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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
FORM 10-K
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ________
COMMISSION FILE NUMBER: 000-27267
I/OMAGIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEVADA 33-0773180
(STATE OR OTHER JURISDICTION OF) (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4 MARCONI, IRVINE, CA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 707-4800
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No |X|
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
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 Act). Yes [ ] No |X|
The aggregate market value of the voting common equity held by nonaffiliates of
the registrant computed by reference to the closing sale price of such stock,
was approximately $8.1 million as of June 29, 2007, the last business day of the
registrant's most recently completed second fiscal quarter.
The registrant has no non-voting common equity. The registrant had 4,540,292
shares of common stock, $.001 par value, outstanding as of March 26, 2008.
DOCUMENTS INCORPORATED BY REFERENCE: None.
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TABLE OF CONTENTS
PAGE
PART I
ITEM 1. BUSINESS......................................................................................1
ITEM 1A. RISK FACTORS.................................................................................17
ITEM 1B. UNRESOLVED STAFF COMMENTS....................................................................29
ITEM 2. PROPERTIES...................................................................................29
ITEM 3. LEGAL PROCEEDINGS............................................................................29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..........................................29
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES...............................................................30
ITEM 6. SELECTED FINANCIAL DATA......................................................................31
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS...................................................................................31
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................................52
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................................................52
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE...................................................................................52
ITEM 9A. CONTROLS AND PROCEDURES......................................................................53
ITEM 9A(T) CONTROLS AND PROCEDURES......................................................................53
ITEM 9B. OTHER INFORMATION............................................................................54
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.......................................54
ITEM 11. EXECUTIVE COMPENSATION.......................................................................58
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS..........................................................................66
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE....................68
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.......................................................71
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES......................................................72
Index to Restated Consolidated Financial Statements and Supplemental Information.......................F-1
Index To Exhibits
Signatures
Exhibits Filed with this Report
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PART I
CAUTIONARY STATEMENT
ALL STATEMENTS INCLUDED OR INCORPORATED BY REFERENCE IN THIS ANNUAL
REPORT ON FORM 10-K, 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 LISTED UNDER "RISK FACTORS" IN ITEM 1A OF THIS REPORT. 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.
PRELIMINARY NOTE AND RECENT DEVELOPMENTS
PRELIMINARY NOTE
THIS AMENDMENT NO. 1 TO ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN
INFORMATION RELEVANT AS OF THE DATE OF THE INITIAL FILING OF OUR 2007 ANNUAL
REPORT ON FORM 10-K IN MARCH 2008. ACCORDINGLY, CERTAIN OF THE INFORMATION
CONTAINED IN THIS AMENDMENT NO. 1 TO ANNUAL REPORT ON FORM 10-K SPEAKS ONLY
AS OF MARCH 2008. IN PARTICULAR, OUR BUSINESS HAS CHANGED SUBSTANTIALLY, AS
WE SELL PRIMARILY OPTICAL DATA STORAGE PRODUCTS AND DO NOT CURRENTLY GENERATE
SIGNIFICANT SALES FROM MAGNETIC DATA STORAGE PRODUCTS OR HDTVS. CERTAIN
IMPORTANT RECENT DEVELOPMENTS THAT HAVE OCCURRED SINCE MARCH 2008 ARE
SUMMARIZED BELOW AND ELSEWHERE IN THIS REPORT.
RECENT DEVELOPMENTS
On October 29, 2008, we 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. The credit facility allows us
to sell accounts receivable to Rexford Funding subject to a maximum 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. The Sale of Accounts and
Security Agreement has an initial term through April 30, 2009 with automatic
six month extensions unless either party terminates the Sale of Accounts and
Security 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 has the right
to terminate the Sales of Accounts and Security Agreement upon 30 days prior
notice.
As of March 26, 2009, we had only $368,600 of cash on hand.
Accordingly, we are presently experiencing 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. See "Management's Discussion and Analysis and Results of
Operations-Critical Accounting Policies, Going Concern Assumption" and
"-Liquidity and Capital Resources, Overview" and "-Liquidity and Capital
Resources, Bank Lines of Credit."
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We continue to experience significant declines in sales of our data
storage products as we are experiencing intense price competition for magnetic
data storage products from major competitors such as Western Digital and
Seagate Technology/Maxtor who are original equipment manufacturers of hard
disk drives, which has significantly reduced selling prices and eroded our
margins for magnetic data storage products. Due to this intense price
competition, we may not be able to sell our 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. In response to these market
conditions, and also as part of its ongoing efforts to bring new products to
market, management is currently exploring other products with our suppliers
and retailers to sell through our sales channels.
We have not been able to obtain supplies of our HDTVs due to the
substantial working capital requirements needed to sustain HDTV inventories.
As a result, our HDTV sales have declined substantially and without
negotiating a new supply arrangement, we will not be able to continue
selling HDTVs.
Behavior Tech Computer Corp. and its affiliated companies, or BTC,
and Lung Hwa Electronics Co., Ltd., or Lung Hwa, two of our significant
stockholders, provided us with significantly preferential trade credit terms.
These terms included extended payment terms, substantial trade lines 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. In fact, we believe that our trade
credit facility with Lung Hwa was likely unique and could not be replaced
through a relationship with an unrelated third party. We do not currently
utilize these trade credit facilities as BTC and Lung Hwa are 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. These trade credit facilities may not be available to us in
the future in the event we endeavor to attempt to again utilize the facilities.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations-Liquidity and Capital Resources."
ITEM 1. BUSINESS.
COMPANY OVERVIEW
We sell data storage products, high-definition televisions, or HDTVs,
utilizing liquid crystal display, or LCD, technology, and other consumer
electronics products. We sell our products in the United States and Canada,
together known as the North American retail marketplace. During 2007, sales
generated within the United States accounted for approximately 99% of our net
sales and sales generated within Canada accounted for approximately 1% of our
net sales. During 2006, sales generated within the United States and Canada
accounted for approximately 84% and 16% of our net sales, respectively.
Our recent product offerings have predominantly consisted of both
mobile and desktop magnetic data storage products and optical data storage
products. Our mobile magnetic data storage products utilizing 1" and 2.5" hard
disk drives, consist of compact and mobile universal serial bus, or USB, hard
disk drives that plug into any standard USB port and that provide from 4
gigabytes, or 4,000 megabytes, to up to 320 gigabytes, or 320,000 megabytes of
storage capacity, depending on a user's operating system and other factors. We
design our mobile magnetic data storage products as cost-effective portable
alternatives to flash media devices and standard hard disk drives. Our mobile
magnetic data storage products accounted for approximately 25% of our net sales
for 2007. Our desktop magnetic data storage products, utilizing 3.5" hard disk
drives, require an independent power source and offer storage capacities ranging
from 250 gigabytes, or 250,000 megabytes, to up to 1 terabyte, or 1,000,000
megabytes, depending on a user's operating system and other factors. Our desktop
magnetic data storage products accounted for approximately 25% of our net sales
for 2007. Our optical data storage products include recordable compact disc, or
CD, drives and recordable digital video or versatile disc, or DVD, drives. Our
CD and DVD drives are primarily for use with personal computers, or PCs. Our
optical data storage products accounted for approximately 24% of our net sales
in 2007. We introduced our line of HDTVs in the fourth quarter of 2007 and from
sales in the fourth quarter alone, HDTVs accounted for approximately 21% of our
net sales in 2007. We also sell other consumer electronics products, which
accounted for approximately 3% of our net sales in 2007.
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We sell our products through computer, consumer electronics and office
supply superstores, wholesale clubs, distributors and other major North American
retailers, including AAFES (Army Air Force Exchange Services), Best Buy
Canada/FutureShop, Circuit City, Costco, Fred Meyer Stores, Micro Center, Office
Depot, OfficeMax, RadioShack, Staples and Target. Our retailers sell our
products in retail locations throughout North America. We also have
relationships with other retailers, catalog companies and Internet retailers
such as Buy.com, Dell, PC Mall, Home Shopping Network and Tiger Direct,
predominantly through distribution by Ingram Micro, GB Micro and Tech Data.
Our sales have historically been seasonal. The seasonality of our sales
is in direct correlation to the seasonality experienced by our retailers and the
seasonality of the consumer electronics industry in general. After adjusting for
the addition of new retailers, our fourth quarter has historically generated the
strongest sales, which correlates to well-established consumer buying patterns
during the Thanksgiving through Christmas holiday season. Our first and third
quarters have historically shown some strength from time to time based on
post-holiday season sales in the first quarter and back-to-school sales in the
third quarter. Our second quarter has historically been our weakest quarter for
sales, again following well-established consumer buying patterns.
During 2007, our most significant retailers were Staples, OfficeMax and
Costco. Collectively, these three retailers accounted for 58% of our net sales
for 2007, or 21%, 20% and 17% of our net sales, respectively. During 2006, our
most significant retailers were Staples, Best Buy Canada, Circuit City and
Office Depot. Collectively, these four retailers accounted for 69% of our net
sales for 2006, or 28%, 14%, 14% and 13% of our net sales, respectively.
We market our products primarily under our I/OMagic(R) and Digital
Research Technologies(R) brand names, but from time to time, we also market
products under our Hi-Val(R) brand name. 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
market our HDTVs under our Digital Research Technologies(R) brand name.
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 in Taiwan and China,
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. Some of our largest
subcontract manufacturers and suppliers are also our stockholders, including
Behavior Tech Computer Corp. and its affiliated companies, or BTC, and Lung Hwa
Electronics Co., Ltd., or Lung Hwa. Both BTC and Lung Hwa provide us with
significant trade lines of credit. Each of BTC and Lung Hwa provide us with
significant benefits by allowing us to purchase products on terms more
advantageous than we believe are generally available in our industry. These
advantageous terms include generous trade lines of credit and extended payment
terms. See "Certain Relationships and Related Transactions, and Director
Independence."
I/OMagic Corporation was incorporated under the laws of the State of
Nevada in October 1992. We have one subsidiary, IOM Holdings, Inc., a Nevada
corporation. Our principal executive offices are located in Irvine, California
and our main telephone number is (949) 707-4800.
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offer new products to both Office Depot and OfficeMax for their consideration to
include in their product offerings during the second half of 2008. However, we
cannot provide any assurance that we will be able to sell any products through
either Office Depot or OfficeMax in the future.
Throughout 2007, we experienced a significant decline in sales of our
data storage products. We believe that this sales decline was an industry-wide
effect. In addition, we are experiencing intense price competition for magnetic
data storage products from major competitors such as Western Digital and Seagate
Technology/Maxtor who are original equipment manufacturers of hard disk drives,
which has significantly reduced selling prices and eroded our margins for
magnetic data storage products. Due to this intense price competition, WE MAY
NOT BE ABLE TO SELL OUR 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. In response to these market conditions, and also as part
of its ongoing efforts to bring new products to market, management is currently
exploring other products with our suppliers and retailers to sell through our
sales channels.
In addition, we are experiencing a shortage in supply of our HDTVs. The
subcontract manufacturer of our HDTVs has experienced a shortage of basic
components and is attempting to correct the supply shortage. If these shortages
continue, we may not be able to meet the demand of our retailers which may cause
a decline in our net sales. Because of the substantial working capital
requirements needed to sustain inventory and profitable sales volumes for HDTVs,
we are negotiating new trade credit facilities to support future HDTV sales. We
do not believe that our existing subcontract manufacturers will be able to
independently provide adequate trade credit facilities.
DATA STORAGE INDUSTRY OVERVIEW
Storing, managing, protecting, securing, retrieving and transferring
electronic data has become critical to individuals and businesses due to their
increasing dependence on and participation in data-intensive activities. The
data storage industry is growing in response to the needs of individuals and
businesses to store, manage, protect, retrieve and transfer increasing amounts
of data resulting from:
o the growth in the number of PCs, and the increase in the
number, size and complexity of computer operating systems,
computer networks and software programs;
o the emergence and development of new data-intensive
activities, such as email, e-commerce, and the increasing
availability of products and services over the Internet,
together with the rise in bandwidth available to access and
download data from the Internet; and
o the existence and availability of increasing amounts of
digital entertainment data, such as movies, music, photos,
video games and other multi-media data.
Traditional PC data generally includes documents, emails, financial
information, software programs and other electronic data. The data storage
industry has grown significantly over the last two decades as the PC has become
a virtually indispensable tool in the home and office, resulting in increasing
amounts of traditional PC data. As a result of these and other developments,
traditional PC data storage requirements have correspondingly increased.
Digital entertainment data generally includes movies, music, photos,
video games and other multi-media data. For nearly two decades, music has been
offered on CDs as the prevailing standard. In the mid-to-late 1990s, the ability
to copy CDs, and to download, remix, and copy or "burn" music to a personalized
CD began to gain popularity and made the recordable CD drive, or "CD burner," a
desirable component of the PC. With the growth and acceptance of the Internet
and the advent of on-line music availability, the demand for on-line music has
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increased and as a result, the demand for faster and easier data storage and
retrieval has grown.
We believe that the increasing amount of traditional PC and digital
entertainment data that is being generated and used is stimulating increased
demand for products offering data storage, management, protection, security,
retrieval and transfer capability. We also believe that those products that
offer flexibility and high-capacity storage in a cost-effective, user-friendly
and secure manner are in highest demand.
KEY FACTORS DRIVING GROWTH IN THE DATA STORAGE INDUSTRY
We believe that the following factors, among others, are driving and
will continue to drive growth in the data storage industry:
o INCREASED USE OF THE INTERNET. As individuals and businesses
continue to increase their use of the Internet for
communications, commerce and data retrieval, the corresponding
need to utilize data storage devices for storage, management,
protection, security, retrieval and transfer of data --
especially high-capacity, cost-effective data storage devices
-- will continue to grow. In addition, bandwidth is increasing
and is expected to continue to increase. Increasing bandwidth
allows faster data transfer rates over the Internet and makes
use of the Internet for data-intensive activities more
convenient and cost-effective.
o GROWTH IN NEW TYPES OF ELECTRONIC DATA. The growth in new
types of data such as movies, music, photos, video games and
other multi-media data, including high-resolution audio and
video data, requires far greater storage capacity than
traditional PC text data. We believe that individual consumers
and businesses increasingly depend on their abilities to
store, manage, protect, retrieve and transfer these types of
data using data storage devices.
o GROWTH IN THE CRITICAL IMPORTANCE OF DATA. Business databases
contain information about customers, suppliers, competitors
and industry trends that may be analyzed and potentially
transformed into a valuable asset and a competitive advantage.
Efficiently storing, managing, protecting, securing,
retrieving and transferring this information has become
increasingly important to many businesses.
o DECREASE IN THE COST OF STORING ELECTRONIC DATA. The cost of
data storage continues to decrease with advances in technology
and improved manufacturing processes. This decrease in cost
encourages and enables individuals and businesses to purchase
more data storage media and devices.
o CONVERGENCE OF TECHNOLOGIES. Product offerings are beginning
to embody the convergence of data storage and digital
entertainment playback technologies. For instance, a digital
video recorder, or DVR, can operate as the primary tool for
storage, management, protection, security, retrieval and
transfer of traditional PC data as well as digital
entertainment data such as movies, music, photos, video games
and other multi-media data.
DATA STORAGE INDUSTRY CHALLENGES AND TRENDS
We believe that the challenges currently facing the data storage
industry include:
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o NEED FOR HIGH-CAPACITY, COST-EFFECTIVE AND FLEXIBLE MEDIA AND
RELATED DATA STORAGE DEVICES. We believe that, as a result of
the rapid growth in electronic data and in new applications
requiring or using high data-content movies, music, photos,
video games and other multi-media content, the data storage
industry needs to offer higher capacities, more cost-effective
and flexible media and data storage devices. To meet this
need, the data storage industry has shifted its product
offerings to DVD- and Blu-Ray-based technologies as well as to
compact and portable hard disk drives.
o NEED TO IDENTIFY AND SATISFY CONSUMER DEMANDS AND PREFERENCES.
The data storage industry is characterized in part by rapidly
changing consumer demands and preferences for higher levels of
product performance and functionality. We believe that, to be
successful, companies in this industry must closely identify
changes in consumer demands and preferences and introduce both
new and enhanced data storage products to provide higher
levels of performance and functionality than existing
products.
We believe that one of the trends in the data storage industry includes
the trend toward higher capacity optical storage media and related drives,
including the trend away from CD-based media and devices and towards DVD- and
Blu-Ray-based media and devices. Blu-Ray technology expands single layer DVD
capacity up to fivefold and dual layer DVD capacity up to tenfold and allows the
storage and retrieval of high definition videos and images for playback on
high-definition televisions and monitors. Blu-Ray has been accepted as the
dominant technology for super-high-capacity optical data storage devices and we
believe that the increased performance offered by this technology will likely
result in increased consumer demand for optical data storage devices.
Furthermore, we believe that we will be able to incorporate Blu-Ray technology
into our product offerings in much the same way as we do today with the large
number of format types ranging from recordable and rewritable CD-based products
to DVD-based products.
Another trend in the data storage industry is the progression toward
smaller, more portable large capacity hard disk drives. We expect that products
with storage capacities of up to 320 gigabytes, or 320,000 megabytes, on a
single 2.5" hard disk drive, and up to 1 terabyte, or 1,000,000 megabytes, on a
single 3.5" hard disk drive will be available in 2008. It is not clear when we
will be able to offer products with similar storage capacities at competitive
prices.
HDTV INDUSTRY OVERVIEW
There are several leading technologies available for HDTVs, each having
its own advantages and disadvantages with respect to the other formats. The
three primary direct view technologies are traditional cathode ray tube, or CRT,
televisions, plasma-based panels, and LCD panels. The three primary rear
projection technologies are digital light processing, or DLP, high-temperature
polysilicon, or HTPS, and liquid crystal on silicon, or LCoS. Manufacturers must
be cognizant of consumer preferences and make quick decisions regarding which
technology to support.
DIRECT VIEW TECHNOLOGIES
Traditional CRT televisions utilize a specialized vacuum tube in which
images are produced when a moving electron beam strikes a phosphorescent
surface.
Plasma technology is a direct-view display that has enabled the
creation of large flat-panel televisions measuring less than six inches deep. In
plasma televisions, the display itself consists of cells. Within each cell, two
glass panels are separated by a narrow gap in which neon-xenon gas is injected
and sealed in plasma form during the manufacturing process. The gas is
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electrically charged at specific intervals when the plasma set is in use. The
charged gas then strikes red, green, and blue phosphors, thus creating a
television image.
LCD televisions feature a matrix of thin film transistors that supply
voltage to liquid crystal filled cells enclosed between two flat panel glass
screens. When hit with an electrical charge, the crystals modulate light
generated by a lamp behind the screen, reproducing colors by attenuating
particular wavelengths from the spectrum of white light until the correct color
is produced.
REAR PROJECTION TECHNOLOGIES
Digital micromirror device, or DMD, is a proprietary product of Texas
Instruments, which calls this device DLP. DLP technology is found widely in both
front and rear projection televisions. At its heart is the digital micromirror
device chip that contains a rectangular array of hinge-mounted individually
movable microscopic mirrors, one for each pixel. The mirrors on a DLP chip can
either tilt toward the light, creating a pixel of light, or swing away from the
light, creating a dark pixel. Most DLP televisions and projectors use a one-chip
design. In order to generate a color image on a one-chip television, the light
passes through a spinning color wheel containing cyan, magenta, and yellow
filters. This enables a one-chip DLP television to display 16.7 million
different colors. In a three-chip design, the need for a color wheel is
eliminated, and instead, the white light is divided into three colors through a
prism with each of the three color beams focused onto its own dedicated chip.
HTPS microdisplays use a transmissive technology and are available from
only two large Japanese companies. HTPS displays sandwich liquid crystal
material between two layers of high-temperature quartz glass. To produce images,
light passes from a projection lamp into a color management and display system.
LCoS micro display technology uses a liquid crystal layer that sits on
top of a pixelated, reflective mirror substrate. Beneath the substrate exists
another layer containing individual transistors to activate each pixel. Light is
projected at the reflective surface, but it must first pass through the liquid
crystal layer. When a pixel is activated, it modulates the light reaching the
reflective surface. Light that is reflected is then magnified and focused onto
the screen through a series of lenses. Because integrated circuits form the
basis of these displays, LCoS technology permits a very high-resolution,
high-performance display.
LCD TECHNOLOGIES
We believe LCD HDTVs provide excellent picture quality with a very thin
form factor. LCDs also have extreme brightness, have rapid response times and
exhibit superior bright room viewing properties.
We believe that LCD HDTVs will capture a majority of the flat panel
HDTV market for screen sizes below 55". We also believe that LCD HDTVs have
already overtaken plasma HDTVs at screen sizes of 37" or less and will overtake
plasma at screen sizes of 42" and 50" within the next few years.
KEY FACTORS DRIVING GROWTH IN THE HDTV INDUSTRY
With the advent of digital devices such as HDTVs, digital cameras,
portable media players, and digital video recorders, as well as the improvement
in connectivity technologies, such as wireless networks, consumers have greater
access to improved content quality and are demanding more from their multimedia
experience. As technologies improve and data transmission speeds increase, video
is increasingly becoming the centerpiece of the multimedia experience. In
addition, HDTVs have become more affordable to a broader range of consumers. As
a result, many consumers are no longer satisfied with televisions that simply
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display basic video. Instead, they are demanding televisions with larger screen
sizes, higher definition, slimmer form factors and greater functionality.
This consumer desire for a higher quality video experience is driving
the rapid growth of flat screen and HDTVs. Research data from DisplaySearch
estimates that approximately 28 million HDTVs were shipped in the fourth quarter
of 2007 and for the first time, LCD television shipments worldwide exceeded
standard CRT television shipments. Penetration of HDTVs as a percentage of total
television shipments in the same period was 47%, which was a 56% year-over-year
rise. According to DisplaySearch, LCD HDTVs are expected to increase to
approximately 122 million units for all of 2010, while penetration of LCD HDTVs
is expected to be approximately 56% of worldwide television shipments and
approximately 84% of worldwide HDTV shipments in 2010. Larger screen sizes are
also expected to drive growth. According to DisplaySearch, LCD screens 35" and
above are expected to increase from approximately 22% of total LCD televisions
shipped in 2006 to approximately 43% of total LCD televisions shipped in 2010,
representing a compound annual growth rate of approximately 53%.
HDTV INDUSTRY CHALLENGES AND TRENDS
We believe that, in order to be a successful digital television
solutions provider, we must meet the increasingly demanding requirements of both
the retailer and the consumer. While consumer preferences trend towards large
screen, high-definition, slim form-factor digital televisions with increased
functionality, price continues to be a primary driver in most consumers'
decisions to purchase a digital television. For a given set of quality,
performance and functionality parameters, we believe most consumers will make
their purchase decision based on their optimal balance between these parameters
and the lowest price at the time of purchase. In addition, many sales channels
for digital television providers, including the international, national,
regional and online consumer electronics distributors and retailers, require
that their digital television suppliers provide both a broad product portfolio
and timely, efficient and dependable delivery of products.
THE I/OMAGIC SOLUTION
We sell data storage products, HDTVs and other consumer electronics
products in the North American retail marketplace. We believe that we possess a
combination of core competencies that provide us with a competitive advantage,
including the ability to successfully identify consumer needs and preferences,
use our sales channels to sell new and enhanced products, efficiently bring to
market newly developed products and enhanced products, efficiently manage our
product supply chain, and use our brands and merchandising efforts to market and
sell our products.
Successfully executing our core competencies yields substantial
benefits including the ability to:
o rapidly bring both new and enhanced products to market in a
cost-effective manner;
o offer high-value products that combine performance,
functionality and reliability at competitive prices; and
o establish and maintain a large market presence for our core
product offerings resulting in significant market share.
We work closely with our retailers to promote our products, monitor
consumer demands and preferences and stay at the forefront of the market for
data storage products. We also work closely with our subcontract manufacturers
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and suppliers and benefit from their substantial research and development
resources and economies of scale. As a result of working with our retailers,
subcontract manufacturers and suppliers, we believe that we are able to rapidly
bring new and enhanced products to market in a cost-effective manner.
We believe that the market intelligence we gain through consultation
with our retailers, subcontract manufacturers and suppliers enables us to
deliver products that combine the performance and functionality demanded by the
marketplace. Obtaining these products through our subcontract manufacturers and
suppliers, along with efficient management of our supply chain, allows us to
offer these products at competitive prices.
OUR STRATEGY
Our primary goal is to remain a leading provider of data storage
products and to expand our market share for data storage products and HDTVs. Our
business strategy to achieve this goal includes the following elements:
o CONTINUE TO DEVELOP AND SOLIDIFY OUR NORTH AMERICAN RETAIL
NETWORK. We have developed, and plan to continue to develop,
broaden and solidify, close working relationships with leading
North American computer, consumer electronics and office
supply superstores and other retailers. These retailers carry
many of the products that we sell. As we offer both new and
enhanced data storage products, HDTVs and other products, we
intend to continue to utilize our existing relationships with
these retailers to offer and sell these products to consumers.
o CONTINUE TO DEVELOP AND EXPAND OUR STRATEGIC SUBCONTRACT AND
SUPPLY RELATIONSHIPS. We have developed, and plan to continue
to develop and expand, strategic relationships with
subcontract manufacturers and suppliers, such as BTC and Lung
Hwa in Asia. These relationships allow us to enhance our
product offerings and benefit from these subcontract
manufacturers' and suppliers' continued development of new and
improved data storage products, HDTVs and other products. Some
of these relationships are particularly strong because some of
our subcontract manufacturers and suppliers are also
stockholders of I/OMagic. We plan to continue to develop and
explore other subcontract manufacturer and supplier
relationships as well. By continuing to subcontract
manufacture and source our products, we intend to increase our
operating leverage by delivering products incorporating new
technology without having to make the substantial investment
in, or having to incur the fixed costs associated with product
development and manufacturing in an industry characterized by
rapid product innovation and obsolescence.
o CONTINUE TO DEVELOP AND OFFER HIGH VALUE PRODUCTS. We intend
to continue to work in conjunction with our retailers,
subcontract manufacturers and suppliers to enhance existing
products and develop new products to satisfy consumer demands
and preferences. We believe that our target consumers seek
high-value products that combine performance, functionality
and reliability at prices competitive with other leading
products offered in the marketplace. We believe that our core
competencies such as our ability to efficiently bring to
market newly developed products and enhanced products and to
efficiently manage our product supply chain will enable us to
enhance our products and offer new products in a
cost-effective and timely manner. We intend to continue to
focus on high value product offerings by promoting and
offering our products that are affordable alternatives to
higher-priced products offered by some of our competitors.
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o MARKET PRODUCTS TO OUR EXISTING CONSUMER BASE. We intend to
market new, enhanced and current products to existing
purchasers of our products. We also believe that existing
users of our products can be an important source of referrals
for potential new purchasers of our products. In addition,
through our websites located at http://www.iomagic.com,
http://www.dr-tech.com and http://www.hival.com, we plan to
increase sales of our products over the Internet by continuing
to offer select products for direct purchase by consumers,
conduct special promotions and offer downloads to existing and
potential purchasers of our products.
OUR PRODUCTS
We have three primary product categories: data storage, HDTV and other
consumer electronics products.
DATA STORAGE PRODUCTS
Our optical data storage products consist of a range internal and
external CD and DVD drives that store traditional PC data as well as movies,
music, photos, video games and other multi-media data, such as:
o Internal and external optical data storage drives based on the
following technologies: CD-RW, DVD+R, DVD+RW, DVD-RAM,
DVD+/-RW+/-; and
o Blu-Ray RW and ROM.
We also offer optical data storage products that use double-layer DVD
technology, which doubles DVD capacity to approximately 8.5 gigabytes, or 8,500
megabytes, depending on the user's operating system and other factors. We plan
to continue our efforts to enhance our optical data storage products by
increasing performance and functionality as well as reducing the size of their
drive units and enclosures to increase portability and ergonomics.
Our magnetic data storage products include:
o 2.5" compact and portable external USB 2.0 hard disk drives
with dimensions measuring 3.0"W x 5.25"L x 0.6"H that provide
from 80 gigabytes, or 80,000 megabytes, up to 320 gigabytes,
or 320,000 megabytes, of storage capacity, depending on the
user's operating system and other factors. We intend to add
push-button back-up capability to all drives and additional
fingerprint ID locking for added security; and
o 3.5" external USB 2.0 hard disk drives with dimensions
measuring 5.0"W x 8.25"L x 1.5"H that provide from 320
gigabytes, or 320,000 megabytes, up to 1 terabyte, or up to
1,000,000 megabytes, of storage capacity, depending on the
user's operating system and other factors. We intend to add
push-button back-up capability to all drives and additional
fingerprint ID locking for added security.
The growth in the availability of digital data, such as movies, music
and photos has generated new data storage applications and created significant
demand for portable data storage devices. The typical portable data storage
device is compact, often small enough to fit into a pocket, consumes low power,
is durable, re-writable and is versatile due to its ease of operation. In
addition, most of these portable data storage devices do not require a separate
power source other than through a standard USB port. USB portable storage
devices, such as USB flash drives and compact USB hard disk drives were
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introduced in late 2002 and compete with our CD- and DVD-based data storage
products. Sales of these devices have continued to represent an increased share
of the market for data storage products.
HDTV PRODUCTS
Our current and planned HDTV products consist of a range of HDTVs that
utilize LCD display technology. We are focusing on higher resolution HDTVs with
1080p resolution that support high definition Blu-Ray technology. Our current
and planned HDTV products include the following models (and current or expected
availability):
o 26" 1080i Widescreen HDTV (November 2007);
o 32" 1080i Widescreen HDTV (November 2007);
o 28" 1080p Widescreen LCD TV (May 2008);
o 32" 1080p Widescreen HDTV (June 2008);
o 37" 1080p Widescreen HDTV (July 2008);
o 42" 1080p Widescreen HDTV (April 2008);
o 47" 1080p Widescreen HDTV (August 2008); and
o 52" 1080p Widescreen HDTV (September 2008).
We believe that the market for HDTVs is expanding and will continue to
grow as a result of the pending change to digital broadcasting in February 2009
when all television programs will be required to be broadcast in digital
formats.
OTHER CONSUMER ELECTRONICS PRODUCTS
Our other consumer electronics products include:
o Digital photo frames with 1.5" (keychain) and 7" (widescreen)
and 8", 10", 12" and 15" (4:3 screen) display formats with
flat panel displays. Our digital photo frames have flash media
inputs to accept flash memory cards from digital cameras to
display digital photos and play digital slide shows. We
believe that this new product line is a potentially large new
segment of the digital camera accessory aftermarket;
o External floppy disk drives that integrate a floppy disk drive
in an external USB device; and
o Case enclosures for 2.5" or 3.5" external or portable hard
disk drives.
We believe that the markets for consumer electronics products are
expanding. We intend to continue to monitor these markets and develop and sell
consumer electronics products as we are able to identify products that we
believe we can sell competitively. Our other consumer electronics products, not
including our data storage and HDTV products, represent only a minor product
category. These products accounted for only approximately 3% and 4% of our net
sales during 2007 and 2006, respectively.
PRODUCT WARRANTIES
Our products are subject to limited warranties of up to one year in
duration. These warranties cover only repair or replacement of the product. Our
subcontract manufacturers and suppliers provide us with warranties of a duration
at least as long as the warranties provided to consumers. The warranties
provided by our subcontract manufacturers and suppliers cover repair or
replacement of the product.
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PRODUCT OFFERINGS
Our product offerings are primarily directed toward satisfying the
demands of the North American retail marketplace for data storage products,
HDTVs and other consumer electronics products. We operate in industries that are
subject to rapid technological change, product obsolescence and rapid changes in
consumer demands and preferences. We attempt to anticipate and respond to these
changes by focusing on the following primary objectives:
o ENHANCEMENT OF EXISTING PRODUCTS. We seek to offer products
with increased performance and expanded functionality to
satisfy existing and emerging consumer demands and
preferences. Our enhanced product offerings are directed
toward, among other things, enhanced user-friendliness and
ease of product installation. These product offerings are also
focused on products with reduced manufacturing costs to enable
us to maintain and improve gross margins while continuing to
offer high-value products to consumers.
o DEVELOPMENT OF NEW PRODUCTS. We seek to offer new products
that, among other things, use existing technology and adopt
new technology to satisfy existing and emerging consumer
demands and preferences. Our new product offerings typically
focus on the implementation of existing technology to offer
products that are compatible with a wide range of media
formats. For our data storage products, these offerings also
typically include implementation of new technology to offer
products that deliver better solutions to the core needs of
the data storage marketplace such as high-capacity,
cost-effective, flexible and portable data storage,
management, protection, security, retrieval and transfer. For
our television products, we expect to offer enhanced features
such as built-in Blu-Ray players and greater picture clarity.
We believe that we are able to quickly adopt new technologies
and bring them to market through our retailers faster than our
competition.
Our retailers, subcontract manufacturers and our suppliers play an
important role in the enhancement of our existing products and the development
of new products. We work closely with our retailers, subcontract manufacturers
and our suppliers to identify existing market trends, predict future market
trends and monitor the sales performance of our products.
Many of our retailers are among the largest wholesale clubs, computer,
consumer electronics and office supply retailers in North America. Over the past
three years, our retailers have included Best Buy Canada/Future Shop, Circuit
City, Costco, Fred Myer Stores, Micro Center, Office Depot, OfficeMax,
RadioShack, Staples and Target. Through their close contact with the marketplace
for data storage products, our retailers are able to provide us with important
information about consumer demands and preferences.
Many of our subcontract manufacturers and suppliers have substantial
product development resources and facilities in Asia, and are among the major
component manufacturers and suppliers in their product categories. Some of our
largest subcontract manufacturers and suppliers are also our stockholders,
including BTC and Lung Hwa. These subcontract manufacturers and suppliers expend
substantial resources on research, development and design of new technologies
and efficient manufacturing processes.
Our corporate headquarters in Irvine, California house a product
development team that coordinates and manages the subcontract logistics and
product development efforts of our subcontract manufacturers and suppliers in
Asia. At our Irvine facility, we also develop user manuals, product packaging
and marketing literature as well as installation guides and supplemental
materials, including software and hardware designed to permit user-friendly
product installation.
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We do not have a traditional research and development team. Instead, we
work closely with our retailers, subcontract manufacturers and suppliers and
conduct various other activities in connection with the enhancement of our
existing products and the development of new products. We have not, in any
reporting period, made any material expenditures on research and development
activities relating to the development of new products, services or techniques
or the improvement of existing products, services or techniques. Our efforts are
largely directed at the evaluation of new products and enhancements to existing
products rather than the actual design and development of new products or
product enhancements.
Our representatives meet frequently with our subcontract manufacturers,
suppliers and our retailers to identify and discuss emerging trends and to
address the sales performance of our products. We provide and receive
product-related input to and from our subcontract manufacturers, suppliers and
our retailers. Much of the input that we provide arises from our technical
service department, which is responsible for assisting end-users in installing
and successfully utilizing our products. Problems in the installation or
utilization of our products are reported to management by our technical service
department and often provide the basis for existing product enhancements. New
products are developed and offered by our subcontract manufacturers and
suppliers, and offered by us and in turn by our retailers largely on the basis
of market research and trends identified in the data storage, television and
consumer electronics industries. We also monitor industry trade publications and
technical papers to understand emerging trends and new technologies and to plan
for new product offerings.
We believe that these activities assist us in attempting to achieve our
goal of being among the first-to-market with new and enhanced product offerings
based on established and emerging technologies.
