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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission File No. 000-12739
AESP, INC.
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(Exact name of registrant as specified in its charter)
FLORIDA 59-2327381
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
1810 N.E. 144TH STREET
NORTH MIAMI, FLORIDA 33181
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(Address of Principal Executive Offices) (Zip Code)
(305) 944-7710
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(Registrant's Telephone Number, Including Area Code)
Securities to Be Registered Pursuant To Section 12(B) Of The Exchange Act:
Name of Each Exchange
Title of Each Class On Which Registered
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NONE N/A
Securities registered pursuant to section 12(g) of the Exchange Act:
COMMON STOCK $.001 PAR VALUE
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
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 pursuant 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the closing bid price of the Company's common
stock, $.001 par value per share (the "Common Stock") as of June 28, 2002 of
$.90 per share (as reported on the NASDAQ SmallCap Market), was approximately
$2,740,236. There is no non-voting stock.
The number of shares of the Company's Common Stock which were
outstanding as of March 27, 2003 was 5,984,221.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits listed in Part IV of this Annual Report on Form
10-K are incorporated by reference from prior filings made by the Registrant
under the Securities Act of 1933, as amended, and the Securities Exchange Act of
1934, as amended.
AESP, INC.
TABLE OF CONTENTS
PAGE
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FORWARD LOOKING STATEMENTS........................................................................................1
PART I............................................................................................................2
Item 1. Description of Business..........................................................................2
Item 2. Description of Properties.......................................................................17
Item 3. Legal Proceedings...............................................................................17
Item 4. Submission of Matters to a Vote of Security Holders.............................................17
PART II..........................................................................................................18
Item 5. Market for Common Equity and Related Stockholder Matters........................................18
Item 6. Selected Financial Data.........................................................................21
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................................22
Item 7(A). Quantitative and Qualitative Disclosures About Market Risks.....................................35
Item 8. Financial Statements and Supplementary Data.....................................................35
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.............................................................35
PART III.........................................................................................................36
Item 10. Directors and Executive Officers of the Registrant..............................................36
Item 11. Executive Compensation..........................................................................39
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.............................................................................44
Item 13. Certain Relationships and Related Transactions..................................................46
Item 14. Controls and Procedures.........................................................................46
PART IV..........................................................................................................47
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................47
i
FORWARD LOOKING STATEMENTS
UNLESS THE CONTEXT OTHERWISE REQUIRES, REFERENCES TO AESP, Inc.,
"AESP," "THE COMPANY," "WE," "OUR" AND "US" IN THIS ANNUAL REPORT ON FORM 10-K
INCLUDES AESP, INC. AND ITS SUBSIDIARIES. THE MATTERS DISCUSSED IN THIS ANNUAL
REPORT ON FORM 10-K CONTAIN OR MAY CONTAIN FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, WHICH ARE
INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED THEREBY. THESE
FORWARD-LOOKING STATEMENTS INVOLVE RISKS, UNCERTAINTIES, AND ASSUMPTIONS,
INCLUDING, IN ADDITION TO THOSE DESCRIBED BELOW, IN "RISK FACTORS RELATED TO OUR
OPERATIONS," IN "RISK FACTORS RELATED TO OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS," AND ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K, COMPETITION FROM
OTHER MANUFACTURERS AND DISTRIBUTORS OF CONNECTIVITY AND NETWORKING PRODUCTS
BOTH NATIONALLY AND INTERNATIONALLY; THE BALANCE OF THE MIX BETWEEN ORIGINAL
EQUIPMENT MANUFACTURER SALES (WHICH HAVE COMPARATIVELY LOWER GROSS PROFIT
MARGINS WITH LOWER EXPENSES) AND NETWORKING SALES (WHICH HAVE COMPARATIVELY
HIGHER GROSS PROFIT MARGINS WITH HIGHER EXPENSES) FROM PERIOD TO PERIOD; OUR
DEPENDENCE ON THIRD PARTIES FOR MANUFACTURING AND ASSEMBLY OF PRODUCTS; AND THE
ABSENCE OF SUPPLY AGREEMENTS. THESE AND ADDITIONAL FACTORS ARE DISCUSSED HEREIN.
YOU SHOULD CAREFULLY CONSIDER THE INFORMATION INCORPORATED BY REFERENCE, AND
INFORMATION THAT WE FILE WITH THE SECURITIES AND EXCHANGE COMMISSION ("SEC")
FROM TIME TO TIME. THE WORDS "MAY," "WILL," "EXPECT," "ANTICIPATE," "BELIEVE,"
"CONTINUE," "ESTIMATE," "PROJECT," "INTEND," AND SIMILAR EXPRESSIONS USED IN
THIS FORM 10-K ARE INTENDED TO INDENTIFY FORWARD-LOOKING STATEMENTS. YOU SHOULD
NOT PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY
AS OF THE DATE MADE. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE ANY REVISION
OF THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE
DATE THEY ARE MADE OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. YOU
SHOULD ALSO KNOW THAT SUCH STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE
AND ARE SUBJECT TO RISKS, UNCERTAINTIES AND ASSUMPTIONS. SHOULD ANY OF THESE
RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD ANY OF OUR ASSUMPTIONS PROVE
INCORRECT, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE INCLUDED WITHIN THE
FORWARD-LOOKING STATEMENTS.
1
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
THE COMPANY
AESP, Inc. designs, manufactures, markets and distributes networking
and computer connectivity products nationally and internationally. We offer a
broad range of products to our customers, including computer cables, connectors,
installation products, data sharing devices, and fiber optic cables, as well as
a complete selection of networking products, such as networking interface cards,
hubs, transceivers, and repeaters for different networking topologies. We
contract with various manufacturers to manufacture and assemble our products
using designs and manufacturing specifications (including quality control)
provided by us. Our products are manufactured from our own designs as well as
from standard industry designs. Our manufacturers are located primarily in the
Far East, allowing us to obtain competitive pricing for our products due to
comparatively lower labor costs in the production of our products. We also
assemble a small percentage of our products at our North Miami facility. We
offer our products to a broad range of original equipment manufacturers ("OEM")
and retailers (such as computer superstores and dealers, and mail order
customers) in North America, Latin America, and Eastern and Western Europe. Our
networking products are marketed under the name "Signamax Connectivity Systems"
and our OEM products are sold under the customer's name. We generally do not
offer our products to end users.
Despite the current economic slowdown generally and particularly in the
computer market, we believe that industry trends will lead to an increased
demand for the use of networking and computer connectivity products designed to
maximize and enhance the functionality of computers, and thereby create a
continuing substantial market for our products. Our overriding mission is to
design, manufacture and market networking and computer connectivity products
which can integrate any computer into any network at any time. Our primary focus
is to anticipate technological advancements and consumer preference as far in
advance as possible, develop new products and improved features to meet such
market demands and transform ideas from concept to market as quickly as
possible. Our strategic objective is to become a leader in the computer
connectivity and networking equipment market, and to make the name "Signamax"
and "AESP" synonymous with state-of-the-art hardware in this segment.
Our strategy is to increase revenues and operating income through
internal growth combined with growth through acquisitions. In 2000 and 2001, we
completed two acquisitions and sold one of our operations.
o In June 2000, we acquired the stock of Lanse AS located in Oslo,
Norway. Lanse distributes networking hardware to the network
installation industry in Norway and also holds exclusive rights in
Norway for the Telesafe (TM) product line;
o During January 2001, we sold our interest in AESP Ukraine, a
distributor of our products located in the Ukraine. We expect that AESP
Ukraine will continue to act as an exclusive distributor of our
products; and
2
o On August 29, 2001, we completed the acquisition of Intelek spol.
s.r.o. for a purchase price of $1,065,700, consisting of $426,142 in
cash, a $213,000 note payable (paid in August 2002), and the issuance
of 139,398 shares of our common stock. Intelek is a distributor and
manufacturer of networking hardware and wireless networking products
with offices in Brno and Prague, Czech Republic.
We were incorporated in Florida in 1983. Our principal executive
offices are at 1810 N.E. 144th Street, North Miami, Florida 33181, and our
telephone number is (305) 944-7710.
RISK FACTORS RELATED TO OUR OPERATIONS
IN ADDITION TO OTHER INFORMATION CONTAINED IN OR INCORPORATED BY
REFERENCE INTO THIS FORM 10-K, YOU SHOULD UNDERSTAND THE FOLLOWING RISK FACTORS
RELATED TO OUR OPERATIONS:
OUR INDUSTRY EXPERIENCES RAPID TECHNOLOGICAL CHANGE WHICH MAY DECREASE REVENUES
In general, the computer industry is characterized by rapidly changing
technology. We must continuously update our existing products to keep them
current with changing technology and must develop products to take advantage of
new technologies that could render existing products obsolete. Our personnel,
through discussions with customers, attendance at trade and association meetings
and industry experience, identify new and improved technologies and work closely
with our vendors, who are responsible for the cost of developing and building
these products. We do not directly spend significant funds on research and
development but instead rely on our suppliers for developmental expertise. These
products must be compatible with the computers and other products with which
they are used. Our future prospects are dependent in part on our ability to
develop new products with our vendors that address new technologies and achieve
market acceptance. We may not be successful in these efforts. If we were unable,
due to resource constraints or technological or other reasons, to develop and
introduce such products in a timely manner, this inability could have a material
adverse effect on our revenues. In addition, due to the uncertainties associated
with the evolving markets which we address, we may not be able to respond
effectively to product demands, fluctuations, or to changing technologies or
customer requirements and specifications, thereby decreasing our future
revenues.
3
THE NETWORKING AND COMPUTER CONNECTIVITY INDUSTRY IS CYCLICAL WHICH COULD MAKE
OUR REVENUES MORE VOLATILE
The networking and computer connectivity industry has been affected
historically by general economic downturns, which have had an adverse economic
effect upon manufacturers, distributors and retailers of computers and
computer-related products. General economic downturns have traditionally had
adverse effects upon the computer-related industry due to the restrictions on
expenses for products of this industry during recessionary periods. We may not
be able to predict or respond to such cycles within the industry, which could
have a material adverse effect on our future revenues.
The networking and computer connectivity industry is also characterized
by inevitable price erosion across the life cycle of products and technologies.
In the face of constantly shrinking gross margins, our strategy is to seek out
low cost producers without sacrificing quality and to seek to develop and
maintain efficient internal operations allowing us to control our internal costs
and expenses.
While the market for networking and computer connectivity products is
one of the fastest growing segments of the technology industry, the technology
industry has historically experienced cyclical downturns. Any such downturns,
unexpected changes in technology or shifts in the distribution channel for
networking and computer connectivity equipment could have a material adverse
effect on our revenues and results of operations.
