UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 0-15596
SPECTRUM INFORMATION TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-1940923
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2700 Westchester Avenue, Purchase, New York 10577
(Address of principal executive offices) (Zip Code)
(914) 251-1800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
------ ------
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the close of the latest
practicable date.
Common stock, $.001 par value, 76,675,448 outstanding at October
31, 1996.
SPECTRUM INFORMATION TECHNOLOGIES, INC. AND SUBSIDIARIES
(Debtors in Possession)
FORM 10-Q
SEPTEMBER 30, 1996
INDEX
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Consolidated Balance Sheets 1
Consolidated Statements of Operations 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 12
PART II. OTHER INFORMATION 18
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Balance Sheets
(Amounts in thousands)
September 30, March 31,
Assets 1996 1996
- --------------------------------------------------------------------------
(Unaudited)
Current assets:
Cash and cash equivalents $5,385 $13,002
Marketable securities 4,786 873
Accounts receivable (net of allowance
for doubtful accounts of $80) 766 1,437
Prepaid expenses and other current assets 454 229
------------- -------------
Total current assets 11,391 15,541
------------- -------------
Furniture, fixtures and equipment, net 232 204
------------- -------------
Intangible assets, net 347 360
------------- -------------
Total assets $11,970 $16,105
============= =============
See accompanying notes to consolidated financial statements.
1
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Balance Sheets
(Amounts in thousands)
Liabilities and Stockholders' Equity September 30, March 31,
1996 1996
- ---------------------------------------------------------------------------
(Unaudited)
Current Liabilities
Accounts payable $ 1,643 $ 3,643
Accrued liabilities 685 1,386
------------ -------------
Total current liabilities 2,328 5,029
------------ -------------
Liabilities subject to compromise:
Accounts payable and accrued liabilities 1,455 1,485
Reserve for litigation 4,719 4,719
Reserve for restructuring 1,972 2,067
Net liabilities of discontinued operations 531 531
Other liabilities 185 185
------------ -------------
Total liabilities subject to compromise 8,862 8,987
------------ -------------
Total liabilities 11,190 14,016
------------ -------------
Commitments and contingencies
Stockholders' Equity:
Common stock, $.001 par value, 110,000 shares
authorized 76,675 issued, respectively 77 77
Paid-in capital 63,961 63,961
Accumulated deficit (62,951) (61,501)
------------ -------------
1,087 2,537
Treasury stock, 100 shares at cost (300) (300)
Unrealized loss on marketable securities (7) (148)
------------ -------------
Total stockholders' equity 780 2,089
------------ -------------
Total liabilities and stockholders'
equity $11,970 $16,105
============ =============
See accompanying notes to consolidated financial statements.
2
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Statements of Operations
(Amounts in thousands,
except per share amounts) Three months ended Six months ended
(Unaudited) September 30, September 30,
1996 1995 1996 1995
- ------------------------ ----------- ----------- ----------- -----------
Revenues:
Licensing revenue $ 579 $ 550 $ 1,337 $ 1,379
Merchandise sales, net 72 119 122 320
----------- ----------- ----------- -----------
Total revenues 651 669 1,459 1,699
----------- ----------- ----------- -----------
Operating costs and
expenses:
Cost of revenues 17 68 41 191
Selling, general
and administrative 1,213 1,420 2,547 3,547
----------- ----------- ----------- -----------
Total operating costs
and expenses 1,230 1,488 2,588 3,738
----------- ----------- ----------- -----------
Operating loss (579) (819) (1,129) (2,039)
----------- ----------- ----------- -----------
Chapter 11
administrative expenses (59) (888) (388) (1,778)
----------- ----------- ----------- -----------
Other income (expense),
net (29) 1,781 67 1,722
----------- ----------- ----------- -----------
Income (loss) from
continuing operation (667) 74 (1,450) (2,095)
----------- ----------- ----------- -----------
Discontinued operations:
Gain on disposal
of Computer Bay - - - 2,539
Income from operations
of Spectrum Global - 445 - 716
----------- ----------- ----------- -----------
Income from
discontinued operations - 445 - 3,255
----------- ----------- ----------- -----------
Net income (loss) $(667) $ 519 $(1,450) $ 1,160
=========== =========== =========== ===========
Net income (loss)
per common share:
Loss from
continuing operations $ (.01) $ - $ (.02) $ (.02)
Income from
discontinued operations - .01 - .04
----------- ----------- ----------- -----------
Net income (loss) $ (.01) $ .01 $ (.02) $ .02
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
3
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Statements of Cash Flows
(Amounts in thousands)
Six months ended September 30, 1996 1995
- ---------------------------------------------------------------------------
(Unaudited) (Unaudited)
Cash flow from operating activities:
Net income (loss) $ (1,450) $ 1,160
Adjustments to reconcile net loss
to net cash used by continuing activities:
Depreciation and amortization 65 223
Gain on Chapter 7 conversion of
Computer Bay - (2,539)
Gain on sale of building - (86)
Gain on sale of Axcell product line - (1,616)
Deferred income - (850)
Loss on sale of equipment - 129
(Increase) decrease in:
Accounts receivable 671 (1,077)
Prepaid expenses and other assets (225) 1,389
Increase (decrease) in:
Accounts payable, accrued liabilities
and other liabilities (2,702) 2,157
Liabilities subject to compromise (124) (73)
------------ -------------
Net cash used by continuing
operations (3,765) (1,183)
Net cash used by discontinued
operations (1) (1,798)
- ---------------------------------------------------------------------------
Net cash used by operating activities (3,766) (2,981)
- ---------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sale of Axcell product line - 3,000
Proceeds from sale of building - 734
Purchase of marketable securities (3,772) (19)
Purchase of property and equipment (80) (40)
------------ -------------
Net cash (used) provided by
continuing operations (3,852) 3,675
Net cash used by discontinued
operations - (57)
- ---------------------------------------------------------------------------
Net cash (used) provided by
investing activities (3,852) 3,618
- ---------------------------------------------------------------------------
Cash flow from financing activities:
Net cash (used) provided by
continuing operations - -
Net cash used by discontinued
operations - (3)
- ---------------------------------------------------------------------------
Net cash provided (used) by
financing activities - (3)
- ---------------------------------------------------------------------------
Net increase (decrease) in cash and
cash equivalents (7,618) 634
Cash and cash equivalents, unrestricted,
beginning of year 13,123 4,409
------------ -------------
Cash and cash equivalents, unrestricted,
end of period 5,505 5,043
Cash and cash equivalents, restricted,
end of period - 291
- ---------------------------------------------------------------------------
Total cash and cash equivalents, end of
period (including cash amounts in net
assets of discontinued operations) $5,505 $5,334
============ =============
Supplemental disclosures of cash flow
information:
Cash paid during the year for interest $ - $ -
Cash paid during the year for income
taxes $ 2 $ 2
See accompanying notes to consolidated financial statements.
4
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
(a) Business
Spectrum Information Technologies, Inc., a Delaware
corporation ("Spectrum"), and its subsidiaries (collectively, the
"Company") own a portfolio of pioneering patents (legacy assets)
relating to commercially practicable methods of data transmission
over circuit-switched cellular networks. Since January 1995,
Spectrum's management has been implementing a strategy that
refocuses the business direction of the Company. While currently
relying on license fees and royalties for income, Spectrum's
business objective is to further develop its core proprietary
technology and become a leading provider of value-added mobile
communications software and related products. Spectrum's
proprietary wireless data transmission technology enables
transmission of data between portable computer devices over
cellular telephone networks. Spectrum licenses its technology to
leading manufacturers of integrated circuits, modems and other
related data communications product providers. Spectrum also
develops direct connect cellular data transmission activation
kits (software cellphone drivers and cables) and markets them to
the Company's licensees. These two components -
development and marketing of activation kits and technology
licensing - are the current primary sources of operating
revenues. (See Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations - Risk Factors.)
