<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-QSB
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
[ ] 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 0-21999
-----------------------
NHANCEMENT TECHNOLOGIES INC.
(NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
DELAWARE 84-1360852
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
39420 LIBERTY STREET, SUITE 250
FREMONT, CALIFORNIA 94538
(Address of principal executive offices)
(510) 744-3333
(Issuer's telephone number)
-----------------------
Check whether the Issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past
12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----- -----
As of May 11, 1999, there were 5,948,335, shares of Common Stock outstanding.
Transitional Small Business Disclosure Format (check one) Yes No X
----- -----
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to the rules
and regulations of the Securities and Exchange Commission, although the
Company believes the disclosures made are adequate to make the information
presented not misleading, and, in the opinion of management, all adjustments
have been reflected which are necessary for a fair presentation of the
information shown. These unaudited financial statements should be read in
conjunction with the audited financial statements for the nine months ended
September 30, 1998. The results for the six months ended March 31, 1999 are
not necessarily indicative of the results of operations for a full year.
2
<PAGE>
NHANCEMENT TECHNOLOGIES INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
MARCH 31, 1999
- ------------------------------------------------------------------------------------------------------------------
<S> <C>
ASSETS
CURRENT
Cash and cash equivalents $1,711,400
Restricted cash 248,400
Accounts receivable, less allowance for doubtful accounts of $241,700 4,441,500
Inventory 1,354,500
Current portion of notes receivable from related parties 149,500
Prepaid expenses and other 239,400
- ------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 8,144,700
- ------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT 2,004,600
Less accumulated depreciation (785,000)
- ------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, net 1,219,600
- ------------------------------------------------------------------------------------------------------------------
Excess of cost over net assets acquired of Voice Plus, Inc., net of accumulated amortization
of $125,000 625,000
Excess of cost over net assets acquired of Infotel, net of accumulated amortization of
$143,800 1,784,200
Long-term portion of notes receivable from related parties 174,400
Other assets 25,300
- ------------------------------------------------------------------------------------------------------------------
$11,973,200
- ------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Lines of credit $792,100
Accounts payable 3,395,800
Accrued liabilities 1,264,500
Deferred revenue 1,452,800
Income tax payable 139,000
Notes payable to stockholders 1,546,700
Capital lease obligations, current portion 84,100
- ------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 8,675,000
CAPITAL LEASE OBLIGATIONS, NET OF CURRENT PORTION 95,100
- ------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 8,770,100
- ------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Convertible preferred stock, $0.01 par value, 2,000,000 shares authorized, 2,441
shares issued and outstanding 192,300
Common stock, $0.01 par value, 20,000,000 shares authorized, 5,948,335, shares
issued and outstanding 59,500
Additional paid-in capital 21,113,800
Accumulated deficit (17,911,100)
Cumulative translation loss (251,400)
- ------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 3,203,100
- ------------------------------------------------------------------------------------------------------------------
$11,973,200
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
3
<PAGE>
NHANCEMENT TECHNOLOGIES INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
1998 1999 1998 1999
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET REVENUES 968,700 $5,714,600 $2,985,700 $8,976,500
Cost of sales 655,900 3,679,700 2,167,800 5,942,800
- ------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 312,800 2,034,900 817,900 3,033,700
- ------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling, general and administrative 953,300 1,710,800 2,165,100 3,961,200
Restructuring Charges (Note 9) -- 189,000 -- 189,000
Amortization of excess of cost over net assets
acquired, including impairment loss of
$4,084,300 in fiscal 1998 75,000 110,700 4,310,100 221,200
- ------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 1,028,300 2,010,500 6,475,200 4,371,400
- ------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS (715,500) 24,400 (5,657,300) (1,337,700)
OTHER INCOME (EXPENSE)
Interest income 21,600 11,300 39,400 22,500
Interest expense (26,500) (32,400) (6,600) (97,600)
Other 35,700 18,600 23,000 18,600
- ------------------------------------------------------------------------------------------------------------------
Total other income (expense) 30,800 (2,500) 55,800 (56,500)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES (684,700) 21,900 (5,601,500) (1,394,200)
INCOME TAX BENEFIT -- -- (92,500) --
- ------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS (684,700) 21,900 (5,509,000) (1,394,200)
- ------------------------------------------------------------------------------------------------------------------
DISCONTINUED OPERATIONS
Loss from operations of Advantis (101,600) -- (98,500) --
- ------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (786,300) $21,900 ($5,607,500) ($1,394,200)
PREFERRED DIVIDENDS -- (3,400) -- (6,800)
- ------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS (786,300) $18,500 ($5,607,500) ($1,401,000)
- ------------------------------------------------------------------------------------------------------------------
BASIC AND DILUTED NET INCOME (LOSS) FROM CONTINUING
OPERATIONS PER COMMON SHARE (NOTE 7) $(.16) -- $(1.24) $(.24)
- ------------------------------------------------------------------------------------------------------------------
BASIC AND DILUTED NET LOSS FROM DISCONTINUED OPERATIONS
PER COMMON SHARE (NOTE 7) $(.02) -- $(.02) --
- ------------------------------------------------------------------------------------------------------------------
BASIC AND DILUTED NET INCOME (LOSS) PER COMMON SHARE
(NOTE 7) $(.18) -- $(1.26) $(.24)
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
4
<PAGE>
NHANCEMENT TECHNOLOGIES INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE LOSS
(UNAUDITED)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK COMMON STOCK ADDITIONAL CUMULATIVE
PAR VALUE PAR VALUE PAID IN ACCUMULATED TRANSLATION
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT LOSS TOTAL
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30,
1998 3,200 $252,200 5,579,235 $55,800 $21,020,900 ($16,510,100) ($174,900) $4,643,900
Dividends on preferred
stock converted to common
shares -- -- 4,700 100 1,900 (2,000) -- --
Dividends payable on
preferred stock -- -- -- -- -- (4,800) -- (4,800)
Preferred shares
converted into common
stock (759) (59,900) 187,200 1,800 58,100 -- -- --
Issuance of common stock
options and warrants for
payment of outside
service fees and
severance benefits -- -- -- -- 34,700 -- -- 34,700
Additional Common stock
issued for Infotel
acquisition -- -- 177,200 1,800 (1,800) -- -- --
Comprehensive loss:
Net loss -- -- -- -- -- (1,394,200) -- (1,394,200)
Cumulative translation
loss -- -- -- -- -- -- (76,500) (76,500)
- ----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive loss -- -- -- -- -- (1,394,200) (76,500) (1,470,700)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 2,441 $192,300 5,948,335 $59,500 $21,113,800 ($17,911,100) ($251,400) $3,203,100
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
5
<PAGE>
NHANCEMENT TECHNOLOGIES INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED
MARCH 31,
1998 1999
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ($5,607,500) ($1,394,200)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Loss from discontinued operations 98,500 --
Depreciation and other amortization 194,400 202,000
Amortization of excess cost over net assets acquired, including
impairment loss 4,210,300 221,200
Gain on sale of fixed assets -- (11,600)
Compensation related to grant of stock options and common stock -- 34,700
Other (100) 10,600
Changes in operating assets and liabilities:
Accounts receivable 1,000,500 85,500
Inventory 84,600 (20,900)
Prepaid expenses and other (114,900) 11,400
Other assets 300,400 221,500
Income tax payable (229,300) (86,800)
Accounts payable and other current liabilities (937,900) 907,900
- ------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED IN) CONTINUING ACTIVITIES (1,001,000) 181,300
CASH USED IN DISCONTINUED OPERATIONS (109,500) --
- ------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (1,110,500) 181,300
CASH FLOWS FROM INVESTING ACTIVITIES
Restricted cash -- 112,700
Deferred acquisition costs (135,600) --
Note receivable from related party (1,100) 12,100
Proceeds on sale of fixed assets -- 116,000
Purchase of property and equipment (79,700) (178,800)
- ------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (216,400) 62,000
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowing under line of credit 124,000 561,100
Principal payments on capital leases -- (16,400)
Principal payment on notes payable -- (700,800)
Principal payment on long-term debt due to stockholders (187,500) --
- ------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (63,500) (156,100)
- ------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash -- (53,000)
- ------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,390,400) 34,200
- ------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,326,300 1,677,200
- ------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $935,900 $1,711,400
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Interest paid $67,000 $134,400
</TABLE>
6
<PAGE>
DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Property and equipment additions of $127,400 were financed by capital lease
obligations.
