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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 June 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 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
HM12
(Address of principal executive offices, zip code)
(441) 295-8639
(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
--- ---
There were 12,910,537 shares of the registrant's Common Stock, par value $.01
per share, outstanding on July 31, 1996.
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INTELECT COMMUNICATIONS SYSTEMS LIMITED
INDEX
PAGE
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets of the Company 2
(unaudited) at June 30, 1996 and December 31, 1995
Consolidated Statements of Operations of the Company 3
(unaudited) for the three and six months ended June 30, 1996 and 1995
Consolidated Statements of Cash Flows of the Company 4
(unaudited) for the three and six months ended June 30, 1996 and 1995
Notes to the Consolidated Financial Statements 5
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL 8
CONDITION AND RESULTS OF OPERATIONS
PART II OTHER INFORMATION
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 11
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 12
SIGNATURES
PART I - FINANCIAL INFORMATION
INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of U.S. Dollars)
(Unaudited)
June 30 December 31
1996 1995
------------------- ------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 3,083 $ 15,039
Marketable securities 85 -
Accounts receivable 2,603 1,375
Inventories 2,759 2,537
Prepaid expenses 439 406
Other current assets 117 -
Loan receivable - 600
------------------- ------------------
9,086 19,957
Property and equipment - net 4,150 1,839
Excess of cost over net assets of companies acquired 19,967 8,685
Software development costs 1,765 -
Deferred financing costs 1,318 -
Deferred income taxes 2,033 -
Other intangible assets 4,611 758
------------------- ------------------
$ 42,930 $ 31,239
=================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,498 $ 1,680
Accrued liabilities 1,701 1,989
Net liabilities of discontinued operations 401 476
Current installments of obligations under capital leases 177 145
Current maturities of long-term debt 3,848 1,041
------------------- ------------------
8,625 5,331
Long-term obligations under capital leases,
net of current maturities 195 200
Long-term debt, net of current maturities 4,010 168
Convertible Debentures 5,028 -
------------------- ------------------
17,858 5,699
------------------- ------------------
SHAREHOLDERS' EQUITY:
Common shares, $0.01 par value,
80,000,000 shares authorized.
12,885,537 issued and outstanding at June 30, 1996
(December 31,1995 - 11,385,117) 129 114
Share premium 18,020 11,673
Unrealized gain on marketable securities 31 -
Retained earnings - since November 1, 1992 6,892 13,753
------------------- ------------------
25,072 25,540
------------------- ------------------
$ 42,930 $ 31,239
=================== ==================
2
INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Thousands of U.S. Dollars, except share data)
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
------------------ ------------------
1996 1995 1996 1995
---- ---- ---- ----
STATEMENT OF OPERATIONS
Revenues:
Net sales $ 1,147 $ 613 $ 3,225 $ 613
Services 769 -- 2,063 --
Interest and other income 128 30 291 56
-------- -------- -------- --------
2,044 643 5,579 669
-------- -------- -------- --------
Costs and expenses:
Cost of sales 2,561 504 5,000 504
Interest 110 2 167 2
Selling, general and administrative 4,130 646 7,531 612
Engineering and development 1,816 490 1,993 490
Equity in loss of investee -- 280 -- 280
-------- -------- -------- --------
8,617 1,922 14,691 1,888
-------- -------- -------- --------
Loss from continuing operations
before income taxes (6,573) (1,279) (9,112) (1,219)
Income tax benefit 1,708 -- 2,261 --
-------- -------- -------- --------
Loss from continuing operations (4,865) (1,279) (6,851) (1,219)
Discontinued operations:
Income (loss) from discontinued operations -- 832 (9) 1,074
-------- -------- -------- --------
Loss before extraordinary item (4,865) (447) (6,860) (145)
Equity in extraordinary gain of investee -- 646 -- 646
-------- -------- -------- --------
Net income (loss) for period $ (4,865) $ 199 $ (6,860) $ 501
======== ======== ======== ========
EARNINGS PER SHARE
Primary and fully diluted earnings
Income (loss) per share
Continuing operations $ (0.36) $ (0.11) $ (0.52) $ (0.11)
Discontinued operations $ -- $ 0.07 $ -- $ 0.09
-------- -------- -------- --------
Loss before extraordinary item $ (0.36) $ (0.04) $ (0.52) $ (0.02)
-------- -------- -------- --------
Extraordinary item $ -- $ 0.06 $ -- $ 0.06
-------- -------- -------- --------
Net income (loss) for period $ (0.36) $ 0.02 $ (0.52) $ 0.04
======== ======== ======== ========
WEIGHTED AVERAGE NUMBER OF SHARES AND
COMMON STOCK EQUIVALENTS OUTSTANDING
(IN THOUSANDS) 13,317 11,415 13,162 11,402
======== ======== ======== ========
INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of U.S. Dollars, except share data)