(b) Bankruptcy Proceedings
On January 26, 1995 (the "Petition Date"), as part of new
management's effort to stem the Company's substantial
financial losses and focus on developing its core
technology, the Company, together with its wholly-owned
subsidiaries, Computers Unlimited of Wisconsin, Inc., a
Wisconsin corporation d/b/a Computer Bay ("Computer Bay"),
Dealer Services Business Systems, Inc., a Delaware
corporation d/b/a Data One ("Data One") and Spectrum
Cellular Corporation ("Cellular") (collectively, the
"Debtors"), filed petitions for relief under Chapter 11 of
the Federal Bankruptcy Code (the "Chapter 11 proceeding").
Upon motion by the Debtors, the United States Bankruptcy
Court for the Eastern District of New York (the
"Bankruptcy Court") converted the action for Computer Bay
to a case under Chapter 7 of the Bankruptcy Code. A
trustee is overseeing the liquidation of Computer Bay's
assets and the Company no longer has control over the
Computer Bay estate. Data One consummated a separate
liquidating plan of reorganization on October 4, 1996,
which had been unanimously supported by Data One's voting
creditors. (Note 3).
In March 1996, the Bankruptcy Court approved the Company's
Third Amended Disclosure Statement (the "Disclosure
Statement") with respect to the Third Amended Consolidated
Plan of Reorganization Proposed by Spectrum and Cellular
(the "Plan") dated as of March 18, 1996 finding the
Disclosure Statement adequate for distribution and vote by
interested parties. As contemplated by the Plan, the
bankruptcy estates of Spectrum and Cellular have been
substantively consolidated. The Plan provides all
administrative creditors with full payment (unless a
lesser amount is agreed upon or ordered by the Bankruptcy
Court) and all general unsecured creditors with 100% of
the value of their claims plus 6% interest per annum from
the filing date thereon. It also settles the class action
lawsuits of approximately $676,000,000 filed against the
Company by the payment by the Company of $250,000 and the
delivery of approximately 45% of the equity ownership in
Spectrum to a trustee to be distributed to the members of
the class. In addition, under the settlement, the
plaintiffs are to receive the proceeds, net of certain
fees and expenses, from insurance policies covering the
liabilities of the Company's directors and officers and,
as a result of court supervised negotiations and at the
recommendation of the District Court, approximately
$1,350,000 (in cash or publicly traded securities) from
the various individual defendants in the action plus
$250,000 from the Company. (Note 3). Although existing
Spectrum shareholders will be substantially diluted under
the terms of the Plan, such shareholders should obtain the
majority of the 45% equity ownership in Spectrum set aside
for existing shareholders and certain creditors. The Plan
also calls for management, employees and non-executive
directors of the Company to receive the remaining 10%
ownership.
On August 14, 1996, the United States Bankruptcy Court of
the Eastern District of New York entered an order
confirming the Plan, as amended. Consummation of the Plan
and its Effective Date remain contingent upon District
Court approval of the Class Action Settlement (Note 3).
5
(c) Basis of Presentation
The accompanying consolidated financial statements of the
Company have been prepared on the basis that it is a going
concern, which contemplates the realization of assets and
the satisfaction of liabilities, except as otherwise
disclosed, in the normal course of business. However, as a
result of Chapter 11 proceedings and circumstances
relating to this event, including the Company's recurring
losses from continuing operations, such realization of
assets and liquidation of liabilities is subject to
significant uncertainty. Further, the Company's ability to
continue as a going concern is dependent upon consummation
of the Plan (Note 1(b)), achievement of the business
objectives described in Note 1(a) and profitable
operations therefrom and the ability to generate
sufficient cash from operations and financing sources to
meet the restructured obligations. (See Item 2 -
Management's Discussion and Analysis of Financial
Condition and Results of Operations for a discussion of
Risk Factors.) Except as otherwise disclosed, the
consolidated financial statements do not include any
adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts
and classification of liabilities that may result from the
possible inability of the Company to continue as a going
concern. The Company continues to monitor expenses in
order to conserve cash. In addition, the Plan (Note 1(b))
contemplates the settlement of all significant litigation.
However, there can be no assurance that these events will
occur according to management's plans. The financial
statements for the quarter ended September 30, 1996
reflect accounting principles and practices set forth in
AICPA Statement of Position 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code",
which the Company adopted as of January 26, 1995, the date
of the Company's Chapter 11 filing (Note 3). The net
assets of Spectrum, Cellular and Data One, excluding
intercompany payables of approximately $11,289,000, were
approximately $780,000 at September 30, 1996.
As part of the restructuring process, Spectrum has
included in its Plan the consolidation of the Company's
bankruptcy estate with that of Cellular. Spectrum and
Cellular are now conducting the Company's core business on
an operating basis as a single entity (Notes 1(b) and 5).
In preparing financial statements in conformity with
generally accepted accounting principles, management is
required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the
date of the financial statements and revenues and expenses
during the reporting period. Actual results could differ
from those estimates. The unaudited interim consolidated
financial statements have been prepared on a basis
substantially consistent with the audited statements for
the fiscal year ended March 31, 1996. Certain information
and footnote disclosures normally included in financial
statements were prepared in accordance with generally
accepted accounting principles and have been condensed or
omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The Company believes
that the disclosures contained herein are adequate to make
the information presented not misleading. The unaudited
financial statements should be read in conjunction with
the audited financial statements and accompanying notes in
the Company's annual report on Form 10-K for the fiscal
year ended March 31, 1996.
In the opinion of management, the accompanying unaudited
consolidated financial statements reflect all adjustments
that are necessary to present fairly the Company's
financial position as of September 30, 1996, and the
results of its operations and its cash flows for the
interim periods presented.
(d) Principles of Consolidation
These consolidated financial statements include the
accounts and results of operations of the Company and its
wholly owned subsidiaries, Data One and Spectrum Cellular,
as of and for the three and six months ended September 30,
1996 and 1995. Its two former subsidiaries, Spectrum
Global Services, Inc. ("Spectrum Global") and Computer
Bay, have been reflected as discontinued operations for
all periods presented (Note 2). All intercompany
transactions have been eliminated.
(e) Long Lived Assets
In March, 1995 the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standard
("SFAS") No. 121, Accounting For the Impairment of Long
Lived Assets and for Long Lived Assets to be Disposed of."
The Company has adopted SFAS No. 121 as of April 1, 1996.
The adoption of SFAS No. 121 was not material to the
Company's financial statements.
6
(f) Income (Loss) Per Common Share
The computation of income (loss) per common share is based
on the weighted average number of common shares
outstanding during the periods presented. The weighted
average number of shares used in the computation of income
(loss) per common share for the quarters and six months
ended September 30, 1996 and 1995 is 76,675,448.
(g) Stock-Based Compensation
In October 1995, FASB issued SFAS No. 123, "Accounting for
Stock-Based Compensation," SFAS No. 123 establishes a fair
value method for accounting for stock-based compensation
plans either through recognition or disclosure. On April
1, 1996, the Company adopted the employee stock-based
compensation disclosure provisions of SFAS No. 123
retroactive to April 1, 1995. The adoption of this
standard did not impact the Company's consolidated results
of operations, financial position or cash flows.
2. Business Dispositions
Spectrum Global
Effective October 17, 1995, the Company sold its Spectrum
Global subsidiary for net proceeds of approximately
$4,549,000, after expenses of $325,000, to a buying group
including certain former members of management. Spectrum
Global was acquired in fiscal 1994 from the nephew of the
former President of the Company for approximately $4,120,000.
Spectrum Global has been reported as a discontinued operation
for all periods presented.
The following table summarizes the net assets of Spectrum
Global for the periods presented:
October 17, 1995 (Amounts in thousands)
-----------------------------------------------------
Cash $1,227
Accounts receivable 1,899
Other assets 2,237
Accounts payable (243)
Other liabilities (117)
-------------------
Net assets $5,003
===================
The summary of Spectrum Global's results of discontinued
operations for the periods presented are as follows:
(Amounts in thousands, except per share amounts)
(Unaudited)
Periods ended Three months ended Six months ended
September 30, 1996 1995 1996 1995
- ---------------- ---------- ----------- ----------- -----------
Revenues $0 $ 3,354 $0 $ 6,317
Net income $0 $ 445 $0 $716
Computer Bay
Due to Computer Bay's continuing losses and loss of market
share, the Company officially closed down its Computer Bay
subsidiary on January 25, 1995. Accordingly, Computer Bay has
been reported as a discounted operation, effective January
25, 1995.