7
<PAGE>
1. LIQUIDITY
The Company had net income of $21,900 for the second quarter ended
March 31, 1999; however the Company incurred losses from continuing
operations for the six months ended March 31, 1998 and 1999 of $5.6 million
and $1.4 million. The losses in 1998 included non-cash charges for
goodwill impairment of $4.0 million. At March 31, 1999, the Company had a
working capital deficit of $530,000, an improvement of $243,000 during the
quarter. The Company believes that the changes in management, cost cutting
measures and its renewed focus on its core businesses implemented in the
second fiscal quarter, along with its current customer order backlog of
$4.3 million has returned the Company to profitability and positioned it
for continued profitability. However if the Company fails to maintain
profitable operations, its financial condition would be adversely effected.
To improve its liquidity and future cash flows, management
restructured operations in early January 1999, resulting in a restructuring
charge of $189,000 in the quarter ended March 31, 1999. Additionally, the
Company increased its short-term credit facility from $1.0 million to $2.0
million. Based on discussions with its financial advisors, management
believes it can raise additional equity and is currently pursuing the
completion of the remaining $1.75 million of its Preferred Stock financing
which was approved by the Company's shareholders on April 19, 1999.
Although no assurance can be given that the above efforts will be
successful, management believes these measures, together with its cash
balance as of March 31, 1999 of about $1.7 million, will provide sufficient
cash flow for future operations.
The Company's current net tangible assets of $793,900 fail to meet the
requirements for listing on the Nasdaq SmallCap Market System. To stay
listed, the Company is required to maintain (i) net tangible assets of $2.0
million; (ii) market capitalization of $35 million; or (iii) net income of
$500,000 in the most recently completed fiscal year or in two of the last
three most recently completed fiscal years. Nasdaq is currently reviewing
management's plan to determine the propriety of continuing the Company's
listing on the Nasdaq Small Cap Market System. The Company submitted a
plan to correct its listing deficiency that was reviewed by Nasdaq at a
hearing attended by the Company on April 29, 1999. As of the date of this
filing Nasdaq has not made a determination concerning the Company's
continued listing. The Company does not currently meet these requirements,
nor can there be any assurance that the Company will in fact meet these
requirements in any future period, or that Nasdaq will rule in favor of
continued listing.
Pursuant to the Infotel Technologies (Pte) Ltd. ("Infotel")
acquisition agreement the Company is required to pay $1,390,400 to the
former Infotel shareholders 30 days after the filing of the 10-KSB which
was filed on January 13, 1999. The Company does not currently have the
available working capital necessary for payment. The Company failed to make
payment to the former Infotel shareholders as required by the terms of the
acquisition agreement. Consequently, the former Infotel shareholders had
the option of accepting either NHancement Common Stock or a minority
interest in the Common Stock of Infotel in lieu of cash. The former
Infotel shareholders had 45 days after non-payment by the Company to notify
the Company in writing of which option they had elected. As of the date of
this filing, the Company had not received written notice from the former
Infotel shareholders. Because the former Infotel shareholders did not
elect either option, the debt began accruing interest on March 30, 1999,
daily at the rate of 3% per year above the prime lending rate of The
Development Bank of Singapore Ltd. and will continue until the date payment
is made. The Company is renegotiating with the former Infotel shareholders
to defer payment and to accept a portion of the payment in additional
shares of NHancement's Common Stock.
8
<PAGE>
2. ORGANIZATION
NHancement Technologies Inc., a Delaware corporation ("NHancement" or
the "Company"), was incorporated in October 1996 as a holding company. The
business of NHancement is conducted by its operating company subsidiaries:
NHancement Technologies North America, Inc. ("NHAN NA", formerly Voice
Plus, Inc.) And Infotel. NHAN NA, a California corporation headquartered
in Fremont, California, is a systems integrator and national distributor of
voice processing and multimedia messaging equipment. Infotel, a Singapore
corporation acquired on June 22, 1998 is (i) a systems integrator of
infrastructure data communications equipment, turnkey project management
services, and radar systems; and (ii) a provider of test measuring systems.
Accordingly, the consolidated financial statements include the results of
operations from NHancement and its NHAN NA subsidiary for both periods
presented and those of Infotel for the three months and six months ended
March 31, 1999. Furthermore, the results of operations of Advantis Network
& Systems Sdn Bhd, which was acquired on December 15, 1997, are classified
as discontinued as this subsidiary was divested on September 30, 1998.
3. FINANCIAL STATEMENT PRESENTATION AND NEW STANDARDS
The accompanying consolidated financial statements as of March 31,
1999 and for the three and six months ended March 31, 1999 and 1998 are
unaudited. Certain information and footnote disclosures normally included
in the financial statements prepared in accordance with generally accepted
accounting principles ("GAAP") have been omitted. These consolidated
financial statements should be read in conjunction with the audited
financial statements and accompanying notes for the nine months ended
September 30, 1998 presented in the Company's latest annual report on Form
10-KSB.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets
and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates.
The consolidated financial statements presented herein reflect all
adjustments which are, in the opinion of management, necessary for a fair
presentation of the financial condition and results of operations for the
periods presented.
4. STOCK OPTIONS AND WARRANTS
During the six months ended March 31, 1999, the Company granted options
to purchase approximately 972,000 shares of the Company's Common Stock to
employees, and options to purchase 75,000 shares of Common Stock to outside
directors, with an exercise price of $1.125 to $1.1563 per share. In
addition the Company issued 50,000 warrants to the former CEO, with an
exercise price of $1.00 and 450,000 warrants to outside consultants to
assist the Company with acquisitions and additional financing, with an
exercise price of $1.00 to $2.00.
5. FINANCING ACTIVITIES
In October 1998, the Company through its NHAN NA subsidiary obtained a
$1.0 million accounts receivable credit line with an U.S. finance company
with an advance rate of 80% of eligible receivables at an interest rate of
2.75% per month. In January 1999, the Company's lender increased the
credit line from $1.0 million to $2.0 million and restrictions were eased
on the receivables eligible for inclusion in the Company's borrowing base.
The Company, through its Infotel
9
<PAGE>
subsidiary, is attempting to complete a credit line with a major Singapore
bank for S$3.5 million with interest at 1.25% above the bank prime rate
to be used for Infotel's overdraft protection, letters of credit, letters
of guarantee, foreign exchange and revolving credit. The Company hopes to
complete this facility within the next quarter.
In June 1998, funds were loaned to the Company by certain management
stockholders totaling $650,000. Of this amount, $125,000, $225,000 and
$300,000 were loaned to NHancement by Esmond T. Goei, Former Chairman of
the Board and Chief Executive Officer of the Company, Douglas S. Zorn,
current President and Chief Executive Officer of the Company, and James S.
Gillespie, currently a member of the Board of Directors of the Company,
respectively. The total principal and interest, originally due September
30, 1998, was repaid on November 5, 1998 without penalty.
6. UNAUDITED PRO FORMA FINANCIAL DATA
The unaudited pro forma statements of operations combine the results
of operations of the Company and Infotel for the six months ended March 31,
1998, as if the acquisition had occurred at the beginning of the period,
after giving effect to certain adjustments, including the amortization of
excess of costs over net assets acquired and interest expense on notes
payable to related parties. The following unaudited pro forma summary does
not necessarily reflect the results of operations as they would have been
had the Infotel acquisition occurred at the beginning of the period
presented and is not necessarily indicative of the results of operations
for any future period. These pro forma results exclude the loss from
discontinued operations.
