UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 29, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ to_______
Commission file number 0-28352
TECHNOLOGY SERVICE GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 59-1637426
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
20 Mansell Court East - Suite 200 30076
Roswell, Georgia (Zip Code)
(Address of principal executive offices)
(770) 587-0208
(Registrant's Telephone Number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, Par Value, $.01 Per Share
(Title of Class)
Redeemable Warrant
(Title of Class)
Units (each Unit comprised of one share of Common Stock
and one Redeemable Warrant)
(Title of Class)
Indicate by check mark whether (1) Registrant has filed all reports required to
be filed by Section 13 or 15(d) of the Securities 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 __ No X
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At May 31, 1996, there were 4,650,000 shares of the Registrant's Common Stock
outstanding.
The aggregate market value of the voting Common Stock held by non-affiliates of
the Registrant at May 31, 1996, based on the closing price on such date, was
approximately $13,221,550.
DOCUMENTS INCORPORATED BY REFERENCE
None
Page 1 of 132
Exhibit Index at Page 109
TECHNOLOGY SERVICE GROUP, INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
Number
PART I
Item 1. Business 3
Item 2. Properties 27
Item 3. Legal Proceedings and Disputes 28
Item 4. Submission of Matters to a Vote of Security Holders 28
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 29
Item 6. Selected Financial Data 30
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 34
Item 8. Financial Statements and Financial Statement Schedules 48
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosures 81
PART III
Item 10. Directors and Executive Officers of the Registrant 82
Item 11. Executive Compensation 85
Item 12. Security Ownership of Certain Beneficial Owners
and Management 92
Item 13. Certain Relationships and Related Transactions 95
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 99
2
PART I
Item 1. BUSINESS
General
The Company is engaged in the design, development, manufacture and
marketing of public communication products consisting of payphone components,
electronic wireline payphone products, microprocessor-based wireline and
wireless payphone products and related payphone software management systems. The
Company's products include smart payphone products sold under the "Gemini,"
"Inmate," "GemStar," and "GemCell" trademarks. Smart payphone products are based
upon microprocessor technology and perform a variety of functions, including
calling card, debit card and credit card control, data storage, call progress
detection, call rating and maintenance, diagnostic and coin administration
functions. The Company is also a provider of payphone and payphone component
repair, refurbishment and upgrade conversion services to the regulated telephone
operating companies in the United States, which consist of the seven Regional
Bell Operating Companies ("RBOCs") and other local exchange carriers. The
Company markets its products and services primarily to the seven RBOCs in the
United States and to inter-exchange carriers and cellular providers in certain
international markets. The Company has derived substantially all of its revenues
from sales to four RBOCs. See "Sales and Markets--Domestic," below. The Company
has also entered the international market place for wireline and cellular
payphone products, which it believes provides a further opportunity for growth.
See "Sales and Markets--International," below.
Forward Looking Statements
This report contains certain forward looking statements concerning the
Company's operations, economic performance and financial condition. Such
statements are subject to various risks and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors,
including those identified under this Item 1 - "Business" and elsewhere herein.
Development of the Company
General. The Company was incorporated in the State of Delaware in 1975 as
Florida Data Corporation for the purpose of developing, manufacturing and
marketing high-speed dot matrix printers. From 1975 to 1986, the Company
incurred significant operating losses from its high-speed dot-matrix printer
business. In June 1986, the Company acquired International Teleservice
Corporation, Inc., a company engaged in the repair and refurbishment of
telecommunication products consisting of residential telephones and payphones,
and changed its name to Technology Service Group, Inc. Between fiscal 1986 and
1988, the Company discontinued its high-speed dot-matrix printer business, sold
the assets of its residential telephone repair and refurbishment business, and
began to focus its business on the public communications industry. The Company
established International Service Technologies, Inc. ("IST"), which established
a foreign division in Taiwan, and Technology Service Enterprises, Inc., and
expanded its public communications business to include the manufacture and
marketing of payphones and payphone components and the provision of services to
convert and upgrade payphones with components designed and manufactured by the
Company and its subsidiaries. In fiscal 1991, Technology Services Enterprises,
Inc. acquired the assets of the Public Communication Systems Division of
Executone Information Systems, Inc. ("PCS"), including its microprocessor-based
technology. In fiscal 1993, the Company established Wireless Technologies, Inc.
and began to develop microprocessor-based wireless payphone products for
international applications. In April 1993, International Teleservice
Corporation, Inc., Technology Service Enterprises, Inc. and Wireless
Technologies, Inc. were merged into the Company.
3
The Acquisition. On October 31, 1994, TSG Acquisition Corp., a wholly-owned
subsidiary of Wexford Partners Fund, L.P. ("Wexford"), acquired all of the
outstanding capital stock of the Company pursuant to an Agreement and Plan of
Merger dated October 11, 1994 (the "Plan of Merger") between Wexford, TSG
Acquisition Corp., the Company and the majority holders of the Company's
preferred and common stock (the "Acquisition"), including Acor S.A and Firlane
Business Corp. (which are also current stockholders of the Company). The
consideration paid by TSG Acquisition Corp. aggregated $3.5 million including
contingent consideration of $329,709 placed in escrow and distributed to former
stockholders in September 1995. The aggregate consideration consisted of
$3,004,000 to acquire the outstanding capital stock of the Company and $496,000
to retire a $400,000 subordinated master promissory note payable to former
stockholders and related accrued interest and preference fees of $96,000
representing 5% of the outstanding principal for each month that the note was
outstanding. Aggregate cash payments to former stockholders, including the
contingent consideration of $329,709 and the retirement of the subordinated
master promissory note, accrued interest and preference fees of $496,000,
amounted to $3,222,090. Consideration of $277,910 was withheld from amounts paid
to former stockholders to pay liabilities of the Company including a success fee
of $75,000 payable to Atlantic Management Associates, Inc. (see Item 10
"Directors and Executive Officers of the Registrant," Item 11 - "Executive
Compensation" and Item 13 - "Certain Relationships and Transactions") and the
settlement of a dispute with respect to a terminated employment contract of a
former executive of $202,910.
The former stockholders of the Company's common stock, Series A preferred
stock and Series B preferred stock received no consideration for their shares.
The former stockholder of Series E Preferred Stock received consideration of
$2.50 per share or $750,000, less a pro rata portion of $17,400 of the success
fee payable to Atlantic Management Associates, Inc. The former stockholders of
Series C preferred stock received consideration of $2,254,000, or $.96 per
share, less a pro rata portion of $57,600 of the success fee paid to Atlantic
Management Associates, Inc. and the $202,910 settlement liability. The former
stockholders also received the consideration paid in respect of the subordinated
master promissory note and related accrued interest and preference fees in
accordance with the terms of the subordinated master promissory note. See Item
13 - "Certain Relationships and Transactions."
In conjunction with the Acquisition, TSG Acquisition was merged into the
Company, which was then wholly-owned by Wexford. The outstanding shares of the
Company's capital stock and rights to purchase the Company's capital stock,
including preferred stock purchase warrants, at October 30, 1994 and the
Company's then existing Incentive Stock Option Plan were cancelled and the
outstanding shares of capital stock of TSG Acquisition held by Wexford were
converted into one share of the Company's common stock, $.05 par value (the
"merger share").
In addition, on October 31, 1994, the Company amended its Certificate of
Incorporation to reflect its current authorized capital. Further, the Company
entered into an Investment Agreement with Wexford, Acor S.A. and Firlane
Business Corp. (collectively the "investors"). Acor S.A. and Firlane Business
Corp. were former stockholders of the Company. Pursuant to the Investment
Agreement, the Company issued an aggregate of 3.5 million shares of common
stock, $.01 par value, (the "Common Stock") at a price of $1.00 per share to
Wexford in exchange for the merger share. Wexford, in turn, sold to Acor S.A.
and Firlane Business Corp. 507,500 and 262,500 shares, respectively, of Common
Stock pursuant to the terms of the Investment Agreement. The consideration paid
by Wexford, Acor S.A. and Firlane Business Corp. for their shares of Common
Stock was $2,730,000, $507,500 and $262,500, respectively. Also, the Company
borrowed $2.8 million from Wexford and Acor S.A. and issued subordinated
promissory notes due November 1, 1999 that bear interest at a rate of 10% per
annum (the "Affiliate Notes"). The Company issued a 10% interest bearing
subordinated note to Wexford in the principal amount of $2,361,082 dated October
31, 1994. The Company also issued 10% interest bearing subordinated promissory
notes to Acor S.A. in the principal amount of $208,216.73 dated October 31,
4
1994, $99,591.93 dated October 31, 1994, $83,497.82 dated November 10, 1994 and
$47,611.52 dated December 23, 1994. See Item 12 "Security Ownership of Certain
Beneficial Owners and Management" and Item 13 - "Certain Relationships and
Transactions."
In connection with the Acquisition, Acor S.A. received aggregate
consideration of $702,037, including $99,200 of principal and related accrued
interest and preference fees pursuant to the subordinated master promissory
note, and $680,843 in respect of Series C preferred stock, before a pro rata
share of the Atlantic Management Associates, Inc. success fee of $16,715 and the
settlement obligation of $61,291. Firlane Business Corp. received aggregate
consideration of $211,881, including $111,600 of principal and related accrued
interest and preference fees pursuant to the subordinated master promissory
note, and $115,551 in respect of Series C preferred stock, before a pro rata
share of the Atlantic Management Associates, Inc. success fee of $4,868 and the
settlement obligation of $10,402. See Item 12 - "Security Ownership of Certain
Beneficial Owners and Management" and Item 13 - "Certain Relationships and
Transactions."
Initial Public Offering. During May 1996, the Company completed an initial
public offering (the "Offering") of 1,150,000 units (the "Units"), each Unit
consisting of one share of Common Stock and one redeemable warrant ("Redeemable
Warrant") at a price of $9.00 per Unit for gross proceeds of $10,350,000. In
connection with the offering, the Company issued warrants to the Underwriters to
purchase 100,000 shares of Common Stock (the "Underwriter Warrants") for gross
proceeds of $10. Net proceeds received by the Company, after underwriting
discounts and expenses of $1,231,897, amounted to $9,118,113. The Company has
incurred other offering expenses of $338,372 as of March 29, 1996. These
expenses have been deferred at March 29, 1996 and, together with offering
expenses incurred subsequent to March 29, 1996, will be charged against the net
proceeds of the Offering. See Item 8 - "Financial Statements and Financial
Statement Schedules" and Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Stock Purchase Agreement. The Company, Wexford, Acor S.A., Firlane Business
Corp. and A.T.T. IV, N.V. ("ATTI") entered into a Stock Purchase and Option
Agreement on May 3, 1996 (the "Stock Purchase Agreement"). Pursuant to the terms
of the Stock Purchase Agreement, Wexford, Acor S.A. and Firlane Business Corp.,
concurrently with the Offering, sold to ATTI an aggregate of 366,300 shares of
Common Stock at a price of $8.14 per share and options to purchase an additional
183,150 shares of Common Stock at an exercise price of $11.00 per share (the
"Options") at a price of $.10 per Option. Wexford sold 285,714 shares and
Options to purchase 142,857 shares. Acor S.A. sold 53,114 shares and Options to
purchase 26,557 shares. Firlane Business Corp. sold 27,472 shares and Options to
purchase 13,736 shares. The consideration received by Wexford, Acor S.A. and
Firlane Business Corp. pursuant to the terms of the Stock Purchase Agreement was
$2,339,998, $435,004 and $224,995, respectively. See Item 12 - "Security
Ownership of Certain Beneficial Owners and Management."
Restructuring. During the latter part of fiscal 1994 and prior to the
Acquisition, the Company's sales and operating performance were adversely
affected by the termination of a sales agreement with respect to a first
generation smart payphone product between the Company and one of its then
significant RBOC customers caused by technical and delivery problems experienced
by the Company and the non-renewal of a refurbishment sales agreement with such
RBOC. See "Changing Product Mix," below. In the fourth quarter of fiscal 1994
prior to the Acquisition, the Company initiated a plan to change certain senior
management, restructure its operations, reduce its costs and expenses, refocus
its development activities, increase sales, turn around its business, improve
liquidity and attain profitable operations. In connection with this plan, the
Company recorded restructuring charges of $2,570,652 during the fiscal year
ended April 1, 1994. See Item 6 - "Selected Financial Data" and Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
5
As part of the restructuring plan and the Company's efforts to improve
liquidity, the Company began to seek additional financing from the venture
capital firms that held the then outstanding preferred stock of the Company.
These venture capital firms invested $400,000 in the Company pursuant to a
subordinated master promissory note dated June 9, 1994, but did not invest
sufficient capital to fund the Company's business for an extended period. These
investors had held their investment in the Company for longer periods than
anticipated, and sought to liquidate their investment. Accordingly, the then
current Board of Directors of the Company authorized management to seek
alternative financing sources interested in acquiring the outstanding capital of
the Company and in investing additional funds in the Company. Such efforts
culminated in the Acquisition described above.
Effective June 8, 1994, the Board of Directors authorized and the Company
executed executive retention agreements with its executive officers. The purpose
of the executive retention agreements was to retain the executives in the employ
of the Company to facilitate the Company's efforts to effect a change in
ownership and attract capital. The executive retention agreements provided for
the payment of bonuses based upon the value of a transaction which resulted in a
change in ownership. On November 1, 1994, the Company's newly constituted Board
of Directors approved the payment of such bonuses as a result of the
Acquisition. See Item 11 - "Executive Compensation" and Item 13 - "Certain
Relationships and Transactions."
During fiscal 1995, the Company reduced its operating costs and expenses.
However, as discussed above, the termination and non-renewal of sales agreements
between the Company and one of its then significant RBOC customers, which events
occurred prior to the Restructuring, had a significant adverse effect on the
Company's sales. See "Changing Product Mix," below. The Company's cost and
expense reductions together with non-recurring gains from the settlement of
litigation and restructuring credits related to the settlement of terminated
employment contracts and the termination of non-cancelable lease agreements were
not sufficient to offset the impact of the sales decline, and the Company
continued to operate at a loss. However, during fiscal 1995, the Company
developed a new smart payphone processor, and entered into a $21.3 million sales
agreement with one of its significant customers to provide the processor and
other components to the customer over a period of three years. As a result, the
Company's sales reached $5.9 million for the three months ended March 31, 1995
as compared to $4.5 million for the three months ended December 31, 1994. This
sales agreement may be terminated at the option of the customer upon prior
notice to the Company. See "Sales and Markets--Domestic" and "Changing Product
Mix," below. Also see Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The Company's sales performance continued to improve as the Company entered
into fiscal 1996. During the three months ended June 30, 1995, the Company's
sales rose to $6.4 million as compared to $4.9 million for the three months
ended July 1, 1994, and the Company incurred a net loss of $230,658 for the
three months ended June 30, 1995 as compared to net income of $1,390 for the
three months ended July 1, 1994, which included a gain from the settlement of
litigation of $261,022. Sales for the three months ended September 29, 1995
approximated $7.7 million as compared to approximately $5 million for the three
months ended September 30, 1994, and the Company generated a profit of $236,104
for the three months ended September 29, 1995 as compared to a net loss of
$357,752 for the three months ended September 30, 1994. Sales for the three
months ended December 29, 1995 approximated $9.6 million as compared to
approximately $4.5 million for the three months ended December 31, 1994, and the
Company generated a profit of $654,957 for the three months ended December 29,
1995 as compared to a loss of $456,040 for the three months ended December 31,
1994 ($67,004 for the Predecessor for the month ended October 30, 1994 and
$389,036 for the Company for the two months ended December 31, 1994). Sales for
the three months ended March 29, 1996 approximated $9.5 million as compared to
approximately $5.9 million for the three months ended March 31, 1995, and the
6
Company generated a pre-tax profit of $843,283 for the three months ended March
29, 1996 as compared to a loss of $676,545 for the three months ended March 31,
1995 . See Item 6 - "Selected Financial Data" and Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
In December 1995, the Company entered into an amendment to a sales
agreement with one of its significant RBOC customers that provides for the sale
of approximately $12 million smart products and other components over an
eight-month period commencing November 1, 1995. This sales agreement may be
terminated at the option of the customer upon prior notice to the Company. See
"Sales and Markets--Domestic" and "Changing Product Mix," below.
Unless the context requires otherwise, Technology Service Group, Inc. and
its subsidiaries are referred to herein collectively as the "Company" or "TSG".
The term "Predecessor" refers to the Company for all periods prior to October
31, 1994, the Acquisition date. The Company's principal executive offices are
located at 20 Mansell Court East, Suite 200, Roswell, Georgia 30076, and its
telephone number at that address is (770) 587-0208.
The Public Payphone Industry
Regulatory Background. Public telecommunication services, including "coin"
or "pay" telephone service, in the United States are presently provided by
regulated telephone operating companies, including those owned by the RBOCs,
referred to as local exchange carriers ("LECs"), AT&T and independent payphone
providers. The operations of AT&T and the local exchange carriers are subject to
extensive regulation by the Federal Communications Commission ("FCC") and state
regulatory agencies (see "Government Regulation," below). Virtually all services
offered by LECs, including payphone services, are provided in accordance with
tariffs filed with appropriate regulatory agencies, including the FCC.
Independent payphone providers are subject to regulations of state regulatory
agencies.
The majority of pay telephones ("payphones") in service are owned and
operated by the regulated telephone operating subsidiaries of the seven RBOCs
which were formed as part of the divestiture by AT&T in 1984 (the "AT&T
Divestiture"). It is believed that the RBOCs control approximately 1.5 million
of an estimated 2.1 million payphones in service. The remaining installed base
of payphones are owned and operated by the large independent telephone operating
companies (such as GTE), other local exchange carriers and independent payphone
providers.
Subsequent to the AT&T Divestiture until 1988, the payphone industry
comprised primarily regulated telephone operating companies (including the
RBOCs) and AT&T. AT&T maintained the coinless payphones in the United States and
the coin payphones were retained entirely by the regulated telephone operating
companies. These payphones remained in the regulated rate base, and
long-distance traffic generated from these devices was sent to the
inter-exchange carrier chosen by the telephone company.
In June 1984, the FCC approved the operation of independently owned
payphones, which theoretically permitted independent payphone providers to enter
the industry. However, barriers to entry into the industry by private payphone
providers were substantial. The RBOCs had in place and available the services of
the central offices to provide payphone service, including call rating and
routing information, the "bong" tone that signals callers to input calling card
numbers, and collection/return signaling for the payphone to collect or return
coins. These services were not required to be made available to independent
payphone providers and placed them at a disadvantage. Also, since the RBOCs
selected the inter-exchange carrier to carry long-distance traffic generated by
payphones, independent payphone operators were generally unable to generate
revenues from non-coin long-distance payphone calls until 1988 upon judicial
rulings that equal access applied to payphones.
7
Development of Smart Payphones. The payphone historically deployed by the
RBOCs was essentially a mechanical device that performed the functions of a
normal residential telephone, with the additional ability to hold and collect or
refund coins. In this conventional payphone system, all of the intelligence
required to provide service is located at the central office or other network
locations of the long distance or local exchange carrier which is supplied to
the payphone via a "coin line."
Regulatory actions, together with the development of technologically
advanced microprocessor-based payphones that perform the functions of the
central office within the telephone, have enabled independent payphone operators
to enter the industry and compete effectively with the regulated telephone
operating companies. Microprocessor-based technology has provided independent
payphone providers with the capability to route and determine the proper charges
("rate") for calls and to deploy payphones containing maintenance diagnostics
and reporting features, coin administration features, and station message detail
recording and reporting features. These features enable independent payphone
providers to either route calls to Alternate Operator Services ("AOS") or to
store and retrieve call data and billing information thereby allowing the owner
to share in the long-distance revenues generated by the phone, reduce the cost
of maintenance and collection, and to monitor coin pilferage, among other
things.
In response to the competitive pressures from independent payphone
providers, many of the RBOCs and other local exchange carriers have begun to
upgrade their payphone base with microprocessor-based technology, which are
referred to in the industry as "smart" payphones. The Company's prospects for
future and continued profitability are largely dependent on such trend
continuing. See "Sales and Markets--Domestic," below.
Domestic Regulatory Outlook. On February 8, 1996, the President signed into
law the Telecommunications Act of 1996 (the "Telecommunications Act"), the most
comprehensive reform of communications law since the enactment of the
Communications Act of 1934. The Telecommunications Act eliminates long-standing
legal barriers separating LECs, long distance carriers, and cable television
companies and preempts conflicting state laws in an effort to foster greater
competition in all telecommunications market sectors, improve the quality of
services and lower prices.
The Telecommunications Act expressly supersedes the consent decree which
led to the AT&T Divestiture, including the line-of-business restrictions that
prohibited the RBOCs from providing inter-exchange services and from
manufacturing telecommunications equipment. The RBOCs are now permitted to
provide inter-exchange service outside their local service areas and to seek
approval from the FCC to provide inter-exchange service within their local
service areas based upon a showing that they have opened their local exchange
markets to competition. After the FCC has given its approval to a request to
provide in-region inter-exchange service, the RBOC may also engage in the
manufacture and provision of telecommunications equipment and the manufacture of
customer premises equipment. Such manufacturing enterprises must be conducted
through separate affiliates for at least three years after the date of enactment
of the Telecommunications Act. In addition, an RBOC may not discriminate in
favor of equipment produced or supplied by an affiliate but rather must make
procurement decisions based on an objective assessment of price, quality,
delivery and other commercial factors.
The Company believes that as a result of the reform legislation, the public
communications industry will undergo fundamental changes, many of which may
affect the Company's business. The legislation is likely to increase the number
of providers of telecommunications services, including perhaps providers of
payphone services. This increase in the number of providers is likely to
stimulate demand for new payphone equipment. In such event, the Company believes
that existing payphone providers, including the RBOCs, could seek to enhance
their technology base in order to compete more effectively with each other and
with new entrants. In addition, as the local exchange and intrastate long
distance markets are opened to competition, inter-exchange carriers seeking to
serve these markets may deploy greater numbers of payphones to capture local and
8
intrastate traffic. The Company believes that, in such an environment, payphone
technology could continue to evolve, perhaps into "Public Access Terminals"
providing a gateway to a network for voice, data and video and information
superhighway applications. There can be no assurance, however, that these trends
will develop, or that if they do develop, they will have a beneficial impact on
the payphone market generally or on the Company's business in particular. See
"Government Regulation," below.
The International Outlook. Internationally, it is estimated that there are
several million payphones in the installed base. Public communication services
in foreign countries are presently provided by large government controlled
postal, telephone and telegraph companies ("PTTs"), former PTTs that have been
privatized for the purpose of investing in and expanding telecommunication
networks and services, and cellular carriers. The Company believes that a
perceived trend toward privatization and liberalization of the international
telecommunication industry is opening the international markets, previously
dominated by monopoly and government infrastructure, to increased competition.
In addition, many countries are allowing private firms to construct cellular
networks and compete with national telecommunication authorities. It is believed
that some of the large United States based telecommunications companies,
including certain RBOCs, have invested in telecommunication opportunities abroad
including the acquisition of interests in the privatized PTTs and consortiums
for the acquisition of licenses and construction of cellular networks to provide
cellular communication services.
Presently, the density of payphone installations in many foreign countries
on a per capita basis is far less than that in the United States. The Company
believes that many of these countries are seeking to expand and upgrade their
telecommunications systems and are funding programs to provide communication
services to the public. The expansion programs include the construction of
wireless networks, and the Company believes that wireless payphone service will
become one of the primary avenues of providing communication services to the
public in certain foreign markets. The Company believes that large scale
payphone deployment programs are underway in Mexico, Argentina, Indonesia, China
and elsewhere, and that the international public communications industry will
continue to evolve and be a significant growth industry over the next several
decades to the extent that privatization and the investment in and expansion of
both wireline and wireless networks progresses.
Although foreign markets are believed to be a potential source of
significant demand for the Company's products, there are impediments to the
Company's ability to penetrate such markets, including resource limitations,
regulations and the normal difficulties attendant on conducting international
business. See "Sales and Markets--International," below.
Products and Services
The Company manufactures and markets "coin" and "coinless" pay telephone
("payphone") products that connect to and operate as integral parts of domestic
and foreign public telecommunication networks. The Company also markets payphone
and payphone component repair, refurbishment and conversion upgrade services to
the regulated telephone companies in the United States. The Company's products
include payphones equipped with non-smart payphone electronics or smart payphone
processors (the primary electronic assemblies or "engines" of payphones) that
connect to wireline telecommunication networks ("wireline payphones") and
payphones equipped with a smart processor or a specially designed cellular
processor that connect to cellular telecommunication networks ("wireless
payphones"). The Company also supplies non-smart payphone electronic retrofit
kits, smart payphone retrofit kits and payphone components (including, among
other things, dials, handsets, chrome doors, payphone electronics and
processors) required to both manufacture payphones and repair and/or upgrade
deployed payphones. In addition, the Company markets "CoinNet", payphone
management software required to remotely manage and communicate with the
Company's smart and cellular payphone processors. A significant portion of the
9
Company's revenues is derived from the sale of smart payphone processors and
payphone retrofit kits to certain RBOCs that are upgrading their installed base
of payphones with technologically advanced processors.
The Company's wireline coin payphones are designed based upon the Western
Electric configuration developed for use in the Bell system versus the GTE
configuration developed for the independent telephone companies and also used by
some of the independent payphone providers. The Western Electric configuration
uses a housing ("case") with a left sided coin slot and coin return bucket
versus the GTE configuration with a right sided coin slot and coin return
bucket. The Company's Western Electric housings are acquired from an
unaffiliated Taiwan corporation under a Manufacturing Rights Agreement dated
September 16, 1991 (see "Manufacturing, Assembly and Sources of Supply," below).
These housings are also acquired from the secondary or "aftermarket" for
payphone components within the United States. Housings acquired in the
"aftermarket" are reconditioned as part of the refurbishment services offered by
the Company, as further described below. Payphones manufactured with
reconditioned housings are generally referred to as "hybrids." The Company's
coinless wireline and wireless payphones are manufactured in several different
configurations, including the Western Electric configuration, depending on the
application. The Company's coin payphones and hybrids are supplied with
electronic coin mechanisms supplied by unaffiliated domestic companies. See
"Manufacturing, Assembly and Sources of Supply," below.
The Company's wireline payphone products were originally developed
specifically for the regulated telephone operating companies in the United
States. However, the Company has begun to expand its business into the
international market, and has adapted its smart wireline payphone technology for
those foreign countries with telecommunication networks similar to the United
States. The majority of foreign countries follow the standards of the
Consultative Committee for International Telephone and Telegraph ("CCITT") as
compared to the U.S. network standard. One of the primary technical network
differences in the payphone industry between the countries following the CCITT
standards and those following the U.S. network relates to call rating. The
Company does not presently offer a product that operates with networks following
the CCITT standards. However, the Company has commenced the design and
development of a smart payphone processor capable of operating with networks
following either standard. This technology would enable the Company to compete
in foreign countries that follow the CCITT standard (see "Research and Product
Development", below). The Company's new smart payphone processor is currently in
the prototype design stage. The Company has scheduled the development project
for completion during fiscal 1997, and anticipates, but cannot ensure, that the
new smart payphone processor will be available to market by the end of fiscal
1997.
The following table outlines products currently offered by the Company:
PRODUCT DESCRIPTION
GEMINI SYSTEM II(R) The Gemini System II(R)("Gemini") product is a
sophisticated microprocessor-based smart payphone
processor which is programmable to operate in either a
regulated mode or a deregulated mode. The regulated mode
uses the rating and answer supervision services provided
by the central office ("CO") and associated network. In
contrast, rating and answer supervision services are
performed within the processor when programmed to
operate in the deregulated mode. Programmable billing,
reporting and operating cost reduction features offered
with the Gemini product include: (i) station message
detail recording, which provides for the storage of all
call data within the phone; (ii) maintenance reporting
and diagnostics, which provides for remote diagnosis of
payphone and component operating status via telemetry;
(iii) coin administration, which provides coin
10
accounting capability and reporting of coin box status;
(iv) call routing, which provides for the routing of
calls to the programmed IXC; and (v) credit card billing
and auditing, which provides the ability to bill credit
card calls and to identify invalid cards or card
numbers. The Gemini product is also interfaced with an
electronic lock to control and to permit remote
monitoring of collection activities. Programmable
revenue enhancement features offered with the Gemini
product include: (i) voice messaging, which enables the
user to record a message to the called party rather than
allow the call to go uncompleted; and (ii) usage based
pricing, which administrates local call costing on the
basis of time. The features available with the Gemini
product are designed to enable customers to enhance
revenue streams and to reduce costs of operation and
maintenance through the scheduling of maintenance and
collection activities. All programming, retrieval,
reporting and telemetry features are performed remotely
using the Company's payphone software management system.
GEMSTAR The GemStar product is a microprocessor-based smart
payphone processor designed for regulated applications
which require the rating and answer supervision
functions performed by the CO network. The GemStar
product offers the primary cost reduction and reporting
features of the Gemini product, including maintenance
reporting and diagnostics and coin administration. With
added memory, the GemStar product also provides station
message detail recording. The GemStar product is also
interfaced with an electronic lock to control and to
permit remote monitoring of collection activities.
INMATE The InMate product is a microprocessor-based smart
payphone processor designed for the prison segment of
the market where cost reduction and revenue enhancement
features as well as other specialized features are
required. The InMate product offers station message
detail recording, maintenance reporting and diagnostics,
voice messaging, usage based pricing and call routing.
In addition, specialized features include: (i) outgoing
call restriction, which can restrict calls to specified
numbers; (ii) call duration, which limits the time
duration of calls; and (iii) personal identification
numbers, which permit valid user access only. Coin
Administration features are not provided in this
coinless environment.
GEMCELL The GemCell product is a microprocessor-based cellular
payphone processor that interfaces to a cellular
transceiver for use in domestic and international
wireless networks. The GemCell product was designed with
all the primary features available with the Gemini
product except coin administration. Instead, the GemCell
product was designed to accept debit ("prepay") or
credit cards as the form of payment. The GemCell product
is not currently marketed in the U.S.
COINNET The CoinNet product is a remote payphone software
management system which operates on personal computers
in a multi-tasking environment. This proprietary
software product provides the Company's customers with
the ability to manage networks of installed payphones
interactively. Downloading software changes, retrieving
station message detail recording data, maintenance and
diagnostics data and coin box data are a few of the
functions of this Unix or MSDOS-based software system.
11
PAYPHONES The Company offers its payphones in a wide range of
electronic and smart configurations depending upon the
application requirements of its customers. The Company's
wireline payphones include coin (or token) payphones
and/or coinless payphones, including credit card
applications. The Company's wireless, coinless payphones
are offered in fixed configurations as well as
configurations for mobile deployment, such as taxis,
trains and buses. The Company's smart wireline payphone
technology derives power strictly from the telephone
line, eliminating the need for external power sources.
The Company's wireless payphones are powered by
commercial electric line power or by a solar powered
platform so that they can be deployed without network
wiring and cabling.
CELLULAR
ASSISTANCE PHONE The Company also offers a specialized Cellular
Assistance Phone designed to provide emergency phone
service in specific applications, such as along highways
and in remote areas. The Cellular Assistance Phone is
provided with a cellular transceiver and a solar powered
platform for deployment without network wiring and
cabling. The features of the Cellular Assistance Phone
are limited to those required for emergency situations
and permit the user to automatically dial a preset
emergency assistance number. With the exception of three
units sold to the U.S. Army, the Cellular Assistance
Phone is not currently marketed in the United States.
PAYPHONE
COMPONENTS Payphone components supplied by the Company include,
among others, non-smart payphone electronics, touchtone
dials, handsets, coin relays, and volume amplification
assemblies. These components are manufactured at the
Company's facilities to Bellcore specifications.
The Company negotiates the sales prices of its products with each customer
based on many factors including volume, configuration, and required features,
among others, and prices of the Company's products vary accordingly. The list
prices of Gemini products, GemStar products and Inmate products range from $299
to $799 per unit. The Company's GemCell product is generally incorporated into
payphones which have list prices ranging from $1,399 to $1,999 per unit. The
list prices of the Company's smart and electronic payphones range from
approximately $999 to $1,499 per unit. The list prices of the Company's Cellular
Assistance Phone ranges from $1,500 to $3,800. The sales prices of the Company's
payphone components and services are dependent upon the nature of services
rendered or the component provided and range from less than ten dollars to
several hundred dollars. The Company's payphone management software is generally
provided at no charge or a nominal one-time license fee. Such software is
licensed to users in perpetuity for a limited geographic area.
The Company's agreements with its manufacturers generally provide that the
Company will bear certain cost increases incurred by the manufacturer.
Accordingly, the Company's manufacturing costs may fluctuate based on costs
incurred by its contract manufacturers and such fluctuations could have a
material and adverse impact on earnings. The Company's sales agreements with
customers generally have fixed product prices with limited price escalation
provisions. Two of the Company's sales agreements commit the customer to
purchase specific quantities of the Company's products at specified prices,
subject to the cancellation provisions of such agreements. Other sales
agreements, however, do not commit the customer to purchase specified quantities
of the Company's products. Consequently, there is a risk that the Company may
not be able to pass on price increases to its customers. In the event the
Company's costs increase or orders are lost due to price increases, the
Company's profitability would be adversely affected. See "Sales and
12
Markets--Domestic," "Changing Product Mix" and "Manufacturing, Assembly and
Sources of Supply," below.
Services
The Company provides payphone and payphone component repair, refurbishment
and upgrade conversion services for its customers. Refurbishment services
involve the rebuilding of payphone components and sets to "like new" condition.
Upgrade conversion services include the modification of payphone components and
sets to an updated or enhanced technology.
Sales and Markets
Domestic. The Company markets its payphone products and services
predominately to the RBOCs (see "General," above and "Changing Product Mix,"
below). In fiscal years 1994, 1995 and 1996, sales to RBOCs accounting for
greater than 10% of the Company's sales aggregated 73%, 72% and 88%,
respectively, of the Company's sales revenues. During fiscal 1994, Bell Atlantic
Corp. ("Bell Atlantic"), BellSouth Telecommunications, Inc. and NYNEX Corp.
("NYNEX") accounted for approximately $6.1 million, $10.5 million and $5.8
million, respectively, of the Company's sales. During fiscal 1995, Ameritech
Services, Inc., Bell Atlantic, Southwestern Bell Telephone Company ("SWB") and
NYNEX accounted for approximately $2.8 million, $5.8 million, $3.8 million and
$2.2 million, respectively, of the Company's sales. During the year ended March
29, 1996, Bell Atlantic, NYNEX and SWB accounted for approximately $5.6 million,
$7.9 million and $15.5 million, respectively, of the Company's sales.
The Company competes for and enters into non-exclusive supply contracts to
provide products, components and services to the RBOCs. The Company has entered
into sales agreements to provide smart products to Ameritech Services, Inc. and
U.S. West. The Company has entered into sales agreements to provide payphone
components to Ameritech Services, Inc., BellSouth Telecommunications, Inc., Bell
Atlantic, NYNEX and SWB. The Company has entered into sales agreements to
provide repair, refurbishment and conversion services to Ameritech Services,
Inc., Bell Atlantic, NYNEX and SWB. These agreements have terms ranging from two
to three years, are renewable at the option of and subject to the procurement
process of the particular RBOC, contain fixed sales prices for the Company's
products and services with limited provisions for cost increases and expire at
various dates from July 1996 to March 1999. These sales agreements are
frameworks for dealing on open account and do not specify or commit the
Company's customers to purchase a specific volume of products or services. If
orders are made, however, the Company has agreed to fill such orders in
accordance with the customer's contract specifications. The agreements are
generally subject to termination at the option of the customer upon 30 days
notice to the Company, or if the Company defaults under any material provision
of the agreement, including provisions with respect to performance. In addition,
the Company has entered into sales agreements to provide smart products to NYNEX
and SWB. The terms of these sales agreements (the "firm commitment sales
agreements"), however, require the customers to purchase specific quantities of
smart products and other components from the Company at specified prices,
subject to the cancellation provisions thereof. See "Changing Product Mix,"
below.
The Company anticipates that it will continue to derive most of its
revenues from such customers, and other regional telephone companies, for the
foreseeable future. The loss of any one of such RBOC customers or a significant
reduction in sales to such RBOCs would have a material adverse effect on the
Company's business. Recently, two mergers between Pacific Telesis Inc. and SBC
Communications, Inc. (the parent of SWB), and between Bell Atlantic and NYNEX
were announced. The Company cannot predict the impact that such mergers or other
future mergers will or may have on the Company's business.
13
The Company's prospects for continued profitability are largely dependent
upon the RBOC's upgrading the technological capabilities of their installed base
of payphones, and utilizing the Company's products and services for such upgrade
conversion programs. To date, the Company believes that two of the seven RBOC's
have commenced or completed a technological upgrade conversion program for their
installed base of payphones. One of such companies, which is a significant
customer of the Company, has entered into a three-year $21.3 million sales
agreement with the Company in connection with the upgrade of a portion of its
installed base of payphones. In December 1995, the Company entered into an
amendment to a sales agreement with another RBOC, also a significant customer of
the Company, that provides for the sale of approximately $12 million of smart
products and other components over an eight-month period commencing November 1,
1995. Both of these sales agreements may be terminated at the option of the
customer upon prior notice to the Company. The termination of these or any of
the Company's sales agreements could have a material adverse effect on the
Company's business. Further, any assessment of damages under the Company's sales
contracts could have a further material adverse effect on the Company's
operating results and liquidity. The Company is also competing for another smart
payphone award with one of its significant customers. The Company's prospects
are dependent upon this award as well as its ability to obtain other sales
agreements with the RBOCs in the future. Further, the Company's ability to
maintain and/or increase its sales is dependent upon its ability to compete for
and maintain satisfactory relationships with the RBOCs, particularly those
significant customers referred to above. See "Changing Product Mix," below.