(Unaudited)
Six Months Ended June 30
------------------------------------------------
1996 1995
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) for period $ (6,860) $ 501
Adjustments to reconcile net income to net cash used in operating activities:
Equity in income of investee - net -- (366)
Depreciation and amortization 1,079 134
(Income) loss from discontinued operations 9 (1,074)
Foreign exchange translation 14 --
Noncash compensation 239 --
Noncash financing costs 61 --
Noncash compensation on acquisition of Mosaic Technologies Inc. 500 --
Noncash interest 9 --
Changes in operating assets and liabilities:
Accounts receivable (595) (257)
Inventories 85 351
Other assets (95) (116)
Deferred tax benefit (2,261) --
Deferred charges (1,764) --
Deferred financing costs (294) --
Accounts payable and accrued liabilities 61 (1,913)
Net liabilities of discontinued operations (75) 114
Noncash adjustment to goodwill (77) 306
-------- --------
Net cash used in operating activities (9,964) (2,320)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in discontinued operation -- (1,560)
Capital expenditures (2,138) (36)
Purchase of marketable securities (55) --
Investment in and advances to Intelect -- --
Investment in other assets (1,276) (406)
Loan receivable 600 --
Proceeds on sale of fixed assets 57 --
Acquisition of Intelect, Inc. -- (632)
Acquisition of DNA Enterprises, Inc. (3,010) --
Acquisition of Mosaic Information Technologies Inc. (2,004) --
-------- --------
Net cash used in investing activities (7,826) (2,634)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible debentures 5,000 --
Proceeds from issuance of notes payable -- 10,502
Payments on notes payable (880) (6,032)
Proceeds from issuance of capital leases 79 10
Payments on capital lease obligations (59) (42)
Payment of long-term debt (119) --
Proceeds from issuance of common shares 1,813 193
Quasi-reorganization -- 499
-------- --------
Net cash provided by financing activities 5,834 5,130
-------- --------
Net increase (decrease) in cash and cash equivalents (11,956) 176
Cash and cash equivalents, beginning of period 15,039 2,555
-------- --------
Cash and cash equivalents, end of period $ 3,083 $ 2,731
======== ========
INTELECT COMMUNICATIONS SYSTEMS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 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
During 1995, 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, September 30 and December 31.
On October 31, 1995 the Company sold its prior principal operating
subsidiary, Savage Corporation ("Savage"). Accordingly, Savage results are
accounted for as discontinued operations 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.
OTHER INTANGIBLE ASSETS
Other Intangible Assets include licensed technology of $3,500,000 of which
$625,000 was paid in June, 1996 with the balance due in quarterly installments,
in arrears, from September, 1996. The licensed technology is carried at its
present value with an imputed interest rate of 7% on the deferred balance and
will be amortized over a three year period to costs of good sold based on
anticipated revenue generation.
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. 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 below. Adjustments made during the second quarter to
certain Mosaic assets and Goodwill are included (thousands of U.S. Dollars):
June 30
-------------------------------------
Mosaic DNA
------ ---
Cash $ (6) $ 3
Accounts receivable 55 621
Inventory 245 -
Property and equipment 81 502
Goodwill 4,675 7,280
Accounts payable and accruals (285) (214)
Debt (16) (180)
---------------- ----------------
$ 4,749 $ 8,012
================ ================
Long-term Debt (thousands of U.S. Dollars)
June 30 December 31
---------------- ----------------
1996 1995
---- ----
Subordinated debentures - at 6% due in five equal
annual installments starting June 1996 $ 216 $ 224
Deferred purchase price payment due in
installments on February 1997 and 1998 (i) 5,000 -
Present value of license technology installment
payments due in quarterly amounts of $325,000
commencing September, 1996 (ii) 2,642 -
Other
- 985
---------------- ----------------
7,858 1,209
Less: current installments (3,848) (1,041)
---------------- ----------------
$ 4,010 $ 168
================ ================
Notes:
(i) Deferred purchase price payments relate to the
acquisition of DNA Enterprises, Inc. (a) $1,000,000 in
cash on February 13, 1997; (b) $400,000 in cash on
February 13, 1998; (c) Warrants issued to certain
shareholders of DNA to purchase 300,000 Common Shares at
$5.00 per share February 13, 1996; and (d) Warrants to be
issued to certain shareholders of DNA to purchase a
further 300,000 Common Shares at $7.00 per share on the
second anniversary of Closing. The Company has agreed to
repurchase the Common Shares issued pursuant to the
warrants under (c) and (d) above at prices of $5.00,
$5.50 and $6.00 per share on the first, second and third
anniversary of Closing, respectively, at the option of
the selling shareholders and a liability of $3,600,000
has been accrued for in anticipation of this Put option.
