U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________
FORM 10-QSB/A
___
| X | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
Commission file number 0-20462
CHATCOM, INC.
(Exact name of Registrant 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
(Registrant's telephone number)
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
---- ---
As of October 31, 1997, there were 12,275,594 shares of the Registrant's
common stock issued and outstanding.
Transitional Small Business Disclosure Format: Yes No X
--- ---
Page 1 of 17
Exhibit Index on Page 16
CHATCOM, INC.
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
BALANCE SHEETS (IN THOUSANDS)
- ----------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, MARCH 31,
ASSETS NOTES 1997 1997
----- ------------- ---------
(UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents $ 446 $ 1,169
Accounts receivable, net of allowances of $577,000
(September 30, 1997) and $109,000 (March 31, 1997) 2,617 1,334
Inventories 2 3,305 2,721
Prepaid expenses and other
current assets 152 108
-------- --------
Total current assets 6,520 5,332
EQUIPMENT AND FIXTURES, Net 3 678 651
DEPOSITS 24 24
-------- --------
TOTAL $ 7,222 $ 6,007
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable 4 $ 3,560 $ 1,427
Accrued expenses 566 687
Current portion of capital lease
obligations 28 23
-------- --------
Total current liabilities 4,154 2,137
CAPITAL LEASE OBLIGATIONS
-less current portion 24 12
SHAREHOLDERS' EQUITY
Preferred stock, no par value;
authorized 1,000,000 shares; 4
Series D Preferred Stock, $1,000 stated value per
share, authorized 5,000 shares, issued and outstanding
2,496 shares at March 31, 1997 1,407
Series E Preferred Stock, $1,000 stated value per
share, authorized 2,000 shares, issued and outstanding
1,100 shares at September 30, 1997 5 940
Common stock, no par value; authorized,
25,000,000 shares; issued and outstanding
12,275,594 shares at September 30, 1997 and
9,826,892 shares at March 31, 1997 6,7 12,111 10,090
Additional paid-in capital 2,404 2,404
Accumulated deficit (12,411) (10,043)
-------- --------
Total shareholders' equity 3,044 3,858
-------- --------
TOTAL $ 7,222 $ 6,007
======== ========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
Page 2 of 17
CHATCOM, INC.
STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
- -------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
---------- ---------- ---------- ----------
SALES $ 2,122 $ 2,208 $ 6,581 $ 4,893
COST OF GOODS SOLD 1,301 1,519 4,157 3,334
---------- ---------- ---------- ----------
GROSS PROFIT 821 689 2,424 1,559
---------- ---------- ---------- ----------
OPERATING EXPENSES:
Selling 822 834 1,891 1,576
General and administrative 1,087 697 1,550 1,204
Research and development 568 256 1,167 453
Severance expense 61
---------- ---------- ---------- ----------
Total operating expenses 2,477 1,787 4,608 3,294
---------- ---------- ---------- ----------
LOSS FROM OPERATIONS (1,656) (1,098) (2,184) (1,735)
INTEREST INCOME 2 12 9 28
INTEREST EXPENSE (16) 2 (17) (11)
---------- ---------- ---------- ----------
LOSS BEFORE INCOME TAXES (1,670) (1,088) (2,192) (1,718)
PROVISION FOR INCOME TAXES (1)
---------- ---------- ---------- ----------
NET LOSS $ (1,670) $ (1,088) $ (2,193) $ (1,718)
---------- ---------- ---------- ----------
DIVIDENDS ON PREFERRED
STOCK (113) (99) (175) (824)
---------- ---------- ---------- ----------
NET LOSS AVAILABLE TO
COMMON SHAREHOLDERS $ (1,783) $ (1,187) $ (2,368) $ (2,542)
========== ========== ========== ==========
LOSS PER SHARE:
Primary and fully diluted
loss per share $ (0.18) $ (0.14) $ (0.24) $ (0.31)
========== ========== ========== ==========
Weighted average number of
common shares and common
share equivalents (primary and :
fully diluted) 9,961,238 8,553,457 9,894,814 8,139,945
========== ========== ========== ==========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
Page 3 of 17
CHATCOM, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
- --------------------------------------------------------------------