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
UNAUDITED PRO FORMA
SIX MONTHS ENDED
MARCH 31, 1998
---------------------------------------------------------------------------------------------------------------
<S> <C>
Net revenues $7,182,100
Net loss ($5,151,500)
Basis and diluted net loss per common share ($1.02)
Weighted average common and common equivalent shares outstanding 5,046,700
---------------------------------------------------------------------------------------------------------------
</TABLE>
7. EARNINGS PER SHARE
Earnings per share were computed under the provisions of SFAS 128,
Earnings Per Share. The following is a reconciliation of the numerators
and denominators of the basic and diluted earnings per share computations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
NET LOSS - NUMERATOR 1998 1999 1998 1999
-------------------- ---- ---- ---- ----
-------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net income (loss) ($786,300) $21,900 ($5,607,500) ($1,394,200)
Preferred stock dividends -- (3,400) -- (6,800)
-------------------------------------------------------------------------------------------------------
Basic net income (loss) applicable to
common stock ($786,300) $18,500 ($5,607,500) ($1,401,000)
-------------------------------------------------------------------------------------------------------
Preferred stock dividends -- 3,400 -- 6,800
-------------------------------------------------------------------------------------------------------
Diluted net income (loss) applicable
to common stock ($786,300) $21,900 ($5,607,500) ($1,394,200)
-------------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
COMMON SHARES - DENOMINATOR
Basic weighted average common shares
outstanding 4,352,600 5,800,200 4,436,500 5,769,400
Options and warrants -- 23,900 -- --
Preferred Stock as if converted -- 496,200 -- --
Other contingently issuable shares -- 177,200 -- --
-------------------------------------------------------------------------------------------------------
Diluted weighted average common
shares outstanding 4,352,600 6,497,500 4,436,500 5,769,400
-------------------------------------------------------------------------------------------------------
</TABLE>
Options and warrants to purchase 2,323,400 shares of Common Stock and
Preferred Stock convertible into 496,200 shares of Common Stock were
outstanding at March 31, 1999 and options and warrants to purchase
1,116,600 shares were outstanding at March 31, 1998. A total of 23,900
options and warrants, 496,200 shares of convertible Preferred Stock and
177,200 additional consideration shares, which would be issuable according
to the antidilution provisions in the Infotel acquisition agreement, are
included in the computation of diluted weighted average common shares
outstanding at March 31, 1999. No options, warrants, or other contingently
issuable Common Shares were included in the computation of diluted loss per
common share for the six month periods ended March 31, 1999 and 1998 or the
quarter ended March 31, 1998 as the effect would be antidilutive due to
losses in the period.
8. SEGMENT REPORTING
NHancement's reportable operating segments include NHancement
Technologies N. A. (NHan NA, formerly Voice Plus) and Infotel. Infotel is
based in Singapore and derives substantially all of its revenue from sales
in Asia.
<TABLE>
<CAPTION>
Financial information for these segments includes the following:
Three months ended March 31, 1999
------------------------------------------------------------------------------------------------------------
NHAN NA INFOTEL OTHER(2) TOTAL
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Sales to external customers $3,637,100 $2,077,500 -- $5,714,600
Income (loss) from continuing operations 576,900 50,600 ($605,600) $21,900
Total assets 3,848,400 7,666,400 458,300 11,973,100
------------------------------------------------------------------------------------------------------------
<CAPTION>
Three months ended March 31, 1998
------------------------------------------------------------------------------------------------------------
NHAN NA INFOTEL OTHER(2) TOTAL
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Sales to external customers $968,300 -- $400 $968,700
Loss from continuing operations (221,300) -- (463,400) (684,700)
Total assets 2,523,700 -- 2,874,600 5,398,300
------------------------------------------------------------------------------------------------------------
<CAPTION>
Six months ended March 31, 1999
------------------------------------------------------------------------------------------------------------
NHAN NA INFOTEL OTHER(2) TOTAL
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Sales to external customers $5,034,000 $3,942,500 -- $8,976,500
Income (loss) from continuing operations 33,700 239,600 ($1,667,500) ($1,394,200)
Total assets 3,848,400 7,666,400 458,300 11,973,100
------------------------------------------------------------------------------------------------------------
<CAPTION>
Six months ended March 31, 1998
------------------------------------------------------------------------------------------------------------
NHAN NA(1) INFOTEL OTHER(2) TOTAL
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Sales to external customers $2,984,300 -- $1,400 $2,985,700
Loss from continuing operations (4,627,200) -- (881,800) (5,509,000)
Total assets 2,523,700 -- 2,874,600 5,398,300
------------------------------------------------------------------------------------------------------------
</TABLE>
(1) NHAN NA loss includes an impairment loss of $4,084,300.
(2) Other includes corporate expenses.
11
<PAGE>
9. RESTRUCTURING CHARGES
The Company restructured its operations in the second quarter ended
March 31, 1999. Restructuring charges consisted mostly of severance
payments to the former CEO and operational and administrative employees of
NHAN NA. A total of five employees were terminated in the quarter ended
March 31, 1999 and a total of $189,000 of expenses related to severance
were expensed and paid in the quarter.
10. SUBSEQUENT EVENTS
At the 1999 Annual Meeting of Shareholders held on April 20, 1999
Messrs. Zorn, Gillespie, Schmier and Walko were elected to the Board of
Directors. Additionally the Board appointed Donna M. Pulvermacher as
acting Chief Financial Officer and Treasurer and Linda V. Moore to the
office of Secretary of the Company.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
NHancement Technologies Inc. ("NHancement" or the "Company") is an
integrator and distributor of voice processing equipment and
telecommunications systems in the United States and Asia.
The Company's consolidated financial statements include the accounts of
the Company and its two operating segments: NHancement Technologies North
America, Inc. ("NHAN NA" formerly Voice Plus, Inc.) and Infotel Technologies
(Pte) LTD. ("INFOTEL").
During 1998, the Company changed its fiscal year end from December 31 to
September 30. As a result of this change the Company's 1998 fiscal year
ended on September 30, 1998 and its 1999 fiscal year began on October 1, 1998.
The following contains forward-looking statements regarding future
events or the future financial performance of the Company that involve risks
and uncertainties. Certain statements included in this Form 10-QSB,
including, without limitation, statements related to anticipated cash flow
sources and uses under "Liquidity and Capital Resources", the mitigation of
the Year 2000 issue under "Impact of the Year 2000 Issue" and other
statements contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" regarding the Company's financing
alternatives, financial position, business strategy, plans and objectives of
management of the Company for future operations, and industry conditions, are
forward-looking statements. Any forward-looking statements herein are subject
to certain risks and uncertainties in the Company's business, including but
not limited to, the risk of delisting of the Company's Common Stock, reliance
on key customers and competition in its markets, market demand, business
strategy, product performance, technological developments, maintenance of
relationships with key suppliers, difficulties of hiring and retaining key
personnel and the changes in current accounting rules, all of which may be
beyond the control of the Company. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth herein.
GENERAL
Management's Discussion and Analysis of Consolidated Results of
Financial Condition and Results of Operations ("MD&A") should be read in
conjunction with the consolidated financial statements included herein.
Further, this second fiscal quarterly report on Form 10-QSB should be read in
conjunction with the Company's Consolidated Financial Statements and Notes to
Consolidated Financial Statements included in its 1998 Annual Report on Form
10-KSB. In addition, you are urged to read this report in conjunction with
the risk factors described herein.
In this MD&A, the Company explains its results of operations and
discusses its financial condition for the three and six-month fiscal periods
ended March 31, 1999, as compared to the corresponding periods in 1998. The
discussion of financial condition includes: (1) changes in the voice
processing, data processing and communications industries including how the
company expects these changes to influence future results of operations; and
(2) liquidity and capital resources, including discussions of capital
financing activities and uncertainties that could affect future results.
On November 20, 1998, the Company informed Nasdaq that due to continued
losses it no longer met the requirements for continued listing on the Nasdaq
SmallCap Market System. Specifically, the Company failed to meet the
requirements of Nasdaq Marketplace Rule 4310(c)(2) which requires that an
issuer maintain (i) net tangible assets of $2.0 million; (ii) market
capitalization of $35 million; or (iii) net
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<PAGE>
income of $500,000 in the most recently completed fiscal year or in two of
the last three most recently completed fiscal years.
The Company currently does not meet these requirements and recently
received correspondence from Nasdaq stating that Nasdaq plans to delist the
Company's Common Stock. Management met with Nasdaq on April 29, 1999 to
discuss the Company's plan to regain listing compliance and the continued
listing of its Common Stock. Although the Company presented plans to bring
NHancement back into compliance with Nasdaq listing requirements, there can
be no assurance that the Company's plan will be accepted and that its Common
Stock will not be delisted. Further, there can be no assurance that if the
Company's stock is delisted that the Company will in the future meet the
listing requirements for the Nasdaq SmallCap Market System.