(ii) $3,500,000 of which $625,000 was paid in June, 1996. The
balance is payable quarterly, in arrears, in installments
of $325,000 from September, 1996.
CONVERTIBLE DEBENTURES
During the quarter ended June 30, 1996, the Company issued Convertible
Debentures (the "June Debentures") in the aggregate principal amount of
$5,000,000 bearing interest at 7.5% payable quarterly in arrears. The June
Debentures mature on June 7, 1998, are redeemable for cash at the Company's
option at 117.5% of their face value and are convertible at the holder's option
into common shares at 82.5% of the NASDAQ trading price on conversion. One half
of the aggregate principal amount of the June Debentures are currently
convertible into Common Shares with the balance convertible after September 5,
1996.
The Company may require the holders of the June Debentures to purchase an
additional $5,000,000 on substantially the same terms as the June Debentures and
the holders have the right to require the Company to issue such additional
debentures, however, the Company will not be required to issue such debentures
if the Company has filed a registration statement with the SEC on or before
October 1, 1996 for the issuance of common shares and, in the opinion of
investment bankers engaged for that purpose, the issuance of debentures would
materially adversely affect the proposed offering.
6
SOFTWARE DEVELOPMENT COSTS
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
involve judgment by management with respect to certain external factors,
including, but not limited to, anticipated future revenues, estimated economic
life and possible developments 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, S4o and Mosaic
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):
June 30 December 31
---------------- ----------------
1996 1995
---- ----
Raw materials $ 2,113 $ 1,554
Work in progress 322 544
Finished goods 974 1,169
---------------- ----------------
3,409 3,267
Less: allowance for obsolescence 650 730
---------------- ----------------
$ 2,759 $ 2,537
================ ================
ACCOUNTING FOR WARRANTS
In October, 1995 the Financial Accounting Standards Board issued Statement
123 ("FAS 123") "Accounting for Stock-Based Compensation", which requires
companies to value all options and warrants issued for compensation at their
"fair value" at the date of issuance. FAS 123 affects all companies whose
financial years begin after December 15, 1995. The Statement establishes
financial accounting and reporting standards for stock based employee
compensation plans and encourages, but does not require, all entities to adopt a
fair value based method of accounting for employee stock option plans. The
Company has elected to continue accounting for its stock based employee
compensation plans in accordance with the intrinsic value based method of
accounting.
The effect of this new accounting standard is twofold (i) all employee
stock options must be valued and disclosed on a pro-forma basis in note form in
the year end financial statements and (ii) all warrants and options granted for
services must be valued on a call option basis and expensed accordingly. The
pricing model used in this calculation, Black-Scholes Model, makes certain
assumptions about the underlying stock based primarily on its past performance
to determine future performance.
During the second quarter 1996, the Company issued certain warrants to
third parties as partial payment of financial advisory fees in connection with
the June Debentures. These warrants were issued to third parties as part payment
of a finders fee and entitle the holders to purchase a total of 125,000 of the
Company's common shares at a price of $13.1875 per share. Using the prescribed
Black-Scholes Model the value placed on these warrants is $1,058,000. This
amount , together with other debt issue costs of $303,000 are being amortized to
financing expense over the life of the June Debentures or until conversion takes
place at which time these costs will be debited to paid in capital.
