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MPC 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2

Table of Contents

 

 

 

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 June 30, 2008

 

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 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  x   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one)

 

Large accelerated filer           o

Accelerated filer                           o

Non-accelerated filer            o

Smaller reporting company          x

(Do not check if a smaller reporting company)

 

 

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 August 1, 2008 there were 34,212,677 shares of the issuer’s no par value Common Stock outstanding.

 

 

 



Table of Contents

 

INDEX

 

 

 

Page No.

 

 

 

 

PART I – FINANCIAL INFORMATION

4

 

 

 

ITEM 1

FINANCIAL STATEMENTS

4

 

Condensed Consolidated Balance Sheets

4

 

Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2008 and 2007

5

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007

6

 

Notes to Interim Condensed Consolidated Financial Statements (unaudited)

7

 

 

 

ITEM 2

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

25

 

 

 

ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

43

 

 

 

ITEM 4T

CONTROLS AND PROCEDURES

43

 

 

 

 

 

 

 

PART II – OTHER INFORMATION

44

 

 

 

ITEM 1

LEGAL PROCEEDINGS

44

 

 

 

ITEM 1A

RISK FACTORS

44

 

 

 

ITEM 6

EXHIBITS

47

 

2



Table of Contents

 

A NOTE ABOUT FORWARD-LOOKING STATEMENTS

 

The statements, other than statements of historical fact, included in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended and within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  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-K for the year ended December 31, 2007 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-K, 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.

 

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Table of Contents

 

PART I – FINANCIAL INFORMATION

 

ITEM 1: FINANCIAL STATEMENTS

 

MPC CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except share data)

 

 

 

June 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

718

 

$

9,009

 

Restricted cash

 

9,766

 

9,852

 

Accounts receivable, net

 

59,673

 

86,056

 

Inventories, net

 

97,796

 

62,050

 

Prepaid maintenance and warranty costs

 

7,627

 

10,699

 

Other current assets

 

1,492

 

1,146

 

Total Current Assets

 

177,072

 

178,812

 

 

 

 

 

 

 

Non-Current Assets

 

 

 

 

 

Property and equipment, net

 

6,827

 

10,697

 

Goodwill

 

45,255

 

45,255

 

Acquired intangibles, net

 

23,814

 

28,455

 

Long-term portion of prepaid maintenance and warranty costs

 

2,108

 

1,388

 

Other assets

 

3,237

 

1,668

 

Total Non-Current Assets

 

81,241

 

87,463

 

TOTAL ASSETS

 

$

258,313

 

$

266,275

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Accounts payable

 

$

105,063

 

$

61,079

 

Accrued expenses

 

13,977

 

26,928

 

Accrued licenses and royalties

 

4,835

 

5,084

 

Current portion of accrued warranties

 

20,479

 

24,700

 

Current portion of deferred revenue

 

31,234

 

33,357

 

Notes payable and debt

 

56,598

 

64,249

 

Derivative financial instruments at estimated fair value

 

1,498

 

1,590

 

Total Current Liabilities

 

233,684

 

216,987

 

 

 

 

 

 

 

Long Term Liabilities

 

 

 

 

 

Non-current portion of accrued warranties

 

14,305

 

16,491

 

Non-current portion of deferred revenue

 

29,547

 

25,848

 

Derivative warrant liability

 

297

 

634

 

Total Long Term Liabilities

 

44,149

 

42,973

 

TOTAL LIABILITIES

 

277,833

 

259,960

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

 

 

 

 

PREFERRED STOCK, Series B, 260,000 shares authorized, 249,171 issued and outstanding

 

6,308

 

6,308

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

Preferred Stock, no par value; 100,000 shares authorized; no shares issued and outstanding at 2008 and 2007

 

 

 

Preferred Stock, Series A, 640,000 shares authorized; 626,546 issued and outstanding

 

9,008

 

9,008

 

Common Stock, no par value, 100,000,000 shares authorized; 34,196,343 and 33,948,489 shares issued and outstanding at 2008 and 2007, respectively

 

85,743

 

85,029

 

Accumulated Deficit

 

(120,579

)

(94,030

)

Total Shareholders’ Equity (Deficit)

 

(25,828

)

7

 

TOTAL LIABILITIES AND EQUITY

 

$

258,313

 

$

266,275

 

 

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

 

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MPC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except for per share data)

 

 

 

Three Months ended

 

Six Months ended

 

 

 

June 30,

 

June 30,

 

 

 

2008

 

2007 (1)

 

2008

 

2007 (1)

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

125,473

 

$

53,613

 

$

249,180

 

$

110,365

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

108,906

 

46,972

 

217,620

 

97,534

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

16,567

 

6,641

 

31,560

 

12,831

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

Research and development expense

 

1,324

 

542

 

2,395

 

1,039

 

Selling, general and administrative expense

 

22,055

 

8,811

 

46,181

 

18,643

 

Depreciation and amortization

 

4,314

 

772

 

7,263

 

1,542

 

Total operating expenses

 

27,693

 

10,125

 

55,839

 

21,224

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(11,126

)

(3,484

)

(24,279

)

(8,393

)

 

 

 

 

 

 

 

 

 

 

Other (income) expense

 

 

 

 

 

 

 

 

 

Interest expense, net

 

1,432

 

1,503

 

2,698

 

3,021

 

Change in estimated fair value of derivative financial instruments

 

15

 

20,559

 

(428

)

19,313

 

Gain on vendor settlements

 

 

(225

)

 

(225

)

Total other (income) expense, net

 

1,447

 

21,837

 

2,270

 

22,109

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(12,573

)

$

(25,321

)

$

(26,549

)

$

(30,502

)

 

 

 

 

 

 

 

 

 

 

Loss per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.37

)

$

(1.91

)

$

(0.78

)

$

(2.35

)

Diluted

 

$

(0.37

)

$

(1.91

)

$

(0.78

)

$

(2.35

)

 

 

 

 

 

 

 

 

 

 

Common shares used to compute net loss per share:

 

 

 

 

 

 

 

 

 

Basic

 

34,190,472

 

13,260,372

 

34,128,763

 

12,979,052

 

Diluted

 

34,190,472

 

13,260,372

 

34,128,763

 

12,979,052

 

 


(1) The results of the Gateway Professional Business have been consolidated effective October 1, 2007, the date the acquisition by MPC Corporation became effective and therefore the results of the Professional Businesses are not included for periods prior to October 1, 2007.

 

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

 

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MPC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2008

 

2007 (1)

 

OPERATING ACTIVITIES

 

 

 

 

 

Net loss

 

$

(26,549

)

$

(30,502

)

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

 

 

 

 

 

Depreciation

 

5,070

 

1,399

 

Amortization of acquired intangibles

 

4,641

 

905

 

Amortization of deferred loan costs

 

 

459

 

Change in estimated fair value of derivative financial instruments

 

(429

)

19,313

 

Stock compensation on vesting of restricted stock units

 

620

 

170

 

Cumulative effect of change in accounting principle

 

 

71

 

Gain on vendor settlements

 

 

(225

)

Provision for bad debt

 

441

 

27

 

Gain on disposal

 

(7

)

 

Changes in assets and liabilities

 

 

 

 

 

Accounts receivable

 

25,942

 

23,917

 

Inventory

 

(35,746

)

(8,343

)

Prepaid maintenance & warranties

 

2,352

 

(1,659

)

Other current assets

 

(346

)

249

 

Other non-current assets

 

(1,569

)

504

 

Accounts payable and accrued liabilities

 

25,828

 

(3,184

)

Accrued licenses and royalties

 

(249

)

(7

)

Accrued warranties

 

(6,407

)

(46

)

Deferred revenue

 

1,576

 

1,919

 

Net cash (used) provided by operating activities

 

(4,832

)

4,967

 

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

Purchase of property and equipment

 

(1,214

)

(76

)

Net cash used by investing activities

 

(1,214

)

(76

)

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

Net activity under financing facility

 

(7,699

)

(7,912

)

Borrowings from debt

 

8,735

 

 

Payment of note payable

 

(3,367

)

(500

)

Restricted cash related to letters of credit and financing facility

 

86

 

549

 

Net cash used by financing activities

 

(2,245

)

(7,863

)

 

 

 

 

 

 

Net cash decrease for period

 

(8,291

)

(2,972

)

 

 

 

 

 

 

Cash at beginning of period

 

9,009

 

4,839

 

 

 

 

 

 

 

Cash at end of period

 

$

718

 

$

1,867

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Interest paid

 

$

2,160

 

$

1,674

 

Income taxes paid

 

-0-

 

-0-

 

 


 (1) The results of the Gateway Professional Business have been consolidated effective October 1, 2007, the date the acquisition by MPC Corporation became effective and therefore the results of the Professional Businesses are not included for periods prior to October 1, 2007.

 

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

 

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MPC CORPORATION

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 Computers”) which we acquired through a merger in July of 2005 and MPC-Pro, LLC (“MPC-Pro”) which acquired the Professional Business from Gateway Inc. on October 1, 2007.

 

NOTE 1.    DESCRIPTION OF BUSINESS

 

We were formed as HyperSpace Communications, Inc. as a Colorado-based company, and completed an initial public offering in October 2004. In July 2005, we acquired MPC Computers, LLC, or MPC Computers, which became a wholly-owned subsidiary and our primary business.  MPC Computers is 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 Internet website and phone centers.  The purchase has substantially increased the size of our 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. In addition we manufacture and market the “E-series” of desktops, notebooks, servers and storage products under a limited license agreement with Gateway expiring in March 2009.  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.

 

Agreement with Flextronics

 

On April 14, 2008, we entered into a Manufacturing Services Agreement (the “MSA”) with Flextronics Computing Mauritius Limited (“Flextronics”).  Under the MSA, Flextronics will perform procurement, supply chain management, manufacturing, assembly and testing for MPC Corporation at the Flextronics manufacturing facility in Juarez, Mexico.  Transition of operations from our Nashville, Tennessee manufacturing facilities to Juarez is expected to be completed by December 31, 2008 with transition of other manufacturing to occur on such schedules as may be determined by MPC Corporation and Flextronics.  The MSA provides for Flextronics to achieve certain cost reduction targets, during the first twelve months following August 31, 2008 that are expected to provide cost savings to MPC Corporation.  If the cost reduction targets are not achieved, our sole remedy is to terminate the MSA if Flextronics fails to cure the default.

 

We anticipate the outsourcing of our manufacturing operations to Flextronics could result in potential manufacturing and overhead cost savings.  Flextronics has a much larger scale of operations than ours that may provide a greater ability to procure products and components at lower prices and with lower labor costs.  After the first twelve months of the MSA, Flextronics will continue to seek to reduce cost of manufacturing products by methods such as elimination of materials, material price reductions, redefinition of specifications and re-design of assembly or test methods.  We will continue to evaluate additional means of reducing costs and improving productivity in connection with our operations and under the MSA with Flextronics.  There is no guaranty, however, that any such cost savings will be achieved.  The transfer of operations to Flextronics will allow MPC Corporation to focus on its sales,

 

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marketing, product development and service and support functions, with reduced remaining manufacturing operations.

 

We are responsible for applicable Nashville facility closure and related costs.  We currently estimate a reduction in workforce of approximately 145 personnel from the Nashville facility.

 

AMEX Notification

 

On June 27, 2008, the American Stock Exchange (“AMEX”) notified us that, although we remain out of compliance with certain of continued listing standards, AMEX has accepted our plan for regaining compliance. AMEX has granted us an extension until November 9, 2009, to regain compliance with its continued listing standards.

 

Previously, on May 8, 2008, the AMEX notified us that we failed to satisfy a continued listing rule. Specifically, the notice from AMEX stated that we are not in compliance with Section 1003(a) (i) of the AMEX Company Guide in that we have stockholder’s equity of less than $2 million and have sustained losses from continuing operations or net losses in two of our three most recent fiscal years. We were afforded the opportunity to submit a plan of compliance. We submitted the plan on June 9, 2008.

 

We will be subject to periodic review by the AMEX staff during the extension period. Failure to make progress consistent with the plan or regain compliance with the continued listing standards by the end of the extension period could result in our being delisted from the AMEX.