SIX MONTHS ENDED
SEPTEMBER 30,
1997 1996
------- -------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss $(2,193) $(1,718)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization 179 114
Provision for losses on accounts receivable 559 143
Interest on subordinated debt 15
Changes in operating assets and liabilities:
Restricted cash 500
Accounts receivable (1,842) 364
Inventories (584) 307
Prepaid expenses and other current assets (44) (22)
Deposits (2)
Accounts payable 2,132 (782)
Accrued expenses (46) (236)
------- -------
Net cash used in operating activities (1,824) (1,332)
------- -------
CASH FLOWS FROM INVESTING
ACTIVITIES-
Capital expenditures (176) (100)
------- -------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Principal payments of notes payable (939)
Principal payments on capital leases (13) (19)
Proceeds from sale of preferred stock 940 1,325
Payment of dividends on preferred stock (10)
Issuance of convertible subordinated debt 350
Exercise of stock options and warrants 850
------- -------
Net cash provided by financing activities 1,277 1,207
------- -------
NET DECREASE IN CASH (723) (225)
CASH, BEGINNING OF PERIOD 1,169 1,067
------- -------
CASH, END OF PERIOD $ 446 $ 842
======= =======
(CONTINUED
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
Page 4 of 17
STATEMENTS OF CASH FLOWS (UNAUDITED) CONTINUED
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
During the six months ended September 30, 1997 and 1996, the Company paid
interest of $2,336 and $10,473, respectively, and taxes of $8,253 and $425,
respectively.
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the six months ended September 30, 1997 and 1996, the Company entered
into capital lease agreements for equipment with costs of $29,541 and $21,588,
respectively.
During the six months ended September 30, 1997, the Company accrued dividends
payable on preferred stock of $175,000 and paid dividends of $175,000 through
the issuance of 156,564 shares of common stock which resulted in an increase
in common stock of $175,000 and a decrease in accrued expenses of $175,000.
During the six months ended September 30, 1996, the Company accrued dividends
on preferred stock of $67,072. Dividends of $10,495 were paid in cash,
dividends of $33,786 were paid through the issuance of 24,194 shares of the
Company's common stock and dividends of $22,792 were accrued but unpaid at
September 30, 1996.
During the six months ended September 30, 1997, the Company exchanged 2,496
shares of Series D preferred stock ($1,407,000) for 2,000,000 shares of
common stock (see Note 6), which resulted in an increase in common stock of
$1,407,000 and a decrease in preferred stock of $1,407,000.
During the six months ended September 30, 1997, the Company converted $350,000
of convertible subordinated debt (received by the Company during May 1997),
plus $15,173 in accrued interest, into 292,138 shares of common stock (see
Note 6), which resulted in an increase in common stock of $365,173 and a
decrease in convertible subordinated debt of $350,000 and a decrease in
accrued expenses of $15,173.
(CONCLUDED)
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
Page 5 of 17
CHATCOM, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
1. ACCOUNTING POLICIES
The accompanying unaudited financial statements of ChatCom, Inc. (the
"Company") have been prepared in accordance with instructions to Form 10-
QSB and, in the opinion of management, include all material adjustments
(consisting only of normal recurring accruals) which are necessary for the
fair presentation of results of operations for the interim periods. These
unaudited financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual
Report on Form 10-KSB for the fiscal year ended March 31, 1997. The
results of operations for the six month period ended September 30, 1997 are
not necessarily indicative of the results to be expected for the full
fiscal year ending March 31, 1998.
Certain prior year amounts have been reclassified to conform with current
year classifications.
