ITEM 1: BUSINESS
DPAC Technologies Corp., a California corporation (“DPAC”) through its wholly owned subsidiary, QuaTech, Inc. (“QuaTech”), designs, manufactures, and sells device connectivity and device networking solutions for a broad market. QuaTech sells its products through a global network of distributors, system integrators, value added resellers, and original equipment manufacturers (“OEM”). The Company sells to customers in both domestic and foreign markets.
Basis of Presentation
On April 28, 2005, DPAC entered into a merger agreement, as subsequently amended, with QuaTech for a transaction to be accounted for as a purchase under accounting principles generally accepted in the United States of America. The merger was approved by both QuaTech and DPAC shareholders on February 23, 2006 and was consummated on February 28, 2006. For accounting purposes, the transaction is considered a “reverse merger” under which QuaTech is considered the acquirer of DPAC. Accordingly, the purchase price was allocated among the fair values of the assets and liabilities of DPAC, while the historical results of QuaTech are reflected in the results of the combined company. Except where otherwise noted, the financial information contained herein represents the results of operations of QuaTech through the merger date, and combined QuaTech and DPAC after the merger date of February 28, 2006.
General Description of Business
QuaTech is an industry leader in device networking and connectivity solutions. Through design, manufacturing and support, QuaTech maintains high standards of reliability and performance. Customers include OEM’s, value added resellers (VAR’s) and System Integrators, as well as end-users in many industries, including banking, retail/POS, access control, building automation and security, and energy management. QuaTech is a leading supplier of data connectivity products to financial institutions, serving five of the top ten U.S. banks.
DPAC was incorporated in California in September 1983, originally under the name Dense-Pac Microsystems, Inc., and changed its name to DPAC Technologies Corp. in August 2001.
QuaTech was incorporated in Ohio in 2000 as W.R. Acquisition, Inc. In July 2000, W.R. Acquisition acquired the assets and business of QuaTech’s predecessor, Qua Tech, Inc., an Ohio corporation, and the company changed its name to QuaTech, Inc. The Company has its worldwide headquarters in Hudson, OH.
At the time of the acquisition in July 2000, Qua Tech, Inc. developed and marketed a data acquisition product line as well as a device connectivity product line. The data acquisition product line consisted of analog-to-digital converters, digital I/O hardware, signal conditioning hardware, and related software. The analog to digital converters as well as the digital I/O products were available for a number of computer bus architectures including ISA, PCI, and PC Card. The device connectivity product line included a number of multi-port serial adapters supporting asynchronous and synchronous transmissions. The products were also available on multiple computer bus architectures including ISA, PCI and PC Card. In addition, Qua Tech, Inc. had just completed the release of the initial USB to Serial product line.
Subsequent to the acquisition, QuaTech evaluated the market opportunities in both the data acquisition and device connectivity markets and made the determination to focus product development, along with sales and marketing activities, on the device connectivity product lines. All product development activities related to the data acquisition products were suspended. Sales and marketing activities in support of the data acquisition products were restricted to support of a limited number of existing original equipment manufacturers and resellers.
QuaTech has continued to enhance the device connectivity product line through the development and release of additional products. These products have been developed as a reaction to both general market and specific customer demand. Significant new products released in this timeframe include a full line of universal PCI multi-port serial cards that support both 5V and 3.3V PCI slots, 8 and 16 port versions of the USB to Serial products, ruggedized multi-port, serial PC Card products, and multi-port serial Compact Flash products.
In 2001, QuaTech initiated the development of its serial device server product line that would allow devices with traditional serial ports to be connected to a Local Area Network (LAN) through a TCP/IP connection. This product line was released for commercial availability in late 2003. QuaTech has continued the development of this product line through the release of new product models, including products capable of connecting to the network through a wireless 802.11b interface.
Products
QuaTech products can be categorized into two broad product lines:
Our Device Connectivity products include:
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Multi-port serial boards that add ports to desktop computers to allow for the connection of multiple peripherals with standard interfaces. These products are used in a variety of industries including banking, transportation management, kiosks, satellite communications, and retail point of sale.
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Mobile products that add ports for laptop and handheld computers. These products include multi-port serial adapters, parallel port adapters, and Bluetooth products.
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USB to Serial products that add standard serial ports to any computing environment through a USB port. These products address the need to add connectivity through a solution that is external to the computer. These products are used in several markets including retail point of sale and kiosks.
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Data acquisition products that consist mainly of PC Cards providing analog to digital conversion capability.
Our Device Networking products include:
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Industrial rated, embedded wireless modules that enable OEM customers to add standard 802.11 connectivity capabilities to their products. These modules address the needs of a number of industries including transportation, telematics, warehouse and logistic, and point of sale.
Multi-port serial boards consists primarily of ISA bus and PCI bus products with 1, 2, 4, or 8 asynchronous serial ports as well as single port synchronous serial ports.
Mobile products consists primarily of PC Card and Compact Flash products with 1, 2, or 4 asynchronous serial ports, PC Cards with a single synchronous serial port and a PC Card with a single parallel port.
In March 2005, QuaTech announced the introduction of new four and eight port multiple electrical interface (MEI) products to the device server product line. These products were released for general availability in May 2005.
In March 2005, QuaTech announced the introduction of six new wireless products to the device server product line. These products were released for general availability in March 2005.
In June 2004, QuaTech announced its intention of developing a line of RFID reader products. A prototype was developed and demonstrated at the RFID World conference in April 2004. No further work has been done in the development of this product line since the development of the initial prototype. QuaTech is continuing to monitor this market prior to committing the resources necessary to complete the development of this product line.
AirborneTM wireless product line - the Airborne wireless product line was acquired with the merger of DPAC and QuaTech and was originally announced by DPAC in September 2003 to address needs in the industrial wireless marketplace with a product known as the Airborne™ Wireless LAN Node module. The wireless product utilizes the 802.11 standard communications protocol (also known as “WiFi”) and targets the identified growth opportunities in embedded and plug-and-play applications, where we believe OEM customers as well as end-user customers have a need for an integrated local area network wireless connectivity solution. The wireless module includes a radio, base-band processor, an application processor and software for a “drop-in” web-enabled WiFi solution for connecting equipment, instrumentation and other devices to a local area network. An additional plug-and-play version of the product was developed and named AirborneDirect™. This product provides a web-enabled wireless connectivity solution for industrial equipment already in field use. Since, for the customer, there is no need to develop the software, or develop the radio frequency and communications expertise in-house, customers can realize reduced product development costs and a quick time-to-market. The AirborneDirect™ modules provide instant local area network and Internet connectivity, and connect through standard serial or Ethernet interfaces to a wide variety of applications.
The Airborne modules are designed to provide wireless local area network and Internet connectivity in transportation, logistics, point of sale devices, medical equipment, and other industrial products and applications. The product was designed to address the needs of small to medium volume applications where time to market, industrial temperature compatibility and ease of implementation are key factors in the decision to implement a wireless connectivity solution. Equipment with an Airborne™ module, either embedded or attached, can be monitored and controlled by a handheld device, by a personal computer in a central location or over the Internet. This eliminates cabling, allows the equipment to be portable and provides an effective mode of supplying the non-PC device to a local area network and the Internet. For example, the module can be a solution for communicating remote sensing and data collection activities through the Internet to a user’s PC or network database software.
Distribution, Marketing and Customers
QuaTech sells its products through a global network of distributors, system integrators, value added resellers, and original equipment manufacturers. Internationally, QuaTech sells and markets its products through over 50 distributors and resellers in more than 30 countries. QuaTech customers operate in a broad array of markets including retail point of sale, industrial automation, financial services and banking, telecommunications, transportation management, access control and security, gaming, data acquisition, and homeland security. All customers are supported from QuaTech’s headquarters in Hudson, OH or from sales and technical support personnel located in Southern California. No single customer accounted for more than 10% of net sales in 2008.
International Sales
The Company had export sales that accounted for 26% of total net sales in both 2008 and 2007 respectively, and 17% in 2006. Export sales were primarily to Canada, Western European, and South American countries. Foreign sales are made in U.S dollars. Specific demand shifts by customers could result in significant changes in our export sales from year to year.
All of QuaTech’s assets are located in the United States. The Company does not own or operate any manufacturing operations or sales offices in foreign countries.
Operations
QuaTech historically has procured all parts and certain services involved in the production of its products, and subcontracted a material portion of its product manufacturing to outside partners who specialize in such services. The Company entered into an agreement (“Agreement”) with one of its contract manufacturers (“Manufacturer”), that was consummated in January 2009, to sell certain of its manufacturing capability consisting of manufacturing equipment, fixtures, tools, shelving and tables. Also pursuant to the Agreement, the Company will sublease to Manufacturer 4,911 square feet of space at the Company’s manufacturing facility located in Hudson, OH. The Company has agreed to utilize Manufacturer as its manufacturer of all products and parts for existing products of the Company (other than under the Company’s Airborne wireless product line) for a period of 24 months under terms and conditions to be determined by the parties. Additionally, the Company sold certain of its inventory, and will sell additional inventory, to the Manufacturer. QuaTech believes that this approach is optimal as it reduces fixed costs, extends manufacturing capacity and increases production flexibility.
QuaTech’s products are manufactured using both standard and semi-custom components. Most of these components are available from multiple sources in the domestic electronics distribution market. There are, however, several components that are provided only by single-source providers.
The manufacturing for the wireless product is being done offshore. We are reliant on the offshore manufacturer to provide a quality product and meet our production requirements. We currently have a six to eight week lead-time on various products and schedule the manufacturing requirements based on our sales forecasts. Changes to the sales forecast could affect the inventory level of the wireless product. There is currently no second source for the production of the wireless module, but QuaTech does have the right to transfer production to another manufacturer if there are problems with the manufacturer. If QuaTech were required to change its primary offshore manufacturer, it would require significant time. This may lead to not having sufficient inventory to meet pending sales requirements. We believe that the offshore manufacturer is of sufficient size and resources to meet any production requirements that we may have, including any foreseeable increased volume needs for the wireless products.
Our reliance on certain single-source and limited-source components exposes us to quality control issues if these suppliers experience a failure in their production process or otherwise fail to meet our quality requirements. A failure in single-source or limited-source components or products could force us to repair or replace a product utilizing replacement components. If we cannot obtain comparable replacements or effectively retune or redesign our products, we could lose customer orders or incur additional costs, which could have a material adverse effect on our gross margins and results of operations.
Research and Development
Our future success will depend in major part on our ability to develop new products or product enhancements to keep up with technological advances and to meet customer needs. Our research and development efforts for 2009 will focus on developing new wireless and related products and expanding our product offerings.
QuaTech’s engineering, research and development expenses were $836,000 in 2008 and $1,179,000 in 2007. Additionally, the Company capitalized in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86 - Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, $162,000 in software development costs incurred in 2008. QuaTech does not rely upon patent protection to protect its competitive position. The nature of the market QuaTech competes in places a heavy emphasis on the ability of QuaTech to service and support the customer along with the reliability of the product’s design and manufacturing. Engineering activities consist of the design and development of new products and the redesign of existing products to keep current with changes in the industry and products offered by the Company’s competitors. The Company also designs and develops new products for specific customers and such activities are often conducted in partnership with our customers.
We are currently involved in research and development for new software and hardware approaches for utilization in our wireless product line, as well as the development of package level products that may incorporate our wireless products as part of the overall system design. Our product development activities are solution driven, and our goal is to create technological advancements by working with each customer to develop advanced cost-effective products that solve each customer’s specific requirements. However, we, for the most part, develop products within the 802.11 standard and infrequently might develop patentable inventions. The 802.11 standards on which our products are based are defined by the IEEE and designed to assure interoperability of all products purporting to meet the standard.
Service and Warranty
We offer warranties of various lengths, which differ by customer and product type and typically cover defects in materials and workmanship. We perform warranty and other maintenance services for our products in Ohio and at our contract manufacturer overseas.
Competitive Conditions
QuaTech competes in the device connectivity and device networking markets. Both of these markets are characterized by a broad number of competitors, both domestic and foreign, of varying size. QuaTech competes on the basis of providing reliable products, marketed at a mid-level price compared to other competitive offerings. QuaTech emphasizes customer service and support as a key differentiator. QuaTech’s ability to meet rapid delivery requirements is a key element of our ability to service the customer. This requires us to carry significant amounts of inventory to meet our customer’s forecasted needs.
As the markets for multi-port serial adapters in both the PC Card form factor and PCI form factor mature, QuaTech has placed emphasis on the development and marketing of products that address the growth markets of multi-port USB to serial adapters and device servers that connect devices to Ethernet Local Area Networks. QuaTech believes that these emerging product lines are significant to its future growth.
We have competition from other wireless products using 802.11 technology. There are also other companies that offer similar products with the same or other configurations and radio communication protocols, including cellular, Bluetooth and proprietary radio solutions that will compete with our Airborne wireless module. The primary competitors in providing embedded 802.11 wireless solutions to OEM customers are Lantronix Inc. and Digi International Inc. Other competitors may provide alternative radio protocols such as cellular or other proprietary technologies for sale to OEM’s. These competitors include Wavecom SA, Maxstream, and Skybility. Other companies such as Symbol Technologies Inc. and Cisco Systems Inc. make wireless solutions that are not primarily aimed at OEM customers, but may be used in those applications and have been in certain circumstances. Many of these companies in the wireless market have greater financial, manufacturing and marketing capabilities than we have.
Backlog
As of December 31, 2008 QuaTech had backlog orders which management believed to be firm commitments of approximately $300,000. As of December 31, 2007 QuaTech had backlog orders which management believed to be firm commitments of approximately $900,000. All of these orders pending as of December 31, 2008 are expected to ship in calendar year 2009. Backlog as of any particular date is not necessarily indicative of QuaTech’s future sales trends.
