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3. CONTINGENCIES
On March 15, 1996, a complaint was filed against the Company and certain of its
current and then directors and executive officers in a securities class action
lawsuit which alleges that Company management engaged in improper accounting
practices and made certain false and misleading statements. The complaint was
filed in the United States District Court for the Central District of California
under the case name Wills, Cohen, et al. v. William Blum et al., Case No.
SACV96-261GLT. On or about November 10, 1997, the Company reached an agreement
in principle with the plaintiffs to settle the lawsuit. Plaintiffs have agreed
to accept payment of $2,325,000 in exchange for a complete release of all claims
arising from the allegations set forth in the plaintiffs' complaint. All of the
terms of the settlement are not final, and the settlement is subject to
preliminary and final approval by Court as well as approval by the members of
the class. The Company's insurers agreed to advance all settlement and defense
costs, including the Company's attorneys' fees and expenses, subject to the
Company's agreement to reimburse the insurers for up to approximately $577,000
of those settlement and defense costs if the Company achieved certain positive
financial results prior to the Federal Court's final approval of the settlement.
Although the Company did not concede that any portion of the class action
settlement is allocable to the Company, the Company agreed to the terms of the
settlement to avoid further costs. The Company's portion of the settlement,
which totaled $232,000, was included in the results of operations for the fourth
quarter ended December 27, 1997.
The Company and certain members and former members of its senior management were
the subject of an investigation by the Securities and Exchange Commission (the
"SEC") relating principally to the restatement of the Company's previously
reported financial results for 1993 and 1994. During the fourth quarter of
1997, the investigation conducted by the SEC relating principally to the
restatement of the Company's previously reported financial results for 1993 and
1994 and for certain interim periods for 1995 involving the Company and certain
former members of its senior management was concluded. The Commission
instituted a cease and desist order
7
against the Company and two former officers and a permanent injunction barring
future violations of certain accounting provisions against a third former
officer, who was also fined $25,000.
The resignation of the Company's prior independent public accountants on
February 20, 1996, led to additional inquiries by the SEC. These inquiries
related principally to the accounting matters discussed in the December 27, 1998
Form 10-K. The inquiries by the SEC were concluded as part of the resolution of
the SEC's investigation.
The Company is also subject to other legal proceedings and claims that arise in
the normal course of business. The outcome of these proceedings cannot be
predicted with certainty.
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THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANINGS OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934. ACTUAL RESULTS AND EVENTS COULD DIFFER MATERIALLY
FROM THOSE PROJECTED AS A RESULT OF THE RISK FACTORS SET FORTH IN THIS
REPORT AS WELL AS IN THE COMPANY'S ANNUAL REPORT ON
FORM 10 - K.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE
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FINANCIAL STATEMENTS AND NOTES THERTO FOR THE YEARS 1997 AND 1998 FROM ITS
--------------------------------------------------------------------------
INDEPENDENT AUDITOR PRINCIPALLY AS A RESULT OF THE INDEPENDENT AUDITOR'S CONCERN
--------------------------------------------------------------------------------
OVER THE ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN. THE READER OF
------------------------------------------------------------------------------
THE FINANCIAL STATEMENTS, NOTES, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF
-----------------------------------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK
--------------------------------------------------------------------------------
OF AN INDEPENDENT AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF
--------------------------------------------------------------------------------
OPERATIONS OF THE COMPANY FOR DECEMBER 27, 1997 AND DECEMBER 26, 1998 PRESENTED
-------------------------------------------------------------------------------
IN THE COMPANY'S FORM 10-K.
----------------------------
Adverse operating results - at the date of this filing the Company has continued
to incur significant losses and has experienced severe cash constraints. Sales
have continually declined in light of significant competition, price pressures
and the uncertainty on the part of potential customers over the financial
condition of the Company. Further, the Company has been unable to raise
alternative sources of funding to fund operating losses. All of these factors
have had a material impact on the Company and its results of operation. Absent
an immediate infusion of capital or significantly increased sales the Company
will seek protection under the Federal bankruptcy laws.
The Company continues to incur significant losses with quarterly sales
significantly below historical levels and those levels required for
profitability. As of the date of this filing, the Company's liabilities
significantly exceed its assets. The Company's liquidity position continues to
be severely constrained. As a result of the Company's severe liquidity
problems, the Company is unable to pay its trade debt on a timely basis. The
Company has sought and has been unable to obtain a forbearance agreement with
its creditors. In the event the Company is unable to obtain some sort of
agreement with the secured and/or unsecured creditors and immediate funding, it
will be unable to operate as a going concern and will seek protection under the
Federal bankruptcy laws.
Net Sales
Net sales were $1,788,000 and $4,006,000 for the thirteen weeks ended March 28,
1998 and March 27, 1999, respectively, representing a year to year decrease of
55%. The decrease in sales is primarily attributable to decreased unit sales as
a result of increased competition, the Company's inability to acquire products
for sale because of the Company's lack of financial resources and the
discontinuance of certain of the Company's legacy products. Virtually all of the
Company's vendors will only sell to the Company on a prepay basis. The first
quarter of 1999 was adversely affected by significant declines in the prices of
disk drives, continued uncertainty among customers created by the news of the
Company's operational and financial difficulties, and the Company's inability to
purchase product because of its financial condition.
