REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
Shareholders and Board of Directors
Computer System Products, Inc.
We have audited the accompanying balance sheet of Computer System Products,
Inc. as of December 31, 2002, and the related statements of operations, changes
in shareholders' deficit, and cash flows for the year 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 audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2002 financial statements referred to above present
fairly, in all material respects, the financial position of Computer System
Products, Inc. as of December 31, 2002, and the results of its operations and
its cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note B to the
financial statements, the Company has sustained operating losses during the last
two fiscal years primarily as a result of a slowing economy. In addition, it has
experienced an accumulated deficit and negative working capital for several
years. These factors raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
described in Note B. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
GRANT THORNTON LLP
Minneapolis, Minnesota
January 24, 2003
INDEPENDENT AUDITOR'S REPORT
Stockholders and Board of Directors
Computer System Products, Inc.
Minneapolis, Minnesota
We have audited the accompanying balance sheet of Computer System Products, Inc.
as of December 31, 2001, and the related statements of operations, changes in
shareholders' deficit and cash flows for the year 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 audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Computer System Products, Inc.
as of December 31, 2001, and the results of its operations and its cash flows
for the year then ended in conformity with accounting principles generally
accepted in the United States of America.
LARSON, ALLEN, WEISHAIR & CO., LLP
Minneapolis, Minnesota
July 1, 2002, Except for Note L, as to
Which the Date is September 3, 2002
COMPUTER SYSTEM PRODUCTS, INC.
BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
ASSETS 2002 2001
---------- ----------
CURRENT ASSETS
Cash and cash equivalents $ 3,742 $ 5,807
Accounts receivable less allowance for doubtful
accounts of $25,000 and $57,000 at 2002
and 2001 690,069 2,696,552
Inventories 1,300,690 3,063,240
Prepaid expenses 39,381 45,652
---------- ----------
Total current assets 2,033,882 5,811,251
PROPERTY AND EQUIPMENT, net 555,628 915,159
OTHER ASSETS 49,018 26,000
---------- ----------
$2,638,528 $6,752,410
========== ==========
The accompanying notes are an integral part of these statements.
LIABILITIES AND SHARE-
HOLDERS' DEFICIT 2002 2001
------------ ------------
CURRENT LIABILITIES
Note payable to bank $ 3,202,782 $ 5,381,305
Current portion of capital lease obligations 65,445 91,058
Current portion of loans payable to vendors 260,873 -
Notes payable - shareholders 576,220 110,905
Accounts payable 628,962 2,842,711
Accounts payable - affiliates 687,612 209,115
Accrued expenses 196,235 507,791
------------ ------------
Total current liabilities 5,618,129 9,142,885
CAPITAL LEASE OBLIGATIONS, net of current portion 107,676 148,201
LOANS PAYABLE TO VENDORS, net of current portion 58,527 -
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' DEFICIT
Common stock, $0.0001 par value; 10,000,000 shares
authorized; 3,680,000 shares issued and outstanding 368 368
Additional paid-in capital 800,000 -
Accumulated deficit (3,946,172) (2,539,044)
------------ ------------
(3,145,804) (2,538,676)
------------ ------------
$ 2,638,528 $ 6,752,410
============ ============
COMPUTER SYSTEM PRODUCTS, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
------------- -------------
Net sales $ 17,276,773 $ 31,885,973
Cost of goods sold 14,406,682 24,350,340
------------- -------------
Gross profit 2,870,091 7,535,633
Operating expenses
General and administrative 2,796,061 3,517,139
Selling 1,685,634 3,162,739
Warehouse 835,408 1,318,599
Marketing expenses 333,134 660,165
------------- -------------
5,650,237 8,658,642
------------- -------------
Operating loss (2,780,146) (1,123,009)
Other income (expense)
Interest expense (512,701) (681,450)
Gain on sale of assets 1,000,000 -
Vendor settlements 857,088 -
Other income 28,631 111,440
------------- -------------
1,373,018 (570,010)
------------- -------------
NET LOSS $ (1,407,128) $ (1,693,019)
============= =============
The accompanying notes are an integral part of these statements.