WE ARE DEPENDENT ON THIRD PARTIES FOR MANUFACTURING AND ASSEMBLY; THE LACK OF
SUPPLY AGREEMENTS COULD DISRUPT OUR DELIVERY OF INVENTORY
We are dependent on a number of manufacturers, both domestic and
foreign, for the manufacture and assembly of our products pursuant to our design
specifications. Although we purchase our products from several different
manufacturers, we often rely on an individual manufacturer to produce a
particular line of products. Although we have several different product lines,
and despite our efforts to minimize such reliance by having other manufacturers
available should the need arise, these manufacturers are currently not bound by
contract other than by individual purchase orders to supply us with our
products. The loss of one or more manufacturers of our original equipment
manufacturer products may materially increase our material costs and/or decrease
our revenues through an inability to deliver timely product to our customers.
While most of the connectivity products sold by us are available from multiple
sources, we may not be able to replace lost manufacturers of connectivity
products with others offering products of the same quality, with timely delivery
and/or similar terms.
Over the last five years, we have progressively expanded our supplier
base. Presently, we work with approximately 65 suppliers. We have one supplier
(located in China), which supplied 8% of our purchases during 2002, 9% of our
purchases during 2001 and 14% of our purchases during 2000. No other source of
supply accounted for more than 10% of our purchases during 2002, 2001 or 2000.
We do not enter into supply or requirements contracts with our suppliers. We
believe that purchase orders, as opposed to supply or requirement agreements,
provide us with more flexibility in responding quickly to customer demand.
4
Nevertheless, the loss of one or more of our suppliers could increase our
product costs and negatively affect our revenues by increasing delivery times.
WE UTILIZE FOREIGN SUPPLIERS AND MANUFACTURERS WHICH MAY INCREASE OUR COSTS
Most of the components we utilize in the manufacture and assembly of
our products are obtained from foreign countries and a majority of our products
are manufactured or assembled in foreign countries, such as the United Kingdom,
Czech Republic, China and Taiwan. The risks of doing business with companies in
these areas include potential adverse changes in the diplomatic relations of
foreign countries with the United States, changes in the relative purchasing
power of the United States dollar, hostility from local populations, changes in
exchange controls and the instability of foreign governments, increases in
tariffs or duties, changes in China's or other countries' most favored nation
trading status, changes in trade treaties, strikes in air or sea transportation,
and possible future United States legislation with respect to import quotas on
products from foreign countries and anti-dumping legislation, any of which could
result in delays in manufacturing, assembly and shipment and our inability to
obtain supplies and finished products and/or commercially reasonable costs.
Alternative sources of supply, manufacture or assembly may be more expensive. We
utilize the services of an unaffiliated trading company in Taiwan which assists
us in working with our suppliers in the Far East. Although we have not
encountered significant difficulties in our transactions with foreign suppliers
and manufacturers in the past, we may encounter such difficulties in the future.
WE ARE DEPENDENT ON THIRD PARTIES FOR DISTRIBUTION; A LOSS OF ANY KEY
DISTRIBUTORS COULD DECREASE OUR REVENUES
Substantially all of our revenues are derived from the sale of our
products through third parties. Domestically, our products are sold to end users
primarily through original equipment manufacturer customers, wholesale
distributors, value added resellers, mail order companies, computer superstores
and dealers. Internationally, our products are sold through wholesale
distributors and mail order companies, dealers, value added resellers, as well
as to original equipment manufacturer customers. Accordingly, we are dependent
on the continued viability and financial stability of our resellers. Our
resellers often offer products of several different companies, including, in
many cases, products that are competitive with our products. Our resellers may
discontinue purchasing our products or providing our products with adequate
levels of support. The loss of, or a significant reduction in sales volume to, a
significant number of our resellers could have a material adverse effect on our
revenues and results of operations.
WE ARE DEPENDENT ON SIGNIFICANT CUSTOMERS; THE LOSS OF WHICH COULD DECREASE
REVENUES
Our exclusive distributor in Russia accounted for 10% of our net sales
for 2002, 14% of our net sales in 2001 and 12% of our net sales in 2000. During
these same periods, our top ten customers (including our Russian distributor)
accounted for 33%, 27% and 38%, respectively, of our net sales. No customer
(other than our Russian distributor) accounted for more than 10% of our net
sales during fiscal years 2002, 2001, or 2000. The loss of one or more
significant customers could have a material adverse effect on our cash flow and
results of operations.
5
WE MAINTAIN SIGNIFICANT INVENTORY WHICH PUTS US AT RISK FOR ADDITIONAL
OBSOLESCENCE WRITE-OFFS
Although we monitor our inventory on a regular basis, we need to
maintain a significant inventory in order to ensure prompt response to orders
and to avoid backlogs. We may need to hold such inventory over long periods of
time and the capital necessary to hold such inventory restricts the funds
available for other corporate purposes. Holding inventory over long periods of
time increases the risk of inventory obsolescence. A significant amount of
obsolete inventory could increase our expense and have a material adverse effect
on our revenues and our results of operations.
We recorded provisions for inventory obsolescence totaling $538,000 in
2002 and $1.1 million in 2001 due to the significant decrease in demand for our
products because of lower spending on technology due to a generally sluggish
economy, as well as our ongoing transition of focusing our core business on
networking products instead of PC connectivity products. These provisions were
calculated based on the carrying value of specific current inventory balances
compared to current sales volumes and prices and estimated future sales price
analysis prepared by our sales departments for computer connectivity and
networking products in each of our geographic areas of operations.
WE COMPETE WITH MANY COMPANIES, SOME OF WHOM POSSESS GREATER RESOURCES
We compete with many companies that manufacture, distribute and sell
computer connectivity and networking products. In our active networking product
line, we compete with hundreds of companies, including Cisco, 3Com, Transition
Networks and Allied Telesyn. In this market, we believe we compete favorably on
service and value, offering a high performance to price ratio. In our passive
networking and connectivity product lines, we compete with approximately 30 - 50
companies, such as Ortronics, Tyco Electrical, Netconnect and Leviton. In these
markets, we stress our breadth of products, service, price and performance.
While these companies are largely fragmented throughout different sectors of the
computer connectivity industry, many of these companies have greater assets and
possess greater financial and personnel resources than we do. Some of these
competitors also carry product lines that we do not carry and provide services
which we do not provide. Competitive pressure from these companies currently
materially adversely affect our business and will likely continue to affect our
business and financial condition in the future by causing erosion of gross
margins in these difficult economic times. In the event that more competitors
begin to carry products which we carry and price competition with respect to our
products significantly increases, competitive pressures could force us to reduce
the prices of our products, which would result in reduced profit margins.
Prolonged price competition would have a material adverse effect on our
operating results and financial condition. A variety of other potential actions
by our competitors, including increased promotion and accelerated introduction
of new or enhanced products, could also have a material adverse effect on our
revenues and results of operations. We may not be able to compete successfully
in the future.
6
OUR GROWTH STRATEGY INCLUDES FUTURE ACQUISITIONS; WE MAY NOT BE ABLE TO COMPLETE
ANY ACQUISITIONS ON SUITABLE TERMS
One element of our growth strategy involves growth through the
acquisition of other companies, assets and/or product lines that would
complement or expand our business. We are seeking companies that market to the
networking, telecommunications and cable audio/video and computer industries. We
believe that acquisitions, mergers, asset purchases or other strategic alliances
in these categories should enable us to achieve operating leverage on our
existing resource base. Our ability to expand by acquisition has been, and will
continue to be limited by the availability of suitable acquisition candidates,
in both the United States and internationally, and by our financial condition
and the price of our common stock. Our ability to grow by acquisition is
dependent upon, and will be limited by, the availability of suitable acquisition
candidates and capital, and by restrictions contained in our credit agreement,
which restrictions include maintaining certain minimum ratios of assets and
liabilities and not permitting any indebtedness, guarantees or liens which could
materially affect our ability to repay our loan. In addition, acquisitions
involve risks that could adversely affect our costs and operating results,
including the assimilation of the operations and personnel of acquired
companies, the possible amortization of acquired intangible assets and the
potential loss of key employees of acquired companies. We may not be able to
complete any acquisitions on suitable terms. No material commitments or binding
agreements have been entered into to date. Other than as required by our
articles of incorporation, by-laws, and applicable law, our shareholders
generally will not be entitled to vote upon such acquisitions.
In August 2001, we completed the acquisition of Intelek spol. s.r.o., a
Czech Republic manufacturer and distributor of networking hardware and wireless
networking products and in May 2000, we completed the acquisition of Lanse AS, a
Norwegian manufacturer and distributor of networking hardware. To date, the
Company has not had any material problems with either of such acquisitions.
However, no assurance can be given that problems in these or other acquired
businesses may not occur in the future or that future acquisitions will not
involve significant risks.
WE RELY ON EXECUTIVE OFFICERS AND KEY EMPLOYEES
Our continued success is dependent to a significant degree upon the
services of Slav Stein, our President and Chief Executive Officer, and Roman
Briskin, our Executive Vice President and Secretary, and upon our ability to
attract and retain qualified personnel experienced in the various phases of our
business. Our ability to operate successfully could be jeopardized if one or
more of our executive officers were unavailable and capable successors were not
found.
OUR PRINCIPAL SHAREHOLDERS MAY CONTROL US THROUGH THE ELECTION OF THE ENTIRE
BOARD OF DIRECTORS
Assuming no exercise of outstanding warrants and options, Messrs. Stein
and Briskin own collectively 1,552,014 shares of our common stock, representing
approximately 26% of our outstanding common stock. Since our articles of
incorporation and bylaws do not provide for cumulative voting, as a result of
their ownership of their shares of common stock, Messrs. Stein and Briskin are
effectively able to control us through the election of our entire board of
directors and the appointment of our officers.
In addition, under such circumstances, we will not, without Messrs.
Stein's and Briskin's approval, be able to consummate transactions involving the
actual or potential change in our control, including transactions in which the
holders of our common stock might otherwise receive a premium for their shares
over then current market prices.
7
OUR STOCK MAY BE SUBJECT TO GREAT PRICE VOLATILITY
The market price of our common stock has fluctuated in the past and is
likely to continue to be highly volatile and could be subject to wide
fluctuations. In addition, the stock market generally, and technology-related
securities in particular, may experience extreme price and volume fluctuations
that may be unrelated or disproportionate to the operating performance of
companies. Such fluctuations, and general economic and market conditions, may
adversely affect the market price of our common stock.