SUBSEQUENT EVENTS
On August 8, 1996 (the "Issuance Date") the Company issued an additional
$10,000,000 in Convertible Debentures (the "August Debentures") due on August 8,
1998, bearing interest at 7.5% and the principal amount of which is convertible
into common shares in equal one-third amounts sixty, ninety and one hundred
twenty days after the Issuance Date at the lower of (i) 15% discount to the
average five day closing bid price on NASDAQ prior to the Notice of Conversion
date and (ii) the fixed price conversion of $11.0825, subject to a maximum of
2,602,107 shares. In the event that the conversion price would result in a
higher number of shares the Company would be required to seek shareholder
approval to issue additional shares or to redeem the unconverted debentures for
cash in an amount equal to 125% of their face value. If shareholder approval is
not obtained and the Company is unable to redeem the debenture balance, the
Company is subject to a penalty of $500 per day, per million, of the remaining
principal amount of the August Debentures.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE PERIOD ENDED JUNE 30, 1996
RESULTS OF OPERATIONS
The Company is transitioning through a period of consolidating and
integrating newly acquired operations, bringing to market innovative new
products, implementing 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.
During the period ended June 30, 1995, the Company completed its purchase
of Intelect, Inc. and included the results of Intelect, Inc. from date of
acquisition April 24, 1995, but had not yet acquired DNA Enterprises, Inc.
("DNA") or Mosaic Information Technologies Inc.("Mosaic"). Management does not
consider that comparisons of the current period to the same period in 1995 would
be meaningful in determining a trend.
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 Six Months Ended
June 30 June 30
------------------------------------- ------------------------------------
1996 1995 1996 1995
------------------------------------- ------------------------------------
Net sales, services and other revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales 125.3% 78.4% 89.6% 75.3%
------------------ ------------------ ----------------- -----------------
Gross profit (25.3%) 21.6% 10.4% 24.7%
Selling, general and administrative 168.3% 79.6% 115.7% 71.5%
Engineering and development 88.9% 76.0% 35.7% 73.1%
Interest expense 5.4% .5% 3.0% .5%
Amortization and depreciation 33.8% 20.8% 19.3% 20.0%
Equity in loss of investee .0% 43.6% .0% 41.9%
------------------ ------------------ ----------------- -----------------
Operating (loss) income before income taxes (321.7%) (198.9%) (163.3%) (182.3%)
Income (loss) from discontinued operations .0% 129.5% (.2%) 160.5%
------------------ ------------------ ----------------- -----------------
Income (loss) before extraordinary item (321.7%) (69.5%) (163.5%) (21.7%)
Equity in extraordinary gain of investee .0% 100.5% .0% 96.6%
------------------ ------------------ ----------------- -----------------
Income (loss) before income taxes (321.7%) (31.0%) (163.5%) (74.9%)
------------------ ------------------ ----------------- -----------------
NET SALES AND SERVICES
Net sales and services revenue for the three months ended June 30, 1996
increased 213% to $1,916,000 from $613,000 in the three month period ended June
30, 1995. For the three months ended June 30 1996 and 1995 respectively, these
sales were comprised of (i) S4o product of 7.2% and 27.1%, manufactured by
Intelect, Inc., (ii) information security products 6.8% and 0%, distributed by
the Company's U.K. based value added reseller, (iii) engineering service fees of
40.1% and 0% , for services provided by DNA, (iv) videoconferencing sales of
1.5% and 0% through Mosaic from the date of acquisition (March 29, 1996) and (v)
other products 44.4% and 72.9%, consisting primarily of analog air traffic
control communications switching systems.
The sales cycle for the Company's new digital switch product line, S4o,
effectively commenced with customer acceptance for its first major commercial
installation in Iceland in February 1996. This installation went "live" during
the third week of July and is functioning on a stand alone basis. The Company
currently expects increased sales of this product during the second half of 1996
and thereafter.
Initial releases of the Company's new SONETLYNX product line were
introduced during the second quarter of 1996. Customer demonstrations, tests and
initial orders of the OC-1 version are underway into the second half of 1996.
Primary emphasis is being placed upon establishing distribution arrangements and
sales channels. Increased sales are expected during the second half of 1996 and
upon completion of the OC-3 version targeted for release during the fourth
quarter of 1996.
8
The Company also expects to realize increased revenues from its sales of
videoconferencing products during the second half of 1996. These products became
commercially available during the second quarter of 1996. Marketing, sales and
service organizations were hired and focused concurrently. Material sales
possibilities are being developed through demonstrations, tests and pilot
programs with customers in the principal category of "Fortune 2000" companies
with established networks and defined applications. Initial sales may vary
materially from quarter to quarter.
