Annual Reports

 
Quarterly Reports

 
8-K

 
Other

MPC 10-Q 2007

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2007

 

o                                 TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to                

 

Commission file number 0-115404

 

MPC CORPORATION

(Name of registrant as specified in its charter)

 

COLORADO

 

84-1577562

(State or other jurisdiction of incorporation or organization)

 

(IRS Employer identification No.)

 

906 E. Karcher Rd., Nampa, ID 83687

(Address of principal executive offices)

 

(208) 893-3434

(Registrant’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  x   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

 

Large accelerated filer  o   Accelerated filer  o   Non-accelerated filer  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b—2 of the Exchange Act).

 

Yes  o   No  x

 

As of October 31, 2007 there were 33,927,005 shares of the issuer’s no par value Common Stock outstanding.

 

 



 

INDEX

 

PART I – FINANCIAL INFORMATION

 

 

 

 

ITEM 1

FINANCIAL STATEMENTS

3

 

Condensed Consolidated Balance Sheets

3

 

Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006

4

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006

5

 

Notes to Interim Condensed Consolidated Financial Statements (unaudited)

6

 

 

 

ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

22

 

 

 

ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

36

 

 

 

ITEM 4T

CONTROLS AND PROCEDURES

37

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

ITEM 1

LEGAL PROCEEDINGS

37

 

 

 

ITEM 1A

RISK FACTORS

38

 

 

 

ITEM 6

EXHIBITS

42

 

1



 

A NOTE ABOUT FORWARD-LOOKING STATEMENTS

 

The statements, other than statements of historical fact, included in this report are forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “plan,” “seek,” “could,” “should,” “continues,” or “believe,” or the negative or other variations thereof. We believe that the expectations reflected in such forward-looking statements are accurate. However, we cannot provide assurance that such expectations will occur. Our actual future performance could differ materially from such statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially. Our Annual Report on Form 10-KSB/A for the year ended December 31, 2006 describes many of the significant factors that could cause actual results and events to differ materially and that constitute material risks to our business. You should carefully review the risk factors set forth in such Form 10-KSB/A, as well as those described in this report. Forward-looking statements apply only as of the date of this report; as such, they should not be unduly relied upon for current circumstances. Except as required by law, we are not obligated to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this report or those that might reflect the occurrence of unanticipated events.

 

2



 

PART I – FINANCIAL INFORMATION

 

ITEM 1: FINANCIAL STATEMENTS

 

MPC CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except share data)

 

 

 

September 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,077

 

$

4,839

 

Restricted cash

 

4,033

 

4,585

 

Accounts receivable, net

 

24,908

 

45,643

 

Inventories, net

 

28,151

 

18,189

 

Prepaid maintenance and warranty costs

 

9,679

 

6,391

 

Other current assets

 

733

 

935

 

Total Current Assets

 

68,581

 

80,582

 

 

 

 

 

 

 

Non-Current Assets

 

 

 

 

 

Property and equipment, net

 

2,898

 

4,914

 

Goodwill

 

22,197

 

22,197

 

Acquired intangibles, net

 

8,750

 

10,108

 

Long-term portion of prepaid maintenance and warranty costs

 

1,419

 

844

 

Other assets

 

2,966

 

3,792

 

Total Non-Current Assets

 

38,230

 

41,855

 

TOTAL ASSETS

 

$

106,811

 

$

122,437

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Accounts payable

 

$

28,691

 

$

32,536

 

Accrued expenses

 

4,906

 

4,354

 

Accrued licenses and royalties

 

1,262

 

1,540

 

Current portion of accrued warranties

 

2,384

 

2,220

 

Current portion of deferred revenue

 

23,789

 

15,607

 

Notes payable and debt

 

30,685

 

34,834

 

Total Current Liabilities

 

91,717

 

91,091

 

 

 

 

 

 

 

Long Term Liabilities

 

 

 

 

 

Non-current portion of accrued warranties

 

1,756

 

2,127

 

Non-current portion of deferred revenue

 

20,269

 

22,979

 

Derivative warrant liability

 

3,939

 

6,129

 

Derivative financial instruments at estimated fair value

 

13,428

 

21,234

 

Total Long Term Liabilities

 

39,392

 

52,469

 

TOTAL LIABILITIES

 

131,109

 

143,560

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preferred Stock, no par value; 1,000,000 shares authorized; no shares issued and outstanding at 2007 and 2006

 

 

 

Common Stock, no par value, 100,000,000 shares authorized; 15,270,020 and 12,147,438 shares issued and outstanding at 2007 and 2006, respectively

 

64,803

 

61,454

 

Accumulated Deficit

 

(89,101

)

(82,577

)

Total Shareholders’ Equity (Deficit)

 

(24,298

)

(21,123

)

 

 

 

 

 

 

TOTAL LIABILITIES AND EQUITY

 

$

106,811

 

$

122,437

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

3



 

MPC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except for per share data)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30

 

September 30

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

57,934

 

$

76,647

 

$

168,298

 

$

211,640

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

48,194

 

67,826

 

144,965

 

186,264

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

9,740

 

8,821

 

23,333

 

25,376

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

Research and development expense

 

584

 

769

 

1,623

 

2,904

 

Selling, general and administrative expense

 

9,243

 

10,310

 

28,011

 

31,408

 

Depreciation and amortization

 

1,098

 

1,182

 

3,402

 

5,222

 

Impairment of acquired intangibles

 

 

 

 

19,484

 

Total operating expenses

 

10,925

 

12,261

 

33,036

 

59,018

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(1,185

)

(3,440

)

(9,703

)

(33,642

)

 

 

 

 

 

 

 

 

 

 

Other (income) expense

 

 

 

 

 

 

 

 

 

Interest expense, net

 

1,381

 

901

 

4,402

 

3,545

 

Gain on vendor settlements

 

(255

)

(734

)

(480

)

(1,577

)

Change in estimated fair value of derivative financial instruments

 

(26,324

)

24,931

 

(7,011

)

25,840

 

Loss on debt extinguishment

 

 

10,511

 

 

10,511

 

Merger related stock compensation expense

 

 

1,261

 

 

1,261

 

Other (income) expense

 

35

 

(4

)

(90

)

(53

)

Total other (income) expense, net

 

(25,163

)

36,866

 

(3,179

)

39,527

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

23,978

 

$

(40,306

)

$

(6,524

)

$

(73,169

)

 

 

 

 

 

 

 

 

 

 

Income (loss) per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.68

 

$

(3.33

)

$

(0.49

)

$

(6.18

)

Diluted

 

$

(0.04

)

$

(3.33

)

$

(0.49

)

$

(6.18

)

 

 

 

 

 

 

 

 

 

 

Common shares used to compute net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

14,289,579

 

12,103,583

 

13,420,695

 

11,833,338

 

Diluted

 

39,242,797

 

12,103,583

 

13,420,695

 

11,833,338

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

4



 

MPC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Nine Months Ended September 30,

 

 

 

2007

 

2006

 

OPERATING ACTIVITIES

 

 

 

 

 

Net Loss

 

$

(6,524

)

$

(73,169

)

Adjustments to reconcile net loss to net cash used in operating activities

 

 

 

 

 

Depreciation

 

2,044

 

2,244

 

Amortization of intangibles

 

1,358

 

2,978

 

Impairment of intangibles

 

 

19,484

 

Amortization of deferred loan costs

 

837

 

523

 

Common stock issued as legal settlement

 

 

29

 

Warrants issued for advisory services

 

 

68

 

Change in estimated fair value of derivative financial instruments

 

(7,011

)

25,840

 

Loss on debt extinguishment

 

 

10,511

 

Stock compensation expense from vesting of restricted stock units

 

333

 

1,531

 

Gain on vendor settlements

 

(480

)

(1,577

)

Valuation of warrant exchange

 

 

767

 

Loss on disposal of assets

 

48

 

43

 

Accrued interest included in notes payable

 

100

 

45

 

Provision for bad debt

 

49

 

(29

)

Changes in Assets and Liabilities

 

 

 

Accounts receivable

 

20,685

 

(3,497

)

Inventory

 

(9,962

)

1,165

 

Prepaid maintenance and warranties

 

(3,862

)

10,662

 

Other current assets

 

200

 

547

 

Other non-current assets

 

465

 

(943

)

Accounts payable and accrued expenses

 

2,664

 

(1,180

)

Accrued licenses and royalties

 

(144

)

(629

)

Accrued warranties

 

(206

)

(460

)

Deferred revenue

 

5,471

 

(5,679

)

Net cash provided (used) by operating activities

 

6,065

 

(10,726

)

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

Purchase of property and equipment

 

(76

)

(116

)

Proceeds from the sale of fixed assets

 

 

2

 

Acquisition costs

 

(476

)

 

 

Net cash used by investing activities

 

(552

)

(114

)

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

Net activity on line of credit

 

(8,455

)

(2,938

)

Net proceeds from notes payable

 

 

9,295

 

Restricted cash related to letters of credit and financing facility

 

551

 

 

 

Payment of notes payable

 

(1,405

)

(128

)

Payments on capital leases

 

 

(185

)

Net proceeds from the exercise of stock options

 

34

 

27

 

Proceeds from the exercise of warrants

 

 

3,104

 

Payment of stock issuance costs

 

 

(155

)

Net cash provided (used) by financing activities

 

(9,275

)

9,020

 

 

 

 

 

 

 

Net cash decrease for period

 

(3,762

)

(1,820

)

 

 

 

 

 

 

Cash at beginning of period

 

4,839

 

3,897

 

 

 

 

 

 

 

Cash at end of period

 

$

1,077

 

$

2,077

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

5



 

Supplemental disclosure of cash flow information:

(In thousands)

 

Cash paid for interest for the nine months ended September 30, 2007 and 2006 was $2,281 and $1,555, respectively.

 

No cash was paid for income taxes for the nine months ended September 30, 2007 and 2006.

 

MPC CORPORATION

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands except share data)

 

The terms “we” “us” and “our” or the “company” as used in this quarterly report refer on a consolidated basis to MPC Corporation and to its wholly-owned subsidiaries, including MPC Computers, LLC, (“MPC”) which we acquired through a merger in July of 2005.

 

NOTE 1.    DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

 

We were formed in 2001 as a Colorado-based company named HyperSpace Communications, Inc. and completed an initial public offering (“IPO”) in October 2004. In July 2005, we acquired MPC Computers, LLC, or MPC, which is now a wholly owned subsidiary.  We are an enterprise IT hardware business providing products and services to customers in mid-sized businesses, government agencies and education organizations. In January 2007, we changed our name to MPC Corporation.  On October 1, 2007, MPC Corporation, through our wholly-owned subsidiary MPC-PRO, purchased from Gateway Inc. (“Gateway”) and Gateway Technologies Inc., Gateway’s Professional Division, the portion of Gateway’s Consumer Direct Division that markets business-related products, and a portion of the Customer Care & Support department that provides technical services to customers of the Professional and Consumer Direct Divisions (collectively, the “Professional Business”).  The Professional Business is primarily engaged in the sale, resale and marketing of desktop computer systems, laptops, servers, networking gear and other peripherals, and replacement parts to educational institutions, government entities (federal, state and local), value-added resellers and certain other resellers, and small business sales generated by Gateway’s web and phone centers.  The purchase has substantially increased the size of our business.   The acquisition of the Professional Business is more fully described in Note 9 “Subsequent Events”.

 

Our primary business is providing PC-based products and services to mid-sized businesses, government agencies and education organizations. We manufacture and market ClientPro® desktop PCs, TransPort® notebook PCs, NetFRAME® servers and DataFRAME™ storage products. We also provide hardware-related support services such as installation, technical support, parts replacement, and recycling. In addition to PCs, servers, and storage products, we also fulfill our customers’ requirements for third party products produced by other vendors including printers, monitors and software.

 

We serve the federal government, state/local government & education (“SLE”), and mid-size enterprise markets. This focus enables us to tailor our operating model to better support the needs of our customers for customized products, services and programs. We sell directly to our customers and use a build-to-order manufacturing process that we believe is an efficient means to provide customized computing solutions.

 

The accompanying consolidated financial statements consolidate the accounts of MPC Corporation and its wholly owned subsidiaries.  All intercompany accounts and transactions have been eliminated in consolidation.  References to a fiscal year refer to the calendar year in which such fiscal year commences. MPC’s fiscal year ends on the Saturday closest to December 31. MPC’s floating fiscal year-end typically results in a 52-week fiscal year, but will occasionally give rise to an additional week resulting in a 53-week fiscal year.

 

NOTE 2.    GOING CONCERN

 

The accompanying consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and liquidation of liabilities in the ordinary course of business. However, there can be no assurance that we will be able to continue in the ordinary course of business due to our significant liquidity constraints, unprofitable operations and negative operating cash flows.

 

6



 

Management’s plans to continue operations in the ordinary course assume adequate financing initiatives along with vendor support through continued, extended or increased credit lines, minimal cancellations of our backlog and successful implementation of previously announced cost cutting initiatives that are expected to be adequate to fund our operations for at least the next twelve months.  There can be no assurance that we will be successful in our efforts to achieve future profitable operations or generate sufficient cash from operations, or obtain additional funding in the event that our financial resources become insufficient. The accompanying condensed consolidated financial statements do not include any adjustments that might result from any outcome of this uncertainty.

 

In conjunction with the acquisition of the Professional Business, on October 1, 2007, 7,545,352 of our outstanding $1.10 warrants were exercised for which we raised approximately $8,300. Although we have raised additional funds as a result of the acquisition of the Professional Business, we are currently seeking to expand credit lines with many of our current vendors, and obtain credit lines from vendors we have not previously done business with. Certain of these vendors have required letters of credit to secure credit lines, and since September 30, 2007 we have put letters of credit in place with three vendors, totaling $3,300. We are currently negotiating with other vendors, and anticipate providing additional letters of credit to secure credit lines with certain vendors. Continuing to provide letters of credit to vendors constrains our liquidity as we are required to cash collateralize the letters of credit, and there can be no assurance that we will be successful in obtaining sufficient vendor credit in the future. In addition, any inability to maintain adequate liquidity in the future may do significant harm to vendor relationships which we are able to secure, and could cause us to experience credit holds, requirements that we pre-pay for products, and/or a refusal to deliver components or termination of supply arrangements, any of which could have a material adverse effect on our financial condition and results of operations.

 

We face liquidity constraints.  Since the acquisition of MPC, we have raised a limited amount of additional funds to operate the business. We have raised $12,139 of equity from the exercise of warrants and $14,486 from the sale of convertible debentures since the acquisition and through September 30, 2007. As noted in Note 5 “Notes Payable and Debt”, we replaced our prior credit facility with Wachovia Capital Finance Corporation (Western) with a new receivables sales financing facility with Wells Fargo Business Credit, Inc. in November 2006, and further amended the facility in February 2007, which has provided us additional limited liquidity.  The shortfall in funding prior to September 30, 2007 had been financed by vendors and other creditors who allowed us to fall behind on our payment obligations or who had settled amounts due to them at amounts less than the original obligation.

 

We may need to raise a significant amount of additional funds to satisfy vendor payment obligations and to fund our business if our losses continue. There can be no assurance that we will be able to secure additional sources of financing. Even if we do obtain additional funding, the amount of such funding may not be sufficient to fully address all of our liquidity constraints, which could negatively and materially impact our business and results of operations.

 

On October 25, 2007, American Stock Exchange (“AMEX”) notified us that it has resolved the continued listing deficiencies based on a review by the AMEX of publicly available information, including the our press release dated October 1, 2007 regarding the acquisition of the Gateway Professional Business, our Securities and Exchange Commission filings, and other correspondence we have provided to the AMEX. Previously, the AMEX issued a notice dated April 13, 2006 that we had failed to satisfy the continued listing standards of Section 1003(a)(iv) of the AMEX Company Guide because we had sustained losses which were so substantial in relation to its overall operations or its existing financial resources, or our financial condition had become so impaired that it appeared questionable, in the opinion of AMEX, as to whether the Company would be able to continue operations and/or meet its obligations as they mature. The October 25, 2007 notice from the AMEX has indicated that the Company is subject to provisions of Section 1009(h) of the AMEX Company Guide for a period of twelve months which provides for the method of evaluation and appropriate action by the AMEX staff should the Company fall below the continued listing standards during that period. Depending on the circumstances, such action includes truncating procedures related to compliance with the continued listing standards or immediately initiating delisting proceedings.

 

NOTE 3.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Interim Financial Information and Basis of Presentation

 

The accompanying unaudited interim condensed consolidated financial statements and related notes have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete

 

7



 

financial statements. These financial statements include the accounts of MPC Corporation and all of its wholly-owned subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.

 

These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited condensed consolidated financial statements and related notes contained in our 2006 Annual Report on Form 10-KSB/A. The comparative balance sheet and related disclosures at December 31, 2006 have been derived from the audited balance sheet and consolidated footnotes referred to above.