Prior to a restructuring instituted in 1994, the Company experienced
difficulties with a first generation smart payphone product, which difficulties
subsequently were remedied. Such difficulties, however, resulted in the
termination of a contract for such product with one of the Company's then
significant RBOC customers (see "Development of the Company--Restructuring,"
above and "Changing Product Mix," below). There can be no assurances that
similar difficulties will not occur in the future. See "Changing Product Mix,"
below and Item 7 - "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Results of Operations."
The Company is dependent upon its third party contract manufacturers to
supply smart products and electronic locks to customers and to meet its sales
commitments pursuant to its firm commitment sales agreements. See
"Manufacturing, Assembly and Sources of Supply," below.
The Company sells its products and services directly to its customers. The
Company involves a wide-range of personnel in its sales and marketing activities
including its Vice President of Sales and Marketing, two experienced sales
directors, three service technicians, its Operations and Plant Vice Presidents,
its engineering staff, its quality managers and its President and CEO. The
Company's engineering staff and service technicians provide support and
technical services over the telephone without charge, and the Company provides
field engineering support services during the initial deployment of products and
when customers encounter unusual or technical problems. The Company's commitment
to service and support throughout its organization is directed at maintaining
strong relationships with customers' operating, technical and administrative
personnel. The Company also conducts training seminars and provides assistance
to customers in the installation and set-up of the Company's payphone software
management system.
International. Internationally, the Company markets its smart wireline and
wireless payphones in foreign markets, primarily consisting of Korea and Mexico.
The Company's wireless payphones have been deployed in Korea, Mexico, Ecuador,
Venezuela and Guatemala. The Company's smart "Gemini" payphone is deployed in
China. The Company markets its products in these foreign markets primarily under
distributor and reseller relationships. The Company has established distributor
relationships in Venezuela, for the South American markets, and in Korea and
China. The Company presently sells its products in Central American markets,
both directly and through an independent sales representative. The Company's
largest foreign customer is presently a cellular service provider in Korea.
14
The Company's export sales during fiscal 1994, 1995 and 1996 approximated
$798,000, $1.4 million and $855,000, respectively. Substantially all of the
Company's international sales are direct sales to foreign customers and
resellers. The Company believes that the international public communications
market represents a growth opportunity. The Company, however, has limited
experience exporting products and operating outside the United States and there
can be no assurance that the Company will be able to generate significant
revenues from international business. Conducting business internationally is
subject to a number of potential risks, including political instability, foreign
currency fluctuations, adverse movements in exchange rates, economic
instability, the imposition of tariffs and import and export controls, changes
in governmental policies (including U.S. policy toward these countries), general
credit and business risks and other factors, one or more of which, if they
occur, could have an adverse effect on the Company's ability to generate
international sales or operations. During the later part of fiscal 1995, the
Company's then largest foreign customer ceased importing the Company's products
as a result of the devaluation of the Mexican peso. The Company's sales to date
have been denominated in U.S. dollars and as a result, no losses related to
currency fluctuations have been incurred. For the same reason, the Company has
not engaged in currency hedging activities. There is no assurance, however, that
the Company will be able to continue to export its products in U.S. dollar
denominations or that its business will not become subject to significant
exposure to foreign currency risks. In addition, the Company intends to develop
wireline payphone products for international CCITT applications (see "Products
and Services," above), and there is no assurance that the Company will be able
to successfully develop or market such products. Finally, many of the Company's
known and potential international competitors have substantially more financial
and other resources than the Company and, therefore, are formidable competitors.
See "Competition," below."
In January 1996, the Company entered into a letter agreement with its
Korean distributor to sell 2,000 Gemini payphones for re-export to China.
However, there is no assurance that the Company will be able to comply with the
customers specifications and supply such payphones on a timely basis, or at all.
Pursuant to the letter agreement, the parties agreed in principle to enter into
a manufacturing and technology transfer agreement that, if entered into, will
enable the Korean distributor to manufacture Gemini products for sale on a
non-exclusive basis in the Far East, including China. Upon consummation of the
manufacturing and technology transfer agreement, the Company shall receive
royalties equal to $50 per unit with respect to Gemini products manufactured and
sold by the distributor. However, there is no assurance that the proposed
relationship will result in any meaningful sales or royalties to the Company.
Changing Product Mix
The Company's business is shifting from repair and service to the provision
of smart payphone products. The Company's sales of smart payphone products
consisting primarily of processors and payphone retrofit kits increased to
approximately $21.8 million during the year ended March 29, 1996 as compared to
$6.6 million in fiscal 1995 and $9.0 million in fiscal 1994. Although the
Company's sales of smart payphone products declined to approximately $6.6
million in fiscal 1995 as compared to fiscal 1994, the decline was attributable
primarily to the termination of a first generation smart product sales agreement
between the Company and one of its then significant RBOC customers caused by
technical and delivery problems experienced by the Company. In addition, such
RBOC failed to renew a refurbishment sales agreement with the Company during the
latter part of fiscal 1995. See "Sales and Markets--Domestic," above. The
Company, however, continues to supply certain payphone components to such RBOC.
Sales to this RBOC customer accounted for 34% of the Company's sales during the
year ended April 1, 1994, 6% of sales during the seven months ended October 30,
1994, 10% of sales during the five months ended March 31, 1995 and 3% of sales
during the year ended March 29, 1996. See "Sales and Markets--Domestic," above.
15
During the initial stages of the roll out of the Company's first generation
smart product during fiscal 1993, the Company's contract manufacturer was unable
to deliver product in accordance with the customer's delivery schedule due to
material shortages and product testing limitations and constraints. In addition,
during the course of the contract, the Company redesigned the product and
selected another contract manufacturer. This contract manufacturer delivered the
product to the Company that later manifested certain hardware problems and
failures that the Company attributed to defective components. These problems
ultimately led to the termination of the smart product sales agreement referred
to above (see Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations"). The Company has disqualified the
suppliers that provided the alleged defective components to the Company's
contract manufacturer and believes that, through improved design and
engineering, it has resolved the hardware and software problems that it
experienced with its first generation smart product. The Company has recently
selected its current contract manufacturer to produce the current generation of
such printed circuit board assemblies, and such products have not experienced
similar problems (see "Manufacturing, Assembly and Sources of Supply," below).
The Company is currently involved in a dispute with the former contract
manufacturer and is involved in litigation with one of the disqualified
component suppliers. See Item 3 - "Legal Procedures and Disputes."
In December 1994, the Company entered into a sales agreement with SWB
pursuant to which the Company agreed to supply and SWB agreed to purchase $21.3
million of smart processors and other components, including electronic locks,
over a three-year period at specified prices. The agreement also includes a
"most favored customer" clause pursuant to which the Company has agreed to
provide SWB price and other terms at least as favorable to SWB as those extended
by the Company to other customers for the products covered by the agreement. The
agreement contains certain covenants and conditions relating to product quality
and delivery requirements, among others. The agreement provides for penalties
and damages in the event that the Company is unable to comply with certain
performance criteria. See "Manufacturing, Assembly and Sources of Supply,"
below. Upon a default by the Company with respect to such covenants and
conditions, SWB has the right to cancel the agreement or reduce its purchase
commitment, provided such default is not cured within a 20-day notice period. In
addition, SWB may in any event terminate the agreement upon at least 30 days
notice. However, upon such a termination, SWB has agreed to purchase all
finished goods then held by the Company and to pay contractor and supplier
cancellation and restocking charges, if any, plus a nominal profit percentage
above the cost of such materials. Because SWB has the right to terminate the
contract on 30 days notice as described above, there can be no assurance that
the Company will ultimately sell $21.3 million of smart processors and other
components pursuant to such contract. The Company is dependent upon its third
party manufacturers to supply products required to meet its sales commitment
under the terms of the agreement (see "Manufacturing, Assembly and Sources of
Supply," below). As of March 29, 1996, the Company estimates that SWB has
acquired approximately 65% of committed volume under such sales agreement.
However, as a result of changes in SWB's delivery requirements, the Company does
not anticipate shipping the remaining volume pursuant to the terms of the
agreement during the 1996 calendar year. See Item 7 - "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
In December 1995, the Company entered into an amendment to a sales
agreement with NYNEX pursuant to which the Company agreed to supply and NYNEX
agreed to purchase approximately $12 million of smart products and other
components over a eight-month period at specified prices. The agreement also
includes a "most favored customer" clause pursuant to which the Company has
agreed to provide NYNEX price and other terms at least as favorable to NYNEX as
those extended by the Company to other customers for the products covered by the
agreement. The agreement contains certain covenants and conditions relating to
product quality and delivery requirements, among others. Upon a default by the
Company with respect to such covenants and conditions, NYNEX has the right to
16
cancel the contract, provided such default is not cured within a 14-day notice
period. Either party may terminate the agreement upon default by the other party
of any material provision of the agreement provided such default is not cured
within a 10-day notice period. In addition, NYNEX has the right to cancel prior
to shipment any and all orders under the agreement and, in such event, would be
liable to the Company only for the cost of goods not otherwise usable or salable
by the Company. Because NYNEX has the right to terminate orders under the
contract as described above, there can be no assurance that the Company will
ultimately sell the $12 million of products under such contract. The Company is
dependent upon its third party manufacturers to supply products required to meet
its sales commitment under the terms of the agreement (see "Manufacturing,
Assembly and Sources of Supply," below). As of March 29, 1996, the Company has
satisfied approximately 43% of its sales commitment to NYNEX.
The Company's service business revenues, including sales of electronic
payphones and payphone components, declined from approximately $21.2 million in
fiscal 1994 to approximately $12.3 million in fiscal 1995 and to approximately
$10.6 million in fiscal 1996. Although a significant portion of the fiscal 1995
decline in service business revenues was attributable to the non-renewal of a
refurbishment sales agreement with one of the Company's RBOC customers discussed
above, the Company believes that as the RBOCs upgrade their payphone base with
new technology, their need for repair and refurbishment services and non-smart
electronic payphone products will decline.
Competition
The Company believes that it is a significant provider of payphone products
and payphone repair services to the regulated telephone operating companies in
the United States. The Company operates in a highly competitive environment and
competes against numerous domestic and foreign providers of payphones and
payphone repair services that have financial, management and technical resources
substantially greater than those of the Company. In addition, there are many
other firms which have the resources and ability to develop and market products
which could compete with the Company's products. The Company believes its
ability to compete depends upon many factors within and outside its control,
including the timing and market acceptance of new products developed by the
Company and its competitors, performance, price, reliability and customer
service and support.
The Telecommunications Act lifts the AT&T consent decree's restriction on
the manufacturing of telecommunications equipment by the RBOCs. After the FCC
finds that the RBOC has opened its local exchange market to competition, the
RBOC, through a separate affiliate, may manufacture and provide
telecommunications equipment and may manufacture customer premises equipment. As
a result of the legislation, the Company could face new competitors in the
manufacture of payphones and payphone components. These new competitors will
probably include one or more of the RBOCs, as well as Lucent Technologies, the
newly created equipment and technology spin-off of AT&T. The RBOCs, Lucent
Technologies and AT&T have financial, management and technical resources
substantially greater than the Company. However, the RBOCs lack manufacturing
expertise, and the legislation does not permit them to create joint
manufacturing operations with each other. The Company believes that these
factors may lead the RBOCs to seek non-affiliated manufacturing enterprises,
such as the Company, with which to collaborate. In addition, the legislation
provides that as long as Bellcore is an affiliate of more than one RBOC,
Bellcore may not engage in manufacturing telecommunications equipment or
customer premises equipment. The Telecommunications Act also incorporates
numerous safeguards to ensure that standards setting organizations conduct
themselves fairly and requires the FCC to establish a dispute resolution process
for equipment manufacturers involved in conflicts over standards setting.
The Company believes that the primary competitive factors affecting its
business with the RBOCs are quality, price, service and delivery performance.
The Company competes aggressively with respect to the pricing of its products
and services, and although the Company's contractual agreements with the RBOCs
17
generally provide the Company with the ability to increase prices if
manufacturing costs increase, the Company attempts to reduce its manufacturing
costs rather than increase its prices. The Company also attempts to maintain
inventory at levels which enable the Company to provide immediate service and to
fulfill the delivery requirements of its customers. The Company also provides
weekly pick-up and delivery services to most of its RBOC customers to ensure
timely performance.
The Company believes that its principal competitors in the United States
include Protel Inc., Elcotel, Inc., Intellicall, Inc., Lucent Technologies and
International Totalizing Systems, Inc., and with respect to repair and
refurbishment services, Restor Industries, Inc. The Company also competes with
numerous foreign companies marketing products in the United States, including
Nortel (previously known as Northern Telecom, Inc.). However, the Company does
not believe that foreign competitors have been able to successfully penetrate
the regulated payphone industry in the United States. Some of the Company's
competitors, including Protel Inc., Intellicall, Inc. and Elcotel, Inc. supply
payphone products to independent payphone providers which compete with the
regulated telephone companies. The Company does not actively market its products
to independent payphone providers.
Many of the Company's competitors are substantially larger than the Company
and have significantly greater financial, technical and marketing resources. As
a result, they may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, promotion and sale of their products than the
Company. It is also possible that new competitors may emerge and acquire
significant market share. Possible new competitors include large foreign
corporations, the Company's RBOC customers and other entities with substantial
resources. In addition, as a result of the Telecommunications Act of 1996, the
RBOCs will be permitted to manufacture and provide telecommunications equipment
and to manufacture customer premises equipment when certain competitive
conditions have been met. It is possible that one or more RBOCs will decide to
manufacture payphone products, which would increase the competition faced by the
Company and could decrease demand for the Company's products by such RBOCs.
Increased competition is likely to result in price reductions, reduced gross
margins and loss of market share, any of which would have a material adverse
effect on the Company's business, results of operations and financial condition.
There can be no assurance that the Company will be able to compete successfully
against current or future competitors or that competitive pressures will not
have a material adverse effect on the Company's business, results of operations
and financial condition. In addition, it is unlikely that the Company will
become a significant supplier of smart payphone products to all seven of the
RBOCs since competition for business with the RBOCs is intense.
Internationally, the Company competes with numerous foreign competitors,
all of which have financial, management and technical resources substantially
greater than the Company. These foreign competitors market payphone products
predominately to the PTT's and thereby dominate the international payphone
market. The Company believes that the primary competitive factors affecting its
international business are the ability to provide products that meet the
specific application requirements of the customers, quality and price.
The Company expects that a number of personal communications technologies
will become increasingly competitive with payphone services provided by the
regulated telephone companies and independent payphone providers. Such
technologies include radio-based paging services, cellular mobile telephone
services and personal communication services. However, the Company believes that
the payphone industry will continue to be a major provider of telecommunications
access.
Prior to 1984, the regulated telephone companies held a monopoly in the
United States payphone market, and they continue to have a dominant share of the
payphone market. The regulated telephone companies have financial, marketing,
management and technical resources substantially greater than those of private
18
payphone providers. The Company believes that the regulated telephone companies
will continue to experience increasing competition from independent payphone
providers. Accordingly, the Company believes, but cannot ensure, that they can
be expected to upgrade their technology base and protect their market share.
The Company believes that wireless payphone services will become one of the
primary avenues of providing communication services to the public in many of the
developing nations in South America and Central America and that these markets
represent a significant growth opportunity. Many of the cellular licenses
awarded to companies in foreign markets to provide services in competition with
national communication authorities have been awarded to consortiums and
companies in which the RBOCs have invested. The Company believes that an
opportunity exists to expand its market channel within the RBOC arena by
deployment of its wireless payphone technology to international wireless
concerns affiliated with the RBOCs. The Company intends to continue to invest in
the development of wireless products and hardware for non-coin technologies
including prepay and debit cards and smart ("chip") cards.
Manufacturing, Assembly and Sources of Supply
The Company's repair, refurbishment and conversion services are performed
and most of the Company's products are assembled at the Company's manufacturing
facilities in Paducah, Kentucky and Orange, Virginia. In addition, certain
components including low-density electronic circuit board assemblies, dials and
handsets, are manufactured at the Company's facilities. Other components are
purchased from various distributors and manufacturers, including contract
manufacturers engaged by the Company. The Company generally assembles its smart
payphone products from assemblies produced by certain manufacturers under
contractual arrangements. To the extent that such manufacturers encounter
difficulties in their production processes that delay shipment to the Company or
that affect the quality of items supplied to the Company, the Company's ability
to perform its sales agreements or otherwise to meet supply schedules with its
customers can be adversely affected.
On October 21, 1994, the Company entered into a manufacturing agreement
with Avex Electronics, Inc., a large contract manufacturer, that provides for
the production of the Company's GemStar circuit board assemblies and the GemStar
payphone processor. Pursuant to the terms of the manufacturing agreement, the
Company committed to purchase $12.2 million of assemblies over an eighteen-month
period beginning in December 1994. Purchases under the terms of the contract
fluctuate based on delivery requirements established by the Company. The
agreement may be terminated by either party for default upon a material breach
of the terms of the agreement by the other party, provided such breach is not
cured within a 30-day notice period. Further, the Company may terminate the
agreement at any time. However, upon a termination of the agreement by the
Company, the Company is obligated to purchase inventories held by the
manufacturer and pay vendor cancellation and restocking charges, and a
reasonable profit thereon. The Company has also engaged the contract
manufacturer to manufacture the printed circuit board assemblies for the
Company's Gemini processors. The Company is dependent upon the contract
manufacturer to manufacture and supply products required to meet sales
commitments under the terms of its firm commitment sales agreements (see "Sales
and Markets--Domestic" and "Changing Product Mix," above).
The Company has entered into several teaming agreements with Control
Module, Inc., a manufacturer of electronic lock devices, to market the products
to certain RBOCs and other telephone companies. The teaming agreements provide
for the award of exclusive dealer contracts to the Company when customers award
purchase contracts to the Company. On November 18, 1994, the Company executed an
exclusive dealer agreement to supply the electronic lock devices to one of the
Company's significant RBOC customers. The dealer agreement commits the Company
to purchase approximately $3.5 million of electronic lock devices at specified
prices over a two-year period. The purchase volume of electronic lock devices
19
varies based on delivery requirements established by the Company. The dealer
agreement expires after the Company's purchase of the committed volume or after
30 months, whichever occurs first. The agreement may be terminated by either
party for default upon a material breach of the terms of the agreement by the
other party, provided such breach is not cured within a 30-day notice period.
Further, the Company may terminate its orders under the agreement upon 45 days
notice. However, upon a termination of outstanding orders by the Company, the
Company is obligated to purchase inventories held by the manufacturer and pay
vendor cancellation and restocking charges. The Company is dependent upon the
electronic lock manufacturer to supply products required to meet its sales
commitment under the terms of one of its firm commitment sales agreements (see
"Sales and Markets--Domestic" and "Changing Product Mix," above).
Pursuant to its agreements with Avex Electronics, Inc. and Control Module,
Inc. discussed above, the Company is obligated to acquire certain product
inventory in a prescribed time period. The Company presently anticipates that
scheduled purchases under such contracts through December 1996 will exceed sales
requirements as a result of changes in delivery requirements of one of the
Company's customers. Although the Company is encouraging its customer to
accelerate purchases and is seeking to reschedule deliveries pursuant to such
agreements, an increase in inventories related to such agreements is anticipated
and such increase could approximate as much as $2.0 million. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Changing Product Mix," above.
On September 16, 1991, the Company entered into a Manufacturing Rights
Agreement (the "Manufacturing Agreement') with Commtek Industries, Inc., an
unaffiliated Taiwan corporation. Pursuant to the Manufacturing Agreement, the
Company granted the Taiwan corporation the exclusive right to utilize the assets
owned by the Company's foreign division for a period of five years to
manufacture many of the non-electronic components and assemblies for the
Company's products in factories based in the Pacific Rim. The Company entered
into the Manufacturing Agreement because it determined that continued operation
of the business was not economical due to the capital commitments required
therefor. The Company agreed to purchase a minimum aggregate annual volume of
$2.5 million during the first year of the agreement and $3 million for each year
thereafter. The Manufacturing Agreement provided for the payment of an annual
fee of $57,155 to the Company through March 31, 1995. The Taiwan corporation is
required to pay royalties to the Company based upon sales to customers other
than the Company. The Manufacturing Agreement also provides that the Company
receives a 20% discount from prices charged to other customers.
The majority of the Company's products in terms of revenues contain
components or assemblies that are purchased from single sources (including those
discussed above). The Company believes that there are alternative sources of
supply for most of the components and assemblies currently purchased from single
sources. Some of the components and assemblies used by the Company for which
there are not immediately available alternative sources of supply are provided
to the Company under standard purchase arrangements. If a shortage or
termination of the supply of any one or more of such components or assemblies
were to occur, however, the Company's business could be materially and adversely
affected. In such event, the Company would have to incur the costs associated
with redesigning its products to include available components or assemblies or
otherwise obtain adequate substitutes, which costs could be material. Also, any
delays with respect to redesigning products or obtaining substitute components
could adversely affect the Company's business.
The Company has entered into two agreements pursuant to which it is
obligated to acquire certain product inventory in prescribed time periods. The
Company presently anticipates that scheduled purchases under such contracts
through December 1996 will exceed sales requirements as a result of changes in
20
the Company's customer delivery requirements. Although the Company is
encouraging its customer to accelerate purchases and is seeking to reschedule
deliveries pursuant to such agreements, an increase in inventories related to
such agreements is anticipated and such increase could approximate as much as
$2.0 million. See Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" and
"Changing Product Mix," above.
The Company attempts to maintain inventory levels adequate to meet the
delivery requirements of its customers. However, the Company's business is
subject to the risk of an interruption in supply that could have a significant
impact on its operations. Suppliers of certain electronic parts and components
to the Company and its contract manufacturers occasionally place their customers
on allocation for those parts. Therefore, there can be no assurance that the
Company's business will not be adversely impacted by allocations and a limited
supply of such electronic components.
The Company's operations are also subject to risks associated with
defective assemblies. In April 1995, the Company determined that GemStar
processors shipped in March 1995 were subject to failure due to contamination
introduced into the manufacturing process by the Company's contract
manufacturer. Accordingly, the Company recalled approximately 5,500 units for
repair or replacement by the contract manufacturer. Although the contract
manufacturer was responsible for the repair or replacement of the recalled
units, the Company was required to pay liquidated damages to its customer under
the terms of the sales contract in the amount of $200,000. This liability was
recorded in the Company's consolidated financial statements at March 31, 1995.
Also, the Company agreed to extend its warranty on up to 5,000 units shipped
under the contract through December 31, 1998.
The recall and associated shipment delays created by the recall had an
adverse impact on the Company's operating results during the first quarter of
fiscal 1996. However, the Company was able to maintain a satisfactory
relationship with the affected customer. During the year ended March 29, 1996,
the contract manufacturer and the Company repaired or replaced the recalled
units. In addition, the Company continued to ship products to its customer in
accordance with the terms of the sales agreement. The contamination introduced
into the manufacturing process was created by a change in the manufacturing
process and the use of a new material without the Company's prior knowledge. The
Company and the contract manufacturer have since taken steps, including quality
control measures, to assure that the processes and materials used in the
manufacturing process of the Company's products do not adversely affect product
quality or performance. Although the Company believes that the problems have
been adequately addressed and has continued its relationship with the contract
manufacturer, there can be no assurance that such events will not occur in the
future, either with this manufacturer or others. In the event that contract
manufacturers delay shipments or supply defective materials to the Company in
the future, and such delays or defects are material, the Company's customer
relations could deteriorate and its sales and operating results could be
materially and adversely affected.
Warranty and Service
The Company provides warranties of 90 days with respect to repair,
refurbishment and conversion services and from one to three years on its
products. Under the Company's warranty program, the Company repairs or replaces
defective parts and components at no charge to its customers. The Company's
contract manufacturers provide warranties on the electronic circuit board
assemblies ranging from 90 days to 120 days. Under warranties provided by
contract manufacturers, defective electronic circuit board assemblies are
replaced or repaired at no charge to the Company.
The Company's technical service and engineering staffs provide support
services over the telephone to customers who have installation or operational
questions. The Company also provides field engineering support services during
21
the initial deployment of the Company's products and when customers encounter
unusual conditions or problems.
The Company generally enters into repair agreements with respect to its
smart products under which the Company agrees to perform non-warranty repair
services at specified prices. The Company also provides repair, refurbishment
and conversion services under agreements with its customers. See "Services" and
"Sales and Markets," above.
Licenses, Patents and Trademarks
The Company has developed the software and engineering designs incorporated
in its smart payphone products from technology acquired in 1991. The engineering
designs incorporated in the Company's electronic products and components were
internally developed by the Company. The Company owns eight United States
patents relating to payphone components, its smart payphone platform, the Gemini
product, and other technology which expire between April 2010 and May 2014. The
Company has filed and has outstanding one patent application with respect to
payphone components and wireless technology. Although the Company believes that
its patents and trademarks are important to its business, it does not believe
that patent protection or trademarks are critical to the operation or success of
its business. It is the Company's policy to seek to protect its patents against
infringement by others. The Company does not believe that it is infringing on
the patents of others and would defend itself against any allegations to that
effect. There can be no assurances, however, that infringement claims will not
be asserted in the future or that the results of any patent related litigation
would not have a material adverse affect on the Company's business.
The Company regards its manufacturing processes and circuit designs as
proprietary trade secrets and confidential information. To protect this
information, the Company relies largely upon a combination of agreements with
its contract manufacturers, confidentiality procedures, and employee agreements.
However, there can be no assurance that the Company's trade secrets will not be
disclosed or misappropriated.
Pursuant to the terms of an asset purchase agreement entered into on
January 11, 1991, the Company is obligated to pay royalties equal to 3.5% of
sales of smart processors and related components to a company affiliated with
certain officers and employees of the Company who were formerly officers and
employees of PCS. On November 9, 1994, the Company entered into an amendment
agreement that provided for the elimination of royalties for the period from
April 2, 1994 to September 30, 1994. In return, the term of the royalty
obligation was extended from December 31, 1995 to June 30, 1996. Royalty expense
under the terms of the agreement approximated $301,000 during the year ended
April 1, 1994, $3,900 during the seven months ended October 30, 1994, $94,000
during the five months ended March 31, 1995 and $564,000 during the year ended
March 29, 1996.
In October 1995, the Company entered into a patent license agreement
effective as of September 1, 1995 that provided the Company with a non-exclusive
paid up license to manufacture and market products embodying certain patented
telephone inventions. The Company paid a non-refundable patent license fee of
$375,000 consisting of $33,000 in cash upon execution of the agreement, $242,000
of deposit payments made pursuant to the terms of a previous agreement and
$100,000 of future services. Previous deposit payments made by the Company in
the amount of $242,000 were charged to operations during the years ended April
2, 1993 and April 1, 1994 due to an uncertainty surrounding their realization.
Accordingly, the patent license was recorded at an amount of $133,000 consisting
of the $33,000 cash payment and the liability of $100,000 with respect to future
services. Pursuant to a letter agreement, the Company agreed to render the
future services over a period of five years in return for the licensors
agreement to provide accurate data to the Company for a five-year period. On
March 14, 1996, the patent licensing agreement was amended pursuant to a letter
22
agreement, and the Company paid to the licensor $100,000 in return for the
licensor's agreement to cancel the Company's obligation to provide future
services.
Prior to the Restructuring, the Company entered into a license agreement
providing the Company with the exclusive rights to certain algorithm software
that is the subject of a patent application. The Company is obligated to pay
license fees aggregating $200,000 at the rate of $50,000 annually over a
four-year period commencing on the date the patent is issued. The agreement also
provides for the payment of royalties on products incorporating the licensed
software. If the patent issues, minimum royalties will range between $125,000 to
$500,000 annually for the life of the patent. The term of the license agreement
will correspond to the term of the patent. As of March 29, 1996, the patent has
not been issued, and the Company has not sold any products incorporating the
licensed software. The Company had believed that the algorithm software would be
a marketable enhancement to its smart products. However, the licensed algorithm
has not been incorporated into any of the Company's products, nor does the
Company have any present plans to incorporate the algorithm into any of its
products. Also, management does not believe, but cannot assure, that a patent
for the algorithm will be issued due to existing prior art. If a patent were to
be issued, however, royalties would be payable as described above regardless of
whether or not the algorithm is incorporated into the Company's products.
Design and Product Development
The Company's engineering department is staffed with software, electrical
and mechanical engineering professionals. Their activities are dedicated to the
development of new products, enhancements to the Company's deployed product
line, including the CoinNet management system, and enhancements to improve
product reliability. Their efforts are also directed to reducing product costs
through new manufacturing methods. During fiscal 1994, 1995 and 1996, the
Company expended approximately $2 million, $938,000 and $1.2 million,
respectively, on engineering, research and development activities, primarily for
GemStar, Gemini and GemCell products. The Company believes that new products and
product enhancements will increase its market opportunities and are essential to
its long-term growth, particularly in international wireline markets. The
Company's ability to fund future research and development activities will be
dependent upon its ability to generate cash in excess of its operating needs.
See Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Employees
At March 29, 1996, the Company had 248 full-time employees of which 175 are
direct labor, 41 are engaged in manufacturing support activities, 17 are engaged
in administrative, sales and finance activities and 15 are engaged in
engineering and engineering support activities. In addition, the Company has one
part time employee, one temporary employee and one independent contractor
engaged in sales and sales support activities, and two temporary employees
engaged in engineering support activities.
The direct labor personnel located at the Company's Paducah, Kentucky
facility (94 persons) are represented by the International Brotherhood of
Teamsters, Chauffeurs, Warehousemen and Helpers of America pursuant to an
October 26, 1993 collective bargaining agreement. The agreement expires on
October 26, 1996 and is automatically renewable for additional one year periods
thereafter unless terminated by either party upon 60 days notice prior to the
renewal date. The Company considers its relations with its employees and the
Union to be satisfactory.
Backlog
The amount of the Company's backlog is subject to large fluctuations
because the Company's business depends upon a small number of customers and
large orders. The Company calculates its backlog by including only items for
which there are purchase orders with firm delivery schedules. Contractual
23
commitments are not included in backlog until purchase orders are received by
the Company. At March 29, 1996, the backlog of all products and services was
approximately $3.8 million as compared to approximately $4.0 million at March
31, 1995. The Company's objective is to ship orders within 30 days and,
therefore, the Company does not expect its backlog, other than orders with
scheduled deliveries under contractual commitments, to exceed monthly sales
levels. Accordingly, the Company's backlog at any given date is not indicative
of future revenues. See Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Seasonality
The Company's sales are generally stronger in the spring, summer and fall
months when the weather does not interfere with the maintenance and installation
of payphone equipment by the Company's customers. Accordingly, reduced sales
volumes could adversely affect the Company's results of operations during
certain periods of the year. However, the Company may also receive large
year-end orders from its customers for shipment in December.
Potential Environmental Liabilities
One of the Company's former facilities in Florida is currently the subject
of evaluation by the Florida Department of Environmental Protection (the
"FDEP"). The Company has completed the initial assessment and monitoring
activities agreed upon with the FDEP and determined that contamination of the
site was below concentration level guidelines set by the FDEP. The Company filed
with the FDEP its report with respect to such assessment and monitoring
activities requesting that a "no further action status" be granted to the site.
However, the FDEP recently requested the Company to perform an additional
analysis of groundwater contamination and report the findings before the FDEP
rules on the site. The Company has concluded, based on its clean-up, testing and
monitoring activities, that detected contaminant concentrations are minimal and
are generally within the state's maximum concentration guidelines, and that
trends of detected contaminant concentrations are declining. The Company
believes, but cannot assure, that the site will be granted a "no further action
status" and that continued monitoring or remediation activities will not be
required by the State. Accordingly, the Company has not accrued any additional
costs with respect to this site. It is possible, however, that the FDEP may
require further remedial or monitoring actions at such site. Accordingly, the
Company cannot estimate a range of costs, if any, that it may incur in the
future since such costs would be dependent upon the scope of additional response
actions, if any, required by the State of Florida.
The Company has been notified by the North Carolina Department of
Environment, Health and Natural Resources ("DEHNR") that it is a Potentially
Responsible Party ("PRP") that may be liable for undertaking response actions at
a facility for the treatment, storage, and disposal of hazardous substances
operated by Seaboard Chemical Corporation from 1975 to 1989 at Jamestown, North
Carolina. The Company has become a member of the PRP groups (the "Seaboard
Groups") formed to cooperatively respond to the DEHNR's Notices of
Responsibility and Imminent Hazard Order to undertake a surface removal action
and an initial remedial investigation at the site, and to take additional
response actions at the site, including a feasibility study and, if necessary,
soil and groundwater remedial action, that may be required pursuant to consent
orders that may be entered into among the PRP groups and the DEHNR. The Company
has been defined by the PRP groups as a small generator of hazardous substances
shipped to the site and is referred to as a "De Minimis" party. As a De Minimis
party, the Company's proportionate share of costs incurred by the PRP groups to
comply with response actions required by the DEHNR have been insignificant. With
respect to the Seaboard site, the Company contributed 1,100 gallons of waste of
a total of 19 million gallons. The Company executed a buy-out agreement with
respect to a Phase I clean-up (the cost of which aggregated $3.753 million) at a
buy-out price of $423. The aggregate cost of a Phase II remedial investigation
and remediation and the cost of post Phase I response actions are estimated to
be $28.5 million. The Company has received notification that it will be able to
execute a buy-out agreement with respect to the remedial investigation and
24
remediation at a buy-out cost of approximately $8,200. The Company believes, but
cannot assure, based on information presently available to the Company, that its
proportionate share of costs incurred by the PRP groups in connection with
additional response actions that may be required will not be material.
The Company has also been notified that it is a PRP that may be liable for
response actions at the Galaxy/Spectron Superfund Site in Elkton, Maryland. The
Company, however, is a De Minimis party with respect to this site, and its
proportionate share of costs to undertake response actions, the Company
believes, will likely be insignificant. The Company contributed 770 gallons of
waste to the site, but has not received any information with respect to the
total number of gallons contributed to the site by other PRPs. The Company has,
however, received notification that the De Minimis parties will be able to buy
out and obtain a release from any further clean-up liability at the site at a
cost presently estimated at $3.70 per gallon of contributed waste, which would
amount to $2,849 with respect to the Company's contribution. The Company has not
incurred any costs with respect to this site and believes that its ultimate
costs will not be material.
The Company has accrued environmental costs amounting to $12,948 in its
consolidated financial statements at March 29, 1996. Based on information
available to the Company, the Company believes that such loss accrual is
adequate to provide for the above-described environmental contingencies.
However, there is no assurance that such estimate will not be revised in the
future upon receipt of additional information or that any such additional
estimated loss accruals will not have a material adverse affect on the Company's
results of operations or financial position. Furthermore, the Company's
potential liability with respect to the above matters may not limited to its
proportionate share of hazardous waste contributed to the sites. To the extent
that other PRPs are unable to pay, and if the large generator PRPs are unable to
bear the cost of remedial actions, the amount that the Company would be required
to pay in connection with future remedial actions could increase to amounts that
would be material to the Company.
Government Regulation
The Company's operations are subject to certain Federal, state and local
regulatory requirements relating to environmental, waste management, health and
safety matters. Management believes that the Company's business is operated in
compliance with applicable regulations promulgated by the Occupational Safety
and Health Administration and the Environmental Protection Agency and
corresponding state agencies which pertain to health and safety in the work
place and the use, discharge and storage of chemicals employed in its
operations, respectively. Current costs of compliance with such regulations are
not material to the Company. However, the adoption of new or modified
requirements not presently anticipated could create additional expense for the
Company.
Certain of the Company's products must comply with FCC rules. The FCC
regulates under Part 15 of its rules the operation and marketing of devices
which emit radiofrequency energy, whether intentionally or unintentionally, and
which do not require an individual license. The marketing of such devices is
also regulated under Part 2 of the FCC's rules. The FCC regulates the direct
connection of terminal equipment to the public switched telephone network and
the marketing of such equipment under Part 68 of its rules. Parts 15 and 68
establish technical standards and procedural and labeling requirements for
equipment subject to these rules. Certain modifications to equipment subject to
these rules must also comply with these technical standards and procedural and
labeling requirements. Manufacturers of products subject to Part 68 also must
implement a continuing compliance program under which products currently in
production must be tested every six months to assure continued compliance with
the applicable technical standards.
25
Coin-line products operated in a regulated mode by the RBOCs are exempt
from the requirements of Part 68 but may be subject to Part 15 if they emit
radiofrequency energy. In addition, certain types of devices sold as components
or subassemblies are exempt from the technical standards and procedural and
labeling requirements of Parts 15 and 68. If such components or subassemblies
are incorporated into and marketed as part of systems or sets subject to Part 15
or Part 68, however, such systems or sets must comply with the applicable rules.
As described in more detail below, the Company has not complied fully with the
requirements of Parts 15 and 68.
The vast majority of the Company's payphone products are coin-line products
operated in a regulated mode by RBOCs which are exempt from registration under
Part 68 of the FCC's rules. However, the Company is required to verify through
testing that these products comply with the radiofrequency radiation standards
set forth in Part 15 of the FCC's rules. The Company has completed the
verification process for some but not all of its currently marketed coin-line
products and is in the process of verifying those coin-line products which were
not previously verified.