Gross Profit (Loss)
Gross loss decreased from $1,017,000 for the thirteen weeks ended March 28,
1998, to a gross profit of $371,000 for the thirteen weeks ended March, 27,
1999. The decrease in gross loss is primarily attributable to significant
inventory obsolescence and lower of cost or market adjustments that were taken
in the prior year. While the gross margin loss has decreased over the
comparable prior year period, the Company continues to experience price
degradation on its products as a result of increased competition in the
recordable CD market. The decline in prices is expected to continue placing
pressure on gross margins in future periods for existing products.
Selling, General and Administrative
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Selling, general and administrative expenses were $1,815,000 and $966,000 in the
thirteen weeks ended March 28, 1998 and March 27, 1999, respectively, and
represented 45.3% and 54.0% of net sales. The decreases in expenditures
resulted primarily from reduced advertising and promotional expenditures and the
continued reduction of Company personnel.
Research and Development
The Company did not incur any Research and Development expenses during the
thirteen weeks ending March 28, 1998 and March 27, 1999. In late 1997, the
Company was forced to abandon the research and development and manufacturing
facility located in Colorado Springs, CO due to increased financial problems and
decreased working capital. The Company began outsourcing all production to a
company in California.
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Liquidity and Capital Resources
Cash and cash equivalents of $53,000 at March, 27, 1999 were $269,000 lower than
the $322,000 balance at December 26, 1998.
The Company's liquidity position continues to be severely constrained. The
Company currently has a revolving line of credit agreement with a lender,
collateralized by substantially all assets of the Company, which expires on
September 30, 1999. Although the Company has a maximum availability of
$10,000,000 under the line of credit based on a percentage of eligible accounts
receivables and inventories, its ability to borrow against the revolving line of
credit is largely dependent upon its level of eligible accounts receivable.
Because of its lower than expected level of shipments, the Company's eligible
account receivables are also lower than expected and the Company frequently has
exceeded the maximum available under the line of credit. Borrowings under the
line of credit totaled $5,503,000 at December 26, 1998 and $5,171,000 at March
27, 1999. The Company's inability to increase sales and find alternative
sources of funding have severely impacted the Company.
In the event that the Company is unable to locate a financial partner or other
sources of immediate funding to meet its current cash needs, it will be unable
to continue to operate as a going concern and will be required to seek
protection under the Federal Bankruptcy Laws.
General and Risk Factors
Sales and Marketing
The Company's sales continue to decline as a result of intense competition,
reduced prices, the inability to market the product as a result of cash
constraints, and the lack of resources to pursue alternative products.
Consequently, a continued decline in sales and the inability to find alternative
sources of cash will require the Company to seek creditor protection under the
Federal bankruptcy laws.
11
Background Risks
The Company's quarterly operating results fluctuate significantly depending on
factors such as timing of product introductions by the Company and its
competitors, market acceptance of new products and enhanced versions of the
Company's existing products, changes in pricing policies by the Company and its
competitors, and the timing of expenditures on advertising, promotion and
research and development.
The Company's component purchases, production and spending levels are made based
upon forecasted demand for the Company's products. Accordingly, any inaccuracy
in forecasting will adversely affect the Company's results of operations. As is
common in many high technology companies, the Company's shipments tend to be
disproportionately higher in the latter part of each quarter. Past results are
not necessarily indicative of future performance for any particular period.
The computer industry in general, and the market for the Company's products in
particular, is characterized by rapidly changing technology, evolving industry
standards, frequent new product introductions and significant price competition,
resulting in short product life cycles and reductions in unit selling prices
over the life of a specific product. The Company faces competition from much
larger magnetic and optical storage device developers, including Fujitsu, Sony
and Philips. These competitors have engineering and manufacturing experience
greater than the Company, and may be able to bring comparable or superior
products to market, which will negatively impact the results of the Company.
The Company faces increasing competition in the "3R" or removable, rewritable
and random access storage market from companies such as Iomega and Sony.
There can be no assurance that there will be acceptance of the Company's
existing products or that the Company's future products will achieve market
acceptance at acceptable margins. The absence of either will require the
Company to seek creditor protection under Federal bankruptcy law.
In the event that the Company is unable to locate other sources of immediate
funding to meet its current cash needs, it will be unable to continue to operate
as a going concern and will seek protection under the Federal bankruptcy laws.
12
SUBMISSION OF MATTERS OF VOTE OF SECURITY HOLDERS
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit Number Description
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27 Financial Data Schedule
(b) Reports on Form 8-K:
December 31, 1998 Resignation of Hans Imhoff and James Roszack
from the Company's board of Directors.
13
SIGNATURES
PINNACLE MICRO, INC.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 3, 1999 By: /s/ William F. Blum
---------------------------------------
William F. Blum
Director, Chairman, President, Chief Executive
Officer and Chief Financial Officer and Chief
Accounting Officer
(Duly Authorized Officer)
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