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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10 - K
Annual Report pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
For the Year Ended December 31, 1998
Commission File Number 0-11630
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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)
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Securities Registered Pursuant to Section 12 (b) of the Act
NONE
Securities Registered Pursuant to Section 12 (g) of the Act
COMMON STOCK PAR VALUE $0.01 PER SHARE
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $36,193,000 as of March 29, 1999 (based upon the
average of the highest bid and lowest asked prices on such date as reported on
the Nasdaq National Market).
There were 36,157,949 shares of Common Stock outstanding as of March 29, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
(December 31, 1998) are incorporated by reference in items 10, 11, 12 and 13 of
PART III hereof.
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PART I
ITEM 1 - BUSINESS
FORWARD LOOKING STATEMENT
This Form 10-K 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 relating 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.
THE COMPANY
Intelect Communications, Inc. (the "Company") was incorporated in
Delaware on May 23, 1995. The Company's predecessor, Intelect Communications
Systems Limited ("Intelect (Bermuda)") was incorporated under the laws of
Bermuda in April 1980 and operated under the name Coastal International, Ltd.
until September 1985 and as Challenger International Ltd. until December 1995.
On December 4, 1997, the shareholders of Intelect (Bermuda) approved a merger
proposal, the principal effect of which was to change the domicile of Intelect
(Bermuda) so that it became a publicly traded United States-domiciled, Delaware
corporation. The effect of the merger was that the shareholders of Intelect
(Bermuda) became shareholders of the Company with the Company becoming the
publicly traded company. In addition, the Company became the holding company for
Intelect (Bermuda) and replaced Intelect (Bermuda) as the holding company for
its subsidiaries. The merger was effected on December 4, 1997.
OVERVIEW
The Company is engaged in the business of designing, developing,
manufacturing, marketing and selling products and services for managing digital
signals and converging voice, data and video networks. The Company's current
operations were established through a series of mergers in 1995 and 1996, at
which time four communications product platforms were defined to respond to the
increasing demands of speed and complexity in communications.
The Company is strategically focusing its product lines and services to
take advantage of the convergence of telecommunications (telecom) and data
communications (datacom). This convergence is being driven by the explosive
growth of Internet applications such as E-commerce, which is accelerating the
expansion of network capacities. These industry trends create requirements for
today's network integrators and directors to manage multiple applications, at
multiple locations, within bandwidth resources and while balancing the need for
network reliability. The Company's product lines are designed to meet these
evolving markets, applications and requirements.
The Company's objective is to develop and bring to market a new
generation of intelligent, flexible, and scalable communications products
designed to combine current voice, data and video networks (for example,
telephones, computers, surveillance) into a single communications network, which
would also upgrade communications into the latest generation of high-speed
technologies, while using a single network management system.
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PRODUCTS, TECHNOLOGIES AND SERVICES
Multi-service Access Platform (MAP)
Marketed initially and currently under the names SONETLYNX and
FIBRETRAX, the Company believes the MAP is a revolutionary networking
infrastructure product for public and private networks to cost-effectively
create voice, data and/or video networks of virtually any size and application.
It is defined as a platform because, from its basic architecture, it can be
configured into many separate products for a variety of functions and
applications. Through the use of different protocol cards, the MAP can
simultaneously combine multiple communication transmissions such as video and
graphics communications, data files, voice and any IP-based service over a
single network. The products are compatible with Synchronous Optical Network
(SONET) and Synchronous Digital Hierarchy (SDH) standards in order to provide
fail-safe networks. The SONETLYNX and FIBRETRAX, in addition to providing
add-drop multiplexing, provide the functions of traditional networking equipment
such as bridges, channel banks, routers and video matrix switches, thus offering
significant savings in cost and time for the user when OC-1 or OC-3 bandwidth is
required. The MAP expands into markets horizontally by increasing the types of
protocols (applications) it can transport, and vertically by increasing its
capacity (transmission speed). Currently, the MAP can transport voice, Fast
Ethernet (10/100baseT), JPEG video and low speed data protocols such as RS-232
and RS-422 at speeds up to the OC-3/STM-1 rate (155 Mbps). Product advancements
scheduled during 1999 include adding the protocol cards for ISDN, digital modem
pool and Frame Relay as well as increasing the MAP's transmission speed to the
OC-12/STM-3 rate (622 Mbps). Video and high speed data modules are planned with
higher port density. Network management systems are under development in the
Windows NT version. The cost effectiveness and competition advantage of the MAP
are expected to increase with the addition of each major protocol and increase
in transmission speed.
Engineering Services
DNA Enterprises, the Company's engineering services operation, provides
advanced product and system design and development services for a variety of
clients in the communications industry. The Company believes DNA Enterprises is
a leading contract and outsource development resource for the communications
industry. DNA provides expertise in digital signal processing (DSP), switching
and transport systems, computer telephony integration (CTI), embedded systems,
data communications, intelligent networks, video processing, and wireless
communications technologies.
Digital Signal Processing
The DSP Design Center is a Center of Excellence within DNA Enterprises
that provides state-of-the-art digital signal processing technology to systems
developers around the world to afford them leading-edge solutions, faster
time-to-market, and reduced technical risk for their product development
programs. The DSP Design Center has developed a product line consisting of
standard designs for high performance circuit boards, and offers custom designed
hardware, application support software, real-time operating systems, and
consulting services to product manufacturers and application developers in the
multimedia, image processing, communications, and remote sensing systems arenas.
The bulk of the Design Center's activities center around the Texas Instruments
("TI") line of Digital Signal Processors, with emphasis on TI's high performance
C5x and C8x devices and a particular focus on the new TI C6000 processor line.
Visual Communications
The LANscape product is designed to provide full motion, collaborative
video communications in a single cost effective solution for desktop PCs to
large room systems. The product has the capability to conduct up to a three-way
conference call without a costly multiconferencing unit (MCU), transmit video
broadcasts using IP multicast, and use its integrated software to switch between
two incoming video sources. Each
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incoming video is contained in an individual window which the user can control
as to size and volume. In addition to video conferencing, LANscape features
video record and playback controls for applications such as education/training
and recorded event distribution. LANscape support of IP multicast allows for
transmission of live or pre-recorded video from one to many.
CS4 Intelligent Services Platform
The Company believes the CS4 represents a revolutionary new class of
product. It is an integrated enhanced network server. Its array of integrated
capabilities transcends traditional product categories to introduce a flexible
system that can host a wide range of intelligent services in a variety of
network configurations. The design of the CS4 positions it to impact the
proliferation and profitability of intelligent services in the network, as well
as to improve the cost paradigm now in place for service nodes, intelligent
peripherals, enhanced service platforms, and programmable switches. Key
technological innovations reflected in the CS4 include highly distributed
processing power to the port level, scalable port capacity that extends up to
64k ports, an advanced call processing structure, a powerful service creation
facility, and an architecture that readily supports integration into low speed,
high speed, and broadband networks, all designed for a fault-tolerant, NEBS
compliant structure.
MARKETS AND CUSTOMERS
Multi-service Access Platform
Primary markets for SONETLYNX and FIBRETRAX are purpose-built networks
such as advanced highway control systems and pipeline communication and control
systems. Target markets include corporate/enterprise networks, utilities,
airports, transportation entities, security services, prisons, health services,
academia, and local and state government, as well as public and private bypass
networks. The Company expects additional products being developed and planned
for the MAP platform to enable increased penetration in public and private
network access markets. The Company markets its SONETLYNX and FIBRETRAX network
products primarily through 25 distributors, system integrators and value added
resellers (51% of SONETLYNX and FIBRETRAX revenue in 1998). Sales are also made
by a direct sales force and through representatives. During 1997, the Company's
largest distributor, reselling to customers in the Republic of Korea, was
responsible for 85% of SONETLYNX sales. In 1998, no customer or distributor
accounted for more than 10% of consolidated sales. SONETLYNX is targeted for
markets and applications where multiple protocol communication mandates the
capacity and reliability of fiber, further strengthened by redundancy of
critical components and architecture.
Engineering Services
The Company's engineering services are employed by clients that span
the spectrum from start-up ventures seeking to launch new products to large
multi-national corporations looking to access key know-how for extending current
product lines or introducing new products/services. The products the Company
develops range from compact circuit boards to multi-board systems that address
the consumer, commercial, industrial, and defense market sectors. The Company
markets its services directly to prospects worldwide. Principal customers for
the Company's services include board manufacturers, telecommunications equipment
vendors, semiconductor suppliers, and communications service providers.
Digital Signal Processing
The products developed by the DSP Design Center are marketed both
directly by the Company and through sales channel partners to customers in North
America, Europe, and Asia. Customers for these products have a common need for
high-performance DSP capabilities for integration into their products, which
include commercial telecommunications systems, industrial control products,
video processing and image enhancement systems, and military communication
systems.
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Visual Communication Products
The Company generally markets its visual communication products
directly and through distributors and value added resellers. Primary markets for
its video communication products are businesses and educational and government
institutions. These markets include corporate networks, financial trading
networks, Internet deployment over digital subscriber lines and other high
capacity services, Educational/Distance learning networks, medical networks and
government networks.
CS4 Intelligent Services Platform
The CS4 is scheduled to commence initial field trials in early second
quarter 1999. The Company currently intends to commercialize the CS4 through a
separate business unit that provides leading-edge solutions for high-value
intelligent voice services in wireline, wireless, and internet-related markets
and is seeking to arrange third party participation in the continuing
development and initial marketing of the CS4.
The CS4 was developed to meet the requirements of high growth segments
in the telecommunications equipment and services market in both circuit-switched
and packet-switched networks. International and domestic target markets include
Competitive Local Exchange Carriers, Competitive Access Providers, PCS and
Cellular Service Providers, Inter-exchange Carriers, Internet Service Providers,
and emerging network infrastructures.
COMPETITION
The market for the Company's products and services is intensely
competitive and rapidly changing. The Company competes, or may in the future
compete, directly or indirectly for customers in the following categories of
products and companies: (i) network transmission product manufacturers such as
Lucent Technologies Corp., Northern Telecom, Ltd., and Reltec; (ii) video
conferencing H.320/323-based product manufacturers such as VTEL Corp and
PictureTel Corp.; (iii) Enhanced Services Platform and Intelligent
Peripheral/Service Node providers such as Lucent Technologies, Ericsson, Nortel,
Comverse Technology, Intervoice, and Centigram Communications Corporation.
In recent months, large telecom equipment companies including Lucent,
Northern Telcom, Alcatel and Siemens have announced acquisitions of datacom
companies. At the same time, a large datacom company, Cisco, has announced plans
for equipment to carry voice, data and video traffic using Internet technology.
These activities constitute the so-called "convergence" of voice and data
switching technologies. Large customers for switching equipment, including AT&T
and MCI WorldCom have announced their intentions to support this convergence.
The Company believes these actions ratify its product design strategies,
especially the development of the MAP and CS4. On the other hand, the recent
actions by large companies also represent an environment of increasing direct
competition for customers of the newly convergent technologies.
The Company believes that the principal competitive factors affecting
the markets for its products and services include effectiveness, scope of
product offerings, technical features, ease of use, reliability, customer
service and support, distribution channels and price. Most competitors are
better capitalized and have greater resources than the Company and, accordingly,
may have a competitive advantage in product development and selling.
MANUFACTURING
The basis of the Company's manufacturing strategy is to identify and
use the appropriate technology to obtain the most favorable combination of
quality and end product cost. The Company's manufactured products consist
largely of assembled printed circuit boards and chassis. These are sold either
as assembled
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systems (such as SONETLYNX or FIBRETRAX) or as a stand-alone product (such as
LANscape). As the Company's product lines expand and mature, the Company expects
to increase manufacturing capacity by means that could include adding employees,
expanding current facilities, leasing or purchasing additional facilities or
equipment, and expanding and adding outsourcing relationships. See ITEM 2 -
Properties.
Raw materials are primarily electronic components available from
multiple sources. Certain sole source components are not generally considered a
vulnerability because they are reliably supplied by large companies. The Company
sources a fiber optic interface card, for the OC-3 product, from a third party
which is the sole source for the component. The Company also buys a video codec
card, used in SONETLYNX video applications from a sole source. Delays in
delivery of either component would restrict the Company's ability to increase
sales. In the event either vendor fails to meet commitments, the Company intends
to rely on its in-house manufacturing capabilities. However, the conversion to
in-house backup supply would not be without some interruption and may increase
cost. The Company has an ongoing program to reduce its exposure to limited
source components where possible.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company believes it has a substantial base of intellectual
property, in the form of software and hardware, some of which is embodied in its
products and applied in its ongoing development programs. The Company believes
that factors such as technological and creative skills of its personnel, new
product developments, frequent product enhancements, name recognition, and
reliable product manufacturing are essential to establishing and maintaining a
technology leadership position.
The Company relies on a combination of patent, copyright, trademark and
trade secret laws, and confidentiality procedures to protect its proprietary
rights. The Company currently has three United States patents relating to video
transmission and audio conferencing technology and has fifteen currently pending
patents relating to DSP, electronic design, internet, operating systems, voice
switching, video distribution and communications. "SONETLYNX(R)," "INTELECT(R),"
"VUBRIDGE(R)," "S4(R)," and "Special Services Switching System(R)" are
registered trademarks of the Company. "FIBRETRAX(TM)" and "PANORAMA(TM)" are
trademarks of the Company. The Company has received notice that its use of the
name LANSCAPE infringes a similar mark. The Company believes it is not
infringing. A third party has advised the Company of a cancellation proceeding
at the Patent and Trademark Office which, if successful, would nullify the
notice party's claim of first use. It is not possible to determine the outcome
of the cancellation proceeding. Under any possible outcome, the Company is
likely to be in a position of negotiating an agreement with another party for
the shared use of the LANSCAPE name. According to federal and state law, the
Company's trademark protection will continue for as long as the Company
continues to use its trademarks in connection with the products and services of
the Company. The Company seeks to protect its software, documentation and other
written materials under trade secret and copyright laws, which afford only
limited protection.
In connection with the acquisition of DNA Enterprises and Intelect
Visual Communications and transactions with certain individuals, licenses were
acquired to support the development of SONETLYNX, video conferencing and DSP
products. The Company also incorporates third-party licenses into its products.
The Company owns the rights to the following internet domain names:
intelectcom.com, intelectinc.com, videoconferencing.com, and dnaent.com.
Litigation may be necessary to enforce the Company's patents and other
intellectual property rights, to protect the Company's trade secrets, to
determine the validity of and scope of the proprietary rights of others, or to
defend against claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of resources and could have a material
adverse effect on the Company's business, financial condition or results of
operations.
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In common with many companies in the telecommunications industry, the
Company has received notices that it may be infringing on certain intellectual
property rights of others. These claims have been defended with advice of
counsel and certain defenses are ongoing. In connection with such claims or
actions asserted against the Company, the Company may seek to obtain a license
under a third party's intellectual property rights, if necessary. There can be
no assurance, however, that a license will be available under reasonable terms
or at all. In addition, the Company could decide to litigate such claims, which
could be expensive and time consuming and which could have materially adverse
effects on the Company's business, financial condition or results of operations.
EMPLOYEES
The Company had 307 full-time employees at December 31, 1998, of which
148 were engaged in engineering and development, 64 were engaged in sales,
marketing, and customer support, 72 were engaged in manufacturing operations,
and 23 were engaged in administration and finance. None of the Company's
employees is represented by a labor union. The Company has experienced no
material work stoppages and believes its relations with its employees to be
good. At December 31, 1997, the Company had 365 full-time employees.
GOVERNMENT REGULATION
The telecommunications industry, including many of the Company's
customers, is subject to regulation from federal and state agencies, including
the Federal Communications Commission ("FCC") and various state public utility
and service commissions. Similar regulatory structures exist in most countries
outside the United States. While such regulation does not affect the Company
directly, the effects of such regulations on the Company's customers may, in
turn, adversely impact the Company's business and results of operations. For
example, FCC regulatory policies, affecting the availability of services and
other terms on which telecommunications service providers ("Telcos") conduct
their business, may impede the Company's penetration of certain markets. Current
FCC regulations restrict Telcos' ability to charge their customers based on
access cost to local subscribers and may affect the timing of Telcos' investment
in the Company's technology. These FCC regulations and policies are under
continuous review by the federal government and the courts and are subject to
change. Although many FCC restrictions on providing services in previously
restricted markets have been eliminated or modified, the failure to change, or a
substantial delay in changing, the existing restrictions on Telcos may
materially adversely affect their demand for products based upon the Company's
technology.
The Telecommunications Act of 1996 removed certain restrictions
relating to the Regional Bell Operating Companies. The Company believes that
this has created and will continue to create increased competition in the
markets served by the Company's products.
In addition, the Company's business and operating results may also be
adversely affected by the imposition of certain tariffs, duties and other import
restrictions on components that the Company obtains from non-domestic suppliers
or by the imposition of export restrictions on products that the Company sells
internationally. The governments of many other countries actively promote and
create competition in the telecommunications industry. Changes in current or
future laws or regulations, in the United States or elsewhere, could materially
and adversely affect the Company's business and results of operations.
ITEM 2 - PROPERTIES
All of the Company's facilities are leased. The facilities are in
Richardson, Texas, New York, New York, and London, England. The Company's
principal operations are serviced from four leased facilities in Richardson,
Texas, (comprising 103,000 square feet) and one in New York (comprising 20,000
square feet). These facilities include manufacturing, engineering, sales,
marketing, and administrative offices. All of the
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Company's manufacturing operations are located in a 28,000 square foot
Richardson, Texas facility. The Company moved its headquarters from Hamilton,
Bermuda to Richardson, Texas in March 1997. In March 1998, the Company closed
its offices in New York and London. The Company believes these facilities, which
total 124,000 square feet, are adequate for its present needs.
ITEM 3 - LEGAL PROCEEDINGS
The Company is involved in various legal proceedings and claims arising
in the ordinary course of business.
On October 28, 1998, in the 192nd Judicial District Court for Dallas
County, Texas, Richard Dzanski filed suit against Intelect Network Technologies
Company, a wholly owned subsidiary of the Company, and Intelect Systems Corp.,
the predecessor of the Company. In the suit, the plaintiff has claimed a breach
of an Irrevocable Option Agreement and that he has not received payments he
claims are due to him in the amount of at least $386,000. The defendants deny
liability to the plaintiff and intend to vigorously defend the case. The parties
are in discovery and it is too early to determine if the outcome of this case
will have a material impact on the Company.
Intelect (Bermuda) is contingently liable for certain potential
liabilities related to its discontinued operations. Specifically, under a stock
purchase agreement dated October 3, 1995 ("1995 Agreement"), Intelect (Bermuda)
agreed to indemnify Savage Sports Corporation, the purchaser of Savage Arms,
Inc. (a manufacturer of fire arms), for certain product liability, environmental
clean-up costs and other contractual liabilities, including certain asserted
successor liability claims. One of the liabilities assumed involves a firearms
product liability lawsuit filed by Jack Taylor individually and as father of
Kevin Taylor in Alaska Superior Court (the "Taylor litigation"). Intelect
(Bermuda) is informed that a defendant in the Taylor litigation, Western Auto
Supply Co., settled the lawsuit for $5 million and, in turn, has asserted a
third-party claim against Savage Arms, Inc. for indemnification in the amount of
the settlement plus attorneys' fees and related costs. Savage Arms has asserted
defenses to the claims and Intelect (Bermuda) believes additional defenses may
be available. Based on the information available to date, it is impossible to
predict the outcome of this litigation or to assess the probability of any
verdict.
Intelect (Bermuda) also has been notified that Savage Sports
Corporation seeks indemnification under the 1995 Agreement in connection with
certain other product liability claims. Most notably, Intelect (Bermuda) has
undertaken the defense of a lawsuit filed against Savage Arms, Inc. by Emhart
Industries, Inc. ("Emhart") in the United States District Court for the District
of Massachusetts (the "Emhart litigation"). In the lawsuit, Emhart requests
indemnification from Savage Arms, Inc. under an agreement Emhart allegedly
executed in 1981 with Savage Industries, Inc., claiming that Savage Arms, Inc.
is a successor to Savage Industries, Inc. To date, Emhart has claimed
indemnification of approximately $2.2 million for five lawsuits it has defended
or settled and also seeks a declaratory judgment that it is entitled to
indemnification for losses and expenses related to firearms product liability
actions which may be filed against Emhart in the future. Intelect (Bermuda)
intends to assert additional defenses. The parties are in discovery and Intelect
(Bermuda) cannot at this time predict the outcome of the litigation.
In the event the Taylor litigation and/or Emhart litigation were to be
resolved adversely to Intelect (Bermuda), there would be a material adverse
effect on the Company's financial condition and results of operations. See Note
20 to the Consolidated Financial Statements.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
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PART II
ITEM 5 - MARKETS FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded in the over-the-counter
market and is listed on the Nasdaq Stock Market under the symbol "ICOM." The
high and low bid prices for the Company's common stock for each full quarter of
the last two fiscal years, as reported on Nasdaq, are as follows:
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1st quarter 1997 - period ended March 31, 1997 5.125 1.875
2nd quarter 1997 - period ended June 30, 1997 4.625 1.375
3rd quarter 1997 - period ended September 30, 1997 11.500 4.250
4th quarter 1997 - period ended December 31, 1997 11.313 3.188
1st quarter 1998 - period ended March 31, 1998 7.625 4.438
2nd quarter 1998 - period ended June 30, 1998 7.250 5.432
3rd quarter 1998 - period ended September 30, 1998 5.625 1.656
4th quarter 1998 - period ended December 31, 1998 3.563 1.438
</TABLE>
The Company believes that as of March 29, 1999, its outstanding shares
of common stock were held by approximately 20,500 owners of record.
The closing bid price of the common stock on the Nasdaq National Market
on March 29, 1999, was $1.00.