The Company's Gemini product is subject to the verification procedure of
Part 15 of the FCC's rules and is subject to Part 68 of the rules when marketed
by the Company to private payphone operators as part of a completed set
operating in the deregulated mode. Although most of the Gemini products have
been sold to regulated telephone companies and are therefore exempt from Part
68, the Company has sold Gemini products in small quantities to private payphone
operators. The Gemini product has undergone a number of revisions intended to
improve its performance. An earlier revision of the Gemini product was verified
under Part 15 and registered under Part 68, and a modification to the product
was registered in July 1993. Subsequent modifications to this product have not
been registered or verified, and the Company has not conducted continuing
compliance tests on these later versions of the product and has not supplied the
required labels on completed sets. The Company is in the process of verifying
and registering the revisions of the Gemini product currently installed by
private payphone operators, preparing labels to be affixed to completed sets
sold to private payphone operators, and reactivating its continuing compliance
program.
The Company's InMate product is subject to the requirements of Part 15 and
68 of the FCC's rules. The product was verified in July 1991 and registered in
August 1992. The last continuing compliance test was conducted on the InMate
product in March 1993. The Company is in the process of updating the
verification and registration and preparing labels for this product.
The Company is currently reviewing the compliance status of all of its
payphone products and may discover additional instances in which a product
subject to Part 15 or Part 68 has not been verified or registered or has not
been subjected to continuing compliance testing. The Company intends through
this process to bring all of its products into full compliance with the FCC's
rules. The FCC has authority under the Communications Act of 1934, as amended,
and its rules to impose penalties for non-compliance with the requirements of
Parts 15 and 68. These penalties may include, from least to most severe, issuing
a letter of admonition, imposing a fine, or revoking a registration. The
Company, through its counsel, has had informal discussions with staff members of
the FCC concerning the penalties, if any, the FCC would be likely to impose for
instances of non-compliance, such as the Company's, with Parts 15 and 68 of the
rules. Although these discussions were in general terms and are non-binding on
the FCC, the Company believes that the FCC is not likely to impose penalties
upon the Company for its non-compliance with the rules and that in the event
penalties were imposed by the FCC, such penalties would not have a material
adverse impact upon the Company. The Company bases this belief on the small
percentage of the Company's products subject to the Part 68 registration
requirement, the Company's overall history of compliance, the Company's
self-discovery and self-disclosure to the FCC of instances of non-compliance,
and the Company's implementation of remedial measures to ensure full compliance
with the rules.
26
The Company's customers in the United States, the local exchange carriers,
operate in an industry that is subject to extensive regulation by the FCC and
state regulatory agencies. Most state public utility commissions have
established rules and regulations governing intrastate telecommunication
services, including provision of pay telephone service.
The Company believes that the regulatory climate in the United States over
recent years has begun to influence the RBOCs deployment of public communication
products. The Company also believes that the RBOCs have begun to upgrade their
payphone base with smart products that reduce their cost of management,
maintenance and coin administration and that include revenue enhancement
features. The deployment and business strategies of the public communication
divisions of the RBOCs have affected and will continue to affect the Company's
business. To the extent that these business strategies were to change, for
regulatory reasons or otherwise, the Company's prospects would be materially and
adversely affected. On February 8, 1996, the President signed into law the
Telecommunications Act of 1996, which deregulates many elements of the
telecommunications industry as a means of stimulating competition. This
deregulation could affect the payphone products industry. Although the Company
believes that deregulation generally will benefit the Company, there can be no
assurance that the Company will benefit from deregulation or that it will not be
adversely affected by deregulation. See "The Public Payphone Industry--Domestic
Regulatory Outlook," above.
Although dramatic regulatory changes, particularly those created by recent
legislative actions (see "The Public Communications Industry," above), have
occurred and may continue to occur, the Company believes that the
telecommunications industry will continue to be regulated in some form by
Federal and/or state authorities. There can be no assurance that changes in
regulations affecting the telecommunications industry, if proposed and adopted,
would not have an adverse impact on the operations of the Company's customers
and, therefore, on the operations of the Company.
Item 2. PROPERTIES
The Company's administration, sales, marketing and engineering activities
are located at its headquarters in approximately 11,800 square feet of office
space, the lease for which expires on December 31, 1997.
The Company's payphone assembly operations, low-density printed circuit
board assembly operations and its repair, refurbishment and conversion service
operations are performed at two leased facilities, consisting of an
approximately 100,000 square-foot facility in Paducah, Kentucky and an
approximately 53,400 square-foot facility in Orange, Virginia.
The Company's Paducah, Kentucky facility is leased pursuant to the terms of
a capital lease dated November 30, 1990. The lease has an initial term of five
and one-half years and is renewable for two additional five-year periods
beginning May 31, 1996. In March 1996, the initial five and one-half year term
of the lease agreement was extended by a year pursuant to the terms of a letter
agreement. The Company has an option to acquire the facility at the end of the
lease term, including the renewal periods, at a cost of $10,000.
The Orange, Virginia facility is leased pursuant to the terms of an
operating lease agreement dated August 1, 1986. The lease had an initial term of
five years and was renewed for an additional five-year term on August 1, 1991.
The lease agreement expires on July 31, 1996.
The Company believes its facilities are adequate for its business.
27
Item 3. LEGAL PROCEEDINGS AND DISPUTES
On July 5, 1994, Multitek Circuitronics, Inc. ("Multitek") filed suit
against the Company in United States District Court for the Northern District of
Illinois Eastern Division to collect unpaid obligations of approximately
$400,000. The Company disputes that any sums are owed and claims that Multitek
supplied defective printed circuit boards to the Company and one of its contract
manufacturers that contributed to the termination of a first generation smart
product sales agreement between the Company and one of its then significant RBOC
customers in fiscal 1994. Management intends to defend and pursue the Company's
positions vigorously. There is no assurance, however, that the suit can be
resolved in the Company's favor. The unpaid obligations, however, have been
recorded in the Company's financial statements. Accordingly, it is the opinion
of management of the Company that the ultimate disposition of the proceeding,
even if unfavorable to the Company, will not have an adverse material effect on
the Company's results of operations or financial position.
In October 1994, the contract manufacturer that delivered the defective
first generation smart products to the Company (see Item 1 "Business--Changing
Product Mix") discontinued operations prior to the scheduled contract
termination date. In April 1995, the contract manufacturer formally terminated
the Company's manufacturing contract as of the scheduled termination date.
Pursuant to the terms of the manufacturing contract, the Company was committed
to acquire the manufacturer's inventories related to the Company's products. The
Company is presently involved in a dispute with the contract manufacturer with
respect to such inventories, which approximate $l million, unpaid obligations of
the Company of approximately $265,000, unpaid obligations of the contract
manufacturer of approximately $125,000 due to the Company, and other matters
including an alleged claim of lost profits by the contract manufacturer of
approximately $916,000 related to the Company's minimum contract purchase
commitment and alleged claims of lost business and expenses of the Company due
to the delivery of defective products and the termination of a significant smart
product sales agreement (see Item 1 "Business--Changing Product Mix," above).
The Company is attempting to settle the dispute with the manufacturer and claims
that the manufacturer supplied defective product and that it breached the
agreement by discontinuing operations prior to the scheduled termination date.
However, there is no assurance that the dispute can be settled in the Company's
favor, or at all. Also, there is no assurance that the dispute will not escalate
into litigation. Should the dispute escalate into litigation, the Company
intends to defend and pursue its positions vigorously. However, there is no
assurance that the outcome of the dispute or potential litigation related
thereto will not have a material adverse effect on the Company's financial
position or results of operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders through the
solicitation of proxies or otherwise during the fourth quarter of fiscal 1996.
28
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Units, Common Stock and Redeemable Warrants were listed on
The Nasdaq Small Cap Market tier of The Nasdaq Market under the symbols "TSGIU,"
"TSGI" and TSGIW effective May 10, 1996. Prior to May 10, 1996, there was no
public trading market for the Units, the Common Stock or the Redeemable
Warrants. There can be no assurance that a regular trading market for the Units,
the Common Stock or the Redeemable Warrants will develop or that, if developed,
will be sustained. The market price of the Units, the Common Stock and
Redeemable Warrants may be highly volatile as has been the case with securities
of many emerging companies. Factors such as the Company's operating results,
announcements by competitors of new products or contracts, or the activities of
the RBOCs may significantly impact the market price of the Units, the Common
Stock and Redeemable Warrants.
The high and low bid quotations of the Units, Common Stock and Redeemable
Warrants for the period May 10, 1996 to May 31, 1996 were as follows:
High Low
---- ---
Units 13 1/2 9
Common stock 12 3/8 10 1/8
Redeemable warrants 2 1/8 1 5/8
The quotations set forth above represent prices between dealers and exclude
commissions, mark-ups or mark-downs and do not necessarily represent actual
transactions.
As of May 31, 1996, the Company had six common stockholders of record.
However, the Company believes that there are over 400 beneficial owners of its
Common Stock at March 31, 1996.
The Company has never paid any cash dividends on its Common Stock and does
not currently intend to pay cash dividends in the foreseeable future. The
Company currently intends to retain its earnings, if any, for the continued
growth of its business. Pursuant to the terms of a Loan and Security Agreement
between the Company and its bank (the "Loan Agreement"), the Company is
prohibited from paying cash dividends or other distributions on capital stock,
except stock distributions. See Item 7 - "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
29
Item 6. SELECTED FINANCIAL DATA
On October 31, 1994, TSG Acquisition Corp. acquired all of the outstanding
capital stock of the Company for aggregate consideration of $3,500,000 including
contingent consideration of $329,709 placed in escrow and distributed to former
stockholders in September 1995. The consideration consisted of $3,004,000 to
acquire the outstanding capital stock of the Company and $496,000 to retire a
$400,000 subordinated master promissory note payable to former stockholders and
related accrued interest and preference fees of $96,000. Aggregate cash payments
to former stockholders, including the contingent consideration and the
retirement of the subordinated master promissory note, accrued interest and
preference fees of $496,000, amounted to $3,222,090. Consideration of $277,910
was withheld from amounts paid to former stockholders to pay certain liabilities
of the Company. Contingent consideration consisting of cash of $230,117 and a
subordinated note of the Company in the principal amount of $99,592 was placed
in escrow and distributed to former stockholders in September 1995. The
Acquisition was accounted for using the purchase method of accounting.
Accordingly, the aggregate purchase price of $3,170,291, exclusive of contingent
consideration, was pushed down and allocated to the net assets acquired based
upon their fair values. The excess of the purchase price over the estimated fair
value of the net assets acquired of $3,853,877 was recorded as goodwill. Upon
distribution of the escrow consideration in September 1995, the aggregate
purchase price was increased to $3,500,000, which increased the excess purchase
price over the estimated fair value of net assets acquired and recorded as
goodwill by $329,709. Prior to the Acquisition, the Company is sometimes
referred to the "Predecessor."
The selected financial data presented herein for the years ended April 3,
1992, April 2, 1993 and April 1, 1994, seven months ended October 30, 1994, five
months ended March 31, 1995 and year ended March 29, 1996 has been derived from
the Company's and the Predecessor's audited consolidated financial statements.
The selected financial data for periods prior to October 30, 1994 relates to the
Predecessor and for periods subsequent to October 30, 1994 relates to the
Company. The financial data for the Predecessor is not comparable in certain
respects to the financial data of the Company due to the effects of the
Acquisition. The selected financial data presented herein should be read in
conjunction with Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements,
including the notes thereto, of the Company and the Predecessor included
elsewhere herein. The audited consolidated financial statements of the Company
as of and for the years ended April 3, 1992 and April 2, 1993 and as of April 1,
1994 and the Accountants' Reports thereon are not included herein.
30
The following schedule sets forth a summary of selected financial data for
the five fiscal years ended March 29, 1996.
Statement of Operations Data
Predecessor Company
------------------------------------------------------------ ----------------------------
Year Ended Seven Months Five Months
-------------------------------------------- Ended Ended Year Ended
April 3, April 2, April 1, October 30, March 31, March 29,
1992 1993 1994 1994 1995 1996
------------ ------------ ------------ ------------ ------------ ------------
Net sales $ 29,310,095 $ 30,535,968 $ 31,048,706 $ 11,108,653 $ 9,161,359 $ 33,201,686
Cost of goods sold 22,330,551 24,083,319 25,761,831 9,176,134 8,226,245 26,082,055
General and administrative
expenses 3,846,972 3,333,996 3,476,932 1,742,324 850,069 2,204,915
Marketing and selling
expenses 1,412,598 1,865,134 1,748,814 366,464 371,757 1,290,349
Engineering, research and
development expenses 1,633,948 2,241,552 2,009,524 457,553 480,495 1,197,183
Restructuring charges
(credits) -- -- 2,570,652 (534,092) -- --
Litigation settlement -- -- -- (261,022) -- --
Loss provision (1) 603,015 -- -- -- -- --
Interest expense 985,794 809,589 911,821 599,276 356,624 941,261
Other (income) expense 68,749 200,875 54,557 (14,618) (58,250) (17,763)
Income (loss) before taxes (1,571,532) (1,998,497) (5,485,425) (423,366) (1,065,581) 1,503,686
Income tax provision (63,300) -- -- -- -- (326,315)
Net income (loss) $ (1,634,832) $ (1,998,497) $ (5,485,425) $ (423,366) $ (1,065,581) $ 1,177,371
Income (loss) per common
and common equivalent
share (2) (3) $ (0.30) $ 0.30
Weighted average number
of common equivalent
shares outstanding 3,541,778 3,870,889
(1) During the year ended April 3, 1992, the Company recorded a loss provision
of $603,015 as a result of an uncertainty with respect to the collection of
notes and advances receivable from the former general manager of the
Company's Taiwan division and a supplier affiliated with the general
manager. These notes and advances receivable were written off during fiscal
1994 upon settlement of litigation between the Company and the former
general manager and the supplier.
(2) Assuming the Acquisition had occurred on April 2, 1994, the Company's and
the Predecessor's net loss for the year ended March 31, 1995 would have
approximated $1,599,000, or ($.45) per common and common equivalent share
outstanding of 3,541,778 shares.
(3) Income (loss) per common and common equivalent share and the weighted
average number of common equivalent shares outstanding are not presented
for periods prior to the five months ended March 31, 1995 since such data
is not meaningful for periods prior to the Acquisition on October 31, 1994.
31
Balance Sheet Data
Predecessor Company
------------------------------------------------------------ ----------------------------
April 3, April 2, April 1, October 30, March 31, March 29,
1992 1993(1) 1994 1994 1995 1996
------------ ------------ ------------ ------------ ------------ ------------
Current assets $ 11,415,601 $ 14,213,270 $ 9,742,477 $ 7,579,857 $ 8,551,369 $ 12,741,489
Total assets 16,453,263 18,868,906 13,421,291 10,397,376 15,669,648 19,633,764
Borrowings under revolving
credit agreement 4,112,692 6,727,726 5,352,040 1,660,965 970,197 --
Current maturities under
long-term debt and capital
lease obligations (2) 778,598 827,198 1,283,792 877,557 813,917 118,444
Current liabilities 8,532,628 12,942,935 13,006,714 8,190,910 6,856,802 8,347,509
Working capital (deficit) 2,882,973 1,270,335 (3,264,237) (611,053) 1,694,567 4,393,980
Long-term debt and capital
lease obligations (3) (4) 2,062,671 2,068,287 957,104 3,627,596 3,532,867 3,414,586
Long-term borrowings
under revolving credit
agreement (5) -- -- -- -- -- 1,093,735
Notes payable to
stockholders (4) -- -- -- 400,000 2,800,000 2,800,000
Other liabilities -- -- 862,517 -- 375,000 378,198
Total liabilities 10,595,299 15,011,222 14,826,335 12,218,506 13,564,669 16,034,028
Retained earnings (deficit) (16,965,987) (18,964,484) (24,449,909) (24,873,275) (1,065,581) 111,790
Stockholders' equity (deficit) $ 5,857,964 $ 3,857,684 $ (1,405,044) $ (1,821,130) $ 2,104,979 $ 3,599,736
(1) A note receivable from a former executive in the amount of $250,000 at
April 3, 1992 has been reclassified to conform with the presentation used
at April 2, 1993.
(2) Current maturities under long-term debt and capital lease obligations at
April 1, 1994 includes subordinated notes payable to stockholders of
$400,000 which were retired in connection with the Acquisition. See Item 7
- "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
(3) Borrowings under the revolving credit agreement at March 29, 1996 were
repaid from a portion of the proceeds from an initial public offering of
securities in May 1996. Accordingly, such borrowings are classified as a
long-term obligation at March 29, 1996. See Item 8 - "Financial Statements
and Financial Statement Schedules" and Item 7 - "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
(4) Indebtedness under a bank term note in the amount of $2,200,000 and notes
payable to stockholders of $2,800,000 outstanding at March 29, 1996 were
repaid from a portion of the proceeds from an initial public offering of
securities in May 1996. See Item 8 - "Financial Statements and Financial
Statement Schedule" and Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(5) Indebtedness under a bank term note in the amount of $309,524 outstanding
at March 29, 1996 was repaid from a portion of the proceeds from an initial
public offering of securities in May 1996. Accordingly, such indebtedness
is classified as a long-term obligation at March 29, 1996. See Item 8 -
"Financial Statements and Financial Statement Schedules" and Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
32
The following sets forth a summary of selected statements of operations
data (unaudited) for the quarter ended July 1, 1994, quarter ended September 30,
1994, month ended October 30, 1994, two months ended December 31, 1994 and
quarter ended March 31, 1995:
Predecessor Company
-------------------------------------------------- -------------------------------
Quarter Ended One Month Two Months Quarter
------------------------------ Ended Ended Ended
July 1, September 30, October 30, December 31, March 31,
1994 (1) 1994 (2) 1994 (3) 1994 (4) 1995 (4)
----------- ----------- ----------- ----------- -----------
Net sales $ 4,862,795 $ 5,045,289 $ 1,200,569 $ 3,261,335 $ 5,900,024
Net income (loss) $ 1,390 $ (357,752) $ (67,004) $ (389,036) $ (676,545)
(1) Includes a gain of $261,022 from the settlement of litigation. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(2) Includes restructuring credits of $25,493. See Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(3) Includes restructuring credits of $508,599. See Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(4) Includes the effects of the Acquisition. See Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The following sets forth a summary of selected statements of operations
data (unaudited) for the quarters ended June 30, 1995, September 29, 1995,
December 29, 1995 and March 29, 1996:
Quarter Ended (1)
------------------------------------------------------
June 30, September 29, December 29, March 29,
1995 1995 1995 1996 (2)
----------- ----------- ----------- -----------
Net sales $ 6,354,145 $ 7,737,680 $ 9,585,664 $ 9,524,197
Net income (loss) $ (230,658) $ 236,104 $ 654,957 $ 516,968
(1) Includes the effects of the Acquisition. See Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(2) Net income for the quarter ended March 29, 1996 reflects an income tax
provision of $326,315. There was no provision for income taxes during the
quarters ended June 30, 1995, September 29, 1995 and December 29, 1995. See
Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
33
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with Item 6 -
"Selected Financial Data" and the consolidated financial statements of the
Company and the notes thereto included elsewhere herein.
Forward Looking Statements
This report contains certain forward looking statements concerning the
Company's operations, economic performance and financial condition. Such
statements are subject to various risks and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors,
including those identified under Item 1 - "Business" and elsewhere herein.
General
On October 31, 1994, TSG Acquisition Corp. acquired all of the outstanding
capital stock of the Company pursuant to the Plan of Merger for aggregate
consideration of $3,170,291, exclusive of contingent consideration of $329,709
placed in escrow. The Acquisition was accounted for using the purchase method of
accounting. Accordingly, the aggregate purchase price was "pushed down" and
allocated to the net assets acquired based upon their fair values. The excess of
the purchase price over the estimated fair value of the net assets acquired of
$3,853,877 was recorded as goodwill. The escrow consideration, the distribution
of which was contingent upon compliance with indemnification provisions set
forth in the Plan of Merger, was distributed to former stockholders in September
1995. Upon distribution of the escrow consideration, the aggregate purchase
price became $3,500,000, which increased the excess of the purchase price over
the estimated fair value of net assets acquired and recorded as goodwill by
$329,709. See the Company's consolidated financial statements and the notes
thereto included elsewhere herein.
In conjunction with the Acquisition, TSG Acquisition Corp. was merged into
the Company. The outstanding shares of the Company's capital stock were
cancelled and the outstanding shares of capital stock of TSG Acquisition Corp.
were exchanged for one share of the Company's common stock, $.05 par value (the
"merger share"). In addition, on October 31, 1994, the Company amended its
Certificate of Incorporation to reflect authorized capital consisting of 10
million shares of common stock, $.01 par value, and 100,000 shares of preferred
stock, $100 par value. Further, the Company entered into an investment agreement
with Wexford and certain former stockholders (collectively the "investors").
Pursuant to that investment agreement, the Company issued 3.5 million shares of
Common Stock in exchange for the merger share. Also, the Company borrowed $2.8
million from Wexford and Acor S.A. and issued the Affiliate Notes to such
persons. See Item 1 - "Business--Development of the Company."
The accompanying analysis compares the results of operations of the
Predecessor for the years ended April 1, 1994 and April 2, 1993, the combined
results of operations of the Company and the Predecessor for the year ended
March 31, 1995 and the Predecessor for the year ended April 1, 1994, and the
results of operations of the Company for the year ended March 29, 1996 and the
combined results of operations of the Predecessor and the Company for the year
ended March 31, 1995.
Because of the Acquisition, certain financial information described below
is not comparable in all respects. In addition, comparability is affected
because of certain purchase accounting adjustments made by the Company on
October 31, 1994. The purchase accounting adjustments made by the Company at
October 31, 1994 consisted of: (i) a net decrease in inventories of $44,734
consisting of a reduction of $491,397 attributable to a change in the method
used to estimate the amount of manufacturing overhead included in inventories to
a method based on labor factors rather than a method based upon a combination of
34
labor and material factors, offset by an increase in the basis of inventories of
$446,664 to reflect their estimated net realizable value; (ii) an increase in
the basis of property and equipment of $382,733 to reflect their estimated fair
value; (iii) an increase in debt obligations of $106,275 to reflect present
values of amounts to be paid determined at current interest rates; (iv) a net
increase in accrued liabilities of $124,859 to reflect the acquisition expenses
of TSG Acquisition Corp. to be paid by the Company, offset by a reduction of
accrued interest and preference fees of $96,000 retired in connection with the
Acquisition; (v) a reduction in accrued restructuring charges of $202,910
retired in connection with the Acquisition; (vi) a reduction of notes payable to
stockholders of $400,000 retired in connection with the Acquisition; (vii) a net
increase in other assets of $429,728 consisting of an increase in identifiable
intangible assets (consisting of product software, patents, customer contracts,
and unpatented technology) of $584,095 to reflect their estimated fair values,
offset by a reduction in goodwill and deferred debt issuance expenses of
$154,367 recorded by the Predecessor; and (viii) an increase in goodwill related
to the Acquisition of $3,853,877. The principal impacts of the purchase
accounting adjustments on the Company's results of operations for the five
months ended March 31, 1995 consisted of a slight increase in depreciation due
to the increase in the basis of property and equipment and their estimated
useful lives, an increase in amortization expense of approximately $100,000 due
to the net increase in the basis of intangible assets, including goodwill, and
their estimated useful lives, and an increase in cost of goods sold of
approximately $235,000 due to the revaluation of inventories. The change in the
method used to estimate the amount of manufacturing overhead included in
inventories did not have a significant effect on the Company's results of
operations for the five months ended March 31, 1995.
Results of Operations
Year Ended March 29, 1996 Compared to the Year Ended March 31, 1995
Sales increased by $12,931,674 or 64%, to $33,201,686 for the year ended
March 29, 1996 (fiscal 1996) from $20,270,012 ($11,108,653 for the Predecessor
for seven months ended October 30, 1994 and $9,161,359 for the Company for the
five months ended March 31, 1995) for the year ended March 31, 1995 (fiscal
1995). Sales of smart payphone products and components during fiscal 1996
approximated $21.8 million as compared to approximately $6.6 million during
fiscal 1995. Sales attributable to refurbishment and conversion services and
related payphone components approximated $10.6 million during fiscal 1996 as
compared to approximately $12.3 million during fiscal 1995. Sales of wireless
payphone products and components consisting primarily of export sales
approximated $856,000 during fiscal 1996 as compared to approximately $1.4
million during fiscal 1995. The $15.2 million increase in sales of smart
payphone products and components during fiscal 1996 as compared to fiscal 1995
is primarily attributable to an increase in GemStar, Gemini and electronic lock
sales volume pursuant to sales agreements entered into in December 1994 and
December 1995. See Item 1 - "Business--Sales and Markets--Domestic" and
"Changing Product Mix." Sales attributable to GemStar, Gemini and electronic
lock products were offset by a reduction in sales volume of Inmate products,
which the Company believes is primarily attributable to the saturation of the
inmate institution market. The 14% decline in sales attributable to
refurbishment and conversion services and related payphone components during
fiscal 1996 as compared to fiscal 1995 is primarily attributable to a reduction
in the volume of the Company's service business. The Company believes that
programs instituted by the RBOCs to convert their installed base of public
payphones to smart configurations as well as competition has and may continue to
have an adverse impact on the Company's service business. The decline in the
Company's wireless product sales during fiscal 1996 as compared to fiscal 1995
is primarily due to a decrease in export volume to Mexico, which is attributable
to the devaluation of the Mexican peso during fiscal 1995. The Company believes,
but cannot ensure, that the economic conditions in Mexico will stabilize, and
that the Company will re-establish its export sales to Mexico during fiscal
1997.
35
Cost of products sold increased by $8,679,676, or 50%, to $26,082,055 (79%
of sales) during fiscal 1996 as compared to $17,402,379 ($9,176,134 for the
Predecessor for the seven months ended October 30, 1994 and $8,226,245 for the
Company for the five months ended March 31, 1994) or 86% of sales during fiscal
1995. The increase in cost of products sold is primarily attributable to the 64%
increase in sales during fiscal 1996 as compared to fiscal 1995. Production
costs as a percentage of sales declined to 79% during fiscal 1996 as compared to
86% during fiscal 1995 as a result of the increase in volume. In addition,
during the five months ended March 31, 1995, the Company accrued damages of
$200,000 attributable to a product recall initiated in April 1995 (see
"Liquidity and Capital Resources," below). Purchase adjustments from the
revaluation of inventories in connection with the Acquisition had the impact of
increasing cost of goods sold by $226,000 and $221,000 during the five months
ended March 31, 1995 and year ended March 29, 1996, respectively.
General and administrative expenses decreased by $387,478, or 15%, to
$2,204,915 during fiscal 1996 from $2,592,393 ($1,742,324 for the Predecessor
for the seven months ended October 30, 1994 and $850,069 for the Company for the
five months ended March 31, 1995) during fiscal 1995. The decline in general and
administrative expenses is primarily related to cost reductions associated with
the Restructuring (see Item 1 "Business--Development of the Company") and
expenses of $166,000 incurred by the Predecessor during the seven months ended
October 30, 1994 in connection with the Acquisition. Amortization of goodwill
and other intangible assets recorded in connection with the Acquisition
approximated $253,000 during fiscal 1996 as compared to approximately $100,000
during the five months ended March 31, 1995.
Marketing and selling expenses increased by $552,128, or 75%, to $1,290,349
during fiscal 1996 as compared to $738,221 ($366,464 for the Predecessor for the
seven months ended October 30, 1994 and $371,757 for the Company for the five
months ended March 31, 1995) during fiscal 1995. The increase is primarily due
to royalties attributable to sales of GemStar and Gemini products, and an
elimination of royalties during the first six months of fiscal 1995 pursuant to
a November 9, 1994 amendment to the royalty provisions of an asset purchase
agreement dated January 11, 1991.
Engineering, research and development expenses increased by $259,135, or
28%, to $1,197,183 during fiscal 1996 as compared to $938,048 ($457,553 for the
Predecessor for the seven months ended October 30, 1994 and $480,495 for the
Company for the five months ended March 31, 1995) during fiscal 1995 primarily
due to an expansion of engineering resources and product development activities.
During the five months ended March 31, 1995, the Company settled severance
obligations pursuant to employment contracts terminated in fiscal 1994 and
negotiated the termination of certain non-cancelable lease obligations with
respect to facilities closed in connection with the Restructuring. The severance
and lease obligations were settled on terms more favorable than estimated during
the year ended April 1, 1994, which resulted in the recognition of restructuring
credits of $248,684 and $274,659, respectively, during the seven months ended
October 30, 1994. Restructuring credits recognized during the seven months ended
October 30, 1994 aggregated $534,092.
During the seven months ended October 30, 1994, the Company settled
litigation against a supplier to recover costs and damages attributable to
defective components supplied to the Company, and realized a gain of
approximately $261,000, net of legal fees of $56,000.
Interest expense decreased to $941,261 during fiscal 1996 as compared to
$955,900 ($599,276 for the Predecessor for the seven months ended October 30,
1994 and $356,624 for the Company for the five months ended March 31, 1995)
during fiscal 1995 primarily due to a 3/4% reduction of the interest rate under
the Loan and Security Agreement between the Company and its bank that became
effective on October 31, 1994, the impact of which was offset by the Affiliate
Notes issued on October 31, 1994.
36
The Company generated income before taxes of $1,503,686 during fiscal 1996
as compared to a net loss of $1,488,947 ($423,366 for Predecessor for the seven
months ended October 30, 1994 and $1,065,581 for the Company for the five months
ended March 31, 1995) during fiscal 1995. The results of the Predecessor during
the seven months ended October 30, 1994 includes a gain from the recognition of
a litigation settlement of $261,022, restructuring credits of $534,092 and
acquisition expenses of $166,000. The results of the Company during fiscal 1996
include the effects of the Acquisition consisting primarily of amortization of
intangible assets, including goodwill, of $253,000 and an increase in cost of
goods sold of approximately $221,000. The results of operations of the Company
for the five months ended March 31, 1995 also included effects of the
Acquisition consisting primarily of amortization of intangible assets of
approximately $100,000 and an increase in cost of goods sold of approximately
$226,000.
During fiscal 1996, the Company recorded an income tax provision of
$326,315 on pre-tax income of $1,503,686, which resulted in net income of
$1,177,371. Benefits of net operating loss carryforwards used to offset current
taxable income during fiscal 1996 aggregated $334,985. Benefits of acquired
deferred tax assets aggregating $211,193 during fiscal 1996, including benefits
of acquired net operating loss carryforwards of $101,993, were used to reduce
goodwill. There was no tax provision during fiscal 1995 as a result of the
reported net loss of $1,488,947.
Year Ended March 31, 1995 Compared to the Year Ended April 1, 1994
Sales declined by $10,778,694 or 35%, to $20,270,012 ($11,108,653 for the
Predecessor during the seven months ended October 30, 1994 and $9,161,359 for
the Company during the five months ended March 31, 1995) for the year ended
March 31, 1995 (fiscal 1995) from $31,048,706 during the year ended April 1,
1994 (fiscal 1994). Sales of smart payphone products and components during
fiscal 1995 approximated $6.6 million as compared to $9.0 million during fiscal
1994. Sales attributable to refurbishment and conversion services and related
payphone components approximated $12.3 million during fiscal 1995 versus $21.2
million during fiscal 1994. Sales of wireless payphone products and components
consisting primarily of export sales approximated $1.4 million in fiscal 1995
versus $833,000 in fiscal 1994. The 27% decline in sales of smart payphone
products and components and the 42% decline in sales attributable to
refurbishment and conversion services and related payphone components resulted
primarily from a decrease in the volume of business due to the termination of a
sales agreement for a first generation smart product and the non-renewal of a
refurbishment sales agreement between the Company and one of the RBOCs during
the latter part of 1994 (see Item 1 - "Business--Changing Product Mix"). The
volume reductions in fiscal 1995 resulting from the termination and non-renewal
of these agreements were offset somewhat by sales under the terms of a sales
agreement between the Company and one of the RBOCs executed in December 1994
(see Item 1 - "Business--Sales and Markets--Domestic" and Item 1 "Changing
Product Mix"). Sales pursuant to the terms of this agreement during the five
months ended March 31, 1995 approximated $2.6 million. The increase in the
Company's wireless product sales in fiscal 1995 as compared to fiscal 1994 is
attributable to an increase in export volume. However, during the third quarter
of fiscal 1995, the devaluation of the Mexican peso had an adverse impact on
export sales to one of the Company's primary foreign customers.
Cost of products sold decreased by $8,359,452, or 32%, to $17,402,379
($9,176,134 for the Predecessor during the seven months ended October 30, 1994
and $8,226,245 for the Company during the five months ended March 31, 1995) in
fiscal 1995 as compared to fiscal 1994 and represented 86% of sales in fiscal
1995 versus 83% of sales in fiscal 1994. The decrease in cost of products sold
is primarily attributable to a 35% decrease in sales, which was offset by a net
increase in production costs during fiscal 1995. Higher production costs as a
percentage of sales, damages of $200,000 attributable to a product recall
initiated in April 1995 (see "Liquidity and Capital Resources," below) and the
effects of the Acquisition consisting primarily of an increase in cost of goods
sold of approximately $235,000 for the five months ended March 31, 1995 offset
37
decreases in provisions for obsolete and excess inventory of approximately
$758,000 and warranty expense of approximately $347,000 related to reserves
established in fiscal 1994.
In connection with the Restructuring initiated during fiscal 1994, the
Company closed one of its manufacturing facilities, three satellite office
locations and relocated its corporate headquarters from Pennsylvania to Georgia.
Primarily as a result of the Restructuring, the Company's general and
administrative personnel and other operating expenses declined by $884,539, or
25%, to $2,592,393 ($1,742,324 for the Predecessor during the seven months ended
October 30, 1994 and $850,069 for the Company during the five months ended March
31, 1995) in fiscal 1995 as compared to $3,476,932 in fiscal 1994. Cost
reductions attributable to the Restructuring were offset somewhat by Acquisition
expenses of approximately $166,000 during the seven months ended October 30,
1994 and amortization expense of approximately $100,000 during the five months
ended March 31, 1995.
Marketing and selling expenses declined by $1,010,593, or 58%, to $738,221
($366,464 for the Predecessor during the seven months ended October 30, 1994 and
$371,757 for the Company during the five months ended March 31, 1995) in fiscal
1995 as compared to $1,748,814 during fiscal 1994. This reduction in marketing
and selling expenses is attributable to personnel and other operating expense
reductions resulting from the Restructuring and the curtailment of participation
at trade shows during fiscal 1995. In addition, royalty expense during fiscal
1995 declined by approximately $188,000 as a result of an amendment to the
royalty provisions of an asset purchase agreement dated January 11, 1991 that
eliminated royalty obligations for the six months ended September 30, 1994.
Engineering, research and development expenses declined by $1,071,476, or
53%, to $938,048 ($457,553 for the Predecessor during the seven months ended
October 30, 1994 and $480,495 for the Company during the five months ended March
31, 1995) in fiscal 1995 as compared to $2,009,524 during fiscal 1994. The
reduction in engineering, research and development expenses is attributable to
personnel and other operating expense reductions resulting from the
Restructuring and the refocus of research and development activities towards
specific products which the Company believes, but cannot assure, have
significant market potential.
Interest expense increased by $44,079, or 5%, to $955,900 ($599,276 for the
Predecessor during the seven months ended October 30, 1994 and $356,624 for the
Company during the five months ended March 31, 1995) in fiscal 1995 from
$911,821 in fiscal 1994 primarily as a result of interest and preference fees
related to $400,000 of subordinated notes payable to former stockholders which
were retired in connection with the Acquisition. Otherwise, interest rate
fluctuations and a rate reduction associated with an October 31, 1994 amendment
to the Loan and Security Agreement between the Company and its bank offset the
impact of higher debt balances during fiscal 1995 as compared to fiscal 1994.
As a result of the foregoing, the Company's net loss decreased by
$3,996,478, from $5,485,425 in fiscal 1994 to $1,488,947 in fiscal 1995
($423,366 for the Predecessor during the seven months ended October 30, 1994 and
$1,065,581 for the Company during the five months ended March 31, 1995). The
results of the Predecessor during the seven months ended October 30, 1994
include the recognition of restructuring credits and the gain from recognition
of the litigation settlement of $534,092 and $261,022, respectively, and
expenses of approximately $166,000 incurred in connection with the Acquisition.
The results of the Company during the five months ended March 31, 1995 included
the recognition of product recall damages of $200,000 and the effects of the
Acquisition consisting primarily of an increase in cost of goods sold of
approximately $235,000 and amortization of intangible assets, including
goodwill, of approximately $100,000.
38
Year Ended April 1, 1994 Compared to the Year Ended April 2, 1993
Sales increased by $512,738, or 2%, to $31,048,706 during the year ended
April 1, 1994 (fiscal 1994) from $30,535,968 during the year ended April 2, 1993
(fiscal 1993). Sales of smart payphone products and components during fiscal
1994 approximated $9.0 million as compared to $7.8 million during fiscal 1993.
