1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
--------------------
FORM 10 - Q/A
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
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, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 76-0471342
(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
(Registrant's Telephone Number, Including Area Code)
-----------------------------------
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
There were 25,437,865 shares of Common Stock, par value $.01 per share,
outstanding on August 10, 1998.
================================================================================
2
ON NOVEMBER 17, 1998, THE COMPANY ANNOUNCED IN ITS FORM 10-Q FOR THE PERIOD
ENDED SEPTEMBER 30, 1998, THAT THE COMPANY WOULD RESTATE ITS FINANCIAL
STATEMENTS FOR THE PERIOD ENDED JUNE 30, 1998.
FINANCIAL STATEMENTS AND RELATED DISCLOSURES CONTAINED IN THIS AMENDED FILING
REFLECT, WHERE APPROPRIATE, CHANGES TO CONFORM TO THE RESTATEMENT.
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX
PAGE
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets of the Company at June 30, 1998
(unaudited) and December 31, 1997 2
Consolidated Statements of Operations of the Company (unaudited) for
the three months and six months ended June 30, 1998 and 1997 4
Consolidated Statements of Cash Flows of the Company (unaudited) for
the six months ended June 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 9
PART II OTHER INFORMATION
ITEM 6 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 14
SIGNATURES 16
3
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Thousands of dollars, except share data)
June 30, December 31,
1998 1997
------------- -------------
(unaudited)
(restated)
Assets
Current assets:
Cash and cash equivalents $ 5,590 $ 2,094
Investments in marketable securities 888 942
Accounts receivable net of allowances of $513 in 1998 and $541 in 1997 12,787 15,569
Inventories 7,828 6,289
Prepaid expenses 905 658
------------- -------------
Total current assets 27,998 25,552
Property and equipment, net 6,684 6,041
Goodwill, net 12,159 13,249
Software development costs, net 3,046 2,229
Other intangible assets, net 1,018 1,168
Other assets 1,481 992
============= =============
$ 52,386 $ 49,231
============= =============
See accompanying notes to consolidated financial statements (Continued)
2
4
INTELECT COMMUNICATIONS INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Continued)
(Thousands of dollars, except share data)
June 30, December 31,
1998 1997
------------- -------------
(unaudited)
(restated)
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable, net of unamortized discount of $2,091 in 1998 and
$578 in 1997 $ 8,349 $ 9,132
Current maturities of long-term debt 862 2,527
Accounts payable 4,246 7,568
Accrued liabilities 2,572 3,173
Net liabilities of discontinued operations 400 400
Deferred income taxes 49 49
Current installments of obligations under capital leases 86 89
------------- -------------
Total current liabilities 16,564 22,938
Long-term obligations under capital leases, net of current installments 11 55
Deferred income taxes 89 89
------------- -------------
16,664 23,082
------------- -------------
Commitments and contingencies
Stockholders' 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; 4,219,409 shares
issued and outstanding 42 42
$4.375, 10% cumulative convertible preferred stock, series B,
$.01 par value (aggregate involuntary liquidation preference
$4,000,000). Authorized 914,286 shares; 914,286 shares
issued and outstanding 9 9
Series C convertible preferred stock, $.01 par value (aggregate
involuntary liquidation preference $10,000,000). Authorized
12,500 shares; 10,000 shares issued and outstanding in 1998 1 -
Series D convertible preferred stock, $.01 par value (aggregate
involuntary liquidation preference $10,000,000). Authorized,
issued, and outstanding 10,000 shares in 1998 1 -
Common stock, $.01 par value. Authorized 50,000,000 shares;
24,316,317 and 23,954,978 shares issued and outstanding in 1998
and 1997 243 240
Additional paid-in capital 100,171 75,940
Unrealized gain on marketable securities - 2
Retained earnings (accumulated deficit) (64,745) (50,084)
-------------
-------------
Total stockholders' equity 35,722 26,149
============= =============
$ 52,386 $ 49,231
============= =============
See accompanying notes to consolidated financing statements.
