 661,765 (159,535) 579,228
Reserves for customer returns and
allowances 625,136 (123,657) 399,841 834
----------- ------------ ----------- ------------
Net cash provided by operating activities 85,631 727,017 (1,606,659) 347,865
----------- ------------ ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (100,372) (33,252) (38,967) (11,180)
----------- ------------ ----------- ------------
Net cash used in investing activities (100,372) (33,252) (38,967) (11,180)
----------- ------------ ----------- ------------
Cash FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations (4,069) (5,351) (3,177) (1,531)
Advances to related parties 0 (192,982) 0 (192,982)
Proceeds from issuance of notes payable 0 250,000 0 150,000
Payments on notes payable (250,000) 0 (45,000) 0
Purchase of treasury stock 0 (165,000) 0 (65,100)
Proceeds from exercise of warrants 69,710 15,751 3,004 13,750
----------- ------------ ----------- ------------
Net cash provided by financing activities (184,359) (97,582) (45,173) (95,863)
----------- ------------ ----------- ------------
Net increase (decrease) in cash and cash
equivalents (199,100) 596,183 (1,690,799) 240,822
Cash and cash equivalents at beginning of
period 1,402,904 713,469 2,894,603 1,068,830
----------- ------------ ----------- ------------
Cash and cash equivalents at end of period $ 1,203,804 $ 1,309,652 $ 1,203,804 $ 1,309,652
=========== =========== =========== ============
Supplemental cash flow information:
Interest paid $ 12,786 $ 10,300 $ 1,402 $ 8,846
Income taxes paid $ 800 $ 800 $ 400 $ 0
The accompanying notes are an integral part of these financial statements
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the nine months ended September 30, 1999, the Company entered into the
following non-cash transactions:
- Issued 16,666,667 (unaudited) shares of common stock for $5,000,000
(unaudited) in inventory.
- Reduction of a related party note payable as a reduction to cost of
sales of $345,500 (unaudited).
During the nine months ended September 30, 1998, the Company entered into the
following non-cash transaction:
- Received $330,735 (unaudited) in inventory subscribed.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS
I/O Magic Corporation (the "Company"), a Nevada corporation, develops,
manufactures through subcontractors, markets, and distributes
multimedia and communication card devices for portable and desktop
computers. The Company sells its products in the United States to
distributors and retail customers.
In March 1996, I/O Magic Corporation, a California corporation ("I/O
Magic California"), originally incorporated on September 30, 1993
entered into a Plan of Exchange and Acquisition Agreement (the
"Acquisition Agreement") with Silvercrest International, Inc.
("Silvercrest"), a Nevada corporation. Pursuant to the Acquisition
Agreement, Silvercrest acquired all of the outstanding stock of I/O
Magic California totaling 6,570,583 shares in exchange for an aggregate
6,570,583 shares of newly-issued common stock. In connection with the
Acquisition Agreement, the Company issued 624,704 shares of common
stock. For accounting purposes, the acquisition has been treated as a
recapitalization of I/O Magic California, with I/O Magic California as
the accounting acquirer (reverse acquisition). The reverse acquisition
was recorded at the historical cost of I/O Magic California. Prior to
the execution of the Acquisition Agreement, Silvercrest was a public
company listed on NASDAQ's over-the-counter market with dormant
operations and no assets or liabilities. Silvercrest subsequently
changed its name to I/O Magic Corporation, a Nevada corporation.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared in accordance with the instructions to Form 10-QSB and
therefore, do not include all information and notes necessary for a
fair presentation of financial position, results of operations, and
cash flows in conformity with generally accepted accounting principles.
The unaudited condensed financial statements include the accounts of
I/O Magic Corporation. The operating results for interim periods are
unaudited and are not necessarily an indication of the results to be
expected for the full fiscal year. In the opinion of management, the
results of operations as reported for the interim periods reflect all
adjustments which are necessary for a fair presentation of operating
results.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and the disclosures of contingent assets and liabilities
at the date of the financial statements, as well as the reported
amounts of revenues and expenses during the reporting period.