 

NOTE 2.    LIQUIDITY ISSUES

 

In February 2008, we commenced the transition of the Professional Business IT and manufacturing systems from Gateway to MPC Computers’ existing systems and experienced material delays in manufacturing and customer deliveries, which resulted in much lower than expected shipment volumes and revenues in the first quarter of 2008 as compared to the fourth quarter of 2007.  We also experienced delays in deliveries of parts needed for service and support-related matters.  Our manufacturing delays limited and stopped production at times over approximately a three week period at our Nashville manufacturing facility.  The delays were caused by a number of issues, including, but not limited to, inaccurate bills of materials for our manufacturing processes, inadequate inventory procurement, routing problems which resulted in parts shortages, and order entry errors that caused some orders to be delayed in getting to our manufacturing floor.  In addition, we moved the manufacture of portable personal computers that had historically been manufactured in China to our Nashville facility, causing the transition-related issues we encountered to have a more pronounced effect on our operations.  Prior to the commencement of the transition, we did not expect a significant slowing of our manufacturing process and shipments, and as a result, we procured more raw material inventory to support our anticipated production than the amount we actually needed to fulfill customer orders.  The issues which slowed and stopped production in our Nashville manufacturing facility also impacted our procurement of peripheral products, such as monitors, speakers, and key boards, from third party vendors.  Also during the transition, we experienced system issues and part delivery delays in our customer service and support area, causing us to procure additional parts to support customer relationships, and resulting in some replacement parts not reaching our customers in a timely manner.  These delays in manufacturing and customer deliveries, and service and support issues have caused our inventory and accounts payable to grow materially during the transition and throughout the first six months of 2008.

 

In connection with the outsourcing of the Nashville manufacturing operations to Flextronics under the MSA, we anticipated that the majority of the Professional Business product lines would be transitioned to Flextronics by August 2008, with the transition of all lines to be completed by December 2008. To date, the ramp up of the manufacturing operations by Flextronics has proceeded slower than planned and there has been a very limited amount of finished products produced for us by Flextronics.  In addition, we have shut down our Nashville operations and a substantial portion of our inventory has either been moved to, or is in transit to, the Flextronics Juarez facility.   We have not yet reached agreement with Flextronics on the amount of inventory Flextronics will ultimately purchase from us under the MSA, the timing of receipt of funds from such sales, and so far have received $6.9 million from the sale of inventory. If Flextronics is not able to achieve acceptable production levels, we would have difficulties in returning manufacturing to our facilities or finding alternatives.

 

These transition issues have materially impacted our liquidity, and caused a substantial deterioration in our working capital from December 31, 2007 through June 30, 2008 and into the third quarter of 2008.  Additionally, because of the delays in production, we have experienced cancellations of some of our orders in backlog and a decline in sales to date during the third quarter.  We continue to extend payment to a number of our vendors well beyond normal

 

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payment terms and the amount of the extended payments increased during the second quarter and into the third quarter of 2008.  Certain of our vendors have lowered their existing credit lines to us, restricted component product shipments to us, or have requested letters of credit to secure credit lines.  Working with lower credit lines, continuing to provide letters of credit or other credit enhancement to vendors constrains our liquidity as we are required to use more of our cash, cash collateralize letters of credit or otherwise incur costs to provide credit enhancement, and there can be no assurance that we will be successful in obtaining sufficient vendor credit in the future.  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, and could cause us to experience credit holds, require that we pre-pay for products, and/or cause suppliers to refuse to deliver components or terminate supply arrangements, any of which could have a material adverse effect on our financial condition and results of operations.

 

Our liquidity is highly dependent upon our sales and the advance of cash to us by Wells Fargo on the accounts receivable from those sales. As described above, the delays in our manufacturing during these transitions significantly impacted our shipments and sales to our customers.   As a result, the advance of cash from our Wells Fargo financing facility significantly declined, requiring us to fund a significant portion of our operations from our limited cash flows from operations from management of our working capital and from limited existing cash reserves. Delays in our manufacturing and service and support fulfillment have caused us to prepay for production and service parts at times, or pay to have parts expedited to our plants and depots to alleviate these shortages.  We also delayed payments to certain vendors, which has impacted, and may continue to impact, our ability to obtain or maintain vendor credit.  To the extent we are unable to purchase parts and components on a timely basis in the future, we may lose orders in backlog and related customers, which could have a further adverse and materially negative effect on our sales and liquidity.

 

We may need to raise a significant amount of additional funds to satisfy vendor payment obligations and fund our business if we do not generate sufficient cash flows from operations and losses continue. There can be no assurance that we will be able to secure additional sources of financing on terms acceptable to us or at all.  Continuing liquidity constraints could negatively and materially impact our business and results of operations could impact our ability to continue operations, or could result in bankruptcy.

 

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 financial statements.  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. The fiscal year of MPC Computers and MPC-Pro ends on the Saturday closest to December 31. The 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.

 

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 2007 Annual Report on Form 10-K. The comparative balance sheet and related disclosures at December 31, 2007 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.

 

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Our significant estimates include the collectability 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 June 30, 2008 and December 31, 2007.

 

Restricted cash

 

Restricted cash at June 30, 2008 and December 31, 2007 includes $4.3 million and $3.5 million, respectively, held as collateral under our receivables financing facility, and $5.5 million and $6.3 million, 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 $3.2 million and $2.7 million respectively, as of June 30, 2008 and December 31, 2007.

 

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 June 30, 2008 and December 31, 2007, our inventory valuation allowance totaled $14.6 million and $12.3 million and was recorded as a reduction of inventory in the consolidated balance sheets. Inventory balances, net of valuation allowances, at June 30, 2008 and December 31, 2007 are:

 

(In thousands)

 

 

 

 

June 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Raw Materials

 

$

72,755

 

$

46,569

 

Work in Process

 

866

 

100

 

Finished Goods

 

24,175

 

15,381

 

 

 

 

 

 

 

Total Inventory

 

$

97,796

 

$

62,050

 

 

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.

 

Business Combinations

 

We account for business combinations under the purchase accounting method. The cost of an acquired company is assigned to the tangible and intangible assets purchased and the liabilities assumed on the basis of their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make

 

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estimates and use valuation techniques when market value is not readily available. Any excess of purchase price over the fair value of the tangible and net intangible assets acquired is allocated to goodwill.  During the six months ended June 30, 2008, we had no changes to the preliminary purchase price allocation of our October 1, 2007 acquisition of the Professional Business.

 

Goodwill

 

Goodwill represents the excess of the purchase consideration over the fair value of assets acquired less liabilities assumed in a business acquisition. Our acquisitions of MPC Computers and the Professional Business gave rise to 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. We conduct goodwill impairment tests annually every October 31 or more frequently if facts and circumstances indicate such assets may be impaired.  We completed our annual assessment in accordance with SFAS 142 in 2007 and determined that there was no impairment.

 

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 principally using accelerated methods over their estimated useful lives ranging from 1 to 10 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. Equipment held for lease is depreciated over the initial term of the lease to the equipment’s estimated residual value.  Our policy is to periodically review the estimated useful lives of our fixed assets.  During the three and six months ended June 30, 2008, depreciation and amortization expense increased $1.3 million due to the outsourcing of the manufacturing of our Nashville, TN facility to Flextronics and the resulting reduction of the estimated useful lives of equipment, leasehold improvements and software at the facility.  We expect an increase in depreciation and amortization expense of $1.0 million during the remainder of 2008.

 

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. Deferred revenue results from the sale of enhanced and extended warranties, which are deferred and recognized as the related services are provided, which generally range from 3-5 years. Enhanced warranties run concurrent with our standard warranties.  Our 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.  Deferred revenue also includes deferred software maintenance revenues for which we are the primary obligor that are recognized over the term of the contract, which is generally one year.

 

Accrued Warranties

 

We record warranty liabilities at the time of sale for the estimated costs that may be incurred under its standard limited warranty. The specific warranty terms and conditions vary depending upon the product sold, but generally include technical support, repair parts, labor over a period ranging from 90 days to five years. Factors that affect the

 

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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 evaluate 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 U.S. federal government. We perform ongoing credit evaluations on a significant number of our customers and collateral from our customers is generally not required.  Seven customers accounted for approximately 14% of trade receivables as of June 30, 2008 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 collectability 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.  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 assuming all other revenue recognition criteria have been met.  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 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.

 

We recorded revenue net of sales taxes.  Such taxes are considered current liabilities and are included in accrued expenses until paid.

 

Shipping Costs

 

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

 

Royalties

 

We have royalty-bearing license agreements allowing us to sell certain hardware and software products and to use

 

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certain patented technology. Royalty costs are accrued and included in cost of revenue when the related revenue is recognized or amortized over the period of benefit when the license terms are not specifically related to units shipped.

 

Research and Development Costs

 

Research and development 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.

 

Through 2007 we have generated losses for both financial reporting and tax purposes.  As a result, for income tax return reporting purposes, we may utilize approximately $36.9 million of net operating loss carryforwards, which begin to expire in 2022 and are available as late as 2027.  We believe these net operating loss carryforwards are subject to an annual limitation on their use of $967 thousand pursuant to Internal Revenue Code Section 382.  However, we have not yet completed our analysis of additional limitations, if any, resulting from the acquisition of the Professional Business and the conversion of our debentures and the exercise of our warrants during 2007.

 

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 the 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 apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. All of our stock options were vested as of December 31, 2005, and we have not issued stock options during the periods presented.

 

Stock Based Compensation – Restricted Stock Units

 

We issue restricted stock units (“RSUs”) as stock based compensation to members of our Board of Directors and employees.  We record non-cash compensation expense over the requisite service period of the RSUs determined by the number of units granted multiplied by the fair market value at the date of grant less an estimate for pre-vesting forfeitures. Compensation expense for RSUs issued is classified on the statement of operations as operating expense. During the six months ended June 30, 2008 and 2007, we recorded $620 thousand and $170 thousand respectively, in stock compensation expense for RSUs.

 

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 six months ended June 30, 2008 and 2007, all potentially dilutive common shares totaling 38,194,463 and 32,311,503, respectively, were excluded from the computation of diluted loss per share because inclusion of such shares would have had an anti-dilutive effect on diluted loss per share.

 

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Reclassifications

 

Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation.  The most significant was the reclassification of depreciation expense of $381 thousand and $762 thousand, respectively, related to production equipment to cost of revenue from depreciation and amortization expense for the three and six months ended June 30, 2007.  The reclassification had no impact on the reported net loss for either period.

 

New Accounting Pronouncements

 

New Accounting Standards

 

In December, 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations. SFAS No.  141R will significantly change the accounting for business combinations. Under SFAS No. 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141R will change the accounting treatment for certain specific items, including:

 

·

Acquisition costs will be generally expensed as incurred;

·

Noncontrolling interests (formerly known as “minority interests” — see SFAS No. 160 discussion below) will be valued at fair value at the acquisition date;

·

Acquired contingent liabilities will be recorded at fair value at the acquisition date and subsequently measured at either the higher of such amount or the amount determined under existing guidance for non-acquired contingencies;

·

In-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date;

·

Restructuring costs associated with a business combination will be generally expensed subsequent to the acquisition date; and

·

Changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense.

 

SFAS No. 141R also includes a substantial number of new disclosure requirements.  The statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009.

 

In December, 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS No. 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, SFAS No. 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS No. 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest.   The statement is effective for us during the first quarter of 2009.  We currently do not have noncontrolling interests.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133. SFAS 161 enhances required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how: (a) an entity uses derivative instruments; (b) derivative instruments and related hedged items are accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities; and (c) derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for us during the first quarter of 2009.  We are currently evaluating the impact of the adoption of the enhanced disclosures requirements of SFAS 161 and currently do not expect the adoption to have a material impact on its consolidated financial statements.

 

In March 2008, the FASB affirmed the consensus of FASB Staff Position (“FSP”) APB 14-a, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement ), which applies to all convertible debt instruments that have a ‘‘net settlement feature’’; which means that such convertible debt instruments, by their terms, may be settled either wholly or partially in cash upon conversion. FSP APB 14-a requires issuers of convertible debt instruments that may be settled wholly or partially in cash upon conversion to separately account for the liability and equity components in a manner reflective of the issuer’s

 

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nonconvertible debt borrowing rate. Previous guidance provided for accounting for this type of convertible debt instrument entirely as debt. FSP APB 14-a is effective for us during the first quarter of 2009. We are currently evaluating the impact the adoption of FSP APB 14-a may have on our consolidated financial statements.

 

In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141R, and other U.S. generally accepted accounting principles. This FSP is effective for us during the first quarter of 2009.  We are currently evaluating the impact the adoption of FSP FAS 142-3-a may have on our consolidated financial statements.