 

In our opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments of a recurring nature that are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the interim periods presented in these unaudited interim condensed consolidated financial statements are not necessarily indicative of results to be expected for the full year.

 

The preparation of our condensed consolidated financial statements in conformity with GAAP necessarily requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of assets and liabilities at the balance sheet dates, and the reported amounts of revenues and costs during the reporting periods. Actual results could differ from those estimates. On an ongoing basis, we review our estimates based on information that is currently available. Changes in facts and circumstances may cause us to revise estimates.

 

Our significant estimates include the collectibility of receivables and corresponding allowance for doubtful accounts, the reserve needed for possible future returns and discounts which may be granted, the carrying value and usefulness of inventory and the related inventory reserves, long-lived asset useful lives and impairment, estimated future volatility in our stock price, the timing and amount of future warranty and other product obligation expenses, the recognition of warranty revenue and the cost and settlement of current litigation or items in dispute.

 

Cash and Cash Equivalents

 

Cash equivalents consist of short-term investments that have a maturity of three months or less at the date of purchase.  We had no cash equivalents at September 30, 2007 and December 31, 2006.

 

Restricted cash

 

Restricted cash at September 30, 2007 and December 31, 2006 includes $1,500 held as collateral under our receivable financing facility, and $2,533 and $3,085 respectively, held as collateral for outstanding letters of credit.

 

Accounts Receivable

 

Accounts receivable are recorded at the invoiced amount and do not bear interest.  We maintain an allowance for doubtful accounts at an amount estimated to be sufficient to provide adequate reserve against losses resulting from collecting less than full payment on receivables. Overdue accounts are reviewed, and an additional allowance is recorded when determined necessary to state receivables at an estimated realizable value. In judging the adequacy of the allowance for doubtful accounts, we consider multiple factors including historical bad debt experience, the general economic environment, the aging of our receivables, and the financial condition of the customer.  A considerable amount of judgment is required when assessing the realization of receivables, including assessing the probability of collection and the current creditworthiness of each customer. The allowance for doubtful accounts totaled $1,780 and $1,830, respectively, as of September 30, 2007 and December 31, 2006.

 

Inventory

 

Inventory is stated at the lower of cost or market, with cost determined on an average cost basis approximating first in first out (FIFO). We regularly evaluate the realizability of our inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, estimated service period, product end-of-life dates, estimated current and future market values, service inventory requirements and new product introductions, as well as other factors. If circumstances related to our inventories change, estimates of the realizability of inventory could materially change. At September 30, 2007 and December 31, 2006, our inventory valuation allowance totaled $5,251 and $5,185, respectively and was recorded as a reduction of inventory in the consolidated balance sheets. Inventory balances, net of valuation allowances, at September 30, 2007 and December 31, 2006 are:

 

8



 

(In thousands)

 

September 30,
2007

 

December 31,
2006

 

 

 

 

 

 

 

Raw materials

 

$

17,004

 

$

16,092

 

Work in process

 

758

 

236

 

Finished goods

 

10,389

 

1,861

 

 

 

 

 

 

 

Total inventory

 

$

28,151

 

$

18,189

 

 

Goodwill

 

We account for Goodwill in accordance with Statement of Accounting Standards (“SFAS”) 142, Goodwill and Other Intangible Assets. SFAS 142 requires that goodwill no longer be amortized and that goodwill be tested annually for impairment or more frequently if events and circumstances warrant.

 

Goodwill represents the excess of the purchase consideration over the fair value of assets acquired less liabilities assumed in a business acquisition. Our acquisition of MPC gave rise to goodwill. We engaged an independent third party valuation expert to express an opinion on the fair value of the identifiable intangible and tangible assets of MPC as of acquisition date. Based on this valuation, we established the carrying amount of goodwill. We conduct goodwill impairment tests annually every October 31 or more frequently if impairment indicators arise.

 

Acquired Intangibles, net

 

Other intangible assets are accounted for in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires that intangible assets with estimable useful lives be amortized over their estimated useful lives, and be reviewed for impairment when changes in circumstances indicate that their carrying amounts are in excess of their estimated fair value. Acquired intangibles are amortized over their estimated useful lives of 4 to 20 years.

 

Long-Lived Assets

 

Equipment and software are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives, primarily three to five years. Additions, improvements and major renewals are capitalized. Maintenance, repairs and minor renewals are expensed as incurred. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the lease term.

 

We assess the recoverability of our long-lived assets whenever adverse events or changes in circumstances or business climate indicate that expected undiscounted future cash flows related to such long-lived assets may not be sufficient to support the net book value of such assets. If undiscounted cash flows are not sufficient to support the recorded assets, impairment is recognized to reduce the carrying value of the long-lived assets to their estimated fair value. Cash flow projections are subject to a degree of uncertainty and are based on management’s estimate of future performance. Additionally, in conjunction with the review for impairment, the remaining estimated lives of certain of our long-lived assets are assessed.

 

Deferred Revenue

 

Deferred revenue includes amounts billed to or received from customers for which revenue has not been recognized. This generally results from deferred software maintenance revenues that are recognized over the term of the contract, which generally range from 1-4 years. Also included in deferred revenue is revenue from the sale of enhanced and extended warranties, which are recognized as the related services are provided, which generally range from 3-5 years. These enhanced/extended warranties are deferred based on guidance provided in Technical Bulletin 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts, and are valued based on the list price, net of discounts offered to the customer.

 

Prepaid Maintenance and Warranty Costs

 

Prepaid maintenance and warranty costs include amounts paid to third party software vendors, outsourced providers of warranty fulfillment services and technology insurance vendors for which the related revenue has been deferred. These costs are recognized ratably with the related revenue.

 

9



 

Accrued Warranties

 

We record warranty liabilities at the time of sale for the estimated costs that may be incurred under our standard limited warranty. The specific warranty terms and conditions vary depending upon the product sold, but generally include technical support, repair parts, labor and a period ranging from 90 days to five years. Factors that affect the warranty liability include the number of installed units currently under warranty, historical and anticipated rates of warranty claims on those units, and cost per claim to satisfy warranty obligations. We regularly reevaluate our estimate to assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary. If circumstances change, or a dramatic change in the failure rates were to occur, the estimate of the warranty accrual could change significantly.

 

Concentrations

 

A concentration of credit risk may exist with respect to trade receivables, particularly customers within the US federal government. We perform ongoing credit evaluations on a significant number of our customers and collateral from our customers is generally not required. Six customers accounted for approximately 48% of trade receivables as of September 30, 2007 and were either agencies of, or resellers to, the federal government.

 

A concentration of risk may exist with respect to our suppliers. We purchase certain products from single sources. In some cases, alternative sources of supply are not available. In other instances, we have established a procurement relationship with a single source if we determine that it makes business sense. In both of these situations, if the supply by a critical single-source supplier were interrupted or suspended, our ability to ship products in a timely manner will be adversely affected. In cases where alternative suppliers are available, the establishment and procurement from these alternative suppliers will result in delays and losses of sales, which will have an adverse effect on our operating results.

 

Revenue Recognition

 

We recognize revenue on hardware and peripherals, net of an allowance for estimated returns, when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is reasonably assured. Delivery is not considered to have occurred until both title and risk of loss transfer to the customer, provided that no significant obligations remain. The timing of revenue recognition is dependent on shipping terms. For FOB destination agreements, which include all sales to the federal government and some sales to state, local and education customers, we defer the cost of product revenue for in-transit shipments until the goods are delivered. In-transit product shipments to customers are included in inventory.

 

Net revenue includes sales of hardware, software and peripherals, and services (including extended service contracts and professional services). These products and services are sold either separately or as part of a multiple-element arrangement. We allocate revenue from multiple-element arrangements to the elements based on the relative fair value of each element, which is generally based on the relative sales price of each element when sold separately. The allocation of fair value for a multiple-element software arrangement is based on vendor specific objective evidence (“VSOE”). Revenue associated with undelivered elements is deferred and recorded when delivery occurs. The value of maintenance services on software sales is determined based on stated renewal rates and a comparison of the stated price of maintenance to software sold in a related transaction. To the extent we do not have VSOE from separate post contract support sales, we defer the software and the maintenance over the term of the agreement. Service revenue from software maintenance and support are recognized ratably over the maintenance term, which in most cases is one year. Term licenses are recognized ratably over the term of the related arrangement.

 

Revenue from extended warranty and service contracts, for which we are obligated to perform, is recorded as deferred revenue and subsequently recognized over the term of the contract or when the service is completed. In multiple element arrangements that include extended warranty and service contracts, we use the separation guidance provisions of Technical Bulletin 90-1 Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts to determine fair valueRevenue from sales of third-party extended warranty and service contracts, for which we are not obligated to perform, is recognized on a net basis at the time of sale.

 

Shipping Costs

 

Shipping and handling costs are included in cost of revenue in the accompanying consolidated statement of operations for all periods presented.

 

10



 

Royalties

 

We have royalty-bearing license agreements allowing us to sell certain hardware and software products and to use certain patented technology. Royalty costs are accrued and included in cost of revenue when the related revenue is recognized.

 

Research, Development, and Engineering Costs

 

Research, development, and engineering costs are expensed as incurred, in accordance with SFAS No. 2, Accounting for Research and Development Costs. Research, development, and engineering expenses primarily include payroll and headcount related costs, contractor fees, infrastructure costs, and administrative expenses directly related to research and development support.

 

Income Taxes

 

We recognize deferred tax assets and liabilities based on the differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. We make no provision for income taxes because, since inception, we have not been profitable. We have a net operating loss carry forward available to offset future federal and state income taxes.

 

Stock-Based Compensation – Stock Options

 

During the first quarter of fiscal 2006, we adopted the provisions of and accounted for stock-based compensation in accordance with SFAS 123R, Share-Based Payments, which replaced SFAS 123 and supersedes APB 25. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. The valuation provisions of SFAS 123R applies to new grants and to grants that were outstanding as of the effective date and are subsequently modified. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. All options are granted at fair market value on the date of approval of the grant. Under the provisions of our incentive option plans, employees with vested options who leave our employment, are required to exercise or forfeit their options within 90 days after leaving employment regardless of the exercise period of the initial grant unless the terms of their departure from us allow for such longer time for exercise based on approval of the administrator. All of our stock options were vested as of December 31, 2005, and we ceased using stock options as a compensation tool.

 

Stock Based Compensation – Restricted Stock Units

 

Subsequent to the acquisition of MPC, we began issuing Restricted Stock Units (“RSUs”) as stock based compensation to members of our Board of Directors and employees. We record a non-cash compensation expense over the vesting life of the RSUs determined by the number of units granted multiplied by the fair market value at the date of grant. Compensation expense for RSUs issued after the acquisition is classified on the statement of operations as operating expense. During the nine months ended September 30, 2007 and 2006, we recorded $333 and $233 respectively, in stock compensation expense for RSUs issued subsequent to the acquisition.  As part of the merger agreement, and pursuant to agreements signed with certain MPC officers and certain key employees, we issued RSUs, which are classified on the statement of operations as “Other Income/Expense” because they relate to the merger transaction.  During the three and nine months ended September 30, 2006, $1,261 was recorded for stock compensation expense for RSUs related to the merger.   We record a non-cash compensation expense over the period the restricted stock units vest.

 

Basic and Diluted Income (Loss) Per Share

 

We apply the provisions of SFAS No. 128, Earnings Per Share. Basic income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted income (loss) per share is computed by dividing net income (loss), as adjusted by the impact of potentially dilutive securities, by the combination of the weighted average number of common shares outstanding and all potentially dilutive common shares outstanding during the period using the treasury stock method unless the inclusion of such shares is anti-dilutive. Our potentially dilutive securities primarily consist of convertible debentures, stock warrants, restricted stock units, and stock options. For the three months ended September 30, 2007, 1,592,970 potentially dilutive common shares consisting of restricted stock units and stock options were excluded because they had an anti-dilutive effect on diluted loss per share. For the nine months ended September 30, 2007, and the three and nine months ended September 30, 2006, all potentially dilutive common shares were excluded from the computation of diluted loss per share because inclusion would have had an anti-dilutive effect. For the nine months ended September 30, 2007, the number of such anti-dilutive securities totaled 21,455,720.

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30,

 

September 30,

 

(In thousands, except share and per share data)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

23,978

 

$

(40,306

)

$

(6,524

)

$

(73,169

)

Income from derivative convertible debentures

 

(17,833

)

 

 

 

Income from derivative warrant liabilities

 

(7,828

)

 

 

 

Net income (loss) - diluted

 

$

(1,683

)

$

(40,306

)

$

(6,524

)

$

(73,169

)

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

14,289,579

 

12,103,583

 

13,420,695

 

11,833,338

 

 

 

 

 

 

 

 

 

 

 

Weighted average potential common shares:

 

 

 

 

 

 

 

 

 

Convertible debentures

 

23,430,037

 

 

 

 

Stock warrants

 

1,523,181

 

 

 

 

Diluted weighted average shares outstanding

 

39,242,797

 

12,103,583

 

13,420,695

 

11,833,338

 

 

 

 

 

 

 

 

 

 

 

Diluted loss per share

 

$

(0.04

)

$

(3.33

)

$

(0.49

)

$

(6.18

)

 

11



 

New Accounting Pronouncements

 

New Accounting Standards

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement 115. SFAS No. 159 permits companies to choose to measure certain 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 at each subsequent reporting date. SFAS No. 159 is effective for us beginning in the first quarter of fiscal year 2008, although earlier adoption is permitted. We are currently evaluating the impact that SFAS No. 159 will have on our consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement applies to other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this statement does not require any new fair value measurements. We will adopt this standard January 1, 2008. We do not expect it to have a material impact on our financial position or results of operations.

 

Recently Adopted Accounting Standards

 

In June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109. FIN No. 48 clarifies the criteria for the measurement, recognition and derecognition of income taxes under FASB Statement No. 109, Accounting for Income Taxes. It also requires additional financial statement disclosures about uncertain tax positions including classification, interest and penalties. FIN 48 is effective January 2007. Because we have not been profitable since our initial public offering, and the uncertainty as a going concern, we have not realized any deferred tax assets. FIN No. 48 did not have a material impact on our financial position or results of operations. If our tax status were to change in the future, we would have to reevaluate the impact of FIN No. 48 on our financial position and results of operations at that time.

 

NOTE 4  ACCRUED WARRANTY

 

We accrue for warranty liabilities at the time of the sale for estimated costs that may be incurred under the basic limited warranty.  Changes in our aggregate accrued warranty are presented in the following table.

 

12



 

 

 

Nine months ended

 

 

 

September 30,

 

(In thousands)

 

2007

 

2006

 

Accrued warranties at beginning of the period

 

$

 4,347

 

$

 4,775

 

Cost accrued for new warranties

 

2,101

 

1,899

 

Service obligation honored

 

(2,348

)

(2,505

)

Accretion of interest under purchase accounting

 

40

 

145

 

Accrued warranties at end of the period

 

$

 4,140

 

$

 4,314

 

 

 

NOTE 5  NOTES PAYABLE AND DEBT

 

(In thousands)

 

September 30, 2007

 

December 31, 2006

 

Wells Fargo Receivables Advance Facility

 

$

25,709

 

$

34,164

 

Debt Incurred in Acquisition

 

370

 

370

 

Convertible Bridge Loans

 

300

 

300

 

Payable to Lessor

 

1,331

 

 

Payable to TPV

 

1,815

 

 

Payable to Wacom Technology Corporation

 

1,160

 

 

 

Total Notes Payable and Debt

 

$

30,685

 

$

34,834

 

 

Wells Fargo Receivables Advance Facility

 

On November 16, 2006, we entered into an agreement with Wells Fargo Business Credit, Inc. (“Wells Fargo”) for an accounts receivable assignment and advance facility (“Receivables Advance Facility”) that replaced our prior line of credit with Wachovia Capital Finance Corporation (Western).  Under the new facility, we may assign to Wells Fargo, and Wells Fargo may purchase from us, Accounts (as defined in the Receivables Advance Facility). Wells Fargo will advance 90% of the value of the purchased Accounts. Wells Fargo may adjust the advancement percentage at any time in its commercially reasonable discretion upon prior notice to us. We will pay fees equal to the Wells Fargo Prime Rate (as defined in the Receivables Advance Facility), plus 1.75% per annum multiplied by the total amount of Accounts purchased and not yet paid by our customers, computed daily. The effective rate at September 30, 2007 was 9.5%.  Wells Fargo has the right to require that we re-purchase the Accounts in the event our customer does not pay the receivable within a timeframe specified under the Receivables Advance Facility, if a material customer dispute arises or in the event of a default under the Receivables Advance Facility. The Receivables Advance Facility is subject to customary default provisions. Wells Fargo has discretion under the Receivables Advance Facility as to the Accounts purchased and the percentage advanced after submission of the Account for approval. Wells Fargo is not obligated to buy any Account from us that Wells Fargo does not deem acceptable in its sole discretion. There is no minimum amount of Accounts to be purchased by Wells Fargo under the Receivables Advance Facility. The facility is secured by substantially all of our assets. The Receivables Advance Facility is for a term of three (3) years. Early termination fees apply if the Receivables Advance Facility is terminated before the end of its term. The Receivables Advance Facility also provides for a $1,500 collateral account for the benefit of Wells Fargo for repayment of any obligations arising under the Receivables Advance Facility.