3
5
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Thousands of dollars, except share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ----------------------------
1998 1997 1998 1997
------------ ------------- ------------ ------------
(restated) (restated)
Net revenues $ 5,156 $ 9,007 $ 10,670 $ 13,544
Cost of revenue 4,827 6,042 8,835 9,812
------------ ------------- ------------ ------------
Gross Profit 329 2,965 1,835 3,732
------------ ------------- ------------ ------------
Expenses:
Engineering and development 1,554 2,522 4,399 4,992
Selling and administrative 4,402 4,427 8,031 8,692
Amortization of goodwill 310 327 641 661
------------ ------------- ------------ ------------
6,266 7,276 13,071 14,345
------------ ------------- ------------ ------------
Operating Loss (5,937) (4,311) (11,236) (10,613)
------------ ------------- ------------ ------------
Other income (expense):
Interest expense (1,088) (958) (2,111) (1,903)
Interest income and other 62 (309) 170 (346)
------------ ------------- ------------ ------------
(1,026) (1,267) (1,941) (2,249)
------------ ------------- ------------ ------------
Loss from continuing operations before income taxes (6,963) (5,578) (13,177) (12,862)
Income tax expense (14) (39) (14) (77)
------------ ------------- ------------ ------------
Loss from continuing operations (6,977) (5,617) (13,191) (12,939)
Loss on disposal of discontinued operations, net of tax (97) (20) (185) (113)
------------ ------------- ------------ ------------
Net loss $ (7,074) $ (5,637) $ (13,376) $ (13,052)
============ ============= ============ ============
Dividends on preferred stock 538 64 1,285 64
------------ ------------- ------------ ------------
Loss available to common stockholders $ (7,612) $ (5,701) $ (14,661) $ (13,116)
============ ============= ============ ============
Basic and diluted loss per share:
Continuing operations $ (0.31) $ (0.28) $ (0.60) $ (0.71)
Discontinued operations - - (0.01) (0.01)
------------ ------------- ------------ ------------
Net loss per share $ (0.31) $ (0.28) $ (0.61) $ (0.72)
============ ============= ============ ============
Weighted average number of common shares outstanding $ 24,271 19,810 24,190 18,210
============ ============= ============ ============
See accompanying notes to consolidated financial statements.
4
6
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Thousands of dollars, except share data)
(unaudited)
-------------------------------------
Six Months Ended June 30,
-------------------------------------
1998 1997
--------------- ---------------
(restated)
Cash flows from operating activities:
Net loss $ (13,376) $ (13,052)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 1,833 1,498
Amortization of loan discount 1,540 1,427
Deferred income taxes - 77
Loss on disposal of discontinued operations 186 113
Stock option compensation 50 121
Noncash operating expenses 93 282
Other - (8)
Change in operating assets and liabilities, Net of effects of acquired
companies:
Accounts receivable 2,782 (6,230)
Inventories (1,539) (620)
Other assets (123) (177)
Accounts payable and accrued liabilities (3,924) 2,407
--------------- ---------------
Net cash used in operating activities (12,478) (14,162)
--------------- ---------------
Cash flows from investing activities:
Payments for disposal of discontinued operations (133) (113)
Purchase of other intangible assets (12) (83)
Capital expenditures (1,402) (1,925)
Purchase of marketable securities - (78)
Software development costs (1,032) (1,021)
Proceeds from sale of marketable securities 52 -
--------------- ---------------
Net cash used in investing activities (2,527) (3,220)
--------------- ---------------
Cash flows from financing activities:
Debt issuance costs (73) (309)
Proceeds from issuance of notes payable 10,020 11,200
Principal payments on notes payable (9,290) -
Payments under capital lease obligations (47) (29)
Principal payments on long-term debt (1,215) (682)
Proceeds from exercise of employee stock options 282 348
Proceeds from issuance of preferred shares 18,824 5,000
--------------- ---------------
Net cash provided by financing activities 18,501 15,528
--------------- ---------------
Net increase (decrease) in cash and cash equivalents 3,496 (1,854)
Cash and cash equivalents, beginning of period 2,094 4,863
--------------- ---------------
Cash and cash equivalents, end of period $ 5,590 $ 3,009
=============== ===============
See accompanying notes to consolidated financial statements.