DIVIDEND POLICY
No cash dividends were paid by the Company during 1996, 1997 or 1998.
The Company does not currently plan to pay any dividends on common stock in the
foreseeable future. The Company is restricted by its agreements with lenders and
the holders of certain of its preferred stock from any payment of dividends on
common stock and from the payment of dividends on preferred stock except
dividends payable with common stock. These restrictions remain in effect for so
long as any balance remains payable on the debt or such preferred stock remains
outstanding. See Note 14 to the Consolidated Financial Statements.
RECENT SALES OF UNREGISTERED SECURITIES
Effective as of January 1, 1999, the Company issued 144,681 shares of
common stock in lieu of a $212,000 cash dividend on its Series A Preferred Stock
for the quarter ended December 31, 1998.
On November 23, 1998 and December 4, 1998, in a transaction exempt from
registration under Section 4(2) of the Securities Act, the Company issued
300,000 shares each in connection with the exercise of warrants to purchase
common stock at a price of $2.00 per share.
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ITEM 6 - SELECTED FINANCIAL DATA
The following tables set forth certain historical consolidated
financial data for the Company.
<TABLE>
<CAPTION>
Two
months
ended
December Years ended
Years ended December 31, 31, October 31,
-------------------------------------- ---------- ------------------------
1998 1997 1996 1995 1995 1994
---------- ---------- ---------- ---------- ---------- ----------
($ Thousands Except Per Share Data)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS:
Net revenues $ 19,341 37,777 9,352 734 2,030 --
========== ========== ========== ========== ========== ==========
Operating loss $ (38,787) (17,642) (33,638) (2,943) (4,652) (558)
========== ========== ========== ========== ========== ==========
Loss from continuing operations $ (42,735) (19,743) (42,983) (2,776) (5,194) (538)
Income from discontinued
operations -- -- -- -- 3,546 3,410
Income (loss) on disposal of
discontinued operations (403) (498) (56) (236) 13,824 --
Income (loss) before ---------- ---------- ---------- ---------- ---------- ----------
extraordinary item $ (43,138) (20,241) (43,039) (3,012) 12,176 2,872
Income (loss) allocable to common ========== ========== ========== ========== ========== ==========
stockholders $ (46,105) (20,798) (43,039) (3,012) 12,811 2,872
========== ========== ========== ========== ========== ==========
Basic and diluted income (loss) per share:
Continuing operations $ (1.76) (0.99) (3.32) (0.24) (0.47) (0.05)
========== ========== ========== ========== ========== ==========
Discontinued operations $ (.02) (0.02) (0.01) (0.02) 1.57 0.34
========== ========== ========== ========== ========== ==========
Extraordinary item -- -- -- -- 0.06 --
========== ========== ========== ========== ========== ==========
Net Income (loss) for period $ (1.78) (1.01) (3.33) (0.26) 1.16 0.29
========== ========== ========== ========== ========== ==========
Weighted average shares (thousands) 25,939 20,558 12,943 11,385 11,024 9,942
</TABLE>
<TABLE>
<CAPTION>
------------------------------------ ---------- -----------------------
December
December 31, 31, October 31,
------------------------------------ ---------- -----------------------
1998 1997 1996 1995 1995 1994
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET:
ASSETS:
Current assets $ 16,413 25,552 11,594 19,957 24,587 2,599
Excess of cost over assets of
companies acquired 4,787 13,249 14,573 8,685 9,349 --
Other long-term assets 10,882 10,430 9,269 2,597 1,786 --
---------- ---------- ---------- ---------- ---------- ----------
Total assets $ 32,082 49,231 35,436 31,239 35,772 12,172
========== ========== ========== ========== ========== ==========
LIABILITIES & SHAREHOLDERS' EQUITY:
Current liabilities including current
maturities of long-term debt $ 9,852 22,939 9,810 5,331 7,091 269
Long-term liabilities 14,698 143 17,895 368 365 --
Shareholders' equity 7,532 26,149 7,731 25,540 28,266 11,903
---------- ---------- ---------- ---------- ---------- ----------
$ 32,082 49,231 35,436 31,239 35,722 12,172
========== ========== ========== ========== ========== ==========
</TABLE>
10
<PAGE> 11
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Results of operations consist of:
o the fiber optic multiplexer and special services switch
businesses of Intelect Network Technologies Company ("INT")
from its April 24, 1995 acquisition,
o the engineering services business of DNA Enterprises, Inc.
("DNA") from its February 13, 1996 acquisition,
o the digital signal processor products business of DNA since
product introductions in 1997 and 1998,
o the visual communication system business of Intelect Visual
Communications Corp. ("IVC") from its March 29, 1996
acquisition, and
o the information security business of Intelect Europe Limited
("IEL") from its August 31, 1995 acquisition until its
liquidation in January 1997.
The following table shows the revenue and gross profits for the
Company's products:
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------------
1998 1997 1996
-------- -------- --------
($ Thousands)
<S> <C> <C> <C>
Revenue:
Fiber optic multiplexer 6,410 26,250 430
Engineering services 8,147 8,632 4,332
Digital signal processor 2,690 277 81
Visual communication 1,448 636 172
Switching and other 646 1,982 4,337
-------- -------- --------
$ 19,341 37,777 9,352
-------- -------- --------
Gross profit (loss):
Fiber optic multiplexer (1,903) 12,035 (625)
Engineering services 2,002 2,375 1,270
Digital signal processor 1,390 (88) (306)
Visual communication 497 41 (826)
Switching and other (1,078) (112) (2,134)
-------- -------- --------
$ 908 14,251 (2,621)
-------- -------- --------
</TABLE>
REVENUES
Revenues in 1998 decreased 49% from 1997 after having increased 304%
over 1996. The revenue increase in 1997 was due to increased sales to Korean
customers, which represented 59% of that year's total revenues. The decline in
1998 revenues was due to the decline in sales to the Korean market reflecting
the financial condition of the Asian region. This decline was partially offset
by a 20%, or $785,000 increase in non-Korean sales.
The Company is not basing future revenue expectations on recovery in
Asia. Prospects for continued growth in non-Asian markets are supported by new
orders in the United States for approximately $10,000,000 of fiber optic
multiplexer product received early in 1999.
11
<PAGE> 12
Engineering service revenues in 1998 approximated the level of 1997
when the revenues increased 99% over 1996. Growth of the services business was
constrained by the concentration of resources on DSP product development in the
DNA DSP Design Center.
DSP products, primarily those based on the Texas Instruments C6000
components, increased 871% to $2,690,000 in 1998. The year included the launch
of development tools for the Texas Instruments components and end products with
powerful computing and signal processing capabilities.
Visual communication product revenues in 1998 increased 127% over 1997
due to the first full year of availability of a redesigned product.
Switching and other revenues consist primarily of the voice and data
switching products used in air traffic control applications, which have declined
in strategic significance to the Company, and certain information security
products phased out in 1996.
GROSS PROFIT (LOSS)
Gross profit decreased to $908,000 in 1998 from $14,251,000 in 1997. A
($2,621,000) gross loss was experienced in 1996. Changes in both years were
primarily the result of the revenue levels of the fiber optic multiplexer
products. The gross profit in 1998 includes the effect of a $900,000 reserve for
obsolescence attributable to the air traffic control products line ("switching"
products above).
The high level of fiber optic multiplexer products shipments in 1997
supported an economic production rate in manufacturing operations, a rate which
was not sustained in 1998. The negative gross profit on fiber optic multiplexer
products in 1998 included $1,820,000 of under absorbed overhead. At the
production levels of 1997, underabsorbed overhead for the SONETLYNX/FIBRETRAX
product was $613,000, all attributable to the first half year when production
volume had not yet increased.
Engineering services gross profit maintained a similar percentage of
sales in 1998 and 1997 (25% and 27% respectively). The increase in 1997 over
1996 was primarily the result of a near doubling of revenue.
DSP products contributed positive gross profit for the first time in
1998 as revenues grew to a level which allowed for a characteristic margin.
The LANscape video products contributed gross profit improvements in
both 1998 and 1997 in line with increases in volume.
12
<PAGE> 13
ENGINEERING & DEVELOPMENT (E&D) EXPENSES
E&D expense decreased to $10,217,000 in 1998 from $11,899,000 in 1997.
The 1997 level was an increase from $8,719,000 in 1996. In all three years,
certain amounts of software development costs were capitalized. Including those
amounts, the total E&D expenditures were $12,117,000, $13,216,000 and
$10,114,000, respectively, in the years 1998, 1997 and 1996. Total E&D
expenditures by product line were distributed as follows:
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------
1998 1997 1996
------- ------- -------
($ Thousands)
<S> <C> <C> <C>
Fiber optic multiplexer $ 5,149 6,400 2,857
CS4 enhanced services platform 4,798 3,816 5,565
Visual communication 1,168 1,443 954
Digital signal processing 988 488 --
Switching and other 14 1,069 738
------- ------- -------
$12,117 13,216 10,114
------- ------- -------
</TABLE>
Despite lower sales in 1998, the Company maintained engineering and
development expenditures in order to advance, enhance and complete strategic
products such as MAP, CS4, DSPs and LANscape. These expenditures are expected to
result in new product contributions in 1999 which are intended to address new
markets and maintain the Company's technological leadership.
The fiber optic multiplexer product line was most significantly
expanded by the introduction of the international standard version, SDH
(Synchronous Digital Hierarchy). Branded FIBRETRAX, the SDH version serves the
approximately 70% of global markets for fiber optic transmission outside North
America. SONETLYNX and FIBRETRAX were enhanced by the addition of interfaces
for:
o Multi-point voice
o Ethernet
o Communication among multiple rings, including different speeds
o T1/E1 backup for seven other interfaces
o Module level protection for T1/E1 and Ethernet
o DS3 transport.
Network management systems were enhanced to support larger networks and
to support mixed modes as well as SONET-only mode. Also the Telenium management
system was offered to meet the demands of the public network environment.
Progress, which did not result in product releases, included:
o Fast (100BaseT) Ethernet
o Byte synchronous E1
o Increased video switching speed and quality
o Management system TL-1 and SNMP interfaces
o An access product strategy
o A new architecture for lower cost and reduced time to market
by allowing integration of third party products.
Progress in the CS4 development program continued with the design and
development of the commercial version of the system. This included the design of
second generation hardware to provide significantly more processing capacity for
handling greater traffic loads and to afford greater flexibility for
13
<PAGE> 14
product migration and manufacturing efficiency. In addition, the software
architecture was refined to provide higher system performance and to address
early stage requirements for product commercialization.
Systems were configured for CS4 subsystem testing, systems integration,
load testing and performance analysis. A beta site customer was identified and a
system was readied for commencement of field testing early in the second quarter
of 1999. Planning for supporting the customer's applications and installation of
the beta system at the customer's site was completed.
Videoconferencing products were developed in Windows NT version.
Progress was made on development of PCI compliant hardware. A Gateway to H.320
conferencing systems was introduced. Enhancements were made to minimize the
installation task.
Digital signal processing product developments built the foundation for
the first year of significant revenues in 1998. Including work funded by a
customer, these developments included:
o A development platform for the C6000 circuits of Texas
Instruments, the EVM module
o A proprietary operating system for C6000 developers
o VME board-level products under a private label arrangement.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses of $17,724,000 includes $1,148,000
of warranty expense, primarily the extra costs of start up and first year
operations of two major installations of the SONETLYNX product in Korea and on
the Alyeska pipeline. Selling expense declined 11% from the prior year,
excluding unusual warranty costs. Administrative expense of $6,547,000 in 1998
was 12% below the prior year level. Expenses in 1998 included sales development
activities which resulted in the approximately $10,000,000 of orders received
for SONETLYNX products early in 1999. General corporate expenses contributed
$800,000 of the decrease from 1997 when extra costs were incurred to remove the
corporate headquarters from Bermuda. The Company estimates that the usual level
of warranty expenses would have been approximately $200,000 but for special
startup difficulties caused by distance, cultural differences and unusual
technical characteristics.
Selling and administrative expenses increased 28% to $18,671,000 in
1997 compared to 1996. Selling expense increased to $11,213,000 from $6,412,000,
primarily due to higher revenues for SONETLYNX products and to market
development activities for SONETLYNX and LANscape products. Administrative
expense of $7,458,000 in 1997 was 9% below the prior year, partly due to the
removal of corporate headquarters from Bermuda during 1997.
ASSET WRITE DOWNS
In accordance with the evolving focus of the Company's primary
technologies, products and markets and forward growth plans, and in accordance
with the Company's accounting policies, including reviews of realizability of
its long-term assets, including goodwill, the Company wrote off the September
30, 1998 balance of $6,888,000 of goodwill from the acquisition in 1995 of
Intelect Inc., which at that time was primarily engaged in the supply of
communications systems for air traffic control and air defense installations,
and is presently operating as Intelect Network Technologies, emphasizing the
SONETLYNX and FIBRETRAX product lines. Goodwill amortization charges in the
amount of $149,000 per quarter also will be eliminated following the writeoff of
goodwill. The writeoff decision was determined by the recent loss of three major
identified business opportunities, the absence of significant identified future
opportunities and business combinations which strengthened competitors, all
leading the Company to reassess the outlook for the air traffic control business
segment. The Company concluded that the outlook for future business would not
support a forecast of revenue and contribution margin adequate to liquidate
inventories and support amortization of the goodwill asset.
14
<PAGE> 15
Accounts and notes receivable from the Company's Korean distributor,
and relating to the sales of the Company's products in Korea, totaled $4,696,000
at the end of September 1998, compared to $9,879,000 at December 31, 1997, from
which $6,731,000 was collected and to which $1,730,000 of shipments were added
during 1998. 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. Accordingly, the Company determined that it would be
prudent and timely to write off or reserve substantially all the distributor's
receivables adjusted for a collection of $1,000,000 received in February 1999.
In connection with this collection, and contingent on certain future payments,
the Company agreed not to pursue any further collections of the receivable.
In connection with the acquisition of IVC, certain assets and licenses,
which constituted the design of a videoconferencing product, were purchased from
a major computer company. The design proved to be flawed and market introduction
was delayed approximately nine months. In 1996, the Company deemed the
recoverability of IVC goodwill to be significantly impaired by the delay in
introduction of the product to a rapidly changing market and accordingly reduced
the carrying value of IVC goodwill by $4,175,000 (its remaining unamortized net
book value at the time) and wrote off $51,000 of fixed assets deemed of no
value. The Company's assessment of the future prospects for the information
security products business in the United Kingdom led to a complete shut down of
those operations in Chesterfield, England at the end of 1996. In January 1997,
liquidation proceedings began. The Company was an unsecured creditor of IEL and
wrote off all net assets related to those operations in England in the amount of
$1,807,000.
INTEREST EXPENSE
Interest expense, primarily non-cash financing charges, of $4,385,000,
$2,863,000 and $9,911,000 in the years ended December 31, 1998, 1997 and 1996
consists of:
<TABLE>
<CAPTION>
Years ended December 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
($ Thousands)
<S> <C> <C> <C>
Interest on debt instruments $ 1,109 930 704
Non-cash financing costs 3,242 1,721 7,534
Other costs of financing 28 199 1,571
Other interest 6 13 102
---------- ---------- ----------
$ 4,385 2,863 9,911
---------- ---------- ----------
</TABLE>
Interest on debt instruments in 1998 was primarily attributable to
amounts borrowed from St. James Capital Corp., SJMB, L.P., and the Coastal
Trust. In 1997, the interest was attributable to St. James Capital Corp. and
Coastal Trust borrowing and to two series of convertible debentures. In 1996,
the interest was attributable to three series of convertible debentures.
Non-cash financing costs in 1998 and 1997 were the result of warrants
to purchase common stock issued in connection with various financings. The
reported expense amount is the value of the warrants determined by using the
Black-Scholes pricing model. In 1996, in addition to $2,942,000 of warrant
values, $4,592,000 of reportable expense was attributable to a beneficial
conversion feature of the convertible debentures.
Other costs of financing consist primarily of legal and placement fees.
15
<PAGE> 16
INCOME (LOSS) FROM DISPOSAL OF DISCONTINUED OPERATIONS
Losses in 1998, 1997 and 1996 represent legal expenses in connection
with the indemnity agreement with Savage Sports Corporation. See ITEM 3, Legal
Proceedings.
YEAR 2000 COMPLIANCE
The Company has conducted a review of its computer systems and products
to identify those 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 or products fail 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 Year 2000 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
Year to year cash balances were lower by $1,103,000 at December 31,
1998. During the year, cash expended in operations ($22,929,000) and in
investing activities ($4,144,000) was funded by the reduction of cash balances
and by securing new financing of $25,970,000 (net of $14,831,000 of debt
repayments).
OPERATING ACTIVITIES
Net cash applied in operations primarily reflects the $43,138,000 net
loss offset by $8,170,000 of non-cash charges, non-cash asset write downs of
$10,628,000, and the $3,948,000 net increase in working capital. The net cash
requirement for operations is the combined effect of a reduced gross profit
contribution compared to 1997 and a continuation of expenditures related to the
Company's technology and product development programs and marketing, selling and
distribution activities. The lower level of gross profit reflects mainly the
abrupt discontinuance of sales in Korea and the lead times to develop sales in
other markets and to launch new products into markets, distribution and sales.
o Accounts receivable were a source of funding due to $4,597,000
collections from customers in excess of new shipments and
billings.
o Inventory increased $565,000 due to restocking, longer term
purchase commitments, and production for orders received near
the end of the year.
o Accounts payable were reduced $3,276,000 due to payments of
obligations similarly related to prior year operating levels.
o The non-cash charges were primarily $4,357,000 of depreciation
and amortization of intangible assets and $3,242,000 of
amortization of deferred financing costs.
o Asset write downs reflect the decision to write off goodwill
related to the air traffic control communication equipment
business and the recognition that the Company's Korean
distributor became illiquid and unable to pay accounts
receivable.
INVESTING ACTIVITIES
Investments during 1998 were primarily $2,035,000 of fixed asset
additions and $1,898,000 of capitalized SONETLYNX and LANscape product
enhancements and advancements. The fixed asset additions were
16
<PAGE> 17
concentrated in computers, software, and test equipment to support engineering
activities, and manufacturing equipment for new products.
FINANCING ACTIVITIES
Cash uses were financed by the following transactions during 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, of which $440,000 remains owed and unpaid at
year end
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
o $5,000,000 borrowed in September through November
o $750,000 borrowed in November
o $1,200,000 from the exercise of common stock warrants in
December
o $1,000,000 from the sale of common stock in December
Proceeds from these financings were used to retire maturing obligations
of $13,410,000 and for additional working capital.
SUBSEQUENT FINANCING ACTIVITIES
In January 1999, the Company sold $1,800,000 of common stock in a
private placement.
On January 13, 1999, the Coastal Trust extended the maturity of the
Receivables Loan previously maturing on August 31, 1999, to February 12, 2000.
On January 13, 1999, the Company elected to extend to February 12, 2000
the maturity of the convertible promissory notes of the Credit Facility.
On March 2, 1999, the Company entered into a Security Purchase
Agreement with a group of private investors. The Agreement provides for the sale
of up to $9,600,000 of Series E preferred stock contingent on certain
conditions. On March 5, 1999, the Company sold $3,000,000 of the Series E
preferred stock in an Initial Closing. An additional $3,000,000 will become
available to the Company in a Mandatory Closing contingent primarily on a
registration statement becoming effective to cover resale of common stock
issuable upon conversion of the preferred and the satisfaction of certain other
conditions.
OUTLOOK
During the last three years, the Company has continued various programs
and activities to design, develop, bring to market and establish distribution
and sales for four product lines targeting multiple markets internationally. For
the network access market, the SONETLYNX product line was introduced in 1996.
The line was expanded in 1998 by the addition of the FIBRETRAX (SDH)
international version. The Company has developed the CS4 Intelligent Services
Platform for beta testing and commercial availability in 1999. The DSP Design
Center in the Company's engineering services group continues to develop products
using advanced DSP circuits and design skills applicable to a variety of
companies in the networking and telecommunications industry. For video
communication, the Company has developed LANscape, a standards-based video
system offering full-motion collaborative communications for desktop and room
applications. These four product lines
17
<PAGE> 18
are each expected to have significant potential revenue and profit opportunities
for the Company and have been the focus of considerable development and
marketing expense during the last three years. The product lines and their
applications are more fully described in the ITEM I above. The Company has
incurred operating losses in 1998, 1997, and 1996 of $46,105,000, $20,798,000
and $43,039,000. Negative cash flows from operations in the same periods were,
respectively, $22,929,000, $24,852,000 and $23,050,000. The cash flows were
funded by proceeds from borrowings under credit facilities and sales of
preferred stock and common stock in 1998 and 1997 and by proceeds from issuance
of convertible debentures in 1996. The Company expects operating losses and
negative operating cash flow to continue at least through mid-year 1999. It is
uncertain when, if ever, the Company will report operating income or positive
cash flow from operations.
Redeploying and refocusing resources and new activities to replace
Korean with non-Korean business are still in process of producing results to
recover sales levels and gross profit contribution.
In response to lower levels of sales and production, the Company has
contained or reduced costs and expenses in engineering, selected product
development, and sales areas (net of non-recurring expenses recognized primarily
in connection with Korean business). Marketing and selling expenditures were
maintained on the SONETLYNX product line in connection with new distribution
relationships and the related quantity and quality of promising prospects. To
better align costs with near-term prospects, expenses related to video product
sales were reduced by closing offices in New York, California, and England.
Development costs of SONETLYNX and FIBRETRAX products were reduced as certain
schedules neared completion and lower cost outsourcing became feasible in some
areas. Expense reductions have not been sufficient to fully compensate for the
reduced gross margin contribution on lower sales volumes. Accordingly, lower
production volumes and ongoing costs and expenses have impeded progress toward
profitability and cash equilibrium.
