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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 MARCH 31, 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 NO. 0-11630
INTELECT COMMUNICATIONS SYSTEMS LIMITED
(Exact name of registrant as specified in its charter)
BERMUDA N/A
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
REID HOUSE, 31 CHURCH STREET
HAMILTON, BERMUDA
HM 12
(Address of principal executive offices, zip code)
(441) 295-8639
(Registrant's telephone number, including area code)
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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 __
There were 12,525,537 shares of the registrant's Common Stock, par value
$.01 per share, outstanding on May 9, 1996.
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INTELECT COMMUNICATIONS SYSTEMS LIMITED
INDEX
PAGE
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PART 1 FINANCIAL INFORMATION
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ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets of the Company
(unaudited) at March 31, 1996 and December 31, 1995 2
Consolidated Statements of Operations of the Company
(unaudited) for the three months ended March 31, 1996 and 1995 3
Consolidated Statements of Cash Flows of the Company
(unaudited) for the three months ended March 31, 1996 and 1995 4
Notes to the Consolidated Financial Statements 5
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 7
PART 2 OTHER INFORMATION
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 10
SIGNATURES 10
INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of U.S. Dollars, except share data)
(Unaudited)
MARCH 31 December 31
1996 1995
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,275 $ 15,039
Marketable securities 61 -
Accounts receivable 2,574 1,375
Inventories 3,826 2,537
Prepaid expenses 537 406
Other current assets 118 -
Deferred income taxes 325 -
Loan receivable - 600
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14,716 19,957
PROPERTY AND EQUIPMENT - NET 3,220 1,839
EXCESS OF COST OVER NET ASSETS OF COMPANIES ACQUIRED 20,112 8,685
CAPITALIZED DEVELOPMENT COSTS 1,632 -
OTHER INTANGIBLE ASSETS 788 758
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$ 40,468 $ 31,239
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,958 $ 1,680
Accrued liabilities 2,330 1,989
Net liabilities of discontinued operations 450 476
Current installments of obligations under capital leases 61 145
Current maturities of long-term debt 3,517 1,041
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10,316 5,331
LONG-TERM OBLIGATIONS UNDER CAPITAL LEASES,
net of current maturities 192 200
LONG-TERM DEBT, net of current maturities 2,663 168
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13,171 5,699
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SHAREHOLDERS' EQUITY:
Common shares, $0.01 par value,
80,000,000 shares authorized.
12,459,487 issued and outstanding at March 31,
1996 (1995 - 10,999,808) 125 114
Share premium 15,409 11,673
Unrealized gain on marketable securities 6 -
Retained earnings - since November 1, 1992 11,757 13,753
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27,297 25,540
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$ 40,468 $ 31,239
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2
INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Thousands of U.S. Dollars,
except share data)
(Unaudited)
Three Months Ended March 31
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1996 1995
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STATEMENT OF OPERATIONS
SALES AND OTHER REVENUES:
Net sales $ 3,372 $ -
Interest and other income 163 126
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3,535 126
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COSTS AND EXPENSES:
Cost of goods sold 2,439 -
Selling, general and administrative 3,401 66
Engineering and development 177 -
Interest 57 -
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6,074 66
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INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAX BENEFIT (2,539) 60
INCOME TAX BENEFIT 553 -
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INCOME (LOSS) FROM CONTINUING OPERATIONS (1,986) 60
DISCONTINUED OPERATIONS:
Income (loss) from discontinued operations (9) 242
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NET INCOME (LOSS) FOR PERIOD $ (1,995) $ 302
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EARNINGS PER SHARE
PRIMARY EARNINGS
INCOME (LOSS) PER SHARE
Continuing operations $ (0.16) $ 0.01
Discontinued operations (0.00) 0.02
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Net income (loss) for period $ (0.16) $ 0.03
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WEIGHTED AVERAGE NUMBER OF SHARES AND
COMMON STOCK EQUIVALENTS OUTSTANDING
(IN THOUSANDS) 12,528 11,346
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3
INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of U.S. Dollars)
(Unaudited)
Three Months Ended March 31
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1996 1995
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) for period $ (1,995) $ 302
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 389 -
Foreign exchange translation 14 -
Income from discontinued operations 9 (242)
Noncash compensation on acquisition of
Mosaic Information Technologies, Inc. 500 -
Deferred tax benefit (553) -
Noncash compensation 117 -
Changes in operating assets and liabilities:
Accounts receivable (564) (4)
Inventories (982) -
Other assets (194) (25)
Capitalized development costs (1,632) -
Accounts payable and accrued liabilities 2,147 (116)
Net liabilities of discontinued operations (26) 110
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Net cash provided by (used in) operating activities (2,770) 25
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CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in discontinued operation - (960)
Capital expenditures (932) -
Purchase of marketable securities (55) -
Investment in other assets (71) -
Loan receivable 600 -
Investment in and advances to Intelect, Inc. - (1,600)
Acquisition of DNA Enterprises, Inc. (3,010) -
Acquisition of Mosaic Information Technologies, Inc. (2,135)
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Net cash used in investing activities (5,603) (2,560)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations (22) -
Payment of long-term debt (100) -
Proceeds from issuance of common shares 734 178
Quasi-reorganization - 159
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Net cash provided by financing activities 612 337
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NET DECREASE IN CASH AND MARKETABLE SECURITIES (7,761) (2,198)
CASH AND CASH EQUIVALENTS, beginning of period 15,036 2,555
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CASH AND CASH EQUIVALENTS, end of period $ 7,275 $ 357
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4
INTELECT COMMUNICATIONS SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1996
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared
by the Company without audit in accordance with generally accepted accounting
principles for interim financial statements and with instructions to Form 10-Q
and Article 10 of Regulation S-X. In the opinion of management, all adjustments
(consisting only of normal recurring accruals) considered necessary for a fair
presentation have been included.