Although the Company had net income of $21,900 for the current quarter
ended March 31, 1999 the Company incurred losses from continuing operations
for the six months ended March 31, 1998 and 1999 of $5.6 million and $1.4
million. The Company believes that the changes in management implemented in
January 1999 and the corresponding cost reduction measures implemented
primarily through a 10% headcount reduction and certain operating expense
cutbacks in travel, outside services, discretionary sales costs, corporate
overhead and administrative costs, along with its current backlog of
approximately $4.3 million, has returned the Company to profitability and
positioned it to remain profitable in the future. Currently management
believes that this return to profitability coupled with an increased credit
facility and planned financing activities will provide adequate cash flow for
future operations, although no assurances can be given that current efforts
will be successful.
RESULTS OF OPERATIONS
In this section, the Company provides the components of its earnings and
explains variances within revenues and expenses for the fiscal three and
six-month periods ended March 31, 1999 and 1998.
The following table shows results of operations, as a percentage of net
sales, for the six-month periods ended March 31, 1999 and 1998.
NHANCEMENT TECHNOLOGIES INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------
SIX MONTHS ENDED
MARCH 31,
1998 1999
------------------------------------------------------------------------------------
<S> <C> <C>
Net sales 100.0 % 100.0 %
Cost of sales 72.6 % 66.2 %
Gross profit 27.4 % 33.8 %
Selling , general and administrative expenses 72.5 % 46.2 %
Loss on impairment and amortization of excess of cost
over net assets acquired 144.4 % 2.5 %
Loss from operations (189.5)% (14.9)%
Other income (expense) 1.9 % (0.6)%
Loss from continuing operations before income taxes (187.6)% (15.5)%
Income tax benefit (3.1)% 0.0 %
Loss from continuing operations (184.5)% (15.5)%
Loss from discontinued operations (3.3)% --
Net loss (187.8)% (15.5)%
------------------------------------------------------------------------------------
</TABLE>
14
<PAGE>
The Company's primary focus in the six months ended March 31, 1999 was
as an integrator and distributor of voice processing, data processing and
communications systems. These operations were conducted through the Company's
NHAN NA and Infotel subsidiaries. Company-wide revenue for the quarter ended
March 31, 1999 increased $4.7 million to $5.7 million as compared to $1.0
million for the same period in 1998. Fiscal year to date revenue increased
200% from $3.0 million to $9.0 million. The increase in revenues for the
three and six month periods in 1999 is due primarily to: (i) the fact that no
Infotel revenues were recorded in the three or six month period ended March
31, 1998 while Infotel revenues are included in 1999 and (ii) an increase in
NHAN NA second quarter 1999 revenues as the Company refocused on its core
business. NHAN NA's net sales for the second quarter of 1999 as a stand-alone
business increased 275%, from $1.0 million for the three months ended March
31, 1998 to $3.6 million for the three months ended March 31, 1999. On a
fiscal year to date basis, NHAN NA's sales increased 67% from $3.0 million
for the six months ended March 31, 1998 to $5.0 million for the six-month
period ended March 31, 1999. The increase in NHAN NA revenues came from
increased sales within its existing customer base and from new customers.
One-fourth of the second quarter NHAN NA revenues came from the new
interactive communication systems being sold by NHAN NA. NHAN NA's order
backlog at March 31, 1999 increased to $2.9 million from $1.6 million the
previous quarter while Infotel's backlog remained fairly constant at $1.4
million. Consequently, management believes that revenues for the third fiscal
quarter will continue to be strong.
Based on the estimated future undiscounted operating cash flows of its
related businesses, the Company periodically evaluates the carrying value of
goodwill associated with its subsidiaries. Due to issues not known by
management at the time of the NHAN NA acquisition, the estimated future
undiscounted operating cash flows of NHAN NA were calculated to be less than
those estimated at the time of its acquisition, February 1997, and less than
the period ending carrying amounts of the excess of cost over net assets
acquired. On December 31, 1997 and September 30, 1998, the Company recorded
impairment losses of $4,084,300 and $525,000, representing the difference
between the carrying amount of goodwill over its estimated fair value. As a
result of these changes, the remaining balance of the NHAN NA goodwill at
September 30, 1998 was reduced to $750,000 and the useful life was reduced to
three years. Management believes that during 1999, revenues for legacy
systems will decline and that NHAN NA revenues will come increasingly from
new technologies and products that were recently introduced to the
marketplace and constituted one-quarter of NHAN NA's second quarter revenue.
The Company is in the process of repositioning its NHAN NA subsidiary to take
advantage of the new trends in the voice processing industry, specifically
the migration from legacy systems to the new interactive communication
systems that merge voice and data communications into a single computer based
system.
The Company's Infotel subsidiary located in Singapore was acquired on
June 22, 1998. Therefore, there were no revenues or income recorded on the
Company's financial statements related to this subsidiary for the three or
six month periods ended March 31, 1998. On a stand-alone basis, net sales
for the second quarter decreased 3% from $2.2 million at March 31, 1998
(preacquisition operating results) to $2.1 million for the same period in
1999. On a fiscal year to date basis revenues are down 6% from $4.2 million
to $3.9 million. The decline in revenue occurred within the networking
products and project management services business segments, due to slower
than expected customer acceptance rates resulting from delays in project
documentation and testing. Management anticipates these issues to be
corrected by fiscal year-end.
Company-wide gross margins for the three months ended March 31, 1999
improved to 35.6% from 32.3% in the same period in 1998. For the six months
ended March 31, 1999, company-wide gross margins improved to 33.8% from
27.4%. NHAN NA's gross margin on a stand-alone basis increased from 32.3%
to 37.9 % for the quarter ended March 31, 1999 as compared to the same period
of 1998, due to lower overhead costs as a percentage of total revenue. For
the six months ended March 31, 1999, NHAN NA's gross margin improved to 34.6%
from 28.3% due to lower product and overhead costs as a
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<PAGE>
percentage of revenue. Infotel's gross margin on a stand-alone basis
declined to 31.6% of sales versus 34.4% of sales for the quarter ended March
31, 1998. Infotel had one-time exceptionally high margins on network revenue
in the March quarter of 1998 due to special pricing that was negotiated on a
bulk deal for two large orders in the same quarter. As special pricing was
not available during 1999, gross margins on these items returned to
historical levels accounting for the decline in gross margin as a percent of
revenues for the quarter ended March 31, 1999. For the six-month periods
ended March 31, 1999 and 1998, Infotel's gross margin improved slightly to
32.8% from 31.5% due to the recording of commission revenues of $0.2 million
in the December 31, 1998 quarter with no offsetting costs, while no
commission revenues were earned in the same period of 1998. Infotel earns
commission when its vendors (Motorola and Rhode & Schwartz) sell directly to
end-user customers in Infotel's territory.
Company-wide selling, general and administrative ("SG&A") expenses as a
percentage of net sales decreased to 33.2% for the three months ended March
31, 1999 versus 98.4% for the same period in 1998. For the six months ended
March 31, 1999, SG&A improved to 46.2% from 72.5% on a company-wide basis.
SG&A for NHAN NA on a stand-alone basis decreased to 19.0% for the second
fiscal quarter of 1999 compared to 49.7% for the same three-month period in
1998. For the six months ended March 31, 1999 NHAN NA's SG&A expenses as a
percentage of revenues improved from 43.2% to 29.4%. The decrease in the
quarter and fiscal year to date is due primarily to: (i) a substantial
increase in the quarter and fiscal year to date revenue versus the prior
year, (ii) a decrease in salary expenses as a percentage of revenue due to a
reduction in headcount from the implementation of management's restructuring
plan as well as reductions in overhead costs as percent of revenue and (iii)
a decrease in other expenses including advertising, office supplies and
repairs as a percentage of revenue. On a stand-alone basis, Infotel's SG&A as
a percent of revenues increased slightly to 30.1% for the three months ended
March 31, 1999 compared to 28.8% for the three months ended March 31, 1998,
on a fiscal year to date basis, Infotel's SG&A as a percent of revenues
increased slightly to 26.0% from 24.7% a year ago; on a dollar basis,
Infotel's SG&A for the quarter and six month periods was relatively
unchanged from the same periods a year ago; thus the percentage increase was
due to a small decrease in Infotel's revenues during the current quarter and
the six months ended March 31, 1999. NHancement's corporate overhead costs
increased by $135,000 for the three months ended March 31, 1999 due primarily
to increased salary expenses for severance pay to the former CEO. Fiscal year
to date corporate overhead costs increased due to (i) increased outside
services as a result of an aborted financing; (ii) increased costs for audit
and legal related to the reporting requirements of the company resulting from
its expansion from the acquisition of Infotel and the preparation of a
special proxy statement related to the Company's Preferred Stock financing;
and (iii) relocation and severance expenses related to the former CEO.
