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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 SEPTEMBER 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________________ TO ___________________
COMMISSION FILE NUMBER 0-11630
INTELECT COMMUNICATIONS SYSTEMS LIMITED
(Exact Name of Company as Specified in Its Charter)
BERMUDA N/A
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1100 EXECUTIVE DRIVE, RICHARDSON, TEXAS
75081
(Address of Principal Executive Offices, Zip Code)
972-367-2100
(Company's Telephone Number, Including Area Code)
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Indicate by check mark whether the Company: (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 Company 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 23,954,978 shares of Common Stock, par value $.01 per share,
outstanding on November 4, 1997.
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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
at September 30, 1997 (unaudited) and December 31, 1996
Consolidated Statements of Operations of the Company 3
(unaudited) for three months and nine months ended September 30, 1997
and 1996
Consolidated Statements of Cash Flows of the Company 4
(unaudited) for the nine months ended September 30, 1997 and 1996
Notes to the Consolidated Financial Statements 6
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL 9
CONDITION AND RESULTS OF OPERATIONS
PART II OTHER INFORMATION
ITEM 2 CHANGES IN SECURITIES 13
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 14
ITEM 5 OTHER INFORMATION 14
ITEM 6 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 15
SIGNATURES 16
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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
Consolidated Balance Sheets
(Thousands of dollars, except share data)
September 30, December 31,
1997 1996
------- -------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents 2,108 4,863
Marketable securities 920 854
Accounts receivable, net 12,298 2,427
Inventories, net 4,098 2,978
Prepaid expenses 671 472
------- -------
Total current assets 20,095 11,594
Property and equipment, net 5,825 4,285
Goodwill, net 13,580 14,573
Software development costs, net 2,431 1,389
Deferred financing costs, net 1,194 582
Other intangible assets, net 3,615 2,879
Other assets 648 716
------- -------
47,388 36,018
======= =======
Liabilities and Shareholders' Equity
Current liabilities:
Notes payable 9,000 --
Current maturities of long-term debt 5,688 4,125
Current installments of obligations under capital leases 81 57
Accounts payable 4,340 1,878
Accrued liabilities 3,988 3,302
Net liabilities of discontinued operations 400 400
Deferred income taxes 47 48
------- -------
Total current liabilities 23,544 9,810
Convertible debentures -- 14,913
Long-term debt, net of current maturities -- 3,238
Long-term obligations under capital leases, net of current installments 46 59
Deferred income taxes 383 267
------- -------
23,973 28,287
------- -------
Shareholders' equity:
$2.0145, 10% cumulative convertible preferred stock, series A, $.01 par
value (aggregate involuntary liquidation preference $20,145,000).
Authorized 10,000,000 shares; 4,999,992 shares issued and
outstanding in 1997 50 --
Common shares, $.01 par value. Authorized 80,000,000 shares; 22,631,160
and 15,027,728 shares issued and outstanding in 1997 and 1996 226 150
Additional paid-in capital 69,951 36,849
Unrealized gain on marketable securities 5 18
Accumulated deficit (46,817) (29,286)
------- -------
Total shareholders' equity 23,415 7,731
------- -------
47,388 36,018
======= =======
See accompanying notes to consolidated financial statements
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INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
Consolidated Statements of Operations
(Thousands of dollars, except share data)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
1997 1996 1997 1996
-------- ------- ------- -------
(Unaudited)
Net revenues:
Products $ 8,358 181 16,869 1,579
Services 2,657 1,577 6,684 4,289
Contracts 61 157 1,067 1,335
-------- ------- ------- -------
11,076 1,915 24,620 7,203
Cost of revenues:
Products 5,159 606 11,030 1,956
Services 1,845 1,023 4,778 3,010
Contracts 137 611 1,146 3,050
-------- ------- ------- -------
7,141 2,240 16,954 8,016
-------- ------- ------- -------
Gross profit (loss) 3,935 (325) 7,666 (813)
-------- ------- ------- -------
Operating expenses:
Selling, general and administrative 4,554 4,260 13,403 10,276
Engineering and development 3,438 1,114 8,430 3,107
Amortization of goodwill 331 1,247 992 1,986
-------- ------- ------- -------
8,323 6,621 22,825 15,369
-------- ------- ------- -------
Operating loss (4,388) (6,946) (15,159) (16,182)
-------- ------- ------- -------
Other income (expense):
Interest expense (96) (459) (1,999) (626)
Interest and other 224 126 36 417
-------- ------- ------- -------
128 (333) (1,963) (209)
-------- ------- ------- -------
Loss from continuing operations before
income taxes (4,260) (7,279) (17,122) (16,391)
Income taxes (40) (1,215) (117) 1,046
-------- ------- ------- -------
Loss from continuing operations (4,300) 8,494 (17,239) 15,345
Loss on disposal of discontinued operations (178) (9) (290) (18)
======== ======= ======= =======
Net loss $ (4,478) (8,503) (17,529) (15,363)
======== ======= ======= =======
Loss per share (primary and fully diluted):
Continuing operations $ (.19) (.63) (.89) (1.14)
Discontinued operations (.01) -- (.01) --
======== ======= ======= =======
Net loss $ (.20) (.63) (.90) (1.14)
======== ======= ======= =======
Weighted average number of shares and common stock
equivalents outstanding (in thousands) 21,905 13,547 19,455 13,499
See accompanying notes to consolidated financial statements.