2. INVENTORIES
The components of inventories are as follows:
September 30,
1997
-------------
Raw materials $ 782,000
Work in process 1,249,000
Finished goods 1,936,000
----------
Inventory at cost 3,967,000
Less: reserve for obsolescence (662,000)
----------
$3,305,000
==========
3. EQUIPMENT AND FIXTURES
Equipment and fixtures consist of the following:
September 30,
1997
-------------
Equipment $1,193,000
Software 138,000
Furniture and fixtures 185,000
Leasehold improvements 88,000
----------
1,604,000
Less: accumulated depreciation (926,000)
----------
Equipment and fixtures, net $ 678,000
==========
Page 6 of 17
4. CONVERSION OF UNSECURED DEBT
On September 30, 1997, the Company executed a letter of intent ("LOA") with
Vermont Research Products, Inc. ("Vermont"), a major supplier of certain
products (which are resold by the Company), for the conversion of the amount
owed by the Company to Vermont at that time (approximately $2.0 million at
September 30, 1997) into $1,300,000 of convertible redeemable preferred stock
(the "Series F Preferred Stock") and a $750,000 convertible debenture (the
"Debenture"). The Series F Preferred Stock would contain certain features
including a dividend rate of 6% payable in preferred stock; convertible to
Common Stock on the basis of $1.375 per share; liquidation rights of equal
preference with other preferred shareholders; dividend restrictions;
registration rights; and anti-dilution provisions. The Debenture would contain
certain features including an interest coupon rate based on prime; convertible
to Common Stock on the basis of $1.375 per share; secured by all of the
Company's foreign accounts receivable (excluding those in North America); and be
automatically reduced by payments of foreign accounts receivable (excluding
North America) on the basis of 40% to Vermont and 60% to the Company. The LOA is
subject to the execution of a definitive agreement prior to November 19, 1997.
No assurances can be given that the Company's debt to Vermont will be
converted based on the terms contained in the LOA or on any other terms
satisfactory to the Company.
5. ISSUANCE OF SERIES E PREFERRED STOCK
On September 26, 1997, the Company entered into Stock Purchase Agreements
(the "Agreements") whereby the Company agreed to sell to two accredited
investors up to 1,700 shares of Series E Convertible Redeemable Preferred Stock,
$1,000 stated value per share (the "Series E Preferred Stock"), and warrants to
purchase 432,727 shares of Common Stock at a price of $1.25 per share (the
"Series E Warrants"). Pursuant to the Agreements, a total of 1,100 shares of
Series E Preferred Stock and 254,545 of the Series E Warrants were sold by the
Company on September 26, 1997 for gross proceeds of $1,100,000. The sale of the
Series E Preferred Stock and the Series E Warrants were exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Regulation D promulgated thereunder. The Company received various
representations and warranties from the investors, including a representation
that the investors are "accredited investors" within the meaning of Regulation
D. Offering costs of $160,000, consisting primarily of cash finders' fees and
legal fees, were incurred by the Company. The sale of the additional 600 shares
of Series E Preferred Stock and 178,182 Series E Warrants ($600,000 of gross
offering proceeds) is scheduled to occur within five days following the
Company's satisfaction of certain conditions which include, among others, a
registration statement covering the sale of the shares issuable upon conversion
of the Series E Preferred Stock and upon the exercise of the Series E Warrants
is declared effective; the market price of the Company's Common Stock for the
ten trading days preceding the additional closing date exceeds $1.00 per share;
and the funding from a strategic investor of at least $1,000,000 from the sale
of equity securities of the Company. One-half of the Series E Preferred Stock is
convertible at the election of the holder into shares of the Company's Common
Stock commencing on the 51st day after the closing date and all of the Series E
Preferred Stock is convertible commencing on the 91st day after such closing
date. The conversion value to determine the number of shares of Common Stock
into which the Series E Preferred Stock is convertible is the lesser of $1.375
or 75% of the average of the closing bid prices of the Common Stock during the
five trading days immediately preceding the conversion date. The Series E
Warrants are exercisable for five years commencing January 1, 1998. The Company
has agreed to register the shares issuable upon the conversion of the Series E
Preferred Stock and upon the exercise of the Series E Warrants.
No assurance can be given that the Company will be able to satisfactorily
meet the conditions required for the sale of the additional 600 shares of Series
E Preferred Stock.