OUR STOCK MAY NO LONGER CONTINUE TO MEET THE LISTING REQUIREMENTS OF THE NASDAQ
SMALLCAP MARKET
Our common stock is currently traded on the Nasdaq SmallCap Market. In
the event we are no longer in compliance with the Nasdaq SmallCap Market
continued listing criteria, which require, among other things, that the market
value of our publicly held shares is not less than $1,000,000 and that the
closing bid price of our publicly held shares is not less than $1.00 for more
than 30 consecutive trading days, then Nasdaq may delist our common stock. We
may then have to seek to have our common stock quoted on the OTC Bulletin Board
maintained by the NASD. The average bid price for our common stock has fallen
below $1.00 in the past and may fall below $1.00 in the future. We cannot assure
you that if our shares of common stock are quoted on the OTC Bulletin Board that
our shares will be as liquid as they have historically been on the Nasdaq
SmallCap Market. Further, the market price for our shares may become more
volatile than it has been historically.
IF OUR COMMON STOCK IS DEEMED A "PENNY STOCK", ITS LIQUIDITY WILL BE ADVERSELY
AFFECTED
If the market price for our common stock falls and remains below $1.00
per share (which has occurred in the past and may occur in the future), our
common stock may be deemed to be penny stock. If our common stock is considered
penny stock, it would be subject to rules that impose additional sales practices
on broker-dealers who sell our securities. For example, broker-dealers must make
a special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to sale. Also, a disclosure
schedule must be prepared before any transaction involving a penny stock and
disclosure is required about sales commissions payable to both the broker-dealer
and the registered representative and current quotations for the securities.
Monthly statements are also required to be sent disclosing recent price
information for the penny stock held in the account as well as information on
the limited market in penny stocks. Because of these additional obligations,
some brokers may not handle transactions in penny stocks. If our stock is deemed
a "penny stock", it could have an adverse effect on the liquidity of our common
stock.
8
IMPACT OF WARRANT EXERCISE ON MARKET
We intend to complete a warrant dividend to the holders of our common
stock as of the record date of April 10, 2003. We will issue to holders of
record on the record date one common stock purchase warrant for each common
share which they own on that date. The warrants will become exercisable upon the
effectiveness of a registration statement registering our sale of the shares of
common stock underlying the warrants. In the event of the exercise of a
substantial number of warrants after the right to exercise commences, the
resulting increase in the amount of our common stock in the trading market could
substantially affect the market price of our common stock. See Item 5. "MARKET
FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS" for a description of the
warrant dividend.
ANTI-TAKEOVER PROVISIONS MAY DISCOURAGE CERTAIN TRANSACTIONS
Our articles of incorporation and bylaws contain provisions that may
have the effect of discouraging certain transactions involving an actual or
threatened change of control of us. In addition, our board of directors has the
authority to issue up to 1,000,000 shares of preferred stock in one or more
series and to fix the preferences, rights and limitations of any such series
without shareholder approval. In addition, our executive officers (Messrs. Stein
and Briskin) have provisions in their employment agreements requiring us to pay
each of them $750,000 in the event of a change in control of our company.
Furthermore, such payments which exceed a certain level of compensation may not
be deductible by us for federal corporate income tax purposes. The ability to
issue preferred stock and the change in control payments could have the effect
of discouraging unsolicited acquisition proposals or making it more difficult
for a third party to gain control of our company, or otherwise could adversely
affect the market price of our common stock.
BUSINESS OPERATIONS
GENERAL
The networking and computer connectivity market consists of two
wholesale categories: manufacturers of computers and peripherals and
distributors; and three resale categories: retail stores, catalog companies and
web-based selling organizations. Our strategy is to market our products to all
five of these potential customer groups.
Manufacturers and distributors of networking and computer connectivity
products range in size from channel dominant companies with annual sales of over
$1 billion to independent or specialized distributors with annual sales of $1-3
million. Small distributors dominate the channel, reflecting both the
specialized nature of technology and the variety of original equipment
manufacturers and end-user customers for connectivity hardware.
In general, the computer industry is characterized by rapidly changing
technology. We must continuously update our existing products to keep them
current with changing technology and we must develop new products to take
advantage of new technologies that could render
9
existing products obsolete. Company personnel, through discussions with
customers, attendance at trade and association meetings and industry experience,
identify new and improved technologies and work closely with our vendors, who
are responsible for the cost of developing and building these products. The
Company does not directly spend significant funds on research and development
but instead relies on its suppliers for development expertise. These products
must be compatible with the computers and other products with which they are
used. Our future prospects are dependent in part on our ability to develop new
products that address new technologies and achieve market acceptance. We may not
be successful in these efforts. If we were unable, due to resource constraints
or technological or other reasons, to develop and introduce such products in a
timely manner, this inability could have a material adverse effect on our future
results of operations. In addition, due to the uncertainties associated with the
evolving markets which we address, we may not be able to respond effectively to
product demands, fluctuations, or to changing technologies or customer
requirements and specifications. See "Risk Factors Related to our Operations."
The computer industry has been affected historically by general
economic downturns, which have had an adverse economic effect upon
manufacturers, distributors and retailers of computers and computer-related
products. General economic downturns have traditionally had adverse effects upon
the computer-related industry, due to the restrictions on expenses for products
of this industry during recessionary periods. We may not be able to predict or
respond to such cycles within the computer industry.
The networking and computer connectivity industry is also characterized
by inevitable price erosion across the life cycle of products and technologies.
In the face of constantly shrinking gross margins, our strategy is to seek out
low cost producers without sacrificing quality and to seek to develop and
maintain efficient internal operations, allowing us to control our internal
costs and expenses.
While the market for networking and computer connectivity hardware has
historically been one of the fastest growing segments of the technology
industry, the technology industry is currently experiencing a cyclical
downturns. If this downturn persists, or if there are unexpected changes in
technology or shifts in the distribution channel for networking and computer
connectivity equipment, these developments could have a materially adverse
effect on us.
PRODUCTS AND SERVICES
Our product line consists of two main categories: networking and
computer connectivity products. In some cases, our OEM business will manufacture
products outside this product classification (e.g., medical equipment).
Networking products are products which connect a computer to another
computer, a network server, the Internet, a public switched telephone network or
another enterprise. Networking products are divided into two sub-categories:
active and passive. Active networking products include interface cards,
transceivers, hubs, routers and repeaters. Passive networking products include
patch panels, patch cables and wallplates.
10
Connectivity products are products which connect a computer to
peripheral equipment, such as printers, external storage devices, scanners,
facsimiles or communications devices. Connectivity products include cables,
plugs and interface devices. Within the computer industry, the trend in
connectivity equipment is toward the development of so-called universal
interfaces, using USB, Firewire and SCSI standards. These universal interfaces
allow many different devices, such as monitors, keyboards, printers and modems,
to be connected using one universal interface per connection. Universal
interfaces have the potential to replace a number of connectivity products
currently marketed by us. However, we believe that future sales of universal
interfaces have the potential to be equal to or greater than sales of the
connectivity devices replaced by such interfaces.
We are constantly expanding and changing our product line within the
aforementioned categories to expand the total number of products we can offer
customers, to attract new customers, to penetrate new geographic and vertical
markets and to increase gross sales. By expanding our product line to include
products for different voltages, frequencies and connection configurations, and
warehousing these products near potential customers, we have successfully
expanded our sales activities into a number of Western and Eastern European
countries.
In order to provide assistance to our customers and to be competitive
with other companies in our industry, we offer our customers several services.
These services include: enhanced packaging; custom packaging; technical and
design support (where the customer receives advice from us on which product or
design specification is appropriate for a particular situation); assembly
support (where a customers relies on us to assemble the component parts the
customer traditionally had done itself); training (where the customer receives
training from us on the different capabilities and applications of our
products); and quality control.
MANUFACTURING AND SUPPLIERS
All our products have been manufactured to our specifications. Those
specifications are derived either from specifications provided to us by our
original equipment manufacturer customers or from industry standard
specifications. Products we sell to our original equipment manufacturer
customers are typically manufactured to the customer's unique specifications.
Products we sell to our networking and connectivity customers are typically
manufactured to industry standard specifications.
We contract with manufacturers using two methodologies. Under the first
methodology, typically used for the manufacture of custom designed products, we
contract with a primary manufacturer (a/k/a an "assembler") and then direct that
manufacturer to various component manufacturers with whom we also have
contracted. The component manufacturers then supply components to the assembler,
who is responsible for final manufacturing of the finished product. The value of
this methodology to the manufacturing of custom designed products is that we can
enforce our specifications at every step of the component manufacturing and
final assembly process. Under the second methodology, typically used for the
manufacture of industry standard specification products, we contract only with
the primary manufacturer, which makes its own arrangements with component
11
suppliers. We enforce our specifications on the primary manufacturer, which is
responsible for the enforcement of our specifications on the component suppliers
with whom it has contracted.
Due to the high volume and labor intensive nature of manufacturing
computer connectivity products, most of the products we sell are manufactured
outside the United States in such countries as Taiwan, the Peoples' Republic of
China, the United Kingdom and the Czech Republic. We utilize the services of an
unaffiliated trading company in Taiwan which assists us in working with our
suppliers in the Far East. The trading company acts as a manufacturers
representative by coordinating our orders and shipments with our Far East
suppliers in exchange for payment based on a percentage of orders invoiced to
us. The Company has made no long-term commitment to the trading company and is
able to terminate the arrangement on short notice. We also assemble a small
percentage of our products at our North Miami, Florida facility.
For the production of each specific type of product, we usually
maintain an on-going relationship with several suppliers to insure against the
possibility of problems with one supplier adversely impacting our business. For
the production of original manufacturer products, we usually use a single
supplier for each product, with other factories providing competitive price
quotes and being available to supply the same product if a primary supplier
fails to supply us with the required product for reasons outside our control.
However, we may not be able to easily replace a sole source of supply if
required. In an effort to produce defect-free products and maintain good working
relationships with our suppliers, we keep in contact with our suppliers,
regularly inspecting the manufacturing facilities of our suppliers and
implementing quality assurance programs in our suppliers' factories.
Over the last five years, we have progressively expanded our supplier
base. Presently, we work with approximately 65 suppliers. We have one supplier
(located in China) which supplied 8% of our purchases during 2002, 9% of our
purchases during 2001 and 14% of our purchases during 2000. No other source of
supply accounted for more than 10% of our purchases during 2002, 2001 or 2000.
We do not enter into supply or requirements contracts with our suppliers. We
believe that purchase orders, as opposed to supply or requirement agreements,
provide us with more flexibility in responding quickly to customer demand.
Nevertheless, the loss of one or more of our suppliers could have an adverse
impact on us.