Product orders in our backlog are subject to changes in delivery schedules or to cancellation at the option of the purchaser without significant penalty. While we regularly review our backlog of orders to ensure that it adequately reflects product orders expected to ship within the one year period, we cannot make any guarantee that such orders will actually be shipped or that such orders will not be delayed or cancelled in the future. We make regular adjustments to our backlog as customer delivery schedules change and in response to changes in our production schedule. Accordingly, we stress that backlog as of any particular date should not be considered a reliable indicator of sales for any future period and our revenues in any given period may depend substantially on orders placed in that period.
Personnel
As of December 31, 2008, QuaTech employed 29 full time employees, 24 of which are located at QuaTech’s facility in Hudson, Ohio, 4 of which are located in Southern California, and 1 of which is located on the East Coast. Of the 29 full-time employees, 4 were in general and administration, 9 were in sales, marketing and customer support, 8 were in engineering, research and development, and 8 were in operations and manufacturing. The Company occasionally hires part-time employees. The Company believes that it has a good relationship with its employees and no employees are represented by a union. In conjunction with the Agreement that was consummated with Manufacturer in January 2009, the Company terminated 5 full-time employees who were engaged in operations and manufacturing, and who were subsequently hired by Manufacturer.
ITEM 1A:
ITEM 1A: RISK FACTORS
Cautionary Statements
Investors should carefully consider the risks described below and all other information in the Form 10-K. The risk and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties not presently known to the Company may also impair the Company’s business and operations.
Statements in this Report that are not historical facts, including all statements about our business strategy or expectations, or information about new and existing products and technologies or market characteristics and conditions, are forward-looking statements that involve risks and uncertainties. These include, but are not limited to, the factors described below which could cause actual results to differ from those contemplated by the forward-looking statements.
Potential Future Insufficiency of Capital and Financial Resources
We required additional financing to meet our ongoing obligations through the end of the year ending December 31, 2008 as referred to above. Despite the refinancing, our continued ability to obtain financing when needed may be unavailable if and when needed. If we obtain additional financing, the terms and conditions of the financing could have material adverse effects on the market price of the common stock. Problems that we could encounter because of insufficient capital are numerous, but include additional costs and expenses, including higher interest rates and the acceleration of maturity dates on other debt financing. Some additional costs might be associated with complying with or defending legal actions by or for creditors, or paying fees, charges or costs of creditors. Other costs may include relative inefficiencies or loss of productivity, which may be reflected in the financial results. We could lose lenders, suppliers, vendors, key employees and service providers due to concerns about the Company’s liquidity. Many costs and fees could become higher as the Company loses liquidity, and this could accelerate the Company’s cash consumption rate. The combined effect of these problems could lead the Company to have to cease operations and/or file for bankruptcy protection.
Product Development and Technological Change
The wireless connectivity industry is characterized by rapid technological change and is highly competitive with respect to timely product innovation. Our wireless products are subject to obsolescence or price erosion because competitors are continuously introducing technologies with the same or greater capacity as our technology. As a result, wireless products may have a product life of not more than one to three years.
Our future success depends on our ability to develop new wireless products and product enhancements to keep up with technological advances and to meet customer needs. Any failure by us to anticipate or respond adequately to technological developments and customer requirements, or any significant delays in product development, firmware or software development, or introduction of wireless technologies could have a material adverse effect on our financial condition and results of operations. Additionally, the Company could incur additional operating costs with the introduction of new products.
There can be no assurance that we will be successful in planned product development or marketing efforts, or that we will have adequate financial or technical resources for planned product development and promotion.
Uncertainty of Market Acceptance or Profitability of New Products
The introduction of new products, such as our product for the wireless marketplace, could require the expenditure of an unknown amount of funds for research and development, tooling, software development, manufacturing processes, inventory and marketing. In order to successfully develop products, we will need to successfully anticipate market needs and may need to overcome rapid technological change and competition. In order to achieve high volume production, we will need to out-source production to third parties or enter into licensing arrangements and be successful in the management of sub-contractors overseas. We are inexperienced in the wireless industry, and our plans in that industry are unproven. We have limited marketing capabilities and resources and are dependent upon internal sales and marketing personnel and a network of independent sales representatives for the marketing and sale of our products. There can be no assurance that our products will achieve or maintain market acceptance, result in increased revenues, or be profitable.
Parts Shortages and Over-Supplies and Dependence on Suppliers
The electronics and components industry is characterized by periodic shortages or over-supplies of parts that have in the past and may in the future negatively affect our operations. We are dependent on a limited number of suppliers and contractors for wireless and semiconductor devices used in our products, and we have no long-term supply contracts with any of them.
Due to the cyclical nature of these industries and competitive conditions, we, or our sub-contractors, may experience difficulties in meeting our supply requirements in the future. Any inability to obtain adequate deliveries of parts, either due to the loss of a supplier or industry-wide shortages, could delay shipments of our products, increase our cost of goods sold and have a material adverse effect on our business, financial condition and results of operations.
Credit Risks
We will be granting credit to customers in a variety of commercial industries. Credit is extended based on an evaluation of the customer’s financial condition and collateral is not required. Estimated credit losses are provided for in the financial statements. Our inability to collect receivables from any larger customer could have a material adverse effect on our business, financial condition, and results of operations.
Intellectual Property Rights
Our ability to compete effectively is dependent on our proprietary know-how and our ability to develop and apply technology. We have applied for patents in the wireless area. There can be no assurance that our patent applications will be approved, that any issued patents will afford our products any competitive advantage or that any of our products will not be challenged or circumvented by third parties, or that patents issued to others will not adversely affect the sales, development or commercialization of our present or future products.
We are involved from time to time in claims and litigation over intellectual property rights, which may adversely affect our ability to manufacture and sell our products.
The wireless industry is characterized by vigorous protection and pursuit of intellectual property rights. We believe that it may be necessary, from time to time, to initiate litigation against one or more third parties to preserve our intellectual property rights. In addition, from time to time, we have received, and may continue to receive in the future, notices that claim we have infringed upon, misappropriated or misused other parties’ proprietary rights, which claims could result in litigation. Such litigation would likely result in significant expense to us and divert the efforts of our technical and management personnel. In the event of an adverse result in such litigation, we could be required to pay substantial damages, cease the manufacture, use and sale of certain products, expend significant resources to develop non-infringing technology, discontinue the use of certain processes or obtain licenses to use the infringed technology. Such a license may not be available on commercially reasonable terms, if at all. Our failure to obtain a license or our failure to obtain a license on commercially reasonable terms could cause us to incur substantial costs and suspend manufacturing products using the infringed technology. If we obtain a license, we would likely be required to make royalty payments for sales under the license. Such payments would increase our costs of revenues and reduce our gross profit. In addition, any litigation, whether as plaintiff or as defendant, would likely result in significant expense to us and divert the efforts of our technical and management personnel, whether or not such litigation is ultimately determined in our favor. In addition, the results of any litigation are inherently uncertain.
Management of Growth or Diversification
Successful expansion or diversification of the Company’s operations will depend on the ability to obtain new customers, to attract and retain skilled management and other personnel, to secure adequate sources of supply on commercially reasonable terms and to successfully manage new product introductions. To manage growth or diversification effectively, we will have to continue to implement and improve our operational, financial and management information systems, procedures and controls. As we expand or diversify, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth or diversification effectively could adversely affect our financial condition and results of operations.
Competition
There are companies that offer or are in the process of developing similar types of wireless products, including Lantronix, Digi-International and others. We could also experience competition from established and emerging network companies. There can be no assurance that our products will be competitive with existing or future products, or that we will be able to establish or maintain a profitable price structure for our products.
We expect to face competition from existing competitors and new and emerging companies that may enter our existing or future markets with similar or alternative products, which may be less costly or provide additional features. In addition, some of our significant suppliers are also our competitors, many of whom have the ability to manufacture competitive products at lower costs as a result of their higher levels of integration. We also face competition from current and prospective customers that evaluate our capabilities against the merits of manufacturing products internally. Competition may arise due to the development of cooperative relationships among our current and potential competitors or third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors will emerge and rapidly acquire significant market share.
We expect our competitors will continue to improve the performance of their current products, reduce their prices and introduce new products that may offer greater performance and improved pricing, any of which could cause a decline in sales or loss of market acceptance of our products. In addition, our competitors may develop enhancements to or future generations of competitive products that may render our technology or products obsolete or uncompetitive.
Product Liability
In the course of our business, we may be subject to claims for product liability for which our insurance coverage is excluded or inadequate.
Variability of Gross Margin
Gross profit as a percentage of sales was 43% for the year ended December 31, 2008 as compared to 42% for the year ended December 31, 2007. Any change in the gross margins can typically be attributed to the mix of products, average selling prices, revenue levels, the use of outside contract manufacturers, and increases to our fixed cost structure. As we market our products, the product mix may change over time and result in changes in the gross margin.
We expect that our net sales and gross margin may vary significantly based on these and other factors, including the mix of products sold and the manufacturing services provided, the channels through which our products are sold, changes in product selling prices and component costs, the level of manufacturing efficiencies achieved and pricing by competitors. The selling prices of our products may decline depending upon the price changes of our cost of sales, which would have a material adverse effect on our net sales and could have a material adverse effect on our business, financial condition and results of operations. Accordingly, our ability to maintain or increase net sales will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in selling prices.
Declining product-selling prices may also materially and adversely affect our gross margin unless we are able to reduce our cost per unit to offset declines in product selling prices. There can be no assurance that we will be able to increase unit sales volumes, introduce and sell new products or reduce our cost per unit. We also expect that our business may experience significant seasonality to the extent it sells a material portion of our products in Europe (due to vacation cycles) and to the extent, our exposure to the personal computer market remains significant.
Our average sales prices have historically declined, and we anticipate that the average sales prices for our products will continue to decline and could negatively impact our gross profit margins.
Decline of Demand for Product Due to Downturn of Related Industries
We may experience substantial period-to-period fluctuations in operating results due to factors affecting the wireless, computer, telecommunications and networking industries. From time to time, each of these industries has experienced downturns, often in connection with, or in anticipation of, declines in general economic conditions. A decline or significant shortfall in growth in any one of these industries or a technology shift, could have a material adverse impact on the demand for our products, and therefore, a material adverse effect on our business, financial condition and results of operations. There can be no assurance that our net sales and results of operations will not be materially and adversely affected in the future due to changes in demand from individual customers or cyclical changes in the wireless, computer, telecommunications, networking or other industries utilizing our products.
Our suppliers, contract manufacturers or customers could become competitors
Many of our customers internally design and/or manufacture their own wireless communications network products. These customers also continuously evaluate whether to manufacture their own wireless communications network products or utilize contract manufacturers to produce their own internal designs. Certain of our customers and prospective customers regularly produce or design wireless communications network products in an attempt to replace products manufactured by us. We believe that this practice will continue. In the event that our customers manufacture or design their own wireless communications network products, such customers could reduce or eliminate their purchases of our products, which would result in reduced revenues and would adversely impact our results of operations and liquidity. Wireless infrastructure equipment manufacturers with internal manufacturing capabilities, including many of our customers, could also sell wireless communications network products externally to other manufacturers, thereby competing directly with us. In addition, our suppliers or contract manufacturers may decide to produce competing products directly for our customers and, effectively, compete against us. If, for any reason, our customers produce their wireless communications network products internally, increase the percentage of their internal production, require us to participate in joint venture manufacturing with them, engage our suppliers or contract manufacturers to manufacture competing products, or otherwise compete directly against us, our revenues would decrease, which would adversely impact our results of operations.
International Sales
International sales may be subject to certain risks, including changes in regulatory requirements, tariffs and other barriers, timing and availability of export licenses, political and economic instability, difficulties in accounts receivable collections, natural disasters, difficulties in staffing and managing foreign subsidiary and branch operations, difficulties in managing distributors, difficulties in obtaining governmental approvals for telecommunications and other products, foreign currency exchange fluctuations, the burden of complying with a wide variety of complex foreign laws and treaties, potentially adverse tax consequences and uncertainties relative to regional, political and economic circumstances. Moreover, and as a result of currency changes and other factors, our competitors may have the ability to manufacture competitive products in Asia or otherwise at lower cost than we would incur to have them manufactured.
We are also subject to the risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether the United States or other countries will implement quotas, duties, taxes or other charges or restrictions upon the importation or exportation of our products. Because sales of our products have been denominated to date in United States dollars, increases in the value of the United States dollar could increase the price of our products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country. Future international activity may result in foreign currency denominated sales. Gains and losses on the conversion to United States dollars of accounts receivable, accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in our results of operations. Some of our customers’ purchase orders and agreements are governed by foreign laws, which may differ significantly from United States laws. Therefore, we may be limited in our ability to enforce any rights under such agreements and to collect damages, if awarded. These factors could have a material adverse effect on our business, financial condition and results of operations.
Limited Experience in Business Combinations or Acquisitions
We may pursue a strategy of acquiring additional companies or businesses. We may pursue selective acquisitions to complement our internal growth. We have limited experience in acquiring other businesses, product lines and technologies. In addition, the attention of our management team may be diverted from our core business if we undertake an acquisition. Potential acquisitions also involve numerous risks, including, among others:
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Problems assimilating the purchased operations, technologies or products;
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Costs associated with the acquisition;
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Adverse effects on existing business relationships with suppliers and customers;
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Sudden market changes;
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Risks associated with entering markets in which we have no or limited prior experience;
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Potential loss of key employees of purchased organizations; and
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Potential litigation arising from the acquired company’s operations before the acquisition.
Our inability to overcome problems encountered in connection with such acquisitions could divert the attention of management, utilize scarce corporate resources and harm our business. In addition, we are unable to predict whether or when any prospective acquisition candidate will become available or the likelihood that any acquisition will be completed.
Cyclical Nature of Wireless and Electronics Industries
The wireless and the electronics industries are highly cyclical and are characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and demand. The industry has experienced significant downturns, often connected with, or in anticipation of, maturing product cycles of both the producing companies’ and their customers’ products and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturns could have a material adverse effect on our business and operating results. Furthermore, any upturn in these industries could result in increased demand for, and possible shortages of, components we use to manufacture and assemble our products. Such shortages could have a material adverse effect on our business and operating results.