Significant estimates made by management include, but are not
limited to, the
provisions for allowance of doubtful accounts and price protection
on accounts receivable, the net realizability of inventory, the
evaluation of potential impairment of furniture and equipment, and
the provision for sales returns and warranties. Actual results could
materially differ from those estimates.
STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," establishes
and encourages the use of the fair value based method of accounting for
stock-based compensation arrangements under which compensation cost is
determined using the fair value of stock-based compensation determined
as of the date of grant and is recognized over the periods in which the
related services are rendered. The statement also permits companies to
elect to continue using the current implicit value accounting method
specified in Accounting Principles Bulletin ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," to account for stock-based
compensation issued to employees. The Company has elected to use the
implicit value based method and has disclosed the pro forma effect of
using the fair value based method to account for its stock-based
compensation. For stock-based compensation issued to non-employees, the
Company uses the fair value method of accounting under the provisions
of SFAS No. 123.
EARNINGS (LOSS) PER SHARE
The Company calculates earnings (loss) per share in accordance with
SFAS No. 128, "Earnings Per Share." SFAS No. 128 replaced the
presentation of primary and fully diluted earnings (loss) per share
with the presentation of basic and diluted earnings (loss) per share.
Basic earnings (loss) per share excludes dilution and is calculated by
dividing income (loss) available to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted earnings (loss) per share includes the potential dilutive
effects that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock ("potential
common stock") that would then share in the earnings (loss) of the
Company.
As of September 30, 1999, the Company had potential common stock as
follows:
Weighted-average common shares
Outstanding during the period (unaudited) 29,778,974
Incremental shares assumed to be
outstanding since the beginning of the
period related to stock options and warrants
outstanding (unaudited) 328,259
-------
FULLY DILUTED WEIGHTED-AVERAGE COMMON
SHARES AND POTENTIAL COMMON STOCK
(UNAUDITED) 30,107,233
----------
As of September 30, 1998 the Company had potential common stock
including options and warrants. The effects of such potential common
stock were not included in diluted earnings per share as their effects
would have been anti-dilutive.
NOTE 3 - NOTES PAYABLE
In May 1998, the Company engaged an agent to assist in a private
placement (the "1998 Private Placement") to sell up to $250,000 of
units, as amended. Each unit consists of a $10,000 note (the "Note")
bearing interest at 10% per annum, repayable in full 90 days after the
declaration of effectiveness of a Registration Statement, as defined,
or 12 months from the date of issue, whichever comes first, and one
warrant, which shall expire thirty days after the declaration of
effectiveness of a Registration Statement of the Company registering
the shares underlying the warrants or twelve months from the date of
issue, whichever comes first. The warrants entitled the holder to
purchase that certain number of shares which was equal to one third of
the note amount divided by the price per share of common stock
registered in the Registration Statement, all at the aggregate exercise
price of $1.00. The warrants were deemed by management to be contingent
consideration based on the requirement of an effective Registration
Statement. As no Registration Statement was effected, none of these
warrants were exercisable at any time prior to their expiration in May
and June 1999. Under the provisions of APB 12, management determined
the relative fair value of the warrants to be nominal due to the
contingent nature of the warrants. Accordingly, none of the proceeds
were allocated to these warrants which expired in May and June 1999.
The Company sold 25 units for proceeds of $250,000. As of December 31,
1998, accrued interest totaled $14,375, and is included in accounts
payable and accrued expenses on the accompanying balance sheets. As of
September 30, 1999 (unaudited), all principal and interest had been
paid.
No expense was recorded for these warrants as such were issued with an
exercise price greater than fair market value. In addition, the Company
paid $25,000 to the agent for services provided. Such is included in
prepaid expenses and other current assets on the accompanying balance
sheet and is being amortized over the term of the Notes.
NOTE 4 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued liabilities consisted of the following:
December 31, September 30,
1998 1999
------------ -------------
(unaudited)
Accounts payable $278,337 $1,494,027
Accrued rebates and marketing 868,113 2,183,241
Accrued compensation and related benefits 142,906 28,395
Other 251,287 268,968
------------ -------------
TOTAL $1,540,643 $3,974,631
============ =============
NOTE 5 - CREDIT LINES FROM RELATED PARTIES
In connection with a 1997 Strategic Alliance Agreement, the Company
also has available a second line of credit through another stockholder
and supplier for borrowings up to $2,000,000. Borrowings are
non-interest bearing and are due 75 days from the date of borrowing.