Most of the components we utilize in the manufacture and assembly of
our products are obtained from foreign countries and a majority of our products
are manufactured or assembled in foreign countries, such as the United Kingdom,
the Peoples' Republic of China, the Czech Republic, and Taiwan. The risks of
doing business with companies in these areas include potential adverse changes
in the diplomatic relations of foreign countries with the United States, changes
in the relative purchasing power of the United States dollar, hostility from
local populations, changes in exchange controls and the instability of foreign
governments, increases in tariffs or duties, changes in China's or other
countries' most favored nation trading status, changes in trade treaties,
strikes in air or sea transportation, and possible future United States
legislation with respect to import quotas on products from foreign countries and
anti-dumping legislation, any of which could result in delays in manufacturing,
assembly and shipment and our inability to obtain supplies of finished products.
Alternative sources of supply, manufacture or
12
assembly may be more expensive. Although we have not encountered significant
difficulties in our transactions with foreign suppliers and manufacturers in the
past, we may encounter such difficulties in the future. See "Risk Factors
Related to Our Operations."
QUALITY CONTROL
Our goal is to provide our customers with defect-free products. Working
with our primary manufacturers and often with our manufacturers of various
component parts, we have instituted quality control measures at five stages
throughout the manufacturing process. At the first stage, we work with our
primary manufacturers to institute a general quality control check upon the
entry of the various component parts into the primary manufacturers' factory
(a.k.a. the incoming inspection). At the second stage, the primary manufacturer
checks to ensure that the component parts function properly. The third and
fourth stages of quality control occur after each molding process, with the
final product being subject to quality control at the time of shipment to us.
The fifth and final stage of quality control occurs at one of our distribution
warehouses (North Miami, Germany, Czech Republic, Sweden and Norway). At this
final stage of quality control, we test a certain percentage of each shipment of
products we receive to ensure the products meet our quality standards.
In 1998, we were certified as being in compliance with the "ISO 9002"
standard. The ISO 9002 standard is an international manufacturing standard which
is becoming more prevalent across numerous industries. Almost all of our current
suppliers are either ISO 9002 compliant or in the process of implementing ISO
9002 procedures.
CUSTOMER BASE
Our customer base is divided into two categories: original equipment
manufacturers and resale customers. Original equipment manufacturer customers
are generally manufacturers of computers and computer-related equipment which
use our products as part of their finished products. Resale customers are local
and regional resellers, value-added resellers and distributors, educational
institutions, web-based selling organizations and catalog houses. Catalog houses
constitute a large share of our U.S. resale sales. The resale mass merchandising
market also represents a significant growth area for us. We generally do not
offer our products directly to end-users.
Substantially all of our revenues are derived from the sale of our
products through third parties. Domestically, our products are sold to end users
primarily through original equipment manufacturer customers, wholesale
distributors, value added resellers, mail order companies, computer superstores
and dealers. In Europe, our products are sold through wholesale distributors and
mail order companies, dealers, value added resellers and web-based distributors.
Accordingly, we are dependent on the continued viability and financial stability
of our resale customers. Our resale customers often offer products of several
different companies, including, in many cases, products that are competitive
with our products. Our resale customers may not continue to purchase our
products or provide us with adequate levels of support. The loss of, or a
significant reduction in sales volume to, a significant number of our resale
13
customers could have a material adverse effect on our results of operations. See
"Risk Factors Related to Our Operations."
Sales to our exclusive distributor in Russia, AESP-Russia, accounted
for 10% of our net sales for 2002, 14% of our net sales for 2001 and 12% of our
net sales for 2000. We are currently selling products to our Russian distributor
on a paid-in-advance basis. Our top 10 customers (including AESP-Russia)
accounted for approximately 33%, 27% and 38% of our net sales for the years
ended December 31, 2002, 2001, and 2000, respectively. Other than AESP-Russia,
no customer accounted for more than 10% of our net sales in 2002, 2001 or 2000.
International sales have become a more significant portion of our consolidated
worldwide sales over the past few years primarily due to sales added by our
European acquisitions. See Note 5 of Notes to the Consolidated Financial
Statements for the disclosure on the geographic areas of our business.
We believe that due to the vagaries of the computer industry, it is
likely that some customers who are significant customers in one period may
become insignificant customers in future periods and vice versa. However, the
loss of one or more significant customers during any particular period could
have a material adverse impact on our future business and results of operations.
MARKETING AND SALES
Our marketing and sales efforts are directed by our Sales and Marketing
department. From a marketing perspective, this department is responsible for,
among other things, publishing our catalogs for each product line as well as the
general company catalog, assisting our sales group in preparing for sales shows,
advertising our products in industry publications, working with mail-order
catalogs to prepare advertising space in such catalogs, and providing designs
for packaging our products. From the sales perspective, this department is
responsible for, among other things, contacting potential customers with
information and prices for our products, following leads from trade shows,
providing customer support and visiting customers on a regular basis. The
department is divided in responsibility by product line and/or geographic
location.
Original equipment manufacturer sales are handled by salespersons
located in our headquarters in North Miami, Florida. All original equipment
manufacturer customers receive their shipments from our North Miami warehouse or
directly from the factory manufacturing their products. Networking and
connectivity sales are generally handled from our headquarters in North Miami,
Florida and from our German, Swedish, Norwegian, and Czech Republic offices and
warehouses.
14
COMPETITION
We compete with many companies that manufacture, distribute and sell
computer connectivity and networking products. In our active networking product
line, we compete with hundreds of companies worldwide, including Cisco, 3Com,
Transition Networks and Allied Telesyn. In this market, we compete favorably on
service and value, offering a high performance to price ratio. In our passive
networking and connectivity product lines, we compete with approximately 30 to
50 companies worldwide, such as Ortronics, Tyco Electrical, Netconnect and
Leviton. With these markets, we stress our breadth of products, service, price
and performance. While these companies are largely fragmented throughout
different sectors of the computer networking and connectivity industry, many of
these companies have greater assets and possess greater financial and personnel
resources than we do. Some of these competitors also carry product lines which
we do not carry and provide services which we do not provide. Competitive
pressure from these companies may materially adversely affect our business and
financial condition in the future. In the event that more competitors begin to
carry products which we carry and price competition with respect to our products
significantly increases, competitive pressures could force us to reduce the
prices of our products, which would result in reduced profit margins. In our
Norwegian market sales volume has been adversely affected by a competitive
situation involving former employees who established a competing company.
Prolonged price competition would have a material adverse effect on our
operating results and financial condition. A variety of other potential actions
by our competitors, including increased promotion and accelerated introduction
of new or enhanced products, could also have a material adverse effect on our
results of operations. We may not be able to compete successfully in the future.
See "Risk Factors Related to Operations."
STRATEGY TO INCREASE NETWORKING AND CONNECTIVITY PRODUCTS & ORIGINAL EQUIPMENT
MANUFACTURER CUSTOMER BASE
We intend to increase our revenues and income in the networking and
original equipment manufacturer markets by continuing to broaden our customer
base in existing markets and by expanding into new markets. In order to increase
our national and international customer base, we intend to continue to market to
large distributor catalog companies, to increase both our product lines and
inventory and to expand our sales reach in the US, Eastern and Western Europe
and in the future into Latin America. To expand our original equipment
manufacturer customer base, we intend to expand our business with computer
product and networking hardware manufacturers, and to solicit manufacturers in
other fast-growing vertical markets, such as networking, telecommunications,
medical instrumentation and cable television.
STRATEGIC ACQUISITIONS
The other element of our growth strategy involves growth through the
acquisition of other companies, assets and/or product lines that will compliment
or expand our business. We are seeking companies which market to the networking,
telecommunications, cable audio/video and computer industries. We believe that
acquisitions, mergers, asset purchases or other strategic alliances in these
15
categories should enable us to achieve operating leverage on our existing
resource base.
Our ability to expand by acquisition has been, and will continue to be,
limited by the availability of suitable acquisition candidates, in both the
United States and internationally, and by our financial condition and the market
price of our common stock. Our ability to grow by acquisition is also impacted
by restrictions contained in our credit agreement. See "Risk Factors Related to
our Operations" for factors that impact our ability to complete acquisitions and
for risks relating to acquisitions that we complete.
CORPORATE ORGANIZATION
Our operations are divided into six departments: (1) the Sales and Marketing
Department, (2) the International Sales Department (including sales offices in
Sweden, Germany, the Czech Republic, and Norway), (3) the Purchasing Department,
(4) the Operations Department (including shipping, warehouse and quality control
and production groups), (5) the Finance/Accounting Department (including MIS),
and (6) manufacturing. The Sales and Marketing Department covers sales in the
United States, Canada, and Latin America. Account Managers and Customer Service
Representatives service this department from our North Miami, Florida
headquarters. The International Sales Department covers sales in Eastern and
Western Europe, with offices in Sweden, Germany, the Czech Republic, and Norway,
and exclusive distributors in Russia and Ukraine. See Note 5 of Notes to the
Consolidated Financial Statements for disclosure on our operating segments.
EMPLOYEES
As of December 31, 2002, we employed 139 people at the following
locations: Miami -44; Norway -24; Pennsylvania -9; Sweden -8; Czech Republic
- -44; and Germany -10. Company wide, 28 employees work in
administration/accounting, 7 employees work in purchasing, 56 employees work in
sales and marketing, and 48 employees work in operations. None of our employees
are covered by collective bargaining agreements. We believe that our
relationship with our employees is good.
GOVERNMENT REGULATION
We are not currently subject to direct regulation by any government
agency, other than regulations applicable to businesses generally, and there are
currently few laws or regulations directly applicable to networking and computer
connectivity products. There can be no assurance that laws or regulations
adopted in the future relating to our business will not adversely affect our
business.
16
ITEM 2. DESCRIPTION OF PROPERTIES
Our executive offices are located in North Miami, Florida. The table
set forth below identifies the principal properties we currently utilize as of
December 31, 2002. All properties are leased, are in good condition and are
adequate for our present requirements. RSB Holdings, Inc., a related party, owns
our corporate headquarters, product assembly and central warehouse, and leases
such property to us. The mortgage on the property, in a principal amount of
approximately $181,000 at December 31, 2002, has been guaranteed by the Company.
Under the terms of our credit agreement, RSB Holdings has executed landlord
waivers, permitting the lender the priority right to enter our premises and
seize collateral in the event of a default under the credit agreement. See Note
8 of Notes to Consolidated Financial Statements for information regarding the
financial terms of our leases.