 

In February 2007, we entered into an amendment of the Receivables Advance Facility under which Wells Fargo agreed to advance an additional 7.5% of the face amount of currently outstanding Accounts assigned to Wells Fargo, provided that the total advance does not exceed 97.5% of the face amount of any Account (the “Temporary Advance”), and increase the advance rate on new Accounts assigned to Wells Fargo to 98% of the amount of the Accounts for a period of eight weeks (the “Special Facility Period”). We must repay the difference between the Advance and the Temporary Advance within four weeks after termination of the Special Facility Period. Failure to repay amounts advanced under the Special Facility would constitute an event of default under the Agreements. At any time when the Temporary Advance has been paid in full for a minimum of 60 days, we may request that the Special Facility be reinstated for another eight week period with repayment to be made within four weeks.

 

On October 1, 2007, we entered into an amendment to the Receivables Advance Facility and additional agreements.  See Note 9 “Subsequent Events – “Account Purchase Agreements” and “Amended Account Purchase Agreements”.

 

13



 

Debt Incurred in Acquisition

 

Debt incurred in connection with the acquisition of MPC of $370 was due July 25, 2006, including any unpaid interest, which is accrued at 5% per annum. We were unable to repay this amount due to our liquidity constraints. We have held discussions with these note holders about an extension to repay the amounts due. There is no assurance that we will be successful in renegotiating the terms of these notes. The holders have the right, at any time prior to payment, to convert all or any part of the then outstanding balance of principal and interest under these notes into shares of common stock at the conversion price of $3.00 per share, which was determined at the date of issuance. The common stock underlying these notes are covered by a registration rights agreement.  We filed the registration statement with the SEC on November 8, 2006 and it was declared effective on June 28, 2007.

 

Convertible Bridge Loans

 

Convertible Bridge Loans were issued prior to our IPO. The outstanding amount was due April 2006, including any unpaid interest which is accrued at 12% per annum. The holder has the right, at any time prior to repayment, to convert all or any part of the then outstanding balance of principal and interest under these notes into shares of common stock at the conversion price of $3.50 per share. The notes include detachable warrants for purchase of common stock. The value of the warrants was recorded as interest expense in 2004. All of our assets at MPC Corporation collateralize the notes. These notes have registration rights. In May 2006, we repaid principal and interest to one note holder. There are two remaining note holders who have not yet been repaid. We are in default of the repayment terms on these notes, and the default interest provision of 18% has been accruing on these notes since April 15, 2006. We have been in discussions with these note holders about an extension to repay the amounts due. There is no assurance that we will be successful in renegotiating the terms of these notes. 

 

Warrants and convertible debt issued in connection with financing activities are subject to the provisions of Emerging Issues Task Force (“EITF”) Issue 00-19: Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. EITF 00-19 provides that derivatives should be classified as either equity or a liability. If the derivative is determined to be a liability, the liability is fair valued each reporting period with the changes recorded to the consolidated balance sheet and consolidated statement of operations. In regard to the convertible debt set out above, we determined that the embedded conversion option qualified as equity under EITF 00-19 and would not be subject to bifurcation from the host instrument.

 

Payable to Lessor

 

We are party to a commercial lease with Micron Technology dated April 30, 2001 (as amended, the “Lease”) under which we lease our primary manufacturing facility in Nampa, Idaho. A Fifth Amendment to the Lease deferred our rent payment obligations due or to become due between January 16, 2006 and May 31, 2007, without incurring late charges, provided that we pay base rent and other amounts (the “Extended Rent Obligation”) under the Lease at any time before May 31, 2007.  The total amount of the Extended Rent Obligation payable on May 31, 2007 was $2,511 and had been recorded as an accrued liability. We had paid only $500 of the Extended Rent by May 31, 2007.

 

On July 2, 2007, we entered into a Sixth Amendment to the Lease of this manufacturing facility. The Sixth Amendment to Lease provides that we will pay the balance of the Extended Rent Obligation in twelve equal monthly installments in the amount of $174, including interest at the annual rate of 12%. If any installment is not made, we will incur a late charge of 5% of the amount of such installment, and interest shall increase to an annual default rate of 18%. The Sixth Amendment also provides that we will pay the full amount of the Extended Rent Obligation in the event we receive equity investment funds in an amount that exceeds $12,000. Additionally, if our unrestricted cash and cash equivalents balance, combined with available lines of credit, exceeds $5,000 at any time after January 1, 2008, the monthly installment amount increases to $348 until the total Extended Rent Obligation is paid in full. In addition to making the Extended Rent Obligation payments, we are obligated to pay current rent and all other Lease obligations as they become due and payable, including property taxes per the terms of the Lease.

 

Payable to TPV

 

On June 30, 2007, we entered into a settlement agreement with TPV International (USA), Inc. and Top Victory Electronics (FUJIANG) Co., Ltd (collectively “TPV”).  See Note 8, “Commitments and Contingencies.”  Under the agreement we agreed to pay TPV $2,145 over a period of twelve months with interest at 8%.  The agreement provides for monthly payments of $120 for six months and $254 thereafter. The settlement amount had been previously recorded as accounts payable.

 

14



 

Payable to Wacom Technology Corporation

 

On August 31, 2007, we entered into a settlement agreement with Wacom Technology Corporation (Wacom).  See Note 8, “Commitments and Contingencies.”  The agreement provides for monthly principal payments of $100 to Wacom beginning September 2007, with interest accruing at 5%.  The settlement amount of $1,207 had previously been recorded as accounts payable.

 

NOTE 6  DERIVATIVE WARRANT LIABILITES AND CONVERTIBLE DEBENTURES

 

Derivative warrant liabilities and convertible debentures consist of the following:

 

 

 

September 30, 2007

 

 

 

Derivative Warrants

 

Convertible Debentures

 

(In thousands)

 

Fair Value

 

Fair Value

 

Face Value

 

 

 

 

 

 

 

 

 

New Convertible Debentures and Warrants

 

$

2,657

 

$

9,520

 

$

8,699

 

September 29, 2006 Financing

 

1,282

 

3,908

 

3,657

 

 

 

$

3,939

 

$

13,428

 

$

12,356

 

 

 

 

December 31, 2006

 

 

 

Derivative Warrants

 

Convertible Debentures

 

(In thousands)

 

Fair Value

 

Fair Value

 

Face Value

 

 

 

 

 

 

 

 

 

New Convertible Debentures and Warrants

 

$

3,123

 

$

14,114

 

$

9,849

 

September 29, 2006 Financing

 

3,006

 

7,120

 

4,936

 

 

 

$

6,129

 

$

21,234

 

$

14,785

 

 

Bridge Loan

 

On April 24, 2006, we entered into a Securities Purchase Agreement with certain existing investors pursuant to which we sold convertible debentures for an aggregate of $5,000. The investors also received an aggregate of 1,370,000 5-year warrants to purchase our no par value common stock for $3.12 per share, the fair market value of our common stock on the day the transaction closed. In connection with the Bridge Loan we issued 64,103 shares of common stock as payment of an origination fee to the investors.

 

The convertible debentures accrued interest at 10% per annum and the $5,000 aggregate principal amount was originally scheduled to become due and payable July 24, 2006. We prepaid interest expense through July 24, 2006 with 40,064 shares of common stock at the time of the closing. On July 24, 2006, the maturity date on these debentures was extended to August 24, 2006 in return for an increase to the effective interest rate to 12%, payable in cash, for the period July 24, 2006 to August 24, 2006.

 

We concurrently entered into a registration rights agreement with the investors that required us to file a registration statement, and have it declared effective, covering all securities issued or issuable under this agreement. We filed the registration statement on November 8, 2006 and it was declared effective on June 28, 2007.  The registration rights agreement contains customary indemnification and contribution provisions.

 

These convertible notes were hybrid financial instruments that embody certain features that meet the definition of derivative financial instruments and require bifurcation under SFAS No. 133 Accounting for Derivative Financial Instruments. These embedded derivatives were required to be combined into one compound derivative financial instrument and carried at fair value as derivative liabilities.

 

We early adopted and applied the provisions of SFAS 155 Accounting for Certain Hybrid Instruments which permits fair value remeasurement for any hybrid instrument (on an instrument-by-instrument basis) that contains an embedded derivative that would otherwise have to be bifurcated. Under SFAS 155, the entire hybrid instrument was initially recorded at fair value and subsequent changes in fair value were recognized in earnings. As noted below, the debentures were rolled into a new financing for New Convertible Debentures and Warrants on September 6, 2006.

 

15



 

New Convertible Debentures and Warrants

 

On September 6, 2006, we entered into a securities purchase agreement with certain existing investors and new investors pursuant to which we sold convertible debentures for an aggregate of $4,550. Additionally, the investors of the April 24, 2006 Bridge Loan exchanged $5,000 face value of their convertible debentures plus $226 of accrued interest thereon into the New Convertible Debentures and the existing and new investors received 4,924,500 warrants. The debentures become convertible into shares of common stock at a conversion price of $0.75 per share. The warrants allow the purchase of our common stock for $1.10 per share and are for a term of 5 years. The debentures accrue interest at 8% per annum after shareholder approval was obtained in December 2006.  The aggregate principal amount becomes due and payable September 6, 2009. In the event that the debentures are not repaid on the maturity date, we will be in default and the debentures will begin to accrue interest at a rate of 22% per annum or the maximum amount permitted by law, whichever is less. The debentures contain various customary events of default as well as negative covenants that, among other things, prohibit us from incurring additional debt.

 

Because the conversion price for the debentures and the exercise price for the warrants was below market value at the time of issuance and below the exercise and/or conversion price for certain previously issued warrants and convertible securities, anti-dilution rights of various security holders were triggered and resulted in the downward adjustment of the exercise and/or conversion price for various security holders, including the holders of our publicly traded warrants. See Note 7 – “Shareholders’ Equity.”

 

Both the debentures and the warrants contain provisions limiting conversion and exercise, or issuance of shares in lieu of interest, as the case may be, in the event that the holder’s beneficial ownership of our common stock would exceed 9.99%.  We concurrently entered into a registration rights agreement with the investors that requires us to register all of the common stock issued and underlying the securities sold to investors. The registration rights agreement contains customary indemnification and contribution provisions. We filed the registration statement with the SEC on November 8, 2006 and it was declared effective on June 28, 2007. Not all of the common stock underlying the debentures and warrants were registered under the registration statement due to blocker provisions imposed by certain investors on their registerable shares and from a reduction in the number of shares as required by the SEC. We believe we have substantially fulfilled our obligation under the registration rights agreement and will register the remaining unregistered shares when the blocker provisions are waived by the investors and when allowed by the SEC.

 

On March 5, 2007, we obtained amendments and waivers to the registration rights agreement and the debentures. Pursuant to a letter agreement, the majority of the investors, including Crestview Capital Master, LLC and Toibb Investment LLC agreed to waive the penalty provisions for not yet having an effective registration statement, and to extend the dates for filing a registration statement and all related deadlines, including the date by which the initial registration statement must be declared effective by the SEC, by 120 days. The investors in this offering also agreed that no Event of Default is presently deemed to have occurred under the debentures. The 120-day extension period lapsed, and the registration statement was not declared effective until June 28, 2007. For the nine months ended September 30, 2007, we incurred liquidated damages of $346 under the registration rights agreement related to the delay in the effectiveness of our registration statement.

 

We issued to one of the investors additional warrants to purchase up to 360,000 shares of common stock for $1.10 per share. The terms of these warrants are identical to the warrants issued as part of the financing. The warrants were accounted for as additional consideration given to the investors as part of the financing. In connection with this financing, we issued 546,000 warrants with a 5-year term to the placement agent to purchase our common stock for $1.10 per share.

 

The New Convertible Debentures are hybrid financial instruments that embody certain features that met the definition of derivative financial instruments and required bifurcation under SFAS No. 133.  Embedded derivatives that require bifurcation are required to be combined into one compound derivative financial instrument and carried at fair value as derivative liabilities. The 4,924,500 of detachable warrants, and related anti-dilution protection features were evaluated as freestanding derivative financial instruments under EITF 00-19, which provides the guidelines for equity classification. The warrants did not possess all of the conditions for equity classification due to the registration rights that require the delivery of registered shares, and did not provide for a mechanism for settlement should we be unable to deliver registered shares; in these instances, net-cash settlement is presumed. As such, the detachable warrants were required to be carried as liabilities at fair value. The warrants issued to the placement agent possessed all of the conditions for equity classification and were therefore classified as equity.

 

We applied the provisions of SFAS 155 for the New Convertible Debentures and Warrants as a hybrid instrument that contains an embedded derivative that would otherwise have to be bifurcated. The entire hybrid instrument was therefore initially recorded at fair value and subsequent changes in fair value were recognized in earnings.

 

16



 

In determining the fair value of our freestanding derivative financial instruments we assumed an expiration term of 3.92 years, a volatility of 90.94% and interest rate of 4.23%. The estimated fair value of these derivative instruments at September 30, 2007 and December 31, 2006 are as follows:

 

 

 

Fair Value

 

Fair Value

 

 

 

(In thousands)

 

of Debt

 

of Warrants

 

Total

 

 

 

 

 

 

 

 

 

September 30, 2007

 

$

9,520

 

$

2,657

 

$

12,177

 

 

 

 

 

 

 

 

 

December 31, 2006

 

$

14,114

 

$

3,123

 

$

17,237

 

 

During the nine months ended September 30, 2007, we issued 1,533,333 shares of common stock upon conversion of $1,150 face value of New Convertible Debentures plus accrued interest and penalties.

 

September 29, 2006 Financing

 

On September 29, 2006 we entered into a securities purchase agreement with certain existing investors and new investors pursuant to which we agreed to sell convertible debentures for an aggregate of $4,936. The majority of the transaction closed October 4, 2006.  The investors also received an aggregate of 2,468,125 warrants to purchase our common stock. The debentures become convertible into shares of common stock at a conversion price of $0.75 per share. The warrants allow the purchase of our common stock for $1.10 per share and are for a term of 5 years. The debentures accrue interest at 8% per annum after shareholder approval was obtained in December 2006 and the aggregate principal amount becomes due and payable September 29, 2009. In the event that the debentures are not repaid on the maturity date, we will be in default and the debentures will begin to accrue interest at a rate of 22% per annum or the maximum amount permitted by law, whichever is less. The debentures contain various customary events of default as well as negative covenants that, among other things, prohibit us from incurring additional debt.

 

Both the debentures and the warrants contain provisions limiting conversion and exercise, or issuance of shares in lieu of interest, as the case may be, in the event that the holder’s beneficial ownership of our common stock would exceed 9.99%. We concurrently entered into a registration rights agreement with the investors that requires us to register all of the common stock issued and underlying the securities sold to the investors. The registration rights agreement contains customary indemnification and contribution provisions. The terms, conditions, features and accounting treatment of these debentures and warrants are substantially identical to the New Convertible Debentures and Warrants.

 

We filed the registration statement with the SEC on November 8, 2006, and it was declared effective on June 28, 2007. Not all of the common stock underlying the debentures and warrants was registered under this registration statement due to the large number of shares of common stock to be registered relative to the number of shares of our common stock then outstanding.  In order to register the shares on a Form S-3, the SEC required that we reduce in the number of shares being registered. We believe we have substantially fulfilled our obligations under the registration rights agreement and will register the remaining unregistered shares as required by the registration rights agreement and as allowed by the SEC.

 

We did not obtain any amendments or waivers from these investors and as a result, as of February 1, 2007 we began incurring liquidated damages under the registration rights agreement at the rate of 1.5% of the aggregate amount invested per month until the registration statement was declared effective on June 28, 2007. These liquidated damages must be paid in cash, and they accrue interest at a rate of 18% per annum. We notified the investors that we are unable to pay the interest and will accrue the interest if unpaid to their account. There is no assurance that they will allow us to defer payment of the liquidated damages. We accrued $383 in liquidated damages under the registration rights agreement during the nine months ended September 30, 2007.  Since we have not paid the interest or penalties due under the debentures or the registration rights agreement, a holder could declare the debentures to be in default and accelerate the debt due under the debentures.  If this were to happen, the debentures would accrue interest at the rate of 22% per annum. We may be required to pay interest or other required payments in cash rather than stock and could be forced to use our limited cash to redeem all or a portion of the outstanding debentures.  As noted in Note 9 – “Subsequent Events” on October 1, 2007 $11,004 in face value of the debentures related to the New Convertible Debentures and Warrants and the September 29, 2006 Financing were converted to common stock and Series A Preferred Stock.