The accompanying consolidated financial statements do not include
certain footnotes and financial presentations normally required under generally
accepted accounting principles and, therefore, should be read in conjunction
with the audited financial statements included in the Company's Transition
Report on Form 10-K as at December 31, 1995.
RESTATEMENTS
The Company changed its fiscal year end to December 31 from October 31.
Accordingly, the Company has filed a Transition Report on Form 10-K for the
transition period from November 1, 1995 to December 31, 1995 (the "Transition
Period"). Going forward, the Company will report results for the quarters ending
March 31, June 30 and September 30.
On October 31, 1995 the Company sold its prior principal operating
subsidiary, Savage Corporation ("Savage"). Accordingly, from October 31, 1995
Savage results are accounted for as discontinued operations and in the
accompanying financial statements.
INCOME TAXES
The Company provides for income taxes in interim periods based on the
estimated effective income tax rate of the complete fiscal year. An income tax
benefit is computed on the pre-tax loss of consolidated entries according to
applicable taxing jurisdictions based on current tax law. Deferred taxes result
from the future tax consequences associated with temporary differences between
the amount of assets and liabilities recorded for tax and financial accounting
purposes. A valuation allowance for deferred tax assets is recorded to the
extent the Company cannot determine, in accordance with the provision of
Statement of Financial Accounting Standards No. 109 "Accounting for Income
Taxes", that the ultimate realization of net deferred tax assets against income
is more likely than not.
ACQUISITIONS
The Company concluded the acquisitions of DNA Enterprises, Inc. ("DNA")
on February 13, 1996 and Mosaic Information Technologies, Inc. ("MOSAIC") on
March 29, 1996. Both acquisitions have been accounted for as purchases and
accordingly the accompanying financial statements include the results of DNA and
MOSAIC from their respective acquisition dates. (REFERENCE IS MADE TO THE
COMPANY'S REPORTS ON FORM 8-K FILED ON FEBRUARY 20, 1996 AND APRIL 12, 1996
RELATING TO THE ACQUISITION OF DNA AND MOSAIC, RESPECTIVELY). The excess of
purchase price over the estimated fair values of the net assets acquired has
been recorded as goodwill, which is being amortized over ten years.
5
The estimated fair values of assets and liabilities of Mosaic and DNA
acquired are summarized as follows (thousands of U.S. Dollars):
MOSAIC DNA
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Cash $ 218 $ 3
Accounts receivable 69 621
Inventory 307 -
Property and equipment 81 502
Goodwill 4,375 7,280
Accounts payable and accruals (285) (214)
Debt (16) (180)
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$ 4,749 $ 8,012
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The results of the Company for the first quarter ended March 31, 1996
would not be materially different if the acquisitions of MOSAIC and DNA had been
accounted for as though the acquisitions had taken place at the beginning of the
period.
Current installments of long-term debt and long-term debt net of
current maturities both include $2,500,000 of debt assumed in connection with
the acquisition of DNA. (REFERENCE IS MADE TO THE COMPANY'S REPORT ON FORM 8-K
FILED ON FEBRUARY 20, 1996 ON THE ACQUISITION OF DNA).