Our reliance on contract manufacturers exposes us to risks of excess inventory or inventory carrying costs
If our contract manufacturer is unable to respond promptly and timely to changes in customer demand, we may be unable to produce enough products to respond to sudden increases in demand resulting in lost revenues, or alternatively, in the case of order cancellations or decreases in demand, we may be liable for excess or obsolete inventory or cancellation charges resulting from contractual purchase commitments that we have with our contract manufacturers. We regularly provide rolling forecasts of our requirements to our contract manufacturers for planning purposes, pursuant to our agreements, a portion of which is binding upon us. Additionally, we are committed to accept delivery on the forecasted terms for a portion of the rolling forecast. Cancellations of orders or changes to the forecasts provided to any of our contract manufacturers may result in cancellation costs payable by us.
By using contract manufacturers, our ability to directly control the use of all inventory is reduced because we do not have full operating control over their operations. If we are unable to accurately forecast demand for our contract manufacturers and manage the costs associated with our contract manufacturers, we may be required to pay inventory carrying costs or purchase excess inventory. If we or our contract manufacturers are unable to utilize such excess inventory in a timely manner, and are unable to sell excess components or products due to their customized nature, our operating results and liquidity would be negatively impacted.
Product Returns and Order Cancellation
To the extent we have products manufactured in anticipation of future demand and that does not materialize, or in the event a customer cancels outstanding orders, we could experience an unanticipated increase in our inventory. In addition, while we may not be contractually obligated to accept returned products, and have typically not done so in the past, we may determine that it is in our best interest to accept returns in order to maintain good relations with our customers. Product returns would increase our inventory and reduce our revenues. We have had to write-down inventory in the past for reasons such as obsolescence, excess quantities and declines in market value below our costs.
We have no long-term volume commitments from our customers that are not subject to cancellation by the customer. Sales of our products are made through individual purchase orders and, in certain cases, are made under master agreements governing the terms and conditions of the relationships. Customers may change, cancel or delay orders with limited or no penalties. We have experienced cancellations of orders and fluctuations in order levels from period-to-period and we expect to continue to experience similar cancellations and fluctuations in the future that could result in fluctuations in our revenues.
Additional Capital Funding May Impair Value of Shareholders’ Investment
We may need to raise additional capital. Our potential means to raise capital potentially include public or private equity offerings or debt financings. Our future capital requirements depend on many factors including our research, development, sales and marketing activities, acquisitions, and other costs. We do not know whether additional financing will be available when needed, or will be available on terms favorable to us. To the extent we raise additional capital by issuing equity securities, our shareholders may experience substantial dilution and the new equity securities may have greater rights, preferences or privileges than our existing common stock. To the extent we raise additional capital by issuing debt, we would incur additional interest expenses that may reduce earnings and cash flows of the Company. Also, plans to borrow and repay the debt are subject to numerous risks. In the event the debt is not repaid as and when due, additional costs and debt would be required to satisfy and refinance the obligation, and the debt therefore could grow. If a company’s debt coverage costs are excessive, its equity can lose value for reasons including a decline in creditworthiness.
Geographic Concentration of Operation
Our wireless product line is manufactured overseas in Taiwan, with some contract manufacturing conducted locally. Due to the geographic concentration, a disruption of the manufacturing operations resulting from sustained process abnormalities, human error, government intervention or natural disasters such as earthquakes, fires or floods could cause us to cease or limit our sub-contractors’ operations and consequently harm our business, financial condition and results of operations.
Compliance with Environmental Laws and Regulations
We are subject to a variety of environmental laws and regulations governing, among other things, air emissions, waste water discharge, waste storage, treatment and disposal, and remediation of releases of hazardous materials. Our failure to comply with present and future requirements could harm our ability to continue manufacturing our products. Such requirements could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. The imposition of additional or more stringent environmental requirements, the results of future testing at our facilities, or a determination that we are potentially responsible for remediation at other sites where problems are not presently known to us, could result in expenses in excess of amounts currently estimated to be required for such matters. Many of these regulations will not be applicable to us after December 31, 2008, as we will no longer be manufacturing our products.
Key Personnel
The Company may fail to attract or retain the qualified technical sales, marketing and managerial personnel required to operate its business successfully.
DPAC’s future success depends, in part, upon our ability to attract and retain highly qualified technical, sales, marketing and managerial personnel. Personnel with the necessary expertise are scarce and competition for personnel with proper skills is intense. Also, attrition in personnel can result from, among other things, changes related to acquisitions, as well as retirement or disability. The Company may not be able to retain existing key technical, sales, marketing and managerial employees or be successful in attracting, assimilating or retaining other highly qualified technical, sales, marketing and managerial personnel in the future. If the Company is unable to retain existing key employees or is unsuccessful in attracting new highly qualified employees, business, financial condition and our results of operations could be materially and adversely affected.
Stock Price Volatility and Market Overhang
Existing shareholders may suffer with each adverse change in the market price of our common stock. The market price of our common stock will be affected by a variety of factors in the future. Most obviously, our shares may suffer adversely if and when our future operating results are below the expectations of investors. The stock market in general, and the market for shares of technology companies in particular, experiences extreme price fluctuations. Our common stock market price is made more volatile because of the relatively low volume of trading in our common stock. When trading is sporadic, significant price movement can be caused by a relatively small number of shares.
Another factor that may affect our common stock price will be the number of our outstanding shares and, at times, the number and prices of warrants that could be exercised. At December 31, 2008, we have reserved a total of 11,379,000 shares for issuance upon exercise of outstanding warrants. Holders of our warrants hold registration rights that are intended to make the warrant shares immediately available for public sale upon exercise, and warrants may be exercised at any time until their expiration. It is foreseeable that when a warrant has an intrinsic value, which is usually called being “in-the-money,” the holder may desire to exercise the warrant and immediately sell the stock. If our common stock trades at prices higher than a warrant’s exercise price, the shares can be sold at a profit. At such times, sales of large numbers of shares received upon exercises of warrants might materially and adversely affect the market price of our common stock.
Other Contingent Contractual Obligations
The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying balance sheets. However, during its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include indemnities to all directors and officers pertaining to claims on account of acting as a director or officer. In the event that the Company has, or is claimed to have, any indemnification obligation related to current or former directors or officers, the costs and expenses could be material to the Company and the amount of cost and expense of such an obligation would not necessarily be limited whatsoever. Other indemnities are made to various lessors in connection with facility leases for certain claims arising from such facility or lease; other indemnities are made to vendors and service providers pertaining to claims based on the negligence or willful misconduct of the Company; and other indemnities involve the accuracy of representations and warranties in certain contracts and are made in favor of the other contractual party. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential for future payments the Company could be obligated to make. The Company may also issue a guarantee in the form of a standby letter of credit as security for contingent liabilities under certain customer contracts, which would customarily be for a limited amount. Product warranty costs are not significant.
ITEM 1B:
ITEM 1B: UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2:
ITEM 2: PROPERTIES
QuaTech’s principal place of business is located at 5675 Hudson Industrial Parkway, Hudson, Ohio 44236 where the company leases approximately 17,100 square feet of combined office, warehousing and product assembly space. QuaTech has leased the space through April 2014.
Additionally, the Company leases sales and administrative offices in Southern California.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
We are subject to various legal proceedings and threatened legal proceedings from time to time as part of our business. We are not currently party to any legal proceedings, the adverse outcome of which, individually or in the aggregate, we believe would have a material adverse effect on our business, financial condition and results of operations or which for damages would exceed 10% of the current assets of the Company. However, any potential litigation, regardless of its merits, could result in substantial costs to us and divert management’s attention from our operations. Such diversions could have an adverse impact on our business, results of operations and financial condition.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of fiscal year 2008.
PART II
ITEM 5:
ITEM 5:
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock trades on the Over The Counter Bulletin Board under the symbol “DPAC.OB.” The following table sets forth the high and low closing sale prices on the Nasdaq Small Cap Market as reported by The Nasdaq Stock Market.
Holders
There were approximately 250 shareholders of record as of March 26, 2009. We believe there are approximately 6,500 beneficial shareholders of DPAC Common Stock held in street name. Development Capital Ventures, LP, hold approximately 57% of the common shares outstanding at March 26, 2009.
Dividends
We have not paid dividends on our common stock in either of the past two fiscal years. We do not expect to pay any dividends on our common stock in the foreseeable future. There are currently contractual arrangements in our loan agreements and other restrictions that preclude our ability to pay dividends.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
Not applicable.
ITEM 7:
ITEM 7:
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this Report. This discussion contains certain forward-looking statements that involve risks and uncertainties, such as statement of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed here. The cautionary statements made in this Report should be read as being applicable to all forward-looking statements wherever they appear. Numerous important factors, risks and uncertainties affect our operations and could cause actual results to differ materially from those expressed or implied by these or any other forward-looking statements made by us or on our behalf. Factors that could cause or contribute to such differences include those discussed in “Risk Factors,” as well as those discussed elsewhere herein. We undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be required to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Period-to-period comparisons of our financial results are not necessarily meaningful and should not be relied upon as indications of future performance. It is likely that from time to time our operating results will be below the expectations of some investors and not above the expectations of enough investors. In such events, the market price of our Common Stock would be adversely affected, in some proportion, and perhaps disproportionately. We ourselves have difficulties forecasting, and there are numerous risks and uncertainties concerning, the timing of our customers’ initiating their production orders and the amounts of such orders, fluctuating market demand for and declines in the selling prices of similar products, decreases or increases in the costs of the components, uncertain market acceptance, our competitors, delays, or other problems with new products, software, manufacturing, inefficiencies, cost overruns, fixed overhead costs, competition from new wireless products using 802.11 with newer technology, and challenges managing production from overseas suppliers, among other factors, each of which will make it more difficult for us to meet expectations.
Successful implementation of the Airborne wireless products and new product lines will require, among other things, best-in-class designs, exceptional customer service and patience. Also, timing of revenue may be affected by the length of time it may take our customers to design our Airborne product into their product lines and introduction of their products. In addition, our revenues are ultimately limited by the success of our customers’ products in relation to their competition.
Fluctuations in Operating Results
The primary factors that may in the future create material fluctuations in our results of operations include the following: timing and amount of shipments; changes in the mix of products sold; any inability to procure required components; whether new customer orders are for immediate or deferred delivery; the sizes and timing of investments in new technologies or product lines; a partial or complete loss of any principal customer; any addition of a significant new customer; a reduction in orders or delays in orders from a customer; excess product inventory accumulation by a customer; and other factors.
The need for continued significant operating expenditures for research and development, software and firmware enhancements, ongoing customer service and support, and administration, among other factors, will make it difficult for us to reduce our operating expenses in any particular period, even if our expectations for net sales for that period are not met. Therefore, our fixed overhead may negatively impact our operating results.
Critical Accounting Policies and Estimates
We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe to be reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. In order to aid you in fully understanding and evaluating our reported financial results, the significant accounting policies which we believe to be the most subjective and critical include the following:
Revenue Recognition
The majority of our revenue is derived from the sales of products. We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable and there are no post-delivery obligations other than warranty. Revenue is recognized from the sale of products at the point of passage of title, which is at the time of shipment to customers, including OEMs, distributors and other strategic end user customers. Revenue recognition is deferred in all instances when the earnings process is incomplete, such as sales to certain customers that may have certain rights of return and price protection provisions. Estimated reserves are established by the company for potential future returns and price protection adjustments based on an analysis of authorized returns compared to received returns, current on hand inventory at certain customers, and sales to certain customers for the current period. QuaTech also offers marketing incentives to certain customers. These incentives are incurred based on the level of expenses the customers incur and are charged to operations as expenses in the same period.
Accounts Receivable
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The amount of our reserves is based on historical experience and our analysis of the accounts receivable balances outstanding. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required which would result in an additional general and administrative expense in the period such determination was made. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past, which could adversely affect our operating results.
Inventories
We value our inventory at the lower of the actual cost to purchase and/or manufacture or the current estimated market value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. We additionally consider additional facts and circumstances in order to determine whether any condition exists that would confirm or deny the need for recording a write-off. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if our inventory is determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of such determination. Likewise, if our inventory is determined to be undervalued, we may have over-reported our costs of goods sold in previous periods and would be required to recognize such additional operating income at the time of sale of the related inventory. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our reported operating results.
Property, Plant and Equipment
The Company periodically reviews the recoverability of its long-lived assets using the methodology prescribed in SFAS No. 144. The Company also reviews these assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is determined by comparing the forecasted undiscounted future net cash flows from the operations to which the assets relate, based on management’s best estimates using appropriate assumptions and projections at the time, to the carrying amounts of the assets. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the asset.
Capitalized Developed Software
Certain software development costs are capitalized after a product becomes technologically feasible and before its general release to customers. Significant judgment is required in determining when a product becomes ''technologically feasible.’’ Capitalized development costs are then amortized over the product’s estimated life beginning upon general release of the product. Periodically, we compare a product’s unamortized capitalized cost to the product’s net realizable value. To the extent unamortized capitalized cost exceeds net realizable value based on the product’s estimated future gross revenues (reduced by the estimated future costs of completing and selling the product) the excess is written off. This analysis requires us to estimate future gross revenues associated with certain products and the future costs of completing and selling certain products. Changes in these estimates could result in write-offs of capitalized software costs. During 2008, certain development costs totaling $162,375 met the criteria of SFAS 86 for the capitalization of software development costs and were capitalized accordingly.
Goodwill and Intangibles
We review the recoverability of the carrying value of goodwill and intangibles on an annual basis or more frequently when an event occurs or circumstances change to indicate that an impairment of goodwill or intangibles has possibly occurred. Since we operate in a single business segment as a single business unit, the determination of whether any potential impairment of goodwill exists is based on a comparison of the fair value of the entire Company to the carrying value of our net assets. In estimating the fair value of the entire Company, the Market Approach and Income Approach were the methodologies deemed the most reliable and were the primary methods used for our impairment analysis. Because of the expertise required to value goodwill and intangible assets, the Company engaged the services of a third party to assist with the year-end impairment analysis. The valuation analysis is dependent upon a number of various factors including estimates of forecasted revenues and costs, appropriate discount rates and other variables. If the fair value of the entire Company is determined to be less than the carrying value of our net assets, we could be required to take the second step of the goodwill impairment test to measure the amount of impairment loss, if any, and to record such impairment loss for our goodwill. Recording an impairment charge for goodwill could have a material adverse impact on our operating results for the period in which such charge was recorded. As of December 31, 2008, based on the Company’s most recent analysis, there was no impairment of goodwill.