OPERATIONS
We do not directly manufacture any of the components incorporated into
the products that we sell. We subcontract manufacture the majority of our
component products or source from our suppliers our data storage, HDTV and other
consumer electronics products and assemble, test and reassemble them in our
Irvine facility. We believe that by outsourcing the manufacturing of our
component products to our subcontract manufacturers or sourcing them from our
suppliers, we benefit from:
o LOWER OVERHEAD COSTS. By subcontract manufacturing or sourcing
our products we believe that we benefit from lower overhead
costs resulting from the elimination of capital expenditures
related to owning and operating manufacturing facilities, such
as expenditures related to acquiring a manufacturing plant,
property and equipment, and staffing, as well as the ongoing
cash requirements to fund such an operation.
o ECONOMIES OF SCALE. By subcontract manufacturing or sourcing
our products with some of the largest production facilities
available in the industry, we believe that we benefit from our
subcontract manufacturers' and suppliers' economies of scale,
which enable us to keep unit production costs low, our supply
chain management efficient and our expansion or contraction of
product orders flexible in response to changing consumer
demands and preferences.
o ENGINEERING AND MANUFACTURING RESOURCES. By subcontract
manufacturing our products we believe that we benefit from our
subcontract manufacturers' substantial engineering and
manufacturing resources, which aid us in offering new and
enhanced products and enable us to rapidly bring them to
market in a cost-effective manner.
o DIVERSIFICATION OF MANUFACTURING RISKS. By subcontract
manufacturing to, or sourcing our products from, a group of
manufacturers or suppliers, we believe that we are able to
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diversify the risks associated with employing a single
manufacturer or supplier. We also believe that we are
potentially able to expand our opportunities with respect to
new products as they arise by virtue of the varying expertise
of those manufacturers and suppliers.
o REDUCTION OF POTENTIAL LIABILITIES. By subcontract
manufacturing or sourcing our products we believe that we
reduce potential significant liabilities associated with
direct product manufacturing, including environmental
liabilities and liabilities resulting from warranty claims. We
believe that the reduction in potential liabilities decreases
our business risks and results in tangible economic benefits
such as cost savings related to insurance and the operation of
compliance programs.
We believe that the relatively low overhead costs resulting from
subcontract manufacturing or sourcing the products we offer for sale, the
economies of scale of our subcontract manufacturers and suppliers, and the
engineering and manufacturing resources of our subcontract manufacturers and
suppliers enable us to offer products combining high levels of performance,
functionality and reliability at prices competitive with other leading products
offered in the marketplace.
We utilize a subcontract logistics and product development consultant
located in Taipei, Taiwan. Our consultant assists us in identifying new
products, qualifying prospective manufacturing facilities and coordinating
product purchases and shipments from some of our subcontract manufacturers and
suppliers. The majority of our products are shipped directly by our subcontract
manufacturers or suppliers to our assembly, packaging, storage and distribution
facility in Irvine, California. These products are then packaged and shipped by
us either directly to retail locations across North America or to a centralized
distribution center. Product shipments are primarily made through major
commercial carriers. We maintain a production staff in Irvine, California, that
assembles "quick turn" and pilot production runs and repackages bulk quantities
received from our subcontractors or suppliers.
QUALITY CONTROL
Our primary subcontract manufacturers and suppliers are among the major
computer and electronic component manufacturers and suppliers in Asia who we
believe have rigorous quality control and shipping guidelines. We regularly
inspect and test product samples, periodically tour our subcontract
manufacturers' and suppliers' facilities, monitor defective product returns and
test defective products.
SALES AND MARKETING
We sell our products primarily through retailers who collectively
operate locations throughout North America. These include nationally-recognized
computer, consumer electronics and office supply superstores and wholesale
clubs. In addition, we sell our products through Internet retailers and mail
order catalogs.
We cooperate with our retailers to promote our products and brand
names. We participate in co-sponsored events with our retailers and industry
trade shows such as CES(R). We participate in these events and trade shows in
order to develop new relationships with potential retailers and maintain close
relationships with our existing retailers. We also fund cooperative advertising
campaigns, develop custom product features and promotions, provide direct
personal contact with our sales representatives and develop and procure certain
products as requested by our retailers. We cooperate with our retailers to use
point-of-sale and mail-in rebate promotions to increase sales of our products.
We also utilize sales circulars and our close working relationships with our
significant retailers to obtain national exposure for our products and our
brands. We believe that these marketing efforts help generate additional
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shelf-space for our products with our major retailers, promote retail traffic
and sales of our products, and enhance our goodwill with these retailers.
We maintain a large database containing information regarding many
end-users of our products. Through a targeted, direct marketing strategy, we
intend to offer these end-users other products to establish repeat end-user
customers, increase our product sales and promote brand loyalty. We currently
sell and plan to continue to sell products, conduct special promotions, and
offer downloads on our websites to existing and potential end-user customers.
Our websites are located at http://www.iomagic.com, http://www.dr-tech.com and
http://www.hival.com.
COMPETITION
We operate in highly-competitive market segments of the consumer
electronics industry.
We believe that our data storage products compete with other types of
data storage devices such as internal, external and portable hard disk drives,
magnetic tape drives, floppy disk drives and flash memory devices, as well as
internal and external optical data storage products offered by other companies.
Companies that offer products similar to our optical data storage
products include Hewlett-Packard, Memorex, Pioneer, Philips Electronics and
Sony. We also now directly compete against original equipment manufacturers such
as Lite-On, LG Electronics and Samsung Electronics to the extent that they
manufacture their own computer peripheral products or incorporate the
functionalities offered by our products directly into PCs. Companies that offer
products similar to our mobile and desktop magnetic data storage products
include Acomdata, Iomega, LaCie, Simpletech and SmartDisk/Verbatim as well as
original equipment manufacturers such as Hitachi, Seagate Technology/Maxtor and
Western Digital. We are currently experiencing intense price competition from
major competitors such as Western Digital and Seagate Technology/Maxtor, which
has significantly reduced selling prices and eroded margins for our magnetic
data storage products. In addition, due to intense price competition, WE MAY NOT
BE ABLE TO SELL OUR 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.
We believe that our digital photo frame products are compatible in
quality and performance with competitors in our market category. The most
notable leaders in this category are Coby, Kodak, PanDigital and SmartParts.
We believe that our HDTV products are compatible in quality and
performance with competitors in our market category. Companies that offer
products similar to our HDTV products include JVC, LG Electronics, Magnavox,
Olevia, Panasonic, Philips, RCA/Thompson, Samsung, Sceptre, Sharp, Sony,
Sylvania, Toshiba, Vizio and Westinghouse.
We believe that our ability to compete in the data storage, HDTV and
other consumer electronics markets depends on many factors, including the
following:
o PRODUCT VALUE. The performance, functionality, reliability and
price of our products are critical elements of our ability to
compete. We believe that we offer, and that our target
consumers seek, products that combine higher levels of
performance, functionality and reliability at lower prices
than other leading products offered in the marketplace. We
focus on offering these high value products by positioning
them as affordable alternatives to products offered by our
competitors.
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o MARKET PENETRATION. Market penetration and brand recognition
are critical elements of our ability to compete. Most
consumers purchase products similar to ours from off-the-shelf
retailers such as large computer, consumer electronics and
office supply superstores. Market penetration in the
industries in which we compete is typically based on the
number of retailers who offer a company's products and the
amount of shelf-space allocated to those products. We believe
that our broad-based, high value product offerings, our
retailer support, our consumer support and our cooperative
marketing and other promotional efforts promote close working
relationships with our retailers and improve our ability to
obtain critical shelf-space which enables us to establish,
maintain and increase market penetration.
o PRODUCT ENHANCEMENT AND DEVELOPMENT AND TIME-TO-MARKET.
Enhancement of our existing products, development of new
products and rapid time-to-market to satisfy evolving consumer
demands and preferences are key elements of our ability to
compete. Consumers continuously demand higher levels of
performance and functionality. We attempt to compete
successfully by bringing products with higher levels of
performance and functionality rapidly to market to satisfy
changing consumer demands and preferences. We believe that the
research and development efforts and economies of scale of our
major subcontract manufacturers and suppliers enable us to
rapidly introduce enhanced products and new products offering
higher levels of performance and functionality. Our products
are often among the first-to-market with new features and
technology made widely available to consumers.
INTELLECTUAL PROPERTY
We currently rely on a combination of contractual rights, copyrights,
trademarks and trade secrets to protect our proprietary rights. I/OMagic(R),
Hi-Val(R) and Digital Research Technologies(R) are our registered trademarks. We
also sell products under various product names such as DataBank(TM),
"DataStation", Data-to-Go(TM), EZ NetShare(TM), GigaBank(TM) and "MediaStation."
As we develop new products, we may file federal trademark applications covering
the trademarks under which we sell those products. There can be no assurance
that we will eventually secure a registered trademark covering these products.
We currently do not have any issued or pending patents.
We own, license or have otherwise obtained the right to use certain
technologies incorporated into our products. We may receive infringement claims
from third parties relating to our products and technologies. In those cases, we
intend to investigate the validity of the claims and, if we believe the claims
have merit, to respond through licensing or other appropriate actions. To the
extent claims relate to technology included in components purchased from
third-party vendors incorporated into our products, we would forward those
claims to the appropriate vendor. If we or our product manufacturers or
suppliers are unable to license or otherwise provide any necessary technology on
a cost-effective basis, we could be prohibited from marketing products
containing that technology, incur substantial costs in redesigning products
incorporating that technology, or incur substantial costs defending any legal
action taken against us.
We have been, and may in the future be, notified of claims asserting
that we may be infringing certain patents, trademarks and other intellectual
property rights of third parties. We cannot predict the outcome of such claims
and there can be no assurance that such claims will be resolved in our favor. An
unfavorable resolution of such claims may have a material adverse effect on our
business, prospects, financial condition and results of operations. The consumer
electronics industry, has been characterized by significant litigation relating
to infringement of patents and other intellectual property rights. We have in
the past been engaged in infringement litigation, both as plaintiff and
defendant. There can be no assurance that future intellectual property claims
will not result in litigation.
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If infringement is established, we may be required to pay substantial
damages or we may be enjoined from manufacturing and selling an infringing
product. In addition, the costs of engaging in the prosecution or defense of
intellectual property claims may be substantial regardless of the outcome.
A number of our agreements with our retailers provide that we will
defend, indemnify and hold harmless our retailers from damages and costs that
arise from product warranty claims or claims for injury or damage resulting from
defects in our products. If such claims are asserted against us, our insurance
coverage may not be adequate to cover the costs associated with our defense of
those claims or any resulting liability we would incur if those claims are
successful. A successful claim brought against us for product defects that is in
excess of, or excluded from, our insurance coverage could have a material
adverse affect on our business, results of operations and financial condition.
GOVERNMENT REGULATION
Our products are designed by our subcontract manufacturers and
suppliers to comply with a significant number of regulations and industry
standards, some of which are evolving as new technologies are deployed. We
believe that we are currently in compliance with each applicable regulation and
industry standard. In the United States, our products must comply with various
regulations defined by the United States Federal Communications Commission, or
FCC, and Underwriters Laboratories, or other nationally recognized test
laboratories. We also must comply with numerous import/export regulations. The
regulatory process in the United States can be time-consuming and can require
the expenditure of substantial resources. We cannot assure you that the FCC will
grant the requisite approvals for any of our products on a timely basis, or at
all. The failure of our products to comply, or delays in compliance, with the
various existing and evolving standards could negatively impact our ability to
sell our products. United States regulations regarding the manufacture and sale
of data communications devices are subject to future change. We cannot predict
what impact, if any, such changes may have upon our business.
EMPLOYEES
As of March 26, 2008, we had approximately 50 full-time employees. We
have no collective bargaining agreements with our employees. We believe that our
relationship with our employees is good.
ITEM 1A. RISK FACTORS.
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN
ADDITION TO THE OTHER INFORMATION IN THIS ANNUAL REPORT ON FORM 10-K AND IN OUR
OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING OUR
SUBSEQUENT REPORTS ON FORMS 10-Q AND 8-K, YOU SHOULD CAREFULLY CONSIDER THE
FOLLOWING RISK FACTORS BEFORE DECIDING TO INVEST IN SHARES OF OUR COMMON STOCK
OR TO MAINTAIN OR INCREASE YOUR INVESTMENT IN SHARES OF OUR COMMON STOCK. THE
RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE.
ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE
CURRENTLY DEEM IMMATERIAL MAY ALSO AFFECT OUR BUSINESS, FINANCIAL CONDITION AND
OPERATING RESULTS. IF ANY OF THE FOLLOWING RISKS, OR ANY OTHER RISKS NOT
DESCRIBED BELOW, ACTUALLY OCCUR, IT IS LIKELY THAT OUR BUSINESS, FINANCIAL
CONDITION AND OPERATING RESULTS COULD BE SERIOUSLY HARMED. AS A RESULT, THE
TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU COULD LOSE PART OR ALL
OF YOUR INVESTMENT.
RISKS RELATED TO OUR BUSINESS
WE ARE PRESENTLY EXPERIENCING A LACK OF LIQUIDITY. IF WE ARE UNABLE TO
INCREASE OUR LIQUIDITY, WE WILL EXPERIENCE A MATERIAL ADVERSE EFFECT ON OUR
ABILITY TO OPERATE OUR BUSINESS.
We are presently experiencing 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
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projections, if we are unable to successfully negotiate extended payment terms
on amounts owed to certain related-party creditors, 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.
IF WE CONTINUE TO SUSTAIN LOSSES, WE WILL BE IN VIOLATION OF A LOAN
COVENANT WITH SILICON VALLEY BANK. WE HAVE VIOLATED LOAN COVENANTS IN THE
PAST AND THERE IS NO ASSURANCE THAT WE WILL NOT BE IN VIOLATION OF OUR LOAN
COVENANTS IN THE FUTURE. IF WE VIOLATE OUR LOAN COVENANTS, WE MAY BE UNABLE
TO BORROW FUNDS TO PURCHASE INVENTORY, TO SUSTAIN OUR CURRENT SALES VOLUME
AND TO FUND OUR DAY TO DAY OPERATIONS.
Our credit facility with Silicon Valley Bank has one financial covenant
that requires us to maintain at all times, on a consolidated basis, to be tested
as of February 28, 2007 and at the end of each month ending thereafter, tangible
net worth of at least $3,500,000, plus (i) 50% of all consideration received
after the date of the related loan agreement for equity securities and
subordinated debt, plus (ii) 50% of our net income in each fiscal quarter ending
after the date of the related loan agreement. For the year ended December 31,
2007, we realized an inventory valuation adjustment to reflect lower market
prices of our consigned inventory of approximately $1.4 million, which reduced
our tangible net worth. We may realize additional downward inventory valuation
adjustments in the future which may result in a breach of our financial covenant
with Silicon Valley Bank. We have violated loan covenants in the past, including
as recently as March 2008, and there is no assurance that we will not be in
violation of our loan covenants in the future. If we violate our loan covenants,
we may be unable to borrow funds to purchase inventory, to sustain our current
sales volume and to fund our day to day operations. See "Managements Discussion
and Analysis and Results of Operations--Liquidity and Capital Resources, Bank
Lines of Credit."
OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM HAS EXPRESSED SUBSTANTIAL
DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN. THIS REPORT MAY
IMPAIR OUR ABILITY TO RAISE ADDITIONAL FINANCING AND ADVERSELY AFFECT THE
PRICE OF OUR COMMON STOCK.
The report of our independent registered public accounting firm
contained in our financial statements as of and for the year ended December 31,
2007 includes a paragraph that explains that we have incurred significant
recurring losses, have serious liquidity concerns and may require additional
financing in the foreseeable future. The report concludes that these matters,
among others, raise substantial doubt about our 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 us to raise additional
financing necessary to grow or operate our business. We urge potential investors
to review this report before making a decision to invest in I/OMagic.
WE HAVE INCURRED SIGNIFICANT LOSSES IN THE PAST, AND WE MAY CONTINUE TO
INCUR SIGNIFICANT LOSSES IN THE FUTURE. IF WE CONTINUE TO INCUR LOSSES, WE
WILL EXPERIENCE NEGATIVE CASH FLOW WHICH MAY HAMPER CURRENT OPERATIONS AND
MAY PREVENT US FROM SUSTAINING OR EXPANDING OUR BUSINESS.
We have incurred net losses in each of the last eight years. As of
December 31, 2007, we had an accumulated deficit of approximately $29.8 million.
During 2007, 2006, 2005, 2004 and 2003 we incurred net losses in the amounts of
approximately $4.8 million, $202,000, $1.8 million, $8.1 million and $460,000,
respectively. Historically, we have relied upon cash from operations and
financing activities to fund all of the cash requirements of our business. If
our extended period of net losses continues, our negative cash flow will
continue and may hamper current operations and prevent us from sustaining or
expanding our business. We cannot assure you that we will attain, sustain or
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increase profitability on a quarterly or annual basis in the future. If we do
not attain profitability, our business will be adversely affected and our stock
price may decline.
THE HIGH CONCENTRATION OF OUR SALES WITHIN THE DATA STORAGE INDUSTRY COULD
RESULT IN A SIGNIFICANT REDUCTION IN NET SALES AND NEGATIVELY AFFECT OUR
EARNINGS IF DEMAND FOR THOSE PRODUCTS DECLINES.
Sales of our data storage products accounted for approximately 74% of
our net sales, HDTVs accounted for approximately 21% of our net sales and our
other consumer electronics products accounted for approximately 3% of our net
sales in 2007. Sales of our data storage products accounted for approximately
94% of our net sales in 2006 and 99% of our net sales in each of 2005 and 2004
and our other consumer electronics products accounted for the remainder of our
net sales in each of those years.
We are experiencing intense price competition from major competitors
such as Western Digital and Seagate Technology/Maxtor, who are original
equipment manufacturers, which has significantly reduced selling prices and
eroded our margins for magnetic data storage products. Due to the intense price
competition, we may not be able to sell our 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. We have only recently diversified our
product categories outside of the data storage industry but expect data storage
products to continue to account for a significant proportion of our net sales
for the foreseeable future. As a result, our net sales and profitability would
be significantly and adversely impacted by a downturn in the demand for data
storage products.
THE CONSUMER ELECTRONICS INDUSTRY IS EXTREMELY COMPETITIVE. ALL OF OUR
SIGNIFICANT COMPETITORS HAVE GREATER FINANCIAL AND OTHER RESOURCES THAN WE
DO, AND ONE OR MORE OF THESE COMPETITORS COULD USE THEIR GREATER RESOURCES
TO GAIN MARKET SHARE AT OUR EXPENSE.
The markets for data storage products and HDTVs are extremely
competitive. All of our significant competitors selling data storage products,
including BenQ, Hewlett-Packard, Hitachi, Iomega, Lite-On, LG Electronics,
Memorex, Philips Electronics, Pioneer, Samsung Electronics, Seagate
Technology/Maxtor, SmartDisk/Verbatin, Sony and Western Digital, and all of our
significant competitors selling HDTVs, including Magnavox, Mitsubishi, Olevia,
Philips, Samsung Electronics, Sceptre, Sharp, Sylvania, Sony, Vizio and
Westinghouse have substantially greater production, financial, research and
development, intellectual property, personnel and marketing resources than we
do. As a result, each of these companies could compete more aggressively and
sustain that competition over a longer period of time than we could. For
example, we are experiencing intense price competition from major competitors
such as Western Digital and Seagate Technology/Maxtor, who are original
equipment manufacturers, which has significantly reduced selling prices and
eroded our margins for magnetic data storage products. Our lack of resources
relative to all of our significant competitors may cause us to fail to
anticipate or respond adequately to technological developments and changing
consumer demands and preferences, or may cause us to experience significant
delays in obtaining or introducing new or enhanced products. These failures or
delays could reduce our competitiveness and cause a decline in our market share,
sales and profitability.
THE CONSUMER ELECTRONICS INDUSTRY IS SUBJECT TO SIGNIFICANT FLUCTUATIONS IN
THE AVAILABILITY OF COMPONENTS AND FINISHED PRODUCTS. IF WE OR OUR
SUBCONTRACT MANUFACTURERS DO NOT PROPERLY ANTICIPATE THE NEED FOR CRITICAL
COMPONENTS OR FINISHED PRODUCTS, WE MAY BE UNABLE TO MEET THE DEMANDS OF
OUR RETAILERS AND CONSUMERS, WHICH COULD REDUCE OUR COMPETITIVENESS, CAUSE
A DECLINE IN OUR MARKET SHARE AND HAVE A MATERIAL ADVERSE EFFECT ON OUR
RESULTS OF OPERATIONS.
As the availability of components and finished products decreases, the
cost of acquiring those components and finished products ordinarily increases.
If we or our subcontract manufacturers fails to procure adequate supplies of
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components or finished products in anticipation of our retailers' orders or
consumer demand, our gross margins may be negatively impacted due to higher
prices that we or our subcontract manufacturers are required to pay for
components and products in short supply. In particular, there are a limited
number of manufacturers for magnetic hard disk drives and certain components for
HDTVs. High growth product categories have experienced chronic shortages of
components and finished products during periods of exceptionally high demand. If
we or our subcontract manufacturers do not properly anticipate the need for
critical components or finished products, we may be unable to meet the demands
of our retailers and consumers, which could reduce our competitiveness, cause a
decline in our market share and have a material adverse effect on our results of
operations.
IF WE FAIL TO SELECT HIGH TURNOVER PRODUCTS FOR OUR CONSIGNMENT SALES
CHANNELS, OUR FINANCING COSTS MAY EXCEED TARGETED LEVELS, WE MAY BE UNABLE
TO FUND ADDITIONAL PURCHASES OF INVENTORY AND WE MAY BE FORCED TO REDUCE
PRICES AND ACCEPT LOWER MARGINS TO SELL CONSIGNED PRODUCTS, WHICH WOULD
CAUSE OUR SALES, PROFITABILITY AND FINANCIAL RESOURCES TO DECLINE.
We retain most risks of ownership of products in our consignment sales
channels. These products remain our inventory until sold 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. For the years ended December 31, 2007 and 2006, we realized
inventory valuation adjustments to our consigned inventories for
lower-of-cost-or-market of approximately $1.4 million and $264,000,
respectively, which is included in cost of sales.
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.
Additionally, if our inventory turnover is not sufficiently frequent, the value
of our consigned inventory could decline significantly. For example, throughout
2007, we experienced intense price competition from major competitors such as
Western Digital and Seagate Technology/Maxtor, who are original equipment
manufacturers, which has significantly reduced selling prices and eroded margins
for our magnetic data storage products. Due to intense price competition, WE MAY
NOT BE ABLE TO SELL OUR INVENTORY OF DATA STORAGE PRODUCTS AT POSITIVE GROSS
MARGINS.
As of December 31, 2007 and 2006, we carried and financed inventory
valued at approximately $2.3 million and $6.9 million, respectively, in our
consignment sales channels. Sales generated through consignment sales were
approximately 46% and 43%, respectively, of our total net sales in 2007 and
2006. If we fail to select high turnover products for our consignment sales
channels, our sales, profitability and financial resources may decline.
WE DEPEND ON A SMALL NUMBER OF RETAILERS FOR THE VAST MAJORITY OF OUR
SALES. A REDUCTION IN BUSINESS FROM ANY OF THESE RETAILERS COULD CAUSE A
SIGNIFICANT DECLINE IN OUR SALES AND PROFITABILITY.
The vast majority of our sales are generated from a small number of
retailers. During 2007, net sales to our three largest retailers, Staples,
OfficeMax and Costco represented approximately 21%, 20% and 17%, respectively,
of our total net sales. During 2006, net sales to our four largest retailers,
Staples, Best Buy Canada, Circuit City and Office Depot represented
approximately 28%, 14%, 14% and 13%, respectively, of our total net sales. We
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expect that we will continue to depend upon a small number of retailers for a
significant majority of our sales for the foreseeable future.
Our agreements with these retailers do not require them to purchase any
specified number of products or dollar amount of sales or to make any purchases
whatsoever. Therefore, we cannot assure you that, in any future period, our
sales generated from these retailers, individually or in the aggregate, will
equal or exceed historical levels. We also cannot assure you that, if sales to
any of these retailers cease or decline, we will be able to replace these sales
with sales to either existing or new retailers in a timely manner, or at all. A
cessation or reduction of sales, or a decrease in the prices of products sold to
one or more of these retailers has significantly reduced our net sales for one
or more reporting periods in the past and could, in the future, cause a
significant decline in our net sales and profitability.
OUR LACK OF LONG-TERM PURCHASE ORDERS AND COMMITMENTS COULD LEAD TO A RAPID
DECLINE IN OUR SALES AND PROFITABILITY.
All of our significant retailers issue purchase orders solely in their
own discretion, often only one to two weeks before the requested date of
shipment. Our retailers are generally able to cancel orders or delay the
delivery of products on short notice. In addition, our retailers may decide not
to purchase products from us for any reason. Accordingly, we cannot assure you
that any of our current retailers will continue to purchase our products in the
future. As a result, our sales volume and profitability could decline rapidly
with little or no warning whatsoever.
We cannot rely on long-term purchase orders or commitments to protect
us from the negative financial effects of a decline in demand for our products.
The limited certainty of product orders can make it difficult for us to forecast
our sales and allocate our resources in a manner consistent with our actual
sales. Moreover, our expense levels are based in part on our expectations of
future sales and, if our expectations regarding future sales are inaccurate, we
may be unable to reduce costs in a timely manner to adjust for sales shortfalls.
Furthermore, because we depend on a small number of retailers for the vast
majority of our sales, the magnitude of the ramifications of these risks is
greater than if our sales were less concentrated with a small number of
retailers. As a result of our lack of long-term purchase orders and purchase
commitments we may experience a rapid decline in our sales and profitability.
ONE OR MORE OF OUR LARGEST RETAILERS MAY DIRECTLY IMPORT OR PRIVATE LABEL
PRODUCTS THAT ARE IDENTICAL OR VERY SIMILAR TO OUR PRODUCTS WHICH COULD
CAUSE A SIGNIFICANT DECLINE IN OUR SALES AND PROFITABILITY.
Data storage products, HDTVs and other consumer electronics products
are widely available from manufacturers and other suppliers around the world.
Our largest retailers include Staples, OfficeMax and Costco. Collectively, these
three retailers accounted for 58% of our net sales in 2007. Each of these
retailers has substantially greater resources than we do, and has the ability to
directly import or private-label data storage products, HDTVs and other consumer
electronics products from manufacturers and suppliers around the world,
including from some of our own subcontract manufacturers and suppliers. Our
retailers may believe that higher profit margins can be achieved if they
implement a direct import or private-label program, excluding us from the sales
channel. Accordingly, one or more of our largest retailers may stop buying
products from us in favor of a direct import or private-label program. As a
consequence, our sales and profitability could decline significantly.
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HISTORICALLY, A SUBSTANTIAL PORTION OF OUR ASSETS HAS BEEN COMPRISED OF
ACCOUNTS RECEIVABLE REPRESENTING AMOUNTS OWED BY A SMALL NUMBER OF
RETAILERS. WE EXPECT THIS TO CONTINUE IN THE FUTURE. IF ANY OF THESE
RETAILERS FAILS TO TIMELY PAY US AMOUNTS OWED, WE COULD SUFFER A
SIGNIFICANT DECLINE IN CASH FLOW AND LIQUIDITY WHICH, IN TURN, COULD CAUSE
US TO BE UNABLE PAY OUR LIABILITIES AND PURCHASE AN ADEQUATE AMOUNT OF
INVENTORY TO SUSTAIN OR EXPAND OUR SALES VOLUME.
Our accounts receivable represented approximately 46% and 45% of our
total assets as of December 31, 2007 and 2006, respectively. As of December 31,
2007, 65% of our accounts receivable represented amounts owed by four retailers,
each of which represented over 10% of the total amount of our accounts
receivable. As of December 31, 2006, 72% of our accounts receivable represented
amounts owed by three retailers, each of which represented over 10% of the total
amount of our accounts receivable. As a result of the substantial amount and
concentration of our accounts receivable, if any of our major retailers fails to
timely pay us amounts owed, we could suffer a significant decline in cash flow
and liquidity which would negatively affect our ability to make payments under
our line of credit with Silicon Valley Bank and which, in turn, could adversely
affect our ability to borrow funds to pay our liabilities and to purchase
inventory to sustain or expand our current sales volume.
WE RELY HEAVILY ON OUR CHIEF EXECUTIVE OFFICER, TONY SHAHBAZ. THE LOSS OF
HIS SERVICES COULD ADVERSELY AFFECT OUR ABILITY TO SOURCE PRODUCTS FROM OUR
KEY SUPPLIERS AND OUR ABILITY TO SELL OUR PRODUCTS TO OUR RETAILERS.
Our success depends, to a significant extent, upon the continued
services of Tony Shahbaz, who is our Chairman of the Board, President, Chief
Executive Officer and Secretary. For example, Mr. Shahbaz has developed key
personal relationships with our subcontract manufacturers, suppliers and
retailers. We greatly rely on these relationships in the conduct of our
operations and the execution of our business strategies. Mr. Shahbaz and some of
these subcontract manufacturers and suppliers have acquired interests in
business entities that own shares of our common stock. Further, some of these
manufacturers also directly hold shares of our common stock. See "Certain
Relationships and Related Transactions, and Director Independence." The loss of
Mr. Shahbaz could, therefore, result in the loss of our favorable relationships
with one or more of our subcontract manufacturers or suppliers. Although we have
entered into an employment agreement with Mr. Shahbaz, that agreement is of
limited duration and is subject to early termination by Mr. Shahbaz under
certain circumstances. In addition, we do not maintain "key person" life
insurance covering Mr. Shahbaz or any other executive officer. The loss of Mr.
Shahbaz could significantly delay or prevent the achievement of our business
objectives. Consequently, the loss of Mr. Shahbaz could adversely affect our
business, financial condition and results of operations.
IF WE FAIL TO ACCURATELY FORECAST THE COSTS OF OUR PRODUCT REBATE OR OTHER
PROMOTIONAL PROGRAMS, WE MAY EXPERIENCE A SIGNIFICANT DECLINE IN CASH FLOW
AND OUR BRAND IMAGE MAY BE ADVERSELY AFFECTED RESULTING IN REDUCED SALES
AND PROFITABILITY.
We have historically relied heavily on product rebates and other
promotional programs to establish, maintain and increase sales of our products.
If we fail to accurately forecast the costs of these programs, we may fail to
allocate sufficient resources to these programs. For example, we may fail to
have sufficient funds available to satisfy mail-in product rebates. If we are
unable to satisfy our promotional obligations, such as providing cash rebates to
consumers, our brand image and goodwill with consumers and retailers could be
harmed, which may result in reduced sales and profitability. In addition, our
failure to adequately forecast the costs of these programs may result in
unexpected liabilities causing a significant decline in cash flow and financial
resources with which to operate our business.
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OUR TWO PRINCIPAL SUBCONTRACT MANUFACTURERS AND SUPPLIERS, WHO ARE ALSO
SIGNIFICANT STOCKHOLDERS OF I/OMAGIC, PROVIDE US WITH SIGNIFICANTLY
PREFERENTIAL TRADE CREDIT TERMS. IF EITHER OF THESE MANUFACTURERS DOES NOT
CONTINUE TO OFFER US SUBSTANTIALLY THE SAME PREFERENTIAL CREDIT TERMS, OUR
SALES AND PROFITABILITY WOULD DECLINE SIGNIFICANTLY.
BTC and Lung Hwa, our two principal subcontract manufacturers and
suppliers, who are also significant stockholders of I/OMagic, provide us with
significantly preferential trade credit terms. These terms include extended
payment terms, substantial trade lines of credit and other preferential buying
arrangements. We believe that these terms are substantially better terms than we
could likely obtain from other subcontract manufacturers or suppliers. In fact,
we believe that our trade credit facility with Lung Hwa is likely unique and
could not be replaced through a relationship with an unrelated third party. If
either of these subcontract manufacturers and suppliers does not continue to
offer us substantially the same preferential trade credit terms, our ability to
finance inventory purchases would be harmed, resulting in significantly reduced
sales and profitability. In addition, we would incur additional financing costs
associated with shorter payment terms which would also cause our profitability
to decline. See "Certain Relationships and Related Transactions, and Director
Independence."
CONSUMER ELECTRONICS PRODUCTS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGES.
IF WE FAIL TO ACCURATELY ANTICIPATE AND ADAPT TO THESE CHANGES, THE
PRODUCTS WE SELL WILL BECOME OBSOLETE, CAUSING A DECLINE IN OUR SALES AND
PROFITABILITY.
Consumer electronics products are subject to rapid technological
changes which often cause product obsolescence. Companies within the consumer
electronics industry are continuously developing new products with heightened
performance and functionality. This puts pricing pressure on existing products
and constantly threatens to make them, or causes them to be, obsolete. Our
typical product's life cycle is extremely short, ranging from 6 to 12 months,
generating lower average selling prices as the cycle matures. If we fail to
accurately anticipate the introduction of new technologies, we may possess
significant amounts of obsolete inventory that can only be sold at substantially
lower prices and profit margins than we anticipated. In addition, if we fail to
accurately anticipate the introduction of new technologies, we may be unable to
compete effectively due to our failure to offer products most demanded by the
marketplace. If any of these failures occur, our sales, profit margins and
profitability will be adversely affected.
OUR INDEMNIFICATION OBLIGATIONS TO OUR RETAILERS FOR PRODUCT DEFECTS COULD
REQUIRE US TO PAY SUBSTANTIAL DAMAGES, WHICH COULD HAVE A SIGNIFICANT
NEGATIVE IMPACT ON OUR PROFITABILITY AND FINANCIAL RESOURCES.
A number of our agreements with our retailers provide that we will
defend, indemnify and hold them and their customers, harmless from damages and
costs that arise from product warranty claims or from claims for injury or
damage resulting from defects in our products. If such claims are asserted
against us, our insurance coverage may not be adequate to cover the costs
associated with our defense of those claims or the cost of any resulting
liability we incur if those claims are successful. A successful claim brought
against us for product defects that is in excess of, or excluded from, our
insurance coverage could adversely affect our profitability and financial
resources and could make it difficult or impossible for us to adequately fund
our day-to-day operations.
IF WE ARE SUBJECTED TO ONE OR MORE INTELLECTUAL PROPERTY INFRINGEMENT
CLAIMS, OUR SALES, EARNINGS AND FINANCIAL RESOURCES MAY BE ADVERSELY
AFFECTED.
Our products rely on intellectual property developed, owned or licensed
by third parties. From time to time, intellectual property infringement claims
have been asserted against us. We expect to continue to be subjected to such
claims in the future. Intellectual property infringement claims may also be
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asserted against our retailers as a result of selling our products. As a
consequence, our retailers could assert indemnification claims against us. If
any third party is successful in asserting an infringement claim against us, we
could be required to acquire licenses, which may not be available on
commercially reasonable terms, if at all, to continue selling certain products,
to pay substantial monetary damages or to develop non-infringing technologies,
none of which may be feasible. Both infringement and indemnification claims
could be time-consuming and costly to defend or settle and would divert
management's attention and our financial resources away from our business. In
addition, we may lack sufficient litigation defense resources, therefore, any
one of these developments could place substantial financial and administrative
burdens on us and our sales, profitability and financial resources may be
adversely affected.
IF WE FAIL TO SUCCESSFULLY MANAGE THE EXPANSION OF OUR BUSINESS, OUR SALES
MAY NOT INCREASE COMMENSURATELY WITH OUR EXPENSES, WHICH WOULD CAUSE OUR
PROFITABILITY TO DECLINE.
We plan to offer new data storage, HDTV and other consumer electronics
products in the future. In particular, we plan to offer enhanced versions of our
HDTVs, additional magnetic and optical media-based products as well as products
with heightened performance and added functionality. We also plan to offer
next-generation Blu-Ray products. These planned product offerings will require
significant purchases of inventory and management's close attention. In offering
new HDTV, our resources and personnel are likely to be strained because we have
little experience in the television industry. Our failure to successfully manage
our planned product expansion could result in our sales not increasing
commensurately with our expenses, causing a decline in our profitability.