 

Recently Adopted Accounting Standards

 

In September 2006, the FASB issued SFAS No. 157 Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosure requirements about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. Measurement of financial assets and financial liabilities was effective for us beginning in fiscal year 2008.  Two FSPs on this Statement were subsequently issued.  On February 12, 2008, FSP No. 157-2 delayed the effective date of this Statement for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. This FSP is effective for us in fiscal year 2009. On February 14, 2008, FSP No. 157-1 excluded SFAS No. 13, Accounting for Leases, and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS No. 13. However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under SFAS Statement No. 141, Business Combinations or SFAS No. 141(R), Business Combinations, regardless of whether those assets and liabilities are related to leases.  This FSP was effective upon our initial adoption of SFAS No. 157. The adoption of SFAS No. 157 relating to financial assets and financial liabilities did not have a material impact on our financial position or results of operations.  We do not expect the impact of SFAS No. 157 related to nonfinancial assets and nonfinancial liabilities will have a material impact on our financial position or results of operations.  See Note 6 – “Derivative Warrant Liabilities and Convertible Debentures – Fair Value Measurements” for disclosures regarding our fair value measurements.

 

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, which are not currently required to be measured 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 was effective for us beginning in the first quarter of fiscal year 2008.   We adopted SFAS No. 159 as of January 1, 2008 and elected not to measure any additional financial instruments or other items at fair value.

 

NOTE 4.    ACCRUED WARRANTIES

 

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.

 

(In thousands)

 

 

 

 

Six months ended

 

 

 

June 30,

 

 

 

2008

 

2007

 

Accrued warranties at beginning of the period

 

$

41,191

 

$

4,347

 

Cost accrued for new warranties

 

7,714

 

399

 

Service obligation honored

 

(14,598

)

(484

)

Accretion of interest under purchase accounting

 

477

 

39

 

Accrued warranties at end of the period

 

$

34,784

 

$

4,301

 

 

NOTE 5.    DEFERRED REVENUE

 

We offer our customers an option of extended or enhanced warranties.  Deferred revenue results from amounts billed to or received from customers for which the warranty revenue is deferred and recognized as the related

 

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services are provided, which generally range from 3-5 years.  Deferred revenue also includes deferred software maintenance revenues that are recognized over the term of the contract, which is generally one year.  A schedule of our deferred revenue, including changes in deferred revenue from extended and enhanced warranties is as follows:

 

(In thousands)

 

 

 

Six months ended

 

 

 

June 30,

 

 

 

2008

 

2007

 

Deferred revenue for extended and enhanced warranties, beginning of the period

 

$

48,173

 

$

32,408

 

Additions to deferred revenue for new extended and enhanced warranties sold

 

17,234

 

5,625

 

Revenue recognized for extended and enhanced warranties

 

(13,720

)

(4,988

)

Deferred revenue for extended and enhanced warranties, end of the period

 

51,687

 

33,045

 

Deferred software maintenance revenue, end of the period

 

9,094

 

7,460

 

Total deferred revenue

 

$

60,781

 

$

40,505

 

 

NOTE 6.    NOTES PAYABLE AND DEBT

 

(In thousands)

 

 

 

 

June 30, 2008

 

December 31, 2007

 

Wells Fargo Receivables Advance Facility

 

$

52,215

 

$

59,914

 

Payable to Flextronics

 

3,588

 

 

Payable to Wacom Technology Corporation

 

390

 

874

 

Convertible Bridge Loans

 

300

 

300

 

Debt Incurred in Acquisition

 

105

 

279

 

Payable to TPV

 

 

1,176

 

Note Payable to Gateway

 

 

862

 

Payable to Lessor

 

 

844

 

Total Notes Payable and Debt

 

$

56,598

 

$

64,249

 

 

Wells Fargo Receivables Advance Facility

 

On November 16, 2006, MPC Computers entered into an agreement with Wells Fargo Business Credit, Inc. (“Wells Fargo”) for an accounts receivable assignment and advance facility (“Receivables Advance Facility”). Under the facility, as amended in February 2007, MPC Computers may assign to Wells Fargo, and Wells Fargo may purchase, 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.  Wells Fargo will 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”). MPC Computers 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, MPC Computers 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, MPC-Pro and GCI (which was acquired by MPC-Pro in connection with the acquisition of 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. In addition, MPC-Pro, Gateway, GCI and Wells Fargo entered into an Intercreditor Agreement (the “Intercreditor Agreement”). The Intercreditor Agreement provides Gateway with a junior security interest in accounts receivable generated on or after the October 1, 2007 acquisition of the Professional Business, inventory, and all other property of MPC-Pro and GCI as specified in the agreement 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 (the “Gateway Blocked Accounts”).  On May 29, 2008 the Intercreditor Agreement was amended to provide that there will be Gateway Blocked Accounts in up to the following amounts: (i) there will be no Gateway Blocked Accounts through August 31, 2008; and (ii) on or after September 15, 2008, a face amount equal to the obligations owing to Gateway under the Transition Agreement for the applicable week (the “Gateway Weekly Payoff Amounts”) minus $10.0 million. The amendment also provides that, if, after November 15, 2008, there is a

 

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remaining positive balance of the Gateway Weekly Payoff Amounts, Gateway may provide a statement to MPC-Pro indicating the positive balance, and Wells Fargo will hold but not purchase Gateway Blocked Accounts submitted to it by MPC-Pro and GCI in a face amount equal to the remaining positive balance.

 

We pay fees equal to the Wells Fargo Prime Rate (as defined in the Receivables Advance Facility), plus 0.75% per annum (the “Wells Fargo Discount”) multiplied by the total amount of Accounts purchased and not yet paid by our customers, computed daily. The effective rate at June 30, 2008 was 6%. The minimum monthly fee to be paid in aggregate by MPC Corporation affiliates to Wells Fargo is determined by multiplying the Wells Fargo Discount, by $2.5 million.

 

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 terminating November 14, 2009. 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 $3.6 million collateral account for the benefit of Wells Fargo for repayment of any obligations arising under the Receivables Advance Facility.

 

On April 1, 2008, Wells Fargo provided an advance to MPC-Pro in the amount of $3.5 million (the “MPC-Pro Advance”). The MPC-Pro Advance was repaid on May 27, 2008, and was in addition to other amounts provided to us by Wells Fargo under the terms of our Account Purchase Agreements with Wells Fargo.

 

On April 10, 2008, MPC-Pro, GCI, and Gateway delivered to Wells Fargo an instruction letter that modified certain terms of the Intercreditor Agreement. The letter confirmed that a requirement under the Intercreditor Agreement to maintain a controlled collateral account in the amount of $1.5 million eliminated. Additionally, the letter confirmed that Wells Fargo is not required to hold certain Gateway funds in trust as previously required under the Intercreditor Agreement.  The impact of the instruction letter was to release approximately $1.0 million to us that was held in the controlled collateral account.

 

On June 24, 2008, Wells Fargo provided an advance to MPC-Pro in the amount of $3 million (the “MPC-Pro Advance”). The MPC-Pro Advance is to be repaid by September 24, 2008 and is in addition to other amounts provided to us by Wells Fargo under the terms of our Receivables Advance Facility with Wells Fargo. Interest on the MPC-Pro Advance is at prime plus 1.75%. We agreed to pay to Wells Fargo an advance fee in the amount of $25 thousand for the MPC-Pro Advance. As a condition of the MPC–Pro Advance, we will use the service of a strategic consultant chosen by us and approved of by Wells Fargo.

 

On July 11, 2008, MPC Computers and MPC-Pro and Wells Fargo, entered into a Master Purchase Order Assignment Agreement.  See Note 11 “Subsequent Events.”

 

Payable to Flextronics

 

On May 8, 2008, we entered into a Flextronics Inventory Purchase Agreement (the “IPA”) with Flextronics. Under the IPA, Flextronics may purchase certain inventory currently located at our Nashville facility which we expect to then repurchase from Flextronics over the 90 day period following the agreement date for production at our Nashville facility. Any remaining inventory after the 90 day period must be repurchased by us. A monthly interest cost of 1.5% per month is charged by Flextronics on the outstanding inventory not repurchased by us in addition to a monthly management fee.  Amounts outstanding under the IPA to be repurchased by us are accounted for as a financing arrangement and payable to Flextronics.

 

Payable to Wacom Technology Corporation

 

In August 2007, we settled a case with Wacom Technology Corporation (“Wacom”). We agreed to pay Wacom $1.2 million in payments of $100 thousand per month beginning September, 2007 plus interest of 5%.

 

Convertible Bridge Loans

 

Convertible Bridge Loans were issued prior to our IPO. The outstanding amount was due April 2006, including any

 

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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.

 

Debt Incurred in Acquisition

 

Debt incurred in connection with the acquisition of MPC Computers of $370 thousand was due July 25, 2006, including any unpaid interest, which is accrued at 5% per annum.  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 is 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.  During the year ended December 31, 2007, we repaid and settled $91 thousand of the debt and related interest and recognized a gain of $52 thousand as we settled for less than the amounts due.  During the first six months of 2008, we made further payments and settlements with the holders.  As of June 30, 2008, $105 thousand remains outstanding to one holder who is the Chief Financial Officer of MPC Corporation.

 

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”).  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.  The payable to TPV was fully repaid on February 1, 2008.

 

Note Payable to Gateway

 

On December 6, 2007, MPC-Pro entered into an unsecured promissory note payable to Gateway (the “Promissory Note”) in the amount of $1.3 million as part of the consideration for the acquisition of the Professional Business.  The Promissory Note was executed pursuant to the Asset Purchase Agreement which contemplated the parties executing the Promissory Note at a point in the future when the principal amount had been determined. The Promissory Note is dated effective October 1, 2007, which was the closing date of the transaction under the Asset Purchase Agreement. The principal amount of the Promissory Note was calculated pursuant to terms set forth in the Asset Purchase Agreement.  The principal amount was due in three equal bi-monthly installments plus interest at 8% per annum beginning December 1, 2007 and ending on April 1, 2008. The note payable was fully paid on April 1, 2008.

 

Payable to Lessor

 

MPC Computers is a 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.

 

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On July 2, 2007, MPC Computers entered into a Sixth Amendment to the Lease of this manufacturing facility. The Sixth Amendment to the Lease provided that MPC Computers 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%.  The extended Rent Obligation was fully paid on June 1, 2008.

 

NOTE 7.    DERIVATIVE WARRANT LIABILITIES AND CONVERTIBLE DEBENTURES

 

Derivative warrant liabilities and convertible debentures consist of the following:

 

 

 

June 30, 2008

 

 

 

Derivative Warrants

 

Convertible Debentures

 

(In thousands)

 

Fair Value

 

Fair Value

 

Face Value

 

 

 

 

 

 

 

 

 

New Convertible Debentures and Warrants

 

$

1

 

$

50

 

$

 

September 29, 2006 Financing

 

296

 

1,448

 

1,353

 

 

 

$

297

 

$

1,498

 

$

1,353

 

 

 

 

December 31, 2007

 

 

 

Derivative Warrants

 

Convertible Debentures

 

(In thousands)

 

Fair Value

 

Fair Value

 

Face Value

 

 

 

 

 

 

 

 

 

New Convertible Debentures and Warrants

 

$

1

 

$

42

 

$

 

September 29, 2006 Financing

 

633

 

1,548

 

1,353

 

 

 

$

634

 

$

1,590

 

$

1,353

 

 

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 April 24, 2006 Bridge Loan exchanged $5.0 million face value of their convertible debentures plus $226 thousand 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.

 

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.

 

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 required 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 registrable 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 may 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 (“Crestview”) and Toibb Investment LLC (“Toibb”) 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

 

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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.

 

On October 1, 2007, we entered into an Amendment No. 1 to the Convertible Debenture with each of Crestview and Toibb pursuant to which their respective Convertible Debentures were converted into Series A Preferred Stock.

 

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.

 

During the year ended December 31, 2007, we issued 8,798,986 shares of common stock and 626,546 shares of Series A Professional Stock upon conversion of $9.8 million face value of New Convertible Debentures plus accrued interest and penalties, and the exercise of 6,652,227 warrants.  See Note 9-”Series A Preferred Stock.”