Deferred Taxes
Deferred taxes and liabilities are recorded based on FAS 109. The Company records an estimated income tax liability to recognize the amount of income taxes payable or refundable for the current year and deferred income tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or income tax returns. Judgment is required in estimating the future income tax consequences of events that have been recognized in the Company’s financial statements or the income tax returns. The Company estimates and provides an allowance for deferred tax assets based on estimated realization of the asset utilizing information related to historical taxable income and projected taxable income.
Included in the total deferred tax assets, the Company has an income tax carryforward for federal net operating losses. The cumulative federal net operating loss carryforward of approximately $10,884,000 expires through 2028; however, as a result of the merger between QuaTech, Inc. and DPAC Technologies Corp, a substantial portion of DPAC’s federal net operating loss carryforward is subject to the provisions of Sec. 382 of the Internal Revenue Code (IRC), and therefore, is not available for immediate benefit to the company. The realization of the Company’s deferred tax assets, including this federal net operating loss, and the related valuation allowance are significant estimates requiring assumptions regarding the sufficiency of future taxable income to realize the future tax deduction from the reversal of deferred tax assets and the net operating loss prior to their expiration. The valuation allowance has been provided based upon the Company’s assessment of future realizability of certain deferred tax assets, as it is more likely than not that sufficient taxable income will not be generated to realize these temporary differences. The net increase in the valuation allowance was $229,170 for 2008 and $884,281 for 2007. The amount of the corresponding valuation allowance could change significantly in the near term if estimates of future taxable income are changed.
Recently Issued Accounting Standards
In December 2007 the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (FAS 141(R)) and No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (FAS 160)”. FAS 141(R) will change how business acquisitions are accounted for and FAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. FAS 141(R) and FAS 160 are effective for fiscal years beginning on or after December 15, 2008 (January 1, 2009 for the Company). The adoption of FAS 141(R) and FAS 160 are not expected to have a material impact on the Company’s consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 was adopted by the Company on January 1, 2008 and elected not to measure any additional financial instruments or other items at fair value.
SFAS No. 157, “Fair Value Measurements,” was adopted on January 1, 2008. SFAS 157 defines fair value, establishes a market-based framework or hierarchy for measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not expand or require any new fair value measures, but is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. In February 2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. 157-2, “Effective Date of FASB Statement No. 157,” which amends SFAS No. 157 by delaying the adoption of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except those items recognized or disclosed at fair value on an annual or more frequently recurring basis, until January 1, 2009. The FASB also amended SFAS 157 to exclude SFAS No. 13 and its related interpretive accounting pronouncements that address leasing transactions. Accordingly, the adoption of this Standard in 2008 was limited to financial assets and liabilities, which affects the disclosure of our put warrant liability and our subordinated debt success fee. The adoption of SFAS 157, as amended, did not have a material impact on the Company’s financial condition, results of operations or cash flows.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS 161). SFAS 161 requires companies with derivative instruments to disclose information that would enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (SFAS 133) and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. The new requirements apply to derivative instruments and non-derivative instruments that are designated and qualify as hedging instruments and related hedged items accounted for under SFAS 133. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We are currently evaluating the impact of SFAS 161, but do not expect its adoption to have a material impact on our financial statements.
In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Lives of Intangible Assets”, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of an intangible asset. This interpretation is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. We are currently evaluating the impact of this staff position, but do not expect its adoption to have a material impact on our financial statements.
Introduction/Business Overview
DPAC, through its wholly-owned subsidiary, QuaTech, designs, manufactures, and sells device connectivity and device networking solutions for a broad market. QuaTech sells its products through a global network of distributors, system integrators, value added resellers, and original equipment manufacturers (“OEM”).
QuaTech products can be categorized into two broad product lines:
Our Device Connectivity products include:
•
Multi-port serial boards that add ports to desktop computers to allow for the connection of multiple peripherals with standard interfaces. These products are used in a variety of industries including banking, transportation management, kiosks, satellite communications, and retail point of sale.
•
Mobile products that add ports for laptop and handheld computers. These products include multi-port serial adapters, parallel port adapters, and Bluetooth products.
•
USB to Serial products that add standard serial ports to any computing environment through a USB port. These products address the need to add connectivity through a solution that is external to the computer. These products are used in several markets including retail point of sale and kiosks.
•
Data acquisition products that consist mainly of PC Cards providing analog to digital conversion capability.
Our Device Networking products include:
•
Industrial rated, embedded wireless modules that enable OEM customers to add standard 802.11 connectivity capabilities to their products. These modules address the needs of a number of industries including transportation, telematics, warehouse and logistic, and point of sale.
This overview of our business reflects DPAC’s acquisition of QuaTech which was completed by way of a reverse merger (the “Merger”) in which QuaTech became a wholly-owned subsidiary of DPAC. The Merger, as previously reported, was consummated on February 28, 2006.
Results of Operations
The following table summarized DPAC’s results of operations as a percentage of net sales for the two years ended December 31, 2008 and 2007:
Net Sales
Net sales for the year ended December 31, 2008 of $9,157,000 decreased by $2,968,000 or 25% compared to net sales for the year ended December 31, 2007. Net sales related to the Company’s Device Connectivity products decreased $2,200,000 or 29%, and net sales related to the Company’s Device Networking products, including the Airborne wireless product line, decreased by $769,000, or 17% from the year ended December 31, 2007. The decrease in revenues for the Device Connectivity product line is primarily due to a reduction in IT infrastructure spending of two major customers in the banking and financial services industry as well as a general slowdown in IT infrastructure spending across the industries we market to. The decrease in revenues for the Device Networking product line is primarily due to a general decrease in IT infrastructure spending across the industries we market which impacted the majority of our customers during the second half of 2008.
Gross Profit
Gross profit decreased by $1,218,000 or 24% to $3,904,000 in 2008 from $5,122,000 in 2007 due to the decrease in net sales. Gross profit as a percentage of sales improved slightly to 43% in 2008 from 42% in 2007. The improvement in gross profit percentage is due to the lower direct material costs as a result of the Company manufacturing a greater percentage of products in house during the most recent period. The reduced material costs were offset by fixed operating expenses as fixed expenses represented a larger percentage of cost of goods sold as a result of the lower revenue figures.
Sales and Marketing
Sales and marketing expenses of $1,164,000 decreased by $240,000 or by 17% from $1,404,000 in fiscal year 2007. The decrease is due primarily to a decrease in personnel costs, including benefits, of $185,000, and a decrease in advertising and Internet search engine costs of $50,000. These cost reductions are the result of the Company’s continuing efforts to integrate the sales and marketing departments of DPAC and Quatech since the date of the Merger and represent a decrease in sales and marketing personnel headcount of 5 individuals.
Research and Development
Research and development expenses of $836,000 in 2008 decreased by $343,000, or 29%, as compared to 2007. The decrease is due primarily to a decrease in personnel and consulting costs incurred, including benefits and travel related costs, of $220,000. Additionally, during 2008, $162,000 of total payroll related expenses were capitalized as software development costs, in accordance with SFAS 86, reducing development expense by the same amount capitalized. These reductions were partially offset by an increase of $43,000 in materials consumed for development projects. The Company will continue to invest in research and development to expand and develop new wireless products. See “Forward-Looking Statements.”
General and Administrative Expense
General and administrative expenses incurred in 2008 of $1,531,000 decreased by $245,000 or 14% from the prior year period. The decrease was due primarily to decreases in salaries and benefits of $106,000, director fees of $28,000, royalty expense of $31,000, and in facilities rent and utilities of $67,000 related to the Company’s Southern California facility. Effective April 1, 2007, the Company terminated its lease and relocated out of its Garden Grove, CA facility into office space sized appropriately for the Company’s needs.
Amortization Expense
Amortization expense of $490,000 in each of 2008 and 2007 is related to the amortization of purchased intangible assets acquired in the merger on February 28, 2006 being amortized over 5 years.
Interest Expense
The Company incurred interest and financing costs of $695,000 in 2008 as compared to $1,455,000 incurred in 2007. The decrease is due to lower average debt balances and lower effective interest rates. Interest expense in the current year period included the payment and write-off of deferred financing fees in the amount of $50,000 due to the termination of a financing placement agreement. The following non-cash charges are included in interest expense during 2008: accretion of success fees of $46,000, amortization of deferred financing costs of $58,000, and amortization of the discount for warrants of $12,000. The following non-cash charges are included in interest expense during 2007: accretion of success fees of $267,000, amortization of deferred financing costs of $99,000, and amortization of the discount for warrants of $242,000.
Fair Value Adjustment of Put Warrant Liability.
For 2008, the Company recorded a net gain of $13,000 related to the adjustment of the liability for the warrant associated with the subordinated debt compared to a net gain of $415,000 for 2007. Under SFAS 150, the Company is required to adjust the put warrant liability to its fair value through earnings at the end of each reporting period. At December 31, 2008, based on the Company’s common stock average share price of $0.018, the Company calculated the fair value of the warrant to be $116,000.
Income Taxes
In the fourth quarter of 2006, a full valuation allowance was recorded against the Company’s related deferred tax assets. The Company recorded an income tax benefit of $151 for 2007.
DPAC regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. To the extent that recovery is not believed to be more likely than not, a valuation allowance is established. Recent net operating losses represent sufficiently negative evidence to require a continued valuation allowance against the net deferred tax assets. This valuation allowance will be evaluated periodically and could be reversed partially or totally if business results have sufficiently improved to support realization of our deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
The Company incurred a net loss of approximately $799,000 for 2008 and ended the year with a cash balance of $9,000 and a deficit in working capital of $805,000. This compares to a net loss of approximately $766,000 for 2007 with a cash balance of $257,000 and a deficit in working capital of $3,745,000 at the end of 2007. These factors created substantial doubt about the Company’s ability to continue as a going concern. In order to mitigate these negative factors, the Company has undertaken a number of initiatives and has implemented various other plans.
Although the Company reported a loss of $799,000 for 2008, a significant portion of our operating expenses are non-cash, including depreciation and amortization of $603,000, non-cash interest expense of $116,000, and non-cash compensation expense for stock options of $74,000.
During the quarter ended March 31, 2008, the Company consummated an equity and financing transaction that provided $491,000 in net cash after paying off the then due existing debt of $2,113,000, and which funds were used for working capital purposes and to bring our payables to a more current position. In addition, in October 2008, the Company secured additional Senior Subordinated Debt financing of $250,000.
In the third quarter of 2008, the Company took actions to reduce its cash operating expenses to align its cost structure with current economic conditions and a downturn in the Company’s revenue levels. It is anticipated that these reductions will result in annualized operating cost savings of approximately $600,000. Additionally, during the first quarter of 2009, the Company entered into an agreement with one of its contract manufactures to sell certain equipment and inventory, sublease a portion of its facility to the manufacturer, and further engage the manufacturer to produce more of the Company’s products. This transaction is expected to improve the operating efficiency of the Company and provide an increase in short term cash flows.
Going forward, the Company is dependent on financing its operations through the use of its bank line of credit and the contribution from future revenues. Management believes that the actions it has taken will enable the Company to generate sufficient cash flows from operations and funding from its bank line of credit to maintain liquidity through December 31, 2009, at currently projected revenue levels. However, a further downturn in our revenue levels can severely impact the availability under our line of credit and limit our ability to meet our obligations on a timely basis and finance our operations as needed. At December 31, 2008, we had remaining net availability under our line of credit of approximately $93,000. Future availability may be impacted by the amount of qualifying receivables and there is no assurance that the Company will be able to obtain additional funding if and when it may need it.
The equity and financing transaction consummated January 31, 2008, consisted of an issuance of cumulative convertible preferred stock and the funding of a new senior bank line of credit and subordinated term debt. The preferred stock issuance for $2.1 million consisted of 20,125 shares of Series A Preferred shares. The Preferred shares carry an initial annual dividend rate of 9% and contain conversion rights allowing the preferred shares to be converted into Company’s common stock. The senior debt is a $3.0 million working capital line of credit from Fifth Third Bank in Cincinnati, OH, with a floating interest rate of the bank’s prime rate plus 1.5%. Availability under the line of credit is formula-driven based on applicable balances of the Company’s accounts receivable and inventories. At December 31, 2008, based on the formula-driven calculation, the Company had available under the line a maximum of approximately $1.5 million, of which the Company had drawn $1.4 million. The line of credit contains certain financial and other covenants that the Company was in compliance with at December 31, 2008. The Company subsequently entered into an amendment with Fifth Third Bank as of April 8, 2009, extending the maturity date for repayment of all borrowings under the line of credit from January 31, 2009 until January 31, 2010. As amended on April 8, 2009, the maximum borrowings available under the line was reduced to $2,000,000 through December 31, 2009, and to $1,500,000 thereafter. Additionally, per the amendment, effective February 1, 2009, the interest rate was modified to be LIBOR plus 6.5%. Additionally, on January 31, 2008, the Company entered into a Senior Subordinated Note and Warrant Purchase Agreement (“Agreement”) with Canal Mezzanine Partners, L.P. (“Canal”), providing the Company with approximately $1.1 million in net funding. The note contained in the Agreement has a stated principal balance of $1.2 million with an annual interest rate of 13% and a five-year maturity date. Interest-only payments are payable monthly during the first five years of the note with all principal due and payable on the fifth anniversary of the note. The Agreement also provides for a formula-driven success fee based on a multiple of the trailing twelve months EBITDA to be paid at maturity and for issuance of a warrant entitling Canal to purchase 3% of the Company’s fully diluted shares at time of exercise at a nominal purchase price.