A SIGNIFICANT PRODUCT DEFECT OR PRODUCT RECALL COULD MATERIALLY AND
ADVERSELY AFFECT OUR BRAND IMAGE, CAUSING A DECLINE IN OUR SALES AND
PROFITABILITY, AND COULD REDUCE OR DEPLETE OUR FINANCIAL RESOURCES.
A significant product defect could materially harm our brand image and
could force us to conduct a product recall. This could result in damage to our
relationships with our retailers and loss of consumer loyalty. A product recall
would be particularly harmful to us because we have limited financial and
administrative resources to effectively manage a product recall and it would
detract management's attention from implementing our core business strategies.
As a result, a significant product defect or product recall could cause a
decline in our sales and profitability, and could reduce or deplete our
financial resources.
IF OUR PRODUCTS ARE NOT AMONG THE FIRST-TO-MARKET, OR IF CONSUMERS DO NOT
RESPOND FAVORABLY TO EITHER OUR NEW OR ENHANCED PRODUCTS, OUR SALES,
PROFITABILITY AND FINANCIAL RESOURCES WILL BE ADVERSELY AFFECTED.
One of our core business strategies is to be among the first-to-market
with new and enhanced products based on established technologies. As a
consequence of this strategy, we are exposed to consumer rejection of our new
and enhanced products to a greater degree than if we offered products later in
their industry life cycle. For example, our anticipated future sales are largely
dependent on future consumer demand for increased functionality and quality.
Accordingly, future sales and any future profits from our new and enhanced data
storage products, HDTVs or other consumer electronics products are substantially
dependent upon widespread consumer acceptance of these new and enhanced
products. If this widespread consumer acceptance of our new and enhanced
products does not occur, or is delayed, our sales, profitability and financial
resources will be adversely affected.
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A LABOR STRIKE OR CONGESTION AT A SHIPPING PORT AT WHICH OUR PRODUCTS ARE
SHIPPED OR RECEIVED COULD PREVENT US FROM TAKING TIMELY DELIVERY OF
INVENTORY, WHICH COULD CAUSE OUR SALES AND PROFITABILITY TO DECLINE.
From time to time, shipping ports experience labor strikes, work
stoppages or congestion that delay the delivery of imported products. The port
of Long Beach, California, through which most of our products are imported from
Asia, experienced a labor strike in September 2002 which lasted nearly two
weeks. As a result, there was a significant disruption in our ability to deliver
products to our retailers, which caused our sales to decline. Any future labor
strike, work stoppage or congestion at a shipping port at which our products are
shipped or received would prevent us from taking timely delivery of inventory
and cause our sales to decline. In addition, many of our retailers impose
penalties for both early and late product deliveries, which could result in
significant additional costs to us. In the event of a similar labor strike or
work stoppage in the future, or in the event of congestion, in order to meet our
delivery obligations to our retailers and avoid penalties for missed delivery
dates, we may be required to arrange for alternative means of product shipment,
such as air freight, which could add significantly to our product costs. We
would typically be unable to pass these extra costs along to either our
retailers or to consumers. Also, because the average selling prices of our
products decline, often rapidly, during their short product life cycle, delayed
delivery of products could yield significantly less than expected sales and
profits.
FAILURE TO ADEQUATELY PROTECT OUR TRADEMARK RIGHTS COULD CAUSE US TO LOSE
MARKET SHARE AND CAUSE OUR SALES TO DECLINE.
We sell our products primarily under our I/OMagic(R) and Digital
Research Technologies(R) brand names and, from time to time, also sell products
under our Hi-Val(R) brand name. Each of these trademarks has been registered by
us with the United States Patent & Trademark Office. We also sell products under
various product names such as DataBank(TM), Data-to-Go(TM), DataStation, EZ
NetShare(TM), GigaBank(TM) and MediaStation. One of our key business strategies
is to use our brand and product names to successfully compete in the industries
in which we operate. We have expended significant resources promoting our brand
and product names and we have registered trademarks for our three brand names.
However, we cannot assure you that the registration of our brand name
trademarks, or our other actions to protect our non-registered product names,
will deter or prevent their unauthorized use by others. We also cannot assure
you that other companies, including our competitors, will not use our product
names. If other companies, including our competitors, use our brand or product
names, consumer confusion could result, meaning that consumers may not recognize
us as the source of our products. This would reduce the value of goodwill
associated with these brand and product names. This consumer confusion and the
resulting reduction in goodwill could cause us to lose market share, cause our
sales to decline and profitability and financial resources could be adversely
affected.
CONSUMER ACCEPTANCE OF ALTERNATIVE SALES CHANNELS MAY INCREASE. IF WE ARE
UNABLE TO ADAPT TO THESE ALTERNATIVE SALES CHANNELS, SALES OF OUR PRODUCTS
MAY DECLINE.
We are accustomed to conducting business through traditional retail
sales channels. Consumers purchase our products predominantly through a small
number of retailers. For example, during 2007, three of our retailers
collectively accounted for 58% of our total net sales. Similarly, during 2006,
four of our retailers collectively accounted for 69% of our total net sales. We
currently generate only a small number of direct sales of our products through
our Internet websites. We believe that many of our target consumers are
knowledgeable about technology and comfortable with the use of the Internet for
product purchases. Consumers may increasingly prefer alternative sales channels,
such as direct mail order or direct purchase from manufacturers. In addition,
Internet commerce is accepted by consumers as a convenient, secure and
cost-effective method of purchasing data storage, television and other consumer
electronics products. The migration of consumer purchasing habits from
traditional retailers to Internet retailers could have a significant impact on
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our ability to sell our products. We cannot assure you that we will be able to
predict and respond to increasing consumer preference of alternative sales
channels. If we are unable to adapt to alternative sales channels, sales of our
products may decline.
OUR OPERATIONS ARE VULNERABLE BECAUSE WE HAVE LIMITED REDUNDANCY AND BACKUP
SYSTEMS.
Our internal order, inventory and product data management system is an
electronic system through which our retailers place orders for our products and
through which we manage product pricing, shipments, returns and other matters.
This system's continued and uninterrupted performance is critical to our
day-to-day business operations. Despite our precautions, unanticipated
interruptions in our computer and telecommunications systems have, in the past,
caused problems or stoppages in this electronic system. These interruptions, and
resulting problems, could occur in the future. We have extremely limited ability
and personnel to process purchase orders and manage product pricing and other
matters in any manner other than through this electronic system. Any
interruption or delay in the operation of this electronic system could cause a
significant decline in our sales and profitability.
RISKS RELATED TO OUR COMMON STOCK
OUR COMMON STOCK HAS A SMALL PUBLIC FLOAT AND SHARES OF OUR COMMON STOCK
ELIGIBLE FOR PUBLIC SALES COULD CAUSE THE MARKET PRICE OF OUR STOCK TO
DROP, EVEN IF OUR BUSINESS IS DOING WELL.
As of March 26, 2008, there were approximately 4.5 million shares of
our common stock outstanding. As a group, our executive officers, directors and
10% stockholders beneficially own approximately 3.3 million of these shares.
Accordingly, our common stock has a public float of approximately 1.2 million
shares held by a relatively small number of public investors. In addition, we
have a registration statement on Form S-8 in effect covering 133,334 shares of
common stock issuable upon exercise of options under our 2002 Stock Option Plan
and a registration statement on Form S-8 in effect covering 400,000 shares of
common stock issuable upon exercise of options under our 2003 Stock Option Plan.
Currently, options covering 74,775 shares of common stock are outstanding under
our 2002 Stock Option Plan and 229,000 options are outstanding under our 2003
Stock Option Plan. The shares of common stock issued upon exercise of these
options will be freely tradable without restriction or further registration,
except to the extent purchased by one of our affiliates.
We cannot predict the effect, if any, that future sales of shares of
our common stock into the public market will have on the market price of our
common stock. However, as a result of our small public float, sales of
substantial amounts of common stock, including shares issued upon the exercise
of stock options or warrants, or anticipation that such sales could occur, may,
materially and adversely affect prevailing market prices for our common stock.
OUR STOCK PRICE IS HIGHLY VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL
LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND IN
LITIGATION AGAINST US.
The market price of our common stock has fluctuated significantly in
the past and may continue to fluctuate significantly in the future. During 2008
through March 25, 2008, the high and low closing bid prices of a share of our
common stock were $1.49 and $1.15, respectively. During 2007, the high and low
closing bid prices of a share of our common stock were $3.85 and $1.05,
respectively. During 2006, the high and low closing bid prices of a share of our
common stock were $5.50 and $1.53, respectively. The market price of our common
stock may continue to fluctuate in response to one or more of the following
factors, many of which are beyond our control:
o changes in market valuations of similar companies;
o stock market price and volume fluctuations;
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o economic conditions specific to the consumer electronics
industry;
o announcements by us or our competitors of new or enhanced
products or technologies or of significant contracts,
acquisitions, strategic relationships, joint ventures or
capital commitments;
o the loss of one or more of our top retailers or the
cancellation or postponement of orders from any of those
retailers;
o delays in our introduction of new products or technological
innovations or problems in the functioning of these new
products or innovations;
o disputes or litigation concerning our rights to use third
parties' intellectual property or third parties' infringement
of our intellectual property;
o changes in our pricing policies or the pricing policies of our
competitors;
o changes in foreign currency exchange rates affecting our
product costs and pricing;
o regulatory developments or increased enforcement;
o fluctuations in our quarterly or annual operating results;
o additions or departures of key personnel; and
o future sales of our common stock or other securities.
The price at which you purchase shares of our common stock may not be
indicative of the price that will prevail in the trading market. You may be
unable to sell your shares of common stock at or above your purchase price,
which may result in substantial losses to you.
In the past, securities class action litigation has often been brought
against a company following periods of stock price volatility. Although we have
not been subject to such litigation, we may be the target of such litigation in
the future. Securities litigation could result in substantial costs and divert
management's attention and our financial resources from our business.
Any of the risks described above could have an adverse effect on our
business, financial condition and results of operations and therefore on the
price of our common stock.
IF THE OWNERSHIP OF OUR COMMON STOCK CONTINUES TO BE HIGHLY CONCENTRATED,
IT MAY PREVENT YOU AND OTHER STOCKHOLDERS FROM INFLUENCING SIGNIFICANT
CORPORATE DECISIONS AND MAY RESULT IN CONFLICTS OF INTEREST THAT COULD
CAUSE OUR STOCK PRICE TO DECLINE.
As a group, our executive officers, directors, and 10% stockholders
beneficially own or control approximately 73% of our outstanding shares of
common stock (after giving effect to the exercise of all outstanding vested
options exercisable within 60 days from March 26, 2008). As a result, our
current executive officers, directors, and 10% stockholders, acting as a group,
have substantial control over the outcome of corporate actions requiring
stockholder approval, including the election of directors, any merger,
consolidation or sale of all or substantially all of our assets, or any other
significant corporate transaction. Some of these controlling stockholders may
have interests different than yours. For example, these stockholders may delay
or prevent a change in control of I/OMagic, even one that would benefit our
stockholders, or pursue strategies that are different from the wishes of other
investors. The significant concentration of stock ownership may adversely affect
the trading price of our common stock due to investors' perception that
conflicts of interest may exist or arise.
OUR ARTICLES OF INCORPORATION, OUR BYLAWS AND NEVADA LAW EACH CONTAIN
PROVISIONS THAT COULD DISCOURAGE TRANSACTIONS RESULTING IN A CHANGE IN
CONTROL OF I/OMAGIC, WHICH MAY NEGATIVELY AFFECT THE MARKET PRICE OF OUR
COMMON STOCK.
Our articles of incorporation and our bylaws contain provisions that
may enable our board of directors to discourage, delay or prevent a change in
the ownership of I/OMagic or in our management. In addition, these provisions
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could limit the price that investors would be willing to pay in the future for
shares of our common stock. These provisions include the following:
o our board of directors is authorized, without prior
stockholder approval, to create and issue preferred stock,
commonly referred to as "blank check" preferred stock, with
rights senior to those of our common stock;
o our stockholders are permitted to remove members of our board
of directors only upon the vote of at least two-thirds of the
outstanding shares of stock entitled to vote at a meeting
called for such purpose or by written consent; and
o our board of directors are expressly authorized to make, alter
or repeal our bylaws.
In addition, we may be subject to the restrictions contained in
Sections 78.378 through 78.3793 of the Nevada Revised Statutes which provide,
subject to certain exceptions and conditions, that if a person acquires a
"controlling interest," which is equal to either one-fifth or more but less than
one-third, one-third or more but less than a majority, or a majority or more of
the voting power of a corporation, that person is an "interested stockholder"
and may not vote that person's shares. The effect of these restrictions may be
to discourage, delay or prevent a change in control of I/OMagic.
WE CANNOT ASSURE YOU THAT AN ACTIVE MARKET FOR OUR SHARES OF COMMON STOCK
WILL DEVELOP OR, IF IT DOES DEVELOP, WILL BE MAINTAINED IN THE FUTURE. IF
AN ACTIVE MARKET DOES NOT DEVELOP, YOU MAY NOT BE ABLE TO READILY SELL YOUR
SHARES OF OUR COMMON STOCK.
On March 25, 1996, our common stock commenced trading on the OTC
Bulletin Board. Since that time, there has been extremely limited trading in our
shares, at widely varying prices, and the trading to date has not created an
active market for our shares. We cannot assure you that an active market for our
shares will be established or maintained in the future. If an active market is
not established or maintained, you may not be able to readily sell your shares
of our common stock.
BECAUSE WE ARE SUBJECT TO "PENNY STOCK" RULES, THE LEVEL OF TRADING
ACTIVITY IN OUR COMMON STOCK MAY BE REDUCED. IF THE LEVEL OF TRADING
ACTIVITY IS REDUCED, YOU MAY NOT BE ABLE TO READILY SELL YOUR SHARES OF OUR
COMMON STOCK.
Broker-dealer practices in connection with transactions in "penny
stocks" are regulated by penny stock rules adopted by the Securities and
Exchange Commission. Penny stocks are, generally, equity securities with a price
of less than $5.00 per share that trade on the OTC Bulletin Board or the Pink
Sheets. The penny stock rules require a broker-dealer, prior to a transaction in
a penny stock not otherwise exempt from the rules, to deliver a standardized
risk disclosure document that provides information about penny stocks and the
nature and level of risks in investing in the penny stock market. The
broker-dealer also must provide the prospective investor with current bid and
offer quotations for the penny stock and the amount of compensation to be paid
to the broker-dealer and its salespeople in the transaction. Furthermore, if the
broker-dealer is the sole market maker, the broker-dealer must disclose this
fact and the broker-dealer's presumed control over the market, and must provide
each holder of a penny stock with a monthly account statement showing the market
value of each penny stock held in the customer's account. In addition,
broker-dealers who sell penny stocks to persons other than established customers
and "accredited investors" must make a special written determination that the
penny stock is a suitable investment for the prospective investor and receive
the purchaser's written agreement to the transaction. These requirements may
have the effect of reducing the level of trading activity in a penny stock, such
as our common stock, and investors in our common stock may find it difficult to
sell their shares.
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ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
Our corporate headquarters is located in Irvine, California in a leased
facility of approximately 55,000 square feet. This facility contains all of our
operations, including sales, marketing, finance, administration, production,
shipping and receiving. The lease term began on September 1, 2003 and expires on
August 31, 2009, with an option to extend the lease for another three year term
upon providing notice 180 days prior to expiration of the current lease term. We
believe this facility is adequate for our anticipated business purposes for the
foreseeable future. We have no other leased or owned real property.
ITEM 3. LEGAL PROCEEDINGS.
On or about May 30, 2003, I/OMagic 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, our 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 I/OMagic and IOM Holdings, Inc. in an
acquisition transaction and in a separate arbitration matter. On or about
November 6, 2003, we filed our First Amended Complaint against all defendants.
Defendants responded to our First Amended Complaint denying our 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. We
denied the allegations in the Cross-Complaint. Trial began on February 6, 2006
and on March 10, 2006, the jury ruled in our favor against Lawrence W. Horwitz,
Horwitz & Beam, Inc., Lawrence M. Cron, Horwitz & Cron and Senn Palumbo
Meulemans, LLP, and awarded I/OMagic $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 us as
to all defendants, which reversed the Judgments in our favor as to Lawrence W.
Horwitz, Horwitz & Beam, Inc. and Lawrence M Cron. The Court of Appeal also
ordered that we are to pay defendants' costs on appeal. We did not further
appeal the decision.
In addition to the matters described above, we 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 our financial position, results of operations or cash
flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We held our annual stockholders' meeting on December 21, 2007. As of
the close of business on November 2, 2007, the record date for the meeting, we
had outstanding 4,540,292 shares of common stock. A total of 2,884,731 shares of
common stock were represented in person or by proxy at the meeting and
constituted a quorum. At the meeting, the following proposals were presented and
voted on:
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1. TO ELECT FOUR DIRECTORS TO SERVE ON OUR BOARD OF DIRECTORS
UNTIL THE NEXT ANNUAL MEETING OF STOCKHOLDERS AND/OR UNTIL
THEIR SUCCESSORS ARE DULY ELECTED AND QUALIFIED. THE NOMINEES
FOR ELECTION ARE TONY SHAHBAZ, STEEL SU, DANIEL YAO AND DR.
WILLIAM TING.
All nominees were re-elected as follows:
o Messrs. Shahbaz and Su each received 2,723,390 votes
"for" and 161,341 votes "against" with no
abstentions.
o Messrs. Yao and Ting each received 2,723,424 votes
"for" and "161,307 votes "against" with no
abstentions.
2. TO RATIFY THE APPOINTMENT OF SWENSON ADVISORS LLP AS OUR
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR THE YEAR
ENDING DECEMBER 31, 2007.
This proposal was approved by a vote of 2,759,985 shares "for"
with no shares voted "against" and 124,746 abstentions.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
MARKET INFORMATION
Our common stock has been traded on the OTC Bulletin Board under the
symbol "IOMG" since December 20, 2002. Prior to that time, it traded on the OTC
Bulletin Board under the symbol "IOMC" since March 25, 1996. The table below
shows for each fiscal quarter indicated the high and low closing bid prices for
shares of our common stock. This information has been obtained from the OTC
Bulletin Board. The prices shown reflect inter-dealer prices, without retail
mark-up, mark-down, or commission and may not necessarily represent actual
transactions.
PRICE RANGE
HIGH LOW
2006:
First Quarter (January 1 - March 31)......... $ 5.50 $ 3.75
Second Quarter (April 1 - June 30)........... $ 3.92 $ 2.40
Third Quarter (July 1 - September 30)........ $ 3.00 $ 1.53
Fourth Quarter (October 1 - December 31)..... $ 2.80 $ 1.55
2007:
First Quarter................................ $ 2.75 $ 1.95
Second Quarter............................... $ 3.85 $ 2.00
Third Quarter................................ $ 2.20 $ 1.15
Fourth Quarter............................... $ 3.00 $ 1.05
SECURITY HOLDERS
As of March 26, 2008, we had 4,540,292 shares of common stock
outstanding held of record by approximately 70 stockholders. These holders of
record include depositories that hold shares of stock for brokerage firms which,
in turn, hold shares of stock for numerous beneficial owners.
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DIVIDENDS
We have not paid dividends on our common stock to date. Our line of
credit with Silicon Valley Bank prohibits the payment of cash dividends on our
common stock. We currently intend to retain future earnings to fund the
development and growth of our business and, therefore, do not anticipate paying
cash dividends on our common stock within the foreseeable future. Any future
payment of dividends on our common stock will be determined by our board of
directors and will depend on our financial condition, results of operations,
contractual obligations and other factors deemed relevant by our board of
directors.
RECENT SALES OF UNREGISTERED SECURITIES
In October 2007, we issued warrants to purchase an aggregate of 50,000
shares of common stock at an exercise price of $3.00 to two financial consulting
firms. The warrants expire on October 3, 2008.
The issuance of our securities in the above-referenced transaction was
effected in reliance upon the exemption from registration under Section 4(2) of
the Securities Act of 1933, as amended, or Securities Act, as transactions not
involving a public offering. Exemption from the registration provisions of the
Securities Act is claimed on the basis that such transactions did not involve
any public offering and the purchaser was sophisticated with access to the kind
of information registration would provide including our most recent Annual
Report on Form 10-K and our most recent Quarterly Report on Form 10-Q.
ITEM 6. SELECTED FINANCIAL DATA.
Not applicable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
RESTATED CONSOLIDATED FINANCIAL STATEMENTS 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 "RISK FACTORS" AND UNDER
OTHER CAPTIONS CONTAINED ELSEWHERE IN THIS REPORT.
OVERVIEW
We sell data storage products, high-definition televisions, or HDTVs,
utilizing liquid crystal display, or LCD, technology, and other consumer
electronics products. Our data storage products collectively accounted for
approximately 74% of our net sales in 2007, our HDTVs accounted for
approximately 21% of our net sales in 2007 and our other consumer electronics
products collectively accounted for approximately 3% of our net sales in 2007.
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 television products consist of a range of LCD
televisions of different sizes, most of which are HDTVs. 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, wholesales clubs, distributors, and other major North
American retailers. Our network of retailers enables us to offer products to
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consumers across North America, including in every major metropolitan market in
the United States. Over the last three years, our largest retailers have
included Best Buy Canada, Circuit City, Costco, Office Depot, OfficeMax and
Staples. Our principle brands are I/OMagic(R) and Digital Research
Technologies(R), however, from time to time, we also sell products under our
Hi-Val(R) brand name.
RECENT DEVELOPMENTS
On March 7, 2008, we received notice from Silicon Valley Bank that we
were in default of our tangible net worth financial covenant. The outstanding
balance with Silicon Valley Bank as of March 7, 2008 was $1,598,461, all of
which was due and payable upon demand by Silicon Valley Bank, and no amounts
were available to us for borrowing as we were in violation of the loan covenant.
On April 18, 2008, we entered into a Loan and Security Agreement dated
as of April 18, 2008 with Silicon Valley Bank, which provided for a credit
facility based on our accounts receivable. The Loan and Security Agreement
served to amend and restated a previous Loan and Security Agreement dated
January 29, 2007 among the parties. The credit facility allowed us to finance
our accounts receivable and borrow up to a maximum aggregate amount of $7.0
million; provided, that we were only permitted to borrow up to a limit of 60% of
each eligible account or such other percentage as Silicon Valley Bank
established. The line of credit was to expire on January 29, 2009. Advances on
the line of credit 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 we pay a collateral handling fee of $2,000 per month and
other customary fees and expenses. On July 31, 2008, we paid off our obligations
owed to Silicon Valley Bank under the Loan and Security Agreement dated April
18, 2008 and terminated the Loan and Security Agreement.
On October 29, 2008, we 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. The credit facility allows us
to sell accounts receivable to Rexford Funding subject to a maximum 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. The Sale of Accounts and
Security Agreement has an initial term through April 30, 2009 with automatic six
month extensions unless either party terminates the Sale of Accounts and
Security 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 has the right to
terminate the Sales of Accounts and Security Agreement upon 30 days prior
notice.
As of March 26, 2009, we had only $368,600 of cash on hand.
Accordingly, we are presently experiencing 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 successfully negotiate extended payment terms
on amounts owed to certain related-party creditors, 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. See "--Critical Accounting Policies, Going Concern
Assumption" and "--Liquidity and Capital Resources, Overview" and "--Liquidity
and Capital Resources, Bank Lines of Credit."
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During the fourth quarter of 2007, we received notice from Office Depot
that it would not offer any of our products during at least the first quarter of
2008 and probably through the second quarter of 2008. In addition, during the
first quarter of 2008, we received notice from OfficeMax that it would not offer
any of our products during the first and second quarters of 2008. Our sales
through both Office Depot and OfficeMax are entirely consignment sales. Office
Depot returned substantial inventory in the fourth quarter of 2007 and OfficeMax
returned substantial inventory in the first quarter of 2008, 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. For the years ended December 31, 2007 and 2006, we realized inventory
valuation adjustments to our consigned inventories for lower-of-cost-or-market
of approximately $1.4 million and $264,000 respectively, which is included in
cost of sales. We intend to offer new products to both Office Depot and
OfficeMax for their consideration to include in their product offerings during
the second half of 2008. However, we cannot provide any assurance that we will
be able to sell any products through either Office Depot or OfficeMax in the
future.
Throughout 2007, we experienced a significant decline in sales of our
data storage products. We believe that this sales decline was an industry-wide
effect. In addition, we are experiencing intense price competition for magnetic
data storage products from major competitors such as Western Digital and Seagate
Technology/Maxtor who are original equipment manufacturers of hard disk drives,
which has significantly reduced selling prices and eroded our margins for
magnetic data storage products. Due to this intense price competition, we may
not be able to sell our 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. In response to these market conditions, and also as part
of its ongoing efforts to bring new products to market, management is currently
exploring other products with our suppliers and retailers to sell through our
sales channels.
In addition, we are experiencing a shortage in supply of our HDTVs. The
subcontract manufacturer of our HDTVs has experienced a shortage of basic
components and is attempting to correct the supply shortage. If these shortages
continue, we may not be able to meet the demand of our retailers which may cause
a decline in our net sales. Because of the substantial working capital
requirements needed to sustain inventory and profitable sales volumes for HDTVs,
we are negotiating new trade credit facilities to support future HDTV sales. We
do not believe that our existing subcontract manufacturers will be able to
independently provide adequate trade credit facilities.
FINANCIAL PERFORMANCE SUMMARY
Our net sales decreased by $13.8 million, or approximately 30%, to
$32.1 million in 2007 from $45.9 million in 2006. Our gross profit decreased by
$4.8 million, or approximately 77%, to $1.4 million in 2007 from $6.2 million in
2006. Our net loss increased by 4.6 million, or approximately 2,252%, to $4.8
million in 2007 from a loss of $202,000 in 2006.
NET SALES. The decrease in our net sales in 2007 as compared to 2006
was primarily due to the following combination of factors:
o a substantial decrease in sales of both our magnetic and
optical data storage products of 40.5% and 54.2%,
respectively, and a 12.1% decrease in sales of our other
consumer electronics products;
o a decrease in the number of national retailers carrying our
products; and
o a decrease in the number of products offered.
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All of which were partially offset by:
o sales of our HDTVs in the amount of approximately $6.9 million
in the fourth quarter of 2007; and
o a decrease in sales and price incentives to 11.7% of net sales
in 2007 as compared to 14.2% in 2006.
GROSS PROFIT. Our gross profit margin decreased to 4.3% in 2007, as
compared to 13.4% in 2006. This decrease is primarily due to the following
combination of factors:
o an increase in material costs to 95.7% of net sales in 2007,
as compared to 86.6% of net sales in 2006, which was partially
offset by a decrease in freight to 0.7% of net sales in 2007
as compared to 1.9% of net sales in 2006;
o a decrease in inventory reserves to 5.8% of net sales in 2007,
as compared to 1.7% of net sales in 2006; and
o a decrease in our production, shipping and handling costs to
2.7% of net sales in 2007 as compared to 3.1% of net sales in
2006.
OPERATING EXPENSES. Our operating expenses decreased to 18.4% of net
sales in 2007, as compared to 18.3% in 2006. The decrease in operating expenses
is primarily due to the following combination of factors:
o selling expenses decreased to 3.9% of net sales in 2007 as
compared to 4.6% of net sales in 2006; and
o general and administrative expenses increased to 13.8% of net
sales in 2007 as compared to 13.4% of net sales in 2006.
OTHER INCOME. Our other income decreased by approximately $2.3 million.
This decrease was due to the receipt of approximately $2.4 million upon
settlement of a litigation matter with OfficeMax in 2006.
A combination of the factors mentioned above affected our net sales,
including a decrease in sales of our mobile and desktop data storage products of
40% to $16.3 million in 2007 as compared to $27.6 million in 2006 resulting from
intense price competition and excess inventories in our sales channels. Sales of
our optical data storage products continue to decline because they are generally
included as a standard component with most new PCs. In addition, the market for
DVD-based products in 2007 continued to be extremely competitive and was
characterized by abundant product supplies. The effects of these factors on
sales of our DVD-based products were substantially similar in this regard to
that of the data storage industry. Net sales of our optical data storage
products decreased by approximately 54% to $7.8 million in 2007 as compared to
$17.1 million in 2006.
In addition to the factors described above, we believe that mobile data
storage devices and our competitors' flash memory devices, thumbdrives and other
mobile data storage devices, which are an alternative to optical data storage
products, continue to cause a decline in the relative market share of optical
data storage products and likewise caused a decline in sales of our optical data
storage products in 2007.
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OPERATING PERFORMANCE AND FINANCIAL CONDITION
We focus on numerous factors in evaluating our operating performance
and our financial condition. In particular, in evaluating our operating
performance, we focus primarily on net sales, net product margins, net retailer
margins, rebates and sales incentives, and inventory turnover as well as
operating expenses and net income.
NET SALES. Net sales is a key indicator of our operating performance.
We closely monitor overall net sales, as well as net sales to individual
retailers, and seek to increase net sales by expanding sales to additional
retailers and expanding sales to existing retailers by increasing sales of
existing products and by introducing new products. Management monitors net sales
on a weekly basis, but also considers sales seasonality, promotional programs
and product life-cycles in evaluating weekly sales performance. As net sales
increase or decrease from period to period, it is critical for management to
understand and react to the various causes of these fluctuations, such as
successes or failures of particular products, promotional programs, product
pricing, retailer decisions, seasonality and other causes. Where possible,
management attempts to anticipate potential changes in net sales and seeks to
prevent adverse changes and stimulate positive changes by addressing the
expected causes of adverse and positive changes. We believe that our good
working relationships with our retailers enable us to closely monitor consumer
acceptance of particular products and promotional programs which in turn enable
us to better anticipate changes in market conditions.
NET PRODUCT MARGINS. Net product margins, from product-to-product and
across all of our products lines as a whole, is an important measurement of our
operating performance. We monitor margins on a product-by-product basis to
ascertain whether particular products are profitable or should be phased out. In
evaluating particular levels of product margins on a product-by-product basis,
we focus on attaining a level of net product margin sufficient to contribute to
normal operating expenses and to provide a profit. The level of acceptable net
product margin for a particular product depends on our expected product sales
mix. However, we occasionally sell products for certain strategic reasons to,
for example, provide a full line of a product category or for promotional
purposes, without a rigid focus on historical product margins or contribution to
operating expenses or profitability.
NET RETAILER MARGINS. We seek to manage profitability on a retailer
level, not solely on a product level. Although we focus on net product margins
on a product-by-product basis and across all of our products lines, our primary
focus is on attaining and building profitability on a retailer-by-retailer
level. For this reason, our mix of products is likely to differ among our
various retailers. These differences result from a number of factors, including
retailer-to-retailer differences, products offered for sale and promotional
programs.
REBATES AND SALES INCENTIVES. Rebates and sales incentives offered to
customers and retailers are an important aspect of our business and are
instrumental in obtaining and maintaining market acceptance through competitive
pricing in generating sales on a regular basis as well as stimulating sales of
slow moving products. We focus on rebates and sales incentives costs as a
proportion of our total net sales to ensure that we meet our expectations of the
costs of these programs and to understand how these programs contribute to our
profitability or result in unexpected losses.
INVENTORY TURNOVER. Our typical product life-cycles range from 6 to 12
months, generating lower average selling prices as the cycles mature. We attempt
to keep our inventory levels at amounts adequate to meet our retailers' needs
while minimizing the danger of rapidly declining average selling prices and
inventory financing costs. By focusing on inventory turnover rates, we seek to
identify slow-moving products and take appropriate actions such as
implementation of rebates and sales incentives to increase inventory turnover.
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Our use of a consignment sales model with certain retailers results in
increased amounts of inventory that we must carry and finance. Our consignment
sales model results in greater exposure to declining average selling prices,
however, our consignment sales model allows us to more quickly and efficiently
implement promotional programs and pricing adjustments to sell off slow-moving
inventory and prevent further price erosion.
Our targeted inventory turnover rates for our combined sales models is
6 to 8 weeks of inventory, which equates to an annual inventory turnover rate of
approximately 6.5 to 8.5. In 2007 our annualized inventory turnover was 3.8
times compared to 4.3 times in 2006 and 5.5 times in 2005, representing a
period-to-period decrease of 12% and 22%, respectively. The decrease in
inventory turns in 2007 is primarily a result of the 30% decline in sales from
2006 resulting from intense competition in 2007. The decrease in inventory
turnover in 2006 is primarily the result of a 47% increase in inventory in 2006
as compared to 2005 to support the 22% increase in sales that occurred in 2006.
OPERATING EXPENSES. We focus on operating expenses to keep these
expenses within budgeted amounts in order to achieve or exceed our targeted
profitability. We budget certain of our operating expenses in proportion to our
projected net sales, including operating expenses relating to production,
shipping, technical support, and inside and outside commissions and bonuses.
However, most of our expenses relating to general and administrative costs,
product design and sales personnel are essentially fixed over large sales
ranges. Deviations that result in operating expenses in greater proportion than
budgeted signal to management that it must ascertain the reasons for the
unexpected increase and take appropriate action to bring operating expenses back
into budgeted proportion.
NET INCOME. Net income is the ultimate goal of our business. By
managing the above factors, among others, and monitoring our actual results of
operations, our goal is to generate net income at levels that meet or exceed our
targets.
In evaluating our financial condition, we focus primarily on cash on
hand, available trade lines of credit, available bank line of credit,
anticipated near-term cash receipts, and accounts receivable as compared to
accounts payable. Cash on hand, together with our other sources of liquidity, is
critical to funding our day-to-day operations. Funds available under our line of
credit with Silicon Valley Bank are also an important source of liquidity and a
measure of our financial condition. We use our line of credit on a regular basis
as a standard cash management procedure to purchase inventory and to fund our
day-to-day operations without interruption during periods of slow collection of
accounts receivable. Anticipated near-term cash receipts are also regarded as a
short-term source of liquidity, but are not regarded as immediately available
for use until receipt of funds actually occurs.
The proportion of our accounts receivable to our accounts payable and
the expected maturity of these balance sheet items is an important measure of
our financial condition. We attempt to manage our accounts receivable and
accounts payable to focus on cash flows in order to generate cash sufficient to
fund our day-to-day operations and satisfy our liabilities. Typically, we prefer
that accounts receivable are matched in duration to, or collected earlier than,
accounts payable. If accounts payable are either out of proportion to, or due in
advance of, the expected collection of accounts receivable, we will likely have
to use our cash on hand or our line of credit to satisfy our accounts payable
obligations, which could reduce our ability to purchase and sell inventory and
may impact our ability, at least in the short-term, to fund other parts of our
business.
SALES MODELS
We employ three primary sales models: standard terms, consignment sales
and special terms. We generally use one of these three primary sales models, or
some combination of these sales models, with each of our retailers.
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STANDARD TERMS
Currently, the majority of our net sales are on standard terms. Under
our standard terms sales model, a retailer is obligated to pay us for products
sold to it within a specified number of days from the date that title to the
products is transferred to the retailer. Our standard terms are typically net 60
days. We typically collect payment from a retailer within 60 to 75 days
following the date title is transferred to the retailer.
CONSIGNMENT
Under our consignment sales model, a retailer is obligated to pay us
for products sold by it within a specified number of days following notification
from the retailer of the sale of those products. Retailers notify us of their
sale of consigned products through delivery of weekly or monthly sell-through
reports. A weekly or monthly sell-through report details sales of consigned
products in the prior week or month, respectively. The period for payment to us
by retailers relating to their sale of consigned products corresponding to these
sell-through reports varies from retailer to retailer. For sell-through reports
generated weekly, we typically collect payment from a retailer within 30 days of
the receipt of those reports. For sell-through reports generated monthly, we
typically collect payment from a retailer within 15 days of the receipt of those
reports. Products held by a retailer under our consignment sales model are
recorded as our inventory at offsite locations until their sale by the retailer.