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INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Thousands of dollars)
Nine Months Ended
September 30,
---------------------
1997 1996
------- -------
(Unaudited)
Cash flows from operating activities:
Net loss (17,529) (15,363)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization of intangible assets 2,448 2,525
Deferred income taxes 115 (1,046)
Noncash compensation -- 500
Stock option compensation 183 380
Amortization of deferred financing costs 1,304 458
Other noncash financing costs 73 --
Noncash operating expenses 180 --
Other 8 (10)
Change in operating assets and liabilities, net of effects of
acquired companies:
Accounts receivable (9,971) (251)
Inventories (1,120) (208)
Other assets (167) (362)
Accounts payable and accrued liabilities 3,462 (24)
Net liabilities of discontinued operations -- (76)
------- -------
Net cash used in operating activities (21,014) (13,477)
------- -------
Cash flows from investing activities:
Purchase of other intangible assets (94) --
Capital expenditures (2,480) (3,283)
Proceeds on sale of fixed assets -- 57
Purchase of marketable securities (78) (55)
Payments for other assets -- (1,582)
Software development costs (1,317) (3,392)
Payment for acquisition of DNA, net of cash acquired -- (3,010)
Loan receivable -- 600
Payment for acquisition of IVC, net of cash acquired -- (2,004)
------- -------
Net cash used in investing activities (3,969) (12,669)
------- -------
(Continued)
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INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
(Thousands of dollars)
Nine Months Ended
September 30,
---------------------
1997 1996
------- -------
(Unaudited)
Cash flows from financing activities:
Debt issuance costs (255) --
Proceeds from issuance of notes payable 14,200 --
Proceeds from issuance of convertible debentures -- 13,799
Payments of principal on capital lease obligations (43) (84)
Payments of long-term debt (122)
Payments on notes payable (1,875) (880)
Proceeds from issuance of common shares 3,307 2,473
Net Proceeds from issuance of preferred stock 4,911 --
Exercise of warrants 1,620 --
Exercise of employee stock options 363
------- -------
Net cash provided by financing activities 22,228 15,186
------- -------
Net decrease in cash and cash equivalents (2,755) (10,960)
Cash and cash equivalents, beginning of period 4,863 15,039
======= =======
Cash and cash equivalents, end of period 2,108 4,079
======= =======
See accompanying notes to consolidated financial statements.
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INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1997
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 Rule 10-01 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 consolidated financial statements included in the Company's
Annual Report on Form 10-K as at December 31, 1996.
INVENTORIES
The components of inventories are as follows (thousands of Dollars):
September 30, December 31,
1997 1996
----- -----
Raw materials 4,476 2,727
Work in progress 263 292
Finished goods 539 1,213
----- -----
5,278 4,232
Less: allowance for obsolescence 1,180 1,254
===== =====
4,098 2,978
===== =====
FINANCING MATTERS
The Company executed a loan agreement on May 8, 1997 (the "Original
Loan Agreement") with the Coastal Corporation Second Pension Trust (the
"Coastal Trust") pursuant to which the Company borrowed $5,000,000, and the
Coastal Trust purchased $5,000,000 of the Company's Cumulative Convertible
Preferred Stock (the "Preferred Stock"). On May 30, 1997, $3,500,000 of the
borrowing, including accrued interest of $35,000 was converted into 1,737,404
shares of Preferred Stock and on August 27, 1997, the Coastal Trust converted
the remaining borrowing of $1,572,000, including accrued interest of $37,000
into an additional 780,583 shares of Preferred Stock at the conversion price of
$2.0145 per share, as provided in the Original Loan Agreement. Also on August
27, 1997, the Coastal Trust and the Company amended and restated the Original
Loan Agreement (the "Amended and Restated Loan Agreement") to provide for new
borrowing on a revolving basis, of up to $5,000,000. Borrowings under the
Amended and Restated Loan Agreement bear interest at 2% over prime, mature on
March 27, 1998, and are secured by all outstanding shares of the Company's
subsidiaries. Pursuant to the terms of the Amended and Restated Loan Agreement,
the Coastal Trust advanced $3,000,000. Outstanding advances are convertible at
any time, at either party's request, at $6.18375 per share, into a new series
of preferred stock with the same rights and preferences as the existing series
of preferred stock. In connection with the advance, the Company issued to the
Coastal Trust a warrant to purchase 450,000 Common Shares, at $6.00 per share,
exercisable at any time until August 26, 2002. The fair value of the warrant at
date of issuance, totaling $987,000, was credited to additional paid-in capital
and is being charged to interest expense using the effective interest method
over the loan period.
Effective on July 2, 1997, in conjunction with a consulting agreement,
the Company issued a warrant to purchase 30,000 Common Shares, at $4.50 per
share, exercisable at any time after August 30, 1997 until December 31, 2001.
The fair value of the warrant at date of issuance, totaling $43,000, was
credited to additional paid-in capital and charged to other financing costs. On
September 26, 1997, the warrant was exercised. The Company received $135,000 in
net proceeds.