In October 2008, the Company entered into an amendment to the Agreement with Canal (“Amendment”) securing additional Senior Subordinated Debt financing of $250,000, which was originally due and payable on February 15, 2009, and which can be extended by the Company until January 31, 2013, upon payment of an extension fee of $25,000. The Company intends to extend the maturity date and is currently in process to do so. The additional debt bears interest at 13% per annum, payable monthly. In connection with the Amendment, if the additional debt is not paid in full on or by February 15, 2009, Canal is entitled to exercise an additional warrant to purchase the common stock of the Company in an amount representing 0.75% of the Company’s fully diluted common stock on the date of exercise, and to increase the multiplier in the success fee, as described above, from 5.5% to 6.0%.
In conjunction with the closing on January 31, 2008, the Company terminated its lending relationship with and paid in full its debt obligations with National City Bank and the Hillstreet Fund, notwithstanding the put warrant liability for the Hillstreet Fund.
The actual amount and timing of working capital and capital expenditures that we may incur in future periods may vary significantly and will depend upon many factors, including the amount and timing of the receipt of revenues from operations, any potential acquisitions or divestitures, an increase in manufacturing capabilities, the reduction of liabilities, the timing and extent of the introduction of new products and services and growth in personnel and operations. There can be no assurance that additional financing will be available if and when needed on terms favorable to the Company, if at all. Any future sale of our equity securities would likely dilute or subordinate the ownership interest of existing shareholders. If internally generated funds are inadequate, we may scale back expenditures or seek other financing, which might include sales of equity securities that could dilute existing shareholders. See “Cautionary Statements.”
Net cash used in operating activities for 2008 of $573,000 consisted of the net loss of $799,000, offset by net non-cash sources of cash totaling $856,000, which included; depreciation and amortization of $603,000, non-cash compensation expense of $74,000, provisions for bad debt and obsolete inventory totaling $76,000, amortization of deferred financing costs of $58,000, and the accretion of discount and success fees on debt of $57,000. Additionally, net cash was used for the decrease in accounts payable of $895,000, other accrued liabilities of $278,000 and the payments of restructuring charges of $278,000, and partially offset by the decrease in accounts receivable of $734,000. Net cash provided by operating activities for 2007 was $109,000 and consisted of the net loss of $766,000, offset by net non-cash sources of cash totaling $924,000, which included depreciation and amortization of $623,000, the accretion of discount and success fees on debt of $508,000, and partially off-set by the fair value adjustment of the liability for the warrant of $415,000. Additionally, net cash was used 2007 for the increase in accounts receivable of $223,000 and the payments of restructuring charges of $402,000.
Net cash used in investing activities in 2008 of $223,000 consisted of equipment purchases of $61,000 and an investment of $162,000 in capitalized internally developed software. Net cash used in investing activities in 2007 of $63,000 was for the purchase of equipment.
Net cash provided by financing activities for the year ended December 31, 2008 was $548,000 as compared to $173,000 provided during 2007. Cash provided in the current year period consisted of proceeds from the issuance of preferred stock of $2.1 million and proceeds from new subordinated term debt of $1.2 million. These amounts were partially offset by the principal pay-off of the previously existing subordinated term debt of $2.0 million, net repayments under revolving credit facilities of $557,000, pay-off of bank term debt of $113,000, principal payments on the Ohio Development loan of $125,000, and deferred financing costs incurred of $158,000. Net cash provided by financing activities for the year ended December 31, 2007 was $173,000 and consisted of net borrowing under the Company’s revolving credit facility of $621,000, off-set by repayments on bank term debt of $283,000, repayments on the Ohio Development loan of $104,000, and capital lease principal payments of $66,000.
The Company operates at leased premises in Hudson, Ohio which are adequate for the Company’s needs for the near term.
The Company does not expect to acquire more than $100,000 in capital equipment during fiscal year 2009.
As of December 31, 2008, we were in compliance with our bank financial covenants.
The actual amount and timing of working capital and capital expenditures that we may incur in future periods may vary significantly and will depend upon numerous factors, including the amount and timing of the receipt of revenues from operations, any potential licensing revenues, and any potential divestitures of assets. There can be no assurance that additional financing will be available when needed on terms favorable to the Company, if at all.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist primarily of conventional operating leases, purchase commitments and other commitments arising in the normal course of business, as further discussed below under “Contractual Obligations and Commercial Commitments.” As of December 31, 2008, we did not have any other relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance, special purpose entities or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual Obligations and Commercial Commitments
We incur various contractual obligations and commercial commitments in our normal course of business. Such obligations and commitments consist primarily of the following:
Capital Lease Obligations
We have various capital lease obligations in connection with equipment purchases. Our outstanding capital lease obligations of $20,549 as of December 31, 2008, relate to manufacturing and test equipment and are included as part of short-term and long-term debt within our balance sheet.
Operating Lease Obligations
As of December 31, 2008, we have operating leases for our facilities with future minimum payments of $848,000 extending through March 31, 2014.
Purchase Commitments with Contract Manufacturers
We generally issue purchase orders to our contract manufacturers with delivery dates from four to six weeks from the purchase order date. In addition, we regularly provide such contract manufacturers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. We are committed to accept delivery of materials pursuant to our purchase orders subject to various contract provisions which allow us to delay receipt of such orders or cancel orders beyond certain agreed lead times. Such cancellations may or may not result in cancellation costs payable by us. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. If we are unable to adequately manage our contract manufacturers and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, financial condition and results of operations.
Other Purchase Commitments
We also incur various purchase obligations with other vendors and suppliers for the purchase of inventory, as well as other goods and services, in the normal course of business. These obligations are generally evidenced by purchase orders with delivery dates from four to six weeks from the purchase order date, and in certain cases, supply agreements that contain the terms and conditions associated with these purchase arrangements. We are committed to accept delivery of such materials pursuant to such purchase orders subject to various contract provisions which allow us to delay receipt of such orders or cancel orders beyond certain agreed lead times. Such cancellations may or may not result in cancellation costs payable by us. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. If we are not able to adequately manage our supply chain and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, financial condition and results of operations.
Severance Agreement Commitments
The Company is party to severance agreements with former employees and is obligated to continue payments under these agreements, with the latest obligation being due in April 2009. The balance due from these arrangements at December 31, 2008 is $42,000, which is included in short-term obligations. The severance liability primarily arose from the accrued restructuring costs assumed at time of the merger and is included in accrued restructuring costs in the financial statements.
Inflation
Management believes that inflation has not had a significant impact on the price of our products, the cost of our materials, or our operating results for either of the two years ended December 31, 2008.
ITEM7A: QUANTITIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements of the Company with related Notes and Report of Independent Registered Public Accounting Firm are attached hereto commencing at page F-l.
ITEM 9:
ITEM 9:
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A:
ITEM 9A: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the fiscal year ending December 31, 2008 covered by this Annual Report on Form 10-K. Our disclosure controls and procedures are intended to ensure that the information we are required to disclose in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as the principal executive and financial officers, respectively, to allow timely decisions regarding required disclosures. Based upon such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as required under Rules 13a-15(e) and 15d-15(e) under the Exchange Act.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) of the Company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2008 under the criteria set forth in the in Internal Control-Integrated Framework.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within DPAC have been detected.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control Over Financial Reporting
No change in the Company’s internal control over financial reporting occurred during the quarter ended December 31, 2008, that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B:
ITEM 9B: OTHER INFORMATION
On April 15, 2009, the Company issued a press release announcing its financial results for the fourth quarter of year ending December 31, 2008 and for the year then ended. A copy of the press release is attached to this Annual Report on Form 10-K as Exhibit 99.1.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following table sets forth certain information regarding our directors as of December 31, 2008:
Position with Company (in addition to Director) and Principal Occupations during the Past Five Years
Samuel W. Tishler, Chairman of our Board of Directors, is an independent consultant, retired in 2003 as vice president for Corporate Development for Acterna Corporation, (Nasdaq:ACTR), a manufacturer of telecommunications test equipment, and is an experienced strategic planning and venture investment professional. He was a vice president of Arthur D. Little Enterprises, Inc. from 1977 to 1986 and a founder of Arthur D. Little Ventures. He also was a vice president of Raytheon Ventures from 1987 to 1994, and in that capacity was responsible for its venture capital portfolio. Mr. Tishler has also served on many of the Boards of venture-backed companies, including Viewlogic Systems and Kloss Video Corporation. Mr. Tishler’s broad strategic planning background includes the early development of technology concepts from planning to development and execution.
Steven D. Runkel is our Chief Executive Officer (CEO) and President, and has served in that role since February, 2006. From July, 2000 until February, 2006 he was Quatech, Inc.’s CEO and President. Quatech, Inc. and DPAC merged in February of 2006. From May of 1999 until July 2000, he was a Sr. Practice Director for Oracle Corporation with a focus on Customer Relationship Management (CRM) system implementations. From April, 1995 to April, 1999 he served in a number of executive management positions for Innovative Systems Inc., a CRM software and services company. These positions included President and Chief Operating Officer from June, 1997 to April 1999. Prior to joining Innovative Systems, Mr. Runkel held leadership positions at Formtek, Inc. and Harris Corporation. Mr. Runkel has a BS from Pennsylvania State University.
Creighton K. Early resumed his position as a Consulting Principal with the Environmental Financial Consulting Group since his resignation as the Chief Executive Officer of DPAC, a position he held from May 1, 2004 until February 28, 2006. From December 18, 2003 to April 30, 2004, he was our interim-CEO. From April 2003 until May 2004, he was a Consulting Principal in the Environmental Financial Consulting Group. From 1988 through 2002, Mr. Early served in several management positions while employed by Earth Tech, Inc., an engineering consulting and asset management company. These positions included Chief Financial Officer from June 1988 through October 1999 and as President of the company’s Global Water Management Division from November 1999 through December 2002. Prior to joining Earth Tech, Mr. Early held senior level finance positions at electronics manufacturers Informer, Inc., Schiff Photo Mechanics and Hi-Tek Corporation. Mr. Early has a BS from Ohio State University and an MBA from the University of Michigan.
Dennis R. Leibel has served as a Director of the Company since February 2006 and chairs the Audit Committee. Mr. Leibel is a founding partner of Equire Associates LLC, a financial consulting business. Mr. Leibel is also a private investor and a retired financial and legal executive. Mr. Leibel also serves on the Board of Directors of Microsemi Corporation, where he is Chairman. Mr. Leibel holds a B.S. degree in accounting, a Juris Doctor degree and an L.L.M. degree.
William Roberts is a 30 year veteran in retailing. He currently is Executive Vice President of merchandising with Belk Inc. Belk is a $4 billion private retail chain based out of Charlotte, NC. Prior to Belk, Mr. Roberts has held various merchandising positions with May Department Stores and Macy’s.
Mark Chapman is Senior Vice President and General Manager at Comarco Inc (Nasdaq: CMRO), a provider of wireless network test equipment. Previously, he was an independent wireless consultant also acting as Vice President of Business Development for WiSpry, a venture funded fabless semiconductor company targeting broadband and wireless communications. From 2001 to 2003, Mr. Chapman served as president and CEO of Ditrans Corp, a developer of Digital Transceiver products. Mr. Chapman’s prior experience also includes various management, sales and marketing positions at Rockwell Semiconductor (now Conexant) where he had responsibility for various modem products and later wireless data products. Mr. Chapman also worked for Thorn EMI, a contractor for British Telecom; and Racal Milgo, Inc., a manufacturer of modems in Reading, England in various systems engineering positions. Mr. Chapman received a BSEE with first class honors from Robert Gordon’s University, Aberdeen, Scotland.
James Bole is Vice President of SOA Solutions at Software AG, a German global enterprise software company. Mr. Bole has more than 20 years of entrepreneurial software development and technical management experience in both startups and Fortune 100 companies. From 2001 to September 2006, Mr. Bole was Vice President of Products and Professional Services at Infravio, a venture capital-backed software startup acquired by webMethods. Prior to joining Infravio, Mr. Bole held executive positions at Lockheed Martin (NYSE: LMT), Formtek (acquired by Lockheed Martin), and WorkExchange Technologies. Mr. Bole holds a BS in Applied Mathematics/Computer Science from Carnegie Mellon University.
Executive Officers
The following information is provided with respect to DPAC’s current executive officers. Information for Mr. Steven D. Runkel is provided under the heading “Directors” above.
DPAC’s executive officers and their ages as of December 31, 2008 are as follows:
Board of Director Meetings and Committees
During the year ended December 31, 2008, the board of Directors held 7 meetings. All members of the Board of directors hold office until the next Annual Meeting of Stockholders or the election and qualification of their successors. Executive officers serve at the discretion of the Board of Directors.
During the year ended December 31, 2008, each Board of Directors member attended at least 75% of the meetings of the board of Directors and at least 75% of the meetings of the committees on which he served.
We currently have two committees of our Board of Directors: the Audit Committee and the Compensation Committee.
The Audit Committee meets periodically with the company’s management and independent registered public accounting firm to, among other things, review the results of the annual audit and quarterly reviews and discuss the financial statements. The audit committee also hires the independent registered public accounting firm, and receives and considers the accountant’s comments as to controls, adequacy of staff and management performance and procedures. As of the end of 2008 the Audit Committee was composed of Mr. Leibel, Mr. Tishler and Mr. Chapman, all of whom are independent directors. Mr. Leibel is the Chairman of the Audit Committee, and also serves as our “audit committee financial expert”, as defined in Item 407(d)(5)(ii) of Regulation S-K. The Audit Committee operates under a formal charter that governs its duties and conduct.
The compensation committee determines the salaries and incentive compensation of our officers and provides recommendations for the salaries and incentive compensation of our other employees. There are currently two members of the Compensation Committee, Mr. Roberts and Mr. Bole. The compensation committee does not operate under a charter.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers and directors and those persons who beneficially own more than 10% of our outstanding shares of common stock to file reports of securities ownership and changes in such ownership with the Securities and Exchange Commission. Officers, directors and greater than 10% beneficial owners are also required by rules promulgated by the SEC to furnish us with copies of all Section 16(a) forms they file.