Sales attributable to refurbishment and conversion services and related payphone
components approximated $21.2 million in fiscal 1994 versus $22.2 million in
fiscal 1993. Sales of wireless payphone products and components consisting
primarily of export sales approximated $833,000 in fiscal 1994 versus $584,000
million in fiscal 1993. The 15% increase in sales of smart payphone products and
components in fiscal 1994 as compared to fiscal 1993 was primarily attributable
to an increase in volume under a first generation smart product sales agreement
with one of the Company's then significant RBOC customers. However, during the
third quarter of fiscal 1994, the Company's sales volume under the terms of such
sales agreement declined substantially and in the fourth quarter, the agreement
was terminated by the RBOC (see Item 1 - "Business--Changing Product Mix"). The
slight decline in sales attributable to refurbishment and conversion services
and related payphone components from fiscal 1993 to fiscal 1994 was primarily
attributable to lower service volumes, which was related to changes in customer
business practices, as well as the non-renewal of one of the Company's
significant refurbishment sales agreements during the latter part of fiscal 1994
(see Item 1 - "Business--Changing Product Mix"). The 43% increase in the
Company's wireless product sales in fiscal 1994 as compared to fiscal 1993 is
attributable to an increase in export volume to Mexico and the establishment of
a distribution relationship in Korea. See Item 1 - "Business--Sales and
Markets".
Cost of products sold increased by $1,678,512, or 7%, in fiscal 1994 as
compared to fiscal 1993 and represented 83% of sales in fiscal 1994 versus 79%
of sales in fiscal 1993. The increase in cost of products sold is primarily
attributable to the increase in sales and increases in provisions for obsolete
and excess inventory of $989,000 and warranty expense of $250,000 related
primarily to estimated losses attributable to the termination and non-renewal of
the above-mentioned sales agreements and estimated additional warranty claims
related to one of such contracts.
General and administrative expenses increased by approximately 4% to
$3,476,932 in fiscal 1994 from $3,333,996 in fiscal 1993. The increase is
primarily related to an investigation into alleged environmental contamination
at one of the Company's former facilities (see Item 1 - "Business--Potential
Environmental Liabilities") and an increase in resources devoted to information
systems.
Marketing and selling expenses declined by approximately 6% to $1,748,814
in fiscal 1994 from $1,865,134 in fiscal 1993 primarily as a result of a
reduction of international marketing activities initiated during fiscal 1993.
Engineering, research and development expenses declined by approximately
10%, and represented 6.5% of sales in fiscal 1994 as compared 7.3% of sales in
fiscal 1993. This reduction in engineering, research and development expenses is
primarily related to a reduction of personnel associated with the development of
certain wireless payphone products which were substantially completed in fiscal
1993 or curtailed in fiscal 1994.
Interest expense increased by $102,232, or 13%, to $911,821 in fiscal 1994
from $809,589 in fiscal 1993 as a result of a slight increase in interest rates
and an increase in average monthly debt balances under a revolving debt
agreement between the Company and its bank. See "Liquidity and Capital
Resources," below.
In February 1994, the Company initiated the Restructuring to consolidate
its business and reduce its costs and expenses. In connection with such
restructuring, the Company recorded a restructuring charge of $2,570,652
39
consisting of estimated severance obligations and payments pursuant to the terms
of terminated employment contracts of $1,089,251, loss provisions of $296,875
representing a note receivable and related accrued interest due from a former
executive, estimated future noncancellable lease payments and write-downs of
facility assets to estimated net realizable value of $894,526, a loss provision
of $150,000 related to the termination of certain product lines and other
estimated plant shut-down costs of $140,000.
During fiscal 1993, the Company ceased efforts to market certain
non-regulated payphone products and recorded a loss provision of $150,000
related to the write-down to estimated net realizable value of assets associated
with the ability to provide rating capability to that segment of the payphone
market. As a result, other charges declined from $200,875 in fiscal 1993 to
$54,557 in fiscal 1994.
As a result of the aforementioned cost and expense increases, consisting
primarily of production costs and the fiscal 1994 restructuring charges, the
Company's net loss increased by $3,486,928, from $1,998,497 in fiscal 1993 to
$5,485,425 in fiscal 1994.
Liquidity and Capital Resources
Initial Public Offering
During May 1996, the Company completed an initial public offering of
1,150,000 Units, each Unit consisting of one share of Common Stock and a
Redeemable Warrant, at a price of $9.00 per Unit for gross proceeds of
$10,350,000. Net proceeds received by the Company, after underwriting discounts
and expenses of $1,231,887, amounted to $9,118,113. The Company has incurred
other offering expenses of $338,372 as of March 29, 1996. These expenses have
been deferred at March 29, 1996 and, together with offering expenses incurred
subsequent to March 29, 1996, will be charged against the net proceeds of the
offering.
The net proceeds of the offering were initially used to repay then
outstanding indebtedness consisting of subordinated notes payable to
stockholders of $2.8 million and bank indebtedness aggregating $6,318,113 (see
"Financing Activities," below). Indebtedness pursuant to the Loan Agreement
between the Company and its bank repaid with the net proceeds consisted of a
$2.2 million term note due November 30, 1997, $309,524 outstanding under a
$650,000 term note due November 30, 1997 and borrowings under a revolving credit
agreement of $3,808,589.
The Loan Agreement
The Loan Agreement between the Company and its bank provides financing to
the Company under a revolving credit agreement and term and installment notes of
up to $9 million. Concurrently with the Acquisition, the Loan Agreement was
amended. Pursuant to the amendment, $2.2 million of debt outstanding under the
revolving credit agreement was converted into a term note payable on November
30, 1997, the interest rate on amounts borrowed under the terms of the Loan
Agreement was reduced by 3/4% and the term of the Loan Agreement was extended
from May 31, 1995 to November 30, 1997. At March 31, 1995 and March 29, 1996,
the Company had borrowed an aggregate of $970,197 and $1,093,735, respectively,
under the revolving credit agreement and $2,857,857 and $2,525,000,
respectively, under term and installment notes, including the $2.2 million term
note due November 30, 1997. At March 29, 1996, the term and installment notes
consisted of a term note with an outstanding balance of $2.2 million and a term
note with an outstanding balance of $325,000. At March 31, 1995, the term and
installment notes consisted of a term note with an outstanding balance of $2.2
million, a term note with an outstanding balance of $417,857 and an installment
note with an outstanding balance of $240,000. As of March 29, 1996, outstanding
indebtedness under the Loan Agreement bears interest at a variable rate per
annum equal to 11/2% above a base rate quoted by Citibank, N.A. The interest
rate was reduced from 2% above a base rate quoted by Citibank, N.A. on March 1,
40
1996. The base rate at March 31, 1995 and March 29, 1996 was 9% and 8.25% per
annum, respectively. Amounts borrowed under the revolving credit agreement and
the term and installment notes are secured by substantially all assets of the
Company, including accounts receivable, inventories and property and equipment.
The Loan Agreement expires on November 30, 1997, and is renewable annually for
one-year periods unless terminated by the bank upon an occurrence of an event of
default or by the Company upon at least 90 days notice.
The Loan Agreement contains conditions and covenants that prevent or
restrict the Company from engaging in certain transactions without the consent
of the bank, including merging or consolidating, payment of subordinated
stockholder debt obligations, declaration or payment of dividends, and
disposition of assets, among others. Additionally, the Loan Agreement requires
the Company to comply with specific financial covenants, including covenants
with respect to cash flow, working capital and net worth. Noncompliance with any
of these conditions and covenants or the occurrence of an event of default, if
not waived or corrected, could accelerate the maturity of the borrowings
outstanding under the Loan Agreement.
At April 1, 1994, the Company was in default of certain conditions and
covenants set forth in the Loan Agreement, including cash flow and net worth
covenants. Although the Loan Agreement was amended in June 1994 to provide less
restrictive financial covenants, the Company was in default of the amended cash
flow covenant soon thereafter. In addition, the conditions of default existed at
October 30, 1994 prior to the Acquisition. However, the October 31, 1994
amendment to the Loan Agreement, as further amended on March 31, 1995, provided
less restrictive covenants which enabled the Company to be in compliance.
Although the Company is in compliance with the covenants set forth in the Loan
Agreement as of March 29, 1996, there is no assurance that the Company will be
able to remain in compliance with such covenants in the future.
The Loan Agreement contains provisions that require the Company to deposit
all cash receipts into a lock box account for repayment of amounts borrowed
under the revolving credit agreement. The Company is able to borrow funds under
the revolving credit agreement up to an aggregate amount based on specified
percentages of accounts receivable and inventories deemed to be eligible
collateral by the bank, less amounts outstanding under the $2.2 million term
note due November 30, 1997. During fiscal 1993 and fiscal 1994 and the first
seven months of fiscal 1995 prior to the Acquisition, the Company generally
maintained its outstanding borrowings under the revolving credit agreement at
the maximum amount permitted. Financing available to the Company during these
periods was not sufficient to fund the working capital, capital expenditure and
debt service requirements of the Company, and the Company was unable to meet its
accrued liability and supplier obligations as they became due.
Under the terms of the Loan Agreement, the Company is subject to certain
covenants which limit its ability to incur additional indebtedness. In addition,
the Loan Agreement pertaining to the revolving credit agreement limits advances
to the Company to specified percentages of the Company's eligible accounts
receivable and inventories. The Company is currently in compliance with all
covenants under the facility. The Company used the net proceeds of its initial
public offering to repay outstanding indebtedness under its working capital
facility in order to reduce its interest expense. The Company intends to use the
financing available under the facility to finance its on-going working capital
needs. If an event of default under the existing working capital facility were
to occur, however, the Company's ability in this regard could be curtailed. In
such event, the Company would seek alternative financing sources.
41
Financing Activities
The Company has historically financed its operations primarily through
borrowings and cash flow from operations.
In April 1994, amounts borrowed under the revolving credit agreement
between the Company and its bank exceeded the maximum amount permitted. However,
the Company and its bank entered into an amendment that provided an overadvance
of $300,000 to the Company that was repaid by May 31, 1994 in accordance with
the terms of the amendment.
In June 1994, the Company borrowed $400,000 from its preferred stockholders
and issued a master subordinated promissory note payable on demand bearing
interest at a rate of 10% per annum. Pursuant to the terms of the master
subordinated promissory note, a loan preference fee in an escalating amount
which, when added to accruing interest, would equal 5% of the outstanding
principal for each month the note was outstanding became immediately due and
payable upon a change in ownership of the Company. In connection with the
Acquisition, the subordinated master promissory note together with accrued
interest and preference fees in the amount of $96,000 were retired. See Item 1 -
"Business--Development of the Company."
Concurrently with the issuance of the subordinated master promissory note,
the Company and its bank entered into an amendment to the Loan Agreement and a
$500,000 installment note obligation with a then outstanding balance of $62,500.
Pursuant to the amendment, the Company borrowed $402,500 and executed an amended
installment note in the amount of $465,000.
Pursuant to the October 31, 1994 Investment Agreement entered into in
connection with the Acquisition, the Company borrowed $2.8 million from Wexford
and Acor S.A., stockholders of the Company, and issued subordinated promissory
notes due November 1, 1999 that bear interest at a rate of 10% per annum. The
Company issued a 10% interest bearing subordinated note to Wexford in the
principal amount of $2,361,082 dated October 31, 1994. The Company issued 10%
interest bearing subordinated promissory notes to Acor S.A. in the principal
amount of $208,216.73 dated October 31, 1994, $99,591.93 dated October 31, 1994,
$83,497.82 dated November 10, 1994 and $47,611.52 dated December 23, 1994.
Concurrently with the Acquisition, the Loan Agreement was amended. Pursuant
to the amendment, $2.2 million of debt outstanding under the revolving credit
agreement was converted into a term note payable on November 30, 1997. The
proceeds of $2,569,298 pursuant to the subordinated promissory notes dated
October 31, 1994 issued to Wexford and Acor, S.A. were used to retire debt
outstanding under the revolving credit agreement. After such repayment, the
initial principal balance outstanding under the $2.2 million term note on
October 31, 1994 amounted to $1,291,667. Between October 31, 1994 and March 31,
1995, the Company borrowed the balance available under the $2.2 million term
note of $908,333, and also re-borrowed $970,196 under its revolving credit
agreement. See Item 1 - "Business--Development of the Company."
Net payments of indebtedness under the Company's revolving credit agreement
during the year ended April 1, 1994, seven months ended October 31, 1994 and
five months ended March 31, 1995 amounted to $1,375,686, $1,491,074 and
$1,599,102, respectively. Net proceeds under the revolving credit agreement
during the year ended March 29, 1996 amounted to $123,538. Principal payments on
other debt and capital lease obligations during the year ended April 1, 1994,
seven months ended October 30, 1994, five months ended March 31, 1995 and year
ended March 29, 1996 amounted to $929,117, $459,084, $482,307 and $813,754,
respectively.
42
The Company has also established a cash management program with its bank
pursuant to which the Company funds drafts as they clear the bank. Accordingly,
the Company maintains bank overdrafts representing outstanding drafts and
utilizes the cash management account as a source of funding. During the year
ended April 1, 1994, the Company repaid bank overdrafts of $709,942. During the
seven months ended October 30, 1994, five months ended March 31, 1995 and year
ended March 29, 1996, the Company's bank overdrafts increased by $323,633,
$120,714 and $501,761, respectively.
At April 1, 1994, the Company was in default of the terms of unsecured
promissory notes with outstanding balances aggregating $425,536 as a result of
its failure to make certain royalty payments. However, on November 9, 1994, the
Company entered into an amendment agreement which brought the Company into
compliance with the terms of the note agreements. Pursuant to the amendment
agreement, the Company executed a non-interest bearing promissory note in the
principal amount of $206,595 representing unpaid royalties as of October 30,
1994. The note is payable in nineteen equal monthly installments of $10,873
commencing in December 1994.
Cash Flows
During fiscal 1994, the Company generated $3,081,294 of cash from operating
activities and used $297,026 and $3,014,745 of cash to fund investing and
financing activities, respectively. During fiscal 1994, the Company used
$618,928 of cash to fund operating losses, net of non-cash charges, but was able
to generate cash from reductions in accounts receivable and inventories of
$2,019,659 and $582,102, respectively, and prepaid expenses of $357,377. The
Company's capital expenditures amounted to $309,851 and principal payments on
long-term debt and capital lease obligations amounted to $929,117. As a result
of the reductions in accounts receivable and inventories, the Company repaid
$1,375,686 of amounts borrowed under the revolving credit agreement. Also, the
Company repaid bank overdrafts of $709,942. The Company's cash resources were
not sufficient to fund the above-mentioned cash requirements, and in addition
thereto, the Company's accrued liability and supplier obligations as they became
due. Accordingly, the Company delayed payments of accrued liability and
suppliers obligations and accrued restructuring charges, which provided cash of
$762,275 during fiscal 1994.
During the seven months ended October 30, 1994, the Company generated
$914,820 of cash from operating activities and used $9,840 and $824,025 of cash
to fund investing and financing activities, respectively. During the seven
months ended October 30, 1994, the Company used $99,688 of cash to fund
operating losses, net of non-cash charges, but was able to generate cash from
reductions in accounts receivable and inventories of $577,671 and $1,387,946,
respectively, and prepaid expenses of $66,940. The Company's capital
expenditures were reduced to $21,481 and principal payments on long-term debt
and capital lease obligations amounted to $459,084. As a result of the
reductions in accounts receivable and inventories, the Company repaid $1,491,074
of amounts borrowed under the revolving credit agreement. An increase in bank
overdrafts provided cash of $323,633. Although the inability of the Company to
meet its accrued liability and supplier obligations as they became due
continued, the Company used $965,672 of cash to reduce accounts payable and
accrued liability obligations and accrued restructuring charges during the seven
months ended October 30, 1994.
In December 1994, the Company sold the rights to certain product software
for an aggregate purchase price of $500,000. The Company received back an
exclusive irrevocable perpetual right to sublicense the software in connection
with the sale of related products. In return, the Company agreed to pay
royalties on sales of licensed products to other customers. Such royalties would
be payable commencing if, and only if, laws, regulations or judicial actions
occur which would permit the purchaser of the software to receive such royalty
payments. The Company is obligated to repay, three years from the date of sale,
a portion of the purchase price up to a maximum amount of $375,000, which is
reflected as deferred revenue in the Company's consolidated financial statements
at March 31, 1995 and March 29, 1996. The actual amount of any repayment is
43
dependent upon the amount of aggregate royalties paid pursuant to the license
agreement. The amount of repayment will equal: (i) $375,000 if aggregate
royalties paid amount to less than $125,000; (ii) $250,000 if aggregate
royalties paid are greater than $125,000 but less than $250,000; or (iii)
$125,000 if aggregate royalties paid are greater than $250,000 but less than
$375,000. If aggregate royalties paid during the first three years of the
agreement exceed $375,000, the Company is not required to repay any portion of
the purchase price. As of March 29, 1996, the Company is not obligated to pay
and has not paid any royalties under the agreement.
The October 31, 1994 investor debt financing and the proceeds from the
software sale enabled the Company to stabilize its liquidity position. During
the five months ended March 31, 1995, the Company generated $1,747,638 of cash
from financing activities and used $1,597,674 and $59,956 of cash to fund
operating and investing activities, respectively. During the five months ended
March 31, 1995, the Company used $358,182 of cash to fund operating losses, net
of non-cash charges, and used $329,469 and $764,211 of cash to fund increases in
accounts receivable and inventories, respectively. The Company's capital
expenditures amounted to $59,956 and principal payments on long-term debt and
capital lease obligations amounted to $482,307. The Company continued to reduce
its accounts payable and accrued liability obligations and accrued restructuring
charges, which resulted in a use of cash of $618,352 in the aggregate.
During the year ended March 29, 1996, the Company generated cash of
$194,390 from operating activities and used $251,724 and $188,455 of cash to
fund investing and financing activities, respectively. During the year ended
March 29, 1996, the Company generated a profit of $1,117,371, and generated
$2,761,030 in cash, net of non-cash charges. The Company borrowed $123,538 under
its revolving credit agreement and generated cash of $501,761 from bank
overdrafts. Cash used to fund increases in accounts receivable and inventories
amounted to $1,206,385 and $3,428,230, respectively. The Company's capital
expenditures amounted to $251,724 and principal payments on long-term debt and
capital lease obligations amounted to $813,754. The Company's cash resources
during fiscal 1996 enabled the Company to normalize supplier relationships and
repay non-disputed past due supplier and accrued liability obligations.
Notwithstanding, a net increase in the Company's supplier and accrued liability
obligations, income taxes payable, deferred revenue and accrued restructuring
charges provided cash of $2,600,034 during fiscal 1996. The Company expended
$474,095 of cash to fund increases in other assets including the acquisition of
a patent license and the expenses of the Company's initial public offering
during the year ended March 29, 1996.
Capital Commitments and Liquidity
The Company has not entered into any significant commitments for the
purchase of capital assets. However, the Company intends to purchase and install
information systems and capital equipment, including printed circuit board
assembly equipment and other manufacturing equipment, to advance its prototype
manufacturing and product testing capabilities during the eighteen months
following the date of the Company's initial public offering. In addition, the
Company intends to expand its manufacturing capabilities through the purchase of
capital equipment in the future as required to meet the needs of its business.
The Company expects to expend approximately $800,000 to fund anticipated capital
expenditures during the next eighteen months. The Company believes, based on its
current plans and assumptions relating to its operations, that its sources of
capital, including capital available under its revolving credit line and cash
flow from operations will be adequate to satisfy its anticipated cash needs,
including anticipated capital expenditures, for at least the next twelve months.
However, there can be no assurance that capital expenditures will be made as
planned or that additional capital expenditures will not be required. The
Company also believes, based on its current plans and assumptions relating to
its operations, that its sources of capital will be adequate to satisfy its
anticipated cash needs, including capital expenditures, for fiscal 1998.
44
However, in the event that the Company's plans or the basis for its assumptions
change or prove to be inaccurate, or cash flow and sources of capital prove to
be insufficient to provide for the Company's cash requirements (due to
unanticipated expenses, loss of sales revenues, problems, operating difficulties
or otherwise), the Company would be required to seek additional financing. In
such an event, there can be no assurance that additional financing will be
available to the Company on commercially reasonable terms, or at all.
Extension of credit to customers and inventory purchases represent the
principal working capital requirements of the Company, and significant increases
in accounts receivable and inventory balances could have an adverse effect on
the Company's liquidity. The Company's accounts receivable, less allowances for
doubtful accounts, at March 29, 1996 and March 31, 1995 amounted to $3,866,372
and $2,670,086, respectively. Accounts receivable at March 29, 1996 and March
31, 1995 consists primarily of amounts due from the RBOCs. The Company's
inventories, less allowances for potential losses due to obsolescence and excess
quantities amounted to $8,658,669 and $5,526,513 at March 29, 1996 and March 31,
1995, respectively. The level of inventory maintained by the Company is
dependent on a number of factors, including delivery requirements of customers,
availability and lead-time of components and the ability of the Company to
estimate and plan the volume of its business. The Company markets a wide range
of services and products and the requirements of its customers vary
significantly from period to period. Accordingly, inventory balances may vary
significantly.
In October 1994, the Company entered into a contract manufacturing
agreement that provides for the production of certain smart payphone processors.
Pursuant to the terms of the manufacturing agreement, the Company committed to
purchase $12.2 million of product over an eighteen-month period beginning in
December 1994. In addition, in November 1994, the Company entered into a dealer
agreement that commits the Company to purchase approximately $3.5 million of
electronic lock devices over a two-year period. See Item 1 -
"Business--Manufacturing, Assembly and Sources of Supply." Purchases under the
terms of these agreements fluctuate based on delivery requirements established
by the Company. The Company initially scheduled purchases pursuant to these
agreements based on anticipated quantities required to meet its sales
commitments (see Item 1 - "Business--Changing Product Mix"). As of March 29,
1996, the Company had acquired approximately 75% and 77%, respectively, of
committed purchase volume pursuant to these purchase agreements. However, the
Company presently anticipates that scheduled purchases through December 1996
will exceed sales requirements as a result of changes in delivery requirements
of one of the Company's customers. Although the Company is encouraging its
customer to accelerate purchases and is seeking to reschedule deliveries
pursuant to such agreements, an increase in inventories related to such
agreements is anticipated and such increase could approximate as much as $2.0
million. See Item 1 - "Business--Manufacturing, Assembly and Sources of Supply."
The Company committed to supply to one of its significant RBOC customers a
minimum of $21.3 million of smart processors and components at specified prices
over a three-year period pursuant to a December 1994 sales agreement. This
agreement also provides for penalties and damages in the event the Company is
unable to meet specified performance criteria. In December 1995, the Company
entered into an amendment to a sales agreement with another significant RBOC
customer that provides for the sale of approximately $12 million of smart
products and other components over a period of eight months commencing November
1, 1995. Both of these sales agreements may be terminated at the option of the
customer upon prior notice to the Company. The termination of these or any of
the Company's sales agreements could have a material adverse effect on the
Company's business and, therefore, its liquidity. Further, any assessment of
penalties and damages under the Company's sales contracts could have a material
adverse effect on the Company's operating results and liquidity. See Item 1 -
"Business--Sales and Markets--Domestic" and "Changing Product Mix."
45
In April 1995, the Company initiated a recall of products due to
contamination introduced into the manufacturing process by the Company's
contract manufacturer. Although the Company's contract manufacturer was
responsible for the repair or replacement of the recalled product, the Company
incurred liquidated damages under the terms of the sales agreement with its
customer in the amount of $200,000. The damages were paid by an $8.00 price
reduction over the next 25,000 units shipped after July 1, 1995. This liability
was recorded in the Company's consolidated financial statements at March 31,
1995. Also, the Company agreed to extend its warranty on up to 5,000 units
shipped under the terms of the sales agreement through December 31, 1998.
However, the Company does not anticipate that it will incur significant warranty
costs as a result of the extended warranty. See Item 1 - "Business--Sales and
Markets--Domestic" and "Changing Product Mix."
During October 1994, the Company, its bank and a contract manufacturer
entered into an escrow agreement as security for the payment of the Company's
obligations to the contract manufacturer. In May 1995, the Company issued common
stock purchase warrants that provide the contract manufacturer with the right to
purchase 40,000 shares of the Common Stock at a price of $4.00 per share for a
period of five years in return for extension of credit of $1.5 million and
45-day payment terms to the Company. This agreement had a significant favorable
impact on the Company's liquidity. However, if the Company defaults with respect
to the payment terms, the Company will be required to utilize the escrow account
previously established, which could have a significant adverse effect on the
Company's liquidity. See Item 1 - "Business--Manufacturing, Assembly and Sources
of Supply."
The Company is the defendant in a suit against the Company to collect
approximately $400,000 of unpaid obligations recorded in the Company's
consolidated financial statements at March 31, 1995 and March 29, 1996. The
Company believes that the supplier supplied defective components that
contributed to the termination of a first generation smart product sales
contract during fiscal 1994. Although the Company believes that it has an
offsetting claim, there is no assurance that the suit can be resolved in the
Company's favor. Since the unpaid obligations are recorded in the Company's
consolidated financial statements, it is the opinion of management that the
ultimate outcome of this proceeding will not have a material effect on the
Company's results of operations or financial position. See Item 3 - "Legal
Proceedings and Disputes."
In October 1994, the contract manufacturer that delivered the defective
first generation smart products to the Company (see Item 1 "Business--Changing
Product Mix") discontinued operations prior to the scheduled contract
termination date. In April 1995, the contract manufacturer formally terminated
the Company's manufacturing contract as of the scheduled termination date.
Pursuant to the terms of the manufacturing contract, the Company was committed
to acquire the manufacturer's inventories related to the Company's products. The
Company is presently involved in a dispute with the contract manufacturer with
respect to such inventories, which approximate $l million, unpaid obligations of
the Company of approximately $265,000, unpaid obligations of the contract
manufacturer of approximately $125,000 due to the Company, and other matters
including an alleged claim of lost profits by the contract manufacturer of
approximately $916,000 related to the Company's minimum contract purchase
commitment and alleged claims of lost business and expenses of the Company due
to the delivery of defective products and the termination of a significant smart
product sales agreement (see Item 1 "Business--Changing Product Mix," above).
The Company is attempting to settle the dispute with the manufacturer and claims
that the manufacturer supplied defective product and that it breached the
agreement by discontinuing operations prior to the scheduled termination date.
However, there is no assurance that the dispute can be settled in the Company's
favor, or at all. Also, there is no assurance that the dispute will not escalate
into litigation. Should the dispute escalate into litigation, the Company
intends to defend and pursue its positions vigorously. However, there is no
assurance that the outcome of the dispute or potential litigation related
thereto will not have a material adverse effect on the Company's financial
position or results of operations.
46
Net Operating Loss Carryforwards
As of March 29, 1996, the Company had net operating loss carryforwards for
income tax purposes of approximately $17 million to offset future taxable
income. Under Section 382 of the Internal Revenue Code of 1986, as amended, the
utilization of net operating loss carryforwards is limited after an ownership
change, as defined in such Section 382, to an annual amount equal to the value
of the loss corporation's outstanding stock immediately before the date of the
ownership change multiplied by the federal long-term tax-exempt rate in effect
during the month the ownership change occurred. Such an ownership change
occurred on October 31, 1994 and could occur in the future. As a result, the
Company will be subject to an annual limitation on the use of its net operating
losses of approximately $210,000. This limitation only affects net operating
losses incurred up to the ownership change and does not reduce the total amount
of net operating losses which may be taken, but limits the amount which may be
used in a particular year. Therefore, in the event the Company maintains
profitable operations, such limitation would have the effect of increasing the
Company's tax liability and reducing net income and available cash resources of
the Company if the taxable income during a year exceeded the allowable loss
carried forward to that year. In addition, because of such limitations, the
Company will be unable to use a significant portion of its net operating loss
carryforwards.
47
Item 8. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Deloitte & Touche LLP 49
Report of Price Waterhouse LLP 50
Consolidated Financial Statements: 50
Consolidated Balance Sheets as of March 31, 1995 and
March 29, 1996 51
Consolidated Statements of Operations for the year ended April 1,
1994, seven months ended October 30, 1994, five months ended
March 31, 1995 and year ended March 29, 1996 52
Consolidated Statements of Cash Flows for the year ended April 1,
1994, seven months ended October 30, 1994, five months ended
March 31, 1995 and year ended March 29, 1996 53
Consolidated Statements of Changes in Stockholders' Equity
(Deficit) for the year ended April 1, 1994, seven months ended
October 30, 1994, five months ended March 31, 1995 and year
ended March 29, 1996 54
Notes to Consolidated Financial Statements 55
Financial Statement Schedule:
Schedule II--Valuation and Qualifying Accounts 100
All other schedules are omitted because they are not required or
are not applicable, or the required information is shown in the
financial statements or notes thereto.
48
INDEPENDENT AUDITORS' REPORT
Stockholders
Technology Service Group, Inc.
We have audited the accompanying consolidated balance sheets of Technology
Service Group, Inc. and subsidiary as of March 29, 1996 and March 31, 1995, and
the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for the year ended March 29, 1996, five months ended
March 31, 1995, and the seven months ended October 30, 1994. Our audits also
included the financial statement schedule listed in the Index at Item 8. These
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Technology Service Group, Inc.
and subsidiary at March 29, 1996 and March 31, 1995 and the results of their
operations and their cash flows for the year ended March 29, 1996, the five
months ended March 31, 1995, and the seven months ended October 30, 1994 in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Atlanta, Georgia
June 6, 1996
49
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders of
Technology Service Group, Inc.
In our opinion, the consolidated statements of operations, of changes in
stockholders' deficit and of cash flows for the year ended April 1, 1994 present
fairly, in all material respects, the results of operations and cash flows of
Technology Service Group, Inc. and its subsidiaries for the year ended April 1,
1994 in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for the opinion expressed
above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations,
has negative working capital, a net capital deficiency and is in violation of a
loan covenant. Such factors raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
As discussed in Note 3 to the financial statements, the Company changed its
method of accounting for income taxes effective April 3, 1993.
We have not audited the consolidated financial statements of Technology
Service Group, Inc. and its subsidiaries for any period subsequent to April 1,
1994.
Our audit of the consolidated financial statements referred to in our
report above also included an audit of the Financial Statement Schedule for the
year ended April 1, 1994 listed in Item 8 of this form 10-K. In our opinion,
this Financial Statement Schedule presents fairly, in all material respects, the
information set forth therein for the year ended April 1, 1994 when read in
conjunction with the related consolidated financial statements.
PRICE WATERHOUSE LLP
Philadelphia, PA
October 4, 1994
50
TECHNOLOGY SERVICE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
March 31, March 29,
1995 1996
------------ ------------
ASSETS
Current assets:
Cash $ 265,576 $ 19,787
Accounts receivable, less allowance for doubtful
accounts of $201,000 and $216,000 2,670,086 3,866,372
Inventories 5,526,513 8,658,669
Deferred income taxes -- 50,544
Prepaid expenses and other current assets 89,194 146,117
------------ ------------
Total current assets 8,551,369 12,741,489
Property and equipment, net 2,740,624 2,198,625
Other assets 4,377,655 4,693,650
------------ ------------
$ 15,669,648 $ 19,633,764
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft $ 500,642 $ 1,002,403
Borrowings under revolving credit agreement 970,197 --
Current maturities under long-term debt and
capital lease obligations 813,917 118,444
Accounts payable 2,960,689 5,030,945
Income taxes payable -- 165,666
Deferred revenue -- 541,245
Accrued liabilities 1,461,040 1,472,379
Accrued restructuring charges 150,317 16,427
------------ ------------
Total current liabilities 6,856,802 8,347,509
Borrowings under revolving credit agreement -- 1,093,735
Long-term debt and capital lease obligations 3,532,867 3,414,586
Notes payable to stockholders 2,800,000 2,800,000
Deferred revenue 375,000 375,000
Other liabilities -- 3,198
------------ ------------
13,564,669 16,034,028
------------ ------------
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock, $100 par value, 100,000 authorized,
none issued or outstanding -- --
Common stock, $.01 par value, 10,000,000 shares
authorized, 3,500,000 shares issued and
outstanding 35,000 35,000
Capital in excess of par value 3,135,291 3,465,000
Retained earnings (deficit) (1,065,581) 111,790
Cumulative translation adjustment 269 (12,054)
------------ ------------
Total stockholders' equity 2,104,979 3,599,736
------------ ------------
$ 15,669,648 $ 19,633,764
============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
51
TECHNOLOGY SERVICE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Predecessor Company
---------------------------- ----------------------------
Seven Months Five Months
Year Ended Ended Ended Year Ended
April 1, October 30, March 31, March 29,
1994 1994 1995 1996
------------ ------------ ------------ ------------
Net sales $ 31,048,706 $ 11,108,653 $ 9,161,359 $ 33,201,686
------------ ------------ ------------ ------------
Costs and expenses:
Cost of goods sold 25,761,831 9,176,134 8,226,245 26,082,055
General and administrative expenses 3,476,932 1,742,324 850,069 2,204,915
Marketing and selling expenses 1,748,814 366,464 371,757 1,290,349
Engineering, research and
development expenses 2,009,524 457,553 480,495 1,197,183
Restructuring charges (credits) 2,570,652 (534,092) -- --
Litigation settlement -- (261,022) -- --
Interest expense 911,821 599,276 356,624 941,261
Other (income) expense 54,557 (14,618) (58,250) (17,763)
------------ ------------ ------------ ------------
36,534,131 11,532,019 10,226,940 31,698,000
------------ ------------ ------------ ------------
Income (loss) before income tax
expense (5,485,425) (423,366) (1,065,581) 1,503,686
Income tax provision -- -- -- (326,315)
------------ ------------ ------------ ------------
Net income (loss) $ (5,485,425) $ (423,366) $ (1,065,581) $ 1,177,371
============ ============ ============ ============
Income (loss) per common and
common equivalent share $ (0.30) $ 0.30
============ ============
Weighted average number of common
equivalent shares outstanding 3,541,778 3,870,889
============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
52
TECHNOLOGY SERVICE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Predecessor Company
-------------------------- --------------------------
Seven Months Five Months
Year Ended Ended Ended Year Ended
April 1, October 30, March 31, March 29,
1994 1994 1995 1996
----------- ----------- ----------- -----------
Cash flows from operating activities
Net income (loss) $(5,485,425) $ (423,366) $(1,065,581) $ 1,177,371
Adjustments to reconcile net income
(loss) to net cash provided by
(used for) operating activities
Depreciation and amortization 959,696 647,717 407,892 1,060,655
Loss on sale of assets 26,766 18,397 4,936 --
Restructuring charges (credits) 2,570,652 (534,092) -- --
Provisions for inventory losses and
warranty expense 1,253,205 164,534 298,038 352,256
Provision for uncollectible accounts
receivable 56,178 27,122 (3,467) 10,099
Provision for deferred tax benefits -- -- -- 160,649
Changes in certain assets and liabilities,
net of effects of acquisition
(Increase) decrease in accounts
receivable 2,019,659 577,671 (329,469) (1,206,385)
(Increase) decrease in inventories 582,102 1,387,946 (764,211) (3,428,230)
(Increase) decrease in prepaid
expenses and other current assets 357,377 66,940 90,778 (56,923)
(Increase) decrease in other assets (12,311) 3,358 6,501 (474,095)
(Decrease) increase in accounts
payable 623,138 (981,786) (172,369) 2,071,856
Increase in income taxes payable -- -- -- 165,666
Increase in deferred revenue -- -- 375,000 541,245
(Decrease) increase in accrued
liabilities 214,161 458,058 (299,310) (104,843)
(Decrease) in accrued restructuring
charges (75,024) (441,944) (146,673) (73,890)
Increase in other liabilities -- -- -- 3,198
Other (8,880) (55,735) 261 (4,239)
----------- ----------- ----------- -----------
Net cash provided by (used for)
operating activities 3,081,294 914,820 (1,597,674) 194,390
----------- ----------- ----------- -----------
Cash flows from investing activities
Capital expenditures (309,851) (21,481) (59,956) (251,724)
Proceeds from sale of assets 12,825 12,001 -- --
----------- ----------- ----------- -----------
Net cash used for investing
activities (297,026) (9,480) (59,956) (251,724)
----------- ----------- ----------- -----------
Cash flows from financing activities
Net proceeds (payments) under
revolving credit agreement (1,375,686) (1,491,074) (1,599,102) 123,538
Proceeds from notes payable to banks -- 402,500 908,333 --
Proceeds from notes payable
to stockholders -- 400,000 2,800,000 --
Principal payments on long-term
debt and capital lease obligations (929,117) (459,084) (482,307) (813,754)
Increase (decrease) in bank overdraft (709,942) 323,633 120,714 501,761
----------- ----------- ----------- -----------
Net cash provided by (used for)
financing activities (3,014,745) (824,025) 1,747,638 (188,455)
----------- ----------- ----------- -----------
Increase (decrease) in cash (230,477) 81,315 90,008 (245,789)
Cash, beginning of period 324,730 94,253 175,568 265,576
----------- ----------- ----------- -----------
Cash, end of period $ 94,253 $ 175,568 $ 265,576 $ 19,787
=========== =========== =========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
53
TECHNOLOGY SERVICE GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
Common Common
Series E Series C Series B Series A Stock Stock
Preferred Preferred Preferred Preferred $.05 Par $.01 Par
Stock Stock Stock Stock Value Value
------------ ------------ ------------ ------------ ------------ ------------
Predecessor
Balance at April 2, 1993 $ 30,000 $ 234,066 $ 30,000 $ 30,667 $ 21,882 $ --
Net loss for the year
Write-off of note
receivable from
related party to
restructuring charges
Foreign currency
translation adjustment
------------ ------------ ------------ ------------ ------------ ------------
Balance at April 1, 1994 30,000 234,066 30,000 30,667 21,882 --
Net loss for the period
Foreign currency
translation adjustment
------------ ------------ ------------ ------------ ------------ ------------
Balance at October 30, 1994 $ 30,000 $ 234,066 $ 30,000 $ 30,667 $ 21,882 $ --
============ ============ ============ ============ ============ ===========
===========================================================================================================================
Company
Balance at October 30, 1994 $ 30,000 $ 234,066 $ 30,000 $ 30,667 $ 21,882 $ --
Business combination (30,000) (234,066) (30,000) (30,667) (21,882) 35,000
Net loss for the period
Foreign currency
translation adjustment 269 269
------------ ------------ ------------ ------------ ------------ ------------
Balance at March 31, 1995 -- -- -- -- -- 35,000
Business combination -
distribution of escrow
consideration
Net income for the year
Foreign currency
translation adjustment
------------ ------------ ------------ ------------ ------------ ------------
Balance at March 29, 1996 $ -- $ -- $ -- $ -- $ -- $ 35,000
============ ============ ============ ============ ============ ===========
Note
Capital in Retained Receivable Cumulative
Excess of Earnings From Related Translation
Par Value (Deficit) Party Adjustment Total
------------ ------------ ------------ ------------ ------------
Predecessor
Balance at April 2, 1993 $ 22,651,826 $(18,964,484) $ (250,000) $ 73,727 $ 3,857,684
Net loss for the year (5,485,425) (5,485,425)
Write-off of note
receivable from
related party to
restructuring charges 250,000 250,000
Foreign currency
translation adjustment (27,303) (27,303)
------------ ------------ ------------ ------------ ------------
Balance at April 1, 1994 22,651,826 (24,449,909) -- 46,424 (1,405,044)
Net loss for the period (423,366) (423,366)
Foreign currency
translation adjustment 7,280 7,280
------------ ------------ ------------ ------------ ------------
Balance at October 30, 1994 $ 22,651,826 $(24,873,275) $ -- $ 53,704 $ (1,821,130)
============ ============ ============ ============ ============
============================================================================================================
Company
Balance at October 30, 1994 $ 22,651,826 $(24,873,275) $ -- $ 53,704 $ (1,821,130)
Business combination (19,516,535) 24,873,275 -- (53,704) 4,991,421
Net loss for the period (1,065,581) (1,065,581)
Foreign currency
translation adjustment
------------ ------------ ------------ ------------ ------------
Balance at March 31, 1995 3,135,291 (1,065,581) -- 269 2,104,979
Business combination -
distribution of escrow
consideration 329,709 329,709
Net income for the year 1,177,371 1,177,371
Foreign currency
translation adjustment (12,323) (12,323)
------------ ------------ ------------ ------------ ------------
Balance at March 29, 1996 $ 3,465,000 $ 111,790 $ -- $ (12,054) $ 3,599,736
============ ============ ============ ============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
54
TECHNOLOGY SERVICE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
Technology Service Group, Inc. (the "Company") was incorporated in the
State of Delaware in 1975. The Company is engaged in the design, development,
manufacture and sale of public communication products presently consisting of
electronic wireline payphone products, microprocessor-based ("smart") wireline
and wireless payphone products and related payphone components. The Company is
also engaged in the conversion, repair and refurbishment of payphone products
and components. The accompanying financial statements include the accounts of
the Company's wholly-owned subsidiary, International Service Technologies, Inc.