SQUARE
FACILITY DESCRIPTION LOCATION FOOTAGE
- -------------------- -------- -------
Corporate Headquarters, Product
Assembly and Central Warehouse North Miami, FL 30,000
Sales Office and Warehouse Oslo, Norway 18,300
Sales Office and Warehouse Munich, Germany 12,000
Sales Office and Warehouse Brno, Czech Republic 10,650
Sales Office and Manufacturing Broomall, Pennsylvania 5,085
Sales Office and Warehouse Tierp, Sweden 5,000
Sales Office and Warehouse Prague, Czech Republic 4,500
We also utilize a bonded warehouse in Rotterdam, Netherlands. We pay
rent for this warehouse based upon the number of pallets which we store in this
facility from time to time.
ITEM 3. LEGAL PROCEEDINGS
As of the date of this Form 10-K, we were not a party to any material
legal proceedings, nor, to our knowledge, are any such proceedings threatened.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders during the
fourth quarter of the 2002 fiscal year.
The Company's common stock is listed on the NASDAQ SmallCap Market and
is required to comply with the NASDAQ SmallCap Market rules. One of those rules
requires that the Company obtain shareholder approval of issuances of more that
20% of the Company's outstanding shares of common stock before issuance. The
Company's 2002 private placement, in which the Company issued an amount of
common stock equal to 24.8% of the Company's then outstanding common stock, did
not comply with such rule. In order to correct the non-compliance, the Company,
in January 2003, with the consent of NASDAQ, exchanged 230,000 shares of its
Series A preferred stock for 230,000 shares of the common stock issued in the
2002 private placement. The preferred stock was then automatically converted
back into common stock upon the approval of the Company's shareholders of the
issuance of the 230,000 shares of common stock at a special meeting held on
March 26, 2003.
At the special meeting, our shareholders approved: (i) the issuance of
230,000 shares of authorized but unissued common stock upon the conversion of an
equal number of shares of our Series A preferred stock, (ii) the issuance of
three-year warrants to purchase up to 118,750 shares of our common stock at an
exercise price of $1.10 per share to the selling agents in our December 2002
private placement, and (iii) the issuance of up to 59,375 shares of our common
stock as liquidated damages if we do not timely satisfy our registration rights
obligation in connection with our December 2002 private placement. Holders of
53% of the Company's outstanding common shares attended the meeting, in person
or by proxy. The matters described above were approved by the following vote:
In Favor: 2,351,705
Against: 155,034
Abstain: 401,800
17
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been quoted on the NASDAQ Small Cap Market under
the symbol "AESP" since February 12, 1997. Our common stock purchase warrants
were quoted on the NASDAQ Small Cap Market from February 12, 1997 until they
expired by their terms on February 12, 2002. The following table sets forth the
high and low bid prices for our common stock for each quarter during our two
most recent fiscal years, as reported by NASDAQ:
COMMON STOCK WARRANTS
--------------------------- --------------------------
HIGH LOW HIGH LOW
------------ ------------ ----------- -----------
2001
- ----
First Quarter $2.59 $1.38 $0.44 $0.09
Second Quarter 3.47 1.53 0.47 0.09
Third Quarter 3.69 2.25 0.27 0.12
Fourth Quarter 3.02 1.46 0.33 0.03
2002
- ----
First Quarter 2.40 0.71 0.01 0.01
Second Quarter 1.43 0.44
Third Quarter 2.15 0.72
Fourth Quarter 2.20 0.79
The above prices reflect interdealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
At March 24, 2003, the number of holders of record of our common stock
was 88. However, we estimate that there are also approximately 1,300 beneficial
holders of our common stock.
On February 12, 2002, our outstanding publicly traded common stock
purchase warrants to purchase 920,000 shares of our common stock at an exercise
price of $6.90 per share (which warrants were issued in connection with our
February 1997 initial public offering), expired by their terms.
We have never paid any dividends on our common stock and we do not
intend to pay any cash dividends on our common stock for the foreseeable future.
We intend to reinvest our earnings, if any, in the growth and expansion of our
business. Other than limitations on our borrowing based upon a borrowing base
formula and other limitations imposed on us by our credit facility, there are no
restrictions that limit our ability to pay dividends.
18
The market price of our common stock has fluctuated in the past and is
likely to continue to be highly volatile and could be subject to wide
fluctuations. In addition, the stock market generally, and technology-related
securities in particular, may experience extreme price and volume fluctuations
that may be unrelated to or disproportionate to the operating performance of
companies. Such fluctuations, and general economic and market conditions, may
adversely affect the market price of our common stock.
In December 2002, we completed the sale of 1,187,500 shares of our
common stock in a private placement at a price of $1.00 per share (before
underwriting commissions and expenses aggregating $245,000), yielding net
proceeds of $943,000. The private placement was completed in accordance with the
exemption from registration provided in Section 4(2) of the Securities Act of
1933, as amended, and Regulation D thereunder. The net proceeds of the placement
were used for working capital. In connection with the placement, the Company
agreed to issue a warrant to designees of Newbridge Securities Corporation and
View Trade Securities Inc., who acted as the placement agents, to purchase an
aggregate of 118,750 shares at an exercise price of $1.10 per share. We have
filed a registration statement (which has not yet become effective) to register
for public resale the shares of common stock sold in the private placement.
The Company's common stock is listed on the Nasdaq SmallCap Market and
is required to comply with the Nasdaq SmallCap Marketplace Rules. One of those
rules requires that the Company obtain shareholder approval of issuances of more
than 20% of the Company's outstanding shares of common stock before issuance.
The Company's 2002 private placement, in which shares of the Company's
authorized but unissued common stock equal to 24.8% of the Company's then
outstanding common stock were issued, did not comply with the Nasdaq Marketplace
Rules. In order to correct the Company's violation of the rule, the Company,
effective January 16, 2003, with the consent of Nasdaq, exchanged 230,000 shares
of common stock sold in the private placement for an equal number of the
Company's Series A preferred stock. The preferred stock was then automatically
converted back into common stock upon the Company's shareholders' approval of
the share issuances at a special shareholders' meeting held on March 26, 2003.
In June 2001, we completed a private placement of 573,900 shares of our
common stock at a price of $2.00 per share before underwriting commissions and
expenses of $210,800. The private placement was completed in accordance with the
exemption from registration provided in Section 4(2) of the Securities Act of
1933, as amended, and Regulation D thereunder. We used the net proceeds of the
placement (approximately $.9 million) to complete the acquisition of Intelek and
for working capital. In connection with the placement, we issued a warrant to
designees of Newbridge Securities Corporation, which acted as the placement
agent, to purchase 57,390 shares of our common stock at an exercise price of
$2.20 per share. Additionally, we have subsequently registered for resale in the
public market all of the shares of common stock issued in the Intelek
acquisition and sold in the private placement.
We intend to distribute to the holders of our outstanding common stock
(the "Warrant Dividend"), as of the record date of April 10, 2003, on a pro-rata
basis, common stock purchase warrants to purchase one share of common stock for
each share owned as of the record date (the "Warrants"). The Warrants will be
non-transferable. The Warrant exercise period
19
will commence on the date following the effectiveness of a registration
statement registering the sale of the shares of common stock underlying the
Warrants (the "Warrant Effective Date") and will continue for a period of
one-year thereafter. The exercise price of the Warrants will be as follows:
o For the 90 day period following the Warrant Effective Date, the
Warrants will be exercisable at an exercise price of $1.50 per
share,
o For the subsequent 90 day period following the completion of the 90
day period referred to above, the Warrants will be exercisable at
an exercise price of $2.50 per share, and
o For the balance of the term of the Warrants, the Warrants will be
exercisable at an exercise price of $5.50 per share.
Any proceeds received by us from the exercise of the Warrants will be
used for general working capital purposes or for acquisitions. Additionally, we
will pay NASD licensed broker-dealers a fee of ten percent (10%) of the gross
proceeds received upon the exercise of the Warrants for their services in
connection with the solicitation of the exercise of the Warrants. Such fee will
only be paid in accordance with applicable NASD rules.
We intend to file a registration statement with the SEC shortly after
the record date of the Warrant Dividend to register the issuance of the shares
of common stock underlying the Warrants.
Our Articles of Incorporation and By-Laws contain provisions that may
have the effect of discouraging certain transactions involving an actual or
threatened change of control of our company. In addition, our Board of Directors
has the authority to issue up to 1,000,000 shares of preferred stock in one or
more series and to fix the preferences, rights and limitations of any such
series without shareholder approval. Further, two of our executive officers
(Messrs. Stein and Briskin), who collectively at present own approximately 26%
of our outstanding common stock, have provisions in their employment agreements
requiring us to pay, under certain circumstances, each of them $750,000 in the
event of a change in control of our company. Furthermore, such payments which
exceed a certain level of compensation may not be deductible for us for federal
corporate income tax purposes. The ability to issue preferred stock and the
change in control payments could have the effect of discouraging unsolicited
acquisition proposals or making it more difficult for a third party to gain
control of our company, or otherwise could adversely affect the market price of
our common stock.
20
ITEM 6. SELECTED FINANCIAL DATA
The following table represents our selected consolidated financial
information. The selected financial data set forth below should be read in
conjunction with the Consolidated Financial Statements and notes thereto and
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS which contains a description of the factors that materially affect
the comparability from period to period of the information presented herein.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ----------- ----------- ------------ ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net Sales $ 29,664 $ 30,183 $ 30,231 $ 26,466 $ 21,969
Cost of sales 20,987 22,114 18,722 16,300 13,646
Operating expenses 10,955 12,050 10,464 9,267 11,697
-------- -------- -------- -------- --------
Income (loss) from operations (2,278) (3,981) 1,045 899 (3,374)
Interest expense and other (188) 218 163 263 1,164
-------- -------- -------- -------- --------
Income (loss) before income taxes (2,090) (4,199) 882 636 (4,538)
Income tax expense 201 15 170 249 267
-------- -------- -------- -------- --------
Net Income (loss) $ (2,291) $ (4,214) $ 712 $ 387 $ (4,805)
======== ======== ======== ======== ========
EARNINGS (LOSS) PER SHARE:
Basic (.49) (1.05) .20 .12 (1.99)
Diluted (.49) (1.05) .18 .10 (1.99)
AS OF DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- ----------
(IN THOUSANDS)
BALANCE SHEET DATA:
Accounts receivable $ 4,347 $ 4,094 $ 3,299 $ 3,058 $ 3,038
Inventories 5,500 5,930 7,411 5,689 6,158
Working capital 1,740 2,556 4,959 4,653 4,496
Total assets 13,846 14,243 15,426 12,488 12,415
Current liabilities 9,740 9,184 7,884 6,353 6,531
Long term debt, less current portion 11 30 119 229 221
Shareholders' equity 4,095 5,029 7,423 5,907 5,663
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS RELATING TO OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
IN ADDITION TO THE OTHER INFORMATION CONTAINED IN OR INCORPORATED BY
REFERENCE INTO THIS FORM 10-K, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK
FACTORS RELATED TO OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
OUR OPERATING RESULTS ARE UNCERTAIN AND LOSSES MAY CONTINUE
Our net income (loss) for the 2002, 2001 and 2000 fiscal years was
$(2,291,000), $(4,214,000) and $712,000, respectively. While we have expended
our capital to make acquisitions and to create an infrastructure to support our
business, we cannot assure you that we will achieve or sustain profitable
operations.
