U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
Commission file number 0-20462
CHATCOM, INC.
(Exact name of small business issuer as specified in its charter)
CALIFORNIA 95-3746596
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9600 TOPANGA CANYON BOULEVARD, CHATSWORTH, CALIFORNIA 91311
(Address of principal executive offices)
818/709-1778
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [_]
As of August 8, 1997, there were 9,896,824 shares of the issuer's common
stock issued and outstanding.
Transitional Small Business Disclosure Format: Yes [_] No [X]
Exhibit Index on Page 13
Page 1 of 13
CHATCOM, INC.
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
BALANCE SHEETS (UNAUDITED) (IN THOUSANDS)
- ----------------------------------------------------------------------------------------
June 30, March 31,
ASSETS NOTES 1997 1997
--------- ---------- -----------
CURRENT ASSETS:
Cash $ 200 $ 1,169
Accounts receivable, net of allowances of $139
(June 30, 1997) and $109 (March 31, 1997) 3,369 1,334
Inventories 2 3,334 2,721
Prepaid expenses and other current assets 118 108
-------- --------
Total current assets 7,021 5,332
EQUIPMENT AND FIXTURES, Net 3 716 651
DEPOSITS 24 24
-------- --------
TOTAL $ 7,761 $ 6,007
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,491 $ 1,427
Accrued expenses 495 687
Convertible subordinated debt 5 350
Current portion of capital lease obligations 20 23
-------- --------
Total current liabilities 4,356 2,137
CAPITAL LEASE OBLIGATIONS
-less current portion 7 12
SHAREHOLDERS' EQUITY 4
Preferred stock, no par value;
authorized 1,000,000 shares;
Series D Preferred Stock, $1,000 stated value
per share, authorized 5,000 shares, issued and
outstanding 2,496 shares at June 30, and
March 31, 1997 1,407 1,407
Common stock, no par value; authorized
25,000,000 shares; issued and outstanding
9,896,824 shares at June 30, 1997
and 9,826,892 shares at March 31, 1997 10,215 10,090
Additional paid-in capital 2,404 2,404
Accumulated deficit (10,628) (10,043)
-------- --------
Total shareholders' equity 3,398 3,858
-------- --------
TOTAL $ 7,761 $ 6,007
======== ========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
Page 2 of 13
CHATCOM, INC.
STATEMENTS OF OPERATIONS (unaudited) (in thousands, except share
and per share data)
- -------------------------------------------------------------------------
Three Months Ended
June 30,
1997 1996
---------- -----------
SALES $ 4,459 $ 2,684
COST OF GOODS SOLD 2,856 1,814
---------- -----------
GROSS PROFIT 1,603 870
OPERATING EXPENSES
Selling 1,069 742
General and administrative 463 507
Research and development 599 197
Severance 61
---------- -----------
Total operating expenses 2,131 1,507
LOSS FROM OPERATIONS (528) (637)
INTEREST INCOME 7 16
INTEREST EXPENSE 1 9
---------- -----------
LOSS BEFORE
INCOME TAXES (522) (630)
PROVISION FOR INCOME TAXES 1
---------- -----------
NET LOSS (523) (630)
DIVIDENDS ON PREFERRED STOCK (62) (725)
---------- -----------
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS $ (585) $ (1,355)
========== ===========
NET LOSS PER SHARE $ (0.06) $ (0.18)
========== ==========
Weighted average number of Common Shares 9,862,242 7,721,889
========== ==========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
Page 3 of 13
CHATCOM, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
- --------------------------------------------------------------------------------
Three Months Ended
June 30,
1997 1996
-------- --------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss $ (523) $ (630)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 86 56
Provision for losses on accounts receivable 30 19
Provision for inventory obsolescence (106) 90
Changes in operating assets and
liabilities:
Restricted cash 500
Accounts receivable (2,065) 351
Inventories (507) 15
Prepaid expenses and other
current assets (10) 17
Deposits (2)
Accounts payable 2,064 (476)
Accrued expenses (129) (125)
------- ------
Net cash used in operating
activities (1,160) (185)
CASH FLOWS FROM INVESTING
ACTIVITIES:
Capital expenditures (151) (56)
------- ------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Principal payments on notes payable (938)
Principal payments on capital leases (8) (10)
Proceeds from sale of preferred stock 1,325
Payment of dividends on preferred stock (8)
Issuance of convertible subordinated debt 350
Exercise of stock options and warrants 851
------- ------
Net cash provided by financing activities 342 1,220
------- ------
NET (DECREASE) INCREASE IN
CASH (969) 979
CASH, BEGINNING OF PERIOD 1,169 1,067
------- ------
CASH, END OF PERIOD $ 200 $2,046
======= ======
(CONTINUED)
Page 4 of 13
CHATCOM, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED) CONTINUED
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
During the three months ended June 30, 1997 and 1996, the Company paid
interest of $1,000 and $9,000, respectively, and taxes of $1,000 and $1,000,
respectively.