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INTELECT COMMUNICATIONS SYSTEMS LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
SEPTEMBER 30, 1997
On August 1, 1997, the Coastal Trust exercised a warrant for 750,000
Common Shares which had been issued pursuant to the Original Loan Agreement
resulting in $1,485,000 in net proceeds to the Company.
On August 22 and 29, 1997, the Company issued 60,000 and 636,400
Common Shares, respectively, in private placement transactions to accredited
investors, including 21,400 shares issued as payment for placement services,
resulting in $3,307,000 in net proceeds to the Company.
On June 19, 1997, in conjunction with a product distribution
agreement, the Company agreed to issue warrants to purchase up to 270,000
Common Shares at $3.6312 per share in increments of 6,750 shares for each
$1,000,000 of sales attributable to the distributor on or before June 19, 2001,
exercisable at any time after issuance until June 19, 2004. As of September 30,
1997, warrants had been issued to purchase 40,500 Common Shares and additional
warrants to purchase 20,250 Common Shares have been issued subsequent to
September 30, 1997. As of September 30, 1997, the fair value of warrants at
issuance, totaling $162,000, was credited to additional paid-in capital and
charged to operating expense.
REVISION OF ESTIMATE REGARDING WARRANT VALUATION
The Company determined that the estimated life of warrants used when
calculating their value under the Black-Scholes method should be revised. The
net effect was to reduce by $775,000 the otherwise reportable interest and other
financing costs in the three month period ending September 30, 1997.
RECENT PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 128 ("SFAS 128"),
"Earnings per Share," which supersedes APB Opinion No. 15, "Earnings per
Share," was issued in February 1997. SFAS 128 requires dual presentation of
basic and diluted earnings per share ("EPS") for complex capital structures on
the face of the statement of operations. Basic EPS is computed by dividing
income (loss) by the weighted average number of common shares outstanding for
the period. Diluted EPS reflects the potential dilution from the exercise or
conversion of securities into common stock, such as stock options. SFAS 128 is
required to be adopted for financial statements issued for periods ending after
December 15, 1997, including interim periods. Earlier application is not
permitted. After adoption, all prior period data presented will be restated to
conform with SFAS 128. The Company does not expect that basic and diluted EPS
measured under SFAS 128 will be materially different from the current
presentation of primary and fully-diluted loss per common share measured under
APB Opinion No. 15. The Company will present both EPS measures on the face of
the statement of operations.
Statement of Financial Accounting Standards No. 129, "Disclosure of
Information About Capital Structure," was issued in February 1997. The Company
does not expect the statement to result in any substantive change in its
disclosure.
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" and SFAS 131 "Disclosures About Segments of an Enterprise
and Related Information" were issued in June 1997. The impact these
pronouncements may have on the Company's disclosures is being evaluated.
SUBSEQUENT EVENTS
In March 1997, Peter G. Leighton, former president of the Company, and
Rhianon M. Pedro, former vice president of the Company, initiated actions
against the Company seeking damages related to their separations from the
Company. In October 1997, the actions were settled on terms favorable to the
Company. All parties executed mutual releases of lawsuit claims and
counterclaims which were dismissed with prejudice. In concert with the
settlement, Mr.
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Leighton and Ms. Pedro exercised their stock options acquiring, respectively,
305,000 and 50,000 Common Shares under the Company's stock option plans. Total
proceeds received by the Company were $1,761,000.
On October 7, 1997, the Coastal Trust, holder of 4,999,992 shares of
Preferred Stock, converted 780,583 shares of Preferred Stock to a like number
of Common Shares.
On October 9, 1997, the Company issued 150,000 Common Shares upon the
exercise of a warrant issued to St. James Capital Corp. dated April 24, 1997.
The warrant was issued to St. James Capital Corp. in connection with a credit
facility provided by St. James Capital Corp. to the Company. The Company
received net proceeds of $300,000 from the exercise.
On October 13, 1997, the Company authorized the issuance of 28,148
Common Shares in lieu of payment of a cash dividend on the Preferred Stock held
by the Coastal Trust from issue date through September 30, 1997. Holders of the
Preferred Stock are entitled to cumulative cash dividends at the rate of
$.20145 per annum per share, payable quarterly, commencing September 30, 1997.
The Company elected to exercise its right to pay such dividends in Common
Shares at the average closing market bid price for the five (5) consecutive
trading days prior to September 30, 1997.
As described in note 8 to the Consolidated Financial Statements
contained in the Company's Form 10-K for the fiscal year ending December 31,
1996, the Company has been in dispute with the licensor of certain video
conferencing technology. On November 6, 1997, the company executed an amended
technology license agreement with the licensor in settlement of the dispute. As
a result of such settlement, the Company is released from paying a disputed
obligation of $2,550,000 under the original license agreement. As part of such
settlement, the Company is required to pay $150,000 to the licensor for accrued
and future minimum royalties. Further royalty payments, if any, will be
contingent on actual sales of certain defined products which are based upon the
licensor's technology, which products do not include the LANscape 2.0
wavelet-based video communications product line. In concert with the
extinguishment of the $2,550,000 liability to the licensor, an intangible asset
of identical value will be written off.