The credit agreement can be mutually terminated at any time. As of
December 31, 1998 and September 30, 1999 (unaudited), there were no
outstanding borrowings under this arrangement.
In connection with an effective February 3, 1999 subscription
agreement, the Company also has available an additional line of credit
through a stockholder and vendor that provides a trade credit facility
of up to $5,000,000 carrying net 75 day terms, as defined. As of
September 30, 1999 (unaudited), there were no outstanding borrowings
under this arrangement.
NOTE 6 - NOTE PAYABLE TO RELATED PARTY
As of December 31, 1998, the note payable to related party represents a
convertible promissory note to a stockholder for inventory purchases.
The note bore interest at 8% and matured March 1, 1997. Accrued
interest related to this note totaling $48,888 is included in accounts
payable and accrued expenses on the accompanying balance sheet as of
December 31, 1998. As of December 31, 1998, the Company was in default
under the agreement and disputes any obligation as no consideration was
received. The Company ceased accruing interest as of August 1997. In
March 1999, the statute of limitations for collection on this note
expired.
During the nine months ended September 30, 1999, the Company has
reflected as a reduction to cost of sales $394,388 (unaudited) of the
total debt and related interest. Management does not believe any
litigation will arise and has had no contact with such related party.
Pursuant to the terms of the note payable, in the event the Company or
its assets were sold or the Company commenced an offering of common
stock, as defined, the note holder had the right to convert the
outstanding balance, including all accrued interest thereon, into
shares of the Company's common stock. The conversion factor was defined
as either the price per share in the event of sale or the initial
public offering price, as defined, divided by 1.5.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
RETAIL AGREEMENTS
In connection with certain retail agreements, the Company has agreed to
pay for certain marketing development and advertising on an ongoing
basis. Marketing development and advertising costs are generally agreed
upon at the time of the event. The Company also records a liability for
co-op marketing based on management's evaluation of historical
experience and current industry and Company trends. During the nine
months ended September 30, 1999 and 1998, the Company incurred $738,918
(unaudited), and $290,152 (unaudited), respectively, related to these
agreements. During the three months ended September 30, 1999 and 1998,
the Company incurred $565,963 (unaudited), and $105,202 (unaudited),
respectively, related to these agreements. Such is included in selling,
marketing, and advertising in the accompanying statements of
operations.
NOTE 8 - CAPITAL TRANSACTIONS
COMMON STOCK ISSUED IN CONNECTION WITH THE EXERCISE OF WARRANTS
During the nine months ended September 30, 1999, the Company issued an
aggregate of 544,938 (unaudited) restricted shares of common stock in
connection with the exercise of warrants for cash totaling $69,710
(unaudited), or at a per share price ranging from $0.01 (unaudited) to
$0.30 (unaudited) per share.
OTHER CAPITAL TRANSACTIONS
Effective February 3, 1999, the Company issued 16,666,667 shares of
restricted common stock to a stockholder and vendor valued at $0.30
per share for $5,000,000 of inventory, as defined (valued at
transferor's cost basis). In connection with this transaction, the
stockholder and vendor established a $5,000,000 line of credit. No
value was assigned to the establishment of the line of credit as
such line was deemed to not carry any market value.
NOTE 9 - SETTLEMENT AGREEMENT
In March 1998, the Company entered into a Modem Card Settlement
Agreement with an outside company whereby the Company assigned
exclusive property rights of a specified product in exchange for
$250,000. In connection with this agreement, an officer and stockholder
was paid a bonus totaling $11,500.
NOTE 10 - RELATED PARTY TRANSACTIONS
During the three and nine months ended September 30, 1999, the Company
purchased inventory totaling $840,370 (unaudited) on behalf of a
related party. Such inventory was sold at cost plus handling expenses
resulting in other income to the Company of $21,938 (unaudited).
During the nine months ended September 30, 1999, the Company had
revenues from two related parties totaling approximately $2,074,000
(unaudited).