 

In determining the fair value of our freestanding derivative financial instruments we assumed an expiration term of 3.19 years, a volatility of 110.98% and interest rate of 3.34%. The estimated fair value of these derivative instruments at June 30, 2008 and December 31, 2007 are as follows:

 

 

 

Fair Value

 

Fair Value

 

 

 

(In thousands)

 

of Debt

 

of Warrants

 

Total

 

 

 

 

 

 

 

 

 

June 30, 2008

 

$

50

 

$

1

 

$

51

 

 

 

 

 

 

 

 

 

December 31, 2007

 

$

42

 

$

1

 

$

43

 

 

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 $4.9 million. 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.

 

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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. Since we have not paid all of 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.

 

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.

 

During the year ended December 31, 2007, we issued 6,314,927 shares of common stock upon conversion of $3.6 million in face value of debentures from the September 29, 2006 Financing plus accrued interest and penalties and exercise of 893,125 warrants.

 

In determining the fair value of our freestanding derivative financial instruments we assumed an expiration term of 3.27 years, a volatility of 110.23% and an interest rate of 3.34%.   In the determination of the fair value of the convertible debentures, we assumed an equivalent volatility of 98.63%, interest rate of 9.86% and yield rate of 30.54%.    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 June 30, 2008 and December 31, 2007 are as follows:

 

 

 

Fair Value

 

Fair Value

 

 

 

(In thousands)

 

of Debt

 

of Warrants

 

Total

 

 

 

 

 

 

 

 

 

June 30, 2008

 

$

1,448

 

$

296

 

$

1,744

 

 

 

 

 

 

 

 

 

December 31, 2007

 

$

1,548

 

$

633

 

$

2,181

 

 

Fair Value Measurements

 

On January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair-value measurements.  SFAS No. 157 does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. Although the adoption of SFAS 157 did not materially impact our financial condition, results of operations or cash flows, we are required to provide additional disclosures within our condensed consolidated financial statements regarding our derivative warrant liabilities and convertible debenture liabilities.

 

SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement and should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS No. 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within levels one and two of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within level three of the hierarchy).

 

·                  Level one inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access.

·                  Level two inputs are inputs other than quoted prices included in level one that are observable for the asset

 

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or liability, either directly or indirectly. Level two inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability, other than quoted prices, such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals.

·                  Level three inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.

 

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a Level 3 fair value measurement may include inputs that are observable, (Levels 1 and 2), and unobservable (Level 3).  Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

The valuation of our derivative warrant liabilities is determined using Level 3 inputs, using a Black-Scholes Merton (BSM) model.  The BSM model considers (i) time value, (ii) risk-free interest rates, (iii) volatility factors, and (iv) current market and contractual prices.  The valuation of our embedded conversion features is determined using Level 3 inputs, using the Flexible Monte-Carlo (FMC) model. The FMC model considers (i) time value, (ii) risk-adjusted interest inputs, (iii) credit-risk inputs, (iv) volatility factors, and (v) current market and contractual prices for the underlying amounts.

 

As of June 30, 2008, we had no other financial instruments requiring fair value measurement.

 

NOTE 8.    SERIES B PREFERRED STOCK

 

In connection with the acquisition of the Professional Business, 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, and 249,171 shares of MPC Corporation Series B Preferred Stock convertible into 4,983,416 shares of our common stock. All MPC Corporation Series B Preferred Stock issued to Gateway converts to MPC Corporation common stock upon (i) shareholder approval by a majority of the MPC Corporation common shareholders and (ii) at such time as the shares may be converted without causing Gateway’s ownership of our common stock to exceed 19.9% (the “Series B Automatic Conversion Event”).  The MPC Corporation Series B Preferred Stock is participating, non-voting, and has a liquidation preference equal to $.00000001 per share.

 

In accounting and valuing for the Series B Preferred Stock, we considered the guidance of EITF D-98 Classification and Measurement of Redeemable Securities. In accordance with EITF D-98, the Series B Preferred Stock was recorded and carried at its fair value at initial date of issue.  The MPC Corporation Common shares and MPC Corporation Series B Preferred Stock issued to Gateway were valued at $7.1 million and $6.3 million, respectively, based on volume-weighted average of MPC Corporation’s closing common stock price of $1.2657 per share over a six business day period, from August 30, 2007 through September 7, 2007. Such period included two business days prior to the date of the Asset Purchase Agreement on September 4, 2007 and two business days after our September 5, 2007 announcement of the transaction. The MPC Corporation Series B Preferred Stock was valued based on the common-equivalent number of shares that would be issued following the Series B Automatic Conversion Event.

 

Under EITF-D-98 the Series B Preferred Stock was classified outside of permanent equity under EITF-D-98 due to the possible cash redemption of the stock in the event the Series B Automatic Conversion Event was not approved by our shareholders.  On July 25, 2008 our shareholders approved the Series B Automatic Conversion Event and therefore the Series B Preferred Stock has subsequently been reclassified to permanent equity.

 

NOTE 9.    SERIES A PREFERRED STOCK

 

As a condition to close under the Asset Purchase Agreement for the acquisition of the Professional Business, 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 our 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 (the “Letter Agreement”) among the parties to the Asset Purchase Agreement.  In satisfaction of this condition, on October 1, 2007 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.

 

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In connection with the obligation under the Letter Agreement, two MPC Corporation investors, Crestview and 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 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 Corporation 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 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.

 

In conjunction with the exercise of the $1.10 warrants and our obligations under the Letter Agreement, on October 1, 2007, 7,545,352 warrants were exercised, $11.0 million in face value of convertible debentures were converted plus accrued interest and penalties thereon, and we issued 12,912,166 shares of MPC Corporation common stock and 626,546 shares of MPC Corporation Series A Preferred Stock. The MPC Corporation Series A Preferred Stock is convertible into 12,530,925 shares of MPC Corporation common stock.  The MPC Corporation Series A Preferred Stock is participating, non-voting, and has a liquidation preference equal to $.00000001 per share. Each share of MPC Corporation Series A Preferred Stock will automatically convert to MPC Corporation common stock at such time the conversion would not cause the beneficial ownership to exceed 9.99% beneficial ownership.

 

NOTE 10.    RELATED PARTY TRANSACTIONS

 

In connection with the acquisition of the Professional Business, on October 1, 2007 MPC-Pro entered into a Transition Services Agreement (the “TSA”) with Gateway.  During the six months ended June 30, 2008, MPC-Pro paid Gateway $1.3 million for accounting, human resource, manufacturing, procurement, marketing, information technology, and other specified services under the terms of the TSA.   Under the TSA, Gateway also undertook certain buy/sell activities related to components on behalf of MPC, which includes procuring components from component suppliers, selling of such components to original design manufacturers (“ODMs”) for manufacture of finished goods that are ordered from ODMs by Gateway, and the subsequent selling of such finished goods to MPC-Pro (the “Buy/Sell Activity”).  In addition to the Buy/Sell activity under the TSA, MPC-Pro acquired certain additional component inventory from Gateway.  During the six months ended June 30, 2008, payments to Gateway under the Buy/Sell Activity and purchases of such component inventory totaled $22.0 million.  At June 30, 2008 we had accounts payable to Gateway totaling $14.1 million, related to the Buy/Sell activity and purchases of inventory and related services.  Under Amendment No. 5 of the TSA, we are obligated to make scheduled payments to Gateway, with the balance fully repaid in November, 2008.  At June 30, 2008 we were delinquent on $ 0.5 million of the scheduled payments to Gateway.  We also did not make a $0.5 million payment due on July 15, 2008.  A scheduled payment of $3.0 million is due on August 15, 2008, which we do not expect to pay.  We are expecting to renegotiate the TSA in August 2008, to further defer payments of the payable to Gateway.

 

In connection with the acquisition of the Professional Business, MPC-Pro issued to Gateway a promissory note in the amount of $1.3 million (the “Promissory Note”).  During the six months ended June 30, 2008, MPC-Pro paid to Gateway $17 thousand of interest and $862 thousand of principal in full payment of the Promissory Note.  See Note 6 “Notes Payable and Debt-Note Payable to Gateway.”

 

During the six months ended June 30, 2008, MPC-Pro provided certain manufacturing services to Gateway, and charged Gateway $1.8 million for such services.  At June 30, 2008, the receivable from Gateway for such services was $0.5 million.

 

MPC-Pro leases from Gateway 45,552 square feet of office space in North Sioux City, South Dakota.  During the six months ended June 30, 2008, MPC-Pro paid Gateway lease payments totaling $283 thousand.

 

We are indebted to Curtis Akey, our chief financial officer, under the terms of a promissory note dated April 13, 2007 for services provided prior to his employment with us.  As of June 30, 2008, the outstanding balance under the

 

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promissory note was $105 thousand plus $18 thousand of accrued interest which amount is currently due and payable.  See Note 5 “Notes Payable and Debt-Debt Incurred in Acquisition.”

 

NOTE 11.    COMMITMENTS AND CONTINGENCIES

 

Letters of Credit

 

We had outstanding letters of credit totaling $5.5 million and $6.3 million on June 30, 2008 and December 31, 2007, respectively.  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.

 

Other Matters

 

On December 17, 2007, the General Services Administration (GSA) served MPC Computers with a subpoena to provide records regarding sales under our GSA Multiple Award Schedule contract.  The subpoena relates to an industry-wide investigation into alleged non-compliance with the Trade Agreements Act.  We are currently investigating the matter and responding to the subpoena.  The matter is in the preliminary stages and we cannot predict an outcome at this time. Our non-compliance could lead to imposition of penalties and termination of the contract.  The termination of the contract could lead to loss of substantial revenues from the federal government.

 

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 12.    SUBSEQUENT EVENTS

 

Master Purchase Order Assignment Agreement

 

On July 11, 2008, MPC Computers and MPC-Pro and Wells Fargo, entered into a Master Purchase Order Assignment Agreement (the “Assignment Agreement”). Under the Assignment Agreement, MPC Computers and MPC-Pro will assign customer purchase orders to Wells Fargo and request Wells Fargo to accept such purchase orders and purchase the required materials to fulfill the purchase orders. On such assigned purchase orders, Wells Fargo will retain MPC Computers and MPC-Pro to manufacture, process, and ship ordered goods and will pay us for our services upon payment by the customer to Wells Fargo for the goods. Accepted purchase orders will be reassigned to us at such time Wells Fargo has received payment in full on account of a purchase order invoice. Accepted purchase orders become delinquent if a purchase order price is not paid to Wells Fargo by the earliest of (i) the due date for payment of the purchase order invoice, (ii) forty-five 45 days following the Funding Date by Wells Fargo, as defined, (iii) the date the purchase order is cancelled, or (iv) the date of occurrence of an event of default as defined. Wells Fargo has the right to require us to promptly purchase any Delinquent Purchase Order as defined, (and inventory of products in the case of a Canceled Purchase Order, as defined) for an amount equal to the full amount outstanding under the purchase order invoice (or the purchase order price in the case of a Canceled Purchase Order). The Assignment Agreement provides for limitations of funding of individual accepted purchase orders by Wells Fargo and the maximum aggregate outstanding funding shall not exceed $5 million.

 

Wells Fargo is to be paid a transaction initiation and set-up fee of 1.0% of the face amount of letters of credit and funds advanced by Wells Fargo with respect to each accepted purchase order, plus a daily maintenance fee in a sum equal to 0.067% of the aggregate of the face amount of all letters of credit and funds advanced by Wells Fargo which remain outstanding for more than fifteen (15) days. In addition, a Product advance fee will be paid to Wells Fargo equal to the J.P. Morgan prime rate plus 2%, divided by 360, multiplied by the aggregate amounts outstanding on all letters of credit and all funds advanced by Wells Fargo in connection the accepted purchase orders. In the event of a Delinquent Purchase Order, a late payment fee is to be paid in a sum equal to 0.067% of the outstanding

 

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portion of the purchase order price multiplied by the number of days from the date an accepted purchase order becomes a delinquent purchase order to and including the date Wells Fargo has received full payment of amounts due. The Assignment Agreement provides for a commitment fee of $100 thousand to be paid to Wells Fargo on the earlier of twelve months following July 11, 2008 or the date of termination of the Assignment Agreement and be paid for each one or more twelve month renewal terms if the agreement is renewed. The commitment fee will be waived in whole if the Product Volume for a term equals or exceeds the Minimum Volume of $10 million, or in part if the Product Volume for a term is less than the Minimum Volume based on the aggregate volume of funds advanced by Wells Fargo in connection with accepted purchase orders as a percentage of the Minimum Volume.