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE PERIOD ENDED SEPTEMBER 30, 1997
NET REVENUES
Net revenue for the three months and nine months ended September 30,
1997 increased 478% and 242%, respectively, over the prior year periods. The
product sales increase was due to the emergence and growth of the SONETLYNX
product line, of which $8,269,000 and $16,421,000, respectively, were sold,
compared to $225,000 in the prior year periods. Service revenue increased by
46% and 49%, respectively, due to the growth of the technology and engineering
services business of DNA Enterprises, Inc. ("DNA") acquired on February 13,
1996. Contract revenues decreased due to the completion of an S4 system without
significant new business in the last three months.
GROSS PROFIT
Gross profit was attributable to revenue sources as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1997 1996 1997 1996
------ ------ ------ ------
(Thousands of Dollars)
Products 3,337 (426) 5,838 (378)
Services 807 554 1,906 1,279
Contracts (209) (453) (78) (1,714)
------ ------ ------ ------
3,935 (325) 7,666 (813)
Gross profit increased over the prior year by $4,260,000 and
$8,479,000 in the three month and nine month periods, respectively. Gross
profit attributable to products improved due to increased SONETLYNX volume in
both time periods. Services margins improved because the engineering services
business of DNA was the primary constituent of the business category in 1997,
and DNA activity expanded from year to year. While improved from the prior
year, contracts margin was reduced in the three month period due to one-time
costs of the first delivery of a new universal console design to an air traffic
control customer.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling expenses increased to $3,014,000 from $1,828,000 in the three
months and to $8,026,000 from $4,006,000 in the nine months ended September 30,
1997. Selling expenses in the three months included $1,872,000 to promote and
secure orders for SONETLYNX products, and $700,000 to increase awareness of and
secure beta sites for the Company's videoconferencing product.
General and administrative (G&A) expenses compared to the prior year
decreased to $1,540,000 from $2,432,000 in the three months and to $5,377,000
from $6,270,000 in the nine months ended September 30, 1997. Included in the
three month period were $774,000 of corporate expenses, up from $541,000 in the
second quarter, due to increased general legal expenses. In the three month
period, $370,000 of expense supported the Company's principal manufacturing
operations, $284,000 supported the engineering services business, and $112,000
was spent in connection with the videoconferencing business. In total, G&A
expenses for the three month period decreased 7% from the prior three month
period.
ENGINEERING AND DEVELOPMENT (E&D) EXPENSE
E&D expenses increased to $3,438,000 and $8,430,000 in the three month
and nine month periods from $1,114,000 and $3,107,000 in the prior year
periods. Combining $296,000 of capitalized software development costs with E&D
expense, total spending for product development increased 37% to $3,734,000
compared to $2,735,000 in the three months ended September 30, 1996. Of these
amounts, SONETLYNX increased to $1,697,000 from $781,000, CS4 spending was
reduced to $848,000 from $1,702,000, videoconferencing product development
costs
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increased to $571,000 from $207,000, and DSP and S4 development spending
increased to $618,000 from $45,000. For the nine month periods, combined
capitalized software and E&D expense increased 50%.
During the third quarter, the SONETLYNX product line was expanded by
the release of a video interface which can be easily upgraded from OC-1 to
OC-3. A Network Management System was first deployed with connectability to the
public network and with a capacity for multiple SONET rings. Interfaces for
synchronization and timing from public or internal sources were demonstrated.
Interoperability of payload and overhead was achieved with a major vendor of
OC-3 equipment.
CS4 development activity consisted of performance optimization of the
prototype, stress testing, and redesign for cost reduction and to accommodate a
new processor.
Video conferencing development work led to the release of LANscape
2.0, a replacement product based on wavelet technology, with industry-leading
image and sound quality and economy in the use of bandwidth.
Spending in support of the S4 product line consisted of the completion
of universal console development.
The total spending on all E&D projects in the third quarter included
approximately $500,000 of extraordinary costs, principally for the benefit of
the videoconferencing and S4 products.
INTEREST EXPENSE
Interest expense in the three month and nine month periods of 1997
includes $290,000 and $695,000 of cash interest principally on the convertible
debentures, the St. James Credit Facility and the Coastal Trust financing.
Interest expense in the prior year was attributable to short-term indebtedness
which has been repaid. Non-cash expenses in 1997 consisted of $582,000
allocated to beneficial conversion features of the convertible debentures
issued in 1996; ($194,000) and $722,000 in the three months and nine months,
respectively, of amortized deferred financing costs in connection with the St.
James Credit Facility and the Coastal Trust financing executed in 1997; and
$73,000 in other financing costs in 1997. The amount of non-cash expense
reported in the three month period reflects the consequences of a revised
estimate of the life of warrants when calculating their value using the
Black-Scholes method. See Notes to Consolidated Financial Statements.
BACKLOG
The Company's backlog of orders increased to $8,914,000 at September
30, 1997, from $3,632,000 at December 31, 1996. Substantially all the September
30, 1997, backlog was scheduled for delivery by year end. Of this amount,
$6,563,000 was for SONETLYNX product.
LIQUIDITY AND CAPITAL RESOURCES
In the nine months ended September 30, 1997, cash used in operations
($21,014,000) and by investing activities ($3,969,000) was funded by $2,755,000
of available cash balances and by securing new financing, including warrant and
stock option exercises, of $22,228,000. Working capital is negative due to (i)
borrowing under the St. James Credit Facility and the Coastal Trust financing
net of redemptions, and (ii) progression of certain long-term debt items to
current status.