 

During the nine months ended September 30, 2007, we issued 1,705,333 shares of common stock upon conversion of $1,279 in face value of debentures from the September 29, 2006 Financing plus accrued interest and penalties.

 

17



 

In connection with this financing, we issued 499,867 warrants with a 5-year term to the placement agent to purchase our common stock for $1.10 per share.

 

In determining the fair value of our freestanding derivative financial instruments we assumed an expiration term of 4.0 years, a volatility of 90.94% and an interest rate of 4.23%.  The estimated probability of a dilutive financing transaction occurring is based on management’s estimate of such a transaction in the future. The estimated fair value of these derivative instruments at September 30, 2007 and December 31, 2006 are as follows:

 

 

 

Fair Value

 

Fair Value

 

 

 

(In thousands)

 

of Debt

 

of Warrants

 

Total

 

 

 

 

 

 

 

 

 

September 30, 2007

 

$

3,908

 

$

1,282

 

$

5,189

 

 

 

 

 

 

 

 

 

December 31, 2006

 

$

7,120

 

$

3,006

 

$

10,126

 

 

NOTE 7  SHAREHOLDERS’ EQUITY

 

During the nine months ended September 30, 2007, we issued 3,238,666 shares of common stock upon conversion of $2,429 face value of convertible debentures plus accrued interest and penalties with a fair value of $2,984. We also issued 1,201,292 shares of common stock upon the vesting of restricted stock units.

 

Warrant Exercise Price Adjustments

 

In August 2007, we announced an adjustment to the exercise price of our publicly traded warrants (AMEX:MPZ.WS). As stated in our September 30, 2004 Prospectus, the exercise price of each warrant was originally $5.50 per share of common stock. Effective August 7, 2007, the exercise price for each warrant was adjusted to $3.77 per share of common stock. A total of 3,600,000 publicly traded warrants were outstanding as of the date of this report. Additionally, the exercise price of certain warrants issued in connection with our acquisition of MPC Computers, LLC in July 2005 were also adjusted. A total of 2,678,238 such warrants initially issued at an exercise price of $5.50 per share of common stock were adjusted to an exercise price of $3.77 per share. A total of 75,008 warrants initially issued at an exercise price of $3.00 per share of common stock were adjusted to an exercise price of $2.06 per share. The adjustments to the respective warrants were made in accordance with the anti-dilution provisions of the warrant agreements. All other terms and conditions of the warrants remain unchanged.

 

Amendments to Articles of Incorporation

 

On September 28, 2007, we amended our amended and restated articles of incorporation with the State of Colorado to designate MPC Corporation Series A and Series B Preferred Stock and authorize the issuance of 615,000 and 240,000 shares respectively.  Both the MPC Corporation Series A and Series B Preferred Stock are participating, non-voting and have a liquidation preference equal to $.00000001 per share.  Each share of Series A Preferred Stock will automatically convert into shares of our common stock at such time the conversion would not cause the beneficial ownership of the holder to exceed 9.99% beneficial ownership, as such term is defined in Rule 13d-3 as promulgated under the Security and Exchange Act of 1934, as amended.   All Series B Preferred Stock converts into shares of our common stock upon shareholder approval by a majority of our common shareholders (the “Series B Automatic Conversion Event”), which we will seek at our next annual meeting of shareholders.  Gateway, Inc. agreed to vote in favor of the Series B Automatic Conversion Event.  See Note 9 “Subsequent Events — Acquisition of Gateway Professional Business.” In the event shareholder approval is not obtained within one year of the date of issuance, all outstanding shares of Series B Preferred Stock must be redeemed by us at 1.5 times the closing price times the number of shares of common stock into which the Series B Preferred Stock is then convertible.

 

Effective October 5, 2007, we further amended our amended and restated articles of incorporation with the State of Colorado to authorize the issuance of 640,000 shares of Series A Preferred Stock and 260,000 shares of Series B Preferred Stock.

 

NOTE 8   COMMITMENTS AND CONTINGENCIES

 

Letters of Credit

 

18



 

On September 30, 2007, we had outstanding letters of credit totaling $2,500. The letters of credit were fully collateralized with cash on deposit at the issuing bank.

 

Litigation

 

Phillip Adams & Associates, LLC

 

We are a defendant in a lawsuit, alleging infringement of certain patents, relating to floppy disk controllers, owned by Phillip Adams & Associates, LLC. We were added to this suit by an amended complaint filed on May 31, 2005 in the U.S. District Court, District of Utah. We have tendered indemnification demands to certain of our component suppliers. Because the case is still in the discovery phase, we are not able to determine the financial impact, if any, arising from an adverse result in the matter.

 

Bingham McCutchen, LLP

 

We were a defendant in a lawsuit filed by a law firm seeking damages for unpaid legal services. Bingham McCutchen alleged that approximately $530 was owed for services rendered. The suit was filed on or about December 20, 2006 in the District Court of the 3rd Judicial Court of the State of Idaho, Canyon County. The matter was settled on July 11, 2007 with a payment to Bingham in the amount of $225.

 

TPV International (USA), Inc. and Top Victory Electronics (FUJIANG) Co., Ltd.

 

We were a defendant in a lawsuit filed by TPV International (USA), Inc. and Top Victory Electronics (FUJIANG) Co., Ltd. filed in the 98th Judicial Court of Travis County, Texas, alleging that we failed to pay invoices for computer equipment.  In June 2007, we settled the case by agreeing to pay $2,146 over a period of 12 months with interest accruing at 8%.

 

Wacom Technology Corporation

 

We are a defendant in a lawsuit filed by Wacom Technology Corporation. This suit was filed on March 6, 2007 in the U.S. District Court, District of Idaho alleging that we have failed to pay invoices for computer equipment in the amount of a $1,207.  In August 2007, we settled the case by agreeing to pay the full $1,207 in monthly payments of $100 per month beginning September 2007 plus interest accruing at 5%.

 

Other Matters

 

We are involved in various other legal proceedings from time to time in the ordinary course of our business. We are not currently subject to any other legal proceedings that we believe will have a material impact on our business. However, due to the inherent uncertainties of the judicial process, we are unable to predict the ultimate outcome or financial exposure, if any, with respect to these matters.

 

NOTE 9   SUBSEQUENT EVENTS

 

Acquisition of Gateway Professional Business

 

On October 1, 2007 (“Closing Date”), MPC Corporation, through our wholly-owned subsidiary MPC-PRO, purchased from Gateway Inc. (“Gateway”) and Gateway Technologies Inc., Gateway’s Professional Division, the portion of Gateway’s Consumer Direct Division that markets business-related products, and a portion of the Customer Care & Support department that provides technical services to customers of the Professional and Consumer Direct Divisions (collectively, the “Professional Business”).  The Professional Business is primarily engaged in the sale, resale and marketing of desktop computer systems, laptops, servers, networking gear and other peripherals, and replacement parts to educational institutions, government entities (federal, state and local), value-added resellers and certain other resellers, and small business sales generated by Gateway’s web and phone centers.

 

The purchase included specified inventory currently valued at approximately $26,000, customer lists and customer relationships, and the sales, marketing, service and administrative functions supporting the Professional Business.   The acquisition included the purchase of all of the capital stock of Gateway Companies Inc. (“GCI”), and the membership interests of Gateway Professional, LLC (“GP”) and Gateway Pro Partners, LLC (“GCC”).

 

19



 

As consideration, MPC-PRO assumed certain warranty obligations and other obligations currently estimated at $70,000 and will issue to Gateway a promissory note currently estimated to be $2,000. The amount of the promissory note is subject to adjustment based on the Final Net Inventory/Liability Statement as defined in the Asset Purchase Agreement. The promissory note will bear interest at a rate of 8% and is repayable by April 1, 2008 in equal bi-monthly installments.   The promissory note will be executed within 5 days after the receipt of the Final Net Inventory/Liability Statement provided by Gateway, Inc.  In addition, we issued 5,602,454 shares of MPC Corporation common stock totaling approximately 19.9% of our outstanding common stock as of the Closing Date (the “MPC Common Shares”), and 249,171 shares of MPC Corporation Series B Preferred Stock convertible into 4,983,416 shares of our common stock (following approval by our shareholders permitting such conversion) representing the difference between (a) 19.9% of our outstanding common stock as of the Closing Date on a fully-diluted basis (excluding securities issued to our employees under our current employee equity plans) and (b) the number of shares of the MPC Common Shares (the “MPC Preferred Shares” and, together with the MPC Common Shares, the “MPC Shares.”)  In the event shareholder approval is not obtained within one year following closing, all outstanding shares of MPC Corporation Series B Preferred Stock must be redeemed by us at 1.5 times the closing price times the number of shares of our common stock into which the MPC Corporation Series B Preferred Stock is then convertible.

 

In connection with the transaction, we entered into several material agreements on the Closing Date that were conditions to closing the transaction: (1) a Lock-Up Agreement between us and Gateway with respect to the MPC Shares (the “Lock-Up Agreement”); (2) a Registration Rights Agreement with Gateway with respect to the MPC Corporation common stock, no par value, and MPC Corporation Series B Preferred Stock issued as consideration to the transaction (the “Registration Rights Agreement”), (3) a Transition Services Agreement between MPC-PRO and Gateway (the “TSA”); and (4) an Intercreditor Agreement between MPC-PRO, Gateway, GCI, and Wells Fargo (the “Intercreditor Agreement”). Additionally, in connection with the transactions contemplated by the Asset Purchase Agreement, MPC Corporation and/or our affiliates entered into the following agreements: (1) Account Purchase Agreements between Wells Fargo and each of MPC-PRO and GCI (the “Account Purchase Agreements”); (2) Second Amendments to the Wells Fargo Receivables Advance Facility between Wells Fargo and each of MPC Computers, LLC, MPC-G, LLC and MPC Solutions Sales LLC (the “Amended Account Purchase Agreements”); (3) Lease Agreement between MPC-PRO and Gateway (the “Lease Agreement”); and (4) Letter Agreement between MPC, MPC-PRO, Gateway and Gateway Technologies.  Each of the foregoing agreements is described in more detail below.

 

Lock up and Registration Rights Agreements

Under the Lock-Up Agreement, Gateway has agreed that it will not offer, sell, contract to sell, short, pledge or otherwise dispose of any MPC Corporation common stock beneficially owned, held or thereafter acquired by Gateway or its affiliates for a period of 12 months (the “Restriction Period”), except for Permitted Transfers as defined by the agreement.

 

The Registration Rights Agreement provides that following the Restriction Period as set forth in the Lock-Up Agreement and upon receipt of a demand request from Gateway, we will file a registration statement with respect to the Registrable Securities, as defined by the agreement, which include the MPC Shares issued in connection with the transaction.  The Registration Rights Agreement grants Gateway customary and piggyback rights.

 

Transition Services Agreement

 

Under the TSA (as amended on October 26, 2007), Gateway will provide accounting, human resource, manufacturing, procurement, marketing, information technology, and other specified services (collectively, “the Services”). Additionally, Gateway will provide buy/sell services for components from suppliers and will procure systems from Original Distribution Manufacturers (ODM’s).  We will pay Gateway a total fee of $6,500, payable as follows: (1) one payment of $724 due on the second Friday after the Closing Date, (ii) one payment of $806 due on the fourth Friday after the Closing Date, (iii) six bi-weekly installments of $765 due on the sixth, eighth, tenth, fourteen and sixteenth Friday after the Closing Date and (iv) one payment of $382 due on the seventeenth Friday after the Closing Date. In addition, the Agreement provides that if any Extended Services are provided by Gateway after the Expiration Date (as defined by the agreement), we will pay Gateway $627 for each week or part thereof, payable on the Friday of every week such Extended Services are performed. We must reimburse Gateway for all components purchased by Gateway, plus a percentage markup of (i) one-half percent during the first eight-week period following close, (ii) one percent during the second eight-week period, and (iii) two percent thereafter.  We will also reimburse Gateway for all software license fees paid in the course of providing the Services and expenses incurred in the Buy/Sell Activity at the rates specified in the TSA.  The TSA will continue in effect from October 1, 2007 until the latest expiration date specified by the Agreement for the Services, generally for 17 weeks, unless the TSA or any Service provided thereunder is earlier terminated by us.

 

20



 

Intercreditor Agreement

 

Under of MPC’s agreement with Wells Fargo, we have granted a senior security position on the assets of MPC Corporation and our affiliates. The Intercreditor Agreement provides Gateway with a junior security interest in accounts receivable generated on or after the Closing Date, inventory, and all other property of MPC-PRO and GCI as specified in the agreement (the “Wells Fargo Collateral”) to secure the payment of obligations owing to Gateway under the Transition Services Agreement (the “TSA Obligations”).  Wells Fargo and MPC-PRO agreed to set aside certain accounts receivable for the payment of the TSA Obligations.

 

Account Purchase Agreements

 

On October 1, 2007, MPC-PRO and GCI (which was acquired by MPC-PRO in connection with the Professional Business, each entered into an Account Purchase Agreement with Wells Fargo.  Under these agreements, MPC-PRO and GCI may assign to Wells Fargo, and Wells Fargo may purchase from MPC-PRO and GCI, Accounts (as defined in the Agreements). Wells Fargo will advance to MPC-PRO and GCI 90% of the value of the purchased Accounts. Wells Fargo may adjust the advancement percentage at any time in its commercially reasonable discretion upon prior notice to MPC-PRO and GCI. MPC-PRO and GCI will pay fees equal to the Wells Fargo Prime Rate (as defined in the Agreements), plus 0.75% per annum (the “Wells Fargo Discount”) multiplied by the total amount of Accounts purchased and not yet paid by MPC-PRO and GCI customers, computed daily. Wells Fargo has the right to require that MPC-PRO re-purchase the Accounts in the event customers of MPC-PRO and GCI do not pay the receivable within a timeframe specified in the Account Purchase Agreements, if a material customer dispute arises or in the event of a default under the Account Purchase Agreements. The Account Purchase Agreements are subject to customary default provisions. Wells Fargo has discretion under the Account Purchase Agreements as to the accounts purchased and the percentage advanced after submission of the Accounts for approval. Wells Fargo is not obligated to buy any Account from MPC-PRO and GCI that Wells Fargo does not deem acceptable in its sole discretion. There is no minimum amount of Accounts to be purchased by Wells Fargo under the Account Purchase Agreements. The facilities are secured by the assets of MPC-PRO and GCI. The Account Purchase Agreements are for a term of three (3) years from November 14, 2006. There is an initial annual combined fee for all MPC Corporation entities of $100 and an annual fee of $200 thereafter in addition to a minimum fee. Early termination fees apply if the Account Purchase Agreements are terminated before the end of their term.  An origination fee of $150 was paid at closing.

 

Amended Account Purchase Agreements

 

On October 1, 2007, MPC and its subsidiaries MPC-G, LLC and MPC Solutions Sales LLC (MPC Computers, LLC and its subsidiaries being referred to collectively herein as “MPC LLC”) entered into separate Second Amendments to Account Purchase Agreements with Wells Fargo. The Amended Account Purchase Agreements modify the Wells Fargo Receivables Advance Facility agreements dated November 14, 2006, as amended, primarily as to minimum fees and Wells Fargo Prime Rate as defined in the Amended Account Purchase Agreements.  The minimum monthly fee to be paid in aggregate by MPC affiliates to Wells Fargo is determined by multiplying the Wells Fargo Discount, times $30,000 times 30 divided by 360.  In addition, the Amended Account Purchase Agreements increased the collateral account for the benefit of Wells Fargo to $3,500 from $1,500 under the Receivables Advance Facility.

 

Lease Agreement

 

MPC-PRO entered into a Lease Agreement with Gateway to lease a portion of a manufacturing facility in North Sioux City, South Dakota, for a term of 5 years from the Lease Commencement Date, as defined in the Lease Agreement, with two 5-year renewal options. Under the Lease Agreement, the monthly initial base rent is $36 per month with annual escalation in base rent as specified in the Lease Agreement.

 

Letter Agreement

 

As a condition to close under the Asset Purchase Agreement, MPC Corporation was to have raised at least $9,000 in additional cash and cash equivalents through the conversion of outstanding convertible securities, the exercise of warrants or the sale of additional equity securities, as measured relative to MPC’s cash and cash equivalents as of the September 4, 2007 date of the Asset Purchase Agreement.  This condition was modified to raising at least $8,000 under a letter agreement dated October 1, 2007 among the parties to the Asset Purchase Agreement.  In satisfaction of this condition, we raised $8,300 from the exercise for cash of $1.10 warrants issued in connection with two private placement financings in September 2006 that included the issuance of convertible debentures.  As of the October 1, 2007 closing, $13,433 of face value of the convertible debentures have been converted into MPC Corporation common stock and Series A Preferred Stock since original issuance.