5
7
INTELECT COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements
(Unaudited)
June 30, 1998
RESTATEMENT
In connection with the Company's initial filing of its quarterly report
for the period ended September 30, 1998, previously recognized revenues were
reviewed. The review was performed in connection with an investigation of
collectibility of receivables from the Company's Korean distributor. The Company
was advised, at a meeting in October, of the distributor's illiquidity and
inability to maintain any certain schedule of payments of receivables. This
event led to a general review of all aspects of the business relationship,
including, among other things, an examination of terms and conditions of
purchase orders from the distributor. Two purchase orders, originally reviewed
under an internal control procedure, were determined to have been subsequently
amended by the distributor and were accepted through the actions of an employee
without proper review. The amended purchase orders (1) extended the
distributor's obligation to pay until product was resold to an end user customer
and (2) allowed for the return of unsold product to the Company. These terms
were appended only on two purchase orders under which $1,915,000 of product was
shipped. As soon as the contingent nature of the purchase was understood, the
Company concluded that the revenue should not have been recognized. Consequently
the financial statements were restated to eliminate the recognition of
$1,915,000 of revenue in the three months ended June 30, 1998. The impact of
this restatement has been reflected in the Form 10-Q filing as of September 30,
1998, and for the nine months then ended, as well as in this filing.
As a result of the restatement, the financial statements shown under
Item 1 in the Index of this Form 10-Q have been restated.
Three Months Ended Six Months Ended
June 30, 1998 June 30, 1998
------------------------------------ --------------------------------------
As Restated As Reported As Restated As Reported
---------------- ------------------ ------------------ -------------------
(Thousands of dollars except share data)
Net revenues $ 5,156 $ 7,071 $ 10,670 $ 12,585
Gross profit 329 2,244 1,835 3,750
Less Available to Stockholders (7,612) (5,697) (14,601) (12,746)
Net loss per share (0.31) (0.23) (0.61) (0.53)
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 financial statements included in the Company's Annual Report on
Form 10-K as at December 31, 1997.
6
8
INVENTORIES
The components of inventories are as follows (thousands of dollars)
June 30, December 31,
1998 1997
--------------- ---------------
Raw materials $ 4,503 $ 5,209
Work in progress 2,283 630
Finished goods 2,703 2,050
--------------- ---------------
9,489 7,889
Less: allowance for obsolescence (1,661) (1,600)
--------------- ---------------
$ 7,828 $ 6,289
=============== ===============
FINANCING MATTERS
Effective as of April 1, 1998, the Company authorized the issuance of
31,308 shares of common stock in lieu of a $212,000 cash dividend on Series A
preferred stock for the quarter ended March 31, 1998 and 17,025 shares in lieu
of a $116,000 cash dividend on Series B preferred stock for the period from date
of issue through March 31, 1998. The share price was the average closing market
bid price for the five consecutive trading days ending March 31, 1998.
On February 12, 1998, the Company established a $15,000,000 credit
facility (the "Facility") with a private lender, and received an initial advance
of $3,000,000. On April 2, 1998, the Company received an additional advance of
$7,000,000. The Facility is due February 12, 1999, is secured by all outstanding
shares of the Company's wholly owned U.S. subsidiaries, and bears interest at
the rate of 7% per annum, payable at maturity. In conjunction with advances
under the Facility, the lender received warrants to purchase 1,500,000 shares of
common stock, exercisable at any time for a three year period at an exercise
price of $7.50 per share. Outstanding advances and accrued interest are
convertible into shares of common stock at a price of $9.082, at the lender's
option, provided the market price of the common stock is less than $13.50, and
at the Company's option if the market price of the common stock is $13.50 or
greater. Market price is defined as the closing bid price for 15 of the 17
consecutive days immediately prior to the conversion date. The Facility may be
extended for an additional year in exchange for warrants to purchase common
stock, exercisable at any time for a three year period, at the rate of 5,000
warrant shares for each $100,000 advanced, at a price equal to $1.50 greater
than the average closing bid price of the common stock for the ten day period
immediately prior to February 12, 1999. All warrants are subject to certain
repricing and anti-dilution adjustments. The Facility, among other things,
prohibits any additional indebtedness. The obligation to make future advances
expired on July 31, 1998. The Company is prohibited from redeeming any capital
stock, declaring any dividends on common stock or making certain other
distributions, as defined. Proceeds of the initial advance were used for working
capital and general corporate purposes. Proceeds of the second advance were used
primarily to retire outstanding loans and accrued interest, totaling $6,630,000
from the previous Credit Facility. The fair value of the warrants at dates of
issue, totaling $909,000 and $2,071,000, evaluated using the Black-Scholes
option pricing model, were credited to additional paid-in capital and are being
charged to interest expense using the effective interest method over the loan
period.