Page 7 of 17
6. CONVERSION OF CONVERTIBLE SUBORDINATED DEBT AND SERIES D PREFERRED
STOCK AND SETTLEMENT
On September 11, 1997, the Company, together with a majority of its Board
of Directors, were sued by The High View Fund and The High View Fund, L.P.
(collectively, "High View"), holders of 2,498 shares of the Company's Series D
Preferred Stock and lenders of a $350,000 convertible subordinated loan made to
the Company in May 1997 (the "$350,000 Loan"). The lawsuits, filed in U.S.
Federal District Court, Southern District of New York and in the State Court of
New York, sought damages from the defendants for alleged wrongful actions
relating to securities fraud and not informing High View regarding the extent of
the Company's financial problems.
On September 25, 1997, the parties entered into settlement agreements
(comprised principally of a Stock Exchange Agreement, Registration Rights and
Lock-up Agreement and Warrant agreements) related to both cases whereby High
View agreed to exchange their 2,498 shares of Series D Preferred Stock
(representing the entire Series D Preferred Stock issued by the Company) for a
total of 2,000,000 shares of the Company's Common Stock and to convert the
$350,000 Loan, plus $15,173 of accrued interest, into 292,138 shares of the
Company's Common Stock. The settlement also included the exchange of High View's
warrants to purchase 400,000 shares of Common Stock, exercisable at $3.125 per
share, issued in connection with the Series D Preferred Stock in exchange for a
warrant to purchase 1,000,000 shares of the Company's Common Stock at an
exercise price of $1.75 per share (the "New Warrants"). The New Warrants are
exercisable in whole or in part effective September 25, 1997 and expire December
13, 2001. The Company is also required to register the shares issued in
connection with the Stock Exchange Agreement (2,000,000); the shares underlying
the New Warrants (1,000,000); the shares issued upon conversion of the $350,000
Loan plus accrued interest (292,138); and the dividend shares issued in
connection with the Series D Preferred Stock (156,564) (collectively, the
"Shares"); such registration statement to become effective on or before March
15, 1998. In the event the registration statement does not become effective by
March 15, 1998, the Company is required to issue 50,000 shares of Common Stock
to High View for each 30 day period after March 15, 1998 (prorated for partial
periods) that such registration is not declared effective. As part of the
settlement, High View is entitled to sell a maximum of 50,000 Shares per month
during the period from December 15, 1997 through March 15, 1998. The settlement
also required the Company to reimburse High View $15,000 for legal expenses
incurred in connection with the settlement.
7. SUBSEQUENT EVENT
On November 6, 1997, the Company executed a letter of intent with Macon
Holdings (S) PTE LTD. ("Macon") for the issuance of 666,666 shares of the
Company's Common Stock ($1,000,000 in the aggregate) to Macon. The letter of
intent provides for the execution of a formal stock subscription agreement
evidencing that the shares being acquired by Macon are for investment purposes
and may not be sold by Macon for a period of one year from date of issuance. In
the event funds are not received by the Company within five days after receipt
of a subscription agreement executed by Macon, the stock purchase offer and
agreements shall terminate on the sixth day. Macon, headquartered in Singapore,
is the Company's master distributor for Southeast Asia.
No assurance can be given that a stock subscription agreement will be
executed by Macon or that the $1,000,000 in funds, or any portion thereof, will
be received by the Company.
Page 8 of 17
CHATCOM, INC.
8. RELATED PARTY TRANSACTIONS
The Assistant Secretary of the Company is also a shareholder of a law firm
that provides legal consultation to the Company. At September 30, 1997 and
1996, the Company owed this law firm $12,889 and $8,525, respectively. During
the six months ended September 30, 1997 and 1996, fees relating to services
provided by this law firm in the amounts of $23,102 and $30,788, respectively,
were included in general and administrative expenses in the accompanying
statements of operations.
Page 9 of 17
CHATCOM, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
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 business
operations and financial condition and other factors as described 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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1996
The Company continued to invest heavily in product development during the
three months ended September 30, 1997 (the "second quarter of fiscal 1998").