At March 31, 1999, the Company provided a 100% reserve against its
deferred tax assets. The Company believes sufficient uncertainty exists
regarding the realizability of the deferred tax assets, such that a full
valuation allowance is required. The Company currently has a $2.5 million
federal net operating loss carryforward available, after considering
limitations on the use of such carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Although the acquisition of complimentary businesses and products has
been an element of the Company's business strategy, the Company's current
ability to engage in acquisitions is subject to severe limitations given the
Company's present financial condition. To engage in such activity, the
Company will need to obtain additional debt or equity financing, neither of
which may be available or, if available, may not be on terms acceptable to
the Company. Debt financing may require the Company to pay significant
amounts of interest and principal payments, thus reducing the resources
available to expand its existing businesses. Equity financing may dilute the
Company's existing stockholders' interest in the
16
<PAGE>
assets or earnings of the Company. There can be no assurance that the
Company will be able to obtain either debt or equity financing if and when it
is needed for acquisitions or general working capital purposes. In April of
1998, the Company negotiated a preferred stock financing for $3.0 million, of
which $1,250,000 was received with substantially all of the net proceeds
having been used for the acquisition of Infotel. The Company recently
received approval of its shareholders to complete the remaining $1.75 million
of the Preferred Stock offering. As part of its effort to regain compliance
with Nasdaq listing requirements, management has obtained written commitments
from its Preferred Stock investors to fund the remaining $1.75 million.
During the six months ended March 31, 1999, net cash provided by
operating activities was $0.2 million. Sources of cash consist primarily of
accounts receivable collections, a decrease in other assets, and an increase
in accounts payable, offset by cash used to fund the Company's net operating
losses. Net cash used by investing and financing activities totaled $0.1
million consisting of: (i) purchases of property and equipment for the
Company's internal computer system and (ii) payment of the notes payable to
management offset by increased borrowings under the Company's line of credit.
At March 31, 1999, the Company's working capital deficit was $0.5 million,
an improvement of $0.3 million over the quarter ended December 31, 1998. The
Company had a cash balance of $1.7 million at March 31, 1999. The Company's
current ratio improved slightly to 0.94 to 1.0 at March 31, 1999. Management
believes that available cash reserves coupled with additional available
credit and improved earnings will provide adequate funds for future
operations, although no assurance can be given that current efforts will be
successful.
In October 1998, the Company through its NHAN NA subsidiary obtained a
$1.0 million accounts receivable credit line with a local finance company
with an advance rate of 80% of eligible receivables at an interest rate of
2.75% per month. In January 1999, the Company's lender increased the credit
line from $1.0 million to $2.0 million and restrictions were eased on the
receivables eligible for inclusion in the Company's borrowing base. The
Company, through its Infotel subsidiary, is attempting to complete a credit
line with a major Singapore bank for S$3.5 million with interest at 1.25%
above the bank prime rate to be used for Infotel's overdraft protection,
letters of credit, letters of guarantee, foreign exchange and revolving
credit. The Company hopes to complete this facility during the next quarter.
The Company's management estimates that it will incur less than $200,000
in capital expenditures during the next 12 months, representing mostly
company-wide business systems hardware and communication systems. The Company
anticipates that all major capital expenditures will be financed through
equipment leases and will not require significant direct outlays of cash.
Pursuant to the Infotel acquisition agreement the Company is required to
pay $1,390,400 to the former Infotel shareholders 30 days after the filing of
the 10-KSB which was filed on January 13, 1999. The Company does not
currently have the available working capital necessary for payment. The
Company failed to make payment to the former Infotel shareholders as required
by the terms of the acquisition agreement. Consequently, the former Infotel
shareholders had the option of accepting either NHancement Common Stock or a
minority interest in the Common Stock of Infotel in lieu of cash. The former
Infotel shareholders had 45 days after non-payment by the Company to notify
the Company in writing of which option they had elected. As of the date of
this filing, the Company had not received written notice from the former
Infotel shareholders. Because the former Infotel shareholders did not elect
either option, the debt began accruing interest on March 30, 1999, daily at
the rate of 3% per year above the prime lending rate of The Development Bank
of Singapore Ltd. and will continue until the date payment is made. The
Company is renegotiating with the former Infotel shareholders to defer
payment and to accept a portion of the payment in additional shares of
NHancement's Common Stock.
Based upon its present earnings and cost reduction plans, management
believes that operating cash
17
<PAGE>
flow, available cash and available credit are adequate to meet the working
capital needs of the Company and its subsidiaries during the next 12 months.
Although the Company intends to issue shares of Common Stock as its primary
method of financing acquisitions, it anticipates that additional funds will
be required to successfully implement any acquisition program.
RISK FACTORS
The following risk factors, in addition to the risks described elsewhere
in the description of the Company's business in this report on Form 10-QSB,
may cause actual results to differ materially from those in any
forward-looking statements contained in the business description, MD&A or
elsewhere in this report or made in the future by the Company or is
representatives. Such forward-looking statements involve known risks,
uncertainties and other factors that may cause the actual results,
performance or achievements of the Company to differ materially from those
expressed or implied by such forward-looking statements.
RISKS ASSOCIATED WITH DELISTING OF COMMON STOCK; PENNY STOCK RULES.
Although the Common Stock was approved for quotation on the Nasdaq
SmallCap Market System in connection with the Company's IPO, there can be no
assurance that it will remain eligible to be included on the Nasdaq SmallCap
Market System. In this regard, on November 20, 1998, the Company informed
Nasdaq that due to continued losses it no longer met the requirements for
continued listing on the Nasdaq SmallCap Market System. Specifically, the
Company failed to meet the requirements of Nasdaq Marketplace Rule 4310(c)(2)
which requires that an issuer maintain: (i) net tangible assets of $2.0
million; (ii) market capitalization of $35 million; or (iii) net income of
$500,000 in the most recently completed fiscal year or in two of the last
three most recently completed fiscal years. Nasdaq is currently reviewing
the propriety of continuing the Company's listing on the Nasdaq SmallCap
Market System. The Company has submitted a plan to correct its listing
deficiency which was reviewed by Nasdaq at a hearing attended by the Company
on April 29,1999. There can be no assurance that the Common Stock will
remain listed. If the Company's Common Stock is delisted from the Nasdaq
SmallCap Market System, the Company will become subject to the Securities and
Exchange Commission's "penny stock" rules, and as a result, an investor will
find it more difficult to dispose of, or to obtain accurate quotations as to
the price of, the Company's Common Stock.
The "penny stock" rules under the Securities and Exchange Act of 1934
imposes additional sales practice and market-making requirements on
broker-dealers who sell and/or make a market in such securities. For
transactions covered by the penny stock rules, a broker-dealer must make
special suitability determinations for purchasers and must have received the
purchaser's written consent to the transaction prior to sale. In addition,
for any transaction involving a penny stock, unless exempt, the rules require
delivery prior to any transaction in a penny stock of a disclosure schedule
prepared by the Commission relating to the penny stock market. Disclosure is
also required to be made about commissions payable to both the broker-dealer
and the registered representative and current quotations for the securities.
Finally, monthly statements are required to be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market and penny stocks. As a result, if the Company were to be
delisted from the Nasdaq SmallCap Market System and become subject to the
rules on penny stocks, it would negatively affect the ability or willingness
of broker-dealers to sell or make a market in the Company's securities and,
therefore, would severely and adversely affect the market liquidity for the
Company's Common Stock.
PRIOR LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY.