On April 2, 1998, the credit facility was retired as described above,
and on May 12, 1998, the Coastal Trust Revolving Loan, outstanding advances and
accrued interest, totaling $3,223,000, was retired.
On May 8 and June 26, 1998, the Company sold 5,000 shares of Series D
Convertible Preferred Stock, in private placements to holders of the Series C
preferred stock, realizing a total of $9,645,000, after issuance
7
9
costs. A premium on the Series D preferred stock accumulates at the rate of 4%
per annum, is payable upon conversion, and may be paid in cash or common stock,
at the Company's option. The preferred stock will automatically convert into
common stock on May 8, 2000, and June 26, 2000, respectively, and may be
converted prior to that date, at the holder's option, at the lesser of $9.082
(or the "reset price," the volume-weighted average trading price of the common
stock for the five trading days following the filing of the Company's Form 10-Q
for the quarter ending June 30, 1998, if less) per share of common stock or at
97% of the market price. Market price is defined as the average of the three
lowest closing bid prices for the common stock within the ten trading days
immediately preceding the conversion date. The Company may fix the conversion
price at $9.082 (or the reset price, if less) if, for any 20 of 30 consecutive
trading days, the daily volume-weighted price of the common stock is $12.00 or
greater. The preferred stock may be redeemed, at the Company's option, at 110%
of the stated value if the daily volume-weighted average trading price is below
$3.00 per share for ten consecutive trading days. Terms of the series, among
other things, limit the rate of conversion and the rate of sale of common stock
acquired upon conversion, prohibit the Company from redeeming any common stock,
or from declaring any dividends on common stock, and allow the holders to
purchase additional shares of preferred stock in lieu of anticipated advances
under the Facility, provided at least 25% of the preferred stock is outstanding
and required waivers are obtained from the Series A and Series B preferred
stockholders. Proceeds from the offering were used for working capital and
general corporate purposes. The series ranks in pari passu with the Series A,
Series B and Series C preferred stock.
CONCENTRATION OF CREDIT RISK
The Company continues to be subject to credit risk through trade
receivables. The Company's distributor for Korea accounted for $4,607,000
(36%)and $9,879,000 (63%) of the accounts receivable at June 30, 1998, and
December 31, 1997, respectively. Of the most recent amount, $3,100,000 dates
from December 1997. In connection with such receivables, the Company also holds
from the distributor a promissory note and pledge of security interests in
certain collateral, including the distributor's accounts receivable. The Company
has continued to receive payments from the distributor; however, in view of the
economic conditions and monetary environment in Korea, there is continuing
uncertainty about future sales to the distributor and the corresponding risk of
collecting amounts due. After assessing the payment intentions and performance
of the distributor, and the financial condition of the distributor, the Company
continues to believe the balance of the note will be collected in full and
accordingly has made no provision for loss on such receivables.
SUBSEQUENT EVENTS
Effective as of July 1, 1998, the Company authorized the issuance of
35,903 shares of common stock in lieu of a $212,000 cash dividend on its Series
A preferred stock and 16,895 shares in lieu of a $100,000 cash dividend on its
Series B preferred stock for the quarter ended June 30, 1998. The share price
was the average closing market bid price for the five consecutive trading days
ending June 30, 1998.
RECENT PRONOUNCEMENTS
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income,"
as of January 1, 1998. SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. Comprehensive income is defined as the total of
net income and all other non-owner changes in equity. The Company does not
believe that SFAS No. 130 will have a significant impact on the Company's
financial statements.