OUR WORKING CAPITAL REQUIREMENTS MAY INCREASE AND FUTURE REQUIRED FUNDING MAY
NOT BE AVAILABLE
We operate our business using working capital derived from our
operations (during periods when our operations are cash flow positive) and from
funds available from our lines of credit. We have made efforts to improve our
cash flow through cost reductions, collections of accounts receivable and
reductions in our inventory. We have also raised working capital through private
placements of our securities. We believe that our internally generated cash flow
from operations combined with the proceeds of our recently completed private
placement and borrowings available under our lines of credit will be sufficient
to fund our current operations for the next twelve months, provided our efforts
to increase our working capital and to obtain a replacement U.S. line of credit
are successful. We may also sell additional debt or equity securities in order
to meet our current and future working capital requirements or to fund future
acquisitions, including shares of common stock issuable upon the exercise of the
warrants to be issued in the Warrant Dividend. If we are unable to generate
sufficient cash flow from operations or reduce our expenses, and we are unable
to obtain the working capital required for our business, our financial condition
and results of operations will be materially and adversely affected.
OUR U.S. CREDIT AGREEMENT IMPOSES RESTRICTIONS AND WE ARE NOT IN COMPLIANCE WITH
SOME OF THE RESTRICTIONS; OUR U.S. LINE OF CREDIT COULD BE CALLED IF WAIVERS OF
FINANCIAL COVENANTS AND DEFAULTS ARE NOT OBTAINED
We have a $1.9 million revolving line of credit with a U.S. financial
institution secured by our U.S. assets. The agreement governing the line of
credit contains covenants that impose limitations on us (including the
requirement that any acquisition which we make be approved by the financial
institution), limits our borrowings based upon a borrowing base formula tied to
the value of our accounts receivable and inventory from time to time, and
22
requires us to be in compliance with certain financial covenants. If we fail to
make required payments, or if we fail to comply with the various covenants
contained in our credit agreement, the lender may be able to accelerate the
maturity of such indebtedness. Our revolving line of credit, as extended,
currently expires on July 22, 2003. As part of the most recent extension
agreement signed in January 2003, the interest rate charged on the outstanding
balance was raised to prime + 2% for the period from January 17, 2003 to April
23, 2003 and to prime + 3% for the period thereafter until maturity. As of
December 31, 2002, we were not in compliance with the financial covenants
regarding tangible net worth and leverage contained in our credit agreement. A
waiver has been granted by the financial institution with respect to the year
ended December 31, 2002. We also anticipate that we may violate the financial
covenants in our credit agreement during future periods, including as of the end
of the quarter ended March 31, 2003, and we will need waivers for such financial
covenant violations unless our results of operations substantially improve.
While there can be no assurance, we anticipate that our lender will continue to
waive such covenant violations. If our lender does not waive such covenant
violations and seeks to foreclose on the assets securing our line of credit, it
would have a material and adverse effect on our business
OUR LENDER HAS ADVISED US THAT IT DOES NOT PRESENTLY INTEND TO RENEW OUR LINE OF
CREDIT
Our lender has advised us that at this time it is unlikely that
they will renew our line of credit, although they have indicated that they will
continue to extend our line of credit for limited periods of time to allow us to
obtain alternative financing from another lender. While we expect to be able to
find alternative financing, there can be no assurance that we will be able to do
so. In the event that we are unable to find alternative financing to replace our
line of credit and our current lender declines to further extend our line of
credit, it would have a material and adverse effect on our business.
OUR OPERATING RESULTS MAY BE ADVERSELY EFFECTED BY MANY FACTORS
Our quarterly and annual operating results are impacted by many
factors, including the timing of orders, the availability of inventory to meet
customer requirements and inventory obsolescence. A large portion of our
operating expenses are relatively fixed. Since we typically do not obtain
long-term purchase orders or commitments from our customers, we must anticipate
the future volume of orders based upon the historic purchasing patterns of our
customers and upon our discussions with our customers as to their future
requirements. Cancellations, reductions or delays in orders by a large customer
or a group of customers and inventory obsolescence could have a material adverse
impact on our revenues and results of operations.
IMPACT OF FLUCTUATIONS IN INTEREST RATES AND EXCHANGE RATES COULD NEGATIVELY
AFFECT OUR RESULTS
We are exposed to market risk from changes in interest rates, and as a
global company, we also face exposure to adverse movements in foreign currency
exchange rates.
Our earnings are affected by changes in short-term interest rates as a
result of our lines of credit. If short-term interest rates averaged 2% more in
2002 and 2001, our interest expense and loss before taxes would have increased
by $44,600 and $32,600, respectively. For 2000, our
23
interest expense would have increased and our income before taxes would have
decreased by $47,800. The increase in the interest rate on our U.S. line of
credit in 2003 will increase our interest expense and decrease our income before
taxes by approximately $31,000 in 2003, compared to interest expense and income
before taxes under the prior interest rate.
Our revenues and net worth are also affected by foreign currency
exchange rates due to having subsidiaries in Norway, Sweden, Germany, and the
Czech Republic. While our sales to our subsidiaries are denominated in U.S.
dollars, each subsidiary owns assets and conducts business in its local
currency. Upon consolidation, our subsidiaries' financial results are impacted
by the value of the U.S. dollar. A uniform 10% strengthening as of December 31,
2002, 2001 and 2000 in the value of the dollar would have resulted in reduced
revenues of $1.6 million, $1.3 million and $1.3 million, respectively. A uniform
10% strengthening as of December 31, 2002, 2001 and 2000 in the value of the
dollar would have resulted in a reduction of our consolidated net worth by
$201,000, $193,600 and $418,400, respectively. We find it impractical to hedge
foreign currency exposure and, as a result, will continue in the future to
experience foreign currency gains and losses.
WE WILL NOT PAY DIVIDENDS ON OUR COMMON STOCK EVEN IF WE ARE PROFITABLE
We can make no assurances that our future operations will be
profitable. Should our operations be profitable, it is likely that we would
retain our earnings in order to finance future growth and expansion. Further,
our U.S. line of credit agreement contains restrictions on the payment of
dividends, including lender approval. Therefore, we do not presently intend to
declare or pay cash dividends on our common stock, and it is not likely that any
dividends will be paid in the foreseeable future. This policy could have an
adverse effect on the market price of our common stock.
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, released by the U.S. Securities and
Exchange Commission, encourages all companies to include a discussion of
critical accounting policies or methods used in the preparation of financial
statements. Our consolidated financial statements include a summary of the
significant accounting policies and methods used in the preparation of our
consolidated financial statements.
Management believes the following critical accounting policies affect
the significant judgments and estimates used in the preparation of the financial
statements.
REVENUE RECOGNITION
The Company's customers include original equipment manufacturers,
distributors and other value added resellers. Sales are generally not made
directly to end-users of the Company's products.
Revenues are recognized at the time of shipment to customers, by
which time the customer has agreed to purchase the merchandise, is obligated to
pay the fixed, reasonably collectible sales price and ownership and risk of loss
has passed to the customer.
24
The Company's sales are not subject to rights of future return.
Warranties are provided on certain of the Company's networking products for
periods ranging from five years to lifetime. Warranty claims have historically
been nominal. The Company estimates provisions for sales returns, allowances,
product warranties and losses on accounts receivable.
The Company's credit policy provides for an evaluation of the
credit worthiness of new customers and for continuing evaluations of customers'
financial condition and credit worthiness. Although the Company generally does
not require collateral, letters of credit or deposits may be required from
customers.
The Company includes shipping and handling fees billed to customers
as revenues. Costs of sales include outbound freight and preparing customers'
orders for shipment. Included in net sales in the accompanying consolidated
statements of operations for the years ended December 31, 2002, 2001, and 2000
are shipping and handling fees of $723,000, $926,000, and $841,000 respectively.
USE OF ESTIMATES
Management's discussion and analysis of financial condition and results
of operations is based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, and expenses, and related disclosure of
contingent assets and liabilities. On an ongoing basis, management evaluates
these estimates, including those related to allowances for doubtful accounts
receivable and the carrying value of inventories and long-lived assets.
Management bases these estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgements about the carrying value
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our
consolidated financial statements and notes thereto.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
For the year ended December 31, 2002, we recorded net sales of $29.7
million, compared to net sales of $30.2 million for the year ended December 31,
2001, a decrease of $.5 million or approximately 1.7%. Revenues in 2002 include
full year Intelek sales of $5.6 million compared to $1.8 million for the prior
year, based on four months of ownership in 2001. Further, the declining value of
the US dollar increased sales in Western Europe when converted from local
currency to U.S. dollars in the amount of approximately $1.6 million. Without
the impact of this acquisition and foreign currency change, revenues would have
declined from $28.4 million in 2001 to $22.5 million in 2002, a decrease of $5.9
million or approximately 20.8%. This drop in net sales for our full year
operations reflects the continuing depressed economic conditions in our
worldwide
25
markets, which have resulted in pricing pressures and to a lesser degree, unit
reductions in volume on certain of our products. As a result, the Company has
had to adjust some of its prices downward to meet competitive situations. Gross
profit percentages did not decline as well, as the Company was able to secure
lower pricing from its suppliers. Overall, the Company posted net revenue
declines in its U.S., Norwegian, Swedish and Russian markets of $1,500,000,
$1,500,000, $400,000 and $1,500,000, respectively, before the effect of foreign
currency changes. The Company's U.S. market was affected by an approximately 10%
- - 20% drop in selling prices, but was able to maintain a relatively consistent
level in unit sales. The Norwegian market's unit volume was adversely affected
by a competitive situation involving former employees who established a
competing company. The Swedish and Russian markets were affected by both sales
price declines and unit volume reductions. Alternatively, the Company's German
operations recorded a sales increase of $500,000 due to the employment in early
2002 of a new sales team that expanded the Company's customer base and product
line in Germany. We expect that the factors which impacted our 2001 and 2002 net
sales will continue to impact our 2003 net sales.