For the years ended December 31, 2007 and 2006 sales under our
consignment sales model accounted for 46% and 43% of our net sales,
respectively. We are in the process of reevaluating our consignment sales model
to determine if there are revisions that will enable us to turn our consigned
inventory more quickly.
Use of our consignment sales model is based in part on the preferences
of some of our retailers. Our retailers often prefer the benefits resulting from
our consignment sales model over our standard terms sales model. These benefits
include payment by a retailer only in the event of the sale of a consigned
product, resulting in less risk borne by the retailer of price erosion due to
competition and technological obsolescence. Deferring payment until following
the sale of a consigned product also enables a retailer to avoid having to
finance the purchase of that product by using cash on hand or by borrowing funds
and incurring borrowing costs. In addition, retailers also often operate under
budgetary constraints on purchases of certain products or product categories. As
a result of these budgetary constraints, the purchase by a retailer of certain
products typically will cause reduced purchasing power for other products.
Products consigned to a retailer ordinarily fall outside of these budgetary
constraints and do not cause reduced purchasing power for other products. As a
result of these benefits, we believe that we are able to sell more products by
using our consignment sales model than by using only our standard terms sales
model.
Managing an appropriate level of consignment inventory is an important
challenge. As noted above, the payment period for products sold on consignment
is based on the day consigned products are sold by a retailer, and the payment
period for products sold on a standard terms basis is based on the day the
product is sold initially to the retailer, independent of the date of resale of
the product. Accordingly, we generally prefer that higher-turnover inventory is
sold on a consignment basis while lower-turnover inventory is sold on a standard
terms basis. Management focuses closely on consignment sales to manage our cash
flow to maximize liquidity as well as net sales. Close attention is directed
toward our inventory turnover rates to ensure they are sufficiently frequent to
maintain appropriate liquidity. If we identify a decline in inventory turnover
rates for products in our consignment sales channels, we can implement price
modifications more quickly and efficiently as compared to implementation of
sales incentives in connection with our standard terms sales model. This affords
us more flexibility to take action to attain our targeted inventory turnover
rates.
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We retain most risks of ownership of products in our consignment sales
channels. These products remain our inventory until their sale by our retailers.
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 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 or to reduce
the carrying value of the slow-moving products. If we fail to select high
turnover products for our consignment sales channels, our sales, profitability
and financial resources may decline.
SPECIAL TERMS
We occasionally employ a special terms sales model. Under our special
terms sales model, the payment terms for the purchase of our products are
negotiated on a case-by-case basis and typically cover a specified quantity of a
particular product. We ordinarily do not offer any rights of return or rebates
for products sold under our special terms sales model. Our payment terms are
ordinarily shorter under our special terms sales model than under our standard
terms or consignment sales models and we typically require payment in advance,
at the time of sale, or shortly following the sale of products to a retailer.
RETAILERS
Historically, a limited number of retailers have accounted for a
significant percentage of our net sales. During 2007 and 2006, our six largest
retailers collectively accounted for approximately 80% and 85%, respectively, of
our total net sales. We expect that sales of our products to a limited number of
retailers will continue to account for a majority of our sales in the
foreseeable future. We do not have long-term purchase agreements with any of our
retailers. If we were to lose any of our major retailers or experience any
material reduction in orders from any of them, and were unable to replace our
sales to those retailers, it could have a material adverse effect on our
business and results of operations.
SEASONALITY
Our sales have historically been seasonal. The seasonality of our sales
is in direct correlation to the seasonality experienced by our retailers and the
seasonality of the consumer electronics industry in general. After adjusting for
the addition of new retailers, our fourth quarter has historically generated the
strongest sales, which correlates to well-established consumer buying patterns
during the Thanksgiving through Christmas holiday season. Our first and third
quarters have historically shown some strength from time to time based on
post-holiday season sales in the first quarter and back-to-school sales in the
third quarter. Our second quarter has historically been our weakest quarter for
sales, again following well-established consumer buying patterns. The impact of
seasonality on our future results will be affected by our product mix, which
will vary from quarter to quarter.
PRICING PRESSURES
We face downward pricing pressures within our market segments that
arise from a number of factors. The products we sell are subject to rapid
technological change and obsolescence. Companies within the consumer electronics
industry are continuously developing new products with heightened performance
and functionality. This puts downward pricing pressures on existing products and
constantly threatens to make them, or causes them to be, obsolete. Our typical
product life-cycle is extremely short and ranges from 6 to 12 months, generating
lower average selling prices as the cycle matures. See "Business--Competition."
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Additionally, our retailers pressure us to offer products to them at
attractive prices. We generally do not believe that the overall goal of our
retailers is to increase their margins on these products. Instead, we believe
that our retailers pressure us to offer products to them at attractive prices in
order to increase sales volume and consumer traffic, as well as to compete more
effectively with other retailers of similar products. Additional downward
pricing pressure and our pricing decisions with regard to certain products are
influenced by the ability of retailers to directly import or private-label
identical or similar products. Therefore, we constantly seek to maintain prices
that are highly attractive to our retailers and that offer less incentive to our
retailers to commence or maintain direct import or private-label programs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our restated consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires us
to make estimates and judgments 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 amount of net sales and expenses for
each period. The following represents a summary of our critical accounting
policies, defined as those policies that we believe are the most important to
the portrayal of our financial condition and results of operations and that
require management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effects of matters that are
inherently uncertain.
GOING CONCERN ASSUMPTION
We have based our financial statements on the assumption of our
operations continuing as a going concern. As a result, we continue to depreciate
fixed assets and show certain debts as long-term. As of December 31, 2007, we
had working capital of approximately $1.4 million and cash and cash equivalents
of approximately $1.5 million and had incurred cumulative net losses of
approximately $29.8 million. On March 7, 2008, we received notice from Silicon
Valley Bank that we were in default of our tangible net worth financial
covenant. The outstanding balance with Silicon Valley Bank as of March 25, 2008
was $1,598,461, all of which was due and payable upon demand by Silicon Valley
Bank, and no amounts were available to us for borrowing as we were in violation
of the loan covenant. See "--Liquidity and Capital Resources, Bank Lines of
Credit." In addition, as of March 26, 2009, we had only $368,600 of cash on
hand. These factors, among others, raise substantial doubt about our ability to
continue as a going concern. Our plans for correcting these deficiencies include
negotiating extended payment terms with BTC, a related-party supplier, timely
collection of existing accounts receivable, and sell-through of inventory
currently in our sales channels. Our restated consolidated financial statements
do not include any adjustments relating to the recoverability and classification
of the recorded asset amounts or the amounts and classification of liabilities
that might be necessary should we be unable to continue our existence.
REVENUE RECOGNITION
We recognize revenue in accordance with Staff Accounting Bulletin
("SAB") No. 104, REVENUE RECOGNITION, CORRECTED COPY. Under SAB No. 104, revenue
is recognized when persuasive evidence of an arrangement exists, delivery has
occurred or services have been rendered, the seller's price to the buyer is
fixed or determinable, and collectibility is reasonably assured. Revenue is
recognized net of sales tax. We apply the specific provisions of SFAS No. 48,
REVENUE RECOGNITION WHEN RIGHT OF RETURN EXISTS. Under SFAS No. 48, product
revenue is recorded at the transfer of title to the products to a retailer, net
of estimated allowances and returns and sales incentives. Transfer of title
occurs and risk of ownership passes to a retailer at the time of shipment or
delivery, depending on the terms of our agreement with a particular retailer.
For transactions not satisfying the conditions for revenue recognition under
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SFAS No. 48, product revenue is deferred until the conditions are met, net of an
estimate for cost of sales. Consignment sales are recognized when our retailers
sell our products to retail customers, at which point the retailers incur an
obligation to pay us.
In accordance with Emerging Issues Task Force ("EITF") Issue No. 01-9,
ACCOUNTING FOR CONSIDERATION GIVEN BY A VENDOR TO A CUSTOMER INCLUDING A
RESELLER OF THE VENDOR'S PRODUCTS, because we did not receive an identifiable
benefit, we reduce our product revenue for marketing promotions, market
development funds and cooperative advertising costs.
We recognize revenue under three primary sales models: standard terms,
consignment sales and special terms. We generally use one of these three primary
sales models, or some combination of these sales models, with each of our
retailers. Under each of these sales models our payment terms are explicitly
stated and agreed to by us and the retailer before goods are shipped, thereby
making our fee fixed or determinable before revenue is recognized.
STANDARD TERMS
Under our standard terms sales model, a retailer is obligated to pay us
for products sold to it within a specified number of days from the date that
title to the products is transferred to the retailer. Our standard terms are
typically net 60 days from the transfer of title to the products to a retailer.
We typically collect payment from a retailer within 60 to 75 days from the
transfer of title to the products to a retailer. Transfer of title occurs and
risk of ownership passes to a retailer at the time of shipment or delivery,
depending on the terms of our agreement with a particular retailer. The sale
price of our products is substantially fixed or determinable at the date of sale
based on purchase orders generated by a retailer and accepted by us. A
retailer's obligation to pay us for products sold to it under our standard terms
sales model is not contingent upon the resale of those products. We recognize
revenue for standard terms sales at the time title to products is transferred to
a retailer, net of an estimate for sales incentives, rebates and returns.
CONSIGNMENT
Under our consignment sales model, a retailer is obligated to pay us
for products sold to it within a specified number of days following notification
to us by the retailer of the sale of those products. through delivery of weekly
or monthly sell-through reports. A weekly or monthly sell-through report details
sales of consigned products in the prior week or month, respectively. The period
for payment to us by retailers relating to their sale of consigned products
corresponding to these sell-through reports varies from retailer to retailer.
For sell-through reports generated weekly, we typically collect payment from a
retailer within 30 days of the receipt of those reports. For sell-through
reports generated monthly, we typically collect payment from a retailer within
15 days of the receipt of those reports. At the time of a retailer's sale of a
product, title is transferred directly to the consumer. Risk of theft or damage
of a product, however, passes to a retailer upon delivery of that product to the
retailer. The sale price of our products is substantially fixed or determinable
at the date of sale based on a product sell-through report generated by a
retailer and delivered to us. Except in the case of theft or damage, a
retailer's obligation to pay us for products transferred under our consignment
sales model is entirely contingent upon the sale of those products. Products
held by a retailer under our consignment sales model are recorded as our
inventory at offsite locations until their sale by the retailer. Because we
retain title to products in our consignment sales channels until their sale by a
retailer, revenue is not recognized until the time of sale. Accordingly, price
modifications to inventory maintained in our consignment sales channels do not
have an effect on the timing of revenue recognition.
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SPECIAL TERMS
Under our special terms sales model, the payment terms for the purchase
of our products are negotiated on a case-by-case basis and typically cover a
specified quantity of a particular product. The result of our negotiations is a
special agreement with a retailer that defines how and when transfer of title
occurs and risk of ownership shifts to the retailer.
We ordinarily do not offer any rights of return or rebates for products
sold under our special terms sales model. A retailer is obligated to pay us for
products sold to it within a specified number of days from the date that title
to the products is transferred to the retailer, or as otherwise agreed to by us.
Our payment terms are ordinarily shorter under our special terms sales model
than under our standard terms or consignment sales models and we typically
require payment in advance, at the time of transfer of title to the products or
shortly following the transfer of title to the products to a retailer. Transfer
of title occurs and risk of ownership passes to a retailer at the time of
shipment, delivery, receipt of payment or the date of invoice, depending on the
terms of our agreement with the retailer. The sale price of our products is
substantially fixed or determinable at the date of sale based on our agreement
with a retailer. A retailer's obligation to pay us for products sold to it under
our special terms sales model is not contingent on the sale of those products.
We recognize revenue for special terms sales at the time title to products is
transferred to a retailer.
SALES INCENTIVES
We enter into agreements with certain retailers regarding price
decreases that are determined by us in our sole discretion. These agreements
allow those retailers (subject to limitations) a credit equal to the difference
between our current price and our new reduced price on units in the retailers'
inventories or in transit to the retailers on the date of the price decrease.
We record an estimate of sales incentives based on our actual sales
incentive rates over a trailing twelve-month period, adjusted for any known
variations, which are charged to operations and offset against gross sales at
the time products are sold. We also record a corresponding accrual for our
estimated sales incentive liability. This accrual is reduced by deductions on
future payments taken by our retailers relating to actual sales incentives. Our
estimated sales incentive liability is offset against accounts receivable.
At the end of each quarterly period, we analyze our existing sales
incentive reserve and apply any necessary adjustments based upon actual or
expected deviations in sales incentive rates from our applicable historical
sales incentive rates. The amount of any necessary adjustment is based upon the
amount of our remaining field inventory, which is calculated by reference to our
actual field inventory last conducted, plus inventory-in-transit and less
estimated product sell-through. The amount of our sales incentive liability for
each product is equal to the amount of remaining field inventory for that
product multiplied by the difference between our current price and our new
reduced price to our retailers for that product. This data, together with all
data relating to all sales incentives granted on products in the applicable
period, is used to adjust our sales incentive reserve established for the
applicable period.
In 2007, our sales incentives were $618,956, or 1.5% of gross sales,
all of which were offset against gross sales, as compared to $836,200, or 1.4%
of gross sales, in 2006, all of which were offset against gross sales.
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MARKET DEVELOPMENT FUNDS AND COOPERATIVE ADVERTISING COSTS, REBATE
PROMOTION COSTS AND SLOTTING FEES
Market development funds and cooperative advertising costs, rebate
promotion costs, new store opening fees and slotting fees are offset against
gross sales in accordance with EITF Issue No. 01-9 because we did not receive an
identifiable benefit. Market development funds and cooperative advertising costs
and rebate promotion costs are each promotional costs. Slotting fees are fees
paid directly to retailers for allocation of shelf-space in retail locations and
new store opening fees are paid to assist in promoting the retailer's new store
openings. In 2007, our market development funds and cooperative advertising
costs, rebate promotion costs, new store opening fees and slotting fees were
$3.7 million, or 9% of gross sales, all of which were offset against gross
sales, as compared to market development funds and cooperative advertising
costs, rebate promotion costs, new store opening fees and slotting fees of $6.7
million, or 11% of gross sales, in 2006, all of which were offset against gross
sales.
Consideration generally given by us to a retailer is presumed to be a
reduction of selling price, and therefore, a reduction of gross sales. However,
if we receive an identifiable benefit that is sufficiently separable from our
sales to that retailer, such that we could have paid an independent company to
receive that benefit and we can reasonably estimate the fair value of that
benefit, then the consideration is characterized as an expense. We estimate the
fair value of the benefits we receive by tracking the advertising done by our
retailers on our behalf and calculating the value of that advertising using a
comparable rate for similar publications.
INVENTORY OBSOLESCENCE ALLOWANCE
Our warehouse supervisor, production supervisor and purchasing manager
physically review our warehouse inventory for slow moving and obsolete products.
All products of a material amount are reviewed quarterly and all other products
are reviewed annually. We consider products that have not been sold within six
months to be slow moving. Products that are no longer compatible with current
hardware or software are considered obsolete. The potential for sale of slow
moving and obsolete inventories is considered through market research, analysis
of our retailers' current needs, and assumptions about future demand and market
conditions. The recorded cost of both slow-moving and obsolete inventories is
then reduced to its estimated market value based on current market pricing for
similar products. We utilize the Internet to provide indications of market value
from competitors' pricing, third party inventory liquidators and auction
websites. The recorded costs of our slow moving and obsolete products are
reduced to current market prices when the recorded costs exceed such market
prices. All adjustments establish a new cost basis for inventory as we believe
such reductions are permanent declines in the market price of our products.
Generally, obsolete inventory is sold to companies that specialize in the
liquidation of such items while we continue to market slow-moving inventories
until they are sold or become obsolete. As obsolete or slow moving inventory is
sold, we reduce the reserve by proceeds from the sale of the products.
Our warehouse supervisor, production supervisor and purchasing manager
physically review our warehouse inventory for obsolete or damaged
inventory-related items on a monthly basis. Inventory-related items (such as
sleeves, manuals or broken products no longer under warranty from our
subcontract manufacturers and suppliers) that are considered obsolete or damaged
are reviewed by these personnel together with our Controller or Chief Financial
Officer. At the discretion of our Controller or Chief Financial Officer, these
items are physically disposed of and we make corresponding accounting
adjustments resulting in inventory adjustments. In addition, on a monthly basis,
our detail inventory report and its general ledger are reconciled by our
Controller and any variances result in a corresponding inventory adjustment.
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Our consignment inventory is reviewed by our Controller or our Chief
Financial Officer to ensure that recorded costs are not impacted by current
market prices for similar products. If it is determined that recorded costs
exceed current costs or market values, the recorded costs are reduced to current
market prices to establish a new cost basis.
LOWER-OF-COST-OR-MARKET RESERVE
Our component parts and finished goods and corporate and consigned
inventories are reviewed by our Controller or our Chief Financial Officer to
ensure that recorded costs are not impacted by current market prices for similar
products. If it is determined that recorded costs exceed current costs or market
values, the recorded costs are reduced to current market prices to establish a
new cost basis and the difference is charged to cost of sales.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Trade accounts receivable are primarily from national retailers and are
recorded at the invoiced amount and do not accrue interest. The allowance for
doubtful accounts reflects management's best estimate of probable credit losses
inherent in the accounts receivable balance. We determine the allowance based on
historical experience, specifically identified nonpaying accounts and other
currently available evidence. We reviews our allowance for doubtful accounts
monthly with focus on significant individual past due balances over 90 days. All
other balances are reviewed on a pooled basis. Account balances are charged off
against the allowance after all means of collection have been exhausted and the
potential for recovery is considered remote. Since our current customers are
primarily national retailers with good payment histories with us, our allowance
for doubtful accounts is not significant. We do not have any off-balance sheet
credit exposure related to our customers.
In dealing with our national retailers, we occasionally have, and
expect that we will continue to have in the foreseeable future, disagreements
with these customers relating to the valuation and completeness of accounts
receivable which may result in a contingent gain or loss to us.
PRODUCT RETURNS
We have a limited 90-day to one year time period for product returns
from end-users. However, our retailers generally have return policies that allow
their customers to return products within only 14 to 90 days after purchase. We
allow our retailers to return damaged or defective products to us following a
customary return merchandise authorization process. We have no informal return
policies. We utilize actual historical return rates to determine our allowance
for returns in each period. Gross sales are reduced by estimated returns and
cost of sales is reduced by the estimated cost of those sales. We record a
corresponding allowance for the estimated liability associated with the
estimated returns. This estimated liability is based on the gross margin of the
products corresponding to the estimated returns. This allowance is offset each
period by actual product returns.
Our current estimated weighted average future product return rate is
approximately 10%. As noted above, our return rate is based upon our past
history of actual returns and we estimate amounts for product returns for a
given period by applying this historical return rate and reducing actual gross
sales for that period by a corresponding amount. Our historical return rate for
a particular product is our trailing 18-month return rate of similar products.
We believe that using a trailing 18-month return rate takes two key factors into
consideration, specifically, an 18-month return rate provides us with a
sufficient period of time to establish recent historical trends in product
returns for each product category, and provides us with a period of time that is
short enough to account for recent technological shifts in our product offerings
in each product category. If an unusual circumstance exists, such as a product
category that has begun to show materially different actual return rates as
compared to our trailing 18-month return rates, we will make appropriate
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adjustments to our estimated return rates. Factors that could cause materially
different actual return rates as compared to our trailing 18-month return rates
include product modifications that simplify installation, or a new product line
within a product category that needs time to better reflect its return
performance and other factors. This allowance is recorded against accounts
receivable.
Although we have no specific statistical data on this matter, we
believe that our practices are reasonable and consistent with those of our
industry.
Our warranty terms under our arrangements with our suppliers are that
any product that is returned by a retailer or retail customer as defective
within the applicable warranty period can be returned by us to the supplier for
full credit against the original purchase price. We incur only minimal shipping
costs to our suppliers in connection with the satisfaction of our warranty
obligations.
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 a 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.
YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006
Results as a Percentage
Year Ended of
December 31, Dollar Percentage Net Sales For
----------------------- Variance Variance -----------------------
2007 2006 Variance Variance 2007 2006
---------- ---------- Favorable Favorable ---------- ---------
(Restated) (Restated) (Unfavorable) (Unfavorable) (Restated) (Restated)
---------- ---------- ------------- ------------- ---------- ----------
(In Thousands)
Net sales $ 32,121 $ 45,889 $ (13,768) (30.0)% 100.0% 100.0%
Cost of sales 30,731 39,727 8,996 22.6% 95.7% 86.6%
---------- ---------- ----------- ------- ------- ------
Gross profit 1,390 6,162 (4,772) (77.4)% 4.3% 13.4%
Selling, marketing and
advertising
expenses 1,251 2,113 861 40.8% 3.9% 4.6%
General and administrative
expenses 4,448 6,134 1,687 27.5% 13.8% 13.4%
Depreciation and amortization 139 166 27 16.3% 0.4% 0.4%
---------- ---------- ----------- ------- ------- ------
Operating loss (4,448) (2,251) (2,197) (97.6)% (13.7)% (4.9)%
Net interest expense (410) (356) (54) (15.2)% (1.3)% (0.8)%
Other income 106 2,406 (2,300) (95.6)% 0.3% 5.2%
---------- ---------- ----------- ------- ------- ------
Loss from operations before
provision for income taxes (4,752) (201) (4,551) (2,264.2)% (14.8)% (0.4)%
Provision for income taxes 1 1 - 0.0% 0.0% 0.0%
---------- ---------- ----------- ------- ------- ------
Net loss $ (4,753) $ (202) $ (4,551) (2,253.0)% (14.8)% (0.4)%
========== ========== =========== ======== ======= ======
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NET SALES. The decrease in our net sales in 2007 as compared to 2006
was primarily the result of a decline in sales of our data storage products as
well as from intense pricing pressures, which were partially offset by sales of
our new line of televisions in the fourth quarter of 2007.
Sales of our televisions accounted for approximately $6.8 million, or
21.1%, of our total net sales in 2007.
Net sales of our optical data storage products decreased by $9.3
million to $7.8 million in 2007 as compared to $17.1 million in 2006, a decrease
of 54.2%, while our average unit sales price increased to $53.15 in 2007, or 2%,
from $52.66 in 2006. Total units sold were 147,300 in 2007 as compared to
324,700 in 2006, a decrease of approximately 55%. This sales decline resulted
from lower demand for CD-and DVD-based products as they are generally included
as a standard component with most PCs and increased competition from portable
USB data storage devices as they continue to gain market share.
Net sales of our magnetic data storage products decrease by $11.1
million, or 40.5%, to $16.4 million in 2007 as compared to $27.6 million in
2006, a decrease of 40.2%, while our average unit sales price decreased to
$64.09 in 2007, or 19%, from $76.82 in 2006. The sales decline and the decrease
in average unit sales price is attributed to intense price competition
experienced throughout 2007. Total units sold were 256,000 in 2007, as compared
to 359,000 in 2006, a decrease of 29%.
GROSS PROFIT. Our gross profit decreased $4.8 million to $1.4 million
in 2007 from $6.2 million in 2006, representing a 77.4% decrease. Our gross
profit margin decreased to 4.3% in 2007 as compared to 13.4% in 2006. The
decrease in gross profit is attributable to the decline in net sales from fewer
units sold and lower gross profit margins on our data storage products which
included valuation adjustments for consigned inventory. Gross profit margins on
our data storage products declined as a result of lower unit net sales prices
due to intense competition. Unit sales prices declined more rapidly than our
costs to buy those units.
For 2007, total sales incentives and market development funds and
cooperative advertising costs, rebate promotion costs and slotting fees
decreased by $3.3 million to $4.3 million, or 10.6% of gross sales, compared to
$7.6 million, or 12.9% of gross sales in 2006.
At December 31, 2007 and 2006, we realized inventory valuation
adjustments to our consigned inventories for lower-of-cost-or-market of
approximately $1.4 million and $264,000, respectively, which is included in cost
of sales. In 2007, this expense is a result of inventory in our consignment
sales channels that was returned during the fourth quarter and required
adjustment caused by the declining value of magnetic data storage products.
Our inventory obsolescence expense, which is included in cost of sales,
was approximately $417,000 in 2007 as compared to $705,000 in 2006. This expense
is a result of our adjustment of the value of slow-moving and obsolete
inventory.
SELLING, MARKETING AND ADVERTISING EXPENSES. The decrease in selling,
marketing and advertising expenses of $862,000, or a decrease of 40.8%, is
primarily due to a decrease in shipping and handling expenses of $545,000, a
$212,000 decrease in outside sales commissions, a decrease in total sales
compensation of $35,000, both resulting from the decrease in sales volume, and a
decrease in sales expenses of $70,000.
GENERAL AND ADMINISTRATIVE EXPENSES. The decrease in general and
administrative expenses of $1.7 million is primarily due to a $1.2 million
decrease in offering costs recognized in 2006, a decrease of $261,000 in legal
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fees, a decrease of $200,000 in compensation and benefits, a decrease of
$142,000 in outside services for interim financial support services, a decrease
of $116,000 in financial relations expenses, and a $145,000 decrease in
insurance expenses, all of which were partially offset by increases of $283,000
in bad debt expense and $100,000 in audit fees.
We have restated our general and administrative expenses for 2007 and
2006 to correct an error in the manner in which we accrued audit fees. We
previously accrued audit fees in the period to which the corresponding audit
applied despite the fact that the audit fees were incurred in a subsequent
period. We have corrected our methodology for accruing audit fees so that our
audit fees are accrued in the period in which they are incurred. Our
previously-reported general and administrative expenses for 2007 were
approximately $4.1 million. Our restated general and administrative expenses for
2007 are approximately $4.5 million. Our previously-reported general and
administrative expenses for 2006 were $6.5 million. Our restated general and
administrative expenses for 2006 are approximately $6.1 million. Our restatement
also resulted in a lower-of-cost-or-market reserve at December 31, 2006 that
reduced by $264,000 the value of certain inventory consigned to retailers that
was sold subsequent to December 31, 2006 at prices below net realizable value.
We previously accrued for sales incentives to account for the reduced sales
prices but deemed it necessary to account for the lower-of-cost-or-market
valuation at December 31, 2006. See our restated consolidated financial
statements--"Note 2 - Restatement of 2006 and 2007 Financial Statements"
included elsewhere in this report.
OTHER INCOME. Our other income decreased by approximately $2.3 million.
This decrease was due to the receipt of approximately $2.4 million upon
settlement of a litigation matter with OfficeMax in 2006.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
During 2007, our principal sources of liquidity were cash provided by
operations and borrowings under our bank and trade credit facilities. Our
principal uses of cash have been to finance working capital, capital
expenditures and debt service requirements. We anticipate that these uses will
continue to be our principal uses of cash in the future. As of December 31,
2007, we had working capital of $1.4 million, an accumulated deficit of $29.8
million, $1.5 million in cash and cash equivalents and $6.9 million in net
accounts receivable. This compares to working capital of $5.9 million, an
accumulated deficit of $25.1 million, $1.8 million in cash and cash equivalents
and $11.5 million in net accounts receivable as of December 31, 2006.
On March 7, 2008, we received notice from Silicon Valley Bank that we
were in default of our tangible net worth financial covenant. The outstanding
balance with Silicon Valley Bank as of March 7, 2008 was $1,598,461, all of
which was due and payable upon demand by Silicon Valley Bank, and no amounts
were available to us for borrowing as we were in violation of the loan covenant.
On April 18, 2008, we entered into a Loan and Security Agreement dated
as of April 18, 2008 with Silicon Valley Bank, which provided for a credit
facility based on our accounts receivable. The Loan and Security Agreement
served to amend and restated a previous Loan and Security Agreement dated
January 29, 2007 among the parties. The credit facility allowed us to finance
our accounts receivable and borrow up to a maximum aggregate amount of $7.0
million; provided, that we were only permitted to borrow up to a limit of 60% of
each eligible account or such other percentage as Silicon Valley Bank
established. The line of credit was to expire on January 29, 2009. Advances on
the line of credit 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 we pay a collateral handling fee of $2,000 per month and
other customary fees and expenses. On July 31, 2008, we paid off our obligations
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owed to Silicon Valley Bank under the Loan and Security Agreement dated April
18, 2008 and terminated the Loan and Security Agreement.
On October 29, 2008, we 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. The credit facility allows us
to sell accounts receivable to Rexford Funding subject to a maximum 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. The Sale of Accounts and
Security Agreement has an initial term through April 30, 2009 with automatic six
month extensions unless either party terminates the Sale of Accounts and
Security 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 has the right to
terminate the Sales of Accounts and Security Agreement upon 30 days prior
notice.
As of March 26, 2009, we had only $368,600 of cash on hand.
Accordingly, we are presently experiencing 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.
As indicated above, our restated consolidated financial statements as
of and for the year ended December 31, 2007, 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 restated 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. Our independent registered public accounting
firm has issued a report expressing substantial doubt about our ability to
continue as a going concern. The restated consolidated financial statements
included in this document do not include any adjustments that might result from
the outcome of this uncertainty.
Our net loss increased by approximately 2,253% to $4.8 million in 2007
from a net loss of $202,000 in 2006. If our net losses continue or increase, 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 used in our operating activities totaled $283,000 during the year
ended December 31, 2007 as compared to cash used in our operating activities of
$631,000 during the year ended December 31, 2006. This decrease of $348,000 in
cash used in our operating activities primarily resulted from:
o a $4.5 million increase in our net loss;
o a $66,000 decrease in our allowance for product returns;
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o a $1.6 million decrease in reserves for sales incentives;
o a $86,000 decrease in our reserve for slow-moving and obsolete
inventory;
o a $4.0 million decrease in accounts payable and accrued
expenses primarily as a result of the decrease in net sales
which required lower purchases;
o a $532,000 decrease in accounts payable to related parties;
and
o a $838,000 decrease in accrued mail-in rebates.
These decreases in cash were partially offset by:
o a $6.1 million decrease in accounts receivable resulting from
a decrease in sales;
o a $5.0 million decrease in inventory, primarily as a result of
our reduced purchases and lower sales as well as inventory
valuation adjustments of approximately $1.4 million;
o a $67,000 increase in share-based compensation expense;
o a $46,000 increase in warrants issued for services rendered;
and
o a $111,000 increase in our allowance for doubtful accounts.
Cash provided by our investing activities totaled $428,000 during 2007
as compared to cash used in our investing activities of $981,000 during 2006.
During 2007, restricted cash decreased by $551,000 as compared to an $862,000
decrease in 2006 as the result of collateral requirements related to our credit
facility. Cash used for equipment additions was $124,000 during 2007 as compared
to $119,000 during 2006.
Cash used in our financing activities totaled $515,000 during 2007 as
compared to cash used in our financing activities of $611,000 during 2006. We
paid down $515,000 of our credit facility with Silicon Valley Bank during 2007
as compared to $673,000 of our prior credit facility with GMAC Commercial
Finance, or GMAC, in 2006. In 2006, we received $62,000 in proceeds from sales
of our common stock upon the exercise of employee stock options.
BANK LINES OF CREDIT
On March 9, 2005, we entered into an asset-based line of credit with
GMAC. Our asset-based line of credit with GMAC was to expire on January 15, 2007
and allowed us to borrow up to $5.0 million. The line of credit bore interest at
a floating interest rate equal to the prime rate of interest plus 2.75%. Our
obligations under our loan agreement with GMAC were secured by substantially all
of our assets and guaranteed by our wholly-owned subsidiary, IOM Holdings, Inc.
As of December 31, 2006, we owed GMAC approximately $4.4 million and had
available to us approximately $569,000 of additional borrowings.
On January 29, 2007, we entered into a Loan and Security Agreement with
Silicon Valley Bank which provided for a revolving line of credit. Our line of
credit with Silicon Valley Bank was initially used to pay off our outstanding
loan balance as of January 29, 2007 with GMAC, which balance was approximately
$5.0 million, and was also used to pay $62,000 of our closing fees in connection
with securing the line of credit. The line of credit was to expire on January
29, 2009.
On December 12, 2007, we entered into an Amendment to Loan and Security
Agreement with Silicon Valley Bank that amended the Loan and Security Agreement
and provided a waiver of the violation of, and amended, our tangible net worth
financial covenant, and reduced the maximum amount of available borrowings under
the line of credit. We were required to pay a fee of $20,000 to Silicon Valley
Bank to cause the Amendment to become effective.
As amended, the line of credit allowed us to borrow up to a maximum
amount equal to the lesser of (a) $7.0 million, or (b) an amount equal to 60% of
eligible accounts plus the lesser of (1) 20% of the value of eligible inventory,
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(2) $750,000 (provided that on and after March 30, 2008, such amount would be
$0.00), and (3) 33% of eligible accounts. As amended, the line of credit imposed
a financial covenant requiring us to have minimum tangible net worth for the
month ended February 28, 2007 and each month ending thereafter of $3,500,000,
plus (i) 50% of all consideration received after January 27, 2007 for equity
securities and subordinated debt, plus (ii) 50% of our net income in each fiscal
quarter ending after January 27, 2007. As amended, amounts outstanding under the
line of credit were to accrue interest at a per annum rate equal to the Prime
Rate plus 2.50%. In addition, we were required to pay to Silicon Valley Bank
customary fees and expenses, including an early termination fee of 0.50% of the
maximum line amount in the event we terminated the facility prior to January 27,
2009, an unused line fee equal to 0.25% per annum and payable monthly, a
commitment fee of $50,000, a monthly collateral monitoring fee of $1,250 and an
anniversary fee of $50,000, as well as for the issuance or renewal of letters of
credit and all expenses incurred by Silicon Valley Bank related to the Loan and
Security Agreement. Our obligations under the line of credit with Silicon Valley
Bank were secured by substantially all of our assets.
On March 7, 2008, we received notice from Silicon Valley Bank that we
were in default of our tangible net worth financial covenant. The outstanding
balance with Silicon Valley Bank as of March 25, 2008 was $1,598,461, all of
which was due and payable upon demand by Silicon Valley Bank, and no amounts
were available to us for borrowing as we were in violation of the loan covenant.
We sought a waiver of the default of our tangible net worth financial covenant
and received a Forbearance Agreement from Silicon Valley Bank in that regard.
On April 18, 2008, we entered into a Loan and Security Agreement dated
as of April 18, 2008 with Silicon Valley Bank, which provided for a credit
facility based on our accounts receivable. The Loan and Security Agreement
served to amend and restated a previous Loan and Security Agreement dated
January 29, 2007 among the parties. The credit facility allowed us to finance
our accounts receivable and borrow up to a maximum aggregate amount of $7.0
million; provided, that we were only permitted to borrow up to a limit of 60% of
each eligible account or such other percentage as Silicon Valley Bank
established. The line of credit was to expire on January 29, 2009. Advances on
the line of credit 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 we pay a collateral handling fee of $2,000 per month and
other customary fees and expenses. On July 31, 2008, we paid off our obligations
owed to Silicon Valley Bank under the Loan and Security Agreement dated April
18, 2008 and terminated the Loan and Security Agreement.
On October 29, 2008, we 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. The credit facility allows us
to sell accounts receivable to Rexford Funding subject to a maximum 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. The Sale of Accounts and
Security Agreement has an initial term through April 30, 2009 with automatic six
month extensions unless either party terminates the Sale of Accounts and
Security 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 has the right to
terminate the Sales of Accounts and Security Agreement upon 30 days prior
notice.