COMPUTER SYSTEM PRODUCTS, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 2002 AND 2001
Common stock Additional Total
------------------ paid-in Accumulated shareholders'
Shares Amount capital deficit deficit
--------- ------- -------- ------------ ------------
Balance at December 31, 2000 3,680,000 $ 368 $ - $ (652,355) $ (651,987)
Distributions to shareholders - - - (193,670) (193,670)
Net loss - - - (1,693,019) (1,693,019)
--------- ------- -------- ------------ ------------
Balance at December 31, 2001 3,680,000 368 - (2,539,044) (2,538,676)
Capital contribution (note L) - - 800,000 - 800,000
Net loss - - - (1,407,128) (1,407,128)
--------- ------- -------- ------------ ------------
Balance at December 31, 2002 3,680,000 $ 368 $800,000 $(3,946,172) $(3,145,804)
========= ======= ======== ============ ============
The accompanying notes are an integral part of these statements.
COMPUTER SYSTEM PRODUCTS, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
------------ ------------
Cash flows from operating activities:
Net loss $(1,407,128) $(1,693,019)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 359,195 411,478
(Gain) loss on disposal of equipment (32,863) 155
Gain on sale of assets (1,000,000) -
Gain on vendor settlements (857,088) -
Write-off of inventory 833,473 220,615
Changes in operating assets and liabilities, net
of sale of assets:
Accounts receivable 2,006,483 3,451,567
Inventories 904,077 2,063,841
Prepaid expenses 6,271 64,649
Other assets (23,018) 8,585
Accounts payable (267,729) (1,037,314)
Accounts payable - affiliates 478,497 99,898
Accrued expenses (283,461) (337,163)
------------ ------------
Net cash provided by operating activities 716,709 3,253,292
Cash flows from investing activities:
Purchases of property and equipment (18,312) (271,618)
Proceeds from the sale of property and equipment 26,030 152,474
Proceeds from sale of assets 1,025,266 -
------------ ------------
Net cash provided by (used in)
investing activities 1,032,984 (119,144)
COMPUTER SYSTEM PRODUCTS, INC.
STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
------------------- -----------------
Cash flows from financing activities:
Proceeds on note payable to bank $ 21,577,000 $ 34,987,000
Payments on note payable to bank (23,077,262) (37,675,312)
Payments on capital lease obligations (99,018) (79,205)
Proceeds on notes payable - shareholders 465,315 -
Payments on notes payable - shareholders - (207,151)
Payments on loans payable to vendors (617,793) -
Distributions to shareholders - (168,400)
------------------- -----------------
Net cash used in financing
activities (1,751,758) (3,143,068)
------------------- -----------------
NET DECREASE IN CASH
AND CASH EQUIVALENTS (2,065) (8,920)
Cash and cash equivalents at beginning of year 5,807 14,727
------------------- -----------------
Cash and cash equivalents at end of year $ 3,742 $ 5,807
=================== =================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 380,725 $ 723,418
=================== =================
Supplemental schedule of noncash investing and financing activities:
Equipment acquired under capital lease $ 32,880 $ 204,400
=================== =================
Distribution to shareholders through note payable -
shareholders $ - $ 25,270
=================== =================
Reduction of accounts payable due to vendor
settlements $ 937,193 $ -
=================== =================
Capital contribution from sale of assets to
affiliated company $ 800,000 $ -
=================== =================
The accompanying notes are an integral part of these statements.
COMPUTER SYSTEM PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
--------------------
Computer System Products, Inc. (the Company) is a full-line manufacturer
and supplier of networking hardware and cabling components. In addition,
the Company is a supplier of premise cabling components and a manufacturer
of custom cable assemblies. It sells to customers throughout the United
States with a concentration in Minnesota.