 

In connection with the obligation under the Letter Agreement, two MPC Corporation investors, Crestview Capital Master LLC (“Crestview”) and Toibb Investment LLC (“Toibb”), intended to exercise their warrants and convertible debentures, but because of their large holdings, their beneficial ownership of our common stock, as defined in Rule 13d-3 as promulgated under the Securities Exchange Act of 1934, as amended, could have exceeded 9.99%.  As

 

21



 

such, on October 1, 2007, we entered into an Amendment No. 1 to Convertible Debenture with each of Crestview and Toibb (the “Debenture Amendments”), pursuant to which their respective Convertible Debentures due on September 6, 2009 were amended such that the debentures were convertible into shares of Series A Preferred Stock.  Additionally, MPC and both Crestview and Toibb agreed that, upon the exercise of their warrants prior to the Closing, we would issue (i) common stock only to the extent that their beneficial ownership reaches 9.99% and (ii) the number of shares of MPC Corporation Series A Preferred Stock that will convert into a number of shares of MPC Corporation common stock equal to the difference between the number of shares of common stock such holder would receive if all of such holder’s warrants were exercised for our common stock and the number of shares of our common stock such holder actually received in order to avoid exceeding 9.99% beneficial ownership.

 

Additionally, on October 1, 2007, we entered into an amendment to the Registration Rights Agreement dated as of September 6, 2006 with Crestview and Toibb such that the registration and other rights applicable to shares of common stock issuable upon conversion of the their debentures apply equally to the shares of common stock issuable on conversion of the Series A Preferred Stock issued pursuant to the Debenture Amendments.

 

License Agreement

 

On the Closing Date, MPC Corporation and Gateway entered into a Limited License Agreement to grant us a non-exclusive, royalty-free, one-year use of Gateway Licensed Marks on Licensed Products, as defined, subject to the terms and conditions of the agreement.  Gateway may, in its sole discretion, terminate the Limited License Agreement in the event of a change of control of MPC Corporation.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(In Dollars)

 

Management’s discussion and analysis of the results of operations and financial condition should be read in conjunction with the financial statements and related notes included in Item 1 of this report and with the Company’s Annual Report in Form 10-KSB/A for the year ended December 31, 2006.

 

OVERVIEW AND EXECUTIVE SUMMARY

 

We were formed in 2001 as a Colorado-based company called HyperSpace Communications, Inc., and completed an IPO in October 2004. In July 2005, we acquired MPC, which is now our wholly owned subsidiary and our sole operating business.  On October 1, 2007, we completed the acquisition of the Gateway Professional Business.  See “October 1, 2007 Acquisition of Gateway Professional Business” further under this Item 2.  This acquisition significantly increases the scale of our business as the Professional Business had reported revenue of $895 million in 2006 as compared to our revenue of $285 million in 2006.  We anticipate that the increased scale will enable us to better compete with our larger competitors including Dell, HP and Lenovo.  As part of the acquisition, we acquired substantially all the employees supporting, and assets of, the Professional Business.

 

In addition, we obtained access to the entire catalog of products and services from the Professional Business and now make them available to both MPC and Gateway Professional customers.  We also acquired Gateway’s leased final assembly facility in Nashville, TN and the portion of Gateway’s Consumer Direct business that targets business with less than 100 employees. With the completion of the acquisition, we have operations in Idaho, South Dakota, Tennessee and Colorado.

 

Under the terms of the transaction, we assumed warranty and other specified obligations of the Professional Business.  Gateway acquired our common stock and Series B Preferred stock constituting an approximate 19.9% equity interest in us.  We will issue to Gateway a promissory note in the approximate amount of $2 million, subject to adjustments described in the Asset Purchase Agreement.  There can be no assurance that the acquisition and future operations of the Gateway Professional Business will be successful.

 

Current Business

 

Our primary business is providing PC-based products and services to mid-sized businesses, government agencies and education organizations. We manufacture and market ClientPro® desktop PCs, TransPort® notebook PCs, NetFRAME® servers and DataFRAME™ storage products, along with the “E-series” of desktops, notebooks, servers and storage that we recently acquired from Gateway under a one-year license agreement. We also provide hardware-related support services such as installation, technical support, parts replacement, and recycling. In

 

22



 

addition to PCs, servers, and storage products, we also fulfill our customers’ requirements for third party products produced by other vendors, including printers, monitors and software.

 

We will continue to focus primarily on three markets: federal government, state/local government & education (“SLE”), and mid-size enterprise. This focus enables us to tailor our operating model to better support the needs of these customers for customized products, services and programs. We sell directly to customers in each of our markets.

 

We use a build-to-order manufacturing process that we believe is an efficient means to provide customized computing solutions.

 

Strategic Plans and Initiatives

 

With the purchase of the Professional Business we have expanded our enterprise IT hardware business of providing products and services to customers in mid-sized businesses, government agencies and education organizations.  This acquisition has expanded our business in the education and state/local government markets in particular, resulting in a more balanced product mix less reliant on the federal government business.  In addition, the acquisition has expanded our product line to include new products, including a more competitive line of notebook PCs and convertible tablet PCs.

 

Professional Business Initiatives

 

To successfully combine our existing operations with the newly acquired Professional Business, we have set forth the following key initiatives:

 

      Effectively integrate/combine the new Professional Business management teams;

      Successfully transfer the financial, human resource, procurement, and other data from the Professional Business into our IT Systems ;

      Carefully manage our liquidity to maximize our use of funds;

      Focus on supplier relationships, reduce procurement costs due to our larger scale, and improve the utilization of vendor credit;

      Successfully integrate our sales efforts between our existing and new Professional Business sales teams;

      Integrate our product lines and continue ongoing research and development activities;

      Fully integrate our warranty obligations;

      Successfully integrate our administrative and financial functions, including the combining of our various licensing and royalty functions;

      Retain Professional Business customers;

      Utilize the Gateway brand name until our license to use the name expires in September 2008, while enhancing the MPC brand name in our various markets;

      Integrate into our overall operations, our lower cost operating methodologies and practices.

 

We cannot give assurance that these initiatives will achieve the intended results, and that our failure to achieve these initiatives and others could have a material adverse effect on our business and financial condition.  See Risk Factors in Part II, Item 1A of this report.

 

Gross Margin Initiatives

 

We continue to focus on gross margin improvement initiatives including the reduction of product returns, freight costs, manufacturing costs, and costs associated with customer evaluation units.  In addition, we are focusing on sales of higher margin products such as servers and storage devices. We continue to be active in cost management and constantly seek ways to run our business more cost effectively.  There can be no assurance that improvements can be achieved.

 

We continue to focus on:

 

      Increasing the liquidity in our business and improving our balance sheet;

      Continuing to make our operations more cost efficient;

      Seeking ways to sell and distribute our products more effectively;

      Penetrating segments of the U.S. federal government where we have historically not made significant sales;

 

23



 

      Continuing to focus on higher margin business such as servers and storage devices; and

      Working with our vendors to negotiate further credit extensions or larger lines of credit

 

RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONS

(In millions)

 

 

 

Three months ended
September 30,

 

 

 

Nine months ended
September 30,

 

 

 

 

 

2007

 

2006

 

% Change

 

2007

 

2006

 

% Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

57.9

 

$

76.6

 

-24.4

%

$

168.3

 

$

211.6

 

-20.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

48.2

 

67.8

 

-28.9

%

145.0

 

186.2

 

-22.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

9.7

 

8.8

 

10.2

%

23.3

 

25.4

 

-8.3

%

Gross margin %

 

16.8

%

11.5

%

13.8

%

12.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development expense

 

0.6

 

0.7

 

-14.3

%

1.6

 

2.9

 

-44.8

%

Selling, general and administrative expense

 

9.2

 

10.3

 

-10.7

%

28.0

 

31.4

 

-10.8

%

Depreciation and amortization

 

1.1

 

1.2

 

-8.3

%

3.4

 

5.2

 

-34.6

%

Impairment of acquired intangibles

 

 

 

 

 

19.5

 

-100.0

%

Total operating expenses

 

10.9

 

12.2

 

-10.7

%

33.0

 

59.0

 

-44.1

%

Operating expenses as a % of revenue

 

18.8

%

15.9

%

 

 

19.6

%

27.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

$

(1.2

)

$

(3.4

)

-64.7

%

$

(9.7

)

$

(33.6

)

-71.1

%

Operating loss as a % of revenue

 

-2.1

%

-4.4

%

 

 

-5.8

%

-15.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other (income) expense

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

1.4

 

0.9

 

 

 

4.4

 

3.5

 

 

 

Gain on vendor settlements

 

(0.3

)

(0.7

)

 

 

(0.5

)

(1.6

)

 

 

Change in estimated fair value of derivative financial instruments

 

(26.3

)

24.9

 

 

 

(7.0

)

25.9

 

 

 

Loss on debt extinguishment

 

 

10.5

 

 

 

 

10.5

 

 

 

Merger related stock compensation expense

 

 

1.3

 

 

 

 

1.3

 

 

 

Other income

 

 

 

 

 

(0.1

)

(0.1

)

 

 

Total other (income) expense, net

 

(25.2

)

36.9

 

 

 

(3.2

)

39.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

24.0

 

$

(40.3

)

 

 

$

(6.5

)

$

(73.1

)

 

 

 

OPERATING RESULTS

 

Revenue

 

Revenue for the three months ended September 30, 2007 was $57.9 million, a decline of $18.7 million or 24.4% from the comparable period in 2006. Revenue for the nine months ended September 30, 2007 was $168.3 million, a decline of $43.3 million or 20.5% from the same period in 2006. The decrease in revenue for the three and nine months ended September 30, 2007 was due to lower sales to our commercial, state/local government, and education customers.  Due to our cash constraints in the second half of 2006, many of these customers’ orders were delayed and they therefore placed fewer orders with us during the first half of 2007.  Lower revenues from commercial, state/local government, and education customers were partially offset by higher revenues from federal government customers.  Our orders in backlog increased from approximately $28 million at the end of 2006 to approximately $48 million at the end of the third quarter 2007.

 

Our revenues have declined from 2005 to 2006, and to date in 2007 compared to 2006.  While we have recently

 

24



 

experienced moderate increases in sales to federal government customers, it is not certain this improvement in federal government sales will continue or whether sales to commercial, state/local government and education customers will decline further.  Economies of scale play an important role in the PC industry.  Our major competitors have significantly larger operations and stronger brand recognition than we do, and generally have stronger financial positions.  Our acquisition of the Professional Business will help us to address our disadvantages in economies of scale, but there can be no assurance that our downward revenue trend will be reversed.

 

Gross Margin

 

As a percentage of net sales, gross margin increased to 16.8% for the three months ended September 30, 2007 from 11.5% for the same period in 2006, and increased to 13.8% from 12% for the nine months ended September 30, 2007 compared to the same period in 2006. The improvements in gross margin for the periods are due principally to sales of higher margin products, coupled with lower costs for certain raw materials purchased during the preceding six months.  We are currently experiencing an amortization of higher levels of deferred revenues related to 4-year and 5-year warranties whose terms are now coming due.  As a result, during the three and nine months ended September 30, 2007, we recognized a greater amount of the deferred revenue associated with extended warranty services than in previous periods, which had a favorable impact on our gross margin percentage.  We do not anticipate that these higher than historical margins will continue in future periods.

 

Research and Development Expense

 

Research and development expenses decreased $0.1 million and $1.3 million for the three and nine months ended September 30, 2007, respectively from the same periods in 2006, primarily due to our cost cutting initiatives initiated in 2006.

 

Selling, General and Administrative Expense (SG&A)

 

Our SG&A expense for the three and nine months ended September 30, 2007 decreased $1.1 million and $3.4 million, or 10.7% and 10.8%, respectively, compared to the same periods in 2006. Our ongoing cost reduction efforts initiated in 2006 and lower sales commissions from lower sales are the primary factors contributing to the decline.

 

Depreciation and Amortization

 

Deprecation and amortization consists of depreciation of purchased fixed assets and the non-cash amortization of acquired intangibles at the time of our acquisition of MPC in July 2005. Depreciation and amortization declined $0.1 million for the three months ended September 30, 2007 and declined $1.8 million for the nine months ended September 30, 2007 from the comparable periods of 2006, primarily due to the $19.5 million impairment of acquired intangibles during the second quarter of 2006. The impairment resulted in a lower remaining balance of acquired intangibles and therefore a reduction of future amortization expense.

 

Impairment of Acquired Intangibles

 

In 2006, we were challenged by difficult market trends such as declining average selling prices and declining margins. Our financial projections in June 2006 were updated to reflect such trends. Based on the updated projections at that time, we determined that acquired intangibles relating to customer relationships that arose at the time of the acquisition of MPC had been impaired primarily due to the future expected declines in revenue to federal government customers and other customers. We recognized a non-cash impairment charge of $19.5 million for the nine months ended September 30, 2006. For the comparable periods in 2007, we had no further indication of impairment of our acquired intangibles.

 

Gain on Vendor Settlements

 

We entered into settlement agreements with vendors whereby we made cash payments at less than the full amounts due to settle the accounts.  For the three and nine months ended September 30, 2007, the gain on vendor settlements decreased $0.4 million and $1.1 million compared to the same periods in 2006.

 

Change in Estimated Fair Value of Derivative Financial Instruments

 

On April 24, 2006, we sold convertible debentures (the Bridge Loan) for an aggregate of $5.0 million and issued 1.37 million 5-year warrants to purchase, our common stock for $3.12 per share, the fair value of our common stock

 

25



 

on the date of the close of the transaction. These debentures plus accrued interest thereon were rolled into a new financing (New Convertible Debentures) on September 6, 2006 for which we received an additional $4.55 million in cash. In addition, we issued 4.9 million 5-year warrants to purchase our common stock for $1.10 per share, which was below the then current market value per share of our common stock on that date. As a result of anti-dilution provisions, the conversion price of the Bridge Loan warrants was reduced to $1.10. We entered into another financing (September 29, 2006 Financing) in which we sold $4.9 million of convertible debentures and issued 2.5 million 5-year warrants to purchase our common stock for $1.10 per share, which was below the market value of our common stock on that date. We did not close on most of the funds received in the September 29, 2006 financing until October 4, 2006. Additional warrants were issued in connection with these transactions.

 

These convertible debentures and warrants are derivative financial instruments that are carried at fair value as derivative liabilities. See Note 6 – “Derivative Warrant Liabilities and Convertible Debentures” in Notes to Interim Condensed Consolidated Financial Statements in Item 1 of this report for more information regarding these financial instruments. During the three and nine months ended September 30, 2007, we recognized non-cash income of $26.3 million and $7 million, respectively, primarily related to a decline in the fair value of these derivative financial instruments as a result of a decrease in the market price of our stock during the third quarter of 2007.  For the three months and nine months ended September 30, 2006, we recognized expense of $24.9 and $25.9 million, respectively, related to the initial recognition of the Bridge Loan and the associated change in the fair value of the underlying derivatives during that quarter.  The significant size of the expense was primarily the result of conversion features of the securities issued at below market prices and the mandatory put option afforded the investors in the event of default.

 

Significant estimates and assumptions are used in the determination of the fair values of these derivative financial instruments. The fair values are determined in part by, and will fluctuate with, the market value of our stock. If the market price of our stock increases during a period, the fair value of the derivatives is expected to increase and will adversely affect our earnings. A decline in the market price of our stock will cause a decrease in fair value of the derivatives and have a positive impact to earnings. The change in the fair value of these derivative financial instruments has no impact on our cash flows.

 

During the nine months ended September 30, 2007, we issued 3,238,666 shares of common stock upon conversion of $2.4 million, respectively, in face value of convertible debentures plus accrued interest and penalties.  On October 1, 2007, $12.4 million in face value of convertible debentures were converted to common stock and Series A preferred stock. In addition, 7,545,352 million warrants were exercised.  We anticipate that the conversion of the debentures and the exercise of the warrants will reduce the impact of changes in the estimated fair value of remaining derivative financial instruments on our results of operations in future periods.

 

Loss on Extinguishment of Debt

 

During the three and nine months ended September 30, 2006, we recognized a loss of $10.5 million related to the extinguishment of the Bridge Loan during the September 6, 2006 financing. The loss was due to the fair value of the consideration received by the investors in exchange for the rollover of the Bridge Loan into the New Convertible Debentures and Warrants. The loss on extinguishment had no effect on our cash flow.  There were no such losses for the comparable periods in 2007.

 

Merger Related Stock Compensation Expense

 

Merger related stock compensation expense for the three and nine months ended September 30, 2006 was $1.3 million related to the restricted stock units that had been issued to several MPC officers and certain key employees in connection with the merger with MPC.  All related restricted stock units were fully vested in 2006, therefore no such merger related compensation expense was incurred in 2007.

 

Income taxes

 

We make no provision for income taxes because, since inception, we have not been profitable. We have a net operating loss carry-forward available to offset future federal and state income tax expenses to an amount that approximates our accumulated deficits. Our net operating loss carry-forward will expire in varying amounts from 2021 to 2026. The utilization of the net operating loss carry-forward as an offset to future taxable income is subject to the limitations under US federal income tax laws. One such limitation is imposed where there is a greater than 50% change in ownership of our company.