Significant new account penetrations for Rains(TM) (or completely integrated
consolidated server/storage) systems, which have long and large follow on sales
potential, have continued to dominate the Company's activities. However, the
Company is investing ahead of its anticipated future profitability in order to
position itself at the forefront of the market which it competes in.
Sales during the second quarter of fiscal 1998 ($2.1 million) decreased
$86,000 or 4% compared to the second quarter of fiscal 1997 primarily as a
result of a decrease in international shipments. The Company believes that sales
may fluctuate on a quarterly basis as a result of a number of factors, including
the status of world economic conditions, fluctuations in foreign currency
exchange rates and the timing of system shipments (the current U.S. list price
of the Company's most powerful system, for example, exceeds $300,000; thus the
acceleration or delay of a small number of shipments from one quarter to the
another can significantly affect the results of operations for the quarters
involved).
Cost of goods sold decreased to $1,301,000 or 61% of sales in the second
quarter of fiscal 1998 from $1,519,000 or 69% of sales in the second quarter of
fiscal 1997. The increase in gross margins during the second quarter of fiscal
1998 compared to the second quarter of fiscal 1997 (39% vs. 31%, respectively)
was primarily the result of lower prices of certain components (i.e.
microprocessors and random access memory components) and lower manufacturing
overhead (including indirect labor) as a result of a cost reduction program
initiated during the second quarter of fiscal 1998. The gross margins in the
second quarter of fiscal 1997 was adversely affected by increased inventory
reserves ($90,000) which was partially related to product repositioning. The
Company's gross margins are affected by several factors including, among others,
sales mix and distribution channels and, therefore, may vary in future periods
from those experienced during the second quarter of fiscal 1998.
Selling expenses decreased $12,000 or 2% in the second quarter of fiscal
1998 compared to the second quarter of fiscal 1997, primarily as a result of
decreased advertising expenses ($132,000) and decreased marketing salaries due
to certain cost reductions implemented during the second quarter of fiscal 1998.
The decreases in fiscal 1998 were substantially offset by increased personnel
costs as a result of additional sales personnel; increased commissions due to
the increase in domestic sales; and increased expenses associated with
international sales.
General and administrative expenses during the second quarter of fiscal
1998 increased by $390,000 or 56% compared to the second quarter of fiscal 1997.
The increase was primarily the result of an increase in bad debt expense, as a
result of the establishment of a reserve ($500,000) during the second
Page 10 of 17
CHATCOM, INC.
quarter of fiscal 1998 related to the delinquency of a significant international
account, as well as increased incentive compensation expense, salary expense and
investor relations expenses during the second quarter of fiscal 1998. These
increases were partially offset by reductions in consulting expenses ($90,000)
during the second quarter of fiscal 1998.
Research and development ("R&D") expenses during the second quarter of
fiscal 1998 increased $312,000 or 12% compared to the second quarter of fiscal
1997. The increase was primarily attributable to increased expenditures for
prototypes and consultants due to the Company's concerted effort to decrease
product development time and increase pre-production product testing.
The operating loss as a percentage of sales for the second quarter of 1998
and 1997 was 65% and 49%, respectively. The decrease in the percentage of
operating loss to total sales during fiscal 1998 was primarily attributable to
the increase in gross margin percentage in 1998 and the decrease in general and
administrative expenses in 1998, as described above.
Interest income decreased to $2,000 during the second quarter of fiscal
1998 from $12,000 during the second quarter of fiscal 1997 as a result of lower
investment balances due primarily to cash used for operating activities during
fiscal 1998.
Interest expense increased to $16,000 during the second quarter of fiscal
1998 from $2,000 in the second quarter of fiscal 1997 primarily as a result of
interest associated with a $350,000 loan received by the Company during May 1997
(see Note 6 of Notes to Financial Statements).
Page 11 of 17
CHATCOM, INC.