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the three months ended June 30, 1997 and 1996, the Company accrued
dividends payable on preferred stock of $62,000 and $30,000, respectively.
During the three months ended June 30, 1996, the Company recognized preferred
stock dividends of $688,000 as a result of the beneficial conversion features
of the Series B Preferred Stock and Series C Preferred Stock, which resulted
in an increase in accumulated deficit of $688,000 and an increase in Common
Stock of $688,000.
During the three months ended June 30, 1997, the Company issued 69,932 shares
of Common Stock in payment of accrued dividends of approximately $125,000 on
the Series D Preferred Stock, which resulted in an increase in Common Stock of
$125,000 and a decrease in accrued expenses of $125,000.
During the three months ended June 30, 1996 the Company entered into a capital
lease agreement for equipment with costs of $22,000.
(CONCLUDED)
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
Page 5 of 13
CHATCOM, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1997
1. ACCOUNTING POLICIES
The unaudited financial statements presented herein have been prepared by
ChatCom, Inc. (the "Company") in accordance with the accounting policies
described in its 1997 audited financial statements and should be read in
conjunction with the notes thereto. In the opinion of management, all
adjustments that are necessary to present fairly the Company's financial
position for the interim periods presented (consisting only of normal
recurring adjustments), have been made.
The results of operations for the three month period ended June 30, 1997,
are not necessarily indicative of the results that may be expected for the
full fiscal year ending March 31, 1998.
2. INVENTORIES
The components of inventories are as follows:
June 30,
1997
----------
Raw materials $1,037,000
Work in process 1,532,000
Finished goods 1,601,000
----------
Inventory at cost 4,170,000
Less: Reserve for obsolescence 836,000
----------
$3,334,000
==========
Page 6 of 13
CHATCOM, INC.
3. EQUIPMENT AND FIXTURES
Equipment and fixtures consist of the following:
June 30,
1997
-----------
Equipment $1,140,000
Software 138,000
Furniture and fixtures 183,000
Leasehold improvements 89,000
----------
1,550,000
Less: accumulated depreciation (834,000)
----------
Equipment and Fixtures, net $ 716,000
==========
4. STOCK OPTIONS AND WARRANTS
During the fiscal quarters ended June 30, 1997 and 1996, the Company
granted options to purchase 58,333 and 250,000 shares of common stock,
respectively, to key employees pursuant to the Company's 1994 Stock Option Plan.
The options vest over a period of three years and are exercisable at the closing
price of the common stock on the date of grant.
5. CONVERTIBLE SUBORDINATED DEBT
During May 1997, the Company was advanced $350,000 by an investor upon
the Company's agreement to issue shares of a to be authorized Series E Preferred
Stock (the "Series E Preferred Stock") or a 10% convertible subordinated note.