 

26



 

OFF BALANCE SHEET ARRANGEMENTS

 

We have no off the balance sheet arrangements.

 

GUARANTEES

 

During our normal course of business, we have made certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to customers and licensees in connection with the use, sale and/or license of our products, (ii) indemnities to lessors in connection with our facility leases for certain claims arising from such facilities or leases, (iii) indemnities to vendors and service providers pertaining to claims based on our negligence or willful misconduct, (iv) indemnities involving the accuracy of representations in certain contracts, and (v) guarantees to certain vendors and creditors for balances owed. The duration of these indemnities and commitments in certain cases may be indefinite. The majority of these indemnities and commitments do not provide for any limitation of the maximum potential for future payments we could be obligated to make. We have not recorded any liability for these indemnities and commitments in the accompanying consolidated financial statements.

 

NEW AND RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

 

New Accounting Standards

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement 115. SFAS No. 159 permits companies to choose to measure certain 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 at each subsequent reporting date. SFAS No. 159 is effective for us beginning in the first quarter of fiscal year 2008, although earlier adoption is permitted. We are currently evaluating the impact that SFAS No. 159 will have on our consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this statement does not require any new fair value measurements. We will adopt this standard January 1, 2008. We do not expect it to have a material impact on our financial position or results of operations.

 

Recently Adapted Accounting Standards

 

In June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109. FIN No. 48 clarifies the criteria for the measurement, recognition and derecognition of income taxes under FASB Statement No. 109, Accounting for Income Taxes. It also requires additional financial statement disclosures about uncertain tax positions including classification, interest and penalties. FIN 48 is effective January 2007. Because we have not been profitable since our initial public offering and the uncertainty as a going concern, we have not realized any deferred tax assets. FIN No. 48 did not have a material impact on our financial position or results of operations. If our tax status were to change in the future, we would have to reevaluate the impact of FIN No. 48 on our financial position and results of operations at that time.

 

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

 

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of GAAP financial statements requires certain estimates, assumptions, and judgments to be made that may affect our consolidated statement of financial position and results of operations. Critical accounting estimates are those that are most important and material to our financial condition and results of operations and require management’s most difficult, subjective, or complex judgments, often as a result of the need to estimate matters that are inherently uncertain. We believe our most critical accounting policies and estimates relate to revenue recognition, including reserves needed for possible future returns and discounts; the carrying value and usefulness of inventory and related inventory reserves; the timing and amount of future warranty obligations; accounting for derivative financial instruments; and the impairment of acquired intangible assets. We have discussed the development, selection, and disclosure of our critical accounting policies and use of estimates with the Audit Committee of our Board of Directors. These critical accounting policies and our other accounting policies are described in Note 1 of “Notes to Interim Consolidated Financial Statements” included in “Item 1 – Financial Statements.”

 

27



 

Revenue Recognition

 

We frequently enter into sales arrangements with customers that contain multiple elements or deliverables such as hardware, software, peripherals, and services. Judgments and estimates are critical to ensure compliance with GAAP. These judgments relate to the allocation of the proceeds received from an arrangement to the multiple elements, the determination of whether any undelivered elements are essential to the functionality of the delivered elements, and the appropriate timing of revenue recognition. We offer extended warranty and service contracts to customers that extend and/or enhance the technical support, parts, and labor coverage offered as part of the base warranty included with the product. Revenue from separately priced extended warranty and service contracts, for which we are obligated to perform, is recorded as deferred revenue and subsequently recognized over the term of the contract. The amount recognized on a periodic basis within this term is based on management’s best estimate of how it will perform its obligations in future periods. This is based on past historic trends and other factors likely to have a future impact on warranty claims. The actual rate of warranty claims could differ materially from management’s estimates.

 

We record reductions in revenue in the current period for estimated future product returns related to current period sales. Management analyzes historical returns, current trends, changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns allowances in any accounting period. If actual returns exceed estimated returns, we would be required to record additional reductions to revenue which would affect earnings in the period the adjustments are made.

 

Inventory Valuation

 

We operate in a business environment subject to rapid changes in technology and customer demand. We record write-downs for components and products which have become obsolete or are in excess of anticipated demand or net realizable value. Historically, these write-downs have primarily related to warranty inventory. We perform an assessment of inventory each quarter, which includes a review of, among other factors, inventory on hand and forecast requirements, product life cycle (including end of life product) and development plans, component cost trends, product pricing and quality issues. Based on this analysis, we record an adjustment for excess and obsolete inventory. We may be required to record additional write-downs if actual demand, component costs or product life cycles differ from estimates, which would affect earnings in the period the write-downs are made.

 

Warranty Liabilities

 

We record warranty liabilities at the time of sale for the estimated costs that may be incurred under our standard limited warranty. The specific warranty terms and conditions vary depending upon the product sold but generally include technical support, parts, and labor over a period ranging from 90 days to three years. Factors that affect our warranty liability include the number of installed units currently under warranty, historical and anticipated rates of warranty claims on those units, and the average cost of claims on our installed base to satisfy our warranty obligation. The anticipated rate of warranty claims is the primary factor impacting our estimated warranty obligation. The other factors are less significant due to the fact that the average remaining aggregate warranty period of the covered installed base is approximately 9 months, repair parts are generally already in stock or available at pre-determined prices, and labor rates which are fairly predictable and historically have not fluctuated significantly from period to period.  Warranty claims are relatively predictable based on historical experience of failure rates. If actual results differ from our estimates, we revise our estimated warranty liabilities to reflect such changes. Each quarter, we reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary.

 

Derivative Financial Instruments

 

The accounting for convertible debt with derivative features is highly complex, subject to a number of accounting pronouncements and subject to broad interpretations. Determination of the treatment of these convertible debt instruments is based on current interpretation of the facts, treatment by other companies and discussion with industry experts. Management is also required to make highly subjective estimates of future share price volatility, the probability of future events and effective discount rates. We anticipate that future changes in the fair value of our derivative financial instruments may have a material impact in our results of operations. Among other factors, the fair value of our derivative financial instruments is affected by the market value of our common stock. Increases in the market price of our common stock will adversely impact our financial results.  Declines in the market value of our common stock will have a positive impact. The changes in the fair value of these derivatives have no impact on our cash flows.

 

28



 

Impairment of Acquired Intangible Assets

 

The estimates used by management in determining the impairment of acquired intangible assets is a critical accounting estimate susceptible to change from period to period. It requires management to make assumptions about future cash flows over future years and utilize an estimated discount rate. Management’s assumptions about future cash flows involves significant judgment because actual operating levels have fluctuated in the past and may continue to do so in the future and economic conditions may change. Also, the adoption of any new strategic plan inherently involves uncertainty. A significant adverse change in our business could result in a future impairment of the value of our acquired intangible assets.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary sources of liquidity have been our Wells Fargo Receivables Advance Facility and additional funding through $14.5 million in private placements made during 2006.

 

We face significant constraints with respect to our liquidity and working capital that have materially impacted our business and may to continue to impact our business.  As of September 30, 2007, we had cash and cash equivalents of $1.1 million, current assets of $68.5 million and current liabilities (exclusive of deferred revenue which is not yet earned) totaling $67.9 million. At September 30, 2007 our shareholder’s equity was a deficit of $24.4 million. Our operations have not generated positive annual cash flows since our IPO. For the nine months ended September 30, 2007, cash provided by operating activities was $6.1 million primarily as a result of collections on accounts receivables, partially offset by an increase in inventory as we prepare for orders received from the federal government.  Cash used by operating activities for the nine months ended September 30, 2006 totaled $10.7 million.

 

Background

 

Our liquidity has been constrained because of various factors. A significant amount of cash withdrawn by MPC Computer’s prior owner in the years before the acquisition left the business without adequate liquidity at the time of the acquisition. Since the acquisition, we have used funds to consummate the MPC acquisition, had insufficient revenues and gross margins to sustain our operations, incurred ongoing operating losses and interest expense on our debt, and have expended cash to support fundraising initiatives.

 

Since inception, we have financed our operations through the private placements of equity securities, convertible debt, loans from our founder and other members of our Board of Directors, short-term loans, a line of credit and net proceeds of $7.1 million from our IPO. In connection with our IPO, we also issued 3.6 million warrants. These warrants were exercisable at $5.50 per share, but have subsequently been adjusted to $3.77 due to anti-dilution provisions triggered due to convertible debentures and warrants issued by us in September 2006 with conversion features at below then current market prices. The warrants are callable by us at $0.25 per share if our common stock trades at or above $9.50 per share for 20 consecutive days. None of these warrants have yet been exercised, and we do not anticipate that a material amount of the warrants will be exercised unless we are able to exercise our call right, which would require our stock trading price to close at a price of at least $9.50 for 20 consecutive trading days. Our stock has never traded above $9.50 per share. From December 2005 to February 2006, we raised approximately $12.6 million, prior to expenses and commissions, through warrant exercises.

 

Because our liquidity has been constrained, we have managed our cash position by extending payments to suppliers, some of whom have placed us on credit hold, reduced credit lines or placed on a pre-pay position for products. On many occasions this has delayed delivery of components to our manufacturing facility until payments were made. We have also received notices of default, threatened litigation and litigation from numerous suppliers, but have generally cured the defaults or settled the amount owed or otherwise managed the supplier relationship.

 

During the quarters ended June 30, 2006 and September 30, 2006, delivery and credit issues with suppliers increased compared to prior periods because of late payments, but were alleviated to a limited extent later in our fourth quarter when we replaced our Wachovia Credit Facility with the Wells Fargo Receivables Advance Facility on November 16, 2006. Initially, the Receivables Advance Facility provided approximately $13 million in availability over the Wachovia Credit Facility. In February 2007, we amended the Receivables Advance Facility to obtain additional temporary liquidity as needed subject to the terms of the amendment as noted below. Financing under the Receivables Advance Facility is dependant upon our sales volume and related receivables to assign to Wells Fargo. Historically, our sales volume has been lower during the first two quarters of the year and increases during the third and fourth quarters due to the Federal-buying season. Periods of lower revenue volume and lower related receivables reduce our assignment of receivables, borrowing capacity, and our ability to cover our operating expenses.

 

29



 

In conjunction with the acquisition of the Professional Business from Gateway, we raised $8.3 million from the exercise for cash of $1.10 warrants issued in connection with two private placement financings in September 2006 that included the issuance of convertible debentures.  Additionally, through the acquisition of the Professional Business, we acquired specified inventory totaling approximately $26 million. We are currently consuming inventory acquired in the transaction to produce finished goods, which we will sell to our customers and will obtain additional cash flow. See Note 9 — “October 1, 2007 Acquisition of Gateway Professional Business” further in this Management Discussion and Analysis for additional information.

 

Although we have raised additional funds as a result of the acquisition of the Professional Business, we are currently seeking to expand credit lines with many of our current vendors, and obtain credit lines from vendors we have not previously done business with as a means to continue to fund our operations in the near term. Certain of these vendors have required letters of credit to secure credit lines, and since September 30, 2007 we have put letters of credit in place with three vendors, totaling $3.3 million. We are currently negotiating with other vendors, and anticipate providing additional letters of credit to secure credit lines with certain vendors. Continuing to provide letters of credit to vendors constrains our liquidity as we are required to cash collateralize the letters of credit, and there can be no assurance that we will be successful in obtaining sufficient vendor credit in the future.  Since the acquisition of the Professional Business, we have also experienced parts shortages in certain instances as a result of not having our IT systems fully integrated with these of the Professional Business.  Any inability to maintain adequate liquidity in the future or inability to integrate our IT systems on a timely basis may do significant harm to vendor relationships we are able to secure, and could cause us to experience credit holds, requirements that we pre-pay for products, and/or a refusal to deliver components or termination of supply arrangements, any of which could have a material adverse effect on our financial condition and results of operations.

 

We may need to raise a significant amount of additional funds to satisfy vendor payment obligations and fund our business if our losses continue. There can be no assurance that we will be able to secure additional sources of financing. Even if we do obtain additional funding, the amount of such funding may not be sufficient to fully address all of our liquidity constraints. Continuing liquidity constraints could negatively and materially impact our business and results of operations.

 

Wells Fargo Receivables Advance Facility

 

On November 16, 2006, we entered into an agreement with Wells Fargo Business Credit, Inc. (“Wells Fargo”) for an accounts receivable assignment and advance facility (“Receivables Advance Facility”) that replaced our existing line of credit with Wachovia Capital Finance Corporation (Western). Under the new facility, we may assign to Wells Fargo, and Wells Fargo may purchase from us, Accounts (as defined in the Receivables Advance Facility). Wells Fargo will advance 90% of the value of the purchased Accounts. Wells Fargo may adjust the advancement percentage at any time in its commercially reasonable discretion upon prior notice to us. We will pay fees equal to the Wells Fargo Prime Rate (as defined in the Receivables Advance Facility), plus 1.75% per annum multiplied by the total amount of Accounts purchased and not yet paid by our customers, computed daily. The effective rate at September 30, 2007 was 9.5%.  Wells Fargo has the right to require that we re-purchase the Accounts in the event our customer does not pay the receivable within a timeframe specified under the Receivables Advance Facility, if a material customer dispute arises or in the event of a default under the Receivables Advance Facility. The Receivables Advance Facility is subject to customary default provisions. Wells Fargo has discretion under the Receivables Advance Facility as to the Accounts purchased and the percentage advanced after submission of the Account for approval. Wells Fargo is not obligated to buy any Account from us that Wells Fargo does not deem acceptable in its sole discretion. There is no minimum amount of Accounts to be purchased by Wells Fargo under the Receivables Advance Facility. The facility is secured by substantially all of our assets. The Receivables Advance Facility is for a term of three (3) years. There is an annual fee of $100 thousand in addition to a minimum fee. Early termination fees apply if the Receivables Advance Facility is terminated before the end of the term. The agreement also provides for a $1.5 million collateral account for the benefit of Wells Fargo for repayment of any obligations arising under the Receivables Advance Facility .

 

In February 2007, we entered into an amendment to of the Receivables Advance Facility under which Wells Fargo agreed to advance an additional 7.5% of the face amount of currently outstanding Accounts assigned to Wells Fargo, provided that the total advance does not exceed 97.5% of the face amount of any Account (the “Temporary Advance”), and increase the advance rate on new accounts assigned to Wells Fargo to 98% of the amount of the accounts for a period of eight weeks (the “Special Facility Period”). We must repay the difference between the Advance and the Temporary Advance within four weeks after termination of the Special Facility Period. Failure to repay amounts advanced under the Special Facility would constitute an event of default under the Receivables Advance Facility. At any time when the Temporary Advance has been paid in full for a minimum of 60 days, we

 

30



 

may request that the Special Facility be reinstated for another eight week period with repayment to be made within four weeks.

 

The terms of Receivables Advance Facility were later amended on October 1, 2007.  See “Amended Account Purchase Agreements’, further in this Management Discussion and Analysis.

 

Bridge Loan

 

On April 24, 2006, we obtained a bridge loan in the amount of $5 million. This bridge loan was obtained through a Securities Purchase Agreement with certain existing investors pursuant to which we sold convertible debentures for an aggregate of $5 million. The investors also received an aggregate of 1,370,000 warrants to purchase our no par value common stock for $3.12 per share, the fair market value on the day the transaction closed.

 

The convertible debentures accrued interest at 10% per annum and the $5 million aggregate principal amount became due and payable July 24, 2006. We prepaid the interest expense through July 24, 2006 with 40,064 shares of common stock at the time of the closing. On July 24, 2006, holders of the $5 million bridge loan agreed to extend the maturity date by 30 days to August 24, 2006 in return for an increase in the effective interest rate to 12%, payable in cash, for the extended term.

 

The debentures were convertible at the option of the holders into shares of common stock at an initial conversion price of $3.12 per share, subject to adjustment as set forth in the debentures. The exercise price of the warrants was reduced to $1.10 in connection with a September 6, 2006 financing. Except for the initial interest paid in shares of common stock at closing, all interest payments were required to be made on cash. The debentures contained various customary events of default as well as negative covenants that, among other things, prohibit us from incurring additional debt.

 

New Convertible Debentures and Warrants

 

On September 6, 2006, we entered into a securities purchase agreement with certain existing investors and new investors pursuant to which we sold convertible debentures for an aggregate of $4.6 million. Additionally, the investors of the April 24, 2006 bridge loan exchanged $5 million face value of their convertible debentures plus accrued interest thereon into the new convertible debentures and the existing and new investors received 4,924,500 additional warrants. The debentures become convertible into shares of common stock at a conversion price of $0.75 per share.  The warrants allow the purchase of our common stock for $1.10 per share and are for a term of 5 years. The debentures accrue interest at 8% per annum after shareholder approval was obtained in December 2006 and the aggregate principle amount becomes due and payable September 6, 2009. In the event that the debentures are not repaid on the maturity date, we will be in default and the debentures will begin to accrue interest at a rate of 22% per annum or the maximum amount permitted by law, whichever is less. The debentures contain various customary events of default as well as negative covenants that, among other things, prohibit us from incurring additional debt.