Upon conversion of Computer Bay's Chapter 11 case to a case
under Chapter 7 on May 25, 1995, which mandates the
liquidation of Computer Bay, control of Computer Bay has been
transferred from the Company to the Computer Bay trustee. As
a result, the net liabilities of Computer Bay have been
eliminated from the consolidated financial statements of the
Company. As a further result of the conversion of Computer
Bay to a case under Chapter 7, the Company recorded a gain of
$2,539,000 by writing off the net liabilities of Computer
Bay. (See Note 3).
7
The following table summarizes the net liabilities of
Computer Bay for the periods presented:
May 25, 1995
Cash $218
Restricted Cash 291
Accounts Receivable 1,078
Income taxes receivable 409
Property and Equipment 100
Other assets 129
Accounts Payable (3,368)
Other liabilities (1,396)
--------------------
Net Liabilities $(2,539)
====================
3. Legal Proceedings
Bankruptcy Proceedings
On January 26, 1995 (the "Petition Date"), the Company and
three of its four operating subsidiaries (Computer Bay, Data
One and Cellular) filed petitions for relief under Chapter 11
of the Bankruptcy Code in the United States Bankruptcy Court
for the Eastern District of New York (the "Bankruptcy
Court"), Case Nos. 195 10690 260, 195 10691 260, 195 10692
260 and 195 10693 260, respectively (the "Chapter 11 case").
Spectrum Global did not file for bankruptcy protection. On
February 8, 1995, the United States Trustee appointed an
Official Committee of Unsecured Creditors to represent the
creditors of Spectrum (the "Committee"), and another
committee for Computer Bay to represent the interests of all
unsecured creditors whose claims arose before the Petition
Date. No other committees were appointed. On May 25, 1995,
the Bankruptcy Court, upon motion by the Debtors, converted
the Computer Bay proceeding to a case under Chapter 7 of the
Bankruptcy Code. A trustee has been appointed to oversee
liquidation of the Computer Bay assets. Spectrum and Cellular
have been substantively consolidated in the bankruptcy
proceeding and are continuing to manage their affairs and
operate their business under Chapter 11 as debtors in
possession while awaiting consummation of the Plan (Note
1(b)). The Bankruptcy Court confirmed the Plan on August 14,
1996. (See Part II, Item I for a description of the Plan).
Consummation of the Plan and its effective date are
contingent upon District Court approval of the Class Action
Settlement becoming final. The District Court has currently
scheduled a fairness hearing for the Class Action Settlement
on January 24, 1997 to decide whether to approve the
settlement. If the Plan is not consummated, the alternatives
include: (a) continuation of the pending Chapter 11 cases;
(b) alternative plans of reorganization; or (c) liquidation
of Debtors under Chapter 7 or Chapter 11 of the Bankruptcy
Code. (See Part II - Item 1 - Legal Proceedings for a summary
of the terms of the Plan and the principal proceedings in the
Chapter 11 case.) On October 4, 1996, a separate liquidating
plan of reorganization under Chapter 11 was consummated for
Data One. The final report regarding Data One's liquidating
plan will be filed in November 1996.
Computer Bay Trustee's Claim
On January 11, 1996 the Computer Bay trustee filed a
complaint commencing litigation against the Company seeking
to substantively consolidate the Computer Bay estate with the
Debtor's estate and, in the alternative, seeking the return
of alleged preferences and fraudulent conveyances in the
amount of $4,351,396 (the "Computer Bay Litigation"). The
Debtors asserted counterclaims against the Computer Bay
estate in the amount of $2,430,436. On March 15, 1996, the
Debtors, the Committee and the Computer Bay trustee agreed to
a settlement of the Computer Bay Litigation, which was
approved by the Bankruptcy Court on March 28, 1996. The
settlement calls for the Computer Bay estate to receive
distributions under the Plan of $600,000 in cash and $300,000
in Spectrum common stock to be distributed approximately one
month after the Plan's effective date. Consummation of the
settlement is contingent upon consummation of the Plan.
Securities Related Proceedings
On February 9, 1994, the class action filed against the
Company and two of its former officers in May 1993 (In re
Spectrum Information Technologies, Inc. Securities
Litigation, United States District Court for the Eastern
District of New York, Civil Action No. 93-2295) (the
"Class Action Suits") was supplemented (i) to extend
the end of the class period from May 21, 1993 to
8
February 4, 1994, (ii) to add additional claims against
Spectrum and the individual defendants, and (iii) to add
certain of its then officers as party defendants. In April
1994, a Second Consolidated Amended Class Action Complaint
was filed adding additional employees as party defendants.
The class and certain subclasses have been certified. A
similar putative class action filed in the United States
District Court for the Southern District of Texas has been
transferred and consolidated with the Class Action Suits.
The plaintiffs in the Class Action Suits claim to have
purchased the Company's securities at prices which the
Company and the individual defendants allegedly artificially
inflated by, among other things: (i) misrepresenting the
potential value of the patent license agreement the Company
entered into with AT&T; (ii) improperly accounting for
revenues and expenses in connection with certain license and
advertising agreements; (iii) failing to disclose the
existence of an inquiry initiated by the Securities and
Exchange Commission (the "SEC"); and (iv) making misleading
statements regarding the employment of John Sculley. In
addition, there are claims against certain of the individual
defendants for improper insider trading. The Company's former
management, based on the advice of its then counsel, believed
the Company had good and meritorious defenses to the claims
against it.
On July 20, 1994, the Company, certain of its then officers
and directors, and two former officers and directors were
served with a class action complaint. The complaint asserts
that Spectrum knowingly or recklessly made material false
statements or omitted material facts in its financial
reporting relating to Computer Bay prior to announcing the
restatement of earnings for the fiscal year 1992 and the
first three quarters of fiscal 1993 to correct inaccurate
accruals of certain items into income. For pretrial purposes,
this litigation has been consolidated with the Class Action
Suits described above.
In November 1995, the Company announced that an agreement in
principle had been reached on a framework for settlement of
the Class Action Suits (the "Class Action Settlement"). The
Class Action Settlement was approved by the Bankruptcy Court,
but remains contingent upon approval by the District Court and
consummation of the Plan. The District Court has scheduled a
hearing regarding approval of the Class Action Settlement for
January 24, 1997. The plaintiffs in the Class Action Suits
filed a claim against the Company in its bankruptcy
proceedings in the amount of approximately $676 million. The
Class Action Settlement, if consummated, will be in
satisfaction of that claim as well as any and all claims of
the individual defendants (former directors and officers) in
that suit against the Company.
Under the terms of the Class Action Settlement, the Company
and the representatives of the Class Action plaintiffs have
agreed to a framework under which the Company will issue to
the plaintiffs in its plan of reorganization a number of
shares of its Class A Preferred Stock that would be equal to
the number of shares of Distributable Common Stock available
to Spectrum's stockholders and certain creditors following
confirmation of the Plan. In addition, under the Class Action
Settlement, the plaintiffs are to receive the proceeds, net
of certain fees and expenses, from insurance policies worth
$10 million covering the liabilities of the Company's
directors and officers and, as a result of court supervised
negotiations and at the recommendation of the District Court,
approximately $1,350,000 (in cash or publicly traded
securities) from the various individual defendants in the
action plus $250,000 from the Company.
One of the uncertainties surrounding the Class Action
Settlement is that issuers of insurance policies representing
$6 million out of the $10 million of the insurance that may
be available to the class plaintiffs pursuant to the Class
Action Settlement have disclaimed coverage. On July 15, 1996,
the District Court issued a decision favorable to the Company
in this coverage dispute. (See Other Proceedings).