Although the Company recorded net income of $21,900 on net revenues of $5.7
million for the
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<PAGE>
quarter ended March 31, 1999, on a fiscal year-to-date basis the Company
incurred a loss of $1.4 million on $9.0 million in revenue. The failure of
the Company to produce positive operating results in the future may affect
the future value of the Common Stock, may contribute to the Company losing
its eligibility for listing of the Common Stock on the Nasdaq SmallCap Market
System, may adversely affect the Company's ability to obtain debt or equity
financing on terms acceptable to the Company, may prevent the Company from
engaging in acquisition activity and could have a material adverse effect on
the financial condition of the Company.
VOLATILITY OF STOCK PRICES.
The over-the-counter markets for securities such as the Common Stock
historically have experienced extreme price and volume fluctuations during
certain periods. Other factors that may also adversely affect the market
price of the Common Stock include new product developments, trends in the
Company's industry, trends in the investment markets generally, as well as
economic conditions and quarterly variations in the Company's results of
operations. In addition, there can be no assurance that the Company's Common
Stock will remain eligible for listing on the Nasdaq SmallCap Market System.
FINANCING RISKS.
The acquisition of complementary businesses is still an element of the
Company's business strategy. If a cash payment in excess of available
working capital is required to make an acquisition, the Company will need to
obtain additional debt or equity financing. Debt financing may require the
Company to pay significant amounts as interest and principal payments, thus
reducing the resources available to expand its existing businesses. Equity
financing may be dilutive to the Company's existing stockholders' interest in
the assets or earnings of the Company. There can be no assurance that the
Company will be able to obtain either debt or equity financing if and when it
is needed for acquisitions or that, if available, such financing will be
available on terms the Company deems acceptable. The inability of the
Company to obtain such financing would have a material adverse effect on the
Company's acquisition strategy. Further, the refusal of potential
acquisition candidates to accept Common Stock in payment of the Company's
purchase price obligations, in whole or in part, could require the Company to
curtail its acquisition strategy altogether. To the extent that Common Stock
is used as consideration in an acquisition transaction, such stock issuance
may be dilutive to the Company's existing stockholders. Even if the Company
is able to obtain financing needed for an acquisition, the terms of such
financing may involve considerable costs to the Company. In this regard, as
of March 31, 1999, of the original 12,500 shares of convertible Preferred
Stock sold in April of 1998, 10,059 shares plus accrued dividends were
converted into 901,160 shares of Common Stock at an average price per share
of about $1.13. The Company intends to soon complete the remaining $1.75
million of the convertible preferred financing. As part of its effort to
regain compliance with Nasdaq listing requirements, the Company has obtained
written commitments from its Preferred Stock investors to fund the remaining
$1.75 million.
RELIANCE UPON COMPANY'S DISTRIBUTOR AND SUPPLIER RELATIONSHIPS; DEPENDENCE ON
SIGNIFICANT CUSTOMERS.
The Company's business is based upon the integration of hardware,
software, and communications and data processing equipment manufactured by
others into systems designed to meet the needs of its customers. Although
the Company has distributor agreements with a number of equipment
manufacturers, a major portion of its revenue is based upon products
manufactured by Centigram Communications Corporation ("Centigram") or
Baypoint Innovations ("Baypoint"), the Mitel Corporation subsidiary which
purchased Centigram's customer premises equipment ("CPE") business. The
Company depends upon Centigram and Baypoint to offer products that are
competitive with products offered by other manufacturers as to technological
advancement, reliability and price. If
19
<PAGE>
Centigram's or Baypoint's competitors should surpass them in any of these
qualities, the Company may be required to establish alternative strategic
relationships. Any such development, or any other adverse change in the
Company's distributor relationship with Centigram or Baypoint, would
adversely affect the Company's business for an indeterminate period of time
until new supplier relationships could be established. In this regard, the
distributor agreement entered into with Centigram may be canceled by either
party upon ninety (90) days' notice and is subject to termination in the
event that the Company defaults on or is otherwise in breach of various of
its obligations under the agreement. Baypoint has continued to distribute the
CPE products and honor the NHAN NA distribution agreement. Any disruption to
product supplied by Centigram or Baypoint would have a significant adverse
impact upon the Company's business for an indeterminate period of time until
new supplier relationships could be established.
In July 1998, the Company signed a "Premier Partner" distribution
agreement with Interactive Intelligence, Inc. ("I3") for the distribution of
its Enterprise Information Center ("EIC") product, a next generation
communication server which merges voice and data functions into a single
computer-based system. Revenue from this product accounted for one-fourth of
NHAN NA revenues in the current quarter ended March 31, 1999. Any disruption
to this relationship or to the products supplied by I3 would have a
significant adverse impact upon the Company's business for an indeterminate
period of time until a new supplier relationship could be established.
NHAN NA has distributor agreements with a number of equipment
manufacturers in addition to Centigram and I3. In accordance with the terms
of these distributor agreements, a manufacturer may discontinue the
distributor relationship because of factors related to a particular
distributor or because of a manufacturer's decision to change its method of
distributing its products to all or parts of its markets. In making such a
change, a manufacturer of key products sold by a distributor may effectively
become a direct competitor of its former distributor. Moreover, a
manufacturer may reduce its dealer discounts, eliminate any exclusive
distribution rights, and/or reduce the manufacturer's support of a
distributor or otherwise adversely affect the competitive environment in
which the distributor sells the manufacturer's products. Any material change
in NHAN NA's distributor relationships with its key suppliers or any
interruption of the delivery of equipment to NHAN NA by any of its key
suppliers would have a material adverse effect upon the Company.
Infotel offers a wide range of infrastructure communications equipment
products. Products supported include manufacturers such as Motorola,
Ericsson, Raytheon, Newbridge and Shiva Corp., Rohde & Schwartz Gmbh, and
Siemans. Infotel also has an established business providing test measuring
instrumentation and testing environments. The business grew out of a
communications relationship with a German conglomerate, Rohde & Schwartz
Gmbh, which evolved into a dependency on Infotel to service other Rohde &
Schwarz products such as test instruments. Infotel is now the regional
distributor and test and repair center for Rohde & Schwarz test instruments,
which provides a steady stream of revenues. Infotel has since expanded its
repair capability to include Alcatel mobile telephones. Infotel focuses
principally on large projects in the government and institutional sectors as
well as in the commercial sector. Any material change in Infotel's
relationship with these manufacturers or any interruption to deliveries to
Infotel by any of its key suppliers would have a material adverse affect upon
the Company.
The Company currently services approximately 1000 customers. Revenues
from the Company's two largest customers accounted for approximately 13% and
7% of total revenues during the six-month period ended March 31, 1999. While
the Company has considerably broadened its customer base, the concentration
of revenues derived by these two customers results in additional risk to the
Company and any disruption of orders from either of these customers would
have an adverse effect on the Company.
20
<PAGE>
COMPETITION IN NHAN NA'S VOICE PROCESSING AND CUSTOMER PREMISES EQUIPMENT
BUSINESSES.
The voice processing and customer premises equipment markets are highly
competitive and competition in this industry is expected to intensify with
the introduction of new product enhancements and new competitors. NHAN NA
competes with a number of larger integrated companies that provide
competitive voice processing products and services as subsets of larger
product offerings, including all the former regional Bell operating companies
and major PBX equipment manufacturers, such as Fujitsu Limited and Lucent
Technologies Inc. ("Lucent"), formerly a division of AT&T. These integrated
public company competitors are substantially larger than the Company and have
substantially greater revenues than the Company, and, as a result, may
encroach on the Company's voice processing equipment and service markets.
Additionally, in the CPE markets, NHAN NA competes with two types of
equipment companies: (i) interconnects (PBX providers), including Lucent,
Northern Telecom Limited, Fujitsu Limited and NEC Corporation, and (ii)
independent voice processing manufacturers, such as Octel Communications
Corporation (now owned by Lucent). Digital Sound Corporation, Active Voice
Corporation, Applied Voice Technology, Inc., Glenayre Technologies, Inc. and
Comverse Technology, Inc., among others, also compete with the Company in the
service provider market. NHAN NA's competitors have better name recognition
in the market; a larger installed base of customers and greater financial,
marketing and technical resources than the Company.
COMPETITION IN INFOTEL'S INFRASTRUCTURE COMMUNICATIONS EQUIPMENT BUSINESSES.
Infotel competes against several large companies in Singapore that are
better capitalized. Although Infotel has in the past managed to compete
successfully against such larger companies on the basis of its engineering
and project management expertise, there can be no assurance that such
expertise will permit Infotel to compete effectively with such larger
companies in the future. Further, various large manufacturers have
established their own branch offices in Singapore and compete against
Infotel.