Although the terms of the Series E Preferred Stock have not been finalized, the
Company anticipates that the Series E Preferred Stock, if issued, is likely to
have terms similar to the Series D Preferred Stock, but with different
conversion and repurchase options and different conversion and exercise prices.
6. RELATED PARTIES
One of the officers of the Company is also a shareholder of a law firm
that provides legal consultation to the Company. At June 30, 1997 and 1996, the
Company owed this law firm $12,000 and $7,000, respectively. During the three
months ended June 30, 1997 and 1996, fees relating to services provided by this
law firm in the amounts of $10,000 and $20,000, respectively, were included in
operating expenses.
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Page 7 of 13
CHATCOM, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THE
THREE MONTHS ENDED JUNE 30, 1996
The Company continued to invest heavily in marketing and product
development thru the quarter. Significant new account penetrations and orders
for RAINS(TM) (or completely integrated consolidated server/storage) systems
which have long and large follow on potential have continued to dominate the
Company's activities. However, the Company is investing ahead of its
profitability in order to position itself at the forefront of the market that it
is a catalyst in developing.
The Company recorded a net loss $523,000 for the quarter ended June 30,
1997 on revenues of $4,459,000 due an increase in international orders as
compared to a net loss of $630,000 on revenues of $2,684,000 for the quarter
ended June 30, 1996.
Sales increased $1,775,000, or 66% from $2,684,000 to $4,459,000 due an
increase in International orders. The increase in sales is a result of the
redirection of the Company's marketing efforts towards the server consolidation
and network emulation markets. The Company believes that its penetration into
these new markets will continue to positively affect revenue levels during the
fiscal year ending March 31, 1998. During the quarter ended June 30, 1997 a new
International customer accounted for 62% of the Company's sales.
Cost of goods sold increased $1,042,000, or 57%, from $1,814,000 to
$2,856,000. The increase was primarily due to the increase in material costs
related to the increase in revenues. Offsetting the increase in material costs
was a $106,000 decrease in inventory obsolescence reserve during the quarter
ended June 30, 1997, due to the sale of previously reserved inventory, as
compared to a $90,000 increase during the quarter ended June 30, 1996. In
addition, manufacturing labor and overhead increased $83,000 primarily due to
the decrease in capitalized overhead.
Selling expenses increased $327,000, or 44%, from $742,000 to
$1,069,000. The increase is the result of an increase in salaries and related
costs, commissions, travel and trade shows, advertising and promotions. Salaries
and related costs increased $114,000 primarily due to the addition of four new
employees and salary increases. Commission increased $39,000 due to a new
commission structure along with higher revenues for the quarter. Travel and
trade shows increased $65,000 primarily due to the Company's expanded presence
at industry trade shows. Advertising and promotions increased $91,000 due to
increased advertising in industry magazines and increased customer promotions.
General and administrative expenses decreased $44,000, or 9%, from
$507,000 to $463,000. The decrease relates primarily to reductions in legal fees
and consulting expense of $23,000 and $26,000, respectively.
Research and development increased $402,000, or 204%, from $197,000 to
$599,000. The increase was primarily attributable to the Company's concerted
effort to decrease development time and increase pre-production product testing.
This effort resulted in increases in salaries and related costs, consulting and
prototype expenses. Salaries and related costs increased $259,000 due to the
addition of six engineers and two support personnel. Consulting and prototype
expenses increased $130,000 and $76,000, respectively.
In June 1996, the Company recorded severance expense of $61,000 related
to the implementation of a plan, which was completed in July 1996, to reduce the
workforce by approximately 20% in connection with a restructuring of the
Company's manufacturing operation to allow for an increase in outsourced
manufacturing and an overall streamlining of the management structure. The
Company did not record any severance expense in the first quarter ended June 31,
1997.
Subsequent to June 30, 1997, the Company reduced its workforce by
thirteen permanent employees and six temporary employees. The estimated annual
savings in salaries and related taxes and benefits from this reduction is
$900,000.