Based solely upon a review of the copies of such forms furnished to us, we believe that during 2008 all Section 16(a) filing requirements applicable to our officers, directors and greater than 10% beneficial owners were complied with.
Code of Ethics for Financial Professionals
Our code of ethics, which we adopted in 2004, will be provided free of charge to anyone upon written request. Request can be made by mail or fax to:
DPAC Technologies Corp.
5675 Hudson Industrial Park
Hudson, Ohio 44236
Fax: 330-655-9020
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
The following table sets forth compensation for services rendered in all capacities to the Company for each person who served as an executive officer during the year ended December 31, 2008 (the “Named Executive Officers”). No other executive officer of the Company received salary and bonus, which exceeded $100,000 in the aggregate during the year ended December 31, 2008:
Summary Compensation Table
(1)
Mr. Runkel’s salary includes $23,000 in payments which were voluntarily deferred from 2007 because of the Company’s cash flow constraints. Mr. Runkel’s other compensation consisted of a vehicle allowance and apartment rental costs. Because Mr. Runkel does not live in Hudson, OH, the Company maintains an apartment in Hudson, OH for Mr. Runkel. Additionally, Mr. Runkel, who serves as a director of the Company, does not receive compensation for such service as a director.
(2)
Mr. Vukadinovich’s other compensation consisted of a vehicle allowance.
Option Grants
During 2008, the Company issued to employees, excluding Directors, stock option grants to purchase 2,950,000 shares of common stock, all vesting over a four year period.
The following tables contain information concerning the stock option grants to the Company’s Named Executive Officers for the year ended December 31, 2008.
Option Grants in Last Fiscal Year
Outstanding Equity Awards at Year End
Employment Agreements
The Company has a written employment agreement with Mr. Runkel that specifies a base salary of $250,000 per year, an auto allowance of $750 per month and eligibility to participate in any incentive compensation program of the Company and all other benefit programs generally applicable to the Company’s senior executives. If DPAC terminates Mr. Runkel’s employment for any reason other than for “cause” or if Mr. Runkel terminates his employment for “good reason”, as those terms are defined in the agreement, Mr. Runkel will be entitled to a severance equal to the continuation of his base salary and auto allowance for twelve months from the termination of his employment. In addition, upon such an event, all unvested stock options to purchase Company common stock held by Mr. Runkel, if any, shall become fully vested and may be exercised by him for two years from the date of his termination. The employment agreement with Mr. Runkel expired on March 31, 2009 and the Compensation Committee is currently working to replace the agreement with a new agreement.
Notwithstanding the salary that as specified by Mr. Runkel’s employment agreement, on July 18, 2008 he voluntarily agreed to a reduction in his total base salary from $250,000 annually to $200,000 annually. Additionally, the Company would pay to Mr. Runkel a quarterly bonus based on the achievement by the Company of certain quarterly performance targets (measured by reference to the Company’s earnings before interest, taxes, depreciation and amortization (EBITDA)). Mr. Runkel would receive a bonus (in cash) of $6,250 for quarterly Company EBITDA of $250,000; $12,500 for EBITDA of $375,000 and $25,000 for EBITDA of $500,000.
The Company has a written employment agreement with Mr. Vukadinovich that specifies a base salary of $146,000 per year, an auto allowance of $500 per month and eligibility to participate in any incentive compensation program of the Company and all other benefit programs generally applicable to the Company’s senior executives. If DPAC terminates Mr. Vukadinovich’s employment for any reason other than for “cause” or if Mr. Vukadinovich terminates his employment for “good reason”, as those terms are defined in the agreement, Mr. Vukadinovich will be entitled to a severance equal to the continuation of his base salary and auto allowance for six months from the termination of his employment. In addition, upon such an event, all unvested stock options to purchase Company common stock held by Mr. Vukadinovich, if any, shall become fully vested and may be exercised by him for two years from the date of his termination. The employment agreement with Mr. Vukadinovich expired on March 31, 2009 and the Compensation Committee is currently working to replace the agreement with a new agreement.
Compensation of Directors
The following table sets forth the compensation of the Board for the 2008 fiscal year:
The Company pays its non-employee directors a cash retainer of $2,000 per quarter. The Chair of the Audit Committee and the Chair of the Compensation Committee are each paid an additional $1,000 and $500 per quarter, respectively. In addition to such retainers, non-employee directors receive fees of $1,500 for each Board meeting attended. In addition, non-employee directors receive fees of $500 for each Audit Committee or Compensation Committee meeting attended. As indicated in footnote (2) to the Director compensation table above, in lieu of payment in cash of the retainer and fee amounts earned in 2008, the Company issued stock options in January 2009 to its directors in the amounts described in the footnote. The Board members are reimbursed their out-of-pocket expenses for attending Board and committee meetings.
Each non-employee director is granted annually an option to purchase up to 50,000 shares of the Company’s Common Stock at the fair market value of such shares at the time of such grant. Such option grants have a 10 year life and are immediately exercisable and fully vested at the time of grant. The annual stock options are granted on the first business day of each fiscal year. For the year ended December 31, 2008, options to purchase 50,000 shares of common stock were granted to each of the following directors: Mr. Early, Mr. Roberts, Mr. Tishler, Mr. Chapman, Mr. Bole and Mr. Leibel. All options granted had an exercise price of $0.014 per share.
ITEM 12:
ITEM 12:
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following tables sets forth certain information as of February 25, 2009, with respect to ownership of the Company’s Common Stock by each person who is known by the Company to own beneficially 5% or more of the Common Stock, each Named Officer, each director of the Company, each nominee for director, and all executive officers and directors of the Company as a group.
Equity Compensation Plan Information
ITEM 13:
ITEM 13:
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Not Applicable.
ITEM 14:
ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES
Maloney + Novotny LLC (formerly Hausser + Taylor LLC) (“Maloney + Novotny”) served as the company’s independent auditor for the years ended December 31, 2008 and 2007. The following is a summary of the fees billed to the Company by Maloney + Novotny, which served as the Company’s auditor, and for professional services rendered during the years ended December 31, 2008 and 2007:
Audit fees consist of fees billed for professional services rendered for the audit of the Company’s consolidated financial statements and review of the interim financial statements included in quarterly reports and services that are normally provided in connection with statutory and regulatory filings or engagements.
Until October 19, 2007, Maloney + Novotny had a continuing relationship with RSM McGladrey, Inc. (“RSM”) from which it leased auditing staff who were full time, permanent employees of RSM and through which its shareholders provided non-audit services. As a result of this arrangement, Maloney + Novotny had no full time employees and, therefore, none of the audit services performed were provided by permanent full time employees of Maloney + Novotny. Maloney + Novotny managed and supervised the audit and audit staff, and is exclusively responsible for the opinion rendered in connection with its examination.
Our audit committee pre-approves all fees for services to be performed by our principal accountant in accordance with our audit committee charter.
ITEM 15:
ITEM 15: EXHIBITS
The following documents are filed as part of this Form 10-K:
*
Management compensatory plan or arrangement.
(c) Financial Statement Schedules Excluded from Annual Report: None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: April 15, 2009 DPAC TECHNOLOGIES CORP.
By: /s/ Steven D. Runkel
Steven D. Runkel
Chief Executive Officer
Director
By: /s/ Stephen J. Vukadinovich
Stephen J. Vukadinovich
Chief Financial Officer & Secretary
(Principal Financial and Accounting Officer)
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints Steven D. Runkel and Stephen J. Vukadinovich, or either of them, his true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, to sign the report on Form 10-K and any or all amendments thereto and to file the same, with all exhibits thereto, and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof in any and all capacities.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Samuel W. Tishler
Samuel W. Tishler
Chairman of the Board
April 15, 2009
/s/ Steven D. Runkel
Steven D. Runkel
Chief Executive Officer, Director
(Principal Executive Officer)
April 15, 2009
/s/ William Roberts
William Roberts, Director
April 15, 2009
/s/ Creighton K. Early
Creighton K. Early
April 15, 2009
/s/ Mark Chapman
Mark Chapman, Director
April 15, 2009
/s/ Dennis R. Leibel
Dennis R. Leibel, Director
April 15, 2009
/s/ Jim Bole
Jim Bole, Director
April 15, 2009
/s/ Stephen J. Vukadinovich
Stephen J. Vukadinovich
Chief Financial Officer & Secretary
(Principal Financial and Accounting Officer)
April 15, 2009
DPAC TECHNOLOGIES CORP.
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
DPAC TECHNOLOGIES CORP.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
DPAC Technologies Corp.
Hudson, Ohio
We have audited the accompanying consolidated balance sheets of DPAC Technologies Corp. and subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of DPAC Technologies Corp. and subsidiary as of December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Cleveland, Ohio
April 9, 2009
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DPAC Technologies Corp.
Consolidated Balance Sheets
December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
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DPAC Technologies Corp.
Consolidated Statements of Operations
For the Years Ended December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
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DPAC Technologies Corp.
Consolidated Statements of Stockholders’ Equity
For the Years Ended December 31, 2007 and 2006
See accompanying notes to consolidated financial statements.
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DPAC Technologies Corp.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
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DPAC Technologies Corp.
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
DPAC Technologies Corp., (“DPAC”) through its wholly owned subsidiary, QuaTech Inc., (“QuaTech”) designs, manufactures, and sells device connectivity and device networking solutions for a broad market. QuaTech sells its products through a global network of distributors, system integrators, value added resellers, and original equipment manufacturers (“OEM”). QuaTech designs and manufactures communication and data acquisition products for personal computer based systems. The Company sells to customers in both domestic and foreign markets.
Basis of Presentation
On April 28, 2005, DPAC entered into a merger agreement, as amended, with QuaTech for a transaction to be accounted for as a purchase under accounting principles generally accepted in the United States of America. The merger was approved by both QuaTech and DPAC shareholders on February 23, 2006 and was consummated on February 28, 2006. For accounting purposes, the transaction is considered a “reverse merger” under which QuaTech is considered the acquirer of DPAC. Accordingly, the purchase price was allocated among the fair values of the assets and liabilities of DPAC, while the historical results of QuaTech are reflected in the results of the combined company (the “Company”). The results of operations are those of QuaTech through the merger date, and combined QuaTech and DPAC after the merger date of February 28, 2006. All intercompany transactions and balances have been eliminated in consolidation.
The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Some historical amounts have been reclassified to be consistent with the current financial presentation.
Use of Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Actual results could differ from those estimates.
The Company calculates its reserve for excess and obsolete inventory based on the best estimate available as to the value of the items, and capitalizes labor and overhead to inventory based on estimates of applicable expenses. The Company estimates an allowance for doubtful accounts of its accounts receivable based upon a review of delinquent accounts and an assessment of the Company’s historical evidence of collections. Additionally, the Company calculated its warranty reserve on the best available measure of claims. Because of the inherent uncertainties in estimating the above, it is at least reasonably possible that the estimates used could change within the near term.
Cash and Cash Equivalents
The Company considers all short-term debt securities purchased with an initial maturity of three months or less to be cash equivalents.
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Accounts Receivable
The Company extends unsecured credit to customers under normal trade agreements, which generally require payment within 30 days. Accounts greater than 90 days past due are considered delinquent. The Company does not charge interest on delinquent trade accounts receivable. Unless specified by the customer, payments are applied to the oldest unpaid invoice. Accounts receivable are presented at the amounts billed.
Management estimates an allowance for doubtful accounts, which was $50,447, and $25,447 as of December 31, 2008 and 2007, respectively. The estimate is based upon management’s review of delinquent accounts and an assessment of the Company’s historical evidence of collections. The Company incurred $25,000 and $0 bad debt expense for the years ended December 31, 2008 and 2007, respectively. Specific accounts are charged directly to the reserve when management obtains evidence of a customer’s insolvency or otherwise determines that the account is uncollectible. Charge-offs of specific accounts for the years ended December 31, 2008 and 2007 totaled $0 and $841, respectively.
Inventories
Inventories, consisting principally of raw materials, sub-assemblies and finished goods, are stated at the lower of average cost or market. The Company regularly monitors inventories for excess or obsolete items and records a provision to write-down excess or obsolete items as required.
Property
Property is stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, generally ranging from 3 to 11 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the useful lives of the improvements or the term of the related lease.
Capitalized Developed Software
Certain software development costs are capitalized after a product becomes technologically feasible and before its general release to customers. Significant judgment is required in determining when a product becomes ''technologically feasible.’’ Capitalized development costs are then amortized over the product’s estimated life beginning upon general release of the product. Periodically, we compare a product’s unamortized capitalized cost to the product’s net realizable value. To the extent unamortized capitalized cost exceeds net realizable value based on the product’s estimated future gross revenues (reduced by the estimated future costs of completing and selling the product) the excess is written off. This analysis requires us to estimate future gross revenues associated with certain products and the future costs of completing and selling certain products. Changes in these estimates could result in write-offs of capitalized software costs. As of December 31, 2008, certain development costs of the Company met the criteria of Statement of Financial Accounting Standards No. 86 - Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (“SFAS 86”) for the capitalization of software development costs. Accordingly, $162,375 of software development costs were capitalized as of December 31, 2008. The product was not yet generally released at December 31, 2008, and therefore no amortization was recorded.
Financing Costs
Financing costs incurred are amortized over the life of the associated financing arrangements using the effective interest method. Amortization expense totaled approximately $58,000 and $99,000 for the years ended December 31, 2008 and 2007, respectively.
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Long-lived Assets
The Company assesses potential impairments to its long-lived assets when there is evidence that events or changes in circumstances indicate the carrying amount of an asset may not be recovered. An impairment loss is recognized when the undiscounted cash flows expected to be generated by an asset (or group of assets) is less than its carrying amount. Any required impairment loss is measured as the amount by which the assets carrying value exceeds its fair value, and is recorded as a reduction in the carrying value of the related asset and a charge to operations.
Goodwill and Intangible Assets
The Company follows SFAS 142 - Goodwill and Other Intangible Assets, which requires that goodwill and certain intangible assets, including those recorded in past business combinations, no longer be amortized against earnings, but instead be tested for impairment at least annually.