Operating Activities
Net cash used in operations was $21,014,000 in the nine months ended
September 30, 1997, consisting primarily of: (i) product development expenses
of $3,438,000, the majority of which did not contribute to current period
sales, (ii) sales and marketing expenses of $8,026,000 primarily of a market
development nature and (iii) an operating cost structure which could support a
higher level of sales as indicated by approximately $1,252,000 of under-applied
overhead, all of which resulted in an operating loss. In addition, $9,971,000
was used to increase accounts receivable and $1,120,000 was used to increase
inventory. These uses were partly offset by a $3,462,000 increase in accounts
payable.
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The Company maintained these levels of expenditure because (i) the
product developments were directed at markets believed to have very large
growth potential and (ii) recent sales experience and production growth
opportunities appeared to justify investment to stimulate the sales and prepare
for production. The revenue increases in the nine months met the Company's
expectations, and backlog is at a level consistent with near-term growth plans.
The increase in receivables was caused primarily by shipments timed near the
end of the period.
Investing Activities
Investment spending included fixed asset expenditures of $2,480,000,
of which $402,000 was for software and equipment to support CS4 development,
$928,000 was for equipment to support engineering and operations growth for
SONETLYNX products, and $312,000 was for equipment and software to support
growth of the engineering services business. Software development costs for
SONETLYNX were capitalized in the amount of $1,317,000.
Financing Activities
On August 1, 1997, the Coastal Trust exercised a warrant for 750,000
Common Shares which was originally issued to the Coastal Trust on May 8, 1997,
in connection with the Original Loan Agreement. Upon the exercise of such
warrants, the Company received $1,485,000 in net proceeds. See Notes to
Consolidated Financial Statements.
On August 22, 1997 and August 29, 1997, the Company issued, in
separate private placement transactions, 60,000 and 636,400 Common Shares,
respectively, and the Company received net proceeds from such sales of $270,000
and $3,037,000, respectively. See Notes to Consolidated Financial Statements.
On August 27, 1997, the Coastal Trust converted the then outstanding
balance of principal and interest under the Original Loan Agreement, in the
amount of $1,572,000, into 780,583 shares of Preferred Stock. Also on August
27, 1997, the Company and the Coastal Trust amended and restated the Original
Loan Agreement to enable the Company to borrow, on a revolving credit basis, up
to $5,000,000. On August 27, 1997, the Company borrowed $3,000,000 under the
Amended and Restated Loan Agreement. See Notes to Consolidated Financial
Statements.
On October 2, 1997, the holder of a warrant for 30,000 Common Shares,
exercised the warrant and the Company received $135,000 in net proceeds. See
Notes to Consolidated Financial Statements.
Outlook and Financial Strategy
The Company's outlook continues to anticipate expanding working
capital requirements and ongoing expenditures for new product and technology
development, marketing and sales programs. Internal cash generation from
operations is not expected to be sufficient to meet all such requirements until
during the 1998 timeframe. The Company's financial strategy is to continue to
utilize external sources of financing to provide funding for net capital
requirements.
External financing totaled $22,228,000 during the nine months ended
September 30, 1997, and was used primarily for expenditures and investments
described above.
On November 6, 1997, the Company executed an amended technology
license agreement in connection with videoconferencing technology, pursuant to
which a disputed obligation to pay $2,550,000 was replaced with an immediate
payment of $150,000 for accrued and future minimum royalties. Future royalty
payments, if any, will be contingent on actual sales of defined products, which
defined products do not include the LANscape 2.0 product line. See Notes to
Consolidated Financial Statements.
At September 30, 1997, operating sources of liquidity included
unrestricted cash balances of $2,108,000 and accounts receivable of
$12,298,000. The Company presently believes the receivables level is higher
than required by the amount of sales in the three month period ended September
30, 1997. The high level was caused by the concentration of sales in September.
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The Company continues to develop its CS4 intelligent service platform
for applications in telecommunications networks. To date, the work has been
entirely self-funded. The Company is reviewing potential corporate partners to
facilitate funding as well as marketing of the product. Presently, the review
includes discussion with a major telecommunications company regarding the
possibility of forming an alliance to finish development and to market the CS4
product. The possibility of engagement with other partners has not been
foreclosed. Any funding from such a source would likely be accompanied by an
upward revision in planned expenses so that market entry could be accelerated.
Funding by the proposed partnering process would be in addition to sources of
liquidity discussed above.
Conclusion
Considering the financing resources available and potentially
available, the outlook for cash available from customer collections, the
outlook for cash uses in operations and investing, and the options available to
reduce spending, the Company believes it has the financial resources to meet
its business requirements through the current year. There can be no assurance,
however, that the proposed financings or the business results assumed in the
Company's financial plans will be realized.
CONTINGENT LIABILITIES
In March 1997, Peter G. Leighton, former president of the Company, and
Rhianon M. Pedro, former vice president of the Company, initiated actions
against the Company seeking damages related to their separations from the
Company. In October 1997, the actions were settled on terms favorable to the
Company. All parties executed mutual releases of lawsuit claims and
counterclaims which were dismissed with prejudice. In concert with the
settlement, Mr. Leighton and Ms. Pedro exercised their stock options acquiring,
respectively, 305,000 and 50,000 Common Shares under the Company's stock option
plans. Total proceeds received by the Company were $1,761,000.