The Company's initiative to arrange third party (partner)
participation(s) in CS4 development, funding and/or marketing led to increases
in spending from the recognition that potential interest is enhanced by the
accelerated commercialization of marketable product applications. The increased
spending of 1998 is being curtailed to a level supporting beta testing.
The Company is obligated to repay the Inventory Loan in two remaining
payments of $250,000 each plus accumulated interest on April 1 and May 1, 1999.
Obligations to two former shareholders of DNA, in the aggregate amount of
approximately $500,000, remain unpaid. The Company is in discussion with the
note holders and expects to reach agreement on a payment schedule for the
balance of the notes. The Credit Facility and Receivables Loan become due on
February 12, 2000. The Company intends to refinance those debts at the maturity
date, but no assurance can be given that a refinancing can be arranged.
The Company may be obligated to redeem all of the outstanding shares of
Series D and Series E Convertible Preferred Stock in the event of a Triggering
Event, which can occur if the Company is unable to make effective the
registration statement covering the resale of the shares issuable upon
conversion of such shares effective by May 19, 1999 for the Series D and July 7,
1999 for the Series E. The Company currently does not have the cash resources
available to effect such a required redemption, or pay the penalties required in
the event of such a redemption.
CONCLUSION
Considering the available financial resources, current business
prospects, the outlook for cash available from customer collections, the outlook
for cash to be used in operations and investing, and actions to control
spending, the Company believes it has or can obtain the financial resources to
meet its business requirements for the balance of the current year. There can be
no assurance, however, that the assumptions and projections underlying or
supporting this outlook will be realized. If cash needs exceed available
resources, there also can be no assurance that additional capital will be
available through public or private equity or debt financings. The
18
<PAGE> 19
financial statements have been prepared assuming the Company will continue as a
going concern and do not include any adjustments that might result from the
unfavorable outcome of such an uncertainty.
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.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk with regard to financial
instruments because two loans from The Coastal Trust bear interest based on the
prime rate.
At December 31, 1998, a hypothetical 100 basis point increase in
interest rates would result in a reduction of approximately $57,000 in annual
pre-tax earnings. The estimated reduction is based upon the increased interest
expense of the Company's variable rate debt and assumes no change in the volume
or composition of debt at December 31, 1998.
19
<PAGE> 20
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Reports of Independent Accountants........................... 21
Consolidated Balance Sheets.................................. 24
Consolidated Statements of Operations........................ 26
Consolidated Statements of Stockholders' Equity.............. 27
Consolidated Statements of Cash Flows........................ 30
Notes to Consolidated Financial Statements................... 32
</TABLE>
20
<PAGE> 21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Intelect Communications, Inc.
We have audited the accompanying consolidated balance sheet of Intelect
Communications, Inc., and subsidiaries as of December 31, 1998, and the related
consolidated statements of operations, stockholder's equity, and cash flows for
the year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Intelect
Communications, Inc. and subsidiaries as of December 31, 1998, and the
consolidated results of their operations and their consolidated cash flows for
the year then ended in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has experienced continuing operating losses
and negative cash flows. Its continued existence is dependent upon the
successful development of its products and obtaining adequate capital, neither
of which is assured. These matters raise substantial doubt about its ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Grant Thornton LLP
Dallas, Texas
March 31, 1999
21
<PAGE> 22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To: The Board of Directors and Shareholders of
Intelect Communications, Inc.
We have audited the accompanying consolidated balance sheet of Intelect
Communications, Inc. (a Delaware corporation) as of December 31, 1997, and the
related statements of operations, stockholders' equity and cash flows for the
year ended December 31, 1997. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Intelect
Communications, Inc. as of December 31, 1997, and the results of their
operations and their cash flows for the year ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Dallas, Texas
March 27, 1998
22
<PAGE> 23
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Intelect Communications Systems Limited
We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows of Intelect Communications Systems Limited
and its subsidiaries for the year ended December 31, 1996. In connection with
our audit of the consolidated financial statements, we have also audited the
financial statement schedule for the year ended December 31, 1996. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audit.
We conducted our audit in accordance with United States generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Intelect
Communications Systems Limited and its subsidiaries for the year ended December
31, 1996, in conformity with United States generally accepted accounting
principles. Also in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements, taken as
a whole, presents fairly, in all material respects, the information set forth
therein.
The accompanying consolidated financial statements and financial statement
schedule have been prepared assuming that the Company will continue as a going
concern. As discussed in Note 1 to the consolidated financial statements, the
Company has suffered recurring losses from continuing operations and is
dependent upon the successful development and commercialization of its products
and its ability to secure adequate sources of capital until the Company is
operating profitably. These matters raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans with regard to these
matters are also described in Note 1. The consolidated financial statements and
financial statement schedule do not include any adjustments that might result
from the outcome of this uncertainty.
/s/ KPMG Peat Marwick
Chartered Accountants
Hamilton, Bermuda
April 9, 1997 ....
23
<PAGE> 24
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1997
(Thousands of dollars, except share data)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 991 2,094
Investments 681 942
Accounts receivable net of allowances of $870
and $542 in 1998 and 1997 7,232 15,569
Inventories 6,854 6,289
Prepaid expenses 655 658
---------- ----------
Total current assets 16,413 25,552
Property and equipment, net 6,386 6,041
Goodwill, net 4,787 13,249
Software development costs, net 3,134 2,229
Other intangible assets, net 916 1,168
Other assets 446 992
---------- ----------
$ 32,082 49,231
---------- ----------
</TABLE>
(continued)
24
<PAGE> 25
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (continued)
December 31, 1998 and 1997
(Thousands of dollars, except share data)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable, net of unamortized discount of $578 in 1997 1,173 9,132
Current maturities of long-term debt 440 2,527
Accounts payable 4,293 7,569
Accrued liabilities 3,375 3,173
Net liabilities of discontinued operations 400 400
Deferred income taxes 45 49
Current installments of obligations under capital leases 126 89
------------ ------------
Total current liabilities 9,852 22,939
Long-term debt, net of unamortized discount of $388 14,612 --
Long-term obligations under capital leases, net of current installments 42 55
Deferred income taxes 44 88
------------ ------------
24,550 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; none and 914,286 shares issued
and outstanding in 1998 and 1997, respectively -- 9
Series C convertible preferred stock, $.01 par value (aggregate
involuntary liquidation preference $10,000,000). Authorized
12,500 shares; 1,843 issued and outstanding in 1998 1 --
Series D convertible preferred stock, $.01 par value (aggregate
involuntary liquidation preference $10,000,000). Authorized
10,000 shares; 8,250 issued and outstanding in 1998 1 --
Common stock, $.01 par value. Authorized 50,000,000 shares;
32,333,085 and 23,954,978 shares issued in 1998 and 1997,
respectively 323 240
Additional paid-in capital 104,451 75,940
Accumulated other comprehensive income -- 2
Accumulated deficit (96,189) (50,084)
------------ ------------
8,629 26,149
Less 191,435 shares of common stock in treasury (1,097) --
------------ ------------
Total stockholders' equity 7,532 26,149
============ ============
$ 32,082 49,231
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 26
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Operations
(Thousands of dollars, except share data)
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net revenue $ 19,341 37,777 9,352
Cost of revenue 18,433 23,526 11,973
------------ ------------ ------------
Gross profit (loss) 908 14,251 (2,621)
------------ ------------ ------------
Expenses:
Engineering and development 10,218 11,899 8,719
Selling and administrative 17,724 18,671 14,601
Amortization of goodwill 1,125 1,323 1,664
Asset writedowns 10,628 -- 6,033
------------ ------------ ------------
39,695 31,893 31,017
------------ ------------ ------------
Operating loss (38,787) (17,642) (33,638)
------------ ------------ ------------
Other income (expense):
Interest expense (4,385) (2,863) (9,911)
Interest income and other 483 636 653
------------ ------------ ------------
(3,902) (2,227) (9,258)
------------ ------------ ------------
Loss from continuing operations
before income taxes (42,689) (19,869) (42,896)
Income tax expense (benefit) 46 (126) 87
------------ ------------ ------------
Loss from continuing operations (42,735) (19,743) (42,983)
Loss on disposal of discontinued
operations, net of tax (403) (498) (56)
------------ ------------ ------------
Net loss (43,138) (20,241) $ (43,039)
Dividends on preferred stock (2,967) (557) --
------------ ------------ ------------
Loss allocable to common stockholders $ (46,105) (20,798) (43,039)
============ ============ ============
Basic and diluted loss per share:
Continuing operations $ (1.76) (0.99) (3.32)
Discontinued operations (0.02) (0.02) (0.01)
Net loss per share $ (1.78) (1.01) (3.33)
============ ============ ============
Weighted average number of common
shares outstanding (thousands) 25,939 20,558 12,943
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE> 27
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1998, 1997 and 1996
(Thousands of dollars, except share data)
<TABLE>
<CAPTION>
Preferred Stock
----------------------------- Accumulated Total
Series A Series B Common Stock Additional Other Stock-
-------------- ------------- ------------------ Paid-in Retained Comprehensive holders'
Shares Par Shares Par Shares Par Capital Earnings Income Equity
------ ------ ------ ----- ---------- ------ ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1995 $ -- -- -- -- 11,385,117 114 11,673 13,753 -- 25,540
Comprehensive Income:
Net loss (43,039) -- (43,039)
Change in unrealized gain
on marketable securities 18 18
-------
Total (43,021)
Conversion of debentures -- -- -- -- 1,837,205 18 10,069 -- -- 10,087
Acquisition of IVC -- -- -- -- 545,420 5 2,747 -- -- 2,752
Exercise of employee stock
options -- -- -- -- 530,000 5 1,012 -- -- 1,017
Exercise of warrants from
acquisition of Savage
Corporation -- -- -- -- 360,000 4 1,076 -- -- 1,080
Settlement of subordinated
debt and contingent
purchase consideration of
INT -- -- -- -- 169,986 2 848 -- -- 850
Purchase of other assets -- -- -- -- 100,000 1 374 -- -- 375
Employee compensation -
IVC -- -- -- -- 100,000 1 499 -- -- 500
Allocation of proceeds to
beneficial conversion features
of convertible debentures -- -- -- -- -- -- 4,947 -- -- 4,947
Detachable warrants issued
with convertible debentures -- -- -- -- -- -- 3,117 -- -- 3,117
Stock option compensation -- -- -- -- -- -- 487 -- -- 487
------ ------ ------ ----- ---------- ------ -------- ---------- ------ --------
Balances at December 31, 1996 $ -- -- -- -- 15,027,728 150 36,849 (29,286) 18 7,731
====== ====== ====== ===== ========== ====== ======== ========== ====== ========
</TABLE>
See accompanying notes to consolidated financial statements
(continued)
27
<PAGE> 28
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1998, 1997 and 1996
(Thousands of dollars, except share data)
<TABLE>
<CAPTION>
Preferred Stock
----------------------------- Accumulated Total
Series A Series B Common Stock Additional Other Stock-
----------------- --------------- ------------------ Paid-in Retained Comprehensive holders'
Shares Par Shares Par Shares Par Capital Earnings Income Equity
----------- ---- -------- ----- ----------- ------ -------- -------- ------------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at
December 31, 1996 $ -- -- -- -- 15,027,728 150 36,849 (29,286) 18 7,731
Comprehensive Income
Net loss (20,241) (20,241)
Change in unrealized
gain on marketable
securities (16) (16)
-------
Total (20,257)
Private placements
Preferred, Series A 2,482,005 25 -- -- -- -- 4,886 -- -- 4,911
Preferred, Series B -- -- 914,286 9 -- 3,868 -- -- 3,877
Common -- -- -- -- 696,400 7 3,323 -- -- 3,330
Conversion of debentures -- -- -- -- 5,376,864 54 14,796 -- -- 14,850
Conversion of notes
payable 2,482,006 25 -- -- -- -- 4,975 -- -- 5,000
Conversion of preferred
stock (780,583) (8) -- -- 780,583 8 -- -- -- --
Detachable warrants issued --
with notes -- -- -- -- -- -- 1,661 -- -- 1,661
Warrants issued for services -- -- -- -- -- -- 250 -- -- 250
Exercise of warrants -- -- -- -- 930,000 9 1,881 -- -- 1,890
Exercise of employee stock
options -- -- -- -- 561,666 6 1,569 -- 1,575
Stock option compensation -- -- -- -- -- -- 354 -- -- 354
Settlement of royalty
agreement -- -- -- -- 542,182 6 841 -- -- 847
Interest expense paid
with stock:
Preferred, Series A 35,981 -- -- -- -- -- 72 -- -- 72
Common -- -- -- -- 11,407 -- 58 -- -- 58
Preferred dividends paid
with stock -- -- -- -- 28,148 -- 296 (296) -- --
Preferred dividends accrued
Series A -- -- -- -- -- -- 215 (215) -- --
Series B -- -- -- -- -- -- 15 (15)
Amortization of beneficial
conversion features of
preferred stock, Series B -- -- -- -- -- -- 31 (31) -- --
----------- ---- -------- ----- ----------- ------ -------- -------- ------ -------
Balances at
December 31, 1997 $ 4,219,409 42 914,286 9 23,954,978 240 75,940 (50,084) 2 26,149
=========== ==== ======== ===== =========== ====== ======== ======== ====== =======
</TABLE>
See accompanying notes to consolidated financial statements
(continued)
28
<PAGE> 29
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1998, 1997 and 1996
(Thousands of dollars, except share data)
<TABLE>
<CAPTION>
Preferred Stock
------------------------------------------------------------------------
Series A Series B Series C Series D Common Stock
----------------- ------------------ ---------------- --------------- ------------------
Shares Par Shares Par Shares Par Shares Par Shares Par
---------- ----- ---------- ----- ------- ------ ------- ----- ---------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1997 $4,219,409 42 914,286 9 -- -- -- -- 23,954,978 240
Comprehensive income:
Net loss -- -- -- -- -- -- -- -- -- --
Change in unrealized gain on
Marketable securities -- -- -- -- -- -- -- -- -- --
Total -- -- -- -- -- -- -- -- -- --
Private placements:
Series C Preferred -- -- -- -- 10,000 -- -- -- -- --
Series D Preferred -- -- -- -- -- -- 10,000 -- -- --
Common -- -- -- -- -- -- -- -- 1,000,000 10
Conversion of notes payable -- -- -- -- -- -- -- -- 10,600 --
Conversion of preferred stock -- -- (914,286) (9) (8,157) -- (1,750) -- 5,997,819 60
Warrants issued with notes -- -- -- -- -- -- -- -- -- --
Warrants issued for services -- -- -- -- -- -- -- -- -- --
Exercise of warrants -- -- -- -- -- -- -- -- 600,000 6
Exercise of employee stock
options -- -- -- -- -- -- -- -- 226,458 2
Settlement of dispute -- -- -- -- -- -- -- -- 18,000 --
Stock option compensation -- -- -- -- -- -- -- -- -- --
Preferred dividends paid
with stock -- -- -- -- -- -- -- -- 333,795 3
Preferred dividends accrued -- -- -- -- -- -- -- -- -- --
Beneficial conversion features
of preferred stock issued -- -- -- -- -- -- -- -- -- --
Issue and subsequent acquisition
of common stock -- -- -- -- -- -- -- -- 191,435 2
---------- ----- ---------- ----- ------- ------ ------- ----- ---------- ------
Balances at December 31, 1998 $4,219,409 42 -- -- 1,843 -- 8,250 -- 32,333,085 323
========== ===== ========== ===== ======= ====== ======= ===== ========== ======
<CAPTION>
Accumu-
lated
Addi- other Total
tional compre- Treasury Stock Stock-
Paid-in Retained hensive ------------------ holders
Capital Earnings Income Shares Cost Equity
-------- ---------- ------ --------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1997 75,940 (50,084) 2 -- -- 26,149
Comprehensive income:
Net loss -- (43,138) -- -- -- (43,138)
Change in unrealized gain on
Marketable securities -- -- (2) -- -- (2)
--------
Total -- -- -- -- -- (43,140)
Private placements:
Series C Preferred 9,117 -- -- -- -- 9,117
Series D Preferred 9,444 -- -- -- -- 9,444
Common 990 -- -- -- -- 1,000
Conversion of notes payable 21 -- -- -- -- 21
Conversion of preferred stock (51) -- -- -- -- --
Warrants issued with notes 2,980 -- -- -- -- 2,980
Warrants issued for services 155 -- -- -- -- 155
Exercise of warrants 1,194 -- -- -- -- 1,200
Exercise of employee stock
options 396 -- -- -- -- 398
Settlement of dispute 101 -- -- -- -- 101
Stock option compensation 105 -- -- -- -- 105
Preferred dividends paid
with stock 1,306 (1,309) -- -- -- --
Preferred dividends accrued 1,040 (1,040) -- -- -- --
Beneficial conversion features
of preferred stock issued 618 (618) -- -- -- --
Issue and subsequent acquisition
of common stock 1,097 -- -- 191,435 (1,097) 2
-------- ---------- ----- --------- ------- --------
Balances at December 31, 1998 104,453 (96,189) -- 191,435 (1,097) 7,532
======== ========== ===== ========= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements
29
<PAGE> 30
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
(Thousands of dollars)
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(43,138) (20,241) (43,039)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 4,357 3,412 3,581
Amortization of loan discount 3,242 1,920 9,105
Asset writedowns 10,628 -- 6,033
Loss on disposal of discontinued
operations 403 498 56
Stock option compensation 100 354 487
Noncash operating expenses (income) (217) 191 500
Other 285 (143) 43
Change in operating assets and liabilities, net of
effects of acquired companies:
Accounts receivable 4,597 (13,242) (898)
Inventories (565) (3,311) (350)
Other assets 599 (165) (95)
Accounts payable and accrued liabilities (3,220) 5,875 1,603
Net liabilities of discontinued operations -- -- (76)
-------- -------- --------
Net cash used in operating activities (22,929) (24,852) (23,050)
-------- -------- --------
Cash flows from investing activities:
Payments for disposal of discontinued operations (403) (498) (56)
Purchase of other intangible assets (69) (94) (1,075)
Capital expenditures (2,035) (2,993) (3,660)
Purchase of marketable securities -- (103) (836)
Purchase of other assets -- (338) (110)
Software development costs (1,898) (1,317) (1,395)
Proceeds from sale of fixed assets -- -- 200
Proceeds from sale of marketable securities 261 -- --
Payment for acquisition of DNA, net of cash
acquired -- (3,009)
Loan to IVC, prior to acquisition -- -- (700)
Payment for acquisition of IVC, net of cash
acquired -- -- (668)
-------- -------- --------
Net cash used in investing activities (4,144) (5,343) (11,309)
-------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements
(Continued)
30
<PAGE> 31
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
Years ended December 31, 1998, 1997 and 1996
(Thousands of dollars)
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of convertible
Debentures $ -- -- 25,000
Proceeds from issuance of notes payable 19,657 14,910 --
Debt issuance costs (155) (255) (1,623)
Principal payments on notes payable (12,557) (200) (880)
Principal payments under capital lease obligations (25) (76) (311)
Principal payments on long-term debt (2,274) (2,473) (100)
Proceeds from issuance of preferred shares 18,815 8,789 --
Proceeds from issuance of common shares 1,000 3,266 --
Proceeds from exercise of common stock warrants 1,200 1,890 1,080
Proceeds from exercise of employee stock options 309 1,575 1,017
-------- -------- --------
Net cash provided by financing
activities 25,970 27,426 24,183
-------- -------- --------
Net (decrease) in cash and cash
equivalents (1,103) (2,769) (10,176)
Cash and cash equivalents, beginning of year 2,094 4,863 15,039
======== ======== ========
Cash and cash equivalents, end of year $ 991 2,094 4,863
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE> 32
INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business
Intelect Communications, Inc. (the "Company") was incorporated in
Delaware on May 23, 1995, and is the successor company of a
reorganization, effective December 4, 1997, whereby the Company became a
U. S. domiciled public company. The previous public company, Intelect
Communications Systems Limited ("Intelect (Bermuda)"), a Bermuda company,
became a subsidiary of Intelect Communications, Inc. Intelect (Bermuda)
had operated under the name of Coastal International, Ltd. until
September 1985 and as Challenger International, Ltd. until December 1995.
The Company operates in one industry segment and is an international
communications technology and products company that designs, develops,
manufactures, markets, and sells products and services for the
integration of voice, data, and video networks. The Company's products
include a multi-service access platform for fiber optic networks, digital
signal processing system components, video communications equipment, and
telecommunications system design and development services.
Former subsidiaries of the Company were engaged in information security
product sales and services (from 1995 to 1997), in the manufacture and
marketing of sporting arms (from 1989 to 1995), and in various energy
related activities (from 1981 to 1988). These subsidiaries were sold or
liquidated before December 31, 1997.
The Company has incurred significant operating losses and negative cash
flows from operations in 1998, 1997 and 1996. The cash flows were funded
by proceeds from borrowings under credit facilities and sales of
preferred stock and common stock in 1998 and 1997 and by proceeds from
issuance of convertible debentures in 1996. The Company expects operating
losses and negative operating cash flow to continue at least through
mid-year 1999. It is uncertain when, if ever, the Company will report
operating income or positive cash flow from operations.
Considering the available financial resources, current business
prospects, the outlook for cash available from customer collections, the
outlook for cash to be used in operations and investing, and actions to
control spending, the Company believes it has or can obtain the financial
resources to meet its business requirements for the balance of the
current year. There can be no assurance, however, that the assumptions
and projections underlying or supporting this outlook will be realized.
If cash needs exceed available resources, there also can be no assurance
that additional capital will be available through public or private
equity or debt financings. The financial statements have been prepared
assuming the Company will continue as a going concern and do not include
any adjustments that might result from the unfavorable outcome of such an
uncertainty.