ENGINEERING AND DEVELOPMENT (E&D)
Capitalization of development costs commences upon the establishment of
technological feasibility. Both the establishment of technological feasibility
and the ongoing assessment of recoverability of capitalized development costs
require considerable judgment by management with respect to certain external
factors, including, but not limited to, anticipated future revenues, estimated
economic life and changes in software and hardware technologies. The company has
not capitalized any costs in prior periods because eligible amounts were
immaterial for those periods. Technological feasibility and future revenue
potential has now been established for the Company's SONETLYNX(TM), S4(TM) and
MOSAIC(TM) product lines. Accordingly, relevant and eligible expenditures for
these products have been capitalized in the accompanying financial statements.
INVENTORIES
The components of inventories are as follows (thousands of U.S. dollars):
MARCH 31 December 31
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1996 1995
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Raw materials $ 3,007 $ 1,554
Work in progress 723 544
Finished goods 856 1,169
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4,586 3,267
Less: allowance for obsolescence 760 730
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$ 3,826 $ 2,537
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6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE THREE MONTH PERIOD ENDED MARCH 31, 1996
RESULTS OF OPERATIONS
First quarter results generally conform to management expectations and
fall within the scope of business unit budgets and forecasts for the current
fiscal year. The Company is transitioning through a period of completing
transactions and integrating newly acquired operations, introducing to market
innovative new products, undertaking extensive development and engineering of
advanced new products, and expanding Company wide marketing and sales efforts.
The costs and other effects of these programs and activities are adversely
impacting current results for intended benefits of improving revenues, operating
performance and financial results in future reporting periods.
The following table shows the results of operations for the periods
indicated as a percentage of net sales and other revenue:
(Thousands of U.S. Dollars)
(Unaudited)
Three Months Ended
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March 31
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1996 1995
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Net sales and other revenues 100.0% 100.0%
Cost of sales 69.0% -
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Gross profit 31.0% 100.0%
Selling, general and administrative 85.2% 52.4%
Engineering and development 5.1% -
Interest expense 1.7% -
Amortization and depreciation 11.1% -
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Operating (loss) income (72.1%) 47.6%
Income (loss) from discontinued operations - 192.1%
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Income (loss) before income taxes (72.1%) 239.7%
Income tax benefit 15.6% -
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Net income (loss) for period (56.5%) 239.7%
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NET SALES
Net sales for the three months ended March 31, 1996 amounted to $3,372,000
and were comprised of information security products (53%) distributed by the
Company's U.K. based value added reseller, engineering service fees (38%) for
services provided by DNA from the date of acquisition (February 13, 1996) and
other products (9%). The Company's principal digital switch product line, S4o,
is commencing its sales cycle after the completion of its first major commercial
installation in Iceland in February 1996. Material sales from this product are
expected to be realized during the third and fourth quarters of 1996. The
Company's SONETLYNXo product line is being rolled out in the second quarter of
1996 with initial test orders of the first OC-1 version expected in the third
quarter of 1996. Material additional sales are expected to be generated upon the
completion of the OC-3 version targeted for the third quarter. No sales for the
MOSAICo product line were recorded because the acquisition was recently
completed on March 29, 1996. The Company believes this product line will to
generate sales during the balance of fiscal 1996.
GROSS PROFIT
The Company's gross profit of $933,000 or 31% for the three months ended
March 31, 1996 was below normal operating margins due to under absorption of
operating costs. The anticipation of increasing sales in the short-term
capabilities has necessitated the maintenance of core personnel in both
operations (manufacturing) and sustaining engineering. Management expects that
higher sales volumes in future quarters should reverse this phenomenon and
result in higher margins.
7
SELLING, GENERAL AND ADMINISTRATIVE (SG&A)
Marketing expenses relating to the rollout of the SONETLYNXo product line
and market development for the S4o in advance of sales amounted to $606,000.
Expenses relating to conversion of the Company to full S.E.C. reporting as a
U.S. domestic issuer and to the completion of two significant acquisitions, DNA
and MOSAIC, affected the expense levels adversely. Included in SG&A is $500,000
of non-recurring expenses related to the acquisition of MOSAIC. Prior year
administrative expenses reflect primarily traditional costs associated with the
Company's public status and related reporting requirements.
INTEREST EXPENSE
Interest expense represents interest on debt incurred to finance the
Company's acquisitions ($40,000) at a fixed rate of 6%. The Company has a line
of credit of $300,000 to finance receivables which bears interest at 12% and
which generated interest expense of $17,000.
AMORTIZATION AND DEPRECIATION
Amortization and depreciation is comprised of the following (thousands of
U.S. Dollars):
Depreciation of Property & Equipment $ 121
Amortization of Goodwill 243
Technology Amortization 25
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$ 389
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Goodwill is amortized over periods from 10 - 15 years. Goodwill arising
from the acquisitions of MOSAIC and DNA amounting to $4,375,000 and $7,280,000
respectively, has been amortized from the dates of acquisition.