 

On July 11, 2008, in connection with the Assignment Agreement, MPC Computers, MPC-Pro and Wells Fargo entered into a Security Agreement and Financing Statement (the “Security Agreement”). Under the Security Agreement, MPC Computers and MPC-Pro grants Wells Fargo a first priority security interest in substantially all merchandise, inventory, goods and supplies in connection with accepted purchase orders under the Assignment Agreement for all payments and other obligations due Wells Fargo there under (the “Primary Collateral”). In addition, the Security Agreement provides Wells Fargo a subordinated security interest in substantially all other assets of MPC Computers and MPC-Pro pledged to a Senior Lender, as defined. Under an Intercreditor Agreement with Gateway, MPC-Pro has granted to Gateway a security interest in all or part of its assets, which is subordinate to a security interest granted by MPC-Pro to Wells Fargo under certain Account Purchase Agreements. On July 11, 2008, in connection with the Assignment Agreement, Gateway and MPC-Pro entered into a Transaction Subordination Agreement with Wells Fargo. Under the Transaction Subordination Agreement, Gateway agrees to further subordinate its interest in the assets of MPC-Pro to Wells Fargo.

 

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

 

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 our Annual Report in Form 10-K for the year ended December 31, 2007.

 

OVERVIEW AND EXECUTIVE SUMMARY

 

We were formed as HyperSpace Communications, Inc. in 2001 as a Colorado-based company, and completed an initial public offering in October 2004. In July 2005, we acquired MPC Computers, 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, we purchased, through our wholly-owned subsidiary MPC-Pro, from Gateway and Gateway Technologies, its Professional Division, the portion of the Consumer Direct Division that markets business-related products to target businesses with less than 100 employees, and the portion of the Customer Care & Support department that provides technical services to customers of the Professional and Consumer Direct Divisions (collectively, the “Professional Business”).  This acquisition significantly increased the scale of our business as Gateway’s Professional Business had reported revenue of $895 million in 2006 as compared to our revenue of $285 million in 2006.  We believe that the increased scale will enable us to better compete with our larger competitors including Dell, HP and Lenovo.

 

We acquired the entire catalog of products and services from the Professional Business as well as a portion of Gateway’s Consumer Direct business.  We now make the complete product line available to both MPC Computers and former Gateway customers.  We also assumed operation of Gateway’s final assembly facility in Nashville, TN. With the completion of the acquisition, we have operations in Idaho, South Dakota and Tennessee. The Professional Business is operated under MPC-Pro.

 

While our business has expanded significantly with the acquisition of the Professional Business, on a combined basis both MPC Computers’ revenues and the Professional Business’ revenues have declined in each of the years from 2005 to 2007.  We expect this declining trend in revenue to continue through 2008, driven largely by lower unit volumes and declining prices.

 

Current Business

 

Our primary business is providing PC-based products and services to mid-sized businesses, government agencies and education organizations.  We use a build-to-order manufacturing process and a direct sales model that we believe is an efficient means to provide customized computing solutions to our customers. We manufacture and market ClientPro® desktop PCs, TransPort® notebook PCs, NetFRAME® servers and DataFRAME™ storage products.  In addition, we manufacture and market the “E-series” of desktops, notebooks, servers and storage

 

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products under an eighteen month limited license agreement with Gateway. We also provide hardware-related support services such as installation, technical support, parts replacement, and recycling. We believe that the quality of our service and support differentiates us from our competitors. In addition to PCs, servers, and storage products, we also fulfill our customers’ requirements for third party products produced by other vendors, including peripherals and software.

 

Recent Agreements with Flextronics

 

On April 14, 2008, we entered into a Manufacturing Services Agreement (the “MSA”) with Flextronics Computing Mauritius Limited (“Flextronics”).  Under the MSA, Flextronics will perform procurement, supply chain management, manufacturing, assembly and testing for MPC Corporation at the Flextronics manufacturing facility in Juarez, Mexico.  Transition of operations from our Nashville, Tennessee manufacturing facilities to Juarez is expected to be completed by December 31, 2008 with transition of other manufacturing to occur on such schedules as may be determined by MPC Corporation and Flextronics.  The MSA provides for Flextronics to achieve certain cost reduction targets, during the first twelve months following August 31, 2008 that are expected to provide cost savings to MPC Corporation.  If the cost reduction targets are not achieved, our sole remedy is to terminate the MSA if Flextronics fails to cure the default.

 

In addition, on a one-time basis, Flextronics will purchase certain materials and inventory at the Nashville facility.  If Flextronics does not use the materials and inventory within a 12 month period, we must buy back the materials. Additionally, a division of Flextronics also agreed to acquire certain of our manufacturing equipment for a cash payment of $1 million subject to our possible retention of the manufacture of a computing platform.

 

We anticipate the outsourcing of our manufacturing operations to Flextronics could result in potential manufacturing and overhead cost savings.  Flextronics has a much larger scale of operations than ours that may provide a greater ability to procure products and components at lower prices and with lower labor costs.  After the first twelve months of the MSA, Flextronics will continue to seek to reduce cost of manufacturing products by methods such as elimination of materials, material price reductions, redefinition of specifications and re-design of assembly or test methods.  We will continue to evaluate additional means of reducing costs and improving productivity in connection with our operations and under the MSA with Flextronics.  There is no guaranty, however, that any such cost savings will be achieved.  The transfer of operations to Flextronics will allow MPC to focus on its, sales, marketing, product development and service and support functions, with reduced remaining manufacturing operations.

 

We are responsible for applicable Nashville facility closure and related costs.  We currently estimate a reduction in workforce of approximately 145 personnel from the Nashville facility.

 

On May 8, 2008, MPC-Pro entered into an Inventory Purchase Agreement (the “IPA”) with Flextronics.  Under the IPA, Flextronics purchased approximately $12.0 million of certain inventory currently located at our Nashville facility which we expect MPC-Pro will then repurchase from Flextronics over the 90 day period following the agreement date for production at our Nashville facility.  Any remaining inventory after the 90 day period must be repurchased by MPC-Pro.  Flextronics will charge a monthly interest cost of 1.5% per month on the outstanding inventory not repurchased by MPC-Pro in addition to a monthly management fee.

 

Professional Business and Flextronics Transition Issues

 

During the transition of the Professional Business IT and manufacturing systems from Gateway to MPC Computers’ existing systems in February, 2008, we experienced material delays in manufacturing and customer deliveries, which resulted in much lower than expected shipment volumes and revenues in the first quarter of 2008 as compared to the fourth quarter of 2007.  We also experienced delays in deliveries of parts needed for service and support-related matters.  Our manufacturing delays limited and stopped production at times over approximately a three week period at our Nashville manufacturing facility.  The delays were caused by a number of issues, including but not limited to, inaccurate bills of materials for our manufacturing processes, inadequate inventory procurement, routing problems which resulted in parts shortages, and order entry errors by our newest sales professionals from the Professional Business that caused some orders to be delayed in getting to our manufacturing floor. As part of the transition, we moved the manufacture of portable personal computers that had historically been manufactured in China to our Nashville facility, causing the transition-related issues we encountered to have a more pronounced effect on our operations.

 

Our delays in manufacturing and customer deliveries, combined with service and support issues we have encountered, have caused our inventory and accounts payable to grow materially during the transition and throughout the first six months of 2008.  Prior to the commencement of the transition, we did not expect a

 

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significant slowing of our manufacturing process and shipments, and as a result, we procured an increased amount of raw material inventory to support our anticipated increased production than the amount we actually needed to fulfill actual customer orders.  As a result, our raw materials inventory increased from $46.6 million as of December 31, 2007 to $72.8 million as of June 30, 2008. The issues which slowed and stopped production in our Nashville manufacturing facility also impacted our procurement of peripheral product, such as monitors, speakers, and key boards, from third party vendors.  Inaccuracies in our bills of materials, parts shortages and order entry errors resulted at times in systems being built in our Nashville facility for which we could not invoice our customers because certain peripheral products from third party vendors had not been properly procured and shipped to our customers.  As a result, our finished goods inventory increased from $15.4 million as of December 31, 2007 to $24.2 million as of June 30, 2008.  In addition, during the first quarter of 2008, a change in policy by certain of our vendors caused us to procure and carry additional inventory stock that we had not needed to carry in the prior quarter. Previously, these vendors had stocked and managed inventory near our Nashville manufacturing plant, allowing us to procure that inventory as needed to manufacture our products. These vendors eliminated their inventory stocks near our plant during the first quarter of 2008.  Previously, they had been willing to provide inventory to Gateway in this manner, but were unwilling to continue providing inventory under this policy with us.  Also, during the transition we experienced system issues and part delivery delays in our customer service and support area, causing us to procure additional parts to support customer relationships, and resulting in some replacement parts not reaching our customers in a timely manner.

 

The operational issues we encountered in the first quarter of 2008 resulted in further extensions of payments to our suppliers during the second quarter of 2008. Consequently, a number of suppliers, including Intel, began reducing our credit line or restricting shipments of component inventory to us, causing additional delays in our manufacturing process and in shipments of finished goods to our customers.  During the quarter we funded payments to certain vendors through sales a portion of our component inventory to Flextronics, which helped reduce our vendor payables and release component inventory shipments to us.  However, our sales during the second quarter were nearly the same as in the first quarter, resulting in continued losses during the quarter and in the growth of our working capital deficit.

 

In connection with the outsourcing of the Nashville manufacturing operations to Flextronics under the MSA, we anticipated that the majority of the Professional Business product lines would be transitioned to Flextronics by August 2008, with the transition of all lines to be completed by December 2008. To date, the ramp up of the manufacturing operations by Flextronics has proceeded slower than planned and there has been a very limited amount of finished products produced for us by Flextronics.  In addition, we have shut down our Nashville operations and a substantial portion of our inventory has either been moved to, or is in transit to, the Flextronics Juarez facility.  We have not yet reached agreement with Flextronics on the amount of inventory Flextronics will ultimately purchase from us under the MSA, the timing of receipt of funds from such sales, and so far have received $6.9 million from the sale of inventory. If Flextronics is not able to achieve acceptable production levels, we would have difficulties in returning manufacturing to our facilities or finding alternatives.

 

These transition issues have materially impacted our liquidity, and caused a material deterioration in our working capital from December 31, 2007 through June 30, 2008 and into the third quarter of 2008.  In addition, the delay in reaching an agreement with Flextronics on an acceptable amount of sales of inventory and delay in the ramp up production at the Juarez facility has further adversely impacted our cash flow and liquidity in July and August of 2008.  The decline in the combined revenues of MPC Computers and the Professional Business and our liquidity issues have made it difficult to cover our fixed costs and warranty obligations.  Additionally, because of the delays in production, we have experienced cancellations of some of our orders in backlog and a decline in sales to date during the third quarter.  We continue to extend payment to a number of our vendors well beyond normal payment terms and the amount of the extended payments increased during the second quarter and into the third quarter of 2008.  Certain of our vendors have lowered their existing credit lines to us, restricted component product shipments to us, or have requested letters of credit to secure credit lines.  Working with lower credit lines, continuing to provide letters of credit or other credit enhancement to vendors constrains our liquidity as we are required to use more of our cash, cash collateralize letters of credit or otherwise incur costs to provide credit enhancement and there can be no assurance that we will be successful in obtaining sufficient vendor credit in the future.  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, and could cause us to experience credit holds, require that we pre-pay for products, and/or cause suppliers to refuse to deliver components or terminate supply arrangements, any of which could have a material adverse effect on our financial condition and results of operations.

 

As a result of the issues we encountered during the transition and in the second quarter of 2008, we have lost some Professional Business customer relationships we had hoped to retain, and it is probable that we will lose additional Professional Business customers in the near future.  Our inability to retain customers of the Professional Business

 

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will likely result in lower than anticipated revenues for the combined company during 2008. The Professional Business customers may choose to buy products from our competitors rather than us if they perceive that our competitors provide better delivery times, higher quality products, better service, have greater financial strength or other determining factors.