TRADE LINES OF CREDIT
On June 6, 2005, we entered into a new trade credit facility with Lung
Hwa that replaced our previous $10.0 million trade credit facility. Under the
terms of the new facility, Lung Hwa agreed to purchase and manufacture inventory
on our behalf. We were permitted to purchase an aggregate of up to $15.0 million
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of inventory manufactured by Lung Hwa or manufactured by third parties, in which
case we used Lung Hwa as an international purchasing office. For inventory
manufactured by third parties and purchased through Lung Hwa, the payment terms
were 120 days following the date of invoice by Lung Hwa. Lung Hwa charged us a
5% handling fee on a supplier's unit price. A 2% discount of the handling fee
applied if we reached an average running monthly purchasing volume of $750,000.
Returns made by us, which are agreed to by a supplier, resulted in a credit to
us for the handling charge. For inventory manufactured by Lung Hwa, the payment
terms were 90 days following the date of invoice by Lung Hwa. We were to pay
Lung Hwa, within one week of the purchase order, 10% of the purchase price on
any purchase orders issued to Lung Hwa as a down-payment for the order. The
trade credit facility had an initial term of one year after which the facility
was to continue indefinitely if not terminated at the end of the initial term.
At the end of the initial term and at any time thereafter, either party had the
right to terminate the facility upon 30 days' prior written notice to the other
party. The agreement containing the terms of the new trade credit facility was
amended and restated on July 21, 2005 to provide that the new facility would be
retroactive to April 29, 2005. As of December 31, 2007, we owed Lung Hwa
$665,000 in trade payables. As of December 31, 2007, we were in violation of the
payment terms in our agreement with Lung Hwa but we arranged a repayment
schedule for satisfaction of the obligation and we satisfied the payment
schedule prior to the filing of this report. As of March 26, 2009, we owed Lung
Hwa no trade payables. We do not currently utilize this trade credit facility as
Lung Hwa 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. This trade credit facility may not be
available to us in the future in the event we endeavor to attempt to again
utilize the facility. See "Certain Relationships and Related Transactions, and
Director Independence."
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. The agreement could be terminated by either party upon 60 days' prior
written notice to the other party. As of December 31, 2007, we owed BTC $6.7
million under this arrangement. BTC USA is a subsidiary of Behavior Tech
Computer Corp., one of our significant stockholders. Mr. Steel Su, a former
director of I/OMagic, is the Chief Executive Officer of Behavior Tech Computer
Corp. As of March 26, 2009, we owed BTC USA $6.4 million under this agreement.
As of March 26, 2009, we were in violation of the payment terms in our agreement
with BTC USA and were 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.
This trade credit facility may not be available to us in the future in the event
we endeavor to attempt to again utilize the facility. See "Certain Relationships
and Related Transactions, and Director Independence."
Lung Hwa and BTC USA provided us with significantly preferential trade
credit terms. These terms included extended payment terms, substantial trade
lines 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. In fact, we believe that our trade
credit facility with Lung Hwa was likely unique and could not be replaced
through a relationship with an unrelated third party. These trade credit
facilities may not be available to us in the future in the event we endeavor to
attempt to again utilize them. See "Certain Relationships and Related
Transactions, and Director Independence."
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LIQUIDITY IMPACT OF CONSIGNMENT SALES MODEL
We retain most risks of ownership of products in our consignment sales
channels. These products remain our inventory until their resale 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. For the year ended December 31, 2007, we realized inventory
valuation adjustments to lower-of-cost-or-market of approximately $1.4 million,
which is included in cost of sales. 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 sales channels, our sales, profitability and financial
resources may decline.
BACKLOG
Our backlog at December 31, 2007 and 2006 was $4.3 million and
$900,000, respectively. The substantial increase in backlog is a function of
inventory levels at our retailers based on their near-term inventory restocking
requirements. Based on historical trends, we anticipate that our December 31,
2007 backlog may be reduced by approximately 10%, or approximately $400,000, to
a net amount of $3.9 million as a result of returns and reclassification of
certain expenses as reductions to net sales. Our backlog may not be indicative
of our actual sales beyond a rotating six-week cycle. The amount of backlog
orders represents revenue that we anticipate recognizing in the future, as
evidenced by purchase orders and other purchase commitments received from
retailers. The shipment of these orders for non-consigned retailers or the
sell-through of our products by consigned retailers causes recognition of the
purchase commitments as revenue. However, there can be no assurance that we will
be successful in fulfilling such orders and commitments in a timely manner, that
retailers will not cancel purchase orders, or that we will ultimately recognize
as revenue the amounts reflected as backlog based upon industry trends,
historical sales information, returns and sales incentives.
CONTRACTUAL OBLIGATIONS
The following table outlines payments due under our significant
contractual obligations over the next five years, exclusive of interest:
PAYMENTS DUE BY PERIOD
CONTRACTUAL OBLIGATIONS AT LESS THAN 1 MORE THAN 5
DECEMBER 31, 2007 TOTAL YEAR 1-3 YEARS 3-5 YEARS YEARS
-------- -------- --------- ----------- -----------
Capital Lease Obligations $113,478 $ 47,593 $ 65,885 $ -- $ --
Credit Facility Fees 50,000 50,000 -- -- --
Operating Leases 621,640 370,040 251,600 -- --
-------- -------- --------- ----------- -----------
Total Contractual Cash Obligations $785,118 $467,633 $317,485 $ -- $ --
======== ======== ======== =========== ===========
The above table outlines our obligations as of December 31, 2007 and
does not reflect the changes in our obligations that occurred after that date.
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IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In December 2007, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("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 our 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 us on a prospective basis in the first quarter of fiscal year
2009. We have not yet determined the impact on our consolidated financial
statements of adopting SFAS No. 160.
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. We expect to adopt SFAS No. 159 in the first quarter of
fiscal 2008. We do not expect SFAS No. 159 to have a material effect on its
financial position, results of operations or cash flows.
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 we have
not yet issued financial statements for that fiscal year, including any
financial statements for an interim period within that fiscal year. We are
currently evaluating the impact SFAS No. 157 may have on its financial position,
results of operations or cash flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Reference is made to the restated consolidated financial statements and
accompanying notes included in this report, which begin on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
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ITEM 9A. CONTROLS AND PROCEDURES.
Not applicable.
ITEM 9A(T). 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
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 December 31, 2007 that our disclosure
controls and procedures were effective at the reasonable assurance level.
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management, including our Chief Executive Officer and Acting Chief
Financial Officer, is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of our
financial statements for external reporting purposes in accordance with U.S.
generally accepted accounting principles ("GAAP"). Internal control over
financial reporting includes those policies and procedures that: (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of a company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with GAAP, and that
receipts and expenditures of a company are being made only in accordance with
authorizations of management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements. Because of its inherent
limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with policies or
procedures may deteriorate.
Management, with the participation of our Chief Executive Officer and
Acting Chief Financial Officer, conducted an evaluation of the effectiveness of
our internal control over financial reporting based on the framework in INTERNAL
CONTROL -- INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this evaluation, management
concluded that our internal control over financial reporting was effective as of
December 31, 2007.
This annual report does not include an attestation report of our
independent registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by our
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independent registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit us to provide only management's
report in this annual report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no change during the registrant's 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.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions held by our directors and executive
officers as of March 26, 2008 and their business experience are as follows:
NAME AGE TITLES
Tony Shahbaz 46 Chairman of the Board, President,
Chief Executive Officer, Secretary
and Director
Thomas L. Gruber 63 Chief Financial Officer and Chief
Operating Officer
Steel Su 56 Director
Daniel Yao(1) 52 Director
Dr. William Ting(1) 60 Director
- ------------
(1) Member of the Audit, Compensation and Nominating Committees.
TONY SHAHBAZ is a founder of I/OMagic and has served as our Chairman of
the Board, President, Chief Executive Officer, Secretary and as a director since
September 1993, and as our Chief Financial Officer from September 1993 to
October 2002. Prior to founding I/OMagic, Mr. Shahbaz was employed by Western
Digital Corporation from September 1986 to March 1993. During his tenure at
Western Digital Corporation, Mr. Shahbaz held several positions including Vice
President of Worldwide Sales for its Western Digital Paradise division, and
Regional Director of Asia Pacific Sales and Marketing Operations.
THOMAS L. GRUBER joined I/OMagic as our Chief Financial Officer on
November 15, 2006. Prior to assuming this position, and from July 2004 through
October 2006, Mr. Gruber was a Partner in a private investment group
specializing in management and leveraged buyouts. Prior to that time, and from
January 2001 to July 2004, Mr. Gruber was President and Chief Financial Officer
of nStor Technologies, an American Stock Exchange listed public company that
designed, developed and manufactured enterprise storage hardware and software.
Mr. Gruber received a BBA degree in Accounting from Ohio University and an MBA
from Pepperdine University with a concentration in Management/Marketing.
STEEL SU has served as a director of I/OMagic since September 2000 and
is a founder of Behavior Tech Computer Corp., one of our principal subcontract
manufacturers and stockholders and has served as its Chairman since 1980. Mr. Su
has served and continues to serve as a director or chairman of the following
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affiliates of Behavior Tech Computer Corp.: Behavior Design Corporation
(chairman), Behavior Tech Computer (USA) Corp. (chairman), Behavior Tech
Computer Affiliates, N.V. (chairman) and BTC Korea Co., Ltd. (director). Mr. Su
has served as chairman of Gennet Technology Corp., Emprex Technologies Corp.,
Maritek Inc. and MaxD Technology Inc. since 1992, 1998, 1999 and 2000,
respectively. Mr. Su has also served as a director of Aurora Systems Corp. and
Wearnes Peripherals International (PTE) Limited since 1998 and 2000,
respectively. Mr. Su received a B.S. degree in Electronic Engineering from Ching
Yuan Christian University, Taiwan in 1974 and an M.B.A. degree from National
Taiwan University in 2001.
DANIEL YAO has served as a director of I/OMagic since February 2001 and
has been a Chief Strategy Officer for Ritek Corporation, an affiliate of Citrine
Group Limited, one of our stockholders, since July 2000. Prior to joining Ritek,
Mr. Yao served as the Senior Investment Consultant for Core Pacific Securities
Capital from July 1998 to July 2000. Prior to that, Mr. Yao was an Executive
Vice President for ABN Amro Bank in Taiwan from July 1996 to July 1998. Mr. Yao
received a B.A. degree in Business Management from National Taiwan University in
1978 and an M.B.A. degree from the University of Rochester in New York in 1984.
DR. WILLIAM TING has served as a director of I/OMagic since December
2005. Dr. Ting is currently Chairman of the Global Advisory Committee for
Redwood Securities. Prior to that, Dr. Ting was founder, Chairman and CEO of
US-Sino Gateway from 2002 to 2005. Prior to that, Dr. Ting was CEO of Adminisoft
in 2001, President and CEO of DataQuad in 2000, President and CEO of BMDP
Statistical Software from 1991 to 1992, and Corporate Director of Financial
Planning and Corporate Vice President of Information Technology of Geneva
Companies from 1989 to 1991. Dr. Ting served as Director of Strategic Planning
at Northrop EMD from 1986 to 1989. Dr. Ting served as Manager of Market
Research, Manager of International Offset and Director of Planning at General
Dynamics units from 1982 To 1986. Dr. Ting was an assistant professor of
political science at the University of Michigan from 1978 to 1982. Dr. Ting
received a B.A. degree in Political Science from Illinois State University in
1970, an M.A. in Political Science from Illinois State University in 1972 and a
Ph.D. in Political Science from the University of Washington in 1976. Our
directors are elected annually and hold office until the next annual meeting of
stockholders, until their respective successors are elected and qualified or
until their earlier death, resignation or removal.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires our executive officers, directors and persons who beneficially own more
than 10% of a registered class of our equity securities, or reporting persons,
to file initial reports of ownership and reports of changes in ownership of our
common stock and other equity securities with the Securities and Exchange
Commission. The reporting persons are required by the Securities and Exchange
Commission regulations to furnish us with copies of all reports that they file.
Based solely upon a review of copies of the reports furnished to us
during our fiscal year ended December 31, 2007 and thereafter, or any written
representations received by us from reporting persons that no other reports were
required, we believe that all Section 16(a) filing requirements applicable to
our reporting persons during 2007 were complied with.
CORPORATE GOVERNANCE
Our Board believes that good corporate governance is paramount to
ensure that I/OMagic is managed for the long-term benefit of our stockholders.
Our Board has adopted corporate governance guidelines that guide its actions
with respect to, among other things, the composition of the Board and its
decision making processes, Board meetings and involvement of management, the
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Board's standing committees and procedures for appointing members of the
committees, and its performance evaluation for our Chief Executive Officer.
Our board of directors has adopted a Code of Business Conduct and
Ethics that applies to all of our directors, officers and employees and an
additional Code of Business Ethics that applies to our Chief Executive Officer
and senior financial officers. The Codes of Ethics, as applied to our principal
executive officer, principal financial officer and principal accounting officer
constitutes our "code of ethics" within the meaning of Section 406 of the
Sarbanes-Oxley Act of 2002. We intend to satisfy the disclosure requirement
under Item 5.05 of Form 8-K relating to amendments to or waivers from provisions
of these codes that relate to one or more of the items set forth in Item 406(b)
of Regulation S-K, by describing on our Internet website, located at
http://www.iomagic.com, within four business days following the date of a waiver
or a substantive amendment, the date of the waiver or amendment, the nature of
the amendment or waiver, and the name of the person to whom the waiver was
granted. Information on our Internet website is not, and shall not be deemed to
be, a part of this report or incorporated into any other filings we make with
the Securities and Exchange Commission.
DIRECTOR INDEPENDENCE
Our corporate governance guidelines provide that a majority of the
Board and all members of the Audit, Compensation and Nominating Committees of
the Board will be independent. On an annual basis, each director and executive
officer is obligated to complete a Director and Officer Questionnaire that
requires disclosure of any transactions with I/OMagic in which a director or
executive officer, or any member of his or her immediate family, have a direct
or indirect material interest. Following completion of these questionnaires, the
Board, with the assistance of the Nominating Committee, makes an annual
determination as to the independence of each director using the current
standards for "independence" established by the Securities and Exchange
Commission and NASDAQ, additional criteria set forth in our corporate governance
guidelines and consideration of any other material relationship a director may
have with I/OMagic.
Our Board has determined that all of its directors are independent
under these standards, except for (i) Mr. Shahbaz, who serves full-time as our
President and Chief Executive Officer, and (ii) Mr. Su, who is a founder of
Behavior Tech Computer Corp., one of our principal subcontract manufacturers.
See "Certain Relationships and Related Transactions, and Director Independence"
below.
BOARD OF DIRECTORS, COMMITTEES AND MEETINGS
Our business, property and affairs are managed under the direction of
our board of directors. Directors are kept informed of our business through
discussions with our executive officers, by reviewing materials provided to them
and by participating in meetings of our board of directors and its committees.
Our bylaws provide that our board of directors shall consist of at least six
directors.
During 2007, our board of directors held nine meetings. During 2007,
each incumbent director attended at least 75% of the aggregate of the total
number of meetings of the board of directors for which he was a director and the
total number of meetings held by all committees of the board on which he served
during the periods that he served. Members of our Board and its committees also
consulted informally with management from time to time and acted at various
times by written consent without a meeting during 2007.
It is our policy to invite and encourage our directors to attend our
annual meetings. At the date of our 2007 annual meeting, we had four members on
our Board, one of whom, namely, Mr. Shahbaz, was in attendance at our 2007
annual meeting.
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Our Board has established standing Audit, Compensation and Nominating
Committees. Each committee has a written charter that is reviewed and revised as
appropriate.
AUDIT COMMITTEE
Our Audit Committee selects our independent registered public
accounting firm, reviews the results and scope of the audit and other services
provided by our independent registered public accounting firm and reviews our
financial statements for each interim period and for our year end. This
committee consists of Mr. Yao and Dr. Ting. The Audit Committee held nine
meetings during 2007. Our board of directors has determined that Mr. Yao and Dr.
Ting are Audit Committee financial experts. Our board of directors has also
determined that Mr. Yao and Dr. Ting are "independent" as defined in NASD
Marketplace Rule 4200(a)(15). The Audit Committee operates pursuant to a charter
approved by our board of directors and the Audit Committee, according to the
rules and regulations of the Securities and Exchange Commission.
COMPENSATION COMMITTEE
Our Compensation Committee consists of Mr. Yao and Dr. Ting. The
Compensation Committee held one meeting during 2007. The Compensation Committee
operates pursuant to a charter approved by our board of directors and the
Compensation Committee.
Our Compensation Committee is responsible for establishing and
administering our overall policies on compensation and the compensation to be
provided to our executive officers, including, among other things, annual
salaries and bonuses, stock options, stock grants, other stock-based awards, and
other incentive compensation arrangements. In addition, the Compensation
Committee reviews the philosophy and policies behind the salary, bonus and stock
compensation arrangements for all other employees. Although our Compensation
Committee makes all compensation decisions as to our executive officers, our
Chief Executive Officer makes recommendations to our Compensation Committee
regarding compensation for the other named executive officers. Our Compensation
Committee has the authority to administer our stock option plans with respect to
grants to executive officers and directors, and also has authority to make
equity awards under those plans to all other eligible individuals. However, our
Board may retain, reassume or exercise from time to time the power to administer
our stock option plans. Equity awards made to members of the Compensation
Committee must be authorized and approved by a disinterested majority of our
Board.
The Compensation Committee evaluates both performance and compensation
to ensure that the total compensation paid to our executive officers is fair,
reasonable and competitive so that we can attract and retain superior employees
in key positions. The Compensation Committee believes that compensation packages
offered to our executives, including the named executive officers, should
include both cash and equity-based compensation that reward performance as
measured against established goals. The Compensation Committee has the authority
to retain consultants and other advisors. In making compensation decisions, our
Compensation Committee compares each element of total compensation against
market data and other factors it deems relevant. The Compensation Committee
generally expects to set total compensation for the named executive officers at
the median of compensation paid to similarly situated executives of comparable
companies.
Additional information concerning the compensation policies and
objectives established by the Compensation Committee is included under the
heading "Executive Compensation--Compensation Discussion and Analysis" below.
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NOMINATING COMMITTEE
Our Nominating Committee selects nominees for the board of directors.
The Nominating Committee consists of Mr. Yao and Dr. Ting. The Nominating
Committee utilizes a variety of methods for identifying and evaluating nominees
for director, including candidates that may be referred by stockholders.
Stockholders that desire to recommend candidates for evaluation may do so by
contacting I/OMagic in writing, identifying the potential candidate and
providing background information. Candidates may also come to the attention of
the Nominating Committee through current board members, professional search
firms and other persons. In evaluating potential candidates, the Nominating
Committee will take into account a number of factors, including, among others,
the following:
o independence from management;
o relevant business experience and industry knowledge;
o judgment, skill, integrity and reputation;
o existing commitments to other businesses;
o corporate governance background;
o financial and accounting background, to enable the Nominating
Committee to determine whether the candidate would be suitable
for Audit Committee membership; and
o the size and composition of the board.
The Nominating Committee held one meeting during 2007. The Nominating
Committee operates pursuant to a charter approved by our board of directors and
the Nominating Committee.
STOCKHOLDER COMMUNICATIONS WITH OUR BOARD OF DIRECTORS
Our board of directors has established a process to receive
communications from security holders. Security holders and other interested
parties may contact any member (or all members) of the board of directors, or
the independent directors as a group, any committee of the board of directors or
any chair of any such committee, by mail. To communicate with the board of
directors, any individual director or any group or committee of directors,
correspondence should be addressed to the board of directors or any such
individual director or group or committee of directors by either name or title.
All such correspondence should be sent "c/o Secretary" at 4 Marconi, Irvine,
California 92618.
All communications received as set forth in the preceding paragraph
will be opened by the Secretary for the sole purpose of determining whether the
contents represent a message to our directors. Any contents that are not in the
nature of advertising, promotions of a product or service, patently offensive
material or matters deemed inappropriate for the board of directors will be
forwarded promptly to the addressee. In the case of communications to the board
of directors or any group or committee of directors, our Secretary will make
sufficient copies of the contents to send to each director who is a member of
the group or committee to which the envelope is addressed.
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION DISCUSSION AND ANALYSIS
COMPENSATION PHILOSOPHY AND COMPONENTS
This section discusses the principles underlying our executive
compensation policies and decisions and the most important factors relevant to
an analysis of these policies and decisions. It provides qualitative information
regarding the manner and context in which compensation is awarded to and earned
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by our executive officers and places in perspective the data presented in the
tables and narrative that follow.
Our compensation committee is responsible for reviewing and approving
base salaries, bonuses and incentive awards for all executive officers,
reviewing and establishing the base salary, bonuses and incentive awards for our
Chief Executive Officer, and reviewing, approving and recommending to the board
of directors the content, terms and conditions of all employee compensation and
benefit plans, or changes to those plans.
Our compensation philosophy is based upon four central objectives:
o To provide an executive compensation structure and system that
is both competitive in the outside industrial marketplace and
also internally equitable based upon the weight and level of
responsibilities in the respective executive positions;
o To attract, retain and motivate qualified executives within
this structure, and reward them for outstanding
performance-to-objectives and business results through
financial and other appropriate management incentives;
o To align our financial results and the compensation paid to
our executive officers with the enhancement of stockholder
value; and
o To structure our compensation policy so that executive
officers' compensation is dependent, in one part, on the
achievement of its current year business plan objectives, and
in another part, on the long-term increase in company net
worth and the resultant improvement in stockholder value, and
to maintain an appropriate balance between short- and
long-range performance objectives over time.
Our executive officers' compensation currently has three primary
components: base compensation or salary, annual discretionary cash bonuses, and
stock option awards granted pursuant to our 2002 and 2003 Stock Option Plans. In
addition, we provide our executive officers a variety of benefits that generally
are offered to all salaried employees in the geographical location where they
are based.
We view the various components of compensation as related but distinct.
Although our compensation committee does review total compensation, we do not
believe that significant compensation derived from one component of compensation
should negate or reduce compensation from other components. We determine the
appropriate level for each compensation component based in part, but not
exclusively, on our view of internal equity and consistency, and other
considerations we deem relevant, such as rewarding extraordinary performance.
Our compensation committee has not adopted any formal or informal policies or
guidelines for allocating compensation between long-term and short term
compensation, between cash and non-cash compensation, or among different forms
of non-cash compensation.
BASE COMPENSATION
Base compensation is targeted to recognize each executive officer's
unique value and historical contributions to our success in light of salary
norms in our industries and the general marketplace. The criteria for
measurement include data available from objective, professionally-conducted
market studies, integrated with additional competitive intelligence secured from
a range of industry and general market sources. Our compensation committee
reviews the base compensation of our Chief Executive Officer, and with our Chief
Executive Officer, the base compensation of all other executive officers,
periodically to assure that a competitive position is maintained.
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EQUITY COMPENSATION
We use stock options to reward long-term performance. Our compensation
committee and/or our board of directors act as the manager of our option plans
and perform functions that include selecting option recipients, determining the
timing of option grants and whether options are incentive or non-qualified, and
assigning the number of shares subject to each option, fixing the time and
manner in which options are exercisable, setting option exercise prices and
vesting and expiration dates, and from time to time adopting rules and
regulations for carrying out the purposes of our plans. For compensation
decisions regarding the grant of equity compensation to executive officers, our
compensation committee typically considers recommendations from our Chief
Executive Officer.
We do not have any program, plan or obligation that requires us to
grant equity compensation on specified dates. We have not made equity grants in
connection with the release or withholding of material non-public information.
Historically, options granted to our directors and executive officers have
generally had exercise prices above the then trading price of our common stock.
Information about outstanding options held by our named executive officers and
directors is contained in the "Outstanding Equity Awards at Fiscal Year End" and
"Director Compensation" tables.
CASH BONUSES
Executive bonuses are used to focus our management on achieving key
corporate financial objectives, to motivate certain desired individual behaviors
and to reward substantial achievement of these company financial objectives and
individual goals. We use cash bonuses to reward performance achievements
generally only as to years in which we are substantially profitable, and we use
salary as the base amount necessary to match our competitors for executive
talent.
Bonuses, if any, are determined and paid on an annual basis after
completion of the bonus year. We paid no bonuses to our named executive officers
for 2007.
In the past, our compensation committee has based bonuses for our named
executive officers on net income. However, our compensation committee believes a
profitable company with little or no growth is not acceptable. Our compensation
committee considers the chosen metrics of net income and growth in revenue to be
the best indicators of our financial success and creation of stockholder value
and expects to design future bonus plans to account for these different metrics.
Individual performance objectives are determined by the executive
officer to whom the potential bonus recipient reports or, in the case of our
Chief Executive Officer, by our compensation committee. For example, the basis
for Mr. Shahbaz's bonus might include such objectives as developing bank and
equity financing, successfully concluding and integrating acquisitions,
developing strategic opportunities or developing our executive team.
Our compensation committee has not considered whether it would attempt
to recover bonuses paid based on our financial performance where our financial
statements are restated in a downward direction sufficient to reduce the amount
of bonus that should have been paid under applicable bonus criteria.
ACCOUNTING AND TAX TREATMENT
We account for share-based compensation paid to our employees under the
rules of SFAS No. 123R, which requires us to estimate and record an expense over
the service period of the award. Accounting rules also require us to record cash
compensation as an expense at the time the obligation is accrued. Unless and
until we achieve sustained profitability, the availability to us of a tax
deduction for compensation expense will not be material to our financial
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position. We structure cash bonus compensation so that it is taxable to our
executives at the time it becomes available to them. We currently intend that
all cash compensation paid will be tax deductible for us. However, with respect
to equity compensation awards, while any gain recognized by employees from
nonqualified options should be deductible, to the extent that an option
constitutes an incentive stock option, gain recognized by the optionee will not
be deductible if there is no disqualifying disposition by the optionee. In
addition, if we grant restricted stock or restricted stock unit awards that are
not subject to performance vesting, they may not be fully deductible by us at
the time the award is otherwise taxable to the employee.
OTHER BENEFITS
We also maintain other executive benefits that we consider necessary in
order to offer fully competitive opportunities to our executive officers. These
include, without limitation, 401(k) retirement savings plans, car allowances and
employment agreements. The compensation committee continues to monitor and
evaluate our executive compensation system and its application throughout our
organization to assure that it continues to reflect our compensation philosophy
and objectives.
Executive officers are eligible to participate in all of our employee
benefit plans, such as medical, dental, vision, group life, disability, and
accidental death and dismemberment insurance, in each case on the same basis as
other employees.
SUMMARY COMPENSATION TABLE
The following table sets forth summary information concerning the
compensation of our principal executive officer and our principal financial
officer (collectively, the "named executive officers"), for all services
rendered in all capacities to us for the years ended December 31, 2007 and 2006.
OPTION NON-EQUITY
----------- INCENTIVE PLAN ALL OTHER
NAME AND SALARY BONUS AWARDS COMPENSATION COMPENSATION TOTAL
PRINCIPLE POSITION YEAR ($) ($) ($)(1) ($) ($)(2) ($)
------------------ ---- ----------- ------- ---------- --------------- ------------ ----------
Tony Shahbaz
President, Chief Executive 2007 $ 197,384 $ -- $ 31,676 $ -- $ --(4) $ 229,060
Officer and Secretary 2006 $ 198,500 -- $ 66,192 $ 39,103(3) $ --(4) $ 303,795
Thomas L. Gruber(5)
Chief Operating Officer and 2007 $ 148,383 $ -- $ 10,218 $ -- $ -- $ 158,601
Chief Financial Officer 2006 $ 20,274 $ -- $ 12,824 $ -- $ -- $ 33,098
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(1) The amounts shown are the compensation costs recognized in our financial
statements for 2007 related to grants of stock options to certain named
executive officers in prior years, to the extent we recognized compensation
cost in 2007 for such awards in accordance with the provisions of SFAS No.
123R. For a discussion of valuation assumptions used in the SFAS No. 123R
calculations, see Note 14 to Restated Consolidated Financial Statements
included elsewhere in this report. The options were issued under our 2002
and 2003 Stock Option Plans. Information regarding the vesting schedule for
Messrs. Shahbaz and Gruber is included in the footnotes to the "Outstanding
Equity Awards at Fiscal Year-End" table below.
(2) The value of perquisites and other personal benefits was less than $10,000
in aggregate for each executive other than Mr. Shahbaz.
(3) Represents compensation under Mr. Shahbaz's Employment Agreement based on
our quarterly net income. See "Employment Agreement--Tony Shahbaz" below.
(4) Mr. Shahbaz is entitled to an automobile allowance in the amount of $1,200
per month under his Employment Agreement. However, in lieu of this
allowance, Mr. Shahbaz used until December 2006, an automobile we purchased
in August 2005 for $84,597. In December 2006, we traded this automobile in
against another automobile that Mr. Shahbaz uses. We purchased for Mr.
Shahbaz's use the second automobile for $68,034, not including the trade-in
value of the first vehicle.
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(5) Mr. Gruber became an employee on November 2, 2006 and became our Chief
Financial Officer effective November 15, 2006.
EMPLOYMENT AGREEMENT
TONY SHAHBAZ
On October 15, 2002, we entered into an employment agreement with Tony
Shahbaz. Under the terms of the employment agreement, which was retroactively
effective as of January 1, 2002, Mr. Shahbaz serves as our President and Chief
Executive Officer and is entitled to receive an initial annual salary of
$198,500 and is eligible to receive quarterly bonuses equal to 7% of our
quarterly net income. Mr. Shahbaz is also entitled to a monthly car allowance
equal to $1,200. The initial term of the employment agreement concluded on
October 15, 2007, but the employment agreement was automatically renewed for an
additional year and will continue to automatically renew for successive one year
periods unless expressly terminated by either party. Under the terms of the
employment agreement, if Mr. Shahbaz is terminated for cause, he is entitled to
receive four times his annual salary and any and all warrants and options
granted to him shall be extended an additional seven years from date of
termination and upon termination without cause, he is entitled to receive his
remaining salary and other benefits for the remaining term of the employment
agreement. Mr. Shahbaz's employment agreement further provides that the
agreement shall not be terminated without the prior written consent of Mr.
Shahbaz in the event of a merger, transfer of assets, or dissolution of
I/OMagic, and that the rights, benefits, and obligations under the employment
agreement shall be assigned to the surviving or resulting corporation or the
transferee of our assets.
GRANTS OF PLAN-BASED AWARDS
There were no grants of plan-based awards made to any named executive
officer during the year ended December 31, 2007.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table sets forth information about outstanding equity
awards held by our named executive officers as of December 31, 2007.
OPTION AWARDS
------------------------------------------------------------------------
NUMBER NUMBER
OF OF
SECURITIES SECURITIES
UNDERLYING UNDERLYING
UNEXERCISED UNEXERCISED OPTION
OPTIONS OPTIONS EXERCISE OPTION
(#) (#) PRICE EXPIRATION
NAME EXERCISABLE UNEXERCISABLE ($) DATE
- ------------------------------- ----------- -------------- ---------- ----------
Tony Shahbaz 59,000(1) -- $ 3.85 03/09/2009
84,219(2) 20,781(2) $ 2.75 07/14/2010
Thomas L. Gruber 31,771(3) 18,229(3) $ 4.00 11/02/2011
- -------------------
(1) The option vested as to 40% of the underlying shares immediately with
the balance vesting in equal amounts in each of the 36 months
following the March 9, 2004 grant date.
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(2) The option vested as to 50% of the underlying shares immediately with
the balance vesting in equal amounts in each of the 48 months
following the July 14, 2005 grant date.
(3) The option vested as to 50% of the underlying shares immediately with
the balance vesting in equal amounts in each of the 48 months
following the November 2, 2006 grant date.
OPTION EXERCISES AND STOCK VESTED
None of the named executive officers acquired shares through the
exercise of options and no stock grants vested during the year ended December
31, 2007.
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL
EMPLOYMENT AGREEMENT. We have entered into an agreement with a named
executive officer that provides certain benefits upon the termination of his
employment under certain prescribed circumstances. The agreement is described
above under "Employment Agreement--Tony Shahbaz."
CALCULATION OF POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL
In accordance with the rules of the Securities and Exchange Commission,
the following table presents our estimate of the benefits payable to the named
executive officers under our 2002 and 2003 Stock Option Plans and their
employment agreements, if any, assuming that (i) for Mr. Shahbaz, (A) a change
in control occurred on December 31, 2007, the last business day of 2007 and none
of his equity awards were assumed by the successor corporation, (B) a qualifying
termination occurred on December 31, 2007, which is a termination by us without
"cause," (C) a non-qualifying termination occurred on December 31, 2007, which
is a termination by us for "cause," or (D) an other termination occurred on
December 31, 2007, which is a termination by executive voluntarily or by us upon
the executive's death or disability; and (ii) for Mr. Gruber, (A) a change in
control occurred on December 31, 2007 and his equity award was not assumed by
the successor corporation, or (B) any termination occurred on December 31, 2007.
VALUE OF
SALARY CONTINUATION OPTION TOTAL
NAME TRIGGER AND BONUS OF BENEFITS ACCELERATION(1) VALUE(2)
- --------------------- ------------------------- -------------- -------------- ---------------- ------------
Tony Shahbaz Change in Control $ -- $ -- $ -- $ --
Qualifying Termination $ 157,146(3) $ 3,013(4) $ -- $ 160,159
Non-Qualifying Termination $ 794,000(5) $ -- $ -- $ 794,000
Other Termination $ -- $ -- $ -- $ --
Thomas L. Gruber Change in Control $ -- $ -- $ -- $ --
Any Termination $ -- $ -- $ -- $ --
- ----------
(1) Represents the aggregate value of the accelerated vesting of the executive
officer's unvested stock options and restricted stock grants. The amounts
shown as the value of the accelerated stock options and restricted stock
grants in connection with a change in control without a qualifying
termination are based solely on the intrinsic value of the options as of
December 31, 2007. This value was calculated by multiplying (a) the
difference between the fair market value of our common stock on December
31, 2007, which was $1.25, and the applicable exercise price by (b) the
assumed number of option shares vesting on an accelerated basis on
December 31, 2007.
(2) Excludes the value to the executive of the continuing right to
indemnification and continuing coverage under our directors' and officers'
liability insurance, if applicable.
(3) Represents 9.5 months additional salary through the end of the term of
executive's employment agreement based on executive's salary in 2007.
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(4) Represents the aggregate value of the continuation of certain employee
benefits through the end of the term of executive's employment agreement
based on the cost of executive's employee benefits in 2007.
(5) Represents four times executive's salary based on executive's salary in
2007.
COMPENSATION OF DIRECTORS
Other than Dr. William Ting, our directors do not receive any cash
compensation for their services as members of our board of directors; however,
each director is entitled to reimbursement of his reasonable expenses incurred
in attending meetings of our board of directors. Dr. Ting receives $1,500 per
meeting for his attendance at meetings of our board of directors and its
committees. We do not have a predetermined or automatic annual or other periodic
program for grants of equity compensation to our directors. Equity compensation
is granted as and when determined appropriate by our Compensation Committee or
our full board.
COMPENSATION OF EMPLOYEE DIRECTOR
Mr. Shahbaz was compensated as a full-time employee and officer but
received no additional compensation for service as a board member during 2007.
Information regarding the compensation awarded to Mr. Shahbaz is included in the
"Summary Compensation Table" above.
DIRECTOR COMPENSATION TABLE
The following table summarizes the compensation of our directors for
the year ended December 31, 2007:
FEES EARNED
OR PAID OPTION ALL OTHER
IN CASH AWARDS COMPENSATION TOTAL
NAME ($) ($)(1) ($)(2) ($)
- ------------------- ----------- -------- ------------ -------
Steel Su(3) $ -- $ 6,618 $ -- $ 6,618
Daniel Yao(4) $ -- $ 7,677 $ -- $ 7,677
Dr. William Ting(5) $12,000 $ -- $ 3,100 $15,100
(1) The amounts shown are the compensation costs recognized in our financial
statements for 2007 related to grants of stock options to each director in
previous years, to the extent we recognized compensation cost in 2007 for
such awards in accordance with the provisions of SFAS No. 123R.