("IST"), which has a foreign division located in Taiwan. On April 3, 1993,
wholly-owned subsidiaries consisting of International Teleservice Corporation,
Inc., Technology Service Enterprises, Inc. and Wireless Technologies, Inc. were
merged into the Company.
On October 31, 1994, TSG Acquisition Corp. ("TSG Acquisition"), a
non-operating corporation wholly-owned by Wexford Partners Fund, L.P.
("Wexford"), acquired all of the outstanding capital stock of the Company
pursuant to an Agreement and Plan of Merger dated October 11, 1994 (the "Plan of
Merger") between Wexford, TSG Acquisition, the Company and the majority holders
of the Company's preferred and common stock (the "Acquisition"). TSG Acquisition
paid an aggregate of $3.5 million in cash pursuant to the Plan of Merger,
including $329,709 of contingent consideration that was placed in escrow. The
consideration consisted of $3,004,000 to acquire the outstanding capital stock
of the Company pursuant to the Plan of Merger and $496,000 to retire a
subordinated master promissory note payable to former stockholders and related
accrued interest and preference fees of $96,000. Cash payments to former
stockholders on October 31, 1994 aggregated $2,991,973 after deducting $277,910
to retire certain obligations of the Company and $230,117 placed in escrow.
Consideration placed in escrow of $329,709 consisting of cash of $230,117 and a
subordinated note of the Company payable to one of the former stockholders in
the principal amount of $99,592 was distributed to former stockholders in
September 1995 upon compliance with indemnification provisions set forth in the
Plan of Merger (see Note 2).
In conjunction with the Acquisition, TSG Acquisition was merged into the
Company, which was then wholly-owned by Wexford. The outstanding shares of the
Company's capital stock and rights to purchase the Company's capital stock,
including preferred stock purchase warrants, at October 31, 1994 and the
Company's Incentive Stock Option Plan were cancelled and the outstanding shares
of capital stock of TSG Acquisition were exchanged for one share of the
Company's common stock, $.05 par value (the "merger share").
In addition, on October 31, 1994, the Company amended its Certificate of
Incorporation to reflect authorized capital consisting of 10 million shares of
common stock, $.01 par value, and 100,000 shares of preferred stock, $100 par
value. Further, the Company entered into an Investment Agreement (the
"Investment Agreement") with Wexford and certain former investors (collectively
the "investors"). Pursuant to the Investment Agreement, the Company issued 3.5
million shares of common stock, $.01 par value, in exchange for the merger share
held by Wexford. Also, the Company borrowed $2.8 million from the investors and
issued subordinated promissory notes due November 1, 1999 that bear interest at
a rate of 10% per annum.
Concurrently with the Acquisition, the Loan and Security Agreement (the
"Loan Agreement") between the Company and its bank (see Note 7) was amended.
Pursuant to the amendment to the Loan Agreement, $2.2 million of debt
outstanding under the revolving credit agreement was converted into a term note
payable on November 30, 1997. In addition, the term of the Loan Agreement was
55
extended from May 31, 1995 to November 30, 1997, and the interest rate on
amounts borrowed under the terms of the Loan Agreement was reduced by ae%.
At April 1, 1994, the Company (sometimes referred to as the "Predecessor"
for periods prior to the Acquisition) had an excess of current liabilities over
current assets of approximately $3.3 million and a net capital deficiency of
approximately $1.4 million, and had incurred net losses aggregating
approximately $7.5 million during the fiscal years ended April 1, 1994 and April
2, 1993. In addition, at April 1, 1994, financing available under the Loan
Agreement and the Company's operating cash flows were not sufficient to permit
the payment of liabilities as they became due. Further, the Company was in
violation of a financial covenant set forth in the Loan Agreement. These facts
indicated that the Predecessor's viability as a going concern at April 1, 1994
was dependent upon raising additional capital and/or financing. The Company
entered into a letter of intent in August 1994 with respect to the Acquisition.
However, until the Acquisition was consummated, there was no assurance that the
Company's efforts to raise additional financing would be successful.
2. ACQUISITION
As described in Note 1, TSG Acquisition Corp. acquired all of the
outstanding capital stock of the Company pursuant to the Plan of Merger. The
Acquisition has been accounted for using the purchase method of accounting.
Accordingly, the aggregated purchase price of $3,170,291 (excluding contingent
consideration) was pushed down and allocated to assets and liabilities of the
Company as of October 31, 1994 (the date of acquisition) based upon their
estimated fair values. The excess of the purchase price over the fair value of
the net assets acquired of $3,853,877 (which increased by $329,709 upon the
payment of contingent consideration during the year ended March 29, 1996) at
October 30, 1994 was recorded as goodwill (see Notes 3 and 6). A summary of the
book value of the assets and liabilities of the Company as compared to their
estimated fair value reflected in the Company's financial statements as of the
date of acquisition is set forth below.
Book Estimated
Value Fair Value
----------- -----------
Cash $ 175,568 $ 175,568
Accounts receivable 2,337,150 2,337,150
Inventories 4,887,167 4,842,433
Prepaid expenses and other current assets 179,972 179,972
Property and equipment 2,601,801 2,984,574
Other assets 215,718 645,447
Bank overdraft (379,928) (379,928)
Borrowings under revolving credit agreement (1,660,965) (1,660,965)
Current maturities under long-term debt
and capital lease obligations (877,557) (888,392)
Accounts payable (3,133,058) (3,133,058)
Accrued expenses (1,624,180) (1,749,039)
Accrued restructuring charges (515,222) (312,312)
Notes payable to stockholders (400,000) --
Long-term debt and capital lease obligations (3,627,596) (3,725,036)
----------- -----------
Net assets acquired (1,821,130) (683,586)
Excess of purchase price over net
assets acquired -- 3,853,877
----------- -----------
$(1,821,130) $ 3,170,291
=========== ===========
56
The increase in the aggregate purchase price and goodwill upon the
distribution of escrow consideration of $329,709 was recognized in the Company's
financial statements during the year ended March 29, 1996.
The accompanying financial statements at March 31, 1995 and March 29, 1996
and for the five months and year then ended, respectively, reflect the effects
of the Acquisition. Assuming the Acquisition had occurred on April 2, 1994, the
Company's and the Predecessor's net loss for the year ended March 31, 1995
including proforma adjustments for depreciation, interest and amortization of
assets to give effect to the accounting bases recognized in recording the
Acquisition would have approximated $1,599,000 (unaudited), or a loss of $.45
per share (unaudited), as compared to the reported loss of $1,488,947 ($423,366
for the seven months ended October 30, 1994 and $1,065,581 for the five months
ended March 31, 1995). The proforma adjustments include an increase in the
amortization of goodwill and other intangible assets of approximately $140,000
(unaudited) due to the increase in the basis of intangible assets and their
estimated useful lives, a decrease in depreciation of approximately $24,000
(unaudited) due to an increase in the basis of property and equipment and their
estimated useful lives and a decrease in interest expense of approximately
$6,000 (unaudited) due to revaluation of capital lease obligations, the
financing received from the investors and the repayment of indebtedness under
the Company's revolving credit agreement.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies followed by the Company is
set forth below:
Fiscal Year
The Company operates on a fiscal year ending the Friday nearest March 31
resulting in a 52/53 week year. The accompanying consolidated financial
statements include the audited financial statements of the Predecessor for the
year (52 weeks) ended April 1, 1994 and seven months (30 weeks) ended October
30, 1994 and the Company, subsequent to the Acquisition, for the five months (22
weeks) ended March 31, 1995 and year (52 weeks) ended March 29, 1996.
Consolidation
All significant intercompany balances and transactions have been eliminated
in consolidation.
Translation of Foreign Currency
The financial position and results of operations of the Company's foreign
division are measured using local currency as the functional currency. Assets
and liabilities of the Company's foreign division are translated into United
States dollars at the applicable exchange rate in effect at the end of the
period. Income statement accounts are translated at the average rate in effect
over the period. Translation adjustments arising from the use of differing
exchange rates from period to period are accumulated in a separate component of
stockholders' equity. Gains and losses resulting from foreign currency
transactions are included in income in the period in which these transactions
occur. The effects of foreign currency translation on the Company's financial
position and results of operations are not significant.
Cash
The Company's cash balances serve as collateral under the Loan Agreement
(see Note 7) and, accordingly, are restricted.
57
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
based upon the first-in, first-out ("FIFO") method or standard cost, which
approximates cost on a FIFO basis.
Reserves to provide for potential losses due to obsolescence and excess
quantities are established in the period in which such losses occur.
Property and Equipment
Property and equipment is recorded at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the established
useful lives of the assets as follows:
Predecessor Company
----------- -----------
Building and building improvements 30 years 30 years
Machinery and equipment 2-10 years 2-5 years
Furniture and fixtures 2-10 years 2-3 years
Leasehold improvements 5-15 years 5 years
Additions, improvements and expenditures that significantly extend the
useful life of an asset are capitalized. Expenditures for repairs and
maintenance are charged to operations as incurred. When assets are retired or
disposed of, the cost and accumulated depreciation thereon are eliminated from
the accounts, and any gains or losses are included in income.
Revenue Recognition
Sales and related costs are recorded by the Company upon shipment of
products. Deferred revenue classified as a current liability consists of
prepayments from customers. Deferred revenue classified as a long-term liability
represents the refundable portion of proceeds received from the sale of software
(see Note 15) and is classified according to the terms of the repayment
obligation. Deferred revenue is recognized as earned upon shipment of products
or pursuant to the terms of the sales contract.
Engineering, Research, and Development Costs
Costs and expenses incurred for the purpose of product research, design and
development are charged to operations as incurred. Engineering, research and
development costs consist primarily of costs associated with development of new
products and manufacturing processes.
Stock-Based Compensation
The Company accounts for compensation cost related to stock options and
other forms of stock-based compensation plans in accordance with the
requirements of Accounting Principles Board Opinion 25 ("APB 25"). APB 25
requires compensation cost for stock-based compensation plans to be recognized
based on the difference, if any, between the fair value of the stock and the
option exercise price. The Company has not recognized any compensation cost with
respect to stock options granted under the Company's plans (see Note 9). In
October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
("SFAS 123"). SFAS 123 established a fair value based method of accounting for
compensation cost related to stock options and other forms of stock-based
compensation plans. SFAS 123 is effective for fiscal years beginning after
December 15, 1995. The Company intends to adopt the provisions or pro forma
disclosure requirements of SFAS 123 in fiscal 1997. The impact of the adoption
of SFAS 123 is not known at this time.
58
Goodwill
The excess of cost over the fair value of acquired business (goodwill)
prior to October 31, 1994 was being amortized to operations over 40 years. The
excess of the purchase price over the fair value of the Company's assets and
liabilities at the date of the Acquisition is being amortized to operations on a
straight-line basis over a period of 35 years. The allocation of the purchase
price (see Note 2) did not include an allocation to goodwill recorded in the
Company's consolidated financial statements at the date of acquisition. At each
balance sheet date, the Company evaluates the realizability of goodwill based on
its expectations of future nondiscounted cash flows. Based on the Company's most
recent analysis, the Company believes that no material impairment of goodwill
exists at and March 29, 1996.
Income Taxes
Provisions (benefits) for income taxes are based upon income (loss)
recognized for financial statement purposes and include the effects of temporary
differences between such income (loss) and that recognized for tax purposes.
Effective April 3, 1993, the Company adopted Statement of Financial Accounting
Standards No. 109 (FAS 109), "Accounting for Income Taxes." The adoption of FAS
109 changed the Company's method of accounting for income taxes from the
deferred method pursuant to Accounting Principles Board Opinion No. 11 (APB 11)
to an asset and liability approach. This approach requires recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the financial statements or tax returns. Using
the enacted tax rate in effect for the year in which the differences are
expected to reverse, deferred tax assets and liabilities are determined based
upon the differences between the financial reporting basis and income tax basis
of the assets and liabilities (see Note 10). These temporary differences arise
primarily from differences in inventory valuation and depreciation methods and
reserves established for inventory obsolescence, uncollectible accounts
receivable and restructuring charges. A valuation allowance is established for
deferred tax assets to the extent realization thereof is not assured. The
prospective adoption of FAS 109 had no impact on the Company's financial
position or results of operations for the year ended April 1, 1994.
Income (Loss) Per Common and Common Equivalent Share
Income per common share for the five months ended March 31, 1995 and year
ended March 29, 1996 is computed on the basis of the weighted average number of
common shares outstanding and dilutive common stock equivalent shares
outstanding during the period, except pursuant to the Securities and Exchange
Commission Staff Accounting Bulletin ("SECSAB") Topic 4:D, stock issued and
stock options covering 89,000 shares of common stock granted during the 12
months prior to a May 10, 1996 initial public offering (see Note 9) at prices
below the public offering price have been included in the calculation of
weighted average shares of common stock outstanding as if they were outstanding
as of the beginning of the periods presented. Also, as a result of the
Acquisition, income (loss) per share is not presented for periods prior to the
five months ended March 31, 1995 in accordance with SECSAB Topic 1:B2.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
59
4. INVENTORIES
Inventories at March 31, 1995 and March 29, 1996 consisted of the
following:
March 31, March 29,
1995 1996
---------- ----------
Raw materials $3,566,950 $6,056,702
Work-in-process 345,811 1,207,080
Finished goods 1,613,752 1,394,887
---------- ----------
$5,526,513 $8,658,669
========== ==========
Substantially all inventories are pledged to secure notes payable (see Note
7). Reserves for potential losses due to obsolescence and excess quantities
recorded at March 31, 1995 and March 29, 1996 aggregated $1,766,199 and
$1,606,195, respectively.
Approximately $150,000 of additional inventory loss reserves established
during the year ended April 1, 1994 were recorded as restructuring charges.
These costs relate to the value of items included in inventory and associated
with product lines discontinued in connection with the Company's restructuring
plan initiated during the year ended April 1, 1994 (see Note 11). During the
year ended April 1, 1994, the Company recorded provisions for obsolete and
excess inventory and warranty expense of approximately $1,003,000 and $250,000,
respectively. The provision for obsolete and excess inventory included estimated
losses attributable to the termination of certain sales contracts. The provision
for warranty expense included estimated additional warranty claims related to
certain products sold pursuant to one of the Company's sales contracts.
5. PROPERTY AND EQUIPMENT
Property and equipment at March 31, 1995 and March 29, 1996 consisted of
the following:
March 31, March 29,
1995 1996
----------- -----------
Land $ 120,634 $ 120,633
Building and building improvements 877,187 877,187
Machinery and equipment 1,788,041 2,009,159
Furniture and fixtures 123,612 119,879
Leasehold improvements 139,000 151,116
----------- -----------
3,048,474 3,277,974
Accumulated depreciation (307,850) (1,079,349)
----------- -----------
$ 2,740,624 $ 2,198,625
=========== ===========
Substantially all property and equipment is pledged to secure notes payable
(see Note 7).
Depreciation expense for the year ended April 1, 1994 aggregated $755,469.
Depreciation expense for the seven months ended October 30, 1994 and five months
ended March 31, 1995 aggregated $454,911 and $308,047, respectively.
Depreciation expense for the year ended March 29, 1996 aggregated $784,039.
60
In connection with restructuring initiated during the year ended April 1,
1994, the Company recorded a reserve for impairment of $253,084 to write down
the net asset bases of certain property to estimated net realizable (or fair)
value. The property included in the Company's impairment reserve consisted
primarily of a building and improvements thereto leased pursuant to a capital
lease obligation and leasehold improvements made to facilities leased under
non-cancelable operating lease agreements that the Company planned to close in
connection with the restructuring. The impairment loss reserve related to
leasehold improvements amounted to $119,182 and represented the estimated net
book value of the assets at the planned closing dates of the facilities. The
impairment loss reserve related to the building and improvements was recorded
based on the Company's estimates of expected cash flow deficits of the facility
to the renewal (or expected termination) date of the capital lease obligation,
and approximated the difference between the net book value of the property and
the outstanding balance of the capital lease obligation (or fair value) as of
the expected lease termination date. The aggregate impairment reserve loss
provision is included in restructuring charges which aggregated $2,570,652
during the year ended April 1, 1994 (see Note 11). During the seven months ended
October 30, 1994, the Company negotiated the termination of certain of the
non-cancelable lease agreements with respect to facilities closed in connection
with the restructuring plan initiated during fiscal 1994, and retired leasehold
improvements included in the reserve for impairment with an aggregate net book
value of $117,807.
Assets under capital leases are capitalized using interest rates
appropriate at the date of purchase or at the inception of the lease, as
applicable. The following is a summary of the Company's assets under capital
leases which are included in property and equipment at March 31, 1995 and March
29, 1996:
March 31, March 29,
1995 1996
----------- -----------
Land ....................................... $ 120,634 $ 120,634
Building and building improvements ......... 877,187 877,187
Machinery and equipment .................... 151,679 60,445
----------- -----------
1,149,500 1,058,266
Accumulated depreciation ................... (33,727) (70,762)
----------- -----------
$ 1,115,773 $ 987,504
=========== ===========
61
6. OTHER ASSETS
Other assets at March 31, 1995 and March 29, 1996, net of accumulated
amortization of $98,844 and $375,481, respectively, consisted of the following:
March 31, March 29,
1995 1996
---------- ----------
Excess of purchase price over fair value of net
assets acquired, net of accumulated
amortization of $45,879 and $169,336 $3,807,998 $3,803,057
Product software, net of accumulated
amortization of $19,500 and $66,300 214,500 167,700
Patents, net of accumulated amortization
of $13,663 and $46,453 150,289 117,499
Customer contracts, net of accumulated
amortization of $16,207 and $55,103 110,206 71,309
Unpatented technology, net of accumulated
amortization of $4,595 and $15,622 55,136 44,109
Patent license, net of accumulated
amortization of $22,667 -- 110,333
Deferred initial public offering expenses -- 338,372
Deposits 32,286 40,500
Other 7,240 771
---------- ----------
$4,377,655 $4,693,650
========== ==========
Amortization expense for the year ended April 1, 1994, seven months ended
October 30, 1994, five months ended March 31, 1995 and year ended March 29, 1996
amounted to $204,227, $192,806, $99,845 and $276,616, respectively.
At April 2, 1993, the Company had a $250,000 note receivable from its then
president and chief executive officer bearing interest at a rate of 10% per
annum. The note became due and payable upon a change in ownership of the Company
as defined in compensation agreements between the Company and the Company's
preferred stockholders. In connection with a restructuring and the termination
of the executive's employment contract during the year ended April 1, 1994, the
collectibility of the note became uncertain. Accordingly, the Company recorded
restructuring charges of $296,875 representing the entire balance of the note
and related accrued interest of $46,875 (see Note 11). In connection with the
settlement of severance obligations as discussed in Note 11, this note was not
repaid and the Company wrote off the note and related accrued interest during
the five months ended March 31, 1995.
7. BORROWINGS UNDER REVOLVING CREDIT AGREEMENT, LONG-TERM DEBT, CAPITAL LEASE
OBLIGATIONS AND NOTES PAYABLE TO STOCKHOLDERS
Borrowings Under Revolving Credit Agreement
At March 29, 1996, the Company is able to borrow up to a maximum of $9
million under term and installment notes and a revolving credit agreement
pursuant to the terms of the Loan Agreement between the Company and its bank. At
March 31, 1995 and March 29, 1996, the Company had outstanding debt of
$2,525,000 and $2,857,857, respectively, under term and installment notes and
$970,197 and $1,093,735, respectively, under the revolving credit agreement.
Amounts borrowed under the revolving credit agreement and installment and term
62
notes are secured by substantially all assets of the Company including accounts
receivable, inventories and property and equipment. The borrowing limit under
the revolving credit agreement is based upon specified percentages applied to
the value of collateral, consisting of accounts receivable and inventories, less
amounts outstanding under a $2.2 million term note due November 30, 1997 and
varies based upon changes in the collateral value. Interest is payable monthly
based upon the greater of the actual outstanding debt balances or $4 million at
a variable rate per annum equal to 1(OMEGA)% (2% from October 31, 1994 to
February 29, 1996 and 2.75% prior to October 31, 1994) above a base rate quoted
by Citibank (9% at March 31, 1995 and 8.25% March 29, 1996). The revolving
credit agreement is renewable annually for one year periods unless terminated by
the bank upon an occurrence of an event of default or by the Company upon at
least 90 days notice. The Company has agreed to pay termination fees of up to 2%
of the average monthly borrowings or the minimum loan amount ($4 million),
whichever is greater, if the Loan Agreement is terminated on the date other than
an anniversary date.
The Loan Agreement contains conditions and covenants that prevent or
restrict the Company from engaging in certain transactions without the consent
of the bank, including merging or consolidating, payment of subordinated
stockholder debt obligations, declaration or payment of dividends and
disposition of assets, among others. Additionally, the Loan Agreement requires
the Company to comply with specific financial covenants, including covenants
with respect to cash flow, working capital and net worth. Noncompliance with any
of these conditions and covenants or the occurrence of any other event of
default, if not waived or corrected, could accelerate the maturity of the
borrowings outstanding under the Loan Agreement.
Concurrently with the Acquisition, the Loan Agreement was amended. Pursuant
to the amendment, $2.2 million of debt outstanding under the revolving credit
agreement was converted into a term note payable on November 30, 1997. Further,
the term of the Loan Agreement was extended from May 31, 1995 to November 30,
1997, and the interest rate on amounts borrowed under the terms of the Loan
Agreement was reduced by ae%.
At April 1, 1994, the Company was in default of certain conditions and
covenants set forth in the Loan Agreement, including specific covenants with
respect to cash flow and net worth. Although the Loan Agreement was amended on
June 9, 1994 to provide less restrictive covenants, the Company was in default
of the amended cash flow covenant soon thereafter. Pursuant to the June 9, 1994
amendment, the aggregate principal obligation under the installment note was
decreased from $500,000 to $465,000, and the Company borrowed an additional
$402,500. The expiration date of the Loan Agreement and the due date of the term
and installment notes were extended from February 28, 1995 to May 31, 1995. The
monthly principal payment under the installment note was increased from $20,833
to $25,000
The Company remained in default of certain conditions and covenants set
forth in the Loan Agreement, including specific financial covenants with respect
to cash flow and net worth until October 31, 1994. On October 31, 1994, an
amendment to the Loan Agreement, as further amended as of March 31, 1995,
provided less restrictive covenants which brought the Company into compliance.
Accordingly, obligations outstanding under the terms of the Loan Agreement at
March 31, 1995 are classified according to the terms of the respective note
agreement. The Company is also in compliance with the covenants and conditions
contained in the Loan Agreement at March 29, 1996.
In May 1996, the Company completed an initial public offering of equity
securities (see Note 9). A portion of the proceeds of the initial public
offering were used to repay the Company's then outstanding indebtedness pursuant
to the Loan Agreement. Accordingly, the Company has classified $1,093,735 of
indebtedness outstanding under the revolving credit facility and $2,509,524 of
indebtedness outstanding under term and installment notes as long-term
obligations at March 29, 1996.
63
Long-Term Debt and Capital Lease Obligations
Long-term debt and capital lease obligations payable at March 31, 1995 and
March 29, 1996 consisted of the following:
March 31, March 29,
1995 1996
----------- -----------
Loan and Security Agreement
$2.2 million secured term note, principal
balance due November 30, 1997 $ 2,200,000 $ 2,200,000
$650,000 secured term note, principal
payable in sixty equal monthly installments
of $7,738, with remaining principal balance
due November 30, 1997 417,857 325,000
$465,000 secured installment note, principal
payable in eighteen equal monthly
installments of $25,000 240,000 --
Other notes payable
Unsecured promissory notes, payable in
sixty equal monthly installments of $21,250,
including interest at 10% per annum 203,077 --
Unsecured non-interest bearing promissory
note, payable in nineteen equal monthly
installments of $10,873 163,101 32,620
Unsecured non-interest bearing promissory
note, payable in sixteen equal monthly
installments of $5,000 and one installment
of $7,414 56,914 --
Obligations under capital leases 1,065,835 975,410
----------- -----------
4,346,784 3,533,030
Less - current maturities (813,917) (118,444)
----------- -----------
$ 3,532,867 $ 3,414,586
=========== ===========
During fiscal 1995 and 1996, the Company had outstanding promissory notes
payable to a company affiliated with certain officers and employees of the
Company bearing interest at a rate of 10% per annum. Outstanding indebtedness
pursuant to such promissory notes amounted to $203,077 at March 31, 1995. The
notes were paid in full during the year ended March 29, 1996. Interest paid
pursuant to such notes during the years ended March 31, 1995 and March 29, 1996
aggregated $48,934 and $9,424, respectively. At October 30, 1994, the Company
was in default of the such notes as a result of its failure to make certain
royalty payments. However, on November 9, 1994, the Company entered into an
amendment agreement which brought the Company into compliance with the terms of
the note agreements. Therefore, the note obligations are classified according to
their terms at March 31, 1995. The notes were repaid during the year ended March
29, 1996. Pursuant to the amendment agreement, the Company executed a
non-interest bearing promissory note in the principal amount of $206,595
representing unpaid royalties as of October 30, 1994. The note is payable in
nineteen equal monthly installments of $10,873 commencing on December 11, 1994.
The notes were paid in full during the year ended March 29, 1996. The note had
an outstanding balance of $163,101 at March 31, 1995 and $32,620 at March 29,
1996.
64
In May 1996, the Company completed an initial public offering of equity
securities (see Note 9). A portion of the proceeds of the initial public
offering were used to repay the Company's then outstanding indebtedness pursuant
to the Loan and Security Agreement. Accordingly, the Company has classified
$309,524 of indebtedness then outstanding under the $650,000 term note as a
long-term obligation at March 29, 1996.
On November 30, 1990, the Company entered into a capital lease obligation
for a one hundred thousand square foot manufacturing facility located in
Paducah, Kentucky. The lease, which provides for a monthly payment of $12,681,
has an initial term of 51/2 years and is renewable for two additional five-year
periods. On March 20, 1996, the initial term of the lease was extended for a
period of one year. The Company has an option to acquire the property at the end
of the lease term, including renewal periods, at a cost of $10,000. In addition,
the Company leases various equipment under capital lease obligations. The
present value of future minimum lease payments for assets under capital leases
at March 29, 1996 is as follows:
1997 $ 167,913
1998 152,172
1999 152,172
2000 152,172
2001 152,172
Thereafter 961,075
-----------
Total minimum capital lease obligations 1,737,676
Less portion representing interest (762,266)
-----------
Present value of minimum lease payments $ 975,410
===========
Aggregate maturities of long-term debt and capital lease obligations
outstanding at March 29, 1996 payable during the ensuing five years are as
follows:
1997 $ 186,286
1998 2,481,446
1999 55,388
2000 62,222
2001 69,900
Thereafter 677,788
-----------
$ 3,533,030
===========
Notes Payable to Stockholders
On June 9, 1994, the Company borrowed $400,000 from its preferred
stockholders and issued a subordinated master promissory note payable on demand
bearing interest at a rate of 10% per annum. This note, by its terms, became due
upon the Acquisition and change in ownership of the Company's capital stock.
Prior to May 31, 1995, interest accrued was payable at the date of a required
principal payment. Interest accrued and unpaid as of May 31, 1995 was to be
capitalized into the outstanding principal of the note. Beginning June 30, 1995,
interest was payable monthly in arrears. Upon the change in ownership of the
capital stock of the Company, a loan preference fee in an escalating amount
which, when added to accruing interest, would equal 5% of the outstanding
principal for each month that the note was outstanding became immediately due
and payable. As described in Note 1, the subordinated master promissory note,
together with accrued interest and preference fees aggregating $96,000, were
retired in connection with the Acquisition.
65
On October 31, 1994, the Company entered into an Investment Agreement with
the investors. Pursuant to the terms of the Investment Agreement, the Company
borrowed $2.8 million from the investors and issued subordinated promissory
notes due November 30, 1999 that bear interest at a rate of 10% per annum.
Interest accrued under the terms of the subordinated promissory notes is payable
semi-annually beginning May 1, 1995. In May 1996, the Company completed an
initial public offering of equity securities (see Note 9). A portion of the
proceeds from the May 10, 1996 initial public offering were used to repay the
Company's outstanding indebtedness pursuant to the subordinated promissory
notes. During the year ended March 29, 1996, the Company paid interest pursuant
to the subordinated notes of $279,847. At March 31, 1995 and March 29, 1996,
interest accrued pursuant to the terms of the subordinated notes aggregated
$115,683 and $116,603, respectively.
8. ACCRUED LIABILITIES
Accrued liabilities at March 31, 1995 and March 29, 1996 consisted of the
following:
March 31, March 29,
1995 1996
---------- ----------
Workers' compensation and employee group
insurance $ 210,480 $ 117,546
Salaries, wages and related employee benefits
and taxes 223,126 339,481
Interest 175,652 149,674
Royalties 157,731 273,169
Warranty expense 353,318 209,500
Sales and use taxes 100,421 24,651
Professional fees 83,051 99,136
Environmental costs 12,948 12,948
Property taxes 36,005 20,840
Bonuses -- 74,790
Other 108,308 150,644
---------- ----------
$1,461,040 $1,472,379
========== ==========
9. STOCKHOLDERS' EQUITY
Preferred Stock
The Company is authorized, pursuant to its Certificate of Incorporation as
amended on October 31, 1994, to issue up to 100,000 shares of preferred stock,
$100 par value, in one or more series or other designations determined by the
Board of Directors ("Board") of the Company. The Board is authorized to
determine, as to any particular series of preferred stock, the dividend rights
including annual dividend rates and whether the dividends shall be cumulative or
non-cumulative, redemption provisions, per-share liquidation preferences, voting
powers, conversion terms and provisions and any other rights or preferences. No
dividends may be paid or declared on the Company's common stock or on any other
class of stock ranking junior to the preferred stock, nor shall any shares of
common stock or any other class of stock ranking junior to the preferred stock
be purchased, retired or otherwise acquired by the Company unless all dividends
accrued and payable on preferred shares and all amounts required to retire the
preferred shares have been paid out of assets legally available for the payment
of such obligations.
As of March 31, 1995 and March 29, 1996, no preferred stock has been
issued, nor has the Board designated any series of preferred stock for issuance
or determined any related rights or preferences.
66
In connection with the Acquisition, the outstanding shares of the Company's
Series A, Series B, Series C and Series E preferred stock at October 30, 1994
were cancelled. The Series A, Series B, Series C, Series E and Series D
preferred stock had per-share liquidation preferences of $15, $5, $2.50, $2.50
and $100, respectively, plus declared and unpaid dividends. The shares of
preferred stock, except shares of Series D preferred stock, were convertible
into an equal number of shares of common stock, subject to certain anti-dilution
provisions. Shares of Series A, Series B, and Series C preferred stock were
convertible into voting common stock. Shares of Series D variable rate
redeemable preferred stock were deemed retired and extinguished and could not be
reissued. Shares of Series E preferred stock were convertible into non-voting
common stock. In the event the Company consummated a public offering of common
stock at a price of at least $10 per share which resulted in net proceeds of at
least $5 million, the convertible shares of preferred stock would have
automatically converted into common stock.
Series A, Series B, and Series C preferred shares had voting rights equal
to the number of shares of common stock which would be received upon conversion
to common shares. The Series D and Series E preferred stock had no voting
rights. However, holders of Series E preferred stock had the right to vote as a
separate class to the extent entitled under Delaware law and on any merger,
recapitalization or reorganization in which shares of Series E preferred stock
would have received or would have been exchanged for per-share consideration
different from shares of Series C preferred stock or would have otherwise been
treated differently from shares of Series C preferred stock, except that shares
of Series E preferred stock could have, without such separate class vote,
received or been exchanged for non-voting securities which were identical on a
per-share basis to voting securities received with respect to or exchanged for
the Series C preferred stock.
The Company could not, without the consent of stipulated percentages of
holders of the applicable series of preferred stock, authorize or create any
class or series of capital stock ranking, either as to payment of dividends or
distribution of assets, prior to or on a parity with such series of convertible
preferred stock or alter or change the powers, preferences or rights of such
series of convertible preferred stock. Further, the Company could not sell
shares of capital stock ranking, either as to payment of dividends or
distribution of assets, prior to or on parity with those of convertible
preferred stock at prices less than the conversion prices or convertible into
common stock at prices less than the conversion prices of convertible preferred
stock without such consent(s).
The aggregate liquidation preference of preferred stock in order of
priority at April 1, 1994 were as follows: Series E - $750,000; Series C -
$5,851,650; Series B - $1,500,000 and Series A - $4,600,020. On January 24,
1992, the Company and holders of the Series C and Series E preferred stock
entered into a Liquidation Rights Agreement. Pursuant to the Liquidation Rights
Agreement, the Series C and Series E preferred stock issued in connection with a
January 24, 1992 private placement had a senior liquidation preference over the
Series C preferred stock outstanding prior to the offering. The Liquidation
Rights Agreement provided that the Company shall require subsequent future
purchasers of additional shares of Series C and Series E preferred stock to
become parties to the Liquidation Rights Agreement.
Common Stock
The Company is authorized, pursuant to its Certificate of Incorporation as
amended on October 31, 1994, to issue up to 10,000,000 shares of common stock,
$.01 par value. As described in Note 1, the Company issued 3.5 million shares of
common stock on October 31, 1994 pursuant to the terms of an Investment
Agreement between the Company, Wexford and certain former investors.
Holders of voting common stock are entitled to one vote per share on all
matters to be voted on by the stockholders. No dividends may be paid or declared
on the Company's common stock until all dividends accrued and payable on
preferred shares outstanding have been paid.
67
In connection with the Acquisition, the outstanding shares of the Company's
common stock at October 30, 1994 were cancelled. Prior to the Acquisition, the
Company was authorized to issue 11,100,000 shares of common stock, $.05 par
value. Non-voting common stock was convertible into an equal number of shares of
voting common stock upon occurrence of certain events, including a public
offering of securities, a sale of securities to a person that owns or has the
right to acquire less than 2% of the outstanding securities of any class of
voting securities after the sale and a sale of securities that results in a
change in control of the Company.
Generally, holders of non-voting common stock had no right to vote on any
matters to be voted on by the stockholders. However, holders of non-voting
shares had the right to vote as a separate class to the extent entitled under
Delaware law and on any merger, recapitalization or reorganization in which
shares of non-voting common stock would receive or be exchanged for
consideration different from shares of voting common stock or would otherwise be
treated differently from shares of voting common stock or in which non-voting
shares would be exchanged for non-voting securities which were not convertible
into voting securities on the same terms as previously provided.