The Company, Engineered Products Co. (EPCO) and Lee Communications, Inc.
(LCI) have common ownership and share common management. Common expenses
are paid by the Company and in turn allocated between the three companies
(see note F).
Revenue Recognition
--------------------
The Company recognizes revenue when completed product is shipped to the
customer.
Cash and Cash Equivalents
----------------------------
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. At times these
balances may be in excess of FDIC insured limits.
Accounts Receivable
--------------------
The Company grants credit to customers in the normal course of business,
but generally does not require collateral or any other security to support
amounts due. Management performs on-going credit evaluation of customers.
The Company maintains allowances for potential credit losses that, when
realized, have been within management's expectations.
Inventories
-----------
Inventories consist primarily of raw materials and purchased parts and are
stated at the lower of cost or market. Cost is determined using weighted
average cost which includes overhead. Inventories were adjusted by $833,473
and $220,615 during the years ended December 31, 2002 and 2001 to reflect
their fair market values.
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Property and Equipment
------------------------
Property and equipment are stated at cost. Depreciation and amortization
are calculated using the straight-line method over the assets' estimated
useful lives of three to seven years.
Income Taxes
-------------
The Company has elected S corporation status under the provisions of the
Internal Revenue Code. In lieu of corporation income taxes, the
shareholders are taxed on their proportionate share of the Company's
taxable income. Therefore, no provision or liability for income taxes has
been included in the accompanying financial statements.
Shareholders' Distributions
----------------------------
As a result of electing S corporation status, the Company elects annually
to make distributions to its shareholders which are used for shareholders'
personal tax liabilities. In addition, other distributions are recorded
when declared by the Board of Directors.
Use of Estimates
------------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could vary from the estimates that were used.
Reclassification
----------------
Certain 2001 amounts have been reclassified to conform with the financial
statement presentation used in 2002.
NOTE B - ABILITY TO CONTINUE AS A GOING CONCERN
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplate continuation of the Company as a going concern. However, the Company
has sustained operating losses during the last two fiscal years primarily as a
result of a slowing economy. In addition, it has experienced an accumulated
deficit and negative working capital for several years.
In response to these issues, management has made adjustments to personnel
throughout 2002, along with other cost reduction measures, to more appropriately
reflect the market, size and revised growth plans of the Company. As a result of
these adjustments, the Company has experienced decreases in monthly operating
expenses. The Company also responded to these issues in 2002 by reaching
settlements with its vendors and by selling a portion of its assets (see notes K
and L).
While there is no assurance that these initiatives will ensure the Company's
viability, the Company believes that these changes will enable it to meet its
obligations and continue operating in the normal course of business. The
ultimate outcome of these actions, however, cannot be determined. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
NOTE C - INVENTORIES
Inventories consist of the following at December 31:
2002 2001
---------- ----------
Raw materials $ 735,850 $1,584,630
Work-in-process 17,400 12,918
Finished goods 547,440 1,465,692
---------- ----------
$1,300,690 $3,063,240
========== ==========
NOTE D - PROPERTY AND EQUIPMENT
At December 31, 2002 and 2001, property and equipment consisted of:
2002 2001
----------- -----------
Furniture $ 246,284 $ 318,901
Office equipment 217,751 295,322
Factory equipment 1,133,015 1,418,122
Data processing equipment 694,868 1,524,010
Leasehold improvements 109,333 248,637
Vehicles 17,341 25,903
----------- -----------
2,418,592 3,830,895
Less accumulated depreciation and amortization 1,862,964 2,915,736
----------- -----------
$ 555,628 $ 915,159
=========== ===========
NOTE E - DEBT OBLIGATIONS
The Company and EPCO have a combined revolving line of credit providing for
borrowings of up to 80% of eligible receivables and 50% of eligible inventories,
plus additional borrowings as negotiated with the bank. At December 31, 2002 and
2001, the Company had outstanding borrowings under this agreement of $3,202,782
and $5,381,305. Total combined borrowings were not to exceed $11,750,000
($9,000,000 available to the Company) at December 31, 2002. Total combined
borrowings of the Company and EPCO at December 31, 2002 and 2001 were $5,211,017
and $6,273,832.