Page 8 of 13
CHATCOM, INC.
FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION DURING THE THREE MONTHS
ENDED JUNE 30, 1997
The Company recorded a net loss of approximately $523,000 for the three
months ended June 30, 1997. Cash decreased $969,000 primarily due to negative
cash flow from operations of $1,160,000. Additionally, $151,000 of cash was
expended for the purchase of capital assets that are used in operations. The
negative operating cash flow was primarily the result of the net loss of
$523,000 and changes in operating assets and liabilities. Working capital
decreased approximately $530,000 which resulted in the issuance of $350,000 of
convertible subordinated debt. Additionally, accounts payable and accrued
expense increased $1,872,000 as compared to an increase in current assets of
only $1,689,000, which is also a result of the Company's liquidity problem.
Accounts receivable increased $2,035,000, or 153%, from $1,334,000 to
$3,369,000. The increase was primarily attributable to shipments representing
approximately 56% of the quarter's revenues occurring in late June 1997. A new
International customer represented 75% of the outstanding accounts receivable
balance at June 30, 1997 due to the late June to that Customer.
Inventories increased $613,000, or 23%, from $2,721,000 to $3,334,000.
The increase was primarily the result of a build-up of inventories to meet
realized and anticipated revenue growth, as the Company continues to penetrate
the server consolidation and network emulation markets. Additionally, the
Company reduced its reserve for obsolescence by $130,000, or 13%, from $964,000
at March 31, 1997 to $834,000 at June 30, 1997 primarily due to the sale of
previously reserved inventory during the quarter.
Equipment and fixtures increased $65,000, or 10%, due to the acquisition
of equipment that cost $151,000, which was partially offset by depreciation of
$86,000. The purchased equipment primarily consisted of test equipment.
Accounts payable increased $2,064,000, or 145%, from $1,427,000 to
$3,491,000. Increases in inventory to meet anticipated revenue growth
contributed to the increase.
Accrued expenses decreased $192,000, or 28%, from $687,000 to $495,000.
The decrease was primarily due to decreases in accrued salaries and executive
compensation of $110,000 and the payment of accrued preferred stock dividends of
$125,000, which was partially offset by the accrual of approximately $62,000 of
dividends on preferred stock.
Convertible subordinated debt increased by $350,000 due to the Company
receiving an advance from an investor. See note 5 to the financial statements.
Common stock increased $125,000. The Company issued 69,932 shares in
payment of accrued dividends on Series D Preferred Stock of approximately
$125,000.
The accumulated deficit increased by approximately $585,000 due to the
net loss of $523,000 recorded for the three months ended June 30, 1997, and the
accrual of approximately $62,000 of dividends on preferred stock.
Liquidity
- ---------
During the quarter ended June 30, 1997, cash decreased $969,000
primarily due to negative cash flow from operations of $1,160,000. Additionally,
$151,000 of cash was expended for the purchase of capital assets that are used
in operations. The negative operating cash flow was primarily the result of the
Page 9 of 13
CHATCOM, INC.
net loss of $523,000 and changes in operating assets and liabilities.
Additionally, working capital during the same period decreased $530,000.
As of June 30, 1997, the Company had working capital of $2,665,000, as
compared to working capital of $3,195,000 as of March 31, 1997. Notwithstanding
the Company's working capital position as of June 30, 1997, the Company must
provide additional liquidity to support its current level of operations or any
significant future increase in revenues and is actively seeking additional
financing to meet its immediate needs as well as its anticipated requirements
for the balance of the current fiscal year. The Company, which currently does
not have any long-term or bank debt, has received a conditional commitment for a
credit line and is in the process of finalizing the implementation of the credit
line and is negotiating equity investments from several strategic partners. The
Company has received a firm commitment for some of the foregoing debt or equity
financing, there can be no assurance that it will be able to obtain additional
commitments for sufficient financing.