 

Because the conversion price for the debentures and the exercise price for the warrants was below market value at the time of issuance and below the exercise and/or conversion price for certain previously issued warrants and convertible securities, anti-dilution rights of various security holders were triggered and resulted in the downward adjustment of the exercise and/or conversion price for various security holders, including the holders of our publicly traded warrants.

 

Both the debentures and the warrants contain provisions limiting conversion and exercise, or issuance of shares in lieu of interest, as the case may be, in the event that the holder’s beneficial ownership of our common stock would exceed 9.99%. We concurrently entered into a registration rights agreement with the investors that requires us to register all of the common stock issued and underlying the securities sold to the investors. The registration rights agreement contains customary indemnification and contribution provisions. We initially filed the registration statement with the SEC on November 8, 2006 and it was declared effective on June 28, 2007. Not all of the common stock underlying the debentures and warrants was registered under this registration statement due to the large number of shares of common stock to be registered relative to the number of shares of our common stock then outstanding.   We believe we have substantially fulfilled our obligations under the registration rights agreement and will register the remaining unregistered shares as required by the registration rights agreement and as allowed by the SEC.

 

On March 5, 2007, we obtained amendments and waivers to, the registration rights agreement and the debentures. Pursuant to a letter agreement, the majority of the investors, including Crestview Capital Master, LLC and Toibb Investment LLC agreed to waive the penalty provisions for not yet having an effective registration statement,

 

31



 

extended the dates for filing a registration statement and all related deadlines, including the date by which the initial registration statement must be declared effective by the SEC, by 120 days. The 120-day extension period lapsed and the registration statement was not declared effective until June 28, 2007. For the nine months ended September 30, 2007, we incurred liquidated damages of $369 thousand under the registration rights agreement.

 

In addition, we issued to one of the investors additional warrants to purchase up to 360,000 shares of common stock for $1.10 per share. The terms of these warrants are identical to the warrants issued as part of the financing. The warrants were accounted for as additional consideration given to the investors as part of the financing.

 

In connection with this financing, we issued 546,000 warrants with a 5 year term to the placement agent to purchase our common stock for $1.10 per share.

 

During the nine months ended September 30, 2007, we issued 1,533,333 shares of common stock upon conversion of $1.2 million in face value of New Convertible Debentures plus accrued interest and penalties.

 

September 29, 2006 Financing

 

On September 29, 2006 we entered into a securities purchase agreement with certain existing investors and new investors pursuant to which we sold convertible debentures for an aggregate of $4.9 million.  The majority of the transaction closed on October 4, 2006.  The investors also received an aggregate of 2,468,125 warrants to purchase our common stock.  The debentures become convertible into shares of common stock at a conversion price of $0.75 per share. The warrants allow the purchase of our common stock for $1.10 per share and are for a term of 5 years. The debentures accrue interest at 8% per annum and the aggregate principal amount becomes due and payable September 29, 2009. In the event that the debentures are not repaid on the maturity date, we will be in default and the debentures will begin to accrue interest at a rate of 22% per annum or the maximum amount permitted by law, whichever is less. The debentures contain various customary events of default as well as negative covenants that, among other things, prohibit us from incurring additional debt.

 

Because the conversion price for the debentures and the exercise price for the warrants was below market value at the time of issuance and below the exercise and/or conversion price for certain previously issued warrants and convertible securities, anti-dilution rights of various security holders have been triggered and will result in the downward adjustment of the exercise and/or conversion price for various security holders, including the holders of our publicly traded warrants.

 

Both the debentures and the warrants contain provisions limiting conversion and exercise, or issuance of shares in lieu of interest, as the case may be, in the event that the holder’s beneficial ownership of our common stock would exceed 9.99%. In connection with this financing, we issued 499,867 warrants with a 5-year term to the placement agent to purchase our common stock for $1.10 per share.

 

We concurrently entered into a registration rights agreement with the investors that requires us to register all of the common stock issued and underlying the securities sold to the investors. The registration rights agreement contains customary indemnification and contribution provisions.

 

We initially filed the registration statement with the SEC on November 8, 2006 and it was declared effective June 28, 2007. Not all of the common stock underlying the debentures and warrants was registered under this registration statement due to the large number of shares of common stock to be registered relative to the number of shares of our common stock then outstanding.  In order to register the shares on a Form S-3, the SEC required that we reduce the number of shares being registered. We believe we have substantially fulfilled our obligations under the registration rights agreement and will register the remaining unregistered shares as required by the registration rights agreement an as allowed by the SEC.

 

We did not obtain any amendments or waivers from these investors and as a result, as of February 1, 2007, we began incurring liquidated damages under the registration rights agreement at the rate of 1.5% of the aggregate amount invested per month until the registration statement was declared effective on June 28, 2007. These liquidated damages must be paid in cash, and they accrue interest at a rate of 18% per annum. We have notified the investors that we are currently unable to pay the interest and will accrue the interest if unpaid to their account. There is no assurance that they will allow us to defer payment of the liquidated damages. For the nine months ended September 30, 2007, we incurred liquidated damages of $344 thousand under the registration rights agreement related to the delay of the effectiveness of our registration statement.  Since we have not paid the interest or penalties due under the debentures or the registration rights agreement, a holder could declare the debentures to be in default and accelerate the debt due under the debentures.  If this were to happen, the debentures would accrue interest at a rate of

 

32



 

22% per annum.  We may be required to pay interest or other required payments in cash rather than stock and could be forced to use our limited cash resources to redeem all or a portion of the outstanding debentures.

 

During the nine months ended September 30, 2007, we issued 1,705,333 shares of common stock upon conversion of $1.3 million face value of debentures from the September 29, 2006 Financing plus accrued interest and penalties.

 

Payable to Lessor

 

We are party to a commercial lease with Micron Technology dated April 30, 2001 (as amended, the “Lease”) under which we lease our primary manufacturing facility in Nampa, Idaho. A Fifth Amendment to the Lease deferred our rent payment obligations due or to become due between January 16, 2006 and May 31, 2007, without incurring late charges, provided that we pay base rent and other amounts (the “Extended Rent Obligation”) under the Lease at any time before May 31, 2007.  The total amount of the Extended Rent Obligation payable on May 31, 2007 was $2.5 million and had been recorded as an accrued liability. We had paid only $500 thousand of the Extended Rent by May 31, 2007.

 

On July 2, 2007, we entered into a Sixth Amendment to Commercial Lease of this manufacturing facility. The Sixth Amendment to Commercial Lease provides that we will pay the balance of the Extended Rent Obligation in twelve equal monthly installments in the amount of $174 thousand, including interest at the annual rate of 12%. If any installment is not made, we will incur a late charge of 5% of the amount of such installment and interest shall increase to an annual default rate of 18%. The Sixth Amendment also provides that we will pay the full amount of the Extended Rent Obligation in the event we receive equity investment funds in an amount that exceeds $12 million. Additionally, if our unrestricted cash and cash equivalents balance, combined with available lines of credit, exceeds $5 million at any time after January 1, 2008, the monthly installment amount increases to $348 thousand until the total Extended Rent Obligation is paid in full. In addition to making the Extended Rent Obligation payments, we are obligated to pay current rent and all other Lease obligations as they become due and payable, including property taxes per the terms of the Lease.

 

Payable to TPV

 

On June 30, 2006 we entered into a settlement agreement with TPV International (USA), Inc. and Top Victory Electronics (FUJIANG) Co., Ltd (collectively “TPV”).    Under the agreement we agreed to pay TPV $2.1 million over a period of twelve months with interest at 8%.  The agreement provides for monthly payments of $120 thousand for six months and $254 thousand thereafter. The settlement amount had been previously recorded as accounts payable.

 

Payable to Wacom Technology Corporation

 

On August 31, 2007 we entered into a settlement agreement with Wacom Technology Corporation (Wacom).   The agreement provides for monthly principal payments to Wacom beginning September 2007, with the interest at 5%.  The settlement amount of $1.2 million had previously been recorded as accounts payable.

 

October 1, 2007 Acquisition of Gateway Professional Business

 

On October 1, 2007 (“Closing Date”) MPC Corporation, through our wholly-owned subsidiary MPC-PRO, purchased from Gateway Inc. (“Gateway”) and Gateway Technologies Inc., Gateway’s Professional Division, the portion of Gateway’s Consumer Direct Division that markets business-related products, and a portion of the Customer Care & Support department that provides technical services to customers of the Professional and Consumer Direct Divisions (collectively, the “Professional Business”) pursuant to an Asset Purchase Agreement dated September 4, 2007.  The Professional Business is primarily engaged in the sale, resale and marketing of desktop computer systems, laptops, servers, networking gear and other peripherals, and replacement parts to educational institutions, government entities (federal, state and local), value-added resellers and certain other resellers, and small business sales generated by Gateway’s web and phone centers.

 

The purchase included specified inventory currently valued at approximately $26 million, customer lists and customer relationships, and the sales, marketing, service and administrative functions supporting the Professional Business.   The acquisition included the purchase of all of the capital stock of Gateway Companies Inc. (“GCI”), and the membership interests of Gateway Professional, LLC (“GP”) and Gateway Pro Partners, LLC (“GCC”).

 

As consideration, MPC-PRO assumed certain warranty obligations and other obligations currently estimated at $70 million and will issue to Gateway a promissory note currently estimated to be $2 million. The amount of the

 

33



 

promissory note is subject to adjustment based on the Final Net Inventory/Liability Statement as defined in the Asset Purchase Agreement. The promissory note will bear interest at a rate of 8% and is repayable by April 1, 2008 in equal bi-monthly installments.   The promissory note will be executed within 5 days after the receipt of the Final Net Inventory/Liability Statement provided by Gateway, Inc.  In addition, we issued 5,602,454 shares of MPC Corporation common stock totaling approximately 19.9% of our outstanding common stock as of the Closing Date (the “MPC Common Shares”), and 249,171 shares of MPC Corporation Series B Preferred Stock convertible into 4,983,416 shares of our common stock (following approval by our shareholders permitting such conversion) representing the difference between (a) 19.9% of our outstanding common stock as of the Closing Date on a fully-diluted basis (excluding securities issued to our employees under our current employee equity plans) and (b) the number of shares of the MPC Common Shares (the “MPC Preferred Shares” and, together with the MPC Common Shares, the “MPC Shares.”)  In the event shareholder approval is not obtained within one year following closing, all outstanding shares of MPC Corporation Series B Preferred Stock must be redeemed by us at 1.5 times the closing price times the number of shares of our common stock into which the MPC Corporation Series B Preferred Stock is then convertible.

 

In connection with the transaction, we entered into several material agreements on the Closing Date that were conditions to closing the transaction: (1) a Lock-Up Agreement between us and Gateway with respect to the MPC Shares (the “Lock-Up Agreement”); (2) a Registration Rights Agreement with Gateway with respect to the MPC Corporation common stock, no par value, and MPC Corporation Series B Preferred Stock issued as consideration to the transaction (the “Registration Rights Agreement”), (3) a Transition Services Agreement between MPC-PRO and Gateway (the “TSA”); and (4) an Intercreditor Agreement between MPC-PRO, Gateway, GCI, and Wells Fargo (the “Intercreditor Agreement”). Additionally, in connection with the transactions contemplated by the Asset Purchase Agreement, MPC Corporation and/or our affiliates entered into the following agreements: (1) Account Purchase Agreements between Wells Fargo and each of MPC-PRO and GCI (the “Account Purchase Agreements”); (2) Second Amendments to the Wells Fargo Receivables Advance Facility between Wells Fargo and each of MPC Computers, LLC, MPC-G, LLC and MPC Solutions Sales LLC (the “Amended Account Purchase Agreements”); (3) Lease Agreement between MPC-PRO and Gateway (the “Lease Agreement”); and (4) Letter Agreement between MPC, MPC-PRO, Gateway and Gateway Technologies.  Each of the foregoing agreements is described in more detail below.

 

Lock up and Registration Rights Agreements

 

Under the Lock-Up Agreement, Gateway has agreed that it will not offer, sell, contract to sell, short, pledge or otherwise dispose of any MPC Corporation common stock beneficially owned, held or thereafter acquired by Gateway or its affiliates for a period of 12 months (the “Restriction Period”), except for Permitted Transfers as defined by the agreement.

 

The Registration Rights Agreement provides that following the Restriction Period as set forth in the Lock-Up Agreement and upon receipt of a demand request from Gateway, we will file a registration statement with respect to the Registrable Securities, as defined by the agreement, which include the MPC Shares issued in connection with the transaction.  The Registration Rights Agreement grants Gateway customary and piggyback rights.

 

Transition Services Agreement

 

Under the TSA (as amended on October 26, 2007), Gateway will provide accounting, human resource, manufacturing, procurement, marketing, information technology, and other specified services (collectively, “the Services”). Additionally, Gateway will provide buy/sell services for components from suppliers and will procure systems from Original Distribution Manufacturers (ODM’s).  We will pay Gateway a total fee of $6.5 million, payable as follows: (1) one payment of $724 thousand due on the second Friday after the Closing Date, (ii) one payment of $806 thousand due on the fourth Friday after the Closing Date, (iii) six bi-weekly installments of $765 thousand due on the sixth, eighth, tenth, fourteen and sixteenth Friday after the Closing Date and (iv) one payment of $382 thousand due on the seventeenth Friday after the Closing Date. In addition, the Agreement provides that if any Extended Services are provided by Gateway after the Expiration Date (as defined by the agreement), we will pay Gateway $627 thousand for each week or part thereof, payable on the Friday of every week such Extended Services are performed. We must reimburse Gateway for all components purchased by Gateway, plus a percentage markup of (i) one-half percent during the first eight-week period following close, (ii) one percent during the second eight-week period, and (iii) two percent thereafter.  We will also reimburse Gateway for all software license fees paid in the course of providing the Services and expenses incurred in the Buy/Sell Activity at the rates specified in the TSA.  The TSA will continue in effect from October 1, 2007 until the latest expiration date specified by the Agreement for the Services, generally for 17 weeks, unless the TSA or any Service provided thereunder is earlier terminated by us.

 

34



 

Intercreditor Agreement

 

Under of MPC’s agreement with Wells Fargo, we have granted a senior security position on the assets of MPC Corporation and our affiliates. The Intercreditor Agreement provides Gateway with a junior security interest in accounts receivable generated on or after the Closing Date, inventory, and all other property of MPC-PRO and GCI as specified in the agreement (the “Wells Fargo Collateral”) to secure the payment of obligations owing to Gateway under the Transition Services Agreement (the “TSA Obligations”).  Wells Fargo and MPC-PRO agreed to set aside certain accounts receivable for the payment of the TSA Obligations.

 

Account Purchase Agreements

 

On October 1, 2007, MPC-PRO and GCI (which was acquired by MPC-PRO in connection with the Professional Business, each entered into an Account Purchase Agreement with Wells Fargo.  Under these agreements, MPC-PRO and GCI may assign to Wells Fargo, and Wells Fargo may purchase from MPC-PRO and GCI, Accounts (as defined in the Agreements). Wells Fargo will advance to MPC-PRO and GCI 90% of the value of the purchased Accounts. Wells Fargo may adjust the advancement percentage at any time in its commercially reasonable discretion upon prior notice to MPC-PRO and GCI. MPC-PRO and GCI will pay fees equal to the Wells Fargo Prime Rate (as defined in the Agreements), plus 0.75% per annum (the “Wells Fargo Discount”) multiplied by the total amount of Accounts purchased and not yet paid by MPC-PRO and GCI customers, computed daily. Wells Fargo has the right to require that MPC-PRO re-purchase the Accounts in the event customers of MPC-PRO and GCI do not pay the receivable within a timeframe specified in the Account Purchase Agreements, if a material customer dispute arises or in the event of a default under the Account Purchase Agreements. The Account Purchase Agreements are subject to customary default provisions. Wells Fargo has discretion under the Account Purchase Agreements as to the accounts purchased and the percentage advanced after submission of the Accounts for approval. Wells Fargo is not obligated to buy any Account from MPC-PRO and GCI that Wells Fargo does not deem acceptable in its sole discretion. There is no minimum amount of Accounts to be purchased by Wells Fargo under the Account Purchase Agreements. The facilities are secured by the assets of MPC-PRO and GCI. The Account Purchase Agreements are for a term of three (3) years from November 14, 2006. There is an initial annual combined fee for all MPC Corporation entities of $100 thousand and an annual fee of $200 thousand thereafter in addition to a minimum fee. Early termination fees apply if the Account Purchase Agreements are terminated before the end of their term.  An origination fee of $150 thousand was paid at closing. 