(2) The value of perquisites and other personal benefits was less than $10,000
in aggregate for each director. However, we paid Dr. Ting an aggregate of
$3,100 for his time spent with our management on strategic financial and
product review and analysis.
(3) At December 31, 2007, Mr. Su held options to purchase an aggregate of
28,000 shares of our common stock.
(4) At December 31, 2007, Mr. Yao held options to purchase an aggregate of
33,000 shares of our common stock.
(5) At December 31, 2007, Mr. Ting held no options to purchase shares of our
common stock.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Our amended and restated articles of incorporation, or Articles, and
our amended and restated bylaws, or Bylaws, provide that we shall, to the
fullest extent permitted by Section 78.751 of the Nevada Revised Statutes,
indemnify all persons that we have power to indemnify against all expenses,
liabilities or other matters covered by Section 78.751. This indemnification is
not exclusive of any other indemnification rights to which those persons may be
entitled and must cover action both in an official capacity and in another
capacity while holding office. Indemnification continues as to a person who has
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ceased to be a director, officer, employee or agent and extends to the benefit
of the heirs, executors and administrators of that person. Section 78.751
provides that the expenses of our officers and directors incurred in defending a
civil or criminal action, suit or proceeding must be paid by us as they are
incurred and in advance of the final disposition of the action, suit or
proceeding, upon receipt of an undertaking by or on behalf of the director or
officer to repay the amount if it is ultimately determined by a court of
competent jurisdiction that the director or officer is not entitled to
indemnification.
Our Articles also provide that a director of I/OMagic shall not be
liable to us or our stockholders for monetary damages for breach of fiduciary
duty as a director, except to the extent exemption from limitation or liability
is not permitted under the Nevada Revised Statutes. Any amendment, modification
or repeal of this provision by our stockholders would not adversely affect any
right or protection of a director of I/OMagic in respect of any act or omission
occurring prior to the time of the amendment, modification or repeal. Our
Articles do not, however, eliminate or limit a director's liability for any act
or omission involving intentional misconduct, fraud or a knowing violation of
law, or the payment of unlawful distributions to stockholders. Furthermore, they
do not limit liability for claims against a director arising out of the
director's responsibilities under the federal securities laws or any other law.
However, we have purchased directors and officers' liability insurance to
protect our directors and executive officers against liability under
circumstances specified in the policy.
Section 2115 of the California General Corporation Law, or the
California Code, provides that corporations such as I/OMagic that are
incorporated in jurisdictions other than California and that meet various tests
are subject to several provisions of the California Code, to the exclusion of
the law of the jurisdiction in which the corporation is incorporated. We believe
that as of December 31, 2007, we met the tests contained in Section 2115.
Consequently, we are subject to, among other provisions of the California Code,
Section 317 which governs indemnification of directors, officers and others.
Section 317 generally eliminates the personal liability of a director for
monetary damages in an action brought by or in the right of I/OMagic for breach
of a director's duties to I/OMagic or our stockholders except for liability:
o for acts or omissions that involve intentional misconduct or a
knowing and culpable violation of law;
o for acts or omissions that a director believes to be contrary
to the best interests of I/OMagic or our stockholders or that
involve the absence of good faith on the part of the director;
o for any transaction from which a director derived an improper
personal benefit;
o for acts or omissions that show a reckless disregard for the
director's duty to I/OMagic or our stockholders in
circumstances in which the director was aware, or should have
been aware, in the ordinary course of performing a director's
duties, of a risk of serious injury to I/OMagic or our
stockholders;
o for acts or omissions that constitute an unexcused pattern of
inattention that amounts to an abdication of the director's
duty to I/OMagic or our stockholders; and
o for engaging in transactions described in the California Code
or California case law which result in liability, or approving
the same kinds of transactions.
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We may enter into separate indemnification agreements with each of our
directors and executive officers that provide the maximum indemnity allowed to
directors and executive officers by applicable law and which allow for certain
procedural protections. We also maintain directors and officers insurance to
insure such persons against certain liabilities.
These indemnification provisions and the indemnification agreements
that may be entered into between us and our directors and executive officers may
be sufficiently broad to permit indemnification of our directors and executive
officers for liabilities (including reimbursement of expenses incurred) arising
under the Securities Act.
To the extent indemnification for liabilities arising under the
Securities Act may be extended to directors, officers and controlling persons of
I/OMagic under the foregoing provisions, or otherwise, we have been advised that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act, and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities is asserted by any director, officer or controlling person in
connection with the securities being registered (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question of whether the
proposed indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the court's final adjudication of the
issue.
The inclusion of the above provisions in our Articles and Bylaws and in
our indemnification agreements with our officers and directors may have the
effect of reducing the likelihood of derivative litigation against our directors
and may discourage or deter stockholders or management from bringing a lawsuit
against our directors for breach of their duty of care, even though the action,
if successful, might otherwise have benefited us and our stockholders. At
present, there is no litigation or proceeding pending involving any of our
directors as to which indemnification is being sought, nor are we aware of any
threatened litigation that may result in claims for indemnification by any of
our directors.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
As of March 26, 2008, a total of 4,540,292 shares of our common stock
were outstanding. The following table sets forth information as of that date
regarding the beneficial ownership of our common stock by:
o each person known by us to own beneficially more than five
percent, in the aggregate, of the outstanding shares of our
common stock as of the date of the table;
o each of our directors;
o each of our current executive officers; and
o all of our directors and current executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Except as indicated in the footnotes to the
table, we believe each security holder possesses sole voting and investment
power with respect to all of the shares of common stock owned by such security
holder, subject to community property laws where applicable. In computing the
number of shares beneficially owned by a security holder and the percentage
ownership of that security holder, shares of common stock subject to options,
warrants or preferred stock held by that person that are currently exercisable
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or convertible or are exercisable or convertible into shares of common stock
within 60 days after the date of the table are deemed outstanding. Those shares,
however, are not deemed outstanding for the purpose of computing the percentage
ownership of any other person or group.
AMOUNT AND NATURE
OF BENEFICIAL PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER(1) TITLE OF CLASS OWNERSHIP OF CLASS OF CLASS
- ---------------------------------------- -------------- ------------------ ---------
Tony Shahbaz........................................... Common 2,485,138(2) 53.04%
Steel Su............................................... Common 597,033(3) 13.08%
Sung Ki Kim............................................ Common 375,529(4) 8.27%
Daniel Yao............................................. Common 367,881(5) 8.05%
William Ting........................................... Common -- --
Thomas L. Gruber....................................... Common 32,813(6) *
All directors and executive officers as a group (5
persons)............................................ Common 3,482,865(7) 73.03%
- ---------
* Less than 1.0%.
(1) Unless otherwise indicated, the address of each person in this table is
c/o I/OMagic Corporation, 4 Marconi, Irvine, California 92618. Messrs.
Shahbaz and Gruber are executive officers of I/OMagic Corporation.
Messrs. Shahbaz, Su, Yao and Ting are directors of I/OMagic Corporation.
(2) Consists of: (i) 493,462 shares of common stock and 145,379 shares of
common stock underlying options held individually by Mr. Shahbaz; (ii)
1,240,423 shares of common stock held by Susha, LLC, a California
limited liability company, or Susha California; (iii) 566,668 shares of
common stock held by Susha, LLC, a Nevada limited liability company, or
Susha Nevada; and (iv) 39,206 shares of common stock held by King Eagle
Enterprises, Inc., a California corporation. Mr. Shahbaz has sole voting
and sole investment power over all of the shares held by Susha
California and Susha Nevada. Mr. Shahbaz and Behavior Tech Computer
Corp. are equal owners of the membership interests in Susha California
and Susha Nevada.
(3) Consists of 406,794 shares of common stock and 23,572 shares of common
stock underlying options held individually by Mr. Su, and 166,667 shares
of common stock held by Behavior Tech Computer Corp. Mr. Su is the Chief
Executive Officer of Behavior Tech Computer Corp. and has sole voting
and sole investment power over the shares held by Behavior Tech Computer
Corp.
(4) Represents 375,529 shares of common stock held by BTC Korea Co., Ltd.,
or BTC Korea. Since October 22, 2003, Mr. Kim has served as Chief
Executive Officer and President of BTC Korea and has sole voting and
sole investment power over the shares held by BTC Korea. The address for
Mr. Kim is c/o BTC Korea Co., Ltd., 160-5, Kajwa-Dong Seo-Ku, Incheon
City, Korea.
(5) Consists of 27,063 shares of common stock underlying options held
individually by Mr. Yao and 340,818 shares of common stock held by
Citrine Group Limited, a wholly owned subsidiary of Ritek Corporation.
Mr. Yao currently serves as the Chief Strategy Officer of Ritek
Corporation. Mr. Yao has sole voting and sole investment power over the
shares held by Citrine Group Limited. The address for Mr. Yao is c/o
Citrine Group Limited, No. 42, Kuanfu N. Road, 30316 R.O.C., HsinChu
Industrial Park, Taiwan.
(6) Represents 32,813 shares of common stock underlying options held
individually by Mr. Gruber.
(7) Includes 228,827 shares of common stock underlying options.
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EQUITY COMPENSATION PLAN INFORMATION
The following table provides information about our common stock that
may be issued upon the exercise of options, warrants and rights under all of our
existing equity compensation plans as of December 31, 2007.
NUMBER OF
SECURITIES TO BE WEIGHTED-AVERAGE NUMBER OF
ISSUED UPON EXERCISE OF EXERCISE PRICE OF SECURITIES REMAINING
OUTSTANDING, OUTSTANDING AVAILABLE
OPTIONS, WARRANTS OPTIONS, WARRANTS FOR FUTURE ISSUANCE UNDER
PLAN CATEGORY AND RIGHTS AND RIGHTS EQUITY COMPENSATION PLANS
- ---------------------------------------- ------------------------ ----------------- -------------------------
Equity Compensation Plans Approved
BY Security Holders.................... 353,775 $ 3.15 229,559
Equity Compensation Plans Not Approved
by Security Holders.................... -- $ -- --
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.
POLICIES AND PROCEDURES FOR APPROVAL OF RELATED PARTY TRANSACTIONS
Our board of directors has the responsibility to review and discuss
with management and approve interested transactions with related parties. During
this process, the material facts as to the related party's interest in a
transaction are disclosed to all board members or an applicable committee. Our
board of directors is to review each interested transaction with a related party
that requires approval and either approve or disapprove of the entry into the
interested transaction. An interested transaction is any transaction in which we
are a participant and any related party has or will have a direct or indirect
interest. Transactions that are in the ordinary course of business and would not
require disclosure pursuant to Item 404(a) of Regulation S-K or approval of the
board or an independent committee of the board would not be deemed interested
transactions. Our board of directors has determined that all of its directors
are "independent" as defined in NASD Marketplace Rule 4200(a)(15), except for
(i) Tony Shahbaz, who serves full-time as our Chief Executive Officer, President
and Secretary, and (ii) Steel Su, who is the Chief Executive Officer of BTC, an
entity with which we conduct significant business; BTC USA, its affiliates and
Mr. Su also have beneficial ownership in or are otherwise affiliated with the
following affiliates of BTC and BTC USA: BTC Korea Co., Ltd., Behavior Tech
Computer (BVI) Corp., BTC Taiwan, Susha, LLC, a Nevada limited liability
company, and Susha, LLC, a California limited liability company, each of which
is also a stockholder of I/OMagic. No director may participate in any approval
of an interested transaction with respect to which he or she is a related party.
Our board intends to approve only those related party transactions that are in
the best interests of I/OMagic and our stockholders.
GENERAL
Other than as described below or elsewhere in this report, since
January 1, 2007 there has not been a transaction or series of related
transactions to which I/OMagic was or is a party involving an amount in excess
of $120,000 and in which any director, executive officer, holder of more than 5%
of any class of our voting securities, or any member of the immediate family of
any of the foregoing persons, had or will have a direct or indirect material
interest. None of the below transactions were separately approved by our Board
as they occurred prior to our adoption of our policies and procedures for
approval of related party transactions.
We are or have been a party to employment and compensation arrangements
with related parties, as more particularly described above. We have entered into
an indemnification agreement with each of our directors and executive officers.
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The indemnification agreements and our certificate of incorporation and bylaws
require us to indemnify our directors and officers to the fullest extent
permitted by Nevada law.
LUNG HWA ELECTRONICS CO., LTD. AND BTC USA
On June 6, 2005, we entered into a new trade credit facility with Lung
Hwa Electronics Co., Ltd., or Lung Hwa, that replaced our previous $10.0 million
trade credit facility. Under the terms of the new facility, Lung Hwa has agreed
to purchase and manufacture inventory on our behalf. We can purchase an
aggregate of up to $15.0 million of inventory manufactured by Lung Hwa or
manufactured by third parties, in which case we use Lung Hwa as an international
purchasing office. For inventory manufactured by third parties and purchased
through Lung Hwa, the payment terms are 120 days following the date of invoice
by Lung Hwa. Lung Hwa charges us a 5% handling fee on a supplier's unit price. A
2% discount of the handling fee is applied if we reach an average running
monthly purchasing volume of $750,000. Returns made by us, which are agreed to
by a supplier, result in a credit to us for the handling charge. For inventory
manufactured by Lung Hwa, the payment terms are 90 days following the date of
invoice by Lung Hwa. We are to pay Lung Hwa, within one week of the purchase
order, 10% of the purchase price on any purchase orders issued to Lung Hwa as a
down-payment for the order. The trade credit facility has an initial term of one
year after which the facility will continue indefinitely if not terminated at
the end of the initial term. At the end of the initial term and at any time
thereafter, either party has the right to terminate the facility upon 30 days'
prior written notice to the other party. The agreement containing the terms of
the new trade credit facility was amended and restated on July 21, 2005 to
provide that the new facility would be retroactive to April 29, 2005.
As of December 31, 2006, we owed Lung Hwa $7.6 million in trade
payables. During 2006, we purchased $22.2 million of inventory from Lung Hwa. As
of December 31, 2007, we owed Lung Hwa $665,000 in trade payables. During 2007,
we purchased $3.8 million of inventory from Lung Hwa. As of December 31, 2007,
we were in violation of the payment terms in our agreement with Lung Hwa but we
arranged a repayment schedule for satisfaction of the obligation and we
satisfied the payment schedule prior to the filing of this report.
We believe that many of the terms available to us under our trade
credit facility with Lung Hwa are advantageous as compared to terms available
from unrelated third parties. For example, Lung Hwa extends us 120 day payment
terms. We believe that the best payment terms that we could likely obtain from
unrelated third parties would be 60-day payment terms; however, payment in
advance or within 30 days is more customary. Also, Lung Hwa charges us a 5%
handling fee on a supplier's unit price, but applies a 2% discount of the
handling fee, so that the net handling fee is 3%, if we reach an average running
monthly purchasing volume of $750,000. In addition, under our trade credit
facility with Lung Hwa, the level of collateral security provided by us to Lung
Hwa was initially $1.5 million, and is currently only 10% of each product order,
for a $15.0 million trade credit facility. We believe that the payment terms,
handling fee and the level of security required are all substantially better
terms that we could obtain from unrelated third parties. In fact, we believe
that our trade credit facility is likely unique and could not be replaced
through a relationship with an unrelated third party.
Our relationship and our trade credit facility with Lung Hwa enables us
to acquire products from manufacturers who we believe are some of the largest
electronics manufacturers in the world. We buy products through Lung Hwa by
using Lung Hwa' size and purchasing power as a source of credit strength. If we
were to acquire these products directly from the manufacturers, we would likely
be required to send payment in advance of shipment of those products. Due to our
relatively small size, we would likely be unable to qualify for extended payment
terms of even 30 days. Accordingly, we believe that our relationship and trade
credit facility with Lung Hwa is likely unique, could not be replaced through a
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relationship with an unrelated third party and is important in enabling us to
secure certain products that we sell.
In February 2003, we entered into a Warehouse Services and Bailment
Agreement with BTC USA, an affiliate of several of our stockholders, namely, BTC
Korea Co., Ltd., Behavior Tech Computer (BVI) Corp. and BTC Taiwan, as well as
an affiliate of one of our principal subcontract manufacturers, namely Behavior
Tech Computer Corp. Under the terms of the agreement, BTC USA has agreed to
supply and store at our warehouse up to $10.0 million of inventory on a
consignment basis. We are 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 provides us with a trade line
of credit of up to $10.0 million with payment terms of net 60 days, without
interest. The agreement may be terminated by either party upon 60 days' prior
written notice to the other party. Steel Su, a director of I/OMagic, is the
Chief Executive Officer of BTC. BTC USA, its affiliates and Mr. Su also have
beneficial ownership in or are otherwise affiliated with the following
affiliates of BTC and BTC USA: BTC Korea Co., Ltd., Behavior Tech Computer (BVI)
Corp., BTC Taiwan, Susha, LLC, a Nevada limited liability company, and Susha,
LLC, a California limited liability company, each of which is also a stockholder
of I/OMagic. Mr. Shahbaz, our Chief Executive Officer, President, Secretary and
a Director, also has beneficial ownership in, and sole voting control of, Susha,
LLC, a Nevada limited liability company, and Susha, LLC, a California limited
liability company. See "Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters" above.
As of December 31, 2006, we owed BTC USA $0.3 million under our
arrangement. During 2006, we purchased $1.2 million of inventory from BTC USA.
As of December 31, 2007, we owed BTC USA $6.7 million under our arrangement.
During 2007, we purchased $8.4 million of inventory from BTC USA.
We believe that many of the terms available to us under our Warehouse
Services and Bailment Agreement with BTC USA are advantageous as compared to
terms available from unrelated third parties. For example, this Agreement allows
us to store up to $10.0 million of consigned inventory at our warehouse, without
obligation to pay BTC USA for the inventory until 60 days after we take title to
the inventory. We believe that it is unlikely that unrelated third parties would
permit this consignment arrangement and that we would instead be subject to
standard payment terms, the best of which would likely be 60-day payment terms;
however, either payment in advance or within 30 days is more customary. Our
$10.0 million line of credit with 60 days payment terms without interest may
also permit terms better than we could obtain from unrelated third parties. The
best payment terms under a line of credit with a unrelated third party
subcontract manufacturer or supplier would likely be 60 day payment terms;
however, payment in advance or within 30 days is more customary.
Our relationships with Lung Hwa and BTC USA provide us with numerous
advantages. We believe that both entities are significant suppliers within their
industries and have substantial manufacturing and product development
capabilities and resources. The advantageous terms we are able to obtain from
them allow us to utilize more capital resources for other aspects of our
business and to remain competitive with larger, more established companies. In
addition, we are better able to manage our cash flow as a result of our
significant trade lines of credit with Lung Hwa and BTC USA. We believe that
these advantageous terms contribute positively to our results of operations.
In the past, equity investments by Lung Hwa and BTC USA, or its
affiliates, have enabled us to obtain inventory with little or no cash
expenditures, which we believe has helped us establish, maintain and grow our
business. We believe that our relationships with these related parties has in
the past benefited our business and contributed positively to our historical
results of operations.
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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The following table presents the aggregate fees paid by us for
professional audit services rendered by Swenson Advisors, LLP, or Swenson, for
the years ended December 31, 2007 and 2006. We appointed Swenson as our
independent registered public accounting firm on December 12, 2006.
2007 2006
-------- --------
Audit Fees $425,761 $ --
Audit-Related Fees -- --
Tax Fees 10,337 --
All Other Fees 20,000 --
-------- --------
Total $456,098 $ --
======== =======
The following table presents the aggregate fees paid by us for
professional audit services rendered by Singer Lewak Greenbaum & Goldstein LLP,
or SLGG, for the years ended December 31, 2007 and 2006. We replaced SLGG as our
independent registered public accounting firm on December 12, 2006.
2007 2006
-------- --------
Audit Fees $100,682 $437,955
Audit-Related Fees -- 1,882
Tax Fees -- 10,000
All Other Fees -- --
-------- --------
Total $100,682 $449,837
======== ========
AUDIT FEES. Consist of amounts paid for professional services rendered
for the audit of our annual consolidated financial statements included in our
Annual Reports on Forms 10-K, and reviews of our interim consolidated financial
statements included in our Quarterly Reports on Forms 10-Q and our Registration
Statements on Forms S-1 and S-8, including amendments thereto.
AUDIT-RELATED FEES. Audit-Related Fees consist of fees billed for
professional services that are reasonably related to the performance of the
audit or review of our consolidated financial statements but are not reported
under "Audit Fees."
TAX FEES. Tax Fees consist of fees for professional services for tax
compliance activities, including the preparation of federal and state tax
returns and related compliance matters.
ALL OTHER FEES. Consists of amounts billed for services other than
those noted above.
Our Audit Committee has determined that all non-audit services provided
by Swenson are and were compatible with maintaining those firm's audit
independence.
Our Audit Committee is responsible for approving all audit,
audit-related, tax and other services. The Audit Committee pre-approves all
auditing services and permitted non-audit services, including all fees and terms
to be performed for us by our independent registered public accounting firm at
the beginning of the fiscal year. Non-audit services are reviewed and
pre-approved by project at the beginning of the fiscal year. Any additional
non-audit services contemplated by us after the beginning of the fiscal year are
submitted to the Audit Committee chairman for pre-approval prior to engaging the
independent auditor for such services. These interim pre-approvals are reviewed
with the full Audit Committee at its next meeting for ratification. During 2007,
all services performed by Swenson were pre-approved by our Audit Committee in
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accordance with these policies and applicable Securities and Exchange Commission
regulations.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a)(1), (a)(2) and (c) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Reference is made to the financial statements and financial statement
schedule listed on and attached following the Index to Restated Consolidated
Financial Statements and Supplemental Information contained on page F-1 of this
report.
(a)(3) and (b) EXHIBITS
Reference is made to the exhibits listed on the Index to Exhibits that
follows the financial statements and financial statement schedule.
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I/OMAGIC CORPORATION AND SUBSIDIARY
INDEX TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
AND SUPPLEMENTAL INFORMATION
PAGE
----
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM................... F-2
RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Restated Consolidated Balance Sheets as of December 31,
2007 and 2006................................................... F-3
Restated Consolidated Statements of Operations for the Years
Ended December 31, 2007 and 2006................................ F-4
Restated Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 2007 and 2006.................. F-5
Restated Consolidated Statements of Cash Flows for the
Years Ended December 31, 2007 and 2006.......................... F-6
Notes to Restated Consolidated Financial Statements.............. F-7
SUPPLEMENTAL INFORMATION
Schedule II - Valuation and Qualifying Accounts.................. F-32
F-1
<page>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
I/OMagic Corporation and Subsidiary
We have audited the accompanying consolidated balance sheets of I/OMagic
Corporation and Subsidiary as of December 31, 2007 and 2006 (restated), and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the two-year period ended December 31, 2007
(restated). Our audits also include the financial statement Schedule II.
I/OMagic Corporation and Subsidiary's management is responsible for these
consolidated financial statements. Our responsibility is to express an opinion
on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of I/OMagic Corporation
and Subsidiary as of December 31, 2007 and 2006 (restated), and the results of
its operations and its cash flows for each of the years in the two-year period
ended December 31, 2007 (restated) in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, the
related financial statement Schedule II, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has incurred significant
operating losses, serious liquidity concerns and may require additional
financing in the foreseeable future. These matters, among others, raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
accompanying consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
As described in Note 2 to the financial statements, the Company has restated its
financial statements for each of the two years in the period ended December 31,
2007 to correct errors related to the accrual of audit fees and
lower-of-cost-or-market valuation of consigned inventory.
/s/ SIMON & EDWARD, LLP
City of Industry, California
April 3, 2009
F-2
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------------
2007 2006
------------ ------------
(restated)(1) (restated)(1)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,463,122 $ 1,833,481
Restricted cash 341,899 893,167
Accounts receivable, net 6,941,856 11,534,687
Inventory, net 5,492,846 10,406,916
Prepaid expenses and other current assets 107,041 71,733
------------ ------------
Total current assets 14,346,764 24,739,984
EQUIPMENT, net 247,551 194,117
TRADEMARKS, net 293,016 361,944
OTHER ASSETS 41,928 41,928
------------ ------------
TOTAL ASSETS $ 14,929,259 $ 25,337,973
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit $ 3,864,942 $ 4,380,133
Accounts payable, accrued expenses and other 1,153,188 5,150,743
Accounts payable - related parties 7,414,212 7,945,980
Capital lease obligations - current portion 47,593 --
Accrued mail-in rebates 432,046 1,269,996
------------ ------------
Total current liabilities 12,911,981 18,746,852
LONG-TERM LIABILITIES
Capital lease obligations 65,885 --
------------ ------------
Total long-term liabilities 65,885 --
------------ ------------
Total liabilities 12,977,866 18,746,852
------------ ------------
STOCKHOLDERS' EQUITY
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 31,794,655 31,681,409
Accumulated deficit (29,847,803) (25,094,829)
------------ ------------
Total stockholders' equity 1,951,393 6,591,121
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 14,929,259 $ 25,337,973
============ ============
__________
(1) See Notes to Restated Consolidated Financial Statements - "Note 2 - Restatement of 2006 and
2007 Financial Statements."
See accompanying notes to these consolidated financial statements
F-3
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
----------------------------
2007 2006
------------ ------------
(restated)(1) (restated)(1)
NET SALES $ 32,121,241 $ 45,889,410
COST OF SALES 30,731,391 39,727,484
------------ ------------
GROSS PROFIT 1,389,850 6,161,926
------------ ------------
OPERATING EXPENSES
Selling, marketing, and advertising 1,251,282 2,113,578
General and administrative 4,447,674 6,133,855
Depreciation and amortization 139,048 165,783
------------ ------------
Total operating expenses 5,838,004 8,413,216
------------ ------------
LOSS FROM OPERATIONS (4,448,154) (2,251,290)
------------ ------------
OTHER INCOME (EXPENSE)
Interest income 6 113
Interest expense (410,214) (356,586)
Currency transaction gain 117 6,952
Gain on disposal of equipment -- 9,403
Other income 106,071 15,166
Litigation settlement -- 2,375,000
------------ ------------
Total other income (expense) (304,020) 2,050,048
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (4,752,174) (201,242)
PROVISION FOR INCOME TAXES 800 800
------------ ------------
NET LOSS $ (4,752,174) $ (202,042)
============ ============
BASIC AND DILUTED LOSS PER SHARE $ (1.05) $ (0.04)
============ ============
BASIC AND DILUTED WEIGHTED-AVERAGE SHARES OUTSTANDING 4,540,292 4,540,292
============ ============
__________
(1) See Notes to Restated Consolidated Financial Statements - "Note 2 -
Restatement of 2006 and 2007 Financial Statements."
See accompanying notes to these consolidated financial statements
F-4
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006
COMMON STOCK ADDITIONAL TOTAL
---------------------------- PAID-IN TREASURY ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL STOCK DEFICIT EQUITY
------------ ------------ ------------ ------------ ------------ ------------
Balances at December 31, 2005 4,531,572 $ 4,532 $ 31,595,952 $ (126,014) $(24,892,787) $ 6,581,683
Retirement of treasury shares (13,493) (13) (126,001) 126,014 -- --
Sales of common stock pursuant to
exercises of stock options at
an average price of $2.86 per
share 22,213 22 62,410 -- -- 62,432
Share-based compensation expense -- -- 149,048 -- -- 149,048
Net loss -- -- -- -- (202,042) (202,042)
------------ ------------ ------------ ------------ ------------ ------------
Balances at December 31, 2006
(restated)(1) 4,540,292 4,541 31,681,409 -- (25,094,829) 6,591,121
Share-based compensation expense -- -- 66,916 -- -- 71,493
Warrants issued for services rendered -- -- 46,330 -- -- 41,753
Net loss -- -- -- -- (4,752,974) (4,752,974)
------------ ------------ ------------ ------------ ------------ ------------
Balances at December 31, 2007
(restated)(1) 4,540,292 $ 4,541 $ 31,794,655 $ -- $(29,847,803) $ 1,951,393
============ ============ ============ ============ ============ ============
___________
(1) See Notes to Restated Consolidated Financial Statements - "Note 2 - Restatement of 2006 and 2007 Financial Statements."
See accompanying notes to these consolidated financial statements
F-5
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------
2007 2006
----------- -----------
(restated)(1) (restated)(1)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,752,974) $ (202,042)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 70,120 96,855
Amortization of trademarks 68,928 68,928
Allowance for doubtful accounts 111,128 31,855
Allowance for product returns (66,139) 288,352
Reserves for sales incentives (254,993) (20,254)
Accrued point-of-sale rebates (1,120,558) (198,746)
Accrued market development funds, cooperative
advertising costs and cross dock fees (193,016) (980,591)
Allowance for obsolete inventory (86,000) 496,310
Share-based compensation expense 66,916 149,048
Warrants issued for services rendered 46,330 --
Capitalized offering costs -- 1,218,655
Changes in assets and liabilities (net of dispositions
and acquisitions)
Accounts receivable 6,116,409 (1,268,450)
Inventory 5,000,070 (3,918,870)
Prepaid expenses and other current assets (35,308) 193,696
Other assets -- (14,896)
Accounts payable, accrued expenses and other (3,997,555) 3,151,378
Accounts payable - related party (531,768) (276,098)
Capital leases 113,478 --
Accrued mail-in rebates (837,950) 554,097
----------- -----------
Net cash used in operating activities (282,882) (630,773)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Restricted cash 551,268 (862,303)
Equipment additions (123,554) (118,967)
----------- -----------
Net cash provided by (used in) investing activities 427,714 (981,270)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net payments on line of credit (515,191) (673,449)
Proceeds from sales of common stock -- 62,432
----------- -----------
Net cash used in financing activities (515,191) (611,017)
----------- -----------
Net decrease in cash and cash equivalents (370,359) (2,223,060)
Cash and cash equivalents at beginning of year 1,833,481 4,056,541
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,463,122 $ 1,833,481
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
INTEREST PAID $ 410,214 $ 356,585
=========== ===========
INCOME TAXES PAID $ 800 $ 800
=========== ===========
__________
(1) See Notes to Restated Consolidated Financial Statements - "Note 2 -
Restatement of 2006 and 2007 Financial Statements."
See accompanying notes to these consolidated financial statements
F-6
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS
Nature of Business
- ------------------
I/OMagic Corporation ("I/OMagic"), a Nevada corporation, and its subsidiary IOM
Holdings, Inc. (collectively, the "Company"), develops, manufactures through
subcontractors or obtains from suppliers, markets and sells data storage
products, and high-definition televisions utilizing liquid crystal display
technology 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 accompanying restated consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. This contemplates
the realization of assets and the satisfaction of liabilities in the normal
course of business. The Company experienced net losses for the years ended
December 31, 2007 and 2006 of $4.8 million and $202,000, respectively. These
matters, among others, raise doubt about the Company's liquidity and ability to
fund future operations.
At December 31, 2007, the Company had cash and cash equivalents of $1,463,122
and had approximately $646,000 available to it for borrowing under its credit
facility with Silicon Valley Bank. As of March 26, 2009, the Company had only
$368,600 of cash on hand.
On March 7, 2008, the Company received notice from Silicon Valley Bank under a
Loan and Security Agreement dated February 2, 2007 between the Company, IOM
Holdings, Inc. and Silicon Valley Bank that the Company was in default of its
tangible net worth financial covenant. As of that date, the Company owed Silicon
Valley Bank $1,598,461, all of which was due and payable upon demand by Silicon
Valley Bank. The Company was also unable to obtain advances under its line of
credit. The Company sought a waiver of the default of its tangible net worth
financial covenant and received a Forbearance Agreement from Silicon Valley Bank
in that regard.
On April 18, 2008, the Company entered into a Loan and Security Agreement dated
as of April 18, 2008 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 restated a previous Loan and Security Agreement
dated January 29, 2007 among the parties. The 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 was only permitted to borrow
up to a limit of 60% of each eligible account or such other percentage as
Silicon Valley Bank established. The line of credit was to expire on January 29,
2009. Advances on the line of credit 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. On July 31, 2008, the
Company paid off its obligations owed to Silicon Valley Bank under the Loan and
Security Agreement dated April 18, 2008 and terminated the Loan and Security
Agreement.
F-7
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
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. The credit facility allows the
Company to sell accounts receivable to Rexford Funding subject to a maximum
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. The Sale of
Accounts and Security Agreement has an initial term through April 30, 2009 with
automatic six month extensions unless either party terminates the Sale of
Accounts and Security 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
has the right to terminate the Sale of Accounts and Security Agreement upon 30
days prior notice.
As of the date of filing of this report, the Company had serious liquidity
concerns and may require additional financing in the foreseeable future. The
Company presently may not have sufficient capital to fund its operations for the
next twelve months or less.
The Company's plans for correcting these deficiencies include the timely
collection of existing accounts receivable, and sell-through of inventory
currently in the Company's sales channels. If, however, the Company's capital
requirements or cash flow vary materially from its current projections, 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.
The restated 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.
NOTE 2 - RESTATEMENT OF 2006 AND 2007 FINANCIAL STATEMENTS
The Company previously accrued audit fees in the period to which the
corresponding audit applied. Upon further examination of its accounting
methodology, the Company determined that it made an error in its application of
the relevant accounting principles and determined that it should have accrued
audit fees in the period in which they were incurred. The Company has determined
the effect of the correction on its previously-issued financial statements and
has restated the accompanying financial statements and the financial information
below for the years ended December 31, 2006 and 2007.
The Company accrued sales incentives but had not established any
lower-of-cost-or-market reserve to account for reduced sales prices of certain
inventory consigned to retailers. Upon further examination, the Company
determined that it should establish a lower-of-cost-or-market reserve in the
amount of $264,000 at December 31, 2006 for certain inventory consigned to
retailers that was sold subsequent to December 31, 2006 at prices below net
realizable value. The Company has determined the effect of the reserve on its
previously-issued financial statements and has restated the accompanying
financial statements and the financial information below for the year ended
December 31, 2006.
The effects of the restatement on cost of sales, gross profit, general and
administrative expenses, net loss, basic and diluted loss per common share,
inventory (net) and stockholders' equity as of and for the year ended December
31, 2006 are as follows:
F-8
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
AS ORIGINALLY RESTATEMENT
REPORTED ADJUSTMENTS AS RESTATED
------------ ------------ ------------
Net sales $ 45,889,410 $ -- $ 45,889,410
Cost of sales $ 39,463,484 $ 264,000 $ 39,727,484
Gross profit $ 6,425,926 $ (264,000) $ 6,161,926
General and administrative expenses $ 6,504,985 $ (371,130) $ 6,133,855
Net loss $ (309,172) $ 107,130 $ (202,042)
LOSS PER COMMON SHARE:
Basic $ (0.07) $ 0.03 $ (0.04)
Diluted $ (0.07) $ 0.03 $ (0.04)
Inventory, net $ 10,670,916 $ (264,000) $ 10,406,916
Stockholders' equity $ 6,483,991 $ 107,130 $ 6,591,121
The effects of the restatement on cost of sales, gross profit, general and
administrative expenses, net loss, basic and diluted loss per common share, and
stockholders' equity as of and for the year ended December 31, 2007 are as
follows:
AS ORIGINALLY RESTATEMENT
REPORTED ADJUSTMENTS AS RESTATED
------------ ------------ ------------
Net sales...............................$ 32,121,241 $ -- $ 32,121,241
Cost of sales...........................$ 30,995,391 $ (264,000) $ 30,731,391
Gross profit............................$ 1,125,850 $ 264,000 $ 1,389,850
General and administrative expenses.....$ 4,139,317 $ 308,357 $ 4,447,674
Net loss................................$ (4,708,617) $ (44,357) $ (4,752,974)
LOSS PER COMMON SHARE:
Basic................................$ (1.04) $ (0.01) $ (1.05)
Diluted..............................$ (1.04) $ (0.01) $ (1.05)
Stockholders' equity....................$ 1,888,620 $ 62,773 $ 1,951,393
The effects of the restatements for the quarterly periods in the years ended
December 31, 2006 and 2007 are summarized below in Note 17 - Selected Quarterly
Financial Data and Quarterly Restatement Adjustments--Unaudited.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
- ---------------------------
The restated consolidated financial statements include the accounts of I/OMagic
and its subsidiary, IOM Holdings, Inc. All material intercompany accounts and
transactions have been eliminated.