Borrowings under the line of credit, which are repayable on demand, bear
interest of 5.75% to 7.25% and 6.25% to 6.75% at December 31, 2002 and 2001,
which represents 1.5% to 3.0% over the prime rate, and are collateralized by
substantially all of the Company's assets. In addition, the obligation is
guaranteed by each of the Company's two shareholders to a maximum of $375,000
each. The line of credit agreement expires in October 2003, and requires the
Company to meet certain restrictive covenants including, but not limited to,
maintaining net worth of at least $100,000, and places restriction on dividends
and capital expenditures. The Company was in compliance with or had obtained
waivers for its covenants at December 31, 2002 and 2001. The Company believes it
will be able to renew the line of credit under similar terms and conditions.
NOTE F - RELATED PARTY TRANSACTIONS
The Company pays for certain common expenses of the Company and its related
companies, EPCO and LCI. Expenses are allocated between the companies based on
detailed information contained in the related invoices. In addition, the Company
charged EPCO and LCI management fees of $102,000 for 2002 and 2001 for an
allocation of management's time and expenses.
The Company sells and purchases goods and shares expenses with other affiliated
companies, including EPCO and LCI. At December 31, 2002 and 2001, the Company
had a net payable to EPCO and LCI of $687,612 and $209,115, respectively.
The Company had several notes payable to its shareholders totaling $576,220 and
$110,905 at December 31, 2002 and 2001, respectively. These notes are due on
demand and bear interest at 1.5% over prime (effective rate of 5.75% and 6.25%
at December 31, 2002 and 2001).
Beginning in October 2002, the Company started sub-leasing a portion of its main
facility to LCI on month-to-month terms. Total sub-lease income for the year
ended December 31, 2002 was $9,285.
NOTE G - SHAREHOLDER'S EQUITY
Redemption and Cross Purchase Agreement
- ---------------------------------------
The Company has entered into an agreement with its shareholders that in the
event a shareholder desires to sell his shares, the Company has a first option
to purchase the shares. The purchase price is to be the fair value as determined
by an independent public accountant. The redemption and cross purchase agreement
is partially funded by life insurance policies on two shareholders.
Authorized shares of common stock
- ---------------------------------
During 2002, the Company amended their articles of incorporation to allow for
10,000,000 shares of common stock with a par value of $.00001 to be authorized.
The financial statements have been restated to reflect this change for all
periods presented.
NOTE G - SHAREHOLDER'S EQUITY - Continued
Stock Split
- -----------
During 2002, the Company declared a 10,000 to 1 stock split. Accordingly, the
number of issued and outstanding shares increased to 3,680,000. The financial
statements have been restated to reflect this change for all periods presented.
NOTE H - RETIREMENT PLANS
The Company has a profit sharing plan with a 401(k) provision for all non-union
employees. Company contributions are at the discretion of the management of the
Company. No contributions were made by the Company for the years ended December
31, 2002 and 2001.
NOTE I - COMMITMENTS AND CONTINGENCIES
Leases
- ------
The Company leases certain equipment, furniture, and vehicles under capital
lease arrangements with interest ranging from 4.5% to 11.8% and terms through
July 2006. The cost of equipment subject to capital leases was $335,048 and
$452,581 at December 31, 2002 and 2001, respectively. The accumulated
amortization related to this equipment was $131,823 and $173,689 at December 31,
2002 and 2001, respectively. Certain leases are guaranteed by the Company's
shareholders.
The Company leases office space under a noncancelable operating lease expiring
in February 2006. The Company also leases warehouse space on month-to-month
terms with 15 days written notice from either party needed to terminate the
lease. The leases require payment of all operating expenses and real estate
taxes over the life of the lease.