Cost of sales for the year ended December 31, 2002, decreased to $21.0
million, compared to cost of sales of $22.1 million for the year ended December
31, 2001. This decrease of $1.1 million, when coupled with a smaller drop in net
sales, led to a rise in gross profit to $8.7 million in 2002 compared to $8.1
million in 2001. The gross profit percentage rose in 2002 to 29.3% compared
26.7% in the prior year. This improvement in gross profit was due to two items,
a decline in the amounts set aside for inventory obsolescence and a change in
the sales mix to higher margin Signamax products in the U.S. The provision for
inventory impairment decreased from $1,129,000 in 2001 to $538,000 in 2002. We
recorded these impairment provisions based on the sudden and significant
decrease in demand which began in 2001 for certain of our products caused by the
worldwide economic slowdown, specifically in the technology markets for our
goods. This decrease in demand had a more significant effect on our inventory in
2001, thereby requiring a greater inventory impairment charge in 2001, compared
to 2002. These provisions were calculated based on the carrying value of
specific inventory items compared to historical and estimated sales volumes and
sales prices. Without the effect of the inventory impairment charges in each
year, the gross profit would have been relatively unchanged from year to year at
approximately $9.2 million, while the gross profit percentage would have
increased from 30.5% in 2001 to 31.1% in 2002. The remainder of the improvement
in gross margin percentage was due to the $1.2 million decrease in U.S. sales to
our Russian distributor in 2002, whereby that customer, whose gross margins at
20% - 25% run lower than the historic consolidated average, accounted for a
smaller percentage of U.S. sales. Essentially, these sales were replaced by
sales at a higher margin.
26
Selling, general and administrative ("S,G & A") expenses increased
to $11.0 million for the year ended December 31, 2002, compared to $10.5 million
for the year ended December 31, 2001. The following table reconciles the S,G & A
expenses for each year by segregating those items that could be considered
isolated or non-recurring (in thousands):
2002 2001
----------- --------
Total S,G & A expenses: 10,954 10,508
Intelek - full year (1,350) --
Intelek - four months -- (553)
Options and stock for services (93) (161)
Goodwill amortization -- (203)
---------- --------
9,511 9,591
---------- --------
Our Czech Republic subsidiary, Intelek, was purchased in August 2001, therefore
only four months of operations are included in 2001. Based on the table above,
operational S,G & A expenses were relatively constant from 2001 to 2002,
decreasing $80,000 or less than 1%. Increases in insurance costs and marketing
expenses (new computer connectivity catalog) of approximately $150,000 were
offset by $200,000 in cost reductions in our U.S. workforce and other variable
expenses, such as office expenses. Subsequent to the Intelek acquisition, in
early 2002, the Company instituted expense reduction measures at Intelek,
thereby decreasing S,G&A expenses at Intelek on an annualized basis from 2001 to
2002. We are continuing to closely monitor our S,G & A expenses and may make
additional headcount reductions if sales levels do not begin to increase in
future periods. We believe that if sales increase in the future, we will see a
reduction in S,G & A expenses as a percentage of net sales, since many of our
S,G & A expenses are relatively fixed.
Amortization of intangible assets was discontinued on January 1, 2002
as we adopted Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets". SFAS 142 requires, among other things,
that companies no longer amortize goodwill, but instead test goodwill for
impairment at least annually. During the quarter ended June 30, 2002, we
completed the transitional goodwill impairment test and at December 31, 2002, we
completed our annual goodwill impairment test, determining that we had no
impairment of our goodwill at either date. We will continue to assess the value
of our goodwill during future periods in accordance with the rules.
In 2001, in accordance with the provisions of Statement of Financial
Accounting Standards No. 121, we determined that the carrying value of certain
long-lived intangible assets associated with certain acquisitions may not be
recoverable. The resulting impairment of $1,542,000, was recorded as an
impairment of long-lived assets in the accompanying Consolidated Statements of
Operations for the year ended December 31, 2001. No such impairment charge was
required in 2002.
As a result of the above factors, the loss from operations for the
year ended December 31, 2002 was $2,278,000, compared to a loss from operations
of $3,981,000 for the year ended December 31, 2001, a reduction in the loss from
operations of $1,703,000.
27
Interest expense dropped from $292,000 in 2001 to $202,000 in 2002
due to a decrease in the average outstanding balance under our U.S. line of
credit, as well as a significant decline in the applicable interest rate, which
is variable and pegged to the prime rate.
Due to a material drop in the value of the U.S. dollar against those
foreign currencies where we conduct operations in local currency, namely
Germany, Norway, Sweden and the Czech Republic, we recorded a gain from foreign
exchange of $243,000 in the year ended December 31, 2002, compared to a loss
from foreign exchange of $19,000 in 2001, when the U.S. dollar performed
relatively well against foreign currencies.
The loss before income taxes narrowed in 2002 to $2,090,000, compared
to $4,199,000 in 2001, as a result of the factors mentioned above.
The provision for income taxes has been recorded for the past two
years on those European subsidiaries that recorded profitable operations, namely
Jotec and Lanse in Norway and Intelek in the Czech Republic. Additionally, we
recorded a provision of $130,000 as a result of a preliminary assessment on an
in-process tax audit at our German subsidiary. For 2002, the provision is
$201,000 and for 2001, the provision is $15,000. Realization of the net deferred
tax assets recorded on the U.S. losses, resulting primarily from net operating
loss carryforwards, is not considered more likely than not and accordingly, a
valuation allowance has been recorded for the full amount of such assets.
As a result of the foregoing factors, we incurred a net loss of $2.3
million for the year ended December 31, 2002, compared to a net loss of $4.2
million for the year ended December 31, 2001. For the year ended December 31,
2002, the loss per common share, both basic and diluted, was $.49, compared to a
basic and diluted loss per common share of $1.05 for the year ended December 31,
2001. Weighted average shares outstanding were 4,685,712 in 2002 and 4,028,112
in 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
For the year ended December 31, 2001, we achieved net sales of $30.2
million, compared to net sales of $30.2 million for the year ended December 31,
2000. Revenues in 2001 were positively impacted by $1.3 million for the full
year sales of Lanse (2001 revenues of $3.0 million compared to 2000 revenues of
$1.7 million for the seven months of ownership in 2000) and by $1.8 million in
2001 sales by Intelek (acquired in August 2001). Without the impact of these
acquisitions, net sales would have decreased by $3.1 million or 10.2% from 2000.
This significant drop in sales throughout our worldwide operations for
the year ended December 31, 2001 was due to several factors including worsening
worldwide economic conditions generally in the technology market and
specifically in several of our markets.
For the year ended December 31, 2001, U.S. original equipment
manufacturer (OEM) sales totaled $4.9 million reflecting a reduction of $900,000
(15.7%) compared to $5.8 million for the year ended December 31, 2000. U.S.
networking sales were $7.3 million for 2001,
28
compared to $7.8 million for 2000. International sales were $17.8 million
reflecting an increase of $1.5 million (9.3%) compared to $16.3 million for the
year ended December 31, 2000. However, this increase related to increased sales
from Lanse and Intelek. Without sales from companies acquired, international
sales for the year ended December 31, 2001 would have been $16.1 million or 8.2
% lower from period to period.
Our gross profit margin for the year ended December 31, 2001 was 26.7%,
compared to 38.1% for the year ended December 31, 2000. The primary reasons for
the gross profit margin decline were the impact of lower margins relating to
sales by Lanse and Intelek (which have gross margins lower than our historic
margins), provisions for inventory impairment taken in 2001, and the economic
slowdown which heightened price competition as a result of reduced demand for
the Company's products. We recorded provisions for inventory impairment totaling
$1.1 million in 2001 due to the sudden and significant decrease in demand for
our products resulting from decreased spending on technology and a generally
sluggish economy, as well as our ongoing business transition from PC
connectivity products to networking products. These provisions were estimated
based on the carrying value of specific current inventory balances compared to
current sales volumes and prices and estimated future sales price analysis
prepared by our sales departments for computer connectivity and networking
products in each of our geographic areas of operations. The provision for
inventory obsolescence was made for certain specific inventory items in the U.S.
of $635,000 and in Western Europe of $494,000. Had we not recorded the $1.1
million provision for inventory impairment in 2001, our gross profit margin
would have been 30.5% of net sales. The remainder of the gross profit percent
decline from 38.1% in 2001 to 30.5% in 2002 (net of the inventory obsolescence
provision), was due to depressed technology market conditions, which pushed
market prices lower for many of the Company's products. We were forced to meet
the lower prices in order to seek to maintain market share and revenue levels,
and this, coupled with an inability to immediately lower our supplier prices to
the same degree, drove our gross margins lower from period to period.
Selling, general and administrative ("SG&A") expenses increased by
approximately $44,000, or .4%, to $10.5 million for the year ended December 31,
2001, from $10.5 million for the year ended December 31, 2000. The increase in
SG&A expenses is as a result of cost reductions offset by $542,000 in expenses
relating to Intelek's operations subsequent to its acquisition by us. We also
incurred a $161,000 non cash charge in 2001 relating to a stock option granted
to an investment banking firm for its services and recorded an increase in our
provision for losses on accounts receivable of $170,000, due to worsening
economic conditions.
Based on current market conditions and an analysis of projected
undiscounted cash flows calculated in accordance with the provisions of
Statement of Financial Accounting Standards No. 121, we determined in 2001 that
the carrying value of certain long-lived assets associated with our 1997
purchase of Focus Enhancement's Networking Division (Focus), March 1999 purchase
of CCCI., May 2000 purchase of Lanse AS, and August 2001 purchase of Intelek
spol. s.r.o. may not be recoverable. The resultant impairment necessitated a
write-down of goodwill of approximately $331,000 related to Focus, $317,000
related to CCCI, $680,000 related to Lanse AS, and $214,000 related to Intelek
spol. s.r.o. The estimated fair value of these long-lived assets has been
determined by calculating the present value of estimated expected future cash
flows using a discount rate commensurate with the risks involved.
29
In the second and third quarters of 2001, we began steps to modify our
cost structure and reduce expenditures in order to respond to the economic
slowdown affecting our sales. As a result, worldwide employment dropped at
December 31, 2001 by 20% from March 31, 2001 levels.
Amortization of intangible assets was $203,000 for the year ended
December 31, 2001, an increase of $20,000 or 11 % over amortization of $183,000
for the year ended December 31, 2000. This increase is primarily attributable to
amortization charges arising as a result of our acquisition of Lanse in May
2000. Due to the our adoption of Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets" during the quarter ended
March 31, 2002, amortization of goodwill has been effectively eliminated as of
January 1, 2002. See "Recent Accounting Pronouncements" for further discussion
of SFAS 142.