As discussed in "ITEM 3, Legal Proceedings" in the Company's Annual
Report on Form 10-K, the Company is exposed to certain contingent liabilities
which, if resolved adversely to the Company, would adversely affect its
liquidity, its results of operations and/or its financial position.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE LIQUIDITY AND OPERATING RESULTS
This Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Securities 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. In particular, the recent growth in production and sales may not be
sustained if materials (including those supplied from sole sources) are not
available, the sales force does not identify new customers, the Company's
credit condition inhibits major customers, or new SONETLYNX and
videoconferencing product developments are delayed. The Company has made
commitments to significant amounts of spending for product development, sales
and marketing activity, and manufacturing capacity predicated on a high rate of
sales growth each quarter. If the rate of sales growth is not sustained,
certain of the expenses will not be sufficiently controllable in the short term
to avoid a negative cash flow impact. There can be no assurance that the
currently high level of credit quality among the Company's customers can be
sustained or that integration of new products will proceed without
extraordinary delays. Accordingly, customer collections may not achieve
expectations. In order to meet increasing levels of demand for manufactured
products, the Company must make estimates of future orders with enough
precision to insure the availability of certain components with long lead
times. Any inaccuracy in such estimates could affect the expected operating
results. In general, there can be no assurance that component parts will be
available in sufficient quantity and on suitable credit terms to support the
planned growth in production rates. External business conditions may also
contribute risk, especially the rate at which telecommunications companies
adopt certain new products and the demand for engineering design services which
are contingent on the development budgets of others. Potential sources of funds
include uncertainties, namely, trade credit may not become available to the
extent required to support production increases, alternative external sources
of financing may not be secured in a timely manner or on terms acceptable to
the Company or at all, availability of external sources may be affected by
general market price volatility, and partner funding of CS4 development may not
be secured soon enough to avoid development delays or to provide expense
relief. The Company's ability to raise funds from external sources may be
restricted by adverse resolution of legal proceedings discussed in Contingent
Liabilities.
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PART II - OTHER INFORMATION
ITEM 2 - CHANGES IN SECURITIES
(c) Recent sales of unregistered securities
Effective on July 2, 1997, the Company issued to Lifeline Industries,
Inc. ("Lifeline") a warrant to purchase 30,000 Common Shares, exercisable at an
exercise price of $4.50 per share, expiring on December 31, 2001. The warrant
was issued as compensation for consulting services. On September 26, 1997,
Lifeline exercised such warrant and the Company issued 30,000 Common Shares to
Lifeline upon such exercise. The Company issued such Common Shares in reliance
on an exemption from registration specified under Section 4(2) of the
Securities Act of 1933, as amended.
On August 1, 1997, the Company issued 750,000 Common Shares to the
Coastal Trust upon exercise of a warrant dated May 7, 1997, which warrant was
issued pursuant to the Original Loan Agreement. See Notes to Consolidated
Financial Statements. In issuing such Common Shares upon exercise of the
warrant, the Company relied on an exemption from registration specified under
Section 4(2) of the Securities Act of 1993, as amended.
On August 22, 1997, the Company issued in a private placement
transaction 30,000 Common Shares to Isaac Arnold, Jr., 10,000 Common Shares to
Arnold Corporation, and 20,000 Common Shares to the Meridian Fund, Ltd.,
pursuant to the terms of Subscription Agreements dated August 22, 1997. In
issuing such Common Shares, the Company relied on exemptions from registration
specified under Section 4(2) of the Securities Act of 1993, as amended.
Pursuant to the terms of a Settlement Agreement dated August 22, 1997,
the Company issued 993,023 Common Shares to Infinity Investors, Ltd.
("Infinity"), 160,116 Common Shares to Seacrest Capital Limited ("Seacrest"),
and 430,000 Common Shares to Zug Investments, each in settlement of a dispute
arising under and in conversion of those certain Series A and Series B
Convertible Debentures issued by the Company to Infinity and Seacrest dated
October 15, 1996. See "Item 5, Other Information." In issuing such Common
Shares, the Company relied on an exemption from registration specified under
Section 4(2)of the Securities Act of 1933, as amended.
On August 27, 1997, the Company issued to the Coastal Trust 780,583
shares of Preferred Stock, which Preferred Stock was issued upon conversion of
$1,572,000 of debt to equity pursuant to the Original Loan Agreement. On
October 7, 1997, the Company issued 780,583 Common Shares upon the conversion
of the Preferred Stock issued to Coastal Trust on August 27, 1997. See Notes to
Consolidated Financial Statements. In issuing such Preferred Stock and the
Common Shares issued upon conversion of the Preferred Stock, the Company relied
on an exemption from registration specified under Section 4(2) of the
Securities Act of 1933, as amended.
On August 29, 1997 the Company issued 636,400 Common Shares in a
private placement transaction to certain accredited investors, 615,000 of such
Common Shares being issuable pursuant to certain Subscription Agreements dated
August 29, 1997, and 21,400 being issued to the selling agent in such
transaction as part of such selling agent's fee. In issuing such shares, the
Company relied on the exemption from registration under Regulation D
promulgated under the Securities Act of 1933, as amended.