NOTE I - COMMITMENTS AND CONTINGENCIES - Continued
The following is a schedule of approximate minimum payments required under the
capital and operating leases offset by sub-lease proceeds:
Capital Operating
Year ending December 31 leases leases
----------------------- -------- ----------
2003 $ 78,746 $ 394,492
2004 51,633 403,450
2005 51,633 408,349
2006 18,559 64,593
-------- ----------
Total minimum lease payments 200,571 $1,270,884
==========
Less: Amounts representing interest 27,450
--------
Present value of future minimum lease
Payments 173,121
Less: Current portion 65,445
--------
Capital lease obligations, net of $107,676
current portion ========
Rent expense incurred under operating lease commitments was approximately
$792,000 and $890,000 in 2002 and 2001.
Self-Insured Health Plan
- ------------------------
The Company has a self-insured employee health plan. It has contracted with an
administrative service company to supervise and administer the program and act
as its representative. The Company insures for excessive or unexpected claims
and is liable for claims not to exceed $35,000 per employee per plan year and an
aggregate amount of $250,000 per plan year. Estimated future claims for medical
services of approximately $29,500 and $25,000 were recorded as a liability at
December 31, 2002 and 2001.
NOTE I - COMMITMENTS AND CONTINGENCIES - Continued
Litigation
- ----------
The Company is subject to litigation in the normal course of its business.
Management believes the outcome of such litigation will not have a material
adverse effect on the operations or financial position of the Company.
NOTE J - CONCENTRATIONS
During the year ended December 31, 2001, the Company had one customer that
amounted to 10% of total sales. No such concentration existed in the year ended
December 31, 2002.
NOTE K - VENDOR SETTLEMENTS
During February 2002, the Company notified vendors of its difficult financial
situation and offered payments of approximately 41% of January 31, 2002 payable
balances. The majority of the Company's vendors responded, while others were
undergoing separate negotiations or have reached other settlements. The
remaining accounts payable balances after each settlement are being paid to the
vendors on a bi-monthly basis beginning June 30, 2002. The payments are made in
equal installments over a two-year period. The Company recognized a gain of
$857,088 during the year ended December 31, 2002 in conjunction with these
agreements. The Company adopted Statement of Financial Accounting Standards No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections," during 2002, and accordingly,
recognized this gain as other income in the statement of operations. The current
and long-term portions of those restructured accounts have been presented
separately on the balance sheet.
NOTE L - SALE OF ASSETS
Crescent Transaction
- --------------------
On September 3, 2002, the Company sold certain assets of its business to
Crescent Electric Company (CES), an unaffiliated company. The sale involved the
transfer of the contractor and end user customer bases along with certain fixed
assets related to that business. The elements of the transaction are as follows:
Cash received $1,025,266
Assets sold:
Fixed assets (53,361)
Liabilities assumed:
Accrued vacation 28,095
-----------
Gain on sale $1,000,000
===========
The agreement provides for additional consideration of up to $1 million to the
Company if CES attains certain financial objectives. The contract prohibits the
Company from competing with CES for five years in those customer markets and
prohibits the Company from selling distributed products as a vendor as it
relates to manufactured products. The Company is now focused on the original
equipment manufacturers and communication providers markets as a supplier of
manufactured cable assemblies. In addition, the company sells to value added
resellers and distributors that do not compete with CES.
NOTE L - SALE OF ASSETS - Continued
EPCO Transaction
- ----------------
On August 31, 2002, the Company sold certain assets of its business to EPCO in
exchange for the assumption of certain liabilities. The sale involved the
transfer of the customer base along with certain fixed assets and inventory
related to that business. As this transaction was with an affiliated company,
the excess of the liabilities assumed over assets sold have been recognized as a
capital contribution to the Company. The elements of the transactions are as
follows:
Cash received $ -
Assets sold:
Inventory (25,000)
Fixed assets (5,000)
Liabilities assumed:
Bank debt 678,261
Accruals 151,739
---------
Capital contribution $800,000
=========