As a result of the aforementioned factors, the loss from operations for
the year ended December 31, 2001 was $(4.0) million, a decrease of $5.0 million
from income from operations of $1 million for the year ended December 31, 2000.
Interest expense was relatively flat from period to period ($292,000 in
2001 compared to $285,000 for 2000). Interest income decreased due primarily to
lower interest rates. Income tax expense decreased to $15,000 in 2001 from
$170,000 in 2000, as a result of decreased profitability in Europe. Since we
have U.S. income tax loss carry-forwards, and currently maintain a tax valuation
allowance of $3.6 million, we do not expect to pay U.S. income tax in the
forseeable future.
As a result of the foregoing factors, we incurred a net loss of $4.2
million for the year ended December 31, 2001, a decrease of $4.9 million
compared to net income of $712,000 for the year ended December 31, 2000. The
loss per diluted share was $(1.05) for the year ended December 31, 2001,
compared to the earnings per diluted share of $.18 for the year ended December
31, 2000. Weighted average shares outstanding were 4,028,112 in 2001, compared
to 3,929,742 in 2000 (on a diluted basis), due principally to shares issued in
our June 2001 private placement.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Historically, we have financed our operations primarily with cash flow
from operations and with borrowings under our available lines of credit.
30
Below is a chart setting forth our contractual payment obligations as
of December 31, 2002 which have been aggregated in order to facilitate a basic
understanding of our liquidity (in thousands):
PAYMENTS DUE BY PERIOD
----------------------------------------------------------
LESS THAN 3-5 MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS YEARS 5 YEARS
----------- ----------------- ------------- ---------- ------------
Lines of credit $2,457 $2,457 $ -- $ -- $ --
Long-term debt 45 34 11 -- --
Operating leases 3,068 627 1,143 792 506
----------- ----------------- ------------- ---------- ------------
Total contractual cash
obligations $5,570 $3,118 $1,154 $ 792 $ 506
=========== ================= ============= ========== ============
We also have employment agreements with two of our officers (who are
also our principal shareholders) which require annual payments of base
compensation, plus, in the event we are profitable, additional bonus
compensation. See Item 11, "Executive Compensation - Employment Agreements."
During 2002, we completed a private placement of shares of our common
stock. We sold 1,187,500 shares in the private placement at a gross purchase
price of $1.00 per share. The net proceeds of the placement ($942,000) were used
for working capital purposes.
At December 31, 2002, our working capital was $1.7 million, a decrease
of 35% from working capital of $2.6 million at December 31, 2001. Similarly, our
current ratio was 1.18 at December 31, 2002, compared to 1.28 at December 31,
2001. The accounts with the most significant changes from December 31, 2001 to
December 31, 2002 were the following (in thousands):
2002 2001
------------ ------------
Inventories $ 5,500 $ 5,930
Inventories declined $325 in the U.S. and $105 in Western Europe as a result of
our efforts to reduce the carrying value of our inventory and therefore the
costs invested in our inventory. Further, we recorded a provision for inventory
obsolescence of $162 in the U.S. and $376 in Western Europe in 2002. However,
the inventory obsolescence charge in Western Europe was offset by the effect of
the declining value of the U.S. dollar, which caused an increase in Western
European inventory when converted from local currency to the U.S. dollar.
2002 2001
------------ -------------
Line of credit $ 2,457 $ 2,000
Line of credit borrowings increased principally due to $347 borrowed in the U.S.
as we utilized our line to partially fund our U.S. losses from operations.
2002 2001
------------ -------------
Accounts payable $ 4,499 $ 5,203
In the U.S., accounts payable decreased $638 as a result of our utilization of a
portion of the funds generated from our 2002 private placement to make
additional payments to our vendors.
31
2002 2001
------------ -------------
Accrued expenses $ 928 $ 357
The increase in accrued expenses is due primarily to two items, additional
accruals in the U.S. for professional and other fees of approximately $190 and
an increase in the liability for the value-added tax ("V.A.T.") in Germany of
$130. This V.A.T. liability is offset by a like asset in accounts receivable due
to the goods that are generating the tax being classified as resale items and
therefore, the tax generated by the vendor invoice is then offset by the tax due
from the customer.
2002 2001
----------- -------------
Customer deposits and other $ 820 $ 449
Customer deposits increased principally in the fourth quarter of 2002, when we
received additional advance payments from a significant customer of
approximately $320.
For the year ended December 31, 2002, $1,154,000 of cash was used by
operations. The primary reasons for the use of cash in 2002 was the net loss of
$2,291,000 reduced by non-cash items such as depreciation and amortization of
$270,000 and a provision for inventory obsolescence of $538,000. Additionally,
uses of cash were generated by a reduction in accounts payable and accrued
expenses of $762,000 and an increase in accounts receivable of $257,000, offset
by an inventory reduction of $675,000. Net cash used in investing activities was
$161,000, due to additions to property and equipment of $295,000 offset by
proceeds on the sale of investments of $78,000 and collections on a note
receivable of $50,000. Cash of $1,031,000 was provided by financing activities
primarily from the 2002 private placement, which raised net cash for the Company
of approximately $942,000. As a result of the foregoing, our cash position
decreased $284,000 between December 31, 2001 and December 31, 2002. That
decrease, combined with a increase of $184,000 attributable to the effects of
exchange rate changes on cash, produced an overall decrease in cash of $100,000.
We are continuing efforts to improve our cash position through personnel and
expense reductions, collection of accounts receivable, and a reduction in our
inventory.
In January, 2003, we obtained an extension of a $1.9 million U.S. based
line of credit from a financial institution. Borrowings available under the line
of credit, which matures on July 23, 2003, bear interest at the rate of prime
plus two percent (increasing to prime plus three percent in April 2003 until
maturity). Borrowings under the line of credit are based on specific percentages
of our receivables and inventories. The line of credit is secured by a lien on
our U.S. assets, including accounts receivable and inventories. The line of
credit is also guaranteed by our principal shareholders, who have pledged a
portion of the shares of our common stock that they own to secure their
respective guarantees. Under the terms of the loan agreement, we are required to
comply with certain affirmative and negative covenants and to maintain certain
financial benchmarks and ratios during future periods. As of December 31, 2002,
we were not in compliance with the tangible net worth and leverage covenants. A
32
waiver has been granted by the financial institution. Additionally, we will
likely not meet our financial covenants in future periods unless our results of
operations substantially improve. While there can be no assurance, we expect
that our lender will continue to waive covenant violations during future
periods. Further, our lender has advised us that at this time it is unlikely
that they will renew our line of credit, although they have indicated that they
intend to continue to extend our line of credit for limited periods of time to
allow us to obtain alternative financing from another lender. While we expect to
be able to find alternative financing, there can be no assurance that we will be
able to do so. As of December 31, 2002, $1,893,000 was outstanding under the
line of credit line and $7,000 was available for borrowing based on applicable
borrowing base formulas. As of March 24, 2003, $1,825,000 was outstanding under
the line of credit and $75,000 was available for borrowing based on
applicable borrowing base formulas.
We believe that revenue growth requires working capital to support the
increased levels of inventory necessary to meet customer demands and to support
accounts receivable generated from increased sales. We further believe that our
internally generated cash flow from operations combined with the proceeds of the
recent private placement of common stock, combined with borrowings available
under our lines of credit, will be sufficient to fund our current operations for
the next twelve months, provided our efforts to increase our working capital and
to obtain a replacement U.S. line of credit are successful. As a result of our
reducing operations at our CCCI facility in Pennsylvania during the latter part
of 2002, we expect to realize expense savings of approximately $400,000 during
2003. We may also consider selling debt or equity securities in order to meet
our current and future working capital requirements or to fund future
acquisitions, including shares issuable upon the exercise of the warrants to be
issued in the Warrant Dividend. If we are unable to generate sufficient cash
flow from operations or in some other fashion, or reduce our expenses, our
operations will be materially and adversely affected.
We do not believe that inflation has had a material effect on our
financial condition or operating results for the last several years, as we have
historically been able to pass along increased costs in the form of adjustments
to the prices we charge to our customers.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting For Asset Retirement Obligations". That standard
requires entities to record the fair value of a liability for an asset
retirement obligation in the period in which it is incurred. When the liability
is initially recorded, the entity will capitalize a cost by increasing the
carrying amount of the related long-lived asset. Over time, the liability is
accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss upon settlement. The standard is effective for fiscal
years beginning after June 15, 2002, with earlier adoption permitted. We believe
that adoption of SFAS No. 143 will not have a material effect on our
consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and technical
corrections. SFAS No. 145 will rescind SFAS No. 4, which required all gains and
losses from extinguishment of debt to be aggregated and, if material, classified
as an extraordinary item, net of related income tax benefit. As a result of SFAS
No. 145, the criteria in APB No. 30 will now be used to classify those gains and
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losses. The new requirements are effective commencing May 15, 2002, with early
application encouraged. We believe that adoption of SFAS No. 145 will not have a
material effect on our consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". The standard requires companies to
recognize costs associated with exit (including restructuring) or disposal
activities at fair value when the related liability is incurred rather than at
the date of a commitment to an exit or disposal plan under current practice.
Costs covered by the standard include certain contract termination costs,
certain employee termination benefits and other costs to consolidate or close
facilities and relocate employees that are associated with an exit activity or
disposal of long-lived assets. The new requirements are effective prospectively
for exit or disposal activities initiated after December 31, 2002 and will be
adopted by us effective January 1, 2003. The adoption of SFAS No. 146 is
expected to impact the timing of recognition of costs associated with future
exit and disposal activities.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure". The Statement amends the
transition provisions of SFAS No. 123 for companies that choose to adopt the
fair value based method of accounting for stock based employee compensation. The
Statement does not amend the provisions of SFAS No. 123 which allow for entities
to continue to apply the intrinsic value-based method as prescribed in APB No.
25, "Accounting for Stock Issued to Employees", however it does amend some of
the disclosure requirements regardless of the method used to account for
stock-based employee compensation. See "Stock-Based Compensation".
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This interpretation addresses the
disclosures required to be made by a guarantor in its interim and annual
financial statements. It also clarifies that a guarantor is required to
recognize at the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. This interpretation was
effective for disclosure purposes as of December 31, 2002 and the recognition
provisions are effective for all guarantees issued or modified after December
31, 2002. As of December 31, 2002 we had no material guarantees for disclosure
purposes.
Interpretation No. 46, "Consolidation of Variable Interest Entities",
clarifies the application of Accounting Research Bulletin No. 51, "Consolidated