RISKS IN INTEGRATING ACQUIRED COMPANIES.
Acquisitions may involve a number of special risks, including adverse
short-term effects on the Company's operating results, diversion of
management's attention from the operations of the Company, dependence on
retention, hiring and training of key personnel, risks associated with
unanticipated problems or legal liabilities and amortization of acquired
intangible assets, some or all of which could have a material adverse effect
on the Company's operations and financial performance. Successfully
integrating the operations of additional companies into those of the Company
will require the cooperative efforts of the managers and employees of the
respective business entities, including the integration of the owners or
managers of smaller companies into roles that require them to report to
supervisors. Significant costs and management time may be required to
integrate management control systems. Furthermore, to manage its operations
effectively, the Company must continue to improve its operational, financial
and management controls and information systems, to accurately forecast sales
demand, to control its overhead and to manage its marketing programs. As
discussed in previous sections, the acquisition of NHAN NA and Advantis,
prior to its divestiture, have yielded operating results that were
significantly lower than expected. Other acquisitions could generate results
different from our expectations. Accordingly, no assurance can be given that
the future performance of the Company's subsidiaries will be commensurate
with the consideration paid to acquire such companies. If management fails
to establish the needed controls and to manage growth effectively, the
Company's operating results, cash flows and overall financial condition will
be adversely affected.
21
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RISKS INVOLVED IN CHANGES OF MANAGEMENT.
Management changes often have a disruptive effect on businesses and can
lead to the loss of key employees because of the uncertainty inherent in
change. On January 6, 1999, Esmond Goei resigned his position as President
and CEO of the Company. Mr. Zorn became interim President and CEO to fill
the vacancies created by Mr. Goei's resignation and on February 2, 1999 the
Board of Directors elected Mr. Zorn to the offices of President and Chief
Executive Officer. On April 20, 1999, the Board appointed Donna M.
Pulvermacher as Acting Chief Financial Officer and Treasurer and Linda V.
Moore to the office of Secretary of the Company. The loss of the key
employees of the Company could have a materially adverse effect on the
Company's operations. Furthermore, no assurances can be given that the
current changes in management of the Company will be adequate to maintain the
Company's profitability or to meet future growth targets.
YEAR 2000 COMPLIANCE
The Company has developed an implementation plan to correct any internal
computer systems that could be affected by the "Year 2000" issue. The Year
2000 problem is the result of computer programs being written using two
digits (rather than four) to define the applicable year. Software programs
that have time-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a major system failure
or miscalculations. The Company presently believes that, with modifications
to or replacement of existing software, the Year 2000 problems will not pose
significant operational problems for the Company's domestic computer systems.
The Company believes that the costs associated with any such upgrade or
replacement of software will not be material, and that all such changes will
be implemented by the end of calendar year 1999. However, if such
modifications are not made in a timely manner, or are not made properly, the
Company may be unable to implement appropriate Year 2000 solutions, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's internal computer systems for North American operations
were purchased in 1998 from well recognized companies and are stipulated by
the manufacturers to be Year 2000 compliant. As for Asian operations, the
Company recently completed its review of the internal computer systems of
Infotel and discovered that Infotel's systems are not Year 2000 compliant. A
plan has been established to purchase a package that is year 2000 compliant
and to install the system in the summer of 1999. The estimated cost of the
new business systems for all locations combined is $425,000 of which $350,000
has been incurred; such systems are needed not only to remedy Year 2000
compliance problems but also to maintain proper controls for management of
the Company.
The Company distributes products from third party voice product
equipment manufacturers in North America, some of which are susceptible to
Year 2000 problems. During fiscal year 1997, the Company initiated a review
of the products that its domestic subsidiary, NHAN NA, distributes to
determine which, if any, are not capable of recognizing the year 2000.
Communications were initiated with all of the manufacturers of such products
to determine the nature and extent of any Year 2000 problems. Where
potential Year 2000 computer problems contained in the products used or
distributed by the Company have been identified, the manufacturers have
stated that they have committed resources to resolve such problems prior to
year 2000. However, there can be no assurance that these manufacturers will,
in fact, timely complete the resolution of their Year 2000 problems or, even
if timely completed, that those solutions will be acceptable in the
marketplace. The solution to be provided by some manufacturers will involve
a significant upgrade cost to the end user, which may give rise to disputes
and/or litigation between the end user and the manufacturer, which may also
involve the Company. The costs of such possible disputes or litigation could
be significant, thereby resulting in a material adverse effect on the
Company's business, financial condition and results of operations.
22
<PAGE>
Infotel, the Company's Singapore subsidiary has not conducted a review
of the products it distributes to determine which, if any, are not capable of
recognizing the year 2000. To determine product confidence, Infotel provides
its customers with the suppliers' compliance or their website information.
As a result, the Company is currently unable to determine whether there are
any Year 2000 problems associated with such third-party products, and, if so,
whether the manufacturers will be able to timely resolve any such problems.
The Company also has not been able to determine whether the legal systems of
Singapore would result in more or less litigation exposure to the Company and
its subsidiaries if there were disputes between the end user of a product
installed by Infotel, and the manufacturer.
23
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 30, 1998, a case entitled C.C.& Associates, et al. V. NHancement
Technologies, Inc., et al. was filed in Santa Clara County Superior Court.
The complaint was allegedly served in September 1998. The dispute arises out
of the request for payment of legal and accounting expenses pursuant to a
non-binding letter of intent. On December 19, 1998, plaintiff filed with the
court a Request for Entry of Default and Clerk's Judgement ("Request")
against the Company in the amount of $54,722.00. On January 30, 1999,
plaintiff agreed to withdraw the Request and allow the Company to answer the
complaint. The Company is contesting the allegations, in particular, the
amount allegedly owing. The Company cannot presently make any determination
regarding the probable outcome of the litigation; however, the parties have
agreed to mediate the dispute within the next sixty (60) days and it is not
anticipated that the resolution will have a material adverse effect on the
financial condition and operations of the Company.
ITEM 2. CHANGES IN SECURITIES
OPTION AND WARRANT GRANTS IN LAST FISCAL QUARTER
<TABLE>
<CAPTION>
CLASS OF DATE OF TITLE OF NUMBER OF SHARES AGGREGATE
PURCHASERS(1) SALE NHANCEMENT PRUCHASE FORM OF
SECURITIES PRICE CONSIDERATION
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Options granted to twenty-eight Shares of
employees(2) 2/02/99 Common Stock 849,500 (2) (2)
Shares of
Options granted to three 2/02/99 Common Stock 75,000 (3) (3)
directors(3)
Shares of
Warrants granted to former CEO(4) 1/06/99 Common Stock 50,000 (4) (4)
Warrants granted to outside Shares of
consultants(5) 2/02/99 Common Stock 300,000 (5) (5)
</TABLE>
(1) The grant of options and warrants to the individuals identified in the
table above were made in reliance on Section 4(2) of the Securities Act of
1933, as amended (the "1933 Act"), and /or Regulation D promulgated
thereunder.
(2) The options were granted to employees of NHancement under the Company's
Equity Incentive Plan. The options are incentive stock options, generally
expire ten years from the date of grant and become exercisable based on the
Company and individual performance for 50% of the shares on the first year
anniversary of the date of grant, and 50% on the second anniversary. The
exercise price on the date of grant was equal to or greater than 100% of
the fair market value as determined on the date of grant.
(3) The options were granted to three outside directors under the Company's
Equity Incentive Plan. The options are non-statutory stock options,
generally expire ten years from the date of grant and the options become
exercisable at the rate of 1/365 per day. The exercise price on the date
of grant was equal to or greater than 100% of the fair market value as
determined on the date of grant.
(4) The warrants were granted to the former CEO pursuant to a termination
agreement dated January 6, 1999. The terms of the warrants are for 3
years. The exercise price on the date of grant was equal to or greater
than 100% of the fair market value as determined on the date of grant.
(5) The warrants were granted to outside consultants to assist the Company in
acquisitions and financings. The terms of the warrants are for 5 years.
The exercise price on the date of grant was equal to or greater than 110%
of the fair market value as determined on the date of grant.