ENGINEERING AND DEVELOPMENT (E&D)
E&D expenses for the three months ended March 31, 1996 were minimal (at
$177,000) due to the capitalization of expenditures relating to the S4o product
in accordance with the Company's policies (SEE ABOVE - NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS).
The Company capitalized $1,632,000 in E&D expenditures in the quarter.
INCOME TAX BENEFIT
The Company recorded a tax benefit for the loss during the quarter ended
March 31, 1996 of $553,000 primarily on the U.S. based operations. This benefit
reflects a tax rate of 34% and the Company's current belief that future taxable
income will be generated from reversals of existing taxable temporary
differences and sales of new and existing products. The timing and amount of
such future taxable income may be impacted by a number of factors, including
those discussed below under "Additional Factors That May Affect Future Results".
To the extent that estimates of future taxable income are reduced or not
realized, the amount of such deferred tax assets and the Company's effective tax
rate may be adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
The Company completed the acquisitions of DNA and MOSAIC in the quarter
ended March 31, 1996. These acquisitions used cash totaling $5,100,000,
including transaction related costs and expenses. The Company's working capital
was reduced from $14,626,000 at December 31, 1995 to $4,400,000 at March 31,
1996 due to these acquisitions, engineering and development (E&D) expenditures
and operating losses. The Company regularly reviews its cash funding
requirements on a consolidated basis and attempts to meet those requirements
through a combination of cash on hand, cash provided by operations and possible
future public or private debt and/or equity offerings. The Company utilizes a
centralized corporate strategy for its cash management activities and invests
its excess cash in investment grade short-term money market instruments.
8
The Company is considering financing alternatives to fund its medium and
longer-term financing requirements, including anticipated accounts receivable
and inventory requirements and future E&D needs. While the Company has, in the
past, been able to maintain access to adequate external financing sources on
favorable terms, no assurances can be given that such access will continue. If
the Company is unable to obtain short-term and long-term funding on favorable
terms from existing financing sources or through secure new sources, the
Company's ongoing operations would be adversely impacted.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
Future operating results may be impacted by a number of factors, including
worldwide economic and political conditions, industry specific factors, the
Company's ability to maintain access to external financing sources and its
financial liquidity, the Company's ability to timely develop and produce
commercially viable products at competitive prices, the availability and cost of
components, the Company's ability to manage expense levels, the continued
financial strength of the Company's dealers and distributors, and the Company's
ability to accurately anticipate customer demand.
The Company's future success is highly dependent upon its ability to
develop, produce and market products that incorporate new technology, are priced
competitively and achieve significant market acceptance. There can be no
assurance that the Company's products will be commercially successful or
technically advanced due to the rapid improvements ininformation technology and
resulting product obsolescence. There is also no assurance that the Company will
be able to deliver commercial quantities of new products in a timely manner. The
success of new product introductions is dependent on a number of factors,
including market acceptance, the Company's ability to manage risks associated
with product transitions, the effective management of inventory levels in line
with anticipated product demand and the timely manufacturing of products in
appropriate quantities to meet anticipated demand. Specifically, the Company has
committed approximately $10 million to the development of an advanced generation
of its S4o product for application in public telecommunications networks (the
"CS4"). The Company currently estimates that the CS4 will be available for
shipment in the third quarter of 1997. Potential customers for the CS4 are
expected to include InterExchange Carriers, Local Exchange Carriers, Wireless,
Personal Communications Service, Competitive Access Providers and, in general,
operators of Advanced Intelligent Networks. The Company will be competing with
established equipment manufacturers with greater financial resources and more
developed channels of distribution. No assurances can be given that the Company
will be successful in completing the CS4 on schedule, that the Company will be
successful in competing in this environment or that it will be able to sell
sufficient quantities of the CS4 to recover its investment or to realize
profits.
9
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
11 - Calculation of Earnings Per Share
24 - Financial Data Schedule
(b) Reports on Form 8-K:
On February 20, 1996, the Company filed a report on Form 8-K
reporting the acquisition of DNA Enterprises, Inc.
On April 12, 1996, the Company filed the audited financial
statements of DNA Enterprises, Inc. on Form 8-K/A to Current
Report on Form 8-K filed February 20, 1996.
On April 12, 1996, the Company filed a report on Form 8-K
reporting its acquisition of Mosaic Information Technologies, Inc.
10
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 thereunto duly authorized.
INTELECT COMMUNICATIONS SYSTEMS LIMITED
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(Registrant)
Date: May 14, 1996 /s/ RHIANON M. PEDRO
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Rhianon M. Pedro
Chief Financial Officer
(principal financial officer)
Date: May 14, 1996 /s/ PETER G. LEIGHTON
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Peter G. Leighton
President
11