(2) Significant Accounting Policies and Practices
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles. The preparation
of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
32
<PAGE> 33
(a) Principles of Consolidation
The consolidated financial statements include the financial
statements of the Company and its subsidiaries, all of which are
wholly owned, since their dates of acquisition. All significant
intercompany balances and transactions have been eliminated in
consolidation.
(b) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures
about Fair Value of Financial Instruments," requires disclosure of
the fair value of certain financial instruments for which it is
practicable to estimate fair value. For purposes of the disclosure
requirements, the fair value of a financial instrument is the
amount at which the instrument could be exchanged in a current
transaction between willing parties, other than in a forced sale
or liquidation. The carrying values of cash, accounts receivable,
marketable securities, notes payable and accounts payable are
reasonable estimates of their fair value due to the short-term
maturity of underlying financial instruments. It was not practical
to estimate the fair value of the Company's long-term debt because
quoted market prices do not exist and comparable securities were
not available.
(c) Revenue and Expense Recognition
Revenue from product sales is recognized upon shipment of
products. Reserves for estimated sales returns and allowances are
recorded in the same accounting period as the related revenues.
Revenue from engineering services is recognized as the services
are provided to the customers.
Contracts that are expected to be completed within one year are
generally considered short-term contracts and revenue is
recognized upon shipment to the customer. Revenue on longer-term
contracts is generally recognized using the
percentage-of-completion method. Under the
percentage-of-completion method, revenue recognition is measured
by the proportion of the contract costs incurred to date to
estimated total costs for each contract. Contract costs include
all direct material and labor costs and those indirect costs
related to contract performance, such as indirect labor, supplies,
tools and repair costs. General, administrative and engineering
and development costs are charged to expense as incurred. Changes
in estimated profit on contracts are recognized in the period in
which the revisions are determined. Provisions for estimated
losses on uncompleted contracts are charged to earnings in the
period in which such losses first become apparent.
(d) Inventories
Inventories consist of raw materials, work in progress and
finished goods, and are stated at the lower of cost (determined on
a first-in, first-out basis) or market.
(e) Property and Equipment
Property and equipment are stated at cost. Equipment under capital
leases is stated at the present value of minimum lease payments.
33
<PAGE> 34
Depreciation on equipment is calculated on the straight-line
method over the estimated useful lives of the assets. Equipment
held under capital leases and leasehold improvements are amortized
on a straight-line basis over the shorter of the lease term or
estimated useful life of the assets and included in depreciation
expense. The estimated useful lives are as follows:
<TABLE>
<CAPTION>
Years
-----
<S> <C>
Machinery and equipment 5 to 7
Computer equipment and software 3 to 5
Furniture and fixtures 5 to 7
Motor vehicles 3
</TABLE>
(f) Deferred Financing Costs
Deferred financing costs in connection with the issuance of debt
are amortized to interest expense using the effective interest
method over the term of the related debt instrument (note 8). A
portion of the proceeds from the issuance of convertible debt
securities with beneficial conversion features and/or detachable
stock purchase warrants is recognized as additional paid-in
capital and as a discount to its related debt instrument and
amortized to interest expense ratably from the date of issuance to
the date the related debt first becomes convertible. Other costs
in connection with the issuance of the same securities are also
deferred and amortized in the same manner.
(g) Engineering and Development and Software Development Costs
Engineering and development costs are expensed as incurred.
Capitalization of software development costs commences upon the
establishment of technological feasibility and ceases when the
product is generally available for sale. Both the establishment of
technological feasibility and the ongoing assessment of
recoverability of capitalized development costs involve judgments
by management with respect to certain external factors, including,
but not limited to, anticipated future revenues, estimated
economic life and possible developments in software and hardware
technologies. In 1996, the Company determined that technological
feasibility and future revenue potential had been established for
the SONETLYNX product line. In 1997, the Company's LANscape
product line achieved technological feasibility and future revenue
potential was established. During the years ended December 31,
1998, 1997 and 1996, the Company capitalized $1,987,735,
$1,317,000 and $1,395,000 of software development costs and
charged operations for $1,083,424, $477,000 and $6,000 of
amortization, respectively. Amortization prior to 1998 is based on
estimated product revenues over the next five years or straight
line, whichever is greater. After 1997, amortization is based on
the greater of product revenues or two years.
During the first three quarters of 1996, the Company capitalized
software development costs associated with the development of the
CS4 programmable switch, having established technological
feasibility early in 1996. In December 1996, a reassessment of the
product definition rendered invalid the establishment of
technological feasibility because feasibility had not been
attained for all the inter-related modules of the product.
Accordingly, all costs that had been capitalized in previous
quarters, totaling $2,442,000, were charged to engineering and
development expense in the fourth quarter of 1996.
During the year ended December 31, 1996, the Company advanced
$396,000 to a software developer in connection with the
development of certain software and related technology. Such
amounts were charged to 1996 engineering and development expense.
34
<PAGE> 35
(h) Earnings (Loss) Per Common Share
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings per Share." SFAS 128 established standards for computing
and presenting earnings per share (EPS) and is effective for
financial statements issued for periods ending after December 15,
1997. This statement requires presentation of basic and dilutive
EPS. Basic EPS excludes the effect of common stock equivalents
while diluted EPS gives effect to all dilutive potential common
shares outstanding during the period.
(i) Foreign Currency Translation
The Company's United Kingdom subsidiaries, Intelect Europe Limited
("IEL") and Intelect Network Systems Limited ("INSL"), used the
local currency as the functional currency and translated net
assets at the exchange rates in effect on the balance sheet dates,
while income and expense accounts were translated at average
rates. Foreign transaction exchange gains and losses were
recognized as income or expense. Foreign currency translation
adjustments and transaction amounts were not significant.
(j) Income Taxes
The Company accounts for income taxes under the liability method
as required by Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes." Under this method, deferred
tax assets and liabilities are determined based on differences
between the financial reporting and income tax bases of assets and
liabilities and are measured using the enacted tax rates and laws
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the
enactment date.
(k) Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash
and cash equivalents include cash held in banks and time deposits
having maturities within three months of the date of purchase by
the Company.
(l) Goodwill
Goodwill, which represents the excess of purchase price over fair
value of net assets acquired, is amortized on a straight-line
basis over 10 to 15 years. Accumulated amortization at December
31, 1998 and 1997 was $4,076,000 and $2,951,000, respectively.
The Company assesses the recoverability of goodwill by determining
whether the amortization of the goodwill balance over its
remaining life can be recovered through undiscounted future
operating cash flows of the acquired operation. The amount of the
goodwill impairment, if any, is measured based on projected
discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of
the recoverability of goodwill will be impacted if estimated
future operating cash flows are not achieved.
35
<PAGE> 36
During the year ended December 31, 1998, the Company charged
$6,888,000 to operations for the writedown of goodwill in
connection with the 1995 acquisition of Intelect Network
Technology Company (INT) (See note 6(a)). The goodwill was
considered impaired due to the loss of three significant bids for
air traffic control (ATC) projects, the absence of any significant
future prospects for the ATC products of INT, and the industry
trend toward consolidation, all combining to diminish the outlook
for the ATC business.
During the year ended December 31, 1996, the Company charged
$4,175,000 to operations for the writedown of goodwill in
connection with the 1996 acquisition of Intelect Visual
Communications Corp. (see note 6(d)). The goodwill was considered
impaired due to design flaws in the products acquired, which
required design changes and enhancements and delayed market
introduction. In addition, due to the liquidation of IEL, as
described in note 6(b), goodwill of $740,000 associated with the
1995 acquisition of IEL was charged to 1996 operations.
The aforementioned writedowns were measured in accordance with the
policy described above. At December 31, 1998, the Company believes
that no significant impairment of the remaining goodwill has
occurred and that no reduction of the estimated useful lives is
warranted.
(m) Other Intangible Assets
Other intangible assets consist of a software license from a
vendor (1996 only) and purchased product technology (note 7).
Product technology assets are being amortized by the straight-line
method over periods ranging from three to five years.
(n) Stock Option Plan
The Company accounts for its stock option plan in accordance with
the provisions of Accounting Principles Board ("APB") Opinion No.
25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense is recorded on the
date of grant only if the current market price of the underlying
stock exceeded the exercise price. On January 1, 1996, the Company
adopted SFAS No. 123, Accounting for Stock-Based Compensation,
which permits pro forma net income and pro forma earnings per
share disclosures for employee stock option grants made in 1995
and future years as if the fair-value-based method defined in SFAS
No. 123 had been applied.
(o) Warranty Reserve
The Company accrues a reserve for warranty expense based on
estimated future costs of startup and first year operations at
customer sites.
(p) Reclassification
Certain prior period balances have been reclassified to conform to
the current year presentation.
36
<PAGE> 37
(3) Investments
Equity securities are considered available-for-sale and are stated at
fair value. Unrealized holding gains and losses, net of the related tax
effect, on available-for-sale securities are excluded from earnings and
are reported as a separate component of shareholders' equity until
realized. Realized gains and losses from the sale of such securities are
determined on a specific identification basis. Holdings of equity
securities were sold in 1998. Certificates of deposit are
interest-bearing and are pledged in the course of contractual performance
and for the purpose of obtaining operating leases. A summary of such
securities follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------
1998 1997
----------------------------------------- ------------------------------------------
Gross Gross
unrealized unrealized
holding Fair holding Fair
Cost gains value Cost gains value
------------ ------------- ------------ ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Equity securities $ - - - 52 2 54
Certificates
of deposit 681 - 681 888 - 888
------------ ------------- ------------ ------------- ------------- ------------
Total $ 681 - 681 940 2 942
============ ============= ============ ============= ============= ============
</TABLE>
(4) Inventories
The components of inventories are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Raw materials $ 5,038 5,209
Work in progress 888 630
Finished goods 3,472 2,050
------------ ------------
9,398 7,889
Less allowance for obsolescence (2,544) (1,600)
------------ ------------
Total $ 6,854 6,289
============ ============
</TABLE>
(5) Property and Equipment
Property and equipment are summarized as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Machinery and equipment $ 6,826 3,883
Computer equipment and software 2,386 3,026
Furniture and fixtures 763 1,138
Leasehold improvement 343 223
------------ ------------
10,318 8,270
Less:
Accumulated depreciation and amortization (3,932) (2,229)
------------ ------------
Total $ 6,386 6,041
============ ============
</TABLE>
37
<PAGE> 38
(6) Acquisitions
During 1995, the Company purchased Intelect Network Technologies Company
("INT") and Intelect Europe Limited ("IEL"). During 1996, the Company
purchased DNA Enterprises, Inc. ("DNA") and Intelect Visual
Communications Corp. ("IVC"). A summary of these acquisitions is as
follows:
(a) Intelect Network Technologies Company
On January 13, 1995, the Company acquired 16% of the capital stock
of INT (formerly known as Intelect, Inc.) for $400,000. On March
31, 1995, the Company entered into an agreement to purchase the
remaining 84% of the capital stock of INT (the "Option
Agreement"). Under the terms of the Option Agreement, the Purchase
Price was payable as follows:
(i) $2,500,000 payable in debentures (the "Debentures") of INT
plus the amount by which certain of INT's debts to two
major customers (the "Debts") were settled for less than
$6,000,000. The Debts were settled by the Company for
$5,180,000 and, accordingly, the face value of the
Debentures was increased to $3,320,000 ($2,500,000 plus
$6,000,000 minus $5,180,000). The face value of the
Debentures was reduced by the amount that defined net
assets at the acquisition date (April 24, 1995) was less
than $1,268,000. The amount of this reduction was
$3,013,000 and, accordingly, the face value of the
Debentures at December 31, 1995 was $307,000.
(ii) $4,000,000 in "Contingent Purchase Consideration"
calculated on the future profitability of INT over the four
year period from January 1, 1995. The additional payments
were payable in cash or common stock, at the Company's
option.
The first step of the acquisition of INT involved the purchase of
a minority interest (16%) for cash. The Company's equity in the
earnings of INT prior to acquisition of the remaining 84%, the
second step, amounted to a loss of $280,000 and equity in the
extraordinary gain arising from the restructuring of certain notes
payable of $646,000, which were stated separately in the 1995
Consolidated Statements of Operations.
On October 7, 1996, the Company reached an agreement with the
holders of the Debentures (the "Vendors"), under which the Vendors
exchanged their remaining rights to the Debentures and Contingent
Purchase Consideration in exchange for 169,986 shares of common
stock. The transaction increased Goodwill by $660,000.
(b) Intelect Europe Limited
On August 31, 1995, the Company acquired 100% of the capital stock
of IEL for $391,000 in cash and up to 300,000 of the Company's
common shares in additional payments based on the future
profitability of IEL over the five year period beginning August
31, 1995.
In December 1996, management made the decision to close the
operations of IEL, which was subsequently placed in voluntary
liquidation. The liquidation represented a disposal of a part of a
line of business. Asset impairments were recorded and estimated
liabilities to be incurred as a result of the liquidation were
accrued, resulting in a charge to expense of $1,807,000 in 1996,
including a writedown of $740,000 of unamortized goodwill.
38
<PAGE> 39
(c) DNA Enterprises, Inc.
On February 13, 1996, the Company acquired 100% of the capital
stock of DNA for $8,000,000, plus costs, payable as follows:
(i) $3,000,000 cash at closing.
(ii) $1,000,000 cash on the first anniversary of closing.
(iii) $400,000 cash on the second anniversary of closing.
(iv) Warrants to purchase 300,000 common shares at $5.00 per
share on the first anniversary of closing.
(v) Warrants to purchase 300,000 common shares at $7.00 per
share on the second anniversary of closing.
The Company agreed to redeem the $5.00 warrants at prices of
$5.00, $5.50 and $6.00 per warrant share on the first, second, and
third anniversaries of closing, respectively, and redeem the $7.00
warrants at prices of $5.50 and $6.00 per warrant share on the
second and third anniversaries of closing, respectively, in each
such case at the option of the warrant holders. The warrants were
classified similar to redeemable preferred stock and included in
long-term debt at their highest redemption price, totaling
$3,600,000 at December 31, 1996 (note 9).
The Company is renegotiating terms of payment of its redemption
obligations (notes 9 and 23). On the first and second
anniversaries, the warrant holders elected to redeem all 300,000
common share warrants available on each date.
(d) Intelect Visual Communications Corporation
On March 29, 1996, the Company acquired 100% of the capital stock
of IVC (formerly known as Mosaic Information Technologies, Inc.)
for 479,370 common shares valued at $5.00 per share. The Company
also paid $695,000 cash, and issued 66,050 common shares, valued
at $5.375 per share, as payment of certain other acquisition
costs. The total cost of the acquisition, including working
capital advances prior to acquisition, was $4,747,000. An
additional 50,000 common shares, valued at $5.00 per share, were
issued to each of two selling shareholders pursuant to employment
agreements, and charged to compensation expense.
All acquisitions have been accounted for by the purchase method of
accounting and, accordingly, the purchase prices have been allocated to
the assets acquired and the liabilities assumed based on the estimated
fair values at the dates of acquisition. The excess of purchase price
over the estimated fair values of the net assets acquired has been
recorded as goodwill, which is being amortized over 10 years for DNA. As
discussed in note 2, all goodwill in connection with the acquisition of
INT was written off in 1998, and in connection with the acquisitions of
IVC and IEL was written off in 1996.
39
<PAGE> 40
The estimated fair values of assets acquired and liabilities assumed on
the respective transaction dates are summarized as follows:
<TABLE>
<CAPTION>
DNA IVC INT IEL
------- ------- ------- -------
<S> <C> <C> <C> <C>
Cash $ 3 27 40 --
Accounts receivable 621 19 454 388
Inventory -- 245 2,683 278
Property and equipment 502 81 700 492
Goodwill 7,280 4,514 8,260 812
Accounts payable and accruals (166) (123) (4,721) (1,293)
Deferred taxes (228) -- -- --
Debt -- (16) (6,530) (286)
------- ------- ------- -------
$ 8,012 4,747 886 391
------- ------- ------- -------
</TABLE>
Purchase prices include legal and other costs associated with the
acquisitions.
Operating results of the acquisitions are included in the Company's
consolidated results of operations from the effective dates of the
acquisitions. The following unaudited pro-forma summary presents the
consolidated results of operations as if the acquisitions of DNA and IVC
had occurred at January 1, 1996 after giving effect to certain
adjustments, including amortization of goodwill, additional interest
expense on the acquisition debt and related income tax effects. These
pro-forma results have been prepared for comparative purposes only and do
not purport to be indicative of what would have occurred had the
acquisitions been made as of those dates or of results which may occur in
the future:
<TABLE>
<CAPTION>
Year ended
December 31, 1996
-----------------
<S> <C>
Net revenues $ 10,320
========
Loss from continuing operations $(43,251)
========
Net loss per common share $ (3.34)
========
</TABLE>
(7) Other Intangible Assets
Other intangible assets are summarized as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Investment in technology associated with
SONETLYNX products (note 14) $ 1,407 1,407
Other intellectual property 230 159
------------ ------------
1,637 1,566
Less accumulated amortization (721) (398)
------------ ------------
$ 916 1,168
============ ============
</TABLE>
40
<PAGE> 41
(8) Notes Payable
In August 1997, the Company executed an amended and restated loan
agreement with The Coastal Corporation Second Pension Trust (the "Coastal
Trust") providing for borrowing, on a revolving credit basis, of up to
$5,000,000 and $3,000,000 was advanced in 1997. The balance was paid in
connection with the revision to the Credit Facility (note 9) in May 1998.
The balance due at December 31, 1997 was $2,598,000.
The note payable with a carrying value of $5,824,000 at December 31,
1997 was refinanced by the Credit Facility described in note 9.
In November 1998, the Company executed with the Coastal Trust a credit
agreement for $750,000 secured primarily by inventory (the "Inventory
Loan").
Notes payable at December 31, 1998, are as follows:
<TABLE>
<S> <C>
Inventory Loan with the Coastal Trust, due in $250,000 amounts each
of March 1, April 1 and May 1, 1999, including interest at the
rate of 3.5% over prime (10.5% at December 31, 1998) secured by
inventory and a second lien on all outstanding shares of the
Company's wholly owned U.S. subsidiaries
$ 750
Unsecured demand promissory notes, bearing interest at 3% over prime (10% at
December 31, 1998), payable to a group of individuals, including $233,000
to directors and $90,000 to employees of the Company, convertible at any
time by the holders into common stock at a price of $2.00 per share
(balance
December 31, 1997, $710,000) 423
--------------
Total $ 1,173
--------------
</TABLE>
(9) Long-term Debt
In February 1998, the Company executed a revolving credit agreement with
a private lender (the "Credit Facility") under which $3,000,000 was
borrowed and warrants to purchase 450,000 shares of common stock were
issued. The agreement was revised in April 1998, refinancing the existing
borrowing of $3,000,000 and adding $7,000,000 to the Facility in exchange
for warrants to purchase 1,050,000 shares of common stock. In February
1999, the due date was extended to March 12, 2000, in exchange for an
additional 535,000 warrant shares. The balance due at December 31, 1997
on a refinanced facility with affiliates of the private lender, was
$5,824,000.
In September 1998, the Company executed with the Coastal Trust a
revolving credit agreement for up to $5,000,000 secured primarily by
accounts receivable (the "Receivables Loan").
41
<PAGE> 42
Components of long-term debt are as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------
1998 1997
-------------- ---------------
<S> <C> <C>
Credit Facility with a private lender, due February 12, 2000,
Including interest at the fixed rate of 7%, secured by all
Outstanding shares of the Company's wholly owned U.S.
Subsidiaries (less unamortized discount of $388,000) $ 9,612 --
Receivables Loan with the Coastal Trust, due February 12, 2000,
including interest at the rate of 3.5% over prime (10.5% at
December 31, 1998) secured by accounts receivable and a second
lien on all outstanding shares
of the Company's wholly owned U.S. subsidiaries 5,000 --
Repurchase agreements for common stock warrants held by former
shareholders of DNA, payable in two installments: (1) $1,500,000
in February 1997, renegotiated and paid in monthly installments
of $200,000, including interest at 6%, through December 1997, and
(2) $2,100,000 in February 1998, renegotiated and paid in monthly
installments of $150,000 including interest at 14.38% through
December 1998. Balance at December 31, 1998 represents the
balance due on three unpaid installments with interest, penalty
and fees (note 6(c)) 440 2,100
Partial purchase price of DNA, payable in two installments -
$1,000,000 in February 1997 and $400,000 in February 1998,
renegotiated into notes payable in monthly installments of
$100,000, including interest of 6% through December 1997, and 8%
after February 1998, through May 1998 (note 6(c)) -- 427
------------ -----------
15,052 2,527
Less current installments (440) (2,527)
------------ -----------
Long-term, due in 2000 $ 14,612 --
============ ===========
</TABLE>
The Credit Facility prohibits additional debt, payment of dividends
except on preferred stock, and encumbering any assets of the operating
subsidiaries. The Credit Facility requires no payment of principal or
interest until maturity. The outstanding balance is convertible into
common stock at $9.082 per share, subject to anti-dilution adjustment, at
the election of the lender. Financing costs in connection with the
issuance of the Credit Facility were $3,053,000, including $2,980,000 in
fair value of warrants to purchase 1,500,000 shares of common stock,
valued using the Black-Scholes model, and $73,000 in cash. In 1998,
amortization of financing costs, using the effective interest method over
the loan period, was $2,665,000.
42
<PAGE> 43
The Receivables Loan and the Inventory Loan prohibit additional debt,
liens on property, dividends or distributions on capital stock (except
dividends on preferred stock payable in common stock). Advances under the
Receivables Loan are limited to 80% of "eligible accounts" as defined.
(10) Convertible Debentures
During the year ended December 31, 1996, the Company issued three series
of convertible debentures: "June Debentures" in the aggregate principal
amount of $5,000,000 bearing interest at 7.5%, "August Debentures" in the
aggregate principal amount of $10,000,000 bearing interest at 7.5%, and
"October Debentures" in the aggregate principal amount of $10,000,000
bearing interest at 7%.