During the nine months ended September 30, 1999 and 1998, the Company
had purchases from related parties totaling approximately $10,143,000
(unaudited) and $1,637,000 (unaudited), respectively.
During the three months ended September 30, 1999, the Company had
revenues from two related parties totaling approximately $1,538,000
(unaudited).
During the three months ended September 30, 1999 and 1998, the Company
had purchases from related parties totaling approximately $1,520,000
(unaudited) and $421,882 (unaudited), respectively.
Revenues for the three and nine months ended September 30, 1998
were not significant.
ITEM 2-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the financial statements of the
Company included in this Form 10-QSB.
FORWARD LOOKING STATEMENTS
The statements contained in this Management's Discussion and Analysis
of Financial Condition and Results of Operations include "forward looking"
information within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and
are subject to the safe harbor provisions created by those sections. The actual
future results of the Company could differ materially from those projected in
the forward looking information. For a discussion of certain factors that could
cause actual results to differ materially from those projected by the forward
looking information, see "Factors That May Affect Future Results" herein.
PLAN OF OPERATION
Since its inception, the Company has financed its operations and
capital expenditures primarily with cash provided by operating activities,
private securities issuances and securities issuances for product. The Company
believes that working capital generated from operations is sufficient to meet
current activity for the next twelve months. However, should the Company grow
significantly in size through additional large customers or acquisitions,
securities issuances or other financing arrangements may be necessary.
The research and development efforts underlying the technology
comprising the eventual products sold by the Company are funded by the Company's
manufacturers (primarily BTC and Lung Hwa). Typically, the Company identifies a
market or technology trend occurring in the marketplace through consultation
with its large retail customers. The Company then provides its Asian
manufacturers with the technical specifications or market trends which it has
identified. The Asian manufacturers then conduct the actual research and
development (in Asia, at their cost) to determine the technical and financial
feasibility of the proposed product. The Company does conduct limited research
and development in designing driver software providing a user friendly
installation, user manual, installation guides, product packaging, marketing
literature and market and sales research.
The Company does not anticipate the purchase or sale of plant or
significant equipment in the next twelve months. The Company currently leases
its plant which is sufficient for the next twelve months based on current
activity. The Company anticipates that it will have to lease additional space
should there be an addition of a major new customer. Management has not yet
ascertained the financial impact of such expansion at this time.
As of the date hereof, the Company has approximately 55 full-time
employees. While the Company does anticipate an increase in its number of
employees, it does not anticipate that it will hire more than 10-20 additional
full-time employees during calendar year 2000. The Company has hired independent
contractors on an "as needed" basis, to develop its web site and to fill
short-term staffing needs such as data entry and product assembly. The Company
has no collective bargaining agreements with its employees. The Company believes
that its employee relationships are satisfactory.
RESULTS OF OPERATIONS
THREE MONTH PERIOD ENDED SEPTEMBER 30, 1999 AND 1998
Revenues for the period ended September 30, 1999 ("1999") were
$8,485,291, compared to revenues for the period ended September 30, 1998
("1998") of $2,380,199. The increase in revenues is primarily attributable to
the addition of several significant customers including: CompUSA in June 1998
(representing $2,460,011 of revenue in 1999 and $471,192 in 1998), Circuit City
in April 1999 (representing $1,883,799 of revenue in 1999 solely) and Office Max
in June 1999 (representing $2,833,475 of revenue in 1999 solely). In addition,
there has been an increase in OEM sales in 1999 to $441,320 compared to $0 in
1998. The Company did not have any sales backlog as of September 30, 1998 and it
had a sales backlog of $4,224,023 as of September 30, 1999.
Cost of sales as a percentage of revenues increased from 68.28%
($1,625,081) in 1998 to 74.72% ($6,339,881) in 1999. Cost of product as a
percentage of revenues increased from 66.25% in 1998 to 70.31% in 1999. This was
primarily due to increased price protection (which decreased net revenue) in
1999. Price protection totaled $60,225 in 1998 and $423,306 in 1999. Freight
expenses as a percentage of revenues increased from 2.03% in 1998 to 4.40% in
1999. This was primarily due to more expensive air freight of products (as
opposed to ocean freight) due to late production by a major vendor. The Company
believes that this situation has been resolved as this time and anticipates
lower future freight expenses.