8
10
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE PERIOD ENDED JUNE 30, 1998
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. The forward looking
statements involve risks and uncertainties that could cause actual results to
differ materially from those expressed in, or implied by, the forward looking
statements. Factors that might cause such a difference include, but are not
limited to, those related to: general economic conditions in the markets in
which the Company operates, success in the development and market acceptance of
new and existing products (particularly SONETLYNX, FibreTrax, LANscape, and
CS4); dependence on suppliers, third party manufacturers and channels of
distribution; customer and product concentration, fluctuations in customer
demand; maintaining access to external sources of capital; ability to execute
management's margin improvement and cost control plans; overall management of
the Company's expansion; and other risk factors detailed from time to time in
the Company's filings with the Securities and Exchange Commission.
As a result of the restatement of the Company's financial statements
for the period ended June 30, 1998, certain information contained in this item
has been changed from that which appeared in the Company's originally filed Form
10-Q for the period ended June 30, 1998. In addition to a revision of this ITEM
2, including the new discussion of "Recent Developments," the reader should
review the Company's recent filing of Form 10-Q/A for the period ending
September 30, 1998.
- --------------------------------------------------------------------------------
COMPARISON OF SECOND QUARTER AND FIRST HALF 1998 TO 1997
- --------------------------------------------------------------------------------
The following table shows the revenue and gross profit for the
Company's products:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
-------------- ------------- ------------- -------------
($ Thousands)
Revenue:
Fiber optic multiplexers $ 1,580 $ 6,128 $ 3,742 $ 8,152
Engineering services and DSP 3,006 2,223 5,857 3,766
Video conferencing 530 107 839 212
Voice switching and other 40 549 232 1,414
-------------- ------------- ------------- -------------
$ 5,156 $ 9,007 $ 10,670 $ 13,544
-------------- ------------- ------------- -------------
Gross profit:
Fiber optic multiplexers (533) 2,410 22 2,644
Engineering services and DSP 678 597 1,549 894
Video conferencing 220 46 356 78
Voice switching and other (36) (88) (92) 116
-------------- ------------- ------------- -------------
$ 329 $ 2,965 $ 1,835 $ 3,732
-------------- ------------- ------------- -------------
NET REVENUE
The Company's technology, marketing, distribution and sales efforts
have been focused on developing and accelerating product applications and
revenues in the United States, Europe, China, Australia and South America to
replace sales in Korea which have been materially lower since the beginning of
1998. During the second quarter, SONETLYNX sales to non-Korean customers
increased 203% and revenues from LANscape
9
11
video conferencing products grew 395%. Engineering services revenues grew 4%.
For the first half, corresponding percentages were 70% for non-Korean SONETLYNX,
296% for LANscape and 33% for engineering services. The overall decrease of net
revenue by 43% and 21% mainly reflects reduced sales in Korea. All revenue
differences reflect differences in product volumes, not prices.
GROSS PROFIT
SONETLYNX margins were adversely affected by decreased volume levels
reflecting the falloff in sales to Korea. Alternatively, engineering services,
DSP and video product margins improved as a result of increasing revenues.
Overall gross profit was lower by 89 % and increased 51%, respectively, over the
prior year periods from this combination of factors.
ENGINEERING AND DEVELOPMENT (E&D) EXPENSE
Combining E&D expense with capitalized software, total development
costs were reduced by 15% and 10% in the three months and six months,
respectively. E&D expense for the three months and six months ended June 30,
1998, decreased to $1,554,000 and $4,399,000, respectively, compared to
$2,522,000 and $4,982,000 in the prior year periods. In the three months,
software development costs of $1,032,000 and $532,000, respectively, were
capitalized. In the six month period, capitalized SONETLYNX software development
cost decreased to $644,000 from $1,021,000 and video software development of
$388,000 was capitalized. The total costs of development were distributed by
product line as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
1998 1997 1998 1997
-------------- ------------- -------------- ------------
($ Thousands)
Fiber optic multiplexers $ 1,276 $ 1,496 $ 2,697 $ 2,573
CS4 925 997 1,863 2,275
Video conferencing 287 200 610 438
DSP and other 98 361 261 727
------------- ------------- ------------- ------------
$ 2,586 $ $3,054 $ 5,431 $ 6,013
During the second quarter of 1998, the SONETLYNX product line was
expanded to include the international standard SDH, Synchronous Digital
Hierarchy. Branded "FibreTrax," the SDH version serves the approximately 70% of
global markets for fiber optic transmission outside North America. Also, an
interface was developed to enable communication between multiple filter rings,
including rings of different speeds. The LANscape product line was enhanced to
support Release 4.0 of Windows NT. Also, the software foundation for connecting
LANscape with other protocols was established.