Information security products are sold primarily to the military market
which is influenced by unpredictable events and budgetary constraints which
cause significant variances in sales from quarter to quarter. The operation that
has marketed these products in the past is being restructured to emphasize sales
of the Company's newly developed SONETLYNX and video-conferencing product lines.
GROSS PROFIT
The Company's gross loss of $517,000 or (25.3%) for the three months ended
June 30, 1996 was a decrease of $656,000 compared to a gross margin of $139,000
or 21.6% for the three months ended June 30, 1995. The second quarter 1996
result was below normal operating margins due to under absorption of operating
costs and the initial placement or sale of new products as test modules with low
or negative margins. In addition, the anticipation of increasing sales in the
short-term and the development of scheduled product releases has necessitated
the hiring and maintenance of core personnel in both operations (manufacturing)
and sustaining engineering. Management expects that higher sales volumes in
future quarters should result in higher margins.
The Company's hardware and software design and development subsidiary DNA
has currently committed over half of its personnel resources to the Company's
CS4 project in order to expedite the completion of a demonstration prototype of
the CS4, scheduled for November, 1996. DNA's profit on the CS4 project is
eliminated on consolidation.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A)
For the three months ended June 30, 1996 SG&A expenses were up $2,928,000
at $3,440,000 or 168.3% from $512,000 or 79.6% compared with the three months
ended June 30, 1995. This increase is due in part to the acquisitions of new
business and ramp up in staffing for the selling, marketing and manufacturing of
the Company's products. Selling and marketing expenses for the three months
ended June 30, 1996 increased 509% to $1,479,000 compared with $243,000 for the
same period 1995. G&A expenses were up 629% at $1,961,000 compared with $269,000
for the same period 1995.
Marketing expenses relating to the rollout of the SONETLYNX product line
and initial marketing for the CS4 in advance of sales amounted to $372,000.
Marketing expenses relating to the Company's videoconferencing product line in
advance of sales amounted to $247,000. Marketing expenses relating to the market
development of the Company's product into the European market amounted to
$278,000. In addition, the Company expensed $157,000 and $202,000 on demo units
and trade shows, respectively.
Prior year administrative expenses reflect traditional costs primarily
associated with the Company's public status and related reporting requirements.
However, legal and audit have increased substantially from prior years and are
expected to continue in a similar trend. Deferred financing costs associated
with the Company's issuance of the June Debentures amounted to $303,000 in cash
expenditures and $1,058,000 in non-cash costs related to the issuance of
warrants pursuant to FAS 123, which are being amortized over the life of the
June Debentures.
INTEREST EXPENSE
Interest expense increased to $110,000 or 5.4% from $3,000 or .5% for the
three months ended June 30, 1996 and 1995 respectively. The current quarter
amount represents interest on (i) debt at a fixed rate of 6% generating $13,000
for the three months ended June 30, 1996, incurred to finance the Company's
acquisitions, which was retired on June 27, 1996, (ii) a line of credit of
$300,000 to finance receivables which bears interest at 12% generating $19,000;
(iii) Debentures owed to the previous owners of Intelect, Inc., which bears
interest at 7.5% generating $22,000, (iv) Convertible Debentures issued by the
Company in June, 1996, which bears interest at 7.5% generating $18,000; (v)
non-cash interest of $28,000 being the 17.5% redemption premium of the June
Debentures, which is being amortized over the life of the June Debentures
pursuant to APB 21; and (vi) capital leases of $12,000.
9
AMORTIZATION AND DEPRECIATION
Amortization and depreciation is comprised of the following (thousands of
U.S. Dollars):
Three Months Ended Six Months Ended
June 30 June 30
------------------------------ ------------------------------
1996 1995 1996 1995
---- ---- ---- ----
Depreciation of Property & Equipment $ 219 $ 27 $ 340 $ 27
Amortization of Goodwill 446 107 689 107
Technology Amortization 25 - 50 -
-------------- -------------- -------------- --------------
$ 690 $ 134 $ 1,079 $ 134
============== ============== ============== ==============
Depreciation of property and equipment has increased in part to the recent
acquisitions. Goodwill is amortized over periods from 10 - 15 years and has also
increased due to the acquisitions of DNA and Mosaic. Technology amortization is
for intellectual property purchased in 1995.