SIX MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER
30, 1996
Sales during the six months ended September 30, 1997 (the "first half of
fiscal 1998") were $6.6 million, an increase of $1.7 million or 34% over the
$4.9 million recorded during the six months ended September 30, 1996 (the "first
half of fiscal 1997). The increase was due primarily to increased international
shipments (primarily the Pacific Rim), the majority of which occurred during the
first quarter of fiscal 1998. International customers accounted for 51% of
sales during the first half of fiscal 1998 compared to 17% during the first half
of fiscal 1997.
Cost of goods sold increased to $4.2 million or 63% of sales in the first
half of fiscal 1998 from $3.3 million or 68% of sales in the first half of
fiscal 1997. The increase in gross margins during the first half of fiscal 1998
compared to the first half of fiscal 1997 (37% vs. 32%, respectively) was
primarily the result of lower prices of certain components (i.e. microprocessors
and random access memory components); lower manufacturing overhead (including
indirect labor) as a result of a cost reduction program initiated during the
second quarter of fiscal 1998; increased manufacturing efficiencies and greater
absorption of overhead as a result of increased production due to greater demand
for the Company's products; and a decrease in inventory obsolescence reserves
($106,000) during the quarter ended June 30, 1997 (due to the sale of certain
inventory previously reserved for) as compared to an increase inventory reserves
($100,000) during the first half of fiscal 1997 which was partially related to
product repositioning.
Selling expenses increased $315,000 or 20% in the first half of fiscal
1998 compared to the first half of fiscal 1997, primarily as a result of
increased personnel costs as a result of additional sales personnel; increased
commissions due to the increase in domestic sales; and increased expenses
associated with international sales. The increases in the first half of fiscal
1998 were partially offset by decreased advertising expenses and decreased
consulting expenses.
General and administrative expenses during the first half of fiscal 1998
increased by $346,000 or 29% compared to the first half of fiscal 1997. The
increase was primarily the result of an increase in bad debt expense, as a
result of the establishment of a reserve ($500,000) during the second quarter of
fiscal 1998 related to the delinquency of a significant international account,
as well as increased salary expense, incentive compensation expense, and
investor relations expenses during the first half of fiscal 1998. These
increases were partially offset by reductions in consulting expense ($99,000)
during the first half of fiscal 1998.
Research and development expenses during the first half of fiscal 1998
increased $714,000 or 158% compared to the first half of fiscal 1997. The
increase was primarily attributable to increased salaries due to additional
personnel and expenditures for prototypes and consultants due to the Company's
concerted effort to decrease product development time and increase pre-
production product testing.
The operating loss as a percentage of sales for the first half of fiscal
1998 and 1997 was 33% and 35%, respectively. The decrease in the percentage of
operating loss to total sales during fiscal 1998 was primarily attributable to
the increase in gross margin percentage in 1998, as described above.
Interest income decreased to $9,000 during the first half of fiscal 1998
from $28,000 during the first half of 1997 as a result of lower investment
balances due primarily to cash used for operating activities during fiscal
1998.
Interest expense increased to $17,000 during the first half of fiscal 1998
from $11,000 in the first half of fiscal 1997 primarily as a result of interest
associated with a $350,000 loan received by the Company during May 1997 (see
Note 6 of Notes to Financial Statements).
Page 12 of 17
CHATCOM, INC.
LIQUIDITY AND CAPITAL RESOURCES
The Company recorded a net loss of $1,670,000 and $2,193,000 during the
three and six months ended September 30, 1997, respectively. During the six
months ended September 30, 1997, cash decreased $723,000 primarily due to
negative cash flow from operations of $1,824,000. The negative cash flow from
operations during the first half of fiscal 1998 was comprised primarily of the
net loss ($2.2 million) and an increase in accounts receivable ($1.8 million),
primarily as a result of a significant portion of system shipments occurring
later in the second fiscal quarter of 1998 compared to the second fiscal quarter
of 1997. These decreases were partially offset by an increase in accounts
payable ($2.1 million), an increase in bad debt expense, as a result of the
establishment of a reserve ($500,000) during the second quarter of fiscal 1998
related to the delinquency of a significant international account, and by non
cash depreciation and amortization ($179,000).