E&D for the CS4 program was $938,000 and $925,000 in the first two
quarters of 1998. CS4 developments included feature enhancements, scheduling and
staffing for fabrication, and preparation for commercial product launch in 1999.
In addition to the E&D expense, fixed assets of $1,120,000 are specific to the
CS4 project.
SELLING AND ADMINISTRATIVE EXPENSE
Selling and administrative expenses in the three months and six months
ended June 30, 1998, were lower by 1% and 8%, respectively, compared to the
prior year. The expense reduction year-to-year also reflects the removal of
corporate headquarters from Bermuda during 1997, and the non-recurrence of
related extraordinary expenses.
10
12
INTEREST EXPENSE
Cash interest expense in the three months ended June 30, 1997 and 1998
was $251,000 and $256,000, respectively. For the six months ended June 30, 1997
and 1998, cash interest expense was $571,000 and $476,000, respectively.
Remaining amounts reportable as interest are non-cash expenses due to
amortization of debt discount and deferred financing costs attributable to
valuation of warrants using the Black-Scholes pricing model except that in the
first half of 1997, $582,000 of the non-cash cost was attributable to a
beneficial conversion feature of certain convertible debentures issued in 1996.
DIVIDENDS ON PREFERRED STOCK
Preferred dividends include $442,000 and $811,000 in the three months
and six months ended June 30, 1998, which the Company has elected to pay in
common stock or which accrue to be paid in common stock only upon conversion.
Also included in the reported amount are additional preferred dividends of
$96,000 and $474,000, respectively, attributable to the value of beneficial
conversion features of Series B, C and D preferred stock at date of issue.
YEAR 2000 COMPLIANCE
The Company has conducted a review of its computer systems to identify
the systems that could be affected by the "Year 2000 Problem," the result of
computer programs using two digits rather than four to define the year portion
of dates. The Company has determined that none of its significant systems fail
to comply with the ability to distinguish the year 2000 from the year 1900. The
review continues, in an ongoing process, to examine the risk, if any, to the
Company, of vendor or customer exposure to the Problem. To date, no exposure has
been discovered which would have a material adverse effect on the Company.
Certain purchased software, resold or used in company products, has been
certified by the vendors to be compliant. The financial impact of Year 2000
compliance has not been and is not anticipated to be material to the Company's
financial position or results of operations in any given year.
- --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
For the six months ended June 30, 1998, cash balances increased by
$3,496,000. During the six-month period, the increased cash balances, cash used
in operations ($12,478,000) and in investing activities ($2,527,000)were funded
by securing new financing of $18,501,000 (net of $9,853,000 of debt repayments).
OPERATING ACTIVITIES
Net cash used in operations consisted primarily of the $13,376,000 net
loss and the $2,804,000 net increase in working capital, offset by $3,702,000 of
non-cash charges. As previously discussed, the net loss primarily reflects the
costs of developing new technologies and products and the costs of operations
during a period of sharply reduced revenues following the sudden and virtual
discontinuance of sales in Korea at the beginning of 1998, as well as the effect
of the restatement of revenues.
Additionally, in this context:
o Accounts receivable were a source of funding due to collections
from customers $867,000 in excess of new shipments and billings.
o Inventory increased $1,539,000 due to restocking, longer term
purchase commitments, and production for orders received near the
end of June.
11
13
o Accounts payable were reduced $3,924,000 due to payments of
accumulated obligations in line with prior operating levels.
o The non-cash charges were primarily $1,833,000 depreciation and
amortization of intangible assets and $1,540,000 amortization of
deferred financing costs.