Intangible assets with indefinite lives at December 31, 2008 and 2007 are comprised of goodwill of $3,822,503 and the QuaTech trade name and customer list of $2,583,000.
The Company operates in a single business segment as a single business unit and at least annually reviews the recoverability of the carrying value of goodwill and other intangibles using the methodology prescribed in SFAS No. 142. Recoverability of goodwill is determined by comparing the fair value of the entire Company to the accounting value of the underlying net assets. If the fair value of the Company is determined to be less than the fair value of the net assets, goodwill is deemed impaired and an impairment loss is recognized to the extent that the carrying value of goodwill and other intangibles exceed the difference between the fair value of the Company and the fair value of all other assets and liabilities. At December 31, 2008, there was no impairment of goodwill and other intangibles based on the Company’s most recent analysis.
Amortizable Intangible Assets
Amortizable intangible assets at December 31, 2008 and 2007 of $1,061,704 and $1,551,724, respectively, consists of developed technology and customer related intangibles acquired in the DPAC - QuaTech merger on February 28, 2006. The fair value was determined to be $2,450,094 at the acquisition date and is being amortized over its estimated life of 5 years, with accumulated amortization of $1,388,390 and $898,370 at December 31, 2008 and 2007. Amortization expense for 2008 and 2007 was $490,020 per year and is expected to remain approximately $490,000 annually until the intangible assets are fully amortized.
Revenue Recognition
Revenues from product sales are recognized upon shipment and transfer of title in accordance with the shipping terms specified in the arrangement with the customer, and collectibility is reasonably assured. Revenue recognition is deferred in all instances where the earnings process is incomplete. A reserve for defective products is recorded for customers based on historical experience or specific identification of an event necessitating a reserve. Development revenue is recognized when services are performed and was not significant for any of the periods presented.
The Company also offers marketing incentives to certain customers. These incentives are incurred based on the level of expenses the customers incur and are charged to operations as expenses in the same period.
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Advertising Costs
The cost of advertising is charged to expense as incurred. Advertising expense for the years ended December 31, 2008 and 2007 totaled approximately $179,000 and $309,000, respectively.
Shipping and Handling Costs
The costs of shipping and handling billed to customers in sale transactions are recorded as revenue. Costs incurred for shipping and handling to customers are reported in cost of good sold. Total shipping and handling costs incurred to ship goods to customers were approximately $88,000 and $79,000 for the years ended December 31, 2008 and 2007, respectively.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of accounts receivable, which are derived primarily from distributors, original equipment manufacturers, and end customers.
The Company maintains its cash balances primarily in two financial institutions which are insured under the Federal Deposit Insurance Corporation. The Company had no uninsured cash balances December 31, 2008.
Stock-Based Compensation
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (or “SFAS 123R”), which supersedes our previous accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees” (or “APB 25”). SFAS 123R requires the recognition of compensation expense, using a fair-value based method, for costs related to all share-based payments including stock options and stock issued under our employee stock plans. SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service periods in our consolidated statements of operations. We adopted SFAS 123R using the modified prospective transition method, which requires that compensation expense be recognized in the financial statements for all awards granted after the date of adoption as well as for existing awards which have not vested as of the date of adoption. The modified prospective transition method does not require restatement of prior periods to reflect the impact of SFAS 123R.
In November 2005, the Financial Accounting Standards Board (the “FASB”) issued FASB Staff Position FAS123(R)-3, Transition Election to Accounting for the Tax Effects of Share-Based Payment Awards (“FSP”). This FSP requires an entity to follow either the transition guidance for the additional-paid-in-capital pool as prescribed in SFAS 123(R) or the alternative transition method as described in the FSP. An entity that adopts SFAS 123(R) using the modified prospective method may make a one-time election to adopt the transition method described in this FSP. An entity may take up to one year from the later of its initial adoption of SFAS 123(R) or the effective date of this FSP to evaluate its available transition alternatives and make its one-time election. This FSP became effective in November 2005. The Company has elected to use the transition method.
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Income Taxes
The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Deferred taxes result from temporary differences between the bases of assets and liabilities for financial statements and tax reporting purposes. Measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and tax bases of the Company’s assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or the entire deferred tax asset will not be realized. During the years ended December 31, 2008 and 2007, the Company recorded a full valuation allowance associated with its net deferred tax assets.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (or “FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (or “SFAS 109”). This Interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 as of January 1, 2007. The implementation of FIN 48 did not have a material impact on the Company’s financial statements. There were no unrecognized tax benefits as of the date of adoption of FIN 48 and therefore, there is no anticipated effect upon the Company’s effective tax rate. Interest, if any, under FIN 48 will be classified in the financial statements as a component of interest expense and statutory penalties, if any, will be classified as a component of general and administrative expense. Tax returns filed for the years ended December 31, 2005, 2006, 2007 and 2008 are still open to audit by the Internal Revenue Service.
Net Income (Loss) per Share
The Company computes net income per share in accordance with SFAS No. 128, Earnings per Share. Basic earnings per share are computed by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per share reflect the potential dilution of securities by including other common stock equivalents, including stock options, in the weighted-average number of common shares outstanding for a period, if dilutive.
The table below sets forth the reconciliation of the denominator of the earnings per share calculation:
The number of shares of common stock, no par value, outstanding at December 31, 2008 and 2007 was 98,006,343 and 92,890,836, respectively.
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Preferred Stock
At December 31, 2008 the Company had outstanding 20,125 shares of convertible, voting, cumulative, 9% Series A preferred stock. Dividends accrue and are payable quarterly in arrears at the annual rate of 9% of the Original Issue Price of $100 per share, either in cash or common stock, at the decision of the Company. If the Company is not listed for trading on the American Stock Exchange, a NASDAQ Stock Market or the New York Stock Exchange on December 31, 2009, effective beginning January 1, 2010 dividends shall accrue and be paid quarterly in arrears at the annual rate of 15%. For purposes of valuing the common stock payable to holders of Series A Preferred in lieu of cash with respect to such quarterly dividends, the value shall be deemed to be the average of the closing bid or sale prices (whichever is applicable) over the 10 day period ending the day prior the dividend payment date. To date, the Company has elected to pay such dividends in common stock. During the year ended December 31, 2008, the Company issued 3,755,887 common shares in payment of dividends of $126,214. At December 31, 2008, accrued dividends distributable in common stock of $47,813 equate to 4,041,631 common shares issuable.
Series A preferred stock can, at the option of the holder, be converted into fully paid shares of common stock. The number of shares of common stock into which shares of Series A preferred may be converted shall be obtained by multiplying the number of shares of Series A preferred to be converted by the Original Issue Price of $100 and dividing the result by the product of $0.034 (the “Reference Price”) times 1.25, which equates to 50 million common shares should the total number of outstanding preferred shares be converted. After December 31, 2009, the Company can redeem the Series A preferred shares at a price per share equal to the Original Issue Price. The holders of preferred stock have preference in the event of liquidation or dissolution of the Company over the holders of common stock.
Fair Value of Financial Instruments
The fair values of cash and equivalents, accounts receivable, accounts payable and other short-term obligations approximate their carrying values because of the short maturity of the financial instruments. The carrying values of the Company’s long-term obligations approximate their fair value. In accordance with SFAS No. 107, “Disclosure About Fair Value of Financial Instruments,” rates available at balance sheet dates to the Company are used to estimate the fair value of existing obligations.
Comprehensive Income
The Company had no items of other comprehensive income for 2008 and 2007.
Recently Issued Accounting Standards
In December 2007 the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (FAS 141(R)) and No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (FAS 160)”. FAS 141(R) will change how business acquisitions are accounted for and FAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. FAS 141(R) and FAS 160 are effective for fiscal years beginning on or after December 15, 2008 (January 1, 2009 for the Company). The adoption of FAS 141(R) and FAS 160 are not expected to have a material impact on the Company’s consolidated financial statements.
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SFAS No. 157, “Fair Value Measurements,” was adopted on January 1, 2008. SFAS 157 defines fair value, establishes a market-based framework or hierarchy for measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not expand or require any new fair value measures, but is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. In February 2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. 157-2, “Effective Date of FASB Statement No. 157,” which amends SFAS No. 157 by delaying the adoption of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except those items recognized or disclosed at fair value on an annual or more frequently recurring basis, until January 1, 2009. The FASB also amended SFAS 157 to exclude SFAS No. 13 and its related interpretive accounting pronouncements that address leasing transactions. Accordingly, the adoption of this Standard in 2008 was limited to financial assets and liabilities, which affects the disclosure of our put warrant liability and our subordinated debt success fee. The adoption of SFAS 157, as amended, did not have a material impact on the Company’s financial condition, results of operations or cash flows.
SFAS 157 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:
Level 1 -
Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 -
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3 -
Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
The following table represents our financial assets and liabilities measured at fair value on a recurring basis and the basis for that measurement:
The Company values the put warrant liability by calculating the difference between the Company’s closing stock price at the end of a reporting period and the exercise price per share multiplied by the number of warrants granted. In accordance with Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Liabilities and Equity,” (“SFAS 150”), the Company has classified the fair value of the warrants as a liability and changes in the fair value of the warrants are recognized in the earnings of the Company. The Company recognized gains of $12,900 and $415,300 for the years ended December 31, 2008 and 2007, respectively, related to the change in value of the put warrant liability. In addition, the actual settlement amount of the put warrant liability could differ materially from the value determined based on the Company’s stock price. There was no change in the valuation technique used by the Company since the last reporting period.
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The Subordinated Debt Agreement, which funded on January 31, 2008, provides for a formula driven success fee equal to 7.0 times the trailing twelve months EBITDA minus indebtedness plus cash, times 5.5%, to be paid at maturity or a triggering event. The success fee is being accounted for in accordance with SFAS 133 “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS 133”), as a separate contingent component of the note and will be revalued at each reporting period. The success fee is calculated at the end of each reporting period based on the trailing twelve months EBITDA, with the resultant amount multiplied times the percentage of the loan period remaining at each measurement date. As such, the liability is trued up at each reporting period based on the time elapsed, with the remaining unamortized portion of the success fee accreted monthly as additional interest expense over the remaining term of the loan. Based on the results of the above calculation, the Company recorded no liability for the success liability as of December 31, 2008. There was no change in the valuation technique used by the Company since the last reporting period.
NOTE 2 - LIQUIDITY AND OPERATIONS
The Company incurred a net loss of approximately $799,000 for 2008 and ended the year with a cash balance of $9,000 and a deficit in working capital of $805,000. This compares to a net loss of approximately $766,000 for 2007 with a cash balance of $257,000 and a deficit in working capital of $3,745,000 at the end of 2007. These factors created substantial doubt about the Company’s ability to continue as a going concern. In order to mitigate these negative factors, the Company has undertaken a number of initiatives and has implemented various other plans.
Although the Company reported a loss of $799,000 for 2008, a significant portion of our operating expenses are non-cash, including depreciation and amortization of $603,000, non-cash interest expense of $116,000, and non-cash compensation expense for stock options of $74,000.
During the quarter ended March 31, 2008, the Company consummated an equity and financing transaction that provided $491,000 in net cash after paying off the then due existing debt of $2,113,000, and which funds were used for working capital purposes and to bring our payables to a more current position. In addition, in October 2008, the Company secured additional Senior Subordinated Debt financing of $250,000.
In the third quarter of 2008, the Company took actions to reduce its cash operating expenses to align its cost structure with current economic conditions and a downturn in the Company’s revenue levels. It is anticipated that these reductions will result in annualized operating cost savings of approximately $600,000. Additionally, during the first quarter of 2009, the Company entered into an agreement with one of its contract manufactures to sell certain equipment and inventory, sublease a portion of its facility to the manufacturer, and further engage the manufacturer to produce more of the Company’s products (see Note 13). This transaction is expected to improve the operating efficiency of the Company and provide an increase in short term cash flows.
Going forward, the Company is dependent on financing its operations through the use of its bank line of credit and the contribution from future revenues. Management believes that the actions it has taken will enable the Company to generate sufficient cash flows from operations and funding from its bank line of credit to maintain liquidity through December 31, 2009, at currently projected revenue levels. However, a further downturn in our revenue levels can severely impact the availability under our line of credit and limit our ability to meet our obligations on a timely basis and finance our operations as needed. At December 31, 2008, we had remaining net availability under our line of credit of approximately $93,000. Future availability may be impacted by the amount of qualifying receivables and there is no assurance that the Company will be able to obtain additional funding if and when it may need it.
NOTE 3 - INVENTORIES
At December 31, 2008 and 2007, inventory is comprised of the following:
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Purchases of component parts from three major vendors represented 29%, 12% and 10% of the total inventory purchased in 2008 and 22%, 17%, and 10% in 2007. The Company has arrangements with these vendors to purchase product based on purchase orders periodically issued by the Company.
NOTE 4 - PROPERTY
At December 31, 2008 and 2007, property consists of the following:
Depreciation expense totaled approximately $113,000 and $133,000 for the years ended December 31, 2008 and 2007, respectively.
The Company had $46,919 of equipment purchased under Capital Leases included in Machinery and equipment at December 31, 2008 and 2007.
NOTE 5 - INCOME TAXES
The income tax benefit consists of the following for the years ended December 31, 2008 and 2007:
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At December 31, 2008 and 2007, net deferred tax balances consisted of the following:
Included in the total deferred tax assets, the Company has an income tax carryforward for federal net operating losses. The cumulative federal net operating loss carryforward of approximately $10,884,000 expires through 2028; however, as a result of the merger between QuaTech, Inc. and DPAC Technologies Corp, a substantial portion of DPAC’s federal net operating loss carryforward is subject to the provisions of Sec. 382 of the Internal Revenue Code (IRC), and therefore, is not available for immediate benefit to the company. Management has not yet determined the final impact of the IRC Sec. 382 limitation on the federal net operating loss carryforward. The realization of the Company’s deferred tax assets, including this federal net operating loss, and the related valuation allowance are significant estimates requiring assumptions regarding the sufficiency of future taxable income to realize the future tax deduction from the reversal of deferred tax assets and the net operating loss prior to their expiration. The valuation allowance has been provided based upon the Company’s assessment of future realizability of certain deferred tax assets, as it is more likely than not that sufficient taxable income will not be generated to realize these temporary differences. The net increase in the valuation allowance was $229,170 for 2008 and $884,281 for 2007. The amount of the corresponding valuation allowance could change significantly in the near term if estimates of future taxable income are changed.