Net cash used for investing activities during the first half of fiscal 1998
($176,000) was the result of expenditures related to computers and manufacturing
equipment.
Net cash provided by financing activities during the first half of fiscal
1998 ($1.3 million) was primarily the result of the issuance of 1,100 shares of
Series E Preferred Stock ($940,000) and the receipt of $350,000 in connection
with a subordinated debt agreement.
As of September 30, 1997, the Company had working capital of $2.4
million, as compared to working capital of $3.2 million as of March 31, 1997.
Approximately $2.4 million of working capital at September 30, 1997 is provided
by accounts receivable owed to the Company by Macon, of which $1.9 million are
delinquent in payment by more than 90 days for which a reserve for doubtful
accounts of $500,000 has been established. 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 purchasers of $1,100,000 of the Series E Preferred
Stock have agreed to purchase an additional $600,000 of such shares but such
purchase is subject to certain conditions which include, among others, a
registration statement covering the resale of the shares issuable upon
conversion of the Series E Preferred Stock and upon the exercise of the Series E
Warrants is declared effective; the market price of the Company's Common Stock
for the ten trading days preceding the additional closing date exceeds $1.00 per
share; and the receipt of at least $1,000,000 from the sale of equity securities
of the Company. Although the Company has also received a letter of agreement
from a supplier for the conversion of approximately $2.0 million in unsecured
debt into $1,250,000 in preferred stock and $750,000 in convertible debt and a
letter of intent from Macon to invest $1.0 million in exchange for 666,666
shares of Common Stock of the Company, no assurances can be given that these
financings will be consummated. Furthermore, there can be no assurance that the
Company 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 has experienced operating losses for four consecutive fiscal quarters.
Even if the Company successfully completes the debt and equity financings it is
currently attempting to consummate, 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
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CHATCOM, INC.
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
September 30, 1997.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On September 11, 1997, the Company, together with a majority of its Board
of Directors, were sued by The High View Fund and The High View Fund, L.P.
(collectively, "High View"), holders of 2,498 shares of the Company's Series D
Preferred Stock and lenders of a $350,000 convertible subordinated loan made to
the Company in May 1997 (the "$350,000 Loan"). The lawsuits, filed in U.S.
Federal District Court, Southern District of New York and in the State Court of
New York, sought damages from the defendants for alleged wrongful actions
relating to securities fraud and not informing High View regarding the extent of
the Company's financial problems.
On September 25, 1997, the parties entered into settlement agreements
(comprised principally of a Stock Exchange Agreement, Registration Rights and
Lock-up Agreement and Warrant agreements) related to both cases whereby High
View agreed to exchange their 2,498 shares of Series D Preferred Stock
(representing the entire Series D Preferred Stock issued by the Company) for a
total of 2,000,000 shares of the Company's Common Stock and to convert the
$350,000 Loan, plus $15,173 of accrued interest, into 292,138 shares of the
Company's Common Stock. The settlement also included the exchange of High View's
warrants to purchase 400,000 shares of Common Stock, exercisable at $3.125 per
share, issued in connection with the Series D Preferred Stock in exchange for a
warrant to purchase 1,000,000 shares of the Company's Common Stock at an
exercise price of $1.75 per share (the "New Warrants"). The New Warrants are
exercisable in whole or in part effective September 25, 1997 and expire December
13, 2001. The Company is also required to register the shares issued in
connection with the Stock Exchange Agreement (2,000,000); the shares underlying
the New Warrants (1,000,000); the shares issued upon conversion of the $350,000
Loan plus accrued interest (292,138); and the dividend shares issued in
connection with the Series D Preferred Stock (156,564) (collectively, the
"Shares"); such registration statement to become effective on or before March
15, 1998. In the event the registration statement does not become effective by
March 15, 1998, the Company is required to issue 50,000 shares of Common Stock