At December 31, 1996, the June Debentures were fully converted into
773,514 shares of common stock, the August Debentures were partially
converted into 883,691 shares of common stock, and the October Debentures
were partially converted into 180,000 shares of common stock.
At December 31,1997, the August Debentures were fully converted into
2,582,106 shares of common stock and the October debentures were fully
converted into 3,868,449 shares of common stock.
Financing costs incurred in 1996 in connection with the issuance of
debentures were $9,687,000, including $4,947,000 allocated to beneficial
conversion features, $3,117,000 in the fair value of warrants to purchase
420,063 shares of common stock (note 14), valued using the Black-Scholes
model, and $1,623,000 in cash. Interest expense included $582,000 and
$9,105,000 in 1997 and 1996, respectively.
(11) Lease Commitments
The Company is obligated under various capital equipment leases that
expire during the next two years. The gross amounts of equipment and
vehicles and related accumulated amortization recorded under capital
leases were as follows:
<TABLE>
<CAPTION>
December 31,
----------------------------------
1998 1997
------------ -----------
<S> <C> <C>
Equipment $ 257 257
Less accumulated amortization (118) (69)
------------ -----------
$ 139 188
============ ===========
</TABLE>
The Company leases office space and certain equipment under leases
expiring at various dates through 2004. Rental expense under operating
leases was approximately$1,607,000, $1,528,000 and $1,032,000 for the
years ended December 31, 1998, 1997 and 1996, respectively.
43
<PAGE> 44
Future minimum commitments as of December 31, 1998 under capital and
operating leases are as follows:
<TABLE>
<CAPTION>
Capital Operating
Years ending December 31, Leases Leases
------------ -----------
<S> <C> <C>
1999 $ 42 1,494
2000 17 772
2001 -- 693
2002 -- 538
2003 -- 434
2004 and thereafter -- 5 135
------------ -----------
Total minimum lease payments $ 59 5,4,066
============ ===========
</TABLE>
Imputed interest included in future minimum commitments on capital leases
is not material.
(12) Employee Benefit Plans
The Company sponsors defined contribution 401(k) plans for substantially
all employees. Pursuant to the plans, employees may request the Company
to deduct and contribute amounts from their salary on a pre-tax basis.
Employee contributions are subject to certain limitations and the Company
may make matching contributions, at its discretion. The Company may also
make discretionary contributions in addition to matching contributions.
Company contributions vest ratably over periods of four to five years,
beginning in the second or first year of employment, respectively.
Company contributions to the plans were $460,000, $345,000 and $459,000
for the years ended December 31, 1998, 1997 and 1996, respectively.
(13) Income Taxes
Total income tax expense was allocated as follows:
<TABLE>
<CAPTION>
Years ended December 31,
-----------------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Loss from continuing operations $ 46 (126) 87
Goodwill, for initial recognition
of acquired tax liabilities -- -- 228
------------- ------------- -------------
$ 46 (126) 315
============= ============= =============
</TABLE>
44
<PAGE> 45
Significant components of the provision for income taxes attributable to
continuing operations for the years ended December 31, 1998, 1997 and
1996 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Current
Federal $ -- -- --
State 94 51 --
---------- ---------- ----------
Total current 94 51 --
---------- ---------- ----------
Deferred:
Federal (48) (171) 84
State -- (6) 3
---------- ---------- ----------
Total deferred (48) (177) 87
---------- ---------- ----------
Total current and deferred $ 46 (126) 87
========== ========== ==========
</TABLE>
The difference between the actual income tax benefit and the benefit
computed by applying the statutory corporate income tax rate of 34% to
pretax losses from continuing operations is attributable to the
following:
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Computed expected tax benefit $ (14,667) (6,755) (14,585)
Increase in net operating loss
carryforwards not providing
current benefit 11,349 5,394 7,530
Permanent items 315 407 1,776
Writeoff of goodwill 2,494 -- --
Tax effect of loss not subject to
U.S. taxation -- 856 4,517
Other 555 (28) 849
------------ ------------ ------------
Tax expense (benefit) $ 46 (126) 87
============ ============ ============
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Deferred tax assets:
Preacquisition net operating loss carryforwards $ 4,831 4,831
Postacquisition net operating loss carryforwards 25,505 14,156
Inventories - due to reserves and additional costs
capitalized for tax 866 544
Accrued contract completion costs 34 34
Goodwill -- 71
License fees and intellectual property 11 11
Other expenses 887 836
Alternative minimum tax and other credit
Carryforwards 298 298
------------ ------------
32,432 20,781
Gross deferred tax assets
Less valuation allowance (32,432) (20,781)
------------ ------------
Deferred tax assets -- --
============ ============
Deferred tax liabilities: $ 89 137
============ ============
</TABLE>
45
<PAGE> 46
At December 31, 1998, the Company had federal net operating loss
carryforwards of approximately $89,225,000 and tax credit carryforwards
of $298,000. The future utilization of $14,210,000 of the preacquisition
net operating losses and the credit carryforwards related to the
acquisition of INT and IVC will be limited under Internal Revenue Code
Sections 382 and 383. The tax benefits from the utilization of the
preacquisition operating loss carryforwards and the tax credits will be
credited to goodwill when realized.
Following is a summary of the carryforwards and the expiration dates as
of December 31, 1998:
<TABLE>
<CAPTION>
Expiration
Amounts Dates
---------------- ----------------
<S> <C> <C>
Postacquisition net operating loss carryforwards $75,015 2012-2018
Preacquisition net operating loss carryforwards 14,210 2008-2009
Alternative minimum tax credit 38 -
General business credit 260 1999-2000
</TABLE>
In 1996, Intelect (Bermuda) was not subject to income tax in Bermuda and
did not consider itself to be engaged in trade or business in the U.S. As
such, Intelect (Bermuda) does not expect to be subject to direct United
States taxation.
(14) Stockholders' Equity
Authorized share capital of $0.01 par value was as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
Preferred Stock 50,000,000 50,000,000
Common Stock 50,000,000 50,000,000
</TABLE>
Share transactions during the year ended December 31, 1998, were as
follows:
a. Authorized 12,500 and sold 10,000 shares of Series C convertible
preferred stock for $10,000,000 in a private placement, resulting
in net proceeds of $9,117,000 after issuance costs of $883,000. A
premium accrues at 4% annually and is payable upon conversion in
cash or common stock at the option of the Company. Shares may be
redeemed at $1,100 per share plus 110% of accrued dividends. The
preferred stock, plus accrued premium, may be converted after May
10, 1998 to common stock at a price which is the lower of $9.082
or 97% of the average of the three lowest closing bid prices for
the ten trading days preceding a notice of conversion. Effective
March 5, 1999, the variable conversion price is 83.5% of the
average of the two lowest closing bid prices for the 40 trading
days prior to the date of conversion.
b. Authorized and sold an aggregate of 10,000 shares of Series D
convertible preferred stock for $10,000,000 in two separate
private placements, resulting in net proceeds of $9,444,000 after
issuance costs of $556,000. A premium accrues at 4% annually and
is payable in cash or common stock at the option of the Company.
Shares may be redeemed at $1,100 per share plus 110% of accrued
premium. The preferred stock, plus accrued premium, may be
converted to common stock at a price which is the lower of $2.998
or 97% of the average of the three lowest closing bid prices for
the ten trading days preceding a notice of conversion. The
conversion right was available June 8, 1998 for the first
placement of 5,000 shares and September 24, 1998 for the second
5,000 shares. Effective March 5, 1999, the variable
46
<PAGE> 47
conversion price is 83.5% of the average of the two lowest closing
bid prices for the 40 trading days prior to the date of
conversion.
c. Sold 1,000,000 shares of common stock in private placements at
$1.00 per share, to accredited investors.
d. Issued 1,325,339 shares of common stock upon conversion of Series
B preferred stock. Issued 4,006,532 shares of common stock upon
conversion of Series C convertible preferred stock. Issued 784,184
shares of common stock upon conversion of Series D convertible
preferred stock.
e. Issued 600,000 shares of common stock upon exercise of warrants at
$2.00 per share by an assignee of St. James Capital Corp., LP.
f. Issued 226,458 shares of common stock upon exercise of employee
stock options.
g. Issued 333,795 shares of common stock in payment for $1,309,000 of
dividends on preferred stock.
h. Issued 18,000 shares of common stock in partial settlement of an
employment dispute with a seller of Mosaic Information
Technologies.
i. Issued 10,600 shares of common stock upon the partial conversion
of a promissory note held by a former employee.
j. Issued warrants exercisable for common stock as follows:
<TABLE>
<CAPTION>
Warrant Exercise
Grant Date Shares Price Exercise Period
------------------------------------ -------------- ------------ ----------------------------------------
<S> <C> <C> <C>
February 12, 1998* 450,000 7.50 February 1998 - February 2001
(*)Replaced with warrant for 300,000 shares on April 2, 1998
April 2, 1998** 300,000 7.50 April 1998 - February 2001
April 2, 1998** 1,200,000 7.50 April 1998 - February 2001
(**) Repriced to $2.998 by its terms on November 10, 1998. Pursuant to anti-dilution provisions in the warrant,
holders have the right to acquire an aggregate of 3,753,000 shares. Holders of such warrants have claimed they
may be entitled to additional antidilution protection due to sales of common stock below the warrant
exercise price.
May 20, 1998 33,036 10.292 May 1998 - May 2003
June 20, 1998*** 30,000 5.00 June 1998 - April 2005
(***) Replaced on September 1, 1998
September 1, 1998 30,000 2.00 September 1998 - April 2005
September 1, 1998**** 200,000 2.00 September 1998 - December 2002
(****) Replacing warrants issued May 1, 1997, 100,000 at $5.00 and 100,000 at $7.00
December 2, 1998 300,000 1.50 February 1999 - March 2002
December 2, 1998 300,000 1.50 February 1999 - March 2002
December 22, 1998 150,000 2.998 February 1999 - December 2003
December 22, 1998 150,000 2.998 February 1999 - December 2003
</TABLE>
47
<PAGE> 48
The fair value of warrants issued was determined using the Black-Scholes
option pricing model with the following assumptions:
<TABLE>
<CAPTION>
Stock Price Exercise Term (years) Interest
Issue Price Volatility Rate Fair Value
-------------------------- ------------ ------------ ------------- ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Credit facility with private lender:
February 12, 1998 7.0125 7.50 1.00 75% 5.6% $ 909,172
April 2, 1998 6.9375 7.50 1.00 75% 5.6% 2,071,195
------------
Total $ 2,980,367
------------
Advisory services agreement:
September 1, 1998 2.2188 2.00 1.00 75% 5.6% 155,408
Equity placement services:
May 20, 1998 Not valued because services were for placement of equity.
June 20, 1998 Not valued because services were for placement of equity.
December 2, 1998 Not valued because services were for placement of equity.
December 22, 1998 Not valued because services were for placement of equity.
</TABLE>
At December 31, 1998, outstanding warrants were as follows:
<TABLE>
<CAPTION>
Warrant Exercise
Grant Date Shares Price Exercise Period
---------- ------- ----- ---------------
<S> <C> <C> <C>
June 7, 1996 125,000 13.1875 June 1996 - June 2001
August 8, 1996 70,063 8.56375 August 1996 - August 2001
September 9, 1996 125,000 9.5625 September 1996 - September 2001
October 5, 1996 225,000 7.50 October 1996 - October 2001
May 1, 1997 100,000 3.00 January 1998 - December 2002
May 8, 1997 50,000 2.00 May 1997 - May 2002
June 19, 1997 6,750*` 3.6313 June 1997 - June 2001
July 25, 1997 6,750* 3.6313 July 1997 - June 2001
August 15, 1997 6,750* 3.6313 August 1997 - June 2001
August 27, 1997 450,000 6.00 August 1997 - August 2002
August 29, 1997 6,750* 3.6313 August 1997 - June 2001
September 17, 1997 13,500* 3.6313 September 1997 - June 2001
April 2, 1998 300,000** 2.998 April 1998 - February 2001
April 2, 1998 1,200,000** 2.998 April 1998 - February 2001
May 20, 1008 33,036 10.292 May 1998 - May 2002
September 1, 1998 30,000 2.00 September 1998 - April 2005
September 1, 1998 200,000 2.00 September 1998 - December 2002
December 2, 1998 300,000 1.50 February 1999 - March 2002
December 2, 1998 300,000 2.50 February 1999 - March 2002
December 22, 1998 150,000 2.998 February 1999 - December 2003
December 22, 1998 150,000 2.998 February 1999 - December 2003
Total 3,848,599
</TABLE>
*Surrendered February 19, 1999 in connection with payment of receivables.
**See comment above regarding antidilution effects.
Share transactions during the year ended December 31, 1997, were as follows:
48
<PAGE> 49
a. Authorized 10,000,000 shares and sold 2,482,005 shares of $2.0145,
10% Cumulative Convertible Preferred Stock, Series A, for
$5,000,000, in conjunction with a loan agreement with the Coastal
Trust, resulting in net proceeds of $4,911,000, after issuance
costs of $89,000. Dividends are payable quarterly, in cash or
common stock, at the Company's option. The Company elected to pay
dividends payable at September 30 and December 31, 1997, in common
stock. The series may be redeemed, at the Company's option, at
110%, 105% and 100% of face value after June 1, 1999, 2000, and
2001, respectively, and is convertible into shares of common stock
on a share for share basis, subject to anti-dilution provisions.
The holders have the right of first refusal to participate in
certain private equity or debt offerings. The series ranks in pari
passu with the Series B and Series C preferred stock.
b. Authorized and sold 914,286 shares of $4.375, 10% Cumulative
Convertible Preferred Stock, Series B, for $4,000,000, in a
private placement, resulting in net proceeds of $3,877,000, after
issuance costs of $123,000. Dividends are payable quarterly, in
cash or common stock, at the Company's option, beginning March 31,
1998. The series may be redeemed, at the Company's option, at the
greater of $5.25 per share or the average closing market bid price
for the five consecutive trading days prior to the date of
redemption. Beginning after May 31, 1998, 50% of the preferred
stock is convertible into common stock and the remaining 50% is
convertible into common stock on June 30, 1998. The number of
common shares the holder is entitled to receive on conversion is
the greater of (i) the number of shares of preferred stock
multiplied by 1.10, or (ii) the number of shares of preferred
stock multiplied by a number, the numerator of which is $4.375 and
the denominator of which is 0.85 multiplied by the average daily
closing market bid price for the common stock, as quoted on the
Nasdaq National Market system, for the five trading days
immediately preceding the date of the notice of election of
conversion. The holders have the right of first refusal to
participate in certain private equity or debt offerings. The
series ranks in pari passu with the Series A and Series C
preferred stock.
c. Sold 675,000 shares of common stock in private placements of
60,000 shares at $5.00 per share and 615,000 shares at $5.25 per
share, to accredited investors, resulting in net proceeds of
$3,330,000, after issuance costs of $199,000. An additional 21,400
shares were issued in payment for placement services related to
the 615,000 shares.
d. Issued 780,583 shares of common stock upon the conversion of
Series A preferred stock by the Coastal Trust.
e. Issued 930,000 shares of common stock upon the exercise of
warrants. 750,000 common shares at $2.00 were issued to the
Coastal Trust; 150,000 shares at $2.00 were issued to the Credit
Facility private lender; and 30,000 shares at $4.50 were issued
pursuant to a consulting agreement, resulting in net proceeds of
$1,890,000 after issuance costs of $45,000.
f. Issued 542,182 shares of common stock at $1.5625, totaling
$847,000, together with $60,000 cash in settlement of all future
royalties under a technology purchase agreement. The royalty
agreement had been initially executed in conjunction with certain
technology purchased by the Company.
g. Issued 11,407 shares of common stock in payment for $58,000 of
interest on Convertible Debentures, due June 30, 1997.
h. Issued 28,148 shares of common stock in payment for $296,000 of
dividends on Series A preferred stock.
49
<PAGE> 50
i. Issued warrants exercisable for common shares as follows:
<TABLE>
<CAPTION>
Warrant Exercise
Grant Date Shares Price Exercise Period
---------- ------- ----- ---------------
<S> <C> <C> <C>
February 26, 1997(*) 300,000 $5.00 February 1997 - February 2002
March 27, 1997(*) 300,000 3.25 March 1997 - March 2002
April 24, 1997(*) 150,000 3.25 April 1997 - April 2002
May 1, 1997 100,000 3.00 January 1998 - December 2002
May 1, 1997 100,000 5.00 January 1998 - December 2002
May 1, 1997 100,000 7.00 January 1998 - December 2002
May 8, 1997 300,000 2.00 May 1997 - February 2002
May 8, 1997 300,000 2.00 May 1997 - March 2002
May 8, 1997 150,000 2.00 May 1997 - April 2002
May 8, 1997 50,000 2.00 May 1997 - May 2002
May 8, 1997 750,000 2.00 May 1997 - May 2002
June 19, 1997 6,750 3.6313 June 1997 - June 2004
July 2,1997 30,000 4.50 August 1997 - December 2001
July 25, 1997 6,750 3.6313 July 1997 - June 2004
August 15, 1997 6,750 3.6313 August 1997 - June 2004
August 27, 1997 450,000 6.00 August 1997 - August 2002
August 29, 1997 6,750 3.6313 August 1997 - June 2004
September 17, 1997 13,500 3.6313 September 1997 - June 2004
(*) Replaced on May 8, 1997.
</TABLE>
The fair value of warrants issued was determined using the Black-Scholes
option pricing model with the following assumptions:
<TABLE>
<CAPTION>
Stock Exercise Term Interest Fair
Issue Price Price (Yrs) Volatility Rate Value
----- ----- ----- ----- ---------- ---- -------
<S> <C> <C> <C> <C> <C> <C>
Credit Facility with private lender:
February 26, 1997(*) $ 4.675 $ 5.00 1.00 70.06% 6.19% $ 381,000
March 27, 1997(*) 2.325 3.25 1.00 74.07 6.67 139,000
April 24, 1997(*) 1.619 3.25 1.00 74.36 6.77 26,000
---------
Total 546,000
---------
(*) Replaced on May 8, 1997. The fair value of the replacement warrants was less than the
unamortized value of the original warrants on date of replacement.
May 8, 1997 1.975 2.00 1.00 74.30 6.62 183,000
May 8, 1997 1.975 2.00 1.00 74.30 6.62 183,000
May 8, 1997 1.975 2.00 1.00 74.30 6.61 91,000
May 8, 1997 1.975 2.00 1.00 74.30 6.59 30,000
Advisory Services Agreement:
May 1, 1997 1.55 3.00 1.67 74.71 6.60 33,000
May 1, 1997 1.55 5.00 1.67 74.71 6.60 16,000
May 1, 1997 1.55 7.00 1.67 74.71 6.60 9,000
---------
Total 58,000
---------
</TABLE>
50
<PAGE> 51
Loan Agreements with Coastal Trust:
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
May 8, 1997 1.975 2.00 1.00 74.30 6.59 457,000
August 27, 1997 6.444 6.00 1.00 75.00 6.24 987,000
Distributor Agreement:
June 19, 1997 3.581 3.6313 1.00 75.00 6.38 8,000
July 25, 1997 6.344 3.6313 1.00 75.00 6.11 22,000
August 15, 1997 6.475 3.6313 1.00 75.00 6.20 23,000
August 29, 1997 6.731 3.6313 1.00 75.00 6.24 25,000
September 17, 1997 9.438 3.6313 1.00 75.00 6.24 84,000
--------
Total 162,000
</TABLE>
Equity Placement Services:
July 2, 1997 Not valued because services were for placement
of equity.
Share transactions during the year ended December 31, 1996, were as
follows:
a. Issued 180,000 common shares at $2.50 per share and 180,000 common
shares at $3.50 per share upon the exercise of warrants issued to
the previous owners of Savage Corporation. The warrants had been
issued in connection with the acquisition of Savage Corporation.
b. Issued 100,000 common shares at $3.75 per share in consideration
for an investment of $375,000 in debentures with a CDN $500,000
face value, previously issued by Lakefield Arms Limited. The
unsecured debentures bear interest at 8% per annum, and mature
August 4, 1999.
c. Issued warrants exercisable for common shares in conjunction with
the issuance of convertible debentures, and in conjunction with
the acquisition of DNA Enterprises, Inc., as follows:
<TABLE>
<CAPTION>
Warrant Exercise
Grant Date Shares Price Exercise Period
---------- ------ -------- ---------------
<S> <C> <C> <C>
February 13, 1996 300,000 $ 5.00 February 1997 - February 1999
February 13, 1996 300,000 7.00 February 1998 - February 1999
June 7, 1996 125,000 13.1875 June 1996 - June 2001
August 8, 1996 70,063 8.56375 August 1996 - August 2001
September 9, 1996 125,000 9.5625 September 1996 - September 2001
October 15, 1996 225,000 7.50 October 1996 - October 2001
</TABLE>
d. The fair value of warrants issued in conjunction with the
convertible debentures was determined using the Black-Scholes
option pricing model with the following assumptions:
<TABLE>
<CAPTION>
Stock Exercise Term Interest Fair
Issue Price Price (Yrs) Volatility Rate Value
----- ----- ----- ----- ---------- ---- -----
<S> <C> <C> <C> <C> <C> <C>
June 7, 1996 $13.1875 $ 13.1875 5.0 70.5% 7.05% $ 1,058,000
August 8, 1996 9.5625 8.56375 5.0 73.1 7.05 453,000
September 9, 1996 7.50 9.5625 5.0 71.6 7.05 561,000
October 15, 1996 7.50 7.50 5.0 68.3 6.00 1,045,000
-----------
Total $ 3,117,000
===========
</TABLE>
There have been no dividends declared on common shares for any of the
periods reported.