INVESTING ACTIVITIES
Investment accounts were increased primarily by $1,402,000 for fixed
asset additions and $1,032,000 of capitalized SONETLYNX and LANscape product
enhancements. The fixed asset additions were concentrated in computers,
software, and test equipment to support engineering activities, leasehold
improvements, and manufacturing equipment to support new products.
FINANCING ACTIVITIES
Cash uses were financed by the following transactions during the six
month period ended June 30, 1998:
o $10,000,000 from the sale of Series C preferred stock in February.
o $3,000,000 borrowed in February.
o A deferred payment arrangement converting $2,100,000 originally due in
February to monthly payments through December 1998.
o $7,000,000 borrowed in April.
o $5,000,000 from the sale of Series D preferred stock in May.
o $5,000,000 from the sale of Series D preferred stock in June.
Proceeds from these financings were used to retire maturing obligations
of $6,630,000 and $3,223,000 and for additional working capital.
OUTLOOK
The materially reduced level of sales in Korea during the first half
fell below the range of the Company's expectations. Should future sales in
Korean markets not increase to previous levels, the Company believes that
prospects are good and expanding for achieving similar and higher levels of
sales in markets other than Korea. In the alternate, should working capital
additions be required by production and sales growth in excess of current plans,
although there can be no assurance of a successful undertaking, the Company
believes it has the experience, relationships and capability to obtain necessary
financing from external sources.
The Company has continued to fund its program to complete development
and bring to market its CS4 intelligent, programmable, enhanced services
platform. The Company is also continuing its efforts to bring a third party
participant or participants into the CS4 program to provide funding, to
contribute to specification and development of selected applications, or to
augment marketing and distribution resources. The current focus of the CS4
program is to complete an initial application for a defined customer service
demonstration in beta form in the time frame of late 1998 or early 1999 and to
position a commercial version of the product for marketing in 1999. The results
of the Company's efforts to involve third party participants may be expected to
impact directly the level of expenditure, the technical and manufacturing scope
of focus, and the ultimate realization of value to the Company from the CS4
program.
Considering the financial 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 control
spending, the Company believes it has, or reasonably has access to, the
financial resources to meet its business requirements through the current year.
The Company cannot assure, however, that the business results assumed in this
outlook will be realized, especially considering the near term impact of reduced
revenues
12
14
from Korea. The Company cannot assure that profitability and positive cash flow
will be achieved when expected. If the Company's sales plans are not achieved,
operating losses and negative cash flows exceed the Company's estimates, or
capital requirements in connection with the design, development, and
commercialization of its principal products are higher than estimated, the
Company will need to raise additional capital. The Company's ability to receive
additional advances under its credit facility expired per terms, July 31, 1998.
If additional financing is in the form of debt, the prior approval of the credit
facility is required. Although the Company believes it could raise additional
capital through public or private equity or debt financings, if necessary, there
can be no assurance that such financings would be available, or available on
acceptable terms. If such financing were not available, the Company has
determined that a significant reduction of engineering, development, selling,
and administrative costs would allow the Company to continue as a going concern
through 1998. Over the longer term, sales would have to increase from current
levels for the Company to operate in its current form with its current product
portfolio.
CONTINGENT LIABILITIES
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.
RECENT DEVELOPMENTS
In connection with the Company's filing of its quarterly report for the
period ended September 30, 1998, previously recognized revenues were reviewed.
The review was performed in connection with an investigation of collectibility
of receivables from the Company's Korean distributor. The Company was advised,
at a meeting in October, of the distributor's illiquidity and inability to
maintain any certain schedule of payments of receivables. This event led to a
general review of all aspects of the business relationship, including, among
other things, an examination of terms and conditions of purchase orders from the
distributor. Two purchase orders, originally reviewed under an internal control
procedure, were determined to have been subsequently amended by the distributor
and . were accepted through the actions of an employee without proper review.
The amended purchase orders (1) extended the distributor's obligation to pay
until product was resold to an end user customer and (2) allowed for the return
of unsold product to the Company. These terms were appended only on two purchase
orders under which $1,915,000 of product was shipped. As soon as the contingent
nature of the purchase was understood, the Company concluded that the revenue
should not have been recognized. Consequently the financial statements were
restated to eliminate the recognition of $1,915,000 of revenue in the three
months ended June 30, 1998. The impact of this restatement has been reflected in
the Form 10-Q filing as of September 30, 1998, and for the nine months then
ended, as well as in this filing. The developments which have impacted the
business and outlook for the Company are more fully set forth in the section
entitled "Management's Discussion and Analysis" in the Form 10-Q/A for the
period ended September 30, 1998, filed February 16, 1999.