 

Our liquidity is highly dependent upon our sales and the advance of cash to us by Wells Fargo on the resulting accounts receivable from those sales. As described above, the delays in our manufacturing operations during the transition significantly reduced our shipments and sales to our customers during the first and second quarters of 2008.   As a result, the advance of cash from our Wells Fargo financing facility significantly declined during the transition and during the second quarter, requiring us to fund a significant portion of our operations from our operating cash flow and limited existing cash reserves. Delays in our manufacturing operations and service and support fulfillment have caused us to prepay for production and service parts, or pay to have production and service parts expedited to our plants and depots to alleviate these shortages.  We have also delayed payments to certain vendors, which has impacted, and may continue to impact, our ability to obtain or maintain vendor credit on terms beneficial to us.  To the extent we are unable to purchase production and serice parts and components on a timely basis in the future, we may lose orders in backlog and related customers, which could have a further adverse and materially negative effect on our sales and liquidity.

 

We may need to raise a significant amount of additional funds to satisfy vendor payment obligations and fund our business if we do not generate sufficient cash flows from operations and losses continue. There can be no assurance that we will be able to secure additional sources of financing on terms acceptable to us or at all. 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, or could result in bankruptcy.

 

AMEX Notification

 

On June 27, 2008, the American Stock Exchange (“AMEX”) notified us that, although we remain out of compliance with certain of continued listing standards, AMEX has accepted our plan for regaining compliance. AMEX has granted us an extension until November 9, 2009, to regain compliance with its continued listing standards.

 

Previously, on May 8, 2008, the AMEX notified us that we failed to satisfy a continued listing rule. Specifically, the notice from AMEX stated that we are not in compliance with Section 1003(a) (i) of the AMEX Company Guide in that we have stockholder’s equity of less than $2 million and have sustained losses from continuing operations or net losses in two of our three most recent fiscal years. We were afforded the opportunity to submit a plan of compliance. We submitted the plan on June 9, 2008.

 

We will be subject to periodic review by the AMEX staff during the extension period. Failure to make progress consistent with the plan or regain compliance with the continued listing standards by the end of the extension period could result in our being delisted from the AMEX. There is no assurance that we will make progress consistent with the Plan accepted by AMEX, or that we will be able to regain compliance and retain its listing.

 

Strategic Plans and Other 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 that is less reliant on the federal government business.  The acquisition has also enhanced our product line offering, including providing us with a more competitive line of notebook PCs and convertible tablet PCs.  To successfully combine our existing operations with the newly acquired Professional Business, we have set forth the following key initiatives:

 

·

Transitioning our Nashville manufacturing operations to the Flextronics facility in Juarez, Mexico. The transition to Flextronics is intended to improve working capital and cash flow by lowering manufacturing, overhead, and component costs, and reducing component inventory;

 

 

·

Successfully integrate the new Professional Business with our existing operations, including:

 

·

Transitioning from Gateway branded products to MPC branded products;

 

 

·

Consolidating our product lines and continuing ongoing research and development activities;

 

 

·

Completing the integration of our customer care and support functions;

 

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·

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

 

·

Satisfy and retain Professional Business customers;

 

 

·

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;

 

 

·

Utilize the Gateway brand name until our license to use the name expires in March 2009, while enhancing the MPC Computers brand name in our various markets; and

 

 

·

Institute lower cost operating methodologies and practices in our overall operations.

 

In addition to integrating and maximizing the return from our acquisition of the Professional Business, we continue to focus on the following:

 

·

Gross margin improvement initiatives, including the reduction of product returns, freight costs, manufacturing costs, and costs associated with customer evaluation units;

 

 

·

Increasing the liquidity in our business and improving our financial position;

 

 

·

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;

 

 

·

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

 

 

·

Working with our vendors to maintain current credit terms and obtain further credit extensions or larger lines of credit.

 

We cannot give assurance that these initiatives will achieve the intended results.  Our failure to achieve these initiatives and others could have a material adverse effect on our business and financial condition.

 

MPC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In millions)

 

 

 

Three Months ended

 

 

 

Six Months ended

 

 

 

 

 

June 30,

 

%

 

June 30,

 

%

 

 

 

2008

 

2007 (1)

 

 Change

 

2008

 

2007 (1)

 

 Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

125.5

 

$

53.6

 

134.0

%

$

249.2

 

$

110.4

 

125.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

108.9

 

47.0

 

131.9

%

217.6

 

97.6

 

123.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

16.6

 

6.6

 

149.5

%

31.6

 

12.8

 

146.0

%

Gross margin %

 

13.2

%

12.4

%

 

 

12.7

%

11.6

%

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development expense

 

1.3

 

0.5

 

144.3

%

2.4

 

1.1

 

118.2

%

Selling, general and administrative expense

 

22.1

 

8.8

 

150.3

%

46.2

 

18.6

 

147.7

%

Depreciation and amortization

 

4.3

 

0.8

 

458.8

%

7.3

 

1.5

 

371.0

%

Total operating expenses

 

27.7

 

10.1

 

173.5

%

55.9

 

21.2

 

163.7

%

Operating expenses as a % of revenue

 

22.1

%

18.9

%

 

 

22.4

%

19.2

%

 

 

Operating loss

 

(11.1

)

(3.5

)

219.3

%

(24.3

)

(8.4

)

189.3

%

Operating loss as a % of revenue

 

-8.9

%

-6.5

%

 

 

-9.7

%

-7.6

%

 

 

Other (income) expense

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

1.5

 

1.4

 

 

 

2.6

 

3.0

 

 

 

Change in estimated fair value of derivative financial instruments

 

 

20.6

 

 

 

(0.4

)

19.3

 

 

 

Gain on vendor settlements

 

 

(0.2

)

 

 

 

(0.2

)

 

 

Total other (income) expense, net

 

1.5

 

21.8

 

 

 

2.2

 

22.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(12.6

)

$

(25.3

)

 

 

$

(26.5

)

$

(30.5

)

 

 

 

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(1)

 

The results of the Professional Business have been consolidated effective October 1, 2007, the date the acquisition by MPC Corporation became effective, and therefore the results of the Professional Business are not included for periods prior to October 1, 2007.

 

OPERATING RESULTS

 

The results of the Professional Business have been consolidated effective October 1, 2007, the date the acquisition by MPC Corporation became effective, and therefore the results of the Professional Business are not included for periods prior to October 1, 2007.

 

Revenue

 

Revenue for the three and six months ended June 30, 2008 was $125.5 million, and $ 249.2 million, respectively, an increase of $71.9 million and $138.8 million or 134.0% and 125.8%, respectively compared to the same periods in 2007.  The increase was due to additional revenue of $83.3 million and $161.0 million for the three and six months ended June 30, 2008, respectively, from the results of operations of the Professional Business which was acquired October 1, 2007.  The increase in revenue for 2008 was partially offset by a decline in revenue by MPC Computers of $11.4 million and $22.2 million for the three and six months ended June 30, 2008, respectively, due in part to lower unit sales and declining sales prices because of competitive pressures.  In addition, our revenue for the first quarter was impacted by transition issues of the Professional Business IT and manufacturing systems from Gateway to MPC Computers’ existing systems during February 2008. The transition issues limited and stopped production at times over a three-week period at our Nashville manufacturing facility. The delays were caused by a number of issues, including but not limited to, inaccurate bills of materials for our manufacturing processes, inadequate inventory procurement, routing problems that resulted in parts shortages, and order entry errors that caused some orders to be delayed in getting to our manufacturing floor. Inaccuracies in our bills of materials, parts shortages and order entry errors resulted at times in systems being built in our Nashville facility which we then could not invoice because core peripheral product from third party vendors had not been properly procured and shipped to our customers.  During the first and second quarters of 2008, transition issues caused credit related issues with suppliers and extension of lead times for shipments to customers.  As a result, we were unable to capitalize on the buying season of our education market to the extent we had hoped, and revenues in the quarter remained relatively flat to the first quarter of 2008.

 

Historically, revenue for MPC Computers and the Professional Business has been the lowest during the first quarter increases during the second and third quarters of the year due to the buying seasons of the education, federal, state, and local governments in those quarters, and declines in the fourth quarter.  However, the Professional Business transition issues have materially impacted our revenue during the first and second quarters of 2008 and it is probable that the delays we are presently experiencing with the transition of our Nashville operations to Flextronics will impact our revenue during the third quarter.  Our revenue backlog at June 30, 2008 and December 31, 2007 was $104.5 million and $47.7 million, respectively.

 

Revenue from MPC Computers has declined from 2005 to 2007 and in the first and second quarters of 2008.  Revenue from the Professional Business has also been declining during the same periods.  For the six months ended June 30, 2007, Gateway reported revenue of $328.4 million for the Professional Division.  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.  We believe that 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.  Based on current trends, revenue for the combined business will be lower in 2008 than 2007 on a pro forma basis.

 

Gross Margin

 

Our gross margin as a percent of revenue for the three and six months ended June 30, 2008 was 13.2% and 12.7%, respectively, as compared to 12.4% and 11.6% for the same periods in 2007. The increase in gross margin was primarily due to an increase in revenue and gross margin from the Professional Business wherein the greater volume reduced the impact of our fixed costs of manufacturing. Our margins were negatively impacted from the transition issues of the Professional Business, as we provided a higher than expected level of discounts to retain some of our customers, along with increased procurement expenses for expedited overseas raw materials shipments and interruptions to our supply chain.

 

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Research and Development Expense

 

Research, development and engineering expense for the three and six months ended June 30, 2008 totaled $1.3 million and $2.4 million, respectively, an increase of $0.8 million and $1.3 million, respectively, from the same periods in 2007.  This increase is due primarily to an increase in the research and development activities as a result of the acquisition of the Professional Business.

 

Selling, General and Administrative Expense (SG&A)

 

For the three and six months ended June 30, 2008, SG&A expense was $22.1 million and $46.2 million, respectively, an increase of $13.3 million and $27.6 million or 150.3% and 147.7%, respectively from the same periods in 2007.  The increase was due to additional SG&A expense as a result of the acquisition and integration of the Professional Business.

 

Depreciation and Amortization

 

Depreciation and amortization consists of depreciation of property and equipment and the non-cash amortization of acquired intangibles from our acquisition of MPC Computers in July 2005 and the Professional Business in October 2007.  For the three and six months ended June 30, 2008, depreciation and amortization expense was $4.3 million and $7.3 million, respectively, a $3.5 million and $5.8 million increase from the comparable periods in 2007.  The increase is due primarily to the amortization of intangibles and depreciation of property and equipment acquired in connection with the acquisition of the Professional Business. During the three and six months ended June 30, 2008, depreciation and amortization expense increased $1.3 million due to the outsourcing of the manufacturing of our Nashville facility to Flextronics and the resulting reduction of the estimated useful lives of equipment, leasehold improvements and software at the facility.  We anticipate an increase in depreciation and amortization expense of $1.0 million during the remainder of 2008.

 

Interest expense, net

 

Interest expense for the three and six months ended June 30, 2008 was $1.5 million and $2.6 million, respectively, an increase of $0.1 million and a decline of $0.4 million, respectively, from the comparable periods in 2007.  The decline for the six months ended June 30, 2008, was principally due to a reduction in the effective interest rate on outstanding advances under our Wells Fargo Receivables Advance Facility.

 

Change in Estimated Fair Value of Derivative Financial Instruments

 

Our 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 months ended June 30, 2008, we had $15 thousand of non-cash expense, and during the six months ended June 30, 2008 we recognized non-cash income of $0.4 million, primarily related to an decrease in the fair value of these derivative financial instruments as a result of an decrease in the market price of our stock during the first and second quarters of 2008.  In addition, during the year ended December 31, 2007 approximately 91% and 83%, respectively of outstanding debentures and warrants were converted or exercised which significantly reduced the impact of the changes of the remaining outstanding derivatives upon our results of operations in 2008.

 

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.

 

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 2022 to 2027. 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.

 

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OFF BALANCE SHEET ARRANGEMENTS

 

We have no off 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

 

The following is a discussion of the significant new accounting standards that have been issued that may have an impact to our consolidated financial statements or disclosures upon adoption.  To the extent possible, we have evaluated and have formed a conclusion regarding the potential impact of each of these standards.  In addition, we adopted two accounting standards during the first quarter of 2008.  The impact of the adoption of each of these standards is discussed below.

 

New Accounting Standards

 

In December, 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations. SFAS No.  141R will significantly change the accounting for business combinations. Under SFAS No. 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141R will change the accounting treatment for certain specific items, including:

 

·

 

Acquisition costs will be generally expensed as incurred;

·

 

Noncontrolling interests (formerly known as “minority interests” — see SFAS No. 160 discussion below) will be valued at fair value at the acquisition date;

·

 

Acquired contingent liabilities will be recorded at fair value at the acquisition date and subsequently measured at either the higher of such amount or the amount determined under existing guidance for non-acquired contingencies;

·

 

In-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date;

·

 

Restructuring costs associated with a business combination will be generally expensed subsequent to the acquisition date; and

·

 

Changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense.