In May 1993, the SEC initiated a confidential and informal
fact gathering inquiry apparently directed toward statements
the Company purportedly made regarding the potential value of
the patent license agreement it had entered into in fiscal
1994 with AT&T. On December 6, 1993, following the Company's
dismissal of its outside auditors, the SEC issued a formal
order of investigation. The Company believes that the
investigation related to accounting and disclosure issues
with respect to certain of the patent license and advertising
agreements it entered into during fiscal 1994 and also to
other activities of the Company's previous management.
In April 1996, the SEC staff informed the Company that it
intended to commence an administrative proceeding to
determine whether during 1993 the Company had violated
certain sections of the Securities Exchange Act of 1934 and
rules promulgated thereunder, including violations of Rule
10b-5, related to accounting and disclosure issues with
respect to certain patent and advertising agreements it
entered into during fiscal 1994. In April 1996, the Company's
current management began discussions with the SEC to resolve
the SEC's ongoing investigation. During these discussions
the SEC informed the Company that it intended to add
alleged violations of the registration provisions of
the Securities Act of 1933 in the administrative proceedings.
9
The discussions contemplate the entry of an administrative
cease and desist order against the Company, but do not
contemplate the imposition of any financial penalties. The
Company's discussions with the SEC are ongoing.
In connection with this investigation, Salvatore T. Marino, a
current employee and former officer of the Company informed
the Company in April 1996 that the SEC staff intended to
commence a proceeding against him for violations of certain
sections of the Securities Exchange Act of 1934 and rules
promulgated thereunder, including violations of Rule 10b-5,
related to accounting and disclosure issues with respect to
certain patent and advertising agreements the Company entered
into during fiscal 1994 and the exercise of options to
purchase and subsequent sale of Spectrum stock in the
relevant time frame. Mr. Marino has denied any wrongdoing and
responded to the staff's allegations. Upon learning of the
SEC staff's position and pending resolution of this issue,
the Company removed Mr. Marino as an executive officer.
The United States Attorney's Office for the Eastern District
of New York has previously informed the Company that it is
the subject of an investigation regarding violations of
securities laws that may have occurred prior to the
appointment of the Company's current Chief Executive Officer
and Board of Directors. The Company is cooperating fully with
the investigation.
Patent Related Proceedings
On September 12, 1996, the Company entered a settlement
agreement resolving an interference proceeding that the
Company has instituted in the U.S. Patent and Trademark
Office to establish that the Company is the inventor of the
claimed subject matter of U.S. Patent 4,991,197 (the "197
Patent"). This proceeding is based on the Company's belief
that Walker Morris, ("Morris") President of Intelligence
Technology Corporation ("ITC"), a party to a joint
development agreement with the Company, wrongfully obtained
the 197 Patent based on the technology invented by the
Company. The Company has been granted a patent to cover this
invention, U.S. Patent 4,972,457. Pursuant to the terms of
the settlement, Morris and ITC conceded priority in the
interference proceeding to the Company, and the Company
granted ITC a limited non-exclusive license under the patent
at issue. The settlement agreement also provides for future
cross licenses of intellectual property.
Other Proceedings
On July 21, 1995, The Home Insurance Company of Illinois
("The Home"), the Company's former directors' and officers'
primary insurance carrier, commenced an adversary proceeding
(the "Home Action") in the Company's bankruptcy proceeding.
The Honorable Frederick Block, United States District Judge
of the District Court, subsequently withdrew the reference
with respect to the Home Action such that the litigation is
now pending before him. The Home sought to rescind a renewal
of a directors' and officers' liability and company
reimbursement policy issued in June 1993 to the Company for
the benefit of its directors and officers (the "Renewal
Policy") and alleged certain material misrepresentations
and/or omissions in the application for the Renewal Policy.
The Home also sought a declaration that coverage is not
afforded under the Renewal Policy for the claims made against
the policy by the Company and certain of its officers and
directors.
In addition to the primary policy, the Company obtained three
excess policies for the insurance year at issue in the Home
Action. Two of the excess carriers, the Agricultural Excess
and Surplus Insurance Company ("AESIC") and The Aetna
Casualty and Surety Company ("Aetna") have intervened in the
Home Action. AESIC has agreed to be bound by any final
judicial resolution regarding The Home (a similar agreement
was previously reached with the third excess carrier) and is
no longer actively participating in the Home Action.
On July 15, 1996, the District Court ruled against the
insurance carriers in their attempt to rescind the directors'
and officers' insurance policies at issue in the Home Action.
The Court also ruled that any losses in the Class Action
Suits related to Spectrum's February 1994 restatement of
earnings would be covered by the policies at issue. The Court
concluded that it could not decide, based on the record
before it, whether the policies at issue would cover claims
in the Class Action Suits related to alleged insider trading
by certain of the Company's former officers and alleged
misstatements regarding John Sculley's employment with the
Company. Home and Aetna have informed the Company that they
intend to appeal certain aspects of the decision.
Notwithstanding this intended appeal, the parties to the
Class Action Suits and the insurance carriers have
tentatively reached an agreement to implement the Class
Action Settlement. Under this agreement, each insurance
carrier has agreed to contribute the full coverage available
under its disputed insurance policy, up to $6 million, if
they are unsuccessful in the appeal. The Class Action
Settlement also remains contingent upon District Court
approval and consummation of the Plan. The Bankruptcy Court
confirmed the Plan on August 14, 1996 but the Plan cannot be
consummated until District Court approval of the Class Action
10
Settlement becomes final. A hearing regarding the Class Action
settlement is scheduled for January 24, 1997 before the District
Court.
From time to time, the Company has been a party to other
legal actions and proceedings incidental to its business. As
of the date of this report, however, the Company knows of no
other pending or threatened legal actions that could have a
material impact on the financial condition of the Company.
4. Subsequent Events
On October 4, 1996, Data One consummated a separate
liquidating plan of reorganization under Chapter 11.
On October 29, 1996, the Bankruptcy Court held a hearing on
the final fee applications filed by professionals who
provided services in Spectrum's bankruptcy proceeding, at
which the court ordered Spectrum to pay a portion of the fees
that the professionals were seeking. These final fee payments
will be approximately $1 million less than the fees for which
the professionals applied because many of the professionals
agreed to waive their claims for a portion of the fees that
had been held back by order of the Bankruptcy Court.
11
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Organization And Business Combination
The Company owns a portfolio of patents relating to
commercially practicable methods to transmit data over
circuit-switched cellular networks. Spectrum has been operating
primarily as an intellectual property company generating much of
its revenues from royalties associated with the licensing of its
proprietary technology. Beginning in January 1995, however,
Spectrum's new management and Board of Directors began
implementing a strategic plan that fundamentally refocuses the
Company. Spectrum's current business strategy is to become a
leading provider of value added mobile communications software
and related products.
Historically, Spectrum had operated as a holding company of
several operating subsidiaries. Beginning in January 1995, when
Spectrum and three of its subsidiaries filed petitions for relief
under Chapter 11 of Federal Bankruptcy Code, and continuing
through the six months ended September 30, 1996, Spectrum's
management began to restructure the Company to focus on its
current business strategy. Spectrum closed two of its
unprofitable subsidiaries, the liquidations of which are under
the supervision of the Bankruptcy Court. The Company sold the
capital stock of its wholly-owned subsidiary, Spectrum Global,
effective October 17, 1995. (See Notes 1(a) and 2 to the
Consolidated Financial Statements). Spectrum Global had not filed
for bankruptcy and was not essential to Spectrum's success in the
mobile communications arena. Finally, as part of the
reorganization process, upon motion by the Debtors, the
Bankruptcy Court substantively consolidated the Company's
bankruptcy estate with that of its Cellular subsidiary. Spectrum
and Cellular are now conducting the Company's core business as a
single corporate entity and the Company intends to merge Spectrum
and Cellular. The discussion of the business of Spectrum in this
report refers to the business that was formerly conducted by either
Spectrum or Cellular. Spectrum Global, Data One and Computer Bay
are reflected in the consolidated financial statements as
discontinued operations.