13
15
PART II - OTHER INFORMATION
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
Registrant with the Securities and Exchange Commission pursuant to Rule 12b-32
under the Securities Exchange Act of 1934, as amended.
Exhibit No. Exhibit
- ----------- -------
4.1 Certificate of Designations establishing the rights and preferences of
the Series D Preferred Stock(1)
4.2 Registration Rights Agreements between the Company and the Buyers,
dated May 8, 1998(1)
4.3 Registration Rights Agreement between the Company and the Buyers dated
June 26, 1998(3)
4.4 Registration Rights Agreement dated June 29, 1998 between the Company
and Lifeline Industries, Inc.(4)
4.5 Certification of Correction dated December 17, 1997 relating to the
Series B Preferred Stock(4)
4.6 Amendment to Registration Rights Agreement dated July 16, 1998 between
the company and Navesink Equity Derivative Fund LDC(4)
10.1 Securities Purchase Agreement among the Company and the Buyers, dated
May 8, 1998(1)
10.2 Assignment and Acceptance executed by St. James Partners and SJMB, L.P.
("SJMB") as to Agreement for Purchase and Sale dated February 12, 1998
by the Company and St. James Capital Partners(2)
10.3 $2,000,000 Convertible Promissory Note issued to St. James Partners by
the Company dated April 2, 1998(2)
10.4 $13,000,000 Convertible Promissory Note issued to SJMB by the Company
dated April 2, 1998(2)
14
16
Exhibit No. Exhibit
- ----------- -------
10.5 Warrant issued to St. James Partners by the Company dated April 2,
1998, exercisable as to 300,000 shares of Common Stock(2)
10.6 Warrant issued to SJMB by the Company dated April 2, 1998, exercisable
as to 1,200,000 shares of Common Stock(2)
10.7 Amendment No. 1 to Registration Rights Agreement dated as of April 2,
1998 between the Company and St. James Partners(2)
10.8 Securities Purchase Agreement dated June 26, 1998 between the Company
and the Buyers(3)
10.9 Warrant issued to Lifeline Industries, Inc. dated June 29, 1998,
exercisable as to 30,000 shares of Common Stock(4)
10.10 Warrant issued to Hambrecht & Quist LLC exercisable to purchase up to
33,036 shares of Common Stock at an exercise price of $10.292 per
share, expiring May 20, 2003(5)
10.11 Letter Agreement dated July 15, 1998 between the Company and Navesink
Equity Derivative Fund LDC(4)
10.12 Form of Amended and Restated Promissory Notes held by various
employees, directors, and related individuals of the Company with face
values totaling $440,000, convertible into Common Stock of the Company
at a rate of $4.00 per share(5)
27.1 Financial Data Schedule
(1) Incorporated herein by reference to the Form 8-K dated May 8, 1998
(2) Incorporated herein by reference to the Form 10-Q for the quarter ended
March 31, 1998
(3) Incorporated herein by reference to the Form 8-K dated June 29, 1998
(4) Incorporated herein by reference to the Form S-3 filed August 10, 1998
(5) Previously filed in Form 10-Q for the period ended June 30, 1998
C. The Company has not filed any report on Form 8-K during the period
covered by this Report, except as follows:
Form 8-K filed May 11, 1998
Form 8-K filed June 29, 1998
15
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTELECT COMMUNICATIONS, INC.
(Registrant)
Date: February 16, 1999 By: /s/ EDWIN J. DUCAYET, JR.
------------------------------- ----------------------------------
Edwin J. Ducayet, Jr.
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: February 16, 1999 By: /s/ HERMAN M. FRIETSCH
------------------------------ ----------------------------------
Herman M. Frietsch
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
16
18
EXHIBIT INDEX
-------------
Exhibit
Number Description
- ------- -----------
27.1 Financial Data Schedule