to High View for each 30 day period after March 15, 1998 (prorated for partial
periods) that such registration is not declared effective. As part of the
settlement, High View is entitled to sell a maximum of 50,000 Shares per month
during the period from December 15, 1997 through March 15, 1998. The settlement
also required the Company to reimburse High View $15,000 for legal expenses
incurred in connection with the settlement.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On September 26, 1997, the Company entered into Stock Purchase Agreements
(the "Agreements") whereby the Company agreed to sell to two accredited
investors up to 1,700 shares of Series E Convertible Redeemable Preferred Stock,
$1,000 stated value per share (the "Series E Preferred Stock") and warrants to
purchase 432,727 shares of Common Stock at a price of $1.25 per share (the
"Series E Warrants"). Pursuant to the Agreement, a total of 1,100 shares of
Series E Preferred Stock and 254,545 of the Series E Warrants were sold by the
Company on September 26, 1997 for gross proceeds of $1,100,000. The sale of the
Series E Preferred Stock and the Series E Warrants were exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Regulation D promulgated thereunder. The Company received various
representations and warranties from the investors including a representation
that the investors are "accredited investors" within the meaning of Regulation
D. Offering costs of $160,000, consisting primarily of cash finders' fees and
legal fees, were incurred by the Company. The sale of the additional 600 shares
of Series E Preferred Stock and 178,182 Series E Warrants ($600,000 of gross
offering proceeds) is scheduled to occur within five days following the
Company's satisfaction of certain conditions which include, among others, a
registration statement covering the resale of the shares issuable upon
conversion of the Series E Preferred Stock and upon the exercise of the Series E
Warrants is declared
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CHATCOM, INC.
effective; the market price of the Company's Common Stock for the ten trading
days preceding the additional closing date exceeds $1.00 per share; and the
funding from a strategic investor of at least $1,000,000 from the sale of equity
securities of the Company. One-half of the Series E Preferred Stock is
convertible at the election of the holder into shares of the Company's Common
Stock commencing on the 51st day after the closing date and all of the Series E
Preferred Stock is convertible commencing on the 91st day after such closing
date. The conversion value to determine the number of shares of Common Stock
into which the Series E Preferred Stock is convertible is the lesser of $1.375
or 75% of the average of the closing bid prices of the Common Stock during the
five trading days immediately preceding the conversion date. The Series E
Warrants are exercisable for five years commencing January 1, 1998. The Company
has agreed to register the shares issuable upon the conversion of the Series E
Preferred Stock and upon the exercise of the Series E Warrants.
No assurance can be given that the Company will be able to satisfactorily
meet the conditions required for the sale of the additional 600 shares of Series
E Preferred Stock.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits
The following exhibits are filed with this Form 10-QSB:
3.1 Certification of Determination of Series E Convertible Redeemable
Preferred Stock (Previously Filed)
10.1 Letter of Agreement between the Company and Vermont Research
Products, Inc. dated September 30, 1997 (Previously Filed)
10.2 Stock Exchange and Settlement Agreement between the Company and
The High View Fund and The High View Fund, L.P. dated September
25, 1997 (Previously Filed)
10.3 Form of Warrant to purchase Common Stock issued to The High View
Fund and The High View Fund, L.P. (Previously Filed)
10.4 Form of Stock Purchase Agreement between the Company and the
purchaser of the Series E Preferred Stock dated September 26,
1997 (Previously Filed)
10.5 Letter of Intent between the Company and Macon Holdings (S) PTE
LTD. dated November 6, 1997 (Previously Filed)
27 Financial Data Schedule
b. Reports on Form 8-K.
None.
No other information is required to be filed under Part II of this Form 10-QSB.
Page 16 of 17
CHATCOM, INC.
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.
CHATCOM, INC.,
a California corporation
Date: April 9, 1998
By: /s/ Richard F. Gordon
------------------------------------
Richard F. Gordon, Chairman of
the Board of Directors
By: /s/ Gordon L. Almquist
------------------------------------
Gordon L. Almquist, Vice President,
Finance and Chief Financial Officer
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