Chapter 11 Proceedings
On January 26, 1995, as part of new management's effort to
stem the Company's substantial financial losses and focus on
developing its core wireless technology, the Company together
with its wholly-owned subsidiaries Computer Bay, Data One and
Cellular (collectively, the "Debtors") filed petitions for relief
under Chapter 11 of the Federal Bankruptcy Code. Upon motion by
the Debtors, the bankruptcy court converted the action for
Computer Bay to a case under Chapter 7 of the Bankruptcy Code. A
trustee is overseeing the liquidation of Computer Bay's assets
and the Company no longer has control over the Computer Bay
estate. Data One consummated a separate liquidating plan of
reorganization on October 4, 1996.
Due to the Chapter 11 filing, the Company's liquidity
position has been positively affected because the cash
requirements for the payment of accounts payable and other
liabilities, which arose prior to the Chapter 11 filings, are in
most cases deferred until confirmation and consummation of a plan
of reorganization. The positive effect has also been enhanced by
the Bankruptcy Court approved sale of certain assets, but has
been offset by the increased administrative and professional fees
associated with the Chapter 11 filing and resolution of claims
subject to compromise. (See Liquidity and Capital Resources).
On March 14, 1996, the Bankruptcy Court approved the
adequacy and distribution of the Third Amended Disclosure
Statement with respect to the Third Amended Consolidated Plan of
Reorganization Proposed by Spectrum Information Technologies,
Inc. and Spectrum Cellular Corporation, Debtors in Possession,
Dated as of March 18, 1996. The Bankruptcy Court confirmed the
Plan on August 14, 1996. Consummation of the Plan and its
effective date remains contingent upon District Court approval of
the Class Action Settlement. (See Note 3 - Legal Proceedings)
12
Summary of Operations
The following table sets forth, for the periods indicated,
the percentage relationship that certain items bear to revenue.
This summary provides trend data relating to the Company's normal
recurring operations. Amounts set forth below reflect the
Company's Spectrum Global, Data One and Computer Bay subsidiaries
as discontinued operations.
(Amounts in thousands)
Three Months
Ended September 30, 1996 % 1995 %
- --------------------------------------------------------------------------
Revenues $ 651 100.0 $ 669 100.0
----------- --------- ---------- ---------
Operating costs
and expenses:
Cost of revenues 17 2.7 68 10.0
Selling, general
and administrative 1,213 186.3 1,420 212.0
----------- --------- ---------- ---------
Total operating costs
and expenses 1,230 189.0 1,488 222.0
----------- --------- ---------- ---------
Operating loss $ (579) (89.0) $ (819) (122.0)
=========== ========= ========== =========
(Amounts in thousands)
Six Months
Ended September 30, 1996 % 1995 %
- --------------------------------------------------------------------------
Revenues $ 1,459 100.0 $ 1,699 100.0
----------- --------- ---------- ---------
Operating costs
and expenses:
Cost of revenues 41 2.8 191 11.0
Selling, general
and administrative 2,547 174.6 3,547 209.0
----------- --------- ---------- ---------
Total operating costs
and expenses 2,588 177.4 3,738 220.0
----------- --------- ---------- ---------
Operating loss $ (1,129) (77.4) $(2,039) (120.0)
=========== ========= ========== =========
Consolidated Revenues
Consolidated revenues decreased approximately $18,000 or 3%
and $240,000 or 14%, respectively, for the three and six months
ended September 30, 1996 as compared to three and six months
ended September 30, 1995. Merchandise sales decreased $47,000 or
39% and $198,000 or 62%, respectively, for the three and six
months ended September 30, 1996 when compared to the same periods
in the prior year because the Company has withheld selling cables
for use with Motorola Inc. cellular telephones until the Company
can fully implement procedural requirements of the cross-license
agreement with Motorola at which time the Company can sell
activation kits. Sales further decreased for the six months due
to the sale of the AXCELL(R) product line in fiscal 1996.
AXCELL(R) sales for the six months ended September 30, 1995 were
approximately $132,000.
Licensing revenues increased $29,000 or 5% for the three
months ended September 30, 1996 as compared to the three months
ended September 30, 1995. For the six months ended September 30,
1996 licensing revenues decreased $42,000 or 3% as compared to
the six months ended September 30, 1995. An increase of
approximately $203,000 and $391,000, for the three and six months
ended September 30, 1996, respectively, related to increased
payments made pursuant to a licensing agreement the Company
entered in fiscal 1994. The three and six month periods ended
September 30,1996 include licensing revenues of $400,000 and
$850,000, respectively, which reflect the final two installment
payments of the upfront license fee pursuant to this agreement.
The Company is also required to pay this licensee a portion of
the royalties or revenues that the Company may receive in certain
circumstances in connection with this license agreement in an
amount not to exceed the amount of the up front payment.
Licensing revenues also increased by approximately $211,000, for
the six months ended September 30, 1996, as a result of a
settlement with a certain licensee for past due royalties. These
increases were offset, for the three and six months ended
September 30, 1996, respectively, by a $184,000 and $693,000
decrease in revenues from a certain licensee. This licensee paid
royalties during the quarter ended September 30, 1995 but did not
pay royalties during the quarter ended September 30, 1996 because
the Company and the licensee converted an existing license to a
paid up license during the quarter ended March 31, 1996 pursuant
to the terms of a Bankruptcy Court approved settlement.
13
Operating Costs and Expenses
Operating costs and expenses decreased $258,000 or 17% and
$1,150,000 or 31%, respectively, for the three and six months
ended September 30, 1996 as compared to the same period in the
prior year due to decreased selling, general and administrative
expenses of $207,000 or 15% and $1,000,000 or 28%, respectively,
and decreased cost of sales of $51,000 or 75% and $150,000 or
79%, respectively.
The decrease in selling, general and administrative
expenses for the three and six months ended September 30, 1996
was the result of several factors, including decreases in
non-bankruptcy related legal fees of approximately $170,000 or
46% and $488,000 or 48%, for the three and six month period,
respectively. A majority of the non-bankruptcy related legal
matters involving the Company have been settled as part of the
Plan. Outside services decreased $85,000 or 67% and $177,000 or
64%, respectively, for the three and six months ended September
30, 1996 as compared to the three and six months ended September
30, 1995 because the Company is no longer using outside
accounting services and has decreased its use of other
consultants. Depreciation and amortization expenses decreased
$31,000 or 48% and $149,000 or 70%, respectively, for the three
and six months ended September 30, 1996 as compared to the three
and six months ended September 30, 1995 primarily because the
Company is no longer depreciating or amortizing certain assets
that it disposed during the fourth quarter of the fiscal year
ended March 31, 1996. For the three and six months ended
September 30, 1996 insurance expense decreased approximately
$24,000 or 15% and $217,000 or 40%, respectively, as compared to
the same periods in the prior fiscal year primarily due to a
reduction in director's and officers' insurance premiums. These
decreases were partially offset by an increase in personnel and
related expenses of approximately $144,000 or 35% and $65,000 or
6%, respectively, for the three and six months ended September
30, 1996 as compared to the three and six months ended September
30, 1995 due to the hiring of research and development staff in
the Boston, Massachusetts area.
The decrease in cost of sales is a direct result of the
decreased merchandise sales for the three and six months ended
September 30, 1996 as compared to the three and six months ended
September 30, 1995.
Operating Loss
For the three and six months ended September 30, 1996, the
Company's operating loss decreased approximately $240,000 to
$579,000 and $910,000 to $1,129,000, respectively, as compared to
$819,000 and $2,039,000, respectively, for the three and six
months ended September 30, 1995. This 29% and 45% reduction is
due to decreased operating costs and expenses of $207,000 or 15%
and $1,000,000 or 28%, respectively, offset by decreased revenues
of $18,000 or 3% and $240,000 or 14%, respectively.
Other Income and Expense
Other income decreased $1,810,000 when comparing income of
$1,781,000 for the three months ended September 1995 to expense
of $29,000 for the three months ended September 1996. Other
income decreased $1,655,000 or 96%, for the six months ended
September 30, 1996 as compared to the six months ended September
30, 1995 primarily because the Company sold its AXCELL(R) product
line in fiscal 1996. This sale resulted in a gain of
approximately $1,616,000 for the quarter ended September 30, 1995.