The Company has incurred operating losses in each of its last three
fiscal years and in the first quarter of its current fiscal year. Even if the
Company successfully completes the debt and equity financings it is currently
attempting to place, if the Company continues to experience operating losses in
the future that results in a significant utilization of its liquid resources,
the Company's liquidity and its ability over the long-term to sustain operations
at current levels could be materially adversely affected.
The Company may seek additional public or private financing to meet its
longer term capital needs if market conditions are favorable. If additional
funds are raised through the issuance of equity securities, it is likely that
the Company will be required to sell such securities at a substantial discount
to the current market price for the Common Stock, the percentage ownership of
the then current shareholders of the Company will be reduced, and such equity
securities may have rights, preferences or privileges senior to those of the
holders of the Company's Common Stock. No assurance can be given that additional
financing will be available or that, if available, it will be available on terms
favorable to the Company or its shareholders. Any increase in the outstanding
number of shares of the Common Stock or options and warrants may have an adverse
effect on the market price of the Common Stock and may hinder efforts to arrange
future financing.
The Company has no material commitments for capital expenditures as of
the date hereof. The Company anticipates, however, acquiring additional
equipment and fixtures from time to time as considered necessary by the
Company's management.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
- --------------------------------------------------------------------------------
Except for the historical information contained herein, the matters
discussed in this quarterly report are forward-looking statements, which involve
risks and uncertainties, including but not limited to economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products and prices, and other factors discussed in the Company's
various filings with the Securities and Exchange Commission, including without
limitation the Company's Form 10-KSB for the fiscal year ended March 31, 1997,
as amended, and the Registration Statements on Form S-3 (Registration No.
333-3792 and 33-99668), which were declared effective by the Securities and
Exchange Commission on June 7, 1996 and February 5, 1996, respectively.
Page 10 of 13
CHATCOM, INC.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits. The following exhibits are filed with this Form 10-QSB
or are incorporated by reference to the document described:
10.1 Indemnification Agreement between the Company and Andrew M.
Brown, dated as of May 14, 1997, is incorporated by
reference to Exhibit 10.26 to the Company's annual report
on Form 10-KSB for the fiscal year ended March 31, 1997,
filed with the Commission on July 15, 1997.
10.2 OEM Agreement between the Company and Vinca Corporation,
dated June 17, 1997, is incorporated by reference to
Exhibit 10.28 to the Company's annual report on Form 10-KSB
for the fiscal year ended March 31, 1997, filed with the
Commission on July 15 1997.
27 Financial Data Schedule
b. Reports on Form 8-K.
A current report on Form 8-K was filed on June 30, 1997, under
Item 5, to file a press release reporting preliminary fourth
quarter results and the Company's need of additional liquidity.
No other information is required to be filed under Part II of this Form 10-QSB.
Page 11 of 13
CHATCOM, INC.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CHATCOM, INC.,
a California corporation
Date: August 19, 1997 By: /s/ James B. Mariner
--------------------
James B. Mariner, President,
Chief Executive Officer and
Chief Financial Officer
By: /s/ Cheryl Smithey
------------------
Cheryl Smithey,
Controller and Principal
Accounting Officer
Page 12 of 13
CHATCOM, INC.
EXHIBIT INDEX
Page No.
10.1 Indemnification Agreement between the Company and Andrew
M. Brown, dated as of May 14, 1997, is incorporated by
reference to Exhibit 10.26 to the Company's annual
report on Form 10-KSB for the fiscal year ended March
31, 1997, filed with the Commission on July 15, 1997.
10.2 OEM Agreement between the Company and Vinca Corporation,
dated June 17, 1997, is incorporated by reference to
Exhibit 10.28 to the Company's annual report on Form 10-
KSB for the fiscal year ended March 31, 1997, filed with
the Commission on July 15 1997.
27 Financial Data Schedule
Page 13 of 13