Further, the Company could not enter into a transaction which would require
holders of non-voting common stock to receive voting securities, or securities
convertible into voting securities, in excess of limits provided under the
requirements of any governmental authority, unless the Company redeemed such
shares of non-voting common stock upon consummation of the transaction at a
price equal to the per-share value placed upon the Company's common stock in
conjunction with the transaction.
Initial Public Offering
In May 1996, the Company completed an initial public offering of 1,150,000
units (the "Units"), each Unit consisting of one share of common stock and one
redeemable warrant ("Redeemable Warrant") at a price of $9.00 per Unit for gross
proceeds of $10,350,000. In connection with the offering, the Company issued
warrants to the Underwriters to purchase 100,000 shares of Common Stock (the
"Underwriter Warrants") for gross proceeds of $10. Net proceeds received by the
Company, after underwriting discounts and expenses of $1,231,897, amounted to
$9,118,113. The Company has incurred other offering expenses of $338,372 as of
March 29, 1996. These expenses have been deferred at March 29, 1996 (see Note 6)
and, together with offering expenses incurred subsequent to March 29, 1996, will
be charged against the net proceeds of the offering.
Two Redeemable Warrants entitle the holder thereof to purchase one share of
common stock at an exercise price of $11.00 per share. Unless the Redeemable
Warrants are redeemed, the Redeemable Warrants may be exercised at any time
beginning on May 10, 1996 and ending May 9, 1999, at which time the Redeemable
Warrants will expire. Beginning on February 10, 1997, the Redeemable Warrants
are redeemable by the Company at its option, as a whole and not in part, at $.05
per Redeemable Warrant on 30 days' prior written notice, provided that the
average closing bid price of the common stock equals or exceeds $12.00 per share
for 20 consecutive trading days ending within five days prior to the date of the
notice of redemption. The Redeemable Warrants will be entitled to the benefit of
adjustments in the exercise price and in the number of shares of common stock
deliverable upon the exercise thereof upon the occurrence of certain events,
including a stock dividend, stock split or similar reorganization.
The Underwriter Warrants are initially exercisable at a price of $10.80 per
share of common stock. The Underwriter Warrants contain anti-dilution provisions
providing for adjustments of the number of warrants and exercise price under
certain circumstances. The Underwriter Warrants grant to the holders thereof
certain rights of registration of the securities issuable upon exercise of the
Underwriter Warrants. The Underwriter Warrants may be exercised at any time
beginning on May 10, 1997 and ending May 9, 2001, at which time the Underwriter
Warrants will expire.
68
Common Stock Purchase Warrants
As of April 1, 1994, the Company had outstanding warrants to purchase an
aggregate of 312,000 shares of Series C preferred stock at a price of $2.50 per
share. The warrants outstanding at April 1, 1994 were cancelled upon
consummation of the Acquisition. Generally, the warrants were exercisable for
five-year periods beginning either on the issuance date or one year thereafter.
The warrant terms provided that the warrants would expire on various dates
through March 31, 1996.
On May 23, 1995, the Company issued a warrant to one of its contract
manufacturers to purchase 40,000 shares of common stock, $.01 par value, at a
price of $4.00 per share in return for the extension of credit under the terms
of a manufacturing agreement between the Company and the contract manufacturer.
The warrant is exercisable in whole or in part for a period of five years from
the date of issuance, and expires on May 23, 2002, unless terminated earlier
upon a breach of the manufacturing agreement by the contract manufacturer. The
number of shares of securities covered by the warrant and the exercise price are
subject to adjustment upon the occurrence of certain events, including stock
splits and reclassification in connection with a merger or consolidation or
otherwise.
Stock Options
On November 1, 1994, the Company's Board of Directors adopted the 1994
Omnibus Stock Plan (the "Stock Plan"). The Stock Plan provides the Board or a
committee of the Board with the authority to grant to officers and employees of
the Company incentive stock options within the meaning of Section 422A of the
Internal Revenue Code and to grant to directors, officers, employees and
consultants of the Company non-qualified stock options and restricted stock
which do not qualify as incentive stock options. The aggregate number of shares
of the Company's common stock that may be issued pursuant to the Stock Plan at
March 31, 1995 and March 29, 1996 was 385,000 shares and 635,000 shares,
respectively. On May 10, 1995, the stockholders of the Company approved an
amendment to the Stock Plan which increased the number of shares of the
Company's common stock that may be issued pursuant to the Stock Plan to 635,000
shares. Further, the amendment added a provision that the maximum number of
shares with respect to which options may be granted to any one employee shall
not exceed 300,000 shares. The Board's authority to grant options under the
Stock Plan expires on November 1, 2004. The Stock Plan is administered by a
Stock Plan Committee consisting of members appointed by the Board.
The Board has the authority to determine option periods, the number of
shares of common stock subject to options granted and such other terms and
conditions under which options may be exercised. The Board also has the
authority to determine at which times options or restricted stock may be
granted, the purchase price of restricted stock, whether an option shall be an
incentive stock option or a non-qualified option, whether restrictions such as
repurchase rights are to be imposed on shares subject to options and restricted
stock, and the nature of such restrictions. The per-share option price of
incentive stock options granted pursuant to the Stock Plan shall not be less
than the per-share fair market value, as determined by the Board, of the
Company's common stock as of the date of grant, or 110% of the per-share market
value with respect to incentive stock options granted to employees owning 10% or
more of the total combined voting power of all classes of the Company's stock.
Option periods shall not exceed ten years from the date options are granted, or
five years with respect to incentive stock options to employees owning 10% or
more of the total voting power of all classes of the Company's stock. Options
granted under the Stock Plan generally expire 60 days after termination of
employment or at the end of the option period stipulated by the Board in the
option agreement, whichever is earlier.
The Board has the authority to accelerate the date of exercise of an option
or any installment thereof, unless, in the case of incentive stock options, such
acceleration would violate the annual vesting limitations contained in Section
422(d) of the Internal Revenue Code. The exercise prices of options granted
69
pursuant to the Stock Plan are subject to adjustment upon any subdivision,
combination, merger, splits, split-up, liquidation, or the like, to reflect such
subdivision, combination or exchange. The number of shares of common stock to be
received upon exercise of options granted pursuant to the Stock Plan are subject
to adjustment upon declarations of stock dividends between the date of grant and
the date of exercise of options. Also, the number of shares of common stock
reserved for issuance pursuant to the Stock Plan shall be adjusted upon the
occurrence of such events.
The Board may grant restricted stock under the Stock Plan pursuant to a
restricted stock agreement. The Board has the authority to determine the number
of shares of common stock to be issued and to the extent, if any, to which they
shall be issued in exchange for cash and/or other consideration. Shares issued
pursuant to restricted stock may not be sold, transferred, pledged, or otherwise
disposed of, except by the laws of descent and distribution, or as otherwise
determined by the Board for a period as determined by the Board from the date
the restricted stock is granted. The Company has the right to repurchase
restricted stock at such price as determined by the Board on the date of grant.
The repurchase rights are exercisable on such terms as determined by the Board
upon the termination of services of the grantee prior to expiration of the
restriction on transfer of the shares, failure of the grantee to pay the Company
income taxes required to be withheld in respect of the restricted stock or under
such other circumstances as the Board may determine.
The following table summarizes the changes in stock options outstanding
under the Stock Plan for the five months ended March 31, 1995 and year ended
March 29, 1996:
Incentive Nonqualified Option
Stock Stock Price
Options Options Range
---------- --------- --------------
Outstanding at October 31, 1994 -- -- --
Granted during the five months
ended March 31, 1995 302,000 55,000 $1.00
---------- ---------
Outstanding at March 31, 1995 302,000 55,000 $1.00
Granted during the year ended
March 29, 1996 69,000 20,000 $1.00 - $5.00
Cancelled during the year ended
March 29, 1996 (11,750) -- $1.00
========== =========
Outstanding at March 29, 1996 359,250 75,000 $1.00 - $5.00
========== =========
Options granted and outstanding under the Stock Plan are generally
exercisable in four equal annual installments beginning on the date of grant. At
March 31, 1995, options covering 89,250 shares of common stock were exercisable
at an exercise price of $1.00 per share and the Company had reserved 385,000
shares of common stock for issuance pursuant to the Stock Plan. At March 29,
1996, options covering 196,750 shares of common stock were exercisable at
exercise prices of $1.00 and $5.00 per share and the Company had reserved
635,000 shares of common stock for issuance pursuant to the Stock Plan.
On May 10, 1995, the Board of Directors approved the adoption of the 1995
Employee Stock Purchase Plan (the "Employee Plan"). The Employee Plan provides
the Board of Directors with the authority to grant to the Company's officers and
employees options to purchase 100,000 shares of common stock at a 15% discount
as compared to the public market price. However, the Company was unable to issue
shares under the plan prior to the initial public offering. Also, no shares may
be issued under the plan absent the receipt of an opinion of counsel that all
applicable securities laws have been complied with. The rights granted under the
Employee Plan are exercisable for an offering period as determined by the Board
70
of Directors, which may not exceed 27 months. No employee may be granted an
option under which the employee's right to purchase shares under the Employee
Plan first become exercisable at a rate in excess of $25,000 in fair market
value (determined at the date of grant) in any calendar year. Also, an employee
may not purchase shares in excess of 10% of his or her compensation. The Board
of Directors established a Stock Plan Committee to administer the Employee Plan.
The Employee Plan was approved by the stockholders of the Company on December
26, 1995.
In May 1996, the Company offered rights to employees to purchase shares of
common stock up to an aggregate amount representing 10% of compensation during
the period from May 10, 1996 to November 15, 1996 based on a per-share price
representing a 15% discount from the public offering price of the Units ($9.00)
or the per-share market value of the common stock on November 15, 1996. The
rights of each employee who accepted the Company's offer to participate to
exercise the purchase rights granted by the Company expires on November 15,
1996. On such date, the Company will issue shares under the plan with respect to
actual payroll deductions and cash contributions of employee participants.
Employees may withdraw from the plan at their option and may reduce the extent
of their participation to the extent cash contribution commitments are not met.
The actual number of shares that may be issued pursuant to the purchase rights
granted by the Company will vary based upon compensation of the employee
participants and the amounts actually funded by such employees as of November
15, 1996, but shall not exceed the number of shares reserved for issuance
pursuant to the Employee Plan.
On May 10, 1995, the Board approved the adoption of the 1995 Non-Employee
Director Stock Option Plan (the "Director Plan"). The Director Plan provides the
Board with the authority to grant to directors who are not employees of the
Company options to purchase up to 100,000 shares of common stock. The Director
Plan is administered by a Stock Plan Committee consisting of members appointed
by the Board. Pursuant to the Director Plan, each non-employee director was
automatically granted non-qualified options to purchase 10,000 shares of common
stock upon the consummation of the Company's initial public offering on May 10,
1996. Thereafter, on September 1 of each year non-employee director of the
Company will receive non-qualified options to purchase 3,000 shares of common
stock. Any non-employee director who is first appointed or elected after the
Company's initial public offering will receive a non-qualified stock option to
purchase 3,000 shares of common stock upon such appointment or election and an
additional option to purchase 3,000 shares of common stock on each anniversary
of his or her election, provided that he or she is then serving as a
non-employee director. Options granted upon consummation of the Company's
initial public offering become exercisable six months from the date the
offering. All other options are exercisable on the anniversary of the date of
grant. All options will expire ten years after grant date. Vesting is
accelerated in the event of a change of control of the Company. The exercise
price of all options will be equal to the fair market value of the common stock
on the date of grant. On May 10, 1996, options to purchase 30,000 shares of
common stock were automatically granted to non-employee directors at an exercise
price of $8.50 per share representing the estimated market value of the
Company's common stock included in the Unit. On May 17, 1996, options to
purchase 3,000 shares of common stock were granted at an exercise price of
$10.781 to a non-employee director elected to the Board on such date.
On October 31, 1994 upon consummation of the Acquisition, the Company's
Incentive Stock Option Plan (the "Plan") adopted by the Board of Directors
effective June 1, 1992 was cancelled. The Plan provided the Board with the
authority to grant to key employees of the Company incentive stock options to
purchase up to a maximum of 300,000 shares of the Company's common stock.
Options granted pursuant to the Plan were intended to constitute incentive stock
options within the meaning of Section 422A of the Internal Revenue Code.
71
The Board had the authority to determine option periods, the number of
shares of common stock subject to options granted and such other terms and
conditions under which options may be exercised. The per-share option price of
options granted pursuant to the Plan was to be equal to or greater than the
per-share fair market value, as determined by the Board, of the Company's common
stock as of the date of grant, or at least 110% of the per-share market value
with respect to options granted to employees owning 10% or more of the total
combined voting power of all classes of the Company's stock. Option periods
could not exceed ten years from the date options were granted, or five years
with respect to options to employees owning 10% or more of the total voting
power of all classes of the Company's stock. Options granted under the Plan were
to expire upon termination of employment or at the end of the option period
stipulated by the Board in the option agreement, whichever was earlier. The Plan
specifically limited the aggregate fair market value of options which could be
exercised by an employee in any one calendar year to $100,000. The Board's
authority to grant options under the Plan was to expire on May 31, 2002. On
August 4, 1994, the Board of Directors authorized management to grant options
covering 253,500 shares of common stock to employees. However, as of the date of
cancellation of the Plan, no options had been granted.
Common Stock Reserved
At March 29, 1996, the Company has reserved 835,000 shares of common stock
for issuance pursuant to the Stock Plan, Employee Plan and Director Plan and
40,000 shares of common stock for issuance pursuant to outstanding warrants.
Common stock reserved for issuance pursuant to the Company's stock option and
purchase plans and outstanding common stock purchase warrants subsequent to the
Company's initial public offering in May 1996 is summarized as follows:
Stock Option and Purchase Plans 835,000
Redeemable Warrants 500,000
Underwriter Warrants 100,000
Common Stock Purchase Warrants 40,000
-----------
1,475,000
===========
10. INCOME TAXES
There was no provision for income taxes for the year ended April 1, 1994,
seven months ended October 30, 1994 and five months ended March 31, 1995. The
provision for income taxes charged to operations for the year ended March 29,
1996 was as follows:
Current tax expense:
Federal $ 295,977
State 80,882
-----------
Total current 376,859
-----------
Deferred tax benefit:
Federal (44,343)
State (6,201)
-----------
Total deferred (50,544)
-----------
Total provision $ 326,315
===========
72
Deferred income taxes at March 31, 1995 and March 29, 1996 reflect the
impact of temporary differences between amounts of assets and liabilities for
financial reporting purposes and such amounts as measured by tax laws. These
temporary differences are determined in accordance with FAS 109. Deferred tax
assets and liabilities arising from temporary differences at March 31, 1995 and
March 29, 1996 are comprised of the following:
March 31, March 29,
1995 1996
----------- -----------
Deferred tax assets:
Net operating loss carryforwards 7,918,408 6,596,897
Inventories 1,017,836 900,258
Accrued liabilities 189,992 165,816
Accrued restructuring charges 58,248 6,365
Deferred revenue 145,313 145,313
Accounts receivable 78,060 83,528
Long-term debt 40,222 35,976
----------- -----------
Total deferred tax assets 9,448,079 7,934,153
Deferred tax liabilities:
Other assets (99,121) (72,128)
Property and equipment (59,116) (59,116)
Depreciation (217,926) (87,083)
----------- -----------
Total deferred tax liabilities (376,163) (218,327)
----------- -----------
Net deferred tax assets 9,071,916 7,715,826
Valuation allowance (9,071,916) (7,665,282)
----------- -----------
$ -- $ 50,544
=========== ===========
The Company adopted FAS 109 effective April 3, 1994. The accounting change
with respect to the adoption of FAS 109 had no cumulative effect on income of
the Company for the year ended April 1, 1994. However, as a result of the
adoption of FAS 109, the Company recorded net deferred tax assets of $5,850,420
at April 1, 1994 and an offsetting valuation allowance.
The provision for income taxes differs from the amount of income taxes
determined by applying the applicable U.S. statutory federal income tax rate to
income (loss) before income taxes as a result of the following differences:
Year Seven Months Five Months Year
Ended Ended Ended Ended
April 1, October 30, March 31, March 29,
1994 1994 1995 1996
----------- ----------- ----------- -----------
Statutory U.S. tax rates $(1,865,045) $ (143,944) $ (362,298) $ 511,253
State taxes, net -- -- -- 47,181
Non-deductible expenses 31,609 15,479 41,177 102,866
Losses for which no tax
benefit was provided 1,833,436 128,465 321,121 --
Utilization of loss
carryforwards -- -- -- (334,985)
----------- ----------- ----------- -----------
Effective tax rates $ -- $ -- $ -- $ 326,315
=========== =========== =========== ===========
73
The net change in the valuation allowance for deferred tax assets during
the year ended April 1, 1994 was an increase of $1,833,436, and was related to
the net increase in deferred tax assets created primarily by additional
operating loss carryforwards and increases in reserves and accrued restructuring
charges. The net change in the valuation allowance for deferred tax assets
during the seven months ended October 30, 1994 and five months ended March 31,
1995 was an aggregate increase of $1,388,060, and was related to the net
increase in deferred tax assets created primarily by additional operating loss
carryforwards, purchase accounting adjustments and deferred revenue offset by
decreases in reserves and accrued restructuring charges. The net change in the
valuation allowance for deferred tax assets during the year ended March 29, 1996
was a decrease of $1,406,634, and was related to the net decrease in deferred
tax assets created primarily by the realization and expiration of net operating
loss carryforwards and net deferred tax assets generated during the year. A full
valuation allowance was maintained through March 31, 1995 because of the
uncertainty of realization of deferred tax assets. During the year ended March
29, 1996, the Company recorded deferred tax assets and benefits of $50,544 with
respect to temporary differences generated during the year.
Income taxes currently payable for the year ended March 29, 1996 were
reduced by $454,868 through the utilization of net operating loss carryforwards.
The tax benefits from the utilization of acquired net operating loss
carryforwards ($101,993) and other deferred tax assets ($110,000) aggregating
$211,193 during the year ended March 29, 1996 were used to reduce goodwill
related to the Acquisition.
As of March 29, 1996, the Company has tax net operating loss carryforwards
available to reduce future taxable income of approximately $17 million, which
expire from 1997 through 2011. The utilization of such net operating loss
carryforwards and realization of tax benefits in future years depends
predominantly upon the recognition of taxable income. Further, the utilization
of these carryforwards is subject to annual limitations as a result of the
change in ownership of the Company (as described in Notes 1 and 2) as defined in
the Internal Revenue Code. The limitation approximates $210,000 annually and
represents the value of the Company's capital stock immediately before the date
of the ownership change multiplied by the federal long-term tax-exempt rate in
effect during the month the ownership change occurred. This limitation does not
reduce the total amount of net operating losses which may be taken, but rather
substantially limits the amount which may be used during a particular year. As a
result, the Company will be unable to use a significant portion of its net
operating loss carryforwards. Therefore, in the event the Company continues to
generate profits, such limitations would have the effect of increasing the
Company's tax liability and reducing net income if the taxable income during any
year exceeds the allowable loss carried forward to that year.
11. RESTRUCTURING CHARGES AND CREDITS
During the year ended April 1, 1994, the Company initiated a plan to
restructure its operations and reduce its costs and expenses. In connection with
this plan, the Company recorded a charge of $2,570,652 consisting of estimated
severance obligations and payments pursuant to terminated employment contracts
of $1,089,251, loss provisions of $296,875 representing a note receivable and
related accrued interest due from the Company's former president, estimated
future non-cancelable lease payments and write-downs of facility assets to
estimated net realizable value of $894,526, a loss provision of $150,000 related
to the termination of certain product lines and other estimated plant shut-down
costs of $140,000.
As a result of the Acquisition and additional financing described in Notes
1 and 2, the Company was able to settle certain severance obligations pursuant
to terminated employment contracts and negotiate the termination of certain
non-cancelable lease obligations with respect to facilities closed in connection
with the restructuring plan initiated in fiscal 1994. The severance and lease
obligations were settled on terms more favorable than estimated at April 1,
1994, which resulted in the recognition of restructuring credits of $248,684 and
$274,659, respectively, during the seven months ended October 30, 1994. In
74
addition, the Company revised its estimate of certain other severance
obligations, and recorded additional restructuring credits of $10,749.
Accordingly, during the seven months ended October 30, 1994, the Company
realized net restructuring credits of $534,092.
12. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the year ended April 1, 1994, seven
months ended October 30, 1994, five months ended March 31, 1995, excluding the
effects of the Acquisition, and year ended March 29, 1996 consists of the
following:
Year Seven Months Five Months Year
Ended Ended Ended Ended
April 1, October 30, March 31, March 29,
1994 1994 1995 1996
-------- -------- -------- --------
Interest paid $881,350 $457,019 $225,860 $966,153
Non-cash activities:
Fixed assets acquired under
capital leases 18,685 33,753 9,069 --
Write-off of property and
equipment against accrued
restructuring charges -- 185,777 -- --
Write-off of property and
equipment against
impairment reserve -- 117,807 -- --
Other current assets
acquired by assumption
of debt obligations 12,000 165,102 -- 131,594
Accrued liabilities converted
to notes payable 243,843 -- 206,595 --
Write-off of inventory
against accrued
restructuring charges -- 70,229 -- --
Write-off of other
assets against accrued
restructuring charges -- -- 15,323 --
Write-off of property and
equipment against
accounts payable -- -- -- 1,600
Increase in goodwill
from distribution of
escrow consideration -- -- -- 329,709
Decrease in goodwill from
utilization of acquired tax
benefits -- -- -- 211,193
75
13. PROFIT SHARING RETIREMENT PLAN
On January 1, 1995, the Company adopted a 401(k) retirement and profit
sharing plan. Eligible employees of the Company who are 21 years of age with one
or more years of service and who are not covered by collective bargaining
agreements may elect to participate in the plan. Employees who elect to become
participants in the plan may contribute up to 15% of their compensation to the
plan up to a maximum dollar limit established by law. The Company may also
contribute to the plan at the discretion of the Board of Directors.
Contributions by the Company may consist of matching contributions,
discretionary profit sharing contributions and other special contributions.
During the five months ended March 31, 1995 and year ended March 29, 1996, the
Company accrued profit sharing and retirement expense of $2,455 and $15,650,
respectively, pursuant to discretionary contributions authorized by the Board of
Directors for the plan year ending December 29, 1995. Contributions to the plan
funded by the Company during the year ended March 29, 1996 amounted to $14,415.
Participants are 100% vested with respect to their compensation contributions to
the plan. Vesting in Company discretionary contributions begins at 20% after one
year of service and increases by 20% annually each year until full (100%)
vesting upon five years of service. The plan pays retirement benefits based on
the participant's vested account balance. Benefit distributions are generally
available upon a participant's death, disability or retirement. Participants
generally qualify to receive retirement benefits upon reaching the age of 65.
Early retirees generally qualify for benefits provided they have reached age 55
and have completed 5 years of service with the Company. Benefits are payable in
lump sums equal to 100% of the participant's account balance.
14. FOREIGN OPERATIONS
On September 16, 1991, the Company entered into a Manufacturing Rights
Agreement (the "Manufacturing Agreement') with an unaffiliated Taiwan
corporation. Pursuant to the Manufacturing Agreement, the Company granted the
Taiwan corporation the exclusive right to utilize the assets owned by the
Company's foreign division for a period of five years to manufacture products
for sale to the Company. The Company's minimum purchase volume commitment
amounts to $3 million annually. The Manufacturing Agreement provides for the
payment of an annual fee of $57,155 to the Company through March 31, 1995.
Further, the Taiwan corporation is required to pay certain royalties to the
Company based upon sales to customers other than the Company. The Manufacturing
Agreement provides that sales prices of products sold to customers other than
the Company exceed the Company's purchase prices by at least 20%. Further, the
Company has the right of first refusal to make certain sales to customers other
than the Company.
Concurrent with the establishment of the Manufacturing Agreement, the
Company's foreign division ceased active operations. The net expenses incurred
by the Company in connection with its foreign division aggregated $50,138 for
the year ended April 1, 1994, $14,667 for the seven months ended October 30,
1994, $44,037 for the five months ended March 31, 1995 and $75,187 for the year
ended March 29, 1996. These net expenses relate primarily to the excess of
losses generated from asset dispositions, depreciation and administrative
expenses over royalty revenues generated by the Manufacturing Agreement.
76
15. COMMITMENTS AND CONTINGENT LIABILITIES
Operating Leases
Minimum future rental payments under non-cancellable operating leases with
an initial term of more than one year are summarized as follows:
1997 $ 202,540
1998 122,591
1999 6,819
2000 160
---------
332,110
Less sublease rentals (67,176)
---------
$ 264,934
=========
Rental expense approximated $851,000 for the year ended April 1, 1994,
$257,000 for the seven months ended October 30, 1994, $176,000 for the five
months ended March 31, 1995 and $376,000, net of sublease income of
approximately $18,000, for year ended March 29, 1996.
Litigation
One of the Company's former facilities is currently the subject of
evaluation by the Florida Department of Environmental Protection. In addition,
the Company has been notified that it is a potentially responsible party with
respect to undertaking response actions at certain facilities for the treatment,
storage and disposal of hazardous substances operated by unaffiliated parties.
In the opinion of management, the ultimate outcome of these environmental issues
will not have a material impact on the Company's financial position or its
results of operations.
The Company is the defendant in a suit filed by a former supplier to
collect approximately $400,000 of unpaid obligations recorded in the
accompanying consolidated financial statements. The Company is also involved in
disputes which are normal in the ordinary course of business. In the opinion of
management, the ultimate outcome of these matters will not have a material
impact on the Company's financial position or its results of operations.
The Company is presently involved in a dispute with the previous contract
manufacturer with respect to inventories acquired by the manufacturer for the
Company's programs, which approximate $l million, unpaid obligations of the
Company of approximately $265,000, unpaid obligations of the contract
manufacturer of approximately $125,000 due to the Company, and other matters
including an alleged claim of lost profits by the contract manufacturer of
approximately $916,000 related to the Company's minimum contract purchase
commitment and alleged claims of lost business and expenses of the Company due
to the delivery of defective products and the termination of a significant sales
agreement. The Company is attempting to settle the dispute with the manufacturer
and claims that the manufacturer supplied defective product and that it breached
the manufacturing agreement by discontinuing operations prior to the scheduled
termination date. However, there is no assurance that the dispute can be settled
in the Company's favor, or at all. Also, there is no assurance that the dispute
will not escalate into litigation. Should the dispute escalate into litigation,
the Company intends to defend and pursue its positions vigorously. However,
there is no assurance that the outcome of the dispute or potential litigation
related thereto will not have a material effect on the Company's financial
position or results of operations.
77
During May 1994, the Company settled litigation against a supplier to
recover costs and damages attributable to defective components supplied to the
Company, and realized a gain of $261,000, net of legal fees of $56,000.
Significant Customers
The Company's primary customers consist of the regional bell telephone
companies. During the year ended April 1, 1994, four of the regional bell
telephone companies accounted for 34%, 20%, 19% and 6% of the Company's
consolidated sales. During the seven months ended October 30, 1994, three of the
regional bell telephone companies accounted for 33%, 23% and 11% of the
Company's consolidated sales. During the five months ended March 31, 1995, four
of the regional bell telephone companies accounted for 34%, 23%, 11% and 10% of
the Company's consolidated sales. During the year ended March 29, 1996, sales to
three of the regional bell telephone companies accounted for 47%, 17% and 24% of
the Company's consolidated sales. Accounts receivable at March 31, 1995 and
March 29, 1996 consists primarily of amounts due from the regional bell
telephone companies.
Royalty and License Agreements
Pursuant to the terms of an asset purchase agreement entered into on
January 11, 1991, the Company is obligated to pay royalties equal to 3.5% of
sales of microprocessor-based components to a company affiliated with certain
officers and employees of the Company. On November 9, 1994, the Company entered
into an amendment agreement that provided for the elimination of royalties for
the period April 2, 1994 to September 30, 1994. In return, the term of the
royalty obligation was extended from December 31, 1995 to June 30, 1996. Royalty
expense under this agreement amounted to $301,000 during the year April 1, 1994,
$3,900 during the seven months ended October 30, 1994, $93,578 during the five
months ended March 31, 1995 and $563,750 during the year ended March 29, 1996.
The Company has entered into a patent license agreement providing the
Company with the exclusive world-wide rights to certain algorithm software
covered by a patent application. The Company is obligated to pay license fees
aggregating $200,000 at a rate of $50,000 annually over a four year period
commencing on the date the patent is issued. Further, the agreement provides for
the payment of royalties on products incorporating the licensed software.
Minimum royalties payable upon issuance of the patent will range between
$125,000 and $500,000 annually during the life of the patent. The term of the
license agreement will correspond to the expiration date of the patent upon its
issuance. As of March 29, 1996, the patent has not been issued. Accordingly, the
Company has not recorded the contingent liability in the accompanying financial
statements. Further, as of March 29, 1995, the Company has not sold any products
incorporating the licensed software or incurred any royalty obligations under
the license agreement.
In December 1994, the Company sold the rights to certain product software
for an aggregate purchase price of $500,000. The Company received an exclusive
irrevocable perpetual right to sublicense the software in connection with the
sale of products to other customers. In return, the Company agreed to pay
royalties equal to the greater of 4.44% of sales or $10 per unit sold. Such
royalties would be payable commencing if, and only if, laws, regulations or
judicial actions occur which would permit the purchaser of the software to
receive such royalty payments. The Company is obligated to repay, three years
from the date of the contract, a portion of the purchase price up to a maximum
amount of $375,000. The actual amount of any such repayment is dependent upon
the amount of aggregate royalties paid pursuant to the agreement. The aggregate
refundable amount of $375,000 is recorded as deferred revenue at March 31, 1995
and March 29, 1996. The Company will recognize the deferred revenue as and if
earned pursuant to the terms of the agreement.
78
In October 1995, the Company entered into a patent license agreement
effective as of September 1, 1995 that provided the Company with a non-exclusive
paid up license to manufacture and market products embodying certain patented
inventions. The Company paid a non-refundable patent license fee of $375,000
consisting of $133,000 in cash and $242,000 of deposit payments made pursuant to
the terms of a previous agreement. Previous deposit payments made by the Company
in the amount of $242,000 were charged to operations during the years ended
April 2, 1993 and April 1, 1994 due to an uncertainty surrounding their
realization. Accordingly, the patent license was recorded at an amount of
$133,000 representing cash payments pursuant to the terms of the patent license
agreement (see Note 6).
Employment Contracts
On October 31, 1994, the Company entered into an employment contract with
one of its executives that provides for minimum annual compensation of $147,200
through December 31, 1997. The contract provides for compensation increases at
the discretion of the Board of Directors, additional compensation in the form of
bonuses based on performance, benefits equal to those provided to other
executives of the Company, reimbursement of business expenses, travel and
temporary living expenses and options to purchase shares of the Company's common
stock. The agreement provides for annual renewals subsequent to December 31,
1997 at the option of the Company. Termination by the Company without cause
entitles the executive to receive his current salary and benefits for the
remaining term of the agreement or for a period of six months, whichever is
greater. The agreement may be terminated by the executive upon 120 days notice
effective on December 31, 1997 or thereafter.
On October 31, 1994, the Company entered into an agreement with the
Chairman of the Board of Directors that provides for minimum annual compensation
of $60,000 through December 31, 1997. The agreement provides for additional
compensation based on services performed not to exceed $2,500 per month,
benefits equal to those provided to other executives of the Company,
reimbursement of business expenses and options to purchase shares of the
Company's common stock. Termination by the Company without cause entitles the
Chairman to receive his current salary and benefits for the remaining term of
the agreement or for a period of six months, whichever is greater. The agreement
may be terminated by the Chairman upon 90 days written notice. Prior to
execution of the Chairman's Agreement, the Chairman provided consulting
services, as President of Atlantic Management Associates, Inc., to the Company
during the seven months ended October 30, 1994 similar to those provided under
the Chairman's Agreement. In addition, Atlantic Management Services, Inc.
assisted the Company and its stockholders in their efforts to attract a buyer
for the equity of the Company, and received a success fee in connection with the
Acquisition of $75,000 representing the compensation for such services. During
fiscal 1995, the Company paid Atlantic Management Associates, Inc. $43,000 for
consulting services, excluding expenses of $7,386, rendered prior to the date of
the Chairman's Agreement. During fiscal 1995, the Company paid the Chairman and
Atlantic Management Associates, Inc. $30,231, excluding expenses of $9,419, for
services rendered under the terms of the Chairman's Agreement. During the year
ended March 29, 1996, the Company paid the Chairman and Atlantic Management
Associates, Inc. $66,000, excluding reimbursed expenses of $9,007, for services
rendered under the terms of the Chairman's Agreement.
Purchase and Sales Commitments
On October 21, 1994, the Company entered into a manufacturing agreement
that provides for the production of one of the Company's microprocessor-based
products. Pursuant to the terms of the manufacturing agreement, the Company
committed to purchase $12.243 million of product over an eighteen-month period
beginning in December 1994. In addition, on November 11, 1994, the Company
entered into a dealer agreement that commits the Company to purchase
approximately $3.5 million of product over a two-year period. Purchases under
the terms of these agreements fluctuate based on delivery requirements
established by the Company. The Company's purchase commitments are not expected
79
to exceed sales requirements. At March 29, 1996, the Company's remaining
purchase commitment under the terms of these agreements approximates $4.1
million.
In December 1994, the Company entered into a supply contract with one of
its customers to sell certain products at specified prices over the next three
years. The Company's aggregate sales commitment under the agreement approximates
$21.3 million. At March 29, 1996, the remaining sales commitment under the terms
of the contract approximates $7.8 million.
In December 1995, the Company entered into an amendment to a supply
contract with one of its customers to supply certain products at specified
prices over an eight month period. The Company's aggregate sales commitment
under the terms of the amendment approximates $12 million. At March 31, 1996,
the remaining commitment under the terms of the amendment approximates $6.1
million.
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Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES
On November 1, 1994, the Company's Board of Directors dismissed Price
Waterhouse LLP as the Company's independent auditor and retained Deloitte &
Touche LLP as the Company's independent auditor. The report of Price Waterhouse
LLP on the Company's consolidated financial statements for the year ended April
1, 1994 included an explanatory paragraph relating to the Company's ability to
continue as a going concern. In connection with audit for the year ended April
1, 1994 and through November 1, 1994, there were no disagreements with Price
Waterhouse LLP on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedure which disagreements, if not
resolved to the satisfaction of Price Waterhouse LLP, would have caused them to
make reference thereto in their report on the Company's consolidated financial
statements for such period.
81
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors and Executive Officers
The following table sets forth the names and ages of the directors and
executive officers of the Company and the positions and offices held by each of
the persons named.
Name Age Position
- ---- --- --------
Directors and Executive Officers
Charles E. Davidson 43 Director
Robert M. Davies 45 Director
Olivier Roussel 49 Director
D. Thomas Abbott 42 Director
David R.A. Steadman 59 Chairman of the Board of Directors
Vincent C. Bisceglia 41 Director, President and
Chief Executive Officer
Darold R. Bartusek 49 Vice President, Sales and Marketing
William H. Thompson 43 Vice President, Finance, Chief
Financial Officer and Secretary
Allen W. Vogl 48 Vice President, Engineering
M. Winton Schriner 49 Vice President, Operations
Ned Rebich 55 Vice President, Plant Operations
Mr. Davidson has served as a director of the Company since November 1,
1994. From November 1994 through December 31, 1995, he served as Chairman of the
Board of Wexford Capital Corporation, which served as the investment manager to
several private investment funds, including Wexford Partners Fund, L.P. Since
January 1, 1995, Mr. Davidson has served as the Chairman and a board member of
Wexford Management LLC, a private investment management company which now serves
as the investment manager to Wexford Partners Fund, L.P. From 1984 to 1994, he
was a partner of Steinhardt Partners, L.P., a private investment firm. From 1977
to 1984, Mr. Davidson was employed by Goldman, Sachs & Co., serving as Vice
President of corporate bond trading. Mr. Davidson is Chairman of Board of DLB
Oil & Gas, Resurgence Properties Inc. and Presidio Capital Corp. and is a
Director of Wahlco Environmental Systems, Inc., an environmental equipment and
services company. He holds a B.A degree and an M.B.A. degree from the University
of California at Los Angeles.
Mr. Davies has been a director of the Company since November 1, 1994. From
November 1994 through December 31, 1995, he served as Vice President of Wexford
Capital Corporation. Since January 1, 1995, Mr. Davies has served as an
Executive Vice President of Wexford Management LLC. From September 1993 to May
1994, he was a Managing Director of Steinhardt Enterprises, Inc., an investment
banking company, and from 1987 to August 1993, he was Executive Vice President
of The Hallwood Group Incorporated, a merchant banking firm. Mr. Davies is a
director of Oakhurst Company, Inc., a holding company, and its majority-owned,
publicly-traded subsidiary, Steel City Products, Inc., a distributor of auto
parts, and of Wahlco Environmental Systems, Inc., an environmental equipment and
services company.
Mr. Roussel has served as a director of the Company since 1986. Mr. Roussel
has served Acor S.A., a private investment company, as Chairman and President
since 1975. From 1974 to 1977, he served as Vice President of Nobel-Bozel and
from 1977 to 1982 as Assistant General Manager of Heli-Union. Mr. Roussel was a
Director of Roussel-Uclaf from 1975 to 1982 and Chairman of Eminence S.A from
82
1987 to 1990. He presently serves as Chief Operating Officer and Director of
Vacsyn S.A., a biotechnology company, and as a Director of Bollore Technologies,
a public company listed on the Paris Stock Exchange.