51
<PAGE> 52
(15) Employee Stock Option Plan
In 1995, Intelect (Bermuda) adopted a stock option plan (the "Plan")
pursuant to which the Company's Board of Directors may grant stock
options to directors, officers and key employees. The Plan, adopted by
the Company as part of the redomiciling process, authorizes grants of
options to purchase up to 5,000,000 shares of authorized common stock.
The exercise price for stock options granted may range from 25% to 110%
of the fair market value of the shares on the date of grant. All stock
options have 10-year terms and vest and become fully exercisable
according to schedules determined by the Board of Directors, generally
one-third on each of the first three anniversaries of the date of grant.
At December 31, 1998, there were 560,840 shares available for grant under
the Plan. The Plan replaced a predecessor plan which continues only to
the extent that there are 140,000 unexercised options outstanding at
December 31, 1998.
The per share weighted-average fair value of stock options granted during
1998, 1997 and 1996 was $1.91, $2.04 and $4.66, respectively, on the
dates of grants. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model, with the
following weighted-average assumptions:
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------------------------------------
1998 1997 1996
------------------ ------------------- ------------------
<S> <C> <C> <C>
Expected dividend yield 0% 0% 0%
Stock price volatility 100% 75% 68%
Risk free interest rate 4.6% 5.7% 6.1%
Expected option term 3 years 3 years 3 years
</TABLE>
The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, has recognized compensation expense with respect to certain
options granted at exercise prices less than the stock's market value on
the date of grant. During the years ended December 31, 1998, 1997 and
1996, the Company recognized compensation expense of $101,000, $354,000
and $487,000, respectively.
Had the Company determined compensation cost based on the fair value on
the grant date for its stock options under SFAS No. 123, the Company's
net losses would have been increased to pro forma amounts as follows:
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------------------------------------
1998 1997 1996
------------------ ------------------- ------------------
<S> <C> <C> <C>
Net loss allocable to common
shareholder:
As reported $ (46,105) (20,798) (43,039)
Pro forma (52,107) (25,217) (45,955)
Loss per share:
As reported $ (1.78) (1.01) (3.33)
Pro forma (2.01) (1.23) (3.55)
</TABLE>
Pro forma net losses reflect only options granted in 1998, 1997 and 1996.
Therefore, the full impact of calculating compensation cost for stock
options under SFAS No. 123 is not reflected in the pro forma net loss
amounts presented above because compensation cost is reflected over the
option's vesting period of three years and compensation cost for options
granted prior to November 1, 1995 is not considered. Furthermore, the
effects of applying SFAS No. 123 may not be representative of the effects
on reported net income for future years.
52
<PAGE> 53
Stock option activity during the periods indicated was as follows:
<TABLE>
<CAPTION>
Years ended December 31,
-------------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
Number of options:
Outstanding, beginning of
period 3,271,000 2,526,500 1,917,800
Granted 3,488,000 2,208,500 1,260,000
Exercised (226,450) (561,666) (530,000)
Canceled (2,501,506) (902,334) (121,300)
--------------- --------------- ---------------
Outstanding, end of period 4,031,044 3,271,000 2,526,500
Weighted average exercise price:
Outstanding, beginning of
period $ 3.93 4.58 2.56
Granted 2.98 3.87 6.85
Exercised 1.76 3.03 1.93
Canceled 5.54 6.32 7.77
Outstanding, end of period $ 2.23 3.93 4.58
</TABLE>
At December 31, 1998, 1997 and 1996, the number of options exercisable
was 1,316,341, 1,056,659, and 734,332, respectively, and the
weighted-average exercise price of those options was $2.49, $3.78, and
$2.79 respectively.
At December 31, 1998, the range of exercise prices and the
weighted-average remaining contractual life of outstanding options, was
$1.00 to $6.25 and 8.8 years, as shown in the following table:
<TABLE>
<CAPTION>
Option
Option shares shares Exercise prices Expiration
outstanding exercisable per share Dates
------------------------- ----------------------- ------------------------ ------------------------
<S> <C> <C> <C>
3,160,703 686,009 $2.000 2007-8
40,000 40,000 2.375 2004
100,000 100,000 2.660 2003
672,000 452,000 3.000 2005-7
10,000 3,333 4.250 2007
25,000 16,666 4.375 2006
15,000 10,000 5.375 2006
8,333 8,333 6.250 2007
</TABLE>
(16) Income (Loss) Per Share
Basic and diluted income (loss) per share is based on the weighted
average number of common shares outstanding for the period. Potential
common shares relating to the exercise of stock options and stock
warrants, conversion of preferred stock or conversion of convertible debt
have been excluded from the computation as the effects would have been
anti-dilutive.
53
<PAGE> 54
Contingent shares, which were part of the INT and IVC acquisitions, have
been excluded from the calculations because it was considered unlikely
that the underlying performance criteria would be met.
(17) Contingencies
On October 28, 1998, in the 192nd Judicial District Court for Dallas
County, Texas Richard Dzanski filed suit against Intelect Network
Technologies Company, a wholly owned subsidiary of the Company, and
Intelect Systems Corp., the predecessor of the Company. In the suit, the
plaintiff has claimed a breach of an Irrevocable Option Agreement and
that he has not received payments he claims are due to him in the amount
of at least $386,000. The defendants deny liability to the plaintiff and
intend to vigorously defend the case. The parties are in discovery and it
is too early to determine if the outcome of this case will have a
material impact on the Company.
Intelect (Bermuda) is contingently liable for certain potential
liabilities related to its discontinued operations. Specifically, under a
stock purchase agreement dated October 3, 1995 ("1995 Agreement"),
Intelect (Bermuda) agreed to indemnify Savage Sports Corporation, the
purchaser of Savage Arms, Inc. (a manufacturer of firearms), for certain
product liability, environmental clean-up costs and other contractual
liabilities, including certain asserted successor liability claims. One
of the liabilities assumed involves a firearms product liability lawsuit
filed by Jack Taylor individually and as father of Kevin Taylor in Alaska
Superior Court (the "Taylor litigation"). Intelect (Bermuda) is informed
that a defendant in the Taylor litigation, Western Auto Supply Co.,
settled the lawsuit for $5 million and, in turn, has asserted a
third-party claim against Savage Arms, Inc. for indemnification in the
amount of the settlement plus attorneys' fees and related costs. Savage
Arms has asserted defenses to the claims and Intelect (Bermuda) believes
additional defenses may be available. Based on the information available
to date, it is impossible to predict the outcome of this litigation or to
assess the probability of any verdict.
Intelect (Bermuda) also has been notified that Savage Sports Corporation
seeks indemnification under the 1995 Agreement in connection with certain
other product liability claims. Most notably, Intelect (Bermuda) has
undertaken the defense of a lawsuit filed against Savage Arms, Inc. by
Emhart Industries, Inc. ("Emhart") in the United States District Court
for the District of Massachusetts (the "Emhart litigation"). In the
lawsuit, Emhart requests indemnification from Savage Arms, Inc. under an
agreement Emhart allegedly executed in 1981 with Savage Industries, Inc.,
claiming that Savage Arms, Inc. is a successor to Savage Industries, Inc.
To date, Emhart has claimed indemnification of approximately $2.2 million
for five lawsuits it has defended or settled and also seeks a declaratory
judgment that it is entitled to indemnification for losses and expenses
related to firearms product liability actions which may be filed against
Emhart in the future. Intelect (Bermuda) intends to assert additional
defenses. The parties are in discovery and Intelect (Bermuda) cannot at
this time predict the outcome of the litigation.
In the event the Taylor litigation and/or Emhart litigation were to be
resolved adversely to Intelect (Bermuda), there would be a material
adverse effect on the Company's financial condition and results of
operations.
54
<PAGE> 55
(18) Segments of Business and Geographic Areas
See Products, Technologies and Services in ITEM I for a description of
the segments in which the Company does business.
Sales to external customers:
<TABLE>
<CAPTION>
Years ended December 31,
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Fiber optic multiplexer $ 6,410 26,250 430
Engineering services 8,147 8,632 4,332
Digital signal processor 2,690 277 81
Visual communication 1,448 636 172
Other - United States 646 1,982 1,892
Other - Europe -- -- 2,445
------- ------- -------
Worldwide total $19,341 37,777 9,352
======= ======= =======
Included in the above were direct and indirect export sales of:
$ 4,068 25,071 1,402
======= ======= =======
</TABLE>
In 1997, 59% of sales were to Asia, substantially all to the Republic of
Korea. See note 20 for a description of customer concentration.
Segment-specific margins (Gross Profit less total engineering and
development costs, including capitalized software, and asset write downs
for the segment):
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Fiber optic multiplexer $(10,792) 5,635 (3,482)
Engineering services 2,002 2,375 1,270
Digital signal processor 402 (576) (306)
Visual communication (671) (1,402) (6,006)
Other (12,747) (4,997) (10,244)
-------- -------- --------
Subtotal segment specific (21,806) 1,035 (18,768)
Capitalized software 1,988 1,317 1,395
All other expenses (18,969) (19,994) (16,265)
-------- -------- --------
Operating loss (38,787) (17,642) (33,638)
======== ======== ========
</TABLE>
55
<PAGE> 56
Assets, capital expenditures and depreciation are identifiable only by
combined segments, as grouped below:
<TABLE>
<CAPTION>
ASSETS At December 31,
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Fiber optic multiplexer, visual
communication and other -
United States $20,906 35,554 12,547
Engineering services and DSP 8,200 8,840 6,607
Other - Europe 221
Not allocable to a segment 2,755 4,837 16,864
------- ------- -------
Worldwide total $32,082 49,231 36,018
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
CAPITAL EXPENDITURES Years ended December 31,
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Fiber optic multiplexer, visual
communication and other $ 1,662 2,539 2,265
Engineering services and DSP 354 454 1,047
Not allocable to a segment 19 -- 348
------- ------- -------
Worldwide total $ 2,035 2,993 3,660
======= ======= =======
DEPRECIATION
Fiber optic multiplexer, visual
communication and other $ 1,161 836 725
Engineering services and DSP 396 354 195
Not allocable to a segment 145 -- 541
------- ------- -------
Worldwide total $ 1,702 1,190 1,461
======= ======= =======
</TABLE>
(19) Related Party Transactions
During the year ended December 31, 1998, the following related party
transactions were recorded:
(a) Renewed a loan to an officer in the amount of $171,000, including
accrued interest and additional advances, which was outstanding at
December 31, 1998. The 5% note is secured by a stock pledge
agreement.
(b) Repaid a loan of $200,000 from an officer, including interest of
$4,000.
During the year ended December 31, 1997, the following related party
transactions were recorded:
(a) Borrowed $200,000 from a director in May and repaid the loan in
September, including interest of $8,000.
(b) Renewed a loan to an officer in the amount of $95,000, including
accrued interest, which was outstanding at December 31, 1997. The
5% note is secured by a stock pledge agreement.
(c) Borrowed $643,000 from a group of individuals, including $233,000
from directors, $200,000 from an officer and $210,000 from
employees.
During the year ended December 31, 1996, the following related party
transactions were recorded:
(a) Purchased patents, intellectual property and related proprietary
information from a company owned by an officer for $125,000 and
entered into a royalty agreement with respect to products sold by
the Company which are covered by the patents.
(b) Loaned an officer $135,000, of which $91,000, including accrued
interest, remained outstanding at December 31, 1996. The 5% note
is secured by a stock pledge agreement.
(c) Borrowed $500,000 from a company controlled by a director who was
also the Company's president in July, and repaid the loan in
September, including interest of $13,000.
(d) Paid $120,000 for management fees and rented facilities from a
company controlled by a director who was also the Company's
president.
(e) Amended employment agreements with the now former president and
the present chairman which, generally upon termination, provide
for continuation of salaries for three years following the current
year of employment.
(20) Significant Customers and Concentration of Credit Risk
In 1998, no customer accounted for more than 10% of consolidated net
revenues.
In 1997, a distributor and one customer represented 59% and 11%,
respectively, of consolidated net revenues. The distributor sold to at
least five end users in the Republic of Korea.
56
<PAGE> 57
In 1996, one customer represented 25% of consolidated net revenue.
The Company is subject to credit risk through trade receivables. At
December 31, 1997, the distributor responsible for all revenue from Korea
accounted for $9,879,000 (63%) of the accounts receivable. In October
1998, the Company was advised of the illiquidity of the distributor and
wrote off or reserved substantially all of the $4,696,000 receivables
remaining unpaid at the end of September 1998, adjusted, effective in
December 1998, for a payment of $1,000,000 in February 1999.
(21) Supplemental Disclosure of Cash Flow Information
<TABLE>
<CAPTION>
Years ended December 31,
-----------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
Cash paid during the period for:
Interest $ 1,126 704 509
</TABLE>
Noncash Items
During the year ended December 31, 1998, the Company recorded the
following noncash transactions:
(a) Converted notes payable into common stock -$21,000.
(b) Converted 914,286 shares of Series B preferred stock and 8,157
shares of Series C preferred stock and 1,750 shares of Series D
preferred stock into 5,997,819 shares of common stock.
(c) Issued common stock in payment of preferred stock dividends -
$1,309,000
(d) Issued common stock warrants in conjunction with notes payable
-$2,980,000.
(e) Issued common stock warrants in conjunction with an advisory
services agreement -$155,000.
(f) Allocation of retained earnings to beneficial conversion feature
of preferred stock issued -$618,000.
During the year ended December 31, 1997, the Company recorded the
following noncash transactions:
(a) Converted convertible debentures into common stock - $14,913,000.
(b) Converted notes payable into preferred stock - $5,000,000.
(c) Converted preferred stock into common stock (par value only) -
$8,000.
(d) Applied a note payable against a technology license asset upon
settlement of a contractual dispute - $2,363,000.
(e) Issued common stock in conjunction with termination of a royalty
agreement - $847,000.
(f) Issued common stock in payment of preferred stock dividends -
$296,000.
(g) Issued preferred stock in payment of interest on notes payable -
$72,000.
(h) Issued common stock in payment of interest on convertible
debentures - $58,000.
(i) Issued common stock warrants in conjunction with notes payable -
$1,661,000.
(j) Issued common stock warrants in conjunction with a distributor
agreement - $162,000.
(k) Issued common stock warrants in conjunction with an advisory
services agreement - $58,000.
(l) Issued common stock warrants upon termination of credit facility -
$30,000.
(m) Allocation of retained earnings to beneficial conversion feature
of preferred stock issued - $31,000.
(n) Acquired equipment under capital leases - $117,000.
57
<PAGE> 58
During the year ended December 31, 1996, the Company recorded the
following noncash transactions:
(a) Converted convertible debentures into stock - $10,087,000.
(b) Allocation of proceeds from convertible debentures to beneficial
conversion features - $4,947,000.
(c) Issued common stock warrants in conjunction with convertible
debentures - $3,117,000.
(d) Obtained a technology license in exchange for a note - $3,267,000.
(e) Issued stock in final settlement of the Intelect, Inc. acquisition
- $850,000.
(f) Issued stock as part of employment agreements - $500,000.
(g) Recognized compensation expense on stock options granted at less
than market price - $487,000.
(h) Acquired a long term asset with stock - $375,000.
(i) Acquired equipment under capital leases - $111,000.
(22) Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Balance at Additions Additions
beginning charged to charged to Balances
of costs and other at end
period expenses accounts Deductions of period
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
For the year ended December 31, 1998:
Allowances deducted from assets:
Accounts and notes receivable $ 541 4,206 -- 3,877(a) 870
Inventories 1,600 1,021 -- 77(b) 2,544
------------ ------------ ------------ ------------ ------------
Total allowances
deducted from assets $ 2,141 5,227 -- 3,954 3,414
============ ============ ============ ============ ============
For the year ended December 31, 1997:
Allowances deducted from assets:
Accounts and notes receivable $ 542 632 -- 633(a)(c) 541
Inventories 1,254 590 -- 244(b)(c) 1,600
------------ ------------ ------------ ------------ ------------
Total allowances
deducted from assets $ 1,796 1,222 -- 877 2,141
============ ============ ============ ============ ============
For the year ended December 31, 1996:
Allowances deducted from assets:
Accounts and notes receivable $ 25 521 -- 4(a) 542
Inventories 730 1,058 -- 534(b) 1,254
------------ ------------ ------------ ------------ ------------
Total allowances
deducted from assets $ 755 1,579 -- 538 1,796
============ ============ ============ ============ ============
</TABLE>
Notes:
(a) Accounts written off
(b) Scrapped, sold or other disposition
(c) Includes liquidation of subsidiary.
58
<PAGE> 59
(23) Subsequent Events
On March 5, 1999, the Company sold 3,000 shares of series E Convertible
Preferred Stock, in the Initial Closing of a private placement, for
$3,000,000. Premiums accumulate at the rate of 8% per year, are payable
on 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 March 5, 2004 and may be converted prior to that date at the holder's
option. The conversion price is the lesser of $1.80 per common share or
83.5% of the average of the two lowest closing bid prices of the common
stock for the forty consecutive trading days before the date of
conversion. Purchasers of the preferred stock received warrants to
purchase 300,000 of common stock at a price of 110% of the "Market Price"
(as defined) on the date of the Initial Closing . Redemption of the
preferred stock may be required by the holders upon the occurrence of
Major Transactions, such as merger or sale of substantially all assets,
or in case of Triggering Events, such as failure to register the resale
of conversion shares by July 2, 1999 and certain other events which would
impair the ability of preferred stockholders to resell conversion shares.
The March 5 Initial Closing is the first of multiple closings subject to
satisfaction of terms and conditions in a Securities Purchase Agreement
all as more fully described in the Form 8-K of the Company filed March 2,
1999.
In connection with the Initial Closing of the Series E preferred stock,
the Company agreed to allow holders to sell all of their remaining 1,843
shares of Series C preferred stock and 1,144 shares of Series D preferred
stock to new investors. In connection with the issuance of the Series E
preferred stock, the holders of the Series C and Series D preferred stock
have the right under the Certificates of Designations of such securities
to use the variable conversion price of the Series E preferred stock.
Thus, after the Initial Closing, when the holders of the Series C and
Series D preferred stock submit a conversion notice, they will likely
elect to use the variable conversion price of the Series E preferred
stock instead of the variable conversion price of the Series C and D
preferred stock (which is 97% of the average of the three lowest closing
bid prices in the ten prior trading days). In addition, the Company has
agreed that the new investors are not required to limit their conversions
of the Series C and Series D preferred stock to 1,200,000 shares of
Common Stock in any continuing thirty (30) day period. Original holders
will continue to be subject to contractually agreed conversion
restrictions.
During January 1999, the Company sold in a private placement 1,800,000
shares of common stock at a price of $1.00 per share and warrants to
purchase 540,000 shares of common stock in connection with the private
placement. The warrants have an exercise price of $2.998. The offering
was made solely to accredited investors. The Company granted to the
purchasers registration rights covering the resale of the common stock
and the warrant shares.
Effective January 13, 1999, the Coastal Trust agreed to extend the
maturity date of the Receivables Loan which previously matured on August
31, 1999, to February 12, 2000. In addition, the Coastal Trust agreed to
extend the maturity date on the Inventory Loan to May 1, 1999, with
payments of $250,000 plus accrued interest due on each of March 1, April
2 and May 1, 1999.
Effective January 13, 1999, as permitted under the terms of the Credit
Facility dated as of February 12, 1998, the Company elected to extend the
maturity date of the Convertible Promissory Notes issued pursuant to the
Facility to February 12, 2000. In connection with the extension, the
Company issued to the investor warrants to purchase an aggregate of
535,000 shares of common stock of the Company. The exercise price of the
warrants is $1.81. The warrants are subject to antidilution provisions
which are triggered in the event that the Company issues or sells common
stock or securities convertible or exercisable into common stock at a
price less than the exercise
59
<PAGE> 60
price then in effect. Such provisions would enable the holder to obtain a
reduction in the warrant exercise price as well as an increase in the
applicable number of warrant shares.
On February 12, 1999, the Company reached an agreement with its
distributor in Korea to forbear from collection of remaining receivable
balances due from the distributor in exchange for (1) immediate payment
of $1,000,000, (2) delivery to the Company of a proprietary product
design, (3) assumption by the distributor of warranty obligations to
Korean customers, (4) surrender of exclusive distribution rights in Korea
after 1999, and (5) surrender of warrants to purchase 40,500 shares of
common stock. The forbearance is voidable if the distributor fails either
to order an additional $1,000,000 of the Company's products before
February 10, 2000 or to pay $250,000 by January 31, 2000.
60
<PAGE> 61
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company's Board of Directors, in accordance with the recommendation
of its Audit Committee, which is composed of non-employees of the Company, has
requested Grant Thornton LLP ("Grant Thornton") to act as independent auditors
of the Company for the 1998 fiscal year, subject to shareholder approval, in
replacement of Arthur Andersen LLP ("Arthur Andersen").