Estimates
- ---------
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
F-9
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Reclassifications
- -----------------
Certain prior year amounts may have been reclassified to conform to the current
presentation. Such reclassification had no effect on the net loss reported in
the consolidated statements of operations.
Cash and Cash Equivalents
- -------------------------
For purposes of the consolidated statements of cash flows, the Company considers
all highly liquid investments purchased with original maturities of three months
or less to be cash equivalents.
Restricted Cash
- ---------------
Restricted cash primarily represents time deposits that are pledged as
collateral for the Company's line of credit with Silicon Valley Bank and GMAC
Commercial Finance at December 31, 2007 and 2006, respectively.
Fair Value of Financial Instruments
- -----------------------------------
For certain of the Company's financial instruments, including cash and cash
equivalents, accounts receivable, inventory, prepaid expenses and other current
assets, line of credit, accounts payable, accrued expenses and other, accounts
payable-related parties and accrued mail-in rebates, the carrying amounts
approximate fair value due to their short maturities.
Accounts Receivable and Allowance for Doubtful Accounts
- -------------------------------------------------------
Trade accounts receivable are primarily from national retailers and are recorded
at the invoiced amount and do not accrue interest. The allowance for doubtful
accounts reflects management's best estimate of probable credit losses inherent
in the accounts receivable balance. The Company determines the allowance based
on historical experience, specifically identified nonpaying accounts and other
currently available evidence. The Company reviews its allowance for doubtful
accounts monthly with focus on significant individual past due balances over 90
days. All other balances are reviewed on a pooled basis. Account balances are
charged off against the allowance after all means of collection have been
exhausted and the potential for recovery is considered remote. Since the
Company's current customers are primarily national retailers with good payment
histories with the Company, its allowance for doubtful accounts is minimal. The
Company does not have any off-balance sheet credit exposure related to its
customers.
The Company occasionally has, and it expects that it will continue to have in
the foreseeable future, disagreements with its national retailers relating to
the valuation and completeness of accounts receivable which may result in a
contingent gain or loss to the Company.
Sales Incentive Reserve
- -----------------------
The Company enters into agreements with certain retailers regarding price
decreases that are determined by the Company in its sole discretion. These
agreements allow those retailers (subject to limitations) a credit equal to the
difference between the Company's current price and its new reduced price on
units in the retailers' inventories or in transit to the retailers on the date
of the price decrease.
The Company records an estimate of sales incentives based on its actual sales
incentive rates over a trailing twelve-month period, adjusted for any known
variations, which are charged to operations and offset against gross sales at
the time products are sold. The Company also records a corresponding accrual for
its estimated sales incentive liability. This accrual is reduced by deductions
on future payments taken by the Company's retailers relating to actual sales
incentives. The Company's estimated sales incentive liability is offset against
accounts receivable.
F-10
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
At the end of each quarterly period, the Company analyzes its existing sales
incentive reserve and applies any necessary adjustments based upon actual or
expected deviations in sales incentive rates from the Company's applicable
historical sales incentive rates. The amount of any necessary adjustment is
based upon the amount of the Company's remaining field inventory, which is
calculated by reference to the Company's actual field inventory last conducted,
plus inventory-in-transit and less estimated product sell-through. The amount of
the Company's sales incentive liability for each product is equal to the amount
of remaining field inventory for that product multiplied by the difference
between the Company's current price and its new reduced price to its retailers
for that product. This data, together with all data relating to all sales
incentives granted on products in the applicable period, is used to adjust the
Company's sales incentive reserve established for the applicable period.
Point-of-Sale Rebate Promotions Accruals
- ----------------------------------------
The Company periodically offers point-of-sale rebate promotions to retailers
that are in turn provided to the retailers' end-user customers. During the
period of the rebate promotion, the Company reduces sales by the estimated
amount of the rebate promotion with a corresponding accrual for the estimated
liability. Estimates for rebate promotions are based on a number of variable
factors that depend on the specific program or product. These variables include
the length of the rebate promotion and the estimated sales during the promotion
based on historical experience. These accruals are offset against accounts
receivable.
Market Development Funds/Cooperative Advertising Accruals
- ---------------------------------------------------------
The Company has agreements with certain retailers in which the retailer is
allowed to use a specified percentage of its net purchases of the Company's
products for various marketing purposes. The purpose of these agreements is to
encourage advertising and promotional events to promote the sale of the
Company's products. Each period the Company reduces sales by the estimated
amounts to be deducted by the retailers on future payments. These accruals are
offset against accounts receivable.
Product Returns
- ---------------
The Company has a limited 90-day to one year time period for product returns
from end-users. However, its retailers generally have return policies that allow
their customers to return products within only 14 to 30 days after purchase. The
Company allows its retailers to return damaged or defective products to it
following a customary return merchandise authorization process. The Company has
no informal return policies. The Company utilizes actual historical return rates
to determine its allowance for returns in each period. Gross sales are reduced
by estimated returns and cost of sales is reduced by the estimated cost of those
sales. The Company records a corresponding allowance for the estimated liability
associated with the estimated returns. This estimated liability is based on the
gross margin of the products corresponding to the estimated returns. This
allowance is offset each period by actual product returns.
F-11
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
As noted above, the Company's return rate is based upon its past history of
actual returns and the Company estimates amounts for product returns for a given
period by applying this historical return rate and reducing actual gross sales
for that period by a corresponding amount. The Company's historical return rate
for a particular product is its trailing 18-month return rate of similar
products. The Company believes that using a trailing 18-month return rate takes
two key factors into consideration, specifically, an 18-month return rate
provides the Company with a sufficient period of time to establish recent
historical trends in product returns for each product category, and provides the
Company with a period of time that is short enough to account for recent
technological shifts in its product offerings in each product category. If an
unusual circumstance exists, such as a product category that has begun to show
materially different actual return rates as compared to the Company's trailing
18-month return rates, the Company will make appropriate adjustments to its
estimated return rates. Factors that could cause materially different actual
return rates as compared to the Company's trailing 18-month return rates include
product modifications that simplify installation, or a new product line within a
product category that needs time to better reflect its return performance and
other factors. This allowance is offset against accounts receivable.
Inventory
- ---------
The Company's inventories are stated at the lower-of-cost-or-market price. The
Company provides for a lower-of-cost-or-market adjustment against gross
inventory values. The Company's lower-of-cost-or-market adjustments to its
consigned inventories were approximately $1.4 million and $264,000 for the years
ended December 31, 2007 and 2006, respectively, which is included in cost of
sales. The December 31, 2007 adjustment is a result of inventory in the
Company's consignment sales channels that was returned during the fourth quarter
of 2007 and the first quarter of 2008 and required adjustment due to the
declining value of magnetic data storage products.
Inventory Obsolescence Allowance
- --------------------------------
The Company's warehouse supervisor, production supervisor and purchasing manager
physically review the Company's warehouse inventory for slow moving and obsolete
products. All products of a material amount are reviewed quarterly and all
products of an immaterial amount are reviewed annually. The Company considers
products that have not been sold within six months to be slow moving. Products
that are no longer compatible with current hardware or software are considered
obsolete. The potential for sale of slow moving and obsolete inventories is
considered through market research, analysis of the Company's retailers' current
needs, and assumptions about future demand and market conditions. The recorded
cost of both slow-moving and obsolete inventories is then reduced to its
estimated market value based on current market pricing for similar products. The
Company utilizes the Internet to provide indications of market value from
competitors' pricing, third party inventory liquidators and auction websites.
The recorded costs of the Company's slow moving and obsolete products are
reduced to current market prices when the recorded costs exceed such market
prices. All adjustments establish a new cost basis for inventory as the Company
believes such reductions are permanent declines in the market price of its
products. Generally, obsolete inventory is sold to companies that specialize in
the liquidation of such items while the Company continues to market slow-moving
inventories until they are sold or become obsolete. As obsolete or slow moving
inventory is sold, the Company reduces the reserve by the sales proceeds.
The Company's warehouse supervisor, production supervisor and purchasing manager
physically review the Company's warehouse inventory for damaged
inventory-related items on a monthly basis. Inventory-related items (such as
sleeves, manuals or broken products no longer under warranty from the Company's
subcontract manufacturers and suppliers) that are considered obsolete or damaged
are reviewed by these personnel together with the Company's Controller or Chief
Financial Officer. At the discretion of the Company's Controller or Chief
Financial Officer, these items are physically disposed of and the Company makes
corresponding accounting adjustments resulting in inventory adjustments. In
addition, on a monthly basis, the Company's detail inventory report and its
general ledger are reconciled by the Company's Controller and any variances
result in a corresponding inventory adjustment.
F-12
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
The Company's consignment inventory is reviewed by its Controller or its Chief
Financial Officer to ensure that recorded costs are not impacted by current
market prices for similar products. If it is determined that recorded costs
exceed current costs or market values, the recorded costs are reduced to current
market prices to establish a new cost basis.
Equipment
- ---------
Equipment is recorded at cost, less accumulated depreciation and amortization.
Depreciation and amortization are calculated using the straight-line method over
estimated useful lives as follows:
Computer equipment and software 5 years
Warehouse equipment 7 years
Office furniture and equipment 5 to 7 years
Equipment under capital leases 5 years
Vehicles 5 years
Leasehold improvements Estimated useful life or lease
term, whichever is shorter
Expenditures for major renewals and betterments that extend the useful lives of
equipment are capitalized. Expenditures for maintenance and repairs are charged
to expense as incurred. Depreciation expense on assets acquired under capital
leases is included with depreciation expense.
Intangible Assets
- -----------------
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS, the Company evaluates the remaining useful
life of an intangible asset that is being amortized each reporting period to
determine whether events and circumstances warrant a revision to the remaining
period of amortization. Trademarks are being amortized over an estimated useful
life of ten years.
Accounting for the Impairment of Long-Lived Assets
- --------------------------------------------------
The Company has adopted SFAS No. 144 which requires impairment losses to be
recorded on long-lived assets, including intangible assets, used in operations
when indicators of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are less than the assets' carrying
amount.
Accrued Mail-in-Rebates
- -----------------------
The Company periodically offers mail-in rebates to end-user customers as sales
incentives. During the period of the mail-in rebates, the Company reduces sales
by the estimated amount of the mail-in rebate with a corresponding accrual for
the estimated liability. Estimates for mail-in rebate promotions are based on a
number of variable factors that depend on the specific program or product. These
variables include the length of the mail-in rebate promotion, the estimated
sales during the promotion and the anticipated redemption rate of the program
based on historical experience.
F-13
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition
- -------------------
The Company recognizes revenue in accordance with Staff Accounting Bulletin
("SAB") No. 104, REVENUE RECOGNITION, CORRECTED COPY. Under SAB No. 104, revenue
is recognized when persuasive evidence of an arrangement exists, delivery has
occurred or services have been rendered, the seller's price to the buyer is
fixed or determinable, and collectibility is reasonably assured. Revenue is
recognized net of sales tax. The Company applies the specific provisions of SFAS
No. 48, REVENUE RECOGNITION WHEN RIGHT OF RETURN EXISTS. Under SFAS No. 48,
product revenue is recorded at the transfer of title to the products to a
retailer, net of estimated allowances and returns and sales incentives. Transfer
of title occurs and risk of ownership passes to a retailer at the time of
shipment or delivery, depending on the terms of the Company's agreement with a
particular retailer. For transactions not satisfying the conditions for revenue
recognition under SFAS No. 48, product revenue is deferred until the conditions
are met, net of an estimate for cost of sales. Consignment sales are recognized
when the Company's retailers sell its products to retail customers, at which
point the retailers incur an obligation to pay the Company.
In accordance with Emerging Issues Task Force Issue No. 01-9, ACCOUNTING FOR
CONSIDERATION GIVEN BY A VENDOR TO A CUSTOMER INCLUDING A RESELLER OF THE
VENDOR'S PRODUCTS, because the Company did not receive an identifiable benefit,
the Company reduces its product revenue for marketing promotions, market
development funds and cooperative advertising costs.
The Company recognizes revenue under three primary sales models: standard terms,
consignment sales and special terms. The Company generally uses one of these
three primary sales models, or some combination of these sales models, with each
of its retailers. Under each of these sales models the Company's payment terms
are explicitly stated and agreed to by the Company and the retailer before goods
are shipped, thereby making the Company's fee fixed or determinable before
revenue is recognized.
STANDARD TERMS
Under the Company's standard terms sales model, a retailer is obligated to pay
the Company for products sold to it within a specified number of days from the
date that title to the products is transferred to the retailer. The Company's
standard terms are typically net 60 days from the transfer of title to the
products to a retailer. The Company typically collects payment from a retailer
within 60 to 75 days from the transfer of title to the products to a retailer.
Transfer of title occurs and risk of ownership passes to a retailer at the time
of shipment or delivery, depending on the terms of the Company's agreement with
a particular retailer. The sale price of the Company's products is substantially
fixed or determinable at the date of sale based on purchase orders generated by
a retailer and accepted by the Company. A retailer's obligation to pay the
Company for products sold to it under the Company's standard terms sales model
is not contingent upon the resale of those products. The Company recognizes
revenue for standard terms sales at the time title to products is transferred to
a retailer, net of an estimate for sales incentives, rebates and returns.
CONSIGNMENT
Under the Company's consignment sales model, a retailer is obligated to pay the
Company for products sold to it within a specified number of days following
notification to the Company by the retailer of the sale of those products
through delivery of weekly or monthly sell-through reports. A weekly or monthly
sell-through report details sales of consigned products in the prior week or
month, respectively. The period for payment to the Company by retailers relating
to their sale of consigned products corresponding to these sell-through reports
varies from retailer to retailer. For sell-through reports generated weekly, the
Company typically collects payment from a retailer within 30 days of the receipt
of those reports. For sell-through reports generated monthly, the Company
typically collects payment from a retailer within 15 days of the receipt of
F-14
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
those reports. At the time of a retailer's sale of a product, title is
transferred directly to the consumer. Risk of theft or damage of a product,
however, passes to a retailer upon delivery of that product to the retailer. The
sale price of the Company's products is substantially fixed or determinable at
the date of sale based on a product sell-through report generated by a retailer
and delivered to the Company. Except in the case of theft or damage, a
retailer's obligation to pay the Company for products transferred under the
Company's consignment sales model is entirely contingent upon the sale of those
products. Products held by a retailer under the Company's consignment sales
model are recorded as the Company's inventory at offsite locations until their
sale by the retailer. Because the Company retains title to products in its
consignment sales channels until their sale by a retailer, revenue is not
recognized until the time of sale. Accordingly, price modifications to inventory
maintained in the Company's consignment sales channels do not have an effect on
the timing of revenue recognition. The Company recognizes revenue for
consignment sales in the period during which the sale occurs.
SPECIAL TERMS
Under the Company's special terms sales model, the payment terms for the
purchase of the Company's products are negotiated on a case-by-case basis and
typically cover a specified quantity of a particular product. The result of the
Company's negotiations is a special agreement with a retailer that defines how
and when transfer of title occurs and risk of ownership shifts to the retailer.
The Company ordinarily does not offer any rights of return or rebates for
products sold under its special terms sales model. A retailer is obligated to
pay the Company for products sold to it within a specified number of days from
the date that title to the products is transferred to the retailer, or as
otherwise agreed to by the Company. The Company's payment terms are ordinarily
shorter under its special terms sales model than under its standard terms or
consignment sales models and the Company typically requires payment in advance,
at the time of transfer of title to the products or shortly following the
transfer of title to the products to a retailer. Transfer of title occurs and
risk of ownership passes to a retailer at the time of shipment, delivery,
receipt of payment or the date of invoice, depending on the terms of the
Company's agreement with the retailer. The sale price of the Company's products
is substantially fixed or determinable at the date of sale based on the
Company's agreement with a retailer. A retailer's obligation to pay the Company
for products sold to it under the Company's special terms sales model is not
contingent on the sale of those products. The Company recognizes revenue for
special terms sales at the time title to products is transferred to a retailer.
Product Warranties
- ------------------
The Company's products are subject to limited warranties ranging in duration of
up to one year. These warranties cover only repair or replacement of the
product. The Company's subcontract manufacturers and suppliers provide the
Company with warranties of a duration at least as long as the warranties
provided by the Company to consumers. The warranties provided by the Company's
subcontract manufacturers and suppliers cover repair or replacement of the
product. The Company has a specific right of offset against its subcontract
manufacturers and suppliers for defective products, therefore the amount of the
Company's warranty claims is not material. The Company incurs only minimal
shipping costs to its suppliers in connection with the satisfaction of its
warranty obligations.
Advertising Costs
- -----------------
The Company expenses advertising costs as incurred. There were no advertising
costs for the years ended December 31, 2007 and 2006.
F-15
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Shipping and Handling Costs
- ---------------------------
Shipping and handling costs incurred in a sales transaction to ship products to
a customer are included in selling, marketing and advertising expenses. For the
years ended December 31, 2007 and 2006, shipping and handling costs were
approximately $654,560 and $1,200,032, respectively. Amounts billed to customers
for shipping and handling are included in revenues. For the years ended December
31, 2007 and 2006, there were no shipping and handling costs billed to
customers.
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, for periods beginning in fiscal 2006. In March 2005,
the Securities and Exchange Commission issued 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 adopted SFAS No. 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006. The Company's restated consolidated financial statements as of and for
the year ended December 31, 2006 reflect the impact of SFAS No. 123(R). In
accordance with the modified prospective transition method, the Company's
consolidated financial statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS No. 123(R). Share-based
compensation expense recognized under SFAS No. 123(R) for employees and
directors for the years ended December 31, 2007 and 2006, was $66,916 and
$149,048, respectively, and is included in general and administrative expense.
For the years ended December 31, 2007 and 2006, cash flows from operations and
cash flows from financing activities were not affected by the adoption of SFAS
No. 123(R).
The Company's determination of fair value of share-based payment awards to
employees and directors on the date of grant using the Black-Scholes model,
which is affected by the Company's stock price as well as assumptions regarding
a number of highly complex and subjective variables. These variables include,
but are not limited to the Company's expected stock price volatility over the
expected term of the awards, and actual and projected employee stock option
exercise behaviors. Prior to 2006, when valuing awards, the Company used the
awards' contractual term as a proxy for the expected life of the award and
historical volatility to approximate expected volatility. During 2006 and for
the year ended December 31, 2007, the Company used the simplified-method under
SAB No. 107 to determine an award's expected term and the Company's historical
volatility to approximate expected volatility.
The Company has elected to adopt the detailed method provided in SFAS No. 123(R)
for calculating the beginning balance of the additional paid-in capital pool
("APIC pool") related to the tax effects of employee share-based compensation,
and to determine the subsequent impact on the APIC pool and consolidated
statements of cash flows of the tax effects of employee share-based compensation
awards that are outstanding upon adoption of SFAS No. 123(R).
The Company expenses share-based compensation in cost of goods sold, selling,
marketing and advertising or general and administrative expenses depending on
the job function of the employee.
F-16
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Comprehensive Income
- --------------------
The Company applies SFAS No. 130, REPORTING COMPREHENSIVE INCOME. This statement
establishes standards for reporting comprehensive income and its components in a
financial statement. Comprehensive income as defined includes all changes in
equity (net assets) during a period from non-owner sources. Examples of items to
be included in comprehensive income, which are excluded from net income, include
foreign currency translation adjustments and unrealized gains and losses on
available-for-sale securities.
Foreign Currency
- ----------------
Gains and losses from foreign currency transactions, such as those resulting
from the settlement of foreign receivables, are included in the consolidated
statement of operations.
Income Taxes
- ------------
Deferred income taxes are recognized for the tax consequences in future years of
differences between the tax basis of assets and liabilities and their financial
reporting amounts at each period end, based on enacted tax laws and statutory
tax rates applicable to the periods in which the differences are expected to
affect taxable income. Valuation allowances are established, when necessary, to
reduce deferred tax assets to the amount expected to be realized. The provision
for income taxes represents the tax payable for the period, if any, and the
change during the period in deferred tax assets and liabilities.
Loss Per Share
- --------------
The Company calculates loss per share in accordance with SFAS No. 128, EARNINGS
PER SHARE. Basic loss per share is computed by dividing the net loss available
to common stockholders by the weighted-average number of common shares
outstanding. Diluted loss per share is computed similar to basic loss per share,
except that the denominator is increased to include the number of additional
common shares that would have been outstanding if the potential common shares
had been issued and if the additional common shares were dilutive.
For the years ended December 31, 2007 and 2006, a total of 353,775 and 504,850,
stock options and warrants outstanding, respectively, were excluded from the
computations of diluted net loss per share because the effect would have been
anti-dilutive.
Recently Issued Accounting Pronouncements
- -----------------------------------------
In December 2007, the Financial Accounting Standards Board ("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.
F-17
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
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 not yet determined the impact on its consolidated financial
statements of adopting SFAS No. 160.
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 expects to adopt SFAS No. 159 in the first
quarter of fiscal 2008. The Company does not expect SFAS No. 159 to have a
material effect on its financial position, results of operations or cash flows.
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 is currently evaluating the
impact SFAS No. 157 may have on its financial position, results of operations or
cash flows.
NOTE 4 - CONCENTRATION OF RISK
Cash and Cash Equivalents
- -------------------------
The Company maintains its cash and cash equivalent balances in several banks and
a financial institution located in Southern California that from time to time
exceed amounts insured by the Federal Deposit Insurance Corporation up to
$100,000 per bank and by the Securities Investor Protection Corporation up to
$500,000 per financial institution. As of December 31, 2007 and 2006, balances
totaling $1,817,241 and $2,527,819, respectively, were uninsured. The Company
has not experienced any losses in such accounts and believes it is not exposed
to any significant credit risk on cash.
Accounts Receivable
- -------------------
As of December 31, 2007, the Company had three retailers that represented 54.8%
of accounts receivable. The amounts due the three retailers were 28.7%, 13.6%
and 12.5% of gross accounts receivable, respectively.
As of December 31, 2006, the company had three retailers that represented 71.7%
of accounts receivable. The amounts due from the three retailers were 32.2%,
24.0% and 15.5% of gross accounts receivable, respectively.
Retailers
- ---------
For the year ended December 31, 2007, the Company's most significant retailers
were Staples, OfficeMax, Costco, Office Depot and Target. Collectively, these
five retailers accounted for 74.9% of the Company's net sales. For the year
ended December 31, 2006, the Company's most significant retailers were Staples,
Best Buy Canada, Circuit City, Office Depot and Costco. Collectively, these five
retailers accounted for 78.7% of the Company's net sales.
F-18
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Related Parties
- ---------------
For the year ended December 31, 2007, the Company purchased inventory from two
related parties, Lung Hwa Electronics Co. Ltd. ("Lung Hwa") and BTC USA, an
affiliate of Behavior Tech Computer Corp. ("BTC"), both of whom are stockholders
of the Company and deemed related parties, in amounts totaling $3.8 million and
$8.4 million, respectively, which represented 15% and 34%, respectively, of
total inventory purchases during the year. As of December 31, 2007 and 2006,
there were $7.4 million and $7.9 million, respectively, in trade payables
outstanding to these related parties.
For the year ended December 31, 2006, the Company purchased inventory from two
related parties, Lung Hwa and BTC, in amounts totaling $22.2 million and $1.2
million, respectively, which represented 61% and 3%, respectively, of total
inventory purchases during the year. As of December 31, 2006, there were $7.6
million and $334,000, respectively, in trade payables outstanding to these
related parties.
Segment and Foreign Operations
- ------------------------------
The Company operates in one segment: consumer electronics. The Company sells its
products in the United States and Canada, together known as the North American
retail marketplace.
For the years ended December 31, 2007 and 2006, the Company had net sales to
Canadian retailers that represented 1% and 16%, respectively, of total net
sales. As December 31, 2007 and 2006, the Company's Canadian retailers
represented 4% and 32%, respectively, of gross accounts receivable.
NOTE 5 - ACCOUNTS RECEIVABLE
Accounts receivable as of December 31, 2007 and 2006, consisted of the
following:
DECEMBER 31, DECEMBER 31,
2007 2006
----------- -----------
(RESTATED)(1) (RESTATED)(1)
Accounts receivable $ 8,246,733 $14,363,142
Less: Allowance for doubtful accounts (146,128) (35,000)
Allowance for product returns (400,268) (466,407)
Reserve for sales incentives (40,988) (295,981)
Accrued point-of-sale rebates (260,529) (1,381,087)
Accrued market development funds, cooperative
advertising costs and cross dock fees (456,964) (649,980)
----------- -----------
TOTAL $ 6,941,856 $11,534,687
=========== ===========
__________
(1) See Note 2 - Restatement of 2006 and 2007 Financial Statements.
F-19
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - INVENTORY
Inventory as of December 31, 2007 and 2006, consisted of the following:
DECEMBER 31, DECEMBER 31,
2007 2006
------------ ------------
(RESTATED)(1) (RESTATED)(1)
Component parts $ 270,083 $ 870,484
Finished goods--warehouse 3,408,544 3,164,825
Finished goods--consigned 2,254,219 6,897,607
------------ ------------
5,932,846 10,932,916
Less: Allowance for obsolete and slow-moving inventory (440,000) (526,000)
------------ ------------
TOTAL $ 5,492,846 $ 10,406,916
============ ============
_________
(1) See Note 2 - Restatement of 2006 and 2007 Financial Statements.
Consigned inventory is located at the stores and distribution centers of certain
retailers with which the Company has consignment agreements. The inventory is
owned by the Company until sold by the retailers.
The Company realized lower-of-cost-or-market adjustments to its consigned
inventories of approximately $1.4 million and $264,000 which are included in
cost of sales for the years ended December 31, 2007 and 2006, respectively. The
December 31, 2007 adjustment is a result of inventory in the Company's
consignment sales channels that was returned during the fourth quarter of 2007
and the first quarter of 2008 and required adjustment due to the declining value
of magnetic data storage products.
NOTE 7 - EQUIPMENT
Equipment as of December 31, 2007 and 2006, consisted of the following:
DECEMBER 31, DECEMBER 31,
2007 2006
----------- -----------
(RESTATED)(1) (RESTATED)(1)
Computer equipment and software $ 975,523 $ 966,170
Warehouse equipment 138,065 69,012
Office furniture and equipment 281,155 236,007
Vehicles 74,742 74,742
Leasehold improvements 106,633 106,633
----------- -----------
1,576,118 1,452,564
Less: Accumulated depreciation (1,328,567) (1,258,447)
----------- -----------
TOTAL $ 247,551 $ 194,117
=========== ===========
____________
(1) See Note 2 - Restatement of 2006 and 2007 Financial Statements.
For the years ended December 31, 2007 and 2006, depreciation and amortization
expense (including capital leases) was $70,120 and $96,855, respectively.
Included in equipment are the following capitalized leases:
F-20
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, DECEMBER 31,
2007 2006
----------- -----------
(RESTATED)(1) (RESTATED)(1)
Computer equipment and software $ 38,281 $ --
Warehouse equipment 69,052 --
Office furniture and equipment 40,148 --
147,481 --
Less: Accumulated depreciation (20,443) --
----------- -----------
TOTAL $ 127,037 $ --
=========== ===========
____________
(1) See Note 2 - Restatement of 2006 and 2007 Financial Statements.
NOTE 8 - TRADEMARKS
Trademarks as of December 31, 2007 and 2006, consisted of the following:
DECEMBER 31, DECEMBER 31,
2007 2006
----------- -----------
(RESTATED)(1) (RESTATED)(1)
Trademarks $ 499,800 $ 499,800
Less: Amortization (206,784) (137,856)
----------- -----------
TOTAL $ 293,016 $ 361,944
=========== ===========
___________
(1) See Note 2 - Restatement of 2006 and 2007 Financial Statements.
Amortization expense on these intangible assets was $68,928 for each of the
years ended December 31, 2007 and 2006. Amortization expense related to these
intangible assets at December 31, 2007 in each of the next five fiscal years is
as follows:
2008 $ 68,928
2009 68,928
2010 68,928
2011 68,928
2012 17,304
----------
TOTAL $ 293,016
==========
NOTE 9 - LINES OF CREDIT
On January 27, 2007, the Company entered into a Loan and Security Agreement with
Silicon Valley Bank which provides for a revolving line of credit. The line of
credit allowed the Company to borrow up to a maximum amount equal to the lesser
of (i) $10.0 million, or (ii) an amount equal to 60% of eligible accounts, plus
the lesser of (a) 25% of the value of eligible inventory, (b) $3 million, or (c)
33% of eligible accounts. The line of credit allowed for a sublimit of $2.5
million for all (x) outstanding letters of credit, (y) foreign exchange
contracts to purchase from or sell to Silicon Valley Bank a specific amount of
foreign currency, and (z) the amount of the revolving line used for cash
management services, including merchant services, direct deposit of payroll,
business credit card and check cashing services. The line of credit expires on
January 29, 2009. Advances on the line of credit bore interest at a floating
rate equal to the prime rate plus 1.0%.
F-21
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
The obligations of the Company under the Loan and Security Agreement are secured
by substantially all of the Company's assets and guaranteed by the Company's
wholly-owned subsidiary, IOM Holdings, Inc. (the "Subsidiary") pursuant to a
Cross-Corporate Continuing Guaranty by the Company and the Subsidiary. The
obligations of the Company and the guarantee obligations of the Subsidiary are
secured pursuant to an Intellectual Property Security Agreement executed by the
Company and an Intellectual Property Security Agreement executed by the
Subsidiary.
If the Company terminates the Loan and Security Agreement prior to the maturity
date, the Company will be subject to a termination fee as follows: (i) if the
termination occurs on or before the first anniversary of the effective date, the
termination fee is equal to 1.50% of the maximum line amount, and (ii) if the
termination occurs after the first anniversary of the effective date and on or
before the second anniversary of the effective date, the termination fee is
equal to 0.50% of the maximum line amount. The credit facility is subject to an
unused line fee equal to 0.25% per annum, payable monthly based on the average
daily unused amount of the line of credit, as determined by Silicon Valley Bank.
The credit facility is also subject to a commitment fee of $50,000, a monthly
collateral monitoring fee of $1,250 and an anniversary fee of $50,000. In
addition, the Company must pay to Silicon Valley Bank customary fees and
expenses for the issuance or renewal of letters of credit and all expenses
incurred by Silicon Valley Bank related to the Loan and Security Agreement.
Until the effective date of the Amendment described below, the credit facility
was subject to a financial covenant on a consolidated basis measuring the
tangible net worth of the Company for each month ending after February 28, 2007,
which was to be at least $4,750,000, plus (i) 50% of all consideration received
by the Company for sales of equity securities and issuances of subordinated
debt, plus (ii) 50% of the Company's net income, if any, for each fiscal
quarter. "Tangible net worth" is defined as the consolidated total assets of the
Company and its subsidiaries, minus (a) any amounts attributable to (1)
goodwill, (2) intangible items, and (3) notes, accounts receivable and other
obligations owing to the Company from its officers and affiliates, and reserves
not already deducted from assets, minus (b) total liabilities, plus (c)
subordinated debt.
In the event of a default and continuation of a default, Silicon Valley Bank may
accelerate the payment of the principal balance requiring the Company to pay the
entire indebtedness outstanding on that date. From and after an event of
default, the outstanding principal balance will bear interest until paid in full
at an increased rate per annum equal to 5% above the rate of interest in effect
from time to time under the credit facility. The Loan and Security Agreement
also contains other customary representations, warranties and covenants.
The Company and Silicon Valley Bank entered into an Amendment to Loan and
Security Agreement (the "Amendment") dated December 12, 2007 that amends the
Loan and Security Agreement. The Amendment includes a waiver by Silicon Valley
Bank of the Company's failure to comply with the minimum tangible net worth
financial covenant set forth in the Loan and Security Agreement. The Amendment
provides for a modified interest rate under the revolving line of credit;
specifically, amounts outstanding thereunder are to accrue interest at a per
annum rate equal to the Prime Rate plus 2.50%.
In addition, the Amendment provides for a new tangible net worth financial
covenant, specifically, the Company must have minimum tangible net worth for the
month ended February 28, 2007 and each month ending thereafter of $3,500,000,
plus (i) 50% of all consideration received after the date of the Loan and
Security Agreement for equity securities and subordinated debt, plus (ii) 50% of
the Company's net income in each fiscal quarter ending after the date of the
Loan and Security Agreement. Finally, the Amendment provides that the Company
may borrow up to a maximum amount under the line of credit equal to the lesser
of (a) $7.0 million, or (b) an amount equal to 60% of eligible accounts plus the
lesser of (1) 20% of the value of eligible inventory, (2) $750,000 (provided
that on and after March 30, 2008, such amount will be $0.00), and (3) 33% of
eligible accounts. The Company was required to pay a fee of $20,000 to Silicon
Valley Bank to cause the Amendment to become effective. The Amendment also
contains other customary representations, warranties and covenants.
F-22
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
The outstanding balance with Silicon Valley Bank as of December 31, 2007 was
$3,864,942. The amount available to the Company for borrowing as of December 31,
2007 was $646,000. The weighted average outstanding loan balance and the
weighted average interest rate for the Silicon Valley Bank facility during 2007
were $3,845,840 and 9.13% and the weighted average outstanding loan balances and
interest rates for the GMAC facility in 2007 and 2006 were $3,754,617 and
10.17%, and $3,432,319 and 9.16%, respectively.
On March 7, 2008, the Company received notice from Silicon Valley Bank under a
Loan and Security Agreement dated February 2, 2007 between the Company, IOM
Holdings, Inc. and Silicon Valley Bank that the Company was in default of its
tangible net worth financial covenant. As of that date, the Company owed Silicon
Valley Bank $1,598,461, all of which was due and payable upon demand by Silicon
Valley Bank. The Company was also unable to obtain advances under its line of
credit. The Company sought a waiver of the default of its tangible net worth
financial covenant and received a Forbearance Agreement from Silicon Valley Bank
in that regard.
On April 18, 2008, the Company entered into a Loan and Security Agreement dated
as of April 18, 2008 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 restated a previous Loan and Security Agreement
dated January 29, 2007 among the parties. The 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 was only permitted to borrow
up to a limit of 60% of each eligible account or such other percentage as
Silicon Valley Bank established. The line of credit was to expire on January 29,
2009. Advances on the line of credit 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. On July 31, 2008, the
Company paid off its obligations owed to Silicon Valley Bank under the Loan and
Security Agreement dated April 18, 2008 and terminated the Loan and Security
Agreement.
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. The credit facility allows the
Company to sell accounts receivable to Rexford Funding subject to a maximum
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. The Sale of
Accounts and Security Agreement has an initial term through April 30, 2009 with
automatic six month extensions unless either party terminates the Sale of
Accounts and Security 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
has the right to terminate the Sale of Accounts and Security Agreement upon 30
days prior notice.
F-23
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses as of December 31, 2007 and 2006,
consisted of the following:
2007 2006
----------- -----------
(RESTATED)(1) (RESTATED)(1)
Trade accounts payable $ 885,867 $ 4,357,535
Accrued compensation and related benefits 116,764 99,580
Other 150,557 693,628
----------- -----------
TOTAL $ 1,153,188 $ 5,150,743
=========== ===========
___________
(1) See Note 2 - Restatement of 2006 and 2007 Financial Statements.