ENGINEERING AND DEVELOPMENT (E&D)
E&D expenses for the three months ended June 30, 1996 were $1,816,000 or
88.9% up from $489,000 or 76.0% for the three months ended June 30, 1995. This
expense is comprised primarily of hardware labor costs that are not
capitalizable under FAS 86 for the CS4 ($804,000) and SONETLYNX ($572,000)
products in accordance with the Company's policies. The balance of $440,000
relates to further development of the Company's videoconferencing ($333,000) and
S4o, ($107,000) products. This compares with E&D expense for the same period in
1995 of $369,000 and $120,000 on the S4o and SONETLYNX products, respectively.
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
The Company sold Savage Corporation ("Savage") on October 31, 1995. The
results of Savage are accounted for as discontinued operations and accordingly
comparative presentations reflect the Company's equity in the earnings of Savage
for the relevant periods. This disposition accounts for the decrease in income
in the three months ended June 30, 1996 to $nil from $832,000 for the same
period in 1995.
INCOME TAX BENEFIT
The Company recorded a tax benefit for the loss during the quarter ended
June 30, 1996 of $1,708,000 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's working capital decreased $13,515,000 at June 30, 1996 to
$1,111,000 compared with $14,626,000 at December 31, 1995 due primarily to the
Company's acquisitions of DNA and Mosaic and to the funding of E&D programs 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.
The Company believes that the cash proceeds from the issuance of the June
Debentures and August Debentures together with the $5,000,000 from the
additional debentures will be sufficient to meet its capital requirements for
the next twelve months. Sales of substantial amounts of common shares, or the
perception that these sales could occur, could adversely affect prevailing
market prices
10
for the common shares and could impair the ability of the Company to raise
additional capital through the sale of its equity securities or through debt
financing.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
This Form 10-Q contains certain forward looking-statements within the
meaning of Section 27A of the Securities Exchange Act of 1933, as amended and
Section 21E of the Securities Exchange Act of 1934 as amended. Actual events and
results could differ materially from those set forth in the forward-looking
statements. Certain factors that may cause such differences include 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 Company's ability to manage
growth, 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 in information 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. In addition, no prediction can be made as to the affect, if any, that
future sales of common shares issued pursuant to the June and August Debentures
will have on the market price of the common shares prevailing from time to time.
PART 2. OTHER INFORMATION
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 1996 Annual General Meeting of the Shareholders of the Company, held
on June 26, 1996, the maximum number of six directors was approved, three
directors were elected and the auditors for the ensuing year were appointed. The
tabulation of the vote was as follows:
Shares Shares Shares
Voted For Withheld Against
--------- -------- -------
Directors
- ---------
Fixing the maximum number of directors at six 8,524,345 3,973,935 27,257
Directors
- ---------
Anton von Liechtenstein 8,566,205 3,945,973 13,359
Jeremy T.G. Posner 8,566,205 3,945,973 13,359
Wendell M. Hollis 8,566,205 3,945,973 13,359
Appointment of Auditors
- -----------------------
Appointment of KPMG Peat Marwick ("KPMG") of
Hamilton, Bermuda as auditors for the ensuing year 8,568,153 3,957,384 -
11
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS.
4 Form of 7.5% Convertible Debenture due June 7, 1998 of Intelect
Communications Systems Limited
10(i) Convertible Securities Agreement dated June 7, 1996 among the
Company and Infinity Investors, Ltd. ("Infinity") and
Seacrest Capital Limited ("Seacrest")
10(ii) Registration Rights Agreement among Intelect Communications
Systems Limited and Infinity Investors, Ltd. and Secrest
Capital Limited
10(iii) Letter Agreement, dated July 31, 1996 among the Company, Infinity
and Seacrest
11 Calculation of Earnings Per Share
27 Financial Data Schedule
(B) REPORTS ON FORM 8-K:
On June 3, 1996, the Company filed the audited financial statements of
Mosaic Information Technologies, Inc. on Form 8-K/A to Current Report on
Form 8-K filed April 12, 1996.
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
---------------------------------------
(Registrant)
Date : August 14, 1996 /s/ RHIANON M. PEDRO
------------------- -------------------------
Rhianon M. Pedro
Chief Financial Officer
(principal financial officer)
Date: August 14, 1996 /s/ PETER G. LEIGHTON
-------------------- --------------------------
Peter G. Leighton
President
12