Discontinued Operations
The Company had recorded a gain of $2,539,000 by writing
off the net liabilities of its Computer Bay subsidiary as a
result of the conversion of Computer Bay's bankruptcy filing into
a Chapter 7. On October 17, 1995, the Company sold its Spectrum
Global subsidiary which is reflected as a discontinued operation.
Income from Global's operations for the three and six months
ended September 30, 1995 was $445,000 and $716,000, respectively.
Liquidity and Capital Resources
Since inception, the Company has experienced significant
operating losses and operating cash flow deficits which
ultimately caused the Company to file for bankruptcy protection
under Chapter 11 on January 26, 1995. The Company continues to
review expenses in order to conserve cash.
During the six months ended September 30, 1996, working
capital (current assets less current liabilities) decreased by
approximately $1,448,000 to $9,064,000 primarily due to the net
loss from continuing operations.
14
Net cash used by operating activities increased from
$2,981,000 for the six months ended September 30, 1995 to
$3,766,000 for the six months ended September 30, 1996 primarily
due to an increase in cash used by continuing operations offset
by a decrease in net cash used by discontinued operations. Net
cash used by continuing operations increased from $1,183,000
during the six months ended September 30, 1995 to $3,765,000 for
the six months ended September 30, 1996. During the six months
ended September 30, 1996 accounts payable and accrued liabilities
decreased approximately $2,702,000 as a result of decreased
professional fees associated with the Company's bankruptcy.
However, for the six months ended September 30, 1995 these fees
increased approximately $2,157,000.
Net cash used by investing activities decreased $7,470,000
for the six months ended September 30, 1996 as compared to the
six months ended September 30, 1995 primarily because the Company
received the proceeds from the sale of the AXCELL(R) product line
in fiscal 1996 that it did not receive during the period ended
September 30, 1996. Also, the Company purchased approximately
$3,772,000 in marketable securities during the six months ended
September 30, 1996.
Capital expenditures amounted to approximately $80,000
for the six months ended September 30, 1996. These
expenditures are primarily related to the outfitting of new
offices in the Atlanta, Georgia and Boston, Massachusetts areas.
For the year ended March 31, 1997, capital expenditures are
expected to be approximately $263,000.
Consummation of the Company's proposed Plan will adversely
impact the Company's short term liquidity because of the cash
payments that the Company will make pursuant to the Plan to
holders of secured, administrative and unsecured claims. Assuming
the Plan is consummated in accordance with the assumptions and
business plan set forth in the Disclosure Statement, however, the
Company projects it will have adequate capital resources and
liquidity to fund its operations. The Company's long term
liquidity is largely dependent upon the Company's ability to
develop and sell value-added mobile communications software and
related products in addition to its current revenue from
licensing to generate a positive cash flow from its reorganized
business and, if necessary, raise additional capital. Further, if
the Company's proposed Plan is not consummated and no alternative
plan of reorganization is approved, then there will be
substantial doubt about the Company's ability to continue as a
going concern and the Company may be forced to liquidate under
either Chapter 7 or Chapter 11 of the Bankruptcy Code.
Risk Factors
The Company's management believes that developing a product
based strategy is essential to the long term success of the
Company as a going concern. Leveraging the Company's proprietary
wireless driver software assets and capabilities into a mobile
communications software business offers near term opportunity to
achieve turnaround. Management's strategy, as described above and
elsewhere throughout this report, contains forward looking
tactics and statements that are subject to significant risk and
uncertainty. Failure to successfully implement this strategy will
raise substantial doubt about the Company's ability to continue
as a going concern.
Spectrum has suffered significant losses from continuing
operations in each fiscal year since inception. Even after the
Company's recent restructuring, management does not believe that
the product sales and expected royalty revenues associated with
the licensing of its existing proprietary technology will be
sufficient to reverse losses given the Company's operating
expenses. Under the current strategy, management expects to have
a continued negative cash flow while it develops and markets a
new line of mobile communications software products. Unlike its
competitors, the Company's limited financial resources do not
allow the Company significant room to err in its product
development and marketing.
Risks associated with the current strategy include, but are
not limited to, overcoming the negative image Spectrum has
developed in the past, and its ability to rebuild credibility, in
the marketplace; successfully developing software products that
bring value to mobile data communications software markets;
developing relationships with existing licensees, some of which
are current competitors, into channels for distribution of new
products; developing new channels for distribution; hiring key
technical and marketing staff to implement the strategy;
competing successfully within markets where competitors have
significantly more resources and access to capital than the
Company; realization of market forecasts by industry specialists
regarding wireless and mobile communications market growth;
limited capital resources upon exiting Chapter 11; the timeliness
of consummation of the Plan and its effective date; and the
ability of the Company to raise additional capital, if necessary.
The following specific risk factors should be considered in
evaluating Spectrum's ability to achieve a successful turnaround.
Bankruptcy Proceedings. District Court approval of the Class
Action Settlement (Notes 3 and 4, and Part II - Other Information
Item 1 - Legal Proceedings - Securities Related Proceeding) is a
condition precedent to consummation and the effective date of the
Plan. (See Notes 3 and 4). If the Class Action Settlement is not
approved, it is highly unlikely that the Plan, as written, will
be consummated. If the Plan is not consummated, the alternatives
include: (a) continuation of the pending Chapter 11 cases; (b)
15
alternative plans of reorganization; or (c) liquidation of the
Debtors under Chapter 7 or Chapter 11 of the Bankruptcy Code.
Each alternative raises substantial doubts about the Company's
ability to continue as a going concern.
Past Operating History. The Company's future must be considered
in light of the risks associated with the past difficulties and
negative press encountered by Company. To address these risks,
the Company must, among other things, rebuild management and
technical credibility with current and potential customers,
continue to attract, retain and motivate qualified persons, and
continue to upgrade its technologies and commercialize products
and services incorporating such technologies. There can be no
assurance that the Company will be successful in addressing such
risks. The Company has incurred net losses since inception and
expects to continue to operate at a loss for the foreseeable
future until new product development and market acceptance of its
products are achieved.
Developing Market; Acceptance of the Company's Products. The
market for the Company's software and services has only recently
begun to develop, and is characterized by an increasing number of
market entrants who have introduced or developed products and
services for mobile communication. As is typical in the case of a
growing industry, demand and market acceptance for recently
introduced products and services are subject to a high level of
uncertainty. While the Company believes that its software products
will offer advantages for mobile data communications, there can be
no assurance that the Company's products for mobile communication
will become widely adopted.
Because the market for the Company's products and services
is evolving, it is difficult to predict the future growth rate, if
any, and size of this market. There can be no assurance that the
market for the Company's products and services will develop, that
the Company's products or services will be adopted, or that
mobile PC users in the business sector will significantly
increase their use of wireless networks for data communication.
If the market fails to develop, develops more slowly than
expected or becomes saturated with competitors, or if the
Company's products do not achieve market acceptance, the
Company's business, operating results and financial condition
will be materially adversely affected.
Competition. The market for mobile data communications software
and services is relatively new, becoming intensely competitive
and subject to rapid technological change. The Company expects
competition to persist, intensify and increase in the future.
Most of the Company's current and potential competitors have
longer operating histories producing software products, greater
name recognition, larger installed customer bases and
significantly greater financial, technical and marketing
resources than the Company. Such competition could materially
adversely affect the Company's business, operating results
or financial condition. The Company's key current competitors
in its legacy business include Megahertz, a subsidiary of U.S.
Robotics, Motorola and AT&T, all of which are licensees of the
Company. Effective September 30,1996, AT&T completed the
divestiture of Lucent Technologies, Inc. ("Lucent"), which had
previously sold its AT&T Paradyne unit. Spectrum is engaged in
discussions with AT&T and Lucent regarding the effect of the
breakup on an intellectual property license between AT&T and
Spectrum. Also, Spectrum is reviewing the business of the purchaser
of Paradyne to assess the appropriateness of a license. This
breakup has provided an opportunity to discuss modification to
the existing license agreement between Spectrum and AT&T or new
relationships with the entities that were spun off, however, there
can be no assurance that these discussions will result in
favorable business arrangements.