On October 9, 1997, the Company issued 150,000 Common Shares upon the
exercise of a warrant issued to St. James Capital Corp. dated April 24, 1997.
In issuing such Common Shares, the Company relied on an exemption from
registration specified under Section 4(2) of the Securities Act of 1933, as
amended.
On October 13, 1997, the Company authorized the issuance of 28,148
Common Shares in lieu of payment of the initial cash dividend on the Company's
Preferred Stock held by the Coastal Trust for the period from issue date
through September 30, 1997. See Notes to Consolidated Financial Statements. In
issuing such shares, the Company relied on an exemption from registration
specified under Section 4(2) of the Securities Act of 1933, as amended.
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ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On August 13, 1997, the Company held its Annual General Meeting of
Shareholders (the "General Meeting"). At such General Meeting, the shareholders
elected directors, fixed the maximum number of directors, increased the number
of Common Shares available for use under the Company's stock incentive plan,
and approved the appointment of independent auditors.
Messrs. Herman M. Frietsch and Philip P. Sudan, Jr. were both elected
at the General Meeting as directors of the Company to hold such offices until
the third annual meeting following the General Meeting. The shareholders vote
was, as to Mr. Frietsch, 16,478,042 for, 142,133 against, and no abstentions,
and as to Mr. Sudan, 16,480,256 for, 139,919 against, and no abstentions.
Continuing to hold offices as directors of the Company after the General
Meeting, in addition to those elected at the General Meeting, were Messrs.
Anton Liechtenstein and Robert E. Garrison II, whose terms expire at the annual
general meetings in 1999 and 1998, respectively.
The number of directors' seats on the Board of Directors was fixed at
five (5) by the shareholders by a vote of 16,165,594 for, 107,515 against, and
347,066 abstentions. In accordance with Section 4.01 of the Company's Bye-Laws,
the shareholders are permitted to fix the number of directors, such number
having been previously fixed at five (5). Because only two of the director
seats expired at the General Meeting, it was proposed that the shareholders
elect two directors to fill the vacancies created by the expiry of the terms of
two of the directors and that, pursuant to the Company's Bye-Laws, the Board of
Directors intended to subsequently fill the vacancy when a suitable candidate
was located.
An amendment to the Company's stock incentive plan (the "Plan") to
increase by one million the number of Common Shares issuable under the Plan
from 3,000,000 to 4,000,000 was approved by the shareholders by a vote of
14,731,704 for, 902,084 against, 272,176 abstentions, and 714,211 broker
non-votes. The purposes of the Plan have been and continue to be to enable the
Company and its subsidiaries to attract and retain directors and key employees,
to provide them with strong incentive to advance the interests of the Company,
and to otherwise align the interests of management more closely with that of
the Company and its shareholders.
The appointment of Arthur Andersen LLP to act as independent auditors
of the Company for the 1997 fiscal year was approved by the shareholders by a
vote of 16,411,469 for, 53,775 against, and 154,931 abstentions. The Board of
Directors, in accordance with the recommendation of its Audit Committee, which
is composed of non-employees of the Company, requested, subject to shareholder
approval, that Arthur Andersen LLP act as independent auditors of the Company
for the 1997 fiscal year, replacing the firm of KPMG Peat Marwick, Chartered
Accountants, Hamilton, Bermuda whose term as independent auditors for the
Company expired at the General Meeting.
ITEM 5 - OTHER INFORMATION
On November 6, 1997, the Company executed an amended technology
license agreement in connection with videoconferencing technology, pursuant to
which a disputed obligation to pay $2,550,000 was replaced with an immediate
payment of $150,000 for accrued and future minimum royalties. Future royalty
payments, if any, will be contingent on actual sales of defined products, which
defined products do not include the LANscape 2.0 product line. See Notes to
Consolidated Financial Statements.
On August 22, 1997, the Company finalized a Settlement Agreement with
Infinity Investors Ltd. ("Infinity"), and Seacrest Capital Limited ("Seacrest")
in settlement of disputes arising under those certain Series A and Series B
Convertible Debentures issued by the Company to Infinity and Seacrest dated
October 15, 1996 (the "October Debentures"). The finalized Settlement Agreement
superseded the Term Sheet previously entered into by the parties dated June 30,
1997. Pursuant to the finalized Settlement Agreement, the disputed principal
balance of $4,114,000 of the October Debentures was converted into an aggregate
of 1,583,139 Common Shares of the Company, and the October Debentures were
cancelled.
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ITEM 6 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The Financial Statements and Financial Statement Schedules filed
as part of this report are listed and indexed on Page 1. Schedules other than
those listed in the index have been omitted because they are not applicable or
the required information has been included elsewhere in this report.
(b) Listed below are all Exhibits filed as part of this report.
Certain Exhibits are incorporated by reference to documents previously filed by
the Company with the Securities and Exchange Commission pursuant to Rule 12b-32
under the Securities Exchange Act of 1934, as amended.