 

Amended Account Purchase Agreements

 

On October 1, 2007, MPC and its subsidiaries MPC-G, LLC and MPC Solutions Sales LLC (MPC Computers, LLC and its subsidiaries being referred to collectively herein as “MPC LLC”) entered into separate Second Amendments to Account Purchase Agreements with Wells Fargo. The Amended Account Purchase Agreements modify the Wells Fargo Receivables Advance Facility agreements dated November 14, 2006, as amended, primarily as to minimum fees and Wells Fargo Prime Rate as defined in the Amended Account Purchase Agreements.  The minimum monthly fee to be paid in aggregate by MPC affiliates to Wells Fargo is determined by multiplying the Wells Fargo Discount, times $30 thousand times 30 divided by 360.  In addition the Amended Account Purchase Agreements increased the collateral account for the benefit of Wells Fargo to $3.5 million from $1.5 million under the Receivables Advance Facility.

 

Lease Agreement

 

MPC-PRO entered into a Lease Agreement with Gateway to lease a portion of a manufacturing facility in North Sioux City, South Dakota, for a term of 5 years from the Lease Commencement Date, as defined in the Lease Agreement, with two 5-year renewal options. Under the Lease Agreement, the monthly initial base rent is $36 thousand per month with annual escalation in base rent as specified in the Lease Agreement.

 

Letter Agreement

 

As a condition to close under the Asset Purchase Agreement, MPC Corporation was to have raised at least $9.0 million in additional cash and cash equivalents through the conversion of outstanding convertible securities, the exercise of warrants or the sale of additional equity securities, as measured relative to MPC’s cash and cash equivalents as of the September 4, 2007 date of the Asset Purchase Agreement.  This condition was modified to raising at least $8.0 million under a letter agreement dated October 1, 2007 among the parties to the Asset Purchase Agreement.  In satisfaction of this condition, we raised $8.3 million from the exercise for cash of $1.10 warrants issued in connection with two private placement financings in September 2006 that included the issuance of convertible debentures.  As of the October 1, 2007 closing, $13.4 million of face value of the convertible debentures have been converted into MPC Corporation common stock and Series A Preferred Stock since original issuance.

 

In connection with the obligation under the Letter Agreement, two MPC Corporation investors, Crestview Capital Master LLC (“Crestview”) and Toibb Investment LLC (“Toibb”), intended to exercise their warrants and convertible

 

35



 

debentures, but because of their large holdings, their beneficial ownership of our common stock, as defined in Rule 13d-3 as promulgated under the Securities Exchange Act of 1934, as amended, could have exceeded 9.99%.  As such, on October 1, 2007, we entered into an Amendment No. 1 to Convertible Debenture with each of Crestview and Toibb (the “Debenture Amendments”), pursuant to which their respective Convertible Debentures due on September 6, 2009 were amended such that the debentures were convertible into shares of Series A Preferred Stock.  Additionally, MPC and both Crestview and Toibb agreed that, upon the exercise of their warrants prior to the Closing, we would issue (i) common stock only to the extent that their beneficial ownership reaches 9.99% and (ii) the number of shares of MPC Corporation Series A Preferred Stock that will convert into a number of shares of MPC Corporation common stock equal to the difference between the number of shares of common stock such holder would receive if all of such holder’s warrants were exercised for our common stock and the number of shares of our common stock such holder actually received in order to avoid exceeding 9.99% beneficial ownership.

 

Additionally, on October 1, 2007, we entered into an amendment to the Registration Rights Agreement dated as of September 6, 2006 with Crestview and Toibb such that the registration and other rights applicable to shares of common stock issuable upon conversion of the their debentures apply equally to the shares of common stock issuable on conversion of the Series A Preferred Stock issued pursuant to the Debenture Amendments.

 

License Agreement

 

On the Closing Date, MPC Corporation and Gateway entered into a Limited License Agreement to grant us a non-exclusive, royalty-free, one-year use of Gateway Licensed Marks on Licensed Products, as defined, subject to the terms and conditions of the agreement.  Gateway may, in its sole discretion, terminate the Limited License Agreement in the event of a change of control of MPC Corporation.

 

CONTRACTUAL OBLIGATIONS

 

During the nine months ended September 30, 2007, estimated purchase obligations increased $5.7 million. During the nine months ended September 30, 2007, an accrued liability for deferred rent obligations to Micron Technology was converted to an interest bearing payable totaling $1.3 million at September 30, 2007. Also accounts payable to TPV and Wacom, respectively, were converted to an interest bearing payable totaling $1.8 and $1.2 respectively at September 30, 2007.  In addition, $2.4 million face value plus accrued interest of convertible debentures were converted to common stock with a fair value of $3.0 million. There were no other material changes in our contractual obligations during the nine months ended September 30, 2007.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are subject to interest rate risk on our Wells Fargo Receivable Assignment Facility. The interest rate is a floating rate based on the prime rate plus 1.75% per annum.  Effective October 1, 2007 the rate was lowered to the prime rate plus 0.75% per annum.  If interest rates continue to rise we will be subject to higher interest payments if outstanding balances remain unchanged.

 

We have convertible debentures and warrants that are derivative financial instruments and are carried at fair value as derivatives liabilities. The fair values are determined in part by, and fluctuate with, the market value of our stock. If the market price of our stock increases during a period, the fair value of the derivatives is expected to increase and will adversely affect our earnings.  A decline in the market price of our stock as expected cause a decrease in fair value of the derivatives and have a positive impact to earnings.

 

Currently, most of our sales are in the United States. All of our foreign sales and purchases of product are denominated in US dollars, minimizing our foreign currency risk. All of our international suppliers, mostly from Asia, denominate contracts in US dollars thereby eliminating foreign currency risk. In the future we may not be successful in negotiating most of our international supply agreements in US dollars, thereby increasing our foreign currency risk. Amounts we pay for components from international suppliers could be affected by a continued weakening of the US dollar as compared with other foreign currencies. We currently have no foreign exchange contracts, option contracts or other foreign currency hedging arrangements. We continue to evaluate our risk position on an ongoing basis to determine whether foreign exchange hedging strategies may need to be employed.

 

We depend on a relatively small number of third party suppliers for substantially all the components in our PC systems. Additionally, we maintain several single-source supplier relationships primarily to increase our purchasing power with these suppliers. If shortages or delays arise, the prices of these components may increase or the components may not be available at all. We do not have long-term supply contracts with suppliers that would

 

36



 

require them to supply products to us for any specific period or in any specific quantities, which could result in shortages or delays. Supplier risks have also increased due to our liquidity problems and many suppliers have reduced credit limits and terms. Some suppliers do not grant us credit at all and require us to pre-pay for products. There is no assurance, absent future financing, that suppliers will continue to grant us credit at all. Should an increasing number of suppliers reduce or cancel our credit terms, and we are forced to pre-pay for products, it would have a material negative impact on our business and results of operations.

 

ITEM 4T. CONTROLS AND PROCEDURES

 

We maintain a set of disclosure controls and procedures designed to reasonably assure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission (“SEC”) rules and forms. Disclosure controls are also designed to reasonably assure that information required to be disclosed is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). The evaluation of our disclosure controls performed by our CEO and CFO included obtaining an understanding of the design and objective of the controls, the implementation of those controls and the results of the controls on this report on Form 10-Q. In the course of the evaluation of disclosure controls, we reviewed the controls that are in place to record, process, summarize and report, on a timely basis, matters that require disclosure in our reports filed under the Securities Exchange Act of 1934. We also considered the adequacy of the items disclosed in this report on Form 10-Q.

 

As of the date of the financial statements, an evaluation was carried out under the supervision and with the participation of our management, including the CEO and CFO, of the effectiveness of our disclosure controls and procedures. Based on that evaluation the CEO and the CFO concluded that as of September 30, 2007 our disclosure controls and procedures were effective at the reasonable assurance level in ensuring that all information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our CEO and CFO, in a manner that allows timely decisions regarding required disclosure.

 

We have also reviewed changes in our internal control over financial reporting during the most recent fiscal quarter, and our CEO and CFO have concluded that there have been no changes that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II.  OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

Phillip Adams & Associates, LLC

 

We are a defendant in a lawsuit, alleging infringement of certain patents, relating to floppy disk controllers, owned by Phillip Adams & Associates, LLC. We were added to this suit by an amended complaint filed on May 31, 2005 in the U.S. District Court, District of Utah. We have tendered indemnification demands to certain of our component suppliers. Because the case is still in the discovery phase, we are not able to determine the financial impact, if any, arising from an adverse result in the matter.

 

Bingham McCutchen, LLP

 

We were a defendant in a lawsuit filed by a law firm seeking damages for unpaid legal services.  Bingham McCutchen alleged that approximately $530 thousand was owed for services rendered. This suit was filed on or about December 20, 2006 in the District Court of the 3rd Judicial Court of the State of Idaho, Canyon County.  The matter was settled on July 11, 2007 with a payment to Bingham in the amount of $225 thousand.  The dismissal date was July 26, 2007.

 

TPV International (USA), Inc. and Top Victory Electronics (FUJIANG) Co., Ltd.

 

We were a defendant in a lawsuit filed by TPV International (USA), Inc. and Top Victory Electronics (FUJIANG) Co., Ltd. filed in the 98th Judicial Court of Travis County, Texas alleging that we failed to pay invoices for computer

 

37



 

equipment.  In June 2007, we settled the case by agreeing to pay $2.1 million over a period of 12 months, with interest accruing at 8%. The lawsuit was dismissed on July 6, 2007.

 

Wacom Technology Corporation

 

We were a defendant in a lawsuit filed by Wacom Technology Corporation. This suit was filed on March 6, 2007 in the U.S. District Court, District of Idaho alleging that we have failed to pay invoices for computer equipment in the amount of approximately $1.2 million.  On August 31, 2007, we settled the case by agreeing to pay the full $1.2 million in monthly payments of $100 thousand beginning September 2007 plus interest accruing at 5%.  There is no date of dismissal. If the settlement is paid, Wacom will file a satisfaction of judgment claim.

 

Other Matters

 

We are involved in various other legal proceedings from time to time in the ordinary course of our business. We are not currently subject to any other legal proceedings that we believe will have a material impact on our business. However, due to the inherent uncertainties of the judicial process, we are unable to predict the ultimate outcome or financial exposure, if any, with respect to these matters.

 

ITEM 1A.  RISK FACTORS

 

Investing in our securities involves a high degree of risk. You should carefully consider the following risk factor, and other information included in or incorporated by reference into this report, including our financial statements and the related notes thereto. You should also carefully review and consider all of the risk factors set forth in “Item I, Risk Factors” in our previously filed Form 10-KSB/A for the period ending December 31, 2006.  Additional risks and uncertainties that we do not presently know about, or have not yet identified, may also adversely affect our business. Our business, operating results and financial condition could be seriously harmed and you could lose your entire investment by the occurrence of any of these risks, or by unforeseen risks not listed below.

 

Risks Related to the Gateway Professional Business

 

The revenue and operating performance of the Professional Business has been declining and we cannot assure you that we will be profitable after the acquisition of the Professional Business.

 

The revenue and segment contribution of Gateway’s Professional business segment relating to the Professional Business has been declining.  According to Gateway’s annual report on Form 10-K for the fiscal year ended December 31, 2006, the Professional segment had revenues of $896 million, $987 million, and $1,114 million, respectively for the years ended December 31, 2006, 2005 and 2004.  Segment contribution for the Professional segment totaled $(6.5) million, $16.9 million, and $58.4 million, respectively, for the years ended December 31, 2006, 2005 and 2004.   We cannot assure you that we will be successful in reversing this trend of declining revenues or that the Professional Business will be profitable.  If we are not successful, there is a material possibility that it would result in the failure of our business, and you could lose your entire investment.

 

Inability to successfully integrate management teams could adversely affect our financial condition and results of operations.

 

The successful acquisition and future operations of the Professional Business is highly dependent on the successful integration of the Professional Business management team.  We may encounter various issues including an inability to retain critical members of the management team, significant differences in management or operating philosophy, or difficulties in the timely execution of critical directives that may impact the integration of the Professional Business and/or combined operations and performance of our company.  If we are unable to integrate management, or if we lose key members of the Professional Business management, it could have a material adverse impact on our business.

 

Our limited liquidity may result in an inability to meet the financing needs of the larger combined company.

 

We face significant liquidity and working capital constraints that negatively impact our business.  We will encounter additional complexities and costs of a significantly larger organization that will cause additional strain on our limited resources. We expect revenues to grow as a result of the acquisition, and we believe that we will have adequate working capital to manage the business. However, our limited liquidity may result in an inability to meet

 

38



 

the future financing needs of the larger combined company, which could impact our business strategies including the full integration of the Professional Business, and could result in the failure of our business and bankruptcy.

 

Inventory may not be sufficient to satisfy backlog or products under warranty, requiring the combined entity to acquire more additional inventory than planned.

 

As a part of the acquisition of the Professional Business, we acquired approximately $26 million of inventory.  The inventory may not be sufficient to satisfy the acquired backlog of orders or products under warranty of the Professional Business and may require us to purchase additional inventory, which may adversely impact our limited liquidity and cash flows.  Since the acquisition of the Professional Business we have experienced parts shortages in certain instances as a result of not having out IT systems fully integrated with those of the Professional Business.  To the extent we are unable to purchase additional parts and components on a timely basis, we may lose orders in backlog and related customers, which could ultimately materially affect our results of operations and financial position.

 

Gateway’s suppliers may not be willing to provide credit terms to us on acceptable terms.

 

Gateway has a stronger financial position, greater liquidity, and a better credit standing than us.  As a result of our acquisition of the Professional Business, it is possible that some of the suppliers to the Professional Business may not be willing to provide credit to us on the same terms as they offer to Gateway or on other acceptable terms.  We are currently seeking to expand credit lines with many of our current vendors, and obtain credit lines from vendors we have not previously done business with.  Certain of these vendors have required letters of credit to secure credit lines, and since September 30, 2007 we have put letters of credit in place with three vendors, totaling $3.3 million.  We are currently negotiating with other vendors, and anticipate providing additional letters of credit to secure credit lines with certain vendors.  Continuing to provide letters of credit to vendors constrains our liquidity , and there can be no assurance that we will be successful in obtaining sufficient vendor credit in the future.  In the event suppliers reduce, restrict or eliminate their credit lines, it would adversely impact our limited liquidity, impact our operating cash flows, cause delays in receiving components, effect our ability to timely deliver to our customers and retain those customers, sell additional products or satisfy other obligations.

 

Payables to Gateway limit the liquidity provided by our Wells Fargo credit facility.

 

We have entered into an additional agreement with Wells Fargo to expand our Receivables Advance Facility after the transaction to acquire the Professional Business closed, to include accounts receivable transactions of the Professional Business under substantially the same credit terms as the Receivables Advance Facility in order to continue to fund our operations post-close. In connection with this arrangement, we entered into the Intercreditor Agreement.

 

Under the Receivables Advance Facility, we may assign to Wells Fargo, and Wells Fargo may purchase from us, certain accounts receivable. Wells Fargo will advance us a percentage of the value of the purchased accounts. The Receivables Advance Facility provides us with liquidity only to the extent that we are able to generate accounts receivable from our operations, and does not provide for borrowing by us against the value of our other assets. Additionally, Wells Fargo has the right to require that we repurchase the purchased accounts in the event our customer does not pay the accounts within specified timeframes, if a material customer dispute arises, or in the event of a default under the Receivables Advance Facility. Wells Fargo has discretion as to the percentage advanced to us against any accounts. Wells Fargo is not obligated to purchase any accounts from us that Wells Fargo deems unacceptable in its sole discretion, and it is not required to purchase any minimum amount of accounts receivable from us. Because of Wells Fargo’s discretion pursuant to the terms of the Receivables Advance Facility and because borrowing is available only against accounts receivable generated from our operations, we cannot assure you of the amount of liquidity, if any, that will be available to us from Wells Fargo.

 

In connection to the expansion of our Receivables Advance Facility with Wells Fargo after the Professional Business acquisition, we have additional constraints under the terms of the Intercreditor Agreement. The Intercreditor Agreement provides among other things, that after our first week of operations post closing, our ability to factor receivables to Wells Fargo is blocked and secured in favor of Gateway up to the amount of our payable with Gateway pursuant to the terms of the Transition Services Agreement for the 4-month period after the close (“Transition Period”). As a result, this agreement limits our liquidity during the Transition Period. In addition, the Intercreditor Agreement gives Gateway a junior security interest in our assets only behind Wells Fargo to secure our obligations to Gateway.

 

39



 

The Receivables Advance Facility with Wells Fargo is secured by substantially all of our assets. In the event we default, our assets are subject to foreclosure by both Wells Fargo and Gateway. Additionally, Wells Fargo has several additional remedies for default, including acceleration of our payment obligations and discontinuation of the purchase of accounts receivable. If, in the event of a default by us, Wells Fargo forecloses under the Receivables Advance Facility, we may be forced to declare bankruptcy and you will likely lose the entire value of your investment.

 

Gateway’s warranty and other obligations assumed by us may exceed those contemplated at the time of the acquisition.