Mr. Abbott was appointed to the Board of Directors of the Company on May
17, 1996 and has served the Company as a director since such date. Since 1995,
he has served as Chairman of MeesPierson Holdings Inc., the United States
operation of a Dutch merchant bank. From 1993 to 1995, Mr. Abbott was Chairman
and CEO of Savin Corporation, an office products company. From 1989 to 1993, he
was President of Harvest Group, Inc., a private investment firm. From 1976 to
1988, Mr. Abbott held various executive positions with Bankers Trust Company.
Mr. Abbott is a director of International Mezzanine Investment N.V., Precise
Holdings Inc., and Coffee Tree Limited. He holds a B.A. degree from Harvard
University.
Mr. Steadman has served as the Company's Chairman since November 1, 1994
and as a consultant since March 1994. He has served as President of Atlantic
Management Associates, Inc., a management services firm, since 1988. From 1990
to 1994, Mr. Steadman served as President and Chief Executive Officer of Integra
- - A Hotel and Restaurant Company ("Integra"), and from 1987 to 1988 as Chairman
and Chief Executive Officer of GCA Corporation, a manufacturer of automated
capital equipment used in the production of integrated circuits by
semi-conductor device manufacturers. Integra filed a petition for relief under
chapter 11 of the United States Bankruptcy Code in July, 1992 and emerged from
such proceeding in March, 1994. Mr. Steadman was a Vice President of Raytheon
Company, a defense electronics manufacturer, from 1980 to 1987, and served as
President of Raytheon Ventures, a venture capital division of Raytheon from 1985
to 1987. Mr. Steadman is a Director of Vitronics Corporation, a manufacturer of
reflow soldering ovens for the electronics industry, Kurzweil Applied
Intelligence, Inc., a voice recognition software company, Aavid Thermal
Technologies, Inc., a provider of thermal management products for the
semiconductor industry, and Wahlco Environmental Systems, Inc., an environmental
equipment and services company.
Mr. Bisceglia has served as a director and as President and Chief Executive
Officer of the Company since February 1994. He has served the Company in various
capacities since 1986, including consultant, Vice President of Sales and
Marketing and Executive Vice President. From 1982 to 1986, Mr. Bisceglia was
employed as Executive Vice President of Transaction Management, Inc., a
manufacturer of point-of-sale systems. Between 1978 and 1982, he held senior
marketing positions with National Semiconductor-DTS and Siemens-Nixdorf Computer
Corporation. Mr. Bisceglia holds a M.B.A. degree from Suffolk University and a
B.B.A. degree from the University of Massachusetts.
Mr. Bartusek has served the Company in various capacities since 1991
including Vice President of Sales and Marketing, Vice President of Worldwide
Sales and Vice President and General Manager of the Company's Smart Product
Business. From August 1989 to January 1991, Mr. Bartusek served as Vice
President of Marketing of the Public Communication Systems Division of Executone
Information Systems, Inc., a supplier of smart payphone systems. From 1973 to
1988, Mr. Bartusek served GTE Communication Systems Corporation in various
capacities including Director of Public Communications and Director of
Advertising and Sales Promotion. Mr. Bartusek holds a B.B.A. degree from Mankato
State University.
Mr. Thompson has served the Company in various capacities since July 1990
including Secretary, Vice President of Finance and CFO and Vice President of
Finance. Prior to joining the Company, Mr. Thompson was employed by Cardiac
Control Systems, Inc., a publicly-held medical device manufacturer, as
Controller and as Vice President of Finance from May 1983 to May 1988 and as
Executive Vice President of Operations and Finance from May 1988 to June 1990.
Between June 1974 and May 1983, he held various positions, most recently Audit
Manager, with Price Waterhouse LLP, certified public accountants. He is a
certified public accountant in the State of Florida and holds a B.S. degree in
accountancy from Florida State University.
83
Mr. Vogl has served the Company since 1981 in various capacities including
Vice President of Engineering and Executive Vice President and Chief Scientist.
Between 1972 and 1981, he was employed in various engineering and research and
development capacities by Harris Corporation and Storage Technology Corporation.
Mr. Schriner was recently appointed Vice President of Operations of the
Company. Previously he served the Company as Director of Contract Manufacturing
since August 1994. From 1991 to 1993, he served the Company in various
capacities including Vice President of Operations, Director of Marketing and
Director of Engineering. Prior to joining the Company, he served BellSouth
Telecommunications Company for a period of 12 years in various management
capacities with duties ranging from public communications to strategic planning
and executive support. He holds a B.S. degree in Industrial Education and an
M.S. degree in Vocational Rehabilitation from the University of Wisconsin.
Mr. Rebich has served the Company since 1986 in various manufacturing
management positions, including Vice President of Plant Operations, Vice
President and General Manager of the Company's Service Business, Director of
Operations and General Manager. Between 1981 and 1986, Mr. Rebich served
Comdial, a business communications company, in various operating positions,
including General Manager. Prior to that, he held various operating positions,
including Manager of Quality, Quality Engineer and Manufacturing Supervisor,
with Stromberg-Carlson over a period of 19 years.
Compliance With Section 16(a) of the Securities and Exchange Act of 1934
Section 16(a) of the Exchange Act requires the Company's directors,
executive officers and persons who own beneficially more than ten percent of a
registered class of the Company's equity securities to file with the Securities
and Exchange Commission ("SEC") initial reports of ownership and reports of
changes in ownership of such securities of the Company. Directors, executive
officers and persons who own beneficially more than ten percent of a registered
class of the Company's equity securities are required by SEC regulations to
furnish the Company with copies of all Section 16(a) reports they file.
During the fiscal year ended March 29, 1996, the Company's directors,
executive officers and persons who own beneficially more than ten percent of a
registered class of the Company's equity securities were not subject to such
filing requirements.
The Company's directors, executive officers and persons who own
beneficially more than ten percent of a registered class of the Company's equity
securities became subject to Section 16(a) requirements on May 10, 1996, the
effective date of the Company's Form S-1 Registration Statement. To the
Company's knowledge, based solely on review of copies of initial reports
furnished to the Company, the initial reports of Messrs. Davidson, Davies,
Roussel, Steadman, Abbott and Bisceglia, directors of the Company, were filed
late, and the initial reports of ownership of the Company's securities of
Messrs. Bartusek, Thompson, Vogl, Schriner and Rebich, executive officers of the
Company, were filed late. Messrs. Davidson, Davies and Roussel may be deemed to
be beneficial owners of 10% or more of the Company's Common Stock (see Item 12 -
"Security Ownership of Certain Beneficial Owners and Management") by reason of
their respective affiliations with Wexford and Acor S.A. Wexford Partners Fund,
L.P. and Acor S.A. are beneficial owners of 10% or more of the Company's Common
Stock (see Item 12 - "Security Ownership of Certain Beneficial Owners and
Management"). To the Company's knowledge, based solely on review of copies of
initial reports furnished to the Company, the initial reports of Wexford
Partners Fund, L.P. and Acor S.A. were also filed late.
84
Item 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth the compensation paid by the Company for
services performed on the Company's behalf during the fiscal years ended March
31, 1995 and March 29, 1996 with respect to the Company's President and Chief
Executive Officer and the Company's other executive officers whose compensation
exceeded $100,000 during the years ended March 31, 1995 and March 29, 1996.
Annual Compensation Long-Term
---------------------------------- Compensation
Other Annual Awards All Other
Name and Salary Bonus Compensation Securities Underlying Compensation
Principal Position Year (1) (2) (3) (4) (5) Options (in Shares) (6) (7)
------------------ ---- -------- -------- ------------ ------------------ ------------
David R.A. Steadman
Chairman of the Board 1996 $ 66,000 $ -- $ -- 15,000 $ 6,972
of Directors 1995 73,231 75,000 -- 50,000 3,024
Vincent C. Bisceglia
President and 1996 147,200 -- 26,915 -- 5,827
Chief Executive Officer 1995 121,970 52,500 37,405 150,000 3,890
Allen W. Vogl
Vice President, 1996 108,400 -- 31,824 15,000 6,289
Engineering 1995 103,814 35,000 38,269 15,000 5,605
William H. Thompson
Vice President,
Finance, CFO and 1996 107,536 -- -- 10,000 5,967
Secretary 1995 102,986 35,000 40,147 30,000 5,735
Darold R. Bartusek
Vice President, 1996 104,000 -- -- 15,000 6,129
Sales and Marketing 1995 99,600 17,500 -- 15,000 5,277
(1) Effective April 1, 1994, the annual salaries of the Company's executive
officers and other employees with an annual salary in excess of $50,000,
were reduced by 10%. On November 1, 1994, the Board of Directors authorized
the reinstatement of annual salary amounts existing prior to the April 1,
1994 salary reduction.
(2) The annual salary reported in this Summary Compensation Table for Mr.
Steadman represents amounts paid to Mr. Steadman or Atlantic Management
Associates, Inc. for consulting services rendered to the Company. The
amount reported excludes business expense reimbursements to Mr. Steadman
and Atlantic Management Associates, Inc. See Item 10 - "Directors and
Executive Officers of the Registrant" and "Compensation of Directors,"
below.
(3) Bonuses during the year ended March 31, 1995 include a $75,000 success fee
paid to Atlantic Management Associates, Inc. in connection with the
Acquisition and executive bonuses paid pursuant to the terms of Executive
Retention Agreements entered into between the executive officers named in
this Summary Compensation Table, among others, and the Company effective as
of June 8, 1994. The purposes of the Executive Retention Agreements were to
retain the executives in the employ of the Company during the Company's
efforts to effect a change in ownership of the Company and to provide
85
incentive to further the objectives of the Company's stockholders. The
Executive Retention Agreements provided for the payment of such bonuses
upon a change in control of the Company based upon a specified percentage
set forth in the respective Executive Retention Agreement applied to the
value of a transaction which resulted in a change in ownership. On October
31, 1994, a change in ownership of the Company as contemplated under the
terms of the Executive Retention Agreements occurred, and the Board of
Directors authorized payment of the retention bonuses as of November 1,
1994. See Item 13 - "Certain Relationships and Transactions" and Item 1 -
"Business -- Development of the Company." Also, see Item 10 "Directors and
Executive Officers of the Registrant" and "Compensation of Directors,"
below.
(4) The Company reimburses or pays on the behalf of Mr. Bisceglia and Mr. Vogl
travel expenses to and from the Company and their respective residences, in
addition to temporary living and all other business expenses incurred on
the Company's behalf. Other compensation reported in this Summary
Compensation Table with respect to Mr. Bisceglia and Mr. Vogl represents
the estimated incremental costs to the Company relating to reimbursements
and payments of travel expenses to and from the Company and their
respective residence and temporary living expenses.
(5) Other compensation reported in this Summary Compensation Table with respect
to Mr. Thompson represents reimbursement of relocation costs and expenses
incurred by Mr. Thompson with respect to his relocation from Pennsylvania
to Georgia in connection with the relocation of corporate headquarters.
(6) All other compensation includes the cost to the Company with respect to
split-dollar universal life insurance and long-term disability insurance
provided to executive officers of the Company.
(7) Excludes compensation received by the executive officers with respect to
term life, medical and dental benefits pursuant to the Company's group
insurance plan available to all full-time employees of the Company.
Option Grants in the Last Fiscal Year
The following table sets forth options to purchase the Company's Common
Stock (options) granted to the directors and executive officers named in the
Summary Compensation Table during the fiscal year ended March 29, 1996 together
with the percentage of such options to the total number of options granted to
directors, executive officers and employees of the Company during the year ended
March 29, 1996, the exercise price and expiration date of options granted to the
named directors and executive officers, and the potential realizable value at
assumed annual rates of stock price appreciation for the option term.
Potential Realizable Value at
Individual Grants Assumed Annual Rates of
------------------------------------------------------------- Stock Price Appreciation
% of Total for Option Term
Options Options to Exercise ------------------------
Granted Employees Price Expiration 5% 10%
Name (in Shares) (1) During Year ($ per Share) Date (in $) (in $)
---- --------------- ----------- ------------- ------------- ------- --------
David R.A. Steadman (2) 15,000 17% 5.00 February 2006 41,373 117,837
Darold R. Bartusek 15,000 17% 5.00 February 2006 41,373 117,837
Allen W. Vogl 15,000 17% 5.00 February 2006 41,373 117,837
William H. Thompson 10,000 11% 5.00 February 2006 27,583 78,558
(1) The options granted to the named individuals are exercisable in four equal
annual installments beginning on the date of grant and expire 10 years from
the date of grant.
(2) Mr. Steadman's options become exercisable in their entirety in the event
that neither Wexford nor one of the investment funds controlled by Wexford
owns at least 51% of the Company's outstanding voting stock. In addition,
in the event that shares of the Company's capital stock are sold at a per
86
share price less than the exercise price, the exercise price of Mr.
Steadman's options shall be reduced to such lesser price and the number of
unexercised options shall be increased to the extent that the total
purchase price of unexercised options shall equal the total purchase price
of unexercised options before such transaction. Also, Mr. Steadman's
options are not subject to cancellation upon termination of employment
unless such termination is for cause or results from voluntary resignation.
Further, the option agreements provide that in the event Mr. Steadman's
employment is terminated for reasons other than cause, or on or before the
third anniversary of the grant date, if the Company's stock is not traded
on a national securities exchange or on the Nasdaq National Market System,
then upon the written request of Mr. Steadman, the Company shall purchase
unexercised options held by him at a price equal to the difference between
the market value of the underlying stock and the option exercise price.
Aggregate Option Exercises in the Last Fiscal Year and Year-End Option Values
The following table sets forth, as to the directors and executive officers
named in the Summary Compensation Table, the number of exercisable options and
the number of unexercisable options outstanding at March 29, 1996 and the value
of outstanding exercisable and unexercisable in-the-money options at March 29,
1996 based on an estimated fair market value of $5.00 per share. No options were
exercised during the 1996 fiscal year.
Number of Securities Value of Unexercised
Underlying Unexercised In-the-money Options at
Options at Fiscal Year End (1) Fiscal Year End
----------------------------- -----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
David R.A. Steadman (2) 28,750 36,250 $ 100,000 $ 100,000
Vincent C. Bisceglia (2) 75,000 75,000 300,000 300,000
Darold R. Bartusek 11,250 18,750 30,000 30,000
Allen W. Vogl 11,250 18,750 30,000 30,000
William H. Thompson 17,500 22,500 60,000 60,000
(1) The options granted to the named individuals are exercisable in four equal
annual installments beginning on the date of grant and expire 10 years from
the date of grant.
(2) Mr. Steadman's and Mr. Bisceglia's options become exercisable in their
entirety in the event that neither Wexford nor one of the investment funds
controlled by Wexford owns at least 51% of the Company's outstanding voting
stock. In addition, in the event that shares of the Company's capital stock
are sold at a per share price less than the exercise price, the exercise
price of Mr. Steadman's and Mr. Bisceglia's options shall be reduced to
such lesser price and the number of unexercised options shall be increased
to the extent that the total purchase price of unexercised options shall
equal the total purchase price of unexercised options before such
transaction. Also, Mr. Steadman's and Mr. Bisceglia's options are not
subject to cancellation upon termination of employment unless such
termination is for cause or results from voluntary resignation. Further,
the option agreements provide that in the event Mr. Steadman's or Mr.
Bisceglia's employment is terminated for reasons other than cause, or on or
before the third anniversary of the grant date, if the Company's stock is
not traded on a national securities exchange or on the Nasdaq National
Market System, then upon the written request of Mr. Steadman or Mr.
Bisceglia, the Company shall purchase unexercised options held by them at a
price equal to the difference between the market value of the underlying
stock and the option exercise price.
During the years ended March 31, 1995 and March 29, 1996, none of the
options granted to the directors and executive officers of the Company were
exercised.
87
Report on Executive Compensation in Fiscal Year 1996
This report has been prepared by the Compensation Committee and the Stock
Plans Committee of the Board of Directors and addresses the Company's
compensation policies with respect to the Chief Executive Officer and executive
officers of the Company in general for the 1996 fiscal year. All members of the
Stock Plans Committee are non-employee directors and a majority of the
Compensation Committee are non-employee directors. Reference is made generally
to the information under "Employment Agreements," below.
Compensation Policy. The overall intent in respect of executive officers is
to establish levels of compensation that provide appropriate incentives in order
to command high levels of individual performance and thereby increase the value
of the Company to its stockholders, and that are sufficiently competitive to
attract and retain the skills required for the success and profitability of the
Company. The principal components of executive compensation in fiscal 1996 were
salary and stock options.
Chief Executive Officer's Compensation. The Chief Executive Officer's
salary, bonus and stock option is the subject of an agreement entered into
between the Company and Mr. Bisceglia. The compensation was determined to be
appropriate by the members of the Board of Directors based on the nature of the
position; the expertise and responsibility that the position requires; his prior
experience as an officer of the Company; and the subjective judgement of the
members of a reasonable compensation level.
Other Executive Officers.
Mr. Steadman. Mr. Steadman's compensation is the subject of agreements
negotiated between him and the Company and was based on Mr. Steadman's extensive
operating and financial experience over many years and on the subjective
judgement of directors of a reasonable compensation level.
Salary. The other executives are long term employees of the Company.
Accordingly, the salary of each executive was based on the level of his prior
salary and the subjective judgement of the members of the Compensation Committee
as to the value of the executive's past contribution and potential future
contribution to the profitability of the business.
Bonuses. No bonuses were paid in fiscal 1996.
Stock Options. The Committees believe that stock ownership by executive
officers is important in aligning management's and stockholders' interests in
the enhancement of stockholder value over the long term. The exercise price of
stock options is equal to the fair market value of the Common Stock on the date
of grant. The stock option grants made to executive officers in 1996 were based
on (i) the executives' services to the Company during the year and prior years;
(ii) the fact that their compensation was reduced as a result of the financial
condition of the Company in prior years; and (iii) the recommendation of the
Chief Executive Officer, and were in amounts deemed in the subjective judgement
of the Committees to be appropriate.
Compliance with Internal Revenue Code Section 162(m). Section 162(m) of the
Internal Revenue Code (enacted in 1993) generally disallows a tax deduction to
public companies for compensation over $1 million paid to its chief executive
officer and its four other most highly compensated executives. The Company's
non-incentive based compensation payable to any one executive officer is
currently and for the foreseeable future unlikely to reach that threshold.
88
This report shall not be deemed incorporated by reference into any filings
of the Company with the Securities and Exchange Commission by implication or by
any reference in any such filings to this report.
The Stock Plans Committee:
Charles E. Davidson
Robert M. Davies
The Compensation Committee:
Charles E. Davidson
Robert M. Davies
David R. A. Steadman
Employment Agreements
On October 31, 1994, the Company and Mr. Bisceglia entered into an
employment agreement for a term commencing on October 31, 1994 and ending on
December 31, 1997, subject to certain termination provisions. Pursuant to the
agreement, Mr. Bisceglia serves as the President and Chief Executive Officer and
as a director of the Company. Mr. Bisceglia receives an annual base salary of
$147,200 per year, which is subject to annual review for merit and other
increases at the discretion of the Board of Directors as of January 1, 1996 and
each year thereafter. Pursuant to the terms of the agreement, Mr. Bisceglia is
entitled to the same benefits made available to the other senior executives of
the Company on the same terms and conditions as such executives. The agreement
provides that the Company will reimburse and/or pay on Mr. Bisceglia's behalf up
to $4,000 per month of temporary living expenses, including travel to and from
the Company and Mr. Bisceglia's residence, until the Company requires Mr.
Bisceglia to relocate, at the Company's expense, to the Company's headquarter
location. Mr. Bisceglia is also entitled to receive an incentive bonus for each
fiscal year during the term of the agreement equal to 2% of the operating
profits of the Company, defined as net income before taxes, amortization and
depreciation, interest, gains and losses arising from revaluation of assets, and
charges or allocations by a parent or affiliated company except to the extent
that such charges are for expenses that directly relate to the operations of the
Company. During the year ended March 29, 1996 accrued bonuses of approximately
$71,400 pursuant to the terms of the agreement. Mr. Bisceglia also received,
pursuant to the terms of the Employment Agreement, options to purchase 150,000
shares of Common Stock at an exercise price of $1.00 per share under the
Company's 1994 Omnibus Stock Plan. Such options become exercisable in four equal
annual installments commencing on the date of grant. Notwithstanding, the
options become exercisable in the event of a change in ownership of the Company
or upon a sale of substantially all of the assets of the Company. The options
expire ten years from the date of grant, unless earlier terminated upon
termination of Mr. Bisceglia's employment for cause or upon Mr. Bisceglia's
resignation. The agreement contains provisions that require the Company, at the
option of Mr. Bisceglia, to purchase unexercised options at market value if Mr.
Bisceglia's employment is terminated by the Company for reasons other than
cause. Otherwise, the options remain in effect until their expiration date.
Also, if the agreement is terminated by the Company without cause, Mr. Bisceglia
is entitled to receive the amount of compensation and to receive benefits
remaining under the term of the agreement or for a six month period, whichever
is greater. The agreement automatically renews for additional one-year periods
unless the Company provides 180-day notice of non-renewal or Mr. Bisceglia
provides 120-day notice of termination on December 31, 1997, or any date
subsequent thereto. Pursuant to the agreement, Mr. Bisceglia shall be
indemnified by the Company with respect to claims made against him as a
director, officer, and/or employee of the Company or any subsidiary of the
Company to the fullest extent permitted by the Company's Certificate of
Incorporation, by-laws and the General Corporation Law of the State of Delaware.
89
On October 31, 1994, the Company and Mr. Steadman entered into a Chairman's
Agreement for a term commencing on October 31, 1994 and ending on December 31,
1997. Pursuant to the terms of the agreement, Mr. Steadman provides consulting
services to the Company on general business matters, operational matters, and
financial matters and participates as a member of any Executive Committee
established by the Board, and receives compensation therefor of $5,000 per
month, in addition to reimbursement of business expenses. Further, with respect
to services performed outside of the New England area, Mr. Steadman receives
additional compensation of $500 per day or part thereof. However, Mr. Steadman's
maximum compensation in any one month cannot exceed $7,500. Mr. Steadman is also
entitled to participate in employee benefit plans made available to other senior
executives of the Company including family medical insurance coverage, group
life insurance coverage, in any 401(k) retirement plan maintained by the Company
and disability coverage on the same basis as such other senior executives.
Pursuant to the terms of the Chairman's Agreement and the Company's 1994 Omnibus
Stock Plan, the Company granted to Mr. Steadman a non-qualified option to
purchase 50,000 shares of Common Stock at an exercise price of $1.00 per share.
On February 5, 1996, the Board of Directors granted to Mr. Steadman an incentive
stock option to purchase 15,000 shares of Common Stock at an exercise price of
$5.00 per share. The options become exercisable in four equal installments
annually over a three-year period beginning on the date of grant. As of March
31, 1996, options to purchase 28,750 shares of Common Stock are exercisable by
Mr. Steadman. Prior to execution of the Chairman's Agreement, Atlantic
Management Associates, Inc., of which Mr. Steadman is President, provided
consulting services to the Company during the seven months ended October 30,
1994 similar to those provided under the Chairman's Agreement. In addition,
Atlantic Management Associates, Inc. assisted the Company and its stockholders
in their efforts to attract a buyer for the equity of the Company, and received
a success fee in connection with the Acquisition of $75,000 as compensation for
such services. During fiscal 1995, the Company paid Atlantic Management
Associates, Inc. $43,000 for consulting services, excluding expenses of $7,386,
rendered prior to the date of the Chairman's Agreement. During fiscal 1995, the
Company paid Mr. Steadman and Atlantic Management Associates, Inc. $30,231,
excluding expenses of $9,419, for services rendered under the terms of the
Chairman's Agreement. During the year ended March 29, 1996, the Company paid Mr.
Steadman and Atlantic Management Associates, Inc. $66,000, excluding reimbursed
expenses of $9, 007, for services rendered under the terms of the Chairman's
Agreement. The Chairman's Agreement may be terminated and Mr. Steadman may be
removed from the Board by the shareholders at any time. If Mr. Steadman is
removed from the Board for cause, he is entitled to receive compensation for
services rendered through the date of termination. If Mr. Steadman is removed
from the Board for reasons other than cause, he is entitled to receive
compensation for the remaining term of the Chairman's Agreement or for a period
of six months, whichever is greater. Mr. Steadman may terminate the Chairman's
Agreement upon 90 days written notice. See Item 13 `Certain Relationships and
Transactions."
Compensation of Directors
Directors are elected at the annual meeting of stockholders to serve during
the ensuing year or until a successor is duly elected and qualified. Directors
are reimbursed for their costs incurred in attending Board of Director meetings.
On May 10, 1995, the Board of Directors adopted of the 1995 Non-Employee
Director Stock Option Plan (the "Director Plan"), which was approved by the
Company's stockholders on December 26, 1995. The Director Plan provides for
automatic annual grants to non-employee directors of options to purchase shares
of Common Stock. A maximum of 100,000 shares of Common Stock are authorized for
issuance under this plan. The Stock Plans Committee appointed by the Board of
Directors is authorized to administer the Director Plan. Under the Director
Plan, each non-employee director serving at the consummation of the Company's
initial public offering on May 10, 1996 (Messrs. Davidson, Davies and Roussel)
was automatically granted non-qualified options to purchase 10,000 shares of
90
Common Stock at exercise prices of $8.50 per share. Thereafter, on each
September 1 of any year in which such persons are serving as non-employee
directors, they will receive non-qualified stock options to purchase an
additional 3,000 shares of Common Stock. Any non-employee director who is first
appointed or elected after May 10, 1996 will receive a non-qualified stock
option to purchase 3,000 shares of Common Stock upon such appointment or
election and an additional option to purchase 3,000 shares of Common Stock on
each anniversary of his or her election, provided that he or she is then serving
as a non-employee director. On May 17, 1996, Mr. Abbott was granted an option to
purchase 3,000 shares of Common Stock at an exercise price of $10.78 per share.
The options to purchase 30,000 shares of the Company's Common Stock granted on
May 10, 1996 become exercisable six months from the date of grant. All other
options under the Director Plan are exercisable on the first anniversary of the
date of grant. All options expire ten years after the grant date. Vesting is
accelerated in the event of a change of control of the Company. The Director
Plan provides that the exercise price of all options granted pursuant to the
plan be equal to the fair market value of the Common Stock on the date of grant.
Compensation Committee Interlocks and Insider Participation
Prior to the formulation of the Compensation Committee, the Company's
former Board of Directors, including Mr. Bisceglia, President and Chief
Executive Officer, Mr. Roussel and Mr. William Geary, a representative of one of
the former stockholders of the Company, participated in deliberations concerning
executive compensation during fiscal 1995. Mr. Roussel and Mr. Geary did not
serve the Company as executive officers or employees during the year ended March
31, 1995, nor were they former executive officers or employees of the Company.
The Board of Directors elected by the stockholders on November 1, 1994
established the Compensation Committee at their initial meeting on November 1,
1994. Mr. Steadman provides consulting services to the Company pursuant to the
terms of the Chairman's Agreement and has been a member of the Compensation
Committee since November 1, 1994. Mr. Davidson and Mr. Davies, the other members
of the Compensation Committee, do not serve, nor have they formerly served, as
executive officers or employees of the Company. No executive officer of the
Company serves or served on the compensation committee of another entity during
fiscal 1996 and no executive officer of the Company serves or served as a
director of another entity who has or had an executive officer serving on the
Board of Directors of the Company.
91
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of May 31, 1996, the number of shares of
the Company's outstanding Common Stock beneficially owned by (i) each person who
is known by the Company to beneficially own more than 5% of the outstanding
Common Stock, (ii) each director of the Company and each executive officer named
in the Summary Compensation Table (see Item 10 - "Directors and Executive
Officers of the Registrant" and Item 11 - "Executive Compensation"), and (iii)
all of the Company's directors and executive officers as a group. Except as
noted below, the address for each such person is c/o Technology Service Group,
Inc., 20 Mansell Court East, Suite 200, Roswell, GA 30075.
Shares Under Total Shares Percentage
Name and Address of Number of Exercisable Options Benefically Benefically
Beneficial Owner Shares Owned (1) and Warrants (2) Owned Owned
------------------- ---------------- -------------------- ----------- -----------
Wexford Partners Fund, L.P. (3)
411 W. Putnam Avenue
Greenwich, CT 06830 2,444,286 2,444,286 53%
Acor S.A. (3)
17, Rue du Colisee
Paris, France 75008 454,386 454,386 10%
Firlane Business Corp. (3)
Box 202
1211 Geneva 12 Switzerland 235,028 235,028 5%
A.T.T. IV, N.V. (3)
c/o Applied Telecommunications
Technologies, Inc.
20 William Street
Wellesley, MA 02181 366,300 183,150 549,450 11%
David R.A. Steadman 28,750 28,750 1%
Vincent C. Bisceglia 200 75,000 75,200 2%
Allen W. Vogl 100 11,250 11,350 *
William H. Thompson 17,500 17,500 *
Darold R. Bartusek 11,250 11,250 *
Charles E. Davidson (4) 2,444,286 2,444,286 53%
Robert M. Davies (5) 2,444,286 2,444,286 53%
Olivier Roussel (6) 454,386 454,386 10%
All Officers and Directors as a group,
ten persons (7) (8) 2,898,972 155,000 3,053,972 64%
- ----------
* Less than 1%
(1) Beneficial ownership has been determined in accordance with Rule 13d-3 of
the Securities Exchange Act of 1934 (the "Exchange Act"). Unless otherwise
noted, the Company believes that all persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
beneficially owned by them.
(2) A person is deemed to be the beneficial owner of voting securities that can
be acquired by such person within 60 days from the date beneficial
ownership is set forth herein upon the exercise of options or warrants.
92
Each beneficial owner's percentage ownership is determined by assuming that
options or warrants that are held by such person (but not those held by
other persons) and which are exercisable within 60 days of the date
beneficial ownership is set forth herein have been exercised. Unless
otherwise noted, the Company believes that all persons named in the table
have sole voting and investment power with respect to all shares of Common
Stock beneficially owned by them.
(3) The Company, Wexford, Acor S.A., Firlane Business Corp. and A.T.T. IV, N.V.
("ATTI") entered into a Stock Purchase Agreement on May 3, 1996. See Item 1
- "Business--Stock Purchase Agreement." Pursuant to the terms of the Stock
Purchase Agreement, Wexford, Acor S.A. and Firlane Business Corp. sold to
ATTI an aggregate of 366,300 shares of Common Stock at a price of $8.14 per
share and options to purchase an additional 183,150 shares of Common Stock
at an exercise price of $11.00 per share (the "Options") at a price of $.10
per Option. Wexford sold 285,714 shares and Options to purchase 142,857
shares. Acor S.A. sold 53,114 shares and Options to purchase 26,557 shares.
Firlane Business Corp. sold 27,472 shares and Options to purchase 13,736
shares. The consideration received by Wexford, Acor S.A. and Firlane
Business Corp. pursuant to the terms of the Stock Purchase Agreement was
$2,339,998, $435,004 and $224,995, respectively. If the Options were
exercised in full, Wexford would beneficially own 2,301,429 (49%) shares,
ACOR would beneficially own 427,829 (9%) shares, Firlane would beneficially
own 221,292 (5%) shares, and ATTI would beneficially own 549,450 shares
(11%). The number of shares of outstanding Common Stock beneficially owned
by Mr. Davies and Mr. Davidson would be 2,301,429 shares or 49% of the
outstanding Common Stock upon exercise of the Options. The number of shares
outstanding Common Stock beneficially owned by Mr. Roussel would be 427,829
shares or 9% of the outstanding Common Stock upon exercise of the Options.
In connection with the Stock Purchase Agreement, the parties entered into
an Amended and Restated Stockholders' Agreement. See Item 13 - "Certain
Relationships and Transactions."
(4) The number of shares owned by Mr. Davidson represent shares owned by
Wexford Partners Fund, L.P., of which Mr. Davidson is an affiliate. Mr.
Davidson disclaims beneficial ownership of such shares.
(5) The number of shares owned by Mr. Davies represent shares owned by Wexford
Partners Fund, L.P. of which Mr. Davies is an affiliate. Mr. Davies
disclaims beneficial ownership of such shares.
(6) The number of shares owned by Mr. Roussel represent shares are owned by
Acor, S.A., of which Mr. Roussel is Chairman and President. Mr. Roussel
disclaims beneficial ownership of such shares.
(7) The number of shares owned by all officers and directors as a group
includes 2,444,286 shares held by Wexford Partners Fund, L.P, of which Mr.
Davidson and Mr. Davies are principals, each of whom disclaim beneficial
ownership of Wexford's shares.
(8) The number of shares owned by all officers and directors as a group
includes 454,386 shares held by Acor, S.A. of which Mr. Roussel disclaims
beneficial ownership.
Wexford beneficially owns approximately 53% of the outstanding Common Stock
at May 31, 1996. As a result, Wexford is able to control most matters requiring
approval by the stockholders of the Company, such as the election of directors
and a merger or consolidation of the Company. Under certain circumstances, such
control could prevent stockholders from recognizing a premium over the then
current market price for their Common Stock.
At May 31, 1996, the Company has 4,650,000 shares of Common Stock
outstanding. Of such shares, the 1,150,000 shares sold in the Offering are
freely tradeable in the public market (other than shares acquired by
"affiliates" of the Company as such term is defined by Rule 144 under the
Securities Act of 1933, as amended (the "Securities Act")). The 3,500,000
remaining shares (the "Restricted Shares"), representing 75% of the outstanding
shares of Common Stock, will be "restricted securities" as that term is defined
in Rule 144. Restricted securities may only be sold pursuant to a registration
statement under the Securities Act or an applicable exemption thereunder, such
as the exemption made available by Rule 144. Generally, the Restricted Shares
will not be eligible for sale in the public market pursuant to Rule 144 until
93
two years from the date of their issuance, which is October 31, 1996. A
registration statement, however, could be used prior to such date to effect a
distribution of such shares. Although the Company cannot predict the timing or
amount of future sales of Common Stock or the effect that such sales or the
availability of such shares for sale could have on the market price for the
Common Stock prevailing from time to time, sales of substantial amounts of
Common Stock in the public market could adversely affect the market price of
Common Stock. However, the Company's principal stockholders, which in the
aggregate hold 3,500,000 shares of Common Stock have agreed not to sell, assign,
or transfer any securities of the Company for a period of 12 months from May 10,
1996 without the prior written consent of the Company's underwriter. In
addition, officers, directors and employees holding options to purchase 434,250
shares of Common Stock at March 29, 1996 have agreed not to sell, assign or
transfer any such shares acquired upon exercise of options for a period of 12
months from May 10, 1996 without the prior written consent of the Company's
underwriter.
The Company has agreed that, under certain circumstances, it will register
under Federal and state securities laws the Representative's Warrants and the
shares of Common Stock issuable thereunder. In addition, certain existing
stockholders of the Company have registration rights. See Item 13 "Certain
Relationships and Transactions." Exercise of these registration rights could
involve substantial expense to the Company at a time when it could not afford
such expenditures and may adversely affect the terms upon which the Company may
obtain additional financing.
94
Item 13. CERTAIN RELATIONSHIPS AND TRANSACTIONS
Pursuant to the terms of an asset purchase agreement with respect to the
acquisition of PCS entered into on January 11,1991, the Company is obligated to
pay royalties equal to 3.5% of sales of microprocessor-based components to OAB,
Inc. Mr. Bartusek, Vice President of Sales and Marketing of the Company, and
certain other employees of the Company who were employees of PCS and are
stockholders in OAB, Inc. Royalty expense under this agreement approximated
$301,000 during the year ended April 1, 1994, $3,900 during the seven months
ended October 30, 1994, $94,000 during the five months ended March 31, 1995 and
$564,000 during the year ended March 29, 1996. The agreement expires on June 30,
1996. During fiscal 1995 and 1996, the Company had outstanding promissory notes
payable to OAB, Inc. bearing interest at a rate of 10% per annum. Outstanding
indebtedness pursuant to such promissory notes amounted to $203,077 at March 31,
1995. The notes were paid in full during the year ended March 29, 1996. Also,
the Company executed a non-interest bearing note of $206,595 on November 9, 1994
representing unpaid royalties as of October 30, 1994. This note is payable in
nineteen equal monthly installments of $10,873, and had an outstanding balance
of $163,101 at March 31, 1995 and $32,620 at March 29, 1996. Interest paid to
OAB, Inc. during the years ended March 31, 1995 and March 29, 1996 aggregated
$48,934 and $9,424, respectively.
On October 31, 1994, the Company and Mr. Steadman entered into a Chairman's
Agreement for a term commencing on October 31, 1994 and ending on December 31,
1997. Pursuant to the terms of the agreement, Mr. Steadman provides consulting
services to the Company on general business matters, operational matters, and
financial matters and participates as a member of any Executive Committee
established by the Board, and receives compensation therefor of $5,000 per
month, in addition to reimbursement of business expenses, in lieu of any other
fees paid to directors of the Company. Further, with respect to services
performed outside of the New England area, Mr. Steadman receives additional
compensation of $500 per day or part thereof. However, Mr. Steadman's maximum
compensation in any one month cannot exceed $7,500. Prior to execution of the
Chairman's Agreement, Mr. Steadman provided consulting services, as President of
Atlantic Management Associates, Inc., to the Company during the seven months
ended October 30, 1994 similar to those provided under the Chairman's Agreement.