Exhibit No. Exhibit
10.1 Settlement Agreement dated August 22, 1997 among the
Company, Infinity Investors Ltd., and Seacrest Capital
Limited (2)
10.2 Subscription Agreements dated August 22, 1997 among the
Company and Isaac Arnold, Jr., Arnold Corporation, and
Meridian Fund, Ltd. (2)
10.3 Loan Agreement dated May 8, 1997 among the Company, Intelect
Systems Corp, and The Coastal Corporation Second Pension
Trust (1)
10.4 Registration Rights Agreements dated May 8 and May 30, 1997
among the Company and The Coastal Corporation Second
Pension Trust (1)
10.5 Warrant to purchase Company Common Stock expiring May 7,
2002 issued to The Coastal Corporation Second Pension Trust
(1)
10.6 Subscription Agreement dated May 30, 1997 among the Company
and The Coastal Corporation Second Pension Trust (1)
10.7 Amended and Restated Loan Agreement dated August 27, 1997
among the Company, Intelect Systems Corp, and The Coastal
Corporation Second Pension Trust (2)
10.8 Warrant to purchase Company Common Stock expiring August 26,
2002 issued to The Coastal Corporation Second Pension Trust
(2)
10.9 Warrant to purchase Company Common Stock dated April 24,
1997 issued to St. James Capital Corp. (2)
10.10 Subscription Agreements dated August 1997 among the Company
and Blake C. Davenport, Fernhill Partners, Fiftieth &
Grover Shopping Center, Carol Filler (James), Douglas
Floren, Richard A. Gray, Alexander Greenberg, Philip
Hempleman, David May, Timothy McCollum, Frank Lyon Polk
III, Sanford Prater, Privet Row, Inc., Leonard Rauner,
Marcus R. Rowan, TCM Partners, L.P., and Wayne Wilkey (2)
10.11 Warrant to purchase Company Common Shares expiring
December 31, 2001 issued to Lifeline Industries, Inc. (2)
10.12 Amended License Agreement between Digital Equipment
Corporation and Intelect Visual Communications Corp. dated
effective November 6, 1997
11.0 Statement re computation of per share earnings
27.0 Financial data schedule
- --------------------------------
(1) Incorporated herein by reference to the Registrant's Form 10-Q for the
fiscal quarter ended June 30, 1997
(2) Incorporated herein by reference to the Registrant's Form S-3 (File No.
333-35841)
(c) Reports on Form 8-K: the Company filed on August 13, 1997 a report
on Form 8-K, reporting changes in the Company's certifying accountant.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
INTELECT COMMUNICATIONS SYSTEMS LIMITED
(Company)
Date: November 12, 1997 By: /s/ EDWIN J. DUCAYET, JR.
----------------------- --------------------------------------
Edwin J. Ducayet, Jr.
Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: November 12, 1997 By: /s/ HERMAN M. FRIETSCH
----------------------- --------------------------------------
Herman M. Frietsch
Chief Executive Officer and Director
(Principal Executive Officer)
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INDEX TO EXHIBITS
Exhibit No. Definition
- ----------- ----------
10.1 Settlement Agreement dated August 22, 1997 among the
Company, Infinity Investors Ltd., and Seacrest Capital
Limited (2)
10.2 Subscription Agreements dated August 22, 1997 among the
Company and Isaac Arnold, Jr., Arnold Corporation, and
Meridian Fund, Ltd. (2)
10.3 Loan Agreement dated May 8, 1997 among the Company, Intelect
Systems Corp, and The Coastal Corporation Second Pension
Trust (1)
10.4 Registration Rights Agreements dated May 8 and May 30, 1997
among the Company and The Coastal Corporation Second
Pension Trust (1)
10.5 Warrant to purchase Company Common Stock expiring May 7,
2002 issued to The Coastal Corporation Second Pension Trust
(1)
10.6 Subscription Agreement dated May 30, 1997 among the Company
and The Coastal Corporation Second Pension Trust (1)
10.7 Amended and Restated Loan Agreement dated August 27, 1997
among the Company, Intelect Systems Corp, and The Coastal
Corporation Second Pension Trust (2)
10.8 Warrant to purchase Company Common Stock expiring August 26,
2002 issued to The Coastal Corporation Second Pension Trust
(2)
10.9 Warrant to purchase Company Common Stock dated April 24,
1997 issued to St. James Capital Corp. (2)
10.10 Subscription Agreements dated August 1997 among the Company
and Blake C. Davenport, Fernhill Partners, Fiftieth &
Grover Shopping Center, Carol Filler (James), Douglas
Floren, Richard A. Gray, Alexander Greenberg, Philip
Hempleman, David May, Timothy McCollum, Frank Lyon Polk
III, Sanford Prater, Privet Row, Inc., Leonard Rauner,
Marcus R. Rowan, TCM Partners, L.P., and Wayne Wilkey (2)
10.11 Warrant to purchase Company Common Shares expiring
December 31, 2001 issued to Lifeline Industries, Inc. (2)
10.12 Amended License Agreement between Digital Equipment
Corporation and Intelect Visual Communications Corp. dated
effective November 6, 1997
11.0 Statement re computation of per share earnings
27.0 Financial data schedule
- --------------------------------
(1) Incorporated herein by reference to the Registrant's Form 10-Q for the
fiscal quarter ended June 30, 1997
(2) Incorporated herein by reference to the Registrant's Form S-3 (File No.
333-35841)