NOTE 11 - ACCOUNTS PAYABLE--RELATED PARTIES
On June 6, 2005, the Company entered into a trade credit facility with a related
party, whereby the related party, Lung Hwa, on of the Company's significant
stockholders, agreed to purchase and manufacture inventory on behalf of the
Company. The Company can purchase up to $15.0 million of inventory either (i)
through the related party as an international purchasing office, or (ii)
manufactured by the related party. For inventory purchased through the related
party, the terms are 120 days following the date of invoice by the related party
and the related party charges the Company a 5% handling fee on a supplier's unit
price. A 2% discount of the handling fee is applied if the Company reaches an
average running monthly purchasing volume of $750,000. Returns made by the
Company, which are agreed to by this supplier, result in a credit to the Company
for the handling charge. For inventory manufactured by the related party, the
payment terms are 90 days following the date of the invoice by the related
party. The Company is to pay the related party 10% of the purchase price on any
purchase orders issued to the related party, as a down-payment for the order,
within one week of the purchase order. The Agreement has an initial term of one
year after which the Agreement will continue indefinitely if not terminated at
the end of the initial term. At the end of the initial term and at any time
thereafter, either party has the right to terminate the facility upon 30 days'
prior written notice to the other party. The agreement containing the terms of
the new trade credit facility was amended and restated on July 21, 2005 to
provide that the new facility would be retroactive to April 29, 2005. For the
years ended December 31, 2007 and 2006, the Company purchased $3.8 million and
$22.2 million, respectively, of inventory under this arrangement. As of December
31, 2007 and 2006, there were $665,000 and $7.6 million, respectively, in trade
payables outstanding under this arrangement. As of December 31, 2007, the
Company was out of compliance with the payment terms of the agreement and
proposed a repayment schedule to Lung Hwa to retire the balance due at December
31, 2007 by January 31, 2008. The Company met the repayment schedule. As of
March 26, 2009 no amounts were outstanding under this agreement.
In February 2003, the Company entered into an agreement with a related party,
whereby the related party, BTC, one of the Company's significant stockholders,
and its affiliated companies, agreed to supply and store at the Company's
warehouse up to $10.0 million of inventory on a consignment basis. Mr. Steel Su,
a director of I/OMagic, is the Chief Executive Officer of Behavior Tech Computer
Corp. Under the agreement, the Company is to insure the consignment inventory,
store the consignment inventory for no charge, and furnish the related party
with weekly statements indicating all products received and sold and the current
consignment inventory level. The agreement may be terminated by either party
with 60 days written notice. In addition, this agreement provides for a trade
line of credit of up to $10.0 million with payment terms of net 60 days,
non-interest bearing. During the years ended December 31, 2007 and 2006, the
Company purchased $8.4 million and $7.4 million of inventory, respectively,
under this arrangement. As of December 31, 2007 and 2006, there were $6.7
million and $7.6 million, respectively, in trade payables outstanding under this
arrangement. As of March 26, 2009, there were a total of $6.4 million in trade
payables outstanding under this agreement and the Company was in violation of
the payment terms under the agreement but is in negotiation with BTC to satisfy
the obligations on a basis that is acceptable to both parties.
F-24
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
- ---------------------------
The Company leases its facilities and certain equipment under non-cancelable
operating lease agreements expiring through August 2009. 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
shall increase at the rate of three percent per annum.
Future minimum lease payments under this non-cancelable operating lease
obligations at December 31, 2007, were as follows:
YEAR ENDING
DECEMBER 31,
------------
2008 $ 417,633
2009 305,492
2010 11,993
---------
TOTAL $ 735,118
=========
Rent expense was $359,240 and $334,816 for the years ended December 31, 2007 and
2006, respectively, and is included in general and administrative expenses in
the accompanying consolidated statements of operations.
Capital Lease Obligations
- -------------------------
The Company entered into various lease agreements during 2007 to acquire certain
equipment. Future payments under these capital lease obligations at December 31,
2007 were as follows:
YEAR ENDING
DECEMBER 31,
------------
2008 $ 417,633
2009 305,492
2010 11,993
---------
TOTAL $ 735,118
=========
YEAR ENDING
DECEMBER 31,
------------
2008 $ 47,593
2009 53,892
2010 11,993
---------
TOTAL $ 113,478
=========
Financial Agreements
- --------------------
The Company entered into a Loan and Security Agreement in January 2007 which
provides for a loan commitment fee of $50,000, a monthly collateral monitoring
fee of $1,250 and an anniversary fee of $50,000. In addition, the Company must
pay customary fees and expenses for the issuance or renewal of letters of credit
and all expenses incurred by the lender related to the Loan and Security
Agreement.
F-25
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
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, and may be payable in
shares of the Company's common stock. During the years ended December 31, 2007
and 2006, the Company incurred expenses of $414,349 and $672,575, respectively,
in connection with such arrangements. These expenses are included in general and
administrative expenses in the accompanying consolidated statements of
operations.
Employment Contract
- -------------------
The Company entered into an employment agreement with one of its officers on
October 15, 2002, the initial term of which expired on October 15, 2007. The
contract automatically renewed for one year and will continue to renew for
successive one year periods unless expressly terminated by either party. The
agreement, which was effective as of January 1, 2002, calls for an initial
salary of $198,500, and provides for certain expense allowances. In addition,
the agreement provides for a quarterly bonus equal to 7% of the Company's
quarterly net income. For the years December 31, 2007 and 2006, bonuses totaling
$0 and $39,103, respectively, were paid under the terms of this agreement. As of
December 31, 2007 and 2006, accrued bonuses under this agreement were $0 and
$12,200, respectively.
Employee Retirement Plan
- ------------------------
The Company offers all eligible employees a 401K retirement plan. The Company is
not required to make annual contributions and has not done so in the past.
Retail Agreements
- -----------------
In connection with certain retail agreements, the Company has agreed to pay for
certain marketing development and advertising costs 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 market
development/cooperative advertising funds based on management's evaluation of
historical experience and current industry and Company trends.
For the years ended December 31, 2007 and 2006, the Company incurred $437,553
and $800,684, respectively, related to its retail agreements with its retailers.
These amounts are netted against revenue in the accompanying consolidated
statements of operations.
The Company has obligations to two of its retailers to provide "back-end" market
development funds if the retailer exceeds certain purchase thresholds. The
Company reviews these two commitments on a quarterly basis to determine the
probability of the retailers exceeding the thresholds. If in management's
opinion, the thresholds will be exceeded, additional accruals will be required
to account for these "back-end" fees. As of December 31, 2007 and 2006, no such
fees were incurred or accrued.
Indemnification Obligations
- ---------------------------
A number of the Company's agreements with its retailers provide that the Company
must defend, indemnify and hold them and their customers, harmless from damages
and costs that arise from product warranty claims or from claims for injury or
damage resulting from defects in the Company's products. The Company has
historically not had any material liabilities arising from these obligations.
F-26
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Litigation
- ----------
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
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 is to pay defendants' costs on appeal. The Company did not further
appeal the decision.
On May 20, 2005, the Company filed a complaint for breach of contract, breach of
implied covenant of good faith and fair dealing, and common counts against
OfficeMax North America, Inc., or defendant, in the Superior Court of the State
of California for the County of Orange, Case No. 05CC06433. The complaint sought
damages of in excess of $22 million arising out of the defendants' alleged
breach of contract under an agreement entered into in May 2001. On or about June
20, 2005, OfficeMax removed the case to the United States District Court for the
Central District of California, Case No. SA CV05-0592 DOC(MLGx). On August 1,
2005, OfficeMax filed its Answer and Counter-Claim against the Company. The
Counter-Claim alleged four causes of action against the Company: breach of
contract, unjust enrichment, quantum valebant, and an action for declaratory
relief. The Counter-Claim alleged, among other things, that the Company was
liable to OfficeMax in the amount of no less than $138,000 under the terms of a
vendor agreement executed between the Company and OfficeMax in connection with
the return of computer peripheral products to the Company for which OfficeMax
alleged it was never reimbursed. The Counter-Claim sought, among other things,
at least $138,000 from the Company, along with pre-judgment interest, attorneys'
fees and costs of suit. The Company filed a response denying all of the
affirmative claims set forth in the Counter-Claim, denying any wrongdoing or
liability, and denying that OfficeMax was entitled to obtain any relief. In
April 2006, the case against OfficeMax North America, Inc. was settled in its
entirety. In settling the matter, each party denied liability and wrongdoing and
the settlement was entered into solely for the purpose of compromising and
settling the litigation and in order to avoid the risk, cost, and burden of
litigation and participation therein. Pursuant to the settlement, OfficeMax paid
the Company $2,375,000 during the second quarter of 2006, which is included in
other income.
F-27
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
In addition, the Company is involved in certain legal proceedings and claims
which arise in the normal course of business. Management does not believe that
the outcome of these matters will have a material affect on the Company's
financial position or results of operations.
NOTE 13 - REDEEMABLE CONVERTIBLE PREFERRED
During December 2000, the Company amended its Articles of Incorporation to
authorize 10,000,000 shares of preferred stock, of which 1,000,000 shares are
designated as Series A preferred stock and 1,000,000 shares are designated as
Series B preferred stock. Series A preferred stockholders do not have voting
powers and are entitled to receive dividends on an equal basis with the holders
of the Company's common stock. Series B preferred stockholders have the same
rights as Series A preferred stockholders, except the Company is obligated to
redeem any issued shares that have been outstanding for two years. At December
31, 2007 and 2006, no shares of Series A or Series B preferred stock were
outstanding.
NOTE 14 - COMMON STOCK, WARRANTS AND STOCK OPTIONS
Common Stock Issued in Connection with the Exercise of Options
- --------------------------------------------------------------
During the year ended December 31, 2007 the Company did not issue any shares of
common stock in connection with the exercise of any employee stock options. For
the year ended December 31, 2006, the Company issued an aggregate of 22,213
shares of common stock in connection with the exercise of 6,900 employee stock
options issued in March 2004 for cash of $24,150 or at an exercise price of
$3.50 per share and with the exercise of 15,313 employee stock options issued in
July 2005 for cash of $38,282 or at an exercise price of $2.50 per share.
Treasury Stock
- --------------
On February 12, 2002, the Company announced the approval by the Board of
Directors of the Company to redeem its own stock in open market transactions of
up to $500,000. During the year ended December 31, 2002, the Company purchased
4,226 shares of common stock for $42,330 on the open market. During the year
ended December 31, 2003, the Company purchased 9,267 shares of common stock for
$83,684 on the open market. The Company cancelled those shares in 2006.
Warrants
- --------
During the year ended December 31, 2005, the Company issued warrants to purchase
150,000 shares of common stock to a financial advisory firm, 50,000 of which
were exercisable at $3.00 per share, 50,000 of which were exercisable at $4.00
per share and 50,000 of which were exercisable at $5.00 per share. These
warrants vested immediately. None of the warrants were exercised, and such
warrants expired in January 2007.
During the year ended December 31, 2005, the Company issued warrants to purchase
30,000 shares of common stock to a financial advisory firm, 15,000 of which were
exercisable at $8.00 per share and 15,000 of which were exercisable at $10.00
per share. These warrants vested immediately. None of the warrants were
exercised, and such warrants expired in November 2006.
F-28
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 2007, the Company issued warrants to purchase
50,000 shares of common stock to two financial advisory firms, all of which are
exercisable at $3.00 per share. These warrants vested immediately. The fair
value of these warrants issued was determined to be $46,330 using the
Black-Scholes Model assuming a 127% expected votality and a risk factor rate of
4.9%. This amount was recorded as a general and administrative expense on the
consolidated statements of operations. None of the warrants have been exercised,
and such warrants expire in October 2008. The assumptions and valuation methods
for valuing the warrants are the same as those used for the Company's stock
options outstanding.
Stock Option Plans
- ------------------
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.
Under the Plans, options granted may be either "incentive stock options," within
the meaning of Section 422 of the Internal Revenue Code, or "nonqualified
options." Incentive options granted under the Plans must have an exercise price
of not less than the fair market value of a share of common stock on the date of
grant unless the optionee owns more than 10% of the total voting securities of
the Company. In this case, the exercise price will not be less than 110% of the
fair market value of a share of common stock on the date of grant. Incentive
stock options may not be granted to an optionee under the Plans if the aggregate
fair market value, as determined on the date of grant, of the stock with respect
to which incentive stock options are exercisable by such optionee in any
calendar year under the Plans, exceeds $100,000. Nonqualified options granted
under the Plans must have an exercise price of not less than the fair market
value of a share of common stock on the date of grant. Nonqualified options
granted under the Plans must have an exercise price of not less than 85% of the
fair market value of a share of common stock on the date of grant.
Under the Plans, options may be exercised during a period of time fixed by the
committee administering the Plans (which could include the entire Board of
Directors). Options granted under the Plans must vest at a rate not less than
20% per year over a consecutive five-year period. No option granted under any of
the Plans may be exercised more than 10 years after the date of grant. Incentive
stock options granted to an optionee who owns more than 10% of the voting
securities of the Company may not be exercised more than five years after the
date of grant.
F-29
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
A summary of option and warrant activity under the Plans for the years ended
December 31, 2007 and 2006 is presented below:
Weighted-
Weighted- Average
Average Remaining Aggregate
Exercise Contractural Intrinsic
Options and Warrants Shares Price Life (Years) Value
- ------------------------------------------------ ----------- ---------- ------------ -----------
Outstanding at January 1, 2006 658,550 $ 3.38 4.2 $ 1,280,000
Granted 50,000 $ 4.00
Exercised (22,213) $ 2.81
Forfeited (182,287) $ 3.82
-----------
Outstanding at December 31, 2006 504,050 $ 3.36 2.5
===========
Exercisable at December 31, 2006 407,208 $ 3.45 2.7
===========
Vested or expected to vest at December 31, 2006 490,000
===========
Granted 50,000 $ 3.00 0.8
Exercised -
Forfeited 201,075 $ 3.65
-----------
Outstanding at December 31, 2007 353,775 $ 3.15 2.4
===========
Exercisable at December 31, 2007 300,119 $ 3.15 2.3
===========
Vested or expected to vest at December 31, 2007 348,508 $ 3.15 2.4
===========
Aggregate intrinsic value excludes those options that are not "in-the-money."
Awards that are expected to vest take into consideration estimated forfeitures
for awards not yet vested.
The weighted-average grant date fair value of awards granted under the Plans for
the years ended December 31, 2007 and 2006 was $0.93 and $1.40 per share,
respectively. Fair value was determined using the Black-Scholes model and the
following assumptions:
DECEMBER 31,
-----------------------
2007 2006
--------- ----------
Weighted-average volatility 127% 120%
Expected dividends -- --
Expected term (in years) 1.00 3.25
Risk-free rate 4.90% 4.60%
The total fair value of shares vested during the years ended December 31, 2007
and 2006 were $213,137 and $463,781, respectively.
There were no options exercised during the year ended December 31, 2007. Cash
received from options exercised in 2006 was $62,400. The intrinsic value of
options exercised in 2006 was $48,600, at the time of exercise. The Company did
not receive any tax deduction from options exercised in 2006. When options are
exercised, the Company's policy is to issue new shares to satisfy share option
exercises.
As of December 31, 2007 and 2006, there were $90,337 and $170,979, respectively,
of total unrecognized compensation costs related to non-vested share-based
compensation arrangements granted, including warrants. That cost is expected to
be recognized over the weighted-average period of 2.2 and 2.8 years,
respectively.
F-30
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
The following table is a summary of the stock options and warrants as of
December 31, 2007:
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
WEIGHTED- EXERCISE PRICE EXERCISE PRICE
STOCK OPTIONS STOCK OPTIONS AVERAGE OF OPTIONS AND OF OPTIONS AND
RANGE OF AND WARRANTS AND WARRANTS REMAINING WARRANTS WARRANTS
EXERCISE PRICES OUTSTANDING EXERCISABLE CONTRACTUAL LIFE OUTSTANDING EXERCISABLE
- --------------- ------------- ------------- ---------------- -------------- --------------
$ 2.50-4.00 353,775 300,119 2.4 years $3.15 $3.15
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
NOTE 15 - INCOME TAXES
The components of the income tax provision for the year ended December31, 2007
and 2006 were as follows:
DECEMBER 31,
-------------------
2007 2006
------ ------
Current $ 800 $ 800
Deferred -- --
------ ------
TOTAL $ 800 $ 800
====== ======
Income tax expense (benefit) for the years ended December 31, 2007 and December
31, 2006 differed from the amounts computed applying the federal statutory rate
of 34% to pre-tax income as a result of:
DECEMBER 31,
--------------------------
2007 2006
----------- -----------
Computed "expected" tax benefit $(1,600,658) $ (52,984)
Income taxes resulting from expenses not
deductible for tax purposes 10,903 8,785
Change in the valuation allowance for deferred tax
assets net of return to provision adjustment 1,862,828 52,056
State and local income taxes, net of tax benefit (272,273) (7,057)
----------- -----------
TOTAL $ 800 $ 800
=========== ===========
F-31
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
Significant components of the Company's deferred tax assets and liabilities for
federal income taxes at December 31, 2007 and December 31, 2006 consisted of the
following:
DECEMBER 31,
----------------------------
2007 2006
------------ ------------
Current deferred tax assets
Allowance for doubtful accounts $ 62,601 $ 14,994
Allowance for product returns 171,475 193,937
Allowance for sales incentives 17,559 126,798
Accrued compensation 27,847 24,514
Inventory 796,929 400,607
Other 89,848 46,117
State taxes effect of tax assets (80,885) (41,479)
Valuation allowance (1,085,374) (765,488)
------------ ------------
Net current deferred tax assets -- --
------------ ------------
Long-term deferred tax assets
Net operating loss carryforward $ 12,658,359 $ 10,772,676
Amortization of trademarks 1,871,708 2,113,318
State taxes effect of deferred tax assets (763,475) (662,346)
Valuation allowance (13,766,592) (12,223,648)
------------ ------------
-- --
------------ ------------
NET DEFERRED TAX ASSETS $ -- $ --
============ ============
SFAS No. 109, ACCOUNTING FOR INCOME TAXES, requires that a valuation allowance
be established when it is more likely than not that a company's 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 December 31, 2007 and 2006, the valuation
allowance for the Company's deferred tax assets totaled $14,851,966 and
$12,989,136, respectively. For the years ended December 31, 2007 and 2006, the
net change in the valuation allowance was $1,862,828 (increase) and $52,056
(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 December 31, 2007, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $31,967,279 and
$20,521,676, respectively, that expire through 2027 and 2017, 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.
F-32
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
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 FASB Interpretation No.
("FIN") 48, ACCOUNTING FOR UNCERTAINTY IN 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.
FIN 48 not only impacts the amount of Company's accrual for uncertain tax
positions but it also impacts the manner in which such accruals should be
classified in 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 December 31, 2007 and
2006, the Company had no accrual for the payment of interest and penalties.
NOTE 16 - RELATED PARTY TRANSACTIONS
During the years ended December 31, 2007 and 2006, the Company made purchases
from related parties totaling $12,200,833 and $23,362,905. See Note 11, Accounts
Payable Related Parties.
F-33
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - SELECTED QUARTERLY FINANCIAL DATA AND QUARTERLY RESTATEMENT
ADJUSTMENTS--UNAUDITED
Quarterly Financial Data--As Restated
- -------------------------------------
The following tables are summaries of the unaudited quarterly financial
information for the years ended December 31, 2006 and 2007 (restated).
FIRST SECOND THIRD FOURTH TOTAL
YEAR ENDED DECEMBER 31, 2006 QUARTER QUARTER QUARTER QUARTER YEAR
- ---------------------------- ----------- ----------- ----------- ----------- -----------
(RESTATED) (RESTATED) (RESTATED) (RESTATED) (RESTATED)
(IN THOUSANDS, EXCEPT SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales $ 8,994 $ 9,882 $ 11,459 $ 15,554 $ 45,889
Cost of sales 8,212 8,548 9,474 13,493 39,727
----------- ----------- ----------- ----------- -----------
Gross profit 782 1,334 1,985 2,061 6,162
Operating expenses 1,860 2,934 1,764 1,855 8,413
----------- ----------- ----------- ----------- -----------
Income (loss) from operations (1,078) (1,600) 221 206 (2,251)
Total other income (expense) (81) 2,287 (54) (102) 2,050
----------- ----------- ----------- ----------- -----------
Income (loss) before provision for income taxes (1,159) 687 167 104 (201)
Provision for income taxes -- 1 -- -- 1
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (1,159) $ 686 $ 167 $ 104 $ (202)
=========== =========== =========== =========== ===========
Net income (loss) per share, basic and diluted $ (0.26) $ 0.16 $ 0.04 $ 0.02 $ (0.04)
=========== =========== =========== =========== ===========
Weighted average shares outstanding,
basic and diluted 4,540,292 4,540,292 4,540,292 4,540,292 4,540,292
=========== =========== =========== =========== ===========
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 2,829 $ 1,363 $ 1,245 $ 1,833 $ 1,833
Working capital $ 4,935 $ 5,691 $ 5,913 $ 5,993 $ 5,993
Total assets $ 20,011 $ 18,707 $ 18,769 $ 25,338 $ 25,338
Stockholders' equity $ 5,518 $ 6,257 $ 6,458 $ 6,591 $ 6,591
FIRST SECOND THIRD FOURTH TOTAL
YEAR ENDED DECEMBER 31, 2007 QUARTER QUARTER QUARTER QUARTER YEAR
- ---------------------------- ----------- ----------- ----------- ----------- -----------
(RESTATED) (RESTATED) (RESTATED) (RESTATED) (RESTATED)
(IN THOUSANDS, EXCEPT SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales $ 7,691 $ 6,488 $ 5,772 $ 12,170 $ 32,121
Cost of sales 6,697 5,926 5,345 12,763 30,731
----------- ----------- ----------- ----------- -----------
Gross profit (loss) 994 562 427 (593) 1,390
Operating expenses 1,294 1,551 1,146 1,847 5,838
----------- ----------- ----------- ----------- -----------
Loss from operations (300) (989) (719) (2,440) (4,448)
Total other expense (116) (111) (7) (70) (304)
----------- ----------- ----------- ----------- -----------
Loss before provision for income taxes (416) (1,100) (726) (2,510) (4,752)
Provision for income taxes 1 -- -- -- 1
----------- ----------- ----------- ----------- -----------
Net loss $ (417) $ (1,100) $ (726) $ (2,510) $ (4,753)
=========== =========== =========== =========== ===========
Net loss per share, basic and diluted $ (0.09) $ (0.24) $ (0.16) $ (0.56) $ (1.05)
=========== =========== =========== =========== ===========
Weighted average shares outstanding,
basic and diluted 4,540,292 4,540,292 4,540,292 4,540,292 4,540,292
=========== =========== =========== =========== ===========
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 80 $ 816 $ 433 $ 1,463 $ 1,463
Working capital $ 5,556 $ 4,457 $ 3,755 $ 1,435 $ 1,435
Total assets $ 20,262 $ 15,985 $ 14,887 $ 14,929 $ 14,929
Stockholders' equity $ 6,193 $ 5,109 $ 4,402 $ 1,951 $ 1,951
F-34
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - SELECTED QUARTERLY FINANCIAL DATA AND QUARTERLY RESTATEMENT
ADJUSTMENTS--UNAUDITED (CONTINUED)
Quarterly Financial Data--Restatement Adjustments
- -------------------------------------------------
The Company previously accrued audit fees in the period to which the
corresponding audit applied. Upon further examination of its accounting
methodology, the Company determined that it made an error in its application of
the relevant accounting principles and determined that it should have accrued
audit fees in the period in which they were incurred.
The Company accrued sales incentives but had not established any
lower-of-cost-or-market reserve to account for reduced sales prices of certain
inventory consigned to retailers. Upon further examination, the Company
determined that it should establish a lower-of-cost-or-market reserve in the
amount of $264,000 at December 31, 2006 for certain inventory consigned to
retailers that was sold subsequent to December 31, 2006 at prices below net
realizable value.
Based on the foregoing, the Company has determined the effect of these
corrections on its previously issued financial statements and has restated the
unaudited quarterly financial information below, reconciling the restatement
adjustments on a quarterly basis, for each of the quarterly periods in the years
ended December 31, 2006 and 2007.
AS ORIGINALLY RESTATEMENT
FIRST QUARTER ENDED MARCH 31, 2006 REPORTED ADJUSTMENTS AS RESTATED
- ---------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 8,994 $ -- $ 8,994
Cost of sales $ 8,212 $ -- $ 8,212
Gross profit $ 782 $ -- $ 782
General and administrative expenses $ 1,799 $ 61 $ 1,860
Net loss $ (1,098) $ (61) $ (1,159)
LOSS PER COMMON SHARE
Basic $ (0.25) $ (0.01) $ (0.26)
Diluted $ (0.25) $ (0.01) $ (0.26)
Inventory, net $ 6,831 $ -- $ 6,831
Stockholders' equity $ 5,579 $ (61) $ 5,518
AS ORIGINALLY RESTATEMENT
SECOND QUARTER ENDED JUNE 30, 2006 REPORTED ADJUSTMENTS AS RESTATED
- ---------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 9,882 $ -- $ 9,882
Cost of sales $ 8,548 $ -- $ 8,548
Gross profit $ 1,334 $ -- $ 1,334
General and administrative expenses $ 2,910 $ 24 $ 2,934
Net income $ 710 $ (24) $ 686
INCOME PER COMMON SHARE
Basic $ 0.17 $ (0.01) $ 0.16
Diluted $ 0.17 $ (0.01) $ 0.16
Inventory, net $ 9,415 $ -- $ 9,415
Stockholders' equity $ 6,342 $ (85) $ 6,257
F-35
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - SELECTED QUARTERLY FINANCIAL DATA AND QUARTERLY RESTATEMENT
ADJUSTMENTS--UNAUDITED (CONTINUED)
AS ORIGINALLY RESTATEMENT
THIRD QUARTER ENDED SEPTEMBER 30, 2006 REPORTED ADJUSTMENTS AS RESTATED
- -------------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 11,459 $ -- $ 11,459
Cost of sales $ 9,474 $ -- $ 9,474
Gross profit $ 1,985 $ -- $ 1,985
General and administrative expenses $ 1,848 $ (85) $ 1,763
Net income $ 83 $ 85 $ 168
INCOME PER COMMON SHARE
Basic $ 0.02 $ 0.02 $ 0.04
Diluted $ 0.02 $ 0.02 $ 0.04
Inventory, net $ 8,544 $ -- $ 8,544
Stockholders' equity $ 6,459 $ (1) $ 6,458
AS ORIGINALLY RESTATEMENT
FOURTH QUARTER ENDED DECEMBER 31, 2006 REPORTED ADJUSTMENTS AS RESTATED
- -------------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 15,554 $ -- $ 15,554
Cost of sales $ 13,229 $ 264 $ 13,493
Gross profit $ 2,325 $ (264) $ 2,061
General and administrative expenses $ 2,228 $ (373) $ 1,855
Net income (loss) $ (5) $ 109 $ 104
INCOME (LOSS) PER COMMON SHARE
Basic $ (0.01) $ 0.03 $ 0.02
Diluted $ (0.01) $ 0.03 $ 0.02
Inventory, net $ 10,671 $ (264) $ 10,407
Stockholders' equity $ 6,484 $ 107 $ 6,591
AS ORIGINALLY RESTATEMENT
FIRST QUARTER ENDED MARCH 31, 2007 REPORTED ADJUSTMENTS AS RESTATED
- ---------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 7,691 $ -- $ 7,691
Cost of sales $ 6,795 $ (98) $ 6,697
Gross profit $ 896 $ 98 $ 994
General and administrative expenses $ 1,285 $ 9 $ 1,294
Net loss $ (506) $ 89 $ (417)
LOSS PER COMMON SHARE
Basic $ (0.11) $ 0.02 $ (0.09)
Diluted $ (0.11) $ 0.02 $ (0.09)
Stockholders' equity $ 5,997 $ 196 $ 6,193
F-36
<page>
I/OMAGIC CORPORATION AND SUBSIDIARY
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - SELECTED QUARTERLY FINANCIAL DATA AND QUARTERLY RESTATEMENT
ADJUSTMENTS--UNAUDITED (CONTINUED)
AS ORIGINALLY RESTATEMENT
SECOND QUARTER ENDED JUNE 30, 2007 REPORTED ADJUSTMENTS AS RESTATED
- ---------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 6,488 $ -- $ 6,488
Cost of sales $ 5,985 $ (59) $ 5,926
Gross profit $ 503 $ 59 $ 562
General and administrative expenses $ 1,232 $ 319 $ 1,551
Net loss $ (840) $ (260) $ (1,100)
LOSS PER COMMON SHARE
Basic $ (0.18) $ (0.06) $ (0.24)
Diluted $ (0.18) $ (0.06) $ (0.24)
Stockholders' equity $ 5,173 $ (64) $ 5,109
AS ORIGINALLY RESTATEMENT
THIRD QUARTER ENDED SEPTEMBER 30, 2007 REPORTED ADJUSTMENTS AS RESTATED
- -------------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 5,772 $ -- $ 5,772
Cost of sales $ 5,374 $ (29) $ 5,345
Gross profit $ 398 $ 29 $ 427
General and administrative expenses $ 1,095 $ 51 $ 1,146
Net loss $ (703) $ (22) $ (725)
LOSS PER COMMON SHARE
Basic $ (0.15) $ (0.01) $ (0.16)
Diluted $ (0.15) $ (0.01) $ (0.16)
Stockholders' equity $ 4,489 $ (87) $ 4,402
AS ORIGINALLY RESTATEMENT
FOURTH QUARTER ENDED DECEMBER 31, 2007 REPORTED ADJUSTMENTS AS RESTATED
- -------------------------------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 12,170 $ -- $ 12,170
Cost of sales $ 12,842 $ (79) $ 12,763
Gross profit $ (672) $ 79 $ (593)
General and administrative expenses $ 1,917 $ (70) $ 1,847
Net loss $ (2,659) $ 149 $ (2,510)
LOSS PER COMMON SHARE
Basic $ (0.59) $ 0.03 $ (0.56)
Diluted $ (0.59) $ 0.03 $ (0.56)
Stockholders' equity $ 1,888 $ 63 $ 1,951
F-37
<page>
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance, Additions Balance,
Beginning of Charged to Deductions End of
Year Operations from Reserve Year
----------- ----------- ----------- -----------
Allowance for doubtful accounts
December 31, 2007 $ 35,000 $ 576,881 $ (465,753) $ 146,128
December 31, 2006 $ 3,145 $ 293,088 $ (261,233) $ 35,000
Allowance for product returns
December 31, 2007 $ 466,407 $ 520,773 $ (568,912) $ 400,268
December 31, 2006 $ 178,055 $ 1,085,458 $ (797,106) $ 466,407
Reserves for sales incentives
December 31, 2007 $ 2,327,048 $ 4,085,806 $(5,654,373) $ 758,481
December 31, 2006 $ 3,526,639 $ 6,799,640 $(7,999,231) $ 2,327,048
Reserves for obsolete inventory
December 31, 2007 $ 526,000 $ 417,000 $ (503,000) $ 440,000
December 31, 2006 $ 29,690 $ 705,023 $ (208,713) $ 526,000
<page>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1 Amended and Restated Articles of Incorporation of I/OMagic
Corporation filed with the Secretary of State of Nevada on December
6, 2002 (7)
3.2 Amended and Restated Bylaws of I/OMagic Corporation dated July 25,
2002 (1)
10.1 Employment Agreement dated October 15, 2002 between I/OMagic
Corporation and Tony Shahbaz (#) (2)
10.2 I/OMagic Corporation 2002 Stock Option Plan (#) (3)
10.3 Warehouse Services and Bailment Agreement dated February 3, 2003
between I/OMagic Corporation and Behavior Tech Computer (USA) Corp.
(4)
10.4 I/OMagic Corporation 2003 Stock Option Plan (#) (6)
10.5 Standard Industrial/Commercial Single-Tenant Lease-Net dated July 1,
2003 between Laro Properties, L.P. and I/OMagic Corporation (5)
10.6 Form of Indemnification Agreement (8)
10.7 Trademark License Agreement dated July 24, 2004 by and between IOM
Holdings, Inc. and I/OMagic Corporation (8)
10.8 Amended and Restated Agreement between Lung Hwa Electronics Co.
Ltd., and I/OMagic Corporation, dated July 21, 2005 (9)
10.9 Loan and Security Agreement dated January 29, 2007 between Silicon
Valley Bank and I/OMagic Corporation (10)
10.10 Amendment to Loan and Security Agreement dated December 12, 2007
between Silicon Valley Bank and I/OMagic Corporation (11)
14.1 I/OMagic Corporation Code of Business Conduct and Ethics dated March
15, 2004 (7)
14.2 I/OMagic Corporation Code of Business Ethics for CEO and Senior
Financial Officers dated March 15, 2004 (7)
14.3 Charter of the Audit Committee of the Board of Directors of I/OMagic
Corporation dated March 15, 2004 (7)
21.1 Subsidiaries of the Registrant (8)
23.1 Consent of Independent Registered Public Accounting Firm (*)
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 Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S. C. Section 350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (*)
- ---------------
(*) Filed herewith.
(#) Management contract or compensatory plan, contract or arrangement required
to be filed as an exhibit.
(1) Incorporated by reference to the Registrant's quarterly report on Form
10-Q for the quarterly period ended June 30, 2002 (File No. 000-27267).
(2) Incorporated by reference to the Registrant's quarterly report on Form
10-Q for the quarterly period ended September 30, 2002 (File No.
000-27267).
(3) Incorporated by reference to Registrant's definitive proxy statement for
the annual meeting of stockholders held November 4, 2002.
(4) Incorporated by reference to the Registrant's annual report on Form 10-K
for the year ended December 31, 2002 (File No. 000-27267).
<page>
(5) Incorporated by reference to the Registrant's quarterly report on Form
10-Q for the quarterly period ended June 30, 2003 (File No. 000-27267).
(6) Incorporated by reference to the Registrant's definitive proxy statement
for the annual meeting of stockholders held December 18, 2003.
(7) Incorporated by reference to the Registrant's annual report on Form 10-K
for the year ended December 31, 2003 (File No. 000-27267).
(8) Incorporated by reference to the Registrant's registration statement on
Form S-1/A No. 1 filed by the Registrant with the Securities and Exchange
Commission on July 30, 2004 (Reg. No. 333-115208).
(9) Incorporated by reference to the Registrant's current report on Form 8-K
filed by the Registrant with the Securities and Exchange Commission on
July 27, 2005 (File No. 000-27267).
(10) Incorporated by reference to the Registrant's current report on Form 8-K
filed by the Registrant with the Securities and Exchange Commission on
February 8, 2007 (File No. 000-27267).
(11) Incorporated by reference to the Registrant's current report on Form 8-K
filed by the Registrant with the Securities and Exchange Commission on
December 14, 2007 (File No. 000-27267).
<page>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on this 3rd day of
April, 2009.
I/OMAGIC CORPORATION
By: /s/ TONY SHAHBAZ
-------------------------------
Tony Shahbaz
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
-------------------------------------------------------------------------------------
/s/ TONY SHAHBAZ Chief Executive Officer and President April 3, 2009
- ------------------------- (Principal Executive Officer), Acting Chief
Tony Shahbaz Financial Officer (Principal Financial and
Accounting Officer), Secretary and Sole
Director
<page>
EXHIBITS FILED WITH THIS REPORT
EXHIBIT
NUMBER DESCRIPTION
------ -----------
23.1 Consent of Independent Registered Public Accounting Firm
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 Chief Executive Officer 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