As disclosed in the Form 10-Q of the Company filed on November 16,
1998, the Company's previous independent auditors, Arthur Andersen, resigned on
November 13, 1998. The report by Arthur Andersen LLP for the year ended December
31, 1997 contained no adverse opinion or disclaimer of opinion, nor was it
qualified or modified as to audit scope or accounting principles. There have
been no disagreements by the Company with Arthur Andersen LLP on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope and procedure, which disagreement(s), if not resolved to the satisfaction
of Arthur Andersen LLP would have caused it to make reference to the subject
matter of the disagreement(s) in connection with its report. There are no
"reportable events" as set forth in Regulation S-K, Item 304(a)(1)(v)(A)-(D)
except as follows: (1) Arthur Andersen LLP informed the Company that it appears
likely its auditor's report for 1998 would have contained a qualification as to
the Company's ability to continue as a going concern, (2) Arthur Andersen
informed the Audit Committee Chairman, the Chairman of the Board and the Chief
Financial Officer that with respect to Capitalized Software Development Costs,
compliance with SFAS #86 had not been evaluated particularly as it relates to
current year additions and realizability of such asset and (3) Arthur Andersen
informed the Audit Committee Chairman, the Chairman of the Board and the Chief
Financial Officer that as a result of the revenue restatement for the quarter
ended June 30, 1998, they would have had to expand the scope of the 1998 audit
if they had not resigned. Arthur Andersen encouraged the Audit Committee
Chairman, the Chairman of the Board and the Chief Financial Officer to closely
monitor these matters. Substantive audit tests and further investigation into
these matters would have been a necessary part of Arthur Andersen's audit
procedures for the year-end December 31, 1998 financial statements had the
client/auditor relationship not terminated. Arthur Andersen has been authorized
by the Company to respond to any and all inquiries by the successor auditors,
without limitation. The Company has indicated that it will cooperate fully with
the new auditors to address these matters. Arthur Andersen has provided to the
Company a letter to the Securities and Exchange Commission stating that it has
reviewed the disclosure provided in this Form 10-Q and has no disagreement with
relevant portions of this disclosure, pursuant to the requirements of Item
304(a)(3) of Regulation S-K. A copy of such letter, dated November 16, 1998, is
filed as an exhibit to the Form 10-Q filed on November 16, 1998.
As disclosed in the Form 8-K of the Company filed on August 18, 1997,
the term of the Company's previous independent auditors, KPMG, expired at the
Company's annual general meeting of its stockholders held August 13, 1997. The
KPMG report dated April 9, 1997 on the consolidated financial statements of the
Company for the year ended December 31, 1996, noted that the Company has
suffered recurring losses from continuing operations and is dependent upon the
successful development and commercialization of its products and its ability to
secure adequate sources of capital until the Company is operating profitably and
noted that these matters raise substantial doubt about the Company's ability to
continue as a going concern, and that management's plans with regard to these
matters were described in Note 1 to the consolidated financial statements.
During the two years ended December 31, 1995 and December 31, 1996, and
the subsequent interim period through the date of the appointment of Arthur
Andersen as the Company's new outside auditors, there were no "disagreements"
between the Registrant and KPMG as described in Item 304(a)(1)(iv) of Regulation
S-K. The Registrant requested KPMG to furnish it with a letter addressed to the
SEC stating whether or not it agreed with the above statements. A copy of such
letter, dated August 14, 1997, was filed as an Exhibit to the Form 8-K of the
Company filed on August 18, 1997.
Arthur Andersen LLP has consented to the Company's inclusion of Arthur
Andersen's report on the company's financial statements for a certain prior
period (1997). In connection with this consent, Arthur Andersen has asked the
Company to indemnify and hold harmless Arthur Andersen LLP for any loss
incurred as a result of the consent to the inclusion of Arthur Andersen's
report, unless such loss results from Arthur Andersen's being adjudicated by a
court, after appeal, to be liable as a result of consenting to the use of its
report. The Company agreed to such request for an indemnification and hold
harmless agreement.
KPMG has consented to the Company's inclusion of KPMG's report on the
Company's financial statements for certain prior periods. In connection with the
consent, KPMG asked the Company to indemnify KPMG for any loss incurred as a
result of the consent to the inclusion of KPMG's report, unless such loss
results from KPMG's professional malpractice. The Company agreed to such request
for indemnification.
61
<PAGE> 62
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company will file with the Securities and Exchange Commission a
definitive Proxy Statement no later than 120 days after the close of its fiscal
year ended December 31, 1998 (the "Proxy Statement"). The information required
by this Item is incorporated by reference from the Proxy Statement.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from
the Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from
the Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from
the Proxy Statement.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A. The Financial Statements filed as part of this report are listed and
indexed on Page 20. 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. Exhibits which are
incorporated by reference are indicated by the information in the parenthetical
following such exhibit.
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
2.1 Plan and Agreement of Merger dated as of October 29, 1997 by and among
Intelect Communications Systems Limited ("Intelect (Bermuda)"), Intelect
Communications, Inc. (the "Company"), and Intelect Merger Co. (1)
3.1 Amended and Restated Certificate of Incorporation of the Company (1)
3.2 Certificate of Correction dated December 17, 1999 to Amended and
Restated Certificate of Incorporation (21)
3.3 Certificate of Amendment to Amended and Restated Certificate of
Incorporation (20)
3.4 Amended and Restated By-Laws of the Company (1)
4.1 Specimen Stock Certificate of the Company (2)
4.2 Certificate of Designations of the Series A Preferred Stock dated
December 2, 1997(1)
4.3 Certificate of Designations of the Series B Preferred Stock dated
December 17, 1997 (22)
4.4 Certificate of Designations of the Series C Preferred Stock dated
February 6, 1998 (3)
4.5 Certificate of Designations of the Series D Preferred Stock dated May 8,
1998 (16)
4.6 Certificate of Designations of the Series E Preferred Stock dated March
3, 1999 (19)
</TABLE>
62
<PAGE> 63
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
10.1 Option Agreement dated March 31, 1995 by and among the Company, certain
sellers and Intelect, Inc. (5)
10.2 Stock Purchase Agreement dated October 3, 1995 by and among Intelect
(Bermuda), Savage Corporation and Savage Sports Corporation (5)
10.3 Management Agreement dated as of October 1, 1995 between the Company and
Herman Frietsch*(6)
10.4 Amendment No. One dated January 1, 1996 to Management Agreement between
the Company and Herman Frietsch referred to in Exhibit 10.4*(7)
10.5 Employment Agreement dated as of April 1, 1996 between the Company and
Eugene Helms*(4)
10.6 Employment Agreement dated as of April 24, 1995 between the Company and
Peter Ianace*(6)
10.7 Stock Purchase Agreement dated January 13, 1996 by and between Intelect
(Bermuda), Intelect Systems Corp., Robert E. Nimon, Kim F. Nimon, Edgar
L. Read, Gregory L. Mayhan and DNA Enterprises, Inc. (8)
10.8 Warrants dated February 13, 1996 issued to Edgar L. Read and Gregory L.
Mayhan to be delivered one year after Closing (9)
10.9 Employment Agreement dated as of February 13, 1996 between Edgar L. Read
and DNA Enterprises, Inc.*(8)
10.10 Employment Agreement dated as of February 13, 1996 between Gregory L.
Mayhan and DNA Enterprises, Inc.*(8)
10.11 Agreement and Plan of Merger dated March 19, 1996 among the Company,
Mid-Ocean, Inc. and Mosaic Information Technologies, Inc. (10)
10.12 Employment Agreement dated March 29, 1996 among Matthew Feldman, the
Company and Mosaic Information Technologies, Inc.*(10)
10.13 Promissory Note dated as of February 26, 1997 to St. James Capital Corp.
from the Company (7)
10.14 Pledge Agreement dated as of February 26, 1997 between the Company and
St. James Capital Corp. (7)
10.15 Warrant to Purchase Common Stock of the Company Expiring February 26,
2002 (7)
10.16 Registration Rights Agreement dated February 26, 1997 between the
Company and St. James Capital Corp. (7)
10.17 Amended and Restated Promissory Note dated as of February 26, 1997 to
St. James Capital Corp. from the Company (7)
10.18 First Amendment to Pledge Agreement dated as of March 27, 1997 between
the Company and St. James Capital Corp. (7)
10.19 Warrant to Purchase Common Stock of the Company Expiring March 27, 2002
(7)
10.20 Amendment No. 1 to Registration Rights Agreement dated as of March 27,
1997 between the Company and St. James Capital Corp. (7)
10.21 Employee Stock Option Plan adopted April 24, 1986* (7) 10.22 Stock
Incentive Plan adopted December 13, 1995* (7)
10.23 Lease Agreement between TCIT Dallas Industrial and Intelect Network
Technologies, dated February 25, 1997 (11)
10.24 Lease Agreement between Campbell Place One Joint Venture and DNA
Enterprises, dated February 1, 1997 (11)
10.25 Advisory Services Agreement with Renaissance Financial Securities
Corporation dated July 8, 1997 (12)
10.26 Warrant issued to AJC, Inc. to Purchase Common Stock of the Company
expiring on December 31, 2002 (12)
10.27 Loan Agreement dated as of May 8, 1997 between the Company and The
Coastal Corporation Second Pension Trust (12)
10.28 Warrant issued to The Coastal Corporation Second Pension Trust to
Purchase Common Stock of the Company expiring on May 7, 2002 (12)
</TABLE>
63
<PAGE> 64
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
10.29 Registration Rights Agreement dated as of May 8, 1997 between the
Company and The Coastal Corporation Second Pension Trust (12)
10.30 Subscription Agreement for Series A Cumulative Preferred Stock dated as
of May 30, 1997 between the Company and The Coastal Corporation Second
Pension Trust (12)
10.31 Registration Rights Agreement dated as of May 30, 1997 between the
Company and The Coastal Corporation Second Pension Trust (12)
10.32 Agreement dated April 25, 1997 between the Company and the beneficiary
of a royalty agreement (12)
10.33 Irrevocable Option Agreement dated October 1, 1995 between the Company
and owners of certain intellectual property rights * (12)
10.34 Agreement dated July 7, 1997 among Robert E. Nimon, Kim F. Nimon, Nimon
Consulting, Inc., Intelect Systems Corp. and the Company (12)
10.35 Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
from the Company (12)
10.36 Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
from the Company (12)
10.37 Amended and Restated Loan Agreement dated August 27, 1997 among the
Company, Intelect Systems Corp., and The Coastal Corporation Second
Pension Trust (13)
10.38 Warrant to purchase Company Common Stock expiring August 26, 2002 issued
to The Coastal Corporation Second Pension Trust (13)
10.39 Amendments Nos. 2 and 3 to Registration Rights Agreements dated April 24
and May 8, 1997 among the Company and St. James Capital Corp. (13)
10.40 Warrants to purchase Company Common Stock dated April 24 and May 8, 1997
issued to St. James Capital Corp. (13)
10.41 Second Amended and Restated Floating Rate Promissory Noted dated
effective February 26, 1997 to St. James Capital Corp. from the Company
(13)
10.42 Second and Third Amendments to Borrower's Pledge Agreement dated April
24 and May 8, 1997 among Intelect Systems Corp. and St. James Capital
Corp. (13)
10.43 Warrant expiring December 31, 2001 issued to Lifeline Industries, Inc.
(13)
10.44 Amended License Agreement among Digital Equipment Corporation and
Intelect Visual Communications Corp., dated effective November 5, 1997
(14)
10.45 Registration Rights Agreement among the Company and Citadel, dated
February 6, 1998 relating to the Series C Preferred Stock (3)
10.46 Registration Rights Agreement dated February 12, 1998 between the
Company and St. James Partners, L.P. (3)
10.47 Warrant to Purchase Common Stock of the Company dated February 12, 1998
issued to St. James Partners, L.P. expiring on February 12, 2001 (3)
10.48 Securities Purchase Agreement among the Company and Citadel, dated
February 6, 1998 (3)
10.49 Agreement for Purchase and Sale dated February 12, 1998 between the
Company and St. James Partners, L.P. (3)
10.50 Convertible Promissory Note dated February 12, 1998 by the Company in
favor of St. James Partners, L.P. (3)
10.51 Pledge Agreement dated February 12, 1998 between the Company and St.
James Partners, L.P. (3)
10.52 Purchase Agreement among the Company and Navesink dated December 16,
1997 (22)
10.53 Registration Rights Agreement among the Company and Navesink dated
December 16, 1997 (22)
10.54 Sales Representative Agreement between Intelect Network Technologies
Company and Amerix Electronics, Inc. dated January 12, 1998 (22)
10.55 Exchange Agreement between Intelect Network Technologies Company and
Amerix Electronics dated February 20, 1998 (22)
10.56 Warrant issued to Amerix Electronics, Inc. to Purchase Common Stock of
the Company expiring on June 19, 2001 (22)
</TABLE>
64
<PAGE> 65
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
10.57 Letter Agreement dated February 9, 1999 among Tehan Oh, Opicom Co. Ltd.,
Optronix Inc., Amerix Electronics, Inc., and Intelect Network
Technologies Company
10.58 Company Stock Incentive Plan Amendment adopted December 4, 1997* (1)
10.59 Registration Rights Agreements between the Company and the Buyers, dated
May 8, 1998 relating to the Series D Convertible Preferred Stock (16)
10.60 Securities Purchase Agreement among the Company and the Buyers, dated
May 8, 1998 relating to the Series D Convertible Preferred Stock (16)
10.61 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 (23)
10.62 $2,000,000 Convertible Promissory Note issued to St. James Partners by
the Company dated April 2, 1998 (23)
10.63 $13,000,000 Convertible Promissory Note issued to SJMB by the Company
dated April 2, 1998 (23)
10.64 Warrant issued to St. James Partners by the Company dated April 2, 1998,
exercisable as to 300,000 shares of Common Stock (23)
10.65 Warrant issued to SJMB by the Company dated April 2, 1998, exercisable
as to 1,200,000 shares of Common Stock (23)
10.66 Amendment No. 1 to Registration Rights Agreement dated as of April 2,
1998 between the Company and St. James Partners (23)
10.67 Registration Rights Agreement between the Company and the Buyers dated
June 26, 1998 relating to the Series D Convertible Preferred Stock (17)
10.68 Registration Rights Agreement dated June 19, 1998 between the Company
and Lifeline Industries, Inc. (21)
10.69 Securities Purchase Agreement dated June 26, 1998 between the Company
and the Buyers relating to the Series D Convertible Preferred Stock (17)
10.70 Warrant issued to Lifeline Industries, Inc. dated June 29, 1998,
exercisable as to 30,000 shares of Common Stock (21)
10.71 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 (23)
10.72 Letter Agreement dated July 15, 1998 between the Company and Navesink
Equity Derivative Fund LDC (21)
10.73 Amended and Restated Warrant issued to AJC, Inc. exercisable to purchase
up to 300,000 shares of Common Stock (24)
10.74 Amended and Restated Warrant issued to Lifeline Industries, Inc.
exercisable to purchase up to 30,000 shares of Common Stock (24)
10.75 Form of Amended and Restated Promissory Notes held by various employees,
directors, and related individuals of the Company with face values
totaling $419,600, convertible into Common Stock of the Company at a
rate of $2.00 per share (24)
10.76 Loan Agreement for Receivables Backed Borrowing dated as of September
14, 1998 between the Company and Coastal (18)
10.77 Promissory Note dated September 14, 1998 issued by the Company to
Coastal (18)
10.78 Security Agreement for Receivables Backed Borrowing dated September 14,
1998 among the Company, Intelect Visual Communications Corp., Intelect
Network Technologies Company, DNA Enterprises, Inc., and Coastal (18)
10.79 Borrower Pledge Agreement dated September 14, 1998 between the Company
and Coastal (18)
10.80 Security Agreement dated September 14, 1998 between the Company and St.
James (18)
10.81 Letter Agreement dated September 14, 1998 among the Company, St. James
and Falcon Seaboard (18)
10.82 Registration Rights Agreement among the Company and the Buyers, dated
February 24, 1999, relating to the Series E Convertible Preferred Stock
and warrants (19)
10.83 Form of Registration Rights Agreement between the Company and the
Buyers, dated as of December 22, 1998 (19)
</TABLE>
65
<PAGE> 66
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
10.84 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc., relating to the Series E Preferred Stock (19)
10.85 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc. at an exercise price of $2.998 (19)
10.86 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc., issued as of December 2, 1998 (19)
10.87 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc. issued to St. James Capital Partners, L.P. and SJMB, L.P., issued
January 13, 1999 (19)
10.88 Securities Purchase Agreement among the Company and the Buyers, dated
February 24, 1999, relating to the Series E Convertible Preferred Stock
and warrants (19)
10.89 Loan Agreement for Inventory Backed Borrowing dated November 24, 1998 by
and between Intelect Communications, Inc. and The Coastal Corporation
Second Pension Trust, as amended by the Addendum to Loan Agreement for
Inventory Backed Borrowing dated December 31, 1998 (19)
10.90 Security Agreement for Inventory Backed Borrowing dated November 24,
1998 by and among Intelect Network Technologies Company, DNA
Enterprises, Inc., and Intelect Visual Communications Corp., Intelect
Communications, Inc., and The Coastal Corporation Second Pension Trust
(19)
10.91 Promissory Note Amended and Restated as of December 31, 1998 in the
original principal amount of $750,000 issued to The Coastal Corporation
Second Pension Trust (19)
10.92 Addendum to Loan Agreement for Receivables Backed Borrowing dated as of
January 13, 1999 between The Coastal Corporation Second Pension Trust
and Intelect Communications, Inc. (19)
10.93 Promissory Note Amended and Restated as of January 13, 1999 in the
original principal amount of $5,000,000 issued to The Coastal
Corporation Second Pension Trust (19)
10.94 Amended and Restated Stock Incentive Plan *(25)
16.1 Letter regarding change in certifying accountants (17)
16.2 Letter from Arthur Andersen, LLP regarding its concurrence with
statements in Item 5 of Form 10Q filed November 16, 1998 (24)
16.3 Letter from KPMG Peat Marwick regarding its concurrence with statements
in Form 8-K filed August 19, 1997 (15)
21.1 Subsidiaries of the Company
23.1 Consents of KPMG Peat Marwick
23.2 Consents of Arthur Andersen LLP
23.3 Consent of Grant Thornton LLP
27.1 Financial data schedule
</TABLE>
- ---------------------------------------------
*Management contract or other compensatory plan or arrangement.
(1) Incorporated herein by reference to the Company's Form S-4 filed October
30, 1997
(2) Incorporated herein by reference to the Company's Form 8-K filed
December 5, 1997
(3) Incorporated herein by reference to the Company's Form 8-K filed
February 17, 1998
(4) Incorporated herein by reference to the Company's Form 10-Q filed
November 13, 1996
(5) Incorporated herein by reference to the Company's Form 8-K dated
November 10, 1995
(6) Incorporated herein by reference to the Company's Form 8-K/A dated April
12, 1996
(7) Incorporated herein by reference to the Company's Form 10-K filed April
15, 1997
(8) Incorporated herein by reference to the Company's Form 8-K dated
February 20, 1996
(9) Incorporated herein by reference to the Company's Form 10-K for the year
ending December 31, 1995
(10) Incorporated herein by reference to the Company's Form 8-K dated April
12, 1996
(11) Incorporated herein by reference to the Company's Form 10-Q filed May
15, 1997
(12) Incorporated herein by reference to the Company's Form 10-Q filed August
14, 1997
66
<PAGE> 67
(13) Incorporated herein by reference to the Company's Form S-3 filed
September 17, 1997
(14) Incorporated herein by reference to the Company's Form 10-Q filed
November 13, 1997
(15) Incorporated herein by reference to the Company's Form 8-K filed August
19, 1997
(16) Incorporated herein by reference to the Company's Form 8-K filed on May
11, 1998
(17) Incorporated herein by reference to the Company's Form 8-K filed on June
29, 1998
(18) Incorporated herein by reference to the Company's Form 8-K filed on
September 16, 1998
(19) Incorporated herein by reference to the Company's Form 8-K filed on
March 2, 1999
(20) Incorporated herein by reference to the Company's Form 8-K filed on
March 8, 1999
(21) Incorporated herein by reference to the Company's Form S-3 filed on
August 10, 1998
(22) Incorporated herein by reference to the Company's Form 10-K filed on
March 31, 1998
(23) Incorporated herein by reference to the Company's Form 10-Q filed on
August 14, 1998
(24) Incorporated herein by reference to the Company's Form 10-Q filed on
November 16, 1998
(25) Incorporated herein by reference to the Company's Definitive Proxy
Statement filed on April 28, 1998.
C. The Registrant has not filed any reports on Form 8-K during the last
quarter of the period covered by this Report, except as follows:
None
67
<PAGE> 68
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: April 2, 1999 By: /s/ Herman M. Frietsch
----------------------------------
Herman M. Frietsch
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
/s/ Herman M. Frietsch /s/ ANTON VON AND ZU LIECHTENSTEIN
- ------------------------------------------ ----------------------------------
Herman M. Frietsch Anton von and zu Liechtenstein,
Chief Executive Officer and Director Director
(Principal Executive Officer)
/s/ EDWIN J. DUCAYET, JR. /s/ PHILIP P. SUDAN, JR.