The 2008 and 2007 valuation allowances were calculated in accordance with the provisions of SFAS No. 109, Accounting for Income Taxes, which requires an assessment of both negative and positive evidence when measuring the need for a valuation allowance. Evidence evaluated by management included operating results during the most recent three-year period and future projections, with more weight given to historical results than expectations of future profitability, which are inherently uncertain. The Company’s net losses in recent periods represented sufficient negative evidence to require a full valuation allowance against its net deferred tax assets under SFAS No. 109. This valuation allowance will be evaluated periodically and could be reversed partially or totally if business results have sufficiently improved to support realization of deferred tax assets.
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A reconciliation of the Company’s effective tax rate compared to the federal statutory rate is as follows:
NOTE 6 - DEBT
At December 31, 2008 and 2007, outstanding debt consisted of the following:
On January 31, 2008, the Company consummated equity and financing transactions which consisted of an issuance of preferred stock and the funding of a new senior bank line of credit and subordinated term loan. In conjunction with the closing on January 31, 2008, the Company terminated its lending relationships with and paid in full its debt obligations with National City Bank and the Subordinated Loan Agreement with the Hillstreet Fund, notwithstanding the put warrant liability for the Hillstreet Fund.
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Revolving Credit Facility
The Company has a revolving line of credit with a bank providing for a maximum $3,000,000 working capital line of credit, with a floating interest rate at the bank’s prime rate (3.25% at December 31, 2008) plus 1.5%, and is payable quarterly. Availability under the line of credit is formula driven based on applicable balances of the Company’s accounts receivable and inventories. Based on the formula, at December 31, 2008 the Company had availability to draw up to a maximum of approximately $1,518,000, leaving net availability of $93,000. The average debt balance on the line of credit was $1,500,000 in 2008 and the weighted average interest rate was 6.2% for 2008, with the interest rate ranging from 4.75% to 7.5%. The line of credit contains certain financial and other covenants that the Company was in compliance with at December 31, 2008. The Credit Facility is secured by substantially all the assets of the Company and expires on January 31, 2010. As amended on April 8, 2009, the maximum borrowings available under the line was reduced to $2,000,000 through December 31, 2009, and to $1,500,000 thereafter. Additionally, per the amendment, effective February 1, 2009, the interest rate was modified to be LIBOR plus 6.5%.
Ohio Development Loan
On January 27, 2006 QuaTech entered into a Loan Agreement with the Director of Development of the State of Ohio pursuant to which QuaTech borrowed $2,267,000 for certain eligible project financing. The State of Ohio debt accrues interest at the rate of 9.0% per year. Payments of interest only were due and payable monthly from March 2006 through February 2007. Thereafter, QuaTech is obligated to make 48 consecutive monthly principal payments of $10,417 plus interest with the balance due on February 1, 2011. On February 1, 2011 QuaTech must also pay the State of Ohio a participation fee equal to the lesser of 10% of the maximum principal amount borrowed or $250,000. The State of Ohio debt is secured by all the assets of QuaTech which security interest is subordinated to the interest of the Bank. The participation fee is being accrued as additional interest each month over the term of the loan.
Subordinated Debt
On January 31, 2008, the Company entered into a Senior Subordinated Note and Warrant Purchase Agreement (“Agreement”) with Canal Mezzanine Partners, L.P. (“Canal”), for $1,200,000. The subordinated note has a stated annual interest rate of 13% and a five year maturity date. Interest only payments are payable monthly during the first five years of the note with all principal due and payable on the fifth anniversary of the note. The Agreement also provides for a formula driven success fee based on a multiple of the trailing twelve months EBITDA, to be paid at maturity or a triggering event, and for issuance of warrants entitling Canal to purchase 3% of the Company’s fully diluted shares at time of exercise at a nominal purchase price.
The warrants have a 10 year life and are exercisable at any time. The subordinated note has been discounted by the fair value of the detachable warrants, with a corresponding contribution to capital. The discount, calculated to be $63,800 at time of issuance, is being amortized as additional interest expense and accretes the note to face value at maturity. The Company determined the fair value of the warrant by using the Black-Scholes pricing model and calculating 3% of fully diluted shares at time of issuance, including a potential 50 million common shares for the conversion of the outstanding Series A preferred stock, which equated to approximately 4.9 million shares and using the closing stock price on the date of the transaction of $0.014 per share.
The success fee is defined as equal to 7.0 times the trailing twelve months EBITDA minus indebtedness plus cash, times 5.5%, to be paid at maturity or a triggering event. The success fee is being accounted for in accordance with SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” as a separate contingent component of the note and will be revalued at each reporting period. The success fee is calculated at the end of each reporting period based on the trailing twelve months EBITDA, with the resultant amount multiplied times the percentage of the loan period remaining at each measurement date. As such, the liability is trued up at each reporting period based on the time elapsed, with the remaining unamortized portion of the success fee accreted monthly as additional interest expense over the remaining term of the loan.
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In October 2008, the Company entered into an Amendment to the Agreement securing additional Senior Subordinated Debt financing from Canal for $250,000, which was due and payable on February 15, 2009, and which maturity date can be extended by the Company until January 31, 2013, upon payment of an extension fee of $25,000. The Company intends to extend the maturity date and is in the process to do so. The additional debt bears interest at 13% per annum, payable monthly. In connection with the Amendment, if the additional debt is not paid in full on or by February 15, 2009, Canal is entitled to exercise an additional warrant to purchase the common stock of the Company in an amount representing 0.75% of the Company’s fully diluted common stock on the date of exercise, and to increase the multiplier in the success fee, as described above, from 5.5% to 6.0%.
Put Warrant Liability
In connection with the Subordinated Loan Agreement between the Company and the Hillstreet Fund, entered into on February 28, 2006 and which was paid in full on January 31, 2008, the Company issued 5,443,457, and per certain default provisions is obligated to issue 1,006,000 additional, 10-year warrants (“Put Warrants”) at an exercise price of $0.00001 per share. The warrants expire on February 28, 2016. The Put Warrants continue to remain outstanding and can be “put” to the Company at any time based on criteria set forth in the warrant agreement at a price equal to the greatest of (i) the fair market value as established by a capital transaction or public offering; (ii) six times the Company’s EBITDA for the trailing 12 month period; and (iii) an appraised value. The Company has determined to value the put warrant liability by calculating the difference between the Company’s closing stock price at the end of a reporting period and the exercise price per share multiplied by the number of warrants granted. In accordance with Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Liabilities and Equity,” (“SFAS 150”), the Company has classified the fair value of the warrants as a liability and changes in the fair value of the warrants are recognized in the earnings of the Company. The Company recognized gains of $12,900 and $415,300 for the years ended December 31, 2008 and 2007, respectively, related to the change in value of the put warrant liability. In addition, the actual settlement amount of the put warrant liability could differ materially from the value determined based on the Company’s stock price.
The aggregate amounts of combined long term debt, exclusive of the put warrant liability and unamortized discount for stock warrants, maturing as of December 31st in future years is $125,000 in 2009, $125,000 in 2010, $1,915,000 in 2011, $0 in 2012, and $1,450,000 in 2012.
Interest expense incurred of $695,000 for the year ended December 31, 2008 included the following non-cash charges: accretion of success fees of $46,000, amortization of deferred financing costs of $58,000, and amortization of the discount for warrants of $46,000.
Interest expense incurred of $1,455,000 for the year ended December 31, 2007 included the following non-cash charges: accretion of success fees of $267,000, amortization of deferred financing costs of $99,000, and amortization of the discount for warrants of $242,000.
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NOTE 7 - COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases office and operation facilities in Hudson, Ohio under an operating lease arrangement that expires on March 31, 2014. The minimum annual rentals under this lease are being charged to expense on a straight line basis over the lease term. Deferred rents were $21,150 as of December 31, 2008 and $9,330 as of December 31, 2007. The facility lease requires additional payments for property taxes, insurance and maintenance costs. Additionally, the Company leases certain equipment under both operating and capital leases. The following table summarizes the future minimum payments under the Company’s operating and capital leases at December 31, 2008:
Rent expense under leases was approximately $199,000 and $269,000 for the years ended December 31, 2008 and 2007, respectively.
Legal Proceedings
We are subject to various legal proceedings and threatened legal proceedings from time to time as part of our business. We are not currently party to any legal proceedings nor are we aware of any threatened legal proceedings, the adverse outcome of which, individually or in the aggregate, we believe would have a material adverse effect on our business, financial condition and results of operations. However, any potential litigation, regardless of its merits, could result in substantial costs to us and divert management’s attention from our operations. Such diversions could have an adverse impact on our business, results of operations and financial condition.
Other Contingent Contractual Obligations
Over time, the Company has made and continues to make certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include: indemnities to past, present and future directors, officers, employees and other agents pursuant to the Company’s Articles, Bylaws, resolutions, agreements or otherwise; indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease; indemnities to vendors and service providers pertaining to claims based on the negligence or willful misconduct of the Company; and indemnities pursuant to contracts involving protection of selling security holders against claims by third parties arising from any alleged inaccuracy of information in registration statements filed by the Company with the SEC or involving indemnification of the other parties to contracts from any damages arising from misrepresentations made by the Company. The Company may also issue a guarantee in the form of a standby letter of credit as security for contingent liabilities under certain customer contracts. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees may not provide for any limitation of the future payments that the Company could potentially be obligated to make. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying balance sheets.
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The Company also has a severance agreement with the current CEO that provides for compensation equivalent to one year of salary should the CEO be terminated for any reason other than cause.
NOTE 8 - RESTRUCTURING COSTS
As a result of the merger on February 28, 2006, QuaTech assumed accrued restructuring costs of approximately $1,119,000, which consisted primarily of accrued severance costs for prior employees of DPAC. Additionally, during 2006, the Company incurred approximately $78,000 in restructuring costs, which consisted of severance costs for the termination of an employee of QuaTech. The accrued restructuring costs are payable through April 2009.
A summary of the activity that affected the Company’s accrued restructuring costs for the years ended December 31, 2008 and 2007 is as follows:
NOTE 9 - STOCK OPTION PLANS
Under the terms of the Company’s 1996 Stock Option Plan, (the “Plan”), qualified and nonqualified options to purchase shares of the Company’s common stock are available for issuance to employees, officers, directors, and consultants. As amended on February 23, 2006, the Plan initially called for options to purchase 15,000,000 shares with an increase to the total number of options available in the plan of 4% of the number of outstanding shares of common stock each year until the end of the option plan. On February 23, 2006, the termination date for the plan was extended to January 11, 2011. At December 31, 2008, 13,805,000 shares were available for future grants under the Plan.
Options issued under this Plan are granted with exercise prices at fair market value and generally vest immediately for options granted to directors and at a rate of 25% per year for options granted to employees, and expire within 10 years from the date of grant or 90 days after termination of employment.
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A summary of activity for the stock option plans is as follows:
No options were exercised in 2008 and the intrinsic value of options exercised in 2007 was $4,674.
During the years ended December 31, 2008 and 2007, the Company recognized compensation expense for stock options of $74,067 and $64,877. The expense is included in the consolidated statement of operations as general and administrative expense. The Company’s calculations were made using the Black-Scholes option-pricing model, with the following weighted average assumptions:
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Expected volatilities are based on historical volatility of the Company’s stock. The Company used historical experience with exercise and post employment termination behavior to determine the options’ expected lives. The expected life represents the period of time that options granted are expected to be outstanding. The risk-free rate is based on the U.S. Treasury rate with a maturity date corresponding to the options’ expected life. The dividend yield is based upon the historical dividend yield.
NOTE 10 - CONCENTRATION OF CUSTOMERS
No single customer accounted for more than 10% of net sales in 2008 and one customer accounted for 10% of net sales in 2007. One customer accounted for 10% of accounts receivable at December 31, 2008.
NOTE 11 - SEGMENT INFORMATION
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company’s chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s chief executive officer reviews financial information and makes operational decisions based upon the Company taken as a whole. Therefore, the Company reports as a single segment.
The Company had export sales that accounted for 26% of total net sales in both 2008 and 2007. Export sales were primarily to Canada and Western European countries. Foreign sales are made in U.S. dollars. All long-lived assets are located in the United States.
NOTE 12 - EMPLOYEE BENEFIT PLAN
The Company has a defined contribution plan covering substantially all employees. The Company matches 25% of employee deferral contributions up to 6% of eligible wages, as defined. The Company contributed matching contributions of approximately $23,000 and $24,000 in the years ended December 31, 2008 and 2007, respectively.
NOTE 13 - SUBSEQUENT EVENT
The Company entered into an Equipment Purchase Agreement (the “Agreement”) that was consummated in January 2009 with one of its contract manufacturers (“Manufacturer”) and has agreed to sell certain of its manufacturing capability (consisting of manufacturing equipment, fixtures, tools, shelving and tables) for a sale price of $74,000. The Manufacturer will also assume the obligations of QuaTech under a certain capital lease with a remaining balance of approximately $21,000 at December 31, 2008. Also pursuant to the Agreement, QuaTech has agreed to initially sell certain inventory valued at a sum of $150,000. QuaTech and Manufacturer have agreed that Manufacturer will purchase additional active inventory thereafter from QuaTech under terms and conditions to be determined. Also pursuant to the Agreement, the Company will sublease to Manufacturer 4,911 square feet of space at the Company’s manufacturing facility located in Hudson, OH. Additionally, The Company has agreed to utilize Manufacturer as its manufacturer of all products and parts for existing products of the Company (other than under the Company’s Airborne wireless product line) for a period of 24 months under terms and conditions to be determined by the parties. No gain or loss is anticipated with regard to the transaction as the assets were sold at the Company’s net carrying value of the assets.
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