The Company did not "write down" any of its inventory during the
three months ended September 30, 1998 or 1999. The inventory that was marked
down at the end of a fiscal year constituted discontinued items for which the
Company was responsible for such costs.
Operating expenses as a percentage of revenues decreased from 31.30%
($745,057) in 1998 to 20.41% ($1,731,609) in 1999.
Selling, marketing and advertising as a percentage of revenues
decreased from 20.62% ($490,732) in 1998 to 14.57% ($1,236,037) in 1999.
Rebates increased from $256,807 in 1998 to $281,344 in 1999, COOP advertising
increased from $105,202 in 1998 to $465,961 in 1999, slotting fees increased
from $0 in 1998 to $100,002 in 1999 and sales department expenses increased
from $128,723 in 1998 to $388,730 in 1999. The percentage decrease is
primarily due to a reduction in the number of rebate programs
relative to the increase in revenues and the fact that marketing expenses are
not a direct function of sales, although related.
General and administrative expenses as a percentage of revenues
decreased from 10.69% ($254,325) in 1998 to 5.84% ($495,572) in 1999. The
decrease on a percentage basis is primarily due to many general and
administrative expenses being indirect and thus increasing at a far smaller
percentage than the increase in sales revenue. Salaries and related expenses
increased from $165,074 in 1998 to $328,407 in 1999. The increase in the amount
expensed is due primarily to additional personnel added in 1999, although as a
percentage of revenues the amounts declined. Outside services increased from
$35,641 in 1998 to $62,759 in 1999 due to additional expenditures for financial
relations services. Other factors in the change in general and administrative
expenses were rent which increased from $17,160 in 1998 to $34,496 in 1999 and
travel which increased from $3,626 in 1998 to $18,092 in 1999. The remaining
general and administrative expenses represent utilities and support functions
whereby no one account or area fluctuated significantly.
Other income (expense) increased as a percentage of sales from 0.20%
($4,758 expense) to 0.30% ($25,469 income).
Income taxes for both periods ended September 30, 1999 and 1998
represent minimum state income taxes. This is due to the fact the Company has
net operating loss carryforwards expiring through 2018 and alternative minimum
tax credits to offset taxable income for both federal and state purposes.
Net profits increased from $5,303 for the three months ended September
30, 1998 to $438,870 for the three months ended September 30, 1999.
NINE MONTH PERIOD ENDED SEPTEMBER 30, 1999 AND 1998
Revenues for the period ended September 30, 1999 ("1999") were
$21,569,160, compared to revenues for the period ended September 30, 1998
("1998") of $6,180,170. The increase in revenues is primarily attributable to
the addition of several significant customers including: CompUSA in June 1998
(representing $6,658,665 of revenue in 1999 and $485,662 in 1998), Circuit
City in April 1999 (representing $7,698,841 of revenue in 1999 solely) and
Office Max in June 1999 (representing $3,411,031 of revenue in 1999 solely).
In addition, there has been an increase in OEM sales in 1999 to $881,438
compared to $498,236 in 1998. Sales to other, smaller customers decreased to
$2,919,185 in 1999 from $5,196,272 in 1998. The offsetting decrease is
primarily due to Fry's Electronics (representing $2,364,391 of revenue in
1998 and $1,364,151 in 1999). This offsetting decrease is due to the
Company's emphasis and shift of resources and product with the larger
national customers. The Company did not have any sales backlog as of
September 30, 1998 and it had a sales backlog of $4,224,023 as of September
30, 1999.
Cost of sales as a percentage of revenues increased from 71.62%
($4,426,379) in 1998 to 75.32% ($16,244,908) in 1999. Cost of product as a
percentage of revenues increased from 69.82% in 1998 to 71.00% in 1999. This was
primarily due to increased price protection (which decreased net revenue) in
1999. Price protection totaled $153,723 in 1998 and $852,384 in 1999. Freight
expenses as a percentage of revenues increased from 1.80% in 1998 to 4.32% in
1999. This was primarily due to more expensive air freight of products (as
opposed to ocean freight) due to late production by a major vendor. The Company
believes that this situation has been resolved as this time and anticipates
lower future freight expenses.