- ------------------------------------------ ----------------------------------
Edwin J. Ducayet, Jr. Philip P. Sudan, Jr., Director
Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ ROBERT E. GARRISON, II
----------------------------------
Robert E. Garrison, II, Director
68
<PAGE> 69
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
2.1 Plan and Agreement of Merger dated as of October 29, 1997 by and among
Intelect Communications Systems Limited ("Intelect (Bermuda)"), Intelect
Communications, Inc. (the "Company"), and Intelect Merger Co. (1)
3.1 Amended and Restated Certificate of Incorporation of the Company (1)
3.2 Certificate of Correction dated December 17, 1999 to Amended and
Restated Certificate of Incorporation (21)
3.3 Certificate of Amendment to Amended and Restated Certificate of
Incorporation (20)
3.4 Amended and Restated By-Laws of the Company (1)
4.1 Specimen Stock Certificate of the Company (2)
4.2 Certificate of Designations of the Series A Preferred Stock dated
December 2, 1997(1)
4.3 Certificate of Designations of the Series B Preferred Stock dated
December 17, 1997 (22)
4.4 Certificate of Designations of the Series C Preferred Stock dated
February 6, 1998 (3)
4.5 Certificate of Designations of the Series D Preferred Stock dated May 8,
1998 (16)
4.6 Certificate of Designations of the Series E Preferred Stock dated March
3, 1999 (19)
10.1 Option Agreement dated March 31, 1995 by and among the Company, certain
sellers and Intelect, Inc. (5)
10.2 Stock Purchase Agreement dated October 3, 1995 by and among Intelect
(Bermuda), Savage Corporation and Savage Sports Corporation (5)
10.3 Management Agreement dated as of October 1, 1995 between the Company and
Herman Frietsch*(6)
10.4 Amendment No. One dated January 1, 1996 to Management Agreement between
the Company and Herman Frietsch referred to in Exhibit 10.4*(7)
10.5 Employment Agreement dated as of April 1, 1996 between the Company and
Eugene Helms*(4)
10.6 Employment Agreement dated as of April 24, 1995 between the Company and
Peter Ianace*(6)
10.7 Stock Purchase Agreement dated January 13, 1996 by and between Intelect
(Bermuda), Intelect Systems Corp., Robert E. Nimon, Kim F. Nimon, Edgar
L. Read, Gregory L. Mayhan and DNA Enterprises, Inc. (8)
10.8 Warrants dated February 13, 1996 issued to Edgar L. Read and Gregory L.
Mayhan to be delivered one year after Closing (9)
10.9 Employment Agreement dated as of February 13, 1996 between Edgar L. Read
and DNA Enterprises, Inc.*(8)
10.10 Employment Agreement dated as of February 13, 1996 between Gregory L.
Mayhan and DNA Enterprises, Inc.*(8)
10.11 Agreement and Plan of Merger dated March 19, 1996 among the Company,
Mid-Ocean, Inc. and Mosaic Information Technologies, Inc. (10)
10.12 Employment Agreement dated March 29, 1996 among Matthew Feldman, the
Company and Mosaic Information Technologies, Inc.*(10)
10.13 Promissory Note dated as of February 26, 1997 to St. James Capital Corp.
from the Company (7)
10.14 Pledge Agreement dated as of February 26, 1997 between the Company and
St. James Capital Corp. (7)
10.15 Warrant to Purchase Common Stock of the Company Expiring February 26,
2002 (7)
10.16 Registration Rights Agreement dated February 26, 1997 between the
Company and St. James Capital Corp. (7)
10.17 Amended and Restated Promissory Note dated as of February 26, 1997 to
St. James Capital Corp. from the Company (7)
10.18 First Amendment to Pledge Agreement dated as of March 27, 1997 between
the Company and St. James Capital Corp. (7)
10.19 Warrant to Purchase Common Stock of the Company Expiring March 27, 2002
(7)
10.20 Amendment No. 1 to Registration Rights Agreement dated as of March 27,
1997 between the Company and St. James Capital Corp. (7)
10.21 Employee Stock Option Plan adopted April 24, 1986* (7) 10.22 Stock
Incentive Plan adopted December 13, 1995* (7)
10.23 Lease Agreement between TCIT Dallas Industrial and Intelect Network
Technologies, dated February 25, 1997 (11)
10.24 Lease Agreement between Campbell Place One Joint Venture and DNA
Enterprises, dated February 1, 1997 (11)
10.25 Advisory Services Agreement with Renaissance Financial Securities
Corporation dated July 8, 1997 (12)
10.26 Warrant issued to AJC, Inc. to Purchase Common Stock of the Company
expiring on December 31, 2002 (12)
10.27 Loan Agreement dated as of May 8, 1997 between the Company and The
Coastal Corporation Second Pension Trust (12)
10.28 Warrant issued to The Coastal Corporation Second Pension Trust to
Purchase Common Stock of the Company expiring on May 7, 2002 (12)
</TABLE>
<PAGE> 70
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
10.29 Registration Rights Agreement dated as of May 8, 1997 between the
Company and The Coastal Corporation Second Pension Trust (12)
10.30 Subscription Agreement for Series A Cumulative Preferred Stock dated as
of May 30, 1997 between the Company and The Coastal Corporation Second
Pension Trust (12)
10.31 Registration Rights Agreement dated as of May 30, 1997 between the
Company and The Coastal Corporation Second Pension Trust (12)
10.32 Agreement dated April 25, 1997 between the Company and the beneficiary
of a royalty agreement (12)
10.33 Irrevocable Option Agreement dated October 1, 1995 between the Company
and owners of certain intellectual property rights * (12)
10.34 Agreement dated July 7, 1997 among Robert E. Nimon, Kim F. Nimon, Nimon
Consulting, Inc., Intelect Systems Corp. and the Company (12)
10.35 Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
from the Company (12)
10.36 Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
from the Company (12)
10.37 Amended and Restated Loan Agreement dated August 27, 1997 among the
Company, Intelect Systems Corp., and The Coastal Corporation Second
Pension Trust (13)
10.38 Warrant to purchase Company Common Stock expiring August 26, 2002 issued
to The Coastal Corporation Second Pension Trust (13)
10.39 Amendments Nos. 2 and 3 to Registration Rights Agreements dated April 24
and May 8, 1997 among the Company and St. James Capital Corp. (13)
10.40 Warrants to purchase Company Common Stock dated April 24 and May 8, 1997
issued to St. James Capital Corp. (13)
10.41 Second Amended and Restated Floating Rate Promissory Noted dated
effective February 26, 1997 to St. James Capital Corp. from the Company
(13)
10.42 Second and Third Amendments to Borrower's Pledge Agreement dated April
24 and May 8, 1997 among Intelect Systems Corp. and St. James Capital
Corp. (13)
10.43 Warrant expiring December 31, 2001 issued to Lifeline Industries, Inc.
(13)
10.44 Amended License Agreement among Digital Equipment Corporation and
Intelect Visual Communications Corp., dated effective November 5, 1997
(14)
10.45 Registration Rights Agreement among the Company and Citadel, dated
February 6, 1998 relating to the Series C Preferred Stock (3)
10.46 Registration Rights Agreement dated February 12, 1998 between the
Company and St. James Partners, L.P. (3)
10.47 Warrant to Purchase Common Stock of the Company dated February 12, 1998
issued to St. James Partners, L.P. expiring on February 12, 2001 (3)
10.48 Securities Purchase Agreement among the Company and Citadel, dated
February 6, 1998 (3)
10.49 Agreement for Purchase and Sale dated February 12, 1998 between the
Company and St. James Partners, L.P. (3)
10.50 Convertible Promissory Note dated February 12, 1998 by the Company in
favor of St. James Partners, L.P. (3)
10.51 Pledge Agreement dated February 12, 1998 between the Company and St.
James Partners, L.P. (3)
10.52 Purchase Agreement among the Company and Navesink dated December 16,
1997 (22)
10.53 Registration Rights Agreement among the Company and Navesink dated
December 16, 1997 (22)
10.54 Sales Representative Agreement between Intelect Network Technologies
Company and Amerix Electronics, Inc. dated January 12, 1998 (22)
10.55 Exchange Agreement between Intelect Network Technologies Company and
Amerix Electronics dated February 20, 1998 (22)
10.56 Warrant issued to Amerix Electronics, Inc. to Purchase Common Stock of
the Company expiring on June 19, 2001 (22)
10.57 Letter Agreement dated February 9, 1999 among Tehan Oh, Opicom Co. Ltd.,
Optronix Inc., Amerix Electronics, Inc., and Intelect Network
Technologies Company
10.58 Company Stock Incentive Plan Amendment adopted December 4, 1997* (1)
10.59 Registration Rights Agreements between the Company and the Buyers, dated
May 8, 1998 relating to the Series D Convertible Preferred Stock (16)
10.60 Securities Purchase Agreement among the Company and the Buyers, dated
May 8, 1998 relating to the Series D Convertible Preferred Stock (16)
10.61 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 (23)
10.62 $2,000,000 Convertible Promissory Note issued to St. James Partners by
the Company dated April 2, 1998 (23)
10.63 $13,000,000 Convertible Promissory Note issued to SJMB by the Company
dated April 2, 1998 (23)
10.64 Warrant issued to St. James Partners by the Company dated April 2, 1998,
exercisable as to 300,000 shares of Common Stock (23)
10.65 Warrant issued to SJMB by the Company dated April 2, 1998, exercisable
as to 1,200,000 shares of Common Stock (23)
10.66 Amendment No. 1 to Registration Rights Agreement dated as of April 2,
1998 between the Company and St. James Partners (23)
10.67 Registration Rights Agreement between the Company and the Buyers dated
June 26, 1998 relating to the Series D Convertible Preferred Stock (17)
10.68 Registration Rights Agreement dated June 19, 1998 between the Company
and Lifeline Industries, Inc. (21)
10.69 Securities Purchase Agreement dated June 26, 1998 between the Company
and the Buyers relating to the Series D Convertible Preferred Stock (17)
10.70 Warrant issued to Lifeline Industries, Inc. dated June 29, 1998,
exercisable as to 30,000 shares of Common Stock (21)
10.71 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 (23)
10.72 Letter Agreement dated July 15, 1998 between the Company and Navesink
Equity Derivative Fund LDC (21)
10.73 Amended and Restated Warrant issued to AJC, Inc. exercisable to purchase
up to 300,000 shares of Common Stock (24)
10.74 Amended and Restated Warrant issued to Lifeline Industries, Inc.
exercisable to purchase up to 30,000 shares of Common Stock (24)
10.75 Form of Amended and Restated Promissory Notes held by various employees,
directors, and related individuals of the Company with face values
totaling $419,600, convertible into Common Stock of the Company at a
rate of $2.00 per share (24)
10.76 Loan Agreement for Receivables Backed Borrowing dated as of September
14, 1998 between the Company and Coastal (18)
10.77 Promissory Note dated September 14, 1998 issued by the Company to
Coastal (18)
10.78 Security Agreement for Receivables Backed Borrowing dated September 14,
1998 among the Company, Intelect Visual Communications Corp., Intelect
Network Technologies Company, DNA Enterprises, Inc., and Coastal (18)
10.79 Borrower Pledge Agreement dated September 14, 1998 between the Company
and Coastal (18)
10.80 Security Agreement dated September 14, 1998 between the Company and St.
James (18)
10.81 Letter Agreement dated September 14, 1998 among the Company, St. James
and Falcon Seaboard (18)
10.82 Registration Rights Agreement among the Company and the Buyers, dated
February 24, 1999, relating to the Series E Convertible Preferred Stock
and warrants (19)
10.83 Form of Registration Rights Agreement between the Company and the
Buyers, dated as of December 22, 1998 (19)
</TABLE>
<PAGE> 71
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
<S> <C>
10.84 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc., relating to the Series E Preferred Stock (19)
10.85 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc. at an exercise price of $2.998 (19)
10.86 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc., issued as of December 2, 1998 (19)
10.87 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc. issued to St. James Capital Partners, L.P. and SJMB, L.P., issued
January 13, 1999 (19)
10.88 Securities Purchase Agreement among the Company and the Buyers, dated
February 24, 1999, relating to the Series E Convertible Preferred Stock
and warrants (19)
10.89 Loan Agreement for Inventory Backed Borrowing dated November 24, 1998 by
and between Intelect Communications, Inc. and The Coastal Corporation
Second Pension Trust, as amended by the Addendum to Loan Agreement for
Inventory Backed Borrowing dated December 31, 1998 (19)
10.90 Security Agreement for Inventory Backed Borrowing dated November 24,
1998 by and among Intelect Network Technologies Company, DNA
Enterprises, Inc., and Intelect Visual Communications Corp., Intelect
Communications, Inc., and The Coastal Corporation Second Pension Trust
(19)
10.91 Promissory Note Amended and Restated as of December 31, 1998 in the
original principal amount of $750,000 issued to The Coastal Corporation
Second Pension Trust (19)
10.92 Addendum to Loan Agreement for Receivables Backed Borrowing dated as of
January 13, 1999 between The Coastal Corporation Second Pension Trust
and Intelect Communications, Inc. (19)
10.93 Promissory Note Amended and Restated as of January 13, 1999 in the
original principal amount of $5,000,000 issued to The Coastal
Corporation Second Pension Trust (19)
10.94 Amended and Restated Stock Incentive Plan *(25)
16.1 Letter regarding change in certifying accountants (17)
16.2 Letter from Arthur Andersen, LLP regarding its concurrence with
statements in Item 5 of Form 10Q filed November 16, 1998 (24)
16.3 Letter from KPMG Peat Marwick regarding its concurrence with statements
in Form 8-K filed August 19, 1997 (15)
21.1 Subsidiaries of the Company
23.1 Consents of KPMG Peat Marwick
23.2 Consents of Arthur Andersen LLP
23.3 Consent of Grant Thornton LLP
27.1 Financial data schedule
</TABLE>
<PAGE> 1
Exhibit 10.57
INTELECT COMMUNICATIONS, INC. LETTERHEAD
February 10, 1999
Via Facsimile
Mr. Tehan Oh
Opicom Company Ltd.
Amerix Electronics, Inc.
Optronix, Inc.
421 E. Grand Avenue
El Segundo, California 90245
We have been in discussion and negotiation concerning the settlement of
claims of Intelect Network Technologies Company ("Intelect") totalling
approximately $6.4 million for unpaid accounts receivable (the "Receivable")
from Opicom Company Ltd. and its affiliates named below ("Opicom"). You have
described and represented to us that business conditions and exchange rate
fluctuations have brought Opicom to imminent bankruptcy, that Opicom has no cash
or prospects to pay any substantial part of the Receivable, that investors
specifically have stated their refusal to place funds in Opicom while the
Receivable remains outstanding, that Opicom will incur a loss of approximately $
7 million for the 1998 fiscal year after taking into account exchange losses,
that Opicom's banking sources in the event of such a loss would terminate
Opicom's line of credit so that an Opicom bankruptcy would be an inevitable
result, and that Opicom presently has approximately $1.5 million in unpaid
salaries, $1.5 million in Korean domestic accounts payable and $ 0.7 million in
unpaid taxes as of the date hereof.
Based on these representations and in consideration for the agreements
of Opicom and its affiliates and principals named below, Intelect agrees to
release its Receivable on the terms stated below. For such agreement by
Intelect, Opicom Company Ltd., Amerix Electronics, Inc., Optronix, Inc. and
Tehan Oh agree as follows:
1. To cause to be paid to Intelect US$1.0 million in good funds at
Intelect's designated U.S. bank by the close of business on
February 11, 1999.
2. To assign and deliver to Intelect all designs and related
materials and intellectual property rights for the fiberoptic
4T-1/El product in order that it can be manufactured and sold by
Intelect.
3. To irrevocably release and hold harmless Intelect, effective from
the date hereof, from all present and future warranty obligations
or claims with customers of the Opicom group of companies in
Korea.
<PAGE> 2
4. To irrevocably release and hold harmless Intelect, effective from
the date hereof, from all claims for past, present and future
field site upgrade fees of firmware (estimated $250,000 per each
upgrade), and Intelect agrees to ship back all the RMA materials
which Intelect currently holds.
5. To surrender any and all exclusive rights to sell Intelect
products, except that Opicom will retain for a transition period
of 10 months from the date hereof exclusive rights to sell
Stargate products in Korea solely in order to reduce existing
inventories and resolve issues with customers.
6. To return to Intelect all outstanding warrants to purchase
Intelect common stock in the possession or name of Amerix
Electronics, Inc. or its affiliates.
Provided all of the above conditions are performed fully and completely
in a timely manner, then Intelect releases the Receivables.
Intelect Network Technologies Company
By: /s/ Willard F. Barnett
----------------------------------
Agreed Jointly and Severally Effective the Date Hereof:
Opicom Company Ltd. By: /s/ Tehan Oh - CEO
----------------------------------
Amerix Electronics, Inc. By: /s/ Tehan Oh - CEO
----------------------------------
Optronix, Inc. By: /s/ Tehan Oh - CEO
----------------------------------
Tehan Oh /s/ Tehan Oh
----------------------------------
<PAGE> 3
February 10, 1999
Via Facsimile
Mr. Tehan Oh
Opicom Company Ltd.
Amerix Electronics, Inc.
Optronix, Inc.
421 E. Grand Avenue
El Segundo, California 90245
Based on the representations stated in an agreement this date among
Opicom and its affiliates and principals named below and Intelect Network
Technologies Company ("Intelect") with regard to the release of Intelect's
Receivable, and for good and valuable consideration, the receipt of which is
hereby acknowledged, including Intelect's promise to execute and deliver such
agreement as to the Receivable, Opicom Company Ltd., Amerix Electronics, Inc.,
Optronix, Inc. and Tehan Oh agree:
1. To place orders for Intelect's equipment of a minimum value of $1 Million
U.S. Dollars no later than twelve months from the date of this agreement.
2. To pay to Intelect the sum of $250 Thousand U.S. Dollars no later than
January 31, 2000 either in the form of cash or in reduced discount accorded
Opicom by Intelect should Opicom not deliver $1 million Dollars in orders
by the date referenced above.
Intelect Network Technologies Company
By: /s/ Willard F. Barnett
----------------------------------
Agreed Jointly and Severally Effective the Date Hereof:
Opicom Company Ltd. By: /s/ Tehan Oh - CEO
----------------------------------
Amerix Electronics, Inc. By: /s/ Tehan Oh - CEO
----------------------------------
Optronix, Inc. By: /s/ Tehan Oh - CEO
----------------------------------
Tehan Oh /s/ Tehan Oh
----------------------------------
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
Following is a list of the Company's subsidiaries:
<TABLE>
<CAPTION>
Organized Percent of
Under Voting Securities
Name the Laws of Owned by Registrant
- ---- ----------- -------------------
<S> <C> <C>
Intelect Network Technologies Company Nevada 100%
Intelect Communications Systems Ltd. Beruda 100%
Intelect Network Systems Limited England 100%
Intelect Visual Communications Corp. Delaware 100%
DNA Enterprises, Inc. Texas 100%
</TABLE>
<PAGE> 1
EXHIBIT 23.1
(page 1)
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Intelect Communications, Inc.
We consent to the incorporation by reference in the registration statement on
Form S-3 (No.s 333-53451, 333-49379 and 333-35841) of our report dated April 9,
1997, relating to the consolidated statements of operations, stockholders'
equity and cash flows of Intelect Communications Systems Limited and
subsidiaries for the year ended December 31, 1996, and the related schedule,
which report appears in the December 31, 1998 annual report on Form 10-K of
Intelect Communications, Inc.
Our report dated April 9, 1997, contains an explanatory paragraph that states
that Intelect Communications Systems Limited has suffered recurring losses from
continuing operations and is dependent upon the successful development and
commercialization of its products and its ability to secure adequate sources of
capital until the Company is operating profitably. These matters raise
substantial doubt about the company's ability to continue as a going concern.
Management's plans with regard to these matters are described in note 1 to the
consolidated financial statements. The consolidated financial statements and
financial statement schedule do not include any adjustments that might result
from the outcome of this uncertainty.
We consent to the use of our report incorporated in the registration statement
by reference and to the reference to our firm under the heading "Experts" in
the prospectus.
/s/ KPMG Peat Marwick
Chartered Accountants
Hamilton, Bermuda
March 31, 1999
<PAGE> 2
EXHIBIT 23.1
(page 2)
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Intelect Communications, Inc.
We consent to the incorporation by reference in the registration statements on
Form S-8 (No.s 333-61333, 33-05918 and 333-03246) of our report dated April 9,
1997, relating to the consolidated statements of operations, shareholders'
equity and cash flows of Intelect Communications Systems Limited and
subsidiaries for the year ended December 31, 1996, and the related schedule,
which report appears in the December 31, 1998 annual report on Form 10-K of
Intelect Communications, Inc.
Our report dated April 9, 1997, contains an explanatory paragraph that states
that the Company has suffered recurring losses from continuing operations and
is dependent upon the successful development and commercialization of its
products and its ability to secure adequate sources of capital until the
Company is operating profitably. These matters raise substantial doubt about
the company's ability to continue as a going concern. Management's plans with
regard to these matters are described in note 1 to the consolidated financial
statements. The consolidated financial statements and financial statement
schedule do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ KPMG Peat Marwick
Chartered Accountants
Hamilton, Bermuda
March 31, 1999
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
reports included in this Form 10-K, into the Company's previously filed
registration statement files No. 333-61333, 333-53451, 333-49379, 333-03246,
333-35841 and 33-05918.
/S/ ARTHUR ANDERSEN LLP
Dallas, Texas
April 2, 1999
<PAGE> 1
Exhibit 23.3
Consent of Independent Public Accountants
We have issued our report dated March 31, 1999, accompanying the consolidated
financial statements for the year ended December 31, 1998, included in the 1998
Annual Report of Intelect Communications, Inc. on Form 10-K. We hereby consent
to the incorporation by reference of said report in the following registration
statements:
Form S-8, File No. 333-61333, filed August 13, 1998;
Form S-3, File No. 333-53451, filed May 22, 1998;
Form S-3, File No. 333-49379, filed April 2, 1998;
Form S-8, File No. 333-03246, filed January 2, 1998;
Form S-3, File No. 333-35841, filed December 30, 1997; and
Form S-8, File No. 333-05918, filed December 23, 1997.
/s/ GRANT THORNTON LLP
Dallas, Texas
April 2, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 991
<SECURITIES> 681
<RECEIVABLES> 8,102
<ALLOWANCES> 870
<INVENTORY> 6,854
<CURRENT-ASSETS> 16,413
<PP&E> 10,318
<DEPRECIATION> 3,932
<TOTAL-ASSETS> 32,082
<CURRENT-LIABILITIES> 9,852
<BONDS> 14,612
0
44
<COMMON> 323
<OTHER-SE> 7,165
<TOTAL-LIABILITY-AND-EQUITY> 32,082
<SALES> 19,341
<TOTAL-REVENUES> 19,341
<CGS> 18,433
<TOTAL-COSTS> 39,695
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (4,385)
<INCOME-PRETAX> (42,689)
<INCOME-TAX> 46
<INCOME-CONTINUING> (42,735)
<DISCONTINUED> (403)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (43,138)
<EPS-PRIMARY> (1.78)
<EPS-DILUTED> (1.78)
</TABLE>