New Product Development and Technological Change. Substantially
all of the Company's current and near term revenues are expected
to be derived from the licensing of its proprietary technology
and sale of its associated activation kits. Accordingly, broader
acceptance of the Company's activation products by customers is
essential to the Company's near term success. The Company's
ability to design, develop, test and support new software
products and enhancements on a timely basis that meet changing
customer needs and respond to technological developments and
emerging industry standards is also critical to the Company's
long term success. There can be no assurance that the Company
will be successful in developing and marketing new software
products and enhancements that meet changing customer needs and
respond to such technological changes or evolving industry
standards. The Company's activation kit products are designed for
use primarily with circuit switched cellular networks. Future
sales of the Company's products will be dependent, in part, on
software products that are independent of networks and are
functional to support mobile user data needs, anyplace, anytime.
The Company's inability to successfully expand its product
offerings will have a material adverse effect on the Company's
business, operating results or financial condition.
Evolving Distribution Channels. The Company's strategy is to
develop multiple distribution channels. The Company has
historically sold its activation kit products only through some
of its licensees which are original equipment manufacturers
("OEMs"). The Company expects to increasingly utilize other OEMs
which have competing products and has recently begun marketing
efforts to these potential customers. In the future, the
Company plans to utilize value added resellers ("VARs") as a
channel for more advanced software products. The Company
expects that increased sales through certain OEMs and VARs
will adversely affect the Company's average selling prices
and gross margins due to the lower unit prices that are
typically charged when selling through indirect channels.
Moreover, there can be no assurance that the Company will
be able to attract VARs that will be able to market the Company's
16
products effectively. Consequently, the Company may be
adversely affected should it fail to adequately penetrate either
channel. The inability to recruit, manage or retain important
VARs, or their inability to penetrate their respective market
segments, could materially adversely affect the Company's
business, future business, operating results or financial
condition.
The Company plans to develop a limited sales force and
expand its marketing. There can be no assurance that such
internal expansion will be successfully completed, that the cost
of such expansion will not exceed the revenues generated, or that
the Company's sales and marketing organization will be able to
successfully compete against the significantly more extensive and
well-funded sales and marketing operations of many of the
Company's current or potential competitors. The Company's
inability to effectively manage its internal expansion could have
a material adverse effect on the Company's business, operating
results or financial condition.
Management of Growth. The timely execution necessary for the
Company to fully exploit the market window for its products and
services requires an effective planning and management process.
Since February 1, 1996, the Company has increased its engineering
staff. To manage its growth, the Company must continue to
implement and improve its operational and financial systems and
to expand, train and manage its employee base. There can be no
assurance that the Company will be able to successfully implement
these activities on a timely basis. Further, the Company will be
required to manage multiple relationships with various customers
and other third parties. Although the Company believes that it
has made adequate allowances for the costs and risks associated
with this expansion, there can be no assurance that the Company's
systems, procedures or controls will be adequate to support the
Company's operations or that the Company's management will be
able to achieve in a timely manner the expansion necessary to
fully exploit the market window for the Company's products and
services. If the Company is unable to manage growth effectively,
the Company's business, operating results and financial condition
will be materially adversely affected.
Dependence on Key Personnel. The Company's performance is
substantially dependent on the performance of its executive
officers and key employees, most of whom have worked together for
only a short period of time. Given the Company's early stage of
transition and restructuring, the Company is dependent on its
ability to retain and motivate high quality personnel, especially
its management and highly skilled engineering and software
development teams. The loss of the services of any of its
executive officers or other key employees could have a material
adverse effect on the business, operating results or financial
condition of the Company.
The Company's future success also depends on its continuing
ability to identify, hire, train and retain other highly qualified
technical personnel. Competition for such personnel is intense,
and given Spectrum's past history, there can be no assurance that
the Company will be able to attract, assimilate or retain other
highly qualified technical and managerial personnel in the future.
The ability to attract and retain the necessary technical and
managerial personnel could have a material adverse effect upon the
Company's business, operating results or financial condition.
Limited Capital Resources. If the Company successfully emerges
from Chapter 11 bankruptcy, it will have limited cash assets to
invest in product development and marketing and selling. It is
critical, therefore, to the Company's business, operating,
results and financial condition that timely product introduction
and market acceptance is achieved. Any delays or reduction in
product shipments will have a material adverse effect on the
Company's business, operating results and financial condition.
Market Listing; Volatility of Stock Price. Spectrum was delisted
from the NASDAQ National Market in April 1995. Since then, the
Company's common stock has been traded on the NASD OTC Bulletin
Board. If the Company successfully emerges from Chapter 11, there
can be no assurance that an active public market for the common
stock will develop or be sustained. Further, the market
price of the Company's common stock is likely to be highly
volatile and could be subject to wide fluctuations in response to
exiting Chapter 11, quarterly variations in operating results,
announcements of technological innovations or new products by the
Company or its competitors, or other events or factors.
Shares Eligible for Future Sale. The preferred stock that will be
distributed to the plaintiffs in the Class Action Suits pursuant
to the Plan is convertible to common stock upon request of the
holder. Conversion to common stock of a significant number of
shares of preferred stock and a subsequent sale in the public
market could adversely affect the future market price for the
common stock. (See Note 3 and Part II - Other Information Item 1
- - Legal Proceedings - Bankruptcy Related Proceedings).
17
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Bankruptcy Proceedings
On January 26, 1995 (the "Petition Date"), the Company and
three of its four operating subsidiaries (Computer Bay, Data One
and Cellular) filed petitions for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the
Eastern District of New York (the "Bankruptcy Court"), Case Nos.
195 10690 260, 195 10691 260, 195 10692 260 and 195 10693 260,
respectively (the "Chapter 11 case"). Spectrum Global did not
file for bankruptcy protection. On February 8, 1995, the United
States Trustee appointed an Official Committee of Unsecured
Creditors to represent the creditors of Spectrum (the
"Committee"), and another committee for Computer Bay to represent
the interests of all unsecured creditors whose claims arose
before the Petition Date. No other committees have been
appointed. On May 25, 1995, the Bankruptcy Court, upon motion by
the Debtors, converted the Computer Bay proceeding to a case
under Chapter 7 of the Bankruptcy Code. A trustee has been
appointed to oversee liquidation of the Computer Bay assets.
Spectrum and Cellular have been substantively consolidated in the
bankruptcy proceeding and are continuing to manage their affairs
and operate their business under Chapter 11 as debtors in
possession while awaiting Bankruptcy Court approval of their
proposed plan of reorganization. During September 1996, the
Bankruptcy Court authorized Data One to distribute a separate
liquidating plan of reorganization under Chapter 11. All of the
voting creditors supported confirmation of this plan. The
Bankruptcy Court confirmed Data One's liquidating plan on August
6, 1996, which was consummated on October 4, 1996.
The Debtors' Proposed Plan of Reorganization
In March 1996, the Bankruptcy Court approved the Company's
Third Amended Disclosure Statement (the "Disclosure Statement")
with respect to the Third Amended Consolidated Plan of
Reorganization Proposed by Spectrum and Cellular (the "Plan")
dated as of March 18, 1996 finding the Disclosure Statement
adequate for distribution and vote by interested parties. As
contemplated by the Plan, the bankruptcy estates of Spectrum and
Cellular have been substantively consolidated. The Plan provides
all administrative creditors with full payment (unless a lesser
amount is agreed upon or ordered by the Bankruptcy Court) and all
general unsecured creditors with 100% of the value of their
claims plus 6% interest per annum from the filing date thereon.
It also settles the class action lawsuits of approximately
$676,000,000 filed against the Company by the payment of $250,000
and the delivery of approximately 45% of the equity ownership in
Spectrum to a trustee to be distributed to the members of the
class. Although existing Spectrum shareholders will be
substantially diluted under the terms of the Plan, such
shareholders should obtain the majority of the 45% equity
ownership in Spectrum set aside for existing shareholders and
certain creditors. The Plan also calls for management, employees
and non-executive directors of the Company to receive the
remaining 10% ownership.