24
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On February 25, 1999, the 1998 Annual Meeting of Shareholders of
NHancement Technologies Inc. was held at the Company's offices in Fremont,
California. At the meeting the following individuals were elected to serve
as directors until the next Annual Meeting of Shareholders:
<TABLE>
<CAPTION>
NOMINEES FOR WITHHELD
-------- --- --------
<S> <C> <C>
Douglas S. Zorn 4,286,405 29,700
James S. Gillespie 4,180,993 135,112
Robert J. Schmier 4,180,993 135,112
N. Bruce Walko 4,286,405 29,700
</TABLE>
In addition the shareholders approved the following proposal:
<TABLE>
<CAPTION>
FOR WITHHELD
--- --------
<S> <C> <C>
Ratify the appointment of BDO Seidman as the 4,167,193 148,912
Company's auditors for the fiscal year ending
September 30, 1998.
</TABLE>
The foregoing matters are described in the Company's definitive proxy
statement dated January 28, 1999.
ITEM 5. OTHER INFORMATION
CHANGES IN MANAGEMENT
On January 6, 1999, Mr. Goei resigned his position as President and CEO
pursuant to the terms of a Separation Agreement approved by the Board of
Directors, which modifies the terms of his Employment Agreement. In exchange
for Mr. Goei's resignation, the Company has agreed to a severance package
with the following principal terms: (i) six and one-half months of regular
pay at his current rate, (ii) continued benefits under the Company's medical
and group insurance plan through May 15, 1999, (iii) use of the Company paid
leased automobile through the end of the lease term in July 1999, (iv)
reimbursement by the Company for certain accrued moving expenses totaling
$70,000 incurred by Mr. Goei, and payment by Mr. Goei in full of a loan
related to costs of relocation, (v) issuance of warrants to purchase 50,000
shares of NHancement Common Stock at the fair market value in effect as of
the date of his resignation, which was $1.00 per share, and (vi) the
agreement of Mr. Goei and the Company to a mutual waiver of all claims
related to Mr. Goei's employment. Mr. Goei continued to serve as Chairman
of the Board and Director of the Company until January 13, 1999 when he
resigned from these positions.
Effective January 6, 1999, Douglas S. Zorn became interim President and
Chief Executive Officer to fill the vacancies created by Mr. Goei's
resignation and on February 2, 1999, the Board of Directors appointed Mr.
Zorn to the offices of Chief Executive Officer and President. On April 20,
1999, the Board elected Donna M. Pulvermacher as Acting Chief Financial
Officer and Treasurer and Linda V. Moore to the office of Secretary of the
Company.
25
<PAGE>
Messers. James Boyle, Santanu Das and Gary Nemetz resigned as Directors
of the Company on January 6, 1999. Thomas J. Lawrence resigned as a Director
on January 13, 1999.
On January 6, 1999, James S. Gillespie was reappointed as a Director of
the Company. Mr. Gillespie had previously served as Vice President of Sales
and a Director of the Company since its incorporation in 1996. He resigned
his position as Vice President of Sales in April 1998, and resigned as a
Director of the Company on September 22, 1998. On February 2, 1999, the Board
approved a consulting arrangement between Mr. Gillespie and the Company.
Messers. Robert J. Schmier and N. Bruce Walko were also elected to the
Board of Directors on January 6, 1999 to fill vacancies created by the
resignations of Messers. Boyle, Das and Nemetz.
On February 2, 1999, the Board of Directors reduced the number of Board
members from seven (7) to five (5). On February 25, 1999, Messrs. Zorn,
Gillespie, Schmier and Walko were elected to the Board of Directors at the
1998 Annual Meeting of Shareholders. On April 20, 1999, Messrs. Zorn,
Gillespie, Schmier and Walko were elected to the Board of Directors at the
1999 Annual Meeting of Shareholders. As of the date of this filing, there is
still one (1) vacancy on the Board of Directors.
AGREEMENT WITH JWGENESIS
Effective February 2, 1999, the Company entered into an exclusive
one-year agreement with JWGenesis Capital Markets to assist the Company as
financial advisors in connection with the possible sale, merger,
consolidation, recapitalization, business combination, exchange offer or
purchase or sale of securities or assets of the Company. The agreement
includes the payment of a non-refundable fee of $25,000, the reimbursement of
out-of-pocket expenses of $25,000, warrants to purchase 300,000 shares of the
Company's Common Stock at a per share exercise price of 100% of the fair
market value as of the date of the agreement and transaction fees due upon
the successful closing of any such transaction of (i) 10% if equity (5% if
merger, acquisition or debt of the first $10 million of the aggregate
consideration), (ii) 7% if equity (3.5% if merger, acquisition or debt of the
next $10 million of the aggregate consideration), (iii) 5% if equity (2.5% if
merger, acquisition or debt of the next $10 million of the aggregate
consideration), and (iv) 4% if equity (2% if merger, acquisition or debt of
the balance of the aggregate consideration) subject to a minimum transaction
fee of $500,000 on each transaction. A seller's remorse fee of $250,000 is
payable to JWGenesis on any bona fide transaction proposal with aggregate
consideration of over $5 million which is accepted by the Company for which
the Company fails to complete the transaction except due to a breach by or
failure of condition under the control of the other party to the transaction.
Due to the Company's improved performance, increased revenues and return
to profitability coupled with the Company's order backlog at March 31, 1999,
the Company is currently not pursuing nor does it have any plans to sell the
securities or assets of the Company. The Company will continue to review all
options presented by JW Genesis including possible acquisition candidates and
financing alternatives.
26
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following Exhibits are filed as part of the Quarterly Report on Form
10-QSB
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------------ -----------------------------------------------------------------------------------------------
<C> <S>
4.7 Warrant Agreement dated February 2, 1999 between the Company and JWGenesis Capital Markets LLC.
4.8 Warrant Agreement dated February 2, 1999 between the Company and Kenneth L. Greenberg.
4.9 Warrant Agreement dated February 2, 1999 between the Company and Mark Goldberg.
10.47 Separation Agreement dated January 13, 1999 between Esmond T. Goei and the Company.(1)
10.48 Letter Agreement dated February 2, 1999 between the Company and JWGenesis Capital Markets LLC.
27.0 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K:
A report on Form 8-K dated January 6, 1999 was filed with the
Commission on February 12, 1999 reporting matters under Item 5 (Other
Events).
- -----------------
(1) Incorporated by reference to the document bearing the same exhibit
number as contained in the Company's Form 8-K, as filed with the Securities
and Exchange Commission on February 12, 1999.
27
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant has
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
NHANCEMENT TECHNOLOGIES INC.
By: /s/ Douglas S. Zorn
--------------------------------
Date: May 11, 1999 Douglas S. Zorn
President and Chief Executive Officer
By: /s/ Donna M. Pulvermacher
--------------------------------
Donna M. Pulvermacher
Acting Chief Financial Officer
and Treasurer
28
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
--------------------------------------------------------------------------------------------------------------
<C> <S>
4.7 Warrant Agreement dated February 2, 1999 between the Company and JWGenesis Capital Markets LLC.
4.8 Warrant Agreement dated February 2, 1999 between the Company and Kenneth L. Greenberg.
4.9 Warrant Agreement dated February 2, 1999 between the Company and Mark Goldberg.
10.47 Separation Agreement dated January 13, 1999 between Esmond T. Goei and the Company.(1)
10.48 Letter Agreement dated February 2, 1999 between the Company and JWGenesis Capital Markets LLC.
27.0 Financial Data Schedule
</TABLE>
29
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED
MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 1,711
<SECURITIES> 0
<RECEIVABLES> 4,684
<ALLOWANCES> 242
<INVENTORY> 1,355
<CURRENT-ASSETS> 8,145
<PP&E> 2,005
<DEPRECIATION> 785
<TOTAL-ASSETS> 11,973
<CURRENT-LIABILITIES> 8,675
<BONDS> 0
0
192
<COMMON> 60
<OTHER-SE> 2,953
<TOTAL-LIABILITY-AND-EQUITY> 14,973
<SALES> 8,977
<TOTAL-REVENUES> 8,977
<CGS> 5,943
<TOTAL-COSTS> 5,943
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 97
<INCOME-PRETAX> (1,394)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,394)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,394)
<EPS-PRIMARY> (.24)
<EPS-DILUTED> (.24)
</TABLE>