The Company did not "write down" any of its inventory during the nine
months ended September 30, 1998. During the nine months ended September 30, 1999
the Company wrote down $72,715 of its inventory due to obsolescence. The
inventory that was marked down at the end of a fiscal year constituted
discontinued items for which the Company was responsible for such costs.
Operating expenses as a percentage of revenues decreased from 32.60%
($2,015,021) in 1998 to 21.13% ($4,558,338) in 1999.
Selling, marketing and advertising as a percentage of revenues
decreased from 19.59% ($1,210,801) in 1998 to 13.83% ($2,983,691) in 1999.
Rebates increased from $602,158 in 1998 to $1,471,904 in 1999, COOP advertising
increased from $290,152 in 1998 to $638,916 in 1999, slotting fees increased
from $0 in 1998 to $100,002 in 1999 and sales department expenses increased from
$318,491 in 1998 to $772,870 in 1999. The percentage decrease is primarily due
to a reduction in the number of rebate programs relative to the increase in
revenues and the fact that marketing expenses are not a direct function of
sales, although related.
General and administrative expenses as a percentage of revenues
decreased from 13.01% ($804,220) in 1998 to 7.3% ($1,574,647) in 1999. The
decrease on a percentage basis is primarily due to many general and
administrative expenses being indirect and thus increasing at a far smaller
percentage than the increase in sales revenue. Salaries and related expenses
increased from $455,453 in 1998 to $934,910 in 1999. The increase in the amount
expensed is due primarily to additional personnel added in 1999, although as a
percentage of revenues the amounts declined. Outside services increased from
$88,911 in 1998 to $159,958 in 1999 due to additional expenditures for financial
relations services. Other factors in the change in general and administrative
expenses were rent which increased from $51,320 in 1998 to $83,172 in 1999 and
travel which increased from $24,448 in 1998 to $69,580 in 1999. The remaining
general and administrative expenses represent utilities and support functions
whereby no one account or area fluctuated significantly.
Other income (expense) decreased as a percentage of sales from 4.07%
($251,370 income) to 0.10% ($22,185). 1998 included one time other income of
$250,000 from the sale of a modem design.
Income taxes for both periods ended September 30, 1999 and 1998
represent minimum state income taxes. This is due to the fact the Company has
net operating loss carryforwards expiring through 2018 and alternative minimum
tax credits to offset taxable income for both federal and state purposes.
Net profits increased from a net loss of $10,660 for the nine months
ended September 30, 1998 to a net profit of $787,299 for the nine months ended
September 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations and
capital expenditures primarily with cash provided by operating activities,
private securities issuances and securities issuances for product. The Company
believes that working capital generated from operations is sufficient to meet
current activity. However, should the Company grow significantly in size through
additional large customers or acquisitions, securities issuances or other
financing arrangements may be necessary. The Company currently has two lines of
credit with its major suppliers: $5 million with BTC and $2 million with Lung
Hwa. Borrowings under those arrangements provided the Company interest free for
up to 75 days. The Company does not have any outstanding balance on either of
these lines as of September 30, 1999.
The Company is in the process of signing an asset based lending
agreement for up to $10,000,000 with IBM Credit in order to continue its growth.
The Company believes that its current cash flow from operations and the amounts
available under its existing vendor lines of credit are sufficient to meet its
working capital and capital expenditure requirements at the current sales volume
for the next twelve months.
For the three months ended September 30, 1999 the Company had a net
decrease in cash in the amount of $1,690,799. This was due to cash used by
operating activities of $1,606,659, cash used in investing activities of $38,967
and cash used by financing activities of $45,173. Cash from all accounts
receivable changes decreased by $3,356,004 and cash from inventory changes
increased by $1,421,358. Cash used for investing activities was for leasehold
improvements, furniture and computer equipment. Cash used for financing
activities was primarily for payment on notes payable ($45,000).
For the nine months ended September 30, 1999 the Company had a net decrease
in cash in the amount of $199,100. This was due to cash used for investing
activities of $100,372 and cash used for financing activities of $184,359
offset by cash provided from operations of $85,631. Cash used for investing
activities was for leasehold improvements, furniture and computer equipment.