 

SFAS No. 141R also includes a substantial number of new disclosure requirements.  The statement applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009.

 

In December, 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS No. 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, SFAS No. 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS No. 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest.   The statement is effective for us during the first quarter of 2009.  We currently do not have noncontrolling interests.

 

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In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133. SFAS 161 enhances required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how: (a) an entity uses derivative instruments; (b) derivative instruments and related hedged items are accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities; and (c) derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for us during the first quarter of 2009.  We are currently evaluating the impact of the adoption of the enhanced disclosures requirements of SFAS 161 and currently do not expect the adoption to have a material impact on its consolidated financial statements.

 

In March 2008, the FASB affirmed the consensus of FASB Staff Position (“FSP”) APB 14-a, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), which applies to all convertible debt instruments that have a ‘‘net settlement feature,’’ which means that such convertible debt instruments, by their terms, may be settled either wholly or partially in cash upon conversion. FSP APB 14-a requires issuers of convertible debt instruments that may be settled wholly or partially in cash upon conversion to separately account for the liability and equity components in a manner reflective of the issuer’s nonconvertible debt borrowing rate. Previous guidance provided for accounting for this type of convertible debt instrument entirely as debt. FSP APB 14-a is effective for us during the first quarter of 2009. We are currently evaluating the impact the adoption of FSP APB 14-a may have on our consolidated financial statements.

 

In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141R, and other U.S. generally accepted accounting principles. This FSP is effective for us during the first quarter of 2009.  We are currently evaluating the impact the adoption of FSP FAS 142-3 may have on our consolidated financial statements.

 

Recently Adopted Accounting Standards

 

In September 2006, the FASB issued SFAS No. 157 Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosure requirements about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. Measurement of financial assets and financial liabilities was effective for us beginning in fiscal year 2008.  Two FSPs on this Statement were subsequently issued.  On February 12, 2008, FSP No. 157-2 delayed the effective date of this Statement for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. This FSP is effective for us in fiscal year 2009. On February 14, 2008, FSP No. 157-1 excluded SFAS No. 13, Accounting for Leases, and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS No. 13. However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under SFAS Statement No. 141, Business Combinations or SFAS No. 141(R), Business Combinations, regardless of whether those assets and liabilities are related to leases.  This FSP was effective upon our initial adoption of SFAS No. 157. The adoption of SFAS No. 157 relating to financial assets and financial liabilities did not have a material impact on our financial position or results of operations.  We do not expect the impact of SFAS No. 157 related to nonfinancial assets and non financial liabilities will have a material impact on our financial position or results of operations.

 

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, which are not currently required to be measured 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 was effective for us beginning in the first quarter of fiscal year 2008.   We adopted SFAS No. 159 as of January 1, 2008 and elected not to measure any additional financial instruments or other items at fair value.

 

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

 

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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 3 of “Notes to Interim Condensed Consolidated Financial Statements” included in “Item 1 — Financial Statements.”

 

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 12 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

 

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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.  Changes in the fair value of our derivative financial instruments have had 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.  A substantial portion of our convertible debt and warrants were converted and exercised during 2007.  We expect that the reduction in the remaining outstanding derivative financial investments will have less of an impact upon our results of operations in 2008 and in future periods.

 

Valuation 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 involve 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.

 

Business Combinations

 

We account for business combinations under the purchase accounting method. The cost of an acquired company is assigned to the tangible and intangible assets purchased and the liabilities assumed on the basis of their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make estimates and use valuation techniques when market value is not readily available. Any excess of purchase price over the fair value of the tangible and net intangible assets acquired is allocated to goodwill.

 

LIQUIDITY AND CAPITAL RESOURCES

 

We have two principal sources of liquidity: (i) existing cash and cash equivalents and (ii) our Wells Fargo Receivables Advance Facility.  As of June 30, 2008, we had unrestricted cash and cash equivalents of $0.7 million and an additional $9.8 million of restricted cash consisting of $4.3 million held as collateral under our receivables advance facility and $5.5 million held as collateral for outstanding letters of credit.

 

We face considerable constraints with respect to our liquidity and working capital that have materially impacted our business and may continue to impact our business.  As of June 30, 2008, we had current assets of $177.1 million and current liabilities (exclusive of deferred revenue which is not yet earned) totaling $202.5 million. At June 30, 2008 our shareholder’s deficit was $25.8 million. Our operations have not generated positive annual cash flows since our initial public offering in 2004.

 

Background

 

We have 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 financing 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. From December 2005 to February 2006, we raised approximately $12.6 million, prior to expenses and commissions, through warrant exercises.  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.

 

Our financing under the Receivables Advance Facility is dependent 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.  Additionally, the Professional Business transition issues discussed above have impeded our sales to Professional Business customers.  Periods of lower revenue volume and lower related receivables reduce our assignment of receivables, borrowing capacity, and our ability to cover our operating expenses.

 

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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 us on a pre-pay position for their 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.

 

Liquidity

 

(In millions)

 

 

 

 

June 30

 

December 31,

 

 

 

2008

 

2007

 

Cash and cash equivalents

 

$

0.7

 

$

9.0

 

Restricted cash

 

9.8

 

9.8

 

Total

 

$

10.5

 

$

18.8

 

 

Cash Flow Activity

 

 

 

(In millions)

 

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2008

 

2007

 

Net cash provided (used) by:

 

 

 

 

 

Operating activities

 

$

(4.8

)

$

5.0

 

Investing activities

 

(1.2

)

(0.1

)

Financing activities

 

(2.3

)

(7.9

)

Increase (decrease) in cash

 

$

(8.3

)

$

(3.0

)

 

·                  Operating Activities

 

During the six months ended June 30, 2008, we used $4.8 million from operating activities consisting of a net loss of $16.2 million as adjusted for $10.3 million of non-cash items including depreciation and amortization expense, income from the increase in fair value of derivative financial instruments and other non-cash items. In addition, operating activities provided $11.4 million from a decrease in working capital, primarily from a $25.9 million decline in accounts receivable, a $25.8 million increase in accounts payable offset by a $35.7 million increase in inventory and a $6.4 million decrease in accrued warranties.  The decline in accounts receivable was principally the result of a consecutive decline in quarterly sales during 2008 from the fourth quarter of 2007 and collections on the 2007 year end receivables.  The increase in inventory was due to the Professional Business Transaction issues and the procurement of more raw material inventory to support our anticipated production than the amount actually needed to fulfill customer orders.

 

During the six months ended June 30, 2007, we generated $5.0 million from operating activities consisting of a net loss of $(8.4) million as adjusted for $22.1 million of non-cash items including depreciation and amortization expense, income from the increase in fair value of derivative financial instruments and other non-cash items. In addition, operating activities provided $13.4 million from a decrease in working capital, primarily from a decrease in accounts receivable offset by an increase in inventory and a decrease in accounts payable and accrued expenses.

 

·                  Investing Activities

 

Investing activities for the six months ended June 30, 2008 included $1.2 million in purchase of equipment.

 

We had no significant investing activities during the six months ended June 30, 2007.

 

·                  Financing Activities

 

During the six months ended June 30, 2008, financing activities used $2.3 million consisting of a $7.7 million reduction in net borrowings under the Wells Fargo Receivables Advance Facility and $3.4 million in payments on notes payable.  In addition, we received $8.7 million from Flextronics under the Flextronics Inventory Purchase Agreement.

 

During the six months ended June 30, 2007, financing activities used net cash of $7.9 million.  Our net borrowings under the Wells Fargo Receivable Advance Facility declined $7.9 million and we had $0.5 in payments on notes payables.  In addition, restricted cash related to collateralized letters of credit and the Receivable Advance Facility declined $0.5 million.

 

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Liquidity and cash flows for 2008

 

As previously discussed under “Professional Business Transition Issues” of this Item, during the transition of the Professional Business IT and manufacturing systems from Gateway to MPC Computers’ existing systems in February, 2008, we experienced material delays in manufacturing and customer deliveries, which resulted in lower than expected shipment volumes and revenues in the first and second quarters of 2008 as compared to the fourth quarter of 2007. These issues have materially impacted our liquidity, and caused a material deterioration in our working capital from December 31, 2007 through June 30, 2008.  We continue to extend payment to a number of our vendors well beyond normal payment terms and the amount of the extended payments increased the second quarter of 2008.  Certain of these vendors, and existing vendors, have lowered our existing credit line, restricted component product shipments to us, or have requested letters of credit to secure credit lines.  In April 2008, we entered into the Flextronics agreement and anticipate an increase in liquidity from the sale of our inventory to Flextronics and have received an increase in our credit line with Flextronics from $15 million to $20 million.  However, at August 11, 2008, we had $9.5 million past due to Flextronics.  Working with lower credit lines, continuing to provide letters of credit or other credit enhancement to vendors constrains our liquidity as we are required to use more of our cash, cash collateralize letters of credit or otherwise incur costs to provide credit enhancement and there can be no assurance that we will be successful in obtaining sufficient vendor credit in the future.  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, and could cause us to experience credit holds, require that we pre-pay for products, and/or cause suppliers to refuse to deliver components or terminate supply arrangements, any of which could have a material adverse effect on our financial condition and results of operations.

 

 Other specific issues which are relevant to understanding 2008 cash flows include:

 

·                  Financing activities

 

We expect to fully utilize available financing under our Wells Fargo Receivables Advance Facility to the extent possible in 2008.  In connection with the Professional Business transition issues in the first quarter of 2008, we encountered liquidity issues requiring additional financing.  We amended our Intercreditor Agreement to temporarily remove restrictions on our Receivables Advance Facility. The restrictions were previously reserved for payment of amounts due to Gateway, and provided approximately $15 million in funding from the Receivables Advance Facility.  In addition, on April 1, 2008, Wells Fargo provided an advance to MPC-Pro in the amount of $3.5 million (the “MPC-Pro Advance”). The MPC-Pro Advance was repaid May 27, 2008.  On June 24, 2008, Wells Fargo provided an additional advance to MPC-Pro in the amount of $3.0 million which is to be repaid by September 24, 2008 and is in addition to other amounts provided to us by Wells Fargo under the terms of our Receivables Advance Facility with Wells Fargo.  We also amended the Transition Services Agreement with Gateway to extend the payments due on approximately $14.1 million of accounts payable to Gateway through November, 2008.

 

On May 8, 2008, we entered into a Flextronics Inventory Purchase Agreement (the “IPA”) with Flextronics. Under the IPA, Flextronics purchased certain inventory currently located at our Nashville facility which we expect to then repurchase from Flextronics over the 90 day period following the agreement date for production at our Nashville facility. Any remaining inventory after the 90 day period must be repurchased by us. During the three months ended June 30, 2008, we received $8.7 million from Flextronics under this arrangement.  We do not anticipate further financings from Flextronics under the IPA due to the transition of the operations of our Nashville facility to the Flextronics Juarez, Mexico facility under the MSA.  In conjunction with the MSA, Flextronics will purchase from us certain materials and inventory at the Nashville facility to utilize in the initial operations at Juarez.  We expect to use the proceeds from the sale of the materials and inventory to reduce our vendor payables and fund current operations and improve our liquidity in the near term.

 

Our sales are seasonal and we expected our sales to increase during our second and third quarters of 2008.  Our sales for the second quarter of 2008 were impacted by Professional business transition issues and it is likely that our third quarter will be impacted by the delay in ramp up of the Flextronics manufacturing facility in Juarez, Mexico.  Any increase in our sales we will experience subsequent to the completion of the ramp up will require additional working capital which we intend to obtain through Temporary Advances under the Receivables Advance Facility allowing us to borrow up to approximately 98% of our purchased accounts.   The Temporary Advances are of limited duration which may require us to seek other sources of cash.  We are looking at opportunities to sell assets, such as certain types of inventory and machinery and equipment and expand or enhance vendor credit where possible. We launched initiatives to further improve our margins beginning in

 

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January 2008. We are focusing on material costs, returns, freight costs, manufacturing productivity and costs as areas of opportunity to improve our gross margin and operating margin, including through our recent agreement signed with Flextronics in April 2008. We continue to be active in cost management and continue to seek ways to run our business more cost effectively.