In addition, Atlantic Management Associates, Inc. assisted the Company and its
stockholders in their efforts to attract a buyer for the equity of the Company,
and received a success fee in connection with the Acquisition of $75,000
representing the compensation for such services. During fiscal 1995, the Company
paid Atlantic Management Associates, Inc. $43,000 for consulting services,
excluding expenses of $7,386, rendered prior to the date of the Chairman's
Agreement. During fiscal 1995, the Company paid Mr. Steadman and Atlantic
Management Associates, Inc. $30,231, excluding expenses of $9,419, for services
rendered under the terms of the Chairman's Agreement. During the year ended
March 29, 1996, the Company paid Mr. Steadman and Atlantic Management
Associates, Inc. $66,000, excluding reimbursed expenses of $9,007, for services
rendered under the terms of the Chairman's Agreement. See Item 10 - "Directors
and Executive Officers of the Registrant" and Item 11 - "Executive
Compensation."
On October 31, 1994, TSG Acquisition acquired all of the outstanding
capital stock of the Company pursuant to an Agreement and Plan of Merger dated
October 11, 1994 between Wexford, TSG Acquisition, the Company and the majority
holders of the Company's preferred and common stock, including Acor S.A. and
Firlane Business Corp. The consideration paid by TSG Acquisition aggregated $3.5
million including contingent consideration of $329,709 placed in escrow and
distributed to former stockholders in September 1995. The aggregate
consideration consisted of $3,004,000 to acquire the outstanding capital stock
of the Company and $496,000 to retire a $400,000 subordinated master promissory
note payable to former stockholders and related accrued interest and preference
fees of $96,000 representing 5% of the outstanding principal for each month that
the note was outstanding. Aggregate cash payments to former stockholders,
95
including the contingent consideration of $329,709 and the retirement of the
subordinated master promissory note, accrued interest and preference fees of
$496,000, amounted to $3,222,090. Consideration of $277,910 was withheld from
amounts paid to former stockholders to pay liabilities of the Company including
a success fee of $75,000 payable to Atlantic Management Associates, Inc. (see
Item 10 - "Directors and Executive Officers of the Registrant" and Item 11 -
"Executive Compensation") and the settlement of a dispute with respect to a
terminated employment contract of a former executive of $202,910.
On October 31, 1994, the Company entered into an Investment Agreement with
Wexford, Acor S.A. and Firlane Business Corp. (collectively the "investors").
Acor S.A. and Firlane Business Corp. were former stockholders of the Company.
Pursuant to the Investment Agreement, the Company issued an aggregate of 3.5
million shares of common stock, $.01 par value, at a price of $1.00 per share
(based on the Acquisition consideration paid by Wexford) in exchange for the
merger share. Wexford, Acor S.A. and Firlane Business Corp. received 2,730,000,
507,500 and 262,500 shares of common stock, respectively, pursuant to the terms
of the Investment Agreement. The consideration paid by Wexford, Acor S.A. and
Firlane Business Corp. amounted to $2,730,000, $507,500 and $262,500,
respectively. Also, the Company borrowed $2.8 million from Wexford and Acor S.A.
and issued subordinated promissory notes due November 1, 1999 that bear interest
at a rate of 10% per annum. The Company issued a 10% interest bearing
subordinated note to Wexford in the principal amount of $2,361,082 dated October
31, 1994. The Company also issued a 10% interest bearing subordinated promissory
notes to Acor S.A. in the principal amounts of $208,216.73 dated October 31,
1994, $99,591.93 dated October 31, 1994, $83,497.82 dated November 10, 1994 and
$47,611.52 dated December 23, 1994. See Item 12 - "Security Ownership of Certain
Beneficial Owners and Management."
In connection with the Acquisition, Acor S.A. received aggregate
consideration of $702,037, including $99,200 of principal and related accrued
interest and preference fees pursuant to the subordinated master promissory
note, and $680,843 in respect of Series C preferred stock, before a pro rata
share of the Atlantic Management Associates, Inc. success fee of $16,715 and the
settlement obligation of $61,291. Firlane Business Corp. received aggregate
consideration of $211,881, including $111,600 of principal and related accrued
interest and preference fees pursuant to the subordinated master promissory
note, and $115,551 in respect of Series C preferred stock, before a pro rata
share of the Atlantic Management Associates, Inc. success fee of $4,868 and the
settlement obligation of $10,402. See Item 12 - "Security Ownership of Certain
Beneficial Owners and Management."
Also on October 31, 1994, the Company, Wexford, Acor S.A. and Firlane
Business Corp. entered into a Stockholders' Agreement pursuant to which Acor
S.A. and Firlane Business Corp. granted Wexford a right of first refusal with
respect to any proposed sale by Acor S.A. or Firlane Business Corp. of any
Common Stock owned by them. In addition, Acor S.A. and Firlane Business Corp.
agreed that they would sell all or a proportionate amount of their Common Stock
to a third party in the event that Wexford requests them to do so in connection
with any such sale by Wexford. On its part, Wexford agreed, in connection with
any sale of its Common Stock to a third party, to include a proportionate amount
of the Common Stock owned by Acor S.A. and Firlane Business Corp., if requested
to do so. In addition, the Stockholders Agreement provides that Wexford, Acor
S.A. and Firlane Business Corp. have piggy-back registration rights with respect
to their shares of Common Stock in the event of any offering by the Company of
its Common Stock (other than in connection with exchange offers or stock option
or similar plans). Wexford, Acor S.A. and Firlane Business Corp. have agreed not
to sell shares of Common Stock for at least 12 months from May 10, 1996 without
the prior written consent of the Company's underwriter.
Effective June 8, 1994, the Board of Directors authorized and the Company
executed executive retention agreements with executive officers. The purpose of
the executive retention agreements were to retain the executives in the employ
96
of the Company during the Company's efforts to effect a change in ownership of
the Company and to provide incentive to further the objectives of the Company's
stockholders. The executive retention agreements provided for the payment of
bonuses upon a change in control of the Company based upon a specified
percentage set forth in the respective executive retention agreement applied to
the value of a transaction which resulted in a change in ownership. On November
1, 1994, the Company's Board of Directors approved the payment of such retention
bonuses as a result of the consummation of the Acquisition. The Company paid
bonuses to Mr. Bisceglia of $52,500, Mr. Vogl of $35,000, Mr. Thompson of
$35,000, Mr. Bartusek of $17,500, Mr. Wright of $17,500 and Mr. Rebich of
$17,500. See Item 11 - "Executive Compensation."
Mr. Davidson is the Chairman of the Board and chief executive officer of
Wexford Capital Corporation which acts as the investment manager to several
private investment funds, including Wexford Partners Fund, L.P., the principal
stockholder of the Company. Mr. Davies is a Vice President of Wexford Capital
Corporation and is an officer of various other affiliates of such corporation.
Mr. Roussel is Chairman and President of Acor, S.A., a private investment firm
and a stockholder of the Company. See Item 10 - "Directors and Executive
Officers of the Registrant" and Item 12 - "Security Ownership of Certain
Beneficial Owners and Management."
Wexford, Acor, S.A. and Firlane Business Corp. are each stockholders of the
Company. See Item 12 - "Security Ownership of Certain Beneficial Owners and
Management." Acor, S.A. and Firlane Business Corp. were stockholders of the
Company prior to the Acquisition. Wexford and Acor, S.A. are parties to an
Investment Agreement pursuant to which they acquired $2,361,082 and $438,918,
respectively, of 10% interest bearing subordinated notes of the Company. Such
entities are also party to a Stockholders' Agreement, pursuant to which Wexford,
Acor, S.A. and Firlane were granted certain "piggy-back" registration rights and
other co-sale rights.
Except for the consideration received by Acor S.A. and Firlane Business
Corp. in connection with the Acquisition, the Company did not make any payments
to such shareholders or to Wexford during the year ended March 31, 1995.
However, at March 31, 1995, interest accrued pursuant to the subordinated
promissory notes amounted to $98,325 with respect to Wexford and $17,358 with
respect to Acor S.A. At March 29, 1996, interest accrued pursuant to the
subordinated promissory notes amounted to $98,325 with respect to Wexford and
$18,278 with respect to Acor S.A. During the year ended March 29, 1996, the
Company paid interest to Wexford of $236,755 and to Acor S.A. of $43,092. Also,
during the year ended March 29, 1996, the Company paid Wexford $59,980 with
respect to insurance coverage acquired by Wexford on the Company's behalf.
The Company, Wexford, Acor S.A., Firlane Business Corp. and ATTI entered
into a Stock Purchase and Option Agreement on May 3, 1996. Pursuant to the terms
of the Stock Purchase Agreement, Wexford, Acor S.A. and Firlane Business Corp.
sold to ATTI an aggregate of 366,300 shares of Common Stock at a price of $8.14
per share and options to purchase an additional 183,150 shares Common Stock
exercisable at a price of $11.00 per share (the "Options") at a price of $.10
per Option. Wexford sold 285,714 shares and Options to purchase 142,857 shares.
Acor, S.A. sold 53,114 shares and Options to purchase 26,557 shares. Firlane
Business Corp. sold 27,472 shares and Options to purchase 13,736 shares.
Consideration received by Wexford, Acor S.A. and Firlane Business Corp. pursuant
to the terms of the Stock Purchase Agreement amounted to $2,339,998, $435,004
and $224,995, respectively. ATTI also received the right to appoint, and the
other stockholders elected, a representative to the Board of Directors. ATTI has
also agreed not to sell, assign, or transfer any of the Company's securities for
a period of 12 months from May 10, 1996 without the prior written consent of the
Company's underwriter.
In connection with the Stock Purchase Agreement, the parties also entered
into an Amended and Restated Stockholders' Agreement pursuant to which Acor
S.A., Firlane Business Corp. and ATTI granted Wexford a right of first refusal
97
with respect to any proposed sale by Acor S.A., Firlane Business Corp. or ATTI
of any Common Stock owned by them. In addition, Acor S.A., Firlane Business
Corp. and ATTI agreed that they would sell all or a proportionate amount of
their Common Stock to a third party in the event that Wexford requests them to
do so in connection with any such sale by Wexford. On its part, Wexford agreed,
in connection with any sale of its Common Stock to a third party, to include a
proportionate amount of Common Stock owned by Acor S.A., Firlane Business Corp.
and ATTI, if requested to do so. In addition, the agreement provides that
Wexford, Acor S.A., Firlane Business Corp. and ATTI shall have piggy-back
registration rights with respect to their shares of Common Stock in the event of
any offering by the Company (other than in connection with exchange offers or
stock option or similar plans). Wexford also received demand registration rights
with respect to their shares of Common Stock which are exercisable at any time
from time to time after May 10, 1997 until Wexford owns less than 5% of the
outstanding Common Stock. Acor S.A., Firlane Business Corp. and ATTI each
received demand registration rights with respect to their shares of Common Stock
which are exercisable on one occasion after May 10, 1997 until they own less
than 5% of the outstanding Common Stock.
----------
98
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8 K
(a) List of Documents filed as part of this Report.
(1) Financial Statements
The index to the financial statements included in this report required by
Item 8 (page 48) is incorporated herein by reference.
(2) Financial Statement Schedules
The index to the financial statement schedules included in this report
required by Item 8 (page 48) is incorporated herein by reference.
Exhibits -- See Item 14(c)
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the fourth
quarter of the fiscal year ended March 29, 1996.
(c) Exhibits
Exhibit No. Description of Exhibit
- ----------- ----------------------
3. (i) Certificate of Incorporation (incorporated by reference to Exhibit 3
(i) to Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
3. (ii) By-laws (incorporated by reference to Exhibit 3 (ii) to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
4.1 (a) Warrant Agreement (incorporated by reference to Exhibit 4.1 to
Amendment No. 2 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 29, 1996).
4.1 (b) Form of Redeemable Warrant (incorporated by reference to Exhibit
4.1(a) to Amendment No. 3 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on April 29, 1996).
4.2 Representative's Warrant Agreement including form of Representative's
Warrant (incorporated by reference to Exhibit 4.2 to Amendment No. 2
to the Registrant's Registration Statement, No. 33-80695, on Form S-1
filed on March 29, 1996).
99
4.3 Form of Common Stock Certificate (incorporated by reference to Exhibit
4.3 to Amendment No. 3 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on April 29, 1996).
10.1 Loan and Security Agreement between Barclays Business Credit, Inc. and
International Teleservice Corporation dated February 23, 1990
(incorporated by reference to Exhibit 10.1 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1 filed
on March 1, 1996).
10.2 Continuing Guaranty Agreement between Barclays Business Credit, Inc.
and International Teleservice Corporation dated February 23, 1990
(incorporated by reference to Exhibit 10.2 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1 filed
on March 1, 1996).
10.3 First Amendment to Loan and Security Agreement between Barclays
Business Credit, Inc. and International Teleservice Corporation dated
January 11, 1991 (incorporated by reference to Exhibit 10.3 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.4 Second Amendment to Loan and Security Agreement between Barclays
Business Credit, Inc. and Technology Service Group, Inc. dated June,
1994 (incorporated by reference to Exhibit 10.4 to Amendment No. 1 to
the Registrant's Registration Statement, No. 33-80695, on Form S-1
filed on March 1, 1996).
10.5 Third Amendment to Loan and Security Agreement between Barclays
Business Credit, Inc. and Technology Service Group, Inc. dated July 8,
1994 (incorporated by reference to Exhibit 10.5 to Amendment No. 1 to
the Registrant's Registration Statement, No. 33-80695, on Form S-1
filed on March 1, 1996).
10.6 Fourth Amendment to Loan and Security Agreement between Barclays
Business Credit, Inc. and Technology Service Group, Inc. dated October
31, 1994 (incorporated by reference to Exhibit 10.6 to Amendment No. 1
to the Registrant's Registration Statement, No. 33-80695, on Form S-1
filed on March 1, 1996).
100
10.7 (a) $650,000 Second Amended, Restated, Substitute and Supplemental Secured
Term Note dated August 25, 1994 made by International Teleservice
Corporation and Technology Service Enterprises, Inc. in favor of
Barclays Business Credit, Inc. (incorporated by reference to Exhibit
10.7 (a) to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).
10.7 (b) $2,200,000 Secured Term Note dated October 31, 1994 made by Technology
Service Group, Inc. in favor of Barclays Business Credit, Inc.
(incorporated by reference to Exhibit 10.7 (b) to Amendment No. 1 to
the Registrant's Registration Statement, No. 33-80695, on Form S-1
filed on March 1, 1996).
10.8 Manufacturing Services Agreement TSG-1O94JLR dated October 21, 1994 by
and between Technology Service Group, Inc. and Avex Electronics Inc.
(incorporated by reference to Exhibit 10.8 to Amendment No. 3 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1, filed
on April 29, 1996).**
10.9 Fifth Amendment to Loan and Security Agreement between Barclays
Business Credit, Inc. and Technology Service Group, Inc. dated as of
April 22, 1996 (incorporated by reference to Exhibit 10.9 to Amendment
No. 3 to the Registrant's Registration Statement, No. 33-80695, on
Form S-1, filed on April 29, 1996).
10.10 Amendment 002 to the Manufacturing Services Agreement TSG-1O49JLR
dated October 21, 1994 by and between Technology Service Group, Inc.
and Avex Electronics Inc. (incorporated by reference to Exhibit 10.10
to Amendment No. 3 to the Registrant's Registration Statement, No.
33-80695, on Form S-1, filed on April 29, 1996).**
10.11 Manufacturing Rights Agreement dated September 16, 1991 between Newco,
Inc. (Commtek Industries, Inc.), Dynacom Corporation and International
Service Technologies, Inc. (incorporated by reference to Exhibit 10.11
to Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.12 Lease Agreement between G.P.E.D.C., Inc. and International Teleservice
Corporation dated November 30, 1990 (incorporated by reference to
Exhibit 10.12 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).
101
10.13 Lease Agreement between Telematics Products, Inc. and William M.
Johnson dated July 14, 1988 (incorporated by reference to Exhibit
10.13 to Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).
10.14 Assignment of Lease between Executone Information Systems, Inc. and
Technology Service Enterprises, Inc. dated January 11, 1991
(incorporated by reference to Exhibit 10.14 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1 filed
on March 1, 1996).
10.15 First Amendment to Lease Agreement between Mansell 400 Associates,
L.P. and Technology Service Group, Inc. dated February, 1993
(incorporated by reference to Exhibit 10.15 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1 filed
on March 1, 1996).
10.16 Lease between Steroben Associates and Comdial TeleServices Corporation
dated August 1, 1986 (incorporated by reference to Exhibit 10.16 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.17 Dealer Agreement between Control Module, Inc. and Technology Service
Group, Inc. dated November 18, 1994 (incorporated by reference to
Exhibit 10.17 to Amendment No. 3 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1, filed on April 29, 1996).**
10.18 Employment Agreement between Technology Service Group, Inc. and
Vincent C. Bisceglia dated October 31, 1994 (incorporated by reference
to Exhibit 10.18 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).*
10.19 Chairman's Agreement between Technology Service Group, Inc. and David
R.A. Steadman dated October 31, 1994 (incorporated by reference to
Exhibit 10.19 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).*
10.20 Articles of Agreement Between Technology Service Group, Inc. and Local
Union No. 236, International Brotherhood of Teamsters, Chauffeurs,
Warehousemen and Helpers of America dated October 26, 1993
(incorporated by reference to Exhibit 10.20 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1 filed
on March 1, 1996).
102
10.21 Patent License Agreement (incorporated by reference to Exhibit 10.21
to Amendment No. 3 to the Registrant's Registration Statement, No.
33-80695, on Form S-1, filed on April 29, 1996).**
10.22 Warrant Agreement between Technology Service Group, Inc. and Avex
Electronics Inc. dated May 23, 1995 (incorporated by reference to
Exhibit 10.22 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).
10.23 Employee Incentive Stock Option Agreement between Technology Service
Group, Inc. and Vincent C. Bisceglia dated November 1, 1994
(incorporated by reference to Exhibit 10.23 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1 filed
on March 1, 1996).*
10.24 Non-Qualified Stock Option Agreement between Technology Service Group,
Inc. and David R.A. Steadman dated November 1, 1994 (incorporated by
reference to Exhibit 10.24 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).*
10.25 Form of Employee Incentive Stock Option Agreement under the 1994
Omnibus Stock Plan of Technology Service Group, Inc. (incorporated by
reference to Exhibit 10.25 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).*
10.26 Agreement and Plan of Merger among Wexford Capital Corporation, TSG
Acquisition Corporation, Technology Service Group, Inc. and certain
shareholders of Technology Service Group, Inc. dated October 11, 1994
(incorporated by reference to Exhibit 10.26 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1 filed
on March 1, 1996).
10.27 Amendment dated October 31, 1994 to Agreement and Plan of Merger among
Wexford Capital Corporation, TSG Acquisition Corporation, Technology
Service Group, Inc. and certain shareholders of Technology Service
Group, Inc. dated October 11, 1994 (incorporated by reference to
Exhibit 10.27 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).
103
10.28 Form of Escrow Agreement between Wexford Partners Fund, L.P.,
Technology Service Group, Inc., William J. Geary and Trachtenberg &
Rodes dated October 31, 1994 (incorporated by reference to Exhibit
10.28 to Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).
10.29 Subordination Agreement between Technology Service Group, Inc.,
Wexford Partners Fund, L.P., Acor, S.A. and Barclays Business Credit,
Inc. dated October 31, 1994 (incorporated by reference to Exhibit
10.29 to Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).
10.30 Investment Agreement between Technology Service Group, Inc., Wexford
Partners Fund, L.P., Acor, S.A. and Firlane Business Corp. dated
October 31, 1994 (incorporated by reference to Exhibit 10.30 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.31 (a) Stockholders' Agreement among Technology Service Group, Inc., Wexford
Partners Fund, L.P., Acor, S.A. and Firlane Business Corp. dated
October 31, 1994 (incorporated by reference to Exhibit 10.31 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.31 (b) Amended and Restated Stockholders' Agreement among Technology Service
Group, Inc., Wexford Partners Fund, L.P., Acor, S.A., Firlane Business
Corp. and A.T.T. IV, N.V.***
10.32 $2,361,082 10% Subordinated Note Due 1999 payable to Wexford Partners
Fund, L.P. dated October 31, 1994 (incorporated by reference to
Exhibit 10.32 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).
10.33 $208,216.73 10% Subordinated Note Due 1999 payable to Acor, S.A. dated
October 31, 1994 (incorporated by reference to Exhibit 10.33 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
104
10.34 $99,591.93 10% Subordinated Note Due 1999 payable to Acor, S.A. dated
October 31, 1994 (incorporated by reference to Exhibit 10.34 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.35 $83,497.82 10% Subordinated Note Due 1999 payable to Acor, S.A. dated
November 10, 1995 (incorporated by reference to Exhibit 10.35 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.36 $47,611.52 10% Subordinated Note Due 1999 payable to Acor, S.A. dated
December 23, 1994 (incorporated by reference to Exhibit 10.36 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.37 Contract No. XO8895D between Technology Service Group, Inc. and NYNEX
(incorporated by reference to Exhibit 10.37 to Amendment No. 3 to the
Registrant's Registration Statement, No. 33-80695, on Form S-1, filed
on April 29, 1996).**
10.38 Contract No. C5262CO between Technology Service Group, Inc. and
Southwestern Bell Telephone Company (incorporated by reference to
Exhibit 10.38 to Amendment No. 3 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1, filed on April 29, 1996).**
10.39 Executive Retention Agreement of Vincent C. Bisceglia (incorporated by
reference to Exhibit 10.39 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).*
10.40 Executive Retention Agreement of Allen Vogl (incorporated by reference
to Exhibit 10.40 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).*
10.41 Executive Retention Agreement of Darold Bartusek (incorporated by
reference to Exhibit 10.41 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).*
10.42 Executive Retention Agreement of James Wright (incorporated by
reference to Exhibit 10.42 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).*
105
10.43 Executive Retention Agreement of Ned Rebich (incorporated by reference
to Exhibit 10.43 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).*
10.44 Executive Retention Agreement of William H. Thompson (incorporated by
reference to Exhibit 10.44 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).*
10.45 1994 Omnibus Stock Plan (incorporated by reference to Exhibit 10.45 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).*
10.46 1995 Employee Stock Purchase Plan (incorporated by reference to
Exhibit 10.46 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).
10.47 1995 Non-Employee Director Stock Option Plan (incorporated by
reference to Exhibit 10.47 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).*
11. Statement re computation of per share earnings.***
16. Letter re change in certifying accountants.***
21. Subsidiaries of Registrant (incorporated by reference to Exhibit 21 to
Amendment No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
* Management compensation contracts and plans.
** Registrant has received confidential treatment of a portion of this
Exhibit, which portion has been separately filed with the Commission.
*** Filed herewith.
106
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Additions
------------------------------------------------
Balance at Charged to Charged to Balance at
Beginning Costs and Other Deductions- End
Description of Period Expenses Accounts-Describe Describe of Period
----------- --------- -------- ----------------- -------- ---------
Year Ended April 1, 1994
Allowance for doubtful accounts $222,412 $56,178 $278,590
Reserve for obsolete and slow moving
inventory 666,584 1,003,200 $109,581 (3) ($135,591) (2) 1,643,774
Reserve for impairment of property
and equipment 253,084 (7) 253,084
Seven Months Ended October 30, 1994
Allowance for doubtful accounts 278,590 27,122 70,000 (4) (102,494) (1) 273,218
Reserve for obsolete and slow moving
inventory 1,643,774 223,064 (19,275) (5) (10,653) (2) 1,836,910
Reserve for impairment of property
and equipment 253,084 (1,375) (7) (117,807) (8) 133,902
Five Months Ended March 31, 1995
Allowance for doubtful accounts 273,218 (3,467) (68,305) (1) 201,446
Reserve for obsolete and slow moving
inventory 1,836,910 80,130 (58,498) (5) (92,343) (2) 1,766,199
Reserve for impairment of property
and equipment 133,902 (133,902) (6) --
Year Ended March 29, 1996
Allowance for doubtful accounts 201,446 10,099 4,014 (1) 215,559
Reserve for obsolete and slow moving
inventory $1,766,199 $408,694 ($57,511) (5) ($511,187) (2) $1,606,195
- ----------
(1) Write-off of uncollected accounts and recoveries.
(2) Write-off of obsolete inventory, net of recoveries.
(3) Includes $150,000 of restructuring charges net of $40,419 of credits to
costs of goods sold with respect to net realizable value reserves.
(4) Charges to cost of goods sold with respect to accounts receivable and
accounts payable offsets.
(5) Credits to cost of goods sold with respect to net realizable value
reserves.
(6) Purchase accounting adjustments.
(7) Restructuring charges (credits).
(8) Write-off of assets included in reserve for impairment.
107
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed, on
its behalf by the undersigned, thereunto duly authorized, on the 21st day of
June 1996..
TECHNOLOGY SERVICE GROUP, INC.
By: /s/ Vincent C. Bisceglia
-----------------------------------
Vincent C. Bisceglia
President & Chief Executive Officer
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature
appears below constitutes and appoints each of Vincent C. Bisceglia, William H.
Thompson and Roger M. Barzun jointly and severally his true and lawful
attorneys-in-fact and agent with full powers of substitution for him and in his
name, place and stead in any and all capacities to sign on his behalf,
individually and in each capacity stated below and to file any and all
amendments to this Annual Report on Form 10-K with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents and each of them
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises as fully as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their substitute or substitutes
may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
TECHNOLOGY SERVICE GROUP, INC.
By: /s/ Vincent C. Bisceglia President & Chief June 21, 1996
----------------------------- Executive Officer, Director
Vincent C. Bisceglia
By: /s/ William H. Thompson Vice President, Finance June 21, 1996
----------------------------- Chief Financial Officer
William H. Thompson Secretary (principal financial
and accounting officer)
By: /s/ David R.A. Steadman Director and Chairman June 21, 1996
----------------------------- of the Board
David R.A. Steadman
By: /s/ Charles E. Davidson Director June 21, 1996
-----------------------------
Charles E. Davidson
By: /s/ Robert M. Davies Director June 21, 1996
-----------------------------
Robert M. Davies
By: /s/ Olivier Roussel Director June 17, 1996
-----------------------------
Olivier Roussel
By: /s/ D. Thomas Abbott Director June 21, 1996
-----------------------------
D. Thomas Abbott
108
EXHIBIT INDEX
Exhibit No. Description of Exhibit Page
- ----------- ---------------------- ----
3. (i) Certificate of Incorporation (incorporated by reference to
Exhibit 3 (i) to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
3. (ii) By-laws (incorporated by reference to Exhibit 3 (ii) to
Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).
4.1 (a) Warrant Agreement (incorporated by reference to Exhibit 4.1
to Amendment No. 2 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 29,
1996).
4.1 (b) Form of Redeemable Warrant (incorporated by reference to
Exhibit 4.1(a) to Amendment No. 3 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
April 29, 1996).
4.2 Representative's Warrant Agreement including form of
Representative's Warrant (incorporated by reference to
Exhibit 4.2 to Amendment No. 2 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 29, 1996).
4.3 Form of Common Stock Certificate (incorporated by reference
to Exhibit 4.3 to Amendment No. 3 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
April 29, 1996).
10.1 Loan and Security Agreement between Barclays Business
Credit, Inc. and International Teleservice Corporation dated
February 23, 1990 (incorporated by reference to Exhibit 10.1
to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).
10.2 Continuing Guaranty Agreement between Barclays Business
Credit, Inc. and International Teleservice Corporation dated
February 23, 1990 (incorporated by reference to Exhibit 10.2
to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).
109
Page
----
10.3 First Amendment to Loan and Security Agreement between
Barclays Business Credit, Inc. and International Teleservice
Corporation dated January 11, 1991 (incorporated by
reference to Exhibit 10.3 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.4 Second Amendment to Loan and Security Agreement between
Barclays Business Credit, Inc. and Technology Service Group,
Inc. dated June, 1994 (incorporated by reference to Exhibit
10.4 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).
10.5 Third Amendment to Loan and Security Agreement between
Barclays Business Credit, Inc. and Technology Service Group,
Inc. dated July 8, 1994 (incorporated by reference to
Exhibit 10.5 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.6 Fourth Amendment to Loan and Security Agreement between
Barclays Business Credit, Inc. and Technology Service Group,
Inc. dated October 31, 1994 (incorporated by reference to
Exhibit 10.6 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.7 (a) $650,000 Second Amended, Restated, Substitute and
Supplemental Secured Term Note dated August 25, 1994 made by
International Teleservice Corporation and Technology Service
Enterprises, Inc. in favor of Barclays Business Credit, Inc.
(incorporated by reference to Exhibit 10.7 (a) to Amendment
No. 1 to the Registrant's Registration Statement, No.
33-80695, on Form S-1 filed on March 1, 1996).
10.7 (b) $2,200,000 Secured Term Note dated October 31, 1994 made by
Technology Service Group, Inc. in favor of Barclays Business
Credit, Inc. (incorporated by reference to Exhibit 10.7 (b)
to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).
110
Page
----
10.8 Manufacturing Services Agreement TSG-1O94JLR dated October
21, 1994 by and between Technology Service Group, Inc. and
Avex Electronics Inc. (incorporated by reference to Exhibit
10.8 to Amendment No. 3 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1, filed on April 29,
1996).**
10.9 Fifth Amendment to Loan and Security Agreement between
Barclays Business Credit, Inc. and Technology Service Group,
Inc. dated as of April 22, 1996 (incorporated by reference
to Exhibit 10.9 to Amendment No. 3 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1, filed on
April 29, 1996).
10.10 Amendment 002 to the Manufacturing Services Agreement
TSG-1O49JLR dated October 21, 1994 by and between Technology
Service Group, Inc. and Avex Electronics Inc. (incorporated
by reference to Exhibit 10.10 to Amendment No. 3 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1, filed on April 29, 1996).**
10.11 Manufacturing Rights Agreement dated September 16, 1991
between Newco, Inc. (Commtek Industries, Inc.), Dynacom
Corporation and International Service Technologies, Inc.
(incorporated by reference to Exhibit 10.11 to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695,
on Form S-1 filed on March 1, 1996).
10.12 Lease Agreement between G.P.E.D.C., Inc. and International
Teleservice Corporation dated November 30, 1990
(incorporated by reference to Exhibit 10.12 to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695,
on Form S-1 filed on March 1, 1996).
10.13 Lease Agreement between Telematics Products, Inc. and
William M. Johnson dated July 14, 1988 (incorporated by
reference to Exhibit 10.13 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.14 Assignment of Lease between Executone Information Systems,
Inc. and Technology Service Enterprises, Inc. dated January
11, 1991 (incorporated by reference to Exhibit 10.14 to
Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).
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10.15 First Amendment to Lease Agreement between Mansell 400
Associates, L.P. and Technology Service Group, Inc. dated
February, 1993 (incorporated by reference to Exhibit 10.15
to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).
10.16 Lease between Steroben Associates and Comdial TeleServices
Corporation dated August 1, 1986 (incorporated by reference
to Exhibit 10.16 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.17 Dealer Agreement between Control Module, Inc. and Technology
Service Group, Inc. dated November 18, 1994 (incorporated by
reference to Exhibit 10.17 to Amendment No. 3 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1, filed on April 29, 1996).**
10.18 Employment Agreement between Technology Service Group, Inc.
and Vincent C. Bisceglia dated October 31, 1994
(incorporated by reference to Exhibit 10.18 to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695,
on Form S-1 filed on March 1, 1996).*
10.19 Chairman's Agreement between Technology Service Group, Inc.
and David R.A. Steadman dated October 31, 1994 (incorporated
by reference to Exhibit 10.19 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).*
10.20 Articles of Agreement Between Technology Service Group, Inc.
and Local Union No. 236, International Brotherhood of
Teamsters, Chauffeurs, Warehousemen and Helpers of America
dated October 26, 1993 (incorporated by reference to Exhibit
10.20 to Amendment No. 1 to the Registrant's Registration
Statement, No. 33-80695, on Form S-1 filed on March 1,
1996).
10.21 Patent License Agreement (incorporated by reference to
Exhibit 10.21 to Amendment No. 3 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1, filed on
April 29, 1996).**
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10.22 Warrant Agreement between Technology Service Group, Inc. and
Avex Electronics Inc. dated May 23, 1995 (incorporated by
reference to Exhibit 10.22 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.23 Employee Incentive Stock Option Agreement between Technology
Service Group, Inc. and Vincent C. Bisceglia dated November
1, 1994 (incorporated by reference to Exhibit 10.23 to
Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).*
10.24 Non-Qualified Stock Option Agreement between Technology
Service Group, Inc. and David R.A. Steadman dated November
1, 1994 (incorporated by reference to Exhibit 10.24 to
Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).*
10.25 Form of Employee Incentive Stock Option Agreement under the
1994 Omnibus Stock Plan of Technology Service Group, Inc.
(incorporated by reference to Exhibit 10.25 to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695,
on Form S-1 filed on March 1, 1996).*
10.26 Agreement and Plan of Merger among Wexford Capital
Corporation, TSG Acquisition Corporation, Technology Service
Group, Inc. and certain shareholders of Technology Service
Group, Inc. dated October 11, 1994 (incorporated by
reference to Exhibit 10.26 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.27 Amendment dated October 31, 1994 to Agreement and Plan of
Merger among Wexford Capital Corporation, TSG Acquisition
Corporation, Technology Service Group, Inc. and certain
shareholders of Technology Service Group, Inc. dated October
11, 1994 (incorporated by reference to Exhibit 10.27 to
Amendment No. 1 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1 filed on March 1, 1996).
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10.28 Form of Escrow Agreement between Wexford Partners Fund,
L.P., Technology Service Group, Inc., William J. Geary and
Trachtenberg & Rodes dated October 31, 1994 (incorporated by
reference to Exhibit 10.28 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.29 Subordination Agreement between Technology Service Group,
Inc., Wexford Partners Fund, L.P., Acor, S.A. and Barclays
Business Credit, Inc. dated October 31, 1994 (incorporated
by reference to Exhibit 10.29 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.30 Investment Agreement between Technology Service Group, Inc.,
Wexford Partners Fund, L.P., Acor, S.A. and Firlane Business
Corp. dated October 31, 1994 (incorporated by reference to
Exhibit 10.30 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.31 (a) Stockholders' Agreement among Technology Service Group,
Inc., Wexford Partners Fund, L.P., Acor, S.A. and Firlane
Business Corp. dated October 31, 1994 (incorporated by
reference to Exhibit 10.31 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.31 (b) Amended and Restated Stockholders' Agreement among
Technology Service Group, Inc., Wexford Partners Fund, L.P.,
Acor, S.A., Firlane Business Corp. and A.T.T. IV, N.V.*** 117
10.32 $2,361,082 10% Subordinated Note Due 1999 payable to Wexford
Partners Fund, L.P. dated October 31, 1994 (incorporated by
reference to Exhibit 10.32 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).
10.33 $208,216.73 10% Subordinated Note Due 1999 payable to Acor,
S.A. dated October 31, 1994 (incorporated by reference to
Exhibit 10.33 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
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10.34 $99,591.93 10% Subordinated Note Due 1999 payable to Acor,
S.A. dated October 31, 1994 (incorporated by reference to
Exhibit 10.34 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.35 $83,497.82 10% Subordinated Note Due 1999 payable to Acor,
S.A. dated November 10, 1995 (incorporated by reference to
Exhibit 10.35 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.36 $47,611.52 10% Subordinated Note Due 1999 payable to Acor,
S.A. dated December 23, 1994 (incorporated by reference to
Exhibit 10.36 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.37 Contract No. XO8895D between Technology Service Group, Inc.
and NYNEX (incorporated by reference to Exhibit 10.37 to
Amendment No. 3 to the Registrant's Registration Statement,
No. 33-80695, on Form S-1, filed on April 29, 1996).**
10.38 Contract No. C5262CO between Technology Service Group, Inc.
and Southwestern Bell Telephone Company (incorporated by
reference to Exhibit 10.38 to Amendment No. 3 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1, filed on April 29, 1996).**
10.39 Executive Retention Agreement of Vincent C. Bisceglia
(incorporated by reference to Exhibit 10.39 to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695,
on Form S-1 filed on March 1, 1996).*
10.40 Executive Retention Agreement of Allen Vogl (incorporated by
reference to Exhibit 10.40 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).*
10.41 Executive Retention Agreement of Darold Bartusek
(incorporated by reference to Exhibit 10.41 to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695,
on Form S-1 filed on March 1, 1996).*
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10.42 Executive Retention Agreement of James Wright (incorporated
by reference to Exhibit 10.42 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).*
10.43 Executive Retention Agreement of Ned Rebich (incorporated by
reference to Exhibit 10.43 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).*
10.44 Executive Retention Agreement of William H. Thompson
(incorporated by reference to Exhibit 10.44 to Amendment No.
1 to the Registrant's Registration Statement, No. 33-80695,
on Form S-1 filed on March 1, 1996).*
10.45 1994 Omnibus Stock Plan (incorporated by reference to
Exhibit 10.45 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).*
10.46 1995 Employee Stock Purchase Plan (incorporated by reference
to Exhibit 10.46 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
10.47 1995 Non-Employee Director Stock Option Plan (incorporated
by reference to Exhibit 10.47 to Amendment No. 1 to the
Registrant's Registration Statement, No. 33-80695, on Form
S-1 filed on March 1, 1996).*
11. Statement re computation of per share earnings.*** 129
16. Letter re change in certifying accountants.*** 131
21. Subsidiaries of Registrant (incorporated by reference to
Exhibit 21 to Amendment No. 1 to the Registrant's
Registration Statement, No. 33-80695, on Form S-1 filed on
March 1, 1996).
* Management compensation contracts and plans.
** Registrant has received confidential treatment of a portion of
this Exhibit, which portion has been separately filed with the
Commission.
*** Filed herewith.
116