The Bankruptcy Court set April 22, 1996 as the deadline for
voting on the Plan. Each class entitled to vote on the Plan
accepted the Plan. Over 97% of Spectrum's voting unsecured
creditors, representing over 99% of the total dollar amount
voted, voted to accept the Plan. Under the Bankruptcy Code, a
class accepts a plan if two-thirds in amount and a majority in
number of the holders of claims voting cast ballots in favor of
acceptance. Holders of Spectrum's common stock representing
approximately 27,600,000 shares returned ballots, with over 95%
of those shares voted in favor of confirmation. A class of equity
interests is deemed to have accepted a plan if the plan is
accepted by holders of at least two-thirds of the allowed
interests that have voted on the plan. On August 14, 1996, the
United States Bankruptcy Court of the Eastern District of New
York entered an order confirming the Plan, as amended.
Consummation of the Plan and its Effective Date remain contingent
upon District Court approval of the Class Action Settlement (Note
3).
The Plan, if confirmed by the Bankruptcy Court, will settle
all material litigation now pending and provide all general
unsecured creditors with 100% of the value of their claims plus
6% interest per annum from the filing date thereon. The Company
has segregated approximately $3.5 million for the payment of
general unsecured claims, the priority non-tax claim and the
Company's cash contribution to the settlement of the class action
lawsuits. To date, the Company has reconciled the majority of the
general unsecured creditor claims, with interest, in the amount
of approximately $2.6 million. Several outstanding claims remain
that the Company is attempting to reconcile before the effective
date of the Plan (the "Effective Date"). The Company does not
believe that the reconciliation of such claims will have a
material effect on the reserve established for payment to
unsecured creditors. The Plan also provides for the payment
of approximately $264,000 on the Effective Date to the holder
of the one priority nontax claim filed against Spectrum. The
Plan will also settle all of the class action lawsuits filed
against the Company by the payment of $250,000 by
18
the Company and the delivery of approximately 45% of the
equity ownership in reorganized Spectrum to a trustee to
be distributed to the members of the class. (See
Securities Related Proceedings and Note 3.) Under the terms of
the proposed Plan, existing shareholders will be substantially
diluted but should obtain the majority of the 45% equity
ownership in reorganized Spectrum set aside for such shareholders
and certain creditors. This should hold true even after the
issuance of $300,000 of stock to the Chapter 7 trustee of
Computer Bay in connection with the recent settlement of his
claim. Holders of allowed administrative claims (as agreed upon
or ordered by the Bankruptcy Court) will be paid in full under
the Plan.
Although the Bankruptcy Court confirmed the Plan at a
hearing on August 14, 1996, consummation of the Plan and its
Effective Date will remain contingent upon District Court
approval of the Class Action Settlement becoming final. A hearing
regarding this approval is scheduled for January 24, 1997 before
the District Court.
The Company will amend its certificate of incorporation and
by-laws on the Effective Date. The Amended Certificate contains
certain provisions affecting the rights of shareholders,
corporate governance, and the transferability of Class A
Preferred Stock and Reorganized Spectrum Common Stock (as defined
below). Under the amended certificate of incorporation, the
authorized capital stock of the Company shall be comprised of (i)
10 million shares of reorganized Spectrum common stock
("Reorganized Spectrum Common Stock"), (ii) 1.5 million shares of
Class A preferred stock reserved for issuance in connection with
the settlement of the Class Action that was filed against the
Company in 1993 ("Class A Preferred Stock") and (iii) 2 million
shares of preferred stock ("Preferred Stock"). A description of
the amount of shares that will be issued within each class is set
forth below.
Issued and outstanding shares of the Company's common stock
will be canceled on the Effective Date and replaced with one (1)
share of Reorganized Spectrum Common Stock for each seventy-five
(75) shares of existing common stock. The Company currently has
authorized 110 million shares of common stock, of which
approximately 76.7 million are issued and outstanding. Therefore,
approximately 1 million shares of Reorganized Spectrum Common
Stock will be issued to existing shareholders on the Effective
Date. An additional $300,000 of Reorganized Spectrum Common Stock
will be issued to the Computer Bay trustee in connection with the
settlement of his claim (collectively, the Reorganized Spectrum
Common Stock issued to existing shareholders and the Computer Bay
trustee is defined as "Distributable Common Stock"). Stock
options issued under the Company's existing stock option plans
will also be reverse split at a 75 to 1 ratio and repriced
accordingly.
Pursuant to the Class Action Settlement, the Company will
issue a number of shares of Class A Preferred Stock equal to the
number of shares of Distributable Common Stock. The Class A
Preferred Stock is convertible to Reorganized Spectrum Common
Stock at any time within two years of its date of issuance and
automatically converts to Reorganized Spectrum Common Stock at
the expiration of two years.
As part of a bonus or success fee to employees, officers
and all non-executive directors for confirming a plan of
reorganization, the Company will also issue Reorganized Spectrum
Common stock pursuant to the two incentive compensation programs
described in the Plan, the Spectrum 1996 Stock Incentive Plan and
the Spectrum 1996 Incentive Deferral Plan, which collectively
authorize the issuance of an aggregate number of shares of
Reorganized Spectrum Common Stock equal to one-ninth (1/9) of the
aggregate number of shares of Distributable Common Stock and
Class A Preferred Stock (i.e., 10% of the reorganized equity
ownership) to directors, officers and employees of the Company on
the Effective Date. Except for 300 shares of Reorganized Spectrum
Common Stock that will be distributed to non-executive directors
on the Effective Date, the distribution of stock to directors,
officers and employees pursuant to such incentive programs shall
be distributed in three equal semi-annual installments following
the effective date. Under the Stock Incentive Plan, employees,
officers and directors will also be eligible to receive future
grants of performance based incentive awards with respect to an
aggregate number of shares equal to an additional one-ninth (1/9)
of the aggregate number of shares of Distributable Common Stock
and Class A Preferred Stock. Also, on the Effective Date, the
Company will distribute a $300,000 success bonus among all
employees.
Consummation of the Plan does not contemplate issuance of
the remainder of the 10 million authorized shares of Reorganized
Spectrum Common Stock, the remainder of the 1.5 million shares of
Class A Preferred Stock, or the 2 million shares of authorized
preferred stock. The details of the Plan, the proposed
recapitalization, and copies of the certificate of incorporation
and by-laws are set forth in detail in the Plan and associated
Disclosure Statement, which the Company filed with the SEC on its
Current Report on Form 8-K dated as of March 26, 1996.
If the Plan is not consummated (consummation is subject to
the District Court's approval of the Class Action Settlement),
the alternatives include: (a) continuation of the pending Chapter
11 cases; (b) alternative plans of reorganization; or (c)
liquidation of Debtors under Chapter 7 or Chapter 11 of the
Bankruptcy Code.
19
Other Proceedings
A description of other legal proceedings involving the
Company is set forth in Part I, Note 3.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
No.
27 Financial Data Schedule
B. Reports on Form 8-K
The Company filed a Current Report on Form 8-K
dated August 14, 1996, which included: Item 3,
"Bankruptcy or Receivership" reporting the United
States Bankruptcy Court of the Eastern District
of New York entered an order confirming the Third
Amended Consolidated Plan of Reorganization, as
amended, proposed by Spectrum Information
Technologies, Inc. and Spectrum Cellular (the
"Plan"). Consummation of the Plan and its
Effective Date remain contingent upon District
Court approval of the Class Action Settlement.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized.
Dated: November 7, 1996
SPECTRUM INFORMATION TECHNOLOGIES, INC.
By /s/ Donald J. Amoruso
--------------------------------------
Donald J. Amoruso
President, Chief Executive Officer and
Chairman of the Board of Directors
By /s/ Barry J. Hintze
--------------------------------------
Barry J. Hintze
Controller and
Principal Accounting Officer
21