Cash used for financing activities was primarily for payment on notes payable
($250,000) offset by proceeds from exercise of warrants ($69,710).
As the Company expands its distribution activities, it may experience
net negative cash flows from operations, pending an increase in gross margins,
and may be required to
obtain additional financing to fund operations through proceeds from
offerings, to the extent available, or to obtain additional financing to the
extent necessary to augment its working capital through public or private
issuance of equity or debt securities.
The high technology requirements of the Internet increasingly require
that consumers upgrade their personal computers to take full advantage of audio
and video streaming capabilities. Further, there are increasing Internet
applications for digitally based graphics data, such as pictures taken by
digital cameras. The Company believes that its current distribution channels
currently fulfill and will continue to fulfill these trends in the computer
peripherals marketplace. In the even the Company continues with the revenue
growth its has experienced between 1998 and 1999 the Company believes that it
will need additional capital. While there is no assurance that it will be
successful in raising additional capital, the Company is currently actively
seeking both institutional debt, as well as private sources of equity capital in
order to assure that it will be capable of financing such growth. In the event
the Company is unsuccessful in securing such financing, it may be required to
curtail its sales growth.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's business, financial condition and results of operations may be
impacted by a number of factors including, without limitation, those listed
below.
Significant Customer Concentration
During the year ended December 31, 1998 the Company had four major customers
which accounted for approximately 81% of the Company's net sales. During the
three month period ended September 30, 1999 the Company had four major customers
which accounted for approximately 90% of the Company's net sales. The amounts
due from these major customers on December 31, 1998 and September 30, 1999
amounted to approximately $3,472,564 and $7,412,162, respectively. The Company's
strategy is to constantly attempt to sign new major retail customers in order to
both increase the Company's growth and to reduce the impact of any one customer.
Sales to a new major retail customer are expected to begin by the end of the
first quarter 2000.
The company has no firm long-term sales commitments from any of its customers
and enters into individual purchase orders with its customers. The Company has
experienced cancellations of orders and fluctuations in order levels from period
to period and expects it will continue to experience such cancellations and
fluctuations in the future. In addition, customer purchase orders may be
canceled and order volume levels can be changed, canceled or delayed with
limited or no penalties. The replacement of canceled, delayed or reduced
purchase orders with new business cannot be assured. Moreover, the
Company's business, financial condition and results of operations will depend
upon its ability to obtain orders from new customers, as well as the financial
condition and success of its customers, its customers products and the general
economy. The factors affecting any of the Company's major customers or their
customers could have a material adverse effect on the Company's business,
financial condition and results of operations.
YEAR 2000
The Company has installed new internal software as of August 1998 that is Year
2000 compliant. Generally, "Year 2000 issues" refers to problems that may arise
due to the inability of some computer software to distinguish between the early
part of the present century and the early part of the next because the software
only used two digits to identify the year. Thus, 2001 would be indistinguishable
from 1901. The Company believes that there are two possible ways that it could
be impacted by this problem. The first concern is the impact that such software
failure would have on the Company's suppliers and customers. Although the
Company has not made a formal inquiry, the Company does not believe that either
its suppliers or customers could not continue to conduct business even in the
face of year 2000 problems. In addition, the Company believes that its customers
and suppliers are sufficiently sophisticated computer users that they will not
experience significant problems, either by remediation or because they are
already using software which can make the distinction between centuries. In the
event tht either its suppliers or customers should experience software failure,
the Company believes that the impact of either eventuality would not be material
to the Company.
The second possible threat posed to the Company by Year 2000 issues is one of a
general downturn in the economy due to software failures.
In the event that the Company's suppliers or customers experience a software
failure, such a failure could have a material adverse impact on the Company's
business, financial condition and results of operations. Similarly, if the
economy as a whole should be adversely impacted by Year 2000 problems, it could
have a material adverse effect on the Company's business, financial condition
and results of operations.
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/O MAGIC CORPORATION
Date: January 4, 2000 By /s/ Tony Shahbaz
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Tony Shahbaz
President/Chief Executive Officer