 

We do not anticipate proceeds from the exercise of warrants, unless there is a significant increase in the market price of our common stock.  We expect some conversions of our Series A Preferred Stock and our Series B Preferred Stock to MPC Corporation Common Stock during 2008.  The conversions have no cash flow impact.

 

As more fully described under “Capital Resources” of this Item, on July 11, 2008 we entered into a Master Purchase Order Assignment Agreement (the “assignment agreement”) with Wells Fargo.  Under the assignment agreement we expect additional limited liquidity through the factoring of purchase orders we receive from our customers that are accepted by Wells Fargo.

 

·                  Capital expenditures

 

Historically, we have not had material capital expenditures and do not currently anticipate significant capital expenditures in 2008.

 

·                  Income taxes

 

From our inception through December 31, 2007, we have generated losses for both financial reporting and tax purposes. As a result, for income tax return, we may utilize approximately $36.9 million of net operating loss carryforwards, which begin to expire in 2022 and are available as late as 2027.  We believe these net operating loss carryforwards are subject to an annual limitation on their use of $967 thousand pursuant to IRC Section 382.  However, we have not yet completed our analysis of additional limitations, if any, resulting from the acquisition of the Professional Business and the conversion of debentures and exercise of warrants in 2007.  For the year ended December 31, 2008, in addition to our loss carryforward limitation, taxable income may be reduced by all losses incurred in 2007 after the October 1, 2007 acquisition of the Professional Business.

 

We may need to raise a considerable amount of additional funds to satisfy vendor payment obligations and fund our business if we do not generate sufficient cash flows from operations and losses continue. There can be no assurance that we will be able to secure additional sources of financing on terms acceptable to us or at all. 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.

 

Capital Resources

 

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, as amended in February 2007, 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.  Wells Fargo will 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, MPC-Pro and Gateway Companies Inc (“GCI”) (which was acquired by MPC-Pro in connection with the acquisition of the Professional Business), each entered into an Account Purchase Agreement

 

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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.  In addition, MPC-Pro, Gateway, GCI, and Wells Fargo entered into an Intercreditor Agreement (the “Intercreditor Agreement”). The Intercreditor Agreement provides Gateway with a junior security interest in accounts receivable generated on or after the October 1, 2007 acquisition of the Professional Business, inventory, and all other property of MPC-Pro and GCI as specified in the agreement 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 (the “Gateway Blocked Accounts”).  On May 29, 2008 the Intercreditor Agreement was amended to provide Gateway Blocked Accounts up to the following amounts: (i) there will be no Gateway Blocked Accounts through August 31, 2008; and (ii) on or after September 15, 2008, a face amount equal to the obligations owing to Gateway under the Transition Agreement for the applicable week (the “Gateway Weekly Payoff Amounts”) minus $10.0 million.  The amendment also provides that, if, after November 15, 2008, there is a remaining positive balance of the Gateway Weekly Payoff Amounts, Gateway may provide a statement to MPC-Pro indicating the positive balance, and Wells Fargo will hold but not purchase Gateway Blocked Accounts submitted to it by MPC-Pro and GCI in a face amount equal to the remaining positive balance.

 

We will pay fees equal to the Wells Fargo Prime Rate (as defined in the Receivables Advance Facility), plus 0.75% per annum (the “Wells Fargo Discount”) multiplied by the total amount of Accounts purchased and not yet paid by our customers, computed daily. The effective rate at June 30, 2008 was 6%. The minimum monthly fee to be paid in aggregate by MPC Computers affiliates to Wells Fargo is determined by multiplying the Wells Fargo Discount, by $2.5 million.

 

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 terminating November 14, 2009. 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 $3.5 million collateral account for the benefit of Wells Fargo for repayment of any obligations arising under the Receivables Advance Facility

 

On April 1, 2008, Wells Fargo provided an advance to MPC-Pro in the amount of $3.5 million (the “MPC-Pro Advance”). The MPC-Pro Advance is to be repaid by May 31, 2008, and is in addition to other amounts provided to us by Wells Fargo under the terms of our Account Purchase Agreements with Wells Fargo.  Interest on the MPC-Pro Advance will be at Wells Fargo Prime Rate plus 1.25%.

 

On April 10, 2008, MPC-Pro, GCI, and Gateway delivered to Wells Fargo an instruction letter that modified certain terms of the Intercreditor Agreement. The letter confirmed that a requirement under the Intercreditor Agreement to maintain a controlled collateral account in the amount of $1.5 million eliminated. Additionally, the letter confirmed that Wells Fargo is not required to hold certain Gateway funds in trust as previously required under the Intercreditor Agreement.  The impact of the instruction letter was to release approximately $1.0 million to us that was held in the controlled collateral account.

 

Master Purchase Order Assignment Agreement

 

On July 11, 2008, MPC Computers and MPC-Pro and Wells Fargo, entered into a Master Purchase Order Assignment Agreement (the “Assignment Agreement”). Under the Assignment Agreement, MPC Computers and MPC-Pro will assign customer purchase orders to Wells Fargo and request Wells Fargo to accept such purchase orders and purchase the required materials to fulfill the purchase orders. On such assigned purchase orders, Wells Fargo will retain MPC Computers and MPC-Pro to manufacture, process, and ship ordered goods and will pay us for our services upon payment by the customer to Wells Fargo for the goods. Accepted purchase orders will be reassigned to us at such time Wells Fargo has received payment in full on account of a purchase order invoice. Accepted purchase orders become delinquent if a purchase order price is not paid to Wells Fargo by the earliest of (i) the due date for payment of the purchase order invoice, (ii) forty-five 45 days following the Funding Date by Wells Fargo, as defined, (iii) the date the purchase order is cancelled, or (iv) the date of occurrence of an event of default as defined. Wells Fargo has the right to require us to promptly purchase any Delinquent Purchase Order as

 

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defined, (and inventory of products in the case of a Canceled Purchase Order, as defined) for an amount equal to the full amount outstanding under the purchase order invoice (or the purchase order price in the case of a Canceled Purchase Order). The Assignment Agreement provides for limitations of funding of individual accepted purchase orders by Wells Fargo and the maximum aggregate outstanding funding shall not exceed $5 million.

 

Wells Fargo is to be paid a transaction initiation and set-up fee of 1.0% of the face amount of letters of credit and funds advanced by Wells Fargo with respect to each accepted purchase order, plus a daily maintenance fee in a sum equal to 0.067% of the aggregate of the face amount of all letters of credit and funds advanced by Wells Fargo which remain outstanding for more than fifteen (15) days. In addition, a Product advance fee will be paid to Wells Fargo equal to the J.P. Morgan prime rate plus 2%, divided by 360, multiplied by the aggregate amounts outstanding on all letters of credit and all funds advanced by Wells Fargo in connection the accepted purchase orders. In the event of a Delinquent Purchase Order, a late payment fee is to be paid in a sum equal to 0.067% of the outstanding portion of the purchase order price multiplied by the number of days from the date an accepted purchase order becomes a delinquent purchase order to and including the date Wells Fargo has received full payment of amounts due. The Assignment Agreement provides for a commitment fee of $100 thousand to be paid to Wells Fargo on the earlier of twelve months following July 11, 2008 or the date of termination of the Assignment Agreement and be paid for each one or more twelve month renewal terms if the agreement is renewed. The commitment fee will be waived in whole if the Product Volume for a term equals or exceeds the Minimum Volume of $10 million, or in part if the Product Volume for a term is less than the Minimum Volume based on the aggregate volume of funds advanced by Wells Fargo in connection with accepted purchase orders as a percentage of the Minimum Volume.

 

On July 11, 2008, in connection with the Assignment Agreement, MPC Computers, MPC-Pro and Wells Fargo entered into a Security Agreement and Financing Statement (the “Security Agreement”). Under the Security Agreement, MPC Computers and MPC-Pro grants Wells Fargo a first priority security interest in substantially all merchandise, inventory, goods and supplies in connection with accepted purchase orders under the Assignment Agreement for all payments and other obligations due Wells Fargo there under (the “Primary Collateral”). In addition, the Security Agreement provides Wells Fargo a subordinated security interest in substantially all other assets of MPC Computers and MPC-Pro pledged to a Senior Lender, as defined. Under an Intercreditor Agreement with Gateway, MPC-Pro has granted to Gateway a security interest in all or part of its assets, which is subordinate to a security interest granted by MPC-Pro to Wells Fargo under certain Account Purchase Agreements. On July 11, 2008, in connection with the Assignment Agreement, Gateway and MPC-Pro entered into a Transaction Subordination Agreement with Wells Fargo. Under the Transaction Subordination Agreement, Gateway agrees to further subordinate its interest in the assets of MPC-Pro to Wells Fargo.

 

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.

 

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.

 

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 required 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

 

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imposed by certain investors on their registrable 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 year ended December 31, 2007, we incurred liquidated damages of $346 thousand under the registration rights agreement related to the delay in the effectiveness of our registration statement.

 

During the year ended December 31, 2007, we issued 8,798,986 shares of common stock and 626,546 shares of Series A Preferred Stock upon conversion of $9.8 million face value of New Convertible Debentures plus accrued interest and penalties and the exercise of 6,652,227 warrants.  See “Series A Preferred Stock” below.

 

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 $4.9 million. 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.  Since we have not paid all of 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.

 

In connection with this financing, we issued 499,867 warrants with a 5-year term to the placement agent to purchase

 

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our common stock for $1.10 per share.

 

During the year ended December 31, 2007, we issued 6,314,927 shares of common stock upon conversion of $3.6 million in face value of debentures from the September 29, 2006 Financing plus accrued interest and penalties and the exercise of 893,125 warrants.

 

Series A Preferred Stock

 

As a condition to close under the Asset Purchase Agreement for the acquisition of the Professional Business, we were required 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 our 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 (the “Letter Agreement”) among the parties to the Asset Purchase Agreement.  In satisfaction of this condition, on October 1, 2007 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.

 

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 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 Corporation 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.

 

In conjunction with the exercise of the $1.10 warrants and our obligations under the Letter Agreement, on October 1, 2007, 7,545,352 warrants were exercised, $12.1 million in face value of convertible debentures were converted plus accrued interest and penalties thereon, and we issued 12,912,166 shares of MPC Corporation common stock and 626,546 shares of MPC Corporation Series A Preferred Stock. The MPC Corporation Series A Preferred Stock is convertible into 12,530,925 shares of MPC Corporation common stock.  The MPC Corporation Series A Preferred Stock is participating, non-voting, and has a liquidation preference equal to $.00000001 per share. Each share of MPC Corporation Series A Preferred Stock will automatically convert to MPC Corporation common stock at such time the conversion would not cause the beneficial ownership to exceed 9.99% beneficial ownership.

 

Series B Preferred Stock

 

In connection with the acquisition of the Professional Business, 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, and 249,171 shares of MPC Corporation Series B Preferred Stock convertible into 4,983,416 shares of our common stock. All MPC Corporation Series B Preferred Stock issued to Gateway converts to MPC Corporation common stock upon (i) shareholder approval by a majority of the MPC Corporation common shareholders and (ii) at such time as the shares may be converted without causing Gateway’s ownership of our common stock to exceed 19.9% (the “Series B Automatic Conversion Event”).  Gateway agreed to vote in favor of the Series B Automatic Conversion Event. In the event the Series B Automatic Conversion Event does not occur within one year from the Closing Date, all outstanding shares of Series B Preferred Stock shares are to 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. The MPC Corporation Series B Preferred Stock is participating, non-voting, and has a liquidation preference equal to $.00000001 per share.

 

On the October 1, 2007 Closing Date, we entered into a Lock-up Agreement and Registration Rights Agreement

 

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with Gateway.  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, MPC Corporation shall file a registration statement with respect to the Registrable Securities, as defined by the agreement, which include the MPC Corporation Shares issued in connection with the transaction. The Registration Rights Agreement grants Gateway customary and piggyback rights. The Registration Rights Agreement is subject to any limitations and conditions set forth in any prior registration rights agreements entered into by MPC Corporation.

 

Other outstanding warrants

 

In connection with our 2004 initial public offering, we issued 3.6 million warrants. These warrants were exercisable at $5.50 per share, but have subsequently been adjusted to $3.77 per share in August 2007 due to anti-dilution provisions triggered from convertible debentures and warrants issued by us in September 2006 with conversion features at below then current market prices. The warrants are c